KB Home

NYSE:KBH

Earnings Call Analysis

Solid Q1 Performance with Strong Backlog

Delivering a solid Q1 with a 6% revenue increase to $1.5 billion and EPS of $1.76, the company is optimistic about the demand for homeownership. Despite margin pressures, 9% more homes were delivered compared to the previous year, showing a quick conversion from backlog reflecting efficient construction times and stable demand. With a strong liquidity position of $1.75 billion, they invested $590 million in land while also returning $65 million to shareholders through buybacks and dividends, signaling confidence and shareholder value focus. Second-quarter revenue forecasts range between $1.6 to $1.7 billion, with full-year projections of $6.5 to $6.9 billion, supported by ongoing demand and strategic growth initiatives.

Optimizing Capital and Lot Inventory

With a total of around 55,500 lots owned or controlled at the end of the quarter, the company is well-poised for growth, having secured all the lots necessary to meet delivery targets through 2025. Their balanced approach to lot development, with over 17,000 finished lots and 7,000 homes in production, fuels a solid growth trajectory at a favorable cost basis, originating mainly from acquisitions made in 2020 or before. In alignment with a focus on capital efficiency, future investments will prioritize growth while also returning value to shareholders through stock repurchasing, as evidenced by the repurchase of $411 million in common stock at an average price of around $44.50.

Revenue Growth Amidst Softened Home Prices

The company reported a 6% climb in housing revenues to $1.46 billion, augmented by a 9% rise in homes delivered contrasted by a 3% dip in the overall average selling price to roughly $480,000, likely reflective of adjustments in the product mix. Regionally, revenue saw upticks up to 35% in high-performing areas like the Southwest, balancing out a 19% revenue shrinkage in the Central Region. Looking ahead, the company forecasts second-quarter housing revenues in the range of $1.6 billion to $1.7 billion and a full-year target set between $6.5 billion and $6.9 billion.

Operating Margins and Profitability Outlook

The first quarter's operating income saw a minor increase, leading to an operating margin of 10.8%, slightly lower than the previous year due to increased selling, general, and administrative (SG&A) costs. Projecting into the second quarter and beyond, the expected operating margin span is 10.1% to 10.5%, with a full-year anticipation of 10.9% to 11.3%. Pricing concessions offered during the past year's challenging market are anticipated to affect the second quarter's housing gross profit margin significantly, though an improvement to margins is expected in the latter half of the year, guiding the full-year gross margin forecast to land between 21% and 21.4%. Elevated SG&A ratios due to investments geared toward growth are set to normalize, with the second-quarter ratio projected at approximately 10.5% and the full-year ratio at 10.2%.

Net Income and Earnings Strength

Net income saw a 10% increase year-over-year, reaching $138.7 million, with a substantial 21% improvement in diluted earnings per share, climbing to $1.76. This strengthening is attributed not only to income growth but also to the strategic share repurchases executed over the past year.

Earnings Call Transcript 2024-Q1

[Operator]

Good afternoon. My name is John, and I will be your conference operator today. I would like to welcome everyone to the KB Home 2024 First Quarter Earnings Conference Call. [Operator Instructions] Today's conference call is being recorded and will be available for replay at the company's website, kbhome.com, through April 19, 2024. And now I would like to turn the call over to Jill Peters, Senior Vice President, Investor Relations. Thank you, Jill. You may begin.

[Jill Peters, executive]

Thank you, John. Good afternoon, everyone, and thank you for joining us today to review our results for the first quarter of fiscal 2024. On the call are Jeff Mezger, Chairman and Chief Executive Officer; Rob McGibney, President and Chief Operating Officer; Jeff Kaminski, Executive Vice President and Chief Financial Officer; Bill Hollinger, Senior Vice President and Chief Accounting Officer; and Thad Johnson, Senior Vice President and Treasurer.During this call, items will be discussed that are considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future results and the company does not undertake any obligation to update them. Due to various factors, including those detailed in today's press release and in our filings with the Securities and Exchange Commission, actual results could be materially different from those stated or implied in the forward-looking statements.In addition, a reconciliation of the non-GAAP measure of adjusted housing gross profit margin, which excludes inventory-related charges, and any other non-GAAP measure referenced during today's discussion to its most directly comparable GAAP measure can be found in today's press release and/or on the Investor Relations page of our website at kbhome.com.And with that, here is Jeff Mezger.

[Jeffrey Mezger, executive]

Thank you, Jill, and good afternoon, everyone.We delivered solid performance in the first quarter, highlighted by our strong net orders as well as financial results that we were either at or above the high-end of our guided ranges. The spring selling season is off to a very good start, which together with our considerable backlog, better build times, and planned new community openings, gives us confidence that we are well positioned to achieve our objectives this year.As for the details of our results, we produced total revenues of $1.5 billion and diluted earnings per share of $1.76. Our margins remained stable at 21.5% in gross and just under 11% in operating income. This performance along with the cumulative benefit of sustained quarterly share repurchases including an additional $50 million during the first quarter drove our book value per share, up 14% year-over-year. Market conditions have improved since the end of our last fiscal year. As we discussed on our earnings call in January, we began to see demand move higher in December, which accelerated as the quarter progressed. Although mortgage interest rates increased modestly in late February from their lowest levels during the quarter, the strong desire for homeownership prevailed. The combination of low housing inventory levels, solid employment, and favorable demographics supports the new home market today, and we expect will continue to be the primary factors that sustain itself longer-term.The momentum in our net orders resulted in sequential gains of 46% in January, followed by 53% in February. We believe these results speak to the underlying demand for homeownership and a more stable housing market. Another sign of this stability is our cancellation rate, which fell significantly, both sequentially and year-over-year. In total, we generated 3,323 net orders in the first quarter, representing 55% year-over-year growth. This result was achieved while we held the mortgage concession study and implemented a modest level of price increases in most of our communities. We have continued to experience strong sales since the start of our second quarter, and believe we are well positioned to respond to this buyer demand given our products and price points as well as planned new community openings in the first half of this year.On a per community basis, our absorption pace accelerated as the quarter progressed, averaging 4.6 monthly net orders for the full quarter. Our strategic goals continue to be optimizing each asset on a community-by-community basis, which generally results in an annualized average absorption pace of about 5 net orders per community per month, and generating high inventory turns. In last year's second quarter, we produced very strong order results, driving an average of 5.2 net orders per community per month. This pace represented an 86% sequential increase and creates a tougher year-over-year comparable for this year. Our expectation is to slightly exceed last year's monthly community order pays for our second quarter in light of more favorable market conditions. We continue to align our starts with sales, and plan to ramp up our starts given stronger demand and to position our business for the second half of 2024. We believe our backlog homes in production, and starts phase are imbalanced to support our projected $6.7 billion in revenues this year.With that, I'll pause for a moment and ask Rob to provide an operational update. Rob?

[Rob McGibney, executive]

Thank you, Jeff. I will begin by adding to Jeff's comment on our order results to provide some additional color. During the quarter, we pursued a higher pace to capture demand and build our backlog, while also raising prices in over 1/2 of our communities. And in another roughly 40% of our communities, we hold prices steady. At 4.6 net orders per community, our monthly absorption pace was above our historical first quarter average. As Jeff mentioned, our cancellation rate improved to 14% of our gross orders and 10% of our backlog at the start of the quarter. These are the lowest levels we've experienced in more than a year, reflecting buyers who were adjusted to the higher rates as compared to a year ago and who were motivated to close.Mortgage concessions were relatively flat as compared to our 2023 fourth quarter with approximately 60% of our orders having some form of mortgage concession associated with them, including rate locks. Assuming market conditions and demand remains strong, we expect to be in a position to lower these types of incentives as the spring selling season progresses. We ended the quarter with almost 7,000 homes in production. Given our first quarter net order results and the elevated level of demand in the market, we expect to accelerate our starts and grow our production levels over the next 6 months.Operationally, our divisions are maintaining the progress we achieved last year in reducing build times. Our construction cycle is over 30% shorter than the prior-year quarter, with a daily focus on additional efficiency enhancements to further reduce construction times to even flow production incorporated into our business model and leveraging relationships with our trade partners to increase speed, which helps improve cash flow for both sides. We believe we can return over time to our historical build times between 4 months and 5 months. This will improve our inventory turns and increase the population of homes available for delivery, as well as further enhance our build-to-order sales approach, as personalized homes with quicker delivery dates are even more compelling to homebuyers. As to direct costs on started homes, they held steady in the first quarter on both a sequential and year-over-year basis. We continue to pursue value engineering and simplification opportunities to drive cost down, which has been effective over the past year and helping to offset overall inflation.Before I wrap up, I'll review the credit metrics of our buyers who finance their mortgages through our joint venture, KBHS Home Loans. We had a solid increase in our capture rate with 85% of the mortgages funded during the quarter, having been financed through our joint venture as compared to 79% in the prior-year quarter. Higher capture rates help us manage our backlog more effectively and provide more visibility in closings. In addition, we see higher customer satisfaction levels from buyers that use KBHS versus other lenders. The average cash down payment was 16% consistent with last year, equating to roughly $77,000. The household income of our KBHS customers was about $126,000, and they had an average FICO score of 743, a number that has steadily climbed over the past few years. Even with 1/2 of our customers purchasing their first home, we are attracting buyers that can qualify at elevated mortgage rates, while making significant down payment.As we look ahead to the rest of 2024, our divisions are focused on maintaining our high customer satisfaction levels, improving build times and value engineering our products to lower direct costs. In addition, our objectives are set on driving net orders, acquiring more lots and opening community on time, all of which will contribute to the future growth of the company. We recently completed several leadership promotions and created a new Executive Vice President of Homebuilding position to which Brian Kunec has been elevated. Many of you are familiar with Brian from his earlier role of successfully leading and growing our Las Vegas business. Most recently, Brian was one of our Regional Presidents responsible for our divisions in Idaho, Nevada, Northern California, and Washington. In addition to Brian, we also promoted two Division Presidents to the role of Regional General Manager and increased the geographic scope of one of our existing Regional Presidents. We believe these organizational changes will help us in driving growth as well as operational performance.And with that. I will turn the call back over to Jeff.

[Jeffrey Mezger, executive]

Thanks, Rob. We invested close to $590 million to acquire and develop land during the quarter, a 60% increase year-over-year and the highest quarterly level since early 2022. We have the capital available to accelerate our investment spend in 2024 and intend to do so, while adhering to our underwriting criteria, product strategy, and price points as we are committed to growth beyond this year. We had roughly 55,500 lots owned or controlled at quarter end, of which, about 40,100 were owned. Over 17,000 of these lots are finished and as Rob referenced, we have about 7,000 homes in production. Approximately 60% of our own lots were tied up in 2020 or prior, which provides us with a solid runway of lots at a favorable cost basis.We are focused on capital efficiency, developing lots wherever possible in smaller phases and balancing development with our starts pace to manage our inventory of finished lots. We currently own or control all the lots that we need to achieve our delivery growth targets for 2025. And as we have stated in the past, our divisions have road maps in place with timelines to achieve at least a top 5 position in each of our served markets. Our balance sheet is healthy and our cash-generating capabilities are strong. We intend to allocate our capital toward reinvestment in growth and returning cash to shareholders in 2024, primarily through share repurchases. This is a continuation of the capital allocation plan that we executed in fiscal 2023, during which, we bought back $411 million of our common stock at an average price of about $44.50, substantially accretive to both our book value and diluted earnings per share.Over the balance of the year, we intend to utilize at a minimum, the roughly $114 million that remains in our current repurchase authorization and we will be requesting an additional authorization from our Board.In closing, I want to thank the entire KB Home team for solid execution in our first quarter and their dedication to our homebuyers. Market conditions have improved and we are seeing dynamics returning to a more normalized state. Supply chain and trade labor availability has stabilized and while cost pressures are still present, they have eased. Mortgage interest rates have also steadied and we do not see any evidence of rates rising this year. Buyers have largely adjusted to the rate environment and we are encouraged by the demand we're seeing at the onset of the spring selling season.Our backlog increased sequentially and is healthy as reflected in the lower cancellation rate we experienced in the first quarter. We expect to compress our build times further, which will contribute to higher inventory turns, unlock cash, and enhance our built-to-order approach. These dynamics are all favorable for our company and we look forward to demonstrating the potential of our business as the year unfolds.With that, I'll now turn the call over to Jeff for the financial review. Jeff?

[Jeff Kaminski, executive]

Thank you, Jeff, and good afternoon, everyone. I will now cover highlights of our 2024 first quarter financial performance as well as provide our second quarter and full year outlook. We are pleased with our execution during the first quarter, with home deliveries up 9% over the prior year, in line with our expectations and supported by our improving construction cycle times and backlog of sold homes. Our healthy operating margin of nearly 11% drove robust cash flow that enabled us to invest almost $600 million in land, return over $65 million to our stockholders through share repurchases and dividends, and end the period with strong liquidity of $1.75 billion.In the first quarter, our housing revenues of $1.46 billion were up 6% year-over-year, driven by the 9% increase in the number of homes delivered, partially offset by a decline in the overall average selling price of those homes. The number of homes delivered in the first quarter reflected a backlog conversion rate of 55%, a significant improvement from 36% for the year-earlier quarter, demonstrating both the impact of our improved build times as well as a lower cancellation rate in the current year period.Housing revenues were up in 3 of our 4 regions, ranging from 3% in the West Coast to 35% in the Southwest, offsetting a 19% decline in the Central Region. We expect stable housing market conditions and favorable supply chain trends to support our forecasted results for the remainder of 2024. For the second quarter, we anticipate generating housing revenues in the range of $1.6 billion to $1.7 billion. For the full year, we expect to generate housing revenues in the range of $6.5 billion to $6.9 billion. We believe we are well positioned to achieve this topline performance supported by our backlog of sold homes, projected net orders per community, anticipated continued improvement in construction cycle times, and expected growth in community count.In the first quarter, our overall average selling price of homes delivered decreased 3% year-over-year to approximately $480,000, mainly due to mix shifts. For the 2024 second quarter, we are projecting an overall average selling price of approximately $483,000, up slightly, both sequentially and compared to the prior year period. We still expect our overall average selling price for the full year will be in the range of $480,000 to $490,000. Homebuilding operating income for the first quarter increased slightly to $157.7 million compared to $156.5 million for the year-earlier quarter. The current quarter included abandonment charges of $1.3 million versus $5.3 million a year ago. Our homebuilding operating income margin decreased to 10.8% compared to 11.4% for the 2023 first quarter, mainly due to a higher SG&A expense ratio in the current year quarter. Excluding inventory-related charges, our operating margin of 10.9% decreased to 80 basis points year-over-year.We anticipate our 2024 second quarter homebuilding operating income margin will be in the range of 10.1% to 10.5% and the full-year metric to be approximately 10.9% to 11.3%. Our 2024 first quarter housing gross profit margin of 21.5% was even with the year-earlier quarter. Excluding inventory-related charges in both periods, our gross margin decreased by 20 basis points year-over-year to 21.6%. We are forecasting a 2024 second quarter housing gross profit margin in the range of 20.5% to 21%, reflecting homebuyer concessions offered for homes sold in the second half of last year amid the challenging conditions at that time that are expected to deliver in the quarter. We project improved quarterly margins in the second half of 2024, supported by the margin profile in our backlog, improved leverage on fixed costs due to higher expected deliveries, and anticipated lower rate buydown incentives. We expect our full-year gross margin will be in the range of 21% to 21.4%, assuming stable housing market conditions.Our selling, general and administrative expense ratio of 10.8% for the first quarter was up from 10.1% for the year-earlier quarter, mainly reflecting higher costs, including marketing, advertising, and other expenses associated with the planned increase in our community count during the year as we position our operations for growth. We are also investing in personnel and other resources in alignment with the expected larger scale of our business. We are forecasting our 2024 second quarter SG&A ratio to be approximately 10.5% and expect our full year 2024 ratio will be approximately 10.2%. Our income tax expense of $36 million for the first quarter represented an effective tax rate of 20.6%, an improvement from 22.6% for the year-earlier quarter. This improvement was predominantly due to an increase in tax benefits related to stock-based compensation in the current period. We expect our effective tax rate for the 2024 second quarter to be approximately 24% and for the full year to be approximately 23% due to the low rate realized in the first quarter. Overall, our first quarter net income increased 10% year-over-year to $138.7 million, and our diluted earnings per share improved 21% to $1.76, reflecting both the growth in net income and the favorable impact of common stock repurchases over the past year.Turning now to community count, our first quarter average of 240 was down 4% from the corresponding 2023 quarter. We ended the quarter with 238 communities. We expect to grow our portfolio of communities during the second quarter by about 5% and end with approximately 250 communities. This would result in an average community count for the second quarter of 244. We remain focused on growing our community count and believe our average community count in the 2024 third and fourth quarters will be higher than in the prior year periods. In addition, our current outlook reflects approximately 260 open communities at year-end, which is about 10 fewer than what we previously expected as a result of the stronger selling environment anticipated to drive more 2024 sellouts as well as a handful of communities now expected to open during the 2025 first quarter.We invested approximately $590 million in land and land development during the first quarter, and we ended the quarter with a pipeline of approximately 55,500 lots owned or under contract. During the first quarter, we repurchased nearly 830,000 shares of our common stock at an average price of $60.48. As Jeff mentioned, we intend to continue to repurchase shares and expect the pace, volume, and timing of share repurchases to be based on considerations of our cash flow, liquidity outlook, land investment opportunities and needs, the market price of our shares, and the housing market and general economic environment.At quarter-end, our total liquidity was approximately $1.75 billion, including over $1.08 billion of available capacity under our unsecured revolving credit facility and $668 million of cash. Our quarter-end stockholders' equity increased to approximately $3.9 billion and our book value per share was up 14% year-over-year to $51.14.In conclusion, we are pleased with our first quarter financial performance and expect to see solid housing market conditions for the remainder of 2024, driven by favorable demographic trends, the ongoing imbalance of housing supply and demand, and expected moderation in interest rates later in the year. We intend to sustain our focus on generating reductions across our operations in build times and construction costs, while also driving growth and expanding our scale through land-related investments in new community openings. We plan to maintain our balanced approach to capital allocation, encompassing significant cash deployment back in the land and development to produce topline growth, while also returning cash to stockholders through common stock repurchases and dividends with an overall focus on long-term stockholder value creation.We will now take your questions. John, please open the lines.

[Operator]

[Operator Instructions] And the first question comes from the line of Matthew Bouley with Barclays.

[Elizabeth Langan, analyst]

You have Elizabeth Langan on for Matt today. So just kind of starting off with the margin. Would you mind talking a little bit about the margin cadence through the year? You're assuming that next quarter will be impacted by the higher incentive levels in the latter part of 2023, would you mind talking a little bit about what we should expect for the second half? You know, kind of what you're seeing with incentive levels right now and how you'd expect those to flow through?

[Jeffrey Mezger, executive]

Sure. As I mentioned in the prepared remarks, we do expect some improvement in the second half of the year to arrive at that overall guide for the full year of 21% to 21.4%. What we are seeing, particularly this year and actually part of last year, pretty stable gross margin quarter-to-quarter. Basically forecasting plus or minus 21% in all 4 quarters of this year. And you'll see some improvement obviously in the back half, particularly in the fourth quarter with improved leverage based on higher deliveries and more revenues. So, that's really the outlook at the current time.

[Elizabeth Langan, analyst]

And would you mind touching a little bit on what you're seeing around buyer affordability and maybe your expectations around pricing? You've said that you think that you can probably bring mortgage concessions down a little bit. Are buyers more responsive to something other than rate buydowns or are they seeing like increasing their customization options or anything that you're seeing around that?

[Jeffrey Mezger, executive]

Look, there are a lot of components to that question, Elizabeth. I can make a few comments and then pass it to Rob for some of the specifics on our buyer profile. As we shared in our comments, in the first quarter, we were focused on building our backlog and driving more sales. So we left the incentive levels for mortgage concessions similar to the prior quarter and pushed the pace and where we could we took some, I called it moderate price increases in my prepared remarks. So part of optimizing the assets, build our backlog, set up the scale for the year, get a higher absorption pace, and then start working a little bit on margin along the way. As we shared in the credit metrics of our buyers, we have a very strong buyer profile right now. In particular, when 50% of our buyers are first time, you put it in that context and think of the FICO scores and the average down payment, this is a very well qualified buyer. We're not having an issue with qualified as you can see from our [indiscernible] on the backlog. And frankly, the orders that we're generating while taken a little bit of price. But what we've been poking around on what's going on with the buyer and the sensitivities to debt ratios and income and qualified. Rob can give you some specifics on that. Go ahead, Rob.

[Rob McGibney, executive]

Yes, as far as the credit ratios, debt ratios, we're really not seeing any major change. In fact in our closings, we've seen debt to income ratios fall slightly. So still a really well-healed buyer. They've got sufficient income, got good credit, seen demand in our price points and I think that speaks to the price points that we're at and the quality of our product. You mentioned studio in buyer behavior and what they're picking design choices and I think this speaks to that as well. So we really haven't seen a change in studio spend, despite some of the affordability challenges that are out there in the market and we've seen some shifting what they're spending that money on more things like permanent features in the home, about room configurations or cabinets or converting it into a bedroom, things you can't easily change down the road. But between everything that Jeff just mentioned and the credit and income levels that we talked about, in addition, we haven't really seen a shift in the square footage that buyers are purchasing. So pretty confident that our buyers are, they've got the ability to qualify, and we're seeing that in our results today.

[Operator]

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

[Stephen Kim, analyst]

I appreciate all the color as always. And, yes, congrats on the good results. A couple of questions, #1, I was wondering if you could give us a sense for what we should be thinking about for, in 2024, kind of a targeted level of operating cash flow as a percentage of net income, that kind of cash conversion. What sort of level we should be thinking about for you? And then also from a longer term perspective, operating margin profitability has been improving. What do you think a level of longer term sustainable operating margin can be for your company? I'm sort of thinking maybe 13% or something like that, I was wondering if you could respond to that.

[Jeffrey Mezger, executive]

Sure. We count that as 2 questions or 1, Steve?

[Stephen Kim, analyst]

No, that's just 1, Jeff.

[Jeffrey Mezger, executive]

We'll give you a break. We'll let you ask a follow up. Okay, so the first question on cash flow, as you guys are probably fairly used to with us, I mean, we don't really go out and forecast cash flow through the fiscal year because it depends on a lot of factors, including most predominantly, including land spend and then over the past couple of years, the level of buybacks. If you go up top and look at operating cash flow, the big opportunity for us continues to be in the area of build time and reduction in the build time. We mined a lot of that cash last year, where we had a very significant improvement in construction cycle time, and it freed up a ton of cash for us, put us in the really strong balance sheet position we're in today with a lot of liquidity and a lot of dry powder to go back and buy shares and reinvest in land. We anticipate continued success in that and continued strong and healthy cash flow, but acknowledging that a lot of the oversized or supersized gains that we had on the reduction in build times was a little bit behind us at this point. Sorry, your second question was...

[Jeff Kaminski, executive]

13%.

[Jeffrey Mezger, executive]

The 13%, yes, on the operating margin. Yes, I think like, when you look at, I saw your report and know that there was the number that you had in there. Look, it's definitely within reach. I mean, we're not going to go out and guide or lay out a plan for the company during a Q&A period of a quarterly conference call, but we're within distance of that already. And I'd hope to see improvement actually over and above that over time. That just requires about a point decrease in what we're anticipating for this year's SG&A, which I think comes with scale and size and leverage on some of our SG&A costs at this point. And as the market stabilizes and improves, particularly with declining rates, that we do expect to see and reinforced today by some of the Fed's comments moving away from some of the incentives, which, you know, is not really part of our business model, to get into that low 20s range, I mean, we're already there, but to improve on where we're at today on the gross margin side. So I think it's a reasonable assumption. I would like to think it's on the very conservative side as far as the long-range target for the company, and certainly attainable. So that's basically my comments on that at a very high level.

[Stephen Kim, analyst]

That's really encouraging. Second question relates to the big news regarding the NAR's settlement that obviously I think has created a lot of turmoil. What I'm intrigued about is the potential for this confusion and the relatively quick time frame by which all these changes need to be made. Whether that might result in a somewhat dysfunctional resale market that large builders such as yourselves could capitalize on with your Internet presence is which. I know you've substantially bolstered over the last several years. And so my question is, can you give us a sense for what share of your leads today are generated through the Internet. And do those Internet-driven leads carry a lower SG&A burden when they ultimately come through in sales?

[Jeffrey Mezger, executive]

Rob, do you have any detail on that, on the Internet leads and the profile?

[Rob McGibney, executive]

Steve, not so much as the percentage, but I would say the majority of buyers that are finding us are finding us through those avenues. And we've seen a big increase. In our internet leads just overall, it was up 34% year-over-year, so pretty big movement there. As far as the opportunity with the NAR and the settlement. I think it's still a little cloudy to predict how that's going to go. I think if anything, it's going to be a positive for us with potentially less that's being paid in broker co-ops and things like that, but I think there's a lot to be worked out there then that goes into effect this summer. One of the components of it is that the compensation can't we advertised on the MLS. But then they likely have other ways to advertise that through Facebook or other methods or face-to-face. So a lot of it remains to be seen, certainly don't see it as a downside to us, our results or our financials, potentially an upside, but I think it's a little too early to tell.

[Operator]

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

[Alan Ratner, analyst]

Nice quarter and I appreciate all the color so far. So my first question, and I really appreciate all the statistics you gave on the credit side. I was admittedly a little surprised from one of your competitors last week kind of talked a little bit about rising early stage yellow flags or red flags in some of their customer credit metrics like credit card delinquencies and things like that and I just want to make sure I'm thinking about your commentary in the same vein because I think a lot of the statistics you gave are maybe on closings and kind of more representative of what might have been going on 6 months or so ago. So can you just be clear that you are not seeing any signs of stress in kind of real-time in terms of the consumers that are coming through your model homes today.

[Jeff Kaminski, executive]

Yes, I'll take that one. I men really when I was speaking about the debt-to-income ratios earlier that actually was based on sales, not closing, then we've seen those ratios improved slightly over the last few quarters. Now our leads are up. I talked a little bit about the Internet leads. So we're seeing a lot more people. So the raw number of people who don't qualify has increased. But as far as the percentage. I don't really see that that's changed much. And we're not seeing those pressures at this point.

[Jeffrey Mezger, executive]

I'd point to our [ can ] rate, Alan. The can rate is now below normal for us and I think that's buyers ability to perform.

[Alan Ratner, analyst]

Yes, makes sense. I appreciate the clarification on that. So my second question is on kind of the land portfolio, and nice pickup in land acquisition activity in the quarter. Your lot count, if I'm looking at this correctly, is down about 10% year-over-year, down almost 40% from 2 years ago. And your year's supply of land is kind of hovering in that 4-ish-year metric, which is among the lower in the industry. And I'm just curious, would you say that's by design, as an effort to kind of improve your capital efficiency or turnover, or is that land supply, I know you mentioned you've got all the land you need for '25, but would you like to see that land pipeline a little bit higher than it is currently?

[Jeffrey Mezger, executive]

Actually, there's a lot of moving parts to it. As you reflect back on the push and pull we've been through, there was a couple of times over the past few years where we pulled out of the land market because it was cloudy. What's really happening post COVID and then that took off, then interest rates run and things stalled. So you pull back again and you reset, and we extended a lot of deals, renegotiated others. We did a lot of things, kept the control of the assets that we liked. So it's kind of deceptive to look at 2 years ago because that was one of the periods where we walked out of a lot of options at that time, because they weren't making the sense that they did when they were first tied up.So we're comfortable with where we're at. We have that healthy tension. We need lots for '26 and beyond, but we don't have to do something outside of our underwriting in order to fill the pipeline. So we have a healthy discipline that we're adhering to and yet at the same time, we're encouraging the divisions to grow. So at a 4-year supply, actually that they have owned, that's probably a little high. I'd rather have it more controlled, less owned, if we can get there. But we're pretty comfortable with how we're positioned heading into '26. Right now, it's a focus on '26 and beyond.

[Operator]

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

[John Lovallo, analyst]

The first one is, can you just help us with the drivers of the 60 basis point gross margin beat versus your expectations in the first quarter? And then help us with sort of the walk from the first quarter to the second quarter in terms of factors like the leverage impact, mix, net price, et cetera?

[Jeffrey Mezger, executive]

Right. So, yes, there were a few things that came into that. One was we had a little bit of mix shift, so we pulled, and interestingly, we pulled a lot of the higher margin deliveries out of Q2 into Q1 on an incremental basis towards the end of the quarter, which we're always driving to close as many homes as we can and try to get those behind us. And this time the mix worked out in our favor, where we had some pickup on that side. The can rate was a pretty important factor for us as well, where we didn't have to resell homes that had already been in our backlog at healthy margins, and we didn't have to quickly discount those homes to get them sold in the quarter. So that helped us incrementally and as far as the forecasts go, that's always a difficult one to forecast out.So we did, I will say, as we were forecasting the 21% for the first quarter, anticipated a can rate similar to what we'd seen in the prior 2 quarters, and had a little bit tucked away on that increment. So those were the main drivers. And we like being up. When you look at it sequentially, we're really based in the second quarter predominantly off what's in our backlog. And we really saw sort of a tick up in some of those incentives and whatnot back in those times and those sales were booked and they're coming through. And the final thing, and it's always the same, and I know everyone hates hearing it, including me, oftentimes, but mix plays a big part of this, between communities, high margin, low margin communities, between regions and between divisions. So all of those factors sort of come together in that.And if you're plus or minus a percent, quarter-over-quarter-over-quarter, for the most part, it kind of reflects an operation that's running pretty smoothly. You're pulling your deliveries from your backlog, you're not seeing many cancellations, you're not having much pressure on you to resell homes and close them in the current quarter due to cancellations. And we really like the steady environment that we saw in the first quarter. It was a really nice start to the year for us, and we're looking forward to the rest of the year as a result of that, particularly selling through the spring.

[John Lovallo, analyst]

Got it. That's helpful, Jeff. And then if we think about the slight uptick in the outlook for SG&A as a percentage of sales to 10.2%, I mean, that's coming with slightly fewer communities than you were previously expecting, a little bit of an uptick in sales. But I guess the question is, does that reflect the need for higher broker commissions or higher marketing spend, things of that nature? Or what exactly is driving that slight uptick?

[Jeffrey Mezger, executive]

It really has nothing to do with the commission side of it. We are putting a little bit more money in the marketing and advertising as we talked about. On the community count, as you pointed out, declining, half that decline was really due to earlier sellouts and the other half is just a few communities that pushed out into the first half at '25. So we're still planning on spending money, marketing, advertising, et cetera, for those communities yet in the fourth quarter as we're approaching openings on those. So it really didn't impact it in a way where it allowed us to reduce expense on that side. But I think overall, if you just go right up top on the SG&A side, we're just preparing the company to operate at a larger scale. We're putting in some personnel resources where we need it.Rob talked a bit about some of the operational assignments and promotions and positions that we have in the business as we're expanding the size of our divisions and the focus on growth and returns. And we just feel that scaling up this company will do some really good things for profitability, capital efficiency and returns. And we're really well positioned at that point in time, having just a rock solid balance sheet and fixing a lot of the issues that were nagging for many, many years and we're well beyond those at this point. So we're just looking forward to growing this company and growing the returns as we move forward.

[Operator]

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

[Unknown Analyst]

This is [ Andrew Landsly ] on from Mike. I appreciate you taking my question. I guess just more on the longer term side, should we be expecting any kind of change to your mix going forward as you grow? I believe in 4Q, your closings, your mix was roughly 50%, entry level, 25% move up, and the rest being active adult and second time move up.

[Jeffrey Mezger, executive]

Yes, I think the market will dictate that more than we will. And I say that because when you're a build-to-order company and you're focused on the median incomes in the submarkets that you're operating in, you cater to everybody and you have a product out there where it may shift to more move up and be the lesser footages, lower price points, or it can shift to the first move up in the larger home and the bigger higher income and the second move up. But the market will dictate that to a degree, our strategy and our positioning is not going to change.So I would say, it's realistic, I guess to assume we'll be 45% to 60% first time and the other buyer components may move around a little bit. We've been around 15% active adult for years and years. It's a natural attraction due to the climate zones that we operate in and a lot of retirees come in and like our product as well. So we don't target a specific buyer profile, we target an income and a price point and then let the buyers come. And when you're at the middle of the market, it'll move around a little bit like it does, but it should stay in the same range we're seeing.

[Operator]

And the next question comes from the line of Susan Maklari from Goldman Sachs

[Susan Maklari, analyst]

My first question is thinking about the potential for lower rates and maybe an increase in activity on the ground in general. If we do see that as we move through the year, how do you think about the ability to retain the improvements that you've seen in the build times and the cycle times, and to retain the labor force and to keep things moving at the rate that they have been more recently?

[Jeffrey Mezger, executive]

I think the opportunity there, Susan, is to continue to capture some build times. And as you look back over the labor shortages and the supply chain disruptions that we dealt with, I would say that on either side, that those companies learned a lot and addressed it and fixed it, whether it's hiring more people or fixing some of the glitches in the supply chain, whether national or internationally. And those are all healing, if not healed. And I think we can still pick up some build time compression, and I think we can control cost. And in part because we're going to even greater scale in the markets we operate in, where we have relationships, in some cases 40 years old with our contractor base. So we see if the interest rates do come down and the markets warm up a little bit, it would be a tailwind for us. We don't think it'll create build time issues and cost pressures.

[Susan Maklari, analyst]

Okay, that's helpful. And then maybe just turning to capital allocation, can you talk a little bit about how you're thinking of that? You've been continuing to buy back some of the stock, which is nice to see. Just anything there that's changed or incremental in how we should be thinking about it?

[Jeffrey Mezger, executive]

I can tell you, Susan, based on the prepared comments I made, we're going to keep repurchasing shares at least the next $113 million that's authorized. So that's the first time we've signaled an intent. We've been active in share repurchases for 3 years now pretty consistently. And it's been a big boost both to our book value per share and our EPS and it helps your ROE along the way. And in part it's because of all the cash we've generated, we're still sitting on a large cash balance with nothing out on our revolver. And we think we have the ability to invest in growth and continue to toggle and give more cash back to shareholders. So we think we can do both through '24. Jeff, if you have anything else you want to...

[Jeff Kaminski, executive]

No, I think that summarizes it. Years ago, we had a focus on the balance sheet from the point of view of paying us in debt and realigning the leverage ratio. That's certainly behind us at this point. And it's full speed ahead with growth, improving returns, increasing scale, and returning cash to shareholders as key components of the capital allocation strategy.

[Operator]

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

[Rafe Jadrosich, analyst]

Can you talk about the level of inflation you're seeing today, maybe on a cash basis, in terms of land and development costs as well as materials?

[Jeffrey Mezger, executive]

Rob, you want to take that?

[Rob McGibney, executive]

Sure. Yes. It's really been kind of spotty on what's moving up and down in regards to materials. I mean, there's some that we've been able to lower our cost last year and it stuck, and others where it's continued to go up. Concrete is one that comes to mind. There's a lot of infrastructure projects going on in most of the cities that we operate in. So concrete is one that's inflated pretty quickly and seems almost programmatic with some of the numbers that we're seeing. As far as the development goes, we're working from a really favorable cost basis in our land and we're well positioned to sustain solid gross margins given we've got that land cost basis favorability. But the cost to develop those lots, those assets, has gone up.And I think the most significant are the contractor labor cost. I mentioned the infrastructure work that's driving part of that, and then just growth in overall construction for home building, too. But with respect to development, kind of a little bit easier to measure because we don't have as many parts and pieces going into it. Depending on the division, we're seeing anywhere from the low-to-mid double-digit range to, in some cases, a little bit higher than that. I'm sorry, low-to-mid single-digits to low double digits is what we're seeing. And as we're looking at these lots and communities that we're developing, it's really inflation that we're going to experience in our closings as we get out into 2025. These are lots that we're developing today. They're not going to be delivered in 2024.

[Rafe Jadrosich, analyst]

That's really helpful. Just remind us how much of the development cost is that as a percentage of the total land cost typically?

[Jeffrey Mezger, executive]

Yes. It varies tremendously by division and by land parcel. So the average, I'd have to reference it, but I don't know that it's that meaningful just because of the variances that we see across the business.

[Operator]

And our final question comes from the line of Jay McCanless with Wedbush Securities.

[James McCanless, analyst]

So the first question I had, maybe sticking on the land topic for a second. As you're looking at lots for 2026 and beyond, what are you seeing in terms of land cost inflation for those further out lots? And from a competitive standpoint, we've heard from some of your competitors that the land market, especially the spring is more fierce than it is normally. So maybe if you could talk about the inflation and what the competitive backdrop looks like?

[Jeffrey Mezger, executive]

Well, I would describe the land market as competitive. There's no easy deal out there. It's not just who are you competing with for the best price for the parcel is, what's the complexity of the improvements and the development. You really need to understand the parcel. And if you have a good land team, it's a strength. You don't have a good land team, it can be a weakness. And overall, while it's competitive, we are finding deals. We spent 60% more in Q1 on land and development than we did a year ago. So it tells you that we're finding deals and we're investing in it. I also said in my prepared remarks that we're sticking to our disciplines on the underwriting, the location, the product type, and the returns that we need to get. So, Rob, I don't know if you have any other color you want to give on what you're seeing out there on the land market.

[Rob McGibney, executive]

Well, I just echo your comments. I mean, it is competitive, and we are seeing land prices move up and it depends just based on the submarket, based on the city. It's hard to give a specific number as far as what lot costs or land is inflated to, and the development is a factor in that, too. I mean, it all goes to the residual that you can pay for the developed lot, but definitely competitive.

[James McCanless, analyst]

And then Jeff K, last quarter you talked about, I think roughly 30% of production in the quarter with spec homes, with a goal of being more like 25%. Could you talk about where specs are now and how we should think about that mix in terms of the gross margin guide for the second quarter and for the rest of the year?

[Jeff Kaminski, executive]

Yes, on the spec side, it remained relatively stable. The nice thing that we're seeing now is with the can rate coming down, we're not having to resell as many homes after start that we had at a point in time just a few years back. So that spec mix, I think, is going to remain fairly stable as we move through it. When we just look at what we have in production, it's roughly where we've been delivering, right around 30% of the total is the production right now of spec homes. And yes, I think that will remain pretty close to those levels. That is the tricky part as you point out, about forecasting gross margin, but it's easier when it's a fairly stable number and particularly with the lower can rate where you're not having as many surprise spec homes versus planned ones. So we're steady as it goes in that metric as we move forward [Technical Difficulty] with the margin guide.

[Rob McGibney, executive]

Jeff just pointed out that the blend is in our margin guide. We always blend it. So as we look out at deliveries next quarter, we always have to make some estimate of what we'll sell and close in the quarter that's not coming out of backlog and we'll put estimates on. We know what the build costs are, we'll estimate the price and then move forward. But it's all embedded in the margin guide that we put out there.

[Operator]

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