Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

KB Home (NYSE:KBH)

F3Q09 Earnings Call

September 25, 2009 11:30 pm ET

Executives

Jeffrey T. Mezger - President, Chief Executive Officer, Director

William R. Hollinger - Senior Vice President, Chief Accounting Officer 0x08 graphic

Kelly K. Masuda - Senior Vice President, Treasurer

Raymond P. Silcock - Chief Financial Officer, Executive Vice President

Analysts

Michael Rehaut - JP Morgan

Ivy Zelman - Zelman & Associates

Steven East - Pali Capital

Kenneth Zener - Macquarie Research

David Goldberg - UBS

Jim Wilson - JMP Securities

Megan Talbott McGrath - Barclays Capital

Joshua Pollard - Goldman Sachs

Nishu Sood - Deutsche Bank

Alex Barron - Agency Trading Group

Susan Berliner - J.P. Morgan

Operator

Good day, everyone and welcome to the KB Home third quarter earnings conference call. As a reminder, today’s conference is being recorded and webcast on the KB Home website at kbhome.com. The recording will also be available via telephone replay until midnight on October 5th. You can access this recording by dialing 719-457-0820, or 888-203-1112 and entering the replay pass code of 3439284.

KB Home's discussion today may include certain predictions and other forward-looking statements that reflect management’s current expectations or forecasts of market and economic conditions and the company’s business activities, prospects, strategies, and financial and operational results. These statements are not guarantees of future performance and due to the number of risks, uncertainties, and other factors outside its control, KB Home's actual results could be materially different from those expressed in or implied by the forward-looking statements. Many of these risk factors are identified in the company’s filings with the SEC, which the company urges you to read with care.

And now for opening remarks and introductions, I would like to turn the conference over to KB Home President and Chief Executive Officer, Mr. Jeffrey Mezger. Please go ahead, sir.

Jeffrey T. Mezger

Thank you, Kelsey. Good morning. I would like to thank you for joining us today for a review of our 2009 third quarter results. With me this morning are Bill Hollinger, our Senior Vice President and Chief Accounting Officer; and Kelly Masuda, our Senior Vice President and Treasurer. I would also like to welcome our new Executive Vice President and Chief Financial Officer, Ray Silcock, to this call.

We are pleased that Ray has joined our team and I know he looks forward to working with you in the coming months.

During this call, I will discuss our third quarter performance and the progress we are making in managing our business to restore profitability. After Bill gives his review of our financial results, I will have some closing comments and then we will open up the phone lines for your questions.

While the direction of the housing market remains uncertain, KB Home's business model is producing favorable results. By staying focused on specific and measurable ways to improve our operations, we are making progress on gross margin, SG&A, and in our sales rates. In the third quarter, we significantly narrowed our net loss on a year-over-year basis, continuing the favorable trends in our gross margin, SG&A, and impairment charges that we reported in the first two quarters.

During the quarter, we also generated substantial growth in our net orders, largely due to the success of our new product line. By continuing to execute on our strategies, we believe we can achieve the important objective of restoring profitability and position our operations for opportunities we believe will arise as markets improve.

During the third quarter, net orders rose 62% year over year as buyers continue responding positively to our new product line, which we have branded the open series, and our cancellation rate continues to improve.

We have strategically designed the open series homes to match the wants and needs of today’s home buyer at a price that is competitive with resale and foreclosures and have introduced the product nationally. This resulted in third quarter order strength across all of our regions, including California, Arizona, Las Vegas, and Florida, which have all been heavily impacted by foreclosures.

With the open series becoming a larger percentage of our homes delivered and competition in our markets continuing to exert downward pressure on prices, our average selling price decreased by $37,000 year over year to $203,000, while at the same time our housing gross margin increased by more than 700 basis points. As a result, our progress in reducing construction costs and gaining operating efficiencies has generated four straight quarters of year-over-year gross margin improvement.

Our demonstrated ability to maintain or increase margins while reducing prices is a tangible result of our product transformation and has positioned us to successfully operate in housing markets facing downward pricing pressures.

We are pleased that our SG&A dropped by 37% year over year, as we continued to identify new opportunities to do more with less. However, as well as we have done in reducing our costs to operate the business, we still have more work to do. Along the way, we will remain focused on retaining the growth platform and operational capability necessary to be opportunistic when markets stabilize.

Our primary objective remains restoring profitability and our third quarter results show real progress. We cannot control the macro environment but we can control how we respond to what I refer to as the new normal within today’s housing markets and we believe the best way to respond to this new normal is to continually enhance the execution of our business model in order to be fully optimized for housing markets that we expect will remain challenged.

While recent new home and resale figures show some encouraging trends, the precise timing of a housing recovery remains uncertain. We expect the early stages of a recovery will be uneven, with some inevitable setbacks before reaching stability. The recovery will also be market specific with some markets achieving price stabilization and reduced inventory levels ahead of others.

Foreclosures and unemployment continue to be the principal drivers influencing stability in each market. Many reports project that foreclosures will continue to inflate total housing inventory in the coming months and may even accelerate from the current rate. Also, it will be difficult for the housing sector to build significant momentum as long as potential homebuyers lack the job security needed for them to make a major purchase.

Due to this continued market pressure, staying competitive with foreclosures and resale’s, and offering payments that are in many cases lower than monthly rent, remains a top priority.

Our product transformation is key to KB Home's continued success in operating in this environment. In fact, in many sub-markets, favorable buyer reaction to the open series has allowed us to increase prices. This response has also given us a more normalized sales pace in our communities so we can underwrite new land deals with greater confidence. Although we have not seen capitulation on land prices in every market, we are beginning to see more land deals that make economic sense in the current environment. As a result, we increased our land acquisition activity in the third quarter from the second quarter, securing lots in all regions. We remain patient and deliberate in pursuing land opportunities, however, only securing lots that are aligned with our product strategy and which meet our return hurdles.

For the most part, we have been targeting finished lots with rolling options and minimal deposits. This allows us to stay conservative with our cash while expanding our growth platform, giving us more flexibility to add revenue and accelerate our return to profitability.

A significant takeaway from this quarter should be that KB Home is increasingly well-positioned to compete in today’s housing market. The reason we have this capability can be traced to many of the strategic decisions we made as housing markets began to turn and the impact of those decisions is starting to become even more apparent.

To begin with, we recognize the need to strengthen our balance sheet as a buffer against the financial impact of rapidly deteriorating housing markets. We continue that imperative today by steadily reducing housing inventory, lowering debt, and protecting our cash. Because of the careful watch we keep on our balance sheet, we are comfortable reiterating our projection of being cash flow positive from operations in 2009.

With a strong balance sheet, we were in a better position to fundamentally improve our operations. We began by focusing on the demographic we wanted to serve and re-emphasizing KB Home's historic core market of first-time homebuyers. In 2006, first-time buyers accounted for less than 40% of our deliveries and that figure has now risen to approximately 80%.

To attract first-time buyers, we knew we needed a different kind of product which combined livability, affordability, and innovative design. On our earnings call a year ago, I outlined the principals of what we ultimately called the open series which we formally launched in the first quarter of 2009.

What was literally on the drawing board in the summer of 2008 is now being offered to customers in volume. I can now confirm our initial projection that the open series will account for more than 50% of all homes delivered in the fourth quarter and we expect this positive trend to continue in 2010.

I believe this kind of operational speed is nearly unprecedented for a product as complex as a new home and is a direct reflection of the strength of our company-wide KB Next business model.

What some may fail to grasp about our new product line is that it’s success has been possible only because of our built-to-order customer experience. We offer homebuyers a very compelling starting price on the home design of their choice, then give them the opportunity to choose exactly where and how they want to spend their budget dollars, such as extra space through our flexible floor plans, structural options, custom design features at the KB Home studio, and much more. We further differentiate our product from resales, foreclosures, and spec homes through our comprehensive commitment to building Energy Star qualified homes. These homes put more money in the customers’ pocket through lower monthly utility costs and they also reflect the buyers’ personal environmental consciousness.

In addition, we continue to be the only national builder whose nationwide construction operations are certified by the NAHB’s national housing quality program.

Our value engineered product, combined with disciplined operational execution, has also enabled us to steadily compress build times. Since 2006, we have taken 50 days out of our build time, which is more than a 35% reduction, and another 25 days out of the time between the sale and the start of construction.

Some of the most dramatic reductions have occurred in the markets where the open series is now our predominant product as another proof point behind our product transformation strategy. We are now down to four-and-one-half months between contract and close on a built-to-order home in many markets, which represents a significant improvement from the six-month timeline that has historically been part of our business model.

From a financial perspective, the reduction in our build time is consistent with our asset-light strategy by lowering our risk and carrying cost and helping us convert backlog into revenue more quickly. It also makes us more competitive with resales and spec homes as we narrow the gap between the time it takes to buy a used home and the time it takes to buy a home that is built to order.

Today, approximately 90% of our homes under construction are sold and we remain committed to our built-to-order business model.

We clearly have improved our operation substantially over the past three years with some of the most impactful changes occurring in just the past 12 months. We have the right product lines for the times and are in the markets we believe offer us considerable opportunities. Above all, we are a far more nimble company than before, which positions us very well for the realities of today’s dynamic housing markets. This has been possible only through the commitment and creativity of the entire KB Home team and I would like to take this opportunity to thank them for their performance during the quarter and throughout 2009.

We remain cautious given the considerable uncertainty that surrounds the housing markets and the economy as a whole, although we believe we can ultimately achieve our strategic objectives. We will continue our relentless focus on business execution with the goal of restoring profitability and look to continue our momentum as we close out the year and head into 2010.

Now I would like to turn the call over to Bill to discuss our financial performance in more detail. Bill.

William R. Hollinger

Thank you, Jeff. Good morning, everyone. Our third quarter results demonstrate that as we continue to execute on our strategic initiatives, we are moving our financial results in the right direction. Just as in the first three quarters of the year we significantly narrowed our net loss from the year earlier quarter largely through the success of initiatives that have expanded our housing gross profit margin, lowered selling, general, and administrative expenses, and reduced the need for asset impairment and land option contract abandonment charges.

We achieved this improvement despite having delivered fewer homes at a lower average selling price and posting lower revenues for the period. In each quarter of 2009, we have advanced closer to our goal of profitability and we are more determined than ever to get there.

Now let me take you through our third quarter financial highlights, starting with the top line.

Our homebuilding revenues in the period totaled $456 million, down 33% from the third quarter of 2008 as a result of lower housing revenues. The year-over-year decline in housing revenues reflected a 20% decrease in the number of homes delivered, largely due to our reduced community count, and a 15% drop in the average selling price. Most of the decrease in homes delivered occurred in our Southwest and Southeast regions, where the number fell 26% and 47% respectively. In our West Coast region, the number of homes we delivered was down only 8% from a year ago while in our central region, the number actually increased by 5%.

The decline in our average selling price to $202,800 in the third quarter reflected decreases in each of our geographic regions, ranging from 13% in the West Coast to 28% in the Southwest. In addition to pricing pressure from competition, we saw our third quarter average selling price reduced by the higher proportion of homes we delivered from the open series which are designed to have lower price points. Sequentially, our average selling price was down 6% from the second quarter of 2009 and it will likely trend down again in the fourth quarter.

Despite the decline in the average selling price, our housing gross profit margin increased to 11.1% in the third quarter from 3.9% a year ago. This 720 basis point improvement occurred despite $16 million of charges for inventory impairments and abandonments in the quarter. In the third quarter of 2008, our inventory impairments totaled $39 million.

Excluding inventory valuation charges, our housing gross margin increased by 500 basis points to 14.6% in the quarter from 9.6% a year ago. As Jeff mentioned, this marks the fourth consecutive quarter that excluding such charges, we have generated year-over-year expansion in our gross profit margin.

On a sequential basis, we increased the gross margin by almost 200 basis points from the 12.7% in the second quarter of 2009.

These housing gross profit margin improvements confirm that we are making meaningful progress in our pursuit of profitability in our homebuilding operations. They are the direct result of our efforts to introduce more competitive product, reduce our cost of build, and enhance operating efficiencies. They also reflect the impact of impairments we were required to take in previous quarters. We currently anticipate year-over-year and sequential gross profit margin comparisons to improve again in the fourth quarter as the open series becomes a larger proportion of our homes delivered.

On another note, during the third quarter of 2009, we identified approximately 140 homes, primarily in Florida, and delivered principally in 2006 and 2007 in which certain sub-contractors installed allegedly defective drywall manufactured in China.

We currently estimate the repair costs will total about $10 million and consequently recorded a charge of $6 million in the third quarter to increase our warranty liability. While we intend to seek reimbursement from various sources for these costs, we have not yet recorded any amounts for potential recoveries due to the early stage of this matter.

We continue to review whether any additional homes may contain this drywall material. Our chief concern in this situation is for the welfare of our homebuyers and the repair of their homes.

Turning to our selling, general and administrative expenses, we reduced these expenses by $49 million, or 37% from the year earlier quarter. Some of the savings resulted from lower variable expenses, such as sales commissions and closing costs that are tied to the volume of homes we deliver. The remainder related to fixed expenses down largely due to lower salary and other payroll related expenses, the result of a 31% year-over-year reduction in our workforce and rigorous cost reduction actions we have taken.

Overall in the third quarter of 2009, our SG&A expenses as a percentage of housing revenues improved to 18.5% from 19.1% in the second quarter of 2009 and 19.9% a year ago.

Generating improvement in our SG&A expense ratio has been challenging due to the steep decline in our revenues. As discussed on previous calls, we continued to concentrate on reducing this percentage while maintaining a long-term strategic view of our business. Although this strategy puts some upward pressure on our expense ratio in the short-term, we believe it is beneficial for us to maintain a team and an infrastructure that can support growth when the housing markets recover.

Results from our homebuilding operations improved significantly in the third quarter with a $66 million reduction in our operating loss relative to a year ago. Our homebuilding business generated an operating loss of $42 million in the current quarter including charges of $24 million for inventory impairments and land option contract abandonments. In last year’s third quarter, our home-building operations posted an operating loss of $108 million, including $39 million of inventory related charges.

Our homebuilding operating margin improved to a negative 9.2% in the third quarter of 2009 from a negative 15.9% a year ago. This represented a year-over-year expansion of 670 basis points.

Evidence that our home-building operations are edging closer to break-even is even more apparent if we exclude inventory valuation and abandonment charges. Excluding such charges from both periods, our homebuilding operating loss would have been $18 million in the current quarter versus $69 million a year ago, an improvement of $51 million or 74%.

In the same light, our homebuilding operating margins would have improved by 620 basis points to a negative 3.9% in the current quarter compared to a negative 10.1% a year ago. In addition to this year-over-year improvement, our homebuilding operating margin also compared favorably to the negative 6.3% margin posted in the second quarter of 2009. The recent trends in our homebuilding results illustrate that the improvement in our overall results is being driven by our operation and underscores the real progress we have made.

With regard to interest, our third quarter net interest expense increased $11 million compared to the prior year. Our interest income decreased $6 million from the year earlier quarter largely due to a shift to safer government guaranteed investments that delivered lower yields.

On a combined basis, our loss on early redemption of debt and interest expense increased by $5 million year over year, largely due to the reduction in our inventory qualifying for interest capitalization. In the third quarter of 2008, we were able to capitalize all of our interest incurred.

We expect to continue to recognize interest expense for the foreseeable future as we anticipate our debt level to exceed the amount of assets qualifying for interest capitalization.

Our pretax loss of $77 million in the third quarter of 2009 was down 49% from the year-earlier quarter. Included in the current quarter loss were $48 million of charges related to inventory and joint venture impairments and land option contract abandonments, which decreased 42% from the $82 million of similar charges a year ago.

Moving to the bottom line, we generated a net loss of $66 million or $0.87 per diluted share for the third quarter, cutting our net loss by 54% from the $145 million, or $1.87 per diluted share we reported in 2008.

The decrease in our impairment charges reflected our lower inventory base and the substantial impairment and abandonment charges we have already incurred, along with the favorable response to the open series product line.

We hope the requirement for future impairment charges will continue to diminish primarily because of our reduced inventory balance and the leveling out of market conditions. The expansion in our housing gross profit margin, the reduction in our selling, general, and administrative expenses, and our diminishing need to record impairment and abandonment charges all significantly contributed to the improvement in our financial results for the third quarter. While we do not expect the operating environment to change radically through the end of the year, we hope to continue the favorable trends in the fourth quarter.

Moving on to the balance sheet, our liquidity at the end of the third quarter totaled $1.5 billion, including $1.1 billion of cash and cash equivalents and the amount of credit available under our bank revolver. This substantial level of liquidity is consistent with our careful focus on generating and preserving cash. We generated $30 million of positive cash flows from our operations during the third quarter.

Outside of operating activities, we used cash to invest in some of our existing joint ventures and to pay down debt, which resulted in an overall net decrease of $42 million in our cash balance from the end of the second quarter.

As mentioned on last quarter’s call, we believe we are on track to product positive cash flow from operations in the fourth quarter and full year that will bring our total cash and cash equivalents to more than $1.1 billion at year-end. Furthermore, we do not anticipate borrowing under our $650 million bank revolver for the remainder of the year.

Turning to inventory, we ended the third quarter with a balance of $1.9 billion, down 25% from a year ago. Our inventory balance at August 31, 2009 was relatively flat with the end of the second quarter, even though we consolidated certain joint ventures that previously had been unconsolidated. However, we expect our inventory balance at the end of the year to be down from the third quarter level.

At August 31, 2009, we owned 31,100 lots, or 77% of our total lot inventory and controlled 9,200 lots or 23% of our total VIA land option contracts. Our total lot count was down 24% from the third quarter of 2008.

We ended the third quarter with 3,546 homes in production, down 32% from last year’s third quarter. About 9% of these homes, some 327, were unsold. That is a reduction from the second quarter of 2009 when 12% of our homes in production were unsold.

It is also down from last year’s third quarter when 18% of our homes in production were unsold.

In addition, we reduced the number of finished unsold homes in inventory to 130 at the end of the third quarter from 142 at the end of the second quarter and 481 a year ago. At August 31, 2009, we had less than one finished unsold home per community.

Regarding our unconsolidated joint ventures, for several quarters now we have actively monitored and evaluated each of our joint ventures to determine the best course of action. During the third quarter, we eliminated three joint ventures through consolidation or termination of the entity. As a result, we ended the third quarter with $172 million invested in 16 joint ventures compared to $250 million invested in 30 joint ventures a year ago.

Over the past year, we have made substantial headway in reducing our unconsolidated joint venture investments and the underlying joint venture assets and debt. At August 31, 2009, our unconsolidated joint ventures held assets of $996 million, down 56% from a year ago and debt of $562 million, which represented a decrease of 61% from the $1.5 billion last year.

We will continue to monitor our unconsolidated joint ventures and currently expect further reductions in the coming quarters. At the end of the third quarter, we had deferred tax assets totaling $946 million that were almost entirely reserved. While the deferred tax asset valuation allowance is a non-cash item, it does impact our balance sheet and book value.

At August 31, 2009, our deferred tax assets equated to more than $12 of book value per share.

Turning to our capital structure, we ended the quarter with total debt of $1.8 billion, up $101 million from the second quarter of 2009, mainly due to the consolidation of certain joint ventures that previously had been unconsolidated. Despite this increase, we remain focused on lowering our debt level and we will endeavor to reduce this additional debt as prudently as possible.

The majority of our debt, $1.7 billion, consisted of well-[lettered] senior notes with maturities extending through 2018. Our next senior note maturity of $100 million occurs in 2011, followed by $250 million of senior notes due in 2014.

Our debt net of cash was $755 million at August 31, 2009, down $180 million from a year earlier period. Despite this year-over-year reduction, our net debt to total capital ratio increased to 55.2% at August 31, 2009 from 45.2% a year ago, reflecting the decrease in our book equity as a result of the losses generated and impairments incurred. Given the cash we expect to generate from the operations in the fourth quarter and our projection of more than $1.1 billion in cash and cash equivalents at fiscal year-end, we anticipate that our ratio of net debt to total capital will remain flat or improved slightly by year-end.

We had no borrowings under our revolving credit facility at August 31, 2009 and remain in compliance with all covenants associated with this facility. Before turning the call back to Jeff, let me briefly comment on our outlook -- approaching our fiscal year-end, we would describe our short-term view of the future as cautiously optimistic yet we believe the long-term prospects are excellent.

For now, many factors, including unemployment and foreclosures, remain outside of our control and continue to weigh on the housing markets. Nevertheless, we can and will continue to seek out improvements with our operations to manage through the downturn, restore profitability and position KB Home for the future. This includes keeping a carefully eye on our financial position to ensure that we maintain the strength and flexibility necessary to meet current needs and take advantage of potential opportunities ahead.

All of us at KB Home are energized by the progress we have made this year both operationally and financially. We intend to build on our positive momentum with additional progress in the fourth quarter, particularly with respect to our highest priority, restoring the profitability of our homebuilding operations. While our homes delivered, average selling price and revenues will very likely remain below year-earlier levels in the fourth quarter, we expect to produce a sequential and year over year improvement in our housing gross profit margin once again. Furthermore, we anticipate that we will further leverage additional savings in our selling, general and administrative expenses and expect our impairments and abandonments to be down from last year. As a result, we currently believe that all these factors combined will produce further improvement in our operating results, delivering our strongest quarterly performance for the year.

Now let me turn the call back to Jeff for some closing thoughts.

Jeffrey T. Mezger

Thanks, Bill. KB Home continues to see many positive results from the strategic initiatives that began three years ago. While we do not yet know when housing markets will completely stabilize, we have repositioned the company to make the most of current market conditions. If where we are today represents a bottom, we are well-positioned to capture growth. If instead we experience more downward pressure going forward, we have the flexibility to respond appropriately.

As part of our strategies, we are also seizing new market opportunities as they arise. A homebuilder should be able to both exit and enter markets rapidly depending on market conditions and opportunities. I previously said that we were comfortable with our growth platform and that is partly because we have this capability. That is why I am pleased to say that we are resuming operations in the Washington, D.C. metro market. We suspended operations previously as part of our strategy of generating cash and lowering overhead but maintained a foothold in the region through our customer service operations and have high quality land assets to start building on. The region is a top 10 market that is beginning to demonstrate stability and aligns perfectly with the development of our growth platform in the Southeast.

This move is yet another example of how KB Home is responding to today’s housing environment. By diligently executing our business model, we have the ability to take advantage of whatever economic conditions we face. We like our product, our markets, our balance sheet, our strategy, and the trajectory we are on. And while there is still plenty of work left to do, profitability is achievable. I have every confidence that the KB Home team working together will enable us to reach this important goal.

Now, Kelsey, let’s open the lines to questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from Michael Rehaut with JP Morgan.

Michael Rehaut - JP Morgan

The first question, with the continued success of the open series and you are getting orders back solidly on the positive side with better year-over-year absorption, I was wondering if you could give us a sense for the level of profitability of those new orders in terms of both gross margins and operating margins as -- I guess you are saying by, over the next several months you are going to be hitting the much higher levels of closings from these communities?

Jeffrey T. Mezger

That’s true, Michael. As I shared in my comments, we have confirmed it will be over 50% of deliveries in the fourth quarter and we expect that trajectory to continue into 2010 and beyond. While I say that, the open series is having a positive impact on margin that was reflected in the numbers that we reported and some of the detail that Bill shared today. Bill also shared we expect sequential improvement in the fourth quarter from the third in gross margin in part because of a larger share of open series deliveries.

Past that, it’s unclear. We think we will have incremental improvement from open series but we still have some lesser performing, non-open series communities that are part of the mix that would have a limiting effect on margin. So I’d say we expect incremental improvement going forward in Q4.

Michael Rehaut - JP Morgan

And just to get a little more granular in terms of the differential on at least a gross margin basis, is it 500 basis points, it is 1,000 basis points? Just to get some sense of the gap between open series and the rest of your communities?

Jeffrey T. Mezger

Well, we look at the whole bucket, Michael. I don’t know that we have the numbers between open and non-open and it gets blurry based on the mix deliveries in the quarter or in the fourth quarter, so as we shared, we attribute some of our margin improvement to the open series mix and we think it will drive a little higher margin in the fourth quarter.

Operator

Your next question comes from Ivy Zelman with Zelman & Associates.

Ivy Zelman - Zelman & Associates

Good morning, gentlemen. I wanted to understand if you could help us just a little bit, although community count, I didn’t get the number exactly quarter to quarter, I’m sure the community count went down and your sequential decline and orders. Was there in your opinion a slower-than-normal third quarter slowing? Because your market share as you’ve been gaining with the open series and your comments last quarter was that you thought you can sustain the same number of sales per neighborhood and it looks as if it slowed a little. So would you say that the market is showing any softening or is it just a timing issue because the summer or the spring was stronger than the summer and it’s as you would have expected?

Jeffrey T. Mezger

It’s a good question, Ivy and as always, there’s a lot of moving parts that contribute to the results and I can share a couple of comments. First off, in the second quarter we had some communities where we introduced the open series where our sales rates exceeded our high side projection, so we actually were pushing price in those communities to slow down sales and raise margin, so that was a good result. So there was tempered sales in many communities because of our pricing strategy.

Past that, normally I don’t like to share trends from month to month because you can't say that one month makes a trend but there are so many things going on right now in the economy and in the housing markets that we though we would provide a little color here on our third quarter sales trajectories. As we stated in our comments, we are a build-to-order builder and we are doing a great job shrinking the time from contract to delivery -- in many cases, four-and-a-half months. We have a federal tax credit that’s been a strong motivator we think for our consumer since we are 80% first-time buyer right now and they get the credit that as the quarter evolved, we had to stop promoting because in a build-to-order model, they would no longer be able to close on the home and qualify for the credit.

As we de-emphasize the credit in August in many of our cities, we did see a softening in sales occur -- not huge but we did see a softening. We do think that impacted our sales trajectory as well.

Ivy Zelman - Zelman & Associates

Jeff, that was very helpful, appreciate it. Just separately on your opportunities that you see with finished lots in the market to acquire them, with what you were able to acquire this quarter, can you give us some more disclosure and just a sense of where those were and roughly what you are underwriting those to, please?

Jeffrey T. Mezger

Sure. Well, we shared a specific number in our second quarter call, Ivy and that was with intent because I wanted to send a message that we are back in the markets. I don’t want to start sharing that number every quarter like the weather report because every acquisition is going to have a different timeline when it turns to revenue but in the quarter, we did tie up some lots in all of our regions, primarily finished lots on easy rollers so the option deposits remain small. We want to retain flexibility in our cash and in most of these cases we’ll be able to start models right away and quickly turn them to revenue. But it wasn’t a bit -- it’s still not a big number. We did do more than the second quarter but we expect that we will be doing more going forward.

We are under-writing to both a margin hurdle and a return hurdle with a real emphasis on returns, so our typical under-writing IRR is 27% to 30% today with an historical margin in the 20 range.

Ivy Zelman - Zelman & Associates

Great job, thank you very much. Congratulations on the improvement.

Operator

Your next question comes from Steven East with Pali Capital.

Steven East - Pali Capital

Jeff, you talked some about the open series sales rate and what happened as it slowed. On your community penetration, where are we now as far as really the split between open series and traditional product being sold in the quarter?

Jeffrey T. Mezger

Steve, as I shared on the last call, we also -- we stopped giving that number because it gets very blurry when you have a community that you can't remove the existing product yet you can introduce some new open series plans to the community, so you can count it as an open series community or a non-open series community and like sales, I hate to give a weather report every quarter and that’s why we guided that it will now be more than 50% of our deliveries in the fourth quarter and we expect that trajectory to go up in 10.

Steven East - Pali Capital

Okay, and then if -- different issue, a couple of your peers have looked at the equity issuance from an ATM perspective, all of that. How are you all looking at that situation and does it make sense for you to go out into the equity markets?

Jeffrey T. Mezger

Well, as we run our business, Steve, we are always evaluating the different options that are out there and everything gets considered. I really don’t want to specifically talk to that because we haven’t done anything there but it’s one of the options just like debt or everything else we look at every day in our business.

Operator

Your next question comes from Ken Zener with Macquarie Capital.

Kenneth Zener - Macquarie Research

I’m wondering, just to go back to the open series profitability, in the second quarter you said basically the open series, you know, you made the comment that it could lower prices by $60,000 and costs by $80,000. That’s a $20,000 net benefit on a 200 base -- it kind of implies a 10% differential between the open series and where you were last year, at a roughly 10% gross margin. Would you agree with that analysis?

Jeffrey T. Mezger

That was specific to one community, not the whole company.

Kenneth Zener - Macquarie Research

Mmmhmm -- so it would be a lot tighter spread, I take it?

Jeffrey T. Mezger

It depends on the size of the home and the lot price of the home and the market that you are in. There’s a lot of things that go into your cost but across the system, we continued to be able to offer a lower priced product and raise margin because of the cost reductions in the open series.

Kenneth Zener - Macquarie Research

But I thought -- given the absence of really a large degree of spec, the fact that your backlog conversions have been kind of in that 70% range, could you expand? Because it seems pretty significant on the fact that you are able to cut the closing -- well, the dates from sale to when you started construction but I believe you said 20 days and 50 days after the construction, or was that 50 in total? Could you expand on that because that seems pretty significant? Thank you.

Jeffrey T. Mezger

Well, it is significant, Ken, and that’s a great point -- we wanted to reinforce that. I’ve always referred to the time from contract to close in our business model as cycle time and there’s three buckets to the cycle time and we’ve attacked all three -- you have the period from contract to start where the buyer gets their loan approval, goes to the studio, selects all their customized options, and then we start the home. And that’s the 20 day or 25 day reduction we shared, which is significant when you consider that a large percentage of our consumers are government loans where the approval process takes a little time and we’ve been able to shrink that timeframe down.

On the build time side, because of the value engineering, enhanced execution in our system, and the product that we are offering, we’ve been able to drop our build time 50 days from 2006, so between the two -- we haven’t shaved too much off of the third bucket, which is from completion to close because we want to make sure the home is complete and the buyer is 100% satisfied before the closing occurs. But between the two, we now have many divisions in our company that are running four-and-a-half months from contract to close on a build-to-order home, compared to our historical business model was six months and at the peak of the market a few years ago, we were as high as eight months.

So we’ve taken the time down with intent -- A, it helps your returns but B, it makes you more competitive with a resale where people -- you know, they will wait four-and-a-half months to get the custom home of their dreams versus the six months or eight months that we were incurring a few years ago.

Operator

Your next question comes from David Goldberg with UBS.

David Goldberg - UBS

Jeff, I was hoping we could follow-up on that question Ken just asked and really focus on the second bucket in terms of the build cycle, in terms of the actual construction times. And I’m trying to get an idea of in that, of the benefit that you guys have realized, is there any benefit that is coming simply because there’s fewer delays in the municipality level? You know, there’s fewer kind of wait times for things to get approved by folks from municipalities? And do you think you can sustain the benefits that you have seen if you were to start to see an acceleration in demand?

Jeffrey T. Mezger

The delays from a municipal standpoint, David, normally occur before you start the home because it was lengthening the permit times. From start to close, the cities are fairly responsive. If you inspection, they show up in their normal timeframes. I don’t know that we’ve seen a lot of time savings there. I do think if the markets were to overheat and there’s a little strain on contractor base, which would be a great problem to have, that you could see our build times lengthen but I don’t think you are going to see that for some time. And we are comfortable we can hold or even shrink a little further from what we are currently generating.

David Goldberg - UBS

Got it -- a follow-up, a second question, and I understand you guys don’t want to give weather reports every quarter but I know in the past you’ve kind of shared what percent of lots that were delivered, homes that were delivered from land that had been impaired as a percentage in calls historically -- do you have any idea what that would be this quarter?

Jeffrey T. Mezger

For the quarter, it was 88%.

David Goldberg - UBS

And just -- I think it was in the 70s last quarter, is that correct?

Jeffrey T. Mezger

Roughly.

David Goldberg - UBS

Okay, great. Thank you.

Operator

Your next question comes from Jim Wilson with JMP Securities.

Jim Wilson - JMP Securities

My questions are kind of about your JV, so obviously good job continuing to reposition them but I was wondering about the remaining exposure, just looking at what you have invested -- 16, that sort of averages $10 million a piece and I was wondering more about the bigger concentration assets and kind of where you think they stand and whether you feel you’ve adequately reserved for them now, particularly in Las Vegas?

Jeffrey T. Mezger

As Bill shared in his comments, Jim, and I’ll turn it to Kelly to give you the specifics here in a second but as Bill shared in his comments, we’ve significantly reduced the JV activity year over year, dropping our debt roughly $1 billion. So we’ve made great progress. We are down to 16 JVs in the whole system, so we’ve materially lowered activity levels and investment and it continues to be a strategy to reduce going forward.

Kelly, do you want to give them some of the details?

Kelly K. Masuda

Really on the JVs, when you talk about the reserves, we treat our JV assets like we do any other asset in the company in terms of impairment calculations and carrying values. So they are reevaluated every quarter and we think we have the appropriate reserves.

Specifically to your exposure, we do have three JVs with loan-to-value maintenance guarantees and if the values of these projects drop to zero, our exposure under these guarantees is approximately $11 million, so Jeff, that’s compared to $90 million a year ago so we’ve significantly worked down our exposure as we worked down the number of JVs that we’ve got outstanding.

Jim Wilson - JMP Securities

Great. And I guess -- I mean, take it from your results and as you gave your order trend but I guess -- I was wondering within the central, was that particular strength in Texas, I would assume? I just want to ask that question.

Jeffrey T. Mezger

It is. That’s the lion’s share of our central region.

Jim Wilson - JMP Securities

All right. Okay, that’s all I have. Thanks.

Operator

Your next question comes from Megan McGrath with Barclays Capital.

Megan Talbott McGrath - Barclays Capital

Thanks. I wanted to follow-up on the absorption piece a little. First if you could actually give us what your active community count was in the quarter and given what you saw in August in terms of not promoting the tax credit, what are your feelings on how that might look in the fourth quarter?

Jeffrey T. Mezger

I’ll let Kelly give you the community count in a minute but I wanted to touch on the tax credit because we are competing primarily with resales that the consumer can still get the credit but that disadvantage that we have is about to end. But we really don’t know what impact it will have if the tax credit doesn’t get extended and the consumer doesn’t have this additional incentive, so we are not giving any real guidance go-forward because we just don’t know. But there was a slight down-tick in sales in August where we stopped promoting it.

Kelly, do you want to give her some of the --

Kelly K. Masuda

Our community counts were down 37% year over year to 147 from 232 the prior year.

Megan Talbott McGrath - Barclays Capital

Okay, thanks and then if I could just follow-up on the gross margin a little bit to get a little bit more color, last quarter you I think had been anticipating that gross margins would be relatively flat sequentially, so you certainly did better than your expectations there. And then you had also said that you expected them to go up pretty significantly in the fourth quarter, so trying to get a sense of did you pull some of that significant up-tick into the third quarter because your mix was a little bit better than expected or are you still expecting 4Q to see a pretty significant up-tick? So I’m trying to get a sense of where the outperformance came from in this quarter.

Jeffrey T. Mezger

As I’ve already shared, Megan, it won't be a significant up-tick in Q4. We do expect that it will go up sequentially and it’s in part due to the mix of more -- our open series. With our build times dropping, we were able to pull some open series deliveries into the Q3 that we thought we were going to deliver in Q4, so that did have a positive impact in the third quarter but for fourth quarter, we are showing sequentially slightly up.

Megan Talbott McGrath - Barclays Capital

Thank you.

Operator

Your next question comes from Joshua Pollard with Goldman Sachs.

Joshua Pollard - Goldman Sachs

I wanted to follow-up on the joint ventures -- can you give us the numbers on how much debt you took on your balance sheet to consolidate joint ventures in addition to how much cash was paid in the form of land purchases and debt guarantees for the quarter?

Kelly K. Masuda

On the debt consolidated, it was about $130 million on the JVs that we consolidated during the quarter. What was your second question?

Joshua Pollard - Goldman Sachs

If you guys purchased any land out of the joint ventures or paid any additional cash in the form of debt guarantees and if you could provide an outlook on what you guys are looking or willing to spend on taking in those joint ventures. I assume that you guys are doing that on an opportunistic, not an obligatory basis?

Kelly K. Masuda

Yeah, we have capital calls on a number of our joint ventures as we continue to develop and work through the lots. As far as specific related to debt, there was minimal re-margin payments but we continue to work through these JVs.

Joshua Pollard - Goldman Sachs

Okay, great. My quick follow-up is on SG&A -- could you provide us with the split of your SG&A that’s fixed versus variable? Ultimately I am trying to determine if KB Home can see revenues grow and SG&A still decline in an effort to get to historical OpEx to revenue levels.

Jeffrey T. Mezger

As you know, Josh, for the last couple of years, we’ve been chasing our revenue down and it’s always difficult to get your SG&A back in line when revenues dropped as much as ours have. We were encouraged in the third quarter that our revenues dropped and our SG&A percentage dropped further -- it was an encouraging sign for us because it was the first time in a few quarters that we were able to accomplish that and we are continuing to try to identify ways to lower SG&A further.

Do you want to give any color, Bill, on the split between fixed and variable?

William R. Hollinger

I don’t have anything that is with precision but I would just say that as Jeff alluded to, it’s a bit of a lagging effect in that our revenues have come down just so quickly that our SG&A has followed and lagged behind. We would see that even with the revenues flattening and/or starting to increase that we would still be able to take out some more fixed as well as, you know, again because of the lagging kind of effect, so the proportions are a little hard to determine with precision.

Joshua Pollard - Goldman Sachs

Got it. If I could just slide one more quick one in there, your tax rate -- could you explain what you guys are looking for going forward? I personally wasn’t forecasting you guys to have an $11 million benefit in the quarter.

William R. Hollinger

That was a little bit of an aberration that -- it was a good thing in that we had previously reserved for some tax issues that we resolved to our benefit in the quarter. However, taking out that noise from that benefit, our overall rate for the year would be roughly around 40%.

Operator

Your next question comes from Nishu Sood with Deutsche Bank.

Nishu Sood - Deutsche Bank

I wanted to ask a question just about the competitive field out there -- I think it’s safe to say that you folks were pretty early in recognizing the need to compete with foreclosures and to recast your product line more towards the first-time buyer but you might also say that after that, that philosophy has become the industry standard pretty quick. What I am thinking back to is at the beginning of the year when you folks were kind of early on it, you were confident enough in the open series plan that you thought orders might improve throughout the year and obviously it hasn’t come in that way and I’m wondering if the rapid adoption of your strategy across the industry might be the main reason for that.

Jeffrey T. Mezger

We still view our main competition as resale. While some builders have introduced lower priced product, that’s not our primary competitor today. It continues to be resales and foreclosures and if you go back over the track, as the momentum picked up in our introduction of the product, we actually in the second quarter exceeded our high side projection on sales and at the time, we guided that we wouldn’t have sequential in the third quarter because the second quarter was so strong; however, we also guided we’d be positive on a year-over-year basis in the third quarter. So our sales per community are still tracking probably the highest in the industry as you look at it and I don’t think it’s because of competitive pressure from the other builders. People ask me all the time, well, why won't everybody else do what you do? I also believe we are the only national first-time builder that has studios and is on a build-to-order business model, where everything is presold and the buyer gets a customized house.

And past that, I can also tell you that one 1600 foot single storey is different than another and we believe that our designs and the way we put these plans together are the way to go and give us a competitive advantage. But if you go back to up top, we still view our toughest and biggest competitor is the resale market.

Nishu Sood - Deutsche Bank

Got it, no that’s helpful. And the second question, I wanted to ask about your re-entry into the DC market -- what exactly that will involve operationally and from a land purchase perspective -- is that simply going to be reopening parcels that you already control, like a crown farm maybe I think if that’s been worked out? Or are you out there purchasing new land to build out?

Jeffrey T. Mezger

It will be both, Nishu. We have more than one asset in the metro area that we will be opening back up with open series product hopefully over the next year and while we assemble the team and gain momentum on our current holdings, we will be looking for additional acquisitions. But we view this as a long-term move, not just to work through a couple of assets.

Nishu Sood - Deutsche Bank

Okay, thanks a lot.

Operator

Your next question comes from Alex Barron with Agency Trading Group.

Alex Barron - Agency Trading Group

My first question has to do with your communities -- I guess it’s come down a lot in the last couple of years and I’m guessing that’s because you mothballed a lot of communities. I’m just kind of wondering, are you basically now going to start reversing that trend at a pretty fast clip and can you give us a sense of how fast?

Jeffrey T. Mezger

Alex, let me clarify -- it’s not that we just mothballed communities. We built through a lot of communities too over the last couple of years and as we shared, we now only -- we own 31,000 lots roughly and control a total of 40, so we are in a fairly land light position.

I shared in my prepared comments that we have not seen capitulation yet in many of the markets. We are anxious to be opportunistic but we are also going to be very diligent and patient and underwriting only to those things that meet our standards in a market that we think has settled. So we are hopeful to load in a lot of acquisitions over the next couple of years but it will depend on the conditions in each specific market.

Alex Barron - Agency Trading Group

Okay, that’s helpful. My other question had to do with your joint ventures, just kind of elaborating on that a little bit more. So you guys had impairments this quarter of I believe $23 million; your equity or your investments in the JVs was roughly flat, and then you mentioned you took on some JVs on balance sheet. Were some of those JVs [Ensperada] and [Kyle Canyon] in particular?

Jeffrey T. Mezger

No, Alex, in fact, the JVs we consolidated are vertical JVs where we have condo buildings under construction and will be delivering into revenue here in the future.

Operator

Ladies and gentlemen, unfortunately we only have time to field one more question -- that will come from Susan Berliner with J.P. Morgan.

Susan Berliner - J.P. Morgan

Sorry to beat a dead horse on the joint ventures, I guess in terms of the joint venture debt maturing, trying to get at is it possible that additional joint ventures could be moved on to your balance sheet?

Kelly K. Masuda

Well, we opportunistically look at joint ventures like we do any other asset so if there is an opportunity to take out a partner or we have a disagreement with a partner, we could certainly come to an agreement and [we can] have further consolidation.

Susan Berliner - J.P. Morgan

But I guess -- is it a case that there could be more debt coming on with these joint ventures more so than offsetting of inventory?

Kelly K. Masuda

It’s nothing that we project but the ones that came on this past quarter is we opportunistically unwound and took out our partners and as a result consolidated the JV and have full control over the project which we see as a big positive to maximize the value of the asset.

Susan Berliner - J.P. Morgan

Okay, and then I apologize if I missed this, I know you guys talked about increasing your land purchases, I was wondering if you had an updated amount of land spend that you were targeting for this year?

Kelly K. Masuda

Our targeted land spend, land and land development, is $360 million versus last year -- last year was over $500 million, still down.

William R. Hollinger

Down significantly year over year.

Susan Berliner - J.P. Morgan

And last quarter, was it -- so that’s not -- it doesn’t sound like it’s up pretty materially though.

Kelly K. Masuda

No, it was about $90 million in land and land development in the past quarter.

Susan Berliner - J.P. Morgan

Okay, great. Thank you.

Operator

Ladies and gentlemen, that is all the time we have for questions. Mr. Mezger, I will turn it back to you for closing or additional remarks.

Jeffrey T. Mezger

Thanks, Kelsey. Thank you again for joining us. We look forward to seeing you over the next few months. Have a great day.

Operator

Thank you, Mr. Mezger. Again, ladies and gentlemen, that concludes our conference for today. On behalf of KB Home, we thank you all for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: KB Home F3Q09 (Qtr End 8/31/09) Earnings Call Transcript
This Transcript
All Transcripts