Earnings Call Transcript - KBH Q1 2022

Operator, Operator

Good afternoon. My name is Alex, and I will be your conference operator today. I would like to welcome everyone to the KB Home 2022 First Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the company's opening remarks, we will open the lines for questions. Today's conference call is being recorded and will be available for replay at the company's website, kbhome.com through April 23. Now I would like to turn the call over to Jill Peters, Senior Vice President-Investor Relations. Jill, you may begin.

Jill Peters, Senior Vice President-Investor Relations

Thank you, Alex. Good afternoon, everyone, and thank you for joining us today to review our results for the first quarter of fiscal 2022. On the call are Jeff Mezger, Chairman, President and Chief Executive Officer; Rob McGibney, Executive Vice President and Co-Chief Operating Officer; Jeff Kaminski, Executive Vice President and Chief Financial Officer; Bill Hollinger, Senior Vice President and Chief Accounting Officer; and Thad Johnson, Senior Vice President and Treasurer. During this call, items will be discussed that are considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are 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 measures referenced during today's discussion to their most directly comparable GAAP measures can be found in today's press release and/or on the Investor Relations page of our website at kbhome.com. And with that, let me turn the call over to Jeff Mezger.

Jeff Mezger, Chairman, President and Chief Executive Officer

Thank you, Jill. Good afternoon, everyone. We delivered solid results in our first quarter that drove year-over-year growth in many key metrics, including revenues, operating margin and diluted earnings per share. Our revenues were up 23%, and we produced significant margin expansion, increasing our operating margin to over 12%. We overcame the impact from lower-than-expected deliveries, which I will address momentarily, to drive a 44% increase in our diluted earnings per share to $1.47. With our backlog value expanding 55% year-over-year to $5.7 billion, its highest level in 15 years, we have sold almost all the homes we need to achieve our projected $7.4 billion in revenues. We continue to focus on managing our construction capabilities by aligning our sales to our starts. Over the past 12 months, we have started roughly 16,800 homes. We have 46% more homes in production at the beginning of the second quarter relative to the prior year. And with these homes being further along in their construction cycle, we believe we are well-positioned to achieve our guidance this year. Market conditions are strong and along with our expected growth in community count throughout the remainder of the year, we believe we have the foundation in place to drive further scale and profitability growth in 2022 and beyond. I want to provide some context for our shortfall in deliveries, then I will ask Rob to go a little deeper into the discussion. The guidance that we provided in January assumed that we would at least hold fourth-quarter cycle times. While we were not counting on relief from the supply chain challenges, neither did we expect that they would worsen. We underestimated the degree to which the Omicron variant would exacerbate an already constrained supply chain and workforce across our trade partners, municipalities, utility companies, and even our own employees. While we take responsibility for our deliveries being below our prior expectations, at the same time, we acknowledge that the variant was a significant contributing factor. In the last six weeks of our first quarter, we lost approximately two weeks in our construction cycle, primarily in the finishing stages while our Foundation and Frame segment held to the fourth quarter's timeline. At a run rate of about 250 deliveries per week, this two-week extension in build times was meaningful. Our team has adapted to the changing conditions, resequencing construction when necessary. We continue to be proactive to the extent possible to mitigate the impact of these issues going forward and are committed to regaining our previous construction efficiency over time. Let me turn it over to Rob to share some details.

Rob McGibney, Executive Vice President and Co-Chief Operating Officer

Thank you, Jeff. In addition to the strain on the labor base that affected both our contractors and our own employees, there were several issues with respect to the availability of materials during the first quarter. And I will begin by sharing a couple of specific examples with you. Flexible ductwork, which is used in heating and air conditioning, is in limited supply due to the lack of stainless steel, a primary component used in manufacturing. We experienced shortages of flex duct in most of our divisions during the first quarter, and our field teams found effective solutions to progress the construction of homes while waiting for this product albeit at a slower pace, as the mechanical trim and other components of a home cannot be finished until the flex duct is installed. We are beginning to see improvement in the availability of flex duct, although our teams are not depending on relief in this area to achieve their current delivery forecast. Appliance manufacturers have not increased their production capacity to satisfy demand. This was compounded in the first quarter by a shortage of double ovens due to a retooling process required to meet a change in federal regulation. In January, we were notified by our supplier that we would be short hundreds of ovens for homes that were scheduled for delivery in the first quarter. Our divisions moved quickly to identify workarounds, including purchasing ovens directly from retailers where available, and we were able to cover most of the shortfall. This retooling issue appears to be a one-time event, and we expect the supply of double ovens to improve in the near term. Garage doors, windows, cabinets, HVAC equipment, and siding all remain constrained within the supply chain. However, we have identified alternate suppliers to supplement many of our product needs with comparable items. In some cases, we are ordering items well in advance of starting homes to mitigate delays, as lead times have extended significantly. Our teams are creative in developing workarounds as issues emerged, and we quickly implemented these practices across our divisions. We've also improved our visibility as to how homes are tracking through each stage of the build cycle and the daily run rate we need within each of those stages to achieve our plan, which improves our ability to both forecast and execute. We expect shortages of materials will stay with us throughout this year, and we will continue to aggressively address any new issues that arise. Over the years, we have taken great pride in our build times and the predictability of our centralized scheduling system. We've had to temporarily adjust our reliance on this system to include more manual processes due to the lack of predictability in getting materials delivered. While the supply chain issues are preventing us from returning to our historical build times in the short term, we are committed to restoring those levels longer term. With that, I'll turn the call back over to Jeff.

Jeff Kaminski, Executive Vice President and Chief Financial Officer

Thanks, Rob. Our biggest challenge today is completing homes, not selling them, as demand continues to be robust. Favorable demographics provide an important tailwind as the largest subset of millennials is nearing the peak age for first-time homeownership and the oldest of the Gen Zs are entering their home-buying years. In addition to demographics, employment and wage growth have both continued to improve, and the shift to working from home is another factor supporting demand. On the supply side, retail inventory remains very limited at 1.7 months, and supply chain challenges have hampered the industry's efforts to catch up on the production of new homes. At 6.6 net orders per community, our monthly absorption rate was seasonally very strong in the first quarter, up from 6.4 in last year's first quarter, even as we continued to implement price increases across the vast majority of our communities, and interest rates began to rise. A particular note is our West Coast region performance, where a healthy increase in our pace and the highest growth in our net order value illustrate the strength of our business in California, both inland and along the coast. Our pricing power is strong, while our pace is solid, and we continue to work toward optimizing each asset. Our order rates speak to the magnitude of demand and also signal that our price points are still attainable. In addition to base price increases, we are capturing higher lot premiums and studio revenues which taken together contributed to a 15% rise in our net order value to $2.2 billion. Net orders in the first quarter were 4,210, down slightly versus the prior year. We are pleased with this outcome given the difficult comparison to the year-ago quarter and an outperforming the projection that we shared in January. Our net orders increased sequentially each month, and we exited the quarter strong, underlying our view that the spring selling season will be robust. In this environment of ongoing strength in market conditions, we are continuing to experience a more rapid pace of community selling out. Our ability to replace these communities and then grow our community count requires ongoing investment through a disciplined process. With an owned lot position of over 51,000 lots and control of an additional 37,000 lots, we have what we need to drive the higher volumes that we expect in 2022 and 2023. We adhere to consistent underwriting criteria, targeting the median household income and assuming an absorption pace per community of between 4 and 6 per month, depending on the specifics of the investment, utilizing current selling prices and construction costs, focusing on communities that provide a two to three-year land supply and staying geographically close to where we currently operate. Affordability for our homes remains reasonable as the key measures that we track for signs of affordability pressures remain consistent with historical levels. One of the most important of these is the credit profile of our buyers. About two-thirds of our buyers qualified for a conventional mortgage, loan-to-value ratios are stable at 85%, which translates to an average down payment of over $70,000. In addition, our buyers' average FICO score in the quarter held at all-time highs of 732. Given that our buyers are well qualified, they have room to adjust if they need to in the type of mortgage product they choose, or in their personalization selections in our build-to-order model. Our buyers can rotate to a smaller square footage home at a lower price. This choice provides an added layer of flexibility, which is key if affordability becomes stretched. We ended the quarter with a backlog of nearly 11,900 homes at a value of $5.7 billion, up 55%. As I noted earlier, almost all the homes that we need to achieve our delivery and margin expectations for the year are already in backlog, and our cancellation rate after start of 5% remains well below historical levels. Our backlog reflects committed buyers with loan approvals on their personalized homes; they generally are closing upon completion. Before I conclude my comments, I would like to thank the entire KB Home team for their tireless efforts and dedication for serving our homebuyers. I would also like to recognize and thank Matt Mandino for his years of leadership and many contributions, as well as to congratulate him on his retirement. Although we acknowledge we are operating at a time of changing dynamics, given geopolitical issues, inflationary pressures, rising interest rates, and the fluid nature of COVID-19, we also recognize the health and resilience of the housing market. We are primed to deliver meaningful, returns-focused growth in 2022, with an expectation of expanding our scale to $7.4 billion and increasing our operating margin above 16%, which would drive a return on equity of over 27%. We look forward to updating you as the year progresses. With that, I'll now turn the call over to Jeff for the financial review. Thank you, Jeff, and good afternoon, everyone. I will now cover highlights of our 2022 first quarter financial performance as well as provide our second quarter and full year outlook. We are pleased that despite increasing supply chain challenges during the back half of the first quarter, we generated a meaningful increase in our housing revenues, which, combined with an improved operating margin, drove 44% growth in our diluted earnings per share compared to the prior year quarter. In addition, sustained strong net order absorption during the quarter, along with our substantial beginning backlog, produced a 55% year-over-year increase in our quarter-end backlog, supporting our revenue and margin outlook for 2022. In the first quarter, our housing revenues of $1.39 billion rose 23% from a year ago, driven entirely by a 22% rise in the overall average selling price of homes delivered, as the number of homes delivered was about even with the year-earlier quarter. Reflecting the broad strength of our operations and the overall housing market, housing revenues were up significantly across all four of our regions with increases ranging from 12% in the Southwest region to 36% in the Southeast. Looking ahead to the 2022 second quarter, we expect to generate housing revenues in the range of $1.55 billion to $1.65 billion. For the full year, we are reaffirming our housing revenue range of $7.2 billion to $7.6 billion, assuming no change in supply chain conditions during the remaining quarters of the year. We believe we are well-positioned to achieve this top-line performance, supported by our first quarter ending backlog value of approximately $5.7 billion and our expectation of continued favorable housing market conditions. In the first quarter, our overall average selling price of homes delivered expanded 22% year-over-year to approximately $486,000 and reflected increases across the business, ranging from 16% in our Southwest region to 24% in our West Coast region. For the 2022 second quarter, we are projecting an average selling price of approximately $490,000. We believe our overall average selling price for the full year will be in the range of $490,000 to $500,000. Homebuilding operating income for the first quarter grew 49% and to $169.6 million from $114.1 million for the year-earlier quarter. The current quarter included nominal inventory-related charges versus $4.1 million a year ago. Our homebuilding operating income margin improved to 12.2% compared to 10.0% for the 2021 first quarter. Excluding inventory-related charges, our operating margin for the current quarter increased 180 basis points year-over-year, reflecting improvements in both our gross margin and SG&A expense ratio, which I will cover in more detail in a moment. For the 2022 second quarter, we anticipate our homebuilding operating income margin, excluding the impact of any inventory-related charges, will be in the range of 14.3% to 14.7%. For the full year, we expect this metric to be in the range of 16.0% to 16.6%, which represents an improvement of 450 basis points at the midpoint as compared to the prior year and a slight increase from our prior guidance. Reflecting our strategy of balancing pace and price to drive higher returns, our 2022 first quarter housing gross profit margin improved 160 basis points to 22.4%. Excluding inventory-related charges, our gross margin expanded by 130 basis points from 21.1% for the prior year quarter. This improvement reflected the favorable impact of higher selling prices outpacing construction cost inflation, particularly elevated lumber prices, and lower amortization of previously capitalized interest, partially offset by greater expenses to support our current operations and expected growth. Assuming no inventory-related charges, we are forecasting a housing gross profit margin for the 2022 second quarter in the range of 24.4% to 25.0%. We anticipate significant sequential expansion in quarterly gross margin during 2022, mainly driven by price increases that have outpaced cost pressures in our established communities, strong selling margins in recently opened communities, and an expected reduction in amortization of previously capitalized interest. We expect our full year gross margin, excluding inventory-related charges, to be in the range of 25.5% to 26.3%, up 410 basis points at the midpoint year-over-year. Our selling, general and administrative expense ratio of 10.2% for the first quarter improved 50 basis points from a year ago, mainly due to operating leverage from higher housing revenues partially offset by higher costs associated with resources to support growth. We are forecasting our 2022 second quarter SG&A ratio to be in the range of 10.0% to 10.5% and expect that our full year SG&A expense ratio will be approximately 9.2% to 9.8%, which represents an improvement of 60 basis points at the midpoint compared to the prior year. Our income tax expense of $43.8 million for the first quarter represented an effective tax rate of approximately 25%, which increased from roughly 21% in the year-earlier quarter, largely due to the expiration of federal tax credits for building energy-efficient homes. We continue to expect our effective tax rate for both the 2022 second quarter and full year to be approximately 25%, assuming the tax credit is not extended. Overall, we reported net income of $134.3 million or $1.47 per diluted share for the first quarter compared to $97.1 million or $1.02 per diluted share for the prior year period. Turning now to community count. Our first quarter average of 213 was down 4% from the corresponding 2021 quarter primarily due to strong net order activity driving accelerated sell-off to communities over the past 12 months. We ended the quarter with 208 communities, essentially even from a year ago. We believe our first quarter end community count represents a low point for the year as grand openings are expected to outpace sellouts during each of the remaining quarters. We expect this dynamic to result in a small sequential increase by the end of the second quarter and low to mid-single-digit percentage growth year-over-year in the second quarter average community count. We believe we are well-positioned for the spring selling season with a growing portfolio of attractive communities across the country. We now expect continued favorable market conditions to drive higher current year net orders and year-end backlog as compared to our prior expectations, resulting in additional community sellouts during the remainder of the year. We continue to anticipate sequential increases in ending community count for each of the remaining quarters and approximately 255 open selling communities at year-end. Given current housing market conditions, our land pipeline, and schedule of new community openings, we are confident that we will achieve expansion of our community count to support future market share gains and growth in housing revenues. During the first quarter, to drive future community openings, we invested $705 million in land and land development, including a 33% year-over-year increase in land acquisition investments to $366 million. In January 2022, Standard & Poor's Financial Services reaffirmed our BBB credit rating and changed its rating outlook to positive from stable. In February, we completed an amendment to our unsecured revolving credit facility, increasing its borrowing capacity by $290 million to $1.09 billion and extending its maturity to February 2027. This upsize and term extension supports our strategy to operate the business with a more efficient level of cash as we continue to drive returns-focused growth. Under the new credit facility, we had $250 million outstanding at the end of the first quarter and expect to end our 2022 fiscal year with no borrowings outstanding. At quarter-end, total liquidity was approximately $1.07 billion, including $831 million of available capacity under the unsecured revolving credit facility. Our quarter-end stockholders' equity was $3.13 billion, and our book value per share increased 18% year-over-year to $35.37. Given our current backlog, community opening plans, and the expected continued strength in the housing market, we are confident that we will generate meaningful year-over-year improvements in our key 2022 financial metrics. We plan to continue to execute on the principles of our return-focused growth strategy with an emphasis on improving our returns by increasing our community count and top line while producing further growth in our operating margins. In summary, for the 2022 full year, using the midpoint of our guidance ranges, we expect a 30% year-over-year increase in housing revenues and a 450 basis point expansion of our operating margin to 16.3%, driven by improvements in both gross margin and our SG&A expense ratio. These anticipated results would, in turn, drive a substantially higher year-end book value per share and a return on equity of over 27%, up in excess of 700 basis points from 19.9% in 2021. We will now take your questions. Alex, please open the lines.

Operator, Operator

Our first question comes from John Lovallo with UBS. Please go ahead with your question.

John Lovallo, Analyst

Thank you for taking my questions. Maybe the first one, it sounds like you haven't seen any or experienced any slowing in demand in any of your markets yet. But I'm curious, do you anticipate some moderation given interest rates, where would you think that you'd see that first? And has there been any incremental use of adjustable rate mortgages, five to seven-year ARMs that you've seen?

Jeff Mezger, Chairman, President and Chief Executive Officer

The buyer profile in our business is currently very robust, which I attribute in part to our operational locations and the demographics I've mentioned. Additionally, we have a strong credit profile among our buyers. Although interest rates have changed, we have not observed any shift in product types or any stress on borrowers' ability to qualify for loans. They simply need to complete a loan application to receive approval. Given the lack of available houses and the strong demographics, we're serving a higher tier of first-time buyers or those moving up, resulting in a diverse group of buyers. So far, we have not noticed any changes in behavior. While we cannot predict the future if rates continue to rise, there have been no signs of a downturn at this time.

John Lovallo, Analyst

Okay. That's encouraging. And just given that bullish outlook, your stock is trading at, I don't know, 20%, 25% discount to book. I mean, why aren't you guys going in and buying a ton of stock?

Jeff Mezger, Chairman, President and Chief Executive Officer

For starters, as we always share, we take a balanced approach to our capital allocation strategy. And first and foremost for us, is to continue to profitably grow the company and improve our returns. If you sort through the various metrics that Jeff shared in his commentary, we're going to be creating incredible value in this company this year, whether it's return on equity or the growth in book value, and that's job one for us. In the past, we've talked about returns-focused growth and improving our debt ratios. We think we've now done that, and our ratio is going to continue to improve through equity growth, and we don't see the need for a lot of debt reduction. We're still generating operating cash. In addition to investing in future growth, if you look back at 2021, we paid dividends, and we also did retire some outstanding stock. So we'll continue to navigate based on our operating needs, what's our excess cash, and what the state of play in the market is like we've always done and continue to have a balanced approach. Rob, do you want to add anything?

Rob McGibney, Executive Vice President and Co-Chief Operating Officer

No, I think it's pretty well covered.

Jeff Mezger, Chairman, President and Chief Executive Officer

Okay.

Operator, Operator

Our next question comes from the line of Truman Patterson with Wolfe Research. Please proceed with your question.

Truman Patterson, Analyst

I just want to follow up on John's first question there, digging in a little deeper. Rates have clearly moved higher in March, and we generally think of California as the most affordability-constrained state in the nation. New home sales today, February sales fell in the West, you all had orders down about 6%. I'm hoping that you can dig in the color in California, either submarket, Northern, Southern, etc., on current March demand and traffic in the state. It sounds like as of now, you are not seeing any sort of pushback. Is that correct?

Jeff Mezger, Chairman, President and Chief Executive Officer

That's correct, Truman. When considering California, it has the highest price point, making it the most affordability-constrained market, as well as the most supply-challenged state. Demand significantly exceeds supply, and due to land constraints, replacing communities is not straightforward. Therefore, we are focusing more on price than on pace. Our order value reflects this strategy; we're not allowing communities to operate at a frenzied pace. We're prioritizing price and seizing the opportunity since replacing communities is difficult. In terms of actual sales, the performance was primarily driven by community comparisons. Our absorption rates were strong. I would say that the coastal urban areas are performing just as well as the more inland areas; both regions are doing very well today.

Truman Patterson, Analyst

Okay. Thank you for that. And then could you help us think through your order versus starts cadence generally at the community level, how quickly do you get the home started after the buyer signs the contract? And generally speaking, how long do you have just costs locked in for with that start?

Rob McGibney, Executive Vice President and Co-Chief Operating Officer

Sure. It varies by division and sometimes by product, but generally, we initiate construction on a home within 30 to 60 days from a book-to-order sale. Once we begin building, our costs are secured. Over the past year, there has been a slight exposure to lumber and a few other materials, but typically, our costs are established right at or shortly after construction begins. Thus, most of our backlog has secured costs.

Operator, Operator

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

Alan Ratner, Analyst

Thanks for taking my questions. So the last couple of days, I've seen popping up on a few builder websites, some incentives related to closing costs and kind of rate lock periods. And I'm sure a lot of this is marketing, and it's probably not very widespread at this point. But I'm just curious in terms of your backlog and kind of your margin outlook for the rest of the year. Are you guys baking in any conservatism around potentially having to fund some closing costs for maybe skittish buyers and backlog that might be reluctant to move forward if rates continue on the upward trajectory they're on right now?

Jeff Mezger, Chairman, President and Chief Executive Officer

Actually, Alan, year-over-year, our closing costs were down. As you know, we don't offer many incentives in our business model, so our closing costs decreased slightly. Considering that our average buyer puts down $70,000, paying $1,000 or $2,000 in closing costs isn't a significant factor. Rob, I’m not aware of any updates in the field regarding incentives or others covering closing costs to help move homes right now.

Rob McGibney, Executive Vice President and Co-Chief Operating Officer

No, Jeff, I'm not either. The demand just continues to be so far ahead of supply that I don't think we certainly haven't gone there.

Alan Ratner, Analyst

I believe you mentioned last quarter that you analyzed your backlog and found that a one-point increase in rates wouldn’t significantly affect it. Now that we’re one point higher, that seems to still hold true. Do you have an updated assessment on when, if ever, this could become an issue for the buyers currently in your backlog? I understand you reference FICO scores and the general financial health of the buyers, but at some point, I assume there must be a threshold where the monthly payments become unaffordable.

Jeff Mezger, Chairman, President and Chief Executive Officer

Yes, Alan, I'll let Rob answer. He's been working directly with our joint venture team at KBH. If you look at our buyer profile and what I mentioned earlier, buyers have shifted towards arms. They're still using fixed-rate loans, which are predominantly conventional. Even with a rate increase, they still qualify and are determined to become homeowners, so they proceed with their purchases. When you ask about the impact of a one-point rate increase on qualification, buyers may choose to increase their down payment or opt for an adjustable-rate mortgage; they still have the desire to own a home. Additionally, the inventory remains extremely low. Therefore, I don't believe we're approaching a stress point due to rising rates, despite what the media is suggesting. Rob, would you like to discuss the specifics regarding the rate increase and its implications?

Rob McGibney, Executive Vice President and Co-Chief Operating Officer

Sure. Rate increases do have some impact, but we're able to qualify buyers at the new rates every day. Although qualification is becoming more challenging for some, the strength of the market in our operating area has enabled us to meet our sales targets, even with rising prices. If one buyer doesn't qualify, there are others ready to step in. Regarding the stress testing we conduct on our backlog and the strong financial position of our buyers, we anticipate minimal fallout if the rate increases are gradual. Buyers are likely to adapt by paying down debt, involving a co-borrower, or choosing a different loan program. With our business model, they can also choose to spend less in the studio or opt for a smaller, more affordable home.

Operator, Operator

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

Mike Rehaut, Analyst

My first question, I guess, just kind of looking at the trajectory of gross margins, which effectively, you've kind of reiterated as you look into the back half of the year. If I'm interpreting it right, I mean, obviously, you're effectively reiterating it. I think you raised it by 10 basis points. Just trying to get a sense of some of the moving pieces because obviously, you most likely incurred some additional costs as you still have some supply chain issues impacting the business. At the same time, it looks like you're continuing to execute price. So, is it safe to say that in terms of thinking of the different moving pieces that, in effect, costs continue to go up and you're just able to continue to offset that with price? Obviously, your full year ASP up $10,000 is proof positive of that. Is that the right way to think about that?

Jeff Kaminski, Executive Vice President and Chief Financial Officer

Yes, Mike, it is. That's a primary factor, right? What's happening on the selling price side relative to costs? We've been dealing with that as a company and as an industry now for a couple of years. It's been a positive dynamic for us actually at the end of the day. The same factors we've been seeing that drive improved margins. There really hasn't been much change in the outlook from last quarter on full year margin, other than costs moved probably a little more than we saw. But price also moved, based on your observation, which is accurate that the ASP is up a little bit. The other things we're seeing, we're seeing really strong performance out of our recently opened communities. It's been very pleasing to see vast majority, almost all of them, opening at a broad land book levels with really strong gross margins that are actually incremental to the whole. As those start delivering out in the back half of the year, we'll start seeing some advantages of that running through the P&L. Interest amortization has been a long-term trend for us of improvement that's continuing. Something I didn't mention in the script, but I think there's a pretty good potential for us to pick up on a little bit of additional leverage on our fixed costs and gross margin again, predominantly starting in the second quarter and running right through the end of the year. So a lot of good positives, nice positive momentum, and really just a continuation of the trends that we've seen, has given us the margin lift that we're seeing in 2022 relative to 2021 and the same thing in 2021 over to 2020. So continuation there, we're very pleased about it.

Mike Rehaut, Analyst

Great. Thanks for that Jeff. I guess secondly, there's been some talk recently about trying to triangulate how much of current demand that's out there is from a primary buyer versus either, in effect, an investor. Besides individual investors, you have the entire kind of single-family rental operator and build-to-rent operators that are out there. I guess more just on a micro level, can you give us a sense today versus perhaps a year ago or two years ago, what percent of your buyers are owner-occupied-type purchases versus investors that would be renting out the property?

Jeff Mezger, Chairman, President and Chief Executive Officer

Mike, I’m not sure about that number because we don’t specifically track investor activity. We are definitely not targeting single-family rental buyers. The majority of our customers continue to be owner-occupied buyers looking for homes for their families in those neighborhoods. Rob, as you monitor the deliveries, do you have any data on what percentage comes from investors?

Rob McGibney, Executive Vice President and Co-Chief Operating Officer

Yes, Jeff, I don't have a data point on that. But just from working with the operators and the regional teams, it's very limited. Not having a number, I hesitate to put one out there, but I'd say it's low single digits. We're where we've got investor sales. It's generally all owner-occupied.

Operator, Operator

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

Stephen Kim, Analyst

I guess my first question relates to your land positioning. I was curious if you could give us a sense for what percent of the land that you took ownership of this quarter was through options, exercising options versus just buying it out in the open market. And if you had to take a stab at what percent of your land that you currently own reflects pricing from, let's say, early to mid-2020. What percent would you say of the land that you own meets that kind of criteria?

Jeff Mezger, Chairman, President and Chief Executive Officer

Yes, pretty specific questions as far as dissecting the land portfolio. I would say in the first question, most of the land that we end up taking down at some point is an option, right? So you're at some point, optioning up land on refundable deposits and going through due diligence and that type of activity. I would say pretty much all of our land at 1.9% was an option. If you're talking just pure rolling option quarterly takes, it's a relatively low percentage because those type deals I wouldn't say pretty much all of it disappeared in the slight land market right now. So that's sort of the condition on that. When you look at our land portfolio and the churn that we're seeing in communities, specifically in communities, we do tend to turn half to two-thirds of our communities every year, and you start getting more and more current on your land. When you're looking out to third and fourth-quarter deliveries, a lot of that land was actually locked up and prices were locked in, in 2020. There were some deferred land closings in 2020. So it was actually even a little bit longer on the tail of that vintage, if you will, land where after the pandemic first hit, we went in and just kicked out a lot of the closings, and sellers were pretty cooperative. We feel we have a really good business relationship with new partnerships with a lot of those sellers and allow us to take a little bit of uncertainty out of the outlook before we close out of land. We're still operating the business. So with some of the newer communities coming in, we're not really at the 2020 mark. The margins are still holding. We're seeing an upward trajectory on margins. We're looking at exiting 2020 at a very, very healthy margin rate that we think will carry into 2023.

Stephen Kim, Analyst

Yes. Thanks, Jeff. So what I heard from you, what I thought was interesting was that you sort of suggested there were factors that play in early 2020, such that the land you may even buy in mid-2020 or maybe even as late as the third quarter reflected very much pre-pandemic kind of pricing, correct?

Jeff Mezger, Chairman, President and Chief Executive Officer

Absolutely.

Stephen Kim, Analyst

No, that's great. I appreciate that. My second question relates to what I guess I would characterize as a bit of a dislocation between or a significant disagreement between the way you see your future business prospects and the way the market seems to be valuing your stock. John earlier sort of alluded to the question about buybacks, whether or not this will be a good time to be stepping in a little bit more aggressively. I think the answer was that, look, there's opportunities to grow the business. I think you've laid out a compelling case that there are reasons to think that demand is going to be strong and you're in a good position to capture that. But by the same token, it does also seem that if that is correct, and that proves to be correct, the way the market is valuing your shares is probably demonstrating the biggest gap versus your perception or your perspective than we've almost ever seen. Because you have done a pretty good job bringing our leverage down to the level that it's at and the likelihood that it will be even lower by year-end. I'm curious if you could talk a little bit more about when you compete incentives of growing the company versus taking advantage of mispricing that the market has provided. How do you think about that at a high level sort of philosophically?

Jeff Mezger, Chairman, President and Chief Executive Officer

Look, it's an interesting question. I think there's a lot of factors that go into it, right? The primary factor is where we're heading and how best to build long-term value for our shareholders. Growth is a very important factor. We want to maintain scale. We've been fighting hard for a number of years to re-grow this company and really get ahead of the curve on community count growth and top line. It's paying off in a big way right now with the metrics. We definitely believe keeping putting points on the scoreboard and sooner or later the market will recognize that. We have not been averse in the past to go in and make opportunistic buybacks when we did feel there was a large dislocation. At the same time, we're not going to debate it on an open conference call, timing and when we do something like that. But we are constantly aware of it and discuss it. We've made several moves on that over the past few years. It's hard to even explain the dislocation that we're seeing right now with how well the business is doing. When I look at the metrics and where we've taken this company to, it's discouraging at times to see it. But also at the same time, I know we're playing a long-term game and we're continuing to grow the value and strengthen the company, and we're pretty happy with that and proud of that.

Operator, Operator

Thank you. Our next question comes from the line of Matthew Bouley with Barclays. Please proceed with your question.

Matthew Bouley, Analyst

Thank you for taking the questions. So on the affordability topic, I know you mentioned your measures of affordability have been consistent, home sizes and upgrades and all that. And then obviously, buyers have their own flexibility with your build-to-order model as well. But just thinking about kind of a go-forward view, I think of late 2018, where, for example, you introduced the smaller square footage plan to kind of get ahead of that rate increase at the time. I guess today, are there any other proactive steps that you can take with your products to, again, sort of get ahead of what could happen here in a higher rate scenario?

Jeff Mezger, Chairman, President and Chief Executive Officer

Matt, we're constantly mindful of household incomes. It is a math equation. People can only afford so much, and it's the combo of supply and demand and affordability. So we get that. In a lot of markets, we've moved to smaller lots, more townhomes, some things like that to keep the prices down and attainable by the median household incomes. While we went through that exercise and moved very quickly in the past with our product, we had rolled out new models that were presented to the market; lo and behold, interest rates came back down. It is out there, and it's a strategy that demonstrates how quickly we can move. We really didn't need it at the time and haven't needed a pet. The good news is all those products are completed on the shelf, and if we have to quickly roll out smaller models and reset our pricing in a community, we can do that in relatively short order. So it's all out there still, and I like the flexibility in our approach. The buyer can choose fewer things in the studio, pick a lot with a lower lot premium, select a smaller home at a lower price point, or change whatever mortgage instrument they decide on to acquire their home. All those things moving together mean there's a lot of flexibility for the consumer and for us right now. We think we're positioned well if rates were to continue to run.

Matthew Bouley, Analyst

Thank you for that, Jeff. I have a question about the gross margin. I'm curious about the guidance for Q2 and how that might impact the second half. From an exit rate perspective, Jeff K, do you think we could see an increase to over 26% in Q4 based on the improved visibility? How should we approach the cadence for the second half that you're suggesting?

Jeff Kaminski, Executive Vice President and Chief Financial Officer

Sure. Yes. Starting with the second quarter guidance of 24.4 million to 25 million, I usually don’t provide too much detail about the second half or quarterly expectations. However, based on the numbers, the third quarter is expected to exceed 26%, and the fourth quarter will likely reach around 27% based on our current outlook. This would bring our average for the year to approximately 26%, with a midpoint of 25.9%. That would represent a strong exit rate for us, and we would be very pleased to achieve that. It’s important to note that most of the revenue we anticipate from home closings by year-end is already reflected in our backlog. This isn’t just theoretical; we already have homes accounted for that will help meet those margin targets, which is a positive trend. We’ve observed solid predictability in our margins over the past couple of years, and we’re looking forward to seeing this continue.

Operator, Operator

Thank you. Our next question comes from the line of Deepa Raghavan with Wells Fargo. Please proceed with your question.

Deepa Raghavan, Analyst

Thanks for taking my question. Just related to that gross margin question a little bit, the peak number from last spring already hit your books and you have been benefiting this Q1? Or are you still paying for the peak pricing from last spring? Therefore, what we would see in Q2 and Q3 will be the benefits once it went lower. But again, the recent lumber spike starts to hit at Q4. How does that number peak and valley hit your connections?

Jeff Mezger, Chairman, President and Chief Executive Officer

Right. You just tried it pretty accurately. I mean Q4 was a real heavy quarter for us, in the peak of lumber. We saw some bleed into Q1. It affected the margins a bit in the first quarter. We'll see some relief and some bounce back in the second and third quarters. We constantly update our cost and our backlog. Anything we’re seeing with the home that starts on a higher lumber price is baked into our cost profile. Over that same time period, obviously, selling prices have escalated quite a bit, and we even saw continued escalation in the ability to increase price in the first quarter to a large degree helping to offset that. So, we just try to capture that accurately. Q4, Q1 heavy Q2, Q3, some more relief keeping that back in a little bit, but pricing has moved as well to help offset it.

Deepa Raghavan, Analyst

Staying just on the constraints, can you help us understand how the quarter progressed with respect to labor constraints? The reason I ask is Omicron likely impacted your December quarter maybe towards the tail end, a good chunk of January. But it looks like February was getting better. Just curious what would explain the second-half incremental challenges that you faced? And how has March so far played out with respect to those labor challenges? Thank you.

Jeff Mezger, Chairman, President and Chief Executive Officer

Rob, do you want to take that?

Rob McGibney, Executive Vice President and Co-Chief Operating Officer

Sure, Jeff. I think the best way is to provide some perspective on the labor, both internal and outside of KB is just through some of the numbers that we saw within our company. Through the fourth quarter and moving up to mid-January, we were seeing roughly 100 KB employees a month that were impacted in some way by COVID and were in a quarantine process. Between mid-January and early February, that number spiked to over 500 employees, so roughly a quarter of our workforce. We really felt the operational impact of that spike in the back half of the first quarter with employees out on quarantine and the COVID exposures or cases were most prevalent in our field teams. We likely had over 30% of our construction staff impacted during that spike. Of course, our trade partners, our suppliers, our inspectors, the utility crews, etc., they were also hit in a big way. Transitioning now, that number tracking at a peak of over 500 in March, we're tracking numbers like 25 employees. The Omicron variant impact was sudden, it hit in a hurry, and then it was all gone quickly, but the impact on our construction in the back half of the quarter was real. Today, we're seeing an improvement in both external labor and internal employee availability relative to what we saw in the back half of last quarter.

Operator, Operator

Thank you. Our next question comes from the line of Susan Maklari with Goldman Sachs. Please proceed with your question.

Susan Maklari, Analyst

Thank you. Good afternoon, everyone. Thanks for taking the questions. My first question is looking at the margins, you actually did a really nice job on the SG&A. This quarter you came in a little lower than what we had expected. The guide implies some further incremental leverage as we move through the year. Can you talk to the potential to continue to see some improvement there? And if things do change, what is your ability to sustain some of this relative benefit that you've seen?

Jeff Mezger, Chairman, President and Chief Executive Officer

We anticipate further improvement in SG&A, especially in the latter half of the year as we expect higher housing revenue. It's been a steady progression, and we are currently investing more in the business because we are in a growth phase, with a significant increase in community count and a strong absorption pace in our communities. This supports the numerous grand openings we have planned. We see potential for a single-digit SG&A number for the year, and we believe we can reduce it even further in the future. By the end of this year, we expect to reach a new level of scale, allowing us to achieve additional cost leverage in the SG&A category.

Susan Maklari, Analyst

And then my second question is going back to the land market, you made the comment that you're saying geographically close as you're buying new parcels. But as you think about an environment where rates are rising, obviously, home prices are going up as well. How do you think about the ability to strike the need to maintain affordability while still also staying geographically close and managing the risk on the land side? With that, are you seeing any signs that the industry overall is overstepping, overreaching at all on the land side? Do you think that everybody is fairly disciplined as it relates to that? Any signs that we're sort of getting closer or maybe just some of the behaviors or activity that we saw in the last cycle, or has it been pretty measured as you think about the growth that everyone is targeting and looking for over the next couple of years?

Jeff Mezger, Chairman, President and Chief Executive Officer

I think measured is a good word. In our case, we're very sensitive to not going out. My reference in our investment committee is to go out where the road ends and the road end because you're chasing a lower price point. We'd rather stay in the more desirable submarkets and target the incomes in those submarkets. It's a healthy tension with our land teams because there's more land available out in the lesser areas, but it's also where the market slows first if the market were to turn. So we stay in, I would call it, the B2B- minus ring and really work with our divisions and our land search efforts to make sure that you're in more desirable submarkets. It probably means it's a little smaller deal in lot count and therefore, you got to find more of them. It's a healthy tension with the teams. But we'd rather go that route than go out to the real experts just for a pure price play.

Operator, Operator

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