KBH - NYSE

Good afternoon. My name is John, and I'll be your conference operator today. I would like to welcome everyone to the KB Home 2024 First Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the company's opening remarks, we will open the lines for questions. Today's conference call is being recorded and will be available for replay at the company's website, kbhome.com, through April 19, 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.

Thank you, John. Good afternoon, everyone. And thank you for joining us today to review our results for the first quarter 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. 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.

Thank you, Jill, and good afternoon, everyone. We delivered solid performance in the first quarter, highlighted by our strong net orders, as well as financial results that we were either at or above the high end of our guided ranges. The spring selling season is off to a very good start, which together with our considerable backlog, better build times and planned new community openings gives us confidence that we are well-positioned to achieve our objectives this year. As to the details of our results, we produced total revenues of $1.5 billion and diluted earnings per share of $1.76. Our margins remain stable at 21.5% in gross and just under 11% in operated income. This performance, along with the cumulative benefit of sustained quarterly share repurchases, including an additional $50 million during the first quarter, drove our book value per share up 14% year-over-year. Market conditions have improved since the end of our last fiscal year. As we discussed on our earnings call in January, we had begun to see demand move higher in December, which accelerated as the quarter progressed. Although mortgage interest rates increased modestly in late February from their lowest levels during the quarter, the strong desire for homeownership prevailed. The combination of low housing inventory levels, solid employment and favorable demographics supports the new home market today and we expect will continue to be the primary factors that sustain its health longer term. The momentum in our net orders resulted in sequential gains of 46% in January, followed by 53% in February. We believe these results speak to the underlying demand for homeownership and a more stable housing market. Another sign of this stability is our cancellation rate, which fell significantly both sequentially and year-over-year. In total, we generated 3,323 net orders in the first quarter, representing 55% year-over-year growth. This result was achieved while we held mortgage concession steady and implemented a modest level of price increases in most of our communities. We have continued to experience strong sales since the start of our second quarter and believe we are well positioned to respond to this buyer demand given our products and price points, as well as plan new community openings in the first half of this year. On a per community basis, our absorption pace accelerated as the quarter progressed, averaging 4.6 monthly net orders for the full quarter. Our strategic goals continue to be optimizing each asset on a community-by-community basis, which generally results in an annualized average absorption pace of about five net orders per community per month and generating high inventory returns. In last year's second quarter, we produced very strong order results, driving an average of 5.2 net orders per community per month. This pace represented an 86% sequential increase and creates a tougher year-over-year comparable for this year. Our expectation is to slightly exceed last year's monthly community order pace for our second quarter in light of more favorable market conditions. We continue to align our starts with sales and plan to ramp up our starts given stronger demand and to position our business for the second half of 2024. We believe our backlog, homes in production and starts pace are in balance to support our projected $6.7 billion in revenues this year. With that, I'll pause for a moment and ask Rob to provide an operational update. Rob?

Thank you, Jeff. I will begin by adding to Jeff's comments on our order results to provide some additional color. During the quarter, we pursued a higher pace to capture demand and build our backlog while also raising prices in over one half of our communities. In another roughly 40% of our communities, we held prices steady. At 4.6 net orders per community, our monthly absorption pace was above our historical first quarter average. As Jeff mentioned, our cancellation rate improved to 14% of our gross orders and 10% of our backlog at the start of the quarter. These are the lowest levels we have experienced in more than a year, reflecting buyers who have adjusted to the higher rates as compared to a year ago and who are motivated to close. Mortgage concessions were relatively flat as compared to our 2023 fourth quarter with approximately 60% of our orders having some form of mortgage concession associated with them, including rate locks. Assuming market conditions and demand remain strong, we expect to be in a position to lower these types of incentives as the spring selling season progresses. We ended the quarter with almost 7,000 homes in production. Given our first quarter net order results and the elevated level of demand in the market, we expect to accelerate our starts and grow our production levels over the next six months. Operationally, our divisions are maintaining the progress they achieved last year in reducing build times. Our construction cycle is over 30% shorter than the prior year quarter with a daily focus on additional efficiency enhancements to further reduce construction times, to even flow production incorporated into our business model and leveraging relationships with our trade partners to increase speed, which helps improve cash flow for both sides. We believe we can return over time to our historical build times of between four months and five months. This will improve our inventory turns and increase the population of homes available for delivery, as well as further enhance our built-to-order sales approach, as personalized homes with quicker delivery dates are even more compelling to homebuyers. As to direct costs on started homes, they held steady in the first quarter on both a sequential and year-over-year basis. We continue to pursue value engineering and simplification opportunities to drive costs down, which have been effective over the past year in helping to offset overall inflation. Before I wrap up, I'll review the credit metrics of our buyers who financed their mortgages through our joint venture, KBHS Home Loans. We had a solid increase in our capture rate, with 85% of the mortgages funded during the quarter having been financed through our joint venture, as compared to 79% in the prior year quarter. Higher capture rates help us manage our backlog more effectively and provide more visibility in closings. In addition, we see higher customer satisfaction levels from buyers that use KBHS versus other lenders. The average cash down payment was 16%, consistent with last year, equating to roughly $77,000. The household income of our KBHS customers was about $126,000 and they had an average FICO score of 743, a number that has steadily climbed over the past few years. Even with one half of our customers purchasing their first home, we are attracting buyers that can qualify at elevated mortgage rates while making a significant down payment. As we look ahead to the rest of 2024, our divisions are focused on maintaining our high customer satisfaction levels, improving build times and value engineering our products to lower direct costs. In addition, our objectives are set on driving net orders, acquiring more lots and opening communities on time, all of which will contribute to the future growth of the company. We recently completed several leadership promotions and created a new Executive Vice President of Homebuilding position to which Brian Kunec has been elevated. Many of you are familiar with Brian from his earlier role of successfully leading and growing our Las Vegas business. Most recently, Brian was one of our Regional Presidents, responsible for our divisions in Idaho, Nevada, Northern California and Washington. In addition to Brian, we also promoted two division presidents to the role of Regional General Manager and increased the geographic scope of one of our existing Regional Presidents. We believe these organizational changes will help us in driving growth, as well as operational performance. And with that, I'll turn the call back over to Jeff.

Thanks, Rob. We invested close to $590 million to acquire and develop land during the quarter, a 60% increase year-over-year and the highest quarterly level since early 2022. We have the capital available to accelerate our investment spend in 2024 and intend to do so while adhering to our underwriting criteria, product strategy and price points as we are committed to growth beyond this year. We had roughly 55,500 lots owned or controlled at quarter end, of which about 40,100 were owned. Over 17,000 of these lots are finished, and as Rob referenced, we have about 7,000 homes in production. Approximately 60% of our own lots were tied up in 2020 or prior, which provides us with a solid runway of lots at a bearable cost basis. We are focused 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 growth targets for 2025. And as we have stated in the past, our divisions have roadmaps in place with timelines to achieve at least a top five position in each of our served markets. Our balance sheet is healthy and our cash generating capabilities are strong. We intend to allocate our capital toward reinvestment in growth and returning cash to shareholders in 2024, primarily through share repurchases. This is a continuation of the capital allocation plan that we executed in fiscal 2023, during which we bought back $411 million of our common stock at an average price of about $44.50, substantially accretive to both our book value and diluted earnings per share. Over the balance of the year, we intend to utilize at a minimum the roughly $114 million that remains in our current repurchase authorization and we will be requesting an additional authorization from our board. In closing, I want to thank the entire KB Home team for solid execution in our first quarter and their dedication to our homebuyers. Market conditions have improved and we are seeing dynamics returning to a more normalized state. Supply chain and trade labor availability have stabilized, and while cost pressures are still present, they have eased. Mortgage interest rates have also steadied and we do not see any evidence of rates rising this year. Buyers have largely adjusted to the rate environment and we are encouraged by the demand we are seeing at the onset of the spring selling season. Our backlog increased sequentially and is healthy, as reflected in the lower cancellation rate we experienced in the first quarter. We expect to compress our bill times further, which will contribute to higher inventory terms, unlock cash and enhance our bill-to-order approach. These dynamics are all favorable for our company and we look forward to demonstrating the potential of our business as the year unfolds. With that, I'll now turn the call over to Jeff for the financial review. Jeff?

Thank you, Jeff, and good afternoon, everyone. I will now cover highlights of our 2024 first quarter financial performance, as well as provide our second quarter and full year outlooks. We are pleased with our execution during the first quarter, with home deliveries up 9% over the prior year, in line with our expectations and supported by our improving construction cycle times and backlog of sold homes. Our healthy operating margin of nearly 11% drove robust cash flow that enabled us to invest almost $600 million in land, return over $65 million to our stockholders through share repurchases and dividends, and end the period with strong liquidity of $1.75 billion. In the first quarter, our housing revenues of $1.46 billion were up 6% year-over-year, driven by the 9% increase in the number of homes delivered, partially offset by decline in the overall average selling price of those homes. The number of homes delivered in the first quarter reflected a backlog conversion rate of 55%, a significant improvement from 36% for the year earlier quarter, demonstrating both the impact of our improved build times, as well as a lower cancellation rate in the current year period. Housing revenues were up in three of our four regions, ranging from 3% in the West Coast to 35% in the Southwest, offsetting a 19% decline in the Central region. We expect stable housing market conditions and favorable supply chain trends to support our forecasted results for the remainder of 2024. For the second quarter, we anticipate generating housing revenues in the range of $1.6 billion to $1.7 billion. For the full year, we expect to generate housing revenues in the range of $6.5 billion to $6.9 billion. We believe we are well-positioned to achieve this topline performance, supported by our backlog of sold homes, projected net orders per community, anticipated continued improvement in construction cycle times and expected growth in community health. In the first quarter, our overall average selling price of homes delivered decreased 3% year-over-year to approximately $480,000, mainly due to mixed shifts. For the 2024 second quarter, we are projecting an overall average selling price of approximately $483,000, up slightly both sequentially and compared to the prior year period. We still expect our overall average selling price for the full year will be in the range of $480,000 to $490,000. Homebuilding operating income for the first quarter increased slightly to $157.7 million, compared to $156.5 million for the year earlier quarter. The current quarter included abandonment charges of $1.3 million versus $5.3 million a year ago. Our homebuilding operating income margin decreased to 10.8%, compared to 11.4% for the 2023 first quarter, mainly due to a higher SG&A expense ratio in the current year quarter. Excluding inventory-related charges, our operating margin of 10.9% decreased to 80 basis points year-over-year. We anticipate our 2024 second quarter homebuilding operating income margin will be in the range of 10.1% to 10.5% and the full year metric to be approximately 10.9% to 11.3%. Our 2024 first quarter housing gross profit margin of 21.5% was even with the year earlier quarter. Excluding inventory-related charges in both periods, our gross margin decreased by 20 basis points year-over-year to 21.6%. We are forecasting a 2024 second quarter housing gross profit margin in a range of 20.5% to 21%, reflecting homebuyer concessions offered for homes sold in the second half of last year amid the challenging conditions at that time that are expected to deliver in the quarter. We project improved quarterly margins in the second half of 2024, supported by the margin profile in our backlog, improved leverage on fixed costs due to higher expected deliveries and anticipated lower rate buy-down incentives. We expect our full year gross margin will be in the range of 21% to 21.4%, assuming stable housing market conditions. Our selling, general and administrative expense ratio of 10.8% for the first quarter was up from 10.1% for the year earlier quarter, mainly reflecting higher costs including marketing, advertising and other expenses associated with the planned increase in our community count during the year as we position our operations for growth. We are also investing in personnel and other resources in alignment with the expected larger scale of our business. We are forecasting our 2024 second quarter SG&A ratio to be approximately 10.5% and expect our full year 2024 ratio will be approximately 10.2%. Our income tax expense of $36 million for the first quarter represented an effective tax rate of 20.6%, an improvement from 22.6% for the year earlier quarter. This improvement was predominantly due to an increase in tax benefits related to stock-based compensation in the current period. We expect our effective tax rate for the 2024 second quarter to be approximately 24% and for the full year to be approximately 23% due to the low rate realized in the first quarter. Overall, our first quarter net income increased 10% year-over-year to $138.7 million and our diluted earnings per share improved 21% to $1.76, reflecting both the growth in net income and the favorable impact of common stock repurchases over the past year. Turning now to community count, our first quarter average of 240 was down 4% from the corresponding 2023 quarter. We ended the quarter with 238 communities. We expect to grow our portfolio of communities during the second quarter by about 5% and end with approximately 250 communities. This would result in an average community count for the second quarter of 244. We remain focused on growing our community count and believe our average community count in the 2024 third and fourth quarters will be higher than in the prior year periods. In addition, our current outlook reflects approximately 260 open communities at year-end, which is about 10 fewer than we previously expected as a result of the stronger selling environment anticipated to drive more 2024 sellouts, as well as a handful of communities now expected to open during the 2025 first quarter. We invested approximately $590 million in land and land development during the first quarter, and we ended the quarter with a pipeline of approximately 55,500 lots owned or under contract. During the first quarter, we repurchased nearly 830,000 shares of our common stock at an average price of $60.48. 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 approximately $1.75 billion, including over $1.08 billion of available capacity under our unsecured revolving credit facility and $668 million of cash. Our quarter end stockholder's equity increased to approximately $3.9 billion and our book value per share was up 14% year-over-year to $51.14. In conclusion, we are pleased with our first quarter financial performance and expect to see solid housing market conditions for the remainder of 2024 driven by favorable demographic trends, the ongoing imbalance of housing supply and demand, and expected moderation in interest rates later in the year. We intend to sustain our focus on generating reductions across our operations and build times and construction costs while also driving growth and expanding our scale through land-related investments and new community openings. We plan to maintain our balanced approach to capital allocation, encompassing significant cash deployment back into land and development to produce topline growth, while also returning cash to stockholders through common stock repurchases and dividends with an overall focus on long-term stockholder value creation. We will now take your questions. John, please open the line.

Thank you. [Operator Instructions] And the first question comes from the line of Matthew Bouley with Barclays. Please proceed with your question.

Hi. You have Elizabeth Langan on for Matt today. So, just kind of starting off with the margin, would you mind talking a little bit about the margin cadence through the year? You're assuming that next quarter will be impacted by the higher incentive levels in the latter part of 2023. Would you mind talking a little bit about what we should expect for the second half, kind of what you're seeing with incentive levels right now and how those – how you'd expect those to flow through?

Sure. Yeah. As I mentioned in prepared remarks, we do expect some improvement in the second half of the year to arrive at that overall guide for the full year of 21%, 21.4%. What we are seeing, particularly this year and actually part of last year, pretty stable gross margin outlook quarter-to-quarter. We're basically forecasting plus or minus 21% in all four quarters of this year. And you'll see some improvement obviously in the back half, particularly in the fourth quarter with improved leverage based on higher deliveries and more revenues. So that's really the outlook at the current time.

Okay. Thank you. And would you mind touching a little bit on what you're seeing around buyer affordability and maybe your expectations around pricing? Do you think that, you've said that, you think that you can probably bring mortgage concessions down a little bit? Are buyers more responsive to something other than rate buydowns or are they seeing options, like, increasing their customization options or anything that you're seeing around that?

Yeah. There are a lot of components to that question, Elizabeth, but I can make a few comments and then pass it to Rob for some of the specifics on our buyer profile. As we shared in our comments in the first quarter, we were focused on building our backlog and driving more sales. So, we left the incentive levels for mortgage concessions similar to the prior quarter and pushed the pace and where we could, we took some, I called it moderate price increases in my prepared remarks. So it's part of optimizing the assets, build our backlog, set up the scale for the year, get a higher absorption pace and then start working a little bit on margin along the way. As we shared in the credit metrics of our buyers, we have a very strong buyer profile right now, in particular when 50% of our buyers are first time. We put it in that context and think of the FICO scores and the average down payment. This is a very well-qualified buyer. We're not having an issue with qualifying, as you can see from our pull-through on the backlog, and frankly, the orders that we're generating while taking a little bit of price. We've been poking around on what's going on with the buyer and the sensitivity to debt ratios and income and qualifying. Rob can give you some specifics on that. Go ahead, Rob.

Yeah. As far as the credit ratios, debt ratios, we're really not seeing any major change. In fact, on our closings, we've seen debt-to-income ratios fall slightly. So still a really well-heeled buyer. They've got sufficient income, got good credit, seeing demand at our price points, and I think, that speaks to the price points that we're at and the quality of our product. You mentioned studio and buyer behavior and what they're picking for design choices. And I think this speaks to that as well, because we really haven't seen a change in studio spend despite some of the affordability challenges that are out there in the markets. And we've seen some shift in what they're spending that money on, more things like permanent features in the home, like room configurations or cabinets or converting it into a bedroom, things that you can't easily change down the road. But between everything that Jeff just mentioned and the credit and income levels that we talked about, in addition, we haven't really seen a shift in the square footage that buyers are purchasing, so pretty confident that our buyers are, they've got the ability to qualify and we're seeing that in our results today.

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

Yeah. Thanks very much, guys. Appreciate all the color, as always, and, yeah, congrats on the good results. A couple of questions. Number one, I was wondering if you could give us a sense for what we should be thinking about for, in 2024, kind of a targeted level of operating cash flow as a percentage of net income, that kind of cash conversion. What sort of level we should be thinking about for you? And then also, from a longer term perspective, operating margin profitability has been improving. What do you think a level of longer term sustainable operating margin can be for your company? I'm sort of thinking maybe 13% or something like that. I was wondering if you could respond to that.

Sure. Are we counting that as two questions or one, Steve?

No. That's just one, Jeff.

We'll give you a break. We'll let you ask a follow-up. Okay. So, the first question on cash flow, as you guys are probably fairly used to with us, I mean, we don't really go out and forecast cash flow through the fiscal year, because it depends on a lot of factors including -- most predominantly including land spend and then over the past couple of years, the level of buybacks. If you go off top and look at operating cash flow, the big opportunity for us continues to be in the area of build time and reduction in build time. We mined a lot of that cash last year, where we had a very significant improvement in construction cycle time and it freed up a ton of cash for us, put us in the really strong balance sheet position we're in today with a lot of liquidity and a lot of dry poverty to go back and buy shares and reinvest in land. We anticipate continued success in that and continued strong and healthy cash flow, but acknowledging that a lot of the oversize or supersize gains that we had on the reduction in build times was a little bit behind us at this point. So, sorry, your second question was?

13%.

Oh! The 13%, yeah, on the operating margin. Yeah. I think, like when you look at, I saw your report and know that that was the number you had in there. Look, it's definitely within reach. I mean, we're not going to go out and guide or lay out a plan for the company on a during a Q&A period of a quarterly conference call, but we're within distance of that already and I'd hope to see improvement actually over and above that over time. That just requires about a point decrease in what we're anticipating for this year's SG&A, which I think comes with scale and size and leverage on some of our SG&A costs at this point. And as the market stabilizes and improves, particularly with declining rates that we do expect to see and reinforce today by some of the Fed's comments, moving away from some of the incentives, which you know is not really part of our business model to get into that low 20s range. I mean, we're already there, but to improve on where we're at today on the gross margin side. So I think it's a reasonable assumption. I think it's -- I would like to think it's on the very conservative side as far as a long-range target for the company and certainly attainable, so that's basically my comments on that at a very high level.

Yeah. Appreciate that. Thanks very much, guys. That's really encouraging. Second question relates to the big news regarding the NAR's settlement that obviously I think has created a lot of turmoil. What I'm intrigued about is the potential for this confusion and the relatively quick time frame by which all these changes need to be made, whether that might result in a somewhat dysfunctional resale market that large builders such as yourselves could capitalize on with your Internet presences, which I know you've substantially bolstered over the last several years, and so my question is, can you give us a sense for what share of your leads today are generated through the Internet and do those Internet-driven leads carry a lower SG&A burden, when they ultimately come through in sales?

Rob, do you have any detail on that, on the Internet leads and the profile?

Yeah. Steve, not so much as the percentage, but I would say, the majority of buyers that are finding us are finding us through those avenues and we've seen a big increase in our Internet leads just overall. It was up 34% year-over-year, so pretty big movement there. As far as the opportunity with the NAR and the settlement, I think it's still a little cloudy to predict how that's going to go. I think, if anything, it's going to be a positive for us with potentially less that's being paid in broker co-ops and things like that, but I think there's a lot to be worked out there when that goes into effect this summer. One of the components of it is that the compensation can't be advertised on the MLS, but then they likely have other ways to advertise that through Facebook or other methods or face-to-face. So a lot of it remains to be seen. Certainly don't see it as a downside to us, our results or our financials, potentially an upside, but I think it's a little too early to tell.

And the next question comes from the line of Alan Ratner with

Hey, guys. Good afternoon. Nice quarter and I appreciate all the color so far. So my first question and I really appreciate all the statistics you gave on the credit side. I was admittedly a little surprised when one of your competitors last week kind of talked a little bit about some rising early-stage red -- yellow flags or red flags in some of their customer credit metrics like credit card delinquencies and things like that. And I just want to make sure I'm thinking about your commentary in the same vein, because I think a lot of the statistics you gave are maybe on closings and kind of more representative of what might have been going on six months or so ago. So, can you just be clear that you are not seeing any signs of stress in kind of real-time in terms of the consumers that are coming through your model homes today?

Yeah. I'll take that one. I mean, really, when I was speaking about the debt-to-income ratios earlier, that actually was based on sales, not closings and we've seen…

Okay.

… those ratios improve slightly over the last few quarters. Now, our leads are up. I talked a little bit about the Internet leads. So we're seeing a lot more people. So the raw number of people that don't qualify has increased. But as far as the percentage, I don't really see that that's changed much and we're not seeing those pressures at this point.

Great. Okay. No. I appreciate that clarification.

I'd point to our can rate, too. And on the can rate, it's now below normal for us and I think that's the buyer's ability to perform.

Yeah. That makes sense. Appreciate the clarification on that. So my second question is on kind of the land portfolio and nice pickup in land acquisition activity in the quarter. Your lot count, if I'm looking at this correctly, is down about 10% year-over-year, down almost 40% from two years ago and your year's supply of land is kind of hovering in that four-ish-year metric, which is among the lower in the industry. And I'm just curious, is that -- would you say that's by design as an effort to kind of improve your capital efficiency or turnover, or is that land supply, I know you mentioned you've got all the land you need for 2025. But would you like to see that land pipeline a little bit higher than it is currently?

Actually, there's a lot of moving parts to it. If you reflect back on the push and pull we've been through, there was a couple times over the past few years where we pulled out of the land market because it was cloudy. What's really happening post-COVID and then that took off. Net interest rate's running. Things stalled. So you pull back again and you reset. And we extended a lot of deals, renegotiated others. We did a lot of things. Kept the control of the assets that we liked. So, it's kind of deceptive to look at two years ago, because that was one of the periods where we walked out of a lot of options at that time, because they weren't making the sense that they did when they were first tied up. So, we're comfortable with where we're at. We have that healthy tension. We need lots for 2026 and beyond. But we don't have to do something outside of our underwriting in order to fill the pipeline. So, we have a healthy discipline that we're adhering to, and yet, at the same time, we're encouraging the division to grow. So, at a four-year supply, actually, of owned, that's probably a little high. I'd rather have it more controlled, less owned if we can get there. But we're pretty comfortable with how we're positioned heading into 2026. Right now it's a focus on 2026 and beyond.

And our next question comes in the line of John Lovallo with UBS. Please proceed with your question.

Hi, guys. Thank you for taking my questions. The first one is, can you just help us with the drivers of the 60-basis-point gross margin beat versus your expectations in the first quarter? And then help us with sort of the walk from the first quarter to the second quarter in terms of factors like the leverage impact, mix, net price, et cetera?

Right. So, yeah, there were a few things that came into that. One was we had a little bit of mixed shifts. So we pulled, and interestingly, we pulled a lot of the higher margin deliveries out of Q2 and the Q1 on an incremental basis towards the end of the quarter, which we're always striving to close as many homes as we can and try to get those behind us, and this time the mix worked out in our favor where we had some pickup on that side. The can rate was a pretty important factor for us as well, where we didn't have to resell homes that had already been in our backlog at healthy margins and we didn't have to quickly discount those homes to get them sold in the quarter. So, that helped us incrementally. And we've been really, as far as the forecasts go, that's always a difficult one to forecast out. So, we did, I will say, as we were forecasting the 21% for the first quarter anticipated a can rate similar to what we'd seen in the prior two quarters and had a little bit tucked away on that increment. So, those were the main drivers. We like to be -- we like being up. When you look at it sequentially, we're really based in the second quarter predominantly up what's in our backlog, and we really saw sort of a tick up in some of those incentives and whatnot back in those times when those sales were booked and they're coming through. And the final thing and it's always the same, and I know everyone hates hearing it, including me oftentimes, but mix plays a big part of this, between communities, high margin, low margin communities, between regions and between divisions. So all of those factors sort of come together in that. And if you're plus or minus a percent quarter-over-quarter-over-quarter for the most part it kind of reflects an operation that's running pretty smoothly. You're pulling your deliveries from your backlog. You're not seeing many cancellations. You're not having many -- much pressure on you to resell homes and close them in the current quarter due to cancellations and we really liked the steady environment that we saw in the first quarter, it was a really nice start to the year for us and we're looking forward to the rest of the year as a result of that, particularly, selling through the spring.

Got it. That's helpful, Jeff. And then, if we think about the slight uptick in the outlook for SG&A as a percentage of sales to 10.2%, I mean, that's coming with slightly fewer communities than you were previously expecting a little bit of an uptick in sales. But I guess the question is, does that reflect the need for higher broker commissions or higher marketing spend, things of that nature? What exactly is driving that slight uptick?

It really has nothing to do with the commission side of it. We are putting a little bit more money into marketing and advertising, as we talked about. On the community count, as you pointed out, declining, I mean, half that decline was really due to earlier sellouts. And the community, the other half is just a few communities that pushed out in the first half of 2025. So we're still planning on spending money marketing, advertising, et cetera, for those communities, yet in the fourth quarters, we're approaching openings on those. So it really did impact it in a way where a lot of reduced expense on that side. But I think, overall, if you just go right up top on the SG&A side, we're just preparing the company to operate at a larger scale. We're putting in some personnel resources where we need it. Rob talked a bit about some of the operational assignments and promotions and positions that we have in the business as we're expanding the size of our divisions and the focus on growth and returns and we just feel that, scaling up this company will do some really good things for profitability, capital efficiency and returns. And we're really well positioned at that point in time, having just a rock-solid balance sheet and fixing a lot of the issues that we're nagging for many, many years and we're well beyond those at this point. So, we're just looking forward to growing this company and growing the returns as we move forward.

And the next question comes from the line of Michael Rehaut with JPMorgan. Please proceed with your question.

Hi, everyone. This is Andrew [ph] on for Mike. I appreciate you taking my question. I guess just more on the longer term side, should we be expecting any kind of change to your mix going forward as you grow? I believe in 4Q, your closings, your mix was roughly 50% entry level, 25% move up and the rest being active adult and second-time move up.

Yeah. I think the market will dictate that more than we will. And I say that because when you're a bill-to-order company and you're focused on the median incomes in the sub-market that you're operating in, you cater to everybody. And you have a product out there where it may shift to more move up and be the lesser footages, lower price points or it can shift to the first move up in the larger home and the bigger, higher income in the second move up. But the market will dictate that to a degree. Our strategy and our positioning is not going to change. So I would say it's realistic, I guess, to assume we'll be 45% to 60% first time and the other buyer components may move around a little bit. We've been around 15% active adult for years and years. It's a natural attraction due to the climate zones that we operate in and a lot of retirees come in and like our product as well. So we don't target a specific buyer profile. We target an income and a price point and then let the buyers come and when you're at the meet of the market, it will move around a little bit like it does. But it should stay in the same range we're seeing.

Thanks for that. I'll pass it on.

And the next question comes in the line of Susan McCleary from Goldman Sachs. Please proceed with your question.

Thank you. Good afternoon, everyone. My first question is thinking about the potential for lower rates and maybe an increase in activity on the ground in general. If we do see that as we move through the year, how do you think about the ability to retain the improvements that you've seen in the build times and the cycle times and to retain the labor force and to keep things moving at the rate that they have been more recently?

I think the opportunity there, Susan, is to continue to capture some build times. And as you look back over the labor shortages and the supply chain disruptions that we dealt with, I would say that, on either side that -- those companies learned a lot and addressed it and fixed it, whether it's hiring more people or fixing some of the glitches in the supply chain, whether national or international, even. And those are all healing, if not healed. And I think we can still pick up some build time compression and I think we can control costs, and in part because we're going to even greater scale in the markets we operate in where we have relationships, in some cases, 40 years old with a contractor base. So, we see if the interest rates do come down and the markets warm up a little bit, it would be a tailwind force. We don't think it'll create build time issues and cost pressure.

Okay. Okay. So that's helpful. And then maybe just turning to capital allocation, can you talk a little bit about how you're thinking of that? You've been continuing to buy back some of the stock, which is nice to see. Is there anything there that's changed or incremental in how we should be thinking about it?

Well, I can tell you, Susan, based on the prepared comments I made, we're going to keep reversing shares at least the next 113 million that's authorized. So that's the first time we've signaled an intent. We've been active in share reverses for three years now, pretty consistently and it's been a big boost both to our book value per share and our EPS and it helps your ROE along the way. And in part it's because of all the cash we've generated. We're still sitting on a large cash balance with nothing out on our resolver and we think we have the ability to invest in growth and continue to toggle and get more cash back to shareholders. So we think we can do both through 2024. I don't see anything else you want to.

No. I think that summarizes it. The focus -- years ago, I mean, we had a focus on the balance sheet from the point of view of paying off some debt and realigning the leverage ratio that's certainly behind us at this point and it's full speed ahead with growth, improving returns, increasing scale and returning cash to shareholders is a key component for the capital allocation strategy.

And the next question comes from the line of Rafe Jadrosich from Bank of America. Please proceed with your question.

Great. Thank you. Thanks for taking my question. Can you talk about the level of inflation you're seeing today, maybe on a cash basis in terms of land and development costs as well as materials?

Rob, do you want to take that?

Sure. Yeah. It's really been kind of spotty on what's moving up and down in regards to materials. I mean, there's some that we've been able to lower our costs last year and it's stuck and others where it's continued to go up, concrete's one that comes to mind. There's a lot of infrastructure projects going on in most of the cities that we operate in. So concrete is one that's inflated pretty quickly and seems almost programmatic with some of the numbers that we're seeing. As far as the development goes, we're working from a really favorable cost basis in our land and we're well positioned to sustain solid gross margins given we've got that land cost basis favorability. But the cost to develop those lots, those assets, has gone up and I think the most significant are the contract and labor costs. I mentioned the infrastructure work that's driving part of that and then just growth and overall construction for home building too. But with respect to development, kind of a little bit easier to measure because we don't have as many parts and pieces going into it. But depending on the division we're seeing anywhere from low-to-mid double-digit range to, in some cases, a little bit higher. Actually, I'm sorry, low to mid-single digits to low-double digits is what we're seeing. And as we're looking at these lots and communities that we're developing, it's really inflation that we're going to experience in our closing as we get out into 2025. These are lots that we're developing today. They're not going to be delivered in 2024.

That's really helpful. Just remind us how much of the development cost is that as a percentage of the total land cost typically?

Yeah. It varies tremendously by division and by land parcel. So, the average, like, I'd have to reference it, but I don't know that it's that meaningful just because of the variances that we see across the business.

Okay.

And our final question comes from the line of Jay McCanless with Wedbush Securities. Please proceed with your question.

Hey. Good afternoon. So the first question I had, maybe sticking on the land topic for a second, as you're looking at lots for 2026 and beyond, what are you seeing in terms of land cost inflation for those further out lots? And from a competitive standpoint, we've heard from some of your competitors that the land market, especially this spring, is more fierce than it is normally. So maybe if you could talk about the inflation and what the competitive backdrop looks like?

Well, I would describe the land market as competitive. There's no easy deal out there. It's not just who are you competing with for the best price for the parcel. It's what's the complexity of the improvements and the development. You really need to understand the parcel and if you have a good land team, it's a strength. If you don't have a good land team, it can be a weakness. And overall, while it's competitive, we are finding deals, we spent 60% more in Q1 on land development than we did a year ago. So it tells you that we're finding deals and we're investing in input. I also said in my prepared remarks that we're sticking to our disciplines on the underwriting, the location, the product type and the returns that we need to get. So Rob, I don't know if you have any other color you want to give on what you're seeing out there on the land market.

Well, I'd just echo your comments. I mean, it is competitive and we are seeing land prices move up, and it depends just based on the submarket, based on the city. It's hard to give a specific number as far as what lots of -- lot costs or land is inflated to and the development is a factor in that, too. I mean, it all goes to the residual that you can pay for the developed lot, but definitely competitive.

Okay. Thank you. And then, Jeff K, last quarter you talked about how I think roughly 30% of production in the quarter were spec homes with a goal of being more like 25%. Could you talk about where specs are now and how we should think about that mix in terms of the gross margin guide for the second quarter and for the rest of the year?

Yeah. On the spec side, it's remaining relatively stable. When you see, you know, the nice thing that we're seeing now is with the can rate coming down, we're not having to resell lay homes after a start that we had at a point in time just a few years back. So that spec mix I think is going to remain fairly stable as we move through it. When we just look at what we have in production, it's roughly where we've been delivering right around 30% of the total is the production right now of spec homes. And, yeah, I think, that will remain pretty close to those levels. That is the tricky part, as you point out, about forecasting gross margin, but it's easier when it's a fairly stable number, and particularly, with the lower can rate where you're not having as many surprise spec homes as versus planned ones. So, we're steady as she goes in that metric as we move forward…

The blend is in our margin.

Okay. Yeah. Oh, sorry. Yeah. Jeff just pointed out that the blend is in our margin guide. We always blend it. So as we look out at delivery the next quarter, we always have to make some estimate of what we'll sell and close in the quarter that's not coming out of backlog and we'll put estimates on. We know what the build costs are. We'll estimate the price and then move forward. But it's all embedded in the margin guide that we put out there.