KB Home - Earnings Call - Q2 2025

Executive Summary

• Q2 2025 revenue and EPS modestly beat S&P Global consensus: $1.53B vs $1.51B and $1.50 EPS vs $1.46; beats driven by faster build times and cost controls despite softer demand and pricing pressure.
• FY 2025 guidance was lowered (housing revenues to $6.30–$6.50B; margins trimmed), reflecting weaker spring demand and mix; Q3 2025 quarterly guidance introduced with lower ASP and margin assumptions.
• Operational execution improved: cycle times fell to ~140 days (132 days BTO), direct costs -3.2% YoY, SG&A at low end; backlog conversion supported by faster builds.
• Orders decelerated in April/May; absorption fell to 4.5/month/community (vs 5.5 LY), cancellations up, backlog value -27% YoY; municipal delays pushed openings, weighing on net orders.
• Capital allocation pivot: $200M buyback at ~$53.55/share (below book value $58.64); management plans $100–$200M buybacks in Q3, creating a near-term catalyst alongside guidance reset.

What Went Well and What Went Wrong

What Went Well

• Adjusted housing gross margin (19.7%) exceeded guided range; SG&A ratio (10.7%) came in at the low end; deliveries beat implied plan on shorter cycle times.
• Cost discipline: direct construction costs -3.2% YoY on homes started; lumber and tariff-related increases largely held off; several divisions building at or near 120–100 day targets.
• Shareholder returns: repurchased 3.73M shares for $200M at $53.55/share; book value/share rose to $58.64 (+10% YoY).

Quotes:

• “Our team is producing improvements in two key areas, lowering our build times and reducing direct construction costs, helping to strengthen our business.” — CEO Jeffrey Mezger.
• “We exceeded our delivery expectations... build times... are now back to pre-pandemic levels.” — CEO Jeffrey Mezger.

What Went Wrong

• Demand softness: monthly absorption fell to 4.5 vs 5.5 LY; orders declined 13% YoY; cancellations rose to 16% (vs 13%); backlog homes and value down materially YoY.
• Margin pressure: housing gross margin fell to 19.3% (21.1% LY) on price reductions, higher relative land costs, mix, and reduced operating leverage.
• Municipal delays: utility sign-offs and COs delayed grand openings; management estimates “a couple hundred” missed sales due to openings slipping into late Q2/Q3.

Transcript

Operator (participant)

Good afternoon. My name is Julian, and I will be your conference operator for today. I would like to welcome everyone to the KB Home 2025 second quarter earnings conference call. All participant lines are in a listen-only mode. Following the company's remarks, there will be an open line for questions. This conference call is being recorded, and the replay will be accessible on the KB Home website until July 23, 2025. I will now turn the call over to Jill Peters, Senior Vice President of Investor Relations. Jill, you may begin.

Jill Peters (SVP of Investor Relations)

Thank you, Julian. Good afternoon, everyone, and thank you for joining us today to review our results for the second quarter of fiscal 2025. On the call are Jeff Mezger, Chairman and Chief Executive Officer; Rob McGibney, President and Chief Operating Officer; Rob Dillard, Executive Vice President and Chief Financial Officer; Bill Hollinger, Senior Vice President and Chief Accounting Officer; and Thad Johnson, Senior Vice President and Treasurer. During this call, items will be discussed that are considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future results, and the company does not undertake any obligation to update them. Due to various factors, including those detailed in today's press release and in our filings with the Securities and Exchange Commission, actual results could be materially different from those stated or implied in the forward-looking statements.

In addition, 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, and good afternoon, everyone. We delivered solid financial results in the second quarter that met or exceeded our guidance ranges across our metrics as we continue to navigate the current environment. With a healthy balance sheet, our financial position and flexibility are strong. We are returning an increasing amount of cash to our shareholders, having repurchased $200 million of our shares in the second quarter. Operationally, we continue to strengthen our business by further reducing our build times and lowering our direct costs. As to market conditions, while longer-term, the outlook for the housing market remains favorable, driven by demographics and an undersupply of homes, consumers are continuing to demonstrate a lack of confidence about the short term, which has impacted their home purchase decisions. Affordability challenges have persisted, compounded by the variability in mortgage interest rates, which remain elevated, as well as macroeconomic and geopolitical uncertainties.

These factors resulted in a more subdued demand during the spring selling season. As a result of this softer environment, we are revising our guidance for fiscal 2025. As to the details of our results, we produced total revenues of $1.5 billion and diluted earnings per share of $1.50 in our second quarter. We exceeded our delivery expectations, driven primarily by faster build times, which improved sequentially by seven days and are now back to pre-pandemic levels. We achieved a gross margin of 19.7%, excluding inventory-related charges, above our guidance range. With a focus on prudently managing our costs, our SG&A was at the low end of our guided range at 10.7%, contributing to an operating income margin of 9%. We increased our book value per share to nearly $59, a 10% year-over-year increase. We generated 3,460 net orders in the second quarter.

The actions we began to take late in our 2025 first quarter, evaluating base pricing in every community relative to local market conditions, then repositioning our communities with a focus on offering the most compelling value, led to strong net orders in March. However, our net orders declined in April and May, which did not follow the typical spring trajectory. As a result, even though our average community count was in line with our projection and our cancellation rate was fairly steady, our monthly absorption pace per community was 4.5 net orders, compared to 5.5 in last year's second quarter. While our net order pace was below our internal goal, we believe it ranks high among the large production home builders. Our focus is on optimizing our assets to generate the highest returns, balancing pace and price on a community-by-community basis.

In stronger market conditions, we believe this will yield an annual average absorption pace of about five net orders per month per community, as we would increase price in order to maximize margins rather than run our communities any faster. When the market slows, we would expect a pace of roughly four net orders per month per community. This is not a fixed approach. It allows for flexibility to adjust to changing market conditions as we determine the appropriate pace to achieve the best possible returns. For example, reducing base prices late in our first quarter at the start of the strongest selling period of the year optimizes our assets. Doing so in the fourth quarter, when demand is typically more inelastic and speculative builders are competing to finish their fiscal years, is not the optimal way to manage our assets.

The incremental volume in that context tends to be minimal and comes at a great cost to our margins. Finding the right balance comes from adjusting prices to maintain or increase our absorption pace so that each community has the appropriate selling cadence while maximizing margins, returns, and cash flow. Market conditions change over time, and when resale inventory was lower over the past few years, we started more speculative homes, which shifted our business away from our historical mix of between 70% and 75% built-to-order. As we continue to sell through our inventory, our goal is to steer our business back to this historical range of built-to-order homes over time. It is our core competency and a key differentiator from a competitive standpoint, setting us apart from the other large production home builders.

More importantly, from a consumer standpoint, it offers buyers' choice with features we know they value based on our survey data. Our buyers can significantly influence their final sales price as they personalize their choice of lot, elevation, and design studio selections, aligning their monthly payment with their budget. Our studios also contribute to our high customer satisfaction scores as buyers draw value from that aspect of our process, and they enhance our gross margins. As our built-to-order mix grows, we believe it will drive a higher gross margin for our company over time. Before I turn the call over to Rob McGibney, let me spend a moment addressing our lower guidance for 2025. With market conditions having softened and taking our net order results from the first half of this year into consideration, resetting our revenue expectation is appropriate.

Rob will provide additional details on how we expect to achieve the new range of between $6.3 billion and $6.5 billion. We anticipate the lower top line will contribute to lower margins, although we continue to pursue additional improvements in build times and direct costs, and we are right-sizing our overhead structure to align with our lower volume this year. Let me pause here for a moment and ask Rob to provide more details on our sales, as well as an operational update. Rob.

Rob McGibney (President and COO)

Thank you, Jeff. Operationally, our divisions are executing well on the fundamentals, maintaining our high customer satisfaction levels, further improving build times, lowering our direct cost, and balancing pace and price to optimize each asset. We exceeded our anticipated deliveries in the second quarter, one example of our solid execution, which had a positive impact on our financial results for the quarter. With respect to sales, on our last earnings conference call, we had outlined the actions that we had begun to take in February to reposition our communities. We simplified our sales approach to provide what our buyers want, which is securing a home that meets their needs at the best possible price. Our strategy focuses on delivering the most compelling value and improving affordability with transparency. Rather than relying on incentives, we focused on adjusting base pricing, and consumers responded.

Three weeks into March, we had achieved solid weekly net orders with an absorption pace that was approaching seasonally normalized levels. Moving into April, consumers grew increasingly apprehensive about the economy and rising geopolitical tensions, driving consumer confidence to a 13-year low. As a result, the housing market cooled. In response, we proactively adjusted base pricing in our underperforming communities to remain aligned with local market dynamics, including rising resale inventory and softening home prices in some markets. Despite these actions, demand weakened. We believe this was due not only to the lack of consumer confidence, but also to mortgage interest rates, which edged up in early April and remained high and variable for the balance of the quarter.

In addition to these broader macroeconomic factors, we encountered municipal delays in final utility sign-offs and certificates of occupancy for model homes that impacted the timing of a number of our planned community openings. While these issues were relatively minor in nature, largely driven by local municipal staffing shortages and administrative bottlenecks, they shifted some of our grand openings to later in the second quarter or into our third quarter, which in turn impacted our net orders in the second quarter. For the full quarter, our average absorption pace was 4.5 net orders per month per community, a good result in this environment, although below our targeted range for the spring. At quarter end, we had 253 active communities, up 2% year-over-year and within our guided range, contributing to an average of 254, an increase of 5% as compared to the prior year period.

We are further strengthening our community opening process by enhancing coordination with municipal stakeholders to improve visibility and responsiveness, helping us better anticipate and navigate potential delays going forward. We continue to expect to maintain roughly 250 active communities for the remainder of fiscal 2025. Our backlog at the end of May was 4,776 homes valued at $2.3 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 20% faster than 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 updated fiscal 2025 revenue expectation now implies about 13,200 deliveries. Using round numbers for simplicity, that means we have roughly 7,300 homes left to deliver.

With approximately 4,800 homes in backlog as of the end of May, we need to sell about 2,500 homes to achieve our planned deliveries for this year. These homes will come from a portion of built-to-order homes that are sold early in our 2025 third quarter, as well as inventory homes sold through October. We have nearly 2,800 unsold homes in production, inclusive of deliverable models. Based on this detailed mapping of our projected 2025 deliveries and the visibility we have for the remaining two quarters of the year, we believe our target is reasonable. Overall, our build times, measured in calendar days, improved sequentially in the second quarter by another seven days to 140 days, which contributed to our beat on deliveries. For built-to-order homes, our build times are currently 132 days.

We have returned to pre-pandemic levels, and this progress 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 customers purchasing a built-to-order home relative to the 60 days it typically takes to complete an existing or speculative home purchase, better inventory turns, and monetizing our assets quicker. 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.

Our value engineering and studio simplification efforts, in addition to an enhanced focus on cost, contributed to direct costs that were 3.2% lower year-over-year on our homes started during the second quarter, helping to offset the impact of our price reductions and increases in land cost. The homes that we started in May came in at the lowest cost per sq ft year-to-date, as our divisions are continuing to drive better performance on cost. Our costs, including lumber, are protected for almost all of our third-quarter starts under the terms of our supply contracts. Our national purchasing team, working with our divisions, has done an excellent job holding off tariff-related cost increases with only two minor price increases to date. Before I wrap up, I will review the credit profile of our buyers who financed their mortgages through our joint venture, KBHS Home Loans.

We maintained our high capture rate with 88% of buyers who financed 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 KBHS versus other lenders. The average cash-down payment was stable both sequentially and year-over-year at 16%, equating to over $78,000. On average, the household income of customers who use KBHS was about $136,000, and they had a FICO score of 743. 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, we believe we are navigating market conditions well and have taken action to support affordability for our buyers while balancing pace and price at the community level. Our divisions have done a solid job in controlling what is controllable by reducing build times, lowering cost, and remaining committed to serving our buyers. Reflecting this commitment, KB Home received an unprecedented number of division-level customer satisfaction honors recently from AvidCX, a trusted platform of home buying experience insights based on comprehensive post-move-in customer surveys. As we look to the second half of fiscal 2025, we are focused on driving results for this year and beginning to shape our fiscal 2026. I will turn the call back over to Jeff.

Jeff Mezger (Chairman and CEO)

Thanks, Rob. With respect to our lot position, we own or control nearly 75,000 lots, 47% of which are controlled. Our built-to-order approach provides visibility into the need and timing for replacement communities based on each community's pace and expected sell-out date, which is beneficial in our effort to be capital efficient. We are developing lots in smaller phases wherever possible and balancing development with our starts pace to manage our inventory of finished lots. We have long employed a balanced approach to allocating the healthy cash flow that our business generates towards our priorities of future growth and returning capital to our shareholders. Although we continue to view the long-term outlook for the housing market favorably, we are scaling back our land-related investment spend to align to the current market conditions.

In the second quarter, we invested over $513 million in land acquisition and development, of which about 75% went toward development and fees on lots we already own. Through our regular review of land deals in our pipeline, we also canceled contracts to purchase approximately 9,700 lots that no longer meet our underwriting criteria. When market stabilized, we had the flexibility to again increase our land investments. With an expected lower level of spend on land for the remainder of the year, and given our healthy lot pipeline to support future growth, we intend to continue a meaningful return of capital to our shareholders. In our 2025 first half, we returned just under $290 million in cash to our shareholders, including $250 million in share repurchases at an average price of approximately $55.70 per share, which is below our current book value.

At these levels, the repurchases provide an excellent return and will enhance both our future earnings per share and our return on equity. For our 2025 third quarter, we expect to repurchase between $100 million and $200 million of our shares. Rob Dillard will provide more detail on our capital allocation perspective in a moment. In closing, I want to recognize and thank the entire KB Home team for the commitment to operating our business with a daily emphasis on serving our homebuyers and a results-oriented focus. We believe we are taking the right steps in the current market environment by lowering our land spend and redirecting capital towards share repurchases to maximize our returns and enhance shareholder value. We believe we're well positioned with a strong balance sheet and significant financial flexibility and an experienced team that has successfully navigated varying market cycles in the past.

I will turn the call over to Rob Dillard.

Rob Dillard (EVP and CFO)

Thanks, Jeff. It's a pleasure to be here, and I'm excited to be part of the KB Home team. I'm also pleased to report on the second quarter 2025 results. As Jeff and Rob stated, we're meeting the market with discipline and with our focus on our employees, our customers, and our shareholders. We continue to emphasize our transparent pricing strategy while we promote our built-to-order advantage. This price and production flexibility is the embodiment of our continued strategy to optimize every asset. We do this by managing absorption by community based on specific market conditions. This strategy fosters healthy communities that then enable us to optimize profitability and improve cash flows and returns. In the second quarter of 2025, we utilized this strategy and operating model to generate total revenues of $1.53 billion and home building revenues of $1.52 billion, a 10% decrease from the prior year.

We delivered 3,120 homes in the quarter. We're pleased with this delivery result as it exceeded our implied guidance during a period when we were refining our pricing strategy to limit or eliminate incentives. In the second quarter, we increased our average selling price on a year-over-year basis to approximately $489,000. We expected this pricing performance despite continued product and regional mix shifts. Prices increased in the West Coast and the Southwest regions, but were down with mixed performance by market in other regions. Housing gross profit margin was 19.3%, and adjusted housing gross profit margin, which excludes inventory-related charges, was 19.7%. This strong margin performance beat expectations due to our continued success managing costs and positive regional mix and appeared where pricing power remained limited. Adjusted housing gross profit margin was 150 basis points lower than a year earlier.

Due to pricing pressure, regional mix, higher relative land cost, and reduced operating leverage, only partially offset by lower construction costs. SG&A expenses as a percent of housing revenues were 10.7%, a 60 basis point increase from a year ago, mainly due to higher marketing expenses and reduced operating leverage. Home building operating income for the second quarter decreased to $131 million, and home building operating income excluding inventory-related charges was $137 million, or 9% of home building revenues. Total pre-tax income was $142 million, or 9.3% of total revenues. We reported net income of $108 million, or $1.50 per diluted share, benefiting from solid operating performance and an 8% reduction in our average diluted shares outstanding from the prior year. Looking ahead, we are adjusting our guidance for 2025 in response to current market conditions, as Jeff and Rob discussed.

Our goal is to remain disciplined and optimize every asset as we focus on maximizing shareholder value. In the third quarter of 2025, we expect to generate housing revenues between $1.5 billion and $1.7 billion. For the full year, we now expect housing revenues between $6.3 billion and $6.5 billion. We expect a third quarter average selling price of between $470,000 and $480,000 and a full year 2025 average selling price of between $480,000 and $490,000. The expected variation in average selling price is due to lower prices and regional mix. Housing gross profit margin, assuming no inventory-related charges, is expected to be between 18.1% and 18.7% in the third quarter and 19% and 19.4% in the full year. This expected margin reduction is due to anticipated pricing pressure and mix variation, which we expect to be partially offset by lower construction costs.

The third quarter SG&A ratio is expected to be between 10.3-10.7%, and the full year SG&A ratio is expected to be between 10.2-10.6%. We're actively managing SG&A for the current environment and will continue to align overhead levels with our volumes. We expect a third quarter home building operating income margin of between 7.6-8.2%, and we expect a full year home building operating income margin of between 8.6-9%. These projections assume no inventory-related charges. Our effective tax rate for the third quarter and the full year is expected to be approximately 24%, as energy tax credits and other adjustments are expected to remain at their current levels. Turning now to the balance sheet, our balanced capital strategy is focused on minimizing the cost of capital, maximizing flexibility, optimizing returns from investment in land and inventories, and returning capital to reward shareholders.

We had inventories consisting of land in various stages of development and homes completed or under construction totaling $5.9 billion at the end of the second quarter. We invested over $513 million in land development and fees during the second quarter. In the first two quarters of fiscal 2025, we invested over $1.4 billion in land development and fees, following investing $2.8 billion in fiscal 2024. We believe that we are well capitalized for the current market and expect to moderate investment in land to focus on only the highest return opportunities until more favorable market conditions emerge. With our inventory position, we own or control over 74,000 lots, over 14% more than this time last year. This provides both a strong basis for future growth and a high degree of flexibility.

Included in the 74,000 lots, we control over 34,000 lots that we have the option but not the obligation to purchase. This provides us with meaningful flexibility to manage our land investment, and we can exercise this flexibility to our advantage when market conditions impact returns. Because we finance our land investments on our balance sheet with extremely limited land banking or other off-balance sheet vehicles, we provide maximum transparency while minimizing cost and preserving flexibility. We view this as a meaningful positive in evaluating our liquidity and leverage. At quarter end, we had total liquidity of $1.2 billion, including $309 million of cash and $882 million available under our revolving credit facility. The current $200 million outstanding on the revolving credit facility is associated with seasonal working capital investment. We expect to pay off the revolver by year-end.

We believe our strong BB positive credit profile is optimal for our business. It provides reliable access to capital at low cost with investment-grade-like covenants and significant flexibility. We will continue to target a total debt-to-capital ratio in the neighborhood of 30% to support this rating, and we are pleased with our current 32.2% ratio. We have no debt maturity until our term loan matures in 2026, and our next note maturity is in 2027. This strong balance sheet enables us to provide shareholders with a healthy dividend, which currently has an approximately 2% yield, as well as return capital to shareholders in the form of share repurchases. We believe our current share price, which is below book value per share, is undervalued and represents a strong investment opportunity.

Repurchasing shares at a price below book value not only improves liquidity in our shares, reduces our weighted average cost of capital, reduces share count and benefits EPS, but also improves return on equity and increases book value per share. In the second quarter, we repurchased 3.7 million shares at an average price of $53.55 for a return of capital of $200 million, which combined with dividends resulted in a total return of capital of $217 million. With this strategy and our solid earnings, we have increased our book value per share to $58.64, a more than 10% increase over the prior year. We have now repurchased over 30% of our outstanding common stock since implementing our share buyback program in late 2021. Over the past four years, we have returned over $1.59 billion to shareholders in the form of dividends and share repurchases.

We have $450 million remaining in2 our current repurchase authorization and expect to repurchase between $100 and $200 million of our common stock in the third quarter, assuming all other things being equal, especially our outlook for the operating environment, capital market conditions, and other investment opportunities. In conclusion, we're pleased with our solid results and disciplined operating strategy, and we expect to optimize shareholder value over the long term by augmenting these results with our shareholder-focused capital strategy that prioritizes minimizing the cost of capital, maximizing flexibility, improving returns from investment, and increasing returns to shareholders in the form of share repurchases. With that, we'll now take your questions. Julian, will you please open the lines?

Operator (participant)

Thank you. We'll now be conducting a question-and-answer session. If you'd like to ask a question, please press Star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press Star 2 to remove yourself from the queue. For participants using speaker equipment, it may be necessary to pick up the handset before pressing the Star keys. As a reminder, we ask that you please limit yourself to one question and one follow-up. Thank you. One moment while we poll for questions. Our first question comes from the line of John Lovallo with UBS. Please proceed with your question.

John Lovallo (Managing Director and Senior Equity Analyst)

Good evening, guys, and thanks for taking my questions. The first one is, you know, I think the flexibility that you guys are demonstrating makes a lot of sense from the production front. The question is on SG&A, though. Despite the 6% cut at the midpoint of revenue, SG&A is only going up by about 20 basis points versus the previous outlook. I'm just curious what steps you're taking to kind of pull back here on some of this fixed overhead cost. What specifically are you guys doing?

Jeff Mezger (Chairman and CEO)

We've always been really focused on keeping our overhead in line with our revenue and scale. In part, there's formulas for what kind of headcount we need in construction or sales or whatever, depending on how many deliveries. We are adjusting our headcount to align with our new revenue projections for this year. Past that, there's buckets everywhere that we look at to see where else can we save some money. I actually think over time we can get our ratio back down under 10% where it was a couple of years ago at this revenue level. We'll be pulling all the levers and really working hard to keep our costs in line.

John Lovallo (Managing Director and Senior Equity Analyst)

Makes sense. And then maybe switching over to the gross margin, the outlook was 19.2-20, went to 19.0-19.4. I mean, obviously, you tightened it a bit and lowered it a bit, but maybe just help us sort of bucket the drivers between volume, lower ASP mix, and maybe higher land costs if you could.

Rob Dillard (EVP and CFO)

Yeah, sure. Hey, John, this is Rob Dillard. A lot of that is operating leverage, right? With the lower number, that kind of reduced the outlook for gross profit margins in the second half. Land costs on a relative basis with prices coming down a little bit has impacted that margin. There is also a pretty meaningful amount that is just mixed between communities and regions. That seems to be working against us a bit. I would also point out that the reduction in construction cost has offset a fair amount of this pricing pressure, but we are still kind of where we are with an expectation for 19% and 19.4% for the full year now.

John Lovallo (Managing Director and Senior Equity Analyst)

Understood. Brenda?

Yeah.

Operator (participant)

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

Steve Kim (Senior Managing Director)

Not anymore. Not for a long time, actually. Steve Kim from Evercore. Guys, appreciate all the color. The guidance does seem to imply a pretty robust closing outlook. Rob, I think you specifically called out the slide for the fourth quarter. It seems to suggest that you're either going to have a very high backlog turnover ratio, maybe in the 80s or something, or you're going to have an awful lot of orders in the third quarter. Typically, I would think that the third quarter absorption cadence would be a little lighter than 2Q, but just wondering if you can help us think through. I know you've given us a lot of guidance already, but just struggling a little bit to try to figure out which lever you're going to be really pulling to get the fourth quarter closings somewhere in the vicinity of 4,000 or something.

Rob McGibney (President and COO)

Steve, I think starting with build times, we've made good progress on build times. I don't think we're done there yet. We continue to see those come down quarter over quarter, even as we look at the monthly cadence, we've seen build times come down. That is going to relieve some of the pressure on units there. As I walk through the setup for the balance of the year, we need about 2,500 more sales. That is less than what we did last year. I would just point out that in 2024, we really took the same approach that Jeff outlined when Q4 was tough. Despite that, we still sold over 2,600 inventory homes between the third and the fourth quarter, and over 1,200 of those were coming in Q4 in tougher market conditions. It is a similar setup as we go into the back half.

Steve Kim (Senior Managing Director)

Okay. So anything particular regarding backlog turnover ratio or absorptions sequentially?

Rob McGibney (President and COO)

We're going to continue to target high backlog turnover ratios. I mean, some of that comes from the inventory that we're covering during the quarter. No, I mean, nothing specific, unless I'm misunderstanding your question. I mean, we're looking at it similar to the way we had going into last year's setup, and it's actually a little more favorable on what we've got to cover on the inventory side from a sales perspective.

Jeff Mezger (Chairman and CEO)

Steve, if you went back to the pre-pandemic build times, it was not uncommon for our backlog conversion to be 70-80%.

John Lovallo (Managing Director and Senior Equity Analyst)

Yeah.

Jeff Mezger (Chairman and CEO)

Because you're building them much quicker.

Steve Kim (Senior Managing Director)

Gotcha. And certainly, with the cycle times being back to normal and even pressing ahead, that would, okay, I guess explain a lot of it. Can you give us a little bit more color regarding the community delay? It was kind of interesting. You mentioned that you were delayed. You had some communities that kind of opened up late in the quarter and kind of, I think, pushed. I would assume that weighed a little bit on your order pace a little bit. I was wondering if you could elaborate on that at all, and to what degree would you say that your community count, and particularly these grand openings, which I know can be pretty important from an order perspective, to what degree did you maybe not get the full benefit of that like you normally would have expected?

Rob McGibney (President and COO)

Yeah, it was pretty significant. I mean, it's not a new issue. Community challenges opening communities is an ongoing thing, but it was, I'd say, more significant in our second quarter. I'd say order of magnitude, we probably missed a couple hundred sales from those delays in community openings that we didn't get, which is one of the reasons why I mentioned it in my prepared remarks. It's something that's difficult to predict with precision. Maybe our forecasting has been a little too aspirational in some cases, but we are pulling levers and making changes out there to get in front of it, to at least be able to forecast better and hopefully also open our communities faster than what we've been doing.

Operator (participant)

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

Michael Rehaut (Executive Director)

Thanks for taking my question. Good afternoon, everyone. Wanted to first try and dive in a little bit to the gross margin cadence in 3Q, 4Q. I believe if our math is right, we're looking for a decent rebound in gross margins in the fourth quarter to the low 19% range, I believe, from the 18.1%-18.7% guidance in the third quarter. Just wanted to understand what's driving that outlook and if there's any anticipated change within that outlook in terms of incentive levels that closings would have in 4Q versus 3Q.

Rob Dillard (EVP and CFO)

Yeah. Hey, Michael, this is Rob Dillard. It's really actually, I mean, you can get the 40 basis points of difference between 3Q and 4Q almost completely from operating leverage. That's what really drove our expectation for margin. There's a little bit of price, but then that's also probably going to create some mix as well. Really, it's really operating leverage.

Michael Rehaut (Executive Director)

Okay. Perfect. Also, I think earlier in the prepared remarks, it was referenced that there are some communities that lowered price during the quarter, obviously in response to the softer demand. I was curious what % of communities did see price reductions and what was the rough average of those price reductions in those communities, and perhaps which markets were those reductions maybe more prominent?

Rob McGibney (President and COO)

Yeah, a few questions embedded there. We moved pricing in over half of our communities. We had some that were up, some that were down. It was really surgical by community as we're working to optimize each asset. We liked how we were positioned coming out of March. We had consumer confidence drop off in April. We found that we had to adjust in more communities above what we did in February to get those communities running at their minimum run rate that we've got established for each one. I'd just tell you, as far as numbers go, that's all baked into our guidance for the back half of the year and into our ASP as well.

The second part of your question on the market color, I'll just take a minute to address kind of what we're seeing across the markets because the story continues to be very local and very dynamic. I would say that all of the markets we operate in experience some level of softening at some point during the quarter. Markets that I would say where we're still seeing relatively strong demand and sales performance would be Las Vegas, the Inland Empire, the North Bay in Northern California, Texas markets like Houston and San Antonio, Tampa, Florida as well. By contrast, some of the markets that are facing some more significant headwinds recently are like Sacramento and Seattle. They've slowed down a little bit, and we've had to do a little more there with price relative to some of the others.

Markets like Austin and Colorado, Jacksonville, Orlando, and Florida, places where resale supply has increased and starts putting pressure on pricing and creating more competition and just more choices for buyers. It is very local, very specific. You can't put a market condition on an entire state or even an entire market in most cases. It's community by community.

Operator (participant)

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

Matthew Bouley (Senior Equity Research Analyst)

Yeah. Thanks, guys. I hope you can hear me this time. My question is back on the topic of ASP and your sort of price philosophy versus incentives. I just kind of wanted to understand exactly what you guys were saying. Obviously, you enacted that strategy back in Q2, and it sounded like April and May maybe ended up a little disappointing relative to expectations. As we look forward, you're talking about optimizing the assets, and obviously, you need to sell through some spec here in the second half.

I'm just kind of curious around, were you messaging that maybe you will kind of pull back a little bit on this philosophy a little, or was the idea that in order to make sure we hit that full year delivery guide, that we will continue to be active with adjusting base prices to kind of make sure we get that volume? Thank you.

Rob McGibney (President and COO)

Yeah. Matt, we'll respond to the market situation and what our experience is in every community. If communities are hitting their pace, we'll let them go. May push price up a little. If they're not hitting their pace, we'll have to take further steps. We've already baked into our guidance what we think it's going to take to hit the sales we need to hit the deliveries for the year.

Matthew Bouley (Senior Equity Research Analyst)

Okay. Fair enough. Secondly, the adjustment to land investment. I hear you loud and clear on the decision you're making around kind of therefore leaning more into share repurchase, especially when you're trading below book value, all kind of well understood and adjusting to market conditions. Obviously, just the result of that and the thought around growth going forward, I think I heard you say you're going to stay around kind of 250 communities for the balance of this year. Please correct me if I'm wrong. As you have pulled back or are pulling back on land development spend, how should we think about the outlook for community growth kind of going beyond 2025 and setting up for 2026? Thank you.

Jeff Mezger (Chairman and CEO)

A lot of that, Matt, will be driven by whatever the market conditions are for the communities we need to fill in, frankly, for 2027 or very, very late in 2026. We shared on the previous call that we have a little slowdown here in community count growth and expect it to come back the other way first quarter of 2026. With the lot count we have today, owned and controlled, we have a platform for growth. It's how much can we mine it out of whatever the market conditions are.

Operator (participant)

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

Stephen Mea (Equity Research Senior Associate)

Hey, everyone. We've actually got Steven Mia on for Mike Dahl today. Thanks for taking my questions. I wanted to ask a question about the backlog here. I don't fully understand the backlog and all your other initiatives like build time are supportive for the volume goals for fiscal 2025 here. Without asking for specific guidance, I was hoping to get a sense of how you're thinking the backlog might shake out at the end of the year and how that may affect your thoughts on potential growth for 2026. Thanks.

Rob McGibney (President and COO)

We have quite a long way and a lot of sales to make between now and when we get to the end of 2025 and get it into 2026. That is all part of our strategy and our plan as we have shifted away from the incentives that we were offering, going to offering the best value to the lowest base price. We are seeing that be attractive to people looking to buy a personalized home. We expect that we will continue to grow that backlog and hit an inflection point. I mean, all this depends on market conditions and where things are headed. We are setting minimum run rates that we want to get by community. That is geared towards building that backlog to get to a sufficient level to support our strategy for 2026, but obviously not guiding to 2026 at this point.

Stephen Mea (Equity Research Senior Associate)

No, that's super helpful. Thanks for the context there. I guess, moving closer in time, I wanted to ask about the fourth quarter and kind of how you're looking at that from a margin perspective that we have the numbers for the third quarter. The full year kind of implies a similar-ish range for the fourth quarter, but slight uptick with the midpoint. Just kind of how you think margins might play out sequentially from the third to fourth quarter, especially in the context of you guys doing a good job of adapting to the market with price adjustments. Thanks.

Rob Dillard (EVP and CFO)

Yeah. Without giving explicit guidance to the fourth quarter, I mean, we've got the third quarter and the full year in there, so you can kind of back into it. But as I said, the deliveries we're expecting to be up in the fourth quarter, and that's going to provide a margin uplift of about 40 basis points, really just through operating leverage. Yes, we do think ASP will be slightly higher, but it's really going to be the operating leverage from having more deliveries in that fourth quarter number.

Operator (participant)

Thank you. Our 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, and thanks for all the detail as usual. Much appreciated. First question, just drilling in a little bit on the pricing strategy. Obviously, you guys are focused on kind of getting away from incentives and more adjusting the base price where necessary. I'm just curious because we've seen from other builders kind of moving in the opposite direction. If anything, it seems like incentives have continued to increase here through the spring. As you think about your order results and March being strong, April, May a bit weaker, how do you guys feel from a competitive perspective when other builders are increasing incentives? Are consumers coming into your communities asking for those incentives? Do they understand how your strategy differs?

Do you feel like the pullback in orders you saw later in the quarter, was it all due to other builders becoming more aggressive with incentives?

Rob McGibney (President and COO)

I think that that's always a factor in a pullback if people are getting really aggressive with incentives out there. Generally, I think our teams have done a good job of being able to sell the value in the price. I mean, in a lot of cases, I believe that there are customers that are overpaying for the home to effectively get an incentive. They are tied into this higher price that they are going to be stuck with forever until they sell that home. They may potentially be upside down when they try to sell that home versus a clean, simple, transparent way of selling the value of what we offer. I'll tell you, we do have people that come in and ask for incentives. The way that we are approaching it, it does not work for everybody.

Some people are enamored by the incentives, and they're just stuck on that, and that's what we want to go after. We're happy with the results that we've seen since we've made this change. It's really the way that we've operated for decades before we had this unique situation with mortgage rates doubling effectively overnight and just getting back to our knitting of what we do well and what our sales teams are geared towards selling. We're happy with the approach and sticking with it.

Alan Ratner (Managing Director)

Got it. Appreciate the thoughts there. Second question on the cost reductions you guys have been able to realize. Are you able to break that down at all by input? I'm just curious, if you look at that 3% plus reduction, how much of that is due to lower lumber, which is more of a commodity and maybe a little bit less in your control versus either labor or other inputs that you've directly been able to negotiate lower?

Rob McGibney (President and COO)

Yeah. I can't really break it down as far as the 3.2%. There's so many things that go into that percentage of whether it's mix by divisions or which batches of housing, even mix within the communities. Obviously, lumber coming down has been a bit of a help. In fact, I didn't look year over year at what lumber did in the prior year that's in that 3.2%, but we've been seeing that trend continue. We just know based on not only our started home budgets, but on our house budgets that we maintain for each of the products out there that our divisions are doing an excellent job of driving down cost and, in some cases, fighting off other commodity-level increases. Despite that, still getting the 3.2%.

I really can't break it down any further for you than that, but there are significant cost decreases coming out of other things than just commodity drops like lumber.

Operator (participant)

Thank you. Our next question comes from the line of Rafe Jordisich with Bank of America. Please proceed with your question.

Rafe Jadrosich (Managing Director and Senior Equity Analyst)

Hi, good afternoon. Thanks for taking my question. I just wanted to follow up a little bit on the land spend. Can you just help us understand how much land inflation is flowing through your P&L today, sort of in the back half of the year? Land that you're contracting today, are you seeing any relief on land prices? Has that come down at all with the softer market? Is there a point here where we could start to see sort of land prices come down as we go on to 2026?

Jeff Mezger (Chairman and CEO)

Rafe, I can make a few comments on that because we do not have the exact numbers that you are asking for here with us. One of the things that we are seeing that you do not hear discussed much is you tie up a piece of land, you get it entitled, you go close, you move on, and the improvement costs went up quite a bit due to the supply chain or, in turn, oil prices that drove it up. A lot of the city's fees went up quite a bit. It is not necessarily just land inflation. We may have owned a piece of land for two years now. We are developing the next phase, and the costs bump up because of those components. The land sellers are definitely showing a willingness to give you time and terms. Normally, that is the first step, and then you start to see price.

I don't think we've seen a lot of price yet, but I expect there will be some coming as we go through the rest of this year.

Rafe Jadrosich (Managing Director and Senior Equity Analyst)

Okay. That's helpful. Just to maybe help us understand the quarterly cadence on gross margin, what's the amount of fixed costs that you have in your cost of goods, and how does it vary by quarter? Just how does that contribute to the lower gross margin guide given the revenue reduction and that sort of 40 basis point sequential step up that you're talking about in the fourth quarter? Just how much of the second-half gross margin cut is just from deleverage?

Rob Dillard (EVP and CFO)

It's not deleverage in the second half, really. It's actually gaining leverage from third to fourth. The second to third sequential difference is really more just margin. I mean, it's really mix and lack of pricing power, right? We're giving up a couple of points of price just as things kind of normalize over that quarter-to-quarter sequence. That's really the primary driver for margin and the sequential component. In the fourth quarter, really, we'll get some margin through operating leverage, as we discussed, just going from third to fourth sequentially. It's really going to be a continuation of the trend of where margins are but stabilizing in the second half.

Operator (participant)

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

Sam Reid (Executive Director of Equity Research)

Awesome. Thanks. Just wanted to ask about some of the lot options that you walked away from during the quarter. I believe it was about 9,700 lots. We'd just love some perspective on some of the metrics that you might be using internally to determine when it makes sense to walk away from a lot. Looking forward, could you just give us a sense as to what gives you confidence that you're optimized from a lot standpoint and that there's not a risk that you might need to walk away from more options in the second half of the year?

Jeff Mezger (Chairman and CEO)

Sam, it's a pretty fluid process. We have a good process that we track with all the deals in every division where if it's an entitlement project, they'll get approval to spend X dollars on the entitlements. When it's time to close on the land, they come back in for approval on the land. As we develop each phase, they'll come in for approval on the development of that phase. Every one of those submittals has market updates tied to it. What's the competitive landscape? How are resales? What's going on with incomes in that submarket? It's a pretty fulsome process all the way through. The lots that we walked on in the last quarter were basically, I would call them earlier-stage controlled lots that we just determined with the market movement in those submarkets.

It was not something that we felt comfortable would hit our returns. We always want to make sure we have quality returns on our investment. It is far better to walk and wait another day on those than to keep putting more money into them. It is where pricing has shifted.

Sam Reid (Executive Director of Equity Research)

No, that's helpful. And then just switching gears on third-party broker relationships, there might be a few of your peers that are actually leaning into these as the market slows. To that end, could you just remind us where your broker attach rates sat in the second quarter, how that compared to Q1? Were there any quarter-over-quarter differences in the commission rate you paid in Q2 versus Q1 that might be worth calling out? Thanks.

Rob McGibney (President and COO)

It's been in a pretty tight band. I think we were about 70% broker participation rate in Q2. It was maybe 68% or 67% in Q1. After the NAR settlement came out, we saw rates drop a little bit, and now they've kind of bounced back. We haven't really seen that incentivizing the broker community results in more sales. We're focused on giving our buyers the best value we can on their home. Our typical commission rate that we're paying is about 2%.

Operator (participant)

Thank you. Our next question comes from the line of Jade Rahmani with KBW. Please proceed with your question.

Jade Rahmani (Managing Director)

Thank you. Was wondering if you could talk about how much of the orders weakness relates to existing home inventory. Do you have any data as to sales prospects you're losing to the existing home market where we've seen a meaningful uptick in homes for sale?

Rob McGibney (President and COO)

I do not have any specific data that I can point to where we track we lost a certain buyer. I mean, we have our teams that they are going to know that by community, and they are going to know where some of their prospects that were an interested lead may have gone. I do know in the markets, as I mentioned, as I was going through some of the regional and market color, those markets where you have seen resale inventory or resale supply get back to norms or above those norms of six or seven months of supply, those resales become a more formidable competitor than they were to us back when we would measure months of supply in terms of weeks instead of months. On the flip side, most of the markets where resale supply has stayed fairly suppressed and limited, we are tending to see better results there.

Jade Rahmani (Managing Director)

On the average selling price, which was down 8% year on year, do you know how much of that related to outright price cuts versus geographic or product mix?

Rob Dillard (EVP and CFO)

We have that. No. No. Yeah. The average selling price year over year in the second quarter was up a percent or so. A lot of that was just regional variation by region, by market, by community. There were some big swings in certain communities. The mix between the regions actually had a pretty meaningful impact there. We do not have the specific data that you are asking for.

Operator (participant)

Great. Our final question comes from the line of Susan Maklari with Goldman Sachs. Please proceed with your question.

Susan Maklari (Senior Equity Research Analyst)

Hello. Thanks for taking the questions. My first one is on the build times. You mentioned that you do think that you could see further improvement there. Can you talk about where that can go, how much of it is being driven by perhaps some of the weakness in the market and maybe a loosening of labor, and how we should think about the sustainability of any of those gains when the market does turn?

Rob McGibney (President and COO)

Sure. Yeah. So we've stated that our target average for the company is 120-day build time. We set that as what seemed like a really bold goal about a year ago, but now that we're getting close to it, and we can kind of see that in our sights, I think that is very achievable. We intend and think that we'll get there this year. Once we do, I don't think we'll rest on that. We'll pursue something faster. I do think it's probably at the point of diminishing returns. I mean, there were times in the market over the last couple of decades where we've had divisions that built in 90 days. We've got some divisions today that are approaching that 100-day mark and others that are above it.

Overall, for the company, with our current mix and current portfolio, we think 120 is a good target. As I said, once we get there, we'll set a more aggressive target, but we believe that one's very achievable. If there was a second part of that question, I—will it hold? Oh, will it hold? I think right now, with what we're seeing in the market, there is more availability. Overall, starts move around, but generally, starts have been in most of our markets have been a little slower, and there's more labor out there. We're taking advantage of that. We're relying on our trade partner relationship. I think it's sustainable. If we get a supply chain crunch or something like what we dealt with back in 2021 and 2022, that could change things. Barring any kind of macro event, I think we can improve.

I think we can hold on to that improved level.

Susan Maklari (Senior Equity Research Analyst)

Okay. That's helpful. Maybe a question for Rob as he's coming into this role. Can you talk a bit about what you're most focused on, how you're thinking about the positioning of the business given the environment that we're in, and any initiatives that we should be aware of?

Rob Dillard (EVP and CFO)

Yeah. I think we're in a really great position. It's still kind of early days, kind of third month coming in. Really focused initially on the team. Have a great team here, and we're really getting stabilized and focused. I think there's a lot of things that finance can do to improve performance here. I think we're really focused on getting those initiatives kind of aligned. Nothing kind of yet to announce, but we're certainly focused on adding value in new ways. I think the focus on shareholders and the share repurchases that we've done initially is a good indication of that.