The full-contact sport where Wall Street's early-'23 relief rally squares off against a quarterly earnings cohort on track to reflect a sharply deteriorating pivot in business conditions gets underway as we speak.

For inflation-watchers, the December '22 CPI arrived this morning on par with expectations – showing a sequential month on month decline of 0.1% and a markedly slower year-on-year growth rate. Chalk one up for the bulls, who're revving for a dovish pitch in the Fed's crusade to crush rising prices. Further, their betting that improvements in reversing inflation will strengthen bond markets and lower borrowing costs to both businesses and households.

Then there are the bellwethers, companies whose operational performance in Q4 lends the clearest view yet of the severity – if not the duration – of challenges to 2023 business results. Their impact on investors and their telltale indication of whether their businesses continue to weaken, show resilience, or regain a positive footing now converge with early-year investment optimism.

Although the rally's still running, stay tuned to when Q4 earnings and Q1 2023-and-beyond guidance unfurls more of a real-world view of America's business outlook as a recession stalks the broad economy, complicating the future of housing.

KB Home, which reported Q4 and full-fiscal-year earnings Wednesday and commented on them with the investment analyst community, stands as a bellwether in homebuilding. The headline KPIs speak to a year of accomplishment – full-year revenues up 16%, EPS up 29%, book value per share up 27%, and return on equity of 24.6%.

KB Home team members can take pride in what they did – especially in supply chain and inflationary circumstances that relentlessly tested their capability and skills at solving hard problems.

Still, given the sub-headline, a fourth-quarter that showed the ways momentum had come undone, and gave a glimpse of the battle that lies ahead in an effort to stem a deteriorating tide, the look forward may turn that pride into a feeling of angst. With a geographic footprint heavy on Western market exposure, and a build-to-order business model that - in volatile economic, pricing, construction cycle, and interest rate circumstances – tests buyers' intestinal fortitude, pressure mounts for both backlog conversions and this year's selling season.

Wolfe Research homebuilder and building products equity research team comments:

Despite the lower Can Rate and KBH turning on the incentive throttle as we enter the Spring Selling Season, fundamentals remain highly challenging as the company still expects F1Q Orders to decline -50% to -60% YoY (1Q QTD -75% YoY first 5 weeks) and the company did not make any prognostication whether F1Q GM would mark the low point for the year." – Truman Patterson, CFA, Wolfe Research

Here, a seven-subject curation of prepared remarks and a few of the Q&A exchanges the KB Home executive strategy team had with investment analysts can help shed light on what other builders – depending on their geographical markets, customer segment focus, price positioning, and operational models – may also face as the 2023 market takes shape in the coming weeks. The source for the quotations are from a transcript prepared by Seeking Alpha [gated].

The Guidance on Q1 2023:

Jeff Mezger, Chairman, President, and CEO

By the end of the first quarter, we expect to be taking steps in most of our communities, as we will have delivered more of our existing backlog. Through the first five weeks of our '23 first quarter, a slower demand period, our net orders are down 72% relative to the comparable prior year period. To support our '23 projected revenue range and given the actions we are taking, we are targeting net orders in the first quarter to be down 50% -- between 50% and 60% -- year-over-year versus an incredibly strong comparison in the prior period. This translates into net orders of approximately 1,900 at the midpoint of this range.

Land Impairment: $21.5 Million

Jeff Kaminsky, Executive VP, Chief Financial Officer

The current quarter inventory related charges included $6.4 million of abandonments relating to 36 projects and $21.5 million of impairments relating to three communities out of our year end portfolio of 246 active selling communities. We anticipate our 2023 first quarter homebuilding operating income margin, excluding the impact of any inventory related charges will be approximately 9.5% to 10.5%.

Owned Lot Vintage ... 20% Contracted Post 2020

Jeff Mezger, Chairman, President, CEO

Our lot position stands at roughly 69,000 lots owned or controlled, a reduction of over 20% year-over-year. Of these, 48,000 are owned and only about 17,300 are finished, with 9,400 having a house under construction, including models. We continue to balance our development phasing with our start space to limit building up a large inventory of finished lots. Our focus is on developing lots on adjusted time basis, creating smaller phases and reducing our cash outlay.

We are also pursuing savings on development costs, as development slows across the industry. Relative to the vintage of our own lots, we contracted approximately 80% of these lots in 2020 or prior before the run-up in both land and average selling prices.

Sales, Sales Sales: When To Hold, and When to ...

Rob McGibney, Executive VP, Chief Operating Officer

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 buy-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 without a significant impact to backlog values.

Holding The Backlog

Jeff Mezger, Chairman, President & CEO

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 [Kaminsky] 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.

Value Engineering, Lower Costs, Faster Build-Times

Rob McGibney, Executive VP, Chief Operating Officer

We are also value engineering our elevations and interiors along with other cost reduction initiatives to ultimately offer a lower base price to our customers. Our initiatives are driving our direct costs down and we've achieved a $10,000 reduction in the average cost of a homes started in November relative to one started in August. Our teams are currently negotiating more significant cost reductions, particularly in the front end of the construction stages.

Build times are coming down in addition to costs. Overall build times improved sequentially by 14 days, and it was bifurcated between the front end and back-end, we experienced a 21 day improvement from sales to frame, but extensions of two days from frame to drywall and five days from drywall to final. While supply chain issues persisted in certain areas, which I will address in a moment, the five day extension from the drywall stage to completion was less about the chronic supply chain issues that have plagued our industry and more about the overall volume of production in our markets combined with ongoing municipal delays and issues related to the availability of electrical infrastructure material as all builders push to complete homes by year-end.

The 21 day improvement from sale to frame is a better reflection of the current market, given the lower volume of homes in production at this stage.

Where Are Cost And ASP Savings Coming From?

Rob McGibney, Executive VP, Chief Operating Officer

I mentioned we were down $10,000 a house from our August start to our November start. 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.