Q3 2022 KB Home Earnings Call
And the attachment to their purchases that sounds from creating their personalized zones on our last day of selected with features and finishes they have chosen.
As to the details of the quarter, we produced total revenues of $1 84 billion.
Up 26% as compared to the prior year period.
And diluted earnings per share of $2 86.
Which grew almost 80% year over year.
While we achieved the low end of our revenue guidance, we experienced an extension in build times due to ongoing supply chain issues, which affected deliveries in the quarter.
Rob will provide more detail on cycle times, and our supply chain shortly.
Our gross margin of 27% as a particular highlight of the quarter demonstrating the impact of our internal initiatives.
Along with our effective management of pace price and starts to optimize each asset.
The robust demand environment earlier in our fiscal year.
In addition, we successfully manage costs driving our SG&A expense ratio down 100 basis points year over year.
We remain committed to balancing our overhead with our revenues as.
As we continue to open additional new communities.
The factor supporting demand for homeownership remained strong, including favorable demographics population and job growth in our served markets and rising rental rates.
Coupled with a limited supply of homes due to the industries under production of new homes and low levels of existing home inventory, particularly at the more affordable price points.
Although the long term outlook remains positive many prospective buyers have paused and move to the sidelines.
Amid higher mortgage rates, along with ongoing inflation and a range of macroeconomic and geopolitical concerns.
As we manage through these uncertain times, we remain committed to our built to order approach.
Our focus is to provide the best value to customers based on their budget and the features that are most important to them.
And not to offer the best incentive on our standing inventory homes.
Homebuyers were making the largest investment of their lifetime and many desire of personalized home with the ability to select their lot.
Floor plan.
<unk> or upgraded interior finishes and exterior elevation.
This flexibility is also important to our customers.
If affordability is a constraint as our buyers can select a smaller square footage home at a lower price with the same number of rooms and functionality.
And also reduce our spend and our studios.
We believe our approach is compelling and can make the difference and whether a customer is able to purchase a home.
By Upsizing choice and personalization as well as the partnership our community teams offer we provide an important service to our buyers.
We think this is a key driver in our consistent achievement of the highest customer satisfaction rating among production homebuilders.
Net orders in 2040 were down relative to a strong $4 85 in the year ago third quarter.
Let me discuss the components of our net orders by first providing some color on our gross orders with a separate discussion of cancellations.
At the start of the third quarter, given the size of our backlog and with only 69 finished homes available for sale. We made the decision not to chase sales.
The quarter unfolded with June's average weekly gross orders coming in softer than May and.
July is gross orders held consistent with June .
And we then experienced an acceleration in gross orders in August .
We have taken steps in July with respect to pricing and some underperforming communities. While at the same time mortgage rates had declined slightly since June .
We were pleased with the activity in August , but following labor day interest rates have again risen.
And we've experienced a softening orders trend.
We will continue to monitor market dynamics and individual community performance.
And we'll adjust pricing as necessary to maintain the balance between preserving our backlog and achieving minimum absorption rates to optimize each asset.
Over the years and throughout cycles, we have typically generated one of the highest sales rate per community in the industry and that remains our objective going forward.
With respect to cancellations due to the unusually low level of gross orders and large beginning backlog of $12 300 homes.
We believe looking at cancellations relative to backlog is a better way to understand the dynamics during the quarter.
At 9% our cancellation rate on beginning backlog did increase sequentially, but it was still well below historical levels.
The number one reason for cancellations was buyer's remorse.
It was not necessarily that the buyers did not qualify they did not feel comfortable moving ahead with the purchase.
We ended the quarter with only 12% of our homes in production unsold consistent with our second quarter level.
And with less than one finished and unsold homes per community.
We expanded our community count in the third quarter due to fewer communities selling out partially offset by some deferred openings.
In this market environment, we are not opening communities for sale until models are 100% completed to optimize the selling effort.
Which contrasts with the past 12 months during which we opened for pre sales while models were still being constructed.
We expect another sequential increase in our ending count in the fourth quarter and year over year growth in 2023.
This will be an important contributor to our future net orders given the moderation in absorption rates.
The credit profile of buyers that use our mortgage joint venture K VHS home loans remained strong and consistent sequentially.
For loans funded during the third quarter, 67% of these customers qualified for a conventional mortgage and nearly all used fixed rate products.
The average loan to value ratio was 84%.
Translating to a cash down payment of over 80000.
The average household income of these buyers was 130 and their FICO score was 734.
While we target the median household income in our sub markets. We are attracting buyers above that income level with healthy credit that are able to qualify at higher mortgage interest rates.
With that let me pause for a moment and ask Rob to provide an operational update Rob.
Thank you Jeff.
We continued to face difficulties in completing and delivering homes in the third quarter and as a result, we were short about 160 deliveries or 4% relative to the midpoint of the guidance that we provided in June .
While we had seen bold times improved modestly in May which we shared with you on our last earnings call. The extended significantly from that point illustrating the larger industry wide challenge in finding a consistent footing and bill times.
During the third quarter built times for our homes under construction expanded by 11 days from the framing stage to completion.
This drove the delivery Miss in the quarter and is also having an impact on our fourth quarter delivery projection, which we have reduced.
There were several factors that contributed to this extension.
Building materials shortages continued to delay in the completion of volumes, we are seeing improvement in the availability of some products such as appliances garage doors insulation and Hvac's flexed up while other areas are still challenging, including electrical materials cabinets, <unk> equipment and flooring products.
As to trade labor the dynamics are mixed with availability on the front end of the construction cycle, improving although continuing to be more difficult in the back end.
The homebuilding industry has been dealing with power infrastructure issues for quite some time and this isn't intensified we had completed homes that we cannot deliver in the third quarter, because our utility providers could not get transformers and electric meters and many of our divisions that build attached product experienced delays in obtaining switch gear and wire.
<unk>.
In Houston, there were 77 homes across three communities that were completed and scheduled to close in the third quarter, but were postponed due to the lack of transformers.
In addition, we continued to experience delays with city inspections in most of our markets due to municipal staffing shortages and elevated production levels in the back end of construction.
We are factoring belongs in municipal lead times ongoing supply chain issues and labor shortages, we experienced in the third quarter into our future delivery projections are.
Our teams are working relentlessly through through the challenges and finding ways to progress homes through the construction cycle.
We are focused on what we can control and we are optimistic that we'll start slowing in most of our markets and our greater scale, we can transition back to our historical build times, although this will take time to achieve.
The lower level of starts is also providing us with an opportunity to reduce our cost to build as we renegotiate them where possible.
And with that I will turn the call back over to Jeff.
Thanks, Rob.
Last quarter, we shared with you our expectation of reducing our land investments in light of current market conditions, and then redeploying this cash to our stockholders.
In the third quarter, we did just that with a year over year reduction in land acquisition and development spend of almost 30%.
With near term visibility limited as to the direction of the economy and its impact on homebuyers, we expect to continue at a lower level of land spend for the foreseeable future.
We've been renegotiating land contracts to reduce prices and extend closing timelines.
In certain cases, where we are no longer comfortable that we can achieve our required returns on the investments we have terminated the contract.
In the third quarter, we canceled contracts to purchase nearly 8800 lots.
Our lot position stands at just under 80000 lots owned or controlled.
Of these 51000 are owned and only about 18300 are finished slots with 11000 of these having a house under construction.
We are balancing our development phasing with our starts pace, so as not to build up a large inventory of finished lots.
Supports higher inventory turns.
Relative to the vintage of our own locks, we contracted approximately 40% of these laws in 2019 or prior.
And another 40% were tied up during 2020.
As a result, the vast majority of our owned lots were underwritten before the run up in average selling prices, which we believe supports our ability to sustain solid gross margins.
The balanced approach, we take towards capital allocation has resulted in $100 million of stock repurchases in the past two quarters, driving a 5% year over year reduction in our diluted share count in the third quarter.
With strong profitability and healthy cash flow expected in our fourth quarter.
And ongoing caution in land investments, we expect to be in a position to redeploy additional capital to our stockholders before the end of this year.
In closing I would like to recognize and thank our entire <unk> team for their hard work and ongoing commitment to serving our homebuyers.
We believe the differentiation, we offer and our built to order approach, providing choice and flexibility that creates an emotional connection between buyers and their personalized homes.
Contributed to our leading absorption rates in the industry over many years.
We are focused on preserving our backlog and achieving our minimum net order targets as we navigate current market conditions.
All of the homes that we need to complete a strong 2022 fiscal year are already in our backlog.
Although we acknowledge that longer build times and ongoing supply chain disruptions have impacted the timing of some of our deliveries.
With about $7 billion in revenues expected for this year.
Reflecting over 20% year over year growth.
And our gross margin of 25%.
We anticipate that we will generate a return on equity of about 26%.
Representing meaningful returns focused growth.
With that I'll now turn the call over to Jeff for the financial review.
Yes.
Thank you, Jeff and good afternoon, everyone I will now review highlights of our financial performance for the 2022 third quarter and discuss our current outlook for the fourth quarter.
In the third quarter, we produced measurable year over year improvements in most of our key financial metrics, including a 26% increase in our housing revenues, a 610 basis point expansion of our operating margin and a 79% rise in our diluted earnings per share. We also completed several significant.
<unk> transactions to improve our capital structure and strengthen our balance sheet, which I will detail shortly.
Our housing revenues grew to $184 billion compared to one $4 6 billion for the prior year quarter.
This improvement reflected a 6% increase in the number of homes delivered and a 19% rise in neuro overall average selling price.
As Rob discussed our current quarter deliveries were tempered by extended build times in most of our served markets driven by building material shortages.
Trade labor challenges power infrastructure issues and delayed city inspections, we have moderated our fourth quarter revenue outlook to reflect an anticipated continuation of these industry challenges.
Considering our quarter end backlog of $5 $3 billion the status of homes under construction and expected construction cycle times, we anticipate our fourth quarter housing revenues will be in a range of $1 $95 billion to $2.05 billion.
Our overall average selling price of homes delivered in the quarter rose to $509000 from 400.
Third 2000 7000.
Average selling prices were higher in each of our four regions with year over year increases ranging from 12% in our west coast region to 26% in our central region for.
For the fourth quarter, we are projecting an overall average selling price of approximately $503000, which would represent a year over year increase of 12%.
Our homebuilding operating income improved to $325 1 million as compared to $169 9 million in the year earlier quarter.
Operating income margin increased 610 basis points to 17, 7% due to meaningful improvements in both our gross profit margin and SG&A expense ratio.
Excluding inventory related charges of $8 $5 million in the current quarter and $6 7 million in the year earlier quarter. Our operating income margin was up 600 basis points year over year to 18, 1%.
The current period inventory related charges were comprised of $5 $9 million of abandonment charges associated with our housing operations and a $2 $6 million impairment charge relating to a planned future land sale.
We expect our fourth quarter homebuilding operating income margin, excluding the impact of any inventory related charges will be approximately 16, 7% compared to 12, 9% in the year earlier quarter.
Our housing gross profit margin was 26, 7% up 520 basis points from 21, 5% from the prior year quarter.
This margin expansion, mainly reflected the favorable selling price environment supported by healthy housing market dynamics, when most buyers contracted to purchase these homes.
Excluding the $5 $9 million of current quarter abandonment charges and $6 7 million of inventory related charges in the prior year quarter.
Our gross margin was up 500 basis points year over year to 27%.
Assuming no inventory related charges, we believe our fourth quarter housing gross profit margin will be in the range of 25% to 26%, which is lower than our prior expectation due mainly to the anticipated impact of selling price adjustments in response to softening housing market conditions and <unk>.
<unk> of leverage on lower expected housing revenues at.
At the midpoint, our fourth quarter gross profit expectation represents a 310 basis point improvement as compared to the prior year period.
Our selling general and administrative expense ratio of eight 9% improved by 100 basis points as compared to nine 9% for the 2021 third quarter, primarily due to a 70 basis point decrease in external sales commissions and increased operating leverage from higher revenues in the.
Current quarter.
Considering an anticipated increase in revenues in our continuing actions to contain and reduce costs. We believe our fourth quarter SG&A expense ratio will be approximately eight 8%, a 100 basis point improvement as compared to the year earlier quarter.
Our effective tax rate was approximately 22%, reflecting $79 million of income tax expense net of $15 $3 million of federal energy tax credits, we earned from building energy efficient homes.
We were able to recognize the tax credits largely due to recently enacted legislation.
We expect our effective tax rate for the fourth quarter to be approximately 24%, including an expected favorable impact from additional energy tax credits.
Overall, we reported net income of $255 $3 million or $2 86 per diluted share compared to $150 1 million or $1 60 per diluted share for the prior year quarter.
Turning now to community count our third quarter average of 221 increased 8% from the year earlier quarter. We ended with 227 communities opened for sales as compared to 210 communities at the end of the 2021 third quarter on.
On a sequential basis, we were up 13 communities.
We expect another sequential increase in the fourth quarter and believe our 2022 year end community count will be in the range of $235 to 250.
Using the midpoint this would represent a 10% year over year rise in our fourth quarter average community count.
Our forecasted your income is lower than our prior expectation as we anticipate fewer fourth quarter openings due to many of the same challenges that affected our third quarter deliveries.
We invested $556 million of land land development and fees during the third quarter with only $135 million of the total representing new land acquisitions as compared to $467 million in the prior year period.
The 71% year over year decline in land acquisitions reflects a pivot toward a more selective land investment strategy in response to softening housing market conditions, and our ability to develop land positions already owned or controlled to drive future new community openings.
In addition to being more selective on new land acquisitions, we abandoned approximately 8800 previously controlled lots during the quarter.
At quarter end, we had total liquidity of approximately $928 million, including approximately $195 million of cash and $733 million available under our unsecured revolving credit facility.
During the quarter, we issued $350 million of 7.25% eight year senior notes and used the net proceeds together with cash on hand to redeem $350 million of seven 5% senior notes prior to their September 15, 2022 maturity.
Recognizing a $3 $6 million loss on this early redemption of debt.
In August we entered into a senior unsecured term loan with $310 million of lender commitments. We are pursuing additional lender commitments and can draw up to the total committed amount at any time through November 23 2022.
We intend to use the proceeds of the term loan to redeem our $705, 8% senior notes due may 15, 2023, which have a par call data six months in advance of their maturity.
After retiring the May 2023 notes our next senior note maturity will be in June 2027.
During the quarter, we repurchased approximately one 6 million shares of common stock at a total cost of $50 million year to date, we have deployed $100 million of cash to repurchase approximately $3 1 million shares, leaving $200 million available for repurchases under our current board of directors.
<unk> authorization.
We ended the quarter with a book value per share of <unk> $40 79.
Our year over year increase of 26%.
In summary, while current housing market and supply chain conditions have negatively impacted our expectations for the fourth quarter our outlook for the 2022 full year reflect significant year over year improvements across most of our key financial metrics with notable increases in our scale housing gross margin.
Operating margin and returns.
We believe we will generate a full year return on equity based on our first quarter fourth quarter expectations of around 26% as compared to 19, 9% for 2021 and.
In addition, during the fourth quarter, we plan to complete the refinancing of our May 2023, senior notes and continue measured common stock repurchases.
We intend to carefully manage our business through the current housing market conditions and believe we are well positioned to achieve solid returns and drive book value accretion in the fourth quarter and into 2023.
We will now take your questions Alex Please open the lines.
Thank you.
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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 John Lovallo with UBS. Please proceed with your question.
Hey, guys. Thank you for taking my question.
First one is I guess, maybe can you help us think about maybe quantify the incentive activity on a sequential and year over year basis, what type of incentives are you using our buyers responding and then along the same lines on the fourth quarter gross margin.
Being now down sequentially does that imply that incentives were used in the backlog as well.
John I can make a few comments on incentives and I'll ticket, Jeff for the specifics on the slight move into growth.
As I shared in my prepared comments, we really don't focus on incentives we look at.
Provided the buyer with the best value, which to US is the most square footage for the best price and then let them personalized.
At the studio.
And as a result of that the buyer builds up their own value versus us building a home and then pushing incentives on the force of value.
And therefore, we don't really use a lot of incentives we may move pricing.
Community, if it's not selling and will take some steps.
So we pick up our sales rate, but I think in the quarter, if I'm not mistaken, Jeff our incentive or less than a percent.
4%, which is what they typically have run over the years so.
For us the incentives closing costs and kind of mortgage financing freebies, there and they're less than 1% and that would hold true for our fourth quarter deliveries as well you want to talk about the sequential sure John Yeah on a sequential gross margin guide I think first of all it's important to point out.
With our guide at 25% to 26% at the midpoint is up 310 basis points year over year, which is a phenomenal level of improvement on a year over year basis. So first of all we're really pleased with that gross margin progression and what we've seen there are there have been a few impacts that have changed that outlook a bit from what we.
We're expecting at the end of last quarter, a couple of them relate to pricing.
One is we took a more cautious approach, reflecting current market conditions on pricing expectations relating to any quick move in homes and notes of the homes either sold in the third quarter or in the fourth quarter for fourth quarter delivery. So that had some impact we did.
<unk> seen some potential selective price adjustments that may be required for some of our customers in backlog.
In certain cases, some of our communities now have pricing.
Bit below where some of the customers have locked in and with current market conditions. We wanted to make sure. We had some provisions in there to cover that in the event we need it.
We've also lost some leverage on the lower fourth quarter revenue expectation and we explain that a little bit with what we're seeing in the supply chain.
For the most parts of that.
It had a small impact as well on our on our fourth quarter gross margin and then finally, we did see some mix impacts we beat the third quarter guide by over 100 basis points at the midpoint of the guide.
And.
As a result are part of the driver of that was closing higher margin deliveries in the third quarter that we expect to close in the fourth so we saw some mix impact also.
Coming into play there.
That was really helpful. Thank you and then.
The order cadence you provided with June being worse than expected July I think down in August actually firming up and being positive.
Relative to July I guess the question is was this gross orders or net orders and then with <unk>.
September softening again are you getting any sense that people are adjusting to a higher interest rate environment or is this still.
In the works.
John .
<unk>.
I'd call it a stair step process so rates ran up.
Then actually soften a bit in August at that time, the buyers seem to.
<unk>.
Digested the higher rate than they were okay and they move ahead and we were encouraged with the activity that we saw in August when you look at September one.
I want to qualify it a little bit of 15 days.
In September and it includes the Labor day weekend, which are so there's always a little noise with that and there is no question. The market is softer than it was.
Last September we thought turned down a bit.
In August if you go back to that point in time, we had also taken some steps in some communities that.
The warrants hitting their sales rates and we think that felt in.
As we go forward if things stay sluggish will take some steps to.
So further generate sales but.
Since even since I made my prepared comments since I some of them over the last week rates have run up again and with the fed comments today, we think they'll move a little more.
What's interesting that I can share also and we didn't included in.
In our mortgage comments.
Some great and compelling interest rates on adjustable rate mortgages, where it's a 10 year fixed.
If I were a buyer I would take that in a minute and those are couple of hundred basis points lower than the 30 year fixed and nobody's taking <unk>.
So far it's a very limited number of people that have shifted to two arms yet.
If you take that dynamic and pair it up with the buyer profile I shared I don't know that they need beyond yet, they're just everyone's just kind of pause there as I said, they've moved to the sideline and they're waiting to see how things.
Play out whether it's our interest rates running up more or.
Inflation concerns all of these things that you're hearing about in the media that the.
Buyers just put it on pause them gone away, they're just not buying at the level they work.
Thank you.
Our next question comes from the line of Stephen Kim with Evercore ISI. Please proceed with your question.
Thanks, very much guys and Jeff yes, thanks for that commentary about the nature of the slowdown in demand.
It sounds like the issues as more and more mental math.
And so thats encouraging I did want to pick up though.
Jeff K on the comment about the gross margin outlook and I believe you mentioned that.
And anticipating that you're going to maybe do some more discounting or something to move your quick move in homes was a part of that and so regarding that.
One of the interesting thing that we've been hearing recently is that quick move in homes or actually in greater demand.
By the by the buyers.
Because.
They like to consummate the deal quickly.
And so I was curious are you generating lower gross margins currently on your quick move in homes.
Then on your <unk>.
And then tied to that you don't have a lot of standing inventory. So I'm curious are you.
Are you it seems like you're maybe selling your <unk> or your quick move in homes pretty.
Pretty quickly so again are.
Are you generating a lower margin because youre selling them pretty quickly this seems to be a lot of demand for it that kind of thing.
My comments really Steve or relative to where we were at a quarter ago.
So what's our expectations on pricing a quarter ago versus today, obviously those expectations have come down a little so it wasn't meant to imply that we're having are deeply discount quick move ins or anything else. Most of our quick move ins are coming from cancellations as you know.
So it's just the dynamic between where it was written that as a bto ordering and where we end up transacting add on the <unk>.
But overall it was really more of a relative comment third quarter versus fourth quarter as far as our expectations.
Okay. That's good so it doesn't sound like a quick move in homes are particularly a problem for you Amit.
And you're already and.
And you already talked about the fact that the can rate on backlog was only 9%, which isn't very much either so.
So then sort of a follow up here I wanted to talk about investor buyers basically landlords.
Would you consider selling more <unk> or more quick move in homes to investor buyers, if higher mortgage rates were to slow retail demand to the <unk>.
Where you do have more standing inventory than you would like.
And is it your expectations that sales to landlords would come at.
Line average margin or better.
On an operating basis.
Okay.
A few comments on that first off on your previous question.
Let me say that buyers prefer spec overbuilt the order we offer the customer.
Nine month lock so they get today's rate rates not going up.
Sure the percentage of our buyers are a lot more cash.
And.
They still value the ability to personalize their homes, so I wouldn't take the position that people prefer.
Spec homes, we really limit or.
<unk> tried to get away from any investors sale activity and one of the things that I'm sensitive to is having a bunch of <unk>.
Rental churn I'll call it.
Mixed into our community. So we're not a company that would go sell a bucket of inventory.
And.
Rental investors in next to our our customers on a broad base.
Approach, maybe a house over here a house over there that are investors purchasing and renting but where we.
We may consider it and we've looked at it hasn't penciled yet, but we may do and if we have.
A larger landholdings and there is a distinct part of lots that you could identify a single family rentals and they have their own <unk>.
They arent mingled in with our purchasers that we may look at something like that.
I would think on a bulk basis, even though we're not doing it I would think that the both products services going to expect some type of discount due to buy in bulk.
Can't believe theyre going to just pay market right pricing right now.
Thank you.
Our next question comes from the line of Matthew Bouley with Barclays. Please proceed with your question.
Good evening, everyone. Thanks for taking the questions. So on the topic of Asps.
I know you mentioned, making.
I'm, making some price adjustments in underperforming communities I think the order ASP overall was.
Maybe down 12% sequentially.
If I'm doing the math right it looks like on the west coast that might have been down more than 20% sequentially.
Are you finding that these price adjustments are I guess reinvigorating sales pace in those communities or should we expect to see.
Perhaps more reductions and I guess, just given the magnitude of that.
Our own land impairment start becoming more realistic give.
Given that move in pricing. Thank you.
Yes, Matt I'll talk to the the price move into western adjustment due to the impairment thoughts.
<unk>.
California is primarily totally mixed we have several communities.
Thats sold extremely well in the second quarter.
Either sold out or approached sellout, where the ASP was $1 5 million to seven up to two.
Yes.
When you get a few of those communities in our coastal business and they sell out and you replace them with Townhomes for 600000.
Anaheim.
It can really move your AFC dawn and Thats, what happened in California, that's not price cuts thats a mix shift.
So.
When we looked at it of the change in.
ASP about two thirds of it was the California mix shift.
And then the rest may have been adjustments or further mixed with some of the other regions, but don't look at that as a pure price club because that's not what what happened in our business. So if you want to give you sure yes in relation to the impairment question.
Just spend a little bit of time during the prepared remarks talking about the vintage of our launch and when those lots for locked in as far as pricing goes we're pretty proud of our inventory right now in our lot position in our communities.
Exiting the year as we guide on the mid twenties.
From a gross margin point of view.
To assist in my tenure with the company at about the safest point, we've had with the most room between where we're currently selling all of that and what would even start to cross the line of impairment. So it's not it's not high on our list right now all the concerns for us at the moment, obviously, we will continue to.
Carefully monitor what we're doing with land and particularly with new investments, but it's not a particular concern right now with those type of margins.
Got it okay. That's really helpful. Thanks for that clarification, particularly on the mix side there.
I guess second one you mentioned at the top of it I think Rob spoke about the potential to.
Begin renegotiating with certain construction materials.
Heard you correctly around.
The decline in housing starts just curious if you could expand a little bit on that and sort of where you see the opportunities to maybe reduce some of your input costs. There. Thank you.
Rob you want to speak to that.
Sure Yes.
The direct.
Starting to see some relief on the front end and I think thats, how we would all expect it to happen because it starts slow down.
The houses that are moving through the fronts front end of the construction cycle, there's just not as much theres not as much out there so the trades and the suppliers get hungrier. So that's what we're attacking right now and really working to drive the cost out of the business. We haven't seen the same success I wouldn't expect to until we get probably through this year on the backend because theres a lot of production.
Following him out there and all of the markets that we operate on the new home side, So the trade base and the product associated with it.
The homes that are say dry wall and beyond is still pretty tough, but that's going to flow through some of the slowdown we're seeing it start to.
First get relief on slab and then framing that moves through the system. So that's really the way that our teams are approaching it in attacking it today.
Thank you.
Our next question comes from the line of Alan Ratner with Zelman and Associates. Please proceed with your question.
Hey, guys. Good afternoon, thanks for taking my questions.
First one would love to get a little bit more color on the roughly 9000 lots you guys walked away from in the quarter.
I'm curious what is there an attempt to renegotiate those deals and the sellers for one reason or another just didn't want to play ball or but those lots that just based on your kind of.
You of where the market is going just didn't make sense to move forward on either.
Price or any kind of takedown schedule that you could have potentially renegotiated.
Alan I think it would be across the board you answered some of it.
But in some cases, the land sellers are sticky and they're not willing to.
<unk> price and they are not extending because they think they've got other people in the wings will come in and take your position, we said, okay fine, but we're not comfortable in.
Can you walk then there is others where.
At the price points or in that city and what was going on around it. We decided we just don't we can support the returns and as we look at our land activity now.
It starts with the underwriting on the price and the pace and unless that sub market has stabilized and we have demonstrated pace of a similar or less.
Similar price points.
We cant get comfortable with it.
Not going to get a little tougher out there so.
But its a full mix of things, we're doing everything and anything.
To preserve these positions, but if it doesn't make sense, we are prepared to work.
Got it and just in terms of the kind.
Vintage or duration on these deals were these primarily lots that would've been community count growth in call. It 24 and beyond or were these deals that you were kind of on the edge of potentially taking down that could have contributed for more near term community count growth.
There might might've been one or two words of fringe 'twenty three deal late in 'twenty three it would also look for the most part is beyond.
Okay.
Finally, we have we've had a very successful run at fill in a very good lot pipeline over the years here and if you look at the last count with this one.
We don't have the urgency to go tie up more right now to have a growth trajectory, we have a nice position.
Software trajectory than we thought two or three years ago, but still a very.
Favorable growth trajectory. So we don't have any urgency right now we can afford to be particularly.
Got it that makes a lot of sense.
Jack you brought up the underwriting and I remember earlier in the year you answered a question of mine related to some of those assumptions on your underwriting and I recall at the time you said.
On land underwriting you were generally assuming monthly absorption rates in the 4% to six range and that was when you are yourself space was obviously much higher today, it's lower and yet it's a point in time of course, but should we think about your current sales pace at three where.
Four to six is really that desired pace you guys want to be at and until you get their price is probably going to be a lever that you are pulling maybe more significantly than you did this quarter or have you changed that view at all are you more comfortable.
Maybe three to four range for the time being I would say three to five.
If I said four to say it could be three to five now.
It depends on how many lots and is it replaceable and what's the price point in all of those things we always we always talk about that.
Three to five we can make very good profits and very good returns at the kind of margins we can run.
Thank you.
Our next question comes from the line of Michael Rehaut with Jpmorgan. Please proceed with your question.
Hi, Thanks, good afternoon, thanks for taking my questions.
First I just wanted to circle back in and clarify.
From an earlier question around.
Margins on on spec.
A quick move in.
It was cited as a driver reduce pricing expectations on quick move in our spec I guess in the fourth quarter. So it would suggest that that that margin on spec is a lower margin than your.
Homes in backlog at least I would presume.
Just wanted to get that right.
And number two.
Jeff K I think you mentioned.
For drivers to the reduced gross margin expectations and I think versus your prior guidance was about 250 bps.
You cited four different drivers and I'm, just trying to get a sense.
<unk> of what each of those drivers represent.
On the on the guidance reduction.
Sure I'll try to address both of those so first of all the <unk> again, it was room nationwide. It was related to where we were at a quarter ago versus.
Any type of comparison between Q my arms and buildup.
Build to order homes or anything else, we have done very very well with anything that we have needed to sell.
On a spec basis, particularly over the last couple of years and there hasnt been much our spec homes into delivery has been pretty small so thats really actually a pretty small impact on the fourth quarter gross margin, but it is one of the factors when you look at order of magnitude.
We mentioned I mentioned four things.
Mix and leverage probably be at the lower end of things <unk> impact lower and probably the largest impact was just provisions that we made.
In the event that potential selected price adjustments are required on the backlog so and it was judged metal bed and we don't know yet where that will land for the fourth quarter, but we wanted to be.
Prudent.
Considering move on that piece of it in the event that conditions keep deteriorating. So that's how we see it today the mix impact also was somewhat impactful when you look at the over performance in Q3 and those homes were in backlog.
Some of those lower margin homes will be closing in the fourth quarter and some of the higher margin homes actually closed in the third so there was a little bit of a trade off there as well but.
That's how we see it right now every time, we kind of redo of forecast we don't go through.
Community by community home by home and quantify all of the differences, but those are the main drivers as we see it.
Right Okay.
I appreciate that Jeff and maybe just to drill down a little further on your answer I guess, when you say that.
Yeah.
Bigger portion of the <unk> gross margin gross margin guidance reduction.
From these.
An assumption around selective price adjustments.
So if I'm hearing that right it sounds like you're saying you haven't.
Made those adjustments yet these are assumptions.
What you might need to do.
Through the end of.
November .
And so.
To me that's a little surprising that you have another 10 weeks to go obviously, that's a decent amount of time.
But you're talking about a large number of closings. So I was little surprised to hear that.
I would've thought that those price adjustments would have already been made.
Just curious if.
That assumption is based on some price adjustments that you've already had to do in the last month or two in your kind of <unk>.
Rejecting out.
Our run rate on that.
Or is it is it something where the head count of.
Active and ongoing and maybe you haven't hit the finish line yet.
But it's certainly in progress.
No price adjustments on homes that are in backlog, Mike are generally made very close to the closing date.
So that if you decrease prices below zones contracted price, but later increase the price.
Slightly beyond that youre, not hitting the lowest common denominator. So it's.
It's always pretty closer to close date on those.
Yes, there is definitely a lot of extrapolation thats in the numbers right now because we just don't know what that environment will look like over the next couple of months and how many buyers may need some help or encouragement to get their homes closed.
Thank you.
Our next question comes from the line of Susan Macquarie with Goldman Sachs. Please proceed with your question.
Thank you good afternoon, everyone.
My first question is can you talk a little bit about the studio sales and how are your buyers thinking about some of the options and the features that we're putting into the homes and any changes there that youre seeing.
It's interesting Susan.
Let's start with the recognition on the.
The lag between contract and close so a lot of R. R.
Our Q3 closings actually were sold December January February and.
In March but the spend in the studio actually went up year over year.
And I didn't really get into the guts of it I don't know whether.
I don't think it's the buyer preferences change I think our studio pricing change because of the costs were going up but the type of items they were choosing and the.
The spend went up with the type of items were pretty much the same as prior year. So we haven't seen a shift there yet the other interesting thing to me.
Are the size of our homes have much change while interest rates have gone up and.
And pricing move and everything.
The footage and the deliveries was similar to a year ago and the footage on orders was almost identical so buyers are not changing their their preference yet I think in part is the profile of the buyers were catering to can afford all of us still.
And so it may shift if rates keep going up.
Moving ahead, but so far we haven't seen anything change.
Okay.
That's helpful color.
Question is I know you mentioned that despite the fact that you are offering 10 year arms and some other alternatives that are several basis points lower than a fixed rate mortgage now you are seeing that people are really just choosing to kind of cause the overall spend.
The buy decision.
Thinking about the buyer psychology, what are they waiting for in order to decide to make that decision and how quickly.
Weighing the rent versus buy decision today, especially considering that rents are also still moving higher.
I just heard a report today driving into work that.
<unk> that.
On average the single family rental payments are up 12% year over year.
Pretty big move and I think that continues to be a compelling reason to be a homeowner and lock in the.
The value and buildup equity over time.
I think the buyer.
It's primarily to me just confidence in the.
The state of play out there, whether it's inflation and whether it's.
Interest rates are and they hear the news coverage on the fed today or no.
What's going on in the Ukraine or all these things are are weighing on the consumer today theyre not going away.
And I was joking when somebody yesterday on how each month theres millions more Gen Z now and they're in their home by years and Theyre not going away.
They have to make a decision to own versus rent.
And theres arguments for both but I think people want to be a homeowner and right now they're just they've taken a pause and.
We keep monitoring it.
It's part of why we elected not to start out chasing sales one we didn't meet them because.
We don't have any inventory and we already have the backlog for several quarters of deliveries and two I think the buyers in elastic right now if they just have locked down so I'm not going to do anything in the short run youre not going to get them off the fence by by throwing more.
So we felt we just pause and see how it all plays out.
Buyers are still out there that has not changed.
Thank you.
Our next question comes from the line of Mike Dahl with RBC capital markets. Please proceed with your question.
Hi, Thanks for taking my questions.
So far.
I wanted to ask a little bit more about the comments on monthly cadence and.
Obviously with orders down 50% net gross down 35, there can be auto moving pieces from month to month and could you just give us a sense of on a year on year basis.
The order trends through the quarter and then when you talk about the softening in September maybe what.
What pace or what type of year on year decline should we really be thinking about that youre tracking to.
Okay.
Yes.
Even track it year on year not for two weeks.
Yes.
Mike I don't know if we can even give you any color on that because it's a two week period in September so I don't I don't.
I couldn't tell you what we did last year in the first two weeks I just know, it's a little softer than August .
Okay.
Can you.
Speak to the kind of June July August trends, more specifically either sales pace.
And each month or the year on year decline in.
Net orders in each month.
And then I guess with respect to September even if theres something on this.
<unk> sales pace.
Down X versus August anything like that.
I don't have that.
The numbers I mean, Jeff Jeff went through a little bit on the quarterly trending during the prepared remarks talked about August so I'm not sure. It's terribly relevant right now the rate moves we've seen since August I mean, one of the things that happened in August .
We saw a little relief on the rates and a little bit of all.
If you've got a relief rally or whatever the same segment of the market the stock market was.
Had some signs of life as well during the months of that May have had some impact on buyer behavior, but as far as trying to get too detailed on this in a short period in September we typically don't go there and probably won't do it again in this call either.
Okay, Okay fair enough, maybe I'll ask.
I guess.
Hey.
Slightly slightly differently.
And then just you also mentioned that kind of new targets three to five on on pace.
I'm not sure if that was kind of underwriting when you think about your land deals or if you're thinking about that as a current selling pace, but given the seasonality in the latter part of the calendar year and things like that things like what youre seeing with the step up.
In rates I mean should we be thinking.
That the that we see seasonality in terms of seasonally lower versus the pace that you saw in <unk> or.
Or could you potentially be a little bit more stable to that as you've adjusted prices yes.
But if you assume.
Just say four to five but I was talking about for on the previous question on the three to five and yet but it was it was relative to land packages in go forward underwriting.
<unk>.
If we can operate our communities just say four to five or four and a half so if youre going to run a four five through a year in a typical year, you'll be at five and a half.
Through March April May and June in that period, and then in the fourth quarter Youll dropdown under four.
That would be a pretty typical seasonal trajectory for us.
If youre trying to model, where our sales headed.
Youre going to do less in the fourth quarter than you did in the third quarter than you did in the second quarter due to seasonality and I do think we're we're returning to a more normalized seasonal pattern.
Thank you.
Our next question comes from the line of Truman Patterson with with Wolfe Research. Please proceed with your question.
Hey, good afternoon, everyone.
First just wanted to follow up on one of <unk> questions and look for a little bit of clarity.
Jeff I believe you said that two thirds of the decline in order ESP.
Sequentially of that 12%.
Was purely a function of product mix shift.
Implying that based pricing.
Is the remaining third are down about 4% quarter over quarter, making sure that I heard that correctly and if so that's kind of a direct four point headwind to gross margin kind of all else equal and Jeff K.
On your fourth quarter gross margin guidance, you ran through some of the items.
Reasons, why it is down quarter over quarter, but.
Are you all seeing any benefit from lower lumber costs.
Hitting the P&L in the fourth quarter sequentially I believe of lumber pricing kind of peaked in February March timeframe.
The longer we expect it to longer to be peaking sort of third and fourth quarter. So we will see some relief I think going forward on that.
I think certainly we will see theres, an lumbers come back kind of within range as I call. It.
Should see some nice benefits of such a large cost factor and not just on the lumber I think as the market softens in.
We're working pretty hard on suppliers in.
Subcontractors and everything else in terms of pricing there is usually some pricing benefits to help our cost benefit itself offset any pricing.
Issues that we've seen.
Then the other question was on units.
Terminal two thirds.
I was referring to the California mix shift only but it's hard to say prices are down.
Because you have ins and outs every month and every quarter, whether it's you opened something in Denver, and you close something in Tampa and the prices are are different but two thirds of the price shift was directly tied to all the the higher price goods that we sold through in coastal California, North and South.
Yes, Im just trying to understand because the one.
Stay SP falling 21% in the quarter I realize mix shift can impact that but I was assuming that.
Price concessions included in that as well so.
Go back to the go back to the order price both from the second quarter was significantly higher than any price we've guided on delivery.
That was just it was a blip because of the mix.
Got you, okay, Okay, and similar for I believe to the other three regions. The order ASP also kind of declined anyways I think what everybody is trying to understand is what level of base price cuts you, all and seeing nationwide, but I'll leave it alone.
On.
The new community.
The new communities that you won't have coming online we've heard of builders.
Maybe not cutting price across all of their existing communities theyre more adjusting pricing on the new communities coming online.
To understand if that's your strategy and maybe any sort of magnitude.
Relative to new communities versus existing communities that you have down the road.
Are you seeing consumers respond to these new communities are they hitting your absorption targets.
Yes.
The most part the openings are working very well in what I would.
Reshape the answer Truman and that as I shared in the prepared comments a lot of these assets have been tied up at a price from three or four years ago five years ago.
And therefore.
The margins that we would plan on are much higher than our underwriting margins because of the market lift so now.
Prices come down.
We adjust and we have a reservation process that helps us.
Focus in on what the right price points are in the community. So we may tweak them down to ensure a successful opening but you're still well above the margins that they were underwritten that.
And but we wanted to make sure that the communities successful openings you can only open up <unk>.
Successful it gets painful so.
We'd like to set the pricing where the.
The community works out of the data and typically.
Good markets or bad new openings were in a lot of excitement and energy and we generate a lot of sales.
Ours are working pretty well.
Thank you.
Our final question comes from the line of Deepa Ragavan with Wells Fargo Securities. Please proceed with your question.
Hey, good evening, Thanks for squeezing me in.
Yes.
<unk> backlog cancellation rate of 9%.
The overall credit card percent cancellation rate can you talk to the risk.
So the backlog you have I mean have you scrubbed the backlog again for a higher qualification rate maybe had conversations with those buyers again I mean, what can proactively do to ensure the backlog.
Well, we're constantly scrubbing the backlog depot, the lesson, we would want us to ever.
Our name on a home thats under construction that isn't prepared to close when the homes completed so.
All those processes are intact, and we have a quality backlog what what we're seeing to some degree we've had buyers that their loan was approved their loan was locked the home gets completed and MSA I just don't feel good about going forward with its purchase even though their interest rate that they locked up in the threes.
And they have 2030 40 grant of equity in the home they still say Im done there is too much noise in the world and I don't feel.
Comfortable with this and we really can't control that but if you look within the quarter and our deliveries with them didn't really impact our deliveries at all and they didn't impact our percent of with the unsold at the same level and at the end of the third quarter. It was at the end of the second quarter and as I shared in my.
Comments for the most part these buyers are closing when the homes completed.
It's still been very predictable.
Okay. That's helpful.
A bigger picture question.
Right.
In the six to $6 five kind of cleaned.
That potential we can see a normalized spring.
<unk> selling season or is it too late to expect.
Demand recovery given just how September .
That's been playing out with the higher interest rate.
Well it depends on what's going on with the economy.
With interest rates inflation, and everything else that that drives.
Consumer confidence, but but I think if rates held where they were and the consumer digested and they still qualified like our buyers do I think you could see.
More normalized spring.
Wouldn't suggest that a couple of week trend right now with everything going on is a precursor for what would happen next spring it's way too early to say that.
Thank you.
Ladies and gentlemen. This concludes today's teleconference. Thank you for your participation you may now disconnect your lines.
[music].
Okay.