This summary is based on the third quarter fiscal 2008 earnings call conducted by KB Home (KBH) on September 26, 2008.
Management:
President and CEO: Jeffrey Mezger
EVP and CFO: Domenic Cecere
Sr. VP and CAO: William Hollinger
Sr. VP and Treasurer: Kelly Masuda
Key Investor Issues:
- Q3 net orders fell 66% to 1,329 homes.
- The Q3 average selling price dipped 10% to $239,700 from $267,700 in the year ago quarter.
- The housing gross margin in Q3 was a positive 3.9% versus a negative 28% in Q3 of 2007.
Third Quarter Financial Highlights:
The past few weeks were historic and represent the most drastic change in the capital markets.
- The management reported that the past few weeks were characterized by government intervention.
- The intervention represents steps towards stabilizing the mortgage markets and increasing consumer confidence.
- The company reported that the current proposal provides no direct relief for housing despite the fact that policy makers recognize that housing will be a cornerstone for the broader economic recovery.
- The broad lending standards are reportedly tightening amidst the changes in the market.
- The company anticipates further decreases in consumer confidence within the mortgage market.
The company reported success with decisions towards being among the first builders to recognize the importance of having a strong balance sheet with plenty of cash on hand during a downturn.
- As a result of the choice, the company entered the third quarter with reduced debt levels and a sizable cash balance of $942 million.
- The management expects to be cash flow positive for the full year 2008 with more than $1 billion in cash and no cash borrowings outstanding on unsecured credit facility at year end.
- The company is now focusing efforts on maintaining the strong balance sheet position while restoring profitability.
The Q3 net orders decline of 66% was driven largely by three factors.
-The management enforced price discipline amidst some very powerful downward pressures.
- As a result of the cash position, the company does not have to sell and build homes at a loss just to generate cash.
- The company’s community count was down by 38% year-over-year and more than 50% from the 2006 peak.
- The company will continue operating with fewer communities until investments in new communities deliver financial results with acceptable returns.
- The management accelerated a major product transition strategy which slowed the sales pace in a number of communities in the short-term.
The most significant move in the quarter was accelerating the transformation of the product line.
- The management sharpened focus on the first-time buyer.
- The company advised that many of the product offerings were not aligned with their current needs and affordability levels.
- The houses were reportedly too big, included too many costly features and as a result were too expensive for our core customer.
- The management has begun downsizing and down-spacing homes.
- In California’s Inland Empire region, the company quickly moved from building 3,400 foot homes that sold for $450,000 to building 2,400 foot homes that sell for $300,000.
- The company has currently introduced a new line of homes that start at three bedrooms and 1,230 square feet for just over $200,000.
- The $200,000 price is very competitive with today’s resales including foreclosures.
The net orders of 1,329 new homes in the third quarter were down 66%.
- The decline was largely due to the reduced community count, down 38% from a year ago, and the strategic decision to hold firm on pricing and reduce the use of sales incentives.
- In addition, the management designed and are introducing new more affordable product at several of the communities better tailored to the needs of today’s first-time home buyer and is more cost effective to build.
- Amidst this transition, the company is shutting down some communities for a short time and consequently is experiencing a temporary lag in orders in other communities where the current product will be discontinued.
- The company anticipates having the new more affordable product on line by the first quarter of 2009 which should have a positive impact on orders going forward.
- There were 232 active selling communities in the third quarter of 2008, down 38% from 372 in the third quarter of 2007.
- The community count was lower across all four of the regions with decreases ranging from 33% to 41%.
- The management reiterated that the highest operating priority remains increasing margins and returning profitability.
- The company will continue to review and adjust community counts as appropriate to maximize performance in each region.
Third quarter order cancellations as a percentage of gross orders were essentially flat at 51% in the third quarter of 2008 compared with 50% in last year’s third quarter.
-The cancellations as a percentage of beginning backlog however continued to improve.
- The rate was 22% in the current quarter, down from 33% in the second quarter of 2008 and 29% in the third quarter of 2007.
- This is the lowest rate experienced since the first quarter of 2006.
The company entered third quarter with 6,233 sold homes in backlog and converted 2,788 or 45% of the beginning backlog to revenue during the period.
- This compares with a conversion ratio of 42% in the third quarter of 2007.
- The backlog remains geographically diverse with the largest portfolio on a value basis located in the West Coast and Southeast regions.
- During the quarter, the company recorded a $58 million charge for a deferred tax asset valuation allowance.
- An estimate 2,788 homes were delivered in the third quarter of 2008, down 51% from the year earlier quarter.
-This reflects the reduced community count and the very challenging market conditions that have hampered net orders for the past several quarters.
- Each of the regions delivered fewer homes compared with the year earlier quarter with decreases ranging from 42% to 63%.
- The management forecasts community counts to remain at reduced levels through the end of the year.
