KB Home (KBH) Earnings Call Transcript

Good morning. I am Matt Bouley, Barclays U.S. Homebuilding Analyst. My pleasure to have the team from KB Home here with us for Day 2 of the 38th Annual Barclays Industrial Select Conference, Jeff Mezger, CEO; Jeff Kaminski, CFO; and Jill Peters in IR. I'm going to let Jill kick it off here with some prepared remarks in a moment. But just for everyone listening, please feel free to e-mail me any questions. On the side, you can see my e-mail address on the left side of the screen there, if you don't have it. And then there's going to be those annual audience response questions up on the right side. I always appreciate it for investors to fill that out every year. So with that, KB Home team, thank you all for joining, and I will let Jill go ahead and kick it off.

Matt, thank you so much. Thanks for hosting us this morning. And apologies to everyone who was waiting for us. We had some technical problems this morning. So thanks for your patience. We have just a few comments to share with you, highlighting our positioning for a very strong 2021. Our substantial beginning backlog value, which is up over 60% year-over-year, together with healthy demand, given robust market conditions, contribute to our ability to generate between $5.5 billion and $6 billion in housing revenues this year. We have multiple factors supporting our expectation for full year gross margin in the range of 20.5% to 21.1%, including the composition of our backlog, a strong lineup of community openings, overhead leverage from our higher revenues, our leaner, more efficient cost structure and lower amortized interest. We anticipate generating a double-digit operating margin this year, which will help to drive our projected return on equity of above 17%, an increase of roughly 500 basis points year-over-year. From a community count standpoint, we expect our ending community count in 2021 to be up in the mid- to high single-digit percentage range year-over-year. And we are well positioned to sustain our growth in 2022 in expecting year-over-year community count growth of a minimum of 10% next year. I would also like to spend a moment summarizing a few key achievements that we have made in our environmental, social and governance program. We lead the industry in building ENERGY STAR certified new homes. And last year, we achieved the milestone of cumulatively delivering over 148,000 ENERGY STAR certified new homes to date. In addition, we delivered our 11,000th solar-powered home. And finally, in 2020, we enhanced our transparency about the social aspect of our sustainability program, publishing a human rights statement, a supplier code of conduct and responsible marketing practices. As a result of our leadership, we were pleased to be named to Newsweek's 2021 list of America's Most Responsible Companies, the only national homebuilder to receive this distinction for demonstrating leading ESG practices. Similarly, we were proud to be selected by Forbes for its 2021 list of America's Best Midsize Employers, and we were the only national builder to receive this honor as well. Before wrapping up, I would like to note that in light of our approaching February 28th quarter end date, we will not be providing a real-time update on net orders or related metrics today. And that's it from our prepared remarks standpoint, Matt, I'll turn it back over to you.

Wonderful. Thank you for that, Jill. So maybe we'll start out on the demand side. I hear you that you're not going to get into the most recent demand trends. But in the 10-K, a couple of weeks ago, you did show order growth of 39% through the first 7 weeks of the quarter. You were at 44% when you reported earnings. And I think that level of deceleration is directionally consistent with what you guys talked about for deceleration in the quarter. So my question is, just how are you kind of set up for the spring here? We just went through the Super Bowl that's the official start of the spring selling season. How are you thinking about kind of demand trends as we kind of head into the spring here?

Matt, as we shared on our call, December and January through the call period were extremely strong. And we didn't have to wait for Super Bowl. We didn't have to wait for the spring. Our orders were very strong first 6, 7 weeks of the quarter. The reason we guided that our orders, the comp would come down over the balance of the quarter, last year, we had an incredibly strong first quarter. Our sales in January, February last year were the highest they've been in over a decade and were setting up a very nice year when the pandemic hit. So our -- the reason for the comp going down is how strong last year was, not that we're seeing a deceleration. The market conditions remain incredibly robust right now. And we expect that to continue through the spring selling season. So it's very strong sales. And if you look forward to our Q2 comp, last year was when we shut down for 6, 7 weeks, and it took a little while to rebuild momentum. So we're absolutely going to have a blow away comp in Q2 as well because of how soft we were last year. So I wouldn't use the word deceleration at all. Right now, orders are very strong.

Got it. Okay. So it seems just how strong this environment is. I mean, we've seen in some of our own checks, and we've heard from some of your peers, you can almost kind of sell whatever you want to at this point. So when we think about selling pace, you guys were running north of 5, close to 6, a month in the second half. Perhaps somewhere near there in the first 7 weeks of the quarter here. My question is just at what point is that case not sustainable from a supply perspective? And I guess the other way to think about that is how far out are you sort of willing to extend the backlog?

Yes. As I shared on our earnings call, we're trying to match our starts pace with our sales pace. And we're doing a pretty good job with that right now. And our build times have extended a little bit, but that just kicks your delivery out an extra month from your cycle time and your current backlog. So as long as we can match the starts pace, we'll keep selling. And we have some communities where sales are out ahead of starts. We do this every week. We've been sharing it for years. Every week, we look at every community from a price/pace perspective. And if we're selling ahead of our needs or our plan, we'll push price hard. And we have a lot of communities right now where we're metering the sales pace through taking price. Then we have others that are grand opening where you want to get them going and sales are running very strong. So it's a mixed bag, but I would expect our sales pace per community will sustain at the levels we've been at because that's about the start pace.

Got you. Okay. So on that point, on the pricing side, you guys always talk about being careful around pricing, offering product close to where incomes are on a local level, and presumably, you're looking closely to the resale market as well. Obviously, resale prices are up, you're seeing new home prices continuing to rise. How are you guys thinking about balancing price with affordability here? You're using price to meter outpace a little bit. At a certain point, you would imagine being an affordable builder that pricing might have a limit at some point. So just how are you thinking about tying that together?

But it's an interesting dynamic right now that it's created a healthy tension out in the divisions. In that if a community is running and we're able to take a lot of price, you celebrate, you take advantage of it. And you build through the community. And if it's in the same submarket, the new investments in the same submarket is where we're taking a lot of price. We still ensure the best of our abilities that the underwriting assumes we're still attainable to the median household income or as close to it as possible, depending on how big the demand base is in that submarket. So the division may have a very successful community that's running. We will still underwrite the next one at pricing that is attainable to the median income. And I'm very sensitive to how these markets can move. And think of how quickly this one moved to -- fortunately to the good side. They can move the other way if interest rates go up or things go on. So we're sensitive to not just resetting and resetting and resetting at the higher price and moving up. Sooner or later, that slows, and we want to be positioned to continue to have strong demand because of the market segments we target.

Got you. Okay. That's helpful. So jumping down to the gross margin side, Jill, you highlighted the guidance. I think you said on the call that the expectation every quarter this year was that you would stay above 20% gross margins. Obviously, since you guided, lumber prices have continued to be elevated, if not moved even higher. So I guess it's a 2-parter, just the comfort on the level of margins and what's in backlog today? And then when you think about the next 7,000 homes you're going to sell in order to hit the full year guide, what are the puts and takes that kind of keep us comfortable with that initial gross margin guide?

Sure. I could take that one. Yes, on -- starting with the backlog, the backlog margins and the way we operate our business as a build to order business, gives us a lot of visibility a couple quarters out in margins. We not only have own -- a sales contract that's locked at a price. We then take the customers through the studio, which is usual an enhancement to margins from that point. But at the same time, as soon as we start the home, the vast majority of our comps are actually locked in. So to the extent lumber is moving on already written contracts, it's really not that relevant for the margins that we've embedded in the backlog. So that one is pretty superior. So we only look out a couple of quarters. We always have, like I said, there's a lot of visibility on that side. For the remainder of the year, we expect market conditions to remain relatively steady. We've been able to offset cost inflation up to this point with the way prices have moved. And even if pricing were to slow, we still believe we're in good shape on that. We're not going to update, obviously, our margin guidance during this call, this late in the quarter. But a lot of positives really in the back half that we looked at as we were guiding out a month or so ago for the full year. And they include some of the things that Jill brought up. I think a really important component for this year is just our enthusiasm and excitement about the new community openings. Most of those openings -- the underlying land was underwritten in much different market conditions. Not nearly the same levels of pricing, certainly not the same absorption pace that we've been experiencing. And while costs are up a bit from the underwriting, the land cost was locked, and that's the largest component of it. So we're optimistic that we can see some really nice openings and some really nice margins in the back half of the year and deliveries coming out of the first half of year grand openings. Of course, volume is a big thing for us, and we do have some fixed costs embedded in our cost of goods sold. So the higher the revenues, the more leverage we get on those fixed costs, that should help margins a bit. And we'll see a continuing trend that we've seen for the past few years on our interest amortization. So we do expect to see some pickup in lower interest amortization for the full year, actually, and as we move through the quarters. So that was kind of what informed us on our guidance for the year and the quarterly cadence as we go through it.

Got it. And then so a little longer term on the margin side. You talked about on the call, they just continued to underwrite to that 19% to 21%. And obviously, this year, you're guiding to close to 21%. So when you think about going beyond this year, without looking for specific guidance, is it simply the factors you just mentioned? That with persistence of strong volume leverage, pricing and continued reduced interest amortization that conceptually, the margin can still be higher than that what you're initially underwriting to beyond 2021?

Yes, yes. We'd like to think so. There's one important factor when you understand how we underwrite. We underwrite at today's prices and today's costs. So we don't bake inflation in at all into our underwriting. And from that point of view, if we were to have some level of price inflation, even if you have some level of cost inflation, they usually go hand-in-hand. And we usually win on the margin side when both costs and pricing are inflating because the land price, again, is the largest component. Our cost of goods sold is relatively fixed once you secure the land. So yes, we're optimistic. We don't really want to look back and say we're going to go back to high teens margins at a point in time. We'd like to maintain above 20s indefinitely if possible, subject to market conditions. And again, while we're not guiding out in the future, we think that double-digit operating margin is an important metric for us. We definitely want to keep our returns at the level or above the level where we expect them in 2021. And we think there's some upside there. And in order to do that, you need pretty strong gross margins on the top.

Matt, if I could add in here, and I don't want to sound like an accountant. But I actually missed on that when I answered that question on our earnings call, in that we underwrite to a variable contribution, not a gross margin, the actual dollars from that house irrespective of how you lever your field, fixed and whatnot. And typically, the gross margin is 1 point or 2 higher than the variable contribution margin. And it depends on how many units you deliver a month from that community. But a 19% to 21% VC should produce a 20% to 22% or 21% to 23% depending on the run rate. But most importantly, we underwrite to the returns. And as long as we can get our returns, everything else takes care of itself on the margin side. So we don't think that right now, we're underwriting to a lesser margin than our current book is generating. I kind of confused everybody with my response. If I'd have said gross margin, it would have probably been clearer for everyone. So glad Jeff is on the call.

That's helpful color. And thank you for that clarification. So maybe thinking about the build-to-order model here. Post COVID, you guys have a great view into what the consumer wants today. What are you seeing with home sizes and with all the upgrade options you guys offer? And I'm curious if you could kind of put some numbers around that, obviously, for KB Home. What does that mean for closing ASPs and margin, as we think about how all that comes together?

Yes. It's an interesting topic, and I always share with people, we're a real-time consumer laboratory. Because we sell what today's customer wants, whether it's the floor plan, the lot, the elevation, the studio revenue, whatever they pick in their home. And as we look at it, it takes time to go from contract trends to delivery trends. But as we dig into our current backlog versus what we've been delivering, the unit size, the home size itself hasn't really changed. We're averaging around 2,200 square feet. That's where it's been. And if you put that in the context that our first-time buyer percentage keeps moving north. It keeps going up. I think it was -- Jill, I think it was 65% in the fourth quarter. So your first-time buyer mix is moving up, the size of the home hasn't changed and our studio revenue is ticking up $1,000 or $2,000 a quarter. So these people are -- they're well off first-time buyers. They have a lot of buying power. And they're putting in their homes what they want. And I think it's a sign that people intend to live in their home a while. This isn't a close it and flip it in 1 year or 2. So their spending is up, $1,000 or $2,000 a unit, and then you go, "Okay, what are they spending it on?" And we're seeing a little bit more spend on health options and a little bit more spend on smart technology. So today's customer, that's things that are important to them.