Earnings Labs

KB Home (KBH)

Q1 2022 Earnings Call· Wed, Mar 23, 2022

$54.42

-1.81%

Key Takeaways · AI generated
AI summary not yet generated for this transcript. Generation in progress for older transcripts; check back soon, or browse the full transcript below.

Same-Day

-6.49%

1 Week

-8.16%

1 Month

-7.91%

vs S&P

-1.30%

Transcript

Operator

Operator

Good afternoon. My name is Alex and I will be your conference operator today. I would like to welcome everyone to the KB Home 2022 First Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the company's opening remarks, we will open the lines for questions. Today's conference call is being recorded and will be available for replay at the company's website, kbhome.com through April 23. Now I would like to turn the call over to Jill Peters, Senior Vice President-Investor Relations. Jill, you may begin.

Jill Peters

Management

Thank you, Alex. Good afternoon, everyone and thank you for joining us today to review our results for the first quarter of fiscal 2022. On the call are Jeff Mezger, Chairman, President and Chief Executive Officer; Rob McGibney, Executive Vice Presidents and Co-Chief Operating Officers; Jeff Kaminski, Executive Vice President and Chief Financial Officer; Bill Hollinger, Senior Vice President and Chief Accounting Officer; and Thad Johnson, Senior Vice President and Treasurer. During this call, items will be discussed that are considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future results, and the company does not undertake any obligation to update them. Due to various factors, including those detailed in today's press release and in our filings with the Securities and Exchange Commission, actual results could be materially different from those stated or implied in the forward-looking statements. In addition, a reconciliation of the non-GAAP measures referenced during today's discussion to their most directly comparable GAAP measures can be found in today's press release and/or on the Investor Relations page of our website at kbhome.com. And with that, let me turn the call over to Jeff Mezger.

Jeff Mezger

Management

Thank you, Jill. Good afternoon, everyone. We delivered solid results in our first quarter that drove year-over-year growth in many key metrics, including revenues, operating margin and diluted earnings per share. Our revenues were up 23%, and we produced significant margin expansion, increasing our operating margin to over 12%. We overcame the impact from lower-than-expected deliveries which I will address momentarily, to drive a 44% increase in our diluted earnings per share to $1.47. With our backlog value expanding 55% year-over-year, to $5.7 billion, its highest level in 15 years, we have sold almost all the homes we need to achieve our projected $7.4 billion in revenues. We continue to focus on managing to our construction capabilities by aligning our sales to our starts. Over the past 12 months, we have started roughly 16,800 homes. We have 46% more homes in production at the beginning of the second quarter relative to the prior year. And with these homes being further along in their construction cycle, we believe we are well-positioned to achieve our guidance this year. Market conditions are strong and along with our expected growth in community count throughout the remainder of the year, we believe we have the foundation in place to drive further scale and profitability growth in 2022 and beyond. I want to provide some context for our shortfall in deliveries, then I will ask Rob to go a little deeper into the discussion. The guidance that we provided in January assumed that we would at least hold fourth quarter cycle times. While we were not counting on relief from the supply chain challenges, neither did we expect that they would worsen. We underestimated the degree to which the Omicron variant would exacerbate and already constrained supply chain and workforce across our trade partners, municipalities, utility companies and even our own employees. While we take responsibility for our deliveries being below our prior expectations, at the same time, we acknowledge that the variant was a significant contributing factor. In the last 6 weeks of our first quarter, we lost approximately two weeks in our construction cycle, primarily in the finishing stages while our Foundation and Frame segment held to the fourth quarter's timeline. At a run rate of about 250 deliveries per week, this two-week extension in build times was meaningful. Our team has adapted to the changing conditions, resequencing construction when necessary. We continue to be proactive to the extent possible to mitigate the impact of these issues going forward and are committed to regaining our previous construction efficiency over time. Let me turn it over to Rob to share some details. Rob?

Rob McGibney

Management

Thank you, Jeff. In addition to the strain on the labor base that affected both our contractors and our own employees, there were several issues with respect to the availability of material during the first quarter. And I will begin by sharing a couple of specific examples with you. Flexible duct work, which is used in the heating and air conditioning is in limited supply due to the lack of stainless steel a primary component used in manufacturing. We experienced shortages of flex duct in most of our divisions during the first quarter, and our field teams found effective solutions to progress the construction of homes while waiting for this product albeit at a slower pace as the mechanical trim and other components of a home cannot be finished until the flex stuff is installed. We are beginning to see improvement in the availability of Flex Duct, although our teams are not depending on relief in this area to achieve their current delivery forecast. Appliance manufacturers have not increased their production capacity to satisfy demand. This was compounded in the first quarter by a shortage of double ovens due to a retooling process required to meet a change in federal regulation. In January, we were notified by our supplier that we would be short hundreds of ovens for homes that were scheduled for delivery in the first quarter. Our divisions moved quickly to identify workarounds, including purchasing ovens directly from retailers where available, and we were able to cover most of the shortfall. This retooling issue appears to be a one-time event, and we expect the supply of double ovens to improve in the near term. Garage doors, windows, cabinets, HVAC equipment and siding all remain constrained within the supply chain. However, we have identified alternate suppliers to supplement many of our product needs with comparable items. And in some cases, we are ordering items well in advance of starting homes to mitigate delays as lead times have extended significantly. Our teams are creative in developing workarounds as issues emerged, and we quickly implemented these practices across our divisions. We've also improved our visibility as to how homes are tracking through each stage of the build cycle and the daily run rate we need within each of those stages to achieve our plan, which improves our ability to both forecast and execute. We expect shortages of materials will stay with us throughout this year, and we will continue to aggressively address any new issues that arise. Over the years, we have taken great pride in our build times and the predictability of our centralized scheduling system. We've had to temporarily adjust our reliance on this system to include more manual processes due to the lack of predictability in getting materials delivered. While the supply chain issues are preventing us from returning to our historical build times in the short term, we are committed to restoring those levels longer term. With that, I'll turn the call back over to Jeff.

Jeff Kaminski

Management

Thanks, Rob. Our biggest challenge today is completing homes, not selling them, as demand continues to be robust. Favorable demographics provide an important tailwind as the largest subset of millennials is nearing the peak age for first-time homeownership and the oldest of the Gen Zs are entering their home-buying years. In addition to demographics, employment and wage growth have both continued to improve, and the shift to working from home is another factor supporting demand. On the supply side, retail inventory remains very limited at 1.7 months and supply chain challenges have hampered the industry's efforts to catch up on the production of new homes. At 6.6 net orders per community, our monthly absorption rate was seasonally very strong in the first quarter, up from 6.4 in last year's first quarter, even as we continued to implement price increases across the vast majority of our communities, and interest rates began to rise. A particular note is our West Coast region performance, where a healthy increase in our pace and the highest growth in our net order value illustrate the strength of our business in California, both inland and along the coast. Our pricing power is strong, while our pace is solid, and we continue to work toward optimizing each asset. Our order rates speak to the magnitude of demand and also signals that our price points are still attainable. In addition to base price increases, we are capturing higher lot premiums and studio revenues which taken together, contributed to a 15% rise in our net order value to $2.2 billion. Net orders in the first quarter were 4,210, down slightly versus the prior year. We are pleased with this outcome given the difficult comparison to the year ago quarter and an outperforming the projection that we shared in January. Our…

Jeff Kaminski

Management

Thank you, Jeff, and good afternoon, everyone. I will now cover highlights of our 2022 first quarter financial performance as well as provide our second quarter and full year outlook. We are pleased that despite increasing supply chain challenges during the back half of the first quarter, we generated a meaningful increase in our housing revenues, which, combined with an improved operating margin drove 44% growth in our diluted earnings per share compared to the prior year quarter. In addition, sustained strong net order absorption during the quarter, along with our substantial beginning backlog and produced a 55% year-over-year increase in our quarter end backlog, supporting our revenue and margin outlook for 2022. In the first quarter, our housing revenues of $1.39 billion rose 23% from a year ago, driven entirely by a 22% rise in the overall average selling price of homes delivered, as the number of homes delivered was about even with the year earlier quarter. Reflecting the broad strength of our operations and the overall housing market, housing revenues were up significantly across all four of our regions with increases ranging from 12% in the Southwest region to 36% in the Southeast. Looking ahead to the 2022 second quarter, we expect to generate housing revenues in the range of $1.55 billion to $1.65 billion. For the full year, we are reaffirming our housing revenue range of $7.2 billion to $7.6 billion, assuming no change in supply chain conditions during the remaining quarters of the year. We believe we are well positioned to achieve this top line performance, supported by our first quarter ending backlog value of approximately $5.7 billion and our expectation of continued favorable housing market conditions. In the first quarter, our overall average selling price of homes delivered expanded 22% year-over-year to approximately $486,000 and…

Operator

Operator

[Operator Instructions] Our first question comes from the line of John Lovallo with UBS. Please proceed with your question.

John Lovallo

Analyst

Thank you for taking my questions. Maybe the first one, it sounds like you haven't seen any or experienced any slowing in demand in any of your markets yet. But I'm curious do you anticipate some moderation given interest rates, where would you think that you'd see that first? And has there been any incremental use of adjustable rate mortgages five to seven year arms that you've seen?

Jeff Mezger

Management

John, as I shared in the prepared comments, the buyer profile is very strong in our business today. And I think it's in part the locations that we're operating in, and it's in part the demographics I touched on, and it's a very strong credit profile buyer. So far -- and rates have moved. But so far, we're not seeing any evidence of a shift in product type. We're not seeing any stress on the borrowers' ability to qualify for a loan. They're not having to do anything other than make a loan app and get their approval. So, when you put it in the context of no house is available and the strong demographics, I think we're catering to a higher tier for the first time buyers or the first move-up buyers, where it's a strong mix of buyers. So we're seeing no change in behavior so far. We don’t have a crystal ball on what will happen if rates keep rising, but so far, we're seeing no sign of things going down.

John Lovallo

Analyst

Okay. That's encouraging. And just given that bullish outlook, your stock is trading at, I don't know, 20%, 25% discount to book. I mean, why aren't you guys going in and buying a ton of stock?

Jeff Mezger

Management

For starters, as we always share. We take a balanced approach to our capital allocation strategy. And first and foremost for us is to continue to profitably grow the company and improve our returns. And if you sort through the various metrics that Jeff shared in his commentary, we're going to be creating incredible value in this company this year, whether it's return on equity or the growth in book value, and that's job one for us. In the past, we've talked about returns-focused growth and improving our debt ratios. We think we've now done that, and our ratio is going to continue to improve through equity growth, and we don't see the need for a lot of debt reduction. We're still generating operating cash. And in addition to investing in future growth, if you look back at 2021, we paid dividends, and we also did retire some outstanding stock. So we'll continue to navigate based on our operating needs, what's our excess cash, what's the state of play in the market like we've always done and continue to have a balanced approach. Rob, do you want to add anything.

Rob McGibney

Management

No I think it's pretty well covered.

Jeff Mezger

Management

Okay.

Operator

Operator

Our next question comes from the line of Truman Patterson with Wolfe Research. Please proceed with your question.

Truman Patterson

Analyst · Wolfe Research. Please proceed with your question.

I just want to follow up on John's first question there, dig in a little deeper, but rates have clearly moved higher in March, and we generally think of California as the most affordability constrained state in the nation, new home sales today, February sales fell in the West, you all had orders down about 6%. I’m hoping that you can dig in the color in California, either submarket, Northern, Southern, et cetera, on current March demand and traffic in the state. It sounds like as of now, you are not seeing any sort of pushback. Is that correct?

Jeff Mezger

Management

That's correct, Truman. I mean if you think of California, highest price point, so obviously, it's the most affordably constrained market, but it's also the most supply challenged market of any of the state. So again, you have demand far in excess of supply. And because it's a land constrained environment, you can't replace your communities as easily -- we'll tilt more to price over pace. And I think when you look at our order value, it reflects that. We're not letting the communities run hot. We're going for price and taking advantage of the opportunity because you can't replace the community. If you look at the actual sales, I think it was community comp driven more than anything else. Our absorption rates were very strong. And I would say that the coastal areas, the urban coastal areas are every bit as strong as more inland areas, both sides are working very well today.

Truman Patterson

Analyst · Wolfe Research. Please proceed with your question.

Okay. Thank you for that. And then could you help us think through your order versus starts cadence generally at the community level, how quickly do you get the home started after the buyer signs the contract. And generally speaking, how long do you have just costs locked in for with that start?

Jeff Mezger

Management

Rob, as the operator expert on the call, do you want to take that one?

Rob McGibney

Management

Sure. Yes. So Truman, -- it depends on the division sometimes depends on the product. But typically, we're getting that home started on a book-to-order sale between 30 and 60 days. And generally, we've got -- when the house starts our costs are locked. Over the past year, there's been a minor amount of exposure to lumber and a few other things, but generally at or shortly after the start, we're locked on that. So the majority of our backlog is locked down on the cost side.

Operator

Operator

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

Alan Ratner

Analyst · Zelman & Associates. Please proceed with your question.

Thanks for taking my questions. So last couple of days, I've seen popping up on a few builder websites, some incentives related to closing costs and kind of rate lock periods. And I'm sure a lot of this is marketing and it's probably not very widespread at this point. But I'm just curious in terms of your backlog and kind of your margin outlook for the rest of the year. Are you guys baking in any conservatism around potentially having to fund some closing costs for maybe skittish buyers and backlog that might be reluctant to move forward if rates continue on the upward trajectory they're on right now?

Jeff Mezger

Management

Actually, Alan, year-over-year, our closing costs were down. We -- as you know, we don't do a lot of incentives at all in our business model. And so our closing costs were down a [10th or 2] (ph). But if you put it in the context of our average buyer is putting $70,000 down, paying $1,000 or $2,000 months a closing cost doesn't really move the needle. Rob, I don't know if you're hearing any color in the field on the incentive game or others moving houses through closing costs, I'm not hearing it right now.

Rob McGibney

Management

No, Jeff, I'm not either. The demand just continues to be so far ahead of supply that I don't think we certainly haven't gone there.

Alan Ratner

Analyst · Zelman & Associates. Please proceed with your question.

Second, I think you gave a data point last quarter that you kind of analyzed your backlog and a one point increase in rates really wouldn't have any impact on them. And here we are one point higher, and that seems to certainly be the case. Do you have an updated analysis on that, just kind of where -- if and when that would that would become problematic for the buyers that you currently have in backlog right now? I know you cite the FICO scores and the overall health of the buyer, but I would imagine at some point, there's got to be an inflection where the monthly payment gets prohibitive.

Jeff Mezger

Management

Yes, Alan, I'll let Rob answer he's been working directly with our JV people at KBH. But if -- if you look at our buyer profile and what I shared in the prepared comments, buyers have moved to arms at all. They're still -- it's a fixed rate loan. It's heavily conventional. And the rate goes up and they still qualify and they want to be a homeowners so they buy the house. So when you say if rates go up a point, what does it do to qualify first buyers will go, they'll either put more down or go to an adjustable rate mortgage, they still want to be a homeowner. And there's still no inventory out there. So I don't think we're anywhere near a stress point because of rates going up the way a lot of the media is hammer it right now. But Rob, do you want to walk through the details on the rate increase and what it would do.

Rob McGibney

Management

Sure. Yes. I mean, obviously, rate increases have some level of impact. But we're qualifying buyers at the new rates every day. And while qualification has become more challenging for some of the buyers, I think the strength of the market, especially in our operating footprint has allowed us to continue achieving our sales targets and even while we're listing price, too. It's a situation where if one buyer doesn't qualify, there are more buyers lined up behind them to step in. And as far as the stress testing that we do with our backlog, and just based on the strong financial position that Jeff mentioned earlier that our buyers have -- we -- I don't have a number for you. But we think we would see minimal fallout if the rate increases are gradual. And as buyers were just likely to adjust and pay down debt or are they paying a co-borrower or they select a different loan program or with our business model, they can simply spend less in the studio or shift to a smaller, lower price tone.

Operator

Operator

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

Mike Rehaut

Analyst · JPMorgan. Please proceed with your question.

My first question, I guess, just kind of looking at the trajectory of gross margins, which effectively, you've kind of reiterated as you look into the back half of the year. If I'm interpreting it right, I mean, obviously, you're effectively reiterating it. I think you raised it by 10 basis points. Just trying to get a sense of, some of the moving pieces because obviously, you most likely incurred some additional costs as you still have some supply chain issues impacting the business. At the same time, it looks like you're continuing to execute price. So, is it safe to say that in terms of thinking of the different moving pieces that, in effect costs continue to go up and you're just able to continue to offset that with price. And obviously, your full year ASP up $10,000 is kind of proof positive of that. Is that the right way to think about that?

Jeff Kaminski

Management

Yes, Mike, it is. And that's a primary factor, right? What's happening on the selling price side relative to costs and we've been dealing with that as a company, as an industry now for a couple of years. So it's been a really positive dynamic for us actually at the end of the day. But, it's the same factors we've been seeing that's driving improved margins. And there really hasn't been much change in the outlook from last quarter on full year margin, other than costs moved probably a little bit more than we saw, but price also moved it based on your observation, which is accurate that the ASV is up a little bit. The other things we're seeing, we're seeing really strong performance out of our recently opened communities. It's been very pleasing to see vast majority, almost all of them, opening at a broad land book levels and with really strong gross margins that are actually incremental to the whole. And as those start delivering out in the back half of the year, we'll start seeing some advantages of that running through the P&L. Interest amortization has been a long-term trend for us of improvement that's continuing, something I didn't actually mention in the script. But I think there's a pretty good potential for us to pick up on a little bit of additional leverage on our fixed costs and gross margin again, predominantly -- well, really starting in the second quarter, running right through the end of the year. So a lot of good positives and nice positive momentum and really just a continuation of the trends that we've seen, has given us the margin lift that we're seeing in 2022 relative to 2021 and the same thing in 2021 over to 2020. So continuation there, we're very pleased about it.

Mike Rehaut

Analyst · JPMorgan. Please proceed with your question.

Great. Thanks for that, Jeff. I guess, secondly, there's been some talk recently about trying to triangulate how much of current demand that's out there is from a primary buyer versus either in effect an investor, there's obviously aside from individual investors, you have the entire kind of single-family rental operator and build-to-rent operators that are out there. But I guess more just on a micro level, can you give us a sense today versus perhaps a year ago or two years ago, what percent of your buyers are owner-occupied-type purchases versus investors that would be renting out the property?

Jeff Mezger

Management

Mike, maybe Rob has that number. I don't because we do not really promote investor activity. We definitely aren't selling to the single-family for rent people. And I think the vast majority of our buyers have been and continue to be owner-occupied as people who want a house for their family and want to live in that neighborhood. Rob, as you track the deliveries. Do you get the data on what percent is investor -- do you have any.

Rob McGibney

Management

Yes, Jeff, I don't have a data point on that. But just from working with the operators and the regional teams, it's very limited. Not having a number, I hesitate to put one out there, but I'd say it's low single digits. We're where we've got investor sales. It's generally all owner occupied.

Operator

Operator

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

Stephen Kim

Analyst · Evercore ISI. Please proceed with your question.

I guess my first question relates to your land positioning. I was curious if you could give us a sense for what percent of the land that you took ownership of this quarter was through options, exercising options versus just buying it out in the open market. And if you had to take a stab at what percent of your land that you currently own reflects pricing from, let's say, early to mid-2020. What percent would you say of the land that you own meets that kind of criteria?

Jeff Mezger

Management

Yes, pretty specific questions as far as dissecting the land portfolio. I would say in the first question, most of the land that we end up taking down at some point is an option, right? So you're at some point, optioning up land on refundable deposits and going through due diligence and that type of activity. And I'd say pretty much all of our land at 1.9% was an option. If you're talking just pure rolling option quarterly takes, it's a relatively low percentage because those type deals I wouldn't say pretty much all of it disappeared in the slight land market right now. So that's sort of the condition on that. When you look at our land portfolio and the churn that we're seeing in communities, specifically in communities, we do tend to turn half to two-thirds of our communities every year and you start getting more and more current on your land. When you're looking out to third and fourth quarter deliveries, a lot of that land was actually locked up and prices were locked in, in 2020. There were some deferred land closings in 2020. So it was actually even a little bit longer on the tail of that vintage, if you will, land, where after the pandemic first hit, we went in and just kicked out a lot of the closings and sellers are pretty cooperative. And we feel we have really a good business relationship with new partnerships with a lot of those sellers and allow us to takes a little bit of uncertainty out of the outlook and all that before we close out of land. So we're still operating the business. So with some of the newer communities coming in, we're not really 2020 mark. So -- the margins are still holding. We're seeing an upward trajectory on margins. We're looking at exiting 2020 at a very, very healthy margin rate that we think will carry into 2023. And we're, I'd say, quite a way away from seeing really high land prices running through the P&L. And at the same time, I think it's also important to point out that land has appreciated value. Selling prices have moved quite significantly and is actually staying ahead of those land price inflation. So we think there's some runway ahead of us for a good solid gross margin performance on it in the future.

Stephen Kim

Analyst · Evercore ISI. Please proceed with your question.

Yes. Thanks, Jeff. So what I heard from you, what I thought was interesting was that you sort of suggested there were factors that play in early 2020. such that the land you may even bought in mid-2020 or maybe even as late as the third quarter reflected very much pre-pandemic kind of price – correct?

Jeff Mezger

Management

Absolute Absolutely. And when you -- absolutely. So bulk of those purchases through the back half of 2021, even it's a early or back half of 2020, excuse me, even into early 2021 reflected some land prices that were locked up quite a bit earlier, in many cases, pre-pandemic. And don’t forget prices been started moving immediately after COVID came out either. It took a few months for things to settle and I would say the real severe land price inflation you can start seeing until the back half of 2020. So again overall -- we're in great shape on the land portfolio. Really happy with the margins kicking off, super happy with the performance of new communities and seeing some runway out of us on that.

Stephen Kim

Analyst · Evercore ISI. Please proceed with your question.

Yes. No, that's great. I appreciate that. My second question relates to what I guess I would characterize as a bit of a dislocation between or a significant disagreement between the way you see your future business prospects and the way the market seems to be valuing your stock, John earlier sort of alluded to, the question about buybacks, whether or not this will be a good time to be stepping in a little bit more aggressively. And I think the answer was that, look, there's opportunities to grow the business. And I think you've laid out a very compelling case that there's reasons to think that demand is going to be strong and you're in a good position to capture that. But by the same token, it does also seem that if that is correct, and that proves to be correct, at the way the market is valuing your shares is probably demonstrating the biggest gap versus your perception or your perspective than we've almost ever seen -- and because you have done a pretty good job bringing our leverage down to the level that it's at and the likelihood that it will be even lower by year end. I'm curious if you could talk a little bit more about when you be competing incentives of growing the company versus taking advantage of mispricing that the market has provided. How do you think about that at a high level sort of, philosophically?

Jeff Mezger

Management

Look, it's an interesting question. I think there's a lot of factors that go into it, right? And the primary factor is where we're heading and how best to build long-term value for our shareholders. And growth is a very important factor. We want to maintain scale. We've been fighting hard for a number of years to re-grow this company and really get ahead of the curve on community count growth and top line. And it's paying off in a big way right now with the metrics. We definitely believe keep putting points on the scoreboard and sooner or later the market will recognize that on the one hand. On the other hand, we have not been a phrase in the past to go in and make opportunistic buybacks when we did feel there was a large dislocation. At the same time, we're not going to debate it on an open conference call, timing and when we do something like that. But, we are constantly aware of it as constantly discussed and we've made several moves on that over the past few years. So, I think it's right just to leave it at that for now. But it's obviously a focus point for us. Honestly, it's hard to even explain the dislocation that we're seeing right now with how well the business is doing. And when I look at the metrics and where we've taken this company to, it's discouraging at times to see it. But also at the same time, I know we're playing a long-term game and we're continuing to grow the value and strengthen the company, and we're pretty happy with that and proud of that.

Operator

Operator

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

Matthew Bouley

Analyst · Barclays. Please proceed with your question.

Thank you for taking the questions. So on the affordability topic, I know you mentioned your measures of affordability have been consistent, home sizes and upgrades and all that. And then obviously, buyers have sort of their own flexibility with your build-to-order model as well. But just thinking about kind of a go-forward view, I think of late 2018, where, for example, you introduced the smaller square footage plan to kind of get ahead of that rate increase at the time. I guess today, are there any other proactive steps that you can take with your products to, again, sort of get ahead of what could happen here in a higher rate scenario? Thank you.

Jeff Mezger

Management

Matt, we're constantly mindful of household incomes. And it is a math equation. People can only afford so much and it's the combo of supply and demand and affordability. So we get that. In a lot of markets, we've moved to smaller lots, more town homes, some things like that to keep the prices down and attainable by the median household incomes. While we went through that exercise and moved very quickly in the past with our product, as we had rolled out, we had built new models were presented to the market loan behold interest rates came back down. And so it is out there, and it's a strategy that demonstrates how quickly we can move. And then we really didn't need it at the time and haven't needed a pet. The good news is all those products are completed on the shelf, and if we have to quickly roll out smaller models and reset our pricing in a community, we can do that in relatively short order. So it's all out there still. And I like the flexibility in our approach. Now the buyer can choose less things in the studio. They can pick a lot with a lower lot premium. They can pick a smaller home at a lower price point or they can change whatever mortgage instrument they decide on to acquire their own. All those things moving together, there's a lot of flexibility for the consumer and for us right now. So we think we're positioned well if rates were to continue to run.

Matthew Bouley

Analyst · Barclays. Please proceed with your question.

Thank you for that, Jeff. I get one on -- I guess, following up on the gross margin side, just kind of zooming into the cadence here. I'm just curious, given what you've guided for Q2 and sort of doing the math into the second half. I'm wondering if from an exit rate perspective, maybe Jeff K, this one's for you. If you kind of drifted to north of $2 million in Q4 just now with a little bit better visibility? Or just how we should kind of think about that second half cadence that you're implying. Thank you.

Jeff Kaminski

Management

Sure. Yes. So starting the second quarter guide, $244 million to $25 million -- what do you usually don't get too detailed on the back half or quarterly. But obviously, if you just do the math, the third quarter is going to be above 26%. And fourth quarter will certainly be about 27% as we see it today. That will go close to about a 26% average for the year, 25.9% at the midpoint. And that would be a pretty nice exit rate for us. We'd be very pleased to see that come through. Keep in mind, when you look at those margin numbers, the vast majority of the dollars that we plan to close and the homes that we plan to close by the end of the year, the dollars that will turn into revenue earning backlog today. So it's really not hypothetical. It's really not what will the selling price be in this new community that community, those homes are actually in backlog and supporting those margin levels. So it's a really nice trend in we've seen very strong predictability on the margins for the past couple of years. So we're excited to see it.

Operator

Operator

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

Deepa Raghavan

Analyst · Wells Fargo. Please proceed with your question.

Thanks for taking my question. Just related to that gross margin question a little bit the peak number from last spring already hit your Books and Novo been benefiting this Q1? Or you're still paying for the peak pricing from last spring. And therefore, what we would see in Q2 and Q3 will be the benefits once it went lower. But again, the recent lumber spike starts to hit at Q4. How does that number peak and valley hit your -- yes.

Jeff Mezger

Management

Right. You just tried it pretty accurately. I mean Q4 was a real heavy quarter for us in the peak lumber. We saw some bleed into Q1. It affected the margins a bit in the first quarter. We'll see some relief and some bounce back in the second and third quarters. We constantly update our cost and our backlog. So anything that we're seeing with the home that starts on a higher lumber price that's baked into our cost profile. Over that same time period, obviously, selling prices have escalated quite a bit, and we even saw continued escalation in ability to increase price in the first quarter to a large degree. -- helping to offset that. So -- but like I said, we just try to pretty accurately. Q4, Q1 heavy Q2, Q3, some more relief keeping back in a little bit but pricing has moved as well to help offset it.

Deepa Raghavan

Analyst · Wells Fargo. Please proceed with your question.

Staying just on the constraints, can you help us understand how the quarter progress with respect to labor constraints -- and the reason I ask is Omicron likely impacted your December quarter, maybe towards the tail end, a good chunk of January. But it looks like February was getting better. Just curious what would explain the second half incremental challenges that you faced? And how does -- how has March so far played out with respect to those labor challenges? Thank you.

Jeff Mezger

Management

Rob, do you want to take that?

Rob McGibney

Management

Sure, Jeff. I think the best way is to provide some perspective on the labor, both internal and outside of KB is just through some of the numbers that we saw within our company, and through the fourth quarter and moving up to mid-January, we were seeing roughly 100 employees, KB employees a month that were impacted in some way by COVID and we're in a quarantine process. And then between mid-January and early February, that number spiked to over 500 employees, so roughly a quarter of our workforce, our KB Home workforce. And we really felt the operational impact of that spike the most in the back half of the first quarter with employees out on Quarantine and the COVID exposures or cases were most prevalent in our field teams. And so we likely had over 30% of our construction staff impacted during that spike. And of course, our trade partners, our suppliers, our inspectors, the utility crews, et cetera, they were also hit in a big way. And transitioning now, that number tracking at a peak of over 500 in March, we're tracking numbers like 25 employees. So, the Omicron variant impact was sudden, it hit in a hurry and then it was all gone quickly, but the impact to our construction in the back half of the quarter was real. And today, we're seeing an improvement in both external labor and internal employee availability relative to what we saw in the back half of last quarter.

Operator

Operator

Thank you. Our next question comes from the line of Susan Maklari with Goldman Sachs. Please proceed with your question.

Susan Maklari

Analyst · Goldman Sachs. Please proceed with your question.

Thank you. Good afternoon, everyone. Thanks for taking the questions. My first question is looking at the margins, you actually did a really nice job on the SG&A. This quarter you came in a little lower than what we had expected. The guide implies some further incremental leverage as we move through the year. Can you talk to the potential to continue to see some improvement there? And if things do change, what is your ability to sustain some of this relative benefit that you've seen?

Jeff Mezger

Management

Right. We are expecting continued improvement in SG&A, particularly in the back half with higher housing revenue expectations. We've -- as you pointed out, it's been a nice cadence. We are investing more in the business right now because we're in a growth phase, and we have community count increasing quite dramatically and really, really healthy absorption pace in the communities. So -- and supporting just the grand openings and the sheer number of grand openings. But we definitely see runway on that. We see definitely a single-digit SG&A number for the year and further potential to bring that down in the future as we’ve really -- we believe, by the end of this year, we'll be a new kind of scale level and be able to gain additional leverage benefits on the cost in the SG&A category.

Susan Maklari

Analyst · Goldman Sachs. Please proceed with your question.

And then my second question is going back to the land market, you made the comment that you're saying geographically close as you're buying new parcels. But as you think about an environment where rates are rising, obviously, home prices are going up as well, how do you think about the ability to strike the need to maintain affordability while still also staying geographically close and managing the risk on the land side. And I guess with that, are you seeing any signs that the industry overall is overstepping over reaching at all on the land side? Do you think that everybody is fairly disciplined as it relates to that. Any signs that we're sort of getting closer or maybe just some of the behaviors or activity that we saw in the last cycle? Or has it been pretty measured as you think about the growth that everyone is targeting and looking for over the next couple of years?

Jeff Mezger

Management

I think measured is a good word. And in our case, we're very sensitive to not going out. My reference in our investment committee is go out where the road ends and the rod end because you're chasing a lower price point, we'd rather stay in the more desirable submarkets and target the incomes in those submarkets. And it's a healthy tension with our land teams because there's more land available out in the lesser areas, but it's also where the market slows first, if the market were to turn. So we stay in, I would call it, the B2B minus ring and really work with our divisions and our land search efforts to make sure that you're in more desirable submarkets. And it probably means it's a little smaller deal in lot count and therefore, you got to find more of them. And it's a healthy tension with the teams. But we'd rather go that route than go out to the real exerts just for a pure price play.

Operator

Operator

Thank you. Ladies and gentlemen, this concludes today's teleconference. Thank you for your participation. You may now disconnect your lines.