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Text: Those and any other projections represent the current opinions of management, which are subject to change at any time, and we assume no obligation to update them.
Home buying activity remained solid during the third quarter.
We continued to experience elevated demand and despite the return of some seasonality in the quarter, monthly demand has improved sequentially from August to September and October.
The macro drivers for market demand continued to be what we've experienced all of '21: limited housing supply, still extremely low interest rates and higher home buying activity from millennials and baby boomers who are experiencing life events associated with changes in housing needs.
New and existing resale housing supply remained tight, especially for affordable entry-level homes.
Mortgage interest rates are still very attractive as entry-level buyers are typically focused on monthly payment.
The low interest rates continued to offset higher ASPS and we are seeing elevated demand persist.
And lastly, we continued to see household formation for millennials and downsizing for baby boomers, both of which create demand for the type of housing that we build.
We believe these underlying demographic factors will not fundamentally change in the near future, and although they may be bumpy if interest rates move materially within a short period of time.
This quarter, we leaned on our deep vendor relations to navigate ongoing industrywide supply chain challenges.
These strategic supply side partnerships and our operating model focus on spec homes and limited SKUs, allowed us to deliver 3,112 homes, which set the company record for the highest third quarter of home closings.
We also set two additional quarterly company records: we generated the highest quarterly home closing gross margin of 29.7% in company history as a result of pricing power, more than offsetting the elevated lumber and other commodity costs; and our quarterly diluted earnings per share of $5.25 was the highest in our company's history.
We grew community count sequentially again this quarter as well as year-over-year, overcoming municipal delays and supply shortages and land development as well.
As of September 30, 2021, we had 236 ending communities and remain confident in our ability to achieve our goal of 300 communities by mid-2022.
On slide four, I want to touch on the latest milestones we achieved this quarter.
The EPA recognized Meritage as a recipient of the 2021 Indoor airPLUS Leader Award.
Our advanced air filtration, ventilation and HVAC as well as spray foam insulation helped minimize the indoor exposure to airborne pollutants and contaminants.
So it's great to be recognized for these accomplishments nationally.
In terms of innovation, we launched self-guided tours in select locations to address customers' changing preferences when it comes to the home buying process.
Self-guided tours allow buyers to sign up for a no contact tour of our model homes on our website and then tour the home after-hours at their convenience.
We expect to have this program rolled out throughout the country in the coming months.
Additionally, we expanded our offering of digital financial services, so Meritage customers can now receive guaranteed on-demand homeowners' insurance quotes on their selected home on our website.
From an ESG perspective, we memorialized our human rights policy, which can now be found on our Investor Relations website, and stay tuned as we will have more to share on ESG -- on the ESG front before year-end.
Overall, it was another successful quarter, where our teams and supplier relationships helped Meritage deliver 3,112 homes.
Affordability was one of the cornerstones of our strategic shift in 2016, and we continue to be focused on today.
From land acquisition to operations, we look to maintain our entry-level products as an affordable home offering in the new home marketplace.
That being said, the sustained favorable pricing environment stemming from the elevated demand for our products over the past few quarters and the tight housing supply conditions led to ASP increase on orders, backlog and closings that are masking our ongoing product mix shift toward entry level.
Although order ASP grew 12% year-over-year, we experienced a deceleration in ASP growth sequentially this quarter, and the new product we'll be bringing on in 2022 and 2023 will allow us to continue repositioning our future communities down the ASP band.
During the third quarter, we continued metering our orders pace to align with the current production environment and supply chain challenges.
Even still, our average absorption pace remained elevated at 5.0 per month.
We were still typically able to sell inventory shortly after releasing it, but we are only releasing homes once we have visibility into our cost structure and confidence about closing times, which is a bit late in the process today due to supply constraints.
It is unclear when the current supply challenges will work themselves out.
We currently have no insight to suggest that it's on the near term, and therefore, we are continuing to model elongated cycle times for the foreseeable future.
Now turning to slide five.
Our third quarter closings totaled 3,112 homes.
They were up 4% over the prior year.
Entry-level comprised 78% of closings, up from 63% in the prior year.
For us, Q3 of last year was the quarterly peak of the surging housing demand since the start of COVID-19, resulting in our all-time highest third quarter absorption pace of 5.8 sales per month.
In 2021, we have been metering orders due to the well-documented supply chain issues.
As a result, the total orders of 3,441 for the quarter of 2021 reflected a decrease of 11% year-over-year, driven by a 15% decline in average absorption pace that was partially offset by a 5% increase in average communities.
Despite metering, our third quarter 2021 absorption pace currently remained elevated at five sales per month.
Entry-level comprised over 80% of quarterly orders, up from nearly 70% in the third quarter of last year.
Entry-level also represented 77% of our average active communities compared to 60% a year ago.
Moving to the regional level trends on slide six.
Our central region, which is comprised of Texas, led in terms of average absorption pace with 5.4 sales per month this quarter, which was 14% lower than prior year.
This decline was partially offset by a 5% greater average active communities, which together contributed to a 10% decline in order volume.
Third quarter order ASP increased 20% year-over-year given solid market conditions in Texas.
Our east region with the highest entry-level product mix with -- representing 80% of the average community was the only region to generate year-over-year growth in order volume of 3% despite metering as a result of an 8% increase in average active communities in the third quarter, which offset a 4% decrease in average absorption pace.
South Carolina opened several new communities later in the third quarter, which resulted in a 3.7 average absorption pace in the third quarter.
This was our lowest absorption pace in the company's quarter, despite South Carolina's orders increasing 11% over prior year.
Given healthy demand in the state, we anticipate the order pace will increase in the near future.
The west region's third quarter 2021 order volume had our largest decline at 24% year-over-year, mainly due to 25% lower average absorption pace to 4.9 per month.
Specifically, Arizona reduced its absorption pace from 6.5 per month in Q3 of 2020 to 4.8 per month this quarter as a result of supply chain challenges.
Colorado remained the lowest percentage of entry-level mix at 48% of its average active communities this quarter.
During the third quarter, California had the highest average absorption pace of all our states at 5.6 per month.
Given 100% of the average active communities are entry-level there, we continue to focus on affordability, particularly as it's our most expensive geography.
The third quarter order ASP increased 15% year-over-year in the west region.
Arizona and Colorado had the largest increase in order ASP in all our states at 26%.
So we are monitoring these markets to ensure we wire ASP to local market condition and continue to introduce products that is more affordable.
Overall, demand remained healthy in all of our markets.
Turning to slide seven.
Of our home closings this quarter, 74% came from previously started spec inventory, which increased from 71% a year ago.
We ended the quarter with nearly 2,100 spec homes in inventory or an average of 11.7 homes per community as we push to get homes in the ground.
This was an important improvement from approximately 2,300 specs or an average of 11.2 in the third quarter of 2020.
At September 30, 2021, less than 5% of the total specs were completed versus our typical run rate of 1/3.
Having available spec is crucial to our business model, but even as we started over 3,400 homes this quarter, maintaining our goal of a four to six-month supply of entry-level spec has been challenging.
As we have been ramping up our new communities, we are working very hard to get enough spec started in all of them.
We didn't accomplish all that we wanted in Q3, but we expect to accelerate our pace in Q4.
We ended the quarter with a backlog of over 1,500 units as our conversion rate declined from 68% last year to 57% this year due to supply delays.
Although we believe our spec strategy and entry-level focus will drive the conversion up in the long-term when the supply chain normalizes, we expect current supply issues and the resulting slower backlog conversions to persist at least for the next couple of quarters.
During the third quarter, bottlenecks abound in various areas along supply chain, some on the front-end and others on the back-end, leading to an additional two weeks or so of construction cycle times sequentially from Q2 to Q3 this year.
In particular, windows and truss delays impacted our operations throughout the country.
As Steve mentioned, our operating structure and strong vendor partnerships have afforded us some advantage as we navigate these disruptions.
We reengineered our product a few years ago which limit our SKU count and planned libraries, allowing us to order material in bulk in advance.
We have also heavily invested in relationships with our vendors, which we have strengthened during the last couple of quarters.
We are maintaining constant communication and remain flexible to substitute or upgrade our SKUs or find alternative supplies as necessary.
We have been benefiting from our 100% spec building strategy for entry-level homes.
Pre-starting homes enable us to maintain a steady cadence of homebuilding construction and makes us a preferred partner to our trades This transparency and scheduling visibility as well as no structural changes makes our products simpler to build.
At times like these, we appreciate that we can leverage our spec building strategy and our operating model to continue to deliver our backlogs and get more homes started.
The 10% year-over-year home closing revenue growth to $1.3 billion in the third quarter of 2021 was the result of the 4% increase in home closings and 7% higher closing ASP despite the mix shift to more entry-level products.
The 820 bp improvement in third quarter 2021 home closing gross margin to 29.7% from 21.5% a year ago was driven by the price increases over the past several quarters as well as the leveraging of our fixed costs on greater home closing revenue.
The pricing power more than offset the increased cost of lumber and other commodities.
Today's more normal lumber cost will start to be reflected in our gross margin in early 2022, but will be partially offset by other increased commodity costs as well as the additional overhead burden in gross margin from our community count ramp up.
Once we're fully selling and closing from all 300 communities in 2022, we will be able to leverage the higher fixed overhead costs across the corresponding higher revenue.
We are also continuing to monitor the recent increases in lumber and the impact they may have on our 2022 gross margin.
Our SG&A leverage of 9.3% remained better than our 10% expectation and continued to benefit from both greater closing volumes and higher ASPs.
The 80 bps year-over-year improvement and SG&A leverage from 10.1% in the third quarter of 2020 also included lower brokerage commissions in 2021 and cost savings from technology innovations that particularly benefited our sales and marketing efforts.
We will continue to find ways to incorporate technology into our operations and expect to be able to better leverage our total SG&A on higher closing volumes in 2022 as well.
The third quarter 2021's effective income tax rate was 23.3% compared to 19.5% in the prior year.
Both years reflect reduced rates primarily from eligible tax credit on qualifying energy-efficient homes closed under the 2019 Taxpayer Certainty and Disaster Tax Relief Act.
Increased profit in states with higher tax rates and reduced benefit of the energy tax credit due to greater overall profitability for the company both contributed to the higher tax rate in 2021.
Higher closing volume, pricing power, expanded gross margin and the improved overhead leverage that we achieved this quarter all led to the 85% year-over-year increase in third quarter diluted earnings per share of $5.25.
To highlight a few year-to-date results through September 30, 2021, on a year-over-year basis, we generated an 85% increase in net earnings, orders decreased 1%, closing were up 15%, we had a 640 bp expansion of our home closing gross margin to 27.4%, and SG&A as a percentage of home closing revenue improved 90 bps to 9.4%.
As seen on slide nine, our balance sheet reflects ample liquidity and flexibility for further growth.
At September 30, 2021, our cash balance was $562 million compared to $746 million at December 30, 2020.
It was down just $184 million despite an $815 million increase in real estate assets over the same time.
Our net debt-to-cap ratio of 17.5% at September 30, 2021, remained low.
We still target a maximum ceiling of net debt-to-cap in the high 20s, which is in line with the quick asset turn we expect from our entry-level and first move-up offerings.
Our capital usage priority is still focused on growth.
The bulk of our cash will be spent on land acquisition and development and to get specs in the ground in our new communities.
We routinely repurchase shares to offset new grants and keep our dilution neutral.
As demonstrated in the third quarter, we will also continue to opportunistically repurchase incremental shares.
We repurchased over 95,000 shares during the quarter for $9.5 million.
Since the end of the quarter, we repurchased an additional nearly 244,000 shares for another $24 million.
Today, over $153 million remains in our share repurchase authorization program.
We expect cash generation to accrete once our 300 communities are operating and delivering homes in the back half of 2022.
On to slide 10.
Our land book increased 46% from September 30, 2020.
With nearly 70,000 lots under control at the end of this quarter, we had 5.4 years supply of lots based on trailing 12-month closings, which was higher than our target range of four to five-year supply of lots under control.
However, looking forward to the closing volume that we would generate once our 300 communities are actively selling in the middle of next year, the ratio drops back to our four to five year objective.
We secured about 9,800 net new lots this quarter compared to approximately 9,000 in the same quarter of 2020.
These new lots will translate to an estimated 45 net new communities, of which 87% are entry-level with an average community size of 196 lots.
Despite the additional demand for land from all builders today, we were able to meet our internal land acquisition goal while making sure our projects meet our underwriting hurdles, modeling a normalized absorption pace and a higher incentive environment.
Our understanding of who we are has sharpened as has our confidence level in the type of projects we bid on.
By knowing the cost of the home and increasing our land development expertise, we feel comfortable bidding on land parcels that others might not, from acquisition of larger lot sizes to those in secondary submarkets that best align with our entry-level products and projects with complexity in land development.
In fact, our year-to-date finished lot cost for newly controlled lots is right around $75,000 a lot.
During the third quarter of 2021, we continued to make excellent progress in our land development despite municipal delays and supply chain constraints, and we opened 40 new communities.
We grew our community count by 10 net communities from 226 at the start of the quarter to 236 actively selling communities at the end of the quarter.
On a year-over-year basis, we were also up 16% or 32 net communities from 204 at September 30, 2020.
We spent $526 million on land acquisition and development this quarter, which was 76% higher than last year's Q3 spending of nearly $300 million.
We continue to expect our annual land acquisition and development to be about $2 billion in 2021 and thereafter.
To preserve liquidity, we use options for staggered purchasing terms where financially feasible.
About 64% of our total lot inventory at September 30, 2021, was owned and 36% was optioned compared to 58% owned and 42% option at September 30, 2020.
Finally, I'll direct you to slide 11.
With limited visibility into when the supply chain will loosen, we continue to forecast supply chain delays and longer cycle times for the rest of 2021 and into 2022.
With more than 5,800 units in backlog and another almost 2,800 specs in the ground today, we are projecting 12,600 to 12,900 home closings for the full year of 2021, which we anticipate will generate $5.05 billion to $5.15 billion in home closing revenue.
We are lifting our full year 2021 guidance on home closing gross margin, which we now anticipate will be between 27.5% to 27.75%.
With an increase to the projected effective tax rate to 23%, we expect diluted earnings per share to be in the range of $18.75 to $19.40 for 2021, a year-over-year increase of over 70%.
For year-end 2021, we also anticipate around 250 active communities.
We are reiterating our commitment to 300 communities by June 2022, with around $2 billion of land acquisition and development spend projected for next year as well.
For 2022, we anticipate double-digit growth in unit and home closing revenue.
As I previously noted, we expect gross margins in '22 to remain elevated, although supply chain issues, commodity costs and recent lumber cost increases may all cap further upside.
With the higher volume of communities operating next year, we anticipate full year 2022 SG&A rate will drop below our current SG&A rate of the low 9s.
To summarize on slide 12.
We have capitalized on the ongoing favorable market conditions by having available supply of entry-level and first move-up homes that are attractive to both millennials and baby boomers, the largest home buying demographic today.
The continued significant investment in land acquisition and development as well as the meaningful growth in community count over the past two quarters to 236 communities as of September 30 demonstrates our ability to attain our strategic goal of 300 communities by mid-2022.
Our operating model, strong execution, growing community count and focus on the entry-level and first move-up markets have all led to the company hitting our closings, achieving an absorption pace of five per month while metering the order pace, growing community count again and obtaining industry-leading gross margins this quarter.
Additionally, these attributes position us well to continue expanding our market share, leveraging our operating costs and driving profitability over the next several years.

user
compname reports third quarter 2021 results, including record gross margin of 29.7% and diluted earnings per share of $5.25.
q3 earnings per share $5.25.
projecting 12,600 to 12,900 home closings for full year 2021.
expect diluted earnings per share to be in range of $18.75-19.40 for 2021.
in quarter delivered 3,112 homes and produced a 10% year-over-year increase in home closing revenue to $1.3 billion.

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