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spk16: Good afternoon, everyone. My name is Devin, and I will be your conference operator for today's call. I would like to welcome everyone to KB Home's 2020 Fourth Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the company's opening remarks, we will open the line for questions. Today's conference call is being recorded and will be available for replay at the company's website, kbhome.com, through February 12th. Now, I would like to turn the call over to Jill Peters, Senior Vice President, Ambassador Relations. Jill, you may begin.
spk12: Thank you, Devin. Good afternoon, everyone, and thank you for joining us today to review our results for the fourth quarter of fiscal 2020. On the call are Jeff Mesger, Chairman, President, and Chief Executive Officer, Matt Mandino, Executive Vice President and Chief Operating Officer, Jeff Kaminsky, Executive Vice President and Chief Financial Officer, Bill Hollinger, Senior Vice President and Chief Accounting Officer, and Thad Johnson, Senior Vice President and Treasurer.
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spk12: Before we begin, let me note that during this call, items will be discussed that are considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future results, and the company does not undertake any obligation to update them. Due to factors outside of the company's control, including those detailed in today's press release and in filings with the Securities and Exchange Commission, actual results could be materially different from those stated or implied in the forward-looking statements. In addition, a reconciliation of the non-GAAP measures referenced during today's discussion to their most directly comparable GAAP measures can be found in today's press release and or on the investor relations page of our website at kbhome.com. And with that, I will turn the call over to Jeff Mesker.
spk02: Thank you, Jill. Good afternoon and Happy New Year. We hope your holidays are enjoyable and safe for you and your families. We finished 2020 strong, producing fourth quarter results that include remarkable net order growth and gross margin expansion. As we continue to rotate into a high quality mix of communities, effectively manage our costs, and reduce our amortized interest, we are generating significantly higher margins. And our balanced approach to optimizing price and pace in this robust demand environment is providing further support. We begin 2021 with momentum, with our backlog value up over 60% year-over-year and the potential to generate as much as $6 billion in housing revenues this year as we focus on building our scale. We are poised for profitable, returns-focused growth given the composition of our backlog, a strong lineup of community openings, and our leaner, more efficient cost structure, all contributing to an expected double-digit operating margin this year. As to the details of the quarter, we generated total revenues of $1.2 billion and diluted earnings per share of $1.12. While our deliveries and revenues were down year over year, This was expected, reflecting the COVID-related disruption in our second quarter net orders and housing starts. Having said this, we earn more on a per-unit basis with a housing gross margin of 21%, excluding inventory-related charges, up 110 basis points year over year. The strength of our gross margin was the key factor driving improvement in our operating income per unit to over $44,000, a sequential increase of $7,000 per home. Our balance sheet is in excellent shape and we are clearly in a solid position to support the expansion of our scale. Investing in land acquisition and development remains our top priority for deploying the substantial operating cash flow we are generating. In the fourth quarter, we increased our land investments by over 60% year-over-year to $650 million. With this fund execution, we grew our lot position by 7,000 lots since the third quarter to end the year with over 67,000 lots owned and controlled. Our lot position is well diversified both across and within our region with our own lots representing 3.8 years of supply and a higher level of option lots, now comprising 40% of our total. We own all of the lots that we need for the sizable increase in delivery volume anticipated for 2021 and owner control all of the lots we need for further delivery growth in 2022. In addition to investing in our future, We continue to focus on increasing shareholder return with another substantial increase in our quarterly cash dividend implemented in the fourth quarter. This is the second consecutive year we have meaningfully increased our dividend, which is now six times its level from two years ago. Our goal with respect to expanding our scale is to increase our market position in each of our served markets. While we expect our growth to come primarily from our existing markets, we are also selectively entering new markets. Seattle is a good illustration of our organic approach to growth. We began with a small startup operation less than three years ago, which turned profitable by the end of year two. This division is now on a path to more than double its profit this year, and contribute more significantly to our overall performance. We are encouraged by the success we've had in Seattle, and we are extending our market strategy in the Carolinas, an area that we already know well. With the improved execution in our Raleigh business over the past couple of years, we have now reentered Charlotte with a similar startup approach. Charlotte is a top 10 home building market, and we hired an industry veteran with deep roots and an extensive network to lead this effort, which has allowed us to move quickly on three land deals. We expect first deliveries in Charlotte in 2022. Our top priority is to expand our community count, and we successfully opened 38 new communities in the fourth quarter, including four communities that opened ahead of schedule. After 21, we expect a low point in our ending community count to occur in the first quarter, with sequential growth in each quarter thereafter, resulting in year-over-year community count expansion in our third and fourth quarters. Looking beyond 2021, we are well positioned with the lots we own and control to sustain this growth sequentially throughout 2022, And we are committed to growing our community count a minimum of 10% next year, a target that we believe is realistic given our balance sheet, cash flow, level of profitability, and the infrastructure already in place. Our monthly absorption pace per community, accelerated to 5.6 net orders during the fourth quarter, represent a year-over-year increase of 51%. We achieved this higher pace even as we increased prices in over 90% of our communities, balancing pace and price in each community to optimize our assets and returns. Our absorption pace has consistently ranked among the highest in the industry for many years. We believe our success is driven by choice and personalization delivered at an affordable price point, which are the cornerstones of our bill-to-order model. Given the increased focus that investors have had with respect to affordability in the past few months, let me spend a moment sharing our thoughts on this point. Our long-standing approach to product positioning is to target the median household income in each submarket and to remain flexible in adjusting our product offerings through higher density and slightly smaller footprint to stay close to the median income levels. By doing so, we believe we make homeownership attainable for the largest demand segments, the millennials and Gen Zs. Our divisions are executing well on our product strategy, enabling us to generate solid margin at our targeted absorption rates with our average selling price in nearly every division below the median new home price and, in many cases, below the median resale price as well. This last point is particularly resonant as resale is our largest competitor. Given these dynamics, we believe that our homes remain affordable. As prices continue to rise, we are well positioned. During the buyer pause of late 2018 and early 2019, when the effect of both rising home prices and rising interest rates hindered affordability, we proactively took steps to reposition our product offerings. We quickly entered in smaller square footage plans from our product series as models, expanded the choices available to our buyers across the square footage band, and lowered the specification levels for standard features in most of our communities. Together, these steps reduced the starting base price in many of our communities, thereby broadening our affordability. We continue to offer these smaller square footage plans with nearly 60% of our communities offering plans below 1,500 square feet. Moving just a little up the footage span, about 75% of our communities offer plans that are below 1,600 square feet. Floor plans in this 1,500 to 1,600-foot range are well-suited for millennials. In addition to offering more choice in the size of our floor plan, the flexibility in our built-to-order model, whether an extra bedroom with a full bathroom, a home office, or a den, provides options that meet the needs of today's buyers. With respect to the macro environment, as I've already mentioned, housing market conditions remain robust as the pandemic has helped to fuel demand for homeownership. Existing single-family home inventory is thin and continues to decline, now sitting at just 2.3 months supply, and below that level in many of our markets, particularly at our price points. This limited level of resale inventory and an underproduction of new homes over the last decade, together with favorable demographic trends, especially with respect to first-time buyers, should continue to drive demand for the foreseeable future. We believe this last point is very favorable for us, given our experience in serving first-time buyers who accounted for 61% of our delivery in the fourth quarter, an increase of eight percentage points year over year. At the time of our last earnings call in September, our net orders were up 32% for the first three weeks of our fourth quarter. Demand remained strong throughout the quarter, resulting in year-over-year net order growth of 42% to nearly 4,000 homes. While we experienced some seasonality in the quarter, it was negligible, as November's order activity held close to October's levels, which is atypical, illustrating the depth of demand for our homes. Geographically, our strength extended across our footprint. with healthy year-over-year growth in each of our four regions. Similar to the trends we experienced in the third quarter, the underlying buyer data for our orders in the fourth quarter remained favorable. Millennial buyers continue to lead our buyer cohorts, representing 57% of our net orders, increasing six percentage points year-over-year. In addition, buyers continue to demonstrate a preference for built-to-order homes which represented over 90% of our net orders compared to just under 70% in the prior year period. Net order growth in the fourth quarter drove a 50% year-over-year increase in our net order value, which in turn fueled the expansion of our backlog value to $3 billion, an increase of 63% year-over-year on roughly 7,800 units. Given this higher backlog, we are confident in our increased revenue expectations for this year. We accelerate our pace of home starts in the fourth quarter by 40% year over year and have continued to do so in the first quarter as we line our starts to net orders. Given our strong net order trends throughout the fourth quarter, our backlog continues to be more heavily weighted to the early stages of construction, either unstarted or as foundation with those two buckets comprising roughly 55% of our backlog as compared to about 44% in the year-ago quarter. This will affect our backlog conversion relative to historical first quarter levels, although we are expecting a sequential increase in deliveries in our first quarter for the first time in my KB home career. As to net orders in the first quarter of 2021, they're up 44% for the first six weeks over the comparable prior year period. Demand remains solid through the holidays and into the new year. However, we acknowledge the tougher weekly net order comparisons we have for the remainder of the quarter, as well as an anticipated decline in community count. As a result, we expect our net order growth to moderate by the end of the quarter from its current level. On the mortgage side, our joint venture, KBHS Home Loans, wrapped up another very productive year. The growth in the JV's capture rate to 81% in the fourth quarter produced a 20% year-over-year increase in its income despite the lower deliveries in the quarter, reflecting a more profitable business. The JV is steadily increasing its contribution to our overall performance and for the full year, generated year-over-year income growth of over 70% to $21 million. In closing, we finished 2020 strong and we are poised for a tremendous 2021 and the resumption of our growth into a larger, more profitable company. While we remain very mindful that the pandemic is not over, and that it retains the potential to disrupt our business until it's brought under control, we are also confident in the strength of our position. We will expand our scale with our considerable backlog, together with continued robust market conditions, contributing to the potential for as much as $6 billion in revenues in 2021. We have multiple factors supporting our higher gross margin this year, including the composition of our backlogs, overhead leverage from our higher revenue, effective cost management, and lower amortized interest, as well as margin enhancements specific to our built-order model, such as lot premiums and studio revenue. As a result, we're expecting our operating margin to hit double digits, thereby driving our projected return on equity to above 17% compared to roughly 12% in 2020. Simply put, we are in the strongest position we have been in over a decade with an experienced, dedicated team, solid balance sheet, the healthy lot position, the cash flow to invest in community account growth, and a business model that generates high customer satisfaction and has demonstrated appeal to homebuyers. We are excited about 2021 and look forward to sharing our results as the year unfolds. With that, I'll now turn the call over to Jeff for the financial review. Jeff? Switch to Liberty Mutual and save $652. Hello.
spk01: Excuse me.
spk07: Thank you, Jeff, and good afternoon, everyone. I will now cover highlights of our financial performance for the 2020 fourth quarter, as well as provide a 2021 first quarter and full year outlook. During the fourth quarter, we continued to produce sequential improvement in our key profitability and credit metrics and generated outstanding growth in our net orders, which contributed to a significant year-over-year increase in backlog value to its highest level in 15 years. In the fourth quarter, our housing revenues of $1.19 billion were down 23% from a year ago, reflecting a decrease in homes delivered that was partially offset by a 5% increase in the overall average selling price of those homes. The lower delivery volume was due to the negative impact the onset of the COVID-19 pandemic and public health control measures had on our second quarter net orders and housing starts. Looking ahead to the 2021 first quarter, we expect to generate housing revenues in the range of $1.14 to $1.22 billion. For the 2021 full year, we are forecasting housing revenues in a range of $5.5 to $6 billion, up $450 million at the midpoint as compared to our prior guidance. Having ended our 2020 fiscal year with a backlog value of approximately $3 billion, we believe we are well positioned to achieve this top-line performance. In the fourth quarter, our overall average selling price of homes delivered increased to approximately $414,000. For the 2021 first quarter, we are projecting an average selling price of approximately $390,000 due to a regional mix shift of homes delivered. We believe our overall average selling price for the 2021 full year will be in the range of $400,000 to $410,000. Home building operating income for the fourth quarter totaled $115.7 million compared to $162.5 million for the year earlier quarter. The current quarter included inventory-related charges of $11.7 million versus $4.1 million a year ago. Our home building operating income margin was 9.7%, down 80 basis points from the 2019 fourth quarter. Excluding inventory related charges, our operating margin was 10.7% for both periods, as the gross margin improvement in the current year quarter was entirely offset by an increase in our SG&A expense ratio that reflected reduced operating leverage from lower housing revenues. For the 2021 first quarter, we anticipate our home building operating income margin, excluding the impact of any inventory-related charges, will be in the range of 9.0 to 9.3%. For the 2021 full year, we expect this metric to be in the range of 10.4 to 11.0%, which represents a year-over-year improvement of 230 basis points at the midpoint. Our 2020 fourth quarter housing gross profit margin improved 40 basis points to 20.0%. Excluding inventory-related charges, our gross margin for the quarter increased by 110 basis points to 21.0% from 19.9% for the prior year quarter. This improvement primarily reflected the impact of higher selling prices, shifts in the geographic and community mix of homes delivered, and lower amortization of previously capitalized interest. Assuming no inventory-related charges, we are forecasting a housing gross profit margin for the 2021 first quarter in a range of 20.0 to 20.3%, up more than 200 basis points as compared to the prior year period. We expect our 2021 full-year gross margin, excluding inventory-related charges, to be in the range of 20.5% to 21.1%, with margins of 20% or above in each quarter. Our selling general and administrative expense ratio of 10.3% for the fourth quarter was up 120 basis points from a year ago, mainly due to the unfavorable impact of decreased operating leverage from lower housing revenues, partly offset by the effects of our ongoing focus on reducing overhead costs. We are forecasting our 2021 first quarter SG&A expense ratio to be in the range of 10.8 to 11.2% as we continue to prioritize containing overhead costs and expect to realize favorable leverage impacts from an anticipated year-over-year increase in housing revenues. We expect that our 2021 four-year SG&A expense ratio will be approximately 9.9 to 10.3%. Our income tax expense of $20 million for the fourth quarter, which was favorably impacted by $8.6 million of federal energy tax credits, represented an effective tax rate of approximately 16%. We currently expect our effective tax rate for both the 2021 first quarter and full year to be approximately 24%. In December, federal legislation was enacted which, among other things, extended the availability of energy tax credits for building energy-efficient homes through December 31, 2021. With our industry leadership in sustainable home building and energy efficiency, The extension of the tax credits will favorably impact our 2021 effective tax rate and is reflected in our first quarter and full-year estimates. Overall, we reported net income of $106.1 million, or $1.12 per diluted share for the fourth quarter, compared to $123.2 million, or $1.31 per diluted share for the prior year period. For the 2020 full year, our net income of $296.2 million, or $3.13 per diluted share, rose 10% compared to 2019. Turning now to community count, our fourth quarter average was 234. Of 234, it was down 8%. from 253 in the corresponding 2019 quarter, primarily due to accelerated closeouts in the second half of the year driven by strong net order activity in both the third and fourth quarters. We ended the year with 236 communities, down 6% from a year ago, with approximately half of this decline due to a reduction in the number of communities that were previously classified as land held for future development. We expect our community count to decrease sequentially in the first quarter to what we believe will be the low point for 2021 as closeouts resulting from expected continued strong net orders outpaced openings for the period. On a year-over-year basis, we anticipate our 2021 first quarter average community count will be down by a low double-digit percentage. We expect our quarter end community count to increase sequentially starting in the second quarter and continuing through the remainder of the year. We anticipate ending the year with a mid to high single-digit percentage increase in our community count, supporting additional top-line growth in 2022. As Jeff mentioned, our goal is to drive an increase in community count of at least 10% in 2022 to support further market share gains and growth in housing revenues. During the fourth quarter, to drive future community openings, we invested $651 million in land and land development with $376 million, or 58% of the total, representing land acquisitions. In 2020, we invested nearly $1.7 billion in land acquisition development and generated $311 million of net operating cash flow. At year-end, total liquidity was approximately $1.5 billion, including $788 million of available capacity under our unsecured revolving credit facility. Our debt-to-capital ratio was 39.6% at year-end, and we expect further improvement in 2021 given our anticipated earnings growth. We expect to generate significant cash flow in the current year to fund levels of land investment sufficient to support our targeted 2021 and 2022 growth in community count and housing revenues. Our year-end stockholders' equity was $2.67 billion as compared to $2.38 billion at the end of the prior year, and our book value per share increased by nearly 10% to $29.09. Given our current community profile and backlog, along with expected continued strength in the housing market, we are very confident in our ability to significantly improve our profitability, credit, and return metrics in 2021. During the year, we plan to further execute on the principles of our returns-focused growth strategy with an emphasis on significantly increasing our returns by expanding our community count and top line while continuing to improve our operating margin. In summary, using the midpoints of our guidance ranges, we expect a 39% year-over-year increase in housing revenues and significant expansion of our operating margin to 10.7%, driven by improvements in both gross margin and our SG&A expense ratio. These anticipated scale and margin improvements should drive our return on equity to above 17%, up over 500 basis points year-over-year. These expected results reflect our view that a continued emphasis on a returns-focused growth strategy will enable us to further enhance long-term stockholder value. We will now take your questions.
spk16: Devin, please open the lines. At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation cell will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. As a reminder, please lend yourself to one main question and one follow-up. Our first question comes from the line of John LaValla from Bank of America. Please proceed with your question.
spk06: Hey guys, thank you for taking my questions tonight. The first one is on the gross margin outlook of 21%, which is clearly impressive. Are you basically implying that pricing is going to be sufficient to offset what we're seeing in lumber and structural panels and then probably what we'll be seeing down the road with labor inflation? And I'm just curious, I mean, I know you guys talked about affordability to some degree versus existing homes, but how do you kind of think about it versus the other alternative product being renting?
spk02: There's a few questions there, John. We tried to illustrate in our prepared comments that our margin and our improvement in gross margin is not necessarily just because we're able to take price from it. As I look at the the puts and takes over a year. If the markets are good, home prices, costs go up. They typically, you know, they'll catch up with each other over a 90 or 120-day period. And if markets are good, land prices go up. If markets are tough, home prices go down, costs go down, land prices may go down. So they kind of work in tandem. And what we're accomplishing right now in our gross margin improvement is that the combination that we outlined, we have a far better mix of of the quality of the communities that we're operating in. You look at our southeast region, it's really picking up steam and margins are enhanced. You look in Indian California, it's picking up steam and margins are enhanced because we're operating better and it's a better mix of communities. Then you go over to the capitalized interest. The amortized interest is continuing to come down in that tailwind because of what we've done over the past three to four years in our returns-focused growth. And then third, you get leverage because we're picking up our pace a little bit per community, and a lot of the costs in running that community don't increase with the pace, so you get some margin expansion due to your leverage. So we have all those things going on, and we feel we still have upside and momentum there, and if we get price on top of it, we'll take it, and we've been able so far to take enough price to cover any cost increases along the way. Relative to the for-rent market, I don't really think about that too much, John. Our buyers are homebuyers. They want to be homeowners today. They want their own place, and It's rare that somebody comes in and says, I'm comparing your home here to a home for rent down the street, and I can't make up my mind. We just don't hear that that often, John.
spk06: Okay, that's helpful. And then you mentioned some organic moves into new markets, into some pretty interesting markets, Seattle and Charlotte. Is organic kind of the way you guys plan on doing things, or are there opportunities from an M&A standpoint that could expedite the move into certain markets?
spk02: Yeah. Well, there's two levels of organic for us, John. One would be just growing our business where we exist today. And we have a great footprint, and we're nowhere near max in our market share in any of the markets we're in. So we'll keep pursuing a bigger market presence. and every city we're in. We quietly expanded into Seattle a couple of years ago and didn't say much about it because we wanted it to mature and get traction. And it's done that now and it's worked very well. Then if you go over to the Carolinas where we were in Charlotte at one time, we left back in the fiscal crash And Raleigh's shored up. Raleigh's performing well. Raleigh's on a nice growth trajectory. And it's logical to expand right back into Charlotte. And we're taking the same approach we did in Seattle, where you go in with a team, you get some deal flow, you pair up your overhead with your revenue growth, and we'll have our first deliveries in Charlotte in 2022. So if you look at Seattle or what we're expecting out of Charlotte, It takes time for those to build into a real contributor to our results. It'll take two years, three years. But you don't pay a dumb tax. You don't have the integration challenge. There is no premiums, no accounting issues, no goodwill hitting your balance sheet. So it's a much cleaner entry if you can do it. And so as a result, we have this one-two punch where we can grow organically in our serve markets and continue to bolt on these other very strong housing markets that we're able to enter that we're not in right now. I think that's a better approach for us than M&A. We look at M&A. Premiums are typically pretty high, and you've got the other things I mentioned. So if we can hit our growth targets, and we certainly have a growth trajectory right now for 21, if we can hit our growth targets and keep fueling this thing organically, that's what we're going to do.
spk16: Our next question comes from the line of Steve Kemp with Evercore ISI. Please proceed with your question.
spk17: Hi, good evening. This is Joe Allersmeyer on for Steve. Thanks for taking our questions. I wanted to start off discussing your community count goals in 2021 and 2022. Thanks for all the great detail there on the growth targets for each of those years, mid to high singles next year and then double digits the year after. I heard the comment regarding the moderation of border growth in one queue on the tougher comps, but our question is, If you continue to see strong order growth throughout 2021, say 25% or better, are you still in a position to hit both of those goals?
spk02: Joel, I'm not sure I understand the question. Are you saying if sales rates slow, do we hit the goals, or if sales rates accelerate, we hit the goals?
spk17: So it may be a deceleration from the 40 or so percent, but if it stays strong, like the 25 plus range, is that going to continue to sell out faster than you can replace and are you at risk of still hitting those targets?
spk02: No, I don't think so. All those things were considered in our guidance. We're actually powering through that right now. It's right in front of us in that the second half sales strength that we saw is playing through, and it'll hit the low point Q1, and we're continuing to load in more as we go out ahead of us. I shared Larry owned and in control everything for 22, let alone 21 that's right in front of us. So we absolutely are committed to those community count growth targets. But whether sales hold or go up or go down, we'll get to the community count.
spk17: Awesome. That's really encouraging. And on a related note, with respect to the land spend, you mentioned the $650 million in the prepared remarks, more than I think you've done in any quarter, at least in recent history here. And I appreciate that positions you well for growth the next couple of years. But first question, were there any projects maybe that you pulled forward just that made sense to take on now? And then second, could you help us understand a little bit more about the composition of that spend? Are you bringing in different types of land? maybe more move-up assets or taking advantage of the work-from-home trends by buying in further outreaches. Thanks again.
spk02: Actually, I think in part the number was outsized in Q4 for the year because of deferrals out of Q2 and Q3. For the year, we spent a little bit more than the prior year, and we're positioned now where we expect to spend more in 21 to fuel our In terms of our strategy on the investment side, it hasn't changed relative to buyer profile and the price points we want to play at. Again, in the shared comments, I talked about our strategy of positioning the product so it's attainable by the median income in that submarket, and we are committed to that. That's where the biggest segments of demand are in every submarket, and that's where we want to play. So the profile of the communities really hasn't changed. We're a little more willing to go into the B-minus submarkets where there's a little more land because the markets are good. But overall, we're tired in the median incomes, and there's plenty of demand if you can bring the lots to market, and that's what we're working on.
spk17: All right. Thanks very much, Jeff.
spk16: Thanks. Our next question comes from Matthew Boulay with Barclays. Good afternoon, everyone.
spk08: Thank you for taking the questions. Question on the orders into Q1 here. You know, it sounds like you didn't really see the normal seasonality in Q4, but you're talking about off of this 44% quarter-to-day growth, you're expecting some deceleration. My question is, I guess, to what degree is that deceleration basically your own efforts to meter out sales pace via price or simply a comp dynamic? I guess the question is, are you actually expecting sales pace to maintain somewhat close to current levels and comps get tougher and perhaps there's a little more of a community gap, or is there actually somewhat of your own efforts to meter out sales pace in there? Thank you.
spk02: Primarily, Matt, is that our comps get tougher. Last year in January and February, we had some very strong selling months, so it's hard to hold a 40% comp as strong as our sales were in January and February. In fact, we wouldn't want to do that. There is a little bit of price and slowing down in communities that aren't replaceable or have a limited lot supply left. But it's primarily just the comp. And if you think of our backlog position and the starts that we're rolling through right now, we can afford to take some price and slow things down. But it's primarily the stronger comp in January, February.
spk08: Okay, got it. Thank you for that. And then I guess secondly, you mentioned the backlog. I'm curious if you have a sense – I guess, of what the gross margin and backlog looks like today. If you could remind us kind of with the KB Home model, you know, what would cause the margin and backlog today to change upon the delivery, whether there can still be, I guess, incremental studio upgrades on the one hand versus, you know, what your exposure would be to construction costs on the other hand? Just what would cause... current margin and backlog to change and if you have any sense of what that looks like today. Thank you.
spk07: Jeff, you want to take that one? Sure. As we look at our guidance and as we forecast out the future, it's a very good point that you make about our backlog because we have a very large backlog to start the year. So at over 7,800 units, we have very, very good visibility to really the first and second quarters deliveries and and related gross margin coming off those deliveries. And what we have basically in the backlog, we have contracted sales prices, so we know the price on those units. We know the price that they'll deliver at. For anything that's started, we basically have locked in costs, and we lock in our costs with the vast majority of our vendors, of our subs, upon start. So we're not really taking any inflation risk, whether it be labor or materials or anything else, on our started homes. And that provides us, like I said, really nice visibility on our gross margins. As we look out, you know, the other, I guess, a little bit unknown variable is not all the homes have been through studio, and that is generally a bit of a lift of margin as we go through studio. And we make that estimate also as we go through the forecast and our guidance numbers. So really the – The largest unknown for us is just, you know, what the future sales would be, both from a sales price point of view and then, you know, as we deliver out those homes, what the cost of build would be. But we generally forecast that at current costs, current selling prices, and as Jeff mentioned earlier, we rely on that dynamic that's been pretty consistent between selling prices and costs. So we feel, you know, we have a really nice visibility, you know, as far as margins go, that backlog supports our guidance and our forecast, I think, quite well. The higher revenue numbers next year, which are up significantly, versus 2020 provides that additional overhead leverage because we do have a fixed cost component in our cost of sales, so that's a real positive. And Jeff mentioned some of the other factors earlier. So, you know, we're pretty comfortable and secure with our margin guidance and really looking forward to seeing a full year where we're above 20% every quarter and achieve the type numbers that we talked about for the full year.
spk16: Our next question comes from Alan Bretman with Zalman & Associates. Please proceed with your question.
spk04: Hey, guys. Happy New Year and congrats on the great results. Appreciate you taking my question. You know, Jeff, you know, several years ago when your margins were lower than where they are today, you provided a really helpful roadmap to kind of talk about, you know, why the margins were being pressured by some of the legacy land that you had that you were moving through and at the same time As some of the newer deals you were underwriting to much higher margins came to market, that would provide a tailwind, and it obviously has come to fruition. So I'm hoping that you can maybe give us a little bit of insight into the land you're underwriting today and how you're thinking about that underwriting relative to the guidance you're giving for 21, because you're obviously tying up a ton of land today. your competitors are doing the same thing. It would seem like it's a pretty competitive land market. So can you talk a little bit about, you know, when you look at your absorption rate, where you're at today, four and a half per month, or your margins, you know, 20 to 21 percent, what type of assumptions are being embedded within the land you're tying up today for 22 and beyond?
spk02: Well, happy new year to you, Alan, as well. When we underwrite land, it's a combination of the the margin and also the IRR on the assets. So you'll take a little lower margin if you get a much higher IRR. Together they have to hit a combined threshold for us. Our underwriting in terms of just the margin today would be in the 19 to 21% range. So pretty similar to what we're seeing in the revenue that we're generating. Land's always a competitive environment. There's no city that we operate in where it's not competitive. You have to be focused. And one of the things that we like about our land effort that we think is an advantage is there's clarity among the divisions on what the product strategy is, what the price point is, what the financial hurdles are. And we can move pretty quickly from feasibility to a committed deal because of the clarity that we have. And I think that is an advantage for us as a company. But in the rhythm of our business, we're not banking in price. We're not assuming inflation to get there. It's got to underwrite today. Today's sales pricing, today's sales pacing in that city. And I'd say it's 19 to 21 on the growth side.
spk04: That's really helpful. I appreciate that. And then my second question is just as we think about these communities coming online, obviously you provided very detailed guidance for 21, which is helpful. I know in the past, you know, occasionally when you've had big growth in community count, there's been some, you know, overhead expenses that have to be pulled forward or, you know, you have to add some headcount to satisfy that type of growth. And I'm curious, should we think about that in maybe 22? Just is there going to be a need to add additional headcount to support the level of type of growth that you're anticipating?
spk02: Actually, we didn't want to get into the weeds too much on what's hitting SG&A and and the gross margin in the fourth quarter that we just finished. But if you think about it, there were 38 community openings, which is the most we've had in a quarter in quite some time. So we already absorbed that overhead and the cost there. And our business is getting more evenly distributed among our regions. So if you grow your community count 20 or 25, that's one a city to two a city. So there's not a lot of overhead associated with it. There is some cost to run the model park once you get the community open, but it should self-fund at that point in time. So we think we're past the increase in overhead for the community kind of growth. We've already incurred it. So there will be some incremental costs for 22, but nothing that will really move the needle versus our core growth in SG&A. You got any other comments or thoughts on that, Jeff?
spk07: I think you hit it on the head, Jeff. At 38 grand openings annualized, it's over 150 grand openings supported by the fourth quarter expense base and overhead base. So we think we're in really good shape, particularly as we work through 2021 on supporting our growth targets.
spk16: Our next question comes from the line of Doug Horn with Raymond James. He's here with a question.
spk03: Hey, thanks for the time. I appreciate it. I was curious if you're noticing any changes in the buyer's preferences in terms of, you know, trying to understand if you've got any intel on, you know, work from home habits, if you're seeing that buyers are, you know, there's a big uplift in the home office upgrades that you guys have offered. Is that getting traction there? And or, you know, are you seeing buyers crossing state lines more often or some of your, you know, whether it's Texas or Florida or Colorado, are you picking up that people are migrating to different markets from high cost in any greater numbers?
spk02: Sure. I'll make a couple of comments, Buck, and then take it to Matt Mandino to give you the insight on the buyer profiles. But it's interesting. We shared it on our last quarterly call. While our buyer mix is tilting to incrementally more first-time buyers, up in the 60s in the percentile now, our studio sales are actually picking up. They were up in the third quarter and are up again in the fourth quarter. Not big numbers, but $1,000 a unit, $1,500, $2,000 a unit, which is contrary to what you would think with a first-time buyer that may not have as high an income. So the studio is continuing to work. Matt, you want to give them any comments on where the buyers are coming from, going to, and what they're taking?
spk09: Yeah. Buck, I think as I hear your question there, it sounds, are we seeing kind of this exodus from California? And what's interesting, while a market like a Vegas or a Denver, we do see some of that move from California. even within the state of California, we're seeing quite a bit of in-state. You know, our sales performance, especially in, like, Inland Empire, has been incredibly strong. And so while it does exist at some level, it's not necessarily just moving across state lines. It's actually pretty interesting. you know we we we also took a look buck is it coming out of cities and just you know getting to the suburbs we do see some of that but much of what we're taking what we've seen in the fourth quarter was within the suburbs itself so um not quite the dynamic buck that that you might think well understood that's very helpful feedback i appreciate that um
spk03: I'm curious just in terms of the land market as well, a follow-up on this one, given that it seems like finished lot availability is becoming increasingly constrained, and maybe this is a bigger picture question for the industry at large. I mean, with everyone out there searching for land and the demand so strong, are you going to have to continue to put more cash to work in land that you need to self-develop internally? How does that change the timeline to which you can bring communities on and does it change the margin profile for self-developed lots?
spk02: It's an excellent question, Buck, and it's something we've been dealing with for quite some time. There's very few finished lots on the ground. That's why I included in my prepared comments that we own and control everything for 22 years. you couldn't go down the street and buy some finished lots somewhere today and help your fourth quarter of 21 necessarily. And so you have to include in your timelines and your projected community growth or revenue growth the extended time it takes to get things entitled and then developed and then brought to market. So if you think back to 20, we started the year with expectations of delivering a few thousand homes more than we did. We owned those lots at the time in order to do that. And then with the pandemic disruption, we didn't hit our delivery numbers. But we still have the lot. So what it's done for us has set up a stronger lot count and pipeline for 21 deliveries. And in turn, we had already targeted growth for 22 back in January of 20 so we already have the cue and own and control what we need to hit our growth targets we're actually working now on what we need exiting 22 in order to have growth in in 23 and it sounds like a long way off but if entitlements take take 18 months in a lot of the cities if not longer in california they'll be here before you know it so we're our horizon has definitely extended and i think the whole industry has in terms of what you have to do in order to fuel your growth. As we've said a few times on this call, we've already got it for 21 and 22.
spk16: Our next question comes from Michael Rehart with J.P. Morgan. Please start with your question.
spk15: Hi. Good evening, everyone. Thanks for taking my question and congrats on the results. Hope everyone is healthy out there. First question, I just wanted to zero in on the gross margin guidance for a moment and try and break down, if it's possible, on a four-year basis, how you're thinking about interest amortization, either on a dollar basis or on a percentage basis. I believe as a percent of sales, interest amortization is down about 40 bps in fiscal 20. to maybe roughly about $130 million on a dollar basis. So how you're thinking about that in 21 and what the remaining core expansion X interest, gross margins X interest might be and be driven by.
spk07: Mr. Kaminsky. I thought that was coming my way. Yeah, thanks for letting me take that. So, Mike, just starting with the interest, as you know, it's been trending down pretty consistently year over year, and we think there is still some fairly significant opportunity over the next several years to continue that trend. On a standalone basis for 2021, right now our forecast is showing about 30 basis points of improvement, I believe that's probably a little bit on the light side. I think there's some opportunity to be above that, but that's what we baked in our guidance, about 30 bits on that piece. And at the midpoint of our guidance, that would leave about 90 basis points towards other factors. As I mentioned earlier, you know the margin for the first a couple quarters is more or less baked into our backlog so what we're seeing in there is not only the leverage impact on our fixed costs and cost of goods sold which is pretty significant if you think about it you know with a increase here every year nearly 40 on the top line We'll see some nice leverage impact going through our margin line. But I think as importantly, if not more importantly, is just the composition of our current communities, the improvements that we've been putting in place throughout the company, and really the end result of some of the efforts we've been working really hard on for the last several years is they've been outcroppings of our returns-focused growth plan. And Jeff was mentioning earlier some of the underwriting on the new land. And, you know, that's been another big benefit for us in that a lot of the land that we've been bringing to market with new community openings in 2020 and expect to bring in 2021 were underwritten in a different market environment. You know, they were underwritten, some of those parcels, a year, year and a half ago. And, you know, we've been developing that land and then eventually grand opening it. And, you know, pricing is actually different. We've seen some margin expansion just coming from market movements and our ability to maintain as best as possible cost control. So, you know, those other components are really important. So, you know, that other 90 basis points, it's, you know, what we're seeing in the backlog combined with mixed impacts from some of the new communities opening up and, you know, some of the pricing moves versus the cost moves that we've been seeing and we've reflected all that into the guidance.
spk15: Great. No, thank you, Jeff. Appreciate that. Secondly, I just wanted to hit on the SG&A side of the equation as well. Your guidance for the full year of low 10%, I guess 10.1 at the midpoint, but still actually a little bit slightly higher than where you were in 2018. despite an outlook for $1.2 billion greater in terms of revenue at the midpoint. So just wondering, and obviously taking a nice amount of leverage year over year, which is obviously very important, but just in terms of how you think about yourselves over the next two or three years, I'm just wondering what is the further potential for leverage going forward as it appears you've been, you know, kind of flirting with getting below 10, but, you know, just wondering about, you know, where the ultimate number can get to, assuming, you know, consistent, you know, double-digit top-line growth. And obviously embedded in that question is, you know, variable SG&A versus fixed as you continue to grow the top line.
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spk07: Right. Yeah, on the SG&A side, you know, similar to what we talked about in a couple of the earlier questions in, you know, anticipating community account growth and supporting growth in the business. We're very growth-minded right now. Our view is that we fixed a lot of the fundamental issues issues that we were facing in the business we made improvements across the capital structure across the balance sheet we made vast improvements across our community portfolio and we're really in a position very strong position right now of being able to expand the top line and grow the company at very strong return levels and really drive shareholder value as a result of that so i think part of what you're seeing in the sgna outlook particularly for 2021 is enough resources in the business to continue that growth and to continue to excessively, you know, not excessively, but to continue to expand that top line as we move forward. And, you know, you need some level of resource to do that. I do believe, you know, if you're talking longer term, and that's one of the reasons why our guidance starts, you know, at a single digit, albeit 9.9%, I do believe a single-digit SG&A expense ratio is very achievable for this company. And as we see our scale expand further and, you know, basically get on this cadence of strong growth year over year, I think we'll be able to achieve that. But, you know, one year at a time, as we always say. So we've forecasted out as best as we can see it today. And, you know, that's where it's coming in at, right around that 10%, 9.9% to 10.3% as we got it. Jeff, in comparing to 2018, wasn't there an accounting change?
spk02: model cost.
spk07: Yeah, very good point. Yeah, that's true. We did implement the new accounting standard and some of that shifted into SG&A for our model cost. So that's a really good point, Jeff. We're probably actually below it if you pull that out.
spk14: That was a full percent, wasn't it?
spk16: Yes. Our next question comes from the line of Nishu Soot with UBS. Please start with your question.
spk05: Thank you. I wanted to revisit the kind of, you know, the order pace, the demand pace versus your start. You had a very nice acceleration in demand, you know, 3Q to 4Q, and it looks like it persisted consistently through the quarter. and into your first fiscal quarter as well. How much of that was the market, and how much of it was the nice pickup you saw in starts, which were, you know, about the same rate? So did your increased pace of starts allow you to sell a little bit, you know, further out? Or, yeah, so just was wondering if you could help us break that down.
spk02: Okay. Nisha, I'll kick it to Matt. here in a minute to give you some color. But if you think of our business model, it's like you prime the engine and then the engine gets going. And once you sell the home, then it takes some time for the buyer to finalize in the studio, and then we get a permit, and they get their loan approved, and then we go. So there's this lag 60 days or so between contract and start. As you look back, the sales really started to pick up June, July, August, and so on. And the starts will pick up 60 days thereafter. And I threw a comment in the prepared remarks. In our normal year, the spring selling season makes our year. It's the strongest selling environment. Then you have the 60 days, then you start to home. And our fourth quarter is always our highest delivery season. quarter by a bunch due to the timing of demand for us in the spring selling season. This year, for the first time in my career, we're actually going to deliver more in the first quarter than we did in the fourth quarter because the spring selling season got delayed with the pandemic disruption. And then when the clouds started to clear a bit and there's such strong housing demand that held so long, It has us on this growth trajectory where Q1 and Q2 ramp up stronger than Q4, which I've never seen before in my career as a KB over a lot of years. And so it's pretty interesting, and it speaks to how strong the demand is right now. But, Matt, you want to talk about the timing of our sales to our starts and how we pace it? Sure, Andy. Sure.
spk09: And that's it. Sales really does drive it for us. And we view that sale as that first step in the process. And as Jeff touched on, what we've seen over the last couple of months has just been really strong. Absolutely no signs of letting up. There was not a holiday lag that we usually see. And if anything, we've historically think about the Super Bowl as being the kickoff for the selling season, I can tell you the season has already started. And so with that, that really does drive the process in which our customers go through our studio and make selections, and we move forward, get permits, and start that home. We have also done some things relative to that up front step of the process and studio selection. It was forced due to COVID, but putting tools in place that has allowed us to have virtual studio appointments is now actually getting traction and we're saving time. As we move forward, you're going to continue to see, hopefully, continue to walk that up to match and stay in sync with the great sales activity that we've seen.
spk05: Gotcha. Gotcha. That's very helpful. So since it was – it seems like it was primarily demand-driven, you know, the strong order acceleration that you folks saw and has continued into this year, it really doesn't seem like the renewed lockdowns, especially, you know, in California, an important state, too – it doesn't seem like that's really affected demand. I was just wondering if you could comment on that a little bit further. I imagine your organization is now well-adjusted to operating in this new reality, so that it seems like consumers weren't dissuaded by increased lockdowns. Maybe you could just discuss that a little bit, please.
spk09: Sure. And we have... We have not seen it slow. And what we have seen, though, is when they do show, they're ready to go. So much of the interaction that would normally take place in our models is now happening over the phone or over a Zoom call. And early on, and I'm going to go back to where we were in March, We rolled out a pretty extensive training program for all of our sales teams on how to use these virtual tools. I don't see that necessarily going away. While it makes it difficult just to monitor foot traffic, because what we see today is a different environment than what we had a year ago. The net of what we're getting through with buyers ready to go and move forward has been very positive. So that's my assessment of where we're at and anticipate that that's going to continue in this environment. And I also anticipate the use of some of these virtual tools surviving post-vaccine distribution.
spk02: I think, Mishu, it's also a fair comment that as these lockdowns have reoccurred and tightened up, it's actually heightened people's desire to buy a home because they want their own place and they want their own backyard and they want their own refuge that they may not get if they're a renter somewhere. It's an interesting dynamic.
spk16: And with that, ladies and gentlemen, this concludes today's teleconference. Thank you for your participation. You may now disconnect your lines and have a wonderful day.
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