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Meritage Homes CORP - Quarter Report: 2013 September (Form 10-Q)

Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 ____________________________________________________________
FORM 10-Q
 ____________________________________________________________
(Mark one)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2013
Or 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission File Number 1-9977
 ____________________________________________________________
MERITAGE HOMES CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
 ____________________________________________________________
Maryland
 
86-0611231
(State or Other Jurisdiction of
 
(I.R.S. Employer
Incorporation or Organization)
 
Identification No.)
 
 
 
17851 North 85th Street, Suite 300
 
 
Scottsdale, Arizona
 
85255
(Address of Principal Executive Offices)
 
(Zip Code)
(480) 515-8100
(Registrant’s Telephone Number, Including Area Code)
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)
 ___________________________________________________________
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  o
Indicate by a checkmark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer
x
Accelerated filer
o
Non-accelerated filer
o  (Do not check if a smaller reporting company)
Smaller reporting company
o
Indicate by a checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x
Common shares outstanding as of October 31, 2013: 36,241,671

Table of Contents

MERITAGE HOMES CORPORATION
FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2013
TABLE OF CONTENTS
 
 
 
 
Items 3-5. Not Applicable
 

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Table of Contents

PART I — FINANCIAL INFORMATION
 
Item 1.
Financial Statements
MERITAGE HOMES CORPORATION AND SUBSIDIARIES
UNAUDITED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
 
 
September 30,
2013
 
December 31,
2012
Assets:
 
 
 
Cash and cash equivalents
$
177,584

 
$
170,457

Investments and securities
92,846

 
86,074

Restricted cash
40,904

 
38,938

Other receivables
35,711

 
20,290

Real estate
1,345,214

 
1,113,187

Real estate not owned
481

 
—

Deposits on real estate under option or contract
34,911

 
14,351

Investments in unconsolidated entities
10,662

 
12,085

Property and equipment, net
18,690

 
15,718

Deferred tax asset
80,390

 
77,974

Prepaids, other assets and goodwill
36,693

 
26,488

Total assets
$
1,874,086

 
$
1,575,562

Liabilities:
 
 
 
Accounts payable
$
76,647

 
$
49,801

Accrued liabilities
178,247

 
96,377

Home sale deposits
28,183

 
12,377

Liabilities related to real estate not owned
346

 
—

Senior, senior subordinated, convertible senior notes and other borrowings
798,337

 
722,797

Total liabilities
1,081,760

 
881,352

Stockholders’ Equity:
 
 
 
Preferred stock, par value $0.01. Authorized 10,000,000 shares; none issued and outstanding at September 30, 2013 and December 31, 2012
—

 
—

Common stock, par value $0.01. Authorized 125,000,000 shares; issued 36,231,201 and 35,613,351 shares at September 30, 2013 and December 31, 2012, respectively
362

 
356

Additional paid-in capital
409,984

 
390,249

Retained earnings
381,980

 
303,605

Total stockholders’ equity
792,326

 
694,210

Total liabilities and stockholders’ equity
$
1,874,086

 
$
1,575,562

See accompanying notes to unaudited consolidated financial statements

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MERITAGE HOMES CORPORATION AND SUBSIDIARIES
UNAUDITED CONSOLIDATED INCOME STATEMENTS
(in thousands, except per share amounts)
 

 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2013
 
2012
 
2013
 
2012
Homebuilding:
 
 
 
 
 
 
 
 
Home closing revenue
$
483,147

 
$
334,880

 
$
1,249,897

 
$
820,242

 
Land closing revenue
8,933

 
7,763

 
28,568

 
8,846

 
Total closing revenue
492,080

 
342,643

 
1,278,465

 
829,088

 
Cost of home closings
(372,772
)
 
(272,726
)
 
(981,557
)
 
(671,029
)
 
Cost of land closings
(6,126
)
 
(7,493
)
 
(24,139
)
 
(8,833
)
 
Total cost of closings
(378,898
)
 
(280,219
)
 
(1,005,696
)
 
(679,862
)
 
Home closing gross profit
110,375

 
62,154

 
268,340

 
149,213

 
Land closing gross profit
2,807

 
270

 
4,429

 
13

 
Total closing gross profit
113,182

 
62,424

 
272,769

 
149,226

Financial Services:
 
 
 
 
 
 
 
 
Revenue
1,684

 
253

 
3,960

 
253

 
Expense
(901
)
 
(317
)
 
(2,229
)
 
(484
)
 
Earnings from financial services unconsolidated entities and other, net
3,511

 
3,049

 
9,784

 
6,974

 
Financial services profit
4,294

 
2,985

 
11,515

 
6,743

Commissions and other sales costs
(33,467
)
 
(25,855
)
 
(90,526
)
 
(67,950
)
General and administrative expenses
(24,412
)
 
(19,209
)
 
(66,587
)
 
(50,446
)
Earnings/(loss) from other unconsolidated entities, net
46

 
(74
)
 
(229
)
 
(348
)
Interest expense
(3,462
)
 
(5,009
)
 
(13,113
)
 
(18,718
)
Other income, net
605

 
(8,276
)
 
1,760

 
(7,481
)
Loss on early extinguishment of debt
—

 
—

 
(3,796
)
 
(5,772
)
Earnings before income taxes
56,786

 
6,986

 
111,793

 
5,254

(Provision for)/benefit from income taxes
(18,595
)
 
(202
)
 
(33,418
)
 
4,781

Net earnings
$
38,191

 
$
6,784

 
$
78,375

 
$
10,035

Earnings per common share:
 
 
 
 
 
 
 
 
Basic
$
1.05

 
$
0.19

 
$
2.17

 
$
0.30

 
Diluted
$
0.99

 
$
0.19

 
$
2.05

 
$
0.30

Weighted average number of shares:
 
 
 
 
 
 
 
 
Basic
36,226

 
35,216

 
36,060

 
33,541

 
Diluted
38,865

 
35,761

 
38,771

 
34,010




See accompanying notes to unaudited consolidated financial statements

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MERITAGE HOMES CORPORATION AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
 

 
Nine Months Ended September 30
 
2013
 
2012
Cash flows from operating activities:
 
 
 
Net earnings
$
78,375

 
$
10,035

Adjustments to reconcile net earnings to net cash used in operating activities:
 
 
 
Depreciation and amortization
7,169

 
5,913

Stock-based compensation
7,040

 
6,095

Loss on early extinguishment of debt
3,796

 
5,772

Equity in earnings from unconsolidated entities
(9,555
)
 
(6,626
)
Deferred tax asset valuation benefit
(4,614
)
 
(7,709
)
Distributions of earnings from unconsolidated entities
10,796

 
6,118

Other
1,338

 
1,976

Changes in assets and liabilities:
 
 
 
Increase in real estate
(221,668
)
 
(190,509
)
(Increase)/decrease in deposits on real estate under option or contract
(20,425
)
 
2,192

Increase in receivables and prepaid expenses and other assets
(14,224
)
 
(1,882
)
Increase in accounts payable and accrued liabilities
106,862

 
31,204

Increase in home sale deposits
15,584

 
5,169

Net cash used in operating activities
(39,526
)
 
(132,252
)
Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(9,717
)
 
(7,139
)
Maturities of investments and securities
132,900

 
190,701

Payments to purchase investments and securities
(139,672
)
 
(109,798
)
Cash paid for acquisitions
(18,379
)
 
—

Other
(1,955
)
 
(3,020
)
Net cash (used in)/provided by investing activities
(36,823
)
 
70,744

Cash flows from financing activities:
 
 
 
Repayment of senior subordinated notes
(102,822
)
 
(315,080
)
Proceeds from issuance of senior notes
175,000

 
426,500

Proceeds from issuance of common stock, net
—

 
87,125

Other
11,298

 
(5,600
)
Net cash provided by financing activities
83,476

 
192,945

Net increase in cash and cash equivalents
7,127

 
131,437

Cash and cash equivalents at beginning of period
170,457

 
173,612

Cash and cash equivalents at end of period
$
177,584

 
$
305,049

See supplemental disclosures of cash flow information at Note 11.
See accompanying notes to unaudited consolidated financial statements

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MERITAGE HOMES CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 — ORGANIZATION AND BASIS OF PRESENTATION
Organization. Meritage Homes is a leading designer and builder of single-family detached homes. We primarily build in the historically high-growth regions of the western and southern United States and offer a variety of homes that are designed to appeal to a wide range of homebuyers, including first-time, move-up, active adult and luxury. We have homebuilding operations in three regions: West, Central and East, which are comprised of seven states: Arizona, Texas, California, Colorado, Florida, the Carolinas and Tennessee. Operations within the Carolinas include the Raleigh and Charlotte metropolitan areas, with some Charlotte communities located across the border into South Carolina. In August 2013, we entered the Nashville, Tennessee market through the acquisition of the assets and operations of Phillips Builders LLC and selected assets of Phillips Development LLC ("Phillips Builders"). With this acquisition, we acquired approximately 500 lots, contributing 30 units in backlog as of September 30, 2013. Through our predecessors, we commenced our homebuilding operations in 1985. In 2012, we commenced limited operations of our wholly-owned title company, Carefree Title Agency, Inc. ("Carefree Title"). Carefree Title's core business consists of title insurance and closing/settlement services we offer to our homebuyers and we expect to be fully operational in applicable markets by the end of 2013. Meritage Homes Corporation was incorporated in 1988 in the state of Maryland.
Our homebuilding and marketing activities are conducted under the name of Meritage Homes in each of our homebuilding markets other than in Tennessee, where we operate under the Phillips Builders brand name. We also operate as Monterey Homes in some markets in Arizona and Texas. At September 30, 2013, we were actively selling homes in 179 communities, with base prices ranging from approximately $130,000 to $994,000.
Basis of Presentation. The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. These financial statements should be read in conjunction with the consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2012. The consolidated financial statements include the accounts of Meritage Homes Corporation and those of our consolidated subsidiaries, partnerships and other entities in which we have a controlling financial interest, and of variable interest entities (see Note 3) in which we are deemed the primary beneficiary (collectively, “us”, “we”, “our” and “the Company”). Intercompany balances and transactions have been eliminated in consolidation. In the opinion of management, the accompanying financial statements include all adjustments (consisting only of normal recurring entries), necessary for the fair presentation of our results for the interim periods presented. Results for interim periods are not necessarily indicative of results to be expected for the full year. Certain reclassifications have been made to the prior year income statements and footnotes to conform to the current year presentation.
Cash and Cash Equivalents. Liquid investments with an initial maturity of three months or less are classified as cash equivalents. Amounts in transit from title companies for home closings of approximately $43.2 million and $30.4 million are included in cash and cash equivalents at September 30, 2013 and December 31, 2012, respectively. Included in our cash and cash equivalents balance as of September 30, 2013 and December 31, 2012 are $20.3 million and $0.3 million, respectively, of money market funds that are invested in short term (three months or less) U.S. government securities.
Restricted Cash. Restricted cash consists of amounts held in restricted accounts as collateral for our letter of credit arrangements. The aggregate capacity of these secured letter of credit arrangements was $60.0 million at September 30, 2013. Our restricted cash accounts invest in money market accounts and U.S. government securities and totaled $40.9 million and $38.9 million at September 30, 2013 and December 31, 2012, respectively.
Investments and Securities. Our investments and securities are comprised of both treasury securities and deposits with banks that are FDIC-insured and secured by U.S. government treasury-backed investments, and therefore we believe bear a limited risk of loss. All of our investments are classified as held-to-maturity and are recorded at amortized cost as we have both the ability and intent to hold them until their respective maturities. The contractual lives of these investments are greater than three months but do not exceed 18 months. Due to their short duration and low contractual interest rates, the amortized cost of the investments approximates fair value with no unrecognized gains and losses or other-than-temporary impairments.
Real Estate. Real estate is stated at cost unless the asset is determined to be impaired, at which point the inventory is written down to fair value as required by Accounting Standards Codification (“ASC”) Subtopic 360-10, Property, Plant and Equipment (“ASC 360-10”). Inventory includes the costs of land acquisition, land development, home construction, capitalized interest, real estate taxes, capitalized direct overhead costs incurred during development and home construction that benefit the entire community, less impairments, if any. Land and development costs are typically allocated and transferred to homes under

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construction when construction begins. Home construction costs are accumulated on a per-home basis, while most selling costs are expensed as incurred. Cost of home closings includes the specific construction costs of the home and all related allocated land acquisition, land development and other common costs (both incurred and estimated to be incurred) that are allocated based upon the total number of homes expected to be closed in each community or phase. Any changes to the estimated total development costs of a community or phase are allocated to the remaining homes in the community or phase. When a home closes, we may have incurred costs for goods and services that have not yet been paid. Therefore, we record an accrued liability to capture such obligations in connection with the home closing and charged directly to cost of sales.
We rely on certain estimates to determine our construction and land development costs. Construction and land costs are comprised of direct and allocated costs, including estimated future costs. In determining these costs, we compile project budgets that are based on a variety of assumptions, including future construction schedules and costs to be incurred. It is possible that actual results could differ from budgeted amounts for various reasons, including construction delays, labor or material shortages, increases in costs that have not yet been committed, changes in governmental requirements, or other unanticipated issues encountered during construction and development and other factors beyond our control. To address uncertainty in these budgets, we assess, update and revise project budgets on a regular basis, utilizing the most current information available to estimate construction and land costs.
Typically, a community’s life cycle ranges from three to five years, commencing with the acquisition of the land, continuing through the land development phase, if applicable, and concluding with the sale, construction and closing of the homes. Actual community lives will vary based on the size of the community, the sales absorption rate and whether the land purchased was raw, partially-developed or in finished status. Master-planned communities encompassing several phases and super-block land parcels may have significantly longer lives and projects involving smaller finished lot purchases may be shorter.
All of our land inventory and related real estate assets are reviewed for recoverability, as our inventory is considered “long-lived” in accordance with GAAP. Impairment charges are recorded to write down an asset to its estimated fair value if the undiscounted cash flows expected to be generated by the asset are lower than its carrying amount. Our determination of fair value is based on projections and estimates. Changes in these expectations may lead to a change in the outcome of our impairment analysis, and actual results may also differ from our assumptions. Our analysis is completed on a quarterly basis with each community or land parcel evaluated individually. For those assets deemed to be impaired, the impairment recognized is measured as the amount by which the assets’ carrying amount exceeds their fair value. The impairment of a community is allocated to each lot on a straight-line basis.
Existing and continuing communities. When projections for the remaining income expected to be earned from existing communities are no longer positive, the underlying real estate assets are not deemed fully recoverable, and further analysis is performed to determine the required impairment. The fair value of the community’s assets is determined using either a discounted cash flow model for projects we intend to build out or a market-based approach for projects to be sold. Impairments are charged to cost of home closings in the period during which it is determined that the fair value is less than the assets’ carrying amount. If a market-based approach is used, we determine fair value based on recent comparable purchase and sale activity in the local market, adjusted for variances as determined by our knowledge of the region and general real estate expertise. If a discounted cash flow approach is used, we compute fair value based on a proprietary model. Our key estimates in deriving fair value under our cash flow model are (i) home selling prices in the community adjusted for current and expected sales discounts and incentives, (ii) costs related to the community — both land development and home construction — including costs spent to date and budgeted remaining costs to spend, (iii) projected sales absorption rates, reflecting any product mix change strategies and expected cancellation rates, (iv) alternative land uses including disposition of all or a portion of the land owned and (v) our discount rate, which is currently 14-16% and varies based on the perceived risk inherent in the community’s other cash flow assumptions. These assumptions vary widely across different communities and geographies and are largely dependent on local market conditions. Community-level factors that may impact our key estimates include:
•
The presence and significance of local competitors, including their offered product type and pricing, comparable lot size, and competitive actions;
•
Economic and related demographic conditions for the population of the surrounding community;
•
Desirability of the particular community, including unique amenities or other favorable or unfavorable attributes; and
•
Existing home inventory supplies, including foreclosures and short sales.
These local circumstances may significantly impact our assumptions and the resulting computation of fair value and are, therefore, closely evaluated by our division personnel in their generation of the discounted cash flow models. The models are also evaluated by regional and corporate personnel for consistency and integration, as decisions that affect pricing or absorption at one community may have resulting consequences for neighboring or nearby communities. We typically do not

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project market improvements in our discounted cash flow models, but may do so in limited circumstances in the latter years of a long-lived community.
Mothball communities. In certain cases, we may elect to stop development of an existing community (mothball) if we believe the economic performance of the community would be maximized by deferring development for a period of time to allow market conditions to improve. When a community is initially placed into mothball status, it is management's belief that the community is affected by local market conditions that are expected to improve within the next 1-5 years. Therefore, a temporary postponement of construction and development work is expected to yield better overall future returns. The decision may be based on financial and/or operational metrics. If we decide to mothball a community, we will, if necessary, impair it to its fair value as discussed above and then cease future development activity until such time as management believes that market conditions have improved and economic performance will be maximized. No costs are capitalized related to communities that are designated as mothballed.

In addition to our quarterly impairment analysis, which is conducted to determine if any current impairments exist, we also conduct a thorough quarterly review of our underperforming and mothballed communities to determine if they are at risk of future impairment. The financial and operational status and expectations of these communities are analyzed as well as any unique attributes that could be viewed as indicators for future impairments. Adjustments are made accordingly and incremental impairments, if any, are recorded at each re-evaluation. Based on the facts and circumstances available as of September 30, 2013, we do not believe that any of our underperforming or mothballed communities will incur material impairments in the future. Changes in market and/or economic conditions could materially impact the conclusions of this analysis, and there can be no assurances that future impairments will not occur.
Inventory assessments on inactive assets. For our mothballed communities as well as our land held for future development, our inventory assessments typically include highly subjective estimates for future performance, including the timing of development, the product to be offered, sales rates and selling prices of the product when the community is anticipated to open for sales, and the projected costs to develop and construct the community. We evaluate various factors to develop our forecasts, including the availability of and demand for homes and finished lots within the marketplace, historical, current and future sales trends, and third-party data, if available. Based on these factors, we reach conclusions for future performance based on our judgment.
Deposits. Deposits paid related to purchase contracts and land options are recorded and classified as Deposits on real estate under contract or option until the related land is purchased. Deposits are reclassified as a component of real estate inventory at the time the deposit is used to offset the acquisition price of the lots based on the terms of the underlying agreements. To the extent they are non-refundable, deposits are charged to expense if the land acquisition is terminated or no longer considered probable. Since the acquisition contracts typically do not require specific performance, we do not consider such contracts to be contractual obligations to purchase the land and our total exposure under such contracts is limited to the loss of the non-refundable deposits and any ancillary capitalized costs. The review of the likelihood of the acquisition of contracted lots is completed quarterly in conjunction with the real estate impairment analysis noted above and therefore, if impaired, the deposits are recorded at the lower of cost or fair value. Our deposits were $34.9 million and $14.4 million as of September 30, 2013 and December 31, 2012, respectively.
Off-Balance Sheet Arrangements —Joint Ventures. In the past, we have participated in land development joint ventures as a means of accessing larger parcels of land, expanding our market opportunities, managing our risk profile and leveraging our capital base; however, in recent years, such ventures have not been a significant avenue for us to access lots. See Note 4 for additional discussion of our investments in unconsolidated entities.
Off-Balance Sheet Arrangements — Other. We may acquire lots from various development and land bank entities pursuant to purchase and option agreements. The purchase price generally approximates the market price at the date the contract is executed (with possible future escalators). See Note 3 for further discussion.
We may provide letters of credit in support of our obligations relating to the development of our projects and other corporate purposes. We may also utilize surety bonds to guarantee our performance of certain development and construction activities. Surety bonds are generally posted in lieu of letters of credit or cash deposits. The amount of these obligations outstanding at any time varies depending on the stage and level of our development activities. Bonds are generally not released until all development activities under the bond are complete. In the event a bond or letter of credit is drawn upon, we would be obligated to reimburse the issuer for any amounts advanced under the bond. We believe it is unlikely that any significant amounts of these bonds or letters of credit will be drawn upon. The table below outlines our surety bond and letter of credit obligations (in thousands):
 

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At September 30, 2013
 
At December 31, 2012
 
Outstanding
 
Estimated work
remaining to
complete
 
Outstanding
 
Estimated work
remaining to
complete
Surety Bonds:
 
 
 
 
 
 
 
Surety bonds related to joint ventures
$
87

 
$
87

 
$
87

 
$
87

Surety bonds related to owned projects and lots under contract
165,852

 
85,828

 
87,305

 
38,936

Total surety bonds
$
165,939

 
$
85,915

 
$
87,392

 
$
39,023

Letters of Credit (“LOCs”):
 
 
 
 
 
 
 
LOCs in lieu of deposits for contracted lots
$
1,685

 
N/A

 
$
—

 
N/A

LOCs for land development
34,289

 
N/A

 
32,475

 
N/A

LOCs for general corporate operations
4,500

 
N/A

 
4,991

 
N/A

Total LOCs
$
40,474

 
N/A

 
$
37,466

 
N/A

Accrued Liabilities. Accrued liabilities consist of the following (in thousands):
 
At September 30, 2013
 
At December 31, 2012
Accruals related to real-estate development and construction activities
$
32,954

 
$
19,954

Payroll and other benefits
29,100

 
11,871

Accrued taxes
34,117

 
3,407

Warranty reserves
22,257

 
22,064

Legal reserves
16,807

 
16,067

Real-estate notes payable (1)
15,876

 
6,288

Other accruals
27,136

 
16,726

Total
$
178,247

 
$
96,377

(1)     Reflects balance of non-recourse notes payable in connection with land purchases
Warranty Reserves. We provide home purchasers with limited warranties against certain building defects and have certain obligations related to those post-construction warranties for closed homes. The specific terms and conditions of these limited warranties vary by state, but overall the nature of the warranties include a complete workmanship and materials warranty typically during the first year after the close of the home and a structural warranty that typically extends up to 10 years subsequent to the close of the home. With the assistance of an actuary, we have estimated these reserves for the structural related warranty based on the number of homes still under warranty and historical warranty data and trends for our communities. We also use industry data with respect to similar product types and geographic areas in markets where our experience may not be sufficient to draw a meaningful conclusion. We regularly review our warranty reserves and adjust them, as necessary, to reflect current claims pace and changes in trends as information becomes available. A summary of changes in our warranty reserves follows (in thousands):
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2013
 
2012
 
2013
 
2012
Balance, beginning of period
$
21,844

 
$
21,243

 
$
22,064

 
$
23,136

Additions to reserve from new home deliveries
2,818

 
2,166

 
8,055

 
5,771

Warranty claims
(2,405
)
 
(436
)
 
(7,862
)
 
(5,934
)
Adjustments to pre-existing reserves
—

 
—

 
—

 
—

Balance, end of period
$
22,257

 
$
22,973

 
$
22,257

 
$
22,973

Warranty reserves are included in accrued liabilities on the accompanying consolidated balance sheets, and additions and adjustments to the reserves are included in cost of home closings within the accompanying consolidated income statements. These reserves are intended to cover costs associated with our contractual and statutory warranty obligations, which include, among other items, claims involving defective workmanship and materials. We believe that our total reserves, coupled

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with our contractual relationships and rights with our trades, are sufficient to cover our general warranty obligations. However, unanticipated changes in legal, weather, environmental or other conditions could have an impact on our actual warranty costs, and future costs could differ significantly from our estimates.
Recently Issued Accounting Pronouncements. In April 2013, the Financial Accounting Standards Board (“FASB”) issued ASU 2013-04, Liabilities ("ASU 2013-04"), which provides guidance for the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation is fixed at the reporting date. ASU 2013-04 is effective for us beginning January 1, 2014. We do not anticipate the adoption of ASU 2013-04 to have an effect on our consolidated financial statements or disclosures.
NOTE 2 — REAL ESTATE AND CAPITALIZED INTEREST
Real estate consists of the following (in thousands):
 
 
At September 30, 2013
 
At December 31, 2012
Homes under contract under construction (1)
$
316,508

 
$
192,948

Unsold homes, completed and under construction (1)
123,602

 
107,466

Model homes (1)
78,017

 
62,411

Finished home sites and home sites under development
721,492

 
634,106

Land held for development (2)
53,053

 
56,118

Land held for sale
19,630

 
21,650

Communities in mothball status (3)
32,912

 
38,488

 
$
1,345,214

 
$
1,113,187

 
(1)    Includes the allocated land and land development costs associated with each lot for these homes.
(2)
Land held for development primarily reflects land and land development costs related to land where development activity is not currently underway but is expected to begin in the future. For these parcels, we may have chosen not to currently develop certain land holdings as they typically represent a portion of a larger land parcel that we plan to build out over several years.
(3)
Represents communities where we have decided to cease operations (mothball) as we have determined that their economic performance would be maximized by deferring development. In the future, some of these communities may be re-opened while others may be sold to third parties. If we deem our carrying value to not be fully recoverable, we adjust our carrying value for these assets to fair value at the time they are placed into mothball status. As of September 30, 2013, we had six mothballed communities with a carrying value of $29.6 million in our West Region and two mothballed communities with a carrying value of $3.3 million in our Central Region. We do not capitalize interest for such mothballed assets, and all ongoing costs of land ownership are also expensed as incurred.
As previously noted, in accordance with ASC 360-10, each of our land inventory and related real estate assets is reviewed for recoverability when impairment indicators are present as our inventory is considered “long-lived” in accordance with GAAP. In recent years, due to the volatile economic environment, we evaluate all of our real estate assets for impairment on a quarterly basis. ASC 360-10 requires impairment charges to be recorded if the asset is not deemed fully recoverable and the fair value of such assets is less than their carrying amounts. Our determination of fair value is based on projections and estimates. We also evaluate alternative product offerings in communities where impairment indicators are present and other strategies for the land exist, such as selling the land or holding the land for sale in the future. Based on these reviews of all our communities, we recorded real-estate impairment charges of $584,000 and $776,000 during the three and nine months ended September 30, 2013, respectively, as compared to $417,000 and $1.6 million for the same periods in 2012. These charges are included in Cost of closings in our income statements.
In the latter part of 2011, we announced our intent to wind-down operations in the Las Vegas, Nevada market. The remaining $11.8 million of assets we own in Nevada relate to properties that we are not currently developing and are either actively marketing for sale or have mothballed.
Subject to sufficient qualifying assets, we capitalize interest incurred in connection with the development and construction of real estate. Completed homes and land not actively under development do not qualify for interest capitalization. Capitalized interest is allocated to real estate when incurred and charged to cost of closings when the related property is delivered to our customers. To the extent our debt exceeds our qualified assets base, we expense a proportionate share of the interest incurred. A summary of our capitalized interest is as follows (in thousands):

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Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Capitalized interest, beginning of period
$
26,294

 
$
17,836

 
$
21,600

 
$
14,810

Interest incurred
12,508

 
11,654

 
37,876

 
33,819

Interest expensed
(3,462
)
 
(5,009
)
 
(13,113
)
 
(18,718
)
Interest amortized to cost of home and land closings
(6,342
)
 
(4,296
)
 
(17,365
)
 
(9,726
)
Capitalized interest, end of period (1)
$
28,998

 
$
20,185

 
$
28,998

 
$
20,185

 
(1)
Approximately $511,000 and $539,000 of the capitalized interest is related to our joint venture investments and is a component of “Investments in unconsolidated entities” on our consolidated balance sheets as of September 30, 2013 and December 31, 2012, respectively.
NOTE 3 — VARIABLE INTEREST ENTITIES AND CONSOLIDATED REAL ESTATE NOT OWNED
We enter into purchase and option agreements for land or lots as part of our normal course of business. These purchase and option agreements enable us to acquire properties at one or multiple future dates at pre-determined prices. We believe these acquisition structures reduce the financial risk associated with land acquisitions and holdings and allow us to better maximize our liquidity.
Based on the provisions of the relevant accounting guidance, we have concluded that when we enter into purchase or option agreements to acquire land or lots from an entity, a variable interest entity, or “VIE”, may be created. We evaluate all purchase and option agreements for land to determine whether they are a VIE. ASC 810, Consolidations, requires that for each VIE, we assess whether we are the primary beneficiary and, if we are, we consolidate the VIE in our financial statements and reflect such assets and liabilities as “Real estate not owned.” The liabilities related to consolidated VIEs are excluded from our debt covenant calculations.
In order to determine if we are the primary beneficiary, we must first assess whether we have the ability to control the activities of the VIE that most significantly impact its economic performance. Such activities include, but are not limited to, the ability to determine the budget and scope of land development work, if any; the ability to control financing decisions for the VIE; the ability to acquire additional land into the VIE or dispose of land in the VIE not under contract with Meritage; and the ability to change or amend the existing option contract with the VIE. If we are not determined to control such activities, we are not considered the primary beneficiary of the VIE. If we do have the ability to control such activities, we will continue our analysis by determining if we are also expected to absorb a potentially significant amount of the VIE’s losses or, if no party absorbs the majority of such losses, if we will benefit from a potentially significant amount of the VIE’s expected gains.
In substantially all cases, creditors of the entities with which we have option agreements have no recourse against us and the maximum exposure to loss in our option agreements is limited to non-refundable option deposits and any capitalized pre-acquisition costs. Often, we are at risk for items over budget related to land development on property we have under option if we are the land developer. In these cases, we have contracted to complete development at a fixed cost on behalf of the land owner and we bear any budget shortfalls and maintain any budget savings. Some of our option deposits may be refundable to us if certain contractual conditions are not performed by the party selling the lots.
The table below presents a summary of our lots under option or contract at September 30, 2013 (dollars in thousands): 

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Number of
Lots
 
Purchase
Price
 
Option/Earnest
Money Deposits
Cash
 
Purchase and option contracts recorded on balance sheet as Real estate not owned
20

 
$
481

 
$
135

  
Option contracts not recorded on balance sheet - non-refundable deposits, committed (1)
3,075

 
231,338

 
22,771

 
Purchase contracts not recorded on balance sheet — non-refundable deposits, committed (1)
3,048

 
153,414

 
9,759

  
Purchase contracts not recorded on balance sheet — refundable deposits, committed
327

 
15,432

 
216

  
Total committed (on and off balance sheet)
6,470

 
400,665

 
32,881

  
Total purchase and option contracts not recorded on balance sheet — refundable deposits, uncommitted (2)
4,140

 
111,108

 
2,165

  
Total lots under contract or option
10,610

 
$
511,773

 
$
35,046

  
Total option contracts not recorded on balance sheet (3)
10,590

 
$
511,292

 
$
34,911

(4
)
 
(1)
Deposits are generally non-refundable except if certain contractual conditions fail or certain contractual obligations are not performed by the selling party.
(2)
Deposits are refundable at our sole discretion. We have not completed our acquisition evaluation process and we have not internally committed to purchase these lots.
(3)
Except for our specific performance option contracts recorded on our balance sheet as Real estate not owned, none of our option agreements require us to purchase lots.
(4)
Amount is reflected in our consolidated balance sheet in the line item “Deposits on real estate under option or contract” as of September 30, 2013.
Generally, our option contracts to purchase lots remain effective so long as we purchase a pre-established minimum number of lots each month or quarter, as determined by the respective agreement. The pre-established number is typically structured to approximate our expected rate of home construction starts. Purchase contracts generally involved bulk purchase terms where we purchase all or a large portion of the lots at one time and are typically short-term in nature.
NOTE 4 — INVESTMENTS IN UNCONSOLIDATED ENTITIES

In the past, we have entered into land development joint ventures as a means of accessing larger parcels of land, expanding our market opportunities, managing our risk profile and leveraging our capital base. While purchasing land through a joint venture can be beneficial, currently we do not view them as critical to the success of our homebuilding operations and have not entered into any new land joint ventures since 2008. Based on the structure of these joint ventures, they may or may not be consolidated into our results. Our joint venture partners generally are other homebuilders, land sellers or other real estate investors. We generally do not have a controlling interest in these ventures, which means our joint venture partners could cause the venture to take actions we disagree with, or fail to take actions we believe should be undertaken, including the sale of the underlying property to repay debt or recoup all or part of the partners' investments. As of September 30, 2013, we had two active equity-method land development ventures.
For land development joint ventures, we, and in some cases our joint venture partners, usually receive an option or other similar arrangement to purchase portions of the land held by the joint venture. Option prices are generally negotiated prices that approximate market value when we enter into the option contract or similar arrangement. For these ventures, our share of the joint venture profit relating to lots we purchase from the joint ventures is deferred until homes are delivered by us and title passes to a homebuyer. Therefore, we allocate the portion of such joint venture profit to the land acquired by us as a reduction in the basis of the property.
In connection with our land development joint ventures, we may also provide certain types of guarantees to lenders financing the joint ventures. These guarantees can be classified into two categories: (i) Repayment Guarantees and (ii) Completion Guarantees, described in more detail below. Additionally, we have classified a guarantee related to our minority ownership in the South Edge joint venture separately, as there is pending litigation with the venture’s lender group and other venture partners regarding that guarantee.

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(In thousands)
At September 30, 2013
 
At December 31, 2012
Repayment guarantees
$
—

 
$
219

Completion guarantees (1)
—

 
—

South Edge guarantee (2)
13,243

 
13,243

Total guarantees
$
13,243

 
$
13,462

 
(1)
As our completion guarantees are typically backed by funding from a third party, we do not believe these guarantees represent a potential cash obligation for us, as they require only non-financial performance.
(2)
See Note 13 regarding outstanding litigation related to a joint venture project known as “South Edge” or "Inspirada" and the corresponding reserves and charges we have recorded relating thereto.
Repayment Guarantees. We and/or our land development joint venture partners occasionally provide limited repayment guarantees on a pro rata basis on the debt of land development joint ventures. If such a guarantee were ever to be called or triggered, the maximum exposure to Meritage would generally be only our pro-rata share of the amount of debt outstanding that was in excess of the fair value of the underlying land securing the debt. Our share of these limited pro rata repayment guarantees as of September 30, 2013 and December 31, 2012 is presented in the table above (excluding any potential recoveries from the joint venture’s land assets).
Completion Guarantees. If there is development work to be completed, we and our joint venture partners are also typically obligated to the project lender(s) to complete construction of the land development improvements if the joint venture does not perform the required development. Provided we and the other joint venture partners are in compliance with these completion obligations, the project lenders are generally obligated to fund these improvements through any financing commitments available under the applicable joint venture development and construction loans. In addition, we and our joint venture partners have from time to time provided unsecured indemnities to joint venture project lenders. These indemnities generally obligate us to reimburse the project lenders only for claims and losses related to matters for which such lenders are held responsible and our exposure under these indemnities is limited to specific matters such as environmental claims. A part of our project acquisition due diligence process is to determine potential environmental risks and generally we or the joint venture entity obtain an independent environmental review. Per the guidance of ASC 460-10, Guarantees, we believe these guarantees are either not applicable or not material to our financial results.
Surety Bonds. We and our joint venture partners also indemnify third party surety providers with respect to performance bonds issued on behalf of certain of our joint ventures. If a joint venture does not perform its obligations, the surety bond could be called. If these surety bonds are called and the joint venture fails to reimburse the surety, we and our joint venture partners may be obligated to make such payments. These surety indemnity arrangements are generally joint and several obligations with our joint venture partners. Although a majority of the required work may have been performed, these bonds are typically not released until all development specifications under the bond have been met. None of these bonds have been called to date and we believe it is unlikely that any of these bonds will be called or if called, that any such amounts would be material to us. See the table in Note 1 for more information on our surety bonds.
The joint venture obligations, guarantees and indemnities discussed above are generally provided by us or one of our subsidiaries. In joint ventures involving other homebuilders or developers, support for these obligations is generally provided by the parent companies of the joint venture partners. In connection with our periodic real estate impairment reviews, we may accrue for any such commitments where we believe our obligation to pay is probable and can be reasonably estimated. In such situations, our accrual represents the portion of the total joint venture obligation related to our relative ownership percentage. We continue to monitor these matters and reserve for these obligations if and when they become probable and can be reasonably estimated. Except as noted above and in Note 13 to these unaudited consolidated financial statements, as of September 30, 2013 and December 31, 2012, we did not have any such reserves.
We also participate in two mortgage and one title business joint ventures. The mortgage joint ventures are engaged in mortgage activities and they provide services to both our homebuyers ad well as other buyers. Although some of these ventures originate mortgage loans, we have limited recourse related to any mortgages originated by these ventures. We intend to wind down the remaining title joint venture with the continued roll out of Carefree Title operations, as discussed earlier. Our investments in mortgage and title joint ventures as of September 30, 2013 and December 31, 2012 were $1.8 million and $2.0 million, respectively.
The joint venture financial information below represent the most recent information available to us.
Summarized condensed financial information related to unconsolidated joint ventures that are accounted for using the equity method was as follows (in thousands):

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At September 30, 2013
 
At December 31, 2012
Assets:
 
 
 
Cash
$
5,387

 
$
7,650

Real estate
34,947

 
36,626

Other assets
3,188

 
3,478

Total assets
$
43,522

 
$
47,754

Liabilities and equity:
 
 
 
Accounts payable and other liabilities
$
4,696

 
$
4,748

Notes and mortgages payable
13,389

 
14,001

Equity of:
 
 
 
Meritage (1)
8,400

 
9,631

Other
17,037

 
19,374

Total liabilities and equity
$
43,522

 
$
47,754

 
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2013
 
2012
 
2013
 
2012
Revenue
$
8,975

 
$
10,268

 
$
25,373

 
$
18,733

Costs and expenses
(3,256
)
 
(3,711
)
 
(9,466
)
 
(8,250
)
Net earnings of unconsolidated entities
$
5,719

 
$
6,557

 
$
15,907

 
$
10,483

Meritage’s share of pre-tax earnings (1)(2)
$
3,578

 
$
2,975

 
$
9,583

 
$
6,626

 
(1)
Balance represents Meritage’s interest, as reflected in the financial records of the respective joint ventures. This balance may differ from the balance reflected in our consolidated financial statements due to the following reconciling items: (i) timing differences for revenue and distributions recognition, (ii) step-up basis and corresponding amortization, (iii) income deferrals as discussed in Note (2) below and (iv) the cessation of allocation of losses from joint ventures in which we have previously impaired our investment balance to zero and where we have no commitment to fund additional losses.
(2)
Our share of pre-tax earnings is recorded in “Earnings from financial services unconsolidated entities and other, net” and “Earnings/(loss) from other unconsolidated entities, net” on our consolidated income statements and excludes joint venture profit related to lots we purchased from the joint ventures. Such profit is deferred until homes are delivered by us and title passes to a homebuyer.
Our investments in unconsolidated entities include $0.6 million and $0.8 million at September 30, 2013 and December 31, 2012, respectively, related to the difference between the amounts at which our investments are carried and the amount of our portion of the venture’s equity. These amounts are amortized as the assets of the respective joint ventures are sold. A de minimis amount of amortization was recorded for these assets in the three and nine months ended September 30, 2013 with no amortization recorded for the same periods in 2012.
The joint venture assets and liabilities noted in the table above primarily represent two active land ventures, two mortgage ventures, one title venture and various inactive ventures in which we have a total investment of $10.7 million. As of September 30, 2013, we believe these ventures are in compliance with their respective debt agreements, if applicable, and such debt is non-recourse to us.

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NOTE 5 — SENIOR, SENIOR SUBORDINATED, CONVERTIBLE SENIOR NOTES AND OTHER BORROWINGS
    
Senior, senior subordinated, convertible senior notes and other borrowings consist of the following (in thousands):
 
 
At September 30, 2013
 
At December 31, 2012
7.731% senior subordinated notes due 2017
$
—

 
$
99,825

4.50% senior notes due 2018
175,000

 
—

7.15% senior notes due 2020. At September 30, 2013 and December 31, 2012, there was approximately $3,163 and $3,528 in unamortized discount, respectively
196,837

 
196,472

7.00% senior notes due 2022
300,000

 
300,000

1.875% convertible senior notes due 2032
126,500

 
126,500

$135 million unsecured revolving credit facility
—

 
—

 
$
798,337


$
722,797

The indentures for our 4.50%, 7.15% and 7.00% senior notes (collectively, "the senior notes") contain covenants including, among others, limitations on the amount of secured debt we may incur, and limitations on sale and leaseback transactions and mergers. Our convertible senior notes do not have any financial covenants.

Borrowings under our unsecured revolving credit facility ("the Credit Facility") are subject to, among other things, a borrowing base. The Credit Facility also contains certain financial covenants, including (a) a minimum tangible net worth requirement of $360.0 million (which amount is subject to increase over time based on subsequent earnings and proceeds from equity offerings), and (b) a maximum leverage covenant that prohibits the leverage ratio (as defined therein) from exceeding 60%. In addition, we are required to maintain either (i) an interest coverage ratio (EBITDA to interest expense, as defined therein) of at least 1.50 to 1.00 or (ii) liquidity (as defined therein) of an amount not less than our consolidated interest incurred during the trailing 12 months. No amounts were drawn under the Credit Facility as of September 30, 2013 or December 31, 2012.
In March 2013, we completed an offering of $175 million aggregate principal amount of 4.50% Senior Notes due 2018. Concurrent with this offering, we announced a tender offer to repurchase all of our 7.731% Senior Subordinated Notes due 2017 ("2017 Notes") and subsequently issued a call offer to repurchase any and all remaining notes not tendered. As a result of the tender offer, as of September 30, 2013, we had repurchased all of the $99.8 million outstanding 2017 Notes. The debt redemption transactions resulted in costs and charges of $3.8 million for the nine months ended September 30, 2013 reflected as Loss on early extinguishment of debt in our consolidated income statements.    
In June 2013, we amended our existing Credit Facility, to among other things, extend the facility maturity date by one year from July 24, 2015 to July 24, 2016, amend the formula for calculating the borrowing base to moderately increase the advance rate for certain categories of assets and to increase the accordion feature to $75 million. In addition, two additional lenders joined the Credit Facility lending syndicate, thereby increasing the total commitment currently available under the Credit Facility to $135 million.
Obligations to pay principal and interest on our notes listed in the table above are guaranteed by all of our wholly-owned subsidiaries (each a “Guarantor” and, collectively, the “Guarantor Subsidiaries”), each of which is directly or indirectly 100% owned by Meritage Homes Corporation. Such guarantees are full and unconditional, and joint and several. In the event of a sale or other disposition of all of the assets of any Guarantor, by way of merger, consolidation or otherwise, or a sale or other disposition of all of the equity interests of any Guarantor then held by Meritage and its subsidiaries, then that Guarantor will be released and relieved of any obligations under its note guarantee. There are no significant restrictions on our ability or the ability of any Guarantor to obtain funds from their respective subsidiaries, as applicable, by dividend or loan. We do not provide separate financial statements of the Guarantor Subsidiaries because Meritage (the parent company) has no independent assets or operations and the guarantees are full and unconditional and joint and several. Subsidiaries of Meritage Homes Corporation that are nonguarantor subsidiaries, if any, are, individually and in the aggregate, inconsequential.

   

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Table of Contents

NOTE 6 — FAIR VALUE DISCLOSURES
We account for the non-recurring fair value measurements of our non-financial assets and liabilities in accordance with ASC 820-10, Fair Value Measurement and Disclosure. This guidance defines fair value, establishes a framework for measuring fair value and addresses required disclosures about fair value measurements. This standard establishes a three-level hierarchy for fair value measurements based upon the significant inputs used to determine fair value. Observable inputs are those which are obtained from market participants external to the company while unobservable inputs are generally developed internally, utilizing management’s estimates, assumptions and specific knowledge of the assets/liabilities and related markets. The three levels are defined as follows:
•
Level 1 — Valuation is based on quoted prices in active markets for identical assets and liabilities.
•
Level 2 — Valuation is determined from quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar instruments in markets that are not active, or by model-based techniques in which all significant inputs are observable in the market.
•
Level 3 — Valuation is derived from model-based techniques in which at least one significant input is unobservable and based on the company’s own estimates about the assumptions that market participants would use to value the asset or liability.
If the only observable inputs are from inactive markets or for transactions which the company evaluates as “distressed”, the use of Level 1 inputs should be modified by the company to properly address these factors, or the reliance of such inputs may be limited, with a greater weight attributed to Level 3 inputs. Refer to Notes 1 and 2 for additional information regarding the valuation of our non-financial assets.
Due to our quarterly review of our long-lived real-estate assets as described in Note 2, we consider the carrying amounts of real-estate assets subject to current period impairments to approximate fair value, although all such adjustments for the three and nine months ended September 30, 2013 and September 30, 2012 were considered immaterial.
     Financial Instruments. The fair value of our fixed-rate debt is derived from quoted market prices by independent
dealers and is as follows (in thousands):
 
 
 
 
September 30, 2013
 
December 31, 2012
 
Hierarchy
Aggregate
Principal
 
Estimated
Fair Value
 
Aggregate
Principal
 
Estimated
Fair Value
7.731% senior subordinated notes
Level 2
 
N/A

 
N/A

 
$
99,825

 
$
102,950

4.50% senior notes
Level 2
 
$
175,000

 
$
171,938

 
N/A

 
N/A

7.15% senior notes
Level 2
 
$
200,000

 
$
216,000

 
$
200,000

 
$
220,760

7.00% senior notes
Level 2
 
$
300,000

 
$
318,000

 
$
300,000

 
$
328,500

1.875% convertible senior notes
Level 2
 
$
126,500

 
$
135,829

 
$
126,500

 
$
127,449

Due to the short-term nature of other financial assets and liabilities, we consider the carrying amounts of our other short-term financial instruments to approximate fair value.








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NOTE 7 — EARNINGS PER SHARE
Basic and diluted earnings per common share were calculated as follows (in thousands, except per share amounts):  
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2013
 
2012
 
2013
 
2012
Basic weighted average number of shares outstanding
36,226

 
35,216

 
36,060

 
33,541

Effect of dilutive securities:
 
 
 
 
 
 
 
Convertible debt (1)
2,176

 
—

 
2,176

 
—

Stock options and unvested restricted stock
463

 
545

 
535

 
469

Diluted weighted average shares outstanding
38,865

 
35,761

 
38,771

 
34,010

 
 
 
 
 
 
 
 
Net earnings as reported
$
38,191

 
$
6,784

 
$
78,375

 
$
10,035

Interest attributable to convertible senior notes, net of income taxes
393

 
—

 
1,180

 
—

Net earnings for earnings per share
$
38,584

 
$
6,784

 
$
79,555

 
$
10,035

Basic earnings per share
$
1.05

 
$
0.19

 
$
2.17

 
$
0.30

Diluted earnings per share (1)
$
0.99

 
$
0.19

 
$
2.05

 
$
0.30

Antidilutive stock options not included in the calculation of diluted income per share
10

 
530

 
5

 
348

 
(1)
In the third quarter of 2012, we issued $126.5 million of 1.875% convertible senior notes convertible into shares of our common stock at a rate of 17.1985 shares per $1,000 principle amount. In accordance with ASC Subtopic 260-10, Earnings Per Share, ("ASC 260-10") we calculate the dilutive effect of convertible securities using the "if-converted" method.

NOTE 8 — STOCKHOLDERS’ EQUITY    
A summary of changes in shareholders’ equity is presented below: 
 
Nine Months Ended September 30, 2013
 
(In thousands)
 
Number of
Shares
 
Common
Stock
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Total
Balance at December 31, 2012
35,613

 
$
356

 
$
390,249

 
$
303,605

 
$
694,210

Net earnings
—

 
—

 
—

 
78,375

 
78,375

Exercise of stock options
335

 
3

 
11,222

 
—

 
11,225

Excess income tax benefit from stock-based awards
—

 
—

 
1,733

 
—

 
1,733

Equity award compensation expense
—

 
—

 
7,040

 
—

 
7,040

Issuance of restricted stock
283

 
3

 
(3
)
 
—

 
—

Non-controlling interest acquisition
—

 
—

 
(257
)
 
—

 
(257
)
Balance at September 30, 2013
36,231

 
$
362

 
$
409,984

 
$
381,980

 
$
792,326


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Nine Months Ended September 30, 2012
 
(In thousands)
 
Number of
Shares
 
Common
Stock
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Treasury
Stock
 
Total
Balance at December 31, 2011
40,377

 
$
404

 
$
478,839

 
$
198,442

 
$
(188,773
)
 
$
488,912

Net earnings
—

 
—

 
—

 
10,035

 
—

 
10,035

Exercise of stock options
259

 
3

 
3,897

 
—

 
—

 
3,900

Equity award compensation expense
—

 
—

 
6,095

 
—

 
—

 
6,095

Issuance of restricted stock
200

 
2

 
(2
)
 
—

 
—

 
—

Issuance of stock (1)
2,645

 
26

 
87,099

 
—

 
—

 
87,125

Cancellation of treasury shares (2)
(7,891
)
 
(79
)
 
(188,694
)
 
—

 
188,773

 
—

Balance at September 30, 2012
35,590

 
356

 
387,234

 
208,477

 
—

 
596,067


(1) In July 2012, we issued a public offering of 2,645,000 shares of common stock, par value $0.01 per share, at a price to the public of $34.75 per share.

(2) During the third quarter of 2012, we canceled and retired all of our treasury shares. These shares remain as authorized and unissued shares.
NOTE 9 — STOCK-BASED COMPENSATION
We have a stock compensation plan, the 2006 Stock Option Plan (the “Plan”), that was adopted in 2006, and superseded a prior stock compensation plan. The Plan has been amended from time to time. The Plan was approved by our stockholders and is administered by our Board of Directors. The provisions of the Plan allow for the grant of stock appreciation rights, restricted stock awards, performance share awards and performance-based awards in addition to non-qualified and incentive stock options. The Plan authorizes awards to officers, key employees, non-employee directors and consultants for up to 8,950,000 shares of common stock, of which 967,743 shares remain available for grant at September 30, 2013. We believe that such awards provide a means of performance-based compensation to attract and retain qualified employees and better align the interests of our employees with those of our stockholders. Non-vested stock awards and stock options granted in previous years are typically granted with a five-year ratable vesting period. Non-vested stock awards and performance-based awards granted to our executive management team and our Board of Directors are typically granted with a three-year cliff vesting.
Compensation cost related to time-based restricted stock awards are measured as of the closing price on the date of grant and are expensed on a straight-line basis over the vesting period of the award. Compensation cost related to performance-based restricted stock awards are also measured as of the closing price on the date of grant but are expensed in accordance with ASC 718-10-25-20, Compensation – Stock Compensation, which requires an assessment of probability of attainment of the performance target. As our performance targets are annual in nature, once we determine that the performance target outcome is probable, the year-to-date expense is recorded and the remaining expense is recorded on a straight-line basis through the end of the award’s vesting period.
Below is a summary of compensation expense and stock award activity (dollars in thousands): 
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2013
 
2012
 
2013
 
2012
Stock-based compensation expense
$
3,099

 
$
2,822

 
$
7,040

 
$
6,095

Non-vested shares granted
3,600

 
16,750

 
345,700

 
386,500

Performance-based non-vested shares granted
—

 
—

 
62,500

 
56,250

Stock options exercised
12,400

 
179,832

 
334,500

 
259,132

Restricted stock awards vested (includes performance-based awards)
2,550

 
3,300

 
283,350

 
200,316


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We did not grant any stock option awards during the nine months ended September 30, 2013 or September 30, 2012.
The following table includes additional information regarding the Plan (dollars in thousands):
 
As of
 
September 30, 2013
 
December 31, 2012
Unrecognized stock-based compensation cost
$
19,529

 
$
13,072

Weighted average years remaining vesting period
2.40

 
2.17

Total equity awards outstanding (1)
1,328,885

 
1,615,235

 
(1)    Includes vested and unvested options outstanding and unvested restricted stock awards.
NOTE 10 — INCOME TAXES
Components of the income tax (provision)/benefit are as follows (in thousands): 
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2013
 
2012
 
2013
 
2012
Federal
$
(18,153
)
 
$
—

 
$
(33,846
)
 
$
—

State
(442
)
 
(202
)
 
428

 
4,781

Total
$
(18,595
)
 
$
(202
)
 
$
(33,418
)
 
$
4,781

The effective tax rate for the three and nine months ended September 30, 2013 is 32.7% and 29.9%, respectively, and reflects the benefit of energy tax credit, the homebuilder manufacturing deduction, and a partial reversal of the state valuation allowance on our deferred tax assets. Due to the effects of the deferred tax asset valuation allowance and federal and state tax net operating losses (“NOLs”), the effective tax rate in 2012 is not meaningful as there is no correlation between the effective tax rate and the amount of pre-tax income or loss for that period.
At September 30, 2013 and December 31, 2012, we have no unrecognized tax benefits due to the lapse of the statute of limitations and completion of audits for prior years. We believe that our current income tax filing positions and deductions would be sustained on audit and do not anticipate any adjustments that would result in a material change. Our policy is to accrue interest and penalties on unrecognized tax benefits and include them in federal income tax expense.
In accordance with ASC 740-10, Income Taxes, we determine our net deferred tax assets by taxing jurisdiction. We evaluate our net deferred tax assets, including the benefit from NOLs, by jurisdiction to determine if a valuation allowance is required. Companies must assess whether a valuation allowance should be established based on the consideration of all available evidence using a “more likely than not” standard with significant weight being given to evidence that can be objectively verified. This assessment considers, among other matters, the nature, frequency and severity of cumulative losses, forecasts of future profitability, the length of statutory carryforward periods, a company's experience with operating losses and experiences of utilizing tax credit carryforwards and tax planning alternatives.
We recorded a full valuation allowance against all of our net deferred tax assets during 2008 due to economic conditions and the weight of negative evidence at that time. During the second quarter of 2012, we determined that the positive evidence exceeded the negative evidence in the tax jurisdiction of Florida and that it was more likely than not that most of the deferred tax assets and NOL carryovers for the Florida jurisdiction would be realized. In the fourth quarter of 2012, we reversed the valuation allowance against our federal deferred tax assets and those in most of our state jurisdictions because the weight of the positive evidence in those jurisdictions exceeded that of the negative evidence. However, we retained a valuation allowance for certain states which have shorter carryforward periods for utilization of NOL carryovers or lower current earnings relative to their NOL carryforward balance. A portion of this remaining allowance relating to state tax assets was released in the second and third quarters of 2013.
We continue to evaluate the remaining state valuation allowance to determine if sufficient positive evidence indicates that it is more likely than not that an additional portion of the underlying state NOL carryforwards should be able to be realized.

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At September 30, 2013 and December 31, 2012, we had a valuation allowance against deferred tax assets as follows (in thousands):
 
September 30, 2013
 
December 31, 2012
State
4,051

 
8,666

Total valuation allowance
$
4,051

 
$
8,666

Our future NOL and deferred tax asset realization depends on sufficient taxable income in the carryforward periods under existing tax laws. Federal NOL carryforwards may be used to offset future taxable income for 20 years. State NOL carryforwards may be used to offset future taxable income for a period of time ranging from 5 to 20 years, depending on the state jurisdiction. At September 30, 2013, we had a federal NOL carryforward benefit of $9.1 million that expires in 2031 and federal tax credit carryforwards of $5.7 million which begin to expire in 2030. At September 30, 2013, we also had tax benefits for state NOL carryforwards of $17.9 million that expire at various times from 2013 to 2031 depending on the state jurisdiction.
At September 30, 2013, we have income taxes payable of $29.6 million, which primarily consists of current federal and state tax accruals as well as tax and interest amounts that we expect to pay within one year for having amended prior-year tax returns. This amount is recorded in accrued liabilities in the accompanying balance sheet as of September 30, 2013.
We conduct business and are subject to tax in the U.S. and several states. With few exceptions, we are no longer subject to U.S. federal, state, or local income tax examinations by taxing authorities for years prior to 2008. We are not subject to any federal or state income tax examination at this time.
The tax benefits from our NOLs, built-in losses, and tax credits would be materially reduced or potentially eliminated if we experience an “ownership change” as defined under Internal Revenue Code (“IRC”) §382. Based on our analysis performed as of September 30, 2013, we do not believe that we have experienced an ownership change. As a protective measure, our stockholders held a Special Meeting of Stockholders on February 16, 2009 and approved an amendment to our Articles of Incorporation that restricts certain transfers of our common stock. The amendment is intended to help us avoid an unintended ownership change and thereby preserve the value of our tax benefits for future utilization.
On January 1, 2013, Congress passed the American Taxpayer Relief Act of 2012 (the “Act”), which the President signed into law on January 2, 2013. The Act extended certain tax provisions which have a retroactive effect on 2012. Among other things, the Act extended for two years the availability of a business tax credit under IRC §45L for building new energy efficient homes, which originally was set to expire at the end of 2011. Under ASC 740, the effects of new legislation are recognized in the period that includes the date of enactment, regardless of the retroactive benefit. In accordance with this guidance, we recorded a tax benefit of approximately $2.6 million in the first quarter of 2013 related to the extension of the IRC §45L tax credit for the qualifying new energy efficient homes that we closed in 2012. We are currently estimating our IRC §45L qualification rates for homes closed in 2012 and 2013 based on best available information, and any additional credits will be recognized in future periods if we determine that we quality for them after completing a more in-depth analysis.
NOTE 11 — SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
The following presents certain supplemental cash flow information (in thousands):
 
 
Nine Months Ended September 30
 
2013
 
2012
Cash paid during the period for:
 
 
 
Interest, net of interest capitalized
$
2,876

 
$
19,615

Income taxes
$
5,192

 
$
909

Non-cash operating activities:
 
 
 
Real estate not owned
$
481

 
$
—

Real estate acquired through notes payable
$
9,588

 
2,800


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NOTE 12 — OPERATING AND REPORTING SEGMENTS
We operate with two principal business segments: homebuilding and financial services. As defined in ASC 280-10, Segment Reporting, we have seven homebuilding operating segments (the seven states in which we operate) within our homebuilding business. These segments are engaged in the business of acquiring and developing land, constructing homes, marketing and selling those homes, and providing warranty and customer service. We aggregate our homebuilding operating segments into reporting segments based on similar long-term economic characteristics and geographical proximity. In latter 2012, management's evaluation of segment reporting led to a re-grouping of our homebuilding segments to more closely align them into long-term expected profitability trends and, accordingly, all prior year segment financial information has been updated to reflect our new aggregation. Our current reportable homebuilding segments are as follows:
West:       Arizona, California and Colorado (1)
Central:  Texas
East:       Florida, the Carolinas and Tennessee

(1)    Activity for our wind-down Nevada operations is reflected in the West Region's results.
Management's evaluation of homebuilding segment performance is based on segment operating income, which we define as homebuilding and land revenues less cost of home construction, commissions and other sales costs, land development and other land sales costs and other costs incurred by or allocated to each segment, including impairments. Each reportable segment follows the same accounting policies described in our 2012 Form 10-K in Note 1, “Business and Summary of Significant Accounting Policies.” Operating results for each segment may not be indicative of the results for such segment had it been an independent, stand-alone entity for the periods presented. The following segment information is in thousands:
 
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2013
 
2012
 
2013
 
2012
Homebuilding revenue (1):
 
 
 
 
 
 
 
West
$
259,669

 
$
186,507

 
$
695,615

 
$
415,471

Central
139,307

 
104,526

 
357,406

 
279,004

East
93,104

 
51,610

 
225,444

 
134,613

Consolidated total
$
492,080

 
$
342,643

 
$
1,278,465

 
$
829,088

Homebuilding segment operating income:
 
 
 
 
 
 
 
West
$
41,298

 
$
15,319

 
$
95,356

 
$
26,970

Central
12,677

 
5,673

 
22,320

 
11,325

East
9,990

 
3,691

 
19,991

 
9,768

Total homebuilding segment operating income
63,965

 
24,683

 
137,667

 
48,063

Financial services profit
4,294

 
2,985

 
11,515

 
6,743

Corporate and unallocated (2)
(8,662
)
 
(7,323
)
 
(22,011
)
 
(17,233
)
Earnings/(loss) from other unconsolidated entities, net
46

 
(74
)
 
(229
)
 
(348
)
Interest expense
(3,462
)
 
(5,009
)
 
(13,113
)
 
(18,718
)
Other income/(expense), net
605

 
(8,276
)
 
1,760

 
(7,481
)
Loss on early extinguishment of debt
—

 
—

 
(3,796
)
 
(5,772
)
Earnings before income taxes
$
56,786

 
$
6,986

 
$
111,793

 
$
5,254

 

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(1)
Homebuilding revenue includes the following land closing revenue, by segment:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
Land closing revenue:
 
 
 
 
 
 
 
West
5,875

 
$
6,488

 
$
11,616

 
$
6,488

Central
3,058

 
485

 
13,482

 
1,568

East
—

 
790

 
3,470

 
790

Consolidated total
$
8,933

 
$
7,763

 
$
28,568

 
$
8,846


(2)
Balance consists primarily of corporate costs and numerous shared service functions such as finance and treasury that are not allocated to the homebuilding or financial services reporting segments.

 
At September 30, 2013
 
West
 
Central
 
East
 
Financial Services
 
Corporate and
Unallocated (1)
 
Total
Deposits on real estate under option or contract
$
13,644

 
$
11,390

 
$
9,877

 
$
—

 
$
—

 
$
34,911

Real estate
738,573

 
370,005

 
236,636

 
—

 
—

 
1,345,214

Investments in unconsolidated entities
205

 
9,340

 
46

 
—

 
1,071

 
10,662

Other assets (2)
33,765

 
167,260

 
30,556

 
553

 
251,165

 
483,299

Total assets
$
786,187

 
$
557,995

 
$
277,115

 
$
553

 
$
252,236

 
$
1,874,086

 
 
At December 31, 2012
 
West
 
Central
 
East
 
Financial Services
 
Corporate and
Unallocated (3)
 
Total
Deposits on real estate under option or contract
$
4,419

 
$
7,168

 
$
2,764

 
$
—

 
$
—

 
$
14,351

Real estate
647,316

 
305,100

 
160,771

 
—

 
—

 
1,113,187

Investments in unconsolidated entities
365

 
10,645

 
16

 
—

 
1,059

 
12,085

Other assets (4)
24,935

 
132,546

 
25,914

 
297

 
252,247

 
435,939

Total assets
$
677,035

 
$
455,459

 
$
189,465

 
$
297

 
$
253,306

 
$
1,575,562

 
(1)(3)    Balance consists primarily of corporate assets not allocated to the reporting segments.
(2)(4)    Balance consists primarily of cash and securities and our deferred tax asset.

NOTE 13 — COMMITMENTS AND CONTINGENCIES
We are involved in various routine legal proceedings incidental to our business. With respect to most pending litigation matters, our ultimate legal and financial responsibility, if any, cannot be estimated with certainty and our actual future expenditure to resolve those matters could prove to be different from the amount that we accrued or reserved. On a quarterly basis, our senior management and legal team conduct an in-depth review of all active legal claims and litigation matters and we record a legal or warranty accrual representing the estimated total expense required to resolve each such matter. As of September 30, 2013, we have reserved approximately $16.8 million related to non-warranty related litigation and asserted claims, which includes reserves for the Joint Venture Litigation discussed below. In addition, our $22.3 million warranty reserve includes accruals for all construction defect claims that are similarly recorded in an amount we believe will be necessary to resolve those construction defect claims. Except as may be specifically disclosed herein, we currently believe that any reasonably possible additional losses from existing claims and litigation in excess of our existing reserves and accruals would be immaterial, individually and in the aggregate, to our financial results.


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Joint Venture Litigation
We are a defendant in a lawsuit filed by the lenders related to a project known as “South Edge” or “Inspirada”. We are also a party to a demand for arbitration made by an entity controlled by certain co-venturers, which demand was made by that entity as Estate Representative of bankrupt South Edge, LLC. The project involves a large master-planned community located in Henderson, Nevada, which was acquired by an unconsolidated joint venture with capital supplied by us and our co-venturers, and a syndicated loan for the project. In connection with the loan obtained by the venture, we provided a narrowly crafted repayment guarantee that could only be triggered upon a “bankruptcy event”. That guarantee covers our 3.53% pro rata share of the project financing.
On December 9, 2010, three of the lenders filed a petition seeking to place the venture into an involuntary bankruptcy. On June 6, 2011, we received a demand letter from the lenders, requesting full payment of $13.2 million, including past-due interest and penalties, the lenders claimed to be owed under the springing repayment guarantee. The lenders claim that the involuntary bankruptcy filed by three of the lenders triggered the “springing” repayment guarantee. We do not believe the lenders have an enforceable position associated with their $13.2 million claim and do not believe we should be required to pay such amount because, among other reasons, the lenders breached their contract with us by refusing to accept the April 2008 full tender of our performance and by refusing to release their lien in connection with our second and final takedown in this project and we do not believe the repayment guarantee was triggered by the lenders’ filing of the involuntary bankruptcy. As a result, on August 19, 2011, we filed a lawsuit against JP Morgan Chase Bank, NA (“JP Morgan”) in the Court of Common Pleas in Franklin County, Ohio (Case No. 11CVH0810353) regarding the repayment guarantee. In reaction to that lawsuit, on August 25, 2011, JP Morgan filed a lawsuit against us in the US District Court of Nevada, which is currently being prosecuted in the name of JP Morgan's agent, ISG Insolvency Group, Inc. regarding the same issues addressed in the Ohio litigation. The Ohio action and the Nevada action have been consolidated. On October 26, 2011, the Bankruptcy Court approved a Plan pursuant to which (i) the lenders have received all payments to which they are entitled, (ii) the project has been conveyed to Inspirada Builders, LLC, which is an entity owned by four of the co-venturers in the South Edge entity (KB Home, Toll Brothers, Pardee Homes and Beazer Homes), and (iii) the four co-venturer builders claim to have succeeded to the lenders' repayment guarantee claim against Meritage.
On September 4, 2012, the Court ruled on a motion for summary judgment that JP Morgan has standing to pursue its repayment guarantee claims against Meritage, that Meritage was liable thereunder to JP Morgan and that the parties should be permitted to conduct discovery with respect to the amount of damages to which JP Morgan is entitled under the repayment guarantee. Following limited discovery, JP Morgan filed a motion for summary judgment with respect to damages, and on June 17, 2013 the Court granted the motion, ruling that Meritage owes JP Morgan $15,053,857. Later, on July 8, 2013, the Court entered Judgment in favor of JP Morgan in the amount of $15,753,344, which included an additional $699,487 for pre-judgment interest that accrued between December 6, 2012 and the date of the Judgment. We immediately appealed the Court's rulings, which is currently pending. On July 17, 2013 we posted a supersedeas bond in the amount of $16,050,604 staying enforcement of the Judgment, which was approved by the Court on July 17, 2013. Pursuant to a stipulation between the parties, the bond amount included the amount of the Judgment and additional sums for a potential award of post-judgment interest and attorneys' fees on appeal. We disagree with many of the conclusions and findings contained in the Court's order, and have challenged and will continue to challenge the rulings. In addition, we believe that the four above-named builders are liable to Meritage for any amounts that Meritage may ultimately be required to pay under the repayment guarantee, and we have filed claims against those builders to, among other things, recover from them any amounts Meritage is required to pay under the repayment guarantee.
In March 2012, Inspirada Builders, LLC, as Estate Representative of South Edge, LLC (the original joint venture) filed demand for arbitration in the United States Bankruptcy Court in the District of Nevada against Meritage Homes of Nevada, Inc. seeking: (1) $13.5 million, relating to alleged breaches of the Operating Agreement of South Edge, LLC, for an alleged failure to pay the amounts Meritage Homes of Nevada fully tendered but South Edge rejected in April 2008; and (2) $9.8 million relating to our supposed pro rata share of alleged future infrastructure improvement costs to be incurred by Inspirada Builders, LLC (the new owner of the project and which is owned by the four builders identified above). The $13.5 million component of this claim represents the same alleged obligation and amount that is the subject of the above described pending repayment guarantee litigation between us and JP Morgan. Meritage filed a response to Inspirada Builders' arbitration claims denying liability, together with cross-claims against each of the four above-named co-venture builders for breach of contract, breach of the implied covenant of good faith and fair dealing, and indemnity. On June 27, 2013, the $9.8 million claim for future infrastructure costs was dismissed. Although the balance of the parties' claims are currently pending and were set to be resolved at a hearing in late 2013, per the parties' stipulation the Arbitration has now been stayed pending resolution of the pending appeal of the Court's rulings in favor of JP Morgan in the federal court action. In connection with these on-going legal proceedings, we have established a reserve in an amount that we believe is appropriate for this matter. Our 3.53% investment in the venture has previously been fully impaired. We do not believe that the ultimate disposition of these matters will have a material adverse effect on our financial condition.

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

The positive momentum the housing market has experienced in recent quarters continued into the third quarter of 2013, despite the increase in mortgage rates and the seasonally slower summer months. The market continues to be largely driven by housing affordability and decreasing levels of home inventory in many markets. While sales pace moderated in the third quarter, we are still benefiting from increased customer interest and traffic in our communities that translate into positive order trends overall as compared to the prior year.

We remain focused on strategically positioning ourselves in well-located and highly-desired communities in many of the top real-estate markets in the United States. During the last few quarters, improving demand for homes has allowed us to place more emphasis on increasing prices over sales pace in order to maximize our profitability in top producing markets. This has resulted in our sales pace decreasing in our most robust markets. We have also begun to actively acquire lot positions through option contracts, more specifically through land banking arrangements that have become more available recently and that allow us to leverage our balance sheet by securing additional land through limited initial cash outlays. (See Note 3 for additional information related to option contracts). We believe we successfully differentiate ourselves from our competition by offering a line-up of plans that highlight the benefits of our industry-leading energy efficient homes. We also offer our buyers the ability to personalize their homes and we provide a home warranty, further setting us apart from the competition we face with resale homes. Our solid operating and financial results during the first nine months of 2013 are reflected in our improved profitability and kept our balance sheet strong.
Company Actions and Positioning
As the homebuilding market recovery continues, we remain focused on increasing community count and securing strategic land positions to support future growth in our orders volume and revenue while reducing costs, thereby growing margins and profitability while maintaining a strong balance sheet. To help meet these goals we continue to execute on the following initiatives:

•
Acquiring and developing lots in high-performing markets we deem key to our success in order to maintain and grow our lot supply and active community count in existing markets as well as entry into new markets;
•
Increasing our lots under control and increasing the percentage controlled through option contracts in order to minimize initial cash outlay for land purchases;
•
Utilizing our enhanced market research to capitalize on the knowledge of our buyers' demands in each community, tailoring our pricing, product and amenities offered;
•
Continuing to innovate and promote the Meritage Green energy efficiency program, where every new home we construct, at a minimum, meets ENERGY STAR® standards, certified by the U.S. Environmental Protection Agency, for indoor air quality, water conservation and overall energy efficiency;
•
Adapting sales and marketing efforts to generate additional traffic and successfully compete with resale homes;
•
Focusing our purchasing efforts to manage costs as homebuilding recovers and demand rises;
•
Growing our inventory balance while ensuring sufficient liquidity through exercising tight control over cash flows; and
•
Striving for excellence in construction; and monitoring our customers' satisfaction as measured by survey scores and working toward improving them based on the results of the surveys.
In addition to the initiatives listed above evidencing our confidence in the long-term demand for housing, we continually evaluate opportunities for expansion into new markets that indicate positive long-term growth trends. We are redeploying our capital into projects both within our geographic footprint and through entry into new markets. In connection with these efforts, in August 2013, we entered the Nashville, Tennessee market through the acquisition of the assets and operations of Phillips Builders. With this acquisition, we acquired approximately 500 lots, contributing 30 units in backlog as of September 30, 2013. We also are now closed out of the Las Vegas, Nevada market, only providing on-going warranty support for our homeowners.
    
In the third quarter of 2013, we opened 27 new communities while closing out 13 communities, ending the quarter with 179 active communities, three of which are from the Phillips Builders acquisition. We expect active community count to continue to grow as our new communities have longer lot positions and are not closing out at the quicker pace of some of our older active communities. We expect to end the year with approximately 185 actively-selling communities.

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We also may continue to opportunistically access the capital markets through various debt and equity transactions, providing additional liquidity, extending our debt maturities and strengthening our balance sheet.

Over the past 18 months, we have taken steps to strengthen our balance sheet and extend debt maturities through debt transactions. Most recently, in March 2013, we concurrently issued $175.0 million of 4.50% senior notes due 2018 and redeemed $16.7 million of our $99.8 million senior subordinated notes due 2017. We redeemed the remaining balance of these notes in April 2013. In June 2013, we amended our Credit Facility to extend the facility maturity date by one year to July 2016 and increased the total commitment currently available under the Credit Facility by $10.0 million to $135.0 million. (See Note 5 to the accompanying unaudited consolidated financial statements for further discussion.)    
Summary Company Results    
Along with most of the homebuilding industry, we continued to experience strong operating and financial performance in the third quarter of 2013. We believe our overall improving trends are attributable to our focus on community placement, coupled with our Meritage Green energy efficiency product offerings as well as the overall improvement in home demand. Demand in our markets continues to outpace supply, allowing us to benefit from price appreciation, which more than offset construction cost increases, and thereby improved our margins. We continue to focus on growing our land positions and strategically increasing our active community count in preferred locations to meet the additional demand we are experiencing and capitalize on improved consumer sentiment regarding home purchases.
In the third quarter of 2013, we benefited from gains in nearly all of our key operating and financial metrics. We recorded 1,300 orders and 1,418 closings, increases of 8.0% and 18.5%, respectively over the third quarter of 2012. Orders pace per average actively selling community slowed slightly, reflecting the effect of recent interest rate increases, home price increases, as well as the overall slower summer months. Most notably, we recorded a significant increase year-over year in home closing gross margin during the three months ended September 30, 2013, increasing 420 basis points from the same period in 2012 to 22.8%. While home closing gross margin may continue to rise slightly over the short term, we expect that home closing gross margin will normalize at a slightly lower percentage rate over the longer term. We believe our results are indicative of successful execution of business initiatives and increased housing demand. We expect the positive housing fundamentals to continue to support moderate growth in upcoming quarters. Comparative positive trends are and will continue to be increasingly more difficult as we began experiencing notable and sustained improvement in the second quarter of 2012. Accordingly, we anticipate the comparative gains to be more tempered as we experience successive quarters of the improved homebuilding environment.
Total home closing revenue was $483.1 million for the three months ended September 30, 2013, increasing 44.3% from the same period last year. The $148.3 million increase is driven by both the 221 additional closing units for the quarter ended September 30, 2013 as compared to the same period last year and the 21.8% increase in average sales prices to $340,700. The increased sales prices were partially due to a shift in order mix to communities and states that have a greater demand for larger homes with higher average home prices and partially due to price appreciation. We reported net earnings of $38.2 million for the three months ended September 30, 2013, as compared to $6.8 million for the same period in 2012. We expect improving revenue and profitability for the remainder of the year, as indicated by our higher ending backlog, average sales prices and improved margins.
Total home closing revenue for the nine months ended September, 2013 was $1.2 billion as compared to $820.2 million for the 2012 period. The 52.4% increase in year-to-date closing revenue is due to a 793-unit increase strengthened by the $56,100 increase in average sales prices. Net earnings for the year-to-date period increased more than six times from $10.0 million in 2012 to $78.4 million in 2013. The same contributing factors for third quarter results mentioned above impacted the year-to-date results.
At September, 2013, our backlog of $805.6 million reflects an increase of 64.6% or $316.1 million, when compared to backlog at September 30, 2012. The improvement reflects a 8.0% increase in unit orders, as well as higher average sales prices on home orders of 19.7% for the three months ended September 30, 2013, as compared to the same period a year ago. In the third quarter of 2013, we were also able to maintain a low cancellation rate on home orders at 14% of gross orders. Cancellations increased from 13% in the third quarter of 2012. These cancellation rates are still a bit below our historical averages.
Critical Accounting Policies
The accounting policies we deem most critical to us and that involve the most difficult, subjective or complex judgments include revenue recognition, valuation of real estate, warranty reserves, off-balance sheet arrangements, and share-

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based payments. There have been no significant changes to our critical accounting policies during the nine months ended September 30, 2013 compared to those disclosed in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in our 2012 Annual Report on Form 10-K.


26
Table of Contents

The composition of our closings, home orders and backlog is constantly changing and is based on a dissimilar mix of communities between periods as new projects open and existing projects wind down. Further, individual homes within a community can range significantly in price due to differing square footage, option selections, lot sizes and quality of lots (e.g. cul-de-sac, view lots, greenbelt lots). These variations result in a lack of meaningful comparability between our home orders, closings and backlog due to the changing mix between periods. The tables below present operating and financial data that we consider most critical to managing our operations (dollars in thousands):
Home Closing Revenue
 
Three Months Ended September 30
 
Quarter over Quarter
 
2013
 
2012
 
Chg $
 
Chg %
Total
 
 
 
 
 
 
 
Dollars
$
483,147

 
$
334,880

 
$
148,267

 
44.3
 %
Homes closed
1,418

 
1,197

 
221

 
18.5
 %
Avg sales price
$
340.7

 
$
279.8

 
$
60.9

 
21.8
 %
West Region
 
 
 
 
 
 
 
Arizona
 
 
 
 
 
 
 
Dollars
$
96,562

 
$
59,519

 
$
37,043

 
62.2
 %
Homes closed
301

 
243

 
58

 
23.9
 %
Avg sales price
$
320.8

 
$
244.9

 
$
75.9

 
31.0
 %
California
 
 
 
 
 
 
 
Dollars
$
113,954

 
$
88,748

 
$
25,206

 
28.4
 %
Homes closed
259

 
244

 
15

 
6.1
 %
Avg sales price
$
440.0

 
$
363.7

 
$
76.3

 
21.0
 %
Colorado
 
 
 
 
 
 
 
Dollars
$
43,033

 
$
27,639

 
$
15,394

 
55.7
 %
Homes closed
104

 
83

 
21

 
25.3
 %
Avg sales price
$
413.8

 
$
333.0

 
$
80.8

 
24.3
 %
Nevada
 
 
 
 
 
 
 
Dollars
$
245

 
$
4,113

 
$
(3,868
)
 
(94.0
)%
Homes closed
1

 
22

 
(21
)
 
(95.5
)%
Avg sales price
$
245.0

 
$
187.0

 
$
58.0

 
31.0
 %
West Region Totals
 
 
 
 
 
 
 
Dollars
$
253,794

 
$
180,019

 
$
73,775

 
41.0
 %
Homes closed
665

 
592

 
73

 
12.3
 %
Avg sales price
$
381.6

 
$
304.1

 
$
77.5

 
25.5
 %
Central Region - Texas
 
 
 
 
 
 
 
Central Region Totals
 
 
 
 
 
 
 
Dollars
$
136,249

 
$
104,041

 
$
32,208

 
31.0
 %
Homes closed
509

 
434

 
75

 
17.3
 %
Avg sales price
$
267.7

 
$
239.7

 
$
28.0

 
11.7
 %
East Region
 
 
 
 
 
 
 
Carolinas
 
 
 
 
 
 
 
Dollars
$
24,361

 
$
14,459

 
$
9,902

 
68.5
 %
Homes closed
62

 
40

 
22

 
55.0
 %
Avg sales price
$
392.9

 
$
361.5

 
$
31.4

 
8.7
 %
Florida
 
 
 
 
 
 
 
Dollars
$
66,464

 
36,361

 
$
30,103

 
82.8
 %
Homes closed
176

 
131

 
45

 
34.4
 %
Avg sales price
$
377.6

 
277.6

 
$
100.0

 
36.0
 %
Tennessee
 
 
 
 
 
 
 
Dollars
$
2,279

 
N/A

 
N/A

 
N/A

Homes closed
6

 
N/A

 
N/A

 
N/A

Avg sales price
$
379.8

 
N/A

 
N/A

 
N/A

East Region Totals
 
 
 
 
 
 
 
Dollars
$
93,104

 
$
50,820

 
$
42,284

 
83.2
 %
Homes closed
244

 
171

 
73

 
42.7
 %
Avg sales price
$
381.6

 
$
297.2

 
$
84.4

 
28.4
 %

27
Table of Contents

 
Nine Months Ended September 30
 
Year over Year
 
2013
 
2012
 
Chg $
 
Chg %
Total
 
 
 
 
 
 
 
Dollars
$
1,249,897

 
$
820,242

 
$
429,655

 
52.4
 %
Homes closed
3,791

 
2,998

 
793

 
26.5
 %
Avg sales price
$
329.7

 
$
273.6

 
$
56.1

 
20.5
 %
West Region
 
 
 
 
 
 
 
Arizona
 
 
 
 
 
 
 
Dollars
$
233,447

 
$
153,190

 
$
80,257

 
52.4
 %
Homes closed
744

 
593

 
151

 
25.5
 %
Avg sales price
$
313.8

 
$
258.3

 
$
55.5

 
21.5
 %
California
 
 
 
 
 
 
 
Dollars
$
329,414

 
$
172,575

 
$
156,839

 
90.9
 %
Homes closed
784

 
489

 
295

 
60.3
 %
Avg sales price
$
420.2

 
$
352.9

 
$
67.3

 
19.1
 %
Colorado
 
 
 
 
 
 
 
Dollars
$
112,238

 
$
75,816

 
$
36,422

 
48.0
 %
Homes closed
298

 
227

 
71

 
31.3
 %
Avg sales price
$
376.6

 
$
334.0

 
$
42.6

 
12.8
 %
Nevada
 
 
 
 
 
 
 
Dollars
$
8,900

 
$
7,402

 
$
1,498

 
20.2
 %
Homes closed
38

 
39

 
(1
)
 
(2.6
)%
Avg sales price
$
234.2

 
$
189.8

 
$
44.4

 
23.4
 %
West Region Totals
 
 
 
 
 
 
 
Dollars
$
683,999

 
$
408,983

 
$
275,016

 
67.2
 %
Homes closed
1,864

 
1,348

 
516

 
38.3
 %
Avg sales price
$
367.0

 
$
303.4

 
$
63.6

 
21.0
 %
Central Region - Texas
 
 
 
 
 
 
 
Central Region Totals
 
 
 
 
 
 
 
Dollars
$
343,924

 
$
277,436

 
$
66,488

 
24.0
 %
Homes closed
1,312

 
1,190

 
122

 
10.3
 %
Avg sales price
$
262.1

 
$
233.1

 
$
29.0

 
12.4
 %
East Region
 
 
 
 
 
 
 
Carolinas
 
 
 
 
 
 
 
Dollars
$
57,849

 
$
30,513

 
$
27,336

 
89.6
 %
Homes closed
153

 
84

 
69

 
82.1
 %
Avg sales price
$
378.1

 
$
363.3

 
$
14.8

 
4.1
 %
Florida
 
 
 
 
 
 
 
Dollars
$
161,846

 
103,310

 
$
58,536

 
56.7
 %
Homes closed
456

 
376

 
80

 
21.3
 %
Avg sales price
$
354.9

 
274.8

 
$
80.1

 
29.1
 %
Tennessee
 
 
 
 
 
 
 
Dollars
$
2,279

 
N/A

 
N/A

 
N/A

Homes closed
6

 
N/A

 
N/A

 
N/A

Avg sales price
$
379.8

 
N/A

 
N/A

 
N/A

East Region Totals
 
 
 
 
 
 
 
Dollars
$
221,974

 
$
133,823

 
$
88,151

 
65.9
 %
Homes closed
615

 
460

 
155

 
33.7
 %
Avg sales price
$
360.9

 
$
290.9

 
$
70.0

 
24.1
 %


28
Table of Contents

Home Orders (1)
 
 
Three Months Ended September 30
 
Quarter over Quarter
 
2013
 
2012
 
Chg $
 
Chg %
Total
 
 
 
 
 
 
 
Dollars
$
473,924

 
$
366,752

 
$
107,172

 
29.2
 %
Homes ordered
1,300

 
1,204

 
96

 
8.0
 %
Avg sales price
$
364.6

 
$
304.6

 
$
60.0

 
19.7
 %
West Region
 
 
 
 
 
 
 
Arizona
 
 
 
 
 
 
 
Dollars
$
80,748

 
$
70,315

 
$
10,433

 
14.8
 %
Homes ordered
234

 
229

 
5

 
2.2
 %
Avg sales price
$
345.1

 
$
307.1

 
$
38.0

 
12.4
 %
California
 
 
 
 
 
 
 
Dollars
$
84,741

 
$
94,974

 
$
(10,233
)
 
(10.8
)%
Homes ordered
165

 
248

 
(83
)
 
(33.5
)%
Avg sales price
$
513.6

 
$
383.0

 
$
130.6

 
34.1
 %
Colorado
 
 
 
 
 
 
 
Dollars
$
44,178

 
$
28,925

 
$
15,253

 
52.7
 %
Homes ordered
96

 
88

 
8

 
9.1
 %
Avg sales price
$
460.2

 
$
328.7

 
$
131.5

 
40.0
 %
Nevada
 
 
 
 
 
 
 
Dollars
$
—

 
$
4,384

 
$
(4,384
)
 
N/A

Homes ordered
—

 
22

 
(22
)
 
N/A

Avg sales price
N/A

 
$
199.3

 
N/A

 
N/A

West Region Totals
 
 
 
 
 
 
 
Dollars
$
209,667

 
$
198,598

 
$
11,069

 
5.6
 %
Homes ordered
495

 
587

 
(92
)
 
(15.7
)%
Avg sales price
$
423.6

 
$
338.3

 
$
85.3

 
25.2
 %
Central Region - Texas
 
 
 
 
 
 
 
Central Region Totals
 
 
 
 
 
 
 
Dollars
$
157,868

 
$
106,116

 
$
51,752

 
48.8
 %
Homes ordered
545

 
425

 
120

 
28.2
 %
Avg sales price
$
289.7

 
$
249.7

 
$
40.0

 
16.0
 %
East Region
 
 
 
 
 
 
 
Carolinas
 
 
 
 
 
 
 
Dollars
$
28,971

 
$
12,709

 
$
16,262

 
128.0
 %
Homes ordered
72

 
36

 
36

 
100.0
 %
Avg sales price
$
402.4

 
$
353.0

 
$
49.4

 
14.0
 %
Florida
 
 
 
 
 
 
 
Dollars
$
74,312

 
$
49,329

 
$
24,983

 
50.6
 %
Homes ordered
177

 
156

 
21

 
13.5
 %
Avg sales price
$
419.8

 
$
316.2

 
$
103.6

 
32.8
 %
Tennessee
 
 
 
 
 
 
 
Dollars
$
3,106

 
N/A

 
N/A

 
N/A

Homes ordered
11

 
N/A

 
N/A

 
N/A

Avg sales price
$
282.4

 
N/A

 
N/A

 
N/A

East Region Totals
 
 
 
 
 
 
 
Dollars
$
106,389

 
$
62,038

 
$
44,351

 
71.5
 %
Homes ordered
260

 
192

 
68

 
35.4
 %
Avg sales price
$
409.2

 
$
323.1

 
$
86.1

 
26.6
 %
 
(1)
Home orders and home order dollars for any period represent the aggregate units or sales price of all homes ordered, net of cancellations. We do not include orders contingent upon the sale of a customer’s existing home or any other material contingency as a sales contract until the contingency is removed.


29
Table of Contents

 
Nine Months Ended September 30
 
Year over Year
 
2013
 
2012
 
Chg $
 
Chg %
Total
 
 
 
 
 
 
 
Dollars
$
1,567,719

 
$
1,060,910

 
$
506,809

 
47.8
 %
Homes ordered
4,484

 
3,701

 
783

 
21.2
 %
Avg sales price
$
349.6

 
$
286.7

 
$
62.9

 
21.9
 %
West Region
 
 
 
 
 
 
 
Arizona
 
 
 
 
 
 
 
Dollars
$
284,139

 
$
200,258

 
$
83,881

 
41.9
 %
Homes ordered
886

 
738

 
148

 
20.1
 %
Avg sales price
$
320.7

 
$
271.4

 
$
49.3

 
18.2
 %
California
 
 
 
 
 
 
 
Dollars
$
331,933

 
$
258,053

 
$
73,880

 
28.6
 %
Homes ordered
730

 
714

 
16

 
2.2
 %
Avg sales price
$
454.7

 
$
361.4

 
$
93.3

 
25.8
 %
Colorado
 
 
 
 
 
 
 
Dollars
$
154,251

 
$
88,012

 
$
66,239

 
75.3
 %
Homes ordered
358

 
266

 
92

 
34.6
 %
Avg sales price
$
430.9

 
$
330.9

 
$
100.0

 
30.2
 %
Nevada
 
 
 
 
 
 
 
Dollars
$
5,795

 
$
11,455

 
$
(5,660
)
 
(49.4
)%
Homes ordered
24

 
61

 
(37
)
 
(60.7
)%
Avg sales price
$
241.5

 
$
187.8

 
$
53.7

 
28.6
 %
West Region Totals
 
 
 
 
 
 
 
Dollars
$
776,118

 
$
557,778

 
$
218,340

 
39.1
 %
Homes ordered
1,998

 
1,779

 
219

 
12.3
 %
Avg sales price
$
388.4

 
$
313.5

 
$
74.9

 
23.9
 %
Central Region - Texas
 
 
 
 
 
 
 
Central Region Totals
 
 
 
 
 
 
 
Dollars
$
472,507

 
$
332,007

 
$
140,500

 
42.3
 %
Homes ordered
1,689

 
1,370

 
319

 
23.3
 %
Avg sales price
$
279.8

 
$
242.3

 
$
37.5

 
15.5
 %
East Region
 
 
 
 
 
 
 
Carolinas
 
 
 
 
 
 
 
Dollars
$
87,461

 
$
38,841

 
$
48,620

 
125.2
 %
Homes ordered
218

 
109

 
109

 
100.0
 %
Avg sales price
$
401.2

 
$
356.3

 
$
44.9

 
12.6
 %
Florida
 
 
 
 
 
 
 
Dollars
$
228,527

 
$
132,284

 
$
96,243

 
72.8
 %
Homes ordered
568

 
443

 
125

 
28.2
 %
Avg sales price
$
402.3

 
$
298.6

 
$
103.7

 
34.7
 %
Tennessee
 
 
 
 
 
 
 
Dollars
$
3,106

 
N/A

 
N/A

 
N/A

Homes ordered
11

 
N/A

 
N/A

 
N/A

Avg sales price
$
282.4

 
N/A

 
N/A

 
N/A

East Region Totals
 
 
 
 
 
 
 
Dollars
$
319,094

 
$
171,125

 
$
147,969

 
86.5
 %
Homes ordered
797

 
552

 
245

 
44.4
 %
Avg sales price
$
400.4

 
$
310.0

 
$
90.4

 
29.2
 %


30
Table of Contents

 
Three Months Ended September 30
 
2013
 
2012
 
Beginning
 
Ending
 
Beginning
 
Ending
Active Communities
 
 
 
 
 
 
 
Total
165

 
179

—

151

 
153

West Region
 
 
 
 
 
 
 
Arizona
36

 
39

 
32

 
34

California
13

 
18

 
20

 
19

Colorado
12

 
12

 
8

 
8

Nevada
—

 
—

 
2

 
2

West Region Total
61

 
69

 
62

 
63

Central Region - Texas
71

 
73

 
68

 
68

Central Region Total
71

 
73

 
68

 
68

East Region
 
 
 
 
 
 
 
Carolinas
13

 
15

 
5

 
7

Florida
20

 
19

 
16

 
15

Tennessee
—

 
3
 
—

 
—

East Region Total
33

 
37

 
21

 
22

 
 
 
 
 
 
 
 
 
Nine Months Ended September 30,
 
2013
 
2012
 
Beginning
 
Ending
 
Beginning
 
Ending
Active Communities
 
 
 
 
 
 
 
Total
158

 
179

 
157

 
153

West Region
 
 
 
 
 
 
 
Arizona
38

 
39

 
37

 
34

California
17

 
18

 
20

 
19

Colorado
12

 
12

 
10

 
8

Nevada
1

 
—

 
2

 
2

West Region Total
68

 
69

 
69

 
63

Central Region - Texas
65

 
73

 
67

 
68

Central Region Total
65

 
73

 
67

 
68

East Region
 
 
 
 
 
 
 
Carolinas
7

 
15

 
3

 
7

Florida
18

 
19

 
18

 
15

Tennessee
—

 
3
 
—

 
—

East Region Total
25

 
37

 
21

 
22

 
 
 
Three Months Ended September 30
 
Nine Months Ended September 30
Cancellation Rates (1)
2013
 
2012
 
2013
 
2012
Total
14
%
 
13
%
 
12
%
 
13
%
West Region
 
 
 
 
 
 
 
Arizona
17
%
 
11
%
 
12
%
 
10
%
California
16
%
 
14
%
 
12
%
 
14
%
Colorado
8
%
 
5
%
 
8
%
 
7
%
Nevada
N/A

 
19
%
 
11
%
 
16
%
West Region Total
15
%
 
12
%
 
11
%
 
11
%
Central Region - Texas
14
%
 
16
%
 
14
%
 
16
%
Central Region Total
14
%
 
16
%
 
14
%
 
16
%
East Region
 
 
 
 
 
 
 
Carolinas
17
%
 
10
%
 
10
%
 
7
%
Florida
12
%
 
7
%
 
10
%
 
16
%
Tennessee
8
%
 
N/A

 
8
%
 
N/A

East Region Total
14
%
 
8
%
 
10
%
 
14
%
 
 
 
 
 
 
 
 
 

31
Table of Contents

(1)
Cancellation rates are computed as the number of canceled units for the period divided by the gross order units for the same period.


Order Backlog (1) 
 
At September 30
 
Year over Year
 
2013
 
2012
 
Chg $
 
Chg %
Total
 
 
 
 
 
 
 
Dollars
$
805,580

 
$
489,522

 
$
316,058

 
64.6
 %
Homes in backlog
2,190

 
1,618

 
572

 
35.4
 %
Avg sales price
$
367.8

 
$
302.5

 
$
65.3

 
21.6
 %
West Region
 
 
 
 
 
 
 
Arizona
 
 
 
 
 
 
 
Dollars
$
131,508

 
$
92,300

 
$
39,208

 
42.5
 %
Homes in backlog
391

 
303

 
88

 
29.0
 %
Avg sales price
$
336.3

 
$
304.6

 
$
31.7

 
10.4
 %
California
 
 
 
 
 
 
 
Dollars
$
127,107

 
$
113,126

 
$
13,981

 
12.4
 %
Homes in backlog
261

 
307

 
(46
)
 
(15.0
)%
Avg sales price
$
487.0

 
$
368.5

 
$
118.5

 
32.2
 %
Colorado
 
 
 
 
 
 
 
Dollars
$
92,102

 
$
35,689

 
$
56,413

 
158.1
 %
Homes in backlog
202

 
109

 
93

 
85.3
 %
Avg sales price
$
456.0

 
$
327.4

 
$
128.6

 
39.3
 %
Nevada
 
 
 
 
 
 
 
Dollars
$
—

 
$
5,129

 
$
(5,129
)
 
N/A

Homes in backlog
—

 
27

 
(27
)
 
N/A

Avg sales price
N/A

 
$
190.0

 
N/A

 
N/A

West Region Totals
 
 
 
 
 
 
 
Dollars
$
350,717

 
$
246,244

 
$
104,473

 
42.4
 %
Homes in backlog
854

 
746

 
108

 
14.5
 %
Avg sales price
$
410.7

 
$
330.1

 
$
80.6

 
24.4
 %
Central Region - Texas
 
 
 
 
 
 
 
Central Region Totals
 
 
 
 


 


Dollars
$
260,900

 
148,065

 
112,835

 
76.2
 %
Homes in backlog
877

 
576

 
301

 
52.3
 %
Avg sales price
$
297.5

 
$
257.1

 
$
40.4

 
15.7
 %
East Region
 
 
 
 
 
 
 
Carolinas
 
 
 
 
 
 
 
Dollars
$
46,953

 
$
16,944

 
$
30,009

 
177.1
 %
Homes in backlog
114

 
49

 
65

 
132.7
 %
Avg sales price
$
411.9

 
$
345.8

 
$
66.1

 
19.1
 %
Florida
 
 
 
 
 
 
 
Dollars
$
137,691

 
$
78,269

 
$
59,422

 
75.9
 %
Homes in backlog
315

 
247

 
68

 
27.5
 %
Avg sales price
$
437.1

 
$
316.9

 
$
120.2

 
37.9
 %
Tennessee
 
 
 
 
 
 
 
Dollars
$
9,319

 
N/A

 
N/A

 
N/A

Homes in backlog
30

 
N/A

 
N/A

 
N/A

Avg sales price
$
310.6

 
N/A

 
N/A

 
N/A

East Region Totals
 
 
 
 
 
 
 
Dollars
$
193,963

 
$
95,213

 
$
98,750

 
103.7
 %
Homes in backlog
459

 
296

 
163

 
55.1
 %
Avg sales price
$
422.6

 
$
321.7

 
$
100.9

 
31.4
 %
 
(1)
Our backlog represented net orders that have not yet closed.


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Operating Results
Companywide. Home closings revenue for the three months ended September 30, 2013 increased 44.3% to $483.1 million on 1,418 units when compared to the prior year, due to a 221-unit increase in units closed and a $60,900 increase in average closing price. Home orders also increased significantly to $473.9 million on 1,300 units for the quarter ended September 30, 2013 as compared to $366.8 million on 1,204 units in the 2012 period, reflecting increased average sales prices of $60,000, or 19.7%, although sales pace on orders from average active communities dipped slightly year over year. The slower pace of growth in orders reflects our focus on asset maximization and price increases over absorptions pace. The improved demand over the past several quarters resulted in a 572-unit, or 35.4%, increase in our ending backlog at September 30, 2013 with 2,190 homes as compared to 1,618 homes at September 30, 2012. Additionally, the value of orders in backlog at September 30, 2013 increased 64.6% due to a $65,300 or 21.6% improvement in average sales price versus the same period a year ago. Our closings revenue and continued orders growth results reflect our ability to convert the higher demand the housing market is experiencing into orders and closings as we benefit from our superior land positions, desirable home designs and industry-leading energy efficiency innovations. Our average price increases are a result of a shift in mix to higher priced markets and states with a greater demand for larger homes, as well as the benefit from price appreciation in many of the markets in which we operate. Our active community count increased to 179 communities as of September 30, 2013 as compared to both 153 at September 30, 2012 and 165 reported at the end of the second quarter of 2013.
Closed units for the nine months ended September 30, 2013 increased 793 homes or 26.5% over the same period in 2012. Order units of 4,484 in the first nine months of 2013 increased 21.2% as compared to 3,701 in the same period in 2012, with a $62,900, or 21.9% increase in average sales price, reflecting the improved demand in 2013 that resulted in an increased ending backlog as mentioned above.
West. In the three months ended September 30, 2013, home closings rose to 665 units, an increase of 12.3% or 73 units over prior year, with a value of $253.8 million, an increase 41.0% from 2012. Despite the increase in actively selling communities during the third quarter of 2013, the Region had a 92-unit decrease in orders offset by an $85,300 increase in average sales price, resulting in a net increase in order dollar value of $11.1 million. The $85,300 increase in average sales price is a result of our community locations with higher-priced homes that have also had successive periods of price increases due to strong buyer demand. These results led to ending backlog in the Region valued at $350.7 million on 854 units, a 108-unit or 14.5% increase over the same period in the prior year. Pent-up demand and our superior community locations, as well as unique energy efficient products, are largely the drivers behind the impressive growth in the states within the West Region.

We believe the successes in the West Region are a testament to our business strategy that emphasizes well-located lot and land positions, innovative product design and our energy-efficient features. Our orders per average active community in the Region maintained a healthy pace of 7.6 units, although that does represent a decrease of 19.1% over the prior year, reflecting the increased average sales prices over the past year. This decrease is also largely due to the exceptional demand the California market experienced in the latter half of 2012 and early 2013. While demand is still good, it is not at the same rate we enjoyed both last year and the first half of this year. Both Arizona and Colorado volumes were pivotal in the overall Region results and represent a larger percentage of the Region's operations. We are opening communities in locations in both Arizona and Colorado where the product demand is for larger homes and where we have been able to successively initiate price increases, driving the impressive average sales price increases in both states, while a larger number of actively selling communities due to recent openings are aiding the bolstered volume in both orders and backlog.
 
As previously discussed, we wound down our operations in Nevada and the only business we are currently conducting in Nevada is servicing warranty calls for our existing homeowners. We closed our final home there in the third quarter of 2013.

For the nine months ended September 30, 2013, home closings in our West Region increased 516 units to 1,864 closings, which together with a $63,600 increase in average sales price resulted in a 67.2% increase in home closing revenue as compared to the same period in the prior year. Orders in the first nine months of 2013 increased 219 units or 12.3%, which coupled with the $74,900 average sales price growth, resulted in an increase of $218.3 million to $776.1 million of order volume over the same period in 2012. These results are indicative of the improved homebuilding environment and buyer demand in these states.
Central. The Central Region, made up of our Texas markets, closed 509 units totaling $136.2 million in revenues in the three months ended September 30, 2013, 17.3% and 31.0% increases in units and dollars, respectively, as compared to those reported in the same period in 2012. The Region also experienced a 28.2% increase in orders to 545 units as compared to 425 units for the same period a year ago. The orders increases were achieved mainly due to growth in our active community count to 73 at September 30, 2013 versus 68 at September 30, 2012 and by our 20.6% increase in orders per average community over the prior year. The Central Region's increase in orders in the three months ended September 30, 2013, aided by a $40,000 average sales price increase, contributed to a higher-ending backlog value of $260.9 million, an increase of $112.8 million or 76.2% as compared to the same

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period a year ago. Community placement and more actively selling communities are largely credited for the year-over-year gains, coupled with the improved general economy.
Year to date, the Region's revenues experienced an increase to $343.9 million of closings volume on 1,312 units, $66.5 million higher than the same period in the prior year. The 319-unit and $140.5 million increases in orders in the first nine months of 2013 mirror the gains experienced in the third quarter. Improvements in the general economy and our new product line up both contributed to our year-to-date gains.
East. Our East Region generated 244 closings with $93.1 million of home revenue in the third quarter of 2013, 42.7% and 83.2% increases, respectively, from the same period in 2012. The Region also reported higher results in orders generating $44.4 million of additional order dollars, due to a 35.4% increase in units as well as a $86,100 or 26.6% increase in average sales price year over year. This is largely attributable to our 63% increase in the number of average actively selling communities in desirable locations, primarily in our new markets in the Carolinas where our average number of actively selling communities more than doubled and, to a lesser extent, our new operations in Tampa and Nashville. Sales pace in the Region held steady year over year, which coupled with the improved orders and average sales prices led to a 163-unit and $98.8 million increase in ending backlog, 55.1% and 103.7% gains, respectively. Significant increases in average sales prices in Florida are due to overall price increases, as well as to a shift to community locations that generate a higher demand for larger homes with typically higher sales prices. The Florida market was the largest contributor to the Region's results, although operations in the Carolinas contributed 62 units, or $24.4 million in closings and 72 units, or $29.0 million, in order volume from 14 average actively-selling communities during the third quarter. Our first month of operations in Tennessee commenced in September 2013, contributing 6 closings and 11 orders valued at $2.3 million and $3.1 million, respectively.

The performance in this Region is a testament to our commitment of expanding our geographical footprint through entry into highly sought-after markets and strategic community positioning efforts with strong buyer demand. Our focus and efforts have been supported by strong orders and average sales price growth in the Region.

The Region's home closings for the nine months ended September 30, 2013 increased 155 units, or 33.7% over the same period in 2012. This generated total home closing revenue of $222.0 million for the nine months ended September 30, 2013, a 65.9% increase over the same period a year ago. Year-to-date orders and order value increased 44.4% and 86.5%, respectively, to 797 units as compared to the same period in 2012. The increasing volume that the new markets in this Region are contributing, coupled with the same factors that impacted the third quarter performance for the rest of the country helped to generate these positive year-to-date results.
Land Closing Revenue and Gross Profit
From time to time, we sell certain land parcels to other homebuilders, developers or investors if we believe the sale will provide a greater economic benefit to us than continuing home construction or where we are looking to diversify or divest our land positions in the specific geography. As a result of such sales, we recognized land closing revenue of $8.9 million and $28.6 million for the three and nine months ending September, 2013, respectively, as compared to $7.8 million and $8.8 million for the three and nine months ending September, 2012, respectively.  The majority of the 2013 land sales are from the sale of certain parcels in communities where we continue to hold extended lot positions as well as the sale of certain Nevada assets as part of our wind-down efforts. Gross profit on land sales improved year over year for both the three and nine months ended September 30, 2013 over 2012 as the 2012 land sales of legacy assets purchased at a higher land basis generated close to break-even margins.

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Operating Information (dollars in thousands)
 
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2013
 
2012
 
2013
 
2012
 
Dollars
 
Percent of Home Closing Revenue
 
Dollars
 
Percent of Home Closing Revenue
 
Dollars
 
Percent of Home Closing Revenue
 
Dollars
 
Percent of Home Closing Revenue
Home Closing Gross Profit
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
$
110,375

 
22.8%
 
$
62,154

 
18.6%
 
$
268,340

 
21.5%
 
$
149,213

 
18.2%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
West
$
62,752

 
24.7%
 
$
33,304

 
18.5%
 
$
159,065

 
23.3%
 
$
72,941

 
17.8%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Central
$
27,705

 
20.3%
 
$
18,787

 
18.1%
 
$
64,362

 
18.7%
 
$
49,374

 
17.8%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
East
$
19,918

 
21.4%
 
$
10,063

 
19.8%
 
$
44,913

 
20.2%
 
$
26,898

 
20.1%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Home Closing Gross Profit
Companywide. Home closing gross profit represents home closing revenue less cost of home closings. Cost of home closings include land and lot development costs, direct home construction costs, an allocation of common community costs (such as model complex costs, common community and recreation areas and landscaping, and architectural, legal and zoning costs), interest, sales tax, impact fees, warranty, construction overhead, closing costs, less impairments, if any.
Home closing gross profit increased to a margin of 22.8% and 21.5% for the three and nine months ended September 30, 2013, respectively, as compared to 18.6% and 18.2% for the three and nine months ended September 30, 2012, respectively. The third quarter of 2013 also experienced a 130 basis point improvement in home closing gross profit sequentially from 21.5% in the second quarter of 2013. We have been successful in maintaining and, in many markets, increasing gross profit despite direct cost increases experienced in the homebuilding industry recently. This is mainly attributable to sales price increases, construction overhead leverage as our volume has increased over the last several quarters, as well as our focus on direct costs containment. We believe that with our improving orders, sales price increases, and strong ending backlog numbers, we should see stability and potentially modest growth in our gross profit throughout the remainder of 2013.
West. Our West Region boasted the highest home closing gross margin figures, increasing to 24.7% for the three months ended September 30, 2013 from 18.5% in the same period of 2012. For the first nine months of 2013, home closing gross margin increased to 23.3% from 17.8% in the first nine months of 2012. The significant improvement year over year is largely the result of price increases we have been able to implement in many communities due to improving market conditions, the desirability of our community locations, as well as overhead leverage experienced with increased volumes.
Central. The Central Region’s 20.3% and 18.7% home closing gross margin for the three and nine months ended September 30, 2013 steadily increased from 18.1% and 17.8% for the same periods of 2012. These increases are mostly due to successful price increases that more than offset rising construction costs. The markets within our Central Region have historically reported lower gross margin results than our other markets.
East. This Region reported home closing gross margins of 21.4% and 20.2% for the three and nine months ended September 30, 2013 as compared to 19.8% and 20.1% for the same periods in the prior year. We continue to focus on cost containment measures, opening superior community locations and implementing strategic sales price increases, which collectively have led to a 150 basis point margin improvement sequentially from the second quarter of 2013. Year-to-date margins in this Region are relatively flat year over year as a result of our units mix in the first quarter of 2013 versus 2012, reflecting the lower margins from close out communities.
Financial Services Profit
 
Three Months Ended
 
Nine Months Ended
 
September 30
 
September 30
 
2013
 
2012
 
2013
 
2012
Financial Services Profit
$
4,294

 
$
2,985

 
$
11,515

 
$
6,743


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Financial services profit represents the net profit of our financial services operations, including the operating profit generated by our wholly-owned title company, Carefree Title, as well as our portion of pre-tax earnings from mortgage and title joint ventures. The majority of our financial services profit stems from these mortgage and title joint ventures. In the future, we expect Carefree Title to comprise a greater portion of our financial services profit as it is currently still in its start-up phase and is not yet fully operational in all of our markets. Increases year over year are attributable to the increase in the number of closings processed through our joint ventures and our corresponding profit.

Selling, General and Administrative Expenses and Other Expenses
 
Three Months Ended
 
Nine Months Ended
 
September 30
 
September 30
 
2013
 
2012
 
2013
 
2012
Commissions and Other Sales Costs
 
 
 
 
 
 
 
Dollars
$
33,467

 
$
25,855

 
$
90,526

 
$
67,950

Percent of home closing revenue
6.9
%
 
7.7
%
 
7.2
%
 
8.3
%
General and Administrative Expenses
 
 
 
 
 
 
 
Dollars
$
24,412

 
$
19,209

 
$
66,587

 
$
50,446

Percent of total closing revenue
5.0
%
 
5.6
%
 
5.2
%
 
6.1
%
Interest Expense
 
 
 
 
 
 
 
Dollars
$
3,462


$
5,009


$
13,113

 
$
18,718

Other Income/(Expense), Net
 
 
 
 
 
 
 
Dollars
605

 
(8,276
)
 
$
1,760

 
$
(7,481
)
Loss on Early Extinguishment of Debt
 
 
 
 
 
 
 
Dollars
$
—

 
$
—

 
$
3,796

 
$
5,772

(Provision for)/Benefit from Income Taxes
 
 
 
 
 
 
 
Dollars
$
(18,595
)
 
$
(202
)
 
$
(33,418
)
 
$
4,781


Commissions and Other Sales Costs
Commissions and other sales costs are comprised of internal and external commissions and related sales and marketing expenses such as advertising and sales and model office costs. Reflecting higher homebuilding revenues and the significant increase of actively selling communities, commissions and other sales costs increased by $7.6 million and $22.6 million for the three and nine months ended September 30, 2013, respectively, as compared to the same periods in 2012; however, a percentage of home closing revenue, these costs dropped 80 basis points to 6.9% and 110 basis points to 7.2% for the three and nine months ended September 30, 2013, respectively. The improved ratio in these costs as a percentage of home closing revenue for both the three and nine months is indicative of our continued focus on containing costs as well as our ability to leverage these costs over our increasing revenue.
General and Administrative Expenses
General and administrative expenses represent corporate and divisional overhead expenses such as salaries and bonuses, occupancy, public company expenses, insurance and travel expenses. General and administrative expenses increased year over year to $24.4 million and $66.6 million for the three and nine months ended September 30, 2013 as compared to $19.2 million and $50.4 million for the three and nine months ended September 30, 2012. The increases in dollars incurred is mainly due to increased compensation costs driven by additional staffing volumes and incentive compensation directly tied to operational metrics as well as overhead costs incurred in our new markets. We remain focused on cost control and maintaining overhead leverage at both the divisional and corporate levels. Due to the increase in revenue and improved operating leverage, these expenses decreased 60 and 90 basis points, respectively, to 5.0% and 5.2% of total revenue for the three and nine months ended September 30, 2013, respectively, as compared to the same periods in 2012.
Interest Expense
Interest expense is comprised of interest incurred but not capitalized. For the three and nine months ended September 30, 2013, respectively, our non-capitalizable interest expense was $3.5 million and $13.1 million as compared to $5.0 million and $18.7 million for the same periods in the prior year. The decrease in expense year over year is a result of a higher amount of active assets under development included in our inventory that qualify for interest capitalization. While we anticipate our non-capitalizable interest expense will continue to decrease, we expect our eligible assets under construction to remain below our debt balance for the remainder of 2013, and therefore, we anticipate that we will continue to incur such interest charges for the remainder of this year.



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Other Income/(Expense), Net
Other income, net primarily consists of (i) interest earned on our cash, cash equivalents, investments and marketable securities, (ii) sub lease income, (iii) forfeited deposits from potential homebuyers who canceled their purchase contracts with us, and (iv) payments and awards related to legal settlements. Other income, net, increased for the three and nine months ended September 30, 2013 as compared to the same periods in the prior year primarily due to the $8.7 million litigation reserve charge recorded in the third quarter of 2012.
Loss on Early Extinguishment of Debt
Loss on early extinguishment of debt for the nine months ended September 30, 2013 is attributable to the charges associated with the tender and redemption of the remaining balance of our 2017 senior subordinated notes. The charges represent both the loss on the extinguishment as well as the write off of remaining unamortized capitalized costs related to the notes. Loss on early extinguishment of debt for the nine months ended September 30, 2012 is attributable to the charges associated with the tender and redemption of our 2015 notes and $26.1 million partial tender of our 2017 senior subordinated notes. See Note 5 to the consolidated financial statements for additional discussion. There were no such charges in the three months ended September 30, 2013 or 2012.
Income Taxes     
During the three and nine months ended September 30, 2013, we reported an effective tax rate of 32.7% and 29.9%  compared to 2.9% and (91.0)%, respectively, for the same periods in 2012. The three and nine month tax rates in 2013 include additional reversals of our state deferred tax valuation allowance, the benefit of energy tax credits, and the homebuilder manufacturing deduction. See Note 10 to the consolidated financial statements for additional discussion. Due to the effects of the deferred tax asset valuation allowance and federal and state tax net operating losses, the effective tax rate in 2012 is not meaningful as there is no correlation between the effective tax rate and the amount of pre-tax income or loss for that period.
Liquidity and Capital Resources
We ended the second quarter with $311.3 million of cash and cash equivalents, investments and securities, and restricted cash, a $15.9 million increase from December 31, 2012. Our principal uses of capital for the nine months ended September 30, 2013 were operating expenses, home construction and land development, the payment of routine liabilities, and the acquisition of new and strategic lot and land positions, including our acquisition of Phillips Builders in Tennessee. We used funds generated by operations to meet our short-term working capital requirements. We remain focused on generating positive margins in our homebuilding operations and acquiring desirable land positions in order to maintain a strong balance sheet and keep us poised for growth.

Operating Cash Flow Activities
During the nine months ended September 30, 2013 and September 30, 2012, net cash used in operations totaled $39.5 million and $132.3 million, respectively. The first nine months of 2013 results benefited from cash generated by the $78.4 million in net income and a $106.9 million increase in accounts payable and accrued liabilities offset by the $221.7 million increase in real estate due to land acquisition and development spending along with dollars spent on home inventory under construction.
Net cash used in operations in the first nine months of 2012 was primarily the result of our increase in real estate assets, attributable to land acquisition and development activities as well as an increase in home inventory under construction.
Investing Cash Flow Activities
During the nine months ended September 30, 2013, net cash used in investing activities totaled $36.8 million as compared to net cash provided by investing activities of $70.7 million for the same periods in 2012. Cash used in investing activities in the first nine months of 2013 is mainly attributable to the difference between the $132.9 million in maturities and $139.7 million in purchases of new investments and securities comprised of treasury securities and treasury-backed investments coupled with cash outlays related to acquisitions and purchases of property and equipment to fund model homes in new communities of $18.4 million and $9.7 million, respectively.
Net cash provided by investing activities in the first nine months of 2012 primarily related to the maturities and purchases of investments and securities of $190.7 million and $109.8 million, respectively.
Financing Cash Flow Activities

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During the nine months ended September 30, 2013 net cash provided by financing activities totaled $83.5 million as compared to $192.9 million for the same period in 2012. The net increase in financing cash in both periods is primarily the net result of our capital transactions. During the first nine months ended September 30, 2013 we issued $175.0 million in senior notes and concurrently tendered our 2017 senior subordinated notes for $102.8 million.
    
Overview of Cash Management
Cash flows for each of our communities depend on their stage 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, as well as construction of model homes, roads, utilities, general landscaping and other amenities. Because these costs are a component of our inventory and not recognized in our income statement until a home closes, we incur significant cash outlays prior to recognition of earnings. In the later stages of a community, cash inflows may significantly exceed earnings reported for financial statement purposes, as the cash outflow associated with home and land construction was previously incurred. From a liquidity standpoint, we are currently actively acquiring land and developing lots in our markets to maintain and grow our lot supply and active community count in strategic and attractive locations we deem key to our success. As demand for new homes continues to improve and we expand our business, we expect that cash outlays for land purchases and land development in order to grow our lot inventory in the near term will continue to exceed our cash generated by operations. During the third quarter of 2013, we closed 1,418 homes, purchased approximately 2,700 lots for $93.1 million, spent $73.4 million on land development, and started 1,489 homes. In addition, we spent $11.4 million on deposits to enter into contracts for lots secured with land bankers in the third quarter of 2013. As a means of accessing large parcels of land with minimal cash outlay, we have recently begun to enter into rolling option contracts through land banking arrangements. Such arrangements provide a way of controlling lot inventory through purchasing lots based on predetermined schedules that are structured to mirror our forecasted pace of home construction starts. Purchasing land through these arrangements allows us greater cash leveraging and the opportunity to enter into larger land deals that otherwise would have been prohibitive due to the amount of initial cash outlay they would have required. (See Notes 1 and 3 to the consolidated financial statements for additional information regarding land contract deposits and their associated committed cash). The opportunity to purchase substantially finished lots in desired locations is becoming increasingly more limited and competitive. As a result, we are spending more dollars on land development as we are purchasing more undeveloped land and partially finished lots than in recent years.
We exercise strict controls and believe we have a prudent strategy for Company-wide cash management, including those related to cash outlays for land and inventory acquisition and development. We continuously evaluate our capital needs in light of the improving homebuilding markets and our existing capital structure. In the first half of 2013, we called and paid our $99.8 million of 2017 debt. Accordingly, we have no debt maturities until 2018. In addition, in the second quarter of 2013, we amended our existing $125 million senior unsecured revolving credit facility ("the Credit Facility") to, among other things, extend the facility maturity date by one year from July 24, 2015 to July 24, 2016 and increase the total commitment currently available under the Credit Facility to $135 million and increase the accordion feature to $75 million. See Note 5 to the consolidated financial statements for additional discussion regarding these capital transactions.
We expect to generate cash from the sale of our inventory, but we intend to redeploy that cash to acquire and develop strategic and well-positioned lots that represent opportunities to generate desired margins, as well as for other operating purposes.
In addition to expanding our business in existing markets, we continue to look into opportunities to expand outside of our existing markets. Accordingly, over the last two years, we entered the Raleigh-Durham and Charlotte, North Carolina markets, and the Tampa, Florida market and most recently, we entered the Nashville, Tennessee market through our August 2013 purchase of Phillips Builders. These opportunities expand our footprint into new markets with positive growth potential and the ability to leverage our existing East Region resources.
We may seek additional capital to strengthen our liquidity position to enable us to opportunistically acquire additional land inventory in anticipation of improving market conditions, and/or strengthen our long-term capital structure. Such additional capital may be in the form of equity or debt financing and may be from a variety of sources. There can be no assurances that we would be able to obtain such additional capital on terms acceptable to us, if at all, and such additional equity or debt financing could dilute the interests of our existing stockholders or increase our interest costs. Reference is made to Note 5 in the notes to the unaudited financial statements included in this Quarterly Report on Form 10-Q.
We believe that our leverage ratios provide useful information to the users of our financial statements regarding our financial position and cash and debt management. Debt-to-capital and net debt-to-capital are calculated as follows (dollars in

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thousands): 
 
At September 30, 2013
 
At December 31, 2012
Senior, senior subordinated and senior convertible notes
$
798,337

  
$
722,797

Stockholders’ equity
792,326

  
694,210

Total capital
$
1,590,663

  
$
1,417,007

Debt-to-capital (1)
50.2
%
 
51.0
%
Senior, senior subordinated and senior convertible notes
$
798,337

  
$
722,797

Less: cash and cash equivalents, restricted cash, and investments and securities
(311,334
)
 
(295,469
)
Net debt
487,003

  
427,328

Stockholders’ equity
792,326

  
694,210

Total capital
$
1,279,329

  
$
1,121,538

Net debt-to-capital (2)
38.1
%
 
38.1
%
 
(1)
Debt-to-capital is computed as senior, senior subordinated and senior convertible notes divided by the aggregate of total senior, senior subordinated and senior convertible notes and stockholders’ equity.
(2)
Net debt-to-capital is computed as net debt divided by the aggregate of net debt and stockholders’ equity. The most directly comparable GAAP financial measure is the ratio of debt to total capital. We believe the ratio of net debt-to-capital is a relevant financial measure for investors to understand the leverage employed in our operations and as an indicator of our ability to obtain financing.
We have an automatically effective shelf registration statement on file with the Securities and Exchange Commission that can be used to register offerings of debt and equity securities we may offer.

Credit Facility Covenants
We were in compliance with all Credit Facility covenants as of September 30, 2013. Borrowings under the Credit Facility are unsecured but availability is subject to, among other things, a borrowing base. The Credit Facility also contains certain financial covenants, including (a) a minimum tangible net worth requirement of $360.0 million (which amount is subject to increase over time based on subsequent earnings and proceeds from equity offerings), and (b) a maximum leverage covenant that prohibits the leverage ratio (as defined therein) from exceeding 60%. In addition, we are required to maintain either (i) an interest coverage ratio (EBITDA to interest expense, as defined therein) of at least 1.50 to 1.00 or (ii) liquidity (as defined therein) of an amount not less than our consolidated interest incurred during the trailing 12 months. We had no borrowings drawn on the facility during the quarter or nine months ended September 30, 2013. Our actual financial covenant calculations as of September 30, 2013 are reflected in the table below:
Financial Covenant (dollars in thousands):
Covenant Requirement
 
Actual
Minimum Tangible Net Worth
$504,942
 
$767,970
Leverage Ratio
< 60%
 
35%
Interest Coverage Ratio (1)
> 1.50
 
3.99
Minimum Liquidity (1)
> $50,192
 
$405,430
Investments other than defined permitted investments
< $260,391
 
$10,662
(1)    We are required to meet either the Interest Coverage Ratio or Minimum Liquidity, but not both.
Off-Balance Sheet Arrangements
Reference is made to Notes 1, 3 and 13 in the accompanying notes to unaudited consolidated financial statements included in this Quarterly Report on Form 10-Q. These Notes discuss our off-balance sheet arrangements with respect to land acquisition contracts and option agreements, and land development joint ventures, including the nature and amounts of financial obligations relating to these items. In addition, these Notes discuss the nature and amounts of certain types of commitments that arise in connection with the ordinary course of our land development and homebuilding operations, including commitments of land development joint ventures for which we might be obligated.
Seasonality
Historically, we have experienced seasonal variations in our quarterly operating results and capital requirements. We typically take orders for more homes in the first half of the fiscal year than in the second half, which creates additional working capital requirements in the second and third quarters to build our inventories to satisfy the deliveries in the second half of the

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year. We expect this seasonal pattern to continue over the long-term, although it has been and may continue to be affected by the current recovery in the homebuilding industry.
Recently Issued Accounting Pronouncements.
See Note 1 to the accompanying notes to unaudited consolidated financial statements included in this Quarterly Report on Form 10-Q.
Special Note of Caution Regarding Forward-Looking Statements
In passing the Private Securities Litigation Reform Act of 1995 (“PSLRA”), Congress encouraged public companies to make “forward-looking statements” by creating a safe-harbor to protect companies from securities law liability in connection with forward-looking statements. We intend to qualify both our written and oral forward-looking statements for protection under the PSLRA.
The words “believe,” “expect,” “anticipate,” “forecast,” “plan,” “intend,” "may," "should," "could," “estimate,” and “project” and similar expressions identify forward-looking statements, which speak only as of the date the statement was made. All statements we make other than statements of historical fact are forward-looking statements within the meaning of that term in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements in this Quarterly Report include statements concerning trends in the homebuilding industry in general, and our markets and results specifically; our operating strategy and initiatives; our perceptions about our exposure to loss with respect to our financial instruments and our intention to hold our investments and securities to maturity; our strategic initiatives; that underperforming or mothballed communities will not incur material impairments in the future; the benefits of our land acquisition strategy and structures; that Carefree Title will be fully operational in applicable locations by the end of 2013 and that we will wind down our remaining title joint venture; that we expect to redeploy cash generated from operations to acquire and develop lot positions; management estimates regarding joint venture exposure, including our exposure to joint ventures that are in default of their debt or guarantee agreements; expectations regarding our industry and our business for the remainder of 2013 and beyond; our land and lot acquisition strategy including our expansion plans relating to new markets; the sufficiency of our warranty reserves; demographic and other trends related to the homebuilding industry in general; the future supply of housing inventory; our expectation that existing guarantees, letters of credit and performance and surety bonds will not be drawn on; the adequacy of our insurance coverage and warranty reserves; our strategy, legal positions and the expected outcome of legal proceedings (including the joint venture litigation relating to the South Edge joint venture) we are involved in and the sufficiency of our reserves relating thereto; the sufficiency of our liquidity and capital resources to support our business strategy; our ability and willingness to acquire land under option or contract; the future impact of deferred tax assets or liabilities; the impact of new accounting standards and changes in accounting estimates; trends and expectations concerning sales prices, sales pace, closings, orders, cancellations, construction costs and gross margins, gross profit (including contributions from Carefree Title), revenues, net earnings, number and growth of active communities, seasonality and the timing of new community openings; our future cash needs; the expected vesting periods of unrecognized compensation expense; the benefits of our equity compensation program; that we may seek to raise additional debt and equity capital; that we will continue to incur direct interest expense (versus capitalizing and amortizing through cost of closings); the sufficiency of our reserves and our support for our uncertain tax filings positions and timing of payments relating thereto; our intentions regarding the payment of dividends and the use of derivative contracts and the impact of seasonality and changes in interest rates.
Important factors currently known to management that could cause actual results to differ materially from those in forward-looking statements, and that could negatively affect our business include, but are not limited to, the following: weakness in the homebuilding market resulting from an unexpected setback in the current economic recovery; the availability of finished lots and undeveloped land; interest rates and changes in the availability and pricing of residential mortgages; the availability and cost of materials and labor; adverse changes in tax laws that benefit our homebuyers; the ability of our potential buyers to sell their existing homes; cancellation rates and home prices in our markets; inflation in the cost of materials used to construct homes; the adverse effect of slower order absorption rates; potential write-downs or write-offs of assets, including pre-acquisition costs and deposits; our potential exposure to natural disasters; competition; the adverse impacts of cancellations resulting from small deposits relating to our sales contracts; construction defect and home warranty claims; our success in prevailing on contested tax positions; our ability to preserve our deferred tax assets and use them within the statutory time limits; delays and risks associated with land development; our ability to obtain performance bonds in connection with our development work; the liquidity of our joint ventures and the ability of our joint venture partners to meet their obligations to us and the joint venture; the loss of key personnel; changes in, or our failure to comply with, laws and regulations; our lack of geographic diversification; fluctuations in quarterly operating results; our financial leverage and level of indebtedness; our ability to take certain actions because of restrictions contained in the indentures for our senior notes and our ability to raise additional capital when and if needed; our credit ratings; successful integration of future acquisitions; government regulations

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and legislative or other initiatives that seek to restrain growth or new housing construction or similar measures; acts of war; the replication of our “Green” technologies by our competitors; our exposure to information technology failures and security breaches; and other factors identified in documents filed by the company with the Securities and Exchange Commission, including those set forth in our Form 10-K for the year ended December 31, 2012 under the caption “Risk Factors,” which can be found on our website.
Forward-looking statements express expectations of future events. All forward-looking statements are inherently uncertain as they are based on various expectations and assumptions concerning future events and they are subject to numerous known and unknown risks and uncertainties that could cause actual events or results to differ materially from those projected. Due to these inherent uncertainties, the investment community is urged not to place undue reliance on forward-looking statements. In addition, we undertake no obligations to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to projections over time.
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
As of September 30, 2013 all of our debt is fixed rate and is made up of our $175.0 million in principal of our 4.50% senior notes due 2018, $200.0 million in principal of our 7.15% senior notes due 2020, $300.0 million in principal of our 7.00% senior notes due 2022 and $126.5 million of our 1.875% convertible senior notes due 2032. Except in limited circumstances, we do not have an obligation to prepay our fixed-rate debt prior to maturity and, as a result, interest rate risk and changes in fair value should not have a significant impact on fixed rate of borrowings unless we would be required to refinance such debt. See Note 5 to the accompanying notes to consolidated financial statements included in this Quarterly Report on Form 10-Q for additional discussion.
Our operations are interest rate sensitive. As overall housing demand is adversely affected by increases in interest rates, a significant increase in mortgage interest rates may negatively affect the ability of homebuyers to secure adequate financing. Higher interest rates could adversely affect our revenues, gross margins and net income and would also increase our variable rate borrowing costs, if any. We do not enter into, or intend to enter into, derivative financial instruments for trading or speculative purposes.
 
Item 4.
Controls and Procedures
In order to ensure that the information we must disclose in our filings with the SEC is recorded, processed, summarized and reported on a timely basis, we have developed and implemented disclosure controls and procedures. Our management, with the participation of our chief executive officer and chief financial officer, has reviewed and evaluated the effectiveness of our disclosure controls and procedures, as defined in Securities Exchange Act Rules 13a-15(e) and 15d-15(e), as of the end of the period covered by this Form 10-Q (the “Evaluation Date”). Based on such evaluation, management has concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective in ensuring that information that is required to be disclosed in the reports we file or submit under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that information required to be disclosed in our reports filed or furnished under the Exchange Act is accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow timely decisions regarding required disclosures.
During the fiscal quarter covered by this Form 10-Q, there has not been any change in our internal control over financial reporting that has materially affected, or that is reasonably likely to materially affect, our internal control over financial reporting.

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PART II — OTHER INFORMATION
 
Item 1.
Legal Proceedings
We are involved in various routine legal and regulatory proceedings, including, without limitation, claims and litigation alleging construction defects. In general, the proceedings are incidental to our business, and most exposure is subject to and should be covered by warranty and indemnity obligations of our consultants and subcontractors. Additionally, some such claims are also covered by insurance. With respect to the majority of pending litigation matters, our ultimate legal and financial responsibility, if any, cannot be estimated with certainty and, in most cases, any potential losses related to these matters are not considered probable. Historically, most disputes regarding warranty claims are resolved prior to litigation. We believe there are not any pending legal or warranty matters that could have a material adverse impact upon our consolidated financial condition, results of operations or cash flows.
Joint Venture Litigation
Since 2008, we have been involved in litigation initiated by the lender group for a large Nevada-based land acquisition and unconsolidated development joint venture in which the lenders were seeking damages in two separate actions on the basis of enforcement of completion guarantees and other related claims (JP Morgan Chase Bank, N.A. v. KB HOME Nevada, et al., U.S. District Court, District of Nevada (Case No. 08-CV-01711 PMP Consolidated)). Our interest in this joint venture is comparatively small, totaling 3.53%, but we have vigorously defended and otherwise sought resolution of these actions. We are the only builder joint venture partner to have fully performed its obligations with respect to takedowns of lots from the joint venture, having completed our first takedown in April 2007 and having tendered full performance of our second and final takedown in April 2008. The joint venture and the lender group rejected our tender of performance for our second and final takedown, and we contend, among other things, that the rejection by the joint venture and the lender group of our tender of full performance was wrongful and constituted a breach of contract and should release us of liability with respect to the takedown and extinguish or greatly reduce our exposure under all guarantees. Pursuant to the lenders’ request and stipulation of the parties, on January 23, 2012, the Court dismissed all of the lenders’ claims against Meritage in this consolidated lawsuit without prejudice.
On December 9, 2010, three of the lenders filed a petition seeking to place the venture into an involuntary bankruptcy (JP Morgan Chase Bank, N.A. v. South Edge, LLC (Case No. 10-32968-bam)). On June 6, 2011, we received a demand letter from the lenders, requesting full payment of $13.2 million the lenders claimed to be owed under the springing repayment guarantee, including past-due interest and penalties. The lenders claim that the involuntary bankruptcy filed by three of the co-lenders triggered the springing repayment guarantee. We do not believe the lenders have an enforceable position associated with their $13.2 million claim and do not believe we should be required to pay such amount because, among other reasons, the lenders breached their contract with us by refusing to accept the April 2008 tender of our performance and by refusing to release their lien in connection with our second and final takedown in this project and we do not believe the repayment guarantee was triggered by the lenders’ filing of the involuntary bankruptcy. As a result, on August 19, 2011, we filed a lawsuit against JP Morgan Chase Bank, NA (“JP Morgan”) in the Court of Common Pleas in Franklin County, Ohio (Case No. 11CVH0810353) regarding the repayment guarantee. In reaction to that lawsuit, on August 25, 2011, JP Morgan filed a lawsuit against us in the US District Court of Nevada, which is currently being prosecuted in the name of JP Morgan's agent, ISG Insolvency Group, Inc. regarding most of the same issues addressed in the Ohio litigation (Case No. 2: 11-CV-01364-PMP). The Ohio and Nevada actions have been consolidated into a single action. On October 26, 2011, the Bankruptcy Court approved a plan pursuant to which (i) the lenders have received all payments to which they are entitled, (ii) the project has been conveyed to Inspirada Builders, LLC, which is an entity owned by four of the co-venturers in the South Edge entity (KB Home, Toll Brothers, Pardee Homes and Beazer Homes), and (iii) the four co-venturer builders claim to have succeeded to the lenders’ repayment guarantee claim against Meritage.
On September 4, 2012, the Court ruled on a motion for summary judgment that JP Morgan has standing to pursue its repayment guarantee claims against Meritage, and that Meritage was liable thereunder to JP Morgan and that the parties should be permitted to conduct discovery with respect to the amount of damages to which JP Morgan is entitled under the repayment guarantee. Following limited discovery, JP Morgan filed a motion for summary judgment with respect to damages, and on June 17, 2013 the Court granted the motion, ruling that Meritage owes JP Morgan $15,053,857. Later, on July 8, 2013, the Court entered Judgment in favor of JP Morgan in the amount of $15,753,344, which included an additional $699,487 for pre-judgment interest that accrued between December 6, 2012 and the date of the Judgment. We immediately appealed the Court's rulings, and on July 17, 2013 posted a supersedeas bond in the amount of $16,050,604 staying enforcement of the Judgment, which was approved by the Court on July 17, 2013. Pursuant to a stipulation between the parties, the bond amount included the amount of the Judgment and additional sums for a potential award of post-judgment interest and attorneys' fees on appeal. We disagree with many of the conclusions and findings contained in the Court's order, and have challenged and will continue to challenge the ruling on appeal which is currently pending. In addition, we believe that four co-venturers in the South Edge

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entity (KB Home, Toll Brothers, Pardee Homes and Beazer Homes) are liable to Meritage for any amounts that Meritage may ultimately be required to pay under the repayment guarantee, and we have filed claims against those builders to, among other things, recover from them any amounts Meritage is required to pay under the arbitration repayment guarantee.
In March 2012, Inspirada Builders, LLC (an entity owned by the above named four co-venturers), as Estate Representative of bankrupt South Edge, LLC (the original joint venture) filed demand for arbitration in the United States Bankruptcy Court in the District of Nevada against Meritage Homes of Nevada, Inc. There were two main demands against us contained in this filing. The first is a demand for $13.5 million, relating to alleged breaches of the Operating Agreement of South Edge, LLC, ironically for not paying the amount Meritage fully tendered but South Edge (at the direction of or as a result of acts of or the failure to perform by the above-named co-venture members) rejected in 2008. The second demand was for $9.8 million relating to our supposed pro rata share of alleged future infrastructure improvement costs to be incurred by Inspirada Builders, LLC, which is the new owner of the project, having purchased it through bankruptcy proceedings. The second demand was dismissed on June 27, 2013. The $13.5 million claim identified above represents the same alleged obligation that is the subject of the already pending repayment guarantee litigation between us and JP Morgan that is described above. Meritage has filed a response to Inspirada Builders' arbitration claims denying liability, together with cross-claims against the four above-named co-venture builders for breach of contract, breach of the implied covenant of good faith and fair dealing, and indemnity. The balance of the parties' claims are currently pending and were set to be resolved at an arbitration hearing in late 2013 but pursuant to a stipulation of the parties that arbitration has now been stayed pending resolution of our pending appeal of the Court's rulings in favor of JP Morgan in the federal court action. We do not believe there is any additional exposure to us related to this new claim beyond that already disclosed and discussed in this Legal Proceedings section.
 
Item 1A.
Risk Factors
In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2012, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may eventually prove to materially adversely affect our business, financial condition and/or operating results.

Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities:
We did not acquire any of our own equity securities during the three months ended September 30, 2013.
We have not declared cash dividends for more than ten years, nor do we intend to declare cash dividends in the foreseeable future. We plan to retain our cash to finance the continuing development of the business. Future cash dividends, if any, will depend upon financial condition, results of operations, capital requirements, compliance with certain restrictive debt covenants, as well as other factors considered relevant by our Board of Directors.

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Item 6.
 Exhibits    
Exhibit
Number
 
Description
 
Page or
Method of Filing
 
 
 
 
 
3.1

 
Restated Articles of Incorporation of Meritage Homes Corporation
 
Incorporated by reference to Exhibit 3 of Form 8-K dated June 20, 2002
 
 
 
 
 
3.1.1

 
Amendment to Articles of Incorporation of Meritage Homes Corporation
 
Incorporated by reference to Exhibit 3.1 of Form 8-K dated September 15, 2004
 
 
 
 
 
3.1.2

 
Amendment to Articles of Incorporation of Meritage Homes Corporation
 
Incorporated by reference to Appendix A of the Company’s Definitive Proxy Statement for the 2006 Annual Meeting of Stockholders
 
 
 
 
 
3.1.3

 
Amendment to Articles of Incorporation of Meritage Homes Corporation
 
Incorporated by reference to Appendix B of the Company’s Definitive Proxy Statement for the 2008 Annual Meeting of Stockholders
 
 
 
 
 
3.1.4

 
Amendment to Articles of Incorporation of Meritage Homes Corporation
 
Incorporated by reference to Appendix A of the Company’s Definitive Proxy Statement filed with the Securities and Exchange Commission on January 9, 2009
 
 
 
 
 
3.2

 
Amended and Restated Bylaws of Meritage Homes Corporation
 
Incorporated by reference to Exhibit 3.1 of Form 8-K dated August 21, 2007
 
 
 
 
 
3.2.1

 
Amendment to Amended and Restated Bylaws of Meritage Homes Corporation
 
Incorporated by reference to Exhibit 3.1 of Form 8-K filed on December 24, 2008
 
 
 
 
 
3.2.2

 
Amendment No. 2 to Amended and Restated Bylaws of Meritage Homes Corporation
 
Incorporated by reference to Exhibit 3.1 of Form 8-K dated May 18, 2011
 
 
 
 
 
4.1

 
First Supplemental Indenture (re 4.5% Senior Notes due 2018)
 
Filed herewith
 
 
 
 
 
4.2

 
Second Supplemental Indenture (re 7% Senior Notes due 2022)
 
Filed herewith
 
 
 
 
 
4.3

 
Supplemental Indenture No. 2 (re 1.875% Convertible Senior Notes due 2032)
 
Filed herewith
 
 
 
 
 
4.4

 
Fifth Supplemental Indenture (re 7.15% Senior Notes due 2020)
 
Filed herewith
 
 
 
 
 
31.1

 
Rule 13a-14(a)/15d-14(a) Certificate of Steven J. Hilton, Chief Executive Officer
 
Filed herewith
 
 
 
 
 
31.2

 
Rule 13a-14(a)/15d-14(a) Certificate of Larry W. Seay, Chief Financial Officer
 
Filed herewith
 
 
 
 
 
32.1

 
Section 1350 Certification of Chief Executive Officer and Chief Financial Officer
 
Filed herewith
 
 
 
 
 
101

 
The following financial statements from Meritage Homes Corporation Quarterly Report on Form 10-Q for the quarter ended September 30, 2013, were formatted in XBRL (Extensible Business Reporting Language); (i) Unaudited Consolidated Balance Sheets, (ii) Unaudited Consolidated Income Statements, (iii) Unaudited Consolidated Statements of Cash Flows, and (iv) Notes to Unaudited Consolidated Financial Statements.
 


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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized this 1st day of November 2013.
 
MERITAGE HOMES CORPORATION,
a Maryland Corporation
 
 
 
 
By:
 
/s/
LARRY W. SEAY
 
 
 
Larry W. Seay
 
 
 
Executive Vice President and Chief Financial Officer
 
 
 
(Duly Authorized Officer and Principal Financial Officer)
INDEX OF EXHIBITS
 
3.1
 
Restated Articles of Incorporation of Meritage Homes Corporation
 
 
 
3.1.1
 
Amendment to Articles of Incorporation of Meritage Homes Corporation
 
 
 
3.1.2
 
Amendment to Articles of Incorporation of Meritage Homes Corporation
 
 
 
3.1.3
 
Amendment to Articles of Incorporation of Meritage Homes Corporation
 
 
 
3.1.4
 
Amendment to Articles of Incorporation of Meritage Homes Corporation
 
 
 
3.2
 
Amended and Restated Bylaws of Meritage Homes Corporation
 
 
 
3.2.1
 
Amendment to Amended and Restated Bylaws of Meritage Homes Corporation
 
 
 
3.2.2
 
Amendment No. 2 to Amended and Restated Bylaws of Meritage Homes Corporation
 
 
 
4.1
 
First Supplemental Indenture (re 4.5% Senior Notes due 2018)
 
 
 
4.2
 
Second Supplemental Indenture (re 7% Senior Notes due 2022)
 
 
 
4.3
 
Supplemental Indenture No. 2 (re 1.875% Convertible Senior Notes due 2032)
 
 
 
4.4
 
Fifth Supplemental Indenture (re 7.15% Senior Notes due 2020)
 
 
 
31.1
 
Rule 13a-14(a)/15d-14(a) Certificate of Steven J. Hilton, Chief Executive Officer
 
 
 
31.2
 
Rule 13a-14(a)/15d-14(a) Certificate of Larry W. Seay, Chief Financial Officer
 
 
 
32.1
 
Section 1350 Certification of Chief Executive Officer and Chief Financial Officer
 
 
 
101
 
The following financial statements from Meritage Homes Corporation Quarterly Report on Form 10-Q for the quarter ended September 30, 2013, were formatted in XBRL (Extensible Business Reporting Language); (i) Unaudited Consolidated Balance Sheets, (ii) Unaudited Consolidated Income Statements, (iii) Unaudited Consolidated Statements of Cash Flows, and (iv) Notes to Unaudited Consolidated Financial Statements.


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