Q3 2021 KB Home Earnings Call
Yeah.
Good afternoon, My name is Alex and I will be your conference operator today.
I would like to welcome everyone to the Kb home 2021 third quarter earnings conference call.
At this time all participants are in a listen only mode.
Following the company's opening remarks, we will open the lines for questions.
Today's conference call is being recorded and will be available for replay at the company's website Kb home Dot com through October 22nd.
No I would like to turn the call over to Jill Peters Senior Vice President Investor Relations Jill you may begin.
Thank you Alex good afternoon, everyone and thank you for joining us today to review our results for the third quarter of fiscal 2021.
On the call are Jeff Mezger, Chairman, President and Chief Executive Officer, Matt.
Man, Dino and Rob Mcgivney, Executive Vice President 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 1095.
Statements are not guarantees of future results and the company does not undertake any obligation to update them.
Due to factors, including those detailed in today's press release and in our filings with the Securities and Exchange Commission actual results could be materially different from those stated or implied in the forward looking statements.
In addition, a reconciliation of the non-GAAP measures referenced during today's discussion to their most directly comparable GAAP measures can be found in today's press release <unk> on the Investor Relations page of our website at Kb home Dot com and with that here is Jeff Mezger.
Thank you Jill and good afternoon.
Our performance in the third quarter, reflecting significant year over year increases across the majority of our key metrics.
We produced solid results and housing market experiencing great demand.
Also facing industry wide challenges in getting homes completed and delivered.
These results will help drive our returns focused growth.
As we continue to expand our scale, while generating a higher return on equity.
Before I get into the highlights of the quarter and there are many I want to address our shortfall in deliveries and revenues.
Disruptions to our supply chain intensified as the quarter progressed.
And along with municipal delays resulted in our build times extending by about two weeks sequentially.
This push many deliveries into our fourth quarter.
And we will similarly delayed some fourth quarter deliveries into our 2020 to first quarter.
We are taking aggressive steps to manage through these delays, including expanding our subcontractor base partnering with our national suppliers and simplifying our products to stabilize our build times.
We produced total revenues of $8.0 billion up nearly 50% as compared to the prior year period and diluted earnings per share of $61.0
We achieved an operating income margin of 12, 1% excluding inventory related charges.
Each grew 250 basis points year over year.
Driving a 40% expansion in our profitability per unit to nearly 52000.
This was accomplished even with the leverage we lost from the delayed deliveries.
A related gross margin of 22% was a particular highlight and demonstrates that we are effectively managing pace price and starts to optimize each asset.
As to capital allocation, we continue to take a balanced approach with disciplined investments in growth remains our top priority.
In the third quarter, we invested about $780 million in land acquisition and development.
We expanded our lot position to almost 81000 lots owned or controlled.
With our inventory continuing to rotate into a higher quality portfolio of communities.
In addition to these investments we returned a significant amount of cash to stockholders through both our regular quarterly cash dividend.
And the repurchase of $188 million of our stock.
These repurchases will further enhance our return on equity in 2022 beyond this year as expected 20% level, especially.
Especially when combined with our projected increase in scale to over $7 billion in revenue and higher operating and gross margins.
Since we embarked on a returns focused growth strategy, we have produced meaningful expansion in our ROE.
While we recognize that returns across the industry have expanded our rate of improvement is meaningful and.
And we believe our return on equity in the low to mid 20% range is sustainable.
During the quarter, we announced the promotion of Rob Mcgivney to executive Vice President and co Chief operating officer, a role he shares with Matt Man Dino.
We created a KOL CLO structure with two simple objectives in mind.
To accelerate the profitable growth of our business in order to drive increasing returns on equity.
And to enhance our execution.
Rob is responsible for our west coast and southwest regions, and Matt is responsible for our central and southeast regions.
In addition to their regional responsibilities.
Matt Rob each have oversight of key strategic corporate functions as well.
The operating environment within our industry has become more complex over the past 18 months, given the supply chain issues and municipal delays that I mentioned earlier and their impact on build times.
Having two proven leaders running our operations will allow for a more hands on approach that is geographically focused and enabling greater day to day collaboration with our regional and Division leadership.
Matt and Rob will join me to respond to questions. Later on this call and can speak more specifically as to what is being done in their regions to compress build times.
We successfully opened over 40, new communities in the third quarter, marking the start of a sequential improvement in net in community count.
That we anticipate will continue over each of the next five quarters.
With the strong and growing lot pipeline that I referenced driving an acceleration of new communities, we expect to expand our community count to roughly 260 by year end 2022.
Our monthly absorption per community accelerated to six six net orders during the third quarter from $5 nine in the year ago quarter and.
And reflecting a more typical seasonal pattern sequentially, while remaining at historically elevated levels.
Net orders were 4085 represented a small decline year over year.
Against a strong result in the prior year quarter.
However, with our actions in taking price a moderating pace.
Net order value was up more than 20% year over year.
We continued to manage our selling pace to production <unk>.
Eliminate our lot releases to prevent our backlog from getting overextended.
And started over 4000 homes during the quarter.
This compares to starts in the year ago quarter of about 3400.
We currently have approximately 9000 homes in production with 93% of these homes are already sold.
Only 240 of these homes are unsold pass the foundation stage and our focus right now is on compression our build times to deliver our backlog.
With the horizon, our net order value to $2 billion, we are laying the foundation for future margin growth.
Our pricing power is solid while our pace remains strong.
And the demand for our homes at higher prices.
US that our price points remain attainable.
The credit profile of our buyers is above our historical level with an average FICO score of 731 and down payment of 14% translating to almost $60000.
Which is noteworthy for a first time buyer.
In addition, the internal indicators that we monitor for changes in customer behavior.
Including the square footage of homes purchased or spending in our design studios remained stable.
Our backlog now stands at roughly 10700 homes, representing future revenues of over $12.0 billion or.
Our backlog value is up nearly 90% year over year with significantly higher margins within this backlog.
This is an excellent position from which to finish 2021 and support another year of growth in revenues and expansion of margins in 2022.
Homeownership remains compelling and attainable.
And we believe the drivers are in place to support healthy market conditions for the foreseeable future.
An insufficient level of supply exists at our price points.
To meet the demand for millennials and Gen Z.
Which together number roughly $140 million.
These two cohorts value, the personalization and choice and our built to order business model.
Which is a significant factor in why our absorption rates have consistently been among the highest in the industry.
This together with our experience in serving first time buyers, who represented 61% of our deliveries in the third quarter has us well positioned to capture demand going forward.
Switching gears for a moment I want to highlight our recent achievement in sustainability.
<unk> home received a record 25 energy Star market leader Awards from the EPA.
Further demonstrating our leadership position as the most energy efficient national homebuilder.
We are proud to continue moving our environmental program forward, which is helping to lower the total cost of homeownership for our buyers while doing our part to reduce reduce the carbon footprint of our homes.
Before I wrap up I would like to recognize and thank all of our employees for their outstanding efforts every day and working through the industry wide challenges of material shortages and municipal delays.
We have a remarkable team that is focused on execution and committed to customer service.
In closing we are growing into a bigger business that is operating at meaningfully higher margins and generating considerably improved returns.
We anticipate a return on equity this year of about 20% and further expansion in 2022 supported by double digit growth in revenues and community count with higher margins as well as our recent share repurchase.
Beyond next year, we believe our return on equity is sustainable in a low to mid 20% range with that I'll now turn the call over to Jeff for the financial review Jeff.
Thank you, Jeff and good afternoon, everyone I'll now review highlights of our financial performance for the 2021 third quarter discuss our current outlook for the fourth quarter and summarize expected improvements in several 2022 metrics.
In the third quarter, we produced measurable year over year improvements in nearly all our key metrics, including a 49% increase in housing revenues that drove a 93% expansion in our earnings per diluted share.
We also made substantial investments in land and land development to support continued growth and completed a significant share repurchase that among other things will enhance future returns and per share earnings.
Our housing revenues grew to $146 billion for the quarter from $979 million for the prior year period.
This improvement reflected a 35% increase in the number of homes delivered and an 11% rise in their overall average selling price.
As Jeff discussed our current quarter deliveries were tempered by industry wide building material shortages and labor constraints that extended build times and most of our served markets.
We anticipate similar challenges will apply to our fourth quarter and have considered these factors and our outlook.
Our ending backlog value expanded 89% to over $12.0 billion driven by strong increases in each of our four regions.
Considering our quarter end backlog the status of our homes under construction and expected construction cycle times, we anticipate our fourth quarter housing revenues will be in the range of 165 to $76.0 billion.
In the third quarter, our overall average selling price of homes delivered rose to approximately $427000.
From approximately 385000, reflecting the strength of the housing market for.
For the fourth quarter, we are projecting an overall average selling price of approximately $450000.
Which would represent a year over year increase of 9%.
Our third quarter homebuilding operating income improved to $178.0 million as compared to $97.0 million in the year earlier quarter.
Operating income margin increased 270 basis points to 11, 6% due to improvements in both our gross profit margin and SG&A expense ratio.
Excluding inventory related charges of $13.0 million in the current quarter.
$15.0 million in the year earlier quarter, our operating margin was up 250 basis points year over year to 12, 1%.
For the fourth quarter, we expect our homebuilding operating income margin, excluding the impact of any inventory related charges will be approximately 11, 8% compared to 10, 7% in the year earlier quarter.
Our housing gross profit margin for the quarter was 21, 5% up 160 basis points from 19, 9% for the prior year period.
This margin expansion, mainly reflecting a favorable selling price environment supported by healthy housing market dynamics.
And lower amortization of capitalized interest.
Excluding inventory related charges, our margin for the quarter was up 140 basis points year over year to 22.0%.
Our adjusted housing gross profit margin, which excludes inventory related charges as well as the amortization of previously capitalized interest was 24, 5% for the third quarter compared to 23, 7% for the same 2020 period.
Assuming no inventory related charges, we believe our fourth quarter housing gross profit margin will be in the range of 21, 6% to 22%, reflecting the impact of peak lumber prices when our forecasted fourth quarter home deliveries were started.
Our selling general and administrative expense ratio of nine 9% for the quarter improved by 110 basis points as compared to 11.0% for the 2023rd quarter, primarily due to increased operating leverage partly offset by higher costs associated with performance base.
Employee compensation plans and additional resources to support growth.
As we position our business for growth in 2022 housing revenues, we believe that our fourth quarter SG&A expense ratio will remain roughly the same as the second and third quarters of this year or approximately 10%.
This would represent an improvement from 10, 3% into 2024th quarter.
Our effective tax rate for the quarter was approximately 14%, reflecting $25.0 million of income tax expense net of 21.5 million of federal energy tax credits.
We expect our effective tax rate for the fourth quarter to be approximately 24%, including a small favorable impact from energy tax credits compared to approximately 16% for the year earlier period.
Overall, we reported net income for the third quarter of $151.0 million.
A $61.0 per diluted share compared to $82.0 million or <unk> 83 per diluted share for the prior year period.
Turning now to community count our third quarter average of 205 decreased 14% from the year earlier quarter.
We ended the quarter with 210 communities open for sales as compared to 232 communities at the end of the 2023rd quarter.
On a sequential basis as anticipated we were up 10 communities from the end of the second quarter.
We are planning to achieve continued sequential quarterly increases in our community count through 2022.
We believe our 2021 year end community count will be up slightly from the third quarter, resulting in a high single digit decrease in the average fourth quarter count as compared to the prior year.
We invested $779 million in land land development and fees during the third quarter with $467 million or 60% of the total representing new land acquisitions in the first three quarters of this year, we invested $1 billion to acquire over 16.
Lots.
We ended the quarter with a strong supply of nearly 81000 lots owned and controlled that we expect to drive a significant number of new community openings and steady growth in community count.
At quarter end, we had total liquidity of over $2.0 billion, including $350 million of cash and $791 million available under our unsecured revolving credit facility.
In early June we issued $390 million of 4% 10 year senior notes and used a portion of the net proceeds to redeem approximately $270 million of tendered 7% senior notes due December 15, 2021, we.
We recognized a $6.0 million loss on this early redemption of debt in the third quarter.
The remaining $180 million of the 7% senior notes were redeemed at par value last week.
The redemption of all of our 7% senior notes, partially offset by the new issuance will result in annualized interest savings of nearly $16 million contributing to our continued trend of lowering the interest amortization included in our housing gross profit margins.
In addition, we see the $350 million maturity in September 2022, or seven 5% senior notes as another opportunity to reduce incurred interests and enhance future gross margins.
During the third quarter, we repurchased approximately four 7 million shares of common stock at a total cost of $190.0 million.
Shares repurchased represented approximately 5% of total outstanding shares and will drive an incremental improvement in our earnings per share and return on equity going forward.
For purposes of calculating diluted earnings per share, we estimate our weighted average share count of $91 million for the 2021 and fourth quarter.
And $98.0 million for the full year.
For 2022.
We are forecasting housing revenues of over $7 billion supported.
Supported by our anticipated 2021 year on backlog.
Unit count growth and an ongoing strong demand environment throughout next year.
We expect approximately 200, new community openings over the next five quarters to drive sequential increases in ending community count.
Consistent with our forecasted double digit growth that we have discussed during the past two quarters. We believe our 2022 year end community count will be up about 20% year over year and the full year average count will be about 10% higher as compared to 2021.
We also believe that gross margin expansion to a level above our guidance for next quarter, along with improvement in the SG&A expense ratio will result in a measurable year over year increase in operating margin.
Further the anticipated increase in scale combined with a higher operating margin and the benefit of the recent share repurchase should drive a meaningful improvement in return on equity relative to the approximately 20% expected for 2021.
In summary, we believe we are well positioned to achieve our targets for both the 2021 fourth quarter and 2022 fiscal year.
Our forecasted 2021 full year results represent significant improvements across virtually all our key metrics with notable increases in our scale absorption pace housing gross margin and operating margin in.
In addition, we are particularly pleased with the forecasted expansion and our full year return on equity and our anticipated further improvement in 2022.
We believe our ongoing focus on accelerating profitable growth and expanding our returns by leveraging our larger scale.
<unk> inventory profile and uniquely compelling built to order business model will produce measurable enhancements in both book and stockholder value in future periods.
We will now take your questions Alex Please open the lines.
Thank you.
At this time, we'll be conducting a question and answer session. If you'd like to ask a question. Please press star one on your telephone keypad.
Confirmation tone will indicate your line is in the question queue. You May press star two if he would like to remove your question from the queue.
For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys.
Please limit to one question and one follow up question.
Our first question comes from the line of Stephen Kim with Evercore ISI. Please proceed with your question.
Yes, Thanks, guys I appreciate all the color.
One of the interesting things that we.
We saw in your results today.
The share repurchase and you actually increased your leverage to do it which is something we haven't seen a lot of the builders do and so I was curious as to if you could give us a sense for where your targeted leverage is going to be over the course of the cycle.
And.
And then how do you think that that may trend in the near term.
Sure CVI I can take that when you look at actually if you look at pro forma.
Leverage at the end of the quarter were actually down 50 basis points from the end of the second quarter. So we paid off the rig.
Remaining notes that were not tendered subs.
Subsequent to quarter end and it wasn't reflected in the actual results. So we're actually down 50 basis.
Said.
We feel pretty comfortable with our current leverage ratio, we've been down below 40% for some time now and we will continue to operate the company I think in a range that that's appropriate and we saw as a tremendous opportunity I think in the quarter.
To repurchasing shares in the future.
Really just utilize some excess cash over and above what we needed to grow the business and also.
At the same time Delevering, a little bit this year by.
Through that transaction of the refinancing took about $60 million out.
As a result of the new issuance in the tender and then finally did redemption in September so that's kind of where it stands right now for us.
But Jeff are you thinking that like are you, saying that around 35% at a level that we should be expecting for you guys or just simply below 40% is that I mean, that's a much higher level than what we've been seeing from the other builders not that it's a bad level necessarily but I just wanted to get a sense for if you could give us a numerical range of where you expect to be sort of to manage the business over the course of.
The next several years.
Yes, I would say, we're comfortable in that 30% to 40% range and we like I said, we've been down below 40 for a while we're treating a lot of equity as a result of the high level of earnings that we've had.
And as long as we're continuing to produce at equity I think we will end with our excess cash we may see opportunities to do what we just did in this quarter, but.
For the moment, we're pretty comfortable with the capital structure and the improvements that we've <unk>.
<unk> over the years.
No that's great I appreciate it Okay and then second question relates to your margin.
Obviously strong performance, but your guide here for the <unk> with a little bit lower than we would've liked to have seen and obviously you've attributed some of that to lumber and peek lumbar running through I was wondering if you could give us a sense for the magnitude of that.
And sort of how that how you are expecting the cadence of that.
Work off or to basically come down what the what the reduction in the lumber cost could potentially benefit.
The early part of 2022.
And then there was another comment that I think Jeff Metzger made regarding simplifying your product and I was curious as to what you Matt if you could elaborate on that a little bit more.
Because it sounded like that might make it more conducive to doing more spec versus bto, but I assume that's not what you meant so just curious if you could elaborate on that.
Steve that was like four questions packed into one.
Yes.
Sure.
Sure.
Let me kick kick the simplified product out to Rob.
Rob you want to take that one.
Sure. Thanks, Thanks, Jeff and Steve.
Over the last several months 18 months or so we've really been focused on product and process simplification and our design studio, we've driven a total SKU reduction of about 48% and our focus has been on retaining the items with the highest take rates from our customers and then matching that to product.
<unk> that we're communicating with our national suppliers and local trade partners about and then.
On structural options, we've reduced almost 40%. So our options are generally standardized across our regions and across the country and it's just about removing complexity from the supply chain and simplifying that issue for us and our trades.
It also goes all the way to architecture and simplified product design with fewer variations, we're reusing our plans leveraging standard product series across our regions and divisions.
And even getting to the design of the homes themselves and we're standardizing windows sizes and cabinet box sizes and garage doors. So just simplifying it for us for our customer for our traits in really keying in on those items in the supply chain that are readily available where we can.
Thank you.
Our next question comes from the line of Truman Patterson with Wolfe Research. Please proceed with your question.
Hey, good afternoon, everyone, sorry, but Steve took all my questions.
No.
Well look.
Clearly supply chain issues are impacting the entire industry just kind of following up on one part of Steve's questions, but.
In the release or in the prepared comments, you all mentioned partnering with national suppliers and expanding your subcontractor base I'm, just hoping you can elaborate a little bit further on those.
Actions, you're taking outside of simplifying the offerings and I realize this is kind.
Kind of a crap shoot at this point, but any any guesstimate on when you think you might see construction cycle times start to stabilize.
Matt you want to talk about the labor base.
Sure.
Chairman I would say.
Right now the primary constraint is coming more from supply chain issues versus labor.
But.
What we're trying to do is get out in front of it and really be proactive and identify where where's the next bottleneck coming from.
And we've got various tools and processes in place, where we can analyze the capacity of our trade base and then as I said get out in front of it and <unk>.
An example of this terminal.
So far year to date, we have already added.
Little over 150, new trade partners. So it's.
<unk> ability when the all clear is coming is difficult to assess but.
We are trying to stay in front of it and with the expansion of our trade base.
We think thats one of the best tools, we have.
Okay, Okay and then.
Sorry go ahead.
And I was going to add add to that as we look at things, where we got caught in the.
In the third quarter was and what I would call the second half of production cabinets windows.
Whatnot and Thats what were working on trying to compress today, we actually feel we've we've stabilized our build times and foundations and frames and income Mechanicals, where we've addressed all the moving parts and we've expanded the base and we think we have that covered.
We're still holding back because we don't know what we haven't even had.
To deal with yet because these things are popping up.
A weekly basis, and it's varied from city to city, but so we think we've stabilized the first half in the second half of the production cycle is what Matt is talking about <unk>.
Addressing right now.
Sure.
Okay, Okay, and then in the press release, you all mentioned.
You mentioned.
The continued expansion of margins in 'twenty two.
Didn't hear it in the prepared remarks was that alluding to gross margin or op margin or both.
It's actually both and yes.
Back I guess to a little bit of Steve's question.
Cadence and trajectory, we do see the fourth quarter is having our peak lumber impact and inclusive in that.
We did lose a little bit in the fourth quarter of our premium versus our previous expectation due to leverage loss with lower volume and also some mix shifts, but we're certainly and clearly seeing improving margins both in our selling gross margins. So on a week to week basis, what we're seeing in the selling gms as well as in our backup.
<unk>.
At the moment.
Really looking at a nice gross margin trajectory into next year.
While we're not providing specific guidance on it we did reference in your prepared remarks that we see our margins next year clearly in excess of our fourth quarter Guide and I think we will see a very strong margin performance.
Basically cascading down in the operating margin and impacting our return on equity and a very favorable way in 2022.
Thank you. Our next question comes from the line of Matthew Bouley with Barclays. Please proceed with your question.
Hey, good afternoon, everyone. Thanks for taking the questions.
Pick back up on a prior comment Jeff you just made about the challenges with the second half of the production cycle.
I wanted to ask about the other side of that to start pace in the first half I guess so.
Relative to the challenges and closings and I don't know, presumably getting communities open.
The country is your ability to put starts in the ground.
Given your business model, therefore, driving sales does that is that less impacted.
Relative to the other challenges that are simply driving cycle times longer or should we assume that your start pace could slow further as well related to the same challenges. Thank you.
Yes, Matt I think we've done a pretty good job navigating the environment.
But to get them to start some first getting the permits pulled them and then get into starts and if you look back over the last 12 months on a rolling 12 basis. We've started about 17000 homes, which is within a couple of hundred of what we've sold so we're pacing our sales.
And our starts are pretty well aligned right now.
<unk>.
As we're working through it we think we've addressed the foundation issues back in January February March It was framer issues, we've addressed those.
We're continuing to push it along so we don't expect any any increased issues relative to starts and I also think we did very well in the quarter on the community openings. We we hit right on top of the number we projected that.
At the beginning of the third quarter so.
Over 40 openings, we had was a great result.
As part of the confidence we have in our community count guidance going forward.
That's actually a perfect segue. Thank you for that Jeff I wanted to ask about the communities just because you did have the one here. This week speaking about certain challenges in municipalities.
The cascading effect of supply chain I'm, just getting communities open.
And I think you gave the number at the top around 200 openings to come.
I'm just curious it's really just following up on the last point, but your confidence around that 200 given.
Challenges in getting communities opening and I guess, the second part of that if there is any regional bias to that as we model. It out. Thank you.
Yeah, the the <unk>.
Community openings are broad based and I wouldnt target any one part of the country has been more more difficult than others.
I think a simple comment towards it as we have already taken the hit for the the delays in our community openings.
As this year unfolds. So we're past a lot of the delays in its into the blocking and tackling it influenced our guide and our confidence for where we're headed next year I wanted to throw the actual number out because we've observed a strategically want to grow community count a minimum of 10% a year, but.
With where the number is ending this year, we wanted to make sure.
Debt.
This group understood that it's much more than 10% next year in fact, we're looking at 'twenty.
Thank you. Our next question comes from the line of Alan Ratner with Zelman <unk> Associates. Please proceed with your question.
Hey, guys. Good afternoon, Thanks for taking my questions and Rob Congratulations on the promotion nice to hear you on the call.
Yes, Jeff maybe the first question just to clarify on the margin comments.
I think the.
Helpful to remind everybody just to you know the accounting nuance for you guys with some of those fixed expenses that flow through your Cogs, because I think that that does explain maybe some of the shift in guidance for <unk> can you just remind us.
What is that rough dollar amount that flows through your cost of goods sold line every quarter and would you expect that to increase in 'twenty two based on your expected community count growth.
It has increased a bit in 'twenty, one as we put more resources towards some of the functions within that.
Fixed cost.
And I think in the in the third quarter is right around $38 million.
And to your point, yes, it with lower revenue as you as I mentioned earlier, you take our leverage here.
On the <unk> on a lower revenue as is.
There's a bit of leverage on that fixed classics containing cost of goods sold.
Got it that's helpful. Jeff Thanks for that update.
Second the the $7 billion plus revenue guide for next year.
I am curious first off what does that assume for cycle times.
Assuming stability from this current level, that's that's extended a bit here.
And you know an add on to that Juan Hi, Ken.
Obviously, it sounds like the stark paces, keeping keeping up with orders, but just given the challenges that you're seeing throughout the supply chain and the elongation there.
Is there any consideration to maybe more.
Significantly slowing that pace of of order activity you know six months to seven sales per community is incredibly strong and obviously the demand is there for it but a lot of your peers have maybe been a little bit more forceful and in bringing that sales pace down recently, so I'm curious if there's any consideration to that just to allow things to kind of catch up a little bit.
If we saw signs of further blockage.
From here in the.
And to build times, we would slow down and in fact, we did slow down some and in many communities, where we we opted for price, but as we look at things today, We're now planning for a longer build time its extended we get it.
It's baked into our our projections in our assumptions and we have a pretty nice rhythm right now, where we're selling homes starting homes getting them now through.
Foundation, and frame and where we're heading into the second half on a lot of the backlog. So we'll we'll see but right now we think we're in a pretty good balance.
Don't want to have backlog that you can't get built because your buyers get irritated with that too and we're very sensitive to the customer along the way. So if we feel we're putting our customer risk, we're not going to do that.
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.
My first question is just following up on the cost side of things and inflation and I know you mentioned that you expect peak lombardo roles around the fiscal fourth quarter, but can you talk to when we should expect the deflation in lumber to start to come through and how youre thinking about inflation on other building product categories that could potentially.
<unk> somewhat offset that.
Right well the way the way, we lock our costs on starch.
Any inflation, we're seeing in the various cost categories are really more affecting future sales and future backlog.
As opposed to what we May deliver out for example in the first or second quarter of next year so on balance.
What we've been seeing as lumber has been tapering off as some pretty significant improvement in the cost side of things leading to obviously higher gross margins in the backlog on a go forward basis I don't have a crystal ball, so I'm not exactly sure where versus second quarter input costs are going are labor costs are growing but.
Given the trends that we've seen on the pricing side and even if we maintain just even just a bit of pricing power I think we'll be able to more than offset any future increases we see again with the assumption that the favorable trend in lumber holds that was a very significant cost category for us for the whole industry for the peers.
And.
As that progresses. It saw some really good news I think for for our margins out into next year and given that we've locked a lot of those costs for deliveries in the first half of next year, we're feeling pretty good about directionally where margins are headed.
Okay. That's helpful. And then my follow up question is around pricing now you guided to about 450000 for the fourth quarter, which is up I think about 9% or so versus last year. I know you mentioned in your comments that youre seeing a buyer with a higher FICO score it sounds like overall there in <unk>.
Our financial position can you just talk to how you're thinking about pricing the ability to continue to get that in your various markets.
Anything thats kind of changing on the ground around the buyers receptivity to pricing.
What Susan as you know every community and every city will have a little bit different story relative to inventory on.
On the ground and there really isn't any and job growth and population growth and whatnot.
Think of our buyer profile the first time buyer.
Predominantly and yet they are putting 60000 down in their home and they have a FICO score of 737 thats the strongest buyer profile I've ever seen in our first time buyer business very strong.
Buying power out there if you will.
<unk>.
The first thing that we would see if we push price too far and we haven't seen anything like that yet would be keep in mind. We're built to order. So the buyer would shift to a little bit smaller home. They still want a four bedroom. They still wanted in that neighborhood and they may say that size home is too high now and I'll I'll come back.
Here or if I don't want to come down here I won't buy at all no we're not seeing anything like that at all today.
If you think about the discussion we're having on the supply chain blockage.
It's really making the inventory situation worse for the consumer not better our industry is way behind in.
And the number of homes, we build versus what demographics and demand would support.
And you have this restriction now on on homes being built because of the supply chain blockage. So we don't think youre going to there is so much demand for the limited supply, we don't think youre going to see.
For a while a customer that says we can afford that.
We're seeing no signs today, so a very strong environment out there.
Thank you.
Our next question comes from the line of Michael Rehaut with Jpmorgan. Please proceed with your question.
Hi, This is Maggie on for Mike.
Following up on the last question I mean, obviously the ear, but the buyers credit profiles remain strong and youre, saying that affordability hasnt really been an issue at this point.
Have you seen any shift in kind of buyer preferences.
As a result.
The recent price appreciation I think last quarter, you said that you hadn't really seen any buyers adjusting the size of the home, but im curious if theres any update there.
No there was no movement at all in the size of the home and.
The spend in the studio actually went up a little bit per unit.
<unk> 1000 Bucks.
The buyers behave in the same way they were last quarter and the quarter before.
Got it thank you and maybe asking kind of an earlier question in a little bit different of a way.
You talked about the share repurchase this quarter and you talked about.
Are you comfortable going forward from a leverage perspective, but.
Can you elaborate a little on.
The potential for share repurchase to become a more regular.
Tool that's used.
If you go back to Jeff's comments to a previous question, what we did in the quarter.
Does take some excess cash that we had and apply it to share repurchases.
We spent over $700 million on land and development.
That would reinforce with first and foremost we're all about growth as we look ahead, our top priority will continue to be.
To support the.
Profitable growth trajectory and improve our returns.
And we also know our leverage ratio will continue to get better as we grow profits.
And that will lower your <unk>.
Our ratio on its own so first and foremost we'll be looking at growing the company. If at some point, we again determine we have excess casually evaluate what to do with it at that time.
Thank you.
Our next question comes from the line of Depot Rock, Gabon with Wells Fargo Securities. Please proceed with your question.
Hi, good afternoon.
The order pace was pretty good.
So that.
I don't know if I heard you talk about this so I apologize if I'm asking this but when do you think your supply chain challenges stabilized I E, you're calling for 11% lower delivery in Q4.
Do you think much of the much of the known supply chain issues.
Impacts Q4, the more most our wood early part of 2020 to also see some strong headwinds there.
Yeah.
Deepa as we shared in our comments, we think we've stabilized.
The early parts of the construction cycle Theres still a lot of variables in.
And unknowns on the finished side.
While we stabilize it it is at an extended timeframe. So we're now navigating were assumed in our guide and our projections that build times.
Don't get worse, but also don't get better I think.
Everybody will have their own crystal ball on how we work through it and we will work through it but it's going to take some time to get back to where we used to be.
Okay. That's fair you talked to some product challenges you face.
<unk> brought you talked about windows and cabinets.
Are there any issues, we should think would get worse.
Before they get better sometime mid mid of next year or you think most of them.
And then start to ease past.
Now this quarter.
Yes, it's hard to answer if you'd have asked me on our last call whether I thought we'd lose a couple more weeks I would've said no because we already thought that it extended.
Pretty significant from Q1 to Q2.
We're seeing good signs in some areas, but theres still a lot of unknown so I.
I don't know that were prepared to say things are going to get better right away and we're hopeful we've taken steps to.
Stabilized and we'll see how it goes over the next couple of quarters.
Thank you.
Your next question comes from the line of Mike Dahl with RBC capital markets. Please proceed with your question.
Hi, Thanks for taking my questions on the car so far.
First of all I, just wanted to circle back to the sorry to beat the horse a little on the fourth quarter margin, but just maybe asking again the impact of lumber and I guess, taking kind of a sequential approach if we look at your.
Guide for ASP.
Youre up about 5% Q on Q and probably most of that is pretty similar on a square foot basis at least.
Up that much Q on Q so.
Revenue per square foot up the way. It is can you just help us understand again sequentially.
I don't know if the fixed cost is really as much of a sequential driver, but just the exact impact of lumber that that's impacting you guys in offsetting that improvement in revenues.
Yeah.
Well Mike.
To give you an exact number it's a little bit difficult and you spend a lot of mix shift between the quarters and we're not selling the same product obviously in the fourth quarter as we did in the third.
The margins are in your range quarter over quarter, there was not a huge.
Change between the two quarters and what we wanted to point out was really we do believe.
We know actually that the lumber price increases and what we saw related to those homes that we expect to.
<unk> and deliver in the fourth quarter. When we started those homes were at peak lumber pricing.
And so as much of an indication that we feel that we wanted to give everyone about where things are heading.
Beyond the fourth quarter as much as it is about specifically for that fourth quarter guide.
When we guide to quarters, particularly in a short period.
We guided delivery body delivery, we roll up from the bottom up we lost a whole lot of deliveries to these construction delays in the supply chain challenges and there was a bit of a mix impact in there as well and anything that we launched in the fourth quarter is coming back to the early part of next year. So we're very optimistic about March.
Expansion on a go forward basis, and not only gross margin expansion, but operating margin as well as the higher revenue guidance for next year. So beyond that I don't really want to get into.
Quarter by quarter sequentially in 'twenty two.
Any details out into that type range will go back up in January.
Reporting out on our fourth quarter and give you guys a lot of detail in 2022, we normally don't even touch on margins. For example, during this call in any kind of limited to community count and revenues, but.
We wanted to give an indication of what we're seeing because the numbers are so strong.
Within our backlog and within or selling gross margins.
We wanted to indicate that industry.
Yes, I appreciate that and if it makes sense in terms of just looking at.
Go into next year with.
We are already about 75% of what you are projecting in revenue is already in backlog, which should.
Look pretty strong on the margin side, so that all makes sense.
I guess the second question just.
The.
The paid side of the equation when youre looking at getting to your turning over I think you are turning over.
If youre opening 200 communities and ending next year at $62.0, as kind of like 75% community turnover anything.
Anything you can share in terms of whether the pace expectations for new community openings.
Are still four roughly similar in terms of the mix or is there a different.
Any sort of difference in what you had what.
What are you direct us towards in terms of pace as you look out to next year and what you've got coming online.
Mike the two hundreds over five quarters not not for so it's not it's not a one year term is a.
A little more than that but.
In the prepared comments, we're talking about is not just.
Where we think we'll be at the end of 'twenty two.
Positioning the business to continue to grow our community count.
Beyond that into 2003, so we have everything owned for 22, most of everything owned and all controlled for 'twenty three so we're comfortable with the guide.
And we like how we're positioned finally with our community count trajectory.
And I'd just add to that Mike when you look at current pace and what we've seen over the last year and as were projecting forward.
There is two things happening one a lot of the new communities. Obviously, we've just replenish a lot of our communities. So we have a lot more lots going forward.
<unk> projecting fewer closeouts in next year than we had in 2021, which is helping us to grow that call and it's not because we are projecting.
Absorption pace being off that much.
Base assumptions are still very strong going into next year. It's just a function of Hanmi launched we have lost going into the year.
And the large number of openings that we've had in 2021 not to mention the new openings next year. So.
<unk>.
I think we're pretty well aligned this year, followed by surprise I think <unk> got a lot of people by surprise with the accelerated pace and a lot more closeouts than.
And then any of us anticipated, but thats. Good news for me is you're closing out a lot of communities in those units and those lots are going from <unk>.
Available in communities to into our backlog.
It take some risk off next year and it supports.
The top line and the delivery numbers and I think thats great.
While you have some pressure on community count as a result of that I'd, rather see the pressure there than the pressure on having to sell.
<unk> fill that revenue expectations. So we're in great shape heading into not only the fourth quarter, but particularly into 2022, which are pretty thing tax rate.
Thank you.
Our next question comes from the line of Jay Mccanless with Wedbush. Please proceed with your question.
Hi, Thanks for taking my questions.
The first one and pretty impressive decline and the cancellation rate.
Just wondering the cancels that you are getting what what's the reasoning behind that.
Yes, Jay it's it's a mixed bag it somebody who got transferred somebody gets divorced.
Occasionally by our remarks, we're not seeing too much of that we do a pretty good job of screening the buyer before we report the sale we get a.
Pre qual, so we're having very little loan issues as well.
<unk>.
Mix bag, that's a small number at the end of the day.
Right understood and then the second question you talked earlier in the call about having the front half of the build cycle completed and now you're working on the back half.
Just wondering if that also includes.
Getting your final inspections, or <unk> et cetera, what type of issues or are you seeing on the municipal side and are those issues improving versus where they were earlier this year.
Yes.
Rob you want to talk to the inspection side and what we're seeing.
Yes sure Jeff.
Jay.
One of the biggest issues that we're seeing on the inspection side on the back end is just COVID-19 and the Delta variant, that's where we're getting the surprises.
Without those surprises it's running.
Fairly smooth and most of the divisions have strong relationships with the people in our municipalities and we're able to navigate that pretty smoothly, where we see some hiccups or when a group of inspectors or even a single Inspector may have an exposure and they get sent home for for 10 days, but that's what we're fighting through out there.
It's not necessarily the volume but.
Impacts from <unk>.
Covid.
Thank you.
Ladies and gentlemen. This concludes today's teleconference. Thank you for your participation you may now disconnect your lines.
Alex.