KB Home (KBH
Q1 2009 Earnings Call Transcript
March 27, 2009 8:30 a.m. PT
Kelly Masuda – Senior VP & Treasurer
Jeffrey Mezger – President & Chief Executive Officer
William Hollinger – Senior VP & Chief Accounting Officer
Carl Reichardt – Wachovia Securities
Dennis McGill – Zelman & Associates
Dan Oppenheim – Credit Suisse
Michael Rehaut – JP Morgan
Jim Wilson -- JMP Securities
David Goldberg – UBS Securities
Stephen East – Pali Capital
Josh Levin -- Citigroup
Kenneth Zener – Macquarie Research
Megan McGrath – Barclay’s Capital
Joshua Pollard -- Goldman Sachs
Nishu Sood – Deutsche Bank
Joel Locker - FBN Securities
Good day everyone and welcome to the KB Home first quarter earnings conference call. (Operator Instructions) As a reminder today’s conference call is being recorded and webcast from KB Home’s website at kbhome.com. The recording will also be available via telephone replay until midnight April 6th 2009. You can access this recording by dialing 719-457-0820 or 888-203-1112 and entering replay pass code of 7081455. KB Home''s discussion today may include certain predictions and other forward-looking statements. These statements may cover market or economic conditions, KB Home''s business and prospects, its future financial and operational performance and/or future actions or strategies and their expected results. They are based on management’s current expectations and projections about future events and business conditions but are not guarantees of future performance. Due to a number of risks, assumptions, uncertainties and events outside its control, KB Home''s actual results could differ materially from those expressed in, or implied by the forward-looking statements. Many of these risk factors are identified in the company’s periodic reports and other filings with the SEC, which the company urges you to read with care. For opening remarks and introductions I would now like to turn the call over to KB Home’s President and Chief Executive Officer, Mr. Jeffrey Mezger; please go ahead sir.
Jeffrey Mezger – Chief Executive Officer
Thank you, Darrell. Good morning and thank you for joining us for a review of our results from the first quarter of 2009. With me this morning are Bill Hollinger our Senior Vice President and Chief Accounting Officer and Kelly Masuda our Senior Vice President and Treasurer. This morning I’d like to share with you my thoughts on the current housing markets our net order performance and our progress towards restoring profitability. I’ll also talk about how KB Home’s strategy is different than others in our industry and how we are executing on our strategy. After Bill provides you with the financial update I’ll have some closing comments about the status of our roll out of the open series array of new home designs where our initial buyer response has been encouraging. Since our last earnings call in January we’ve continued to experience a difficult national housing environment still burdened by an over supply of homes and declining sales prices. The recessionary economic environment punctuated by rising unemployment and falling consumer confidence has only added to these difficulties. Yet in the middle of these ongoing economic challenges we are seeing some signs that the housing market is functioning according to fundamental economic principles. The median home sales price is now less relative to income levels than has been at any time in the past forty years. In addition to these low prices, mortgage rates have fallen to all time lows increasing affordability even further. As a result of this combination of low prices and low interest rates, buyers have become more active. Data released earlier this week from the National Association of Realtors shows that February existing home sales bounced sharply off their lows. Resale inventory picked up slightly as foreclosures continued adding to the housing supply. But the current inventory of unsold homes should begin clearing if the sales rates continue their current trend. While the median resale price in February declined 15% year-over-year the NAR reports reflects that sales prices stabilized sequentially from January levels, an event that has not happened quite sometime. While one month does not establish a sustainable trend these early indicators are encouraging and the federal government has made it clear that it remains committed to reducing foreclosures keeping mortgage rates low and ensuring that homes remained affordable. We see a great deal of buyer awareness about the $8,000 federal tax credit for qualified first time homebuyers in all our markets. But at this point we do not believe that tax credit alone is having a material impact on traffic or sales.
In California however the additional $10,000 tax credit for buyers of new homes has created a significant $18,000 total combined tax credit which we believe is helping contribute to increased sales activity in the state. Lastly, we are hopeful that the unprecedented amount of federal stimulus money being injected into the economy would have its intended affect of creating jobs and building consumer confidence which are prerequisites for housing market recovery. All that being said I want to repeat what I have shared over the past few earning calls. We are now relying on outside intervention for help and our strategy is not based on unrealistic assumptions about the future of the housing markets. Instead we continue to identify and implement actions that enable us to operate successfully no matter the economic climate. We’ve consistently focused on a set of core strategic objectives that include generating cash and strengthening our balance sheet, developing innovative new products that help us to compete with resales and foreclosures, restoring profitability by executing our KB Next business model, reducing overhead, and lowering our cost to build and provision ourselves to be opportunistic when the housing market stabilizes. While it is till early, our progress toward these objectives confirms that we are on the right track. Turning to first quarter net orders are 26% year-over-year increase is certainly a positive development. This is the first time in 13 quarters that our net orders were up on year-over-year basis. These results were due in large part to a combination of product positioning that enabled us to compete effectively with resales and foreclosures, favorable buyer response to the open series array of new home designs and the intensity with which our sales team executed on our sales strategy.
built-to-order KB Home offers.
As I have noted on previous calls, and consistent with the NAR data release this week, we believe first-time buyers represent the most attractive segment of the market and that they do not have to sell a home before purchasing and can access readily available FHA& VA financing. Our strategy of targeting these buyers continues to generate results. Not only did our net orders grow this quarter, we also increased the number of homes delivered to first-time buyers to 70% of our deliveries. This is a significant increase from 53% in the first quarter of 2008 and 65% in the fourth quarter of 2008. While we expect our second quarter ''09 net orders to fall below their year earlier levels, primarily due to a more difficult comparison against 2008, we do expect sequential growth in net orders in the second quarter and through the remainder of 2009. We believe we can sustain increased sales even with a lower community count due to higher absorption rates per community. We also expect our year-over-year net order comparisons to be positive for both the third and fourth quarters. Our backlog increased during the first quarter as net orders exceeded the number of homes we delivered by approximately 400 units. Looking out over the next two quarters our goal is to continue to build our backlog as net orders should outpace deliveries. Of course our overriding objective is to position ourselves to restore profitability. And a growing number of performance indicators confirm that we are on the right strategic path. While we are not there yet, we are approaching break even. Once we achieve break even we can advance toward our goal of turning sustainable net profit.
Our SG&A expenditures were down more than 50% year-over-year and we constantly look to identify additional opportunities to reduce overhead further. While SG&A as a percentage of revenue increased during the quarter due to the sharp decrease in our revenue, we believe we have both the right framework and urgency to drive additional cost reductions over the balance of 2009. Our KB Next operational business model will continue to be the centerpiece of our cost reduction efforts. By continuing enhancing our execution of the model and implementing our new product strategy we are developing a long-term capability to build and deliver homes profitably at much lower price points. Our objective is to ensure that KB Home will be the low-cost producer of quality homes for the first time, first move up and active adult buyers. We are in an extremely competitive housing market where buyers face an abundance of inventory from resales, foreclosures and other builders. That is why we believe it is essential to relentlessly differentiate ourselves in the marketplace. And while we are aggressively developing and promoting KB Homes product and brand attributes to potential homebuyers, our most important differentiator is the built-to-order experience we offer. That experience becomes especially attractive to buyers when they compare a KB Home to a resale or foreclosure. A home purchase is a deeply personal decision and the aspiration of buyers is for their new home to be their dream home. By offering choice on location and floor plan and then on the options available at our KB home studios we create a personalized home buying experience that is simply not available elsewhere. While other builders have been deemphasizing choice and closing their studios we are offering our buyers more choices to customize their homes and our studio sales have been consistently strong. And not only does our built-to-order experience deliver high customer satisfaction, the homes we build meet a high standard of quality. With the NAHB research center this week we are firming our position as the only builder to earn the rigorous National Housing Quantity Certified Builder designation for our nationwide operations.
We also associate the KB Home brand with some of the world''s leading brands such as Disney and Marcus stores. Our latest collaboration with Disney to create personalized Disney themed bedroom designs which are exclusively available at every KB home community is just one example of how we differentiate ourselves in a competitive market. As I have asserted for sometime now we believe buyers want their new home to be environmentally friendly and energy-efficient. That is why we have made a long-standing commitment to Energy Star and to educating buyers about how energy efficient, environmentally friendly homes can save their money on energy costs while promoting sustainability. We were recently recognized by the US Environmental Protection Agency as the only national home builder honored with its 2009 excellence in Energy Star Promotion Award. Beginning this year, all of our new home communities are fully Energy Star qualified, another differentiator in the marketplace. Homes that are fully Energy Star qualified have been shown to be as much as 45% more energy efficient than homes built as recently as a decade ago saving our home buyer''s money and energy costs for years to come. I believe that our commitment to innovation and continuous improvement is a big reason why we were honored on Fortune Magazine 2009 list of the world’s most admired companies as the #1 home builder. It is the second year in a row we topped the Fortune list and the third time in four years. These rankings are based on voting by our peers in the home building industry and the financial analyst community and we are proud to join other industry leaders such as Google, Nike, IBM and Wal-Mart. This recognition reflects the dedication and commitment of the entire KB Home team and I’d like to thank them for their hard work and congratulate them on their performance during the quarter. So, before I turn it over to Bill, let me recap our position. To begin with despite the challenging economic environment we were able to generate positive sales momentum and look to continue sequential net order grow. This growth should also enable us to continue to increase our backlog over the next few quarters. We are positioning ourselves to restore profitability by keeping pressure on overheads and driving a disciplined execution of our KB Next operational business model. We continue to focus on generating cash and strengthen our balance sheet and maintain our commitment to managing the positive cash flow from operations for the full year 2009. And we are aggressively differentiating KB Home in the market versus resales, foreclosures and other builders, a strategy that we believe is already paying dividend. There is much more work to do but I believe we have energy and momentum. We are well positioned to make the most of today’s housing market and seize new opportunities as they arise. Now, I’ll turn it over to Bill for more detailed recap of our first quarter. Bill?
William Hollinger – Chief Accounting Officer
Thank you Jeff and good morning everyone. Our first quarter financial result demonstrated the progress we have made towards restoring the profitability of our operations through sound strategy and strong execution. Compared to a year ago we significantly reduced asset valuation charges, improved our gross profit margin and lowered our overhead costs. As a result we reduced our net loss considerably in the quarter despite delivering fewer homes. For the first quarter of 2009 we reported a net loss of $58 million or $.75 per diluted share compared to a net loss of $268 million or $3.40 per diluted share a year ago. Our first quarter results included pre tax non-cash charges of $32 million for inventory and joint venture impairment and land option contract abandonment. That is an 86% decrease from 223 million impairment charges last year. Our inventory impairment charges decreased substantially from both a year earlier quarter and from the fourth quarter of 2008 despite our overall average selling price dropping 15% year-over-year and 9% from the fourth quarter of 2008. Our impairments are more closely tied to the prices on orders we are taking than they are on current delivery. For the most part we experienced no significant decline in prices on orders in the first quarter versus the level we had anticipated in our impairment analysis in the fourth quarter. As a result we did not have sizeable impairments this quarter. However, while our impairments have dropped considerably, we recognize that if market conditions deteriorate from here it is possible we will have additional impairments charges in the future. Adjusting for the asset valuation charges our first-quarter pretax loss would have been $27 million versus $44 million a year ago, that is a 38% improvement year-over-year. With similar adjustments, our current quarter net loss would have been $16 million or $0.21 per diluted share compared to a $27 million or $0.35 per diluted share in the first quarter of 2008.
Home building revenues in the first quarter totaled $306 million down 61% from a year ago, primarily due to lower housing revenues. Housing revenues for the quarter were $304 million down 58% year-over-year, the result of a 51% decrease in new homes delivered and a 15% decline in our average selling price. The reduction in the homes delivered was primarily driven by a 46% decline in our community count. The lower average selling price reflected both the state of our housing market which continued to absorb downward pressure on prices and our continued roll out of more affordable value-engineered homes designed to attract today''s cost-conscious first-time buyers. Our housing gross profit margin improved to 4.9% in the first quarter up 11.1 percentage points from a -6.2% a year ago. If we exclude inventory-related valuation charges from both periods, this margin increased by 400 basis points to 13.0%. Furthermore, our gross profit margin was nearly flat with the fourth quarter of 2008, despite a 9% decline in average selling price. We are pleased and encouraged by our progress to date and are improving our housing gross profit margin particularly with our average selling price having decreased. Some of the year-over-year gross profit margin improvement was due to reductions in our comps to build homes. Out home building business is now seeing real benefits from the execution of our strategic initiatives to value engineer our products, reduced direct construction costs and increase operating efficiencies, all of which are shaped by the discipline of our KB Next operational business model as Jeff mentioned earlier.
Our year-over-year improved gross profit margins also reflected the benefits of impairments taken in prior quarters. Selling, general and administrative expenses totaled $61 million in the first quarter, down 52% from a year earlier period. Significant savings in the first quarter came out of marketing expenses, salaries and other payroll related expenses and compensation plan. We‘ve curbed our advertising print media by shifting even more to the Internet, an outlet we’ve found very effective in the reaching our buyers. Our savings in the payroll area reflects the dramatically reduced headcount which was driven largely by division consolidations. During the quarter we made additional consolidations in Arizona, Florida, North Carolina and Texas. The savings realized from these consolidations should become more apparent as the year unfolds. Meanwhile overhead cost reductions remain our top priority. We will continue to scrutinize expenditures, challenge our organizational structure and look for new opportunities to achieve further cost savings but always with an eye toward preserving our ability to respond quickly when the markets stabilize.
Our SG&A expense ratio was elevated in the first quarter even with the major steps we have taken to streamline our organizational structure. As a percent of housing revenues the SG&A expenses were 20.1% in the quarter versus 17.6% a year ago primarily due to the sharp decrease in our housing revenues. While we will continue to take actions to reduce this percentage it will run on the high side relative to historical levels due to our conscious choice to maintain a strategic platform for growth and markets that have generated delivery volumes that are more than triple our current levels. The combined effects of our gross profit and SG&A expenses resulted in our home building business generating an operating loss of $46 million in the first quarter. That includes charges of $25 million for inventory impairments and land option contract abandonments which are reflected in cost of sales. Most of these impairments occurred in our West Coast and South West regions where selling prices fell. By comparison our business generated an operating loss of $249 million a year ago including a $188 million of consumer valuation charges. Adjusting for these charges our home building business generated a first quarter operating loss of $22 million in 2009 and $61 million in 2008.