KB Home (NYSE:KBH) Q3 2023 Earnings Call Transcript

KB Home (NYSE:KBH) Q3 2023 Earnings Call Transcript September 20, 2023

KB Home beats earnings expectations. Reported EPS is $1.8, expectations were $1.43.

Operator: Good afternoon. My name is John, and I will be your conference operator today. I would like to welcome everyone to the KB Home 2023 Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the company’s opening remarks, we will open the lines for questions. Today’s conference call is being recorded and will be available for replay at the company’s website kbhome.com through October 20. And now, I would like to turn the call over to Jill Peters, Senior Vice President, Investor Relations. Thank you, Jill. You may begin.

Jill Peters: Thank you, John. Good afternoon, everyone, and thank you for joining us today to review our results for the third quarter of fiscal 2023. On the call are Jeff Mezger, Chairman, President and Chief Executive Officer; Rob McGibney, Executive Vice President and Chief Operating Officer; Jeff Kaminski, Executive Vice President and Chief Financial Officer; Bill Hollinger, Senior Vice President and Chief Accounting Officer; and Thad Johnson, Senior Vice President and Treasurer. During this call, items will be discussed that are considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future results and the company does not undertake any obligation to update them.

Due to various factors, including those detailed in today’s press release and in our filings with the Securities and Exchange Commission, actual results could be materially different from those stated or implied in the forward-looking statements. In addition, a reconciliation of the non-GAAP measures of adjusted housing gross profit margin, which excludes inventory related charges and any other non-GAAP measure referenced during today’s discussion to its most directly comparable GAAP measure can be found in today’s press release and/or on the investor relations page of our website at kbhome.com. And with that, here is Jeff Mezger.

Jeff Mezger: Thank you, Jill, and good afternoon, everyone. We delivered another quarter of strong performance highlighted by our closings and margins, which exceeded our previous guidance. With these favorable results and our improved outlook for the fourth quarter, we are again raising our revenue and earnings outlook for our 2023 fiscal year. Our business is performing well and our teams are executing on their plans to balance pace, price and starts, reduce build times and drive high customer satisfaction while growing their volumes and profits. As for the details of the third quarter, we generated total revenues of $1.6 billion and diluted earnings per share of $1.80. We closed 3,375 homes, a strong outcome that was driven primarily by a continued reduction in build times and fewer cancellations.

Our margins were healthy at 11.3% in operating income and a 21.5% gross margin. While the year-over-year comparisons are difficult due to the record profits we achieved in last year’s third quarter, our results and the cumulative benefit of ongoing share repurchases drove our book value per share to $48.29, an increase of 18% year-over-year. The outlook remains healthy for housing market conditions driven by low existing home inventory and constrained availability of new homes at our price points. With over 140 million combined millennials and Gen Zs, first-time buyers will likely fuel the housing market over the next decade, which is favorable for our business as we primarily serve the first-time and affordable first move-up segments. Demand for our product at our price points was solid.

On a per community basis, our absorption pace averaged 4.3 monthly net orders, higher than our historical pre-pandemic third quarter average. Although interest rates rose as the quarter progressed, our net orders remained fairly consistent month to month. The combination of an acute shortage of homes, together with the demographic factors I just referenced, led to strong absorption and a cancellation rate that has returned to historical levels. We generated net orders of 3,097, within our guided range, a healthy result during a seasonally slower time of year. While we are pleased with our net orders and pace during the third quarter, we recognize the impact of both higher mortgage rates and overall economic conditions may have on our buyers.

With that in mind, and based on normal fourth quarter seasonality, we project a monthly absorption pace of between three and four net orders per community, producing a range of between 2,070 and 2,760 net orders in our fourth quarter. We believe we are well positioned to navigate any possible shift in demand should rates go higher or if the economy softens and we are prepared to take the steps necessary to adjust to changing conditions as we have done in past cycles. The flexibility inherent in our Built to Order approach with buyers selecting their lot, floor plan and finishes in our design studios is a meaningful differentiator as buyers are empowered to significantly influence our overall sales price based on their choices. Approximately 70% of our communities offer plans with square footage below 1,600, smaller homes which features similar room counts and livability that are a more affordable option.

Offering a range of products and price points that buyers choose gives us early insight in how the market is moving, allowing us to adjust appropriately in the homes we model and price points we feature. Our backlog was just over 7,000 homes valued at approximately $3.4 billion. As we saw in our results, our large backlog provides a stable base of deliveries with good visibility on margins. We are now primarily focused on selling the homes we need to support deliveries in the first half of 2024. We started 3,850 homes during the quarter, ramping up our starts to position ourselves for growth given the steady demand we’ve experienced. We ended the quarter with close to 7,800 homes in production, of which about 73% are sold consistent with our targeted range.

With that, I’ll pause for a moment and ask Rob to provide an operational update. Rob?

Rob McGibney: Thank you, Jeff. Let me begin by providing some color on our net order results. I want to emphasize a point that Jeff made in that our strategy has remained consistent on optimizing each asset on a community-by-community basis, balancing pace, price, and margin. Demand was healthy across our markets, enabling us to raise prices in 65% of our communities while decreasing prices in only 10%. We offered mortgage concessions as needed, primarily in cases where the buyer did not qualify. Anecdotally, we hear from our teams in the field that buyers are compelled by the combination of the best price and value, not just the best interest rates which is aligned with our business model and our culture of selling Built to Order homes.

Our divisions executed well on our plans to reduce build times with a 35-day sequential reduction in the third quarter. As a result, we are currently building homes in approximately six months and this progress puts us another step closer to returning to our historical level of between four and five months. Further improvement remains a priority, which we expect to achieve by simplifying and refining our product offerings while leveraging the even flow production inherent in our Built to Order model and the long-term relationships we have developed with our trade partners and suppliers. Lower build times will help to generate incremental deliveries and drive higher inventory turns and cash flow, in addition to helping our sales effort in personalized homes.

We are essentially back to business as usual with our supply chain outside of some specific challenges related to roofing materials and electrical equipment, specifically transformers which has been widely discussed across our industry. We also seeing an improvement in the availability of labor for our trades. We significantly reduced are direct costs by over $20,000 in the first half of 2023 relative to their peak in August 2022, which helped to offset the price reductions we did earlier in the year to generate sales. Costs on homes started in the third quarter held steady despite pressure from certain items including concrete, roofing materials and diesel fuel. Going forward, our focus is on incremental cost reductions through value engineering.

As we work to finish the year strong, our key operational priorities remain centered on executing our Built to Order business model and maintaining our high customer satisfaction scores in addition to the areas that are already discussed. And with that, I will turn the call back over to Jeff.

Jeff Mezger: Thanks, Rob. Switching gears to our mortgage joint venture, KBHS Home Loans, 84% of the mortgages funded during the quarter were financed through our JV, which is meaningfully higher year-over-year and a positive development as higher capture rates help us manage our backlog more effectively. These buyers continue to have strong credit profiles with about 60% of KBHS customers utilizing a conventional mortgage and over 90% using fixed rate products. The average cash downpayment held steady with the second quarter at 15%, equating to roughly $70,000 down. The average household income of our KBHS customers was over $130,000, higher than the median household income in our submarkets and we had an average FICO score of 735.

Even with one half of our buyers purchasing their first home in the quarter, we are attracting buyers above our targeted income levels with healthy credit who can qualify at elevated mortgage rates and make a significant downpayment. These data points underscore the solid demand amid the lack of supply. We sequentially increased our land investment by about $100 million, spending approximately $550 million to both acquire and develop land while remaining diligent with respect to our underwriting criteria, product strategy and price points. We expect to accelerate our investment activity in the fourth quarter and beyond to support our future growth targets. Our lot position stands at roughly 57,100 lots owned or controlled, of which approximately 42,700 are owned, representing just over three years supply, consistent with our historical level.

We continue to focus on developing lots in smaller phases to limit our capital outlays and balance our development phasing with our starts pace to manage our inventory of finished lots. We believe we are well positioned as we currently own or control the vast majority of the lots we need to achieve our delivery growth targets through 2025 and are working on filling the gaps for 2026. We do anticipate our community count will be lower at year-end relative to the prior year before growing again in 2024. As we have shared on previous calls, we had intentionally paused on developing lots in most of our communities from mid-2022 through the first quarter of 2023, given market conditions at the time, which has delayed many openings into 2024. We now have a significantly higher year-over-year number of grand openings projected for next year and expect community count growth of 15% in 2024.

Our balance sheet is in excellent shape, with a leverage ratio of about 30% at the low end of our targeted range. This enables us to continue to allocate our strong operating cash flow toward reinvestment for future growth and the return of capital to our shareholders. Since we began our share repurchase initiative in August 2021, we have deployed approximately $590 million to buyback more than 15 million shares, representing almost 17% of the outstanding shares at that time, at an average price below $39 per share. These repurchases have resulted in a meaningful increase to diluted earnings per share at $0.27 just in the third quarter and an increase of nearly 2 percentage points in our return on equity. Over the same period, together with our regular quarterly dividends which we increased in July, we have now returned nearly $700 million to shareholders.

In closing, I want to recognize the entire KB Home team for their contributions to our strong third quarter results. We are now projecting roughly $6.3 billion in revenues for 2023 at healthy margins and we are positioned for meaningful community count growth in 2024. We remain committed to becoming a larger, more profitable company that will generate solid returns and maximize long-term stockholder value. With that, I’ll now turn the call over to Jeff for the financial review. Jeff?

Jeff Kaminski: Thank you, Jeff, and good afternoon, everyone. I will now review highlights of our financial performance for the 2023 third quarter, discuss our current outlook for the fourth quarter and provide our full year revenue and community count expectations for 2024. In the third quarter, we realized significant construction cycle time improvements favorably impacting our deliveries that resulted in our housing revenues exceeding the upper end of our guidance range. We also generated a solid monthly sales absorption pace of 4.3 net orders per community and a higher-than-expected operating margin. In addition, our robust operating cash flow allowed us to repurchase an additional 1.5 million shares of our common stock, while ending the quarter with over $600 million of cash and $1.7 billion of total liquidity.

Our housing revenues were $1.57 billion for the quarter compared to $1.84 billion for the prior year period. This reflected a 7% decrease in the number of homes delivered and an 8% decline in their overall average selling price. Though down relative to our strong 2022 third quarter results, our current quarter delivery performance reflected continued construction cycle time improvements and lower cancellation rates. We anticipate similar positive factors benefiting our fourth quarter deliveries and have considered them in our updated outlook. Based on our current backlog, expected construction cycle times and incremental move-in ready home deliveries we anticipate our 2023 fourth quarter housing revenues will be in a range of $1.55 billion to $1.65 billion.

In the third quarter, our overall average selling price of homes delivered was approximately $466,000 compared to approximately $509,000 in the prior year period, primarily reflecting a mix shift away from our higher priced West Coast region along with lower year-over-year pricing and higher mortgage interest rate and other concessions in the current quarter. For the fourth quarter we are projecting an increase of $20,000 in the overall average selling price to approximately $486,000 due to an expected mix shift towards higher price West Coast deliveries. Our third quarter homebuilding operating income totaled $179.2 million as compared to $325.1 million in the year earlier period, which was a third quarter record. Operating income margin reached 11.3%, exceeding the high end of our guidance by more than 100 basis points due to both our gross profit margin and SG&A expense ratio surpassing expectations.

The current quarter included abandonment charges of $600,000 versus $8.5 million of inventory-related charges a year ago. For the fourth quarter, we expect our homebuilding operating income margin excluding the impact of any inventory-related charges will be approximately 10.5%. Our housing gross profit margin for the quarter was 21.5%, down 520 basis points from the prior year period and 80 basis points higher than the midpoint of our guidance range. The margin result relative to the prior year was primarily due to price decreases and other concessions aligned to housing market conditions, particularly the higher mortgage rate environment as well as higher construction costs and a shift in the mix of homes delivered. Excluding inventory-related charges from both periods, our 21.5% margin for the quarter was down 550 basis points year-over-year.

We expect to see a sequential decline in our fourth quarter gross margin due to both the pull forward of higher margin deliveries into the third quarter and the fact that a majority of our expected fourth quarter deliveries were contracted in the first quarter when we implemented selective pricing adjustments and offered other buyer concessions to improve our sales pace. Gross margins relating to 2023 first quarter sales contracts represented a trough and the gross margin on orders taken in the second and third quarters has steadily increased. As a result, we believe the fourth quarter deliveries will reflect a gross margin inflection point. Assuming no inventory-related charges, we expect our fourth quarter housing gross profit margin will be approximately 20.5%.

At the same time, our expected full year margin of approximately 21.3% is slightly above our prior guidance due to the strength of our third quarter performance and higher full year revenue expectations providing incremental leverage on fixed costs included in cost of goods sold. Our selling, general and administrative expense ratio of 10.2% for the quarter increased by 130 basis points as compared to the prior year, primarily due to reduced operating leverage from lower housing revenues and higher sales commissions. As we position our business for growth in 2024 housing revenues, we believe that our fourth quarter SG&A expense ratio will be about 10%. Our income tax expense for the third quarter of $44.6 million represented an effective tax rate of 23% compared to 22% for the prior year period.

We expect our effective tax rate for the 2023 fourth quarter to be approximately 24%. Overall, we reported net income for the third quarter of $149.9 million or $1.80 per diluted share compared to $255.3 million, or $2.86 per diluted share for the prior year period, which were the highest third quarter levels in our history. Turning now to community count. Our third quarter average of 240 increased 9% from the year-earlier quarter. We ended the quarter with 230 communities open for sales that’s compared to 227 communities at the end of the 2022 third quarter. We believe our 2023 year-end community count will be approximately flat sequentially as compared to the third quarter. We invested $555 million in land, land development and fees during the third quarter with $199 million or 36% of the total representing new land acquisitions.

We ended the quarter with a pipeline of over 57,000 lots owned or under contract that we expect will support a significant number of new community openings to drive community count growth in 2024. At quarter end, we had total liquidity of $1.7 billion, including $612 million of cash and $1.08 billion available under our unsecured revolving credit facility with no cash borrowings outstanding. During the third quarter, our Board of Directors increased the quarterly cash dividend on our common stock to $0.20 per share, up 33% from $0.15 per share. In addition, we repurchased approximately 1.5 million shares of our common stock at a total cost of $82.5 million, while driving our quarter-end leverage ratio to historic low of 30.6%. With $325 million remaining under our current common stock repurchase authorization, we intend to continue to repurchase shares with the pace, volume and timing based on considerations of our operating cash flow, liquidity outlook, land investment opportunities and needs, the market price of our shares and the housing market and general economic environments.

Year to date, we have repurchased 5.7 million shares at an average cost 9% below our book value per share at the end of the third quarter. Shifting to our expectations for 2024, we are forecasting full year housing revenues in a range of $6.5 billion to $7 billion, supported by our anticipated 2023 year-end backlog, expected cycle time improvements and community count growth and assumed stable housing market conditions throughout next year. We expect more than 150 new community openings over the next five quarters to drive sequential increases in ending community count beginning in the second quarter of next year. We believe our 2024 year-end community count will be up about 15% year-over-year. In summary, we are very pleased with our solid third quarter financial performance and strong operational execution and believe we are well positioned to achieve our goals for the 2023 fourth quarter.

In addition, considering our third quarter performance and expected fourth quarter results, we have raised our full year 2023 outlook with forecasted housing revenues of approximately $6.3 billion, up $300 million compared to the midpoint of our prior guidance and a 30 basis point improvement in our operating margin excluding inventory-related charges to about 11.3%. We believe our ongoing focus on accelerating profitable growth and expanding our returns by leveraging our larger scale, strong community portfolio and uniquely compelling Built to Order business model will, along with our stock repurchase activity, produce measurable enhancements in both book value per share and stockholder value in future periods. We will now take your questions.

John, please open the lines.

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Q&A Session

Operator: Thank you, sir. We will now be conducting a question-and-answer session. [Operator Instructions] And the first question comes from the line of Matthew Bouley with Barclays. Please proceed with your question.

Matthew Bouley: Good afternoon, everyone. Thanks for taking the questions. Maybe just to start off with the question on the kind of pricing strategy here. I think you said you were able to raise price in 65% of communities. Curious how that trended as you got into August, and maybe September, given this latest move in interest rates and strategically thinking about sort of what happened a year ago, where you guys sort of chose to protect the backlog perhaps at the expense of orders in the near term. How are you kind of thinking about how that may play out here into the fourth quarter? Thank you.

Jeff Mezger: Matt, I’ll answer the second half of the question first and then kick it to Rob for any comments on the pricing trends month to month in the quarter. But, we are in a totally different spot than we were a year ago. First off, interest rates moved really quickly and the buyers were in shock basically because their payments moved so much of their rates weren’t locked. This year, while rates have picked up, it’s been a more gradual increase and the buyers have been digesting them and moving with us. So the buyer psyche and the backlog, I think, are in far better shape than a year ago. And at the same time last year, our backlog was really extended because of our build times. We were selling a lot of houses and we couldn’t get them built in through the system in our historical timeframes.

So you had a much larger backlog to protect, and we are more sensitive to a year ago than we are today where our backlog is now down really in balance with our build times. So, we like how we are positioned with the backlog to support our revenue projections and you don’t have to go to the extreme to protect the backlog, the way we did last year. So as things go forward and if something happens and demand shifts, if that were to occur, we would take the steps we need real-time on a per community basis and what both Rob and I shared in our comments that we evaluate every community, every week and its pace, price, optimize the asset and some go up and most did in the quarter, but we’ll be moving pretty quickly. We don’t have the same dynamic as last year.

Rob, any thoughts on pricing? I know every community is a different story, but anything you want to add on that?

Rob McGibney: Well, I’d just say it was fairly broad-based, the price increases we implemented in the third quarter across the majority of our footprint. Every division had at least some communities where we lifted price during the quarter, and I don’t necessarily track it by week or by month, but all the way through August, despite rates increasing as we — as Jeff mentioned, balance, pase price, margin, optimize the asset, we had many communities where we continued to raise prices based on those dynamics. So really didn’t see it slow down. Obviously, we’re sensitive to what’s going on with rates in the market. But if the demand is there and we’re selling faster than our targeted pace, we’re going to continue leaning on price and improving margins in those communities where we’ve got the pace.

Matthew Bouley: Got it. That’s very helpful color there. Thank you, both. Second one, just kind of zooming into the margin outlook. I think you sort of highlighted that the fourth quarter margin might be reflecting a more challenging environment on sales back in the first quarter. So I guess just any color around early 2024. What might be some of those puts and takes, assuming the fourth quarter is the trough? I think you said margins were better on sales in Q2 and Q3. So any additional color on the kind of magnitude there, whether it’s on those cost reductions you mentioned, some price increases that were occurring at that time. How can we think about that early ’24 gross margin? Thank you.

Rob McGibney: Sure. Just looking at gross margins, just pointing out, for the full year, we’re actually up a little bit incrementally versus our last quarter guide, which we’re obviously pleased about. We had some dynamics shifting some of those margins quarter-to-quarter. And as you rightly point out, the fourth quarter is impacted by the selling environment earlier in the year when we had a lot of pricing activity and whatnot to help support our sales pace. When we look out into ’24, as I mentioned, our current order activity and backlog definitely supports an improving trend for ’24. But as we all know, gross margins impacted by both favorable and unfavorable factors relating to housing market and general economic environments, which can impact things like sales price and sales pace and need for concessions, build costs, et cetera, et cetera.

So we are encouraged by the favorable trends we’re seeing in the order gross margins. We’ll come back and provide a more detailed outlook for 2024 during the fourth quarter call, including, obviously quantitative and numbers on the quarterly trends and what we see for the full year. But so far so good, and we like the trend that we’re seeing right now with our — relating to our margins embedded in the orders.

Operator: Thank you. And our next question comes from the line of Stephen Kim with Evercore. Please proceed with your question.

Stephen Kim: Yeah, thanks very much guys. Appreciate all the color. And I guess my first question relates to mortgage. I think you refer to mortgage incentives and I guess I’m thinking mortgage rate buydown specifically. That’s something that I know that you all have not really felt like you really needed to use all that much. I was curious if you could sort of talk about in this quarter that we just — that you’re reporting, what was the percentage, if you will, of the sales that you’ve made that did have a mortgage rate buydown? Would you expect that to increase? And is it — is that something that you are going into the market and sort of buying forward commitments for, or you are doing it more on a case-by-case basis?

Jeff Mezger: Steve, you asked five questions there. We’ll do our best. I can let Rob go to the specifics. But at a high level, if you think of our business, we’re Built to Order and on a Built to Order sale and with that customer, you’re working to lock the rate and it costs a little more because you’re further out, but they want comfort knowing they will get the rate when the home is completed and other than that we are not really doing financing concessions on our Built to Order sale. That buyer picks everything like I said in my comments, and it’s all about the best price for the best value and they build it and they are happy at that price. But whether it was the higher can rate earlier in the year or late last year and we had some inventory build-up, we are actually also started some more inventory homes to have that choice available if the customer wants it and that’s where you fall into that situation where you typically have to offer some type of financing concessions or mortgage concessions as you call it to move that inventory.

So that the — where we had that type of activity was on the specs, not on built-to-order sales. But, Rob, you want to get into the numbers on the magnitude or any trends you saw from Q2 to Q3?

Rob McGibney: Sure. The trend, Stephen, didn’t really change that much. I mean, as Jeff mentioned the — any mortgage buydowns or points that we paid primarily went to move-in inventory homes that were later along in the cycle and closer to closing. But as far as the total percentage on mortgage concessions, it was roughly the same quarter-over-quarter, 1.6%, I believe as a percentage of revenue this quarter versus 1.5% or 1.6% last quarter. So it stayed relatively flat quarter-over-quarter.

Stephen Kim: Yeah. Appreciate that. I mean I think that — it’s really interesting how you’re able to see your demand remaining strong, despite not really having to rely very much on rate buydowns. I think there’s are misconception on the part of a lot of folks that the only way builders are getting sales is by doing a rate buydown, but I think you are showing very clearly that your buyer is actually extremely well-qualified. So that’s really encouraging. I did want to shift gears and ask about your community count decline. This is something that I know you’ve attributed to slower development sort of in the back half of last year, but it seems like maybe you had hoped that you would be able to maybe make up some ground, no pun intended, and you weren’t able to.