KB Home (KBH) 2008 Q2 法說會逐字稿

Good day everyone and welcome to the KB Home's second quarter earnings conference call. As a reminder, today's conference is being recorded and webcast on the KB Home website at KBHome.com. The recording will also be available via telephone replay until midnight on July 6. You can access the recording by dialing 719-457-0820 or 888-203-1112 and entering the replay passcode of 991-6184.

KBHome'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 that are not guarantees of future performance.

But due to risks, uncertainties, assumptions and the events outside of control, KB Home's actual results could differ materially from those expressed or implied by the forward-looking statements. Many of this 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.

Now for opening remarks and introductions, I would like to turn the conference over to KB Home President and Chief Executive Officer, Mr. Jeffrey Mezger. Please go ahead, Mr. Mezger.

Good morning everyone. Thank you for joining us today for a review of our second quarter results. With me this morning are Dom Cecere, our Executive Vice President and Chief Financial Officer; Bill Hollinger, our Senior VP and Chief Accounting Officer; and Kelly Masuda, our Senior VP of Investor Relations and Treasurer.

This morning I will cover the state of the housing market, our second quarter results, and our outlook and strategies for the remainder of the year. Dom will take you through our second quarter financial results, and I will have some brief closing remarks before we open it up for your questions.

Let's start with market conditions. The second quarter remained very challenging for homebuilders. Inventories of both new and existing homes hovered at a 10 to 11 month supply throughout the period, with buyers remaining on the sidelines, concerned with the weakening economy and tightening mortgage lending standards. Foreclosure activity continues to rise, compounding the inventory overhang and maintaining pressure on prices.

This was borne out by the S&P/Case-Shiller Composite 20 Index, which reported that prices in April had dropped 15.3% from a year earlier, as well as the Conference Board's recent releases, which indicated that the Consumer Confidence Index fell to 50.4 in June, the lowest level since February 1992.

Taken as a whole, these operating conditions are some of the most difficult the home-building industry has ever experienced. Our financial results for the second quarter reflect this persistently challenging environment, and the decisive actions we have taken to address these conditions over the last two years.

The market price declines in the quarter and the uncertain timeframe for housing market recovery required additional revaluation of our assets in the quarter. We took pretax noncash charges of $177 million for inventory and joint venture impairments and abandonments, and $25 million for goodwill impairment. We also recorded a $99 million deferred tax asset valuation allowance charge for the quarter.

Largely due to these charges, we reported a net loss for the quarter of $256 million or $3.30 per diluted share. About 90% of our total impairments and abandonments in the second quarter were recorded against assets in California, Arizona, Nevada and Florida, the states hardest-hit by foreclosures and falling prices. While we are disappointed with the substantial impairment charges in the quarter, they're driven by the difficult market conditions that we and other homebuilders continue to confront.

Generally accepted accounting principles required that we book an additional charge in the second quarter to fully reserve the tax benefits generated from our pretax loss. As of May 31, 2008 our valuation allowance on our deferred tax assets exceeded $720 million. From my perspective, this represents nearly $10 of potential additional book value per share, which I believe is one of the highest among our peers, and a real opportunity to unlock value in the future.

We believe that a meaningful improvement in market conditions will require a sustained decrease in inventory levels, price stabilization, reduced foreclosure rates, and the restoration of consumer confidence in making the homebuying decision. While it is difficult to predict when these events will occur, what I can tell you with confidence is that we have responded quickly end judiciously to the dramatic reversal in the housing markets, and I believe we will emerge from this downcycle a stronger, leaner and better Company than ever before.

In the remainder of my opening remarks this morning I will give you a picture of where KB Home stands today and where we're headed. Let's begin with the here and now. For the past two years we have made financial strength and operating flexibility the centerpiece of our strategic response to rapidly declining markets. As a result, KB Home is among the financially strongest and best positioned national homebuilders operating today.

Since early 2006 we have focused relentlessly on strengthening our balance sheet and repositioning our operations to align with market realities. We have built up and preserved our cash position, reduced our inventory and community count, and consolidated operations in some markets, while selectively exiting others. This strategy has generated tangible results. At May 31, 2008 we had a cash balance of over $1.3 billion, more than triple the year earlier amount.

Typically, our operations use cash in the first half of our fiscal year. But with a disciplined focus on curtailing expenditures, we finished the second quarter with essentially the same cash level we reported at year-end and at the end of the first quarter. Cash flow from operations was positive for each of the first two quarters of 2008, and we anticipate generating positive cash flows from our operations for the remainder of the year.

We have reduced inventory levels by 50% from a year ago to $2.6 billion at May 31, 2008. We ended the second quarter with approximately 56,600 lots owned or controlled, down 70% from a peak of 186,000 lots in the first quarter of 2006.

We currently have an attractive, geographically diverse land portfolio that represents about a three-year supply to us. We believe that our short land position is prudent, given the current environment. As the market stabilizes, we expect to reload our pipeline with lower-cost lots at a competitive advantage that should expedite our return to profitability.

Our leverage ratio, net of cash, was 40.2% at quarter end. This is at the low end of our targeted range of 40 to 50%. Net debt was $856 million at quarter end, down from $2.4 billion at the 2007 quarter end, a reduction of 65%.

We had approximately $2.4 billion of liquidity at the end of the second quarter, with an undrawn revolver and $1.3 billion of cash. This will enable us to be opportunistic with land acquisitions from distressed builders, developers and banks as they arise.

With our lower inventory levels and strong liquid balance sheet, we recently decided to reduce debt further. In July we will redeem all $300 million of our outstanding 7 3/4% senior subordinated notes. The economic case for the redemption is compelling. Based on our current cash yields this should generate almost $16 million of annual savings and a 4.5 month breakeven on the 1.9% redemption premium. This is another example of a measured action that we're taking to position ourselves to return to profitability.

All of these targeted measures have given us ample dry powder for the future so let's look forward. Our central priority now is to restore the profitability of our home-building operations. For the immediate future this means selling at the right price, with the right product and the right marketing strategy for each individual market in which we operate. Single-minded pursuit of market share or higher volume has no economic traction in today's environment. And given the strength of our financial position, we believe that generating a profit is more critical to our shareholders than generating additional cash.

It also means continuing our focus on cost reduction and operating more efficiently. Our KBnxt principles of lean, build to order production have never been more important. Finally, it means looking to the future and preparing for the recovery. We have the financial strength to capitalize on land and lot purchase opportunities as they arise. And we're ready to do so to create an inventory base that can generate future profitable growth.

Here's a brief look at our current key strategies. First, we will operate in individual markets at a size that optimizes economic returns, and avoid markets where profitability currently appears improbable at any size. As you know, over the past several quarters we have aligned the size of our business with lower levels of demand. Our community count is down 37% from a year ago as a result of our downsizing operations in certain markets as backlog is delivered, and completely exiting others.

We are comfortable with our current position in markets across the country, and believe they will provide a solid platform for growth in the future. We will continue to assess and reassess our geographic footprint, seeking optimal volume levels at which to operate, and we will adjust our community counts to maximize financial performance. We're confident that our current platform positions us well for solid growth as each market stabilizes.

Next, we will use our financial strength to acquire land and lots in good, long-term markets at distressed prices. Opportunities will inevitably arise to reload our pipeline and we will not hesitate to do so when the price and timing are compelling. Even now we are in the market actively analyzing potential land acquisitions.

Deal flow is increasing, and we are seeing both portfolio and single asset transactions; however, we're being careful and patient in order to seize the right opportunities. Our land acquisition and development will remain limited in the near term, as we continue to rescale our business with reduced sales rates. We're developing smaller phases and restructuring our land development expenditures at each community to match with demand. Currently for 2008 we're budgeting total land acquisition expenditures of approximately $300 million and total development expenditures of approximately $400 million.

We remain conservative in our assumptions, and thoroughly evaluate the specifics of each deal. We will also be highly strategic in our choice of submarkets and product types.

Next, we will develop product type and marketing strategies on an individual region, market and even community level. Our entire team is dedicated to improving our pretax results. This may mean implementing a specific set of marketing decisions for individual market conditions. We will continue to balance sales rates and pricing, and evaluate the best use for our assets, including whether we should modify entitlements or redesign product if the profit potential is greater.

With little pricing power in today's markets, we will be particularly vigilant in maintaining a competitive value proposition. In most of our markets we believe our prices are already at or below the resale median for that market. While existing home prices are likely to fall further in 2008, we have anticipated this, and have taken steps to ensure that our selling prices remain competitive and our value proposition continues to be compelling to consumers.

We will also remain focused on lowering our direct costs. We have already made substantial progress in reducing square footage and simplifying our floor plans to meet buyer demand. We have also offset pricing pressures to some degree with strategic cost reductions, including value engineering our home designs and renegotiating labor and supply contracts. We continue to focus on featuring design elements that blend low-cost with high-value, putting the custom home experience within reach of our home buyers.

We will continue to pursue further cost reductions and improve efficiency by streamlining our core business processes with the goal of improving gross margins. We will also remain relentless in removing unnecessary overhead costs. Our selling, general and administrative expenses decreased by $75 million or 38% in the second quarter of 2008 from the year earlier quarter. While a portion of these expenses are variable, the sizable overhead reductions we have achieved have been outpaced by the rapid and dramatic decrease in our revenues. As margins are likely to remain compressed due to pricing pressure, we will continue to bring overhead in line with our reduced revenues. We expect to see further improvements on this front over the next several quarters due to our ongoing initiatives.

One analyst report recently pointed out that we have the highest revenues per employee among our peers, a testament to our disciplines and business model. Based on the latest available data for 2007, our revenue per employee was $2.2 million, while the next highest of our peers was $1.8 million and the average was $1.3 million.

If we maintain our financial discipline and concentrate on the markets and product types we know best, and we will, I am confident that KB Home will continue to be successful -- continue to successfully manage through this downturn. But the larger picture is even more compelling, because looking a little further down the road I believe the prospects for our industry and our Company are excellent.

The fundamentals of our business remain strong, especially for builders like KB Home that focus on first-time home buyers. I believe no one understands this market segment better than we do. No one anticipates buyer trends more accurately, no one innovates more effectively in product design and marketing strategies.

Recently Fortune Magazine featured KB Home in its pages, making essentially the same point. After the magazine named us the number one homebuilder, on its list of most admired companies of 2008, its editor-at-large, Shawn Tully, took an in-depth look at our Company in its June 9 issue. The story highlighted our renewed focus on the needs of first-time home buyers and our diligent efforts to ensure we are offering the right homes at the right price for today's market.

He referred to our obsession was making homes affordable, while still offering features that sharply distinguished KB Home from the competition. In answering his own question, why will housing come back, Kelly concludes that it will be, and I quote, "for a reason as solid as floor joists. The entry-level buyer for the first time in years is finding that owning a new house is suddenly just as cheap as renting.". And I totally agree.

Home prices have come down in many areas of the country for nearly two years, while rents have increased, closing the affordability gap between renting and owning a home. At KB Home we're effectively demonstrating this increased affordability to our first-time buyers by featuring potential low monthly payments in our marketing and advertising outreach. These monthly payments allow renters to make a direct comparison to what they are paying in rent today, often discovering that homeownership is within their reach.

We are encouraged that the precursors of a housing market recovery are in place, and we believe that KB Home is uniquely positioned to respond. The great uncertainty, of course, is when that recovery will begin. Whatever the future brings, we remain focused on running our business prudently at whatever volume market conditions support.

We will pursue our goal of restoring profitability, while maintaining our strong financial position. By adhering to our proven KBnxt operating business model and leveraging our strengths, we are poised to emerge from the downturn as one of the strongest national players in the home-building industry.

Now I will turn the call over to Dom for his financial review.

Net orders of 4,200 new homes in the second quarter were down 42% on a year-over-year basis due primarily due to a 37% decrease in our community counts and a softening demand in a number of our served markets. We had 215 active selling communities in the second quarter of 2008 compared to 342 in the second quarter of 2007. Community count was lower in each of our four regions, with decreases ranging from 24% to 45%. We anticipate operating with lower year-over-year community counts for the remainder of the year, consistent with our renewed focus on restoring profitability.

Second quarter net orders were nearly triple the 1,449 we posted in the first quarter of 2008, partly due to our improved cancellation rate. The order cancellation rate in the second quarter of 2008 improved to 27% of gross orders from 53% in the first quarter of 2008, 58% in the fourth quarter of 2007, and 34% in the year earlier quarter. Cancellation rates have been volatile over the past couple of years, but have recently returned to more normal levels. This metric may indicate some stability in returning to the market.

We entered the second quarter was 4,843 sold homes in backlog, and converted 2,810 or 58% of beginning backlog to revenue in the quarter. This compares to a conversion ratio of 43% in the second quarter of 2007. The higher conversion rate and lower cancellation rate suggest the quality of our backlog is improving. Our backlog does remain geographically diverse, with the largest portion on a value basis in our West Coast and Southeast regions.

We incurred a net loss of $256 million or $3.30 per diluted share in the second quarter, largely due to pretax noncash charges of $177 million for inventory and joint venture impairments and abandonments, and $25 million for goodwill impairment. We also recorded a $99 million charge for our deferred tax asset valuation allowance.

In the second quarter of 2007 our net loss totaled $149 million, or $1.93 per diluted share, including a pretax noncash charge of $308 million for impairment and abandonment charges, partially offset by an after-tax income of $25 million, or $0.33 per diluted share, from our French discontinued operations. Excluding the impairment and abandonment charges and the valuation allowance, we would have reported a net loss of $32 million, or $0.41 per diluted share, in the second quarter of 2008, and net income of $37 million, or $0.47 per diluted share, in the second quarter of 2007.

We delivered 2,810 homes in the second quarter of 2008, down 41% from the year earlier quarter, mainly due to our reduced community counts. Each of our regions delivered fewer homes compared to the year earlier quarter, with decreases ranging from 30 to 50%. With our emphasis on improving margins and gaining profitability, we will continue to review and adjust our community counts as necessary to maximize our performance in each region.

Consistent with the rate of broader market price declines our average selling price for the second quarter decreased 17% to $226,600 from $271,600 in the second quarter of 2007. The lower average sales price was the exact result of the efforts we have taken over the last several quarters to address affordability. Floor plans were simplified. The average square footage was lower by 10%. And pricing was adjusted to remain competitive in the market.

We expect increasing supply and weakening demand to exert additional downward pressure on the housing market through the remainder of this year. We're calibrating our pricing and sales rate to strike an appropriate balance that will lead to improved financial performance. However, our bias is to hold pricing as much as possible to maximize future results. We are also reducing production costs, re-evaluating spec levels, refining and value engineering our home designs, and renegotiating supplier contracts to achieve better terms.

Our housing gross margin in the second quarter of 2008 fell to a negative 17.5% from a negative 3.9% in the second quarter of 2007. Excluding inventory impairment and abandonment charges, the housing gross margin was 8.7% in the second quarter compared to 9.0% in the first quarter, and 10.1% in the fourth quarter as 2007 and 14.9% in the second quarter of 2007. We anticipate that our margins will remain compressed in the second half of the year. Having said that, our goal is to mitigate prices -- pressures on margins with cost savings.

Selling, general and administrative expenses in the second quarter decreased $75 million or 38% from a year ago. This is a significant reduction in gross SG&A dollars, but our revenues have followed even faster. SG&A as a percent of housing revenues was 18.7%, up from 14.9% in the year earlier quarter. We expect this percentage to remain above 2007 levels for the remainder of the year. It will take some time for overhead to fully align with our lower revenue levels. This area will be a constant focus for us as we work hard to close the gap.

Our home-building pretax loss of $258 million for the second quarter of 2008 included $156 million of inventory and joint venture impairment charges, $21 million of option abandonment charges related to about 800 lots under option contract we have chosen not to pursue, and a $25 million goodwill impairment charge. During the quarter we impaired approximately 40 projects. Around 90% of the second quarter impairments and abandonments incurred in California, Arizona, Nevada and Florida.

The impairments were mainly driven by price reductions in markets as housing inventory increased in the face of rising foreclosures and softening demand. Overall our inventory in joint venture related charges of $177 million in the current quarter were 43% lower than the $308 million of similar charges in the year earlier quarter. The lower charge may indicate that fewer impairments will be needed in future periods, unless market prices drop dramatically.

The financial services business contributed pretax income of $3 million in the second quarter of 2008. Our Countrywide KB Home Loan mortgage joint venture continues to perform well. Within the joint venture the retention rate for the second quarter of 2008 was 80% compared to 70% a year ago. And average FICO score of the joint venture mortgage customers in the quarter was 696, slightly lower than 706 a year ago. Buyers also continue to use more fixed-rate product. Just 4% of the quarter chose an adjustable-rate mortgage. Government and conforming loans were used in 97% of our second our quarter delivers.

Over two-thirds of our backlog of sold homes were qualified with an FHA loan. There has also been some recent press on down payment assistance programs. It is not a meaningful portion of our business, representing only 74 deliveries in our most recent quarter.

Our total pretax loss was $256 million in the second quarter of 2008 compared to [$149] million in the second quarter of 2007. Our income tax provision of $0.6 million in the period reflects a $99 million deferred tax asset valuation allowance charge that we were required to book under accounting rules. Normally if we generate a loss we recognize a tax benefit; however, this required allowance essentially eliminated any tax benefit for the quarter.

While the deferred tax asset valuation allowance is a noncash item, it didn't -- it did impact our balance sheet and our book value. Including the valuation allowances we reported in the fourth quarter of 2007 and the first half of 2008, we had over $720 million of deferred tax assets fully reserved as of May 31, 2008.

As we generate taxable income in the future to utilize these tax benefits we expect to be able to reverse the valuation allowance, and our effective tax rate on future income would decrease. However, to the extent we generate future opening losses, we would continue to add to the valuation allowance and income tax provision would be adversely impacted.

As a result of the strategic actions Jeff noted in his remarks, we have streamlined our land position significantly, reducing inventory and community counts, while consolidating or exiting underperforming markets. At May 31, 2008 we had $2.6 billion in inventories compared to $3.3 billion at November 30, 2007 and $5.2 billion at May 31, 2007.

At the end of the quarter we owned or controlled approximately 56,600 lots, down 70% from a peak of 186,300 lots in the first quarter of 2006, and 41% from the 96,700 lots in the second quarter of 2007. Our land position also decreased from the 65,700 lots at November 30, 2007. Our current inventory represents about a three-year supply, based on trailing 12 month deliveries. Of the 56,600 total we own less than 39,800 lots, and have approximately 16,800 lots controlled via land option contracts.

Our view is that it is better to be short rather than long in lots during these uncertain times. There will be opportunities to reload our lot pipeline at attractive terms with finished lots as the markets begin to stabilize.

Homes in production are down almost 73% from the peak at the end of the second quarter of 2006, and 57% from the second quarter of 2007. This is a clear illustration of our adherence to a build to order business model. We currently have approximately 4,700 homes in production, with 17% or 800 homes unsold. That is down from about approximately 1,400 homes unsold in the first quarter of 2008, and is one of the lowest spec production levels in the industry. We had approximately 500 finished unsold homes in inventory at quarter end.

The decrease in or inventory contributed about $218 million in operating cash flows in the first half of 2008. At May 31, 2008 we had $1.3 billion of cash. Through the first half we held our cash balances essentially flat, with a balance in November 30, 2007 which demonstrates our ability to manage spending.

Historically we experience negative cash flows in the first half of our fiscal year. We generated positive cash flows from operations in each of the past four quarters, and expect our operations to continue producing positive cash flows in the second half of 2008.

We had total debt of $2.2 billion at May 31, 2008, which was $651 million lower than the balance at May 31, 2007. As of the end of the second quarter our debt net of cash totaled approximately $856 million, compared to $2.4 billion a year ago. Our net debt to total capital ratio was approximately 40.2% at the end of the second quarter, compared to 31.1% at the end of 2007 and 46.6% at May 31, 2007. The increase on bad debt to total capital ratio from year-end was due to the impairment and abandonment charges and the deferred tax allowances recorded in the first half of the year, which reduced our retained earnings.

With $1.3 billion of cash at quarter end and about $1.1 billion net of letters of credit available under our bank revolving credit agreement, which matures in November 2010, we believe we have substantial liquidity to navigate the current environment and to capitalize on opportunities as they arise.

We recently decided to call $300 million of a 7 3/4% senior subordinated notes on July 14 at a redemption price of 101.938%. We believe this makes economic sense due to the generation of nearly $16 million of annual savings and a 4.5 month breakeven on redemption premium. Following the redemption, we still expect to have a substantial cash position. We do not anticipate having any outstanding borrowings under our bank revolving credit agreement for the remainder of the year.

As of May 31, 2008 we had $295 million invested in 34 consolidated joint ventures. Of these, 22 had more than $10 million in assets, and only 11 had more than $50 million of total assets. Now five consolidated joint ventures represent almost 80% of the $295 million investment, the majority with public builders and financially sound developers in good submarkets. 20 of our unconsolidated joint ventures have bank debt with varying levels of obligations under debt.

As we discussed on our last quarter, we continue to tightly manage the challenges some of our joint ventures face in light of the difficulties of the current housing environment. Although we cannot disclose any details, we continue to work with select partners and banks to find the best solutions for us and our stockholders.

We expect our joint venture investments to continue to decrease as we move ahead. Joint ventures have a place in our business, but in the short term we are limiting our participation and reviewing each investment to ensure it fits into our overall marketing plans and business objectives.

Now let me turn it back to Jeff.

Let me add a few comments before we take your questions. Although currently experiencing a prolonged downturn, the housing market will return. People have and will continue to buy homes, and the American dream will continue to exist for the substantial number of new U.S. households that our country will experience in the next several decades.

From the 2008 report of Harvard University's Joint Center for Housing Studies issued this past week, we learned that changes in the number and age distribution of the adult population should lift household growth from 12.6 million in the decade of 1995 to 2005, to 14.4 million in the decade of 2010 to 2020. KB Home will be there, and we will be ready to meet the demand generated from these expected demographic trends.

In past calls we have discussed some of the distinct competitive advantages that differentiate KB Home from other homebuilders. I think they bear repeating. Our KBnxt business model defines how we operate no matter what conditions exist. The KBnxt discipline maintains our focus on our customer and employs a fact-based and process driven approach to what and where we build. It helps us deliver even flow production and outstanding customer service. And its build to order system gives buyers both choice and value. There is no better model for both strong and challenging housing conditions.

We're committed to our long-term strategy of providing high-quality homes for the first time, first move up and active adult buyer. No matter what market conditions exist, we firmly believe the desire for homeownership is a constant for Americans and fuels the first-time buyer market. Serving first-time buyers is an especially attractive position, since they do not have the additional obstacle of selling an existing home.

We remain fundamentally a presold builder, a business model that provides maximum choice to our customers, and predictable delivery results for us. Our build to order approach offers buyers the lowest possible base price for their new home, with personalized design options from our KB Home Studios that fit their needs and budget. In fact, our Studio revenues per unit have remained relatively constant through the downturn, and in our second quarter were 14% of our base price revenues, the highest level ever, underscoring the value proposition of choice.

Our largest and most important geographic footprint remains in the Sunbelt, the region likely to experience the strongest population and job growth going forward. Today we operate in 32 of the top MSAs, in nine states across the country. Once market conditions stabilize, these attractive markets could support 2 to 3 times the delivery volumes we are currently generating. We're strategically positioned in the right markets to fuel our future growth.

We're focused on unique, high impact marketing strategies that increase traffic at the community level, while building national brand awareness. Our present marketing campaigns are designed to address the concerns of first-time buyers. Our strategic partnerships with Martha Stewart and Disney need also give us an exclusive competitive advantage over other builders, as well as an advantage over the resale market.

Our Countrywide soon-to-be Bank of America KB Home Loans joint venture provides a reliable source of funding and makes available to our buyers all programs currently offered in the marketplace. In the second quarter of 2008, 80% of our homebuyers who finance their home purchase used Countrywide KB Home Loans. Operating through this joint venture structure is beneficial because it lowers our financial risk and allows us to focus on our core competency of home-building.

Recently we have been working hard to foster another advantage, one that benefits our environment as well as our buyers. This year KB Home became the first national builder to sell new homes exclusively with ENERGY STAR qualified appliances. We now offer a wide variety of environmentally friendly options to homebuyers at our KB Home Studios, as part of our My Home, My Earth environmental initiative. And these options are becoming extremely popular.

Eight KB Home divisions have just received the 2008 ENERGY STAR Leadership in Housing Award from the EPA for building new homes that are energy-efficient and help protect the environment. These divisions are in Austin, Dallas-Fort Worth, Houston, Las Vegas, Phoenix, Sacramento, San Antonio and Southern California. Last month KB Home was named the number one Green National Homebuilder by the prestigious investment firm, Calvert Asset Management, and the Boston College Institute for Responsible Investment. It is certainly gratifying to be recognized, although it is clear that we, along with the entire home-building industry, have more to do in this area.

Our goal is to be a leading environmentally friendly national builder. Environmental sustainability is yet another distinction that sets our homes apart from other choices in the marketplace, particularly resale homes.

In closing, I would like to recognize our employees at KB Home for their dedicated work and outstanding achievements, and for continuing to make our buyers their highest priority. I am confident that together we will continue to meet the challenges ahead and build a bright future for KB Home.

With that, let me open up the call for your questions.

(OPERATOR INSTRUCTIONS). Dan Oppenheim, Credit Suisse.

This is actually Mike Doyle in for Dan. Can you talk about some of the markets where you saw better order trends, and what did you have to do on pricing in those markets to get there?

It is a good question, and I don't know that we have that kind of detail because the story will vary by community and by submarket within City. I think we do have the sales by region, if you guys to want to share that.

Yes, it is in our press release. (multiple speakers) press release.

I was just thinking a bit more local than that.

What I can tell you is that our entry-level products and our more affordably priced products are selling better than the move up products where the buyer has a home to sell.

Could you give us an idea of how orders trended throughout the quarter?

We don't normally disclose that. You can't respond too much to what happens in one month. It is a quarterly look for us.

Dennis McGill, Zelman & Associates.

My first one is just an easy one. On the carryback opportunity for what you could get in 2009, what is the amount that you paid a couple of years ago?

You mean on the tax carryback? There isn't any -- I don't think, is it, Bill? (multiple speakers).

You don't have any --?

I think we have used it all up, yes.

Then secondly, Dom, did you say the $21 million of option abandonments related to 800 option lots or 8,000?

800.

Michael Rehaut, JP Morgan.

A couple of questions. First, your comments about the low exposure to the down payment assistance program really surprised me. A few years ago we had it that you had about 13% of your consumers using down payment assistance. The FHA as an overall entity, about 35% of their loans have down payment assistance. And yesterday Lennar said that about one-third of their loans use down payment assistance. So it is just kind of surprising to hear you say only 74 closings. I was wondering if you could describe how you get to that conclusion and how you track your mortgages?

Within our venture we have the ability to track loan specific, what loan type it was. So I can to you that a few years ago we moved away from DPA, stopped offering it all together. There is a lot of pressure, as you have seen in the news, from Congress to eliminate the program and we're sensitive to that. So we don't want to create a business that relies on something that could possibly go away in the future.

So you are pretty comfortable with the accuracy of that statistics then?

Yes, we are.

Jim Wilson, JMP Securities.

I was wondering if you could talk a little bit about as you're targeting deploying capital, how you feel about your inventory position in certain markets. You have reduced it significantly. Are there places now you really feel you are short and you might be targeting, or is it just purely any market price driven?

It is a good question. I believe strongly that a land light position right now is very prudent and the right position to be in. We do have markets that by the end of '09 we will be tight on lots. However, I think that is a healthy tension right now because there are opportunities coming across the transom every week in just about every market now to acquire lots.

We're remaining very patient because I think the opportunities will get better. The only deals we're doing right now are those that are in a submarkets at a price point that we feel is strategic for that market, preferably at the low end of the price scale in that markets. And we are also being very cautious in our underwriting to ensure we have some cushion in case the market were to erode further wherever that asset is.

And we like much better being in a position to pick up finished lots where our cash inflow to first delivery is probably a year quicker than it would be if we had to develop those lots.

A follow-up to that, what are the terms on those look like? Are you able -- the cash -- are you actually going to buy lots? Can you option them? Do the terms look significantly different than they did in prior years?

Every story is different, as you know. The terms loosened up a year ago, so terms have been our there. And it is the trade-off. If you do an option, you are probably going to pay a little higher price. If you pay cash, you will get a little lower price. Most of the deals we're doing right now are on easy rollers. We're not doing a lot of cash book -- I don't think we are doing any cash book deals right now. It is all small option takes.

David Goldberg, UBS.

I am wondering, Jeff, if you could give us -- or Dom maybe -- a little bit more color on the cost side of the business. And really kind of two parts in that. First, the direct cost, the material cost, and what kind of savings are you quantifying -- what kind of savings do you think you are seeing there? And then also some of the efforts you guys who put forward on the logistics side of the business supply chain and where that stands?

Okay. There is a lot that goes into cost. As we have shared now strategically for the last 18 months to two years, we have been working diligently to retool our productlines to go to smaller footages than we had back in '05 and '06. As Dom mentioned on the call, our average size home was done about 10% in the last 12 months. So it lowers your cost an equivalent amount. Whatever our average price per foot is, you can take that right off as a cost savings.

For the year right now we're tracking -- we're approaching a 10% reduction in directs. I am concerned with the unknowns out there about what the price of fuel does to directs going forward. So we will continue to fight that fight.

On our directs by third-party logistics program that you referred to, we have rolled it out in Southern Cal. It is working very well. We are seeing some synergies due to the direct buy and distribution. We're about to put it on the test pilot in Texas, where we were expecting to see similar synergies. But it is still in its infancy. These things take time to roll out, and we will have a better story for you by the end of the year.

One way you could look at it is that our -- our prices dropped sequentially 7% in the fourth quarter and they dropped another 8 and 9% this quarter, yet our margins on the business have remained relatively flat. They are down slightly, but we have reduced price, and part of it is because we reduced square footage and taken some of the amenities out of the house. But also it has been cost reduction that has helped us to kind of hold the margin while taking -- while making a home much more affordable.

And if I could just get one follow-up. Jeff, you were talking about the ENERGY STAR program and the energy efficiency. And I am just wondering how much more it cost you guys to put in the ENERGY STAR appliances relative to doing some of these more environmentally friendly stuff, and if consumers are starting to pay a premium for homes that are energy-efficient and environmentally friendly?

It is a great question. As we shared in the past, the cost increase to go to ENERGY STAR was very, very minimal. In part because we could roll it -- because we have one business model, we could roll it across the whole system and work with Whirlpool on a volume scale for ENERGY STAR and get better pricing. So there wasn't a margin adjustment for us as a result of the ENERGY STAR appliances.

We continue to endeavor to find additional low hanging fruit that we can offer to the consumer that don't increase our costs a lot. The mainstream consumer right now is focused on affordability, can I really buy this home or not. They will purchase options where is an economic trade-off, where they know over a period of time they can recoup their investment. That is the beauty of our Studios. For the buyer that is really into the environmental side, they have the choice to go buy whatever they want. And then the mainstream consumer that into the environment, but about maybe not to the same degree, we're offering what we can that doesn't increase our costs. So we're hitting it both ways.

Timothy Jones, Wasserman & Associates.

The first question is -- I missed the first ten minutes, and maybe you touched it, but I don't think so -- is your margins continue to be at high single digit -- I mean low single -- high single digit right now. And your operating margin before impairment was about a 10% loss. One of your competitors had a similar thing last quarter, saying basically they were getting rid of a lot of spec units. Another competitor earned about 0.5%, and another one lost maybe 2%. Why are your losses so much greater, given the fact that you really are holding down your spec units?

I don't think it is directly related to spec units.

Is it related to California?

No, I think that where we are -- where we are now is, if there's a loss it is because our SG&A has moved up a little bit. And that for us has been really essentially the fact that revenue is down 50% and we have been able to take our cost down almost 40%.

I know the SG&A, but the gross margin of 8.7 or whatever it was, that is what is bothering me.

There's a few things that impact that. It bothers us also, and it is where we're spending a lot of our time right now. We know they we're not going to see a lot of price increase, obviously, in the short run, so the only way to improve your margin is cost or being a little more strategic on pricing one plan to another, if they're not tracking.

But as we continue to whittle away at our community count and our investment, some of the costs, there's a tail to. I always call it the tail to the comet, where your overhead doesn't move down as fast as your revenue, because you have a lag on the cost side. As we closed out a lot of communities, there's another quarter where the cost continue to flow through the system while the revenue is gone.

Our challenge right now is how do we keep lowering our overhead; how do we keep lowering our cost to produce the houses, and at the right time reload with a lower lot that is going to really lift our margins.

We said in the overall Q&A or discussion that we had focused for a long time on generating a lot of cash. We would continue to be cash flow positive this first half of the year. Some others were not. And we said that we will be positive cash flow in the second half of the year. And then we said strategically we're going to go back and try to work the margins backup because we have done all the heavy lifting on becoming -- on generating cash and rolling our inventories. (multiple speakers).

We think we did a good job on the balance sheet. Now we are going back to focus on profitability.

One of the questions is, one competitor that went up 230 basis points, saying they benefited from about a 9% decline in raw materials, a 7% to 8% decline. And two obviously, the written down land of a year ago are coming into cheaper prices. Why aren't you benefiting from that kind of thing?

I don't think you can take one or two quarters and say we are or we're not benefiting. You've got to look at it in the long term, and I think when we come out of this you'll see the full benefit.

You can also link it back -- we are benefiting in that our price was down significantly because we're repositioning for first-time buyers, insulating ourselves from any additional resale market downturn, yet our margins were flat.

Joel Locker, FBN Securities.

Just on the order front, obviously that improved a lot from the first quarter. I'm wondering if you could give some kind of figure on how much your price per order declined sequentially?

Well, I mean on orders, which is on the deliveries.

Right.

I think it is probably pretty consistent, wouldn't you? When we looked at all our price and backlog I would say it is pretty consistent with what you saw first quarter, second quarter deliveries, where are prices I think sequentially were down 8 to 9%. And I think the backlog would be similar.

So a similar situation there. Just a question, I guess, in more theory. Have you seen -- there is a lot of management teams from the private side that are out of work now, and a lot of the capital on the private equity side. Have you seen any new homebuilders actually in the stages of being formed where those who split the capital or with the private equity, hire the management team, and then go to the distressed playing sellers and buy permanent property or lots to actually build on?

I'm not sure I understand your question. Where the builder would go to a fund to buy the asset?

No, not a builder, an actual like out-of-work say management team hooks up with a private equity who puts $1 billion in there to buy land from distressed land sellers?

The one thing that we have been hearings is they can generate some equity, but they're having a hard time finding the debt side of capital to go with the equity to do deals. So I don't think you've seen a lot being done.

There's a lot of funds that have been created and a lot of home-building executives that have gone to manage those funds, but they aren't doing a lot of transactions today. At the right point in time we will align ourselves with the right fund, with the right managers, and take advantage of that for future opportunities.

Larry Taylor, Credit Suisse.

A couple of things. One, net debt at $856 million has been about flat for the last couple of quarters. You're going to use cash to repay this debt that you're going to take on in July. Is that about the right number, somewhere in that range, that you are comfortable supporting as far as net debt is concerned, given current earnings power?

It will probably improve because we said we would be positive cash flow in the second half of the year, so you would -- probably the net net should actually go down.

I guess a related follow-up question is, when we think about the order of magnitude of the land purchases that you might do opportunistically in the second half of this year relative to the potential for cash flow, how should we think about that in terms of a plug versus how much debt the business is supporting today?

Our strategy right now is to hold our ratio between 40 and 50%. One of the keys to the reload is to continue to get terms to align yourself strategically so you're not using all your cash. But we do think that when the opportunities hit that we're going to use some of our cash and the ratio is going to go up from whatever level it is at that time.

Don't forget that we have $720 million of deferred tax assets that when we turn to property will be an influx of cash for us.

Alex Barron, Agency Trading Group.

I have a couple of questions related to impairments. One was if you could give us, of the communities that you guys currently have, how many have been impaired at least once?

And my second question is, I'm trying to understand a little bit of your impairment methodology, because my impression was that if impairments are taken that at some point the gross margins would start trending back up. So since we haven't seen it, I'm just trying to understand what might be going on there. Thanks.

Actually, when you take an impairment you don't -- you are going to see a much higher gross margin than we have today. You've got to get some price back or your cost down to bring your margins up. But generally the impairments don't yield a higher margin than -- I don't know what you would say, 10, 11, 12% max. Kelly, do know how many of have been impaired more than once in our communities?

Yes. Of our current impairments for the quarter, about half the projects were impaired more than once. And in aggregate a little bit more than 100 of our communities have been impaired more than once.

Could I ask another one?

No, that was your two questions.

Jay McCanless, FTN Midwest.

I just wanted to talk very quickly about the deferred tax assets rolling back onto the income statement. How many quarters of profitability do you think you'll have to see in order to get those back?

They haven't come out with a clear rule on how fast that can be restored.

And then my follow-up, I wanted to ask on the foreclosures. I would assume that the markets that ran up the most during the upturn are the ones where you are seeing the most foreclosures, but are there any specific markets where you're having undue burden from foreclosures?

The markets that we referenced in our comments, the Nevada, Arizona, Florida and California is where the foreclosure levels are the highest. Based on the research we have seen, it is expected to continue at high levels for a little while still.

Ladies and gentlemen, again, that is all the time we have today for questions. Mr. Mezger, I will turn the conference back to you for closing or additional remarks.

Thank you for joining us today for our second quarter 2008 conference call. Have a great day, and we will look forward to speaking with you again soon.

Thank you so much. Ladies and gentlemen, again that does conclude our conference for today. On behalf of KB Home, I would like to thank you for your participation. Enjoy the rest of your day.