KB Home Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
June 18, 2024

There are 12 speakers on the call.

Operator

Good afternoon. My name is John, and I will be your conference operator today. I would like to welcome everyone to the KB Home 20 24 Second Quarter Earnings Conference Call. Currently, all participants are in a listen only mode. Following the company's opening remarks, we will open the lines for questions.

Operator

Today's conference call is being recorded and will be available for replay at the company's website, kbhome.com, through July 18, 2024. And now, I would like to turn the call over to Jill Peters, Senior Vice President, Investor Relations. Thank you, Jill. You may begin.

Speaker 1

Thank you, John. Good afternoon, everyone, and thank you for joining us today to review our results for the Q2 of fiscal 2024. On the call are Jeff Mezger, Chairman and Chief Executive Officer Rob McGibney, President and Chief Operating Officer Jeff Kaminski, Executive Vice President and Chief Financial Officer Bill Hollinger, Senior Vice President and Chief Accounting Officer and Thad Johnson, Senior Vice President and Treasurer. During this call, items will be discussed that are considered forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future results, and the company does not undertake any obligation to update them.

Speaker 1

Due to various factors, including those detailed in today's press release and in our filings with the Securities and Exchange Commission, actual results could be materially different from those stated or implied in the forward looking statements. In addition, a reconciliation of the non GAAP measure of adjusted housing gross profit margin, which excludes inventory related charges, and any other non GAAP measure referenced during today's discussion to its most directly comparable GAAP measure can be found in today's press release and or on the Investor Relations page of our website at kbhome.com. And with that, here is Jeff Mezger.

Speaker 2

Thank you, Jill, and good afternoon, everyone. Our performance in the Q2 was solid with key metrics that were above the high end of our guidance ranges. In addition, we achieved positive year over year comparisons for both net orders and net order value. We believe we are well positioned to achieve our goals over the remainder of 2024 with a backlog of committed buyers valued at over $3,000,000,000 and meaningful improvement in our build times. As for the details of our results, we generated total revenues of over $1,700,000,000 and detailed earnings per share of $2.15 Our margins were healthy with over 21% in gross and above 11% in operating income margin.

Speaker 2

This performance along with the cumulative benefit of ongoing quarterly share repurchases including an additional $50,000,000 during the second quarter drove our book value per share up 14% year over year. Longer term housing market conditions remained favorable supported by an undersupply of new and resale homes, solid employment, wage growth, favorable demographics and rising household formations. However, during the second quarter, we did see volatility return to the market correlated to the rise in mortgage rates. Periods of rate increases create uncertainty for consumers, which can delay their purchase decisions. Despite this, the desire for homeownership is strong and the appeal of a personalized home is clear as we generated a higher mix of sales of built to order homes in our 2nd quarter than we have in several quarters.

Speaker 2

Personalization is a key differentiator for our company and its appeal is even stronger as our build times are normalizing and as most large production billers have migrated to an all spec model, particularly for first time buyers. We are affordably positioned in our served markets with products that include features that we know buyers value based on our survey data. Our buyers can then significantly influence their final sales price as they personalize their choice of lot, elevation and selections in our design studio, aligning their monthly payment with their budget. While the majority of our business is built to order, we've always offered quick move in homes in each of our communities. As a result, we are in a unique position to satisfy the majority of customers who value choice, while also accommodating those buyers who prioritize a quicker move in date.

Speaker 2

Operationally and financially, we gained several key benefits from our built to order model. The Evenflo production inherent in our approach provides visibility and consistency in deliveries, which is particularly important in periods of housing market volatility as we work from a large backlog and do not need to sell homes at any price to achieve our delivery targets in a given quarter. In addition, the revenue that we generate from lot premiums and studio revenues help to enhance our gross margin. Despite the movement in rates during the quarter, we saw indicators that reinforced strength in demand. As the quarter progressed, we experienced a sequentially higher level of traffic in our communities.

Speaker 2

In addition, our cancellation rate was well below our average levels and one of the lowest that we have seen during a quarter of volatile rates. Both of these factors contributed to nearly 4,000 net orders during the quarter, a positive comparison relative to the year ago period. On a per community basis, our absorption pace grew to 5.5 monthly net orders in line with the expectation that we shared on our last earnings call. Our focus remains consistent in optimizing each asset on a community by community basis and generating high inventory turns. With that, I'll pause for a moment and ask Rob to provide an operational update.

Speaker 2

Rob?

Speaker 3

Thank you, Jeff. I will begin by providing additional color on our order results. At 5.5 net orders per community, our monthly absorption pace was above our average second quarter level of the last decade. This is notable given the volatility in interest rates during the quarter moving above 7% and the fact that we raised prices modestly in the majority of our communities helping to offset the cost of mortgage concessions. As Jeff mentioned, our cancellation rate remained low, improving slightly as compared to the Q1 to 13% of our gross orders and stable at 10% of our backlog at the beginning of the quarter.

Speaker 3

These levels are below our historical averages, which indicate to us that buyers have confidence in their purchase decisions. Mortgage concessions in the 2nd quarter were flat as compared to each of the prior two quarters with roughly 60% of our orders having some form of mortgage concession associated with them. While we believe that we can lower our use of these incentives as spring selling season unfolded, given the strength of the market conditions early in the spring, the move in rates impacted demand to an extent and we continued using mortgage concessions to support our buyers. As we had anticipated, we accelerated our starts in the 2nd quarter on a sequential basis. We started nearly 4,300 homes ending the quarter with about 7,700 homes in production.

Speaker 3

Together with the backlog of 6,270 homes, we believe we are well positioned for the second half of twenty twenty four and we are beginning to shape the early part of our fiscal 2025 as well. Moving on to build times, we achieved a significant sequential improvement during the Q2 and as a result, our starts are now being completed in about 5 months. We are realizing the benefits of product and design studio simplification, efficiency enhancements in our construction schedules and systems and processes that are back in rhythm given the return of a predictable supply chain in most areas. Now that we have lowered our build times to the high end of our 4 to 5 month historical range, we are focused on further improvement to drive build times closer to 4 months. Delivering a personalized home in a shorter timeframe will make our built to order homes even more appealing to buyers as the gap between a 60 day spec home and a 4.5 month personalized built to order home narrows.

Speaker 3

We are seeing the benefit of this with built to order homes representing more than 60 percent of our net orders in the Q2 as Jeff referenced. In addition, faster construction times improve our inventory turns and expand the population of homes available for delivery. Before I wrap up, I will review the credit metrics of our buyers who finance their mortgages through our joint venture KBHS Home Loans. We had a solid increase in our capture rate with 86% of the mortgages funded during the quarter having been financed through our joint venture, as compared to 80% in the prior year quarter. Higher capture rates help us manage our backlog more effectively and provide more visibility in closings, which benefits our company as well as our buyers.

Speaker 3

In addition, we see higher customer satisfaction levels from buyers who use KBHS versus other lenders. The average cash down payment was 16%, up slightly year over year equating to over $77,000 On average, the household income of our KBHS customers was about 130,000 and they had a FICO score of 744. Even with about 1 half of our customers purchasing their first home, we are attracting buyers who can qualify for their mortgage while making a significant down payment. With the first half of the year now behind us, we are focused on a strong close to 2024 with a daily emphasis on maintaining our high customer satisfaction levels, further improving build times and value engineering our products to lower direct cost. More broadly, our objectives are to increase our scale, profitability and returns by acquiring more lots while adhering to our underwriting standards, opening up our communities on time, driving net orders and balancing pace and price to grow our margins and returns.

Speaker 3

And with that, I will turn the call back over to Jeff.

Speaker 2

Thanks, Rob. During the quarter, we invested over 2 $75,000,000 to acquire land and another $390,000,000 to develop lots that we already own. In total, an increase of nearly 70% year over year. We are accelerating our land investment in 2024 as we position the company for future growth, while remaining diligent with respect to our underwriting criteria, product strategy and price points. We are also mindful of macroeconomic conditions and we will remain flexible in adjusting our pace of investment as market conditions warrant.

Speaker 2

We grew our lot position by 17%, ending the quarter with over 65,500 lots owned or controlled, of which roughly 39,900 were owned. Of these owned lots, over 16,000 are in a finished condition. We are pleased with the composition of our portfolio, including the quality of the locations, geographic mix and cost basis. Our focus is on capital efficiency, developing lots wherever possible in smaller phases and balancing development with our start space to manage our inventory of finished lots. We currently own or control all the lots that we need to achieve our delivery targets for 2025 as well as the majority of our deliveries in 2026.

Speaker 2

As we have stated in the past, our divisions have roadmaps in place to reach at least the top 5 position in each of our certain markets. For those divisions that are already top 5, the next step is to achieve a top 3 ranking. And for those divisions currently in the top 3 in their markets, we have targeted growth plans in place. Overall, we feel we have significant upside opportunities through taking share in the markets we serve. We continue to generate a strong level of cash flow and are taking a balanced approach in allocating this capital.

Speaker 2

We are reinvesting in our growth and returning cash to stockholders through a significant share repurchase program, utilizing the $1,000,000,000 authorization that our board approved in April, as well as our quarterly dividend, which we raised during the Q2. Our top priority is to invest in the growth of our business. Having said that, we are generating sufficient cash to accomplish our growth goals and also return cash to stockholders. While we had previously guided to share repurchases this year in the range of $200,000,000 to $400,000,000 we're now raising the minimum level of repurchases to 250,000,000 dollars Since we began repurchasing shares on a regular basis in 2021, we have repurchased over 22% of the shares then outstanding accretive to both our diluted earnings per share and returns. Over this period of time, we have returned more than $1,000,000,000 in cash to our stockholders.

Speaker 2

In closing, I want to thank the entire KB Home team for their commitment to serving our homebuyers and contributing to our solid performance. We are realizing the potential of our business as our operations return to a steady rhythm given faster build times and a normalizing supply chain. Our buyers are demonstrating a preference for our built to order model and see the benefit of flexibility in making choices based on what they value and can afford. We have a healthy backlog, which together with our homes in production and starts is well balanced to achieve our $6,800,000,000 revenue projection this year. Our expanding lock count will drive future community count growth and our business is better diversified today relative to the past few years as our newest divisions ramp up their scale.

Speaker 2

We remain committed to driving stockholder value through the profitable growth of our company in driving volume and returns as well as returning capital to stockholders, which we continue to execute on. We have again incrementally raised our full year guidance, which we expect will drive an increase in our year over year return on equity. As we move through the remainder of 2024, we look forward to updating you on our business. With that, I'll now turn the call over to Jeff for the financial review. Jeff?

Speaker 4

Thank you, Jeff, and good afternoon, everyone. I will now cover highlights of our 2024 Q2 financial performance and provide our current outlook for the Q3 and full year. We are pleased with our 2nd quarter execution that produced financial results exceeding our expectations across all key metrics amid a volatile and uncertain mortgage interest rate environment. Alongside our healthy top line performance and double digit operating margin, we generated robust cash flow enabling us to reinvest in our business, return capital to our stockholders through common stock repurchases and a higher quarterly dividend and end the period with over $1,700,000,000 of liquidity. Our housing revenues of $1,700,000,000 for the quarter were down 3% from the prior year period, reflecting a 4% decrease in the number of homes delivered, partially offset by a slight increase in our overall average selling price.

Speaker 4

The number of homes delivered in the 2nd quarter represented a backlog conversion rate of 61%, the highest second quarter rate since 2013 and a significant improvement from 52% for the year earlier quarter due to both our improved build times as well as the lower cancellation rate in the current period. Based on our current construction cycle times and backlog, we anticipate our 2024 Q3 housing revenues will be in a range of $1,650,000,000 to $1,750,000,000 Additionally, based on housing market conditions and anticipated continued improvement in our build times, for the full year, we expect to generate housing revenues in a range of $6,700,000,000 to $6,900,000,000 an increase of $100,000,000 at the midpoint versus our prior guidance. In the Q2, our overall average selling price of homes delivered increased to $483,000 from $479,500 in the prior year period, reflecting shifts in geographic and product mix. For the 2024 Q3, we are projecting an overall average selling price of approximately $482,000 and expect a sequential increase in the 4th quarter due to a higher mix of deliveries from our West Coast region, which has the highest ASP of our 4 regions. We believe our average selling price for the full year will be approximately $485,000 to $495,000 Homebuilding operating income in the current quarter was $188,200,000 as compared to $202,100,000 in the year earlier quarter.

Speaker 4

The current quarter included abandonment charges of $1,200,000 versus $4,300,000 a year ago. Excluding inventory related charges, our operating margin for the current quarter was 11.1% as compared to 11.7% in the prior year period, primarily reflecting higher selling, general and administrative expenses incurred to position our operations for future growth. We expect our 2024 Q3 homebuilding operating income margin, excluding the impact of any inventory related charges, to be in the range of 10.8% to 11.4%. For the full year, we expect our operating margin, again excluding any inventory related charges, to be in the range of 11.0 to 11.4%. Our 2024 second quarter housing gross profit margin of 21.1% was even with the year earlier quarter.

Speaker 4

Excluding inventory related charges in both periods, our gross margin decreased by 20 basis points to 21.2%. Assuming no inventory related charges, we are forecasting a 20 24 Q3 housing gross profit margin in the range of 21.0% to 21.4% and a full year margin in a range of 21.1% to 21.5%. Our selling, general and administrative expense ratio was 10.1% for the 2024 Q2 compared to 9.6% for the 2023 Q2, mainly reflecting higher marketing and other expenses associated with the planned increase in community count and growth in housing revenue. We believe our 2024 Q3 SG and A expense ratio will be in the range of 9.9% to 10.3% and our full year ratio will be about 10.1%. Moving on from operating income, another contributor to our pre tax earnings in the current quarter was a $12,500,000 gain on sale of an ownership interest in a privately held technology company, which was included in the interest and other line item.

Speaker 4

Our income tax expense for the Q2 of $52,700,000 represented an effective tax rate of 23 0.8% compared to 23.5 percent for the prior year period. We expect our effective tax rate for the 2024 Q3 to be approximately 24% and for the full year to be approximately 23%. Overall, we produced net income for the 2nd quarter of $168,400,000 or $2.15 per diluted share compared to 160 $4,400,000 or $1.94 per diluted share for the prior year period. The 11% year over year growth in earnings per share reflected both the 2% improvement in net income and the favorable impact of our share repurchases over the past several quarters. Turning now to community count.

Speaker 4

Our 2nd quarter average of 243 decreased 4% from the year earlier quarter. We ended the quarter with 2 47 communities, roughly flat year over year and up 4% sequentially. We anticipate our average community count for the 2024 Q3 to be up in the low single digits year over year with a sequentially flat quarter and community count resulting in a mid to high single digit increase over the Q3 of 2023. We believe our 2024 Q4 average community count will also be higher than in the prior year period as we remain focused on increasing the number of open selling communities to drive top line growth and market share. At the same time, while we expect year over year growth in our community count in the last two quarters of 2024, we are anticipating more sellouts in the second half of the year.

Speaker 4

This will impact our year end community count now expected to be in the range of 250 to 255. To drive continued new community openings, we invested 6.60 $8,000,000 in land and development during the Q2, an increase of 69% compared to the prior year and ended the quarter with a pipeline of over 65,500 lots of which 61% were owned and 39% were under contract. The percentage of lots under contract is up significantly compared to 27% as of our 2023 year end and 25% a year ago. During the quarter, Moody's Investor Service upgraded the company's debt rating to BA1, reflecting the company's scale and anticipated expansion, strong market position across our regions, deleveraging track record and disciplined approach to balance sheet management. We ended the quarter with a debt to capital ratio of 29.8%.

Speaker 4

In April, our Board approved an increase in the quarterly cash dividend to $0.25 per share from $0.20 per share and authorized a repurchase of up to $1,000,000,000 of our outstanding common stock. We repurchased nearly 765,000 shares of our common stock at an average price of $65.38 during the quarter. As Jeff mentioned, we intend to continue to repurchase shares and expect the pace, volume and timing of share repurchases to be based on considerations of our cash flow, liquidity outlook, land investment opportunities and needs, the market price of our shares and the housing market and general economic environment. At quarter end, our total liquidity was over $1,700,000,000 including nearly $1,100,000,000 of available capacity under our unsecured revolving credit facility with no cash borrowings outstanding and $644,000,000 of cash. In conclusion, we are very pleased with our solid Q2 financial performance and strong operational execution.

Speaker 4

We intend to sustain our focus on expanding our scale through land investments and new community openings, while also maintaining our balanced approach to capital allocation by returning cash to stockholders through common stock repurchases and quarterly dividends. We will now take your questions. John, please open the lines.

Operator

Thank you, sir. We will now be conducting the question and answer And the first question comes from the line of John Lovallo with UBS. Please proceed with your question.

Speaker 5

Hi, guys. Thank you for taking my questions. The first one, just kind of trying to do this quickly, the back of the envelope math. It looks like the outlook would sort of imply that 4th quarter revenue of about, call it, dollars 1,900,000,000 so call it 14 ish percent sequential step up from the Q3. And it seems like gross margin will be relatively flat Q3 to Q4 in the way you're thinking about it.

Speaker 5

So first question is, are we thinking about that correctly? And why would there not be a little bit more leverage on the gross margin front? What are the kind of the puts and takes there?

Speaker 4

Right. First of all, yes, you are thinking about that correctly. You did the math on the fly pretty accurately. On the leverage, we're facing a lot of things on the gross margin side. As we talked about earlier in the year, we like most people had an expectation of rates actually coming down and being able to reduce some of the mortgage interest rate incentives that we've had out there that unfortunately has not happened as of this point.

Speaker 4

And that put a little bit of pressure on the back end margins. We are seeing some mix shift in deliveries in the back half of the year. But honestly, we're pretty happy that we've been able to raise incrementally the full year gross margin outlook for the company despite some of those headwinds. And we're continuing to work on all the factors that go into it. Obviously, pricing has been more difficult, but despite that, we've had some limited price increases in the majority of our communities during the quarter.

Speaker 4

And the largest headwind right now is on this mortgage rate side, but we've been powering through that pretty well. And we're actually fairly pleased with the outlook for the second half of the year and especially being able to incrementally raise some of those guidance points as we look towards the end of 2024.

Speaker 5

Yes, makes sense. Okay. And then on the land front, the owned and controlled lots, I think as of last quarter, you had what you needed to satisfy 2025 deliveries and now you're talking about through the majority of 2026. I guess the first part of that is, how would you sort of frame your confidence in the near term demand? Is that are you feeling better about that versus just kind of building the pipeline?

Speaker 5

And secondarily, I mean, should we expect you to sort of take your foot off the gas at this point? Or how are you thinking about future land spend?

Speaker 2

John, good question. It's really a pedal and a break. Demand remains very solid right now as we shared in our prepared comments. There is sensitivity to affordability and we are not strained from our underwriting approach targeting the median incomes, what type of products in that submarket can allow us to accomplish that. So there's a healthy tension in that land isn't readily available in all locations to achieve that type of strategy.

Speaker 2

So we're finding enough deal flow to expand our investments and we are not looking at it right now as if we would slow that down. We are however remaining diligent in our standards. So for the year, we think our land spend will be up pretty significantly year over year and we're comfortable with the investments we're making and the returns we expect on those.

Operator

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

Speaker 6

Take on the longer term outlook for growth. I think you sort of talked about what you're expecting here in the next quarter or so a quarter or 2. But from a longer term perspective, can you give us a sense for what kind of volume growth or revenue growth you are setting your land strategy up to be able to achieve?

Speaker 2

Steve, it's a ground up build in every market. And I shared the targets we have for the scale we want in every city and we're working on that and we're making inroads more into the top 5 and more into the top 3 and several that have the opportunity possibly over next year or 2 to be number 1 in their market. So it's more about the market share in each city. With our investment strategy and how we're allocating capital, we think we can fuel growth in over 10% a year community count range around the system. That probably means on average 14% to 20% revenue growth between a little bit of price and the continued community count growth.

Speaker 2

So if we do all that, you'll hit 10% to 20% revenue growth and your bottom line growth would be a little higher than that. But it's built ground up with a strategy in each market and we don't have limits on the divisions right now on what we'll invest. It's up to them to go find the deals that pencil.

Speaker 6

Yes, got it. That's great. That's exactly what I was looking for. And so that kind of leads to my second question, which relates to absorptions. I guess that those kind of numbers suggest that you expect absorptions here to have reached it higher.

Speaker 6

You talked about the rapid absorptions are a little above historical levels. And whether or not we can expect this to why we can expect this to be kind of a new normal. Our larger key factors are capturing into some of the increase in absorptions or are there other things that we should be thinking about there?

Speaker 2

Steve, as you know, it's a balance. And we heard about 20% of your question. It was really a bad connection, but I'll take a shot at it. We're balancing things to optimize each asset, and we've been talking that way for quite a while. And our margins are higher now, and we have a nice profit equation working.

Speaker 2

And in areas where the land is easily replaceable, we'll go for more absorption than the 5.5%. If it's an infill location in California, we'll go for the best margin we can because you can't replace it and you take your time to optimize profits. But as we build our strategy of growth with the community count we're targeting, will assume current absorption rates. And if our margins were to move a little higher because there's no inventory, which I think they could over time, Our margins moved higher, you'd see a higher absorption rate along with it. But at the same time, we've kind of got floor on our run rates at around 4, 4.5 per community.

Speaker 2

And so you can do the math and toggle between community count growth and any unit growth we get, but it will always be to optimize the asset.

Operator

Thank you. And our next question comes from the line of Michael Rehaut with JP Morgan. Please proceed with your question.

Speaker 7

Great. Thanks everyone. Thanks for taking my questions. Good afternoon. Wanted to first kind of zero in a little bit on how you felt demand has progressed throughout the quarter and even so far into the Q3.

Speaker 7

Rates obviously came up a bit throughout the 1st month, month and a half, have come down a little bit more recently. Has this impacted, you kind of alluded to earlier, maybe incentives being elevated a little bit more in terms of mortgage concessions or other areas of closing costs perhaps. Just wanted to get a sense for how demand and pricing has progressed and any take on the last several weeks with the most recent move in rates?

Speaker 2

Sure. Yes. Mike, I'll ask Rob to answer that question relative to the rhythm and the demand. But just to clarify one thing, it's not that concessions are up, they've held steady. We expect that they may go down a little bit as the year unfolded because of the stronger conditions we saw in March and early April before the rates came up at about the time of our last call.

Speaker 2

So we're not seeing concessions go up this time. They're just not going down the way we thought they would. Rob, do you want to give us some commentary on the demand through the quarter?

Speaker 3

Sure. In terms of the second quarter sales, I would say the business performed very well on a portfolio basis. We mentioned we had 5.5 net orders per month per community. But in addition to that, each one of our regions on an individual basis achieved 5 a month or more every single month of the quarter. And we really didn't see much change.

Speaker 3

We do expect to see things slow down as it always does seasonally as we move into the summer here. But demand really across our footprint and from month to month was fairly consistent. And as Jeff mentioned, not really a change in the incentives that we had to offer to drive that. It's just we didn't get the mortgage rate pullback that we thought we might and they remain relatively flat over the last couple of quarters.

Speaker 7

Okay. I know that's very helpful. Appreciate that. I guess secondly, would love to just get your thoughts on how to think about gross margins maybe a little bit longer term. And you look at what you did from 2013 to 2018, 2019, you averaged about 18%.

Speaker 7

You've kind of been more consistent in the last year, year and a half around 21%, mid-twenty 1. What's changed in your view that that's kind of allowed you to hold on to this higher level? And I don't want to put words in your mouth, so a few factors would come to mind. But what are your thoughts on the sustainability of current margins? And if you decide to continue to shift perhaps a little bit more to option lots, which sometimes carry a lower gross margin, if that any potential strategy shift might impact that going forward?

Speaker 4

Sure. So yes, just a few comments on the margins. So when you look at the company, scale helps a lot, not only on leveraging some of the fixed costs that are included in margin, but particularly on the supplier side, materials, labor, etcetera in the market. So that's why there's such a focus within the company, within the company's divisions on achieving a large scale in each of our served markets. So that's been a very favorable factor for the company.

Speaker 4

Number 2, as you know, Mike, we've done a tremendous amount of work on our capital structure over the years and particularly back to the period that you mentioned, our interest amortization is way down compared to prior and that's a direct improvement in margin that just went right to the margin line and that is very sustainable. And in fact, some future potential there as well as our inventory balance continues to grow, our debt levels stay either constant or slightly decreasing and we have a really nice capital structure now. And now with our new BA. 1 status with Moody's and the recent upgrade that we also received, we're in really good shape on the capital side of things and the interest side of things. So that's good.

Speaker 4

So as far as sustainability goes, if you look at 21 percent low 20s, let's call it margins, I think they're very sustainable and in fact, things that we can build upon as we achieve higher levels of scale in our served markets as we grow the total company top line And as we move forward with some of our supplier and cost strategies, I certainly think margins are sustainable and could even expand from here. So we'll see as we go. I think that the single largest tailwind that we could experience is just reduction of incentives. As you know, we're not really an incentive based company. We've been playing that game for a while in the face of these higher interest rates in order to generate affordability for our buyers.

Speaker 4

But, us along with most people don't think these rates are here to stay for the long term and although they may not reach the low levels that they once were at, there's a fairly sizable margin pickup that could be gained just from seeing that go away. So those are the I guess my high level thoughts on that margin question. As far as auction lot strategy, we're not seeing much change internally from a margin point of view on that side of things. We'll take the option lots if they're out there and available. If they're not, we're pretty focused on just expanding community count and developing our own lots as we go.

Speaker 4

So we'll see how that shakes out. But overall, pretty pleased with margins, very pleased with the expansion and the sustained higher level that we've been experiencing in the last few years and hopefully we can build upon those in the future.

Operator

And the next question comes from the line of Matthew Bouley with Barclays. Please proceed with your question.

Speaker 8

Good evening. You have Anika Dulaki on for Matt today. Thanks for taking my questions. So first off, I think you said that build times are now at around 5 months, which is within your target historic 4 to 5 range. Just wondering if this is still the target range or maybe if there's further to push on this?

Speaker 8

And then what levers you're taking to get there? Thanks.

Speaker 3

Rob? So, yes, we're at 5 months, not satisfied with 5 months. We've been faster than that in the past. We've talked about a range of 4 to 5 months. We've had many businesses that have built in faster than 4 months.

Speaker 3

So we're not going to take our foot off the gas on that. I think there are still opportunities out there. We have some divisions that are performing much better than others. So that's an opportunity to kind of get the underperforming divisions aligned with the better performing ones, but also proactive things that we're doing and we've been talking about for several quarters like simplifying our product and building in a cadence, driving cost out, just an overall simpler formula. That combined with really things getting back in rhythm with the supply chain now being much more stable, the systems, the processes that we've used for years are working as they should.

Speaker 3

And I think that's going to create additional opportunities for us to keep driving them driving build times down and reap the benefits that provides for

Speaker 7

our business.

Speaker 8

Got it. Super helpful. Thanks. And then my second question, you guys talked about the resiliency in buyer demand. I guess more specifically, what trends are you maybe seeing in consumers utilizing the design studio and like around options and upgrades?

Speaker 8

Any thoughts on that would be helpful. Thanks.

Speaker 2

It's very interesting and it's why we always like to share the credit profile of the buyers. When you think we're 50% first time and the average income is over $130,000 and they're putting $77,000 down with a high FICO. It's a very well yield first time buyer. Having said that, the size of the homes has not moved much for many quarters and the studio spend has been very consistent. What they're selecting in the studio can move around some.

Speaker 2

But the dollars that they're spending in the studio has been pretty consistent for the last 8 to 12 quarters. So not seeing really any change in consumer preference even with the higher prices that we've been operating at.

Operator

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

Speaker 9

Hey guys, good afternoon. Nice quarter and thanks for all the details so far. First question, and maybe this is digging in a little bit to the regional trends a bit, but we have seen you mentioned obviously rates have stayed higher for longer than expected. I think probably the one other macro development that may or may not be surprising is we have seen resale inventories moving higher in certain markets at a pretty decent rate, albeit off of incredibly low levels. And if I look at your order performance by region, the Southeast kind of stands out a little bit, roughly flat sequentially orders and normally you would see a 20% to 30% sequential uptick in your 2nd quarter.

Speaker 9

And that also kind of overlaps where we've seen some pretty decent increases in resell inventory. So I was just hoping you can kind of discuss a little bit what you're seeing on the resell front. Do you feel like you are seeing more competition in certain markets? And if so, what are you doing to respond to that?

Speaker 6

Rob, you want

Operator

to take that?

Speaker 3

Sure. It's a good question. Resale is always our biggest competitor. So we're always focused on it. We've got to stay tethered to resale pricing.

Speaker 3

We have to have a reasonable premium. But I don't think we've really seen any big changes in demand yet related to resale levels coming up. I mean, you talk about Florida and the headline is going to be something like resale inventory levels have exploded. They're double year over year. But when you dig into the markets like I was specifically looking at Tampa earlier today, we're talking about going from, I think, 1.8 months of supply to 3.6 months of supply.

Speaker 3

So while it has increased and it has become more of a formidable competitor than it was when the supply was less than 2 months, it's still well below the historical norms. I think historical norms close to 6 months of supply that would be considered imbalance. So definitely keeping an eye on it, probably some impact to our sales in Florida in the quarter. But as I mentioned earlier, all of our regions perform well, every one of them with sales per month per community above 5 each month of the quarter. So I wouldn't say that we're seeing a big impact from that yet.

Speaker 3

It's just something that we will certainly stay tuned into and adjust as needed though.

Speaker 9

Perfect. I appreciate that detail. Second question on the land front. So your total lot count increased 18% sequentially and got to go back to Q2 of 2004 to find a quarter where your lot count rose by such a meaningful rate. And I know when we've talked about this in the past, one of the things you always highlight is a lot of these deals are either in due diligence or have been kind of tied up or locked in way before it shows up as an increase in your lock count.

Speaker 9

So I'm not assuming you went out and all of a sudden contracted for 10,000 lots this quarter. But I was hoping you can give us a little color in terms of where are these lots centered, what type of negotiation or pricing, what that has been given the fact that it seems like this growth has all come through option lots as opposed to owned because it is a pretty significant 1 quarter increase compared to what we've seen historically?

Speaker 2

A lot of it, Alan, is the timing of when it's secured. To your point, we could be working on a purchase agreement for 3, 4, 5 months sometimes with sellers hammering out the details before you put the money up and control it and then entitle or whatever you need to do. We've intentionally staffed up our land teams and are working with the division pretty intensively to grow our community count. And we've had fits and starts. Over ever since COVID, there's been interest rate rises, COVID demand, no demand.

Speaker 2

And we pulled some chips off the table a few times to keep the dry powder and let's see where the market is headed. And that did impact our community count over the last couple of years. We're past that now. We see many markets where the dynamics are no inventory and the lots have value. As I shared, we're continuing to be diligent in our underwriting standards, but we're finding adequate deal flow.

Speaker 2

And it's the healthy tension that I've already mentioned of holding divisions accountable to our standards in underwriting and product and geography and encouraging them to go tie up deals and the deals then have to hit our returns. So we were successful in the quarter and it's not 1 or 2 large deals, it's many, many 100 or 150 lot deals that we've secured around the system. And we were seeing growth in all of our markets right now in our lots owned and controlled. So we like the portfolio and the strategy and it's setting up a pretty nice trajectory for 2025 and 2026.

Operator

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

Speaker 10

Thank you. Good afternoon. Thanks for taking the questions. My first question is I want to go back a bit to the gross margin. You made a comment that you have seen lot premiums and upgrades that are benefiting the profitability of the business.

Speaker 10

Can you quantify that? And then can you also talk to the potential upside from there as you think about rates coming down and your buyers perhaps having a bit more purchasing power, where that could go over time and how it could benefit profitability?

Speaker 4

Sure, Susan. I'll take the second part of that first and then come back on lot premiums in the studios. Like I mentioned before, we're at an unusually high level of incentives out there in this mortgage interest rate. And if we can eliminate that, it's full percentage basis margin improvement for the company, all else being equal. So if we hold costs equal, assuming land values stay equal, etcetera, it's a pretty significant upside for us.

Speaker 4

So that factor alone, I think, gives me some really good feelings about the future potential for gross margins. When you start looking at things like lock premiums in studio, the good news on the studio side is the spend. And even as ASPs have gone up and as affordability, there's been a lot of headlines on affordability. We're still seeing buyers coming to the studio and use their studio process. And as we've talked often in the past, we use our studio mainly as a differentiator on the sales side and to pull more buyers in.

Speaker 4

We do believe that's part of the reason why we see very high absorption pace per community relative to the peers. But despite that, we still do have incrementally higher margin on studio sales in our base house margins, but it's not an area where we really focused to kind of cream it and add big dollars on that side of it. We'll take it where it comes in. We try to keep our options pretty close to market and go from there. Lot premiums is always a focus area.

Speaker 4

I think it's a focus area of all builders. It's almost if you think about a pure profit, there's no incremental cost to one lot versus another lot, a developed community. But to the extent you could get lot premiums on those lots, it's incrementally positive to gross margins. So that's really how we look at it on those two factors. And again, on the incentive thing, we're looking forward to getting back to our base business model and how we like to operate the business, which is more or less everyday low pricing without offering huge incentives out there, without discounting our homes and offering the buyers choice and personalization in order to drive an above average absorption pace per community.

Speaker 10

Yes. Okay. That's helpful color. And then maybe thinking about the consumer at a higher level, there's been a lot of different data points that have come through and comments from various companies across the consumer landscape in the last couple of months or so. And even your competitor this morning made some comments about consumers perhaps being under more financial stress, which seems like that's in contrast to the stats that you gave around your buyer in your prepared comments.

Speaker 10

I guess when you step back, how do you think about the health of the consumer and the buyer that's coming through today? And has that changed at all? Are you seeing anything different in there? And how do you think about the profile of the businesses as perhaps rates start to come down and we expand that pool of demand?

Speaker 2

I think you touched on it, Susan. I was we quote Rob quoted in his script the income levels, the FICO score and how much they're putting down. I observed it's a well heeled first time buyer. But their debt loads are up. You see it in all the statistics.

Speaker 2

Credit card balances are higher, car loans, whatever it is, there's a lot of pressure in their cost of living outside of homeownership. So we are very sensitive and in tune to doing what we can to help improve affordability. And I think if rates came down, it would help a lot of things, but we don't assume rates are going to come down anytime soon. So you have to navigate through it. And where we're benefiting is the buyer demand is strong enough that you're able to operate your business pretty successfully with this higher credit profile customer.

Speaker 2

But I think we would say too that they're a little more credit challenged and there's a little more debt burden than there was a couple of years ago.

Operator

Thank you. And our final question comes from the line of Jay McCanless with Wedbush Securities. Please proceed with your question. Jay, your line is live.

Speaker 11

Thanks for taking my questions. I guess, Rob, could you talk more about what was going on in the Southeast and also in the West region during the quarter? I know you said absorptions were pretty solid relative to the overall average, but the orders were down there. Is that a function of communities? And do you expect to catch up on the community side in those regions later this year?

Speaker 3

Part of it is a little bit driven by community count in Florida and I do expect that to catch up. We've had just some general delays in getting communities open. There's not communities that are going away, but just get pushed out a little bit. So I don't know, JK, if you've got the specific stat, but I think it was community count was down sequentially there a little bit. But overall, demand in both regions remained relatively strong.

Speaker 3

And we talked about the Southwest, Las Vegas continued to have the highest sales rate we've had in the community. Inland Empire did really well in the West, all of California really. Texas performed very well. Those businesses are back in sync. The normalized can rate actually lower than normal that drove a better net sales result.

Speaker 3

So outside of the uptick in inventory in Florida that we've been reading about, which I think is still well below the historical norms. I don't really see any storm clouds out there for us. But as I mentioned before, we'll continue to monitor and watch it.

Speaker 11

Got it. And then just on gross margin, it sounds like you're getting decent amount of pricing, not big pricing, but enough to cover mortgage concessions. It also sounds like you might get a positive product shift with more California in the Q4. I guess why not be a little more aggressive on the gross margin guide, especially for the full year? What's holding you back there?

Speaker 4

Jay, we forecast gross margins based on our backlog and it's one of the advantages of the BTO business. We have a lot of visibility into the future. And for the sales, particularly in the spring selling season, which will mainly deliver out in the Q4, the mix of business and the mix of sales and the mix between the divisions that we see, basically, we rolled them all up and we're telling you what we're seeing right now in our backlog numbers and what we anticipate selling through move in ready homes in the 3rd Q4 that deliver out before the end of the year. So there's not tons of guesswork there. We've been pretty consistent in gross margin in our estimates and really have been coming in close to the high end of our ranges now for the past several quarters.

Speaker 4

And we're pleased with the consistency in the business and what we're seeing and how things are progressing. And we'll keep you guys updated as we go. So we lifted the full year range up very incrementally right now and we'll continue to monitor it. We did expect at the beginning of the year to see a similar pattern of what we're seeing now, but for different reasons. We thought we'd get a little more help on the interest rate side and be able to do things with incentives and pricing that we have not been able to do because of the macro, but we've been able to offset that through other initiatives within the company and we're pleased with that.

Operator

And ladies and gentlemen, that does conclude today's teleconference. We thank you for your participation. You may now disconnect your lines.

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Earnings Conference Call
KB Home Q2 2024
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