Kb Home (KBH) Q4 2021 Earnings Call Transcript

Kb Home (NYSE: KBH) Q4 2021 earnings call dated Jan. 12, 2022

Corporate Participants:

Jill Peters — Senior Vice President, Investor Relations

Jeffrey T. Mezger — Chairman of the Board, President and Chief Executive Officer

Jeff Kaminski — Executive Vice President and Chief Financial Officer

Robert McGibney — Executive Vice President and Co-Chief Operating Officer

Analysts:

Truman Patterson — Wolfe Research — Analyst

Alan Ratner — Zelman & Associates — Analyst

Stephen Kim — Evercore — Analyst

Matthew Bouley — Barclays — Analyst

Susan Maklari — Goldman Sachs — Analyst

Michael Rehaut — JPMorgan — Analyst

Mike Dahl — RBC Capital Markets — Analyst

Presentation:

Operator

Good afternoon. My name is Alix, and I will be your conference operator today. I would like to welcome everyone to the KB Home 2021 Fourth 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 February 12.

Now I would like to turn the call over to Jill Peters, Senior Vice President, Investor Relations. Jill, you may begin.

Jill Peters — Senior Vice President, Investor Relations

Thank you, Alix. Good afternoon, everyone, and thank you for joining us today to review our results for the fourth quarter of fiscal 2021. On the call are Jeff Mezger, Chairman, President and Chief Executive Officer; Matt Mandino, and 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, here is Jeff Mezger.

Jeffrey T. Mezger — Chairman of the Board, President and Chief Executive Officer

Thank you, Jill. Good afternoon, everyone, and Happy New Year. We had a remarkable year in 2021, producing revenue growth in excess of 35% and an increase in our earnings per share of more than 90%. We achieved our objectives of expanding our scale and profitability, driving our return on equity up by over 800 basis points to 20%. Our results are even more notable, considering they were accomplished despite the supply chain challenges and municipal delays that were pervasive throughout the year, as our teams have been successfully navigating these issues.

As we begin 2022, we are poised to continue to leverage delivering returns focused growth. Our backlog value of $5 billion, which grew 67% year-over-year, provides a strong base of support of roughly $7.4 billion and expected revenues in 2022. This represents substantial top line expansion, which combined with our expectation of a dramatic increase in our gross margin to nearly 26%, will drive our return on equity meaningfully higher.

With respect to the fourth quarter, we generated total revenues of $1.7 billion and diluted earnings per share of $1.91, representing a year-over-year increase of more than 70% on the bottom line.

We achieved an operating income margin approaching 12%, resulting in a 28% expansion in our operating profit per unit to over $56,000. In addition to the significant profit growth, our business is generating a healthy level of cash flow and we remain consistent in our balanced approach toward allocating this capital. Disciplined investment in community count growth is our top priority. And in 2021, we put over $2.5 billion to work in land acquisition and development. We expanded our lot position to nearly 87,000 lots under control, which is almost 30% higher from year-end 2020. Our lot position is diversified both across and within our regions. And we own all of the lots that we need for our anticipated 2022 delivery goals. We also now own or control the lots that we need for sustained growth in 2023.

In addition to reinvesting in our business, we returned over $240 million in cash to stockholders through the share repurchases that we completed in our third quarter, along with our quarterly dividend. And we reduced our debt during the year by over $60 million.

Throughout 2021, we implemented price increases across nearly all of our communities, along with managing lot releases for balance, pace, price and production in order to optimize each asset. Although costs rose as we moved through the year, our pricing strength outpaced the rate of cost inflation, driving our backlog margins higher. This dynamic continued in our fourth quarter, contributing to a rise in our net order value of 12% year-over-year, despite net orders decreasing 10%, a level similar to the decline in our community count. This increase in net order value contributed to a backlog value that is more than 65% higher.

With the extension of our cycle times, most of the pricing power we experienced in 2021 will be reflected in our gross margin beginning in our 2022 second quarter. In addition, our results will continue to benefit from structural tailwinds, including the performance of our more recently opened communities where margins are running in excess of the company average, the ongoing rotation into higher quality mix of assets as the impact from reactivated communities continues to diminish, a reduction in amortized interest and the impact that higher monthly deliveries per community has on field overhead. All of these factors combined are driving our expectation of a gross margin of nearly 26% for this year.

We successfully opened 130 new communities in 2021, our largest number in many years, including 33 in the fourth quarter. The higher lot count that I mentioned will enable us to accelerate our new community openings in 2022. As a result, we now expect to end 2022 with about 265 communities up over 20% year-over-year and ahead of our initial projection that we shared in September. In addition of supporting our roughly 30% increase in revenue planned for 2022, our community count expansion will also contribute to our growth in 2023.

Our monthly absorption per community of 5.5 net orders during the fourth quarter reflected a typical seasonal pattern sequentially. For the year, our absorption pace averaged 6.3 net orders per community per month, the best annual rate we have seen in more than a decade.

Homebuyers value the choice and personalization inherent in our built-to-order model, which we believe is the primary reason that we have long generated among the highest absorption rates in the industry.

With the expectation of interest rates will rise this year and with a strong home price appreciation the market has experienced, it is appropriate to spend a moment addressing affordability. Our strategy, it’s a target the median household income of a sub-market, positioning our homes to be attainable by the largest segment of buyers. We strive to be below the median new home price and at a reasonable medium — reasonable premium to the median resale price when we open a community, and then be opportunistic in raising price, based on demand at that location once opened.

Our average selling price on deliveries rose about 9% year-over-year in 2021, well below the reported increase for overall pricing levels nationally, highlighting the affordability of our locations and products.

As we’ve discussed on previous calls, we track a number of internal key indicators to gauge changes in consumer behavior that could signal affordability challenges, which we are not seen at this time. One of the most current of these is the square footage of homes that buyers are selecting as they will typically rotate down to a smaller home if they need to in order to achieve homeownership. Although we offer floor plans below 1,600 square feet in about 80% of our communities, buyers continue to choose larger footage homes.

Over the past year, our deliveries have averaged between 2,000 and 2,100 feet, consistent with our historical trends. And our homes in backlog are slightly above that range. We also look at our studio revenues and lot premiums, which we view as discretionary spending for our buyers. We would expect to see a decline if buyers are stretched, but our studio revenues and lot premiums have increased even as base prices have risen. On a combined basis, buyers spent about $48,000 per home in these two categories in the fourth quarter, a solid enhancement to our revenues.

Finally, and perhaps most importantly is the credit profile of our buyers. The average FICO score in the quarter was 732, an all-time high. In addition, about two-thirds of our buyers qualified for a conventional mortgage. And our buyers overall are averaging a down payment of over $67,000. Taken together, these metrics illustrate our buyers’ strong credit.

I’ll also note that the recent increases in loan limits, both conventional and FHA should help with mortgage financing, provide an incremental benefit to the industry. We started over 3,800 homes during the quarter, as we work to position our production for growth in 2022 deliveries. At year-end, we had over 9,100 homes in production with 90% of these homes already sold. Generally, our cancellation rate once we start the home is extremely low and at 5% in the fourth quarter it remains so. We’re focusing our customers strong desire to purchase their personalized homes.

As to build times, while we extended about two weeks sequentially in the quarter, we are encouraged to see some signs of stabilization. Construction times in November and December were consistent with September and October, pointing to a leveling out over the last four months. Our projections for this year, assume that we hold at these levels and depending on timing, any improvement in build times could increase our expected closings in the latter part of this year.

Our backlog is comprised of over 10,500 homes with a value of $5 billion, representing the bulk of our revenues expected for 2022. One aspect of our built-to-order business model that tends to get overlooked is a dynamic between our revenue growth and community count. In our count, we do not include communities that we consider to be sold out, meaning that they have less than five homes left to sell. That doesn’t mean the community is closed out, and that those communities will continue to contribute to our revenues and profits. In fact, our backlog includes almost 1,900 homes, from 150 sold-out communities that will deliver approximately $1 billion in 2022 revenues.

Since we are well into our first quarter at the time of this call, we typically provide an update on net orders. While we have not seen a slowdown in demand across our geographic footprint in the past couple of months and we foresee a strong spring selling season ahead. A combination of factors has resulted in a negative year-over-year net order comparison for the first six weeks of this quarter at 17%. In the prior-year, net orders throughout December and into 2021 were particularly strong, creating a difficult comparison.

As the first quarter progresses and we benefit from the additional community openings we have scheduled along with easier weekly comparisons, we expect to end the quarter with net orders down about a mid-single digit percentage year-over-year, similar to our anticipated decline in average community count for the quarter.

Market conditions remain very healthy as favorable demographics, low mortgage interest rates and an extremely limited supply of homes, particularly for first time buyers continue to drive demand. Specific to KB Home, we believe the location of our communities, price point of our products and the ability to choose in personalized homes in our built-to-order approach are compelling for buyers.

Shifting gears for a moment, 2021 was also marked by solid progress in our environmental, social and governance initiatives. KB Home was once again recognized with multiple honors from the U.S. Environmental Protection Agency, leading our industry with the ENERGY STAR Partner of the Year award. A record number of ENERGY STAR market leader awards. And once again being the only homebuilder to receive the WaterSense Sustained Excellence Award.

Our environmental program is robust and we are proud that our homes have the lowest national average HERS score among production builders with a long track record of annual improvement in this key metric, which we expect to continue in 2022. Our ESG leadership is being recognized as KB Home is the only national builder named to Newsweek’s list of America’s Most Responsible Companies for the second year in a row.

Before I wrap up, I would like to recognize and thank all of our employees for an incredible year. We significantly increased our volume in 2021 and that’s the most challenging and fluid operating conditions that I’ve seen in my homebuilding career. These results came about from the determined and relentless efforts of our entire team.

In closing, 2021 was a rewarding year for KB Home. In addition to generating significant revenue and earnings growth, we also produced substantial increases in our book value per share and our return on equity. Alongside these meaningful financial results, we maintain our leadership in providing the highest customer satisfaction levels among large production homebuilders and continue to drive innovation through the introduction of energy-efficient and healthier home features. As result of these and many other factors, KB Home was named to the list of the 250 most effectively managed companies in the U.S., a ranking that was developed by the Drucker Institute in conjunction with the Wall Street Journal.

As we look to the year ahead, during which we will celebrate our 65th anniversary, we anticipate another year of remarkable growth, which we expect will ultimately drive a return on equity of more than 26%. We look forward to sharing our progress with you as 2022 unfolds.

With that, I’ll now turn the call over to Jeff, for the financial review. Jeff?

Jeff Kaminski — Executive Vice President and Chief Financial Officer

Thank you, Jeff, and good afternoon, everyone. I will now cover highlights of our financial performance for the 2021 fourth quarter and full year, as well as provide our outlook for the 2022 first quarter and full year.

We finished 2021 with strong fourth quarter results, including significant year-over-year growth in revenues and a 310 basis point expansion in our operating margin that drove a 71% increase in our diluted earnings per share. While we faced supply chain issues that extended our cycle times as well as construction cost inflation challenges during 2021, our exceptional portfolio of communities and solid operational execution, along with the strong housing market generated impressive full-year results that I will summarize in a few minutes.

With a robust 2021 ending backlog value of nearly $5 billion and 29% year-over-year expansion in a number of lots owned or controlled, we are well positioned for continued meaningful growth in revenues, community count, earnings per share and returns in 2022. In the fourth quarter, our housing revenues of $1.66 billion were up 39% from a year ago, reflecting a 28% increase in homes delivered and a 9% increase in their overall average selling price. Housing revenues were up significantly in all four of our regions, ranging from a 28% increase in the central region, to 114% in the Southeast.

Looking ahead to the 2022 first quarter, we anticipate housing market conditions will continue to be favorable with strong home buyer demand, while we navigate expected continued supply chain challenges. For the 2022 first quarter, we expect to generate housing revenues in the range of $1.43 billion to $1.53 billion. For the 2022 full year, assuming no change in supply chain dynamics, we are forecasting housing revenues in a range of $7.2 billion to $7.6 billion, up over $1.7 billion or 30% at the midpoint as compared to 2021.

Having ended our 2021 fiscal year with our highest yearend backlog level since 2005, along with our expectations for a higher community count and continued strong housing market conditions, we believe we are well positioned to achieve this top line performance for 2022.

In the fourth quarter, our overall average selling price of homes delivered increased to approximately $451,000. Reflecting our higher average selling price per net order in leasing quarter, we’re projecting an average selling prices of approximately $472,000 for the 2022 first quarter. For the 2022 full year, we believe our overall average selling price in the range of $480,000 to $490,000.

Homebuilding operating income for the fourth quarter totaled $214.4 million, up 85% as compared to $115.7 million for the year-earlier quarter. The current quarter included inventory related charges of approximately $700,000 versus $11.7 million a year ago. Our operating margin was 12.8%, up 310 basis points from the 2020 fourth quarter. Excluding inventory related charges, our operating margin was 12.9%, as compared to 10.7% a year ago, reflecting improvement in both our gross margin and SG&A expense ratio.

We anticipate our 2022 first quarter homebuilding operating income margin, excluding the impact of any inventory related charges will be approximately 12% compared to 10.4% to the year earlier quarter. For the 2022 full year, we expect this metric to be in the range of 15.7% to 16.5%, which represents a significant year-over-year improvement of 450 basis points at the midpoint, reflecting continued positive momentum in both our gross margin and SG&A expense ratio.

Our 2021 fourth quarter housing gross profit margin improved 230 basis points from the year earlier quarter to 22.3%. Excluding inventory related charges, our gross margin for the quarter reflect the year-over-year increase of 140 basis points to 22.4%. The year-over-year improvement primarily reflected the impact of higher selling prices and lower amortization of previously capitalized interest, partly offset by higher costs for lumber and other construction materials and labor.

We are forecasting a housing gross profit margin for the first quarter in the range of 22.0% to 22.6%, representing the low point for the year. We anticipate significant sequential expansion in quarterly gross margin during 2022, mainly driven by price increases that have outpaced cost pressures in our established communities, strong selling margins in our recently opened communities and an expected reduction in amortization of previously capitalized interest. For the full year, we expect this metric will be in a range of 25.4% to 26.2%, an increase of 400 basis points at the mid-point as compared to 2021.

Our selling, general and administrative expensive ratio of 9.8% for the fourth quarter improved 50 basis points from a year ago, mainly reflecting enhanced operating leverage due to higher revenues, partly offset by increased performance-based compensation expenses and costs to support our expanding scale. We are forecasting our 2022 first quarter SG&A ratio, to be approximately 10.4%, an improvement of 30 basis points versus the prior year. And as expected favorable leverage impacts from an anticipated year-over-year increase in housing revenues are partially offset by increased investments in personnel and other resources to support a projected meaningful expansion in community count. We expect that our 2022 full year SG&A expense ratio will be in the range of 9.4% to 9.9%.

Our income tax expense of $49.7 million for the fourth quarter which represented an effective tax rate of approximately 22% was favorably impacted by $7 million of federal energy tax credits, reflecting another benefit of our industry leading sustainability initiatives. We currently expect our effective tax rate for the 2022 first quarter and full year to be approximately 25%, both excluding any favorable impacts from energy tax credits.

Federal legislation extending the availability of tax credits for building energy efficient homes in 2022 has not yet been enacted. If the Section 45 of our tax credit is extended at its current level, our 2022 effective tax rate will be favorably impacted by approximately 200 basis points. Overall, we reported net income of $174.2 million or $1.91 per diluted share for the fourth quarter, a notable improvement from $106.1 million or $1.12 per diluted share for the prior year period.

Reflecting on the full year, we are very pleased with the strong 2021 financial results. We increased our housing revenues by 37% to nearly $5.7 billion, expanded our operating margin by 400 basis points to 11.6%, with measurable improvements in both our gross margin and SG&A expense ratio, and reported $6.01 of diluted earnings per share, an increase of 92%. We also completed $188 million of share repurchases, refinanced $390 million of our senior notes, resulting in annualized savings of $16 million of incurred interest and improved our year end leverage ratio by 380 basis points.

Turning now to community count. Our fourth quarter average of 214 was down 9% from 234 in the corresponding 2020 quarter and up 4% sequentially. We ended the year with 217 communities, down 8% from the year ago and up 3% sequentially. We expect our 2022 first quarter ending community count to remain relatively flat sequentially and represent the low point for 2022. On a year-over-year basis, we anticipate our 2022 first quarter average community count will be down by a low-single digit percentage.

We expect our quarter-end community count to increase sequentially through the remainder of the year, starting in the second quarter as openings each quarter are expected to outpace sell outs. We anticipate ending the year with a 20% to 25% increase in our community count, supporting additional top line growth in 2023 and beyond.

During the fourth quarter to drive future community openings, we invested $622 million in land and land development, with $258 million or 41% of the total representing land acquisitions. In 2021, we invested over $2.5 billion in land acquisition development compared to $1.7 billion in the previous year. At year end, our total liquidity was approximately $1.1 billion, including $791 million of available capacity under our unsecured revolving credit facility.

Our debt to capital ratio improved to 35.8% at year-end 2021 compared to 39.6% the previous year. We expect to generate significant cash flow in the current year to fund land investment supporting our targeted 2022 and future year’s growth in community count and housing revenues.

Our 2021 year end stockholders equity was $3.02 billion as compared to $2.67 billion a year ago, and our book value per share increased by 18% to $34.23. Finally, one of the most notable 2021 achievements was a significant improvement in return on equity to 19.9% for the full year, a year-over-year expansion of over 800 basis points.

Given our current backlog and community opening plans and the expected continued strength in the housing market, we are confident that we will generate significant year-over-year improvements in our key 2022 financial metrics. We plan to continue to execute on the principles of our returns focused growth strategy with an emphasis on meaningfully improving our returns by increasing our community count and top line, while producing further expansion in our operating margin.

In summary, using the midpoints of our guidance ranges, we expect a 30% year-over-year increase in housing revenues and significant expansion of our operating margin to 16.1%, driven by improvements in both gross margin and our SG&A expense ratio. These in turn drive a return on equity of over 26% of an excess of 600 basis points from 19.9% in 2021. This outlook reflects our view that with the returns-focused growth strategy, attractive business model, seasoned leadership team and continued favorable housing market conditions, we will be able to further and meaningfully enhance long-term stockholder value in 2022.

We will now take your questions. Alix, please open the lines.

Questions and Answers:

Operator

Thank you. [Operator Instructions] Our first question comes from the line of Truman Patterson with Wolfe Research. Please proceed with your question.

Truman Patterson — Wolfe Research — Analyst

Hey, good afternoon, everyone. Thanks for taking my questions. So first on your ’22 gross margin guidance of about 26%, I think the highest in 15 plus years. Just trying to understand — this might be an unfair question, but trying to understand how much of the improvement is being driven by pricing outstripping costs and versus some of your internal initiatives such as working down the legacy land, streamlining SKUs, simplifying offerings and partnering with the national suppliers?

Jeff Kaminski — Executive Vice President and Chief Financial Officer

Right, Truman. Yeah, there is — as you point out, there is a number of levers impacting 2022. As we went through the detail, certainly the decreased interest, amortization, and the driver. We have — I would say, the number one driver is just the performance of the communities. With our existing communities we have seen pricing outstrip cost increases as we’ve gone through the year and a lot of that is coming through the deliveries in 2022. But I think also importantly, I think it’s very important actually to point out that we opened 130 new communities in 2021, and the performance of those communities have been very, very encouraging, as we’re seeing the backlog build, a nice margin coming-off those community. So that rotation of communities from ’21 to ’22, I think we have a large impact on the margin.

So at the point in time when we underwrote, we’re seeing those communities open at much higher margins and nice pace. In fact, in most cases, higher pace and where we underwrote, and those are the main drivers for the 2022 improvement.

Jeffrey T. Mezger — Chairman of the Board, President and Chief Executive Officer

Hi, Truman, this is Jeff, if I could expand on a little bit. And we are not spiking a football here because we have a lot of work to do and we have our eyes set on even better results. But the transformation of the company is pretty much complete now. You were with us back in ’16 when we went on the returns-focused growth initiative. And part of that was to shore up and really strengthen the balance sheet and create a growth platform. And we did very well with that. We laid out a plan, shared it with the analyst community and off we went and we delivered on what we said we would do. Then coming out of ’19, it was about quality growth, continuing to refine and enhance and retool. And we were on that path, the pandemic hit, you deal with that, you manage through that. And I would say, the two-step transformation is now complete and it’s all about running the business with quality growth and continuing to improve profitability. And there is things I touched on in my comments, like our studios are performing better.

And we know how to — we get a good idea on one studio and we can share it across the system and, boom, everybody enhances their studio revenues. Then we come up with some ideas on lot premiums. We share it across the company, boom, you get more lot premium across the system through a best idea that’s shared across the footprint. Your absorption per community is up a couple a month from where it was three, four years ago. That helps your financial performance. We’re out of the old communities and into the new. And as Jeff shared there, they’re performing well above our average. Is it the location? Is it the product? Is it the strength of the market? I think it’s all the above. So I wouldn’t just pin it on riding the way from the pricing environment that we’re in. We’ve structurally changed how this company is operating, and I think we’ve taken ourselves to a new level and it’s reflected in our guide for this year.

Truman Patterson — Wolfe Research — Analyst

No, thank you for that. And I remember that call in 2016 well. My next question, just two-part question. Omicron has clearly been flaring up here. Hopefully, this is the last wave. But just hoping — first part, just hoping to get an idea of how that’s impacted labor availability? And if you could quantify any impact that might be baked into the first quarter closings guide? And then Omicron and the COVID flare upside, had you all started to see any incremental improvement in availability of certain products by the end of 2021?

Jeffrey T. Mezger — Chairman of the Board, President and Chief Executive Officer

I can kick that to Rob and Matt, Truman. Obviously, we’re seeing a little flare up in Omicron, like you reading about in the media, whether it’s in the sub-contractor base. We’ve seen some within our own business where we have a very good playbook and we locked it back down and people go away for five days or 10 days, dependent on symptoms and what state they’re in and then they come back to work. So you have these little flare-ups and then they go right away and you move on to the next one. What’s unknown for me is whether it’s having an impact on the supply chain relative to the manufacturing or not. And I don’t think that’s played out yet. And as I think it’s moving along, I think as a society, we’re getting smarter about how to manage through it and we’re sensitive to it. And companies are responding better than we were when it first hit back in ’20. But Rob, you want to give any thoughts on what you’re seeing out in the field?

Robert McGibney — Executive Vice President and Co-Chief Operating Officer

Yes, I’ll just touch on outside of Omicron, some of the things that we’re seeing. I mean, we’re almost two years in this — 18 months, two years into it. And we are seeing some improvements in several areas. So a lot of that just because we’re far more experienced in developing workarounds for the supply chain gaps. We’ve developed methods for continuing to progress our homes despite missing parts and pieces. And we’ve adjusted our processes to sync up with the delays and extended lead times. And we’re in lockstep with our trade partners and suppliers and communication around our future needs, what their capacities are. But we are seeing some areas improve, but at the same time others get worse. For example, in Q4, garage doors was one of our biggest challenges. There are still real issues around garage door that we’ve taken some action to minimize the disruptions from that through finding alternative suppliers and manufacturers. We work to minimize the door styles that we offer to match what’s more readily available on the supply chain and allows our suppliers and partners to focus on producing a smaller range of those products. But then on the flip side, when we solve one issue or one issue improves, another one tends to pop-up, like earlier in the year the foam that we used for stucco lath wasn’t really an item on our radar. But now the supply of that has becomes scarce. So one issue kind of gets traded for another. We’ll claw back time in one area and lose some in another, that’s led to what we’re seeing in the stabilized cycle time, just at an elevated level.

Operator

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

Alan Ratner — Zelman & Associates — Analyst

Hey, guys, Happy New Year, and nice job in the quarter and the year, congratulations. First question, obviously very strong gross margin guidance, and you guys have a lot of visibility into that based on your backlog and built-to-order model. I’m just curious when you look at kind of the cost and pricing environment today as it sits, we’re obviously seeing a ton of inflation across the board. Lumber has spiked back up close to those peak levels we saw six, nine months ago. And presumably, those costs won’t roll through as much this year, maybe towards the tail end, but that’s probably more of a ’23 — early ’23 dynamic. So in the current environment, do you have pricing power that is sufficient to offset the — what seems like accelerating cost pressures we’re facing today? Just talk a little bit about how you’re faring on the pricing side, if it’s strong as it was earlier in ’21?

Jeffrey T. Mezger — Chairman of the Board, President and Chief Executive Officer

Yes. Alan, lumber is moving back up, which is interesting to me, and I think you’ll see it bounce around some. But at this point in time, as I shared in the comments, we’re seeing price ahead of costs. So costs are going up at a different level in every city, but we’ve been able to move pricing up more than the cost have increased.

Alan Ratner — Zelman & Associates — Analyst

Right. That’s good to hear. Second question on the community count growth, again very bullish outlook there. And I think a lot of your peers have similar growth outlooks, maybe not to the same extent. I’m just curious if you have any sense for what the community growth outlook looks like in your MSAs on a competitive landscape? And do you think the 6, 6.5 per month absorption pace that you guys put up in ’21 can be sustained with 20% plus more communities hitting the market over the next 12 months?

Jeffrey T. Mezger — Chairman of the Board, President and Chief Executive Officer

Our internal goal, Alan, is to have community count growth of at least 10% a year. And obviously this year we’re going to do a little better than that. It’s not dynamic right now because the markets are so supply constrained. I don’t know that there is a lid on how many community you could open in a city. It’s more about how many you can get approved and developed and brought to market. It’s not that the demand isn’t there, because it is today. So I couldn’t tell you what the community count growth is per city. And it could be with our rate that we’re taking share and maybe the markets aren’t getting larger, but we’ll take share because we successfully brought more communities to market.

When you look at our absorption rate right now, if the world stayed where it is today, and the margins we’re generating each week in our sales stayed where they are today, you’d see us continue to run at six a month. It’s a healthy pace. We like to turn the asset. There is benefit to having that kind of volume per community with the subs and suppliers. And I think that’s what we do. If the markets were to slow up a little bit, you could see our pace drop back down. Maybe margins move a little bit, I don’t know. But right now, heading into ’23 we like how we’re positioned and what we’re seeing in price and pace.

Operator

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

Stephen Kim — Evercore — Analyst

Yes. Thanks a lot, guys. I appreciate the gross margin guide. It makes a lot of sense, but it’s certainly nice to hear somebody say it. I wanted to ask you a question, kind of a higher — sort of a bigger picture question, regarding what the potential ability of housing demand to remain robust in a rising rate environment. Obviously, that’s a question that all of us are wrestling with and getting all the time. And the presumption is that demand is extremely strong and it’s going to weaken when rates rise, kind of like what we saw in 2018 is what people say.

My own personal view, and I’d be curious as to yours, is that the demand right now is much more need-based than it was in 2018. I mean, if you look at the surveys, it seems like everybody thinks it’s a horrible time to buy a house and most people are very mistrustful of actually where home prices are. And so I think that as much you actually need a house, you’re probably not looking to buy one right now. Which means by extension that if rates rise, you probably won’t see as much of a sticker shock or buyer strike like you did in 2018. How do you think about that?

Jeffrey T. Mezger — Chairman of the Board, President and Chief Executive Officer

Yes, I would agree with you Stephen. And to put it in the context of the demographics, you’ve heard everything about the millennials and how large it is a group, how big the cohort is, and how they deferred the home buying decision for a decade. So you have 70 million people out there, that are not seeing their needs met. They’re getting married, they’re getting better jobs, they’re relocating, they’re working from home, all these things you hear about that are creating strong demand. And then right behind that you have another generation of 70 million people are now hitting the homebuying years, that are just now starting their homeownership journey. So we see demand very strong right now. And if rates go up a little bit, I think you’ll see demand stay strong.

We’ve analyzed our backlog. And if rates went up 1%, it’s not a real impact. And that’s if everything stayed the same and rates went up 1 point, think of the profile I shared with you. Here we are predominantly a first-time builder and our buyers putting down on average $67,000 in down payment. They have all the flexibility in the world to navigate a little bit higher interest rate and they all want a house. And at the same time you go to the resale side, there is no inventory. There is metropolitan areas with 1,000 homes available for sale in a city of 4 million to 5 million. So there is no product on the market. And as we bring communities to bear in each of these cities, we have waiting list or interest list I’ll say, 300, 400, 500 people waiting. And it’s not unique to just one submarket, it’s a national phenomenon.

Stephen Kim — Evercore — Analyst

Yes, that’s good to hear. I guess my only other question for you would be related to market share gains. We seem to be in an unprecedented period where scale really matters. And I’m curious as to whether you’re seeing any indication that some of the smaller builders are actually able to accelerate their product or starts and production the way you are? Or whether this is going to be yet another year of significant market share growth for builders such as yourself?

Jeffrey T. Mezger — Chairman of the Board, President and Chief Executive Officer

Yes, I think you’ll continue to see the larger builders take share. If you’re a plumbing contractor, would you rather get a commitment for five to 10 homes a week or one home every other week. And they’re going where the volume is and the relationships that the large builders have created with the trade partners. And we certainly have a great relationship nationally, it helps you.

And within our own business, our larger divisions are definitely having better success navigating the supply chain challenges, where in Vegas as opposed to where we’re just getting going in Charlotte, compare that to — you’re well down the list in Charlotte for a framing contractor in Vegas, where’s it’s the top of the list. And I think if you use that as a proxy for what’s going on out there with the small privates, they’re struggling compared to what we can get them.

Operator

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

Matthew Bouley — Barclays — Analyst

Good afternoon, everyone. Thank you for taking the questions and congrats on the results. So on the 2022 outlook, clearly guiding a significant step-up in net income, just purely on a dollar basis. You’ve always reinvested a large portion of the cash generation back into the business. But as we think about this sort of a large step up here in 2022, is there any thoughts on sort of excess capacity from a balance sheet and cash perspective that could be deployed to something more shareholder friendly, perhaps a more programmatic share repurchase, just sort of how do you harvest the type of cash flow you’ll be generating this year? Thank you.

Jeffrey T. Mezger — Chairman of the Board, President and Chief Executive Officer

I’ll let Jeff pile on that. It’s a good question and we shared in our comments that it’s a balanced approach, just like we have over the last five or six years. First and foremost, it’s a key to profitably growing quality investments, quality growth, take market share and grow our EPS, and in turn improve our returns. But we always will look to the balance, just like we did in ’21, where we bought back some shares at a good price. We upped our dividend, paying more in dividends and we took down debt while investing $2.5 billion and growing our company. So it’s a very balanced approach.

And I’d rather stay and keep putting the periscope up as the year unfolds and see how things are going and where we’re headed and how we’re doing in our growth initiatives, in our profit projections and then we’ll make a call on how our cash is running and what we should do with it. But I think that’s a better approach for us than to declare we’re going to buyback so many shares of stock a quarter or we’re going to do this or we’re going to do that. I don’t know if you want to add any?

Jeff Kaminski — Executive Vice President and Chief Financial Officer

Yes. No, I only had a couple of comments. I think first and foremost increasing our scale and expanding our returns by as much as we’re looking at, I think is extremely shareholder-friendly. And we’re hoping to see some repricing in shares, obviously in multiples and everything else, reflecting the strong return potential to business and sustainability out beyond 2022. So that’s first and foremost. But as Jeff said, we are focused on reinvestment. We like the opportunities we’re seeing. We think that’s a really good use of capital.

We’re always open to it. We’ve opportunistically made share repurchases in past with excess cash and we probably look at doing the same in the future. We don’t have the huge goal that we had years ago of reducing the debt side of things. We have that fairly in line. So I think we’re really well-positioned right now and that scale and return expansion, I think is really meaningful for the company, and should be very meaningful for our shareholders.

Matthew Bouley — Barclays — Analyst

Got it. No, that’s really helpful. Thank you for that. And second question, you zooming in on the near-term, you gave kind of the decline in orders quarter-to-date. And I hear you loud and clear that it’s a difficult year-over-year comparison. Obviously, we’re talking about December and January here, so how much should we really read into all that? And clearly, you gave assumption around Q1 orders. But it just simply begs the question, given there is a relatively large decline in orders, can you just kind of elaborate a little bit on that, why do you look at all that and say that you’re still — that there isn’t some kind of signal around underlying demand there over the past six weeks? Thank you.

Jeffrey T. Mezger — Chairman of the Board, President and Chief Executive Officer

Yes. Okay. Matt, you kind of touched on one thing that I didn’t include in my shared comments, is the softest five or six weeks of the year in the industry saw a negative comp there versus February-March or April is a much smaller number. And it’s really the timing of weeks and how many communities we have open. But one thing I’d like everybody to take away on the call, we are seeing no weakening in demand and home buyer interest right now. The markets remain very strong. We have a lot of waiting list. We’re continuing to balance price and pace like we have been for the last year. And we think we’re going to see a very strong spring selling season. It’s very good out there right now on the demand side.

Operator

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

Susan Maklari — Goldman Sachs — Analyst

Thank you. Good afternoon, everyone, and congrats on the nice end of the year. My first question is, you know, you’ve talked in the past about reducing the SKUs in the design centers by about half and taking down some of the structural options in the business as well. Can you talk a little bit to where you are within that process and how you’re thinking about the contribution of that simplification to 2022?

Jeffrey T. Mezger — Chairman of the Board, President and Chief Executive Officer

Sure, Susan. Rob is the owner of our studios, so he can provide the insight. What I can share from my lens, strategically where drop-in SKUs right now to help ease the supply chain. And if you’re offering that three or four of an item, take it down to one or two and you reduce choice a little for the customer, but you improve your ability to get the product and compress build times. So our mantra right now is to retain the personalization that’s required to get the customer choice. But it has to be something that doesn’t get in the way of the supply chain and build times and that’s what Rob is working on.

So Rob, you want to provide some color to Susan?

Robert McGibney — Executive Vice President and Co-Chief Operating Officer

Sure. Susan, I mean, I would just say that it’s an ongoing process, it’s not an event. It’s something that we’re going to continue to be focused on, just simplification and speed throughout the whole organization. And as Jeff mentioned, part of that is just finding the right or the appropriate balance or the sweet spot between personalization for our customers and construction speed. But they’re not — some of them are win-wins all the way around. An example with Whirlpool, our appliance supplier and we converted to stainless steel appliances as the included feature in all of our homes. And just that action well minimized the SKU count from over 400 appliances to under 150, which significantly improved our lead times and simplified our internal processes. And it also adds value for our customers, because they’re getting a better product.

Susan Maklari — Goldman Sachs — Analyst

Yes, I guess just following up on that, does it suggest that even as the supply chain normalizes and some of these headwinds, they — that perhaps you can stick to something that is just a bit more refined for the consumer? Because it doesn’t seem like you’re having any pushback on it from the consumers’ perspective, you’re sort of getting to still that personalization that they’re looking for, but at the same time just making things a bit more efficient for everyone?

Robert McGibney — Executive Vice President and Co-Chief Operating Officer

Yes, I think that’s a good way to look at it. I mean it’s almost a necessity right now because of the supply chain issues. And we’re focused on maintaining the SKUs that are most readily available in the supply chain. But even once those supply chains and the cycle time issues go away, it allows us to run a more efficient operation. So again, it’s just finding the right balance between what our customers want in personalization and what’s efficient for our business.

Operator

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

Michael Rehaut — JPMorgan — Analyst

Hi. Good afternoon, everyone. Congrats on the results. First question, I just wanted to circle back a little bit to the gross margin trajectory, and it makes a lot of sense that, aside obviously from a lot of the hard work that you guys have done over the last couple of years, repositioning the company. From a timing perspective, looking for gross margins to start expanding in the first quarter — I’m sorry, second quarter — It’s pretty important to me kind of in our view, at least coincides with potentially some of that lumber benefit coming down, coming through the pike. And I was hoping, if possible to try and isolate that particular factors that impact on gross margins, as you think about 2Q and 3Q of ’22. And also Jeff K, you had mentioned lower interest amortization. If you had a sense of from a basis point perspective what type of differential that might be in ’22?

Jeff Kaminski — Executive Vice President and Chief Financial Officer

Sure, Mike, I can help you out with those. I mean the amortization side and the interest, I think it’s going to be somewhere in the neighborhood of 50 basis point for the full year of improved margin coming off of that. Relating to the cadence, second quarter we’re looking at a pretty nice step-up in margin right now, through what we’re seeing in the backlog that obviously always changes depending on the mix and what we deliver out in Q1 supply chain and construction cycle time and everything else, but we should start seeing that nice step-up beginning in Q2. If you think about those Q2 and Q3 deliveries when those sales were booked and those homes were started, one was always at a relatively low point as we saw a dip down and they’re coming back up again. So it’s probably more risk, I’d say in the fourth quarter on any lumber moves than we’d earlier in the year. But we are expecting to see sequential improvement as we move through the year.

And I think very importantly with the new sort of portfolio and we have half our portfolio over year, it’s more or less new. With the portfolio that we’re seeing coming through this year and the performance of those new communities, I think that exit rate would be a really nice indicator for strong margins in 2023. So we’re not — I’ll restrict the guide out there far at this point. There’s a lot of things between now and the end of the year to consider. But I’m really quite happy to see sequential improvement as we move through the year, because it just gives you a nice exit rate for future years. So that’s the way we’re seeing it right now.

Michael Rehaut — JPMorgan — Analyst

Right. Okay. So I appreciate that, Jeff. And just to be clear what you’re implying and from that perspective obviously makes all the sense is that, 4Q gross margins would be higher than the full-year average. Kind of the second question and correct me if I’m wrong there. But the second question just on going back to sales pace, obviously roughly 6 or 6.5 for the full year of ’21, extremely impressive. And I believe, Jeff Mezger, you said earlier that you think, given the current demand backdrop that that is effectively sustainable for the upcoming year. I was curious if, in the most recent quarter, what — roughly what percent of communities might have been still on restriction or restraining sales to better match production capacity and cost matching, in terms of that nature? Because if you’re doing the rate that you’ve done in ’21, with those sales restrictions, it certainly adds confidence to the statement that you could have sold it even better rates. And therefore, you know kind of adds confidence to a view that maybe 6, 6.5, is still the right number for the next 12 months?

Jeffrey T. Mezger — Chairman of the Board, President and Chief Executive Officer

Yes. Well, Michael, it’s a good observation. It’s what I shared in my comments. You can say we’re limiting releases because we’re managing to no more than 6 a month and that’s the average. Every asset has got a different story, if it’s a high-end community with a limited number of lots, and we’re not going to replace it. You have a lower sales rate because you want to mine all the price you can in that location if it’s easily replaceable out in the suburbs and there is vacant land near you and it’s not a cost-intensive market today as in Texas, you go and you let it run and then you go replace it with the next one. And my comment was that the market stayed where it is today and we sustain the margins we are today, which we think we are, you can run this thing at over six months and it’s a real sweet spot. You get to leverage everything, you get the benefit of scale and you grow your returns. There is a lot of benefit to doing six a month instead of four a month in our business model. So we think it’s sustainable right now.

Operator

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

Mike Dahl — RBC Capital Markets — Analyst

Thanks for fitting me in. First question, just wanted to follow-up to put a finer point on some of the cadence. I mean, it not only looks like 4Q exit rate would be above the full-year average. But it seems like you’re targeting something like a 28%, 29% as you kind of ramp through the year and having to get to that level to reach your full-year. So maybe if you could put any context around whether that’s fair?

And then within that, I know someone asked about kind of what you’re seeing on cost currently. But maybe just what is the net inflation number that’s embedded in your full-year guide?

Jeffrey T. Mezger — Chairman of the Board, President and Chief Executive Officer

Sure. So first of all on the exit rate, you’re probably quite high in your range, probably get more 27%, 28%, but we’ll refine that as we go through the year and the quarters. Obviously, we haven’t sold a lot of those homes yet. Most of that selling would take place during the spring selling season for deliveries out in the fourth quarter. So it’s still a little bit of a paper forecast as opposed to looking at our backlog, but it’s probably a little higher than what I would expect any year, but we’ll see.

The second part of your question was, remind me, Mike?

Jeff Kaminski — Executive Vice President and Chief Financial Officer

Cost.

Mike Dahl — RBC Capital Markets — Analyst

Just what is the net-net inflation assumption embedded in that?

Jeffrey T. Mezger — Chairman of the Board, President and Chief Executive Officer

Right. Yes. So what we do on the costs and on the margins on anything in backlog, where we have lot cost and the lot price, we just look at our backlog margins. So in essence, there is no further cost inflation assumed on those sales. You’re making assumptions on a little bit of sold and delivered spec inventory as we go through the year, and what’s happening there and what’s happening on pricing. But we’re not — because of the way we like the cost, we’re really — we really don’t have to be very concerned about cost inflation on our backlog. And it’s, what, two-thirds of our total deliveries, I mean, we have $5 billion in backlogs, so we’re pretty safe on that.

The uncertainty for the year is mainly in the back half and especially in the fourth quarter. It involves some of the pricing coming-off new opened communities during the spring selling season. And what happens with cost is they move particularly over the next three or four months, that’s where we had more risk on that cost/price relationship. But from what we’re seeing today and what we’ve seen week after week after week as we’ve gone through particularly over the last six to nine months, we see margins expanding almost every single week. So we’re pretty excited about where the markets at and very excited about the portfolio communities that we have right now.

Mike Dahl — RBC Capital Markets — Analyst

Yes, that makes sense. Thanks for that, Jeff. And then my follow-up question is, I know you had some helpful commentary around the things that you look at, which aren’t showing any signs of stress from an affordability standpoint. Jeff M, I think your opening comments, still said, you do still want to be watchful around affordability. So the question is, you’ve got pricing power today, clearly. How do you expect to approach your pricing decisions through the spring through the year as you keep an eye on that? And how much may or may not be governed by what you end up seeing on rates?

Jeffrey T. Mezger — Chairman of the Board, President and Chief Executive Officer

Well, that’s a weekly look and every community like we always do, Mike. We worked through what’s the right run rate at this community, at this margin to give us the highest return with how many lots we have left and what’s coming behind it. And there is a process that we literally go through every week. And in today’s environment, it’s been a nice combination where we lift in pace and lift in margin. At the same time if rates go up, we will have real-time feedback on what that means if anything, with those customer today. And part of what I was trying to get across, this buyer profile, a lot of people look at a first-time builder and say, well, it’s a more challenged buyer. And that’s absolutely not the case. With the amount of equity that our buyers are putting into their home, the high credit FICO score that they have and their desire to be homeowners, it is nowhere near or even close to what transpired today. They have a lot of flexibility to navigate this thing with us, and we’ll have indications along the way. So we’ll continue to toggle pricing pace. And as I’ve said a few times now, we really expect a strong spring, really strong spring selling season. Demand is very strong out there.

Operator

[Operator Closing Remarks]