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EX-4.3 - EXHIBIT - Meritage Homes CORPa43_mth-edgarxsixthsupplem.htm
EX-31.2 - EXHIBIT - Meritage Homes CORPex312_q22014.htm
EX-4.1 - EXHIBIT - Meritage Homes CORPa41_mth-edgarxsecondsupple.htm
EX-32.1 - EXHIBIT - Meritage Homes CORPex321_q22014.htm
EX-4.6 - EXHIBIT - Meritage Homes CORPa46mth-fourthsupplementali.htm
EX-31.1 - EXHIBIT - Meritage Homes CORPex311_q22014.htm
EX-4.8 - EXHIBIT - Meritage Homes CORPa48_mth-fourthsupplemental.htm
EX-4.2 - EXHIBIT - Meritage Homes CORPa42-mthxthirdsupplementali.htm
EX-4.5 - EXHIBIT - Meritage Homes CORPa45_mth-edgarxthirdsupplem.htm
EX-4.7 - EXHIBIT - Meritage Homes CORPa47_mth-edgarxthirdsupplem.htm
EX-4.4 - EXHIBIT - Meritage Homes CORPa44_mth-seventhsupplementa.htm
EXCEL - IDEA: XBRL DOCUMENT - Meritage Homes CORPFinancial_Report.xls

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 June 30, 2014
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.)
 
 
 
8800 East Raintree Drive, Suite 300
 
 
Scottsdale, Arizona
 
85260
(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 July 29, 2014: 39,121,706



MERITAGE HOMES CORPORATION
FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2014
TABLE OF CONTENTS
 
 
 
 
Items 3-5. Not Applicable
 

2


PART I — FINANCIAL INFORMATION
 
Item 1.
Financial Statements
MERITAGE HOMES CORPORATION AND SUBSIDIARIES
UNAUDITED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
 
 
June 30, 2014
 
December 31, 2013
Assets:
 
 
 
Cash and cash equivalents
$
230,630

 
$
274,136

Investments and securities
59,944

 
89,687

Other receivables
50,695

 
38,983

Real estate
1,638,028

 
1,405,299

Real estate not owned
4,999

 
289

Deposits on real estate under option or contract
58,881

 
51,595

Investments in unconsolidated entities
9,903

 
11,638

Property and equipment, net
28,828

 
22,099

Deferred tax asset
68,289

 
70,404

Prepaids, other assets and goodwill
42,481

 
39,231

Total assets
$
2,192,678

 
$
2,003,361

Liabilities:
 
 
 
Accounts payable
$
83,960

 
$
68,018

Accrued liabilities
151,796

 
166,611

Home sale deposits
27,533

 
21,996

Liabilities related to real estate not owned
4,299

 
289

Senior, convertible senior notes and other borrowings
904,771

 
905,055

Total liabilities
1,172,359

 
1,161,969

Stockholders’ Equity:
 
 
 
Preferred stock, par value $0.01. Authorized 10,000,000 shares; none issued and outstanding at June 30, 2014 and December 31, 2013

 

Common stock, par value $0.01. Authorized 125,000,000 shares; issued 39,121,706 and 36,244,071 shares at June 30, 2014 and December 31, 2013, respectively
391

 
362

Additional paid-in capital
531,403

 
412,961

Retained earnings
488,525

 
428,069

Total stockholders’ equity
1,020,319

 
841,392

Total liabilities and stockholders’ equity
$
2,192,678

 
$
2,003,361

See accompanying notes to unaudited consolidated financial statements

3


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

 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2014
 
2013
 
2014
 
2013
Homebuilding:
 
 
 
 
 
 
 
 
Home closing revenue
$
502,800

 
$
436,040

 
$
908,579

 
$
766,750

 
Land closing revenue
2,804

 
13,910

 
5,370

 
19,635

 
Total closing revenue
505,604

 
449,950

 
913,949

 
786,385

 
Cost of home closings
(392,839
)
 
(342,435
)
 
(706,019
)
 
(608,785
)
 
Cost of land closings
(2,762
)
 
(12,463
)
 
(6,355
)
 
(18,013
)
 
Total cost of closings
(395,601
)
 
(354,898
)
 
(712,374
)
 
(626,798
)
 
Home closing gross profit
109,961

 
93,605

 
202,560

 
157,965

 
Land closing gross profit/(loss)
42

 
1,447

 
(985
)
 
1,622

 
Total closing gross profit
110,003

 
95,052

 
201,575

 
159,587

Financial Services:
 
 
 
 
 
 
 
 
Revenue
2,451

 
1,434

 
4,350

 
2,276

 
Expense
(1,131
)
 
(755
)
 
(2,206
)
 
(1,328
)
 
Earnings from financial services unconsolidated entities and other, net
2,297

 
3,486

 
4,498

 
6,273

 
Financial services profit
3,617

 
4,165

 
6,642

 
7,221

Commissions and other sales costs
(36,105
)
 
(31,180
)
 
(67,039
)
 
(57,059
)
General and administrative expenses
(24,571
)
 
(22,451
)
 
(46,242
)
 
(42,175
)
Loss from other unconsolidated entities, net
(61
)
 
(120
)
 
(230
)
 
(275
)
Interest expense
(1,396
)
 
(4,523
)
 
(4,109
)
 
(9,651
)
Other income, net
3,749

 
685

 
4,397

 
1,155

Loss on early extinguishment of debt

 
(3,096
)
 

 
(3,796
)
Earnings before income taxes
55,236

 
38,532

 
94,994

 
55,007

Provision for income taxes
(20,157
)
 
(10,389
)
 
(34,538
)
 
(14,823
)
Net earnings
$
35,079

 
$
28,143

 
$
60,456

 
$
40,184

Earnings per common share:
 
 
 
 
 
 
 
 
Basic
$
0.90

 
$
0.78

 
$
1.55

 
$
1.12

 
Diluted
$
0.85

 
$
0.74

 
$
1.48

 
$
1.06

Weighted average number of shares:
 
 
 
 
 
 
 
 
Basic
39,118

 
36,151

 
38,904

 
35,976

 
Diluted
41,598

 
38,758

 
41,487

 
38,662




See accompanying notes to unaudited consolidated financial statements

4


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

 
Six Months Ended June 30,
 
2014
 
2013
Cash flows from operating activities:
 
 
 
Net earnings
$
60,456

 
$
40,184

Adjustments to reconcile net earnings to net cash used in operating activities:
 
 
 
Depreciation and amortization
5,182

 
4,658

Stock-based compensation
5,264

 
3,941

Loss on early extinguishment of debt

 
3,796

Excess income tax benefit from stock-based awards
(2,194
)
 
(1,687
)
Equity in earnings from unconsolidated entities
(4,268
)
 
(5,998
)
Deferred tax asset valuation benefit

 
(3,057
)
Distributions of earnings from unconsolidated entities
6,119

 
7,236

Other
3,955

 
4,022

Changes in assets and liabilities:
 
 
 
Increase in real estate
(234,884
)
 
(113,992
)
Increase in deposits on real estate under option or contract
(7,986
)
 
(7,361
)
Increase in receivables and prepaid expenses and other assets
(15,121
)
 
(13,167
)
Increase in accounts payable and accrued liabilities
3,290

 
48,715

Increase in home sale deposits
5,537

 
13,189

Net cash used in operating activities
(174,650
)
 
(19,521
)
Cash flows from investing activities:
 
 
 
Investments in unconsolidated entities
(233
)
 
(116
)
Distributions of capital from unconsolidated entities

 
74

Purchases of property and equipment
(11,864
)
 
(5,787
)
Proceeds from sales of property and equipment
146

 
32

Maturities of investments and securities
65,388

 
71,024

Payments to purchase investments and securities
(35,614
)
 
(76,938
)
Increase in restricted cash

 
(4,327
)
Net cash provided by/(used in) investing activities
17,823

 
(16,038
)
Cash flows from financing activities:
 
 
 
Repayment of senior subordinated notes

 
(102,822
)
Proceeds from issuance of senior notes

 
175,000

Debt issuance costs

 
(1,403
)
Excess income tax benefit from stock-based awards
2,194

 
1,687

Non-controlling interest acquisition

 
(257
)
Proceeds from issuance of common stock, net
110,420

 

Proceeds from stock option exercises
707

 
10,916

          Net cash provided by financing activities
113,321

 
83,121

Net (decrease)/increase in cash and cash equivalents
(43,506
)
 
47,562

Cash and cash equivalents at beginning of period
274,136

 
170,457

Cash and cash equivalents at end of period
$
230,630

 
$
218,019

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

5


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 based on the number of home closings. 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 eight states: Arizona, Texas, California, Colorado, Florida, North Carolina, South Carolina and Tennessee. Through our predecessors, we commenced our homebuilding operations in 1985. We also operate a wholly-owned title company, Carefree Title Agency, Inc. ("Carefree Title"). Carefree Title's core business lines include title insurance and closing/settlement services we offer to our homebuyers. 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 Tennessee, where we operate under the Phillips Builders brand. We also operate as Monterey Homes in some markets. At June 30, 2014, we were actively selling homes in 175 communities, with base prices ranging from approximately $130,000 to $875,000.
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, 2013. 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 to conform with current year presentation, including any adjustments recorded to previously established warranty reserves.

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 $42.5 million and $26.4 million are included in cash and cash equivalents at June 30, 2014 and December 31, 2013, respectively. Included in our cash and cash equivalents balance as of June 30, 2014 and December 31, 2013 are $20.3 million and $68.3 million, respectively, of money market funds that are invested in short term (three months or less) U.S. government securities.
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 not exceeding 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 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.

6


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 a small number of finished lots 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 conducted if indicators of a decline in value of our land and real estate assets exist. If an asset is 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.
Deposits. Deposits paid related to purchase contracts and land options are recorded and classified as Deposits on real estate under option or contract 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. Our deposits were $58.9 million and $51.6 million as of June 30, 2014 and December 31, 2013, 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.

7


The table below outlines our surety bond and letter of credit obligations (in thousands):
 
 
At June 30, 2014
 
At December 31, 2013
 
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
237,310

 
95,882

 
191,742

 
86,115

Total surety bonds
$
237,397

 
$
95,969

 
$
191,829

 
$
86,202

Letters of Credit (“LOCs”):
 
 
 
 
 
 
 
LOCs in lieu of deposits for contracted lots
$
200

 
N/A

 
$
1,685

 
N/A

LOCs for land development
22,043

 
N/A

 
35,883

 
N/A

LOCs for general corporate operations
4,500

 
N/A

 
4,500

 
N/A

Total LOCs
$
26,743

 
N/A

 
$
42,068

 
N/A

Accrued Liabilities. Accrued liabilities consist of the following (in thousands):
 
At June 30, 2014
 
At December 31, 2013
Accruals related to real-estate development and construction activities
$
36,736

 
$
29,992

Payroll and other benefits
26,663

 
36,232

Accrued taxes
11,205

 
22,902

Warranty reserves
20,882

 
21,971

Legal reserves
16,298

 
16,463

Real-estate notes payable (1)
17,036

 
15,993

Other accruals
22,976

 
23,058

Total
$
151,796

 
$
166,611

(1)     Reflects balance of non-recourse notes payable obtained 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 estimate these reserves for the structural 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 changes in trends as information becomes available. A summary of changes in our warranty reserves follows (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Balance, beginning of period
$
21,482

 
$
21,384

 
$
21,971

 
$
22,064

Additions to reserve from new home deliveries
2,759

 
2,666

 
5,035

 
4,737

Warranty claims
(3,859
)
 
(2,706
)
 
(6,624
)
 
(5,457
)
Adjustments to pre-existing reserves
500

 
500

 
500

 
500

Balance, end of period
$
20,882

 
$
21,844

 
$
20,882

 
$
21,844

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 with our contractual relationships and rights with our trades and the general liability insurance we maintain, are sufficient to

8


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 2014, the Financial Accounting Standards Board ("FASB") issued ASU 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant and Equipment (Topic 360) - Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity (“ASU 2014-08”), which changes the criteria for classifying activities as discontinued operations and increases the related disclosure requirements. Pursuant to ASU 2014-08, only disposals representing a strategic shift, such as a major line of business, a major geographical area or a major equity investment, should be presented as a discontinued operation. If the disposal does qualify as a discontinued operation under ASU 2014-08, the entity will be required to provide expanded disclosures. The guidance will be applied prospectively to new disposals and new classifications of disposal groups as held for sale after the effective date. ASU 2014-08 is effective for us on January 1, 2015. We do not anticipate the adoption of ASU 2014-08 will have a material effect on our consolidated financial statements or disclosures.     
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), (“ASU 2014-09”). ASU 2014-09 requires entities to recognize revenue that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services by applying the following steps: (1) identify the contract(s) with a customer; (2 )identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when (or as) the entity satisfies a performance obligation. ASU 2014-09 supersedes the revenue recognition requirements in ASU 605, Revenue Recognition, most industry-specific guidance throughout the industry topics of the Accounting Standards Codification, and some cost guidance related to construction-type and production-type contracts. ASU 2014-09 is effective for us on January 1, 2017. Early adoption is not permitted. We are currently evaluating the potential impact of adopting this guidance on our consolidated financial statements.
In June 2014, the FASB issued ASU 2014-12, Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period (“ASU 2014-12”). ASU 2014-12 requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. A reporting entity should apply existing guidance in ASC 718, Compensation — Stock Compensation, as it relates to awards with performance conditions that affect vesting to account for such awards. The amendments in ASU 2014-12 are effective for us on January 1, 2016. Early adoption is permitted. We do not anticipate the adoption of ASU 2014-12 will have a material effect on our consolidated financial statements or disclosures.


NOTE 2 — REAL ESTATE AND CAPITALIZED INTEREST
Real estate consists of the following (in thousands):
 
At June 30, 2014
 
At December 31, 2013
Homes under contract under construction (1)
$
370,626

 
$
262,633

Unsold homes, completed and under construction (1)
182,719

 
147,889

Model homes (1)
91,509

 
81,541

Finished home sites and home sites under development
890,036

 
813,135

Land held for development (2)
51,012

 
52,100

Land held for sale
28,267

 
19,112

Communities in mothball status (3)
23,859

 
28,889

 
$
1,638,028

 
$
1,405,299

 
(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 June 30,

9


2014, we had four mothballed communities with a carrying value of $21.1 million in our West Region and one mothballed community with a carrying value of $2.8 million in our Central Region. We do not capitalize interest for such mothballed assets, and all ongoing costs of land ownership (i.e. property taxes, homeowner association dues, etc.) are also expensed as incurred.
In the latter part of 2011, we announced our intent to wind-down operations in the Las Vegas, Nevada market. We do not have any remaining operations in Nevada as of June 30, 2014; however, we still own 174 lots that we are marketing for sale. The carrying value of those lots was $10.1 million as of June 30, 2014, which is classified as land held for sale.
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):
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Capitalized interest, beginning of period
$
38,701

 
$
24,198

 
$
32,992

 
$
21,600

Interest incurred
14,382

 
12,642

 
28,638

 
25,368

Interest expensed
(1,396
)
 
(4,523
)
 
(4,109
)
 
(9,651
)
Interest amortized to cost of home and land closings
(7,332
)
 
(6,023
)
 
(13,166
)
 
(11,023
)
Capitalized interest, end of period (1)
$
44,355

 
$
26,294

 
$
44,355

 
$
26,294

 
(1)
Approximately $511,000 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 June 30, 2014 and December 31, 2013.
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 land 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.” Historically, such consolidations have been immaterial to our financial statements, and the liabilities related to consolidated VIEs are excluded from our debt covenant calculations.
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.





10


The table below presents a summary of our lots under option or contract at June 30, 2014 (dollars in thousands): 
 
Projected
Number of
Lots
 
Purchase
Price
 
Option/Earnest
Money Deposits
Cash
 
Purchase and option contracts recorded on balance sheet as Real estate not owned
70

 
$
4,999

 
$
700

  
Option contracts not recorded on balance sheet - non-refundable deposits, committed (1)
4,168

 
363,242

 
41,918

 
Purchase contracts not recorded on balance sheet — non-refundable deposits, committed (1)
2,224

 
128,122

 
13,997

  
Purchase contracts not recorded on balance sheet — refundable deposits, committed
1,071

 
38,342

 
675

  
Total committed (on and off balance sheet)
7,533

 
534,705

 
57,290

  
Total purchase and option contracts not recorded on balance sheet — refundable deposits, uncommitted (2)
3,455

 
136,509

 
2,291

  
Total lots under contract or option
10,988

 
$
671,214

 
$
59,581

  
Total option contracts not recorded on balance sheet (3)
10,918

 
$
666,215

 
$
58,881

(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 June 30, 2014.
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 these ventures 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 June 30, 2014, 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: Repayment Guarantees and Completion Guarantees, described in more detail below. Additionally, we have classified separately a guarantee related to our minority ownership in the South Edge joint venture, as there is pending litigation with the successors -in-trust to the venture’s lender group and other venture partners regarding that guarantee.

11


(In thousands)
At June 30, 2014
 
At December 31, 2013
Repayment guarantees
$

 
$

Completion guarantees (1)

 

South Edge guarantee (2)
13,243

 
13,243

Total guarantees
$
13,243

 
$
13,243

 
(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 June 30, 2014 and December 31, 2013 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 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. Upon the occurrence of specific events, 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 would represent the portion of the total joint venture obligation related to our relative ownership percentage. Except as noted above and in Note 13 to these unaudited consolidated financial statements, as of June 30, 2014 and December 31, 2013, we did not have any such reserves.
We also participate in one mortgage joint venture, which is engaged in mortgage activities and provides services to both our homebuyers as well as other buyers. Our investment in this joint venture as of June 30, 2014 and December 31, 2013 was $1.2 million and $2.9 million, respectively. Prior year balances included investments in wind down title joint ventures that are no longer in operation.
    




12


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):
 
At June 30, 2014
 
At December 31, 2013
Assets:
 
 
 
Cash
$
3,316

 
$
7,299

Real estate
34,968

 
34,949

Other assets
3,223

 
3,067

Total assets
$
41,507

 
$
45,315

Liabilities and equity:
 
 
 
Accounts payable and other liabilities
$
3,701

 
$
2,889

Notes and mortgages payable
13,555

 
13,453

Equity of:
 
 
 
Meritage (1)
7,841

 
10,332

Other
16,410

 
18,641

Total liabilities and equity
$
41,507

 
$
45,315

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Revenue
$
6,614

 
$
9,994

 
$
11,923

 
$
16,398

Costs and expenses
(3,112
)
 
(3,833
)
 
(5,865
)
 
(6,210
)
Net earnings of unconsolidated entities
$
3,502

 
$
6,161

 
$
6,058

 
$
10,188

Meritage’s share of pre-tax earnings (1)(2)
$
2,236

 
$
3,371

 
$
4,268

 
$
6,005

 
(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 written down 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 “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 at both June 30, 2014 and December 31, 2013 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. No amortization was recorded for these assets in the three and six months ended June 30, 2014 with a de minimus amount of amortization recorded for the same periods in 2013.
The joint venture assets and liabilities noted in the table above primarily represent two active land ventures, one mortgage venture and various inactive ventures in which we have a total investment of $9.9 million. As of June 30, 2014, we believe these ventures are in compliance with their respective debt agreements, if applicable, and such debt is non-recourse to us.

13


NOTE 5 — SENIOR, CONVERTIBLE SENIOR NOTES AND OTHER BORROWINGS
    
Senior, convertible senior notes and other borrowings consist of the following (in thousands):
 
 
At June 30, 2014
 
At December 31, 2013
4.50% senior notes due 2018
175,000

 
175,000

7.15% senior notes due 2020. At June 30, 2014 and December 31, 2013 there was approximately $3,271 and $3,555 in net unamortized premium, respectively
303,271

 
303,555

7.00% senior notes due 2022
300,000

 
300,000

1.875% convertible senior notes due 2032
126,500

 
126,500

$400 million unsecured revolving credit facility

 

 
$
904,771


$
905,055

In the second quarter of 2014, we entered into an amended and restated unsecured, four years revolving credit facility (the “Credit Facility”). The Credit Facility provides for total lending commitments of up to $400 million, $200 million of which is available for letters of credit. In addition, the Credit Facility has an accordion feature under which we may increase the total commitment by a maximum aggregate amount of $100 million, subject to certain conditions, including the availability of additional bank commitments. The Credit Facility matures June 13, 2018 and amends, restates and replaces our previous $200 million unsecured revolving credit facility. No amounts were drawn under the current or previous Credit Facility as of June 30, 2014 or December 31, 2013 or at any time during the six months ended June 30, 2014. As of June 30, 2014, we had outstanding letters of credit totaling $26.7 million, leaving $373.3 million under the Credit Facility available to be drawn.

Borrowings under our unsecured revolving 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 $670.3 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.
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.
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.
The convertible senior notes are convertible into shares of our common stock at a conversion rate of 17.1985 shares of our common stock per $1,000 principal amount of Convertible Notes, or a conversion price of $58.14 per share.

14


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.

     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):
 
 
 
June 30, 2014
 
December 31, 2013
 
Hierarchy
Aggregate
Principal
 
Estimated
Fair Value
 
Aggregate
Principal
 
Estimated
Fair Value
4.50% senior notes
Level 2
 
$
175,000

 
$
179,813

 
$
175,000

 
$
174,125

7.15% senior notes
Level 2
 
$
300,000

 
$
334,500

 
$
300,000

 
$
325,500

7.00% senior notes
Level 2
 
$
300,000

 
$
330,390

 
$
300,000

 
$
318,750

1.875% convertible senior notes
Level 2
 
$
126,500

 
$
132,667

 
$
126,500

 
$
142,154

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.




15


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 June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Basic weighted average number of shares outstanding
39,118

 
36,151

 
38,904

 
35,976

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

 
2,176

 
2,176

 
2,176

Stock options and unvested restricted stock
304

 
431

 
407

 
510

Diluted weighted average shares outstanding
41,598

 
38,758

 
41,487

 
38,662

 
 
 
 
 
 
 
 
Net earnings as reported
$
35,079

 
$
28,143

 
$
60,456

 
$
40,184

Interest attributable to convertible senior notes, net of income taxes
378

 
393

 
757

 
782

Net earnings for diluted earnings per share
$
35,457

 
28,536

 
$
61,213

 
40,966

Basic earnings per share
$
0.90

 
$
0.78

 
$
1.55

 
$
1.12

Diluted earnings per share (1)
$
0.85

 
$
0.74

 
$
1.48

 
$
1.06

Antidilutive stock options not included in the calculation of diluted earnings per share
254

 
5

 
20

 
3

(1)
In accordance with ASC Subtopic 260-10, Earnings Per Share, 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: 
 
Six Months Ended June 30, 2014
 
(In thousands)
 
Number of
Shares
 
Common
Stock
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Total
Balance at December 31, 2013
36,244

 
$
362

 
$
412,961

 
$
428,069

 
$
841,392

Net earnings

 

 

 
60,456

 
60,456

Exercise/vesting of equity awards
348

 
4

 
703

 

 
707

Excess income tax benefit from stock-based awards

 

 
2,194

 

 
2,194

Equity award compensation expense

 

 
5,264

 

 
5,264

Issuance of stock (1)
2,530

 
25

 
110,395

 

 
110,420

Other

 

 
(114
)
 

 
(114
)
Balance at June 30, 2014
39,122

 
$
391

 
$
531,403

 
$
488,525

 
$
1,020,319


16


 
 
Six Months Ended June 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

 

 

 
40,184

 
40,184

Exercise/vesting of equity awards
603

 
6

 
10,910

 

 
10,916

Excess income tax benefit from stock-based awards

 

 
1,687

 

 
1,687

Equity award compensation expense

 

 
3,941

 

 
3,941

Non-controlling interest acquisition

 

 
(257
)
 

 
(257
)
Balance at June 30, 2013
36,216

 
$
362

 
$
406,530

 
$
343,789

 
$
750,681

(1) In January 2014, we issued 2,530,000 shares of common stock in a secondary public offering, par value $0.01 per share, at a price of $45.75 per share.

NOTE 9 — STOCK-BASED COMPENSATION
We have a stock compensation plan, the Amended and Restated 2006 Stock Incentive Plan (the “Plan”), that was adopted in 2006 and was amended and restated effective May 2014. 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, restricted stock units, 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 10,050,000 shares of common stock, of which 1,553,578 shares remain available for grant at June 30, 2014. The remaining shares available for grant are inclusive of a stockholder approved share increase of 1,100,000 shares that occurred at our May 2014 annual meeting of stockholders. 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. We have not granted any stock option awards since 2009.
Compensation cost related to time-based restricted stock awards is measured as of the closing price on the date of grant and is expensed on a straight-line basis over the vesting period of the award. Compensation cost related to performance-based restricted stock awards is also measured as of the closing price on the date of grant but is 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 June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Stock-based compensation expense
$
2,853

 
$
2,097

 
$
5,264

 
$
3,941

Non-vested shares granted
19,400

 
10,000

 
374,683

 
342,100

Performance-based non-vested shares granted

 

 
52,083

 
62,500

Stock options exercised

 
199,827

 
40,245

 
322,100

Restricted stock awards vested (includes performance-based awards)
7,220

 
6,200

 
307,390

 
280,800


17


The following table includes additional information regarding the Plan (dollars in thousands):
 
As of
 
June 30, 2014
 
December 31, 2013
Unrecognized stock-based compensation cost
$
27,668

 
$
17,385

Weighted average years remaining vesting period
2.66

 
2.18

Total equity awards outstanding (1)
1,336,921

 
1,317,710

 
(1)    Includes vested and unvested options outstanding and unvested restricted stock awards.
NOTE 10INCOME TAXES
Components of the income tax (provision)/benefit are as follows (in thousands): 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Federal
$
(17,976
)
 
$
(11,919
)
 
$
(30,858
)
 
$
(15,694
)
State, net of federal benefit
(2,181
)
 
1,530

 
(3,680
)
 
871

Total
$
(20,157
)
 
$
(10,389
)
 
$
(34,538
)
 
$
(14,823
)
The effective tax rate for the three and six months ended June 30, 2014, is 36.5%and 36.4%, respectively, and for the three and six months ended June 30, 2013 was 27.0% and 26.9% respectively; reflecting the homebuilder manufacturing deduction in 2014, and the benefit of energy tax credits and a partial reversal of the state valuation allowance on our deferred tax assets during 2013.
At June 30, 2014 and December 31, 2013, 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 net operating losses ("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 and NOL carryovers during 2008 due to economic conditions and the weight of negative evidence at that time. During 2012 and 2013, we evaluated the weight of the evidence by each jurisdiction and determined that the positive evidence exceeded the negative evidence in all jurisdictions. The valuation allowances were accordingly reversed during 2012 and 2013. At June 30, 2014 and December 31, 2013, we no longer have a valuation allowance against any of our deferred tax assets and state NOL carryovers.
Our future NOL and deferred tax asset realization depends on sufficient taxable income in the carryforward periods under existing tax laws. 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 June 30, 2014, we had no federal NOL carryforward benefit and no federal tax credit carryforwards and net tax benefits for state NOL carryforwards of $11.5 million that expire at various times from 2014 to 2031 depending on the state jurisdiction.
At June 30, 2014, we have income taxes payable of $6.6 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 amending prior-year tax returns. This amount is recorded in accrued liabilities in the accompanying balance sheet as of June 30, 2014.
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 2009. We are not subject to any federal income tax examinations at this time. We have one state income tax examination pending.
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

18


performed as of June 30, 2014, 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 had 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 $1.7 million in 2013 related to the extension of the IRC §45L tax credit for the qualifying new energy efficient homes that we closed in 2012. Additional IRC §45L credits for qualifying homes sold in 2013 produced a net benefit of $2.0 million. At this time, Congress has not extended the benefit of §45L beyond 2013.
NOTE 11 — SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
The following presents certain supplemental cash flow information (in thousands):
 
 
Six Months Ended June 30,
 
2014
 
2013
Cash paid during the period for:
 
 
 
Interest, net of interest capitalized
$
2,413

 
$
7,061

Income taxes
$
41,519

 
$
992

Non-cash operating activities:
 
 
 
Real estate not owned
$
4,710

 
$

Real estate acquired through notes payable
$
1,043

 
1,388

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. These segments are engaged in the business of acquiring and developing land, constructing homes, marketing and selling those homes, and providing warranty and customer services. We aggregate our homebuilding operating segments into reporting segments based on similar long-term economic characteristics and geographical proximity. 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.

19


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. Each reportable segment follows the same accounting policies described in our 2013 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 June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Homebuilding revenue (1):
 
 
 
 
 
 
 
West
$
231,965

 
$
246,741

 
$
424,646

 
$
435,946

Central
160,143

 
127,310

 
279,858

 
218,099

East
113,496

 
75,899

 
209,445

 
132,340

Consolidated total
$
505,604

 
$
449,950

 
$
913,949

 
$
786,385

Homebuilding segment operating income:
 
 
 
 
 
 
 
West
$
27,384

 
$
34,895

 
$
52,194

 
$
54,058

Central
18,720

 
7,263

 
28,189

 
9,643

East
10,580

 
6,765

 
21,244

 
10,001

Total homebuilding segment operating income
56,684

 
48,923

 
101,627

 
73,702

Financial services profit
3,617

 
4,165

 
6,642

 
7,221

Corporate and unallocated (2)
(7,357
)
 
(7,502
)
 
(13,333
)
 
(13,349
)
Loss from other unconsolidated entities, net
(61
)
 
(120
)
 
(230
)
 
(275
)
Interest expense
(1,396
)
 
(4,523
)
 
(4,109
)
 
(9,651
)
Other income, net
3,749

 
685

 
4,397

 
1,155

Loss on early extinguishment of debt

 
(3,096
)
 

 
(3,796
)
Earnings before income taxes
$
55,236

 
$
38,532

 
$
94,994

 
$
55,007

 
(1)
Homebuilding revenue includes the following land closing revenue, by segment:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Land closing revenue:
 
 
 
 
 
 
 
West
$

 
$
100

 
$
1,050

 
$
5,741

Central
581

 
10,340

 
2,097

 
10,424

East
2,223

 
3,470

 
2,223

 
3,470

Consolidated total
$
2,804

 
$
13,910

 
$
5,370

 
$
19,635


(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.


20


 
At June 30, 2014
 
West
 
Central
 
East
 
Financial Services
 
Corporate and
Unallocated
 
Total
Deposits on real estate under option or contract
$
19,783

 
$
25,010

 
$
14,088

 
$

 
$

 
$
58,881

Real estate
908,667

 
439,342

 
290,019

 

 

 
1,638,028

Investments in unconsolidated entities
204

 
8,572

 

 

 
1,127

 
9,903

Other assets (1)
45,160

 
183,505

 
36,707

 
570

 
219,924

 
485,866

Total assets
$
973,814

 
$
656,429

 
$
340,814

 
$
570

 
$
221,051

 
$
2,192,678

 
 
At December 31, 2013
 
West
 
Central
 
East
 
Financial Services
 
Corporate and
Unallocated
 
Total
Deposits on real estate under option or contract
$
26,415

 
$
12,198

 
$
12,982

 
$

 
$

 
$
51,595

Real estate
800,288

 
369,464

 
235,547

 

 

 
1,405,299

Investments in unconsolidated entities
204

 
8,941

 
50

 

 
2,443

 
11,638

Other assets (1)
26,900

 
165,403

 
31,372

 
497

 
310,657

 
534,829

Total assets
$
853,807

 
$
556,006

 
$
279,951

 
$
497

 
$
313,100

 
$
2,003,361

 
(1)    Balance consists primarily of cash and securities and our deferred tax asset.
NOTE 13COMMITMENTS AND CONTINGENCIES
We are involved in various routine legal proceedings incidental to our business, some of which are covered by insurance. 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 June 30, 2014, we have reserved approximately $16.3 million related to non-warranty related litigation and asserted claims, which includes reserves for the Joint Venture Litigation discussed below. In addition, our $20.9 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 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.
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

21


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. On February 14, 2014 the Court awarded JP Morgan an additional $877,241 for pre-judgment attorneys’ fees.  Meritage has appealed this Judgment as well, and per stipulation of the parties, has posted an amended bond in the total amount of $16,930,477, covering both judgments. 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.

22



NOTE 14 — SUBSEQUENT EVENTS
On July 10, 2014 we announced a definitive agreement to acquire the homebuilding assets and operations of Atlanta-based Legendary Communities ("Legendary"). We expect to close this transaction in the third quarter of 2014 for approximately $130 million.
Legendary was founded in 2009 and builds homes primarily for first and second move-up buyers with base home prices ranging from approximately $120,000 to $550,000. Legendary closed approximately 500 homes and generated approximately $156 million of revenue in 2013. As of June 30, 2014, Legendary owned or controlled approximately 4,000 home sites, mostly through option contracts.

23


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

Most housing markets continued to benefit from generally favorable conditions in the second quarter of 2014, with relatively low inventories of homes available and an improving economy and job market that have helped lead to steady housing demand. While sales pace moderated over the past several quarters and overall housing affordability has declined somewhat, we are still benefiting from good customer interest and traffic in our communities that translate into generally steady order demand and pricing power in most markets.

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. Results vary in our individual housing markets, but in most of our markets we are placing more emphasis on increasing pricing power over sales pace in order to maximize our profitability. This has resulted in increasing average sales prices and margins and a corresponding slowdown in orders pace in our year over year results. We offer our buyers the ability to personalize their homes and we provide a home warranty, successfully setting us apart from the competition we face with resale homes. We also 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. Our consistent operating and financial results during the three and six months ended June 30, 2014 are reflected in our improved profitability over the same periods in 2013.
Company Actions and Positioning
As the homebuilding market continues to improve, albeit at a more stabilized pace than in the prior year, we remain focused on our main goals of growing our orders and revenue, and generating profit while maintaining a strong balance sheet. To help meet these goals we continue to execute on the following initiatives:

Strategic expansion through acquisitions into new markets that indicate positive long-term growth trends:
Announced in July 2014 our plans to enter the Atlanta, Georgia, and Greenville, South Carolina markets and grow our Charlotte, North Carolina operations through the pending acquisition of Legendary Communities;
Entered the Nashville, Tennessee market through the acquisition of the assets and operations of Phillips Builders in August 2013, acquiring approximately 500 lots;
Strengthening our balance sheet:
Completed two new senior note issuances in 2013, and extended our earliest debt maturities until 2018;
Increased the capacity of our unsecured revolving credit facility to $400 million in the second quarter of 2014;
Completed an equity offering in January 2014;
Increased the percentage of controlled lots through optioned contracts in order to minimize initial cash outlays for land purchases;
Continuing to actively acquire and develop lots in markets we deem key to our success in order to maintain and strategically grow our lot supply and active community count over the long term; increasing controlled lots by 14.2% year over year;
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 all new homes we construct (except those we construct in areas in which we have recent acquisitions), 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;
Focusing our purchasing efforts to manage cost increases; 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 strategic acquisitions mentioned above, we also continue to acquire lot positions within our existing geographic footprint through with an increased usage of 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 to the unaudited consolidated financial statements for additional information related to option contracts).
    
In the second quarter of 2014, we opened 13 new communities while closing out 27 communities, ending the quarter with 175 active communities. Year over year, our average active community count increased by 9.3%, and we expect it to

24


increase in the last half of 2014 as we continue to focus on growing our land positions and strategically increasing our active community count in preferred locations. Our active community count decreased sequentially from the first quarter of 2014 mainly due to delays in obtaining governmental plan approvals which postponed community openings. We expect our total community count to increase in the third quarter as these delayed communities come on line.
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. During 2014, we took steps to strengthen our balance sheet through two capital transactions. In the first quarter of 2014 we issued common stock, raising $110.4 million, net of offering costs, in a public offering. In the second quarter of 2014, we replaced our prior unsecured revolving credit facility with a new and expanded facility of $400 million. (See Note 5 to the accompanying unaudited consolidated financial statements for further discussion regarding our debt).
Summary Company Results    
We began 2014 with higher beginning backlog and have been successful in maintaining increased backlog year-over-year. Home closing revenue and net earnings increased by 15.3% and 24.6%, respectively, over the second quarter of 2013, whereas growth in new home orders has slowed somewhat with relatively flat year-over-year results. We believe our focus on community placement, coupled with our appealing Meritage Green energy efficiency product offerings, as well as improving general and economic conditions will help to drive demand as the year moves forward that will help us continue to generate positive trends in closing revenue and net earnings.
In the second quarter of 2014, we experienced improvements in many of our key operating and financial metrics both year-over-year and sequentially from the first quarter of 2014. We recorded 1,368 closings and $502.8 million in associated revenue, reflecting a moderate 3.6% rise in closing units and more notably an 11.3% increase in averages sales prices translating to a 15.3% increase in revenue over 2013. We experienced a slight increase in home orders year over year with 1,647 and 1,637 orders in the second three months of 2014 and 2013, respectively and an 8.0% increase over the first quarter of 2014. Our average orders pace was 9.0 units in the second quarter of 2014 down from 9.8 for the same period in 2013, which to some extent reflects the effect that recent interest rate and home price increases have had as home buyers adjust to the recovering market, as well as general slowing in specific markets. Individual markets have responded to the changes in the real estate environment differently, with our West Region posting declines year-over-year in both orders and orders pace whereas the East and Central Regions reported gains in both metrics. The West Region declines are largely due to the very strong results that 2013 posted, which were unsustainable for the long-term, as well as a softening housing market in Arizona.
Through our efforts to focus on optimizing profitability, we recorded an increase year-over year in home closing gross margin during the three months ended June 30, 2014, up from 21.5% in 2013 to 21.9% in 2014. Our 40-basis point improvement stems largely from the higher average sales prices we generated from orders in the latter half of 2013, although that does represent a drop sequentially from 22.8% reported in the first quarter of 2014. The first quarter 2014 results benefited largely from the increased average prices generated in 2013 that closed in the first quarter of 2014, particularly in the West Region. In the second quarter, our Central Region increased in both volume and gross margin, which helped to offset some of the declines in the West Region. We anticipate the comparative results in units and average sales prices to continue to temper sequentially as we progress further into the year. We believe that the current housing environment still has room for growth, although comparative positive year over year revenue and profitability trends are and will continue to be difficult as we began experiencing notable and sustained improvement throughout all of 2013. However, we expect that our comparisons on year over year orders should ease as the significant 2013 gains began to slow as the year progressed into its second half.
The $66.8 million increase in home closing revenue is primarily driven by the $37,400 or 11.3% increase in average sales price and to a lesser extent the 47 additional closing units for the three months ended June 30, 2014 as compared to the same period in the prior year. Increased average sales prices for homes closed were realized in every state in which we operate. Much of that increase is due to changes in product mix as more of our closings in recent quarters are from higher-priced and larger product offerings. We reported pre-tax earnings and net earnings of $55.2 million and $35.1 million, respectively for the three months ended June 30, 2014, as compared to $38.5 million and $28.1 million, respectively, for the same period in 2013, highlighting our ability to leverage the higher average sales prices we earned. Our increased tax rate for the both the three and six months ended June 30, 2014 was higher than the same periods in 2013 largely due to the absence in 2014 of energy tax credits and a partial reversal of the state valuation allowance on our deferred tax assets that occurred during 2013. We expect improving year over year revenue and profitability for the remainder of the year, as indicated by our 18.0% and 11.6% higher ending backlog dollars and units, respectively, although the pace of margin growth is expected to level out due to slowing in certain markets.
At June 30, 2014, our backlog of $951.6 million reflects an increase of $145.3 million, when compared to backlog at June 30, 2013. The improvement is the result of increased sales prices on orders for the first half of 2014. In the second quarter
of 2014, we maintained a low cancellation rate on home orders at 13% of gross orders, as compared to 11% in the second quarter of 2013, both of which were 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 and warranty reserves. There have been no significant changes to our critical accounting policies during the six months ended June 30, 2014 compared to those disclosed in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in our 2013 Annual Report on Form 10-K.
    

25


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 June 30,
 
Quarter over Quarter
 
2014
 
2013
 
Chg $
 
Chg %
Total
 
 
 
 
 
 
 
Dollars
$
502,800

 
$
436,040

 
$
66,760

 
15.3
 %
Homes closed
1,368

 
1,321

 
47

 
3.6
 %
Avg sales price
$
367.5

 
$
330.1

 
$
37.4

 
11.3
 %
West Region
 
 
 
 
 
 
 
Arizona
 
 
 
 
 
 
 
Dollars
$
84,606

 
$
79,736

 
$
4,870

 
6.1
 %
Homes closed
252

 
251

 
1

 
0.4
 %
Avg sales price
$
335.7

 
$
317.7

 
$
18.0

 
5.7
 %
California
 
 
 
 
 
 
 
Dollars
$
95,067

 
$
124,818

 
$
(29,751
)
 
(23.8
)%
Homes closed
185

 
297

 
(112
)
 
(37.7
)%
Avg sales price
$
513.9

 
$
420.3

 
$
93.6

 
22.3
 %
Colorado
 
 
 
 
 
 
 
Dollars
$
52,292

 
$
37,001

 
$
15,291

 
41.3
 %
Homes closed
115

 
100

 
15

 
15.0
 %
Avg sales price
$
454.7

 
$
370.0

 
$
84.7

 
22.9
 %
Nevada
 
 
 
 
 
 
 
Dollars
N/A

 
$
5,086

 
N/M

 
N/M

Homes closed
N/A

 
21

 
N/M

 
N/M

Avg sales price
N/A

 
$
242.2

 
N/M

 
N/M

West Region Totals
 
 
 
 
 
 
 
Dollars
$
231,965

 
$
246,641

 
$
(14,676
)
 
(6.0
)%
Homes closed
552

 
669

 
(117
)
 
(17.5
)%
Avg sales price
$
420.2

 
$
368.7

 
$
51.5

 
14.0
 %
Central Region - Texas
 
 
 
 
 
 
 
Central Region Totals
 
 
 
 
 
 
 
Dollars
$
159,562

 
$
116,970

 
$
42,592

 
36.4
 %
Homes closed
524

 
449

 
75

 
16.7
 %
Avg sales price
$
304.5

 
$
260.5

 
$
44.0

 
16.9
 %
East Region
 
 
 
 
 
 
 
Carolinas
 
 
 
 
 
 
 
Dollars
$
36,127

 
$
19,273

 
$
16,854

 
87.4
 %
Homes closed
89

 
51

 
38

 
74.5
 %
Avg sales price
$
405.9

 
$
377.9

 
$
28.0

 
7.4
 %
Florida
 
 
 
 
 
 
 
Dollars
$
60,732

 
53,156

 
$
7,576

 
14.3
 %
Homes closed
155

 
152

 
3

 
2.0
 %
Avg sales price
$
391.8

 
349.7

 
$
42.1

 
12.0
 %
Tennessee
 
 
 
 
 
 
 
Dollars
$
14,414

 
N/A

 
N/M

 
N/M

Homes closed
48

 
N/A

 
N/M

 
N/M

Avg sales price
$
300.3

 
N/A

 
N/M

 
N/M

East Region Totals
 
 
 
 
 
 
 
Dollars
$
111,273

 
$
72,429

 
$
38,844

 
53.6
 %
Homes closed
292

 
203

 
89

 
43.8
 %
Avg sales price
$
381.1

 
$
356.8

 
$
24.3

 
6.8
 %

26


 
 
 
 
 
 
 
 
 
Six Months Ended June 30,
 
Year over Year
 
2014
 
2013
 
Chg $
 
Chg %
Total
 
 
 
 
 
 
 
Dollars
$
908,579

 
$
766,750

 
$
141,829

 
18.5
 %
Homes closed
2,477

 
2,373

 
104

 
4.4
 %
Avg sales price
$
366.8

 
$
323.1

 
$
43.7

 
13.5
 %
West Region
 
 
 
 
 
 
 
Arizona
 
 
 
 
 
 
 
Dollars
$
156,388

 
$
136,885

 
$
19,503

 
14.2
 %
Homes closed
463

 
443

 
20

 
4.5
 %
Avg sales price
$
337.8

 
$
309.0

 
$
28.8

 
9.3
 %
California
 
 
 
 
 
 
 
Dollars
$
174,994

 
$
215,460

 
$
(40,466
)
 
(18.8
)%
Homes closed
350

 
525

 
(175
)
 
(33.3
)%
Avg sales price
$
500.0

 
$
410.4

 
$
89.6

 
21.8
 %
Colorado
 
 
 
 
 
 
 
Dollars
$
92,214

 
$
69,205

 
$
23,009

 
33.2
 %
Homes closed
204

 
194

 
10

 
5.2
 %
Avg sales price
$
452.0

 
$
356.7

 
$
95.3

 
26.7
 %
Nevada
 
 
 
 
 
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