During an investor presentation this morning at the UBS Building and Building Products Conference in New York, KB Home CEO and president Jeffrey Mezger told audience members that he felt the California-based company was not only well prepared to meet the current market challenges but also was well positioned to be on the offensive once the market turns around.
Mezger said that the company's built-to-order business model, which focuses on the pre-selling of homes rather than speculative building, was a proven winner in challenging times. KB transitioned to the model following the 1996 acquisition of Texas-based Rayco, whose management team had developed what Mezger deemed the "revolutionary" pre-sold business model during the 1980s Texas downturn. The process was effective at that time in competing against a surge in foreclosures because it allowed the company to dial down base home prices while creating a competitive edge by offering buyers choice.
However, he noted that the company was working diligently to reduce costs while making some changes operationally to further ensure success in the market. Chief among those changes was the launch of several new value-driven product lines. The new products are smaller and therefore more affordable to the consumer and less costly to construct for the builder, Mezger said. However, he was quick to note that the downsizing preserved livability, particularly when it came to the number of bedrooms. The new products will be available for sale in 25% to 30% of the company's communities in 1Q2009.
Moreover, Mezger said the company's strong balance sheet was another measure of the company's future success. Mezger said that he anticipated the company would be cash flow positive through the remainder of 2008, switching to cash flow neutral in 2009 as the company increased its land spending to take advantage of some distressed land deals. Mezger also pointed to the company's liquidity--he said he expects KB to have $1.6 billion in liquidity at the close of 2008--and well laddered debt maturity schedule--following the expected pay off of $200 million in debt due in 1Q2009, the company has no additional debt due before 2011--as powerful indicators of future success.
"We don't have to build homes unprofitably just to generate cash," he said.
However, Mezger's comment generated discussion during the Q&A session following his presentation. The main question was a two-part issue: First, why, if the company's cash position allows it the luxury of not needing to build unprofitably, is the company continuing to lose money on its core operations? And second, do the losses suggest that ample impairments on owned assets have yet to be realized?
The unidentified audience member launched the discussion by saying the following to Mezger:
"You said you don't need profitless sales to generate cash, and yet, your profits are less than zero and your cash flow is greater than zero--just like everybody else. I'd like you to reconcile that, and then the follow up is a lot easier. The charges came down sharply for you in the third quarter, and I'm wondering, given those comments about not generating profitless sales for cash, if those comments mean that maybe we are near the end of that cycle for charges if you think you are able to turn your profit margins back positive again."
To which Mezger responded: "We've elected to dramatically retool communities rather than to continue to build more of the same, trigger more impairments, trigger more losses, and, you know, everything that goes with it. We have the luxury of having a cash balalnce that allows us to retool rather than grinding away with more of the same. We're definitely focused on a return to profitability. ... We think that this new product line--or lines, because there are more than one--will get us there. So, I wouldn't react to just one quarter's results. As we get into the new year, we are pretty optimistic with our product and our sales with this approach."
For further clarification, the audience member asked: "If you are successful with the new product line and able to generate positive margins off the new product, given where land has been written down, does it mean the charges can come to an end?"
Mezger replied: "It certainly lessens impairments because it lowers the cost structure that you're putting on a lot. So, yes. But what we don't control is what pricing does in every market, new and used."
In 3Q2008, KB Home had an operating loss of $107.8 million for the quarter, after roughly $39 million in impairments on owned land.