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KB Home (NYSE:KBH)

November 09, 2011 10:45 am ET

Executives

Jeff J. Kaminski - Chief Financial Officer and Executive Vice President

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

Analysts

Unknown Analyst -

David Goldberg

All right, we're going to get started again here. It is a pleasure to welcome Jeff Kaminski and Jeff Mezger from KB. You guys, thank you very much for joining us. We're looking forward to the presentation and I will turn it over to Mr. Mezger. Thank you, sir.

Jeffrey T. Mezger

Thanks, David. Good morning, everyone. It's a pleasure for me to be here this morning. With me today is Jeff Kaminski, our Executive Vice President and CFO.

Our focus at KB Home has been to manage the current market realities, while at the same time repositioning our company as a leaner, more efficient business for the long term.

As a result, today, I believe we are better positioned to deliver positive financial results than we have been in many years. The stabilization process and housing markets continues, and economic expansion will inevitably move housing from a stabilized environment to a growth environment once again.

In the meantime, we believe we're on the right path. Our continued progress in many financial measures combined with our innovative home designs and features that are setting KB Home apart in the marketplace has laid a solid foundation for our business going forward.

Before we begin, as always, I would like to refer you to our disclosure on forward-looking statements. My comments today on our business will be limited to our historical results through the third quarter and at August 31, and may include a few comments we shared on our earnings call in September.

KB Home has built more than 0.5 million homes for families in our 54-year history. Our long-term success is based on our customer-focused approach to designing and building homes. At the center of this approach is our well-established KBnxt Built to Order business model, which has helped us to quickly adjust to changing market conditions and operate efficiently in any environment. The core strengths of our business today include: a geographically diverse footprint; innovative new products that compete with resales and foreclosures; reduced overhead and lower cost to build; a transformed land and community positioning and higher-priced, desirable submarkets; a solid balance sheet and a strong and tenured senior management team in place at both the corporate and division level.

Our recent results show that the actions we have taken in our business are gaining momentum. We have substantially lowered our breakeven point while establishing a sales pace that is setting us up for a brighter future.

Our sales in the third quarter were up 40% year-over-year, while our backlog at the end of the quarter was up 22%. As we shared on our third quarter conference call, we expect the momentum to continue in the fourth quarter.

Today, KB Home is well positioned for the current environment and even more so as the housing markets continue to recover.

Even as we have repositioned our business and right sized our overhead, we have been mindful of preserving our company's growth platform. Ours is a very local business and the 30 markets in which we operate today have been carefully chosen for their long-term economic and population growth.

Within these markets, we are focusing our investment and development on a, submarkets that are stable and provide opportunities today. These are desirable areas close to major employment centers and good schools where supply and demand are in balance, there's less foreclosure pressure, pricing is favorable and affordability levels are incredible.

We have invested $1.1 billion in land and development in these more desirable areas over the past 2 years, primarily in coastal California and Texas.

As a result of this investment, we opened over 90 new communities through the third quarter of this year. Total community count open for sale at quarter end was 233, a 10% increase over last year.

We have been able to achieve community count growth in spite of selling through many of our opened communities this year.

This chart illustrates that our community count has been higher in every quarter of 2011 versus the prior year, and we are working diligently to identify additional opportunities to sustain this growth trend going forward.

Here's an illustration of our units and revenue by geographic segment for third quarter 2011 deliveries. It is fairly well distributed among the 4 regions with a heavier weighting to our Central and West Coast operations.

On the left is the unicount distribution, and on the right is the revenue distribution. You can see how the higher average sales prices in California influenced the larger revenue share we get from this part of our business. As I mentioned, since the beginning of 2009, over 75% of our land investment has been made in coastal California and Texas. It is these 2 states where we expect to continue to see heavy weighting of units and revenue going forward over the next few years.

Our sales comp in Q3 year-over-year in California was up 70%, which reinforces this trend. Another great example of our growth strategy in Texas was our sizable acquisition of 1,900 lots and 11 communities in San Antonio from Fieldstone Homes. Nearly all of the new communities resulting from this acquisition will have models opened in the fourth quarter and these communities are expected to provide over 300 deliveries in fiscal 2012.

We have strong pipeline of land and lots to grow the business. We have always been a relatively land-like company and as this slide shows, we have a very liquid lot pipeline that represents about a 4-year supply based on our current run rate. We are continuing to open new communities that should drive our margins higher and improve our returns in these more desirable submarkets.

Down at the bottom left, we have 5,600 option lots, which are basically finished today. When you combine that with the 16,500 finished lots we already own, in those 2 categories alone, you have over 22,000 lots we could very quickly turn to revenue. So we have a spring coil where we are prepared to take advantage of whatever increase in demand there could be. In the meantime, we'll optimize our communities for margin and absorption and continue to invest opportunistically.

The KBnxt business model has now been with us as our guide for 15 years, and it continues to drive our actions, our accomplishments and also our long-term strategies. KBnxt utilizes a fact-based process-driven approach that emphasizes choice and value to the consumer through operational excellence and a Built to Order process. Our leading energy efficiency initiatives are now allowing us to offer the lowest cost of homeownership in our served markets for our buyers. The strength of our business model have not always been evident when you have been in an industry of decline like we have for the last 4 to 5 years. I'm convinced that as housing markets stabilize, the strength and the benefits of this model will continue to become more apparent, and we are confident it is going to resonate in our markets as we move forward toward growth once again.

We remain committed to our Built to Order model, which historically provides for stronger margins and better consistency and visibility in our business, as well as higher customer satisfaction.

As we continually strive to become more efficient, our cycle time from contract to close has been reduced dramatically by 45% since 2006. We set another company record in the third quarter for an average Built to Order cycle time from contract through home start and to closing of just 128 days. As we have reduced our cycle time to just over 4 months on average, our buyers are more than happy to make the choice to buy a brand-new Built to Order KB Home or over other new home inventory or resale homes.

Our most recent third quarter results reflect the progress we are making in repositioning our company. Many of our third quarter financial metrics, including gross margin and SG&A percentages, continued their sequential improvement since the beginning of 2011. We reported positive operating income in the third quarter and our bottom line results improved dramatically from the second quarter of 2011.

A highlight of the quarter was our sales pace, which increased 40% over the prior year and was higher in all 4 of our operating regions. This was the highest third quarter year-over-year comp in the industry.

Our backlog was also higher in all 4 of our operating regions, up 22% versus the prior year. As I mentioned, deliveries, average sales price, gross margin and SG&A percentages all continued their sequential improvement since the beginning of 2011.

Our third quarter studio revenue per home was the highest it has been in over 2 years, demonstrating that our Built to Order model continues to be valued by the consumer.

The company's debt balance at August 31 was $1.6 billion, down nearly $200 million from $1.8 billion at November 30, 2010. This was due impart to the repayment of $100 million of debt that matured in the third quarter as part of our balanced approach to navigating the current environment.

Our next bond maturity is not until 2014.

We're now reaping the rewards of our strategy on investment, our overhead reductions and our better market positioning. We believe the improvements we have made in sales, community count, average selling price, margin and backlog all bode well for our future. One of our innovations that has helped us compete in this new environment was the development and launch of our new line of homes, the Open Series, which were designed to be built more efficiently while enhancing quality choice and value for today's consumers.

Our national rollout of the Open Series homes is now complete. These homes capture the sensibilities and needs of a new kind of home buyer in the marketplace, with flexible plans ranging from 1,000 to 4,000 square feet and with numerous structural options, these homes meet the needs of move-up buyers and first-time buyers equally well.

Our home buyer profile and product mix has evolved as the housing market downturn unfolded. In 2006, we had a roughly equal number of first-time and first move-up homebuyers at 40% each. As the markets softened, first-time homebuyers began to increasingly dominate the new home market as they did not have an existing home to sell and financing remained readily available.

Now you can see, that as the housing market slowly begins its recovery, our percentage of move-up homebuyers is once again growing. As our new communities come online in more highly desirable submarkets, our home buyer profile is shifting to higher income, first-time buyers and move-up buyers who are responding to our unique Built to Order product positioning.

Reflecting this strategy, our average selling price has also been increasing, our ASP was 227,400 in the third quarter, compared to 213,400 in the second quarter, a sequential increase of 6%.

Another key strategic initiative for our company that is helping us to stand out and better compete in the marketplace is sustainability. And KB Home is the established industry leader in this area. Our commitment to sustainability is evident from the way we run our business with less waste at our job sites and in our offices to the environmentally friendly homes we are building across the country. We have been recognized and honored by numerous organizations for our work in this area including the only builder to be recognized by the EPA with a 2011 ENERGY STAR sustained Excellence Award, the agency's highest honor, the first builder and only national builder to be named a 2011 WaterSense partner of the year by EPA. Once again ranking as the #1 Green Homebuilder by a wide margin based on a study conducted by Calvert Investments. And also honored by the U.S. Green Building Council for the outstanding multifamily project of the year for our lead platinum certified community in Southern California.

But we're not in this for the awards and candidly, we're not in it purely because it's good for our environment. We are in it for the many benefits it brings to our customers. When we can identify ways to reduce the total cost of homeownership by lowering monthly utility bills without charging materially more for the home, it is a powerful selling proposition and we believe it has positively influenced the strong sales numbers we just reported in the third quarter.

Within the Calvert report that I just mentioned, there are some compelling references to our company. Our overall score was almost double that of the next best performing homebuilder and over 10x the average score of the remaining 8 builders in the story.

This independent recognition of our programs from a respected organization such as Calvert is increasingly important for today's investors and consumers. Sustainability is a journey not a destination. It has taken us a decade and a lot of hard work to get to where we are today.

Over this period, KB Home has been continually raising the bar in our sustainability initiatives and commitments. We've come along way since building our first ENERGY STAR qualified homes back in 2001. It is now part of our culture and you can see that our initiatives have really gained momentum in the last couple of years.

Just one of KB Home's many first in the area of sustainability is our new KB Home Energy Performance Guide. Like an MPG sticker found on all new cars, the KB Home Energy Performance Guide or EPG contains key information about the relative energy efficiency of a KB Home versus a typical new or resale home, as well as estimated monthly electric and/or gas costs for homeowners.

As a result of the incredible media buzz since its launch in mid-February, the EPG program is not only bringing more traffic to our communities, homebuyers are now choosing KB Home specifically because of the EPG projected savings and peace of mind that it brings as they plan their monthly homeownership cost.

This EPG shows the estimated monthly electric and gas charges for a 2,200 square foot home in Austin at $130, which represents an estimated monthly savings of $87 compared to a typical resell home.

When you consider that the average home buyer today will live in their home for at least 8 years, the savings on this home adds up to more than $8,000 dollars over that time period for no additional cost up front.

This EPG shows the estimated monthly electricity and gas charges for a 2,200 square foot home in our Ecopoint community in Southern California at just $61, which includes a 1.4 kilowatts solar system that is included on the home as a standard feature.

You can see the incredible impact that our solar program has on reducing our buyers' monthly cost.

In today's economy, where every dollar is important, this kind of savings is very meaningful to our buyers. The end of the third quarter, almost 70% of our communities in Southern California included solar power as a standard or optional feature when we started offering this program in other select communities as well.

Recently, we launched the first KB communities in the country that feature our new ZeroHouse 2.0, an exciting net-zero energy home option for our buyers that we can offer in a standardized way through our Built to Order and Studio process.

While a new energy Star qualified KB Home may save homeowners $1,000 annually their utility cost when compared to a typical resell home, selecting a ZeroHouse 2.0 may eliminate their monthly electricity charges entirely.

The first ZeroHouse 2.0 model homes include solar power systems and building techniques and features that enhance the efficiency well beyond KB Home's Energy Star qualified standard.

We recently opened a net-zero program in Tampa, San Antonio and Austin. The initial openings were met with tremendous response bringing out hundreds of interested consumers. The national roll out of ZeroHouse 2.0 to more KB Home markets will continue through 2012. This is the next evolution of our Built to Order model, a major differentiator over resale.

KB Home recently unveiled Primera Terra, one of the largest communities of LEED Platinum certified homes in California and currently the only LEED platinum community open for sale in the state. As I mentioned earlier, the project was just honored by the U.S. Green Building Council with a 2011 LEED's for homes award in the multifamily category.

Located in a prime location on the Westside of Los Angeles, the 52 luxury condominiums imply of this are equipped with energy and water saving features and built with sustainable materials to make them more comfortable and efficient than a typical new or resale home.

They're priced in the $500,000 to $600,000 range and are at least 40% more energy-efficient than California's new home standards.

The KB Home EPG at Primera Terra shows that heating and cooling costs can be as little as $57 per month in select homes.

In these times, it's critical to differentiate your homes from both resale and new home competition. A KB Home offers clear consumer benefits starting with a tremendous appeal of a home that is brand-new, customized, Built to Order and backed by a 10-year limited warranty.

The many environmentally-conscious features of our homes are another way we are standing out in the marketplace. Homebuyers have a huge desire to save on the monthly cost of homeownership and this is a key differentiator for us.

We're the first and only homebuilder to adopt the rigorous third-party certification of our quality controls through the NAHB Research Center's National Housing Quality Program.

Over the last 18 months, we've had the highest levels of customer satisfaction in the history of our company. In addition, our unique partnership with global brand, Martha Stewart, continues to drive traffic, generate sales and distinguish KB Home from our competition.

As we look ahead, while the markets are not necessarily getting better, we are better as a company. Although it is difficult to make predictions in a market as unpredictable as the one we've been operating in, we do believe we are well-positioned strategically and financially for today's housing market. We expect to end the year with a substantially higher backlog than we did entering 2011 and are confident that this hard-earned momentum will continue into next year. Our focus on reinvesting in more desirable submarkets in coastal California and Texas is paying dividends and our overhead levels are now aligned with today's revenue levels. At the same time, the U.S. population is growing and the life-changing events that drive a new home purchase continued to unfold for families across the country.

Our team is ready, our products are aligned with the market, our strategy is sound and our business is well positioned for growth and profitability.

We look forward to taking KB Home to the next level of performance and in the process creating lasting value for our stockholders, our employees and our customers.

Thank you very much and now, we'll take any questions you may have.

Question-and-Answer Session

David Goldberg

Thanks, Jeff. Yes, I want to start it off on maybe the elephant in the room is about liquidity. And I think, I imagine you guys mentioned a lot of questions about liquidity over the last couple of months. But maybe we can talk about -- if the environment were, let's say, flat in terms of sales and maybe you guys pick up a little bit of market share because you're growing community count with the other publics. What do you think, if you had a flat year in '12, would you guys be -- would you generate cash, would you use your cash or would cash kind of flat as we move through the year?

Jeffrey T. Mezger

CFO question.

David Goldberg

Thank God we have him.

Jeffrey T. Mezger

Talk in the mic, Jeff.

Jeff J. Kaminski

[indiscernible] Okay, so what I started to say was -- I mean, a lot of that will depend on the environment that we see. If we assume a flat sales environment and a flat delivery environment, we'll really be looking at land opportunities and what we see going here. I think we have a tremendous ability to control liquidity through the reinvestment. We talked a lot about what we saw coming out of the third quarter, talked about our fourth quarter estimates on cash. We're not constraining our business right now due to liquidity or due to cash concerns. And in fact, during 2011, we've taken about $200 million of debt off the balance sheet, which we see is a good thing on reducing interest carry and helping out on the P&L side. We're continuing to carefully manage the capital profile of the company and the opportunities, but with everything being equal, I think you'd probably handicap it at equal. We're not going to be burning or using cash in 2012, although that's not -- it's not guidance for next year, but assuming at that point, I'd say probably that's a safe bet.

David Goldberg

Can you talk about the decision around the credit revolver? Whether to put one in place, not have one in place, kind of how you're thinking about that? And the availability of a revolver if you wanted to -- if you had growth and you want a financial work in progress or the revolver?

Jeff J. Kaminski

Right, right. I think the reason we would put a revolver in place or go for higher leverage would be to finance growth. And as we see strengthening markets and a need for capital, we'd look at it from that point of view. Under our current indenture agreement, we really don't have limitations or secured debt goes or secured revolver capacity, it's certainly in the cards and options that we look at pretty much constantly. But as you know, in 2010, we actually came out of the revolver that we had in place at that time due to basically P&L issues and hits that we are taking to the P&L for really no reason. [Audio Gap] point in time we're pretty comfortable with the profile.

David Goldberg

I'm going to ask another one, we're going to ask an operations question. Yes, so you get the [indiscernible], right? It's interesting and I think I understand the rationale between focusing on California and Texas in terms of your land acquisition strategy, but can you talk to us what actually goes into your decision-making process when you decide okay, look, these are the markets that I really want to focus on. Is it your land teams that are in place? Do you think that's where you get the best opportunities, is it market dynamics, do you think this is the best supply demand? How do you weigh the competitive dynamics of local markets versus your position and some of the kind of broader national trends too?

Jeffrey T. Mezger

It's a good question to answer, the simple answer is all of the above. But if you look at the markets around the country and how they're performing, the 2 places that are performing best today happen to be coastal California and Texas, and it's for different reasons. In coastal California, it's an extremely desirable place to live that's incredibly affordable relative to historical standards. And in Texas, you have some job growth. So the economies are performing better. In those 2 states at the peak in '06, I think we delivered 19,000 homes, but we're no where near that today as a company. And there's a lot of upside in taking market share there and also coincidentally, we have great management teams on the ground. If you look at coastal California, we have teams that have been together for 20 years, and they know the markets, they get things approved in cities. They get things entitled that others may not be able to. They're very land constrained. It's our home base so it makes sense to us to invest heavily there and it's not that we're -- we don't want to invest in all 30 markets we're in, but right now, we think the best opportunities due to the team and the market dynamics are in those 2 states.

David Goldberg

I mean, I guess, the reason I asked the question is because I think we're going to hear from 6 or 7 builders today and they are going to say the same thing, right? Texas is a good market for us, we're going to try to put money there. California and Coastal California is a good market not inland and Southern California. And I just wonder about how competitive dynamics in the industry get factored in the equation. Are you worried that there's going to be some issues, look, I want to grow my business in Texas, I'm going to take whatever IRR vertical you want think about maybe below what you guys would underwrite to gain some share relative. Do you feel you're efficient enough that you just overcome that?

Jeffrey T. Mezger

Well, I do. And when you have a large franchise, you become, what I call, a builder of choice. Land sellers know you can perform and they would like to have certainty of close and a great example is the Fieldstone deal in San Antonio. We bought 1,900 lots in the city at a very attractive price that we could quickly turn into, it was plug-and-play, it was our product. We've got models opened already in many of the locations, and you can quickly hit 300 deliveries next year. That deal was out there for a lot of the major builders. We were able to bring it into a conclusion. We really like the play and in California, a lot of builders have really downsized or left the market. So I believe the last number I saw we were once again the largest builder in California, and we have teams that can navigate extremely well where others may not be as successful. No different than us in Raleigh, where we're not that large and we don't have as a strong a capability as some others may have. So I think you'll see some regional differentiations come out based on where people have strong teams and markets or in their mind performing better.

David Goldberg

We have a question.

Unknown Analyst -

Yes, can you walk us through what's going on with South Edge and what the potential litigation payment for that would be and how will you finance that?

Jeff J. Kaminski

Yes. South Edge is again as we talked about, we had targeted a resolution on that issue by the end of our fiscal year, which is the end of this month. Just a week or so ago, we received final approval of the plan of reorganization through the bankruptcy court, so the path is more or less paid for final resolution in the next couple of weeks. We do expect to fund the liabilities and take control of the land prior to our fiscal year end and really the processes as it went through, throughout most of the fourth quarter for us was pretty much as expected. We talked about the liabilities that we had on the books, we got roughly $226 million that the way the plan was approved and put together very much on expectation for us on the final result here.

David Goldberg

I was wondering if we could talk about the financial services joint venture, First Bank of America, now MetLife is going to get out of this business. The first question that I have is have you seen any change in MetLife's behavior since they decided they were going to sell the business? And the reason I asked is if you were going to sell a mortgage origination or a corresponding lending business, you might think that you might want to tighten, make a potential buyers say, well, maybe the mortgage put bad risk isn't as big, because we look at their underwriting. Are you seeing any change in their behavior since they've decided to exit the business? And my second question is given some of the changes that we're seeing in the course of the lending business, is having a joint venture with a single partner the right way to have this structured as you move forward? I mean, is this going to be optimal, because you do put a lot of eggs in one basket and we've seen some changes obviously in the industry.

Jeffrey T. Mezger

There's no question that the mortgage world is changing by the day. MetLife has been a great business partner. To clarify one thing, David, we have a marketing agreement with MetLife, not a joint venture. And they strategically decided to get out of the business due to regulatory pressures of some kind. But in the meantime, it's business as usual, if anything, the performance has been improving because we just formed the relationship in June and the teams are becoming more efficient and working better together. So we're actually seeing an upgrade in performance in this effort. Because while it's a marketing agreement, it's still a team effort. The sales teams have to be working with the processors and communicating with the customer. And they have committed to me that they'll continue to service our buyer and ensure we get our closings as projected, so they're a good business partner today. Heading on the final outcome there, it'll influence where we go. We still have a lot of flexibility in alternates as well.

David Goldberg

In terms of the long-term structure about how you think about Financial Services business. Do you think as you move forward, you bring in more partners? You try to use 2 or 3 sources like some other builders do versus are you having kind of a more exclusive marketing arrangement or the joint venture that you used to have?

Jeffrey T. Mezger

Everybody will have their own strategy. I think there's a lot of synergy to the scale and don't look at today when we're a 7,000 unit builder, whatever we are. Look when you expand your business, you need to have the capacity and your partner to ensure that you're closings occur. Our primary focus is to make sure that there's consistency and predictability and then if there's a financial benefit, it's secondary. But I think if you have a solid partner, you'll get better performance than having 2 or 3 or 4 partners out there. There's a lot of regulation going on right now in the mortgage world. So it's unclear to me what the landscape will look like as you look out a couple of years from now. And we'll continue to navigate it. But right now, Mets doing a good job.

David Goldberg

All right, we have time for one more question to anyone in the audience, if not, we'll probably cut it there.

Jeffrey T. Mezger

I'm not going to dance for you.

David Goldberg

That's my job, not yours. Thank you so much, guys.

Jeffrey T. Mezger

All right. Thank you.

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Source: KB Home Presents at UBS Building & Building Products Ninth Annual CEO Conference, Nov-09-2011 10:45 AM
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