Meritage Homes CORP 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Overview and Outlook Demand for new homes in the third quarter of 2023 held steady with that experienced in first half of the year, despite the persistence of elevated interest rates and high inflation. This environment has homebuyers looking for assistance with monthly mortgage affordability, requiring greater use of financing incentives, including interest rate locks and buy-downs. Millennial and baby boomer generations are seeking affordable, move-in ready homes that meet their changing lifestyle needs, which has created elevated demand for new inventory, as existing homeowners with lower mortgage rates are not listing their homes, resulting in a short supply of total inventory. We believe our all-spec strategy with a commitment to affordability will meet the persisting demographic demand, providing us with ample opportunity to capture and grow our market share. While we have experienced some limited relief in material costs, primarily due to the retraction in lumber commodities, most other home costs have held relatively steady at their elevated levels. Our cost savings year over year were primarily generated by improvements in our construction cycle time. During the third quarter of 2023, we further reduced our construction cycle time by over two weeks as supply chain and labor constraints have continuously lessened throughout the year. We continue to rebid all of our construction inputs and expect costs to begin to trend down to historical levels as the economy resets into stabilizing inflation rates. Higher land development costs have also begun to impact margins for newer communities and will continue to do so in the near-to-mid term. Summary Company Results We achieved record third quarter home closing revenue and units volume of 3,638 homes valued at $1.6 billion in the third quarter of 2023, improving 4.3% and 2.6%, respectively, year over year. The increase in home closing revenue was driven by the higher volume as the average sales price ("ASP") on closings decreased 1.6% due to higher incentives. Third quarter home closing gross margin of 26.7% for home closing gross profit of $429.6 million compared to 28.7% and $450.6 million, respectively, in the third quarter of 2022. The 200 basis point margin deterioration is due primarily to increased incentives and higher land development costs, while direct costs held relatively steady. Commissions and other sales costs of $99.1 million in the three months ended September 30, 2023 increased $21.2 million due to the combined effect of higher home closing volume and increased commissions offered in response to the current sales environment. General and administrative expenses of $63.1 million were 3.9% of home closing revenue for the three months ended September 30, 2023, compared to $48.4 million, or 3.1% of home closing revenue, for the same period in 2022. The increase in General and administrative expenses is due to higher compensation, inclusive of newer market operations and competitive market adjustments. Other income, net of $13.3 million increased from a net other expense of $0.1 million in the prior year primarily due to higher interest rates earned on a larger cash balance. In September 2023 we partially redeemed $150.0 million of our 2025 Notes, resulting in charges of $0.9 million reflected in Loss on early extinguishment of debt, with no similar charges in 2022. Earnings before income taxes for the third quarter of 2023 of $285.7 million decreased $43.8 million year over year from $329.5 million in 2022. The effective income tax rate for the third quarter of 2023 was 22.4%, compared to 20.3% in 2022. The 2022 effective tax rate reflects the catch-up of tax credits for energy efficient homes closed in the first nine months of 2022 for the extension of the §45L energy-efficient homes federal tax credit enacted by the IRA in third quarter of 2022. The decrease in year-over-year profitability and a higher tax rate, resulted in net earnings of $221.8 million in the third quarter of 2023 versus $262.5 million in the third quarter of 2022. For the nine months ended September 30, 2023, home closing volume of 10,025 units increased 4.8% from 2022, leading to a 4.5% increase in home closing revenue to $4.4 billion. Home closing gross margin of 24.7% decreased 540 basis points, resulting in a $184.0 million decrease in home closing gross profit. Lower gross margin and profitability, partially offset by a lower effective tax rate of 21.8%, led to net income of $539.9 million for the nine months ended September 30, 2023, compared to $729.8 million for the 2022 period. Home orders of 3,474 for the quarter ended September 30, 2023 were 50.4% higher than the third quarter of 2022, as market conditions stabilized over the last twelve months, increasing consumer confidence and buyer demand, and our cancellation rate in the third quarter of 2023 of 11% improved significantly from the elevated 30% in the third quarter of 2022. Our average active community count decrease of 2.6% for the third quarter of 2023 was overshadowed by a 51.9% increase in orders pace to 4.1 per month compared to 2.7 in the 2022 third quarter. Home order value increased 53.5% year-over-year, to $1.5 billion during the three months ended September 30, 2023, versus $1.0 billion in the same period of 2022, due to the 22 higher volume and a 2.1% increase in ASP on orders. The higher ASP on orders year over year is due to geographic mix, with a greater proportion of orders in higher ASP markets in the third quarter of 2023 as compared to 2022. For the nine months ended September 30, 2023, home orders increased 3.5% and home order value decreased 1.6% over the prior year, with a cancellation rate of 13% compared to 16% for the prior year period. We ended the third quarter of 2023 with 3,608 homes in backlog valued at $1.6 billion, decreases of 40.5% and 44.9%, respectively, from September 30, 2022. The decrease in backlog units is due to a 96.4% backlog conversion rate during the third quarter of 2023. We ended the third quarter of 2023 with 272 active communities, down from 275 at September 30, 2022 as our accelerated orders pace resulted in early community close outs. We purchased approximately 9,100 lots for $486.0 million, spent $769.7 million on land development and started construction on 10,547 homes during the nine months ended September 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. In addition to these strategic initiatives, we also remain committed to the following: • Carefully managing our liquidity and a strong balance sheet, including a $150.0 million early redemption of debt this quarter; we ended the third quarter with an 18.5% debt-to-capital ratio and a (1.0)% 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; • Targeting a strong yet sustainable 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 from existing available inventory. 23 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 nine months ended September 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. 24 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 September 30, Quarter over Quarter 2023 2022 Change $ Change % Total Dollars $ 1,610,317 $ 1,569,032 $ 41,285 2.6 % Homes closed 3,638 3,487 151 4.3 % Average sales price $ 442.6 $ 450.0 $ (7.4) (1.6) % West Region Dollars $ 606,833 $ 590,027 $ 16,806 2.8 % Homes closed 1,172 1,086 86 7.9 % Average sales price $ 517.8 $ 543.3 $ (25.5) (4.7) % Central Region Dollars $ 452,687 $ 499,713 $ (47,026) (9.4) % Homes closed 1,102 1,218 (116) (9.5) % Average sales price $ 410.8 $ 410.3 $ 0.5 0.1 % East Region Dollars $ 550,797 $ 479,292 $ 71,505 14.9 % Homes closed 1,364 1,183 181 15.3 % Average sales price $ 403.8 $ 405.1 $ (1.3) (0.3) % Nine Months Ended September 30, Quarter over Quarter 2023 2022 Change $ Change % Total Dollars $ 4,415,261 $ 4,223,435 $ 191,826 4.5 % Homes closed 10,025 9,566 459 4.8 % Average sales price $ 440.4 $ 441.5 $ (1.1) (0.2) % West Region Dollars $ 1,543,372 $ 1,539,529 $ 3,843 0.2 % Homes closed 2,954 2,875 79 2.7 % Average sales price $ 522.5 $ 535.5 $ (13.0) (2.4) % Central Region Dollars $ 1,334,368 $ 1,269,868 $ 64,500 5.1 % Homes closed 3,244 3,139 105 3.3 % Average sales price $ 411.3 $ 404.5 $ 6.8 1.7 % East Region Dollars $ 1,537,521 $ 1,414,038 $ 123,483 8.7 % Homes closed 3,827 3,552 275 7.7 % Average sales price $ 401.8 $ 398.1 $ 3.7 0.9 % 25 Home Orders (1) Three Months Ended September 30, Quarter over Quarter 2023 2022 Change $ Change % Total Dollars $ 1,495,542 $ 974,314 $ 521,228 53.5 % Homes ordered 3,474 2,310 1,164 50.4 % Average sales price $ 430.5 $ 421.8 $ 8.7 2.1 % West Region Dollars $ 521,049 $ 241,098 $ 279,951 116.1 % Homes ordered 985 456 529 116.0 % Average sales price $ 529.0 $ 528.7 $ 0.3 0.1 % Central Region Dollars $ 425,165 $ 253,321 $ 171,844 67.8 % Homes ordered 1,099 635 464 73.1 % Average sales price $ 386.9 $ 398.9 $ (12.0) (3.0) % East Region Dollars $ 549,328 $ 479,895 $ 69,433 14.5 % Homes ordered 1,390 1,219 171 14.0 % Average sales price $ 395.2 $ 393.7 $ 1.5 0.4 % Nine Months Ended September 30, Quarter over Quarter 2023 2022 Change $ Change % Total Dollars $ 4,477,148 $ 4,551,894 $ (74,746) (1.6) % Homes ordered 10,301 9,951 350 3.5 % Average sales price $ 434.6 $ 457.4 $ (22.8) (5.0) % West Region Dollars $ 1,672,310 $ 1,486,674 $ 185,636 12.5 % Homes ordered 3,261 2,636 625 23.7 % Average sales price $ 512.8 $ 564.0 $ (51.2) (9.1) % Central Region Dollars $ 1,286,063 $ 1,293,282 $ (7,219) (0.6) % Homes ordered 3,237 3,027 210 6.9 % Average sales price $ 397.3 $ 427.2 $ (29.9) (7.0) % East Region Dollars $ 1,518,775 $ 1,771,938 $ (253,163) (14.3) % Homes ordered 3,803 4,288 (485) (11.3) % Average sales price $ 399.4 $ 413.2 $ (13.8) (3.3) % (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. 26 Order Backlog (1) At September 30, Quarter over Quarter 2023 2022 Change $ Change % Total Dollars $ 1,558,637 $ 2,826,759 $ (1,268,122) (44.9) % Homes in backlog 3,608 6,064 (2,456) (40.5) % Average sales price $ 432.0 $ 466.2 $ (34.2) (7.3) % West Region Dollars $ 579,787 $ 905,080 $ (325,293) (35.9) % Homes in backlog 1,179 1,627 (448) (27.5) % Average sales price $ 491.8 $ 556.3 $ (64.5) (11.6) % Central Region Dollars $ 370,279 $ 790,227 $ (419,948) (53.1) % Homes in backlog 956 1,766 (810) (45.9) % Average sales price $ 387.3 $ 447.5 $ (60.2) (13.5) % East Region Dollars $ 608,571 $ 1,131,452 $ (522,881) (46.2) % Homes in backlog 1,473 2,671 (1,198) (44.9) % Average sales price $ 413.2 $ 423.6 $ (10.4) (2.5) % (1) Our backlog represents net home orders that have not closed. Active Communities and Cancellation Rates Active Communities Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 2023 2022 Ending Average Ending Average Ending Average Ending Average Total 272 281.5 275 289.0 272 278.4 275 276.7 West Region 84 91.0 102 104.5 84 93.1 102 92.1 Central Region 82 82.0 74 77.0 82 81.8 74 75.6 East Region 106 108.5 99 107.5 106 103.5 99 109.0 Cancellation Rates (2) Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 2023 2022 Total 11 % 30 % 13 % 16 % West Region 14 % 43 % 14 % 21 % Central Region 13 % 37 % 14 % 20 % East Region 8 % 18 % 11 % 10 % (2) Cancellation rates are computed as the number of canceled units for the period divided by the gross sales units for the same period. 27 Operating Results Companywide . We had our highest third quarter home closing revenue and volume in Company history, improving 2.6% and 4.3%, respectively, over prior year, with 3,638 closings valued at $1.6 billion for the three months ended September 30, 2023, compared to 3,487 closings valued at $1.6 billion in 2022. Despite entering the 2023 third quarter with lower backlog than prior year, home closing volume increased over the third quarter of 2022 due to a backlog conversion rate of 96.4% versus 48.2% in the prior year. The improvement in backlog conversion was bolstered by reduced cycle times combined with 31.6% of our third quarter 2023 home closings also being sold within the same quarter. Order cancellations of 11% for the third quarter of 2023 improved greatly from 30% in the third quarter of 2022, resulting in a 50.4% increase in home order volume of 3,474 homes, compared to 2,310 homes in the third quarter of 2022, and our orders pace improved 51.9% to 4.1 per month from 2.7 per month. ASP on orders increased 2.1% due to geographic mix, which combined with the higher order volume for a 53.5% increase in home order value of $1.5 billion. For the nine months ended September 30, 2023, home closing revenue of $4.4 billion increased 4.5% from $4.2 billion, due to a 4.8% increase in home closing volume to 10,025, up from 9,566 homes in the prior year period, as ASP on closings was relatively flat. Home order volume of 10,301 increased 3.5% from prior year due primarily to a 2.5% increase in orders pace of 4.1 homes per month, up from 4.0 in 2022, on a relatively consistent average active community count. Despite the increase in order volume, home order value decreased 1.6% from prior year due to increased incentives that caused ASP on orders to decline 5.0%. We ended the third quarter of 2023 with 272 actively selling communities, down from 275 at September 30, 2022. At September 30, 2023, we had 3,608 homes in backlog valued at $1.6 billion, down from 6,064 units valued at $2.8 billion at September 30, 2022, due to a higher backlog conversion rate and improved cycle times. West . The West Region generated $606.8 million in home closing revenue on 1,172 homes in the third quarter of 2023, up from $590.0 million on 1,086 homes in the prior year period. The 7.9% increase in volume resulted in a 2.8% increase in home closing revenue, as ASP on closings decreased 4.7% due to higher incentives. Home orders in the third quarter of 2023 of 985 were up 116.0% from 456 in the prior year, as the buyer hesitancy and elevated cancellations in the third quarter of 2022 have dramatically lessened as the economy stabilizes coupled with increased incentives to alleviate affordability concerns. The West Region cancellation rate of 14% in the third quarter of 2023 improved from 43% in the prior year, resulting in a 140.0% higher orders pace of 3.6 homes per month in the third quarter of 2023 compared 1.5 per month in 2022. This accelerated orders pace contributed to a 12.9% decrease in average active communities due to early close outs. Home order value of $521.0 million for the third quarter of 2023 increased proportionately with order volume, as ASP on orders remained consistent. For the nine months ended September 30, 2023, home closing revenue of $1.5 billion was consistent with prior year, as a 2.7% increase in home closing volume was offset by a 2.4% decrease in ASP on closings. Order volume in the West Region increased 23.7% year-to-date driven by a return to more normalized demand. With just a 1.1% increase in average active communities, year-to-date orders pace of 3.9 homes per month improved 21.9% compared to 2022, although last year's orders pace was negatively impacted by elevated cancellations. Home order value of $1.7 billion was up 12.5% from 2022 due to higher volume, offset by a 9.1% decrease in ASP on orders caused by increased buyer financing incentives. The year-to-date cancellation rate of 14% was down from 21% in the prior year period. The West Region ended the third quarter of 2023 with 1,179 homes in backlog valued at $579.8 million, compared to 1,627 units valued at $905.1 million at September 30, 2022, decreases of 27.5% and 35.9%, respectively. Central . The Central Region closed 1,102 homes in the three months ended September 30, 2023, down 9.5% from 1,218 home closings in 2022, which was the Region's highest quarterly home closings in its history. Home closing revenue of $452.7 million decreased 9.4% due to lower home closing volume as ASP on closings was flat. The Central Region cancellation rate of 13% in the third quarter of 2023 was down from 37% in the third quarter of 2022, resulting in significant improvement in home order volume and orders pace. Home order volume increased 73.1% to 1,099 homes in the third quarter of 2023 due to a 6.5% increase in average active communities coupled with a 66.7% increase in orders pace to 4.5 homes per month from 2.7 in 2022. Order value of $425.2 million in the three months ended September 30, 2023 increased 67.8% from $253.3 million in the third quarter of 2022 due to entirely to the higher order volume, as the Region experienced a 3.0% decrease in ASP on orders resulting from higher incentives year over year. Year-to-date, Central Region home closing revenue of $1.3 billion on 3,244 home closings increased 5.1% and 3.3%, respectively, from the nine months ended September 30, 2022, and ASP on home closings increased 1.7%, buoyed by favorable results in the first half of 2023 which more than offset the difficult third quarter comparisons. Home order volume of 3,237 for the nine months ended September 30, 2023 increased 6.9% because of a higher average active community count, as orders pace of 4.4 homes per month was consistent with the same period in 2022. ASP on orders declined 7.0% year-over-year, resulting in a 0.6% decrease in order value of $1.3 billion. The year-to-date cancellation rate of 14% was down from 20% in the prior year. The Central Region ended the quarter with 956 units in backlog valued at $370.3 million, down 45.9% and 53.1%, respectively, compared to September 30, 2022. 28 East . During the three months ended September 30, 2023, the East Region closed 1,364 homes for $550.8 million in home closing revenue, compared to 1,183 closings and $479.3 million in the comparable prior year period. The 15.3% increase in home closing volume resulted in a 14.9% improvement in home closing revenue while ASP on closings held steady. Home orders of 1,390 valued at $549.3 million for the third quarter of 2023 increased 14.0% and 14.5%, respectively, due to a 13.2% increase in orders pace of 4.3 homes per month coupled with a relatively flat average active community count. ASP on orders was up just slightly from 2022 due to geographic mix. The cancellation rate of 8% in the third quarter of 2023 improved from 18% in 2022. For the nine months ended September 30, 2023, the East Region delivered 3,827 home closings for $1.5 billion in home closing revenue, up 7.7% and 8.7%, respectively, compared to the 2022 period, with a 0.9% improvement in ASP on closings. Order volume decreased 11.3% due to the combined impact of a 5.0% decrease in average active communities and a 6.8% decrease in orders pace for the nine months ended September 30, 2023. Order value of $1.5 billion decreased 14.3% year over year due to decreased volume and a 3.3% decrease in ASP on orders. Year-to-date, the East Region's cancellation rate of 11% is up slightly from 10% in the prior year, although still in line with historically normal rates. The East Region ended the third quarter of 2023 with 1,473 homes in backlog valued at $608.6 million, down 44.9% and 46.2%, respectively, from 2,671 homes valued at $1.1 billion at September 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 $2.8 million and $9.0 million and gross profit of $0.2 million and $0.4 million for the three months ending September 30, 2023 and 2022, respectively. Year-to-date land sales resulted in profits of $1.9 million and $11.9 million for 2023 and 2022, respectively. Other Operating Information (dollars in thousands) Three Months Ended September 30, Nine Months Ended September 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 $ 429,575 26.7 % $ 450,638 28.7 % $ 1,089,016 24.7 % $ 1,273,026 30.1 % West $ 141,632 23.3 % $ 156,999 26.6 % $ 311,267 20.2 % $ 449,632 29.2 % Central $ 128,387 28.4 % $ 150,337 30.1 % $ 360,529 27.0 % $ 390,281 30.7 % East $ 159,556 29.0 % $ 143,302 29.9 % $ 417,220 27.1 % $ 433,113 30.6 % (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 . Home closing gross profit for the third quarter of 2023 was $429.6 million with a home closing gross margin of 26.7%, down 200 basis points from 28.7% in the third quarter of 2022, due to increased buyer financing incentives and higher land development costs, partially offset by costs savings from shorter construction cycle times as direct costs were relatively flat year over year. Home closing gross margin in the third quarter of 2022 included $8.8 million in charges associated with the termination of land purchase agreements, while only $0.2 million of such charges were recorded in third quarter of 2023. For the nine months ended September 30, 2023, gross profit of $1.1 billion and gross margin of 24.7% decreased from $1.3 billion and 30.1% in 2022 due to the combined impact of higher direct costs and increased sales incentives. West. The West Region home closing gross margin of 23.3% for the third quarter of 2023 declined 330 basis points from 26.6% in the third quarter of 2022. The West Region contains some of our most expensive markets that were most impacted by 29 the volatile economic conditions that began in the latter half of 2022, both in terms of ASP as well as land costs, and has led us to offering significant incentives to assist homebuyers with monthly affordability. The home closing gross margin for the third quarter of 2023 was impacted by these higher incentives and land development costs. For the nine months ended September 30, 2023, the West Region home closing gross margin of 20.2% declined from 29.2% in the 2022 period due to higher incentives and elevated cost of production and land development. Central. The Central Region's third quarter 2023 home closing gross margin of 28.4% decreased from 30.1% in the prior year quarter, due to elevated incentives and increased land development costs. Year-to-date, the Central Region gross margin of 27.0% in 2023 is down from 30.7%, mostly as a result of elevated sales incentives. East. The East Region had the highest home closing gross margin in the Company, at 29.0% in the third quarter of 2023, a 90 basis point decline from 29.9% for the comparable 2022 period. With relatively consistent direct costs, the East Region margin decline is due almost entirely to increased financing incentives. The East Region's year-to-date home closing gross margin of 27.1% is down from 30.6% in 2022 as a result of higher sales incentives. Financial Services Profit (in thousands) Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 2023 2022 Financial services profit $ 5,700 $ 4,842 $ 6,066 $ 12,255 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 of $5.7 million in the three months ended September 30, 2023 increased from $4.8 million in the comparable prior year period due to higher home closing volume. Financial services profit for the nine months ended September 30, 2023 decreased $6.2 million year over year, due primarily to $7.9 million in charges in the second quarter of 2023 related to unused prepaid interest rate locks that expired. Selling, General and Administrative Expenses and Other Expenses (dollars in thousands) Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 2023 2022 Commissions and other sales costs $ (99,122) $ (77,884) $ (277,766) $ (212,807) Percent of home closing revenue 6.2 % 5.0 % 6.3 % 5.0 % General and administrative expenses $ (63,091) $ (48,443) $ (162,750) $ (136,370) Percent of home closing revenue 3.9 % 3.1 % 3.7 % 3.2 % Interest expense $ — $ — $ — $ (41) Other income/(expense), net $ 13,331 $ (74) $ 35,037 $ (849) Loss on early extinguishment of debt $ (907) $ — $ (907) $ — Provision for income taxes $ (63,974) $ (67,002) $ (150,664) $ (217,242) 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 $21.2 million to $99.1 million in the three months ended September 30, 2023, due to higher home closing revenue and increased broker commissions. As a percentage of home closing revenue, Commissions and other sales costs were up 120 basis points to 6.2% of home closing revenue in the third quarter of 2023 from 5.0% in 2022, due to increased commission rates reflective of the current sales environment as well as a higher external broker participation rate. For the nine months ended September 30, 2023, Commissions and other sales costs of $277.8 million were 6.3% of home closing revenue, increasing $65.0 million and 130 basis points, respectively, due to increased 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 September 30, 2023, General and administrative expenses of $63.1 million increased $14.6 million from $48.4 million in 2022, and as a percentage of home closing revenue increased 80 basis points to 3.9% from 3.1%. The increase in both dollars and as a percentage of home closing revenue is largely due to higher compensation costs, including increases as part of new and growing market operations, some of which are not yet producing offsetting earnings, as well as competitive pay adjustments to reflect current market conditions in many of our geographies. For the nine months ended September 30, 2023, General and 30 administrative expenses were $162.8 million, up $26.4 million and 50 basis points from $136.4 million in the 2022 period, due primarily to higher compensation costs and increased spending on technology and insurance. 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 nine months ended September 30, 2023 as all interest was capitalized to qualifying assets. We recognized no interest expense in the three months ended September 30, 2022, and interest expense of $41,000 for the nine months ended September 30, 2022. Other Income/(Expense), Net. Other income, net, primarily consists of (i) interest earned on our cash and cash equivalents, (ii) sublease income, (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 nine months ended September 30, 2023, Other income was $13.3 million and $35.0 million, respectively, compared to net other expense of $0.1 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. Loss on Early Extinguishment of Debt. Loss on early extinguishment of debt of $0.9 million for the three and nine months ended September 30, 2023 is related to the $150.0 million partial redemption of our 2025 Notes. There were no similar charges for the three and nine months ended September 30, 2022. See Note 6 to the unaudited consolidated financial statements included in this report for more information related to the partial redemption of our 2025 Notes. Income Taxes. Our effective tax rate was 22.4% and 20.3% for the three months ended September 30, 2023 and 2022, respectively, and 21.8% and 22.9% for the nine months ended September 30, 2023 and 2022, respectively. The higher effective tax rate for the three months ended September 30, 2023 is due to the catch-up of energy-efficient homes tax credits on qualifying homes under the IRC §45L energy-efficient homes federal tax credit from the IRA that was enacted in the third quarter of 2022. The lower effective tax rate for the nine months ended September 30, 2023 reflects the increased per-home energy-efficiency credit amount starting in 2023. 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 senior notes, as we did this quarter with a $150.0 million partial redemption of our 2025 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 and we may curtail community count. 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 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. 31 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, common stock repurchases and payments of dividends. We expect our existing and future generated cash will be adequate to fund our ongoing operating activities as well as provide 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 September 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 September 30, 2023 or December 31, 2022. Operating Cash Flow Activities During the nine months ended September 30, 2023, net cash provided by operating activities totaled $460.1 million, compared to net cash used in operations of $169.8 million during the nine months ended September 30, 2022. Operating cash flows in the first nine months of 2023 benefited from cash generated from net earnings of $539.9 million and were partially offset by a $137.5 million increase in real estate. Operating cash flows in the first nine months of 2022 benefited from cash generated from net earnings of $729.8 million and an increase in accounts payable and accrued liabilities of $118.6 million due to timing of payments for routine transactions, offset by a $990.1 million increase in real estate and an $89.2 million increase in other receivables, prepaids and other assets. The increase in real estate in both periods was due to construction activities on a greater number of homes under construction, land acquisition and development activities. The increase in other receivables, prepaids and other assets for the first nine months of 2022 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. 32 Investing Cash Flow Activities During the nine months ended September 30, 2023 and 2022, net cash used in investing activities totaled $34.7 million and $24.9 million, respectively. Cash used in investing activities in both periods was mainly attributable to the purchases of property and equipment and investments in unconsolidated entities. Financing Cash Flow Activities During the nine months ended September 30, 2023 and 2022, net cash used in financing activities totaled $238.2 million and $124.3 million, respectively. The net cash used in financing activities in 2023 includes $150.0 million for the partial redemption of our 2025 Notes and associated early tender fees of $0.9 million, $55.0 million in share repurchases and $29.7 million of dividends paid. 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 September 30, 2023 December 31, 2022 Senior notes, net, loans payable and other borrowings $ 1,005,420 $ 1,150,647 Stockholders’ equity 4,421,042 3,949,611 Total capital $ 5,426,462 $ 5,100,258 Debt-to-capital (1) 18.5 % 22.6 % Senior notes, net, loans payable and other borrowings $ 1,005,420 $ 1,150,647 Less: cash and cash equivalents (1,048,755) (861,561) Net debt (43,335) 289,086 Stockholders’ equity 4,421,042 3,949,611 Total net capital $ 4,377,707 $ 4,238,697 Net debt-to-capital (2) (1.0) % 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 September 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 nine months ended September 30, 2023 totaled $0.81 per share. There were no such transactions in the three and nine months ended September 30, 2022. 33 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 September 30, 2023. Our actual financial covenant calculations as of September 30, 2023 are reflected in the table below. Financial Covenant (dollars in thousands): Covenant Requirement Actual Minimum Tangible Net Worth > $3,021,938 $4,376,362 Leverage Ratio < 60% (0.8)% Investments other than defined permitted investments < $1,337,909 $15,062 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.