KB Home - Earnings Call - Q4 2025

Transcript

Operator (participant)

Good afternoon. My name is John, and I will be your conference operator today. I would like to welcome everyone to the KB Home 2025 Fourth Quarter Earnings Conference Call. All participants are in a listen-only mode. Following the company's opening remarks, we will open the lines for questions. This conference call is being recorded, and a replay will be accessible on the KB Home website until January 18th, 2026. I'll now turn the call over to Jill Peters, Senior Vice President, Investor Relations. Thank you, Jill. You may now begin.

Jill Peters (SVP of Investor Relations)

Thank you, John. Good afternoon, everyone, and thank you for joining us today to review our results for the fourth quarter and full year 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, an explanation and/or reconciliation of the non-GAAP measures of Adjusted Housing Gross Profit Margin, Adjusted Net Income, and Adjusted Diluted Earnings Per Share, as well as any other non-GAAP measure referenced during today's discussion to its most directly comparable GAAP measure, can be found in today's press release and/or on the Investor Relations page of our website at kbhome.com. And finally, please note all figures are based on our fiscal November 30th year-end, and all comparisons are on a year-over-year basis unless otherwise stated. And with that, here is Jeff Mezger.

Jeffrey Mezger (Chairman and CEO)

Thank you, Jill, and good afternoon, everyone. We are pleased to share our results for our 2025 fourth quarter and fiscal year. It was a year that tested consumers' resilience as they faced various economic and geopolitical issues, yet through it all, they continued to demonstrate a desire to own a home. We helped nearly 13,000 individuals and families achieve the dream of homeownership while maintaining our industry-leading customer satisfaction ratings. With total revenues of over $6.2 billion and nearly $430 million in net income, we produced a 10% increase in our book value per share. We further strengthened our financial flexibility with the recent expansion of our new $1.2 billion revolving credit facility and the extension of our term loan, and through our balanced approach to capital allocation, we rewarded our shareholders with a healthy return of capital totaling more than $600 million in fiscal 2025, including dividends.

We continue to lead our peer group in the cumulative amount of capital returned to our shareholders over the past 4.5 years as a percentage of market capitalization. In 2025, we repurchased 13% of our outstanding shares at an average price below our current book value, which we believe is an excellent use of our cash and accretive to both our earnings and book value per share. As for the details of our fourth quarter results, we produced total revenues of just under $1.7 billion and Adjusted Diluted Earnings Per Share of $1.92. We returned about $115 million in cash to our shareholders, including the repurchase of 1.6 million shares. We remain optimistic about the housing market as we believe favorable demographics will be a key driver supporting higher demand over time, together with the structural undersupply of homes.

Near-term conditions continue to reflect underlying demand for homes supported by population, household formation, job, and wage growth. However, low consumer confidence, affordability concerns, and elevated mortgage rates continue to constrain the pool of actionable buyers. Consumers are demonstrating their interest in buying a home, reflected in our website visits, leads, and traffic to our communities. They're just taking much longer to make their home buying decisions. We produced 2,414 net orders in the fourth quarter with a consistent approach to pricing, offering transparent and affordable prices rather than inflated prices masked by heavy incentives. This remains the foundation of our competitive position as it allows us to advertise our compelling pricing directly on our website and is also how we build trust with our customers. We were disciplined in not taking overly aggressive steps to capture sales during the seasonally slower fourth quarter.

By doing so, we believe we are positioned to achieve better margins on these sales in our 2026 first quarter than we would otherwise have produced. Before I turn the call over to Rob McGibney, I will make a comment on the approach we are taking with respect to our guidance for fiscal 2026. As detailed in today's press release, we are providing our outlook for fiscal 2026 deliveries and housing revenues. We expect to have greater visibility on both operating and gross margins as we get into the spring selling season and plan to provide our projections for these metrics when we report our 2026 first quarter results in March. Let me pause here for a moment and ask Rob to provide more details on our sales as well as an operational update. Rob?

Robert McGibney (President and COO)

Thank you, Jeff. Consistent with our operational success throughout fiscal 2025, our divisions continued to execute well in the fourth quarter in maintaining high customer satisfaction levels, further improving build times, lowering direct cost, and balancing pace and price to optimize each asset. Traffic in our communities was steady during the fourth quarter, and at 18%, our cancellation rate was stable, supporting net orders at an average absorption pace of three per month per community. This pace was in line with our average fourth quarter pace of the past two years. As we look ahead to the full year 2026, although we begin the year with a lower backlog than we have carried in some time, the fundamentals of our operating model and the improvements we have made over the last few years provide a clear and, we believe, achievable path to meeting our delivery objectives.

Our beginning backlog represents 27% of the midpoint of our full year delivery target compared to 34% at the start of 2025. While this is a smaller starting position, it must be viewed in the context of our significantly faster build times and our expectation of expanding our community count with new community openings. We have become more efficient in building homes, with build times improving roughly 20% year-over-year in the fourth quarter. We achieved our company-wide target of 120 days or better from home start to completion on Built-to-Order homes during the quarter, with several divisions averaging fewer than 100 days in November. Our faster build times allow us to extend sales much deeper into the year and still achieve delivery of the home. At quarter end, we had 271 active communities, up 5% as compared to the prior year period.

In our 2026 first quarter, we are planning to open between 35 and 40 new communities and expect to hit a high watermark for community count during our second quarter at the height of the spring selling season. With this broader base of communities, we are very well positioned to capture the typical seasonal lift in demand during this period. Our new communities typically generate strong early demand, benefiting from the newness and excitement of grand openings and supported by our disciplined community opening process. Importantly, these new communities are expected to generate favorable gross margins supported by a sales mix that is predominantly Built-to-Order. As we have discussed, we are focused on returning our Built-to-Order homes to a higher percentage of our total deliveries from 57% in Q4 2025 to our historical 70% or higher.

While we always have some inventory homes available for those buyers that need a quicker move-in date, the superior margins we generate on BTO homes will allow us to realize greater value from our communities. Our gross margins on BTO homes are trending 3 percentage points-5 percentage points higher than on inventory sales, and we began to see a shift toward more BTO sales during November, an encouraging trend that has continued into December. As we remain focused on selling our BTO homes and these sales become deliveries over the course of fiscal 2026, we expect to achieve a favorable trajectory in our gross margins. We are aligning our starts with our BTO sales and started 1,827 homes in our fourth quarter. Our divisions, together with our national purchasing team, are doing an outstanding job in driving costs lower.

These efforts, combined with our value engineering and studio simplification initiatives, contributed to direct costs that were about 4% lower sequentially and 6% lower year-over-year on our homes started during the fourth quarter, helping to offset the impact of higher land costs. Before I wrap up, I will review the credit profile of our buyers who financed their mortgages through our joint venture, KBHS Home Loans. Our capture rate was high, with 80% of our buyers who financed their homes in the fourth quarter using KBHS. Higher capture rates help us manage our backlog more effectively and provide more certainty in closing dates, 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 moved up slightly, both sequentially and year-over-year, to 17%, equating to nearly $80,000.

On average, the household income of customers who use KBHS was about $130,000, and they had a FICO score of 743. Even with over 1/2 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 or pay in cash. 10% of our deliveries in the fourth quarter were to all cash buyers. In conclusion, we remain firmly committed to delivering high customer satisfaction and strong operational execution to drive our results. We believe our portfolio of communities, products, and pricing are well aligned with the needs of today's buyers, and with improved build times, an expanded community footprint, and stronger operational consistency, we are confident in our ability to achieve our fiscal 2026 delivery objectives, and with that, I will turn the call back over to Jeff.

Jeffrey Mezger (Chairman and CEO)

Thanks, Rob. With respect to our lot position, we owned or controlled roughly 65,000 lots at year-end, 43% of which were controlled. Our footprint is focused on markets that we believe are positioned for long-term economic and demographic growth. As our newest divisions in Seattle, Boise, and Charlotte continue to mature, their contribution to our results is becoming more meaningful. In addition, we see an opportunity to expand our share in all of our Sunbelt markets over time. We remain selective with our land positions across our business. And as part of our regular review of land purchases in our pipeline, we canceled contracts to purchase approximately 3,500 lots, representing about 20 communities in the fourth quarter, which no longer met our underwriting criteria.

Our lot pipeline is healthy, providing us with the flexibility to be patient in adding to our controlled lot count until we find opportunities with better terms that will provide higher returns. One of the key benefits of our Built-to-Order approach is that it provides visibility into the need and timing for replacement communities based on each community's sales pace, local market dynamics, and expected sell-out date, which is beneficial in our effort to be capital efficient. We are also developing lots in smaller phases wherever possible and balancing development with our starts pace to manage our inventory of finished lots. Our business generates healthy cash flow, and we remain consistent in our balanced approach toward allocating it. We are achieving our priorities of positioning our business for future growth, managing our leverage within our targeted range, and rewarding our shareholders through share repurchases and our quarterly cash dividend.

We are maintaining our land investments at a level that will support our current growth projections and invested $665 million in land acquisition and development in the fourth quarter, with about 2/3 of our investment going toward developing the land we already own. With nearly $430 million in net income generated for the year, lower land acquisition and development spend, and the improvement in our build times unlocking cash, we returned more than $600 million in capital to our shareholders in fiscal 2025. This includes approximately $540 million in share repurchases at an average price of $57.37 per share. At these levels, the repurchases are an excellent use of capital and will enhance both our future earnings per share and our return on equity. In closing, I want to thank the entire KB Home team for their commitment to serving our home buyers.

We believe we have the most talented and experienced operators in the business who are driven to produce results. Our divisions executed well this past year despite challenging market conditions and controlled the controllable in achieving a significant reduction in build times, lowering direct costs, and opening a meaningful number of new communities. In fiscal 2025, we returned the highest level of capital to our shareholders in a single year in our company's history. We plan to continue our share repurchase program in fiscal 2026 with between $50 million and $100 million of repurchases planned for our first quarter. As we begin the new year, we do so with a balance sheet that is stronger than it has ever been and with added financial flexibility.

We believe we are well positioned for the spring selling season with our expected community count growth and have confidence that our renewed focus on Built-to-Order sales will generate higher margins as the year progresses. Our objectives for fiscal 2026 are centered on continuing to deliver outstanding service to our home buyers and driving higher shareholder value, and we look forward to updating you as the year unfolds. Now, I will turn the call over to Rob Dillard for the financial review.

Robert Dillard (EVP and CFO)

Thanks, Jeff. I'm pleased to report on the fourth quarter and full year 2025 results. As Jeff and Rob said, we continue to manage the business with discipline, with a focus on optimizing every asset by pricing to the market, maintaining a healthy pace, and delivering our Built-to-Order advantage. This strategy has led to relatively consistent results in a constrained market in 2025. In the fourth quarter of 2025, we exceeded the midpoint of our guidance range with total revenues of $1.69 billion and housing revenues of $1.68 billion, a 15% decrease. We delivered 3,619 homes, which exceeded the midpoint of our implied guidance, largely due to reduced average build times in our 268 average communities for the quarter. Average selling price declined 7% to $466,000 due to regional and product mix and general market conditions.

Housing gross profit margin was 17%, and Adjusted Housing Gross Profit Margin, which excluded $13.7 million of inventory-related charges, was 17.8%. Adjusted Housing Gross Profit Margin was 310 basis points lower due to pricing pressure, negative operating leverage, higher relative land costs, regional mix, and product mix, which was pronounced due to the age and price of incremental volume versus guidance. This margin pressure was again partially offset by lower direct construction costs per unit. It's notable that average costs per unit declined in the quarter as direct construction costs and material costs declined more than lot costs increased. SG&A expenses as a percent of housing revenues was 10%. The SG&A expense ratio was 9.1% when adjusted for the $16 million of accelerated equity-based compensation expense. This expense reflects a change in policy for the vesting of certain long-term incentive awards.

This affected only the timing of expense recognition, and there was not an increase in the total compensation cost of these awards. Homebuilding operating income for the fourth quarter decreased to $117 million, or 6.9% of homebuilding revenues, and homebuilding operating income excluding the inventory-related charges and the accelerated equity-based compensation expense was $147 million, or 8.7% of homebuilding revenues. Net income was $102 million, or $1.55 per diluted share, benefiting from a 13% reduction in our weighted average diluted shares outstanding. Adjusted Net Income, which excludes the inventory-related charges, the accelerated equity-based compensation expense, and approximately $1 million for early extinguishment of debt, was $126 million, or $1.92 per diluted share. For the full year 2025, we delivered 12,902 homes and generated $6.24 billion of total revenues. Housing revenues were down 10% to $6.21 billion.

Diluted earnings per share was $6.15, and book value per share increased 10% to $61.75. Turning now to our guidance. Our guidance for the first quarter and full year 2026 is based on our belief that we're well positioned for the present operating environment through our strategy of providing customers the best buying experience and the best value by delivering a personalized Built-to-Order home. In the first quarter of 2026, we expect to generate housing revenues between $1.05 and $1.15 billion based on expected deliveries of between 2,300 and 2,500 homes. Housing gross profit margin, assuming no inventory-related charges, is expected to be between 15.4% and 16% for the first quarter of 2026.

Margins are expected to be affected primarily by negative operating leverage and typical seasonality in the quarter, though we also expect continued margin trend impacts of pricing pressure and higher lot costs, as well as some regional mix. We expect to continue to partially offset this margin pressure with lower construction costs per unit. We expect margins to improve throughout 2026 due to positive operating leverage and typical seasonality, as well as our strategy to shift the mix of homes sold and delivered to favor Built-to-Order homes. We believe that we are well positioned to execute this mix shift in 2026 as we start the year with 271 communities, and we expect a considerable number of new community openings in the first half of 2026. The first quarter 2026 SG&A ratio is expected to be between 12.2% and 12.8%, due mainly to expected reduced operating leverage despite cost controls.

This is our highest seasonal SG&A quarter and compares to 11% in the first quarter of 2025. We had solid results reducing both fixed costs and direct costs throughout 2025, and we expect this to continue in 2026. Our effective tax rate for the first quarter is expected to be approximately 19%. It's notable that we expect the tax rate to be lower only in Q1 of 2026. We expect the tax rate to increase and end the year with an average of between 24% and 26% due to reduced energy credits given the end of 45L credits in 2026. For the full year 2026, we expect housing revenues of between $5.1 billion and $6.1 billion based on between 11,000 and 12,500 deliveries.

This full year's guidance is based on current market conditions and will be expanded to include our customary components as we gain an understanding of spring selling season market dynamics. Turning now to the balance sheet. We believe that we're well positioned with over $5.7 billion in inventory at the end of 2025. We owned or controlled over 64,000 lots, including 27,000 lots that we have the option to purchase. Our option lot position is 27% lower than a year ago due to our continued focus on only allocating capital to positions that align with our strategy and return expectations. We continue to invest selectively to augment our land position, and we invested over $665 million in land development and fees during the fourth quarter and over $2.6 billion in 2025.

During the fourth quarter, we entered into a new credit facility to increase liquidity and improve covenants, and we amended our $360 million term loan to extend its maturity to 2029. We now have no debt maturities until June of 2027. At quarter end, we had total liquidity of $1.43 billion due to $229 million in cash and no cash borrowings on our $1.2 billion revolving credit facility. We continue to target a total debt-to-capital ratio in the neighborhood of 30% to support our strong BB+ credit rating, and we are pleased with our current 30.3% ratio. This strong balance sheet enables us to provide shareholders with a healthy dividend, which currently has an approximately 1.6% yield, as well as return capital to shareholders in the form of share repurchases. In the fourth quarter, we repurchased 1.6 million shares for a return of capital of $100 million.

In 2025, we repurchased approximately 9.4 million shares, or 13% of our outstanding shares at the beginning of the year. We have now repurchased nearly 36% of our outstanding common stock since implementing our share buyback program in late 2021. Over the past four and a half years, we have returned over $1.9 billion to shareholders in the form of dividends and share repurchases. In the fourth quarter, our board of directors approved a new $1 billion share repurchase authorization to support our capital return strategy. We ended the year with $900 million available under this authorization, and we expect to repurchase between $50 million and $100 million of our common stock in the first quarter. As we look ahead, our strategy is to enhance our results through continued discipline and a focus on higher margin Built-to-Order homes.

We believe that this operating strategy, when combined with our shareholder-focused capital strategy, will maximize shareholder value over the long term. With that, I'll now take your questions. John, would you please open the lines?

Operator (participant)

Yes, thank you. We will now conduct a question-and-answer session. If you would like to ask a question, please press star and then one on your telephone keypad. A confirmation tonal indicates that your line is in the queue. You may press star two to remove yourself from the queue. For anyone using speaker equipment, we ask that you please pick up your handset to provide optimum sound quality. We ask that you please limit yourself to one question and one follow-up. Thank you. One moment, please, while we pull for questions. And the first question comes from the line of John Lovallo with UBS. Please proceed with your question.

John Lovallo (Managing Director of Equity Research)

Guys, thank you for taking my questions tonight. The first one is maybe just a little bit more philosophical. I mean, I understand the changes in the way you're providing the outlook relating to the full year deliveries and the gross margin, but there also seems to be a bit of conservatism, particularly in the gross margin guide that maybe wasn't always the case. So I mean, can you help me understand if there's been some change there and maybe instilling a little bit more conservatism into the outlook, and also, is there a chunk of spec that's going to be delivered in the first quarter that's going to negatively impact that margin?

Jeffrey Mezger (Chairman and CEO)

John, I can make a few comments and then pass it over to Rob Dillard. There is still some inventory that we have to clear as part of our transition to more Built-to-Order sales, and we have factored that in in the guidance that we provided. One of the things that we touched on in our comments is that some of this inventory is aged in that it was built at much higher build costs, and as we've reacted to the market, we're lowering our costs on new deliveries, but we have to clear these older specs that have a higher cost base in, so it is impacting the margin. It's a short-term thing, but it's something we have to power through. Within our guide, I would say that it's just a guide. It's not conservative. It's not aggressive. It's just realistic.

If you think about it, one of the real drivers of the lesser margin in the quarter is the loss leverage because our revenue is down. It's a fairly significant move sequentially from Q4 to Q1 due to the loss in revenue leverage. If you got any other color, Rob, you want to?

Robert Dillard (EVP and CFO)

Yeah, those are the two main points there, John. I think that you can't express enough how important in Q1 the seasonality and the leverage is having an impact on that Q1 margin expectation. Typically, that's 100 basis points-150 basis points, and we think that we'll be near the top end of that, if not above it, that there is a real opportunity for leverage as we get through the year, as Jeff said, and that the leverage in Q1, given kind of our conservatism on the delivery number, is creating some conservatism as you see it through the cycle of that guide. There also, as Jeff said, was some product mix as we shift through some of the older specs that haven't had the benefit of the direct cost reductions.

We saw a bit of that also in Q4 as well, which I think was really the incremental units versus guide and a big part of the margin compression versus where we thought we were going to be. We think that there's real opportunity as we go through the year, but we're really pegging where we expect to be in Q1 on those factors.

John Lovallo (Managing Director of Equity Research)

Okay. Yeah, that's really helpful. And maybe sticking on a similar topic, I don't recall you guys ever giving an Adjusted EPS number before. And I'm curious kind of the thought process behind excluding the accelerated stock comp if it's really just timing related and seemingly future quarters could benefit from less stock comp if the total amount's changing. And also, it seems a little bit unusual to exclude impairments from Adjusted EPS. So just maybe your thoughts on that would be very helpful.

Robert Dillard (EVP and CFO)

Yeah, John, we just wanted to give you a like-for-like number because the timing on the equity expense, just where it was, it was significant enough that we wanted to give you a like-for-like number that was relevant so that you could make comparisons and so that you could also make a comparison versus our guide.

Operator (participant)

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

Stephen Kim (Senior Managing Director and Head of Housing Research Team)

Yeah, thanks a lot, guys. Just to start off with, if we could get the spec numbers, the finished and the under construction specs at the end of the quarter, and also a clarification on your community count comment. I think you said Q2 was going to be the high watermark. I just want to make sure that we're clear that you're saying that the community count will actually be highest in Q2, and then it will descend from there?

Jeffrey Mezger (Chairman and CEO)

The community count cadence and color.

Robert McGibney (President and COO)

Okay. So yeah, Stephen, as we're looking at the setup for the year, I mentioned in my prepared remarks, we ended the quarter with 271, and we're on an upward trajectory for that. We do expect to hit the peak for community count for the year, kind of right in the heart of the spring selling season, right in the middle of Q2, and be up from that 271. We're not pinpointing a number, but we think we'll be up somewhere between nine to 13 communities from that number by the time we get right into the middle of that second quarter. So that's driving some of our assumptions and projections on the deliveries for the year. As far as the inventory levels, we've got about 1,700 homes in inventory right now across the company, and those are inventory that we're expecting to cover here over the next few months.

Stephen Kim (Senior Managing Director and Head of Housing Research Team)

Okay. That's total, right? Total inventory, not necessarily finished inventory. Is that right? Just trying to get a sense. How much is finished and how much is under construction?

Robert McGibney (President and COO)

Since we haven't been starting specs, we've seen some of that shift out of the under construction. Of the 1,700, we've got a little over 1,000 that are at or near the finished stage.

Stephen Kim (Senior Managing Director and Head of Housing Research Team)

Okay. Gotcha. That's helpful. And then a general question about your community-I'm sorry, your shift to BTO. What you're describing is that you have a number of new communities that are going to be opening up, and that will really facilitate your transition to more BTO sales, which are also higher margin. And I guess it would be helpful for me to understand what is it about a new community that necessarily makes it easier for you to make a shift in your BTO strategy? Because to a degree, I would think that most of your-pretty much all of your communities were initially designed around the BTO concept, and sort of market reality sort of kind of pushed you to do a little bit more spec than you would normally like. So that's my perception. Is that an incorrect perception?

Do you actually have communities that you kind of just earmark to be kind of spec communities, and you're just not doing any of those as we go forward? Just if you can help me understand how the transition is facilitated by a new community opening up, per se.

Robert McGibney (President and COO)

Yeah. Let me go back up top and start with when we got into starting specs. It was largely driven by the supply chain crunch that we had in our cycle times. It expanded big time, and it just made it difficult for a lot of reasons to sell BTO when it was taking 220 days, 240 days to deliver that home. So yeah, that combined with virtually no inventory in the market, and then as we've worked through this process, it's been difficult to get off of that, and we drew a hard line in the sand earlier this year or in 2025, and as I look at it, I think a core strength of our company is the ability to sell the advantage of the Built-to-Order model, and frankly, we created an internal conflict with ourselves with those specs that we started.

And in a lot of ways, we've been competing with ourselves to some extent. And with our BTO program, with our build times, we're now building in less than 120 days. So that competes much better with the timeline for resales and spec homes. And we're giving our customers the ability to lock their loan and leverage the one-time float down in the event that mortgage rates decline. So it's really what's driving the improvement is sharper alignment around our Built-to-Order model and just execution and driving that discipline and consistency in how our teams position our value with a great base price and transparency and the ability to personalize.

Our focus is really reinforcing the importance of selling the home through the customer's eyes and helping them understand the trade-offs and the cost certainty and the long-term value of getting exactly what they want rather than pushing that spec solution. I would characterize this as less of a change in strategy, just more stronger execution against a proven business model that we've operated with for a long time. When our sales teams fully believe in and consistently sell the benefits of that Built-to-Order, the results follow. With these new communities, we don't have specs to compete with at all, and we're quickly working through the specs in our existing communities where it's creating that competition.

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. Thanks for all the details so far. I was hoping to get an update on kind of your pricing strategy shift. I know you're obviously focusing on increasing the BTO mix. And I guess part of that, or in addition to that, I know a few quarters ago you mentioned kind of the push to get towards more of a base price model as opposed to the kind of kitchen sink incentive model that a lot of your competitors are operating with. And it seems like since then, if anything, the incentive environment has gotten even more competitive. I mean, we're seeing buy-downs advertised on a lot of builder websites, 2%, 3%. So I'm just curious, A, how has it been competing in this environment with your new strategy?

And B, do you have an update on kind of what the actual base price adjustments you've seen up to this point and what the expectation is going forward? Thank you.

Robert McGibney (President and COO)

Yeah. So there's really not much to report on the price change front. I mean, overall, it was a relatively stable quarter for us in terms of pricing. And as Jeff said in the beginning, and we said last quarter, we've been disciplined and didn't chase volume during what was typically a lower demand environment and more inelastic. So not a lot of change on the price front. I expect that that will probably change as we get here deeper into Q1 and into the selling season. But so far, what we've seen, especially in communities where we've worked down the level of specs we have and we're not competing with ourselves, we've seen our mix shift trend more towards BTO. And in November, we saw that move into the mid- to high-50s. December, we don't have a lot of data to go off of in December.

We've only had one full week of reported sales so far, but so far, we've seen that shift up into the 60s. So we like the trend that we're seeing and expect that's going to result in higher margins over time.

Alan Ratner (Managing Director)

Got it. Well, that was kind of the second question I was going to ask on that improvement or increase in BTO you've seen. Is there something you can attribute the increase you've seen recently to? Is that a function of maybe the overall inventory environment kind of improving across the industry? We've heard from a lot of your spec-focused peers like they pulled back a lot on starts over the last handful of months. So are you actually seeing a little bit of relief on the spec competition side, or is it more something you're doing internally that's driven that recent mix shift?

Jeffrey Mezger (Chairman and CEO)

Yeah. Alan, one of the things that got blurred with what Rob walked through on the supply chain crunch and then the inventory that we put in and others put in is you lose sight of the value in the Built-to-Order approach. Don't underestimate the benefit of many of our divisions now building in less than 100 days. So would you rather have a completed spec with a lot of incentives to move it, or do you want to build your own home and create your own value and close 30 days later or 45 days later? So what we're seeing is with our build times coming down, the value proposition of the personalized home at an attractive price is more compelling. So we don't think that our customers are competing with the specs.

We focus on resale, and we offer a brand new home that's within range of the resale median, and they really value the personalization. So it's naturally coming back to us because we're prioritizing it and focusing on it much better than we did the last couple of years.

Operator (participant)

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

Rafe Jadrosich (Research Analyst)

Hi. Good evening. Thanks for taking my question. I just wanted to kind of follow up on some of the comments on the BTO mix. I think you said 57% of deliveries were BTO in the fourth quarter. What are you expecting for the fiscal first quarter? And then what would that be for the full year kind of at the midpoint of guidance? Wondering sort of where the exit rate will be for the year compared to that 70% target you have.

Robert McGibney (President and COO)

Yeah. That's a good question. I mean, in the first quarter, I expect that we are going to continue covering some of that inventory. So the ratio is going to be tilted more so towards probably that 57%-60% range. The exit rate, I think, is what's more important. And we're very focused on getting back to at least a 70/30 ratio. And we see a great opportunity to drive that change with the new communities we've got coming with the onset of the spring selling season as we work the Built-to-Order model and could go that route. We expect that we'll exit at that rate, and it'll be kind of a gradual progression to get there through the first couple of quarters of the year.

Rafe Jadrosich (Research Analyst)

Great. So similar mix in fiscal first quarter versus the fourth quarter?

Robert McGibney (President and COO)

Most likely, yes.

Rafe Jadrosich (Research Analyst)

And then just the fiscal first quarter gross margin, the quarter-over-quarter decline. You spoke about the fixed costs, the leverage, and the amount that you're getting pressured there. But the decline is sort of greater than that. What are the other pieces to sort of bridge us to the first quarter decline?

Robert McGibney (President and COO)

It's outside of the leverage piece. It's just largely driven by regional and product mix within our cities combined with some pricing pressure on moving the inventory. As Jeff mentioned, we've got this tail of inventory that we're working through that has higher direct cost and a lower margin. And that bled into the deliveries and will continue in the short term. Overall, with the higher margin BTO sales becoming a larger percentage of our deliveries and the improved leverage that we'll get on fixed as we move throughout 2026, we expect Q1 to be the bottom in margins, and we're going to go up from there.

Operator (participant)

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

Michael Dahl (Managing Director of Equity Research)

Hi. Thanks for taking my questions. One more on the BTO dynamic. I guess if you call it your spec starts, it's pretty easy to mathematically move your mix of BTO up. So I'm trying to understand, still in context, your order pace was light. So as you go into next year, you have a view that you can kind of manage this transition and the demand will be there. What are you willing to tolerate on kind of pace to force the issue versus just if you get into the spring selling season and the demand response isn't there, kind of pivoting back to spec? And anything you can give us on, aside from just percentage mix, maybe some sales pace stats on some of the newer communities that are more BTO versus some of the spec communities? Just looking for a little more color there.

Jeffrey Mezger (Chairman and CEO)

Yeah. Michael, there's a few factors in the response. One, every community is a different story. And while Rob was sharing the mix shift we're seeing to BTO, it's not just on the brand new communities. Some communities had little inventory and had sustained the mix, and others had more than they should have and were slowly working through that. But it's working across the system. And I've shared on past calls, we keep walking through the optimize the asset approach. And for our company, it seems to you get the best returns of doing at least four a month on average per community. Our sales pace in the fourth quarter would seasonally adjust to four a month. So we were on the four-a-month pace in the quarter.

As we look ahead into the spring selling season, our intent is to support our sales rate with Built-to-Order sales more so than forcing the inventory. And in part, we like it because we know what the margin is when we start the home. And you can fool yourself with a spec start into thinking you're going to make this margin and then lo and behold, five months later, it's down four or five points. So we would rather pull the levers on a Built-to-Order approach in the spring per community and ensure that we hold to that four-a-month pace.

Michael Dahl (Managing Director of Equity Research)

Okay. Thanks, Jeff. My second question, look, I appreciate the dynamics at play with the margin between seasonality and the spec dynamic that you expect to work past as the year goes on. If we look at the Q1 operating margin guidance, it is low single-digits, which if we think about normal distribution, there would presumably be some healthy number of communities that were kind of break-even or below. So my question is really around your impairment process and testing. And I know there's a component that's probably duration and your projections about BTO. But hypothetically, if you were to sustain these types of margins in kind of the mid-teens, what are the set of assumptions that would be required to make the charge? I mean, $14 million charge is still kind of nominal this quarter.

What would lead you to take kind of, I guess, for lack of a better word, much larger charges? Because it seems like this is getting closer to where some land might be impaired.

Jeffrey Mezger (Chairman and CEO)

Mike, I'll say a few things and hand it to Rob Dillard. We've already shared that the first quarter margins are the low-water mark, and we expect improvement quarter-over-quarter as the year progresses from there. And it's a combination of better leverage as we grow revenue back and better margins as our community mix rotates around. I can say we've had the same impairment process for years and years. It's very rigorous. Every community is analyzed every quarter. And it starts with what's the margin in the community and do you have a positive margin or not? And even at today's margin, there's a significant gap before any kind of major impairments would get triggered. And when you throw out that number on impairments, keep in mind half of it was abandonments on communities we elected not to go forward with.

So it's not a reflection of a margin. It's a reflection of a community we decided not to go close on. I don't know if you want to say anything else.

Robert Dillard (EVP and CFO)

Yeah. I mean, just to concur with what Jeff said, I mean, the impairment process is incredibly rigorous, and it is community by community, and it's pretty much actually a constant process that we're evaluating these communities and understanding what the trends are within the communities and the relative returns and profitability of the communities. We have a certain number of communities that kind of hit excess scrutiny, and that list of communities is actually relatively limited. We did decide to take an impairment on two communities, one of which was relatively small as it was about to close out.

And then the other one was a community in our Central division in Colorado where we had had, which was associated with the same issue, which is a change in some of the requirements on housing, which changed the cost profile of those houses and led us to an impairment on those products. We think that that's fully behind us now. So as we evaluate these impairments, there would have to be some kind of meaningful shift or a trigger that would change our perception of the community's profitability over time. And right now, we haven't seen that. And so I would also say that all of these profitability measures are fully loaded with corporate and everything else in there. And so that has an impact. And those are also costs that we're evaluating as we go forward.

Operator (participant)

Thank you, and the next question comes from the line of Trevor Allinson with Wolfe Research. Please proceed with your question.

Trevor Allinson (Director of Equity Research)

Hi. Good evening. Thank you for taking my questions. First question on the ASP implied by the midpoint of your 2026 revenue and deliveries guidance. I believe the midpoint in 2026 is above your 4Q 2025 ASPs. Is the expectation to be able to increase prices in fiscal 2026, or are there mixed impacts driving that? Just trying to understand why should the base case be for pricing to move higher versus where it was in 4Q 2025?

Jeffrey Mezger (Chairman and CEO)

Trevor, we're not assuming price. That is totally mixed. We have some very high-end communities and very good locations in California that are opening soon. In fact, one's already open, and they'll be delivering a pretty sizable number of homes in the third and fourth quarter, so our mix shift is going to trigger a higher ASP as these higher-priced communities hit volume.

Trevor Allinson (Director of Equity Research)

Okay. Makes sense. And then the second one is on returning cash to shareholders in fiscal 2026. You gave the guide for Q1. Typically, it's a smaller quarter for you guys. So should we think that you continue to return capital to shareholders at a similar $50 million-$100 million rate post Q1, or how are you thinking about that beyond the first quarter? Thanks.

Jeffrey Mezger (Chairman and CEO)

Well, we've demonstrated with our activity that we're programmatic now with the share buyback program. And we typically are a little lighter in the first quarter because of the cash position we're in at the end of the year. And we want to evaluate it as the spring comes. And it's a few factors that we evaluate, not just our cash and balance sheet, but where's the stock price, and do we have a lot of opportunity to grow the company? And that's one of the key areas that we want to continue to pursue as well. But I would say that as the quarters roll by, the 50-100 a quarter is reasonable.

Operator (participant)

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

Jade Rahmani (Managing Director and Equity Research Analyst)

Thank you very much. You mentioned transparency on price and emphasizing pricing over incentives. Are you seeing other builders follow suit in cutting price, and are you worried at all that this could lead to price wars in many locations?

Robert McGibney (President and COO)

I really haven't seen it. I mean, most of what we see is that builders are trying to cover their spec inventory that they've got, and it's kind of the same game. You've got inventory, you've designed it, and it's out there, and it may not be exactly what people want. So they're discounting that product and giving rate buydowns and everything else. We see very little competition with our Built-to-Order focus, especially on the first-time buyer space.

Jade Rahmani (Managing Director and Equity Research Analyst)

And then on the option walkaway charges, have you identified a pool of communities that you may not exercise additional options, and do you anticipate further charges through this year, 2026?

Jeffrey Mezger (Chairman and CEO)

That's just a normal part of our land procurement process that we have options, which are really just payments, earnest money, or what have you as we go through the process and execute due diligence. And sometimes we decide to proceed, and sometimes we don't. And I think that we're holding the line with really stringent underwriting standards, and we're ensuring that we're sticking to our strategy. And that's kind of led to maybe what is more than typical kind of abandonments, but it's not something that's indicative of a low quality or anything like that. We're pretty pleased with how that's progressing and think that it's not a normal way thing that we expect to see in a really fulsome market, but it's a characteristic of this market.

Operator (participant)

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

Sam Reid (Senior Analyst)

Yeah. Thanks so much. Just curious where incentive loads landed in the fourth quarter as a percent of revenues and any sense to what's embedded in the first quarter. And then kind of a knock-on to that is talk through how you're incentivizing some of this aged inventory that you're selling through.

Robert McGibney (President and COO)

So yeah, I'm not sure I have a perfect answer for you on the incentive piece on Q4. I know that of any mortgage concessions that we did, it was right around 1%. When we look at our book of business and the inventory that we've got, that's really one of the few places we're applying any of those incentives at all. So most of that's coming through that side of it. As we look out through the balance of the year, we projected we're going to get even further away from that, and incentive usage should come down even more.

Jeffrey Mezger (Chairman and CEO)

Yeah. There's no unusual incentives. What you would read through our incentive disclosure is really more just the normal way incentive that we give, which is closing cost assistance and things like that. There's nothing unusual, and that equates to just 1% or 2% typically.

Sam Reid (Senior Analyst)

That helps. And then this is perhaps more of a follow-up to some of the prior questions. But when you look at your range of delivery volume outcomes in 2026, it's pretty wide. The question really is, is there a different assumption for spec versus Build-to-Order embedded at the high end of that delivery volume range versus the low end? And then, I mean, would it be fair to assume that the low end of that range is just a scenario where Build-to-Order doesn't come in as planned? We just love some context on that.

Robert McGibney (President and COO)

Yeah. We're really focused on driving the build-to-order sales, as we said. And the range is driven by we're in December right now. We've got the spring selling season in front of us. We've got a lot of communities open, but we just don't have great visibility into what the spring might be. And I'd say that the 2025 spring selling season was a disappointment, and we've prepared our plan and our strategy for the year around what I would consider a normal spring selling season with that community count growth, maybe even slightly below average. As we piece it all together, we're only counting on needing to drive about just slightly over four build-to-order sales per community in the first half of the year.

And as we look at the past years, to get us to the midpoint of our delivery range, and when we look at past years, it seems like that should be relatively easy to do. If we're better than that and we have a spring selling season like we saw a couple of years ago, then we'll probably hit the high end, but we just don't know yet.

Operator (participant)

Thank you. And our final question comes from the line of Michael Rehaut with JPMorgan. Please proceed with your question.

Andrew Aziz (VP of Equity Research)

Hi, guys. You have Andrew Aziz here, on for Michael. Just wanted to drill down. I believe you guys said traffic was relatively stable within the quarter. Was there any meaningful difference in sales trends month to month, or was it more of the same?

Robert McGibney (President and COO)

Month to month, I mean, September was our strongest month, and we see that almost every year. Then it ticks down in October and November. This year followed that typical seasonal pattern that we did, that we saw. Traffic's held steady. Our conversion has actually improved a little, so we're focused on driving more traffic. It's just challenging to do in November and December, so.

Andrew Aziz (VP of Equity Research)

Okay. I appreciate that. And then maybe within Q1's gross margin and even as we go throughout the year, what are kind of your assumptions for construction costs and lot costs within your guide and Q1 and maybe your outlook for the year?

Jeffrey Mezger (Chairman and CEO)

Yeah. I mean, we're not expecting a meaningful change in construction or lot costs. I mean, we do feel really good that we've kind of bent the curve a little bit on unit costs in the sense that direct construction costs and material costs, we've been able to offset the lot cost inflation. And sequentially, the year-over-year change in lot costs went down pretty meaningfully from third quarter to fourth quarter. And so we feel like we're getting to a better position there in terms of being able to drive some profitability off of our cost savings initiatives. But we don't have a specific guide on lot cost change that we would give you at this point. Yeah. It's baked in.

Operator (participant)

Thank you. And ladies and gentlemen, that does conclude the question and answer session, and that also concludes today's teleconference. We thank you for your participation. You may disconnect your lines at this time.