# Dream Finders Homes, Inc. (DFH) FY 2023 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Dream Finders Homes, Inc.'s 10-K for fiscal year 2023.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1825088/000182508824000015/dfh-20231231.htm
Accession: 0001825088-24-000015
Filing date: 2024-02-29
Report date: 2023-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary. Published MD&A gate trimmed front/tail over-capture.
Confidence: high

Company profile: /company/DFH/
All MD&A years: /company/DFH/mda/
Previous year: /company/DFH/mda/fy2022/ (FY 2022)
Next year: /company/DFH/mda/fy2024/ (FY 2024)

ITEM 7.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the accompanying financial statements and related notes thereto. Unless the context otherwise requires, the terms “Dream Finders,” “DFH,” “the Company,” “we,” “us” and “our” refer to Dream Finders Homes, Inc. and its subsidiaries.

The following discussion and analysis of our financial condition and results of operations is intended to help the reader understand our business, operations and present business environment and is provided as a supplement to, and should be read together with the sections entitled “Risk Factors,” and the financial statements and the accompanying notes included elsewhere in this Form 10-K. In addition, the statements in this discussion and analysis regarding outlook, our expectations regarding the performance of our business, anticipated financial results and liquidity are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described in “Forward-Looking Statements” and in “Risk Factors” above. Our actual results may differ materially from those contained in or implied by any forward-looking statements."

Business Overview and Outlook

We design, build and sell homes in high-growth markets using our asset-light lot acquisition strategy. Our primary focus is on constructing and selling single-family homes across entry-level, first-time move-up, second-time move-up, and active adult markets. To fully serve our homebuyers and capture ancillary business opportunities, we have financial services operations that offer title insurance and mortgage banking solutions.

The easing of mortgage interest rates toward the end of 2023 resulted in accelerated demand for homebuilders heading into the spring selling season. Although macroeconomic indicators suggest that interest rates will continue to fall moderately in 2024, which, if those indicators come to fruition, should have a consistent positive impact on demand, we remain cautious and committed to our goals to deliver affordability and value to our homebuyers. We continue to strategically release quick move-in homes in our communities at competitive price points and we offer flexible sales incentives aimed at reducing our homebuyers’ monthly mortgage payments and closings costs. This strategy has served us well during 2023, and we believe it will continue to effectively generate new sales and faster inventory turnover in 2024.

Inflation in the United States materially increased during the year ended December 31, 2022, and has remained elevated throughout 2023. Despite this fact, the homebuilding industry has shown consistent growth in 2023, driven by constrained housing supply dynamics that favor new home sales as the resale home market continues to face inventory shortages. If interest rates start to decline in 2024, increased demand for homes is likely to follow.

Through our close monitoring of net new orders and community-level traffic, we are able to respond promptly to changes in local market conditions. As needed, we are able to strategically renegotiate lot option takedowns to match sales pace, which exemplifies how advantageous our asset-light strategy can be. Excluding built-for-rent deals that occurred in 2022 that did not repeat in 2023, the Company had an increase in net new orders of 43% when compared to the prior year.

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These focused efforts by management not only drove our strong performance this year, but also showcase our ability to navigate a challenging macroeconomic environment.

Key Results

Key financial results for the year ended December 31, 2023, as compared to the year ended December 31, 2022 (unless otherwise noted) were as follows:

•Revenues increased 12% to $3.7 billion from $3.3 billion

•Home closings increased 6% to 7,314 from 6,878

•Average sales price of homes (“ASP”) closed increased 7% to $505,764 from $474,292

•Net new orders decreased 5% to 5,744 from 6,045

•Gross margin as a percentage of homebuilding revenues increased 100 basis points (“bps”) to 19.4% from 18.4%

•Adjusted gross margin (non-GAAP) as a percentage of homebuilding revenues increased 260 bps to 27.2% from 24.6%

•Income before taxes increased 14% to $404 million from $356 million

•Net and comprehensive income attributable to DFH increased 13% to $296 million from $262 million

•Basic earnings per share (“EPS”) was $3.03 and diluted EPS was $2.79, compared to $2.67 and $2.45, respectively

•EBITDA (non-GAAP) as a percentage of total revenues increased 130 bps to 13.9% from 12.6%

•Active community count increased to 221 from 206

•Backlog of sold homes decreased 28% to 3,978 from 5,548, and the value of backlog decreased 25% to $1.9 billion from $2.5 billion

•Return on participating equity was 36.3%, compared to 49.1%

•Issuance of $300 million in aggregate principal amount of 8.25% senior unsecured notes used to repay a portion of the outstanding balance under the revolving credit facility

•Net debt to net capitalization of 23.3% as of December 31, 2023, compared to 42.9% as of December 31, 2022

•Total liquidity, comprised of cash and cash equivalents, and availability under the revolving credit facility, increased to $828 million as of December 31, 2023, compared to $487 million as of December 31, 2022

For reconciliations of the non-GAAP financial measures, including adjusted gross margin and EBITDA, to the most directly comparable GAAP financial measures, see “—Non-GAAP Financial Measures .”

Recent Developments

Crescent Homes Acquisition

On February 1, 2024, we acquired the majority of the homebuilding assets of Crescent Ventures, LLC (“Crescent Homes”), expanding our operations into the Charleston and Greenville, South Carolina and Nashville, Tennessee markets. Refer to Note 15, Subsequent Events to our consolidated financial statements for more information.

Expansion in the Southeast Segment

In 2023, we expanded into the Tampa, Florida market. As of December 31, 2023, we owned 12 lots and controlled 623 lots in Tampa. We opened for sales in Tampa in January 2024.

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Results of Operations

Year Ended December 31, 2023 Compared to Year Ended December 31, 2022

The following table sets forth our results of operations and balance sheet data (in thousands, except per share and share amounts) for the periods indicated:

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["","","2023","","2022","","Amount Change","","% Change"],["Revenues:"],["Homebuilding","","$","3,738,888","","","$","3,334,559","","","$","404,329","","","12","%"],["Other","","9,698","","","7,776","","","1,922","","","25","%"],["Total revenues","","3,748,586","","","3,342,335","","","406,251","","","12","%"],["Homebuilding cost of sales","","3,011,813","","","2,722,139","","","289,674","","","11","%"],["Selling, general and administrative expense","","308,795","","","271,040","","","37,755","","","14","%"],["Income from unconsolidated entities","","(18,075)","","","(16,122)","","","(1,953)","","","12","%"],["Contingent consideration revaluation","","46,590","","","11,053","","","35,537","","","322","%"],["Other income, net","","(4,962)","","","(1,931)","","","(3,031)","","","157","%"],["Income before taxes","","404,425","","","356,156","","","48,269","","","14","%"],["Income tax expense","","(96,483)","","","(81,859)","","","(14,624)","","","18","%"],["Net and comprehensive income","","307,942","","","274,297","","","33,645","","","12","%"],["Net and comprehensive income attributable to noncontrolling interests","","(12,042)","","","(11,984)","","","(58)","","","\u2014","%"],["Net and comprehensive income attributable to Dream Finders Homes, Inc.","","$","295,900","","","$","262,313","","","$","33,587","","","13","%"],["Earnings per share(1)"],["Basic","","$","3.03","","","$","2.67","","","$","0.36","","","13","%"],["Diluted","","$","2.79","","","$","2.45","","","$","0.34","","","14","%"],["Weighted-average number of shares"],["Basic","","93,066,564","","","92,745,781","","","320,783","","","\u2014","%"],["Diluted","","106,027,548","","","106,691,248","","","(663,700)","","","(1)","%"],["Consolidated Balance Sheets Data (as of period end):"],["Cash and cash equivalents","","$","494,145","","","$","364,531","","","$","129,614","","","36","%"],["Total assets","","$","2,562,439","","","$","2,371,137","","","$","191,302","","","8","%"],["Total debt","","$","824,302","","","$","966,248","","","$","(141,946)","","","(15)","%"],["Total mezzanine and stockholders\u2019 equity","","$","1,086,150","","","$","800,693","","","$","285,457","","","36","%"],["Other Financial and Operating Data"],["Active communities as of period-end(2)","","221","","","206","","","15","","","7","%"],["Home closings","","7,314","","","6,878","","","436","","","6","%"],["Average sales price of homes closed(3)","","$","505,764","","","$","474,292","","","$","31,472","","","7","%"],["Net new orders","","5,744","","","6,045","","","(301)","","","(5)","%"],["Cancellation rate","","18.3","%","","21.5","%","","(3.2)","%","","(15)","%"],["Ending backlog - homes","","3,978","","","5,548","","","(1,570)","","","(28)","%"],["Ending backlog - value (in thousands)","","$","1,887,368","","","$","2,502,564","","","$","(615,196)","","","(25)","%"],["Return on participating equity(4)","","36.3","%","","49.1","%","","(12.8)","%","","(26)","%"],["Net debt to net capitalization(5)","","23.3","%","","42.9","%","","(19.6)","%","","(46)","%"],["Gross margin (in thousands)(6)","","$","727,075","","","$","612,420","","","$","114,655","","","19","%"],["Gross margin %(7)","","19.4","%","","18.4","%","","1.0","%","","5","%"],["Adjusted gross margin (in thousands)(8)","","$","1,015,624","","","$","820,158","","","$","195,466","","","24","%"],["Adjusted gross margin %(7)(8)","","27.2","%","","24.6","%","","2.6","%","","11","%"],["EBITDA (in thousands)(8)","","$","521,495","","","$","422,582","","","$","98,913","","","23","%"],["EBITDA margin %(8)(9)","","13.9","%","","12.6","%","","1.3","%","","10","%"],["Adjusted EBITDA (in thousands)(8)","","$","535,593","","","$","429,378","","","$","106,215","","","25","%"],["Adjusted EBITDA margin %(8)(9)","","14.3","%","","12.8","%","","1.5","%","","12","%"]]
[[/GREPCENT_TABLE]]

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(1)Refer to Note 14, Earnings Per Share to the consolidated financial statements for disclosures related to the calculation of EPS. Diluted shares were calculated by using the treasury stock method for stock grants and the if-converted method for the convertible preferred stock and the associated preferred dividends.

(2)A community becomes active once the model is completed or the community has its fifth net sale. A community becomes inactive when it has fewer than five homesites remaining to sell.

(3)Average sales price of homes closed is calculated based on homebuilding revenues, adjusted for the impact of percentage of completion revenues, and excluding deposit forfeitures and land sales, over homes closed.

(4)Return on participating equity is calculated as net income attributable to DFH, less redeemable preferred stock distributions, dividends and redemptions, divided by average beginning and ending participating equity. Participating equity is stockholders’ equity excluding noncontrolling interests.

(5)Net debt to net capitalization is defined as the sum of the senior unsecured notes, net, and construction lines of credit, less cash and cash equivalents (“net debt”), divided by the sum of net debt and total mezzanine and stockholders’ equity.

(6)Gross margin is homebuilding revenues less homebuilding cost of sales.

(7)Calculated as a percentage of homebuilding revenues.

(8)Adjusted gross margin, EBITDA and adjusted EBITDA are non-GAAP financial measures. For definitions of these non-GAAP financial measures and a reconciliation to our most directly comparable financial measures calculated and presented in accordance with GAAP, see “—Non-GAAP Financial Measures.”

(9)Calculated as a percentage of total revenues.

The following tables summarize homes closings, and ASP of homes closed by homebuilding segment for the years ended December 31, 2023 and 2022, as well as active communities as of December 31, 2023 and 2022:

[[GREPCENT_TABLE]]
[["","","Year Ended December 31, 2023","","As of December 31, 2023"],["Segment","","Home Closings","","ASP","","Active Communities"],["Southeast","","3,170","","","$","470,405","","","57"],["Mid-Atlantic","","1,597","","","396,462","","","44"],["Midwest","","2,547","","","618,306","","","120"],["Total","","7,314","","","$","505,764","","","221"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","","Year Ended December 31, 2022","","As of December 31, 2022"],["Segment","","Home Closings","","ASP","","Active Communities"],["Southeast","","2,722","","","$","439,150","","","57"],["Mid-Atlantic","","1,562","","","358,548","","","37"],["Midwest","","2,594","","","580,865","","","112"],["Total","","6,878","","","$","474,292","","","206"]]
[[/GREPCENT_TABLE]]

The following table presents income before taxes (in thousands), and homebuilding gross margin percentage by segment for the years ended December 31, 2023 and 2022:

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["","","2023","","2022"],["Segment","","Income Before Taxes","","Gross Margin %","","Income Before Taxes","","Gross Margin %"],["Southeast","","$","183,537","","","18.9","%","","$","165,367","","","19.4","%"],["Mid-Atlantic","","54,646","","","17.9","%","","40,028","","","14.1","%"],["Midwest","","168,115","","","20.6","%","","164,377","","","19.1","%"],["Total","","$","406,298","","","19.4","%","","$","369,772","","","18.4","%"]]
[[/GREPCENT_TABLE]]

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Revenues. Revenues for the year ended December 31, 2023 were $3.7 billion, an increase of $0.4 billion, or 12%, from $3.3 billion for the year ended December 31, 2022. The increase in revenues was attributable to home closings of 7,314 for the year ended December 31, 2023, an increase of 436 homes, or 6%, from 6,878 for the year ended December 31, 2022. Also contributing to the increase was the average sales price of homes closed for the year ended December 31, 2023 was $505,764, an increase of $31,472, or 7%, from $474,292 for the year ended December 31, 2022. The increase was due to overall price appreciation, as well as product mix.

Homebuilding Cost of Sales and Gross Margin. Homebuilding cost of sales for the year ended December 31, 2023 was $3.0 billion, an increase of $0.3 billion, or 11%, from $2.7 billion for the year ended December 31, 2022. Homebuilding gross margin for the year ended December 31, 2023 was $727 million, an increase of $115 million, or 19%, from $612 million for the year ended December 31, 2022. Homebuilding gross margin percentage was 19.4% for the year ended December 31, 2023, an increase of 100 bps, or 5%, from 18.4% for the year ended December 31, 2022. The increase in gross margin percentage was primarily a result of continued cost management and cycle time improvement efforts. The increase was partially offset by higher financing and closing costs. To facilitate home closings, we provided closing cost incentives, which, among other options, could be used by the customer to buy down their mortgage interest rate.

Adjusted Gross Margin. Adjusted gross margin for the year ended December 31, 2023 was $1.0 billion, an increase of $196 million, or 24%, from $820 million for the year ended December 31, 2022. Adjusted gross margin as a percentage of homebuilding revenues for the year ended December 31, 2023 was 27.2%, an increase of 260 bps, or 11%, from 24.6% for the year ended December 31, 2022. The adjusted gross margin percentage increased due to effective cost management strategies, partially offset by higher closing costs. Adjusted gross margin is a non-GAAP financial measure. For the definition of adjusted gross margin and a reconciliation to our most directly comparable financial measure calculated and presented in accordance with GAAP, see “—Non-GAAP Financial Measures.”

Southeast. Our Southeast segment total revenues for the year ended December 31, 2023 were $1.5 billion, an increase of $0.3 billion, or 23%, from $1.2 billion for the year ended December 31, 2022. This revenue growth was primarily driven by an increase in home closings of 448, or 16%. Additionally, the ASP of homes closed of $470,405 for the year ended 2023, reflected an increase of 7% when compared to 2022, a result of price appreciation and product mix. Homebuilding gross margin percentage was 18.9% for the year ended December 31, 2023, representing a decrease of 50 bps, or 0.5%, when compared to the year ended December 31, 2022. The reduction in gross margin percentage was primarily attributed to higher financing and closing costs.

Mid-Atlantic. Our Mid-Atlantic segment total revenues for the year ended December 31, 2023 were $633 million, an increase of $66 million, or 12%, from $567 million for the year ended December 31, 2022. This revenue growth was primarily driven by an increase in ASP of homes closed of 11% to $396,462. The increase in ASP of homes closed was largely influenced by changes in product mix. Additionally, there was an increase in home closings of 35, or 2%, for the year ended December 31, 2023 compared to 2022. Homebuilding gross margin percentage was 17.9% for the year ended December 31, 2023, representing an increase of 380 bps, or 3.8%, when compared to the year ended December 31, 2022. The improvement in gross margin percentage was primarily due to cost management efforts, including cycle time reductions, partially offset by higher financing costs.

Midwest. Our Midwest segment total revenues for the year ended December 31, 2023 were $1.6 billion, an increase of $0.1 billion, or 4%, from $1.5 billion for the year ended December 31, 2022. This additional revenue was due to an ASP of homes closed of $618,306 for the year ended 2023, an increase of 6% when compared to 2022, partially offset by a decrease in home closings of 47, or 2%. Homebuilding gross margin percentage was 20.6% for the year ended December 31, 2023, representing an increase of 150 bps, or 1.5%, when compared to the year ended December 31, 2022. The growth in gross margin percentage year over year is due to effective cost management including impacts from overall cycle time reduction, partially offset by higher financing and closing costs.

Selling, General and Administrative Expense. Selling, general and administrative expense (“SG&A”) for the year ended December 31, 2023 was $309 million, an increase of $38 million, or 14%, from $271 million for the year ended December 31, 2022. SG&A as a percentage of homebuilding revenues for the year ended December 31, 2023 increased 20 bps to 8.3% compared to 8.1% for the year ended December 31, 2022. For the year ended December 31, 2023, SG&A included $28 million of costs related to mortgage forward commitment programs, allowing our homebuyers to lock their interest rates on home loans at the point of sale, which were not incurred in 2022. We expense these costs as incurred.

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Income from Unconsolidated Entities. Income from unconsolidated entities for the year ended December 31, 2023 was $18 million, an increase of $2 million, or 12%, from $16 million for the year ended December 31, 2022. The increase in income from unconsolidated entities is primarily attributable to increased income from Jet HomeLoans, partially offset by fewer distributions of profits from DF Capital funds, as Fund I is nearing its final stage, and as Fund II is still in its investment period.

Contingent Consideration Revaluation. Contingent consideration revaluation expense (“contingent consideration expense”) for the year ended December 31, 2023 was $47 million, an increase of $36 million, or 322%, from $11 million for the year ended December 31, 2022. The increase in contingent consideration expense was primarily due to actual 2023 pre-tax earnings of previously acquired entities, primarily MHI, being better than projected as well as revised projections for the MHI operations.

Contingent consideration liabilities are impacted by various inputs and estimates in addition to the fair value accretion, including: (i) updates to the applied discount rate, (ii) changes to current year inputs based on year to date actual results, (iii) changes to future year’s forecast assumptions, which are affected by macro-economic conditions and local market conditions, as well as management actions including capital allocation, growth plans, and restructuring, and (iv) contractual modifications that may merit additional adjustments to final pre-tax income prior to the calculation of the annual earn out payments. The change in estimates used to calculate the contingent consideration revaluation adjustment could be material at times and could potentially fluctuate between expense and income. Our policy is to separately disclose the impact of contingent consideration revaluation adjustments within the Consolidated Statements of Comprehensive Income.

Other Income, Net. Other income, net for the year ended December 31, 2023 was $5 million, an increase of $3 million, or 157%, from $2 million in other income, net for the year ended December 31, 2022. The additional income was primarily due to increased interest income from our cash deposits with financial institutions.

Net and Comprehensive Income. Net and comprehensive income for the year ended December 31, 2023 was $308 million, an increase of $34 million, or 12%, from $274 million for the year ended December 31, 2022. The increase in net and comprehensive income was primarily attributable to an increase in gross margin on homes closed of $115 million, or 19%, during the year ended December 31, 2023 as compared to the year ended December 31, 2022. This increase was partially offset by an increase in contingent consideration expense of $36 million, primarily related to the MHI acquisition, and forward commitment program costs, both discussed above. The net and comprehensive income for the year ended December 31, 2023 includes income tax expense of $96 million, an increase of $14 million, or 18%, from $82 million of income tax expense for the year ended December 31, 2022. This increase is primarily due to the increase in income before taxes and to a lesser extent the effective income tax rate increase of 0.9%. The changes in net and comprehensive income attributable to Dream Finders Homes, Inc. were consistent with the changes in net and comprehensive income as there were no significant changes in noncontrolling interests for the period.

Refer to the Form 10-K for the year ended December 31, 2022 filed on March 2, 2023 for the results of operations and related discussion for December 31, 2022 compared to the year ended December 31, 2021.

Financial Services

Income before taxes for the year ended December 31, 2023 for our Financial Services segment, net of reconciling items from equity method investments, was $19 million, an increase of $4 million, or 27%, from $15 million for the year ended December 31, 2022. The increase in income before taxes for the Financial Services segment was primarily attributed to increased loans originated by Jet HomeLoans.

For the year ended December 31, 2023, Jet HomeLoans originated and funded 3,189 home loans with an aggregate principal amount of approximately $1.3 billion as compared to 2,370 home loans with an aggregate principal amount of approximately $879 million for the year ended December 31, 2022. For the years ended December 31, 2023 and 2022, respectively, Jet HomeLoans had net income of approximately $20 million and $12 million. Our interest in Jet HomeLoans is accounted for under the equity method and is not consolidated in our consolidated financial statements, as we do not control and are not deemed the primary beneficiary of the VIE. Refer to Note 1, Nature of Business and Significant Accounting Policies, to our consolidated financial statements for a discussion of accounting treatment of VIEs.

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For the year ended December 31, 2023, our wholly owned subsidiary, DF Title, had income before taxes of $4 million, an increase of $1 million, or 33%, from $3 million for the year ended December 31, 2022. The increase in income before taxes was driven by the increase in home closings and ASP of homes closed, as well as effective cost management.

Net Sales, Backlog and Closings

The following table presents information concerning our net new orders (“net sales”), starts and closings in each of our homebuilding segments for the periods set forth below:

[[GREPCENT_TABLE]]
[["","Year Ended December 31,","","Period Over Period Percent Change"],["","2023","","2022"],["Segment","Net Sales(1)","Starts","Closings","","Net Sales(1)","Starts","Closings","","Net Sales","Starts","Closings"],["Southeast","1,822","","2,693","","3,170","","","3,113","","3,034","","2,722","","","-41","%","-11","%","16","%"],["Mid-Atlantic","1,360","","1,627","","1,597","","","1,151","","1,224","","1,562","","","18","%","33","%","2","%"],["Midwest","2,562","","2,551","","2,547","","","1,781","","2,343","","2,594","","","44","%","9","%","-2","%"],["Total","5,744","","6,871","","7,314","","","6,045","","6,601","","6,878","","","-5","%","4","%","6","%"]]
[[/GREPCENT_TABLE]]

(1) Net sales are sales of homes during the period, less cancellations of existing sales contracts during the period. Excluding net sales under built-for-rent contracts, 2023 net sales in the Southeast segment increased 19% when compared to 2022.

The following table presents information concerning our ending backlog in number of homes, ASP and aggregate value (in thousands) for our homebuilding segments as of the dates set forth below:

[[GREPCENT_TABLE]]
[["","As of December 31,"],["","2023","","2022"],["Segment","Homes(1)","ASP","Value","","Homes(1)","ASP","Value"],["Southeast","2,234","","$","393,356","","$","878,757","","","3,582","","$","398,246","","$","1,426,517"],["Mid-Atlantic","599","","427,593","","256,128","","","836","","335,642","","280,597"],["Midwest","1,145","","657,190","","752,483","","","1,130","","703,938","","795,450"],["Total","3,978","","$","474,451","","$","1,887,368","","","5,548","","$","451,075","","$","2,502,564"]]
[[/GREPCENT_TABLE]]

(1) Ending backlog represents the number of homes in backlog from the previous period, plus net sales during the period, minus the number of home closings during the current period.

Backlog of sold homes as of December 31, 2023 was 3,978 homes valued at approximately $1.9 billion based on ASP, a decrease of 1,570 homes and $0.6 billion in value, or 28% and 25%, respectively, from 5,548 homes valued at approximately $2.5 billion as of December 31, 2022. The overall decrease in backlog is reflective of an increase in sales of move-in ready spec homes relative to pre-order sales. Spec homes typically result in quicker closings and turnover of the backlog. Approximately 704 of the homes in our backlog are expected to be delivered in 2025 and beyond.

Southeast. Backlog for the Southeast segment as of December 31, 2023 was 2,234 homes, a decrease of 1,348 from 3,582 homes as of December 31, 2022. The decrease was primarily attributable to an increase in sales of move-in ready spec homes relative to pre-order sales and to a lesser extent built-for-rent sales in 2022 backlog that did not repeat in 2023.

Mid-Atlantic. Backlog for the Mid-Atlantic segment as of December 31, 2023 was 599 homes, a decrease of 237 from 836 homes as of December 31, 2022. The decrease in backlog was attributable to the increase in spec inventory sales relative to pre-order sales and to a lesser extent fewer sales under built-for-rent contracts in 2023 relative to 2022.

Midwest. Backlog for the Midwest segment as of December 31, 2023 was 1,145 homes, an increase of 15 from 1,130 homes as of December 31, 2022. The modest increase was primarily attributable to the higher net sales relative to closings in 2023, when compared to 2022.

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The following table presents information concerning our cancellation rates for each of our homebuilding segments for the periods set forth below:

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["Segment","2023","","2022"],["Southeast","21.5","%","","16.0","%"],["Mid-Atlantic","14.4","%","","31.0","%"],["Midwest","17.8","%","","27.0","%"],["Total(1)","18.3","%","","21.5","%"]]
[[/GREPCENT_TABLE]]

(1) Our cancellation rate for a given period is calculated as the total number of new sales contracts cancelled during the period, divided by the total number of new home sales contracts entered into during the period.

Our cancellation rate for the year ended December 31, 2023 was 18.3%, an improvement of 320 basis points when compared to the 21.5% cancellation rate for the year ended December 31, 2022. The reduction in the overall cancellation rate was primarily a result of significant improvement in the cancellation rates for the Mid-Atlantic and Midwest segments, driven by improved homebuyer sentiments in 2023 following a sharp spike in interest rates that occurred in the latter half of 2022. This was partially offset by a higher proportion of 2022 gross sales under built-for-rent contracts for the Southeast segment relative to 2023. Built-for-rent sales have a lower cancellation rate than retail sales. The Southeast cancellation rate remained in line with the Company’s historical cancellation rates.

Non-GAAP Financial Measures

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 excluding the effects of capitalized interest, lot option fees, amortization included in homebuilding cost of sales (adjustments resulting from the application of purchase accounting in connection with acquisitions) and commission expense. Our management believes this information is meaningful because it isolates the impact that these excluded items have on gross margin. We include internal and external commission expense in homebuilding cost of sales, not selling, general and administrative expense, and therefore commission expense is taken into account in gross margin.

As a result, in order to provide a meaningful comparison to the public company homebuilders that include commission expense below the gross margin line in selling, general and administrative expense, we have excluded commission expense from adjusted gross margin. However, because adjusted gross margin information excludes capitalized interest, lot option fees, purchase accounting amortization and commission expense, which have real economic effects and could impact our results of operations, 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.

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The following table presents a reconciliation of adjusted gross margin to the GAAP financial measure of gross margin for each of the periods indicated (unaudited and in thousands, except percentages):

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2023","","2022","","2021"],["Gross margin(1)","$","727,075","","","$","612,420","","","$","306,969"],["Interest charged to homebuilding cost of sales(2)","122,759","","","60,595","","","32,508"],["Amortization in homebuilding cost of sales(3)","\u2014","","","6,701","","","9,873"],["Commission expense","165,790","","","140,442","","","67,032"],["Adjusted gross margin","$","1,015,624","","","$","820,158","","","$","416,382"],["Gross margin %(4)","19.4","%","","18.4","%","","16.0","%"],["Adjusted gross margin %(4)","27.2","%","","24.6","%","","21.7","%"]]
[[/GREPCENT_TABLE]]

(1)Gross margin is homebuilding revenues less homebuilding cost of sales.

(2)Includes interest charged to homebuilding cost of sales related to our construction lines of credit and senior unsecured notes, net, as well as lot option fees.

(3)Represents amortization of purchase accounting adjustments from the Company’s prior acquisitions.

(4)Calculated as a percentage of homebuilding revenues.

EBITDA and Adjusted EBITDA

EBITDA and adjusted EBITDA are not measures of net income as determined by GAAP. EBITDA and adjusted EBITDA are supplemental non-GAAP financial measures used by management and external users of our consolidated financial statements, such as industry analysts, investors, lenders and rating agencies. We define EBITDA as net income before (i) interest income, (ii) capitalized interest charged in homebuilding cost of sales, (iii) interest expense, (iv) income tax expense and (v) depreciation and amortization. We define adjusted EBITDA as EBITDA before stock-based compensation.

Management believes EBITDA and adjusted EBITDA are useful because they allow management to more effectively evaluate our operating performance and compare our results of operations from period to period without regard to our financing methods or capital structure or other items that impact the comparability of financial results from period to period. EBITDA and adjusted EBITDA should not be considered as alternatives to, or more meaningful than, net income or any other measure as determined in accordance with GAAP. Our computations of EBITDA and adjusted EBITDA may not be comparable to EBITDA or adjusted EBITDA of other companies. We present EBITDA and adjusted EBITDA because we believe they provide useful information regarding the factors and trends affecting our business. EBITDA and adjusted EBITDA information should be considered only as a supplement to net income information as a measure of our performance.

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The following table presents a reconciliation of EBITDA and adjusted EBITDA to the GAAP financial measure of net income for each of the periods indicated (unaudited and in thousands, except percentages):

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2023","","2022","","2021"],["Net and comprehensive income attributable to Dream Finders Homes, Inc.","$","295,900","","$","262,313","","$","121,133"],["Interest income","(4,299)","","(169)","","(6)"],["Interest charged to homebuilding cost of sales(1)","122,759","","60,595","","32,508"],["Interest expense","1","","32","","672"],["Income tax expense","96,483","","81,859","","27,455"],["Depreciation and amortization(2)","10,651","","17,952","","13,205"],["EBITDA","$","521,495","","$","422,582","","$","194,967"],["Stock-based compensation","14,098","","6,796","","5,233"],["Adjusted EBITDA","$","535,593","","$","429,378","","$","200,200"],["EBITDA margin %(3)","13.9%","","12.6%","","10.1%"],["Adjusted EBITDA margin %(3)","14.3%","","12.8%","","10.4%"]]
[[/GREPCENT_TABLE]]

(1)Includes interest charged to homebuilding cost of sales related to our construction lines of credit and senior unsecured notes, net, as well as lot option fees.

(2)Includes amortization of purchase accounting adjustments from prior acquisitions of $7 million and $10 million for the years ended December 31, 2022 and 2021, respectively, which is included in homebuilding cost of sales reported on the Consolidated Statements of Comprehensive Income. For the year ended December 31, 2023, there was no such amortization of fair value adjustments of inventory.

(3)Calculated as a percentage of total revenues.

Liquidity and Capital Resources

Overview

We generate cash from the sale of our inventory and we intend to re-deploy the net cash generated from the sale of inventory to acquire and control land and further grow our operations year over year. We believe that our sources of liquidity are sufficient to satisfy our current commitments. Our liquidity comes from a variety of sources, including cash, borrowings under a credit agreement (the “Credit Agreement”), and net proceeds from the senior unsecured notes (“2028 Notes”).

As of December 31, 2023, we had $494 million in cash and cash equivalents, excluding $54 million of restricted cash.

The Credit Agreement had an aggregate commitment of up to $1.2 billion and $1.1 billion, and outstanding borrowings of $530 million and $965 million as of December 31, 2023 and 2022, respectively. The Company had $334 million of availability under the Credit Agreement with a borrowing base of $1.2 billion as of December 31, 2023.

On August 22, 2023, the Company issued the 8.25% 2028 Notes with $300 million in aggregate principal amount. The Company used the net proceeds from the issuance of the 2028 Notes to repay a portion of the then outstanding borrowings under the Credit Agreement.

Total liquidity as of year-end was $828 million, inclusive of reduced availability under the Credit Agreement for the 2028 Notes, which are permitted unsecured indebtedness. The Credit Agreement will mature on July 17, 2026. Certain of our subsidiaries guaranteed the Company’s obligations under the Credit Agreement and the 2028 Notes.

As of December 31, 2023, we were in compliance with the covenants set forth in our Credit Agreement and under the indenture related to the 2028 Notes. See below and refer to Note 2, Debt to our consolidated financial statements for more information on the Credit Agreement and the 2028 Notes.

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We continue to evaluate our capital structure and explore options to strengthen our balance sheet. We will remain opportunistic while assessing available capital in the debt and equity markets.

Our principal uses of capital are for lot deposits, lot purchases just-in-time for construction, vertical home construction, operating expenses and the payment of routine liabilities.

Cash flows generated by our projects can differ materially from our results of operations, as these depend upon the stage in the life cycle of each project. The majority of our projects begin at the land acquisition stage when we enter into finished lot option contracts by placing a deposit with a land seller, banker or developer. Our lot deposits are an asset on our balance sheets and these cash outflows are not recognized in our results of operations. Early stages in our communities require material cash outflows relating to finished rolling option lot purchases, entitlements and permitting, construction and furnishing of model homes, roads, utilities, general landscaping and other amenities, as well as ongoing association fees and property taxes. Except for furnishings of model homes, these costs are capitalized within our real estate inventory and are not recognized in our operating income until a home sale closes. As such, we incur significant cash outflows prior to the recognition of revenues.

In later stages of the life cycle of a community, cash inflows could significantly exceed our results of operations, as the cash outflows associated with land purchase and home construction and other expenses were previously incurred.

We actively enter into finished lot option contracts by placing deposits with land sellers based on the aggregate purchase price of the finished lots. When entering into these contracts, we also agree to purchase finished lots at predetermined prices, time frames, and quantities that match our expected selling pace in the community. We also enter into land development arrangements with land sellers, land developers and land bankers. Furthermore, to satisfy performance-related obligations in connection with certain land option agreements, we enter into surety bonds and letters of credit arrangements. Refer to “—Off-Balance Sheet Arrangements” for additional information.

The above cash strategies allow us to maintain adequate lot supply in our existing markets and support ongoing growth and profitability. Although currently there is economic uncertainty that is impacting the homebuilding industry, we continue to operate in geographic regions with consistent increases in demand for new homes and constrained lot and inventory supply compared to population and job growth trends. We intend to continue to reinvest our earnings into our business and focus on expanding our operations. In addition, as the opportunity to purchase finished lots in desired locations becomes increasingly more limited and competitive, we are committed to allocating additional liquidity to land bank deposits on land development projects, as this strategy mitigates the risks associated with holding undeveloped land on our balance sheet, while allowing us to control adequate lot supply in our key markets to support forecasted growth.

Senior Unsecured Notes

On August 22, 2023, the Company issued $300 million in aggregate principal amount of 8.25% senior unsecured notes due August 15, 2028, which were issued pursuant to an indenture (the “Indenture”). Interest on the 2028 Notes is payable in arrears semiannually on each February 15 and August 15. The 2028 Notes are fully and unconditionally guaranteed on a joint and several senior unsecured basis by certain of the Company’s subsidiaries.

The Company received net proceeds from the issuance and sale of the 2028 Notes of $294 million after unamortized debt issuance costs of $7 million, which reduce the carrying value of the 2028 Notes reported on the Consolidated Balance Sheets. The net proceeds from the 2028 Notes were used to repay a portion of the then outstanding balance under the Company’s Credit Agreement.

The 2028 Notes are redeemable by the Company prior to August 15, 2025 through the payment of the principal amount due, which can be accomplished through the issuance of certain restricted equity offerings for specified portions of principal notes outstanding, plus specified rates and accrued and unpaid interest, and a make-whole premium in the event 100% of the principal amount is redeemed. On or after August 15, 2025, the 2028 Notes are redeemable at specified rates equal to 104.1% of the principal balance, plus accrued and unpaid interest, and periodically decrease to 100% on August 15, 2027. Upon the occurrence of a Change of Control (as defined in the Indenture), the holders of the 2028 Notes will have the right to require the Company to repurchase all or a portion of the 2028 Notes at a price equal to 101% of the aggregate principal amount of the 2028 Notes, plus any accrued and unpaid interest.

The Indenture includes customary events of default. Subject to specified exceptions, the Indenture contains certain restrictive covenants that, among other things, limit our ability to incur or guarantee certain indebtedness, issue certain equity interests or engage in certain capital stock transactions. In addition, the Indenture contains certain limitations related to mergers, consolidations, and transfers of assets.

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Credit Agreement

On July 19, 2023, the Company entered into amendments to its existing credit agreement. As amended, the Credit Agreement provides for a senior unsecured revolving credit facility with a syndicate of lenders with Bank of America, N.A. acting as administrative agent. The Credit Agreement provides for aggregate commitments of $1,240 million, which includes a $25 million letter of credit sublimit, is subject to a borrowing base, and has an accordion feature which allows the facility to expand up to $1,625 million. The maturity date for lenders with $1,085 million worth of commitments is July 17, 2026. The remaining lenders have a maturity date of June 2, 2025, but such lenders have the option, with the Company’s consent, to extend their applicable maturity date to July 17, 2026.

Outstanding borrowings under the Credit Agreement are subject to, among other things, a borrowing base. The borrowing base includes, among other things, (a) 90% of the net book value of presold housing units, (b) 85% of the net book value of model housing units, (c) 85% of the net book value of speculative housing units, (d) 70% of the net book value of finished lots, (e) 85% of the net book value of certain built-for-rent units, and (f) 75% of the net book value of other built-for-rent units, in each case subject to certain exceptions and limitations set forth in the Credit Agreement. The borrowing base availability is reduced dollar-for-dollar for any outstanding unsecured indebtedness permitted under the Credit Agreement.

Under the Credit Agreement, the Company has the option to draw “Term SOFR Rate Loans” or “Daily Simple SOFR Rate Loans”. Term SOFR Rate Loans bear interest based on Term SOFR rates for one, three or six-month interest periods, which include SOFR adjustments of 10, 15 and 25 basis points for each interest period, respectively. Daily Simple SOFR Rate Loans bear interest based on Daily Simple SOFR rates and include a SOFR adjustment of 10 basis points. Interest under Term SOFR Rate Loans and Daily Simple SOFR Rate Loans also include an “applicable rate margin” determined based on the Company’s net debt to capitalization ratio, equivalent to credit spreads of 2.5% to 3.3%.

The Credit Agreement contains covenants that, among other things, require that we (i) maintain a maximum debt to capitalization ratio, as of the last day of each fiscal quarter, of 60.0%; (ii) maintain an interest coverage ratio, as of the last day of each fiscal quarter, of not less than 2.0 to 1.0; (iii) maintain a liquidity ratio, as of the last day of each fiscal quarter, of not less than 1.0 to 1.0; (iv) maintain tangible net worth of not less than the sum of (A) $607 million, (B) 50.0% of net income earned in each fiscal quarter after March 31, 3023 and (C) 50.0% of the aggregate increases in shareholders’ equity of the consolidated group after March 31, 2023 by reason of the issuance and sale of equity interests of the members of the consolidated group; (v) maintain a risk assets ratio (defined as (A) the sum of the GAAP net book value for all finished lots, lots under development and land held for future development or disposition to (B) tangible net worth), as of the last day of each fiscal quarter, of no more than 1.0 to 1.0; (vi) not allow aggregate investments in unconsolidated affiliates to exceed 15.0% of tangible net worth, as of the last day of any fiscal quarter; and (vii) not incur indebtedness other than, among other things, (A) the obligations under the Credit Agreement, (B) non-recourse indebtedness in an amount not to exceed 15.0% of tangible net worth, as of the last day of each fiscal quarter, (C) operating lease liabilities, finance lease liabilities and purchase money obligations for fixed or capital assets not to exceed $5 million in the aggregate, (D) indebtedness of financial services subsidiaries and variable interest entities, (E) indebtedness under hedge contracts entered into for purposes other than for speculative purposes, and (F) permitted unsecured indebtedness (including the 2028 Notes). The Company was in compliance with all debt covenants as of December 31, 2023 and 2022. The Company expects to remain in compliance with all debt covenants over the next 12 months.

The Company had capitalized debt issuance costs, net of amortization, related to construction lines of credit totaling $7 million as of both December 31, 2023 and 2022, which were included in other assets on the Consolidated Balance Sheets. Debt issuance costs that are recorded to capitalized interest are expensed in cost of sales as the homes close.

Contingent Consideration

Based on the terms of the purchase agreement, at the time of an acquisition, the Company may record a contingent consideration liability based on the expected fair value of any future earn out payments due to the acquiree for a typical period of up to five years post-acquisition. This liability is remeasured to fair value quarterly and the adjustment is recorded in contingent consideration revaluation in the Consolidated Statements of Comprehensive Income. As of December 31, 2023, the contingent consideration liability totaled $117 million, with approximately $50 million payable within 12 months. Further information regarding our contingent consideration liability is provided in Note 1, Nature of Business and Significant Accounting Policies to our consolidated financial statements.

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Leases

The Company has operating leases primarily associated with office space that is used by divisions outside of the Jacksonville area, model home sale-leasebacks and a corporate office building sale-leaseback. The Company also has finance leases for corporate office furniture. As of December 31, 2023, the future minimum lease payments required under these leases totaled $25 million, with $7 million payable within 12 months. Further information regarding our leases is provided in Note 5, Commitments and Contingencies to our consolidated financial statements.

Series B Preferred Units

On August 31, 2023, the Company redeemed all of its previously outstanding Series B preferred units. The Company made an aggregate cash payment to the Series B holders of $11 million, which included $7 million in principal plus cumulative undistributed earnings, less a negotiated discount on that date. Following the redemption, no Series B preferred units remain outstanding. Refer to Note 12, Mezzanine and Stockholders’ Equity to the consolidated financial statements for disclosure related to the redemption.

Convertible Preferred Stock

On September 29, 2021, we sold 150,000 shares of newly-created convertible preferred stock with an initial liquidation preference of $1,000 per share and a par value $0.01 per share, for an aggregate purchase price of $150 million. We used the proceeds from the sale of the convertible preferred stock to partially fund the MHI acquisition and for general corporate purposes. Pursuant to the Certificate of Designations, the convertible preferred stock ranks senior to the Class A and B common stock with respect to dividends and distributions on liquidation, winding-up and dissolution. Accordingly, upon a liquidation, dissolution or winding up of the Company, each share of convertible preferred stock is entitled to receive the initial liquidation preference of $1,000 per share, subject to adjustment, plus all accrued and unpaid dividends thereon. In addition, the convertible preferred stock has the following terms:

•Cumulative Dividends: The convertible preferred stock accumulates cumulative dividends at a rate per annum equal to 9% payable quarterly in arrears.

•Duration: The convertible preferred stock is perpetual with call and conversion rights. The convertible preferred stock is not convertible by the Purchasers in the first five years following issuance, with the exception of the acceleration of the Conversion Right (as defined below) upon breach of the protective covenants (described below). We can call the outstanding convertible preferred stock at any time for one-hundred and two percent (102%) of its liquidation preference during the fourth year following its issuance and for one-hundred and one percent (101%) of its liquidation preference during the fifth year following its issuance, plus accrued but unpaid dividends, if any. Subsequent to the fifth anniversary of its issuance, a purchaser can convert the convertible preferred stock into Class A common stock (the “Conversion Right”). The conversion price will be based on the average of the ninety trading days for the Class A common stock immediately preceding but not including the date of the optional conversion notice (as defined in the certificate of designations for the convertible preferred stock), less 20% of the average and subject to a floor conversion price of $4.00 (the “Conversion Discount”).

•Protective Covenants: The protective covenants of the convertible preferred stock require us to maintain compliance with all covenants related to (i) the Credit Agreement, as may be further amended from time to time; provided that any amendment, restatement, modification or waiver of the Credit Agreement that would adversely and materially affect the rights of the Purchasers will require the written consent of holders of a majority of the then-outstanding shares of convertible preferred stock; and (ii) any agreement between the Company and any Purchaser (the covenants referred to in clauses (i) and (ii), collectively, the “Protective Covenants”). Non-compliance beyond any applicable cure period with the Protective Covenants (in the case of the Protective Covenants related to the Credit Agreement) will accelerate the Conversion Right, and in the event of such acceleration that occurs before the fifth anniversary following the issuance of the convertible preferred stock, the Conversion Discount shall be increased from 20% to 25%.

•Voting Rights: Except as may be expressly required by Delaware law, the shares of convertible preferred stock have no voting rights.

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•Redemption in a Change of Control: The convertible preferred stock will be redeemed, contingent upon and concurrently with the consummation of a change of control of the Company. Shares of convertible preferred stock will be redeemed in a change of control of the Company at a price, in cash, equal to the liquidation preference, subject to adjustment, plus all accumulated and unpaid dividends, plus, if the change of control occurs before the fourth anniversary of the date of issuance of the convertible preferred stock, a premium equal to the dividends that would have accumulated on such share of convertible preferred stock from and after the change of control redemption date and through the fourth anniversary of the issuance of the convertible preferred stock.

Pursuant to the terms of the Certificate of Designations, unless and until approval of the Company’s stockholders is obtained, no shares of Class A common stock will be issued or delivered upon conversion of any convertible preferred stock to the extent that such issuance would (i) result in the holder beneficially owning in excess of 19.99% of the outstanding Class A common stock as of the date of the Certificate of Designations or (ii) exceed 19.99% of the outstanding shares of Class A and Class B common stock combined as of the date of the Certificate of Designations.

Cash Flows

The following table summarizes our cash flows for the periods indicated (in thousands):

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["","","2023","","2022","","2021"],["Net cash provided by/(used in) operating activities","","$","374,234","","","$","(27,623)","","","$","64,972"],["Net cash used in investing activities","","(4,484)","","","(5,524)","","","(523,043)"],["Net cash (used in)/provided by financing activities","","(216,424)","","","146,955","","","646,020"]]
[[/GREPCENT_TABLE]]

Year Ended December 31, 2023 Compared to Year Ended December 31, 2022

Net cash provided by operating activities was $374 million for the year ended December 31, 2023, compared to $28 million of net cash used in operating activities for the year ended December 31, 2022. The change in net cash provided by operating activities was primarily driven by a lower increase in inventories when compared to the prior year of $250 million, as well as higher net income in 2023, largely driven by an increase in home closings when compared to 2022. There was also a decrease in lot deposits in 2023, compared to an increase in lot deposits in 2022. Customer deposits also increased versus a decrease in customer deposits in the prior year.

Net cash used in investing activities was $4 million for the year ended December 31, 2023, compared to $6 million of cash used in investing activities for the year ended December 31, 2022, primarily attributable to higher purchases of property and equipment during the year ended December 31, 2022.

Net cash used in financing activities was $216 million for the year ended December 31, 2023, as compared to $147 million of cash provided by financing activities for the year ended December 31, 2022. The change in net cash used in financing activities was primarily attributable to higher net payments on the construction lines of credit of $436 million in 2023 compared to $203 million of net proceeds in 2022, and to a lesser extent, a one-time payment related to the redemption of the Series B preferred units during the year ended December 31, 2023. The full net proceeds from the issuance of unsecured senior notes of $300 million during the year were used to pay down a portion of the outstanding balance under the Credit Agreement.

Refer to the Form 10-K for the year ended December 31, 2022 filed on March 2, 2023 for the cash flows and related discussion for December 31, 2022 compared to year ended December 31, 2021.

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Off-Balance Sheet Arrangements

Asset-Light Lot Acquisition Strategy

We employ an asset-light and cost-effective lot acquisition strategy to achieve our growth goals. This strategy involves two key approaches: finished lot option contracts and land bank option contracts. These contracts grant us the right to purchase finished lots at predetermined fixed prices from various land developers, sellers, and land bank partners. Our sole legal obligation and economic loss as a result of such forfeitures is limited to the amount of the deposits paid pursuant to such option contracts and, in the case of land bank option contracts, our loss is limited to the related lot option fees paid to the land bank partner, any potential performance obligations, management of the land development to completion and any cost overruns relative to the project.

As of December 31, 2023, our lot deposits for finished lot option and land bank option contracts that are within the Consolidated Balance Sheets were $247 million. As of December 31, 2023, we controlled 29,748 lots under finished lot option and land bank option contracts.

Refer to “Item 1. Business—Land Acquisition and Development Process” for more information.

Surety Bonds, Letters of Credit and Financial Guarantees

We enter into surety bonds and letters of credit arrangements with local municipalities, government agencies and land developers. These arrangements relate to certain performance-related obligations and serve as security for certain land option agreements.

As of December 31, 2023, we had outstanding surety bonds and letters of credit totaling $195 million and $1 million, respectively. We believe we will fulfill our obligations under the related arrangements and do not anticipate any material losses under these surety bonds and letters of credit.

Critical Accounting Policies and Estimates

We prepare our consolidated financial statements in accordance with GAAP. Our critical accounting policies are those that we believe have the most significant impact to the presentation of our financial position and results of operations and that require the most difficult, subjective or complex judgments. In many cases, the accounting treatment of a transaction is specifically dictated by GAAP without the need for the application of judgment.

In certain circumstances, however, the preparation of consolidated financial statements in conformity with GAAP requires us to make certain estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements, as well as the reported amounts of revenues and expenses during the reporting period.

While our significant accounting policies are more fully described in Note 1, Nature of Business and Significant Accounting Policies to our consolidated financial statements, we believe the following topics reflect our critical accounting policies and our more significant judgment and estimates used in the preparation of our consolidated financial statements.

Revenue Recognition

We recognize revenue in two ways in accordance with Accounting Standards Codification (“ASC”) 606. This includes revenues from home sales with respect to homes that we construct on homesites to which we own title that are recorded at the time each home sale is closed and title and possession are transferred to the buyer, or upon delivery of homes sold to third-party investors intending to lease the homes, as well as revenues from home sales in which the buyer retains title to the homesite while we build the home that are recognized based on the percentage of completion of the home construction, which is measured on a quarterly basis. We determine the percentage of completion based on the number of days of construction completed to the total estimated number of days to construct the home.

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Real Estate Inventory and Homebuilding Cost of Sales

Inventories include the cost of direct land acquisition, land development, construction, capitalized interest, lot option fees, real estate taxes and direct overhead costs incurred related to land acquisition and development and home construction. Indirect overhead costs are charged to selling, general and administrative expense as incurred.

Land and development costs are typically allocated to individual residential lots on a pro rata basis based on the number of lots in the development, and the costs of residential lots are transferred to construction work in progress when home construction begins. Sold units are expensed on a specific identification basis as homebuilding cost of sales. Homebuilding cost of sales for homes closed includes the specific construction costs of each home and all applicable land acquisition, land development and related costs allocated to each residential lot.

Inventories are carried at the lower of accumulated cost or net realizable value. We periodically review the performance and outlook of our inventories for indicators of potential impairment.

Business Combinations and Valuation of Contingent Consideration

The Company accounts for business combinations using the acquisition method. Under ASC 805 a business combination occurs when an entity obtains control of a “business.” The Company determines whether or not the gross assets acquired meet the definition of a business. If they meet this criteria, the Company accounts for the transaction as a stock purchase. If they do not meet this criteria the transaction is accounted for as an asset purchase. The consideration transferred in the acquisition is generally measured at fair value, as are the identifiable net assets acquired. Any goodwill that arises is tested annually for impairment. Any gain on a bargain purchase is recognized in profit or loss immediately. Transaction costs are expensed as incurred, except if related to the issuance of debt or equity securities. Any contingent consideration is measured at fair value at the date of acquisition and is based on expected cash flow of the acquisition target discounted over time using an observable market discount rate. The Company generally utilizes outside valuation experts to determine the amount of contingent consideration. Contingent consideration is remeasured at fair value at each reporting date and subsequent changes in the fair value of the contingent consideration are recognized in other income or other expense in the Consolidated Statements of Comprehensive Income.

Recent Accounting Pronouncements

Refer to Note 1, Nature of Business and Significant Accounting Policies to our consolidated financial statements.