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

Executives

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

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

Analysts

Susan Maklari - UBS Investment Bank, Research Division

Michael Rehaut - JP Morgan Chase & Co, Research Division

Robert C. Wetenhall - RBC Capital Markets, LLC, Research Division

Anto Savarirajan - Goldman Sachs Group Inc., Research Division

Ivy Lynne Zelman - Zelman & Associates, Research Division

Daniel Oppenheim - Crédit Suisse AG, Research Division

Adam Rudiger - Wells Fargo Securities, LLC, Research Division

KB Home (KBH) Q2 2012 Earnings Call June 29, 2012 11:30 AM ET

Operator

Good day, everyone, and welcome to KB Home's 2012 Second Quarter Earnings Conference Call. Today's conference is being recorded and webcast on the KB Home's website at kbhome.com. The recording will be available via telephone replay until 4:30 p.m. Eastern Time on July 7 by calling (719) 457-0820 and using the replay access code of 8933147. The replay will also be available through KB Home's website for 30 days.

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, strategy and financial and operational results. These statements are not guarantees of future performance. And due to a number of risks, uncertainties and other factors outside of its control, KB Home's actual results could be materially different from those expressed and/or implied by the forward-looking statements. Many of these risk factors are identified on KB Home's filings with the SEC, which the company urges you to read with care.

The discussion today may also include references to non-GAAP financial measures as defined in Regulation G. The reconciliation of these non-GAAP financial measures to those most directly comparable GAAP financial measures and of Regulation G require information -- required information is provided in the company's earnings release issued earlier today, which is posted on the Investor Relations page of the company's website under Recent Releases and through the Financial Information News Releases linked on the right-hand side of the page.

And now your host for today's call, Mr. Jeff Mezger. Mr. Mezger, please go ahead, sir.

Jeffrey T. Mezger

Thank you, Rufus, and good morning, everyone. Thank you for joining us today to discuss our second quarter results. With me this morning are Jeff Kaminski, our Executive Vice President and Chief Financial Officer; and Bill Hollinger, our Senior Vice President and Chief Accounting Officer.

My remarks today will provide you with highlights of the second quarter, a brief overview of how we see the macroeconomic environment, an outline of our growth strategies and review of our performance drivers to restore profitability. Then Jeff will walk you through our detailed financial results, after which, I will make a few closing comments and then we'll be pleased to take your questions.

I'd like to begin today's call by saying that as our overall results reflect, we continue to make significant progress against our strategic objectives. Most importantly, we expect to achieve profitability by the fourth quarter of 2012 and also for the full year 2013.

Before we discuss the macroeconomic environment, let me share with you some of the financial highlights from the quarter. Net orders were 2,049, up 3% year-over-year and up 71%, compared to the first quarter of 2012. While our net orders were up 3%, the net order value of $503 million increased 18% year-over-year and 81% over the first quarter of 2012.

Our backlog continues to grow substantially. We ended the second quarter with 2,962 homes in backlog, representing $693 million in potential future housing revenues, up 38% year-over-year and 51% over Q1 2012. Our revenues grew to $303 million in the quarter, up 11% from a year ago.

We significantly reduced our net loss to $24 million or $0.31 a share from a net loss of $69 million or $0.89 a share in the same period of 2011. We generated positive net cash flow for the quarter while continuing to fuel future growth. We spent $83 million on land and development, growing our lot count by almost 1,600 lots from the first quarter of 2012. We ended the quarter with our lot count up 21% from a year ago.

We are pleased with the progress of our transition to Nationstar, our new preferred lender. Nationstar began accepting new applications from homebuyers on May 1. We've been very impressed with what we are seeing thus far and are confident that this alliance, although it did not have a significant impact on our second quarter, will have a positive impact on our business and financial performance in the future.

Before I discuss the second quarter results in detail, I would like to provide you with our view of the current macroeconomic environment. Sustained job growth and improved consumer confidence are key drivers in an economic recovery, and both have demonstrated variability in recent months. Job growth has shown signs of improvement, although it is unclear whether this growth is at a level that will sustain an economic recovery. We're also concerned that consumer confidence has now declined for 4 consecutive months. I'm pleased to say, however, that the overall housing market appears to have largely stabilized and is moving into a period of recovery.

Real estate remains very localized, and the pace of recovery varies by city. Specific to the markets in which KB Home operates, we are seeing improvements in virtually every one of our 32 markets across the country. In fact, dynamics have improved significantly over the past 90 days as compared to late last year or early this year, with declining inventory levels and heightened consumer demand.

Prices have stabilized and in some select areas, increased as inventories of unsold homes are down significantly from year-earlier levels. Affordability, a key driver in this housing recovery, continues to be strong with attractive prices and historically low interest rates. As a result, we are observing a heightened sense of urgency among potential homebuyers. We are seeing healthy traffic levels with customers appearing more confident in making a home-buying decision. At the same time, however, mortgage availability remains challenging, freezing some homebuyers out of the market. As the recovery strengthens, we are hopeful mortgage underwriting will become less restrictive, which could unlock these potential buyers as well.

With the momentum we are building on our business and the Nationstar alliance gaining traction, we are generating net order and revenue growth, controlling our overhead expenses, increasing our backlog, enhancing margins and strategically positioning our communities with the right products in highly desirable submarkets. Now with the housing market stabilizing and our markets, in particular, rapidly improving, we are going on offense. We have intensified our focus on growing the business across all of our regions through the following 4 strategic initiatives: First, we are aggressively reinvesting in new land assets and communities, with plans to spend approximately $350 million on land and land development in the second half of the year.

Second, we are activating communities previously held for future development, capitalizing on markets that have now stabilized, where we know with confidence we can achieve desired returns. We have identified 10 such communities, primarily in Florida and Arizona, representing nearly 500 lots. We're in the process of permitting and constructing models to support opening these communities for 2013 deliveries and are continuing to evaluate our landholdings on an ongoing basis to identify additional activation opportunities.

Third, we are increasing revenues per community by driving sales performance and also refining product offerings to larger homes and higher price points.

And finally, we are strengthening our division management teams by bringing additional resources to the markets where we operate. During the downturn, we consolidated some of our divisions to gain efficiencies. In turn, now that the markets are recovering, an expansion in the number of divisions is prudent. As an example, we recently divided our Northern California division into 2 separate management teams: one prioritizing the Bay Area and the other prioritizing the Sacramento, Central Valley and Reno markets. We are already seeing a positive impact from this change with the benefits of improved community performance and increased land activity, far outweighing the incremental overhead. We have established growth targets for each city with action plans in place, and we are following up weekly with each division to track their progress. As I said, we are going on offense, and this is our game plan.

Now taking a closer look at our second quarter, as I mentioned in my opening highlights, we are very pleased with Nationstar, our new preferred mortgage lender. Nationstar began accepting new applications from our buyers on May 1, and the integration is progressing as planned. We are all very excited about where this opportunity with Nationstar can take us going forward, and we expect this to be a successful long-term alliance that will result in better mortgage origination execution and a more predictable business flow. The quality of our backlog, the predictability of deliveries and the efficiency of our business requires a reliable mortgage partner.

As we reflect on the last 18 months, we underestimated the impact that our mortgage relationships with Bank of America and MetLife had on our business. We experienced a great deal of disruption in the mortgage process for our customers during this period, first, when Bank of America pulled out of our joint venture, and subsequently, when MetLife withdrew from the Residential Mortgage business. At the time these lenders announced their intentions and started winding down their business, they further tightened already conservative underwriting requirements. Additional disruptions in the lenders' performance resulted from the turmoil associated with personnel departures. While in wind-down mode, neither lender had strong motivation to originate mortgage loans. While it's difficult to quantify the full impact of the disruptions, there's no question that it affected our business significantly. Our Built to Order model, which relies on the benefits and efficiencies of even-flow starts and deliveries, was impacted as loan approvals were delayed or lost on the front end and closings were postponed or canceled at the back end, understandably frustrating our customers.

Now that we have an alliance with Nationstar, which is committed to servicing our customers' mortgage needs, we can expect to see marked improvements. Although we recognize that it will take some time for Nationstar to fully integrate and achieve its targeted 70% sales capture rate, we expect to see significant positive impacts on our business with increased net sales, fewer cancellations, a better quality backlog, enhanced predictability and improved profitability.

Turning now to our initiatives for enhancing revenues, we continue to drive our strategy of moving into preferred submarkets, where we are attracting higher end first-time and first move-up homebuyers, who are purchasing larger homes. As a result, our average selling price continues to increase. Our average sales price for the second quarter was $233,000, an increase of 9% from the same quarter of 2011 and up 6% over the first quarter of this year. The primary driver of the increase in average selling price was in California, where the second quarter ASP increased by almost $100,000 per unit, up 33% over the same period last year, reflecting our evolution in the more desirable coastal locations.

In the second quarter, the average square footage of the homes delivered was approximately 2,100 feet as compared to the level [ph] of about 1,800 feet, which occurred in the second quarter of 2010. While we are opportunistically increasing pricing where we can, the majority of our revenue increase per unit is tied to our favorable community locations and higher square footage homes being selected by the consumer. And based on what we are seeing in our backlog, we anticipate the trends of higher average selling prices and larger homes will continue going forward.

Our Built to Order business model enables us to seamlessly meet this emerging consumer preference for larger homes and focuses on value and choice for the consumer. Not only the choice of floor plan and lot location, but also the exterior elevation, structural options and designer features. Each buyers selects options which are specific to their lifestyle, their wants, needs and budget. We believe our focus on providing the best value to the customer for a semi-custom-built experience, which they absolutely desire, drives demand and will ultimately result in our selling more homes at higher margins.

An integral part of the Built to Order model is the design studio, where the homebuyers select their personal design features and structural options that truly customize the home. Company-wide systems allow us to efficiently manage the studio and construction process at high levels of customer satisfaction. While the primary purpose of the studio is to help us sell homes, our studio pricing strategy is to set margins net of studio overhead that, on a percentage basis, are higher than the margins on the base home. As the markets eventually normalize, we are confident that the financial and operational benefits of our business model will become increasingly apparent.

Turning now to our net orders, I would first like to review how our investment strategy and ongoing repositioning of the company has influenced our short-term community count trends, which are a key driver in net order comparisons. As we have discussed on previous earnings calls, the majority of our land investment over the last 2 years has occurred in coastal California and Texas. We remained optimistic about our other markets, but we're not comfortable that they were demonstrating enough stability to ensure we would achieve adequate returns and therefore, our investments were more limited in the Southeast and Southwest regions. As I've already shared on this call, we are now seeing a recovery emerge across all of our served markets, and we are aggressively working to expand our community count in each of our markets going forward.

In the meantime, we have been going through a repositioning, where we've been closing out of a significant number of communities, while primarily only growing community count in our Central and West Coast regions. Jeff will give you more details on this in a few moments. While our community count was down in the second quarter, our net order performance per community improved, which resulted in the overall increase of 3% in our net orders and net order value growth of 18% year-over-year. This strengthening in net order value reinforces that our strategy is working and is why I am observing today, that we are much better positioned than we have been in quite some time. Our regional net order results reflect this strategic emphasis with the land-constrained markets in coastal California and the Central region performing particularly well. Our West Coast region, which includes our higher-margin coastal California communities and our slowly recovering inland locations, had a net order increase of 11% and net order value increase of 31% versus the prior-year period.

A great example of our ability to enter the higher-priced, land-constrained coastal locations is our newly opened Bay Area communities in Dublin, a highly desirable land-constrained East Bay suburb with very good schools and located near major employment centers and transportation. We opened 2 communities in March with strong sales from each at an average selling price of $462,000. Also, in our Central region, which includes Texas and Colorado, net orders increased 7% and net order value increased by 12%.

Boston and San Antonio continue to be 2 of the best housing markets in the company, with net order growth of 29%. We are retooling community and product offerings in Houston and Denver, which are both showing consistent improvement and are positioned for future growth. Southwest net orders were down 15%, and the net order value was down 3%, reflecting areas where we reduced community count as we discussed last quarter. However, in both Arizona and Las Vegas, the markets are benefiting from extremely low inventory due to strong resell activity. We are particularly excited about our Inspirada master plan development in Las Vegas, where we have just grand opened 2 communities in the new village, with sales prices and absorption rates well above projections.

In the Southeast region, net orders were down 8%, while the net order value increased by 6%. This was the region most affected by the community count reduction associated with our strategic shift. But the fact that our order value was up reinforces that our strategy of opening communities in more desirable areas is working.

Let me also share with you a couple of examples of how we are pushing new community openings as part of our strategy to grow our top line. As we announced on June 26, we acquired 174 finished lots in Irvine, California in the prestigious and highly successful Irvine Ranch master plan community. This is a great example of how quickly we can move to open a new community. We closed in June, and in July, we will be grand opening 2 communities with furnished models, offering homes ranging in size from 2,000 to more than 3,400 square feet and priced from the high $600,000s to over $1 million. We anticipate these communities will generate significant deliveries in the fourth quarter of this year and for all of 2013.

In the fourth quarter, we'll be opening a new townhome community in the heart of downtown San Jose, adjacent to Santana Row, the nationally renowned redevelopment project. With prices starting in the mid-$700,000s, this is an affordable community given its premier Silicon Valley location and we expect it to be extremely successful. We're also very excited about our upcoming opportunities in the Washington D.C. market, where we have 4 new communities grand opening in the second half of this year and where we introduced our net-zero model last week to enthusiastic consumer response.

These are just a few examples of the things we're doing to grow our revenue. With improving markets, the momentum in our business, the integration of Nationstar and our intensified growth strategies, we expect to be profitable by the fourth quarter of 2012 and profitable for the full year in 2013.

Now I'll turn the call over to Jeff Kaminski, who will offer the details on our financials in the quarter. Jeff?

Jeff J. Kaminski

Thank you. As Jeff mentioned, we made progress in our pursuit of profitability during the second quarter of 2012, and I will walk you through some of the details of our fiscal quarter financial results.

Starting with the bottom line, we narrowed our net loss by over $44 million during the second quarter, as compared to the same period of the prior year. The company posted a net loss of $24.1 million or $0.31 per diluted share for the quarter, as compared to a net loss of $68.5 million or $0.89 per diluted share reported for the same quarter last year. The 2012 results included $9.9 million of inventory impairment charges, while the 2011 second quarter included $20.6 million of inventory-related charges.

Total revenues for the quarter increased to $302.9 million, up 11% from the $271.7 million reported in the same period of 2011. This revenue growth was driven by a higher average selling price and a modest increase in the number of homes delivered. Revenues were up in 3 of our 4 geographic regions, with revenues in the fourth region nearly flat with the year-earlier quarter.

Our West Coast region generated an increase of 24% and was the largest contributor to the year-over-year revenue growth. Consistent with the guidance we provided last quarter, our quarter revenues reflect a conversion rate of approximately 59% of beginning backlog. We expect a similar conversion rate in our third quarter and more than 70% in the fourth quarter, as we continue to transition to our new preferred mortgage provider and manage the business towards a strong close of fiscal 2012. In fact, we anticipate that the combination of our higher expected Q4 backlog conversion rate and increasing average selling price should result in a sequential jump in Q4 revenues by as much as 35% over Q3.

The average selling price of our homes increased almost $20,000 to $233,000 in the second quarter from about $213,000 in the prior year. As Jeff mentioned, this 9% year-over-year growth reflects both the realignment of our operations in land investments toward higher-priced, better-located communities in stronger submarkets, as well as the increasing square footage trend. On a sequential basis, we expect our average selling price to slightly improve in Q3, with a strong increase in Q4.

Our housing gross margin for the second quarter was 16.9% compared to 7.3% in the same quarter of 2011 and 9.7% in the first quarter of this year. Excluding impairment and land option contract abandonment charges for all periods, the second quarter housing gross margin was 20.3% compared to 14.9% in the second quarter of 2011 and 12.3% in the first quarter of 2012.

Our housing gross margin in the second quarter benefited from favorable warranty adjustments of $11.2 million that resulted primarily from positive trends in our overall warranty claims experience. We are pleased that our past efforts to build high-quality homes and our solid track record in resolving claims on homes we have previously delivered were able to contribute a positive impact on our Q2 financial results.

We also recorded an insurance recovery of $10 million in the quarter. This represents a partial settlement with an insurance carrier for previously incurred expenses relating to construction defects, including Chinese drywall repair costs. While our discussions and negotiations with our insurance carriers are ongoing, as of the end of the second quarter, we have not recorded any additional amounts for potential future recoveries.

We are starting to experience higher costs for labor and direct construction materials such as lumber, concrete and drywall. Through the end of the second quarter, the impact of these higher costs has been offset by sales price increases, which we have implemented in a majority of our communities during the first 6 months of the year. We believe incremental price increases can continue to offset any further cost increases for the remainder of 2012, which should not result in margin erosion but maybe a headwind in relation to our margin expansion plans.

As I mentioned, our current quarter housing gross margin was impacted by the warranty adjustments, insurance recovery and inventory impairment charges. Excluding these items, our housing gross margin reflected a sequential improvement of 90 basis points as compared to the first quarter. We are anticipating sequential improvements in gross margin in the third quarter and again in the fourth quarter, when we expect a higher year-over-year comparison versus Q4 of 2011. We expect the improvements will manifest these higher-margin homes in backlog are delivered in the second half of the year.

Our selling, general and administrative expenses were $66.5 million in the second quarter 2012 compared to $62.5 million in the second quarter of 2011. As a percentage of housing revenues, our SG&A ratio improved by 1.1 percentage points in Q2 2012 to 22.1% from 23.2% in the same period of the prior year. The current quarter includes an $8.8 million non-cash charge resulting from a disappointing court decision in a Southern California contract dispute that we are appealing and intend to fight vigorously. Excluding the legal charge, our SG&A as a percentage of housing revenues was 19.2% in the second quarter of 2012, reflecting improvements of 400 basis points year-over-year and 290 basis points sequentially as compared to the first quarter.

Our consistent goal has been to align our overhead with current revenue levels and we are making progress. As we anticipate higher future revenues, we expect to capture further improvements due to operating leverage as we grow our top line and control costs.

Our operating loss for the quarter was $15.5 million versus $57.5 million in the second quarter of 2011. The operating loss as a percentage of homebuilding revenues for the second quarter is 5.2% compared to 21.3% for the second quarter of 2011. Excluding impairment and land option abandonment charges, the operating loss percentage improved to 1.9% from 13.7% in the second quarter of last year.

We expect to continue to report positive operating earnings for the full 2012 fiscal year, excluding impairment and land option contract abandonment charges. In relation to our operating margin, utilizing the operating income or loss number from our GAAP statements, the improvement should be well over 500 basis points as compared to the prior year. As you know, we have a number of favorable and unfavorable items impacting our operating results in both 2012 and 2011, including impairments, legal recoveries and charges, a gain on the sale of an apartment complex, warranty adjustments and the loss on loan guarantees. After adjusting our operating results for the impact of these items in both years, we believe we still will reflect a year-over-year improvement in the operating margin of between 400 and 500 basis points.

Moving to the community count, we ended the quarter with 217 communities opened for sale compared to 227 communities a year ago. During the second quarter, we opened 14 new communities and had 26 closeouts. It is important to note that a number of the communities that sold out during the quarter were some of the weaker-performing legacy communities and less-preferred submarkets generating relatively low margins. We are currently planning to open about 25 new communities during Q3 and Q4, and as we mentioned, we are actively pursuing additional opportunities to acquire land and develop land already owned to support additional top line growth in 2013. The number of closeouts in the second half of the year will obviously depend on the sales pace, but we do expect the community count to decline in Q3, with plans to increase the count as we start our new fiscal year in preparation to the 2013 spring selling season.

Our total land and land development investment in the second quarter was approximately $83 million, following first quarter investments of $113 million. We've increased our lot count by more than 4,500 lots since the beginning of the year, ending the quarter with about 45,000 lots owned and controlled.

As Jeff mentioned earlier, with signs of improvement in the housing markets, we have plans to aggressively pursue land acquisition and development. Our plans are to spend closer to the top end of our previous guidance of $400 million to $600 million for the year, and our current estimate is approximately $550 million. As always, the investment levels for the remaining quarters will depend heavily on overall housing market conditions and specific land opportunities.

We were pleased with our cash performance during the second quarter and our ability to increase lot count and still generate positive cash flow. We realized a significant year-over-year improvement in cash management, generating $20 million of positive operating cash flow in Q2 2012, as compared to $110 million of net cash used by operations in the same period in 2011. We anticipate that we will see a dip in the cash in the third quarter, reflecting our planned land and development investments and will be cash neutral for the full fiscal year.

Now I will turn the call back over to Jeff for some final remarks.

Jeffrey T. Mezger

Thanks, Jeff. Before I open the call up for questions, I want to reiterate today's key takeaway messages. The markets in which we operate demonstrated increasingly favorable supply and demand trends as the quarter developed. We're excited about our alliance with Nationstar as the transition is progressing very well and gaining momentum. We expect Nationstar to achieve their targeted capture rate of 70% of our new buyers as we are entering 2013. This should enable us to achieve improved net sales, fewer cancellations, greater predictability of deliveries and better mortgage banking customer service and ultimately, increased profitability.

We have a strong backlog in place as we enter the third quarter, up 38% year-over-year, with $693 million in potential future revenues at higher gross margins. We expect our average selling price to continue to increase as our product mix and strategic community shift in the higher-priced submarkets is proving successful. I want to reaffirm that we are expecting an average selling price of over $240,000 for the year.

With our operational momentum and the markets improving, we are going on offense, and I have personally made this my top priority. We are aggressively investing in land assets and communities, activating communities in stabilizing markets, increasing revenues per community and strengthening management teams with additional resources.

All of us at KB Home are committed to restoring consistent profitability and achieving our long-term growth goals. I'd like to thank the dedicated and hard-working employees of KB Home, whose contributions and talents continue to move our business forward.

Looking ahead, we expect to see further improved results in the second half of the year, particularly in the fourth quarter with ongoing year-over-year improvements in our deliveries, gross margin, average selling price and SG&A ratio, all of which will contribute to better overall financial results for the remainder of the year. With this momentum, we expect to achieve profitability by the fourth quarter and to be profitable for the year in 2013.

With that, I'll take your questions. Rufus?

Question-and-Answer Session

Operator

[Operator Instructions] And for our first question, we go to David Goldberg with UBS.

Susan Maklari - UBS Investment Bank, Research Division

Hi, this is actually Sue on for David. I wanted to get some more details in terms of the gross margins. You noted that you are basically offsetting the higher costs that you're seeing for labor and materials with the price increases. Can you give us some sense, though, of how much of the price increases are going to this and are any of them just going down to the bottom line to actually improve the underlying margins?

Jeffrey T. Mezger

Jeff, go ahead.

Jeff J. Kaminski

Yes, okay, sure. The first thing I'd like to say, I mean, just looking at the margin for the year, we do expect sequential improvements in both the third and the fourth quarter, and we do expect favorable year-over-year comp in Q4. What we saw last year, and I think it is important to remind everyone, we did have a $7.4 million warranty adjustment in the third quarter of 2011. And that benefited our gross margin by about 200 basis points last year. So there are a few things impacting the margin now turning to this quarter. We had a 90 basis point improvement, of course, versus the first quarter of 2012. That includes all the warranty and insurance recoveries. It was up about $9 million actually in dollars as a result of our rising ASP, which we thought was an important thing to note. It was about what we expected. We talked about that last quarter, and we did talk about the improvements in the back half. Turning now more specifically to your question on the labor and material prices. We think we had cost increases of about $1,200 a house. And we did offset, we believe, actually incrementally maybe just a little bit more than that with the pricing. So we are taking pricing opportunistically, but it has been relatively modest across the board. And we're moving it carefully on a month-to-month basis for a number of reasons, including being able to assure we can appraise our houses when we sell them. We are seeing continued improvement of margin in our backlog, and we should see that recorded gross margin as we deliver out those units in the back half of the year.

Susan Maklari - UBS Investment Bank, Research Division

Okay. And then my second question is just trying to get some sense around your confidence in the backlog. The cancellation rate moderated very nicely during the quarter despite the fact that you were still in the process of getting Nationstar integrated, and you're still going through that. Do you think that most of the noise, though, in terms of that integration is behind you? And we should just continue to see it come -- the cancellation sort of moderate as we go through the year?

Jeffrey T. Mezger

So let me make a few comments. We shared on our first quarter call that we had gone through an exhaustive scrub of our backlog at that time, and we felt our backlog was in much better position heading into Q2 than what we dealt with in -- at the end of the year in the first quarter. Nationstar really didn't have much of an impact on our backlog in Q2. That's a go-forward benefit that will be seen. Our can rate actually settled to the range that we've historically seen over the years may come down a little more with Nationstar over time. I don't know that we're really counting on that. What we do know is that we'll be able to hold and continue to improve the quality of the backlog going forward.

Operator

For our next question, we go to Michael Rehaut with JPMorgan.

Michael Rehaut - JP Morgan Chase & Co, Research Division

First question, appreciate the guidance in terms of the back half of this year and into next. And I just wanted to kind of do a little bit of a sanity check, very helpful in terms of the backlog conversion and revenue comments. But it would seem that to get to profitability in 4Q and also profitability in 2013, that you'd be looking towards a much more meaningful improvement in gross margins than you have demonstrated in the second quarter. And when I say that, I'm talking about excluding the -- both the land impairment charges, as well as the one-time benefits that the 2 different benefits you had. So right now, you're around 13% -- a little over 13%. I mean, it would seem that you'll need to get at least in the mid-15s if not 16% in the fourth quarter to hit profitability, and also for that matter, at least around 16% in 2013. Is that something that's achievable and makes sense to you?

Jeffrey T. Mezger

Yes. Mike, let me make a couple of comments and I'll hand it to Jeff for the math. It absolutely makes sense to us or we wouldn't share it. We did include in our prepared comments that we're going to have a crossover in gross margin in the fourth quarter, where we will be above year-over-year. And I also guided that we expect an ASP for the year of over $240,000. So you can do the math on where we think our ASP is headed in the back half of the year versus what you've seen in the first half of the year. So we have momentum with better product at higher price points and higher margins in backlog, and that's how we're projecting the crossover later in the year. Jeff, anything else you want to add?

Jeff J. Kaminski

Sure. Yes, I had a few things. The -- number one, I think you are thinking, Mike, about the margins in the right direction. As Jeff mentioned, last year fourth quarter, we did 15.1%. And you were north of that with your comments, and I think that's thinking about it the right way. We did mention, last quarter in our backlog -- inherent in our backlog, we're up about 200 basis points from year end. We're now up about 250 basis points from year end. And those deliveries will be closing out in the fourth quarter, so we are anticipating an increase there. And we're also increasing a pretty sizable jump in revenues. We believe our backlog conversion rate will be higher in the fourth quarter. We'll see a higher ASP in the fourth quarter. And the combination, I think, on the margin side and the leverage impact on our SG&A coming from the higher revenues will produce a result that we're forecasting.

Michael Rehaut - JP Morgan Chase & Co, Research Division

Great. And second question on the order trends. Last quarter, it was very helpful when you broke out that the spec business was down 30% and the to be built was up 20%. I wanted to know if you had a similar type of impact or trend in the second quarter. And more importantly, you've been -- looking into the back half, you have a year-ago comp dramatically more difficult than in terms of year-over-year growth that you saw in 2011. Do you expect the order -- I would think that perhaps the year-over-year order growth may decelerate or slip back into a negative territory in the back half, particularly with your community count comments. Is that the right way to think about that? Or if there are other kind of variables that we're missing? Because I believe you said also that the Nationstar would not necessarily materially further help the can rate from this point.

Jeffrey T. Mezger

Mike, that was more than one question. But I'll do my best because you rattled a lot off there. First, back to Nationstar, I would expect our community can rate may moderate a little bit, but we're already back to historical levels and can manage it. There's no question we had a strong second half in sales last year so we'll see how we're doing. We're not going to do -- we're not going to give guidance on this call. And underneath that, what you can tell from our comments is we're continuing to push significant revenue growth through the order value being generated. So if you look at Q2, units up 3% in revenue or sales value, I call it, up 18%. So it's a very nice trajectory that's still driving our top line.

Operator

For our next question, we go to Bob Wetenhall with RBC Capital Markets.

Robert C. Wetenhall - RBC Capital Markets, LLC, Research Division

I just wanted to ask about how you intend to fund your pretty sizable land spend. I think on your prepared remarks, you said you're looking to put out approximately $350 million of new land spend during the back half of the year. And I was also trying to understand, I think, Jeff Kaminski's remarks about being cash neutral for the year and where you would see year-end cash balance.

Jeff J. Kaminski

Right, Bob. As we said last quarter, we had a range, $400 million to $600 million on land spend, and we've been talking pretty much consistently all year that we anticipate a cash-neutral year in 2012. We do see consistent and improving operating performance as a first priority of our balance sheet strengthening strategy. We were pretty pleased with generating positive cash flow this quarter, albeit on a lower land spend. But nonetheless, in a quarter where we typically have a net usage of cash, we were quite pleased with that. So that was helpful for us. We do -- we definitely have current -- currently sufficient liquidity around our business. We're able to be flexible and opportunistic with potential new investments. Jeff spoke of a few pretty sizable investments, in fact, during the prepared remarks that we think will bring nice revenue and margin growth to the business in the future. The focus on the business right now is returning to profitability, purchasing and developing land to support our top line growth going forward, especially as we're seeing the markets improve. Maintaining adequate liquidity is an absolute focus of ours and strengthening the balance sheet. And we do think we can do those things together. If we have to make trade-offs as we go through the year and we see some great land opportunities that will bring growth to the business especially in the short term, we may prioritize that a bit over the cash-neutral stance that we're taking in order to reap the benefits from that. But overall, our financial forecasts support it. We're in store for a pretty sizable revenue increase in the fourth quarter and in addition to the profits that, that will bring, it will monetize a lot of the land investments that we already have in the floor. And we've been doing a pretty good job of churning through the land and reinvesting, I think, over time, so that's the game plan going forward.

Robert C. Wetenhall - RBC Capital Markets, LLC, Research Division

That's very helpful.

Jeffrey T. Mezger

Bob, if I could reinforce a couple of things. As you know in our business cycle, the fourth quarter is an absolute ATM in terms of generating cash, and we're projecting revenue increase over last year. And last year, I think it was $200 million or $250 million in cash we generated just in the fourth quarter. So -- and part of our normal rhythm, there's a lot of cash coming in over the second half of the year. And I also wanted to reiterate what Jeff shared. While we're saying that level of land spend, cash neutral, if we were to drop $40 million or $50 million because of some great opportunities in the fourth quarter, we're going to chase the opportunities. It doesn't put our company at risk at all. We have ample liquidity. We're going to run the business. Business is stable and improving, markets are stable and improving, and we're comfortable with our liquidity position.

Robert C. Wetenhall - RBC Capital Markets, LLC, Research Division

I guess going on offense, right?

Jeffrey T. Mezger

Yes.

Robert C. Wetenhall - RBC Capital Markets, LLC, Research Division

Just -- if I could just get a little more granular on your gross margin performance. If you had to rank it in terms of where the upside is coming from in the second half of the year, is it better ASPs, is it lower incentives or is it the benefit of the closeout of lower-margin communities from a mix standpoint? If you had to rank those 3 in terms of providing upside, what's the real driver?

Jeffrey T. Mezger

Well, I think it's all of the above, Bob. It's hard to identify just one thing. We're not an incentive-heavy company in the first place. So that you won't see a lot of margin enhancement because of incentives. But the communities that we have opened today are frankly far better than those that we closed out of the year ago. So we have the natural margin expansion of our newer communities at much higher sales prices. We're not banking on inflation. We don't anticipate. I always take the view, if you get a little price, it's covering costs because costs go up when price goes up. So there's no banking on the markets giving it to us. It's through our hard work.

Operator

We go next to Joshua Pollard with Goldman Sachs.

Anto Savarirajan - Goldman Sachs Group Inc., Research Division

This is Anto for Joshua Pollard. For the Arizona and Florida, where are the activation opportunities that you see? And related to that, as you un-mothball these communities, how much of a margin dilution do you expect coming from these communities?

Jeffrey T. Mezger

Great question. We've actually seen some situations where submarkets have rallied, where the activation actually comes in at a normalized margins. I don't know that we would say that in all of them. And it's a balance. It's not just the margin. It's how much cash do we get out. The Arizona activations are in the Phoenix Metro area. And in Florida, it's Central Florida, around Orlando and headed down toward Sarasota.

Anto Savarirajan - Goldman Sachs Group Inc., Research Division

Understood. On the issue of adding additional resources, can you talk us through how you figure that flow-through to operational leverage? Because the gross margin opportunities are slightly better than laid out. The thing that we can get a little bit more clarity on is how you figure on operational leverage as you add those additional personnel.

Jeffrey T. Mezger

Okay, let me give you a little geography lesson relative to my comments on Northern Cal, because we have one division covering that territory that ran from San Francisco to Reno and 70 miles north of Sacramento all the way down to Fresno. And it wasn't physically possible in a business like ours for that team to optimize the management of the marketplace. We knew that when we made the decision in that we knew we weren't going to be acquiring a lot of new communities in the Central Valley until the markets had settled down and stabilized. And we went into asset management mode in the Central Valley and pushed growth in the Bay Area, and that was the team's primary focus. And as the Central Valley, Sacramento, Reno are now improving, if you need local boots on the ground, as I call it, to be out hunting for new deals and in the sales offices and understanding the competition while your Bay Area team is focused on finding the next Dublin deal or the next Santana Row where the margins are incredible. So you continue to push your business in the coastal California area and the incremental cost for the management that you've added in the Central Valley, you get back with the first community that they identify and along with better execution on a daily basis in the stores that are open. I don't know if you want to give him any math on that.

Jeff J. Kaminski

Sure, I'll just add a little bit to it. I mean, it comes down to redeployment of resources as much as anything. I mean, you still have the construction supervisors out there in a well-spread geographic region. When you split it, it's the same resources out the field. We did what we could to lean up the old operation that included both divisions. When we split it, so obviously, we split out some resources. And on an incremental basis, it really wasn't that much of an increment on the SG&A side.

Jeffrey T. Mezger

It's a very nice outcome in that example.

Operator

And for our next question, we go to Ivy Zelman with Zelman & Associates --

Ivy Lynne Zelman - Zelman & Associates, Research Division

When you talk about the land spend going forward, we've seen a heated land market, especially on desirable finished lots and a concern by the investment community that builders are going to have to pay up for those lots or expand into less desirable locations, BNCs [ph], and actually going -- we've seen an increase in activity on the raw undeveloped or partially developed and titled side. And so wondering if you can give us some maybe direction or transparency. As you're talking about acquiring as much land as you are, your views of the land market and maybe some benchmarks in terms of are you using the absorptions in your underwriting that you're currently running at, what are your assumptions on underwriting them? And at what percent of revenue would you say that the finished lot cost would be running? And will you go to undeveloped because that's really not been part of your strategy, so understanding if you can break that down. That's the first question, please.

Jeffrey T. Mezger

Sure. What -- as I always say, Ivy, and you and I have talked about it, every market has a little different story in your questions. On the -- in terms of finished lots that are readily available and everyone chases, there's no question in A locations, those are hard to come by today. That's typically not where we find our lot deals. Most of our acquisitions are those that were created to our local land teams that have a network with sellers, banks, developers, other builders on communities that frankly may not ever even hit the market. And through your relationships, you're able to mine things that way. We've been doing development deals in coastal California for a couple of years. And it's an area of expertise that I think actually is a competitive advantage for us in California. We wouldn't be as interested, obviously, on development deal further inland, where you may not have the same financial returns. And I compare and contrast that to Houston, where there's -- there are lots on the ground around the market that you can acquire today in A locations, where, while land prices are up, they're not up to a point where you can underwrite and get your returns today. If you go over to San Antonio and Austin, it's a little more land-constrained and a little more development-oriented. And again, there, we have a great team on the ground that's been doing development deals over the last year or 2. And so it's a mixed bag across the system. There's no question that it's tight. If you have good teams on the ground, you can still find opportunities. And we have a significant level of deal flow that we're looking at right now to make sure that we invest appropriately in the right deals. We are not banking on price. It has to underwrite with the current market conditions, whether sales-paced or price assumption in that submarket. So no price, no increase. We're not banking on anything getting better, and it has to hit our return hurdles today, which we have not compromised.

Ivy Lynne Zelman - Zelman & Associates, Research Division

That's very helpful. And Jeff, just a follow-up, in terms of the current land that you own and control, can you tell us of that just a breakdown of what's finished and what's either partially developed or being developed or just starting out undeveloped? And then also, how many communities are mothballed, currently, as a percent of all communities that will come on, that might be part of the growth going forward?

Jeff J. Kaminski

Okay. Ivy, I'll try to give you some numbers there. As far as owned land that's not under option, we have about 13,000 lots. We have lots under option about 12,000, and we have about 19,000 lots held for future development. I don't have that broken down specifically by community, but it's pretty sizable amount in each of those categories on a go-forward basis. So it's about $1 billion of 13,000 lots, about $1 billion homes under construction, land under development currently in the balance sheet plus the other 2 categories.

Jeffrey T. Mezger

Was that 2 separate billions?

Operator

And we go next to Dan Oppenheim with Credit Suisse.

Daniel Oppenheim - Crédit Suisse AG, Research Division

I was wondering, you talked about a very positive environment, clearly better trends from buyers, more predictability with the mortgage issues being resolved here, going on offense. I guess, just thinking about that, can you talk about with the land acquisition, how you'd pursue some of those at the expense of potentially being cash flow negative for the year? Given the much stronger environment, why not do something to add more dry powder in the near term to then enable you to do that and to ease some of the worries about the balance sheet?

Jeffrey T. Mezger

Well, Dan, for starters, we didn't say we'd be cash flow negative for the year, we just said we'd be cash flow neutral, spending a pretty significant amount of money on new deals in the second half of the year. We're not going to use the $350 million as a cap, though. If that -- if we spent $350 million and it's cash flow neutral, we have a lot of dead cash on our books, frankly, because we are not putting it to work and it's way more than we need to run the business. So we would err on the side of -- if we used a little more cash but it was a great opportunity, we would do it. And at this time, we're not even discussing the ability and capability we have if you wanted to go do some kind of financing deal with the seller and all that. We look at these deals first and foremost right now as a cash play, because we want to get the highest margin possible. But we're very comfortable with our liquidity at this time.

Daniel Oppenheim - Crédit Suisse AG, Research Division

Okay. And then I guess you talked a lot about coastal California, and I think you said East Bay and Dublin in terms of higher margins on that. And such, when you're looking at those projects, how much more you're willing to do? And clearly, I think Ivy had mentioned in terms of a heated market, and how are you thinking about margins on some of these communities if you -- as you look forward? Clearly, there's been some price appreciation as of late. X that appreciation, where do you think you can go in terms of margins on new acquisitions there?

Jeffrey T. Mezger

Well, let me give you another example, Dan. I said you're only as good as your land team on the ground in my response to Ivy. The 2 communities that we just acquired from Irvine aren't communities that any builder could come in and acquire. They're a very relationship-oriented company. And frankly, they came to us first because of all the great business we've done together over the years. Up in Dublin or the Bay Area, we have a land team that's been in place almost 20 years with a phenomenal track record of getting things entitled and navigating through that maze at a level that most companies in California could not do. So there's ways we can generate opportunities, especially in California, where we've been so long and are so tenured that other people just couldn't get done. Our typical approach has been to focus on IRR first, and our range has been around 25% IRR. D.C. needs to be at least 17% or 18% on that IRR, which would equate to a little over 20% growth. And if I had to give you a math trade-off between D.C. and the IRR, it would need to be above 40%. So if the IRR is 20%, the margin's got to be higher. And if the IRR is 25%, you'll take a little bit lower margin. And we haven't changed on that. And what's always interesting to me while there's no question the housing markets are getting better, the land sellers figured it out first. So land prices are going up every bit as fast, if not faster, than home prices are. And that's why the margins -- I don't think we'll see much margin expansion.

Operator

We go next to Adam Rudiger with Wells Fargo.

Adam Rudiger - Wells Fargo Securities, LLC, Research Division

Just to make sure I understand the whole Nationstar impact, can you describe the selling process or maybe the closing process, if that's more important, pre-May 1 and post-May 1, just so we really understand exactly how this can positively impact your business and how it can streamline the buying process for the buyers?

Jeffrey T. Mezger

Certainly, Adam. Pre-May 1, I can paint you a picture at the depths of despair in Met. While MetLife was winding down, their capture rate was actually below 25%. 75% of our customers were being directed outside to a lender who had no interest in frankly supporting KB Home. And that, that loan could be one of thousands they would have under process. And if you reflect back on my comments on our business model, where we're a little different, is we get the loan approved before we start the home. And then it may take 3 months to build and close the home from that point in time. So a loan officer doesn't get compensated until the home closes 4 months later. When it's an outside lender, their priority is how do they get paid this month. And giving us a loan approval for a start isn't always their top priority. So we had no alignment, whether it was MetLife, because they were winding down or BofA before them or with all these outside lenders, who didn't have the same desire to build a business with us that Nationstar now does. So as we've rolled over to Nationstar and they're out taking loan apps and building their teams and they took whatever was left of the MetLife pipeline, which I think was about 25% of our business at the time, they are now giving us the daily process and daily reports that we used to have, where we can get approvals every day to start a home and then in turn, project out closings and have a more predictable closing process. So the processes are now in place with them. They're just now ramping up the capture rate. And that's why it'll take some time before we see the full benefits. But we're very excited about what they've done to date. They've delivered on every promise.

Adam Rudiger - Wells Fargo Securities, LLC, Research Division

Okay. And so when you think about your orders relative to your peers, where they've shown some -- and even, let's look at it on a per-community basis, some stronger growth recently, do you attribute all of that or most of that to Nationstar? Or are there any other factor or to a lack of mortgage partner recently? Or are there any other factors that you think are explaining some of the differences?

Jeffrey T. Mezger

I certainly believe that our mortgage situation impacted our sales, whether gross or can rate in the in turn, net. It's very hard to quantify. I know if this thing gets fully up and running, we'll sell more houses. I think on a per-community basis that our sales are typically in the higher end of the range among builders, and that's where we were last year as well. So I don't know that because of -- we've been fighting this Nationstar thing for a while and actually been doing relatively well per community. I think you'll now see us lift a little bit. So the caution is it'll take some time for Nationstar to have full impact, and it'll get a little bit better each month that goes by. And coming out of the year, we think that they'll be there. And we do have tough comp coming at us in Q3 and Q4, so we'll see how the 2 quarters unfold.

Operator

And with that, ladies and gentlemen, we will conclude our question-and-answer session. And Mr. Mezger, I will turn the conference back over to you for any closing remarks.

Jeffrey T. Mezger

Thanks again, Rufus, and thank you, everyone, on the call for again joining us this morning. Have a great day, and we look forward to speaking with you again soon. Thank you.

Operator

And again, ladies and gentlemen, this does conclude today's conference. Thank you 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 Management Discusses Q2 2012 Results - Earnings Call Transcript
This Transcript
All Transcripts