KB Home (NYSE:KBH) Q1 2024 Earnings Call Transcript

KB Home (NYSE:KBH) Q1 2024 Earnings Call Transcript March 20, 2024

KB Home beats earnings expectations. Reported EPS is $1.76, expectations were $1.56. KBH isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good afternoon. My name is John, and I’ll be your conference operator today. I would like to welcome everyone to the KB Home 2024 First 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 April 19, 2024. 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 first quarter of fiscal 2024. On the call are Jeff Mezger, Chairman and Chief Executive Officer; Rob McGibney, 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 measure 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 solid performance in the first quarter, highlighted by our strong net orders, as well as financial results that we were either at or above the high end of our guided ranges. The spring selling season is off to a very good start, which together with our considerable backlog, better build times and planned new community openings gives us confidence that we are well-positioned to achieve our objectives this year. As to the details of our results, we produced total revenues of $1.5 billion and diluted earnings per share of $1.76. Our margins remain stable at 21.5% in gross and just under 11% in operated income. This performance, along with the cumulative benefit of sustained quarterly share repurchases, including an additional $50 million during the first quarter, drove our book value per share up 14% year-over-year.

Market conditions have improved since the end of our last fiscal year. As we discussed on our earnings call in January, we had begun to see demand move higher in December, which accelerated as the quarter progressed. Although mortgage interest rates increased modestly in late February from their lowest levels during the quarter, the strong desire for homeownership prevailed. The combination of low housing inventory levels, solid employment and favorable demographics supports the new home market today and we expect will continue to be the primary factors that sustain its health longer term. The momentum in our net orders resulted in sequential gains of 46% in January, followed by 53% in February. We believe these results speak to the underlying demand for homeownership and a more stable housing market.

Another sign of this stability is our cancellation rate, which fell significantly both sequentially and year-over-year. In total, we generated 3,323 net orders in the first quarter, representing 55% year-over-year growth. This result was achieved while we held mortgage concession steady and implemented a modest level of price increases in most of our communities. We have continued to experience strong sales since the start of our second quarter and believe we are well positioned to respond to this buyer demand given our products and price points, as well as plan new community openings in the first half of this year. On a per community basis, our absorption pace accelerated as the quarter progressed, averaging 4.6 monthly net orders for the full quarter.

Our strategic goals continue to be optimizing each asset on a community-by-community basis, which generally results in an annualized average absorption pace of about five net orders per community per month and generating high inventory returns. In last year’s second quarter, we produced very strong order results, driving an average of 5.2 net orders per community per month. This pace represented an 86% sequential increase and creates a tougher year-over-year comparable for this year. Our expectation is to slightly exceed last year’s monthly community order pace for our second quarter in light of more favorable market conditions. We continue to align our starts with sales and plan to ramp up our starts given stronger demand and to position our business for the second half of 2024.

We believe our backlog, homes in production and starts pace are in balance to support our projected $6.7 billion in revenues this year. With that, I’ll pause for a moment and ask Rob to provide an operational update. Rob?

Rob McGibney: Thank you, Jeff. I will begin by adding to Jeff’s comments on our order results to provide some additional color. During the quarter, we pursued a higher pace to capture demand and build our backlog while also raising prices in over one half of our communities. In another roughly 40% of our communities, we held prices steady. At 4.6 net orders per community, our monthly absorption pace was above our historical first quarter average. As Jeff mentioned, our cancellation rate improved to 14% of our gross orders and 10% of our backlog at the start of the quarter. These are the lowest levels we have experienced in more than a year, reflecting buyers who have adjusted to the higher rates as compared to a year ago and who are motivated to close.

Mortgage concessions were relatively flat as compared to our 2023 fourth quarter with approximately 60% of our orders having some form of mortgage concession associated with them, including rate locks. Assuming market conditions and demand remain strong, we expect to be in a position to lower these types of incentives as the spring selling season progresses. We ended the quarter with almost 7,000 homes in production. Given our first quarter net order results and the elevated level of demand in the market, we expect to accelerate our starts and grow our production levels over the next six months. Operationally, our divisions are maintaining the progress they achieved last year in reducing build times. Our construction cycle is over 30% shorter than the prior year quarter with a daily focus on additional efficiency enhancements to further reduce construction times, to even flow production incorporated into our business model and leveraging relationships with our trade partners to increase speed, which helps improve cash flow for both sides.

We believe we can return over time to our historical build times of between four months and five months. This will improve our inventory turns and increase the population of homes available for delivery, as well as further enhance our built-to-order sales approach, as personalized homes with quicker delivery dates are even more compelling to homebuyers. As to direct costs on started homes, they held steady in the first quarter on both a sequential and year-over-year basis. We continue to pursue value engineering and simplification opportunities to drive costs down, which have been effective over the past year in helping to offset overall inflation. Before I wrap up, I’ll review the credit metrics of our buyers who financed their mortgages through our joint venture, KBHS Home Loans.

We had a solid increase in our capture rate, with 85% of the mortgages funded during the quarter having been financed through our joint venture, as compared to 79% in the prior year quarter. Higher capture rates help us manage our backlog more effectively and provide more visibility in closings. In addition, we see higher customer satisfaction levels from buyers that use KBHS versus other lenders. The average cash down payment was 16%, consistent with last year, equating to roughly $77,000. The household income of our KBHS customers was about $126,000 and they had an average FICO score of 743, a number that has steadily climbed over the past few years. Even with one half of our customers purchasing their first home, we are attracting buyers that can qualify at elevated mortgage rates while making a significant down payment.

As we look ahead to the rest of 2024, our divisions are focused on maintaining our high customer satisfaction levels, improving build times and value engineering our products to lower direct costs. In addition, our objectives are set on driving net orders, acquiring more lots and opening communities on time, all of which will contribute to the future growth of the company. We recently completed several leadership promotions and created a new Executive Vice President of Homebuilding position to which Brian Kunec has been elevated. Many of you are familiar with Brian from his earlier role of successfully leading and growing our Las Vegas business. Most recently, Brian was one of our Regional Presidents, responsible for our divisions in Idaho, Nevada, Northern California and Washington.

In addition to Brian, we also promoted two division presidents to the role of Regional General Manager and increased the geographic scope of one of our existing Regional Presidents. We believe these organizational changes will help us in driving growth, as well as operational performance. And with that, I’ll turn the call back over to Jeff.

Jeff Mezger: Thanks, Rob. We invested close to $590 million to acquire and develop land during the quarter, a 60% increase year-over-year and the highest quarterly level since early 2022. We have the capital available to accelerate our investment spend in 2024 and intend to do so while adhering to our underwriting criteria, product strategy and price points as we are committed to growth beyond this year. We had roughly 55,500 lots owned or controlled at quarter end, of which about 40,100 were owned. Over 17,000 of these lots are finished, and as Rob referenced, we have about 7,000 homes in production. Approximately 60% of our own lots were tied up in 2020 or prior, which provides us with a solid runway of lots at a bearable cost basis.

We are focused on capital efficiency, developing lots wherever possible in smaller phases and balancing development with our start space to manage our inventory of finished lots. We currently own or control all the lots that we need to achieve our delivery growth targets for 2025. And as we have stated in the past, our divisions have roadmaps in place with timelines to achieve at least a top five position in each of our served markets. Our balance sheet is healthy and our cash generating capabilities are strong. We intend to allocate our capital toward reinvestment in growth and returning cash to shareholders in 2024, primarily through share repurchases. This is a continuation of the capital allocation plan that we executed in fiscal 2023, during which we bought back $411 million of our common stock at an average price of about $44.50, substantially accretive to both our book value and diluted earnings per share.

Over the balance of the year, we intend to utilize at a minimum the roughly $114 million that remains in our current repurchase authorization and we will be requesting an additional authorization from our board. In closing, I want to thank the entire KB Home team for solid execution in our first quarter and their dedication to our homebuyers. Market conditions have improved and we are seeing dynamics returning to a more normalized state. Supply chain and trade labor availability have stabilized, and while cost pressures are still present, they have eased. Mortgage interest rates have also steadied and we do not see any evidence of rates rising this year. Buyers have largely adjusted to the rate environment and we are encouraged by the demand we are seeing at the onset of the spring selling season.

Our backlog increased sequentially and is healthy, as reflected in the lower cancellation rate we experienced in the first quarter. We expect to compress our bill times further, which will contribute to higher inventory terms, unlock cash and enhance our bill-to-order approach. These dynamics are all favorable for our company and we look forward to demonstrating the potential of our business as the year unfolds. 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 cover highlights of our 2024 first quarter financial performance, as well as provide our second quarter and full year outlooks. We are pleased with our execution during the first quarter, with home deliveries up 9% over the prior year, in line with our expectations and supported by our improving construction cycle times and backlog of sold homes. Our healthy operating margin of nearly 11% drove robust cash flow that enabled us to invest almost $600 million in land, return over $65 million to our stockholders through share repurchases and dividends, and end the period with strong liquidity of $1.75 billion. In the first quarter, our housing revenues of $1.46 billion were up 6% year-over-year, driven by the 9% increase in the number of homes delivered, partially offset by decline in the overall average selling price of those homes.

The number of homes delivered in the first quarter reflected a backlog conversion rate of 55%, a significant improvement from 36% for the year earlier quarter, demonstrating both the impact of our improved build times, as well as a lower cancellation rate in the current year period. Housing revenues were up in three of our four regions, ranging from 3% in the West Coast to 35% in the Southwest, offsetting a 19% decline in the Central region. We expect stable housing market conditions and favorable supply chain trends to support our forecasted results for the remainder of 2024. For the second quarter, we anticipate generating housing revenues in the range of $1.6 billion to $1.7 billion. For the full year, we expect to generate housing revenues in the range of $6.5 billion to $6.9 billion.

We believe we are well-positioned to achieve this topline performance, supported by our backlog of sold homes, projected net orders per community, anticipated continued improvement in construction cycle times and expected growth in community health. In the first quarter, our overall average selling price of homes delivered decreased 3% year-over-year to approximately $480,000, mainly due to mixed shifts. For the 2024 second quarter, we are projecting an overall average selling price of approximately $483,000, up slightly both sequentially and compared to the prior year period. We still expect our overall average selling price for the full year will be in the range of $480,000 to $490,000. Homebuilding operating income for the first quarter increased slightly to $157.7 million, compared to $156.5 million for the year earlier quarter.

The current quarter included abandonment charges of $1.3 million versus $5.3 million a year ago. Our homebuilding operating income margin decreased to 10.8%, compared to 11.4% for the 2023 first quarter, mainly due to a higher SG&A expense ratio in the current year quarter. Excluding inventory-related charges, our operating margin of 10.9% decreased to 80 basis points year-over-year. We anticipate our 2024 second quarter homebuilding operating income margin will be in the range of 10.1% to 10.5% and the full year metric to be approximately 10.9% to 11.3%. Our 2024 first quarter housing gross profit margin of 21.5% was even with the year earlier quarter. Excluding inventory-related charges in both periods, our gross margin decreased by 20 basis points year-over-year to 21.6%.

We are forecasting a 2024 second quarter housing gross profit margin in a range of 20.5% to 21%, reflecting homebuyer concessions offered for homes sold in the second half of last year amid the challenging conditions at that time that are expected to deliver in the quarter. We project improved quarterly margins in the second half of 2024, supported by the margin profile in our backlog, improved leverage on fixed costs due to higher expected deliveries and anticipated lower rate buy-down incentives. We expect our full year gross margin will be in the range of 21% to 21.4%, assuming stable housing market conditions. Our selling, general and administrative expense ratio of 10.8% for the first quarter was up from 10.1% for the year earlier quarter, mainly reflecting higher costs including marketing, advertising and other expenses associated with the planned increase in our community count during the year as we position our operations for growth.

We are also investing in personnel and other resources in alignment with the expected larger scale of our business. We are forecasting our 2024 second quarter SG&A ratio to be approximately 10.5% and expect our full year 2024 ratio will be approximately 10.2%. Our income tax expense of $36 million for the first quarter represented an effective tax rate of 20.6%, an improvement from 22.6% for the year earlier quarter. This improvement was predominantly due to an increase in tax benefits related to stock-based compensation in the current period. We expect our effective tax rate for the 2024 second quarter to be approximately 24% and for the full year to be approximately 23% due to the low rate realized in the first quarter. Overall, our first quarter net income increased 10% year-over-year to $138.7 million and our diluted earnings per share improved 21% to $1.76, reflecting both the growth in net income and the favorable impact of common stock repurchases over the past year.

Turning now to community count, our first quarter average of 240 was down 4% from the corresponding 2023 quarter. We ended the quarter with 238 communities. We expect to grow our portfolio of communities during the second quarter by about 5% and end with approximately 250 communities. This would result in an average community count for the second quarter of 244. We remain focused on growing our community count and believe our average community count in the 2024 third and fourth quarters will be higher than in the prior year periods. In addition, our current outlook reflects approximately 260 open communities at year-end, which is about 10 fewer than we previously expected as a result of the stronger selling environment anticipated to drive more 2024 sellouts, as well as a handful of communities now expected to open during the 2025 first quarter.

We invested approximately $590 million in land and land development during the first quarter, and we ended the quarter with a pipeline of approximately 55,500 lots owned or under contract. During the first quarter, we repurchased nearly 830,000 shares of our common stock at an average price of $60.48. As Jeff mentioned, we intend to continue to repurchase shares and expect the pace, volume and timing of share repurchases to be based on considerations of our cash flow, liquidity outlook, land investment opportunities and needs, the market price of our shares, and the housing market and general economic environment. At quarter end, our total liquidity was approximately $1.75 billion, including over $1.08 billion of available capacity under our unsecured revolving credit facility and $668 million of cash.

Our quarter end stockholder’s equity increased to approximately $3.9 billion and our book value per share was up 14% year-over-year to $51.14. In conclusion, we are pleased with our first quarter financial performance and expect to see solid housing market conditions for the remainder of 2024 driven by favorable demographic trends, the ongoing imbalance of housing supply and demand, and expected moderation in interest rates later in the year. We intend to sustain our focus on generating reductions across our operations and build times and construction costs while also driving growth and expanding our scale through land-related investments and new community openings. We plan to maintain our balanced approach to capital allocation, encompassing significant cash deployment back into land and development to produce topline growth, while also returning cash to stockholders through common stock repurchases and dividends with an overall focus on long-term stockholder value creation.

We will now take your questions. John, please open the line.

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Q&A Session

Operator: Thank you. [Operator Instructions] And the first question comes from the line of Matthew Bouley with Barclays. Please proceed with your question.

Elizabeth Langan: Hi. You have Elizabeth Langan on for Matt today. So, just kind of starting off with the margin, would you mind talking a little bit about the margin cadence through the year? You’re assuming that next quarter will be impacted by the higher incentive levels in the latter part of 2023. Would you mind talking a little bit about what we should expect for the second half, kind of what you’re seeing with incentive levels right now and how those – how you’d expect those to flow through?

Jeff Kaminski: Sure. Yeah. As I mentioned in prepared remarks, we do expect some improvement in the second half of the year to arrive at that overall guide for the full year of 21%, 21.4%. What we are seeing, particularly this year and actually part of last year, pretty stable gross margin outlook quarter-to-quarter. We’re basically forecasting plus or minus 21% in all four quarters of this year. And you’ll see some improvement obviously in the back half, particularly in the fourth quarter with improved leverage based on higher deliveries and more revenues. So that’s really the outlook at the current time.

Elizabeth Langan: Okay. Thank you. And would you mind touching a little bit on what you’re seeing around buyer affordability and maybe your expectations around pricing? Do you think that, you’ve said that, you think that you can probably bring mortgage concessions down a little bit? Are buyers more responsive to something other than rate buydowns or are they seeing options, like, increasing their customization options or anything that you’re seeing around that?

Jeff Mezger: Yeah. There are a lot of components to that question, Elizabeth, but I can make a few comments and then pass it to Rob for some of the specifics on our buyer profile. As we shared in our comments in the first quarter, we were focused on building our backlog and driving more sales. So, we left the incentive levels for mortgage concessions similar to the prior quarter and pushed the pace and where we could, we took some, I called it moderate price increases in my prepared remarks. So it’s part of optimizing the assets, build our backlog, set up the scale for the year, get a higher absorption pace and then start working a little bit on margin along the way. As we shared in the credit metrics of our buyers, we have a very strong buyer profile right now, in particular when 50% of our buyers are first time.

We put it in that context and think of the FICO scores and the average down payment. This is a very well-qualified buyer. We’re not having an issue with qualifying, as you can see from our pull-through on the backlog, and frankly, the orders that we’re generating while taking a little bit of price. We’ve been poking around on what’s going on with the buyer and the sensitivity to debt ratios and income and qualifying. Rob can give you some specifics on that. Go ahead, Rob.

Rob McGibney: Yeah. As far as the credit ratios, debt ratios, we’re really not seeing any major change. In fact, on our closings, we’ve seen debt-to-income ratios fall slightly. So still a really well-heeled buyer. They’ve got sufficient income, got good credit, seeing demand at our price points, and I think, that speaks to the price points that we’re at and the quality of our product. You mentioned studio and buyer behavior and what they’re picking for design choices. And I think this speaks to that as well, because we really haven’t seen a change in studio spend despite some of the affordability challenges that are out there in the markets. And we’ve seen some shift in what they’re spending that money on, more things like permanent features in the home, like room configurations or cabinets or converting it into a bedroom, things that you can’t easily change down the road.

But between everything that Jeff just mentioned and the credit and income levels that we talked about, in addition, we haven’t really seen a shift in the square footage that buyers are purchasing, so pretty confident that our buyers are, they’ve got the ability to qualify and we’re seeing that in our results today.

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

Stephen Kim: Yeah. Thanks very much, guys. Appreciate all the color, as always, and, yeah, congrats on the good results. A couple of questions. Number one, I was wondering if you could give us a sense for what we should be thinking about for, in 2024, kind of a targeted level of operating cash flow as a percentage of net income, that kind of cash conversion. What sort of level we should be thinking about for you? And then also, from a longer term perspective, operating margin profitability has been improving. What do you think a level of longer term sustainable operating margin can be for your company? I’m sort of thinking maybe 13% or something like that. I was wondering if you could respond to that.

Jeff Mezger: Sure. Are we counting that as two questions or one, Steve?

Stephen Kim: No. That’s just one, Jeff.

Jeff Mezger: We’ll give you a break. We’ll let you ask a follow-up. Okay. So, the first question on cash flow, as you guys are probably fairly used to with us, I mean, we don’t really go out and forecast cash flow through the fiscal year, because it depends on a lot of factors including — most predominantly including land spend and then over the past couple of years, the level of buybacks. If you go off top and look at operating cash flow, the big opportunity for us continues to be in the area of build time and reduction in build time. We mined a lot of that cash last year, where we had a very significant improvement in construction cycle time and it freed up a ton of cash for us, put us in the really strong balance sheet position we’re in today with a lot of liquidity and a lot of dry poverty to go back and buy shares and reinvest in land.