Q2 2022 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 2022 second quarter earnings Conference call.
At this time all participants are in a listen only mode.
Following the company's opening remarks, we will open the lines for questions.
Today's conference call is being recorded and will be available for replay at the company's website Kb home Dot com through July 22nd.
Now I would like to turn the call over to Thad Johnson Senior Vice President and Treasurer, you may begin.
Thank you Alex good afternoon, everyone and thank you for joining us today to review our results for the second quarter of fiscal 2022.
On the call are Jeff Mezger, Chairman, President and Chief Executive Officer, Rob Mcgivney, Executive Vice President and Chief Operating Officer, Jeff Kaminski Executive Vice President and Chief Financial Officer, Bill Hollinger, Senior Vice President and Chief Accounting Officer.
During this call items will be discussed that are considered forward looking statements within the meaning of the private securities Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future results and the company does not undertake any obligation to update them.
Due to various factors, including those detailed today 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.
Directly comparable GAAP measures can be found in today's press release and or on the Investor Relations page of our website at Kb home Dot com and with that here is Jeff Mezger.
Thank you Pat and good afternoon, everyone.
We delivered strong financial results in our second quarter with 19% year over year growth in revenues.
Alongside our increased scale, we've significantly stepped up our profitability expanding our homebuilding operating margin by more than 400 basis points to over 15%.
As a result, we grew our diluted earnings per share by 55% to $2 32.
With a backlog of more than 12300 homes.
And a value of over $6 1 billion.
We are well situated as we have sold all the homes that we need to achieve our delivery and margin expectations for the year.
We are also beginning to shape, our fiscal 2023 and have most of our first quarter deliveries and backlog as well.
The size and composition of our backlog provide us with good visibility toward achieving our achieving our guidance midpoint of about $7 $4 billion in revenues.
And roughly a 26% gross margin contributing to a return on equity of over 27% this year.
Kb home as a much stronger company today with greater scale solid profitability and a healthy balance sheet.
<unk>, an excellent portfolio of performing communities.
Our business has a more geographically diverse footprint with.
With less concentration in our West Coast region as illustrated by the distribution of our future revenues and backlog.
We are maintaining our scale in the west while at the same time growing our other regions.
We believe the strength of our company together with our built to order business model.
Enable us to navigate the changing market dynamics.
Order rates are moderating from the exceptional levels that the industry experienced beginning in late 2020 as higher interest rates and increased home prices along with other inflationary pressures are impacting current demand.
That said, we believe the factors underlying long term demand continued to be healthy, particularly with respect to the demographics and the work from home trends, coupled with an ongoing under supply of new homes and low existing home inventory.
Our net orders were 3914 down 9% versus a year ago. When we reported the highest second quarter net orders in the prior 14 years.
While our gross orders were flat year over year, a higher cancellation rate created the negative net order comparison at some buyers were affected by the larger monthly payments from the increase in mortgage rates.
For the quarter, our cancellation rate remained below historical averages with about one half of the cancellations occurring on onstar and homes.
Our cancellations reported after start remained in single digits and we ended the quarter with only 69 finished unsold homes in inventory.
And $6 two net orders per community in the second quarter.
Our monthly absorption rate was aligned with our production starts.
As we continue to manage pace and price to optimize our assets.
As the community count the second quarter marked the beginning of our planned growth with anticipated sequential quarterly increases in our ending count for the remainder of the year.
New community openings, typically garner strong interest and demand from homebuyers driving these communities to perform above our company averages.
With absorption rates moderating, we anticipate our higher community count as well as more reliance on our virtual selling efforts will help support our net orders going forward.
We believe our built to order model also contributes to our industry, leading customer satisfaction levels.
Together with offering the most energy efficient homes among national Homebuilders. These.
These factors helped us generate among the highest absorption rates in the industry.
The differentiating feature of our built to order home is the choice that we provide to customers based on their budget and what they value.
We believe the flexibility to rotate into a smaller square footage home at a lower base price with the same number of rooms and functionality is a compelling benefit in today's environment when affordability is under pressure.
This can be the difference that makes our homes attainable for buyers.
And we already have these floor plans available in our communities.
In addition to the size of the home.
Our customers have other choices as well from the location of their lot two upgrading their finishes in our design studios or not as buyers can also select from included finishes again based on their preferences and ability to spend.
Our business model allows us to move with demand and responding to what buyers want and need and.
And this strength is reflected in our first time and first move up buyer percentages, the largest demand segments holding steady sequentially in the second quarter and 56% for first time buyers and 78% for the two combined.
The credit profile of our buyers that use our mortgage joint venture <unk> home loans remained strong.
For loans funded during the quarter about two thirds of these customers utilize the conventional mortgage.
Loan to value ratios held steady at 85% translating to an average cash down payment of roughly $75000.
And close to 100% of buyers use fixed rate products.
The average household income of these buyers was about 125000.
And their FICO score showed a slight sequential improvement to 734.
While we target the median household income in our Submarkets, we are attracting buyers well above that income level with healthy credit who recognize the value of our personalized built to order homes and their preferred location.
Our buyers incomes and credit metrics provide them with the flexibility to adjust the type of loan program they choose if needed.
Other fixture adjustable rate mortgages or conventional versus FHA loans.
In addition, K VHS has been proactive in working with buyers who wanted to lock their rates.
As of the end of the second quarter, we estimate the buyers who have locked their rates or will purchase with cash represented roughly two thirds of our backlog, providing us with good visibility on deliveries.
The <unk> team together with our community team at each location are both in weekly communication with our customers.
Our standard process for them.
Rates can generally be locked at any point during the construction cycle.
With that let me pause for a moment and ask Rob to provide an operational update on build times and production Rob.
Thank you Jeff.
Our division delivered about 200 more homes in the second quarter than the midpoint of the guidance. We shared with you in March a sequential improvement in cycle times, a key factor in our ability to accomplish this while we based our second quarter delivery projections on our 2022 first quarter build times, we actually improved by two days in the second quarter.
<unk> with cycle times getting better in every stage we measure in may.
Relative to the first five months of the fiscal year. The second quarter marked the first time in more than a year that we did not experience an extension in our build times and while we acknowledge that they remain higher than historical levels. We are encouraged by our progress.
There is a perception that a built to order home takes longer to build than a speculative home and that is not the case the stages sequencing of construction and build times are the same in both approaches and or Bto model. We utilize a standard planned series, which is a library of floor plans that were created based on our market survey data and.
Our customers most frequently selected plans our homes, our personalized not customized our buyers finalize their standardized design studio selections before we start the home. So our trade partners know exactly what is going into the home before it has started.
With respect to the supply chain, we're seeing mixed dynamics with the availability of some materials such as paint plumbing products interior doors and door hardware improving sequentially.
Other materials, such as engineered wood products cabinets installation and concrete continue to be difficult to obtain but have stabilized and the third group of products, including heating and cooling materials and electrical equipment appliances and windows remained challenged.
S trade labor the impacts from Covid related shortages was less severe than it was in our first quarter. However, we continued to manage through trade labor shortages in our second quarter and remain watchful of any shifts in contractor labor availability.
Overall, the supply and delivery of products and construction services are still unpredictable, but our teams are resilient and working through the challenges and quick to creatively address delays and developed workarounds to keep our homes progressing.
We would expect supply constraints will prevent us from returning to our historical build times in the short term. We believe the actions we have taken and simplifying our skus, adding trade partners and suppliers and communicate in real time with suppliers about future needs have helped to stabilize our build times.
And with housing starts across the industry down 14% as reported last week, we expect the overall pace of starts in our markets to lessen providing some expected relief to build times, which will help us to return to our historical build times longer term.
And with that I will turn the call back over to Jeff.
Thanks, Rob.
The final topics I wanted to discuss in my prepared comments, our land spend and capital allocation.
We're in a favorable position today with assets that we believe will support strong gross margins beyond 2022, and new communities that continue to perform well at their opening.
We have prioritized our capital allocation towards investments in our future growth through a disciplined process.
This means adhering to consistent underwriting criteria targeting the median household income and assuming an absorption pace per community.
<unk> 46 per month, depending on the specifics of the investment.
Utilizing current selling prices and construction costs.
Focusing on communities that provide a two to three year lot supply.
And staying geographically close to where we currently operate.
In the past 12 months, we have invested $2 8 billion in land acquisition and development.
We have expanded our lot position to approximately 90000 lots owned or controlled providing us with the lots needed to achieve our growth targets through 2024.
Roughly one half of our owned lots were contracted for in 2019 or prior and.
40% of our lots were tied up during 2020.
As a result.
The vast majority of our own lots were underwritten before the significant run up in average selling prices.
This supports our ability to sustain solid gross margins.
Is it typically takes two to three years from the time, we tie up a piece of land to the point at which we deliver the first home to our customers.
We strive to take a balanced approach to capital allocation over.
Over the past year. In addition to the land investments that I just mentioned, we returned nearly $300 million to stockholders.
This included a regular quarterly cash dividends of over $53 million and nearly $240 million in stock buybacks as we repurchased over 6 million shares.
Or roughly 7% of our shares outstanding.
With strong profitability and an anticipated tightening of our land investments in response to the changing market conditions.
We expect that we will have opportunities to continue to redeploy capital to stockholders.
Before I wrap up I would like to thank the entire Kb home team for their hard work and ongoing commitment to serving our homebuyers.
In closing, we are mindful of market conditions and the various macroeconomic factors that are impacting homebuyers.
We believe our built to order model is well suited to navigate the changing environment given the flexibility it provides.
With more than $6 billion in potential future revenues and backlog. We believe we are well positioned to deliver meaningful returns focused growth. This year with an anticipated expansion of our scale to seven 4 billion.
An increase in our operating margin to over 16%.
Which together will drive our return on equity of over 27%.
We look forward to updating you again later this year.
With that I will now turn the call over to Jeff for the financial review Jeff.
Thank you, Jeff and good afternoon, everyone I will now cover highlights of our 2022 second quarter financial performance and provide our current outlook for the third quarter and full year.
We are pleased with our second quarter results, which reflected improvements in virtually all key financial metrics. In addition, we repurchased one 5 million shares of our common stock during the quarter and earlier today completed the issuance of $350 million of 725% eight year senior notes.
With plans to use the net proceeds to redeem our seven 5% senior notes maturing in September .
Our housing revenues of $1 $71 billion for the quarter increased from 144 billion in the prior year period, reflecting a 21% increase in our overall average selling price and approximately the same number of homes delivered.
Based on our current construction cycle times and backlog, we anticipate our 2022 third quarter housing revenues will be in the range of $1 eight two to $1 $92 billion.
For the full year, we are projecting housing revenues in a range of seven three to seven $5 billion.
We believe we are well positioned to achieve this topline full year forecast based on the construction status of homes included in our second quarter ending backlog.
In the second quarter, our overall average selling price of homes delivered increased to $494000 from $410000 in the prior year period, reflecting the strong housing market conditions over the past 12 months, which supported the successful opening of new communities and <unk>.
<unk> us to raise prices across our operational footprint.
Average selling prices were higher in each of our four regions with year over year increases ranging from 18% in our southwest region to 23% in our southeast region for.
For the 2022 third quarter, we are projecting an overall average selling price of $495000. We believe our ASP for the full year will be approximately $500000.
Homebuilding operating income was up 62% to $264 $5 million as compared to $162 9 million in the year earlier quarter, reflecting an increase of 410 basis points and operating margin to 15, 4% due to meaningful improvements in <unk>.
Both our housing gross profit margin and SG&A expense ratio.
Inventory related charges were immaterial in both the 2022 and 2021 second quarters.
We expect our third quarter homebuilding operating income margin, excluding the impact of any inventory related charges to improve to approximately 16, 9%.
For the full year, we still expect our operating margin, excluding any inventory related charges to be in the range of 16.0 to 16, 6%.
Our housing gross profit margin for the second quarter expanded to 25, 3% up 390 basis points from the prior year period.
The current quarter metric reflected the favorable pricing environment and lower amortization of previously capitalized interest, partially offset by higher construction costs and increased expenses supporting future growth.
Our continued gross margin improvement trend demonstrates our success in offsetting input cost inflation with selling price increases.
In addition, with our strategy of locking material labor cost when we start each home, we have been able to largely mitigate the impact of cost inflation during the construction process.
Assuming no inventory related charges, we expect a sequential increase in our 2022 third quarter housing gross profit margin to approximately 26, 5% and further improvement in the fourth quarter.
Considering this expected favorable trend we believe our full year housing gross profit margin, excluding inventory related charges will be in the range of 25, six to 26, 2%, representing a 410 basis point year over year increase at the midpoint.
Our selling general and administrative expense ratio of nine 8% for the quarter improved from 10, 1% for the 2021 second quarter.
The 30 basis point improvement, mainly reflected lower external sales commissions and increased operating leverage from higher revenues in the current quarter, partly offset by higher expenses to support growth.
Considering anticipated increases in future revenues in our continuing actions to contain costs. We believe our 2022 third quarter SG&A expense ratio will be approximately nine 6% and our full year ratio will be in the range of nine three to nine 7%.
Pretax income from our financial services operations was $18 $7 million in the quarter, representing a year over year increase of $8 million.
The year over year improvement was largely due to a significant increase in interest rate lock commitments within DHS home loans, our mortgage banking joint venture as most customers elected to lock their mortgage interest rates for an extended period of time.
The accounting treatment for these rate lock commitments had a favorable pull forward effect on pretax income in the quarter.
K VHS was proactive in working with customers, who wanted to lock due to the high probability of further mortgage rate increases.
At the end of the quarter over 60% of the outstanding rate locks were for 180 days or longer.
While our overall projected financial services pretax income for 2022 has not changed the pull forward impact shifted some earnings to the first half of the year.
As a result, we now anticipate approximately $12 million of financial services pre tax earnings in the second half of the year.
Our income tax expense for the quarter of $72 2 million represented an effective tax rate of 26% compared to 17% for the prior year period.
The nine percentage point increase was entirely due to the favorable impacts of federal energy tax credits on the 2021 second quarter.
We expect our effective tax rate for the remaining quarters of 2022 as well as the full year to be approximately 25%.
Overall, we produced net income for the second quarter of $210 $7 million or $2 32 per diluted share compared to $143 4 million or $1 50 per diluted share for the prior year period.
Turning now to community count our second quarter average of 211 increased 3% from the year earlier quarter. We ended the quarter, a 214 communities up 7% year over year with 35 community openings and 29 sellouts during the current year quarter.
We anticipate our 2022 third quarter ending community count will reflect a small sequential increase followed by a more significant sequential increase in the fourth quarter.
We believe we will have approximately 250 open selling communities at year end up approximately 15% compared to year end 2021.
To drive continued new community openings and market share, we invested $700 million in land and development during the quarter and ended with nearly 90000 lots owned or under contract in the first half of 2022, we invested a total of $1 $4 billion in land and land development of which.
Approximately 55% was in land development.
In connection with the bond offering I mentioned earlier, Moody's investors service reaffirmed our <unk> credit rating and revised its outlook to positive from stable.
We plan to use the net proceeds from the new issuance for the redemption in full on July 7th of our outstanding $350 million of seven 5% senior notes maturing on September 15 2022.
We expect to record a charge of approximately $4 million for this early extinguishment of debt in the third quarter.
During the second quarter, we repurchased approximately one 5 million shares of our common stock for $50 million, leaving $250 million available for repurchases under our current board of directors authorization.
We ended the quarter with a book value per share of $37 76.
Our year over year increase of 21%.
In summary, we are pleased with our second quarter financial performance and expect we will deliver robust operating results for the full year supported by the strong revenue and margin potential embedded in our quarter end backlog value of over $6 $1 billion.
We are carefully managing the business in response to the higher mortgage interest rate environment and believe we are well positioned to generate higher revenues and expanded margins in the second half of the year.
Our 2022 full year financial projections have remained consistent with our expectation from the end of the first quarter of generating a return on equity in excess of 27%.
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.
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You May press star two if you'd like to remove your question from the queue for.
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We ask that you please limit to one question and one follow up.
Our first question comes from the line of Matthew Bouley with Barclays. Please proceed with your question.
Good afternoon, everyone.
For taking the questions I think at the top Jeff that you mentioned that your backlog.
Stands today. It gives you some visibility into the first quarter of 2023.
My question is thinking about just the changes in the market here over the past months.
Are you starting to see.
Some of those consumer moves towards either the smaller square footage offerings or changes in the design studio and as a result.
Should we think about you know without looking for hard 2023 guidance of course, but how should we think about kind of changes in profitability beyond your you know your current backlog visibility as a result of all that thank you.
Sure Matt Good good question, we analyzed specifically in the quarter, just or May order activity because that was the most recent.
Data after frankly, all of the interest rates had run up and what we saw in consumer behavior was nothing really changed in the footage of the home that they were picking and so far nothing has really changed.
The dollar spend at the studio so it stayed very consistent.
If you go back to the comments I made about our buyer profile that closed in the quarter.
It had an average income of a 100 quarter credit metrics and the down payment they actually could absorb more interest rate than we've seen so far and still buy the homes that they're choosing.
So.
With this.
The moderation in orders.
We've been seeing I think it's more of the consumer digesting these higher rates in all of these cost pressures.
Where they can still afford it they may not be comfortable making that kind of a payment or our commitment or they may just be paused because of everything.
Going on but so far they're picking the same the same homes in the same features.
As we look ahead.
Just before we we have smaller plans available with the same functionality and if the buyers were to pick a smaller home our studio revenue typically tracks as a percent of revenue so it's a little bit lower.
Base price home, it'll have a little bit lower spend in the studio, but the percentage margins and the percentage of returns overtime will hold you make a little less profit per unit, but you turn your inventory you still have healthy margins.
They'll have.
Comparable operating margin was just a little bit lower overall revenue. So we're watchful of the trends, but so far the consumer really hasnt shifted their preferences, which I find interesting.
Got it okay interesting what's that thank you for that color.
Second one on the cancellations I think you said that half of the cancellations that occurred in the quarter were on Unstarry at homes.
I'm curious number one is that is that typical or is that sort of a I guess, a one time adjustment as as rates spiked relatively quickly.
Where you had folks that had just recently entered contract. So that's part one and part two is I guess.
Presumably as future cancellations, maybe on homes that have already started you know.
If you could sort of remind us.
What you do to either incentivize moving those finish.
Finished or partially completed.
It turns into a spec home.
And just kind of what the margin impact of the cancellation side of it would be thanks again okay.
Yes.
A few parts to that question Matt.
On the the cancellations that occurred before we started the home in a lot of cases, they did not have a locked interest rates because they haven't finalized at the studio. So therefore, it didn't have a fully loaded sales price or at a fully loaded loan approval in order to.
Two locked alone and I do think there were some consumers in that bucket that we're surprised with where their payment centered up versus what they thought they would get when they originally contracted.
I'd actually flip it the other way, we always stay far more focused on the can rate after start because that's our predictability in revenue and for years now our can rate after start has been single digits.
Good times and bad and if you think about it in this perspective, especially for a first time buyer.
Our biggest fear is do they qualify for a loan.
We get rid of it after when we tell them or K Bhf's tells them that their loans approved then they lock their rate. So now they know their loans approved they are emotionally committed to the home.
And they weighed on us for the home to be completed in along the way right now.
Buyers have equity in the homes, because they've been on our books for 3456 months.
And they are very committed to close so our can rate after close.
<unk> low and very predictable and it is part of why we have the comfort to hold the guidance that we did for the year.
Converting on our backlog and frankly, the incentive we offer is a great home that they've personalized on the lot that they picked they already know their loans approved and we're not having to do things to hold that backlog in there committed and waiting on us frankly get the housebuilding.
Thank you.
Our next question comes from the line of Stephen Kim with Evercore ISI. Please proceed with your question.
Yeah, Thanks, very much guys if I could.
Continue the line of thinking there I thought I think it's important and interesting with respect to the behavior of your customer are you sort of talked about the slowdown in overall activity, but suggested that you werent seeing evidence that it's really just about math, it's really a lot of psychology, there's some fear in the marketplace.
And so forth so.
You gave us the information about what your buyers are doing with footage and option spend in the studio.
That I had related rate buy downs.
My understanding is that.
A lot of investors sort of feel like builders need to cut their prices in order to.
You don't get affordability back to where it was let's say when you had a 5% mortgage rate to see the mortgage rate went from five to six they do the percentage increase and that payment and then they say well that's how much the home price needs to drop by so they're just doing math.
But my understanding is that you could do a rate buy down and you could buy down probably a full percentage point on the mortgage rate with.
Four point, meaning 400 basis points theoretically.
So I wanted to check if that was correct.
You are doing rate buy downs right now and whether you think that that is actually.
The way people are responding would suggest that that's what it's all about that it's about numbers.
Or do you think that it's more psychology, and just a pause.
Reflecting in reassessing.
Steve in your assumptions correct, you can buy the rate down for three or four points and offer a lower payment we're not doing that today.
I think we've done a couple of inventory homes to move them, but.
Of built to order home youre not locking in the rate and buying is down for 270 days that would take that cost a lot more than four points, but.
We really don't do that in our in our approach its give the buyer the best price, let them create their own value.
And one of the things that I touched on our buyers are not moving to arms yet.
They are taking a fixed rate 30 years.
The arms have now settled downwards favorable pricing if a 30 year fixed as is around six you can get an arm for around for a 10 year arm.
Qualify at that 4%. So it is already out there for the customer if that's what they wanted and they're not moving there yet either so I actually believe right now we're in a digestion period similar to what happened in 2018 when prices ran in and interest rates peaked.
And they're just they're trying to figure it out there's buyer we're dealing with today can afford these homes with todays rates.
It's whether they're comfortable with everything else that they're trying to absorb inflation in gas prices in Ukraine.
Maybe their job situation I don't know, but.
Right now it's not this math equation, where we're having to do that to shoehorn a byron.
That's not what it is so we're staying focused on getting the best value price per foot personalize the home.
We'll see how it goes.
Yeah, and that's very very interesting.
The second question I had I did want to talk about your average selling price and in particular, the order price really shot up quite a bit I was wondering.
If there is anything.
One time ish in nature, you know if there's some sort of a temporary mix shift we saw in terms of community. So if you could just sort of talk about that average order price, which jumped from $5 12 in the first quarter to $5 43, I think in the second quarter.
Yes, Rob you want to take that.
Yes, I think it's just the <unk>.
Ongoing price lift that we've seen.
It's been increasing sequentially.
<unk> over quarter.
You know I I don't know I would expect that that does not continue on the pace that it's been on as.
Affordability challenges with great and everything keep moving up so I would expect that to level off but.
I don't know that it's really driven by anything regionally other than just ongoing price lift that we've had and.
Even through April we were continuing to lift prices in the majority of our divisions and communities less so in May and don't really expect that to continue going forward with some of the challenges that we've talked about but I think that's why we're seeing that Steve.
Thank you.
Our next question comes from the line of Mike Rehaut with Jpmorgan. Please proceed with your question.
Sure.
Hey, good afternoon, everyone. Thanks for all the color as always.
Wanted to.
Kind of revert to the broader market and some of the changes Im sure Youre aware of that.
A couple of days ago.
One of your large competitors talked about.
A combination in many markets of both increasing incentives as well as <unk>.
Price reductions or.
Or targeted price reductions in certain markets or communities.
Wanted to get a sense.
If you are seeing.
Across your markets not in terms of how you yourselves are acting.
But just across the markets broadly if you are starting to see.
Either or a combined are a combination of.
An increase in incentives or price reductions.
And if that were if thats the case or if you think we're at it.
Come more of an issue.
What is the cave playbook in terms of reacting to that.
If you would expect that perhaps it would just be a mix shift towards lower priced products.
I know you don't do a lot of incentives yourselves, but if theres anything along that path that you might.
React and.
Put into action.
Michael I'll share the the company philosophy on this and then Rob can give you some other color on what he's seeing out in the in the field.
There's a couple of different competitors here one is retail.
So you have to resell that should keep an eye on and you also have the new home peers and what are what are they doing.
And.
I would comment with us with the observation that this isn't every market moving together in fact, it's not even every submarket moving together in every city. There are submarkets that today are performing very well and then theres other sub markets that are challenged and there is different degrees.
Of strength or weakness.
From city to city so.
What's interesting for me and this evolution is markets are again falling backward each market has its own personality, which is what we had as an industry for 40 years and for two years now they all traded the same so I think things are going to start to settle down back to you.
The more normal things like job growth and income growth.
In migration and those type of things. So there are some parts of the country, where our industry the price of our products move too far too much of a premium versus retail and I think as things moderate and normalize youll see that gap close.
And that's going to drive some of your behavior and when we underwrite we target resale medians as well and we understand that then you have a builder who may have a heavy inventory position in this community and that's a onetime thing and you ignore them over here maybe peers that.
Get more aggressive to move something.
And through it all as Rob just observed our pricing is up dramatically. We're we're selling at margins above what we just reported and have been.
So we have a lot of room to navigate without.
While continuing to generate above average returns and above average operating margins and we have a lot of communities, we're going to be opening that we tied up three.
Three years ago, you know what's happened to price in the last three years versus when we underwrote those assets. So we really like our position and we think between all of that and rotating left we have all the tools, we need to be competitive to hold are our absorption paces and maybe they come off from six and go down to five but at the margins.
They go to four we'll we'll work to.
Optimize the pricing the pace that at the right margin and we think we've got all the tools, we need to navigate through this thing right now.
That being said, Rob do you want to give me some color on what we're seeing in the field.
Yes, you mentioned the incentives and we have seen the incentives game kind of creep up and starting to see more than that and it really is just that it depends on the location. It depends on the region, sometimes the submarket within a city onto what level what level. We're seeing so it's hard to give you a real real.
Specific color on the level, but we have seen it increase primarily what I've been seeing is.
Incentives go get higher for homes.
Can be delivered by the end of our builders fiscal year. So some that are carrying a heavier inventory load are incentivizing those homes to get them in the queue to close this year.
And as Jeff mentioned in some of his comments our focus is getting the base price right to start with and then giving the buyer choice given the the ability to.
Shift left select a smaller square footage plan.
Create their own affordability that way so we're not playing in the incentive game and sticking with their business model.
Okay.
Thanks, a lot that's that's very helpful.
I guess just secondly.
Yeah.
Probably a slightly reduced the year end community count this.
This quarter from $2 55 to $2 50.
Still representing very healthy <unk>.
17% growth year over year.
Any thoughts.
As you know I'm sure a lot of plans are in the final stages for fiscal 'twenty three.
Any thoughts Directionally in terms of I believe you said in the past do you expect continued growth in this metric.
For next year, but any sense directionally in terms of the <unk>.
<unk> of magnitude, if we shouldn't be expecting more like maybe perhaps a mid single digit growth or could it be something again kind of approaching.
Reaching double digits.
Jeff can handle it.
Yes, just a little bit of color on community count as you know, we don't really guide out too far into 'twenty three at this point of the year, especially with some of the uncertainty we're seeing but.
We've been building a nice land bank for a while.
Jeff I thought gave some very insightful statistics during his prepared remarks on the vintage of that land and some of the price inherent in it and some physicians that we still strongly believe we are going to be really good communities for us and we will bring those communities to market as we develop through them. So we are anticipating.
Further growth in 2023 and community count.
And depending on what happens with Closeouts et cetera, it could be.
More significant than the growth we saw this year, but will bubble up again.
Third quarter, and hopefully at that point and give you guys a little bit more to go on relating to communities for next year and the count but.
We'll be deploying those assets that we've been investing in over the last 18 months into new open selling communities.
And we believe the combination of having more stores on the ground as well as.
We're hopeful to see some tightening on our build times be able to support continued revenue growth, but we'll see as time goes on those on those two factors.
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 all the great detail as always.
I guess first question, maybe on the supply chain, Jeff you kind of alluded to a little bit of helpfulness thereabout cycle times.
I guess my.
My question is more on the cost side. Obviously this environment has been pretty favorable for your suppliers passing along price increases over the last year or two and it would seem like given that this shift in the market. Even though you guys are still seeing pretty healthy demand overall, I would say that there might be an opportunity to push back a little bit on the suppliers either.
Kind of.
Retrace some of the increases that you've seen or maybe pushback on future increases. So im curious whats the real time update on on pricing increases from your suppliers is there any progress being made there or any any optimism that there could be some.
Yeah.
Rob I want to start with lumber and what we're seeing and then get down to that next level of labor and everything.
Yes.
Lumber has been the main driver of the cost increases certainly everything has moved up but not to the degree that lumber has an lumbers dropped drastically over the last few months.
We're seeing the benefit of that in.
And starts today.
But we won't see that in our closings until first part of 2023.
Just kind of order of magnitude I mean framing just a material component of framing in Q2 of 'twenty one versus 'twenty two was up.
It was up.
Roughly $25000 in framing material up to 41, so a substantial increase now they've come back down.
We're seeing random lengths composite that we're tracking in the fives now versus in the <unk> hundreds just a few months ago. So there are some definite benefit coming on the lumber side.
As far as the other increases usually theres, a theres a lag between what we're seeing out there on the sales side and starts to when we start seeing the cost decreases, but we're we're definitely pursuing that and we expect that.
It'll be some.
<unk> is coming from cost there as well.
Great I appreciate that.
And secondly, I'd love to drill down a little bit on your comments earlier about kind of tightening some of the land investments I'm not sure. If you if you updated the guidance there on land spend or if that's just more of a qualitative comment but.
Can you just talk a little bit about what's shifted on your strategy on the land side are there option deals perhaps that are coming to the finish line to be taken down that year.
Rethinking whether you move forward with those or is it more in reference to new deals youre, putting under contract I know you've mentioned you've entered a few markets over the last year new markets over the last year.
Is there any contemplation there and pulling back just kind of talk a little bit about where you see the land spend going over the next year or so given the shifting market.
Yes.
I would couple it with.
The comment I made that we already own and control everything we need for a nice growth rate in 'twenty, three and 24. So we're set for 'twenty, three and 'twenty four and as we look at things.
It doesn't make sense to drive more investment to try to grow even more.
Until there's more clarity in where demand is going to end up in.
Where land sellers end up in there then we are seeing movement right now with the land sellers were there there's more openness to.
Smaller deposits extended times to close things like that so that's normally step one and step two you start working on options instead of a cash play. So I do think youll see that but what I was referring to is.
Until there is real clarity in this market is that.
A brief digestion or is it a structural shift in either case, what does it mean, we're going to take our time, because we have the ability to do so right now and we will be pulling back on our land spend coming out of this year until until we have clarity and what that means is you youre set up to grow your company you spend less on land.
Should over time be in AR.
A nice position to have flexibility in how to reallocate the capital.
Thank you.
Our next question comes from the line of John Lovallo with UBS. Please proceed with your question.
Hey, guys I. Thank you for taking my questions. The first one is could you help us with sort of the monthly order cadence in the second quarter. If you can give us any color into June that would be helpful.
Okay.
Rob you want to take that.
Sure.
Not to get into.
Two specific numbers, but the order the order cadence was fairly consistent March and April we did see a softening in may.
As cancellations increase too.
I would say has been similar to me.
Where we're seeing some ongoing.
Softness over the last couple of months I think what Jeff was talking about earlier with buyers kind of being locked up for frozen right now trying to decide what to do as part of that.
But we're also taking actions now as we talked about earlier to get the sales paces moving in just looking at it on a community by community basis to optimize each asset each community that we got part of that is pace.
And that's an exercise that we're going through right now.
Got it.
And then.
John I'm sorry go ahead, I'm wondering if that would add to that that I think is as relevant if we're assuming here that markets are overtime here just normalizing normal normally this was before COVID-19 for the five years prior to Covid our orders in the third quarter typically are down sequentially, 20%.
From Q2 to Q3, that's our normal cadence through our year and so it wouldn't surprise me if we have a similar cadence this year it moves a bit due to community count in sellouts and.
And whatnot, but in.
And when you look at it from a comp basis in.
2021 we did not have seasonality, we actually had a stronger fourth quarter in 'twenty than we did a third.
And last year and 21 in Q3, and Q4 were every bit as strong as Q2, and it's not normal because there is seasonality to our business. So I would expect youre going to see a more of a seasonal trend develop here this year.
That's helpful. I appreciate that and then the second question is the $75000 down payment that you talked about it as meaningful obviously and probably helps lock folks in to some extent, but what percentage of the cancellations do you actually refund that down payment.
Rob you know that number I mean, it's it's only at the loan got rejected which is rare because we got the loan approval before we start the house.
Yeah, I mean, if we're talking about I think down payment versus the earnest money deposits are two different things and typically on the earnest money, where we're keeping that really in every case unless it's a buyers' inability to qualify.
And typically that's we're giving that back I'm not sure if that answers your question.
I was talking more about the 75000.
Yes.
Well, yeah I mean.
If a buyer cancels were not keeping all of the downpayment really.
Deposits that were keeping us.
That's that's the earnest money deposit.
Okay. Thank you guys.
Our next question comes from the line of Depot Ragavan with Wells Fargo Securities. Please proceed with your question.
Hi.
Everyone. Thanks for taking a question for taking my questions.
It's interesting to know Youre not playing the incentive game, yet, but are you able to comment what would be the general competent the response from the industry.
Overall.
Some of your peers, noting the big ones are taking some taking incentives higher also adjusting prices are lower so just curious any industry level commentary able to fare and competent the restaurants.
Deepa I think I think Rob touched on that what you always see.
A market correction I'll call. It builders that have inventory so they've already built the home and may or may not be what the buyer wants and you have to do something to get the buyer to want it. So you either lower the price or offer some type of incentive or do both and it could be higher realtor commissions.
Or.
Who knows what it gets pretty creative.
We're not seeing radical moves where incentives.
<unk> got in excess of yet as people doing a little bit here and a little bit there to try to move some of their inventory, but it's a game that we've never played we always just focus on giving them the best price for the best value.
Over time, we've always had a customer that really values that versus buying a home that's already built in and somebody inducing them to buy by giving them a better deal.
Okay, that's fair.
<unk>.
Since the last earnings call.
You incorporating any pharma slowdown in your second half guide it doesn't appear because good amount of your backlog was already locked in as of last quarter.
The rest of the year, but just curious I wanted to ask if there were any puts and takes within the second half.
What is the last time, we heard from you on the call.
Right. The main changes in the guidance. This quarter, we're just really a tightening of the ranges, which just reflects.
Less time period, and the higher level of confidence over the next couple of quarters on our part.
The advantage we have right now is the large backlog.
And the assurance and the quality of the backlog frankly that we will be able to close those homes. So we know the prices we know the costs.
And the vast majority of the cases, we have customers that are very well qualified and a lot of those cases are actually have a lock mortgage interest rates. So we don't expect to see a lot of volatility in that.
And on the other side of it if we do see some.
Spike in can rate for example on started homes or homes that are supposed to close either in the third or fourth quarter. We've been very successful reselling homes as we've gone through this latest cycle and there is still very very thin layer of.
Inventory that we have in our system out there so any any homes that are coming off Canada or otherwise.
Fairly quickly reselling and in most cases reselling at higher prices.
And they were originally sold that so we feel pretty confident I mean look theres a lot of things that can happen. There is a lot of uncertainty out there right now but from our view of the next six months, we're in really good shape as far as delivering these results.
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 in your SG&A continues to come down really nicely over time as people think.
About the underlying conditions normalizing or moderating in there and maybe some of that normal seasonality coming through can you talk to your ability to sustain this improvement that you've realized and maybe where that could get to over time as things do change on the ground.
Right, we've been progressing nicely as you've noted on SG&A, it's nice to hit a single digit number now.
In the SG&A on a quarterly basis at the same time as we've been.
Basically on a glide path down towards improvement in that number we've also been putting resources in for growth for future growth of the business.
So we will be carefully watching and managing the business.
And based on macro conditions, and what we see and whether we pulled back on some of that growth investment or not time will tell but we do have some ability to continue to.
Guy that number and to make it better.
Do believe.
As far as a long term run rate I think it's single digit SG&A number is the right number for the company and we're quickly approaching that in fact for the full year, it's satisfying to see it dropped below the 10% level. So.
Like I said, we will see is entitled tell but we stay very focused on it particularly in times like these.
And we will continue to manage the business appropriately for.
Both near term quarters, as well as future quarters.
Yes, okay.
And then obviously it was encouraging to see you buying back stock this quarter. When you consider the move in the valuations just over the last week or so and everything that sort of going on operationally. How are you thinking about repurchases going forward and just any thoughts there on the potential cadence.
So as long as we have always.
Sheridan the view, we have is a balanced approach and we want to make sure we have the the.
Capital to run the business.
If things are slowing you want to have the capital to be opportunistic on.
The land side and so we're not going to do something shortsighted and we will keep this balanced approach up and.
And as we look ahead, if if we have comfort that our our capital has the ability to be redeployed and values are where they are we'll buy more stock back.
We don't have a set number in mind right now that we would share.
But our actions speak that we've been willing to do it at the right time.
Thank you.
Our final question comes from the line of Jay Mccanless with Wedbush. Please proceed with your question.
Hey, Thanks for fitting me in.
The first question I had with what's happening in June are there any places where you might still be limiting sales or are you going ahead and kind of opening that up, especially now that supply chain seems to be getting better.
Rob you want to take that.
Yes.
It has shifted where there were a lot of communities a lot of locations, where we were limiting sales in matching our sales to our construction cadence but beats.
Between supply chain, appearing to at least stabilize if not getting better in picking up some days on cycle time.
With the market softening a bit in most locations that's become more limited there.
There are still some communities out there where we're limiting.
Austin in Vegas come to mind, but.
Generally.
We've moved away from that.
Okay Gotcha.
And then.
Just digging in on the cycle time improvement.
Just wondering was that improvement more about internal processes that you worked on with your subs or are you actually getting more goods in a timely fashion now than you were say three or six months ago.
Uh huh.
I think it's a combination.
We talked in the first quarter about some of the impacts that we had from the spike in Covid. That's certainly got a lot better which has freed up capacity.
The labor side.
I think we are seeing some bright spots in the supply chain, but it's still we still don't know necessarily what we're going to get what kind of products are going to get until the truck shows up on the job and we are able to open it up and see so I think most of the improvement has come from some of our own efforts, whether that's our communication with our trade partners about upcoming.
Needs or the simplification efforts, we've done and just our teams getting better now that we're several quarters into it and finding workarounds to keep the houses movie.
Thank you.
Ladies and gentlemen. This concludes today's teleconference. Thank you for your participation you may now disconnect your lines.
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