After posting a drastic year-over-year 75% decline in new orders in 1Q2008, all eyes will be on KB Home's sales figures on Thursday when the company releases its 2Q2008 results. Last quarter's sales plunge shocked analysts and stakeholders alike and contributed to a $267.9 million loss for the quarter.
"We are not pleased with our sales results," CEO Jeffrey Mezger said during the company's first quarter earnings call. Both a 38% reduction in the number of active selling communities and an elevated cancellation rate of 53% contributed to the severe decline.
Last week, during a presentation at a Bank of America investor meeting, senior vice president of investor relations and treasurer Kelly Masuda was reluctant to give audience members any indication of whether sales traffic had picked up in the second quarter.
"We are in our quiet period, so there's not much we can say about that," Masuda said.
However, in an FTN Midwest May traffic survey of more than 60 public builder communities, survey respondents at KB communities noted that traffic levels were up in May from the previous month and traffic quality was better.
The weak sales numbers arguably have been surprising. Not only has the company long relished its reputation as being on the leading edge of sales and marketing in the industry, but it has been touting its back-to-basics strategy as a forward-thinking survival tactic in the mainstream media. The company's efforts over the past couple of years have been concentrated on bringing its home prices back within reach of the entry-level buyer--its former bread and butter--by reducing square footage.
The push to capture first-time buyers mitigates the company's exposure to contingency sales, as this buyer segment doesn't have an existing home to sell before purchasing a new home. However, whether that strategy will play out to management's expectations remains to be seen.
JP Morgan analyst Michael Rehaut, for one, is watching KB's sales numbers, looking to gauge whether the one-two combo of falling prices and tightening credit is truly keeping these buyers on the sidelines. In a recent research note, Rehaut wrote: "The company's results will give us a good read on how this buyer segment is performing and whether any pent-up demand truly exists, especially at lower prices."
Last quarter's high level of cancellations also challenges management's theory that the company's home personalization program curbs can rates by getting buyers emotionally invested in their new homes through the purchase of options and upgrades.
Despite the creep up in cancellations, company executives have held fast to the idea that the company's retail-like design centers add up to a competitive advantage--or at least some degree of margin preservation. Average spending in the design centers has remained fairly flat, according to company executives, despite deteriorating market conditions.
But even if sales failed to improve over 2Q2008, the company is sitting on $1.3 billion in cash, a sizeable cushion that would allow it to comfortably absorb another quarter of losses. Moreover, the company redeemed $300 million in senior subordinated notes earlier this month and has nothing drawn on its credit revolver.
While the company may be on enviable financial footing, CFO Dom Cecere said last week during the Bank of America conference that it's likely the company will sit tight on the cash rather than seek out investment opportunities, even if land prices are becoming more attractive at cents on the dollar.
"Today, what we have is all long-term debt, and we have nothing drawn on our revolver," he said. "We're sitting on $1.3 billion in cash, and we don't think the market's going to go nuts anytime soon. So, we don't think we're going to be in a position where we're going to want to borrow money to grow our business. And we think a lot of the land deals that are going to be coming to the table in the future are not going to be 'buy the land and wait 24 months before you have your first delivery.' It's going to be more finished-lot deals available on a takedown basis so that cash outflow deals are going to be nothing like what we saw when we started to take off in growth three, four years ago."
With expansion tabled for now, it could be that the company will further shrink its footprint. Last quarter, the company announced a shutdown of operations in Illinois, Maryland, New Mexico, and Virginia. The company entered Chicago in 2003 with the acquisition of Zale Homes but never became a Top-10 player in the market. A 2005 start-up Mid-Atlantic division proved to have poor timing. And Albuquerque failed to become the big-time housing market that the company had hoped for when it acquired Oppel Jenkins in 1995.