Good afternoon. My name is John and I'll be your conference operator today. I would like to welcome everyone to the KB Home 2024 Third Quarter Earnings Conference Call. Currently, all participants are in a listen-only mode. Following the company's opening remarks, we will open the lines for questions. Today's conference call is being recorded and will be available for replay at the company's website, kbhome.com through October 24th, 2024. And now I would like to turn the call over to Jill Peters, Senior Vice President, Investor Relations. Thank you, Jill. You may begin.

Thank you, John. Good afternoon, everyone and thank you for joining us today to review our results for the third quarter of fiscal 2024. On the call are Jeff Mezger, Chairman and Chief Executive Officer; Rob McGibney, President and Chief Operating Officer; Jeff Kaminski, Executive Vice President and Chief Financial Officer, 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 in today's press release and in our filings with the Securities and Exchange Commission, actual results could be materially different from those stated or implied in the forward-looking statements. In addition, a reconciliation of the non-GAAP measure of adjusted housing gross profit margin, which excludes inventory-related charges, and any other non-GAAP measure referenced during today's discussion to its most directly comparable GAAP measure can be found in today's press release and on the Investor Relations page of our website at kbhome.com. And with that, here is Jeff Mezger.

Thank you, Jill. Good afternoon, everyone. We achieved double-digit year-over-year growth in revenues and diluted earnings per share in the third quarter. With these results and our expectations for the remainder of this year, we believe we are well positioned to produce about $6.9 billion in revenues in 2024, at a gross margin exceeding 21%. As we work to finish the year strong, we remain focused on growing our community count, maintaining our high levels of customer satisfaction, and executing our personalized Build-to-Order model, offering customers choice and flexibility based on what they value and can afford. As for the details of our results, we generated total revenues of over $1.75 billion and diluted earnings per share of $2.04. We delivered more homes during the quarter than we had anticipated, as cancellation rates remained low and our build times have compressed. Our gross margin was slightly lower than we have seen in the past two quarters at 20.6%, which we will provide some detail on in a moment. Although our operating income margin was within our guided range at 10.8%. Our performance drove our book value per share up 13% year-over-year. Long-term housing market conditions remain positive, supported by an under supply of new and resale homes, solid employment, wage growth, and favorable demographics and household formations. Although resale inventory is rising in certain of our markets, it remains well below historically normalized levels, is very limited at our price points, and days on the market are still low. We generated 3,085 net orders in the third quarter, flat with the year-ago period. Our monthly absorption pace per community of 4.1 homes was in line with our third quarter average over the past decade, although slightly below the 4.3 pace in last year's third quarter. Our cancellation rate remained stable sequentially at a historically low level, indicating a solid pool of buyers ready and able to close on their homes when completed. The desire for homeownership is strong, and we saw evidence of this during the third quarter with higher year-over-year traffic within our communities and increased leads from our digital marketing efforts. That said, buyers were hesitant, as interest rates remained elevated and concerns about a slowing economy increased, and demand began to soften in late June through July. In this environment, we took steps to adjust pricing as necessary to hold our pace. Rates moderated in August and demand strengthened, with our weekly net orders improving sequentially in each of the last three weeks of August. We are encouraged by this positive trend and we continue to see solid sales quarter-to-date in September. With the Federal Reserve lowering interest rates by 50 basis points last week, we believe this will further benefit consumer confidence and affordability. Given the soft comparison in the year-ago fourth quarter, even normal seasonality will produce a strong year-over-year comparison in our 2024 fourth quarter net orders, setting us up with momentum as we enter the new year. And with that, I'll pause for a moment and ask Rob to provide an operational update. Rob?

Thank you, Jeff. I will begin by providing additional color on our net order results. Although traffic increased 8% year-over-year, some buyers hesitated on their purchase decision due to concerns about transacting too early given the uncertainty around interest rates and news headlines fueling an expectation of interest rate cuts by the Federal Reserve. Ultimately, lower mortgage rates do help to stimulate demand, and we saw evidence of this in August, with net orders increasing sequentially week by week, as the month progressed. While buyers are rate sensitive, we believe the primary motivation of most customers is to secure a home that meets their needs at the best price, not the biggest incentive or rate buy down. Understanding this, and considering the price increases we had taken in most of our communities in the first half of this fiscal year, we strategically and selectively adjusted pricing at the community level as needed to stimulate demand and optimize the pace-price balance of each asset, which favorably impacted our net orders in August. Our pricing strategy focuses on offering the best possible price versus continually increasing incentives. Although we achieve the same gross margin by offering a reduction in price or an equivalent dollar value of incentives, buyers care about the price of the home and our teams emphasize the value of the personalized home in the community more than an incentive or mortgage rate. That said, we did continue to utilize mortgage concessions in the third quarter with net orders that had some form of mortgage concession, whether a rate lock or a buy down in the low 60% range, consistent with the past three quarters. We began to reduce the dollar amount of mortgage concessions on our net orders in August in conjunction with the lower prices that I just spoke of, and we expect to be able to lower our use of this incentive in the fourth quarter considering improved affordability levels provided by the recent relief in mortgage rates. As to mortgage concessions on homes delivered in the third quarter, they average just under 2% of housing revenues. We started nearly 3,000 homes in the quarter, ending the quarter with over 7,700 homes in production, including models. Our expectation is to end the year having started roughly 20% more homes in 2024 than we did in 2023. Given our production, backlog, and lower build times, we have returned to more historical levels of converting our backlog to deliveries. Going forward, we plan to continue aligning our starts with sales, which will help keep our production in balance with the majority of those starts already sold. Our build times on homes delivered during the quarter was about 150 days, a two-week improvement sequentially and a factor in delivering more homes in the third quarter than we projected. Going forward, we are focused on continued progress to drive build times down to four months, which is the lower end of our historical range. We reduced cost on our homes started during the third quarter, which were down sequentially in a low single-digit range, helping to offset the impact of pricing changes, incentives, and land costs. The categories where we have seen the biggest changes recently are in lumber and stucco. We are aggressively pursuing additional opportunities to further reduce our direct cost, enhancing affordability and expanding our reach to a wider range of potential customers. Before I wrap up, I will review the credit metrics of our buyers who finance their mortgages through our joint venture KBHS Home Loans. We had a solid year-over-year increase in our capture rate with 88% of the mortgages funded during the quarter having been financed through our joint venture. As compared to 84% in the prior year quarter, higher capture rates help us manage our backlog more effectively and provide more visibility in closings which benefits our company, as well as our buyers. In addition, we see higher customer satisfaction levels from buyers who use KBHS versus other lenders. The average cash down payment was stable both sequentially and year-over-year at 16%, equating to about $77,000. On average, the household income of customers who use KBHS was nearly $133,000, and they had a FICO score of 742. Even with about one-half of our customers purchasing their first home, we are attracting buyers who can qualify for their mortgage while making a significant down payment. As we head into year end, we do so with a continued daily emphasis on maintaining our high customer satisfaction levels, further improving build times, and value engineering our products to lower direct cost. Our objectives remain consistent in increasing our scale, profitability, and returns. We expect to execute on these goals by reinvesting in our growth, opening our communities on time, offering a compelling value proposition to our customers, and optimizing each asset on a community-by-community basis to increase our margins and returns. And with that, I will turn the call back over to Jeff.

Thanks, Rob. During the quarter, we invested $845 million in land acquisition and development, an increase of over 50% year-over-year, with more than $425 million going toward acquiring new land. Year-to-date, we have invested $2.1 billion in acquiring and developing land—more than we spent in all of fiscal 2023. As we continue to accelerate our land investment in 2024, we remain diligent with respect to our underwriting criteria, product strategy, and price points. We increased our lot position 21% year-over-year, ending the quarter with over 69,000 lots owned or controlled, positioning the company for future growth. Overall, we remain focused on capital efficiency, developing lots in smaller phases wherever possible, balancing development with our starts pace to manage our inventory of finished lots. The composition of our land portfolio is strong, aligned with our product and pricing strategy, and provides opportunities for us to gain share in our served markets. In addition to growing our established divisions, we are also beginning to see solid growth in our newest markets, Boise and Charlotte, as well as Seattle, which had its first deliveries only five years ago and is already on the cusp of a top three market share position. These three divisions are a great representation of our geographic expansion strategy, as we can absorb the overhead costs of a new market entry in our existing business and as these new markets mature, they become meaningful contributors to our results. We maintain a balanced approach in allocating our cash, enabling us to meaningfully reinvest in our growth, which remains our top priority, while also returning capital to stockholders. With the $150 million in share repurchases that we completed in our third quarter, the highest quarterly amount this year, we have already achieved the increased level of buybacks for the year that we shared on our last earnings call. We do plan to continue repurchasing our shares in the remainder of this fiscal year and intend for it to be an ongoing part of our capital allocation plans beyond 2024. Since we began repurchasing shares on a regular basis in 2021, we have repurchased more than 24% of the shares then outstanding, accretive to both our diluted earnings per share and return on equity. Over that timeframe, we have returned nearly $1.2 billion in cash to our stockholders, including dividends. In closing, I want to recognize the entire KB Home team for their commitment to serving our home buyers and contributing to our performance in the third quarter. Our company is well-positioned for future growth, as we meaningfully invest in the expansion of our business and diversify our geographic footprint. We have an experienced management team and a business model that provides customers choice and flexibility in purchasing a home that meets their needs and budgets. With about two months remaining in this fiscal year, we are on track to achieve about $6.9 billion in revenues with the highest level of deliveries in many years, which will drive well over $8 in diluted earnings per share representing significant year-over-year growth. This increase in scale and profitability, together with the favorable impact of share repurchases, will contribute to a return on equity of around 16.5%. As we look ahead to fiscal 2025, our initial guidance for revenue next year is about $7.5 billion. We are committed to enhancing stockholder value by profitably expanding our volume, driving higher returns as well as continuing to return cash to stockholders through both share repurchases and our quarterly dividend. 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 2024 third quarter and provide our current outlook for the fourth quarter and full year. We are pleased with our execution during the third quarter, as our housing revenues increased 11% compared to the prior year and reached the high-end of our guidance range. Combined with our healthy operating margin of nearly 11%, we generated robust cash flow that enabled us in the quarter to invest approximately $845 million in land and development and returned roughly $168 million to our stockholders through share repurchases and our quarterly dividend. Our housing revenues grew to $1.75 billion for the quarter compared to $1.57 billion for the prior year period. The growth in our overall housing revenue was driven by increases of 8% in the number of homes delivered and 3% in their overall average selling price. Our third quarter deliveries of 3,631 represented a backlog conversion rate of 58%, a significant improvement from 46% in the year earlier period. Our current quarterly delivery performance was favorably impacted by continued improvements in construction cycle time and lower cancellation rates. We anticipate these factors will also benefit our fourth quarter deliveries and have considered them in our guidance. Based on our current backlog and expected construction cycle times, we project our 2024 fourth quarter housing revenues will be in the range of $1.94 billion to $2.04 billion. In the third quarter, our overall average selling price of homes delivered was approximately $481,000, up from approximately $466,000 in the prior year period. This increase primarily reflected a mix shift in homes delivered towards our high-priced West Coast region. Looking ahead to the fourth quarter, we are projecting a year-over-year increase of $23,000 in the overall average selling price to approximately $510,000 mainly driven as in the third quarter, by an expected higher proportion of deliveries from our West Coast region. Our homebuilding operating income for the third quarter increased to $189 million as compared to $179 million for the year earlier period. Operating income margin of 10.8% compared to 11.3% in the prior year. For the fourth quarter, we expect improvements in both our housing gross margin and SG&A expense ratio to drive expansion in our homebuilding operating income margin to the range of 11.4% to 11.8%, assuming no inventory-related charges, representing both a sequential and year-over-year improvement. Our housing gross profit margin for the quarter was 20.6%, as compared to 21.5% for the prior year period. The margin result relative to the prior year was primarily due to product and geographic mix shift of homes delivered, along with other factors, including the impact of pricing adjustments to support demand, partly offset by reduced total home buyer incentives. The mix impact mainly resulted from a higher percentage of revenues in the West Coast region with gross margins below the company average. Excluding inventory-related charges of $1.2 million in the quarter and $0.6 million a year ago, our margin of 20.7% for the quarter was down 80 basis points year-over-year. We expect to see a sequential improvement in our fourth quarter gross margin. Assuming no inventory-related charges, we believe our fourth quarter housing gross profit margin will be in the range of 21% to 21.4%. Our selling, general and administrative expense ratio of 9.8% for the quarter improved by 40 basis points as compared to 10.2% in the prior year, primarily due to increased operating leverage from higher housing revenues. Supported by another expected sequential increase in quarterly housing revenues, we believe our SG&A expense ratio will further improve in the fourth quarter to approximately 9.6%. Our income tax expense for the third quarter of $50.1 million represented an effective tax rate of 24.2% compared to 22.9% for the prior year period. We expect our effective tax rate for the 2024 fourth quarter to be approximately 24%. Overall, we reported net income for the third quarter of $157.3 million or $2.04 per diluted share compared to $149.9 million or $1.80 per diluted share for the prior year period. The 13% increase in our diluted earnings per share reflected higher earnings as well as the stock repurchases we have completed over the past several quarters. Turning now to community count. Our third quarter average of 251 increased 5% from the year earlier quarter. We ended the quarter with 254 communities open for sales, up 10% as compared to 230 communities at the end of the 2023 third quarter. We still believe our 2024 year-end community count will be in the range of 250 to 255 resulting in a 7% to 8% increase in the fourth quarter average community count. As Jeff mentioned, we invested $845 million in land and development during the third quarter, a significant increase from the same quarter of the prior year. 50% of the current quarter investment represented new land acquisitions contributing to the growth in our land pipeline to over 69,000 lots at quarter end, of which 58% were owned and 42% were under contract. At quarter end, we had total liquidity of $1.46 billion, including $375 million of cash and $1.08 billion available under our unsecured revolving credit facility with no cash borrowings outstanding. During the third quarter, in addition to significantly increasing our land investments, we repurchased roughly 1.9 million shares of our common stock, at a total cost of $150 million, while maintaining our historic low leverage ratio of 29.8%. With $800 million remaining under our current common stock repurchase authorization, we intend to continue to repurchase shares with the pace, volume and timing based on considerations of our operating cash flow, liquidity outlook, land investment opportunities and needs, the market price of our shares in the housing market and general economic environments. Year-to-date, we have repurchased 3.46 million shares at an average cost of $72.24 per share, helping to drive an improvement in our expected full year return on equity to approximately 16.5%. In summary, we are pleased with our solid third quarter financial performance and operational execution and believe we are well-positioned to both achieve our goals for the 2024 fourth quarter and drive higher housing revenues in 2025. Using the midpoints of our fourth quarter guidance, we expect full year housing revenues of approximately $6.9 billion, with an operating income margin of over 11%, exceeding both our 2023 results and our initial expectations for 2024 as shared during our January earnings call. As Jeff mentioned, we also expect growth in our 2025 housing revenues reaching approximately $7.5 billion. We believe our ongoing focus on accelerating profitable growth and expanding our returns by leveraging our larger scale, strong community portfolio and uniquely compelling Build-to-Order business model will produce measurable expansion in our book value per share and enhance long-term stockholder value. We will now take your questions. John, please open the lines.

Thank you. We will now begin the question-and-answer session. The first question is from Matthew Bouley with Barclays. Please go ahead with your question.

Good afternoon everyone. Thank you for taking the questions. Maybe I'll start on that $7.5 billion revenue outlook for 2025; I see if we can unpack that a little bit. It sounds like you're talking to an ASP of around $510,000 here in Q4 due to mix but I'm not sure if we should really draw that into next year. So I guess we talk about $7.5 billion, is this going to be more kind of volume driven, price driven? And I guess how does the community growth sort of play into that volume side? Thank you.

Yes. On a high level, Matt, we decided to provide some high-level guidance this quarter. We believe our community count, our backlog, our starts, our absorption assumptions all support our estimate of the $7.5 billion. Given where we're at today economically and particularly with some of the uncertainty around what the Fed actions will be for the rest of the year, the election results, the macroeconomic, geopolitical, et cetera, we decided to keep it very high level and really keep our guidance really only that top-line number. So at this point in time, we are not going to provide a lot of detail or dive into some of the components of it. As typical you see pretty much all the above, usually when you are driving volume from the point of view of absorption, growth, community count and price, probably fair to assume the same for next year, but we're going to wait till we come back to you guys in January and discuss all of our key metrics and guidance and expectations at that point in time like we normally do.

Thank you for that, Jeff. You mentioned your strategy of focusing on adjusting home prices instead of significantly changing incentives. Now that mortgage rates are lower compared to a few months ago, I'm curious about your approach in this lower rate environment. It seems like you might pull back a bit on mortgage concessions in Q4. What can we expect regarding home prices? How did the trend shift in August as demand began to improve? Is there a possibility of adjusting home prices upward given the current rates, or is it too soon for that? Any insights on how you plan to navigate this lower rate environment would be appreciated. Thank you.

Rob, do you want to take that?

Sure. So obviously, lower rates are good for us. They're good for the consumer, for our buyer. Affordability has been a big challenge. Rates have been a big piece of that. So we're certainly happy to see them come down, as we mentioned in our prepared remarks. We are focused on selling the home and the value of that home versus just who can offer the biggest buy down and the biggest mortgage incentive. And we put that in play throughout the quarter. June started off fairly strong from a sales perspective, and then it got weaker as we move through the latter part of June, a little weaker still in July, and better in August. And as we've done that, as the market was weakening, we found the need to lower prices in some of our communities to drive pace and to optimize that asset. At the same time, we had others where we were lifting price again. So it really just gets to managing each asset individually and what that buyer needs or what that community needs to hit the volume levels that we're pursuing to optimize each of those assets. But certainly, as rates come down and if they continue to come down, we expect to be able to lower our incentives and do that without having to further lower revenue, which should expand our overall gross margins on orders.

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

Thank you very much, everyone. I want to follow up on Matthew's question. That $7.5 billion figure is very encouraging and suggests that there could be at least 15,000 closings. You've mentioned absorptions, and I want to clarify the relationship between absorptions and community count going forward. Do you believe there is room for growth in your absorptions from the current level? Regarding community count, it seems it will be relatively stable in the next few months. When do you expect to see a change in community count? Is it coming soon, or do you anticipate it will happen by the end of next year?

Yes, as we mentioned, we are not going to provide too many specifics about our outlook for next year. I wanted to share the top-line target for the company and inform you of our direction. A lot will unfold in the coming months due to the macroeconomic environment and particularly as we move through the election cycle. We are hopeful for a robust spring selling season. Regarding absorptions, there is certainly room for improvement in that area. As we have discussed extensively in recent quarters, we are not an incentive-based company. However, we have had to offer some incentives on mortgage rates, more than we prefer. As demand conditions improve and mortgage rates ideally decrease, we anticipate less need for such incentives, which we believe will drive demand into next year. Personally, I don’t have a crystal ball, but with a lower interest rate environment and given that consumers are more accustomed to higher rates over the past couple of years, we expect a strong spring selling season under the right circumstances. That said, we still have a lot to address before reaching that stage. Therefore, we are holding back on many details until we gain greater visibility into the macro situation, but we wanted to give you an overview of next year. We appreciate your understanding regarding the lack of details at this moment. As mentioned, we will provide much more information in January and follow up with you then.

It’s encouraging to see that your revenues are higher than many expected, and it's good to know you're aiming for that level while identifying internal opportunities. Looking at your operating margin from a long-term perspective, it seems like many of the past challenges, such as the Mothball communities and interest expenses impacting the cost of goods sold, are now largely behind you. I’m curious if the potential for your long-term operating margin is significantly greater than the current level of around 11%. Can you share your thoughts on what you believe is a suitable long-term operating margin range for the company?

Sure. I’ll speak qualitatively on this. We are concentrating on expanding our scale by gaining market share and increasing our community count, while also anticipating some market growth through improved affordability for consumers. With the added scale, we see potential for an increase in operating margin. We've maintained a SG&A ratio above 10% for several quarters, which we believe is sustainable with a stronger top-line. Considering that our margins have trended where they have over the past year, and given the numerous incentives we've provided, even a slight reduction in incentives at our current price points could positively impact gross margin. While I won't provide specific guidance for next year's operating margin, I believe there is room for improvement, and it remains a goal for the company. We will assess whether we can achieve this based on the macroeconomic environment.

Thank you. And the next question comes from the line of John Lovallo with UBS. Please proceed with your question.

Hi guys. Thanks for taking my questions as well. I know you gave some of the factors on the gross margin, but I'm just curious in the quarter, the 20.7% relative to the 21.4% outlook. Just maybe if you could just kind of bucket those a little bit, help us understand what the delta was there. And then along the same lines, what's the driver of that sequential increase as we move into the fourth quarter, please?

Yes. Yes. Both very good questions. So on the quarter itself relative to guidance, as I mentioned in the prepared remarks, a lot of it was just driven by the West Coast mix in the quarter. Virtually all of the upside that we had on the top-line relative to the midpoint of our guidance came from our West Coast business. And currently, that business is carrying margins lower than the company average. So that was a little bit of a drag on the percent margin that we had for the quarter in dollar terms. Obviously, it was nice to have it. The other two factors that I mentioned was pricing was a negative. So we did see some price moves. But on the positive side, total incentives total homebuyer concessions in the quarter were actually a little bit favorable. So those three factors were really the drivers, but the largest of the three as far as the guidance miss was the West Coast mix. When you look at it sequentially, we will have some additional West Coast deliveries and revenues in the fourth quarter, but the delta won't be as high as it was, especially on a year-over-year basis as it was in the third quarter. So there will be a little bit of drag there. But on the upside, we are also looking at the West Coast margins improving between third quarter and fourth quarter. So there'll be a little less going into it. And as always, I mean, we guide margins based on a very detailed forecast. So we started actually with our backlog, which is actually house by house, it gets rolled up to community, gets rolled up to a division and gets consolidated. So the vast majority of our deliveries in the quarter are already on the books with known pricing and known costs. The swing factor often for us is just which homes get closed. So what does the mix factor look like in the quarter? And also, we typically run about 20% of quarterly deliveries that are sold and closed in the same quarter. So those are obviously just estimates that we have to do at the beginning of the quarter. But that sequential improvement looks pretty solid to us at this point, and we'll see how the quarter progresses and see where we get our deliveries, but we are pretty confident in the guidance numbers that we provided.

Okay, that's really helpful. Some of the cautious feedback we're receiving is that, while interest rates are decreasing, it's not a new issue that existing home inventory will re-enter the market. We're already noticing builders are facing lower than anticipated gross margins due to this challenge. However, you suggest that existing home inventories are mostly stable, with some markets seeing an uptick, and you expect to reduce incentives as rates go down. I want to ensure I fully understand your perspective on this and how you perceive the dynamic of existing home inventory returning in certain markets.

John, I believe you expressed it correctly. If there is more resale inventory, it will benefit the overall housing market. Many people are unable to move up because there isn't enough product available, or they are reluctant to sell their current homes even though they need to move up. If inventory increases slightly, it would help unlock what we refer to as the housing food chain. As I mentioned earlier, the days on the market remain quite favorable. Although inventory is rising, it is clearing fairly quickly in most markets. It's important to analyze each submarket within every city. Despite headlines about price reductions and increasing inventory, these trends are mainly seen in higher-priced submarkets rather than those where we operate. In the more affordable categories we focus on, inventory remains quite limited. Therefore, we believe we are well-positioned to compete favorably as resale opportunities increase.

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

Hi everyone. I'm filling in for Mike. Thank you for taking my questions. I wanted to follow up on the recent NAR settlement and ask if there are any changes you are planning to implement with brokers, and whether there are any notable impacts from those changes. I would also like to hear your general thoughts on brokers.

It is still very early in the process. And like everyone else, we are watching the movements and trying to come up with whatever our strategy would be. But Rob, why don't you share what we're seeing right now?

Yes, it is indeed a process that is currently in transition. We believe it will continue to evolve over time, and we are noticing that the pace of this evolution is quickening since buyers are now required to sign agreements with their realtors that outline the compensation terms. Recently, we have encountered some interesting scenarios where buyers didn’t fully understand the agreements they signed. Additionally, some customers have expressed that they opted not to work with realtors because they did not want to be responsible for the commission. We are now engaging directly with these buyers through our team. We value our relationships with realtors and appreciate the business they bring us, especially if they are the procuring cause of a sale. However, the commission adds a significant cost to the home, affecting affordability, and we are committed to reducing any unnecessary expenses. One change we have implemented is requiring buyers to show us their compensation agreement with their realtor, which typically means we pay up to 2%, or a flat fee depending on what the agreement stipulates. This situation remains fluid, and we will adapt our strategy as we learn more. Our primary focus is to connect with buyers directly through digital marketing, our website, and other advertising efforts, providing a simple home purchasing process. Notably, in Q3, we observed that realtor participation decreased by about 5 percentage points, though we are unsure if this is directly linked to the NAR settlement or simply fluctuations in the numbers. We will continue to monitor this closely.

Thanks. That was very thorough and helpful. Maybe moving on to kind of your build cycle times having somewhat normalized recently. Do you think maybe there's an opportunity to bring those cycle times lower than your historical average over time?

Yes, definitely. We still have a bit more to go to reach the lower end of our historical average, which is about another 30 days. However, many of our divisions are currently building at times lower than that. Some are in the 110-day range. Other divisions have less available labor, resulting in slower progress. We have programs in place aimed at continuing to accelerate these build times. This is crucial for us, especially when it comes to managing our deliveries from future quarters and our return ratios. It's definitely a focus area for us and an opportunity. If we can bring those divisions that are lagging closer to our company average, we will be much nearer to that four-month timeframe. I remember during a past period in Vegas, we managed to build houses in about 90 days from sale to close. That might be an ambitious target, but we will strive to achieve what we can.

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

Hi guys, good afternoon. Thanks for all the details so far. First, I guess, Jeff K, on the '25 outlook, and I'm going to be very careful not to ask you to parse it too finely. Your message was clear. But one of the things that you mentioned that gives you the confidence in growth next year, you pointed to your backlog and kind of the homes under production. And I just want to make sure I'm thinking about this right because on a year-over-year basis, your backlog has been pretty consistently down roughly 15%. I believe the homes under production number you gave was roughly flat year-over-year. So I'm just trying to figure out, like from a spec mix standpoint, you came into this year building more specs and that allowed you to grow closings even though your backlog was lower. Should we expect an incremental increase in spec building ahead of next spring given your optimism there? Or are you just taking a forward view of what demand is going to be in the spring and given your improving cycle times are confident that you can get those homes built and delivered and hit that closing target?

Yes, you said it the right way. I should have actually combined that cycle time with the backlog in that comment because that's a pretty important factor for us, and the improving cycle time has been a big generator and a nice increment on our revenues. But yes, it's our forward look of where we expect things to go based on all the starts plans and what we expect to see going into the spring.

Got it. Okay. That's helpful. And then second question, kind of on the balance sheet, asset efficiency side. You guys have done a really great job with the capital allocation, buying back stock. And as I look at your cash balance today and the cash flow year-to-date, you're roughly breakeven on a free cash basis. Your option share of land has increased, but the owned supply is still kind of sitting three years to four years, which is similar to where it's been of late. So how should we think about your free cash generation going forward? Other builders have kind of set a target of roughly 100% conversion earnings to cash flow. I'm assuming fourth quarter will be a solid cash generation quarter for you guys, but it would seem like in order to get to that 100% number or something close, you would need to see that your supply of owned land move closer to maybe one or two years where some other builders are.

We primarily focus on asset efficiency through inventory turnover. Our company operates at a high pace in terms of absorption, often ranking among the best in the industry for turning inventory once our communities are operational. This is our main goal regarding asset efficiency, which can lead to significant cash generation. The reduction in build times has been a substantial cash driver for our business, and as Rob pointed out earlier, we believe there's still considerable opportunity to generate additional cash going forward. That is our primary focus. Additionally, if we can achieve operating margin expansion, that would be an added benefit. Land monetization is crucial for us; it is a significant cash driver, and we will continue to allocate capital judiciously based on our projections for cash flow and our balance sheet. One advantage for us is that we can prioritize what I would call shareholder-friendly capital allocation, especially given the robust state of our balance sheet today, which has never been better in terms of leverage. This is also a significant positive factor for us.

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

Hi, good afternoon. Thanks for taking my question. First, you mentioned that direct costs have decreased a bit and there are some opportunities. Can you discuss the outlook for direct costs going forward? Also, what are your observations on land inflation at this time?

Rob, that's right up your alley.

Okay. So yes, we've driven direct costs down sequentially. I still think on Direct, some of it's going to be based on market conditions and how busy our suppliers and our trade partners are. But I think we've got opportunities to continue driving it down. It may not necessarily come from simple things like rebidding, but we've got initiatives going on throughout the company in an effort to get to better affordability for our buyers of driving costs out of those homes, whether it is the elevation, the look at the outside of the home, whether that's simplifying the options that we offer that we've been working on. It is an ongoing process, and we are seeing a relief in cost from that. And just value engineering the projects. We've got San Antonio, for example, as we are trying to get to a more affordable price point, we're introducing new models with they're a little less elevated and more simplified in terms of their box-on-box type construction, getting rid of offsets and overhangs and things like that. So real opportunity that we are continuing to drive there that I expect to see more cost decreases on the direct cost side coming. And of course, we'll take everything the market will give us as well in terms of rebidding and just negotiating lower cost. I'm sorry, what was the question on land?

Just what you're seeing in terms of land cost today, what level of inflation and how has it changed?

There is an ongoing land grab in most of our markets, which puts pressure on both the raw land and development costs. I would say that these aspects have generally slowed down and stabilized compared to what we experienced in 2022 and 2023. Regarding land costs, we see higher overall lot costs. While this may not necessarily represent an increase as a percentage of our revenue, we are incorporating it into all of our underwriting. We are only pursuing deals that make sense for us. As land costs rise, something else will have to decrease, whether that’s directly related or not. We are focused on ensuring that every deal we undertake meets our underwriting criteria, and we feel confident about our portfolio and the process moving forward.

And then second question is just where is your spec versus BTO mix right now? And how do we think about the margin differential between the two segments?

In terms of sales, it's currently about 60-40, and we anticipate that will likely revert to a more historical range which has been closer to 80-20. We observe a decline in sales, but we achieve higher margins when selling a build-to-order home that customers personalize for themselves, which is why we aim to maintain that ratio around 80-20. Our primary focus remains on selling personalized homes, and we will continue with that approach.

Thank you. Our next question comes from the line of Trevor Allinson with Wolfe Research. Please proceed with your question.

Hi, good afternoon and thank you for taking my questions. I want to follow up on Alan's question regarding your land-bank. Your option lot percentage has really increased over the last couple of quarters. Is that due to timing, or has there been a different approach? Do you expect it to remain at these higher levels, or will it move back towards the 25% option level you have recently maintained?

Trevor, Rob touched on the fact that most of the markets we are in land is very competitive. And you'd love to buy every deal on a rolling option in some markets you can do it and some you can't. We have been successful with a lot of our bulk purchases going to a phased takedown where you may buy half of it today and half of it 18 months out. And as you look at our percentage movement, as we are investing more in our growth I would say it's all of the above. We are seeing more option deals. We're seeing more phased takedowns, we're also buying some deals both within it. And I think over time, you'll see the option percentage go up a little more from where it is today. But our primary mission right now is to create a bigger growth platform and capture the business that we can and grow our share.

Yes, makes a lot of sense. And then a second question on geography. Clearly, Florida and Texas have gotten a lot of attention in the last few months from an order standpoint. It looks like the central was maybe a little bit softer for you guys sequentially, but the Southeast was improved relative to the overall company average, it only moved down modestly quarter-over-quarter. Can you talk about how Florida and Texas demand trended throughout the quarter and how that compares to your business overall? Thanks.

Rob?

Yes, it was a little – we talked about the resale and inventory. Just to give you an example, we've got – it really is market by market. I look at a division like Jacksonville, where the resale inventory, it's about 5.5 months of supply now, which is approaching the longer-term historical average, and it's up more than two months year-over-year. So there is more pressure on there from resales. And I think that was a factor Orlando is similar, some of the Florida markets that we've got. So as we looked at the moves that we needed to make to lift our sales pace, those were some of the areas that we did lower prices in. And we've seen that those have been fairly effective and sales have bounced back in August. Texas, I would say, is similar, really different if you go from Austin to San Antonio as far as buyer profile and price point. But both of those markets, too, we've seen resale inventory start to climb back up. It is become a bigger competitor, and we've taken a similar approach there. We've taken steps to find the market. Some of that included lowering prices in certain communities. And then again, saw it come back, and we're pleased with where things headed in August, with sales improving each week of the month and continuing on into September. As we look at early September, we are also seeing really strong activity on our leads and traffic. So it gives us good optimism here as we look through the fourth quarter.

Thank you. Our next question comes from the line of Jade Rahmani with KBW. Please proceed with your question.

Thank you very much. Absorption pace dipped to 4.1%. Could you just comment on what your target is and what you're expecting, say, for next year?

Sure. I could have addressed Stephen's question earlier. Thank you for asking. If we reflect on 2022, when the markets were very strong in the early part of the year, we were seeing growth around 6% to 6.5% per month during the spring. This demonstrates our strategy to optimize our assets by balancing pricing and pace. Over time, we found that maintaining a minimum of about 4% per month is essential. Therefore, we take the necessary steps to reach that 4%. If we have a large lot position in a submarket that can be easily replenished, we may allow it to exceed 6%, even going up to 7% or 8%, as we've done in some communities. As we assess this year, we are managing considerable fluctuations in market demand and are likely to stay around 4% a month based on our current situation and future outlook. However, that 4% is not a ceiling; it's the minimum. If the markets improve, we would expect to rise above that 4%. Our stated range is an average of 4% to 6%, but each community has its own unique circumstances.

Thank you very much. And honing in on California, how would you characterize the demand trends you saw in the quarter since that's your largest market?

Rob, do you want to handle that?

Yes. California has been strong for us. Southern California has done really well. Inland Empire has been one of our strongest divisions in terms of sales. They kept on chugging in Q3 overall, pleased with our demand in California and continues to do very well. I don't have a lot to add to that. It's been a good story for us.

Thank you. And our final question comes from the line of Susan Maklari with Goldman Sachs. Please proceed with your question.

Thank you and thank you for taking the questions. My first question is around buyer sentiment. The election, housing has gotten a lot more attention from both of these candidates? Do you think that, that's having an effect on people's decision-making process and their willingness to perhaps step into the market today?

Well, it's pleasing, Susan, to hear both sides talking about doing things to help housing. That's encouraging for us. Our industry continues to under-build. We have real affordability issues that we're navigating as an industry and anything that they can do would be a help. So that would be a good thing. And whatever they do, it will still take some time to catch up if we ever catch up, frankly, because there are some structural things that we're dealing with. The consumer has a lot of triggers when they make a home buying decision. Most of them are life-changing, whether it's getting married, having a baby, relocating promotion, demotion all those things, retire. All those things drive the need to change your home ownership. And all those have been going on all year. So I think there was a pause because interest rates stuck, everybody thought they were at a peak and sooner or later the Fed would move and they now have. And as interest rates slid, we saw almost an instant reaction out of the consumer where in the month of August, leads went up, traffic went up, visits to the community. Everything was very favorable. And I think that's just the human nature of things, not necessarily somebody's platform for what they're going to do for housing. But I think it is something, if either side does something, I think it will be helpful, but I don't think that's the principal driver right now with the decisions being made.

Yes. Okay. That's helpful color. And then just one last question on the design studios. As we move through the quarter and you saw the movements on the demand side and thinking about the outlook for the fourth quarter and even into next year. Any changes in the options and things that people are picking there and the amount that they're spending in the design studios?

It's been pretty static. But we keep sharing that the buyers are spending what they're spending and the percentage on the price really hasn't moved in a couple of years.

Thank you. And ladies and gentlemen, that does conclude the question-and-answer session, and this also concludes today's teleconference. Thank you for your participation. You may now disconnect your lines.