Q3 2020 KB Home Earnings Call
Good afternoon, My name is government and I'll be your conference operator today I would.
I would like to welcome everyone to Kb homes, 2023rd 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 Kb home dotcom through October 22nd No I would like to turn the call over.
To Jill Peters Senior Vice President Investor Relations, Joe you may begin.
Thank you Devin good afternoon, everyone and thank you for joining us today to review our results for the third quarter of fiscal 2020 on the.
On the call are Jeff Metzger, Chairman, President and Chief Executive Officer, Matt Man, Dino Executive Vice President and Chief Operating Officer, Jeff Kaminski Executive Vice President and Chief Financial Officer, So Hollander Senior Vice President and Chief Accounting Officer, and Thad Johnson Senior Vice President and.
Treasurer Bill.
Before we begin let me note that during this call items will be discussed that are considered forward looking statements within the meaning of the private Securities Litigation Reform Act of 1995.
These statements are not guarantees of future results and the company does not undertake any obligation to update them due.
Due to factors outside of the company's control, including those detailed in today's press release and in filings with the Securities and Exchange Commission.
Actual results could be materially different from those stated or implied in the forward looking statements. In addition, a reconciliation of the non-GAAP measures referenced during today's discussion to their most directly comparable GAAP measures can be found in today's press release and also on the Investor Relations page of our website.
At Kb home dotcom and with that I will turn the call over to Jeff NASCAR.
Thank you Joe Good afternoon, everyone. We hope you your families and your colleagues continue to be healthy and safe.
After navigating through the initial disruption from cobot 19 that we experience in the spring.
We are encouraged by the robust recovery in housing market demand that has favorably impacted our business.
We're very pleased with our solid third quarter results.
A key highlight of which was our significantly higher margins, reflecting the strong demand.
And a leaner more efficient business.
Equally as important as the strength of our financial results.
This quarter was the acceleration in our net orders and growth in our backlog.
Physicists and positions us very well as we move into 2021.
Specific to the quarter, we generated total revenues of about $1 billion and diluted earnings per share of 83 cents.
We delivered higher profitability year over year on a lower revenue base with an hour.
With an operating income margin that expanded 180 basis points to 9.6% excluding inventory related charges.
Our operating margin growth was due almost entirely to the expansion of our housing gross margin, which.
Which increased to 20.6%.
On a per unit basis, we grew our operating income to nearly $37000 an increase of 23%.
Finally, our execution during the quarter drove our pre tax income, 10% higher year over year to over $100 million.
Our balance sheet is solid with over 1.5 billion in liquidity, no goodwill and a leverage ratio of 40.5%.
Which was down nearly 500 basis points year over year.
On a net basis, our leverage ratio was 28.6%.
From an inventory standpoint, we own all the lots we need to support our growth target for 2021 and all.
And own or control all the lots we need for 2022.
With our ability to generate significant levels of cash flow and the health of our balance sheet. We are operating from a position of strength.
And we have the ability to capitalize on future opportunities to drive growth and returns.
One of the ways. The cobot 19 impacted us during our second quarter was our temporary pause in our land development and construction of models.
As a result, we opened only 19 new communities during our third quarter.
At the same time, our sizable absorption rate contributed to selling through more communities than we had anticipated just three months ago, causing our average community count to decline by about 7%.
We are working to rebuild our community count with over 30, new community openings planned for the fourth quarter.
Additionally, as we look ahead to 2021 when.
We anticipate approximately 135 new communities.
The highest annual number of openings in many years.
The composition of our portfolio continues to strengthen with our core communities expected to represent approximately 95% of our count next year.
Given the profile of deliveries from reactivated communities with lower Asps and gross margins decline.
The quality of our overall book of business continues to improve as we rotate out of these communities.
On a macro level mortgage interest rates remain at historically low levels underpinning favorable supply and demand dynamics.
Existing single family home inventory is just 3.1 months and below that level in many of our markets, particularly at our price points.
This limited level of resale inventory and.
And an under production of new homes over the last decade.
Along with favorable demographic trends are fueling demand.
In particular, the demand for new homes has arisen because of the perceived health and safety benefits energy efficiency advantages Smart technology features and the desire to move away from dense urban areas.
During the quarter, our monthly absorption pace per community accelerated to 5.9 net orders representing a year over year increase of 36%.
This was our highest pace of any quarter in more than a decade.
Even as we increased prices in the vast majority of our communities and.
And was achieved within our overall objective to balance price and pace.
Optimize each asset and maximize returns.
We continue to believe that the choice and personalization offered by our built to order model are the key drivers of our absorption rate, which has long been one of the highest in the industry.
Our business model also enables us to quickly shift our product offerings in response to consumer trends to.
To that point, we announced our new Kb home office options in August.
We are excited to have moved quickly to offer a feature so relevant to buyers today and.
And we look forward to seeing how our customers respond to this option.
As it continues to be rolled out in model homes across our footprint.
At the time of our last earnings call in June our net orders were up 2% for the first three weeks of our third quarter.
We gained momentum as the quarter progressed with year over year net order increases of 11% in June 23% in July and 50% in August.
Overall, our net orders advanced 27% in the third quarter.
On top of a robust 24% year over year comparison in last years third quarter.
From a geographic standpoint, our order strength was broad based across our footprint from a low.
From a low of 5% year over year growth in our southeast region to a high of 39% growth in our West Coast region.
We believe our strategy of building communities and desirable areas.
And pricing our homes to be attainable to the median household income for that specific location are compelling for buyers.
Because of the cautious approach we took in reassessing our backlog in our second quarter, our cancellation rate has not own a normalized it declined to 17% in the third quarter.
Looking at our underlying buyer data for orders in the third quarter, we see a few interesting post pandemic shifts taking place that we view as favorable for our business.
First we experienced a solid increase in our share of millennial buyers, which.
Which accounted for about 56% of our orders as comes.
As compared to 51% in the prior year quarter.
With population estimates showing that millennials are now the nations largest adult population.
And with millennials in their prime household formation years.
This cohort will remain a key driver of home buying demand.
Gen Z is even larger in size at $90 million and is poised to follow as they are now at the start of their home buying years.
Second our percentage of first time buyers increased to 64% of orders.
Up more than 10 full percentage points from the third quarter of last year.
The third and final point is that buyers are expressing a preference for build to order homes.
Which represented 75% of our orders as compared to 70% in the third quarter of last year.
While our base prices have risen and our first time buyer share has increased we're seeing buyers spending slightly more on personalizing their homes and our design studios.
Taken together these data points reflect what we believe is a significant opportunity ahead as we continue capturing the dimmit demand from millennials and the emerging demand from Gen Z's.
On the mortgage side, our joint venture KVH has home loans continues to effectively support and communicate with our customers which is.
Which in turn provides better predictability for us and managing through the closing process.
The JV is capture rate continued to rise in the third quarter to 79% the highest since its inception.
Contributing to the increase in our deliveries and growth in the JV was income of about 85% year over year.
With the significant level of net order growth in the third quarter, our net order value expanded 29% to 1.6 billion driving our backlog value up to $2.6 billion on nearly 6800 units.
We are working to convert this backlog to deliveries pacing our starts with our order rates.
We have historically operated with a roughly six month cycle time, which we define as the time from contract to closing.
As a result of the disruption from covet our cycle time has extended to approximately seven months.
Weve incurred slight delays in various components of the process that I'll add up to about a 30 day extension.
We are making progress in addressing the areas, causing the delays and expect to return to more normalized cycle times on deliveries by the end of our 2021 first quarter.
Another factor we are monitoring is the wildfires in California.
While the fires have not had a material impact on our business to date. There is some unpredictability. During this fire season with respect to utility crews potentially being redeployed for emergency purposes.
It could cause some additional delivery delays.
Turning now to current trends in the first three weeks of September our net orders are up 32% over the comparable prior year period.
For the remainder of the quarter, we expect to continue to be able to lean on price in our balancing price and pace each week to optimize every asset.
These price increases are also expected to help offset cost inflation and support our margins.
In closing the resumption of housing market demand that marked our third quarter was remarkable and we're now poised to end the year with much higher revenue and margins than we expected just three months ago.
Looking ahead while.
While we remain mindful of the pandemic, we expect continued favorable market conditions and.
And a significantly higher backlog at the end of the year and we believe we are well positioned to support over 5 billion in revenues and expanded returns in 2021, we.
We look forward to updating you on our progress on our next earnings call in January.
With that I will now turn the call over to Jeff for the financial review Jeff.
Jeff.
Thank you, Jeff and good afternoon, everyone.
I will now review highlights of our financial performance for the 2023rd quarter provide details on our outlook for the fourth quarter and discuss our 2021 housing revenue in community count expectations.
During the third quarter, we produced strong results that reflect a considerable improvement from our cobot 19 impacted second quarter.
With higher than expected deliveries signal.
Significant growth in our gross profit margin enhance.
Enhanced efficiency and an accelerated order pace.
In addition, we continued to strengthen our balance sheet and liquidity.
In the third quarter housing revenues totaled $979 million compared to $1.15 billion in the prior year period due prior.
Due primarily to a 16% decline in the number of homes delivered.
The lower deliveries in housing revenues, principally reflected the substantial impact of the cobot 19 pandemic related disruptions on our net orders and cycle times during our second quarter.
Despite lower third quarter revenues, we generated double digit percentage increases in both net income and earnings per share as compared to the year earlier quarter.
Reflecting the pandemic related impacts in the second quarter, our backlog at the beginning of the third quarter was down 14% year over year how.
However, with our strong absorption pace driving a significant year over year increase in net orders. We ended the third quarter with 6749 homes in backlog.
Up 8% from 6230 homes a year ago.
Our ending backlog value increased to $2.6 billion up 12% versus the prior year.
Both the number of homes in backlog and our backlog value were at their highest third quarter level since 2007.
Considering our quarter end backlog status of our homes under construction and current construction cycle times, we anticipate our fourth quarter housing revenues to be in the range of $1.05 billion to $1.15 billion.
Due to our strong third quarter delivery performance and higher fourth quarter expectations. We expect our full year housing revenues at the midpoint of our guidance will be up over $200 million versus the midpoint of our prior guidance.
In the third quarter, our overall average selling price of homes delivered was up slightly year over year to approximately $385000.
We anticipate that was previously implemented selling price increases and a greater proportion of our deliveries coming from higher price communities, we will generate both sequential and year over year improvement in our average selling price in the fourth quarter to approximately $415000.
Third quarter homebuilding operating income increased to $88.9 million, reflecting a 150 basis point improvement in operating margin to 8.9%.
Excluding inventory related charges of $6.9 million in the current quarter and $5.3 million in the year earlier quarter. Our operating margin was up 180 basis points year over year to 9.6%.
Primarily due to expansion in our housing gross profit margin.
For the fourth quarter, we expect our homebuilding operating income margin, excluding the impact of any inventory related charges will be in the range of 9% to 9.4%.
Given our strong third quarter operating margin performance and our raise expectations for the fourth quarter, we have lifted our full year projection by approximately 120 basis points at the midpoint as compared to our prior guidance.
Our housing gross profit margin for the quarter was 19.9% up 140 basis points from 18.5% for the prior year period the curve.
The current quarter metric reflected favorable impacts from a mix shift of homes delivered lower.
Lower amortization of capitalized interest.
Reduced workforce expenses included in our construction costs and a favorable pricing environment during the period.
Excluding inventory related charges, our gross margin for the quarter was up 170 basis points year over year to 20.6%.
Our adjusted housing gross profit margin, which excludes inventory related charges as well as the amortization of previously capitalized interest was 23.7% for the third quarter compared to 22.3% for the same 2019 period.
Assuming no inventory related charges, we expect our fourth quarter housing gross profit margin to be in the range of 20.0% to 20.4%.
Our selling general and administrative expense ratio of 11% for the quarter improved slightly from 11.1% for the 2019 third quarter due to cost reductions implemented late in the second quarter, partly offset by decreased operating leverage from lower housing revenues.
As we anticipate selectively adding resources to support the expected growth in topline revenues during 2021, we.
We believe that our fourth quarter SGN, a expense ratio will be in the range of 10.8% to 11.2%.
Our effective tax rate for the quarter was approximately 23%, reflecting $22.9 million of in income tax expense net of a $3.1 million benefit from federal energy tax credits we.
We expect our effective tax rate for the fourth quarter to be approximately 24%.
Overall, we reported net income for the third quarter of $78.4 million or 83 cents per diluted share compared to $68.1 million or 73 cents per diluted share for the prior year period.
Turning now to community count our third quarter average of 238 decreased 7% from 255 in the year earlier quarter.
We ended the quarter with 232 communities as compared to 254 communities at the end of the 2019 third quarter with over half of the decline due to a reduction in the number of communities that were previously classified as land held for future development.
Our lower community count reflects accelerated closeouts due to our net orders per community increasing to 5.9 per month as.
As well as delays in opening new communities.
We invested $410 million in land land development fees during the third quarter with $220 million of the total representing new land acquisitions.
We ended the quarter with a strong supply of more than 60000 lots owned and controlled representing a 3.3 year supply of owned lots based on home deliveries in the last 12 months in lots controlled comprising 37% of the total.
As we expect continued robust absorptions to drive additional community Closeouts, we anticipate our fourth quarter average community count will decline in the mid to high single digit range as compared to the 2019 fourth quarter.
Favorable operating cash flow drove total quarter end total for sorry drove quarter and total liquidity to over $1.5 billion, including $722 million of cash and $788 million available under our unsecured revolving credit facility.
This compares very favorably to both our 2019 year on total liquidity of $1.2 billion.
And the $611 million of total liquidity at the end of the 2019 third quarter.
Contributing to our substantial cash position was an eight A.M.T. tax credit refund of $43 million, we received during the third quarter.
We currently expect to receive an additional $40 million refund in the fourth quarter.
We have had no cash borrowings under our 800 million dollar credit facility at any point in time during 2020.
For 2021, with our anticipated higher year end backlog strong quarter pace per community and more normalized cycle times, we expect to generate full year housing revenues in the range of 5.12 $5.5 billion.
In addition, we believe our ending community count will remain relatively flat on a sequential basis for the next two quarters and then start to increase in the 2021 second quarter.
We believe this relatively modest near term progression will result in an approximately flat full year average community count as compared to 2020.
However, with planned community openings anticipated to exceed Closeouts in the last three quarters of next year, we expect our community count at the end of 2021 to be up year over year in the mid to high single digit range.
In summary, we are pleased with the third quarter financial performance and believe we are well positioned to achieve our targets in the fourth quarter and beyond we.
We believe the improvement in our already strong average sales pace per community solid quarter end backlog expanded gross profit margin and more efficient operating structure support our goals of accelerating profitable growth and enhancing our returns.
We will now take your questions Devon. Please open the lines.
At this time, we'll be conducting a question and answer session. If you would like to ask a question. Please press star one on your telephone keypad a confirmation. So we're indicating line is in the question queue you may begin.
You mean for start to fuel the term will be a question from the queue for participants in speaker equipment. It may be necessary to pick up your handset for price and the starts and as a reminder, we ask that you limit yourself to one question and one follow up.
Our first question comes from the line of Matthew Blair with Barclays. Please proceed with your question.
Good afternoon. Thank you for taking the quest.
Thank you for taking the questions and congrats on the quarter.
Wanted to start out asking.
Looking around the cadence of orders that you disclosed the August up 50% in September up 32% for the first three weeks.
I guess, if you could delve into that a little more than one thing we've seen in our checks is pretty minimal evidence of that typical seasonal slowing so I guess.
I guess, if you could speak to maybe the year over year comparisons as you think September is actually indicating some normalization in housing here or or things like the labor day shift is there anything else comp wise on a year over year basis is distorting that thank you.
Yes.
Thanks, Matt.
The comp in September is is down because September last year was stronger for us than August and it's it's one of the dangers when you're given monthly trends your orders can move up and down.
In one year in any given month and then at that May distort what's going on in the following year, but we can tell you for the first three weeks of September we've seen no slowdown from August it's.
It's purely the timing of the year over year come September demands very strong.
Okay got exactly what I was looking for.
And then secondly, just the gross margin guide that.
That Jeff K., you just gave.
The sequentially lower in Q4, which is a little bit unusual for you guys. So curious if you could kind of walk through the pieces that are driving that whether there's an assumption of lumber and labor that thats starting to impact you already.
Obviously, you've had some strong pricing trends, which seem to have already helped Q3. So just why that wouldn't necessarily offset some of the.
Some of these inflationary impacts in Q4, just any additional color on how you're getting to that number. Thank you.
Jeff you want to walk through that.
Jeffrey out there.
Yeah, sorry helps if I take it off mute sorry about that so.
Thanks, a question, Matt relative to the third quarter, a couple of things to keep in mind, one we had a pretty strong pull forward into the third quarter of higher margin deliveries. So the big the strong beat in our topline in Q3 was due in part to some pull forward in that pull forward and happened to be in some of the higher margin communities.
It's helped us.
The second point typically what we see in the fourth quarter is a lot more leverage on the fixed cost assets included in our construction cost number this.
This year, we are not expecting to see that primarily for two reasons. One we're not seeing as much of a delta as much of an increase in fourth quarter revenues as guided as we just experienced in the third quarter and number two we are looking to add incrementally to some of those fixed costs in the fourth quarter as we prepare.
For a big surge in deliveries in revenues in 2021, so that leverage factor that we normally see that helps us in Q4 relative to Q3 is probably wont be there at least not as strong as typical so really when you look at it if you shift back to looking at it on a year over year basis.
The midpoint of our guide we are up about 30 basis points. If you consider the loss of leverage on a year over year basis were actually up about 60 basis points year over year, partially.
Partially coming from reduced amortization, partially coming from reduced headwind from reactivated communities and the rest.
The rest of it just basically coming from mix so.
I think the guidance pretty solid for the fourth quarter I think the high.
A highlight for me absolute highlight as we were able to not only beat.
Our expectations in Q3, but we were actually able to actually lift our expectations for.
For Q4, and hopefully it's not lost on anyone that this would be if we achieve our our guidance range in the fourth quarter. This will be two quarters in a row of 20% plus gross margins, which is a.
A big deal for Us and a nice number as we move forward.
Our next question comes on line and Stephen Kim with Evercore ISI. Please proceed with your question.
Yes, thanks, very much guys, obviously with strong environment out there.
Your build to order model.
It looks like we're really not seeing yet all the goodness that is sort of building up in your backlog a year ago.
Your guidance sort of assume that at a 40% backlog turn which as you know much lower and you've addressed the cycle time issues. So what I'm really curious about is what's happening in that backlog.
With the build to order model I would think that you.
That you are seeing an increase in upgrade.
Like that home office set up you launched earlier in the quarter. So I was curious can you give us a sense for what to the trends look like in your backlog with respect to spend on up options and upgrades.
Where that stands relative to history.
And was there any of that that landed in Threeq Q. I would guess not but just thought I'd ask.
Yes.
Stephen It's an astute observation that the best is yet to come.
If you think about a built to order business and the cycle times the strengthen in sales in July and August isn't going to materialize till Q1.
Of next year, not Q4 and didn't do anything really to the Q3. This FICO.
I shared in the prepared comments that are in our orders, we thought it'd be helpful to compare our order mix because as post pandemic and there's no noise than this was real buyers on what they're doing we're move.
We're moving our sales prices up we shared that and we're seeing an incremental uptick in studio spend not dramatic our studio spend has been fairly consistent for a few years now, but it did tick up a little bit here in.
Q3, so it tells you that even a first time buyer who's paying a higher price for the home is still personalizing, including a little more into the studio. We just rolled the office concept out in late August and it's currently going across the footprint, we think its a real.
A real appeal for todays consumer and this shift to to work from home more and we think it can help with our not only selling homes, but the revenue side as people finish out their selections on the the office, but most.
Most of the strength in the in the third quarter as you touched on it will show up in Q1.
Got it yeah, that's a that's really encouraging.
As we think about the cycle time issue I think you said, Jeff that you expected it to be pretty much back to normal by the end of your first quarter next year. So like February of next year I, just want to make and I assume that means like be on back to kind of a six month kind of a cadence.
So should we be thinking is that normal means backlog turnover ratios similar to what you experienced in 2019.
Or does normal mean something different in light of any changes that may have happened over the course of this kind of unusual year.
Yeah.
Well, it's certainly not a normal year end and as our backlog ramps up but we'll see how the the conversion plays out in 21, but as as things fully settle out I think you will see us get back to a normal backlog conversion is you have a.
A nice problem right now and that your backlog is much higher than your your run rate. So you're building up backlog and you can.
In play through as you fix a cycle times I have.
Yeah.
That man Dino is on the call our Chief operating Officer, Matt you want to talk a little bit about what we see in the cycle times and what what we are doing what we've already done and what we've already accomplished to to gain back some of what we lost in early Q3.
Sure Steve.
Stephen I.
I do think we're going to we're on the path to get us back to.
More traditional 2019 type rates, we look at.
The Ed up fraud before we start the house, what does that take us what's our traditional build type as well as from final to close and if you break all three out over the last 90 days, we've made improvements across.
All three categories.
In large part where we're relying on virtual and digital tools.
And kind of this hybrid approach, but it.
We're making meaningful progress and a good example is even the time going through the studio process for us.
It is now.
Now we're at a 50 50 split between virtual appointments and in person appointments and.
What originally started Stephen as a as a means to keep things going in the early stages of Covance has now turned into a unique way to expand capacity and potentially get customers through at a at a faster clip. So I do feel we're on track in as you described the key.
Because getting back into more of a norm.
Our next question and of Allen Latin.
Yes.
Oh. Please proceed.
Well I was going to share that.
As not only in the studio the cities have had to learn how to handle permit applications and they all had a big log jam. So we'd final people in the studio and then you couldn't pull the permit with the options. They selected because of the cities were backed up than we got past that we get into starts that inspections. Good.
Backed up so there are all these little things that were happening.
In.
June and July is the the whole country pulled out of the initial disruption and were quickly seeing everyone figure out their part of the process how to compress time. That's why we we have confidence we'll be right back to normal by delivers the end of Q1.
Go ahead Alan.
And our next question comes from the line of Alan Ratner with Zelman and Associates. Please proceed with your question.
Hey, guys. Good afternoon, and congrats on a really strong quarter glad to hear everyone is doing well.
So I guess my question is kind of a follow up from that the topic on cycle times and obviously.
Obviously it sounds like you guys are very focused on it Mike. My question is and this might not be a data point that you have handy, but I guess the question is what are your starts.
Trending at in terms of growth on a year over year basis, because we're seeing some pretty remarkable order numbers from you and others over the last few days and it's occurring to me that at some point. These homes are going have to be started so that at the time when you seem to be pretty confident you're going to be getting your cycle times back to normal levels. It.
Seems like the industry is going to be wrestling with a pretty dramatic surge in starts which might work against you. So I'm just curious what what you are seeing on the start growth side and if there is still a lot of ground to be caught up here to to match with your your recent order success.
But I shared in the prepared comments Allan that were mentioned starts with sales and there is a little bit of a lag because our sales were in ramp up and then your starts will ramp up 45 to 60 days after that so.
We're not going to sell them unless we can start them and close them. So we're pretty much in balance right now our starts to ramp them up proportionate to the sales growth.
But would that 45 60 day lag I'm just looking at the trajectory on orders you know your August orders were up 50, so presumably your starts if thats going to be more representative of maybe July right. So there's still a lot of growth that that's out ahead of us.
Well again, I touched on or before the August comp was stronger.
Our gross sales were better in August and July but part of the comp is because August last year for whatever reason was.
It was a little softer than July or September so our sales have been pretty constant for the last eight to 12 weeks and we're now starting to push those starts out the door in alignment with the sales.
And I think there has been to your point macro there has been an uptick in in housing activity in all the cities we operate in and the cities have had to figure out how to deal with it as well and they've all got their own nuances in stores with the cities are doing much better now I'm pulling permits than they were.
90 days ago now once you get past the permit and the start then it's the arm wrestle for the the subcontractor base and we love our position there because we have scale in the cities. We're in with relationships that are in some cases 30 to 40 years long. So we don't have any concern right now on some capacity.
Got it okay, that's helpful and good to hear.
And then second on I apologize if I missed this but with the price increases that you've been pushing forward over the last couple of months do you have an estimate on what kind of your apples to apples pricing either on a price per square foot basis, or however, you guys look at it is.
Is up over the last call it six months since before the pandemic.
Yeah, I don't know, Jeff if you have a sense of that I I certainly don't because the.
The mix can change.
I know there are up.
No it absolutely could be speculation.
Right same for me, Jeff I mean, you have the mix that comes into it plus you have the pricing relating to deliveries versus orders. So koujalgi with Alan Alan I will say the pricing activity that we've seen.
<unk> has obviously been a net positive for us and we anticipate.
The ability to offset that fairly large increase in costs as we have coming up.
Yes, and that were to happen into next year. So we want to stay ahead of the cost moves for sure and if the market allows that we'd like to be able to price for that and then in the quarter. We had a lot of success and.
And moving price and a lot of the communities in small increments generally but definitely helpful. On the gross margin side.
Our next question comes from the line of Truman Patterson with Wells Fargo. Please proceed with your question.
Hi, Good afternoon, guys great results the first.
You will essentially have the highest absorptions in the industry you know a touch over four per month.
Throughout the entire year.
Third quarter absorptions were up really strong 36% or so.
What is the absorption level that you're assuming to really hit that 2021 community count targets do.
Do you think there's a little there's room to run a bit hotter or above that four per month or are you. All you know really looking to curb it pretty meaningfully was with pricing.
Yes.
A little of both Truman because it is balancing price and pace.
We've we've raised our stated strategy now to five a month and we did that it prior to the last quarter call frankly, but.
At 5.9, it tilted to the high side, but we're playing will catch up relative to the backlog, we need to turn our our assets and as we laid out our plan for next year it would be higher than the four but not at the certainly not the 5.9, we ran in Q3 and if market.
Conditions remained strong we have the lots to do more than.
What's in our plan so.
We like our position on that side and if you think about it heading into this year. Our plan was higher than were going to deliver by a few thousand due to the disruption in Q2. So you already have all those lives and then you had everything you had tied up for the following year to grow from there. So we have a very.
Solid land and lot position right now to achieve our targets next year. If the market holds like today you'd have upside from our targets.
Okay, Okay and then.
Jeff Kay.
Question for you on on gross margin no. It's clearly been a key focus for you all it's really helped drive.
Returns higher but whenever I'm looking out to 2021 it looks.
It looks like you're going to be turning over to maybe 60% of your communities.
How should we think about.
Gross margins going out a year is there any risk of them rolling over just due to the newness of the communities, which usually have lower margins.
To start and then kind of netting out.
Your your reactivated land rolling off lower interest expense et cetera, how should we kind of think about the moving parts.
Right well a couple of things on it as you know we're very focused on operating margin expansion, we really see that as a critical.
Lever for us to drive increased returns and we'd like to continue to to focus on expanding that operating margin gross margins very key component of that and.
And you know the the phenomenon that we're seeing now with the rolling over of communities in a lot of Closeouts replaced a lot of Grand openings. We've been in this phase true actually several years now.
We tend to turn.
Turn over a lot of communities. So you have different communities at different stages in their life cycle.
And although land has been appreciating so as pricing. So we do believe we can maintain gross margins, we'd like that 20% plus number at this point, we're not really prepared to guide on under give a lot of detail in the next year other than to say, we are definitely targeting more expansion on the operating margin side.
And that would.
But a lot of focus on that gross margins being at or above those levels.
We also think for next year with the improvement on the topline and.
Pretty large step up actually in topline housing revenues that we'll see much better leverage on our SGN today, and we were we've been a little disappointed with some of the volume fall off this year and yesterday percentage and we'd like to see that we'll be back down. So we're optimistic actually in our ability to drive further operating margin expansion.
We'll come back in January give you guys more details into forecast in more details on the components in the numbers, but.
Rest assured we are targeting.
Improvement in that area.
Our next question comes from the line of John Lovallo with Bank of America. Please proceed with your question.
Hey, guys. Good evening, thanks for taking my questions.
The first one Jeff that CHF and it seems like you are pretty confident that you guys have balanced sales and starts pretty effectively but do you think that the industry at large has done the same or you think that you are kind of the surge in sales that Allen was alluding to is that going to drive labor cost inflation and maybe sustain the rise in lumber that.
We've seen although it typically would pull back on a seasonal basis.
Yeah well.
I don't know that the the lumber pricing is tied to to a surge in volume as much as it was tied to a shortage of supply while the mill shutdown.
They had a heavy inventory position then covert hits the mills shutdown and end up with no product and Thats, what pushed the prices up and as the mills are reopening and gaining production again, that's why you're seeing the lumber futures come back down already so I don't know that that was necessarily.
Homebuilding activity driven couldn't tell you about other builders and how their position with their their starts but we feel in our approach where we have these long term relationships, we build to a cadence tied to a sales rate tied to our backlog the subs value every day.
We haven't starts and they'll plant their teams in our communities and know that we can keep them busy and they stay there and there is no peak in value. So if if we start.
Eight a month for four months in a location and somebody else started 16, and then non and then 16 and then on the subs value our approach far better and they are more profitable at a lower price to us because they don't have the the peaks and valleys of managing their labor and materials.
So.
I do believe that the market is going to go up.
Pick up in activity I didn't touch on it before when Matt and I were talking about the cycle time buckets, but a lot of our subs have had to react to.
Two.
The disruption another rebuilding their teams and it's taken us some time to.
Create the foreman to handle another crew.
Another foundation crew in the city, but theyre not doing that as well. So I think the industry has the capacity and I think you'll see the industry create a lot of jobs out of us.
Okay. That's helpful and then southeast division seem to to lag a little bit in terms of orders pick up 5.5% year over year was this a community count issue or something else.
It absolutely is community count driven the Jeff you've got the detail I think on the the improvement in the absorption rate and what we're looking for next year.
Right, Yes is specifically for the third quarter the absorption pace increased 26% in the southeast so that was offsetting.
The community count decline and opened to rebuild that community count as we get into next year.
Our next question comes on line of Buck Horne with Raymond James. Please proceed with your question.
Hey, Thanks, good afternoon.
I'm curious on the three the third quarter order totals just how many of those might have been repeat buyers that would have cancelled their original order in April just wondering how you handled those buyers showed.
Those buyers showed back up and where are you able to reprice any of those cancellations that came through in April.
Well I know, we had a handful bulk of people that came back and purchased one stage, one from furloughed or rehire or whatever I don't think it was significant.
We quantified on our last call from the cans I think it was 250 units that can were opened deliver in Q2, we carry 250 units.
Into Q3, we sold some and close them and then whatever else, we had we sell and close or now deliver because are sold in Q4 and along the way we were lifting price. So it's it's possible that we picked.
We picked up some margin through that process, but it's certainly not a core strategy of ours.
Because we'd rather focus on the build to order, but there could have been a little margin lift to it.
Okay.
I appreciate that and then maybe a quick one on the land sided you're reinvesting and obviously I think you guys alluded to that land prices are appreciating here I'm wondering if there's any additional commentary just in terms of what you're seeing in terms of the tightness of the land market in but as you're looking to replenish the land.
And things have certainly changed in terms of the degree buyer groups and the demographics that are showing up now and maybe potentially how.
How far out there willing to live is that opening up more options in terms of where you guys might be able to look at in terms of further out locations or or more suburban territory.
As the window opened a little bit further in terms of where you can reinvest in the land side.
I think it has in part because prices are running up.
It's the classic.
The evolution in a cycle, where the urban dense suburban or.
Suburban urban areas not necessarily downtown but the the job clusters that ring of city are more desirable cool so less of a commuter there's more amenities around you and then the further out you get.
Prices go down because there's compromises and.
As prices that lifted in those more desirable areas in the suburbs. It does push the next bring out because affordability is an issue and I think it has opened up some opportunities, but you have to be more mindful of the price for the consumer for the trade off of being in a more real.
Our location and you have to underwrite that in what you can pay for the Atlanta. If you go back through Q2 and Q3 for us we.
We didnt walk on very many deals at all we got time from sellers and for the most part then performed when the extension.
Expired or we did obtain the entitlements that had been delayed due to covance. So we we kept replenishing the lot pipeline. That's a lot of the spend we had in.
The third quarter. So the the pricing was already in place and.
Today I would say there is.
There is a healthy tension right now out in the land markets, where theres a lot of people looking for lots I think that will push pricing up.
And the beauty for us as I shared in.
In my prepared comments, we already own everything we need for 21, we already own and control everything we need for 22, they have solid growth in the company. So we don't have the pressure of doing deals just to do them. So we're going to stay diligent on our underwriting strategy diligent on our price points in our.
Our product positioning and to continue to to drive that process to help us grow into 23, but for 21 and 22 recovered.
Yeah.
Our next question comes from the line of Mike Dahl with RBC capital markets. Please proceed with your question.
Hi, Thanks for taking my questions and appreciate the color. So far had a couple of follow ups on costs. So Jeff appreciate that there's certainly.
Not a tremendous amount of visibility on where lumber RSV will ultimately settle.
Given given what you're looking at today in terms of your framing package in terms of.
Potential for Labour inflation, what what can you tell us about the level of direct costs that you you do think you're going to have to cover and costs and I know it might not hit next quarter given your build to order model, but as you look out to first half next year whats. The magnitude that you think you have to cover.
Sure.
Well ill take that one too.
The math to handle Mike, but you already see in lumber come down the lumber futures that.
The September futures 60 days ago were at 900, and some you are already back down to 600 insulin and it's a reflection of the product that is now coming to market. So yes lumber spike it's already coming back down typically won't get all the way back to where it was.
But it'll come down more from where it is today and we've been in our lock process, we've been working that.
Division specific what's your locks strategy, what do we have to do to pricing and.
We certainly already incurred some lumber increases that are reflected in our guidance for our Q4 margin. So we've been able to manage that and navigated pretty effectively.
That you want to give a little more color on thoughts and what we're doing on lumber and direct cost.
Yes, sure and as Jeff said in our guide for Q4.
We've anticipated the area that our directs are up about 1.5% since the beginning of the year.
Well the teams in the field.
I think have done a good job in navigating through a very unique situation with the spike that we saw each of our divisions takes.
An approach to.
To their locks and to how they buy we monitor that and kind of oversee it at a corporate level and provide guidance. We've got a very senior team of purchasing leaders that are helping us get through this but.
What we've been able to do from a pricing standpoint, and lean on that price lever to to more than cover for these costs.
As put us in a in a very good position as we move forward. We will continue to watch this and see how it plays out that we anticipate lumber coming down as well as our pricing strength continuing as we move through.
Over the next couple of quarters.
Okay. That's helpful. Thanks, and my second question and maybe this will help go back Matt also but Jeff in your in some of the other prepared remarks, you talked about layering in some some cost strategically to help support the plan for next year. It sounded like that has an impact in both gross margin and.
DNA can you just elaborate a little more on.
Just.
Give us some examples of what these costs are.
And and the plan from Premier.
Jeff you want to handle that.
Oh sure wasn't.
Wasn't sure, which Jeff is referring to but yes, there's you're right. It's in both sides. It's in the fixed costs, it's embedded in our construction costs in the sausage TSG nay start.
Starting with the fixed costs in construction.
The two main categories in their construction supervisors as well as land resources and with the large backlog that we're building and the continued improvement in the backlog we want to make sure. We can achieve those deliveries going into next year. So we're making selective.
Resource.
Enhancements in that area sales.
Same thing on the land side that we want to continue to grow the business and want to make sure. We have the right resources. There. So we had a fairly.
Significant reduction in that category in the third quarter and will will.
Put a little bit backend that as much as where we're at in the second or first quarter this year, but a little bit back back into to support future deliveries on the M&A side we've.
We've had efficiencies in many areas most the SGN a.
Add back you'll see a one. Good example is we had a very positive quarter in terms of advertising spend where our growth our grand openings were down a little bit you tend to spend a little bit more during grand opening periods and the market frankly was just so strong we were able to ratchet that back a bit. So you know as a grant.
Running activity increases over the next few quarters, we anticipate a little bit more on the advertising spend side.
Be some support staff type resources that will put back into the business as we move forward, but I would say for the most part it's not terribly significant I'm I think it's fairly measured.
I think its they are definitely very smart investments to support growth in the top line.
We're 30% plus growth year over year next year that we're anticipating so we want to make sure. We can book those revenues and.
Achieve those operating margins from that growth and in terms of resources, we're going to match it up to our our sales pace starts pace and delivery pace as we move forward.
Our next question comes from the line of Michael Rehaut with JP Morgan. Please proceed with your question.
Thanks, Good afternoon, everyone. Thanks for taking my question.
First I just wanted to circle back a little bit to the order trends and obviously the acceleration is really impressive and.
Inline with that.
That August lumber.
Only gets you up there with a lot of your peers you mentioned some of the.
[noise] comparisons going into September that a year ago September was a at a higher pace than.
In August.
Just trying to get a sense did you say for this September that you're seeing a similar sales pace.
Compared to August so that sequentially. The sales pace is similar and would you expect that to continue into.
October November at this point.
Yeah, Mike I think that's Oh.
An interesting question and we all have our own crystal ball in a in a normal year and this is not normal but in a normal year with seasonality August for US is typically softer than September in that year in Arizona, Florida, Nevada.
Inland, California, its a lot hotter people are taking vacations before the kids go back to school or they're starting to the school year and we typically see a dip in August and then right. After labor day September is pretty good and Thats, a normal cycle and then october's little less than September and November is a little less than.
And then the October so you have the slow gradual decline.
Through our fourth quarter I don't know what we'll see this year in that August was very strong September is holding at strong levels and there's there's still enough pent up demand out there we may not see as much of a slowdown in October and November because of all these dynamics that.
The industries.
Positive dynamics that the industry is facing on the demand side.
But in a normal year, you would expect October and November to start to slow a little bit due to the seasonality is it will play out and we'll see but.
Certainly through the first three weeks of holding are good.
And where would you peg thanks for that Jeff.
Where would you peg.
The monthly sales pace throughout the.
Throughout the third quarter. The average is 5.9, where you hitting.
[music].
Closer to a seven in August.
Give us a sense of the of the month to month the sales.
Sales pace cadence.
Yes, I would say that it got incrementally better from June to July and July to August. It wasn't like July was good in August was great. They were all good and it just kept building little more momentum as each week went by.
In the three months and then from August till now is held at a high level.
So August was strong, but I don't know that I don't know that Jeff maybe you have some yes the DJ.
The release, we put out the first week of August where we had summarized that June July.
Sales, our net order pace as we we had it pegged at about five and a half a month. So yeah. It got a little bit incrementally better in August and lifted that averaged 5.9, but it was pretty solid even for the first two months of the quarter.
And our final question comes from the line of Jim The Kens Wedbush. Please proceed with your question.
Hey, Thanks for taking my questions.
The first one just on the fiscal 21 revenue guidance did you talk.
Did you talk about what you guys are expecting in terms of average price growth versus volume growth and that God.
We did not typically early on we we try to give a range of topline revenues and what it looks like for the upcoming year and we'll refine that again as we report out on our fourth quarter and get into more detailed guidance numbers for 2021. So we just thought we'd help out everyone with over the top.
I was looking at this point for us.
Got it.
And then I guess the second question in terms of could you walk me through where you see how you expect the community counts to develop through 21, and then also is there going to be a heavier focus on one geography over another as we move through the year.
Right.
As I mentioned to prepared remarks, we think actually the community count to be relatively flat for the next couple of quarters. So the ending community count at the end of the fourth quarter as well as the end of the first quarter, we think will pretty much be replenishing. So we'll be grand opening communities at about the same pace as we're closing out.
Starting in the second quarter of next year, we're anticipating on an absolute growth in net communities opened during the quarter. So.
By the end of the second quarter, we think we'll be back on that growth path.
Moving through the second half of next year and arrive at a number by the end of next year.
Given that three quarters of grand openings in excess of Closeouts, we should be in that mid to high single digit op range as a final community count at the end of next year.
That said given that it's a five quarter average for the year and you know one of the one of those points was the end of year. This year and then the first quarter of next year, which would be relatively flat.
Sequentially, but down year over year, we think on an average basis.
Year over year will be about flat to 2020, but with an improving trend and I think thats pretty important because as we start the year the strength of our absorption pace that we've seen in the third quarter and what we expect in the fourth quarter will drive really strong beginning backlog number for us and that should provide.
A lot of dry powder as far as accelerating revenues in the first half of the year and in the second half of the year, we should be getting our community count back up and providing some sales.
Support for improved revenues in half two so it's a pretty nice trend is shaping up right now and we're looking forward to to rebuilding the scale in the business as we as we move through 2021.
Ladies and gentlemen. This concludes today's question and answer session as well as today's teleconference. Thank you for your participation you may now disconnect your lines and have a wonderful day.
Hi, Devin.
Yeah.