Kb Home Q3 FY2025 Earnings Call

Good afternoon. My name is John, and I will be your conference operator today. I would like to welcome everyone to the KB Home 2025 Third Quarter Earnings Conference Call. This conference call is being recorded, and a replay will be accessible on the KB Home website until October 24, 2025. And I will now turn the call over to Jill Peters, Senior Vice President, Investor Relations. Thank you, Jill. You may now begin.

Thank you, John. Good afternoon, everyone, and thank you for joining us today to review our results for the third 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, an explanation and/or reconciliation of the non-GAAP measure of adjusted housing gross profit margin, which excludes inventory-related charges and any other non-GAAP measure referenced during today's discussion to its most directly comparable GAAP measure can be found in today's press release and/or on the Investor Relations page of our website at kbhome.com. And with that, here is Jeff Mezger.

Thank you, Jill. Good afternoon, everyone. We are pleased with the solid financial results that we achieved in our third quarter, meeting or exceeding our guidance ranges across our key metrics as we continue to navigate the current environment. And with a healthy balance sheet and significant cash flow, our flexibility remains strong. While we continue to invest in new communities to position ourselves for future growth, we are also returning a significant amount of cash to our shareholders. We repurchased more than $188 million of our shares in the third quarter, near the high end of our guided range, contributing to total repurchases of roughly $440 million year-to-date. This total represents approximately 11% of our outstanding share count at the beginning of the fiscal year, which was repurchased at an average price that is below our current book value. We believe this is an excellent use of our cash and highly accretive to both our earnings and book value per share. Including dividends, we have now returned more than $490 million in capital to our shareholders this year. From an operational standpoint, we had some critical achievements in terms of materially reducing our build times, which helped to generate closings that were slightly above our expectations and also continuing to lower our direct costs. These accomplishments were realized while maintaining outstanding customer satisfaction levels. As for the details of our results, we produced total revenues of over $1.6 billion and diluted earnings per share of $1.61. We delivered higher profitability on our revenues than we had projected with a gross margin of 18.9%, excluding inventory-related charges, above the high end of our guided range. With a continued focus on prudently managing our costs and aligning our overhead structure with our delivery volume, we held SG&A expenses to 10% of our housing revenues. The outperformance of these two metrics relative to guidance drove an adjusted operating income margin of 8.8%. We grew our book value per share to over $60, an 11% year-over-year increase. Moving on to market conditions. The longer-term outlook for the housing market remains favorable, driven by demographics and the ongoing undersupply of homes. With respect to current conditions, we are pleased to see stability in demand in June, which continued as our third quarter progressed. We are encouraged by the decline in mortgage interest rates, which should support greater demand for homeownership. We produced 2,950 net orders in the third quarter, maintaining the pricing approach we implemented earlier this year. Our focus is on offering the most compelling value at a transparent price while limiting the use of incentives. When we discuss with buyers the alternative of the lower sales price we offer versus a much higher price that can be offset by incentives, buyers recognize that they have a better opportunity for building wealth through equity over time with our home that has the lower starting price point. We continue to focus on optimizing our assets to generate the highest returns, balancing pace and price on a community-by-community basis relative to local market conditions. We exceeded our community count guidance, which, together with a stable cancellation rate, contributed to a monthly absorption pace per community of 3.8 net orders. This pace was lower than our third quarter pace of the past couple of years. And as a result, our net orders were below our internal sales goal. Our fourth quarter sales approach will emphasize our built-to-order homes while continuing to sell through our inventory. As we discussed on our last earnings call, our goal is to steer our business back to our historical range of built-to-order homes, which has averaged close to 70% over more than a decade from around 50% currently. It is our core competency and a key competitive differentiator. And with the significant reduction in our build times, that has become a more compelling selling proposition. We offer buyers an attractive home at an affordable price with features we know they value based on our survey data. Our buyers can then meaningfully influence their final sales price in selecting their lot, floor plan and exterior elevation as well as personalized design studio selections, aligning their monthly payment with their budget. This choice model contributes to our high customer satisfaction scores as buyers draw value from our process and is a key driver of our monthly absorption pace, which is among the highest in our industry. As our build-to-order mix grows, we believe it will support a higher gross margin as these homes currently generate a gross margin that is 250 to 500 basis points higher than our inventory homes. In addition, increasing our built-to-order mix will help us establish a larger backlog, which provides greater visibility into future closing projections. As we have shared in past years, our fourth quarter is typically one in which we elect not to take aggressive steps to capture inventory sales as it is a seasonally slower period and discounting by the speculative home builders pursuing year-end deliveries tends to be elevated in the final months of their fiscal years. Our land positions are valuable, and there is merit in exhibiting discipline when incremental volume gains are low. We do not intend to sell at any price to make up for the shortfall in net orders in our third quarter. Taking this into consideration, we are projecting $1.65 billion in housing revenues in our 2025 fourth quarter and $6.15 billion in housing revenues for our 2025 fiscal year, both at the midpoints of our guidance ranges. Let me pause here for a moment and ask Rob McGibney to provide more details on market conditions as well as an operational update.

Thank you, Jeff. One of the key operational themes of our third quarter was our strong execution. Our divisions continue to perform well on the fundamentals of our business, maintaining high customer satisfaction levels, consistently improving build times, further lowering direct costs and balancing pace and price to optimize each asset. In addition, we successfully opened 32 new communities during the quarter. The significant progress we made in continually reducing build times during the third quarter helped to drive better financial performance from capturing slightly more deliveries than we had planned. Traffic in our communities was steady, and our cancellation rate was stable at 17%, supporting net orders at an average absorption pace of 3.8 per month per community. We continue to utilize a simplified approach to sales, focused more on offering a transparent price rather than incentives to provide the most compelling value that is competitive with resale pricing. By advertising the true base price on our website, we let buyers know exactly what to expect before they ever visit a community without the need for back-and-forth negotiations to uncover the real deal. It is a clear upfront way of doing business that makes the home buying process easier and more straightforward. As a result, we believe we draw more traffic to our communities than we might otherwise attract if our pricing was dependent on incentives. In the third quarter, pricing in our communities was as stable as we've seen this fiscal year, with 70% of our communities experiencing steady or increased prices and the other 30% price reductions as we continue to balance pace and price to optimize our assets. We are encouraged by the stabilization and believe our communities are well positioned in the current market. In terms of affordability, it has improved compared to the start of our third quarter, driven by the decrease in mortgage interest rates, which have fallen roughly 60 basis points. This equates to approximately $30,000 of additional purchasing power at our average sales price, a significant boost for a first-time or first-time move-up buyer, which comprise about 70% of our homebuyers. I will add to Jeff's comments on our fourth quarter sales approach by reiterating our focus on optimizing our assets as we maintain an appropriate selling cadence in our communities, including sales of inventory homes. We do not need to chase incremental volume in a seasonally inelastic demand period where speculative builders are discounting heavily to close out their fiscal years. In those conditions, the additional sales produced tend to be limited, and they come at a great cost to our margins. We have approximately 3,000 homes in backlog that can be delivered in our 2025 fourth quarter, leaving just over 500 same quarter sales and closings needed to achieve our implied fourth quarter delivery guidance. This is less than the number of homes that we sold and delivered in the fourth quarter of last year and equates to less than one sale per community per month. At quarter end, we had 264 active communities, up 4% year-over-year, contributing to an average of 259, an increase of 3% as compared to the prior year period. The third quarter marked our best performance in several years in opening communities and the number of communities we opened was the highest in any quarter in more than a year. We typically see an above-average sales pace in new communities and the sales performance of our third quarter openings was strong with an absorption pace that outperformed our overall average pace for the quarter. We expect to end our 2025 fiscal year with 260 active selling communities with a projected ramp-up in early 2026 in time for the spring selling season. We moderated our starts in the third quarter with 2,761 homes started as part of our effort to rotate our business back to a higher mix of built-to-order homes over time. We ended the quarter with 6,550 homes in production, including models, of which 52% were sold. Further improving our build times was another area of strong execution by our divisions in the third quarter with a 10-day reduction sequentially to 130 calendar days. Compared to our annual build times going back a decade, we are building homes at some of our best levels today. Although continuous improvement becomes more difficult as we move further away from the peak, our divisions have been producing results each quarter with a focus on returning to a company-wide average of 120 days or better from start to home completion. We are quickly approaching this point at 122 days for built-to-order homes, and some of our divisions are already below our target level. The benefits of lower build times are numerous, including a more compelling selling proposition for our customers purchasing a built-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. The focus from our divisions, together with our national purchasing team to drive lower costs as well as our value engineering and studio simplification efforts collectively contributed to direct costs that were about 2% lower sequentially and 3% lower year-over-year on our homes started during the third quarter helping to offset the impact of higher land cost. 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 a high capture rate with 83% of buyers who finance their homes in the third quarter using KBHS. Higher capture rates help us manage our backlog more effectively and provide more certainty in closing dates, which benefits our company as well as our buyers. In addition, we see higher customer satisfaction levels from buyers who use our joint venture versus other lenders. The average cash down payment was stable, both sequentially and year-over-year at 16%, equating to over $76,000. On average, the household income of customers who use KBHS was more than $130,000, and they had a FICO score of 740. 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 or paying in cash. 11% of our deliveries in the third quarter were to all cash buyers. In conclusion, we are focused on delivering results, and our third quarter performance reflected strong operational execution across multiple dimensions. We believe our communities are well positioned in their submarkets, and we are approaching sales in a simple and transparent way, which we feel best serves our buyer. Our divisions are committed to achieving our projected fourth quarter results for a solid finish to fiscal 2025. And with that, I'll turn the call back over to Jeff.

Thanks, Rob. With respect to our lot position, we own or control over 65,000 lots, 42% of which are controlled. Our footprint is focused on markets that we believe are positioned for long-term economic and demographic growth, and we've been selective with our land positions in these markets. Our lot pipeline is healthy and at a sufficient level to support our community count growth targets. We regularly review the land deals in our pipeline to ensure that the rationale for each deal is still sound. During the third quarter, we canceled contracts to purchase approximately 6,800 lots, representing about 45 communities that no longer meet our underwriting criteria. We feel we have ample opportunity in our served markets to add to our controlled lot count with lots that have better economics and terms. And with our lot position at quarter end, we can wait until we find better prospects. One of the key benefits of our build-to-order approach is that it provides visibility into the need and timing for replacement communities based on each community's pace and expected sellout date, which is beneficial in our effort to be capital efficient. We are also developing lots in smaller phases wherever possible and balancing development with our starts pace to manage our inventory of finished lots. We remain consistent in our balanced approach toward allocating the healthy cash flow that our business generates. We are achieving our priorities of positioning our business for future growth, managing our leverage within our targeted range and rewarding our shareholders through share repurchases and our quarterly cash dividend. We are maintaining our land investments at a level that will support our current growth projections and invested $514 million in land acquisition and development in the third quarter with almost 80% going toward development and fees on the land we already own. We are beginning to see a more constructive land market as prices have softened somewhat, and we were able to obtain more favorable terms. As I mentioned earlier, we continue to view the long-term outlook for the housing market favorably and have the flexibility to resume a higher level of investment at any time. With the earnings that we have generated to date in fiscal '25, land acquisition and development spend that is 7% lower year-over-year and the improvement in our build times unlocking cash, we have returned more than $490 million in capital to our shareholders in the first 9 months of fiscal 2025. This includes approximately $440 million in share repurchases at an average price of $56.30 per share, which, as I noted earlier, is below our current book value. At these levels, the repurchases are an excellent use of capital and will enhance both our future earnings per share and our return on equity. In closing, I want to thank the entire KB Home team for their commitment to serving our homebuyers and driving the best possible performance from our business in the current market. We believe we have the most talented operators in the industry, and we are honored to be the only homebuilder named to Time Magazine's 2025 list of World's Best Companies. One of the three dimensions that define the companies recognized on this list was employee satisfaction based on anonymous survey data of a large sample of employees. For this reason, the recognition is particularly meaningful to us. Our divisions are executing well and producing results across some of the most impactful operational areas of our business by reducing build times and direct costs and opening new communities on time. We continue to approach our land opportunities through a thoughtful and selective lens with a healthy lot position that has our business primed for growth. Year-to-date, we've returned the highest level of capital to our shareholders for a nine-month period in our company's history. Over the past four years, our cumulative return of cash for share repurchase and dividends as a percent of market cap leads the industry. We plan to continue our share repurchase program in both our '25 fourth quarter and in fiscal 2026. Our balance sheet is strong. We have significant financial flexibility and an experienced team that is committed to producing results going forward. And now I will turn the call over to Rob Dillard for the financial review.

Thanks, Jeff. I'm pleased to report on the third quarter 2025 results. As Jeff and Rob stated, we're managing the business with discipline in an effort to drive employee engagement, customer satisfaction and long-term shareholder value. We believe that we are well positioned to deliver solid results in the present operating environment with our dedicated customer focus, leading brand, transparent pricing strategy and differentiated built-to-order product. In the third quarter of 2025, we generated total revenues of $1.62 billion. Housing revenues exceeded the midpoint of our guidance range at $1.61 billion, an 8% decrease from the prior year. We delivered 3,393 homes in the quarter, which exceeded the midpoint of our implied guidance, largely due to reduced build times. While we experienced consistent traffic at our communities, net orders totaled 2,950, a 4% decline. Lower orders and improved build times, which reduced backlog more quickly and efficiently, contributed to a 24% reduction in our ending backlog to about 4,300 homes. In the third quarter, our overall average selling price was relatively consistent on a year-over-year basis and decreased 1% to $475,700. Mix was a factor as lower average selling prices in the Central and Southeast regions were largely offset by increases in our West Coast and Southwest regions. Housing gross profit margin was 18.2%, and adjusted housing gross profit margin, which excludes inventory-related charges, was 18.9%. This strong margin performance exceeded the high end of our guidance range, mainly due to our continued success at managing costs. Adjusted housing gross profit margin was 180 basis points lower than a year earlier due to pricing pressure, higher relative land cost, and geographic mix, partially offset by lower construction costs. SG&A expenses as a percent of housing revenues were 10%, a 20 basis point increase from a year ago, primarily due to decreased operating leverage. We're actively managing SG&A for the current market environment and have reduced our headcount to align with volume levels. This focus led to a favorable result relative to our guidance range. Homebuilding operating income for the third quarter decreased to $131 million or 8.1% of homebuilding revenues and homebuilding operating income, excluding inventory-related charges, was $143 million or 8.8% of homebuilding revenues. Total pretax income was $143 million or 8.8% of total revenues. We reported net income of $110 million or $1.61 per diluted share, benefiting from solid operating performance and a 12% reduction in our weighted average diluted shares outstanding from the prior year. Consistent with our strategy to optimize every asset, we are maintaining discipline on price and pace and have adjusted our guidance for 2025 to reflect this priority. In the fourth quarter of 2025, we expect to generate housing revenues between $1.6 billion and $1.7 billion. For the full year, we now expect housing revenues between $6.1 billion and $6.2 billion. We expect a fourth quarter average selling price between $465,000 and $475,000 and a full-year 2025 average selling price of approximately $483,000. This variation in projected average selling price is primarily due to regional mix. Housing gross profit margin, assuming no inventory-related charges, is expected to be between 18% and 18.4% for the fourth quarter and between 19.2% and 19.3% for the full year. This expected year-over-year margin reduction is due to market conditions, higher land costs, including development and fees as well as mix variation which we expect to be partially offset by lower construction costs. The fourth quarter SG&A ratio is expected to be between 9.3% and 9.7%, and the full year SG&A ratio is expected to be between 10.2% and 10.3%. We expect the fourth quarter homebuilding operating income margin of between 8.5% and 8.9%, and we expect the full year operating income margin of approximately 8.9%. These projections assume no inventory-related charges. Our effective tax rate for the fourth quarter and the full year is expected to be slightly above 23% as energy tax credits and other adjustments are expected to remain approximately 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 returning capital to reward shareholders. We believe that we are well capitalized for the current market. We continue to invest in land to drive future growth with a continued focus on the highest return opportunities while also returning more capital to shareholders in the form of share repurchases. We had inventories consisting of land in various stages of development and home completed or under construction totaling $5.8 billion at the end of the third quarter. We invested over $514 million in land development and fees during the third quarter compared to $845 million in the third quarter of 2024. In the first nine months of 2025, we invested over $1.9 billion in land development and fees compared to $210 million in the corresponding period of 2024. With our inventory position, we own or control over 65,000 lots, including 27,000 lots that we have the option to purchase. We believe that we are well positioned to benefit from improving market conditions. At quarter end, we had total liquidity of $1.2 billion or $331 million of cash and $832 million available under our revolving credit facility. The current $250 million outstanding on the revolving credit facility is associated with seasonal working capital investment. Our strategy is to maintain our strong BB positive credit profile as we believe it facilitates reliable access to capital at low cost and significant flexibility. We'll continue to target a total debt-to-capital ratio in the neighborhood of 30% to support this rating, and we are comfortable with our current 33.2% ratio. This strong balance sheet enables us to provide shareholders with a healthy dividend, which currently has an approximately 1.6% yield as well as return capital to shareholders in the form of share repurchases. In the third quarter, we repurchased 3.3 million shares at an average price of $57.12 for a return of capital of more than $188 million, which combined with dividends, resulted in a total return of capital of $205 million. Over the first nine months of 2025, we have repurchased approximately 7.8 million shares or approximately 11% of outstanding shares at the beginning of the year. With this strategy and our solid earnings, we have increased our earning book value per share to $60.25, an 11% increase over the prior year. Over the past four years, we've returned over $1.8 billion to shareholders in the form of dividends and share repurchases. We have now repurchased over 34% of our outstanding common stock since implementing our share buyback program in late 2021. We believe that this is the highest percentage of shares repurchased based on market capitalization among our homebuilder peers over this period and is an indication of our shareholder-focused strategy. We expect to repurchase between $50 million and $150 million of common stock in the fourth quarter, subject to our outlook for the operating environment, capital market conditions, and land investment opportunities, among other factors. 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 a shareholder-focused capital strategy that balances investing for growth, optimizing returns, and increasing returns to shareholders. With that, we'll now take your questions. John, would you please open the line?

Yes. Thank you. We'll now conduct a question-and-answer session.

I appreciate all the commentary and guidance. We've seen good results in a challenging environment. I wanted to ask about the order average selling price, which has significantly declined sequentially. I know you've discussed the more transparent pricing model, but I found your comment that 70% of your communities have stable to increasing prices interesting. I'm trying to reconcile that with the 4% sequential drop in the order average selling price. Can you help us understand this situation and share your outlook for the order average selling price as we approach the fourth quarter and next year? Are you comfortable with the current level of average selling price, or do you believe it may decrease further?

A lot of the direction we're headed will depend on market conditions. We mentioned in our prepared comments that we're focused on optimizing each asset, and we will continue to do so. We've successfully reduced costs, and some of that is reflecting in our results. However, much of what you're observing in the average selling price is driven by the mix of deliveries. Year-over-year, we're seeing an increase in deliveries from the Southeast and a decrease from California. Additionally, within the West, we have ramped-up deliveries from Boise and Seattle, which tend to have lower average selling prices compared to other areas in California. Therefore, much of what you see is related to these delivery mixes. Regarding comfort with the average selling price, we're clearly focused on the margin aspect. If we can keep reducing costs and offset any necessary price decreases, we’ll be satisfied with that.

Yes, that's helpful. I mean, I guess what I'm hearing you say, Rob, is that nobody should read into the sequential order price decline as a leading indicator of a step down in the margins. There's really more mix effects going on. So I appreciate that. Speaking about the demand, we've kind of had a number of weeks here where the mortgage rate has sort of moved down pretty meaningfully. I was wondering if you could comment on sort of what you've seen. We've heard that there's been a pickup in traffic pretty much across a lot of builders we speak to and people are kind of waiting for the conversion into sales. I was wondering if you could comment on what you are seeing with respect to the conversion of traffic and whether or not you would be more inclined at this point to push price if demand comes in stronger or if you would be more inclined at this point to maybe push volume given the fact that you've pulled your volume down a lot most recently?

I guess the way that we would react to it really depends on the community. If it's a community, we've got a lot of runway in front of us, we see an opportunity to get higher volumes with more demand we'll probably be less aggressive on price and get a little more volume. If I contrast that with some of the, we call them jewel box communities we've got in California that are infill type communities that are difficult to replace. We're going to continue leaning on price and margin. As far as the way the buyers have reacted, I mentioned in my prepared remarks, it's a huge impact to the buyer in terms of affordability. I mean, $30,000 of purchasing power at our ASP is big. We've seen traffic stay steady. Orders have been good, but I wouldn't say that we've seen a big uptick yet or maybe the uptick that we would expect to see from such a change in mortgage rates. And I think to some extent, buyers are in maybe a bit of a wait-and-see mode. maybe waiting for rates to come down further. Maybe they were waiting around for the actual Fed event expecting that to have some immediate impact on rates. But the thing that we're focused on is really our messaging and the way that we're approaching this in the sales offices. And with our build-to-order model, we're really talking to all of our customers about their ability to buy a built-to-order home. And if they believe rates are coming down in the future, then it's perfect because we've got a one-time float-down option for them. And if that happens, they can take advantage of that. And I think that's something that is unique to our approach, and we're leveraging that everywhere we can.

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

The first one is, if we think about sort of the third quarter gross margin beat versus expectations and about 20 basis points on the high end and maybe a slightly lower-than-anticipated fourth quarter gross margin. I'm curious if there was some toggle on delivery timing or mix between the quarters relative to internal expectations, given the fact that the full year gross margin is maybe up a touch from where you had thought before.

Yes, that's a good question. It's something we think about a lot, but it wasn't really a factor this time. The main drivers were a strong performance on the construction side and selling the right products. We're very pleased with how the third quarter ended from a margin standpoint. We're also being careful about what the fourth quarter will bring as we continue to manage our inventory and transition to more build-to-order products.

Understood. And then maybe with that in mind, how should we sort of think about the year-over-year and sequential movement in stick and brick costs in land into the fourth quarter? And to the extent that you can comment on what you're expecting in 2026, that would be helpful.

Yes. In fourth quarter, we're not expecting like a trend shift from the third quarter in terms of the year-over-year impact of land or sticks and bricks. Like I think that we've been able to offset most of that with construction productivity, but you're seeing that kind of having an impact on the margins for sure. I think going forward, we think that there's still opportunity to continue to offset that. And as Rob said, from a community-by-community perspective, there's a lot of play in price there as well.

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

If we go back historically on this third quarter call, you've sort of given an outlook on the out year revenue, at least like a preliminary view. I understand that that's a pretty volatile environment. So it might be a little bit tougher right now. But can you maybe just help us and maybe puts and takes like kind of going into next year as you shift back to BTO, just how we might think about the revenue outlook for next year or if you're still providing that?

Rafe, and we're not going to give guidance on this call for next year. But directionally, we shared we're going to have an uptick in community count in time for the spring selling season. And with rates coming down and improving affordability at some point in time, that has to have a favorable impact, and we just don't know when or how strong it will be. So, our expectation is that as we look ahead to next year, affordability improves, community count is up. We'll be setting up a solid year again. And as we shift to more build-to-order and work through the last of the inventory, we expect that our margins will improve over time.

That's helpful. And then just on the fourth quarter, the guidance implies, I think, pretty good leverage on SG&A or at least better than normal seasonality. Can you talk about, one, do I have that right? And then maybe what's driving some of that improvement sequentially as you go into the fourth quarter?

Detail on that?

Yes, it's not really leverage as much as it is actually the gross number is expected to be down 15% on a year-over-year basis quarterly. And a lot of that is just kind of the fixed costs we've taken out of the business and how the yearly kind of total compensation scheme is going to play through the SG&A profile.

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

Thanks for all the detail so far and nice performance in a tough market. I would love to chat a little bit about the goal or the target to get back to your more historical BTO share. I think this is a market where a lot of builders that have historically been more heavy on BTO have seen that share decline, and there's a lot of spec inventory out there that you're competing with. And I'm just curious, as you move towards that pivot, have you made any headway there yet either throughout this quarter or maybe even thus far in September in terms of the mix of your orders? Is it skewed a little bit more towards BTO? And I guess from a profitability perspective, can you talk about the current margin differentials between your BTO business and specs today?

I can share a few insights, Alan, and then I will pass it to Rob McGibney. We were over 70% sold as recently as 2022. Looking at the industry's situation, the supply crunch began in 2022, which extended build times significantly. In many cities, build times reached as high as 11 months. This creates a challenge for build-to-order sales since buyers can't lock in rates that far in advance. It's difficult to provide them with payment details for an 11-month wait, and most buyers won't wait that long for a customized home. As a result, we had to adjust our strategy by introducing more inventory into our work in progress. However, over the last couple of years, these were the hardest homes for us to sell because our sales team's focus has traditionally been on the build-to-order values. Additionally, rising rates further complicated our situation. Fortunately, rates have decreased, and our build times have returned to historical norms, making our offerings more attractive. We don't plan to introduce a large amount of inventory; instead, we will concentrate on the build-to-order aspect. We have observed some gradual improvement in the build-to-order mix, and we anticipate greater progress as we approach 2026. Rob, would you like to add anything or discuss the margin differences?

Yes. We mentioned in our prepared remarks that the margin difference can vary by community and plan, ranging from 250 to 400 basis points, which is a significant difference. As Jeff mentioned, we currently have the inventory available because we initiated it, and we need to adopt a balanced approach to manage it. Looking ahead, especially as we introduce new communities, our focus will be exclusively on build-to-order. While this won't lead to an immediate change, we anticipate making substantial progress as we move into early 2026. We expect to return to a 70-30 ratio or better, with higher margins.

Got it. That's really helpful, Rob. And then in terms of the 4Q margin guide, I think if I'm doing the math, it's down about 70 bps sequentially. Given your comments about pricing being pretty stable through the quarter in the majority of your communities, should I interpret that sequential decline is more kind of flushing through some of the remaining spec you have and that mix headwind and then hopefully, as you get into '26, that reverses?

A couple of things, Alan. There's a lag effect from sale to when everything runs through into revenue. So a lot of the deliveries were on houses that were sold in the spring selling season when it got pretty competitive out there. So there is a lag, and you're seeing more of that than you are an assumption that we're going to go deeper on inventory. In fact, we stated in our prepared comments, we're not going to chase the units by dumping inventory with a heavy discount. We'd rather be prudent with it and strategic and take our time and cover the inventory in the better selling season in January, February, and March. So, I can't remember what the other part of his question was. I was going to kick it to you. Was it...

The margin differential. Yes, a fair amount of it is still mix, Alan. You're totally right. And some of it is like market conditions, but really a lot of it is just the mix.

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

You have Elizabeth Langan on for Matt today. I was wondering if you could discuss the success you've had in lowering direct costs. Could you elaborate on what those direct costs are and highlight any specific categories where you've seen more success?

It's really a broad situation. Lumber costs have decreased, which has been beneficial for us since lumber is a significant part of overall construction expenses. However, the impact isn't limited to commodities. In many of our markets, we have observed a notable decline in construction starts over the past few months, and we are using this situation to collaborate with our trade partners who are eager for work. This allows us to reduce costs as we introduce new starts into the market. On the cost side, we are examining all direct costs. When sales prices are under pressure, we seek every opportunity to reduce costs, whether they are direct expenses or SG&A. Overall, we see this trend broadly across all direct cost components involved in our homes. Part of the reduction comes from renegotiating deals due to shifting market conditions and fewer starts, and part of it involves true value engineering and altering the products we construct. So, I would say the improvements we've experienced are fairly evenly split between these two areas.

Okay. And just to kind of follow up on the general dynamics of those negotiations. Is that something that would carry on into 2026 in terms of seeing those benefits? Or is it something where it's more real-time, and so you might see depending on the demand and if there's a recovery in starts next year?

Yes. The recent reductions in lumber will impact our deliveries early next year. We have consistently focused on this issue, although the market may not always be receptive. A few years ago, during labor and supply chain challenges, we struggled to reduce direct costs effectively. However, we've made more progress in that area now, though it is somewhat contingent on market conditions. Even though starts and volumes are down, we will continue to work on lowering costs. If we have a strong spring selling season, our effectiveness may be reduced, but our house prices will likely increase. That's my perspective on the situation.

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

To begin, I would like to follow up on the recent demand dynamics. To be clearer, this is typically a period where you observe a seasonal decline in your absorption rate. When you mention that demand remained steady throughout the quarter, it indicates that there hasn’t been an increase in the fourth quarter so far. Could you provide more details about your monthly sales pace and how you're performing in September?

Yes, Mike, looking back at the third quarter, our performance was quite consistent. June was our strongest month, with July and August closely following. Orders remained stable throughout the quarter, influenced by the timing of openings and sell-outs. We haven't noticed any significant changes yet in September, but it's still early in the month. So, I don’t want to draw any conclusions about September just yet; it feels like a continuation of the same trend.

Okay. Understood. Jeff, from a broader perspective, when considering the timing of this shift back to a build-to-order model, and in light of your thoughts on the uncertainty of when we might see an inflection point, it appears that this strategy relies heavily on a substantial increase in demand next year, especially given that the backlog in both unit and dollar terms is expected to decline significantly. If we don’t see this increase, there could be a notable gap in your revenue for the upcoming year. I’m curious if you could expand on that. Additionally, a specific question: if mortgage rates don’t decrease, which we've noted has risen recently, will you adjust your strategy going into next year? How do you plan to approach this if you don’t achieve the relief you’re anticipating?

Yes, there are a few aspects to your question, Mike, and it's a good one. Our backlog will decrease by the end of the year. Fourth quarter sales and deliveries will obviously affect that, but it will decline in a similar range to our reduced build time. This actually sets us up for comparable pull-throughs based on the backlog leading into 2026. Each year, as we enter the new year, the spring selling season determines how well or poorly our results might be for that year. It's not simply a matter of deciding to be built to order. The inventory we release creates competition among ourselves, consumers, and sales teams when trying to sell both inventory and build-to-order products. Margin erosion to manage inventory hampers our ability to sell build-to-order. We’ve started to see communities where we are moving away from aged inventory, focusing instead on our core value and offering the best value to customers, which works effectively. Thus, we do not anticipate a trough, as you mentioned. We expect to see consistent performance. Depending on the spring, we’ll update you then, as that will be a key factor in our second half performance next year.

And our next question comes from the line of Michael Rehaut with JPMorgan.

This is Andrew Azzi on for Michael Rehaut. I just wanted to drill down a little bit in terms of the inventory charges and such, if you could comment on the land environment and your ability to find new lots for future growth, especially as the industry is developing a stronger appetite for the land-light model?

Well, as we shared, the land markets are rolling over a little bit. We're seeing some cities where prices have come down a little. You definitely can get more terms, meaning you can close with a better entitlement in place. so you can get to turning the dirt and developing the lots quicker. So that's a good thing. So that's helping us on the land market. Relative to what we shared in the quarter on the abandonments, we walked on deals that we've had tied up and with the ships in the market, they don't hit our underwriting hurdles. So we elected to abandon them and write off the entitlement and pursuit costs that we had incurred. And we know that in some cases, we could go back in and buy the same asset with better price and better terms. We've seen some of that already, but that's a future move. But it's our expectation with starts being way down and what went on in the market this year, we think that the land market will be a little friendlier as we look ahead.

That makes a lot of sense. I appreciate that. Are there any markets where you're seeing progress that you can highlight? Specifically, are you noticing any increased competition from resale or anything related?

It's a broad question, but I'll provide a quick overview. Generally, demand across our business is mixed. We see clear strengths in some areas, while others are softer, and some markets are improving or stabilizing faster. It’s challenging to generalize about any specific metro or region, as demand varies based on submarkets and even within those submarkets. In the last quarter, some stronger markets included Inland Empire, Riverside, and San Bernardino, along with North Bay and the Central Valley in California. Las Vegas, Houston, and Charlotte also showed solid demand. Conversely, higher-priced communities in coastal California faced challenges, and Seattle was particularly tough for us in Q3, although we've noticed recent improvements there. Denver remains a challenging market as home prices surged after COVID without corresponding income growth, and supply has increased significantly. However, we are seeing starts decline by 15% to 20%, which is a positive sign of industry discipline in not adding to supply in weaker markets. In Florida and Texas, we noticed an increase in resale and new home inventory, prompting targeted price adjustments and cost reductions to enhance absorption. In Florida, our Q3 orders were higher than in Q2, indicating signs of stabilization thanks to our efforts. We are now focused on raising prices where possible and, in some instances, we've exceeded what was initially needed to optimize our assets. Texas shows similar trends but varies by metro; Houston remains strong while San Antonio and Austin have seen more price increases and higher resale inventory. Overall, I view Texas and Florida as stabilizing markets, which is promising for our communities as well.

Our next question comes from the line of Trevor Allinson with Wolfe Research.

I want to ask a question about the Southeast region specifically. Order prices were down almost 6% sequentially, but volumes were actually quite good. They're up about 7% quarter-over-quarter. Rob, I think you were just referring to some of that in Florida. That's quite a bit better than normal seasonality. You've talked about not chasing volume. But was the strategy different in the Southeast in the quarter, just to liquidate some inventory? Or what drove the order ramp there, but a pretty big ASP decline sequentially?

Yes. It wasn't really chasing the inventory. I think that was a market that we saw the resale inventory and new home inventory start to accumulate and sales had really slowed for us in Q2, which was normally our best time of the year. So we took action, and we reduced price. I think that's what's showing up in the numbers that you're seeing. But I think the good news for us is that worked, which now you're seeing the orders come back up as a result of that. It's also, as I mentioned earlier, one of the markets where we've seen the biggest decline in starts. So we've had some of our best results in cost reductions there, too. And now as I'm calling that is starting to stabilize, we've got that combination. And I think we found that we found the market. We've driven cost down and now we're starting to take it back the other way. So I'm not necessarily calling it's an inflection point for the whole state of Florida, but we've been encouraged by what we've seen recently.

Okay. Makes a lot of sense. And then Jeff, I wanted to follow up on your comment about starting to see land prices soften. Can you just talk about how widespread that is? Any specific geographies where that's most common? And can you help us with some sort of number on the magnitude of declines that you're seeing in the markets where you are seeing it.

I believe there's a slight easing happening. While we're not experiencing sharp declines, there is some softening, and our strategy of saying no is proving effective. We've walked away from deals, only to have them return with lower offers. This indicates that land sellers are realizing that the market isn't as strong as it was, and they also need to reduce their inventory. We're observing this trend across the board. While none of these changes are significant enough to impact the market drastically, they are slowly starting to soften, and we find that encouraging.

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

My first question is on the design studios. As you think about the shift back to more BTO, can you talk about how you can position the design studios? Is there anything that you're focused on from that element of the business in order to help drive that shift and attract the consumer back to that side of the business relative to the specs that are out there?

Yes. Good question. I don't think we need to change anything as far as our approach to the studio. It's just leveraging what we've always done. And we really use the studio as a tool to help us sell homes. And we want to start by offering the best base price we can with a quality home that's designed based on our market survey and the data that we have as kind of a starting point and then really use the studio to let people personalize their home there if they choose to. So I think that there's a lot of personalization options and choices that we offer, and we're always kind of rotating through that to make sure that they stay current and they're up to date with what people want. But I don't really see it as a shift in the way that we're approaching that business. We just want to drive more of the business to build-to-order and leveraging the studio.

Yes. Okay. That's helpful. And then maybe turning to capital allocation. You mentioned the continued focus on shareholder returns, especially the share repurchases. Just any thoughts on how we should be thinking about the magnitude and what we can expect there as we finish up this year and look to the next year and how you're balancing that relative to the budget that you put out for land development and acquisitions?

Yes, Susan, that's a good question. we're very thoughtful about kind of how we're allocating capital. You can see this year, we've been really thoughtful and responsive to ensuring that we can continue to fund growth, but do it in a smart way and ensure that we're rewarding shareholders as well. And the capital return and the cash flow that we're generating right now is really healthy. And so we feel like in the future, we'll be able to continue to reward shareholders at a similar rate, but we haven't quite yet figured out the magnitude. And I think that there's also a component of that, which is market-driven by how attractive the land market is. So we feel really good about our land position going into next year and feel really good about how it's set us up for the next three to four years. And I think that, that's going to give us a lot of flexibility in terms of returning capital.

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