KB Home

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 fourth quarter earnings conference call. At this time, all participants are in a listen-only mode. Following the company's opening remarks, we will open the lines for questions. Today's conference call is being recorded and will be available for replay at the company's website, kbhome.com, through February 12th. Now, I would like to turn the call over to Jill Peters, Senior Vice President, 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 fourth quarter of fiscal 2021. On the call are Jeff Mesger, Chairman, President, and Chief Executive Officer, Nat 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 various 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, the 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 is Jeff Mesker.

Thank you, Jill. Good afternoon, everyone, and Happy New Year. We had a remarkable year in 2021, producing revenue growth in excess of 35%, and an increase in our earnings per share of more than 90%. We achieved our objectives of expanding our scale and profitability, driving our return on equity up by over 800 basis points to 20%. Our results are even more notable, considering they were accomplished despite the supply chain challenges and municipal delays that were pervasive throughout the year, as our teams have been successfully navigating these issues. As we begin 2022, we are poised to continue delivering returns-focused growth. Our backlog value of $5 billion, which grew 67% year-over-year, provides a strong base to support our roughly $7.4 billion in expected revenues in 2022. This represents substantial top line expansion, which, combined with our expectation of a dramatic increase in our gross margin to nearly 26%, will drive our return on equity meaningfully higher. With respect to the fourth quarter, we generated total revenues of $1.7 billion and diluted earnings per share of $1.91, representing a year-over-year increase of more than 70% on the bottom line. We achieved an operating income margin approaching 12%, resulting in a 28% expansion in our operating profit per unit to over $56,000. In addition to that significant profit growth, our business is generating a healthy level of cash flow and we remain consistent in our balanced approach toward allocating this capital. Discipline investment and community count growth is our top priority, and in 2021, we put over $2.5 billion to work in land acquisition and development. We expanded our lot position to nearly 87,000 lots under control, which is almost 30% higher from year-end 2020. Our lot position is diversified both across and within our regions, and we own all of the lots that we need for our anticipated 2022 delivery goals. We also now owner control the lots that we need for sustained growth in 2023. In addition to reinvesting in our business, we return over $240 million in cash to stockholders, through the share repurchases that we completed in our third quarter, along with our quarterly dividend. And we reduced our debt during the year by over $60 million. Throughout 2021, we implemented price increases across nearly all of our communities, along with managing lot releases to balance pace, price, and production in order to optimize each asset. Although costs rose as we moved through the year, our pricing strength outpaced the rate of cost inflation, driving our backlog margins higher. This dynamic continued in our fourth quarter, contributing to a rise in our net order value of 12% year over year, despite net orders decreasing 10%, a level similar to the decline in our community count. This increase in net order value contributed to a backlog value that is more than 65% higher. With the extension of our cycle times, most of the pricing power we experienced in 2021 will be reflected in our gross margin beginning in our 2022 second quarter. In addition, our results will continue to benefit from structural tailwinds, including the performance of our more recently opened communities where margins are running in excess of the company average, the ongoing rotation into a higher quality mix of assets as the impact from reactivated communities continues to diminish, a reduction in amortized interest, and the impact that higher monthly deliveries per community has on field overhead. All of these factors combined are driving our expectation of a gross margin of nearly 26% for this year. We successfully opened 130 new communities in 2021, our largest number in many years, including 33 in the fourth quarter. The higher lot count that I mentioned will enable us to accelerate our new community openings in 2022. As a result, we now expect to end 2022 with about 265 communities, up over 20% year over year, and ahead of our initial projection that we shared in September. In addition to supporting our roughly 30% increase in revenue plans for 2022, our community count expansion will also contribute to our growth in 2023. Our monthly absorption per community of 5.5 net orders during the fourth quarter reflected a typical seasonal pattern sequentially. For the year, Our absorption pace averaged 6.3 net orders per community per month, the best annual rate we have seen in more than a decade. Homebuyers value the choice and personalization inherent in our built order model, which we believe is the primary reason that we've long generated among the highest absorption rates in the industry. With the expectation that interest rates will rise this year, And with the strong home price appreciation the market has experienced, it is appropriate to spend a moment addressing affordability. Our strategy is to target the median household income of a submarket, positioning our homes to be attainable by the largest segment of buyers. We strive to be below the median new home price and add a reasonable premium to the median resale price when we open a community and then the opportunistic and raising price based on demand at that location once opened. Our average selling price on deliveries rose about 9% year-over-year in 2021, well below the reported increase for overall pricing levels nationally, highlighting the affordability of our locations and products. As we've discussed on previous calls, we track a number of internal key indicators to gauge changes in consumer behavior that could signal affordability challenges, which we are not seeing at this time. One of the most telling of these is the square footage of homes that buyers are selecting, as they will typically rotate down to a smaller home if they need to in order to achieve home ownership. Although we offer floor plans below 1,600 square feet in about 80% of our communities, buyers continue to choose larger footage homes. Over the past year, our deliveries have averaged between 2,000 and 2,100 feet, consistent with our historical trend. And our homes in backlog are slightly above that range. We also look at our studio revenues and lot premiums, which we view as discretionary spending for our buyers. We would expect to see a decline if buyers are stretched, but our studio revenues and lot premiums have increased, even as base prices have risen. On a combined basis, buyers spent about $48,000 per home in these two categories in the fourth quarter, a solid enhancement to our revenues. Finally, and perhaps most importantly, is the credit profile of our buyers. Their average FICO score in the quarter was 732, an all-time high. In addition, About two-thirds of our buyers qualified for a conventional mortgage, and our buyers overall are averaging a down payment of over $67,000. Taken together, these metrics illustrate our buyers' strong credit. I'll also note that the recent increases in loan limits, both conventional and FHA, should help with mortgage financing, providing an incremental benefit to the industry. We started over 3,800 homes during the quarter as we worked to position our production for growth in 2022 deliveries. At year end, we had over 9,100 homes in production with 90% of these homes already sold. Generally, our cancellation rate once we start the home is extremely low, and at 5% in the fourth quarter, it remained so. reflecting our customers' strong desire to purchase their personalized homes. As to build times, while they extended about two weeks sequentially in the quarter, we are encouraged to see some signs of stabilization. Construction times in November and December were consistent with September and October, pointing to a leveling out over the last four months. Our projections for this year assume that we hold at these levels, and depending on timing, any improvement in build times could increase our expected closings in the latter part of this year. Our backlog is comprised of over 10,500 homes with a value of $5 billion, representing the bulk of our revenues expected for 2022. One aspect of our built-to-order business model that tends to get overlooked is is the dynamic between our revenue growth and community count. In our count, we do not include communities that we consider to be sold out, meaning that they have less than five homes left as well. That doesn't mean the community is closed out, in that those communities will continue to contribute to our revenues and profits. In fact, our backlog includes almost 1,900 homes from 150 sold-out communities that will deliver approximately $1 billion in 2022 revenues. Since we are well into our first quarter at the time of this call, we typically provide an update on net orders. While we have not seen a slowdown in demand across our geographic footprint in the past couple of months, and we foresee a strong spring selling season ahead, a combination of factors has resulted in a negative year-over-year net order comparison for the first six weeks of this quarter at 17 percent in the prior year net orders throughout december and into 2021 were particularly strong creating a difficult comparison as the first quarter progresses and we benefit from the additional community openings we have scheduled along with easier weekly comparisons we similar to our anticipated decline in average community count for the quarter. The favorable demographics, low mortgage interest rates, and particularly for first-time buyers continue to drive demand.

Specific to KB Home, we believe the location of our communities and the ability to choose and personalize homes are compelling for buyers. Shifting gears for a moment, 2021 was also marked by solid progress in our environmental, social, and governance initiatives.

KB Home was once again recognized with multiple honors from the U.S. Environmental Protection Agency, leading our industry with the Energy Star Partner of the Year Award, a record number of Energy Star Market Leader Awards, and once again being the only home builder to receive the WaterSense Sustained Excellence Award. Our environmental program is robust, and we are proud that our homes have the lowest national average HERS score among production builders, with a long track record of annual improvement in this key metric, which we expect to continue in 2022. America's most responsible companies for the second year in a row. Before I wrap up, I would like to recognize and thank all of our employees for an incredible year. We significantly increased our volume in 2021 amidst the most challenging and fluid operating conditions that I have seen in my home building career. These results came about from the determined and relentless efforts of our entire team. In closing, 2021 was a rewarding year for KB Home. In addition to generating significant revenue and earnings growth, we also produced substantial increases in our book value per share and our return on equity. Alongside these meaningful financial results, we maintained our leadership in providing the highest customer satisfaction levels among large production home builders and continued to drive innovation through the introduction of energy efficient and healthier home features. As a result of these and many other factors, KB Home was named to the list of the 250 most effectively managed companies in the U.S., a ranking that was developed by the Drucker Institute in conjunction with the Wall Street Journal. As we look to the year ahead, during which we will celebrate our 65th anniversary, We anticipate another year of remarkable growth, which we expect will ultimately drive a return on equity of more than 26%. We look forward to sharing our progress with you as 2022 unfolds. With that, I'll now turn the call over to Jeff for the financial review. Jeff? Thank you, Jeff, and good afternoon, everyone. I will now cover highlights of our financial performance for the 2021 fourth quarter and full year, as well as provide our outlook for the 2022 first quarter and full year. We finished 2021 with strong fourth quarter results, including significant year-over-year growth in revenues and a 310 basis point expansion in our operating margin that drove a 71% increase in our diluted earnings per share. While we face supply chain issues that extended our cycle times, as well as construction cost inflation challenges during 2021, our exceptional portfolio of communities and solid operation execution, along with the strong housing market, generated impressive full-year results that I will summarize in a few minutes. With a robust 2021 ending backlog value of nearly $5 billion and 29% of lots owned or controlled, we are well positioned for continued meaningful growth in revenues, community count, earnings per share, and returns in 2022. In the fourth quarter, our housing revenues of $1.66 billion were up reflecting a 28% increase in homes delivered and a 9% increase in their overall average selling price. Housing revenues were up significantly in all four of our regions, ranging from a 28% increase in the central region to 114% in the southeast. Looking ahead to the 2022 first quarter, we anticipate housing market conditions will continue to be favorable with while we navigate expected continued supply chain challenges. For the 2022 first quarter, we expect to generate housing revenues in the range of $1.43 to $1.53 billion. For the 2022 full year, assuming no change in supply chain dynamics, we are forecasting housing revenues of $1.2 to $7.6 billion up over $1.7 billion, or 30%, at the midpoint as compared to 2020. Having ended our 2021 fiscal year with our highest year-end backlog level since 2005, along with our expectations for a higher community count and continued strong housing market conditions, we believe we have achieved the highest top-line performance for 2022. In the fourth quarter, our overall average selling price of homes delivered increased to approximately $451,000.

Reflecting our higher average selling price per net order in recent quarters, we are projecting an average selling price of approximately $472,000 for the 2022 first quarter.

For the 2022 full year, we believe our overall is $480,000 to $490,000. Home building operations are up 85% as compared to $115.7 million for the year earlier quarter. The current quarter included inventory-related charges of approximately $700,000

Operating margin was 12.8%, up 310 basis points from the 2020 fourth quarter. Excluding inventory-related charges, our operating margin was 12.9%, as compared to 10.7% a year ago, reflecting improvements in both our gross margin and SG&A expense rate.

We anticipate our 2022 first quarter home building operating income margin, excluding the impact of any inventory-related charges, will be approximately 12% compared to 10.4% for the year earlier quarter. For the 2022 full year, we expect this metric to be in the range of 15.9, which represents a significant year-over-year improvement of 450 basis points at the midpoint reflecting continued positive momentum in both our gross margin. Our 2021 fourth quarter housing gross profit margin improved 230 basis points from the year earlier quarter to 22.3%. Excluding inventory-related charges, our gross margin for the quarter reflected a year-over-year increase of 140 basis points to 22.4%. The year-over-year improvement primarily reflected the impact of higher selling prices and lower amortization of previously capitalized interest, partly offset by higher costs for lumber and other construction materials and labor. We are forecasting a housing gross profit margin for the first quarter in the range of 22.0 to 22.6%, representing the low point for the year. We anticipate significant sequential expansion in quarterly gross margins during 2022, mainly driven by price increases that have outpaced cost pressures in our established communities, strong selling margins in our recently open communities, and an expected reduction in amortization of previously capitalized interest. For the full year, we expect this metric will be in the range of 25.4% to 26.2%, an increase of 400 basis points at the midpoint as compared to 2021. Our selling general administrative expense ratio of 9.8% for the fourth quarter improved 50 basis points from a year ago, mainly reflecting enhanced operating leverage due to higher revenues, partly offset by increased performance-based compensation expenses and costs to support our expanding scale. We are forecasting our 2022 first quarter SG&A ratio to be approximately 10.4%, an improvement of 30 basis points versus the prior year, as expected favorable leverage impacts from an anticipated year-over-year increase in housing revenues are partially offset by increased investments in personnel and other resources to support a projected meaningful expansion in community count. We expect that our 2022 full-year SG&A expense ratio will be in the range of 9.4 to 9.9%. Our income tax expense of $49.7 million for the fourth quarter, which represented an effective tax rate of approximately 22%, was favorably impacted by $7 million of federal energy tax credits, reflecting another benefit of our industry-leading sustainability initiatives. We currently expect our effective tax rate for the 2022 first quarter and full year to be approximately 25%, both excluding any favorable impacts from energy tax credits. Federal legislation extending the availability of tax credits for building energy-efficient homes in 2022 has not yet been enacted. If the Section 45L tax credit is extended at its current level, our 2022 effective tax rate would be favorably impacted by approximately 200 basis points. Overall, we reported net income of $174.2 million, or $1.91 per diluted share for the fourth quarter, a notable improvement from $106.1 million, or $1.12 per diluted share for the prior year period. Reflecting on the full year, we're very pleased with their strong 2021 financial results. We increased our housing revenues by 37% to nearly $5.7 billion, expanded our operating margin by 400 basis points to 11.6%, with measurable improvements in both our gross margin and SG&A expense ratio, and reported $6.01 of diluted earnings per share, an increase of 92%. We also completed $188 million of share repurchases, refinanced $390 million of our senior notes, resulting in annualized savings of $16 million of incurred interest, and improved our year-end leverage ratio by 380 basis points. Turning now to community count, our fourth quarter average of 214 was down 9% from 234 in the corresponding 2020 quarter, and up 4% sequentially. We ended the year with 217 communities, down 8% from the year ago, and up 3% sequentially. We expect our 2022 first quarter ending community count to remain relatively flat sequentially and represent the low point for 2022. On a year-over-year basis, we anticipate our 2022 first quarter average community count will be down by a low single-digit percentage. We expect our quarter and community count to increase sequentially through the remainder of the year, starting in the second quarter as openings each quarter are expected to out pay sellouts. We anticipate ending the year with a 20 to 25% increase in our community count, supporting additional top line growth in 2023 and beyond. During the fourth quarter to drive future community openings, we invested $622 million in land and land development. with $258 million or 41% of the total representing land acquisitions. In 2021, we invested over $2.5 billion in land acquisition development compared to $1.7 billion in the previous year.

At year end, our total liquidity was approximately $1.1 billion, including $791 million of available capacity under our unsecured revolving credit facility.

Our debt-to-capital ratio improved to 35.8% at year-end 2021, compared to 39.6% the previous year. We expect to generate significant cash flow in the current year to fund land investment, supporting our targeted 2022 and future years growth in community count and housing revenues. Our 2021 year-end stockholders' equity was $3.02 billion as compared to $2.67 billion a year ago, and our book value per share increased by 18% to $34.23. Finally, one of the most notable 2021 achievements was our significant improvement in return on equity to 19.9% for the full year, a year-over-year expansion of over 800 basis points. Given our current backlog in community opening plans and the expected continued strength in the housing market, we are confident that we will generate significant year-over-year improvements in our key 2022 financial metrics. We plan to continue to execute on the principles of our returns-focused growth strategy with an emphasis on meaningfully improving our returns by increasing our community count and top line while producing further expansion in our operating margins. In summary, using the midpoints of our guidance ranges, we expect a 30% year-over-year increase in housing revenues and significant expansion of our operating margin to 16.1%, driven by improvements in both gross margin and our SG&A expense ratio. These, in turn, should drive a return on equity of over 26%, up in excess of 600 basis points from 19.9% in 2021. This outlook reflects our view that with our returns-focused growth strategy, attractive business model, seasoned leadership team, and continued favorable housing market conditions, we will be able to further and meaningfully enhance long-term stockholder value in 2022. We will now take your questions. Alex, please open the lines.

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. Our first question comes from the line of Truman Patterson with Wolf Research. Please proceed with your question.

Hey, good afternoon, everyone. Thanks for taking my questions. So first on your 22 gross margin guidance of about 26%, I think the highest in 15 plus years, just trying to understand, this might be an unfair question, but trying to understand how much of the improvement is being driven by pricing out stripping costs and And, you know, versus some of your internal initiatives, such as working down the legacy land, streamlining SKUs, simplifying, you know, offerings and partnering with the national suppliers.

Right, Truman. Yeah, as you point out, there's a number of levers impacting 2022. You know, as we went through the details, certainly the decreased interest amortization of the driver. We have, I would say, the number one driver is just the performance of the communities. With our existing communities, we have seen pricing outstrip cost increases as we've gone through the year, and a lot of that is coming from through the deliveries in 2022. But I think also importantly, I think it's very important actually to point out that we opened 130 new communities in 2021 and the performance of those communities have been very, very encouraging as we're seeing the backlog build and nice margins coming off those communities. So that rotation of communities from 21 to 22, I think will have a large impact on the margins. You know, at the point in time when we underwrote, we're seeing those communities open at much higher margins and nice pace. In fact, in most cases, higher pace than where we underwrote. And those are the main drivers for the 2022 improvement. If I could expand on it a little bit. And we are not spiking a football here because we have a lot of work to do and we have our eyes set on even better results. But the transformation of the company is pretty much complete now. You were with us back in 2016 when we went on the Returns Focused Growth Initiative, and part of that was to shore up and really strengthen the balance sheet and create a growth platform. And we did very well at that. We laid out a plan, shared it with the analyst community, and off we went and we delivered on what we said we would do. And coming out of 19, it was about quality growth and continuing to refine and enhance and retool. And we were on that path. The pandemic hits. You deal with that. You manage through that. And I would say the two-step transformation is now complete. And it's all about running the business with quality growth and continuing to improve profitability. And, you know, there's things I touched on in my comments, like our studios are performing better. And we know how to – we get a good idea in one studio and we can share it across the system, and boom, everybody enhances their studio revenue. Then we – We come up with some ideas on lot premiums. We share it across the company. Boom. You get more lot premium across the system through a best idea that's shared across the footprint. Your absorption per community is up a couple a month from where it was three, four years ago. That helps your financial performance. We're out of the old communities and into the new. And as Jeff shared, they're performing well above our average performance. Is it the location? Is it the product? Is it the strength of the market? I think it's all of the above. So I wouldn't just pin it on riding the wave from the pricing environment that we're in. We've structurally changed how this company is operating. And I think we've taken ourselves to a new level, and it's reflected in our guide for this year.

Yeah, no, thank you for that. And I remember that call in 2016 well. My next question, just a two-part question. Omicron has clearly been flaring up here. Hopefully, this is the last wave. But just hoping, first part, just hoping to get an idea how that's impacted labor availability and if you could quantify any impact that might be baked into first quarter closings guide. And then Omicron and the COVID flare up aside, Had you all started to see any incremental improvement in availability of certain products by the end of 2021?

I can kick that to Rob and Matt Truman. Obviously, we're seeing a little flare-up in Omicron, like you're reading about in the media, whether it's in the subcontractor base. We've seen some within our own business where – We have a very good playbook and we locked it back down and people go away for five days or 10 days depending on symptoms and what state they're in and then they come back to work. So you have these little flare-ups and then they go right away and you move on to the next one. What's unknown for me is whether it's having an impact on the supply chain relative to manufacturing or not. And I don't think that's played out yet. And as the thing keeps moving along, I think... As a society, we're getting smarter about how to manage through it, and we're sensitive to it. And companies are responding better than we were when it first hit back in 20. But, Rob, you want to give any thoughts on what you're seeing out in the field? Yeah, you know, I'll just touch on, you know, outside of Omicron, some of the things that we're seeing. I mean, we're almost two years into this, 18 months, two years into it, and You know, we are seeing some improvements in several areas, but a lot of that's just because we're far more experienced in developing workarounds for the supply chain gaps. You know, we've developed methods for continuing to progress our homes despite missing parts and pieces, and we've adjusted our processes to sync up with the delays and extended lead times, and we're in lockstep with our trade partners and suppliers with communication around, you know, our future needs and what their capacities are. We are seeing some areas improve, but at the same time, others get worse. For example, in Q4, garage doors was one of our biggest challenges, and there are still real issues around garage doors, but we've taken some action to minimize the disruptions from that through finding alternate suppliers or manufacturers. We've worked to minimize the door styles that we offer to match what's more readily available in the supply chain and allows our suppliers and partners to focus on producing a smaller range of those products. But then on the flip side, you know, when we solve one issue or one issue improves, another one tends to pop up. Like earlier in the year, the foam that we used for stucco laugh wasn't really an item on our radar, but now the supply of that has become scarce. So while one issue kind of gets traded for another, we'll claw back time in one area and lose some in another. But That led to, you know, what we're seeing in the stabilized cycle time just at an elevated level.

Thank you. Our next question comes from the line of Alan Ratner with Zellman & Associates. Please proceed with your question.

Hey, guys. Happy New Year and nice job in the quarter and the year. Congratulations. First question, obviously very strong gross margin guidance, and you guys have a lot of visibility into that based on your backlog and built-to-order model. I'm just curious, when you look at the cost and pricing environment today as it sits, we're obviously seeing a ton of inflation across the board. Lumber has spiked back up close to those peak levels we saw six, nine months ago. And presumably, you know, those costs won't roll through as much this year, maybe towards the tail end, but that's probably more of a 23, early 23 dynamic. So in the current environment, do you have pricing power that's sufficient to offset the, you know, what seems like accelerating cost pressures we're facing today? You know, just talk a little bit about how you're faring on the pricing side, if it's as strong as it was earlier in 21.

Yeah, the animal lumber is, is moving back up, which is interesting to me. And I think you'll see it bounce around some. But at this point in time, as I shared in the comments, we're seeing price ahead of cost. So costs are going up at a different level in every city, but we've been able to move pricing up more than the costs have increased.

Great. That's good to hear. Second question on the community account growth, again, very bullish outlook there. I think a lot of your peers have similar growth outlooks, maybe not to the same extent. You know, I'm just curious if you have any sense for, you know, what the community growth outlook looks like in your MSAs, you know, on a competitive landscape. And do you think the, you know, six, six and a half per month of disruption pace that you guys put up in 21 can be sustained with 20% plus more communities hitting the market over the next 12 months?

Our internal goal, Alan, is to have community account growth of at least 10% a year. and obviously this year we're going to do a little better than that. It's not dynamic right now because the markets are so supply constrained. I don't know that there's a lid on how many communities you could open in a city. It's more about how many you can get approved and developed and brought to market. It's not that the demand isn't there because it is today. So I couldn't tell you what the community count growth is today, And it could be with our rate that we're taking share and maybe the markets aren't getting larger, but we'll take share because we've successfully brought more communities to market. When you look at our absorption rate right now, if the world stayed where it is today, And the margins we're generating each week in our sales stayed where they are today. You'd see us continue to run at six a month. It's a healthy pace. We like to turn the assets. There's benefit to having that kind of volume per community with the subs and suppliers. And I think that's what we do. If the markets were to slow up a little bit, you could see our pace drop back down. Maybe margins move a little bit. I don't know. But right now, heading into 23, we like how we're positioned and what we're seeing in price and pace.

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

uh... yeah thanks a lot guys uh... appreciate the gross margin guide makes uh... makes a lot of times but it's certainly like to hear somebody said i wanted to ask you a question account a higher uh... those are sort of you know a uh... bigger picture question regarding what the potential ability of housing demand to remain robust in a rising rate environment. Obviously, that's a question that all of us are wrestling with and getting all the time. And the presumption is that demand is extremely strong and it's going to weaken when rates rise, kind of like what we saw in 2018 is what people say. My own personal view, and I'd be curious as to yours, is that demand right now is much more need-based than it was in 2018. I mean, if you look at the surveys, it seems like everybody thinks it's a horrible time to buy a house, and most people are very mistrustful of actually where home prices are. And so I think that unless you actually need a house, you're probably not looking to buy one right now, which means by extension that if rates rise, you probably won't see as much of a sticker shock or a buyer strike like you did in 2018. How do you think about that?

Yeah, I would agree with you, Stephen. And if you put it in the context of the demographic, you've heard everything about the millennials and how large it is, a group, how big the cohort is, and how they deferred the home buying decision for a decade. So you have 70 million people out there that are not seeing their needs met. They're getting married. They're getting better jobs. They're relocating. They're working from home, all these things you hear about that are creating strong demand. And then right behind that, you have another generation of 70 million people that are now hitting the home buying years that are just now starting their homeownership journey. So we see demand very strong right now. And if rates go up a little bit, I think you'll see demand stay strong. We've analyzed our backlog, and if rates went up a percent, it's not a real impact. And that's if If everything stayed the same and rates went up a point, think of the profile I shared with you. Here we are predominantly a first-time builder, and our buyer is putting down on average $67,000 in down payment. They have all the flexibility in the world to navigate a little bit higher interest rate, and they all want a house. And at the same time, you go to the resale side, There is no inventory. There's metropolitan areas with 1,000 homes available for sale in a city of 4 to 5 million. So there's no product on the market. And as we bring communities to bear in each of these cities, we have waiting lists or interest lists, I'll say, 300, 400, 500 people waiting. It's not unique to just one sub-market. It's a national phenomenon.

and that's good to hear uh... i guess my my only other question for you would be uh... related to market share i came to a big we seem to be in a unprecedented period where scale uh... really matters and um... i'm curious as to whether you're seeing any indication that uh... some of the the smaller builders are actually able to uh... accelerate their the product uh... or starts and production the way you are, or whether this is going to be yet another year of significant market share growth for builders such as yourself.

Yeah, I think you'll continue to see the larger builders take share. If you're a plumbing contractor, would you rather get a commitment for five to ten homes a week or one home every other week? And they're going where the volume is and the relationships that the large builders have created with the trade partners. And we certainly have a great, great relationship nationally. It helps you. And within our own business, our larger divisions are definitely having better success navigating the supply chain challenges where in Vegas, as opposed to where we're just getting going in Charlotte. Compare the two. You're well down the list in Charlotte for a framing contractor. In Vegas, we're at the top of the list. And I think if you use that as a proxy for what's going on out there with the small privates, they're struggling compared to what we can get done.

Thank you. Our next question comes from the line of Matthew Boulay with Barclays. Please proceed with your question.

Good afternoon, everyone. Thank you for taking the questions. And congrats on the results. So on the 2022 outlook, you know, clearly guiding a significant step up in net income, just purely on a dollar basis. You've always reinvested a large portion of the cash generation back into the business.

But as we think about this sort of large step up here in 2022,

You know, is there any thought to sort of excess capacity from a balance sheet and cash perspective that could be deployed to something more shareholder friendly, perhaps a more programmatic share repurchase? Just, you know, sort of how do you harvest the type of cash flow you'll be generating this year? Thank you.

I'll let Jeff pile on, Matt. It's a good question, and we share in our comments that it's a balanced approach just like we have over the last, five or six years. First and foremost is to keep profitably growing, quality investments, quality growth, take market share and grow our EPS and in turn improve our returns. But we always will look to the balance, just like we did in 21, where we bought back some shares at a good price. We upped our dividend, paying more in dividend, and we took down debt while investing $2.5 billion growing our company. So it's a very balanced approach. And I'd rather stay and keep putting the periscope up as the year unfolds and see how things are going and where we're headed and how are we doing in our growth initiatives and our profit projections. And then we'll make a call on how our cash is running and what we should do with it. But I think that's a better approach for us than to declare we're going to buy back so many shares of stock a quarter or we're going to do this or we're going to do that. I don't know if you want to add any. Yeah, I'd only add a couple comments. I think, you know, first and foremost, increasing our scale and expanding our returns by as much as we're looking at, I think is extremely shareholder friendly. And we're hoping to see some repricing in the shares, obviously, and the multiples and everything else reflecting the strong return potential to business and sustainability out beyond 2022. So that's first and foremost. But as Jeff said, you know, we are focused on reinvestment. We like the opportunities we're seeing. We think that's a really good use of capital. We're always open to it. We've opportunistically made sure we purchased it in the past with excess cash, and we probably look at doing the same in the future.

We don't have the the huge goal that we had years ago of reducing the debt side of things.

We have that fairly in line. So I think we're really well positioned right now, and that scale and return expansion I think is really meaningful for the company and should be very meaningful for our shareholders. Got it. Now that's really helpful. Thank you for that. And the second question, you know, Zooming in on the near term, you gave kind of the decline in orders quarter to date, and I hear you loud and clear that it's a difficult year-over-year comparison. Obviously, we're talking about December and January here, so how much do we really read into all that? And clearly, you gave the assumption around Q1 orders. But it just simply begs the question, given there is a relatively large decline in orders, Can you just kind of elaborate a little bit on that? Why, you know, do you look at all that and say that, you know, you're still – that there isn't some kind of signal around underlying demand there over the past six weeks?

Thank you. Yeah, okay. Matt, you kind of touched on one thing that I didn't include in my shared comments. It's the softest five or six weeks of the year in the industry, so a negative – there versus February, March or April is a much smaller number. And it's really the timing of weeks and how many communities we have open One thing I'd like everybody to take away on the call, we are seeing no weakening in demand and home buyer interest right now. The markets remain very strong. We have a lot of waiting lists. We're continuing to balance price and pace like we have been for the last year, and we think we're going to see a very strong spring selling season. It's very good out there right now on the demand side.

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

Thank you. Good afternoon, everyone, and congrats on a nice end of the year. My first question is, you know, you've talked in the past about reducing the SKUs in the design centers by about half and taking down some of the structural options in the business as well. Can you talk a little bit to where you are within that process and how you're thinking about the contribution of that simplification to 2022? Sure, Susan.

Rob's the owner of our studio, so... He can provide the insight. What I can share from my lens, strategically we're dropping SKUs right now to help ease the supply chain. And if you're offering three or four of an item, take it down to one or two, and you reduce choice a little for the customer, but you improve your ability to get the product and compress build time. So our mantra right now is to retain the personalization that's required and to give the customer choice, but it has to be something that doesn't get in the way of the supply chain and build times, and that's what Rob is working on. So Rob, do you want to provide some color for Susan? Sure, Susan. I would just say that it's an ongoing process. It's not an event. It's something that we're going to continue to be focused on, just simplification and speed throughout the whole organization. As Jeff mentioned, part of that is just finding the right or the appropriate balance or the sweet spot between personalization for our customers and construction speed, but um you know they're not some of them are win-wins all the way around example with whirlpool our appliance uh supplier we converted to Stainless steel appliances is the included feature in all of our homes, and just that action alone minimized the SKU count from over 400 appliances to under 150, which significantly improved our lead times. It simplified our internal processes, and it also adds value for our customers because they're getting a better product.

Yeah, and I guess just following up on that, does it suggest that even as the supply chain normalizes and some of these headwinds abate, that perhaps you can stick to something that is just a bit more refined for the consumer? Because it doesn't seem like you're having any pushback on it from the consumer's perspective. You're sort of getting to still that personalization that they're looking for, but at the same time just making things a bit more efficient for everyone.

Yeah, I think that's a good way to look at it. I mean, it's almost a necessity right now because of the supply chain issues, and we're focused on maintaining the SKUs that are most readily available in the supply chain. But even once those supply chains and the cycle time issues go away, it allows us to run a more efficient operation. So, again, it's just finding the right balance between what our customers want and personalization and what's efficient for our businesses.

Thank you. Our next question comes from the line of Michael Rehart with J.P. Morgan. Please proceed with your question.

Hi, Rehart. Good afternoon, everyone. Congrats on the results. First question, I just wanted to circle back a little bit to gross margin trajectory, and it makes a lot of sense that, you know, aside obviously from a lot of the hard work that you guys have done over the last couple years repositioning the company, you know, from a timing perspective, you know, looking for gross margins to start expanding in the first quarter. I'm sorry, second quarter is pretty important from a, you know, kind of in our view, at least coincides with potentially some of that lumber benefit coming down, coming through the pike. And I was hoping it's possible to try and isolate That particular, you know, factors impact on gross margins as you think about 2Q and 3Q of 22. And also, you know, Jeff Kaye, you had mentioned lower interest amortization. If you had a sense of, from a basis point perspective, what type of differential that might be in 22. Okay.

Sure, Mike, I can help you out with those. On the amortization side, on the interest, I think it's going to be somewhere in the neighborhood of 50 basis points for the full year of improved margin coming off that. Relating to the cadence, you know, second quarter, we're looking at a pretty nice step up in margin right now through what we're seeing in the backlog that obviously always changes depending on mix and what we deliver out in Q1 and supply chain and construction cycle time and everything else. But we should start seeing that nice step up beginning in Q2. You know, if you think about those Q2 and Q3 deliveries, when those sales were booked and those homes were started, you know, lumber was at a relatively low point as we saw it dip down and now coming back up again. So there's probably more risk, I'd say, in the fourth quarter on any lumber moves than we'd see earlier in the year. But we are expecting to see sequential improvement as we move through the year. And I think very importantly, with the new sort of portfolio, and we have, you know, half our portfolio every year is more or less new. And with the portfolio that we're seeing coming through this year and the performance of those new communities, I think that exit rate will be a really nice indicator for strong margins in 2023. So, you know, we're not obviously going to guide out that far at this point. There's a lot of things between now and the end of the year. to consider. But I'm really quite happy to see sequential improvements as we move through the year because it just gives you a nice exit rate for future years. So that's the way we're seeing it right now.

Right. Okay. So, no, I appreciate that, Jeff. And just to be clear, you know, what you're implying and from a math perspective obviously makes all the sense is that you know, 4Q gross margins would be higher than the full year average. You know, kind of the second question, and correct me if I'm wrong there, but the second question just on going back to sales pace, obviously the, you know, roughly six or six and a half for the full year of 21, extremely impressive. And, you know, I believe Jeff Nesger, you said earlier that you'd think, given the current demand backdrop, that that is effectively sustainable for the upcoming year. I was curious if, you know, in the most recent quarter, you know, roughly what percent of communities might have been still on restriction or, you know, restraining sales to better match production capacity and cost matching and things of that nature? Um, you know, because, you know, if you're doing the rate that you've done in 21 with those sales restrictions, um, you know, it, it certainly, um, adds confidence to the statement that, you know, you could have sold at even better rates, uh, and, and therefore, you know, kind of adds confidence to, to, to a view that maybe six, six and a half is still, you know, the right number for, for the next 12 months.

Yeah. Well, Michael, it's a good observation. It's what I shared in my comments. You can say we're limiting releases because we're managing to no more than six a month, and that's the average. Every asset's got a different story. If it's a high-end community with limited number of lots and you're not going to replace it, you have a lower sales rate because you want to mine all the price you can in that location if it's easily replaceable. out in the suburbs and there's vacant land near you and, you know, it's not a cost-intensive market, say it's in Texas, you go and you let it run and then you go replace it with the next one. And my comment was that the market stayed where it is today and we sustain the margins we are today, which we think we are. You can run this thing at over six a month, and it's a real sweet spot. You get to leverage everything. You get the benefit of scale. and you grow your returns. There's a lot of benefit to doing six a month instead of four a month in our business model. So we think it's sustainable right now.

Thank you. Our final question comes from the line of Mike Dahl with RBC. Please proceed with your question.

Thanks for putting me in. This first question, I just want to follow up to put a finer point on some of the cadence, I mean, it not only looks like 4Q exit rate would be, you know, above the, you know, the full year average, but it seems like you're targeting something like a 28 to 29% as you kind of ramp through the year and having to get to that level to reach your full year. So maybe if you could put any context around whether that's fair. And then within that, I know someone asked about kind of, what you're seeing on costs currently but um maybe just what is what is the net inflation number that's that's embedded in your your full year um guide sure so first of all on the exit rate you're probably a point high in your range um you know probably probably get more 27 28 but we'll we'll refine that as we go through the year in the quarters um obviously we haven't sold a lot of those homes yet um Most of that selling will take place during the spring selling season for deliveries out in the fourth quarter. So it's still a little bit of a paper forecast as opposed to looking at our backlog. But it's probably a little higher where I would expect to end the year, but we'll see. The second part of your question, remind me, Mike. Just what is the net inflation assumption embedded in that? Right, yeah, so what we do on the costs and on the margins on anything in backlog where we have locked costs and locked price, we just look at our backlog margins. So, you know, in essence, there's no further cost inflation assumed on those sales. You're making assumptions on a little bit of, you know, sold and delivered spec inventory as we go through the year and what's happening there and what's happening in pricing, but we're not – Because of the way we lock the cost, we really don't have to be very concerned about cost inflation on our backlog. And it's, you know, what, two-thirds of our total deliveries. I mean, we have $5 billion in backlog, so we're pretty safe on that. The uncertainty for the year is mainly in the back half, and especially in the fourth quarter. It involves, you know, some of the pricing coming off. And what happens with costs is they move, particularly over the next three or four months. That's, you know, where we have more risk on that cost-price relationship. But, you know, from what we're seeing today and what we've seen week after week after week as we've gone through, particularly over the last six or nine months, we're seeing margins expanding almost every single week. So we're pretty excited about, you know, where the markets are. I'm very excited about the portfolio communities that we have right now. Yeah, that makes sense. Thanks for that, Jeff. And then my follow-up question is, you know, I know you had some helpful commentary around, you know, the things that you look at which aren't showing any signs of stress from an affordability standpoint. You know, Jeff and I think your opening comments, Still said, you know, you do still want to be watchful around affordability. So the question is, you know, you've got pricing power today, clearly. How do you expect to approach your pricing decisions through the spring, through the year? Keep an eye on that. And how much, you know, may or may not be governed by what you end up seeing on rates? Well, that's a weekly look. Every community, like we always do, Mike, we work through what's the right run rate at this community at this margin to give us the highest return with how many lots we have left and what's coming behind it. And there's a process that we literally go through every week. And in today's environment, it's been a nice combination where we're lifting pace and lifting margin at the same time. If rates go up, we'll have real-time feedback on what that means, if anything, with this customer today. And part of what I was trying to get across, this buyer profile, a lot of people look at a first-time builder and say, well, it's a more challenged buyer. And that's absolutely not the case with the amount of equity that our buyers are putting into their home, the high credit FICO score that they have. and their desire to be homeowners, this is nowhere near even close to a stress buyer today. They have a lot of flexibility to navigate this thing with us, and we'll have indications along the way. So we'll continue to toggle price and pace. And as I've said a few times now, we really expect a strong spring, really strong spring selling season. Demand is very strong out there.

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

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