This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.
spk04: Good afternoon. My name is Alex, and I will be your conference operator today. I would like to welcome everyone to the KB Home 2021 third 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 October 22nd.
spk02: now i would like to turn the call over to jill 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 third quarter of fiscal 2021 on the call are jeff mesger chairman president and chief executive officer matt mandino and rob mcgidney executive vice presidents and co-chief operating officers Jeff Kaminski, 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 including those detailed in today's press release and in our 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, here's Jeff Mesger.
spk07: Thank you, Jill, and good afternoon. Our performance in the third quarter was reflected significant year-over-year increases across the majority of our key metrics as we produce solid results in a housing market experiencing great demand while also facing industry-wide challenges in getting homes completed and delivered. These results will help drive our returns-focused growth as we continue to expand our scale while generating a higher return on equity. Before I get into the highlights of the quarter, and there are many, I want to address our shortfall in deliveries and revenues. Disruptions to our supply chain intensified as the quarter progressed and along with municipal delays resulted in our build times extending by about two weeks sequentially. This pushed many deliveries into our fourth quarter and will similarly delay some fourth quarter deliveries into our 2022 first quarter. We are taking aggressive steps to manage through these delays, including expanding our subcontractor base, partnering with our national suppliers, and simplifying our products to stabilize our build times. We produced total revenues of $1.47 billion, up nearly 50% as compared to the prior year period, and diluted earnings per share of $1.60. We achieved an operating income margin of 12.1% excluding inventory-related charges, which grew 250 basis points year over year, driving a 40% expansion in our profitability per unit to nearly 52,000. This was accomplished even with the leverage we lost from the delayed deliveries. Our related gross margin of 22% was a particular highlight and demonstrates that we are effectively managing pace, price, and starts to optimize each asset. As to capital allocation, we continue to take a balanced approach with disciplined investments in growth remaining our top priority. In the third quarter, we invested about $780 million in land acquisition and development. We expanded our lot position to almost 81,000 lots owned or controlled with our inventory continuing to rotate into a higher quality portfolio of communities. In addition to these investments, we return a significant amount of cash to stockholders through both our regular quarterly cash dividend and the repurchase of $188 million of our stock. These repurchases will further enhance our return on equity in 2022 beyond this year's expected 20% level especially when combined with our projected increase in scale to over $7 billion in revenue and higher operating and gross margins. Since we embarked on our returns-focused growth strategy, we have produced meaningful expansion in our ROE. While we recognize that returns across the industry have expanded, our rate of improvement is meaningful, and we believe a return on equity in the low to mid-20% range is sustainable. During the quarter, we announced the promotion of Rob McGidney to Executive Vice President and Co-Chief Operating Officer, a role he shares with Matt Mandino. We created a co-COO structure with two simple objectives in mind, to accelerate the profitable growth of our responsible for our west coast and southwest regions, and Matt is responsible for our central and southeast regions. In addition to their regional responsibilities, Matt and Rob each have oversight of key strategic corporate functions as well. The operating environment within our industry has become more complex over the past 18 months given the supply chain issues and municipal delays that I mentioned earlier and their impact on build times. Having two proven leaders running our operations will allow for a more hands-on approach that is geographically focused, enabling greater day-to-day collaboration with our regional and division leadership. Matt and Rob will join me to respond to questions later on this call and can speak more specifically as to what is being done in their regions to compress build times. We successfully opened over 40 new communities in the third quarter, marking the start of a sequential improvement in any community count that we anticipate will continue over each of the next five quarters. With the strong and growing lot pipeline that I referenced driving an acceleration in new communities, we expect to expand our community count to roughly 260 by year-end 2022. Our monthly absorption per community accelerated to 6.6 net orders during the third quarter, from 5.9 in the year-ago quarter, and reflecting a more typical seasonal pattern sequentially, while remaining at a historically elevated level. Net orders were 4,085, representing a small decline year-over-year, against a strong result in the prior year quarter. However, with our actions in taking price and moderating pace, our net order value was up more than 20% year over year. We continued to manage our selling pace to production, limiting our lot releases to prevent our backlog from getting overextended, and started over 4,000 homes during the quarter. This comparison starts in the year-ago quarter of about 3,400. We currently have approximately 9,000 homes in production, with 93% of these homes already sold. Only 240 of these homes are unsold past the foundation stage, and our focus right now is on compressing our build times to deliver our backlog. With the rise in our net order value to 2 billion, we are laying the foundation for future margin growth. Our pricing power is solid, while our pace remains strong, and the demand for our homes at higher prices tells us that our price points remain attainable. The credit profile of our buyers is above our historical level with an average FICO score of 731 and down payment of 14%, translating to almost $60,000, which is noteworthy for a first-time buyer. In addition, the internal indicators that we monitor for changes in customer behavior, including the square footage of homes purchased or spending in our design studios, remain stable. Our backlog now stands at roughly 10,700 homes, representing future revenues of over $4.8 billion. Our backlog value is up nearly 90% year-over-year, with significantly higher margins within this backlog. This is an excellent position from which to finish 2021 and support another year of growth in revenues and expansion of margins in 2022. Homeownership remains compelling and attainable, and we believe that drivers are in place to support healthy market conditions for the foreseeable future. An insufficient level of supply exists at our price points to meet the demand from millennials and Gen Zs which together number roughly 140 million. These two cohorts value the personalization and choice in our built-to-order business model, which is a significant factor in why our absorption rates have consistently been among the highest in the industry. This, together with our experience in serving first-time buyers, who represent 61% of our deliveries in the third quarter, has us well positioned to capture demand going forward. Switching gears for a moment, I want to highlight our recent achievement in sustainability. KB Home received a record 25 Energy Star Market Leader Awards from the EPA, further demonstrating our leadership position as the most energy efficient national home builder. We are proud to continue moving our environmental program forward which is helping to lower the total cost of home ownership for our buyers while doing our part to reduce the carbon footprint of our homes. Before I wrap up, I would like to recognize and thank all of our employees for their outstanding efforts every day in working through the industry-wide challenges of material shortages and municipal delays. We have a remarkable team that is focused on execution and committed to customer service. In closing, we are growing into a bigger business that is operating at meaningfully higher margins and generating considerably improved returns. We anticipate a return on equity this year of about 20% and further expansion in 2022, supported by double-digit growth in revenues and community count with higher margins, as well as our recent share repurchase. Beyond next year, we believe our return on equity is sustainable in a low to mid 20% range. 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 review highlights of our financial performance for the 2021 third quarter, discuss our current outlook for the fourth quarter, and summarize expected improvements in several 2022 metrics. In the third quarter, we produced measurable year-over-year improvements in nearly all our key metrics, including a 49% increase in housing revenues that drove a 93% expansion in our earnings per unit share. We also made substantial investments in land and land development to support continued growth and completed a significant share repurchase that, among other things, will enhance future returns and per share earnings. Our housing revenues grew to $1.46 billion for the quarter from $979 million for the prior year period. This improvement reflected a 35% increase in the number of homes delivered and an 11% rise in their overall average selling price. As Jeff discussed, our current quarter deliveries were tempered by industry-wide building material shortages and labor constraints, that extended build times in most of our served markets. We anticipate similar challenges will apply to our fourth quarter and have considered these factors in our outlook. Our ending backlog value expanded 89% to over $4.8 billion, driven by strong increases in each of our four regions. Considering our quarter-end backlog, the status of our homes under construction, and expected construction cycle times, We anticipate our fourth quarter housing revenues will be in the range of $1.65 to $1.75 billion. In the third quarter, our overall average selling price of homes delivered rose to approximately $427,000 from approximately $385,000, reflecting the strength of the housing market. For the fourth quarter, we are projecting an overall average selling price of approximately $450,000, which would represent a year-over-year increase of 9%. Our third quarter home building operating income improved to $169.9 million as compared to $88.9 million in the year earlier quarter. Operating income margin increased 270 basis points to 11.6%, due to improvements in both our gross profit margin and SG&A expense ratio. Excluding inventory-related charges of $6.7 million in the current quarter and $6.9 million in the year earlier quarter, our operating margin was up 250 basis points year-over-year to 12.1%. For the fourth quarter, we expect our home building operating income margin, excluding the impact of any inventory-related charges, will be approximately 11.8% compared to 10.7% in the year earlier quarter. Our housing gross profit margin for the quarter was 21.5%, up 160 basis points from 19.9% for the prior year period. This margin expansion mainly reflected a favorable selling price environment supported by healthy housing market dynamics and lower amortization of capitalized interest. Excluding inventory-related charges, our margin for the quarter was up 140 basis points year-over-year to 22.0%. Our adjusted housing gross profit margin, which excludes inventory-related charges as well as the amortization of previously capitalized interest, was 24.5% for the third quarter compared to 23.7% for the same 2020 period. Assuming no inventory-related charges, we believe our fourth quarter housing gross profit margin will be in the range of 21.6% to 22% reflecting the impact of peak lumber prices when our forecasted fourth quarter haul deliveries were started. Our selling general and administrative expense ratio of 9.9% for the quarter improved by 110 basis points as compared to 11.0% for the 2020 third quarter, primarily due to increased operating leverage, partly offset by higher costs associated with performance-based employee compensation plans, and additional resources to support growth. As we position our business for growth in 2022 housing revenues, we believe that our fourth quarter SG&A expense ratio will remain roughly the same as the second and third quarters of this year, or approximately 10%. This would represent an improvement from 10.3% in the 2020 fourth quarter. Our effective tax rate for the quarter was approximately 14% of income tax expense, net of 21.5 million of federal energy tax credits.
spk01: We expect our effective tax rate for the fourth quarter to be approximately 16% for the year earlier period. For all, we reported net income for the third quarter of $1.60 per or $78.4 million or $0.83 per share for the prior year period. Turning now to community count, our third quarter average of 205 decreased 14% from the year earlier quarter.
spk07: We ended the quarter with 210 communities open for sales, as compared to 232 communities at the end of the 2023 quarter. On a sequential basis, as anticipated, we were up 10 communities from the end of the second quarter. We are planning to achieve continued sequential quarterly increases in our community count through 2022. We believe our 2021 year-end community count will be up slightly from the third quarter, resulting in a high single-digit decrease in the average fourth quarter count as compared to the prior year. We invested $779 million in land, land development, and feeds during the third quarter, with $467 million, or 60% of the total, representing new land acquisitions. In the first three quarters of this year, we invested $1 billion to acquire over 16,000 lots. We ended the quarter with a strong supply of nearly 81,000 lots owned and controlled that we expect to drive a significant number of new community openings and steady growth in community accounts. At quarter end, we had total liquidity of over $1.1 billion, including $350 million of cash and $791 million available under our unsecured revolving credit facility.
spk01: In early June, we issued $390 million of 4% 10-year senior notes and used a portion of the net proceeds to redeem approximately $270 million of tendered 7% senior notes due December 15, 2021.
spk07: We recognized a $5.1 million loss on this early redemption of debt in the third quarter. The remaining $180 million of the 7% senior notes, partially offset by the new issuance, will result in annualized interest savings of nearly $16 million, contributing to our continued trend of lowering the interest amortization included in our housing gross profit margins. In addition, we see the $350 million maturity in September 2022 of 7.5% senior notes as another opportunity to reduce incurred interest and enhance future gross margins.
spk01: During the third quarter, we repurchased approximately 4.7 million shares of common stock at a total cost of $180 million.
spk07: The shares repurchased represented approximately 5% of total outstanding shares and will drive an incremental improvement in our earnings per share and return on equity going forward. For purposes of calculating diluted earnings per share, we estimate a weighted average share count of 91 million for the 2021 fourth quarter and 93.5 million for the full year. For 2022, we are forecasting housing revenues of over $7 billion, supported by our anticipated 2021 year-end backlog, community count growth, and an ongoing strong demand environment throughout next year. We expect approximately 200 new community openings over the next five quarters to drive sequential increases in ending community count. Consistent with the forecasted double-digit growth that we have discussed during the past two quarters, we believe our 2022 year-end community count will be up about 20% year-over-year, and the full-year average count will be about 10% higher as compared to 2021. We also believe that gross margin expansion to a level above our guidance for next quarter along with improvement in the SG&A expense ratio, will result in a measurable year-over-year increase in operating margin. Further, the anticipated increase in scale combined with a higher operating margin and the benefit of the recent share repurchase should drive a meaningful improvement in return on equity relative to the approximately 20% expected for 2021. In summary, we believe we are well positioned to achieve results, represent significant improvements across virtually all our key metrics, with notable increases in our scale, absorption pace, housing gross margin, and operating margin. In addition, we are particularly pleased with the forecasted expansion in our full-year return on equity in our anticipated further improvement in 2022. We believe our ongoing focus on accelerating profitable growth and expanding our returns by leveraging our larger scale, attractive inventory profile, and uniquely compelling bill-to-order business model will produce measurable enhancements in both book and stockholder value in future periods. We will now take your questions. Alex, please open the lines.
spk04: 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 Stephen Kim with Evercore ISI. Please proceed with your question.
spk05: Yeah, thanks, guys. I appreciate all the color. One of the interesting things that we saw in your results today was the share repurchase, and you actually increased your leverage to do it, which is something we haven't seen a lot of the builders do. And so I was curious as to, If you could give us a sense for where your targeted leverage is going to be over the course of the cycle, and then how do you think that that may trend in the nearer term?
spk07: Sure, Steve. Yeah, I can take that. When you look at – actually, if you look at pro forma, our leverage at the end of the quarter, we're actually down straight off the remaining notes that were not tendered.
spk01: uh, subsequent to quarter end and it wasn't reflected in the actual results. So we're actually, uh, down to about 30 days, like I said.
spk07: You know, we feel pretty comfortable with our current leverage ratio. We've been down below 40% for some time now, and we'll continue to operate the company, I think, in a range that's appropriate. And we saw the tremendous opportunity, I think, in the quarter to repurchase some shares and help the future and really just utilize some evidence and also at the same time be levered a little bit this year by companies you know, through that transaction of the refinance and took about $60 million out, you know, as a result of the new issuance and the tender and then finally the redemption in September. So that's kind of where it stands right now for us. But, Jeff, are you thinking that, like, are you saying that around 35% is a level that we should be expecting for you guys or just simply below 40%? I mean, that's a much higher level than what we've been seeing from the other builders. Not that it's a bad level necessarily, but I just wanted to, get a sense for if you could give us a numerical range of where you expect to be, you know, sort of to manage the business over the course of the next several years. Yeah, I would say we're comfortable in that 30% to 40% range. And, you know, like I said, we've been down below 40% for a while. We're accreting a lot of equity as a result of the high-level earnings that we've had. And, you know, as long as we're continuing to produce that equity, I think with our excess cash, we may see opportunities to do what we just did in this quarter. But for the moment, we're pretty comfortable with the capital structure and the improvements that we've generated over the years. Yeah, that's great. Yeah, obviously strong performance, but your government, we would have liked to have seen, and obviously you've attributed some of that to lumber and peak lumber running through.
spk05: I was wondering if you could give us a sense for, you know, the magnitude of that.
spk01: and sort of how you're expecting the cadence of that to work off or to basically come down, what the reduction in the lumber costs could potentially benefit the early part of 2022.
spk05: And then there was another comment that I think Jeff Metzger made regarding simplifying your product, and I was curious as to what you meant, if you could elaborate on that a little bit more, because it sounded like that might make it more conducive to doing more spec versus BTO, but I assume that's not what you meant, so just curious if you could elaborate on that.
spk07: Steve, that was like four questions patched into one. Okay. Let me kick the simplified product out to Rob. Rob, do you want to take that one?
spk01: Sure. Thanks, Jeff and Steve.
spk07: Over the last several months, 18 months or so, we've really been focused on product and process simplification. And in our design studio, we've driven a total SKU reduction of about 48%. And our focus has been on retaining the items with the highest take rates from our customers and then almost 40%. So our options are generally standardized across our regions and across the country. And it's just about removing complexity from the supply chain and simplifying that issue for us and our trades. You know, at all times, with fewer variations, we're reusing our plans, leveraging standard product series across, you know, our regions and divisions. You know, even getting to the design of the homes themselves, we're standardizing window sizes and cabinet boxes, just simplifying it for us.
spk01: us, for our customer, for our trades, and really, you know, keying in on those items in the supply chain that are readily available where we can.
spk04: Thank you. Our next question comes from the line of Truman Patterson with Wolf Research. Please proceed with your question.
spk01: Hey, good afternoon, everyone.
spk06: Sorry, but Steve took all of my questions. You know, look, clearly supply chain issues are impacting the entire industry, just kind of following up on one part of Steve's questions.
spk07: But in the release or in the prepared comments, you all mentioned partnering with national suppliers. and expanding your subcontractor base. I'm just hoping you can elaborate a little bit further on those actions you're taking outside of simplifying the offerings. And, you know, I realize this is kind of a crapshoot at this point, but any guesstimate on when you think you might see construction cycle times start to stabilize? Matt, you want to talk about the labor base?
spk06: Sure. And, Truman, I would say right now the primary constraint is coming more from supply chain issues versus labor. But what we're trying to do is get out in front of it and really be proactive and identify where's the next bottleneck coming from. And we've got various tools and processes in place where we can analyze the capacity of our trade base and and then as i said get out in front of it and an example of this truman is so far year to date we have already added a little over 150 new trade partners so it's uh you know visibility on when the all clear is coming is difficult to assess but um we are trying to stay in front of it and with the expansion of our trade base we think that's that's one of the best tools we have
spk07: okay okay and then sorry go ahead i'm trying i was going to add add to that as we look at things where we got caught in the in the third quarter was in what i would call the second half of production cabinets windows uh whatnot and that's what we're working on trying to compress today we actually feel we've we've stabilized our build times in foundations and frames and into mechanicals where we've addressed all the moving parts and we've expanded the base, and we think we have that covered. And where we're still holding back is we don't know what we haven't even had to deal with yet because these things are popping up on a weekly basis, and it's varied from city to city. So we think we've stabilized the first half, and the second half of the production cycle is what Matt's talking about today. addressing right now. Okay. Okay. And then in the press release, you all mentioned continued expansion of margins in 22. I didn't hear it in the prepared remarks. Was that alluding to gross margin or op margin or both? It's actually both. And, yeah, just coming back, I guess, to a little bit of Steve's question on you know, cadence and trajectory. We do see the fourth quarter as having our peak lumber impact and inclusive in that. We did lose a little bit in the fourth quarter versus our previous expectation due to leverage loss with lower buy-in and also some mix shifts. But we're certainly and clearly seeing improving margins both in our selling gross margins, so on a week-to-week basis, what we're seeing in the selling GMs as well as in our backlogs. And at the moment, we're really looking at a nice gross margin trajectory into next year. And while we're not providing specific guidance on it, you know, we did reference in the prepared remarks that we see our margins next year clearly in excess of our fourth quarter guide. And I think we'll see a very strong margin performance basically cascading down in the operating margin and then impacting return on equity in a very favorable way in 2022.
spk04: Thank you. Our next question comes from the line of Matthew Boulay with Barclays. Please proceed with your question.
spk07: Hey, good afternoon, everyone. Thanks for taking the questions. Can I pick back up on a prior comment, Jeff, you just made about the challenges with the second half of the production cycle? I want to ask about the other side of that, the start pace in the first half, I guess. So, you know, relative to the challenges in closings and, I don't know, presumably getting communities open, you know, across the country, is your ability to put starts in the ground and, you know, given your business model, therefore driving sales, is that less impacted, you know, relative to the other challenges that are simply driving cycle times longer, or should we assume that your start pace could slow further as well related to the same challenges? Thank you. Matt, I think we've done a pretty good job navigating the environment and getting the starts and first getting the permits pulled and then getting the starts. And if you look back over the last 12 months, on a rolling 12 basis, we've started about 17,000 homes, which is within a couple hundred of what we've sold. So we're pacing our sales and our starts are pretty well aligned right now. and as we're working through it we think we've addressed the foundation issues back in january february march it was framer issues we've addressed those and we're continuing to push it along so we don't expect any any increased issues relative to starts and i also think we did very well in the quarter on the community openings we we hit right on top of the number we projected at the beginning of the third quarter. So the over 40 openings we had was a great result, and it's part of the confidence we have in our community count guide going forward. That's actually a perfect segue. Thank you for that, Jeff. I wanted to ask about communities just because, you know, you did have the one peer this week speaking about certain challenges in municipalities and sort of the cascading effect of supply chain on just getting communities open. And I think you gave the number at the top around 200 openings to come. I'm just curious. It's really just following up on the last point, but your confidence around that 200 given, you know, challenges in getting communities opening. And I guess the second part of that, if there's any regional bias for that as we model it out. Thank you. Yeah, the community openings are broad-based and I wouldn't target any one part of the country as being more difficult than others. I think a simple comment towards it is we've already taken the hits for the delays in our community openings as this year unfolded. So we're past a lot of the delays and it's into the blocking and tackling and It influenced our guide and our confidence for where we're headed next year. And I wanted to throw the actual number out because we've observed that strategically we want to grow community count a minimum of 10% a year. But with where the number is ending this year, we wanted to make sure that this group understood that it's much more than 10% next year. In fact, we're looking at 20. Thank you.
spk04: Our next question comes from the line of Alan Ratner with Zelman & Associates. Please proceed with your question.
spk05: Hey, guys, good afternoon. Thanks for taking my questions. And, Rob, congratulations on the promotion. Nice to hear you on the call. Jeff, maybe the first question, just to clarify on the margin comments, I think it's helpful to remind everybody just the accounting nuance for you guys with some of those fixed expenses that flow through your COGS, because I think that does explain maybe some of the shift in guidance for 4Q. Can you just remind us, what is that rough dollar amount that flows through your cost of goods sold on every quarter, and would you expect that to increase in 2022 based on your expected community account growth?
spk07: Right. It has increased a bit in 21 as we've put more resources towards some of the functions within that fixed cost. I think in the third quarter it was right around $38 million. And to your point, yeah, with lower revenues, as I mentioned earlier, you take a leverage hit on the lower revenues as you lose a bit of leverage on that fixed cost that's contained in cost of goods flow.
spk05: Got it. That's helpful, Jeff. Thanks for that update. Second, the $7 billion-plus revenue guide for next year, I'm curious, first off, what does that assume for cycle times? Does it assume stability from this current level that's extended a bit here? And an add-on to that one, again, obviously it sounds like the start pace is keeping up with orders, but just given the challenges that you're seeing throughout the supply chain and the elongation there, Is there any consideration to maybe more significantly slowing that pace of order activity? Six to seven sales per community is incredibly strong, and obviously the demand is there for it. But a lot of your peers have maybe been a little bit more forceful in bringing that sales pace down recently. So I'm curious if there's any consideration to that just to allow things to kind of catch up a little bit.
spk07: If we saw signs of further blockage, From here in the build times, we would slow it down. In fact, we did slow it down some in many communities where we opted for price. But as we look at things today, we're now planning for a longer build time. It's extended. We get it. It's baked into our projections and our assumptions, and we have a pretty nice rhythm right now where we're selling homes, starting homes, getting them now through foundation and frame, and we're heading into the second half on a lot of the backlog, so we'll see. But right now we think we're in a pretty good balance. You don't want to have backlog that you can't get built because your buyers get irritated with that too, and we're very sensitive to the customer. So if we feel we're putting our customers at risk, we're not going to do that.
spk04: Thank you. Our next question comes from the line of Susan McClary with Goldman Sachs. Please proceed with your question.
spk03: Thank you. Good afternoon, everyone. My first question is just following up on the cost side of things and inflation. I know you mentioned that you expect peak lumber to roll through in the fiscal fourth quarter, but can you talk to when we should expect the deflation in lumber to start to come through and how you're thinking about inflation in other building product categories that could potentially somewhat offset that?
spk07: Right. Well, the way we lock our costs on start, any inflation we're seeing in the various cost categories are really more affecting future sales and future backlog as opposed to what we may deliver out, for example, in the first or second quarter of next year. So on balance, what we've been seeing is lumber's been tapering off. There's some pretty significant improvement in the cost side of things, leading to obviously higher gross margins in the backlog on a go-forward basis. I don't have a crystal ball, so I'm not exactly sure where first or second quarter input costs are going or labor costs are going. But given the trend that we've seen on the pricing side, and even if we maintain I think we'll be able to more than offset any future increases we see, again, with the assumption that the favorable trend in lumber holds. That was a very significant cost category for us, for the whole industry, for the peers. And, you know, as that progresses, it's still some really good news, I think, for our margins out in the next year. And given that we blocked a lot of those costs for our deliveries in the first half of next year, we're feeling pretty good about the direction of where margins are headed.
spk03: Okay, that's helpful. And then my follow up question is around pricing. You know, you got into about 450,000 for the fourth quarter, which is up, I think, about 9% or so versus last year. You know, I know you mentioned in your comments that you're seeing a buyer with a higher FICO score. It sounds like overall they're in better financial position. Can you just talk to how you're thinking about pricing, the ability to continue to get that in your various markets and, you know, anything that's kind of changing on the ground around the buyer's receptivity to pricing?
spk07: Yeah, well, Susan, as you know, every community and every city will have a little bit different story relative to inventory on the ground, and there really isn't any, and job growth and population growth and whatnot. If you think of our buyer profile, the first-time buyer predominantly, and yet they're putting $60,000 down on their home and they have a FICO score of 737, that's the strongest buyer profile I've ever seen in a first-time buyer business. Very strong buying power out there, if you will. And the first thing that we would see if we pushed price too far, and we haven't seen anything like that yet, would be keep in mind we're built to order, so the buyer would shift to a little bit smaller home. They still want a four-bedroom, they still want it in that neighborhood, and and they may say that size home is too high now and I'll come down here, or if I don't want to come down here, I won't buy at all. But we're not seeing anything like that at all today. And if you think about the discussion we're having on the supply chain blockage, it's really making the inventory situation worse for the consumer, not better. Our industry is way behind in the number of homes we've built versus what demographics and demand is. with support. And you have this restriction now on homes being built because of the supply chain blockage. So we don't think you're going to, there's so much demand for the limited supply. We don't think you're going to see for a while a customer that says we can't afford that. We're seeing no signs today. It's a very strong environment out there.
spk04: Thank you. Our next question comes from the line of Michael Rehart with JP Morgan. Please proceed with your question.
spk03: Hi, this is Maggie for Mike. Following up on the last question, I mean, obviously the buyer's credit profiles remain strong and you're saying that affordability hasn't really been an issue to this point. Have you seen any shift in kind of buyer preferences As a result of the recent price appreciation, I think last quarter you said that you hadn't really seen any buyers adjusting the size of the home, but I'm curious if there's any update there.
spk07: There was no movement at all in the size of the home, and the spend in the studio actually went up a little bit per unit, incrementally $1,000. So the buyers behave in the same way they were last quarter and the quarter before.
spk03: Got it. Thank you. And maybe asking kind of an earlier question in a little bit different of a way. You talked about the share repurchase this quarter, and you talked about kind of where you're comfortable going forward from a leverage perspective. But can you elaborate a little on the potential for share repurchase to become a more regular tool that's used?
spk07: Yeah. If you go back to Jeff's comments to a a previous question, what we did in the quarter was take some excess cash that we had and apply it to share repurchases. We spent over $700 million on Land Act and development, so that would reinforce that first and foremost we're all about growth. And as we look ahead, our top priority will continue to be to support the profitable growth trajectory and improve our returns. And we also know our leverage ratio will continue to get better as we grow profits, and that will lower your ratio on its own. So first and foremost, we'll be looking at growing the company. If at some point we again determine we have excess cash, we'll evaluate what to do with it at that time.
spk04: Thank you. Our next question comes from the line of Deepa Rakoban with Wells Fargo Securities. Please proceed with your questions.
spk00: Hi, good afternoon. I thought the order of pace was pretty good. Thanks for that. I don't know if I heard you talk about this, so I apologize if I'm asking this, but when you think your supply chain challenges stabilize, i.e., you know, you're calling for 11% lower delivery in Q4, do you think much of the known supply chain issues
spk07: uh impact your q4 the more most or would early part of 2022 also see some strong headwinds there yeah well uh deep as we we shared in our comments we we think we've stabilized the early parts of the construction cycle there's still a lot of variables and and unknowns on the finish side While we stabilize it, it is at an extended timeframe. So we're now navigating. We're assuming in our guide and our projection that build times don't get worse but also don't get better. And I think everybody will have their own crystal ball on how we work through it, and we will work through it. But it's going to take some time to get back to where we used to be.
spk00: Okay, that's fair. You talked to some product challenges you faced. You talked about windows and cabinets. Are there any issues we should think would get worse before they get better sometime mid of next year? Or you think most of them start to ease past this quarter?
spk07: It's hard to answer if you'd have asked me On our last call, whether I thought we'd lose a couple more weeks, I would have said no, because we already thought that it extended it pretty significant from Q1 to Q2. And we're seeing good signs in some areas, but there's still a lot of unknowns. So I don't know that we're prepared to say things are going to get better right away. And we're hopeful we've taken steps to stabilize, and we'll see how it goes over the next couple quarters.
spk04: Thank you. Our next question comes from the line of Mike Dahl with RBC Capital Markets. Please proceed with your question.
spk07: Hi, thanks for taking my questions on the call so far. First, I just wanted to circle back to the, Sarah, to beat the horse a little on the fourth quarter margin, but just maybe asking again on the impact of lumber and I guess taking kind of a sequential approach if we look at your guide for ASP, you're up about 5% queue on queue, and probably most of that is pretty similar on a square foot basis, at least up that much queue on queue. So with revenue per square foot up the way it is, can you just help us understand again, I mean, sequentially, I don't know if the fixed cost is really as much of a sequential driver, but just the exact impact of lumber that that's impacting you guys and offsetting that improvement in revenues? Well, Mike, you know, like to give you an exact number, it's a little bit difficult. I mean, there's been a lot of mixed shifts between the quarters, and we're not selling the same product, obviously, in the fourth quarter as we did in the third. You know, the margins are in the range quarter over quarter. There's not a huge change between the two quarters. And what we wanted to point out was, Really, we do believe, we know actually that the number price increases and what we saw related to those homes that we expect to complete in delivering the fourth quarter, when we started those homes, we were at peak number pricing. And this is much an indication that we feel that we wanted to give everyone about where things are heading beyond the fourth quarter as much as it is about, you know, specifically for that fourth quarter guide. When we guided quarters, particularly in a short period, we guided delivery by delivery. You know, we roll up from the bottom up. We lost a lot of deliveries due to these construction delays and supply chain challenges. And there was a bit of mix and back in there as well. And anything that we lost in the fourth quarter is coming back to this early part of next year. So we're very optimistic about margin expansion on a go-forward basis. And not only gross margin expansion, but operating margin as well with the higher revenue guide for next year. So, you know, beyond that, I don't really want to get into quarter-by-quarter sequentially in 2022 or any details out into that type of range. We'll bubble back up in January when we're reporting out on our fourth quarter and give you guys a lot of detail in 2022. We normally don't even touch on margins, for example, during this call. We normally kind of limit the community count and revenues, but We wanted to get an indication of what we're seeing because the numbers are so strong within our backlog and within our selling gross margins that we wanted to indicate that to the street. Yes, I appreciate that. And it makes sense in terms of just looking at going to next year with we're already about 75% of what you're projecting in revenues already in backlog, which should should look pretty strong on the margin side. So that all makes sense. I guess the second question, just, you know, the paid side of the equation, when you're looking at getting to, you're turning over, I think you're turning over if you're opening 200 communities and then the next year at 260, you've got like 75% community turnover. Anything Anything you can share in terms of, you know, whether the pace expectations for new community openings are still for, you know, roughly similar in terms of the mix or if there are different, any sort of difference in what you'd direct us towards in terms of pace as you look out at next year and what you've got coming online? Mike, the 200 is over five quarters, not four, so it's, It's not a one-year target set, a little more than that. In the prepared comments, what we were talking about is not just where we think we'll be at the end of 22. We're positioning the business to continue to grow our community account beyond that into 23. So we have everything owned for 22, most of everything owned and all controlled for 23. So we're comfortable with the guidance. And we like how we're positioned finally with our community count trajectory. Right. And I just add to that, Mike, you know, when you look at current pace and what we've seen over the last year and as we're projecting forward, there's two things happening. One, a lot of the new communities, obviously we've just replenished a lot of our communities, so we have a lot more lots going forward. And we're actually projecting fewer closeouts in next year than we had in 2021, which is helping us to grow that count. And it's not because we're projecting, you know, absorption pace being off that much. You know, the base assumptions are still very strong going into next year. It's just a function of how many lots we have left going into the year and the, you know, large number of openings that we had in 2021, not to mention in the openings next year. So, you know, I think we're pretty well aligned. You know, this year caught us by surprise. I think it caught a lot of people by surprise with the accelerated pace and a lot more closeouts. than any of us anticipated, but that's good news. You know, for me, if you're pulling down a lot of communities and those units and those lots are going from available in communities into our backlog, that takes some risk off next year, and it supports, you know, the top line and the delivery numbers, and I think that's great. You know, while you have some pressure on community count as a result of that, I'd rather see the pressure there than the pressure on having to sell to fill that revenue expectation. So we're in great shape heading into not only the fourth quarter, but particularly into 2022. It's a pretty exciting time for us.
spk04: Thank you. Our next question comes from the line of Jay McAnlis with Wedbush. Please proceed with your question.
spk07: Thanks for taking my questions. The first one, pretty impressive decline in the cancellation rate. I'm just wondering, you know, with the cancels that you are getting, what's the reasoning behind that? Jay, it's a mixed bag. It's somebody that got transferred, somebody gets divorced, occasionally buyer remorse. We're not seeing too much of that. We do a pretty good job of screening the buyer before we report the sale. We get a pre-call, so we're having very little loan issues as well. Okay. It's a mixed bag that's a small number at the end of the day. All right, understood. And then the second question, you talked earlier in the call about having the front half of the build cycle completed, and now you're working on the back half. Just wondering if that also includes, you know, getting your final inspections, your COs, et cetera. What type of issues are you seeing on the municipal side, and are those issues improving versus where they were earlier this year? Yeah. Rob, do you want to talk to the inspection side and what we're seeing? Yeah, sure, Jeff. Jay, it's... You know, one of the biggest issues we're seeing on the inspection side on the back end is just COVID and the Delta variant. You know, that's where we're getting the surprises. You know, without those surprises, it's running fairly smooth and most of the divisions have strong relationships with the people in our municipalities and we're able to, you know, navigate that pretty smoothly. Where we see, you know, some hiccups are when a group of inspectors or even a single inspector may have an exposure and they get sent home for for 10 days. But, you know, that's what we're fighting through out there. It's not necessarily the volume, but the impacts from COVID.
spk04: Thank you. Ladies and gentlemen, this concludes today's teleconference. Thank you for your participation. You may now disconnect your lines.
spk01: After saving with customized car insurance from Liberty Mutual, I customized
Disclaimer