KB Home (KBH) Q4 2006 Earnings Call Transcript
Published at 2007-02-13 15:36:00
Jeffrey Mezger - President & CEO Dom Cecere - EVP & CFO Bill Hollinger - SVP & CAO
Michael Rehaut - JP Morgan Margaret Whelan - UBS Stephen Kim - Citigroup Ivy Zelman - Credit Suisse Mike Wood - Banc of America Steven Fockens - Lehman Brothers Timothy Jones - Wasserman & Associates Susan Berliner - Bear Stearns Carl Reichardt - Wachovia Securities Ken Zener - Merrill Lynch Michael Rehaut - J.P Morgan
Good day everyone and welcome to KB Home's Fourth Quarter Earnings Call. As a reminder, today's call is being recorded and webcast on KB Home's website at www.kbhome.com. KB Home's discussion today may include certain projections and forward-looking statements regarding KB Home's business, future actions, and expected results. These are based on management's assessment of the company's current business and assumptions about future operating conditions, but should not be considered guarantees of future performance. Please be aware that KB Home's actual results may differ from those that are expressed or implied by the projections and forward-looking statements that may be made today due to risks, assumptions, uncertainties, and other risks and events outside of the company's control and that the differences may be material. Many of these risk factors are identified in the company's periodic reports filed with the SEC, including the annual report on Form 10-K to be filed later today and the company urges you to read them. For opening remarks and introduction, 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.
Thank you. Good morning everyone. Thank you for joining us today to discuss the financial results for our fourth quarter and fiscal year ended November 30th, 2006. With me this morning are Dom Cecere, our Executive Vice President and CFO; Bill Hollinger, our Senior Vice President and Chief Accounting Officer; and Kelly Masuda, our Senior Vice President of Investor Relations and Treasurer. I want to thank everyone for their understanding and patience, while our independent committee y of the Board diligently worked to complete their stock option review. Today, we are pleased to resume our regular communication of KB Home's quarterly results to shareholders, investors, and analyst. During this Board review period, I can assure you that all of us at KB Home kept focus on our customers and our business, and I am very happy to report that we will file our third quarter 10-Q and 2006 10-K today, bringing our financial reporting up-to-date. We are also very pleased to share with you our financial performance for 2006, given the challenging market conditions. Our results are driven by our customer focused business model, which reflects on all the employees of KB Home, who execute the fundamentals of KBNXT everyday. While I am honored and humbled to have been selected by the Board as our company's Chief Executive, I am also very proud to be leading the amazing group of employees at KB Home. Your investment is a vote of confidence in our future and I promise you our organization will continue to earn the trust you have placed in us. Now, let me share some of the financial highlights with you. We posted solid top-line revenue growth in the fourth quarter with revenues of $3.5 billion, up 13% over the fourth quarter of 2005, and for the year reached $11 billion in revenues, up 17% on year-over-year basis. We entered the fourth quarter with a strong backlog of sold homes and we delivered 12,553 new homes during the quarter, up 5% over the fourth quarter of 2005. This performance was a result of converting 53% of our backlog to revenue. The highest conversion level we have been had in some time and as compared to the 43% converted in the fourth quarter of 2005. Housing gross margin in the fourth quarter, excluding non-cash charges for impairments and land-option contract abandonments was 18.8% of revenues, reflecting a healthy margin for a difficult quarter where we faced the spiking cancellations and intense pressure on pricing. We took a non-cash charge of $343 million to earnings in the fourth quarter, to align our inventories and land pipeline to market value and to demand. Lots owned and controlled in the US was reduced by 38% from approximately 180,000 lots at this time last year to 111,000 at fiscal year end 2006. Of this total, we own approximately 64,000 lots and have an option to buy an additional 47,000 lots. As a result, we are positioned very well as we entered 2007, having ability to carefully reload our pipeline of owned lots at lot prices that support our minimum return on investment hurdles when each market begins to show signs of stability. At our Investor Day Meeting in New York in May of last year, we shared with you the actions we were taking to reduce overhead, lower inventory levels, and focus on free cash flow in preparation for the industry slowdown that we began to see unfold. At that time, we'd already commenced actions to reduce our investments in new land and land development and also in rightsizing our overhead levels. The benefit of these actions came to light in the fourth quarter. Inventory was reduced by $1.4 billion from $7.9 billion at the end of the third quarter of '06 to $6.5 billion by year end. We delivered more homes year-over-year, lowered the overall number of homes under construction, reduced land purchases, and delayed or curtailed land development. In addition, we took a non-cash charge to earnings to reflect the decline in fair market value of owned land and walked away from unprofitable lot option contracts that no longer generated viable returns. As a result of these actions, we generated over $1.2 billion in free cash flow in the fourth quarter, and in the year with $639 million in cash and nothing outstanding on our revolver. These results position us to reduce our debt, net of cash by 33% from $3.7 billion at the end of the third quarter to $2.5 billion at our fiscal year end. As stated, despite the difficult market conditions, we concluded 2006 with $11 billion in revenues, up17% on year-over-year basis. Excluding the non-cash charges for impairment of inventory and option abandonments, we generated $1.1 billion in pre-tax profits, with a pre-tax profit ratio of 10.3%. We are maintaining our discipline as a build-to-order homebuilder, authorizing the start on the vast majority of our homes only when we have a qualified buyer, and while providing these qualified buyers the opportunity to customize their homes with extensive choice at our studios. We continue to maintain that our choice value approach with a pre-sold builder is a far better model than spec building and enforcing our choices and values on the eventual buyer through the use of incentives. We entered 2007 with 17,384 sold homes in backlog, one of the largest in the homebuilding industry. We have taken the actions necessary to continue to generate significant free cash flow in 2007, with the land pipeline and overhead structure that has been realigned based on our backlog position and sales rate expectations. We are operating in an environment where there continues to be an imbalance of supply, demand, and affordability to varying degrees in each market. Once markets are stabilized, we will have the financial flexibility to quickly reinvest in our core business as opportunities present themselves. Now, I'll ask Dom to take you through the financial highlights for the fourth quarter.
What if there was a way to promote your company to a perfectly targeted group of potential customers, partners, acquirers and investors? What if you could tailor your pitch to them at the moment of maximum interest? And what if you could do this for a no-brainer price?:
Company sponsors its own earnings call transcript
Company sponsors partner's transcript: Company sponsors competitor's transcript: Issuer-sponsored research firm sponsors client's transcript:
Investment newsletter sponsors transcripts of successful stock picks
IR firm sponsors transcript of micro-cap company: Consulting company sponsors company's transcript in sector of interest: Your company's name and promotion could have been on this transcript! Learn more, or email Zack Miller for details.
Thank you, Jeff. The average sales price of homes delivered in the fourth quarter of 2006 increased 4% to 273,400 from 262,700 in the fourth quarter of 2005. In the US, the average sales price in the fourth quarter was up 1% over the prior year. Our cancellation rate entering the fourth quarter improved slightly to 22% of beginning backlog entering the fourth quarter from 25% on a comparable basis in the third quarter. We believe the continued high level of order cancellations experienced in the fourth quarter were driven by high levels of unsold homes available in the market and heavy incentives being offered by competitors to move finished unsold homes. We averaged 444 active selling communities in the US in 2006, which was up 2% on a year-over-year basis, both for the year as well as for the fourth quarter. We are curtailing community count growth in submarkets where there is an excess supply of finished lots and returns on invested capital are below our targeted return threshold. For 2007, we are currently forecasting approximately 423 active selling communities, down 5% from the 444 averaged in 2006. Housing gross margin excluding non-cash charges for inventory was 18.8% this quarter, down 830 basis points from the all time high of 27.1% in the fourth quarter of 2005. SG&A as a percent of housing revenues in 2006 was 12.7% compared to 12.5% in 2005. Excluding the expensing of stock options, our SG&A ratio was about the same as 2005, having absorbed the one-time cost for rightsizing of overhead and for the one-time cost related to the stock option review. As we entered 2007, we have our SG&A and other fixed cost inline with the deliveries based on the order backlog of sold homes. We expect our SG&A expense ratio to remain flat in 2007, despite significantly fewer unit deliveries compared to the prior year. Pretax profit margins before the $431 million of inventory impairments and land option cost write-offs taken this year were approximately $1.1 billion or 10.3% of revenues in 2006, compared to $1.3 million or 13.7% of revenues in 2005. Our EPS for the year was $5.82 compared to $9.32 in EPS on a restated basis in 2005. EPS in 2006, excluding the $431 million of non-cash charges, was approximately $9.42, just slightly above a record 2005. Debt to total capital, net of cash equivalent was 46%, a 900 basis points improvement from the end of our third quarter. We generated in excess of $1.2 billion in cash in the fourth quarter ending the year with zero drawn on our revolver and $639 million in cash. Company wide, we had approximately 131,000 lots, owned and controlled at November 30th, 2006, including France, compared to 191,000 lots one year ago. In United States, we own and control 111,000 lots, which represents less than a full-year supply of land on a forward-looking basis, with 64,000 lots owned and approximately 47,000 lots optioned. Of the 64,000 lots owned, 15,000 are on the West Coast, 12,000 are in the Southwest, 20,000 are in the Central region, and 17,000 are in the Southeast. In 2006, we took $431 million in non-cash charges, associated with inventory impairments and land option contract abandonments. Included in the 431 million was the $144 million for option abandonments, $229 million for inventory impairments, and $58 million for joint venture impairments. On a regional basis, 49% of the charge was in our West Coast region, approximately 30% within our Southeast region, primarily Florida, 9% was in the Southwest region, and 12% in our Central region. With our continued focus as a build-to-order homebuilder, we had only 734 completed unsold homes in inventory at quarter end. We currently have approximately 10,000 homes under construction in the US, 83% of these homes are sold, and only 17% are spec. While 17% is higher than normal for KB Home, it is still by far one of the lower percentages of spec homes in production in this industry. Our backlog at the end of the fourth quarter of 17,384 sold homes valued at $4.4 billion was lower than one year ago by 32% in units and 34% in dollar. On a forward-looking basis we still have a six-month order backlog of sold homes, one of the largest in the industry as a foundation for even flow production and optimization of construction cost efficiencies. In summary, revenues for the fourth quarter and total year of $3.5 billion and $11 billion were up 13% and 17% respectively. Pretax income, excluding non-cash inventory charges for the fourth quarter and total year were $216 million and $1.0 billion, 6.1% of revenues in the fourth quarter and 10.3% of revenues for the total year. We entered 2007 with our lot pipeline, the number of homes under construction, SG&A, headcount and fixed overhead, all right-sized to the realities of today's housing market. We've generated in excess of $1.2 billion in free cash flow this past quarter, demonstrating the controls that we have put in place to turn inventory faster, deliver homes on time, control land purchases, and control the flow of expenditures for land development. Now, I will turn it back to Jeff for the wrap-up of our fourth quarter conference call.
Thank you, Dom. We are encouraged by the number of potential home buyers that are visiting our communities and also the success we are having in our co-branded communities with Martha Stewart, where sales and margins continue to demonstrate that choice, quality, and brand are more important than price concessions. We are also encouraged by the national statistics for new housing permits and housing starts which indicate the homebuilders are reducing housing starts, which will eventually reduce the excess supply of unsold new and resale homes that still exist in the market today. We continue to focus on our KBNXT operating model, as a build-to-order homebuilder, featuring choice and value with a six-month order backlog and experienced management team and world-class training tools essential to creating value for our shareholders. We are staying very selective in land purchases, until markets become more stable and the cost of land gets in balance with today's home prices. With only 64,000 lots owned in US, we are well positioned to begin purchasing land at lot prices that will provide better margins and returns than we are experiencing today. We are reducing the cycle time from the sale of home to close to our even flow production focus, which reduces cost and improves inventory turns. In many of our businesses, we have already experienced over a 30-day reduction in the cycle time to deliver a home. We are driving additional direct cost savings through our KBNXT initiative called Pathfinder. In fact in many of our new communities in the one supply constrained coastal markets we are seeing an 8% to 10% reduction in the cost per square foot to build. Our Pathfinder initiative applies to our overhead structure as well, where we have quickly position ourselves this year to comparable SG&A ratios as in '06 on lower projected revenues. We believe that in 2007, these actions will provide significant free cash flow, a healthy balance sheet, and streamlined operations which will deliver above average shareholder returns through the current slowdown and the ability to aggressively improve profitability when the fundamentals driving housing demand returned to more normal conditions. As you know, we don't typically share sales and traffic data before quarter end. However, we are two weeks away from the end of our first quarter, and in these fluid times, we want to be as current as possible in our communication. Quarter-to-date, we are seeing cancellation rates return to more normalized levels. As planned, community counts in the US are down 8% from the first quarter of 2006, traffic volume is down 10% for the total company, and net orders are also down approximately 10% quarter-to-date compared to one year ago. While this is modestly good news, we are just now entering the peak selling season, and we will have a much better feel for our financial outlook for the year in another 10 weeks to 12 weeks. We expect the next two quarters to be challenging, with continued pressure on pricing until supply and demand become more in balance. In the first half of the year, gross margin on housing and earnings per share will continue to moderate. In the second half of the year, when many of our cost control initiatives are in full swing and we have closed out many of our underperforming communities, there is opportunity for housing gross margins to rebound and earnings may improve, assuming market conditions and pricing stabilize. Until then, we are focused on generating free cash flow from operations, carefully reloading our lot pipeline, and maintaining a healthy balance sheet. We will now open up the lines to take your questions.
Thank you. (Operator Questions) And we'll go first to Michael Rehaut with JP Morgan. Michael Rehaut - JP Morgan: Hi, good morning.
Good morning Michael. Michael Rehaut - JP Morgan: I just wanted to make sure I understood that correctly regarding your comments on quarter-to-date trends. When you said the Can rate returning to normal levels, as I've looked over the last couple of years, it appears that the normal Can rate for KB is maybe in the high 20s to low 30s. Is that type of level that you saw quarter to-date?
That's correct Michael. We will be changing the way we report our Cans to go to a percent of backlog at the beginning of the quarter. But at our quarter end call, we will clarify that. But as we said here today, our Can rate as we've historically reported is flat with '06. Michael Rehaut - JP Morgan: That's great. And in terms of the order you set down 10%. Were there any regions that were positive year-over-year or were most still negative?
Interesting question Michael, I appreciate it. We actually are seeing positive sales comps on the coast, both California and on the East Coast. Our sales are off in the Central region in large part because our community count is down significantly, where we've lowered our investment due to not obtaining our required returns. Michael Rehaut - JP Morgan: Okay. And just last question on order ASP that we noticed for 4Q, it's down about 25%. I was wondering if you could give some color on that, it appears that there -- might have been in part of mix shift. But, for example, in the South West you're down to -- we calculated 155,000 per unit per order. But in many regions you are still looking at a pretty sizable decline. So if you can talk about if its mix and also I assume there is a lot of pricing action going on as well?
Yeah. Michael let me refer to Dom on that question.
Mike, you are backing into it by looking at the backlog, entering the year in the backlog at the end. And since you have adjustments to the backlog and pricing when they come to the table, it distorts the orders. I would tell you that the average price is probably down about 4% or 5% entering 2007 from the fourth quarter. The fourth quarter prices were up 1%, year-over-year it will be down 4% or 5% as we begin our 2007. I would also like to tell you Mike just so you understand that, as we bring in new communities with lower square footage and a lower spec level, our prices will be coming down without impacting margins. So, that is happening as on an ongoing basis starting in the second half of last year. Michael Rehaut - JP Morgan: I appreciate that. And when you said the 4%, that's on a nominal basis, correct?
Yes. Michael Rehaut - JP Morgan: Okay. Thank you.
And next we will go to Margaret Whelan with UBS. Margaret Whelan - UBS: Good morning, guys.
Good morning Margaret. How are you? Margaret Whelan - UBS: Perfect. Thanks, congratulations on the promotion, both of you.
Thank you. Margaret Whelan - UBS: Okay. So, here is the first question I have for Dom. If you think that your SG&A is going to be flat, does that mean that you are going to kind of maintain kind of focus on margin strategy and not chase volume what so ever?
Well, our SG&A is going to stay flat and volume will come when we start to see some demand and the market pick up. So, the answer is we are focusing still on maintaining our margins and taking volume when can get it. Margaret Whelan - UBS: Okay. But you are just not going to compete on pricing, not going to discounting as much as some of your peers, it sounds like?
Well, I think I would agree with that.
Yeah, Margaret, we are focused on returns and it's a per community analysis, we will set a run rate and a margin rate to give us the most cash back and that -- then we hold to that to the get sales and if we can't get our returns, we are not going to keep chasing the units. Margaret Whelan - UBS: Okay. Good.
I mean the good news, Margaret, in the first quarter was that, our community counts were down 8%, however our orders were -- and were only down 10%. Margaret Whelan - UBS: Yeah.
So, our sales per community, we are actually doing pretty good on a year-over-year basis. Margaret Whelan - UBS: If I am thinking about that right, then you have about 24,000 houses in backlog, is that at 17 plus about 7,000 orders to date?
No, because of deliveries also, we've about 18,000 homes in backlog. Margaret Whelan - UBS: Okay.
With 17,700 going in the year. Margaret Whelan - UBS: Okay.
I mean deliver homes and pick up orders, and that hasn't changed much. Margaret Whelan - UBS: Okay. So, that -- so, what kind of….
And in the first quarter, I would guess it might be up slightly. Margaret Whelan - UBS: You're order?
The backlog. Margaret Whelan - UBS: You're backlog. Okay. And did Jeff say you have 111,000 lots?
We have a 111,000 lots in the US, 64,000 of those are owned. Margaret Whelan - UBS: Okay
And the 47,000 are the optioned. Then, we have 20,000 lots in France. Margaret Whelan - UBS: Okay. And then, so that's about for years of supply, at what point would you be buying dirt. It seems like you're more liquid then lot of the other big cap here?
We definitely are Margaret. And with the dry powder we have we can be selective and opportunistic. We have the lots to achieve our business plan for '07 and frankly '08. So, we don't have the urgency to go do something. We will, as we sense each market stabilize and we see opportunities in the market, we're going to go after them at that time. But, it is not something we're going to rush out and do in the next month or two. Margaret Whelan - UBS: Do you see anything that's penciling right now? Any --
Yeah. We're actually approving a few deals in our Land Committee process and it's most easy options in markets that haven't depreciated as much, but not a lot, very little. Margaret Whelan - UBS: And so, last question from me, what is your priority on use of cash? Should we expect any buybacks this year? And then any plans to divest France in '07?
As we've always said Margaret, we have a balanced approach to cash. We've been the largest buyback company over the last few years. We want to wait and see how the business shapes up for the year, so we have a firm understanding of our cash projections for the end of the year. If we think there is opportunities in acquiring assets we will go that way. If we don't see those opportunities, we could take our debt down or we can go buyback more stock. We do have 4 million authorized on our buyback by the Board today. But, we want to, again, wait and see how the year unfolds. Relative to France, as I keep saying, it’s a world-class situation to be in. We have a great business over there. We are the second largest builder in France. I have known [Gee] for 14 years. I visited Paris in December to gain his commitment and trust in our relationship. They have a great year projected for '07. They are very profitable, very tenured. It's a low risk for us, but it also may be an opportunity. So, we haven't finalized any strategic analysis yet on what to do.
And next we will go to Stephen Kim with Citigroup. Stephen Kim - Citigroup: Thanks. I was wondering if you could elaborate a little bit on your comment about the gross margin. I thought I heard you say that in the first half of next -- I guess this year, you anticipate that the gross margins would continue to moderate and then in the second half there was opportunity for rebound. Could you talk a little bit more about what you meant by -- continuing to moderate, moderate year-over-year, moderate sequentially, some sort of order of magnitude that sort of thing?
Stephen, I would say moderate sequentially. The fact is we are still under pricing pressure. There is still an excess supply and therefore, we believe in the first half. And by the way margins in our business, because deliveries are stronger in the second half than the first half, always start out the year lower than they were in the third and fourth quarter than in first and second quarter. So, all of those trends are going against us, and the fact is that as we begin to swap out old communities with new communities. And by the way, by the time that we get through this year, we will probably have replaced two-thirds of our communities with new communities with lower square footages and better price points which will help our margins overall. All of these things are going to start to really, will start to see the full benefit of in the second half of 2007. So we got a couple more quarters where we think pricing and margins will be under some pressure until we start to see some of the dynamics move more in our favor. Stephen Kim - Citigroup: And you were saying that you saw the opportunity for a rebound in margin in the back half, not just the stabilization I guess, right as you see the --
Things like that. Stephen Kim - Citigroup: Right. Okay, and you had --
Actually, we said they could improve if the market stabilizes. Stephen Kim - Citigroup: Exactly right, okay. And in terms of your subdivision count, I think you indicated that your subs were down about 8% here in -- currently. And I was curious as to whether you had a projection for where that might be later this year?
We said overall for the year that we would be at around 423, down 5% from the 444 that we averaged this year and actually being up on both coasts, but down in the Central, some in the Southwest.
And next, we'll go to Ivy Zelman with Credit Suisse. Ivy Zelman - Credit Suisse: Hi guys, good morning, and congratulations.
Good morning Ivy. Ivy Zelman - Credit Suisse: Relative performance obviously doing very good. Can you kind of talk a little bit about some of the buyers today, what's your requirement on deposit for today's buyer on average when they are --
It will vary by market, Ivy, but it's about 2%. Ivy Zelman - Credit Suisse: 2%. Okay.
Yeah. Ivy Zelman - Credit Suisse: And one of the things that I am sure you guys are focused on, or worried about as your comments have been very balanced, Jeff, with respect to the expectation on '07 and, if and could, I like those words, I think they are carefully chosen. When you think about the lending environment today, we're hearing from the mortgage originators out there that some of the subprime blow up is spilling over into the convectional prime market with clearly tightening going on with the documentation. First thing, we are seeing is low-doc loans or no-doc loans are starting to no longer be easily underwritten and even pullback entirely. Seconds, they are being eliminated by some mortgage originators, Fremont announced that they are not going to do seconds any more. So there is a lot of concern that even prime and conventional mortgages are going to start to be impacted 100% LTVs, IOs. Is this something that you're factoring into your outlook and clearly the demand improvements that you might be seeing today, some of those underwriters. Can you talk about what the mortgage portfolio of your buyers look like? How much of it is 100% LTV? How much of it has seconds, I guess that's the same saying? How much of it is interest only, kind of walk us through it, so we can understand where the demand or how the demand is shaping out?
Okay. What I can share with you Ivy because the question was raised earlier this week, for starters, we have a great partner in Countrywide, very sophisticated, very stable long-term company. And when I was getting ready this morning, I heard that another subprime company out here in California closed yesterday. So it's the classic case of a mortgage industry tightening up. The quality performers will stay. Those that were opportunistic and didn't run so well are now going away. In the terms of subprimes within our venture, it's about 12% of our business, primarily in the Central region. The coastal buyers are more conventional, high FICO scores, solid incomes. They do have a lot of 100% loans. I think Dom has the numbers here. But if subprime were to go, my point is that it may impact our markets where we have lesser margins in the first place and a little lower quality buyer profile than some of the higher price product we have on the coast.
I think the good news is that our FICO scores for buyers still remain slightly above 700, so they can qualify for a loan. And the more we can do, when we open new communities to lower the price point, the more affordable for buyers and that's our focus. Ivy Zelman - Credit Suisse: No, and I appreciate that. I guess what I am trying to understand is how much of your business is 100% LTV and then clearly even with Countrywide, I am realizing that the environment is changing. They may get a little bit tougher to underwrite someone who might be a 7% -- a 700 FICO score with only a 90% LTV or a 100% LTV, and clearly demand to be negativity impacted by what's happening in the mortgage arena. And I am just wondering if you look at the people that are in current backlog, can you give us the sort of the profile of that buyer, how much is the 100% LTV? You gave the FICO score, how much is interest only, how does that interest only breakdown years in terms of a reset?
No, Ivy, I will get that for you. I honestly don't have for Countrywide in front of me. Ivy Zelman - Credit Suisse: Okay.
But I mean I can't argue the fact that these will all cause some level of the demand -- impact on demand. The good news is that at least to a quarter, our traffic and our communities have only been done about 10%. We didn’t see the net orders at the last half or last year because we had cancellation rates, but now when those cancellation rates subsided, we are now seeing orders being in line with traffic.
I do think, Ivy, it's a fair comment that if subprime tightens up and underwriting tightens up, it's going to restrict demand. If it's not new, it's resale and we'll have to cycle through that. These large vendors have been creative for years and whenever one program goes away, they've quickly come up with another program that replaces it, maybe more conservative, but still has flexibility. So, I think that's what you'll see. But, certainly could affect affordability in the short run. As to how much we don’t know.
(Operator Instructions) And next we'll go to Dan Oppenheim with Banc of America. Mike Wood - Banc of America: Hi this is [Mike Wood]. Can you characterize the improvement that you've seen in the first quarter so far with the less -- lesser the decline in orders in terms of -- is this primarily the result of pricing or you seeing a pick up in demand? Just if you could give us some color on that?
I think a good data point, Mike, is that our traffic levels are tracking with our community count and tracking with sales. So, there is buyers in the market, there is affordability pressure, and we've told you that our margins have moderated some, and I think it's parts of the spring selling season. I think it's part what we have done to sell homes. That’s why we are cautious about the year, because it's unclear at this point in time how strong the spring selling season is going to be. And in another 10 or 12 weeks, we'll have a very clear picture on where the markets are heading and where our year is heading.
We also think that our KB's price point as a price point will be more in demand than the second move up to luxury buyer. Mike Wood - Banc of America: Okay. And can you just also give us sense of the -- with the homes sold I guess so far this quarter and last quarter, just how that breaks out generally with spec homes and pre-sales?
Well, we have only -- in our production and this is been pretty consistent. 83% of the homes we have under construction are sold and only 17% are spec. So we've been -- and that’s probably one of the best production spec levels in the industry. So, based on -- and that's been that way for several quarter. So, the vast majority of the homes that we have in construction and are selling are sold. Mike Wood - Banc of America: Okay. Thanks.
And next we will go to Steven Fockens with Lehman Brothers. Steven Fockens - Lehman Brothers: Thanks guys. Hey, as you look forward and when business starts to moderate a little bit, what are your thoughts about ongoing redeployment of cash and maybe being ongoing more consistent generator of cash -- free cash, I guess, I should say?
I think going forward, Steve, you will us focus on a balance of -- in normal times, we want to have 10% top-line and generate cash every quarter. And we think we can do both.
Steven, remember we -- I mean -- I think the footprint would say, hey we generated being to [encash] in last three months. And we are not expanding community counts for growth, we are curtailing community counts until we see the market demand more communities. And by curtailing community accounts, you are not putting more into land and land development going into year. So, we have a plan in place that we will continue to generate free cash flow and we will use some of that free cash flow to invest in land. If the opportunity arises, that's a good opportunity and markets have stabilized. And it's a market-by-market look. But right now we are free cash flow generator. Steven Fockens - Lehman Brothers: Great, thanks very much.
And next we will go to Timothy Jones with Wasserman & Associates. Timothy Jones - Wasserman & Associates: Good morning.
Good morning Tim. Timothy Jones - Wasserman & Associates: Kelly, your main number isn't working, may be some people who are listening on the Internet would like the backup number 866-558-6905, just to let you know. Okay. I have first question, and on you gave the lot count, could you give the owned and optioned last year with the 180,000?
Over the last year, I believe it was around 54% options and 46% owned and closed. Timothy Jones - Wasserman & Associates: Okay, close enough. Okay. 46% owned, right?
It's, yeah, we are 54%. 54.46, that was pretty good. Timothy Jones - Wasserman & Associates: Okay. The -- I want to make sure that something you just said. Do you see today that your homes -- did your spec homes are 17% of your homes under construction, because there is no other builder that is under 25 and there is a number of home that at 50%?
That's exactly right. That's why we are a built-to-order homebuilder, not a spec production builder and to do that you have to have a backlog.
Tim, philosophically we believe strongly in our business model and the senior management team is driving starts through having a pre-sold backlog. We are not going to chase a business plan by building a bunch of specs and hoping the buyer show up. They are much more predictable.
And next we will go to Susan Berliner with Bear Stearns. Susan Berliner - Bear Stearns: First some comments on some of your larger markets in California, Las Vegas et cetera, and also I was wondering with the sizeable amount of cash you have sitting on your balance sheet, if you thought about taking out your 9.5 callables?
Well the 9 and 9.5 callables we have thought about taking back. And probably we will do that further years out. No doubt Jeff will give the--
As I shared in my comments, Susan, we are actually seeing positive sales comps in the East Coast, and the West Coast we are off, and the Southwest and Central in part due to community count in the case of Vegas or Phoenix, while we are seeing signs that it starting to stir, they are still pretty challenged and competitive. So we are not seeing big sales through out of Las Vegas or Arizona. Within California, it's spotty. We actually have communities where we hit the price points that target what I call the local demographic, the incomes in the area, and job levels in the area. When you can hit those price points today, you actually can still have campouts for your product. And we've had that in an area in the Inland Empire where we brought a product to market around 400,000 which believe or not is a first-time homebuyer and had campouts in the community. So if you can get to the price point in any market, there is underlying demand there, where it gets slow is when you are above that and it's just an affordability issue. Susan Berliner - Bear Stearns: Are you having better -- do you think the markets will rebound faster in Las Vegas or Phoenix?
Phoenix is not as land constrained. Susan Berliner - Bear Stearns: Right.
There is a lot more inventory on the ground, which will probably put pressure on pricing. I think my hunch and this is the crystal ball would be that Vegas would rebound ahead of Phoenix, but that -- both on them still to be told. Susan Berliner - Bear Stearns: Great. Thanks very much.
And next, we'll go to Carl Reichardt with Wachovia Securities. Carl Reichardt - Wachovia Securities: Hi guys. How are you?
Good morning, Carl. Carl Reichardt - Wachovia Securities: Give me a moment into the call. I assume I just shouldn’t ask this question because I missed part of it. But can you talk a little bit about your net community openings in the first quarter and second quarter of the year relative to last year in terms of sort of pricing and square footage, Jeff? I am sorry if that was just asked.
Dom can give you the net community number. As to square footage Carl, there is really three buckets that we are chasing to lower our cost and lower our price to the buyer. One is by building smaller homes as the market were so strong over the last few years, you could make more money by building a bigger home on the same lots, in our average size home in many communities was up 300 to 400 square feet. So we are quickly retooling product on our new openings to go to smaller product. In some cases, we can lower our spec level by $20,000 to $30,000 from what was in the larger product. And then third would be whatever we can get back from the subcontractor base in the way of savings. Between the three, you can potentially lower your price, $50,000, $60,000, $70,000 and that impact your margin, and that's where we are headed with our new community openings in '07. Dom, do you have the number for?
Yeah. In '07, we are going to open 180 new communities. It's about 42% of the average communities that will have opened this year and it's 80 in the first half and 100 in the second half. Last year it was about 260 communities, and again that was about 150 that came in the second half. So we have been able to at least in at that level be able to on those new ones that will open in the second half we are looking to reducing the cost per square footage and making it more affordable. Carl Reichardt - Wachovia Securities: Terrific. Okay. I appreciate that very much guys. Thank you.
And next we'll hear from Ken Zener with Merrill Lynch. Ken Zener - Merrill Lynch: Good morning.
Good morning, Ken. Ken Zener - Merrill Lynch: I am just -- if you could quantify you are facing some pricing pressure. I realized, Jeff, you talked about -- you guys ability to offset the cost input. But could you kind of give us a little more sense of, what do you mean by moderating margins in the first few quarters here sequentially relative to the fourth quarter?
I will defer that to my good friend and running buddy Dom Cecere.
I mean it's just what you have seen. We are going into the New Year and we are only two weeks into the sales cycle. We still have pressures on pricing. And therefore, our best look today is that margins are going to moderate some until we some demand pick up. And we just want to make sure that the analyst understood that the margin improvement that will happen in this industry is, well, it going to be a second half of that and not a first half of that. It's still going to be difficult to peg the margins until we understand what happens with pricing in the first quarter and the second quarter. Ken Zener - Merrill Lynch: Right, I guess would you consider the 300 basis point decline third quarter to fourth quarter as moderating?
No, I wouldn't. And you have to remember, in the third quarter, there were significant cancellations starting in the industry. That ended up -- we ended up with a lot of unsold spec homes by builders being pushed through the system. And when that happened that really drove prices down more. So, I think the fourth quarter was probably a tougher quarter. The first and sixth should not be as bad as the fourth as far as declining margins go. Ken Zener - Merrill Lynch: Okay. And then, in terms of the communities where you have the impairments, what is the margin that you're kind of resetting these communities to, if you can kind of describe your thought process? And then, how much of the charges that you've taken in '06 will be benefiting '07 deliveries? Thank you.
By community, each one can be different, but our net margins are only between 10% to 15% gross margins on these impaired communities and in the -- what is it Kelly? It's about 40% of that flows to the P&L in 2007.
Yeah. In 2006, we had about 37 impaired communities and about 29% flows through '07, 43% in '08, and remainder after '08.
We can underwrite every quarter, every community to our net present value on cash. And while we do that methodology it defaults back to a margin that will range from 10% to 15%.
(Operator Instructions). And next we'll turn to Michael Rehaut with J.P Morgan. Michael Rehaut - J.P Morgan: Hi. Thanks. I was wondering Jeff, if you could address one of the, I think unique aspect of KB, now that you are moving into the CEO seat, which is the France unit. And obviously from time-to-time people ask about that in terms if that's going to continue to be a core part of the business as most other US builders concentrate domestically. What are your thoughts on that business and is that something that you might take a fresh look at over the next 12 months?
Mike, I don't know if you were on the phone, but somebody already raised this question. We've been in France for over 30 years. We have a phenomenal business with a tenured management team with succession plans in place. We've had a great growth track for the last two years. They now build in every province. So, it's a very well run, very profitable business with projections in '07 for more growth in revenue and earnings. So, we have this business that runs well, it's been part of our strategy for the years. I think we are the only US public builder that has a success story in another country, and we are in no hurry to make a decision to do anything right now, because we're -- it's running very well and we have a good relationship with our French management team. So, we will continually evaluate their results and opportunities in the future. Right now, we haven't cutout our strategy.
And Mike, it's hidden matters that we probably don't get as -- enough credit for it. I mean, the KBSA has -- stock has rallied up 20% just in last few weeks and it's current market value is about $800 million. So, one of the things that people should realize when they own KB Home is we have got an $800 million market value that I think is only on our books for a couple of million bucks. So, it's, from a book value perspective it's a jewel. Michael Rehaut - J.P Morgan: I appreciate that, and sorry I repeated the question there. But just switching gears for a moment, you mentioned some very good balance sheet shape, particularly in terms of spec. I was wondering, looking into '07 in the first half of the year, particularly, do you expect to continue to reduce your spec and also your [lock count] and with the 10,000 homes under -- under construction only 17% without an order. I mean is that something that can continue to come down?
Over the years, Mike, our typical ratio was 90% sold, 10% unsold. With the cancellations spike in Q3 and Q4, that number went up even above 17, I think at the end of the third quarter, early fourth quarter. So, we're going continue to work that number down back to the 10% range. And the market and the sales rates and everything we do per community will drive how bigger construction pipeline we have and what our lot needs on a go forward basis. Michael Rehaut - J.P Morgan: Do you have an idea what the differential is between the cancelled homes that you're reselling now versus the new orders that you are writing today in terms of looking at the gross margins?
When we've looked at it Mike, it has ranged from 500 to 1000 basis points lower and price per our cancelled home that’s resold versus build-to-order home. So, it's a significant difference.
And that will conclude our question-and-answer session for today. I will now turn things back over to Jeff Mezger for any additional or concluding remarks.
Thank you. Thank you for joining us today for our fourth quarter and total year 2006 Earnings Call. I hope to see many of you later this month at the Wachovia Homebuilding conference in Las Vegas. Have a great day.
And that does conclude our conference. Thank you everyone to your participation.
Company sponsors its own earnings call transcript
Company sponsors partner's transcript: Company sponsors competitor's transcript: Issuer-sponsored research firm sponsors client's transcript:
Investment newsletter sponsors transcripts of successful stock picks
IR firm sponsors transcript of micro-cap company: Consulting company sponsors company's transcript in sector of interest: Your company's name and promotion could have been on this transcript! Learn more, or email Zack Miller for details.