KB Home

My name is Alex, and I will be your conference operator today. I would like to welcome everyone to the KB Home 2021 Second 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, kbhome.com, through July 23rd. Now, I would like to turn the call over to Joe Peters, Senior Vice President, Investor Relations. Jill, you may begin.

Thank you, Alex. Good afternoon, everyone, and thank you for joining us today to review our results for the second 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. 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. Before I turn the call over to Jeff, I will note that year-over-year comparisons should be considered in the context that our performance in the 2020 second quarter was significantly and negatively affected by the broad economic downturn and the extensive public safety measures put in place across the country beginning in March due to the COVID-19 pandemic. And with that, here is Jeff Mesker.

Thank you, Jill, and good afternoon. We delivered healthy results in the second quarter, marked by one of the strongest quarters for both operating and gross margin performance in some time. Operationally, our divisions are doing an excellent job of navigating this environment of demand strength and well-publicized supply chain constraints as we effectively balance pace, price, and starts to optimize our assets and manage our production. With our full year coming into better view, we are poised for continued returns-focused growth, expanding our scale to about $6 billion in revenues and generating a return on equity of roughly 20%. As for the details of the quarter, we produced total revenues of $1.44 billion and diluted earnings per share of $1.50. We achieved an operating income margin of 11.3%, driven by several factors. In addition to strong market conditions, we are benefiting from solid performance in our newer communities, operating leverage from both the increase in our community absorption rate as well as overall higher revenues, discipline management of our SG&A costs, and the ongoing tailwind from lower interest amortization. Our profitability per unit grew meaningfully on a sequential basis to nearly $47,000. We achieved or surpassed our expectations across our financial metrics, although deliveries were at the low end of our range, as some of our deliveries shifted into the third quarter due to supply shortages and municipal delays. That said, with the benefit of local scale in most of our divisions, we are relying on our longstanding relationships with subcontractors and trade partners to mitigate delays. With the progression of our work in process and our success in accelerating starts, we are confident in our ability to achieve full-year deliveries of between 14,000 and 14,500 homes. Our balance sheet is solid. Having worked through the bulk of our inactive assets, our inventory has rotated into a higher quality portfolio of communities. We've grown our equity while reducing our debt, resulting in a significantly lower leverage ratio, which we expect will decline further by year end. We recently completed a $390 million debt offering, the net proceeds from which, together with a portion of our existing cash, will be used to retire our 21 maturity in full. Ultimately, the offering will contribute to a reduction of our debt levels and lower our average borrowing rate, providing an ongoing tailwind to our future margins. We continue to allocate the substantial cash we are generating in a consistent manner, prioritizing our future growth to drive greater earnings and returns. In addition, our balanced approach includes returning cash to stockholders, primarily through our quarterly dividend, which we have raised in each of the past two years, and reducing our debt, as I just mentioned. In the second quarter, we invested $575 million in land acquisition and development, expanding our lot position sequentially by 7,800 lots to roughly 77,500 lots owned or controlled, with 45% of the total optioned. This growth in active inventory together with improving margins, should help to drive further improvement in our return on equity. As we discussed last quarter, we are assuming a lower monthly absorption in our underwriting as compared to our current pace, and no inflation either in ASP or costs. In addition, we are pursuing moderately sized deals in our preferred sub-markets, averaging between 100 and 150 lots, and staying on strategy in positioning these new communities to be attainable near the median household income for that submarket. We believe using this disciplined approach helps to manage our risk as we acquire land throughout a cycle. While we expect our near-term growth to come primarily from our existing markets, as we work to gain market share and expand our scale, we're also selectively entering new markets, Along with our success in Seattle and recent reentry into Charlotte, we're announcing today that we have started up a division in Boise, Idaho, a top 25 housing market. We see a meaningful opportunity in this fast-growing metro area to offer our personalized homes at affordable prices, and we're excited about extending our market strategy to Boise. We now have over 900 lots under control, and anticipate our first land parcel closing in the third quarter. We successfully opened 33 new communities in the second quarter. However, as a result of the heightened demand for our homes, we sold out of more communities than we had projected and also experienced slippage in some community openings. Jeff will provide more detail on our community count expectations for this year in a moment. Looking forward to 2022, with our strong lot pipeline, we remain on track for double-digit, year-over-year community count growth. As we prepare for the significant acceleration of new community openings over the next six quarters, we have also stayed focused on building our backlog to drive our revenues for the balance of this year and into 2022. Our monthly absorption rate rose to seven net orders per community during the second quarter, even as we manage sales primarily through price increases and secondarily through lot releases in order to balance pace, price, and starts. We're sensitive to affordability as we work to stay within appropriate range near the median household income of each sub-market. Our order ASP has climbed in the past three months reflecting a combination of mix as well as rising prices. Our largest sequential net order increase was in our West Coast region. Although this region carries our highest average selling price, it remains competitive with resales within our submarkets. Our Los Angeles Ventura business provides a good example. This division generated the strongest sequential order growth in the second quarter, And although it operates at a higher ASP, it is still below the median resale price of homes in its sub-markets, which are as much as $100,000 higher and selling within a few weeks of being listed. Resale prices have moved significantly, and our relative position has actually been enhanced. As to lot releases, our approach is similar to how we gauge interest in a new community. Homebuyers complete an application, and go through their initial credit process to join a list of qualified buyers. We then work through that list as we release lots. We are typically raising prices in conjunction with each lot release and have not seen a decrease in the conversion of qualified buyers, even as base prices have risen. Our teams work hard to earn our place as the number one customer-ranked national home builder, and third-party customer satisfaction surveys by prioritizing service and the relationships we have with our buyers, and we're focused on continuing to do so during this time of limited supply. The metrics that we monitor internally for shifts in affordability are stable. Buyers are not adjusting the size of the homes they are purchasing to stay in the market. Although we offer floor plans below 1,600 square feet in over 75% of our communities, buyers are still selecting homes averaging 2,100 feet, which is consistent with their choices over the past couple of years. As is evident in our results, the desire for homeownership is strong, and we believe will remain so for the foreseeable future. There are two primary factors informing our view. The first is an acute shortage of supply stemming not only from limited resale inventory, but also from the underproduction of new homes over the past 15 years. This deficit will take many years to correct, and until inventory reverts to more normalized levels, the imbalance between supply and demand should continue to support new home sales. Another key factor is demographics. The size of the millennial population and the pent-up demand from this cohort, together with the Gen Zs now reaching their home buying years, form a large and healthy pool of prospective buyers. These demographic groups value personalization, and we believe we are well positioned to capture increases in home sales given our expertise in serving the first-time buyer, which represented 64% of our deliveries this past quarter with our bill-to-order approach. Net orders were 4,300, our best second quarter since 2007, with strength throughout the quarter, resulting in year-over-year growth of 145%. This comparison narrowed at the end of May when we experienced a significant acceleration in order rates that has lasted for the past year. We are matching starts to sales, and in the first half of this year, we have quickly scaled up our production to start over 8,500 homes. To put this in context, the homes we started in the past two quarters represent about 75% of the total homes we started for the full year 2020. Almost 95% of the homes in production are already sold, We remain committed to our bill-to-order business model. We value the visibility that our even flow production provides and the flexibility that it affords in positioning our communities to move with demand. Offering a personalized home creates meaningful differentiation for our company, which we view as an advantage because buyers value choice. Nearly 80% of our orders in the second quarter were for personalized homes, which also creates an additional revenue stream from our design studios and with lot premiums. Our studio revenue per unit rose sequentially in the second quarter and is continuing to average about 9% of our higher base prices. We continually monitor the frequency of studio selections and have been raising prices on some products enhancing an already accretive studio margin. As to lot premiums, we have found over time that if buyers can pick the home they want and build that home on a lot they choose, they're willing to pay for that choice, and we can generate additional revenue. Every incremental dollar of lot premium is an additional dollar of margin. Between studio revenue and lot premiums, we're averaging about $40,000 per home today, and believe there is opportunity to continue to grow this going forward. We ended the quarter with a robust backlog value of $4.3 billion, up 126% year-over-year, representing over 10,000 homes. As I referenced earlier, our backlog supports the higher revenues we anticipate this year and sets the stage for another year of revenue growth in 2022. KBHS Home Loans, our mortgage joint venture, continues to be a solid partner for our customers, handling the financing for 75% of the homes we delivered in the second quarter. These buyers have a strong and consistent credit profile with an average down payment of about 13% or over $50,000 and an average FICO score that inched up to 727. the majority of our buyers are opting for conventional loans similar to the past few years. Pitching gears, we published our 14th annual sustainability report in April, the longest running report in our industry. We've been on this journey for over 15 years, and the commitment we have made to sustainable home building has resulted in KB Home being the industry leader in energy efficiency. We have built over 150,000 Energy Star certified homes to date, more than any other builder, and have the lowest published average home energy rating system, or HERS, index score among production home builders. And we're striving to be even better with an aggressive goal to further improve our average HERS score from 50 down to 45 by 2025, a level which translates into an additional estimated reduction in a KB home's carbon emissions of about 8% per year. In closing, we are poised for an incredible year of expansion in revenues, margins, and return on equity as we execute on our ongoing plan to increase our scale while driving a higher ROE. Equally as important, we are positioned for a strong start to 2022 with the expected increase in our year-end backlog and projected community calendar growth next year. We are pleased with how this year has unfolded and look forward to updating you on our continued progress. I'm appreciative of the hard work and commitment of the entire KD Home team, and I want to thank them for their efforts as we navigated through the challenges brought about by the pandemic while never wavering from delivering high levels of customer satisfaction throughout this past year. With that, I'll now turn the call over to Jeff for the financial review.

Thank you, Jeff, and good afternoon, everyone. I will now cover highlights of our financial performance for the 2021 second quarter and provide our current outlook for the third quarter and full year. During the quarter, we generated improvements in all our key profitability measures and continued to enhance our balance sheet strength and liquidity. With our operations performing well, we leveraged 58% growth in housing revenues to generate a 216% increase in operating income for the quarter. In addition, our net orders reached their highest second quarter level in 14 years. Based on our robust financial results and net order performance, we are once again raising our outlook for the remainder of 2021. Our housing revenues of $1.44 billion for the quarter increased from $910 million in the prior year period, reflecting a 40% increase in homes delivered and a 13% increase in overall average selling price. Considering our current backlog and construction cycle times, We anticipate our 2021 third quarter housing revenues will be in the range of $1.5 to $1.58 billion. For the full year, we are projecting housing revenues in the range of $5.9 to $6.1 billion. We believe we are very well positioned to achieve this top line performance due to our strong second quarter net orders and ending backlog of over 10,000 homes representing nearly $4.3 billion in ending backlog value. In the second quarter, our overall average selling price of homes delivered increased to nearly $410,000, reflecting strong housing market conditions, which enabled us to raise prices in the vast majority of our communities, as well as product and geographic mix shifts of homes delivered. For the 2021 third quarter, we are projecting an overall average selling price of $420,000. We believe our ASP for the full year will be in the range of $415,000 to $425,000. Home building operating income significantly improved to $162.9 million as compared to $51.6 million in the year earlier quarter, reflecting an increase of 560 basis points in operating income margin to 11.3% due to meaningful improvements in both our housing gross profit margin and SG&A expense ratio. Excluding inventory-related charges of $0.5 million in the current quarter and $4.4 million of inventory-related charges and $6.7 million of severance charges in the year earlier quarter, This metric improved to 11.4% from 6.9%. We expect our home building operating income margin, excluding the impact of any inventory-related charges, to further improve to a range of 11.7% to 12.1% for the 2021 third quarter. For the full year, we expect our operating margin, excluding any inventory-related charges, to be in the range of 11.5 to 12.0%. Our housing gross profit margin for the second quarter expanded to 21.4%, up 320 basis points from the prior year period. The current quarter metric reflected the favorable pricing environment over the past several quarters, when most of the orders relating to the second quarter deliveries were booked, increased operating leverage due to higher housing revenues, and lower amortization of previously capitalized interest. Excluding inventory-related charges, our gross margin for the quarter increased to 21.5% from 18.7% for the prior year period. Our adjusted housing gross profit margin which excludes inventory-related charges as well as the amortization of previously capitalized interest, was 24.2% for the 2021 second quarter compared to 21.9% for the same 2020 period. Our continued gross margin improvement trend demonstrates that we have been successful in offsetting input cost inflation with selling price increases. In addition, with our strategy of locking in material and labor costs at the time each home starts, we have largely mitigated the impact of cost inflation during the construction process. Assuming no inventory related charges, we expect a sequential increase in our 2021 third quarter housing growth profit margin to approximately 21.7% and further improvement in the fourth quarter. Considering this expected favorable trend, we believe our four-year housing gross profit margin, excluding inventory-related charges, will be within the range of 21.5 to 22.0%, representing a 215 basis point year-over-year increase at the midpoint. Our selling general administrative expense ratio of 10.1% for the quarter improved from 12.6% for the 2020 second quarter. The 250 basis plan improvement reflected the continued benefit of overhead cost reductions implemented last year in the early stages of the pandemic, increased operating leverage from higher revenues, and the severance charges in the year earlier quarter. Considering anticipated increases in future revenues and our continuing actions to contain costs, we believe that our 2021 third quarter SG&A expense ratio will be approximately 9.8%, and our full-year ratio will be in a range of 9.8 to 10.2%. Our income tax expense for the quarter of $30.3 million, which represented an effective tax rate of 17%, reflected the favorable impact of $14.8 million of federal energy tax credits recorded in the quarter relating to qualifying energy-efficient homes. We expect our effective tax rate for the full year to be approximately 20%, including the expected favorable impact of additional federal energy tax credits in the third and fourth quarters. Overall, we produced net income for the second quarter of $143.4 million, or $1.50 per diluted share, compared to $52 million, or $0.55 per diluted share for the prior year period. Turning now to community count, our second quarter average of 205 communities decreased 17% from the year earlier quarter. We ended the quarter with 200 communities as compared to 244 communities at the end of the 2020 second quarter. On a sequential basis, our average community count decreased 8% from the first quarter and ending community count was down 4%. The decreases were due to our strong absorption pace of seven monthly net orders per community during the quarter, which drove 42 closeouts, as well as community openings that were delayed to the third quarter. Over the past 12 months, our robust absorption pace has driven the closeout of over 150 selling communities. Although they will not generate additional net orders, we will continue to produce revenues and profit in future quarters associated with nearly 80% of these sold-out communities as we work through the construction and delivery of the sold homes. The upside from our strong pace of orders is now reflected in our backlog, which will drive increased future housing revenues. Our expectation of continued strong net order activity will drive elevated levels of community closeouts in the second half of this year. Our goal is to offset the impact of these closeouts by opening a higher number of new communities in both the third and fourth quarters to achieve sequential growth. We anticipate our 2021 third quarter ending community count will increase sequentially by approximately 5%, followed by another modest sequential improvement in the fourth quarter. With our significant year-over-year increase in lot supply and our focus on developing and opening new communities as quickly as possible over the next six quarters, we believe we can achieve sequential increases in our quarter and community count over that period. We remain committed to our target of double-digit year-over-year growth and community count for 2022. Available operating cash flow in the quarter generated primarily from homes delivered met of higher levels of land investment resulted in quarter and total liquidity of approximately $1.4 billion, including $608 million of cash and $788 million available under our unsecured revolving credit facility. Earlier this month, we completed the $390 million issuance of 4% 10-year senior notes and used a portion of the proceeds to redeem approximately $270 million of tendered 7% notes that mature on December 15, 2021. We expect to realize the charge of approximately $5 million for this early extinguishment of debt in the third quarter. It is our intention to redeem the remaining $180 million of the 7% notes at par value on September 15th. Once completed, this redemption, partially offset by the new issuance, will result in a net $60 million reduction in debt and an annualized interest savings of nearly $16 million, contributing to our continuing trend of lowering the interest amortization included in future housing gross profit margins. In addition, we believe the $350 million maturity in 2022 of 7.5% senior notes represents another opportunity to reduce incurred interest and enhance future gross margins. In summary, given the size and composition of our quarter and backlog of over 10,000 homes, along with our expanded production capacity, We expect further improvement in our financial results and return metrics in 2021 as compared to our expectations at the time of our last earnings call. Using the midpoints of our new guidance ranges, we now expect a 45% year-over-year increase in housing revenues and further expansion in our operating margin to 11.75%. This profitability level should drive a return on average equity of approximately 20% for the full year. We believe our emphasis on return-focused growth will continue to drive improved financial results, increased scale, and higher returns to further enhance long-term stockholder value. We will now take your questions. Alex, please open the line.

Thank you. At this time, we will be conducting a question and answer session. If you'd 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'd 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. Please limit to one question and one follow-up question. Our first question comes from the line of Matthew Boulet with Barclays. Please proceed with your question.

Hey, good afternoon. Congrats on the results. Thanks for taking the questions. First one on the pricing relative to resale on a market level. Jeff, you gave some great color there on the L.A. Ventura market. Curious if you could expand a little bit on that point, you know, because I think it is an important point. Perhaps you could maybe walk around some of your markets. Just any other interesting anecdotes or quantification on how, you know, your product is comparing versus resale in this market? clearly an environment where resale prices continue to move much higher.

Thank you. Sure. Thanks for the question and the comments, Matt. It's a different story in every submarket, as you know, around the country. But the pricing on resale homes in most of the submarkets we're in is moving pretty dramatically, primarily because there's no inventory on the resale side either. And A lot of the headline coverage of home building has been talking about how much our prices have moved, and they ignore how the resale pricing, which is our biggest competitor, is moving as fast, if not faster. And we're sensitive to affordability, as I shared in my comments, and we're also always mindful of how are we positioned versus the resale market situation. Whatever our prices are up in the submarkets we operate in, the resales are up a similar level, if not higher. And in many cases, we're actually enhancing our position. So a specific city doesn't come to mind. I can tell you in general, every city we operate in, resale pricing is moving as quickly, if not quicker, than the new home side where builders are mindful of, of affordability, and while we're opportunistic, we may not be as opportunistic as resales because we're mindful of that.

No, wonderful. That's really great color there. Second one, you know, obviously in an environment of production constraints, you talked about, I believe you said 8,500 starts year to date. And correct me if I'm wrong, but if that equates to roughly six to seven starts per month per community, should we think of that as kind of your ongoing production capacity? And therefore, could you continue to sell at that pace if demand is there? As you mentioned, seven selling pace this past quarter. Or conversely, should we think of some more normal seasonality in in general, to demand perhaps rearing its head again this year.

Thank you. Matt, it's an interesting topic, and you've followed us for a while. If you go back over the evolution of the past few years in our business, we worked hard to lift our margins and get our margins back up to normalized levels, and we've now done that. There were years when we put a cap on how many we would sell and opted for just margins. until we could get our margins up. And when we did that, our construction machine had the capability to build more houses, but we were pushing on the price and the margin pedal a little harder. Over the last year, obviously, incredible demand and a strong selling environment, and we've been letting out the string, if you will. on sales because our margins are strong and improving and we have the capability to build more. So I thought it was important to communicate in my comments that we're not selling out ahead of starts. We're selling and starting at a comparable level around the system. My hunch is that everybody will have a different crystal ball. It wouldn't surprise me if sales slow a little bit through the summer. I think we slowly revert back to a normal home sales environment. I don't know what we'll do each month of the third quarter, but we don't need to do seven to hit our growth targets. But if we're in a community where the market's strong and we have the ability to to start that many homes a month and we're lifting our margins, we would take advantage of the opportunity. So to wrap that up, we may not sell at seven in this quarter. We'll see how the market conditions are and how things operate, but we have the capability to build at that level. And, again, I thought it was important to make sure the investor world understands that our construction machine has more capacity than we had demonstrated in the last few years.

Thank you. Our next question comes from Stephen King with Evercore ISI. Please proceed with your question.

Yeah, thanks a lot, guys. You said that you were – I think you said you ramped your production to be about 18.5, which I guess is basically what you started this quarter times four. and you said that you're basically starting in line with your sales base. So I just want to make sure that I'm clear on that. It suggests that you're not trying to in any way change the point at which you sell the home to be later in the construction cycle at all. You're very happy where it is. So roughly, where is that level right now? At what point, relative to the starts, would you say that you are selling your homes?

Yeah, good question, Stephen. The cycle time, as we call it, we're averaging today 45 to 60 days from contract to start, and five months, a little over five months, depending on the city, for the build time. So it's a seven to seven and a half month cycle from contract to close. We continue to really prioritize, sell it, get the loan approved, let the buyer pick everything at the studio, and then start the home. And that's our business model. And I believe over the long run, that will prove out to be the best returns, the lowest risk. You can take the argument that, well, you can sell it more down the road if you hold off on releasing it, but we'd rather have certainty of close, visibility of margin, and keep the balance to our business. So we're continuing to sell them and then start them, and every city's got a different strategy on how far out you sell to set up your pipeline and your construction whip in that city.

Great. Yeah, that's really helpful. So just so I'm clear, you're definitely taking a strategy where you do not want to follow some other players in the market who are deliberately selling homes later in the construction process. feeling that while you may theoretically be underpricing the market near term, but longer term the risk-reward favors a consistent strategy. I just want to make sure that that's actually, you know, that I'm saying that properly.

Yeah, that is our view, Stephen. I'd rather know when we start the home. We know what the margin is. When we start the home, our costs are locked. So you have a little risk there. between the contract and the start is something weird happens on your cost structure. And you may give up a point or two of price versus down the road, but you're also not exposed to that nasty incentives word if you get the home completed and it hasn't sold. And we've seen that movie. So we like knowing when we start the home, it's going to close. And we know what the margin is, and it's predictable for our contractor base, and it helps us in our forecasting.

Thank you. Our next question comes from Truman Patterson with Wolf Research. Please proceed with your question.

Hey, good afternoon, everyone. I just wanted to touch on, you know, some affordability, very strong margins, strong pricing. You know, it looks like as of the fourth quarter, you're getting more than enough pricing to cover all the spot costs today. And lumber's come back in, or at least lumber futures have come back in. You know, if inflation levels off in the back part of the year as you're attempting to bring on more communities, how should we think about pricing? Are you all going to step off the gas a little bit to try and maintain affordability? Or, you know, is it truly just kind of pricing the market without really concern for potentially rising interest rates?

Yeah. When a community is open, Truman, we'll price it to the opportunity. Before we open a community, we create interest lists. We call them an intent. We can figure out where demand is and where the price can be, and if it's above your pro forma, you'll take the higher price and you'll run. And so we're opportunistic once we're open in that sub-market. When it comes to the investment in the new community in a sub-market, we're very mindful of of affordability and household incomes and needs to be attainable. And we can move around with lot size or the size of the homes that we offer in a model park to get close to that median income. And then if you open up and demand is stronger, you take advantage of the opportunity. So it's per community, and it's pricing to market, not necessarily to cost. So if we can be opportunistic, we'll take it.

Okay, thanks for that. And then I don't know if there's any way you can help us out with this to quantify how deep the buyer pool is. I know you all have interest lists or weight lists. Have you seen those change at all compared to maybe a few months ago? Are you seeing any buyer pushback or fatigue from recent price increases? Just trying to understand how deep that buyer pool is.

I shared in the comments, Truman, the markets are very strong today. And we may spend two to three months developing an interest list before we grand open a community. And if in that two or three month period you can get hundreds of people on a waiting list and the early entry to the waiting list then are going to see the prices move more than the later entries on the waiting list. And we've had some cases where somebody's pre-qualified and okay, we open for sale and they don't like the price and they say, nevermind, I don't want it. But there's many people behind them saying, I'll take it. Let's write it up today as the prices have increased. But I shared in my comments as we're releasing lots for sale today at the higher prices per phase release, we're not seeing a tapering in demand. It may be off a little bit from the, the strength it was in March, but in March it was really, really strong, and now it's just really, really strong. It's a very good market environment out there today.

Thank you. Our next question is from Alan Ratner with Zellman & Associates. Please proceed with your question.

Hey, guys. Good afternoon. Thanks for taking my questions. Thanks. Jeff, first question, I just want to clarify. So I think you made a comment earlier on that from the time you start the house, you have kind of certainty of costs. And then you said afterwards that your typical timeline is about 45 to 60 days from contract to start. So Am I thinking about that right where in that call it 60-day window, if there are cost increases like that, that's the variability on your margin? And I guess the follow-up to that is, you know, I'm hearing some builders are starting to build in some, like, cost escalator clauses into sales contracts in case costs do go up a lot. So I'm curious if you're doing that to protect yourself against any cost pressures in that window.

We're not putting the escalators in the contracts with the customer. Our divisions do factor in contingencies in their budgets and all that when we're pricing the product so we can absorb, I'll say, some of the cost. I mean, the lumber run-up was much stronger and quicker than anybody anticipated. Now it's coming back down. But in our larger businesses with scale that are good at going from contract to start, we didn't see much, if any, margin erosion from that. contract to start in that 45- to 60-day window. In a smaller business where we may not have the scale, you're a little more exposed. But as Jeff just shared in our guidance, we've been able to not only cover that cost but increase our pricing more than the cost where we expect over the second half of the year to continue to expand margin from what we just reported. So it's in a pretty good place right now.

Okay. That's helpful. Yeah, I just wanted to understand the timeline there. Second question, you guys have been entering a handful of new markets lately, and I think you mentioned Boise on the call today, and Boise has been a fascinating market. It's probably one of the hottest, if not the hottest in the country, at least in terms of price appreciation. So I'm curious, as you enter these markets and maybe pick on Boise specifically specifically, How long have you been looking at that market, and how do you get comfortable with kind of starting to buy land in a market that has seen the type of run-up in home prices, and I'm assuming land prices as well, over the last 12 months or so?

Good question, Alan. I'd compare it to Seattle. If you look at what we did in Seattle, everybody said Seattle's very land-constrained. You can't get scale, and it's very expensive. And we have a very good team up there. that are very seasoned in the Seattle land market with a lot of connections. And we were able to introduce product that was priced well below where the new homes were offered, competitive with resale, and we quickly grew a market share through our ability to penetrate the market in that approach. So we're well below the median new home price in Seattle today and running very strong margins. And as we look at Boise, The person that we've had there pursuing the land activity is a seasoned veteran in the market, been there a long time, and we're doing the same thing. We're targeting affordability and approaching it a little bit different than a lot of local builders who have moved upscale in their footage and moved up in their pricing and are chasing price. We're coming in underneath. So we think it's a good time and a a real good opportunity for our business model to go into Boise where nobody really operates that way today.

Thank you. Our next question comes from Deepa Raghavan with Wells Fargo. Please proceed with your question.

Hi, good evening, everyone. Thanks for taking my question. Jeff, can you comment on how much of your delivery was pushed out to Q3? You mentioned the timing issue there. You also mentioned you also called out some municipal delays and supply chain. Could you elaborate on that as well?

Sure. As far as deliveries, it was less than 100. I don't know that we have the exact number, but somewhere in that range. I would say that, quote, we took the bullet in the second quarter for a lot of things that went on where our build times extended a little bit. And we've now adapted to that and adjusted in how we're looking at things. And that's why we, based on how our WIP is today and how we're projecting out our completions, we're confident in the delivery numbers that we shared. And talk about municipal delays. We're seeing issues as the cities ramp back up. where inspectors don't show up to do final inspections for many days from when they were supposed to, or we're seeing some cities where utility companies are seeing a lot of delays in setting meters or showing up to put in the undergrounds, and we throw the utility companies in with the municipal delays. So a crude analogy is like whack-a-mole. in the cities we operate in, every city has a little different menu of things that are coming up, whether it's the lumber drop didn't show up the day it was supposed to, or the insulation didn't show up, or the inspector didn't show up, or we can't get garage doors today. And it's all those things you have to manage through and navigate when you're in a building supply-constrained environment. And we have good teams out there, and we think we've adapted and adjusted, and that's why we're still confident with the numbers we gave for you.

Okay, got it. Did that increase your cycle time versus, you know, a few months ago, or is that still similar? It's just a problem than you are because you took that back in the old example.

Different problems and added a few days to our build time. Nothing dramatic, just a few days here, a week over there in this city. But, you know, if you lose three days, it's more than 100 units at our scale. So you have to keep working to compress your build times.

Thank you. Our next question comes from Susan McClary with Goldman Sachs. Please proceed with your question. Thank you.

My first question is, you know, you mentioned in your comments that your studio options and your lot premiums are adding about $45,000 per home. Can you give us some sense of how that compares historically where that's been? And, you know, you mentioned that there is upside to that over time. Can you talk to how you think about where that can get to and the benefit that that can drive in margins over time?

Good question, Susan. The way we separate the two, and if you go to the studio, the primary focus for us in the studio is to help sell houses and give people choice and allow them to personalize. So that's job one. Job two, along the way, you can make additional profit and keep finding ways to make more money in the studio. And what I wanted to make sure that in the comments what was heard, and you heard it, While our base pricing has gone up, the percent of base out of the studio is held steady. So if a year ago our ASP was 370 or 80, and it was 9% of base, and now we're 420, it's still 9% of base. So buyers are spending more in the studio, and it's a combination of what they're selecting and also with our frequencies, we can gauge what's the strongest interest for the buyer. And if it's something that they can't go shop at Home Depot because it's custom for that floor plan, we can get a higher margin there. And that's what we're looking at now, to mine more margin, which is resulting in a little more studio revenue. So I would expect that over time, if our base pricing continues to go up, that we'll still find ways to keep the studio at about 9% of base. So it's an increment. On the lot premium side, our company goal right now is 2.5% of base. I'm having trouble hearing you. My smartwatch loved that comment. And it's having trouble hearing me, by the way. So in the lot premiums, we targeted 2.5% of base. And, you know, we've ranged in some years we've been as low as one and a quarter, one and a half, and then there's years we've done two and a half. We're not at two and a half today, so we think we can at the least get to our state of goal, and that's what we're working on. So both of them are driving additional margin opportunity in the future for us.

Yes. Okay. All right. And then, you know, obviously you've seen some delays in bringing some of these communities online. I know you mentioned that you still expect to grow your community count double digit next year. But as we think about, you know, the puts and the takes that are coming, I expect that there's actually maybe some upside to that 10% target that you've given us for 2022. How should we think about that?

We certainly have. the lots and the communities in the queue to create upside from that. We committed to exceed 10%. So there could be upside if all goes well. It's such a difficult number to guide because how quickly you sell out changes depending on the city and the price points and what's going on there. And the delays... In the second quarter, all those communities are opening in June for the most part. So we missed the community number, but it's by a couple of weeks. It's not, you know, and we guided to it and thought we were going to get there. So we did it to that and are back hard at it right now. And if you look at our business and our cadence, we can end the year. nice increase in our backlog. We have the backlog today to support. We're already selling into Q1 this year. Backlog to support the revenue guide that we gave and set us up for nice momentum into 22, and then the community account growth all will... I think we're set up to sustain nice revenue growth for 22.

Thank you. Our next question comes from... Jay, please proceed with your question.

Hi, this is Maggie on for Mike. Question, just a sense of how your sales pace trended sequentially. On an absolute basis, could you give us a month-to-month during the quarter and maybe any comments on what you've seen through the first three weeks?

I don't know that we have it by week or the trends through the month, Maggie, but we didn't see demand lighten up at all from March through May. And, you know, you've seen the demand is very good right now.

Got it. And one more question. For 3Q, you're expecting the gross margin of about 21.7. And to get to your full year, step up into 4Q. So could you give us any puts and takes there? I mean, is that primarily volume leverage, price-cost dynamics that you're foreseeing?

I think as far as the progression goes for the remainder of the year, it's just more a reflection of what we've been seeing in the markets as we've been selling into our third and fourth quarters. The third quarter represents probably the first quarter that we'll see the brunt of the lumber price increases hitting full quarter deliveries, and likewise in the fourth quarter. So that's a challenge that we have to overcome in order to continue that sequential increase. You know, we just had five consecutive quarters of increasing gross margins, and we just guided to two additional quarters of increasing gross margins, which if we achieve it, it makes seven in a row, which we're quite happy about and proud of. So, you know, everything's kind of going the right way for us. We're seeing expansion in our selling margins right now. We're seeing expanded margin contained within our backlog. As I mentioned, you know, we are seeing the additional cost pressure from the lumber price spike on those starts that will be generating the third and fourth quarter deliveries. But, you know, it will be overcome by other factors. We do expect to see continuing good news out of amortized interest. And we've seen that also continue at least for the past couple of years. And we think we have some runway ahead of us on that one. And a lot of favorable trends right now as far as the margin goes. And it just really supports our focus towards increasing our returns. And we think the two levers of increasing our scale and expanding our gross margin are the key items with that return expansion goal and target that we have. We think we're very well supported by that. We're very happy to increase our estimate for the current year up to around that 20% range for ROE, and expect to be able to continue to build on that. So margins, very, very important and very key for us, and we're seeing some excellent trends. Like I said, definitely expect to see them continue into the foreseeable future.

Thank you. Our next question comes from Mike Dahl with RBC Capital Markets. Please proceed with your question.

Thanks for taking my questions. I wanted to ask one more on the affordability side. Jeff, I think you mentioned early on that in your internal tracking, you're seeing stability in the affordability-based metrics or affordability-related metrics that you're looking at. I think you cited... square footage as one, but can you just elaborate a little bit more about, you know, what you're looking at internally and when you're referencing the stability there?

Well, in part, it's how deep the demand is, Mike, versus the supply that's out there. So if we have a 100-lock community and you have an interest list of 300 or 400 when you open it, there's way more demand than there is supply. And buyers are moving right along when we release lots and saying, I'll take that one at that price. And the buyer profile that we have, it's very interesting to me. You think of the high mix we have of first-time buyers at 64%, and our average borrower through our JV, which is 75% of our sales, a good good indication, they're putting $50,000 down. And the FICO scores actually went up in the quarter. The quality of the buyers today are strong, and we're not seeing any issues with qualifying payments right now versus income. It's a very strong buyer out there. We're not seeing any indication that affordability is stressed. If that does start to appear, then we'll quickly pivot to small product and move on some lot sizes and move with the demand like we've done in the past. But right now, the demand is way outpacing supply. Okay.

That's helpful. Thanks. My second question just relates to some of the new market entries and also, I guess, broader capital markets. you've now entered three major markets organically, which is kind of an interesting choice if you look at history of what public builders often do. And it coincides with the period where just given the dynamics in the land market, we would expect that some M&A activity would potentially pick up. Could you just talk about how you're evaluating the organic versus M&A decision when you're looking at these new markets, and is M&A a potential avenue for you as you look at additional ones?

Well, M&A is certainly an additional avenue, and as things come along, we do engage with people that want to sell their companies. The premium's not light, so you're you're absorbing a premium and then you have the integration risk. So we'll always look at those, but what we feel right now, we have a nice growth trajectory in our organic growth in our existing markets where we're nowhere near maxed out on where we can take our existing business. So we have the ability to bolt on these softer market entries at the same time and let them mature And, you know, just like our Seattle example where it took a couple years and then you have revenue and then you have real revenue and profits and it becomes a real driver in your company profitability. And that's how we look at Charlotte and Boise. We have the – with our current growth trajectory, we have the capacity to continue to grow and bring these markets along at a little slower pace, but you avoid any big premium. any integration issues, and it's typically a better quality entry. It just takes a couple years longer. But we'll also look at M&A. So we're not opposed to anything. We're continuing to look at ways to grow our top plant.

Thank you. Our next question comes from Alex Barron with Housing Research Center. Please proceed with your question.

Yeah, thanks, guys, and good job on the quarter. I was just kind of curious as far as, you know, the sharp price increases we've seen so far this year, especially this year to date, and how you guys are thinking about that, you know, particularly, like, do you have a measure on what percentage of your buyers are coming in from other states that might be driving these prices up the way they have?

I don't have it on the call, Alex. I don't know how much we really track that, what percentage of buyers come from California or New York or wherever they source from. I do think that's part of it. But I think the bigger driver right now of price is the strong demand in all the markets and no supply. It's the classic lack of supply, and I think it's going to take time to correct that. And you know, the California out migration that you hear so much about, I think is overstated. I think there's some of that, but there's been some of that for three, four decades. People have been moving to Arizona, Texas, Nevada, California, or moving to Florida from, from New York. I think it's more just core demand and a lot of it in, in all the cities that we operate in today.

Got it. And, um, What's your sense if the lumber costs start to go down and supply chain issues start to resolve themselves, is it your sense that pricing is going to stay up here and margins are going to expand, or is it your sense that somehow the prices are going to start to work their way back down? In other words, will builders pass along some of the cost savings when those start to happen?

I think we'll be taking it to margin. It'll depend on the competitiveness. landscape in each city. And when I say the competition is not just new, it's used homes. But our hope and expectation is we'll take it to margin.

Thank you. Our final question comes from Jay McCandless of Wedbush Securities. Please proceed with your question.

Thanks for taking my questions. The first one I had, with the land that you're out buying today, when do you anticipate that land will go into service? And maybe could you talk about what you're assuming for HPA as you move forward on land buying? Is HPA home price appreciation, Jack? Yes. We don't assume any appreciation on price. We take the view that it's got to work today, and if prices go up, costs probably went up with it, and you're not going to get more margin over time. That's typically how it happens. So we don't underwrite with, inflation, we own and control everything for 22 and a good chunk of 23, you know, 80, 85, 90% of 23 today. So the things that we're looking at probably are late 23, if not into 24. So there are ways out. So, you know, the things we're bringing to market today, we probably controlled two years ago for the most part. Okay, that's helpful. The other question I had just at the beginning of the prepared comments, Jeff, you talked about how KB is flexed up the starts and the ability to start more homes inside the company. But then can you relay that back to basically just raising the lower end of the guidance and not taking the guidance up further? I mean, was that comment to mean that you ramped up starts so you could maintain the pace you expected at the beginning of the year? I just want to figure out how those two comments relate with each other. Well, our bill times... A lot of the starts in May are probably kicking into even December delivery. So I think you'll continue to see an evolution of the benefits of our community absorptions flow through, not just coming out of the fourth quarter, but into the first quarter of next year and beyond. We've actually been raising the revenue guide each quarter, I believe. Yeah, the midpoint's up $100 million. Yeah. So we are lifting it as we go, Jen.

Ladies and gentlemen, this concludes today's teleconference. Thank you for your participation. You may now disconnect your lines. An all-time classic.

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