KB Home (KBH) 2005 Q3 法說會逐字稿

Good day, everyone, and welcome to KB Home's third-quarter earnings conference call. As a reminder, today's call is being recorded. KB Home's discussion today will include certain projections and forward-looking statements intended to help investors better understand KB Home's business prospects. These are based on management's assessments of the Company's current business and operating conditions. Please be aware that KB Home's actual results may differ from those that may be expressed or implied by the projections and forward-looking statements that will be made by -- today and that the differences may be material.

Similar forward-looking discussions on the Company's annual report on Form 10-K, quarterly reports on Form 10-Q, and current report on Form 8-K filed with the SEC identify various factors that could cause KB Home's actual results to differ from those that the Company will be projecting in the forward-looking statements that we will be making today, and the Company urges you to read those.

I would like to remind everyone that this conference call is being webcast on KB's Home website at KB Home.com. For opening remarks and introductions, I would now like to turn the call over to KB Home's Chairman and Chief Executive Officer, Mr. Bruce Karatz. Please go ahead, sir.

Good morning, everybody, and thank you for joining us today to discuss the results of our third quarter. With me this morning are Jeff Mezger, our Executive Vice President and COO; Dom Cecere, our Senior Vice President and CFO; Bill Hollinger, our Senior Vice President and Controller; and Kelly Masuda, Senior Vice President of Investor Relations and Treasurer.

Today we will be hosting an investor luncheon where we will be sharing with you the state of our business as well as our operational and financial objectives for the next three years. Check in and lunch will begin at 11:30 this morning in New York at to St. Regis Hotel, with the meeting starting promptly at noon. The meeting will be webcast on www.KBHome.com.

We are pleased to report strong third-quarter and nine-month results that mark 41 consecutive quarters of KB Home meeting or beating analyst expectations. Our financial performance this quarter reflects our expansive geographic footprint, continued focus on superior customer service, and refinement of our KBNext operating model to improve all aspects of our business.

Let me share with you some of the third-quarter financial highlights. Companywide net orders in the quarter of 10,467 new homes increased by 17% when compared to a strong third quarter of last year, which had been up 23% over the previous year. We finished out the third quarter with a solid order backlog of 27,744 sold homes, with a revenue value of approximately $7.1 billion. Our backlog value entering the fourth quarter is up approximately 2.3 billion or 47% compared to a $4.8 billion backlog at the beginning of third quarter of last year. We posted solid top-line revenue growth in the third quarter, with companywide net unit deliveries up 22% to 9,812 homes and revenues up 44% to $2.5 billion, compared to the 8,041 homes and 1.75 billion of revenue in the third quarter of last year. Our average sales price in the U.S. for homes delivered in the quarter was approximately 263,500, up approximately 22% from the third quarter of last year.

Construction pretax income for the quarter was 351 million, which doubled from the 175 million of pretax income in the third quarter of 2004. Construction pretax margin as a percentage of revenue improved by 4 percentage points to 14% this quarter from 10% in the third quarter of last year.

Diluted earnings per share for the quarter grew 80% to $2.55, up from $1.42 in the third quarter of last year, with 89.2 million diluted average shares outstanding this quarter, compared to 83 million shares a year ago. It was another terrific quarter, contributing to a terrific nine months in every aspect, solidifying a very strong financial outlook for the year.

We are very well positioned both geographically and financially entering the fourth quarter, with pretax income of 814 million for the nine months, up 85% year-over-year and 13% higher than the 718 million in pretax for the total year last year. The backlog value of sold homes at the end of the third quarter is well balanced geographically, up 47% year-over-year to 7.1 billion, with the average price in the U.S. backlog up 19%.

Now I will ask Dom to take you through the financial highlights for the quarter.

Thank you, Bruce. We began the quarter with 27,089 homes in backlog and converted 9,812 homes or 36% of our unit backlog to revenues in the quarter. Deliveries of new homes were up 20% in the second quarter, 22% in the third quarter, and are forecasted to be up 25% in the upcoming fourth quarter.

The average sales price of homes of the U.S. delivered in the third quarter increased 22% to 263,500 from 216,900 in the third quarter of 2004. The average sales price of homes benefited from favorable regional mix, price improvement, and the continued diversification of our product mix to reach a broader array of move-up buyers in the market.

Our housing gross margin further strengthened in the third quarter, reaching 27.4%, up 330 basis points from 24.1% in the third quarter of 2004. SG&A expenses as a ratio to housing revenues improve by 70 basis points to 12.6% this quarter, compared to 13.3% in the third quarter of 2004.

During the third quarter, we raised our overall tax rate from 34% in the first half of the year to reflect the revised outlook of 35% for the year. The impact on EPS for the year of increasing the tax rate 1 percentage point is expected to be approximately $0.15. We have also increased our tax rate for 2006 an additional percentage point to 36% from 35% in 2005.

The Company closed at this quarter with approximately 60 million in cash related to our construction operations. Our net debt to total capital at the end of the quarter net of cash was 50.4%, which improved by 220 basis points over 52.6% in net debt to total cap at this time last year.

Inventory to quarter end totaled 5.7 billion, including both land and homes under construction. Our inventory supports our community count and unit delivery growth, both of which are forecasted to have double-digit year-over-year increases in the fourth quarter and into 2006. We continue to have a very liquid balance sheet with over 70% of our inventory flowing through the income statement over the next six quarters.

Companywide, we have about a four-year supply of land with approximately 185,000 lots owned and controlled at August 31, 2005, compared to approximately 161,000 lots at this time last year. Approximately 52% of these lots at August 31, 2005, are under option contract. Our investment in inventory continues to be guided by our detailed analysis of each submarket where we sell homes and our overall focus on after-tax returns on invested capital, which for the last several years has ranged between 16% and 16.5%, well above our cost of capital, delivering real economic value to our shareholders.

In 2005, returns on invested capital are forecasted to improve by almost 300 basis points to over 19% as we reap the expected benefits of having expanded our community counts in California and Florida and maintained our market leadership position in Nevada.

We enter the fourth quarter with a very strong and geographically diverse backlog of nearly 28,000 sold homes with a revenue value of 7.1 billion, up 47% year-over-year. Pricing and backlog is up 19% in the U.S. SG&A improved by 70 basis points this quarter. Returns on invested capital are excellent, and our land position supports our three-year growth objectives.

Now I will turn it back to Bruce for the wrap-up of our third-quarter conference call.

Thanks, Dom. We continue to be excited about the prospects for long-term profitable growth at KB Home. Today at our investor luncheon we will be announcing a new three-year plan that raises the bar for ourselves in setting and achieving continued high standards of performance.

While 2005 is clearly a banner year for KB Home, it is still only one year of our strategic plan to build homes in attractive housing markets where there are clear competitive advantages driven by our KBNext operating model. We're still forecasting to deliver 38,000 homes in 2005, which is a 20% increase year-over-year, with approximately 12,800 of these homes to be delivered in the fourth quarter, a 25% increase over the fourth quarter of last year.

We're raising our earnings per share guidance for 2005 from $9.00 per share to $9.30, up 63% from the $5.70 delivered last year. This is $0.17 higher than the current consensus estimates for 2005 of $9.13. We believe this is a realistic outlook for 2005, with any modest upside from SG&A and margin improvement being offset by some modest risk that a few deliveries could slip into 2006.

We continue to maintain a land pipeline and community count projection that supports the market strategy and three-year plans within each of our operating divisions. We're well positioned for 2006 with a solid backlog of sold homes and average community counts projected to be up by approximately 19%; and we look forward to sharing our 2006 and three-year plan with all of you this afternoon.

Again, it's been a terrific nine months and we're very well positioned for a solid fourth quarter. I am very pleased with our results, which have been driven by a well-defined business model, world-class training, and very good people. We will now be happy to open up the lines for questions.

(OPERATOR INSTRUCTIONS) Margaret Whelan with UBS.

It's actually Dave Goldberg on for Margaret. Quick question for you. In terms of the price improvement that you saw, how much do you think was related to mix? How much do you think was just pure pricing?

Well, Dave, it's a little difficult to say, but I would say the majority of it is due to pricing in each one of our markets, with some still due to mix. But the majority is pricing in each individual market.

Are you kind of finding that, as you're looking forward a little bit, you're expecting the price to kind of -- the pricing remains strong in some of those markets? Or have you seen kind of a slowdown in the acceleration that you have seen in pricing in certain markets?

Pricing for our Company in the U.S., with the exception of this year, for the last four years was up 6% a year. This year on average it will be up 16. Sure; we are assuming it is going to subside in '06 to be closer to 10%.

If I could just get one more question. It seems like in France the average sales prices have been falling relative to the U.S. Is that right?

No, they are flat at around 210,000.

Is that more product mix, just moving further away from --?

It is; and it is also related to a program in France favoring sales to investors who rent them under guaranteed contracts. That is a lower-priced product since there is a limitation on price.

Okay, thank you very much. Great quarter.

Carl Reichardt from Wachovia Securities.

I think Bruce and maybe Dom mentioned risk of delivery slippage in Q4. I'm just curious, but can you expand on that a little bit? What is your sense there? Is it material shortage, labor shortage, weather? You're just not far along with what you've got in backlog? What is your (multiple speakers)?

No, it is that deliveries are up significantly, and 25%, and so we are just hedging our bets. It is a big number. If everyone comes through it will be fabulous, but I think we are covered in the event there is some slippage.

Carl, the word was modest.

Thanks for the clarification, Dom. Can you just give me your attached-detached mix this quarter and then what your expectation is for next year?

Well, interesting, I think the attached-detached mix in the U.S. is around 8%. Is that right, Jeff? Closer to 10%.

That is domestic? 10% domestic?

And it is going up. We have looked at our land pipeline of our land deals over the last 18 months, and it is significantly more attached versus detached. That is really all low, medium density, not high density in the land pipeline.

Great, I will get back in. Thanks, guys.

Dan Oppenheim, Banc of America Securities.

Hi, this is Mike Woodon (ph). Just given the strong sales that you're seeing and the growth that you have in your backlog, I just wanted to get your sense for what you're doing to increase your construction capacity going forward, and if you're seeing any delays in any of your markets such as Florida or Arizona?

This is Jeff. We are seeing some extension in the build times, primarily due to constraints on labor. Some of our markets are still very, very hot in terms of activity levels; and there is only so many subs to go around. From a material point of view, we're not really seeing any shortages at this time. It is a regional thing. Some parts of the country continue to do well. Like in Texas we build very quickly. Then others like Florida or California have slowed up a little bit.

Okay. Also, just another question. In the central region I noticed that the growth in orders accelerated there. Based on the calculations if we back into a selling price, it looks like there was a sequential decline year. What is driving that? Is that a mix tissue?

I actually thought central was relatively flat in the buy side (ph) year-over-year.

Okay. Year-over-year. Okay, but is that a growth of communities driving that, the growth in orders in the central region?

Yes, the demand in the central region has picked up overall for us.

It is not just communities. We are feeling better today than we were a few quarters ago about demand in the region.

Remember, it was weak last quarter. So sometimes this is just the seasonality of the business. So it was weak the last quarter, strengthened this quarter.

Okay, thank you.

(OPERATOR INSTRUCTIONS) Ivy Zelman with Credit Suisse First Boston.

This is Justin Spiron (ph) for Ivy. I had a quick question on your central orders. Where exactly are those coming from? Where is the pretty strong growth in the quarter?

The central region for reporting purposes is Texas, along with Colorado, Chicago, and Indianapolis. As Bruce mentioned, we are seeing a lot of momentum building in our Texas business. So the sales growth is coming out of Texas.

Just a quick question with the hurricane. How much standing inventory or construction in progress do you have in that Houston market, and what is your risk there?

Well, Houston represents about 5% of our deliveries, a smaller, much smaller percent with respect to our inventory. We have got about 40 communities in the greater Houston area, a couple of which are southern part; 30, I guess, 30-some miles west of Galveston that would be the most affected. We have very few deliveries coming out of those two communities.

While we have closed our office and evacuated, I guess, as we speak about 70 people, and our concern -- we think that our emergency plan went into effect very nicely late yesterday afternoon, and we think from a business perspective, we have got little downside.

That's good news. In the West, in your detached versus attached product and orders, is there any difference there in terms of demand and traffic? Particularly in like Sacramento, for example, or some of your -- Riverside/San Bernardino, is there any color you can provide there?

We are still seeing very strong demand in all regions in California. In some of the higher priced submarkets we're saying the price increases slow. You don't have the velocity in price increases you had a year ago, but we continue to sell homes as released in our communities throughout California.

Is there any, in terms of margin implications, of slowing pricing? And also the attached versus detached price -- product?

Our margins remain very strong California and we don't anticipate a decline due to pricing deceleration in our business model modeling that we have done for the next three years, that we will share later today. We will share our assumption that margins will moderate in California, but moderate at a very high level.

Okay, also in your foreign operations, is there a level of margin -- is that compared to the -- how does that compare to the corporate and also your peers in that market?

Our margins in France are very close to the overall corporate averages here in the U.S.; I don't know about the competitive picture in France.

Last question, I didn't catch your community count.

Because we didn't give you our community count. Our community count still in the U.S. for 2005 is expected to be right around 450; and our committee counts in the third quarter were around 459, which were up 14%. We probably saw about 10 or 11 communities slip out of the quarter; nothing major.

Thanks a lot, guys.

Michael Rehaut with JP Morgan.

First question just on gross margins, they had a great expansion there. I was wondering if you could give a little more color in terms of how much you might think has come from pricing versus the operating efficiencies from your KBNext model? And where you -- how much do you expect on an annual basis, if you have been able to quantify the benefits from the operating efficiencies?

A big swing, Mike, in the margins, in my opinion, has been when we looked at the quarter, is that we are seeing the southeast business closing quickly in gross margins on the overall corporate average. So we now have a business that was up, I believe, in revenues 50% year-over-year with margins approaching the Company average. So our next leg in the stool is firmly in place, and that has been a big driver of our margins this quarter.

Also it was volume related. Any time that your volume is up 22% you have some benefit of improved margins as a result. So it's just been an excellent quarter.

Are you guys able to quantify your overall business model operating efficiencies, economies of scale, type of benefits year-to-year?

Unfortunately, this is not a manufacturing operations where you're building the same widget every day, so it's very hard to compare houses that are being built in different communities and different markets. So it's very difficult to do. Except that we know these disciplines drive best practices across all of our Company; and those best practices are driving businesses to perform better.

Okay. Last question just on the tax rate. It did come up this quarter. You had mentioned that -- if you could just repeat what you expect the next quarter to be in '06 and what has been driving that move?

The next quarter will be 35.5%. Truthfully, our tax strategy has given us one of the best effective tax rates in the sector. But our pretax profits will be up 75% this year, and our tax benefits have less weight overall with these profit gains (ph). So that is why we took the tax rate up and why we are taking it up to 36% next year. It is kind of a high-class problem to have.

Is 36% good to model going forward beyond that?

36 for '06; and 37 for '07 and '08.

37 for '07 and '08?

Yes.

Thank you.

Alex Baron (ph) with JMP Securities.

Great job. I wanted to ask, is there any regions in particular where you guys are finding the need to hold back sales in order to raise price and maybe not get the backlog too high?

Definitely in the Southwest region, both Las Vegas and Phoenix, that we have very solid backlog position and we are metering sales in some of the communities to ensure we don't sell too far out ahead of ourselves.

Okay. I guess in the West region you guys had talked about achieving sort of a 30% growth rate going forward; but your orders were up 20%. Is that something you think will start coming back up later?

We have a lot of communities opening here in the fourth quarter in the West region that will boost our sales rates going into next year. Whether it will be up 15%, 20%, 30% we don't know sitting here. But we do expect a much higher volume level out of California next year.

Okay, great. Thanks.

Stephen East with Susquehanna.

You talked about on the raw materials you're not seeing any shortages. Can you talk a little bit about what you are seeing on raw material pricing; and whether there is any impact now; and what do you think will happen as we get into the peak building season in the spring?

Overall, what we next year is that we still believe our direct cost, blended direct cost in '06 will probably be up about 6%, 6.5% over this year. There is still a lot of unknowns. But the two major cost items, one is lumber. I am still a believer that there is a significant overcapacity of lumber, all this year in the market. We believe that will settle back down as soon as these storms settle down. Concrete is probably going to go up. The rest of it we see on balance being up about the level of inflation.

Okay, all right. Then on -- you talked about metering orders in Las Vegas and Arizona. What type of pricing are you seeing in those two markets year-over-year?

Today, you mean?

Yes.

Our average prices in the southwest, if you looked in our release, is up approximately 39% year-over-year; and the average price on the West Coast is up 13.

Is that what you are seeing currently? Or are you starting to see some moderation come through (multiple speakers)?

No, it is moderating. We said that overall our prices in the U.S. will be up 16% this year and will settle down overall to 10% next year.

Okay. All right, thanks.

William Nobler (ph) with Adalana Sognof (ph).

Congratulations again on very good numbers. When you talked about the tax rate next year being 36%, it sounded almost as though you were adding to your provision this year to raise next year's tax rate. Or were you just giving the number for guidance purposes?

We were giving the number -- I mean, that is what our effective tax rate will be next year -- so that in people's models they can use the proper tax rate. Again as I said, we have had some defined tax benefits that have given us one of the lowest tax rates in the industry. Unfortunately our profits are going up so much that that the weight of those tax benefits and overall profits has caused us to raise our rate.

Second question. You just said before that prices due to mix and increases will be up 16 this year, but may be up 10 next year. Now your backlog, the prices in your backlog, as you very well know, are up 19. You also said that the West, you have a lot of community counts coming on and should be much stronger next year than this year. Wouldn't those factors that I just said suggest fairly strong prices, maybe higher than what you are suggesting?

It may; except that, remember, probably 40% of this backlog will flow through the P&L in the fourth quarter. Then you will be comparing yourself to next year. Our average price that we have in the plan for next year is 285,000 for a house, which compares to our backlog, which is currently at 266. So it does reflect prices being much higher next year than it is today.

Great. Last question, in terms of -- well, I will leave it for lunch. But I look forward to hearing your three-year forecast.

See you later, Bill.

Carl Reichardt with Wachovia Securities.

Two more, Dom, I want to make sure I understood this. You said you're thinking that '06 average selling price growth will be up about 10%. Is that domestic? Or does that include France? Or did I hear that wrong?

That was U.S.

U.S.? Okay. And that is a function of geographic mix, or a function of product mix as you guys diversify more out of entry-level price points?

Of course it is both, Carl.

I mean where is the emphasis?

The big emphasis will be geographic.

More geographic, all right. Then last question, just in terms of D.C. and your entry there, in terms of what you think your ramp is likely to be there. You know when in (ph) greenfield not with an acquisition; what is your sense of how fast you can grow that particular division? How large do you think you expect it to be?

Carl, when we made the announcement we included in the announcement that we have a few communities already tied up and under development. We do expect to ramp up there hopefully with a similar trajectory to what we have done with our either de novos. We have not posted a top-side number for what we think it could get to. (indiscernible) we certainly would expect it to become another large business for us. First deliveries we're projecting right now coming out in the fourth-quarter '06 or first-quarter '07.

Jeff, how much dirt do you have there now wholly-owned?

Three communities.

Three communities, okay. That is wholly-owned? That is ex the Centex deal, right?

Yes.

Okay, great. Thanks, guys.

Timothy Jones, Wasserman & Associates.

I hope you're having a good conference there. Now, you said that you had 10% of your business right now in attached units in the U.S. Is that correct?

Correct.

What was it a year ago?

Five to seven.

Five to seven, okay. Now you said you expected it to increase dramatically based on the lots that you had. What numbers are we using next year? 15 or closer to 20?

15 is a good number, Tim.

Okay. With that change in mix, can you suggest that your average price will in fact be maybe less than the 10% that you're looking for? Because of the mix turning to more attached units. Or maybe will it be offset by the rest of the housing mix going the other way?

The housing mix offsets it, but we have assumed the increased attached business in the guidance we have given you for '06.

You passed over one of the most important numbers very lightly. I would like to -- that was the nice 70 basis point improvement in your SG&A. Was that mostly volume related or was there some other things there too?

I was hoping that someone would ask that question. We have had these --

I aim to please.

Remember, same quarter year-over-year, we were really hoping that people would comment on the fact that finally we are seeing some of the SG&A initiatives that we put in place to take hold. That is the 70 basis point improvement. It was really an effort by the whole team to (multiple speakers) --

Are there any specific things, any two or three things that you did specifically over the last year to enhance that?

There are two or three things we did. This is in all businesses. We went division by division, SG&A category by SG&A category, and set tougher targets. And they came back with commitments, and that is what drove the overall result.

Where did they -- was there one specific area that most of them found basis to cut? Either in advertisement or in --?

We didn't cut advertising and we didn't cut sales commissions. The real focus was on overhead and it came from two big things, in my opinion. One is the southeast business really took off. As I said to a lot of people, when we wanted them to grow the business we didn't ask them to over-control SG&A, because we wanted to get the business up and running. Now that they've got business of size, we expect the SG&A improvements to take hold. So that is what we did with that sector.

Then the West Coast business, they had seen a lot of price. And we said, hey, we want your SG&A per unit to stay under control, even though your top line is growing faster.

So those two things.

In that respect, did you cut the percentages on the commissions because the prices are getting so high?

We kept them on some communities where we thought there was -- the practice we had (ph).

Okay.

In many of our markets the commission is set on a per-unit basis, not percent of revenue, so we control that.

Okay, thanks a lot.

Joel Locker, (ph) Carlin Financial.

I just wanted to actually ask about the California margins and where you expect those in 2006 versus 2005? If you see them up, down, kind of where they are right now, just based on backlog and what you are seeing in land prices?

We are saying and what we have said is that -- in our three-year plan is that California when normalized can come back closer to the Company average. So we expect California would be down a bit next year. That was expected in our overall plan.

Down a bit meaning, like, what are this year on a gross margin basis?

I haven't given that out by business or by sector.

Right, but you think actually may be down like 5% or 10% just based on maybe going -- ?

I haven't given it out.

Right, all right, thanks a lot.

Ladies and gentlemen that does conclude today's question-and-answer session. At this time I would like to turn the call back over to Mr. Bruce Karatz for any closing or additional remarks.

Thank you; and thank you all for joining us today. We hope to see many of you here later today at our investor luncheon here at the St. Regis. Have a great morning, and see you in a few hours. Bye.

That does conclude today's conference. You may now disconnect.