It was a sure sign of the times when KB Home reported a net loss of $307.3 million, or $3.96 per share, during its fiscal fourth quarter--and that was considered by some analysts' accounts a better-than-expected performance. Most of the company's out-performance related to improved profitability--the company tamed its SG&A and fattened its margins--as well as continued cash generation.
But the big question on analysts' minds during today's earnings call was sustainability--and not of the environmental variety. Analysts repeatedly questioned CEO Jeffrey Mezger and chief accounting officer Bill Hollinger about whether the recent balance sheet improvements were short-term blips or early signs of sustainable improvement going forward.
In terms of SG&A, the answer was maybe. During its fiscal fourth quarter, the company's SG&A expenses totaled $121.1 million, marking a 47%, or $107.6 million, reduction from a year ago. In terms of dollar value, Mezger said he expected SG&A costs to continue to decline in 2009. Calling it a "tail on the comet" effect, Mezger noted there was a lag between when the company took action to cut costs--reducing headcount, consolidating divisions, and exiting select markets--and when the expense benefit would show up on the balance sheet.
As a percentage of revenue, the company also made impressive strides from its third quarter, slashing that metric to 13.3% from 19.9% last quarter. But Mezger was less confident that the company would continue that level of aggressive reduction.
"Certainly that's our goal, but, quite frankly, it will depend on sales," he said. "We intend to keep chiseling away at it."
Sales and closings suffered during the quarter as the company's cancellation rate hit 46%. Net new orders for the quarter were half of what they were a year ago at 1,296, and deliveries were down 52% from fiscal 4Q2007 to 3,912 units.
In contrast to the sales and closings slide, the company's gross margin, including inventory impairments and abandonment charges, improved from -8.6% during the same quarter a year ago to -4.3% in 4Q2008; excluding those charges, its gross margins grew 3.8 percentage points to 13.9% from 10.1% in 4Q2007.
When asked if more margin improvement was expected going forward, Mezger took a conservative position, saying the company's margins would be a reflection of the market. However, he added that with the national rollout of the company's newest product line, now being branded under the "Open Series" mantle, the company would be more profitable on a per unit basis.
"Our expectation is margins will be enhanced with this product, not reduced," Mezger said.
Mezger noted that the company was starting to see "incredible savings on directs," meaning material and labor costs. He offered an example: In Tucson, it used to cost $89,000 to build a 1,700-square-foot home; with the new product, it costs $63,000 to build the same size house.
"It's a significant game changer," he said.
Positive results from several pilot launches have led the company to begin rapidly mobilizing to roll out the Open Series across all markets.
"We are seeing favorable, positive sales where we have this new product; they are outperforming the previous product and communities in the area," Mezger said, noting that 50% of the communities slated to offer the Open Series are schedule to have their grand openings in the first half of 2009.
Mezger described the product line as a "bolder transformation" of previous KB product. He said it offered buyers "tremendous freedom" in designing their home and was the "fullest expression of KB's 'built to order' brand differentiator."
"It accommodates the style and budget of a home buyer instead of asking them to choose between them," he explained.
With a new product launch expected to give a boost to sales volumes and profitability, KB's management changed its cash flow outlook for 2009 from negative/neutral to positive, although the team noted that 1Q2009 could see negative cash flow. In 4Q2008, the company beat analysts' expectations for operating cash flow, generating $311.1 million and growing its corporate coffer to $1.3 billion in cash.
However, analysts wondered how continued cash generation could continue given that home prices, backlogs, and community counts have been trending down. Pali Capital's Stephen East pointed out that, at its current pace, the company's cash flow generation per unit is roughly 35% of the company's average selling price.
Mezger responded, saying the sales momentum and cost savings generated by the new product line combined with the right-sizing of operations would contribute to cash flow. In addition, he noted the company would decrease its land spend.
"Thirty-five percent of revenues are lot costs, so we aren't buying a lot of lots, so that's cash generation," he said.
For a deeper dive into KB's fourth quarter financial performance, click here.