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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, 1998
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
(Formerly Monterey Homes Corporation)
(Exact Name of Registrant as specified in its charter)
Maryland 86-0611231
(State or other jurisdiction of incorporation or organization) (IRS Employer
Identification No.)
6613 North Scottsdale Road, Suite 200 85250
Scottsdale, Arizona (Zip Code)
(Address of principal executive offices)
(602) 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. [X]
At March 15, 1999 the aggregate market value of common stock held by
non-affiliates of the Registrant was $35,478,619. 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,
1999 was 5,425,830.
DOCUMENTS INCORPORATED BY REFERENCE
Portions from the Registrant's Proxy Statement relating to the Annual Meeting of
Stockholders to be held on May 19, 1999 have been incorporated by reference into
Part III, Items 10, 11, 12 and 13.
<PAGE>
TABLE OF CONTENTS
PAGE NO.
PART I
Item 1. Business....................................................... 3
Item 2. Properties..................................................... 12
Item 3. Legal Proceedings.............................................. 12
Item 4. Submission of Matters to a Vote of Security Holders............ 12
PART II
Item 5. Market for the Registrant's Common Stock and Related
Stockholder Matters ........................................... 13
Item 6. Selected Financial Data ....................................... 14
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations ........................... 15
Item 7A. Quantitative and Qualitative Disclosures About Market Risk..... 22
Item 8. Financial Statements and Supplementary Data.................... 22
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure ........................... 39
PART III
Item 10. Directors and Executive Officers of the Registrant............. 39
Item 11. Executive Compensation......................................... 39
Item 12. Security Ownership of Certain Beneficial Owners
and Management ................................................ 39
Item 13. Certain Relationships and Related Transactions ................ 39
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K ................................................... 40
SIGNATURES ................................................................. S-1
2
<PAGE>
PART I
ITEM 1. BUSINESS
HISTORY OF THE COMPANY
Meritage Corporation ("Meritage" or the "Company") designs, constructs
and sells single family homes ranging from entry-level to semi-custom luxury in
three large and growing Sunbelt states; Arizona, Texas and California. Meritage
has recently undergone significant growth and at December 31, 1998, was actively
selling homes in 36 communities. Meritage pursues a strategy of diversifying its
product mix and the geographic scope of its operations.
Meritage originally was formed as a real estate investment trust
("REIT") under the name of Homeplex Mortgage Investments Corporation. Homeplex
invested in mortgage-related assets and selected real estate loans. On December
31, 1996, the Company acquired by merger the homebuilding operations of various
entities under the Monterey Homes name (the "merger"). Following the merger the
Company focused on the business of homebuilding, and changed its name to
Monterey Homes Corporation. On July 1, 1997, as part of its strategy to further
diversify operations, the Company combined with Legacy Homes (the
"combination"), a group of entities with homebuilding operations in Texas.
Legacy has been in business since 1987, and designs, builds and sells
entry-level and move-up homes. In July 1998, the Company acquired Sterling
Communities, a homebuilder in northern California. In September 1998, with
shareholder approval, Meritage Corporation became the new corporate name.
Operations continue in Arizona under the Monterey Homes name, in Texas as Legacy
Homes and in California as Meritage Homes of Northern California.
As a result of losses from operations as a REIT through December 31,
1996, the Company had net operating loss carryforwards of $53 million for
federal income tax purposes. At December 31, 1998 approximately $12.5 million of
the carryforward remained unused. Accordingly, Meritage currently pays limited
income taxes.
BUSINESS STRATEGY
Meritage seeks to distinguish itself from other production homebuilders
and to respond rapidly to changing market conditions through a business strategy
focused on the following:
SUPERIOR DESIGN AND QUALITY. Meritage believes it maximizes customer
satisfaction by offering homes that are built with quality materials and
craftsmanship, exhibit distinctive design features and are situated in premium
locations. The Company believes that it generally offers higher caliber homes in
their defined price range or category than those built by its competitors.
PRODUCT BREADTH. Meritage offers new homes to a wide variety of
consumers. In Arizona, the focus is on the luxury market, which is characterized
by unique communities and distinctive luxury homes, and the move-up homebuyers'
market. Continued expansion into the first and second-time move-up segments of
the Arizona market reflects the Company's desire to increase its share of the
overall housing market in the Phoenix and Tucson metropolitan areas. In Texas,
Meritage targets entry-level and move-up buyers, offering homes at prices that
reflect the production efficiencies of a high-volume tract builder. In
California, the focus is on quality first and second-time move-up homes. This
product breadth and geographical diversity helps to reduce exposure to variable
economic cycles.
HIGHEST LEVEL OF SERVICE. Meritage is committed to achieving the
highest level of customer satisfaction as an integral part of its competitive
strategy. During the sales process the Company's experienced sales personnel
keep customers informed of their home's construction progress. After delivery,
the Meritage customer care departments deal with any questions or warranty
matters a customer may have.
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CONSERVATIVE LAND ACQUISITION POLICY. The Company seeks to maximize its
return on capital employed by practicing a conservative land acquisition policy
that minimizes risks associated with land investment. Meritage generally
purchases land subject to complete entitlement, including zoning and utility
services, with a focus on development sites where the Company expects to have
less than a three-year lot inventory. Lots are often controlled on a
non-recourse, rolling option basis where Meritage has the right, but not the
obligation, to buy lots at predetermined prices based on a takedown schedule
which reflects anticipated home closings. To date, Meritage has not speculated
in raw land held for investment.
PENETRATION OF NEW MARKETS. Depending on market conditions, Meritage
may explore expansion opportunities in other parts of the country, targeting its
market niches in areas where it perceives an ability to exploit a competitive
advantage. Expansion may take place through strategic acquisitions of other
existing homebuilders or through internal growth.
COST MANAGEMENT. Throughout its history, Meritage has focused on
controlling costs and minimizing overhead, and considers this a key factor in
maintaining profitability. Management seeks to reduce costs by:
+ using subcontractors to carry out home construction and site
improvement on a fixed-price basis;
+ reducing interest carry by minimizing its inventory of unsold homes
and shortening the home construction cycle;
+ obtaining favorable pricing from subcontractors through long-term
relationships and large volume jobs;
+ minimizing overhead by centralizing certain administrative activities;
and
+ maintaining management information systems to allow the monitoring of
homebuilding production, scheduling and budgeting.
DECENTRALIZED OPERATING STRUCTURE WITH EXPERIENCED DIVISION MANAGERS.
Meritage relies upon the expertise of divisional managers, each with significant
experience in the homebuilding industry, to serve the needs of its regional
markets. Corporate-level management provides centralized control for risk
elements such as land acquisition approval, financing, cash management, capital
allocation and risk management.
MARKETS AND PRODUCTS
Meritage operates in the Phoenix and Tucson, Arizona markets using the
Monterey Homes brand name, in the Dallas/Fort Worth, Austin and Houston, Texas
markets as Legacy Homes and in the San Francisco Bay and Sacramento, California
markets as Meritage Homes of Northern California. The Company believes that
these areas represent attractive homebuilding markets with opportunities for
long-term growth. Meritage also believes that its operations in certain markets,
such as Phoenix and Dallas/Fort Worth, are well established and that it has
developed a reputation for building distinctive quality homes within the market
segments served by these communities.
Meritage-built homes range from entry-level to semi-custom luxury, with
base prices ranging from $100,000 to $600,000. A summary of activity by market
and product type follows (dollars in thousands).
4
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<TABLE>
<CAPTION>
NUMBER OF AVERAGE UNITS IN DOLLAR VALUE NUMBER OF
HOMES CLOSED CLOSING BACKLOG AT OF BACKLOG HOME SITES ACTIVE
IN 1998 PRICE YEAR END AT YEAR END REMAINING(1) SUBDIVISIONS
------------ ------- ---------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Arizona - Luxury 197 $ 402.3 146 $ 59,721 474 6
Arizona - Move-up 120 222.4 34 6,658 1,097 5
Texas - Move-up 633 148.4 392 62,584 1,326 17
Texas - Entry level 299 121.4 111 14,594 925 6
California - Move-up 42 456.7 5 1,737 773 2
----- -------- --- -------- ----- --
Total Company 1,291 $ 198.3 688 $145,294 4,595 36
===== ======== === ======== ===== ==
</TABLE>
(1) "Home Sites Remaining" is the number of homes that could be built both on
the remaining lots available for sale and land to be developed into lots as
estimated by management.
LAND ACQUISITION AND DEVELOPMENT
Meritage usually purchases 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 usually within the developer's
control. Even though entitlements are usually obtained before land is purchased,
the Company is 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, Meritage may consider purchasing unentitled property in the future when
it can do so in a manner consistent with its business strategy.
Meritage selects land for development based upon a variety of factors,
including:
+ internal and external demographic and marketing studies;
+ project suitability, which are generally developments with fewer than
150 lots;
+ suitability for development generally within a one to three 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, return 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, economic trends,
and experience in a particular market.
The Company occasionally purchases larger properties consisting of 200
to 500 lots or more if the situation presents an attractive profit potential and
acceptable risk limitations.
Meritage acquires land through purchases and rolling option contracts.
Purchases are financed through traditional bank financing or through working
capital. Rolling options allow Meritage to control lots and land through a third
party who owns or buys the property on which Meritage plans to build homes.
Meritage enters into an option contract with the third party to purchase
finished lots as home construction begins. The option contracts are generally
non-recourse and require non-refundable deposits of 2% to 10% of the sales
price. Meritage acquires a majority of its land through rolling option
contracts.
Once Meritage has acquired land, it generally initiates 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. Meritage often
builds homes in master planned communities with home sites that are along or
near a major amenity, such as a golf course.
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<PAGE>
Meritage develops a design and marketing concept for each project,
which includes determination of size, style and price range of homes, street
layout, size and layout of individual lots, and overall community design. The
product line offered in a particular project depends upon many factors,
including the housing generally available in the area, the needs of a particular
market, and the Company's lot costs for the project.
Meritage occasionally uses partnerships or joint ventures to purchase
and develop land where these arrangements are necessary to acquire the property
or appear to be otherwise economically advantageous.
The following table presents land owned or land under contract or
option by market as of December 31, 1998.
LAND UNDER CONTRACT
LAND OWNED(1) OR OPTION(1)
--------------------- ---------------------
LOTS UNDER LOTS UNDER
FINISHED DEVELOPMENT FINISHED DEVELOPMENT
LOTS (ESTIMATED) LOTS (ESTIMATED) TOTAL
-------- ----------- -------- ----------- -----
ARIZONA:
Phoenix Area 85 351 87 544 1,067
Tucson Area 122 -- 84 327 533
--- ----- --- ----- -----
Total Arizona 207 351 171 871 1,600
--- ----- --- ----- -----
TEXAS:
Dallas/Ft. Worth Area 280 961 291 371 1,903
Austin Area 14 107 69 201 391
Houston Area 51 -- 43 166 260
--- ----- --- ----- -----
Total Texas 345 1,068 403 738 2,554
--- ----- --- ----- -----
CALIFORNIA:
Sacramento Area 1 -- 32 226 259
San Francisco Bay Area -- -- -- 492 492
--- ----- --- ----- -----
Total California 1 -- 32 718 751
--- ----- --- ----- -----
TOTAL COMPANY 553 1,419 606 2,327 4,905
=== ===== === ===== =====
(1) Excludes lots with finished homes or homes under construction
CONSTRUCTION
Meritage is the general contractor for its projects and typically hires
subcontractors on a project-by-project or reasonable geographic proximity basis
to complete construction at a fixed price. The Company usually enters into
agreements with subcontractors and materials suppliers after receiving
competitive bids on an individual basis. Meritage obtains information from
prospective subcontractors and suppliers with respect to their financial
condition and ability to perform their agreements before formal bidding begins.
Meritage occasionally enters into longer-term contracts with subcontractors and
suppliers if management can obtain more favorable terms. The Company's project
managers and field superintendents, who coordinate and supervise the activities
of subcontractors and suppliers, subject the work to quality and cost controls,
and assure compliance with zoning and building codes.
Meritage specifies that quality, durable materials be used in
construction of its homes and does 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 Meritage's production volume. Usually, access to the Company's
principal subcontracting trades, materials and supplies is readily available in
each of its markets. Prices for these goods and services may fluctuate due to
various factors, including supply and demand shortages that may be beyond the
Company's or its vendors' control. Meritage believes that its relations with
suppliers and subcontractors are good.
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<PAGE>
Meritage generally builds and sells homes in clusters or phases within
a project, which management believes creates efficiencies in land development
and construction, and improves customer satisfaction by reducing the number of
vacant lots surrounding a completed home. A typical Meritage home is completed
within three to eight months from the start of construction, depending upon home
size and complexity. Schedules may vary depending on the availability of labor,
materials and supplies, product type, location and weather. Meritage homes are
usually designed to promote efficient use of space and materials, and to
minimize construction costs and time.
The Company generally provides a one-year limited warranty on
workmanship and building materials with each home. Subcontractors usually
provide an indemnity and a certificate of insurance prior to receiving payment
for their work and, therefore, claims relating to workmanship and materials are
usually the primary responsibility of the subcontractors. 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 3/10 of one per cent to 3/4 of one percent of a home's sale price. To
date, these reserves have been sufficient to cover warranty repair.
MARKETING AND SALES
The Company believes that it has an established reputation for
developing high quality homes, which helps generate interest in each new
project. Meritage also uses advertising and other promotional activities,
including magazine and newspaper advertisements, brochures, direct mail, and the
placement of strategically located signs in the immediate areas of its
developments.
Meritage uses furnished model homes as a tool in demonstrating the
competitive advantages of its home designs and features to prospective
homebuyers. Meritage generally employs or contracts with interior designers who
are responsible for creating an attractive model home for each product line
within a project. The Company generally builds 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. Meritage occasionally sells its model
homes and leases 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 follows:
MODEL HOMES MODEL HOMES MONTHLY LEASE MODELS UNDER
OWNED LEASED BACK AMOUNT CONSTRUCTION
----------- ----------- ------------- ------------
Arizona 16 9 $23,000 7
Texas 22 - -- 7
California 3 - -- 3
-- -- ------- --
Total 41 9 $23,000 17
== == ======= ==
The Company's homes generally are sold by full-time, commissioned sales
employees who typically work from a sales office located in the model homes for
each project. The Company's goal is to ensure that the sales force has extensive
knowledge of its operating policies and housing products. To achieve this goal,
Meritage trains its sales personnel and conducts 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 Meritage homes, and are usually paid a sales commission on the
base price of the home.
The Company occasionally offers 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.
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<PAGE>
BACKLOG
Most Meritage 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". Meritage does not recognize revenue on
homes in backlog until sales are closed and ownership has been legally
transferred to the buyer. The Company sometimes builds one or two homes per
project before obtaining a sales contract, though these homes are not included
in backlog until a sales contract is signed. The Company believes it will
deliver almost all homes in backlog at December 31, 1998 to customers during
1999.
The number of units in backlog increased to 688 at December 31, 1998
from 472 at December 31, 1997. The dollar value of the backlog increased to
$145.3 million at December 31, 1998 from $99.0 million at December 31, 1997.
These increases in backlog are primarily due to additional communities that
opened for sale in 1998, along with strong home sales.
CUSTOMER FINANCING
Meritage attempts to help qualified homebuyers who require financing to
obtain loans from unaffiliated mortgage lenders that offer a variety of
financing options. The Company provides mortgage-banking services in its
Dallas/Fort Worth markets through a related mortgage lending company, Texas Home
Mortgage Corporation, which originates loans on behalf of third party lenders.
Meritage may pay a portion of the closing costs and discount mortgage points to
assist homebuyers with financing. Since many buyers use long-term mortgage
financing to purchase homes, adverse economic conditions, unemployment increases
and high mortgage interest rates may deter or reduce the number of potential
homebuyers.
CUSTOMER RELATIONS AND QUALITY CONTROL
Management believes that positive customer relations and an adherence
to stringent quality control standards are fundamental to continued success. The
Company believes that its commitment to customer satisfaction and quality
control have significantly contributed to its 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 allocate responsibility
to:
+ 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 their homes.
COMPETITION AND MARKET FACTORS
The development and sale of residential property is a highly
competitive industry. Meritage competes for sales in each of its markets with
national, regional, and local developers and homebuilders, existing home
resales, and to a lesser extent, condominiums and available rental housing. Some
competitor homebuilders have significantly greater financial resources and/or
lower costs than Meritage. Competition among both small and large residential
homebuilders is based on a number of interrelated factors, including location,
reputation, amenities, design, quality and price. The Company believes that it
compares favorably to other homebuilders in the markets in which it operates due
to its:
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+ experience within its geographic markets which allows it to develop
and offer new products;
+ ability to reflect and adapt to changing market conditions;
+ ability, from a capital and resource perspective, to respond to market
conditions;
+ ability to exploit 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, prevalent economic conditions in general,
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. Real estate
analysts predict that new home sales in the Phoenix metropolitan area may slow
in 1999 and that sales in the Tucson area will remain relatively flat. Home
sales in the Texas and northern California markets are expected to show moderate
growth or remain relatively flat. Any slowing in new home sales would increase
competition among homebuilders in these areas. There is no assurance that
Meritage will be able to compete successfully against other homebuilders in its
current markets in a more competitive business environment resulting from a
slowdown in home sales or that such increased competition will not have a
material adverse affect on the Company's business and operating results.
GOVERNMENT REGULATIONS AND ENVIRONMENTAL MATTERS
Meritage purchases most of its land with entitlements, providing for
zoning and utility service to project sites and giving it the right to obtain
building permits. Construction may begin almost immediately upon compliance with
specified conditions, which generally are within the Company's 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 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 the Company's development activities, though there is no
assurance that these and other restrictions will not adversely affect future
operations.
Because most of the Company's land is entitled, construction
moratoriums generally would only adversely affect Meritage if they arose from
health, safety, and welfare issues, such as insufficient water or sewage
facilities. Local and state governments have broad discretion regarding the
imposition of development fees for projects under their jurisdiction. These fees
are normally established when Meritage receives recorded maps and building
permits. As Meritage expands, it may also become increasingly subject to
periodic delays or may be precluded entirely from developing communities due to
building moratoriums, "slow growth" initiatives or building permit allocation
ordinances which could be implemented in future operating markets.
The Company is 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, Meritage is subject to environmentally
sensitive land ordinances which mandate open space areas with public elements in
housing developments, and prevent development on hillsides, wetlands and other
protected areas. Meritage must also comply with flood plain restrictions, desert
wash areas, 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 the Company's operations, though no
assurance is given that such a material adverse effect will not occur in the
future.
The Company usually will condition its obligation to purchase property
on, among other things, an environmental review of the land. However, there is
no assurance that Meritage will not incur material liabilities relating to the
removal of toxic wastes or other environmental matters affecting land currently
or previously owned. To date, Meritage has not incurred any unanticipated
liabilities relating to the removal of unknown toxic wastes or other
environmental matters.
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<PAGE>
BONDS AND OTHER OBLIGATIONS
Meritage obtains letters of credit and performance, maintenance, and
other bonds in support of its related obligations with respect to the
development of its 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, the Company would be obligated to reimburse the
issuer of the bond or letter of credit. At December 31, 1998 there were
approximately $2.1 million and $8.9 million of outstanding letters of credit and
performance bonds, respectively, for such purposes. Meritage does not believe
that any of these bonds or letters of credit are likely to be drawn upon.
MORTGAGE ASSETS ACQUIRED PRIOR TO MERGER
Prior to the merger, the Company acquired a number of mortgage assets,
consisting of mortgage interests (commonly known as "residuals") and mortgage
instruments. During 1998 and 1997, Meritage sold the mortgage assets for a gain
or generated interest income from these assets prior to sale, of approximately
$5.2 and $5.1 million, respectively.
EMPLOYEES AND SUBCONTRACTORS
At December 31, 1998, Meritage had 239 employees, including 58 in
management and administration, 51 in sales and marketing, and 130 in
construction operations. The employees are not unionized, and the Company
believes that its employee relations are good. Meritage acts solely as a general
contractor and all construction operations are conducted through project
managers and field superintendents who manage third party subcontractors. The
Company uses independent contractors for construction, architectural and
advertising services, and believes that its relations with subcontractors and
independent contractors are good.
NET OPERATING LOSS CARRYFORWARD
At December 31, 1998, Meritage had a federal income tax net operating
loss (NOL) carryforward of approximately $12.5 million, which expires at various
times between 2007 and 2009. Income tax payments are to be reduced during the
period the NOL carryforward is available and will consist primarily of state
income taxes (since use of the Company's state net operating loss may be
significantly limited) and the federal alternative minimum tax.
The ability to use the NOL carryforward to offset future taxable income
would be substantially limited under federal tax laws if an "ownership change"
of the Company, within the meaning of the laws, has occurred or occurs before
the NOL carryforward expires. Management believes that:
+ there was no "ownership change" prior to the effective date of the
merger;
+ the merger did not cause an "ownership change"; and
+ the Legacy combination did not cause an "ownership change".
In connection with the merger, the Company's Articles of Incorporation
were amended to make limitations on the transfer of common stock more
restrictive to preserve maximum use of the NOL carryforward. The Articles of
Incorporation generally prohibit concentrated ownership of Meritage that may
jeopardize the NOL carryforward. The transfer restrictions generally prevent,
for a period of up to five years following the effective date of the merger,
anyone from transferring shares of common stock (or any subsequently issued
voting or participating stock), or rights to acquire common stock, if the effect
would:
+ make any person or group an owner of 4.9% or more of the outstanding
shares of the stock (by value);
+ increase the ownership position of any person or group that already
owns 4.9% or more of the outstanding shares of the stock (by value);
or
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+ cause any person or group to be treated as the owner of 4.9% or more
of the outstanding shares of the stock (by value) for tax purposes.
Direct and indirect ownership of common stock and rights to acquire
common stock are taken into consideration for purposes of the transfer
restrictions.
Meritage's Articles of Incorporation gives the Board of Directors the
authority to waive the transfer restrictions under certain conditions. The Board
also may accelerate or extend the period of time during which the transfer
restrictions are in effect or modify the applicable ownership percentage that
will trigger the transfer restrictions if there is a change in law making such
action necessary or desirable. The Board has the general power to make other
necessary or appropriate legal changes to preserve Meritage's tax benefits. The
transfer restrictions may impede an "ownership change" involving the Company.
Under federal tax laws, Meritage may not be permitted to use the NOL
carryforward to offset taxable income resulting from sales of assets owned by
Monterey Homes at the time of the merger with Homeplex or of certain assets
acquired in the Legacy combination, to the extent that the fair market value of
these assets at the merger or combination dates exceeded their tax basis.
YEAR 2000 COMPLIANCE
The year 2000 presents potential concerns for business computing due to
calculation problems from the use of a two-digit format as the year changes from
1999 to 2000. The problem affects certain computer software, hardware, and other
systems containing processors and embedded chips. Consequently, information
technology ("IT") systems and non-IT systems (collectively, "business systems")
may not be able to accurately process certain transactions before, during, or
after January 1, 2000. As a result, business and governmental agencies are at
risk for potential disruption from business systems malfunctions or failures.
This is commonly referred to as the Year 2000 ("Y2K") issue. Meritage could be
impacted by failures of its own business systems as well as those of its
suppliers and business partners, and is in the process of implementing its Y2K
compliance program that consists of business systems identification, testing and
remediation, assessments of critical suppliers, and contingency planning.
The compliance program's first component is the identification of
Meritage's business systems for purposes of evaluating which systems are Y2K
compliant and which will be replaced or remediated. This phase is complete.
The second part of the program is the evaluation and replacement or
remediation of the Company's business systems that are not Y2K compliant.
Meritage has converted to new versions of substantially all of its homebuilding
database systems, which has reduced the scope of the compliance program. The
Company believes the replacement or remediation of the remaining systems will be
complete by June 1, 1999.
Meritage has identified critical suppliers and business partners ("key
business partners") and is taking steps to determine their Y2K readiness. These
steps include interviews and other types of inquiries. Because of the number of
business systems used by key business partners and the varying levels of Y2K
readiness, it is difficult to assess the likelihood and impact of a malfunction
due to this issue. The Company is not currently aware of any business
relationships with key business partners that it believes will likely result in
a significant disruption of its business. However, a Y2K failure could occur and
have an adverse impact on the Company. Management currently believes its
greatest risk is with suppliers, banking and financial institutions, and
suppliers of telecommunications services, all of which are operating within the
United States. Potential consequences of Meritage or its key business partners
having business systems that are not Y2K compliant include delays in receiving
homebuilding components and supplies.
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Concurrent with the remediation and evaluation of its business systems
and those of its key business partners, Meritage is developing contingency plans
to decrease the risks that could occur in the event of a Y2K related business
disruption. Contingency plans may include increasing the level of homebuilding
components, securing additional financing or other actions management deems
advisable. Estimated costs associated with developing and implementing
contingency measures are expected to be minimal.
The remediation and testing of the Company's business systems will cost
an estimated $160,000. These costs are to be expensed in the period incurred and
funded through cash flows from operations. Expenses to date have approximated
$110,000. The financial impact is not expected to be material to the Company's
financial position or results of operations.
The scheduled completion dates and costs associated with the various
components of the Y2K compliance program described above are estimated and are
subject to change.
ITEM 2. PROPERTIES
Meritage leases the following office space:
SQUARE ANNUAL LEASE
CITY FOOTAGE RATE TERM EXPIRATION
---- ------ ------------ ---- ----------
Plano, Texas* 13,000 $171,300 5 years 5/15/02
Phoenix, Arizona* 11,000 211,700 5 years 9/1/99
Tucson, Arizona 2,800 49,700 3 years 11/1/01
Austin, Texas 1,100 21,800 1 year 3/31/99
Houston, Texas 900 9,500 1 year 7/1/99
Walnut Creek, California 2,800 50,500 2 years 7/14/00
* Leases are with companies owned beneficially either by one of Meritage's
Co-Chairmen or by one of Meritage's Co-Chairmen and a director. Management
believes lease rates are competitive with rates for comparable space in the
area and terms of the leases are similar to those Meritage could obtain in
an arm's length transaction.
Meritage leases nine model homes at a total monthly lease amount of
$23,000. The leases are for terms ranging from six months to 26 months, with
renewal options ranging from one to six months, on a month-to-month basis.
ITEM 3. LEGAL PROCEEDINGS
Meritage is involved in various routine legal proceedings incidental to
its business. Management believes that none of these legal proceedings, certain
of which are covered by insurance, will have a material adverse impact on the
financial statements of Meritage taken as a whole.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company did not submit any matters to a vote of shareholders in the
fourth quarter of 1998.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
GENERAL
The Company's common stock is publicly traded on the New York Stock
Exchange ("NYSE") under the symbol "MTH". The high and low closing sales prices
of the common stock, as reported by the NYSE, follow:
1998 1997
---- ----
HIGH LOW HIGH LOW
---- --- ---- ---
First Quarter $19 15/16 $12 3/8 $ 7 1/4 $ 5 1/2
Second Quarter 19 1/4 15 5/8 8 3/4 4 3/8
Third Quarter 19 3/4 12 1/16 14 3/4 8 1/2
Fourth Quarter 14 11/16 9 11/16 14 3/4 11 3/16
On March 15, 1998, the closing sales price of the common stock as
reported by the NYSE was $11.00 per share. At that date, there were
approximately 380 owners of record. There are approximately 2,800 beneficial
owners of common stock.
The transfer agent for Meritage common stock is ChaseMellon Shareholder
Services, L.L.C., Overpeck Centre, 85 Challanger Road, Ridgefield Park, NJ
07660.
The Company paid cash dividends $.06 per share in 1996, representing
distributions of taxable income arising out of its prior REIT status. Meritage
did not pay cash dividends in 1998 or 1997, nor does it intend to pay cash
dividends in the foreseeable future. Earnings will be retained to finance the
growth of the business. Future payments of cash dividends, if any, will depend
upon the Company's financial condition, results of operations and capital
requirements, as well as other factors considered relevant by the board of
directors.
On October 2, 1998, Meritage issued $15,000,000 in 9.1% Senior
Unsecured Notes due September 1, 2005 in a private placement to accredited
investors under Section 4(2) of the Securities Act. Warburg Dillon Read and Dain
Rauscher Wessels were the underwriters of the issue and were paid a fee of 2.75%
of the face amounts of the notes. The notes were sold at par to four entities
controlled by Massachusetts Mutual Life Insurance Company. The proceeds of the
issue were used to pay down existing indebtedness.
FACTORS THAT MAY AFFECT FUTURE STOCK PERFORMANCE
The performance of Meritage 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 Future
Results and Financial Condition."
RESTRICTIONS ON TRANSFER; INFLUENCE BY PRINCIPAL STOCKHOLDERS. In order
to preserve its net operating loss carryforward, Meritage's charter does not
allow:
+ anyone to transfer Meritage shares if the effect would be to make any
person or group an owner of 4.9% or more of the outstanding shares of
common stock, or
+ an increase in the ownership position of any person or group that
already owns 4.9% or more of the outstanding shares.
The above factors, coupled with the level of ownership by current
directors and officers, could delay or prevent a future change of control of
Meritage, which could depress the stock price.
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POSSIBLE VOLATILITY OF STOCK PRICE. The market price of Meritage common
stock could be subject to significant fluctuations in response to certain
factors, such as variations in anticipated or actual results of Meritage's
operations or that of other homebuilding companies, changes in conditions
affecting the general economy, widespread industry trends and analysts' reports,
as well as other factors unrelated to Meritage's operating results.
ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected historical consolidated financial
data of the Company for each of the years in the five-year period ended December
31, 1998. The data for 1998, 1997 and 1996 are derived from the Meritage's
Consolidated Financial Statements audited by KPMG LLP, independent auditors. The
data for 1995 and 1994 are derived from the Consolidated Financial Statements
audited by Ernst & Young LLP, independent auditors. For additional information,
see the Consolidated Financial Statements included elsewhere in this Annual
Report. The following table should be read in conjunction with Management's
Discussion and Analysis of Financial Condition and the Results of Operations.
Due to the merger and the combination, historical results may not be indicative
of future results.
<TABLE>
<CAPTION>
HISTORICAL CONSOLIDATED FINANCIAL DATA
YEARS ENDED DECEMBER 31,
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
------------------------------------------------------
1998(3) 1997(4) 1996 1995 1994
------- ------- ---- ---- ----
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Home sales revenue $ 255,985 $ 149,385
Cost of home sales (204,409) (124,369)
--------- ---------
Gross profit 51,576 25,016
Earnings from mortgage assets and
other income (loss) 6,331 5,455 $ 2,244 $ 3,564 $ (1,203)
Interest expense (461) (165) (238) (868) (1,383)
General, administrative and other
expenses (24,925) (15,107) (1,684) (1,599) (1,938)
Minority interest in net income of
consolidated joint ventures (2,021) -- -- -- --
--------- --------- -------- -------- --------
Earnings (loss) before income taxes
and extraordinary loss 30,500 15,199 322 1,097 (4,524)
Income taxes(1) (6,497) (962) (26) -- --
Extraordinary loss(2) -- -- (149) -- --
--------- --------- -------- -------- --------
Net earnings (loss) $ 24,003 $ 14,237 $ 147 $ 1,097 $ (4,524)
========= ========= ======== ======== ========
Earnings (loss) per diluted share
before effect of extraordinary loss $ 3.92 $ 2.68 $ .09 $ .34 $ (1.40)
Extraordinary loss per diluted share -- -- (.05) -- --
--------- --------- -------- -------- --------
Diluted earnings (loss) per share $ 3.92 $ 2.68 $ .04 $ .34 $ (1.40)
========= ========= ======== ======== ========
Cash dividends per share(1) $ N/A $ N/A $ .06 $ .09 $ .06
========= ========= ======== ======== ========
1998 1997 1996(5) 1995 1994
---- ---- ------- ---- ----
BALANCE SHEET DATA:
Real estate under development $ 104,759 $ 63,955 $ 35,991 -- --
Residual interests -- 1,422 3,909 $ 5,457 $ 7,654
Total assets 152,250 96,633 72,821 27,816 31,150
Notes payable 37,205 22,892 30,542 7,819 11,783
Total liabilities 79,971 50,268 45,876 9,368 13,508
Stockholders' equity 72,729 46,365 26,945 18,448 17,642
</TABLE>
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(1) For any taxable year in which Meritage qualified and elected to be treated
as a REIT under federal tax laws, Meritage was not subject to federal
income tax on that portion of its taxable income that was distributed to
stockholders in or with respect to that year. Regardless of such
distributions, however, Meritage may be subject to tax on certain types of
income. Due to the merger, Meritage did not qualify as a REIT in 1996, 1997
or 1998. Due to the use of its net operating loss carryforward, Meritage
paid limited income taxes during 1997 and 1998.
(2) Reflects extraordinary loss from early extinguishment of long-term debt.
(3) Includes the accounts of Meritage Homes of Northern California from July 1,
1998, the acquisition date.
(4) Includes the accounts of Legacy Homes from July 1, 1997, the combination
date.
(5) Reflects the merger with Homeplex consummated on December 31, 1996.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998 COMPARED TO 1997
The following discussion and analysis provides information regarding
the results of operations of Meritage and its subsidiaries for the years ended
December 31, 1998 and December 31, 1997. All material balances and transactions
between Meritage and its subsidiaries have been eliminated. Total results
include those of the Texas operations from July 1, 1997 and of the California
operations from July 1, 1998. Texas 1997 results are pro forma in that they are
shown for the entire year, even though the Texas operations were not acquired
until July 1, 1997. This data is presented for comparative purposes only. In
management's opinion, the data reflects all adjustments, consisting of only
normal recurring adjustments, necessary to fairly present the Company's
financial position and results of operations for the periods presented.
HOME SALES REVENUE
Home sales revenue is the product of the number of units closed during
the period and the average sales price per unit. Comparative 1998 and 1997
housing revenues follow (dollars in thousands):
YEAR ENDED
DECEMBER 31, DOLLAR/UNIT PERCENTAGE
--------------------- INCREASE INCREASE
1998 1997 (DECREASE) (DECREASE)
---- ---- ---------- ----------
TOTAL
Dollars .................... $255,985 $149,385 $ 106,600 71%
Units closed ............... 1,291 644 647 100%
Average sales price ........ $ 198.3 $ 232.0 $ (33.7) (15%)
ARIZONA
Dollars .................... $105,942 $ 97,922 $ 8,020 8%
Units closed ............... 317 284 33 12%
Average sales price ........ $ 334.2 $ 344.8 $ (10.6) (3%)
TEXAS*
Dollars .................... $130,860 $ 91,190 $ 39,670 44%
Units closed ............... 932 633 299 47%
Average sales price ........ $ 140.4 $ 144.1 $ (3.7) (3%)
CALIFORNIA
Dollars .................... $ 19,183 N/A N/A N/A
Units closed ............... 42 N/A N/A N/A
Average sales price ........ $ 456.7 N/A N/A N/A
* Full year 1997 Texas information includes pre-combination results and is for
comparative purposes only.
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<PAGE>
The increase in revenues and number of units closed in 1998 compared to
1997 resulted mainly from the inclusion of the Texas operations for the full
year. The lower average sales price in 1997 is also due to sales in the Texas
market, where the Company focuses on entry-level and move-up home sales.
GROSS PROFIT
Gross profit equals home sales revenue, net of housing cost of sales,
which include developed lot costs, unit construction costs, amortization of
common community costs (such as the cost of model complex and architectural,
legal and zoning costs), interest, sales tax, warranty, construction overhead
and closing costs. Comparative 1998 and 1997 housing gross profit follows
(dollars in thousands):
YEAR ENDED
DECEMBER 31, DOLLAR/
------------------- PERCENTAGE PERCENTGE
1998 1997 INCREASE INCREASE
---- ---- -------- --------
Dollars ...................... $51,576 $25,016 $26,560 106%
Percent of housing revenues... 20.1% 16.7% 3.4% 20%
The dollar increase in gross profit for the twelve months ended
December 31, 1998 is attributable to the increase in number of units closed due
to the inclusion of Texas operations for the full year, along with increased
closings in highly profitable Arizona communities. The gross profit margin
increased in 1998 due to generally higher margins in Texas, the addition of the
California operations in the last half of the year and an increase in sales of
more profitable custom options and upgrades with respect to Arizona home
closings.
RESIDUAL INTEREST AND REAL ESTATE LOAN INTEREST INCOME
The increase in residual interest and real estate loan interest income
primarily is due to gains from the sales of Meritage's remaining mortgage
securities in 1998. These gains exceeded 1997 gains from residual sales by
approximately $2.1 million. The increase was somewhat offset by decreased
residual interest earned in 1998.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were approximately $10.6 million in
1998, as compared to approximately $6.8 million in 1997, an increase of 56%.
Operating costs associated with the expansions into Texas and California,
including the amortization of goodwill, primarily caused the increase.
OTHER INCOME
The increase in other income primarily is due to the sale of land in
Arizona and an increase in interest income on cash accounts and overnight
investments. Texas operations were included for the full year in 1998, which
also contributed to higher income amounts.
MINORITY INTEREST
The increase in minority interest in 1998 is due mainly to Meritage's
acquisition of Sterling Communities, which included two 50% owned limited
partnership interests which Meritage controls. The Company has recorded the
minority interest partners' share of net income as an expense. The limited
partnerships' operations were concluded in the fourth quarter of 1998.
INCOME TAXES
The increase in income taxes to $6.5 million for the year ended
December 31, 1998 from $962,000 in the prior year resulted from a significant
increase in pre-tax income and a higher effective tax rate. The lower 1997
effective tax rate was caused by a larger reduction in the valuation allowance
applicable to deferred tax assets than occurred in 1998. In future periods
Meritage expects to have an effective tax rate approximating the statutory
federal and state tax rates.
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<PAGE>
SALES CONTRACTS
Sales contracts for any period represent the number of units ordered by
customers (net of units canceled) multiplied by the average sales price per unit
ordered. Comparative 1998 and 1997 sales contracts follow (dollars in
thousands):
YEAR ENDED DOLLAR/
DECEMBER 31, PERCENTAGE PERCENTAGE
------------------- INCREASE INCREASE
1998 1997 (DECREASE) (DECREASE)
---- ---- -------- ----------
TOTAL
Dollars .................... $283,746 $157,479 $126,267 80%
Sales contracts ............ 1,466 693 773 112%
Average sales price ........ $ 193.5 $ 227.2 $ (33.7) (15%)
ARIZONA
Dollars .................... $115,375 $112,207 $ 3,168 3%
Units ordered .............. 329 332 (3) **
Average sales price ........ $ 350.7 $ 338.0 $ 12.7 4%
TEXAS*
Dollars .................... $166,020 $102,261 $ 63,759 62%
Units ordered .............. 1,131 740 391 53%
Average sales price ........ $ 146.8 $ 138.2 $ 8.6 6%
CALIFORNIA
Dollars .................... $ 2,351 N/A N/A N/A
Units ordered .............. 6 N/A N/A N/A
Average sales price ........ $ 391.8 N/A N/A N/A
* Full year 1997 Texas information includes pre-combination results and is for
comparative purposes only.
** Represents less than 1%
Meritage does not include sales contingent upon the sale of a
customer's existing home as a sales contract until the contingency is removed.
Historically, Meritage has experienced a cancellation rate of less than 20% of
gross sales. Total sales contracts increased in 1998 compared to 1997 due to the
expansion into Texas and California, and the economic strength of all of the
Company's operating markets.
NET SALES BACKLOG
Backlog represents net sales contracts that have not closed.
Comparative 1998 and 1997 net sales backlog follows (dollars in thousands):
DECEMBER 31,
--------------------- DOLLAR/UNIT PERCENTAGE
1998 1997 INCREASE INCREASE
---- ---- -------- --------
TOTAL
Dollars ....................... $145,294 $98,963 $46,331 47%
Units in backlog .............. 688 472 216 46%
Average sales price ........... $ 211.2 $ 209.7 $ 1.5 *
ARIZONA
Dollars ....................... $ 66,379 $56,945 $ 9,434 17%
Units in backlog .............. 180 168 12 7%
Average sales price ........... $ 368.8 $ 339.0 $ 29.8 9%
17
<PAGE>
TEXAS
Dollars ....................... $ 77,178 $42,018 $35,160 84%
Units in backlog .............. 503 304 199 65%
Average sales price ........... $ 153.4 $ 138.2 $ 15.2 11%
CALIFORNIA
Dollars ....................... $ 1,737 N/A N/A N/A
Units in backlog .............. 5 N/A N/A N/A
Average sales price ........... $ 347.4 N/A N/A N/A
* Represents less than 1%
Total dollar backlog increased 47% over the prior year due to a
corresponding increase in units in backlog. Units in backlog have increased 46%
over the prior year due mainly to the increase in net orders caused by expansion
into Texas and California.
Arizona and Texas backlogs have increased due to the number of sales
orders taken in 1998, along with slight industry-wide construction delays. These
delays caused more closings to be pushed into the following year than usual.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO 1996
The Company had net earnings of $14.2 million or $2.68 per diluted
share for the twelve months ended December 31, 1997 compared to net earnings of
$147,000, or $.04 per diluted share in 1996. The increase was caused by the
addition of the homebuilding operations during 1997. Home sales revenue, cost of
home sales, and commissions and other sales costs all increased in 1997,
reflecting the addition of homebuilding operations in 1997 and the expansion
into Texas markets in July 1997. Results for the year ended December 31, 1996
include a $149,000, or $.05 per diluted share, extraordinary loss from the early
extinguishment of debt.
Residual interest and real estate loan interest income was higher in
the twelve months ended December 31, 1997 than in the previous year mainly due
to the sale of two of its mortgage securities, which resulted in gains of
approximately $3.1 million.
General and administrative expenses were $6.8 million in 1997 and $1.7
million in 1996. The increase was caused by homebuilding administrative costs,
including amortization of goodwill and expenses related to the addition of the
Texas division, which were not incurred in 1996.
The increase in income taxes to $962,000 for the twelve months ended
December 31, 1997 from $26,000 in the prior year resulted from a significant
increase in 1997 pre-tax earnings. The favorable effective tax rates of 6% in
1997 and 8% in 1996 result from the use of the Company's net operating loss
carryforward.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal uses of working capital are land purchases, lot
development and home construction. Meritage uses a combination of borrowings and
funds generated by operations to meet its working capital requirements.
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<PAGE>
Cash flow for each Meritage community 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
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, 1998 Meritage had short-term secured revolving
construction loan facilities totaling $100 million and had $24.5 million in
acquisition and development facilities, of which approximately $15.6 and $5.7
million were outstanding, respectively. An additional $22.5 million of
unborrowed funds supported by approved collateral were available under its
credit facilities at that date. Borrowings under the credit facilities are
subject to the Company's inventory collateral position and a number of other
conditions, including minimum net worth, debt to equity and debt coverage tests.
Meritage also has $15 million outstanding in unsecured, senior subordinated
notes due September 15, 2005, which were issued in October 1998.
Management believes that the current borrowing capacity, cash on hand
at December 31, 1998 and anticipated cash flows from operations are sufficient
to meet liquidity needs for the foreseeable future. There is no assurance,
however, that future amounts available from the Company's sources of liquidity
will be sufficient to meet future capital needs. The amount and types of
indebtedness that Meritage incurs may be limited by the terms of the indenture
governing its senior subordinated notes and the credit agreements.
SEASONALITY
Meritage historically has closed more units 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 their semi-custom luxury and move-up homes. Management expects
this seasonal trend to continue, though it may vary as operations continue to
expand.
FACTORS THAT MAY AFFECT FUTURE RESULTS AND FINANCIAL CONDITION OF THE COMPANY
Future operating results and financial condition depend on the
Company's ability to successfully design, develop, construct and sell homes that
satisfy dynamic customer demand patterns. Inherent in this process are factors
that Meritage must successfully manage to achieve favorable future operating
results and financial condition. These operating and financial conditions, along
with many other factors, could affect the price of Meritage common stock.
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. Although management believes that many Meritage customers
(particularly purchasers of luxury and move-up homes) tend to be less
price-sensitive than generally is the case for other homebuilders, such
uncertainties could adversely affect the Company's performance. 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. In
1999, increased demand for construction labor in Arizona markets pushed many of
Meritage's scheduled first quarter home closings into the second quarter.
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. There is no assurance that the occurrence or continuation of
any of the above items will not have a material adverse effect on Meritage's
business.
Customer demand for new housing also impacts the homebuilding industry.
Real estate analysts predict that new home sales in the Phoenix metropolitan
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<PAGE>
area may slow in 1999 and that sales in the Tucson metropolitan area may remain
relatively flat. Any such slowing in sales would have a material adverse effect
on the Company's business and operating results. In general, home sales in the
Texas and northern California markets are expected to show moderate growth or
remain relatively flat.
The homebuilding industry is subject to the potential for significant
variability and fluctuations in real estate values, as evidenced by the changes
in real estate prices in recent years in Arizona, Texas and northern California.
Although Meritage believes that its projects are currently reflected on its
balance sheet at appropriate values, there is no assurance that write-downs of
some or all of its projects will not occur if market conditions deteriorate, or
that such write-downs will not be material in amount.
FLUCTUATIONS IN OPERATING RESULTS. Meritage historically has
experienced, and expects to continue to experience, variability in home sales
and net earnings on a quarterly basis. As a result of such variability, the
Company's 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;
+ the ability to continue to acquire additional land or options to
acquire additional land on acceptable terms;
+ conditions of the real estate market and the general economy in areas
where Meritage operates;
+ the cyclical nature of the homebuilding industry, changes in
prevailing interest rates and the availability of mortgage financing;
+ costs or shortages of materials and labor; and
+ delays in construction schedules due to strikes, adverse weather, acts
of God, and the availability of subcontractors or governmental
restrictions.
INTEREST RATES AND MORTGAGE FINANCING. Meritage believes that many of
its move-up and luxury home customers have been less sensitive to interest rate
fluctuations than other homebuyers. However, most buyers of Meritage homes
finance their purchase through third-party lenders providing mortgage financing.
In general, housing demand is adversely affected by increases in interest rates
and housing costs, and the unavailability of mortgage financing. If mortgage
interest rates increase and the ability of prospective buyers to finance home
purchases is consequently affected adversely, home sales, gross margins and net
income may also be adversely impacted and the impact may be material. The
Company's homebuilding activities depend upon the availability and costs of
mortgage financing for buyers of homes owned by potential customers so those
customers ("move-up buyers") can sell their homes and purchase a Meritage home.
Any limitations or restrictions 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 eliminate or limit tax-free rollover treatment provided under
current law where the proceeds of the sale of a principal residence are
reinvested in a new principal residence. Enactment of such proposals may have an
adverse effect on the homebuilding industry in general, and on demand for the
Company's products in particular. No prediction can be made whether any such
proposals will be enacted and, if enacted, the particular form such laws would
take.
COMPETITION. The single-family residential housing industry is highly
competitive. Homebuilders vie for desirable properties, financing, raw
materials, and skilled labor. Meritage competes for residential home sales with
other developers and individual resales of existing homes. Competitors include
large homebuilding companies, some of which have greater financial resources
than Meritage, and smaller homebuilders, who may have lower costs. Competition
is expected to continue and become more intense, and there may be new entrants
in the markets in which Meritage currently operates and in markets it may enter
in the future.
LACK OF GEOGRAPHIC DIVERSIFICATION. Meritage operates in Arizona, Texas
and northern California. Failure to be more geographically diversified could
have an adverse impact on the Company if the homebuilding business in its
current markets should decline, for there may not be a balancing opportunity in
a healthier 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, Meritage incurs substantial indebtedness to
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finance its homebuilding activities. At December 31, 1998, the Company's debt
totaled approximately $37 million. Meritage 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. If Meritage cannot obtain sufficient capital to
fund its planned capital or other expenditures, new projects may be delayed or
abandoned, which could result in a reduction in home sales and may adversely
affect operating results. There is no assurance that additional debt or equity
financing will be available in the future or on acceptable terms.
The terms and conditions of its current indebtedness limit the amount
and types of indebtedness that Meritage can incur. Meritage must comply with
numerous operating and financial maintenance covenants and there is no assurance
that the Company will be able to maintain compliance with these financial and
other covenants. Failure to comply with the covenants would result in default
and resulting cross defaults under the Company's other indebtedness, and could
result in an acceleration of all indebtedness, which would have a material
adverse affect on the Company.
GOVERNMENT REGULATIONS; ENVIRONMENTAL CONDITIONS. Meritage is subject
to local, state, and federal statutes and rules regulating certain developmental
matters, as well as building and site design. The Company is subject to various
fees and charges of governmental authorities designed to defray the cost of
providing certain governmental services and improvements. Meritage 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. Meritage must also obtain licenses, permits, and approvals from
government agencies to engage in certain activities, the granting or receipt of
which are beyond the Company's control.
Meritage and its competitors 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 areas. Environmental regulations can also
have an adverse impact on the availability and price of certain raw materials
such as lumber.
RECENT AND FUTURE EXPANSION. Meritage recently concluded significant
expansions into the Texas and northern California markets, and may continue to
consider growth in other areas of the country. 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, the Company's
financial capabilities, and general economic and business conditions. New
acquisitions may result in the incurrence of additional debt and/or amortization
of expenses related to goodwill and intangible assets that could adversely
affect the Company's profitability, or result in potentially dilutive issuances
of equity securities. Acquisitions also involve numerous risks, including
difficulties in the assimilation of the acquired company's operations, the
diversion of management's attention from other business concerns, risks of
entering markets in which Meritage has had no or only limited direct experience
and the potential loss of key employees of the acquired company. There can be no
assurance that Meritage will be able to expand into new markets on a profitable
basis or that it can successfully manage its expansion into Texas, California or
any additional markets.
DEPENDENCE ON KEY PERSONNEL. Meritage's success is largely dependent on
the continuing services of certain key employees, and the ability to attract new
personnel required for the Company's favorable development. Meritage has entered
into employment agreements with various key officers, and loss of their services
could have a material adverse affect on the Company's business.
DEPENDENCE ON SUBCONTRACTORS. Meritage conducts its business only as a
general contractor in connection with the design, development and construction
of its communities. Virtually all architectural and construction work is
performed by subcontractors. As a consequence, Meritage is dependent upon the
continued availability and satisfactory performance by unaffiliated third
parties for the design and construction of its homes. There is no assurance that
21
<PAGE>
there will be sufficient availability and satisfactory performance by
unaffiliated third-party subcontractors, and such a lack could have a material
adverse affect on the Company's business.
NET OPERATING LOSS CARRYFORWARD. Meritage's ability to use the NOL
carryforward to offset future taxable income would be substantially limited
under federal tax laws if an "ownership change", within the meaning of the laws,
has occurred or occurs with respect to the Company before the NOL carryforward
expires. Management believes that (i) there was not an "ownership change" of the
Company prior to the effective date of the Homeplex merger, (ii) the merger did
not cause an "ownership change", and (iii) the Legacy combination did not cause
an "ownership change".
Under federal tax laws, Meritage may not be permitted to use the NOL
carryforward to offset taxable income resulting from sales of assets owned by
Monterey Homes at the time of the merger or of certain assets acquired in the
Legacy combination, to the extent that the fair market value of these assets at
the merger or combination dates exceeded their tax basis.
SPECIAL NOTE OF CAUTION REGARDING FORWARD-LOOKING STATEMENT
Certain statements in this annual report may constitute
"forward-looking statements" within the meaning of federal securities laws.
Forward-looking statements are based on management's beliefs, assumptions and
expectations of Meritage's future economic performance, taking into account the
information currently available to them. These statements are not statements of
historical fact. Forward-looking statements involve risks and uncertainties that
may cause the Company's actual results, performance or financial condition to be
materially different from the expectations of future results, performance or
financial condition expressed or implied in any forward-looking statement.
When used in this annual report, the words "anticipate," "estimate,"
"expect," "objective," "projection," "forecast," "goal" or similar words are
intended to identify forward-looking statements. Management qualifies any
forward-looking statements entirely by these cautionary factors.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Meritage does not trade in derivative financial instruments and at
December 31, 1998 had no significant financial instruments. Meritage does have
other financial instruments in the form of notes payable and senior debt. The
publicly held debt and other notes are at fixed interest rates. Meritage's lines
of credit and credit facilities are at variable interest rates and are subject
to market risk in the form of interest rate fluctuations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Meritage's Consolidated Financial Statements as of December 31, 1998
and 1997 and for each of the years in the three-year period ended December 31,
1998, 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.
22
<PAGE>
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of
Meritage Corporation
We have audited the accompanying consolidated balance sheets of
Meritage Corporation and subsidiaries (previously known as Monterey Homes
Corporation and subsidiaries) as of December 31, 1998 and 1997 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, 1998. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion of these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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, 1998 and 1997, and the
results of their operations and cash flows for each of the years in the
three-year period ended December 31, 1998, in conformity with generally accepted
accounting principles.
KPMG LLP
Phoenix, Arizona
February 4, 1999
23
<PAGE>
MERITAGE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
-----------------------------
1998 1997
---- ----
ASSETS
Cash and cash equivalents $ 12,386,806 $ 8,245,392
Real estate under development 104,758,530 63,955,330
Deposits on real estate under
option or contract 7,338,406 3,070,420
Other receivables 2,460,966 985,708
Deferred tax asset 6,935,000 10,404,000
Goodwill 14,640,712 5,970,773
Property and equipment, net 2,566,163 2,046,026
Other assets 1,163,737 1,955,855
------------ ------------
Total Assets $152,250,320 $ 96,633,504
============ ============
LIABILITIES
Accounts payable and accrued liabilities $ 34,068,178 $ 21,171,301
Home sale deposits 8,587,245 6,204,773
Notes payable 37,204,845 22,892,250
Minority interest in consolidated joint ventures 110,922 --
------------ ------------
Total Liabilities 79,971,190 50,268,324
------------ ------------
STOCKHOLDERS' EQUITY
Common stock, par value $.01 per share;
50,000,000 shares authorized; issued and
outstanding - 5,334,942 shares at
December 31, 1998, and 5,255,440 shares at
December 31, 1997 53,349 52,554
Additional paid-in capital 99,319,669 97,819,584
Accumulated deficit (27,093,888) (51,096,675)
Treasury stock - 53,046 shares at
December 31, 1997 -- (410,283)
------------ ------------
Total Stockholders' Equity 72,279,130 46,365,180
------------ ------------
Total Liabilities and Stockholders' Equity $152,250,320 $ 96,633,504
============ ============
See accompanying notes to consolidated financial statements
24
<PAGE>
MERITAGE CORPORATION AND SUBSIDIARIES
CONSOLDIATED STATEMENTS OF EARNINGS
YEARS ENDED DECEMBER 31,
--------------------------------------------
1998 1997 1996
---- ---- ----
Home sales revenue $ 255,984,499 $ 149,384,548
Cost of home sales (204,408,950) (124,368,782)
------------- -------------
Gross profit 51,575,549 25,015,766
Residual interest and real estate
loan interest income 5,230,549 5,088,693 $ 1,610,386
Commissions and other sales costs (14,292,152) (8,294,028) --
General and administrative expense (10,632,212) (6,812,171) (1,683,407)
Interest expense (461,475) (165,173) (237,945)
Other income, net 1,100,701 366,271 633,449
Minority interest in net income of
consolidated joint ventures (2,021,230) -- --
------------- ------------- -----------
Earnings before income taxes and
extraordinary loss 30,499,730 15,199,358 322,483
Income taxes (6,496,943) (961,916) (26,562)
------------- ------------- -----------
Earnings before extraordinary loss 24,002,787 14,237,442 295,921
Extraordinary loss from early
extinguishment of debt -- -- (148,433)
------------- ------------- -----------
Net earnings $ 24,002,787 $ 14,237,442 $ 147,488
============= ============= ===========
Basic earnings per share $ 4.51 $ 2.93 $ .05
============= ============= ===========
Diluted earnings per share $ 3.92 $ 2.68 $ .04
============= ============= ===========
See accompanying notes to consolidated financial statements
25
<PAGE>
MERITAGE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
-----------------------------------------------------------------------------
ADDITIONAL
NUMBER OF COMMON PAID-IN ACCUMULATED TREASURY
SHARES STOCK CAPITAL DEFICIT STOCK TOTAL
------ ----- ------- ------- ----- -----
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995 .......... 3,291,885 $ 32,919 $ 84,112,289 $(65,287,275) $(410,283) $ 18,447,650
Net earnings .......................... -- -- -- 147,488 -- 147,488
Cash dividends ........................ -- -- -- (194,330) -- (194,330)
Shares issued in connection with the
merger .............................. 1,288,726 12,887 8,531,369 -- -- 8,544,256
--------- -------- ------------ ------------ ------ -----------
Balance at December 31, 1996 .......... 4,580,611 45,806 92,643,658 (65,334,117) (410,283) 26,945,064
Net earnings .......................... -- -- -- 14,237,442 -- 14,237,442
Exercise of employee stock options .... 8,162 81 118,510 -- -- 118,591
Shares issued in connection with
the Legacy combination .............. 666,667 6,667 3,393,335 -- -- 3,400,002
Stock option and contingent stock
compensation expense ................ -- -- 1,664,081 -- -- 1,664,081
--------- -------- ------------ ------------ ------ -----------
Balance at December 31, 1997 .......... 5,255,440 52,554 97,819,584 (51,096,675) (410,283) 46,365,180
Net earnings .......................... -- -- -- 24,002,787 -- 24,002,787
Exercise of employee stock options .... 43,660 437 513,135 -- -- 513,572
Contingent and warrant shares issued .. 88,888 888 (888) -- -- --
Stock option and contingent stock
compensation expenses ............... -- -- 1,397,591 -- -- 1,397,591
Retirement of treasury stock .......... (53,046) (530) (409,753) -- 410,283 --
--------- -------- ------------ ------------ -------- -----------
Balance at December 31, 1998 .......... 5,334,942 $ 53,349 $ 99,319,669 $(27,093,888) $ -- $72,279,130
========= ======== ============ ============ ======== ===========
</TABLE>
See accompanying notes to consolidated financial statements
26
<PAGE>
MERITAGE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings ............................... $ 24,002,787 $ 14,237,442 $ 147,488
Adjustments to reconcile net earnings to net
cash provided by operating activities:
Extraordinary loss from early extinguishment
of debt .................................. -- -- 148,433
Depreciation and amortization .............. 1,637,474 376,916 38,300
Minority interest in net income of
consolidated joint ventures .............. 2,021,230 -- --
Deferred tax expense ....................... 4,969,000 -- --
Stock option compensation expense .......... 1,397,591 1,664,081 --
Gain on sales of residual interests ........ (5,180,046) (3,067,829) --
Increase in real estate under development .. (32,045,609) (10,575,738) --
Increase in deposits on real estate under
option or contract ....................... (3,577,986) (1,712,139) --
(Increase) decrease in other receivables
and other assets ......................... (1,775,151) 2,313,632 1,701,426
Increase in accounts payable and accrued
liabilities .............................. 8,547,275 5,825,516 317,094
Increase in home sale deposits ............. 1,809,629 465,409 --
------------- ------------ ------------
Net cash provided by (used in) operating
activities .............................. (5,195,880) 6,676,216 2,352,741
------------- ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash acquired in merger/acquisition ........ 785,403 1,306,998 6,495,255
Cash paid for merger/acquisition ........... (6,914,706) (1,952,857) (779,097)
Purchases of property and equipment ........ (1,568,642) (174,257) --
Principal payments received on real estate
loans .................................... -- 2,124,544 3,710,000
Real estate loans funded ................... -- (428,272) (1,358,457)
Decrease in short term investments ......... -- 4,696,495 4,272,605
Proceeds from sales of residual interest ... 6,600,000 5,500,000 --
Decrease in funds held by Trustee .......... -- -- 5,637,948
------------- ------------ ------------
Net cash provided by (used in) investing
activities ............................. (1,097,945) 11,072,651 17,978,254
------------- ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings ................................. 174,445,708 67,900,899 --
Repayment of borrowings .................... (164,524,041) (92,896,553) (7,818,824)
Stock options exercised .................... 513,572 118,591 --
Dividends paid ............................. -- (194,330) (291,496)
------------- ------------ ------------
Net cash provided by (used in) financing
activities ............................. 10,435,239 (25,071,393) (8,110,320)
------------- ------------ ------------
Net increase (decrease) in cash and
cash equivalents ......................... 4,141,414 (7,322,526) 12,220,675
Cash and cash equivalents at beginning
of year .................................. 8,245,392 15,567,918 3,347,243
------------- ------------ ------------
Cash and cash equivalents at end of year ... $ 12,386,806 $ 8,245,392 $ 15,567,918
============= ============ ============
Supplemental information:
Cash paid for interest ..................... $ 3,996,771 $ 3,801,764 $ 286,276
Cash paid for income taxes ................. $ 2,332,604 $ 49,871 $ --
</TABLE>
See accompanying notes to consolidated financial statements
27
<PAGE>
MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
NOTE 1 - ORGANIZATION AND BASIS OF PRESENTATION
BUSINESS. Meritage Corporation ("Meritage" or the "Company") develops,
constructs and sells new high-quality, single family homes in the semi-custom
luxury, move-up and entry-level markets.
The Company was formed in 1988 as a real estate investment trust
("REIT") that invested in mortgage-related assets and real estate loans. On
December 31, 1996, the Company acquired by merger the homebuilding operations of
various entities operating under the Monterey Homes name (Monterey), and has
phased out the mortgage-related operations. Monterey has been building homes in
Arizona for over 13 years, specializing in move-up and semi-custom luxury homes.
As part of its strategy to diversify operations, on July 1, 1997, the
Company combined with Legacy Homes (Legacy), a group of entities with
homebuilding operations in Texas. Legacy has been in business since 1988, and
designs, builds and sells entry-level and move-up homes. On July 1, 1998 the
Company acquired Sterling Communities, now Meritage Homes of Northern
California, which has homebuilding operations in the San Francisco Bay and
Sacramento metropolitan areas, and designs, builds and sells move-up homes.
BASIS OF PRESENTATION. Consolidated financial statements include the accounts of
Meritage Corporation and its subsidiaries. Intercompany balances and
transactions have been eliminated in consolidation and certain prior period
amounts have been reclassified to be consistent with current financial statement
presentation. Results include the operations of Legacy from July 1, 1997 and of
Meritage Homes of Northern California from July 1, 1998.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS. Short-term investments with an initial maturity of
three months or less are considered to be cash equivalents. Amounts in transit
from title companies for home closings are included in cash.
REAL ESTATE UNDER DEVELOPMENT. Amounts are carried at cost unless such costs
would not be recovered from the cash flows generated by future disposition. In
this 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 which benefit the entire community.
Common costs are allocated on a community by community basis to residential lots
based on the number of lots to be built in the community, which approximates the
relative sales value method.
Deposits paid related to options and contracts to purchase land are
capitalized 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 under development.
28
<PAGE>
MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
COST OF HOME SALES. Cost of sales include land acquisition and development
costs, direct home construction costs, development period interest and closing
costs, and an allocation of common costs.
REVENUE RECOGNITION. Home sales revenue is recognized when homes are delivered
and title transfers to the buyer.
PROPERTY AND EQUIPMENT. Property and equipment are stated at cost less
accumulated depreciation. Depreciation is calculated on a straight-line method
over the estimated useful lives of the assets, which range from three to seven
years. Accumulated depreciation was approximately $2,862,000 and $1,960,000 at
December 31, 1998 and 1997, respectively. Maintenance and repair costs are
expensed as incurred.
GOODWILL. The excess of purchase price over fair value of net assets acquired
(goodwill) is amortized on a straight-line basis over a 20-year period.
Accumulated amortization was approximately $704,600 at December 31, 1998 and
$162,500 at December 31, 1997. Management periodically evaluates the businesses
to which the goodwill relates to insure the carrying value of goodwill has not
been impaired. The amount of goodwill impairment, if any, is measured based on
projected discounted future operating cash flows using a discount rate
reflecting Meritage's average cost of funds. No goodwill impairment was recorded
in the accompanying statements of earnings.
RESIDUAL INTERESTS. Prior to year-end 1998, Meritage owned residual interests in
collateralized mortgage obligations (CMOs) and in mortgage participation
certificates (MPCs) (collectively residual interests). The Company used the
prospective net level yield method, in which interest is recorded at cost and
amortized over the life of the related CMO or MPC issuance, to account for the
residual interests. Estimated fair value of residual interests at December 31,
1997 was $6.6 million. Residual interests of $1.4 million are included as other
assets at December 31, 1997. Meritage sold the remaining residual interests in
1998.
INCOME TAXES. The Company accounts for income taxes in accordance with Statement
of Financial Accounting Standards (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.
EARNINGS PER SHARE. Basic earnings per share is computed by dividing income
available to common stockholders by the weighted-average number of common shares
outstanding for the period. Diluted earnings per share reflects the potential
dilution that could occur if 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 the Company's earnings. Meritage adopted SFAS No. 128,
"Earnings Per Share" in 1997 and restated prior period amounts.
USE OF ESTIMATES. The preparation of financial statements in accordance with
generally accepted accounting principles requires management to make estimates
and assumptions relating to amounts reported in the financial statements and
accompanying notes. Actual results could differ materially from these estimates.
29
<PAGE>
MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
FAIR VALUE OF FINANCIAL INSTRUMENTS. The carrying amounts of
receivables, cash and cash equivalents, deposits on real estate under option or
contract, accounts payable and accrued liabilities and home sale deposits
approximate fair value due to the short term maturity of these assets and
liabilities. Notes payable carry interest rates comparable to 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 Meritage would pay or receive in actual market transactions.
STOCK OPTION PLANS. Meritage has 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 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
exceeded the exercise price. The pro forma disclosures that are required by SFAS
No. 123 are presented in Note 6.
NEW ACCOUNTING PRONOUNCEMENTS.
FASB NO. 131. The FASB issued Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments for an Enterprise and Related
Information" in June 1997. FASB No. 131 establishes standards for the way that
public companies report selected information about operating segments in
financial reports issued to stockholders. Meritage has adopted the provisions of
FASB No. 131, which had no significant impact on the Company's definitions of
its operating segments and related disclosures.
NOTE 3 - REAL ESTATE UNDER DEVELOPMENT AND CAPITALIZED INTEREST
The components of real estate under development at December 31 follow
(in thousands):
1998 1997
-------- --------
Homes under contract, in production $ 44,186 $ 30,523
Finished lots and lots under development 46,558 28,471
Model homes and homes held for resale 14,015 4,961
-------- --------
$104,759 $ 63,955
======== ========
Meritage capitalizes certain interest costs during development and
construction. Capitalized interest is allocated to real estate under development
and charged to cost of home sales when the units are delivered. Summaries of
interest capitalized and interest expensed follow (in thousands):
YEAR ENDED DECEMBER 31,
1998 1997
---- ----
Beginning unamortized capitalized interest ......... $ 1,890 $ --
Interest capitalized ............................... 3,711 3,679
Amortized cost of home sales ....................... (3,619) (1,789)
------ ------
Ending unamortized capitalized interest ............ $ 1,982 $ 1,890
======= =======
Interest incurred .................................. $ 4,172 $ 3,844
Interest capitalized ............................... 3,711 3,679
------ ------
Interest expense ................................... $ 461 $ 165
======= =======
30
<PAGE>
MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 4 - NOTES PAYABLE
Notes payable at December 31 consist of the following (in thousands):
1998 1997
---- ----
$50 million bank construction line of credit,
interest payable monthly approximating prime
(7.75% at December 31, 1998) or LIBOR (30 day
LIBOR 5.1% at December 31, 1998), plus 2.25%
payable at the earlier of close of escrow,
maturity date of individual homes within the
line or June 9, 2000, secured by first deeds of
trust on homes ...................................... $ 4,641 $ 4,664
$50 million bank construction line of credit,
interest payable monthly approximating prime or
LIBOR plus 2.5%, payable at the earlier of close
of escrow, maturity date of individual homes
within the line or July 31, 1999, secured by
first deeds of trust on homes ....................... 10,925 9,769
$20 million bank acquisition and development
credit facility, interest payable monthly
approximating prime or LIBOR plus 2.25%, payable
at the earlier of funding of construction
financing, the maturity date of individual
projects within the line or June 19, 2000,
secured by first deeds of trust on land ............. 3,314 2,394
Other acquisition and development credit
facilities totaling $4.5 million, interest
payable monthly, ranging from prime to prime
plus .25%; payable at the earlier of funding of
construction financing or the maturity date of
the individual projects, secured by first deeds
of trust on land .................................... 2,407 --
Senior unsecured notes, maturing September 15,
2005, annual interest of 9.10% payable
quarterly, principal payable in three equal
installments on September 15, 2003, 2004 and
2005 ................................................ 15,000 --
Senior subordinated unsecured notes, paid in full
October 1998 ........................................ -- 6,000
Other ................................................. 918 65
-------- --------
Total ................................................. $ 37,205 $ 22,892
======== ========
The bank credit facilities and senior subordinated notes contain
covenants which require certain levels of tangible net worth, the maintenance of
certain minimum financial ratios, 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, 1998 and throughout the year, Meritage was
in compliance with these covenants.
31
<PAGE>
MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Scheduled maturities of notes payable as of December 31, 1998 follow (in
thousands):
YEAR ENDED
DECEMBER 31,
1999 ......................... $21,326
2000 ......................... --
2001 ......................... 879
2002 ......................... --
2003 ......................... 5,000
Thereafter ................... 10,000
------
$37,205
=======
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, 1998, 1997 and 1996
follows. 1996 shares have been adjusted to reflect a one-for-three stock split
effective at the merger (in thousands, except per share amounts):
1998 1997 1996
---- ---- ----
Net earnings $24,003 $14,237 $ 147
Basic EPS - Weighted average shares
outstanding 5,317 4,864 3,242
------- ------- ------
Basic earnings per share $ 4.51 $ 2.93 $ .05
======= ======= ======
Basic EPS - Weighted average shares
outstanding 5,317 4,864 3,242
Effect of dilutive securities:
Contingent shares and warrants 158 114 --
Stock options 641 330 93
------- ------- ------
Dilutive EPS - Weighted average shares
outstanding 6,116 5,308 3,335
------- ------- ------
Diluted earnings per share $ 3.92 $ 2.68 $ .04
======= ======= ======
Antidilutive stock options not included
in diluted EPS 59 4 4
======= ======= ======
Basic and diluted earnings per share for the extraordinary loss in 1996
were $.05 and $.04, respectively.
NOTE 6 - STOCK OPTIONS AND CONTINGENT STOCK
The Compensation Committee of the Board of Directors administers
Meritage's stock option plans. The plans provide for stock option grants to key
personnel and directors, and provide a means of performance-based compensation
in order to attract and retain qualified employees.
32
<PAGE>
MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Meritage applies APB Opinion No. 25 and related interpretations in
accounting for its plans. No compensation cost has been recognized for its stock
based compensation plans, which are fixed stock option plans. Had compensation
cost for these plans been determined consistent with SFAS 123, the Company's net
earnings and earnings per share would have been reduced to the following pro
forma amounts (in thousands, except for per share amounts):
1998 1997 1996
---- ---- ----
Net earnings (loss) As reported $24,003 $14,237 $147
Pro forma 23,573 13,892 (151)
Basic earnings (loss) per share As reported 4.51 2.93 .05
Pro forma 4.43 2.86 (.05)
Diluted earnings (loss) per share As reported 3.92 2.68 .04
Pro forma 3.85 2.62 (.05)
The per share weighted average fair values of stock options granted
during 1998, 1997 and 1996 were $9.91, $4.58 and $1.63, respectively, on the
dates of grant using the Black-Scholes pricing model based on the following
weighted average assumptions:
1998 1997 1996
---- ---- ----
Expected dividend yield .5% 1.2% 1.4%
Risk-free interest rate 5.75% 6.0% 5.85%
Expected volatility 51% 43% 36%
Expected life (in years) 7 5 5
THE MERITAGE PLAN
Shareholders approved a new stock option plan at the 1997 Annual
Meeting. The plan authorizes grants of incentive stock options and non-qualified
stock options to Meritage executives, directors, employees and consultants. A
total of 225,000 shares of the Meritage common stock were reserved for issuance
upon exercise of stock options granted under this plan, with an additional
250,000 shares added to the reserve by vote of the shareholders at the 1998
Annual Meeting. The options vest over periods from two to five years, are based
on continued employment, and expire five to ten years after the date of grant.
THE PRIOR PLAN
The 1988 Homeplex Mortgage Investments Corporation Stock Option Plan
(the prior plan) was in effect at the time of the merger. No new grants have
been issued under this plan since the merger, and 103,102 option shares were
outstanding under this plan at December 31, 1998. Accounts payable and accrued
liabilities in the accompanying 1998 and 1997 balance sheets include
approximately $524,800 and $778,600, respectively, related to options granted
under the prior plan. This liability will remain on the consolidated balance
sheets until the options are exercised, canceled or expire.
OTHER OPTIONS
In connection with the merger and Legacy combination, Mssrs. Hilton,
Cleverly and Landon each received 166,667 non-qualified stock options that vest
over three years. The exercise price of the 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 and Mr. Landon's expire in June 2003.
33
<PAGE>
MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
A current member of Meritage's board of directors who served as the
Company's president and chairman prior to the merger holds 250,000 non-qualified
stock options. The options were granted in exchange for the director forgoing
his annual salary and bonus, and were approved by shareholders at the 1996
annual meeting. These options are fully vested, have an exercise price of $ 4.50
per share and expire on December 21, 2000.
<TABLE>
<CAPTION>
SUMMARY OF STOCK OPTION ACTIVITY:
1998 1997 1996
------------------- -------------------- -------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
------- -------- ------- -------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
Options outstanding at beginning
of year 1,041,480 $ 5.86 732,975 $5.78 398,392 $6.21
Options granted 57,500 16.54 150,000 7.16 1,249 7.96
Merger/combination options granted -- -- 166,667 5.25 333,334 5.25
Options exercised (43,660) 10.04 (8,162) 9.36 -- --
Options canceled (27,018) 7.22 -- -- -- --
---------- ------ ---------- ----- ------- -----
Options outstanding at end of year 1,028,302 $ 6.25 1,041,480 $5.86 732,975 $5.78
========== ====== ========== ===== ======= =====
</TABLE>
Options exercisable at end of year 613,579 515,090 399,641
Price range of options exercised $4.50-$11.25 $4.37-$6.38
Price range of options outstanding $4.50-$17.63 $3.62-$13.32 $3.62-$13.32
Total shares reserved at December 31 1,525,547 1,383,146 666,307
Stock options outstanding at December 31, 1998 were:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------- -------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
REMAINING EXERCISE EXERCISE
RANGE OF EXERCISE PRICES OPTIONS CONTRACTUAL LIFE PRICE OPTIONS PRICE
- ------------------------ ------- ---------------- ----- ------- -----
<S> <C> <C> <C> <C> <C>
$ 4.50 - $ 6.38 863,480 5.0 years $ 5.08 550,757 $ 4.95
$ 8.50 - $12.50 106,106 5.5 10.00 59,106 10.80
$13.37 - $17.63 58,716 9.2 16.64 3,716 15.38
--------- --------- ------ ------- ------
1,028,302 5.3 years $ 6.25 613,579 $ 5.58
========= ========= ====== ======= ======
</TABLE>
34
<PAGE>
CONTINGENT SHARES
In connection with merger, 266,666 shares of contingent stock were
reserved for equal issuance to Mr. Hilton and Mr. Cleverly on the first, second
and third anniversaries of the transaction. Stock trading prices are required to
meet certain thresholds and the officer must be a Meritage employee at the time
of issuance. All price thresholds had been exceeded, and Mr. Hilton and Mr.
Cleverly were each issued 44,444 shares of common stock subsequent to both the
first and second anniversary of the merger.
NOTE 7 - COMMITMENTS AND CONTINGENCIES
Meritage is involved in legal proceedings and claims that arise in the
ordinary course of business. Management believes the amount of ultimate
liability with respect to these actions will not materially affect the Company's
financial statements taken as a whole.
Also in the normal course of business, Meritage provides standby
letters of credit and performance bonds issued to third parties to secure
performance under various contracts. At December 31, 1998 outstanding letters of
credit were $2.1 million and performance bonds were $8.9 million.
Meritage leases office facilities, model homes and equipment under
various operating lease agreements. Approximate future minimum lease payments
for noncancellable operating leases as of December 31, 1998 are as follows:
MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
YEAR ENDING
DECEMBER 31
-----------
1999 .................................. $715,200
2000 .................................. 348,200
2001 .................................. 223,800
2002 .................................. 85,000
2003 and thereafter ................... --
----------
$1,372,200
==========
Rental expense was approximately $1,074,900 in 1998, $1,185,400 in 1997
and $21,800 in 1996. Included in these amounts are $380,000 in 1998 and $274,000
in 1997 related to office facilities leased from companies owned beneficially
either by one of Meritage's Co-Chairmen or by one of Meritage's Co-Chairmen and
a director.
NOTE 8 - MERGERS/COMBINATIONS/ACQUISITIONS
MONTEREY HOMES
On December 23, 1996, the stockholders of Homeplex Mortgage Investments
Corporation, now known as Meritage Corporation, approved the merger with
Monterey Homes. The merger was effective on December 31, 1996, and homebuilding
became the Company's primary business. At consummation of the merger, 1,288,726
new shares of common stock, $.01 par value per share, were issued equally to
Monterey's prior owners, and management of the homebuilding operations assumed
effective control of the Company.
Consideration paid for the net assets of the homebuilding entities was
$9,323,353, which included 1,288,726 shares of the Company's common stock valued
at $8,544,256 and $779,097 of transaction costs. The Company used the purchase
method of accounting and the purchase price was allocated among the Company's
net assets based on their estimated fair market value at the date of the
transaction, resulting in goodwill of $1,763,488 which is being amortized over
20 years.
LEGACY HOMES
On May 29, 1997, the Company signed a definitive agreement to acquire
the homebuilding and related mortgage service business of Legacy Homes, Ltd. and
its affiliates. The transaction was effective on July 1, 1997. Legacy Homes has
been building entry-level and move-up homes in Texas since 1988 and is
headquartered in the Dallas/Fort Worth metropolitan area.
Consideration consisted of approximately $1.5 million in cash, 666,667
shares of Meritage common stock valued at $3.4 million and $370,000 of
transaction costs. Meritage used the purchase method of accounting and the
purchase price was allocated among the Company's net assets based on their
estimated fair market value at the transaction date. Goodwill of approximately
$1.5 million was recorded, which is being amortized over 20 years. Provisions
were also made to pay additional consideration not to exceed $15 million, based
on the Company's earnings. Additional consideration was approximately $7.0
million in 1998 and $2.8 million in 1997, and was paid subsequent to each
year-end. These amounts are recorded as goodwill and are being be amortized over
20 years. Meritage's Board of Directors removed the contingent nature of the
remaining $5.2 million in 1999. Goodwill of $5.2 million will therefore be
recorded in 1999 and this amount will be paid in January 2000.
35
<PAGE>
MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
STERLING COMMUNITIES
On June 15, 1998, Meritage signed a definitive agreement with Sterling
Communities, S.H. Capital, Inc., Sterling Financial Investments, Inc., Steve
Hafener and W. Leon Pyle (together, the Sterling Entities), to acquire
substantially all of the assets of Sterling Communities. The transaction was
effective as of July 1, 1998. Assets acquired principally consist of real
property and other residential homebuilding assets located in the San Francisco
Bay and Sacramento areas of California. The Company will continue the operations
of the Sterling Entities under the name Meritage Homes of Northern California.
Consideration paid for the assets and stock acquired, and various
liabilities assumed, consisted of $6.9 million in cash and additional
consideration to be paid for up to four years after the transaction date.
Meritage used the purchase method of accounting and the purchase price was
allocated among the Company's net assets based on their estimated fair market
value at the transaction date. Goodwill of approximately $2.2 million was
recorded, which is being amortized over 20 years. The additional consideration
will be equal to 20% of the pre-tax income of Meritage's California division and
will be expensed as earned. Unpaid consideration was approximately $318,000 at
December 31, 1998.
The following unaudited pro forma information presents a summary of
consolidated results of operations as if the Legacy combination and Sterling
acquisition had occurred at January 1, 1997, with pro forma adjustments together
with related income tax effects. The pro forma results have been prepared for
comparative purposes only and do not purport to be indicative of the results of
operations that would actually have occurred had the combination been in effect
on the date indicated (in thousands except per share data).
YEARS ENDED DECEMBER 31,
------------------------
(UNAUDITED)
1998 1997
---- ----
Home sales revenue ................ $274,754 $220,852
Net earnings ...................... $ 24,949 $ 19,835
Basic earnings per share .......... $ 4.69 $ 3.82
Diluted earnings per share ........ $ 4.08 $ 3.49
NOTE 9 - INCOME TAXES
Components of income tax expense are (in thousands):
1998 1997 1996
---- ---- ----
Current taxes:
Federal ........................ $ 561 $222 $19
State .......................... 967 740 8
------ ---- ---
1,528 962 27
------ ---- ---
Deferred taxes:
Federal ........................ 4,587 -- --
State .......................... 382 -- --
------ ---- ---
4,969 -- --
------ ---- ---
Total ...................... $6,497 $962 $27
====== ==== ===
36
<PAGE>
MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 9 - INCOME TAXES (CONT.)
Deferred tax assets and liabilities have been recognized in the
consolidated balance sheets due to the following temporary differences and
carryforwards (in thousands):
12/31/98 12/31/97
-------- --------
Net operating loss carryforward .................. $ 4,360 $ 13,895
Residual interest basis differences .............. -- 970
Real estate basis differences .................... 509 590
Debt issuance costs .............................. -- 310
Deductible merger/acquisition costs .............. 1,163 260
Alternative minimum tax credit ................... 782 220
Other ............................................ 121 80
------- --------
6,935 16,325
Valuation allowance .............................. -- (5,891)
------- --------
6,935 10,434
Deferred tax liabilities ......................... -- (30)
------- --------
Net deferred tax asset ........................... $ 6,935 $ 10,404
======= ========
Management believes 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, 1998, 1997 and
1996 from the amounts computed using the federal statutory income tax rate as a
result of the following (in thousands):
1998 1997 1996
---- ---- ----
Expected taxes at current federal
statutory income tax rate ............... $ 10,678 $ 5,320 $ 60
State income taxes ........................ 967 740 8
Utilization of NOL ........................ (5,709) (5,320) (60)
Alternative minimum tax ................... 561 222 19
-------- ------- ----
Income tax expense .................... $ 6,497 $ 962 $ 27
======== ======= ====
CARRYFORWARDS.
At December 31, 1998, Meritage had a federal net operating loss
carryforward of approximately $12.5 million. The carryforward will expire
beginning in 2007.
37
<PAGE>
MERITAGE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 10 - SELECTED QUARTERLY FINANCIAL DATA SUMMARY (UNAUDITED)
(in thousands, except per share amounts)
BASIC DILUTED
HOME SALES EARNINGS EARNINGS
REVENUE NET EARNINGS PER SHARE PER SHARE
------- ------------ --------- ---------
1998 - THREE MONTHS ENDED:
March 31 $36,513 $5,452 $ 1.03 $ .90
June 30 55,608 6,696 1.26 1.10
September 30 68,417 4,268 .80 .70
December 31 95,446 7,587 1.42 1.28
1997 - THREE MONTHS ENDED:
March 31 $12,573 $ 288 $ .06 $ .06
June 30 24,544 1,958 .43 .42
September 30 42,685 5,079 .98 .86
December 31 69,583 6,912 1.33 1.17
NOTE 11 - SEGMENT INFORMATION
Meritage classifies its operations into three primary segments:
Arizona, Texas and California. These segments generate revenues through the sale
of homes to external customers. Meritage is not dependent on any one major
customer.
Operational information relating to the different business segments
follows. Information has been included for the Texas operations from July 1,
1997, the combination date, and for the California operations from July 1, 1998,
the acquisition date. Certain information has not been included by segment due
to the immateriality of the amount to the segment or in total. Meritage
evaluates segment performance based on several factors, of which the primary
financial measure is earnings before interest and taxes (EBIT). The accounting
policies of the business segments are the same as those described in Notes 1 and
2 for the Company. There are no significant transactions between segments.
(in thousands )
---------------------------------
1998 1997 1996
---- ---- ----
HOME SALES REVENUE:
Arizona $105,942 $ 97,922 $ --
Texas 130,860 51,463 --
California 19,183 -- --
-------- -------- -------
Total $255,985 $149,385 $ --
======== ======== =======
EBIT:
Arizona $ 12,918 $ 9,744 $ --
Texas 18,300 7,059 --
California 1,858 -- --
Corporate and other 1,504 350 560
-------- -------- -------
Total $ 34,580 $ 17,153 $ 560
======== ======== =======
38
<PAGE>
AMORTIZATION OF CAPITALIZED INTEREST:
Arizona $ 2,408 $ 1,397 $ --
Texas 1,143 392 --
California 66 -- --
-------- -------- -------
Total $ 3,619 $ 1,789 $ --
======== ======== =======
ASSETS AT YEAR END:
Arizona $ 58,758 $ 36,438 $36,803
Texas 53,554 27,751 --
California 10,161 -- --
Corporate and other 29,777 32,445 36,018
-------- -------- -------
Total $152,250 $ 96,634 $72,821
======== ======== =======
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 regarding this item is included under the captions
"Election of Directors," "Director and Officer Information," and "Section 16(a)
Beneficial Ownership Reporting Compliance" in Meritage's Notice and Proxy
Statement relating to its 1999 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, the Registrant's 1999 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," "Compensation Committee Interlocks and Insider
Participation," "Director Compensation" and "Employment Agreements" in
Meritage's the 1999 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
"Security Ownership of Principal Stockholders and Management" in Meritage's 1999
Proxy Statement and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this item is set forth under the caption
"Certain Transactions and Relationships" and "Compensation Committee Interlocks
and Insider Participation" in Meritage's 1999 Proxy Statement and is
incorporated herein by reference.
39
<PAGE>
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 23
2. Consolidated Financial Statements and Notes to
Consolidated Financial Statements of the Company,
including Consolidated Balance Sheets as of
December 31, 1998 and 1997 and related
Consolidated Statements of Earnings,
Stockholder's Equity and Cash Flows for each
of the years in the three-year period ended
December 31, 1998 Page 24
(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
Current reports on Form 8-K, dated October 13, 1998 and December 22,
1998 were filed with the Securities and Exchange Commission. These reports
related to the change of the corporate name to Meritage Corporation from
Monterey Homes Corporation, and the Company's response to an unsolicited tender
offer, respectively.
(c) EXHIBITS
EXHIBIT
NUMBER DESCRIPTION PAGE OR METHOD OF FILING
------- ----------- ------------------------
2 Agreement and Plan of Incorporated by reference to
Reorganization, dated as of Exhibit 2 of Form S-4
September 13, 1996, by and Registration Statement No.
among Homeplex, the Monterey 333-15937 ("S-4 #333-15937").
Merging Companies and the
Monterey Stockholders
2.1 Agreement of Purchase and Sale Incorporated by reference to
of Assets, dated as of May 29, Exhibit 2 of Form 8-K/A dated
1997, by and among Monterey, June 18, 1997.
Legacy Homes, Ltd., Legacy
Enterprises, Inc., and John
and Eleanor Landon
3.1 Restated Articles of Incorporated by reference to
Incorporation of the Company Exhibit 3.2 of Form 10-Q for
the quarterly period ended
September 30, 1998.
3.2 Amendment to Articles of Incorporated by reference to
Incorporation Exhibit 3.1 of Form 10-Q for
the quarterly period ended
September 30, 1998.
3.3 Amended and Restated Bylaws of Incorporated by reference to
the Company Exhibit 3.3 of Form S-3
#333-58793.
4.1 Specimen of Common Stock Incorporated by reference to
Certificate Exhibit 4 to the Form 10-K for
the year ended December 31,
1996.
40
<PAGE>
4.2 Warrant Agreement dated as of Previously filed.
October 17, 1994 among
Monterey and the Warrant Agent
4.3 Assumption Agreement dated as Previously filed.
of December 31, 1996 modifying
the Warrant Agreement in
certain respects, and relating
to the assumption of the
Warrant Agreement by the
Company and certain other
matters
4.4 Specimen Warrant Certificate Previously filed.
4.5 Note Purchase Agreement Incorporated by reference to
Exhibit 4.1 of Form 10-Q for
the quarterly period ended
September 30, 1998.
10.1 Master Revolving Line of Incorporated by reference to
Credit by and between Norwest Exhibit 10.5 to the Form 10-K
Bank Arizona, N.A. and the for the year ended December
Company 31, 1996.
10.2 Revolving Model Home Lease Incorporated by reference to
Back Agreement between AMHM-1, Exhibit 10.6 to the Form 10-K
L.P. and the Company for the year ended December
31, 1996.
10.3 Stock Option Plan* Incorporated by reference to
Exhibit 10(d) of Form 10-K for
the fiscal year ended December
31, 1995 ("1995 Form 10-K").
10.4 Amendment to Stock Option Plan* Incorporated by reference to
Exhibit 10(e) of 1995 Form
10-K.
10.5 Amendment to Stock Option Plan Previously filed.
dated as of December 31, 1996*
10.6 Meritage Corporation Stock Incorporated by reference to
Option Plan Exhibit 10.9 to the Form 10-K
for the year ended December
31, 1996.
10.7 Meritage Corporation 1997 Previously filed.
Stock Option Plan*
10.8 Employment Agreement between Incorporated by reference to
the Company and William W. Exhibit 10.10 to the Form 10-K
Cleverly* for the year ended December
31, 1996.
10.9 Employment Agreement between Incorporated by reference to
the Company and Steven J. Exhibit 10.11 to the Form 10-K
Hilton* for the year ended December
31, 1996.
10.10 Employment Agreement between Incorporated by reference to
the Company and John R. Exhibit C of the Form 8-K
Landon* filed on June 18, 1997.
10.11 Stock Option Agreement between Incorporated by reference to
the Company and William W. Exhibit 10.12 of the Form 10-K
Cleverly* for the year ended December
31, 1996.
10.12 Stock Option Agreement between Incorporated by reference to
the Company and Steven J. Exhibit 10.13 to the Form 10-K
Hilton* for the year ended December
31, 1996.
10.13 Stock Option Agreement between Incorporated by reference to
the Company and John R. Exhibit C of the Form 8-K
Landon* filed on June 18, 1997.
10.14 Registration Rights Agreement Incorporated by reference to
between the Company and Exhibit 10.14 to the Form 10-K
William W. Cleverly* for the year ended December
31, 1996.
10.15 Registration Rights Agreement Incorporated by reference to
between the Company and Steven Exhibit 10.15 to the Form 10-K
J. Hilton* for the year ended December
31, 1996.
41
<PAGE>
10.16 Registration Rights Agreement Incorporated by reference to
between the Company and John Exhibit C of the Form 8-K
R. Landon* filed on June 18, 1997.
10.17 Escrow and Contingent Stock Incorporated by reference to
Agreement Exhibit 10.16 of the Form 10-K
for the year ended December
31, 1996.
10.18 Amended and Restated Incorporated by reference to
Employment Agreement and Exhibit 10(g) of the 1995 Form
Addendum between the Company 10-K.
and Alan D. Hamberlin*
10.19 Stock Option Agreement between Incorporated by reference to
the Company and Alan D. Exhibit 10(h) of the 1995 Form
Hamberlin* 10-K.
10.20 Agreement regarding sale of Incorporated by reference to
residual interests between the Exhibit 10.24 to Form 10-K for
Company and PaineWebber the year ended December 31,
1996.
10.21 Employment Agreement between Incorporated by reference to
the Company and Larry W. Seay* Exhibit 10.2 of Form 10-Q for
the quarterly period ended
June 30, 1998.
10.22 Employment Agreement between Incorporated by reference to
the Company and Anthony C. Exhibit 10.3 of Form 10-Q for
Dinnell* the quarterly period ended
June 30, 1998.
23 Consent of KPMG LLP Filed herewith.
24 Powers of Attorney See signature page.
27 Financial Data Schedules Filed herewith.
- ----------
* Indicates a management contract or compensation plan.
42
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly cause this report on Form 10-K to
be signed on its behalf by the undersigned, thereunto duly authorized, this
22nd day of March, 1999.
MERITAGE CORPORATION,
a Maryland Corporation
By /s/ Steven J. Hilton
---------------------------------------
Steven J. Hilton
Co-Chairman and Co-Chief Executive Officer
By /s/ John R. Landon
---------------------------------------
John R. Landon
Co-Chairman and Co-Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Steven J. Hilton, John R. Landon 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,
this report on Form 10-K has been signed below by the following persons on
behalf of the registrant and in the capacities and on the dates indicated:
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Steven J. Hilton Co-Chairman and March 22, 1999
- -------------------------- Co-Chief Executive Officer
Steven J. Hilton
/s/ John R. Landon Co-Chairman and March 22, 1999
- -------------------------- Co-Chief Executive Officer
John R. Landon
/s/ Larry W. Seay Chief Financial Officer, Vice March 22, 1999
- -------------------------- President-Finance, Secretary and
Larry W. Seay Treasurer (Principal Financial and
Accounting Officer)
<PAGE>
SIGNATURE TITLE DATE
--------- ----- ----
/s/ William W. Cleverly Director March 22, 1999
- --------------------------
William W. Cleverly
/s/ Alan D. Hamberlin Director March 22, 1999
- --------------------------
Alan D. Hamberlin
/s/ Raymond Oppel Director March 22, 1999
- --------------------------
Raymond Oppel
/s/ Robert G. Sarver Director March 22, 1999
- --------------------------
Robert G. Sarver
/s/ C. Timothy White Director March 22, 1999
- --------------------------
C. Timothy White
CONSENT OF KPMG LLP
The Board of Directors
Meritage Corporation:
We consent to incorporation by reference in Registration Statement No. 333-58793
on Form S-3 and Registration Statements Nos. 33-38230 and 333-37859 on Forms S-8
of Meritage Corporation (previously known as Monterey Homes Corporation) of our
report dated February 4, 1999, relating to the consolidated balance sheets of
Meritage Corporation and subsidiaries as of December 31, 1998 and 1997 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, 1998 which
appears in the December 31, 1998 annual report on Form 10-K of Meritage
Corporation.
/s/ KPMG LLP
Phoenix, Arizona
March 19, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1
<CASH> 12,386,806
<SECURITIES> 0
<RECEIVABLES> 2,460,966
<ALLOWANCES> 0
<INVENTORY> 104,758,530
<CURRENT-ASSETS> 130,674,608
<PP&E> 5,428,601
<DEPRECIATION> 2,862,437
<TOTAL-ASSETS> 152,250,320
<CURRENT-LIABILITIES> 42,655,423
<BONDS> 37,205,000
0
0
<COMMON> 53,349
<OTHER-SE> 72,225,781
<TOTAL-LIABILITY-AND-EQUITY> 152,250,320
<SALES> 255,984,499
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<CGS> 204,408,950
<TOTAL-COSTS> 14,292,152
<OTHER-EXPENSES> 6,322,192
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<INTEREST-EXPENSE> 461,475
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<INCOME-TAX> 6,496,943
<INCOME-CONTINUING> 24,002,787
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 24,002,787
<EPS-PRIMARY> 4.51
<EPS-DILUTED> 3.92
</TABLE>
