ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For purposes of this Management’s Discussion and Analysis of Financial Condition and Results of Operation, references to “we,” “our,” “us” or similar terms refer to LGI Homes, Inc. and its subsidiaries.
Business Overview
We are engaged in the design, construction and sale of new homes in the following markets:
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West
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Northwest
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Central
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Midwest
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Florida
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Southeast
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Mid-Atlantic
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Phoenix, AZ
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Seattle, WA
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Houston, TX
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Minneapolis, MN
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Tampa, FL
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Atlanta, GA
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Washington, D.C.
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Tucson, AZ
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Portland, OR
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Dallas Ft. Worth, TX
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Orlando, FL
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Charlotte, NC
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Richmond, VA
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Albuquerque, NM
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Denver, CO
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San Antonio, TX
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Fort Myers, FL
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Raleigh, NC
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Las Vegas, NV
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Colorado Springs, CO
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Austin, TX
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Jacksonville, FL
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Wilmington, NC
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Northern CA
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Oklahoma City, OK
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Fort Pierce, FL
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Winston-Salem, NC
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Southern CA
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Daytona Beach, FL
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Columbia, SC
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Sarasota, FL
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Greenville, SC
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Birmingham, AL
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Nashville, TN
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Our management team has been in the residential land development business since the mid-1990s. Since commencing home building operations in 2003, we have constructed and closed over 40,000 homes. During the six months ended June 30, 2020, we had 3,840 home closings, compared to 3,172 home closings during the six months ended June 30, 2019.
We sell homes under the LGI Homes and Terrata Homes brands. Our 117 active communities at June 30, 2020 included three Terrata Homes communities.
During the three months ended June 30, 2020, we recorded $38.1 million in wholesale revenues as a result of 199 home closings, representing 9.9% of the total homes closed during the three months ended June 30, 2020. During the three months ended June 30, 2019, we recorded $18.4 million in wholesale revenues as a result of 82 wholesale home closings, representing 4.2% of the total homes closed during the three months ended June 30, 2019. We believe our wholesale home closings provide opportunities for us to leverage our systems and processes to meet the needs of companies looking to acquire multiple homes for rental purposes, primarily through bulk sales agreements.
COVID-19
On March 11, 2020, the World Health Organization declared the current outbreak of the novel strain of coronavirus (“COVID-19”) to be a global pandemic, and on March 13, 2020, the United States declared a national emergency. In response to these declarations and the rapid spread of COVID-19, federal, state and local governments have imposed varying degrees of restrictions on business and social activities to contain COVID-19, including business shutdowns and closures, travel restrictions, quarantines, curfews, shelter-in-place orders and “stay-at-home” orders in certain of our markets. State and local authorities have also implemented multi-step policies with the goal of re-opening. However, certain jurisdictions have begun re-opening only to return to restrictions in the face of increases in new COVID-19 cases. We have experienced resulting disruptions to our business operations, as these restrictions have significantly impacted many sectors of the economy, with businesses curtailing or ceasing normal operations. In March 2020, certain markets in which we do business temporarily stopped our construction of homes. Beginning in April 2020, we resumed construction of homes in those markets. Although we continued to build and sell homes in all of our markets, the pace of sales declined and we experienced an increase in the rate of contract cancellations. Since May 2020, the pace of sales has rebounded and we have experienced increased demand in our markets. There is considerable uncertainty regarding the extent to which COVID-19 will continue to spread and the extent and duration of governmental and other measures implemented to try to slow the spread of COVID-19, such as large-scale travel bans and restrictions, border closures, quarantines, shelter-in-place orders and business and government shutdowns. Restrictions of this nature have caused, and may continue to cause, us, our subcontractors, suppliers and other business counterparties to experience operational delays.
Demand for our homes is dependent on a variety of macroeconomic factors, such as employment levels, interest rates, changes in stock market valuations, consumer confidence, housing demand, availability of financing for home buyers, availability and prices of new homes compared to existing inventory, and demographic trends. These factors, and in particular consumer confidence, can be significantly adversely affected by a variety of factors beyond our control. The outbreak of COVID-19 has caused the shutdown of large portions of our national economy. The spread of COVID-19 has also caused significant volatility in U.S. and international debt and equity markets, which can negatively impact consumer confidence.
In response to COVID-19, we continue to take steps to prioritize the health and safety of our employees, customers, subcontractors and suppliers, including expanded safety policies and practices based on Center for Disease Control guidelines to reduce the spread of COVID-19. Additionally, the majority of our corporate personnel continue to work remotely.
As a homebuilder and developer, we provide an important service to our customers. During the COVID-19 outbreak, our main focus beyond the health and safety mentioned above, will be to continue our efforts to sell homes and complete our homes under construction. In addition to the measures discussed above, beginning in March 2020, we implemented certain cash management policies, including eliminating business air travel, cancelling group meetings, delaying or canceling land acquisitions, deferring new starts to manage our overall inventory, significantly reducing marketing expenditures and delaying major expenditures. In May 2020, we began to acquire land and release starts for home construction in addition to increasing marketing expenditures.
We cannot estimate with any degree of certainty the full impact of COVID-19 on our financial condition and future results of operations. We also cannot predict the full impact that the significant disruption and volatility currently being experienced in the markets will have on our business, cash flows, liquidity, financial condition and results of operations at this time, due to numerous uncertainties. The ultimate impacts of COVID-19 and related mitigation efforts will depend on future developments, including, but not limited to, the duration and geographic spread of COVID-19, the impact of government actions designed to prevent the spread of COVID-19, the development of effective treatments, actions taken by customers, subcontractors, suppliers and other third parties, workforce availability, and the timing and extent to which normal economic and operating conditions resume. For additional discussion regarding risks associated with the COVID-19 pandemic, see Item 1A. Risk Factors in Part II of this Quarterly Report on Form 10-Q. While we expect COVID-19 to continue to have an influence on our future results, we believe that the desire for single-family homes outside of densely populated urban areas combined with historically low mortgage rates and low availability of existing homes is driving an increase in demand for new homes.
Recent Developments
During the three months ended June 30, 2020, we increased our market presence in three of our operating segments with the opening of additional communities in Northern California, Seattle, Denver, and Raleigh.
Key Results
Key financial results as of and for the three months ended June 30, 2020, as compared to the three months ended June 30, 2019, were as follows:
•Home sales revenues increased 4.3% to $481.6 million from $461.8 million.
•Homes closed increased 3.1% to 2,005 homes from 1,944 homes.
•Average sales price of our homes increased 1.1% to $240,200 from $237,567
•Gross margin as a percentage of home sales revenues increased to 24.5% from 24.1%.
•Adjusted gross margin (non-GAAP) as a percentage of home sales revenues increased to 26.6% from 26.3%.
•Net income before income taxes increased 13.3% to $68.6 million from $60.5 million.
•Net income increased 20.8% to $55.6 million from $46.1 million.
•EBITDA (non-GAAP) as a percentage of home sales revenues increased to 16.1% from 15.1%.
•Adjusted EBITDA (non-GAAP) as a percentage of home sales revenues increased to 16.2% from 14.8%.
•Total owned and controlled lots decreased 11.9% to 44,307 lots at June 30, 2020 from 50,273 lots at March 31, 2020.
For reconciliations of the non-GAAP financial measures of adjusted gross margin, EBITDA and adjusted EBITDA to the most directly comparable GAAP financial measures, please see “—Non-GAAP Measures.”
Key financial results as of and for the six months ended June 30, 2020, as compared to the six months ended June 30, 2019, were as follows:
•Home sales revenues increased 24.9% to $936.3 million from $749.4 million.
•Homes closed increased 21.1% to 3,840 homes from 3,172 homes.
•Average sales price of our homes increased 3.2% to $243,836 from $236,262.
•Gross margin as a percentage of home sales revenues increased to 24.0% from 23.7%.
•Adjusted gross margin (non-GAAP) as a percentage of home sales revenues increased to 26.1% from 25.8%.
•Net income before income taxes increased 50.2% to $123.5 million from $82.2 million.
•Net income increased 52.9% to $98.5 million from $64.4 million.
•EBITDA (non-GAAP) as a percentage of home sales revenues increased to 15.1% from 12.9%.
•Adjusted EBITDA (non-GAAP) as a percentage of home sales revenues increased to 15.1% from 12.8%.
•Total owned and controlled lots decreased 7.8% to 44,307 lots at June 30, 2020 from 48,062 lots at December 31, 2019.
For reconciliations of the non-GAAP financial measures of adjusted gross margin, EBITDA and adjusted EBITDA to the most directly comparable GAAP financial measures, please see “—Non-GAAP Measures.”
Results of Operations
The following table sets forth our results of operations for the periods indicated:
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Three Months Ended June 30,
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Six Months Ended June 30,
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2020
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2019
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2020
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2019
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(dollars in thousands, except per share data and average home sales price)
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Statement of Income Data:
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Home sales revenues
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$
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481,602
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$
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461,830
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$
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936,329
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$
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749,424
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Expenses:
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Cost of sales
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363,629
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350,519
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711,792
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571,809
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Selling expenses
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29,960
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33,890
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62,723
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60,681
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General and administrative
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20,179
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18,980
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40,102
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37,418
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Operating income
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67,834
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58,441
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121,712
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79,516
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Loss on extinguishment of debt
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—
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169
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—
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169
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Other income, net
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(763)
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(2,263)
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(1,774)
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(2,882)
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Net income before income taxes
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68,597
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60,535
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123,486
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82,229
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Income tax provision
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12,973
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14,480
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25,023
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17,840
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Net income
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$
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55,624
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$
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46,055
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$
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98,463
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$
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64,389
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Basic earnings per share
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$
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2.22
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$
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2.01
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$
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3.91
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$
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2.82
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Diluted earnings per share
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$
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2.21
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$
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1.82
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$
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3.88
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$
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2.55
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Other Financial and Operating Data:
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Average Community Count
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116.0
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93.0
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112.3
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88.7
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Community Count at end of period
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117
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93
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117
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93
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Home closings
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2,005
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1,944
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3,840
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3,172
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Average sales price of homes closed
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$
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240,200
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$
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237,567
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$
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243,836
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$
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236,262
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Gross margin (1)
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$
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117,973
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$
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111,311
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$
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224,537
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$
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177,615
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Gross margin % (2)
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24.5
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%
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24.1
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%
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24.0
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%
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23.7
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%
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Adjusted gross margin (3)
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$
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127,909
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$
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121,256
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$
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244,026
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$
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193,584
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Adjusted gross margin % (2)(3)
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26.6
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%
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26.3
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%
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26.1
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%
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25.8
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%
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EBITDA (4)
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$
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77,437
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$
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69,685
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$
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141,417
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$
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96,938
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EBITDA margin % (2)(4)
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16.1
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%
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15.1
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%
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15.1
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%
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12.9
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%
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Adjusted EBITDA (4)
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$
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77,926
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$
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68,547
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$
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141,518
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$
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95,811
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Adjusted EBITDA margin % (2)(4)
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16.2
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%
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14.8
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%
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15.1
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%
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12.8
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%
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(1)Gross margin is home sales revenues less cost of sales.
(2)Calculated as a percentage of home sales revenues.
(3)Adjusted gross margin is a non-GAAP financial measure used by management as a supplemental measure in evaluating operating performance. We define adjusted gross margin as gross margin less capitalized interest and adjustments resulting from the application of purchase accounting included in the cost of sales. Our management believes this information is useful because it isolates the impact that capitalized interest and purchase accounting adjustments have on gross margin. However, because adjusted gross margin information excludes capitalized interest and purchase accounting adjustments, which have real economic effects and could impact our results, the utility of adjusted gross margin information as a measure of our operating performance may be limited. In addition, other companies may not calculate adjusted gross margin information in the same manner that we do. Accordingly, adjusted gross margin information should be considered only as a supplement to gross margin information as a measure of our performance. Please see “—Non-GAAP Measures” for a reconciliation of adjusted gross margin to gross margin, which is the GAAP financial measure that our management believes to be most directly comparable.
(4)EBITDA and adjusted EBITDA are non-GAAP financial measures used by management as supplemental measures in evaluating operating performance. We define EBITDA as net income before (i) interest expense, (ii) income taxes, (iii) depreciation and amortization and (iv) capitalized interest charged to the cost of sales. We define adjusted EBITDA as net income before (i) interest expense, (ii) income taxes, (iii) depreciation and amortization, (iv) capitalized interest charged to the cost of sales, (v) loss on extinguishment of debt, (vi) other income, net and (vii) adjustments resulting from the application of purchase accounting. Our management believes that the presentation of EBITDA and adjusted EBITDA provides useful information to investors regarding our results of operations because it assists both investors and management in analyzing and benchmarking the performance and value of our business. EBITDA and adjusted EBITDA provide indicators of general economic performance that are not affected by fluctuations in interest rates or effective tax rates, levels of depreciation or amortization and items considered to be unusual or non-recurring. Accordingly, our management believes that these measures are useful for comparing general operating performance from period to period. Other companies may define these measures differently and, as a result, our measures of EBITDA and adjusted EBITDA may not be directly comparable to the measures of other companies. Although we use EBITDA and adjusted EBITDA as financial measures to assess the performance of our business, the use of these measures is limited because they do not include certain material costs, such as interest and taxes, necessary to operate our business. EBITDA and adjusted EBITDA should be considered in addition to, and not as a substitute for, net income in accordance with GAAP as a measure of performance. Our presentation of EBITDA and adjusted EBITDA should not be construed as an indication that our future results will be unaffected by unusual or non-recurring items. Our use of EBITDA and adjusted EBITDA is limited as an analytical tool, and you should not consider these measures in isolation or as substitutes for analysis of our results as reported under GAAP. Please see “—Non-GAAP Measures” for reconciliations of EBITDA and adjusted EBITDA to net income, which is the GAAP financial measure that our management believes to be most directly comparable.
Three Months Ended June 30, 2020 Compared to Three Months Ended June 30, 2019
Homes Sales. Our home sales revenues, home closings, average sales price (ASP), average community count, average monthly absorption rate and closing community count by reportable segment for the three months ended June 30, 2020 and 2019 were as follows (revenues in thousands):
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Three Months Ended June 30, 2020
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Revenues
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Home Closings
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ASP
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Average Community Count
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Average
Monthly
Absorption Rate
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Central
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$
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167,924
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|
747
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$
|
224,798
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34.0
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7.3
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Southeast
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|
128,577
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|
559
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230,013
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37.3
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|
5.0
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Northwest
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56,369
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|
|
153
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368,425
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11.3
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|
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4.5
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West
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60,592
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|
236
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256,746
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15.3
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|
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5.1
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Florida
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|
68,140
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|
310
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219,806
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18.0
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|
|
5.7
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Total
|
|
$
|
481,602
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|
2,005
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$
|
240,200
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|
|
116.0
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|
|
5.8
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|
|
Three Months Ended June 30, 2019
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|
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|
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Revenues
|
|
Home Closings
|
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ASP
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|
Average Community Count
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Average
Monthly
Absorption Rate
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Central
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|
$
|
189,894
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|
|
888
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|
|
$
|
213,845
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|
|
33.3
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|
|
8.9
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Southeast
|
|
77,820
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|
|
360
|
|
|
216,167
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|
|
24.0
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|
|
5.0
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|
Northwest
|
|
78,996
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|
|
214
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|
|
369,140
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|
|
11.0
|
|
|
6.5
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|
West
|
|
66,933
|
|
|
248
|
|
|
269,891
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|
|
13.0
|
|
|
6.4
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|
Florida
|
|
48,187
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|
|
234
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|
|
205,927
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|
|
11.7
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|
|
6.7
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|
Total
|
|
$
|
461,830
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|
|
1,944
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$
|
237,567
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|
|
93.0
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|
|
7.0
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of June 30,
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Community count
|
2020
|
|
2019
|
Central
|
34
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|
|
33
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Southeast
|
38
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|
|
24
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|
Northwest
|
12
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|
|
11
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|
West
|
15
|
|
|
13
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|
Florida
|
18
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|
|
12
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|
Total community count
|
117
|
|
|
93
|
|
While direct immediate impacts related to the COVID-19 pandemic remain short lived to date, we believe that the long term effects of the pandemic will take an extended time to work through our operational results. Although our home closings for the second quarter of 2020 were higher than our home closing for the second quarter of 2019, shutdowns and stay-at-home orders slowed the pace of our sales in March 2020 and April 2020, which ultimately resulted in home closings during the second quarter of 2020 being lower than we would have predicted prior to the pandemic. Additionally, as a result of reducing starts in March 2020 and April 2020 to preserve cash, our availability of completed homes was reduced, which could slow the pace of our home closings in later periods.
Home sales revenues for the three months ended June 30, 2020 were $481.6 million, an increase of $19.8 million, or 4.3%, from $461.8 million for the three months ended June 30, 2019. The increase in home sales revenues is primarily due to a 3.1% increase in homes closed and an increase in the average sales price per home during the three months ended June 30, 2020 as compared to the three months ended June 30, 2019. The average sales price per home closed during the three months ended June 30, 2020 was $240,200, an increase of $2,633, or 1.1%, from the average sales price per home of $237,567 for the three months ended June 30, 2019. This increase in the average sales price per home is primarily due to changes in product mix, higher price points in new markets and a favorable pricing environment. The increase in homes closed was largely due to
deepening our presence within certain markets in the Southeast and Florida reportable segments during the three months ended June 30, 2020 as compared to the three months ended June 30, 2019.
Home sales revenues in our Central reportable segment decreased by $22.0 million, or 11.6%, during the three months ended June 30, 2020 as compared to the three months ended June 30, 2019, primarily due to a 15.9% decrease in the number of homes closed, partially offset by an increase in the average sales price per home in this segment. Home sales revenues in our Southeast reportable segment increased by $50.8 million, or 65.2%, primarily due to an increase in community count within existing markets. Home sales revenues in our Northwest reportable segment decreased by $22.6 million, or 28.6%, primarily due to a decrease in the number of homes closed and due to the close out of or transition between, and to a lesser extent available inventory in, certain active communities for the three months ended June 30, 2020 as compared to the three months ended June 30, 2019. Home sales revenues in our West reportable segment decreased by $6.3 million, or 9.5%, during the three months ended June 30, 2020 as compared to the three months ended June 30, 2019, primarily due to a 4.9% decrease in average sales price and a 4.8% decrease in the number of homes closed in this reportable segment, as a result of close out of or transition between, and to a lesser extent available inventory in, certain active communities. Home sales revenues in our Florida reportable segment increased by $20.0 million, or 41.4%, largely due to an increase in the number of homes closed resulting from an increase in community count for the three months ended June 30, 2020 as compared to the three months ended June 30, 2019. Our community count at June 30, 2020 increased to 117 from 93 at June 30, 2019. All reportable segments added communities by deepening our presence within existing markets during the three months ended June 30, 2020.
Cost of Sales and Gross Margin (home sales revenues less cost of sales). Cost of sales increased for the three months ended June 30, 2020 to $363.6 million, an increase of $13.1 million, or 3.7%, from $350.5 million for the three months ended June 30, 2019, primarily due to the increase in homes closed and product mix. As a percentage of home sales revenues, we experienced higher lot costs offset by lower capitalized interest costs and operating leverage driven by the increase in home sales revenues benefiting our home construction costs during the three months ended June 30, 2020 as compared to the three months ended June 30, 2019. Gross margin for the three months ended June 30, 2020 was $118.0 million, an increase of $6.7 million, or 6.0%, from $111.3 million for the three months ended June 30, 2019. Gross margin as a percentage of home sales revenues was 24.5% for the three months ended June 30, 2020 and 24.1% for the three months ended June 30, 2019. This increase in gross margin as a percentage of home sales revenues is primarily due to operating leverage and lower capitalized interest costs recognized for the three months ended June 30, 2020 as compared to the three months ended June 30, 2019.
Selling Expenses. Selling expenses for the three months ended June 30, 2020 were $30.0 million, a decrease of $3.9 million, or 11.6%, from $33.9 million for the three months ended June 30, 2019. Sales commissions remained flat at $18.0 million for both the three months ended June 30, 2020 and 2019. Selling expenses as a percentage of home sales revenues were 6.2% and 7.3% for the three months ended June 30, 2020 and 2019, respectively. The decrease in selling expenses as a percentage of home sales revenues reflects cost saving measures implemented and the increased demand for our homes in response to the COVID-19 pandemic, as well as operating leverage realized from the increase in home sales revenues during the three months ended June 30, 2020 as compared to the three months ended June 30, 2019.
General and Administrative. General and administrative expenses for the three months ended June 30, 2020 were $20.2 million, an increase of $1.2 million, or 6.3%, from $19.0 million for the three months ended June 30, 2019. The increase in the amount of general and administrative expenses is primarily due to increased personnel associated with an increase of active communities during the three months ended June 30, 2020 as compared to the three months ended June 30, 2019. General and administrative expenses as a percentage of home sales revenues were 4.2% and 4.1% for the three months ended June 30, 2020 and 2019, respectively. The increase in general and administrative expenses as a percentage of home sales revenues reflects costs associated with an increase of active communities during the three months ended June 30, 2020 as compared to the three months ended June 30, 2019.
Operating Income, Net Income before Taxes and Net Income. Operating income for the three months ended June 30, 2020 was $67.8 million, an increase of $9.4 million, or 16.1%, from $58.4 million for the three months ended June 30, 2019. Net income before income taxes for the three months ended June 30, 2020 was $68.6 million, an increase of $8.1 million, or 13.3%, from $60.5 million for the three months ended June 30, 2019. All reportable segments contributed to net income before income taxes during the three months ended June 30, 2020 as follows: Central - $29.6 million or 43.2%; Southeast - $16.9 million or 24.6%; Northwest - $8.5 million or 12.4%; West - $6.9 or 10.1%; and Florida - $7.9 or 11.5%. Net income for the three months ended June 30, 2020 was $55.6 million, an increase of $9.6 million, or 20.8%, from $46.1 million for the three months ended June 30, 2019. The increases in operating income, net income before income taxes and net income is primarily attributed to operating leverage realized from the increase in home sales revenues, higher average sales price and retroactive tax benefit recognized for the three months ended June 30, 2020 as compared to the three months ended June 30, 2019.
Six Months Ended June 30, 2020 Compared to Six Months Ended June 30, 2019
Homes Sales. Our home sales revenues, home closings, average sales price (ASP), average community count and average monthly absorption rate by reportable segment for the six months ended June 30, 2020 and 2019 were as follows (revenues in thousands):
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Six Months Ended June 30, 2020
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Revenues
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Home Closings
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ASP
|
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Average Community Count
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Average
Monthly
Absorption Rate
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Central
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$
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333,699
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1,488
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$
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224,260
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34.0
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7.3
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Southeast
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217,024
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962
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225,597
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34.2
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4.7
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Northwest
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158,317
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426
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371,636
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11.8
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6.0
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West
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119,077
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472
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252,282
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15.0
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5.2
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Florida
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108,212
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492
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219,943
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17.3
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4.7
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Total
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$
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936,329
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3,840
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$
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243,836
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112.3
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5.7
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Six Months Ended June 30, 2019
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Revenues
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Home Closings
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ASP
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Average Community Count
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Average Monthly
Absorption Rate
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Central
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$
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314,091
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1,466
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$
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214,250
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32.7
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7.5
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Southeast
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130,234
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590
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220,736
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21.5
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4.6
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Northwest
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115,250
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313
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368,211
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11.0
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4.7
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West
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112,750
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427
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264,052
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12.2
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5.8
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Florida
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77,099
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376
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205,051
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11.3
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5.5
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Total
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$
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749,424
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3,172
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$
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236,262
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88.7
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6.0
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Home sales revenues for the six months ended June 30, 2020 were $936.3 million, an increase of $186.9 million, or 24.9%, from $749.4 million for the six months ended June 30, 2019. The increase in home sales revenues is primarily due to a 21.1% increase in homes closed and an increase in the average sales price per home during the six months ended June 30, 2020 as compared to the six months ended June 30, 2019. The average sales price per home closed during the six months ended June 30, 2020 was $243,836, an increase of $7,574, or 3.2%, from the average sales price per home of $236,262 for the six months ended June 30, 2019. This increase in the average sales price per home was primarily due to changes in product mix and higher price points in certain new markets, partially offset by additional wholesale home closings. All reportable segments experienced an increase in home closings during the six months ended June 30, 2020 as compared to the six months ended June 30, 2019. The average monthly absorption rate fluctuations relate to timing associated with the opening, close out or transition between certain active communities during the six months ended June 30, 2020 as compared to the six months ended June 30, 2019.
Home sales revenues in our Central reportable segment increased by $19.6 million, or 6.2%, during the six months ended June 30, 2020 as compared to the six months ended June 30, 2019, primarily due to a 1.5% increase in the number of homes closed in this reportable segment, increased average sales price and increased community count at a slightly lower absorption rate. Home sales revenues in our Southeast reportable segment increased by $86.8 million, or 66.6%, during the six months ended June 30, 2020 as compared to the six months ended June 30, 2019, primarily due to an increase in community count associated with deepening our presence within existing markets and to a lesser extent our geographic expansion into certain markets in South Carolina and Virginia at June 30, 2020 as compared to June 30, 2019. Home sales revenues in our Northwest reportable segment increased by $43.1 million, or 37.4%, during the six months ended June 30, 2020 as compared to the six months ended June 30, 2019, primarily due to a 36.1% increase in the number of homes closed in this reportable segment, which is due to close out of or transition between certain active communities during the six months ended June 30, 2019. Home sales revenues in our West reportable segment increased by $6.3 million, or 5.6%, during the six months ended June 30, 2020 as compared to the six months ended June 30, 2019, primarily due to a 10.5% increase in the number of homes closed in this reportable segment, offset by a 4.5% decrease in average sales price as a result of close out of or transition between, and to a
lesser extent available inventory in, certain active communities. Home sales revenues in the Florida reportable segment increased, largely due to increased community count at a slightly lower absorption rate during the six months ended June 30, 2020 as compared to the six months ended June 30, 2019.
Cost of Sales and Gross Margin (home sales revenues less cost of sales). Cost of sales increased for the six months ended June 30, 2020 to $711.8 million, an increase of $140.0 million, or 24.5%, from $571.8 million for the six months ended June 30, 2019. This overall increase is primarily due to a 21.1% increase in homes closed and product mix. As a percentage of home sales revenues, we experienced higher lot costs offset by lower capitalized interest costs and operating leverage driven by the increase in home sales revenues benefiting our home construction costs during the six months ended June 30, 2020 as compared to the six months ended June 30, 2019. Gross margin for the six months ended June 30, 2020 was $224.5 million, an increase of $46.9 million, or 26.4%, from $177.6 million for the six months ended June 30, 2019. Gross margin as a percentage of home sales revenues was 24.0% for the six months ended June 30, 2020 and 23.7% for the six months ended June 30, 2019. This increase in gross margin as a percentage of home sales revenues for the six months ended June 30, 2020 as compared to the six months ended June 30, 2019 is primarily due to higher average sales price fueled by our product mix, favorable pricing environments and operating leverage obtained, partially offset by an increase in wholesale home closings as a percentage of total home closings.
Selling Expenses. Selling expenses for the six months ended June 30, 2020 were $62.7 million, an increase of $2.0 million, or 3.4%, from $60.7 million for the six months ended June 30, 2019. Sales commissions increased to $34.5 million for the six months ended June 30, 2020 from $29.7 million for the six months ended June 30, 2019, partially due to a 24.9% increase in home sales revenues during the six months ended June 30, 2020 as compared to the six months ended June 30, 2019. Selling expenses as a percentage of home sales revenues were 6.7% and 8.1% for the six months ended June 30, 2020 and 2019, respectively. The decrease in selling expenses as a percentage of home sales revenues reflects operating leverage obtained from the increase in home sales revenues, our cost saving measures implemented and the increased demand for our homes in response to the COVID-19 pandemic. This decrease was partially offset by increased community count and increased personnel, during the six months ended June 30, 2020 as compared to the six months ended June 30, 2019.
General and Administrative. General and administrative expenses for the six months ended June 30, 2020 were $40.1 million, an increase of $2.7 million, or 7.2%, from $37.4 million for the six months ended June 30, 2019. The increase in the amount of general and administrative expenses is primarily due to increased personnel associated with an increase of active communities during the six months ended June 30, 2020 as compared to the six months ended June 30, 2019. General and administrative expenses as a percentage of home sales revenues were 4.3% and 5.0% for the six months ended June 30, 2020 and 2019, respectively. The decrease in general and administrative expenses as a percentage of home sales revenues reflects operating leverage realized from the increase in home sales revenues during the six months ended June 30, 2020 as compared to the six months ended June 30, 2019.
Operating Income, Net Income before Income Taxes and Net Income. Operating income for the six months ended June 30, 2020 was $121.7 million, an increase of $42.2 million, or 53.1%, from $79.5 million for the six months ended June 30, 2019. Net income before income taxes for the six months ended June 30, 2020 was $123.5 million, an increase of $41.3 million, or 50.2%, from $82.2 million for the six months ended June 30, 2019. All reportable segments contributed to net income before income taxes during the six months ended June 30, 2020 as follows: Central - $53.8 million or 43.6%; Southeast - $24.8 million or 20.1%; Northwest - $25.0 million or 20.2%; West - $12.2 million or 9.9%; and Florida - $10.4 million or 8.4%. Net income for the six months ended June 30, 2020 was $98.5 million, an increase of $34.1 million, or 52.9%, from $64.4 million for the six months ended June 30, 2019. The increases in operating income, net income before income taxes and net income is primarily attributed to an increase in the number of homes closed with an overall higher gross margin percentage, as a result of higher average sales price and retroactive tax benefit recognized during the six months ended June 30, 2020 as compared to the six months ended June 30, 2019.
Non-GAAP Measures
In addition to the results reported in accordance with accounting principles generally accepted in the United States (“GAAP”), we have provided information in this Quarterly Report on Form 10-Q relating to adjusted gross margin, EBITDA and adjusted EBITDA.
Adjusted Gross Margin
Adjusted gross margin is a non-GAAP financial measure used by management as a supplemental measure in evaluating operating performance. We define adjusted gross margin as gross margin less capitalized interest and adjustments resulting from the application of purchase accounting included in the cost of sales. Our management believes this information is useful because it isolates the impact that capitalized interest and purchase accounting adjustments have on gross margin. However, because adjusted gross margin information excludes capitalized interest and purchase accounting adjustments, which have real economic effects and could impact our results, the utility of adjusted gross margin information as a measure of our operating performance may be limited. In addition, other companies may not calculate adjusted gross margin information in the same manner that we do. Accordingly, adjusted gross margin information should be considered only as a supplement to gross margin information as a measure of our performance.
The following table reconciles adjusted gross margin to gross margin, which is the GAAP financial measure that our management believes to be most directly comparable (dollars in thousands):
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Three Months Ended June 30,
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Six Months Ended June 30,
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2020
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2019
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2020
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2019
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Home sales revenues
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$
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481,602
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$
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461,830
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$
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936,329
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$
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749,424
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Cost of sales
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363,629
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350,519
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711,792
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571,809
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Gross margin
|
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117,973
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|
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111,311
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|
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224,537
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|
|
177,615
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Capitalized interest charged to cost of sales
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8,684
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|
|
8,989
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|
17,614
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|
|
14,383
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|
Purchase accounting adjustments (1)
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1,252
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|
956
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|
|
1,875
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|
|
1,586
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Adjusted gross margin
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$
|
127,909
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|
|
$
|
121,256
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|
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$
|
244,026
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|
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$
|
193,584
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Gross margin % (2)
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24.5
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%
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24.1
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%
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24.0
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%
|
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23.7
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%
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Adjusted gross margin % (2)
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26.6
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%
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26.3
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%
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26.1
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%
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25.8
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%
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(1)Adjustments result from the application of purchase accounting for acquisitions and represent the amount of the fair value step-up adjustments included in cost of sales for real estate inventory sold after the acquisition dates.
(2)Calculated as a percentage of home sales revenues.
EBITDA and Adjusted EBITDA
EBITDA and adjusted EBITDA are non-GAAP financial measures used by management as supplemental measures in evaluating operating performance. We define EBITDA as net income before (i) interest expense, (ii) income taxes, (iii) depreciation and amortization and (iv) capitalized interest charged to the cost of sales. We define adjusted EBITDA as net income before (i) interest expense, (ii) income taxes, (iii) depreciation and amortization, (iv) capitalized interest charged to the cost of sales, (v) loss on extinguishment of debt, (vi) other income, net and (vii) adjustments resulting from the application of purchase accounting included in the cost of sales. Our management believes that the presentation of EBITDA and adjusted EBITDA provides useful information to investors regarding our results of operations because it assists both investors and management in analyzing and benchmarking the performance and value of our business. EBITDA and adjusted EBITDA provide indicators of general economic performance that are not affected by fluctuations in interest rates or effective tax rates, levels of depreciation or amortization and items considered to be unusual or non-recurring. Accordingly, our management believes that these measures are useful for comparing general operating performance from period to period. Other companies may define these measures differently and, as a result, our measures of EBITDA and adjusted EBITDA may not be directly comparable to the measures of other companies. Although we use EBITDA and adjusted EBITDA as financial measures to assess the performance of our business, the use of these measures is limited because they do not include certain material costs, such as interest and taxes, necessary to operate our business. EBITDA and adjusted EBITDA should be considered in addition to, and not as a substitute for, net income in accordance with GAAP as a measure of performance. Our presentation of EBITDA and adjusted EBITDA should not be construed as an indication that our future results will be unaffected by unusual or non-recurring items. Our use of EBITDA and adjusted EBITDA is limited as an analytical tool, and you should not consider these measures in isolation or as substitutes for analysis of our results as reported under GAAP. Some of these limitations are:
(i) they do not reflect every cash expenditure, future requirements for capital expenditures or contractual commitments, including for purchase of land;
(ii) they do not reflect the interest expense or the cash requirements necessary to service interest or principal payments on our debt;
(iii) although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced or require improvements in the future, and EBITDA and adjusted EBITDA do not reflect any cash requirements for such replacements or improvements;
(iv) they are not adjusted for all non-cash income or expense items that are reflected in our statements of cash flows;
(v) they do not reflect the impact of earnings or charges resulting from matters we consider not to be indicative of our ongoing operations; and
(vi) other companies in our industry may calculate them differently than we do, limiting their usefulness as a comparative measure.
Because of these limitations, our EBITDA and adjusted EBITDA should not be considered as measures of discretionary cash available to us to invest in the growth of our business or as measures of cash that will be available to us to meet our obligations. We compensate for these limitations by using our EBITDA and adjusted EBITDA along with other comparative tools, together with GAAP measures, to assist in the evaluation of operating performance. These GAAP measures include operating income, net income and cash flow data. We have significant uses of cash flows, including capital expenditures, interest payments and other non-recurring charges, which are not reflected in our EBITDA or adjusted EBITDA. EBITDA and adjusted EBITDA are not intended as alternatives to net income as indicators of our operating performance, as alternatives to any other measure of performance in conformity with GAAP or as alternatives to cash flows as a measure of liquidity. You should therefore not place undue reliance on our EBITDA or adjusted EBITDA calculated using these measures.
The following table reconciles EBITDA and adjusted EBITDA to net income, which is the GAAP measure that our management believes to be most directly comparable (dollars in thousands):
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Three Months Ended June 30,
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Six Months Ended June 30,
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2020
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2019
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2020
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2019
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Net income
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$
|
55,624
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|
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$
|
46,055
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|
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$
|
98,463
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|
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$
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64,389
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Income taxes
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12,973
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|
|
14,480
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|
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25,023
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|
|
17,840
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Depreciation and amortization
|
|
156
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161
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|
317
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|
|
326
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Capitalized interest charged to cost of sales
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8,684
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|
8,989
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|
17,614
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|
|
14,383
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EBITDA
|
|
77,437
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|
|
69,685
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|
|
141,417
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|
|
96,938
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Purchase accounting adjustments(1)
|
|
1,252
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|
|
956
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|
|
1,875
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|
|
1,586
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Loss on extinguishment of debt
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—
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|
|
169
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—
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169
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Other income, net
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(763)
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(2,263)
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(1,774)
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(2,882)
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Adjusted EBITDA
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$
|
77,926
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$
|
68,547
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$
|
141,518
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$
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95,811
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EBITDA margin %(2)
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16.1
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%
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15.1
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%
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15.1
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%
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12.9
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%
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Adjusted EBITDA margin %(2)
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16.2
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%
|
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14.8
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%
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15.1
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%
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12.8
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%
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(1)Adjustments result from the application of purchase accounting for acquisitions and represent the amount of the fair value step-up adjustments included in cost of sales for real estate inventory sold after the acquisition dates.
(2)Calculated as a percentage of home sales revenues.
Backlog
We sell our homes under standard purchase contracts, which generally require a homebuyer to pay a deposit at the time of signing the purchase contract. The amount of the required deposit is minimal (generally $1,000). The deposits are refundable if the retail homebuyer is unable to obtain mortgage financing. We permit our retail homebuyers to cancel the purchase contract and obtain a refund of their deposit in the event mortgage financing cannot be obtained within a certain period of time, as specified in their purchase contract. Typically, our retail homebuyers provide documentation regarding their ability to obtain mortgage financing within 14 days after the purchase contract is signed. If we determine that the homebuyer is not qualified to obtain mortgage financing or is not otherwise financially able to purchase the home, we will terminate the purchase contract. If a purchase contract has not been cancelled or terminated within 14 days after the purchase contract has been signed, then the homebuyer has met the preliminary criteria to obtain mortgage financing. Only purchase contracts that are signed by homebuyers who have met the preliminary criteria to obtain mortgage financing are included in new (gross) orders. As a result of COVID-19, it has been, and may continue to be, more difficult for our homebuyers to qualify for and obtain mortgage financing to purchase a home.
Our “backlog” consists of homes that are under a purchase contract that has been signed by homebuyers who have met the preliminary criteria to obtain mortgage financing but have not yet closed and wholesale contracts for which vertical construction is set to occur within the next six months. Since our business model is generally based on building move-in ready homes before a purchase contract is signed, the majority of our homes in backlog are currently under construction or complete. Ending backlog represents the number of homes in backlog from the previous period plus the number of net orders (new orders for homes less cancellations) generated during the current period minus the number of homes closed during the current period. Our backlog at any given time will be affected by cancellations, the number of our active communities and the timing of home closings. Homes in backlog are generally closed within one to two months, although home closings have been, and may continue to be, delayed during the COVID-19 pandemic. In addition, we may experience cancellations of purchase contracts at any time prior to closing. It is important to note that net orders, backlog and cancellation metrics are operational, rather than accounting data, and should be used only as a general gauge to evaluate performance. Backlog may be impacted by customer cancellations for various reasons that are beyond our control, and in light of our minimal required deposit, there is little negative impact to the potential homebuyer from the cancellation of the purchase contract.
As of the dates set forth below, our net orders, cancellation rate and ending backlog homes and value were as follows (dollars in thousands):
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Backlog Data
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Six Months Ended June 30,
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2020 (4)
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2019 (5)
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Net orders (1)
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4,734
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4,196
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Cancellation rate (2)
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21.8
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%
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17.8
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%
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Ending backlog – homes (3)
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2,127
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1,648
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Ending backlog – value (3)
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$
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558,007
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$
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410,006
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(1)Net orders are new (gross) orders for the purchase of homes during the period, less cancellations of existing purchase contracts during the period.
(2)Cancellation rate for a period is the total number of purchase contracts cancelled during the period divided by the total new (gross) orders for the purchase of homes during the period.
(3)Ending backlog consists of homes at the end of the period that are under a purchase contract that has been signed by homebuyers who have met our preliminary financing criteria but have not yet closed and wholesale contracts for which vertical construction is set to occur within the next six months. Ending backlog is valued at the contract amount.
(4)As of June 30, 2020, we have 208 units related to bulk sales agreements associated with our wholesale business.
(5)As of June 30, 2019, we have 110 units related to bulk sales agreements associated with our wholesale business.
Land Acquisition Policies and Development
We increased our active communities to 117 as of June 30, 2020 from 106 as of December 31, 2019. Our lot inventory decreased to 44,307 owned or controlled lots as of June 30, 2020 from 48,062 owned or controlled lots as of December 31, 2019 primarily due to certain cash management policies we implemented beginning in March 2020, which included delaying or canceling land acquisitions to manage our overall inventory.
The table below shows (i) home closings by reportable segment for the six months ended June 30, 2020 and (ii) our owned or controlled lots by reportable segment as of June 30, 2020.
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Six Months Ended June 30, 2020
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As of June 30, 2020
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Reportable Segment
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Home Closings
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Owned (1)
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Controlled
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Total
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Central
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1,488
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15,506
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4,295
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19,801
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Southeast
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962
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9,700
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4,583
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14,283
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Northwest
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426
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2,097
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953
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3,050
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West
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472
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1,987
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1,592
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3,579
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Florida
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492
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2,498
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1,096
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3,594
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Total
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3,840
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31,788
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12,519
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44,307
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(1)Of the 31,788 owned lots as of June 30, 2020, 20,506 were raw/under development lots and 11,282 were finished lots.
Homes in Inventory
When entering a new community, we build a sufficient number of move-in ready homes to meet our budgets. We base future home starts on home closings. As homes are closed, we start more homes to maintain our inventory. As of June 30, 2020, we had a total of 1,503 completed homes, including information centers, and 2,105 homes in progress.
Raw Materials and Labor
When constructing homes, we use various materials and components. We generally contract for our materials and labor at a fixed price for the anticipated construction period of our homes. This allows us to mitigate the risks associated with increases in building materials and labor costs between the time construction begins on a home and the time it is closed. Typically, the raw materials and most of the components used in our business are readily available in the United States. In addition, the majority of our raw materials is supplied to us by our subcontractors, and is included in the price of our contract with such subcontractors. Most of the raw materials necessary for our subcontractors are standard items carried by major suppliers. Substantially all of our construction work is done by third-party subcontractors, most of whom are non-unionized. We continue to monitor the supply markets to achieve the best prices available. Typically, the price changes that most significantly influence our operations are price increases in labor, commodities and lumber.
Seasonality
In all of our reportable segments, we have historically experienced similar variability in our results of operations and in capital requirements from quarter to quarter due to the seasonal nature of the homebuilding industry. We generally close more homes in our second, third and fourth quarters. Thus, our revenue may fluctuate on a quarterly basis and we may have higher capital requirements in our second, third and fourth quarters in order to maintain our inventory levels. Our revenue and capital requirements are generally similar across our second, third and fourth quarters.
As a result of seasonal activity, our quarterly results of operations and financial position at the end of a particular quarter, especially the first quarter, are not necessarily representative of the results we expect at year end. We expect this seasonal pattern to continue in the long term.
Liquidity and Capital Resources
Overview
As of June 30, 2020, we had $49.1 million of cash and cash equivalents. Cash flows for each of our active communities depend on the status of the development cycle and can differ substantially from reported earnings. Early stages of development or expansion require significant cash outlays for land acquisitions, land development, plats, vertical development, construction of information centers, general landscaping and other amenities. Because these costs are a component of our inventory and are not recognized in our statement of operations until a home closes, we incur significant cash outflows prior to recognition of home sales revenues. In the later stages of an active community, cash inflows may exceed home sales revenues reported for financial statement purposes, as the costs associated with home and land construction were previously incurred.
Our principal uses of capital are operating expenses, land and lot purchases, lot development, home construction, interest costs on our indebtedness and the payment of various liabilities. In addition, we may purchase land, lots, homes under construction or other assets as part of an acquisition.
We generally rely on our ability to finance our operations by generating operating cash flows, borrowing under the Credit Agreement (as defined below) or the issuance and sale of shares of our common stock. As needed, we will consider accessing the debt and equity capital markets as part of our ongoing financing strategy. We also rely on our ability to obtain performance, payment and completion surety bonds as well as letters of credit to finance our projects.
We have an effective shelf registration statement on Form S-3 (Registration No. 333-227012) that was filed on August 24, 2018 with the Securities and Exchange Commission, registering the offering and sale of an indeterminate amount of debt securities, guarantees of debt securities, preferred stock, common stock, warrants, depositary shares, purchase contracts and units that include any of these securities. Under the shelf registration statement, we have the ability to access the debt and equity capital markets as needed as part of our ongoing financing strategy.
While the COVID-19 pandemic and related mitigation efforts have created significant uncertainty as to general economic and housing market conditions for the remainder of 2020 and beyond, as of the date of this Quarterly Report on Form 10-Q, we believe that we will be able to fund our current and foreseeable liquidity needs for at least the next twelve months with our cash on hand, cash generated from operations and cash expected to be available from the Credit Agreement or through accessing debt or equity capital, as needed. However, with the uncertainty surrounding COVID-19, our ability to engage in the transactions described above may be constrained by volatile or tight economic, capital, credit and financial market conditions, as well as moderated investor or lender interest or capacity and our liquidity, leverage and net worth, and we can provide no assurance as to successfully completing, the costs of, or the operational limitations arising from any one or series of such transactions.
Revolving Credit Facility
On April 30, 2020, we entered into the Second Amendment to Fourth Amended and Restated Credit Agreement (the “Second Amendment”), which amends the Fourth Amended and Restated Credit Agreement, dated as of May 6, 2019 (as amended by the Lender Addition and Acknowledgement Agreement and First Amendment to Fourth Amended and Restated Credit Agreement, dated as of December 6, 2019, the “2019 Credit Agreement” and, together with the Second Amendment, the “Credit Agreement”), with several financial institutions, and Wells Fargo Bank, National Association, as administrative agent. In the Second Amendment, lenders with $520.0 million, or 80%, of the $650.0 million of commitments under the 2019 Credit Agreement, agreed to extend the maturity of their commitments to May 31, 2023, with the remaining lenders retaining their existing maturity of May 31, 2022. The Second Amendment also reduced the minimum EBITDA to interest expense ratio from 2.50 to 1.75, increased the sublimit for letters of credit to $40.0 million and established a London Interbank Offered Rate (“LIBOR”) floor of 0.70%. The Credit Agreement otherwise has substantially similar terms and provisions to the 2019 Credit Agreement and continues to provide for a $650.0 million revolving credit facility, which can be increased at the request of the Company by up to $100.0 million, subject to the terms and conditions of the Credit Agreement.
The Credit Agreement matures on May 31, 2023 with respect to 80% of the commitments thereunder and on May 31, 2022 with respect to 20% of the commitments thereunder. Before each anniversary of the Credit Agreement, we may request a one-year extension of its maturity date. The Credit Agreement is guaranteed by each of our subsidiaries that have gross assets equal to or greater than $0.5 million. The borrowings and letters of credit outstanding under the Credit Agreement, together with the outstanding principal balance of our 6.875% Senior Notes due 2026 (the “Senior Notes”), may not exceed the borrowing base under the Credit Agreement. As of June 30, 2020, the borrowing base under the Credit Agreement was $899.2 million, of which borrowings, including the Senior Notes, of $597.6 million were outstanding, $18.7 million of letters of credit were outstanding and $282.9 million was available to borrow under the Credit Agreement.
Interest is paid monthly on borrowings under the Credit Agreement at LIBOR plus 2.50%. The Credit Agreement applicable margin for LIBOR loans ranges from 2.35% to 2.75% based on our leverage ratio. At June 30, 2020, LIBOR was 0.18%; however, we are subject to the 0.70% LIBOR floor as stipulated in the Credit Agreement.
The Credit Agreement requires us to maintain (i) a tangible net worth of not less than $625.0 million plus 75% of the net proceeds of all equity issuances plus 50.0% of the amount of our positive net income in any fiscal quarter after December 31, 2019, (ii) a leverage ratio of not greater than 60.0%, (iii) liquidity of at least $50.0 million and (iv) a ratio of EBITDA to interest expense for the most recent four quarters of at least 1.75 to 1.00. The Credit Agreement contains various covenants that, among other restrictions, limit the amount of our additional debt and our ability to make certain investments. At June 30, 2020, we were in compliance with all of the covenants contained in the Credit Agreement.
In July 2017, the Financial Conduct Authority in the United Kingdom, which regulates LIBOR, announced that it intends to phase out LIBOR as a benchmark by the end of 2021. At the present time, the Credit Agreement has a term that extends beyond 2021, and borrowings under the Credit Agreement bear interest at LIBOR plus an applicable margin. The Credit
Agreement provides for a mechanism to amend the Credit Agreement to reflect the establishment of an alternate rate of interest upon the occurrence of certain events related to the phase-out of any applicable interest rate. However, we have not yet pursued any technical amendment or other contractual alternative to address this matter. We are currently evaluating the potential impact of the eventual replacement of the LIBOR interest rate on the Credit Agreement.
Senior Notes Offering
On July 6, 2018, we issued $300.0 million aggregate principal amount of the Senior Notes in an offering to persons reasonably believed to be qualified institutional buyers in the United States pursuant to Rule 144A under the Securities Act of 1933, as amended (the “Securities Act”), and to certain non-U.S. persons in transactions outside the United States pursuant to Regulation S under the Securities Act. Interest on the Senior Notes accrues at a rate of 6.875% per annum, payable semi-annually in arrears on January 15 and July 15 of each year, commencing on January 15, 2019, and the Senior Notes mature on July 15, 2026. Terms of the Senior Notes are governed by an Indenture and First Supplemental Indenture thereto, each dated as of July 6, 2018, and a Second Supplemental Indenture thereto, dated as of April 30, 2020, as may be supplemented from time to time, among us, our subsidiaries that guarantee our obligations under the Credit Agreement and Wilmington Trust, National Association, as trustee.
Convertible Notes
On November 15, 2019, our 4.25% Convertible Notes due 2019 (the “Convertible Notes”) matured, which resulted in the principal payment of $70.0 million and the issuance of 2,381,751 shares of our common stock for the premium associated with the Convertible Notes.
Letters of Credit, Surety Bonds and Financial Guarantees
We are often required to provide letters of credit and surety bonds to secure our performance under construction contracts, development agreements and other arrangements. The amount of such obligations outstanding at any time varies in accordance with our pending development activities. In the event any such bonds or letters of credit are drawn upon, we would be obligated to reimburse the issuer of such bonds or letters of credit.
Under these letters of credit, surety bonds and financial guarantees, we are committed to perform certain development and construction activities and provide certain guarantees in the normal course of business. Outstanding letters of credit, surety bonds and financial guarantees under these arrangements, totaled $120.0 million as of June 30, 2020. Although significant development and construction activities have been completed related to the improvements at these sites, the letters of credit and surety bonds are not generally released until all development and construction activities are completed. We do not believe that it is probable that any outstanding letters of credit, surety bonds or financial guarantees as of June 30, 2020 will be drawn upon.
Cash Flows
Operating Activities
Net cash provided by operating activities was $146.1 million for the six months ended June 30, 2020. The primary drivers of operating cash flows are typically cash earnings and changes in inventory levels, including land acquisition and development. Net cash provided by operating activities during the six months ended June 30, 2020 was primarily driven by net income of $98.5 million, and included cash inflow from the $41.7 million decrease in the net change in real estate inventory, which was primarily related to our homes under construction and land acquisitions and development level of activity offset by changes in non-inventory balances of $5.9 million.
Net cash used in operating activities was $18.9 million for the six months ended June 30, 2019, primarily driven by net income of $64.4 million, and included cash outlays for the $99.7 million increase in the net change in real estate inventory, which was primarily related to our homes under construction and land acquisitions and development level of activity offset by changes in non-inventory balances of $16.4 million.
Investing Activities
Net cash used in investing activities was $1.7 million for the six months ended June 30, 2020, primarily due to the additional investment in an unconsolidated entity and purchase of property and equipment.
Net cash used in investing activities was $0.3 million for the six months ended June 30, 2019, which reflects the purchase of property and equipment.
Financing Activities
Net cash used in financing activities was $133.6 million for the six months ended June 30, 2020, primarily driven by $235.0 million of payments on the Credit Agreement and by the $31.3 million payment for shares repurchased under our stock repurchase program to be held as treasury stock, offset by borrowings of $133.0 million under the Credit Agreement.
Net cash provided by financing activities was $10.1 million for the six months ended June 30, 2019, primarily driven by net borrowings under the 2019 Credit Agreement.
Off-Balance Sheet Arrangements
In the ordinary course of business, we enter into land purchase contracts in order to procure land and lots for the construction of our homes. We are subject to customary obligations associated with entering into contracts for the purchase of land and improved lots. These contracts typically require cash deposits and the purchase of properties under these contracts is generally contingent upon satisfaction of certain requirements by the sellers, which may include obtaining applicable property and development entitlements or the completion of development activities and the delivery of finished lots. We also utilize contracts with land sellers as a method of acquiring lots and land in staged takedowns, which helps us manage the financial and market risk associated with land holdings and minimize the use of funds from our corporate financing sources. Such contracts generally require a non-refundable deposit for the right to acquire land or lots over a specified period of time at pre-determined prices. We generally have the right at our discretion to terminate our obligations under purchase contracts during the initial feasibility period and receive a refund of our deposit, or we may terminate the contracts after the end of the feasibility period by forfeiting our cash deposit with no further financial obligations to the land seller. In addition, our deposit may also be refundable if the land seller does not satisfy all conditions precedent in the respective contract. As of June 30, 2020, we had $28.8 million of cash deposits pertaining to land purchase contracts for 12,519 lots with an aggregate purchase price of $436.6 million. Approximately $20.4 million of the cash deposits as of June 30, 2020 are secured by third-party guarantees or indemnity mortgages on the related property.
Our utilization of land purchase contracts is dependent on, among other things, the availability of land sellers willing to enter into contracts at acceptable terms, which may include option takedown arrangements, the availability of capital to financial intermediaries to finance the development of optioned lots, general housing conditions and local market dynamics. Land purchase contracts may be more difficult to procure from land sellers in strong housing markets and are more prevalent in certain markets.
Inflation
Our business can be adversely impacted by inflation, primarily from higher land, financing, labor, material and construction costs. In addition, inflation can lead to higher mortgage rates, which can significantly affect the affordability of mortgage financing to homebuyers.
Contractual Obligations
As of June 30, 2020, there have been no material changes to our contractual obligations appearing in the “Contractual Obligations” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019.
Critical Accounting Policies
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. On an ongoing basis, management evaluates such estimates and judgments and makes adjustments as deemed necessary. Actual results could differ from these estimates using different estimates and assumptions, or if conditions are significantly different in the future.
We believe that there have been no significant changes to our critical accounting policies during the six months ended June 30, 2020 as compared to those disclosed in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019.
Cautionary Statement about Forward-Looking Statements
From time to time we make statements concerning our expectations, beliefs, plans, objectives, goals, strategies, future events or performance and underlying assumptions and other statements that are not historical facts. These statements are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those expressed or implied by these statements. You can generally identify our forward-looking statements by the words “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “forecast,” “goal,” “intend,” “may,” “objective,” “plan,” “potential,” “predict,” “projection,” “should,” “will” or other similar words.
We have based our forward-looking statements on our management’s beliefs and assumptions based on information available to our management at the time the statements are made. We caution you that assumptions, beliefs, expectations, intentions and projections about future events may, and often do, vary materially from actual results. Therefore, we cannot assure you that actual results will not differ materially from those expressed or implied by our forward-looking statements.
The following are some of the factors that could cause actual results to differ materially from those expressed or implied in forward-looking statements:
•the impact of the COVID-19 pandemic and its effect on us, our business, customers and subcontractors, and the markets in which we operate, U.S. and world financial markets, mortgage availability, potential regulatory actions, changes in customer and stakeholder behaviors and impacts on and modifications to our operations, business and financial condition relating to COVID-19;
•adverse economic changes either nationally or in the markets in which we operate, including, among other things, increases in unemployment, volatility of mortgage interest rates and inflation and decreases in housing prices;
•a slowdown in the homebuilding industry;
•volatility and uncertainty in the credit markets and broader financial markets;
•disruption in the terms or availability of mortgage financing or increase in the number of foreclosures in our markets;
•the cyclical and seasonal nature of our business;
•our future operating results and financial condition;
•our business operations;
•changes in our business and investment strategy;
•the success of our operations in recently opened new markets and our ability to expand into additional new markets;
•our ability to successfully extend our business model to building homes with higher price points, developing larger communities and producing and selling multi-unit products, townhouses, wholesale products, and acreage home sites;
•our ability to develop our projects successfully or within expected timeframes;
•our ability to identify potential acquisition targets and close such acquisitions;
•our ability to successfully integrate any acquisitions with our existing operations;
•availability of land to acquire and our ability to acquire such land on favorable terms or at all;
•availability, terms and deployment of capital and ability to meet our ongoing liquidity needs;
•decisions of the Credit Agreement lender group;
•decline in the market value of our land portfolio;
•shortages of or increased prices for labor, land, or raw materials used in land development and housing construction, including due to changes in trade policies;
•delays in land development or home construction resulting from natural disasters, adverse weather conditions or other events outside our control;
•uninsured losses in excess of insurance limits;
•the cost and availability of insurance and surety bonds;
•changes in, liabilities under, or the failure or inability to comply with, governmental laws and regulations;
•the timing of receipt of regulatory approvals and the opening of projects;
•the degree and nature of our competition;
•increases in taxes or government fees;
•negative publicity or poor relations with the residents of our projects;
•existing and future litigation, arbitration or other claims;
•availability of qualified personnel and third-party contractors and subcontractors;
•information system failures, cyber incidents or breaches in security;
•our ability to retain our key personnel;
•our leverage and future debt service obligations;
•the impact on our business of any future government shutdown;
•other risks and uncertainties inherent in our business;
•the risk factor set forth in Item 1A. Risk Factors in this Quarterly Report on Form 10-Q; and
You should not place undue reliance on forward-looking statements. Each forward-looking statement speaks only as of the date of the particular statement. We expressly disclaim any intent, obligation or undertaking to update or revise any forward-looking statements to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statements are based. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements contained in this Quarterly Report on Form 10-Q.