Meritage Homes CORP 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Overview and Outlook The second quarter of 2023 continued to see increased new home demand similar with the first quarter of this year as compared to the latter half of 2022. Homebuyers have begun to acclimate to higher interest rates and their previous hesitancy to purchase a home during uncertain economic conditions has adjusted accordingly. Despite the normalization of higher interest rates, homebuyers are still looking for assistance with monthly mortgage affordability, primarily in the form of interest rate locks or buy-downs. While there is a continuing lack of visibility in the economy, demand has been healthy in 2023. We expect the housing undersupply in the resale market and favorable demographics to provide a strong long-term runway for future homebuying demand, particularly for affordable, quick move-in homes, and believe that our all-spec strategy with a commitment to finding the market price will allow us to meet the demand and continue to grow our market share. Production costs continue to be elevated due to persistent inflation but have come down slightly from the second quarter of 2022. We expect that over the long term, costs will decline and cycle times will continue to shorten and stabilize as the homebuilding market returns to normal levels. We reduced our construction cycle time by over three weeks for new home starts in the second quarter of 2023 as compared to the first quarter, nearing our historical averages. Summary Company Results We achieved record second quarter home closing revenue and units volume of $1.5 billion on 3,490 homes, up from $1.4 billion on 3,221 homes closed in the second quarter of 2022. The 9.5% increase in home closing revenue year-over-year was driven primarily by the 8.4% higher volume and aided by a 1.1% increase in average sales price ("ASP") on closings. ASP on closings improved despite increased incentives due to a favorable mix of closings in higher-priced markets. Second quarter home closing gross margin declined to 24.4% for home closing gross profit of $377.0 million compared to 31.6% and $444.7 million, respectively, in the second quarter of 2022. The margin deterioration is due primarily to the increased incentives offered in response to the market slowdown that began in 2022. Financial services loss of $2.6 million in the second quarter of 2023, as compared to profit of $4.1 million in 2022, reflects $7.9 million of charges taken for unused prepaid interest rate locks that expired during the period. Commissions and other sales costs of $95.8 million in the three months ended June 30, 2023 increased $26.4 million due to higher home closing revenue and higher broker commission rates paid in response to current market conditions. General and administrative expenses of $52.1 million in the three months ended June 30, 2023 were 3.4% of home closing revenue, consistent with the same period in 2022. Other income, net of $12.9 million increased from a net expense of $0.5 million in the prior year primarily due to the higher interest rate earned on a larger cash balance. Earnings before income taxes for the second quarter of 2023 of $239.5 million decreased $92.2 million year over year from $331.7 million in 2022. The lower effective income tax rate of 22.0% compared to 24.6% 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 $186.8 million in the second quarter of 2023 versus $250.1 million in the second quarter of 2022. Similar to the second quarter, 5.1% higher home closing volume led to a 5.7% improvement in home closing revenue for the six months ended June 20, 2023 versus 2022. Home closing gross margin of 23.5% declined 750 basis points year over year, for a $162.9 million decrease in home closing gross profit. Lower gross margin, profitability and a lower effective tax rate of 21.4% led to net income of $318.1 million for the six months ended June 30, 2023, compared to $467.3 million for the 2022 period. Home orders of 3,340 for the quarter ended June 30, 2023 were 11.3% lower than the second quarter of 2022 on a relatively flat average active community count, reflecting an 11.4% decrease in orders pace to 3.9 per month compared to 4.4 in 2022. The lower orders pace in the second quarter of 2023 was primarily from the timing of community openings and closings with a disproportionate share of closings in the first month of the quarter and openings in the last month of the quarter. Home order value decreased 18.5% year-over-year, to $1.5 billion during the three months ended June 30, 2023, versus $1.8 billion in the same period of 2022, due to the lower volume as well as an 8.1% decrease in ASP on orders. The lower ASP on orders year over year is due to increased incentives to assist homebuyer affordability, primarily related to interest rates. Our cancellation rate returned to a more normalized 12% in the second quarter of 2023, down sequentially from 15% in the first quarter of 2023 and 13% in the second quarter of 2022. Similar to the second quarter, for the six months ended June 30, 2023, home orders and home order value decreased 10.7% and 16.7%, respectively, over the prior year, with a cancellation rate of 13% compared to 11% for the prior year period. We ended the second quarter of 2023 with 3,772 homes in backlog valued at $1.7 billion, decreases of 47.9% and 50.9%, 22 respectively, from June 30, 2022. The decrease in backlog units is due to an 89.0% backlog conversion rate during the second quarter of 2023 combined with lower order volume. We ended the second quarter of 2023 with 291 active communities, down from 303 at June 30, 2023 although up sequentially from 278 at March 31, 2023. We purchased approximately 5,700 lots for $241.6 million, spent $477.0 million on land development and started construction on 6,558 homes during the six months ended June 30, 2023. Company Positioning We believe that the investments in our new communities designed for the first-time and first move-up homebuyer, our commitment to being primarily an all-spec builder, 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. Our efforts were recognized in the second quarter of 2023 with the 2023 ENERGY STAR ® Residential New Construction Market Leader Award from the Environmental Protection Agency. 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 second quarter with a 21.4% debt-to-capital ratio and a (0.2)% 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 six months ended June 30, 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): Home Closing Revenue Three Months Ended June 30, Quarter over Quarter 2023 2022 Change $ Change % Total Dollars $ 1,543,021 $ 1,408,947 $ 134,074 9.5 % Homes closed 3,490 3,221 269 8.4 % Average sales price $ 442.1 $ 437.4 $ 4.7 1.1 % West Region Dollars $ 519,217 $ 486,078 $ 33,139 6.8 % Homes closed 997 925 72 7.8 % Average sales price $ 520.8 $ 525.5 $ (4.7) (0.9) % Central Region Dollars $ 456,801 $ 422,327 $ 34,474 8.2 % Homes closed 1,094 1,048 46 4.4 % Average sales price $ 417.6 $ 403.0 $ 14.6 3.6 % East Region Dollars $ 567,003 $ 500,542 $ 66,461 13.3 % Homes closed 1,399 1,248 151 12.1 % Average sales price $ 405.3 $ 401.1 $ 4.2 1.0 % Six Months Ended June 30, Quarter over Quarter 2023 2022 Change $ Change % Total Dollars $ 2,804,944 $ 2,654,403 $ 150,541 5.7 % Homes closed 6,387 6,079 308 5.1 % Average sales price $ 439.2 $ 436.7 $ 2.5 0.6 % West Region Dollars $ 936,539 $ 949,502 $ (12,963) (1.4) % Homes closed 1,782 1,789 (7) (0.4) % Average sales price $ 525.6 $ 530.7 $ (5.1) (1.0) % Central Region Dollars $ 881,681 $ 770,155 $ 111,526 14.5 % Homes closed 2,142 1,921 221 11.5 % Average sales price $ 411.6 $ 400.9 $ 10.7 2.7 % East Region Dollars $ 986,724 $ 934,746 $ 51,978 5.6 % Homes closed 2,463 2,369 94 4.0 % Average sales price $ 400.6 $ 394.6 $ 6.0 1.5 % 24 Home Orders (1) Three Months Ended June 30, Quarter over Quarter 2023 2022 Change $ Change % Total Dollars $ 1,474,713 $ 1,809,870 $ (335,157) (18.5) % Homes ordered 3,340 3,767 (427) (11.3) % Average sales price $ 441.5 $ 480.5 $ (39.0) (8.1) % West Region Dollars $ 515,325 $ 632,227 $ (116,902) (18.5) % Homes ordered 990 1,075 (85) (7.9) % Average sales price $ 520.5 $ 588.1 $ (67.6) (11.5) % Central Region Dollars $ 440,377 $ 491,394 $ (51,017) (10.4) % Homes ordered 1,065 1,096 (31) (2.8) % Average sales price $ 413.5 $ 448.4 $ (34.9) (7.8) % East Region Dollars $ 519,011 $ 686,249 $ (167,238) (24.4) % Homes ordered 1,285 1,596 (311) (19.5) % Average sales price $ 403.9 $ 430.0 $ (26.1) (6.1) % Six Months Ended June 30, Quarter over Quarter 2023 2022 Change $ Change % Total Dollars $ 2,981,606 $ 3,577,580 $ (595,974) (16.7) % Homes ordered 6,827 7,641 (814) (10.7) % Average sales price $ 436.7 $ 468.2 $ (31.5) (6.7) % West Region Dollars $ 1,151,261 $ 1,245,576 $ (94,315) (7.6) % Homes ordered 2,276 2,180 96 4.4 % Average sales price $ 505.8 $ 571.4 $ (65.6) (11.5) % Central Region Dollars $ 860,898 $ 1,039,961 $ (179,063) (17.2) % Homes ordered 2,138 2,392 (254) (10.6) % Average sales price $ 402.7 $ 434.8 $ (32.1) (7.4) % East Region Dollars $ 969,447 $ 1,292,043 $ (322,596) (25.0) % Homes ordered 2,413 3,069 (656) (21.4) % Average sales price $ 401.8 $ 421.0 $ (19.2) (4.6) % (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 Order Backlog (1) At June 30, Quarter over Quarter 2023 2022 Change $ Change % Total Dollars $ 1,687,536 $ 3,438,853 $ (1,751,317) (50.9) % Homes in backlog 3,772 7,241 (3,469) (47.9) % Average sales price $ 447.4 $ 474.9 $ (27.5) (5.8) % West Region Dollars $ 669,636 $ 1,259,771 $ (590,135) (46.8) % Homes in backlog 1,366 2,257 (891) (39.5) % Average sales price $ 490.2 $ 558.2 $ (68.0) (12.2) % Central Region Dollars $ 401,601 $ 1,042,689 $ (641,088) (61.5) % Homes in backlog 959 2,349 (1,390) (59.2) % Average sales price $ 418.8 $ 443.9 $ (25.1) (5.7) % East Region Dollars $ 616,299 $ 1,136,393 $ (520,094) (45.8) % Homes in backlog 1,447 2,635 (1,188) (45.1) % Average sales price $ 425.9 $ 431.3 $ (5.4) (1.3) % (1) Our backlog represents net home orders that have not closed. Active Communities and Cancellation Rates Active Communities Three Months Ended June 30, Six Months Ended June 30, 2023 2022 2023 2022 Ending Average Ending Average Ending Average Ending Average Total 291 284.5 303 285.5 291 280.1 303 276.9 West Region 98 97.0 107 94.0 98 96.0 107 88.7 Central Region 82 82.0 80 77.5 82 81.7 80 76.1 East Region 111 105.5 116 114.0 111 102.4 116 112.1 Cancellation Rates (2) Three Months Ended June 30, Six Months Ended June 30, 2023 2022 2023 2022 Total 12 % 13 % 13 % 11 % West Region 15 % 17 % 14 % 14 % Central Region 11 % 17 % 14 % 14 % East Region 9 % 7 % 12 % 7 % (2) Cancellation rates are computed as the number of canceled units for the period divided by the gross sales units for the same period. 26 Operating Results Companywide . We had our highest second quarter home closing revenue and volume in Company history, improving 9.5% and 8.4%, respectively, over prior year, with 3,490 closings valued at $1.5 billion for the three months ended June 30, 2023, compared to 3,221 closings valued at $1.4 billion in 2022. Despite entering the 2023 second quarter with lower backlog than prior year, home closing volume increased 8.4% over the second quarter of 2022 due to a backlog conversion rate of 89.0%, as compared to 48.1% in the prior second quarter period. Home order volume declined by 11.3% to 3,340 homes as compared to 3,767 homes in the second quarter of 2022, primarily due to an 11.4% decline in orders pace of 3.9 per month, down from 4.4 per month in the same period of 2022. Home order value of $1.5 billion declined 18.5% from the second quarter of 2022 due to the decrease in order volume combined with an 8.1% lower ASP on orders as we increased incentives to meet the market's need for affordability impacted by successive interest rate hikes. Order cancellations of 12% for the second quarter of 2023 improved slightly from 13% in the second quarter of 2022 and are in line with historical averages for the Company. For the six months ended June 30, 2023, home closing volume increased 5.1% to 6,387 closings, which combined with a 0.6% year-over-year increase in ASP on closings led to home closing revenue of $2.8 billion, up 5.7% from $2.7 billion in the prior year period. Similar to the second quarter, home order volume of 6,827 was down 10.7% from prior year due to a 10.9% decrease in orders pace that was partially offset by a 1.2% increase in average active communities. As demand returns to normalized levels, our 2023 year-to-date orders pace of 4.1 homes per month was down from the elevated pace of 4.6 in 2022 but still exceeded our target of 4 homes per month. The lower order volume and a 6.7% decrease in ASP on orders led to 16.7% decrease in order value of $3.0 billion. We ended the second quarter of 2023 with 291 actively selling communities, down from 303 June 30, 2022 but up sequentially from 278 at March 31, 2023. The quarter ended with 3,772 homes in backlog valued at $1.7 billion, compared to 7,241 units valued at $3.4 billion at June 30, 2022, due to entering the quarter with fewer homes in backlog, higher home closing volume, higher backlog conversion rate and lower orders. West . The West Region generated $519.2 million in home closing revenue on 997 homes in the second quarter of 2023, up from $486.1 million on 925 homes in the prior year period. The 7.8% increase in volume resulted in a 6.8% increase in home closing revenue, as ASP on closings decreased 0.9% due to higher incentives. Home orders in the second quarter of 2023 of 990 were down 7.9% from 1,075 in the prior year, despite a 3.2% increase in average active communities due to a 10.5% decrease in orders pace to 3.4 homes per month from 3.8 per month in 2022. Home order value of $515.3 million for the second quarter of 2023 decreased 18.5% from prior year, due to the decrease in order volume coupled with lower ASP. The West Region had 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 clearing price. In response, we have increased incentives in the Region, resulting in an 11.5% decrease in ASP on orders. The West Region cancellation rate of 15% in the second quarter of 2023 improved from 17% in the prior year. For the six months ended June 30, 2023, home closing revenue of $936.5 million decreased 1.4% due to slight declines in both home closing volume and ASP on closings. Home closing volume gains in both California and Colorado were offset by a decrease in Arizona, and all markets experienced a decrease in ASP on closings. Order volume in the West Region increased 4.4% year-to-date due entirely to an 8.2% increase in the average number of actively selling communities, as year-to-date orders pace decreased 2.4% to 4.0 homes per month. ASP on orders decreased 11.5%, and home order value of $1.2 billion was down 7.6% from the combined effect of higher volume and lower ASPs. The year-to-date cancellation rate of 14% is consistent with the prior year period. The West Region ended the second quarter of 2023 with 1,366 homes in backlog valued at $669.6 million, compared to 2,257 units valued at $1.3 billion at June 30, 2022, decreases of 39.5% and 46.8%, respectively. Central . The Central Region closed 1,094 homes in the three months ended June 30, 2023, up 4.4% from 1,048 in 2022. Home closing revenue of $456.8 million increased 8.2%, driven by the increased volume and a 3.6% increase in ASP on closings from geographic mix. Home order volume decreased 2.8% to 1,065 homes in the second quarter of 2023, despite a 5.8% increase in average active communities, due to an 8.5% decrease in orders pace to 4.3 homes per month. Demand remains high in the Central Region, although is returning closer to normalized levels in 2023 from the elevated pace of 4.7 per month in the second quarter of 2022. The lower order volume combined with a 7.8% decrease in ASP on orders drove a decrease in order value of 10.4%, to $440.4 million in the second quarter of 2023, from $491.4 million in the prior year quarter. The Central Region had significant improvement in its cancellation rate of 11% in the second quarter of 2023, down year over year and sequentially from 17% in both the second quarter of 2022 and the first quarter of 2023. Year-to-date results in the Central Region were similar to those of the second quarter. For the six months ended June 30, 2023, home closing revenue of $881.7 million on 2,142 home closings increased and 14.5% and 11.5%, respectively. Orders and ASP on orders both declined year-over-year, down 10.6% and 7.4%, respectively, resulting in a 17.2% decrease in order value of $860.9 million on 2,138 homes. Order volume was lower due to a 15.4% decrease in orders pace, as the Region increased their average active community count by 7.4%. While orders pace decreased compared to prior year, the Central Region orders pace exceeded our target of 4 homes per month at 4.4, down from an elevated 5.2 in 2022. The year-to-date 27 cancellation rate of 14% is consistent with prior year. The Central Region ended the quarter with 959 units in backlog valued at $401.6 million, down 59.2% and 61.5%, respectively, compared to June 30, 202. East . During the three months ended June 30, 2023, the East Region closed 1,399 homes for $567.0 million, compared to 1,248 closings and $500.5 million in home closing revenue in the comparable prior year period. The 12.1% increase in volume due to improved backlog conversion and closings from our new markets in 2023, coupled with a 1.0% increase in ASP on closings resulted in 13.3% higher home closing revenue. With 7.5% fewer average active communities and a 12.8% decline in orders pace, home orders fell 19.5% to 1,285 in the second quarter of 2023 from 1,596 in the prior year. Similar the Central Region, the East Region orders pace of 4.1 homes per month in the second quarter of 2023 exceeded our target pace of 4 per month and is returning closer to normalized levels in 2023 from the elevated orders pace of 4.7 per month in 2022. The cancellation rate increased to 9% in the second quarter of 2023 from 7% in the second quarter of 2022, although sequentially is down significantly from 15% in the first quarter of 2023. Home order value of $519.0 million decreased 24.4% from $686.2 million in the prior year period due to the decreased volume and a 6.1% reduction in ASPs. The year-to-date results of the East Region were similar to those of the second quarter, with 4.0% and 5.6% improvements in home closing volume and revenue, respectively, compared to the 2022 period, closing 2,463 homes for $986.7 million in home closing revenue for the six months ended June 30, 2023. Orders volume decreased 21.4% due to the combined impact of an 8.7% decrease in average active communities and a 15.2% decrease in orders pace for the six months ended June 30, 2023. Order value of $969.4 million decreased 25.0% year over year due to decreased volume and a 4.6% decrease in ASP on orders. Year-to-date, the East Region's cancellation rate of 12% is up from 7% in the prior year, although still in line with historically normal rates. The East Region ended the second quarter of 2023 with 1,447 homes in backlog valued at $616.3 million, down 45.1% and 45.8%, respectively, from 2,635 homes valued at $1.1 billion at June 30, 2022. 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 $24.4 million and $3.4 million for the three months ending June 30, 2023 and 2022, respectively, and profit of $0.2 million and $0.7 million for the three months ending June 30, 2023 and 2022, respectively. Year-to-date land sales resulted in profits of $1.6 million and $11.4 million for 2023 and 2022, respectively. Other Operating Information (dollars in thousands) Three Months Ended June 30, Six Months Ended June 30, 2023 2022 2023 2022 Dollars Percent of Home Closing Revenue Dollars Percent of Home Closing Revenue Dollars Percent of Home Closing Revenue Dollars Percent of Home Closing Revenue Home Closing Gross Profit (1) Total $ 376,980 24.4 % $ 444,739 31.6 % $ 659,441 23.5 % $ 822,388 31.0 % West $ 95,548 18.4 % $ 148,874 30.6 % $ 169,635 18.1 % $ 292,633 30.8 % Central $ 126,432 27.7 % $ 135,539 32.1 % $ 232,142 26.3 % $ 239,944 31.2 % East $ 155,000 27.3 % $ 160,326 32.0 % $ 257,664 26.1 % $ 289,811 31.0 % (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 second quarter of 2023 was $377.0 million, with a margin of 24.4%, declined 720 basis points from 31.6% in the second quarter of 2022 resulting from increased sales incentives, primarily interest rate locks and buy-downs, coupled with continued elevated labor, direct and lot costs. 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. Sequentially, our gross margin improved 200 28 basis points from the first quarter of 2023, benefiting from our ability to start scaling back on incentives. Similar to the second quarter, gross profit of $659.4 million and margin of 23.5% for the six months ended June 30, 2023, decreased from $822.4 million and 31.0% in 2022 due to higher production costs and increased sales incentives offered in response to buyer hesitancy that started in the back half of 2022. West. The West Region delivered home closing gross margin of 18.4% for the second quarter of 2023 versus 30.6% in the second quarter of 2022. The West Region experienced steep price appreciation over the past few years and through mid-2022, causing demand to slow substantially when interest rates rose in the back half of 2022 and buyers had affordability concerns. To find the market clearing price, the West Region offered significant incentives, which combined with persistently higher direct and land development costs and weaker overhead leverage resulted in home closing gross margin deterioration. Similar to the second quarter, the West Region home closing gross margin of 18.1% for the six months ended June 30, 2023 declined from 30.8% in the 2022 period. Central. The Central Region's second quarter 2023 home closing gross margin of 27.7%, was down only 440 basis points from 32.1% in the prior year quarter. While ASP on closings increased due to geographic mix in Texas, the higher sales incentives, still elevated direct costs and increasing lot costs negatively impacted the Region's gross margin. Compared to the first quarter of 2023, the Central Region's home closing gross margin improved 280 basis points due to fewer incentives. Year-to-date, the Central Region gross margin of 26.3% in 2023 is down from 31.2% as a result of elevated sales incentives. East. The East Region home closing gross margin of 27.3% in the second quarter of 2023 declined 470 basis points from 32.0% for the comparable 2022 period. Similar to the other Regions, the home closing gross margin deterioration is due to the increased sales incentives, primarily interest rate locks and buy downs, and continued elevated direct costs that impacted the homebuilding industry nationwide. Like the Central Region, the East Region also had a 280 basis point improvement in home closing gross margin sequentially from the first quarter of 2023 as we scaled back on incentives, and direct costs declined moderately. For the six months ended June 30, 2023, the East Region home closing gross margin declined 490 basis points to 26.1%, similar to the second quarter of 2023. Financial Services (Loss)/Profit (in thousands) Three Months Ended June 30, Six Months Ended June 30, 2023 2022 2023 2022 Financial services (loss)/profit $ (2,557) $ 4,079 $ 366 $ 7,413 Financial services (loss)/profit represents the net (loss)/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 loss of $2.6 million in the three months ended June 30, 2023 includes $7.9 million in charges related to unused prepaid interest rate locks that expired in the second quarter of 2023, resulting in a year-over decrease of $6.6 million, versus profit of $4.1 million in the three months ended June 30 2022. Similar to the second quarter results, year-to-date financial services profit decreased $7.0 million, primarily due to the write off of unused prepaid interest rate locks. There were no similar charges in the three and six months ended June 30, 2022. Excluding the write off of unused prepaid interest rate locks for the three and six months ended June 30, 2023, financial services profit increased over prior year due to higher home closing volume and geographical mix. Selling, General and Administrative Expenses and Other Expenses (dollars in thousands) Three Months Ended June 30, Six Months Ended June 30, 2023 2022 2023 2022 Commissions and other sales costs $ (95,798) $ (69,383) $ (178,644) $ (134,923) Percent of home closing revenue 6.2 % 4.9 % 6.4 % 5.1 % General and administrative expenses $ (52,140) $ (47,932) $ (99,659) $ (87,927) Percent of home closing revenue 3.4 % 3.4 % 3.6 % 3.3 % Interest expense $ — $ — $ — $ (41) Other income/(expense), net $ 12,862 $ (458) $ 21,706 $ (775) Provision for income taxes $ (52,688) $ (81,611) $ (86,690) $ (150,240) 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 $26.4 million to $95.8 million in the three months ended June 30, 2023, due to higher home closing revenue and increased 29 commissions and advertising activities. Commissions and other sales costs were 6.2% of home closing revenue in the second quarter of 2023, up 130 basis points from 4.9% due to higher external commission rates and increased advertising to spur traffic in our communities. Similar to the second quarter, commissions and other sales costs of $178.6 million were 6.4% of home closing revenue, increasing $43.7 million and 130 basis points, respectively, due to higher home closing revenue and elevated commissions and advertising spend. General and Administrative Expenses. General and administrative expenses represent corporate and divisional overhead expenses such as salaries and bonuses, occupancy, insurance and travel expenses. For the three months ended June 30, 2023, general and administrative expenses were $52.1 million, increasing proportionally with home closing revenue, and were 3.4% of home closing revenue in both the second quarter of 2023 and 2022. For the six months ended June 30, 2023, general and administrative expenses were $99.7 million, up $11.7 million and 30 basis points from $87.9 million in the 2022 period, due primarily to severance-related expenses and increased spending on technology and insurance incurred in the first quarter of the year, as well as incremental expenses in newer markets as operations ramp up. 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 and months ended June 30, 2023 because all interest was capitalized to qualifying assets. We recognized no interest expense in the three months ended June 30, 2022, and interest expense of $41,000 for the six months ended June 30, 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. For the three and six months ended June 30, 2023, Other income was $12.9 million and $21.7 million, respectively, compared to net expense of $0.5 million and $0.8 million in the 2022 comparable periods. The increase in both quarter and year-to-date is due to higher interest earned on larger cash and cash equivalents balances. Income Taxes. Our effective tax rate was 22.0% and 24.6% for the three months ended June 30, 2023 and 2022, respectively, and 21.4% and 24.3% for the six months ended June 30, 2023 and 2022, respectively. The lower tax rate for the three and six months ended June 30, 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 half 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 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. In addition, we may opportunistically 30 retire or redeem a portion of our senior notes. 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 June 30, 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. We do not engage in commodity trading or other similar activities. We had no derivative financial instruments at June 30, 2023 or December 31, 2022. Operating Cash Flow Activities During the six months ended June 30, 2023, net cash provided by operating activities totaled $355.9 million, compared to net cash used in operations of $206.8 million during the six months ended June 30, 2022. Operating cash flows in the first six months of 2023 benefited from cash generated by net earnings of $318.1 million. Operating cash flows in the first six months of 2022 benefited from cash generated by net earnings of $467.3 million and an increase in accounts payable and accrued liabilities of $113.4 million due to timing of payments for routine transactions, offset by a $729.5 million increase in real estate assets largely related to the increase in homes under construction and a $90.4 million increase in other receivables, prepaids and other assets. 31 Investing Cash Flow Activities During the six months ended June 30, 2023 and 2022, net cash used in investing activities totaled $22.1 million and $18.3 million, respectively. Cash used in investing activities in the first half of 2023 was mainly attributable to the purchases of property and equipment. Cash used in investing activities in the first half of 2022 was mainly attributable to the purchases of property and equipment of $12.9 million and investments in unconsolidated entities of $5.7 million. Financing Cash Flow Activities During the six months ended June 30, 2023 and 2022, net cash used in financing activities totaled $32.1 million and $121.1 million, respectively. The net cash used in financing activities in 2023 includes $19.9 million of dividends paid and $10.0 million in share repurchases. The net cash used in financing activities in 2022 primarily reflects $109.3 million in share repurchases. See 'Part II, Item 2 - Unregistered Sales of Equity Securities, Use of Proceeds and Issuer Purchases of Equity Securities' 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 June 30, 2023 December 31, 2022 Senior notes, net, loans payable and other borrowings $ 1,155,346 $ 1,150,647 Stockholders’ equity 4,248,295 3,949,611 Total capital $ 5,403,641 $ 5,100,258 Debt-to-capital (1) 21.4 % 22.6 % Senior notes, net, loans payable and other borrowings $ 1,155,346 $ 1,150,647 Less: cash and cash equivalents (1,163,243) (861,561) Net debt (7,897) 289,086 Stockholders’ equity 4,248,295 3,949,611 Total net capital $ 4,240,398 $ 4,238,697 Net debt-to-capital (2) (0.2) % 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. Dividends During the three months ended June 30, 2023, our Board of Directors approved, and we paid, a quarterly cash dividend on common stock of $0.27 per share. Quarterly dividends declared and paid during the six months ended June 30, 2023 totaled $0.54 per share. There were no such transactions in the three and six months ended June 30, 2022. 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 $2.8 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%. We were in compliance with all Credit Facility covenants as of June 30, 2023. Our actual financial covenant calculations as of June 30, 2023 are reflected in the table below. Financial Covenant (dollars in thousands): Covenant Requirement Actual Minimum Tangible Net Worth > $2,911,058 $4,248,295 Leverage Ratio < 60% (0.1)% Investments other than defined permitted investments < $1,286,027 $12,451 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. Historical cycles were impacted in 2020 by unprecedented demand that continued through the middle of 2022, and were further impacted by supply chain and labor constraints and rising interest rates. Historical seasonality returned in the back half of 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.