KB Home (KBH) 2009 Q1 法說會逐字稿

Good day everyone and welcome to KB Home's first quarter earnings conference call. As a reminder, today's conference call is being recorded and webcast on KB Home's website at KBHome.com. A recording will also be available via telephone replay until midnight April 6th, 2009. You can access this recording by dialing 719-457-0820 or 888-203-1112, and entering the replay passcode of 7081455.

KB Home's discussion today may include certain predictions and other forward-looking statements. These statements may cover market or economic conditions, KB Home's business and prospects, its future financial and operational performance, and/or future actions or strategies and their expected results. They are based on managements current expectations and projections about future events and business conditions but are not guarantees of future performance. Due to a number of risks, assumption, uncertainties and events outside its control, KB Home's actual results could differ materially from those expressed, my apologies, from those expressed and/or implied by the forward-looking statements. Many of these risk factors are identified in the Company's periodic reports and other filings with the SEC, which the Company urges you to read with care.

For opening remarks and introductions, I would now like to turn the call over to KB Home's President and Chief Executive Officer, Mr. Jeffrey Mezger. Please go ahead, sir.

Thank you, Darrel. Good morning, and thank you for joining us for a review of our results from the first quarter of 2009. With me this morning are Bill Hollinger, our Senior Vice President and Chief Accounting Officer and Kelly Masuda, our Senior Vice President and Treasurer.

This morning, I'd like to share with you my thoughts on the current housing market, our net order performance, and our progress toward restoring profitability. I will also talk about how KB Home's strategy is different than others in our industry and how we are executing on our strategy. After Bill provides you with the financial update, I will have some closing comments about the status of our roll out of the Open Series array of new home designs where our initial buyer response has been encouraging.

Since our last earnings call in January, we have continued to experience a difficult national housing environment, still burdened by an oversupply of homes and declining sales prices. The recessionary economic environment, punctuated by rising unemployment and falling consumer confidence has only added to these difficulties. Yet, in the middle of these ongoing economic challenges, we are seeing some signs that is the housing market is functioning according to fundamental economic principles. The median home sale price is now less relative to income levels than it has been at any time in the past 40 years. In addition to these low price, mortgage rates have fallen to all-time lows increasing affordability even further.

As a result of this combination of low prices and low interest rates, buyers have become more active. Data released earlier this week from the National Association of Realtors shows that February existing home sales bounced sharply off their lows. Resale inventory ticked up slightly as foreclosures continued adding to the housing supply. But the current inventory of unsold homes should begin clearing if sales rates continue their current trend.

While the median resale price in February declined 15% year-over-year, the NAR report reflects that sales prices stabilized sequentially from January levels, an event that has not happened in quite some time. While one month does not establish a sustainable trend, these early indicators are encouraging. And the federal Government has made it clear that it remains committed to reducing foreclosures, keeping mortgage rates low, and ensuring that homes remain affordable. We see a great deal of buyer awareness about the $8,000 federal tax credit for qualified first-time home buyers in all our markets. But at this point we do not believe the tax credit alone is having a material impact on traffic or sales. In California, however, the additional $10,000 tax credit for buyers of new homes has created a significant $18,000 total combined tax credit, which we believe is helping contribute to increased sales activity in the state.

Lastly, we are hopeful that the unprecedented amount of federal stimulus money being injected into the economy will have its intended effect of creating jobs and building consumer confidence which are prerequisites for housing market recovery. All that being said, I want to repeat what I have shared over the past few earnings calls; we are not relying on outside intervention for help and our strategy is not based on unrealistic assumption about the future of the housing market. Instead, we continue to identify and implement actions that enable us to operate successfully no matter the economic climate.

We have consistently focused on a set of core strategic objectives that include; generating cash and strengthening our balance sheet, developing innovative new products that help us to compete with resales and foreclosures, restoring profitability by executing our KBnxt business model, reducing overhead, and lowering our cost to build, and positioning ourselves to be opportunistic when the housing market stabilizes. While it is still early, our progress toward these objectives confirms that we are on the right track.

Turning to first quarter net orders, our 26% year-over-year increase is certainly a positive development. This is a first time in 13 quarters that our net orders were up on a year-over-year basis. These results were due in large part to a combination of product positioning that enabled us to compete effectively with resales and foreclosures, favorable buyer response to Open Series array of new home designs and the intensity with which our sales teams executed on our sales strategy. We achieved this growth in net orders despite the fact that our active community count was about half of what it was a year ago. Our ability to generate increased sales on a smaller community count is a very encouraging sign as we continue transitioning communities to the new product lines.

We will expand the number of active communities in the second half of the year as more transformed communities reopen. We are mindful that, even in this difficult economic environment, the fundamental desire for home ownership has not diminished. If buyers find the right home in the right location at a price they can afford, they will make the purchase decision. And while our buyers are shopping resales, they're also increasingly responding to the overall value position that a competitively priced build to order KB Home offers.

As I have noted on previous calls and consistent with the NAR data released this week, we believe first-time buyers represent the most attractive segment of the market. In that they do not have to sale a home before purchasing and can access readily available FHA and VA financing. Our strategy of targeting these buyers continues to generate results. Not only did our net orders grow this quarter, we also increased the number of homes delivered to first-time buyers to 70% of our deliveries. This is a significant increase from 53% in the first quarter of 2008 and 65% in the fourth quarter of 2008.

While we expect our second quarter '09 net orders to fall below their year earlier level, primarily due to a more difficult comparison against 2008, we do expect sequential growth in net orders in the second quarter and through the remainder of 2009. We believe we can sustain increased sales even with a lower community count, due to higher absorption rates per community. We also expect our year-over-year net order comparisons to be positive for both the third and fourth quarters. Our backlog increased during the first quarter, as net orders exceeded the number of homes we delivered by approximately 400 units. Looking out over the next two quarters, our goal is to continue to build our backlog as net orders should outpace deliveries.

Of course, our overwriting objective is to position ourselves to restore profitability and a growing number of performance indicators confirm that we are on the right strategic path. While we are not there yet, we are approaching break even. Once we achieve break even, we can advance toward our goal of turning sustainable net profits. Our SG&A expenditures were down more than 50% year-over-year and we constantly look to identify additional opportunities to reduce overhead further. While SG&A as a percentage of revenue increased during the quarter, due to the sharp decrease in our revenue, we believe we have both the right frame work and urgency to drive additional cost reductions over the balance of 2009.

Our KBnxt operation business model will continue to be the centerpiece of our cost reduction efforts. By continually enhancing our execution of the model and implementing our new product strategy, we are developing a long-term capability to build and deliver homes profitably at much lower price points. Our objective is to ensure that KB Home will be the low cost producer of quality homes for the first time, first move up, and active adult buyers. We are in an extremely competitive housing market where buyers face an abundance of inventory from resales, foreclosures and other builders. That is why we believe it is essential to relentlessly differentiate ourselves in the marketplace, and why we are aggressively developing and promoting KB Home's product and brand attributes to potential home buyers.

Our most important differentiator is the build to order experience we offer. That experience becomes especially attractive to buyers when they compare a KB home to a resale or foreclosure. A home purchase is a deeply personal decision and the aspiration of buyers is for their new home to be their dream home. By offering choice on location and floor plan and then on the options available at our KB Home studios, we create a personalized home buying experience that is simply not available elsewhere. While other builders have been de-emphasizing choice and closing their studios, we are offering our buyers more choices to customize their homes and our studio sales have been consistently strong.

And not only does our build to order experience deliver high customer satisfaction, the homes we build meet a high standard of quality. With the NAHB research center this week reaffirming our position as the only builder to earn the rigorous National Housing Quality Certified Builder designation for our nationwide operations. We also associate with the KB Home brand with some of the worlds leading brands, such as Disney and Martha Stewart. Our latest collaboration with Disney to create personalized Disney themed bedroom designs, which are exclusively available at every KB Home community, is just one example of how we differentiate ourselves in a competitive market.

As I have asserted for some time now, we believe buyers want their new home to be environmentally friendly and energy efficient. That is why we have made a long standing commitment to ENERGY STAR and to educating buyers about how energy efficient, environmentally friendly homes can save them money on energy costs, while promoting sustainability. We were recently recognized by the US Environmental Protection Agency as the only national home builder honored with its 2009 excellence in ENERGY STAR promotion award. Beginning this year, all of our new home communities are fully ENERGY STAR qualified, another differentiator in the marketplace. Homes that is are fully ENERGY STAR qualified have been shown to be as much as 45% more energy efficient than homes built as recently as a decade ago, saving our home buyers money on energy costs for years to come.

I believe that our commitment to innovation, and continuous improvement is a big reason why we were honored on Fortune Magazines 2009 list of the world's most admired companies as the number one home builder. It is second year in a row we topped the Fortune list and the third time in four years. These rankings are based on voting by our peers in the home building industry and the financial analysts community and we are proud to join other industry leaders such as Google, Nike, IBM and Wal-Mart. This recognition reflects the dedication and commitment of the entire KB Home team and I would like to thank them for their hard work and congratulate them on their performance during the quarter.

So, before I turn it over to Bill, let me recap our position. To begin with, despite the challenging economic environment, we were able to generate positive sales momentum and look to continue sequential net order growth. This growth should also enable us to continue to increase our backlog over the next few quarters. We are positioning ourselves to restore profitability by keeping pressure on overhead, driving a disciplined execution of our KBnxt operational business model.

We continue to focus on generating cash and strengthening our balance sheet, and maintain our commitment to managing to positive cash flow from operations for the full year of 2009. And we are aggressively differentiating KB Home in the market versus resales, foreclosures, and other builders, a strategy that we believe is already paying dividends. There's much more work to do, but I believe we have energy and momentum. We are well positioned to make the most of today's housing market, and seize new opportunities as they arise.

Now, I will turn it over to Bill for a more detailed recap of our first quarter. Bill?

Thank you, Jeff and good morning, everyone. Our first quarter financial results demonstrated the progress we have made toward restoring the profitability of our operations through sound strategy and strong execution. Compared to a year ago, we significantly reduced asset valuation charges, improved our gross profit margin and lowered our overhead costs. As a result, we reduced our net loss considerably in the quarter despite delivering fewer homes.

For the first quarter of 2009, we reported a net loss of $58 million or $0.75 per diluted share compared to a net loss of $268 million or $3.40 per diluted share a year ago. Our first quarter results included pretax noncash charges of $32 million for inventory and joint venture impairments and land option contract abandonments. That is an 86% decrease from $223 million in similar charges last year. Our inventory impairment charges decreased substantially from both the year earlier quarter and from the fourth quarter of 2008, despite our overall average selling price dropping 15% year-over-year and 9% from the fourth quarter of 2008. Our impairments are more closely tied to the prices on orders we are taking than they are on current deliveries.

For the most part, we experienced no significant decline in prices on orders in the first quarter versus the level we had anticipated in our impairment analysis in the fourth quarter. As a result, we did not have sizable impairments this quarter. However, while our impairments have dropped considerably, we recognize that if market conditions deteriorate from here, it is possible we will have additional impairment charges in the future. Adjusting for the asset valuation charges, our first quarter pretax loss would have been $27 million versus $44 million a year ago. That is a 38% improvement year-over-year. With similar adjustments, our current quarter net loss would have been $16 million or $0.21 per diluted share compared to $27 million or $0.35 per diluted share in the first quarter of 2008.

Home building revenues in the first quarter totaled $306 million, down 61% from a year ago, primarily due to lower housing revenues. Housing revenues for the quarter were $304 million, down 58% year-over-year. The result of a 51% decrease in new homes delivered and a 15% decline in our average selling price. The reduction in homes delivered was primarily driven by a 46% decline in our community count. The lower average selling price reflected both the state of our housing markets, which continue to absorb downward pressure on prices, and our continued roll out of more affordable value engineered homes designed to attract today's cost conscious first-time buyers.

Our housing gross profit margin improved to 4.9% in the first quarter up 11.1 percentage points from a negative 6.2% a year ago. If we exclude inventory-related valuation charges from both periods, this margin increased by 400 basis points to 13.0%. Furthermore, our gross profit margin was nearly flat with the fourth quarter of 2008 despite a 9% decline in average selling price. We are pleased and encouraged by our progress to date in improving our housing gross profit margin, particularly with our average selling price having decreased.

Some of the year-over-year gross profit margin improvement was due to reductions in our cost to build homes. Our home building business is now seeing real benefits from the execution of our strategic initiatives to value engineer our product, reduce direct construction costs and increase operating efficiencies, all of which are shaped by the disciplines of our KBnxt operational business model as Jeff mentioned earlier. Our year-over-year improved gross profit margin also reflected the benefit of impairments taken in prior quarters.

Selling, general and administrative expenses totaled $61 million in the first quarter, down 52% from a year earlier period. Significant savings in the first quarter came out of marketing expenses, salaries and other payroll-related expenses and compensation plans. We have curbed our advertising print media by shifting even more to the Internet, an outlet we have found very effective in reaching our buyers. Our savings in the payroll area reflected our dramatically reduced head count, which was driven largely by division consolidations.

During the quarter we made additional consolidations in Arizona, Florida, North Carolina, and Texas. The savings realized from these consolidations should become more apparent as the year unfolds. Meanwhile, overhead cost reductions remain a top priority. We will continue to scrutinize expenditures, challenge our organizational structure and look for new opportunities to achieve further cost savings, but always with an eye toward preserving our ability to respond quickly when the market stabilizes.

Our SG&A expense ratio was elevated in the first quarter even with the major steps we have taken to streamline our organizational structure. As a percent of housing revenues, the SG&A expenses were 20.1% in the quarter versus 17.6% a year ago, primarily due to the sharp decrease in our housing revenues. While we will continue to take actions to reduce this percentage, it will run on the high side relative to historical levels due to our conscious choice to maintain a strategic platform for growth in markets that have generated delivery volumes that are more than triple our current levels.

The combined effects of our gross profits and SG&A expenses resulted in our home building business generating an operating loss of $46 million in the first quarter. That included charges of $25 million for inventory impairments and land option contract abandonments which are reflected in cost of sales. Most of these impairments occurred in our west coast and southwest regions where selling prices fell. By comparisons, our business generated an operating loss of $249 million a year ago, including $188 million of similar valuation charges. Adjusting for these charges, our home building business generated a first quarter operating loss of $22 million in 2009 and $61 million in 2008.

Now let's turn to a review of our balance sheet. Our focus on strengthening and enhancing our financial position as we navigate the current downturn has provided stability to our Company. We ended the first quarter with cash and cash equivalents of $1.1 billion and liquidity of approximately $1.6 billion. These amounts reflect the impact of a $221 million federal income tax refund we received and the maturity of our $200 million senior subordinated notes. With the tax refund and reduction in our inventories, we generated $105 million in cash flow from operations in the first quarter.

Our substantial liquidity should provide valuable financial flexibility going forward. For the next couple of quarters, we expect to use cash flow from operations to build our work in process inventories as well as support our transition to new valued engineered product. Our ability to generate positive cash flows will also be affected by overall market conditions and behavior of housing markets as the Government stimulates the economy and housing in particular. As with past years, we expect operating cash flow to turn positive again in the fourth quarter. Overall, we currently anticipate that we will generate positive cash flows from operations for the full year, ending 2009 with more than $1.1 billion in cash and cash equivalents on the balance sheet. A healthy balance sheet will be essential to capitalizing quickly on new opportunities so our focus on preserving or generating cash will remain a key priority.

Our inventories totaled $2 billion at the end of the quarter, down from $2.9 billion a year ago. We continue to pair down inventories in the first quarter exclusive of impairments and abandonments. Our lot count was 44,300 at the end of the first quarter, down 6% from year-end 2008, and 26% from last year's quarter end. As of February 28th, 2009, we own 77% of our total lots. About 34,300 lots and controlled 23% or approximately 10,000 lots via land option contracts. The total lot count represented about a four-year supply based on our trailing 12 month deliveries.

Our current inventory supply is one of the lowest in the industry and there will be further reductions as we continue to align our inventory holdings with our forecast of homes to be delivered. Our land acquisition spending continues to be limited as we remain selective and disciplined in our land investments in order to preserve cash and wait for the right opportunities. We currently expect to spend less than $400 million on land purchases and land development in 2009. This is about $150 million less than 2008. Similar to last year, we will continue to review and adjust our land investments throughout the year based on market conditions.

We ended the quarter with 2,518 homes in production, a figure that is down 86% from the peak in the second quarter of 2006 and 46% below the first quarter of 2008. Some 618 of these homes, about 25% remain unsold. We also had approximately 282 finished unsold homes in inventory at the end of the first quarter. Our deferred tax assets of $881 million at February 28th, 2009 were almost entirely offset by a valuation allowance. We are taking steps to preserve the long-term value of our net operating losses under section 382 of the Internal Revenue code. We have proposed a protective amendment to our restated certificate of incorporation and a successor rights plan, both of which are up for stockholder vote at the annual meeting scheduled for April 2nd, 2009.

Our balance sheet at the end of the quarter was $1.7 billion down $204 million from year-end 2008 and $424 million from a year ago. Our debt decreased in the first quarter with the maturity of our $200 million of senor subordinated notes on December 15th, 2008. We will no cash borrowings outstanding under our unsecure credit facility at the end of the first quarter and our next debt maturity is not until August 2011. The remaining $1.6 billion of senior notes on our balance sheet are well laddered with maturities extending through 2018.

Our debt, net of cash, totaled $606 million at the end of the first quarter. That is down $85 million from year-end 2008 and down $239 million from last year's first quarter. Our net debt to total capital ratio was 44% at the end of the quarter compared to 45% at year-end 2008. Our liquidity at quarter end totaled $1.6 billion including $1.1 billion of cash and cash equivalents, plus the amount of credit available under our bank revolver. This reflects the capacity under revolving credit facility being reduced from $800 million to $650 million due to our consolidated tangible net worth falling below $800 million as of February 28th, 2009.

Nonetheless, we believe we have sufficient liquidity and financial flexibility to navigate the current environment. As we anticipate generating positive cash flows from operations with no additional debt maturities in 2009, we do not expect to borrow against our bank revolving credit agreement. We ended the first quarter in compliance with all covenants associated with our revolving credit facility.

With regard to unconsolidated joint ventures, we reduced our count by one in the quarter. We had approximately $175 million invested in 24 joint ventures at quarter end. That is down 38% from $281 million at the end of last year's first quarter and slightly below the $178 million at year-end 2008. The debt of our unconsolidated joint ventures totaled $859 million at February 28th, 2009, representing a slight decrease from year-end 2008, and a 43% decline from a year ago.

While our unconsolidated joint venture numbers did not change significantly from year end 2008, we continue to make every reasonable effort to reduce both our joint venture investments and their individual debt levels. As joint ventures typically have by their nature added complexity because of the involvement in other [parties] that often have different objectives, it is taking time to work through these arrangements. Nevertheless, we are unrelenting and expect to show measurable progress in the next few quarters as we continue to focus on negotiations with banks and partners and look for opportunistic buy outs.

Looking at our business more broadly, we expect to deliver reduced volumes of new homes on a year-over-year basis throughout 2009. However as we move beyond 2009, our deliveries may begin to improve if current positive sales and backlog trends persist. We continue to monitor market conditions carefully, and we are ready to adjust community counts if market conditions warrant it. In the meantime our highest priorities remain generating positive operating cash flows, maintaining a strong financial position, restoring our profitability, and making prudent investments that will allow us to capitalize on a market turn when it comes.

We made progress on each of these goals during the quarter, and our efforts to date have produced better financial results. We gained momentum from the reductions in impairments and we made headway in reducing our cost structure and improving our gross profit margins. All three contributed to a significant reduction in our net loss for the quarter. We are determined to improve on that performance as we move through the year.

While we cannot predict when the housing markets will rebound, we can assure you that we will work long and hard to effectively execute on our strategies to maximize our financial and operating results no matter what conditions we face. As Jeff noted, we have more work ahead of us, but with the improvement in our financial metrics in the first quarter including the 26% increase in our net orders, which represented the first increase in 13 quarters and what we hope will be a growing backlog, we are all energized to accomplish more and are prepared for the opportunities yet to come.

Let me turn the call back to Jeff who will provide some closing comments.

Thanks, Bill. Before we begin taking your questions, I want to give you an update on our progress with the Open Series, our new array of value engineered home designs we are introducing across the country.

At the end of February we had approximately 30 communities offering the Open Series. In every community where we transitioned to the new product line, sales of the Open Series exceeded previous sales rates often by a significant order of magnitude. Results have been consistent wherever we introduced the new product whether in Southern Cal, Tucson, Houston, Orlando, North Carolina, or the other regions where we have launched. The new home designs contributed 20% of our build to order sales for the month of February and that percentage has been steadily rising in the opening weeks of our second quarter. This performance confirms our belief that our new product is very compelling to home buyers.

By designing the Open Series to compete directly with resales and foreclosures we have given home buyers a quality, new build to order alternative to depreciated homes. They're responding to the affordability, energy efficiency, smart design, flexibility and choice offered by the Open Series. Because of smart design and value engineering, we have dramatically lowered our cost to build and even while pricing these homes more competitively, we have still improved our gross margin. In addition, we build the Open Series much faster enabling us to convert our backlog to revenue more quickly. Our roll out of the Open Series nationwide remains on schedule, and we continue to believe that deliveries of the new product should constitute approximately 50% of all deliveries by the end of 2009.

As I have said before, the worst decision a builder could make in the current economic climate is to keep building what they have built in the past and stay purely defensive while waiting for the market to rebound. Instead we believe homes must change with the times. We have developed a differentiated product that is the foundation of our differentiated strategy. It is not simply about reducing prices. It is about increasing value to the consumer, providing them innovative features, and a build to order purchase experience that they cannot find elsewhere. That is the philosophy behind the Open Series, and while we are still early in the roll out, we are all very excited about the early response from our home buyers.

Thank you, and now, Darrell let's open up the lines to questions.

All right, thank you, sir. (Operator Instructions). We will take as many questions as time permits. We ask you limit yourself to one question and one follow up question only. (Operator Instructions). We will take our first question, we have Carl Reichardt with Wachovia Securities.

Good morning, guys. How are you?

Good.

Hope you can hear me. Real quick, Jeff if -- congratulations on the orders. And I am curious if you look at your deliveries this quarter and X out your corporate allocation of expense, do you have a sense either on a community level or a per home level how many homes you are delivering that are actually operating profitable? And how would you think about that for the rest of the year, what percentage of homes can you deliver that are actually making money?

Carl, I don't know how I can answer the question because we don't look at it per house. We definitely have financial statements per community. And we first look at it from a cash flow point of view and convert once we are positive cash how do we make profits as well. And our goal over the year is to continue to increase our revenue at the top line, hopefully improve margins and hopefully lower our SG&A along the way. We don't break it out per home.

Okay. Great, thanks, Jeff. I appreciate that, I will get back in queue. Thanks.

We'll take our next question is from Dennis McGill with Zelman and Associates.

Good morning, guys. And thanks for the info. Jeff I was hoping you can go to on the Open Series particularly what you are seeing in California because I would think that would be an area where, with foreclosures so high you have an opportunity to take some share, but orders were down there. So I am wondering if you can put a little color behind that?

Orders, Dennis were down in large for part because our community count was down. AS we have shared on previous calls, some of our first introductions of the Open Series actually occurred in Southern California, and actually have sold as well or better than any other part of the country. I've had the opportunity last week to visit one of our communities in the middle of the week, and at that time there was a lot of traffic, there was a lot of interest. There was actually a sale occurring while I was there. So, it was a very exciting experience.

What did you say that, what is the absolute level of communities for the first quarter relative to the number from last year? I think you had 224 last year --

Average for the quarter were 120 which is down 46% from 224 a year ago.

So walk me through how you go from 260 communities in the fourth quarter to 120 in the first quarter, when you're opening communities related to the Open Series; right?

Many of those communities, Dennis just opened at the end of February. So we are, the average for the quarter was low. But we always have a spike in community count at the end of the year as we deliver through and close out communities. So, if you go back over history our highest count is always in fourth quarter as we transition through closings on the old and we start to introduce the new. As I have shared ton last few calls we shut down many communities and are retooling to this new product and they're now coming on line. And you will continue to see our community count grow as we work through the rest of '09.

We take our next question from Dan Oppenheim with Credit Suisse.

Thanks very much. Was wondering if you can talk about the margins on the Open Series, if you were to build those on newly purchased land opposed to land you already had there in terms of retooling, what margins would you targeting on that versus margins on traditional communities?

That's a great question, Dan. We are not, I am not aware of any Open Series that we have opened on new acquisition of lots because we still don't think it's the right time to acquire more lots. Going forward, we would underwrite any acquisitions pretty consistently with a margin at 20 or above in our format and more importantly an IRR at 30 above. So we are conservative on the go forward acquisitions. But the beauty of the Open Series because of the cost we build it for, it will allow us to acquire lots at an acceptable margin in return that we may not have previously been able to.

Okay. Thanks. And just wondering about early on you talked about the sequential increase, you're saying the NAR pricing there. Given what you are saying in terms of the goals for the orders and cash flow, should we assume that your strategy is still going to be focused on the orders and we shall not expect you to be a price leader in the market here?

I don't know, Dan, that we, we observed increased sales prices. We were sequentially talking about our sales pace, that we think we can grow sales in Q2 over Q1 and sequentially.

Right. You just mentioned the NAR stats. I want to make sure you were talking about those as an aside opposed to your strategy in terms of pushing that, your strategy will be to continue to push volume; right?

Yes, the balance of top line to overhead to margin like we have been doing for years. And our primary priorities are to continue to strengthen our balance sheet and restore profitability. So we had will be attacking on both side. I don't expect pricing to go up through the year.

Okay thanks very much.

We'll take our next question from Michael Rehaut with JPMorgan.

Thanks. Good morning, everyone.

Morning, Michael.

First question just on trying to get a little more granularity on the orders. And looking at the different segments that you report you had a lot of strength coming out of the central region whereas the West coast was still down 15%, Southwest and Southeast were up but not on the overall corporate average numbers. So I was wondering if you can walk through perhaps if it was the Open Series communities that really affected relative performance on a regional basis? And perhaps you can give us some color in terms of pockets of relative strength or weakness across our different major markets?

Sure, Michael. I are will take a stab at that because there's a lot to your question. In central specifically, our Houston market in particular is performing well. We have introduced new product in several communities in Houston and it was a big driver in the year-over-year comp for the central region. If you go to a national perspective, as we shared on the call we compete with resales. The only markets where resales, we feel are in balance -- and balance for us is a six month supply, would be Southern Cal and Denver. Every other market we are in continues to have excess inventory position on the resale front.

So, my color overall would be that the majority of the markets are still challenged. And the Open Series as we roll it out is working well because we are competing with foreclosures. I think in a quarterly basis, the community count does drive some of the comp, where we have opened the Open Series in California it is working extremely well and we have more on the boards to open in the future. So I wouldn't, I wouldn't jump to one region it is working better than others. We just have to get it opened more broad based across our Company.

Okay. I appreciate that, Jeff. And just as a follow up, I guess, the community count, where do you see that getting up to by the year? And I am sorry, I just one quick follow up after that.

Yes, again we had 120 in the first quarter on average for the year, we expect about 150, with community counts a lot of that growth coming in the second half of the year.

Okay. The second question really just on pricing. And you had mentioned before that you don't see pricing strengthening throughout the year and that overall, as you said in your prepared comments you don't expect a material improvement in the housing markets. But, what we have observed over the last couple of years is that when one Company kind of puts a stake in the ground and really resets their pricing and what you are doing is much more structural than that with the Open communities.

But it takes a quarter or some times two quarters for other builders to react to that and try to get orders and traffic back in their backyard. So I was just wondering if you are starting to see that in the regions where the communes have been open for a couple of months? And if you have the ability to, to further lower price and costs, a couple of quarters from now, in reaction to the competition making their moves?

Michael, as I said in the comment, we are focused on competing with foreclosures and resales. It is a much bigger market. If you look at this week's data, there's 4.7 million resales annualized and 330,000 new home sales annualized. So your market pressures will come from resale not necessarily the new home builder. So I -- every builder has a strategy. We think ours is different. And we are setting our price to compete with what we feel is the true competition, resales and foreclosures.

We are seeing markets like Southern Cal where resales are picking up and turning and price is stabilize. So it could be that you have a floor on pricing in Southern Cal, if this trend continues and we are priced right where we want to be relative to that floor. Past that any pricing pressure we see it is going to based on resale inventory in that market.

But I would say, Mike, what we said in the opening remarks it is encouraging that although our pricing is down 15% year-over-year, our gross margin is up 400 basis points.

We take our next question from Jim Wilson with JMP Securities.

Thanks. Good morning, guys. So my two questions, first one is we are still on the Open Series. If you're thinking that it could be 50% of your sales by year-end, coming back to the subdivision count, is it going to be, do you think it will be 50% of your subdivision count also by year end or more or less than that?

The comment was tied to the delivery site, Jim.

Okay.

But we are seeing higher absorption rates out of this product than in our previous product. And as you know, out here in many of the states in the West, you don't have the ability to, to flat out change product like we are trying to. So it is taking time. And as we work through and open more communities, we are getting higher sales rates, and I wouldn't say, I wouldn't jump to half our communities will be Open Series at the end of the year.

Okay. Fair enough. And then the second question, can you give any more color on sort of how sales trends are going so far in the month of March, either in general, by area, or even just, even within, even within the Open Series, and its impact of sales, on sales?

Jim, we don't, we don't share data intra-quarter, but as I said in my prepared remarks, we are seeing continued strength in sales in the Open Series communities.

Okay. All right, thanks.

We take our next question from David Goldberg with UBS.

Thanks, good morning.

Morning, David.

Jeff, I was wondering if you can start by giving us more color and or maybe just a little more detail. I know you said a couple of time that is the sales pace in the Open Series communes is greater than in kind of the normal communities. And what I am trying to get a handle on is kind of on a per month kind of basis, what do you think in terms of sales, you're looking at in order to be comfortable with the idea that the sales are going to increase sequentially through the year?

Well, it ties to the if you look at the first quarter results and what we generated in sales, and the fact we are opening more of the Open Series communities, so our community count will be going up through the year and it is logical progression that sales will go up with it, in that we are seeing strong sales due to how each of these communes is positioned. So it is sales growth tied to the success of the product and the expected community count growth through the year.

Let me try to maybe ask it a different way. If you look in the Open Series communities that you've had open, do you see when you first grand open them that there's a higher and then it tails off over time or have you been able to keep the sales pace pretty consistent after the open? I realize it is early in the process but just generally speaking.

Any grand opening, David our view is you can only grand open once so you do it right. We will take the time to property promote the community and we always see a spike in sales above our intended run rate I will call it at the grand opening period. Past that though we have been able to sustain sales rates past the opening at fairly historical levels, the six, seven, eight a month kind of a track versus a one, two or three a month that we were seeing on the old product? We have been able to sustain sales after an opening period.

That is great. I guess the follow up question would be about the benefit from prior impairments in this quarter, how much that helped margins?

We don't really disclose the profit component but on a number, or the proportion of delivery on the quarter it was just slightly over 70% were from deliveries that had previous impairments.

Is that up, Bill as a percentage sequentially?

Yes.

It is, okay.

Our next question comes from Stephen East with Pali Capital.

Good morning, guys. If we look at the profitability of the Open Series, Jeff and also looking at land you have talked in the past that you had a mis match in land where you had really historically purchased land for much bigger houses, et cetera and you have got to work through that. If you look at that in conjunction with the profitability of Open Series, when do you work through and we see profitability throughout and where land is, is at the right percentage of ASP? .

Well, if you, as I reflect back on the process, Stephen, the, what we were doing before was keeping the same product out there, which was out of alignment with the consumer today. You'd lower your price, you'd impair it, you'd get your cash out and wouldn't have any margin really to speak of at the end of the day. As we have put the Open Series out there, on lots that were acquired in some cases years ago intended for a much larger product, we have dropped our cost enough where we, and it is a product that is aligned with what the consumer today wants, where we have been able to slow the impairment, drop the price and raise margin all at the same time. So it is a good combo.

As you go forward I call it the profit equation balance, how much revenue can you get at what margin relative to your overhead. Our strategic goals right now would be to get enough volume and get enough margin where ideally over time you would get your margins above 15 and get your SG&A below 15. Our sales rate and margin performance over the next couple of quarters will tell us whether we are going to get there or not. I don't see margins moving north of that range, where we are at today, until we acquire more land.

Okay. How long do you think it takes sort of to work through that mismatch on land if you will?

It is market specific. Some markets were pretty lean on lots so we will be reloading earlier if the opportunities are there. It is a difficult thing to, to peg as a Company but we will get there over time.

Okay. And on your SG&A since you're bringing absolute sales dollars down, what do you need to do so bring that back into alignment?

It is a function of revenue and hard costs. And as we shared, we dropped it 50% year-over-year, unfortunately our revenue through the unit count and the average price dropped 60%. So we are still chasing it down. As Bill mentioned in his comments, we did some more organizational realignment in the first quarter. It takes time for the saving to flow through. You will see more of it as we move through the year but remain committed and dedicated to getting our SG&A back in line with our top line.

Okay. Thanks.

Next question is from Josh Levin with Citi.

Good afternoon, everybody. I have a question regarding orders during the first quarter. I guess in late 2008, particularly October, November, which would have been your fourth quarter, it is probably fair to say that the world felt like it was falling apart, consumer confidence wasn't in a very good state. Do you have any sense, or do you think a material amount of the orders you got in the first quarter were pent up demand from the fourth quarter of last year, meaning people who were going to buy in October and November but backed off and then came back in the first quarter?

I don't know that it is that simple, Josh. We actually did share at our year-end call our sequential sales in the fourth quarter. And our November was actually over October and our October was up over September. So sequentially, through the quarter, our sales improved. I think what we are seeing in the, our sales results here in the first quarter is directly linked to the continued effort to realign our product to be more competitive. I don't think it is consumer psyche that was on the fence and has now come back.

Okay. One more question. You talked about I think 70% of your deliveries were to first time home buyers. Given the down payment requirements now and then FICO score requirements, do you have a sense, have you done any research about how big the pool of potential buyers out there who actually qualify?

Well, I know the pool is very large, Josh. Along with our 70% first-time, we're are focused heavily on price points that offer FHA financing. On a FHA loan the requirement down is 3.5% today. And they don't use FICO scores, they use other criteria. So it is still a ready available loan instrument. You just have to document your income and your job and your credit.

Yes but the --

The financing is out there. It is not a road block for the first time buyer.

Okay. Thank you.

We move to Ken Zener with Macquarie Capital.

Morning.

Morning, Ken.

The order rates that you guys are getting in the 120 communities in the first quarter was pretty high. How do you guys think about when you talk about the order rates, obviously the second quarter is a tougher comp, but as you think about it really I mean going forward, I mean are you thinking that you can sale four or five homes out of a community? Each month or --

That was our experience in the first quarter, Ken, and it is what we are now modeling as we roll out this new product going forward.

Because that's obviously a very solid rate. I mean that's just, you are back to a more normalized rate of absorption per month there. What do you think are the risks to that assumption given that you are not necessarily try to fend off other new time buyer, you are really targeting that entry level that is competing with resale, I mean what do you think are some of the risks to that assumption?

The risk would be if sales continue to fall dramatically there is a point in time where you are not going to chase the sales. As we have opened this product up and positioned it to compete head on with foreclosures in places like Southern Cal where prices have actually stabilize on the resale front, it is encouraging. Because perhaps there's a floor now in Southern Cal and if you are selling well and inventory, it is a little more predictable result.

There are other markets we're in where resale inventory is 20 to 25 months. Prices are still going down. We have priced aggressively to compete in that environment. If prices were to continue to go down we may not have the appetite to chase it but as we sit here today, we are comfortable with the sales rates we are seeing.

Right. I guess given that absorption pace, internally on your own forecast, which I mean you didn't give an explicit order rates or closings for year but I mean I assume it would be a pretty wide variance if you are looking at first quarter five orders per community when you were doing two in the second half of '08. How do you kind of balance the potential upside given first quarter's rates versus what we saw in the latter half of '08?

It speaks volumes to the new product we're rolling out. So we are basing it on our current experience and I tempered my comments about where the markets are heading because I am concerned about the economy and the job loss and a lot of the media is jumping to we are calling a bottom. We are not calling a bottom yet. We think it will be difficult for a while. We are being prudent, yet we are also trying to recognize the experience we are now seeing where we have effectively rolled out and introduced the Open Series.

We'll take our next question from Megan McGrath with Barclays Capital.

Hi, thanks. Just another quick follow up on the order growth. Can you give us any color even if not the specific numbers on how the order growth trended in the quarter? And as a follow up to that, how sustainable do you think this cancellation rate is going forward?

Well we shared in the month of February, the Open Series accounted for 20% of build to order sales. And we qualify build to order because we don't have any inventory of Open Series product. They're new communities opening and we are seeing good momentum we can carry going forward. The cancellation rate we now report both ways. When your growth sales are declining your can rate will go up as a percent of sales even if your can rate as a percent of beginning backlog holds. Our can rate improved as a percent of sales because our gross went up. Our can rate as a percent of backlog was actually in the historical range that we have seen for the last few years. So we think the can rate was fairly typical.

Okay. That's helpful. Thanks and just a little bit of clarification on the forward-looking order growth. You talked about net orders going up sequentially although historically the second quarter has been from a seasonal perspective, a lot higher. So because you are increasing community count do you think that the August to November quarter can actually be higher than 2Q?

We do.

Okay. Thank you.

And we wanted to clarify the guidance because we know we are not going to achieve the sales we generated in the second quarter of last year because our community count was higher. However we do think we can build on our sales rate through the year.

Great. Thank you very much.

Next question is from Joshua Pollard with Goldman Sachs.

Hi, most of my questions have been answered but I have two. One is could you give us a sense of how much square footage pricing has changed, how much is pricing down year-over-year on a square footage basis? And my second question is what are your thoughts on issuing equity here given where your stock price is?

I don't know Josh that we have the price per foot on the call. We can probably take a stab at it but when you get to -- don't confuse price per foot with absolute price. The consumer can only afford so much and if you are building a much smaller home, albeit your price per foot could be higher, the price could be down $100,000 to the consumer. My hunch is since we are offering smaller product, the absolute price is way down but the price per foot actually could be up a little bit. I'm sorry. I can't remember your second question.

Equity.

Equity, no. Our equity is too cheap right now. We think there's upside so why give it away.

And given our liquidity position with the $1.1 billion of cash and $1.6 billion of liquidity, and the maturity not until August 2011, our balance sheet's is in pretty good shape right now.

We move to Nishu Sood with Deutsche Bank.

Thanks. I also wanted to ask a couple questions about the new Open Series plan given how important it is going be. I can really understand the appeal of it in markets like Florida and California where there's much more intense competition with the resale market and where prices have fallen a lot more significantly. I am trying to understand and especially also relative to your competitors, other builders it is probably more differentiated, I am trying to understand though the kind of basis for success in, in a mark like let's say like Texas where there isn't as much competition from foreclosures. The 1200 square foot box for entry level buyers is a much more typical and prices haven't fallen as much. So maybe if you can give me a sense of how it plays in a place like Texas?

While the Texas certainly hasn't seen the deflation that the coastal markets have, it is still very competitive there, and there is still excess inventory on the resale side. And inventory levels continue to climb. So there is a lot of competitive pressure in Texas. And Nishu, right now one of your best stories in sales is Houston where we have rolled out this product and it is being received extremely well. Income levels overall in Texas are a little lower than they are out here in California for instance, and affordability is absolutely critical. So it is a key strategy for us and I think it is a differentiator in Texas just like it is California or Florida.

Got it. And in terms of it sounds like a great principle to be able to offer the customers the flexibility to design their own house, in other words they can in a sense make it or tailor it to their own level of affordability or whatever they can afford. I can imagine that introduces a lot more uncertainty to your revenue stream. So how do you, what do you model as you looking at an Open Series community in terms of revenues, are you expecting everyone just going to pick the most basic option and I guess a related question would be how does then factor into your impairments as well?

We have years and years now, Nishu of experience with the studio results. And what we are seeing, even with these lower priced products, the results out of the studio as a percent of revenue are fairly typical with what we have been generating over the years. So we will take a historical track on the studio results and factor it with the base price to do our revenue projections. As to impairments, the price is the price. While we have a business model we understand what the studio expectation would be and that's all factored in if we were to book any impairments.

Got it. Okay. Great. Thanks a lot.

We take a question from Larry Taylor with Credit Suisse.

Thanks very much. We talked pricing in a number of forms here. So I want to either ask it a different way or clarify it. I apologize if you have given this information I didn't catch it. But I am trying to sort out what the difference in pricing might be in the backlog or new orders currently relative to your closings during the quarter?

The guidance that we gave on the call, Larry is that we don't expect our pricing to move much through the year. It didn't, it is down a little bit from the end of the year but our expectation is our pricing is in the range.

Okay. So you are not seeing a significant difference on the, on new orders on current orders in terms of pricing relative to the pricing on closings during the quarter?

That's correct.

Great. Thank you.

We take our final question from Joel Locker with FBN Securities.

Hi guys, just on was wondering on the competition, to your Open Series you were obviously the first mover or one of them. And just in recent weeks have you been seeing similar type houses being built by your competitors?

Joel, somebody asked a question similar to yours and I keep reiterating our biggest competitor today is resale. Other builders obviously are doing things to lower their prices and everybody has a different strategy on how they're going to compete with resale and foreclosure. I can't speak to those but I can speak to we feel strongly that our strategy is the right one and is a differentiator in that it is not only an affordable product, it is designed with the consumer in mind a product that appeals to their needs today. And we are the builder of choice because they can go to studio and customize it and it is more than just price. It is the whole package.

Right. And just a follow up, on communities, if you include all communities even with homes less than five homes, what would it still have been 120 communities or would it have been higher? And if so what would be the number?

Joel, the number is the number. There is probably communities with one or two left to close, that wouldn't be in that but it is not a material impact.

Not a material impact. All right. Thanks a lot.

This does conclude our question-and-answer session for today. Mr. Mezger, I will turn things back to you for any closing remark.

Thank you, Darrell and thank you everyone for joining us. And we look forward to seeing you over the next few months. Have a great day.

This does conclude today's conference. Thank you for participating. Have a great weekend.