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Item 7. Management’s Discussion and Analysis

2023-02-15 compared with 2022-02-16 · 131 added, 124 removed, 348 unchanged (42% of the section changed)

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Industry Conditions

The housing market was exceptionally strong in 2021 as the high demand that we experienced in 2020 continued, driven by favorable market factors including low mortgage interest rates, record low supply of existing homes and persistent demand, particularly from the millennial and baby boomer generations who are experiencing increased levels of household savings alongside life events that align with home ownership.

We believe that the elevated demand created by these underlying economic and demographic factors will continue in the near to mid-term but will taper to a normalized pace over time.

We believe our strategy for providing affordable new homes in desirable locations with inventory available for quick move-in is well positioned to address these buyer concerns.

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, balance sheet management and long-term community count growth.

As of December 31, 2021, 98% of our ending number of actively selling communities are targeted to first-time or first move-up buyers and those buyer segments represented approximately 98% of our orders in 2021.

In 2021, supply chain constraints and labor shortages caused by COVID-19 and other economic-related disruptions impacted our production and the homebuilding industry as a whole.

Through long cultivated relationships with our national and local partners, we were able to navigate the limitations and expect to continue to utilize our spec-heavy, limited SKU operating model to manage the supply chain concerns that are expected to continue for at least the next several quarters.

During the second half of 2020 and throughout all of 2021, the homebuilding industry experienced unprecedented growth.

The expansion continued in the first quarter of 2022, but the market steadily weakened throughout the rest of 2022, as interest rates began rapidly increasing in mid-2022 and significantly cooled demand in the second half of the year.

Affordability constraints combined with the uncertainty of future interest rates, inflation levels and deterioration in the general economy created homebuyer hesitancy, leading to reduced demand and a significant increase in cancellations in the back half of the year and reduced net orders year over year.

Although these economic conditions are applying current downward pressure on the housing market, we believe favorable homebuyer demographics support long-term demand, although at a more normalized pace than what was experienced in the past two years.

We believe our all-spec strategy targeting affordable homes offers our customers readily available inventory which is highly desired in today's market, and when combined with our financing and other incentives, still provides an attractive opportunity for homeownership.

At Meritage, we continue to focus on our entry-level and first move-up homes and streamlined processes and remain focused on our key financial measures of home closing volume, home closing gross margin, selling, general and administrative cost control, balance sheet management and long-term community count growth.

As of December 31, 2022, nearly all of our actively selling communities are targeted to first-time or first move-up buyers and those buyer segments together represented approximately 99% of our orders in 2022.

In both 2021 and 2022, disruptions in the supply chain impacted production costs and cycle times in the homebuilding industry as a whole.

We were successful through the middle of 2022 in offsetting the higher costs with sales price increases due to the elevated buyer demand, although we have experienced elongated cycle times and more recently, have not been able to offset these cost increases as we previously had.

We continue to carefully navigate this constrained operating environment by rebidding all costs with our vendors, expanding our vendor base and strengthening existing critical relationships.

We expect that over time, with lower, normalized volume in the homebuilding market, costs will begin to decline and cycle times will shorten.

Summary Company Results

Our results for 2022 reflect the mixed market, which started strong and weakened in the second half due to rapidly rising interest rates, uncertainty about current economic conditions and changes in personal finances.

We ended 2022 with 14,106 closings, our highest closing volume in Company history and a 10.2% increase over 12,801 closings in 2021.

Order volume declined 14.8% to 11,759 orders for the year compared to 13,808 in 2021 due to decreased overall demand and a higher cancellation rate of 21.0% in 2022 compared to 10.2% in 2021.

Higher home closing volumes and lower sales orders year-over-year resulted in 41.3% fewer homes in backlog at December 31, 2022, with 3,332 units valued at $1.5 billion compared to 5,679 units at $2.5 billion at December 31, 2021.

In order to ensure we are entering 2023 with only buyers who are committed to close and can re-deploy available homes back into the market, we proactively and aggressively validated every sale in our backlog during the fourth quarter.

Total home closing revenue increased 21.8% due to higher home closing volume and higher ASPs, growing to our highest annual home closing revenue in Company history of $6.2 billion for the year ended December 31, 2022 from $5.1 billion in 2021.

Home closing gross margin for the year ended December 31, 2021 improved by 580 basis points to 27.8% while gross margin for the year ended December 31, 2020 was 22.0%.

The higher margin in 2021 reflects increased pricing power, higher closings and effective cost controls, despite rising prices for lumber and other commodities.

We recorded impairment charges of approximately $2.1 million during the year ended December 31, 2021, primarily resulting from the decision to sell land assets that no longer fit our strategy, compared to $24.9 million of similar charges in 2020.

General and administrative expenses as a percentage of home closing revenue held steady at 3.6% in both 2021 and 2020, but did increase $22.4 million over the prior year to $181.4 million, primarily driven by higher performance related compensation expenses and a higher employee headcount.

Interest expense decreased to $0.3 million for the year ended December 31, 2021 from $2.2 million in 2020, as we benefited from lower interest rates as a result of our debt refinancing in April 2021 and more capitalization of interest on a higher balance of qualified assets.

In connection with the debt refinancing transaction, we recognized an $18.2 million loss on early extinguishment of debt (see Note 7 in the accompanying financial statements for additional information).

Pre-tax net earnings of $954.8 million in 2021 increased 79.0% from $533.6 million in 2020.

Our effective tax rate in 2021 was 22.8% as compared to a 20.6% effective tax rate in 2020.

Net income for the year ended December 31, 2021 was $737.4 million compared to $423.5 million in 2020.

Our results for 2021 reflect strong growth in both closings and orders as buyers took advantage of the persistent 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 2021 with 12,801 closings, our highest closing volume in Company history and represented an 8.2% increase over 11,834 closings in 2020.

Orders were relatively flat year-over-year, at 13,808 orders for the year compared to 13,724 in 2020 due to our metering of orders to align with production constraints.

At December 31, 2021, our backlog of $2.5 billion on 5,679 units increased by 38.8% in value, compared to $1.8 billion on 4,672 units at December 31, 2020.

Supported by strong market demand, our full year cancellation rate on sales orders as a percentage of gross sales units in 2021 decreased to 10.2% as compared to 13.6% for the year ended December 31, 2020.

Home closing gross margin for the year ended December 31, 2022 improved by 80 basis points to 28.6% compared to 27.8% in 2021.

The margin improvement in 2022 resulted from higher ASPs on closings and improved leverage of our land costs which held steady on increased home closing revenue, both of which more than offset rising material and labor costs and higher incentives.

We recognized land closing gross profit of $11.6 million for the year ended December 31, 2022, compared to a loss of $1.1 million for the year ended December 31, 2021.

Commissions and other sales costs of $323.3 million increased 13.3%, or $37.9 million from 2021, due to higher home closing revenues and associated commission expense, and increased advertising and selling costs due to the higher number of average active communities.

As a percentage of revenue, these expenses improved by 40 basis points due to greater leverage of fixed expenses on higher home closing revenue.

General and administrative expenses increased $11.5 million during the year ended December 31, 2022, primarily due to higher employee headcount, but as a percentage of home closing revenue decreased to 3.1% compared to 3.6% in 2021.

During the year ended December 31,2021, we recognized an $18.2 million loss on early extinguishment of debt in connection with the early redemption of our 2022 Senior Notes in April 2021.

There were no such transactions in 2022.

Earnings before income taxes of $1.3 billion in 2022 increased 35.0% from $954.8 million in 2021.

Our effective tax rate in 2022 was 23.0% as compared to 22.8% in 2021, leading to net income of $992.2 million and $737.4 million for the years ended December 31, 2022 and 2021, respectively.

Company Positioning

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Our focus includes the following strategic initiatives:

• Expanding our community count and market share;

• Growing our community count and market share;

• Delivering affordable homes on a shorter timeline through simplification of production processes and maintaining market-appropriate levels of spec inventory;

• Continuously improving the overall home buying experience through simplification and innovation;

• Maintaining our home closing gross profit by growing closing volume, allowing us to better leverage our overhead;

• Leveraging and expanding on technological solutions through digital offerings to our customers, such as our virtual home tours, interactive maps, digital financial services offerings and online warranty portal;

• Increasing homeowner satisfaction by setting industry standards for energy-efficiency and offering healthier, safer homes that come equipped with standard features such as multi-speed HVAC systems to save energy and improve air quality and enhanced security features;

• Simplifying our production process to allow us to more efficiently build our homes and reduce our construction costs, which in turn allows us to competitively price our homes and deliver them on a shorter timeline;

• Improving our home closing gross profit by growing closing volume, allowing us to better leverage our overhead;

• Increasing homeowner satisfaction by offering healthier, energy-efficient homes that come equipped with a suite of home automation standard features.

In order to maintain focus on growing our business, we also remain committed to the following:

• Maintaining a healthy orders 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;

• Continuing to innovate and promote our energy efficiency program and our M.Connected® Automation Suite to create differentiation for the Meritage brand;

• Managing construction efficiencies and costs through national and regional vendor relationships with a focus on quality construction and warranty management;

• Carefully managing our liquidity and a strong balance sheet;

we ended the year with a 27.6% debt-to-capital ratio and a 15.1% net debt-to-capital ratio;

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

we ended the year with a 22.6% debt-to-capital ratio and an 6.8% net debt-to-capital ratio;

• Maximizing returns to our shareholders, through both our improved financial performance and share repurchase program;

• Achieving or maintaining a position of at least 5% market share in all of our markets;

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

• Promoting a positive environment for our employees through our commitment to foster DE&I and providing market-competitive benefits in order to develop and motivate our employees and to minimize turnover and to maximize recruitment efforts;

• Maintaining a solid orders 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;

• Continuing to innovate and promote our energy efficiency program and our M.Connected ® Automation Suite to create differentiation for the Meritage brand.

Critical Accounting Estimates

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The judgments, assumptions and estimates we use and believe to be critical to our business are based on historical experience, knowledge of the accounts, industry practices, and other factors, which we believe to be reasonable under the circumstances.

Because of the nature of the judgments and assumptions we have made, actual results may differ from these judgments and estimates and could have a material impact on the carrying values of assets and liabilities and the results of our operations.

Because of the

nature of the judgments and assumptions we have made, actual results may differ from these judgments and estimates and could have a material impact on the carrying values of assets and liabilities and the results of our operations.

The critical accounting estimates that we deem to involve the most difficult, subjective or complex judgements are as follows:

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

We accrue a liability to capture such obligations in connection with the home closing which is charged directly to cost of sales.

We accrue a liability to capture such obligations in connection with the home closing which is charged directly to Cost of home closings.

We capitalize qualifying interest to inventory during the development and construction periods.

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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 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.

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

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

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

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

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

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

All of our land inventory and related real estate assets are periodically reviewed for recoverability when certain criteria are met, but at least annually, as our inventory is considered “long-lived” in accordance with GAAP.

If the undiscounted cash flows expected to be generated by an asset are lower than its carrying amount, impairment charges are recorded to write down the asset to its estimated fair value.

Community-level reviews are performed quarterly to determine if indicators of potential impairment exist.

If indicators of potential impairment exist and the undiscounted cash flows expected to be generated by an asset are lower than its carrying amount, impairment charges are recorded to write down the asset to its estimated fair value.

The impairment of a community is allocated to each remaining lot in the community on a straight-line basis and is recognized in Cost of home closings in the period in which the impairment is determined.

Our determination of fair value is based on projections and estimates.

Changes in these expectations may lead to a change in the outcome of our impairment analysis, and actual results may also differ from our assumptions.

We conduct an analysis if indicators of a decline in value of our land and real estate assets exists.

If an asset is deemed to be impaired, the impairment recognized is measured as the amount by which the assets’ carrying amount exceeds their fair value.

The impairment of a community is allocated to each lot on a straight-line basis and is recognized in Cost of closings in the period in which the impairment is determined.

We recorded $0.2 million and $2.1 million of impairment charges during the years ended December 31, 2022 and 2021, respectively, due to the disposition of certain assets that no longer align with our focus on entry-level and first move-up homes.

We have not made any material changes in our methodology or significant assumptions used to record and evaluate our Real estate and Cost of home closings during the past three years.

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Reserves are reviewed on a regular basis and, with the assistance of an actuary for the structural warranty, we determine their sufficiency based on our and industry-wide historical data and trends.

These reserves are subject to variability due to uncertainties regarding material or construction defect claims, the markets in which we build, claim settlement history, insurance, legal interpretations and expected recoveries, among other factors.

These reserves are subject to variability due to uncertainties regarding materials or construction defect claims, the markets in which we build, claim settlement history, insurance, legal interpretations and expected recoveries, among other factors.

At December 31, 2022, our warranty reserve was $35.6 million, reflecting an accrual of 0.1% to 0.5% of a home’s sale price depending on our loss history in the geographic area in which the home was built.

A 10% increase in our warranty reserve rate would have increased our accrual and corresponding cost of sales by approximately $3.3 million in 2022.

There were no adjustments to our reserve balance for the years ended December 31, 2021 and December 31, 2020.

As a result of the regular review described previously, we increased our reserve balance $10.9 million related to specific cases during the year ended December 31, 2022.

See Notes 1 and 16 in the accompanying consolidated financial statements for more information.

There were no adjustments to our reserve balance during the year ended December 31, 2021.

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.

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Home Closing Revenue, Home Orders and Order Backlog - Segment Analysis

The composition of our closings, home orders and backlog is constantly changing and is based on a dissimilar mix of communities between periods as new projects and product lines open and existing projects wind down.

The composition of our closings, home orders and backlog is constantly changing and is based on a dissimilar mix of communities between periods as new projects open and existing projects wind down.

Further, individual homes within a community can range significantly in price due to differing square footage, option selections, lot sizes and quality and location of lots (e.g.

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East Region Totals 14.1 % 8.5 %

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

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

At December 31, Year Over Year

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Average sales price $ 427.2 $ 402.8 $ 24.4 6.1 %

(1) Our backlog represents net sales that have not closed.

(1) Our backlog represents net home orders that have not closed.

Fiscal 2022 Compared to Fiscal 2021

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In 2022, home closing revenue grew by 21.8% to $6.2 billion on 14,106 units compared to $5.1 billion on 12,801 units in 2021.

The improved revenue reflects an 8.2% increase in volume and a 5.5% increase in ASP on closings resulting from pricing power on continued elevated demand in the homebuilding market due to the macroeconomic events discussed in "Industry Conditions." Order value increased 12.0% to $5.8 billion from $5.2 billion, due almost entirely to pricing power, as ASP on orders increased 11.3% year-over-year, while both order volume and orders pace were comparable with prior year as we metered orders in 2021 to align with our current production capacity.

Order volume was 13,808 and 13,724 for the years ended December 31, 2021 and 2020, respectively, as a 1.9% higher number of average active communities was offset by a 1.3% decline in orders pace of 5.1 per month in 2021 compared to 5.2 in 2020.

We ended the year with 5,679 homes in backlog valued at $2.5 billion, 21.6% and 38.8% higher backlog units and value, respectively, compared to 2020.

ASP on homes in backlog grew by 14.2% to $443,100 at December 31 2021, compared to $388,000 in 2020, reflective of the persistent pricing power experienced throughout the year.

The West Region generated $1.9 billion in home closing revenue for the year ended December 31, 2021, a 6.6% increase over the $1.8 billion in the prior year, closing 4,055 homes in 2021, up 1.7% from the 3,988 homes closed in 2020.

Order value for the West Region held steady at $2.2 billion in 2021 as compared to $2.1 billion in 2020, as a 12.5% increase in ASP on orders offset the 10.6% decrease in order volume of 4,276 homes during the year ended December 31, 2021 from 4,781 home orders in 2020.

The decrease in order volume is primarily the result of a 10.1% decline in year-over-year orders pace per community to 5.1 per month in 2021 compared to 5.7 in 2020, due to the metering of orders as previously discussed, and a relatively consistent average active community count year-over-year.

In the West Region, approximately 80% of our communities target first-time buyers at December 31, 2021.

The West Region ended 2021 with backlog of 1,866 homes valued at $963.8 million versus 1,645 homes at $723.3 million in 2020, 13.4% and 33.2% increases over the prior year, respectively.

The improved revenue reflects a 10.2% increase in volume and a 10.6% increase in ASP on closings resulting from pricing power on continued elevated demand in the homebuilding market due to the macroeconomic environment during the first half of the year, as discussed in "Industry Conditions." Order value decreased 9.3% to $5.3 billion from $5.8 billion, as a 14.8% decrease in volume was partially offset by a 6.5% increase in ASP on orders.

Despite a 23.0% increase in average active communities, order volume of 11,759 for the year ended December 31, 2022 was down from 13,808 in 2021 due to the decreased demand and increase in cancellations caused by rising interest rates and inflationary concerns.

The slower demand and higher cancellation rate of 21.0% in 2022 compared to 10.2% in 2021 led to a corresponding decline in orders pace of 3.6 homes per community per month in 2022 compared to 5.1 in 2021.

We ended the year with 3,332 homes in backlog valued at $1.5 billion, down 41.3% and 39.4%, respectively, compared to 2021, as the lower number of homes was partially offset by a 3.3% increase in ASP on homes in backlog.

The West Region generated $2.2 billion in home closing revenue for the year ended December 31, 2022, a 15.0% increase over the $1.9 billion in the prior year, with pricing power contributing almost entirely to the increase as closings were relatively flat at 4,092 homes in 2022 compared to 4,055 homes in 2021.

Order value of $1.7 billion in 2022 decreased 20.6% compared to $2.2 billion in 2021, as a 27.5% decrease in order volume during the year ended December 31, 2022 to 3,098 homes from 4,276 home orders in 2021 was offset by a 9.6% increase in ASP on orders.

The West Region has been the most impacted by the recent macroeconomic decline as this region experienced some of the most significant price increases over the past few years and accordingly have required the steepest sales price adjustments to combat buyer hesitancy.

The decline in order volume was caused by the decreased demand, particularly in the second half of the year as previously discussed.

The West had the highest cancellation rate in the Company at 25.7% in 2022 versus 10.5% in 2021, contributing to a 45.1% decline in year-over-year orders pace per community to 2.8 per month in 2022 compared to 5.1 in 2021.

The West Region also had the largest increase in average actively selling communities of 32.4%, and ended 2022 with 94 actively selling communities as compared to 78 for the prior year.

Backlog of 872 homes valued at $459.9 million at December 31, 2022, versus 1,866 homes at $963.8 million in 2022, decreased 53.3% and 52.3% over the prior year, respectively.

The Central Region, made up of our Texas markets, closed 4,556 homes for the year ended December 31, 2022 compared to 4,165 in 2021.

The 7.0% improvement in closing units combined with 10.1% higher ASP generated a 17.8% increase in home closing revenue to $1.5 billion, up from $1.3 billion in 2020.

The Central Region also reported a 15.5% improvement in order value year-over-year due to a 17.2% increase in ASP on orders that was partially offset by 1.4% lower order volume.

The decline in order volume was driven entirely by a 2.2% decline in average active communities.

The Central Region ended 2021 with 4,413 orders valued at $1.7 billion compared to 4,476 orders at $1.5 billion in the prior year.

The Region ended 2021 with backlog of 1,878 units valued at $772.9 million compared to 1,630 units valued at $572.2 million at December 31, 2020, reflecting a 17.2% improvement in ASP.

The East Region generated the strongest year-over-year improvements in both volume and value of closings and orders.

The East Region posted increases of 20.4% and 15.9% in home closing revenue and volume, respectively, to $1.7 billion on 4,581 homes in 2021 from $1.4 billion on 3,952 homes in 2021.

Home closing revenue benefited from the increase in volume and a 3.9% higher ASP on closings.

The East Region was the only region to see improvement in order volume, with order volume and value improving by 14.6% and 24.4%, respectively, in 2021 to 5,119 units valued at $1.9 billion compared to 4,467 units valued at $1.6 billion in the prior year.

The year-over-year improvement in orders is due to both a 7.0% higher orders pace and a 7.1% increase in average active communities, with the East as our only region to have an increase in average active communities.

The East Region also delivered the greatest improvement in backlog units and value, ending 2021 with 1,935 units in backlog valued at $779.5 million, 38.5% and 50.8% increases, respectively, compared to the prior year.

Land Closing Revenue and Gross Profit

From time to time, we may sell certain 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.

The 9.4% improvement in closing units and 11.8% higher ASP generated a 22.3% increase in home closing revenue to $1.8 billion, up from $1.5 billion in 2021.

Similar to the West Region, the Central Region had year-over-year declines in both order volume and value of 17.5% and 11.7%, respectively, with a 7.0% increase in ASP on orders partially offsetting the lower order volume.

Orders during the year ended December 31, 2022 were 3,641 valued at $1.5 billion, compared to 4,413 valued at $1.7 billion in 2021.

The decline in order volume was driven entirely by the softening demand and elevated cancellation rate of 25.1%, offset by a 17.1% increase in average active communities, While orders pace decreased 28.6% year over year, the Central Region had the Company's highest orders pace in 2022 of 4.0 homes per month.

The Central Region ended 2022 with backlog of 963 homes valued at $425.4 million compared to 1,878 units valued at $772.9 million at December 31, 2021, reflecting a 7.3% improvement in ASP.

The East Region generated the strongest year-over-year improvements in both volume and value of closings.

Home closing volume and revenue increased 19.1% and 29.2%, respectively, to $2.2 billion on 5,458 homes in 2022 from $1.7 billion on 4,581 homes in 2021.

Home closing revenue benefited from the increase in volume and an 8.4% higher ASP on closings.

Despite a slight decline in orders volume, the East Region was the only region to see improvement in order value, as slower price appreciation over the past two years have protected the East Region from the same level of declines in demand and affordability concerns that were experienced by the Central and West regions.

Order value improved 5.3% to $2.0 billion on 5,020 homes compared to $1.9 billion on 5,119 homes, with a 7.3% increase in ASP on orders offsetting the 1.9% decline in order volume.

The year-over-year decline in order volume was caused by a lower orders pace of 3.9 homes per month in 2022, down 18.8% from 4.8 in 2021, offsetting the 19.9% increase in average active communities.

The East Region ended 2022 with 1,497 units in backlog valued at $639.5 million, decreases of 22.6% and 18.0%, respectively, compared to the prior year.

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 buy larger parcels of land or land with commercial tracks that provide better all-in pricing.

As a result of such sales, we recognized land closing revenue of $61.2 million and $25.2 million for the years ending December 31, 2022 and 2021, respectively.

We recognized losses of $1.1 million and $20.8 million in 2021 and 2020, respectively.

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 $2.0 million and $21.8 million, in 2021 and 2020, respectively.

We recognized land closing profit of $11.6 million in 2022, compared to a loss of $1.1 million in 2021.

The loss recognized in 2021 includes impairment charges of $2.0 million.

Other Operating Information (dollars in thousands)

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(1) Home closing gross profit represents home closing revenue less cost of home closings, including impairments, if any.

Cost of home closings includes land and lot development costs, direct home construction costs, an allocation of common community costs (such as architectural, legal and zoning costs), interest, sales tax, impact fees, warranty, construction overhead and closing costs.

Cost of home closings includes land and associated development costs, direct home construction costs, an allocation of common community costs (such as architectural, legal and zoning costs), interest, sales tax, impact fees, warranty, construction overhead and closing costs.

Fiscal 2022 Compared to Fiscal 2021

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Home closing gross margin improved to 28.6% for the year ended December 31, 2022 compared to 27.8% in the prior year.

Home closing gross profit increased by $438.0 million to $1.4 billion in 2021 versus $980.4 million in 2020, driven by the higher home closing revenue and 580 basis point increase in home closing gross margin.

The improvement in home closing gross margin is primarily due to pricing power from robust buyer demand combined with leverage of fixed costs on greater home closing revenue, which have more than offset the rising lumber prices and increases in other commodity costs.

Our West Region home closing gross margin improved 590 basis points to 27.1% in 2021 versus 21.2% in 2020.

Pricing power and leverage of fixed costs on greater revenues led to improved margins year-over-year.

The Central Region produced the highest home closing gross margin and the greatest improvement of 600 basis points for the year ended December 31, 2021 at 29.9%, up from 23.9% in the prior year.

The improvement in gross margin was due to pricing power resulting in the highest ASP increase in the Company of 10.1% combined with leverage of fixed costs.

The East Region experienced a 560 basis point improvement in 2021 of 26.8% versus 21.2% for 2020.

The margin improvement in the Region is the result of greater leverage of fixed costs on 20.4% higher closing revenue year-over-year as well as a 3.9% increase in ASP.

Home closing gross profit increased by $354.6 million to $1.8 billion in 2022 versus $1.4 billion in 2021, driven by higher home closing revenue and an 80 basis point increase in home closing gross margin.

The improvement in home closing gross margin is primarily due to pricing power from the strong buyer demand that existed in 2021 and continued into the first half of 2022, combined with the benefit of land costs holding steady year-over-year on higher home closing revenue, which more than offset the rising commodity costs and increased incentives in the second half of the year.

Our West Region home closing gross margin was relatively flat year over year, at 27.4% in 2022 versus 27.1% in 2021.

The 30 basis point improvement was achieved despite the heavy economic impact experienced in this Region in the latter half of the year, as pricing power provided leverage on consistent land costs year-over-year, offset increases in material and labor costs and higher incentives in the latter half of the year.

The Central Region home closing gross margin of 29.0% declined 90 basis points year-over-year from 29.9% in the prior year.

The decline in gross margin was primarily due to increased incentives and material and labor costs, which were offset by leverage of stable land costs on higher home closing revenue year-over-year.

The East Region reported the highest home closing gross margin and the greatest margin improvement in the Company in 2022.

Home closing gross margin of 29.4% was a 260 basis point improvement over 26.8% in 2021.

The margin improvement in the Region is due to pricing power, leverage of higher home closing revenue on land costs that remained steady year-over-year, and ramped up operations in some of our newer divisions.

Years Ended December 31,

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Financial services profit represents the net profit of our financial services operations, including the operating profit generated by our wholly-owned title and insurance companies, Carefree Title and Meritage Insurance, as well as our portion of earnings from a mortgage joint venture.

The increase of $1.6 million, or 10.0%, is in line with the increase in home closing volume year-over-year .

Year-over-over results were relatively flat with an increase of $0.3 million, despite the higher home closing volume in our homebuilding operations.

This is due largely to a change in the geography of closing volume in markets where we provide financial services, as well as increased overhead expenses due to a higher employee headcount.

Years Ended December 31,

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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 decreased $2.5 million and decreased as a percentage of home closing revenue by 80 basis points in 2021 over 2020.

The decrease as a percentage of home closing revenue is due to lower broker commissions in 2021 and our utilization of digital sales solutions.

Additionally, the latter half of 2020 was negatively impacted by increased commission incentives that were temporarily offered during the early stages of the pandemic.

The decrease in commissions and other sales costs in dollars was primarily the result of savings in marketing and advertising spend as we leveraged more digital platforms and efficiencies integrated into our sales and marketing structure.

These costs increased $37.9 million, or 13.3%.

The higher spend year-over-year is primarily attributable to commissions paid on higher home closing revenue and increased advertising and selling costs associated with a higher community count.

As a percentage of home closing revenue, commissions and other sales costs improved 40 basis points to 5.2% in 2022 compared to 5.6% in 2021, primarily due to leverage of higher home closing revenue on fixed overhead expenses and lower commissions and advertising costs in the first half of the year.

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 year ended December 31, 2021, general and administrative expenses were $181.4 million or 3.6% of home closing revenue as compared to $159.0 million or 3.6% of home closing revenue for the 2020 period.

The $22.4 million increase is due primarily to increased payroll and performance based bonus compensation expenses on higher employee headcount and one-time items totaling approximately $5.0 million included retirement payments to our former General Counsel who retired in December 2021 and a change in the Company's retirement vesting eligibility for equity awards.

As a percentage of home closing revenue, general and administrative expenses were consistent at 3.6% for both periods, as we realized the efforts of our cost control objectives.

We have also continued our restrictions on certain corporate expenditures, particularly as they relate to precautions taken to address ongoing COVID-19 concerns.

As COVID-19 restrictions ease, we expect these costs to gradually return as more employees return to the office and resume travel.

For the year ended December 31, 2022, general and administrative expenses were $193.0 million or 3.1% of home closing revenue as compared to $181.4 million or 3.6% of home closing revenue in 2021.

The $11.5 million increase is due primarily to increased payroll and performance-based bonus compensation expenses on higher employee headcount.

As a percentage of revenue, general and administrative expenses improved 50 basis points due to leverage of fixed costs on higher home closing revenue.

We continually strive to optimize overhead leverage through cost control efforts at both corporate and divisional levels.

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 decreased to $0.3 million in 2021 compared to $2.2 million for the 2020 period due to lower interest incurred in 2021 resulting from the early redemption of the $300.0 million 7.00% Senior Notes due 2022 ("2022 Notes") during the second quarter of 2021 and no outstanding borrowings on our Credit Facility during 2021.

In 2020 we incurred interest charges from our Credit Facility which had $500.0 million outstanding for several months during the first half of 2020.

Interest expense is comprised of interest incurred, but not capitalized, on our senior notes, other borrowings and our Credit Facility.

For the years ended December 31, 2022 and 2021 interest expense totaled $41,000 and $318,000, respectively.

Other Income, Net.

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 $1.8 million in 2021 compared to 2020 due to a one-time benefit payment in 2020 of approximately $1.5 million for company-owned life insurance proceeds.

Other income, net decreased to $2.7 million in 2022 compared to $4.9 million in 2021.

Loss on Early Extinguishment of Debt.

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The effective tax rate was 23.0% and 22.8% for 2022 and 2021, respectively.

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 has been extended through 2021.

The higher rate in 2021 reflects increased profit in states with higher tax rates and a reduced benefit of the energy tax credit applied to greater earnings before income taxes.

The effective rate in both years reflects the availability of the Internal Revenue Code 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") for 2021 and by the Inflation Reduction Act of 2022 (the "IRA") for 2022.

Liquidity and Capital Resources

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Additional sources of funds may include additional debt or equity financing and borrowing capacity under our unsecured revolving credit facility ("Credit Facility").

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.

Our principal uses of cash include acquisition and development of new and previously controlled land and lot positions, home construction, operating expenses, and the payment of interest and routine liabilities.

From time to time, we opportunistically repurchase our senior notes and common stock.

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

Our principal uses of cash include acquisition and development of land and lots, home construction, operating expenses, and the payment of interest and routine liabilities.

We also opportunistically repurchase our common stock and, from time to time, our senior notes.

Cash flows for each of our communities depend on their stage of the development cycle, and can differ substantially from reported earnings.

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In the later stages of a community, cash inflows may significantly exceed earnings reported for financial statement purposes, as the cash outflow associated with home and land construction was previously incurred.

Similarly, in times of community count growth, we incur significant outlays of cash through the land purchase, development and community opening stages whereas in in times of community count stability, these cash outlays are incurred in a more even-flow cadence with cash inflows from actively selling communities that are contributing closing volume and home closing revenue.

Conversely, in a down turn environment, cash outlays for land and community count growth may be scaled back.

Short-term Liquidity and Capital Resources

Over the course of the next twelve months, we expect that our primary demand for funds will be for the construction of homes, as well as acquisition and development of both new and existing lots, operating expenses, including general and administrative expenses, interest payments on current and future debt financings and opportunistic common stock repurchases.

We expect to meet these short-term liquidity requirements primarily through our cash and cash equivalents on hand and our net cash flows provided by operations.

Between our cash and cash equivalents on hand combined with the availability of funds in our Credit Facility, we believe that we currently have sufficient liquidity.

We expect to meet these short-term liquidity requirements primarily through our cash and cash equivalents on hand and the net cash flows provided by our operations.

Between our cash and cash equivalents on hand combined with the availability of liquidity from 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 acquire additional land inventory in anticipation of improving market conditions, and/or strengthen our long-term capital structure.

Long-term Liquidity and Capital Resources

Beyond the next twelve months, our principal demands for funds will be for the construction of homes, land acquisition and development activities needed to grow our lot supply and active community count, payments of the principal amounts and interest on our senior notes as they become due or mature and common stock repurchases.

Beyond the next twelve months, our principal demands for funds will be for the construction of homes, land acquisition and development activities needed to maintain our lot supply and active community count, payments of principal and interest on our senior notes as they become due or mature and common stock repurchases.

We expect our existing and generated cash will be adequate to fund our ongoing operating activities as well as providing capital for investment in future land purchases and related development activities.

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These obligations impact both short-term and long-term liquidity and capital resource needs.

Certain contractual obligations are reflected on our consolidated balance sheets as of December 31, 2021, while others are considered future commitments.

Our contractual obligations primarily consist of principal and interest payments on our senior notes, loans payable and other borrowings, including our Credit Agreement, letters of credit and surety bonds and operating leases.

Certain contractual obligations are reflected on our consolidated balance sheets as of December 31, 2022, while others are considered future commitments for materials or services not yet provided.

Our contractual obligations primarily consist of principal and interest payments on our senior notes, loans payable and other borrowings, including our Credit Facility, letters of credit and surety bonds and operating leases.

We have no debt maturities until 2025.

We also have certain short-term lease commitments, commitments to fund our existing unconsolidated joint

ventures and other purchase obligations in the normal course of business.

Future commitments include land acquisition spend under purchase and option agreements.

We also have requirements for certain short-term lease commitments, funding working capital needs of our existing unconsolidated joint ventures, and other purchase obligations in the normal course of business.

Other material cash requirements include land acquisition and development costs, home construction costs and operating expenses, including our selling, general and administrative expenses, as previously discussed.

We plan to fund these commitments primarily with cash flows generated by operations, but may also utilize additional debt or equity financing and borrowing capacity under our Credit Facility.

Our maximum exposure to loss on our purchase and option agreements is generally limited to non-refundable deposits and capitalized pre-acquisition costs.

For information about our lease obligations, loans payable and other borrowings and senior notes, reference is made to Notes 4, 6, and 7 in the accompanying Notes to the consolidated financial statements included in this Annual Report on Form 10-K and are incorporated by reference herein.

For information about our lease obligations, loans payable and other borrowings, including our Credit Facility, and senior notes, reference is made to Notes 4, 6, and 7 in the accompanying Notes to the consolidated financial statements included in this Annual Report on Form 10-K and are incorporated by reference herein.

Reference is made to Notes 1, 3, 5, and 16 in the accompanying Notes to the consolidated financial statements included in this Annual Report on Form 10-K and are incorporated by reference herein.

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Operating Cash Flow Activities

During the year ended December 31, 2021, net cash used in operations totaled $152.1 million versus net cash provided by operations of $530.4 million during the year ended December 31, 2020.

During the years ended December 31, 2022 and 2021, net cash provided by operations totaled $405.3 million versus net cash used in operations of $152.1 million during the year ended December 31, 2021.

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

Operating cash flow results in 2021 primarily reflect $737.4 million in net earnings, which were offset by a $948.1 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 2020 reflect the $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 2022 primarily reflect $992.2 million in net earnings, which were offset by a $624.5 million increase in real estate and a $103.0 million increase in receivables, prepaids and other assets.

The increase in real estate was due to construction activities on a greater number of homes under construction, as well as land acquisition and development activities.

The increase in other receivables, prepaids and other assets was largely due to receivables from municipalities for land development reimbursements and the purchase of fixed rate interest locks for eligible buyers in our backlog.

Operating cash flow results in 2021 reflect the $737.4 million in net earnings which were offset by a $948.1 million increase in real estate due to construction of homes and land acquisitions.

Investing Cash Flow Activities

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Financing Cash Flow Activities

During the year ended December 31, 2021, net cash provided by financing activities totaled $51.6 million as compared to net cash used in financing activities of $86.0 million for the same period in 2020.

During the year ended December 31, 2022, net cash used in financing activities totaled $129.8 million, versus net cash provided by financing activities of $51.6 million for the same period in 2021.

The net cash used in financing activities in 2022 primarily reflects $109.3 million in share repurchases.

See 'Part II, Item 5 - Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities' for more information about our authorized share repurchase program.

The net cash provided by financing activities in 2021 primarily reflects the net proceeds of $450.0 million from the issuance of our 3.875% Senior Notes due 2029, offset by the early redemption of our 7.00% Senior Notes due 2022 of $300.0 million principal and associated early tender fees of $17.7 million, along with share repurchases of $61.0 million.

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.

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.

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.

On August 12, 2021, 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 639,346 and 1,100,000 shares of our common stock at an aggregate purchase price of $61.0 million and $69.6 million for the years ended December 31, 2021 and 2020, respectively.

As of December 31, 2021, there was approximately $153.4 million available under this program to repurchase shares.

The Company entered into the unsecured revolving Credit Facility in 2014 that has been amended from time to time.

In December 2021, the Credit Facility was amended, extending the maturity date from December 2025 to December 2026 and replacing LIBOR as the benchmark interest rate with the Secured Overnight Financing Rate ("SOFR").

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 our leverage ratios provide useful information to the users of our financial statements regarding our financial position and cash and debt management.

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Net debt-to-capital (2) 6.8 % 15.1 %

(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.

(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, 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 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 total capital.

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, although we may do so in the future.

Currently, we plan to utilize our cash to manage our liquidity and fund operations, while also considering opportunities to increase our shareholder returns.

Future cash dividends, if any, will depend upon economic and financial conditions, results of operations, capital requirements, statutory requirements, restrictions imposed by our Credit Facility, as well as other factors considered relevant by our Board of Directors.

Credit Facility Covenants

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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