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Item 7. Management’s Discussion and Analysis

2021-02-12 compared with 2020-02-18 · 110 added, 110 removed, 424 unchanged (34% of the section changed)

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Industry Conditions

Housing market conditions were generally healthy in 2019, as strong underlying economic and housing market fundamentals drove demand along with historically low interest rates and a limited supply of entry-level homes, where homebuying activity was most prevalent.

Homebuilders with attractive, lower price-point product in desirable locations captured this demand for affordable homes, as buyers in this environment are primarily motivated by affordability.

We believe the longer-term economic data supports a continuation of the current homebuilding cycle, although individual market results will vary, responding to each respective market's economic factors.

At Meritage, we continue to focus on our pivot to the first-time and first move-up buyer through our commitment to simplification and our key strategic initiatives of home closing gross margin improvement, selling, general and administrative cost control and long-term community count growth.

We have made considerable progress as 87% of our current communities are targeted to first-time or first move-up buyers and those buyer segments represented approximately 90% of our orders in 2019.

We expect to continue to open an increasing number of communities that target the first-time and first move-up buyers.

We believe this strategy will allow us to achieve higher gross margins and better opportunities to leverage our overhead costs.

Housing market conditions were very strong in 2020, despite a short pause in March and April due to COVID-19 uncertainties, as healthy underlying economic and housing market fundamentals drove demand with historically low interest rates, a limited supply of homes, and an increased desire for healthier, safer homes.

Homebuilders with attractive, lower price-point product in desirable locations captured this demand that has been bolstered in part by millennials entering the market in a meaningful way, as well as the baby boomer generation downsizing.

We believe the longer-term economic data supports a continuation of a solid homebuilding cycle, although individual market results will vary, responding to each respective market's economic factors.

At Meritage, we continue to focus on enhancing our entry-level and first move-up product through our commitment to simplification and remaining focused on our key financial initiatives of home closing gross margin improvement, selling, general and administrative cost control and long-term community count growth.

As of December 31, 2020, 94% of our current communities are targeted to first-time or first move-up buyers and those buyer segments represented approximately 95% of our orders in 2020.

We believe our strategy will allow us to achieve higher gross margins and better opportunities to leverage our overhead costs in the years to come.

Summary Company Results

Total home closing revenue increased by 3.7% to $3.6 billion for the year ended December 31, 2019 from $3.5 billion in 2018.

Total home closing revenue increased 23.9% due to higher closing volume, to $4.5 billion for the year ended December 31, 2020 from $3.6 billion in 2019.

Home closing gross margin for the year ended December 31, 2020 improved by 310 basis points to 22.0% while gross margin for the year ended December 31, 2019 was 18.9%.

The improved margin in 2019 reflects efficiencies in our construction process and effective cost controls.

Improved revenue from higher closing volume resulted in pre-tax net earnings of $302.9 million in 2019 as compared to $283.3 million in 2018.

The improved margin in 2020 reflects increased pricing power, increased volume and efficiencies in our construction process and effective cost controls, despite increasing lumber prices.

We recorded impairment charges of approximately $24.9 million during the year ended December 31, 2020, primarily resulting from the decision to sell land assets that no longer fit our strategy, compared to $7.3 million of similar charges in 2019.

Interest expense decreased to $2.2 million for the year ended December 31, 2020 from $8.4 million in 2019, due to the the early redemption of senior notes in the fourth quarter of 2019, partially offset by interest charges from our Credit Facility which had $500.0 million outstanding for several months during the first half of 2020.

Pre-tax net earnings of $533.6 million in 2020 increased 76.1% from $302.9 million in 2019.

Our effective tax rate in 2020 was 20.6% as compared to a 17.6% effective tax rate in 2019.

Net income for the year ended December 31, 2020 was $423.5 million compared to $249.7 million in 2019.

We ended 2019 with 9,267 closings, an 8.6% increase over 8,531 closings in 2018.

Our results for 2020 reflect strong growth in both closings and orders as buyers took advantage of the historically low interest-rate environment and capitalized on their desire to purchase their first home or 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.

We ended 2020 with 11,834 closings, a 27.7% increase over 9,267 closings in 2019.

Orders improved by 42.7% in 2020 with 13,724 orders for the year compared to 9,616 in 2019.

Increases in both closings and order value were muted compared to the volume increases, resulting from lower average sales prices reflecting our continuing transition to entry-level product.

At December 31, 2020, our backlog of $1.8 billion on 4,672 units increased by 65.1% in value, compared to $1.1 billion on 2,782 units at December 31, 2019.

Similar to closings and orders, average sales price for homes in backlog decreased compared to prior year at $394,700 from $417,600 at December 31, 2018.

Our cancellation rate on sales orders as a percentage of gross sales in 2019 decreased to 14.2% as compared to 15.7% for the year ended December 31, 2018.

Despite the instability of the market in the early stages of the COVID-19 pandemic, our full year cancellation rate on sales orders as a percentage of gross sales in 2020 decreased to 13.6% as compared to 14.2% for the year ended December 31, 2019.

Company Positioning

We believe that the investments in our new communities, particularly those designed for the first-time and first move-up homebuyer, our unique selling process, and industry-leading innovation in energy-efficient product offerings and automation create a differentiated strategy that has aided us in our growth in the highly competitive new home market.

We believe that the investments in our new communities designed for the first-time and first move-up homebuyer, our commitment to an all-spec strategy for our entry-level homes, our simplified first move-up design studio process, and industry-leading innovation in energy-efficient product offerings and automation create a differentiated strategy that has aided us in our growth in the highly competitive new home market.

Our focus includes the following strategic initiatives:

• Expanding the number of LiVE.NOW® communities that target the growing first-time and first move-up homebuyers;

• 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, and a shortened construction timeline;

• Demonstrating our commitment to innovation through a new fully-automated and secured digital loan pre-approval process available on our website;

• Expanding our community count and market share;

• Continuously 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, and a shortened construction timeline;

• Demonstrating our commitment to innovation by extending our digital offerings, including virtual tours in all of our communities for both prospective buyers and home closing walkthroughs, 3-D tours and dynamic floor plans, and

partial or fully virtual closings in states where such services are permitted.

We also offer a fully-automated and secured digital loan pre-approval process available on our website;

• Enhancing our website and sales offices through investments in technology.

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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;

• Increasing orders and maintaining a healthy 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 a position of at least 5% market share in all of our markets;

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• Carefully managing our liquidity and a strong balance sheet;

in 2019 we reduced our outstanding debt and ended the year with a 34.0% debt-to-capital ratio and a 26.2% net debt-to-capital ratio;

we ended the year with a 30.3% debt-to-capital ratio and a 10.5% net debt-to-capital ratio;

• Maximizing returns to our shareholders, most recently through our improved financial performance 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.

• Promoting a positive environment for our employees through our commitment to drive diversity, equity, and inclusion and providing market-competitive benefits in order to develop and motivate our employees and to minimize turnover and to maximize recruitment efforts.

Critical Accounting Policies

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(3) determine the transaction price;

(4) allocate the transaction price to the

performance obligations in the contract, if applicable;

(4) allocate the transaction price to the performance obligations in the contract, if applicable;

and (5) recognize revenue when (or as) we satisfy the performance obligation.

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• Revenue from land sales is recognized when a significant down payment is received, title passes and collectability of the receivable is reasonably assured, and we have no continuing involvement with the property, which is generally upon the close of escrow.

• Revenue from financial services is recognized when closings have occurred and all financial services have been rendered, which generally occurs as each home is closed.

Revenues associated with our insurance company operations represent insurance brokerage commissions from home and other insurance policies placed with third party carriers.

Our performance obligations for policy renewal commissions are considered satisfied upon issuance of the initial policy.

• Revenue from financial services is recognized when closings have occurred and all financial services have been rendered, which is generally upon the close of escrow.

Real estate is stated at cost unless the community or land is determined to be impaired, at which point the inventory is written down to fair value as required by ASC 360-10, Property, Plant and Equipment.

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Land and development costs are typically allocated and transferred to homes under construction when home construction begins.

Home construction costs are accumulated on a per-home basis.

Cost of home closings also includes all related allocated land acquisition, land development and other common costs (both incurred and estimated to be incurred) based upon the total number of homes expected to be closed in each community or phase.

Home construction costs are accumulated on a per-home basis, while selling costs are expensed as incurred.

Cost of home closings includes the specific construction costs of the home and all related allocated land acquisition, land development and other common costs (both incurred and estimated to be incurred) and are allocated based upon the total number of homes expected to be closed in each community or phase.

Any changes to the estimated total development costs of a community or phase are allocated to the remaining homes in the community or phase.

When a home closes, we may have incurred costs for goods and services that have not yet been paid.

Therefore, an accrual to capture such obligations is recorded in connection with the home closing and charged directly to cost of sales.

An accrued liability to capture such obligations is recorded in connection with the home closing and charged directly to cost of sales.

We rely on certain estimates to determine our construction and land development costs.

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In determining these costs, we compile project budgets that are based on a variety of assumptions, including future construction schedules and costs to be incurred.

Actual results can differ from these budgeted amounts for various reasons, including construction delays, labor or material shortages, slower absorptions, increases in costs that have not yet been committed, changes in governmental requirements, or other unanticipated issues encountered during construction and development and other factors beyond our control.

To address uncertainty in these budgets, we assess, update and revise project budgets on a regular basis, utilizing the most current information available to estimate construction and land costs.

Typically, an entitled community’s life cycle ranges from three to five years, commencing with the acquisition of the land, continuing through the land development phase and concluding with the sale, construction and closing of the homes.

Actual community lives will vary based on the size of the community, the absorption rates and whether the land purchased was raw land or finished lots.

Actual results can differ from budgeted amounts for various reasons, including construction delays, labor or material shortages, slower absorptions, increases in costs that have not yet been committed, changes in governmental requirements, or other unanticipated issues encountered during construction and development and other factors beyond our control.

To address uncertainty in these budgets, we assess, update and revise project budgets on a regular basis, utilizing the most current information available to estimate home construction and land costs.

Typically, a community’s life cycle ranges from three to five years, commencing with the acquisition of the land, continuing through the land development phase, if applicable, and concluding with the sale, construction and closing of the homes.

Actual community lives will vary based on the size of the community, the sales absorption rates and whether the land purchased was raw, partially-developed or in finished status.

Master-planned communities encompassing several phases and super-block land parcels may have significantly longer lives and projects involving smaller finished lot purchases may be significantly shorter.

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The impairment of a community is allocated to each lot on a straight-line basis.

Warranty Reserves

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There were no adjustments to our reserve balance for the years ended December 31, 2020 and December 31, 2019.

While we believe that the warranty reserve is sufficient to cover our projected costs, there can be no assurances that historical data and trends will

accurately predict our actual warranty costs.

While we believe that the warranty reserve is sufficient to cover our projected costs, there can be no assurances that historical data and trends will accurately predict our actual warranty costs.

Furthermore, there can be no assurances that future economic, financial or legislative developments might not lead to a significant change in the reserve.

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(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.

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

Years Ended December 31,

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Companywide .

Home closing revenue for the year ended December 31, 2019 increased 3.7% to $3.6 billion when compared to $3.5 billion in 2018 due entirely to 736 additional units closed as average sales prices decreased 4.5% compared to the prior year.

We also ended 2019 with a positive comparison year-over-year in home orders with $3.7 billion in order value on 9,616 units in 2019 as compared to $3.2 billion on 8,089 units in 2018.

A decrease in average sales price for both closings and orders was reflective of our shift to a higher percentage of mix coming from entry-level and first move-up homes.

Simplifying our business and improving our buyers' experiences through a strategic shift to product and communities that appeal to the first-time and first move-up buyers has been a key focus for us and we believe our results reflect it.

At December 31, 2019 we had 244 actively selling communities, 10.3% lower than prior year, as an 18.8% improvement in orders pace to 37.3 in 2019 compared to 31.4 in 2018 resulted in faster community close-outs.

In 2020, home closings improved 27.7% to 11,834 units valued at $4.5 billion compared to 9,267 units valued at $3.6 billion in 2019.

The increase in closings year-over-year reflects a 42.7% increase in order volume to 13,724 units valued at $5.2 billion in 2020 as compared to 9,616 units valued at $3.7 billion in 2019, as well as increased backlog conversion due to selling and closing more speculative inventory homes in 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 due to the macroeconomic events discussed in "Industry Conditions".

This customer demand is aligned with our focus on the first-time 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.

The increase in home closing revenue was due entirely to 2,567 additional units closed as average sales prices ("ASP") decreased 3.0%, reflective of a higher percentage of lower-priced entry-level homes in our closing mix that was partially offset by sequential price increases throughout 2020 in all of our geographies.

At December 31, 2020 we had 195 actively selling communities, 20.1% lower than prior year, as a 67.7% improvement in orders pace to 5.2 per month in 2020 compared to 3.1 in 2019 resulted in communities selling and closing out faster than we were able to open replacement communities.

We ended the year with 4,672 homes in backlog valued at $1.8 billion, reflecting 67.9% and 65.1% increases in backlog units and value, respectively, compared to 2019.

Average sales prices of homes in backlog declined by 5.5% to $394,700 from $417,600 in 2018 primarily a result of our shift to entry-level homes, as noted above.

Our West region generated $1.4 billion in home closing revenue, flat with the prior year.

In 2019, the West region closed 3,167 homes, a 6.2% increase from the 2,982 homes closed in 2018 which was fully offset with a $30,200 or 6.4% decline in average sales price.

The West region ended 2019 with $1.5 billion in order value on 3,400 units compared to $1.3 billion on 2,758 units in 2018, increases of 17.3% and 23.3%, respectively, over prior year.

Overall, average community count grew by 2.7% and orders pace in the Region improved by more than 19.8%, in 2019 compared to prior year.

We achieved an orders pace of 45.3 homes per average community, which leads the company as our entry-level footprint with a higher absorption pace has been established in this Region for the longest period of time, most notably in Arizona.

These results led to ending backlog in the Region of $375.9 million on 852 units versus $303.4 million on 619 units in 2018, 23.9% and 37.6% increases over the prior year, respectively.

The Central Region, made up of our Texas markets, closed 2,976 units totaling $1.0 billion in home closing revenue for the year ended December 31, 2019.

The 4.8% improvement in closing units, offset partially by a 1.9% decline in average sales prices, resulted in $27.5 million higher home closing revenue up 2.7% from 2018.

ASP of homes in backlog declined by 1.7% to $388,000 from $394,700 in 2019 primarily a result of our shift to entry-level homes offset by price increases, as noted previously.

The West Region generated $1.8 billion in home closing revenue for the year ended December 31, 2020, a 27.3% increase over revenue of $1.4 billion for the prior year, closing 3,988 homes, up 25.9% from the 3,167 homes closed in 2019.

Order volume for the West Region was 4,781 homes during the year ended December 31, 2020, a 40.6% improvement from 3,400 home orders in 2019.

Order value increased 44.5% to $2.1 billion in 2020 from $1.5 billion in 2019.

The improvement in order volume was driven by a 50.6% higher year-over-year orders pace per community.

This stronger orders pace more than offset the 6.5% decline in average active communities.

All states in the Region saw significant increases in orders pace, most notably in California which experienced a 66.7% increase to lead the Region with 5.5 homes sold per month per community, as compared to 3.3 in the 2019 period.

In the West Region, approximately 68% of our communities target the first-time buyers at December 31, 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.

These results led to the strongest year-over-year improvement in backlog by Region, ending with $723.3 million on 1,645 units versus $375.9 million on 852 units in 2019, 92.4% and 93.1% increases over the prior year, respectively.

The Central Region, made up of our Texas markets, generated the strongest year-over-year improvements in volume of closings and orders.

The Region closed 3,894 units totaling $1.3 billion in home closing revenue for the year ended December 31, 2020.

The 30.8% improvement in closing units was partially offset by a 5.8% decline in ASP, generating an increase in home closing revenues of $239.9 million, or 23.2%, from $1.0 billion in 2019 to $1.3 billion in 2020.

The Region also reported improvement in orders year-over-year with 47.1% and 42.7% increases in orders and order value, respectively.

The improvement in orders was achieved despite a 22.2% decline in average active communities, due to the 89.0% higher orders pace year-over-year.

The Region ended the year with 3,043 orders valued at $1.0 billion in 2019 compared to 2,801 orders at $995.5 million in the prior year.

The Region ended 2019 with backlog of 1,048 units valued at $372.5 million compared to 981 units valued at $372.8 million at December 31, 2018, reflecting a $24,600 lower average sales prices from the higher percentage of entry-level and first move-up homes compared to 2018.

The East Region generated the strongest year-over-year improvements in closings, orders and backlog.

The Region delivered 15.3% and 10.5% increases in closing volume and revenue, respectively, delivering 3,124 closings and $1.2 billion of home closing revenue in 2019 compared to 2,709 closings and $1.1 billion of revenue in 2018.

The increase in closing volume was partially offset by a $16,300 decrease in average sales price resulting from our transition to offering more entry-level and first move-up product.

Orders and order value in the East region improved by 25.4% and 19.1%, respectively, in 2019 with 3,173 units valued at $1.2 billion compared to 2,530 units valued at $981.7 million in the prior year.

The improvement in orders is due to an 18.1% higher orders pace combined with 6.0% more communities open for sales in 2019 compared to 2018.

The Region ended the year with 4,476 orders valued at $1.5 billion in 2020 compared to 3,043 orders at $1.0 billion in the prior year.

The Region ended 2020 with backlog of 1,630 units valued at $572.2 million compared to 1,048 units valued at $372.5 million at December 31, 2019, reflecting a $4,400 lower ASP from the shift to lower-priced homes mix compared to 2019.

The East Region experienced 26.5% and 20.2% increases in closing volume and revenue, respectively, delivering 3,952 closings and $1.4 billion of home closing revenue in 2020 compared to 3,124 closings and $1.2 billion of revenue in 2019.

The increase in closing volume was partially offset by a $18,500 decrease in ASP resulting from our transition to offering more affordable product.

Orders and order value in the East region improved by 40.8% and 33.5%, respectively, in 2020 with 4,467 units valued at $1.6 billion compared to 3,173 units valued at $1.2 billion in the prior year.

The improvement in orders is due entirely to a 65.1% higher orders pace, as the Region experienced a 14.7% decline in average active communities open for sales in 2020 compared to 2019.

The higher orders led to an improved backlog in the Region to end 2020 with 1,397 units in backlog valued at $517.0 million, 58.4% and 47.8% increases, respectively, compared to the prior year.

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We recognized losses of $20.8 million and $1.0 million in 2020 and 2019, respectively.

The losses recognized in both years is due to the sale of assets that no longer fit our strategic focus on entry-level and first move-up homes.

The losses recognized in both years were due to the upcoming dispositions of certain assets that no longer fit our strategic focus on entry-level and first move-up homes and includes associated impairment charges of $21.8 million and $4.1 million, in 2020 and 2019, respectively

Other Operating Information (dollars in thousands)

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Home closing gross margin improved to 22.0% for the year ended December 31, 2020 compared to 18.9% in the prior year.

Home closing gross profit increased by $48.7 million to $680.7 million in 2019 versus $632.0 million in 2018, driven by higher home closing revenue and a 70 basis point increase in home closing gross margin.

With gains in pricing power resulting from high demand and our lower direct costs from our more efficient product offerings, we have been successful in achieving higher profitability in our home closings.

Home closing gross profit increased by $299.7 million to $980.4 million in 2020 versus $680.7 million in 2019, driven by the higher home closing revenue and 310 basis point increase in home closing gross margin.

With robust homebuilding market dynamics, increased closing volume and pricing power were major drivers in our gross margin improvement.

Despite a year-over-year ASP decline resulting from the mix of lower-priced entry-level homes, all of our geographies experienced sequential price increases corresponding with the strong demand as the year progressed, which more than offset the impact of rising lumber costs.

With our simplified product, we have shortened our construction cycle times and achieved national purchasing savings on materials, while also gaining efficiency from production, all of which are contributing to higher gross margin.

Our West Region reported a 250 basis point improvement in year-over-year home closing gross margin of 21.2% in 2020 versus 18.7% in 2019.

Decreases in material and labor costs coupled with construction efficiencies driven by our simplified product offerings, and shorter construction cycle times have favorably impacted margins.

Margin in this Region also benefited from pricing power, most notably in Arizona due to strong demand.

The Central Region produced the highest home closing gross margin in the company for the year ended December 31, 2019 at 20.2%, up from 19.7% in the prior year.

Construction efficiencies driven by our simplified product offerings and lower costs combined with higher revenue have expanded our leverage of overhead costs to improve gross margin.

The East Region experienced our most notable year-over-year gain in home closing margin, a 130 basis point improvement in 2019 of 17.9% versus 16.6% for 2018.

The margin improvement in the Region is a result of our strategic initiatives to improve profitability as communities with our new value-engineered product offerings began to contribute fully to the closing mix in the Region in 2019.

In 2018, we had larger volumes of legacy product and plan designs that were less efficient and more costly to build.

The higher volume of closings and associated revenue in the Region also helped leverage construction overhead costs which further improved margins.

Pricing power, particularly in Arizona, contributed significantly to the improved margins year over year, as demand has been very strong in our 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 produced the highest home closing gross margin in the Company and the most notable year-over-year increase for the year ended December 31, 2020 at 23.9%, up from 20.2% in the prior year.

Construction efficiencies driven by our simplified product offerings and national purchasing savings combined with higher revenue have expanded our leverage of overhead costs to improve gross margin.

The East Region experienced a 330 basis point improvement in 2020 of 21.2% versus 17.9% for 2019.

The margin improvement in the Region is the result of a change in our product line-up to 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.

Years Ended December 31,

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Meritage Insurance commenced operations in the fourth quarter of 2019 and provided only nominal results for the year ended December 31, 2019.

The $3.5 million lower financial services profit year-over-year is due to a change in the structure of customer incentives offered by our mortgage joint venture.

The main driver of the $4.2 million lower financial services profit year-over-year is due to a change in the structure of customer incentives offered by our mortgage joint venture.

In the fourth quarter of 2019, the profits associated with these incentives began to be captured as part of home closing revenue rather than through financial services earnings .

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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 increased by $4.8 million in 2019 over 2018 as a result of increased closing volume, but decreased as a percentage of home closing revenue to 6.8% in 2019 versus 7.0% in 2018, from more streamlined marketing efforts, primarily for our entry-level products.

These costs increased by $41.2 million in 2020 over 2019 as a result of higher closing volume, but decreased 40 basis points year over year.

The increase in commissions and other sales costs in dollars compared to prior year reflects higher home closing revenue, 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 efficiencies integrated into our sales and marketing structure.

General and Administrative Expenses.

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For the twelve months ended December 31, 2020, general and administrative expenses were $159.0 million or 3.6% of home closing revenue as compared to $146.1 million or 4.1% of home closing revenue for the 2019 period.

The dollar increase year over year is largely the result of higher expenses from accelerated equity compensation costs due to a change in the expense period of some of our equity awards, as well as from severance charges incurred in the first half 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 and our Credit Facility.

Our non-capitalizable interest expense increased to $8.4 million for the twelve months ended December 31, 2019 compared to $0.8 million for the 2018 period reflecting shortened construction cycle times and faster inventory turnover, resulting in lower interest capitalized to our inventory assets.

Our non-capitalizable interest expense decreased to $2.2 million for the twelve months ended December 31, 2020 compared to $8.4 million for the 2019 period reflecting the early redemption of $300.0 million of senior notes 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 several months during the first half of 2020.

Other Income, Net.

Other income, net primarily consists of (i) payments and awards related to legal settlements, (ii) sub lease income, and (iii) interest earned on our cash and cash equivalents.

Other income, net decreased by $1.6 million in 2019 compared to 2018 primarily due to a $4.8 million favorable legal settlement in 2018 from a previous joint venture.

Excluding this settlement, other income, net in 2019 was favorable as compared to the prior year due to higher interest earned on cash balances throughout the year.

Other income, net primarily consists of (i) sub lease 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.

Other income, net decreased by $2.9 million in 2020 compared to 2019, due to a decrease in interest earned on our cash and cash equivalents as a result of lower interest rates in 2020 as compared to 2019.

Loss on Early Extinguishment of Debt.

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The effective tax rate was 20.6% and 17.6% for 2020 and 2019, respectively.

The reduced rate in 2019 is due to the extension of the Internal Revenue Code §45L new energy efficient homes credit for homes closed in 2019 and 2018, and additional energy tax credits obtained by qualifying more homes in open prior tax years.

In 2018, there was also a revaluation adjustment to our deferred tax assets in accordance with the SEC Staff Accounting Bulletin No.

118 based on a completion of our 2017 tax returns in 2018.

The effective rate in both years reflects the availability of the Internal Revenue Code §45L energy efficient homes credits (the "energy tax credit") from the enactment of the Taxpayer Certainty and Disaster Tax Relief Act of 2019 (the "2019 Act") that was signed into law on December 20, 2019 and extended the energy credit tax benefit from 2017 to 2020.

The reduced rate in 2019 also reflects the benefit of energy tax credit for the 2018 tax year that was realized in the 2019 tax year due to the retroactive application of the 2019 Act.

In December of 2020, the energy tax credit was extended through the end of 2021 and we expect to recognize a benefit from this extension.

Liquidity and Capital Resources

Overview of Cash Management

Our principal uses of capital for 2019 were acquisition and development of new and previously controlled lot positions, home construction, operating expenses, the payment of routine liabilities and, repurchasing our common stock.

In addition, in 2019 we early redeemed our $300.0 million 7.15% senior notes due in 2020.

Our principal uses of capital for 2020 were acquisition and development of new and previously controlled land and lot positions, home construction, operating expenses, the payment of routine liabilities and repurchasing our common stock.

We remain focused 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.

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Generally, our operating cash flows fluctuate primarily based on changes in our net earnings, real estate inventory and from timing of payments of accounts payable and accrued liabilities.

Operating cash flow results in 2019 primarily reflect the $249.7 million in net earnings and a $42.7 million increase in accounts payable and accrued liabilities due to the timing of cash payments for real estate and construction spending.

Operating cash flow results in 2018 reflect the $227.3 million in net earnings, offset by an increases in real estate of $19.4 million.

Operating cash flow results in 2020 primarily reflect $423.5 million in net earnings and an $88.9 million increase in accounts payable and accrued liabilities due to the timing of cash payments and an increase in income taxes payable, partially offset by a $40.1 million increase in real estate due to increased spending on homes under construction as well as acquisition of new land positions.

Operating cash flow results in 2019 reflect the $249.7 million in net earnings and a $42.7 million increase in accounts payable and accrued liabilities due to the timing of cash payments for real estate and construction spending.

Investing Cash Flow Activities

During the year ended December 31, 2020, net cash used in investing activities totaled $18.2 million as compared to $13.5 million for the same period in 2019.

Cash used in investing activities in 2019 and 2018 is mainly attributable to the purchases of property, plant and equipment of $24.4 million and $33.4 million, respectively.

Cash used in investing activities in both 2020 and 2019 is mainly attributable to the purchases of property, plant and equipment of $19.9 million and $24.4 million, respectively.

Financing Cash Flow Activities

During the year ended December 31, 2020, net cash used in financing activities totaled $86.0 million as compared to $325.3 million for the same period in 2019.

The net cash used in financing activities in 2019 reflects the $305.6 million repayment of our 7.15% senior notes due in 2020.

The net cash used in financing activities in 2018 reflects the $175.0 million repayment of our 4.50% senior notes along with the repurchase of $100.0 million of our common stock partially offset by $202.8 million in net proceeds received from our 6.00% bond issuance.

The net cash used in financing activities in 2020 consists of $69.6 million in share repurchases and $16.4 million in repayments of loans payable and other borrowings.

The net cash used in financing activities in 2019 is primarily from the early redemption of $300.0 million of our 7.15% senior notes.

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 are not recognized in our income statement until a home closes, we incur significant cash outlays prior to recognition of earnings.

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From a liquidity standpoint, we are currently acquiring and developing lots in our markets to grow our lot supply and active community count.

We are also using our cash on hand and draws under our Credit Facility, as needed, to fund operations.

We intend to increase our land and development spending in order to build a pipeline of desirable land positions to position us for community count growth and to replenish our supply of lots, as we are seeing a significantly higher year over year orders pace which depletes our lot supply more rapidly than in recent years.

During 2019, we closed 9,267 homes, purchased approximately 12,600 lots for $429.4 million, spent $376.3 million on land development, and started 10,126 homes.

We currently primarily purchase undeveloped land or partially-developed requiring development dollars in order to bring them to a finished status ready for home construction.

We intend to increase our land and development spending in order to develop and prepare the land we currently control to achieve our community count targets and to replenish our land pipeline beyond 2022.

We are also using our cash on hand to fund operations.

During 2020, we closed 11,834 homes, purchased approximately 20,200 lots for $737.3 million, spent $527.2 million on land development, and started construction on 13,123 homes.

We currently primarily purchase undeveloped or partially-developed land requiring development dollars in order to bring them to a finished status ready for home construction.

We exercise strict controls and believe we have a prudent strategy for Company-wide cash management, including those related to cash outlays for land and inventory acquisition and development.

We ended 2019 with $319.5 million of cash and cash equivalents, an $8.0 million increase from December 31, 2018 with no outstanding borrowings on our Credit Facility.

We expect to generate cash

from the sale of our inventory, but we intend to redeploy that cash to acquire and develop strategic and well-positioned lots to grow our business.

On July 25, 2018, the Board of Directors approved a stock repurchase program, authorizing the expenditure of up to $100.0 million to repurchase shares of our common stock, subject to certain price parameters.

This program replaced the previously authorized program that was in place and there was no stated expiration for this program.

Prior to December 31, 2018, we repurchased the entire $100.0 million allowed under the program at an average price of $38.71 per share, retiring 2.6 million shares of our common stock.

We ended 2020 with $745.6 million of cash and cash equivalents, a $426.2 million increase from December 31, 2019 with no outstanding borrowings on our Credit Facility.

We expect to generate cash from the sale of our inventory, but we intend to redeploy that cash primarily to acquire and develop strategic and well-positioned lots to grow our business.

On February 13, 2019, the 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.

We acquired 308,840 shares of our common stock at an aggregate purchase price of $16.0 million for the year ended December 31, 2019.

On November 13, 2020, the Board of Directors authorized the expenditure of an additional $100.0 million to repurchase shares of our common stock under this program.

We acquired 1,100,000 and 308,840 shares of our common stock at an aggregate purchase price of $69.6 million and $16.0 million for the years ended December 31, 2020 and 2019, respectively.

As of December 31, 2020, there was approximately $114.4 million available under this program to repurchase shares.

The Company entered into an amended and restated unsecured revolving credit facility ("Credit Facility") in 2014 that has been amended from time to time.

In June 2019, the Credit Facility was amended, extending the maturity date to July 2023, along with minor administrative changes.

In December 2020, the Credit Facility was amended, extending the maturity date from July 2023 to December 2025 and providing for the replacement of LIBOR in the event such rate is no longer available.

The Credit Facility's aggregate commitment is $780.0 million with an accordion feature permitting the size of the facility to increase to a maximum of $880.0 million, subject to certain conditions, including the availability of additional bank commitments.

We believe that we currently have strong liquidity.

Between our available cash and liquidity in our Credit Facility, we believe that we currently have sufficient liquidity.

Nevertheless, we may seek additional capital to strengthen our liquidity position, enable us to opportunistically acquire additional land inventory in anticipation of improving market conditions, and/or strengthen our long-term capital structure.

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During the second quarter of 2010, we completed an offering of $200.0 million aggregate principal amount of 7.15% senior notes due 2020 ("2020 Notes").

The 2020 Notes were issued at 97.567% of par value to yield 7.50%.

In the fourth quarter of 2013, we completed a $100.0 million add-on offering to the 2020 Notes at 106.699% of par value to yield 5.875%.

In the fourth quarter of 2019, we redeemed all of the outstanding 2020 Notes, incurring a $5.6 million Loss on early extinguishment of debt charge included in our accompanying consolidated income statement.

During 2013, we completed a $100.0 million add-on offering to the 2020 Notes.

7.00% Senior Notes

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The 2027 notes were issued at par.

Using the proceeds from the 2027 Notes offering, we retired all $126.5 million of our convertible senior notes ("Convertible Notes") aggregate principal amount.

Using the proceeds from the 2027 Notes offering, we retired all $126.5 million of our convertible senior notes aggregate principal amount.

The indentures for all of our senior notes contain non-financial covenants including, among others, limitations on the amount of secured debt we may incur, and limitations on sale and leaseback transactions of non-model home assets and mergers.

We believe we are in compliance with all such covenants as of December 31, 2019.

We were in compliance with all such covenants as of December 31, 2020.

Loans Payable and Other Borrowings

The Company has a $780.0 million unsecured revolving credit facility ("Credit Facility") with an accordion feature that permits the size of the facility to increase to a maximum of $880.0 million, subject to certain conditions, including the availability of additional bank commitments.

In June 2019, the maturity date of the credit facility was extended to July 2023.

The Company has a $780.0 million unsecured revolving Credit Facility with an accordion feature that permits the size of the facility to increase to a maximum of $880.0 million, subject to certain conditions, including the availability of additional bank commitments.

In December 2020, the Credit Facility was amended to extend the maturity date to December 22, 2025 and provide for the replacement of LIBOR in the event such rate is no longer available.

We had no outstanding borrowings under the Credit Facility as of December 31, 2020 or December 31, 2019.

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During the twelve months ended December 31, 2019 we had $90.0 million of gross borrowings and repayments.

Borrowings and repayments during the twelve months ended December 31, 2017 totaled $415.0 million and $430.0 million, respectively.

During the twelve months ended December 31, 2018 we had $285.0 million of gross borrowings and repayments.

As of December 31, 2020 we had outstanding letters of credit issued under the Credit Facility totaling $97.4 million, leaving $682.6 million available under the Credit Facility to be drawn.

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We secured approximately 29,500 lots with an aggregate purchase price of $946.4 million in 2020 as compared to approximately 18,100 lots with an aggregate purchase price of $685.2 million in 2019.

At December 31, 2019, our total option and purchase contracts had aggregated purchase prices of approximately $1.0 billion, on which we had made deposits of approximately $50.9 million in cash, of which approximately 90.8% is non-refundable.

At December 31, 2020, our total option and purchase contracts had aggregated purchase prices of approximately $1.3 billion, on which we had made deposits of $59.5 million in cash, substantially all of which is non-refundable.

Off-Balance Sheet Arrangements

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Total (2) $ 1,296,186 $ 87,257 $ 411,112 $ 471,990 $ 325,827

(1) Represents other long-term obligations for items such as software and marketing licenses and equipment leases that do not meet the criteria for ASC 842.

(1) Includes operating lease obligations that meet the criteria of ASC 842, equipment leases that do not meet the criteria for ASC 842, and other long-term obligations for items such as software and marketing licenses.

(2) See Notes 6, 7 and 16 to our consolidated financial statements included in this report for additional information regarding our contractual obligations.

(3) Excludes operating lease obligations that meet the criteria of ASC 842, see Note 4 to our consolidated financial statements included in this report for additional information on operating lease obligations.

We do not engage in commodity trading or other similar activities.

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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-K

Item 7. Management’s Discussion and Analysis