KB Home - Earnings Call - Q1 2025

Executive Summary

• Q1 2025 revenue of $1.39B and diluted EPS of $1.49 both missed Wall Street consensus; management cut FY2025 guidance as demand started the spring selling season more muted and deliveries lagged plan due to fewer inventory home sales and wildfire-related utility delays in Southern California.
• Consensus vs actual: Revenue $1.50B* vs $1.39B; EPS $1.58* vs $1.49 — both misses; net orders fell 17% YoY to 2,772 and monthly absorption dropped to 3.6 per community.
• Housing gross margin compressed to 20.2% (20.3% adjusted), driven by higher relative land costs, buyer concessions, and reduced operating leverage; SG&A increased to 11.0% of housing revenues.
• FY2025 guidance lowered: housing revenues to $6.60–$7.00B (from $7.00–$7.50B), ASP $480k–$495k (from $488k–$498k), homebuilding operating margin ~9.4% (from ~10.7%), and gross margin 19.2%–20.0% (from 20.0%–21.0%).
• Near-term catalyst: guidance reset and pricing strategy shift to transparent base-price reductions over incentives; management reports improving weekly sales post mid-February actions (last five weeks averaging ~5.1 orders per community per month).

What Went Well and What Went Wrong

What Went Well

• Transparent pricing actions in mid-February drove a meaningful improvement in weekly net orders; last five weeks averaged ~300 net sales (~5.1/month/community) as buyers responded to compelling value positioning.
• ASP rose 4% YoY to $500,700 despite volume shortfall, with West Coast ASP up to $708,700 and Southwest up to $461,500.
• Build times improved to 147 days company-wide (139 days for built-to-order), enabling higher backlog conversion and supporting year-end delivery visibility; management is targeting 120 days over time.

What Went Wrong

• Deliveries missed internal plan by ~225 homes (≈150 fewer inventory home sales than projected and ~75 Southern California closings delayed due to wildfire-related utility sign-offs), pressuring revenue and margins.
• Net orders fell 17% YoY to 2,772; absorption pace slowed to 3.6/month/community and cancellation rate rose to 16% amid weaker consumer confidence and elevated mortgage rates.
• Housing gross margin declined to 20.2% (20.3% adjusted) on higher relative land costs, concessions, and reduced operating leverage; homebuilding operating margin fell to 9.2% and SG&A deleveraged to 11.0%.

Transcript

Operator (participant)

Good afternoon. My name is John, and I'll be your conference operator today. I would like to welcome everyone to the KB Home 2025 Q1 Earnings Conference Call. Currently, all participants are in a listen-only mode. Following the company's opening remarks, we will open the lines for questions. Today's conference call is being recorded and will be available for replay at the company's website kbhome.com through 24 April 2025. I would like to turn the call over to Jill Peters, Senior Vice President, Investor Relations. Thank you, Jill. You may begin.

Thank you, John. Good afternoon, everyone, and thank you for joining us today to review our results for the Q1 of fiscal 2025. On the call are Jeff Mezger, Chairman and Chief Executive Officer; Rob McGibney, President and Chief Operating 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. With that, here is Jeff Mezger.

Jeff Mezger (Chairman and CEO)

Thank you, Jill. Good afternoon, everyone. In addition to reporting our Q1 results today, we also announced that Rob Dillard will be joining the company as our Executive Vice President and Chief Financial Officer. Rob is a well-rounded leader with a solid financial and operational background. He's an excellent addition to our deeply talented and long-tenured finance and accounting team. We're excited for him to join us next week. Moving on to market conditions. Consumers are continuing to cope with affordability concerns and uncertainties around macroeconomic and geopolitical events. As a result, consumer confidence has declined sequentially each month for the past several months, and homebuyers are moving more slowly in making their purchase decisions.

While longer-term housing market conditions remain favorable, driven by demographics and an undersupply of homes, demand at the start of the spring selling season has been more muted than we have seen over the past few years. As a result of this softer selling environment, we are lowering our revenue guidance for fiscal 2025. As for the details of our results, we produced total revenues of $1.4 billion and diluted earnings per share of $1.49 in our Q1. We delivered fewer homes than we anticipated due to about 150 less inventory home sales than we projected, and a timing issue that impacted roughly 75 of our deliveries in Southern California following the wildfires early this year. Even with this lower level of deliveries, our gross margin held up well at 20.3%, excluding inventory-related charges, above the midpoint of our guided range.

With our SG&A of 11%, we produced an operating income margin of 9.3%. We increased our book value per share to over $57, a 12% year-over-year increase. We generated 2,772 net orders in the Q1. While our average community count was in line with our projection and our cancellation rate was fairly steady, our monthly absorption pace per community was 3.6 homes compared to 4.6 in last year's Q1. At the time of our last earnings call in January, traffic in our communities was higher year-over-year, along with higher website leads, and mortgage interest rates were similar to where they were in the year-ago period. These metrics indicated to us that we were set up to experience a typical start to the spring selling season, similar to how the 2024 spring season unfolded, with the strongest weeks of the Q1 still ahead of us.

With a meaningful number of planned new community openings, we expected to achieve a flat year-over-year net order comparison for the full quarter. As the quarter progressed following our last call, it became apparent that demand was softer than we expected. We took action in mid-February, evaluating our base pricing in every community relative to local market conditions, then repositioning our communities with a focus on offering the most compelling value. We were encouraged by buyers' responses to these actions and saw a meaningful improvement in our net orders in the last two weeks of the quarter, which has continued into the first three weeks of our Q2. For the trailing five weeks, our weekly net sales have averaged about 300, which equates to an absorption pace of 5.1 net orders per month per community. This is approaching a more normalized order pace for the spring.

While we're pleased with this progress, we recognize that the environment is dynamic, and we are committed to taking further action if necessary, depending on how market conditions evolve. Let me pause here for a moment and ask Rob to provide more details on our deliveries and sales, as well as an operational update. Rob.

Rob McGibney (President and COO)

Thank you, Jeff. I will begin by addressing our shortfall in deliveries, which trailed our Q1 expectation by approximately 225 homes. Our revenue guidance is comprised of anticipated deliveries of homes from our backlog, together with sales of inventory homes, which has represented about 40% of our business in each of the past two fiscal years. We expected about 150 more sales of inventory homes than we generated and fell short of this projection due to factors impacting our sales overall, which I will discuss in a moment. We also had roughly 75 deliveries in Southern California shift into the Q2 as we were unable to get meters, utility hookups, and final clearances on completed homes, with crews diverted to priorities related to wildfires in the Los Angeles area that occurred in January.

While we expect to close all of these homes in the Q2, and many have already been delivered, we will continue to navigate any wildfire-related issues that arise. Moving on to net orders. At the time of our last earnings conference call, six weeks into our Q1, our net orders were down about 12% year-over-year. Historically, we begin to see net order momentum build in late January and early February, similar to what we experienced in the year-ago Q1, even with mortgage interest rates in the high 6% range at that time. However, the 2025 spring selling season started slower than in previous years, reflecting a decline in consumer confidence as consumers processed the variables relating to macroeconomic and geopolitical issues. This decline in confidence is leading homebuyers to take longer to make their purchase decisions.

In addition, a number of our planned community openings were delayed until late in the Q1 or early in the second, contributing to our Q1 net sales result. With healthy traffic in our communities, we took steps in mid-February to drive an increased urgency to purchase by improving affordability for our customers. We focused on offering the most compelling value, reducing base prices, and in many cases, lowering or eliminating incentives, helping to offset the margin impact of those price changes. As we have shared in the past, although buyers are sensitive to rates and monthly payments, the primary motivation of most of our customers is securing a home that meets their needs at the best price. We thoughtfully and selectively adjusted pricing as needed on a community-by-community basis to stimulate demand and achieve a higher selling pace. As Jeff shared, consumers responded to these adjustments.

We believe we have found the market and are encouraged with our trend over the last five weeks, equating to an average absorption pace of 5.1 net orders per month per community within our targeted range for the spring. While base price is the main motivator for our customers, we also provided mortgage-related support to our buyers as needed. Mortgage concessions represented approximately 2% of our housing revenues in our Q1, two-thirds of which were rate buy-downs, and the other one-third was the cost of loan locks. Our sales goals for this year are closely connected to our community count expectations. At the end of the Q1, we had 255 active communities, up 7% year-over-year, contributing to an average of 257, which also increased 7%. We continue to expect to maintain roughly 250 to 260 active communities throughout our 2025 second and Q3s.

In addition, we anticipate ending the year with approximately 250 communities before growing our count again in early 2026, just ahead of that spring selling season. Our backlog at the end of February was over 4,400 homes valued at $2.2 billion. We maintained a normalized cancellation rate during the quarter, indicating that buyers are ready and able to close on their homes. While our backlog is lower year-over-year, our build times are nearly 20% faster as compared to the prior year quarter. This allows us to sell built-to-order homes later in the year while still achieving a year-end closing. Our 2025 deliveries will be comprised of the homes we have in backlog, built-to-order homes sold through the early part of our Q3, and sales of inventory homes. We started approximately 2,800 homes in the Q1, contributing to over 6,500 total homes in production.

We remain consistent in aligning our starts with sales, with the majority of those starts already sold. Overall, our build times, measured in calendar days, improved sequentially in the Q1 to 147 days, our best level in the last four years. For build-to-order homes, our build times are currently 139 days. This progress in the Q1 moves us closer to our goal of 120 days from start to home completion, which is at the lower end of our historical range. Several of our divisions are already building homes at this target level, and we are confident in our ability to achieve this goal company-wide.

The benefits of lower build times are numerous, including a more compelling selling proposition for our customers purchasing a build-to-order home relative to the 60 days it takes to complete an existing or speculative home sale, better inventory turns, monetizing our assets quicker, and a lower cost of interest rate locks due to the shorter duration of the lock, which will help reduce our mortgage concession cost over time. We are continuing to rely on our long-standing trade relationships with our Even flow production to ensure that we have the crews necessary to get our homes built. We have not seen any meaningful trade labor shortages to date. Our value engineering and studio simplification efforts are yielding results as we further reduce direct costs on our homes started during the Q1.

Direct costs were down both sequentially and year-over-year, helping to offset the impact of our price reductions and increases in land costs. Our costs, including lumber, are protected for almost all of our Q2 starts under the terms of our supply contracts. Regarding lumber, we had started moving toward longer locks in expectation of tariffs being implemented. Our national purchasing team, working with our divisions, has effectively managed to hold off anticipated tariff-related cost increases to date. Before I wrap up, I will review the credit metrics of our buyers who finance their mortgages through our joint venture, KBHS Home Loans. We increased our capture rate sequentially with 90% of buyers who finance their homes using KBHS. Higher capture rates help us manage our backlog more effectively and provide more visibility in closings, which benefits our company as well as our buyers.

In addition, we see higher customer satisfaction levels from buyers who use our joint venture versus other lenders. The average cash down payment was stable both sequentially and year-over-year at 16%, equating to about $80,000. On average, the household income of customers who use KBHS was about $133,000, and they had a FICO score of 746. Even with one-half of our customers purchasing their first home, we are still attracting buyers with strong credit profiles who can qualify for their mortgage while making a significant down payment. In conclusion, while we believe we are aligned with current market conditions based on the solid net orders we have generated over the past five weeks, we will remain nimble in our approach to the spring selling season, balancing pace and price at the community level.

Our community count trajectory is consistent with the update we provided at the start of the year, and we have a significant number of planned grand openings in the Q2, as well as the second half of this year. We are committed to executing on the day-to-day fundamentals of our business, maintaining our high customer satisfaction levels, further improving build times, value engineering our products to lower direct costs, and balancing pace and price to optimize each asset. We are confident in our ability to navigate varying market conditions. With that, I will turn the call back over to Jeff.

Jeff Mezger (Chairman and CEO)

Thanks, Rob. We continue to view the long-term outlook for the housing market favorably and are investing in our future community count growth to support our objective of expanding our scale. During the quarter, we invested $920 million in land acquisition and development, of which about 40% went toward development and fees. The Q1 will likely represent the high watermark in our land spend for this year and included the purchase of two large parcels in Las Vegas, which will provide continuity as we replace our highly successful Inspirada community. Over the past five years, we've averaged nearly 450 deliveries each year at Inspirada across multiple product lines, and the community is approaching closeout. The two new parcels will offer similar product lines as Inspirada at affordable price points.

Our Las Vegas business is one of our largest and strongest performers, having consistently generated the highest gross margins and profitability in the company. We continue to adhere to our underwriting criteria, product strategy, and price points, and remain mindful of the housing market and overall economy with the intention of adjusting our investment spend as necessary to match local market conditions. Our investments have contributed to increasing our lot position by 41% year-over-year to over 78,200 lots owned or controlled, 46% of which are optioned. We have expanded our lot position with a focus on capital efficiency, developing lots in smaller phases wherever possible, and balancing development with our start space to manage our inventory of finished lots. We've continued our balanced approach of investing in our growth while returning nearly $70 million in capital to shareholders in our Q1, including $50 million in share repurchases.

In closing, I want to recognize the entire KB Home team for their ongoing commitment to serving our homebuyers. Although we have reduced our revenue guidance for fiscal 2025 to between $6.6 billion and $7 billion, primarily to reflect the lower level of net orders that we generated in our Q1, we are encouraged that homebuyers have responded to the actions we took to offer the most compelling value, and we have experienced solid net orders in the past five weeks since implementing those adjustments. While we believe we have taken the appropriate steps to achieve our sales targets, we have a strong and experienced team that has successfully navigated varying market conditions while supporting our customers and operating our business effectively. We are confident in our ability to continue to do so.

Our company is well-positioned for future growth with the lots owned or controlled to support higher revenues with a strong balance sheet and significant financial flexibility. Long-term, we remain committed to enhancing shareholder value through profitable scale expansion and producing higher returns, as well as continuing to return cash to shareholders. Bill Hollinger will be providing a financial review today, and I'll turn the call over to Bill.

Bill Hollinger (SVP and Chief Accounting Officer)

Thank you, Jeff. As Jeff and Rob mentioned, the Q1 proved to be challenging for a variety of reasons. As a result, our performance fell short of our expectations, primarily due to lower-than-anticipated deliveries, which impacted both our revenues and net income. Nevertheless, several other key metrics for the quarter were aligned with our previous guidance. Regarding our current outlook for the remainder of 2025, we are revising our guidance to reflect our Q1 results, including the more muted start to the spring selling season, as well as the selective price adjustments we implemented in mid-February to stimulate demand and support a higher sales pace. In the 2025 Q1, we produced housing revenues of $1.39 billion, net income of $110 million, and diluted earnings per share of $1.49.

We continued our balanced approach to capital allocation with $920 million in land-related investments, up 57% year-over-year, while returning over $69 million to our stockholders through share repurchases and dividends. We also kept our debt-to-capital ratio at a healthy level. Our housing revenues for the Q1 were down 5% compared to $1.46 billion in the prior year period due to a 9% decrease in the number of homes delivered, partly offset by a 4% increase in their overall average selling price. The 2,770 homes delivered in the quarter represented a backlog conversion rate of 62% compared to 55% in a year-earlier period, largely reflecting our improved build times. As Rob mentioned, the number of homes delivered was below expectations, mainly due to fewer-than-expected deliveries from inventory sales and utility services related to delays at some of our Southern California communities as local resources were diverted to address wildfire-related priorities.

With our revised outlook, we expect Q2 housing revenues to range from $1.45 billion-$1.55 billion. Looking at the 2025 full year, we are now forecasting housing revenues in the range of $6.6 billion-$7.0 billion. The upper end of this range remains within our previous guidance. In the Q1 our overall average selling price of homes delivered was $500,700, also in line with our guidance. Reflecting our selective price adjustments and anticipated mix of deliveries, we expect our Q2 overall average selling price to be approximately $488,000. For the full year, we are revising our overall average selling price projection to be in the range of $480,000-$495,000. For context, our prior guidance was $488,000-$498,000. Homebuilding operating income was $127.3 million compared to $157.7 million for the year-earlier quarter.

Operating income included inventory-related charges, totaling $1.5 million in the current quarter and $1.3 million in the prior quarter, consisting in both periods entirely of land option contract abandonments. Our homebuilding operating income for the quarter was 9.2% compared to 10.8% in last year's Q1, mainly due to our lower housing gross profit margin. We anticipate our 2025 Q2 homebuilding operating income margin will be approximately 8.5%. For the 2025 full year, we are projecting this metric to be approximately 9.4%, which primarily reflects expected sequential improvement in the latter half of the year, driven by increased operating leverage on higher revenues. Our current projection is lower compared to both our prior guidance of approximately 10.7% and the year-earlier results of 11.1%. These operating income margins assume no inventory-related charges. Our 2025 Q1 housing gross profit margin was 20.2% compared to 21.5% for the year-earlier quarter.

The decrease mainly reflected higher relative land costs, increased homebuyer concessions, and reduced operating leverage. Excluding inventory-related charges, our housing gross profit margin was 20.3%, above the midpoint of our guidance for the 2025 Q1. For the year-earlier quarter, it was 21.6%. We are forecasting a housing gross profit margin for the 2025 Q2 in the range of 19.1% to 19.5%, and for the full year, in the range of 19.2% to 20.0%, assuming no inventory-related charges. Our gross margin outlook for both periods reflects lower selling prices than we anticipated in January, reduced operating leverage on lower delivery volume, and the challenging operating environment. Our selling, general, and administrative expense ratio for the quarter of 11% was up slightly from the year-earlier quarter.

Considering the operating leverage effect was approximately 40 basis points, we would have achieved our guidance had we delivered or we had generated the delivery volume we were expecting. We are forecasting a 2025 Q2 SG&A ratio to be in the range of 10.6% to 11.0%, and expect our 2025 full year SG&A ratio will be in the range of 10.0%-10.4%. Our income tax expense of $29.8 million for the quarter represented an effective tax rate of 21.4% compared to 20.6% for the year-earlier quarter. The current quarter rate compared favorably to our guidance primarily due to the impact of tax benefits related to stock-based compensation. We expect our effective tax rate to be approximately 24% for the Q2 and full year. As we said on our previous earnings call, our 2025 full year tax rate is expected to be up slightly from the previous year.

This is primarily due to decreases in energy tax credits. In terms of our bottom line results for the quarter, we generated net income of $109.6 million and diluted earnings per share of $1.49. This compares to net income of $138.7 million and diluted earnings per share of $1.76 for the same quarter of last year. Turning to land, we continue the positive momentum of the past few quarters in expanding our lot portfolio to position our business for future growth and larger scale. In the Q1, we significantly increased our investment in land acquisition and development to $920 million, ending the quarter with inventory balance of just under $6 billion, up 13% from a year ago. In keeping with our balanced approach to capital allocation, we repurchased 754,000 shares of our common stock at a total cost of $50 million during the quarter.

With $650 million remaining under our current common stock purchase authorization and our healthy balance sheet, we have both the ability and intent to repurchase additional shares. However, the pace, volume, timing will depend on factors such as our operating cash flow, liquidity forecasts, land investment prospects and needs, the market price of our shares, and the conditions in the housing market and broader economic environment. We ended the quarter with total liquidity of $1.25 billion, including $268 million of cash and $982 million available under our unsecured revolving credit facility, with $100 million of cash borrowings outstanding. Our Q1 is typically when we have the lowest cash inflows and highest outflows of our fiscal year. As such, in executing on our priority of investing in land and land development for future growth during the 2025 Q1, we utilize cash borrowings from our credit facility.

As a result, our debt-to-capital ratio increased to 30.5% at the end of the quarter compared to 29.4% at the end of 2024. We do not expect to have any cash borrowings outstanding under the credit facility by the end of our fiscal year. We have no debt maturities until our term loans' 2026 expiration, with our next senior note maturity in June of 2027. In closing, although conditions were more challenging than anticipated in the 2025 Q1, we believe we are well-positioned to meet our updated outlook for the remainder of the year. At the same time, we plan to remain flexible to meet the evolving market conditions as we maintain our focus on balancing pace and price at each of our communities.

Overall, we believe our solid financial position, including our liquidity profile and long runway for debt maturities, and robust land portfolio will enable us to navigate the current environment, continue to be opportunistic and balanced with allocating capital in 2025 and beyond, and sustain our returns-focused growth strategy centered on enhancing long-term stockholder value. We will now take your questions. John, please open the line.

Operator (participant)

Thank you. We will now be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate that your line is in the queue. You may press star two to remove yourself from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. We ask that you please limit yourself to one question and one follow-up. Thank you.

One moment, please, while we poll for questions. The first question comes from the line of Matthew Bouley with Barclays. Please proceed with your question.

Matthew Bouley (Director and Senior Equity Research Analyst)

Hey, good afternoon, everyone. Thank you for taking the questions. I wanted to start with the price adjustments and specifically the question around kind of customer elasticity. I guess what level or what magnitude of price adjustments would you say was enough to kind of get consumers off of the fence here? How are you kind of able to separate what you were doing with these price adjustments relative to the kind of typical seasonal uptick that you would see in March anyway? Just any more detail around the magnitude and thinking about sort of protecting the backlog as well and customer elasticity. Thank you.

Jeff Mezger (Chairman and CEO)

Matt, I can make a few comments, and then I'll hand it to Rob for some specifics. There are a lot of things going on in the market, and as we always share, it really is sub-market specific and community specific. As the divisions were working to get sales, in a lot of cases, they fell in the trap of starting to offer what I would call a pocket incentive where you do not advertise it. The consumer does not know about it until they get into the sales office, and then they would find out there is a $10,000 studio credit available if you buy this weekend and things like that.

As we analyzed things, we decided, "Let's get rid of all that, what I would call noise, and just take it to price so we can advertise on the website what the real price is net that we were already offering anyway." A lot of the moves we made really were cleaning out incentives and taking it to price. That was step one. Past that, as we analyzed each community, if there were communities not selling that were not aligned with the resale data in that sub-market or what new home competitors were doing, we took additional steps to pull the price down further as needed. It's not like you can identify that price will work. You have to keep going till you get your sales momentum back. We took some steps, and we were bold all the way around.

As I shared in my comments, it was the very first week after that our sales picked up quite a bit. Rob can give you some of the detail between offsets by reducing incentives versus pure price adjustments.

Rob McGibney (President and COO)

Just to add some specifics to it, it was roughly half of our communities that we lowered base price. As Jeff said, at the same time, we were cleaning up some of the clutter with the incentives. It was a range, just depending on what the sales pace was, where resale levels are trending and tracking, all of those factors kind of into the mix. It ranged from $5,000 up to $30,000 in some cases. I think the average, if you put them all together, of the communities that we decreased, it was $15,000 or $16,000. Call it 3% on our ASP.

At the same time, when we cleaned up the incentives and the other things that Jeff mentioned that were being offered, the net reduction or impact to margins is much lower than that. In fact, since we've made those moves, the margin roughly on deals that we're seeing come into backlog is only about 75 basis points lower. We feel pretty good about where we are right now. The communities where we've made the moves are performing. We've got some that have actually started performing better than what our expectations are. We've got some opportunity to claw back price and margin there. A handful of others that we still need to do some work on. Generally, we feel good about how we're positioned after making those moves, and the consumer has really responded to it well.

Matthew Bouley (Director and Senior Equity Research Analyst)

Okay. Great. No, thank you for that color.

I guess that leads me then to the next question around the margin. I think the way you implied the kind of gross margin cadence, I think you even said the operating margin should be improving sequentially by the second half relative to Q2. I think I heard you say that leverage on some of your fixed costs is a driver of that. You just mentioned there is a 75 basis point hit from the kind of net price adjustments. If I think about kind of what is going on with land basis and development costs, other type of inflation, you mentioned lumber on top as well. Can you just kind of bridge all those pieces together and pluses and minuses and give a little confidence on what drives that step up in margins in the second half? Thank you.

Jeff Mezger (Chairman and CEO)

Yeah.

Matt, in general terms, the margin per house is holding pretty similarly as the year unfolds. Everything that we've done is already included in the guide that we provided today. The improvement in the operating margin is coming from leverage. Whether it's SG&A improvement or a little bit of gross margin improvement, both sides, it comes from delivering more houses.

Operator (participant)

Thank you. The next question comes from the line of John Lovallo with UBS. Please proceed with your question.

Matt Johnson (Head of Real Estate)

Hey. Thanks, guys. You actually have Matt Johnson on for John. I appreciate the time. I guess just following up on that last question, I'll try and do some quick math. I think at the midpoint of your guide's guide, the implied back half gross margin is roughly, call it 19.5%.

Bill Hollinger (SVP and Chief Accounting Officer)

It would be down about 30 basis points relative to the first half, despite home sales being up, call it 36%, half over half. I guess could you just help us think through some of the puts and takes there as we go from the first half into the second half? Maybe how much of that is from mix as opposed to like-for-like deterioration?

Jeff Mezger (Chairman and CEO)

I want to take a shot at that.

Rob McGibney (President and COO)

Yeah, it was a little hard to hear your question, but if I got it. There is always mix involved, but we are not expecting a whole lot of mix here. We are expecting, and not to say it this way, but the midpoint of the uncertainty, let's say, ranges. We did look at kind of a high low. Sort of looking at things as they are today is kind of what our forecast reflects.

There is really not much more I can add to that than just say that we are expecting some smaller than improvement in the housing gross profit margin, mostly due to leverage, not due to anything else. That is because of our second half, it is going to be what we believe is going to be far stronger volume-wise. We think most of the leverage that we are going to get to an operating income level will come from the SG&A side.

Matt Johnson (Head of Real Estate)

That all makes sense. I appreciate it. I guess just one more. For the full year, you guys are expecting home building operating margins of 9.4%. That would be down, call it 170 basis points year-over-year.

If we look back at last year, operating margins on a regional basis were actually up in both the Southwest and West Coast, while the pressure really came from the Central and the Southeast. I guess do you guys expect a similar story to play out this year or how we kind of think about that on a regional basis?

Jeff Mezger (Chairman and CEO)

Yeah, I think that's the right way to look at it. West and Southwest are performing better financially right now.

Operator (participant)

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

Stephen Kim (Senior Managing Director)

Yeah, thanks very much, guys. Appreciate all the detail. I guess my first question relates to the cycle times. Rob, you talked about the fact that cycle times are down and all the benefits that that provides for the company.

I think you indicated you had not seen any trade labor shortages to date. We are curious as to, are you not seeing, have you not seen any, for lack of a better term, ICE raids in any of your communities or your neighboring communities? Is that what you meant by no trade labor shortages or are you, in fact, seeing some of that, but it is just not meaningfully disruptive enough to call out? You had said, I think direct costs were down year-over-year and quarter to quarter. I was wondering if you could quantify that a little bit for us.

Rob McGibney (President and COO)

Sure. I will start with the first one last. Sequentially, our direct costs are down about 1%. year-over-year, we are looking at about 3%. That is to quantify that piece.

On the labor, I'd say outside of the normal things that we would deal with outside of any kind of regulatory change or ICE or immigration policy change, it's really just been the same. We've seen nothing at all related to immigration. I mean, any kind of normal-type labor shortage we might see on a day-to-day basis in a typical year may still be there, but nothing at all, Steve, related to immigration policy.

Stephen Kim (Senior Managing Director)

That is really encouraging. I appreciate that. Right, of course. Yeah. We always have to add that these days, for sure. Okay. That is helpful. I guess if you could just mention, I think you gave a very nice discussion about how you've eliminated the pocket incentives and you sort of went to sort of putting these base prices on the internet and all that.

It sounds like you're talking about this as a permanent change. I just want to make sure that I'm interpreting that correctly. You've referred to it as, I think, cleaning up and getting rid of some of the noise and all that kind of thing. I just wanted to understand, is this something that you feel no longer has value, or is there something maybe more nuanced that you want to message there?

Jeff Mezger (Chairman and CEO)

Steve, it's an interesting evolution in that when you have a large backlog, you're sensitive to moving price because then you've got to go also deal with the backlog. Our division started doing these pocket incentives. Q4, we were already working hard to get sales, and a lot of them crept in. They were still there in the Q1.

It was not reflected in our pricing, but it was reflected in the margins we were generating. We decided, "Let's get out of it and get back to our core values." I would say it is a permanent move because it is the way we like to run the business. Unfortunately, we fell in the trap of doing some things to try to get sales that really were not aligned with how we present the best value to the customer.

Thank you. The next question comes from the line of Mike Dahl with RBC Capital Markets. Please proceed with your question.

Mike Dahl (Managing Director)

Hi, thanks for taking my questions. I guess I want to press on gross margins a little bit more. Maybe just remind us kind of in the current environment with what your guidance incorporates for the revenue ramp as the year goes on.

How would you normally think about how that translates to seasonal gross margin uplift? Just trying to get a sense of really the flat-top guide in second half at face value does not seem awfully conservative. Maybe you can just help us think through and remind us what that seasonal component actually is from a quantitative standpoint. Leverage by quarter.

Bill Hollinger (SVP and Chief Accounting Officer)

Yeah. I would say that it is, again, our normal sequential cadence in that we are going to see improving quarter to quarter with really what I will say, taking out the leverage impact with a more or less flat gross. The improvement is, again, mostly from the leverage. We are not looking to get much uplift in our gross margin without the leverage. I think, again, what we are hoping and what I maybe said earlier was that there is, again, a lot of uncertainty out there.

We're not expecting it to get worse. We're not expecting it to get better. This really reflects kind of what we think is in our backlog. With the sales price reductions that we've taken to date, obviously, things change. It'll impact our margins. Right now, it seems or it assumes a relatively static order right now.

Mike Dahl (Managing Director)

Okay. My follow-up is still along the same lines. It's more, why is that really the base case assumption when you just saw in a short period of time the need to make some changes? Your competitors are making changes based on what we see in terms of price. The demand environment has been very uncertain. There's an uncertain cost environment. Your sales pace, it's great to hear that it picked up, but it's still down year-on -year.

Why is assuming that conditions will remain stable the right base case under the current conditions?

Jeff Mezger (Chairman and CEO)

We're pleased with our sales right now. As I shared in my prepared comments, we're approaching a normal Q2 sales pace with the current margins we're guiding to. It's based on everybody's going to have their own crystal ball on where the world's headed. As we see it today, we took steps that are working. The steps we took are reflected in the margin guide we've provided, and we're hitting our sales numbers. Right now, we're pretty comfortable with where things are at.

Operator (participant)

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

Michael Rehaut (Managing Director and Senior Equity Analyst)

Thanks. Good afternoon, everyone.

First, I just wanted to, and I apologize if I missed this earlier, but I'd love to get kind of any regional differentiation across your footprint when you talk about, in particular, adjustments that you needed to make with incentives or pricing. If there were certain markets or even sub-markets that were kind of more prevalent or at the top of the list, and by contrast, which markets might be on the stronger end of the spectrum?

Rob McGibney (President and COO)

Sure, Mike. I'll take that, Rob. As we always say, it really is market by market or even sub-market by sub-market. I'll talk about resale a little bit here because we've always viewed resale as our biggest competitor, regardless of what the new home competition is doing. We've got to stay tethered to that pricing with a reasonable new home premium to drive volume.

As far as the regional color, I would say in broad terms that Florida was our softest state in terms of sales demand in the Q1. Because of that, we took the most pricing action there to find the market. I'd say roughly two-thirds of our communities, probably the same price range between $5,000 and $30,000. We had to do more in Florida to find that market. I'll just start with Jacksonville, for example, using that as a proxy. They've got just under, right at, seven months of supply. It's a month or so above what a historical norm would be in terms of resale supply or where most people consider a balanced market. Resale is a really efficient market. One positive that we see in that market is it is getting absorbed.

You've got days on market are actually down year-over-year despite that higher supply, but it's likely because pricing has moved. We're seeing that market react. We've done the same thing in that market to find where we need to be to sell. Where we can offer that new personalized energy-efficient product with a small premium to resale, we find that we win. You look at the rest of Florida, Orlando was similar. They've seen their days on or their months of supply increased to about the same level. Have not seen the pricing levels adjust there like they've started to in Jacksonville. Their days on market continues to be pretty elevated. Made some more significant adjustments there. The other business we have is Tampa. It's a similar situation, but lower overall months of supply than Jacksonville or Orlando.

Even within those three markets, it's sub-market by sub-market. Some perform better than others, and we've had to adjust the moves that we're making based on that. Texas, I would say the story was a little more mixed. Many of our communities continued to perform very well, while there were others that we had to adjust in. I'd say Houston and Austin held the best. The moves there were smaller and more surgical, where San Antonio required some more broad-based adjustments. When you get into the West, really resale is still very low in terms of where it's been historically. I mean, most of them are in the three or four months of supply range and haven't had to make as many moves in the West, and Southwest has held better.

Michael Rehaut (Managing Director and Senior Equity Analyst)

Thanks. That's a great overview. Appreciate all the detail there.

I guess secondly, I'd love to shift towards the balance sheet. If you could just kind of remind us how you're thinking about leverage over the longer term and kind of the dividends and share repurchase and perhaps what the potential is for that over time.

Jeff Mezger (Chairman and CEO)

Mike, our strategy really hasn't changed from where we've been the last few years. Our ratios will improve because we're growing the equity. We don't see the need to go get more debt. We don't have any maturities for a while. When they do come up, we'll deal with them. Top priority, we have to grow the business and get scaled and be more profitable. Along the way, we're taking our excess cash and repurchasing shares. We've done a lot of that over the last three to four years. That's more of an opportunistic play.

It depends on the price and what our cash forecasts are and where we think we're headed. As Bill shared in his comments, we don't expect to have anything out on the revolver. We had a little blip in Q1 because of the two Vegas land deals. That'll get absorbed and go away over the balance of the year. Our ratio guide would be it's going to keep coming down as we grow the equity. It's not going to be taking debt out. Grow the business and be opportunistic with the other things and take your excess cash and give it back to the shareholders.

Operator (participant)

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

Alan Ratner (Managing Director)

Hey, guys. Good afternoon. Thanks for all the detail so far.

My question on the price adjustments, I'm just curious if you can look at the last five weeks of solid order results following those adjustments. Would you say those have been driven more by kind of going back to buyers that were already in the pipeline, giving yourselves the tools to kind of go back and say, "We've made these adjustments," and that kind of pulling them off the sidelines given the hesitancy? Or would you say that it's actually translated to significant increases in new traffic, maybe coming from the website advertising and actually pulling through more sales from new individuals coming into the pipeline?

Yeah, that's a good question. It's both. I think more so it's bringing in new buyers. I mean, as Jeff said, we are putting our best foot forward, advertising the best price on the internet. That's where most people see us first.

I think that's generating new traffic that we weren't seeing before. I don't have a ratio or a percentage for you. I'd tell you that some percentage of it is going back to buyers that we already had in the queue or that were former leads that didn't purchase, couldn't purchase, maybe couldn't qualify. With some of the adjustments we've made, we have made sales from going back to past traffic. The majority of it is new traffic that's being generated from the website.

Got it. That's encouraging. I think what we've heard in the past is one of the, I guess, trickier things for build-to-order builders making base price adjustments is the large backlogs that you guys have. I'm curious how you're dealing with your backlog.

Are you proactively reaching out to them in the 50% or so of communities where you have adjusted prices? Are you offering those same adjustments? Are you taking it on a case-by-case basis as they get closer to the closing dates? Any color there would be helpful.

Rob McGibney (President and COO)

Yeah, we're taking it on a case-by-case basis. Really, when you look at a lot of the deals that we have in backlog, everybody struck their own deal. I mean, Jeff mentioned some of the other incentives that were being offered and deals being made. As we looked at that, we really do not think there is a lot of backlog exposure. We have taken some adjustments where that was not the case, and the new deal might be better than what somebody had in backlog. In the grand scheme of things, it is pretty small.

Operator (participant)

The next question comes from the line of Jay McCanless with Wedbush. Please proceed with your question.

Jay McCanless (Managing Director and Senior Equity Research Analyst)

Hey, thanks for taking my questions. The first one I had, just wanted to find out, are you guys still having problems getting meters and other things in California as the rebuild has started there?

Rob McGibney (President and COO)

It's interesting. We kind of always have problems getting meters in California. Yeah, it is a little, it's still a little more delayed from the impact of the fires. I think we're through the worst part of that. A lot of the rebuilding hasn't started. I think that's going to be a long and ongoing process. It's a big state, a lot of volume, a lot of crews. I don't expect that that's going to be a significant ongoing drag on our timing to get meters and utility hookups on houses.

Still there a little bit, getting better every day. I think that that'll be back to normal fairly soon.

Jay McCanless (Managing Director and Senior Equity Research Analyst)

Okay, good. That's good to hear. In the 50% of communities where you didn't adjust pricing, I guess, were you able to raise prices in some areas? If so, maybe highlight one or two that did well during the quarter or highlight one or two regions that did well during the quarter.

Rob McGibney (President and COO)

Yeah. As I mentioned, the West and Southwest has performed better. I mean, on the half that we didn't move prices down, we didn't move prices down because they're selling at pace, and we're happy with what they've done. Now that the spring selling season is here, there are opportunities to lift. I'll just use Las Vegas as one of the examples. I mean, that market continues to do very well for us.

Jeff mentioned the two large purchases that we've had there, but we've continually raised price there and continue with really strong absorptions. We've got similar examples throughout some places in California as well on the communities that were already performing well that are now doing even better.

Operator (participant)

The next question comes from the line of Sam Reid with Wells Fargo. Please proceed with your question.

Sam Reid (Senior Equity Research Analyst and Executive Director)

Awesome. Thanks so much. Just looking at your updated delivery guide, especially on the back of the Q1 orders, just on my very rough math, it looks like we're going to need to see backlog conversion accelerate in the second half. Could you just break down the balance between kind of maybe better cycle times or more spec homes? Because it would seem like one of those would potentially need to change to hit the revenue guide in the second half.

Just hoping to unpack that.

Rob McGibney (President and COO)

Yeah. I mean, I think it's all the things that you just mentioned there, whether it's the improvement in cycle time or covering more of the inventory that's available. While it does increase from where we were in Q1, we think it's a very achievable number. I mean, you just look at where we were in Q4. It's similar to that. As we said, we're still targeting 120 days company average on cycle time. As we continue to progress towards that, that helps with the backlog conversion as well.

Sam Reid (Senior Equity Research Analyst and Executive Director)

Yeah, that helps. Just to follow up to something in the prepared remarks, you delivered, I believe, slightly fewer inventory homes during the quarter than you were expecting. Can you just talk to why that number was a little bit lower? I think it was about 150 units.

Apologies if I missed. Can you just remind us what the gross margin spread historically has been between your build-to-order and your inventory homes? Was there any mixed benefit in the Q1 from that lower inventory home sale volume that we should be aware of? Thanks.

Jeff Mezger (Chairman and CEO)

At the time we made our earnings call back in January, we assumed another 150 would sell and close in the quarter. We assumed more than that, but we missed it by the 150. If you think through the story we shared, we did not really take the steps to get our sales going until the second week of February. One could argue that we were a little slow on taking those steps on the inventory sale, and we missed it. Hindsight is always good, but we have taken the steps now, and we are selling.

It was a one-quarter short-term event, and we think we've addressed it. You want to go over anything else?

Rob McGibney (President and COO)

No, I think that covers it. I mean, I personally expected that we would get more same-quarter sales and closings in Q1 than we did in Q4, and it did not turn out that way.

Operator (participant)

Thank you. Next question comes from Susan McClary with Goldman Sachs. Please proceed with your question. Thank you.

Susan McClary (Senior Equity Research Analyst)

Good afternoon, everyone. My first question is on the design studios. Given that the consumer does seem to be under a bit more pressure, and you did have to take some actions to improve affordability, have there been any changes in what you're seeing in the design studios, either in terms of what they're choosing or anything in terms of what you're offering there?

Rob McGibney (President and COO)

Not really, Susan. It's interesting.

Our percentage of revenue that people are spending in the studio has stayed really consistent. Our square footage of homes has stayed really consistent. As to what they're picking, I think we've seen somewhat of a shift. Really, we started seeing that, oh, maybe a couple of years ago when rates moved up, it was less kind of fit-and-finish type things and spending more on things that buyers knew they couldn't change or that were difficult to change later, like room configuration, structural options, cabinets, countertops, things like that. No, they continue to spend about the same amount. For the most part, buyer behavior in the studio has been consistent.

Susan McClary (Senior Equity Research Analyst)

Okay. That's helpful. You mentioned that you are locking in your lumber for a bit longer just given the potential inflation or the inflation that we're already seeing in that product.

Can you talk a bit more about how long that goes out for, how we should think about the potential impact if lumber continues to move from here? What you're seeing in other wood products as well, has there also been upward movement in some of those too?

Rob McGibney (President and COO)

I haven't seen it in the other products. That may be something that's coming down the road. We haven't seen that yet. As to the lumber, we try to diversify on how we lock. We'll have 90 days, maybe 120 days on the long-term end. Some divisions we're locking for shorter term. As we look at the recent locks, most of our divisions are covered for the majority of the quarter here.

At some point, if lumber continues to go up and depending on what happens with tariffs, and we do not know what that is going to do to domestic lumber pricing, but when those locks expire, we will have to adjust.

Operator (participant)

Thank you. Our final question comes from the line of Trevor Allinson with Wolfe Research. Please proceed with your question. Good evening.

Trevor Allinson (Director and Senior Research Analyst, Homebuilders & Building Products)

Thank you for taking my questions. First, you talked about closing out of Inspirata, and Las Vegas has been a really strong margin market for you guys. Can you talk about what type of gross margins you are earning at Inspirata and maybe the margin impacts as that closes out? When do you expect final sales to be from there?

Jeff Mezger (Chairman and CEO)

Yeah. Trevor, we really do not get into what the gross margin is per community.

Rob and I have both shared that our Vegas margins are strong and well above the company average. The two land deals that we acquired, we had tied up for a couple of years each, had to take them through the entitlement process. They have a very good basis, very similar products to what we offer at Inspirata. And we have a lot of builders knocking on the door wanting to get lots from us. So we know we're in a good spot. Our expectation is Vegas will continue to be at the top for us in terms of profitability and margins. It's a great team and a very land-constrained market.

Trevor Allinson (Director and Senior Research Analyst, Homebuilders & Building Products)

Okay. Understood. Appreciate that color. Second question is on spec production levels. We've heard several builders talk about pulling back on spec production given the slower start to the year.

Are you guys adjusting your spec production as well? What are your expectations for spec mix as a percentage of 2025 deliveries, and how does that compare to your spec mix as a percentage of 2024 deliveries? Thanks.

Rob McGibney (President and COO)

Right now, we're running about the same. We've been about 60% BTO, 40% spec. Historically, we've been closer to 80/20. Our goal right now is to drive BTO sales. We do see higher margins on BTO sales. Our goal is to fill the pipeline with build-to-order sales. That will drive our starts and get back towards, over time, get back closer to that mix of 80% BTO, 20% inventory, or spec.

Operator (participant)

Thank you. Ladies and gentlemen, that does conclude the question-and-answer session. That also concludes today's teleconference. We thank you for your participation. You may now disconnect your lines.