Good afternoon. My name is Devon, and I will be your conference operator today. I would like to welcome everyone to the KB Home 2020 Second 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 July 24th. 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 second quarter of fiscal 2020. On the call 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 Web site at kbhome.com. And with that, I will turn the call over to Jeff Mezger.

Thank you, Jill. Good afternoon, everyone. We hope you, your families and your colleagues are healthy and staying safe. We entered the second quarter well positioned with a substantial backlog, expanding profitability, employees for momentum and net order growth in what look to be a strong selling season. About two weeks later, a national emergency was declared for the COVID-19 pandemic and every state in which we operate issued stay home restrictions, effectively shutting down their local economies. While residential construction was deemed an essential activity and we were able to continue to construct and deliver homes in the majority of our markets, we curtailed many aspects of our business until we gain better visibility on market dynamics and the economy. These steps allowed us to effectively navigate through the disruption and with our absorption pace now beginning to normalize, we have quickly re-established a steady rhythm to our business in selling, starting and delivering homes. As we emerge from the second quarter and look to 2021 and beyond, we are more efficient business and believe we are well positioned to restore our higher volume delivery levels. I'm proud of the entire KB Home team for their extraordinary effort and dedication to our customers and our company. In spite of the challenges we faced, our teams executed well, safely delivering 2,500 homes to our customers, which produced total revenues of $914 million and diluted earnings per share of $0.55, representing year-over-year growth of 8%. Getting into the details of our results, our profitability increased, marking the highlight of the quarter with a 100 basis point year over year expansion in our housing gross profit margin, which fueled a 19% increase in our pretax income. We have a strong balance sheet with no goodwill and $1.4 billion in liquidity. Our leverage…

Thank you, Jeff and good afternoon everyone. I will now provide highlights of our financial performance for the 2020 second quarter. During the quarter, we navigated through a very challenging operating environment, generated improvements in many of our key profitability measures and continued to enhance our balance sheet strength and liquidity. In addition with positive weekly sales trends in May and June that reflect progress on the path toward normalized activity in our served markets, we're providing forward guidance for the 2020 third quarter and full year. In the second quarter, our housing revenues totaled $910 million compared to just over $1 billion in the prior year period, reflecting 10% decline in the number of homes delivered and a slight decrease in their overall average selling price. The lower deliveries in housing revenues reflected in severe COVID-19 pandemics induced economic and social disruption and related uncertainty during the quarter, which drove increased home purchase contract cancellations and slowed our delivery cycle. We ended the second quarter with 5,080 homes in backlog as compared to the year earlier level of 5,927. Our ending backlog value was $1.9 billion, a decrease of 12% versus the prior year. Considering our quarter end backlog, current construction cycle times and recent improvement in our net orders, we anticipate our 2020 third quarter housing revenues to be in the range of $820 million to $880 million. For the full year, we believe our housing revenues will range from $3.75 billion to $3.95 billion. In the second quarter, our overall average selling price of homes delivered was down slightly year-over-year to approximately $364,000. We anticipate an increase in mix of deliveries from higher price communities will result in higher average selling prices in the second half of the year as compared to both the first half of…

At this time, we will be conducting a question-and-answer session [Operator Instructions]. Our first question comes from the line of Truman Patterson with Wells Fargo.

First, I wanted to touch on your second quarter and June orders, they seem a little bit lighter than what we've heard in the markets. I'm hoping you all could just elaborate on this a little bit? Seems like maybe you were a bit more aggressive in scrubbing your backlog, maybe a bit more aggressive in closing communities, slower to reopen. I don't know if there was anything with the technological or video initiatives? Just trying to understand or even if you think it's just the end markets. Just trying to understand the moving parts there.

Truman, you touched on a lot of them with when you stretch your sales offices down to protect your employees you're not going to sell lot of houses for that period. But I also think we did take an aggressive position on the backlog, because we wanted to make sure as we're building homes that there's some that can perform when the home is completed. And all that process and everything we went through was in April in early May. As we share my prepared comments coming out of May, orders strengthened each week both gross and net. And here in June as we shared we’re at normalized levels. So I can't speak to Tom's versus other builders. Last year, our third quarter was the strongest orders per community we'd had in many years and right now we're slightly out of that. So we actually feel good about our current sales pace.

Just a quick question on recent trends. In June, how are your incentives trending relative to March and April? Have they started to normalize? And then also from a demand standpoint, we're a little over three weeks into June. How did the third week trend versus the first two? Did it continue to improve? Or are you seeing possibly a slowdown in any of the markets that are starting to spike with virus cases again?

Well, you just, you exceeded the two question limit, but I'll go ahead and answer them all. As I shared in the comments, sequentially through June each week has gotten a little stronger. So we see no slowdown here in the month of June. As you know, we're not a big incentive focus company. So, we didn't do anything with incentives for the last four months. Our incentives are less than a percent of revenue. Because of the extraordinary nature of the disruption, it was an inelastic demand. So we didn't fall, we were working through trough in gross sales and working through the can rates. We didn't do anything to try to chose sales, because we didn't think it would really make that much of a difference. We did share and most of it happened in May. But as orders strengthened in May, we ended up raising prices in about 60% of our communities. So demand is solid for all the reasons I shared in the comments, and we're seeing buyers that really want to be come in and get a brand new home today. So incentive is low. We’re raising prices and our sales pace is right where we want it to be today.

Our next question comes from the line of Alan Ratner with Zelman & Associates.

Glad to hear you're both doing well and thank you for all the guidance in color. Appreciate it. You know, first question, Jeff I think early on we heard from a lot of builders that the initial pop in demand coming out the worst period of the pandemic seems to be a little bit more focused on spec inventory, and you guys walked through you know, your commitment to the to be built strategy. I'm curious as you look at the order improvement you've seen over the last several weeks, I would imagine you probably came out of April with a little bit more spec inventory than you typically have given the cancellations. So have you seen, you know a greater share of orders or demand coming on those spec homes, understanding it's not huge part of your business or has that improvement accelerated to be built business as well?

Again, in my prepared comments, we were specific to the majority of that cans were on homes that hadn't been started yet. We did take some cans on homes that were under construction or completed in for a very short period of the quarter, our inventory levels were up a little bit just moderately up. And as I also shared in the prepared comments during the second quarter, our gross orders on our to be built homes performed better year over year than gross orders on inventory. So even though our inventory levels were up moderately, our built order mix of our business still outperformed. And as we sit here today,we always look at it as a percent of width and our inventory as a percent of width right now is lower than it was at any point in the second quarter. So our challenge is to create more width we're working diligently now to get as many permits hold in as many sold starts in the ground that we can that frankly were frozen in April and the first half of May. So that's our focus. In the meantime, our built order business is working very well.

Second I was hoping you can maybe just provide a little bit more information on your virtual home selling capabilities at this point, we've heard from some other builders that they've been pretty surprised that the willingness of shoppers to actually shop and even execute contracts seen on homes completely online. And I'm curious if you guys have those capabilities and if so, and what percentage of your orders in May and June have come entirely virtually without a buyer stepping foot in the community?

I don't have the percentages at hand Allen, but it's definitely similar to the trends you're hearing from other builders. I'm kind of old school and I like the emotional side of the home selling. You have to feel it and live it and touch it. But the new consumer, a lot of them are comfortable buying homes virtually. And so we sold a lot of homes virtually and we're going to continue to tweak that if you get on our website, you can see all the capabilities we now have. I was also surprised at the willingness of buyers to final in the studio virtually, which is an even more emotional part of it because it's the way they personalize their home. And there were weeks in the quarter, we finaled 200 customers all virtually online and through the studio process. And they're very comfortable there and it didn't impact the sales per unit at all. So they're finalizing online and it's actually caused us to reflect more here on how to refine our business model approach and leverage these virtual tools more. You can be more efficient, lower your overhead and keep or improve on your productivity with the customer. We're pretty bullish on it.

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

I wanted to follow up on the built to order versus spec dynamic a little bit here, because I think that there's two ways in which the built to order strategy in this particular near term or this particular short term window may have been hurting you. And I was curious if you could comment on whether you agree with that? On the one hand, first off on the cancellations because the built to work strategy always makes it that you have a lot of homes that you're selling that haven't been started. It's a lot easier. One would think before the customers cancel those and because of the fact that they are doing a lot of options, the back and forth process, and may make it harder for you to sell virtually. So there's kind of two things one that might affect your cancellations, the other one that might affect your gross orders negatively, because of the built to order strategy. I was curious as to whether or not you think that is something that caused your results to be impacted this quarter versus let's say if you would pursue a spec strategy? And whether that is something that might therefore leave you more vulnerable with a second wave environment where they manifest again over the back half of the year?

Well, hopefully we don't have to experience that again. Stephen, it's been very painful in this disruption that the industries had to manage through is something I've certainly never seen in my career and hopefully nobody ever sees it again. And you have to assume we lost some built to order sales when they couldn't even access the studio, couldn't go to the community and stand on the lot they were picking and all that. So I would assume we probably lost some sales there, I couldn't tell you how many. We didn't pick it up by selling a lot more inventory that's why I shared the comments that I did. Our build to order sales performed better in Q2 than our inventory sales and about 20% of our WIP is unsold at any one time. So the inventory was out there. Our built to order still, the consumer is telling us they value the choice proposition. And now that cities are more predictable, and we can get starts and we can tell people when their home is going to be delivered again, which we couldn't do in March and April certainly. And there's consistency to it. In June, our built to order sales are right back to where they were before March 15th and are performing very well. So it may have been, I couldn't tell you what the impact was for the 60 day disruption that we went through. But I do think overtime, it's a far better business. And I think it's in part why we could hold our revenue as well as we did in the second quarter, because the backlog wanted to move in. It was the most motivated backlog that I've seen in a long time where people were challenging us, hey, can I get in there? So we're still big proponents of this approach.

Yes, no doubt. And obviously it shows up in your margins, which were good too. The second question relates to the most recent information you've given about sales for the first two weeks of June, which are admittedly good. But also not particularly very different. Certainly, not better than what we've heard from some others and maybe there's some positive bias to what kind of makes news. But it seems that that number is kind of what you would expect, maybe a little light is the way I'm feeling that and lot of investors reacted to it. But given the amount of cancellations that you would had, I kind of would have thought that you would have had a lot of return business on top of just the general improvement in the overall market that you guys would get kind of like a double boost and that therefore, your June numbers and maybe July from these returning customers will be additive to the new customers that would wander in the door. You said that you saw some of those cancellations return. I was curious if you give us a little more color on that whether it's as much as you would have expected or not?

Well, I think some is, it's an appropriately the generic comment. Stephen, we've seen some come back but these people that canceled where you lost your job, you have to get a job back to come back and buy from us again. So whilst it’s, I’ll call it a repeat customer, because they come back it's really a new customer, because they're employed again and you start over. So I don't know that, you still have a lot of people that are furloughed where it's a question mark and who knows what will happen with that group. But if our sales in the third quarter ended up in the range of where they're at right now compared to last year on a lower community count, we'd be pleased with the selling results.

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

So I wanted to ask about, I guess sort of with the benefit of hindsight and seeing the market come back as quickly as it did. Obviously, you guys took a lot of these proactive steps around closing communities and scrubbing the backlog and pausing land development and acquisition. I mean, going forward, if there is I mean in a unfortunate such situation in the second wave or just simply rolling lockdowns, we look at the headlines today I think this is worth addressing [Technical Difficulty] the question is, would you take any more of a risk on approach reacting to future shutdowns or at least act differently in any way?

As I reflect on the last 90 days, we put our employees safety first and it was the right thing to do. And the experience we've had with COVID paces in our company reinforces that we did the right thing, because we've been very fortunate within the KB Home team with everybody's health and well being. We took the steps on the overhead reduction. We're not, even though you see this quick recovery in demand, we're not quickly going back and adding the overhead back in. So it's a pedal and break. So we'll keep moving it along. And if things continue to look okay, we'll keep getting a little more aggressive. But if it turn down, we've already taken the steps to deal with the turn down. We have plenty of liquidity. We are comfortable with our cash position. We may slow down land spend, again if things turn down. But I think we, as a company we’re more efficient today, we're smarter, and we're better positioned than we were in March. So it's a second as I said, I think we're already there.

And then just secondly, I wanted to drill in on the cancellations a little. And just, I guess, wondering if you could elaborate any further on some of those efforts that you called out and particularly the employment status of buyers and you mentioned the financing availability as well. Do you have any ability to quantify how much each of those contributed to the cancellations? Or I mean, really the question going forward is given where employment is, you know is there any further risk from that, you know, as you look at the current backlog as it stands? Thank you.

I would say that the percentage of it was tied to financing was very limited, people that where their income dropped, because they're no longer working overtime or their job scope changed, or they're no longer getting tip income as they're no longer working at a casino in Vegas cause they were closed. And so their income dropped and that would affect their ability to qualify. But the largest driver was people that either lost their job or have a long term furlough. So I don't sense that there's another wave of unemployment hitting today. And as we monitor the cans each week, we're not seeing that kind of the driver anymore. Now it's the normal nuts and bolts cans I’ll call them versus the intensity of loss job and furlough. So I don't think we'll see that again unless there was a severe downturn that hit the economy and we're not expecting that right now.

Our next question comes from the line of Buck Horne with Raymond James.

I just want to start maybe backup to like the revenue guidance for third and fourth quarter and the backlog conversion. And it does seem reasonably conservative at least my first glance here. And I'm just wondering if some of that relates to, are you seeing cycle times extend here in the field? Are there some bottlenecks that could be lasting in the construction process? And what are you seeing out there whether it's safety protocol, or labor shortage, or land availability, I don’t know if you could highlight just, or is that just reasonable conservatism in the guidance in terms of how you see the backlog converting from here?

Buck, it's if you split the components of cycle time, our time from contract to start has lengthened because a lot of cities are still having to sort through the permit process. So, in the old days if it was 30 days to start it's longer than that now 45 days whatever. The build times actually in the quarter were down a few days and we're continuing to work with our contractors to see if we can compress build times going forward. I think you'll see the delays in construction hit in the third quarter, because of our pause on production not because the subs weren't out there we couldn't get things done. The subs have quickly rallied around going to work and figuring out how to build homes with only one contractor in the home at a time. And if you think about the build time, the majority of the days are in foundation frame, getting it under roof. That's where all the days are. And in that part of the process it’s typically only one contractor on the site anyway, there's only a framer there. The plumber has to go in or the HVAC guys. They're the only ones there at that time. So you're, where you're limited now is in the finish. And if the electrical trim was going in at the same time as the plumbing trim, which on their own are each one day, so now it's two days instead of one day on the other end. So it incrementally in the build time, we have figured out how to hold build times, while ensuring that our contractors are safe. There's been a couple of days added on the post completion cycle time, because the lenders are looking for more employment verifications right before the…

Let me ask you a little bit on the demand and kind of the uptick we're seeing here recently, and if you've gotten any extent or ability to characterize where it's coming from, whether or not are we getting a tangible sense that more first time buyers are showing up whether they're former apartment renters, or are you seeing more cross market or out of market demand from people actually migrating to more affordable locations? Any characterization you can give to this uptick in demand each week?

Well, I do think that there's some of the resetting of where people live, like up in the Bay Area a lot of the tech companies have already announced that you can work from home permanently. And if you can work from home, why would you stay in San Jose if you can live in Sacramento for half the price and still do your job. So I do think there's a little relocation going on for the group of employees that can permanently work from home. And we'll see how that plays out. We are seeing some relocation again from one state to another, Texas and Florida are big benefactors of influx right now. Other than that it’s fairly broad based. Our first-time buyer in the second quarter was the highest we've seen in a long, long time and it was definitely up year-over-year at 58%. So, I would say that buyer is a well-heeled first-time buyer with 710 FICO that has good employment today.

Our next question comes from the line of John Lovallo with Bank of America. Please proceed with your question.

First one is on gross margin and just sort of sustainability of the positive mix and pricing that we're seeing. I know there was also some benefit from lower amortization. But I'm just wondering, how sustainable the mix portion particularly is? And then is there anything on the input side and maybe materials that are benefitting as well here?

Yes, I'll take that in segments. I guess, first talking about the amortization. We do expect to see continuing benefit from lower amortization on a year-over-year basis that was part of what we included in the guidance for the third quarter. Of course, we're losing a little bit of leverage on lower volumes but will pickup most of that frankly through lower amortization. On the mix side, there is a little bit spread. I mean we had, we still have a little bit continued tailwind from the lower percentage of reactivated deliveries that we're seeing, and at the same time a higher gross margin within that category. So, we've seen gross margins improve in that category and we've seen the category reduce overall as a percentage of the total. So that helped us about half of the mix uptick in the quarter is actually just from that, and we do expect to see that again in the third quarter. So it's much as same as what we just saw, little tick down in operating leverage, some positive on the amortization side and certainly some positive on the mix side and we think we're going to be pretty consistent with what we just saw in the second quarter leading into the third and then onward into the fourth and powering through some decent gross margin improvement considering the current conditions.

And then maybe just on the homebuilding equity income. Looks like there's a nice gain there, look like about kind of maybe $0.06 or $0.07 in the quarter. What drove this? I imagine it's more one time in nature?

You're talking about the joint venture income…

Yes.

We have a project in the Bay Area that delivered quite a few units in the quarter and that was the driver from it. We have a few more units to deliver in the third and then on into the fourth quarter. We don't expect these quite as much, to see quite as much income coming from it in the third and fourth, but it's basically a single high value project that are very profitable project in the Bay Area.

Our next question comes from the line of Mike Dahl with RBC Capital Markets.

I wanted to go back and kind of follow up to a question prior around actions taken in March, April and some learnings from that. But wanted to focus specifically on safety since from a community and a design center standpoint you guys did act fairly aggressively and proactively. So just I guess in light of some of the upticks in cases across your core footprint today. Can you describe kind of how you're -- from a sales, from a community and design center standpoint, how your safety measures are today? And how you plan to approach those in light of some of these recent upticks?

And we've been pretty diligent in ensuring that we're in full compliance with either CDC or for each local set of standards. And in a lot of the cities we're in the standards have been more rigorous, made more rigorous the last week or two. But it's things that we were fundamentally already doing like, okay, everybody should wear mask but our employees were already wearing masks and they have masks available for our customers as well. It's now a little more rigorous in the wording. So hopefully the general public is more diligent and wear mask right now. But our standards are already there. So if cases pick up 1,000 a day across all of California, it won't change our standards. If they really got elevated from there, we'll be sensitive to it and take the appropriate steps. We're continuing to focus on the health and well being of our customers and our employees.

And my second question, just on the pricing front and I think, Jeff, you mentioned the 60% of communities in your opening remarks for, I thought it was for the quarter. And then in response to another question, I think you said that was maybe a May specific comment. I just wanted to clarify when you think about kind of pricing trends in the quarter and how many and when you were raising prices in communities, was that a May specific comment…

Well, there was probably some in late April, there was none in early April, but it was weighted to the back half of the quarter certainly and most of it in May, because the sales pace was right there and let's take advantage of the demand.

Our final question comes from the line of Michael Rehaut with JP Morgan.

Hi, this is Maggie on for Mike, first and I apologize if I missed this. But I was wondering if you could talk through how the rebound in demand is played out in your different buyer segments. I know that you called out the first-time buyers, but I was hoping you could give a little bit more color around that.

Well, Maggie, the mix has been pretty consistent. First-time buyers up 3 or 4 percentage points from the last several quarters and the first move up is where it has moved down a couple of points and our active adults over 55 buyer has held pretty steady. So, I think the resurgence in demand is pretty broad based right now. I don't think it's just first-time buyers. I do think when you get to the highest price points, it's probably a little more discretionary right now but people that want to be in a home the first time or the first move up, or an empty nester that's relocating to a small new home, I think those, all those buyer profiles are pretty strong right now.

And second, in terms of the drivers of the recent uptick in demand, I mean you've already called out some buyers returning and some relocation as more people are working from home. But to what extent are you thinking about these as kind of temporary drivers of demand and maybe kind of a release of some pent up demand versus a return to more normal sales environment and kind of a longer term trend?

Well, I do think there's still pent up demand, because the country shut down in the strongest selling period of the year, the demographics didn't go away. And I think the headline employment, unemployment numbers are not necessarily home buyers, it's low level wage service employees or whatever. So there's a lot of demand out there from the demographics and the people that are employed and there's no inventory. Then you add onto that people want a new house, it's healthier, it’s safer, there's -- you read it in the media every day where they're talking with people that don't want to buy used, they want to buy a brand new home now. And then you throw on top of it that people want to get to a little less dense situation. So, there's a lot of things pushing the demand side right now that I think could be structural shifts in favor of the industry.

Ladies and gentlemen, this concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation and have a wonderful day.