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Edited Transcript of KBH earnings conference call or presentation 24-Jun-20 9:00pm GMT

Q2 2020 KB Home Earnings Call

LOS ANGELES Jul 8, 2020 (Thomson StreetEvents) -- Edited Transcript of KB Home earnings conference call or presentation Wednesday, June 24, 2020 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jeff J. Kaminski

KB Home - Executive VP & CFO

* Jeffrey T. Mezger

KB Home - Chairman, President & CEO

* Jill S. Peters

KB Home - SVP of IR

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Conference Call Participants

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* Alan S. Ratner

Zelman & Associates LLC - MD

* Buck Horne

Raymond James & Associates, Inc., Research Division - SVP of Equity Research

* John Lovallo

BofA Merrill Lynch, Research Division - VP

* Margaret Jane Wellborn

JP Morgan Chase & Co, Research Division - Analyst

* Matthew Adrien Bouley

Barclays Bank PLC, Research Division - VP

* Michael Glaser Dahl

RBC Capital Markets, Research Division - MD of U.S. Homebuilders & Building Products

* Stephen Kim

Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Housing Research Team

* Truman Andrew Patterson

Wells Fargo Securities, LLC, Research Division - VP & Senior Analyst

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Presentation

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Operator [1]

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Good afternoon. My name is Devin, and I will be your conference operator today. I would like to welcome everyone to the KB Home 2020 Second Quarter Earnings Conference Call. (Operator Instructions) Today's conference call is being recorded and will be available for replay at the company's website, kbhome.com, through July 24. Now I would like to turn the call over to Jill Peters, Senior Vice President, Investor Relations. Jill, you may begin.

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Jill S. Peters, KB Home - SVP of IR [2]

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Thank you, Devin. Good afternoon, everyone, and thank you for joining us today to review our results for the second quarter of fiscal 2020. On the call are Jeff Mezger, Chairman, President and Chief Executive Officer; Matt Mandino, Executive Vice President and Chief Operating Officer; 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.

Before we begin, let me note that 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 factors outside of the company's control, including those detailed in today's press release and in 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, I will turn the call over to Jeff Mezger.

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Jeffrey T. Mezger, KB Home - Chairman, President & CEO [3]

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Thank you, Jill. Good afternoon. We hope you, your families and your colleagues are healthy and staying safe. We entered the second quarter well positioned with a substantial backlog, expanding profitability, and poised for momentum in net order growth in what looked to be a strong selling season. About 2 weeks later, a national emergency was declared for the COVID-19 pandemic. And every state in which we operate, issued stay-at-home restrictions effectively shutting down their local economies. While residential construction was deemed an essential activity, and we were able to continue to construct and deliver homes in the majority of our markets, we curtailed many aspects of our business until we gain better visibility on market dynamics and the economy. These steps allowed us to effectively navigate through the disruption. And with our absorption pace now beginning to normalize, we have quickly reestablished a steady rhythm to our business in selling, starting and delivering homes. As we emerge from the second quarter and look to 2021 and beyond, we are a more efficient business, and believe we are well positioned to restore our higher volume delivery levels. I'm proud of the entire KB Home team for their extraordinary effort and dedication to our customers and our company. In spite of the challenges we faced, our teams executed well, safely delivering 2,500 homes to our customers, which produced total revenues of $914 million, and diluted earnings per share of $0.55, representing year-over-year growth of 8%.

Getting into the details of our results, our profitability increased marking a highlight of the quarter with a 100-basis point year-over-year expansion in our housing gross profit margin, which fueled a 19% increase in our pretax income. We have a strong balance sheet with no goodwill and $1.4 billion in liquidity. Our leverage ratio was healthy at 41.5%, reflecting a 430-basis point improvement as compared to the prior year quarter. On a net basis, our ratio is 32.4%. Throughout these past few months, a high priority has been and remains the health and well-being of our employees, customers and business partners and their families. This guiding principle drove our decision to temporarily close our communities in mid-March, and then move in early April to a limited reopening by appointment only, with only 1 customer group permitted in our sales centers, model homes and design studios at any one time. We continue with this approach until more fully reopening in the third week of May, now accepting walk-in traffic, while still restricting the number of customer groups, allowed in our communities at any one-time, to 2. This was a conservative path to follow. Quickly closing our communities during 3 of the busiest sales weeks of the year and reopening more slowly than some other builders did. But we felt, we needed to take aggressive action in the interest of safety, while continuing to effectively run our business. At the same time, we took steps to enhance our virtual selling and studio tools. We set up systems to allow customers to visit our communities and tour homes privately without a KB Home employee present. We also created a process by which buyers could finalize their studio selections online. Once we resumed welcoming walk-in traffic in all of our communities and design studios, we continue to offer these options along with private appointments, providing flexibility in the most comfortable way for our customers to engage with us and capturing efficiency to the process. We plan to continue enhancing our virtual efforts given their success. And in fact, we recently introduced our reimagined website with a range of new tools to make the home buying experience even easier for our customers.

Given the uncertainty that we were operating under, we quickly moved to defer land acquisition and to suspend land development as well as put a hold on starts in production to preserve cash until we have more clarity on the status of our backlog and the direction of the economy. In addition, we adjusted our headcount to appropriately align our structure with anticipated volumes; a painful, but necessary step that we expect will result in approximately $40 million in annualized savings. Our cash preservation actions were successful. We increased our cash balance by $145 million sequentially and by nearly $450 million year-over-year, after adjusting for a modest level of cash that was drawn on our revolver in last year's second quarter. And we accomplished this increase in a quarter where our cash outlay is typically one of the highest of the year. During the quarter, we elected not to draw on our revolver as we were confident in our ability to generate adequate cash flow to operate our business. We did invest roughly $230 million in land acquisition and development, over 70% of which was used for development and fees early in the quarter. As conditions have improved in recent weeks, we have now fully resumed land development and increased our acquisition activity once again as well. From an orders perspective, my remarks this afternoon will focus on our gross orders with a separate discussion of cancellations. We believe this will provide more clarity on the underlying demand trends in our business in that we took a proactive approach to evaluating our backlog, which materially impacted our net order results. I'll provide more detail on this in a few moments.

At the time of our last earnings call in March, our year-over-year gross orders were positive, but quickly decelerated from that point and ended up declining 4% for the month. This decline became more pronounced in April, with gross orders down about 60% year-over-year representing a low point for the quarter. We were encouraged to see an acceleration in gross orders at the beginning of May as many counties and cities in our served markets began their phased approaches to reopening. In addition to the optimism fueled by the reopenings, demand was also driven by low mortgage interest rates, limited resale inventory and a heightened desire among consumers to both own a new home for health and safety reasons and also to relocate away from dense urban areas. This improvement in our weekly gross order trends in the first week of May, continued steadily as the month progressed. In the final week of the month, gross orders were at their best levels since the second week of March. Along the way, we did not take steps that would compromise margins in order to stimulate sales and, in fact, we were able to increase prices in about 60% of our communities for the quarter overall. From a geographic standpoint, the increase in demand was broad-based, across our entire footprint, and I will highlight a couple of markets. In spite of the compounding effect of depressed oil prices, Houston's weekly gross orders were healthy in May, and by the final week of the month at their best level since August of 2019. This performance reflects our affordable price points and the ability of Houston's diverse economy to withstand volatility in the oil market.

As to California, which was the first state to issue stay-at-home restrictions, its local governments began lifting these orders at varying points during May, contributing to some unevenness in demand trends market by market. We saw solid order activity in several markets as they reopened, particularly the Inland Empire, Sacramento and the Central Valley and also in the Bay Area. With respect to cancellations, we entered the quarter with a substantial backlog of 5,800 buyers. As counties and cities shutdown and layoff, furloughs and wage reductions intensified, we took a proactive approach to confirming the intentions and capabilities of our customers in backlog. This reassessment process resulted in significant order cancellations. In these situations, we refunded most deposits and maintained good relationships with our customers so that they would return to us when they were able and ready to buy again. In a number of our communities, we are seeing some of these buyers coming back to purchase a home upon returning to work. The combination of lower gross orders and higher cancellations resulted in a year-over-year increase in our cancellation rate to 43% in the second quarter. The majority of cancellations were on orders already in backlog at the beginning of the quarter, primarily on homes that have not yet been started. Although roughly 20% of the cancellations were on homes that were scheduled for delivery during the second quarter.

Of note, our Las Vegas and Orlando divisions, 2 of our larger volume businesses were hit particularly hard, reflecting their economy's dependence on travel and tourism and accounting for roughly 25% of our overall cancellations in the quarter. We are now comfortable with the stability of our backlog as our cancellation rate has returned to a more normalized level. As we move past the disruption and head into our third quarter, it now makes sense to return to evaluating our order trends on a net basis. So far in June, demand continues to accelerate and week-over-week net orders have further improved from May's levels. Overall, our net orders for the first 3 weeks of the month are modestly positive year-over-year, which is noteworthy given the strength in orders in June 2019. We're pleased to have ended the quarter with a backlog of nearly 5,100 orders and a value of $1.9 billion, considering the operating environment. That said, given our pause in land development, housing starts and production during the quarter, we expect our backlog conversion in the second half of 2020 will be below historical levels as some of the deliveries that we would normally have anticipated will shift into 2021.

On the mortgage side, KBHS has been a strong partner in supporting and communicating with our customers and in providing better predictability in managing through the closing process. The JV's capture rate increased in the second quarter to 76%, driving its income up about 90% year-over-year. This past quarter highlighted the power of the JV's technology, which enhances its ability to serve our homebuyers remotely, and increases our efficiencies in delivering homes. KBHS offers a digital mortgage platform, allowing customers to complete their loan application online or via the mobile app. The platform automatically verifies employment and assets and borrowers can upload any other required documents electronically, simplifying the process and streamlining loan approval. At closing, borrowers can review all loan disclosures prior to closing and sign a majority of the documents electronically. Any documents requiring a wet signature can be signed curbside at the title company, or a remote notary can meet borrowers at their existing residents. The JV is also piloting a remote online notarization capability beginning in the third quarter for homebuyers with conventional loans in our Arizona, Florida, Nevada and Texas divisions. This program will allow borrowers to sign all loan documents electronically. Our buyers' credit profile remains stable with an overall average FICO score of 720, which has been consistent over the past 5 years. Our first-time buyers who represented 58% of our deliveries in the second quarter, a slight uptick both year-over-year and sequentially, have an average FICO score of close to 710.

Turning our focus to our business model. We remain committed to build-to-order as we view it as the right approach for our company and one that buyers value. Build-to-order offer certain advantages that we find very compelling. First, we can align our business to demand and build to our sales pace. This allows us to minimize our spec starts and cash tied up in production, thereby mitigating inventory risk and managing capital outflows, both important tools, particularly as we navigate it through the uncertain conditions of the past 3 months. Second, in working from a large backlog of sold homes, we can manage starts to achieve even-flow production in our communities. This helps us to provide greater predictability on deliveries and margins with consistently higher margins on our built-to-order sales. And finally, we are proponents of giving homebuyers choice. Consumers value personalization and a studio process, and we saw evidence of this in the second quarter with a year-over-year increase in studio revenue per home. We have long believed that our build-to-order model is one of the primary drivers behind our sustained high absorption rates over the years. In fact, during the second quarter, our gross orders of personalized homes performed better than orders on inventory homes. With build-to-order representing roughly 75% of our business, we gained the benefits of this business model while maintaining adequate availability of homes available in each of our communities to meet the needs of buyers who want a quicker move-in.

In closing, while the second quarter posed numerous challenges, we emerged a stronger company as a result of the actions that we took and the efficiencies we gained, which have lowered our cost structure. Our balance sheet is strong. Our backlog is stable, and our net orders are modestly positive in the first 3 weeks of June. While our deliveries and revenues will end the year lower than we had originally planned, we are a more efficient and profitable business than we would have otherwise been, with a gross margin that is approaching 19% for 2020 ahead of last year. We are mindful of the risk present in the economy and that COVID-19 continues to pose, yet with our orders having normalized, we are working to restore our higher annual volume levels and intend to keep growing from there. We are encouraged as we look ahead to 2021 and the opportunity it provides. We look forward to updating you on our progress as we move through the balance of this year.

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

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Jeff J. Kaminski, KB Home - Executive VP & CFO [4]

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Thank you, Jeff, and good afternoon, everyone. I will now provide highlights of our financial performance for the 2020 second quarter. During the quarter, we navigated through a very challenging operating environment, generated improvements in many of our key profitability measures and continue to enhance our balance sheet strength and liquidity. In addition, with positive weekly sales trends in May and June that reflect progress on the path toward normalized activity in our served markets, we are providing forward guidance for the 2020 third quarter and full year. In the second quarter, our housing revenues totaled $910 million compared to just over $1 billion in the prior year period, reflecting a 10% decline in the number of homes delivered and a slight decrease in their overall average selling price. The lower deliveries and housing revenues reflected the severe COVID-19 pandemic-induced economic and social disruptions and related uncertainty during the quarter, which drove increased home purchase contract cancellations and slowed our delivery cycle.

We ended the second quarter with 5,080 homes in backlog as compared to the year earlier level of 5,927. Our ending backlog value was $1.9 billion, a decrease of 12% versus the prior year. Considering our quarter-end backlog, current construction cycle times and recent improvement in our net orders, we anticipate our 2020 third quarter housing revenues to be in the range of $820 million to $880 million. For the full year, we believe our housing revenues will range from $3.75 billion to $3.95 billion. In the second quarter, our overall average selling price of homes delivered was down slightly year-over-year to approximately $364,000. We anticipate an increased mix of deliveries from higher-priced communities will result in higher average selling prices in the second half of the year as compared to both the first half of the year and the year earlier period. For the 2020 third quarter, we are projecting an overall average selling price in a range of $395,000 to $400,000. We believe our ASP for the full year will be in the range of $385,000 to $395,000.

Homebuilding operating income decreased slightly from the year earlier quarter to $51.6 million. At the same time, homebuilding operating income margin increased 60 basis points to 5.7%. Excluding inventory-related charges of $4.4 million and severance charges of $6.7 million in the current quarter and inventory-related charges of $4.3 million in the year-earlier quarter, this metric improved by 140 basis points year-over-year to 6.9%, primarily due to improvement in our housing gross profit margin. The inventory-related charges for the current quarter were comprised of abandonment charges and mostly related to one land option contract in Texas. We had no inventory impairment charges in the quarter. For the 2020 third quarter, we expect our homebuilding operating income margin, excluding the impact of any inventory-related charges, will be in the range of 5.7% to 6.5%. For the full year, we expect this metric, excluding inventory-related charges and the second quarter severance charges to be in the range of 6.4% to 7.2%. Our housing gross profit margin for the second quarter was 18.2%, up 100 basis points from 17.2% for the prior year period. The current quarter metric reflected favorable impacts from the mix of homes delivered and lower amortization of capitalized interest, partly offset by reduced operating leverage due to lower housing revenues. Excluding inventory-related charges, our gross margin for the quarter was up 110 basis points year-over-year to 18.7%. Our adjusted housing gross profit margin, which excludes inventory-related charges as well as the amortization of previously capitalized interest, was 21.9% for the 2020 second quarter compared to 21.3% for the same 2019 period. Assuming no inventory-related charges, we expect a sequential increase in our 2020 third quarter housing gross profit margin to a range of 18.8% to 19.4% and further improvement in the fourth quarter. Considering this expected favorable trend, we believe our full year housing gross profit margin, excluding inventory-related charges, will be within the range of 18.6% to 19.2%, reflecting a 20-basis point year-over-year increase at the midpoint.

Our selling, general and administrative expense ratio of 12.6% for the quarter compared to 12.1% for the 2019 second quarter. Excluding the current quarter severance charges of $6.7 million, the SG&A expense ratio was 11.8%, a year-over-year improvement of 30 basis points due to reduced expenses for certain employee compensation plans, partly offset by decreased operating leverage from lower housing revenues. Due to the mid-May implementation of the workforce reductions, the related second quarter expense savings were not material. Beginning in the 2020 third quarter, we expect to realize annualized SG&A savings of approximately $25 million resulting from these unfortunate but necessary actions. In addition to the workforce reductions, during the quarter, we focused on achieving additional cost efficiencies across virtually all company-wide expense categories. Considering these actions and anticipated future revenues, we believe that our 2020 third quarter SG&A expense ratio will be in the range of 12.7% to 13.3% and our full year ratio, excluding the severance charges, will be in the range of 11.8% to 12.4%. Income tax expense for the quarter was $15.8 million, which reflected $3 million of favorable impacts with federal energy tax credits. We expect our effective tax rate for the remaining quarters of 2020 to be approximately 24%, excluding potential impacts from stock-based compensation. Overall, we reported net income for the second quarter of $52 million or $0.55 per diluted share compared to $47.5 million in net income and $0.51 per diluted share for the prior year period.

Turning now to community count. Our second quarter average of 247 decreased 2% from 252 in the year-earlier quarter. We ended the quarter with 244 communities as compared to 255 communities at the end of the 2019 second quarter, a reduction of 4%, primarily due to a decline in the number of active communities that were previously classified as land held for future development. As a result of the uncertain macro environment due to the COVID-19 crisis, we implemented actions early in the second quarter to preserve cash and enhance liquidity. As part of this effort, we moderated land investments, working with land sellers to extend the closing dates for certain planned land purchases as well as delaying some development activities. This resulted in a reduction in our investments in land, land development and fees during the quarter to approximately $230 million with $65 million of the total representing new land acquisitions. Despite our lower land spend, we ended the quarter with an ample supply of more than 60,000 lots owned and controlled with a 3.1-year supply of owned lots based on homes delivered in the last 12 months.

On a year-over-year basis, we anticipate our 2020 third quarter average community count will decline in the low single digits range as compared to the 2019 third quarter. We expect our average community count for the 2020 full year to be approximately flat year-over-year. Favorable operating cash flow in the quarter generated primarily from homes delivered, together with lower levels of land investment drove quarter end total liquidity to approximately $1.4 billion including $575 million of cash and $788 million available under our unsecured revolving credit facility. This compares favorably to both our 2019 year-end total liquidity of $1.2 billion and the $600 million of total liquidity at the end of the 2019 second quarter. We have had no cash borrowings under our $800 million credit facility at any point in time during 2020.

In summary, our focus during the quarter was on quickly adapting to the unprecedented disruptions and uncertainty caused by the COVID-19 pandemic and a wide-ranging public health efforts to control it. We made significant changes in our business practices and processes to help protect our employees, customers and business partners, while continuing to deliver essential shelter to our home buyers and implemented expense reduction and cash preservation initiatives. We ended the quarter with a stronger balance sheet, enhanced liquidity and a solid backlog value of over $1.9 billion. While we cannot predict the trajectory of the pandemic, the public health efforts to combat it or the magnitude or duration of the current recession, we believe that we are well positioned to continue to navigate through the housing market conditions we currently expect for the remainder of the year. We will now take your questions. Devin, please open the lines.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Truman Patterson with Wells Fargo.

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Truman Andrew Patterson, Wells Fargo Securities, LLC, Research Division - VP & Senior Analyst [2]

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First, I wanted to touch on your second quarter and June orders. They seem a little bit lighter than what we've heard in the market. So I'm hoping you all could just elaborate on this a little bit. It seems like maybe you were a bit more aggressive in scrubbing your backlog, maybe a bit more aggressive in closing communities, slower to reopen. I don't know if there was anything with the technological or video initiatives, just trying to understand or even if you think it's just the end markets, just trying to understand the moving parts there?

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Jeffrey T. Mezger, KB Home - Chairman, President & CEO [3]

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Well, Truman, you touched on a lot of them. When you shut your sales office down to protect your employees, you're not going to sell a lot of houses for that period. But I also think we did take an aggressive position on the backlog because we wanted to make sure as we're building homes that there's somebody that can perform when the home gets completed. And all that process and everything we went through was into April and early May. As we shared in our prepared comments, coming out of May, orders strengthened each week, both gross and net. And here in June, as we shared, we're at normalized levels. So I can't speak to comps versus other builders. Last year, our third quarter was the strongest orders per community we've had in many years. And right now, we're slightly ahead of that. So we actually feel good about our current sales pace.

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Truman Andrew Patterson, Wells Fargo Securities, LLC, Research Division - VP & Senior Analyst [4]

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Okay. Okay. Just a quick question on recent trends. In June, how are your incentives trending relative to March and April? Have they started to normalize? And then also from a demand standpoint, we're 3 -- a little over 3 weeks into June, how did the third week trend versus the first 2? Did it continue to improve? Or are you seeing possibly a slowdown in any of the markets that are starting to spike with virus cases again?

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Jeffrey T. Mezger, KB Home - Chairman, President & CEO [5]

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Okay. Well, you just -- you exceeded the 2 question limit, but I'll go ahead and answer them all. As I shared in the comments, sequentially through June, each week has gotten a little stronger. So we've seen no slowdown here in the month of June. Our -- as you know, we are not a big incentive-focused company, so we didn't do anything with incentives for the last 4 months. Our incentives are less than 1% of revenue. Because of the extraordinary nature of the disruption, it was an inelastic demand. So we didn't -- while we were working through trough and gross sales and working through the can rate, we didn't do anything to try to juice sales because we didn't think it would really make that much of a difference. We did share as, and most of it happened in May, but as our orders strengthened in May, we ended up raising prices in about 60% of our communities. So demand is solid. For all the reasons I shared in the comments, and we're seeing buyers that really want to come in and get a brand-new home today. So incentive is low. We're raising prices and our sales pace is right where we want it to be today.

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Operator [6]

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Our next question comes from the line of Alan Ratner with Zelman & Associates.

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Alan S. Ratner, Zelman & Associates LLC - MD [7]

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Glad to hear you're both doing well, and thank you for all the guidance and color. Appreciate it. First question, Jeff. I think early on, we heard from a lot of builders that the initial pop in demand coming out of the worst period of the pandemic, seems to be a little bit more focused on spec inventory, and you guys walked through your commitment to the to-be-built strategy. I'm curious as you look at the order improvement you've seen over the last several weeks, I would imagine you probably came out of April with a little bit more spec inventory than you typically have given the cancellations. So have you seen a greater share of orders or demand coming on those spec homes, understanding it's not a huge part of your business? Or has that improvement accelerated to the to-be-built business as well?

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Jeffrey T. Mezger, KB Home - Chairman, President & CEO [8]

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Yes. Good questions, Alan. Again, in my prepared comments, we were specific. The majority of the cans were on homes that hadn't been started yet. We did take some cans on homes that were under construction or completed. And for a very short period of the quarter, our inventory levels were up a little bit, just moderately up. And as I also shared in the prepared comments, during the second quarter, our gross orders on our to-be-built homes performed better year-over-year than gross orders on inventory. So even though our inventory levels were up moderately, our build-to-order mix of our business still outperformed. And as we sit here today, we always look at it as a percent of WIP. And our inventory as a percent of WIP right now is lower than it was at any point in the second quarter. So our challenge is to create more WIP. So we're working diligently now to get as many permits pulled and as many sold starts in the ground that we can that, frankly, we're frozen in April and the first half of May. So that's our focus. In the meantime, our build-to-order business is working very well.

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Alan S. Ratner, Zelman & Associates LLC - MD [9]

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Got it. That's helpful. I appreciate the extra color there. Second, I was hoping you can maybe just provide a little bit more information on your virtual home selling capabilities at this point? We've heard from some other builders that they've been pretty surprised at the willingness of shoppers who actually shop and even execute contract site unseen on homes completely online. And I'm curious if you guys have those capabilities. And if so, what percentage of your orders in May and June have come entirely virtually without a buyer stepping foot in the community?

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Jeffrey T. Mezger, KB Home - Chairman, President & CEO [10]

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I don't have the percentage at hand, Alan, but it's definitely similar to the trends you're hearing from other builders. I'm kind of old school, and I like the emotional side of home selling. You have to feel it and live it and touch it. But the new consumer, a lot of them are comfortable buying homes virtually. And so we sold a lot of homes virtually, and we're going to continue to tweak that. If you get on our website, you can see all the capabilities we now have. But I was also surprised that the willingness of buyers to finalizing the studio, virtually, which is an even more emotional part of it because it's the way they personalize their home. And there were weeks in the quarter, we finaled 200 customers all virtually online and through the studio process. And they are very comfortable there, and it didn't impact the sales per unit at all. So they're finalizing online. And it's actually caused us to reflect more here on how to refine our business model approach and leverage these virtual tools more. You can be more efficient, lower your overhead and keep or improve on your productivity with the customer, so we're pretty bullish on it.

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Operator [11]

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Our next question comes from the line of Stephen Kim with Evercore ISI.

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Stephen Kim, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Housing Research Team [12]

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I wanted to follow-up on the build-to-order versus spec dynamic a little bit here because I think that there's 2 ways in which the build-to-order strategy in this particular near-term or in this particular short-term window may have been hurting you. And I was curious if you could comment on whether you agree with that. On the one hand or on -- first off, on the cancellations, because the build-to-order strategy always makes it that you have a lot of homes you're selling that haven't been started. It's a lot easier, one would think, for the customer to cancel those. And because of the fact that they are doing a lot of options, there's a back and forth process, it may make it harder for you to sell virtually. So there's kind of 2 things, one that might affect your cancellations, the other one that might affect your gross orders negatively because of the build-to-order strategy. I was curious as to whether or not you think that is something that caused your results to be impacted this quarter versus, let's say, if you would pursue the spec strategy. And whether that is something that might, therefore, leave you more vulnerable if a second wave environment were to manifest again over the back half of the year?

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Jeffrey T. Mezger, KB Home - Chairman, President & CEO [13]

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Yes. Well, hopefully, we don't have to experience that again, Stephen. It's been very, very painful and this disruption that the industry has had to manage through is something I've certainly never seen in my career and, hopefully, nobody ever sees it again. It's -- you have to assume we lost some build-to-order sales when they couldn't even access the studio, couldn't go to the community and stand on the lot they were picking and all that. So I would assume we probably lost some sales there. I couldn't tell you how many. We didn't pick it up by selling a lot more inventory. That's why I shared the comments that I did. Our built-to-order sales performed better in Q2 than our inventory sales. And about 20% of our WIP is unsold at any one time. So the inventory was out there, our build-to-order is still -- the consumers telling us they value the choice proposition. And now that cities are more predictable and we can get starts and we can tell people when their home is going to be delivered, again, which we couldn't do in March and April, certainly. And there's consistency to it. In June, our build-to-order sales are right back to where they were before March 15 and are performing very well. So it may have been -- I couldn't tell you what the impact was for the 60-day disruption that we went through. But I do think over time, it's a far better business. And I think it's in part why we could hold our revenue as well as we did in the second quarter because the backlog wanted to move in. It was the most motivated backlog that I've seen in a long time where people were challenging us, "Hey, can I get in there." So we're still big proponents of this approach.

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Stephen Kim, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Housing Research Team [14]

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Yes. No doubt. And obviously, it shows up in your margins, which were good, too. The second question relates to the most recent information you've given about sales for the first 3 weeks of June, which are admittedly good, but also not particularly very different, well, certainly not better than what we've heard from some others. And maybe there's some positive bias to what kind of made to news, but it seems that, that number is kind of what you would expect maybe a little light is the way I'm feeling and a lot of investors are reacting to it. But given the amount of cancellations that you had had, I kind of would have thought that you would have had a lot of return business on top of the -- just the general improvement in the overall market, that you guys would get kind of like a double boost. And that, therefore, your June numbers and maybe July, from these returning customers, will be additive to the new customers that would wander in the door. You said that you saw some of those cancellations return. I was curious if you could give us a little more color on that, whether it's as much as you would have expected or not?

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Jeffrey T. Mezger, KB Home - Chairman, President & CEO [15]

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Well, I think some is an appropriately generic comment, Stephen. We've seen some come back. But these people they canceled, where you lost your job. You have to get a job back to come back and buy from us again. So while it's, I'll call it, a repeat customer because they come back, it's really a new customer because they're employed again and you start over. So I don't know that -- you still have a lot of people that are furloughed, where it's a question mark, and who knows what will happen with that group. But if our sales in the third quarter ended up in the range of where they're at right now compared to last year, on a lower community count, we'd be pleased with the selling results.

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Operator [16]

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Okay. Our next question comes from the line of Matthew Bouley with Barclays.

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Matthew Adrien Bouley, Barclays Bank PLC, Research Division - VP [17]

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I hope everyone's doing well. So I wanted to ask about, I guess, sort of with the benefit of hindsight and seeing the market come back as quickly as it did. Obviously, you guys took a lot of these proactive steps around closing communities and scrubbing the backlog and pausing land development and acquisition. I mean, going forward, if there is, I mean, an unfortunate situation of a second wave or just simply rolling lockdowns, look at the headlines today, I think this is worth addressing that the question is, would you take any more of a risk on approach reacting to future shutdowns or at least act differently in any way?

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Jeffrey T. Mezger, KB Home - Chairman, President & CEO [18]

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As I reflect on the last 90 days, we put our employee safety first, and it was the right thing to do. And the experience we've had with COVID cases in our company reinforces that we did the right thing because we've been very fortunate within the KB Home team with everybody's health and well-being. We took the steps on the overhead reduction. We're not -- even though you see this quick recovery in demand, we're not quickly going back and adding the overhead back in. It's a pedal and break. So we'll keep moving it along as things continue to look okay. We'll keep get a little more aggressive. But if it turned down, we've already taken the steps to deal with the turndown. We have plenty of liquidity. We are comfortable with our cash position. We may slow down land spend again if things turn down. But I think we -- as a company, we're more efficient today. We're smarter, and we're better positioned than we were in March. So if a second wave hit, I think we're already there.

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Matthew Adrien Bouley, Barclays Bank PLC, Research Division - VP [19]

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Got it. Okay. And then just secondly, I wanted to drill in on the cancellations a little. And just I guess, wondering if you could elaborate any further on some of those efforts that you called out, and particularly the employment status of buyers, and you mentioned the financing availability as well. Do you have any ability to quantify how much each of those contributed to the cancellations? Or I mean, really, the question going forward is, given where employment is, is there any further risk from that as you look at the current backlog as it stands?

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Jeffrey T. Mezger, KB Home - Chairman, President & CEO [20]

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I don't -- I would say that the percentage that was tied to financing was very limited. It's people where their income dropped because they're no longer working overtime or their job scope changed or they're no longer getting tip income if they're working at a casino in Vegas because they were closed. And so their income dropped, and that would affect their ability to qualify. But other -- the largest driver was people that either lost their job or have a long-term furlough. So -- and I don't sense that there's another wave of unemployment hitting today. And as we monitor the cans each week, we're not seeing that kind of a driver anymore. Now it's the normal nuts and bolts cans, I'll call them, versus the intensity of last job and furlough. So I don't think we'll see that again unless there was a severe downturn that hit the economy, and we're not expecting that right now.

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Operator [21]

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Our next question comes from the line of Buck Horne with Raymond James.

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Buck Horne, Raymond James & Associates, Inc., Research Division - SVP of Equity Research [22]

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I just want to start making back up to like the revenue guidance for third and fourth quarter and the backlog conversions. And it does seem reasonably conservative, at least my first glance here, and I'm just wondering if some of that relates to -- are you seeing cycle times extend here in the field? Are there some bottlenecks that could be lasting in the construction process? And what are you seeing out there, whether it's around the safety protocol or labor shortage or land availability, I don't know if you can highlight just -- or is that just reasonable conservatism in the guidance in terms of how you see the backlog converting from here?

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Jeffrey T. Mezger, KB Home - Chairman, President & CEO [23]

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Yes. Buck, it's -- if you split the components of cycle time, our time from contract to start has lengthened because a lot of cities are still having to sort through the permit process. So in the old days, if it was 30 days to start, it's longer than that now, 45 days or whatever. The build times actually in the quarter were down a few days. And we're continuing to work with our contractors to see if we can compress build times going forward. I think you'll see the delays in construction hit in the third quarter because of our pause on production, not because the subs weren't out there or we couldn't get things done. The subs have quickly rallied around going to work and figuring out how to build homes with only 1 contractor in the home at a time. And if you think about the build time, the majority of the days are in foundation frame, getting it under roof. That's where all the days are. And in that part of the process, there's typically only 1 contractor on the site anyway. There's only a framer there. The plumber has to go in or the HVAC guy. They're the only ones there at that time. So you're -- where you're limited now is in the finish and if the electrical trim was going in at the same time as the plumbing trim, which on their own are each 1 day. So now it's 2 days instead of 1 day on the other end. So incrementally in the build time, we have figured out how to hold build times while ensuring that our contractors are safe. There's been a couple of days added on the post completion cycle time because the lenders are looking for more employment verifications right before the closing or the fundings and things like that. So the -- if you look at what we call our cycle time, it's costing us time on the start, and it's costing us a couple of days after the home is completed. The portion in the middle, we're doing fairly well.

The backlog conversion, getting back to that is, our build times, we think, are pretty normal right now for us. But when you stop production for 4, 5, 6 weeks, whatever the time frame was, when you reset it, you don't just flip a switch and everything starts the next day. First, you have to get your homes that were sheetrock moving again, then you go back to your frames, then you go back to your foundations. Until you clear the foundations, you have a lot of starts to go that you don't put in the ground until you clear the foundation. So our backlog at the end of May at a higher percentage that hadn't started yet. And those are the ones we're just now getting in the ground, and we don't think in some cities that we'll be able to deliver them in November. So it's a WIP pressure that we have that we're trying to power through right now.

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Buck Horne, Raymond James & Associates, Inc., Research Division - SVP of Equity Research [24]

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That's really helpful. I appreciate all that. So let me ask you a little bit on the demand and kind of the uptick we're seeing here recently. And if you've gotten any center ability to characterize where it's coming from? Whether or not -- are we getting a tangible sense that more first-time buyers are showing up, whether they're former apartment renters or are you seeing more cross-market or out-of-market demand from people actually migrating to more affordable locations? Any characterization you can give to this uptick in demand each week?

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Jeffrey T. Mezger, KB Home - Chairman, President & CEO [25]

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Well, I do think that there's some of the resetting of where people live. Like up in the Bay Area, a lot of the tech companies have already announced that you can work-from-home permanently. And if you can work from home, why would you stay in San Jose, if you can live in Sacramento for half the price and still do your job. So I do think there's a little relocation going on for the group of employees that can permanently work from home. And we'll see how that plays out. We are seeing some relocation again from 1 state to another. Texas and Florida are big benefactors of influx right now. Other than that, it's fairly broad-based. Our first-time buyer in the second quarter was the highest we've seen in a long, long time, and it was definitely up year-over-year at 58%. So I would say that buyer, it's a well-heeled first-time buyer with a 710 FICO that has good employment today.

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Operator [26]

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Our next question comes from the line of John Lovallo with Bank of America.

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John Lovallo, BofA Merrill Lynch, Research Division - VP [27]

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First one is on gross margin and just sort of the sustainability of the positive mix and pricing that we're seeing. I know there is also some benefit from lower amortization. But I'm just wondering how sustainable the mix portion, particularly is? And then is there anything on the input side, maybe in materials that are benefiting as well here?

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Jeff J. Kaminski, KB Home - Executive VP & CFO [28]

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Yes. I'll take that in segments, I guess. First, talking about the amortization. There's -- we do expect to see some continuing benefit from lower amortization on a year-over-year basis. That was part of what we included in the guidance for the third quarter. Of course, we're losing a little bit of leverage on lower volumes, but we'll pick up most of that, frankly, through lower amortization. On the mix side, it was a little bit split. I mean, we had -- we still have a bit of a continued tailwind from the lower percentage of reactivated deliveries that we're seeing. And at the same time, a higher gross margin within that category. So we've seen gross margins improve in that category, and we've seen the category reduce overall as a percentage of the total. So that helped us -- about half the mix uptick in the quarter was actually just from that. And we do expect to see that again in the third quarter. So it's much the same as what we just saw. It will tick down in operating leverage, some positive on the amortization side and certainly some positive on the mix side. And we think it will be pretty consistent with what we just saw in the second quarter leading into the third, and then onward into the fourth, empowering through some decent gross margin improvement considering the current conditions.

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John Lovallo, BofA Merrill Lynch, Research Division - VP [29]

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That's helpful. And then maybe just on the homebuilding equity income. Looks like there is a nice game there, looks like about, I don't know, maybe $0.06 or $0.07 in the quarter. What drove this? I imagine it's more onetime in nature.

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Jeffrey T. Mezger, KB Home - Chairman, President & CEO [30]

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You're talking about the joint venture income fee?

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John Lovallo, BofA Merrill Lynch, Research Division - VP [31]

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Yes.

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Jeff J. Kaminski, KB Home - Executive VP & CFO [32]

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We have a project in the Bay Area that delivered quite a few units in the quarter, and that was the driver from it. We have a few more units to deliver in the third and then on into the fourth quarter. We don't expect the quite as much -- quite as much income coming from it in the third and fourth, but it's basically a single high-value project, a very profitable project in the Bay Area.

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Operator [33]

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Our next question comes from the line of Mike Dahl with RBC Capital Markets.

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Michael Glaser Dahl, RBC Capital Markets, Research Division - MD of U.S. Homebuilders & Building Products [34]

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Wanted to go back and kind of follow-up to a question about prior around actions kind of taken in March, April, and some earnings from that. But I wanted to focus specifically on safety since from a community and a design center standpoint, you guys did act fairly aggressively and proactively. So just, I guess, in light of some of the upticks in cases across your core footprint today, can you describe kind of how you're from a sales, from a community and a design center standpoint, how your safety measures are today? And how you plan to approach those in light of some of these recent upticks?

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Jeffrey T. Mezger, KB Home - Chairman, President & CEO [35]

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Good question. And we've been pretty diligent in ensuring that we're in full compliance with either CDC or each local set of standards. And in a lot of the cities we're in, the standards have been more rigorous -- made more rigorous the last week or 2. But it's things that we were fundamentally already doing, like, okay, everybody should wear a mask. Well, our employees were already wearing mask and we have masks available for our customers as well. It's now a little more rigorous in the wording. So hopefully, the general public is more diligent and wear a mask right now. But our standards are already there. So if cases pick up 1,000 a day across all of California, it's -- it won't change our standards. If they really got elevated from there, we'll be sensitive to it and take the appropriate steps. We're continuing to focus on the health and well-being of our customers and our employees.

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Michael Glaser Dahl, RBC Capital Markets, Research Division - MD of U.S. Homebuilders & Building Products [36]

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Okay. And my second question, just on the pricing front. And I think, Jeff, you mentioned the 60% of communities in your opening remarks for -- I thought it was for the quarter. And then in response to another question, I think you said that was maybe a May-specific comment. I just wanted to clarify when you think about kind of pricing trends in the quarter and how many and when you were raising prices in communities. Was that a May-specific comment?

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Jeffrey T. Mezger, KB Home - Chairman, President & CEO [37]

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Well, there was probably some in late April. There was none in early April. But it was weighted to the back half of the quarter, certainly, and most of it in May, because the sales pace was right there, and let's take advantage of the demand.

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Operator [38]

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Our final question comes from the line of Michael Rehaut with JPMorgan.

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Margaret Jane Wellborn, JP Morgan Chase & Co, Research Division - Analyst [39]

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This is Maggie on for Mike. First, and I apologize if I missed this, but I was wondering if you could talk through how the rebound in demand has played out in your different buyer segment? I know that you called out the first time buyer, but I was hoping you could give a little bit more color around that?

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Jeffrey T. Mezger, KB Home - Chairman, President & CEO [40]

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Well, Maggie, the mix has been pretty consistent. First-time buyer is up 3 or 4 percentage points from the last several quarters. And the first move-up is where it has moved down a couple of points, and our active adult over 55 buyer has held pretty steady. So I think the resurgence in demand is pretty broad-based right now. I don't think it's just first-time buyers. I do think when you get to the highest price points, it's probably a little more discretionary right now, but people that want to be in a home for first time or the first move-up or an empty nester that's relocating to a small new home, I think those -- all those buyer profiles are pretty strong right now.

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Margaret Jane Wellborn, JP Morgan Chase & Co, Research Division - Analyst [41]

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Got it. And second, in terms of the drivers of the recent uptick in demand, I think you've already called out some buyers returning and some relocation as more people are working from home. But to what extent are you thinking about these as kind of temporary drivers of demand and maybe kind of a release of some pent-up demand versus a return to more normal sales environment and kind of a longer term trend?

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Jeffrey T. Mezger, KB Home - Chairman, President & CEO [42]

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Well, I do think there's still pent-up demand because the country shut down in the strongest selling period of the year. The demographics didn't go away. And I think the headline employment -- unemployment numbers are not necessarily homebuyers. It's low level wage service employees or whatever. So there's a lot of demand out there from the demographics and the people that are employed, and there's no inventory. Then you add on to that, people want a new house, it's healthier, it's safer. There's -- you read it in the media every day, where they're talking with people that don't want to buy used. They want to buy a brand-new home now. And then you throw on top of it, that people want to get to a little less dense situation. So there's a lot of things pushing the demand side right now that I think could be structural shifts in favor of the industry.

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Operator [43]

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Ladies and gentlemen, this concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation, and have a wonderful day.