What changed in this filing

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Item 2. Management’s Discussion and Analysis

2020-10-27 compared with 2020-07-27 · 146 added, 144 removed, 415 unchanged (41% of the section changed)

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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:

However, the desire to have larger, healthier single-family homes with additional space and technological capabilities to accommodate work or school-from-home scenarios, a limited supply of existing homes, coupled with low interest rates, have contributed to an unanticipated spike in the demand for new home offerings as a whole, particularly for readily-available inventory at lower price points, which aligns well with our strategy.

As a result, we have experienced significant increases in sales, closings, and pricing power across our geographies throughout the second and third quarters of 2020.

We have also accelerated various company-wide digital initiatives that were already in progress that facilitate the marketing, selling and closing of homes for buyers who are more comfortable transacting remotely.

We believe the digital and online efforts helped us effectively navigate the initial shelter-in-place orders and continue to provide a simple, streamlined solution to our customers through:

• Offering virtual tours in all of our communities to prospective customers;

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• Collecting earnest money payments remotely through third-party hosted money-transfer solutions;

• 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;

• Offering drive-through and partial 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 build in.

Since the inception of this pandemic, we have followed all applicable government orders and guidelines of public health agencies, and have modified our standards and protocols to safeguard all of our stakeholders as conditions change.

In order to address the changing environment, we 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;

• 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.

We have implemented responsible hygiene and cleaning, social distancing and other processes in all of our operations.

As of September 30, 2020 approximately 93% of our communities are targeted to first-time or first move-up buyers and those buyer segments represented approximately 94% of our orders in the third quarter of 2020.

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.

Our results for the third quarter of 2020 reflect continued strong growth in closings and orders, compared to the third quarter of 2019 as buyers took advantage of the historically low interest-rate environment and capitalized on their desire to move out of their existing home and transition to a larger, healthier home with indoor space to accommodate work and school from home needs and outdoor space to enjoy while practicing social distancing.

Total home closing revenue was $1.1 billion on 3,004 homes closed for the three months ended September 30, 2020 compared to $939.2 million on 2,419 homes closed for the third quarter of 2019, 20.7% and 24.2% increases, respectively.

In addition to higher home closing revenue, third quarter results benefited from a 170 basis point increase in home closing gross margin that resulted in a $57.5 million year-over-year increase in home closing gross profit to $243.6 million compared to $186.1 million in the third 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, we experienced pricing power in all of our geographies due to the strength of the new home market, which more than offset building material costs increases, particularly with respect to lumber.

We also realized significant savings in sales and marketing spending as we leveraged more digital platforms and scaled back certain corporate expenditures due to COVID-19.

Earnings before income taxes improved by $43.1 million year over year to $135.5 million for the third quarter of 2020.

These improved year-over-year results combined with a lower effective income tax rate of 19.5% as compared to 24.4% in 2019 led to net earnings of $109.1 million in the third quarter of 2020 versus $69.8 million in the third quarter of 2019.

For the nine months ended September 30, 2020, home closing revenue was $3.1 billion on 8,090

homes closed, 22.2% and 25.7% increases over 2019, respectively.

Similar to the third quarter, year-to-date results reflect an increase of $180.9 million in home closing gross profit versus the nine months ended September 30, 2019.

Higher gross profit, lower selling, general, and administrative expenses, combined with a $6.2 million decrease in interest expense year-over year due to the December 2019 early redemption of $300 million of senior notes, led to net income of $270.9 million for the nine months ended September 30, 2019 compared to $146.0 million for the 2019 period.

In addition to the positive trends in our home closings and financial results, orders for the three and nine months ended September 30, 2020 were up significantly as well.

Home orders were 70.5% and 40.2% higher, respectively, over the prior year, and our order cancellation rate dropped to 13% for the third quarter of 2020 compared to 17% for the prior year period.

We ended the third quarter of 2020 with 5,242 homes in backlog valued at $2.0 billion, a 49.0% increase in units and a 43.5% increase in value over September 30, 2019.

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.

We believe that our on-going investments in new communities designed for the first-time and first move-up homebuyer, 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;

• Expanding the number of actively selling communities that target the growing number of first-time and first move-up homebuyers.

After a short pause 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, leveraging our simplified 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 and sales processes, and in some geographies the closing process, to be conducted on-line;

• Simplifying our production process and adding consistency to our production cadence allowing 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;

• Improving our home closing gross profit by growing closing volume while streamlining our operations, allowing us to better leverage our overhead.

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• 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;

• Achieving or maintaining 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;

• Managing construction efficiencies and costs through national and regional vendor relationships with a focus on simplified product and limited SKUs, quality construction and warranty management;

• Carefully managing our liquidity and maintaining a strong balance sheet.

We ended the quarter with a 31.7% debt-to-capital ratio and a 15.7% net debt-to-capital ratio;

• Maximizing returns to our shareholders, most recently through our improved financial performance, debt repayment and share repurchase program;

• 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.

• Creating an inclusive and positive culture focused on cultivating an environment where every team member can be highly engaged in embracing opportunities to develop and grow in their careers.

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.

There have been no significant changes to our critical accounting policies during the nine months ended September 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.

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.

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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

Three Months Ended September 30, Quarter over Quarter

2020 2019 Change $ Change %

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Average sales price $ 348.7 $ 367.9 $ (19.2) (5.2) %

Six Months Ended June 30, Quarter over Quarter

2020 2019 Chg $ Chg %

Nine Months Ended September 30, Quarter over Quarter

2020 2019 Change $ Change %

Home Closing Revenue

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Average sales price $ 357.0 $ 370.9 $ (13.9) (3.7) %

Three Months Ended June 30, Quarter over Quarter

Three Months Ended September 30, Quarter over Quarter

2020 2019 Change $ Change %

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We do not include orders contingent upon the sale of a customer’s existing home as a sales contract until the contingency is removed.

Six Months Ended June 30, Quarter over Quarter

2020 2019 Chg $ Chg %

Nine Months Ended September 30, Quarter over Quarter

2020 2019 Change $ Change %

Home Orders (1)

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Average sales price $ 348.6 $ 370.8 $ (22.2) (6.0) %

Three Months Ended June 30,

Three Months Ended September 30,

Ending Average Ending Average

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East Region Totals 80 85.0 95 97.5

Six Months Ended June 30,

Nine Months Ended September 30,

Ending Average Ending Average

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East Region Totals 80 88.4 95 97.5

Three Months Ended June 30, Six Months Ended June 30,

Three Months Ended September 30, Nine Months Ended September 30,

2020 2019 2020 2019

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(1) Cancellation rates are computed as the number of canceled units for the period divided by the gross sales units for the same period.

At June 30, Quarter over Quarter

At September 30, Quarter over Quarter

2020 2019 Change $ Change %

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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.

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.

In the third quarter of 2020, home closing volume improved by 24.2% to 3,004 closings valued at $1.1 billion compared to 2,419 closings valued at $939.2 million in the third quarter of 2019.

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 healthier single-family homes at affordable price points as previously discussed.

Home closing revenue increased by 20.7% over the third quarter of 2019 due entirely to the increase in closing volume as our average sales prices declined 2.9%, reflective of a higher percentage of lower-priced entry-level homes in our closing mix.

Home order volume improved by 70.5% to 3,851 homes valued at $1.5 billion in the third quarter of 2020 as compared to 2,258 homes valued at $0.9 billion in the third quarter of 2019.

The improvement in orders was due to a 94.4% increase in orders pace year-over-year to 17.5 homes ordered per average active community, up from 9.0 in the third quarter of 2019, representing our highest quarterly orders pace since 2005.

We ended the quarter with 204 actively selling communities, an 18.4% decline from the prior year as communities experienced accelerated close-outs due to higher orders volume and delays in certain community openings due in part to municipal delays related to COVID-19.

While we have a robust pipeline of community openings scheduled over the next four to eight quarters, we expect our community counts to be choppy due to early close-outs and municipal delays.

Order cancellation rates were 13% and 14% for the first three and nine months of 2020, as compared to 17% and 14% during the three and nine month periods in 2019.

For the nine months ended September 30, 2020, home closing volume grew by 1,653 units, or 25.7%, and home closing revenue improved by $554.3 million from 8,090 closings valued at $3.1 billion.

Orders also increased significantly year over year by 3,027 units and $1.1 billion to 10,550 orders valued at $4.0 billion for the nine months ended September 30, 2020, 40.2% and 37.5% increases, respectively from prior year results.

Similar to third quarter results, demand for our affordable entry-level homes drove the increase in orders, resulting in a 58.0% higher orders pace than in 2019.

We ended the quarter with 5,242 homes in backlog valued at $2.0 billion, compared to 3,519 units valued at $1.4 billion at September 30, 2019.

The West Region closed 944 homes and generated $434.3 million in home closing revenue in the third quarter of 2020 compared to 809 homes and $366.1 million in home closing revenue in the comparable 2019 period.

The Region ended the third quarter of 2020 with 1,407 orders valued at $648.8 million versus 836 orders valued at $358.5 million in the third quarter of 2019.

The 16.7% improvement in closings was driven by entering the quarter with 31.8% higher backlog than the 2019 period.

The 68.3% improvement in order volume was driven by an 88.3% year-over-year increase in orders pace per community, which was achieved on a 10.5% decline in average active communities.

All states in the Region saw significant increases in orders pace, most notably in California which experienced a 136.7% increase in quarterly orders pace to lead the Company with 21.3 homes sold per community, as compared to 9.0 in the 2019 period.

In the West Region, approximately 65% and 26% of our communities target the first-time and first move-up buyers, respectively, at September 30, 2020.

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 third quarter of 2020 with 2,003 homes in backlog valued at $865.0 million, up from 1,195 units valued at $517.4 million in 2019.

Year-to-date results in the West Region were similar to those of the third quarter.

The number and value of homes closed versus prior year increased by 26.6% and 27.3%, respectively, while the average sales price was nominally higher year over year.

Orders for the Region improved 42.4% year-to-date which resulted in 46.1% 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.

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.

Despite the shift to lower priced entry-level and first move-up homes, average sales price increased in the Region due to additional California volume year over year, which has the highest average sales prices in the Region.

Similar to third quarter results, orders pace improved by 53.6% and the average number of actively selling communities declined by 7.1% in the Region for the nine months ended September 30, 2020.

In the third quarter of 2020, the Central Region, made up of our Texas markets, closed 1,059 homes and generated $349.9 million in home closing revenue, up 30.7% and 25.5%, respectively, from prior year comparable period results of 810 homes and $278.7 million of home closing revenue.

Average sales prices in the Region declined 4.0% 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

26.5%, respectively.

Orders and value grew by 82.3% and 81.7%, respectively, due to a 113.6% increase in orders pace in the Region, more than offsetting the 14.3% decrease in average community count compared to the prior year period.

The Region ended the third quarter of 2020 with 1,183 units ordered valued at $395.5 million compared to 649 units valued at $217.6 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 new replacement communities.

We have responded to the entry-level demand in this Region with a strong transition to first-time buyer product

offerings over recent years.

Approximately 69% and 29% of actively selling communities at September 30, 2020 were targeted toward the first-time and first move-up buyers, respectively.

We also saw overall improvements in the Region for the nine months ended September 30, 2020.

Home closings and home closing revenue were up 26.2% and 18.6%, respectively, and orders and order value were up year-over-year by 47.4% and 41.5%, respectively.

Orders pace increased by 77.0%, helping the Region end the quarter with 1,758 units in backlog, up 52.7% and backlog value of $602.7 million, up 45.9%, compared to the prior year.

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

During the three months ended September 30, 2020, the East Region delivered 1,001 closings and $349.0 million in home closing revenue compared to 800 closings and $294.3 million in home closing revenue in the comparable prior year period, improvements of 25.1% and 18.6%, respectively.

Orders and order value in the East Region improved by 63.1% and 57.4%, respectively, for the third quarter of 2020 with 1,261 units valued at $444.2 million compared to 773 units valued at $282.3 million in the prior year period.

The improvement in orders is due to a 87.3% increase in orders pace which more than offset the 12.8% decrease in average active communities.

Approximately 58% and 33% of actively selling communities at September 30, 2020 were targeted toward the first-time and first move-up buyers, respectively.

The year-to-date results of the East Region were similar to those of the third quarter, with 24.2% and 19.6% improvements in home closing volume and revenue, respectively, compared to 2019 providing 2,688 closings and $959.6 million in home closing revenue for the nine month period ending September 30, 2020.

The number and value of orders improved by 31.3% and 23.4%, respectively, due to a 44.7% increase in orders pace for the nine months ended September 30, 2020 compared to prior year.

The East Region ended the quarter with 1,481 homes in backlog valued at $537.2 million compared to 1,173 homes valued at $466.4 million at September 30, 2019, a 26.3% increase in units and 15.2% in order value from the shift to more entry-level homes and lower average sales prices.

Land Closing Revenue and Gross Profit/(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.

As a result of such sales, we recognized land closing revenue of $4.9 million and $1.7 million for the three months ending September 30, 2020 and 2019, respectively, a profit of $0.5 million in the third quarter of 2020 and a loss of $26,000 for the third quarter of 2019.

Year to date land sales resulted in losses of $0.6 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.

Land sales in 2020 and 2019 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,

Three Months Ended September 30, Nine Months Ended September 30,

2020 2019 2020 2019

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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.

Home closing gross margin for the third quarter of 2020 improved 170 basis points to 21.5% compared to 19.8% in the third quarter of 2019.

The higher margin combined with higher revenue contributed to a $57.5 million improvement in home closing gross profit to end the quarter with $243.6 million compared to $186.1 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.

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.

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.

With our growing demand, pricing power was a major driver in our gross margin improvement as we have experienced price increases in

all of our markets, which offset the impact of rising lumber costs .

For the nine months ended September 30, 2020, gross margin was up 250 basis points to 21.0% versus 18.5% for the same period in the prior year.

As expected with our shift to entry-level and first-time move up product offerings, we have shortened our construction cycle times and simplified our product, achieving national purchasing savings on materials, while also gaining efficiency from production, all of which are contributing to higher gross margin.

Home closing gross margin for the West Region improved by 60 basis points to 20.4% for the third quarter of 2020 versus 19.8% in the third quarter of 2019.

For the nine months ended September 30, 2020, home closing gross margin improved by 210 basis points to 20.4% versus 18.3% 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.

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.

The Central Region provided the highest home closing gross margin in the company, which at 23.8% for the third quarter of 2020 was our most notable improvement and up 260 basis points from 21.2% 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.

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.

For the nine months ended September 30, 2020, gross margin was up 290 basis points to 22.8% as compared to 19.9% for the same 2019 period.

Home closing gross margin in the East Region was up 200 basis points year-over-year to 20.5% in the third quarter of 2020 versus 18.5% for the comparable 2019 period.

For the nine months ended September 30, 2020, gross margin was up 280 basis points to 20.2% versus 17.4% for the same period in the prior year.

The quarter-over-quarter improvement in gross margin is the result of pricing power resulting from high demand combined with greater leverage of overhead costs on higher closing volume as compared to the prior quarter period.

The year-over-year improvement in gross margin 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.

Financial Services Profit (in thousands)

Three Months Ended June 30, Six Months Ended June 30,

Three Months Ended September 30, Nine Months Ended September 30,

2020 2019 2020 2019

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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.

Financial services profit declined $1.3 million in the third quarter of 2020 to $4.3 million versus $5.6 million in 2019 and by $5.4 million for the nine months ended September 30, 2020 to $10.9 million versus $16.3 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.

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Selling, General and Administrative Expenses and Other Expenses (dollars in thousands)

Three Months Ended June 30, Six Months Ended June 30,

Three Months Ended September 30, Nine Months Ended September 30,

2020 2019 2020 2019

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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 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.

These costs were $73.3 million for the three months ended September 30, 2020, $9.8 million higher than the prior year comparable period, although as a percentage of home closing revenue, decreased 30 basis points to 6.5% for the third quarter of 2020 compared to the prior year period.

For the nine months ended September 30, 2020, commissions and other sales costs decreased 30 basis points, and were $28.7 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 the early stages of the pandemic, partially offset by savings in advertising spend as we leveraged more digital platforms.

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.

For the three months ended September 30, 2020, general and administrative expenses were $40.7 million, $3.5 million higher than $37.2 million for the 2019 period, although as a percentage of home closing revenue, these expenses decreased by 40 basis points.

For the nine months ended September 30, 2020 and 2019, general and administrative expenses were $111.1 million or 3.6% of home closing revenue, as compared to $105.5 million or 4.2% 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.

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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.

Interest expense for the three months ended September 30, 2020 totaled $0.1 million compared to $1.1 million in the corresponding prior year period reflecting the early redemption of $300.0 million of senior notes which we redeemed in the fourth quarter of 2019.

We experienced similar decreases in year to date interest expense with $2.2 million in 2020 compared to $8.4 million in the prior year resulting from the previously mentioned early redemption, partially offset by interest charges from our Credit Facility which had $500.0 million outstanding for the majority of the first half of 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.

For the three months ended September 30, 2020, Other income, net was $1.2 million, compared to $2.4 million in the 2019 comparable period.

For the nine months ended September 30, 2020, Other income, net was $3.3 million compared to $5.8 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.

Our effective tax rate was 19.5% and 24.4% for the three months ended September 30, 2020 and 2019, respectively, and 19.9% and 24.1% for the nine months ended September 30, 2020 and 2019, respectively.

The reduced rate at September 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.

recorded a larger amount of tax benefit from equity-based compensation for stock awards that vested in the nine months ended September 30, 2020 as compared to the same period in 2019.

Liquidity and Capital Resources

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.

Our principal uses of capital in the first nine 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.

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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.

During the nine months ended September 30, 2020, net cash provided by operating activities totaled $373.1 million versus $167.4 million during the nine months ended September 30, 2019.

Operating cash flows in 2020 and 2019 benefited from cash generated by net earnings of $270.9 million and $146.0 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.

For the nine months ended September 30, 2020, operating cash flows also benefited from an increase in accounts payable and accrued liabilities of $60.0 million due to timing of payments for routine transactions.

For the nine months ended September 30, 2019, operating cash flows were negatively impacted by an increase in real estate of $110.3 million, but benefited from an increase in accounts payable and accrued liabilities of $84.6 million due to timing of cash payments for increased real estate and construction spending.

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.

During the nine months ended September 30, 2020, net cash used in investing activities totaled $13.2 million as compared to $12.0 million for the same period in 2019.

Cash used in investing activities in the first nine months of 2020 and 2019 is mainly attributable to the purchases of property and equipment of $14.8 million and $18.4 million for the 2020 and 2019 periods, respectively.

For the 2019 period, this was partially offset by a final distribution from the sale of our interest in an unconsolidated entity of $7.3 million.

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.

During the nine months ended September 30, 2020, net cash used in financing activities totaled $69.3 million as compared to $12.0 million for the same period in 2019.

The activity in 2020 is primarily from $60.8 million in share repurchases.

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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.

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 have significantly increased our acquisition and development of lots in our markets to grow our lot supply and active community count.

During the nine months ended September 30, 2020, we closed 8,090 homes, purchased approximately 11,500 lots for $407.2 million, spent $351.4 million on land development and started construction on 9,511 homes.

We primarily purchase undeveloped land or partially-finished lots requiring development 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.

We ended the third quarter of 2020 with $610.0 million of cash and cash equivalents, an increase of $290.5 million from December 31, 2019.

During the nine months ended September 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 September 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.

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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.

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.

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.

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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.

In the nine months ended September 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 September 30, 2020, $23.2 million remained available under this program.

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):

June 30, 2020 December 31, 2019

September 30, 2020 December 31, 2019

Notes payable and other borrowings $ 1,019,801 $ 1,018,981

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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.

We have never declared cash dividends.

Currently, 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.

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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.

We were in compliance with all Credit Facility covenants as of September 30, 2020.

Our actual financial covenant calculations as of September 30, 2020 are reflected in the table below.

Financial Covenant (dollars in thousands):

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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.

In 2020, historical cycles have been impacted by low interest rates and COVID-19 related demand;

however, we expect our historical seasonal pattern to continue over the long term.

Recent Issued Accounting Pronouncements

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis