KB Home (KBH) 2010 Q1 法說會逐字稿

Good day, everyone. Welcome to the KB Home first quarter earnings conference call. Today's conference call is being recorded and webcast on KB Home's website on kbhome.com. The recording will also be available via telephone replay until midnight on April 2. You can access the recording by dialing 719-457-0820 or 888-203-1112 and entering the replay passcode of 5468882.

KB Home's discussion today may include certain predictions and other forward-looking statements that reflect management's current expectations or forecasts of market and economic conditions, and of the Company's business activities, prospects, strategies, and financial and operational results. These statements are not guarantees of future performance and due to a number of risks, uncertainties and other factors outside its control, KB Home's actual results could materially differ with those expressed in, or implied by the forward-looking statements. Many of these risk factors are identified in KB Home's filings with the SEC which the Company urges you to read with care. KB Home's comments today will also include non-GAAP financial measures as defined in Regulation G. The reconciliation of these non-GAAP financial measures to their most directly comparable GAAP financial measures and other information required by Regulation G is provided in the Company's earnings release which is posted on the Investor Relations page of the Company's website under recent releases, and through the Financial Information News Releases link on the right side of the page.

And now at this time, I will turn the conference over to Mr. Jeff Mezger. Please go ahead sir.

Thanks Kelsey. Morning everyone. Thank you for joining us today for a discussion of our 2010 first quarter results.

With me this morning are Bill Hollinger, our Senior Vice President and Chief Accounting Officer, and Kelly Masuda, our Senior Vice President and Treasurer. Before we get started, I want to let you know that based on your feedback, we have shortened our prepared remarks to allow more time for Q&A. After I share an overview of the quarter and our outlook for the future, we will open it up to your questions.

I will begin with a summary of the current market conditions, followed by some insight into KB Home's first quarter performance. Then I will cover our strategic vision for the remainder of 2010, which we believe sets us up for a stronger 2011.

The housing market today is continuing to steadily work through excess inventory. In many regions, the supply/demand equilibrium that is essential to a healthy market is starting to take shape. Record affordability is bringing both new and experienced home buyers back. Many buyers are finding that home ownership is within their reach for the first time, while others want to move up to a larger home, or downsize to a smaller one. The key drivers of housing affordability, compelling interest rates and lower prices are evident across our operating regions and should continue to help fuel this encouraging market trend going forward. At the same time, short term government stimulus in the form of federal tax credit for home buyers, appears to be having the desired affect of getting buyers off the fence today and deciding that now is the time to buy.

In addition to greater affordability, the long term demographics for the US housing market are also strong. As our population grows, households are forming, and demand for homes over the next 20 years, is still expected to outpace demand of the past 20 years. In other words, the life events that drive the need for a new home continue to unfold across the country. Of course, job growth and consumer confidence remain the foundation for any sustained housing recovery and a healthy overall economy. The better than expected employment report in February was certainly a welcome step in the right direction.

There was some mixed news out this morning with sales of existing homes down for the third consecutive month in February, some of which was attributed to weather conditions. However the sales decline was generally less than expected. While we cannot predict what lies ahead, the view from where we stand today has significantly improved over the last year, and we remain bullish on our Company's ability to compete in the current environment. We are not declaring that the overall health of the housing market is strong and robust, however our relentless efforts to improve our business over the past few years have us well positioned to capitalize on future opportunities.

As we entered our new fiscal year in December, market conditions remain challenging, as the softness we experienced in the fall continued. In fact, our December orders were down significantly over the prior year. The extension of the federal tax credit in November occurred just as we were entering the holiday season, but it was too late to have an impact during this typically slower period, and the new expiration date was too far out to create any immediate urgency. As a result of our many strategic and proactive actions, however, sales steadily grew over the remainder of the first quarter and we were able to make up this substantial initial shortfall. In particular, we had a very solid February with a notable increase in sales and traffic. Overall, KB Home generated 1,913 net orders in the first quarter up 5% over the same period last year. We are hopeful the momentum created by our marketing efforts, our well-received product offerings, and our new communities opening will carry into the second quarter. However the uncertainty surrounding what to expect following the tax credit expiration in April, will ultimately determine whether the year-over-year net orders will be favorable. Just as the month of February was critical to the outcome of our first quarter, the month of May will largely determine the outcome of our second quarter.

We grand opened 40 communities in the quarter, many of which occurred in the month of February. Half of these communities were brand new neighborhoods, while the other half were existing communities in which we introduced new product offerings from The Open Series. These new home designs continue to meet today's buyer preferences and are resulting in a higher sales pace. In fact, on a per community basis, we are selling very well. The challenge now is to grow our community count. In early 2006, as market conditions started to weaken, we embarked on a strategy of hoarding cash, reducing inventory levels, and lowering our cost to build and operate. At that time, we also made the decision to curtail investment in land and lots until the environment improved. Our current cash position and owned and controlled lot count illustrate how well we executed on our strategy. Our resulting outcome, however, is a lower community count, which we are now diligently working to increase.

With our markets beginning to stabilize, and our Open Series product generating solid results, we think the time is right to once again reinvest in our future growth. We began this process in the second half of 2009, and it continues today. We have the liquidity and resources to ramp up our community count throughout this year and to position us for strong growth in 2011. Although it will take some time before housing returns to a more normalized environment, we believe our strategy now and throughout the downturn is, and has been, the right one for our business.

Turning to our financial results, we delivered 1,326 homes during the quarter, which represented a decrease of 8% from the prior year. With our average selling price of $197,700, down 6% year-over-year, we generated total housing revenues of $262 million. Despite our housing revenues declining 14% from a year ago, we narrowed our net loss for the 7th consecutive quarter and continued to make solid progress in many areas of our business. Our net loss for the first quarter was $55 million, a 6% improvement over the $58 million net loss we incurred last year. I am pleased to report that the first quarter marked KB Home's 6th straight quarter of year-over-year margin growth. Our housing gross margin, excluding inventory related charges, grew to 18.8%, from 13% a year ago. This 580 basis point improvement is especially notable, given the decline in our average selling price for the period. Going forward, as a higher percentage of our deliveries come from our Open Series product line, along with new communities opening, we anticipate our gross margin for the year in 2010 to be higher than it was in 2009.

Our total inventory related charges decreased significantly from a year ago to approximately $13.4 million, the lowest level we have seen since the first quarter of 2007. At this point we believe these charges are mostly behind us.

Our selling, general and administrative expenses increased by approximately $11 million over the prior year and represented 27.5% of housing revenue for the quarter. While disappointing, it is important to keep in mind that the reduced volume we typically experience in the first quarter can cause expenses that are even relatively small in dollars to have a bigger impact on our SG&A percentage. The quarterly increase primarily consisted of two non-operating items, the costs associated with long term cash settled compensation tied to the Company's stock price, and higher legal expenses. These two expenses are likely to continue at elevated levels in the second quarter. For the full year, we anticipate that SG&A will settle out in the 18.5% range, depending in part on where our stock price ends up. Increased volume will also be an important factor in improving this ratio. Of course, we remain committed to looking for ways to be more efficient in our business and reduce our costs, while being mindful of retaining and leveraging our growth platform.

KB Home's strong and liquid balance sheet continues to be an advantage for our business. We had $1.3 billion in cash at the end of the quarter, roughly flat with our year-end level, despite having spent approximately $80 million on land acquisition to fuel future growth. We have earmarked $600 million for land acquisition and development for the year, and we still expect to finish 2010 with a healthy cash position of well other $1 billion. Our net debt to total capital remains below 45%. In short, we have a solid platform from which to grow our community count and position the Company for higher revenue levels and profitability entering 2011. We have also succeeded in strengthening our backlog, and for the first time in four years, the number of homes in backlog increased year-over-year, setting up additional momentum going forward. Moreover, we are converting our backlog at record levels, which speaks to our business efficiency, compressed cycle times, and the compelling value proposition we offer to our buyers. With our community count growing throughout 2010, we anticipate ending this year with a higher number of homes in backlog than at the end of 2009.

As we move into the 2nd quarter, we are seeing more sales activity driven by the federal tax credit, which has become a real motivator for our home buyers. We have a targeted tax credit strategy to start inventory homes in select markets and communities, which we believe will be instrumental in allowing us to capitalize on the increased urgency as the April 30, deadline approaches. It goes without saying that we remain firmly dedicated to our KBnxt Built to Order business model for our buyers and for our Company. KB Home was the first national builder to employ this pre-sold, customizing approach on a large scale, in the 1990's, and it will continue to be a cornerstone of our business as we work to become a low-risk, high performing Company with strong returns on invested capital. At the same time KB Home has the defining characteristic of being able to move fast, to meet the rapidly changing demands of this marketplace. With the strategy of proactively starting more homes than we would under normal circumstances, our buyers can still benefit from the many personalization options that they truly value, while qualifying for the limited time tax credit opportunity. In terms of the number of homes we are building for this purpose, our general guideline is approximately one month sales in entry-level communities that have demonstrated consistent and predictable absorption rates.

If the housing market stabilizes at current levels, and depending on where demand is after the tax credits expires, we believe KB Home is positioned to restore profitability at some point in the latter part of 2010, and we intend to build on our momentum entering 2011. Our entire team has a tremendous sense of urgency and dedication to making this happen. To that end, we are working to open new communities in all of our markets that fit our product strategy, while continuing to execute our proven KBnxt Built to Order business model. Our hard work and reposition on balance sheet has resulted on one of the lowest lot position in the industry and we are now poised to reload at better prices. A snapshot of our current holdings and inventory balance underscores this strategy. At the end of the first quarter, we owned or controlled 37,300 lots, roughly a four year supply. However, more than 70% of our $1.6 billion of inventory is related to homes sold and in backlog, finished lots or lots that are over 50% finished. With this pipeline we are very liquid and can be opportunistic. We are supplementing this pipeline by securing finished lots that will enable us to grow our community count and topline. Over the past two quarters, we have spent $140 million on land purchases, the majority of which was invested in the first quarter, as we are now seeing increased opportunities.

With the success of the Open Series, we have confidence in underwriting new acquisitions, as we now have more predictable pricing and sales pace. We are also able to turn these newly acquired lots into revenue producing communities much more quickly, which enhances returns. Our average community count for the year is expected to be in the range of 145, roughly the same as 2009. However, we anticipate a higher community count in the second half of the year, and that growth trajectory should accelerate into 2011. We firmly believe we are on the right path to achieve our strategic objectives. We have previously estimated our 2010 deliveries to be in the range of 8,000 to 9,000 homes for the year. We are now comfortable in raising the floor of that range to 8,300 units. Following the spring selling season, we will have better clarity on expected annual deliveries.

Looking beyond this year to 2011, we believe the picture will become significantly better. We expect our volume of deliveries in 2011 to benefit from the increased pace of land acquisition and communities opening in 2010. In fact, we have set solid internal growth targets for homes delivered in 2011, while maintaining our disciplined return requirements and strategic product alignment. Reaching our goal of profitability at some point in the latter part of this fiscal year will primarily be the result of gross margin improvement, but we believe it will be the powerful combination of higher volume and operating leverage that will fuel our profitability in 2011 and beyond. This is not so much a prediction as it is a strategic vision for where we believe we can take the Company as we continue to execute on our plan.

With operations in 30 of the top 75 markets from coast to coast, or balanced and diversified geographic footprint is the right one. The markets we operate in have favorable long term projections for population and job growth. We are also in a market environment with substantially fewer builders as compared to a few years ago. Additionally, many private builders today likely do not have access to capital which is critical to operating successfully. In the current competitive landscape, the opportunity for a financially sound builder, such at KB Home, to quickly grow its business is clear.

Before I wrap up, I would like to take a moment to reiterate the attributes that differentiate KB Home from other builders and the strengths that we will continue to leverage going forward. The strict processes, controls and operational disciplines of our KBnxt Built to Order business model have generated solid results including improved margins, compressed cycle times, and the effective use of cash. Our business also benefits from the evenflow production and greater visibility this model represents. Our land light position, transformed product offerings, substantial cash on hand, and proven capacity for quickly turning new land purchases into viable communities should allow us to deliver superior returns on capital.

Our Built to Order experience is as important to our customers as it is to our business. As buyers develop a heightened emotional connection to a home they have customized, cancellations are reduced, and customer satisfaction is increased. We were the first, and are still the only home builder to adopt the rigorous third party certification of our quality controls through the NAHB Research Center's National Housing Quality Program.

In addition, as part of KB Home's "My Home, My Earth" initiative, we continue to be a leader in building earth friendly homes that reduce our homeowners monthly utility bills without adding to the cost of the home for us or for them. This month, we were again recognized by the U.S. Environmental Protection Agency as an Excellence in Energy Star promotion award winner. Finally, our unique partnerships with global brands, including Martha Stewart and Disney, continue to drive traffic and distinguish KB Home from our competition. With all of these industry leading initiatives, KB Home has been named to Fortune Magazine's 2010 list of the world's most admired companies for the sixth consecutive year. And KB Home ranked number one for innovation among home builders, which is a source of great pride for our employees. This honor shows that our proactive efforts have been recognized and are producing results.

In the almost 17 years that I have been with KB Home, I have never been more enthusiastic about the Company's future. Our core values, our focus on the customer, our high performance culture, our passion for the business. It is these attributes that have allowed us to successfully navigate through the market challenges, and will once again take our Company to new heights in the years ahead. We will continue to strive to meet the needs of our customers and our stockholders by operating our business with efficiency, integrity and ingenuity. And now, we will open it up for your questions.

(Operator Instructions) Our first question will come from Dan Oppenheim with Credit Suisse.

Thanks, very much. I was wondering, Jeff if you can elaborate, you talked about how the environment now is better than the home building environment a year ago. At that point the thought was to see sequential improvement throughout the course of 2009 and then clearly with the tax credit there has been some impact. What is it you are seeing differently this year? What gives you the confidence in thinking that 2010 so that the overall outlook is better now than what we had a year ago?

Sure, Dan. There's a few things going on. First off, in many if not most of the markets we operate in today the resale housing prices have been stable for many months. We always share on these calls that we view a market imbalance when there is a 6 month supply of resales and that pricing has stabilized. In many of the markets we are in, inventories below six months, and price has been stable in some cases for as long as a year. So there is inventory clearing and the markets appear stable, while at the same time we've continued to transform our business to have product in those market that compete favorably with the resale business at those price points. So market stability and the transformation of our business continuing.

Okay, thanks. I guess the second question, wondering about the SG&A, talking about that as 8 .5% for the full year, can you give a little clarification? How much of the higher cost came from legal? Is that from the SCC investigation? Or what is that relating to? And do you have a goal in terms of (inaudible) that some of those charges where SG&A should be?

Sure, first off, I can tell you it is not due to any SCC investigation costs. As I indicated, Dan, in the prepared remarks, the increase was primarily non-operating cost which will decrease over time and be less impactful, as our deliveries grow throughout the rest of the year. However, let me kick this to Bill that can share more details on the first quarter SG&A.

Yes, thanks Jeff. There were two factors that obviously gave rise to the $11 million increase in our SG&A. Those two were, as we said in the press release and Jeff said on his openings comments, one being our cash settled stock awards and legal expenses. The cash level stock based awards are really primarily our stock appreciation rights and our phantom shares. Those were issued in place of stock options. Those two awards really, the phantom and the stock appreciation rights, under the rules of accounting today, actually have a mark-to-market, or type, re-evaluation that occurs every quarter. And so with our increase in our stock price during the quarter of about 20%, it actually threw off about $6 million additional of expenses in the quarter, whereas a year ago with our stock price having dropped during the quarter, it actually generated income of $3 million. So there is a $9 million Delta between last year and this year. That volatility will continue as the stock price changes and these instruments remain outstanding.

The other component to our increase in our SG&A and giving rise to our 27.5% as a percent of revenues, was also due to, as Jeff said, higher legal expenses. Those legal expenses really are about $3 million year-over-year as a result of defense costs that we are incurring on behalf of our former Chairman and Chief Executive Officer in connection with his current litigation. Under Delaware law, the Company is required to pay such legal defense costs. And so if you combine those two of about $12 million, and back that out of then our SG&A for this year, it would bring our SG&A ratio to just slightly under 23%. So, that is, again, the clear majority of the both the absolute increase, as well as the ratio.

If I could add, Dan, as I shared in my comments, we are guiding that for the year we will be at 18.5% range of revenue. We do see these costs being elevated in the second quarter, but dropping down from there. At the same time our revenue will be going up later in the year. Then the last comment I can make also to build in share with you is we have taken a conserve accounting approach on these legal costs. We are expensing as incurred, and depending on the outcome of the process, we will get some recovery. It is just unclear at this time how much.

Our next question will come from Michael Rehaut, with JPMorgan.

Hi, thanks. Good morning everyone.

Morning Mike.

I was wondering -- you mentioned December orders down significantly. I was wondering if you could give us -- quantify that a little bit more specifically? And also what the year-over-year trend was for January and February? And, as part of this question, before I hit my second question limit, just what the community count average was for the first quarter?

Okay. I thought you would be happy, Mike, that we were actually sharing some month to month trends because we normally don't do that within the quarter.

It is never enough for us.

We felt it was important to provide that color because we are in such fluid times with these extraordinary influences like a tax credit coming and going. So in December we were down significantly. What -- the trend we saw in November continued, where it was soft both on traffic and sales activity. January was about neutral and February we picked up the -- not only the shortfall in December, but ended 5% up year-over-year. So the trajectory was favorable through the quarter. We won't give color on March, because we don't want to focus on a couple of week's activity either relative to trends, but it was encouraging how we saw the market conditions improve. I will refer the community side to Kelly.

Mike, on community counts, our community count in Q1 was 109, down 9% year-over-year from 120. I think as Jeff indicated on his prepared remarks, that we expect to be down slightly year-over-year for the first half of the year with growth in the second half of the year to be relatively flat at 145 for 2010. Then we expect community count growth to accelerate in 2011 as we reload our loss pipeline throughout 2010.

Okay. Thanks. Just a second question. Was interested in your commentary, or thoughts on order friends and, I guess, relative market strength on a regional basis. With the $600 million in land-spend goal, if that is going to be concentrated in certain geographies? And perhaps, you said the 140 you already spent most was in the first quarter, where was that concentrated, as well? So, another two parter. First, current trends in terms of regional strength, and second, plans and geographic focus for the land spend.

Sure. That is three questions now, Mike, but we will answer them for you.

Thank you.

Clearly California is performing well now for us. Inventory levels are way down in the State. In fact, we were told this morning that the assembly incentive approved a new tax credit for California that it is expected the governor would sign later this week. That would be a nice boost to our California business.

Nevada, interestingly , where some people call the foreclosure capital of America, is one of our better performing divisions in terms of sales per community. We are selling very well there. Still sluggish in Phoenix. Texas has held well around the State. San Antonio and Austin, in particular, are doing well. Dallas not quite as strong, but not that large a business for us.

When you get over to the east coast, it's fairly choppy. Parts of each city of Florida are doing well in the sub markets and others aren't doing so well. It is mixed in Florida. North Carolina not performing as well as Charleston, yet Charleston is doing well. And we are encouraged also, we opened up again in Washington, D.C. with a town home community in Alexandria in February. And in spite of all the news about the winter weather and the impact there, we actually had 6 net sales the first weekend we were open in D. C. So we are very encouraged with the D.C. activity.

And as you -- if you go back up top from an investment strategy perspective, every market we are in has opportunities today. There is a sub market in every city where supply is in balance, prices are stable and we can underwrite deals and go today. So we have not restricted our investment anywhere in the Company today. I don't know if you want to add any color that that,

No.

We will move on to Carl Reichardt, of Wells Fargo Securities.

Good morning, guys. How are you?

Good, Carl.

Hey Jeff, I have one technical question and one bigger picture. The technical question is on gross margin. As you begin to deliver homes related to the tax credit, you have a little more spec than would be normal for you it sounds like. But your fiscal quarter splits when the tax -- when deliveries end in June, so it splits the tax rev -- trying to think if you will have a camel bump in deliveries in Q2 and Q3? And whether or not that will be positive for gross margins because you will have more volume? Or whether or not the spec will creep in there and compress gross margins a little? So can you help me think a little bit about how your margin trend ought to be? If it's anti-seasonal in Q2 and Q3?

Sure.

Yes, thanks.

That is if first time I have thought of our housing cycle as a camel bump. One bump or two? Anyway, the spec strategy, as I shared in mu comments, we are a pre-sold, built to order Company. However, we were at a disadvantage last fall and we want to make sure we are protected from that disadvantage. With our build times where they are, if we start one months worth of sales in select communities, we are still expecting them to be sold before the homes even hit sheet rock. So we are continuing to offer choice to this consumer, which they value, and as a result, we are not expecting any margin erosion, because it is not like we are loading up and have a bunch of standing inventory around. With it having to be sold in April, close in June, with a 90 to 105 day build time, these will be sold before they get to completion. So, the tax credit is creating some interesting dynamics. We don't know whether May and June demand is going to be pulled forward to April or not, or whether post tax credit the economy is better and the sales demand continues. Our margin guidance we will be able to give you more clarity after this camel bump, as you called it, but overall as a Company, we have always done better on margins on pre-sold than on inventory. But we are trying to bridge this without a big impact on margins. Kelly, do you have any other thoughts on it?

Yes, Carl, as -- nationally as a bigger percentage of our deliveries is Open Series, and secondly as new land starts coming, coming online in new communities, you will have a natural expansion of our margin.

Okay, great. Thanks guys. And then the bigger question, Jeff, I noticed your comment on return on capital in the release. I am curious, if you think a few years out and you are trying to manage the top line growth with free cash flows. You know most builders generate fairly significant negative free cash as they growing rapidly, are you thinking about managing the balance between the two better as you come out t=of this cycle trying to generate cash while still growing on a modest pace? Or would you rather try to take advantage of a bottom in the cycle, if you see it, and grow real rapidly and have the same free cash flow dynamics as the industry has historically had? How do you think about that?

We're -- we have a balanced approach, Carl. We are going to grow as fast as we can, but we're going to stay disciplined on the return side. I think in our business model, as quickly as we can return from tie up a lot to get to revenue, that we can have a superior return on invested capital and generate cash. So, you are not going to see us fall back to writing big checks for partially entitled land and take two or three years to bring it to market. So, as solid a growth rate as we can drive while adhering to the of our financial hurdles.

Terrific --

Carl, I think with -- Carl, I think with single family starts at around $0.5 million, you're naturally, as the start number comes back, you're naturally going to see a higher growth rate coming out of the downturn, but when the housing markets stabilizes and starts to stabilize overall, you will see a more modest growth rate than you have seen in the past.

Thanks, Kelly. Thanks, guys.

Our next question will come from Dennis McGill with Zelman and Associates.

Hello guys.

Morning Dennis.

The first question, just elaborating the data that Bill gave us, appreciate all the color on the SG&A. Just trying to understand some of the underlying drivers. If we think about it year-over-year and based on the (Inaudible) Bill gave, you are kind of flat on a dollar basis, yet revenues are down in that 15% range. So I am trying to understand what would be offsetting the lower variable expenses that you would have there like commissions and so forth, and how should we think about that big picture as sort of the fixed versus variable leverage opportunity that you have?

Dennis, I am not sure I completely understand your question, but what we said, recall what we said on our last call, year-end, we said unlike what we had done in 2009, where we had significantly brought down our overhead through all the various initiatives that we took place, that took place, we said that our overhead for this year would remain relatively flat. And that is still the guidance that we are giving, except for the fact that, what we are probably adding on to fact that there are these two other issues that are going, these non-operating expenses of the legal costs as well as the variable accounting to the cash settled based stock awards. So, we have not really changed our view, we so really see an increase really only coming from those two things right now. Otherwise relatively flat from where we were a year ago.

Maybe we can follow-up offline but I guess the numbers based on what you talked about earlier, it seemed like you expensed around $60 million in each quarter this year and last year. But yet your revenues are down. So if you're holding your overhead comps, then I am trying to understand on the variable side, what would offset that? But maybe we can follow-up offline if the numbers are wrong.

The second question just had to do with, on the lots you said you control about 37,000. Can you give us a sense of how much of that you put on the books over the last 5 quarters or so?

Kelly?

Well, we spent $140 million over the last two quarters. That doesn't include lots that we -- transactions we have approved but have not yet closed. I will tell you of our 30,200 lots that are owned, about 18,300 are lots that are sold and in backlog, finished lots and lots that are majority finished.

Right. But there is no way for us to sort of understand the opportunity based on what you have done over the last year?

You mean in terms of number of lots that we have approved? Look, we have done transactions across all of our regions and our sequentially, our overall lot count is relatively flat.

We will move on to Jonathan Ellis with Bank of America.

Thanks. Good morning guys.

Good morning.

Wanted to -- first question, with respect to Open Series, do you have a figure for what percentage of your deliveries this quarter were Open Series? And also if you have, in the backlog, a percentage of (inaudible) product in the backlog?

Jonathan, as we shared on our last quarterly call our deliveries in the fourth quarter were over 50%. It has continue today grow since then. We really -- we got out of wanting to share that because it gets very blurry. There's communities where we have added one Open Series plan where the city would let us, but it is not really Open Series. I can tell you that almost 80% of our deliveries in the first quarter were to first time buyers. And a good percentage of that was on Open Series product. We expect to continue to see Open Series become a higher percentage of our deliveries as we transition into more new communities and close out existing.

Okay, great. Then just, second question, I wanted to ask about upgrades. Both in terms of the first-time market, which I understand is obviously 80% of your sales in the quarter, but also in the move-up market. Are you seeing any increase or change in terms of the mix of options or upgrade that the buyers are pursuing?

Our studios, Jonathan, continue to perform well. Sales per unit are off slightly from the peak, but they are still running roughly 10% of the base price. One of the consumer trends, I would say we picked up on, is people are less about sizzle and more about value these days. They are putting the money in room options, construction options, cabinets and counters, instead of jaccuzi's or upgraded plumbing trim in their bedrooms. It is all about value today. But our sales continue to hold well.

Okay. Thank you.

Moving on to David Goldberg with UBS.

Thanks, morning guys.

Morning David.

The first question, I wanted to delve into the SG&A a little bit but maybe from a different angle. I was hoping we can talk about how the opening ibn new communities is going to impact the SG&A through the year? And if you think it's going to be difficult maybe to bring that number down as a percentage of revenue if you're opening a lot of communities where you might not have quite as much leverage?

David, again, as I guided in my comments, we think we will be in the range of 18.5% for the year, which will be up a point over 2009 primarily attributable to these things that Bill gave you detail on. Included in that number is our assumptions for the incremental costs to open up new communities, offset by communities we are closing out. I do think, at some point in time, as we cross over to growing our top line, there will be the natural increase in cost on the SG&A side, but we are comfortable with the 18.5% we are giving for this year.

Got it. Follow-up question, second question, and I know this might be difficult with the JV on the financial services side, but just trying to get an idea on how you think average FICO scores are looking. How -- What is the kind of credit quality of your buyer, maybe? And how do you think if we look back past the camel humps in the next couple quarters, or whatever, and we just think about, maybe in June with the FHA changing seller finance concessions, how that impacts the first time buyer, the entry-level buyer for you guys?

Sure. David, let me make a couple of comments and then I will refer to Kelly for specific answers. We continue to be very pleased with our joint venture with Bank of America. We have a high capture rate. The service levels are very good. Most importantly, deliveries are occurring when projected, so it helps us with our business. And with the FHA changes that were announced, for the most part, we were already operating at that level. We don't have a lot of incentives. So if they drop a seller contribution to 3 points, we were already well under that. We actually think that is a good thing for the industry and competitively. They raised FICO to 620. We were already operating at that level. And the increase on the mortgage insurance premium was a small number. So we don't think it is going to have a significant impact on our business.

Interestingly, and Kelly will give you the details here, our FICO scores have been very flat to slightly up for a few years now. We have a high quality buyer as evidenced by our Can rates being at the low side of our historical levels both as a percent of growth and as a percent of backlog. The buyers we are seeing today are very good quality. Do you want to share some of the specifics, Kelly?

Sure. Dave, our capture rate in Q1 was 81%. The average FICO score was 706. And approximately 70% of our loans are FHA and VA loans. 61% being FHA loans and about 9% being VA. So the FHA and VA market remain one of the most -- and the conforming loans market, are the most liquid parts of the mortgage market today.

Great. Thank you.

We will now hear from Stephen East with Ticonderoga Securities LLC

Good morning guys.

Morning Stephen.

Jeff, if you could talk a little bit, 80% of your sales are going to first time buyers. As this tax credit rolls off, how do you all get to a comfort level that, if we see first time buyers in a total percentage of the market going from 40% or 35%, or 30% or 25%, how do you get comfortable that your business doesn't follow suit?

It is a good question, Stephen, and we are comfortable with the demand. This tax credit has been a motivation for people to buy. It is not creating buyers. The buyers are out there. And, what kind of got lost in the run up, is there were a lot of people that elected not to buy and stay renters, because prices got so high they couldn't live in an area they wanted to live in or they just weren't comfortable making that decision. So there is actually pent up demand in the rental sector today that passed the tracks credit. I think you will continue to see demand hold. It is the normal process in what I call the resetting of the food chain. You see the first time buyer come back first. Slowly people build up equity, they move up. Then the first move-up buyer builds up equity and they move up, but it always starts in these cycles with the first time buyer. I think that is the case here. It's that we have this extraordinary influence that is motivating the buyer on a short term basis. I think in the long run you will continue to see a lot of demand in this niche. We are not even close to it happening.

Steve, the other thing I would add is that the Open Series has been a strong seller for us at the entry level because the first time buyer doesn't have a home to sell. But this product, it also, we also have a 2,000 product that goes up to 3500 feet so it really can address the move-up market as well. It is just that the entry-level is a stronger part of the market today.

Okay. All right. And then if you could talk a little about what you are looking for, what you are doing on the land acquisition side, this $600 million. Are you going after distressed communities that have gone back to the banks primarily? Or are you looking for just finished lots? Or do you think -- A lot of builders are saying now that, hey, we are going to have to buy lots and develop them because there just aren't enough A and B lots around for everybody who wants them.

I agree with your comments, Steve. As always, it is a different story in each sub-market around the country. The banks still -- while we are seeing more activity and more opportunity with the banks, they are still holding on to their portfolios. We are buying lots on the ground from developers, from landholders, from other builders, from banks. It is really a mixed bag out there. I can't reinforce strongly enough that you are only as good as your local team and their network and their relationships to find deals. The ones that keep the transactions, or the offerings you see in the media, are where a realtor does a broadcast bid for some lot somewhere. But, frankly, we are not really pursuing those because the price gets bid up where it doesn't make sense and it is typically an investor that jumps in on a buy and hold, hoping for inflation to fix it. We are more strategic and disciplined and only buying things that we can turn into revenue right away.

Jim Wilson, with JMP Securities has the next question.

Thanks. Good morning guys.

Morning, Jim.

I was wondering, drilling back into the local sale a bit, so should I assume, I guess, looking at just the net orders and California being down a bit, but your comments about them being strong at the community level and where your total community count is versus were you expect it to be for the year. Obviously California's community count must be down, a fair amount, at least, I assume year-over-year? Driven the lower total number?

Kelly can answer that.

The California community counts are down, relatively in line with our nationally.

Okay. All right. So, then maybe another way to look at this is with that real big ramp you expect in the community count for the rest of the year, how geographically balanced or imbalanced might that look?

It is up in the second half of the year, and regionally, it is not far off. There is no anomalies regionally. It is up across the board across all of our regions.

Okay. And then, maybe, last question. What, as you get to the end of the year, what percentage of communities open do you expect to be Open Series?

Well, we will see that year unfolds, Jim. Definitely higher than the 50% that we were in the 4th quarter, but it'll -- fourth quarter of '09. It'll depend on how many new communities we roll in and how successful we are in closing out existing, but it'll be, our deliveries will be up over the 50% in Q4 of 2009.

Okay. All right. Good, thanks.

Moving on to Megan McGrath, of Barclays Capital.

Hi it's actually Matt [Landon] on for Megan. I've been having trouble recently reconciling builder commentary with some of the softness we have seen on the national [macros] side of things. For instance, you said that the operating environments and the home building industry is better today than last year at this time, yet new home sales data in January registered a new low. So I was wonder if you believe this is kind of an anomaly, or if you think that because you are taking share, for instance, this trend is likely to continue?

It is a good question. I don't get too caught up in one months trends, because they always seem to adjust them and one month does not a trend make. When I say things are better, I am referring specifically to how our Company has transformed. I answered another question earlier in this Q&A. Many of the markets we are in, the resale side of things, where there are 5 million-plus transactions a year, the resale size as stabilized. And that is where we are trying to take share. Whether new home activity is 300,000, 500,000, 600,000, whatever the number annualizes to, we are more focused on our market share specific to a submarket, targeting taking sales away from the larger resale business.

Got you. And then just two housekeeping questions. First, can we get your ending deferred tax asset and size of evaluation allowance. And second, I believe with regard to monthly order trends, you said December was down, January was neutral, and February was up about 5%, yet for the whole quarter you averaged up 5%. Did I mishear something?

Yes. February picked up the shortfall from December, covered last February, and pulled us positive 5% for the quarter.

I see. Okay. And your deferred tax asset?

It is currently $771 million, or just right around $10 per share.

All right. Thanks a lot.

Our next question will come from Joshua Pollard, with Goldman Sachs.

Hi. Thanks for taking my call. My first question is around margins. It looks like it came in at the high end of where you guys guided, (inaudible), that it would be above where 1Q '09 was, but slightly below, or somewhere below the 19% you reported in your November quarter. I am wondering what is going on there? Are incentives coming down drastically? Or was that right in line with what your internal targets were? And along those same lines, I am trying to understand the margin differential between specs and Build to Order homes for you all. I would assume that that has come in pretty drastically over time now, that home prices seem to be pretty stable in your markets.

Sure. Well, Josh, on the margin side, I would give credit to our Open Series product. As we continue to deliver more, we've been able-- because of the cost to build it versus the value to the consumer, we have been able to drop our prices and raise our margins. It is a great combination and that's, that was a key driver on why our margins are what they are relative to the past. I mean, you do have previous impairment that improve your go-forward margins, as well. Over time, in our business, specs typically have a margin 4 points to 5 points below the Built to Order deliveries, so it is part of the reason that we like being a Built to Order builder. Incentives come into play when you build specs and it gets completed and the consumer doesn't want it, so you increase incentives to make it more compelling. In our business model where we are pre-sold, incentives don't play a big part. Our incentive side hasn't materially moved much over the last several years, frankly. We always focus on best price to the consumer.

Josh, there is one thing I would like to add, too. Unlike the trajectory that we saw last year where we started off the first of the quarter with a gross margin of about 13% and ended the year with 19%, that is a pretty steep rate of climb. We don't see that really happening this year. We think the trajectory will be much flatter, even though we still maintain, though, year-over-year for the full year will be up. We are not going to see the same rate of climb like we saw last year.

That makes a ton of sense. Jeff, I have another follow-up for you which is, you go on your website and you actually see a countdown for the tax credit. What is your marketing strategy post the ending of the tax credit? Do you think post the tax credit you have a strategic advantage versus resale homes?

Most definitely we do, Josh, because it is a custom home as a competitive price to resales. With our cycle times in the most cities, we are turning from contract to close in 4.5 months, which is competitive with how long it takes on the -- in many of the resale transactions.

As we shared last fall, we were at this odd disadvantage when we were Built to Order in August and September, and competing against a resale that had an $8,000 tax credit we didn't have. We are going to put some houses on the ground so we can offer the consumer choice and the tax credit here in the next 30 to 45 days. After the tax credit expires, I think there will be a settling down period, and that is when our business model will really demonstrate value tied to the resale at the time. The buyer would much rather have a brand new energy efficient home than a 20-year-old used home. And we give them that choice.

We will now hear from Nishu Sood, with Deutsche Bank.

Thanks. I wanted to ask about the land spend environment and maybe the competitive conditions out there. I think if you look at the top four builders, previous top five over the last couple of quarters, you have seen some pretty aggressive behavior from some of them. Obviously one is wrapped up in a merger. You folks have taken what I describe as a little more of a cautious approach so far, but the $600 million land spend budget, for this year implies, obviously, a ramping up. Now, obviously as you've described it, KB takes a balanced and disciplined approach, so, I imagine that the increased land spend is coming out of internal priorities, but how much of this is also the competitive environment. Obviously it is a real heated race in a lot of these markets to kind of secure the land right now. So I was just wondering if you could walk us through your thinking in terms of internal priorities versus the competitive landscape as you are picking up your land spend here?

Nishu, really, they are one in the same for us, in that we are staying very disciplined in hitting out return hurdles with product that meets our strategies. So we are not going to chase a deal that doesn't align with those two components. And frankly, I would like to spend more than $600 million if we could, because it means we are finding more deal flow that aligns with those two opponents. We are staying prudent and disciplined. We are doing more options. We've done a couple of bulk takes but they're small. I don't think you'll see us in a ,major play unless we've partnered with somebody, because we don't want to bleed off too much of our cash, but, as I said before, your only as good as your local team in every city. And there are deals getting done locally that make a lot of sense for us right now. And we will continue to load in as long as it hits our two criteria.

And Nishu, you've got to remember, although $600 million is up year-over-year, it is still down 80% of where we were at our peak. So, we -- and with more than five quarters of data from our encouraging results from our Open Series, we're at a more normalized sales pace and so we can better underwrite these new deals.

Got it. Got it. Okay. So, second question I wanted to ask, also kind of related to the land spend. Like a lot of the other builders, you are sitting on tremendous liquidity. I wanted to get a sense of what type of feedback you get from your stakeholders, shareholders and bondholders on that liquidity? During more normal times there might be calls for debt repurchases or share repurchases. What is the message you get from your stakeholders? Are they -- it seems to be from judging from the behavior of the builders, that stakeholders really want you folks to go out and aggressively spend on land. So, I was just wondering if you can maybe talk through what kind of pressures or feedback you are getting from the stakeholders.

Nishu, I think maintaining a strong balance, especially in this type of housing environment, is a real positive to all of our stakeholders. We are operating now with much smaller revolvers than we had in the past, so the bank and project finance availability is not what it used to be. The public debt markets are open today, but our access to capitol is going to be different in the -- when the cycle returns than it was in the past cycle. So I think operate with more liquidity is something that --what you need to do in this type of environment. So we have maintained a lot of liquidity, and we've laddered out our maturities, so our next maturity isn't until -- it's $100 million in 2011, and then our maturity after that isn't until 2014.

Okay. Thanks a lot.

Our next question will come from Alex Barron, with Housing Research Center.

Yes, thanks. Good morning.

Hi Al.

I wanted to ask you, in some conversations I have had with land brokers and various private builders recently, it seems like the competitive landscape for the land has picked up I guess quite a bit in the last six month to the point where a lot of them are saying land prices are going up pretty substantially versus where they were six months ago. So I'm just trying to figure out if you guys are finding that that is the case, and is it much harder to find deals at 10% or 20% these days versus six months ago?

Alex, I will take that. I will share an interesting anecdote that will provide the answer. We're actually, while sellers may try to push land prices up, you either hit your margin and your returns or you don't. So the market will tell you what they can get. What the seller can get for a price. But in southern California, I will use that as an example, we have actually are seeing more deal flow. There was a frenzy in the fall where you would get these scattered, give us a bid deadline type sales, and you would have multiple offers coming in. We have actually seen that soften where they are doing the same approach, they'll put an asset on the market, give us bids by March 1st, then on March 1st they're extending the deadline because they didn't get any bids. I think you had a initial frenzy out there that has since softened a bit because markets are still stabilizing and people that were banking on inflation found out they made a mistake. So, we are actually seeing more deal flow now than we were last August or September.

Okay. That is helpful. My other question was with regard to the impairment that you guys showed this quarter. I wasn't sure if you mentioned where that happened or what specific region that might have happened, and, what it was attributed to? Did you have to cut prices, or was it just too low of a sale's pace?

Alex, it was basically four communities across three of our regions. So, one region, our central region, did not have any impairments, so it was in the other three. I don't recall specifically what gave rise to the impairment, but, obviously with the impairments being about $7 million and the abandonment being another $7 million, it is a pretty small number for those four projects. So it was, they were all minor.

And we have time for one more question with Joel Locker, of FBN Securities.

Hi guys. Just a couple of quick ones. Do you have a total amount of customers deposits at the end of the first quarter?

We will look that up, Joel. Go ahead with your other question.

Then gross margin differential between Open Series and traditional in the first quarter. What was that roughly in basis points?

I don't know that we even have that, Joel, because we stopped differentiating.

Okay. And what -- I guess, those were the only two I really had left.

Hold it. Bill has the answer.

$6.7 million at the end of the first quarter.

How much was it?

$6.7 million.

$6.7 million in customer deposits. All right. Thanks a lot, guys.

Okay, thank you.

Gentlemen, I will turn it back to you for closing or additional remarks.

Thank you everyone for your questions. As we shared today on the call, KB Home made solid progress during the quarter and we are well positioned for the future. We look forward to sharing our results with all of you as the year progresses. Thanks for attending the call, and everyone have a great day.

Again, ladies and gentlemen that, concludes our conference for today. We thank you all for your participation.