MTH

Meritage Homes Corp. 10-K Summary (Fiscal Year Ended Dec 31, 2003)

Business Context and Reporting Period

This Form 10-K covers the fiscal year ended December 31, 2003. Meritage Corporation is a leading designer and builder of single-family homes in the Sunbelt states of Texas, Arizona, California, and Nevada. The company operates through four primary segments: Texas, Arizona, California, and Nevada. At year-end, Meritage was actively selling homes in 123 communities with base prices ranging from $98,000 to $730,000. The company focuses on first-time, move-up, active adult, and luxury markets.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 31% to $1.47 billion, driven by a 23% increase in homes closed (5,642 units) and a 7% increase in average sales price ($259,100).
• Profitability: Net earnings rose 35% to $94.4 million. Gross margin improved to 19.9% from 19.2%, aided by the absence of purchase accounting adjustments related to 2002 acquisitions and pricing power exceeding cost increases.
• Acquisitions: The company completed the acquisition of Citation Homes of Southern California in January 2004. Full-year impacts from 2002 acquisitions (Hammonds Homes in Texas and Perma-Bilt in Nevada) contributed significantly to volume growth.
• Cash Flow: Operating cash flow turned negative ($56.9 million used) compared to a slight positive in 2002, primarily due to increased purchases of real estate and inventory buildup to support growth.
• Debt Structure: The company increased its unsecured credit facility to $400 million and issued $125 million in additional senior notes, increasing total indebtedness to $351.5 million.

Guidance, Outlook, Risks, and Unusual Items

• Outlook: Management expects to deliver substantially all homes in the 2003 backlog during 2004. The company anticipates continued growth driven by strong demographics and low mortgage rates in its Sunbelt markets.
• Unusual Item (Pipeline Rupture): In Q3 2003, a gasoline pipeline ruptured under a Tucson community, damaging five homes under construction. Approximately 24 sales were cancelled. The company incurred ~$400,000 in costs but expects to recover substantially all damages from the pipeline owner (a Fortune 500 company).
• Accounting Risk (FIN 46R): The adoption of FASB Interpretation No. 46R regarding Variable Interest Entities (VIEs) may require the company to consolidate certain land purchase agreements onto the balance sheet. This could impact leverage ratios and liquidity metrics. The company is currently evaluating transactions entered into in Q1 2004.
• Insurance Risk: As of October 1, 2003, the company's insurance policy began excluding mold coverage. Management believes self-insured retentions are sufficient but notes that increased insurance costs or claims could materially affect results.
• Market Risk: The company is exposed to interest rate fluctuations on its variable-rate revolving credit facility ($62.9 million outstanding). A 1% rate increase would increase annual debt service by approximately $630,000.

Investor Verification Checklist

• FIN 46R Impact: Verify the extent to which land option contracts must be consolidated onto the balance sheet in 2004 and the resulting impact on debt-to-equity ratios.
• Backlog Conversion: Monitor the rate at which the $710.8 million backlog is converted to revenue in 2004, noting the historical 25% cancellation rate.
• Land Inventory: Review the composition of the $678 million real estate asset, specifically the ratio of finished lots to land held for development, to assess liquidity risk.
• Debt Covenants: Confirm continued compliance with credit facility covenants, specifically the tangible net worth and debt-to-tangible net worth ratios, given the increased leverage.
• Acquisition Integration: Assess the financial performance of the newly acquired Citation Homes (effective Jan 2004) and the full-year contribution of Hammonds and Perma-Bilt.