KB Home

Good afternoon. My name is Devin, and I will be your conference operator today. I would like to welcome everyone to KB Home's 2021 First 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 lines for questions. Today's conference call is being recorded and will be available for replay at the company's website at kbhome.com through April 24th. Now, I would like to turn the call over to Joe Peters, Senior Vice President, Investor Relations. Joe, you may begin.

Thank you, Devin. Good afternoon, everyone, and thank you for joining us today to review our results for the first quarter of fiscal 2021. 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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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 Mezger.

Thank you, Jill, and good afternoon, everyone. We're off to a strong start in 2021 with solid execution in our first quarter that highlights our ability to strike an effective balance between capturing demand in this robust housing market and measurably increasing our margins. We are poised for profitable, returns-focused growth this year based on a number of factors, most notably our backlog, both its composition and size, the success of our newly opened communities, and a compelling lineup of planned openings for the remainder of the year. As to the details of the quarter and diluted earnings per share, 62% year over year in Texas, which shifted some deliveries from our first quarter into our second quarter. Texas is our largest market by units, and the severe weather shut down our operations for roughly 10 days in mid-February. We resumed activity in our communities by the last week of the month and nearly all of the impacted homes have already been delivered. Our profitability was substantially higher year over year with a more than 400 basis point increase in our operating income margin to 10.4% excluding inventory related charges. This result was driven by several key factors. First, strong demand for our personalized products at affordable price points, and our success in balancing pace and price. Second, operating leverage from increasing our community absorption rate and the resulting higher revenues. Third, the ongoing benefit from the cost containment efforts we put in place last spring. And finally, the continuing tailwind from lower interest amortization. Our profitability per unit grew meaningfully to over $41,000 in the first quarter, 73% higher than in the prior year period.

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These results are also generating a healthy level of operating cash flow to fuel the expansion of our scale. In the first quarter, we increased our land investments by 37% year-over-year to roughly $560 million. We grew our lot position by approximately 3,000 lots since year-end to nearly 70,000 lots owned and controlled and maintained our option lots at 40% of our total. We own or control all the lots we need to support our growth target for 2022, and although we remain opportunistic in seeking additional lots that can provide deliveries next year, we are now primarily approving land acquisitions for deliveries in 2023 and beyond. We are achieving our objectives in growing our lot count with a higher quality portfolio of assets and increasing our returns all at the same time. A healthy tension exists within our division as they work to expand their business while staying on strategy. We have experienced land teams in our markets who have strong local relationships with land developers and sellers, and we continue to see good deal flow that meets our investment criteria. Although every acquisition is different, requiring a tailored set of assumptions regarding the sub-market, the number of lots, the type of product we plan to offer, and the price point, we are generally underwriting our deals to a monthly absorption of between four and five. We're being prudent with our investments, yet opportunistic with pace and price based on market conditions once each community opens. Our long-standing approach has been to underwrite in today's dollars, and as such, our land deals reflect our current ASPs as well as our current costs and assume no future price appreciation or cost inflation. Geographically, we remain in close proximity to where we've been investing in land over the past couple of years, entering neighboring submarkets in order to grow our scale but without moving to the more remote submarkets of each city. Our Las Vegas business provides a good example of this strategy. This division has increased its annual deliveries by almost 50% in the last three years and has achieved the number one ranking in the market. We have a large business in Henderson at Inspirata, and we are well established in Summerlin. To expand further, we are investing more heavily in the northwest and southwest areas adjacent to our existing submarkets, which still offer good schools, shopping, and amenities at more affordable prices. In terms of deal size, we continue to acquire lots that typically represent a one- to two-year supply per community, consistent with our approach over the past several years. We remain on track with respect to our 2021 and 2022 community count goals that we share with you in January as we execute on our growth plan. In the first quarter, we successfully opened 22 new communities out of the approximately 150 openings we anticipate for this year. As we look to the remainder of 2021, we continue to expect a sequential increase in our ending count each quarter, and year-over-year community count growth in the fourth quarter. We remain well-positioned to extend this growth into 2022 and still expect year-over-year community count expansion of at least 10% next year. Our monthly absorption per community accelerated to 6.4 net orders during the first quarter, a year-over-year gain of 39%. We achieved this sales rate even as we raised prices in the vast majority of our communities and managed lot releases in order to balance pace, price, and starts as we optimized each asset. Municipalities have increased their capacity for processing permits, heightening our ability to accelerate our starts, which were up 40% year over year in the first quarter. Going forward, we expect to continue matching starts to our order rates. While we have remained sensitive to affordability levels throughout the past year, we have utilized price as our primary mechanism to manage our sales pace and to cover construction costs, which are under some pressure right now. That being said, our ASP expectation for this year reflects only mid-single-digit percentage growth year-over-year. This modest increase in our blended ASP reflects our effective approach to our community location and product positioning to help maintain affordability. By targeting the median household income in each sub-market and with our bill-to-order approach, we provide the consumer flexibility in floor plan size and price enabling them to quickly adjust their purchase decision if interest rates increase further. We strive to position our communities below the new home median price and at a reasonable premium to an older resale home. Each of our divisions is aligned with this strategy, and in some cases, we are finding that we are actually below median resale levels as well, given the steeper appreciation in price that the existing home market has experienced.

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We offer floor plans below 1,600 square feet in approximately 75% of our communities. The median square footage of our homes in backlog is almost 2,100 square feet, which is consistent with the median footage of homes we delivered in 2020. Buyers are not adjusting the size of the homes they are purchasing, nor have they reduced their spend on our design studios, which tells us that even with the uptick in rates, affordability remains favorable. As to overall market conditions, supply remains tight, with existing home inventory down nearly 30% year-over-year. Resale home availability is sitting at record low levels, below that level in many of our markets. This, combined with the underproduction of new homes over the last decade, has resulted in supply being virtually nonexistent. In terms of demand, Mortgage rates, while higher relative to where they were in January, are down year over year and remain attractive, generally around the low 3% range for a 30-year fixed-rate mortgage. Most notably, demographic trends are favorable, especially with respect to first-time buyers, as over 70 million millennials are in their prime home-buying years, with an even larger Gen Z cohort, right behind them, now entering their home buying age. As a result of all these factors, but particularly the strong demographics, we believe demand will stay healthy for the foreseeable future. Net orders in the first quarter grew 23% year over year to nearly 4,300, a solid result given the strength in net orders that we experienced in the prior year's first quarter. Net orders increased as the quarter unfolded, reflecting typical seasonal trends, and remained at high levels exiting the quarter. We produced double-digit growth in each of our four regions as demand for our affordable price points remained robust across our footprint. We continue to observe trends in our underlying order data that are consistent with the patterns that emerged in the second half of last year. Buyers favored a personalized, built-to-order home, and Millennials represented our largest segment of buyers. The increasing presence of this cohort in our order activity is naturally translating into a higher percentage of deliveries to first-time buyers and 65% of our deliveries in the first quarter, up 11 percentage points year-over-year. The pent-up demand among first-time buyers and their ease of mobility is an advantage for us given our expertise in serving these buyers along with our location, products, and price points. We offer features in our homes that today's consumers value. A prime example of these features is our advanced energy efficiency, which helps to lower the total cost of home ownership. We lead the industry in building ENERGY STAR certified new homes having delivered more than 150,000 of these homes to date, as well as over 11,000 solar-powered homes. As a result of our leadership, we were the only national home builder to be named ESG Practices Sustainability Report. We're excited to share our latest achievements in the 14th edition of our report, which is scheduled for release in conjunction with Earth Day next month. Our backlog value grew substantially in the first quarter to $3.7 billion. The 9,200 homes we have in backlog, together with our first quarter deliveries, represent about 85% of the deliveries that were implied in our full-year outlook we provided in January. With housing market conditions still healthy, our ability to match starts with sales, and reasonable build times, we are confident that we can exceed our original volume expectation for this year. This is driving our full-year revenue guidance higher, which Jeff will discuss momentarily. On the mortgage side, our joint venture, KBHS Home Loans, continued its strong execution for our customers. Our JV handled the financing for 79% of our deliveries in the first quarter, of eight percentage points year over year, producing a significant increase in its income.

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Consistent with the past few years, conventional loans represented the majority of KVHS volume, and the credit profile of our buyers remained very healthy, with an average down payment of about 13%, and an average FICO score of 724, which is striking considering our high percentage of first-time buyers. As we continue to accelerate our revenue growth over the balance of this year, we expect our income stream from the JV will grow as well. We are positioned for a remarkable 2021 in achieving our objectives of expanding our scale and improving our profitability while driving a meaningfully higher return on equity, which we now anticipate will be above 18%. I'd like to take a moment to recognize the outstanding team of individuals that are producing our strong results. We were gratified to be recognized by Forbes in its 2021 list of America's Best Midsize Employers, again, the only national builder receiving this honor. In closing, we remain mindful that the pandemic is still present. However, we are encouraged by the progress we are making as a country to emerge from it. We are energized by how our year is shaping up and look forward to updating you on our progress. With that, I'll now turn the call over to Jeff for the financial review. Jeff.

Thank you, Jeff, and good afternoon, everyone. I will now cover highlights of our 2021 first quarter financial performance, as well as provide our second quarter and full year outlook. We are very pleased with our first quarter results, with higher housing revenues and considerable expansion in our operating margin, driving a 62% increase in our diluted earnings per share. In addition, strong net orders in the quarter, combined with our substantial beginning backlog resulted in a 74% year-over-year increase in our quarter end backlog value, supporting our raised revenue and margin outlook for 2021. In the first quarter, our housing revenues of $1.14 billion rose 6% from a year ago, reflecting increases in both homes delivered and the overall average selling price of those homes. Looking ahead to the 2021 second quarter, We expect to generate housing revenues in the range of $1.42 to $1.5 billion. For the full year, we are forecasting housing revenues in the range of $5.7 to $6.1 billion, up $150 million at the midpoint as compared to our prior guidance. We believe we are well positioned to achieve this top-line performance supported by our first quarter ending backlog value of approximately $3.7 billion, and our expectation of continued strong housing market conditions. In the first quarter, our overall average selling price of homes delivered increased 2% year-over-year to approximately $397,000, reflecting variances ranging from a 5% decline in our West Coast region to an 11% increase in our Southwest region. The West Coast decline was mainly attributable to product and geographic mix shifts of homes delivered. For the 2021 second quarter, we are projecting an average selling price of approximately $405,000. We believe our overall average selling price for the full year will be in the range of $405,000 to $415,000 a relatively modest year-over-year increase, and a result of our focus on offering affordable product across our footprint. Home building operating income for the first quarter increased 90 percent to $114.1 million from $60.2 million for the year-earlier quarter. The current quarter included inventory-related charges of $4.1 million versus $5.7 million a year ago. Our home building operating income margin improved to 10.0% compared to 5.6% for the 2020 first quarter. Excluding inventory-related charges, our operating margin for the current quarter increased 430 basis points year-over-year to 10.4%, reflecting improvements in both our gross margin and SG&A expense ratio, which I will cover in more detail in a moment. For the 2021 second quarter, we anticipate our home building operating income margin, excluding the impact of any inventory-related charges, will be in a range of 10.0 to 10.5%. For the full year, we expect this metric to be in a range of 11.0 to 11.8%, which represents an improvement of 310 basis points at the midpoint as compared to the prior year. Our 2021 first quarter housing gross profit margin improved 340 basis points to 20.8%. Excluding inventory-related charges, our gross margin for the quarter increased to 21.1% from 17.9% for the prior year quarter. This improvement reflected the favorable impact of selling price increases outpacing construction cost inflation, increased operating leverage on fixed costs, and lower amortization of previously capitalized interest. Assuming no inventory-related charges, we are forecasting a housing gross profit margin for the 2021 second quarter in a range of 20.5 to 21.1%. We expect our four-year gross margin, excluding inventory-related charges, to be in a range of 21 to 22%. an improvement of 70 basis points at the midpoint compared to our prior guidance, and up 190 basis points year over year. Our selling general and administrative expense ratio of 10.7% for the first quarter reflected an improvement of 110 basis points from a year ago, mainly due to the continued containment of costs following overhead reductions implemented in the early stages of the COVID-19 pandemic, lower advertising costs, and increased operating leverage from higher housing revenues. We are forecasting our 2021 second quarter SG&A ratio to be in a range of 10.4% to 10.8%, a significant improvement compared to the pandemic-impacted prior year period, as we expect to realize favorable leverage impacts from an anticipated increase in housing revenues. We still expect that our full-year SG&A expense ratio will be approximately 9.9 to 10.3%, which represents an improvement of 120 basis points at the midpoint compared to the prior year. Our income tax expense of $26.5 million for the first quarter represented an effective tax rate of approximately 21%, and was favorably impacted by excess tax benefits from stock-based compensation and federal tax credits relating to current year deliveries of energy-efficient homes, the cornerstone of our industry-leading sustainability program. We currently expect our effective tax rate for both the 2021 second quarter and the full year to be approximately 24%, including the impact of energy tax credits relating to current year deliveries. Overall, we reported net income of $97.1 million or $1.02 per diluted share for the first quarter compared to $59.7 million or $0.63 per diluted share for the prior year period. Turning out a community count, our first quarter average of 223 was down 11% from the corresponding 2020 quarter primarily due to strong net order activity driving accelerated community closeouts over the past 12 months. Consistent with our forecast, we ended the quarter with 209 communities, down 16% from a year ago. We believe our quarter end community count represents the low point for the year as grand openings are expected to outpace closeouts during each of the remaining quarters. While we expect this dynamic to result in a sequential increase of five to 10 communities by the end of the second quarter, we anticipate our second quarter average community count will be down by a low to mid double digit percentage on a year over year basis. We currently expect continued strong market conditions to drive an elevated number of community closeouts during the remainder of the year, resulting in a single digit year over year percentage increase in our community count at year end. However, we remain very focused on our goal of meaningfully growing our community count. Given our land pipeline and current schedule of community openings, we are confident that we will achieve at least a 10% increase in our 2022 community count to support further market share gains and growth in housing revenues. During the first quarter, to drive future community openings, We invested $556 million in land and land development, including a 43% year-over-year increase in land acquisition investments to $275 million. At quarter end, total liquidity was approximately $1.4 billion, including $788 million of available capacity under our unsecured revolving credit facilities. We had no borrowings under the credit facility in the 2021 first quarter. Our debt-to-capital ratio is 38.9% at quarter end, and we expect continued improvement through the end of the year. We still expect strong operating cash flow in the current year to fund levels of land acquisition and development investment needed to support our targeted future growth in community count and housing revenues.

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Given our current community portfolio and backlog, along with expected ongoing strength in the housing market, we continue to expect significant year-on-year improvement in our revenues, profitability, credit, and return metrics in 2021. In summary, using the midpoints of our new guidance ranges, we expect a 42% year-over-year increase in housing revenues and significant expansion of our operating margin to 11.4%, driven by improvements in both gross margin and our SG&A expense ratios. In addition, achieving our new revenue and profitability expectations would drive a return on equity of over 18% for the year. These expected results reflect our view that continued emphasis on our returns-focused growth strategy will enable us to further enhance long-term stockholder value. We will now take your questions. 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 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 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, when asking a question, we ask that you limit yourself to one main question and one follow-up. Our first question comes from the line of Truman Patterson with Wolf Research. Please proceed with your question.

Hey, good afternoon, everyone. Thanks for taking my questions. I appreciate it. First, Jeff, Jeff, orders in first quarter, I believe you all said we're up about 44% in the first six weeks. It looks like they were basically flattish in the final six weeks. Could you just really walk us through what's driving this? It sounds like you know, internal initiatives driving pricing or, you know, maybe capping production and limiting lot sales. But on the flip side, if I heard you correctly, it doesn't sound like interest rates have had any real negative impact to demand yet. So if you could just walk me through what's really driving that. And I don't think I heard a March to date order update.

Truman, I can... Talked to that from Jeff Pilon. A couple things going on with our order comp. As we shared back in January with our year-end call, our January and February last year were very good. And, yes, our comp was up 40-some percent at that point in the quarter, but we knew it would come down because last year, frankly, February, demand was as good as it is today, and our orders were very strong. So we had a much tougher comp. We had favorable numbers through the quarter. Demand remained strong through the quarter. No sign of slowing up. So you had this math on the comp, while at the same time, we did take some steps in February in particular to slow down sales a bit and capture the price opportunity that's out there. We have a large backlog. We're balancing our starts with our sales and our backlogs. and we elected to go for more price and more margin opportunity and still generated a pretty significant orders per community for the quarter at 6.4. So I think that answered your question on the comp. Actually, the comp ended up about where we guided in the first quarter call because we said it would come down. We didn't talk specifically to March in that, as everyone on the call knows, we had a very disrupted – Q2 last year, and for the quarter, the comp's going to be very large. But it isn't really a reflection on what we're doing now. It's a reflection on the speed bump we had in orders last year. So rather than give a distorted number, I just share that demand trends remain very strong right now. We're not seeing any impact from interest rates. Affordability is still favorable. And as you look at our Q2 from last year, the comp is going to be incredible.

Okay, okay. And maybe asked another way, you know, you all did a little bit under 4,300 orders and you're matching starts to orders. Is that a level that you're comfortable with?

Yeah, our starts were up 40% in the first quarter, and we'll continue to keep our starts and our sales in line. If we can keep starting at the pace we're at, we'll keep selling at the pace we're at.

Okay, okay. And... On your community count, I believe you said at the year end of 21, up low to mid single digits, and then in 2022, you're comfortable with 10% growth. Could you just run through what absorptions is included in that guidance? And could you just talk a little bit or characterize the health of the horizontal land developers and the municipalities, the regulatory process? Are you seeing any incremental tightness that might delay some community openings?

Right. I could talk a little bit about the community count and maybe Jeff, if you want to comment on the land development. But as far as the community count numbers go, the largest variable, like always, is in our closeouts. Our focus right now is on getting our openings up and running and driving count based on that. If we get to the end of the year and we have some variance in count up or down, it's just going to be a tradeoff between the community count and our backlog numbers, frankly. So if the pace continues at the current levels or even goes higher than what we've seen, we may close out a few more communities, but those sales would obviously end up in backlog and not really impact either current year revenues or next year revenues, we think will still be around the same number. So we're just driving towards that. As far as cadence goes, we do expect to see sequential improvement, and not only sequential improvement through the end of the year, but out into 2022 as well. And as we're getting deeper into 21, We're starting to really shore up our plans for next year. We have a large number of grand openings on the docket again, and we do expect next year to see the closeouts moderate a little bit as we have some larger lot counts to start the year in some of those communities than we did in this year, which I'd call an abnormal number or level of closeouts in the current year. You know, as we try to forecast that, I guess getting back to your original question, we try to consider current absorption pace in the numbers and, you know, take into account seasonality a bit in that and, you know, do the best job we can on forecasting those closeouts. But actually the grant openings are much more impactful on the future of the business and the growth in the community account than the closeouts. Those would just be timings.

Our next question comes from the line of Matthew Voulay with Barclays. Please proceed with your question.

Hey, good afternoon. Congrats on the quarter. Thanks for taking the questions. Let's go back, I guess, to the sales pace of 6.4. You know, you talked about obviously the 10 days in Texas is impacting the deliveries. Did it have an impact on the sales pace as well? And overall, just You know, Jeff, you're talking going forward about matching starts and, you know, in order to continue to keep this pace elevated is, you know, and you had the 40 percent in the quarter. So. You know, has the capacity to get those starts in the ground, has that changed at all versus, you know, how you guys were thinking a couple months ago, given everything we're seeing around labor and materials and all that? It's kind of a two-parter on sales pace in Texas and start space. Thank you.

All right. Thanks, Matt. I'll make a few comments and refer it to Matt can give you the color on the capacity. In Texas in February, it impacted deliveries more than it would impact sales. Sales are in the queue for a while, and it's more of a paper process. You can do it virtually. People can do it from their apartment, and we can do it remotely as well. On the delivery side, where we got pinched was the last group of city finals, the last group of appraisals that you need when the home is completed, those types of things. I would say that it was a slight speed bump in deliveries, and I shared that we've already closed the vast majority of them here in March. Whether it's land development that Truman asked about or here on the operational side, in general, I can say that the industry and the municipalities and everyone has responded in ways to navigate through this post-COVID environment that we're in and the the hits that we took in the delays actually were last summer and fall and we've now got a much more predictable business we're continuing to work on ways to compress things whether it's on the land development side whether it's on the the permit side where the cities are doing far better and in turn on the construction side as well so it's not we're not feeling stress on our capacity right now. It's making sure things just go in their normal rhythm and we're more predictable business right now. But, Matt, you want to give them some color on build times and what we're doing?

Sure. As Jeff touched on, all of our divisions are very focused on expanding our overall capacity. That's That's simply recruiting additional trades, getting them on board. And Matt, I think as we progress through the year, we're gonna see a reduction in cycle time as we can take advantage of that additional capacity. On the municipality side, As the economy starts to open up, you know, and staffing with the cities improves, we'll see a reduction there. So I think there are, while there are certainly some challenges still in front of us in this environment, there are many things coming that as we progress that our cycle time, which has been running, you know, around seven months, can get back to our norm of six months. We're not assuming that improvement within the guidance we've provided, but, you know, we've got enough things in place that we're optimistic that we can start to get back to our norm.

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Perfect. No, thank you for the details for hitting both parts of my question there. Second one on the gross margin, just thinking a little more near term, the guide suggests a step lower in the second quarter. I'm just curious, you know, to the extent you're guiding deliveries higher sequentially, so perhaps some greater fixed leverage. You know, clearly the pricing trends have been you know, on the favorable side. Is the expectation that that just cost has gotten that much worse, such that the price versus cost is a little less favorable in Q2, or is it more just mix? Any more color on that? Thank you.

Right. Yeah, the dynamic between Q1 and Q2 is mainly mix. We ended up beating the first quarter guide and our first quarter forecast by quite a bit. A lot of that was just the units that were closed. So we closed higher margin units in the first quarter, obviously, Those will not be closed now in the second quarter, and some of the lower margin units will be. So it's mainly mixed. If you really look at the guide for the full year, the second half margin is going to be closer to 22% margin, and the first half margins altogether for the first six months will be closer to 21%. And we are seeing improvements sequentially as we go from Q2 to Q3 to Q4. So actually, you know, the outlook is quite positive and quite favorable as far as continued strength on the margin side, and we were quite pleased to be able to lift that guidance by 70 basis points this quarter based on our backlog, what we're seeing in the backlog, success for our new communities, and, you know, very importantly, the pricing versus construction cost inflation dynamic that we've been experiencing and able to control quite effectively up to now.

Our next question comes from the line of Stephen Kim with Evercore. Please proceed with your question.

Yeah, thanks, guys. Strong results, obviously. Jeff, I guess it'd be fair to say that the pricing environment and the sales environment is about as strong as we've ever seen in history. You go back a long way, obviously, but my guess is you could probably sell every home you can build. You made a comment that I thought was very interesting about the existing home market, you know, pricing being up a little more or very aggressively. And, you know, in general, my thought is that in the existing market, you know, every home that sells is effectively an auction, whereas builders generally have, you know, an asking price and they generally don't sell over the asking price. But recently we've heard that some major builders, or at least in some communities, actually they're shutting the communities down for additional sales. But if you are willing to pay a surcharge of tens of thousands of dollars, they'll go ahead and actually sell it to you. And I'm curious as to whether you're doing that or whether you would consider doing auctions or not, and if not, why not?

Steve, that's a good question. For starters, what you're describing is not very customer-centric, and you can get more price on that sale, but you're going to lose brand over time. I'm very sensitive to that because we've got a great brand. What we will do is part of what I touched on with our metered sales releases. What we'll do is drop back to reservations where we can gauge the interest level at different price ranges and do some whisper pricing, if you will, and if we get strong enough interest, you open up for sale at a much higher price. And people are on a waiting list, and we go through the waiting list right now, but I'd rather keep the good relationships with the customer base and the realtor community and go through our process to capture higher prices. We're taking a lot of price right now, but it's in a controlled way to make sure we retain the relationships with the customers.

Okay. Have you heard of what I'm describing happening, and is this something that you are actually competing against, or is this something that you have not heard of yet?

Well, I saw it. To me, it's more of a one-off that was covered on another builder's analyst coverage, but it's certainly not something we're seeing broad-based or that we would entertain. Got it.

Great. And then secondly, Jeff Kaminsky, you had given the guide for 2Q gross margins, and obviously gross margins have been like a balloon that you're trying to catch. I mean, it just keeps going up and up here a little faster than you can expect. And I'm curious as to whether maybe part of the reason for that is because there are – you know, increased sales going on in the design studio perhaps or other sorts of things which happen after the home has been sold that you're maybe not quite capturing in your methodology and whether, you know, that dynamic, which drove nearly 100 basis points better gross margin in the first quarter than you thought three months ago, could possibly play a role again in 2Q or if, you know, there's some reason why you don't think the upside surprises on 1Q is repeatable.

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Right. Look, I'd never say, you know, doing better than what we say is not repeatable. You know, that's always potential. We kind of call it how we see it. You know, we have a large backlog and a pretty consistent backlog that closes. Again, you know, we did see some mix shifts in the quarter, and the total units came in a little lower than what we had expected, so that certainly had an impact. The other impact that we see every quarter is, We do have a certain number of units that sell and close within a quarter. So as you know, we're a build-order builder, but typically we'll have 70% build-order, about 30% inventory, and of the inventory, about a third of that sells and closes in the same quarter. So we'll see some variability there. And typically, you know, we'll forecast slightly lower margins on that. And frankly, in the first quarter, the environment was so strong, we didn't really take a haircut on those sales and closings. So there's potential for that. But again, you know, we call it like we see it. We don't really cushion it. We're showing up 70 basis points for the full year, reflecting the strong sales that we saw in the quarter and the cost containment and everything else altogether. So, you know, we'll stand by our guidance for the second quarter and full year and I'm enjoying the more favorable outlook and more favorable forecast. It's driving not only margins, but it returns up quite significantly as well for the full year, so we're happy about that.

Our next question comes online. I'm Alan Ratner with Zellman & Associates. Please, see with your question.

Hey, guys. Good afternoon, and congrats on the very strong results. Jeff, maybe first question kind of similar to the last one on margin. I was just curious, a few other builders have kind of talked to this idea that as communities close out, they generally generate the strongest gross margins over the life of that project. For a multitude of reasons, you've got obviously price appreciation, but also kind of some true-ups of accruals over the course of the life of the project. And you guys are turning your community's quite a bit this year. You're closing out of a lot and you're also opening up quite a bit. And obviously a lot of the new openings probably won't be deliveries until next year. But I was just hoping you could kind of talk through what impact, if any, that turnover in community account is potentially going to have on your gross margin over the next, you know, call it 12 to 18 months.

Sure. One of the deposits really about the communities we're opening today are the time when they went through our underwriting, it was pre-pandemic and pre-market run-up. They had fairly, I'd say, modest ASPs involved. Obviously, we've seen some cost inflation since that time, but more so on the price. They're a little bit better than how we underwrote. And quite frankly, our base community portfolio is in the same boat. With improving market conditions, we're seeing more strength in those margins as well. So as far as the tradeoff goes, I'm optimistic about the new communities. They're performing very well. The vast majority of them are performing above the land book and really contributing to that low 20s gross margin that we're now enjoying. And I don't see any real risk of that coming off the rails just because we opened a bunch of new communities. And it's been so far so good. We've closed quite a few communities over the last two or three quarters have closed out. And the replacements that have come in haven't really missed a beat. We've been right there on the margin side. So as far as the portfolio itself goes, it's solid and it's improving. I like what I'm seeing, you know, from the point of those new openings, and the fact that most of our deliveries next year will still be generated off what I'll call pre-pandemic land prices is another real positive, I think, for the overall health of the community portfolio.

Great. That's very helpful. I appreciate that. Second question, maybe for Jeff, I'm just Obviously, your built order model, your buyers are sitting in your backlog for a while, and rates have moved. I know you don't seem overly concerned about that, but I'm curious, your can rate right now is probably at all-time lows, if not pretty close to it. Have you seen any increased chatter or call volume from buyers in backlog that are, you know, asking questions about locking in rates or what they could do to lock in rates to prevent further increases going forward or anything that would be a potential warning sign about, you know, that there's some skittishness unfolding there?

Yeah, I wouldn't call it skittishness necessarily, Alan. They are coming in now and asking to lock their rates, which when rates are sliding, they don't like to do. And as soon as they hear rates are going up, they'll the lock and the lock program we have covers the time to build the home. So if they think rates are going up and they want to come in and lock, we accommodate that. Matt, you have another color you want to give on that?

Yeah, Alan, taking a look at our pipeline of what we have currently, the percentage of buyers who have elected to lock is 10% to 15%, and that's very comparable to where we were a year ago. So even with the headlines on rates and rates potentially moving up, it has not triggered our buyers to make an additional step. But the good thing is we have a program in place. The buyer elects to do that. We can put them in that lock, but have not seen that happen yet, Alan.

Our next question comes from the line of Susan McLaren with Goldman Sachs. Please proceed with your question.

Thank you. Good afternoon, everyone. My first question is, you know, can you talk a little bit about the construction costs that you're seeing, you know, how inflation kind of came through in the quarter and how you're thinking about that as we look through the next couple of quarters?

Sure. So, you know, as far as construction costs go, the percentage of overall average selling price, it's remained incredibly steady and constant for quite some time now. So, you know, what we've been saying and doing, we continue to see, which is offsetting inflation on the construction cost side with selling prices, and that's working quite effectively. You know, there are concerns, obviously, in a tight market and a hot market like we're seeing now. There's a lot of pressure on the supply chain, both, you know, in materials and certain commodity categories as well as in labor. And, you know, our purchasing folks are very, very busy right now trying to manage that. And they're doing a really good job. It's very challenging. It's a challenging environment. But, you know, they get paid to solve problems and they've been solving the problems. So, I think what we're really seeing now is just our ability to just continue to rely on our long-term relationships and whether some of the large national suppliers that we've had in in partnership or that we've been in partnership with for a long time or some of the large local labor providers and subcontractors. We've just really gotten in play with the supply base and providing a lot of visibility. We have a big backlog built, so it's a huge advantage for us. We know exactly what we're building, where we're building it. We share those backlog details with our suppliers so that they can plan accordingly and You know, it's a tough environment, but so far so good. And, you know, it's a high-class problem. You might rather be facing this than trying to go out and get sales or anything else you can think of. And so far the operations have been doing, I would say, an outstanding job managing through it, not only getting their deliveries and, you know, trying to compress their cycle times but also controlling as much as possible the inflation on that side of it.

Okay, that's that's very helpful color. And then my next question is going back to the question around higher rate. 1 of the things that we have heard is that with the savings rate, having risen pretty significantly last year and stimulus money coming through and the fact that just home prices overall have risen some people that are. either doing a move up or moving from an existing home to a new home, are putting more down payment down to help mitigate the impact of the higher rates. And I know you mentioned that your average down payment is around 13% or so. Have you seen that change at all? Are you seeing that people are able to put more down? And is that to any extent kind of helping in terms of the rate environment and their ability to get in there and get all the options and the upgrades and all those kinds of things that they still want?

Susan, I don't know that the 13% has changed much in the last couple of years, maybe a percentage point, no more. But if you put it in the context of 65% of the buyers were first-time buyers in the quarter and our average selling price about 400, so they're putting $50,000 down on their home purchase. In the traditional lens, a first-time buyer is going FHA, putting down the minimum because that's all they have. This is a well-heeled first-time buyer, and it's what we've been catering to for the last couple of years. FICO score is 724. They can borrow more. They're not stressed in qualifying, and I don't think they're draining the bank at closing either. I think they have liquidity left over. Matt, do you have any other color on that relative to studio or?

Well, or just as you think about, you know, the loan product that they're selecting, you know, a year ago they were 55% conventional, and we're still seeing that. So there just has not been a significant, you know, movement over the last six quarters on the loan that they're selecting. And as Jeff touched on in his comments, this is a high credit score. You know, this is a buyer in a very strong position and ready to move forward. You know, and is this the, you know, the millennial who waited and has now been able to accumulate a very strong deposit, good credit score? That's what we're seeing.

And our next question comes online of John Lovallo with Bank of America. Please stay with your question.

Hey, guys. Thank you for taking my questions tonight. Obviously, you're performing at a very high level, which is encouraging. I just have a question just rounding out the affordability conversation here. If we think back to 2018, the economy was improving, home building demand was solid and also improving, fiscal stimulus was expected to to put more money in buyers' pockets and offset the effect of higher rates and ASPs. You know, everything felt pretty good from a home building standpoint. And then the music sort of stopped in the fall. So I guess the question is, you know, what were some of the early signs, if you can recall, that things were kind of coming to a head and getting ready to pause? Any thoughts around that?

As we look back on it, John, there's a couple things that are different. Back then, interest rates ticked up more than they have right now, and builders were pushing price. There's a couple other things going on. One, there is literally no inventory, and back in 18 and 19, inventory was more plentiful and in balance, and I think the maturing of the millennials And the starting the family and saving the money, there's significantly more demographic demand today than there was back in 18 and 19. And we've shared the story when we saw the slowdown, I would say our traffic probably ticked down a little or people took a little longer to buy. You'll see things like that. But we quickly moved to reposition our model parks to smaller homes that were lower priced, more affordable. where we would go from a 2,200-foot model down to a 1,700 or 1,800-foot model, put it in the model park. It would have a similar room count, albeit a little smaller room, but would live the same. And we were ready for this affordability crunch. And the buyer came back after about 120 days. I think it was more the adjustment to the rate at the time, because rates didn't come back down when our sales picked up again. So we were positioned for a tougher affordability environment. And the buyer came right back. Rates then did come down. And we didn't need to take advantage of what we had done. And our average home size today is similar to what it was back in 18 and 19. But we're well positioned if it were to happen again because we still have the product out there and can move just as quickly. And we've actually done a lot of look-back research right now Because this is so topical. And if you look at many of our markets, we took same communities where we've moved price, but rates are lower. And in some cases, the payment right now, year over year, is up $30. I think the worst one I saw was up $180 in that community. This move with interest rates, while it's come up a little bit, it's still pretty compelling out there and affordability still, as I said in my comments, still very favorable.

Okay, that's helpful, Jeff. And then, you know, maybe one other one. I think you mentioned that your land purchases are pretty consistent with recent history at sort of one to two years supply per community. One of the things that we've heard from folks in the field is that other builders may not be being quite as disciplined and are buying lots in greater size and paying up quite a bit for some of these lots. Are you seeing any of this kind of land grab in any of the markets that you're competing in?

Well, we are seeing larger purchases occur, and somebody wants to do that, and that's their strategy. Hopefully it works out for them. We like our approach. We like to be in the community, make your money being a home builder, turn the asset, move on. And we think over time that's part of why our return on equity is increasing so well. where we're now up north of 18, and we call it returns-focused growth. And if you can keep turning your assets, generate your profits, generate your cash, move on to the next one like we've effectively done, you can get to very nice returns along the way. And we think our approach is the right one.

Our next question comes from the line of Michael Rehart with JPMorgan. Please, start with your question.

Thanks. Good afternoon, everyone. Just a couple of questions here, maybe more clarifications. You know, on the guidance, I was just curious on the raising of the revenues, which is obviously encouraging, given some of the timing issues in first quarter, second quarter. But at the same time, it sounded interesting that you did not lower SG&A, which typically, you know, LLC would have some operating leverage against that higher revenue rate. So any comments around that would be helpful.

Right. The leverage impact on the $150 million raise is not terribly significant. We are trying to prepare the company and moving the company to a larger scale. So we're pushing that pretty hard. And, you know, as we're scaling up the business, we're trying to scale up the resources at the same time. So you're seeing a little bit of SG&A dollar build as you go through the year. We also have a lot of new communities opening. As Jeff mentioned, we're looking to open about 150 communities this year, that's about 50% up on what we've seen last year. And in fact, over the last two or three years, it's a pretty large step up and you end up, you know, you put in a little more expense up front on that. But we're seeing pretty nice leverage. We're going to see a nice step down in SG&A second quarter as compared to second quarter of last year. And, you know, for the full year, we'll see some progress on the SG&A side as well. So, We're pleased with that, and, you know, it's driving a very strong operating margin for us as well as we go through the year. We'll continue to look for opportunities and continue to cost-contain on the SG&A side, but first and foremost for us is to get this operating model scaled up, and we'll continue to investigate it scaled up, and we're seeing a lot of success, obviously, on the order side. And the construction side now with our starts, you know, basically matching our our sales page, so we want to continue to support it with company resources as we move forward.

That's great, Jeff. Thank you for that. Secondly, I just wanted to zero in a little bit on current demand trends, and I know obviously been discussed a lot so far this call um and you know noted you've noted that you basically haven't seen much of an impact or any of an impact from rates so far demand trends remain strong um so you know are we to take that that you know look you did um that 6.4 orders per month um per community in the first quarter. Should we be expecting something similar or even slightly stronger as you typically, you know, get some improvement as you go through the spring selling season? Is that a fair expectation? And, again, obviously you're trying to match sales pace with starts. So maybe, you know, the answer is, you know, we're seeing a capacity limit on starts and expect a similar sales pace, but just trying to get a sense for how we should think about 2Q on that regard, because again, you've said demand does remain strong. You are looking to maintain this starts pace. So, you know, just trying to, I mean, logic would say perhaps that you would be able to hit a similar sales pace, if not a little bit stronger, just given the general seasonal improvement.

Michael, there's a couple of things to qualify that. If market conditions remain as they are today, we'll continue to be opportunistic and, frankly, take pace and price like we did in the first quarter. If you think of our business model and our stated blended absorptions five a month and the spring is the stronger time of year, so the average five a month for a year, you're going to be six, six and a half in our second quarter. So I think it's fair to assume similar absorptions to what we saw in Q1. And at that level, we hit the starts everywhere and we're in a nice balance and a a nice rhythm to deliver on the year and set up a growth for 22. I think that's a reasonable assumption.

And our final question comes from the line of Mike Dahl with RBC Capital Markets. Please proceed with your question.

Thanks for squeezing me in and I appreciate the color so far. I guess, Jeff, just a quick follow-up on that. I wanted to ask about just how the kind of phasing of bot releases plays into the pace, and maybe if you could give any quantification around what percentage of your communities you've shifted to a phased release model and anything around kind of what those phases or timing of those phases actually look like compared to, say, three or six months ago if they're either shorter or longer periods in between when you release the next set of laws.

Matt, you want to take that? Sure. As we look at our business, we think about each community and how we underwrote that deal and what was that pace that we used to underwrite it. We will toggle as we move forward and occasionally tap the brake, so to speak, and restrict some of the releases within a given week. But it does vary by community, and it's fluid, and I don't mean to be vague, because in some cases we will elect to continue to run it at an accelerated pace if we secured an additional community that could be in the same sub-market. If that community is progressing and is going to be in place, we will take that current community and run it at a slightly accelerated pace. So, it is a weekly community by community type analysis and review that I do with all of our division presidents in trying to meter it out, but also make sure that we're positioning ourselves for growth as we're moving through the year. Mike, I don't know if that hit what you were looking for. If not, feel free to, you know, clarification question.

Oh, that helps, Matt. Thank you. My second question, you know, I know you guys have spoken numerous times throughout the call around kind of your on the cost side and price-cost side and matching price with cost, so clearly exceeding cost with your pricing based on the margin guide. I was wondering if I could get a little more color on your overall ASP expected to be up 5% for the year. Clearly, there's some mixed impact there. Any quantification that you could provide on what your underlying price-per-square-foot trend is would be doing or any other way that you would kind of normalize that and help us understand a bit better what kind of the true core pricing power is? Sure.

Yeah, the number one driver on the cost side has been lumber, as we all know. You know, when you look outside of that and across all the other commodity categories, there's been ups and downs, including labor costs, but it really hasn't moved the needle much. So, you know, the whole game, the whole story on on costs has been on lumber, and it's a commodity, and it's a market where there's future pricing and everything else, and they're expected to come down as we go through the year, but who knows? What I can tell you is when you look at our forecast, we're fairly consistent. in our total cost percentage of ASP relative to the quarterly cadence as we go through the year, Q1 through Q4. So it's about matching on a percentage basis what you're seeing on the selling price side of what we're currently forecasting. But just caution, a lot of variability on the lumber. I think at a point in time, this whole lumber issue is going to become more of a tailwind for the industry and for everyone then than what we've seen. I think there is a limit to how high it can go. I'm not sure what that limit is just yet. I'm not sure the timing of it, but I do believe that's going to come back into a range we're more accustomed to, and I think there's going to actually be some upside coming off of that. But for now, it's been satisfying, and we're very excited thankful that we've been able to manage the costs as well as we have given the big pressures on lumber and continuing to keep the construction machine going and the costs in a fairly, I'd say a good state of control given the margin expansion that we're seeing and being able to take advantage of what we're seeing in the market and offsetting the cost inflation. I'm not overly concerned at this point. In fact, we've been confident enough and and thought about the year favorably enough to lift the margin guidance as we go. So we're actually even feeling a little bit better about profitability than we were three months ago.

And with that, this concludes today's question and answer session, as well as today's conference call. You may now disconnect your lines at this time. Thank you for your participation, and have a wonderful day.