Good afternoon. My name is John and I'll be your conference operator today. I would like to welcome everyone to the KB Home 2022 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 11. And now, I'd like to turn the call over to Jill Peters, Senior Vice President, Investor Relations. Thank you, Jill, you may begin.

Thank you, John. Good afternoon, everyone and thank you for joining us today to review our results for the fourth quarter of fiscal 2022. On the call, are Jeff Mezger, Chairman, President and Chief Executive Officer; Rob McGibney, 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. 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 various factors, including those detailed in today's press release and in our 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, here is Jeff Mezger.

Thank you, Jill. Good afternoon, everyone, and Happy New Year. We are pleased with our financial results in 2022, during which we produced revenues of $6.9 billion, a year-over-year increase of 21%; net income of $817 million, a rise of 45%; and diluted earnings per share of $9.09, up 51%. Our top line growth, together with the expansion of our operating margin to over 15%, drove our return on equity of 470 basis points to 24.6% and contributed to 27% growth in book value per share to over $43. I am proud of our team and their hard work in generating one of the strongest years of financial performance in our company's history. Although we acknowledge that the homes we delivered this year were sold under different market conditions than we are navigating today, we also recognize these remarkable results were accomplished despite numerous obstacles, including supply chain issues and municipal delays that significantly extended our construction times, as well as persistent inflation and rising interest rates. Given the current market environment, we are providing guidance today for our 2023 first quarter and for the full year we are only giving a range of expected housing revenues. As we begin 2023, we do so with a significant backlog of over 7,600 homes, valued at roughly $3.7 billion, supporting our revenue projection for the year. While our backlog has become overextended relative to historical levels due to longer build times, we are committed to reducing our cycle times to achieve deliveries within a more traditional timeframe of between six months and seven months from sale to close. With our Built-to-Order model, our buyers tend to have an emotional attachment to the homes they select, choosing their floor plan on their lot and personalizing the home with their preferred features and finishes.…

Thank you, Jeff. Let me start by reiterating our focus on protecting our backlog and generating new orders to rebuild our backlog as it delivers out. This effort requires a deep understanding of the competitive dynamics of each submarket with respect to product, price, concessions and finished inventory in both the new and resale markets, which our sales teams and division leadership are continuously analyzing. I have also been heavily engaged with the teams on this effort. We are utilizing two different sales strategies depending on how many homes we have in the backlog in a community. For communities that have large backlogs, particularly those with far more in backlog than remaining to sell, you're are placing more emphasis on our temporary interest rate by down and lock programs to help produce sales and de-emphasizing price reductions until more of our backlog is delivered. While we recognize that price is the most effective sales lever to generate new orders, we also know that if we lower the base price in a community on new sales, many buyers in backlog would expect to receive a similar reduction regardless of the rate in which they may have locked their loan. As a result, it is typically not advantageous for us to lower the base price to a market clearing point in our high backlog communities as the impact to the prices of homes that are resold could be significant, particularly in what is traditionally a slower time of year for sales. That said, we have adjusted pricing in communities with smaller backlogs, where only a small percentage of that backlog will be impacted. The market turned very quickly in the 2022 second half as interest rates rose, and in certain instances, we were able to pull back the most recent price increases…

Thanks, Rob. The credit profile of buyers that use our mortgage joint venture KBHS Home Loans remain strong. For loans we funded during the fourth quarter, 66% of these customers qualified for a conventional mortgage. And while the vast majority of KBHS customers use fixed rate products, we saw an uptick in the use of adjustable rate products, as buyers took advantage of the lower interest rates these products offer. The average cash down payment was 17%, which equates to nearly $87,000. As to income levels, the average household income of these buyers was over $130,000 and their FICO score was 734. While we target immediate household income in our submarkets, we continue to attract buyers above that income level with healthy credit that are able to qualify at higher mortgage rates and make a significant down payment. In the fourth quarter, we again reduced our land acquisition spend, with investments heavily skewed toward development and related fees. We have also been renegotiating land contracts to reduce purchase prices and extend closing timelines. In certain cases, where we are no longer comfortable that we can achieve our required returns on the investment, we have terminated the contract. We canceled contracts to purchase about 6,900 lots during the quarter, walking away from deposits and due diligence expenses. For the year, we remain balanced in our capital approach, investing $2.4 billion in land acquisition and development and returning over $200 million of cash to stockholders through share repurchases and dividends. Our land spend was lower by about $100 million year-over-year and our investments were heavily weighted towards the first half of the year. With the anticipation that both our land spend will be materially lower in '23 and our build times will improve, which will reduce our investment in homes under production,…

Thank you, Jeff and good afternoon, everyone. I will now cover highlights of our financial performance for the 2022 fourth quarter and full year, as well as commentary on our outlook for 2023. In the quarter, we produced solid financial results, including significant year-over-year growth in revenues and an expansion in our operating margin that drove a 29% increase in our diluted earnings per share. In addition, while we experienced persistent supply chain and inflationary challenges throughout the year, and softening demand in the second half, our exceptional portfolio of communities and solid operational execution enabled us to generate strong full year financial results. These results included meaningful revenue growth, considerable operating margin expansion, higher diluted earnings per share and robust returns. In the fourth quarter, our housing revenues of $1.93 billion were up 16% from a year ago, reflecting a 3% increase in homes delivered and a 13% rise in their overall average selling price. Housing revenues were up in all four of our regions, with increases ranging from 5% in the Southwest region to 51% in the Southeast. Looking ahead to the 2023 first quarter, as we anticipate housing market conditions will continue to be challenging, we will focus on delivering our large backlog of sold homes and navigating ongoing though improving supply chain constraints. For the quarter, we expect to generate housing revenues in a range of $1.25 billion to $1.4 billion. For the 2023 full year, we are forecasting housing revenues in a range of $5 billion to $6 billion, supported by our backlog and growing portfolio of open selling communities. As Jeff mentioned, given the uncertain economic and housing market outlooks for 2023, we are providing full year guidance only for revenues. In the fourth quarter, our overall average selling price of homes delivered increased…

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] And our first question comes from the line of Matthew Bouley with Barclays. Please proceed with your question.

Hey, good afternoon, everyone. Thanks for taking the questions and for all the very helpful detail you gave there at the top. So first question just to understand the margin outlook, you saw the sequential margin or gross margin decline in Q4 and guiding to further decline in Q1 there, but it seems to be this is sort of before you've made the more aggressive price adjustments, if I'm hearing you correctly? So, yeah, I know you're holding off on giving hard 2023 margin guidance, but is the implication therefore, that we should think about sort of another reset to gross margins beyond Q1 as you do start to get more aggressive on the price side?

Matthew, I think the implication really is that there's just a fair amount of uncertainty out there right now, which is why we didn't guide beyond the first quarter. A lot of the remainder of the year just depend on what the Spring selling season holds, both in terms of new sales and what it takes to close out our current backlog. And we have a lot of offsets we're working on as well. We're looking to pull a lot of levers to potentially offset any further market price decline. We expect to achieve construction cost decreases. We'll see a lot of the lumber price decreases, mainly reflecting in our gross margin starting next -- in the second quarter. There's fluctuations that could happen based on, related to rate buy-downs, depending on where the mortgage interest rates move. Cancellation activity as well is one where we are looking for some mitigation. We expect to see some mitigation and that removes a little bit of pressure on having the resell those homes into a weaker market. And then finally, we see some levers that we can pull on the cost side in terms of lowering our spec levels and continued value engineering and initiatives of that nature. So it's just uncertain right now which is why we didn't guide and just prefer to keep it that way until we see what the Spring holds for us in the market.

Got it. No, that's helpful there, Jeff. Thank you for that. Second one, I mean, you talked about sort of careful capital deployment in 2023. So as you do reduce land spend build times, I mean, it does sound like there is an expectation for more meaningful cash generation this year. So can you just sort of expand on that just on the capital deployment side and sort of share repurchase in that scenario?

Right. I think what you should expect to see from us is a continuation of a balanced approach. We've always talked about focus on growing the business in the future of the base business, we're very confident, very optimistic about the base business. In the past, we used to focus in order of priority on land investments and then dividends and quite a few years ago now, on debt reduction. And now, we've been able to pivot those three priorities to land, dividends and share buybacks. We do expect to see strong cash generation in 2023 and all I can say right now, we'll continue to be measured and thoughtful on deployment of capital. We consider ourselves to be good stewards of capital and see opportunities out there to deploy it. My view right now is that the buyback strategy has been a real winner for us, especially given the current market value, which has been so much under our book value per share. And with each buyback we've initiated, we've been able to increase future earnings per share, increase future returns and amazingly at the same time increase our book value per share with every buyback. So we really like that strategy. But we will maintain, like I said, a balanced approach and be measured and thoughtful as we move forward.

Thank you. And our next question comes from the line of Stephen Kim with Evercore ISI. Please proceed with your question.

Yeah, thanks very much, guys. Appreciate it. And wanted to just sort of follow-up, Jeff, on the construction cost side of the equation. We've been starting to hear that builders are actually getting real reductions, not just sort of stabilization in price. And I guess we're certainly hearing it on the labor side. So I'm curious what you're actually seeing, can you quantify maybe some of the success you're having around cost reductions? Is it just labor? Are you seeing it on products, too? Is it spreading to sort of late-stage type of trades as well? And you talked about the lumber benefit, but I would love it if you could give us a little quantification on what is reasonable to expect given the implosion in the lumber prices?

Rob, do you want to take that?

Sure, Jeff. Steve, on the construction cost side, it's -- I mentioned, we were down $10,000 a house from our August starts to our November starts. So that's not just lumber, there's other costs in there, too. But I would say, we're still in the early innings of the cost reduction effort and it's, we're getting more traction on the front end trades, where there's less -- those trade partners are feeling the impact of lower starts across our markets more so than the back half of it is. So I'd say, early innings of the cost reduction work that we're doing on the front end, it's really just getting started on the back end, as a lot of those trades haven't felt it yet. And this isn't just renegotiating and allowing the market and the cost reductions to come to us, and we have a lot of initiatives in play right now through value engineering, simplification, lowering our spec levels, adjusting elevations to drive cost out and it'll likely pass those savings onto our customers.

Yeah, that's really, helpful. And it's going to be something that we're going to be looking for, I'm sure, in the communities you're opening up next year. In that vein, I wanted to ask a little bit about the balance sheet and your, in particular, land spend. I think you talked, Jeff, about owned lots. Well, I think, I observed that your own lots, owned lots, not including the options, but your own lots were down a little over 3,000 this quarter, but obviously, things are sort of -- continue to be sort of tough out there. I'm curious whether it's reasonable to think we might see another reduction of that magnitude as we get into the first quarter in terms of owned lots, that would take you to somewhere in the 45,000 on lots. And overall, is it reasonable, Jeff, to think that total inventory dollars could be down about $500 million by year-end?

I'll leave the dollar value, Steve, to Jeff to talk about. But if you look at our fourth quarter, I don't know the exact number, but it’s like 700 lots we purchased total. And so you know our delivery numbers, so therefore, your lot count went down, I would expect that it will go down further in Q1. I don't know that we've looked at it, but we're being pretty tight right now with any land spend and at the same time, we're continuing to deliver on our backlog and our WIP. So I do think you'll see our lot count go down. We own lots that support growth right now for '23, '24, '25, so we're in a good spot, with good basis on our lot portfolio, so we don't feel the pressure to have to buy anything to grow and we'd rather hold our cash and wait for the right time to go back and redeploy. So we could, we will see a lot count down in Q1. It could continue for a little while. Jeff, you want to talk dollars?

Yeah. As far as dollars go, Steve, I mean, we generally don't forecast, things like that on the balance sheet. But I think it is a reasonable expectation to assume that our inventory investment would be lower at the end of the year and generate some operating cash flow for the company that we could redeploy into other uses as we move through 2023.

Thank you. Our next question will come from the line of Michael Rehaut, with J.P. Morgan. Please proceed with your question.

Thanks, good afternoon, everyone. I appreciate you taking my questions. I wanted to circle back first to the gross margins and the guidance for the first quarter. Help me reconcile the statements that you're protecting your backlog and not getting as aggressive or getting a least aggressive as you can on the backlog, maybe I guess you said in some instances where they're smaller backlogs in certain communities maybe incentivizing a little bit but broadly, trying to maintain the gross margin of let's say three or six months ago, and help me reconcile that statement with the first quarter guidance of 20% to 21%, which is several hundred basis points lower than a couple of quarters ago. I know you mentioned as part of the drivers there, mix and a lower amount of operating leverage, so it does sound like some of the delta is in that, I guess that's my first question, I'll go onto the second one.

Right. As we talked about in the prepared remarks, it really, it's our outlook on the homes that are going to close, we have most of them in backlog right now, what those margins look like, we have an offering certain concessions pretty close to closing a lot of homes in order to basically convince buyers are closing their homes, and there's a little bit of set aside for continued activity in that area. Higher construction costs are hitting in the first quarter, just based on when homes are started and keeping in mind that our lumber lags a little bit because of the way we lock lumber prices, so that trough that hit starting to go down about mid-year last year is more or less going to hit us more like the second quarter as opposed to the first quarter. The lower pricing obviously, has been the main driver on the quarter-over-quarter decline in margin and we're just basically call it like we see it right now and what's expected to close in the first quarter.

Well, I appreciate that. I guess maybe just as a follow on around that, it would be really helpful to kind of get a sense of, to the extent that again, you've tried to keep it to a minimum but what amount of incremental incentive on average is in the backlog today versus six months ago? And more importantly, you highlighted in your prepared remarks, the Inland Empire, where you're starting to kind of work through the backlog more quickly and you said that in the last few weeks, you've generated better sales growth -- sorry, better sales pace with what you said were solid margins, I'm kind of curious what solid margins mean there and perhaps that's kind of a clue in terms of how we should think about margins going forward for the broader company?

Right. I'll just reiterate my comments from earlier, Mike, I mean there's a lot of uncertainty in the back half of the year and I think it's too early to call a lot on very much on what could happen in Q2 through Q4 on margins. Well, there's a lot of initiatives underway in the Company right now. We expect to see a lot of offset to whatever negative they come out of the general market. The largest difference between the margin in the first quarter and the expected margin in the first quarter and what we saw in the first half of last year, was the rate environment and the necessity to offer some concessions related to mortgage rate buy-downs to our buyers that we didn't have at all in the first half of 2022. So that's a pretty significant gating factor, very dependent on what happens with mortgage rates. And if we see those coming back in, there is significant margin pickup from that type of activity that we might see in the general market. So that's I guess that if you're trying to really dial-in on back half and what could happen in second quarter and everything else, and we're trying to provide as much information as we know today without seemingly having a crystal ball and what could happen, especially in the macro environment. So we're just trying to call like we see it right now, Mike.

Thank you. And our next question comes from the line of John Lovallo with UBS. Please proceed with your question.

Hi guys. Thank you for taking my questions. The first one is, rates have certainly come down in December and January, I mean, call it 100 basis points plus from the highs. I mean what are you seeing from an order pace, cancellation pace and is the volume, is the quality of traffic improving at all?

Different topics, John, it's the time of year when traffic improves anyway. So we are seeing a pickup in traffic certainly, after the first half of the year. But the summer was okay, I'll call it with traffic, we shared in our prepared comments that cancellations are actually moderate, that's a good thing. The wildcard is what do rates do versus how strong is the spring selling season? And rates have come down and the consumer is starting to digest the higher rate. So I think that's a positive for the consumer, and then we'll see how the spring selling season evolves, but so far so good.

Okay, next question is, you know, just trying to better understand the sales approach heading into the spring selling season here, not lowering prices in the high backlog communities because the backlog would expect concessions. I mean intuitively that makes sense. But I guess the question is, what stops that backlog from going next door to a competitor if you're not at the market price, I mean, does it make sense to define the market price in order to get closer to in each community.

John, that's a good question, one of the things that we all have to be mindful of is that a house isn't a commodity. It's somebody's home, that's where they live and it's where they make memory. So there's a lot that goes into the home besides x square feet for this price, and our buyers that, as I said in my comments, our buyers picked their floor plan, pick their lot, personalize their home, finish their home and they're waiting for us to complete and so they can close it, and for the most part, they're closing it. It isn't a 100%. If some other builders out there with a crazy discount that they can't ignore, they may move, but for the most part, they're -- they appreciate the process, the value proposition, the high levels of customer satisfaction. The leading industry energy efficiency, the smart home technology, all those things that we put into our product over the years are meaningful to the buyer, and it's more than just a price for footage. And if you couple that with what Jeff was talking about before, we went through pretty significant period of turbulence when rates moved up as fast as they did. And we had a lot of buyers that weren't locked, that we had to work with the keep in the backlog because they were scared to death of 6%, when they bought it at 3.5% or 4%, and a lot of what's coming through here in the first quarter, hitting margins as we did more than we normally do on financing concession to keep the backlog, but if you spend 2 points or 3 points on loan as opposed to a broad-based price discount, as a Company, financially, we're far better off. So as this backlog rotates through, that's when we'll go back out and evaluate what's the right price for the community, and you get out of the financing concessions and you go to a better price proposition for the consumer. We won't do both, we'll go back to price, which is what we always do and we're far better off letting the backlog turnover and clear than we would be -- the example Rob gave is, it'd be bloody if you just cut your prices when you got 50, 60, 70 backlog in a community. So we think our approach is the right one.

Thank you. And our next question comes from the line of Alan Ratner with Zelman and Associates. Please proceed with your question.

Hey, guys, Happy New Year, good afternoon, thanks for all the detail. I found the -- kind of walking through the examples of the community is helpful that you gave as far as ones where backlog might be a bit larger and taking a different price action there versus the smaller one, do you have any sense, if you look at your kind of 240 or so communities active today, what percentage would fit the bill of a community where the backlog is still quite large and you're focusing maybe a little bit more on delivering that backlog as opposed to generating improved order activity versus communities where you've kind of made the progress working through the backlog or maybe it's a newer community and you are kind of more pedal-to-the-metal trying to generate activity. I'm just curious what that share looks like today versus maybe three months ago when you started this quarter?

Simple math using averages, Alan, is our backlog per community is still more than 30-per-community on average, so some are 50, some are 15, and it's all over the place. So each community rotates through. We'll take the steps at the right time. This isn't a problem, by the way, it's a good thing. If the backlog is solid and at decent margins. But Rob, I don't know if you were looking at it, what was the range on communities where we had taken steps. It wasn't that big in the fourth quarter at all?

No, especially not at the start of the fourth quarter. So start the fourth quarter, the kind of filter the main filter, we're using CFO community as a candidate for a price reduction or not is whether it has more in backlog than remaining to sell. So in those cases, with more backlog than remaining to sell, we take a really hard look at those before we decide to pull the pricing lever because of the impact on backlog. When we started the fourth quarter, about 70% of our communities were not a candidate for a pricing change based on that criteria. But today, that's shifted more to mid-to-high 30% range. So that caused us to be more defensive, I would say, in most of Q4, but with some of our communities now with lower backlog and more remaining to sell, we've got more communities that we're looking at price adjustments to drive additional net sales.

Thank you. And our next question comes from the line of Susan Maklari with Goldman Sachs. Please proceed with your question.

Thank you. Good afternoon. My first question is talking a little bit about the design centers and are you seeing any change there in what people are choosing to put in their homes or any other sort of adjustments in order to reach that affordability?

Well, it's interesting, Susan, you've tracked us for a while, you know, the design center, it's a great consumer laboratory every day for what the consumer values and what they choosing because they are voting with their checkbook and our studio revenue in the fourth quarter deliveries was actually the highest it has been in many years. Not by a big number, it's tweaked up a couple of grand a unit from Q1 to Q4 but it cleared 40,000 a unit. And for the most part, it continues to be value type items. It's not the seasonal items but it's the value items, I need more cabinets, I need this converted to a den or an office, as opposed to a bedroom, I want a bigger covered patio because of the climate where this community is, it's not giving a seventh level of granite, not the second level because I want nicer granite in my home. But the consumer is continuing to spend in the studio.

Okay. Thank you. And then the follow-up question is, thinking about the financing piece of it, I think that you said that the down payments on average are 17% and that you actually saw more cash buyers on a sequential basis in the quarter. Are you seeing that people are preferring to either use cash or just have bigger down payments as opposed to say using floating rate or other sort of alternatives?

Well, I think it's interesting that the down payment, our pricing has been moving up a little bit and the down payment percent has been moving up a little bit as '22 unfolded. I think people like to put more down in order to avoid the mortgage insurance. And if you think about the conventional percentage, we had at 66% and then they put down that much, they can have a much lower mortgage insurance and it helps their -- with their monthly out of pocket. I also mentioned that adjustable rate ticked up, which they did, but it was like from 1% to 6%. So the vast majority of buyers are still taking a fixed rate.

Thank you. And the last question we have time for comes from Jay McCanless from Wedbush. Please proceed with your question.

Hey, Good afternoon and thanks for taking my questions. Could you talk about what your spec count was at the end of the quarter and maybe some notion of where you want to run that in the first quarter?

Well, Jay, I shared in the prepared comments, we're, our WIP right now is about 80% sold and it's at 8,800, so that's roughly 1,700 inventory spread across various stages and that's about where we've always run it historically. So depending on how our sales track and our built-to-order sales and our starts will try to target the 80, 20 going into Q2 and Q3 deliveries.

The other question I had, just thinking about the cadence of quarterly closings for '23, with the orders being down so much this quarter, should we expect some type of gap out in 2Q or 3Q or is there enough homes in backlog to make up for that?

Actually, Jay, I think what we're falling back into a more normal seasonal cycle. We entered the year with a nice backlog that sets us up first half of the year and then the spring selling season will deliver out in second part of Q3 and in Q4, which is what we've typically done around here. Normally, a backlog of 7600 would be a much higher delivery count than we're guiding to, because we still have to get our build times back but as Rob shared, we're starting to see that compress.

And ladies and gentlemen, this does conclude today's question and answer session. And this also concludes today's teleconference. Thank you for your participation, you may now disconnect your lines. Have a great rest of the day.