Jeffrey Mezger says he loves a good challenge.


As the new chief executive of KB Home he's got more than a few the declining housing market, newly tightened lending standards prompted by the subprime meltdown and a tarnished corporate image.


"I've heard that where there are great challenges, there are also opportunities," said Mezger, who was interviewed in the boardroom of the company's Westwood headquarters. "We have plenty of the former, so hopefully that will lead to plenty of the latter."


After 13 years with KB Home, Mezger took the helm of the nation's fifth-largest home builder nearly six months ago when his predecessor and mentor, Bruce Karatz, retired amid a scandal over backdated stock options.


Since then, the Los Angeles company reported its first quarterly loss in more than five years though it rebounded slightly in the more recent quarter and has seen its stock of unsold homes remain at higher levels as Southern California and the nation remained mired in a housing slump.


But Mezger, who has 30 years in the industry, has a reputation of being the driving force behind KB's successful strategy of serving customized homes to the masses. And he hasn't been afraid to act.


He's shaken up the company's board, appointing Hilton Hotel Chief Executive Stephen Bollenbach as KB's first non-executive chairman. And while he's put the brakes on expansions into new geographic areas a hallmark of his tenure as chief operating officer during the housing boom he has pushed ahead with the company's higher end co-branded homes with homemaking maven Martha Stewart.


Still, with the company's stock trading at about $43 lately, far off its 52-week high of nearly $62, it's unclear how much time Wall Street will give the 51-year-old chief executive to turn things around.


"Jeff is still in a good situation," said Greg Gieber, an analyst with A.G. Edwards. "Any problems can still be blamed on the previous guy. But not for much longer."

Combating the Crunch

Mezger, a Chicago native, was tapped by the KB board in November to replace Karatz after the 61-year-old chief executive was determined by an internal investigation to have personally chosen the dates of options granted to him over a seven year period.


The announcement noted Mezger had no role in the scandal. The board chose a known quantity with a strong reputation not only in operations, but in strategic thinking.


Under his tenure as the chief operating office since 1999, KB pushed a strategy called KBNxt, which turned the company's reputation as a builder of inexpensive, entry-level homes on its head. Instead, KB focused more on higher quality homes that could be customized from a wide list of options.


"We're far more focused on the customer than we were 20 years ago," said Mezger, who noted that customers tend to spend about $35,000 per home on custom upgrades.


These upgrades account for about 11 percent of the company's annual revenues, something that has caught analysts' attention and favor. "Instead of offering five different types of tile for your kitchen, KB offers 25," Gieber said. "Think of going to buy a BMW and you have 1,500 options available. It's very similar to that."


At the same time, Mezger pushed to expand the company's number of national markets to 34 from 17. However, since he has taken over, the new chief executive has temporarily put a halt to expansion plans. He's hunkering down and attempting to build share in existing markets, even those where housing sales have slowed.


"We feel that the tougher markets are our sweet spots. For now, we're going to focus on those markets instead of looking at new ones," he said.


Another strategy is to move ahead with its so far successful collaboration with Martha Stewart Living Omnimedia Inc. in which KB builds homes with traditional touches such as wainscoting and front porches. The company already has two of the developments in Southern California and is adding another in Stockton by the end of the year.


There are 10 Martha Stewart branded subdivisions nationwide totaling 2,300 homes, which have pulled in as much as 10 times the regular traffic on their grand openings and helped KB's larger profile.


"The co-branding deal with Martha Stewart has definitely helped sales at our surrounding communities," Mezger said.


And at least publicly, the new chief executive said he isn't worried about the collapse of the subprime lending industry, which has seen big names such as Santa Monica-based Fremont General Corp. exit the business and New Century Financial Corp. file for bankruptcy even though 13 percent of the homes KB sold in 2006 were financed by subprime mortgages.


"Lenders will find a way to help people buy homes. The market will correct. It always does. Back in 1981, when rates were at 17 percent, I bought my first home with one of the most exotic loans I've ever heard of," Mezger said, with a laugh.


Mezger said he also sees loans sponsored by the U.S. Department of Veterans Affairs and the Federal Housing Authority replacing the loans that borrowers with poor credit had been receiving from subprime lenders.


Also, KB Home in 2005 struck a strategic relationship with Countrywide Financial Corp., the Calabasas lender that is the nation's largest. The partnership puts a Countrywide loan representative in every new KB community so loans can be speedily approved.


Given some recent lending figures announced by Countrywide, it seems a prescient move. Despite lending standards that are tightening as a result of the subprime failures, Countrywide reported an 11 percent hike in overall lending to $40 billion in April.


Building confidence

But if Mezger has taken a relaxed attitude toward the subprime meltdown, that's not the case in his approach toward restoring investor confidence in the company's corporate governance.


After the exit of Karatz, a prot & #233;g & #233; of company co-founder Eli Broad who was respected for growing the business, Mezger last month named Hilton's Bollenbach KB's first non-executive chairman.


Bollenbach, who joined Hilton more than a decade ago, has real financial bonafides, having served as chief financial officer for Walt Disney Co. and as a member of the boards of Harrah's Entertainment Group and Time Warner Inc.


Mezger said that he expects Bollenbach will provide strong leadership, a keen knowledge of corporate practices and acute financial oversight.


"Everyone I spoke to gave gleaming reviews of Stephen," Mezger said. "He has extensive experience, he runs a very tight ship at Hilton and he's right down the street."


Mezger may need the help. In the first quarter ended Feb. 28, KB announced that home deliveries were off 16 percent and orders had decreased 12 percent. Among the bright spots, the company's cancellation rate had dropped, though that may only reflect a smaller pool of highly qualified buyers.


"There's no doubt about it we're in the middle of a tough market," Mezger mused. "But somewhere, someone is having a baby or someone's child is set to start school and we've found those are the catalysts for home buying. We just have to stand pat."

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