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 | | Northwest | | Central | | Midwest | | Florida | | Southeast | | Mid-Atlantic |
Phoenix, AZ | | Seattle, WA | | Houston, TX | | Minneapolis, MN | | Tampa, FL | | Atlanta, GA | | Washington, D.C. |
Tucson, AZ | | Portland, OR | | Dallas Ft. Worth, TX | | | | Orlando, FL | | Charlotte, NC | | Norfolk, VA |
Albuquerque, NM | | Denver, CO | | San Antonio, TX | | | | Fort Myers, FL | | Raleigh, NC | | Richmond, VA |
Las Vegas, NV | | | | Austin, TX | | | | Jacksonville, FL | | Wilmington, NC | | Baltimore, MD |
Northern CA | | | | Oklahoma City, OK | | | | Fort Pierce, FL | | Winston-Salem, NC | | |
Southern CA | | | | | | | | Daytona Beach, FL | | Columbia, SC | | |
| | | | | | | | Sarasota, FL | | Greenville, SC | | |
| | | | | | | | | | Birmingham, AL | | |
| | | | | | | | | | Nashville, TN | | |
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 50,000 homes.
During the three months ended September 30, 2022, we continued to adapt our business to respond to the slowdown in demand caused by the Federal Reserve’s ongoing actions to stem inflation. Mortgage rates during the three months ended September 30, 2022 were double what they were during the three months ended September 30, 2021, further impacting sentiment and affordability for potential buyers. As a result, many buyers have paused their home purchasing decisions. We expect that mortgage rates will remain elevated until inflation subsides. Additionally, challenges from ongoing supply chain disruptions and higher construction and development costs continued during the three months ended September 30, 2022.
We continue to combat the demand headwinds and drive continued sales through increased advertising spending to connect with more potential homebuyers. During the three months ended September 30, 2022, we began offering mortgage buy-down programs and other sales incentives to offset some of the affordability pressures resulting from higher mortgage rates. Additionally, we increased our allocation of inventory available for sale to our wholesale channel. At the same time, we are carefully evaluating our land position and we significantly reduced our owned and controlled lots during the three months ended September 30, 2022. Finally, given the current market conditions and our focus on future community count growth, during the three months ended September 30, 2022, we chose to allocate available capital to near-term land development, rather than repurchase shares of our common stock.
During the three months ended September 30, 2022, we had 1,547 home closings, compared to 2,499 home closings during the three months ended September 30, 2021. During the nine months ended September 30, 2022, we had 5,173 home closings, compared to 7,916 home closings during the nine months ended September 30, 2021. The decline in home closings for both the three and nine months ended September 30, 2022 was primarily due to our strong prior year comparable numbers, exacerbated by the momentum of higher mortgage rates experienced this year and lower average community count and absorption rates. Throughout 2022, our results were negatively impacted by longer lead times relating to materials, municipality and labor activities that increased our construction and development cycle times and slowed the timing of home closings. We expect continued cost inflation, building material shortages and longer municipality lead times to persist until global supply chain constraints ease.
At September 30, 2022, we had 93 active communities, including eleven Terrata Homes communities. At September 30, 2021, we had 103 active communities, including three Terrata Homes communities.
Demand for our homes is dependent on a variety of macroeconomic factors, such as employment levels, mortgage rates, financial market stability, 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. During the three months ended
September 30, 2022, we continued to experience significant supply chain disruptions, stemming from COVID-19 and variants thereof (collectively, “COVID-19”), that extended construction and development cycles and delayed home closings and the opening of new communities. While we endeavor to manage our supply chain to limit impacts to our business and customers, we believe these global shortages will continue to impact our operations as long as the dynamics surrounding the COVID-19 pandemic persist.
Despite the current demand environment headwinds, we believe the long-term outlook for new homes remains strong, driven by solid fundamentals, including a historically low inventory of new and existing homes for sale, an aging housing stock, rising rents, strong household formations and low unemployment. However, the housing market is currently in a state of transition and we expect affordability constraints and buyer reticence to continue to impact demand for the foreseeable future.
For additional discussion regarding our business and operations, see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021. For additional discussion regarding risks associated with our business and operations, see Item 1A. Risk Factors in Part I of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021 and in Item 1A. Risk Factors in Part II of this Quarterly Report on Form 10-Q for the three months ended September 30, 2022. Key Results
Key financial results as of and for the three months ended September 30, 2022, as compared to the three months ended September 30, 2021, were as follows:
•Home sales revenues decreased 27.2% to $547.1 million from $751.6 million.
•Homes closed decreased 38.1% to 1,547 homes from 2,499 homes.
•Average sales price per home closed increased 17.6% to $353,635 from $300,764.
•Gross margin as a percentage of home sales revenues increased to 28.5% from 26.9%.
•Adjusted gross margin (non-GAAP) as a percentage of home sales revenues increased to 29.5% from 28.2%.
•Net income before income taxes decreased 14.4% to $108.7 million from $127.0 million.
•Net income decreased 10.1% to $90.4 million from $100.6 million.
•EBITDA (non-GAAP) as a percentage of home sales revenues increased to 20.8% from 18.1%.
•Adjusted EBITDA (non-GAAP) as a percentage of home sales revenues decreased to 18.4% from 19.7%.
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 nine months ended September 30, 2022, as compared to the nine months ended September 30, 2021, were as follows:
•Home sales revenues decreased 19.2% to $1.8 billion from $2.2 billion.
•Homes closed decreased 34.7% to 5,173 homes from 7,916 homes.
•Average sales price per home closed increased 23.6% to $351,091 from $284,117.
•Gross margin as a percentage of home sales revenues increased to 30.0% from 27.0%.
•Adjusted gross margin (non-GAAP) as a percentage of home sales revenues increased to 31.2% from 28.4%.
•Net income before income taxes decreased 7.0% to $371.3 million from $399.4 million.
•Net income decreased 8.1% to $292.5 million from $318.3 million.
•EBITDA (non-GAAP) as a percentage of home sales revenues increased to 21.3% from 19.1%.
•Adjusted EBITDA (non-GAAP) as a percentage of home sales revenues increased to 20.4% from 19.6%.
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.” We owned and controlled 76,453 lots at September 30, 2022 as compared to 89,984 lots at June 30, 2022 and 91,845 lots at December 31, 2021.
Results of Operations
The following table sets forth our results of operations for the three and nine months ended September 30, 2022 and 2021:
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| | Three Months Ended September 30, | | Nine Months Ended September 30, |
| | 2022 | | 2021 | | 2022 | | 2021 |
| | (dollars in thousands, except per share data and average home sales price) |
Statement of Income Data: | | | | | | | | |
Home sales revenues | | $ | 547,074 | | | $ | 751,608 | | | $ | 1,816,193 | | | $ | 2,249,073 | |
Expenses: | | | | | | | | |
Cost of sales | | 391,275 | | | 549,319 | | | 1,270,628 | | | 1,642,756 | |
Selling expenses | | 33,938 | | | 39,871 | | | 111,605 | | | 127,450 | |
General and administrative | | 27,284 | | | 24,480 | | | 84,657 | | | 72,479 | |
Operating income | | 94,577 | | | 137,938 | | | 349,303 | | | 406,388 | |
Loss on extinguishment of debt | | — | | | 13,314 | | | — | | | 13,976 | |
Other income, net | | (14,124) | | | (2,370) | | | (21,960) | | | (6,979) | |
Net income before income taxes | | 108,701 | | | 126,994 | | | 371,263 | | | 399,391 | |
Income tax provision | | 18,311 | | | 26,444 | | | 78,811 | | | 81,049 | |
Net income | | $ | 90,390 | | | $ | 100,550 | | | $ | 292,452 | | | $ | 318,342 | |
Basic earnings per share | | $ | 3.88 | | | $ | 4.10 | | | $ | 12.42 | | | $ | 12.85 | |
Diluted earnings per share | | $ | 3.85 | | | $ | 4.05 | | | $ | 12.29 | | | $ | 12.72 | |
Other Financial and Operating Data: | | | | | | | | |
Average community count | | 93.0 | | | 102.7 | | | 91.1 | | | 104.7 | |
Community count at end of period | | 93 | | | 103 | | | 93 | | | 103 | |
Home closings | | 1,547 | | | 2,499 | | | 5,173 | | | 7,916 | |
Average sales price per home closed | | $ | 353,635 | | | $ | 300,764 | | | $ | 351,091 | | | $ | 284,117 | |
Gross margin (1) | | $ | 155,799 | | | $ | 202,289 | | | $ | 545,565 | | | $ | 606,317 | |
Gross margin % (2) | | 28.5 | % | | 26.9 | % | | 30.0 | % | | 27.0 | % |
Adjusted gross margin (3) | | $ | 161,578 | | | $ | 211,844 | | | $ | 565,900 | | | $ | 639,245 | |
Adjusted gross margin % (2)(3) | | 29.5 | % | | 28.2 | % | | 31.2 | % | | 28.4 | % |
EBITDA (4) | | $ | 113,722 | | | $ | 135,892 | | | $ | 387,262 | | | $ | 429,941 | |
EBITDA margin % (2)(4) | | 20.8 | % | | 18.1 | % | | 21.3 | % | | 19.1 | % |
Adjusted EBITDA (4) | | $ | 100,760 | | | $ | 147,788 | | | $ | 370,772 | | | $ | 440,148 | |
Adjusted EBITDA margin % (2)(4) | | 18.4 | % | | 19.7 | % | | 20.4 | % | | 19.6 | % |
(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 September 30, 2022 Compared to Three Months Ended September 30, 2021
Homes Sales. Our home sales revenues, home closings, average sales price per home closed (ASP), average community count, average monthly absorption rate and closing community count by reportable segment for the three months ended September 30, 2022 and 2021 were as follows (revenues in thousands):
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| | Three Months Ended September 30, 2022 | | As of September 30, 2022 |
| | Revenues | | Home Closings | | ASP | | Average Community Count | | Average Monthly Absorption Rate | | Community Count at End of Period |
Central | | $ | 228,448 | | | 681 | | | $ | 335,460 | | | 33.0 | | | 6.9 | | | 34 | |
Southeast | | 138,478 | | | 419 | | | 330,496 | | | 23.3 | | | 6.0 | | | 24 | |
Northwest | | 46,774 | | | 95 | | | 492,358 | | | 7.0 | | | 4.5 | | | 7 | |
West | | 65,064 | | | 155 | | | 419,768 | | | 11.0 | | | 4.7 | | | 11 | |
Florida | | 68,310 | | | 197 | | | 346,751 | | | 18.7 | | | 3.5 | | | 17 | |
Total | | $ | 547,074 | | | 1,547 | | | $ | 353,635 | | | 93.0 | | | 5.5 | | | 93 | |
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| | Three Months Ended September 30, 2021 | | As of September 30, 2021 |
| | Revenues | | Home Closings | | ASP | | Average Community Count | | Average Monthly Absorption Rate | | Community Count at End of Period |
Central | | $ | 287,878 | | | 1,072 | | | $ | 268,543 | | | 34.7 | | | 10.3 | | | 33 | |
Southeast | | 146,166 | | | 551 | | | 265,274 | | | 24.0 | | | 7.7 | | | 26 | |
Northwest | | 148,515 | | | 325 | | | 456,969 | | | 12.3 | | | 8.8 | | | 12 | |
West | | 90,592 | | | 248 | | | 365,290 | | | 12.7 | | | 6.5 | | | 13 | |
Florida | | 78,457 | | | 303 | | | 258,934 | | | 19.0 | | | 5.3 | | | 19 | |
Total | | $ | 751,608 | | | 2,499 | | | $ | 300,764 | | | 102.7 | | | 8.1 | | | 103 | |
Home sales revenues for the three months ended September 30, 2022 were $547.1 million, a decrease of $204.5 million, or 27.2%, from $751.6 million for the three months ended September 30, 2021. The decrease in home sales revenues is primarily due to a 38.1% decrease in homes closed, partially offset by an increase in the average sales price per home closed during the three months ended September 30, 2022 as compared to the three months ended September 30, 2021. The average sales price per home closed during the three months ended September 30, 2022 was $353,635, an increase of $52,871, or 17.6%, from the average sales price per home closed of $300,764 for the three months ended September 30, 2021. The increase in the average sales price per home closed in all reportable segments is primarily due to favorable pricing environments that allowed us to pass through cost increases associated with the construction of our homes. The overall decrease in home closings is a result of lower average community count and overall lower absorption pace during the three months ended September 30, 2022 as compared to the three months ended September 30, 2021. Our community count at September 30, 2022 decreased to 93 from 103 at September 30, 2021. The decrease in community count is due to the close out of or transition between certain active communities for the three months ended September 30, 2022 as compared to the three months ended September 30, 2021. The overall decrease in absorption primarily relates to the lower demand environment as a result of higher mortgage rates and increased cycle times resulting from pandemic related production disruptions.
Included within our home sales revenues for the three months ended September 30, 2022 is $127.9 million in wholesale revenues as a result of 443 home closings, representing 28.6% of the 1,547 total homes closed during the three months ended September 30, 2022. Included within our home sales revenues for the three months ended September 30, 2021 is $101.6 million in wholesale revenues as a result of 433 home closings, representing 17.3% of the 2,499 total homes closed during the three months ended September 30, 2021. The increase in home closings as a percentage of revenues through our wholesale channel was primarily related to allocating more inventory available for sale to the wholesale channel during the three months ended September 30, 2022 as compared to the three months ended September 30, 2021, when we limited the writing of wholesale contracts due to higher retail demand and supply chain uncertainty.
Home sales revenues in our Central reportable segment decreased by $59.4 million, or 20.6%, during the three months ended September 30, 2022 as compared to the three months ended September 30, 2021, primarily due to a 36.5% decrease in the number of homes closed driven by a decrease in the average community count at a lower absorption rate, partially offset by an increase in the average sales price per home closed. Home sales revenues in our Southeast reportable segment decreased by $7.7 million, or 5.3%, during the three months ended September 30, 2022 as compared to the three months ended September 30, 2021, primarily due to a 24.0% decrease in the number of homes closed driven by a decrease in the average community count at a lower absorption rate, partially offset by an increase in the average sales price per home closed. Home sales revenues in our Northwest reportable segment decreased by $101.7 million, or 68.5%, during the three months ended September 30, 2022 as compared to the three months ended September 30, 2021, primarily due to a 70.8% decrease in the number of homes closed driven by a decrease in the average community count at a lower absorption rate, partially offset by an increase in the average sales price per home closed. Home sales revenues in our West reportable segment decreased by $25.5 million, or 28.2%, during the three months ended September 30, 2022 as compared to the three months ended September 30, 2021, primarily due to a 37.5% decrease in the number of homes closed driven by a decrease in the average community count at a lower absorption rate, partially offset by an increase in the average sales price per home closed. Home sales revenues in our Florida reportable segment decreased by $10.1 million, or 12.9%, during the three months ended September 30, 2022, as compared to the three months ended September 30, 2021, primarily due to a 35.0% decrease in the number of homes closed driven by a decrease in the average community count at a lower absorption rate, partially offset by an increase in the average sales price per home closed.
Cost of Sales and Gross Margin (home sales revenues less cost of sales). Cost of sales decreased for the three months ended September 30, 2022 to $391.3 million, a decrease of $158.0 million, or 28.8%, from $549.3 million for the three months ended September 30, 2021, primarily due to a 38.1% decrease in homes closed, offset by higher average construction costs per home closed. Gross margin for the three months ended September 30, 2022 was $155.8 million, a decrease of $46.5 million, or 23.0%, from $202.3 million for the three months ended September 30, 2021. Gross margin as a percentage of home sales revenues was 28.5% for the three months ended September 30, 2022 and 26.9% for the three months ended September 30, 2021. This increase in gross margin as a percentage of home sales revenues was primarily due to raising prices higher than increases in input costs during the three months ended September 30, 2022 as compared to the three months ended September 30, 2021.
Selling Expenses. Selling expenses for the three months ended September 30, 2022 were $33.9 million, a decrease of $5.9 million, or 14.9%, from $39.9 million for the three months ended September 30, 2021. Sales commissions decreased to $17.9 million for the three months ended September 30, 2022 from $28.0 million for the three months ended September 30, 2021, primarily due to a 27.2% decrease in home sales revenues during the three months ended September 30, 2022 as compared to the three months ended September 30, 2021. Selling expenses as a percentage of home sales revenues were 6.2% and 5.3% for the three months ended September 30, 2022 and 2021, respectively. The increase in selling expenses as a percentage of home sales revenues was primarily due to higher advertising and other expenses incurred during the three months ended September 30, 2022 as compared to the three months ended September 30, 2021.
General and Administrative. General and administrative expenses for the three months ended September 30, 2022 were $27.3 million, an increase of $2.8 million, or 11.5%, from $24.5 million for the three months ended September 30, 2021. The increase in the amount of general and administrative expenses is primarily due to costs related to the termination of land purchase agreements incurred during the three months ended September 30, 2022 as compared to the three months ended September 30, 2021. General and administrative expenses as a percentage of home sales revenues were 5.0% and 3.3% for the three months ended September 30, 2022 and 2021, respectively. The increase in general and administrative expenses as a percentage of home sales revenues is primarily due to the 27.2% decrease in homes sales revenue, increased personnel costs and terminated land purchase agreements, partially offset by reductions in other personnel associated costs, including performance based compensation, incurred during the three months ended September 30, 2022 as compared to the three months ended September 30, 2021.
Loss on Extinguishment of Debt. There was no loss on extinguishment of debt for the three months ended September 30, 2022. Loss on extinguishment of debt for the three months ended September 30, 2021 was $13.3 million, due to the redemption premium associated with our 6.875% Senior Notes due 2026 (the “2026 Senior Notes”), as well as debt issuance costs and discount previously capitalized that were associated with our 2026 Senior Notes for the three months ended September 30, 2021.
Other Income. Other income, net of other expenses was $14.1 million for the three months ended September 30, 2022, an increase of $11.8 million from $2.4 million for the three months ended September 30, 2021. Other income, net of other expenses, primarily reflects the sale in July 2022 of the three-year interest rate cap of LIBOR prior to its expiration that resulted in $7.1 million in other income, income associated with our investment in unconsolidated entities and gains realized from the sale of land and lots not directly associated with our core homebuilding operations.
Operating Income and Net Income before Income Taxes. Operating income for the three months ended September 30, 2022 was $94.6 million, a decrease of $43.4 million, or 31.4%, from $137.9 million for the three months ended September 30, 2021. Net income before income taxes for the three months ended September 30, 2022 was $108.7 million, a decrease of $18.3 million, or 14.4%, from $127.0 million for the three months ended September 30, 2021. All reportable segments contributed to net income before income taxes during the three months ended September 30, 2022 as follows: Central - $46.4 million or 42.7%; Southeast - $31.6 million or 29.1%; Northwest - $6.4 million or 5.9%; West - $8.3 million or 7.7%; and Florida - $9.8 million or 9.0%. The overall decreases in operating income and net income before income taxes are primarily attributed to lower home closings across all reportable segments and lower average community count at a lower absorption pace, partially offset by higher gross margins and higher average sales price per home closed during the three months ended September 30, 2022 as compared to the three months ended September 30, 2021.
Income Taxes. Income tax provision for the three months ended September 30, 2022 was $18.3 million, a decrease of $8.1 million, or 30.8%, from income tax provision of $26.4 million for the three months ended September 30, 2021. The decrease in our effective tax rate to 16.8% from 20.8% for the three months ended September 30, 2021 results from the retroactive extension of the 45L tax credit and the deductions in excess of compensation cost for share-based payments, offset by an increase in the rate for the compensation limitation under Section 162(m) of the Internal Revenue Code, as amended, and for state income taxes, net of the federal benefit.
Net Income. Net income for the three months ended September 30, 2022 was $90.4 million, a decrease of $10.2 million, or 10.1%, from $100.6 million for the three months ended September 30, 2021. The decrease in net income is primarily attributed to higher gross margins and higher average sales price per home closed recognized during the three months ended September 30, 2022 as compared to the three months ended September 30, 2021.
Nine Months Ended September 30, 2022 Compared to Nine Months Ended September 30, 2021
Homes Sales. Our home sales revenues, home closings, average sales price per home closed (ASP), average community count and average monthly absorption rate by reportable segment for the nine months ended September 30, 2022 and 2021 were as follows (revenues in thousands): | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Nine Months Ended September 30, 2022 | | |
| | Revenues | | Home Closings | | ASP | | Average Community Count | | Average Monthly Absorption Rate | | |
Central | | $ | 807,400 | | | 2,460 | | | $ | 328,211 | | | 31.3 | | | 8.7 | | | |
Southeast | | 328,510 | | | 1,018 | | | 322,701 | | | 21.0 | | | 5.4 | | | |
Northwest | | 220,440 | | | 429 | | | 513,846 | | | 8.6 | | | 5.5 | | | |
West | | 244,603 | | | 598 | | | 409,035 | | | 11.2 | | | 5.9 | | | |
Florida | | 215,240 | | | 668 | | | 322,216 | | | 19.0 | | | 3.9 | | | |
Total | | $ | 1,816,193 | | | 5,173 | | | $ | 351,091 | | | 91.1 | | | 6.3 | | | |
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| | Nine Months Ended September 30, 2021 | | |
| | Revenues | | Home Closings | | ASP | | Average Community Count | | Average Monthly Absorption Rate | | |
Central | | $ | 924,591 | | | 3,547 | | | $ | 260,668 | | | 36.7 | | | 10.7 | | | |
Southeast | | 442,431 | | | 1,731 | | | 255,593 | | | 25.8 | | | 7.5 | | | |
Northwest | | 372,903 | | | 876 | | | 425,688 | | | 11.1 | | | 8.8 | | | |
West | | 252,553 | | | 729 | | | 346,438 | | | 11.3 | | | 7.1 | | | |
Florida | | 256,595 | | | 1,033 | | | 248,398 | | | 19.8 | | | 5.8 | | | |
Total | | $ | 2,249,073 | | | 7,916 | | | $ | 284,117 | | | 104.7 | | | 8.4 | | | |
Home sales revenues for the nine months ended September 30, 2022 were $1.8 billion, a decrease of $0.4 billion, or 19.2%, from $2.2 billion for the nine months ended September 30, 2021. The decrease in home sales revenues is primarily due to a 34.7% decrease in homes closed, partially offset by an increase in the average sales price per home closed during the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021. The average sales price per home closed during the nine months ended September 30, 2022 was $351,091, an increase of $66,974, or 23.6%, from the average sales price per home closed of $284,117 for the nine months ended September 30, 2021. The increase in the average sales price per home closed in all reportable segments is primarily due to favorable pricing environments that allowed us to pass through cost increases associated with the construction of our homes. The overall decrease in home closings is a result of lower average community count and overall lower absorption pace during the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021. The overall decrease in average community count relates to timing associated with the opening, close out or transition between certain active communities during the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021. The overall decrease in absorption relates to the normalization of demand, increased mortgage rates and increased cycle times stemming from pandemic-related production disruptions. These disruptions have caused varying degrees of supply chain constraints in the markets we serve.
Included within our home sales revenues for the nine months ended September 30, 2022 is $216.6 million in wholesale revenues as a result of 802 home closings, representing 15.5% of the 5,173 total homes closed during the nine months ended September 30, 2022. Included within our home sales revenues for the nine months ended September 30, 2021 is $258.6 million in wholesale revenues as a result of 1,146 home closings, representing 14.5% of the 7,916 total homes closed during the nine months ended September 30, 2021. The increase in home closings as a percentage of revenues through our wholesale channel was primarily related to allocating more inventory available for sale to the wholesale channel during the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021.
Home sales revenues in our Central reportable segment decreased by $117.2 million, or 12.7%, during the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021, primarily due to a 30.6% decrease in the number of homes closed driven by a decrease in average community count at a lower absorption rate, partially offset by an increase in the average sales price per home closed. Home sales revenues in our Southeast reportable segment decreased by $113.9 million, or 25.7%, during the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021, primarily due to a 41.2% decrease in the number of homes closed driven by a decrease in the average community count at a lower absorption rate, partially offset by an increase in the average sales price per home closed. Home sales revenues in our Northwest reportable segment decreased by $152.5 million, or 40.9%, during the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021, primarily due to a 51.0% decrease in the number of homes closed driven by a decrease in the average community count at a lower absorption rate, partially offset by an increase in the average sales price per home closed. Home sales revenues in our West reportable segment decreased by $8.0 million, or 3.1%, during the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021, primarily due to an 18.0% decrease in the number of homes closed driven by a decrease in the average community count at a lower absorption rate, partially offset by an increase in the average sales price per home closed. Home sales revenues in our Florida reportable segment decreased by $41.4 million, or 16.1%, during the nine months ended September 30, 2022, as compared to the nine months ended September 30, 2021, primarily due to a 35.3% decrease in the number of homes closed driven by a decrease in the average community count at a lower absorption rate, partially offset by an increase in the average sales price per home closed.
Cost of Sales and Gross Margin (home sales revenues less cost of sales). Cost of sales decreased for the nine months ended September 30, 2022 to $1.3 billion, a decrease of $0.4 billion, or 22.7%, from $1.6 billion for the nine months ended September 30, 2021. This overall decrease is primarily due to a 34.7% decrease in homes closed, offset by increased construction costs. Gross margin for the nine months ended September 30, 2022 was $545.6 million, a decrease of $60.8 million, or 10.0%, from $606.3 million for the nine months ended September 30, 2021. Gross margin as a percentage of home sales revenues was 30.0% for the nine months ended September 30, 2022 and 27.0% for the nine months ended September 30, 2021. The increase in gross margin as a percentage of home sales revenues during the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021 was primarily due to raising prices higher than increases in input costs.
Selling Expenses. Selling expenses for the nine months ended September 30, 2022 were $111.6 million, a decrease of $15.8 million, or 12.4%, from $127.5 million for the nine months ended September 30, 2021. Sales commissions decreased to $68.5 million for the nine months ended September 30, 2022 from $84.7 million for the nine months ended September 30, 2021, partially due to a 19.2% decrease in home sales revenues during the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021. Selling expenses as a percentage of home sales revenues were 6.1% and 5.7% for the nine months ended September 30, 2022 and 2021, respectively. The slight increase in selling expenses as a percentage of home sales revenues was driven primarily by higher advertising and other expenses incurred during the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021.
General and Administrative. General and administrative expenses for the nine months ended September 30, 2022 were $84.7 million, an increase of $12.2 million, or 16.8%, from $72.5 million for the nine months ended September 30, 2021. The increase in the amount of general and administrative expenses is primarily due to increased personnel and associated costs, as well as professional fees and terminated land purchase agreements incurred during the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021. General and administrative expenses as a percentage of home sales revenues were 4.7% and 3.2% for the nine months ended September 30, 2022 and 2021, respectively. The increase in general and administrative expenses as a percentage of home sales revenues is primarily due to increased personnel and associated costs, as well as professional fees and terminated land purchase agreements incurred during the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021.
Loss on Extinguishment of Debt. There was no loss on extinguishment of debt for the nine months ended September 30, 2022. Loss on extinguishment of debt for the nine months ended September 30, 2021 was $14.0 million, primarily due to the redemption premium associated with our 2026 Senior Notes, as well as debt issuance costs and discount previously capitalized that were associated with our 2026 Senior Notes and debt issuance costs previously capitalized that were associated with our credit agreement then in effect for the nine months ended September 30, 2021.
Other Income. Other income, net of other expenses was $22.0 million for the nine months ended September 30, 2022, an increase of $15.0 million from $7.0 million for the nine months ended September 30, 2021. The increase in other income primarily reflects the sale in July 2022 of the three-year interest rate cap of LIBOR prior to its expiration that resulted in $7.1 million in other income, income associated with our investment in unconsolidated entities and gains realized from the sale of land and lots not directly associated with our core homebuilding operations.
Operating Income and Net Income before Income Taxes. Operating income for the nine months ended September 30, 2022 was $349.3 million, a decrease of $57.1 million, or 14.0%, from $406.4 million for the nine months ended September 30,
2021. Net income before income taxes for the nine months ended September 30, 2022 was $371.3 million, a decrease of $28.1 million, or 7.0%, from $399.4 million for the nine months ended September 30, 2021. The following reportable segments contributed to net income before income taxes during the nine months ended September 30, 2022 as follows: Central - $189.0 million or 50.9%; Southeast - $70.4 million or 19.0%; Northwest - $49.7 million or 13.4%; West - $27.3 million or 7.3%; and Florida - $30.9 million or 8.3%. The decreases in operating income and net income before income taxes are primarily attributed to the decrease in home sales revenues, partially offset by higher average sales price per home closed at higher gross margins on a per home basis, during the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021.
Income Taxes. Income tax provision for the nine months ended September 30, 2022 was $78.8 million, a decrease of $2.2 million, or 2.8%, from income tax provision of $81.0 million for the nine months ended September 30, 2021. The decrease in the amount of income tax provision is primarily due to the tax benefits relating to the federal energy efficient homes tax credits that previously expired in 2021 and were subsequently extended for 2022. The increase in our effective tax rate to 21.2% from 20.3% results from an increase in the rate due to an increase in the rate for the state income taxes, net of the federal benefit, and the compensation limitation under Section 162(m) of the Internal Revenue Code, as amended, offset by the retroactive extension of the 45L tax credit and the deductions in excess of compensation cost for share-based payments for the nine months ended September 30, 2022.
Net Income. Net income for the nine months ended September 30, 2022 was $292.5 million, a decrease of $25.9 million, or 8.1%, from $318.3 million for the nine months ended September 30, 2021. The decrease in net income is primarily attributed to overall lower homes closed across all reportable segments, offset by higher average sales price per home closed at higher gross margins on a per home basis, during the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021.
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 September 30, | | Nine Months Ended September 30, |
| | 2022 | | 2021 | | 2022 | | 2021 |
Home sales revenues | | $ | 547,074 | | | $ | 751,608 | | | $ | 1,816,193 | | | $ | 2,249,073 | |
Cost of sales | | 391,275 | | | 549,319 | | | 1,270,628 | | | 1,642,756 | |
Gross margin | | 155,799 | | | 202,289 | | | 545,565 | | | 606,317 | |
Capitalized interest charged to cost of sales | | 4,617 | | | 8,603 | | | 14,865 | | | 29,718 | |
Purchase accounting adjustments (1) | | 1,162 | | | 952 | | | 5,470 | | | 3,210 | |
Adjusted gross margin | | $ | 161,578 | | | $ | 211,844 | | | $ | 565,900 | | | $ | 639,245 | |
Gross margin % (2) | | 28.5 | % | | 26.9 | % | | 30.0 | % | | 27.0 | % |
Adjusted gross margin % (2) | | 29.5 | % | | 28.2 | % | | 31.2 | % | | 28.4 | % |
(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 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 September 30, | | Nine Months Ended September 30, |
| | 2022 | | 2021 | | 2022 | | 2021 |
Net income | | $ | 90,390 | | | $ | 100,550 | | | $ | 292,452 | | | $ | 318,342 | |
Income tax provision (benefit) | | 18,311 | | | 26,444 | | | 78,811 | | | 81,049 | |
Depreciation and amortization | | 404 | | | 295 | | | 1,134 | | | 832 | |
Capitalized interest charged to cost of sales | | 4,617 | | | 8,603 | | | 14,865 | | | 29,718 | |
EBITDA | | 113,722 | | | 135,892 | | | 387,262 | | | 429,941 | |
Purchase accounting adjustments(1) | | 1,162 | | | 952 | | | 5,470 | | | 3,210 | |
Loss on extinguishment of debt | | — | | | 13,314 | | | — | | | 13,976 | |
Other income, net | | (14,124) | | | (2,370) | | | (21,960) | | | (6,979) | |
Adjusted EBITDA | | $ | 100,760 | | | $ | 147,788 | | | $ | 370,772 | | | $ | 440,148 | |
EBITDA margin %(2) | | 20.8 | % | | 18.1 | % | | 21.3 | % | | 19.1 | % |
Adjusted EBITDA margin %(2) | | 18.4 | % | | 19.7 | % | | 20.4 | % | | 19.6 | % |
(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 (typically $1,000 to $5,000). 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.
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 generally set to occur within the next six to twelve 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.
Our net orders decreased for the nine month period ended September 30, 2022 compared to the same period last year primarily due to the strength of the prior year comp, our decision to write contracts later in the construction process, the availability of finished lots, longer construction cycle times and, to a lesser extent, rising mortgage rates for our homebuyers that impacted levels of demand for our homes starting in the third quarter of 2022.
The number of homes in our backlog at September 30, 2022 decreased 59.4% compared to September 30, 2021. The increase in cancellation rates generally corresponds with the rapid increase in mortgage rates for our homebuyers in the second and third quarters of 2022. We believe that, over time, our inventory levels and sales pace will return to our pre-pandemic levels as demand normalizes and mortgage rates decrease from current levels.
As of the dates set forth below, our net orders, cancellation rate and ending backlog homes and value were as follows (dollars in thousands):
| | | | | | | | | | | | | | |
Backlog Data | | Nine Months Ended September 30, |
2022 (4) | | 2021 (5) |
Net orders (1) | | 4,373 | | | 8,044 | |
Cancellation rate (2) | | 21.0 | % | | 18.8 | % |
Ending backlog – homes (3) | | 1,255 | | | 3,090 | |
Ending backlog – value (3) | | $ | 428,293 | | | $ | 959,786 | |
(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 retail 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 generally set to occur within the next six to twelve months. Ending backlog is valued at the contract amount.
(4)As of September 30, 2022, we had 591 units related to bulk sales agreements associated with our wholesale business.
(5)As of September 30, 2021, we had 563 units related to bulk sales agreements associated with our wholesale business.
Land Acquisition Policies and Development
We had 93 and 101 active communities as of September 30, 2022 and December 31, 2021, respectively. The overall decrease in community count is seen as transitory, primarily due to the close out of active communities and to a lesser extent available finished lots in certain active markets. Generally, it takes us two to three years to turn raw or undeveloped land into an active community. To mitigate our exposure to real estate inventory risks, we utilize, on a limited and strategic basis, land banking financing arrangements.
Our lot inventory decreased to 76,453 owned or controlled lots as of September 30, 2022 from 91,845 owned or controlled lots as of December 31, 2021, primarily related to controlled lots that were terminated during the second and third quarters of 2022 to manage our overall inventory. Additionally, throughout 2022 we have experienced intermittent delays that have lowered the lot counts and have been compounded by nationwide inflationary headwinds.
During the three months ended September 30, 2022, we have entered into several land banking financing arrangements with a third-party land banker to repurchase land that we sold to the land banker as a method of acquiring finished lots in staged takedowns, while limiting risk and minimizing the use of funds from our available cash or other financing sources. In consideration for this repurchase option, we paid a non-refundable commitment fee. Based on our right to control the ultimate economic outcome of these finished lots, these assets will continue to be held within our inventory and a corresponding obligation was established within our accrued liabilities to recognize this relationship. While we are not legally obligated to purchase the balance of the lots, we will be subject to certain performance obligations, financial and other penalties if the lots are not purchased. We do not have any ownership interest or title to the assets and do not guarantee their liabilities.
The table below shows (i) home closings by reportable segment for the nine months ended September 30, 2022 and (ii) our owned or controlled lots by reportable segment as of September 30, 2022.
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| | Nine Months Ended September 30, 2022 | | As of September 30, 2022 |
Reportable Segment | | Home Closings | | Owned (1) | | Controlled (2) | | Total |
Central | | 2,460 | | | 23,326 | | | 4,512 | | | 27,838 | |
Southeast | | 1,018 | | | 15,687 | | | 4,035 | | | 19,722 | |
Northwest | | 429 | | | 6,814 | | | 2,162 | | | 8,976 | |
West | | 598 | | | 9,698 | | | 1,960 | | | 11,658 | |
Florida | | 668 | | | 5,102 | | | 3,157 | | | 8,259 | |
Total | | 5,173 | | | 60,627 | | | 15,826 | | | 76,453 | |
(1)Of the 60,627 owned lots as of September 30, 2022, 48,516 were raw/under development lots and 12,111 were finished lots.
(2)Of the 15,826 controlled lots as of September 30, 2022, 716 were associated with land banking financing arrangements.
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 September 30, 2022, we had a total of 1,541 completed homes, including information centers, and 2,569 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 are supplied to us by our subcontractors, and are 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 possible. Typically, the price changes that most significantly influence our operations are price increases in labor, commodities and lumber. For the nine months ended September 30, 2022, we have experienced delays and cost increases, to varying degrees, in our building materials and other construction costs. We could see additional cost pressures associated with lumber and other materials in future quarters. Generally, we have been able to increase the sales prices of our homes to absorb these increased costs.
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 revenues 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 revenues 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 September 30, 2022, we had $52.7 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.
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 and repurchase shares of our common stock. 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.
Short-term Liquidity and Capital Resources
We generally rely on our ability to finance our operations by generating operating cash flows and borrowing under the Credit Agreement (as defined below) to adequately fund our short-term working capital obligations and to purchase land and other assets, develop lots and homes and repurchase 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 rely on our ability to obtain performance, payment and completion surety bonds as well as letters of credit to finance our projects. Furthermore, we utilize, on a limited and strategic basis, land banking financing arrangements to access short-term liquidity.
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.
Long-term Liquidity and Capital Resources
We believe that our long-term principal uses of liquidity and capital resources will be inventory related purchases concerning land, lot development, repurchase shares of our common stock, other capital expenditures, and principal and interest payments on our debt obligations maturing in 2025 and 2029. We believe that we will be able to fund our long-term liquidity needs with cash generated from operations and cash expected to be available to borrow under the Credit Agreement or through accessing debt or equity capital, as needed, although no assurance can be provided that such additional debt or equity capital will be available when needed or on terms that we find attractive. Additionally, we plan to further utilize, on a limited and strategic basis, land banking financing arrangements to maximize long-term liquidity for lot development projects where we have sufficient finished lot availability in certain markets. To the extent these sources of capital are insufficient to meet our needs, we may also conduct additional public or private offerings of our securities, refinance our indebtedness, or dispose of certain assets to fund our operating activities and capital needs.
Revolving Credit Facility
On April 29, 2022, we entered into that certain Lender Addition and Acknowledgement Agreement and Second Amendment to Fifth Amended and Restated Credit Agreement with several financial institutions, and Wells Fargo Bank, National Association, as administrative agent (the “Second Amendment” and, as so amended, “the Credit Agreement”), which amended that certain Fifth Amended and Restated Credit Agreement, dated as of April 28, 2021, with several financial institutions, and Wells Fargo Bank, National Association, as administrative agent (the “2021 Credit Agreement”). The Credit Agreement contains revolving commitments of $1.1 billion, subject to a borrowing base primarily consisting of a percentage of commercial land, land held for development, lots under development and finished lots held by the Company and its subsidiaries that guarantee the obligations under the Credit Agreement.
The Credit Agreement matures on April 28, 2025. Before each anniversary of the Credit Agreement, we may request a one-year extension of its maturity date. The Credit Agreement is guaranteed by, among others, each of our subsidiaries that have gross assets of at least $0.5 million.
The borrowings and letters of credit outstanding under the Credit Agreement, together with the outstanding principal balance of our 4.000% Senior Notes due 2029 (the “2029 Senior Notes”), may not exceed the borrowing base under the Credit Agreement. As of September 30, 2022, the borrowing base under the Credit Agreement was $1.4 billion, of which borrowings, including the 2029 Senior Notes, of $1.2 billion were outstanding, $29.8 million of letters of credit were outstanding and $127.3 million was available to borrow under the Credit Agreement.
For a further description of the Credit Agreement, please refer to Note 4, “Notes Payable” to our consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.
Senior Notes Offering
On June 28, 2021, we issued $300.0 million aggregate principal amount of the 2029 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 2029 Senior Notes accrues at a rate of 4.000% per annum, payable semi-annually in arrears on January 15 and July 15 of each year. The 2029 Senior Notes mature on July 15, 2029. The terms of the 2029 Senior Notes are governed by an Indenture, dated as of July 6, 2018, and Third Supplemental Indenture thereto, dated as of June 28, 2021, 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.
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 $338.7 million as of September 30, 2022. 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 September 30, 2022 will be drawn upon.
Stock Repurchase Program
In February 2022, our Board of Directors (the “Board”) approved a $200.0 million increase to our previously authorized stock repurchase program, pursuant to which we may purchase up to $550.0 million of shares of our common stock through open market transactions, privately negotiated transactions or otherwise in accordance with applicable laws. During the three months ended September 30, 2022, we did not repurchase any shares of our common stock. During the nine months ended September 30, 2022, we repurchased 892,916 shares of our common stock for $95.1 million to be held as treasury stock. A total of 2,939,472 shares of our common stock has been repurchased since our stock repurchase program commenced. As of September 30, 2022, we may purchase up to $211.5 million of shares of our common stock under our stock repurchase program. The timing, amount and other terms and conditions of any repurchases of shares of our common stock under our stock repurchase program will be determined by our management at its discretion based on a variety of factors, including the market price of our common stock, corporate considerations, general market and economic conditions and legal requirements. Our stock repurchase program may be modified, discontinued or suspended at any time.
Cash Flows
Operating Activities
Net cash used in operating activities was $359.6 million for the nine months ended September 30, 2022. The primary drivers of operating cash flows are typically cash earnings and changes in inventory levels, including land acquisition and development. Net cash used in operating activities during the nine months ended September 30, 2022 was primarily driven by cash outflow from the $791.7 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 and partially offset by net income of $292.5 million, as well as the $41.1 million and $43.8 million increase in the net change in accounts payable, and accrued expenses and other liabilities, respectively.
Net cash provided by operating activities was $101.1 million for the nine months ended September 30, 2021. 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 nine months ended September 30, 2021 was primarily driven by net income of $318.3 million, and included cash outflow from the $286.6 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 and increases of $66.8 million and $20.6 million in the net change in accounts receivable and accounts payable, respectively.
Investing Activities
Net cash used in investing activities was $2.1 million for the nine months ended September 30, 2022, primarily due to the purchase of property and equipment and additional investment in unconsolidated entities.
Net cash used in investing activities was $69.8 million for the nine months ended September 30, 2021, primarily due to the payment for a business acquisition, additional investment in unconsolidated entities, and purchase of property and equipment.
Financing Activities
Net cash provided by financing activities was $363.8 million for the nine months ended September 30, 2022, primarily driven by $534.9 million of borrowings under the 2021 Credit Agreement and the Credit Agreement and $35.9 million of proceeds related to a financing arrangement with a third-party land banker. These were partially offset by $110.0 million of repayments on the Credit Agreement and by $95.1 million in payments for shares of our common stock repurchased under our stock repurchase program to be held as treasury stock.
Net cash used in financing activities was $20.5 million for the nine months ended September 30, 2021, primarily driven by $944.0 million of payments on our credit agreement then in effect and the 2021 Credit Agreement and by the $137.7 million payment for shares of our common stock repurchased under our stock repurchase program to be held as treasury stock, offset by $1.1 billion related to the proceeds received from the offering of the 2029 Senior Notes, and borrowings under our credit agreement then in effect and the 2021 Credit Agreement.
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. During the nine months ended September 30, 2022, we have experienced a significant increase in land, labor, materials and construction costs, which we currently expect to continue for the foreseeable future. Generally, we have been able to increase the sales prices of our homes to absorb such increased costs. See “Industry and Economic Risks—Inflation could adversely affect our business and financial results” in Item 1A. Risk Factors in Part I of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021.
Material Cash Requirements
As of September 30, 2022, there have been no material changes to our known contractual and other obligations appearing in the “Material Cash Requirements” 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, 2021. Critical Accounting Policies and Estimates
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 and estimates during the nine months ended September 30, 2022 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, 2021. 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:
•adverse economic changes either nationally or in the markets in which we operate, including, among other things, potential impacts from political uncertainty, civil unrest, increases in unemployment, volatility of mortgage rates, supply chain disruptions (including due to the conflict between Russia and Ukraine and the wide-ranging sanctions the United States and other countries have imposed or may further impose on Russian business sectors, financial organizations, individuals and raw materials), inflation, the possibility of recession and decreases in housing prices;
•the impact of the COVID-19 pandemic and its effect on us, our business, customers, subcontractors and suppliers (including associated supply chain disruptions), 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;
•a slowdown in the homebuilding industry or changes in population growth rates in our markets;
•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, close such acquisitions and realize the benefits of 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, including environmental 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;
•our continued ability to qualify for additional federal energy efficient homes tax credits and the extension of the availability of such tax credits beyond 2032;
•information system failures, cyber incidents or breaches in security;
•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;
•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;
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.