UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark one)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2010

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 (State or Other Jurisdiction of Incorporation or Organization)		86-0611231 (I.R.S. Employer Identification No.)
17851 North 85th Street, Suite 300
Scottsdale, Arizona		85255
(Address of Principal Executive Offices)		(Zip Code)

(480) 515-8100
(Registrant’s Telephone Number, Including Area Code)

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 þ 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 o 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 o		Accelerated filer þ		Non-accelerated filer o		Smaller reporting company o
				(Do not check if a smaller reporting company)

Indicate by a checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

Common shares outstanding as of November 2, 2010: 32,125,986

 

 

MERITAGE HOMES CORPORATION
FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2010

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION			3
Item 1. Financial Statements			3
Unaudited Condensed Consolidated Balance Sheets as of September 30, 2010 and December 31, 2009			3
Unaudited Condensed Consolidated Statements of Operations for the Three and Nine months Ended September 30, 2010 and 2009			4
Unaudited Condensed Consolidated Statements of Cash Flows for the Nine months Ended September 30, 2010 and 2009			5
Notes to Unaudited Condensed Consolidated Financial Statements			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			23
Item 3. Quantitative and Qualitative Disclosures About Market Risk			39
Item 4. Controls and Procedures			39
PART II. OTHER INFORMATION			40
Item 1. Legal Proceedings			40
Item 1A. Risk Factors			40
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			41
Item 3. Not Applicable
Item 4. Removed and Reserved
Item 5. Not Applicable
Item 6. Exhibits			41
SIGNATURES			42
INDEX OF EXHIBITS			42
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

MERITAGE HOMES CORPORATION AND SUBSIDIARIES

		September 30,				December 31,
		2010				2009
Assets:
Cash and cash equivalents		$	145,324			$	249,331
Investments and securities			265,571				125,699
Restricted cash			8,948				16,348
Income tax receivable			0				92,509
Other receivables			20,782				22,934
Real estate			744,808				675,037
Real estate not owned			4,105				10,527
Deposits on real estate under option or contract			10,887				8,636
Investments in unconsolidated entities			11,196				11,882
Property and equipment, net			15,064				15,251
Intangibles, net			2,511				3,590
Prepaid expenses and other assets			11,465				10,923
Total assets		$	1,240,661			$	1,242,667
Liabilities:
Accounts payable		$	29,501			$	30,296
Accrued liabilities			94,369				103,236
Home sale deposits			7,839				9,501
Liabilities related to real estate not owned			4,027				9,200
Senior and senior subordinated notes			605,623				605,009
Total liabilities			741,359				757,242
Stockholders’ Equity:
Preferred stock, par value $0.01. Authorized 10,000,000 shares; none issued and outstanding at September 30, 2010 and December 31, 2009			0				0
Common stock, par value $0.01. Authorized 125,000,000 shares; issued and outstanding 40,002,903 and 39,710,958 shares at September 30, 2010 and December 31, 2009, respectively			400				397
Additional paid-in capital			467,232				461,403
Retained earnings			220,443				212,398
Treasury stock at cost, 7,891,250 shares at September 30, 2010 and December 31, 2009			(188,773	)			(188,773	)
Total stockholders’ equity			499,302				485,425
Total liabilities and stockholders’ equity		$	1,240,661			$	1,242,667

See accompanying notes to condensed consolidated financial statements

MERITAGE HOMES CORPORATION AND SUBSIDIARIES

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2010				2009				2010				2009
Home closing revenue		$	233,803			$	231,816			$	725,790			$	683,208
Land closing revenue			0				0				1,222				1,285
Total closing revenue			233,803				231,816				727,012				684,493
Cost of home closings			(190,562	)			(198,279	)			(590,809	)			(594,816	)
Cost of land closings			0				0				(964	)			(1,195	)
Real estate impairments			(680	)			(10,354	)			(1,526	)			(86,943	)
Land impairments			0				(281	)			0				(540	)
Total cost of closings and impairments			(191,242	)			(208,914	)			(593,299	)			(683,494	)
Home closing gross profit			42,561				23,183				133,455				1,449
Land closing gross (loss)/profit			0				(281	)			258				(450	)
Total closing gross profit			42,561				22,902				133,713				999
Commissions and other sales costs			(19,624	)			(18,382	)			(58,452	)			(55,625	)
General and administrative expenses			(15,678	)			(14,269	)			(47,100	)			(41,913	)
Earnings/(loss) from unconsolidated entities, net			1,243				(899	)			3,832				1,350
Interest expense			(8,425	)			(8,853	)			(25,273	)			(28,515	)
Other income, net			654				1,862				4,637				6,512
(Loss)/gain on extinguishment of debt			0				0				(3,454	)			9,390
Income/(loss) before income taxes			731				(17,639	)			7,903				(107,802	)
Benefit from/(provision for) income taxes			488				(146	)			142				(1,940	)
Net income/(loss)		$	1,219			$	(17,785	)		$	8,045			$	(109,742	)
Income/(loss) per common share:
Basic		$	0.04			$	(0.56	)		$	0.25			$	(3.52	)
Diluted			0.04				(0.56	)			0.25				(3.52	)
Weighted average number of shares:
Basic			32,095				31,718				32,038				31,197
Diluted			32,297				31,718				32,277				31,197

See accompanying notes to condensed consolidated financial statements

MERITAGE HOMES CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

		Nine Months Ended
		September 30,
		2010				2009
Cash flows from operating activities:
Net income/(loss)		$	8,045			$	(109,742	)
Adjustments to reconcile net income/(loss) to net cash provided by operating activities:
Depreciation and amortization			6,139				6,547
Real-estate-related impairments			1,526				87,483
Stock-based compensation			4,062				4,512
Loss/(gain) on early extinguishment of debt, net of transaction costs			3,454				(9,390	)
Equity in earnings from unconsolidated entities (includes $0.1 and $2.8 million of joint venture impairments in 2010 and 2009, respectively)			(3,832	)			(1,350	)
Distributions of earnings from unconsolidated entities			5,236				5,341
Other operating expenses			(266	)			0
Changes in assets and liabilities:
(Increase)/decrease in real estate			(70,883	)			87,589
(Increase)/decrease in deposits on real estate under option or contract			(1,038	)			7,131
Decrease in receivables and prepaid expenses and other assets			96,638				117,149
Decrease in accounts payable and accrued liabilities			(9,256	)			(40,991	)
(Decrease)/increase in home sale deposits			(1,662	)			3,155
Net cash provided by operating activities			38,163				157,434
Cash flows from investing activities:
Investments in unconsolidated entities			(546	)			(1,218	)
Distributions of capital from unconsolidated entities			152				1,153
Purchases of property and equipment			(5,039	)			(2,128	)
Proceeds from sales of property and equipment			65				128
Purchase of investment securities			(240,716	)			0
Proceeds from sales and maturities of investment securities			100,220				0
Decrease/(increase) in restricted cash			7,400				(18,604	)
Net cash used in investing activities			(138,464	)			(20,669	)
Cash flows from financing activities:
Repayments of senior notes			(197,543	)			0
Proceeds from issuance of senior notes			195,134				0
Debt issuance costs			(3,067	)			0
Proceeds from stock option exercises			1,770				4,263
Net cash (used in)/provided by financing activities			(3,706	)			4,263
Net (decrease)/increase in cash and cash equivalents			(104,007	)			141,028
Cash and cash equivalents at beginning of period			249,331				205,923
Cash and cash equivalents at end of period		$	145,324			$	346,951

See supplemental disclosures of cash flow information at Note 10.

See accompanying notes to condensed consolidated financial statements

MERITAGE HOMES CORPORATION AND SUBSIDIARIES

NOTE 1 — ORGANIZATION AND BASIS OF PRESENTATION

Organization. Meritage Homes is a leading designer and builder of single-family detached and attached homes in the historically high-growth regions of the western and southern United States based on the number of home closings. We offer first-time, move-up, active adult and luxury homes to our targeted customer base. We have operations in three regions: West, Central and East, which are comprised of 12 metropolitan areas in Arizona, Texas, California, Nevada, Colorado and Florida. Through our predecessors, we commenced our homebuilding operations in 1985. 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 markets, except for Arizona and Texas, where we also operate under the name of Monterey Homes. At September 30, 2010, we were actively selling homes in 150 communities, with base prices ranging from approximately $89,900 to $971,900.

Basis of Presentation. The accompanying 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, 2009. The condensed 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 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.

Restricted Cash. Restricted cash consists of amounts held in restricted accounts as collateral for our letter of credit arrangements that were established to replace those previously available under our Credit Facility. See Note 5 for additional discussion of the termination of our Credit Facility during 2009.

Investments and Securities. Our investments and securities are comprised of both treasury securities and deposits with banks that are FDIC-insured and secured by treasury-backed investments. 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 typically less than 18 months. The amortized cost of the investments approximates fair value.

Real Estate. Real estate is stated at cost unless the community or land 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, direct overhead costs incurred during development and home construction that benefit the entire community and 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. Cost of home closings includes the specific construction costs of the home and all related 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, an accrual to capture such obligations is recorded in connection with the home closing and charged directly to cost of sales.

Typically, a community’s life cycle ranges from three to five years, commencing with the acquisition of the entitled land and continuing through the land development phase 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 or finished lots. Master-planned communities encompassing several phases and super-block land parcels may have significantly longer lives and projects involving smaller finished lot purchases may be significantly shorter.

All of our land inventory and related real estate assets are reviewed for recoverability quarterly, as our inventory is considered “long-lived” in accordance with GAAP. Impairment charges are recorded if the fair value of an asset is less than its carrying amount. Our determination of fair value is based on projections and estimates. Changes in these expectations may lead to a change in the outcome of our impairment analysis, and actual results may also differ from our assumptions. Our analysis is completed on a quarterly basis at a community level with each community or land parcel evaluated individually. For those assets deemed to be impaired, the impairment recognized is measured as the amount by which the assets’ carrying amount exceeds their fair value. The impairment of a community is allocated to each lot on a straight-line basis.

Existing and continuing communities. When projections for the remaining income expected to be earned from existing communities are no longer positive, the underlying real estate assets are deemed not fully recoverable, and further analysis is performed to determine the required impairment. The fair value of the community’s assets is determined using either a discounted cash flow model for build-out projects or a market-based approach for projects to be sold. Impairments are charged to cost of home closings in the period during which it is determined that the fair value is less than the assets’ carrying amount. If a market-based approach is used, we determine fair value based on recent comparable purchase and sale activity in the local market, adjusted for known variances as determined by our knowledge of the region and general real estate expertise. If a discounted cash flow approach is used, we compute our fair value based on a proprietary model. Our key estimates in deriving fair value under our cash flow model are (i) home selling prices in the community adjusted for current and expected sales discounts and incentives, (ii) costs related to the community — both land development and home construction — including costs spent to date and budgeted remaining costs to spend, (iii) projected sales absorption rates, reflecting any product mix change strategies implemented to stimulate the sales pace and expected cancellation rates, (iv) alternative land uses including disposition of all or a portion of the land owned and (v) our discount rate, which is currently 14-16% and varies based on the perceived risk inherent in the community’s other cash flow assumptions. These assumptions vary widely across different communities and geographies and are largely dependent on local market conditions. Community-level factors that may impact our key estimates include:

	•		The presence and significance of local competitors, including their offered product type and competitive actions;
	•		Economic and related demographic conditions for the population of the surrounding community; and
	•		Desirability of the particular community, including unique amenities or other favorable or unfavorable attributes.

These local circumstances may significantly impact our assumptions and the resulting computation of fair value and are, therefore, closely evaluated by our division personnel in their creation of the discounted cash flow models. The models are also evaluated by regional and corporate personnel for consistency and integration, as decisions that affect pricing or absorption at one community may have resulting consequences for neighboring communities. We typically do not project market improvements in our discounted cash flow models, but may do so in limited circumstances in the latter years of a long-lived community. In certain cases, we may elect to stop development (mothball) an existing community if we believe the economic performance of the community would be maximized by deferring development for a period of time to allow market conditions to improve. The decision may be based on financial and/or operational metrics. If we decide to mothball a project, we will impair it to its fair value as discussed above and then cease future development activity until such a time where management believes that market conditions will improve and economic performance will be maximized. Quarterly, we review all communities, including mothballed communities, for potential impairments.

Option deposits and pre-acquisition costs. We also evaluate assets associated with future communities for impairments on a quarterly basis. Using similar techniques described in the existing and continuing communities section above, we determine if the contribution margins to be generated by our future communities are acceptable to us. If the projections indicate that a community is still meeting our internal investment guidelines and is generating a profit, those assets are determined to be fully recoverable and no impairments are required. In cases where we decide to abandon a project, we will fully impair all assets related to such project and will expense and accrue any additional costs that we are contractually obligated to incur. In certain circumstances, we may also elect to continue with a project because it is expected to generate positive cash flows, even though it may not be generating an accounting profit, or due to other strategic factors. In such cases, we will impair our pre-acquisition costs and deposits, as necessary, to record an impairment to bring the book value to fair value. Refer to Note 2 of these consolidated financial statements for further information regarding our impairments.

Deposits. Deposits paid related to land options and contracts to purchase land are capitalized when incurred and classified as deposits on real estate under option or contract until the related land is purchased. Deposits are recorded as a component of real estate 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. As our exposure associated with these non-refundable deposits is limited to the deposit amount, we do not consider the options a contractual obligation. The review of the likelihood of the acquisition of contracted lots is completed quarterly in conjunction with the real estate impairment analysis noted above. Our deposits were $10.9 million and $8.6 million as of September 30, 2010 and December 31, 2009 respectively.

Off-Balance-Sheet Arrangements — Joint Ventures. Historically, we have participated in land development joint ventures as a means of accessing larger parcels of land and lot positions, 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 desired lots. We currently have one active venture. We also participate in six mortgage and title business joint ventures. The mortgage joint ventures are engaged in mortgage brokerage activities, and they originate and provide services to both our clients and other homebuyers. See Note 4 for additional information.

Off-Balance-Sheet Arrangements — Other. We often acquire lots from various development entities pursuant to option and purchase agreements. The purchase price typically approximates the market price at the date the contract is executed, although in light of recent economic conditions over the last couple of years, we have been successful in renegotiating more preferential terms on some lots we have under contract. See Note 3 for further discussion.

We provide letters of credit and performance, maintenance and other bonds in support of our related obligations with respect to option deposits and the development of our projects. The amount of these obligations outstanding at any time varies depending on the stage and level of our development activities. In the event a letter of credit or bond is drawn upon, we would be obligated to reimburse the issuer. We believe it is unlikely that any significant amounts of these letters of credit or bonds will be drawn upon. The table below outlines our letter of credit and surety bond obligations (in thousands):

		September 30, 2010								December 31, 2009
						Estimated work								Estimated work
						remaining to								remaining to
		Outstanding				complete				Outstanding				complete
Sureties:
Sureties related to joint ventures		$	1,594			$	32			$	1,672			$	32
Sureties related to owned projects and lots under contract			61,382				25,063				93,744				31,145
Total sureties		$	62,976			$	25,095			$	95,416			$	31,177
Letters of Credit:
LOC in lieu of deposit for contracted lots		$	0				N/A			$	4,414				N/A
LOC for land development			2,060				N/A				3,977				N/A
LOC for general corporate operations			6,653				N/A				6,607				N/A
Total letters of credit		$	8,713				N/A			$	14,998				N/A

Accrued Liabilities. Accrued liabilities consist of the following (in thousands):

		At				At
		September 30, 2010				December 31, 2009
Accruals related to real estate development and construction activities		$	14,258			$	19,832
Payroll and other benefits			13,659				9,714
Accrued taxes			7,464				4,592
Warranty reserves			29,912				33,541
Other accruals			29,076				35,557
Total		$	94,369			$	103,236

Warranty Reserves. We have certain obligations related to post-construction warranties and defects for closed homes. With the assistance of an actuary, we have estimated these reserves based on the number of home closings and historical data and trends for our communities. We also use industry averages with respect to similar product types and geographic areas in markets where our experience is incomplete 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								Nine months Ended
		September 30,								September 30,
		2010				2009				2010				2009
Balance, beginning of period		$	31,197			$	28,596			$	33,541			$	28,891
Additions to reserve from new home deliveries			1,742				716				5,434				2,105
Warranty claims			(2,758	)			(1,549	)			(8,717	)			(3,617	)
Adjustments to pre-existing reserves			(269	)			1,739				(346	)			2,123
Balance, end of period		$	29,912			$	29,502			$	29,912			$	29,502

Warranty reserves are included in accrued liabilities on the accompanying condensed consolidated balance sheets, and additions and adjustments to the reserves are included in cost of home closings within the accompanying condensed consolidated statements of operations.

Our warranty represents reserves for post-construction warranties and defects for closed homes. 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 the general liability insurance we maintain, are sufficient to cover our general warranty obligations.

As of September 30, 2010, we have confirmed that 90 homes we built in 2005 and 2006 were constructed using defective Chinese drywall installed by subcontractors. Eighty-seven of those homes are located in Florida and three are located in the Houston, Texas area. We recently discovered the three Houston area homes and we are still conducting investigations to determine if other Texas homes are impacted, although it currently appears that the exposure in Texas may be isolated. The $29.9 million of warranty reserves we have recorded as of September 30, 2010 include $1.1 million of net reserves for the completion of our repair of the affected homes and the resulting damage related to defective Chinese drywall. If our continuing investigations reveal other homes containing defective Chinese drywall, it may be necessary to increase our warranty reserves. We are seeking recovery of the costs we have incurred or expect to incur related to defective Chinese drywall from the manufacturers, suppliers, and installers of the defective drywall and their insurers as well as from our general liability insurance carrier.

Recently Issued Accounting Pronouncements. In January 2010, the Financial Accounting Standards Board (“FASB”) amended ASC Subtopic 820-10, Fair Value Measurements and Disclosures — Overall. The amendment requires additional disclosures and provides clarification regarding existing disclosures for recurring and nonrecurring fair value measurements. The amendment became effective on January 1, 2010 for us and did not have any material impact to our existing disclosures.

In May 2009, the FASB amended ASC Subtopic 810-10, Consolidation (“ASC 810-10”). The amendment revised prior guidance and accounting and reporting requirements for entities’ involvement with variable interest entities. The new provisions of ASC 810-10 became effective on January 1, 2010 for us. Refer to Note 3 for additional discussion of the impact of the amendment.

NOTE 2 — REAL ESTATE AND CAPITALIZED INTEREST

Real estate consists of the following (in thousands):

		At				At
		September 30, 2010				December 31, 2009
Homes under contract under construction (1)		$	114,363			$	114,769
Finished home sites and home sites under development			431,341				407,592
Unsold homes, completed and under construction (1)			101,998				73,442
Model homes (1)			39,938				37,601
Land held for development or sale (2)			57,168				41,633
		$	744,808			$	675,037

As previously noted, in accordance with ASC 360-10, each of our land inventory and related real estate assets is reviewed for recoverability when impairment indicators are present, as our inventory is considered “long-lived” in accordance with GAAP. Due to the current economic environment, we evaluate all of our real estate assets for impairment on a quarterly basis. ASC 360-10 requires impairment charges to be recorded if the fair value of such assets is less than their carrying amounts. Our determination of fair value is based on projections and estimates. Based on these reviews of all our communities, we recorded the following real-estate and joint-venture impairment charges during the three- and nine-month periods ended September 30, 2010 and 2009 (in thousands):

		Three Months Ended								Nine months Ended
		September 30,								September 30,
		2010				2009				2010				2009
Terminated option/purchase contracts and related pre-acquisition costs:
West		$	0			$	0			$	0			$	5,922
Central			0				3,224				50				59,213
East			0				0				0				544
Total		$	0			$	3,224			$	50			$	65,679
Real estate inventory impairments (1):
West		$	38			$	2,385			$	131			$	10,882
Central			597				2,453				1,300				6,807
East			45				2,292				45				3,575
Total		$	680			$	7,130			$	1,476			$	21,264
Impairments of joint venture investments:
West		$	112			$	55			$	112			$	274
Central			0				2,556				0				2,556
East			0				0				0				0
Total		$	112			$	2,611			$	112			$	2,830
Impairments of land held for sale:
West		$	0			$	0			$	0			$	323
Central			0				281				0				217
East			0				0				0				0
Total		$	0			$	281			$	0			$	540
Total impairments:
West		$	150			$	2,440			$	243			$	17,401
Central			597				8,514				1,350				68,793
East			45				2,292				45				4,119
Total		$	792			$	13,246			$	1,638			$	90,313

		Three Months Ended								Nine months Ended
		September 30,								September 30,
		2010				2009				2010				2009
Individual home impairments:
West		$	38			$	535			$	131			$	7,410
Central			597				1,420				1,300				5,503
East			45				876				45				2,159
Total		$	680			$	2,831			$	1,476			$	15,072

The tables below reflect the number of communities with real estate inventory impairments for the three- and nine-month periods ended September 30, 2009, excluding home-specific impairments (as noted above) and the fair value of these communities as of September 30, 2009 (dollars in thousands). The only such impairment for the nine-month period ended September 30, 2010 related to one community in the Central Region and aggregated $50,000 and there were no such impairments for the three months ended September 30, 2010.

		Three Months Ended September 30, 2009
										Fair Value of Communities
		Number of Communities				Impairment				Impaired
		Impaired				Charges				(Carrying Value less Impairments)
West			4			$	1,850			$	11,750
Central			6				1,033				6,482
East			3				1,416				9,505
Total			13			$	4,299			$	27,737

		Nine months Ended September 30, 2009
										Fair Value of Communities
		Number of Communities				Impairment				Impaired
		Impaired				Charges				(Carrying Value less Impairments)
West			6			$	3,472			$	12,599
Central			8				1,304				7,868
East			3				1,416				9,505
Total			17			$	6,192			$	29,972

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. A summary of our capitalized interest is as follows (in thousands):

		Three Months Ended								Nine months Ended
		September 30,								September 30,
		2010				2009				2010				2009
Capitalized interest, beginning of period		$	12,437			$	19,584			$	14,187			$	29,779
Interest incurred			10,848				11,414				32,593				36,419
Interest expensed			(8,425	)			(8,853	)			(25,273	)			(28,515	)
Interest amortized to cost of home, land closings and impairments			(3,183	)			(4,540	)			(9,830	)			(20,078	)
Capitalized interest, end of period		$	11,677			$	17,605			$	11,677			$	17,605

At September 30, 2010, approximately $750,000 of the capitalized interest is related to our joint venture investments and is a component of “Investments in unconsolidated entities” on our condensed consolidated balance sheets.

NOTE 3 — VARIABLE INTEREST ENTITIES AND CONSOLIDATED REAL ESTATE NOT OWNED

In June 2009, FASB revised its guidance regarding the determination of a primary beneficiary of a variable interest entity (“VIE”). In December 2009, ASC 810, Consolidation, was amended to incorporate this guidance. The amendments to ASC 810 replace the prior quantitative computations for determining which entity, if any, is the primary beneficiary of the VIE with a methodology based on both (1) the ability of an entity to control the activities of a VIE that most significantly impact the VIE’s economic performance and (2) the obligation to absorb losses of the VIE and/or the right to receive benefits from the VIE. The amendments also increased the required disclosures about a reporting entity’s involvement with VIEs. We adopted the amended provisions of ASC 810 on January 1, 2010. The adoption resulted in a deconsolidation of several VIEs that were previously reported as “Real estate not owned” in our consolidated balance sheets.

Based on the provisions of the relevant accounting guidance, we have concluded that when we enter into an option or purchase agreement to acquire land or lots from an entity and pay a non-refundable deposit, a VIE may be created because we are deemed to have provided subordinated financial support that will absorb some or all of an entity’s expected losses if they occur. Since adopting the new provisions of ASC 810, for each VIE, we assess whether we are the primary beneficiary by first determining if we have the ability to control the activities of the VIE that most significantly impact its economic performance. Such activities include, but are not limited to, the ability to determine the budget and scope of land development work, if any; the ability to control financing decisions for the VIE; the ability to acquire additional land into the VIE or dispose of land in the VIE not under contract with Meritage; and the ability to change or amend the existing option contract with the VIE. If we are not determined to control such activities, we are not considered the primary beneficiary of the VIE. If we do have the ability to control such activities, we will continue our analysis by determining if we are expected to absorb a potentially significant amount of the VIE’s losses or, if no party absorbs the majority of such losses, if we will benefit from potentially a significant amount of the VIE’s expected gains. If we are the primary beneficiary of the VIE, we will consolidate the VIE in our financial statements and reflect such assets and liabilities as “Real estate not owned.” The liabilities related to consolidated VIEs are excluded from our debt covenant calculations. Prior to the adoption of the amended guidance of ASC 810, we determined if we were the primary beneficiary of a VIE solely by reviewing the expected losses and residual returns based on a probability of future cash flows.

In most 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 any budget savings or shortfalls are borne by us. Some of our option deposits may be refundable to us if certain contractual conditions are not performed by the party selling the lots.

The table below presents a summary of our lots under option or contract at September 30, 2010 (dollars in thousands):

										Option/Earnest
										Money Deposits
		Number of				Purchase								Letters of
		Lots				Price				Cash				Credit
Option contracts recorded on balance sheet as real estate not owned (1), (2)			125			$	4,105			$	78			$	0
Option contracts not recorded on balance sheet — non-refundable, committed (1)			2,407				98,590				10,101				0
Purchase contracts not recorded on balance sheet — non-refundable, committed (1)			309				10,149				450				0
Total committed (on and off balance sheet)			2,841				112,844				10,629				0
Purchase contracts not recorded on balance sheet — refundable deposits, uncommitted (3)			1,308				18,186				336				0
Total uncommitted			1,308				18,186				336				0
Total lots under option or contracts			4,149				131,030				10,965				0
Total option contracts not recorded on balance sheet			4,024			$	126,925			$	10,887	(4)		$	0

Generally, our options 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. Although the pre-established number is typically structured to approximate our expected rate of home construction starts, during a weakened homebuilding market, as we have recently been experiencing, we may purchase lots at an absorption level that exceeds our sales and home starts pace to meet the pre-established minimum number of lots or we may try to restructure our original contract to include terms that more accurately reflect our revised sales pace expectations.

NOTE 4 — INVESTMENTS IN UNCONSOLIDATED ENTITIES

In the past, we have entered into homebuilding and land development joint ventures as a means of accessing larger parcels of land and lot positions, expanding our market opportunities, managing our risk profile and leveraging our capital base. Based on the structure of these joint ventures, they may or may not be consolidated into our results. Our joint venture partners generally are other homebuilders, land sellers or other real estate investors. We generally do not have a controlling interest in these ventures, which means our joint venture partners could cause the venture to take actions we disagree with, or fail to take actions we believe should be undertaken, including the sale of the underlying property to repay debt or recoup all or part of the partners’ investments. As of September 30, 2010, we had one active land venture. Due to the current homebuilding environment, although we view our involvement with land joint ventures to be beneficial, we do not view such involvement as critical to the success of our homebuilding operations.

We also participate in six mortgage and title business joint ventures. The mortgage joint ventures are engaged in mortgage activities and they originate and provide services to both our clients and other homebuyers. Although some of these ventures originate mortgage loans, we have limited recourse related to any mortgages originated by these ventures. Our investments in mortgage and title joint ventures as of September 30, 2010 and December 31, 2009 were $1.4 million and $1.0 million, respectively.

For land development joint ventures, we, and in some cases our joint venture partners, usually have an option or other similar arrangement to purchase portions of the land held by the joint venture. Option prices are generally negotiated at prices that approximate market value when we enter into the option contract. 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 joint ventures, we may also provide certain types of guarantees to associated lenders and municipalities. These guarantees can be classified into three categories: (i) Repayment Guarantees, (ii) “Bad Boy Guarantees”, and (iii) Completion Guarantees, described in more detail below (in thousands). Additionally, see Note 1 to these consolidated financial statements for a summary of our joint venture surety obligations.

		At September 30, 2010				At December 31, 2009
Repayment guarantees (1)		$	7,884			$	8,188
“Bad Boy” guarantees			61,170				60,917
Completion guarantees (2)			0				0
Total guarantees		$	69,054			$	69,105

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 the land development joint ventures. If such a guarantee were ever to be called, 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. At September 30, 2010 and December 31, 2009, our share of these limited pro rata repayment guarantees related to two joint ventures and was approximately $7.9 million and $8.2 million, respectively, of which $7.1 million is a “bad boy” guaranty (see below for a discussion about “bad boy” guarantees); however, as the other joint venture partners could trigger such a guaranty without our consent, we have classified this $7.1 million as a repayment guaranty.

“Bad Boy” Guarantees. In addition, we and/or our joint venture partners occasionally provide guarantees that are only applicable if and when the joint venture directly, or indirectly through agreement with its joint venture partners or other third parties, causes the joint venture to voluntarily file a bankruptcy or similar liquidation or reorganization action or take other actions that are fraudulent or improper (commonly referred to as “bad boy” guarantees). These types of guarantees typically are on a pro rata basis among the joint venture partners and are designed to protect the secured lender’s remedies with respect to its mortgage or other secured lien on the joint venture or the joint venture’s underlying property. To date, no such guarantees have been invoked and we believe that the actions that would trigger a guarantee would generally be disadvantageous to the joint venture and to us, and therefore are unlikely to occur; however, there can be no assurances that certain of our ventures will not elect to take actions that could trigger a bad boy guarantee, as it is possible that it could be considered in their economic best interest to do so. At September 30, 2010 and December 31, 2009, we had one such guaranty (exclusive of the guaranty classified as a repayment guaranty) totaling approximately $61.2 million and $60.9 million, respectively. These bad boy guarantees, as defined, unless invoked as described above, are not considered guarantees of indebtedness under our senior and senior subordinated indentures.

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. As part of our project acquisition due diligence process to determine potential environmental risks, we generally obtain, or the joint venture entity generally obtains, an independent environmental review. Per the guidance of ASC Subtopic 460-10, Guarantees, we believe these other 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 would 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 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. See Note 1 of these consolidated financial statements for detail of our surety bonds.

The joint venture obligations, guarantees and indemnities discussed above are generally provided by us or one or more of our subsidiaries. In joint ventures involving other homebuilders or developers, support for these obligations is generally provided by the parent companies of the joint venture partners. In connection with our periodic real estate impairment reviews, we may accrue for any such commitments where we believe our obligation to pay is probable and can be reasonably estimated. In such situations, our accrual represents the portion of the total joint venture obligation related to our relative ownership percentage. In the limited cases where our venture partners, some of whom are homebuilders or developers who may be experiencing financial difficulties as a result of current market conditions, may be unable to fulfill their pro rata share of a joint venture obligation, we may be fully responsible for these commitments if such commitments are joint and several. We continue to monitor these matters and reserve for these obligations if and when they become probable and can be reasonably estimated. As of September 30, 2010 and December 31, 2009, we did not have any such reserves. See discussion below regarding outstanding litigation for certain of our joint ventures and corresponding reserves.

Summarized condensed financial information related to unconsolidated joint ventures that are accounted for using the equity method follows (in thousands):

		At				At
		September 30, 2010				December 31, 2009
Assets:
Cash		$	4,146			$	6,734
Real estate			487,261				512,931
Other assets			4,801				6,023
Total assets		$	496,208			$	525,688
Liabilities and equity:
Accounts payable and other liabilities		$	5,263			$	8,899
Notes and mortgages payable			328,165				350,966
Equity of:
Meritage (1)			35,653				40,516
Others			127,127				125,307
Total liabilities and equity		$	496,208			$	525,688

		Three Months Ended								Nine months Ended
		September 30,								September 30,
		2010				2009				2010				2009
Revenues		$	8,903			$	6,527			$	19,343			$	14,510
Costs and expenses			(6,376	)			(24,552	)			(13,059	)			(28,796	)
Net earnings/(losses) of unconsolidated entities		$	2,527			$	(18,025	)		$	6,284			$	(14,286	)
Meritage’s share of pre-tax earnings/(loss) (1) (2) (3)		$	1,362			$	(3,259	)		$	4,059			$	(1,162	)

Our investments in unconsolidated entities include $0.9 million at September 30, 2010 and December 31, 2009, 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. We amortized approximately $0 and $71,000 of such assets in the first nine months of 2010 and 2009, respectively.

Of the joint venture assets and liabilities in the table above, $442.6 million and $305.8 million, respectively, relates to one inactive joint venture in which we have a 20% interest as of September 30, 2010. Of our “Bad Boy” debt guarantees, the entire $61.2 million at September 30, 2010 relates to this venture. This venture owns one large asset that was purchased near the peak of the market and the venture is currently in default of its debt agreements. Although we and our joint venture partners have attempted to work with the lenders to renegotiate the debt, we have not reached any satisfactory alternatives. All of this debt is non-recourse to the partners and our associated joint venture investment has been fully impaired as of September 30, 2010. At this time we believe there is limited exposure to us from this investment.

The balance of the other venture assets and liabilities noted in the table above primarily represent our one active land venture, six mortgage ventures and other various inactive ventures in which we have a total investment of $11.2 million. As of September 30, 2010, we believe these ventures are in compliance with their respective debt agreements, and except for $0.8 million of our limited repayment guarantees, the debt is non-recourse to us. These ventures have no “Bad Boy” guarantees.

In addition to joint ventures accounted for under the equity method summarized in the above table, our investments in unconsolidated entities include two joint ventures recorded under the cost method. These joint ventures were formed to acquire large parcels of land in Nevada, to perform off-site development work and to sell lots to the joint venture members and other third parties. Our ownership percentage in these two ventures is 3.53% in one of the ventures and 4.09% in the other. The lenders of both ventures have filed lawsuits against the joint ventures and/or their members alleging liability under the completion guarantees executed severally by each of the members and their parent companies, including Meritage. We continue to dispute allegations contained in each of the lawsuits and intend to vigorously defend our position regarding liability under these completion guarantees and related claims. We have fully impaired our investment in these joint ventures in previous periods. One of these ventures has already been dis-possessed of its land holdings and is now considered inactive while the other venture that still has land holdings and corresponding debt has a $7.1 million “Bad Boy” guaranty allocable to Meritage that could be triggered upon events beyond our control and, accordingly, is disclosed as a limited repayment guaranty. In one of the ongoing lawsuits related to this venture, all members of the joint venture participated in arbitration regarding their respective performance obligations in response to one of the members’ claims. On July 6, 2010, the arbitration decision was issued, which denied the specific performance claim, but did award damages to one member on other claims. We and other members have submitted motions to vacate or modify that decision and are awaiting a decision on these motions. In any event, we believe our potential share of the award, if any, will not be material to our financial position and that our existing legal reserves are sufficient to cover the expected claim. Although the final disposition of these suits remains uncertain, we do not, at this time, anticipate outcomes that will be materially adverse to us. See Note 11 for breakdown of our investments in consolidated entities by Region.

NOTE 5 — SENIOR AND SENIOR SUBORDINATED NOTES AND OTHER BORROWINGS

Senior and senior subordinated notes consist of the following (in thousands):

		At				At
		September 30, 2010				December 31, 2009
7.0% senior notes due 2014. At September 30, 2010, and December 31, 2009, there was approximately $0 and $38,000 in unamortized premium, respectively		$	0			$	130,038
6.25% senior notes due 2015. At September 30, 2010 and December 31, 2009, there was approximately $629,000 and $904,000 in unamortized discount, respectively			284,371				349,096
7.731% senior subordinated notes due 2017			125,875				125,875
7.15% senior notes due 2020. At September 30, 2010 and December 31, 2009, there was approximately $4.6 million and $0 in unamortized discount, respectively			195,377				0
		$	605,623			$	605,009

The indentures for our 6.25% senior notes and 7.731% senior subordinated notes contain covenants that require maintenance of certain minimum financial ratios, place limitations on investments we can make, and the payment of dividends and redemptions of equity, and limit the incurrence of additional indebtedness, asset dispositions, mergers, certain investments and creations of liens, among other items. As of and for the quarter ended September 30, 2010, we believe we were in compliance with our covenants. The indenture for our 7.15% senior notes contains covenants including, among others, limitations on the amount of secured debt we may incur, and limitations on sale and leaseback transactions and mergers. The covenants contained in the 7.15% senior notes are generally no more restrictive, and in many cases less restrictive, than the covenants contained in the indentures for the 6.25% senior notes and 7.731% senior subordinated notes.

Obligations to pay principal and interest on the senior and senior subordinated notes are guaranteed by all of our wholly-owned subsidiaries (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. We do not provide separate financial statements of the Guarantor Subsidiaries because Meritage (the parent company) has no independent assets or operations, the guarantees are full and unconditional and joint and several, and any subsidiaries of Meritage Homes Corporation other than the non-guarantor subsidiaries are, individually and in the aggregate, minor. There are no significant restrictions on the ability of the Company or any Guarantor Subsidiary to obtain funds from their respective subsidiaries, as applicable, by dividend or loan.

During the three months ended June 30, 2010, we completed an offering of $200 million aggregate principal amount of 7.15% senior notes due 2020. The notes were issued at a 97.567% discount to par value. Concurrent with the issuance of the 2020 notes, we repurchased all of our $130 million 7.0% senior notes maturing 2014 and $65 million of our 6.25% senior notes maturing 2015. In connection with these transactions, we recorded a $3.5 million net loss on early extinguishment of debt, which is reflected in our statement of operations for the nine months ended September 30, 2010.

During the nine months ended September 30, 2009, we retired $24.1 million of our 7.731% senior subordinated notes maturing in 2017 by issuing approximately 783,000 shares of our common stock in a privately negotiated transaction. The transaction was completed at an average discount of 41% from the face value of the notes, resulting in a $9.4 million gain on early extinguishment of debt which is reflected in our statement of operations for the nine months ended September 30, 2009.

In September 2009, we voluntarily terminated our Senior Unsecured Credit Facility (the “Credit Facility”). There were no penalties or costs associated with the termination, although we recorded a non-cash charge in the third quarter of 2009 of approximately $800,000 to write off previously capitalized origination fees that were scheduled to amortize through May 2011. We did not believe we would need the Credit Facility to finance our operations during the foreseeable future and that it was in our interest to terminate the facility to avoid non-use and other fees. Prior to and as of the date of termination, we were in compliance with all of the covenants, limitations and restrictions of the Credit Facility.

In connection with the Credit Facility termination, we entered into secured letter of credit arrangements with the three banks that have issued outstanding letters of credit under the Credit Facility. The aggregate capacity of these secured letters of credit is approximately $65 million. These outstanding letters of credit are secured by corresponding pledges of restricted cash accounts, totaling of $8.9 million and $16.3 million at September 30, 2010 and December 31, 2009, respectively, and are reflected as restricted cash on our consolidated balance sheets.

NOTE 6 — FAIR VALUE DISCLOSURES

Effective January 1, 2009, we adopted ASC Subtopic 820-10, Fair Value Measurement and Disclosure, for non-recurring fair value measurements of our non-financial assets and liabilities. This guidance defines fair value, establishes a framework for measuring fair value and expands 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.

A summary of our long—lived real-estate assets measured at fair value on September 30, 2010 is as follows (in thousands):

						Fair Value Measurements at Reporting Date Using
		As of September 30, 2010				Level 1				Level 2				Level 3
Description:
Long-lived real-estate assets		$	8,865				0				0			$	8,865
Investments in unconsolidated entities		$	0				0				0			$	0

Of the total $744.8 million of long—lived real-estate assets, some of which have previously been written down to fair value, long-lived assets held and used with an initial basis of $9.5 million were impaired and written down to their fair value of $8.9 million during the three months ended September 30, 2010, resulting in an impairment of $680,000, which is included in our consolidated statement of operations for the three months ended September 30, 2010. Additionally, $112,000 of investments in unconsolidated entities were fully impaired to a net zero value during the quarter ended September 30, 2010.

Financial Instruments. The fair value of our fixed-rate debt is derived from quoted market prices by independent dealers and is as follows (in thousands):

		September 30, 2010								December 31, 2009
		Aggregate				Estimated				Aggregate				Estimated
		Principal				Fair Value				Principal				Fair Value
Financial Liabilities:
7.00% senior notes			N/A				N/A			$	130,000			$	124,150
6.25% senior notes		$	285,000			$	275,593			$	350,000			$	322,000
7.731% senior subordinated notes		$	125,875			$	111,955			$	125,875			$	104,004
7.15% senior notes		$	200,000			$	185,696				N/A				N/A

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.

NOTE 7 — INCOME/(LOSS) PER SHARE

Basic and diluted income/(loss) per common share was calculated as follows (in thousands, except per share amounts):

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2010				2009				2010				2009
Basic weighted average number of shares outstanding			32,095				31,718				32,038				31,197
Effect of dilutive securities:
Stock options and restricted stock (1)			202				0				239				0
Diluted weighted average shares outstanding			32,297				31,718				32,277				31,197
Net income/(loss)		$	1,219			$	(17,785	)		$	8,045			$	(109,742	)
Basic income/(loss) per share		$	0.04			$	(0.56	)		$	0.25			$	(3.52	)
Diluted income/(loss) per share (1)		$	0.04			$	(0.56	)		$	0.25			$	(3.52	)
Antidilutive stock options not included in the calculation of diluted income per share			1,040				1,704				737				1,704

NOTE 8 — STOCK-BASED COMPENSATION

We have two stock compensation plans, the Meritage Stock Option Plan, which was adopted in 1997 and amended from time to time (the “1997 Plan”), and the 2006 Stock Incentive Plan that was adopted in 2006 and amended from time to time (the “2006 Plan” and together with the 1997 Plan, the “Plans”). The Plans were approved by our stockholders and are administered by our Board of Directors. The provisions of the Plans are generally consistent with the exception that the 2006 Plan allows for the grant of stock appreciation rights, restricted stock awards, performance share awards and performance-based awards in addition to the non-qualified and incentive stock options allowed under the 1997 Plan. The Plans authorize awards to officers, key employees, non-employee directors and consultants for up to 7,750,000 shares of common stock, of which 872,549 shares remain available for grant at September 30, 2010. 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. Option awards are granted with an exercise price equal to the market price of Meritage stock at the date of grant, and generally have a five-year ratable vesting period and a seven-year contractual term. Restricted stock awards are usually granted with either a three-year or five-year ratable vesting period.

The fair value of option awards is estimated using a Black-Scholes option pricing model that uses the assumptions noted in the following table. Expected volatilities are based on a combination of implied volatilities from traded options on our stock and historical volatility of our stock. Expected term/life, which represents the period of time that options granted are expected to be outstanding, is estimated using historical data. The risk-free interest rate is based on the U.S. Treasury yield curve for the expected term of the grant. Groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. The Black-Scholes assumptions used for stock options grants during the first nine months of 2009 are as follows. We only granted non-vested shares in 2010.

		Nine Months Ended
		September 30, 2009
Expected volatility			86.51	%
Expected dividends			0	%
Expected term (in years)			3.68
Risk-free interest rate			1.60	%
Weighted average grant date fair value of options granted		$	8.69

As of September 30, 2010, we had $9.2 million of total unrecognized compensation cost related to non-vested stock-based compensation arrangements granted under the Plans that will be recognized on a straight-line basis over the remaining respective vesting periods — a weighted-average period of 2.39 years. For the three months ended September 30, 2010 and 2009, our total stock-based compensation expense was $1.6 million and $2.2 million, respectively. For the nine months ended September 30, 2010 and 2009, our total stock-based compensation expense was $4.1 million and $4.5 million, respectively. We granted 315,000 non-vested shares during the first nine months of 2010. We also granted an additional 67,500 non-vested shares that will only vest if certain performance criteria are met. The expense associated with these performance-based non-vested shares will only be recognized when it is determined to be probable that the target performance thresholds will be met and the shares will vest.

NOTE 9 — INCOME TAXES

Components of the income tax benefit/(provision) are (in thousands):

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2010				2009				2010				2009
Federal		$	589			$	(138	)		$	519			$	(1,916	)
State			(101	)			(8	)			(377	)			(24	)
Total		$	488			$	(146	)		$	142			$	(1,940	)

Unrecognized tax benefits were $4.7 million at September 30, 2010 and relate to items from prior years. The entire balance is due to the limited reopening of expired statutes of limitation for years to which the 2009 loss was carried back pursuant to the Worker, Homeowner and Business Assistance Act of 2009, which extended the permitted carryback period for net operating losses. Interest and penalties are accrued on unrecognized tax benefits and included in federal income tax expense. The total amount of interest and penalties on uncertain tax positions included in income tax expense for the three months ended September 30, 2010 was $30,000 of interest on the positions reopened due to the 2009 loss carryback.

In accordance with ASC 740-10, Income Taxes, we evaluate our deferred tax assets, including the benefit from net operating losses (“NOLs”), 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 current and cumulative losses, forecasts of future profitability, the length of statutory carryforward periods, our experience with operating losses and our experience of utilizing tax credit carryforwards and tax planning alternatives. Given the downturn in the homebuilding industry over the past several years, the degree of the economic recession, the instability and deterioration of the financial markets, and the resulting uncertainty in projections of our future taxable income, we recorded a full valuation allowance against our deferred tax assets during 2008. We continue to maintain a full non-cash valuation allowance against the entire amount of our remaining net deferred tax assets at September 30, 2010 as we have determined that the weight of the negative evidence exceeds that of the positive evidence and it continues to be more likely than not that we will not be able to utilize all of our deferred tax assets relating to our federal and state NOL carryovers. Although we have fully reserved our deferred tax asset, we have not forfeited our right to carry forward tax losses 20 years and apply such tax losses against taxable income in such years, thereby reducing our future tax obligations. Therefore, during any periods where we earn taxable income, we anticipate being able to reverse a portion of our previously recognized tax valuation allowance.

At September 30, 2010 and December 31, 2009, we had a valuation allowance of $88.4 million ($61.8 million federal and $26.6 million state) and $92.6 million ($65.2 million federal and $27.4 million state), respectively, against deferred tax assets. Our future deferred tax asset realization depends on sufficient taxable income in the carryforward periods under existing tax laws, which currently would allow us to offset future federal taxable income generated through 2029. State deferred tax assets include $21.4 million of state net operating loss carryovers as of December 31, 2009 that begin to expire in 2012. On an ongoing basis, we will continue to review all available evidence to determine if and when we expect to realize our deferred tax assets and state NOL carryovers.

At September 30, 2010, the income tax payable of $1.9 million primarily consists of tax and interest amounts that we expect to pay within one year for having amended a prior-year federal tax return. We collected $90.5 million of our December 31, 2009 receivable in the first quarter of 2010. The federal loss carryback period reverted back to two years for our 2010 fiscal year and there is no available taxable income in the two-year carryback period for us to utilize any tax loss coming out of 2010.

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 2005. Due to the recently enacted Act, the federal statutes of limitations reopened on a limited basis for years to which the 2009 loss was carried back. In 2008, the IRS commenced an audit of our consolidated U.S. tax return and refund claim for 2007. The audit is now complete. There were no audit adjustments to report that would materially affect our deferred tax assets or income tax payable at September 30, 2010.

The tax benefits from our net operating losses, built-in losses, and tax credits would be materially reduced or potentially eliminated if we experienced an “ownership change” as defined under IRC §382. Based on our analysis performed as of September 30, 2010, we do not believe that we have experienced an ownership change. As a protective measure, we held a Special Meeting of Stockholders on February 16, 2009, and our stockholders approved an amendment to our Articles of Incorporation that restricted certain transfers of our common stock. The amendment will help us avoid an unintended ownership change and thereby preserve the value of our tax benefits for future utilization.

NOTE 10 — SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

The following presents certain supplemental cash flow information (in thousands):

		Nine Months Ended
		September 30,
		2010				2009
Cash paid/(received) during the period for:
Interest, net of interest capitalized		$	24,708			$	27,935
Income taxes		$	(94,640	)		$	(107,624	)
Non-cash operating activities (decrease)/increase:
Real estate not owned		$	(6,422	)		$	5,826
Non-cash investing activities:
Distributions from unconsolidated entities		$	294			$	261
Non-cash financing activities:
Equity issued for debt extinguishment		$	0			$	14,312

NOTE 11 — OPERATING AND REPORTING SEGMENTS

As defined in ASC Subtopic 280-10, Segment Reporting, we have six operating segments (the six states in which we operate). These segments are engaged in the business of acquiring and developing land, constructing homes, marketing and selling those homes, and providing warranty and customer service. We aggregate our operating segments into a reporting segment based on similar long-term economic characteristics and geographical proximity. Our reporting segments are as follows:

West:		California and Nevada
Central:		Texas, Arizona and Colorado
East:		Florida

Management’s evaluation of segment performance is based on segment operating income/(loss), which we define as homebuilding and land revenue less cost of home construction, commissions and other sales costs, land development and other land sales costs and other costs incurred by or allocated to each segment, including impairments. Each reportable segment follows the same accounting policies described in Note 1, “Business and Summary of Significant Accounting Policies,” to the consolidated financial statements in our 2009 Annual Report on Form 10-K. Operating results for each segment may not be indicative of the results for such segment had it been an independent, stand-alone entity. The following is our segment information (in thousands):

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2010				2009				2010				2009
Revenue (1):
West		$	47,207			$	26,954			$	127,126			$	99,766
Central			161,658				192,246				535,682				548,885
East			24,938				12,616				64,204				35,842
Consolidated total			233,803				231,816				727,012				684,493
Operating income/(loss) (2):
West			3,316				(4,307	)			6,474				(23,053	)
Central			6,830				2,661				32,446				(52,466	)
East			2,874				(2,620	)			5,989				(4,963	)
Segment operating income/(loss)			13,020				(4,266	)			44,909				(80,482	)
Corporate and unallocated (3)			(5,761	)			(5,483	)			(16,748	)			(16,057	)
Earnings/(loss) from unconsolidated entities, net			1,243				(899	)			3,832				1,350
Interest expense			(8,425	)			(8,853	)			(25,273	)			(28,515	)
Other income, net			654				1,862				4,637				6,512
(Loss)/gain on extinguishment of debt			0				0				(3,454	)			9,390
Income/(loss) before income taxes		$	731			$	(17,639	)		$	7,903			$	(107,802	)

		At September 30, 2010
														Corporate and
		West				Central				East				Unallocated (4)				Total
Deposits on real estate under option or contract		$	200			$	10,515			$	172			$	0			$	10,887
Real estate			166,667				528,863				49,278				0				744,808
Investments in unconsolidated entities			158				10,540				97				401				11,196
Other assets			6,602				41,329				3,585				422,254				473,770
Total assets		$	173,627			$	591,247			$	53,132			$	422,655			$	1,240,661

		At December 31, 2009
														Corporate and
		West				Central				East				Unallocated (4)				Total
Deposits on real estate under option or contract		$	25			$	8,340			$	271			$	0			$	8,636
Real estate			142,829				499,319				32,889				0				675,037
Investments in unconsolidated entities			260				11,339				64				219				11,882
Other assets			10,498				41,529				1,248				493,837				547,112
Total assets		$	153,612			$	560,527			$	34,472			$	494,056			$	1,242,667