KB Home Exec INSIGHTS: Gross Margins, Order Trends

On Friday, KB Home (NYSE:KBH) reported its second quarter earnings and discussed the following topics in its earnings conference call. Take a look.

Gross Margins

Sue – UBS: This is actually, (Sue) on for David. I wanted to get some more details in terms of the gross margins. You noted that you are basically offsetting the higher costs that you are seeing for labor and materials with the price increases. Can you give us some sense though of how much of the price increases are going to this and are any of them just going down to the bottom line to actually improve the underlying margins?

Jeffrey T. Mezger – President, CEO and Director: Jeff, go ahead.

Jeff Kaminski – EVP and CFO: Yeah. Okay, sure. The first thing I’d like to say, I mean just looking at the margin for the year, we do expect sequential improvements in both the third and the fourth quarter, and we do expect favorable year-over-year comp in Q4. What we saw last year, and I think it is important to remind everyone, we did have a $7.4 million warranty adjustment in the third quarter of 2011 and that benefited our gross margin by about 200 basis points last year. So, there were few things impacting the margin. Now turning to this quarter, we had a 90 basis point improvement, of course, versus the first quarter of 2012. That includes all the warranty and insurance recoveries. It was up about $9 million actually in dollars as a result of our rising ASP, which we thought was an important thing to note. It was about what we expected. We talked about it last quarter and we did talk about the improvements in the back half. Turning now more specifically to your question on the labor and material prices, we think we had cost increases of about $1,200 a house and we did offset we believe actually incrementally maybe just a little bit more than that with the pricing. So, we are taking pricing opportunistically but it has been relatively modest across the board and we’re moving it carefully on a month-to-month basis for a number of reasons including been able to show we can appraise our houses when we sell them. We are seeing continued improvement of margin in our backlog and we should see that reported gross margin as we deliver out those unit in the back half of the year.

Sue – UBS: My second question is just trying to get some around your confidence in the backlog. The cancellation rate moderated very nicely during the quarter despite the fact that you were still in the process of getting Nationstar integrated and you’re still growing through that, do you think that most of the noise though in terms of that integration is behind you and we suggest continue to see it come – the cancellation sort of moderate as we go through the year?

Jeffrey T. Mezger – President, CEO and Director: So, let me make a few comments. We shared on our first quarter call that we had gone through and exhaustive scrub of our backlog at that time and we felt our backlog was in much better position heading into Q2 than what we’ve dealt within at the end of year in the first quarter. Nationstar really didn’t have much of an impact on our backlog in Q2. That’s a go forward benefit that we’ll be seeing. Our can rate actually settled to the range that we’ve historically seen over the years may come down a little more with Nationstar over time. I don’t know that we’re really counting on that, what we do know is that we’ll be able to hold and continue to improve the quality of the backlog going forward.

Order Trends

Michael Rehaut – JPMorgan: First question. I appreciate the guidance in terms of the back half of this year into next, and I just wanted to kind of do a little bit of a sanity check, very helpful in terms of the backlog conversion and revenue comments. But, it would seem that to get the profitability in 4Q and also profitability in 2013 that you’d be looking towards a much more meaningful improvement in gross margins than you have demonstrated in the second quarter, and when I say that, I’m talking about excluding both the land impairment charges as well as the one-time benefits, the two different benefits you had. So, right now, you’re around 13%, little over 13%. I mean, it would seem that you’d need to get at least in the midst 15% if not 16% in the fourth quarter to hit profitability and also for that matter, at least around 16% in 2013. Is that something that’s achievable and it makes sense to you?

Jeffrey T. Mezger – President, CEO and Director: Yeah. Mike, let me make a couple of comments, then I’ll hand it to Jeff for the math. It absolutely makes sense to us or we wouldn’t share it. We did include in our prepared comments that we’re going to have a crossover in gross margin in the fourth quarter, where we will be above year-over-year. I also guided that we expect in ASP for the year of over 240,000, so you can do the math on where we think our ASP is headed in the back half of the year versus what you’ve see in the first half of the year. So, we have momentum with better product at higher price points and higher margins in backlog, and that’s how, we’re projecting the crossover later in the year. Jeff, anything else you want to add?

Jeff Kaminski – EVP and CFO: Sure. Yeah, I had a few things. The number one, I think you are thinking, Mike, about the margins in the right direction. As Jeff mentioned, last year fourth quarter we did 15.1% and you were north of that with your comments, and I think that’s thinking about it the right way. We did mention last quarter in our backlog, inherent in our backlog. We were up about 200 basis points from year-end. We are now up about 250 basis points from year-end, and those deliveries will be closing out in the fourth quarter. So, we are anticipating an increase there. And we are also increasing a pretty sizeable jump in revenues. We believe our backlog conversion rate will be higher in the fourth quarter or seeing a higher ASP in the fourth quarter and the combination I think on the margin side and the leverage impact on our SG&A coming from the higher revenues will produce a result that we are forecasting.

Michael Rehaut – JPMorgan: Second question on the order trends. Last quarter it was very helpful when you broke out that the spec business was down 30% and the 2B built was up 20. I wanted to know if you had a similar type of impact or trend in the second quarter, and more importantly, looking into the back half you have a year-ago comp dramatically more difficult than in terms of year-over-year growth that you saw in 2011. Do you expect the order – I would that perhaps the year-over-year order growth may decelerate or slip back into a negative territory in the back half, particularly with your community count comments. Is that the right way to think about that or if there are other kind of variables that we are missing, because I believe you said also that the Nationstar would not necessarily materially further help the can rate from this point?

Jeffrey T. Mezger – President, CEO and Director: Mike, that was more than one question. I’ll do my best, because you rattled a lot off there. First back to Nationstar, I would expect our community can rate may moderate a little bit, we are already back to the historical levels and can manage. There is no question we had a strong second half in sales last year, so we will see how we are doing, we are not going to – we are not going to give guidance on this call and underneath that what you can tell from our comments is we are continuing to push significant revenue growth through the order value being generated. So, if you look at Q2, units are up 3 and revenue or sales value I will call it, up 18%. So, it’s a very nice trajectory that’s still driving our top line.

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