KB Home (KBH) 2022 Q2 法說會逐字稿

Good afternoon. My name is Alex, and I will be your conference operator today. I would like to welcome everyone to the KB Home 2022 Second Quarter Earnings Conference Call. (Operator Instructions) Today's conference call is being recorded and will be available for replay at the company's website, kbhome.com, through July 22.

Now I would like to turn the call over to Thad Johnson, Senior Vice President and Treasurer. Thad, you may begin.

Thank you, Alex. Good afternoon, everyone, and thank you for joining us today to review our results for the second quarter of fiscal 2022. On the call are Jeff Mezger, Chairman, President and Chief Executive Officer; Rob McGibney, Executive Vice President and Chief Operating Officer; Jeff Kaminski, Executive Vice President and Chief Financial Officer; and Bill Hollinger, Senior Vice President and Chief Accounting Officer.

During this call, items will be discussed that are considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future results, and the company does not undertake any obligation to update them. Due to various factors, including those detailed today in today's press release and in our filings with the Securities and Exchange Commission, actual results could be materially different from those stated or implied in the forward-looking statements.

In addition, a reconciliation of the non-GAAP measures referenced during today's discussion to their most directly comparable GAAP measures 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, Thad. Good afternoon, everyone. We delivered strong financial results in our second quarter with 19% year-over-year growth in revenues. Alongside our increased scale, we significantly stepped up our profitability, expanding our homebuilding operating margin by more than 400 basis points to over 15%.

As a result, we grew our diluted earnings per share by 55% to $2.32. With a backlog of more than 12,300 homes, at a value of over $6.1 billion, we are well situated as we have sold all the homes that we need to achieve our delivery and margin expectations for the year. We are also beginning to shape our fiscal 2023 and have most of our first quarter deliveries in backlog as well.

The size and composition of our backlog provide us with good visibility toward achieving our guidance midpoint of about $7.4 billion in revenues and roughly a 26% gross margin contributing to a return on equity of over 27% this year. KB Home is a much stronger company today with greater scale, solid profitability and a healthy balance sheet, including an excellent portfolio of performing communities. Our business has a more geographically diverse footprint with less concentration in our West Coast region as illustrated by the distribution of our future revenues in backlog.

We are maintaining our scale in the West, while at the same time growing our other regions. We believe the strength of our company, together with our build-to-order business model, will enable us to navigate the changing market dynamics. Order rates are moderating from the exceptional levels that the industry experienced, beginning in late 2020 as higher interest rates and increased home prices, along with other inflationary pressures, are impacting current demand. That said, we believe the factors underlying long-term demand continue to be healthy, particularly with respect to demographics and the work-from-home trends, coupled with an ongoing undersupply of new homes and low existing home inventory.

Our net orders were 3,914, down 9% versus a year ago when we reported the highest second quarter net orders in the prior 14 years. While our gross orders were flat year-over-year, a higher cancellation rate created a negative net order comparison as some buyers were affected by the larger monthly payments from the increase in mortgage rates.

Thank you, Thad. Good afternoon, everyone. We delivered strong financial results in our second quarter with 19% year-over-year growth in revenues. Alongside our increased scale, we significantly stepped up our profitability, expanding our homebuilding operating margin by more than 400 basis points to over 15%.

As a result, we grew our diluted earnings per share by 55% to $2.32. With a backlog of more than 12,300 homes, at a value of over $6.1 billion, we are well situated as we have sold all the homes that we need to achieve our delivery and margin expectations for the year. We are also beginning to shape our fiscal 2023 and have most of our first quarter deliveries in backlog as well.

The size and composition of our backlog provide us with good visibility toward achieving our guidance midpoint of about $7.4 billion in revenues and roughly a 26% gross margin contributing to a return on equity of over 27% this year. KB Home is a much stronger company today with greater scale, solid profitability and a healthy balance sheet, including an excellent portfolio of performing communities. Our business has a more geographically diverse footprint with less concentration in our West Coast region as illustrated by the distribution of our future revenues in backlog.

We are maintaining our scale in the West, while at the same time growing our other regions. We believe the strength of our company, together with our build-to-order business model will enable us to navigate the changing market dynamics. Order rates are moderating from the exceptional levels that the industry experienced, beginning in late 2020 as higher interest rates and increased home prices along with other inflationary pressures are impacting current demand. That said, we believe the factors underlying long-term demand continue to be healthy, particularly with respect to demographics, and the work-from-home trends, coupled with an ongoing undersupply of new homes and low existing home inventory.

Our net orders were 3,914, down 9% versus a year ago when we reported the highest second quarter net orders in the prior 14 years. While our gross orders were flat year-over-year, a higher cancellation rate created a negative net order comparison as some buyers were affected by the larger monthly payments from the increase in mortgage rates.

For the quarter, our cancellation rate remained below historical averages with about 1/2 of the cancellations occurring on unstarted homes. Our cancellations reported after start remained in single digits, and we ended the quarter with only 69 finished unsold homes in inventory. And 6.2 net orders per community in the second quarter, our monthly absorption rate was aligned with our production starts as we continue to manage pace and price to optimize our assets.

As to community count, the second quarter marked the beginning of our planned growth with anticipated sequential quarterly increases in our ending count for the remainder of the year. New community openings typically garner strong interest and demand from homebuyers driving these communities to perform above our company averages. With absorption rates moderating, we anticipate our higher community count as well as more reliance on our virtual selling efforts will help support our net orders going forward.

We believe our build-to-order model also contributes to our industry-leading customer satisfaction levels. Together with offering the most energy-efficient homes among national homebuilders, these factors help us generate among the highest absorption rates in the industry. The differentiating feature of a build-to-order home is the choice that we provide to customers based on their budget and what they value. We believe the flexibility to rotate into a smaller square footage home at a lower base price with the same number of rooms and functionality is a compelling benefit in today's environment when affordability is under pressure. This can be the difference that makes our homes attainable for buyers, and we already have these floor plans available in our communities.

In addition to the size of the home, our customers have other choices as well from the location of their lot to upgrading their finishes in our design studios or not as buyers can also select from included finishes, again, based on their preferences and ability to spend. Our business model allows us to move with demand and responding to what buyers want and need. And this strength is reflected in our first-time and first move-up buyer percentages, the largest demand segments, holding steady sequentially in the second quarter at 56% for first-time buyers and 78% for the 2 combined.

The credit profile of our buyers that use our mortgage joint venture, KBHS Home Loans, remain strong. For loans funded during the quarter, about 2/3 of these customers utilize the conventional mortgage. Loan-to-value ratios held steady at 85%, translating to an average cash down payment of roughly $75,000 and close to 100% of buyers use fixed rate products. The average household income of these buyers was about $125,000, and their FICO score showed a slight sequential improvement to 734. While we target the median household income in our submarkets, we are attracting buyers well above that income level with healthy credit who recognize the value of a personalized build-to-order home in their preferred location.

Our buyers' incomes and credit metrics provide them with the flexibility to adjust the type of loan program they choose if needed, whether fixed or adjustable rate mortgages or conventional versus FHA loans. In addition, KBHS has been proactive in working with buyers who wanted to lock their rates. As of the end of the second quarter, we estimate that buyers who have locked their rates or will purchase with cash, represented roughly 2/3 of our backlog, providing us with good visibility on deliveries. The KBHS team, together with our community team at each location are both in weekly communication with our customers, a standard process for them and rates can generally be locked at any point during the construction cycle.

With that, let me pause for a moment and ask Rob to provide an operational update on build times and production. Rob?

Thank you, Jeff. Our divisions delivered about 200 more homes in the second quarter than the midpoint of the guidance we shared with you in March. A sequential improvement in cycle times was a key factor in our ability to accomplish this. While we based our second quarter delivery projections on our 2022 first quarter build times, we actually improved by 2 days in the second quarter with cycle times getting better in every stage we measure in May. Relative to the first 5 months of the fiscal year, the second quarter marked the first time in more than a year that we did not experience an extension in our build times. And while we acknowledge that they remain higher than historical levels, we are encouraged by our progress.

There is a perception that a built-to-order home takes longer to build than a speculative home, and that is not the case. The stages, sequencing of construction and build times are the same in both approaches. In our BTO model, we utilize a standard plan series, which is a library of floor plans that were created based on our market survey data and represent our customers' most frequently selected plans.

Our homes are personalized, not customized. Our buyers finalize their standardized design studio selections before we start the home, so our trade partners know exactly what is going into the home before it has started.

With respect to the supply chain, we are seeing mixed dynamics with the availability of some materials such as paint, pluming products, interior doors and door hardware improving sequentially. Other materials such as engineered wood products, cabinets, insulation and concrete continue to be difficult to obtain, but have stabilized. And the third group of products, including heating and cooling materials and electrical equipment, appliances and windows remain challenged.

As to trade labor, the impact from COVID-related shortages was less severe than it was in our first quarter. However, we continue to manage through trade labor shortages in our second quarter and remain watchful with any shifts in contractor labor availability. Overall, the supply and delivery of products and construction services are still unpredictable, but our teams are resilient in working through the challenges and quick to creatively address delays and develop workarounds to keep our homes progressing.

We expect supply constraints will prevent us from returning to our historical build times in the short term, but we believe the actions we have taken in simplifying our SKUs, adding trade partners and suppliers and communicating real-time with suppliers about future needs have helped to stabilize our build times. And with housing starts across the industry down 14% as reported last week, we expect the overall pace of starts in our markets to lessen, providing some expected relief to build times, which will help us to return to our historical build times longer term.

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

Thanks, Rob. The final topic I want to discuss in my prepared comments are land spend and capital allocation. We are in a favorable position today with assets that we believe will support strong gross margins beyond 2022 and new communities that continue to perform well at their opening. We have prioritized our capital allocation toward investments in our future growth through a disciplined process. This means adhering to consistent underwriting criteria, targeting the median household income and assuming an absorption pace per community of between 4 and 6 per month, depending on the specifics of the investment. Utilizing current selling prices and construction costs, folks in our communities have provided a 2- to 3-year life supply and staying geographically close to where we currently operate.

In the past 12 months, we have invested $2.8 billion in land acquisition and development. We have expanded our lot position to approximately 90,000 lots owned or controlled, providing us with the lots needed to achieve our growth targets through 2024. Roughly 1/2 of our owned lots were contracted for in 2019 or prior and 40% of our lots were tied up during 2020. As a result, the vast majority of our owned lots were underwritten before the significant run-up in average selling prices. This supports our ability to sustain solid gross margins as it typically takes 2 to 3 years from the time, we tie up a piece of land to the point at which we deliver the first home to our customers.

We strive to take a balanced approach to capital allocation. Over the past year, in addition to the land investments that I just mentioned, we returned nearly $300 million to stockholders. This included our regular quarterly cash dividends of over $53 million and nearly $240 million in stock buybacks as we repurchased over 6 million shares or roughly 7% of our shares outstanding.

With strong profitability and an anticipated tightening of our land investments in response to the changing market conditions, we expect that we will have opportunities to continue to redeploy capital to stockholders. Before I wrap up, I would like to thank the entire KB Home team for their hard work and ongoing commitment to serving our homebuyers.

In closing, we are mindful of market conditions and the various macroeconomic factors that are impacting homebuyers. We believe our build-to-order model is well suited to navigate the changing environment given the flexibility it provides. With more than $6 billion in potential future revenues in backlog, we believe we're well positioned to deliver meaningful returns focused growth this year with an anticipated expansion of our scale to $7.4 billion and an increase in our operating margin to over 16%, which together would drive a return on equity of over 27%. We look forward to updating you again later this year.

With that, I will now turn the call over to Jeff for the financial review. Jeff?

Thank you, Jeff, and good afternoon, everyone. I will now cover highlights of our 2022 second quarter financial performance and provide our current outlook for the third quarter and full year. We are pleased with the second quarter results, which reflected improvements in virtually all key financial metrics.

In addition, we repurchased 1.5 million shares of our common stock during the quarter and earlier today, completed the issuance of $350 million of 7.25% 8-year senior notes with plans to use the net proceeds to redeem 7.5% senior notes maturing in September.

Our housing revenues of $1.71 billion for the quarter increased from $1.44 billion in the prior year period, reflecting a 21% increase in our overall average selling price and approximately the same number of homes delivered. Based on our current construction cycle times and backlog, we anticipate our 2022 third quarter housing revenues will be in the range of $1.82 billion to $1.92 billion. For the full year, we are projecting housing revenues in the range of $7.3 billion to $7.5 billion. We believe we are well positioned to achieve this top line full year forecast based on the construction status of homes included in our second quarter ending backlog.

In the second quarter, our overall average selling price of homes delivered increased to $494,000 from $410,000 in the prior year period, reflecting the strong housing market conditions over the past 12 months, which supported the successful opening of new communities and enabled us to raise prices across our operational footprint.

Average selling prices were higher in each of our 4 regions, with year-over-year increases ranging from 18% in our Southwest region to 23% in our Southeast region. For the 2022 third quarter, we are projecting an overall average selling price of $495,000. We believe our ASP for the full year will be approximately $500,000.

Homebuilding operating income was up 62% to $264.5 million as compared to $162.9 million in the year earlier quarter, reflecting an increase of 410 basis points in operating margin to 15.4% due to meaningful improvements in both our housing gross profit margin and SG&A expense ratio. Inventory-related charges were immaterial in both the 2022 and 2021 second quarters. We expect our third quarter homebuilding operating income margin, excluding the impact of any inventory-related charges to improve to approximately 16.9%.

For the full year, we still expect our operating margin, excluding any inventory-related charges, to be in the range of 16.0% to 16.6%.

Our housing gross profit margin for the second quarter expanded to 25.3%, up 390 basis points from the prior year period. The current quarter metric reflected the favorable pricing environment and lower amortization of previously capitalized interest, partially offset by higher construction costs and increased expenses supporting future growth. Our continued gross margin improvement trend demonstrates our success in offsetting input cost inflation with selling price increases.

In addition, with our strategy of locking material and labor costs when we start each home, we have been able to largely mitigate the impact of cost inflation during the construction process. Assuming no inventory-related charges, we expect a sequential increase in our 2022 third quarter housing gross profit margin to approximately 26.5% and further improvement in the fourth quarter. Considering this expected favorable trend, we believe our full year housing gross profit margin, excluding inventory-related charges, will be in the range of 25.6% to 26.2%, representing a 410 basis point year-over-year increase at the midpoint.

Our selling, general and administrative expense ratio of 9.8% for the quarter improved from 10.1% for the 2021 second quarter. The 30 basis point improvement mainly reflected lower external sales commissions and increased operating leverage from higher revenues in the current quarter, partly offset by higher expenses to support growth. Considering anticipated increases in future revenues and our continuing actions to contain costs, we believe our 2022 third quarter SG&A expense ratio will be approximately 9.6% and our full year ratio will be in the range of 9.3% to 9.7%.

Pretax income from our financial services operations was $18.7 million in the quarter, representing a year-over-year increase of $8 million. The year-over-year improvement was largely due to a significant increase in interest rate lock commitments within KBHS Home Loans, our mortgage banking joint venture as most customers elected to lock their mortgage interest rates for an extended period of time. The accounting treatment for these rate lock commitments had a favorable pull-forward effect on pretax income in the quarter. KBHS was proactive in working with customers who wanted to walk through the high probability of further mortgage rate increases.

At the end of the quarter, over 60% of the outstanding rate locks were for 180 days or longer. While our overall projected financial services pretax income for 2022 has not changed, the pull-forward impact shifted some earnings to the first half of the year. As a result, we now anticipate approximately $12 million of financial services pretax earnings in the second half of the year.

Our income tax expense for the quarter of $72.2 million represented an effective tax rate of 26% compared to 17% for the prior year period. The 9 percentage point increase was entirely due to the favorable impacts of federal energy tax credits on the 2021 second quarter. We expect our effective tax rate for the remaining quarters of 2022 as well as the full year to be approximately 25%.

Overall, we produced net income for the second quarter of $210.7 million or $2.32 per diluted share compared to $143.4 million or $1.50 per diluted share for the prior year period.

Turning now to community count. Our second quarter average of 211 increased 3% from the year earlier quarter. We ended the quarter with 214 communities, up 7% year-over-year, with 35 community openings and 29 sellouts during the current year quarter.

We anticipate our 2022 third quarter ending community count will reflect a small sequential increase, followed by a more significant sequential increase in the fourth quarter. We believe we will have approximately 250 open selling communities at year-end, up approximately 15% compared to year-end 2021. To drive continued new community openings and market share, we invested $700 million in land and development during the quarter and ended with nearly 90,000 lots owned or under contract.

In the first half of 2022, we invested a total of $1.4 billion of land and land development, of which approximately 55% was in land development. In connection with the bond offering, I mentioned earlier, Moody's Investors Service reaffirmed our BA2 credit rating and revised its outlook to positive from stable. We plan to use the net proceeds from the new issuance for the redemption in full on July 7 of our outstanding $350 million of 7.5% senior notes maturing on September 15, 2022. We expect to record a charge of approximately $4 million for this early extinguishment of debt in the third quarter.

During the second quarter, we repurchased approximately 1.5 million shares of our common stock for $50 million, leaving $250 million available for repurchases under our current Board of Directors authorization. We ended the quarter with a book value per share of $37.76, a year-over-year increase of 21%.

In summary, we are pleased with our second quarter financial performance and expect we will deliver robust operating results for the full year, supported by the strong revenue and margin potential embedded in our quarter-end backlog value of over $6.1 billion.

We are carefully managing the business in response to the higher mortgage interest rate environment and believe we are well positioned to generate higher revenues and expanded margins in the second half of the year. Our 2022 full year financial projections have remained consistent with our expectation from the end of the first quarter of generating a return on equity in excess of 27%.

We will now take your questions. Alex, please open the lines.

(Operator Instructions) Our first question comes from the line of Matthew Bouley with Barclays.

I think at the top, Jeff, you mentioned that your backlog, as it stands today, gives you some visibility into the first quarter of 2023. So my question is thinking about just the changes in the market here over the past months. Are you starting to see some of those consumer moves towards either the smaller square footage offerings or changes in the design studio? And as a result, how should we think about -- without looking for a hard 2023 guidance, of course, but how should we think about kind of changes in profitability beyond your current backlog visibility as a result of all that?

Sure. Matt, good question. We analyzed specifically in the quarter, just our May order activity because that was the most recent data after, frankly, all the interest rates had run up. And what we saw in consumer behavior was nothing really changed in the footage of the home that they were picking. And so far, nothing has really changed in the dollar spend at the studio. So it stayed very consistent.

If you go back to the comments I made about our buyer profile that closed in the quarter at an average income of $125,000 in the credit metrics and the down payment, they actually could absorb more interest rate than we've seen so far and still buy the homes that they're choosing.

So I think with this -- the moderation in orders that we've been seeing, I think it's more the consumer digesting these higher rates and all these cost pressures where they can still afford it. They may not be comfortable making that kind of a payment or commitment or they may just be paused because of everything going on. But so far, they're picking the same homes and the same features. As we look ahead, and we've shared this before, we have smaller plans available with the same functionality. And if the buyers were to pick a smaller home, our studio revenue typically tracks as a percent of revenue. So if it's a little bit lower base price home, it will have a little bit lower spend in the studio, but the percentage margins and the percentage returns over time will hold. You make a little less profit per unit, but you turn your inventory, you still have healthy margins, you still have comparable operating margins, it's just a little bit lower overall revenue. So we're watchful of the trends. But so far, the consumer really hasn't shifted their preferences, which I find interesting.

Got it. Okay. Interesting. Second one on the cancellations. I think you said that half of the cancellations that occurred in the quarter were on unstarted homes. I guess I'm curious, number one, is that typical? Or is that sort of, I guess, a onetime adjustment as rates spiked relatively quickly where you had folks that had just recently entered contract. So that's part one.

And part two is, I guess, presumably, as future cancellations may be on homes that have already started, if you could sort of remind us what you do to either incentivize moving those finished or partially completed what turns into a spec home and just kind of what the margin impact of the cancellation side of it would be?

Okay. A few parts to that question, Matt. On the cancellations that occurred before we started the home in a lot of cases, they did not have a locked interest rate because they hadn't finalized at the studio. So therefore, didn't have a fully loaded sales price or a fully loaded loan approval in order to lock the loan. And I do think there were some consumers in that bucket that were surprised with where their payments entered up versus what they thought they would get when they originally contracted.

I'd actually flip it the other way. We always stay far more focused on the can rate after start because that's our predictability in revenue. And for years now, our can rate after start has been single digits, good times and bad. And if you think about it in this perspective, especially for a first-time buyer, their biggest fear is do they qualify for a loan.

We get rid of after when we tell them or KBHS tells them that their loans approved then they lock their rate. So now they know their loans approved, they are emotionally committed to the home, and they weighed on us for the home to be completed. And along the way right now, these buyers have equity in the homes because they've been on our books for 3, 4, 5, 6 months, and they're very committed to close.

So our can rate after close remains low and very predictable. And it's part of why we have the comfort to hold the guidance that we did for the year and converting on our backlog. And frankly, the incentive we offer is a great home that they've personalized on the lot that they picked. They already know their loans approved, and we're not having to do things to hold that backlog in. They're committed and waiting on us, frankly, get the house build.

Our next question comes from the line of Stephen Kim with Evercore ISI.

If I could continue the line of thinking there. I thought I think it's important and interesting with respect to the behavior of your customer. You sort of talked about the slowdown in overall activity but suggested that you weren't seeing evidence that it's really just about math, it's really a lot of psychology. There's some fear in the marketplace and so forth. So you gave us the information about what your buyers are doing with footage and options spent in the studio.

A question that I had related to rate buydowns. My understanding is that a lot of investors sort of feel like builders need to cut their prices in order to get affordability back to where it was, let's say, when you had a 5% mortgage rate, you see the mortgage rate went from 5% to 6%. They do the percentage increase in that payment and then they say, "Well, that's how much the home price needs to drop by, so they're just doing math. But my understanding is that you could do a rate buydown and you could buy down probably a full percentage point on the mortgage rate with 4 points, meaning 400 basis points theoretically.

So I wanted to check if that was correct? Whether you are doing rate buydowns right now and whether you think that, that is actually the way people are responding would suggest that, that's what it's all about, but it's about numbers? Or do you think that it's more psychology and just a pause as they're sort of reflecting and reassessing?

Stephen, your assumption is correct. You can buy the rate down for 3 or 4 points and offer a lower payment. We're not doing that today. I think we've done it on a couple of inventory homes to move them. But on a build-to-order home, you're not locking the rate and buying it down for 270 days. That would take -- that cost a lot more than 4 points. But we really don't do that in our -- our approach is give the buyer the best price, let them create their own value. And one of the things that I touched on, our buyers are not moving to arms yet. They're taking a fixed rate 30 years. And the arms have now settled downwards favorable pricing. If a 30-year fixed is around 6, you can get an arm for around 4, a 10-year arm and qualify it that 4%.

So it is already out there for the customer, if that's what they wanted and they're not moving there yet either. So I actually believe right now, we're in a digestion period, similar to what happened in 2018 when prices ran and interest rates peaked. And they're just -- they're trying to figure it out. This buyer we're dealing with today can afford these homes at today's rates. It's whether they're comfortable with everything else that they're trying to absorb on inflation and gas prices in Ukraine and maybe their job situation, I don't know. But right now, it's not this math equation where we're having to do that to shoehorn a buyer and that's not what it is. So we're staying focused on getting the best value price per foot, personalize the home, and we'll see how it goes.

Yes. That's very interesting. The second question I had, I did want to talk about your average selling price. And in particular, the order price really shot up quite a bit. I was wondering if there is anything onetime-ish in nature? Is there some sort of a temporary mix shift we saw in terms of communities? So if you could just sort of talk about that average order price which jumped from 512 in the first quarter to 543, I think, in the second quarter.

Yes. Rob, do you want to take that?

Yes. I think it's just the ongoing price lift that we've seen. It's been increasing sequentially quarter-over-quarter. I don't know -- I would expect that, that does not continue on the pace that's on as affordability challenges with rate and everything keeps moving up. So I would expect that to level off. But yes, I don't know that it's really driven by anything regionally other than just ongoing price lift that we've had. And even through April, we were continuing to lift prices in the majority of our divisions and communities, less so in May and don't really expect that to continue going forward with some of the challenges that we've talked about. And I think that's why we're seeing that, Steve.

Our next question comes from the line of Mike Rehaut with JPMorgan.

Thanks for all the color as always. Wanted to kind of revert to the broader market and some of the changes. I'm sure you're aware that a couple of days ago, one of your large competitors talked about combination in many markets of both increasing incentives as well as price reductions in -- or targeted price reductions in certain markets or communities. Wanted to get a sense if you're seeing across your markets, not in terms of how you yourselves are acting, but just across the markets broadly, if you are starting to see either or a combination of an increase in incentives or price reductions. And if that were -- if that's the case or if you think it were to become more of an issue, what is the KB playbook in terms of reacting to that, if you would expect that perhaps it would just be a mix shift towards lower-priced products? Or I know you don't do a lot of incentives yourselves, but if there's anything along that path that you might react and put into action.

Mike, I'll share the company philosophy on this, and then Rob can give you some of the color on what he's seeing out in the field. There's a couple of different competitors here, one is resale. And so you have the resale that you keep an eye on, and you also have the new home peers and what are they doing. And I would come of this with the observation that this isn't every market moving together. In fact, it's not even every submarket moving together.

In every city, there are some markets that today are performing very well, then there's other submarkets that are challenged. And there's different degrees of strength or weakness from city to city. So what's interesting for me in this evolution is markets are again falling back where each market has its own personality, which is what we had as an industry for 40 years. And for 2 years now, they all traded the same.

So I think things are going to start to settle down back to the more normal things like job growth and income growth and in migration and those type of things. So you have -- there are some parts of the country where our industry, the price of our products move too far too much of a premium versus resale. And I think as things moderate and normalize, you'll see that gap close. And that's going to drive some of your behavior. And when we underwrite, we target resale medians as well, and we understand that, then you have a builder who may have a heavy inventory position in this community it's a onetime thing and you ignore them.

Over here, it may be peers that get more aggressive to move something. And through it all, as Rob just observed our pricing is up dramatically. We're selling at margins above what we just reported and have been. So we have a lot of room to navigate without -- while continuing to generate above-average returns and above-average operating margins. And we have a lot of communities we're going to be opine that we tied up 3 years ago, you know what's happened to price in the last 3 years versus when we underwrote those assets.

So we really like our position. And we think between all that and rotating left, we have all the tools we need to be competitive to hold our absorption paces and maybe they come off from 6% and go down to 5%, but at the margins we're at, they go to 4%. We'll work to optimize the price and the pace at the right margin. And we think we've got all the tools we need to navigate through this thing right now. That being said, Rob, do you want to give some color on what we're seeing in the field?

Yes. You mentioned the incentives, and we have seen the incentive game kind of creep up and starting to see more of that. And it really, as Jeff said, it depends on the location. It depends on the region, sometimes the submarket within a city on to what level we're seeing. So it's hard to give you a real specific color on the level, but we have seen it increase.

Primarily, what I've been seeing is incentives go, get higher for homes that can be delivered by the end of a builder's fiscal year. So some that are carrying a heavier inventory load are incentivizing those homes to get them in the queue to close this year. And as Jeff mentioned in some of his comments, our focus is getting the base price right to start with and then giving the buyer of choice, given the ability to ship left, select a smaller square footage plan, create their own affordability that way. So we're not playing the incentive game and sticking with our business model.

Okay. Fair. That's very helpful. I guess just secondly, you kind of slightly reduced the year-end community count this quarter from 255 to 250, still representing very healthy 17% growth year-over-year. Any thoughts as -- I'm sure a lot of plans are in the final stages for fiscal '23, any thoughts directionally in terms of -- I believe you said in the past that you expect continued growth in this metric for next year. But any sense directionally in terms of degree of magnitude if we should be expecting more like maybe perhaps of a mid-single-digit growth? Or could it be something again kind of in reaching double digits.

Jeff can handle that.

Yes. Mike, yes, just a little bit of color on community count. As you know, we don't really guide out too far in the '23 at this point in the year, especially with some of the uncertainty we're seeing. But we've been building a nice land bank for a while. Jeff, I thought gave some very insightful statistics during his prepared remarks on the vintage of that land and some of the price inherent in it and some positions that we still strongly believe are going to be really good communities for us. And we'll bring those communities to market as we develop through them.

So we are anticipating further growth in 2023 in community count. And depending on what happens with closeouts, et cetera, it could be more significant than the growth we saw this year. But we'll bubble up again at the third quarter and hopefully, at that point, give you guys a little bit more to go on relating to communities for next year in account. But we'll be deploying those assets that we've been investing in over the last 18 months into new open selling communities. And we believe the combination of having more stores on the ground as well as we're hopeful to see some tightening on the build times, be able to support continued revenue growth. But we'll see as time goes on those 2 factors.

Our next question comes from the line of Alan Ratner with Zelman & Associates.

Thanks for all the great detail, as always. I guess first question, maybe on the supply chain, Jeff, you kind of alluded to a little bit of hopefulness there about cycle times. I guess my question is more on the cost side. Obviously, this environment has been pretty favorable for your suppliers passing along price increases over the last year or 2?

And it would seem like given the shift in the market even though you guys are still seeing pretty healthy demand overall, I would say that there might be an opportunity to push back a little bit on those suppliers, either kind of to retrace some of the increases that you've seen or maybe push back on future increases. So I'm curious what's the real-time update on pricing increases from your suppliers? Is there any progress being made there? Or any optimism that there could be some?

Yes. Rob, why don't you start with lumber and what we're seeing, then get down to that next level of labor and everything.

Yes. I mean lumber has been the main driver of the cost increases. Certainly, everything has moved up, but not to the degree that lumber has and lumbers dropped drastically over the last few months.

We're seeing the benefit of that in starts today, but we won't see that in our closings until first part of 2023. Just kind of order of magnitude, I mean, framing just a material component of framing in Q2 of '21 versus '22 was up -- it was up roughly $25,000 in framing material up to $41,000. So a substantial increase. Now those have come back down, we're seeing random links composites that we're tracking in the 5s now versus in the 1,200 just a few months ago. So there's some definite benefit coming on the lumber side.

As far as the other increases, usually, there's a lag between what we're seeing out there on the sales side and starts to when we start seeing the cost decreases. But we're definitely pursuing that, and we expect that there will be some tailwinds coming from costs there as well.

Great. I appreciate that. And second, I'd love to drill a little bit on your comments earlier about kind of tightening some of the land investments. I'm not sure if you updated the guidance there on land spend or if that's just more of a qualitative comment. But can you just talk a little bit about what's shifted on your strategy on the land side? Are there option deals perhaps that are coming to the finish line to be taken down that you're rethinking whether you move forward with those? Is it more in reference to new deals you're putting under contract? I know you've mentioned you entered a few markets over the last year -- new markets over the last year. Is there any contemplation there in pulling back? Just kind of talk a little bit about where you see the land spend going over the next year or so given the shifting market.

Alan, I would couple it with the comment I made that we already own and control everything we need for a nice growth rate in '23 and '24. So we're set for '23 and '24. And as we look at things, it doesn't make sense to drive more investment to try to grow even more until there's more clarity in where demand is going to end up and where land sellers end up in there. We are seeing movement right now with the land sellers where there's more openness to smaller deposits, extended times to close, things like that.

So that's normally step 1. And then step 2, you'd start working on options instead of a cash price. So I do think you'll see that. But what I was referring to is until there's real clarity in this market, is it a brief digestion or is it a structural shift? And in either case, what does it mean? We're going to take our time because we have the ability to do so right now. And we'll be pulling back on our land spend coming out of this year until we have clarity. And what that means is you're set up to grow your company, you spend less on land. We should, over time, be in a nice position to have flexibility in how to reallocate the capital.

Our next question comes from the line of John Lovallo with UBS.

The first one is, could you help us with sort of the monthly order cadence in the second quarter? If you can give us any color into June, that would be helpful.

Okay. Rob, you want to take that.

Sure. Not to get into 2 specific numbers. But the order cadence was fairly consistent. March and April, we did see it soften in May, as cancellations increased too. June, I would say, has been similar to May. We're seeing some ongoing softness over the last couple of months. I think what Jeff was talking about earlier with buyers kind of being locked up or frozen right now trying to decide what to do as part of that. But we're also taking actions now as we talked about earlier to get the sales paces moving and just looking at it on a community-by-community basis to optimize each asset, each community that we've got, part of that is pace. And that's an exercise that we're going through right now.

Got it. And then the -- sorry, go ahead.

One thing that I would add to that, that I think is relevant. If we're assuming here the markets are over time here are just normalizing. Normally, this is before COVID for the 5 years prior to COVID. Our orders in the third quarter typically are down sequentially 20% from Q2 to Q3. That's our normal cadence through our year. And so it wouldn't surprise me if we have a similar cadence this year, it moves a bit due to community count and sellouts and whatnot.

But in -- when you look at it from a comp basis in 2021, we did not have seasonality. We actually had a stronger fourth quarter in '20 than we did a third. And last year, in '21, Q3 and Q4 were every bit as strong as Q2. And it's not normal because there is seasonality to our business. So I would expect you're going to see more of a seasonal trend develop here this year.

That's helpful. I appreciate that. And then the second question is the $75,000 down payment that you talked about is meaningful, obviously, and probably helps lock folks into some extent. But what percentage of the cancellations do you actually refund that down payment?

Rob, do you know that number? I mean it's only at the long got rejected, which is rare because we get the loan approval before we start the house.

Yes. I mean if we're talking to, I think, down payment versus the earnest money deposits are 2 different things. And typically, on the earnest money, we're keeping that really in every case, unless it's a buyer's inability to qualify. And typically, that's we're giving that back. I'm not sure if that answers your question.

I was talking more about the $75,000.

Yes. Well, yes, I mean if a buyer cancels, we're not keeping all of the down payment, really the deposit that we're keeping is -- that's the earnest money deposit.

Our next question comes from the line of Deepa Raghavan with Wells Fargo Securities.

It's interesting to know you're not playing the incentive game yet. But are you able to comment what be the general competitive response from the industry overall? Because some of your peers, including the big ones are taking some -- taking incentives higher, also adjusting prices lower. So just curious, any industry-level comments you're able to share on competitive response.

Deepa, I think Rob touched on that. What generally see in a market correction, I'll call it, builders that have inventory. So they've already built a home. It may or may not be what the buyer wants. And you have to do something to get the buyer to want it. So you either lower the price or offer some type of incentive or do both. And it could be higher realtor commissions or who knows what gets pretty creative.

We're not seeing radical moves where incentives have gotten excess of yet. It's people doing a little bit here and a little bit there to try to move some of their inventory. But it's a game that we've never played. We always just focus on give them the best price for the best value. Over time, we've always had a customer that really values that versus buying a home that's already built and somebody inducing them to buy by giving them a better deal.

Okay. That's fair. Versus the last earnings call, are you incorporating any form of slowdown in your second half guide? It doesn't appear because a good amount of your backlog was already locked in as of last quarter for the rest of the year. But just curious, I wanted to ask if there were any puts and takes within the second half versus the last time we heard from you on the call?

Right. The main changes in the guidance this quarter were just really a tightening of the ranges, which just reflects less time period and a higher level of confidence in the next couple of quarters on our part. The advantage we have right now is the large backlog and the assurance and the quality of the backlog, frankly, that we'll be able to close those homes.

So we know the prices, we know the cost in the vast majority of the cases, we have customers that are very well qualified and a lot of those cases are -- actually have lock mortgage interest rates. So we don't expect to see a lot of volatility in that. And on the other side of it, if we do see some spike in can rate, for example, on started homes or homes that are supposed to close either in the third or fourth quarter, we've been very successful reselling homes as we've gone through this latest cycle, and there's still very, very thin layer of inventory that we have in our system out there. So any homes that are coming off can or otherwise are fairly quickly reselling, and in most cases, reselling at higher prices than they were originally sold at. So we feel pretty confident. I mean, look, there's a lot of things that can happen. There's a lot of uncertainty out there right now. But from our view of the next 6 months, we're in really good shape as far as delivering these results.

Our next question comes from the line of Susan Maklari with Goldman Sachs.

My first question is your SG&A continues to come down really nicely over time. As we think about the underlying conditions normalizing or moderating in there and maybe some of that normal seasonality coming through. Can you talk to your ability to sustain this improvement that you've realized? And maybe that where that could get to over time as things do change on the ground?

Right. We've been progressing nicely, as you've noted on SG&A. It's nice to hit a single-digit number now in the SG&A on a quarterly basis. At the same time, as we've been basically on a glide path down towards improvement in that number, we've also been putting resources in for growth, for future growth of the business. So we'll be carefully watching and managing the business and based on macro conditions, what we see and whether we pull back on some of that growth investment or not, time will tell.

But we do have some ability to continue to guide that number and to make it better. I do believe as far as a long-term run rate, I think it's single-digit SG&A number is the right number for the company, and we're quickly approaching that. In fact, for the full year, it's satisfying to see it drop below the 10% level. So -- like I said, we'll see as time will tell, but we stay very focused on it, particularly in times like these, and we'll continue to manage the business appropriately for both near-term quarters as well as future quarters.

Yes. Okay. And then obviously, it was encouraging to see you buying back stock this quarter. When you consider the move in valuations just over the last week or so and everything that's sort of going on operationally, how are you thinking about repurchases going forward? And just any thoughts there on the potential cadence.

Susan, as we've always shared in the view, we have is a balanced approach, and we want to make sure we have the capital to run the business. If things are slowing, you want to have the capital to be opportunistic on the land side. And so we're not going to do something shortsighted and we'll keep this balanced approach up. And as we look ahead, if we have comfort that our capital has the ability to be redeployed and values are where they are, we'll buy more stock back. We don't have a set number in mind right now that we would share, but our actions speak that we've been willing to do it at the right time.

Our final question comes from the line of Jay McCanless with Wedbush.

I guess the first question I had with what's happening in June? Are there any places where you might still be limiting sales? Or are you going to head kind of opening that up, especially now that supply chain seems to be getting better?

Rob, do you want to take that?

Yes. It has shifted where there were a lot of communities, a lot of locations where we were limiting sales and matching our sales to our construct cadence. But between supply chain appearing to at least stabilize, if not getting better and picking up some days on cycle time with the market softening a bit in most locations, that's become more limited. There are still some communities out there where we're limiting Austin and Vegas come to mind. But generally, we've moved away from that, Jay.

Okay. Got you. And then just digging in on the cycle time improvement. Just wondering, was that improvement more about internal processes that you worked on with your subs or are you actually getting more goods in a timely fashion now than you were, say, 3 or 6 months ago?

I think it's a combination. It's -- we talked in the first quarter about some of the impacts that we had from the spike in COVID. That certainly got a lot better, which has freed up capacity on -- through the labor side. I think we are seeing some bright spots in the supply chain, but it's still -- we still don't know necessarily what we're going to get, what kind of products are in to get until the truck shows up on the job and we're able to open it up and see. So I think most of the improvement has come from some of our own efforts, whether that's our communication with our trade partners about upcoming needs or the simplification efforts we've done. And just our teams getting better now that we're several quarters into it and finding workarounds to keep the houses moving.

Thank you. Ladies and gentlemen, this concludes today's teleconference. Thank you for your participation. You may now disconnect your lines.