KB Home (KBH) 2010 Q4 法說會逐字稿

Good day, everyone, and welcome to the KB Home 2010 fourth-quarter and year-end earnings conference call. Today's conference is being recorded and webcast on KB Home's website at kbhome.com.

The recording will be available via telephone replay until midnight on January 16 by calling 719-457-0820 or 888-203-1112 and using the replay passcode of 4152590. A replay will also be available through KB Home's website for 30 days.

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 condition 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 of its control, KB Home's actual results could be materially different from those expressed 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.

The discussion today may also include references to 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 Regulation G required information 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 Release link on the right-hand side of the page.

Now I would like to turn the conference over to Mr. Jeff Mezger. Please go ahead, sir.

Thanks, Kelsey. Happy new year everyone. Thank you for joining us today for a discussion of our fourth-quarter and full-year 2010 results. With me this morning are Jeff Kaminski, our Executive Vice President and Chief Financial Officer; and Bill Hollinger, our Senior Vice President and Chief Accounting Officer.

This morning I will provide some color on our operational and financial results and also discuss how our disciplined approach to executing on our strategic goals continues to generate steady improvement on many fronts despite the historic market conditions in which we are operating. Next, Jeff Kaminski will offer details on our financials, and then I will conclude our prepared remarks by summarizing our outlook for KB Home as we begin the new year. As always we will then open the call to your questions.

One of our key message points today that is our fourth-quarter results reinforce the fact that our strategy to return our Company to profitability is working. The primary components of this strategy, which we have consistently shared with you over the last couple of years, have remained the same.

These actions include continuing to execute on our disciplined KBnxt Built to Order business model; improving and refining our successful Open Series product offerings; rightsizing our overhead for current market conditions, while retaining our growth platform; maintaining a liquid balance sheet that allows us to be nimble and opportunistic; and reinvesting in highly desirable submarkets at attractive lot costs. As we continue to follow this successful roadmap, we are very pleased with how we have transformed and repositioned our Company as we head into 2011.

We are also very pleased to report a profit for the fourth quarter of 2010 based on our solid financial performance in a number of areas of our business. We generated net income for the quarter of $17.4 million or $0.23 per diluted share, with these earnings driven by improvements in our core homebuilding operations.

These favorable results demonstrate that we now have the capability to generate earnings on lower revenue levels, based in large part on our tremendous progress in improving our gross margin and lowering our SG&A expenses. Our reinvestment in top-performing submarkets in 2010 will create immediate opportunities for us in 2011.

For the long-term, we continue to operate in 28 of the best-positioned growth markets in the US where we have experience delivering significantly higher volumes than our current levels. In essence, we have reset our cost to operate and breakeven volume needs, and have a great opportunity to leverage our business platform as housing markets recover.

As we shared with you early in 2010, our goal was to achieve profitability at some point in the latter part of the year. In fact, on a cumulative basis we actually achieved positive net income for the entire second half of the year in spite of the volatility created by the homebuyer tax credits and the stronger-than-expected economic headwinds we experienced.

While recent data suggest that the economy has started to recover, this improvement has not yet resulted in sustained job growth or higher consumer confidence -- the two necessary components of any housing recovery. We recognize that without these two drivers the combination of soft demand and excess supply will continue to be a challenge, and the overall housing recovery will be a slow one.

Having said that, there are some encouraging signs. In many markets the most desirable submarkets that are close to employment centers are stabilizing. These areas are demonstrating price stability, fewer foreclosures, and supply and demand that are in balance.

This dynamic is a result of incredible levels of affordability that are attracting buyers to these areas, where they want to live but previously could not afford to. This trend will in the course of a typical recovery continue to gradually expand over time to locations that are a little farther out. At KB Home we have been investing in these more desirable submarkets that will be the first to significantly benefit once the eventual recovery in housing takes hold.

Turning back to our results, we were pleased with our overall financial performance in the fourth quarter, especially in light of the fact that we missed on our delivery projections. We delivered 1,918 homes in the fourth quarter as our backlog conversion averaged a highly efficient rate of nearly 90%. However, deliveries were impacted by an unexpected increase in our cancellation rate, particularly during the month of November, primarily due to a more cautious mortgage underwriting market.

In many cases, buyers who received loan approval at the start of construction were subsequently declined as their homes neared completion. Underscoring this issue is the fact that the average FICO score of our buyers in the fourth quarter was 723, the highest level it has been in at least five years, reflecting the more stringent lending standards.

Net orders during the quarter totaled 1,085, a 25% decrease from the fourth quarter of 2009, in part due to the increased cancellation rate and new stricter underwriting guidelines I just referred to. In contrast, our gross orders were down just 17%.

While our orders were disappointing, we did continue our sequential year-over-year improvement that has been occurring since the tax credit expired. We are hopeful this trend continues as we enter 2011.

During the quarter, we remained disciplined in our pricing strategy as we emphasized profit over volume. We will continue to evaluate the trade-off of sales pace versus margins, depending on demand, as we enter the selling season.

On a positive note, for the first time in nearly five years we saw an increase in year-over-year traffic levels in the fourth quarter of 2010. While encouraging, it is also our experience that today's consumer is both patient and diligent and is not buying a home on their first, second, or even their third visit.

Because of this lengthened buying process, driving increased traffic to our communities is an absolute priority. We are constantly developing new ways to bring potential buyers in, from offering free holiday family portraits at our communities in December to relaunching our How to Buy a Home events this month, which were such a great success last year.

In particular we have an expanded emphasis on the advantages of our Built to Order approach. Our Company has a history of creative marketing efforts, and we have a lot planned for 2011.

When you couple higher traffic levels with increased marketing outreach, the spring selling season, and our plans to Grand Open 70 new communities in the first half of the year, it is our expectation that order rates will improve.

We have also been prudently planning for the future growth of our business by investing approximately $560 million in land and land development in 2010. Our strong and liquid balance sheet has allowed us to opportunistically reinvest in highly desirable submarkets at lower prices, the kind of investments that can not only perform in today's market but have the potential for even greater margins or higher absorption rates as the market improves over time.

Our focus remains on finished lots or fully entitled land that can quickly go from land closing to housing revenue as we continue to transition KB Home into a more land-light homebuilding company.

While our average community count in 2010 was down year-over-year, we do expect for the first time in many years that we will increase our average community count in 2011. With sales per community that continue to be among the best in the industry, we are confident that our growing community count will bode well for our business going forward.

Now I will turn it over to Jeff Kaminski, who will provide a review of our financials.

Thank you, Jeff. As previously mentioned, we substantially improved our operating performance for the 11th consecutive quarter. After reporting positive homebuilding operating income for the first time in nearly four years last quarter, we repeated that encouraging result again in the fourth quarter of 2010, generating homebuilding operating income of $29.1 million, compared to a loss of $81.5 million in the prior year's quarter.

On a pretax basis we reported income of $15.4 million compared to the prior year's fourth-quarter pretax loss of $91 million. It was especially satisfying to report net income of $17.4 million or $0.23 per share in the quarter.

These results included non-cash charges of just $3.2 million for inventory impairments and abandonment in the fourth quarter of 2010 versus $77.2 million of charges in the fourth quarter of 2009 relating to inventory and joint-venture impairments and the abandonment of land option contracts. On a full-year basis, impairments and abandonments totaled $19.9 million in fiscal 2010, with the majority of those occurring in the first quarter, compared to $206.7 million incurred in fiscal 2009.

Despite the fact that we had anticipated some pricing pressures and product mix impact, reflecting in part the sale of more spec homes, our margins actually improved in the fourth quarter. Our housing gross margin excluding impairments increased to 19.7% in the quarter versus 19% in the prior year and was also up 150 basis points sequentially over the third quarter of 2010.

Factors contributing to this performance included continued pricing discipline as we emphasized profits over volume; an increased proportion of deliveries coming out of higher-priced communities in California; improved operating efficiencies; and product mix. In addition the trend of increased deliveries coming from new communities continued during the quarter. 37% of our bout deliveries in the fourth quarter related to previously impaired communities, compared to 79% during the same period of 2009 and 47% in the third quarter of 2010.

We delivered 1,918 homes in Q4 at an average selling price of $232,500, generating $446 million in housing revenues. This higher average selling price was primarily due to regional and product mix rather than pure price appreciation.

Our backlog at November 30, 2010, stood at 1,336 homes, representing potential future housing revenues of approximately $263.8 million. This lower year-over-year number reflects our high backlog conversion rate, increased cancellations, and softer sales in the fourth quarter.

Our SG&A expense ratio narrowed steadily throughout 2010, representing 12.5% of housing revenues in the fourth quarter. Our continued actions to reduce overhead produced our third consecutive quarter of improvement and a notable change from where we started out in the first quarter of 2010 at 27.5%.

This figure also compared favorably to the 13.8% reported in the fourth quarter of 2009. On a full-year basis, we achieved an SG&A expense ratio of 18.4% in 2010, in line with our guidance at the beginning of the year.

We ended our fiscal year with over $1 billion in total cash, maintaining our strong and flexible balance sheet even as we made considerable investments in land and land development totaling approximately $560 million in fiscal 2010.

Now I'll turn the call back over to Jeff Mezger for closing remarks.

Thanks, Jeff. As we have shared today, we are making strong progress on our financial results while maintaining a sharp focus on the disciplines of our KBnxt Built to Order business model and diligently expanding our growth platform. We are also constantly looking for ways to differentiate KB Home in the marketplace, recognizing that resales remain our biggest competitor.

One of the most impactful ways we are standing out against other new homes and in particular resale homes is through our sustainability initiatives. KB Home is receiving a lot of media and other third-party recognition for our sustainability programs, and consumers are responding favorably as well.

We have developed ways to include features that provide significant benefits to our customers without materially affecting the price of their home. In fact, our EPA ENERGY STAR qualified homes dramatically reduce our buyers' ongoing cost of homeownership. In an industry that does not have many game-changers this is definitely one of them, and KB Home has clearly established itself as the front runner in this area.

We were recently named the number one Green Homebuilder based on a study conducted by Calvert Investments, a leading voice on corporate sustainability performance across all industries. Our overall score was almost double that of the next best-performing homebuilder and over 10 times the average score of the remaining eight builders in the study. These results firmly establish KB Home as the leader of the industry when it comes to sustainability.

Our spirit of leadership and innovation in the area of Earth-friendly homebuilding will in many ways be embodied in our GreenHouse Idea Home created with Martha Stewart, which will be unveiled at the International Builders Show in Orlando next week. This beautiful and highly functional home is our first net-zero energy home, which means it produces more energy than it consumes over the course of a year -- a maximized energy-efficient home, according to the Department of Energy, that results in an annual energy credit rather than a cost for the homeowner.

This is an actual KB Home floor plan that we will offer in Orlando that has been inspired by Martha Stewart and equipped with state-of-the-art features we believe could one day be standard in all new production homes. The KB Home GreenHouse has served as a laboratory for us to explore technologies that are new to KB Home, and we look forward to showcasing how a volume homebuilder can apply these technologies that are good for the environment and a real benefit for our customers.

We will also leverage the showcase event to promote a new Martha Stewart community nearby that will feature this floor plan and open for sales in the spring. Our sustainability initiatives are not only ingrained in our culture; these accomplishments are cementing the KB Home brand as the number one environmental choice for home buyers.

In addition to sustainability, we have also differentiated KB Home through our brand and marketing efforts, our Open Series product innovation, and the many benefits of our Built to Order business model -- from the value and choice consumers appreciate as they go through the studio process to the risk-averse attributes of our presold delivery cycle, land-light positioning, and mortgage venture with Bank of America. We also believe our business is concentrated in the right markets for when housing recovers.

In closing, let me summarize our 2010 accomplishments. We continuously improved our operating performance including reducing costs and growing margins, culminating in a fourth quarter and second-half profit. We refined our popular Open Series product lines, lowered our cost to build, and accelerated our Earth-friendly homebuilding initiatives to meet the demands of today's homebuyers.

We achieved record high customer satisfaction levels based on both the recent J.D. Power & Associates surveys and our own internal customer satisfaction scores. And we invested in well-positioned submarkets that set us up for future growth, while maintaining over $1 billion in cash.

As gratifying as it is for our Company to reach profitability in the fourth quarter and second half of 2010, we recognize that there are many challenges still facing the housing market that will likely persist until the improving economy translates into job growth and higher consumer confidence. It was the transformation of our Company over the past few years with a constant focus on operating efficiencies that allowed us to report a fourth-quarter profit and set up the capability to achieve profitability at lower revenue levels. At the same time we have retained the strategic leverage of our growth platform, which will provide significant opportunities as the markets recover.

As we look forward to 2011, the essential elements of our strategy as a Company include adhering to the pure execution of our KBnxt Built to Order business model; working diligently to expand our top line by growing our community count and increasing traffic and sales conversion levels; continuing to opportunistically invest in targeted desirable submarkets; seeking out additional efficiencies and driving down our costs; maintaining our strong balance sheet; remaining nimble and proactive in response to the market conditions; and achieving world-class customer satisfaction levels.

As I have said many times, we cannot control the market but we can control how we operate within it. And these strategic actions are all within our control.

We do believe the economy is starting to improve. However, it will be some time before housing markets fully recover. In the meantime, KB Home will continue to execute our integrated strategy that allows us to successfully compete in today's environment as we remain committed to the goal of running a profitable business at whatever scale the market will sustain.

I would like to recognize and congratulate the KB Home employees for their continued efforts and accomplishments. I know our Company would not be this well positioned without the commitment, pride, and enthusiasm that the KB Home team brings to work each day.

As we begin the new year we are confident that our business strategy and results have positioned us to be profitable. If the market gains strength, we are poised to generate upside. If the market does not strengthen, then we will react accordingly and make adjustments.

We are both optimistic and cautious; but above all we are prepared for whatever the future holds. With that Jeff, Bill, and I will now take your questions.

(Operator Instructions) Jonathan Ellis, Bank of America, Merrill Lynch.

Thanks and good morning guys. First wanted to talk about just the cost structure. Gross margins and SG&A -- on gross margins, given the strength in orders in your California market, would you expect gross margins through the first half of 2011 to remain around current levels? Or perhaps because of product mix shifts there may be some gross margin compression?

Then on SG&A, any reason to think that the current level of SG&A -- and obviously putting aside how sales commissions may affect that number -- but just the G&A portion, any reason to think that that would deviate from where we are right now going into 2011?

Jonathan, let me make a couple of comments, then I will refer it to Jeff K -- to differentiate us today -- to give you the specific numbers.

Relative to gross margin and mix, based on where we have invested in 2010 we do expect over the year for California and Texas to become larger parts of our mix, California in particular being the driver. It is difficult to peg it and say margins will be higher, in that even within California there is a big difference in margin between a home that we deliver in Redwood Shores and a home we deliver in Sacramento, within the same division.

So in any given month with our revenue levels you can influence margin a lot by a handful of communities within the mix. Again, I will let Jeff speak to the specifics.

As to SG&A I can share that the improvements in SG&A have not necessarily been tied to the variable sales costs. I believe that our selling cost, whether it is commissions or closing costs, have remained fairly static. The improvement is more in the other costs within that bucket. Any color for him, Jeff?

Yes, I will add a little bit of color on the SG&A side especially. The volume impact, we are running at about 6% variable; that stayed pretty much consistent quarter over quarter as Jeff said, as well as in last year same quarter. That brought us about $10 million of savings in the current quarter due to the top-line volume levels.

We had some pretty significant savings in categories such as salaries, rent, in some compensation, and insurance of about $12 million. We did have some legal recoveries during the quarter, which is good news for us.

As everyone is aware we had some unusually high legal expenses in the first part of the year, and we are going through some tremendous efforts right now to gain recoveries, whether it be through insurance or through any other means possible as we go forward. So we had about $3 million of recoveries in the quarter and plan to continue to push for that as we go into 2011.

Then professional fees and outside services were also down about $3 million in dollar terms. So the way I characterize it, actually both on the margin side and on the SG&A side, is we had as always a number of things going both ways; but the predominance of the activity this quarter and during the closing process were on the positive side.

So we had just about everything going the right way for us. It was a very satisfying quarter both from an expense control point of view as well as from a margin point of view. And we were pleased with that result.

Okay, great. My second question is just looking into community count; and I appreciate the guidance in terms of 70 new community openings. I think you had previously given a target of 25% growth in 2011.

Maybe if you can just help us out with where community count ended this year, so we have a sense of what the starting point is. And then to the extent -- do you still feel that your community count will grow for the full year around 25%?

Go ahead.

Yes, we ended the year at about 132 communities, which gave us an average for the year of 130 under our calculation methodology. As we had mentioned we are planning to open about 70 communities in the first six months.

I think importantly, the regions where we are planning to open those communities are heavily weighted towards California and our central region, with about 50 communities opening in those two markets overall. We are still expecting 25% increase in that average, so it is pretty much as planned as we have been talking about for the past couple of quarters.

It is actually a very nice mix. As we have shared, we are positioned now where we are incurring the cost -- we are starting to incur the costs of these openings as they come online in the next five months, at the same time having lowered our overhead structure. So you have a nice revenue opportunity at a lower cost level.

Ivy Zelman, Zelman & Associates.

Good morning, guys. With respect to your impressive profitability, I think everyone is kind of looking at the sustainability of that. You said that you were challenged with underwriting that is more stringent, which resulted in a pretty nice increase in cancellations.

So I guess whether we ask it slightly different than the prior question -- your sustainability going into 2011, even on your backlog being as low as it is, do you feel pretty comfortable with that? And that the revenues, although likely to be down because of backlog and continued struggles or challenge in the market, should not be mitigating the profitability and enabling you to remain profitable in the first and second quarter?

Ivy, I will talk to the backlog and the market situation, and then Jeff can go to any guidance on where we are headed. As we mentioned in our prepared comments, we were surprised by the cancellations we incurred, which were primarily on homes under construction, not dirt. As you know, in our business model normally your can rate is higher on homes you haven't started, as you filter through it before you start the home.

We are trying to get our arms around whether it is changes in documentation. The cautious approach that lenders are taking -- and I say the industry, not just our venture partner -- has required us to kind of reset expectations on what you have to provide to lenders in the process and up front so we don't have any surprises at the 11th hour.

I don't think that that is a sustained can rate. I think it is a short-term spike, because we will reset and we'll figure it out, and we'll go right back to work.

Relative to backlog, obviously we'd like more backlog at any time because it is a crystal ball for us, since we are going to say stay disciplined as a Built to Order Company.

We have shortened our cycle times where we can take backlog and convert it into deliveries and revenue much faster than in the past. And heading into the year we have some work to do.

Our backlog is down. Well, you look at the percentage; I want to say it is 400 or 500 in units, something like that. So it is not a big number to catch up and pass.

We will wait and see what happens as we open these communities and as we see how the spring selling season evolves. We elected not to chase sales in early November, at that time in the year, by getting very aggressive on pricing because there is not that many buyers that are going to show up and close in three weeks during the Thanksgiving season or certainly into December.

So we elected -- let's turn the corner in 2011 and see what type of market we are facing.

Okay. On the guidance side, given the current uncertainty around the markets and the lower order rates that we have recently experienced, we are really not planning to give detailed guidance during this call as far as how 2011 will shape up. Instead we would like to make a few more directional comments.

I guess first of all starting with the first quarter, given the backlog levels and what we expect volume and top line to be, it is not likely to be a profitable quarter for us. While we would certainly like to push for that, it is probably not in the cards for us in the first quarter.

Despite that, however -- subject to the selling season again, and the strength in the top line -- we do believe we are well positioned to have a profitable 2011 in total as we go through the year. So that is pretty much where we are at right now. As far as specifics, as far as percentages, we are basically going to stay away from that during the call.

Appreciate that. My second question, with the media having recently discussed the joint venture you are involved in with the largest builder, at 48% of Inspirada, can you give us much information to I guess mitigate uncertainty around the potential risk associated with this joint venture, with JPMorgan trying to push you guys into involuntary bankruptcy, and the risk associated with the debt and taking down lots priced at $500,000 as the original value in '04?

Sure; I am glad you asked that question, Ivy. Because I know that that issue has gotten some media coverage recently. Before Jeff gives you the financial details I would like to make a few comments about the actual Inspirada community itself, which is the development that is underlying the South Edge joint venture.

To date we have delivered 534 homes at Inspirada since it opened in 2007, and it continues to be one of our best-selling communities in Las Vegas due to its highly desirable location in one of the top-performing submarkets in Vegas today. We are currently open for sale within the development, and we will actually be introducing an additional product line this spring.

During the fourth quarter, we delivered 40 homes in the various Inspirada communities where there's amenities in place including pools; there's clubhouses; there's parks; there is an amphitheater. It is really a nice community where we are selling the homes today.

I say that because we have a real stake in the success of this community where we have our employees and also our customers that matter greatly to us. I will talk briefly about the recent news regarding Inspirada, and then Jeff can give you the financial detail, all of which is intended to address the questions that the people on the call may have.

As you have seen and heard, on December 9 JPMorgan and two of the other lenders filed an involuntary Chapter 11 bankruptcy petition against the South Edge joint venture. It is another step in what has been a several-year litigation process.

Yesterday the South Edge JV filed papers asking the bankruptcy court to dismiss the involuntary bankruptcy petition. We agree with the South Edge filing. The bankruptcy judge is scheduled to decide by early February whether the case would proceed or whether it will be dismissed.

Jeff, recognizing it is in litigation, can you provide the details that we can share?

Yes, I would be happy to, Jeff. Much of this we have shared in past public filings, but I think it will be helpful to go over a few things again.

First of all, we have accounted for this entity as an unconsolidated joint venture. A subsidiary of KB Home -- KB Home Nevada Inc. -- owns 48.5% of the entity. At year-end for us we had $49 million of investment balance and the unconsolidated joint venture had bank debt of approximately $328 million in outstanding principal. The original capacity of the bank facility was about $585 million.

As you can read in our third-quarter 10-Q, the Company has also provided to the lenders a limited several guarantee of certain of the JV's obligations, which may be triggered by an involuntary bankruptcy of the venture that is not dismissed within 60 days. At November 30, 2010, if the guarantee were then in force the Company's maximum potential responsibility under the guarantee could have been about $180 million in principal.

In addition there may be claims by the banks for fees and for accrued and unpaid interest, our share of which could run into the tens of millions of dollars if the banks are successful. However none of these figures take into account any offsets or defenses that could be available to us.

Also disclosed in our third-quarter 10-Q on July 6, 2010, a decision was issued in an arbitration proceeding regarding the South Edge joint venture in order to address one member's claims for specific performance of lot takedown contracts and, in the alternative, damages.

In its decision the arbitration panel denied the specific performance claims that would have forced the purchase of the land. Instead the panel awarded damages to one of the venture members in the amount of $36.8 million, which we thought was erroneously high and which we are seeking to reduce on appeal. KB Home Nevada Inc. will be responsible for a share of the final award.

Now let me take a minute to return to the involuntary bankruptcy filing that we discussed earlier. You may have read that the lenders are seeking the appointment of a trustee for the venture who would then, according to the press report, attempt to force the builders -- including our subsidiary KB Home Nevada Inc. -- to buy land from South Edge. For a number of reasons we do not believe that this should occur.

As Jeff said, we believe that the involuntary bankruptcy petition should be dismissed. If that happens, litigation between the builders and the lenders will continue in the federal court. The lenders have asserted claims under guarantees as well other claims, all of which are disputed.

In connection with our period-end closing procedures and in accordance with US GAAP, we assess the carrying value of our joint-venture investments and we assess our potential liabilities resulting from pending litigation. In prior periods we recorded and at year-end we carried significant provisions on our balance sheet for potential contingencies relating to this issue.

There's a wide range of possible outcomes in the South Edge litigation, from good to bad, as in any complex litigation; and the ultimate result could be materially different than our assessment.

As Jeff said we are proud of the Inspirada community and we want it to continue to succeed. We remain hopeful that we can reach a mutually satisfactory resolution with the lenders.

Due to the outstanding litigation we really can't comment much beyond the above. Please also reference our 2010 Form 10-K that will be filed prior to the end of January for disclosure relating to our unconsolidated joint ventures, including this one.

So like I said, that is pretty much what we are prepared to say today on the JV; and hopefully that provides some additional level of detail to the folks on the phone and helps clarify some of the uncertainty around the issue.

Michael Smith, JMP Securities.

Just a couple quick questions. One is, could you just give some color on what is happening out there in the land market? I know we heard early in 2009 it really got heated, and then it slowed down quite a bit.

I am wondering, in anticipation of maybe a little bit better 2011, especially in the spring, if you have seen it start to heat up again and what effect that is having on pricing in the places where you guys are looking.

Well, you are absolutely correct that back in the spring of '10 there was some frenzy out there as people started feeling better about things, whether it was builders or some of the speculators that are out there playing in the land market. That frenzy quickly went away by late summer and into early fall.

The public builders in particular continue to be very disciplined. We are not seeing a lot of pressure right now on land prices moving up. I think it has calmed down again.

We remain very disciplined on underwriting to our hurdles and very selective in where we are going to invest. So if the things that hit the media -- like the portfolio auction with 50 bidders and the high-gloss brochure -- we are not even participating in those kind of things.

Most of our acquisitions continue to be created through our network, our relations with -- our long-term relationships with developers and land sellers. And frankly in many cases the parcel doesn't even go to market when we have tied it up.

So I think if the market improves you will see more pressure on land pricing. But we are not seeing it at this point in time.

Okay, thanks, guys. Then another question just to follow up. You were speaking earlier, Jeff, about not lowering your prices in November as a way of bringing out buyers, because you understood you didn't have much time -- or they wouldn't have much time to close.

I am wondering if that is a way of saying that you might be more open to some price cuts or some added incentives in spring if the demand doesn't materialize. Or are you guys still of the opinion that demand is pretty inelastic at this point and the buyers are going to come and the buyers are going to come, and there is not a whole lot of pricing options that you have there?

Sure. Well, I can make a few comments, Michael. It is kind of a numbers game. The more traffic and the more demand and the more buyers, the less you have to do to sell homes. Pretty fundamental theory.

In November your traffic levels are lower than they are in February or March, so you will have more people and more interest naturally. We just elected not to even test -- hey, if we lowered prices by X% how many more could we sell in November? Because I just don't think it would have had that much of an impact.

As we enter the year -- and we have always shown flexibility to do what it takes to run our business -- we will continue to manage each asset. It is not a Company strategy; it is a community strategy, where we will try to balance the sales pace to the price to the margin to the cash flow.

What is the return? What is the best way to manage in that subdivision? And if in a submarket in that subdivision we are not getting close to the sales we need, we will do something to make that a more attractive value proposition to the consumer.

Having said that, we don't fall in the trap of throwing more incentives out there. Our business model is based on value to the customer, so you won't see us playing Let's Make a Deal.

We will offer the best value. And if we are out of the market, and it is not selling, and we have got to get out of the asset it would probably come in adjustments to price.

We are hopeful here, between the mix of community openings, the traffic uptick that we saw, which tells us there is momentum building in consumer demand, that we can fall into what I will call a muted typical spring selling season. And if we get that I think we will be fine. If it doesn't show up we will take whatever steps we need to, to keep selling at a level that covers our overhead.

Michael Rehaut, JPMorgan.

Thanks. Good morning, everyone. First question, if I could just circle back to the order trends during the quarter. I was wondering if -- just to peel back the onion a little bit more. You had mentioned that the can rate difficulties were centered -- popped up in November. Did they come back down in December?

I was wondering if you could also just walk us through how the can rate trended throughout the quarter. And also order trends in general, if you saw a softer sales pace or absorption rate as you got through the quarter as well?

Michael, I mentioned the can rate spike in particular in November. It was higher in October than it had been. September was fairly typical.

The can rate normally is a sign of how stable or instable the market is. For a five-quarter period our can rate had been pretty consistent. When I say can rate, we look at it both as a percent of backlog or a percent of gross.

As a percent of backlog even it had been pretty consistent for five quarters. All of a sudden it spiked here in October and November.

I don't think it was a spike because of a big shift in consumer sentiment or people that don't want to buy a home. Normally when people have made the decision to buy with us, been through the studio process, have been advised that their loan is either approved or very approvable, they are now relieved and they wait for us to get their home completed.

What happened here in the fall -- again particularly in November -- as homes were getting completed, new conditions came up. More requirements came up, and people that were once approved now can't qualify for the home. So it was an odd dynamic that we are trying to get our arms around.

As we said in our prepared comments, the traffic trends in November are very encouraging because they were up -- well, not just November, the whole quarter. But November our traffic held very well.

So we can say it is a softer holiday season, but traffic levels were high. Traffic was up about 11%.

In December we can share -- we don't like to do a lot within the current quarter and you certainly don't like to gauge December as a reflection on what the overall market is going to do because of the influence of all the activities and the holidays. But even in December our traffic levels continued to be up year-over-year.

So it is very encouraging as we head into 2011, and we will see what it means.

Okay. I appreciate that. Just the second question. First off, just following up on the first question, if there is any way just to comment on if can rates receded as you said you expect it to be -- it's a spike; you expect it to come back down. I was just curious if you could comment on December.

But aside from that, my follow-up, my second question is on the comments from last quarter regarding spec -- that you thought you might increase spec as a percent of your product offering. Historically I think with the KBnxt Built to Order it is in the single digits perhaps of closings. I was under the impression that you were thinking of maybe pushing it up to a 20%-ish type range, which is still below I think a lot of other builders but higher for you guys.

With the volatility in the can rates, does that give you pause to maybe go back to historically how you approach spec, in the lower single digits? Or are you going to stick with maybe a higher level of spec for you guys as we go into the spring?

Michael, you just exceeded two questions by the way, so -- but we will answer it since you successfully blended it together and tied it to the same thing. I don't have and Bill is telling me we don't have with us right now what the can rate is in December. Again we are early in the quarter.

My hunch is it will settle down. And whatever it is, we will manage to that issue.

But relative to the spec strategy and our Built to Order model and where we are going ahead of time -- or not ahead of time, but into '11, it has been my experience over the years that it is not unusual to resell a spec two or three times. It is not a predictable business model. So the last thing I would want to do is throw more specs in the ground to lower a can rate or to have more of a predictable revenue stream.

Jeff can talked to the spec and the backlog ratios in a minute. We as a Company have always had the goal of a 90/10 ratio, 90% sold under construction, 10% unsold.

It has been elevated a little bit over the last few years depending on what level of stability there is in the marketplace. So it has probably been 80/20, 85/15.

It broke my heart to decide to go into that spec strategy going into the second half of '10. When you take a look back at the 10 or 12 years I personally sweated and bled in order to get us to this business model, you risk giving it away as you are dealing with today's business environment.

Nevertheless we did; and I think along the way it created some confusion for our sales team or our brand or our customer. We have an intense focus on getting back to our core business model, are not starting much if any inventory today -- maybe that odd lot that is left on a cul-de-sac. We are pure on our business model from a selling effort point of view.

The spec strategy was successful relative to helping us cover revenue and achieve the deliveries that we did in the fourth quarter. But it is not something we are sustaining going forward. The flag is in the ground; we are committed to being a Built to Order Company.

Yes, Mike, I will give you a little more detail on the numbers more specifically. As you know when we ended the third quarter we had a higher amount of unsold inventory than is usual for KB. We had about 400 units of finished and about 600 under construction, or a little over 1,000 units total.

The spec sales during the fourth quarter helped cover a part of our unexpected spike in backlog that we experienced.

Can. Can spike.

Right, I'm sorry; yes, can spike. So we are happy with that. The strategy worked well. We sold through a fair amount of the inventory during the quarter.

We ended Q4 reducing the total unsold inventory by about 300 units. So we were down about 30%, from 1,000 units down to about 700 units at the end of the fourth quarter.

Of the 700 -- and I think it is important to note that of the 700, about 175 of those units relates to the two Southern California condo projects that we have discussed in the past, and that is a pretty significant number. So if you pull those out you are at about 500 specs at the end of the quarter, both finished and under construction, and a much more reasonable number for the business.

So in summary a few things. During the quarter again we did think the strategy worked well. It helped cover some of the cans that we had.

As Jeff said most of the additional specs, if any, that started during the quarter were actually as a result of cancellations. So we are really back to the business model as we have operated in the past and as we will continue to operate it.

We will continue to work through those unsold units through the system, and we expect to work through those in the first half of 2011 as we get to a much more normalized level for the business and for the strategy. So we really don't see it as a problem or an issue, and we are really not totally out of align as we are entering 2011.

We do believe it will be an issue that we will address, and we will continue to stay on our strategy of Built to Order.

The other thing that I could add, in our experience in the fourth-quarter deliveries, the margins on the inventory we did sell was lower than our Built to Order delivery. So while it got us to top line and helps cover the overhead, it does mute your gross margin because your margins don't run as high.

So I like being predictable with higher margins, and that is our goal.

Buck Horne, Raymond James.

Thanks, gentlemen. I guess just talking a little bit about buyer preferences right now, for those that are qualifying for the mortgages and aren't having to get canceled, have you noticed any shifts in buyer preferences? Has the economy started to improve here? Are buyers -- feel very value focused, or are they starting to look at larger floor plans or more upgrades and options?

Is there any change in the consumer? Are they loosening up the purse strings any?

It is a great question, Buck. One of the things I would like to add to your question, when we talk about some signs that maybe things are normalizing, certainly in the more highly desirable submarkets. But prior to the frenzy in the middle of the decade, about 50% of our buyers would go to the studio, identify what options and features they wanted in their home, and then go buy the house.

And that had been in place for seven or eight years prior to that. That would have suggested at the time that a buyer intended to live in the home longer and wanted exactly their features and benefits in the home.

In the frenzy, when people started buying to flip or buying as an investment or not expecting to live there very long, that process really was muted. Most of the people bought the home and then went to the studio.

Over the last 90 to 120 days we have seen the trend reemerge where a lot of the buyers -- I don't know that it is half, but it is a big number -- are once again visiting the studios before they buy their home. So it tells me we are back to a buyer that is value conscious and wants to put in the home what they want for features and benefits because they intend to live there.

Having said that, I don't know that we have seen any material shifts over the last six to nine months relative to the selections that they are putting in the home. For most of last year the buyer was very much value conscious. My quote is always -- the Jacuzzis and granite are gone, and they would rather have an extra bedroom or a second bathroom or functions in the home, or a little bit larger cabinet combination in the kitchen, things like that.

So very value conscious and a buyer that intends to live there.

Great, thank you. My follow-up is kind of a shift gear, but I just want to drill down really on the Florida markets. Just wondering what your current thoughts are and kind of the state of Florida in terms of the housing situation right now.

Would you plan to I guess possibly shrink your presence here until we start to work through some of these foreclosure and excess vacancy issues?

Buck, I don't know if you saw any of the comments from Bernanke this morning, but he and I seem to be on the same page because he observed that, while the economy is definitely headed in the right track, there hasn't been a lot of traction on jobs. You need the jobs to help housing, and he went from there right to housing and that housing still has issues.

I think those two combinations are most appropriate for Florida where a lot of the markets were driven by second-home buyers or pure speculators instead of people wanting to live in the home, because they were occurring in markets that didn't have a lot of jobs in the first place. I think it will be some time before those peripheral areas get any kind of traction in housing. You know, up around Punta Gorda and north of Fort Myers or the stretch between Palm Beach and Daytona Beach.

Having said that, we are very bullish in the long run on the core markets that we are in of Jacksonville, Orlando in central Florida, and then Tampa in the West Coast. I smiled when you asked if we are reducing our presence, in that we already have by default. We are a much smaller business than we once were.

I do believe we are a large builder in Orlando, the last number I saw. We're, if not the largest, one of the top builders. I'd say the same in Jacks and to a lesser extent Tampa.

So our intent is to manage our assets, keep our position, keep our network, keep our brand. Be as lean as you can on overhead, and when things show the stability that we are seeing in Texas or in California, we will go right back in and have a spring coil. So we like the state; we just think it is going to be one of the slower recoveries.

Joshua Pollard, Goldman Sachs.

Thanks for taking my question. The first is you talked about having higher traffic levels in the fourth quarter, and I think even into December. I am looking at the comp and the fact that the first version of the homebuyer tax credit expired right around this time last year.

When you guys look out to the second half -- or excuse me, the first half of 2011, would you anticipate that traffic levels would continue to be higher than they were versus the previous year comp?

Let me make an observation for you, Josh, and then I will give you my thoughts. We stopped promoting that first tax credit in July and August because we are a Built to Order Company, and you had to sell it in order to build it and still qualify for the credit. So our promotions tied to the credit actually ended midyear.

In '10, about this time last year, we saw an uptick in traffic. We saw an uptick in interest. My sense is the tax credit didn't start to be a real driver till March and April when you approached the deadline and there was this urgency created because of the deadline.

It is normal this time of year for traffic to tick up. I find it very interesting that in the November-December period traffic ticked up when in theory it's everything else going on and people aren't out looking for houses.

So it is encouraging. I would expect traffic levels overall will be up in the next few months because of the time of year we are in. Unclear whether it is going to be up greater than it was with the tax credit influence, but we will see. It is an encouraging sign.

Got it. The other question I have and I will make it a two-part question in Mike Rehault fashion, but I won't tie them together.

The first is on your balance sheet. With your debt levels I think you guys are net debt to cap roughly 55%. Are you guys comfortable there? Or in the cautiousness of your outlook do you guys think that it starts to make more sense to start paying down debt with your cash?

I'd love to understand what you guys think is more than just a long-term capital structure, but where you think your capital structure should be over the next 12 to 18 months.

The other question I had -- because I want to try and sneak it in -- is, if you look at your spec as a percentage of your backlog, it was under 40% at the beginning of this fourth quarter. As you guys head into the first quarter, it is over 50%. That is just a quick calculation of what your spec count is relative to your backlog.

I am trying to understand how that supports stable to higher margins. Thanks for taking those questions, guys.

Okay. Josh, I will speak high level and then Jeff can share his thoughts on our balance sheet. First off, in normal times our range of a comfortable ratio as we have been for years is 45% to 55%. We are net debt 55% today; but you are excluding the value of the DTA. As we can restore profitability, if that DTA were to reverse, you've got a ratio significant below that. I think it is even under 30%.

Obviously nobody knows when that will be reversed and what impact it would be. But I wanted to remind people that there is another element to this that is influencing our ratio relative to historical.

On the spec level, again keep in mind -- of those numbers you just rattled off, 170 of them are tied to two condo projects, one of which we just started reporting those numbers in the fourth quarter.

So you have to look at each community on its own. These condo buildings you don't open for sale until they are completed, so it is going to look like we have more inventory. If you backed those two out where it is not backlog, and you have got this inventory, I think your ratio is much better.

We demonstrated in the fourth quarter we got rid of some inventory. It did hurt margin, yet our overall margin was favorable. As I have shared on this call we will deal with each community on its own and keep the balance of sales, pace, and margin.

Any thoughts on capital structure?

Yes, I will talk about the balance sheet for a minute. First of all, Josh, yes, we are comfortable with our debt levels right now from the point of view of being able obviously to service the debt and also to refinance the Company as we have maturities.

I think you are aware that we do have $100 million maturing in August of this year, which we obviously intend to take down and at this point not replace. So we will get some lower leverage out of that.

We also have some project debt that we are looking at taking down actually as early as the first quarter. With the combination of the two we will obviously we have some leverage improvement.

There are some opportunities beyond that. There's opportunities that we are exploring to reduce the negative carry. As you know with $1 billion in cash and the debt levels we have and with the current interest rate environment, we are experiencing some significant carry -- a very obvious statement -- on the outlook or on the profile right now. And we are exploring those opportunities to reduce that.

I can share also that we recognize the cash. It is an interesting observation when you say the cash is a debt asset. It is relative to it is not generating any return, or it could be used to lower your cost through debt restructuring.

Having said that, it is also our opportunity for growth and our assurance that we can be able to manage through an extended downturn.

I continue to look at the economic environment. If things were to work here again I think the cash will come in handy.

There isn't a day that goes by that Jeff and the team aren't talking about what to do with this, or I am in there talking about what to do with this. So it is definitely on our radar. And as Jeff said we are exploring alternatives, but there is nothing we're ready to say we want to do right now.

David Goldberg, UBS.

The first question I had -- I was wondering if there was a way to tie the increase in traffic maybe not coming through in orders at this point to something with the underwriting standards. In other words do you think the people that are coming to the community can qualify under tighter underwriting standards? Do you think that is an issue for people that are out there shopping now but maybe not moving forward with the decision?

Obviously tighter underwriting standards are going to reduce the number of potential buyers. But some of the anecdotes I was sharing, David, these buyers that we were managing through in Q4, it wasn't always income or credit. It was other issues, other conditions, other documents, other requirements that came into play that may not have been as big an issue in the past.

Whether it is FHA and VA or conforming conventional, the money is still available. We have been selling homes at the prerequisite FICO scores under FHA for some time now.

So it absolutely reduces your pool, but there is still a pool out there for us that is more than ample to service our business needs.

I think it gets down to people may or may not feel good about the economy; may or may not feel good about their jobs. Definitely see the traction to the affordability levels that are out there today and the appeal of our proposition, the product that we have to offer. They are just taking their time.

The days of the floor pop are gone, as I used to call it. I think because of that, our strategy is -- let's go invest and be more aggressive to generate more traffic.

It is a numbers game. The more traffic you get, the more sales you get. And depending on your conversion of traffic to sales, you will target a traffic goal that will eventually turn into a sales goal.

I wouldn't tie it to the qualifying. I would just say people are cautious and concerned.

Got it. Then Jeff Kaminski, just to make sure I understand. With the change in the SG&A that you outlined in the comments, my understanding was about -- if we look sequentially and the number was about a $23 million reduction in the SG&A, and I think you said $10 million of that came from variable cost reduction and just lower volumes generally. And the remainder was from fixed cost, if I understood you correctly.

Within the fixed cost it seems like it was a $6 million delta from legal costs, of which about half of that was recoveries and the other half was not incurring the additional legal costs that were out there. Is that correct, how I heard that?

Well, yes, it is correct in some respects; it may be incorrect in others. First of all the comp in the numbers I went through were year-over-year. So it wasn't third quarter to fourth; it was fourth to fourth. I thought that was a fairer comparison and way to depict it due to some seasonality that you always get in the fourth quarter.

So you know, with the $173-odd-million reduction in volume, that had about a 6% expense savings associated with it that would be because -- that's about our variable cost ratio. So that is where we started; the other comp numbers were compared to that prior-year period.

You are correct in your assessment on the legal side. We did have $3 million as recoveries, and we had $3 million of improvements of reduced basically professional. And not just legal but overall professional and other outside service costs during the quarter.

Dan Oppenheim, Credit Suisse.

I was wondering if you can talk a little bit more about the specs. I guess last quarter you talked about 850 specs; now you're saying that number was really 1,000 but that either way it came down to 700.

But you said that the cancellation rate went up in October and November closer to the end of the quarter and that you weren't pushing the volume. Was it that your spec levels came down significant in September at the start of the quarter?

I guess trying to understand what happened and if you expect -- if you have cancellations at the end of the quarter typically that means more specs, not fewer.

Yes, Dan, just to clarify on the numbers at the end of last quarter the 1,000 specs -- that was total. That was the gross.

It was 850 or roughly 850 net of the condo units. So just a quick clarification on that.

We have been separating that as we talked about before because of the nature of condo buildings, where you are putting up the building and you are building the units; and by definition if you choose to open the building all at once you have all those spec units either under construction or final. So that is the situation with the numbers.

The other thing I could add, Dan, and you have tracked us for a long time, but typically we have had the benefit of a backlog that is stable and delivers when the home is completed. It got disrupted earlier, a few years ago when things got a little more fragile.

It had settled down for five quarters in a row. The can rate, we didn't break it out between inventory we sold in the quarter and presold homes that came to completion then the buyer couldn't qualify or didn't perform. But there was a lot of cans that occurred on homes that were sold and in construction at the start of the fourth quarter.

So if you look at it, we are covering some of the inventory and we have shared that that did help with the revenue. We had some cans on some of those that were started that we then would have covered. But overall we dropped our -- if you eliminate the noise of these condos that are not a large part of our business, we dropped our inventories. Jeff, 300 units was your number?

300 units.

About 300 units in the quarter.

Okay. I guess on gross margins, and there is a significant sequential increase there in contrast to what we were seeing from most others in the industry. You were selling more specs in the quarter which typically isn't good for gross margins. The ASP on closings was significantly higher than the ASP in backlog.

It seems there are some things going on there, I guess. How do you describe what is the underlying trends there and as you think about that into the start of 2011?

I shared, Dan, we know the margins were lower on the inventory deliveries, the spec sales that delivered. We also shared that we are seeing more business come out of our new communities as we open them.

So you have this lift going on of the good bank, quote unquote; and I put specs in the bad bank. So you had offsets going both ways on margin that, blended together, had a very nice outcome.

At our revenue size your margin can move around a lot depending on the mix. If we deliver 50 homes out of San Jose or Redwood Shores at $100,000 a copy in margin versus a suburban Houston home at $15,000 a copy in margin, it is a big difference.

So we don't have the straight line we once had when we had a lot more scale. I don't know if you want to give him any more thoughts on margin or (multiple speakers).

No, I think that pretty well sums it up. The drivers that we talked about during the first part were the main drivers on the margin. The pricing discipline. The specs were less of an impact than we had thought coming into it.

Our mix shifted a bit during the quarter versus what we had anticipated. And it is significant that we did decrease the level of deliveries coming from previously impaired communities by another 10 percentage points during the quarter.

So it was like I said earlier on the SG&A and the margin. Virtually any of the factors, almost all the factors were positive this quarter, which is a little bit unusual. Usually you get more offsets going both ways. We had a very fortunate quarter and a very good quarter of management by the team here at KB Home to generate that result.

Carl Reichardt, Wells Fargo Securities.

Just one -- two on land. First, do you have the owned and option lot count at the end of the quarter, Bill?

Yes, Carl.

I have it right here, Bill.

Okay.

Yes, we had 9,300 lots optioned at the end of the quarter. We had 39,500 in total.

Okay. Then you can you talk a little bit about -- to the extent you have it -- projected land spend for 2011 and land and development spend?

Also do you think there will be a point over '11 or into '12, a tipping point where your qualifying inventory balance will start to allow you to cut back your interest expense and capitalize more?

Carl, I can make a few comments. We haven't pegged a number yet for '11 on land spend, whether acquisition or development. Frankly our sales experience over the next three or four months will drive that.

We continue to be opportunistic in these preferred submarkets that I am talking about. We continue to underwrite at today's price, which gives you on automatic governor on how much money you're going to spend, and to our hurdle. So we have these governors in place where we are opportunistic, but it needs to make sense and it needs to be aligned with our strategy.

For the year in '10 as I recall, we ended up growing our lots owned and controlled by about 2,000 through the year. Heading into '11 we have now demonstrated -- and you know we have $1 billion on the books -- we can be as aggressive as we are comfortable with and we can be as prudent as we need to be, depending on where the market takes us.

It was -- I don't think anybody has asked the question yet, but our investment heavily, heavily weighted to highly desirable submarkets in California right now. I say that because in a lot of the other markets it's an easy term option and you can buy a lot when you sell a home.

But those also are places where the market is not as robust. So we are spending the dollars in the right places.

But we are not really going to give a guidance. You know we have capacity and the ability; but we want to see how the year unfolds.

Just to add to that a little bit, as Jeff said, the underwriting process continues to very disciplined at the Company. We will continue that as we go into 2011 and it won't waver as we go forward.

On the capitalized interest question, my view on that -- and maybe coming from outside the industry it's a little bit different than you hear from others. But interest is interest to me.

Whether you're going to put it up in the inventory and defer the expensing of it into a future period or take it upfront, I am less sensitive on it. I tend to look more on the cash side and the cash impact on the business.

KB Home has a relatively conservative capitalization policy here within the Company. As a result we probably cap less than you might see out of some of the peers.

But I do know at the bottom line it really doesn't make a difference over time on that policy. It is just a deferral of expense.

Whether we hit an inflection point during 2011 as you said, to be seen I guess depending on the land spend. We like our land-light position. We definitely like the underwriting that we are going through in the new communities that we have coming online. And depending on the spend pretty much I would say it is going it depend more on the spend in the second of the year whether we actually hit that inflection point or not.

I can also add the observation our inventory was up year over year for the first time in many years. To me that is a good thing because it is inventory coming in the door in desirable submarkets as we continue to clean out and whittle away some of our holdings that weren't performing so well.

So it is not tied to house inventory; it is investment in our future. So you would love to see our inventory grow more right now, but it would only be if the investments make sense.

Megan McGrath, Barclays Capital.

Thanks. Most of my questions have been answered, but just wanted to see if you could give us any more detail on the submarkets that you talked about or the two areas that you are really focusing on for the first half of '11, being California and Texas.

And why your decision to go very aggressively there? Is that where you found the best deals on land, so you are seeing the returns? Or are you seeing incrementally better traffic patterns in those two areas of the country? Or both?

Good questions, Megan. You will never find the best deals where your strategy is targeted because everyone knows that's where the better opportunities are. It requires a lot of digging and hard work to uncover and negotiate and tie up the assets that are in a more preferred market, because they are typically more land constrained. That is what creates a better supply and demand balance.

When we walk through our investment dashboard in every city, we will balance how resale inventory is performing; what level is it at; what is pricing doing -- is it stable or not? And to us a market is in balance when prices are stable or up and there is a six-month or less supply of resales.

Through pretty much all of 2010 the more coastal-oriented markets of California were demonstrating all the statistics that would suggest it is a good place to invest. The Bay Area in particular has held very well frankly through this whole cycle.

Southern Cal had a bump; the prices dropped much more. But where they dropped was 60 to 100 miles from the coast, not in Orange County, or closer to the coast in LA County, or around Chino and Corona and those more close-in submarkets near jobs.

So we have a strategy in every city. Those metrics will drive it.

If you go over to Texas, Austin and San Antonio in particular are seeing good job growth right now. They're easier places to play in the market and find opportunities that align with your strategy. But whether it is the military that is stimulating things there or just the overall Texas economy, they are performing better.

Compare that and contrast it with a Phoenix where there is a lot of inventory still and prices are still under a lot of pressure. You wouldn't strategically say, let's go grow our Phoenix business.

We like every city we are in. We just will use our dashboard and our underwriting requirements to keep control of where we spend.

Thanks. In California, no concern there that you had a doubly positive impact in 2010 because they had their own tax credit? Or have they really -- they have maintained that same momentum throughout the year?

The first tax credit in California, Megan, absolutely was favorable. It was favorable because it was only on new homes. It was $10,000; and you could literally monetize it at closing.

Between the federal and state tax credit, you therefore had $18,000 in tax credit. Definitely a motivator that helped us in the spring and summer of '09.

The tax credit for '10 did not have nearly that kind of impact. For starters the refund was spread over three years, and you needed a calculus degree to understand what your refund would be. It was a very complex formula tied to specific tax situations for each customer. So it didn't have the impact that the previous one did.

Nishu Sood, Deutsche Bank.

Thanks. The trend from your third-quarter EPS to your fourth-quarter EPS, if I look at the last few years -- the last three years, there has been a dramatic, dramatic upswing in your margin performance from the third to the fourth quarter. Now, obviously there is seasonality for every builder related to the fourth quarter; but it has been a lot more dramatic for you folks both on the gross and the [SG&A] margin line.

So I was wondering if you could maybe help us to understand that. Maybe it has to do with your fiscal year-end. Maybe the November versus the calendar quarters for the other builders. Maybe it was just a function of the downturn since it was just the last three years and that should go away. I was just wondering if you could maybe help us wrap our heads around that.

Nishu, I will make a couple comments again and then Jeff can give you his thoughts. It is very interesting in the years I have been in public homebuilding, which are now too many for me to even share anymore because I am starting to feel old. Every company depending on when their fiscal year-end is has a great fourth quarter.

We always say it is a seasonal business. But whether it was a spring fiscal, a fall fiscal, or December you seem to have a great quarter in results typically in your fourth quarter.

One of the interesting things for us that does influence the margins is that these communities that we are getting into are not several-year investment. They are typically 60 lots, 100 lots, 140 lots. We work hard to get them open in January, February, March. And then a lot of them close out in your fourth quarter.

So many of the smaller, more desirable area communities that we open will open and close in the same year. They typically have a delivery spike in Q4, so that is one of the influences.

I also know that volume can influence these ratios as well to a degree. If you look at this year our Q3 and Q4 had a lot higher delivery volume than the first half. Any other thoughts for you, Jeff?

No, I think that covers it.

Nothing? Okay. All right.

Second question if I could, in the first question I was -- I am not sure, maybe I didn't ask it correctly. I was asking why the seasonality would have been more pronounced in the last couple of years as opposed to -- normally I understand the fourth quarter is obviously the strongest. But I don't know if you have any particular thoughts on that.

But my second question was just -- you had mentioned the percentage of your closings that were from communities that are not impaired. Should I take the inverse of that to be the percentage of closings that are in new communities? I was just wondering if you could give us a sense of what that number is and how that has trended and what you expect it to be going forward.

Yes, I'd say generally you can look at the inverse of that as being newer communities. It is not 100% across the board, because we do obviously have some older communities, quote unquote, that were not impaired.

But generally you can look at that as meaning newer land, newer land purchases, and newer acquisitions that we are working through.

Ladies and gentlemen, once again that was all the time we have for questions. Mr. Mezger, I'll turn it back to you for closing or additional remarks.

Thanks again, Kelsey. When you combine the power of a more efficiently run homebuilding company with an expanded community count, and an even more compelling value proposition for consumers, plus the reduced competitive landscape -- the incredible opportunity ahead of us really begins to come into view, and we are excited as we enter 2011.

I would like to thank everyone for attending. Have a great day, and we look forward to talking to you again soon.

Thank you, Mr. Mezger. Again, ladies and gentlemen, that does conclude our conference for today. We thank you all for your participation.