Meritage Homes CORP 10-K

Item 8. Financial Statements and Supplementary Data Our consolidated financial statements as of December 31, 2021 and 2020 and for each of the years in the three-year period ended December 31, 2021, together with related notes and the report of Deloitte & Touche LLP, independent registered public accounting firm (PCAOB ID: 34 ), are on the following pages. 41 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the stockholders and the Board of Directors of Meritage Homes Corporation: Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Meritage Homes Corporation and subsidiaries (the "Company") as of December 31, 2021 and 2020, the related consolidated income statements, stockholders' equity and cash flows, for each of the three years in the period ended December 31, 2021, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021, in conformity with accounting principles generally accepted in the United States of America. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 16, 2022, expressed an unqualified opinion on the Company's internal control over financial reporting. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Valuation of Real Estate — Refer to Notes 1 and 2 to the financial statements Critical Audit Matter Description The Company’s land inventory and real estate assets are periodically reviewed for recoverability when certain criteria are met, but at least annually. The Company’s impairment analysis is conducted if indicators of a change in conditions that could result in a decline in value of the Company’s land and real estate assets exist. 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. The Company’s determination of fair value is based on projections and estimates. Changes in these expectations may lead to a change in the outcome of the Company’s impairment analysis, and actual results may also differ from management’s assumptions. If an asset is deemed to be impaired, the impairment recognized is measured as the amount by which the asset’s carrying amount exceeds its fair value. The Company’s evaluation included whether indicators of a decline in value of the Company’s land and real estate assets exist and the determination of value to evaluate the recoverability of real estate assets used in the undiscounted cash flows. This evaluation requires management to make significant projections and estimates, which required a high degree of auditor judgment and an increased extent of audit effort. 42 How the Critical Audit Matter Was Addressed in the Audit We tested the effectiveness of the Company’s internal controls related to the Company’s evaluation of the recoverability of real estate assets. We also evaluated the significant assumptions used in the Company’s evaluation of the recoverability of real estate assets, by comparing the assumptions to actual recent home sales and closings in that community and external analyst and industry reports for the respective geography. For certain communities that did not have actual recent home closings, we compared to historical home sales and closings in nearby communities taking into consideration factors such as location, size, and type of community. In addition, we met with management to understand how recent trends in home sales and closings have been considered in the Company’s evaluation of the recoverability of real estate assets. /s/ DELOITTE & TOUCHE LLP Phoenix, Arizona February 16, 2022 We have served as the Company's auditor since 2004. 43 MERITAGE HOMES CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS At December 31, 2021 2020 (In thousands, except share data) Assets Cash and cash equivalents $ 618,335 $ 745,621 Other receivables 147,548 98,573 Real estate 3,734,408 2,778,039 Real estate not owned 8,011 — Deposits on real estate under option or contract 90,679 59,534 Investments in unconsolidated entities 5,764 4,350 Property and equipment, net 37,340 38,933 Deferred tax assets, net 40,672 36,040 Prepaids, other assets and goodwill 124,776 103,308 Total assets $ 4,807,533 $ 3,864,398 Liabilities Accounts payable $ 216,009 $ 175,250 Accrued liabilities 337,277 296,121 Home sale deposits 42,610 25,074 Liabilities related to real estate not owned 7,210 — Loans payable and other borrowings 17,552 23,094 Senior notes, net 1,142,486 996,991 Total liabilities 1,763,144 1,516,530 Stockholders’ Equity Preferred stock, par value $ 0.01 . Authorized 10,000,000 shares; none issued and outstanding at December 31, 2021 and 2020 — — Common stock, par value $ 0.01 . Authorized 125,000,000 shares; 37,340,855 and 37,512,127 shares issued and outstanding at December 31, 2021 and 2020, respectively 373 375 Additional paid-in capital 414,841 455,762 Retained earnings 2,629,175 1,891,731 Total stockholders’ equity 3,044,389 2,347,868 Total liabilities and stockholders’ equity $ 4,807,533 $ 3,864,398 See accompanying notes to consolidated financial statements 44 MERITAGE HOMES CORPORATION AND SUBSIDIARIES CONSOLIDATED INCOME STATEMENTS Years Ended December 31, 2021 2020 2019 (In thousands, except per share data) Homebuilding: Home closing revenue $ 5,094,873 $ 4,464,389 $ 3,604,629 Land closing revenue 25,237 17,731 45,854 Total closing revenue 5,120,110 4,482,120 3,650,483 Cost of home closings ( 3,676,496 ) ( 3,483,981 ) ( 2,923,969 ) Cost of land closings ( 26,320 ) ( 38,525 ) ( 46,899 ) Total cost of closings ( 3,702,816 ) ( 3,522,506 ) ( 2,970,868 ) Home closing gross profit 1,418,377 980,408 680,660 Land closing gross loss ( 1,083 ) ( 20,794 ) ( 1,045 ) Total closing gross profit 1,417,294 959,614 679,615 Financial Services: Revenue 21,207 19,097 16,461 Expense ( 9,182 ) ( 7,797 ) ( 6,781 ) Earnings from financial services unconsolidated entities and other, net 6,009 5,088 10,899 Financial services profit 18,034 16,388 20,579 Commissions and other sales costs ( 285,403 ) ( 287,901 ) ( 246,728 ) General and administrative expenses ( 181,449 ) ( 159,020 ) ( 146,093 ) Interest expense ( 318 ) ( 2,177 ) ( 8,370 ) Other income, net 4,864 6,662 9,577 Loss on early extinguishment of debt ( 18,188 ) — ( 5,635 ) Earnings before income taxes 954,834 533,566 302,945 Provision for income taxes ( 217,390 ) ( 110,091 ) ( 53,282 ) Net earnings $ 737,444 $ 423,475 $ 249,663 Earnings per common share: Basic $ 19.61 $ 11.23 $ 6.55 Diluted $ 19.29 $ 11.00 $ 6.42 Weighted average number of shares: Basic 37,610 37,718 38,100 Diluted 38,233 38,484 38,891 See accompanying notes to consolidated financial statements 45 MERITAGE HOMES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY Years Ended December 31, 2021, 2020 and 2019 (In thousands) Number of Shares Common Stock Additional Paid-In Capital Retained Earnings Total Balance at January 1, 2019 38,073 $ 381 $ 501,781 $ 1,218,593 $ 1,720,755 Net earnings — — — 249,663 249,663 Issuance of stock 435 4 ( 4 ) — — Equity award compensation expense — — 19,607 — 19,607 Share repurchases ( 309 ) ( 3 ) ( 16,032 ) — ( 16,035 ) Balance at December 31, 2019 38,199 382 505,352 1,468,256 1,973,990 Net earnings — — — 423,475 423,475 Issuance of stock 413 4 ( 4 ) — — Equity award compensation expense — — 19,995 — 19,995 Share repurchases ( 1,100 ) ( 11 ) ( 69,581 ) — ( 69,592 ) Balance at December 31, 2020 37,512 375 455,762 1,891,731 2,347,868 Net earnings — — — 737,444 737,444 Issuance of stock 468 4 ( 4 ) — — Equity award compensation expense — — 20,069 — 20,069 Share repurchases ( 639 ) ( 6 ) ( 60,986 ) — ( 60,992 ) Balance at December 31, 2021 37,341 $ 373 $ 414,841 $ 2,629,175 $ 3,044,389 See accompanying notes to consolidated financial statements 46 MERITAGE HOMES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 2021 2020 2019 (In thousands) Cash flows from operating activities: Net earnings $ 737,444 $ 423,475 $ 249,663 Adjustments to reconcile net earnings to net cash (used in)/provided by operating activities: Depreciation and amortization 26,245 31,052 27,923 Stock-based compensation 20,069 19,995 19,607 Loss on early extinguishment of debt 18,188 — 5,635 Equity in earnings from unconsolidated entities ( 4,657 ) ( 4,496 ) ( 11,945 ) Distributions of earnings from unconsolidated entities 4,951 3,594 13,438 Other ( 2,911 ) 14,406 9,273 Changes in assets and liabilities: (Increase)/decrease in real estate ( 948,055 ) ( 40,089 ) 3,621 (Increase)/decrease in deposits on real estate under option or contract ( 31,946 ) ( 9,477 ) 453 (Increase)/decrease in receivables, prepaids and other assets ( 65,114 ) 2,130 ( 9,112 ) Increase in accounts payable and accrued liabilities 76,158 88,942 42,654 Increase/(decrease) in home sale deposits 17,536 828 ( 4,390 ) Net cash (used in)/provided by operating activities ( 152,092 ) 530,360 346,820 Cash flows from investing activities: Investments in unconsolidated entities ( 1,708 ) ( 5 ) ( 1,113 ) Distributions of capital from unconsolidated entities — 1,000 11,550 Purchases of property and equipment ( 25,664 ) ( 19,932 ) ( 24,385 ) Proceeds from sales of property and equipment 551 703 459 Maturities/sales of investments and securities 2,795 2,489 754 Payments to purchase investments and securities ( 2,795 ) ( 2,489 ) ( 754 ) Net cash used in investing activities ( 26,821 ) ( 18,234 ) ( 13,489 ) Cash flows from financing activities: Repayment of loans payable and other borrowings ( 13,589 ) ( 16,379 ) ( 3,676 ) Repayment of senior notes ( 317,690 ) — ( 305,620 ) Proceeds from issuance of senior notes 450,000 — — Payment of debt issuance costs ( 6,102 ) — — Repurchase of shares ( 60,992 ) ( 69,592 ) ( 16,035 ) Net cash provided by/(used in) financing activities 51,627 ( 85,971 ) ( 325,331 ) Net (decrease)/increase in cash and cash equivalents ( 127,286 ) 426,155 8,000 Cash and cash equivalents, beginning of year 745,621 319,466 311,466 Cash and cash equivalents, end of year $ 618,335 $ 745,621 $ 319,466 See Supplemental Disclosure of Cash Flow Information in Note 13. See accompanying notes to consolidated financial statements 47 MERITAGE HOMES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021, 2020 and 2019 NOTE 1 — BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization. Meritage Homes Corporation ("Meritage Homes") is a leading designer and builder of single-family homes. We primarily build in historically high-growth regions of the United States and offer a variety of entry-level and first move-up homes. We have homebuilding operations in three regions: West, Central and East, which are comprised of nine states: Arizona, California, Colorado, Texas, Florida, Georgia, North Carolina, South Carolina and Tennessee. These three regions are our principal homebuilding reporting segments. We also operate a financial services reporting segment. In this segment, we offer title and escrow, mortgage, and insurance services. Carefree Title Agency, Inc. ("Carefree Title"), our wholly-owned title company, provides title insurance and closing/settlement services to our homebuyers. Managing our own title operations allows us greater control over the entire escrow and closing cycles in addition to generating additional revenue. Meritage Homes Insurance Agency (“Meritage Insurance”), our wholly-owned insurance broker, works in collaboration with insurance companies nationwide to offer homeowners insurance and other insurance products to our homebuyers. Our financial services operations also provides mortgage services to our homebuyers through an unconsolidated joint venture. We commenced our homebuilding operations in 1985 through our predecessor company known as Monterey Homes. Meritage Homes Corporation was incorporated in the state of Maryland in 1988 under the name of Homeplex Mortgage Investments Corporation and merged with Monterey Homes in 1996, at which time our name was changed to Monterey Homes Corporation and later ultimately to Meritage Homes Corporation. Since that time, we have engaged in homebuilding and related activities. Meritage Homes Corporation operates as a holding company and has no independent assets or operations. Its homebuilding construction, development and sales activities are conducted through its subsidiaries. Our homebuilding activities are conducted under the name of Meritage Homes in each of our homebuilding markets. At December 31, 2021, we were actively selling homes in 259 communities, with base prices ranging from approximately $ 214,000 to $ 962,000 . Basis of Presentation . The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and 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. 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 or closing agents for home closings of approximately $ 95.4 million and $ 61.3 million are included in cash and cash equivalents at December 31, 2021 and 2020, respectively. Real Estate. Real estate inventory 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”) 360-10, Property, Plant and Equipment ("ASC 360-10"). Inventory includes the costs of land acquisition, land development and home construction, capitalized interest, real estate taxes, and 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 when home construction begins. Home construction costs are accumulated on a per-home basis, while selling and marketing 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 that community or phase. When a home closes, we may have incurred costs for goods and services that have not yet been paid. We accrue a liability to capture such obligations in connection with the home closing which is charged directly to cost of sales. We capitalize qualifying interest to inventory during the development and construction periods. Capitalized interest is included in cost of closings when the related inventory is closed. Included within our real estate inventory is land held for development and land held for sale. Land held for development primarily represents 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 have chosen not to currently develop certain land holdings as they typically represent a portion or phases of a larger land parcel that we plan to build out over several years. We do not capitalize interest for these inactive assets, and all ongoing costs of land ownership (i.e. property taxes, homeowner association dues, etc.) are expensed as incurred. 48 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. Actual results can differ from budgeted amounts for various reasons, including construction delays, labor or material shortages, slower absorptions, 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 home construction and land development 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 orders absorption rates and whether the land purchased was raw, partially-developed or in finished status. Master-planned communities encompassing several phases and super-block land parcels may have significantly longer lives and projects involving smaller finished lot purchases may be significantly shorter. All of our land inventory and related real estate assets are periodically reviewed for recoverability when certain criteria are met, but at least annually, as our inventory is considered “long-lived” in accordance with GAAP. If the undiscounted cash flows expected to be generated by an asset are lower than its carrying amount, impairment charges are recorded to write down the asset to its estimated fair value. 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. We conduct an analysis if indicators of a decline in value of our land and real estate assets exists. 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. See Note 2 for additional information related to real estate and impairments. Deposits. Deposits paid related to land option and purchase contracts 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 land 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 our 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 any nonrefundable deposits and any ancillary capitalized costs. Our Deposits on real estate under option or contract were $ 90.7 million and $ 59.5 million as of December 31, 2021 and December 31, 2020, respectively. Goodwill. In accordance with ASC 350, Intangibles, Goodwill and Other ("ASC 350"), we analyze goodwill on an annual basis (or whenever indication of impairment exists) through a qualitative assessment to determine whether it is necessary to perform a goodwill impairment test. ASC 350 states that an entity may assess qualitative factors to determine whether it is necessary to perform a goodwill impairment test. Such qualitative factors include: (1) macroeconomic conditions, such as a deterioration in general economic conditions, (2) industry and market considerations such as deterioration in the environment in which the entity operates, (3) cost factors such as increases in raw materials, labor costs, etc., and (4) overall financial performance such as negative or declining cash flows or a decline in actual or planned revenue or earnings. If the qualitative analysis determines that additional impairment testing is required, a two-step impairment test in accordance with ASC 350 would be initiated. We continually evaluate our qualitative inputs to assess whether events and circumstances have occurred that indicate the goodwill balance may not be recoverable. See Note 10 for additional information on our goodwill assets. 49 Property and Equipment, net. Property and equipment, net consists of computer and office equipment, model home furnishings and capitalized sales office costs. Depreciation is generally calculated using the straight-line method over the estimated useful lives of the assets, which range from three to seven years . Depreciation expense was $ 15.3 million, $ 18.9 million, and $ 17.3 million for the years ended December 31, 2021, 2020 and 2019, respectively. Maintenance and repair costs are expensed as incurred. At December 31, 2021 and 2020, property and equipment, net consisted of the following (in thousands): At December 31, 2021 2020 Computer and office equipment $ 62,806 $ 59,407 Model home furnishings and capitalized sales office costs 61,112 76,398 Gross property and equipment 123,918 135,805 Accumulated depreciation ( 86,578 ) ( 96,872 ) Total $ 37,340 $ 38,933 Deferred Costs. At December 31, 2021 and 2020, deferred costs representing debt issuance costs related to our Credit Facility of approximately $ 3.6 million and $ 4.7 million, net of accumulated amortization, are included on our consolidated balance sheets within Prepaids, other assets and goodwill. The costs are primarily amortized to interest expense using the straight line method which approximates the effective interest method. See Note 7 for additional information related to net debt issuance costs associated with our senior notes. Investments in Unconsolidated Entities . We use the equity method of accounting for investments in unconsolidated entities over which we exercise significant influence but do not have a controlling interest. Under the equity method, our share of the unconsolidated entities’ earnings or loss is included in Other income net, or Earnings from financial services unconsolidated entities and other, net, in our income statements. We use the cost method of accounting for investments in unconsolidated entities over which we do not have significant influence, if any. We track cumulative earnings and distributions from each of our ventures. For cash flow classification, to the extent distributions do not exceed cumulative earnings, we designate such distributions as return on capital. Distributions in excess of cumulative earnings are treated as return of capital. We evaluate our investments in unconsolidated entities for impairment when events that trigger an evaluation of recoverability present themselves. See Note 5 for additional information related to investments in unconsolidated entities. Accrued Liabilities . Accrued liabilities at December 31, 2021 and 2020 consisted of the following (in thousands): At December 31, 2021 2020 Accruals related to real estate development and construction activities $ 115,214 $ 92,701 Payroll and other benefits 102,773 88,337 Accrued interest 5,556 8,457 Accrued taxes 37,297 34,373 Warranty reserves 26,264 23,743 Lease liabilities (1) 26,171 28,254 Other accruals 24,002 20,256 Total $ 337,277 $ 296,121 (1) Refer to Note 4 for additional information related to our leases. Revenue Recognition. In accordance with ASC 606 , Revenue from Contracts with Customers , we apply the following steps in determining the timing and amount of revenue to recognize: (1) identify the contract with our customer; (2) identify the performance obligation(s) in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract, if applicable; and (5) recognize revenue when (or as) we satisfy the performance obligation. The performance obligation and subsequent revenue recognition for our three sources of revenue are outlined below: • Revenue from closings of residential real estate is recognized when closings have occurred, the risks and rewards of ownership are transferred to the buyer, and we have no continuing involvement with the property, which is generally upon the close of escrow. Revenue is reported net of any discounts and incentives. 50 • Revenue from land sales is recognized when a significant down payment is received, title passes and collectability of the receivable is reasonably assured, and we have no continuing involvement with the property, which is generally upon the close of escrow. • Revenue from financial services is recognized when closings have occurred and all financial services have been rendered, which generally upon the close of escrow. Home sale contract assets consist of cash from home closings that are in transit from title companies, which are considered cash in transit and are classified as cash on our accompanying consolidated balance sheets. See "Cash and Cash Equivalents" in this Note 1 for further information. Contract liabilities include home sale deposit liabilities related to sold but unclosed homes, and are classified as Home sale deposits in our accompanying consolidated balance sheets. Substantially all of our home sales are scheduled to close and be recorded as revenue within one year from the date of receiving a customer deposit. Revenue expected to be recognized in any future year related to remaining performance obligations (if any) and contract liabilities expected to be recognized as revenue, excluding revenue pertaining to contracts that have an original expected duration of one year or less, is not material. Revenue from financial services includes estimated future insurance policy renewal commissions as our performance obligations are satisfied upon issuance of the initial policy with a third-party broker. The related contract assets for these estimated future renewal commissions are not material at December 31, 2021 and 2020. Our three sources of revenue are disaggregated by type in the accompanying consolidated income statements. Cost of Home Closings . Cost of home closings includes direct home construction costs, closing costs, land acquisition and development costs, development period interest and common costs, and impairments, if any. Direct construction costs are accumulated during the period of construction and charged to cost of closings under specific identification methods, as are closing costs. Land development, acquisition and common costs are allocated to each lot based on the number of lots remaining to close. Estimates of costs incurred or to be incurred but not paid are accrued and expensed at the time of closing. Income Taxes. We account for income taxes using the asset and liability method, which requires that deferred tax assets and liabilities be recognized based on future tax consequences of both temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply in the years in which the temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in earnings in the period when the changes are enacted. We record deferred tax assets to the extent we believe these assets will more likely than not be realized. In making such determination, we consider all available objectively verifiable positive and negative evidence, including scheduled reversals of deferred tax liabilities, whether we are in a cumulative loss position, projected future taxable income, tax planning strategies and recent financial operations. If we determine that we will not be able to realize our deferred tax assets in the future, we will record a valuation allowance, which increases the provision for income taxes. We recognize interest and penalties related to unrecognized tax benefits within Provision for income taxes in the accompanying consolidated income statements. Accrued interest and penalties are included within Accrued liabilities in the accompanying consolidated balance sheets. See Note 12 for additional information related to income taxes. Advertising Costs. We expense advertising costs as they are incurred. Advertising expense was approximately $ 8.2 million, $ 10.5 million and $ 14.6 million in fiscal 2021, 2020 and 2019, respectively. Earnings Per Share. We compute basic earnings per share by dividing net earnings by the weighted average number of common shares outstanding during the period. Diluted earnings per share gives effect to the potential dilution that could occur if securities or contracts to issue common stock that are dilutive were exercised or converted into common stock or resulted in the issuance of common stock that then shared in our earnings. In periods of net losses, no dilution is computed. See Note 9 for additional information related to earnings per share. Stock-Based Compensation . We account for stock-based compensation in accordance with ASC 718-10, Compensation—Stock Compensation ("ASC 718"). This guidance requires us to estimate forfeitures in calculating the expense related to stock-based compensation. Awards with either a graded or cliff vesting are expensed on a straight-line basis over the life of the award. See Note 11 for additional information on stock-based compensation. 401(k) Retirement Plan. We have a 401(k) plan for all full-time Meritage employees. We match portions of employees’ voluntary contributions , and contributed to the plan approximately $ 5.3 million, $ 4.7 million and $ 4.1 million for the years ended 2021, 2020 and 2019, respectively. 51 Off-Balance Sheet Arrangements - Joint Ventures . We may participate 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, although our participation in such ventures is currently very limited. See Note 5 for additional discussion of our investments in unconsolidated entities. Off-Balance Sheet Arrangements - Other. In the normal course of business, we may acquire lots from various development 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) and may have staggered purchase schedules. See Note 3 for additional information on off-balance sheet arrangements. Surety Bonds and Letters of Credit. We provide surety bonds and letters of credit in support of our obligations relating to the development of our projects and other corporate purposes, in lieu of 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 wholly 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 or letter of credit. We believe it is unlikely that any significant amounts of these bonds or letters of credit will be drawn upon. The table below outlines our surety bond and letter of credit obligations (in thousands): At December 31, 2021 2020 Outstanding Estimated work remaining to complete (unaudited) Outstanding Estimated work remaining to complete (unaudited) Sureties: Sureties related to owned projects and lots under contract 620,297 352,152 478,788 216,708 Total Sureties $ 620,297 $ 352,152 $ 478,788 $ 216,708 Letters of Credit (“LOCs”): LOCs for land development 57,396 N/A 93,661 N/A LOCs for general corporate operations 5,000 N/A 3,750 N/A Total LOCs $ 62,396 N/A $ 97,411 N/A 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 for the first year after the close of the home, a major mechanical warranty for two years after the close of the home and a structural warranty that typically extends up to 10 years after the close of the home. With the assistance of an actuary, we have estimated these reserves for the structural warranty based on the number of homes still under warranty and historical data and trends for our communities. We may use industry data 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. Based on such reviews of warranty costs incurred, we did not adjust the warranty reserve balance in the twelve months ended December 31, 2021 and 2020. Included in the warranty reserve balances at December 31, 2021 and December 31, 2020 reflected in the table below are case-specific reserves for warranty matters, as discussed in Note 16. A summary of changes in our warranty reserves follows (in thousands): Years Ended December 31, 2021 2020 Balance, beginning of year $ 23,743 $ 22,015 Additions to reserve from new home deliveries 17,883 18,503 Warranty claims ( 15,362 ) ( 16,775 ) Adjustments to pre-existing reserves — — Balance, end of year $ 26,264 $ 23,743 52 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 insurance we maintain, are sufficient to cover our general warranty obligations. However, as unanticipated changes in legal, weather, environmental or other conditions could have an impact on our actual warranty costs, future costs could differ significantly from our estimates. Recent Accounting Pronouncements. In December 2019, the Financial Accounting Standards Board issued Accounting Standards Update ("ASU") No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes ("ASU 2019-12"), which simplifies the accounting for income taxes by eliminating certain exceptions within ASC Topic 740, Income Taxes , and clarifying other areas of existing guidance. ASU 2019-12 was effective for us on January 1, 2021, and the adoption did not have a material impact on our financial statements or financial statement disclosures. NOTE 2 — REAL ESTATE AND CAPITALIZED INTEREST Real estate consists of the following (in thousands): At December 31, 2021 2020 Homes under contract under construction (1) $ 1,039,822 $ 873,365 Unsold homes, completed and under construction (1) 484,999 357,861 Model homes (1) 81,049 82,502 Finished home sites and home sites under development (2) (3) 2,128,538 1,464,311 $ 3,734,408 $ 2,778,039 (1) Includes the allocated land and land development costs associated with each lot for these homes. (2) Includes raw land, land held for development and land held for sale, less impairments, if any. Land held for development primarily represents 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 have chosen not to currently develop certain land holdings as they typically represent a portion or phases of a larger land parcel that we plan to build out over several years. We do not capitalize interest for inactive assets, and all ongoing costs of land ownership (i.e. property taxes, homeowner association dues, etc.) are expensed as incurred. (3) Includes land held for sale of $ 62.1 million and $ 72.7 million as of December 31, 2021 and 2020, respectively. As previously noted, in accordance with ASC 360-10, each of our land inventory and related real estate assets is reviewed for recoverability when certain criteria are met, but at least annually, as our inventory is considered “long-lived” in accordance with GAAP. ASC 360-10 requires impairment charges to be recorded if the asset is not deemed recoverable and the fair value of such assets is less than their carrying amounts. Our determination of fair value is based on projections and estimates. We also evaluate alternative product offerings in communities where impairment indicators are present and other strategies for the land exist, such as selling or holding the land for sale. We recorded impairment charges of approximately $ 2.1 million, $ 24.9 million and $ 7.3 million for the years ended December 31, 2021, 2020, and 2019 respectively, primarily as a result of upcoming dispositions of certain assets that no longer fit our strategy of entry-level and first move-up communities. Subject to sufficient qualifying assets, we capitalize our development period interest costs incurred to applicable qualifying assets in connection with our real estate development and construction activities. Capitalized interest is allocated to active 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): 53 Years Ended December 31, 2021 2020 2019 Capitalized interest, beginning of year $ 58,940 $ 82,014 $ 88,454 Interest incurred 62,836 66,289 83,856 Interest expensed ( 318 ) ( 2,177 ) ( 8,370 ) Interest amortized to cost of home and land closings ( 65,205 ) ( 87,186 ) ( 81,926 ) Capitalized interest, end of year (1) $ 56,253 $ 58,940 $ 82,014 (1) Approximately $ 208,000 , $ 217,000 and $ 279,000 of the capitalized interest is related to our joint venture investments and is a component of Investments in unconsolidated entities in our consolidated balance sheets as of December 31, 2021, 2020 and 2019, respectively. NOTE 3 — VARIABLE INTEREST ENTITIES AND CONSOLIDATED REAL ESTATE NOT OWNED We enter into purchase and option agreements for land or lots as part of the normal course of business. These purchase and option agreements enable us to acquire properties at one or multiple future dates at pre-determined prices. We believe these acquisition structures allow us to better leverage our balance sheet and reduce our financial risk associated with land acquisitions. 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, a variable interest entity, or “VIE”, may be created. We evaluate all option and purchase agreements and amendments for land to determine whether they are a VIE. ASC 810, Consolidation , 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 and Liabilities related to real estate not owned, respectively. The liabilities related to consolidated VIEs are generally excluded from our debt covenant calculations. In order to determine if we are the primary beneficiary, we must first assess whether we have the ability to control the activities of the VIE that most significantly impact its economic performance. Such activities include, but are not limited to, the ability to determine the budget and scope of land development work, if any; the ability to control financing decisions for the VIE; the ability to acquire additional land into the VIE or dispose of land in the VIE not under contract with Meritage; and the ability to change or amend the existing option contract with the VIE. If we are not determined to control such activities, we are not considered the primary beneficiary of the VIE. If we do have the ability to control such activities, we will continue our analysis by determining if we are also expected to absorb a potentially significant amount of the VIE’s losses or, if no party absorbs the majority of such losses, if we will benefit from a potentially significant amount of the VIE’s expected gains. In substantially all cases, creditors of the entities with which we have option agreements have no recourse against us and the maximum exposure to loss in our option agreements is limited to non-refundable option deposits and any capitalized pre-acquisition costs. Often, we are at risk for items over budget related to land development on property we have under option if we are the land developer. In these cases, we have typically 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. 54 The table below presents a summary of our lots under option that are not recorded on the balance sheet at December 31, 2021 (dollars in thousands): Projected Number of Lots (unaudited) Purchase Price (unaudited) Option/ Earnest Money Deposits–Cash Purchase and option contracts recorded on balance sheet as Real estate not owned (1) 1 $ 8,011 $ 801 Option contracts — non-refundable deposits, committed (2) 11,983 653,847 55,400 Purchase contracts — non-refundable deposits, committed (2) 12,963 330,696 25,888 Purchase and option contracts —refundable deposits, committed 1,548 42,650 596 Total committed 26,495 1,035,204 82,685 Purchase and option contracts — refundable deposits, uncommitted (3) 25,534 775,276 8,795 Total lots under contract or option 52,029 $ 1,810,480 $ 91,480 Total purchase and option contracts not recorded on balance sheet (4) 52,028 $ 1,802,469 $ 90,679 (5) (1) Real estate not owned represents a single parcel of land intended for multi-family housing that, once purchased, the Company intends to sell. (2) Deposits are non-refundable except if certain contractual conditions are not performed by the selling party. (3) 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. (4) Except for our specific performance contracts recorded on our balance sheet as Real estate not owned (if any), none of our purchase or option contracts require us to purchase lots. (5) Amount is reflected in our consolidated balance sheets in the line item “Deposits on real estate under option or contract” as of December 31, 2021. 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, we may purchase lots at an absorption level that exceeds our sales and home starts pace needed to meet the pre-established minimum number of lots or restructure our original contract to terms that more accurately reflect our revised orders pace expectations. During a strong homebuilding market, we may accelerate our pre-established minimum purchases if allowed by the contract. NOTE 4 - LEASES We lease certain office space and equipment for use in our operations. We assess each of these contracts to determine whether the arrangement contains a lease as defined by ASC 842, Leases ("ASC 842"). In order to meet the definition of a lease under ASC 842, the contractual arrangement must convey to us the right to control the use of an identifiable asset for a period of time in exchange for consideration. We recognize lease expense for these leases on a straight-line basis over the lease term and combine lease and non-lease components for all leases. Some of our leases contain renewal options and in accordance with ASC 842, our lease terms include those renewals only to the extent that they are reasonably certain to be exercised. The exercise of these lease renewal options is generally at our discretion. In accordance with ASC 842, the lease liability is equal to the present value of the remaining lease payments while the right of use ("ROU") asset is based on the lease liability, subject to adjustment, such as for lease incentives. Our leases do not provide a readily determinable implicit interest rate and therefore, we must estimate our incremental borrowing rate. In determining our incremental borrowing rate, we consider the lease period, market interest rates, current interest rates on our senior notes and the effects of collateralization. Our lease population at December 31, 2021 is comprised of operating leases where we are the lessee and these leases are primarily real estate for office space for our corporate office, division offices and design centers, in addition to leases of certain equipment. As allowed by ASC 842, we adopted an accounting policy election to not record leases with lease terms of twelve months or less on the consolidated balance sheets. Lease cost included in our consolidated income statements in General and administrative expenses and Commissions and other sales costs is in the table below (in thousands). Our short-term lease costs and sublease income are de minimis. 55 Years Ended December 31, 2021 2020 Operating lease expense $ 7,613 $ 7,657 Non-cash lease expense $ 6,342 $ 6,037 Cash payments on lease liabilities $ 9,065 $ 9,013 ROU assets obtained in exchange for new operating lease obligations $ 5,756 $ 1,364 ROU assets are classified within Prepaids, other assets and goodwill on our consolidated balance sheets, while lease liabilities are classified within Accrued liabilities on our consolidated balance sheets. The following table contains additional information about our leases (dollars in thousands): At December 31, 2021 2020 ROU assets $ 21,038 $ 21,624 Lease liabilities $ 26,171 $ 28,254 Weighted-average remaining lease term 4.1 years 4.0 years Weighted-average discount rate (incremental borrowing rate) 4.76 % 4.54 % Maturities of our operating lease liabilities as of December 31, 2021 are as follows (in thousands): Year ended December 31, 2021 $ 9,009 2022 7,505 2023 4,633 2024 3,408 2025 2,187 Thereafter 2,114 Total payments 28,856 Less: imputed interest ( 2,685 ) Present value of lease liabilities $ 26,171 NOTE 5 - INVESTMENTS IN UNCONSOLIDATED ENTITIES We may enter into joint ventures as a means of accessing larger parcels of land, expanding our market opportunities, managing our risk profile, optimizing deal structure for the impacted parties and leveraging our capital base. While purchasing land through a joint venture can be beneficial, currently we do not view joint ventures as critical to the success of our homebuilding operations. 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. Based on the structure of these joint ventures, they may or may not be consolidated into our results. As of December 31, 2021, we had two active equity-method land ventures and one mortgage joint venture, which is engaged in mortgage activities and primarily provides services to our homebuyers. 56 Summarized condensed combined financial information related to unconsolidated joint ventures that are accounted for using the equity method was as follows (in thousands): At December 31, 2021 2020 Assets: Cash $ 7,983 $ 4,656 Real estate 7,989 5,745 Other assets 3,903 5,118 Total assets $ 19,875 $ 15,519 Liabilities and equity: Accounts payable and other liabilities $ 7,899 $ 5,588 Equity of: Meritage (1) 4,752 5,330 Other 7,224 4,601 Total liabilities and equity $ 19,875 $ 15,519 Years Ended December 31, 2021 2020 2019 Revenue $ 41,929 $ 39,823 $ 53,841 Costs and expenses ( 34,693 ) ( 31,918 ) ( 31,375 ) Net earnings of unconsolidated entities $ 7,236 $ 7,905 $ 22,466 Meritage’s share of pre-tax earnings (1) (2) $ 4,667 $ 4,559 $ 11,945 (1) Balance represents Meritage’s interest, as reflected in the financial records of the respective joint ventures. This balance may differ from the balance reported 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) capitalization of interest on qualified assets, (iv) income deferrals as discussed in Note (2) below and (v) 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. As discussed in Note 2 to these consolidated financial statements, the balances above do not include $ 208,000 , $ 217,000 and $ 279,000 of capitalized interest that is a component of our investment balances at December 31, 2021, 2020 and 2019, respectively. (2) Our share of pre-tax earnings is recorded in Earnings from financial services unconsolidated entities and other, net or Other income, net, as applicable, 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 total investment in all of these joint ventures is $ 5.8 million as of December 31, 2021. We believe these ventures are in compliance with their respective debt agreements, if applicable, and such debt is non-recourse to us. NOTE 6 — LOANS PAYABLE AND OTHER BORROWINGS Loans payable and other borrowings consist of the following (in thousands): At December 31, 2021 2020 Other borrowings, real estate note payable (1) $ 17,552 $ 23,094 $ 780.0 million unsecured revolving credit facility — — Total $ 17,552 $ 23,094 (1) Reflects balance of non-recourse notes payable in connection with land purchases. The Company entered into an amended and restated unsecured revolving credit facility ("Credit Facility") in 2014 that has been amended from time to time. In December 2021, the Credit Facility was amended to extend the maturity date to December 57 22, 2026 and replace LIBOR as the benchmark interest rate with the Secured Overnight Financing Rate ("SOFR") as described below. The Credit Facility's aggregate commitment is $ 780.0 million with an accordion feature permitting the size of the facility to increase to a maximum of $ 880.0 million, subject to certain conditions, including the availability of additional bank commitments. Borrowings under the Credit Facility bear interest at the Company's option, at either (1) term SOFR (based on 1, 3, or 6 month interest periods, as selected by the Company) plus a 10 basis point adjustment plus an applicable margin (ranging from 125 basis points to 175 basis points (the "applicable margin")) based on the Company's leverage ratio as determined in accordance with a pricing grid, (2) the higher of (i) the prime lending rate, (ii) an overnight bank rate plus 50 basis points and (3) term SOFR (based on a 1 month interest period) plus a 10 basis point adjustment plus 1 %, in each case plus a margin ranging from 25 basis points to 75 basis points based on the Company's leverage in accordance with a pricing grid, or (iii) daily simple SOFR plus a 10 basis point adjustment plus the applicable margin. At December 31, 2021, the interest rate on outstanding borrowings under the Credit Facility would have been 1.40 % per annum. We are obligated to pay a fee on the undrawn portion of the Credit Facility at a rate equal to the applicable margin then in effect. The Credit Facility also contains certain financial covenants, including (a) a minimum tangible net worth requirement of $ 1.9 billion (which amount is subject to increase over time based on subsequent earnings and proceeds from equity offerings), and (b) a maximum leverage covenant that prohibits the leverage ratio (as defined therein) from exceeding 60 %. In addition, we are required to maintain either (i) an interest coverage ratio (EBITDA to interest expense, as defined therein) of at least 1.50 to 1.00 or (ii) liquidity (as defined therein) of an amount not less than our consolidated interest incurred during the trailing 12 months. We were in compliance with all Credit Facility covenants as of December 31, 2021. We had no outstanding borrowings under the Credit Facility as of December 31, 2021 and December 31, 2020. During the twelve months ended December 31, 2021, we had no gross borrowings or repayments. During the twelve months ended December 31, 2020 and 2019, we had $ 500.0 million and $ 90.0 million of gross borrowings and repayments, respectively. As of December 31, 2021 we had outstanding letters of credit issued under the Credit Facility totaling $ 62.4 million, leaving $ 717.6 million available under the Credit Facility to be drawn. NOTE 7 — SENIOR NOTES, NET Senior notes, net consist of the following (in thousands): At December 31, 2021 2020 7.00 % senior notes due 2022 $ — $ 300,000 6.00 % senior notes due 2025. At December 31, 2021 and December 31, 2020 there was approximately $ 2,795 and $ 3,614 in net unamortized premium, respectively. (1) 402,795 403,614 5.125 % senior notes due 2027 300,000 300,000 3.875 % senior notes due 2029 450,000 — Net debt issuance costs ( 10,309 ) ( 6,623 ) Total $ 1,142,486 $ 996,991 (1) $ 200.0 million of the total $ 400.0 million of 6.00 % Senior Notes due 2025 outstanding at December 31, 2021 was issued at par and had no unamortized premium. The indentures for all of our senior notes contain non-financial covenants including, among others, limitations on the amount of secured debt we may incur, and limitations on sale and leaseback transactions and mergers. We were in compliance with all such covenants as of December 31, 2021. Obligations to pay principal and interest on the senior notes are guaranteed by substantially 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, minor. 58 During 2010, we completed an offering of $ 200.0 million aggregate principal amount of 7.15 % senior notes due 2020 (the "2020 Notes"). During 2013, we completed a $ 100.0 million add-on offering to the existing 7.50 % senior notes due 2020. In the fourth quarter of 2019, we redeemed the 2020 Notes, incurring $ 5.6 million in charges reflected as Loss on early extinguishment of debt in the accompanying income statements. In April 2012, we completed an offering of $ 300.0 million aggregate principal amount of 7.00 % Senior Notes due 2022 (the "2022 Notes"). In June 2015, we completed an offering of $ 200.0 million aggregate principal amount of 6.00 % Senior Notes due 2025 (the "2025 Notes"). The 2025 Notes were issued at par, and the proceeds were used for general corporate obligations and future land spend. In March 2018, the Company completed an offering of $ 200.0 million aggregate principal amount of additional 2025 Notes (the "Additional Notes"). The Additional Notes were issued as an add-on to the existing 2025 Notes that were issued in June 2015 which resulted in a combined $ 400.0 million aggregate principal amount of 6.00 % Senior Notes due 2025 outstanding as of December 31, 2021. The Additional Notes were issued at a premium of 103 % of the principal amount. In June 2017, we completed an offering of $ 300.0 million aggregate principal amount of 5.125 % Senior Notes due 2027 (the "2027 Notes"). The 2027 notes were issued at par. Using the proceeds from the 2027 Notes offering, we retired all $ 126.5 million of our convertible senior notes through a repurchase of $ 51.9 million in privately negotiated transactions and a redemption of the remaining $ 74.6 million through a combination of holder redemptions and an exercise of our call option at a redemption price equal to 100 % of the principal amount of the notes redeemed, plus accrued and unpaid interest. In April 2021, we completed an offering of $ 450.0 million aggregate principal amount of 3.875 % Senior Notes due 2029. We used a portion of the net proceeds from this offering to redeem all $ 300.0 million aggregate principal outstanding of the 2022 Notes, incurring $ 18.2 million in early debt extinguishment during the year ended December 31, 2021, reflected as Loss on early extinguishment of debt in the accompanying unaudited consolidated income statements. Scheduled principal maturities of our senior and notes as of December 31, 2021 follow (in thousands): Year Ended December 31, 2022 $ — 2023 — 2024 — 2025 400,000 2026 — Thereafter 750,000 Total $ 1,150,000 NOTE 8 — FAIR VALUE DISCLOSURES ASC 820-10, Fair Value Measurement, 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. 59 Financial Instruments : The fair value of our fixed-rate debt is derived from quoted market prices by independent dealers (Level 2 inputs as per the discussion above) and is as follows (in thousands): At December 31, 2021 2020 Aggregate Principal Estimated Fair Value Aggregate Principal Estimated Fair Value 7.00 % senior notes $ — $ — $ 300,000 $ 319,758 6.00 % senior notes $ 400,000 $ 446,520 $ 400,000 $ 451,913 5.125 % senior notes $ 300,000 $ 329,640 $ 300,000 $ 333,328 3.875 % senior notes $ 450,000 $ 472,500 $ — $ — Due to the short-term nature of other financial assets and liabilities including our Loans payable and other borrowings, we consider the carrying amounts of our other short-term financial instruments to approximate fair value. Non-Financial Instruments : Our Real estate assets are Level 3 instruments that are required to be recorded at fair value on non-recurring basis when events and circumstances indicate that the carrying value may not be recoverable. Refer to Notes 1 and 2 for information regarding the valuation of these assets. Our Real estate assets measured at fair value are as follows (in thousands): Year Ended December 31, 2021 2020 Description: Initial basis of long-lived real estate assets $ 7,369 $ 71,769 Impairments $ 2,115 $ 24,852 Adjusted basis of long-lived real estate assets $ 5,254 $ 46,917 At December 31, 2021 and 2020, we remeasured these assets at fair value because of a decision to sell certain assets that are no longer aligned with our strategy to focus on first-time and first move-up homebuyers. The non-recurring fair values included in the table above represent only those assets whose carrying values were adjusted to fair value as of the respective balance sheet dates. NOTE 9 — EARNINGS PER SHARE Basic and diluted earnings per common share were calculated as follows (in thousands, except per share amounts): Years Ended December 31, 2021 2020 2019 Basic weighted average number of shares outstanding 37,610 37,718 38,100 Effect of dilutive securities: Unvested restricted stock 623 766 791 Diluted average shares outstanding 38,233 38,484 38,891 Net earnings $ 737,444 $ 423,475 $ 249,663 Basic earnings per share $ 19.61 $ 11.23 $ 6.55 Diluted earnings per share $ 19.29 $ 11.00 $ 6.42 60 NOTE 10 — ACQUISITIONS AND GOODWILL Goodwill. In prior years, we have entered new markets through the acquisition of the homebuilding assets and operations of local/regional homebuilders in Georgia, South Carolina and Tennessee. As a result of these transaction, we recorded approximately $ 33.0 million of goodwill. Goodwill represents the excess purchase price of our acquisitions over the fair value of the net assets acquired. Our acquisitions were recorded in accordance with ASC 805, Business Combination s and ASC 820, using the acquisition method of accounting. The purchase price for acquisitions was allocated based on estimated fair value of the assets and liabilities at the date of the acquisition. The combined excess purchase price of our acquisitions over the fair value of the net assets is classified as goodwill and is included in our consolidated balance sheets in Prepaids, other assets and goodwill. In accordance with ASC 350, we assess the recoverability of goodwill annually, or more frequently, if impairment indicators are present. A summary of the carrying amount of goodwill follows (in thousands): West Central East Financial Services Corporate Total Balance at January 1, 2020 $ — $ — $ 32,962 $ — $ — $ 32,962 Additions — — — — — — Balance at December 31, 2020 — — 32,962 — — 32,962 Additions — — — — — — Balance at December 31, 2021 $ — $ — $ 32,962 $ — $ — $ 32,962 NOTE 11 — STOCK BASED AND DEFERRED COMPENSATION We have a stock compensation plan, the Meritage Homes Corporation 2018 Stock Incentive Plan (the “2018 Plan"), that was approved by our Board of Directors and our stockholders and adopted in May 2018. The 2018 Plan is administered by our Board of Directors and allows 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. All available shares from expired, terminated, or forfeited awards that remained under prior plans were merged into and became available for grant under the 2018 Plan. The 2018 Plan authorizes awards to officers, key employees, non-employee directors and consultants. The 2018 Plan authorizes 6,600,000 shares of stock to be awarded, of which 1,047,626 shares remain available for grant at December 31, 2021. 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 are usually granted with a five-year ratable vesting period for employees, a three-year cliff vesting for both non-vested stock and performance-based awards granted to senior executive officers and either a three-year cliff vesting or one-year vesting for non-employee directors, dependent on their start date. 61 Summary of Nonvested (Restricted) Shares and Units Activity: We grant time-based and performance-based restricted shares or units. Performance-based restricted shares are only granted to executive officers. All performance shares only vest upon the attainment of certain financial and operational criteria as established and approved by our Board of Directors. The number of shares that may be issued to the award recipients may be greater or lesser than the target award amount depending on actual performance achieved as compared to the performance targets set forth in the awards. Nonvested Restricted Share Activity (time-based) Weighted Average Grant Date Fair Value Nonvested Restricted Share Activity (performance- based) Weighted Average Grant Date Fair Value Outstanding at January 1, 2019 923,290 $ 38.25 378,455 $ 38.77 Granted (1) 385,328 44.46 115,191 40.46 Vested (Earned/Released) ( 347,555 ) 37.15 ( 87,737 ) 34.39 Forfeited (2) ( 126,443 ) 40.45 — — Outstanding as of December 31, 2019 834,620 41.25 405,909 40.20 Granted (3) 225,593 72.51 80,193 61.06 Vested (Earned/Released) ( 234,842 ) 38.80 ( 178,174 ) 34.10 Forfeited (2) ( 34,754 ) 46.31 — — Outstanding at December 31, 2020 790,617 50.67 307,928 49.16 Granted (4) 226,936 85.19 86,384 65.91 Vested (Earned/Released) ( 264,513 ) 46.09 ( 203,561 ) 44.92 Forfeited (2) ( 60,511 ) 60.96 — — Outstanding at December 31, 2021 692,529 $ 62.94 190,751 $ 61.68 (1) Performance-based shares granted for the year ended December 31, 2019 includes 21,039 shares that were issued as a result of the performance achievement exceeding the performance targets related to grants to our executive officers for the year ended December 31, 2016. These shares vested in March 2019. (2) Forfeitures on time-based nonvested shares are a result of terminations of employment, while forfeitures on performance-based nonvested shares are the result of failing to attain certain goals as outlined in our executive officers' compensation agreements. (3) Performance-based shares granted for the year ended December 31, 2020 includes 24,054 shares that were issued as a result of the performance achievement exceeding the performance targets related to grants to our executive officers for the year ended December 31, 2017. These shares vested in February 2020. (4) Performance-based shares granted for the year ended December 31, 2021 includes 37,425 shares that were issued as a result of the performance achievement exceeding the performance targets related to grants to our executive officers for the year ended December 31, 2018. These shares vested in March 2021. Performance-based shares granted for the year ended December 31, 2021 also includes 1,670 shares and 696 shares that were issued to our General Counsel, who retired on December 15, 2021, as a result of the performance achievement exceeding the performance targets related to grants to our executive officers for the years ended December 31, 2019 and 2018, respectively. These shares vested in December 2021 in accordance with his employment agreement. Compensation cost related to time-based restricted stock awards is measured as of the closing price on the date of grant and is expensed, less forfeitures, 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 ("ASC 718"), which requires an assessment of probability of attainment of the performance target. As our performance targets are dependent on performance over a specified measurement period, once we determine that the performance target outcome is probable, the cumulative expense is recorded immediately with the remaining expense recorded on a straight-line basis through the end of the award vesting period. A portion of the performance-based restricted stock awards granted to our executive officers contain market conditions as defined by ASC 718. ASC 718 requires that compensation expense for stock awards with market conditions be expensed based on a derived grant date fair value and expensed over the service period. We engage a third party to perform a valuation analysis on the awards containing market conditions and our associated expense with those awards is based on the derived fair value from that analysis and is being expensed straight line over the service period of the awards. Below is a summary of compensation 62 expense and stock award activity (in thousands): Years Ended December 31, 2021 2020 2019 Stock-based compensation expense $ 20,069 $ 19,995 $ 19,607 The following table includes additional information regarding our stock compensation plan (dollars in thousands): At December 31, 2021 2020 Unrecognized stock-based compensation cost $ 25,007 $ 22,687 Weighted average years expense recognition period 1.97 2.01 Total equity awards outstanding (1) 883,280 1,098,545 (1) Includes unvested restricted stock awards, restricted stock units and performance-based awards (assuming 100 %/target payout). We also offer a non-qualified deferred compensation plan ("deferred compensation plan") to highly compensated employees in order to allow them additional pre-tax income deferrals above and beyond the limits that qualified plans, such as 401(k) plans, impose on highly compensated employees. We do not currently offer a contribution match on the deferred compensation plan. All contributions to the plan to date have been funded by the employees and, therefore, we have no associated expense related to the deferred compensation plan for the years ended December 31, 2021, 2020 and 2019, other than minor administrative costs. NOTE 12 — INCOME TAXES Components of income tax expense are as follows (in thousands): Years Ended December 31, 2021 2020 2019 Current taxes: Federal $ 180,469 $ 99,174 $ 41,019 State 39,930 21,012 11,644 220,399 120,186 52,663 Deferred taxes: Federal ( 4,033 ) ( 9,725 ) ( 8 ) State 1,024 ( 370 ) 627 ( 3,009 ) ( 10,095 ) 619 Total $ 217,390 $ 110,091 $ 53,282 Income taxes for the years ended December 31, 2021, 2020 and 2019, differ from the expected amounts computed using the federal statutory income tax rate of 21 % as a result of the following (in thousands): Years Ended December 31, 2021 2020 2019 Expected taxes at current federal statutory income tax rate $ 200,515 $ 112,049 $ 63,618 State income taxes, net of federal tax benefit 31,967 16,307 9,999 Federal tax credits ( 20,872 ) ( 16,523 ) ( 20,582 ) Non-deductible costs and other 5,780 ( 1,742 ) 247 Income tax expense $ 217,390 $ 110,091 $ 53,282 The effective tax rate was 22.8 %, 20.6 %, and 17.6 % for 2021, 2020 and 2019, respectively. The rates in all three years reflect a benefit from the extension of the Internal Revenue Code ("IRC") §45L new energy efficient homes credits, and additional energy tax credits obtained by qualifying more homes in open prior tax years. The rate in 2019 also includes the 63 additional benefit of energy tax credit for the 2018 tax year that was realized in the 2019 tax year due to the retroactive application of the 2019 Act. Deferred tax assets and liabilities are netted on our balance sheet by tax jurisdiction. Net overall deferred tax assets for all jurisdictions are grouped and included as a separate asset. Net overall deferred tax liabilities for all jurisdictions are grouped and included in Accrued liabilities. At December 31, 2021, we have a net deferred tax asset of $ 40.7 million. We also have net deferred tax liabilities of $ 6.1 million. Deferred tax assets and liabilities are comprised of timing differences (in thousands) as follows: At December 31, 2021 2020 Deferred tax assets: Real estate $ 25,960 $ 18,710 Warranty reserve 6,273 5,588 Wages payable 5,834 7,798 Equity-based compensation 5,465 7,114 Accrued expenses 199 193 Other 7,836 5,498 Total deferred tax assets 51,567 44,901 Deferred tax liabilities: Goodwill 1,611 879 Prepaids 2,498 1,487 Fixed assets 6,786 6,495 Total deferred tax liabilities 10,895 8,861 Deferred tax assets, net 40,672 36,040 Other deferred tax liabilities - state franchise taxes 6,099 4,476 Net deferred tax assets and liabilities $ 34,573 $ 31,564 At December 31, 2021 and December 31, 2020, we have no unrecognized tax benefits. We believe that our current income tax filing positions and deductions will be sustained on audit and do not anticipate any adjustments that will 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. We determine our deferred tax assets and liabilities in accordance with ASC 740, Income Taxes ("ASC 740" ) . We evaluate our 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 carry forward periods, experiences with operating losses and experiences of utilizing tax credit carry forwards and tax planning alternatives. We have no valuation allowance on our deferred tax assets and no NOL carryovers at December 31, 2021. In December of 2019, Congress passed the Taxpayer Certainty and Disaster Tax Relief Act of 2019 as a part of the Further Consolidated Appropriations Act, 2020 (the "2020 Act") which the President signed into law on December 20, 2019. The 2020 Act further extended the availability of the IRC §45L new energy efficient homes credit (the "energy tax credit") through the end of 2020. The Taxpayer Certainty and Disaster Relief Act of 2020, signed into law by the President on December 27, 2020 extended the energy tax credit through the end of 2021. Under ASC 740, the effects of the 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 $ 16.9 million during the year ended December 31, 2021 based on our estimate for qualifying new energy efficient homes that we closed in 2021. The estimated tax effected benefit is reflected in our effective 64 tax rate reconciliation as the benefit from federal tax credits. The energy tax credit expired at December 31, 2021, and a benefit for the year-ended December 31, 2022 can only occur with new legislation extending the credit. Our future deferred tax asset realization depends on sufficient taxable income in the carryforward periods under existing tax laws. Federal NOL carryforwards may be used to offset future taxable income for 20 years. State NOL carryforwards may be used to offset future taxable income for a period of time ranging from 5 to 20 years, depending on the state jurisdiction. At December 31, 2021, we had no remaining un-utilized federal NOL carryforward, federal tax credits, or state NOL carryforwards. At December 31, 2021, we have a current tax payable of $ 23.7 million, which consists of current federal and state income tax accruals net of current energy tax credits and estimated tax payments, and is recorded in Accrued liabilities in the accompanying balance sheet. At December 31, 2021, we have no current tax receivables. We conduct business and are subject to tax in the U.S. both federally and in 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 2017. We have no federal or state income tax examinations being conducted at this time. The future tax benefits from NOLs, built-in losses, and tax credits would be materially reduced or potentially eliminated if we experience an “ownership change” as defined under IRC §382. Based on our analysis performed as of December 31, 2021, 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 any tax benefit for future utilization. NOTE 13 — SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION The following table presents certain supplemental cash flow information (in thousands): Years Ended December 31, 2021 2020 2019 Cash paid during the year for: Interest, net of interest capitalized $ ( 249 ) $ 355 $ 10,810 Income taxes paid $ 221,103 $ 84,739 $ 64,658 Non-cash operating activities: Real estate not owned increase $ 8,011 $ — $ — Real estate acquired through notes payable $ 8,047 $ 16,597 $ 11,721 NOTE 14 — RELATED PARTY TRANSACTIONS From time to time, in the normal course of business, we have transacted with related or affiliated companies and with certain of our officers and directors. We believe that the terms and fees negotiated for all transactions listed below are no less favorable than those that could be negotiated in arm’s length transactions. We charter aircraft services from companies that use the private plane of Steven Hilton, our Executive Chairman and former CEO, although Mr. Hilton does not have an ownership interest in the charter companies. Payments made to these charter companies were approximately $ 535,000 , $ 408,000 and $ 466,000 for the years ended December 31, 2021, 2020 and 2019, respectively. NOTE 15 — 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 nine homebuilding operating segments. The homebuilding 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: 65 West: Arizona, California and Colorado Central: Texas East: Florida, Georgia, North Carolina, South Carolina and Tennessee Management’s evaluation of segment performance is based on segment operating income, which we define as home and land closing revenues less cost of home and land closings, 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.” 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: Years Ended December 31, 2021 2020 2019 Homebuilding revenue (1): West $ 1,935,845 $ 1,800,223 $ 1,422,516 Central 1,504,481 1,282,339 1,038,052 East 1,679,784 1,399,558 1,189,915 Consolidated total 5,120,110 4,482,120 3,650,483 Homebuilding segment operating income: West 379,093 213,918 141,435 Central 319,435 185,202 101,686 East 302,487 157,971 87,285 Total homebuilding segment operating income 1,001,015 557,091 330,406 Financial services segment profit 18,034 16,388 20,579 Corporate and unallocated costs (2) ( 50,573 ) ( 44,398 ) ( 43,612 ) Interest expense ( 318 ) ( 2,177 ) ( 8,370 ) Other income, net 4,864 6,662 9,577 Loss on early extinguishment of debt ( 18,188 ) — ( 5,635 ) Net earnings before income taxes $ 954,834 $ 533,566 $ 302,945 (1) Homebuilding revenue includes the following land closing revenue, by segment: Years Ended December 31, Land closing revenue: 2021 2020 2019 West $ 21,426 $ 4,974 $ 12,463 Central 3,799 8,678 4,297 East 12 4,079 29,094 Total $ 25,237 $ 17,731 $ 45,854 (2) Balance consists primarily of corporate costs and numerous shared service functions such as finance and treasury that are not allocated to the homebuilding or financial services reporting segments. At December 31, 2021 West Central East Financial Services Corporate and Unallocated Total Deposits on real estate under option or contract $ 26,687 $ 11,132 $ 52,860 $ — $ — $ 90,679 Real estate 1,571,477 1,076,300 1,086,631 — — 3,734,408 Investments in unconsolidated entities 87 2,974 1,707 — 996 5,764 Other assets 66,897 (1) 199,791 (2) 102,073 (3) 610 607,311 (4) 976,682 Total assets $ 1,665,148 $ 1,290,197 $ 1,243,271 $ 610 $ 608,307 $ 4,807,533 (1) Balance consists primarily of cash and cash equivalents, development reimbursements from local municipalities and property and equipment. 66 (2) Balance consists primarily of cash and cash equivalents, development reimbursements from local municipalities and prepaid expenses and other assets. (3) Balance consists primarily of cash and cash equivalents, real estate not owned, goodwill, prepaid expenses and other assets and property and equipment. (4) Balance consists primarily of cash and cash equivalents, deferred tax assets and prepaid expenses and other assets. At December 31, 2020 West Central East Financial Services Corporate and Unallocated Total Deposits on real estate under option or contract $ 22,493 $ 11,154 $ 25,887 $ — $ — $ 59,534 Real estate 1,154,488 814,919 808,632 — — 2,778,039 Investments in unconsolidated entities 261 3,090 — — 999 4,350 Other assets 51,271 (1) 122,933 (2) 81,601 (3) 612 766,058 (4) 1,022,475 Total assets $ 1,228,513 $ 952,096 $ 916,120 $ 612 $ 767,057 $ 3,864,398 (1) Balance consists primarily of cash and cash equivalents and property and equipment. (2) Balance consists primarily of cash and cash equivalents, development reimbursements from local municipalities and prepaid expenses and other assets. (3) Balance consists primarily of cash and cash equivalents, goodwill, prepaid expenses and other assets and property and equipment. (4) Balance consists primarily of cash and cash equivalents, deferred tax assets and prepaid expenses and other assets. NOTE 16 — COMMITMENTS AND CONTINGENCIES We are involved in various routine legal and regulatory proceedings, including, without limitation, claims and litigation alleging construction defects. In general, the proceedings are incidental to our business, and most exposure is subject to and should be covered by warranty and indemnity obligations of our consultants and subcontractors. Additionally, some such claims are also covered by insurance. With respect to the majority of pending litigation matters, our ultimate legal and financial responsibility, if any, cannot be estimated with certainty and, in most cases, any potential losses related to these matters are not considered probable. Historically, most disputes regarding warranty claims are resolved prior to litigation. We believe there are no pending legal or warranty matters as of December 31, 2021 that could have a material adverse impact upon our consolidated financial condition, results of operations or cash flows that have not been sufficiently reserved. As discussed in Note 1 under the heading “Warranty Reserves”, we have case specific reserves within our $ 26.3 million of total warranty reserves related to alleged stucco defects in certain homes we constructed predominantly between 2006 and 2017 and for water drainage issues in a single community in Florida that we developed in 2016. Our review and handling of these two matters is ongoing and our estimate of and reserves for resolving these matters is based on internal data, our judgment and various assumptions and estimates. Due to the degree of judgment and the potential for variability in our underlying assumptions and data, as we obtain additional information, we may revise our estimate and thus our related reserves. As of December 31, 2021, after considering potential recoveries from the consultants and contractors involved and their insurers and the potential recovery under our general liability insurance policies, we believe our reserves are sufficient to cover the above mentioned matters. See Note 1 for information related to our warranty obligations. Lease Agreements See Note 4 for information related to our leases. 67 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure None