Kb Home Q3 FY2021 Earnings Call

Good afternoon. My name is Alex and I will be your conference operator today. I'd like to welcome everyone to the KB Home 2021 Third 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 line for questions. Today's conference call is being recorded and will be available for replay at the company's website, kbhome.com through October 22nd. Now, I'd like to turn the call over to Jill Peters, Senior Vice President, Investor Relations. Jill, you may begin.

Thank you, Alex. Good afternoon, everyone, and thank you for joining us today to review our results for the third quarter of fiscal 2021. On the call are Jeff Mezger, Chairman, President, and Chief Executive Officer; Matt Mandino and Rob McGibney, Executive Vice Presidents and Co-Chief Operating Officers; 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 guarantees of future results, and the company does not undertake any obligation to update them. Due to 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 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's Jeff Mezger.

Thank you, Jill, and good afternoon. Our performance in the third quarter reflected significant year-over-year increases across a majority of our key metrics as we produced solid results in a housing market experiencing great demand, while also facing industry-wide challenges in getting homes completed and delivered. These results will help drive our returns-focused growth as we continue to expand our scale while generating a higher return on equity. Before I get into the highlights of the quarter, and there are many, I want to address our shortfall in deliveries and revenues. Disruptions to our supply chain intensified as the quarter progressed and along with municipal delays, resulted in our build times extending by about 2 weeks sequentially. This pushed many deliveries into our fourth quarter and will similarly delay some fourth quarter deliveries into our 2022 first quarter. We are taking aggressive steps to manage through these delays, including expanding our subcontractor base, partnering with our national suppliers, and simplifying our products to stabilize our build times. We produced total revenues of $1.47 billion, up nearly 50% as compared to the prior year period and diluted earnings per share of $1.60. We achieved an operating income margin of 12.1%, excluding inventory-related charges, which grew 250 basis points year-over-year, driving a 40% expansion in our profitability per unit to nearly $52,000. This was accomplished even with the leverage we lost from the delayed deliveries. Our related gross margin of 22% was a particular highlight and demonstrates that we are effectively managing pace, price, and starts to optimize each asset. As to capital allocation, we continue to take a balanced approach with disciplined investments in growth, remaining our top priority. In the third quarter, we invested about $780 million in land acquisition and development. We expanded our lot position to almost 81,000 lots owned or controlled with our inventory continuing to rotate into a higher-quality portfolio of communities. In addition to these investments, we returned a significant amount of cash to stockholders through both our regular quarterly cash dividend and the repurchase of $188 million of our stock. These repurchases will further enhance our return on equity in 2022 beyond this year's expected 20% level, especially when combined with our projected increase in scale to over $7 billion in revenue and higher operating and gross margins. Since we embarked on our returns-focused growth strategy, we have produced meaningful expansion in our ROE. While we recognize that returns across the industry have expanded, our rate of improvement is meaningful, and we believe a return on equity in the low to mid-20% range is sustainable. During the quarter, we announced the promotion of Rob McGibney to Executive Vice President and Co-Chief Operating Officer, a role he shares with Matt Mandino. We created a Co-COO structure with 2 simple objectives in mind: to accelerate the profitable growth of our business in order to drive increasing returns on equity; and to enhance our execution. Rob is responsible for our West Coast and Southwest regions, and Matt is responsible for our Central and Southeast regions. In addition to their regional responsibilities, Matt and Rob each have oversight of key strategic corporate functions as well. The operating environment within our industry has become more complex over the past 18 months, given the supply chain issues and municipal delays that I mentioned earlier and their impact on build times. Having 2 proven leaders running our operations will allow for a more hands-on approach that is geographically focused, enabling greater day-to-day collaboration with our regional and division leadership. Matt and Rob will join me to respond to questions later on this call and can speak more specifically as to what is being done in their regions to compress build times. We successfully opened over 40 new communities in the third quarter, marking the start of a sequential improvement in community count that we anticipate will continue over each of the next 5 quarters. With the strong and growing lot pipeline that I referenced driving acceleration in new communities, we expect to expand our community count to roughly 260 by year-end 2022. Our monthly absorption per community accelerated to 6.6 net orders during the third quarter from 5.9 in the year-ago quarter and reflecting a more typical seasonal pattern sequentially while remaining at a historically elevated level. Net orders were 4,085, representing a small decline year-over-year against a strong result in the prior year quarter. However, with our actions in taking price and moderating pace, our net order value was up more than 20% year-over-year. We continue to manage our selling pace to production, limiting our lot releases to prevent our backlog from getting overextended and started over 4,000 homes during the quarter. This compares to starts in the year ago quarter of about 3,400. We currently have approximately 9,000 homes in production, with 93% of these homes already sold. Only 240 of these homes are unsold past the foundation stage, and our focus right now is on compressing our build times to deliver our backlog. With the rise in our net order value to $2 billion, we are laying the foundation for future margin growth. Our pricing power is solid, while our pace remains strong, and the demand for our homes at higher prices tells us that our price points remain attainable. The credit profile of our buyers is above our historical level profile with an average FICO score of 731 and down-payment of 14%, translating to almost $60,000, which is noteworthy for a first-time buyer. In addition, the internal indicators that we monitor for changes in customer behavior, including the square footage of homes purchased or spending in our design studios remain stable. Our backlog now stands at roughly 10,700 homes representing future revenues of over $4.8 billion. Our backlog value is up nearly 90% year-over-year with significantly higher margins within this backlog. This is an excellent position from which to finish 2021 and support another year of growth in revenues and expansion of margins in 2022. Homeownership remains compelling and attainable, and we believe the drivers are in place to support healthy market conditions for the foreseeable future. An insufficient level of supply exists at our price points to meet the demand for millennials and Gen Zs, which together number roughly 140 million. These 2 cohorts value the personalization and choice in our build-to-order business model, which is a significant factor in why our absorption rates have consistently been among the highest in the industry. This, together with our experience in serving first-time buyers who represent 61% of our deliveries in the third quarter, has us well positioned to capture demand going forward. Switching gears for a moment, I want to highlight our recent achievement in sustainability. KB Home received a record 25 ENERGY STAR market leader awards from the EPA, further demonstrating our leadership position as the most energy-efficient national homebuilder. We are proud to continue moving our environmental program forward, which is helping to lower the total cost of homeownership for our buyers while doing our part to reduce the carbon footprint of our homes. Before I wrap up, I would like to recognize and thank all of our employees for their outstanding efforts every day and working through the industry-wide challenges of material shortages and municipal delays. We have a remarkable team that is focused on execution and committed to customer service. In closing, we are going into a bigger business that is operating at meaningfully higher margins and generated considerably improved returns. We anticipate a return on equity this year of about 20% and further expansion in 2022 supported by double-digit growth in revenues and community count with higher margins as well as our recent share repurchase. Beyond next year, we believe our return on equity is sustainable in a low to mid-20% range. 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 review highlights of our financial performance for the 2021 third quarter, discuss our current outlook for the fourth quarter, and summarize expected improvements in several 2022 metrics. In the third quarter, we produced measurable year-over-year improvements in nearly all our key metrics, including a 49% increase in housing revenues that drove a 93% expansion in our earnings per diluted share. We also made substantial investments in land and land development to support continued growth and completed a significant share repurchase stack, among other things, will enhance future returns and per share earnings. Our housing revenues grew to $1.46 billion for the quarter from $979 million for the prior year period. This improvement reflected a 35% increase in the number of homes delivered and an 11% rise in their overall average selling price. As Jeff discussed, our current quarter deliveries were tempered by industry-wide building material shortages and labor constraints that extended build times in most of our served markets. We anticipate similar challenges will apply to our fourth quarter and have considered these factors in our outlook. Our ending backlog value expanded 89% to over $4.8 billion driven by strong increases in each of our 4 regions. Considering our quarter-end backlog, the status of our homes under construction and expected construction cycle times, we anticipate our fourth quarter housing revenues will be in the range of $1.65 billion to $1.75 billion. In the third quarter, our overall average selling price of homes delivered rose to approximately $427,000 from approximately $385,000, reflecting the strength of the housing market. For the fourth quarter, we are projecting an overall average selling price of approximately $450,000, which would represent a year-over-year increase of 9%. Our third quarter homebuilding operating income improved to $169.9 million as compared to $88.9 million in the year earlier quarter. Operating income margin increased 270 basis points to 11.6% due to improvements in both our gross profit margin and SG&A expense ratio. Excluding inventory-related charges of $6.7 million in the current quarter and $6.9 million in the year earlier quarter, our operating margin was up 250 basis points year-over-year to 12.1%. For the fourth quarter, we expect our homebuilding operating income margin, excluding the impact of any inventory-related charges, will be approximately 11.8% compared to 10.7% in the year earlier quarter. Our housing gross profit margin for the quarter was 21.5%, up 160 basis points from 19.9% for the prior year period. This margin expansion mainly reflected a favorable selling price environment supported by healthy housing market dynamics and lower amortization of capitalized interest. Excluding inventory-related charges, our margin for the quarter was up 140 basis points year-over-year to 22.0%. Our adjusted housing gross profit margin, which excludes inventory-related charges as well as the amortization of previously capitalized interest, was 24.5% for the third quarter compared to 23.7% for the same 2020 period. Assuming no inventory-related charges, we believe our fourth quarter housing gross profit margin will be in the range of 21.6% to 22%, reflecting the impact of peak lumber prices when our forecasted fourth quarter home deliveries were started. Our selling, general and administrative expense ratio of 9.9% for the quarter improved by 110 basis points as compared to 11.0% for the 2020 third quarter, primarily due to increased operating leverage, partly offset by higher costs associated with performance-based employee compensation plans and additional resources to support growth. As we position our business for growth in 2022, we believe that our fourth quarter SG&A expense ratio will remain roughly the same as the second and third quarters of this year or approximately 10%. This would represent an improvement from 10.3% in the 2020 fourth quarter. Our effective tax rate for the quarter was approximately 14%, reflecting $24.1 million of income tax expense, net of $21.5 million of federal energy tax credits. We expect our effective tax rate for the fourth quarter to be approximately 24%, including a small favorable impact from energy tax credits compared to approximately 16% for the year earlier Overall, we reported net income for the third quarter of $150.1 million or $1.60 per diluted compared to $78.4 million or $0.83 per diluted share for the prior year period. Turning now to community count. Our third quarter average of 205 decreased 14% from the year earlier quarter. We ended the quarter with 210 communities opened for sales as compared to 232 communities at the end of the 2020 third quarter. On a sequential basis, as anticipated, we were up 10 communities from the end of the second quarter. We are planning to achieve continued sequential quarterly increases in our community count through 2022. We believe our 2021 year-end community count will be up slightly from the third quarter, resulting in a high single-digit decrease in the average fourth quarter count as compared to the prior year. We invested $779 million in land, land development, and fees during the third quarter with $467 million or 60% of the total, representing new land acquisitions. In the first 3 quarters of this year, we invested $1 billion to acquire over 16,000 lots. We ended the quarter with a strong supply of nearly 81,000 lots owned and controlled that we expect to drive a significant number of new community openings and steady growth in community count. At quarter end, we had total liquidity of over $1.1 billion including $350 million of cash and $791 million available under our unsecured revolving credit facility. In early June, we issued $390 million of 4% 10-year senior notes and used a portion of the net proceeds to redeem approximately $270 million of tendered 7% senior notes due December 15, 2021. We recognized a $5.1 million loss on this early redemption of debt in the third quarter. The remaining $180 million of the 7% senior notes were redeemed at par value last week. The redemption of all our 7% senior notes, partially offset by the new issuance, will result in annualized interest savings of nearly $16 million, contributing to our continued trend of lowering the interest amortization included in our housing gross profit margins. In addition, we see the $350 million maturity in September 2022 of 7.5% senior notes as another opportunity to reduce incurred interest and enhance future gross margins. During the third quarter, we repurchased approximately 4.7 million shares of common stock at a total cost of $188.2 million. The shares repurchased represented approximately 5% of total outstanding shares and will provide an incremental improvement in our earnings per share and return on equity going forward. For purposes of calculating diluted earnings per share, we estimate a weighted average share count of 91 million for the 2021 fourth quarter and 93.5 million for the full year. For 2022, we are forecasting housing revenues of over $7 billion, supported by our anticipated 2021 year-end backlog, community count growth, and ongoing strong demand environment throughout next year. We expect approximately 200 new community openings over the next 5 quarters to drive sequential increases in ending community count. Consistent with the forecasted double-digit growth that we have discussed during the past 2 quarters, we believe our 2022 year-end community count will be up about 20% year-over-year and the full year average count will be about 10% higher as compared to 2021. We also believe that gross margin expansion to a level above our guidance for next quarter, along with improvement in the SG&A expense ratio, will result in a measurable year-over-year increase in operating margin. Further, the anticipated increase in scale, combined with a higher operating margin and the benefit of the recent share repurchase, should drive a meaningful improvement in return on equity relative to the approximately 20% expected for 2021. In summary, we believe we are well positioned to achieve our targets for both the 2021 fourth quarter and 2022 fiscal year. Our forecasted 2021 full-year results represent significant improvements across virtually all our key metrics with notable increases in our scale, absorption pace, housing gross margin, and operating margin. In addition, we are particularly pleased with the forecasted expansion in our full-year return on equity and our anticipated further improvement in 2022. We believe our ongoing focus on accelerating profitable growth and expanding our returns by leveraging our larger scale, attractive inventory profile, and uniquely compelling build-to-order business model will produce measurable enhancements in both book and stockholder value in future periods. We will now take your questions. Alex, please open the lines.

Our first question comes from Stephen Kim with Evercore ISI.

One of the interesting things that we saw in your results today was the share repurchase, and you actually increased your leverage to do it, which is something we haven't seen a lot of the builders do. And so I was curious as to if you could give us a sense for where your targeted leverage is going to be over the course of the cycle? And then how do you think that may trend in the near term?

Sure, Steve, I can take that. When looking at our leverage at the end of the quarter on a pro forma basis, we are down 50 basis points from the end of the second quarter. We have paid off the remaining notes that were not tendered after the quarter ended, which is not reflected in the actual results. So, as I mentioned, we are down about 50 basis points. We feel quite comfortable with our current leverage ratio, having been below 40% for some time. We plan to operate within a suitable range. We also saw a significant opportunity this quarter to repurchase shares, which will benefit us in the future and allow us to effectively use excess cash beyond what we needed for growth. Additionally, we are slightly reducing our leverage this year through the refinancing transaction, which resulted in approximately $60 million from the new issuance and the tender, followed by the redemption in September. That’s where we currently stand.

But Jeff, are you indicating that approximately 35% is a target we should anticipate for your company, or is it simply below 40%? That's a noticeably higher level compared to what we've observed from other builders. While it's not necessarily a negative level, I would like to know if you could provide us with a numerical range for your expected performance to manage the business over the next several years.

Yes. I would say we're comfortable in that 30% to 40% range. And like I said, we've been down about 40% for a while. We're accreting a lot of equity as a result of the high level of earnings that we've had. And as long as we're continuing to produce at equity, I think and with our excess cash, we may see opportunities to do what we just did in this quarter. But for the moment, we're pretty comfortable with the capital structure and the improvements that we've generated over the years.

Yes, that's great. I appreciate it. My second question relates to your margin. You've shown strong performance, but your guidance for the fourth quarter was slightly lower than we expected. You've mentioned that some of this is due to lumber and peak lumber costs. Can you provide insight into the extent of that impact? How do you anticipate this affecting your costs moving forward, particularly in early 2022? Additionally, there was a comment from Jeff Mezger about simplifying your product. Could you elaborate on that? It sounded like this might enable more speculative building versus build-to-order, but I want to clarify if that was your intention.

Steve, that was quite a few questions combined into one. I’ll hand over the clarifying product question to Rob. Rob, would you like to address that?

Sure. Thanks, Jeff, and Steve. Over the last several months, 18 months or so, we've really been focused on product and process simplification. And in our design studio, we've driven a total SKU reduction of about 48%. And our focus has been on retaining the items with the highest take rates from our customers and then matching that to product availability that we're communicating with our national suppliers and local trade partners about. And then on structural options, we've reduced almost 40%. So that is across our regions and across the country, and it's just about removing complexity from the supply chain and simplifying that issue for us and our trades. It also goes all the way to architecture, simplify product design with fewer variations. We're reusing our plans, leveraging standard product series across our regions and divisions, even getting to the design of the homes themselves, we're standardizing window sizes and cabinet box sizes and garage doors. So just simplifying it for us, for our customers, for our trades and really keying in on those items in the supply chain that are readily available where we can.

Sorry, but Steve took all my questions. No. Look, clearly, supply chain issues are impacting the entire industry, just kind of following up on one part of Steve's question. But the prepared comments, you all mentioned partnering with national suppliers and expanding your subcontractor base. I'm just hoping you can elaborate a little bit further on those actions you're taking outside of simplifying the offerings. And I realize this is kind of a crapshoot at this point, but any testament on when you think you might see construction cycle time start to stabilize?

Matt, do you want to talk about the labor base?

Sure. And Truman, I would say right now, the primary constraint is coming more from supply chain issues versus labor. But what we're trying to do is get out in front of it and really be proactive and identify where is the next bottleneck coming from. And we've got various tools and processes in place where we can analyze the capacity of our trade base. And then, as I said, I get out in front of it. An example of this, Truman, is, so far year-to-date, we have already added a little over 150 new trade partners. So it's visibility on when the all clear is coming is difficult to assess, but we are trying to stay in front of it. And with the expansion of our trade base, we think that's one of the best tools we have.

Truman, I was going to add that as we look at things where we got caught in the third quarter was in what I would call the second half of production, cabinets, windows, and whatnot. And that's what we're working on trying to compress today. We actually feel we've stabilized our build times in foundations and frames and into mechanicals, where we've addressed all the moving parts, and we've expanded the base, and we think we have that covered. And where we're still holding back is we don't know what we haven't even had to deal with yet because these things are popping up on a weekly basis, and it's varied from city to city. But we think we've stabilized the first half and the second half of the production cycle is what Matt is talking about addressing right now.

Okay, okay. And then in the press release, you all mentioned continued expansion of margins in '22. I didn't hear it in the prepared remarks. Was that alluding to gross margin or op margin or both?

It's actually both. And yes, just coming back, I guess, to Steve's question on cadence and trajectory, we do see the fourth quarter as having our peak lumber impact and inclusive in that. We did move a little bit in the fourth quarter of our pre-our previous expectation due to leverage loss with lower volume and also some mix shifts. But we're certainly and clearly seeing improving margins both in our selling gross margin, so on a week-to-week basis what we're seeing in the selling GMs as well as in our backlog. And at the moment, we're really looking at a nice gross margin trajectory into next year. And while we're not providing specific guidance on it, we did reference in the prepared remarks that we see our margins next year clearly in excess of our fourth quarter guide, and I think we'll see a very strong margin operating margin and then impacting return on equity in a very favorable way in 2022.

Can I pick back up on a prior comment, Jeff, you just made about the challenges with the second half of the production cycle? I want to ask about the other side of that, the start pace in the first half, I guess. So relative to the challenges in closings and I don't know, presumably getting communities open across the country, is your ability to put starts in the ground? And given your business model, therefore, driving sales, is that less impacted relative to the other challenges that are simply driving cycle times longer? Or should we assume that your start your start...

Yes, Matt, I believe we've managed the environment well by obtaining the necessary permits and then starting our projects. In the past 12 months, we have initiated around 17,000 homes, which is just a few hundred short of our sales. Our sales and starts are currently well aligned. We believe we have resolved the foundation issues we faced earlier this year, which were primarily related to framing. We are making progress and do not anticipate any significant increases in relation to our starts. Additionally, we performed strongly in the quarter with community openings, achieving the numbers we projected at the beginning of the third quarter. The over 40 openings we completed were an excellent outcome and reflect our confidence in our community count guidance moving forward.

That's actually a perfect segue. Thank you for that, Jeff. I wanted to ask about the communities just because you did have the 1 peer this week speaking about certain challenges in municipalities and sort of the cascading effect of supply chain and just getting communities open. And I think you gave the number at the top around 200 openings to come. I'm just curious that it's really just following up on the last point, but your confidence around that 200 given challenges in getting communities opening. And I guess the second part of that, if there's any regional bias for that as we model it out?

Yes. The community openings are broad-based, and I wouldn't target any one part of the country as being more difficult than others. I think a simple comment towards it is we've already taken the hits for the delays in our community openings as this year unfolded. So we're past a lot of the delays, and it's into the blocking and tackling, and it influenced our guide and our confidence for where we're headed next year. And I wanted to throw the actual number out because we've observed that strategically, we don't allow to grow community count a minimum of 10% a year. But with where the number is ending this year, we wanted to make sure that this group understood that it's much more than 10% next year. In fact, we're looking at 20%.

Thanks for taking my questions and congratulations on the promotion, Rob. It's great to hear you on the call. Jeff, my first question is about the margin comments. It’s important to remember the accounting details related to some of those fixed expenses that are included in your cost of goods sold, as this may clarify the changes in your guidance for the fourth quarter. Could you remind us of the approximate dollar amount that is included in your cost of goods sold each quarter? Additionally, do you anticipate that amount will increase in 2022 given your expected growth in community count?

It has increased a bit in '21 as we've allocated more resources to some functions within that fixed cost. In the third quarter, it was approximately $38 million. To your point, yes, with lower revenues, as I mentioned earlier, you experience a leverage hit on the reduced revenues as you lose some leverage on that fixed cost that affects the cost of goods sold.

Got it. That's helpful, Jeff. Second, the $7 billion plus revenue guide for next year, I'm curious, first off, what does that assume for cycle times? Does it assume stability from this current level that's extended a bit here? And add on to that one, if I can. Obviously, it sounds like the start pace is keeping up with orders. But just given the challenges that you're seeing throughout the supply chain and the elongation there. Is there any consideration to maybe more significantly slowing that pace of order activity? 6 to 7 sales per community is incredibly strong, and obviously, the demand is there for it, but a lot of your peers have maybe been a little bit more forceful in bringing that sales pace down recently. So I'm curious if there's any consideration to that just to allow things to kind of catch up a little bit?

If we saw signs of further blockage from here in the build times, we would slow it down. And in fact, we did slow it down some in many communities where we opted for price. But as we look at things today, we're now planning for a longer build time. It's extended. We get it. It's baked into our projections and our assumptions. And we have a pretty nice rhythm right now where we're selling homes, starting homes, getting them now through foundation and frame, and we're heading into the second half on a lot of the backlog, so we'll see. But right now, we think we're in a pretty good balance. You don't want to have backlog that you can't get built because your buyers get irritated with that, too. And we're very sensitive to the customer along the way. So if we feel we're putting our customer at risk, we're not going to do that.

My first question is just following up on the cost side of things and inflation. I know you mentioned that you expect peak lumber to roll through in the fiscal fourth quarter. But can you expect the deflation in lumber to start to come through? And how you're thinking about inflation in other building product categories that could potentially somewhat offset that?

Right. Well, the way we lock our cost on starts, any inflation we're seeing in the various cost categories are really more affecting future sales and future backlog as opposed to what we may deliver out, for example, in the first or second quarter of next year. So on balance, what we've been seeing is lumber has been tapering off as some pretty significant improvement in the cost side of things, leading to, obviously, higher gross margins in the backlog on a go forward basis. I don't have a crystal ball, so I'm not exactly sure where first or second quarter input costs are going or labor costs are going. But given the trends that we've seen on the pricing side and even if we maintain just even just a bit of pricing power, I think we'll be able to more than offset any future increases we see, again, with the assumption that the favorable trend in lumber holds. That was a very significant cost category for us, for a whole industry, for the peers. And as that progresses, it's got some really good news, I think, for our margins out into next year. And given that we've locked a lot of those costs for our deliveries in the first half of next year, we're feeling pretty good about directionally where margin is headed.

And then my follow-up question is around pricing. You guided to about 450,000 for the fourth quarter, which is up, I think, about 9% or so versus last year. I know you mentioned in your comments that you're seeing a buyer with a higher FICO score. It sounds like, overall, they're in better financial position. Can you just talk to how you're thinking about price the ability to continue to get that in your various markets? And anything that's kind of changing on the ground around the buyer's receptivity to pricing?

Yes, Susan, as you know, every community in every city has a somewhat different situation regarding inventory, job growth, and population growth. Our buyer profile is predominantly first-time buyers, and they are putting down $60,000 on their homes with an impressive FICO score of 737. This represents the strongest buyer profile we've ever encountered in our first-time buyer segment, indicating significant buying power. Regarding the supply chain issues, they are exacerbating the inventory challenges for consumers rather than alleviating them. Our industry is considerably behind in the number of homes constructed compared to what demographics and demand would warrant, and the ongoing supply chain problems are further restricting new home construction. Given the excess demand relative to the limited supply, we don't anticipate seeing customers who feel they can afford more for some time. Currently, there are no signs indicating otherwise. It's a very strong environment out there.

This is Maggie on for Mike. Following up on the last question. I mean, obviously, the buyers' credit profiles remain strong, and you're saying that affordability hasn't really been an issue to this point. Have you seen any shift in kind of buyer preferences as a result of the recent price depreciation? I think last quarter, you said that you hadn't really seen any buyers adjusting the size of the home, but I'm curious if there's any update there?

Yes. There was no movement at all in the size of the home, and the spend in the studio actually went up a little bit per unit, incrementally $1,000. But the buyers behave in the same way they were last quarter and the quarter before.

And maybe asking kind of an earlier question in a little bit different of a way. You talked about the share repurchase this quarter, and you talked about kind of where you're comfortable going forward from a leverage perspective. But can you elaborate a little on the potential for share repurchase to become a more regular tool that's used?

Yes. Well, if you go back to Jeff's comments to a previous question, what we did in the quarter was take some excess cash that we had and apply it to share repurchases. We spent over $700 million on land acquisition and development. So that would reinforce the first and foremost, we're all about growth. And as we look ahead, our top priority will continue to be to support the profitable growth trajectory and improve our returns. And we also know our leverage ratio will continue to get better as we grow profits, and that will lower your ratio on its own. So first and foremost, we'll be looking at growing the company. If at some point, we again determine we have excess cash, we'll evaluate what to do with it at that time.

I thought the order pace was pretty good. Thanks for that. I don't know if I heard you talk about this, so I apologize if I'm asking this. But when do you think your supply chain challenges stabilized, i.e., you're calling for 11% lower delivery in Q4, do you think the much of the known supply chain issues impact your Q4 the most? Or would early part of 2022 also see some strong headwinds there?

Yes. Well, Deepa, as we shared in our comments, we think we've stabilized the early parts of the construction cycle. There's still a lot of variables and unknowns on the finish side, while we stabilize it, it is at an extended timeframe. So we're now navigating. We're assuming our guide and our projections that build times don't get worse but also don't get better. And I think everybody will have their own crystal ball on how we work through it and we will work through it. But it's going to take some time to get back to where we used to be.

You mentioned some product challenges related to windows and cabinets. Are there any issues we should anticipate worsening before improving around the middle of next year, or do you believe most of these challenges will begin to resolve by the end of this quarter?

It's hard to answer. If you'd have asked me on our last call whether I thought we'd lose a couple more weeks? I would have said no because we already thought that it extended its pretty significant from Q1 to Q2. And we're seeing good signs in some areas, but there's still a lot of unknowns. So I don't know that we're prepared to say things are going to get better right away, and we're hopeful we've taken steps to stabilize, and we'll see how it goes over the next couple of quarters.

I wanted to revisit the fourth quarter margin and inquire about the impact of lumber on your guidance for average selling price. You're showing an increase of about 5% quarter-on-quarter, which seems to be consistent on a per square foot basis as well. Given the rise in revenue per square foot, can you clarify the sequential impact of lumber on your results and how it offsets the revenue improvement?

Mike, providing an exact figure is a bit challenging. There's been considerable variation between the quarters, and the products we're selling in the fourth quarter differ from those in the third. Margins are relatively consistent quarter-over-quarter, with no significant change between the two quarters. We want to highlight that we are aware of the lumber price increases related to the homes we plan to complete and deliver in the fourth quarter. When we started those homes, we experienced peak lumber pricing. This is not only about the outlook for the fourth quarter but also about what lies ahead beyond it. When we provide guidance for quarters, especially in a shorter timeframe, we proceed delivery by delivery, compiling the numbers from the ground up. We've faced many delivery losses due to construction delays and supply chain issues, with some mix impact as well. However, everything we lost in the fourth quarter is expected to return to us in the early part of next year. Thus, we are quite optimistic about margin expansion moving forward, including both gross and operating margins, along with a higher revenue forecast for next year. Beyond this, I prefer not to delve into a detailed quarter-by-quarter analysis for 2022. We will provide more information in January when we report our fourth-quarter results. Typically, we don’t discuss margins during this call; we usually focus on community counts and revenues. However, we wanted to share our observations because the numbers within our backlog and selling gross margins are particularly strong, and we felt it was important to convey that to the market.

Yes, I appreciate that. It makes sense to consider moving into next year, as we already have about 75% of your projected revenues in our backlog, which should indicate strong margins. Regarding the second question about the pace, if you're opening 200 communities and ending next year with 60, that represents around 75% community turnover. Can you share any information about the expectations for the pace of new community openings? Are they expected to remain similar in terms of mix, or should we anticipate any changes as you look ahead to next year and the upcoming projects?

Mike, the 200 is over 5 quarters, not 4. So it's not a 1-year term. It's a little more than that. But in the prepared comments, what we were talking about is not just where we think we'll be at the end of '22. We're positioning the business to continue to grow our community count beyond that into '23. So we have everything owned for '22, most of everything owned and all controlled for '23. So we're comfortable with the guide and we like how we're positioned finally with our community count trajectory.

Right. I'd like to add to that, Mike. When you consider the current pace and what we've observed over the past year while looking ahead, there are two things to note. First, we have replenished many of our communities, giving us a larger inventory of lots moving forward. We're also anticipating fewer closeouts next year compared to 2021, which is helping us increase that count. This isn't due to a significant drop in our projected absorption pace; our primary assumptions remain very solid for the upcoming year. It simply reflects the number of lots available at the start of the year and the substantial number of openings we experienced in 2021, along with new openings planned for next year. I believe we're in a favorable position. This year surprised many of us with an accelerated pace and more closeouts than we expected, but that is positive news. If we're closing out numerous communities and those units are transitioning from available lots to our backlog, it reduces some risk for next year and bolsters our top line and delivery figures. While there may be some pressure on community count as a result, I would prefer to see that pressure rather than having to sell more to meet revenue expectations. We're well-prepared heading not only into the fourth quarter but especially into 2022, which is quite exciting for us.

The first one, pretty impressive decline in the cancellation rate. Just wondering, with the cancels that you are getting, what's the reasoning behind that?

Yes. Jay, it's a mixed bag. It's somebody that got transferred, somebody gets divorced. Occasionally, by remorse, we're not seeing too much of that. We do a pretty good job of screening the buyer before we report the sale. We get a prequal. So we're having very little loan issues as well. So it's a mixed bag that's a small number at the end of the day.

And then the second question, you talked earlier in the call about having the front half of the build cycle completed, and now you're working on the back half. Just wondering if that also includes getting your final inspections or COs, etc.? What type of issues are you seeing on the municipal side? And are those issues improving versus where they were earlier this year?

Yes. Rob, do you want to talk to the inspection side and what we're seeing?

Sure, Jeff. One of the major challenges we're encountering on the inspection side is related to COVID and the Delta variant. This is where we are experiencing unexpected delays. Aside from that, operations are running quite smoothly, and most divisions have solid relationships with local municipalities, which allows us to manage the process effectively. However, there are times when an inspector or a group of inspectors may be exposed and need to stay home for 10 days, which causes some disruptions. Overall, the primary issue is the impacts of COVID rather than the volume of inspections.

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