Good afternoon. My name is Devon, and I will be your conference operator today. I would like to welcome everyone to the KB Home 2019 Fourth 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 February 9. Now, I would like to turn the call over to Jill Peters, Senior Vice President, Investor Relations. Jill, you may begin.

Thank you, Devon. Good afternoon, everyone and thank you for joining us today to review our results for the fourth quarter of fiscal 2019. With me are Jeff Mezger, Chairman, President and Chief Executive Officer; Matt Mandino, Executive Vice 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. Before we begin, let me note that 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 factors outside of the Company's control, including those detailed in today's press release and in 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 measures referenced during today's discussion to their most directly comparable GAAP measures can be found in today's press release and/or on the Investor Relations page of our website at kbhome.com. And with that, I will turn the call over to Jeff Mezger.

Thank you, Jill. Good afternoon everyone and Happy New Year. We finished 2019 strong with fourth quarter results that reflected solid demand for our products as home buyers continued to prioritize choice and personalization in their home buying decisions. In addition, our performance under our returns focused growth plan produced measurable results, most notably, in the year-over-year expansion of our housing gross profit margin. With the conclusion of the third year of this plan, there are several achievements to highlight. First, at roughly $270 million, our net income in 2019 is up by over 150% relative to 2016 when we launched the plan. This helped drive our return on equity to 12.2% nearly doubling its 2016 level to a point that was solidly within the plan’s target range. Next, the significant cash from operations that we generated in the past three years enabled us to invest over $5 billion in land acquisition and development as well as returned $73 million in capital to shareholders through dividends and share repurchases while also repaying about $850 million in debt. As a result, we worked our debt-to-capital ratio down considerably to 42.3% from 60.5%, also achieving our [tightened] [ph] target goal and reduced our interest incurred meaningfully benefiting our gross margins. With the success of our plan, we are a larger, higher margin, more profitable and less leveraged company. Going forward, our strategy will remain consistent with a continued focus on profitably expanding our scale while increasing return. Specific to the quarter, we produced total revenues of $1.6 billion and diluted earnings per share of $1.31. Housing revenues were up 15% year-over-year despite falling a bit short of our anticipated range as some of our deliveries in the Bay area were delayed due to the fires and power shutdowns which impacted our ability…

Thank you, Jeff, and good afternoon, everyone. I will now cover highlights of our financial and operational performance for the 2019 fourth quarter, as well as provide our outlook for the 2020 first quarter and full year. We are very pleased with our strong fourth quarter performance. We generated improvements in virtually all of our key profitability measures, and achieved solid absorptions and community count growth, which contributed to a significant year-over-year increase in backlog value. During the quarter, we also increased the borrowing capacity of our unsecured revolving credit facility and successfully refinanced our March 2020 senior note maturity. In the fourth quarter, our housing revenues were up 15% from a year ago to $1.5 billion due to 16% increase in homes delivered that was partially offset by a slight decline in their overall average selling price. Looking to the 2020 first quarter, we expect to generate housing revenues in a range of $910 million to $917 million, up 18% at the midpoint over the same period of 2019. For the 2020 full year, we still anticipate housing revenues in a range of $4.9 billion to $5.3 billion. Having ended our 2019 fiscal year with a backlog value of approximately $1.8 billion, up 26% from a year ago, we believe we are well positioned to achieve these expectations. In the fourth quarter, our overall average selling price of homes delivered declined slightly to 392,500, primarily due to a shift in mix in our West Coast region towards lower price communities within our Bay area operation. For the 2020 first quarter, we are projecting an overall average selling price of approximately $375,000. We believe our overall average selling price for the 2020 full year will be in a range of $380,000 to $400,000. Homebuilding operating income for the fourth quarter…

[Operator Instructions] Our first question comes from the line of Alan Ratner with Zelman & Associates. Please proceed with your questions.

Hey guys, good afternoon. Congrats on another very strong quarter and good end to the year. I think, obviously the order number was very impressive, we’ve been seeing some big numbers recently out of the other builders as well. And I am just curious as we head here into the spring selling season, how does the supply side of the business seem right now? Just thinking about all the various things that have been constrained to various points in the cycle, labor, land, it doesn’t seem like there is too much concern out there as far as an ability to get these homes built and delivered and kind of maintain a strong absorption pace for 2020. But I am just curious what you guys are seeing on the ground related to all of those various inputs?

Alan, a few things. We already own and control all the lots for 2020 and we are very deep into 2021 and working on that. As Jeff just guided, we expect revenue growth this year. So we own the lots that support a nice growth trajectory in 2020 and we are working on 2021. In terms of input cost, the land is tight out there but it’s rational and we are able to invest just like we did in the fourth quarter to support our goal. On the direct side, it’s pretty flat right now for us, lumber came way down. Labor is fairly rational. We are working on growing our scale in our markets to retain all the great relationships we have with our trade partners on the ground. So, direct cost flat. Land is tight but we are finding it and we are pretty comfortable with being able to support our growth goals.

Great. Now that’s really good to hear and helpful. The second – thank you for providing the order guide for 1Q. Obviously, that helps with the modeling off of a tough comp period from a year ago. As you move past the first quarter and just thinking about the interplay between community count and absorption right now, right now it seems like everything is kind of clicking on all cylinders. You’ve got margin lift. You’ve got absorption growth, but how much from here is it reasonable to expect your ability to drive absorption higher? I mean, right now, you guys are probably the highest in the industry from an absolute standpoint. So, is there expectation that maybe absorptions flat line a little bit once you get past the easy comps and maybe more of the upside might be on price and margin or should I think about that more even in terms of where that upside might come from if the market stays strong?

Good question. And it’s one we spend time on every week in here, Alan. As we shared in our comments, our fourth quarter pace was the highest we’ve seen for fourth quarter in over a decade. So, sales pace is strong and demand is strong. We continue to toggle it in every community every week where we are optimizing the pace versus price to get the highest return on the assets. It wouldn’t surprise me if sales ticks up incrementally because of the strong market conditions, but our focus is going to be more on getting margin as opposed to pushing a higher sales pace in the short run, so we get to our margin goal. We get to our margin goals and you’d see us pull back for more pace. But for now, it’d be [hold] [ph] rates to maybe go up a little and focus more on lifting our margin.

Our next question comes from the line of Truman Patterson with Wells Fargo. Please proceed with your questions.

Hi, good evening guys. Nice results. First, just wanted to talk about your capital structure and the potential tailwinds of the lower interest expense. Your net debt-to-total capital has declined nicely the past couple years. It’s in that kind of 35%. How do you think about your correct capital structure going into kind of 2020, 2021? Any chance that you actually work that down kind of below 30%?

What we have a target out there relating to our gross debt-to-capital of 35% to 45% and I would say that the target remains relevant for us and something we are focused on. We had forecasted at the end of the third quarter that we got these down within that range by the end of this year which we have accomplished. We do believe that we’ll be to able to see below 40% by the end of 2020 and comfortably within that range and I’d say our capital priorities remain the same as they have been with the only slight differences in 2020 we believe more of that improvement on the leverage ratio comes from equity accretion as opposed to debt reduction. We are really focused on growing the business and reinvesting in the business as a primary use of capital that will continue to maintain our now higher level of dividend and we’ll opportunistically work that leverage ratio as we have chances to do so.

Okay, okay. And then a couple questions on California. Very strong demand, but have you actually seen the higher price point coastal areas really start to heal or improve at all? And then, California’s 2020 solar mandate, could you give us an update on that whether you’ll eat some of the cost and it possibly impacts margins. Do you see this possibly stalling the construction cycle given potential installation labor constraints? Anything you can really discuss about the solar initiative.

Sure. Truman, first on the markets we are seeing minor improvement, I would say at the higher price points along the coast. The lower price points are showing strong demand, higher up you get in price the softer it gets, it’s better than it was in the fall. But it’s still not back, if you go to the OC houses in $2.5 million, $3 million aren’t - it’s still little soft out there. But overall, at the more affordable price points the demand is very strong right now in the state which is in part why we rotated down again in our product positioning to cater to where the demand is. Relative to solar, it’s a good question and it’s still playing out and the industry is trying to get its arms around it. As a company, not sure if this group is aware of it, but we’ve been the largest provider of solar homes in the state. We’ve now delivered over 10,000 solar homes. So we get it and we know how to do it and there is a different story in every community. In some communities we’re grandfather to other communities. We have permits. We have already have in place to avoid the solar mandates. Where you get past those types of nuances though the consumer has a choice you can either lease the system or we can include it in the price. Order of magnitude if they lease it the payment is around 50 bucks a month. That’s not a crazy number. You can’t say with certainty it’s not going affect demand in some way because it is 50 bucks. You could otherwise put toward a house payment. But as we get our arms around, we think it’s more of an incremental thing than some significant shift in demand or supply out there. No concerns right now on our ability to install the solar, because we’ve been doing it for so long and we have great partners out there.

Our next question comes from the line of Stephen Kim with Evercore ISI. Please proceed with your questions.

Yes, thanks very much guys and again, let me add my congratulations for the quarter. I wanted to ask you about the land spend in the quarter if I could. This quarter your land spend was pretty modest and your yearly spend declined, I believe on a year-over-year basis. And so I was curious as to, given the growth outlook that you’ve laid out for 2020, what kind of land spend do you think we should expect in 2020? Do you think you could see yet another decline? Or do you think that you are going to see in order to sort of maintain the growth that you’ve outlined here you are going to need to see your land spend pick up in dollars?

Stephen, a good news as we have the dry powder to do whatever we want to pursue our growth. We were down a little bit in 2019 versus 2018. But if you get into the numbers, the down can be one or two deals in California. It’s not a broad base decline in land spend and some of it’s timing, some of it’s structure. We are working toward controlling more, owning less that influenced the number a little bit. But our plan right now and our hope is that for 2020 we’d spend more than we did in 2019, because we want to fuel our growth trajectory. And that’s the way our plan is laid out right now.

Got it. Okay. That’s helpful. And last quarter, I believe you said two things and I wanted to sort of see whether or not your thoughts have changed or if things have changed at all in the last three months. Last quarter I believe you said your raised prices in 90% of your communities. How do that looks this quarter? And then I think you also mentioned that you really weren’t interested in the built to rent model and that’s one of those themes that seems to be continuing to track a lot of folks. So, curious to see whether or not your thoughts have evolved there?

Stephen, I shared in the prepared comments that we raised prices about 35% of our communities which, for a fourth quarter is pretty good.

Yes.

So, there was purchasing power in the quarter, 6.5.

Okay. Got it.

And then, on the for rent, our view right now as we are homebuilders, anytime we’d analyze this we get a better return on the assets a homebuilders than we would as a landlord. And until we get to a growth trajectory that we are struggling with, I think we’ll stay focused on what we do well. It doesn’t mean we’ll look at it and if there could be an opportunity if we have a multi-product asset, we want to acquire where a portion of it to be for rent and lease, we’d figure it out. But it’s not a primary initiative for us at this time.

Our next question comes from the line of Mike Dahl with RBC Capital Markets. Please proceed with your questions.

Hi, thanks for taking my questions. I had a two-part question related to gross margins first and as Jeff K just on the amortized interest and also the percentage of deliveries expected from reactivated communities in 2020 versus 2019, could you provide us an update on how you are looking at those two metrics with respect to the 2020 numbers?

Sure, Mike. We believe both of those will remain tailwinds to our gross margin next year. Perhaps it is slightly reduced level, I mean, in 2019, we had 90 basis points of improvement coming from interest amortization and I do believe it will be less than that. Same thing with the reactivated headwinds that should reduce, but probably not by as much as what we’ve been seeing in the – for example in the fourth quarter, we were down 50 basis points year-over-year in the reactivated. But there – we were kind of getting to the end of the story on that. I think we saw some upside coming from continuing to sell-out and close out those communities. But there is probably less opportunity. But still both nice tailwinds for us on gross margin next year. Both are included in our guidance metrics in addition to all the change in mix et cetera at our community portfolio for next year and I think more good news to come from both those areas.

Okay. That’s helpful. Thank you and then the second question is, related as well, which is those seem to be tailwinds and your margin guidance, midpoint is up 30 basis points. With those as tailwinds on the market conditions that you are speaking to, it seems like that’s a kind of conservative number to be up 30 basis points at the midpoint on gross margin. So, maybe you could give us some of the other puts and takes that you are thinking about whether it’s mix-related or labor inflation or directs. Any additional color will be helpful. Thanks.

Sure. The largest impact and largest factor for us in 2020 will just be this community mix change. We closed over a 100 communities out. In 2019, it was over 40% of our beginning community count. So, the community portfolio is quite a bit different. As we go into next year, we are trying to forecast gross margins coming off those communities, many of which have not been opened yet. So we have a lot of openings to occur still in the first half of 2020 that will generate revenues and margins in the back half of the year. So, we are trying to do the best job we can anticipating and forecasting where those margins will be. At this point, we have pretty good visibility as, I think most people are aware with our large backlog to the first half of the year and very critical spring selling season that’s coming up where we’ll be refining our estimates and expectations for the full year. In speaking to the spring, I mean, we are pretty excited about it. We think we are really well positioned as a company. Probably best positioned we’ve been in quite some time relative to the market and combined with very strong market conditions right now, we are really optimistic about the spring and we’ll be updating those gross margin metrics and expectations as we go through the year like we always do every quarter. But right now, right at the midpoint, we are at about a 19% for the year up and our operating margins were up about 50 basis points year-over-year at the midpoint of our operating margin guidance. So, pretty nice improvement on a base of right around $5 billion of top-line revenue. So, we are excited about what that will do to the bottom-line.

Our next question comes from the line of Matthew Bouley with Barclays. Please proceed with your question.

Hi, this is actually Christina Chiu on for Matt. My first question is just on your community count growth expectations for 2020, specifically, geographically. Are there any markets or price points that you are specifically focused on in 2020?

Well, what we try to do with community count is, we try to grow the business throughout. We don’t constrain our divisions. We don’t constrain our regions at all with budgets and saying you can only spend so much on land. If they are hitting our hurdles, and they are bringing good land deals to the table, that’s how we go forward with it. What we saw in 2019, which will impact 2020 revenues since we saw an outsize increase in our West Coast region for their community count growth, as well as our Southwest region, which has been a very strong market for us, and little more modest improvement, flattish actually in central, little more modest improvement in Southeast. So those factors will impact 2020 top-line a lot more than what we do with the 2020 count. But as always, we’ll try to focus on opening as many communities as we can that they are hitting our hurdle rates. We are staying very disciplined on the hurdle rate side. We will continue with the company’s strategy of focus on first time and first move of buyers and also happen to be really quite a bit of a strength in the market in that area right now. So we are right in the sweet spot and intend to continue to manage the business in that fashion.

Okay, got it. And then, can you quantify or maybe give a timing update of how you are expecting SG&A leverage in 2020 in light of accelerating revenue growth and coupled with moderating community count growth?

Right. Basically, on the SG&A side, I mean, we always hit kind of a high point is, it’s at a negative, but a high SG&A ratio in the first quarter as our revenues are typically lowest in the first quarter and it progresses as we go through the year usually hitting out a low point in the fourth quarter and we expect pretty much the same trend that we see in the prior years in 2020.

Great. Thank you.

Our next question comes from the line of Michael Rehaut with JPMorgan. Please proceed with your questions.

Yes, hi. Thanks very much. I wanted to spend the first question just on the gross margin. Just trying to dig in a little better and maybe kind of rephrase or ask around some of Mike’s earlier questions in terms of fiscal 2020 guidance. You had, as you said, 90 BPS of interest expense amortization improvement in 2019. You expect further improvement in 2020 although at a lesser rate. So even if it that’s a half of that amount, you could still be looking at your core gross margins excluding interest flat to down a little bit. So, just want to understand why you’d save that if I think you kind of pointed earlier towards actually a continuing improvement of mix of your community from a gross margin standpoint, you are coming off of an easier comp at least in the first half from, perhaps higher incentives in the marketplace from the back half of 2018. And by contrast, also I mean, you’ve – I think what people are just trying to understand is, is there just a basic level of cushion or conservatism that you are baking in, given you are four quarters now averaging 50, 60, 70 BPS higher gross margins than at least our estimates and I am sure many on the street in terms what you’ve been able to beat. So just trying to also reconcile and connect the dots or the drivers after next year.

The basis of our guidance is really a rollup right from the community level to the division level, from the division level to the region and region to the company. So, it’s very much a detailed forecast. The mix impact is huge. Like I mentioned earlier, over 40% of our communities are changing on a year-over-year basis you don’t have the same communities that you are selling out of, you are dealing with things like land cost inflation and trying to offset that with some of your new land parcels and we basically forecast based on what we know today. So, we base our forecast on our backlog gross margins, as well as our selling gross margins in anticipating what those buying gross margins would be later in the year. As I mentioned earlier, we are not even to this critical spring selling season yet. So we don’t have anything on the books really for the third and fourth quarters. So it’s all on paper right now and I’d say our best estimate as we see it. And I think what’s underappreciated generally by folks outside of the industry or trying – folks like you guys trying to come up with your own guidance there, or your own estimates for companies is, the impact that mix can have and how much community changeover can impact the numbers that it’s not just simple math of price up, cost down and there is certainly other. It’s different store count, it’s different stores, it’s different markets and the mix has a big piece of it. So, at this point in time, we are – that midpoint guidance number of 19% is kind of what we are seeing. We do believe with the right market conditions in the spring that we could potentially do better than that. That’s why we have a range around and right now we will stick with the guidance numbers and update you as we go through the year.

Thanks, Jeff. I appreciate that and obviously, as you said to your point, mix can be a pretty big driver in terms of variation. Maybe just flipping to this past fourth quarter in an effort maybe to better understand guidance versus actual results. Your gross margin for the fourth quarter came in 40 BPS above the high-end of your guidance range, 70 BPS above the midpoint. So, I was just curious if you had a sense of what drove that difference relative to your expectations relative to the guidance range?

All right. The two largest items are really – we did a little bit better in the amortization than we thought. We were expecting something more similar to the third quarter. We will have 20 basis ahead of the third quarter in our amortization and really one of the largest drivers was the reactivated headwind was much lower than it’s been pretty much in for years. I think, we picked up 50 basis points relative to the third quarter and reduced headwind from our reactivated communities and that was a function of two things. One, revenues were a lower percentage of the total, but also I think importantly, the reactivated communities actually had a pretty strong gross margin performance in the quarter and lifted the gross margin. As Jeff had mentioned, we increased prices in about two-thirds of our communities during the quarter and the other thing that’s usually outside of our guidance is we have a certain percentage of spec sales and deliveries within the quarter which obviously don’t start off in our backlog and we end up forecasting those and to the extent you could take price in the quarter and we have to take less of a discount on our spec sales, that was also a positive. So those three factors are probably the main things on behind the margin beat.

Our next question comes from the line of Susan Maklari with Goldman Sachs. Please proceed with your questions.

Thank you. Good afternoon. My first question is just on – you noted in your commentary that you've seen buyers increase their spend in the design centers even as the size of the home has come down modestly. I guess, can you just give us a little more color on what you are seeing there? And maybe how you are thinking about that coming through? And especially maybe in the margin and in some of that mix as we think about 2020?

Susan, to understand you’d asked to look what each buyer is picking. One buyer will pick up higher level of upgrade cabinet, and a different buyer will pick some more cabinet option or a den option or structural option. It really – when you look at the data, it really reinforces how personalized the homes are that we produce, because there are no two that are the same. What’s interesting for me is the studio spend goes up while the home goes down and a lot of the cost in the studio are tied to the size of the home. So it tells you the – even the buyer that was buying a larger home had the ability to put things in their house and chose not to and with a little bit smaller home apparently they are choosing to put more in the studio. So, we priced in the studio, it’s accretive to margin to a degree. It’s not a big lift to margin. It’s just more revenue at our normalized margin for the most part. So, as we model, we have a margin analysis per community that includes studio revenue based on our experience at that community or with that price point in that city. So, it’s all baked into our guidance. We don’t look to the studio right now as another upside for the year. It’s just part of the ASP and the revenue that we guided.

Yes, I know, sure. I was just trying to get a sense of, are you seeing more of a lift as the size of the house has shrunk, and should – is that something that generally could kind of continue as you get this move to more smaller homes?

It could, it could, I bet. Literally, and you’ve been to our studios. Every buyer is different and some want a big home with less amenities and others want a smaller home and load everything in it and everything in between and that’s as part of why we sell so well, because we can cater to everybody.

Our next question comes from the line of Jade Rahmani with KBW. Please proceed with your questions. Our next question comes from the line of Jay McCanless and he will be our final question from Wedbush. Please proceed with your question.

Hey, good afternoon. Thank you for fitting me on. First question I had, a small decline in orders in the southeast this quarter. Could you talk about what was going on there, because that part of the world has had a pretty good run in the past few quarters in terms of order growth? Hello?

No, no, we are looking at the notes, Jay. One of the things that happened last year in the fourth quarter, we had acquired that builder in Jacksonville Landon and had a bunch of inventory that we sold through. So there was a spike in sales in Jacksonville that didn’t replicate because this is getting out of old product that we weren’t going forward with. So that’s probably the sum of it. The number is not that big. Our business in the major cities is very good. The Orlando, Jacks, Tampa, and Raleigh, we are seeing good demand in all of them. So I think it was just the timing of that acquisition.

And then the other question I had, could you all quantify how many closings were pushed because of the fire? I am sorry to hear that you were affected by the fire, but how many closings were pushed and are those pushed closings having any impact on your assumptions for the 1Q 2020 gross margins?

No, it’s a pretty modest impact. It was well under a hundred units, but they are high ASPs. So it had a bit more of an impact on the revenues, but it wasn’t terribly significant and it held our full year revenues in about the same range as we were at the end of last quarters. So not a huge effect.

Ladies and gentlemen, this concludes the question-and-answer session, as well as today's call. You may now disconnect your lines at this time. Thank you for your participation and have a wonderful day.