KB Home Earnings Call Insights: Inspirada and Gross Margins

KB Home (NYSE:KBH) recently reported its third quarter earnings and discussed the following topics in its earnings conference call.

Session 1:

Robert Wetenhall – RBC Capital Markets: Just wanted to see how much upside is there to ASP’s lot, given the fact you’re up 22% year-over-year and I was hoping, Jeff if you could give us little bit more color on your outlook for Inspirada as we go into ’14?

Jeffrey T. Mezger – President, CEO and Director: Well, as Jeff shared in his comments Bob, we do expect our sales price to go up a little bit more in the fourth quarter, 299 in the third quarter and a little bit above 300 is what he guided for the fourth quarter. Moving forward, a lot of it will depend on mix of what’s opening and closing and we think we’ll continue to be able to push our overall pricing up through the mix of the communities that we’re bringing to market. We don’t bank on prices going up as we project our business and my hunch is that the little uptick in interest rates probably slowed down the inflation side of things for a while in housing, which I actually think is healthy for the recovery in the long run. As to Inspirada, there’s a few moving parts to it, as you know, the development agreement applies to the villages and primarily 3, 4, 5 and beyond. We do have assets in village 2 that are in the entitlement process that we intend to open up in 2014, hopefully in the spring and we’ll come right behind that as the development agreement turns into actual development on site and all the builders are hopeful of getting communities open later in the year in the ensuing villages beyond. So, it’s a pretty exciting development in a very land constrained market and we think it’s an incredible opportunity for us now.

Robert Wetenhall – RBC Capital Markets: Just as a follow-up, Jeff, you’ve done a great job on managing costs. Are we kind of at the end of the rope in terms of getting the SG&A ratio to where it’s at or is there room for improvement as sales continue to grow?

Jeff Kaminski – EVP and CFO: Yeah, we believe there’s generally some room for improvement. Obviously, we made tremendous progress over the last 18 months or so in improving the SG&A ratio, but as the volume continues to come in the top line and we’re continuing to contain costs within the operations and control basically both resources and where we’re spending, we do believe there’s some incremental improvement. We are starting to put some money back into the business to continue to generate top line growth, as we’ve mentioned in previous quarters. We’ve added quite a few land resources. For example, supporting what we’re estimating to be about $1.2 billion of land investment this quarter and we think we’re making some pretty wise decisions as far as what areas of the business to invest in, to drive future revenues and profits and where we look to continue to control cost to drive consistently improving SG&A ratio.

Gross Margins

Michael Rehaut – JPMorgan: My first question just on actually the gross margins, you noted that – you actually hit a little bit above 19% excluding the water intrusion charge, and given the trends that you’re seeing in backlog and ASPs etcetera, is that a good number to work off of in terms of going into 4Q in 2014 from which would it be reasonable to expect incremental improvement from that 19.3% level?

Jeff Kaminski – EVP and CFO: Just specifically talking about Q4, I guess, first, we do see in our backlog the potential for improved sequential increase in our gross margin and we are expecting a sequential increase in the fourth quarter. We’re seeing some nice increases as we move through this year particularly year-over-year and also sequentially, and we think that trend will continue through the fourth quarter. We’re really at this point not guiding out into 2014 yet, but based on what we’re seeing in our new communities and the communities we currently have in the portfolio, we’re certainly not looking to step backward…

Michael Rehaut – JPMorgan: Just to be clear though in terms of like what base to think of in terms of from 3Q and given that, I wouldn’t expect you to be – obviously you think you’ve fully reserved hopefully for the water intrusion, that, that…?

Jeff Kaminski – EVP and CFO: I would move it off our adjusted base of about 19.3%.

Michael Rehaut – JPMorgan: Perfect. Also on the SG&A, you mentioned that benefited a little bit by a change in income associated with equity compensation. What was the amount of that benefit roughly on a dollar basis point level, and is that something that we should think about as an ongoing improvement or kind of think of that SG&A on an ongoing basis that maybe – if that was more of a one-time adjustment?

Jeff Kaminski – EVP and CFO: I’ll make a few comments on the SG&A just to add a little context to the number in the quarter. First of all, as most of you guys are aware, we’ve always looked at it as a variable component in our SG&A and what we call a fixed component. On the variable side, we’re running at about 4.5% of our top line revenue right now, and while that can range 10, 20, 30 basis points up or down in a particular quarter, a 4.5% number on top line revenue is a pretty good number to use for the variable piece. And the fixed component side, it does include certain expenses that are not tied to top line revenue, but vary based on other factors, and one such item was referenced in the press release, which was cash based comp that’s tied to our equity value. The dollar amount of impact in the current quarter on that was about $6 million, and we also have a couple of other legacy benefit programs that vary quarter-to-quarter as well and those were actually about a negative $1 million in the quarter. So, on a net basis between all those plans, it contributed about $5 million of income or an SG&A offset depending on how you look at it during the current quarter. As far as repeatability, it all really depends on stock price and with our benefit plans, the overall performance of the stock market, actuarial valuations and other things. So, while we call that piece fixed, there are, like I said often times in the past, there are variations in it, but not tied to the top line.