Filed pursuant to Rule 424(b)(3)
File No. 333-15937
Prospectus
MERITAGE CORPORATION
92,924 Shares of Common Stock
Meritage Corporation
6613 North Scottsdale Rd., Suite 200
Scottsdale, Arizona 85250
(480) 998-8700
We design, construct and sell single family homes ranging from entry-level to
semi-custom luxury homes in three large and growing Sunbelt states; Arizona,
Texas and California. We have recently undergone significant growth and at
December 31, 1998, were actively selling homes in 36 communities. We pursue a
strategy of diversifying our product mix and the geographic scope of our
operations. The trading symbol for our common stock on the NYSE is "MTH." The
warrants are not listed on any exchange or on NASDAQ and we do not expect any of
these warrants to officially trade in any public market.
* Meritage Corporation was formerly known as Monterey Homes Corporation.
* This prospectus relates to the offering by Meritage of shares of our
common stock upon exercise of 76,994 outstanding warrants. Specific
terms of these warrants are set forth in a warrant agreement and
certain provisions are highlighted in this prospectus.
* The exercise of outstanding warrants will amount to the ultimate
purchase of up to 92,924 shares of Meritage common stock (subject to
adjustment.)
* Each warrant is exercisable for the purchase of 1.2069 shares of our
common stock at an exercise price of $4.0634 per warrant.
* We will not receive any of the proceeds upon the sale of the shares
upon future exercise of these warrants.
* The warrants are currently exercisable at any time from now until
October 15, 2001, or earlier in certain events.
----------------------------------------------------
This investment involves a high degree of risk. Before making an investment in
our securities, you should carefully consider certain risks described in "Risk
Factors" beginning on page 8.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus is accurate or complete. Any representation to the contrary is a
criminal offense.
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July 28, 1999
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TABLE OF CONTENTS
Page
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ABOUT THIS PROSPECTUS.......................................................2
WHERE YOU CAN FIND MORE INFORMATION.........................................3
SPECIAL NOTE OF CAUTION REGARDING FORWARD-LOOKING STATEMENTS................4
PROSPECTUS SUMMARY..........................................................5
RISK FACTORS................................................................8
USE OF PROCEEDS............................................................13
THE MERGER BETWEEN HOMEPLEX AND MONTEREY...................................13
THE LEGACY COMBINATION.....................................................15
EMPLOYMENT AND OPTION AGREEMENTS...........................................15
SELECTED FINANCIAL AND OPERATING DATA......................................19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS......................................20
BUSINESS OF MERITAGE.......................................................26
DESCRIPTION OF CAPITAL STOCK...............................................38
PRICE OF COMMON STOCK AND DIVIDEND POLICY..................................44
LEGAL MATTERS..............................................................45
EXPERTS ..................................................................45
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS................................F-1
Prospective investors should rely only on information contained or
referred to in this prospectus. We have not authorized anyone, including any
underwriter, dealer or agent, to provide you with any information other than
what is contained in this prospectus. This prospectus is not an offer for any
securities other than those specifically referred to in this document. We are
not making an offer of these securities in any state where the offer is not
permitted. The information in this prospectus is complete and accurate as of its
date.
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ABOUT THIS PROSPECTUS
This prospectus relates to the offering from time to time by Meritage
Corporation, a Maryland corporation, of up to 92,924 shares of our common stock,
par value $.01 per share, upon exercise of warrants (163,421 shares were
previously offered upon the exercise of 135,404 warrants). The warrants were
assumed by us in connection with the merger, effective December 31, 1996, of the
homebuilding operations of various entities under the Monterey Homes name
(collectively, "Monterey") with and into Homeplex Mortgage Investments
Corporation, a Maryland corporation ("Homeplex"). The warrants were originally
issued by Monterey. Homeplex survived the merger and changed its name to
Monterey Homes Corporation. See "The Merger between Homeplex and Monterey." On
September 16, 1998, Monterey Homes Corporation changed its name to Meritage
Corporation. Any reference in this prospectus to "we," "our," or "Meritage" is
meant to refer to Meritage. The number of shares obtainable upon exercise of the
warrants is subject to change under certain antidilution provisions. The
warrants became exercisable on the effective date of the merger and will
continue to be exercisable at any time on or before October 15, 2001, or earlier
upon the dissolution, liquidation or winding up of Meritage. Each warrant may be
exercised for the purchase of 1.2069 shares of Meritage common stock at an
exercise price of $4.0634 per warrant. See "The Merger between Homeplex and
Monterey - Consideration for the Merger" and "Description of Capital Stock."
Meritage will not receive any of the proceeds from the exercise of the
warrants. William W. Cleverly and Steven J. Hilton (the "Monterey Stockholders")
have received proceeds of $550,202 upon exercise of 135,404 warrants and will
receive additional proceeds of $312,857 if all of the remaining 76,994 warrants
are exercised. See "Prospectus Summary," "Use of Proceeds" and "The Merger
between Homeplex and Monterey - Consideration for the Merger." The cost of
registering the shares is being borne by Meritage.
Our common stock is traded on the NYSE under the symbol "MTH." On April
26, 1999, the closing sale price for the common stock as reported by the NYSE
was $12.625 per share. See "Price of Common Stock and Dividend Policy."
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WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission ("SEC")
post-effective amendment no. 4 to the registration statement on Form S-4
(together with all amendments and exhibits, the "registration statement") under
the Securities Act with respect to the securities offered by this prospectus.
This prospectus, which is a part of the registration statement, does not contain
all of the information in the registration statement because certain parts are
omitted in accordance with the rules and regulations of the SEC. For further
information with respect to us and the offering described in this prospectus,
reference is made to the entire registration statement.
We file annual, quarterly and current reports, proxy statements, and
other information with the SEC. The documents we have filed with the SEC may be
inspected and copied at the SEC's public reference rooms at Room 1024, Judiciary
Plaza, 450 Fifth Street N.W., Washington, D.C. 20549 and at the SEC's regional
offices at Seven World Trade Center, 13th Floor, New York, New York 10048, and
Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661.
Copies of these materials can be obtained from the SEC's Public Reference
Section at 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates,
and can also be obtained electronically through the SEC's Electronic Data
Gathering, Analysis and Retrieval System at the SEC's internet web site
(http://www.sec.gov). Our common stock is listed on the NYSE and copies of the
registration statement and of our reports, proxy statements, and other
information can also be inspected at the offices of the NYSE at 20 Broad Street,
17th Floor, New York, New York 10005.
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SPECIAL NOTE OF CAUTION REGARDING
FORWARD-LOOKING STATEMENTS
Certain statements in this prospectus, including those under the
captions "Prospectus Summary," "Risk Factors," "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Business of
Meritage" may constitute "forward-looking statements" within the meaning of
federal securities laws. Forward-looking statements are based on our
management's beliefs, assumptions, and expectations of our future economic
performance, taking into account the information currently available to them.
These statements are not statements of historical fact. Forward-looking
statements involve many risks and uncertainties that may cause our actual
results, performance or financial condition to be materially different from the
expectations of future results, performance or financial condition we express or
imply in any forward-looking statements. Some of the important factors that
could cause our actual results, performance or financial condition to differ
materially from our expectations are:
* The strength and competitive pricing environment of the single-family
housing market;
* Changes in the availability and pricing of residential mortgages,
including changes in interest rates;
* Changes in the availability and pricing of real estate in our markets;
* Changes in demand for our homes;
* Changes in the economy;
* The success of our marketing and promotional campaigns;
* Our ability to successfully integrate our operations with the
operations of any companies we may acquire;
* The degree, nature, and intensity of competition with other
homebuilders; and
* Other factors described in this prospectus or the documents we file
with the SEC.
When used in our documents or other presentations, the words
"anticipate," "believe," "estimate," "expect," "objective," "projection,"
"forecast," "goal" or similar words may identify forward-looking statements. We
qualify these forward-looking statements entirely by the cautionary factors
provided above and elsewhere in this prospectus. Any forward-looking statements
speak only as of the date of this prospectus, and we do not intend to update or
revise these statements when changes occur after this date.
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PROSPECTUS SUMMARY
The following summary contains basic information about Meritage and
this offering. It may not contain all the information that is important to you.
We urge you to read the entire prospectus, including the risk factors and
financial statements, to find more detailed information.
OUR COMPANY
We design, build and sell single family homes in Arizona, Texas and
California. We build move-up and semi-custom, luxury homes and operate in the
Phoenix and Tucson, Arizona, Dallas/Fort Worth, Austin and Houston, Texas, and
San Francisco and Sacramento, California metropolitan areas. We have undergone
significant growth in recent periods and are pursuing a strategy of diversifying
the geographic scope of our operations.
We were originally 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,
we acquired, by merger between Homeplex and Monterey, the homebuilding
operations of various entities under the Monterey Homes name, which had been a
homebuilder in Arizona for over 10 years. We essentially discontinued our
mortgage-related operations to focus principally on the business of homebuilding
and changed our name to Monterey Homes Corporation. Following the merger, the
management of Monterey assumed effective management control of the combined
entity.
As part of our strategy to diversify our homebuilding operations, on
July 1, 1997, we combined with Legacy Homes, a group of entities with
homebuilding operations in Texas. In business in the Texas market since 1987,
Legacy designs, builds, and sells entry-level and move-up homes. In connection
with the acquisition, John R. Landon, the founder and Chief Executive Officer of
the Legacy Homes entities, joined senior management and the Board of Directors
of Meritage, and continues to oversee the operations of Legacy Homes.
In July 1998, we acquired Sterling Communities and related companies, a
homebuilder in northern California operating primarily in the San Francisco Bay
and Sacramento areas. We have continued Sterling's operations under the name
Meritage Homes of Northern California. Sterling builds and designs quality first
and second-time move-up homes. In connection with the acquisition, Steve
Hafener, an officer and director of Sterling, joined Meritage as Vice President
and Division Manager of our northern California operations.
In September 1998, we changed our corporate name to Meritage
Corporation. Monterey Homes is used as our primary brand name in Arizona, with
the Meritage Homes name being used for our newly established lower priced
division in the Phoenix area. Legacy Homes is the brand name for our homes in
the Texas markets and Meritage Homes of Northern California is our brand name in
our northern California markets.
As a result of losses from our operations as a REIT, we had net
operating loss carryforwards for federal income tax purposes of approximately
$12.5 million at December 31, 1998. Accordingly, we paid limited income taxes in
1998.
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We are a Maryland corporation with our headquarters in Scottsdale,
Arizona. Our principal executive offices are located at 6613 North Scottsdale
Road, Suite 200, Scottsdale, Arizona 85250, and our telephone number is (480)
998-8700.
In connection with the merger between Homeplex and Monterey, we
effected, and all share information herein reflects, a one-for-three reverse
stock split.
For additional information concerning our business, see "Business of
Meritage," "Management's Discussion and Analysis of Financial Condition and
Results of Operations," and the financial statements (including the notes to the
financial statements) included at the back of this prospectus.
THE OFFERING
Securities Offered......... 92,924 shares of common stock of Meritage, subject
to adjustment under certain antidilution provisions
under the documents governing the warrants. The
shares are equal to approximately 1.7% of the
outstanding common stock of Meritage (as of April
26, 1999), after giving effect to the exercise of
the warrants, but not to the exercise or conversion
of any other stock options, convertible securities,
or warrants.
Transfer Restrictions...... Certain transfer restrictions apply to the
ownership of our common stock and will also applies
to the ownership of the warrants. See "Description
of Capital Stock" and "Business of Meritage - NOL
Carryforward" for a description of these
restrictions.
Warrants Outstanding....... 76,994 warrants are outstanding.
Common Stock Outstanding... As of April 26, 1999, 5,425,830 shares of our
common stock were outstanding.
Use of Proceeds............ We will not receive any proceeds from sale of the
shares upon exercise of the warrants. Upon the
exercise of warrants, we will remit the exercise
price of $4.0634 per warrant (subject to
adjustment), or total gross proceeds of
approximately $312,857 if all of the remaining
warrants are exercised, to Messrs. William W.
Cleverly and Steven J. Hilton. See "Use of
Proceeds" and "The Merger between Homeplex and
Monterey."
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DESCRIPTION OF WARRANTS
Expiration of Warrants... October 15, 2001 or earlier upon the dissolution,
liquidation, or winding up of our operations (the
"Expiration Date").
Exercise................. Each warrant entitles the holder to purchase 1.2069
shares of common stock for $4.0634 (subject to
adjustment). The warrants may be exercised at any
time on or prior to the Expiration Date.
Adjustments.............. The number of shares of common stock for which a
warrant is exercisable and the purchase price
provided in the warrant are subject to adjustment
from time to time upon certain events, including
certain issuances of our stock, options, or other
securities, liquidating distributions, and certain
subdivisions, combinations, and reclassifications
of our common stock. A warrant does not entitle the
holder to receive any dividends paid on common
stock.
For additional information concerning the warrants and the shares
issuable upon exercise of the warrants, see "The Merger between Homeplex and
Monterey - Consideration for the Merger" and "Description of Capital Stock."
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RISK FACTORS
Our future operating results and financial condition depend on our
ability to successfully design, develop, construct and sell homes that satisfy
dynamic customer demand patterns. Inherent in this process are a number of
factors that we must successfully manage to achieve favorable future operating
results and financial condition. The value of our securities, including our
common stock and the warrants, could be affected by these and other risk
factors. Potential risks and uncertainties that could affect our operating
results and financial condition and the value of our common stock and the
warrants include the factors discussed below.
FACTORS RELATING TO FUTURE STOCK PERFORMANCE
In addition to the industry and business factors described below, other
factors may affect the value or future market prices of our common stock and the
warrants, including the following:
TRANSFER OF OUR SECURITIES IS RESTRICTED AND THE OWNERSHIP LEVELS OF OUR
DIRECTORS AND OFFICERS COULD LIMIT THE VOTING RIGHTS OF OTHER INVESTORS AND
NEGATIVELY IMPACT OUR SECURITIES PRICES
In order to preserve our net operating loss carryforwards, our charter
does not allow:
* anyone to transfer Meritage securities if the effect would be to make
any person or group the owner of 4.9% or more of our 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 our outstanding shares.
The above restrictions apply to the shares of common stock issuable
upon exercise of the warrants and to the warrants, and ownership of our common
stock would be included with ownership of warrants otherwise held by the same
person to determine if the allowable ownership percentage is exceeded. In
addition, our current directors and officers beneficially hold approximately 51%
of our outstanding common stock (assuming exercise of certain options and
warrants held by them). The above charter provisions, coupled with the level of
ownership by our current directors and officers, could delay or prevent a future
change of control of Meritage, which could depress our stock price.
OUR STOCK PRICE MAY BE VOLATILE
The market price of our common stock could be subject to significant
fluctuations in response to certain factors, such as variations in anticipated
or actual results of our operations or that of other home building companies,
changes in conditions affecting the general economy or the local economies where
our operations are located, widespread industry trends and securities analysts'
reports, as well as other factors unrelated to our actual operating results or
financial condition.
INDUSTRY AND BUSINESS FACTORS
We face certain risks relating to our industry. While some may affect
all industry participants, we believe each should be understood before investing
in our securities. These industry risks include:
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* market cycles;
* competition;
* interest rates and mortgage financing conditions;
* tax treatment;
* extent of geographic diversification; and
* extent of expansion opportunities.
These factors are described in more detail below.
ECONOMIC CYCLES AND CHANGING CONSUMER PREFERENCES MAY ADVERSELY AFFECT OUR
PERFORMANCE OR FINANCIAL CONDITION
The homebuilding industry is cyclical and is affected by numerous
factors, including general and local economic factors and consumer demand and
demographic trends. These factors dictate the strength of our markets and
consequently can impact our operating results and the value of our securities.
There can be no assurance that we will be able to compete successfully against
other homebuilders in our current markets in more competitive business
environments.
COMPETITION IS INTENSE IN THE HOMEBUILDING INDUSTRY AND MAY ADVERSELY IMPACT OUR
OPERATING RESULTS
The single-family residential housing industry is highly competitive.
Homebuilders vie for desirable properties, financing, raw materials, and skilled
labor. We compete for residential home sales with other developers and
individual resales of existing homes. Competitors include large home building
companies, some of which have greater financial resources than Meritage, and
smaller homebuilders, who may have lower operating costs. Competition is
expected to continue and become more intense, and there may be new entrants in
the markets in which we currently operate and in markets that we may enter in
the future.
OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE AND ADVERSELY AFFECT OUR STOCK
PRICE
We have historically experienced, and expect to continue to experience,
variability in home sales and net earnings on a quarterly basis. As a result of
this variability, our historical performance may not be a meaningful indication
of future results. Factors that contribute to this variability include:
* timing of home deliveries and land sales;
* our ability to continue to acquire land and options to acquire
land on acceptable terms;
* conditions of the real estate market, the general economy and
the local and regional economies where we operate;
* the cyclical nature of the homebuilding industry;
* costs or shortages of materials and labor; and
* delays in construction schedules due to strikes, adverse
weather, acts of God, the availability of subcontractors and
governmental restrictions.
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INTEREST RATES AND MORTGAGE FINANCING CONDITIONS AFFECT THE DEMAND FOR OUR HOMES
AND COULD NEGATIVELY IMPACT OUR BUSINESS
We believe that many of our move-up and luxury home customers have been
less sensitive to interest rate fluctuation and mortgage financing requirements
than some other homebuyers. However, many purchasers of our homes finance their
acquisition through third-party lenders providing mortgage financing. In
general, housing demand is adversely affected by increases in interest rates,
housing costs, and the availability of mortgage financing. If mortgage interest
rates increase or financing conditions change, the ability of prospective buyers
to finance home purchases may consequently be adversely affected, and our home
sales, gross margins and net income may be adversely impacted. Such adverse
impact may be material to our operating results. Our homebuilding activities
depend upon the availability and costs of mortgage financing for buyers of homes
owned by potential customers as many of our customers, particularly move-up
buyers, need to sell their original homes in order to purchase one of ours. Any
limitations or restrictions on the availability of such financing could
adversely affect home sales.
INCOME TAX CHANGES REDUCING HOMEOWNER TAX BENEFITS COULD DECREASE DEMAND FOR OUR
HOMES AND ADVERSELY AFFECT OUR BUSINESS
Changes in federal income tax laws may also affect demand for new
homes. Various publicly discussed proposals propose to limit mortgage interest
deductions and eliminate or limit tax-free rollover treatment. Enactment of such
proposals may have an adverse effect on the homebuilding industry in general,
and on demand for our 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.
OUR LACK OF GEOGRAPHIC DIVERSIFICATION MAKES US VULNERABLE TO LOCAL ECONOMIES
We operate in seven metropolitan areas in Arizona, Texas, and
California. Lack of geographic diversification could have an adverse impact on
our operations and the value of our securities if our homebuilding markets
stagnate or decline, for there may not be a balancing opportunity in a healthier
market in other geographic regions. While we may continue to expand
geographically, we nevertheless are exposed to the risk that our current markets
may weaken and be unable to support our expansion.
OUR SUCCESS MAY DEPEND ON OUR EXPANSION OPPORTUNITIES AND THE INABILITY TO
EXPAND MAY ADVERSELY AFFECT OUR BUSINESS
We recently concluded significant expansions into the Texas and
northern California markets. We 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;
* our 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. This
additional debt and/or amortization could adversely affect
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our profitability or result in potentially dilutive issuances of our 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 we have had no or only limited experience, and the potential loss of
key employees of the acquired company. There can be no assurance that we will be
able to expand into new markets on a profitable basis or that we can
successfully manage our expansion into Texas, northern California, or any
additional markets.
WE ARE DEPENDENT ON EXTERNAL FINANCING TO FUND OUR OPERATIONS
The homebuilding industry is capital intensive and requires significant
up-front expenditures to acquire land and begin development. Accordingly, we
incur substantial indebtedness to finance our homebuilding activities. At
December 31, 1998, our debt totaled approximately $37 million. We may be
required to seek additional capital in the form of equity or debt financing from
a variety of potential sources, including bank financing and securities
offerings. Also, lenders are increasingly requiring developers to invest
significant amounts of equity in a project both in connection with origination
of new loans as well as the extension of existing loans. If we cannot obtain
sufficient capital to fund our 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 our current indebtedness limit the amount
and types of indebtedness that we can incur. We must comply with numerous
operating and financial maintenance covenants and there is no assurance that we
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 our other indebtedness, and could result in an acceleration of
all indebtedness, which would have a material adverse affect on us.
REAL ESTATE VALUE FLUCTUATIONS MAY ADVERSELY AFFECT OUR OPERATIONS AND FINANCIAL
CONDITION
The homebuilding industry is subject to significant volatility and
fluctuations in real estate values. This volatility has been evident in cyclical
real estate price changes which have occurred in Arizona, Texas, and California.
Although we believe that our projects are currently reflected on our balance
sheet at appropriate values, we may have to write-down some or all of our
projects if market conditions deteriorate. These write-downs may materially
adversely affect our operations and the value of our securities. In addition,
these write-downs could cause us to default on current debt obligations.
GOVERNMENT REGULATIONS AND ENVIRONMENTAL CONDITIONS MAY INCREASE OUR COSTS AND
ADVERSELY AFFECT OUR BUSINESS
We are subject to many local, state, and federal laws and regulations
governing certain developmental matters, as well as building and site design. We
are also subject to various fees and charges of governmental authorities
designed to defray the cost of providing certain governmental services and
improvements. We may become subject to additional costs and delays or may be
precluded entirely from developing communities due to building moratoriums,
"slow growth" or "no growth" initiatives, building permit ordinances, or similar
governmental regulations that could be implemented in the future. Because most
of our current land is entitled, construction moratoriums generally would only
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adversely affect us due to health, safety, welfare or environmental concerns. We
must also obtain licenses, permits, and approvals from government agencies to
engage in certain activities, the granting or receipt of which are beyond our
control.
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 may also
have an adverse impact on the availability and price of certain raw materials,
such as lumber.
WE COULD LOSE A MEMBER OF OUR SENIOR MANAGEMENT TEAM, WHICH COULD NEGATIVELY
IMPACT OUR OPERATIONS
Our success is largely dependent on the continuing services of certain
key persons, including Steven J. Hilton and John R. Landon, and the ability to
attract new personnel required to continue our development. We have entered into
employment agreements with Messrs. Hilton and Landon. Loss of the services of
these two officers, or certain other key personnel, could have a material
adverse affect on our operations and the value of our securities.
WE ARE DEPENDENT ON SUBCONTRACTORS AND THE FAILURE TO SECURE SATISFACTORY
SUBCONTRACTORS COULD ADVERSELY AFFECT OUR BUSINESS
We act only as a general contractor in the design, development, and
construction of our communities. Virtually all architectural and construction
work is performed by subcontractors. As a consequence, we are dependent upon the
continued availability and satisfactory performance of unaffiliated third
parties. We may not be able to secure satisfactory subcontractors in the future.
Failure to secure satisfactory subcontractors would have a material adverse
affect on our operations.
WE MAY BE SUBJECT TO INCREASED TAXES RELATING TO THE AVAILABILITY OF OUR NET
OPERATING LOSS CARRYFORWARD
As of December 31, 1998, our net operating loss carryforward (the "NOL
Carryforward") was approximately $12.5 million. Our 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 those
laws, has occurred or occurs with respect to us before expiration of the NOL
Carryforward. We believe that there was not an "ownership change" of us prior to
the effective date of the merger between Homeplex and Monterey, the merger did
not cause an "ownership change," and the Legacy combination did not cause an
"ownership change."
Under the tax laws, we may not be permitted to use the NOL Carryforward
to offset taxable income resulting from sales of assets owned by Monterey at the
time of the Homeplex merger (or to offset taxable income resulting from sales of
certain assets acquired in the Legacy combination) to the extent that the fair
market value of such assets at the time of the merger (or at the time of the
Legacy combination) exceeded their tax basis as of the relevant date.
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There is no assurance that we will have sufficient earnings in the
future to fully utilize the NOL Carryforward prior to expiration. Upon
expiration or usage by us of the NOL Carryforward, we will experience more
income tax expense than we have experienced in the past due to the historical
availability of our NOL Carryforward to offset taxes. This could cause our
results of operations to differ from prior periods even if we are able to
maintain growth in our revenues and gross earnings.
WE COULD SUFFER YEAR 2000 COMPUTER PROBLEMS THAT COULD INCREASE OUR EXPENSES,
SUBJECT US TO LIABILITY AND ADVERSELY AFFECT OUR OPERATIONS OR FINANCIAL
CONDITION
The Year 2000 ("Y2K") issue is the result of computer programs being
written using two digits rather than four to define the applicable year.
Mistaking "00" for the year 1900 rather than 2000 could result in
miscalculations and errors and cause significant business interruptions and
costs for us, as well as the government and other companies. We have initiated
procedures to identify, evaluate and implement the necessary changes to our
computer systems, applications and embedded technologies resulting from the Y2K
conversion. We are coordinating these activities with others with whom we have
business relationships. We cannot give any assurance that we will achieve full
compliance in a timely manner. If we or others experience problems with the Y2K
conversion, we could be experience significant business interruptions and
expenses and our business and operating results could be materially and
adversely affected.
USE OF PROCEEDS
We will not receive any proceeds from the sale of shares of common
stock upon exercise of the warrants. Upon exercise of the warrants and the
issuance of the shares, we will remit the exercise price of $4.0634 per warrant,
or the aggregate gross proceeds of approximately $312,857 if all of the
remaining warrants are exercised, to the Monterey Stockholders.
THE MERGER BETWEEN HOMEPLEX AND MONTEREY
We were initially formed to operate as a REIT, investing in mortgage
related assets and selected real estate loans. We suffered significant losses
several years ago and determined to try to acquire a home builder that could
utilize its cash balances and other assets, as well as maximize our status as a
publicly traded entity. On September 13, 1996, we entered into an Agreement and
Plan of Reorganization by and among Homeplex, Monterey, and the Monterey
Stockholders. On December 31, 1996, Homeplex and Monterey were merged. As a
result of the merger, our status as a REIT was terminated, our name was changed
to Monterey Homes Corporation and our NYSE ticker symbol was changed to MTH. In
addition, a one-for-three reverse stock split of our issued and outstanding
common stock was effected. The share information contained in this prospectus
reflects the one-for-three reverse stock split. Following the merger, our
principal activity has been homebuilding.
CONSIDERATION FOR THE MERGER
As consideration for the merger, the Monterey Stockholders (who owned
all of the common stock of Monterey before the merger) received 1,288,726 shares
of our common stock (the "Exchange Shares").
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<PAGE>
Before the merger, Monterey had issued and outstanding warrants to
purchase 133,334 shares of its common stock (the "Monterey warrants") at an
exercise price of $18.75 per share. The Monterey warrants represented
approximately 16.5% of the fully diluted capitalization of Monterey (809,259
shares). On the effective date of the merger, the Monterey warrants were
converted into the warrants now subject to this prospectus based on a formula
that would allow the holders to purchase a number of shares of Meritage common
stock determined by multiplying 133,334 by the ratio of (i) the total number of
Exchange Shares divided by (ii) 809,259 (the "Warrant Conversion Ratio"). The
exercise price of the warrants was adjusted by dividing the exercise price of
the Monterey warrants immediately prior to the merger by the Warrant Conversion
Ratio. In addition, the exercise price of the warrants was adjusted by a factor
designed to compensate for certain distributions made to the Monterey
Stockholders prior to the merger. Following completion of audited financials for
the year ended December 31, 1996, we established the number of warrants as
212,398. Each warrant was exercisable for the purchase of 1.2069 shares of
common stock at an exercise price of $4.0634 per Warrant, or 256,345 shares
(including 16.5% of the Contingent Stock discussed below), approximating 16.5%
of both the original shares of Homeplex issued in the merger and the Contingent
Stock. As of April 26, 1999, 135,404 of the original warrants had been exercised
and 76,994 warrants remain outstanding.
Although all of the Exchange Shares were issued in the names of the
Monterey Stockholders, we initially held approximately 16.5%, or 256,345
(including 16.5% of the Contingent Stock discussed below) of the shares issued
in the names of the Monterey Stockholders for release to holders of warrants
upon their exercise, and we will remit the exercise price paid upon such
exercises to the Monterey Stockholders. Upon expiration of unexercised warrants,
we will distribute the appropriate amount of remaining Exchange Shares to the
Monterey Stockholders. The Monterey Stockholders are entitled to vote the shares
issued in their names in the merger but allocated to the warrants, prior to the
time the warrants are exercised. Including the shares allocated to the warrants,
Mr. Cleverly owns 667,692 shares or 13.7% of the outstanding common stock of
Meritage and Mr. Hilton owns 664,359 shares or 13.7% (as of April 26, 1999). If
all of the warrants are exercised, Mr. Cleverly would own 621,228 shares or
12.9% of our outstanding common stock and Mr. Hilton would own 617,895 shares or
12.8% of our outstanding common stock (as of April 26, 1999). These numbers
exclude the Employment Options and the Contingent Stock described below.
In addition to the shares of Homeplex issued in the merger, we have
reserved for issuance 266,666 shares of common stock, subject to certain
contingencies relating to our common stock average trading price thresholds
following the merger (the "Contingent Stock"). As of September 5, 1997, each of
the common stock trading thresholds had been achieved. Therefore, in January
1998, 88,888 shares of Contingent Stock were issued to the Monterey
Stockholders; in January 1999, 88,888 shares were issued to the Monterey
Stockholders; and on January 1, 2000 or as soon thereafter as is practicable,
the remaining 88,890 shares will be issued to the Meritage Stockholders, but in
the case of Mr. Hilton only if he remains employed with Meritage at such time.
The employment of Mr. Cleverly with Meritage was terminated effective as of
March 18, 1999; however, his termination was considered to be without cause, and
it was acknowledged that he was vested in and would be entitled to his portion
of the remaining Contingent Stock on the date such shares are to be delivered to
him. Mr. Cleverly remains a consultant to Meritage and a member of its Board of
Directors.
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<PAGE>
THE LEGACY COMBINATION
In an effort to further diversify our homebuilding operations, we
entered into an Agreement of Purchase and Sale of Assets dated May 29, 1997 with
Legacy Homes, Ltd., Legacy Enterprises, Inc., and John and Eleanor Landon, and a
related Agreement and Plan of Merger dated June 25, 1997 (collectively, the
"combination agreement"), with John and Eleanor Landon, Texas Home Mortgage
Corporation, and Monterey Mortgage Acquisition Corp. (collectively, Legacy
Homes, Ltd., Legacy Enterprises, Inc. and Texas Home Mortgage Corporation are
referred to as "Legacy"). Under the combination agreement, we acquired
substantially all of the operations and assets of Legacy, a Texas-based
homebuilder with related mortgage brokerage operations. The transaction closed
on July 1, 1997. We have contributed these assets to a wholly-owned limited
partnership and related entities (collectively, the "Texas Division").
The Legacy Combination Consideration
The consideration for the Legacy combination consisted of $1,553,004 in
cash, 666,667 shares of our common stock and deferred contingent payments for
the four years following the close of the transaction (the "Contingent
Payments"). In addition, we assumed substantially all of the liabilities of
Legacy including indebtedness that was incurred prior to the closing of the
transactions to fund distributions to the partners of Legacy Homes that reduced
its book value to less than $200,000.
The Contingent Payments were initially payable for five consecutive
earn-out periods following the effective date of the combination. The total of
the Contingent Payments was not to exceed $15 million. The Contingent Payments
were approximately $2.8 million in 1997 and $7.0 million in 1998, and were paid
subsequent to each year-end. Meritage's Board of Directors removed the
contingent nature of the remaining $5.2 million in 1999, which will be paid to
Mr. Landon in January 2000.
EMPLOYMENT AND OPTION AGREEMENTS
In connection with the Homeplex merger, we entered into an employment
agreement and related stock option agreement with Mr. Steven J. Hilton and Mr.
William W. Cleverly. Mr. Cleverly resigned from Meritage effective March 18,
1999. In connection with the Legacy combination, we entered into an employment
agreement and related stock option agreement with Mr. John R. Landon. These
agreements with Mr. Hilton and Mr. Landon are described together below.
Meritage's employment agreements with each of Mr. Hilton and Mr. Landon
provide for an initial base salary of $200,000 per year (increasing by 5% of the
prior year's base salary per year) and an annual bonus for 1997 and 1998 equal
to the lesser of 4% of Meritage's pre-tax consolidated net income or $200,000.
Thereafter, the agreements provide that the bonus percentage payout of
consolidated net income will be determined by the Compensation Committee of the
Board of Directors. In no event may the bonus paid in any year exceed $200,000
per employee. The Hilton agreement has a term ending December 31, 2001 and the
Landon agreement has a term ending June 30, 2001. Messrs. Hilton and Landon
serve as Co-Chairmen and Co-Chief Executive Officers of Meritage.
Under his agreement, if Mr. Hilton voluntarily terminates his
employment or is discharged for "cause," Meritage has no further obligation to
pay him salary or bonus. If Mr. Hilton is terminated during the term of his
agreement without "cause", Meritage will be obligated to pay him his then
current annual
15
<PAGE>
salary through the term of the agreement. If Mr. Hilton is terminated as a
result of his death or permanent disability, Meritage will be obligated to pay
him his current annual salary for six months after termination, plus a pro rated
bonus.
Under his agreement, if Mr. Landon voluntarily terminates his
employment without good reason or is discharged for cause, Meritage has no
further obligation to pay him salary or bonus. Meritage will be obligated to pay
Mr. Landon his then current base salary through the end of the stated term of
employment in the event of termination by Meritage without cause or if Mr.
Landon resigns for good reason, or for six months after termination in the event
of death or disability and a pro rated bonus.
"Cause" under the Hilton agreement and the Landon agreement is defined
to mean an act or acts of dishonesty constituting a felony and resulting or
intended to result directly or indirectly in substantial personal gain or
enrichment at the expense of Meritage. "Cause" under the Landon agreement also
includes willful disregard of the employee's primary duties to Meritage. "Good
Reason" under the Landon agreement is defined to include:
* assignment of duties inconsistent with the scope of the duties
associated with Mr. Landon's titles or positions or which would
require Mr. Landon to relocate his principal residence outside the
Dallas/Fort Worth, Texas metropolitan area;
* failure by Meritage to pay any part of the deferred payments due in
connection with the Legacy combination agreement;
* termination of Mr. Landon for cause and it is determined that cause
did not exist; or
* Meritage's failure to make certain working capital arrangements
available to the Texas division.
The agreements with Messrs. Hilton and Landon contain five-year
non-compete provisions that restrict them from:
* engaging in the homebuilding business and, with respect to Mr. Landon,
the mortgage brokerage or banking business;
* recruiting, hiring or discussing employment with any person who is, or
within the past six months was, an employee of Meritage;
* soliciting any customer or supplier of Meritage for a competing
business or otherwise attempting to induce any customer or supplier to
discontinue its relationship with Meritage; or
* except solely as a limited partner with no management or operating
responsibilities, engaging in the land banking or lot development
business.
The foregoing provisions shall not restrict:
* the ownership of less than 5% of a publicly-traded company; or
* if the employment of either Mr. Hilton or Mr. Landon is terminated
under his respective employment agreement, engaging in the custom
homebuilding business, or the production homebuilding business outside
a 100 mile radius of any Meritage project or outside Northern
California, or engaging in the land banking or lot development
business. The non-compete provisions survive the termination of the
Hilton agreement unless Mr. Hilton is terminated without cause. The
non-compete provisions under the Landon agreement
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<PAGE>
survive termination of that agreement unless Mr. Landon is terminated
without cause or resigns for good reason.
The Hilton employment agreement also provides for the grant to Mr.
Hilton (and our employment agreement with Mr. Cleverly also provided for the
grant to Mr. Cleverly) of options to purchase an aggregate of 166,667 shares of
common stock each at an exercise price of $5.25 per share (the "Employment
Options"). The Employment Options expire on December 31, 2002 and vest annually
over three years in equal increments beginning on the first anniversary of the
effective date of the Homeplex merger; provided, however, the Employment Options
will vest in full and will be exercisable upon a change of control of Meritage
prior to the third anniversary of the effective date of the Homeplex merger. If
Mr. Hilton voluntarily terminates his employment with Meritage, his Employment
Options will be exercisable for a period of six months following such
termination. If Mr. Hilton is terminated without cause, his Employment Options
will be immediately vested in full and will be exercisable until December 31,
2002. If Mr. Hilton's employment with Meritage is terminated as a result of
death or disability, his Employment Options will be exercisable for a period of
one year following such termination. If Meritage terminates Mr. Hilton's
employment for Cause, his Employment Options will terminate immediately.
The Landon employment agreement also provides for the grant to Mr.
Landon of an option to purchase an aggregate of 166,667 shares of our common
stock at an exercise price of $5.25 per share (the "Landon Employment Option").
The Landon Employment Option is exercisable as follows: 55,555 shares on July 1,
1998, 55,556 shares on July 1, 1999, and 55,556 shares on July 1, 2000;
provided, however, that the Landon Employment Option shall become exercisable in
full if there is a change of control of Meritage prior to July 1, 2000. If we
discharge Mr. Landon for cause, the Landon Employment Option will terminate
immediately. If Mr. Landon voluntarily terminates his employment with us, or if
his employment is terminated as a result of his death or disability, then the
Landon Employment Option (all 166,667 shares) will be exercisable for a period
of six months following such termination. If Mr. Landon is terminated without
cause, the Landon Employment Option (all 166,667 shares) will be immediately
exercisable until July 1, 2001.
Effective March 18, 1999, William W. Cleverly, one of the Monterey
Shareholders, resigned as a Managing Director of Meritage. Mr. Cleverly will
continue to serve on Meritage's Board of Directors and as a consultant to
Meritage. In connection with Mr. Cleverly's resignation, Meritage and Mr.
Cleverly entered into a separation and consulting agreement (the "separation
agreement"). Under the separation agreement, Meritage agreed to buy out Mr.
Cleverly's employment agreement for $656,375, an amount equal to his salary
through the end of his employment term and his pro-rated bonus through March 31,
1999. Mr. Cleverly also remains entitled to the Contingent Stock he was granted
in connection with the merger with Homeplex and to his Employment Options, which
contains terms identical to Mr. Hilton's Employment Options described above. The
separation was deemed a termination without cause under Mr. Cleverly's
employment agreement with Meritage.
For three years from the effective date of the separation agreement,
Mr. Cleverly will consult on Meritage's new product development and other areas
agreed upon by the parties. Mr. Cleverly will not be required to spend more than
25 hours per month in his capacity as a consultant to Meritage. The separation
agreement contains a non-compete provision which prohibits Mr. Cleverly from
competing with Meritage for three years following the effective date. The
non-compete provision is subject to various exceptions. In consideration for Mr.
Cleverly's covenant not to compete, Meritage will pay Mr. Cleverly $285,000
payable in quarterly installments of $23,750 beginning in June 1999.
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<PAGE>
For five years from the effective date of the separation agreement,
Meritage will nominate Mr. Cleverly for election to the Meritage Board of
Directors, so long as he owns greater than 275,000 shares of Meritage stock or
unless he has committed any act that constitutes "cause" as defined in his
previous employment agreement (which was identical to Mr. Hilton's described
above).
In connection with the separation agreement, both Mr. Cleverly and
Meritage released the other party from any liabilities or obligations either
party had or may have against such party in the future, subject to certain
exceptions.
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<PAGE>
SELECTED FINANCIAL AND OPERATING DATA
The following table presents selected historical condensed consolidated
financial data of Meritage for each of the years in the five-year period ended
December 31, 1998. The data for, and as of the end of, each of the years in the
three-year period ended December 31, 1998, are derived from the consolidated
financial statements of Meritage, which financial statements have been audited
by KPMG LLP, independent certified public accountants. The 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, and the report thereon, are
included elsewhere in this prospectus. The data for 1995 and 1994 is derived
from the consolidated financial statements audited by Ernst & Young LLP,
independent auditors. Due to the Homeplex merger and the Legacy combination, our
historical results are not indicative of future results.
Historical Consolidated Financial Data
(In Thousands, Except Per Share Amounts)
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------------------------
1998(3) 1997(4) 1996 1995 1994
--------- --------- -------- ------- -------
<S> <C> <C> <C> <C> <C>
Operating 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 $ 0.09 $ 0.34 $ (1.40)
Extraordinary loss per diluted share...... -- -- (.05) -- --
--------- --------- ------- ------- -------
Diluted earnings (loss) per share......... $ 3.92 $ 2.68 $ 0.04 $ 0.34 $ (1.40)
========= ========= ======= ======= =======
Cash dividends per share(1)............... N/A N/A $ 0.06 $ 0.09 $ 0.06
========= ========= ======= ======= =======
At December 31,
-------------------------------------------------------
1998(3) 1997(4) 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...................... 72,279 46,365 26,945 18,448 17,642
</TABLE>
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<PAGE>
(1) For any taxable year in which we qualified and elected to be treated as a
REIT under federal tax laws, we were not subject to federal income tax on
that part of our taxable income that was distributed to stockholders with
respect to that year. Regardless of such distributions, however, we may be
subject to tax on certain types of income. Due to the merger with Homeplex,
we did not qualify as a REIT in 1996, 1997, or 1998. Due to the use of our
net operating loss carryforward, we 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 on December 31, 1996.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
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 our subsidiaries for the years ended
December 31, 1998 and December 31, 1997. All material balances and transactions
between Meritage and our 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 our 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%)
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TEXAS(1)
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
- ----------
(1) Full year 1997 Texas information includes pre-combination results and is
for comparative purposes only.
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 1998 is also due to sales in the Texas
market, where we focus 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 complexes 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):
DOLLAR/
YEAR ENDED DECEMBER 31, PERCENTAGE PERCENTAGE
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.
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<PAGE>
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 our 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 our
acquisition of Sterling Communities, which included two 50% owned limited
partnership interests which Meritage controls. We have recorded the minority
interest partners' share of net income as an expense. The operations of the
limited partnerships 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 we
expect to have an effective tax rate approximating the statutory federal and
state tax rates.
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):
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<PAGE>
DOLLAR/
YEAR ENDED PERCENTAGE PERCENTAGE
DECEMBER 31, 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) --(2)
Average sales price..... $ 350.7 $ 338.0 $ 12.7 4%
TEXAS(1)
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
- ----------
(1) Full year 1997 Texas information includes pre-combination results and is
for comparative purposes only.
(2) Represents less than 1%.
We do not include sales contingent upon the sale of a customer's
existing home as a sales contract until the contingency is removed.
Historically, we have 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 our
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):
23
<PAGE>
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 --(1)
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%
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
- ----------
(1) 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
We 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 mortgage securities, which resulted in gains of approximately
$3.1 million.
24
<PAGE>
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 our NOL Carryforwards.
LIQUIDITY AND CAPITAL RESOURCES
Our principal uses of working capital are land purchases, lot
development and home construction. We use a combination of borrowings and funds
generated by operations to meet our working capital requirements.
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 we 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 our credit facilities at
that date. Borrowings under the credit facilities are subject to our inventory
collateral position and a number of other conditions, including minimum net
worth, debt to equity and debt coverage tests. We also have $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 our liquidity needs for the foreseeable future. There is no assurance,
however, that future amounts available from our sources of liquidity will be
sufficient to meet future capital needs. The amount and types of indebtedness
that we incur may be limited by the terms of the indenture governing our senior
subordinated notes and the credit agreements.
SEASONALITY
We have historically closed more units in the second half of our fiscal
year than in the first half, due in part to the slightly seasonal nature of the
market for our semi-custom luxury and move-up homes. Management expects this
seasonal trend to continue, though it may vary as operations continue to expand.
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MARKET RISK DISCLOSURE
We do not trade in derivative financial instruments and at December 31,
1998 we had no significant derivative financial instruments. We do have other
financial instruments in the form of notes payable and senior debt, which are at
fixed interest rates. Our lines of credit and credit facilities are at variable
interest rates and are subject to market risk in the form of interest rate
fluctuations.
BUSINESS OF MERITAGE
OUR HISTORY
We design, construct, and sell single family homes ranging from
entry-level to semi-custom luxury in three large and growing Sunbelt states:
Arizona, Texas, and California. We have recently undergone significant growth.
As of December 31, 1998, we were actively selling homes in 36 communities. We
pursue a strategy of diversifying our product mix and the geographic scope of
our operations.
We were originally formed as a REIT under the name of Homeplex Mortgage
Investments Corporation. Homeplex invested in mortgage-related assets and
selected real estate loans. On December 31, 1996, we acquired by merger the
homebuilding operations of various entities under the Monterey Homes name.
Following the merger, we focused on the business of homebuilding and changed our
name to Monterey Homes Corporation. On July 1, 1997, as part of our strategy to
further diversify operations, we combined with Legacy Homes, 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, we
acquired Sterling Communities, a homebuilder in northern California. In
September 1998, with shareholder approval, Meritage became our new corporate
name.
As a result of losses from our operations as a REIT through December
31, 1996, we had a NOL Carryforward of $53 million for federal income tax
purposes. At December 31, 1998, approximately $12.5 million of the NOL
Carryforward remained unused. Accordingly, we currently pay limited income
taxes.
BUSINESS STRATEGY
We seek to distinguish ourself from other production homebuilders and
to respond rapidly to changing market conditions through a business strategy
focusing on the following:
SUPERIOR DESIGN AND QUALITY
We believe that we maximize customer satisfaction by offering homes
that are built with quality materials and craftsmanship, exhibit distinctive
design features, and are situated in premium locations. We believe that we
generally offer higher caliber homes in their defined price range or category
than those built by our competitors.
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PRODUCT BREADTH
We offer new homes to a wide variety of consumers. In Arizona, our
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 our desire to increase our share of the overall housing market in the
Phoenix and Tucson metropolitan areas. In Texas, we target 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 our exposure to variable economic cycles.
HIGHEST LEVEL OF SERVICE
We are committed to achieving the highest level of customer
satisfaction as an integral part of our competitive strategy. During the sales
process, our experienced sales personnel keep customers informed of their home's
construction process. After delivery, our customer care departments deal with
any questions or warranty matters a customer may have.
CONSERVATIVE LAND ACQUISITION POLICY
We seek to maximize our return on capital by practicing a conservative
land acquisition policy that minimizes risks associated with land investment. We
generally purchase land subject to complete entitlement, including zoning and
utility services, with a focus on development sites where we expect to have less
than a three-year lot inventory. Lots are often controlled on a non-recourse,
rolling option basis where we have the right, but not the obligation, to buy
lots at predetermined prices based on a takedown schedule which reflects
anticipated home closings. To date, we have not speculated in raw land held for
investment.
PENETRATION OF NEW MARKETS
Depending on market conditions, we may explore expansion opportunities
in other parts of the country, targeting market niches in areas where we
perceive 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 our history, we have focused on controlling costs and
minimizing overhead, and consider this a key factor in maintaining
profitability. Our 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 our 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.
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DECENTRALIZED OPERATING STRUCTURE WITH EXPERIENCED DIVISION MANAGERS
We rely upon the expertise of divisional managers. Each of our
divisional managers has significant experience in their region's homebuilding
market. Interaction between our divisional managers and corporate management
provides enhanced operating results.
MARKETS AND PRODUCTS
We operate in the Phoenix and Tucson, Arizona markets using the
Monterey Homes brand name and recently announced the start of another division
in Phoenix which will focus on more affordably priced homes and operate under
the Meritage Homes name. In the Dallas/Fort Worth, Austin, and Houston, Texas
markets, we operate as Legacy Homes. In the San Francisco Bay and Sacramento,
California markets we operate as Meritage Homes of Northern California. We
believe that these areas represent attractive homebuilding markets with
opportunities for long-term growth. We also believe that our operations in
certain markets, such as Phoenix and Dallas/Fort Worth, are well established and
that we have 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. Below is a summary of activity by
market and product type (dollars in thousands):
<TABLE>
<CAPTION>
Number of Dollar
Homes Average Units In Value of Home Sites Number of
Closed Closing Backlog at Backlog At Remaining Active
In 1998 Price Year End Year End (1) Communities
------- ----- -------- -------- --- -----------
<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.
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LAND ACQUISITION AND DEVELOPMENT
We usually purchase land only after necessary entitlements have been
obtained so that development and 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,
we are still required to secure a variety of other governmental approvals and
permits during development. The process of obtaining such approvals and permits
can substantially delay the development process. For this reason, we may
consider purchasing unentitled property in the future when we can do so in a
manner consistent with our business strategy.
We select land for development based upon a variety of factors,
including:
* internal and external demographic and marketing studies;
* project suitability, which are generally developments with fewer than
150 lots;
* suitability for development 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.
We occasionally purchase larger properties consisting of 200 to 500
lots or more if the situation presents an attractive profit potential and
acceptable risk limitations.
We acquire land through purchases and rolling option contracts.
Purchases are financed through traditional bank financing or through working
capital. Rolling options allow us to control lots and land through a third party
who owns or buys the property on which we plan to build homes. We enter 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. We acquire a majority
of our land through rolling option contracts.
Once land is acquired, we generally begin development through
contractual agreements with subcontractors. These agreements include site
planning and engineering as well as constructing road, sewer, water, utilities,
drainage, recreation facilities and other refinements. We often builds homes in
master planned communities with home sites that are adjacent to or near a major
amenity, like a golf course.
We develop 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 the overall community design. The
product line offered in a particular project depends upon many factors,
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including the housing generally available in the area, the needs of a particular
market, and our lot costs for the project.
We occasionally use partnerships or joint ventures to purchase and
develop land where these arrangements are necessary to acquire the property or
appear to be otherwise economically feasible.
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
We are the general contractor for our projects and typically hire
subcontractors on a project-by-project or reasonable geographic proximity basis
to complete construction at a fixed price. We usually enter into agreements with
subcontractors and materials suppliers after receiving competitive bids on an
individual basis. Before formal bidding begins, we obtain information from
prospective subcontractors and suppliers in order to assess their financial
condition and ability to perform their agreements. We occasionally enter into
longer-term contracts with subcontractors and suppliers if our management can
obtain more favorable terms. Our project managers and field superintendents
coordinate and supervise
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the activities of subcontractors and suppliers, subject the work to quality and
cost controls, and assure compliance with zoning and building codes.
We specify that quality durable materials be used in the construction
of our homes. We do not maintain significant inventories of construction
materials with the exception of work in process materials for homes under
construction. When possible, our management negotiates price and volume
discounts with manufacturers and suppliers on behalf of subcontractors to take
advantage of our production volume. Usually, access to our principal
subcontracting trades, materials, and supplies is readily available in each of
our markets. Prices for these goods and services may fluctuate due to various
factors, including supply and demand shortages that may be beyond our or our
vendors' control. We believe that our relations with suppliers and
subcontractors are good.
We generally build and sell homes in clusters or phases within a
project. We believe this 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 the home's
size and complexity. Schedules may vary depending on the availability of labor,
materials, supplies, product type, location, and weather. We design our homes to
promote efficient use of space and materials and to minimize construction costs
and time.
We generally provide a one-year limited warranty on workmanship and
building material with each home. Subcontractors usually provide an indemnity
and a certificate of insurance prior to receiving payments for their work. Thus,
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 repairs.
MARKETING AND SALES
We believe that we have established a reputation for developing high
quality homes. This reputation helps generate interest in each new project. We
also use 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 our developments.
We use furnished model homes as a tool in demonstrating the competitive
advantages of our home designs and features to prospective homebuyers. We
generally employ or contract with interior designers responsible for creating an
attractive model home for each product line within a project. We generally build
between one and four model homes for each active community, depending upon the
number of homes to be built in the project and the products to be offered. We
occasionally sell our model homes and lease them back from buyers who purchased
the homes for investment purposes or who do not intend to move in immediately. A
summary of model homes owned or leased follows:
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MODEL MODEL HOMES
HOMES LEASED MONTHLY LEASE MODELS UNDER
OWNED BACK AMOUNT CONSTRUCTION
----- ---- ------ ------------
Arizona ............. 16 9 $23,000 7
Texas ............... 22 -- -- 7
California .......... 3 -- -- 3
--- --- ------- ---
Total ........ 41 9 $23,000 17
=== === ======= ===
Our homes are generally sold by full-time commissioned sales employees
who typically work from a sales office located in the model homes for each
project. Our goal is to ensure that the sales force has extensive knowledge of
our operating policies and housing products. To achieve this goal, sales
personnel are trained and attend periodic meetings to be updated on:
* sales techniques;
* competitive products in the area;
* financing availability;
* construction schedules;
* marketing and advertising plans;
* available product lines, and
* pricing, options, and warranties offered.
Sales personnel are licensed real estate agents where required by law.
Independent brokers also sell our homes and are usually paid a sales commission
on the base price of the home.
We 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.
BACKLOG
Most of our home sales are made under standard sales contracts signed
before construction of the home begins. The contracts require substantial cash
deposits and are usually subject to certain contingencies such as the buyer's
ability to qualify for financing. Homes covered by such sales contracts but not
yet closed are considered "backlog." We do not recognize revenue on homes in
backlog until sales are closed and ownership has been legally transferred to the
buyer. We sometimes build 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. We believe that we will deliver almost all homes in backlog as of
December 31, 1998 to customers during 1999.
CUSTOMER FINANCING
We attempt to help qualified homebuyers who require financing to obtain
loans from unaffiliated mortgage lenders that offer a variety of financing
options. We provide mortgage-banking services to our customers in our Dallas/Ft.
Worth markets through a related mortgage lending company, Texas Home Mortgage
Corporation, which originates loans on behalf of third party lenders. We may pay
a portion of the closing costs and discount mortgage points to assist homebuyers
with financing.
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Since many homebuyers utilize long-term mortgage financing to purchase a home,
adverse economic conditions, increases in unemployment, and high mortgage
interest rates may deter or reduce the number of potential homebuyers.
CUSTOMER RELATIONS AND QUALITY CONTROL
We believe that strong customer relations and an adherence to stringent
quality control standards are fundamental to our continued success. We believe
that our commitment to customer satisfaction and quality control have
significantly contributed to our reputation as a high quality builder.
A Meritage project manager or project superintendent, and a customer
relations representative generally oversee compliance with our 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 of their homes.
COMPETITION AND MARKET FACTORS
The development and sale of residential property is a highly
competitive industry. We compete for sales in each of our markets with national,
regional, and local developers and homebuilders, existing home resales, and to a
lesser extent, condominiums and 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. We believe that we compare favorably to
other homebuilders in the markets in which we operate due to our:
* experience within our geographic markets which allows us to
develop and offer new products;
* ability to 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 we
will be able to compete successfully against other homebuilders in our current
markets in a more competitive business environment resulting from a
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<PAGE>
slowdown in home sales or that such increased competition will not have a
material adverse affect on our business and operating results.
GOVERNMENT REGULATIONS AND ENVIRONMENTAL MATTERS
We purchase most of our land with entitlements, providing for zoning
and utility service to project sites and giving us the right to obtain building
permits. Construction may begin almost immediately upon compliance with
specified conditions, which generally are within our control. The time needed to
obtain such approvals and permits affects the carrying costs of the 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 our development activities, though there is no assurance that these
and other restrictions will not adversely affect future operations.
Because most of our land is entitled, construction moratoriums
generally would only adversely affect us 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
we receive recorded maps and building permits. As we expand, we 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.
We are also subject to a variety of local, state, and federal statutes,
ordinances, rules and regulations concerning the protection of health and the
environment. In some markets, we are subject to environmentally sensitive land
ordinances which mandate open space areas with public elements in housing
developments, and prevent development on hillsides, wetlands and other protected
areas. We must also comply with flood plain restrictions, desert wash 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 our operations, though no assurance is given that such a
material adverse effect will not occur in the future.
We usually will condition our obligation to purchase property on, among
other things, an environmental review of the land. However, there is no
assurance that we will not incur material liabilities relating to the removal of
toxic wastes or other environmental matters affecting land currently or
previously owned. To date, we have not incurred any unanticipated liabilities
relating to the removal of unknown toxic wastes or other environmental matters.
BONDS AND OTHER OBLIGATIONS
We obtain letters of credit and performance, maintenance, and other
bonds in support of our related obligations with respect to the development of
our projects. The amount of these obligations outstanding at any time varies in
accordance with pending development activities. In the event the bonds or
letters are drawn upon, we would be obligated to reimburse the issuer of the
bond or letter of credit. At December 31, 1998 there were approximately $2.1
million of outstanding letters of credit and
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<PAGE>
$8.9 million of performance bonds for such purposes. We do 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 with Homeplex, we acquired a number of mortgage
assets, consisting of mortgage interests (commonly known as "residuals") and
mortgage instruments. During 1998 and 1997, we 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, we 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 we believe that our employee
relations are good. We act solely as a general contractor and all construction
operations are conducted through project managers and field superintendents who
manage third party subcontractors. We use independent contractors for
construction, architectural and advertising services, and believe that our
relations with subcontractors and independent contractors are good.
NOL CARRYFORWARD
As of December 31, 1998, we had a federal income tax 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 our state net operating loss may be significantly limited) and
the federal alternative minimum tax. Although the NOL Carryforward provides us
with a significant financial benefit, there is a risk that failure to utilize
this tax limitation could have a material adverse affect on our operations and
the value of our securities.
The 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 tax laws has occurred or occurs with respect to Meritage
before the NOL Carryforward expires. We believe that:
* there was no "ownership change" of Meritage prior to the
effective date of the merger with Homeplex;
* the merger with Homeplex did not cause an "ownership change;" and
* the Legacy combination did not cause an "ownership change."
Amendments to our Articles of Incorporation, which became effective on
the effective date of the Homeplex merger, include restrictions on the transfer
of our common stock designed to prevent an "ownership change" after the merger.
Under Federal tax laws, we may not be permitted to use the NOL
Carryforward to offset taxable income resulting from sales of assets owned by
Monterey at the time of the merger (or to offset taxable income resulting from
the sale of certain assets acquired in the Legacy combination) to the extent
that the fair market value of such assets at the time of the merger (or at the
time of the Legacy combination)
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<PAGE>
exceeded their tax basis as of the relevant date. There is no assurance that we
will have sufficient earnings in the future to fully utilize the NOL
Carryforward.
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 Y2K issue. We could be impacted by failures
of our own business systems as well as those of our suppliers and business
partners. We are in the process of implementing our 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 our business systems that are not Y2K compliant. We have
converted to new versions of substantially all of our homebuilding database
systems, which has reduced the scope of the compliance program. We believe the
replacement or remediation of the remaining systems will be complete by June 1,
1999.
We have identified critical suppliers and business partners ("key
business partners") and are 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. We are not currently aware of any business relationships with
key business partners that we believe will likely result in a significant
disruption of our business. However, a Y2K failure could occur and have an
adverse impact on us. Management currently believes that Meritage's 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.
Concurrent with the remediation and evaluation of our business systems
and those of our key business partners, we are 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 measure are expected to be minimal.
The remediation and testing of our 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.
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Expenses through December 31, 1998 approximated $110,000. The financial impact
is not expected to be material to our 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.
FACILITIES
Meritage leases the following office space:
SQUARE ANNUAL
CITY FOOTAGE LEASE RATE TERM EXPIRATION
---- ------- ---------- ------- ----------
Plano, Texas(1) ............. 13,000 $171,300 5 years 5/15/02
Phoenix, Arizona(1) ......... 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
- ----------
(1) 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.
We lease 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.
LEGAL PROCEEDINGS
We are involved in various routine legal proceedings incidental to our
business. Management believes that none of these legal proceedings, certain of
which are covered by insurance, will have a material adverse impact on our
financial statements taken as a whole.
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DESCRIPTION OF CAPITAL STOCK
The following summary contains certain information about our capital
stock. This section describes material provisions of, but does not purport to be
complete and is subject to, and qualified in its entirety by, our Articles of
Incorporation and By-laws and by the provisions of applicable law.
COMMON STOCK
We are authorized to issue up to 50,000,000 shares of common stock,
$0.01 par value. As of April 26, 1999 there were 5,425,830 shares of common
stock outstanding, held of record by approximately 380 holders. Holders of our
common stock are entitled to one vote for each share held on all matters
submitted to a vote of stockholders and do not have cumulative voting rights.
Accordingly, holders of a majority of the shares of our common stock entitled to
vote in any election of directors may elect all of the directors standing for
election. Holders of common stock are entitled to receive ratably such
dividends, if any, as may be declared by the board of directors. Upon the
liquidation, dissolution or winding up of Meritage, the holders of common stock
of all debts and other liabilities and subject to the prior rights of any
outstanding preferred stock. Holders of our common stock have no preemptive
(other than as determined in the sole discretion of our board of directors),
subscription, redemption or conversion rights. The outstanding shares of our
common stock are, and the shares subject to warrants will be, when issued and
paid for, fully-paid and nonassessable. The rights, preferences, and privileges
of holders of common stock are subject to, and may be adversely affected by, the
rights of the holders of shares of any series of preferred stock which we may
issue in the future. We are not currently authorized to issue preferred stock
under our Articles of Incorporation.
Our Articles of Incorporation contain a provision allowing action to be
authorized by the affirmative vote of the holders of a majority of the total
number of shares of common stock outstanding and entitled to vote thereon
notwithstanding any provision of law requiring the authorization of the action
by a greater proportion than such a majority. This provision may allow
authorization of certain extraordinary transactions and amendment of our
Articles of Incorporation, including an amendment changing the terms or contract
rights of any of our outstanding common stock by classification,
reclassification, or otherwise, by the affirmative vote of the holders of a
majority of the shares of common stock outstanding. But for such provision,
under Maryland law, such extraordinary transactions and amendment of our
Articles of Incorporation, with certain limited exceptions, would require the
affirmative vote of the holders of two-thirds of the outstanding common stock
entitled to vote thereon. The common stock is also subject to significant
restrictions on transfer. See "-- Stock Transfer Restrictions" below and
"Business of Meritage -- NOL Carryforward."
WARRANTS
The warrants were issued in October 1994 and are governed by the
warrant agreement effective as of October 17, 1994 (the "warrant agreement")
between us and Norwest Bank Minnesota, N.A. (the "warrant agent"). Holders of
warrants are referred to the warrant agreement which is included as an exhibit
to the Registration Statement for a complete statement of the terms of the
warrants. The following summary does not purport to be complete and is qualified
in its entirety by reference to all of the provisions of the warrant agreement.
Capitalized terms used in this description of the warrants and not defined
herein have the meanings given to them in the warrant agreement.
38
<PAGE>
Each warrant entitles the holder to purchase one share of common stock
for $4.0634 per share (the "Purchase Price"), subject to adjustment as described
herein. Warrants currently entitle the holders thereof to acquire 92,924 shares
of common stock. The warrants became exercisable on the effective date of the
merger between Homeplex and Monterey and will continue to be exercisable through
October 15, 2001 except as provided in the following sentence. In the event that
notice is given in accordance with the warrant agreement in connection with the
liquidation, dissolution, or winding up of Meritage, the right to exercise the
warrants will expire at the close of business on the third full business day
before the date specified in such notice as the record date for determining
registered holders entitled to receive any distribution upon such liquidation,
dissolution, or winding up. We may not redeem the warrants.
On the effective date of the merger between Homeplex and Monterey, the
Monterey warrants were converted into the warrants, and Meritage assumed all of
the rights and obligations of Monterey under the warrant agreement.
The warrants may be exercised in whole or in part by surrendering at
the office of the warrant agent in Minneapolis, Minnesota, the warrant
certificate evidencing such warrants, together with a subscription in the form
set forth on the reverse of the warrant certificate, duly executed and
accompanied by payment of the Purchase Price, in U.S. dollars, by tender of
federal funds or a certified or bank cashier's check, payable to the order of
the warrant agent. As soon as practicable after such exercise, we will cause to
be issued and delivered to the holder or upon his order, in such name or names
as may be directed by him, a certificate or certificates for the number of full
shares of common stock to which he is entitled. If fewer than all of the
warrants evidenced by a warrant certificate are exercised, the warrant agent
will deliver to the exercising warrant holder a new warrant certificate
representing the unexercised portion of the warrant certificate. Fractional
shares will not be issued upon exercise of a warrant, and in lieu thereof, we
will pay to the holder an amount in cash equal to such fraction multiplied by
the Current Market Price Per Share, determined in accordance with the warrant
agreement.
The person in whose name the certificate is to be issued will be deemed
to have become the holder of record of the stock represented thereby on the date
when the warrant certificate with the subscription duly executed and completed
is surrendered and payment of the purchase Price is made, unless the stock
transfer books of ours are closed on such date, in which case, such person will
be deemed the record holder of the shares at the close of business on the next
succeeding date on which the stock transfer books are opened.
No service charge will be made for registration of transfer or exchange
of any warrant certificate. We may require payment of a sum sufficient to cover
any stamp or other tax or governmental charge that may be imposed in connection
with any registration of transfer or exchange of warrant certificates.
Subject to certain conditions and limitations, the number of shares of
common stock issuable upon the exercise of the warrants and/or the Purchase
Price are subject to adjustment in certain events including: (i) the issuance of
common stock (including in certain cases the issuance in a public offering of
any stock, securities, obligation, option, or other right or warrant that may be
converted into, exchanged for, or satisfied in shares of common stock) for
consideration per share less than the Purchase Price prior to such issue, (ii)
the declaration of a dividend on common stock payable in
39
<PAGE>
common stock or the subdivision, combination, or issuance of capital stock in
connection with a reclassification of common stock, (iii) any distribution of
Meritage's assets upon or with respect to its common stock as a liquidating or
partial liquidating dividend, and (iv) the issuance of stock, securities,
rights, options, or warrants to all holders of the common stock or in an
integrated transaction where more than 99% of such instruments or securities are
acquired by persons who, prior to the transaction, were Meritage security
holders, entitling them to subscribe for or purchase common stock or securities
convertible into common stock at a price per share less than the Current Market
Price Per Share on the record date for the issuance of such securities,
instruments, or rights or the granting of such securities, options, or warrants.
The Current Market Price Per Share of our common stock on any date is determined
in reference to (i) the average of the daily closing prices (or if no sale is
made on any trading date, the average of the closing bid and asked prices) for
the thirty consecutive trading days commencing thirty-five trading days before
such date, if our common stock is listed on an exchange, (ii) the average of the
last reported sale price or prices or the mean of the last reported bid and
asked prices reported by the NASDAQ, or if not so quoted on NASDAQ, as quoted on
the National Quotations Bureau, Inc., for the thirty consecutive trading days
commencing thirty-five days before such date, or (iii) if neither (i) or (ii) is
applicable, the fair market value of the common stock as determined in good
faith by our Board of Directors.
In the event that Meritage consolidates with, merges with or into, or
sells all or substantially all of its assets (for a consideration consisting
primarily of securities) to, another corporation, each warrant thereafter shall
entitle the holder to receive upon exercise, the number of shares of common
stock or other securities or property which the holder would have received had
the warrant been exercised immediately prior to the consolidation, merger, or
sale of assets.
In the event a bankruptcy or reorganization is commenced by or against
Meritage, a bankruptcy court may hold that unexercised warrants are executory
contracts which may be subject to rejection by Meritage with approval of the
bankruptcy court. As a result, holders of the warrants may not be entitled to
receive any consideration or may receive an amount less than they would be
entitled to if they had exercised their warrants prior to the commencement of
any such bankruptcy or reorganization.
The holders of unexercised warrants are not entitled, by virtue of
being holders, to exercise any rights as stockholders of Meritage.
Subject to certain requirements, from time to time Meritage and the
warrant agent, without the consent of the holders of the warrants, may amend or
supplement the warrant agreement for certain purposes, including curing
ambiguities, defects, inconsistencies, or manifest errors, provided that such
amendments and supplements are not prejudicial to the rights of the warrant
holders as indicated by the general intent of the original language.
MARYLAND LAW AND CERTAIN CHARTER PROVISIONS
We are incorporated in Maryland and are subject to the provisions of
the Maryland General Corporations Law (the "MGCL"), certain of which provisions
are discussed herein.
BUSINESS COMBINATIONS. The MGCL prohibits certain "business
combinations" (including, in certain circumstances and subject to certain
exceptions, a merger, consolidation, share exchange, asset transfer, issuance of
equity securities, or reclassification of securities) between a Maryland
corporation
40
<PAGE>
and an Interested Stockholder or any affiliate of an Interested Stockholder.
Subject to certain qualifications, an "Interested Stockholder" is a person (a)
who beneficially owns 10% or more of the voting power of the corporation's
shares after the date on which the corporation had 100 or more beneficial owners
of its stock, or (b) is an affiliate or associate of the corporation and was the
beneficial owner of 10% or more of the voting power of the corporation's shares,
at any time within the two-year period immediately prior to the date in question
and after the date on which the corporation had 100 or more beneficial owners of
its stock. Unless an exemption applies, such business combinations are
prohibited for five years after the most recent date on which the Interested
Stockholder became an Interested Stockholder. Unless an exemption applies, any
business combination that is not so prohibited must be recommended by the board
of directors and approved by the affirmative vote of at least (a) 80% of the
votes entitled to be cast by outstanding voting shares of the corporation, and
(b) 66 2/3% of the votes entitled to be cast by the holders of voting shares of
the corporation, other than voting shares held by the Interested Stockholder, or
an affiliate or associate of the Interested Stockholder, with whom the business
combination is to be effected. The MGCL specifies a number of situations in
which the business combination restrictions described above would not apply. For
example, such restrictions would not apply to a business combination with a
particular Interested Shareholder that is approved or exempted by the board of
directors of a corporation prior to the time that the Interested Stockholder
becomes an Interested Stockholder. A Maryland corporation also may adopt an
amendment to its charter electing not to be subject to the special voting
requirements of the foregoing legislation. Any such amendment would have to be
approved by the affirmative vote of the same percentages and groups of the
outstanding shares of voting stock of the corporation as described above for
approval of a business combination. No such amendment to our charter has been
effected.
CONTROL SHARE ACQUISITIONS. The MGCL provides that "control shares" of
a Maryland corporation acquired in a "control share acquisition" have no voting
rights except to the extent approved by a vote of two-thirds of the votes
entitled to be cast on the matter, excluding shares of stock owned by the
acquiror or by officers or directors who are employees of the corporation.
"Control shares" are voting shares of stock which, if aggregated with all other
shares of stock previously acquired by such a person or which that person is
entitled to vote (other than by revocable proxy), would entitle the acquiror to
exercise voting power in electing directors within one of the following ranges
of voting power: (a) 20% or more but less than 331/3%; (b) 331/3% or more but
less than a majority; or (c) a majority of all voting power. Control shares do
not include shares of stock an acquiring person is entitled to vote as a result
of having previously obtained stockholder approval. A control share acquisition
means, subject to certain exceptions, the acquisition of, ownership of, or the
power to direct the exercise of voting power with respect to, control shares.
A person who has made or proposed to make a "control share
acquisition," upon satisfaction of certain conditions (including an undertaking
to pay expenses), may compel the Board of Directors to call a special meeting of
stockholders to be held within 50 days of demand therefor to consider the voting
rights of the shares. If no request for a meeting is made, the corporation may
itself present the question at any stockholders' meeting.
If voting rights are not approved at the meeting or if the acquiring
person does not deliver an acquiring person statement as permitted by the
statute, then, subject to certain conditions and limitations, the corporation
may redeem any or all of the control shares (except those for which voting
rights have previously been approved) for fair value determined, without regard
to voting rights, as of the date of the last acquisition of control shares by
the acquiring person in a control share acquisition or
41
<PAGE>
if any meeting of stockholders was held at which the rights of such shares were
considered, as of the date of such meeting. If voting rights for "control
shares" are approved at a stockholders' meeting and the acquiror becomes
entitled to vote a majority of the shares entitled to vote, all other
stockholders may exercise appraisal rights. The fair value of the stock as
determined for purposes of such appraisal rights may not be less than the
highest price per share paid by the acquiring person in the control share
acquisition, and certain limitations and restrictions otherwise applicable to
the exercise of dissenters' rights do not apply in the context of a "control
share acquisition."
The control share acquisition statute does not apply to stock acquired
in a merger, consolidation or stock exchange if the corporation is a party to
the transaction, or to acquisitions previously approved or excepted by a
provision in the charter or bylaws of the corporation. Neither our charter nor
our Bylaws have provisions exempting any control share acquisitions.
STOCK TRANSFER RESTRICTIONS
In connection with the merger with Homeplex, our Articles of
Incorporation were amended to, among other things, (i) change the name of
Homeplex to "Monterey Homes Corporation," (ii) reclassify and change each share
of Homeplex common stock issued and outstanding into one-third of a share of
Meritage common stock, (iii) amend and make the limitations on the transfer of
common stock more restrictive to preserve maximum use of our NOL Carryforward
(see " Business of Meritage--NOL Carryforward"), and (iv) provide for Class I
and Class II Directors.
Our Articles of Incorporation generally prohibit concentrated ownership
of Meritage which might jeopardize its NOL Carryforward. The amended transfer
restrictions generally preclude for a period of up to five years any person from
transferring shares of our common stock (or any other subsequently issued voting
or participating stock) or rights to acquire our common stock, if the effect of
the transfer would be to:
* make any person or group an owner of 4.9% or more of the
outstanding shares of such stock (by value);
* increase the ownership position of any person or group that
already owns 4.9% or more of the outstanding shares of such stock
(by value); or
* cause any person or group to be treated like the owner of 4.9% or
more of the outstanding shares of such 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.
These transfer restrictions will not apply to:
* the exercise of any stock option issued by Meritage that was
outstanding on the effective date of and immediately following
the Homeplex merger;
* exercise of the stock options issued to Alan D. Hamberlin by
Homeplex;
* issuance of the Contingent Stock; or
* exercise of the Employment Options.
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<PAGE>
Our Board of Directors has the authority to waive the transfer
restrictions under certain conditions. The Board of Directors may also
accelerate or extend the period of time during which such 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 also has the power to make other necessary or
appropriate legal changes to preserve our tax benefits. The transfer
restrictions discussed above will apply to the transfer and exercise of our
warrants. Ownership of our warrants will be aggregated with shares of our common
stock otherwise owned by a holder to determine if the applicable ownership
percentage has been exceeded. These transfer restrictions may impede a change of
control of Meritage.
In connection with the Legacy combination, William W. Cleverly, Steven
J. Hilton, John R. Landon and Eleanor Landon entered into a letter agreement,
dated June 24, 1997, under which each of the parties agreed that he or she will
not directly or indirectly acquire or dispose of beneficial ownership of any
shares of voting securities of Meritage or rights to acquire voting securities
which would adversely affect the use of our NOL Carryforward. Subject to the
notice provision described below, each party further agreed that for a period of
five years following the effective date of the Legacy combination, he or she
will not purchase voting securities which would cause his or her beneficial
ownership of voting securities to exceed the greatest number of shares
beneficially owned by any other party to the letter agreement. The party
desiring to purchase voting securities agreed to provide the other parties to
the letter agreement at least seven days written notice of his or her intent to
purchase voting securities. Each other party would then be permitted to purchase
the same number of voting securities.
In connection with the letter agreement, the employment option
agreements of William W. Cleverly, Steven J. Hilton and John R. Landon were also
amended. The amended employment options provide for the deferment of the
exercise of the option to acquire 15,000 shares of our common stock, otherwise
exercisable on December 31, 1997, to January 30, 2000 for Messrs. Cleverly and
Hilton, and with respect to Mr. Landon, options to acquire 15,000 shares of our
common stock, otherwise exercisable on July 1, 1998, to July 31, 2000.
LIMITATION OF LIABILITY AND INDEMNIFICATION OF DIRECTORS. Under the
MGCL, a corporation's articles may, with certain exceptions, include any
provision expanding or limiting the liability of its directors and officers to
the corporation or its stockholders for money damages, but may not include any
provision that restricts or limits the liability of its directors or officers to
the corporation or its stockholders to the extent that (i) it is proved that the
person actually received an improper benefit or profit in money, property, or
services for the amount of the benefit or profit in money, property, or services
actually received; or (ii) a judgment or other final adjudication adverse to the
person is entered in a proceeding based on a finding in the proceeding that the
person's action, or failure to act, was the result of active and deliberate
dishonesty and was material to the cause of action adjudicated in the
proceeding. Our charter contains a provision limiting the personal liability of
officers and directors to Meritage and its stockholders for money damages to the
fullest extent permitted under Maryland law.
In addition, with certain exceptions, the MGCL permits a corporation to
indemnify its present and former directors and officers, among others, against
liability incurred, unless it is established that (i) the act or omission of the
director or officer was material to the matter giving rise to the proceeding and
was committed in bad faith or was the result of active and deliberate
dishonesty, or (ii) the director or officer actually received an improper
personal benefit in money, property, or services, or (iii) in the case
43
<PAGE>
of any criminal proceeding, the director or officer had reasonable cause to
believe that the act or omission was unlawful. Our charter provides that it will
indemnify (i) its directors to the full extent allowed under Maryland law, (ii)
its officers to the same extent it shall indemnify its directors, and (iii) its
officers who are not directors to such further extent as shall be authorized by
the board of directors and be consistent with law.
TRANSFER AGENT AND REGISTRAR; WARRANT AGENT
The transfer agent and registrar for Meritage's common stock is
ChaseMellon Shareholder Services, 400 Hope Street, 4th Floor, Los Angeles,
California 90071. The warrant agent is Norwest Bank Minnesota, N.A., and its
address is Norwest Center, Sixth and Marquette, Minneapolis, Minnesota
55479-0069.
PRICE OF COMMON STOCK AND DIVIDEND POLICY
PRICE OF COMMON STOCK
Our common stock is publicly traded on the NYSE under the ticker symbol
"MTH." The following table presents the high and low closing sales prices,
adjusted for stock splits, of the common stock, as reported by the NYSE.
HIGH LOW
---- ---
1999
First Quarter $15 11/16 $11
1998
Fourth Quarter 14 11/16 9 11/16
Third Quarter 19 3/4 12 1/16
Second Quarter 19 1/4 15 5/8
First Quarter 19 15/16 12 7/16
1997
Fourth Quarter 14 3/4 11 3/16
Third Quarter 14 3/4 8 1/2
Second Quarter 8 3/4 4 3/8
First Quarter 7 1/4 5 1/2
1996
Fourth Quarter 7 7/8 6 3/4
Third Quarter 8 1/4 6
Second Quarter 8 5/8 4 7/8
First Quarter 6 4 1/8
On April 26, 1999, the closing sales price of our common stock as
reported by the NYSE was $12.675 per share. At that date, there were
approximately 380 stockholder accounts of our common stock. We believe that
there are approximately 2,800 beneficial owners of our common stock.
44
<PAGE>
DIVIDEND POLICY
We did not pay any cash dividends in 1997 or 1998, nor do we intend to
do so in the foreseeable future. We paid cash dividends per share of $.06 in
1996, $.09 in 1995, and $.06 in 1994, representing distributions of taxable
income arising out of our former status as a REIT. Our loan and debt agreements
contain certain covenants that restrict the payment of dividends if the
financial condition, results of our operation, and capital requirements fail to
meet certain specified levels. Earnings will be retained to finance the growth
of our business. The future payment of cash dividends, if any, will depend upon
our financial condition, results of our operations, and capital requirements, as
well as other factors deemed relevant by the Board.
LEGAL MATTERS
The validity of the issuance of the shares has been passed on for
Meritage by Hughes & Luce, L.L.P., Dallas, Texas.
EXPERTS
The consolidated financial statements of Meritage as of December 31,
1998 and 1997 and for each of the years in the three-year period ended December
31, 1998, have been included herein and in the prospectus and in the
registration statement in reliance upon the report of KPMG LLP, independent
certified public accountants, appearing elsewhere herein, and upon the authority
of said firm as experts in accounting and auditing.
45
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
MERITAGE CORPORATION
Report of Independent Auditors.......................................... F-2
Consolidated Balance Sheets............................................. F-3
Consolidated Statements of Earnings..................................... F-4
Consolidated Statements of Stockholders' Equity......................... F-5
Consolidated Statement of Cash Flows.................................... F-6
Notes to Consolidated Financial Statements.............................. F-7
F-1
<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
F-1
<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
F-2
<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
F-3
<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
F-4
<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 .............................. 1,545,201 2,974,442 317,094
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
F-5
<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.
F-6
<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.
F-7
<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
======= =======
F-8
<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.
F-9
<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.
F-10
<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.
F-11
<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>
F-12
<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.
F-13
<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
====== ==== ===
F-14
<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.
F-15
<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
======== ======== =======
F-16
<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
======== ======== =======
F-17
