Century Communities Inc

NYSE:CCS

Earnings Call Transcript 2022-Q4

[Operator]

Hello and welcome to the Century Communities Fourth Quarter 2022 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded.

I would now like to turn the conference over to Senior Vice President of Investor Relations, Tyler Langton. Please go ahead.

[Tyler Langton, Senior Vice President, Investor Relations]

Good afternoon. Thank you for joining us today for Century Communities earnings conference call for the fourth quarter and full year 2022. Before the call begins, I would like to remind everyone that certain statements made during this call may constitute forward-looking statements. These statements are based on management's current expectations and are subject to a number of risks and uncertainties that could cause actual results to differ materially from those described or implied in the forward-looking statements.

Certain of these risks and uncertainties can be found under the heading Risk Factors in the company's latest 10-K as supplemented by our other SEC filings. We undertake no duty to update our forward-looking statements. Additionally, certain non-GAAP financial measures will be discussed on this conference call. The company's presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP.

Hosting the call today are Dale Francescon, Chairman and Co-Chief Executive Officer; Rob Francescon, Co-Chief Executive Officer and President; and David Messenger, Chief Financial Officer. Following today's prepared remarks, we will open the line up for questions.

With that, I will turn the call over to Dale.

[Dale Francescon, Chairman and Co-Chief Executive Officer]

Thank you, Tyler, and good afternoon, everyone. During the fourth quarter, we focused our sales efforts and incentives towards available homes with near-term deliveries to monetize these homes, even though they carried lower margins due to inflated direct construction costs, given their start dates earlier in the year. The goals behind this strategy included increasing our cash position, reducing leverage metrics, and positioning us to start new and lower cost homes. As a result of the efforts, we generated $382 million of operating cash flow during the fourth quarter and reduced our net debt to net capital ratio down to 23.5%, the lowest year-end level in our history as a public company.

Our solid results this quarter also included $102 million in pre-tax income, net income of $79 million, diluted earnings per share of $2.47 and EBITDA of $121 million. In the fourth quarter, we delivered 2,903 homes, the second highest level of closings in our history, and only 12 homes off a record level of homes delivered in the fourth quarter of 2021. While supply chain pressures weighed on the pace at which we could deliver homes throughout most of 2022, these disruptions improved as the year progressed, helping us to achieve the strong level of closings in the fourth quarter.

Revenues from home sales were $1.2 billion, the highest quarterly level in our history; while our average sales price increased by less than 1% on a year-over-year basis to $397,000 consistent with our goal of building affordable homes.

Gross new contracts in the fourth quarter totaled 2,008 homes and net new contracts were 1,258, due to an elevated cancellation rate, mortgage rate volatility and overall economic uncertainty keeping many potential homebuyers on the sidelines. Our quarter end backlog consisted of 1,810 sold homes valued at $671 million. While we expect home sales will continue to be pressured in the near-term as buyers adjust to higher mortgage rates and uncertainty in the economy, we also believe that underlying demographics remain favorable.

Additionally, we think buyers are beginning to return to the market now that rates are stabilizing at levels below recent highs. An indication of this is that both our net and gross new contracts in November and December were well above October levels, leading us to believe that the decline in mortgage rates that started in November, led to an improvement in sales. During January, we've experienced further improvement in home buyer activity.

Similar to the past several quarters, homebuyers are continuing to look for homes that are closer to completion in order to lock in their interest rates. Consistent with our strategy, we intend to continue concentrating our sales efforts on homes with more near-term completions and are not focused at this point on building up a significant sold backlog of major term deliveries.

Incentives on closed homes in the fourth quarter increased to about 900 basis points of average sales price from roughly 300 basis points in the third quarter. A significant amount of these incentives were in the form of forward commitments and rate buydowns that drove traffic and sales, especially when mortgage rates went above 7%. While we will continue to move inventory by finding the market clearing price on a community by community basis, we expect the average level of incentives that we're offering to moderate a bit, especially with the recent retrenchment in interest rates.

In the fourth quarter, we generated adjusted gross margins of 20% with higher incentives being the largest driver of this expected decline compared to last quarter. These incentives applied not only to new sales with near-term closings, but also to many backlog homes that had been sold earlier in the year. Consistent with our strategy of prioritizing the sale of complete and completing inventory, we expect our margins in the first quarter of 2023 will be consistent with those of the fourth quarter of 2022 as the homes delivering will be burdened with similar elevated construction costs, given their start dates earlier last year and higher incentives than historical norms.

Many of our planned starts in the second half of last year were postponed due to increased incentives and elevated input costs that had become commonplace in our industry. Our corporate, regional and divisional purchasing teams rose to the challenge, and have made great strides in reducing costs across the board. As a result, we began starting homes at a greater pace in November and December, which has accelerated into this year. Due to the improvement in direct construction costs, reduced incentives and shorter cycle times, these homes are expected to carry a higher margin profile as they begin to close. As a result, beginning in the second quarter of 2023, we expect homebuilding gross margins to trend positively on a sequential basis through the balance of the year as they return to more normalized levels.

Before turning the call over to Rob, I wanted to briefly recap our record setting performance for the full year 2022. During the year, which was not only the company's 20th anniversary but the 20th consecutive year of profitability, we delivered 10,594 homes, the second highest level in our history. Gross margins and adjusted gross margins for the year averaged 25% and 26% respectively, both company records. Net income increased 5% year-over-year to a company record $525 million and earnings per diluted share increased 10% to $15.92 per share, also a company record. Finally, our book value per share at year end increased to a record level of $67.67, with our total stockholders' equity increasing to $2.2 billion, the highest in our history.

We believe we have the right strategy to navigate the current headwinds in the housing market and one that positions us well as conditions normalize. Buyers are currently looking for affordably priced homes with near-term completions and we intend to meet this demand. We will find the market clearing price for our homes nearing completion, knowing that it may weigh on margins in the near-term. We are also confident that we will be able to redeploy capital and start new homes from our current lot supply that will earn both better margins and higher returns going forward, due to lower direct costs, improved cycle times and reduced levels of incentives.

In closing, on behalf of the entire senior management team, I want to thank our employees across our national footprint. Our achievements this year would not have been possible without their hard work and dedication, and we greatly appreciate their commitment to both Century and our valued customers.

I'll now turn the call over to Rob to discuss our business and plans going forward in more detail.

[Rob Francescon, Co-Chief Executive Officer and President]

Thank you, Dale, and good afternoon, everyone. Our strategy of concentrating sales efforts and incentives on inventory with near-term completions was very productive and enabled us to deliver 2,903 homes, representing 84% of beginning backlog, an approach we intend to continue. We have a strong presence within the affordable new home category with approximately 81% of fourth quarter deliveries coming from homes priced below FHA limits, allowing us to target the widest range of potential buyers in any given market.

Additionally, back in December, the FHA announced higher loan limits for 2023. And with these higher limits, approximately 90% of our fourth quarter deliveries would have come from homes priced below FHA limits. Our homebuyers continue to have a healthy financial profile. Century Communities and Century Complete's homebuyers had respective average FICO scores of 737 and 711, consistent with levels experienced throughout the year. Our cancellation rate was 37% in the fourth quarter, with roughly equal rates at our Century Communities and Century Complete brands. Our cancellation rate declined as the quarter progress to a rate of 28% in December, with also roughly equal rates at both brands. The number of cancellations further declined in January.

The homebuilding industry continues to be challenged by municipal and utility delays, supply chain issues and trade shortages. These pressures are starting to ease especially as housing starts have slowed and capacity has improved. We have seen improvements in our direct costs throughout the construction cycle, which declined by roughly 9% in the fourth quarter, versus the high watermark in the second quarter of the year, an average of approximately 16,000 per home. Looking forward, we expect our direct costs to continue to decline and our cycle times to improve as supply chain and trade shortages further subside.

We ended the quarter with approximately 53,000 owned and controlled lots, with roughly 60% owned and 40% controlled. This total lot pipeline was down from roughly 63,000 lots at the end of the third quarter 2022 and 80,000 lots at the beginning of the year. This decline was almost entirely within our bucket of controlled lots, as our own lots have remained relatively unchanged compared to the last quarter and the beginning of the year. Our 32,000 owned lots provide approximately three years of deliveries based on 2022 volumes, which is consistent with past years. We continued to step away from land deals throughout the second half of 2022 that no longer met our investment standards and that were generally higher in price than our owned lots.

Given the effectiveness of our land strategy, we were able in the fourth quarter to reduce our land pipeline by nearly 10,000 lots and our acquisition commitments by approximately $270 million, while incurring minimal abandonment costs of roughly $4 million. For the full year, we reduced our land pipeline by a total of nearly 27,000 lots and our acquisition commitments by over $650 million for only $12 million in abandonment costs. This strategy allows us to control significant amounts of land for future growth during periods of high sales absorptions for limited investment, and exit those positions at a reasonable cost in the event of a market downturn, all without adversely impacting our near-term need for lots on which to start homes. Looking forward, we expect the recent decreases in our controlled lots to start leveling off.

Century's total community count at quarter end stood at 208, down from 217 in the previous quarter, but up from 202 in the year ago period. Our community count dropped sequentially in the fourth quarter due to closeout of various communities and our conscious decision to delay the opening of certain new communities in the second half of the year as market conditions deteriorated. Looking ahead, we expect to grow our community count at a measured pace as the recent declines in direct costs, moderation of incentives, and expected improvements in cycle times has given us increased confidence in our ability to generate solid margins and returns from the new communities we opened. Given the extent of our existing land pipeline, our year end 2023 community count could be in the range of 250 to 260 communities if we elect to open all communities that we expect to be available.

In the face of numerous market challenges, we are very pleased with our performance this quarter and for the full year. Going forward, our strategy remains consistent: Continue to find market prices for completed and completed homes that were started earlier last year with elevated costs, manage land spend and generate operating cash flow that will be reinvested in new homes with improving margin profiles that will be started in the first half of 2023 and beyond.

I'll now turn the call over to Dave to discuss our financial results in more detail.

[David Messenger, Chief Financial Officer]

Thank you, Rob. We met our objectives and delivered healthy results this quarter, which resulted in the generation of strong operating cash flow and meaningful reductions in our gross and net homebuilding debt ratios. During the fourth quarter of 2022, net income was $79.5 million compared to $165 million in the prior year quarter or earnings per diluted share of $2.47 compared to $4.78 in the year ago period. Full year net income increased to $525.1 million, while earnings per diluted share increased to $15.92, both company records. Fourth quarter pre-tax income was $102.4 million. And our full year pre-tax income increased to $676.9 million, the highest in the company's history.

Home sales revenues for the fourth quarter were $1.2 billion, slightly above last year's levels. Home deliveries of 2,903 homes were down less than 1% on a year-over-year basis, while our average sales price of $397,000 was up by less than 1%. Home sales revenues for the full year increased 9% to a company record of $4.4 billion driven by an 11% increase in our average sales price. Home deliveries of 10,594 homes were the second highest in our company history and nearly flat with last year's record levels of 10,805.

In the fourth quarter, net new contracts across our footprint were 1,258. Similar to last quarter, this year-over-year decline was primarily due to elevated cancellation rates and the impact that the sharp increase in interest rates had on potential homebuyers. New contracts before cancellations totaled 2,008 homes. At quarter end, our backlog of sold homes was 1,810 valued at $671 million, with an average price that had decreased by 8% year-over-year. In the fourth quarter, adjusted homebuilding gross margin percentage was 19.8% compared to 27.3% in the prior year quarter. Homebuilding gross margin was 17.6% or 18.4% when excluding inventory impairments, compared to 25.9% for the same period last year. As we discussed on our last quarterly call, this reduction in margin percentage was expected and primarily resulted from our strategy of generating cash and reducing our leverage profile by focusing our sales efforts and incentives on near-term deliveries, even though they carried elevated construction costs due to their start dates earlier in the year.

In the fourth quarter of 2022, we also recorded an inventory impairment charge of $10.1 million. For the full year, homebuilding gross margin percentage improved to 24.5% compared to 24.2% and adjusted homebuilding gross margin percentage improved to 26% from 25.9%. SG&A as a percent of home sales revenue was 9.5% in the fourth quarter compared to 9.3% in the prior year. This minor increase was a result of higher commission costs year-over-year due to market conditions with the balance of the costs below the prior year levels. For the full year, SG&A as a percent of home sales revenue was 9.8% compared to 9.7% in 2021.

Pre-tax income margin for the quarter was 8.7% compared to 17.6% in the prior year. For the full year, pre-tax income margin was essentially flat at 15% versus 15.2% in 2021. We incurred $5.1 million of other expense in the fourth quarter, including $4.2 million of expense from the abandonment of certain deposits and feasibility costs. For the full year, we incurred $11.6 million of expenses from the abandonment of deposits and feasibility costs. As a reminder, our charge-off of these deposits and feasibility costs was a result of our deliberate decision to step away from land deals that no longer met our investment standards as a result of the market shift.

During the fourth quarter, financial services captured 65% of the closings, generating $23.1 million in revenues compared to $31.2 million in the prior year quarter, primarily due to forward commitments entered into in prior quarters, fewer loan originations and increased competitive pressures. The business contributed $12 million in pre-tax income compared to $12.7 million in the prior year quarter, a significant accomplishment given the decline in revenues and volatility surrounding the mortgage market.

During the quarter, we maintained our quarterly cash dividend of $0.20 per share and did not repurchase any shares of our common stock. As a reminder, in the first three quarters of this year, we invested [$120.6 million] in repurchasing 2.3 million of our common stock at an average share price of approximately $52.32 or a roughly 23% discount to our year end 2022 book value of $67.67 per share. These share repurchases in 2022 reduced our share count by approximately 7% with approximately 1.5 million shares remaining available for repurchase under our current authorization. As a result of executing on our objectives, we generated $382 million in operating cash flow in the fourth quarter. Our net homebuilding debt to net capital ratio declined significantly to 23.5% compared to third quarter 2022 levels of 32.5% and the lowest year end level in our history as a public company.

Our homebuilding debt-to-capital ratio declined to 32% at quarter end compared to 36.3% as of the end of the third quarter of 2022. For the 12 months ending December 31, 2022, we generated a return on equity of 26.8%, which represented our seventh consecutive quarter with a return on equity above 25%. We ended the quarter with a strong financial position, including $2.2 billion in stockholders' equity, a 22% year-over-year increased, and $1.2 billion in total liquidity, including $353.3 million in cash.

In the fourth quarter, we paid off the $165 million outstanding on our revolving credit facility and have no borrowings outstanding on the $800 million facility that does not mature until April 2026. Additionally, we have no senior debt maturities for five years, providing us ample flexibility with our leverage management.

Now turning to guidance, the homebuilding industry last year was impacted with increasing interest rates, rising costs, declining ASPs, and deteriorating demand. We have begun to see mortgage rates stabilize and homebuyer traffic on sites increase. For the first and second quarters, we expect our deliveries to be below prior year levels. This expected decrease is due to the fact that we delayed community openings, started fewer homes in the second half of 2022 as the market softened and successfully executed in the fourth quarter on our strategy of prioritizing the sale of near-term deliveries, leaving us with a limited number of completed spec homes. As a result, we will simply have fewer homes available for delivery in the first two quarters of 2023, while we start new homes with lower input costs for delivery in the second half of 2023. For the full year 2023, we expect our deliveries to be in the range of 7,000 to 8,000 homes, and our home sales revenues to be in the range of $2.6 billion to $3.1 billion.

In closing, we believe that our spec based model, dedicated focused on our own more affordable homes, geographic footprint and solid balance sheet, positions us well to navigate the current market, as well as thrive in improved economic environments.

With that, I'll open the line for questions. Operator?

[Operator]

[Operator Instructions] Today's first question comes from Carl Reichardt with BTIG.

[Carl Reichardt, BTIG]

I wanted to ask a regional question. Southeast orders came down quite a bit I think 70% and the store count was flat. Just curious, with the performance there, can you talk a little bit about what happened there? And then following on to that, from a West and Mountain Region perspective, you've got a lot of lots, backlogs pinned up in the West. So is the focus, especially in the first half of the year going to be on working through lots and houses in the West?

[David Messenger, Chief Financial Officer]

Hey, Carl. This is Dave. I'd say, the answer to your question on the Southeast community count was flat and sales were down, but that was really a function of the Southeast throughout the first half of the year was still strong on sales, leaving '21 and the '22 both strong on sales. We just didn't have any product and so we just didn't have enough near-term completing specs or completed specs really available in those markets for us to be selling in Q4. So we saw that drop off, even though we've got some open communities. On the West Coast, yes, the first half of this year, as sales have come down, you're going to see us work through some of that existing inventory that was started earlier last year. And that's something we started at higher direct costs, and we've seen those prices come down, and we'll work through that inventory here the first half of 2023.

[Carl Reichardt, BTIG]

Thanks, Dave. So Southeast then is a function more of product availability as opposed to an excessively elevated can rate compared to the rest of the company?

[David Messenger, Chief Financial Officer]

Correct, correct. We definitely still see the Southeast being a strong region. It’s been just more a function of homes under construction.

[Carl Reichardt, BTIG]

And then one -- when you talked a little bit about the trends continuing in January from the improvement as you saw through the quarter and 4Q, would you describe what you're seeing in January as better than what you'd expect seasonally, worse than or about what you'd expect seasonally? Thanks.

[Dale Francescon, Chairman and Co-Chief Executive Officer]

Well, in terms of seasonal, I mean, we're certainly seeing an improvement in sales traffic and overall sales. And so, whether you call it seasonally or just an improvement because of the lower interest rates that are now in the market, it's hard to tell. But the easiest thing to say is, January is improving over December. And from what we can see, we expect that to continue as we go forward.

[Operator]

The next question comes from Alan Ratner with Zelman & Associates.

[Alan Ratner, Zelman & Associates]

Thanks for all the great info. A lot of interesting comments there. First, I'd love to drill in a little bit on some of your comments on pricing and incentives. It sounds like if I'm interpreting the comments correctly that you think that pricing or net pricing has effectively bottomed here, given that you're kind of guiding for incentives to decline as the year goes on. So first of all, I want to make sure I'm understanding that correctly. And as soon as I am, does that imply that you feel like among your cohort of buyers, that affordability is kind of where it needs to be to kind of generate volume growth in the business over obviously a longer time period?

[Dale Francescon, Chairman and Co-Chief Executive Officer]

Alan in the fourth quarter, we were really addressing affordability across all subdivisions. And we had forward commitments, we had rate buydown programs available. We don't have any of those in place now. We obviously still help some of our buyers on a case by case basis, but has -- as rates have come down, we don't see the need that we have to do it across our entire portfolio.

[Alan Ratner, Zelman & Associates]

And to that point, have there been any offsets to that, that we should think about as far as pricing, like have there been base price adjustments or anything? I'm just trying to think like, obviously incentives is one way you attack the affordability equation. But home prices have gone up quite a bit over the last several years. So are you keeping the base price flat even as you're pulling back on those mortgage incentives that you had been offering?

[Dale Francescon, Chairman and Co-Chief Executive Officer]

Well, typically in an existing community, we won’t be dropping base prices. But as we're opening new communities, it becomes far easier to adjust base prices. We don't have any backlog. And more importantly, we're bringing out homes that have lower input costs in them than something that would have been started quite some time ago. But in general, as we are seeing in our -- in the fourth quarter, our incentives went up pretty significantly over what we had in the third quarter and what we would normally see. And a significant component of that related to really the company-wide mortgage programs that we were offering.

[Alan Ratner, Zelman & Associates]

Okay. And I appreciate that. You brought up the input cost, which was kind of the second question I was going to throw at you guys. If I heard you correctly, I think you said that your direct costs are down about $16,000 from the peak. Correct me if I'm wrong on that. But, generally, I think your commentary, it sounds more bullish than I think a lot of other builders up to this point and a lot of them have been kind of highlighting their optimism that they will be able see some cost relief as '23 goes on. But I think you guys are probably the first to kind of highlight significant reductions. And I'm curious if you could kind of split that out a little bit, like how much of that is lumber versus other inputs or labor that you have actually seen some relief on?

[Dale Francescon, Chairman and Co-Chief Executive Officer]

It's around two-thirds of it on lumber, and the balance on some of the other areas. And it depends too. And some of the back end areas we got released, but really a lot more on the front end where things have slowed down on starts across the board and people are not nearly as busy as they were. So we are getting that potential reduction there, where people are more readily available to come and perform their work at the pricing. So it's an ongoing focus of ours and not only in the division but regionally and then from the corporate team as well. And I think our team has done a really good job of getting the input costs down, because candidly, they were just way too high at the beginning and middle of last year.

[Alan Ratner, Zelman & Associates]

Got it. That's helpful. So that $16,000, if I just look at some rough math here, your average pricing backlog is about $370,000. So call it a 4% margin impact all else equal. Is that how we should think about your comments as far as once you get past the first half of the year, you see margins lifting sequentially. Is that 400 basis points kind of assuming all else equal pricing stays flat, everything else stays flat and what we should expect to see?

[David Messenger, Chief Financial Officer]

You hit it right on the head. You did the math and that's exactly it. So yes.

[Operator]

The next question comes from Jay McCanless with Wedbush. Please go ahead.

[Jay McCanless, Wedbush Securities]

Good afternoon. Just a couple of questions on the guidance for '23. If you average out the community count to around 225, 230, and then the closings -- the midpoint of the closings, it looks like you guys are expecting maybe less than three closings per month for fiscal '23 versus being anywhere between three and four really since fiscal '18. I guess it seems a bit cautious, a bit hesitant. Maybe talk us through why you are going to such a low closure -- what we perceive to be a relatively low closing guidance to start the year?

[Dale Francescon, Chairman and Co-Chief Executive Officer]

Jay, I think a lot of that is just based on where we sit today with homes under construction. We significantly reduced the number of starts in the second half of the year. We started picking them up in November and December. And we've continued those into January. So when we look at it, part of it is we just need to build back up. And so in the first half the year, our deliveries will be down, and then they'll start increasing. And then as we look at that, we'll have at the end of the year, we'll have more houses under construction. And by that time, we'll be at a higher run rate. But as we just look at balancing out the first half and second half the year, that's where we see that we'll have the available homes to deliver.

[Jay McCanless, Wedbush Securities]

So basically just a timing issue, because you got to get communities open, and you got to get more specs up. I guess what were your total homes under construction at year-end and how many of those were spec?

[David Messenger, Chief Financial Officer]

We don't disclose the number of homes that we have under construction at any given time, but nearly 100% of them are spec. That's always been our model.

[Jay McCanless, Wedbush Securities]

And then just…

[David Messenger, Chief Financial Officer]

Other than our backlog. Go ahead.

[Jay McCanless, Wedbush Securities]

I guess the other question, just thinking about price, I mean, it looks like kind of a drift down through the year, I mean with these newer, smaller base prices, I mean are you guys thinking you'll have a drift somewhere down by like 5% to 10% by year-end? Or is it going to be something smaller than that? And I know that the midpoint of the guidance works out to 380,000. But if you've already started to put in some of these lower priced homes and lower price floor plans, just kind of wondering where average prices should end the year up?

[Dale Francescon, Chairman and Co-Chief Executive Officer]

Well, I think part of it is and it's hard because of our two brands. And there's obviously a big pricing disparity between them. And when we look at it last year, our Century Complete brand really grew. And so we think that, that is well set up for the affordability challenges that we saw last year, and obviously as prices have gone up, continue to a certain extent. So there's -- some of that is a higher percentage of Century Complete, as well as we pivoted a number of our plans to smaller plans and subdivisions, and particularly on new communities where we've done that to get the overall price point down. So it's really a combination of those two things.

[Operator]

The next question comes from Michael Rehaut with JP Morgan.

[Michael Rehaut, JPMorgan]

Wanted to just circle back and make sure thinking about the gross margins correctly. And appreciate the additional color on question around the 400 basis point math. When originally though, when you describe that you're saying that you could think that you expect second quarter to improve, and eventually, I guess in the back half, the second half of the year, get back to more normalized levels, when you look at normal -- I mean I guess the question is, what do you consider normalized gross margin levels? Because just a quick look from 2016 to 2020, you averaged 18.3% including interest amortization -- after interest amortization. With the 400 basis point math that's putting you to like 22.5%. So just want to get a sense of, if indeed, that's what you're thinking, again, to get to that 22%, 23% range by year end? Is that's what you consider the new normal, or if there's other factors we should consider?

[David Messenger, Chief Financial Officer]

Hey, Mike, it's Dave. We've talked about this on past calls in terms of how margins have been all over the board over the last year or two. They've obviously swung in our favor. And now they're a little bit against us being, probably 18.5 in Q4. As we talked about before, we think there's been a lot of improvements in our pricing, our scale, our plans, our efficiencies, our cycle times, and such that if we start getting all that back into a good rhythm in Q4, we ought to be building at a more normalized margin, which will be higher than what we had in the past. We are recording something in on 18% and 19% range. And now the new norm is hopefully going to be something in that low 20s range. But I think that's going to be a result of a lot of the stuff we've put in place over the past several years.

[Michael Rehaut, JPMorgan]

That’s helpful. So, something, 21, 22, 23, that type of range is kind of what you're thinking?

[David Messenger, Chief Financial Officer]

Yes.

[Michael Rehaut, JPMorgan]

Secondly -- appreciate that. Secondly, just kind of looking a little closer term on the first quarter. I guess you kind of said that expect gross margins, again, after or inclusive of interest to be similar to 4Q’s 18.24, can you give us any directional guidance on the closings? Obviously, you talked about 7,000 to 8,000 for the full year, you kind of talked to the issue that in the first half of the year, you'll be working off a very low backlogs and as a result of your strategic approach, has couple of quarters. How should we think about closings in terms of any type of range? Or perhaps first half, second half split? I think that would be pretty helpful just for modeling.

[David Messenger, Chief Financial Officer]

Yes, I think that you're going to see Q1 be our lowest closing quarter of the year. And then they should grow sequentially as not only do we work through our backlog, when we start bringing online a lot of the homes that we've started construction on here in December, January, that we'd expect to start construction on through the balance of Q1 and Q2 that we could still deliver into Q3 and Q4. And so I think, it's going to be back end weighted to the third and fourth quarters, while we get back to a little bit more of a traditional trend for us where the first quarter is your lowest closing quarter, and then it begins to grow through the course of the year.

[Michael Rehaut, JPMorgan]

One last one, if I could sneak it in, just around, how to think about SG&A? Obviously, you've had a lot of success over the years that you've grown significantly. This is going to be more challenging year, obviously. Anything in terms of just variable expense or any ways to think about the type of deleveraging that we should be expecting?

[David Messenger, Chief Financial Officer]

Yes. I think next year, deleveraging gets a little bit more difficult just because you've got closings of revenue coming down, and we've got a fairly large national footprint across 18 different states that we're managing. We've been running about a 65-35 split on a fixed versus variable basis. I think we probably continue that split over the course of full year. And as we've been prone to act quickly in the past, whether it's staffing adjustments, division adjustments, whatever the case is, we will look for any opportunity we have to find that deleveraging opportunity within the SG&A categories, and put more to the bottom-line. But we acknowledge that next year it gets a little more difficult with lower revenue line.

[Operator]

[Operator Instructions]. The next question comes from Alex Barron with Housing Research Center. Please go ahead.

[Alex Barron, Housing Research Center]

Thank you, gentlemen. I wanted to see if you guys could talk about improvement in build times. How much did the build times get extended out to last year and where do you feel they are today and where do you think they'll be, I don't know, six months from now?

[Dale Francescon, Chairman and Co-Chief Executive Officer]

So it's basically a mixed bag, Alex, looking back over the past 12 months. And depending on the particular market, the particular plan and all, the cycle times vary quite significantly with the supply chain challenges, the labor challenges and all. Going forward though, that's a real focus to reduce that down. As I mentioned earlier in the prepared remarks, the supply chain is easing. We are seeing more availability of labor and everything else. So all of that are great. As we look at our new templates going forward on homes that we are starting now versus homes that we are started, let's say, at the peak pricing six months ago, we are looking at a 57 day reduction on cycle times on average. There is variations from that, but on average. We are also shooting for a maximum as a round number of a six month build time. In some areas, we can do much better than that; other areas, it's still elongated. But we are getting great traction on getting our cycle times reduced.

Where we are going to be at the end of this year? I think it's going to be back to a more normalized basis on what pre-pandemic cycle times were. It's going to be closer that type of a scenario. But it's getting...

[Alex Barron, Housing Research Center]

Great, great. Good to hear. And then on the subject of costs, obviously, at the beginning of last year or first half of last year, everybody was up, up and away in terms of home prices and home costs. And so I imagine a lot of those specs that were started had high cost and as you are mentioning, you are now starting to achieve lower cost on the new stuff. But I'm just kind of curious, how far along do you guys think you are through flushing out the high cost inventory, such that you don't need to focus so much selling that, but can focus more on selling the lower cost stuff going forward?

[David Messenger, Chief Financial Officer]

If we have homes listed for sale, we are focused on selling them. I think that you are going to see in the first quarter, we are still going to have some of those older homes that we started last year at higher direct costs. You are going to see those coming through and that's what's weighing on our gross margin, such that we think that Q1 is going to be in a similar range compared to what Q4 was. And so we will get through a lot of them probably in Q1. But I think you are going to see them bleed into Q2. It's just going to take us some time to work through all of that inventory. But we are definitely focusing on building new homes that have better costs, affordable, better pricing and will produce better margins for us in the latter half of the year.

[Alex Barron, Housing Research Center]

And if I could ask one last one. So you guys mentioned that pretty much all the homes, new starter, specs, that cycle times are going to be down I think I just heard you say, close to 60 days or something on the new stuff.

[Dale Francescon, Chairman and Co-Chief Executive Officer]

That’s the projected, yes.

[Alex Barron, Housing Research Center]

So what about the ranging of those houses or the average? What about the average price or the average size of those of that inventory that you're creating? Is that generally speaking, smaller, cheaper houses? Or is it the same type of stuff as before?

[Dale Francescon, Chairman and Co-Chief Executive Officer]

Generally, it would be smaller or similar, but generally just a little bit smaller. And how we are doing that is, in our plan library, we may not be building the largest plan in a particular series or whatever to get it down from the square footage standpoint, affordability standpoint. So as a trend, it would be smaller homes at a lower price point.

[Operator]

The next question is a follow-up from Mike Rehaut with JP Morgan.

[Michael Rehaut, JPMorgan]

Just wanted to get any more granular sense, if you're able to provide it on the level of improvement that you saw in terms of describing November in December well above October and further improvement in January. If it could be either on a year-over-year, what the year-over-year declines have done, or even sales pace? Any additional color would be helpful there.

[Dale Francescon, Chairman and Co-Chief Executive Officer]

Mike, some of it is just anecdotal, from a standpoint of where our focus is. And, as we’ve made it very clear, our focus is on completing, completing homes. And if something is further downstream in terms of delivery, we've not been incentivizing those homes. So it's -- when we look at it, it's really more a function of have we been able to sell all the homes that we've prioritized for sale. And that's how we're really quantifying it, that and really the traffic and the amount of incentives that we have to provide.

And so as we've said, as the quarter progressed, things improved, which means that we were selling more of the near-term delivery houses, and we were doing it with less incentives. Same thing has continued into January.

So from our standpoint, it's not really a focus on the number of houses that we're selling, but it's making sure that we're selling the proper homes.

[Michael Rehaut, JPMorgan]

I guess, secondly, you're saying that you expect incentives to moderate a bit. Any way to how to think about that from a quantification standpoint? I mean, you talked about incentives reaching 900 basis points as part of your 4Q deliveries, so up 600 basis points sequentially. Is that expectation for incentives moderating a bit, something that you've already seen in your January orders? And moderating a bit, would that be a couple of hundred basis points or something a little more than that, or less than that?

[Dale Francescon, Chairman and Co-Chief Executive Officer]

As we said, our historical norm has been around 300 basis points. It spiked to 900 basis points in Q4. And a significant component of that were the forward commitments that we were purchasing really across our entire company. So when we look at it, we've taken that away. And so, that's probably somewhere that impacted our margins somewhere between 1.5 points and 2 points. So, we don't expect to get back to 300 basis points of incentives overnight, but we're moving in that direction. So to say we're down a couple of hundred basis points is probably where we are.

[Operator]

This concludes our question-and-answer session. I would like to turn the conference back over to Dale Francescon for any closing remarks.

[Dale Francescon, Chairman and Co-Chief Executive Officer]

Thank you, operator. I'd like to take this opportunity to once again thank all of our team members for their incredible work and continued dedication to our valued homebuyers. I'd also like to thank our investors for their time today. We appreciate your continued support and investment and look forward to speaking to you again next quarter.

[Operator]

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.