Kb Home Q2 FY2025 Earnings Call

Good afternoon. My name is Julian, and I will be your conference operator for today. I would like to welcome everyone to the KB Home 2025 Second Quarter Earnings Conference Call. This conference call is being recorded, and a replay will be accessible on the KB Home website until July 23, 2025. I will now turn the call over to Jill Peters, Senior Vice President of Investor Relations. Jill, you may begin.

Thank you, Julian. Good afternoon, everyone, and thank you for joining us today to review our results for the second quarter of fiscal 2025. On the call are Jeff Mezger, Chairman and Chief Executive Officer; Rob McGibney, President and Chief Operating Officer; Rob Dillard, Executive Vice President and Chief Financial Officer; Bill Hollinger, Senior Vice President and Chief Accounting Officer; and Thad Johnson, Senior Vice President and Treasurer. During this call, items will be discussed that are considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future results, and the company does not undertake any obligation to update them. Due to various factors, including those detailed in today's press release and in our filings with the Securities and Exchange Commission, actual results could be materially different from those stated or implied in the forward-looking statements. In addition, a reconciliation of the non-GAAP measure of adjusted housing gross profit margin, which excludes inventory-related charges and any other non-GAAP measures referenced during today's discussion to its most directly comparable GAAP measure can be found in today's press release and/or on the Investor Relations page of our website at kbhome.com. And with that, here is Jeff Mezger.

Thank you, Jill, and good afternoon, everyone. We delivered solid financial results in the second quarter that met or exceeded our guidance ranges across our metrics as we continue to navigate the current environment. With a healthy balance sheet, our financial position and flexibility are strong. We are returning an increasing amount of cash to our shareholders, having repurchased $200 million of our shares in the second quarter. Operationally, we continue to strengthen our business by further reducing our build times and lowering our direct costs. As to market conditions, while longer term, the outlook for the housing market remains favorable, driven by demographics and an undersupply of homes, consumers are continuing to demonstrate a lack of confidence about the short term, which has impacted their home purchase decisions. Affordability challenges have persisted, compounded by the variability in mortgage interest rates, which remain elevated, as well as macroeconomic and geopolitical uncertainty. These factors resulted in a more subdued demand during the spring selling season. As a result of the softer environment, we are revising our guidance for fiscal 2025. As to the details of our results, we produced total revenues of $1.5 billion and diluted earnings per share of $1.50 in our second quarter. We exceeded our delivery expectations, driven primarily by faster build times, which improved sequentially by 7 days and are now back to pre-pandemic levels. We achieved a gross margin of 19.7%, and excluding inventory-related charges, above our guidance range. With a focus on prudently managing our costs, our SG&A was at the low end of our guided range at 10.7% and contributing to an operating income margin of 9%. We increased our book value per share to nearly $59, a 10% year-over-year increase. We generated 3,460 net orders in the second quarter. The actions we began to take late in our 2025 first quarter, evaluating base pricing in every community relative to local market conditions, then repositioning our communities with a focus on offering the most compelling value led to strong net orders in March. However, our net orders declined in April and May, which did not follow the typical spring trajectory. As a result, even though our average community count was in line with our projection and our cancellation rate was fairly steady, our monthly absorption pace per community was 4.5 net orders compared to 5.5 in last year's second quarter. While our net order pace was below our internal goal, we believe it ranks high among the large production homebuilders. Our focus is on optimizing our assets to generate the highest returns, balancing pace and price on a community-by-community basis. In stronger market conditions, we believe this will yield an annual average absorption pace of about 5 net orders per month per community as we would increase price to maximize margins, rather than run our communities any faster. When the market slows, we would expect the pace of roughly 4 net orders per month per community. This is not a fixed approach; it allows for flexibility to adjust to changing market conditions as we determine the appropriate pace to achieve the best possible returns. For example, reducing base prices late in our first quarter at the start of the strongest selling period of the year optimizes our assets. Doing so in the fourth quarter, when demand is typically more inelastic and speculative builders are competing to finish their fiscal years, is not the optimal way to manage our assets. The incremental volume in that context tends to be minimal and comes at a great cost to our margins. Finding the right balance comes from adjusting prices to maintain or increase our absorption pace so that each community has the appropriate selling cadence while maximizing margins, returns, and cash flow. Market conditions change over time. And when resale inventory was lower over the past few years, we started more speculative homes, which shifted our business away from our historical mix of between 70% and 75% built to order. As we continue to sell through our inventory, our goal is to steer our business back to this historical range of built-to-order homes over time. It is our core competency and a key differentiator from a competitive standpoint setting us apart from the other large production homebuilders. More importantly, from a consumer standpoint, it offers buyers choice with features we know they value based on our survey data. Our buyers can significantly influence their final sales price as they personalize their choice of lot, elevation, and design studio selections, aligning their monthly payment with their budget. Our studios also contribute to our high customer satisfaction scores as buyers draw value from that aspect of our process and they enhance our gross margins. As our build-to-order mix grows, we believe it will drive a higher gross margin for our company over time. Before I turn the call over to Rob McGibney, let me spend a moment addressing our lower guidance for 2025. With market conditions having softened and taking our net order results from the first half of this year into consideration, resetting our revenue expectation is appropriate. Rob will provide additional details on how we expect to achieve the new range of between $6.3 billion and $6.5 billion. We anticipate the lower top line will contribute to lower margins, although we continue to pursue additional improvements in build times and direct costs, and we are rightsizing our overhead structure to align with our lower volume this year. Let me pause here for a moment and ask Rob to provide more details on our sales as well as an operational update. Rob?

Thank you, Jeff. Operationally, our divisions are executing well on the fundamentals, maintaining our high customer satisfaction levels, further improving build times, lowering our direct costs and balancing pace and price to optimize each asset. We exceeded our anticipated deliveries in the second quarter. One example of our solid execution had a positive impact on our financial results for the quarter. With respect to sales on our last earnings conference call, we had outlined the actions that we had begun to take in February to reposition our communities. We simplified our sales approach to provide what our buyers want, which is securing a home that meets their needs at the best possible price. Our strategy focuses on delivering the most compelling value and improving affordability with transparency. Rather than relying on incentives, we focused on adjusting base pricing and consumers responded. Three weeks into March, we had achieved solid weekly net orders with an absorption pace that was approaching seasonally normalized levels. Moving into April, consumers grew increasingly apprehensive about the economy and rising geopolitical tensions, driving consumer confidence to a 13-year low. As a result, the housing market cooled. In response, we proactively adjusted base pricing in our underperforming communities to remain aligned with local market dynamics, including rising resale inventory and softening home prices in some markets. Despite these actions, demand weakened. We believe this was due not only to the lack of consumer confidence but also to mortgage interest rates, which edged up in early April and remain high and variable for the balance of the quarter. In addition to these broader macroeconomic factors, we encountered municipal delays in final utility sign-offs and certificates of occupancy for model homes that impacted the timing of a number of our planned community openings. While these issues were relatively minor in nature, largely driven by local municipal staffing shortages and administrative bottlenecks, they shifted some of our grand openings to later in the second quarter or into our third quarter, which in turn impacted our net orders in the second quarter. For the full quarter, our average absorption pace was 4.5 net orders per month per community, a good result in this environment, although below our targeted range for the spring. At quarter end, we had 253 active communities, up 2% year-over-year and within our guided range, contributing to an average of 254, an increase of 5% compared to the prior year period. We are further strengthening our community opening process by enhancing coordination with municipal stakeholders to improve visibility and responsiveness, helping us better anticipate and navigate potential delays going forward. We continue to expect to maintain roughly 250 active communities for the remainder of fiscal 2025. Our backlog at the end of May was 4,776 homes valued at $2.3 billion. We maintained a normalized cancellation rate during the quarter, indicating that buyers are ready and able to close on their homes. While our backlog is lower year-over-year, our build times are 20% faster than the prior year quarter. This allows us to sell built-to-order homes later in the year while still achieving a year-end closing. Our updated fiscal 2025 revenue expectation now implies about 13,200 deliveries, using round numbers for simplicity, that means we have roughly 7,300 homes left to deliver. With approximately 4,800 homes in backlog as of the end of May, we need to sell about 2,500 homes to achieve our planned deliveries for this year. These homes will come from a portion of built-to-order homes that are sold early in our 2025 third quarter as well as inventory homes sold through October. We have nearly 2,800 unsold homes in production, inclusive of deliverable models. Based on this detailed mapping of our projected 2025 deliveries and the visibility we have for the remaining two quarters of the year, we believe our target is reasonable. Overall, our build times measured in calendar days improved sequentially in the second quarter by another 7 days to 140 days, which contributed to our beat on deliveries. For build-to-order homes, our build times are currently 132 days. We have returned to pre-pandemic levels, and this progress moves us closer to our goal of 120 days from start to home completion, which is at the lower end of our historical range. Several of our divisions are already building homes at this target level, and we are confident in our ability to achieve this goal company-wide. The benefits of lower build times are numerous, including a more compelling selling proposition for customers purchasing a build-to-order home relative to the 60 days it typically takes to complete an existing or speculative home purchase. Better inventory turns and monetizing our assets quicker. We are continuing to rely on our long-standing trade relationships with our even flow production to ensure that we have the crews necessary to get our homes built. Our value engineering and studio simplification efforts, in addition to an enhanced focus on costs contributed to direct costs that were 3.2% lower year-over-year on our homes started during the second quarter helping to offset the impact of our price reductions and increases in land cost. The homes that we started in May came in at the lowest cost per square foot year-to-date, as our divisions are continuing to drive better performance on costs. Our costs, including lumber, are protected for almost all of our third quarter starts under the terms of our supply contracts. Our national purchasing team, working with our divisions has done an excellent job holding off tariff-related cost increases with only two minor price increases to date. Before I wrap up, I will review the credit profile of our buyers who finance their mortgages through our joint venture, KBHS Home Loans. We maintained our high capture rate with 88% of buyers who finance their homes using KBHS. 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 our JV versus other lenders. The average cash down payment was stable, both sequentially and year-over-year at 16%, equating to over $78,000. On average, the household income of customers who use KBHS was about $136,000, and they had a FICO score of 743. Even with half of our customers purchasing their first home, we are still attracting buyers with strong credit profiles who can qualify for their mortgage while making a significant down payment. In conclusion, we believe we are navigating market conditions well and have taken action to support affordability for our buyers while balancing pace and price at the community level. Our divisions have done a solid job in controlling what is controllable by reducing build times, lowering costs, and remaining committed to serving our buyers. Reflecting this commitment, KB Home received an unprecedented number of division-level customer satisfaction honors recently from AvidCX, a trusted platform of home buying experience insights based on comprehensive post move-in customer surveys. As we look to the second half of fiscal 2025, we are focused on driving results for this year and beginning to shape our fiscal 2026. And with that, I will turn the call back over to Jeff.

Thanks, Rob. With respect to our lot position, we own or control nearly 75,000 lots, 47% of which are controlled. Our build-to-order approach provides visibility into the need and timing for replacement communities based on each community's pace and expected sell-out date, which is beneficial in our effort to be capital efficient. We are developing lots in smaller phases wherever possible and balancing development with our starts pace to manage our inventory at finished lots. We have long employed a balanced approach to allocating the healthy cash flow that our business generates towards our priorities of future growth and returning capital to our shareholders. Although we continue to view the long-term outlook for the housing market favorably, we are scaling back our land-related investment spend to align with the current market conditions. In the second quarter, we invested over $513 million in land acquisition and development, of which about 75% went toward development and fees on lots we already own. Through our regular review of land deals in our pipeline, we also canceled contracts to purchase approximately 9,700 lots that no longer meet our underwriting criteria. When markets stabilize, we have the flexibility to again increase our land investments. With an expected lower level of spend on land for the remainder of the year and given our healthy lot pipeline to support future growth, we intend to continue a meaningful return of capital to our shareholders. In our 2025 first half, we returned just under $290 million in cash to our shareholders, including $250 million in share repurchases at an average price of approximately $55.70 per share, which is below our current book value. At these levels, the repurchases provide an excellent return and will enhance both our future earnings per share and our return on equity. For our 2025 third quarter, we expect to repurchase between $100 million and $200 million of our shares. Rob Dillard will provide more detail on our capital allocation perspective in a moment. In closing, I want to recognize and thank the entire KB Home team for their commitment to operating our business with a daily emphasis on serving our homebuyers and a results-oriented focus. We believe we are taking the right steps in the current market environment by lowering our land spend and redirecting capital towards share repurchases to maximize our returns and enhance shareholder value. We believe we're well positioned with a strong balance sheet and significant financial flexibility and an experienced team that has successfully navigated varying market cycles in the past. And now I will turn the call over to Rob Dillard.

Thanks, Jeff. It's a pleasure to be here, and I'm excited to be part of the KB Home team. I'm also pleased to report on the second quarter 2025 results. As Jeff and Rob stated, we're meeting the market with discipline and with our focus on our employees, our customers, and our shareholders. We continue to emphasize our transparent pricing strategy while we promote our build-to-order advantage. This price and production flexibility is the embodiment of our continued strategy to optimize every asset. We did this by managing absorption by community based on specific market conditions. This strategy fosters healthy communities that then enable us to optimize profitability and improve cash flows and returns. In the second quarter of 2025, we utilized this strategy and operating model to generate total revenues of $1.53 billion and homebuilding revenues of $1.52 billion, a 10% decrease from the prior year. We delivered 3,120 homes in the quarter. We're pleased with this delivery result as it exceeded our implied guidance during a period when we were refining our pricing strategy to limit or eliminate incentives. In the second quarter, we increased our average selling price on a year-over-year basis to approximately $489,000. We expected this pricing performance despite continued product and regional mix shifts. Prices increased in the West Coast and the Southwest regions but were down with mixed performance by market and other regions. Housing gross profit margin was 19.3% and adjusted housing gross profit margin, which excludes inventory-related charges, was 19.7%. This strong margin performance beat expectations due to our continued success in managing costs and positive regional mix in a period where pricing power remained limited. Adjusted housing gross profit margin was 150 basis points lower than a year earlier due to pricing pressure, regional mix, higher relative land costs, and reduced operating leverage, only partially offset by lower construction costs. SG&A expenses as a percent of housing revenues were 10.7% and a 60 basis point increase from a year ago, mainly due to higher marketing expenses and reduced operating leverage. Homebuilding operating income for the second quarter decreased to $131 million and homebuilding operating income, excluding inventory-related charges, was $137 million, or 9% of homebuilding revenues. Total pretax income was $142 million, or 9.3% of total revenues. We reported net income of $108 million, or $1.50 per diluted share, benefiting from solid operating performance and an 8% reduction in our average diluted shares outstanding from the prior year. Looking ahead, we are adjusting our guidance for 2025 in response to current market conditions, as Jeff and Rob discussed. Our goal is to remain disciplined and optimize every asset as we focus on maximizing shareholder value. In the third quarter of 2025, we expect to generate housing revenues between $1.5 billion and $1.7 billion. For the full year, we now expect housing revenues between $6.3 billion and $6.5 billion. We expect a third quarter average selling price of between $470,000 and $480,000 and the full year 2025 average selling price of between $480,000 and $490,000. The expected variation in average selling price is due to lower prices and regional mix. Housing gross profit margin, assuming no inventory-related charges, is expected to be between 18.1% and 18.7% in the third quarter and 19% and 19.4% in the full year. This expected margin reduction is due to anticipated pricing pressure and mix variation, which we expect to be partially offset by lower construction costs. The third quarter SG&A ratio is expected to be between 10.3% and 10.7%, and the full year SG&A ratio is expected to be between 10.2% and 10.6%. We're actively managing SG&A for the current environment and will continue to align overhead levels with our volumes. We'll expect the third quarter homebuilding operating income margin of between 7.6% and 8.2%, and we expect the full year homebuilding operating income margin of between 8.6% and 9%. These projections assume no inventory-related charges. Our effective tax rate for the third quarter and the full year is expected to be approximately 24% as energy tax credits and other adjustments are expected to remain at their current levels. Turning now to the balance sheet. Our balanced capital strategy is focused on minimizing the cost of capital, maximizing flexibility, optimizing returns from investment in land and inventories, and returning capital to reward shareholders. We had inventories consisting of land in various stages of development and homes completed or under construction, totaling $5.9 billion at the end of the second quarter. We invested over $513 million in land development and fees during the second quarter. In the first two quarters of fiscal 2025, we invested over $1.4 billion in land development and fees, following investing $2.8 billion in fiscal 2024. We believe that we are well capitalized for the current market and expect to moderate investment in land to focus on only the highest return opportunities until more favorable market conditions emerge. With our inventory position, we own or control over 74,000 lots, over 14% more than this time last year. This provides both a strong basis for future growth and a high degree of flexibility. Included in the 74,000 lots, we control over 34,000 lots that we have the option but not the obligation to purchase. This provides us with meaningful flexibility to manage our land investment, and we can exercise this flexibility to our advantage when market conditions impact returns. Because we finance our land investments on our balance sheet, with extremely limited land banking or other off-balance sheet vehicles, we provide maximum transparency while minimizing cost and preserving flexibility. We view this as a meaningful positive in evaluating our liquidity and leverage. At quarter end, we had total liquidity of $1.2 billion, including $309 million of cash and $882 million available under our revolving credit facility. The current $200 million outstanding on the revolving credit facility is associated with seasonal working capital investment, we expect to pay off the revolver by year-end. We believe our strong BB+ credit profile was optimal for our business. It provides reliable access to capital at low cost with investment-grade like covenants and significant flexibility. We will continue to target a total debt to capital ratio in the neighborhood of 30% to support this rating, and we are pleased with our current 32.2% ratio. We have no debt maturity until our term loan matures in 2026 and our next note maturities in 2027. This strong balance sheet enables us to provide shareholders with a healthy dividend, which currently has an approximately 2% yield, as well as return capital to shareholders in the form of share repurchases. We believe our current share price, which is below book value per share, is undervalued and represents a strong investment opportunity. Repurchasing shares that are priced below book value not only improves liquidity in our shares, reduces our weighted average cost of capital, reduces share count, and benefits EPS but also improves return on equity and increases book value per share. In the second quarter, we repurchased 3.7 million shares at an average price of $53.55, for a return of capital of $200 million, which combined with dividends, resulted in a total return of capital of $217 million. With this strategy and our solid earnings, we have increased our book value per share to $58.64, a more than 10% increase over the prior year. We have now repurchased over 30% of our outstanding common stock since implementing our share buyback program in late 2021. Over the past four years, we have returned over $1.59 billion to shareholders in the form of dividends and share repurchases. We have $450 million remaining in our current repurchase authorization and expect to repurchase between $100 million and $200 million of our common stock in the third quarter, assuming all other things being equal, especially our outlook for the operating environment, capital market conditions, and other investment opportunities. In conclusion, we're pleased with our solid results and disciplined operating strategy and we expect to optimize shareholder value over the long term by augmenting these results with our shareholder-focused capital strategy that prioritizes minimizing the cost of capital, maximizing flexibility, improving returns from investment, and increasing returns to the shareholders in the form of share repurchases. With that, we'll now take your questions.

And our first question comes from the line of John Lovallo with UBS.

The first one is, I think the flexibility that you guys are demonstrating makes a lot of sense on the production front. The question is on SG&A though. Despite the 6% cut at the midpoint of revenue, SG&A is only going up by about 20 basis points versus the previous outlook. I'm just curious what steps you're taking to kind of pull back here on some of this fixed overhead costs. What specifically are you guys doing?

John, we've always been really focused on keeping our overhead in line with our revenue and scale. And in part, there are formulas for what kind of headcount we need in construction or sales or whatever, depending on how many deliveries. So we are adjusting our headcount to align with our new revenue projections for this year. And past that, there are buckets everywhere that we look at to see where else we can save some money. So I actually think, over time, we can get our ratio back down under 10%, where it was a couple of years ago at this revenue level. So we'll be pulling all the levers and really working hard to keep our costs in line.

Makes sense. And then maybe switching over to the gross margin. The outlook was 19.2 to 20, it went to 19.0, 19.4. I mean obviously, you tightened it a bit and lowered a bit but maybe just help us sort of bucket the drivers between volume, lower ASP mix, maybe higher land costs, if you could.

Yes, sure. John, this is Rob Dillard. A lot of that is operating leverage. The lower number has reduced the outlook for gross profit margins in the second half. Relative land costs, with prices coming down slightly, have impacted that margin. Additionally, there is a significant amount related to the mix between communities and regions that seems to be working against us. I would also mention that the reduction in construction costs has offset some of this pricing pressure, but we now expect margins to be between 19 and 19.4 for the full year.

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

Not anymore. Not for a long time, actually. It's Steve Kim from Evercore. I appreciate all the details provided. The guidance implies a strong closing outlook. Rob, regarding the fourth quarter, it seems to suggest that you might have a very high backlog turnover ratio, perhaps in the 80s, or you may have a significant number of orders in the third quarter. Typically, I would expect the third quarter absorption to be lighter than in the second quarter, but I’m curious if you can help clarify. I know you've given us a lot of guidance already, but I'm trying to understand which strategy you'll focus on to achieve fourth quarter closings around 4,000 or so.

Well, Steve, regarding build times, we've made good progress, but there's still more work to be done. We've seen build times decrease from quarter to quarter and even on a monthly basis, which should help ease some pressure on the units. However, as I look ahead for the rest of the year, we need about 2,500 more sales, which is actually less than what we achieved last year. I want to emphasize that in 2024, we approached things similarly to how Jeff described our strategy when Q4 was challenging. Despite the difficulties, we managed to sell over 2,600 inventory homes between the third and fourth quarters, with more than 1,200 of those sales occurring in Q4 under tougher market conditions. We're facing a similar situation as we head into the second half of the year.

Okay. So is there anything specific regarding backlog turnover ratio or absorptions sequentially?

We will continue to focus on achieving high backlog turnover ratios. Some of this is related to the inventory we managed during the quarter. I'm not aware of anything specific unless I misunderstood your question. We're approaching it in a manner similar to last year's strategy, and the situation on the inventory side from a sales perspective is actually a bit more favorable.

Steve, if you went back to the pre-pandemic build times, it was not uncommon for our backlog conversion to be 70% to 80% because you're building them much quicker.

Got you. With the cycle times returning to normal and even improving, that explains a lot. Could you provide more details about the community delay? You mentioned some communities opened later in the quarter, which I assume affected your order pace a bit. Can you elaborate on that? How much impact did your community count and these grand openings, which are important for orders, have? Did you miss out on the benefit you typically would have expected?

Yes, it was pretty significant. I mean it's not a new issue, community challenges of being communities is an ongoing thing but it was, I'd say, more significant than our second I'd say order of magnitude, we probably missed a couple of hundred sales from those delays in community openings that we didn't get, which is one of the reasons why I mentioned it in my prepared remarks. It's something that's difficult to predict with precision. Maybe our forecasting has been a little too aspirational in some cases but we are pulling levers and making changes out there to get in front of it to at least be able to forecast better and hopefully also open our communities faster than what we've been doing.

And our next question comes from the line of Matthew Bouley with Barclays.

I hope you can hear me this time. My question is about the topic of average selling price and your pricing philosophy versus incentives. I wanted to understand what you meant. You implemented that strategy back in Q2, and it seems like April and May may have been a bit disappointing compared to expectations. Looking ahead, you mentioned optimizing the assets, and you need to sell through some inventory in the second half. I'm curious if you are suggesting that you might pull back a bit on this pricing philosophy or if the plan is to remain active in adjusting base prices to ensure you meet the full year delivery guidance and achieve the desired volume.

Matt, we will adapt to the market conditions and based on our experiences in each community. If certain communities are meeting their sales targets, we may allow prices to increase slightly. If they are not reaching their targets, we will need to take additional actions. However, we have already factored into our guidance what we believe will be necessary to achieve the sales needed for our deliveries this year.

Okay. Fair enough. Secondly, the adjustment to land investment and hear you loud and clear on the decision you're making around kind of therefore, leaning more into share repurchase, especially when you're trading below book value, all kind of well understood and adjusting to market conditions. But obviously, just the result of that and the thought around growth going forward? I think I heard you say you're going to say around kind of 250 communities for the balance of this year, and please correct me if I'm wrong. But as you have pulled back or are pulling back on land development spend, how should we think about the outlook for community growth kind of going beyond 2025 and setting up for '26?

A lot of what we do will depend on the market conditions for the communities we need to establish, particularly for 2027 or late 2026. We previously mentioned that we have seen a slight slowdown in the growth of community counts, but we expect it to improve in the first quarter of 2026. With the lot count we currently own and control, we have a solid foundation for growth. The question is how much we can extract from the existing market conditions.

And our next question comes from the line of Mike Dahl with RBC Capital Markets.

You've actually got Stephen Mea on for Mike Dahl today. I wanted to ask a question about the backlog here. I fully understand the backlog and all your other initiatives like build time are supportive for the volume goals for fiscal '25 here and without asking for a specific guidance, I was hoping to get a sense of how you're thinking the backlog might shake out at the end of the year and how that may affect your thoughts on potential growth through 2026.

So we have quite a long way, a lot of sales to make between now and when we get to the end of '25, and get it into '26. But that's all part of our strategy and our plan as we've shifted away from the incentives that we were offering going to offering the best value to the lowest base price, we're seeing that be attractive to people looking to buy a personalized home. So we expect that we'll continue to grow that backlog and hit an inflection point. And all this depends on market conditions and where things are headed. But we're setting minimum run rates that we want to get by community. That's geared towards building that backlog to get to a sufficient level to support our strategy for '26, but obviously not guiding to '26 at this point.

No, that's super helpful. And then I guess, moving closer in time, I wanted to ask about the fourth quarter and kind of how you're looking at that from a margin perspective that we have the numbers for the third quarter and the full year kind of implies a similar-ish range for the fourth quarter but a slight uptick at the midpoint. Just kind of how you think margins might play out sequentially from the third to fourth especially in the context of you guys doing a good job of adapting to the market with price adjustments.

Yes, without giving explicit guidance to the fourth quarter, I mean we've got the third quarter and the full year in there. So you can kind of back into it. But as I said, the deliveries we're expecting to be up in the fourth quarter, and that's going to provide a margin uplift of about 40 basis points really just through operating leverage. And so yes, we do think ASP will be slightly higher, but it's really going to be the operating leverage from having more deliveries in that fourth quarter number.

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

Thank you for the detailed information as always. I really appreciate it. My first question is about your pricing strategy. It seems you are trying to move away from incentives and instead focus on adjusting base prices when needed. I’m curious because we’ve noticed that other builders seem to be going in the opposite direction, with incentives actually increasing this spring. Considering your strong order results in March but weaker in April and May, how do you compete when other builders are ramping up their incentives? Are consumers coming into your communities asking for these incentives? Do they recognize how your strategy differs? And do you think the decline in orders you experienced later in the quarter was entirely due to other builders being more aggressive with their incentives?

I believe that the aggressive incentives being offered by competitors are a factor. However, our teams have effectively communicated the value of our pricing. In many situations, customers may be overpaying for a home just to obtain an incentive, which can leave them in a tough position when it comes time to sell. They might find themselves in a worse financial situation, tied to a higher price until they sell. We have potential buyers asking for incentives, but our strategy doesn’t appeal to everyone. Some customers are solely focused on incentives, which is where we want to engage them. Overall, we’re pleased with the results from our updated approach, which aligns with how we’ve traditionally operated. This shift came in response to the dramatic increase in mortgage rates, and we're returning to our core strengths and what our sales teams are best at. We’re satisfied with our strategy and are committed to following it.

Got it. I appreciate the thoughts there. Second question on the cost reductions you guys have been able to realize, are you able to break that down at all by input? I'm just curious, if you look at that 3% plus reduction, how much of that is due to lower lumber, which is more of a commodity and maybe a little bit less in your control versus either labor or other inputs that you've directly been able to negotiate lower?

Yes. I can't really break it down as far as the 3.2%. There are so many things that go into that percentage, whether it's mix by divisions or which batches of house, even mix within the communities. Obviously, lumber coming down has been a bit of a help. In fact, I didn't look year-over-year at what lumber did in the prior year that's in that 3.2% but we've been seeing that trend continue. We just know based on our not only our started home budgets but on our house budgets that we maintain for each of the products out there that our divisions are doing an excellent job of driving down costs. And in some cases, fighting off other commodity level increases. And despite that, still getting the 3.2%. So I really can't break it down any further for you than that. But there are significant cost decreases coming out of other things than just commodity drops like lumber.

And our next question comes from the line of Rafe Jadrosich with Bank of America.

I just wanted to follow up a little bit on the land spend. Can you just help us understand how much land inflation is flowing through your P&L today sort of in the back half of the year and land that you're contracting today? Are you seeing any relief on land prices? Has that come down at all with the softer market? And is there a point here where we could start to see sort of land prices come down as we go out into '26?

Rafe, I can make a few comments on that. We don't have the exact numbers that you're asking for here with us. One of the things that we're seeing that you don't hear discussed much is you tie up a piece of land, you get it entitled, you go close, you move on, and the improvement costs went up quite a bit due to the supply chain or, in turn, oil prices that drove it up. And a lot of the cities fees went up quite a bit. So it's not necessarily just land inflation. So we may have owned a piece of land for two years now. We're developing the next phase and the cost bump up because of those components. The land sellers are definitely showing a willingness to give you time and terms. Normally, that's the first step, and then you start to see price. I don't think we've seen a lot of price yet, but I expect there will be some coming as we go through the rest of this year.

Okay, that's useful. Can you help us understand the quarterly pattern of gross margin? What portion of fixed costs is included in your cost of goods, and how does it change each quarter? How does this factor into the lower gross margin guidance, especially considering the anticipated revenue decline and the 40 basis points sequential increase you're mentioning for the fourth quarter? Specifically, how much of the gross margin reduction in the second half is due to deleverage?

Well, it's not deleverage in the second half really. It's actually gaining leverage from third to fourth. The second to third sequential difference is really more just margin. I mean it's really mix and lack of pricing power, right? So we're giving up a couple of points of price just as things kind of normalize over that quarter-to-quarter sequence. And that's really the primary driver for margin and the sequential component. And then in the fourth quarter, really, we'll get some margin through operating leverage, as we discussed, just going from third to fourth sequentially. But it's really going to be a continuation of the trend of where margins are but stabilizing in the second half.

And our next question comes from the line of Sam Reid with Wells Fargo.

Just wanted to ask about some of the lot options that you walked away from during the quarter. I believe it was about 9,700 lots. Would just love some perspective on some of the metrics that you might be using internally to determine when it makes sense to walk away from a lot. And then looking forward, could you just give us a sense as to what gives you confidence that you're optimized from a lot standpoint and that there's not a risk that you might need to walk away for more options in the second half of the year.

Sam, it's a pretty fluid process, and we have a good process that we track with all the deals in every division where if it's an entitlement project, they'll get approval to spend X dollars on the entitlements. And then when it's time to close on the land, they come back in for approval on the land. Then as we develop each phase, they'll come in for approval on the development of that phase. And every one of those submittals has market updates tied to it, what's the competitive landscape, how is resales, what's going on with incomes in that submarket. So it's a pretty fulsome process all the way through. The lots that we walked on in the last quarter was basically, I would call them, earlier-stage controlled lots that we just determined what the market movement in those submarkets, it wasn't something that we felt comfortable would hit our returns. And we always want to make sure we have quality returns on our investment. So it's far better to walk and wait another day on those than to keep putting more money into them. But it's where pricing has shifted.

No, that's helpful. And then just switching gears on third-party broker relationships. There might be a few of your peers that are actually leaning into these as the market slows. So to that end, could you just remind us where your broker attach rate set in the second quarter? How that compared to Q1? And then were there any quarter-over-quarter differences in the commission rate you paid in Q2 versus Q1 that might be worth calling out?

So it's been in a pretty consistent range. I think the broker participation rate was around 70% in Q2, compared to about 68 or 67% in Q1. After the NAR settlement was announced, we noticed a slight decrease in rates, but they've since recovered. However, we haven't seen that incentivizing the broker community has led to an increase in sales. Our focus remains on providing the best value for our buyers regarding their homes. The typical commission rate we are paying is about 2%.

And our next question comes from the line of Jade Rahmani with KBW.

I was wondering if you could talk about how much of the orders weakness relates to existing home inventory. Do you have any data as to sales prospects you're losing to the existing home market where we've seen a meaningful uptick in homes for sale?

I don't have any specific data that I can point to where we track, we lost a certain buyer. I mean we have our teams that they're going to know that by community, and they're going to know we're some of the prospects that we're an interested lead may have gone. But we do know in the markets, as I mentioned, as I was going through some of the regional and market color, those markets where you've seen resale inventory or resale get back to norms or above those norms of 6 or 7 months of supply. Those resales become a more formidable competitor than they were to us back when we would measure months of supply in terms of weeks instead of months. And on the flip side, most of the markets were resale supply has stayed fairly suppressed and limited. We're tending to see better results there.

And on the average selling price, which was down 8% year-on-year. Do you know how much of that related to outright price stuff versus geographic or product mix?

Yes, the average selling price year-over-year in the second quarter was up 1% or so. And a lot of that was just regional variation by region, by market, by community, there were some big swings in certain communities, and the mix between the regions actually had a pretty meaningful impact there. But we don't have the specific data that you're asking for.

And our final question comes from the line of Susan Maklari with Goldman Sachs.

My first one is on the build times. You mentioned that you do think that you could see further improvement there. Can you talk about where that can go? How much of it is being driven by perhaps some of the weakness in the market and maybe a loosening of labor? And how we should think about the sustainability of any of those gains when the market does turn?

We have set a target average build time of 120 days for the company, which we initially considered a bold goal. As we approach this target, it seems very achievable, and we aim to reach it this year. After achieving this milestone, we plan to pursue faster timelines, though I believe improvements might become less impactful. In the past, some divisions managed to complete builds in 90 days, and currently, some divisions are nearing the 100-day mark, while others exceed that. For our present portfolio, 120 days is a reasonable target, and once we hit it, we will aim for a more ambitious goal. Regarding the sustainability of these timelines, there's increased availability in the market right now, and while starts have been relatively slow across most of our markets, there is more labor available, which we are leveraging through our trade partner relationships. I believe this level of performance is sustainable. However, if we encounter supply chain issues similar to those we faced in 2021 and 2022, that could impact our progress. Absent significant macroeconomic challenges, I think we can improve and maintain this enhanced level.

Okay. That's helpful. And then maybe a question for Rob as he's coming into this role. Can you talk a bit about what you're most focused on? How you're thinking about the positioning of the business given the environment that we're in? And any initiatives that we should be aware of?

Yes. I believe we're in a very strong position. While it's still early, being in the third month, our primary focus has been on the team. We have an excellent team here, and we're getting stable and concentrated. I see many opportunities for the finance department to enhance performance, and we're dedicated to aligning those initiatives. While there’s nothing concrete to announce yet, we are certainly committed to creating value in new ways. Our emphasis on shareholders and the share repurchases we've made so far clearly reflects that.

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