Meritage Homes CORP 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Overview and Outlook The United States and world economies have been dramatically affected by COVID-19 as there has been inherent uncertainty due to rapidly changing governmental orders, public health concerns, the resulting market reactions, related unemployment and the psychology of potential homebuyers. Such a fluid environment makes it challenging to estimate the impact that this pandemic may have on the future performance of our business. However, the desire to have larger, safer single-family shelter with additional space with technological capabilities to accommodate work-from-home scenarios, coupled with low interest rates have contributed to an unanticipated spike in the demand for new home offerings as a whole, and particularly for readily-available inventory at lower price points, which aligns well with our strategy. We have, therefore, experienced significant increases in demand across our geographies since latter April 2020. We have also made significant progress in accelerating various company-wide digital initiatives that were already in progress to assist and facilitate the marketing, selling and closing of homes during shelter-in-place orders for buyers hesitant to leave their homes. We believe the digital and online efforts helped us effectively navigate the current situation by allowing us to continue to operate efficiently, through: • Offering virtual tours in all of our communities to prospective customers; • Offering extensive online tools such as 3-D tours and dynamic floor plans to mimic the live experience of walking through a model home; • Offering our homebuyers virtual tours of homes that are pending closing; • Offering virtual grand opening events to the broker community to introduce our new communities; • Continuing to pre-qualify buyers for mortgages through digital solutions on our website; • Collecting earnest money payments remotely through third-party hosted money-transfer solutions; and • Offering drive-through or fully virtual closings in states where such services are permitted. Throughout this ever changing environment, our primary concern has and continues to be the health and well-being of our employees, customers, business partners and the communities we serve. We follow all applicable government orders and guidelines of public health agencies, and have been since the inception of this pandemic, modifying our standards and protocols to safeguard all of our stakeholders as conditions change. In order to address the changing environment, we instituted the following operational changes: • Temporarily closed our corporate and divisional offices with work-from-home requirements in effect for all non-field employees in all of our markets in March 2020; all markets are re-opened to varying degrees based on local requirements; • Temporarily closed our sales centers and model homes, as well as our Studio M design centers, to the general public, shifting to an appointment-only home sales process in March 2020; all sales centers and Studio M centers are now open; • Continued with home construction and land development in March 2020 as in nearly all of our markets residential construction has been deemed “essential” by most local governments; and • Temporarily shifted to an emergency-only model for interior warranty work, for the safety of our employees and owners of our homes in March 2020. We have since opened our warranty work to service all calls as allowed by local authorities. • We have implemented responsible hygiene, cleaning, social distancing and other processes in all of our operations to safeguard our employees, trade partners, customers and the communities we serve. As of June 30, 2020 approximately 90% of our communities are targeted to first-time or first move-up buyers and those buyer segments represented approximately 96% of our orders in the second quarter of 2020, effectively completing our strategic shift to cater to entry-level and first-time move up buyers. 22 Summary Company Results Our results for the second quarter of 2020 reflect continued strong growth in closings and orders, compared to the second quarter of 2019 as buyers took advantage of the low interest-rate environment and capitalized on their desire to move out of their existing home and transition to a larger, safer home with indoor space to accommodate work from home needs and outdoor space to enjoy while practicing social distancing. Total home closing revenue was $1.0 billion on 2,770 homes closed for the three months ended June 30, 2020 compared to $863.1 million on 2,253 homes closed for the second quarter of 2019, 20.0% and 22.9% increases, respectively. In addition to higher home closing revenue, second quarter results benefited from a 300 basis point increase in home closing gross margin that resulted in a $61.6 million year-over-year increase in home closing gross profit to $220.7 million compared to $159.1 million in the second quarter of 2019. We attribute this gross profit improvement to our simplified product offerings with more efficient product designs which reduce both construction costs and construction cycle times, in addition to construction overhead leverage on higher home closing revenue and some temporary negotiated cost savings in light of COVID-19. The impact from closings of our non-core product was fairly limited and only represented 6% of our closing volume. Interest expense decreased $1.1 million year-over-year, reflecting a reduction in total interest incurred due to the December 2019 early redemption of $300 million 7.15% senior notes due in 2020 partially offset by the interest income on the $500 million credit facility draw in mid-March that was outstanding through May 26, 2020. Earnings before income taxes improved by $48.2 million year over year to $115.9 million for the second quarter of 2020. These improved year-over-year results combined with a lower effective income tax rate of 21.7% as compared to 24.9% in 2019 led to net earnings of $90.7 million in the second quarter of 2020 versus $50.8 million in the second quarter of 2019. For the six months ended June 30, 2020, home closing revenue was $1.9 billion on 5,086 homes closed, 23.1% and 26.6% increases, respectively. Similar to the second quarter, year-to-date results reflect an increase in home closing revenue of $360.3 and a $123.5 million increase in home closing gross profit versus the six months ended June 30, 2019. Higher gross profit combined with a $5.2 million decrease in interest expense year-over year led to net income of $161.8 million for the six months ended June 30, 2019 compared to $76.2 million for the 2019 period. Orders for the three and six months of 2020 were up 31.5% and 27.2%, respectively, over the prior year. Our order cancellation rate was 15% for the second quarter of 2020 compared to 12% for the prior year period; cancellation rates peaked at a high of 20% in April 2020 and then declined to 15% and 13% in May and June, 2020, respectively. We ended the second quarter of 2020 with 4,395 homes in backlog valued at $1.6 billion, a 19.4% increase in units and an 11.6% increase in value over June 30, 2019, reflecting lower average sales prices. 23 Company Positioning We believe that our on-going investments in new communities, particularly those designed for the first-time and first move-up homebuyer, and industry-leading innovation in our energy-efficient product offerings, automation, and transformative customer buying experience, create a differentiated strategy that has aided us in our success in the highly-competitive new home market and will continue to do so in the long-term. Our focus includes the following strategic initiatives: • Ensuring sufficient speculative/started inventory is available in all communities to accommodate our customers' desire for a quick move-in home; • Expanding the number of LiVE.NOW ® communities that target the growing first-time and first move-up homebuyers. After a short delay in the latter part of the first quarter and the start of the second quarter due to COVID-19 uncertainties, we have been aggressively acquiring and contracting for lots and communities; • Improving the overall customer experience, most recently through a simplification of the customer home purchase and option selection process for move-up buyers at Studio M; • Demonstrating our commitment to innovation through digital tours and solutions available to our customers that allow the entire home marketing, sales and in some geographies, the closing process to be conducted on-line; • Simplifying our production process to allow us to more efficiently build our homes, shorten our construction timeline and reduce our construction costs, which in turn allows us to competitively price our homes; and • Improving our home closing gross profit by growing closing volume while streamlining our operations, allowing us to better leverage our overhead. In order to maintain focus on growing our business, we also remain committed to the following: • Increasing orders and order pace through the use of our consumer and market research to ensure that we build homes that offer our buyers their desired features and amenities; • Becoming or maintaining our position of at least 5% market share in all of our markets; • Continuing to innovate and promote our energy efficiency program and our M.Connected ® Automation Suite to create differentiation for the Meritage brand; • Managing construction efficiencies and costs through national and regional vendor relationships with a focus on quality construction and warranty management; • Carefully managing our liquidity and a strong balance sheet, we ended the quarter with a 32.8% debt-to-capital ratio and a 20.4% net debt-to-capital ratio; • Maximizing returns to our shareholders, most recently through our improved financial performance, debt repayment and share repurchase program; and • Promoting a positive environment for our employees with market-competitive benefits in order to develop and motivate them and to minimize turnover and to maximize recruitment efforts. Critical Accounting Policies The accounting policies we deem most critical to us and that involve the most difficult, subjective or complex judgments include revenue recognition, valuation of real estate, warranty reserves and valuation of deferred tax assets. There have been no significant changes to our critical accounting policies during the six months ended June 30, 2020 compared to those disclosed in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in our 2019 Annual Report on Form 10-K. 24 Home Closing Revenue, Home Orders and Order Backlog The composition of our closings, home orders and backlog is constantly changing and is based on a changing mix of communities with various price points between periods as new projects open and existing projects wind down. Further, individual homes within a community can range significantly in price due to differing square footage, option selections, lot sizes and quality and location of lots (e.g. cul-de-sac, view lots, greenbelt lots). These variations result in a lack of meaningful comparability between our home orders, closings and backlog due to the changing mix between periods. The tables on the following pages present operating and financial data that we consider most critical to managing our operations (dollars in thousands): Three Months Ended June 30, Quarter over Quarter 2020 2019 Change $ Change % Home Closing Revenue Total Dollars $ 1,031,591 $ 863,053 $ 168,538 20.0 % Homes closed 2,770 2,253 517 22.9 % Average sales price $ 372.4 $ 383.1 $ (10.7) (2.8) % West Region Arizona Dollars $ 142,359 $ 125,388 $ 16,971 13.5 % Homes closed 427 389 38 9.8 % Average sales price $ 333.4 $ 322.3 $ 11.1 3.4 % California Dollars $ 150,343 $ 83,454 $ 66,889 80.2 % Homes closed 247 132 115 87.1 % Average sales price $ 608.7 $ 632.2 $ (23.6) (3.7) % Colorado Dollars $ 89,087 $ 90,130 $ (1,043) (1.2) % Homes closed 184 169 15 8.9 % Average sales price $ 484.2 $ 533.3 $ (49.1) (9.2) % West Region Totals Dollars $ 381,789 $ 298,972 $ 82,817 27.7 % Homes closed 858 690 168 24.3 % Average sales price $ 445.0 $ 433.3 $ 11.7 2.7 % Central Region - Texas Central Region Totals Dollars $ 295,975 $ 289,839 $ 6,136 2.1 % Homes closed 914 823 91 11.1 % Average sales price $ 323.8 $ 352.2 $ (28.3) (8.0) % East Region Florida Dollars $ 138,608 $ 111,736 $ 26,872 24.0 % Homes closed 367 281 86 30.6 % Average sales price $ 377.7 $ 397.6 $ (20.0) (5.0) % Georgia Dollars $ 58,698 $ 43,317 $ 15,381 35.5 % Homes closed 166 122 44 36.1 % Average sales price $ 353.6 $ 355.1 $ (1.5) (0.4) % North Carolina Dollars $ 98,738 $ 70,629 $ 28,109 39.8 % Homes closed 288 196 92 46.9 % Average sales price $ 342.8 $ 360.4 $ (17.5) (4.9) % South Carolina Dollars $ 30,206 $ 23,163 $ 7,043 30.4 % Homes closed 98 70 28 40.0 % Average sales price $ 308.2 $ 330.9 $ (22.7) (6.9) % Tennessee Dollars $ 27,577 $ 25,397 $ 2,180 8.6 % Homes closed 79 71 8 11.3 % Average sales price $ 349.1 $ 357.7 $ (8.6) (2.4) % East Region Totals Dollars $ 353,827 $ 274,242 $ 79,585 29.0 % Homes closed 998 740 258 34.9 % Average sales price $ 354.5 $ 370.6 $ (16.1) (4.3) % 25 Six Months Ended June 30, Quarter over Quarter 2020 2019 Chg $ Chg % Home Closing Revenue Total Dollars $ 1,922,008 $ 1,561,703 $ 360,305 23.1 % Homes closed 5,086 4,018 1,068 26.6 % Average sales price $ 377.9 $ 388.7 $ (10.8) (2.8) % West Region Arizona Dollars $ 293,603 $ 223,842 $ 69,761 31.2 % Homes closed 886 686 200 29.2 % Average sales price $ 331.4 $ 326.3 $ 5.1 1.6 % California Dollars $ 285,145 $ 169,291 $ 115,854 68.4 % Homes closed 455 264 191 72.3 % Average sales price $ 626.7 $ 641.3 $ (14.6) (2.3) % Colorado Dollars $ 180,771 $ 178,805 $ 1,966 1.1 % Homes closed 370 338 32 9.5 % Average sales price $ 488.6 $ 529.0 $ (40.4) (7.6) % West Region Totals Dollars $ 759,519 $ 571,938 $ 187,581 32.8 % Homes closed 1,711 1,288 423 32.8 % Average sales price $ 443.9 $ 444.1 $ (0.1) — % Central Region - Texas Central Region Totals Dollars $ 551,884 $ 481,445 $ 70,439 14.6 % Homes closed 1,688 1,366 322 23.6 % Average sales price $ 326.9 $ 352.4 $ (25.5) (7.2) % East Region Florida Dollars $ 232,397 $ 202,560 $ 29,837 14.7 % Homes closed 603 507 96 18.9 % Average sales price $ 385.4 $ 399.5 $ (14.1) (3.5) % Georgia Dollars $ 100,696 $ 85,456 $ 15,240 17.8 % Homes closed 281 241 40 16.6 % Average sales price $ 358.3 $ 354.6 $ 3.8 1.1 % North Carolina Dollars $ 178,155 $ 127,170 $ 50,985 40.1 % Homes closed 510 352 158 44.9 % Average sales price $ 349.3 $ 361.3 $ (12.0) (3.3) % South Carolina Dollars $ 47,611 $ 42,745 $ 4,866 11.4 % Homes closed 151 127 24 18.9 % Average sales price $ 315.3 $ 336.6 $ (21.3) (6.3) % Tennessee Dollars $ 51,746 $ 50,389 $ 1,357 2.7 % Homes closed 142 137 5 3.6 % Average sales price $ 364.4 $ 367.8 $ (3.4) (0.9) % East Region Totals Dollars $ 610,605 $ 508,320 $ 102,285 20.1 % Homes closed 1,687 1,364 323 23.7 % Average sales price $ 361.9 $ 372.7 $ (10.7) (2.9) % 26 Three Months Ended June 30, Quarter over Quarter 2020 2019 Change $ Change % Home Orders (1) Total Dollars $ 1,290,454 $ 1,043,995 $ 246,459 23.6 % Homes ordered 3,597 2,735 862 31.5 % Average sales price $ 358.8 $ 381.7 $ (23.0) (6.0) % West Region Arizona Dollars $ 231,057 $ 188,215 $ 42,842 22.8 % Homes ordered 737 582 155 26.6 % Average sales price $ 313.5 $ 323.4 $ (9.9) (3.1) % California Dollars $ 224,639 $ 135,519 $ 89,120 65.8 % Homes ordered 388 207 181 87.4 % Average sales price $ 579.0 $ 654.7 $ (75.7) (11.6) % Colorado Dollars $ 70,831 $ 110,314 $ (39,483) (35.8) % Homes ordered 153 220 (67) (30.5) % Average sales price $ 462.9 $ 501.4 $ (38.5) (7.7) % West Region Totals Dollars $ 526,527 $ 434,048 $ 92,479 21.3 % Homes ordered 1,278 1,009 269 26.7 % Average sales price $ 412.0 $ 430.2 $ (18.2) (4.2) % Central Region - Texas Central Region Totals Dollars $ 392,502 $ 275,380 $ 117,122 42.5 % Homes ordered 1,215 827 388 46.9 % Average sales price $ 323.0 $ 333.0 $ (9.9) (3.0) % East Region Florida Dollars $ 136,362 $ 131,958 $ 4,404 3.3 % Homes ordered 390 331 59 17.8 % Average sales price $ 349.6 $ 398.7 $ (49.1) (12.3) % Georgia Dollars $ 65,434 $ 51,977 $ 13,457 25.9 % Homes ordered 190 149 41 27.5 % Average sales price $ 344.4 $ 348.8 $ (4.4) (1.3) % North Carolina Dollars $ 106,383 $ 89,571 $ 16,812 18.8 % Homes ordered 326 240 86 35.8 % Average sales price $ 326.3 $ 373.2 $ (46.9) (12.6) % South Carolina Dollars $ 29,262 $ 22,806 $ 6,456 28.3 % Homes ordered 95 69 26 37.7 % Average sales price $ 308.0 $ 330.5 $ (22.5) (6.8) % Tennessee Dollars $ 33,984 $ 38,255 $ (4,271) (11.2) % Homes ordered 103 110 (7) (6.4) % Average sales price $ 329.9 $ 347.8 $ (17.9) (5.1) % East Region Totals Dollars $ 371,425 $ 334,567 $ 36,858 11.0 % Homes ordered 1,104 899 205 22.8 % Average sales price $ 336.4 $ 372.2 $ (35.8) (9.6) % (1) Home orders for any period represent the aggregate sales price of all homes ordered, net of cancellations. We do not include orders contingent upon the sale of a customer’s existing home as a sales contract until the contingency is removed. 27 Six Months Ended June 30, Quarter over Quarter 2020 2019 Chg $ Chg % Home Orders (1) Total Dollars $ 2,470,391 $ 2,020,974 $ 449,417 22.2 % Homes ordered 6,699 5,265 1,434 27.2 % Average sales price $ 368.8 $ 383.9 $ (15.1) (3.9) % West Region Arizona Dollars $ 414,428 $ 333,613 $ 80,815 24.2 % Homes ordered 1,307 1,039 268 25.8 % Average sales price $ 317.1 $ 321.1 $ (4.0) (1.2) % California Dollars $ 449,571 $ 243,993 $ 205,578 84.3 % Homes ordered 740 374 366 97.9 % Average sales price $ 607.5 $ 652.4 $ (44.9) (6.9) % Colorado Dollars $ 169,296 $ 215,562 $ (46,266) (21.5) % Homes ordered 352 424 (72) (17.0) % Average sales price $ 481.0 $ 508.4 $ (27.4) (5.4) % West Region Totals Dollars $ 1,033,295 $ 793,168 $ 240,127 30.3 % Homes ordered 2,399 1,837 562 30.6 % Average sales price $ 430.7 $ 431.8 $ (1.1) (0.3) % Central Region - Texas Central Region Totals Dollars $ 735,492 $ 581,645 $ 153,847 26.5 % Homes ordered 2,274 1,697 577 34.0 % Average sales price $ 323.4 $ 342.7 $ (19.3) (5.6) % East Region Florida Dollars $ 255,804 $ 258,032 $ (2,228) (0.9) % Homes ordered 707 632 75 11.9 % Average sales price $ 361.8 $ 408.3 $ (46.5) (11.4) % Georgia Dollars $ 120,417 $ 102,204 $ 18,213 17.8 % Homes ordered 346 293 53 18.1 % Average sales price $ 348.0 $ 348.8 $ (0.8) (0.2) % North Carolina Dollars $ 207,638 $ 172,556 $ 35,082 20.3 % Homes ordered 613 470 143 30.4 % Average sales price $ 338.7 $ 367.1 $ (28.4) (7.7) % South Carolina Dollars $ 57,176 $ 48,020 $ 9,156 19.1 % Homes ordered 182 150 32 21.3 % Average sales price $ 314.2 $ 320.1 $ (6.0) (1.9) % Tennessee Dollars $ 60,569 $ 65,349 $ (4,780) (7.3) % Homes ordered 178 186 (8) (4.3) % Average sales price $ 340.3 $ 351.3 $ (11.1) (3.1) % East Region Totals Dollars $ 701,604 $ 646,161 $ 55,443 8.6 % Homes ordered 2,026 1,731 295 17.0 % Average sales price $ 346.3 $ 373.3 $ (27.0) (7.2) % 28 Three Months Ended June 30, 2020 2019 Ending Average Ending Average Active Communities Total 237 239.0 254 257.0 West Region Arizona 38 35.5 40 37.0 California 28 28.5 20 20.5 Colorado 13 13.0 21 22.0 West Region Totals 79 77.0 81 79.5 Central Region - Texas Central Region Totals 68 73.0 73 78.5 East Region Florida 36 35.0 36 34.0 Georgia 17 16.0 21 20.0 North Carolina 21 20.5 23 24.0 South Carolina 5 6.0 9 10.0 Tennessee 11 11.5 11 11.0 East Region Totals 90 89.0 100 99.0 Six Months Ended June 30, 2020 2019 Ending Average Ending Average Active Communities Total 237 240.5 254 263.0 West Region Arizona 38 34.5 40 40.0 California 28 26.0 20 18.5 Colorado 13 15.5 21 20.5 West Region Totals 79 76.0 81 79.0 Central Region - Texas Central Region Totals 68 72.5 73 84.0 East Region Florida 36 34.5 36 33.5 Georgia 17 17.5 21 21.5 North Carolina 21 23.0 23 24.0 South Carolina 5 7.0 9 10.5 Tennessee 11 10.0 11 10.5 East Region Totals 90 92.0 100 100.0 29 Three Months Ended June 30, Six Months Ended June 30, 2020 2019 2020 2019 Cancellation Rates (1) Total 15 % 12 % 14 % 12 % West Region Arizona 11 % 10 % 12 % 10 % California 18 % 14 % 16 % 14 % Colorado 18 % 11 % 15 % 9 % West Region Totals 14 % 11 % 14 % 11 % Central Region - Texas Central Region Totals 20 % 16 % 17 % 15 % East Region Florida 15 % 9 % 14 % 9 % Georgia 9 % 18 % 11 % 15 % North Carolina 9 % 8 % 8 % 9 % South Carolina 11 % 15 % 12 % 18 % Tennessee 14 % 6 % 20 % 7 % East Region Totals 12 % 10 % 12 % 11 % (1) Cancellation rates are computed as the number of canceled units for the period divided by the gross sales units for the same period. 30 At June 30, Quarter over Quarter 2020 2019 Change $ Change % Order Backlog (1) Total Dollars $ 1,648,451 $ 1,477,007 $ 171,444 11.6 % Homes in backlog 4,395 3,680 715 19.4 % Average sales price $ 375.1 $ 401.4 $ (26.3) (6.6) % West Region Arizona Dollars $ 307,302 $ 243,449 $ 63,853 26.2 % Homes in backlog 932 696 236 33.9 % Average sales price $ 329.7 $ 349.8 $ (20.1) (5.7) % California Dollars $ 256,694 $ 141,196 $ 115,498 81.8 % Homes in backlog 430 201 229 113.9 % Average sales price $ 597.0 $ 702.5 $ (105.5) (15.0) % Colorado Dollars $ 86,158 $ 140,304 $ (54,146) (38.6) % Homes in backlog 178 271 (93) (34.3) % Average sales price $ 484.0 $ 517.7 $ (33.7) (6.5) % West Region Totals Dollars $ 650,154 $ 524,949 $ 125,205 23.9 % Homes in backlog 1,540 1,168 372 31.8 % Average sales price $ 422.2 $ 449.4 $ (27.3) (6.1) % Central Region - Texas Central Region Totals Dollars $ 556,787 $ 473,968 $ 82,819 17.5 % Homes in backlog 1,634 1,312 322 24.5 % Average sales price $ 340.8 $ 361.3 $ (20.5) (5.7) % East Region Florida Dollars $ 187,241 $ 220,544 $ (33,303) (15.1) % Homes in backlog 475 497 (22) (4.4) % Average sales price $ 394.2 $ 443.8 $ (49.6) (11.2) % Georgia Dollars $ 69,559 $ 63,158 $ 6,401 10.1 % Homes in backlog 198 175 23 13.1 % Average sales price $ 351.3 $ 360.9 $ (9.6) (2.7) % North Carolina Dollars $ 109,026 $ 112,808 $ (3,782) (3.4) % Homes in backlog 322 295 27 9.2 % Average sales price $ 338.6 $ 382.4 $ (43.8) (11.5) % South Carolina Dollars $ 34,054 $ 37,672 $ (3,618) (9.6) % Homes in backlog 102 112 (10) (8.9) % Average sales price $ 333.9 $ 336.4 $ (2.5) (0.7) % Tennessee Dollars $ 41,630 $ 43,908 $ (2,278) (5.2) % Homes in backlog 124 121 3 2.5 % Average sales price $ 335.7 $ 362.9 $ (27.2) (7.5) % East Region Totals Dollars $ 441,510 $ 478,090 $ (36,580) (7.7) % Homes in backlog 1,221 1,200 21 1.8 % Average sales price $ 361.6 $ 398.4 $ (36.8) (9.2) % (1) Our backlog represents net sales that have not closed. 31 Operating Results Companywide . In the second quarter of 2020, home closing volume improved by 22.9% to 2,770 closings valued at $1.0 billion compared to 2,253 closings valued at $863.1 million in the second quarter of 2019. The increase in closings year-over-year was driven primarily by entering the quarter with a higher backlog as compared to prior year, a higher volume of orders in the current quarter as well as increased backlog conversion due to selling and closing more speculative inventory homes in the second quarter of 2020 compared to the prior year. The higher volume of spec sales and a notably higher orders pace year-over-year are due to the heightened demand in today's market for available, new and safe single-family homes at affordable price points as previously discussed. This customer demand is aligned with our focus on the entry level and first move-up buyers, as our entry-level communities offer only spec homes for sale, and in both our entry-level and first move-up communities we have achieved shorter construction cycle times. Home closing revenue increased by 20.0% over the second quarter of 2019 due entirely to the increase in closing volume as our average sales prices declined 2.8%, reflective of a higher percentage of lower-priced entry-level homes in our closing mix. Home order volume improved by 31.5% to 3,597 homes valued at $1.3 billion in the second quarter of 2020 as compared to 2,735 homes valued at $1.0 billion in the second quarter of 2019. The improvement in orders was due to a 42.5% increase in orders pace year-over-year to 15.1 homes ordered per average active community, up from 10.6 in the second quarter of 2019. We ended the quarter with 237 actively selling communities, a 6.7% decline from the prior year as communities experienced accelerated close-outs due to higher orders volume and timing of our delayed community openings due to COVID-19. Order cancellation rates were 15% and 14% for the first three and six months of 2020, as compared to 12% during both the three and six month periods in 2019. For the six months ended June 30, 2020, home closing volume grew by 1,068 units, and home closing revenue improved by $360.3 million on 5,086 closings valued at $1.9 billion. Orders also increased by 1,434 units and $449.4 million to 6,699 orders valued at $2.5 billion for the six months ended June 30, 2020, 27.2% and 22.2% increases, respectively from prior year results. Similar to second quarter results, demand for our affordable entry-level homes drove the increase in orders, as we experienced a 39.5% higher orders pace than in 2019. We ended the quarter with 4,395 homes in backlog valued at $1.6 billion, compared to 3,680 units valued at $1.5 billion at June 30, 2019. West . The West Region closed 858 homes and generated $381.8 million in home closing revenue in the second quarter of 2020 compared to 690 homes and $299.0 million in home closing revenue in the comparable 2019 period. The Region ended the second quarter of 2020 with 1,278 orders valued at $526.5 million versus 1,009 orders valued at $434.0 million in the second quarter of 2019, despite a slight decline in average active selling communities by 3.1%. The 24.3% and 26.7% improvements in closing and order volume, respectively, were driven by the higher year-over-year orders pace per community, as many of homes that were sold in the second quarter also closed in the second quarter of this year, a direct output of our strategy of focusing on entry-level and first move-up product that have shorter construction cycle times. The exceptionally strong demand in Arizona offset some delays in California, which had the most restrictive COVID-19 measures in our geographic footprint, although community count helped in California as well. In the West Region, approximately 90% of our communities target the first-time or first move-up buyers at June 30, 2020 and we believe the high demand in this Region was directly attributable to the product offerings and desirable locations we have designed for these buyers. The West Region ended the first quarter of 2020 with 1,540 homes in backlog valued at $650.2 million, up from 1,168 units valued at $524.9 million in 2019. Year-to-date results in the West Region were similar to those of the second quarter. The number and value of homes closed versus prior year increased by 32.8%, while the average sales price was flat year over year with additional California volume in the mix. Orders for the Region improved 30.6% year-to-date which resulted in 30.3% higher order value. Orders pace improved by 35.6% despite the average number of actively selling communities declining by 3.8% in the Region for the six months ended June 30, 2020. Central . In the second quarter of 2020, the Central Region, made up of our Texas markets, closed 914 homes and generated $296.0 million in home closing revenue, up 11.1% and 2.1%, respectively, from prior year comparable period results of 823 homes and $289.8 million of home closing revenue. Average sales prices in the Region declined 8.0% year-over-year resulting from our focus on the first-time and first move-up buyer. Orders grew by 46.9%, which, partially offset by a 3.0% lower average sales price, led to order value increasing by 42.5%. Order volume improved in the second quarter of 2020 due to a 58.1% increase in orders pace in the Region, more than offsetting the 7.0% decrease in average community count compared to the prior year period. The Region ended the second quarter of 2020 with 1,215 units ordered valued at $392.5 million compared to 827 units valued at $275.4 million in the prior year quarter. The fast absorption pace of our communities has resulted in us selling out of communities faster than we have been able to open replacement communities. We have responded to the entry-level demand in this Region with a strong transition to first-time buyer product offerings over the past several years. Over 90% of actively selling communities at June 30, 2020 were targeted toward the first time and first move-up buyers. We also saw overall improvements in the Region for the six months ended June 30, 2020. Home closings and home closing revenue were up 23.6% and 14.6%, respectively, and orders and order value were up year-over-year by 34.0% and 32 26.5%, respectively. Orders pace increased by 55.4%, helping the Region end the quarter with 1,634 units in backlog, up 24.5% and backlog value of $556.8 million, up 17.5%, compared to the prior year. East . During the three months ended June 30, 2020, the East Region delivered 998 closings and $353.8 million in home closing revenue compared to 740 closings and $274.2 million in home closing revenue in the comparable prior year period, improvements of 34.9% and 29.0%, respectively. Orders and order value in the East Region improved by 22.8% and 11.0%, respectively, for the second quarter of 2020 with 1,104 units valued at $371.4 million compared to 899 units valued at $334.6 million in the prior year period. The improvement in orders is primarily due to a 36.3% increase in orders pace which more than offset the 10% decrease in average active communities. The year-to-date results of the East Region were similar to those of the second quarter, with 23.7% and 20.1% improvements in home closing volume and revenue, respectively, compared to 2019 providing 1,687 closings and $610.6 million in home closing revenue for the six month period ending June 30, 2020. The number and value of orders also improved by 17.0% and 8.6%, respectively, due to a 27.2% increase in orders pace for the six months ended June 30, 2020 compared to prior year. The East Region ended the quarter with 1,221 homes in backlog valued at $441.5 million compared to 1,200 homes valued at $478.1 million at June 30, 2019, a 1.8% increase in units with a value decline of 7.7% from the shift to more entry-level homes and lower average sales prices. Land Closing Revenue and Gross Loss From time to time, we may sell certain lots or land parcels to other homebuilders, developers or investors if we feel the sale will provide a greater economic benefit to us than continuing home construction or where we are looking to diversify our land positions in the specific geography. As a result of such sales, we recognized land closing revenue of $1.5 million and $1.6 million for the three months ending June 30, 2020 and 2019, respectively and losses of $1.5 million and $1.7 million for the second quarters of 2020 and 2019, respectively. Year to date land sales resulted in losses of $1.1 million in 2020 and a $1.4 million loss in the prior year. Land sales in 2020 primarily reflect the sale of land in communities that do not fit our current focus on entry-level and first move-up product offerings. Other Operating Information (dollars in thousands) Three Months Ended June 30, Six Months Ended June 30, 2020 2019 2020 2019 Dollars Percent of Home Closing Revenue Dollars Percent of Home Closing Revenue Dollars Percent of Home Closing Revenue Dollars Percent of Home Closing Revenue Home Closing Gross Profit (1) Total $ 220,696 21.4 % $ 159,118 18.4 % $ 399,056 20.8 % $ 275,580 17.6 % West $ 80,166 21.0 % $ 53,504 17.9 % $ 154,597 20.4 % $ 98,899 17.3 % Central $ 67,788 22.9 % $ 57,617 19.9 % $ 121,979 22.1 % $ 91,980 19.1 % East $ 72,742 20.6 % $ 47,997 17.5 % $ 122,480 20.1 % $ 84,701 16.7 % (1) Home closing gross profit represents home closing revenue less cost of home closings, including impairments. Cost of home closings includes land and lot development costs, direct home construction costs, an allocation of common community costs (such as model complex costs and architectural, legal and zoning costs), interest, sales tax, impact fees, warranty, construction overhead and closing costs. Companywide . Home closing gross margin for the second quarter of 2020 improved 300 basis points to 21.4% compared to 18.4% in the second quarter of 2019. The higher margin combined with higher revenue contributed to a $61.6 million improvement in home closing gross profit to end the quarter with $220.7 million compared to $159.1 million in 2019. For the six months ended June 30, 2020, gross margin was up 320 basis points to 20.8% versus 17.6% for the same period in the prior year. Margins for the second quarter 2020 were negatively impacted by 30 basis points due to terminated land contract costs for exiting non-core communities, with a charge of $3.3 million compared to $0.5 million of such charges in the 2019 period. As expected with our shift to entry-level and first time move up product offerings, we have improved our backlog conversion and simplified our product which is less costly and more efficient to build all of which are contributing to higher gross margin. Our 33 higher volume also helped better leverage our fixed costs in gross margin and we also benefited in the quarter from some negotiated temporary cost concessions achieved due to COVID-19. West . Home closing gross margin for the West Region improved by 310 basis points to 21.0% for the second quarter of 2020 versus 17.9% in the second quarter of 2019. For the six months ended June 30, 2020, home closing gross margin also improved by 310 basis points to 20.4% versus 17.3% for the same period in the prior year. Pricing power, particularly in Arizona, contributed significantly to the improved margins year over year, as demand has been very strong in our entry-level and first move-up communities. In addition, greater leverage of our overhead costs on higher revenue combined with construction efficiencies driven by our simplified product offerings and shorter construction cycle times have favorably impacted margins across the West Region. Central . The Central Region continued to provide the highest home closing gross margin in the company at 22.9% for the second quarter of 2020, up 300 basis points from 19.9% in the prior year quarter. Construction efficiencies driven by our simplified product offerings and lower costs combined with higher closing volume have expanded our leverage of overhead costs to improve gross margin. For the six months ended June 30, 2020, gross margin was also up 300 basis points to 22.1% as compared to 19.1% for the same 2019 period. East . Home closing gross margin in the East Region reflect our most notable improvements, up 310 basis points year-over-year to 20.6% in the second quarter of 2020 versus 17.5% for the comparable 2019 period. For the six months ended June 30, 2020, gross margin was up 340 basis points to 20.1% versus 16.7% for the same period in the prior year. The year-over-year improvement in gross margin for the three month period is the result of more efficient plan designs with shorter construction cycle times combined with greater leverage of overhead costs on higher closing volume as compared to the prior year period. We have fully transitioned to our updated product and plan designs in this Region whereas prior years included larger volumes of legacy product and plan designs that were less efficient and more costly to build. Financial Services Profit (in thousands) Three Months Ended June 30, Six Months Ended June 30, 2020 2019 2020 2019 Financial services profit $ 3,789 $ 6,031 $ 6,627 $ 10,733 Financial services profit represents the net profit of our financial services operations, including: (1) the operating profit generated by our wholly-owned title company, Carefree Title, (2) our portion of earnings from a mortgage joint venture and (3) to a lesser degree, the limited activity from our wholly owned insurance company, which is still in its infancy. Financial services profit declined $2.2 million in the second quarter of 2020 to $3.8 million versus $6.0 million in 2019 and by $4.1 million for the six months ended June 30, 2020 to $6.6 million versus $10.7 million for the same period in 2019. The lower financial services profit year-over-year both for the quarter and year to date results is due to a change in the structure of customer incentives offered by our mortgage joint venture. The profits associated with these incentives in the 2020 periods are captured as part of home closing revenue, whereas in the 2019 periods these incentives were recorded as financial services earnings. This change was effective in the fourth quarter of 2019. Selling, General and Administrative Expenses and Other Expenses (dollars in thousands) Three Months Ended June 30, Six Months Ended June 30, 2020 2019 2020 2019 Commissions and other sales costs Dollars $ (70,408) $ (60,125) $ (131,581) $ (112,680) Percent of home closing revenue 6.8 % 7.0 % 6.8 % 7.2 % General and administrative expenses Dollars $ (36,176) $ (34,779) $ (70,346) $ (68,345) Percent of home closing revenue 3.5 % 4.0 % 3.7 % 4.4 % Interest expense Dollars $ (2,105) $ (3,197) $ (2,121) $ (7,282) Other income, net Dollars $ 1,514 $ 2,368 $ 2,125 $ 3,414 Provision for income taxes Dollars $ (25,184) $ (16,846) $ (40,865) $ (23,804) 34 Commissions and Other Sales Costs. Commissions and other sales costs are comprised of internal and external commissions and related sales and marketing expenses such as advertising and sales office costs. These costs were $70.4 million for the three months ended June 30, 2020, $10.3 million higher than the prior year comparable period, although as a percentage of home closing revenue, decreased 20 basis points to 6.8% for the second quarter of 2020 compared to prior year period. For the six months ended June 30, 2020, commissions and other sales costs decreased 40 basis points, but were $18.9 million higher than the corresponding prior year period. The increase in commissions and other sales costs in dollars compared to prior year reflects higher home closing revenue as well as certain increased commission incentives that were temporarily offered during COVID-19 sales events. The decline as a percentage of home closing revenue is due to the combination of leverage from higher closing volume and the more efficient sales and marketing structure of our entry-level and first-time move-up communities. General and Administrative Expenses. General and administrative expenses represent corporate and divisional overhead expenses such as salaries and bonuses, occupancy, insurance and travel expenses. For the three months ended June 30, 2020, general and administrative expenses were $36.2 million, $1.4 million higher than $34.8 million for the 2019 period, although as a percentage of home closing revenue, these expenses decreased by 50 basis points. For the six months ended June 30, 2020 and 2019, general and administrative expenses were $70.3 million or 3.7% of home closing revenue, as compared to $68.3 million or 4.4% of home closing revenue in 2019. The increased leveraging of costs against higher revenue and the pull-back on certain corporate expenditures due to COVID-19 aided in the improvement. We continually strive to optimize overhead leverage through cost control efforts and expect some long-term improvements to result from the technological enhancements achieved during COVID-19. Interest Expense. Interest expense is comprised of interest incurred, but not capitalized, on our senior notes, other borrowings, and our amended and restated unsecured revolving credit facility ("Credit Facility"). Interest expense for the three months ended June 30, 2020 totaled $2.1 million compared to $3.2 million in the corresponding prior year period. We experienced similar decreases in year to date interest expense with $2.1 million in 2020 compared to $7.3 million in the prior year. This year-over-year decrease is the result of less interest charges incurred resulting from the early tender of $300.0 million Senior Notes that were due in the first quarter of 2020, which we redeemed in the fourth quarter of 2019 partially offset by interest charges from our Credit Facility which had $500.0 million outstanding for the first half of second quarter 2020. Other Income, Net. Other income, net, primarily consists of (i) sublease income, (ii) interest earned on our cash and cash equivalents, (iii) payments and awards related to legal settlements and (iv) our portion of pre-tax income or loss from non-financial services joint ventures. For the three months ended June 30, 2020, Other income, net was $1.5 million, compared to $2.4 million in the 2019 comparable period. For the six months ended June 30, 2020, Other income, net was $2.1 million compared to $3.4 million in the 2019 period. Income Taxes. Our effective tax rate was 21.7% and 24.9% for the three months ended June 30, 2020 and 2019, respectively, and 20.2% and 23.8% for the six months ended June 30, 2020 and 2019, respectively. The reduced rate at June 30, 2020, is due to availability of the IRC §45L energy efficient homes credits from the enactment of the Taxpayer Certainty and Disaster Tax Relief Act on December 20, 2019, which extended the energy credit tax benefit to 2020. We also recorded a larger amount of tax benefit from equity-based compensation for stock awards that vested in the six months ended June 30, 2020 as compared to the same period in 2019. Liquidity and Capital Resources Overview Our principal uses of capital in the first six months of 2020 were acquisition and development of new and strategic lot positions, home construction, operating expenses, the payment of routine liabilities, and repurchases of our common stock. We used funds generated by operations to meet our short-term working capital requirements. We remain focused long-term on acquiring desirable land positions, generating increasing margins in our homebuilding operations and maintaining a strong balance sheet to support future needs and growth, while leveraging land options where possible. Operating Cash Flow Activities During the six months ended June 30, 2020, net cash provided by operating activities totaled $237.4 million versus $113.3 million during the six months ended June 30, 2019. Operating cash flows in 2020 and 2019 benefited from cash generated by net earnings of $161.8 million and $76.2 million, respectively. For the six months ended June 30, 2020, operating cash flows also benefited from an increase in accounts payable and accrued liabilities of $34.8 million due to timing of payments for routine transactions. 35 Investing Cash Flow Activities During the six months ended June 30, 2020, net cash used in investing activities totaled $9.1 million as compared to $5.8 million for the same period in 2019. Cash used in investing activities in the first six months of 2020 and 2019 is mainly attributable to the purchases of property and equipment of $10.3 million and $12.1 million for the 2020 and 2019 periods, respectively. Financing Cash Flow Activities During the six months ended June 30, 2020, net cash used in financing activities totaled $63.2 million as compared to$11.6 million for the same period in 2019. The activity in 2020 is primarily from $60.8 million in share repurchases. Similarly in 2019, the net cash used in financing activities in 2019 primarily reflects repurchases of our common stock of $9.0 million. Overview of Cash Management Cash flows for each of our communities depend on their stage of the development cycle and can differ substantially from reported earnings. Early stages of development or expansion require significant cash outlays for land acquisitions, zoning plat and other approvals, community and lot development, and construction of model homes, roads, utilities, landscape and other amenities. Because these costs are a component of our inventory and not recognized in our income statement until a home closes, we incur significant cash outlays prior to recognition of earnings. In the later stages of a community, cash inflows may significantly exceed earnings reported for financial statement purposes, as the cash outflow associated with home and land construction was previously incurred. From a liquidity standpoint, with the exception of a limited pause due to COVID-19 uncertainties in late first quarter and early second quarter, we are actively acquiring and developing lots in our markets to grow our lot supply and active community count. During the six months ended June 30, 2020, we closed 5,086 homes, purchased about 5,600 lots for $240.6 million, spent $219.4 million on land development and started construction on approximately 5,600 homes. We primarily purchase undeveloped land or partially-finished lots requiring development dollars in order to bring them to a finished status ready for home construction. We exercise strict controls and believe we have a prudent strategy for Company-wide cash management, including those related to cash outlays for land and inventory acquisition and development . We ended the second quarter of 2020 with $484.6 million of cash and cash equivalents, an increase of $165.2 million from December 31, 2019. During the six months ended June 30, 2020, we had gross borrowings and repayments on our Credit Facility of $500 million, each, and had no outstanding borrowings on our Credit Facility at June 30, 2020 and December 31, 2019. Between our available cash and liquidity in our Credit Facility, we believe that we currently have sufficient liquidity to manage through both our strategic growth goals and the uncertainties of the current COVID-19 environment. Nevertheless, we may seek additional capital to strengthen our liquidity position. Such additional capital may be in the form of equity or debt financing and may be from a variety of sources. There can be no assurances that we would be able to obtain such additional capital on terms acceptable to us, if at all, and such additional equity or debt financing could dilute the interests of our existing stockholders or increase our interest costs. We may also from time to time engage in opportunistic repurchases of our common stock in open market or privately-negotiated transactions as well as repurchase or redeem our outstanding senior notes although we do not currently intend to do so. On February 13, 2019, the Company's Board of Directors authorized a new stock repurchase program, authorizing the expenditure of up to $100.0 million to repurchase shares of our common stock. There is no stated expiration for this program. The repurchases of the Company's shares may be made in the open market, in privately negotiated transactions, or otherwise. The timing and amount of repurchases, if any, will be determined by the Company's management at its discretion and be based on a variety of factors such as market price of the Company's common stock, corporate and contractual requirements, prevailing market and economic conditions and legal requirements. The share repurchase program may be modified, suspended or discontinued at any time. The Company intends to retire any shares repurchased. In the six months ended June 30, 2020, we purchased and retired 1,000,000 shares of our common stock at an aggregate purchase price of $60.8 million and as of June 30, 2020, $23.2 million remained available under this program. 36 We believe that our leverage ratios provide useful information to the users of our financial statements regarding our financial position and cash and debt management. Debt-to-capital and net debt-to-capital are calculated as follows (dollars in thousands): As of June 30, 2020 December 31, 2019 Notes payable and other borrowings $ 1,017,437 $ 1,018,981 Stockholders’ equity 2,084,601 1,973,990 Total capital $ 3,102,038 $ 2,992,971 Debt-to-capital (1) 32.8 % 34.0 % Notes payable and other borrowings $ 1,017,437 $ 1,018,981 Less: cash and cash equivalents (484,622) (319,466) Net debt 532,815 699,515 Stockholders’ equity 2,084,601 1,973,990 Total net capital $ 2,617,416 $ 2,673,505 Net debt-to-capital (2) 20.4 % 26.2 % (1) Debt-to-capital is computed as senior notes, net and loans payable and other borrowings divided by the aggregate of total senior notes, net and loans payable and other borrowings and stockholders' equity. (2) Net debt-to-capital is computed as net debt divided by the aggregate of net debt and stockholders' equity. Net debt is comprised of total senior notes, net and loans payable and other borrowings, less cash and cash equivalents. The most directly comparable GAAP financial measure is the ratio of debt-to-capital. We believe the ratio of net debt-to-capital is a relevant financial measure for investors to understand the leverage employed in our operations and as an indicator of our ability to obtain financing. We have never declared cash dividends, nor do we intend to declare cash dividends in the foreseeable future. We plan to utilize our cash to manage our liquidity and to grow community count. Future cash dividends, if any, will depend upon economic and financial conditions, results of operations, capital requirements, statutory requirements, compliance with certain restrictive debt covenants, as well as other factors considered relevant by our Board of Directors Credit Facility Covenants Borrowings under the Credit Facility are unsecured, but availability is subject to, among other things, a borrowing base. The Credit Facility also contains certain financial covenants, including (a) a minimum tangible net worth requirement of $1.1 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 in the credit facility) of at least 1.50 to 1.00 or (ii) liquidity (as defined in the credit facility) 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 June 30, 2020. Our actual financial covenant calculations as of June 30, 2020 are reflected in the table below. Financial Covenant (dollars in thousands): Covenant Requirement Actual Minimum Tangible Net Worth >$1,407,911 $2,046,324 Leverage Ratio < 60% 17.6% Interest Coverage Ratio (1) > 1.50 7.46 Minimum Liquidity (1) >$75,033 $1,123,692 Investments other than defined permitted investments <$613,897 $3,646 (1) We are required to meet either the Interest Coverage Ratio or Minimum Liquidity, but not both. 37 Off-Balance Sheet Arrangements Reference is made to Notes 1, 3, 4 and 15 in the accompanying notes to the unaudited consolidated financial statements included in this Quarterly Report on Form 10-Q, which are incorporated by reference herein. These Notes discuss our off-balance sheet arrangements with respect to land acquisition contracts and option agreements, and land development joint ventures, including the nature and amounts of financial obligations relating to these items. In addition, these Notes discuss the nature and amounts of certain types of commitments that arise in connection with the ordinary course of our land development and homebuilding operations, including commitments of land development joint ventures for which we might be obligated. Seasonality Historically, we have experienced seasonal variations in our quarterly operating results and capital requirements. We typically take orders for more homes in the first half of the fiscal year than in the second half, which creates additional working capital requirements in the second and third quarters to build our inventories to satisfy seasonally higher deliveries in the second half of the year. Recent Issued Accounting Pronouncements See Note 1 to our unaudited consolidated financial statements included in this report for discussion of recently issued accounting standards.