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, 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; • 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 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. 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 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 23 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 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 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; 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; • 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 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; and • 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. 24 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 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. 25 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 and close-out. 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 September 30, Quarter over Quarter 2020 2019 Change $ Change % Home Closing Revenue Total Dollars $ 1,133,221 $ 939,185 $ 194,036 20.7 % Homes closed 3,004 2,419 585 24.2 % Average sales price $ 377.2 $ 388.3 $ (11.1) (2.9) % West Region Arizona Dollars $ 143,630 $ 144,920 $ (1,290) (0.9) % Homes closed 429 440 (11) (2.5) % Average sales price $ 334.8 $ 329.4 $ 5.4 1.6 % California Dollars $ 202,460 $ 135,555 $ 66,905 49.4 % Homes closed 332 200 132 66.0 % Average sales price $ 609.8 $ 677.8 $ (68.0) (10.0) % Colorado Dollars $ 88,199 $ 85,674 $ 2,525 2.9 % Homes closed 183 169 14 8.3 % Average sales price $ 482.0 $ 506.9 $ (24.9) (4.9) % West Region Totals Dollars $ 434,289 $ 366,149 $ 68,140 18.6 % Homes closed 944 809 135 16.7 % Average sales price $ 460.1 $ 452.6 $ 7.5 1.7 % Central Region - Texas Central Region Totals Dollars $ 349,907 $ 278,744 $ 71,163 25.5 % Homes closed 1,059 810 249 30.7 % Average sales price $ 330.4 $ 344.1 $ (13.7) (4.0) % East Region Florida Dollars $ 124,836 $ 118,804 $ 6,032 5.1 % Homes closed 339 302 37 12.3 % Average sales price $ 368.2 $ 393.4 $ (25.2) (6.4) % Georgia Dollars $ 62,921 $ 46,984 $ 15,937 33.9 % Homes closed 178 139 39 28.1 % Average sales price $ 353.5 $ 338.0 $ 15.5 4.6 % North Carolina Dollars $ 98,322 $ 77,696 $ 20,626 26.5 % Homes closed 295 206 89 43.2 % Average sales price $ 333.3 $ 377.2 $ (43.9) (11.6) % South Carolina Dollars $ 25,502 $ 23,768 $ 1,734 7.3 % Homes closed 78 75 3 4.0 % Average sales price $ 326.9 $ 316.9 $ 10.0 3.2 % Tennessee Dollars $ 37,444 $ 27,040 $ 10,404 38.5 % Homes closed 111 78 33 42.3 % Average sales price $ 337.3 $ 346.7 $ (9.4) (2.7) % East Region Totals Dollars $ 349,025 $ 294,292 $ 54,733 18.6 % Homes closed 1,001 800 201 25.1 % Average sales price $ 348.7 $ 367.9 $ (19.2) (5.2) % 26 Nine Months Ended September 30, Quarter over Quarter 2020 2019 Change $ Change % Home Closing Revenue Total Dollars $ 3,055,229 $ 2,500,888 $ 554,341 22.2 % Homes closed 8,090 6,437 1,653 25.7 % Average sales price $ 377.7 $ 388.5 $ (10.8) (2.8) % West Region Arizona Dollars $ 437,233 $ 368,762 $ 68,471 18.6 % Homes closed 1,315 1,126 189 16.8 % Average sales price $ 332.5 $ 327.5 $ 5.0 1.5 % California Dollars $ 487,605 $ 304,846 $ 182,759 60.0 % Homes closed 787 464 323 69.6 % Average sales price $ 619.6 $ 657.0 $ (37.4) (5.7) % Colorado Dollars $ 268,970 $ 264,479 $ 4,491 1.7 % Homes closed 553 507 46 9.1 % Average sales price $ 486.4 $ 521.7 $ (35.3) (6.8) % West Region Totals Dollars $ 1,193,808 $ 938,087 $ 255,721 27.3 % Homes closed 2,655 2,097 558 26.6 % Average sales price $ 449.6 $ 447.3 $ 2.3 0.5 % Central Region - Texas Central Region Totals Dollars $ 901,791 $ 760,189 $ 141,602 18.6 % Homes closed 2,747 2,176 571 26.2 % Average sales price $ 328.3 $ 349.4 $ (21.1) (6.0) % East Region Florida Dollars $ 357,233 $ 321,364 $ 35,869 11.2 % Homes closed 942 809 133 16.4 % Average sales price $ 379.2 $ 397.2 $ (18.0) (4.5) % Georgia Dollars $ 163,617 $ 132,440 $ 31,177 23.5 % Homes closed 459 380 79 20.8 % Average sales price $ 356.5 $ 348.5 $ 8.0 2.3 % North Carolina Dollars $ 276,477 $ 204,866 $ 71,611 35.0 % Homes closed 805 558 247 44.3 % Average sales price $ 343.4 $ 367.1 $ (23.7) (6.5) % South Carolina Dollars $ 73,113 $ 66,513 $ 6,600 9.9 % Homes closed 229 202 27 13.4 % Average sales price $ 319.3 $ 329.3 $ (10.0) (3.0) % Tennessee Dollars $ 89,190 $ 77,429 $ 11,761 15.2 % Homes closed 253 215 38 17.7 % Average sales price $ 352.5 $ 360.1 $ (7.6) (2.1) % East Region Totals Dollars $ 959,630 $ 802,612 $ 157,018 19.6 % Homes closed 2,688 2,164 524 24.2 % Average sales price $ 357.0 $ 370.9 $ (13.9) (3.7) % 27 Three Months Ended September 30, Quarter over Quarter 2020 2019 Change $ Change % Home Orders (1) Total Dollars $ 1,488,480 $ 858,395 $ 630,085 73.4 % Homes ordered 3,851 2,258 1,593 70.5 % Average sales price $ 386.5 $ 380.2 $ 6.3 1.7 % West Region Arizona Dollars $ 240,151 $ 159,778 $ 80,373 50.3 % Homes ordered 709 482 227 47.1 % Average sales price $ 338.7 $ 331.5 $ 7.2 2.2 % California Dollars $ 319,680 $ 124,201 $ 195,479 157.4 % Homes ordered 510 198 312 157.6 % Average sales price $ 626.8 $ 627.3 $ (0.5) (0.1) % Colorado Dollars $ 88,972 $ 74,498 $ 14,474 19.4 % Homes ordered 188 156 32 20.5 % Average sales price $ 473.3 $ 477.6 $ (4.3) (0.9) % West Region Totals Dollars $ 648,803 $ 358,477 $ 290,326 81.0 % Homes ordered 1,407 836 571 68.3 % Average sales price $ 461.1 $ 428.8 $ 32.3 7.5 % Central Region - Texas Central Region Totals Dollars $ 395,453 $ 217,648 $ 177,805 81.7 % Homes ordered 1,183 649 534 82.3 % Average sales price $ 334.3 $ 335.4 $ (1.1) (0.3) % East Region Florida Dollars $ 179,607 $ 111,471 $ 68,136 61.1 % Homes ordered 491 293 198 67.6 % Average sales price $ 365.8 $ 380.4 $ (14.6) (3.8) % Georgia Dollars $ 62,541 $ 47,527 $ 15,014 31.6 % Homes ordered 172 138 34 24.6 % Average sales price $ 363.6 $ 344.4 $ 19.2 5.6 % North Carolina Dollars $ 132,988 $ 69,017 $ 63,971 92.7 % Homes ordered 386 188 198 105.3 % Average sales price $ 344.5 $ 367.1 $ (22.6) (6.2) % South Carolina Dollars $ 28,140 $ 17,520 $ 10,620 60.6 % Homes ordered 90 55 35 63.6 % Average sales price $ 312.7 $ 318.5 $ (5.8) (1.8) % Tennessee Dollars $ 40,948 $ 36,735 $ 4,213 11.5 % Homes ordered 122 99 23 23.2 % Average sales price $ 335.6 $ 371.1 $ (35.5) (9.6) % East Region Totals Dollars $ 444,224 $ 282,270 $ 161,954 57.4 % Homes ordered 1,261 773 488 63.1 % Average sales price $ 352.3 $ 365.2 $ (12.9) (3.5) % (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. 28 Nine Months Ended September 30, Quarter over Quarter 2020 2019 Change $ Change % Home Orders (1) Total Dollars $ 3,958,870 $ 2,879,369 $ 1,079,501 37.5 % Homes ordered 10,550 7,523 3,027 40.2 % Average sales price $ 375.2 $ 382.7 $ (7.5) (2.0) % West Region Arizona Dollars $ 654,579 $ 493,391 $ 161,188 32.7 % Homes ordered 2,016 1,521 495 32.5 % Average sales price $ 324.7 $ 324.4 $ 0.3 0.1 % California Dollars $ 769,251 $ 368,194 $ 401,057 108.9 % Homes ordered 1,250 572 678 118.5 % Average sales price $ 615.4 $ 643.7 $ (28.3) (4.4) % Colorado Dollars $ 258,268 $ 290,060 $ (31,792) (11.0) % Homes ordered 540 580 (40) (6.9) % Average sales price $ 478.3 $ 500.1 $ (21.8) (4.4) % West Region Totals Dollars $ 1,682,098 $ 1,151,645 $ 530,453 46.1 % Homes ordered 3,806 2,673 1,133 42.4 % Average sales price $ 442.0 $ 430.8 $ 11.2 2.6 % Central Region - Texas Central Region Totals Dollars $ 1,130,943 $ 799,293 $ 331,650 41.5 % Homes ordered 3,457 2,346 1,111 47.4 % Average sales price $ 327.1 $ 340.7 $ (13.6) (4.0) % East Region Florida Dollars $ 435,411 $ 369,503 $ 65,908 17.8 % Homes ordered 1,198 925 273 29.5 % Average sales price $ 363.4 $ 399.5 $ (36.1) (9.0) % Georgia Dollars $ 182,958 $ 149,731 $ 33,227 22.2 % Homes ordered 518 431 87 20.2 % Average sales price $ 353.2 $ 347.4 $ 5.8 1.7 % North Carolina Dollars $ 340,626 $ 241,573 $ 99,053 41.0 % Homes ordered 999 658 341 51.8 % Average sales price $ 341.0 $ 367.1 $ (26.1) (7.1) % South Carolina Dollars $ 85,316 $ 65,540 $ 19,776 30.2 % Homes ordered 272 205 67 32.7 % Average sales price $ 313.7 $ 319.7 $ (6.0) (1.9) % Tennessee Dollars $ 101,518 $ 102,084 $ (566) (0.6) % Homes ordered 300 285 15 5.3 % Average sales price $ 338.4 $ 358.2 $ (19.8) (5.5) % East Region Totals Dollars $ 1,145,829 $ 928,431 $ 217,398 23.4 % Homes ordered 3,287 2,504 783 31.3 % Average sales price $ 348.6 $ 370.8 $ (22.2) (6.0) % 29 Three Months Ended September 30, 2020 2019 Ending Average Ending Average Active Communities Total 204 220.5 250 252.0 West Region Arizona 35 36.5 37 38.5 California 20 24.0 24 22.0 Colorado 11 12.0 20 20.5 West Region Totals 66 72.5 81 81.0 Central Region - Texas Central Region Totals 58 63.0 74 73.5 East Region Florida 34 35.0 36 36.0 Georgia 11 14.0 18 19.5 North Carolina 20 20.5 22 22.5 South Carolina 6 5.5 10 9.5 Tennessee 9 10.0 9 10.0 East Region Totals 80 85.0 95 97.5 Nine Months Ended September 30, 2020 2019 Ending Average Ending Average Active Communities Total 204 232.1 250 261.0 West Region Arizona 35 34.3 37 38.5 California 20 25.3 24 20.5 Colorado 11 13.8 20 20.0 West Region Totals 66 73.4 81 79.0 Central Region - Texas Central Region Totals 58 70.3 74 84.5 East Region Florida 34 34.4 36 33.5 Georgia 11 15.3 18 20.0 North Carolina 20 21.6 22 23.5 South Carolina 6 6.8 10 11.0 Tennessee 9 10.3 9 9.5 East Region Totals 80 88.4 95 97.5 30 Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Cancellation Rates (1) Total 13 % 17 % 14 % 14 % West Region Arizona 10 % 14 % 11 % 12 % California 13 % 16 % 15 % 15 % Colorado 15 % 18 % 15 % 12 % West Region Totals 12 % 16 % 13 % 12 % Central Region - Texas Central Region Totals 15 % 22 % 16 % 17 % East Region Florida 12 % 13 % 12 % 10 % Georgia 12 % 17 % 12 % 16 % North Carolina 11 % 11 % 9 % 10 % South Carolina 15 % 20 % 13 % 19 % Tennessee 12 % 12 % 17 % 9 % East Region Totals 11 % 14 % 12 % 12 % (1) Cancellation rates are computed as the number of canceled units for the period divided by the gross sales units for the same period. 31 At September 30, Quarter over Quarter 2020 2019 Change $ Change % Order Backlog (1) Total Dollars $ 2,004,981 $ 1,397,033 $ 607,948 43.5 % Homes in backlog 5,242 3,519 1,723 49.0 % Average sales price $ 382.5 $ 397.0 $ (14.5) (3.7) % West Region Arizona Dollars $ 404,044 $ 258,341 $ 145,703 56.4 % Homes in backlog 1,212 738 474 64.2 % Average sales price $ 333.4 $ 350.1 $ (16.7) (4.8) % California Dollars $ 373,949 $ 129,880 $ 244,069 187.9 % Homes in backlog 608 199 409 205.5 % Average sales price $ 615.0 $ 652.7 $ (37.7) (5.8) % Colorado Dollars $ 87,047 $ 129,167 $ (42,120) (32.6) % Homes in backlog 183 258 (75) (29.1) % Average sales price $ 475.7 $ 500.6 $ (24.9) (5.0) % West Region Totals Dollars $ 865,040 $ 517,388 $ 347,652 67.2 % Homes in backlog 2,003 1,195 808 67.6 % Average sales price $ 431.9 $ 433.0 $ (1.1) (0.3) % Central Region - Texas Central Region Totals Dollars $ 602,709 $ 413,229 $ 189,480 45.9 % Homes in backlog 1,758 1,151 607 52.7 % Average sales price $ 342.8 $ 359.0 $ (16.2) (4.5) % East Region Florida Dollars $ 242,419 $ 213,427 $ 28,992 13.6 % Homes in backlog 627 488 139 28.5 % Average sales price $ 386.6 $ 437.4 $ (50.8) (11.6) % Georgia Dollars $ 69,204 $ 63,730 $ 5,474 8.6 % Homes in backlog 192 174 18 10.3 % Average sales price $ 360.4 $ 366.3 $ (5.9) (1.6) % North Carolina Dollars $ 143,741 $ 104,162 $ 39,579 38.0 % Homes in backlog 413 277 136 49.1 % Average sales price $ 348.0 $ 376.0 $ (28.0) (7.4) % South Carolina Dollars $ 36,723 $ 31,474 $ 5,249 16.7 % Homes in backlog 114 92 22 23.9 % Average sales price $ 322.1 $ 342.1 $ (20.0) (5.8) % Tennessee Dollars $ 45,145 $ 53,623 $ (8,478) (15.8) % Homes in backlog 135 142 (7) (4.9) % Average sales price $ 334.4 $ 377.6 $ (43.2) (11.4) % East Region Totals Dollars $ 537,232 $ 466,416 $ 70,816 15.2 % Homes in backlog 1,481 1,173 308 26.3 % Average sales price $ 362.7 $ 397.6 $ (34.9) (8.8) % (1) Our backlog represents net sales that have not closed. 32 Operating Results Companywide . 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 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 third 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 healthier 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, allowing quicker move-ins for our customers. 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. West . 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. 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. Central . 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 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 33 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. East . 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 $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 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 September 30, Nine Months Ended September 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 $ 243,567 21.5 % $ 186,117 19.8 % $ 642,623 21.0 % $ 461,697 18.5 % West $ 88,655 20.4 % $ 72,380 19.8 % $ 243,252 20.4 % $ 171,279 18.3 % Central $ 83,452 23.8 % $ 59,156 21.2 % $ 205,431 22.8 % $ 151,136 19.9 % East $ 71,460 20.5 % $ 54,581 18.5 % $ 193,940 20.2 % $ 139,282 17.4 % (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 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. With our growing demand, pricing power was a major driver in our gross margin improvement as we have experienced price increases in 34 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. West . 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. Central . 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 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. East . 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 September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Financial services profit $ 4,315 $ 5,582 $ 10,942 $ 16,315 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 only began operating in the fourth quarter of 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. 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. 35 Selling, General and Administrative Expenses and Other Expenses (dollars in thousands) Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Commissions and other sales costs Dollars $ (73,282) $ (63,450) $ (204,863) $ (176,130) Percent of home closing revenue 6.5 % 6.8 % 6.7 % 7.0 % General and administrative expenses Dollars $ (40,737) $ (37,191) $ (111,083) $ (105,536) Percent of home closing revenue 3.6 % 4.0 % 3.6 % 4.2 % Interest expense Dollars $ (55) $ (1,068) $ (2,176) $ (8,350) Other income, net Dollars $ 1,188 $ 2,402 $ 3,313 $ 5,816 Provision for income taxes Dollars $ (26,388) $ (22,557) $ (67,253) $ (46,361) 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 $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. 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 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 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. 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 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 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 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. We also 36 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 Overview 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. 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 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 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 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 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. 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 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 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. 37 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. 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 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): As of September 30, 2020 December 31, 2019 Notes payable and other borrowings $ 1,019,801 $ 1,018,981 Stockholders’ equity 2,199,849 1,973,990 Total capital $ 3,219,650 $ 2,992,971 Debt-to-capital (1) 31.7 % 34.0 % Notes payable and other borrowings $ 1,019,801 $ 1,018,981 Less: cash and cash equivalents (609,979) (319,466) Net debt 409,822 699,515 Stockholders’ equity 2,199,849 1,973,990 Total net capital $ 2,609,671 $ 2,673,505 Net debt-to-capital (2) 15.7 % 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. 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. 38 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 September 30, 2020. Our actual financial covenant calculations as of September 30, 2020 are reflected in the table below. Financial Covenant (dollars in thousands): Covenant Requirement Actual Minimum Tangible Net Worth >$1,462,470 $2,161,742 Leverage Ratio < 60% 13% Interest Coverage Ratio (1) > 1.50 8.67 Minimum Liquidity (1) >$69,817 $1,240,759 Investments other than defined permitted investments <$648,523 $3,819 (1) We are required to meet either the Interest Coverage Ratio or Minimum Liquidity, but not both. 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. 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 See Note 1 to our unaudited consolidated financial statements included in this report for discussion of recently issued accounting standards.