Meritage Homes CORP 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Overview and Outlook In the first quarter of 2023, housing demand was stronger than anticipated despite ongoing economic uncertainty, the regional banking turmoil and continuing volatility in interest rates. We saw demand stabilize as we entered the spring selling season as buyers acclimated to the current interest rate environment. Homebuyers are looking for quick move-in homes, which are increasingly difficult to find as the shortage of readily-available new inventory coupled with extremely limited resale inventory persists, especially in the markets where we operate. We expect the housing undersupply and favorable demographics to provide a strong long-term runway for future homebuying demand, and believe that our affordable, all-spec strategy with a focus on the largest buying segments of millennials and move-down buyers, provides us the opportunity to capitalize on that demand and continue to grow our market share. Production costs and cycle times continue to be elevated due to the continuing labor and supply chain issues that first presented themselves in 2020; however, in the first quarter of 2023 our construction cycle was approximately a week shorter than the same period last year. We continue to carefully navigate this volatile and 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 continue to shorten. Summary Company Results We achieved our highest first quarter home closing revenue and volume of $1.3 billion on 2,897 homes in the first quarter of 2023, compared to $1.2 billion on 2,858 homes closed for the first quarter of 2022. The 1.3% increase in home closing revenue year-over-year was driven entirely by the 1.4% higher volume, as average sales price ("ASP") on closings was flat. First quarter home closing gross margin declined 790 basis points to 22.4%, for home closing gross profit of $282.5 million compared to $377.6 million in the first quarter of 2022. The margin deterioration is the combined effect of higher direct costs and increased incentives offered in response to the market slowdown that begin in the latter months of 2022. Commissions and other sales costs of $82.8 million increased $17.3 million due to higher spend on commissions and advertising costs. General and administrative expenses of $47.5 million in the three months ended March 31, 2023 increased due to severance-related costs and higher spend on technology and insurance, compared to $40.0 million in the prior year quarter. Earnings before income taxes for the first quarter of 2023 of $165.3 million decreased $120.6 million year over year from $285.9 million in 2022. The lower effective income tax rate of 20.6% compared to 24.0% in 2022 reflects the benefit from earned eligible energy tax credits on qualifying homes under the Inflation Reduction Act ("IRA") enacted in August 2022. The decrease in year-over-year profitability partially offset by a lower tax rate, resulted in net earnings of $131.3 million in the first quarter of 2023 versus $217.3 million in the first quarter of 2022. Home orders of 3,487 for the quarter ended March 31, 2023 were 10.0% lower than the first quarter of 2022, which was our highest quarterly orders volume in Company history. Order volume declined despite a 4.2% increase in average active communities due to relatively softer demand, resulting in a 14.3% decline in orders pace to 4.2 per month compared to 4.9 per month in 2022. We exceeded our orders pace target of 3 - 4 homes per month in the first quarter of 2023 due to the availability of move-in ready homes and a combination of price cuts, mortgage interest rate locks and buy downs, and other incentives tailored to the customer expectations in each of our markets. Our cancellation rate declined to 15% sequentially in the first quarter of 2023 from 39% in the fourth quarter of 2022, returning to a normalized rate. Home order value decreased 14.8% year-over-year, to $1.5 billion during the three months ended March 31, 2023, versus $1.8 billion in the same period of 2022, due to the lower volume as well as a 5.3% decrease in ASP on orders. The lower ASP on orders was due to offering increased incentives to alleviate homebuyer concerns of affordability. We ended the first quarter of 2023 with 3,922 homes in backlog valued at $1.8 billion, a decrease in units and value of 41.4% and 42.0%, respectively, from March 31, 2022. The decrease in backlog units is due to an 86.9% backlog conversion rate combined with lower order volume in the first quarter of 2023. 22 We ended the first quarter of 2023 with 278 active communities, up from 268 at March 31, 2022 and up sequentially from 271 at December 31, 2022. We purchased approximately 2,100 lots for $89.1 million, spent $221.0 million on land development and started construction on 2,462 homes during the three months ended March 31, 2023. In recognition of our ongoing efforts to improve the energy efficiency of our homes, we were awarded the 2023 ENERGY STAR® Partner of the Year for Sustained Excellence by the Environmental Protection Agency during the first quarter of 2023, making us a ten-time recipient of this award since 2013. Company Positioning 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 on growing our community count and market share includes the following strategic initiatives: • Achieving or maintaining a position of at least 5% market share in all of our markets; • 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; and • Increasing homeowner satisfaction by offering healthier, energy-efficient homes that come equipped with a suite of home automation standard features. In addition to these strategic initiatives, we also remain committed to the following: • Carefully managing our liquidity and a strong balance sheet; we ended the first quarter with a 22.1% debt-to-capital ratio and a 4.5% net debt-to-capital ratio; • Maximizing returns to our shareholders through improved financial performance, dividend payments and share repurchases; • 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 diversity, equity, and inclusion ("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; and • 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 The critical accounting estimates that we deem to involve the most difficult, subjective or complex judgments include valuation of real estate and cost of home closings, warranty reserves and valuation of deferred tax assets. There have been no significant changes to our critical accounting estimates during the three months ended March 31, 2023 compared to those disclosed in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in our 2022 Annual Report on Form 10-K. 23 Home Closing Revenue, Home Orders and Order Backlog The composition of our closings, home orders and backlog is constantly changing and is based on a changing mix of communities with various price points between periods as new projects open and existing projects wind down and close-out. Further, individual homes within a community can range significantly in price due to differing square footage, option selections, lot sizes and quality and location of lots (e.g. cul-de-sac, view lots, greenbelt lots). These variations result in a lack of meaningful comparability between our home orders, closings and backlog due to the changing mix between periods. The tables on the following pages present operating and financial data that we consider most critical to managing our operations (dollars in thousands): Three Months Ended March 31, Quarter over Quarter 2023 2022 Change $ Change % Home Closing Revenue Total Dollars $ 1,261,923 $ 1,245,456 $ 16,467 1.3 % Homes closed 2,897 2,858 39 1.4 % Average sales price $ 435.6 $ 435.8 $ (0.2) — % West Region Arizona Dollars $ 143,585 $ 198,095 $ (54,510) (27.5) % Homes closed 355 458 (103) (22.5) % Average sales price $ 404.5 $ 432.5 $ (28.0) (6.5) % California Dollars $ 178,035 $ 187,410 $ (9,375) (5.0) % Homes closed 270 275 (5) (1.8) % Average sales price $ 659.4 $ 681.5 $ (22.1) (3.2) % Colorado Dollars $ 95,702 $ 77,919 $ 17,783 22.8 % Homes closed 160 131 29 22.1 % Average sales price $ 598.1 $ 594.8 $ 3.3 0.6 % West Region Totals Dollars $ 417,322 $ 463,424 $ (46,102) (9.9) % Homes closed 785 864 (79) (9.1) % Average sales price $ 531.6 $ 536.4 $ (4.8) (0.9) % Central Region - Texas Central Region Totals Dollars $ 424,880 $ 347,828 $ 77,052 22.2 % Homes closed 1,048 873 175 20.0 % Average sales price $ 405.4 $ 398.4 $ 7.0 1.8 % East Region Florida Dollars $ 170,856 $ 168,075 $ 2,781 1.7 % Homes closed 427 438 (11) (2.5) % Average sales price $ 400.1 $ 383.7 $ 16.4 4.3 % Georgia Dollars $ 59,541 $ 56,434 $ 3,107 5.5 % Homes closed 142 127 15 11.8 % Average sales price $ 419.3 $ 444.4 $ (25.1) (5.6) % North Carolina Dollars $ 120,065 $ 119,004 $ 1,061 0.9 % Homes closed 309 297 12 4.0 % Average sales price $ 388.6 $ 400.7 $ (12.1) (3.0) % South Carolina Dollars $ 27,628 $ 39,713 $ (12,085) (30.4) % Homes closed 87 121 (34) (28.1) % Average sales price $ 317.6 $ 328.2 $ (10.6) (3.2) % Tennessee Dollars $ 41,631 $ 50,978 $ (9,347) (18.3) % Homes closed 99 138 (39) (28.3) % Average sales price $ 420.5 $ 369.4 $ 51.1 13.8 % East Region Totals Dollars $ 419,721 $ 434,204 $ (14,483) (3.3) % Homes closed 1,064 1,121 (57) (5.1) % Average sales price $ 394.5 $ 387.3 $ 7.2 1.9 % 24 Three Months Ended March 31, Quarter over Quarter 2023 2022 Change $ Change % Home Orders (1) Total Dollars $ 1,506,893 $ 1,767,710 $ (260,817) (14.8) % Homes ordered 3,487 3,874 (387) (10.0) % Average sales price $ 432.1 $ 456.3 $ (24.2) (5.3) % West Region Arizona Dollars $ 268,238 $ 240,007 $ 28,231 11.8 % Homes ordered 704 550 154 28.0 % Average sales price $ 381.0 $ 436.4 $ (55.4) (12.7) % California Dollars $ 272,674 $ 247,343 $ 25,331 10.2 % Homes ordered 420 346 74 21.4 % Average sales price $ 649.2 $ 714.9 $ (65.7) (9.2) % Colorado Dollars $ 95,024 $ 125,999 $ (30,975) (24.6) % Homes ordered 162 209 (47) (22.5) % Average sales price $ 586.6 $ 602.9 $ (16.3) (2.7) % West Region Totals Dollars $ 635,936 $ 613,349 $ 22,587 3.7 % Homes ordered 1,286 1,105 181 16.4 % Average sales price $ 494.5 $ 555.1 $ (60.6) (10.9) % Central Region - Texas Central Region Totals Dollars $ 420,521 $ 548,567 $ (128,046) (23.3) % Homes ordered 1,073 1,296 (223) (17.2) % Average sales price $ 391.9 $ 423.3 $ (31.4) (7.4) % East Region Florida Dollars $ 156,787 $ 226,914 $ (70,127) (30.9) % Homes ordered 376 572 (196) (34.3) % Average sales price $ 417.0 $ 396.7 $ 20.3 5.1 % Georgia Dollars $ 82,760 $ 100,891 $ (18,131) (18.0) % Homes ordered 195 220 (25) (11.4) % Average sales price $ 424.4 $ 458.6 $ (34.2) (7.5) % North Carolina Dollars $ 126,758 $ 163,008 $ (36,250) (22.2) % Homes ordered 333 373 (40) (10.7) % Average sales price $ 380.7 $ 437.0 $ (56.3) (12.9) % South Carolina Dollars $ 35,473 $ 52,656 $ (17,183) (32.6) % Homes ordered 106 154 (48) (31.2) % Average sales price $ 334.7 $ 341.9 $ (7.2) (2.1) % Tennessee Dollars $ 48,658 $ 62,325 $ (13,667) (21.9) % Homes ordered 118 154 (36) (23.4) % Average sales price $ 412.4 $ 404.7 $ 7.7 1.9 % East Region Totals Dollars $ 450,436 $ 605,794 $ (155,358) (25.6) % Homes ordered 1,128 1,473 (345) (23.4) % Average sales price $ 399.3 $ 411.3 $ (12.0) (2.9) % (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 or a mortgage pre-approval as a sales contract until the contingency is removed. 25 Three Months Ended March 31, 2023 2022 Ending Average Ending Average Active Communities Total 278 274.5 268 263.5 West Region Arizona 45 45.5 40 39.5 California 34 32.5 23 22.5 Colorado 17 17.0 18 17.5 West Region Totals 96 95.0 81 79.5 Central Region - Texas Central Region Totals 82 81.5 75 74.0 East Region Florida 32 30.5 41 41.0 Georgia 20 19.5 15 15.0 North Carolina 30 29.5 29 27.5 South Carolina 9 9.5 13 13.5 Tennessee 9 9.0 14 13.0 East Region Totals 100 98.0 112 110.0 Three Months Ended March 31, 2023 2022 Cancellation Rates (1) Total 15 % 10 % West Region Arizona 13 % 12 % California 13 % 12 % Colorado 16 % 9 % West Region Totals 13 % 12 % Central Region - Texas Central Region Totals 17 % 11 % East Region Florida 17 % 4 % Georgia 18 % 12 % North Carolina 16 % 7 % South Carolina 11 % 11 % Tennessee 7 % 4 % East Region Totals 15 % 7 % (1) Cancellation rates are computed as the number of canceled units for the period divided by the gross sales units for the same period. 26 At March 31, Quarter over Quarter 2023 2022 Change $ Change % Order Backlog (1) Total Dollars $ 1,763,832 $ 3,038,927 $ (1,275,095) (42.0) % Homes in backlog 3,922 6,695 (2,773) (41.4) % Average sales price $ 449.7 $ 453.9 $ (4.2) (0.9) % West Region Arizona Dollars $ 328,996 $ 535,586 $ (206,590) (38.6) % Homes in backlog 834 1,237 (403) (32.6) % Average sales price $ 394.5 $ 433.0 $ (38.5) (8.9) % California Dollars $ 272,550 $ 331,321 $ (58,771) (17.7) % Homes in backlog 412 464 (52) (11.2) % Average sales price $ 661.5 $ 714.1 $ (52.6) (7.4) % Colorado Dollars $ 74,589 $ 246,932 $ (172,343) (69.8) % Homes in backlog 127 406 (279) (68.7) % Average sales price $ 587.3 $ 608.2 $ (20.9) (3.4) % West Region Totals Dollars $ 676,135 $ 1,113,839 $ (437,704) (39.3) % Homes in backlog 1,373 2,107 (734) (34.8) % Average sales price $ 492.5 $ 528.6 $ (36.1) (6.8) % Central Region - Texas Central Region Totals Dollars $ 419,822 $ 973,828 $ (554,006) (56.9) % Homes in backlog 988 2,301 (1,313) (57.1) % Average sales price $ 424.9 $ 423.2 $ 1.7 0.4 % East Region Florida Dollars $ 356,130 $ 411,478 $ (55,348) (13.5) % Homes in backlog 781 1,002 (221) (22.1) % Average sales price $ 456.0 $ 410.7 $ 45.3 11.0 % Georgia Dollars $ 107,070 $ 136,266 $ (29,196) (21.4) % Homes in backlog 255 296 (41) (13.9) % Average sales price $ 419.9 $ 460.4 $ (40.5) (8.8) % North Carolina Dollars $ 142,034 $ 269,898 $ (127,864) (47.4) % Homes in backlog 365 641 (276) (43.1) % Average sales price $ 389.1 $ 421.1 $ (32.0) (7.6) % South Carolina Dollars $ 26,939 $ 57,643 $ (30,704) (53.3) % Homes in backlog 77 166 (89) (53.6) % Average sales price $ 349.9 $ 347.2 $ 2.7 0.8 % Tennessee Dollars $ 35,702 $ 75,975 $ (40,273) (53.0) % Homes in backlog 83 182 (99) (54.4) % Average sales price $ 430.1 $ 417.4 $ 12.7 3.0 % East Region Totals Dollars $ 667,875 $ 951,260 $ (283,385) (29.8) % Homes in backlog 1,561 2,287 (726) (31.7) % Average sales price $ 427.9 $ 415.9 $ 12.0 2.9 % (1) Our backlog represents net home orders that have not closed. 27 Operating Results Companywide . In the first quarter of 2023, we achieved our highest first quarter home closing revenue and volume in Company history of 2,897 closings valued at $1.3 billion, compared to 2,858 closings valued at $1.2 billion in the prior year. Despite entering the 2023 first quarter with lower backlog than the prior period, home closing volume increased 1.4% over the first quarter of 2022 as we successfully sold and closed a high volume of homes in the same quarter, reflecting our availability of move-in ready inventory. The increase in volume translated to a 1.3% improvement in home closing revenue, as ASP on closings was flat year-over-year. Despite a 4.2% increase in average active communities, home order volume declined by 10.0% to 3,487 homes as compared to 3,874 homes in the first quarter of 2022. Home order value of $1.5 billion declined 14.8% from the first quarter of 2022, due to the decrease in order volume and a 5.3% lower ASP on orders. The first quarter 2023 orders pace of 4.2 per month exceeded our target orders pace of 3 - 4 homes per month, although down from 4.9 per month in the same period of 2022. Sequentially from the fourth quarter of 2022, orders pace increased notably in every market and returned to historical levels as homebuyers acclimated to the higher interest rates and we adjusted pricing and offered different types of incentives to find the market clearing price. Community count increased 3.7% year-over-year, ending the first quarter with 278 actively selling communities at March 31, 2023, up from 268 at March 31, 2022 and also up sequentially from 271 at December 31, 2022. We plan to return to a community count of 300 by the end of 2023. The quarter ended with 3,922 homes in backlog valued at $1.8 billion, compared to 6,695 units valued at $3.0 billion at March 31, 2022, due to the lower order volume and a high backlog conversion rate during the first quarter of 2023. West . The West Region generated $417.3 million in home closing revenue on 785 homes in the first quarter of 2023, down from $463.4 million and 864 homes in the prior year period. The 9.1% decrease in volume was the mixed result of declines in Arizona and California, while Colorado grew closing volume. Colorado was the most impacted by the elevated cancellations in the last half of 2022, but experienced some stabilization in the first quarter of 2023. Home closing revenue decreased 9.9% due to the lower volume and a 0.9% decrease in ASP on closings. The West Region had the largest decline in ASP on closings in the Company, as it experienced some of the most significant price increases over the past few years and accordingly has required the steepest sales price adjustments to find the market. Home orders in the first quarter 2023 of 1,286 increased 16.4% over the prior year, driven entirely by the 19.5% increase in average active communities. The cancellation rate of 13% in the West Region is a return to historical normal levels, although Colorado continues to be slightly elevated. ASP on orders declined 10.9% as the West Region adjusted pricing to meet market demand. The increased volume and lower ASPs resulted in a 3.7% increase in home order value to $635.9 million in the first quarter of 2023, up from $613.3 million in the prior year. The West Region ended the first quarter of 2023 with 1,373 homes in backlog valued at $676.1 million, down from 2,107 units valued at $1.1 billion at March 31, 2022, due to a lower order volume and a 90.0% backlog conversion rate. Central . The Central Region, made up of our Texas markets, was the only region to grow both home closing revenue and volume in the first quarter of 2023. With a 20.0% increase in volume to 1,048 homes, and a 1.8% increase in ASP on closings, home closing revenue grew 22.2% to $424.9 million, up from $347.8 million in 2022. Despite a 10.1% increase in average active communities, home order volume decreased 17.2% to 1,073 homes in the first quarter of 2023. The decline is partially due to the Region's slightly elevated cancellation rate of 17%, although sequentially it is down significantly from the fourth quarter 2022 rate of 43%. The lower demand caused a 24.1% decrease in orders pace to 4.4 homes per month, which is still well above our target pace of 3 to 4 homes. The lower order volume combined with a 7.4% decrease in ASP on orders drove a decrease in order value of 23.3%, to $420.5 million in the first quarter of 2023, from $548.6 million in the prior year quarter. The Central Region ended the quarter with 988 units in backlog valued at $419.8 million, down 57.1% and 56.9%, respectively, compared to March 31, 2022. East . During the three months ended March 31, 2023, the East Region closed 1,064 homes for $419.7 million, compared to 1,121 closings and $434.2 million in home closing revenue in the comparable prior year period. The 5.1% decrease in volume was partially offset by a 1.9% increase in ASP on closings, resulting in a 3.3% decrease in home closing revenue. With 10.9% fewer average active communities and a 15.6% decline in orders pace to 3.8 per month, home orders fell 23.4% to 1,128 in the first quarter of 2023 from 1,473 in the prior year. The cancellation rate increased to 15% in the first quarter of 2023 from 7% in the first quarter of 2022, but is down significantly sequentially from 31% in the fourth quarter of 2022. Home order value of $450.4 million decreased 25.6% from $605.8 million in the prior year period due to the decreased volume and a 2.9% reduction in ASPs. The East Region ended the quarter with 31.7% fewer units in backlog of 1,561 homes in backlog valued at $667.9 million compared to 2,287 homes valued at $951.3 million at March 31, 2022 due to the lower home order volume and a backlog conversion rate of 71.1% during the first quarter of 2023 as the result of a high number of spec homes being sold and closed in the first quarter of 2023. 28 Land Closing Revenue and Gross Profit From time to time, we may sell certain lots or land parcels to other homebuilders, developers or investors if we feel the sale will provide a greater economic benefit to us than continuing home construction or where we are looking to diversify our land positions in a specific geography or divest of assets that no longer align with our strategy. As a result of such sales, we recognized land closing revenue of $17.4 million and $41.5 million for the three months ending March 31, 2023 and 2022, respectively, and profit of $1.4 million and $10.8 million for the three months ending March 31, 2023 and 2022, respectively. Other Operating Information (dollars in thousands) Three Months Ended March 31, 2023 2022 Dollars Percent of Home Closing Revenue Dollars Percent of Home Closing Revenue Home Closing Gross Profit (1) Total $ 282,461 22.4 % $ 377,649 30.3 % West $ 74,087 17.8 % $ 143,759 31.0 % Central $ 105,710 24.9 % $ 104,405 30.0 % East $ 102,664 24.5 % $ 129,485 29.8 % (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 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. Companywide . Gross profit for the first quarter of 2023 was $282.5 million, with a margin of 22.4%. This is a 790 basis point decline compared to 30.3% in the first quarter of 2022 resulting from the combined impact of increased sales incentives and continued elevated direct costs, including interest rate locks and buy-downs. Our use of mortgage rate locks and buy-downs did not begin to impact our home closing gross margins until the back half of 2022. West. The West Region delivered home closing gross margin of 17.8% for the first quarter of 2023 versus 31.0% in the first quarter of 2022. As previously discussed, the West Region experienced steep price appreciation over the past few years, causing significant levels of homebuyer hesitancy when interest rates rose. To find the market clearing price, the West Region offered significant price cuts and incentives. These aggressive sales incentives combined with a shift in product mix and the continued elevated direct costs led to the West Region's decline in home closing gross margin year-over-year. Central. In the first quarter of 2023, the Central Region's home closing gross margin of 24.9% declined 510 basis points from 30.0% in the prior year quarter. The Central Region's gross margin was negatively impacted by sales incentives that largely began in the second half of 2022, combined with persistent elevated direct costs. East. The East Region home closing gross margin of 24.5% in the first quarter of 2023 declined 530 basis points from 29.8% for the comparable 2022 period. Similar to the other Regions, the home closing gross margin deterioration is due to the increased sales incentives and continued elevated direct costs that have impacted the homebuilding industry nationwide. Financial Services Profit (in thousands) Three Months Ended March 31, 2023 2022 Financial services profit $ 2,923 $ 3,334 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 Agency, Inc. and Meritage Homes Insurance Agency, respectively, as well as our portion of earnings from a mortgage joint venture. Financial services profit was $2.9 million and $3.3 million for the three months ended March 31, 2023 and 2022, respectively. 29 Selling, General and Administrative Expenses and Other Expenses (dollars in thousands) Three Months Ended March 31, 2023 2022 Commissions and other sales costs $ (82,846) $ (65,540) Percent of home closing revenue 6.6 % 5.3 % General and administrative expenses $ (47,519) $ (39,995) Percent of home closing revenue 3.8 % 3.2 % Interest expense $ — $ (41) Other income/(expense), net $ 8,844 $ (317) Provision for income taxes $ (34,002) $ (68,629) Commissions and Other Sales Costs. Commissions and other sales costs are comprised of internal and external commissions and related sales and marketing expenses such as advertising and sales office costs. These costs increased $17.3 million to $82.8 million in the three months ended March 31, 2023, primarily resulting from higher commissions as well as increased advertising activities, reflecting the current market dynamics. Commissions and other sales costs were 6.6% of home closing revenue in the first quarter of 2023, up 130 basis points from 5.3% as home closing revenue was relatively flat year-over-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 three months ended March 31, 2023, general and administrative expenses were $47.5 million, $7.5 million higher than the 2022 period, due primarily to severance-related expenses and increased spending on technology and insurance. As a percentage of home closing revenue, general and administrative expenses increased 60 basis points to 3.8% in the first quarter of 2023. Interest Expense. Interest expense is comprised of interest incurred, but not capitalized, on our senior notes, other borrowings, and our Credit Facility. We recognized no interest expense for the three months ended March 31, 2023 as all interest was capitalized. Interest expense was $41,000 for the same period in 2022. Other Income/(Expense), Net. Other income, net, primarily consists of (i) sublease income, (ii) interest earned on our cash and cash equivalents, (iii) payments and awards related to legal settlements and (iv) our portion of pre-tax income or loss from non-financial services joint ventures. Other income, net of $8.8 million for the three ended March 31, 2023 increased from an expense of $0.3 million in the prior year, primarily due to a higher interest rate on a higher cash balance. Income Taxes. Our effective tax rate was 20.6% and 24.0% for the three months ended March 31, 2023 and 2022, respectively. The lower tax rate for the three months ended March 31, 2023 reflects energy-efficient homes tax credits on qualifying homes under the Internal Revenue Code ("IRC") §45L energy-efficient homes federal tax credit from the IRA that was enacted in August 2022. There were no such credits available in the first quarter of 2022. Liquidity and Capital Resources Overview We have historically generated cash and funded our operations primarily from cash flows from operating activities. Additional sources of funds may include additional debt or equity financing and borrowing capacity under our 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 acquisition and development and spec home construction. Our principal uses of cash include acquisition and development of land and lots, home construction, operating expenses, share repurchases and the payment of interest, routine liabilities and dividends. 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. 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. 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 30 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 and dividend payments and common stock repurchases. 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 maintain our lot supply and active community count, payments of principal and interest on our senior notes as they become due or mature, payments of dividends and common stock repurchases. We expect our existing and future 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. To the extent the sources of capital described above are insufficient to meet our long-term cash needs, we may also conduct additional public offerings of our securities, refinance or secure new debt or dispose of certain assets to fund our operating activities. There can be no assurances that we would be able to obtain such additional capital on terms acceptable to us, if at all, and such additional equity or debt financing could dilute the interests of our existing stockholders or increase our interest costs. Material Cash Requirements We are a party to many contractual obligations involving commitments to make payments to third parties. These obligations impact both short-term and long-term liquidity and capital resource needs. Certain contractual obligations are reflected on our unaudited consolidated balance sheets as of March 31, 2023, 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 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 or committed pre-acquisition costs. For information about our loans payable and other borrowings, including our Credit Facility, and senior notes, reference is made to Notes 5 and 6 in the notes to our unaudited consolidated financial statements included in this report and are incorporated by reference herein. For information about our lease obligations, reference is made to Note 4 in the consolidated financial statements included in the Annual Report on Form 10-K for the year ended December 31, 2022. Reference is made to Notes 1, 3, 4, and 15 in the notes to our unaudited consolidated financial statements included in this report and are incorporated by reference herein. These Notes discuss our off-balance sheet arrangements with respect to land acquisition contracts and option agreements, and land development joint ventures, including the nature and amounts of financial obligations relating to these items. In addition, these Notes discuss the nature and amounts of certain types of commitments that arise in connection with the ordinary course of our land development and homebuilding operations, including commitments of land development joint ventures for which we might be obligated, if any. We do not engage in commodity trading or other similar activities. We had no derivative financial instruments at March 31, 2023 or December 31, 2022. 31 Operating Cash Flow Activities During the three months ended March 31, 2023 and 2022, net cash provided by operating activities totaled $124.5 million and $12.2 million, respectively. Operating cash flows in the first quarter of 2023 benefited from cash generated by net earnings of $131.3 million. Operating cash flows in the first quarter of 2022 benefited from cash generated by net earnings of $217.3 million and an increase in accounts payable and accrued liabilities of $115.9 million due to timing of payments for routine transactions, offset by a $283.9 million increase in real estate assets and a $52.1 million increase in other receivables, prepaids and other assets due to the purchase of fixed rate interest locks for eligible buyers in our backlog. Investing Cash Flow Activities During the three months ended March 31, 2023 and 2022, net cash used in investing activities totaled $8.7 million and $6.2 million, respectively. Cash used in investing activities for both periods is mainly attributable to the purchases of property and equipment. Financing Cash Flow Activities During the three months ended March 31, 2023 and 2022, net cash used in financing activities totaled $20.1 million and $103.9 million, respectively. The net cash used in financing activities in 2023 includes $9.9 million of dividends paid and $10.0 million in share repurchases. The net cash used in financing activities in 2022 primarily reflects $99.3 million in share repurchases. See 'Part II, Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds' for more information about our authorized share repurchase program. We believe that our leverage ratios provide useful information to the users of our financial statements regarding our financial position and cash and debt management. Debt-to-capital and net debt-to-capital are calculated as follows (dollars in thousands): As of March 31, 2023 December 31, 2022 Senior notes, net, loans payable and other borrowings $ 1,150,755 $ 1,150,647 Stockholders’ equity 4,067,210 3,949,611 Total capital $ 5,217,965 $ 5,100,258 Debt-to-capital (1) 22.1 % 22.6 % Senior notes, net, loans payable and other borrowings $ 1,150,755 $ 1,150,647 Less: cash and cash equivalents (957,210) (861,561) Net debt 193,545 289,086 Stockholders’ equity 4,067,210 3,949,611 Total net capital $ 4,260,755 $ 4,238,697 Net debt-to-capital (2) 4.5 % 6.8 % (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 considered a non-GAAP financial measure, and is computed as net debt divided by the aggregate of net debt and stockholders' equity. Net debt is comprised of total senior notes, net and loans payable and other borrowings, less cash and cash equivalents. The most directly comparable GAAP financial measure is the ratio of debt-to-capital. We believe the ratio of net debt-to-capital is a relevant financial measure for investors to understand the leverage employed in our operations and as an indicator of our ability to obtain financing. On February 16, 2023, our Board of Directors approved the initiation of a recurring quarterly cash dividend on common stock of $0.27 per share. The first dividend was paid on March 31, 2023 to shareholders of record as of the close of trading on March 15, 2023. 32 Credit Facility Covenants Borrowings under the Credit Facility are unsecured, but availability is subject to, among other things, a borrowing base. The Credit Facility also contains certain financial covenants, including (a) a minimum tangible net worth requirement of $1.9 billion (which amount is subject to increase over time based on subsequent earnings and proceeds from equity offerings), and (b) a maximum leverage covenant that prohibits the leverage ratio (as defined therein) from exceeding 60%. In addition, we are required to maintain either (i) an interest coverage ratio (EBITDA to interest expense, as defined therein) of at least 1.50 to 1.00 or (ii) liquidity (as defined therein) of an amount not less than our consolidated interest incurred during the trailing 12 months. We were in compliance with all Credit Facility covenants as of March 31, 2023. Our actual financial covenant calculations as of March 31, 2023 are reflected in the table below. Financial Covenant (dollars in thousands): Covenant Requirement Actual Minimum Tangible Net Worth > $2,630,039 $4,025,200 Leverage Ratio < 60% 3.8% Interest Coverage Ratio (1) > 1.50 21.33 Minimum Liquidity (1) > $60,416 $1,687,724 Investments other than defined permitted investments < $1,207,560 $11,280 (1) We are required to meet either the Interest Coverage Ratio or Minimum Liquidity, but not both. Seasonality Historically, we have experienced seasonal variations in our quarterly operating results and capital requirements. We typically sell more homes in the first half of the fiscal year than in the second half, which creates additional working capital requirements in the second and third quarters to build our inventories to satisfy the deliveries in the second half of the year. We typically benefit from the cash generated from home closings more in the third and fourth quarters than in the first and second quarters. During 2020, historical cycles were impacted by COVID-19 and since then have been further impacted by increased demand and supply chain and labor constraints. Historical seasonality returned in 2022 and we expect it to continue over the long term, although it may, from time to time, be affected by short-term volatility in the homebuilding industry and in the overall economy. Recent Issued Accounting Pronouncements See Note 1 to our unaudited consolidated financial statements included in this report for discussion of recently issued accounting pronouncements.