KB Home (KBH) 2014 Q4 法說會逐字稿

Good morning. My name is Rob and I will be your conference operator today. I'd like to welcome everyone to the KB Home 2014 fourth-quarter and year-end earnings conference call. (Operator Instructions). Today's conference is being recorded and a live webcast is available on KB Home's website at KBHome.com. Following the Company's opening remarks, we will open the lines for questions. (Operator Instructions).

KB Home's discussion today may include forward-looking statements that reflect management's current views and expectations of market conditions, future events and the Company's business performance. These statements are not guarantees of future results and the Company does not undertake any obligation to update them. Due to a number of factors outside of its control, including those identified in its SEC filings, the Company's actual results could be materially different from those expressed and/or implied by the forward-looking statements. A reconciliation of non-GAAP measures referenced during today's discussion to their most directly comparable GAAP measures can be found in the Company's earnings release issued earlier today and/or on the Investor Relations page of the Company's website. It is now my pleasure to introduce your host, Chief Executive Officer for KB Home, Mr. Jeff Mezger. Mr. Mezger, you may begin.

Thank you, Rob. Good morning, everyone. Thank you for joining us today for our review of our fourth-quarter and full-year 2014 results. With me today are Jeff Kaminski, Executive Vice President and Chief Financial Officer; Bill Hollinger, Senior Vice President and Chief Accounting Officer; and Thad Johnson, Vice President and Treasurer.

I will begin with a summary of our fourth-quarter performance and provide some color on our accomplishments and some challenges we encountered during the period. Then I will share our key areas of focus for 2015 as we continue to pursue top-line growth and improvement in profitability while also now working to enhance our returns through improving our capital efficiency. Following this, Jeff Kaminski will provide greater detail on our financial results, after which I will offer some concluding remarks before opening the call up to your questions.

During the fourth quarter, we achieved continued progress across many of our core financial metrics. We reported $796 million in revenues, an increase of 29% over the prior year on 2,229 deliveries. Our average selling price of $351,500, which increased by 17% year-over-year, was a key contributor to our top-line growth as our investment in product strategies continued to drive results. Our adjusted gross margin was 18.7%. I'm disappointed with this result as we expected to perform better and I'll provide additional detail around this topic in a moment.

During the quarter, our SG&A ratio continued to improve coming in at 10.5% as we work to contain overhead costs while growing our revenue. Net income for the quarter rose to $853 million, or $8.36 per diluted share, reflecting both our operational results and the positive impact of our DTA reversal. With this result, we now have $1.6 billion in book equity, nearly 3 times our equity at the prior year-end. While we continued to make progress in many areas of our business during the quarter, we also recognize there is still much work to be done to achieve our financial goals going forward.

Now I'd like to address our fourth-quarter housing gross margin performance. At the time of our last earnings call, with our expectation that the housing market would continue its slow yet steady recovery, we indicated that we believed our housing gross profit margin for the fourth quarter would improve sequentially from the third quarter. Unfortunately, we experienced a softening in demand in some of our served markets as the quarter progress with increased pricing pressure while at the same time we continued to face cost pressure among other things. As a result, we generated a disappointing fourth-quarter adjusted housing gross margin of 18.7%, which was down 30 basis points from the third quarter.

While regionally results in the inland markets of our West Coast operations had the most significant effect, several factors contributed to the difference between our actual and projected gross margin results. First, we were impacted as a result of delivering fewer homes than we had previously expected. Consequently, we lost some operating leverage on our indirect construction costs. These costs have been increasing ahead of deliveries as we continue to staff our operations in support of our current and future community count growth.

Second, against the backdrop of tighter market conditions, we had an increased use of sales incentives and price reductions on spec home deliveries in the quarter.

Third, we continued to experience cost pressures with our construction labor and material costs. We believe that all of these factors taken together had about an 80 basis point impact on our gross profit margin for the quarter.

Looking to 2015 with this lower fourth-quarter gross margin comparable to the prior year as a starting point, we know that our gross margin will continue to lag the prior year comp for some time. As a result, we are projecting our first-quarter 2015 gross margin will drop significantly from the first quarter of 2014, hitting the low point for the year before improving sequentially for the remaining three quarters of 2014.

As we often observe, there is no one item that will drive an improvement in gross margin. It is a menu of many actions in both revenue and cost and we are aggressively addressing all of them. Although at this time we do not expect to reach our housing gross profit margin goal of 20% in 2015 as we had hoped, this remains the target level we are working toward for the near future.

Moving on to the sales and traffic trends for the quarter, our net order value increased to $587 million, up 22% on a unit increase of 10%. This increase in net orders is consistent with our average community count growth for the quarter of 13%. As we have shared, we will continue to balance price and pace to optimize each asset and expect our sales rate per community will not increase until we achieve our targeted gross margins. In the meantime, we do expect that our future order growth will coincide within the range of our community count growth.

Our traffic levels per community remain strong, up 15% over the prior year. This data point reinforces that there continues to be strong interest in homeownership. Our year-end backlog value rose to $914 million, a 34% increase over the prior year and our highest year-end backlog value since 2007. Between our backlog position, our growing community count and our product mix continuing to generate a higher ASP, we are well-positioned to drive unit and revenue growth entering 2015.

Before I review our key priorities looking forward, I'd like to revisit the journey we have been on over the past few years. As we entered 2012, we knew that we would need to further accelerate revenue growth in order to achieve and sustain profitability. We announced at that time that we were going on offense and it was a rallying cry within our organization. We made significant investments in land and lots to grow community count and repositioned our locations and products within our current business footprint while at the same time minimizing overhead increases as we supported this growth strategy.

Our 2014 results reflect the culmination of these actions and with these profits, we achieved our short-term goal of recognizing the DTA reversal. Now that we've established a larger scale and sustained profitability, we will be expanding our focus to not only growing our revenues and enhancing profitability, but also to improving our returns. Due to the investments we have made, we own and control all the lots needed for our 2015 business and substantially all the lots needed for 2016. Having now made significant progress with our land pipeline, and in profitability, in late 2014, we began augmenting this focus with a greater emphasis on enhancing our asset efficiency and improving our returns on invested capital.

As part of these efforts, we have been evaluating potential opportunities to more quickly monetize certain long-term development assets in order to redeploy the capital into more productive assets that have a shorter lifecycle. In that regard, in October, we sold our last remaining land position in Atlanta, a market where we no longer have ongoing operations. In addition, we have increased our efforts to reactivate properties previously held for future development in various markets where we continue to operate.

Reflecting this change in our corporate strategy to more quickly monetize certain long-held development assets, we recorded inventory impairment charges of $34 million in Q4 related to seven properties, the majority, or $23 million, of these impairment charges related to an 80-acre land parcel located in the Coachella Valley area of Southern California, a submarket that has not recovered as quickly as we had anticipated.

Similar to Atlanta, this is a market where we no longer actively participate. This particular property, which was earmarked as an active adult community, is not aligned with our core business and will require significant additional investment dollars in land development and infrastructure over an extended period of time to build out.

Taking all of this into account, we decided to better optimize this nonstrategic asset by monetizing it in the short term through a planned future land sale and redeploying the cash to generate healthier returns rather than building and selling homes on the property as we had previously intended. The remainder, or $11 million, of the fourth-quarter impairment charges related to six communities primarily located in inland California and Arizona. Based on our evaluation of the markets where these assets are located, we decided to monetize these land positions sooner by opening for sales more quickly than anticipated and accelerating our overall timing and pace for building and delivering homes.

In addition, some of the Q4 impairment charges related to certain active communities where housing market conditions have softened. In 2015, as we plan to continue to work to improve our asset efficiency and generate a greater return on invested capital, we may identify and evaluate other opportunities to more quickly monetize assets, particularly those with longer-term horizons or that would require a significant additional cash outlay for development and infrastructure before the first home would be delivered.

It is important to note that in the two-year period prior to this quarter, we have activated 34 communities. Of these, only three communities had impairment charges at the time of their activation or in a subsequent period. To the extent we change our strategy on any given asset, it is possible that we may have additional impairments in the future. As a result of our growing profitability and our actions to enhance our capital efficiency, we believe that we can support our current growth strategy without having to access the capital markets for equity.

I'd also like to briefly comment on the status of Home Community Mortgage, our mortgage joint venture. In its first full quarter of operations after the rollout in July, this team continued to elevate their execution. While still not optimal, we are pleased with the steady progress being demonstrated each month and look forward to the increasingly positive impact the venture will have on the predictability of our business as 2015 unfolds. As service levels continue to improve and our capture rate increases, we're also looking forward to the added benefit of the additional income stream.

In closing, while many of our served markets remain sluggish in their pace of recovery with our larger scale and expectation for continued community count growth, we believe we have momentum. We will continue to drive our top-line growth while taking every action possible to enhance our profitability while also now working diligently to improve our return on invested capital. With that, I'll hand the call over to Jeff Kaminski for a more detailed discussion of our financial results. Jeff?

Thank you, Jeff and good morning. We continued our profitable growth trajectory in the fourth quarter largely through the successful execution of our three strategic initiatives. Perhaps most notably during the quarter, we reversed $825 million of our deferred tax asset valuation allowance. The steady operational improvements and expected future performance that supported the reversal also set the stage for the introduction of our fourth strategic initiative, improving asset efficiency and increasing our return on invested capital.

Since Jeff has just covered the headline results for the quarter, I will focus on providing more details surrounding some of our key financial metrics for the period and our expectations heading into 2015. Certainly one highlight for the quarter was the increase in our overall average selling price to $351,500 representing a 17% rise from a year ago. Double-digit increases in three of our four homebuilding regions combined with the expected favorable mix shift towards higher priced submarkets within our Northern California division were the main drivers of this improvement.

For the first quarter of 2015, we currently expect to experience a sequential decline in our average selling price due to the changing mix of deliveries within our homebuilding regions, as well as a relative shift of deliveries away from our higher price West Coast region to our other homebuilding regions. We also anticipate selling price growth to moderate in 2015 given the higher price levels we have reached after 18 consecutive quarters of year-over-year increases. We expect the first-quarter ASP to be in the range of $325,000, which is closer to what we reported in the second and third quarters of 2014.

Our housing gross profit margin for the fourth quarter was 17.3% versus 17.9% for the same quarter of 2014. The current quarter included $34.2 million of inventory impairment charges of which $11 million were housing inventory-related. The 2013 fourth quarter included $8.5 million of warranty-related charges and $3.3 million of housing inventory impairment and land option contract abandonment charges. Excluding these housing impairment and warranty charges, our fourth-quarter adjusted housing gross profit margin decreased to 18.7% in 2014 from 19.8% in 2013. While our goal of achieving a minimum 20% housing gross profit margin remains intact, we believe our timing to achieve this goal will be extended largely due to the current headwinds discussed earlier.

During the fourth quarter, our selling, general and administrative expense ratio increased by 20 basis points from a year ago to 10.5%. This slightly higher ratio was mainly due to the reversal of an $8.2 million accrual in the 2013 fourth quarter following a favorable court decision. Excluding this reversal, our ratio would've improved by 110 basis points year-over-year. Sequentially the fourth-quarter ratio improved by 190 basis points as compared to Q3 of 2014 reflecting the continued success of our cost-containment efforts and the favorable leverage impact of increasing revenues.

We ended the fourth quarter with 227 communities open for sales, up 19% from 191 communities a year earlier. During the fourth quarter, we opened 40 new communities and closed out of 13. Our fourth-quarter average community count of 214 was up 13% as compared to the same period of last year. During the quarter, we invested $272 million in land bringing our total owned and controlled lot count at year-end to 52,198. We expect further community count growth in 2015 with the full-year average projected to increase in a range of 15% to 20% versus 2014 depending, of course, on sales absorption rates and the resulting timing of community closeouts.

Our net order performance during the quarter was consistent with our stated strategy of maintaining pace on a per community basis, roughly in line with the year-earlier quarter and increasing overall net orders in line with community count growth. Fourth-quarter 2014 net orders increased 10% to 1,706, or 2.7 orders per average community per month, approximately the same rate that we experienced in Q4 of 2013. Our net order value for the quarter increased 22% from a year ago to $587.4 million due to higher net orders and average selling prices.

Turning now to our balance sheet and capital structure, we were able to achieve our goal of reversing a significant portion of our deferred tax asset valuation allowance during the fourth quarter and we ended the year with a net debt to capital ratio of 57.9%. At year-end, we had over $550 million of liquidity and our strategic prioritization of asset efficiency will place additional focus on asset monetization opportunities, as well as balancing land investment in managing growth within our capital structure goals. We are targeting a lower rate of land investment in 2015 in the range of $1.1 billion to $1.4 billion, which we believe will support our revenue growth objectives.

Other than in connection with the planned refinancing of our senior notes due in June of this year, we have no anticipated capital raises for the foreseeable future and have no plans to issue equity. In addition, our target net debt to capital ratio in the 40% to 50% range remains consistent with past comments. We are pleased with the progress we made during the 2014 fiscal year. Our focused operational and investment strategies yielded broad improvements across most of our core financial metrics demonstrating the success of our strategic initiatives. However, we believe the headwinds that have developed will likely create a pause in this progress and we have moderated our expectations for the first quarter of 2015. We currently expect housing revenues of between $440 million and $490 million in Q1. With the anticipated significant decrease in the housing gross profit margin mentioned earlier and the inclusion of a projected land sale gain of approximately $7 million, we believe our first-quarter bottom line will be approximately breakeven. Now I will turn the call back over to Jeff for his final remarks.

Thanks, Jeff. In closing, I would like to review some highlights of our full-year results. Revenues increased to $2.4 billion, or 14% year-over-year. Most of this revenue growth can be attributed to our higher average selling price as the geographic and product mix of our investments over the last few years continues to gain traction. Growing our top line and improving our profitability allowed us to achieve our goal of reversing the DTA valuation allowance. As a result of both our operational earnings and this reversal, our net income for the year was $918 million, or $9.25 per diluted share. Our reported book equity at year-end was $1.6 billion, up substantially over the prior year and is now at a value of approximately $16 per fully diluted share.

We enter the year with a strong backlog in place and with a year-ending community count that is up 19% over last year. This leaves us in a much better position to capitalize on this year's spring selling season. Looking ahead, we expect to sustain our community count growth, which combined with an increase in ASP year-over-year will continue to drive real top-line growth. At the same time, we will be diligently working to enhance profitability with a particular focus on improving gross margins. With our increasing revenue and improving profitability, we believe we're positioned to support our growth targets while placing a greater emphasis on also improving our return on invested capital. Thank you all for joining us this morning. Rob, let's open up the call to questions.

(Operator Instructions). Michael Rehaut, JPMorgan.

Thanks, good morning, everyone. First question I had was on I guess the gross margins. Obviously an area of concern and you've talked about it a bit already, but just wanted to clarify, when you talk about your expectation for first-quarter gross margins to be down materially sequentially, it would appear that given the outlook for breakeven net income, that it would also be down materially on a year-over-year basis. Is that correct? And also for the outlook for the full year, are you expecting gross margins to, on a full-year basis, improve, be flat or even be down year-over-year?

Okay, yes, Mike, I think I'll cover the first. Yes, on a year-over-year basis, we do expect the first-quarter margin to be down. There's really two, I'd say maybe two or three main impacts affecting the margins in the first quarter. The first one is what we typically see every year in the first quarter, which is the leverage impact or the loss of leverage impact on the fixed costs that we have included in our construction costs. We think that can be up to 2 full percentage points of margin impact just from that. We have the conditions and the items discussed during the script on the market pricing, higher incentives that we're seeing in the marketplace, price, the ability to increase price not equal to some of the cost increases that we're seeing that we think will affect it. And we also have a couple of very high value, very high margin communities in our West Coast region that have closed out now in the fourth quarter and we won't enjoy the benefit from those coming in the first quarter.

I think it is important to note that we do believe that first quarter will be a low point for the year and that we will have sequential improvement going further into that. As far as the full-year estimate on gross margin, right now, I'd say it really depends on market conditions through the spring and our ability to raise price and offset some of the cost increases that we've been experiencing. But I would say that the 20% target is not likely in 2015.

Thank you.

David Goldberg, UBS.

Thanks. I was wondering if you guys could give some clarity on the return on capital focus and specifically what does that translate to? I assume it means greater free cash flow generation. Is it just the way that you invest the capital maybe on a market basis or is it thinking maybe about paying down some debt or maybe stock buybacks? I was wondering if you could give us some focus on how you're thinking about maximizing the return on capital if it is going to become more efficient within the business.

Well, Dave, as I shared in my lookback on history, we had to get to a higher scale to be able to sustain profit and we've done that. So your first priority is to create a return and we have now done that and we're going to pull every lever to continue to improve our profitability, so improve the return.

On the other side of the equation, we think we can drive our growth with our own cash generation and whether it's some of the things we talked about, monetizing old assets, whether it's selling some lots where we're lot heavy in a location, just a general review every month of our balance sheet where our assets are, what the status is and what can we do to monetize things while continuing to grow our business. And we know that over time we want to get to an inventory turn over 2X; we're not there today. But I think where you started with the comment on generating more cash, that's where we're starting. We want to drive our business with our balance sheet and not have to go access the markets anymore.

Megan McGrath, MKM.

Good morning. Thanks. I wanted to ask a little bit about your expectations for community count growth among what sounds like a relatively cautious outlook for the year in terms of the soft demand continuing. If you could comment specifically, you talked a little bit about inland California. Could you talk a little bit about if you're seeing anything in Texas now, specifically in Houston, as we started to see some layoffs there. Also has the expectation that Houston could be soft this year impacted your growth plans in that region? Sorry, long question.

Megan, I will cover as many of them as I can recall from your question. Let me start up top with a couple of comments. We entered the year with a community count up 19%. We normally don't like talking about trends within a quarter, but in this case because we're halfway through our first quarter, we can share that our sales are tracking within range this quarter of our community count growth. Traffic levels remain solid, sales per community are pretty consistent with what we saw in Q4. So we like how we're positioned and my comments on the growth are more relative to in some locations we're seeing some pressure on pricing while we're also seeing some pressure on cost. So we're selling homes, but in some cases we're having to do some things to hold to the sales rate strategy in that community.

If you go specific to Texas, our trends there are very similar to what we're seeing around the rest of the system. Our sales per community are holding fine, traffic is up. It's tracking with community count, so we're seeing no indication of any pullback by the consumer at this time. We're sensitive to the Houston situation. We're very watchful right now. In fact, we actually pulled out of a couple of land transactions in the fourth quarter because of our sensitivity there. So we're going to keep an eye on it and see how things develop as there is more clarity on the economy there.

Having said all that, I'd like to kick it to Jeff to give some clarity to what our Houston business really means or our Texas business relative to the whole Company because there have been a lot of different numbers spinning out there.

Thanks, Jeff. I guess before I start on that, Rob, if you could please allow a follow-up question as people are dialing in. I'm not sure on the first two if they had a follow-up or not, but two questions per person is fine. Relating to Houston, I want to clarify a few of the facts that we see. We've seen some analyst reports trying to estimate the percentage of our business, etc. that's associated with it. For 2014, as a percent of our total housing revenues, Houston represented about 8.5% of the total Company's revenues. So again, like many things with the Company, because of the higher ASP in our West Coast operations, although the delivery and the community count in the Houston market were higher, it was really only an 8.5% total mix on revenue.

In terms of deliveries, it was about 14% and in terms of year-end community count, it was about 16%. That's one thing we wanted to clarify I think in relation to that business. So Megan, did you have a follow-up?

I do. I just wanted to ask a little bit about your 1Q guidance on revenues, $440 million to $490 million. That also sounds like you might have a lower backlog conversion rate in the quarter and you talked a little bit about closings coming in lower than expected this quarter. So is it the same issues impacting you next quarter that did this quarter and if you could talk a little bit about that?

Megan, our backlog rotation right now, as we looked at it entering the year, while our backlog is up, it's weighted a little more to early stage construction or homes that are about -- or have now been started, but won't be completed till the second quarter. So we do expect our backlog conversion to go down relative to prior year. It's the way the backlog is positioned and over time, you will see it get into a better balance.

I would just add to that a little bit. On the build times, we've also seen a slight expansion to build times, which is due, what I would say, due primarily to the higher price point product that we're building right now today and to tighter labor market conditions. So I think the combination of the two factors has impacted our expectation on first-quarter backlog conversion.

Robert Wetenhall, RBC.

Hi, guys, this is actually Collin filling in for Bob. So a quick question on your long-term guidance for 20% gross margin. You said that this isn't going to be achievable in 2015, but what would you think your timing expectations for achieving this goal would be?

Well, a lot of it, Collin, will be impacted by market conditions. From time to time, we'll review all the different things that we're addressing to improve our gross margin. The message we want to make sure everyone heard is we're starting out of the gate lower than we did a year ago and with that, it makes the 20% a much higher hurdle to get to. If your first half is well under, that means you have to be well over in the second half to average 20. We just don't think we can do that today. We shared that we will continue to have sequential improvement and it remains our near-term goal. We just don't think we can get there in 2015.

Stephen Kim, Barclays.

Thanks very much, guys. I was wondering, first, if you could talk a little bit about your comment of reactivating some previously mothballed communities and bringing them online. Around the same time you were saying that, you were talking about possibly taking additional impairments and I just wanted to understand a little bit are those two things related in your mind as you reactivate some of these parcels that have been sitting idle for a while and maybe require some longer-term investments? Are you looking to reactivate them and then sell them or are these completely different parcels that you're referring to for the impairments?

Stephen, in my prepared comments, I walked through why we've decided to sell the community out in the Palm Springs area. It would be very cash-intensive to develop. The market out there is extremely volatile and we could not see ourselves in the near future -- based on where we're at today and our strategy to utilize our own cash to grow our business, we wouldn't want to put the kind of dollars that one would have required in the ground and the long term it would take to get it back. So it wasn't consistent with improving our capital efficiencies.

As we look at each asset, some could be sold, though typically that's a harder financial hit. We will create more value through building things, but we may sell something, we may build something. It's one phase, two phase. Every asset has its own strategy and each quarter, we look at the timing and the potential and the market conditions and how much cash would it take to activate this. We want to keep whittling this thing down so we can take those dollars and grow our business with higher returns elsewhere.

I think that strategy, Stephen, is most closely associated with our new initiative of really focusing on asset efficiency as we go into 2015 and I think as Jeff mentioned in the prepared remarks, we have been activating communities over the last couple years and have had very few impairments relating to those activations and will continue to review our balance sheet for monetization opportunities whether they be in buildout or in sales as we move forward.

Great. That's great. I guess my next question relates to anything you might be seeing in terms of the entry level of the market and what you're telling your folks there. Obviously we've seen this FHA fee action, which will be in effect I guess at the end of the month. What are you telling your folks in the field with respect to how to position around that or how to react to any move in demand that were to happen? Do you expect something to happen? Just if you could talk a little bit about that and the entry level. And then one housekeeping thing, can I get the homes under construction number for the quarter?

Stephen, within the quarter, our first-time buyer percentage ticked up a point I think, basically consistent with what we've seen. It's higher in Texas than it is in most of our other regions because there's been job growth there and there's population growth and all of the things that unlock the first-time buyer. The FHA insurance premium reduction, I'm sure you've seen the reports, they are estimating it unlocked another 250,000 buyers both new and used that otherwise wouldn't have qualified. So it's a meaningful boost to the overall housing market and each city, it will have a different impact.

Our current FHA backlog does get the benefit of this reduction and so we have some communication out to the field on how to manage to that because that goes into effect here at the end of January, so it helps your current backlog and it clearly changes the payments to qualify on future sales. Time will tell how big an impact it has. Today, our FHA business is at, what, Jeff, 30% or so? It's much lower than it used to be and I think as you see the first-time buyer unlock, that will probably go up again, but right now it's less than a third.

Right, and on the housekeeping item, Stephen, total in production at the end of the quarter was 3,002.

Stephen East, Evercore.

Thank you. Good morning guys. Jeff, I appreciate you walking through what's sort of driving it and how you all think this plays out. If you look at the 1Q where you say you think this will be the bottom, I guess what gives you confidence there that 1Q is the bottom and then you grind off of that -- off of that level?

Well, for starters, Stephen, you have the leverage side and our first quarter is always our lowest revenue quarter, so we have the biggest leverage impact on the fixed portion of our gross margin. And as I shared in my comments, we've been growing in this area, so you have a double hit and that's your revenue's down while your cost is up. If you go back to our community count guidance, your community count is going to be up year-over-year 40 or 50 communities, whatever the number is and there are costs associated with that in many cases without the revenue tied to it until the second, third for fourth quarter. So we have this inflection point where our costs are being hit by overhead and we don't have the revenue pullthrough yet. So you'll see that come through as the quarters play out over the year.

And on top of that, the other side that, as we look at it, is the mix of our business and communities opening and communities closing. So that's how we see it today and we're hopeful of finding upside in the cost areas and the revenue areas going forward, but those two certainly are driving the support for our comments.

Okay, that makes sense. And the second question is sort of a combined question. If you look at your markets, let's take leverage out of the picture for a minute. When you look at your pricing incentives versus your costs, which would be the bigger driver of reducing gross margins or putting pressure on gross margins and then historically if you've just looked between your California margins and the rest of your regions, what type of magnitude did you historically see there?

I think it's hard to differentiate between price and cost because we have both going on in any given location. It's hard to say it's just one or the other. If you're in the Bay area and prices are continuing to move up quickly, costs are probably -- hopefully they are not, but they are probably going up right with it and then we have other areas where you have this crossover where cost have increased while pricing in the short run has softened. So you have that component going on with it as well and if you go back to my prepared comments, what we did see in the quarter, the inland areas of California were quite a bit softer than they have been while the coastal areas held very well. So you have this dislocation that built up where within the same reporting region for us, you have areas like the Bay area where it's as good as it has ever been while the inland region softened quite a bit.

Michael Dahl, Credit Suisse Group.

Hi, thanks for taking my questions. Just I guess with respect to margins, it's an environment that you've acknowledged is increasingly difficult to hit the 20% gross margin. You've introduced the new focus on return on capital, which isn't necessarily gross margin-dependent. So what makes 20% the right long-term target for KBH? I guess what I'm getting at is if you were able to hit your 2 times inventory turn with 18% margin, how do you view that trade-off right now?

Well, it's a balance certainly, Mike. We refer to our bottom line and all the components as a profit equation and if you can hit an 18% gross, but your SG&A is 8% or 9%, that's the same thing as a 20% gross and a higher SG&A. So within each city, we have a balance of those two and we continue to chase levers we can pull on all of those areas, not just one or the other. Typically, in the past, in order to achieve our return on invested capital targets, you have to have a bottom line around 8% to 10%. So it's how do you get to the bottom line and then play into the returns. Our messaging, if you go back and think of the components I walked through, we had to get to scale because of our cost structure, debt structure, everything in it. We had to get to a higher scale in order to achieve profitability. And now that we've done that and we can mine the cash out of this scale, our message is that we can drive our growth through cash generation in our current business. Therefore, we think we can grow our returns while at the same time improving our profitability going forward.

Okay, thanks. Second question, I think Jeff K. mentioned that Texas is 16% of communities today. If you think about the growth plans for Houston was 16%, if you think about the growth plans for 2015, would that number -- would that percentage currently be expected to increase? And if so, I guess with some of those communities, if you were to see any issues, how many of them are early on and offer a little amount of dollars in the ground that you could turn it off quickly in response? Thank you.

Right, on the community count growth expectations for 2015, Jeff mentioned earlier that we've been pretty measured with continued investment in Texas and while we intend to continue to invest in open communities, I think on a net basis we will see a relatively flat community count in Texas in total and Houston in particular in 2015. So we're taking a measured approach. We'll see what happens and develops in the market. I certainly wouldn't expect our exposure there to increase in 2015 and hold right around that 8% or 9% of total Company revenues as we go into the year.

Ivy Zelman, Zelman & Associates.

Thank you. I think it would be helpful (inaudible) maybe delve a little bit deeper. You talked about some of the market differentiation with the inland slowing. There has been some discussion that the Phoenix market is improving and the Bay area remains really red-hot. Maybe with respect to the trends, do you expect home prices on an apples-to-apples basis to still show increases and are you concerned about coastal California, Southern California where we're hearing that Asian buyers are starting to pull back as a part of -- pull money out of China? Are you hearing anything that would confirm that? How do we think about the trajectory given markets like Southern Cal and Northern Cal have been so strong in the coastal areas? Just an overall sense of the market specifics might be really helpful for everyone.

One of the things that we've seen, a trend we've picked up on, Ivy, relative to Orange County, there has been a pullback on the new home side with the Chinese buyer, and these people are heavily controlled by realtors that they are comfortable doing business with. Where the realtors are taking them today is the resale side in that the new home pricing in 2014 increased pretty significantly in those areas and resales became a more attractive opportunity in the eyes of the realtor and the consumer. So I don't know if that's the typical push-pull in a market and as resale pricing goes up, as it has now in the last 60 days in Orange County, it has been moving up. So it could just be the competitive push-pull and at some point, they will come back to the new home side.

It's hard to say whether it's a short-term move or the competitive pressure from other builders, but in the Inland Empire or Central Valley up north in California, we saw a big increase in incentives and price pressures. I don't know if those people were closing out their year or closing out communities and we're watchful, we'll see how the new year unfolds here and relative to Phoenix, we are seeing improved demand in Phoenix. We are not that large there, but we are seeing improve demand there. I think you will see activity levels go up before you'll see a lot of price in Phoenix because people need to work through their assets.

Vegas I'd say is okay. Demand is good. We don't see prices moving, but there is demand there. So it is a mixed bag. Interestingly, in Texas, our pricing is favorable right now. We're not seeing any price pressures in our Texas business. So as you go around the country, it's a mixed bag and the good areas are still good and the bad areas got a little tougher.

That's helpful, Jeff. Just a follow-up on -- really appreciating the dynamics of what's happening in certain Texas areas with concern about the headwinds. Your same-store sales per community were down in the central region just modestly and you indicated that you expect growth to be just really driven by the new stores and new communities you're opening. So when you're thinking about level of same store being where it is right now, how much growth would you need to see in same-store in order to resume margin expansion or you said that you will not (inaudible) for strategically trying to increase same-store if it means negatively impacting the margins. So that relationship strategically how should we think about it?

Yes, I think as we look at it, Ivy, as always, we look at it on a community by community basis across the business and we currently have certain communities that are running very well and running above pace or above forecasted pace for those communities and we're taking pricing actions within those communities and we've had communities on either side of that spectrum as well. So I think it's important to understand how we're running the business and it's really done at the division level and even more detailed at the community level beyond that.

The pace so far in the first quarter we're pretty happy with. As Jeff mentioned, it is tracking very close, in fact a little bit above our community count growth expectation for the quarter. So there's good signs for the spring and we'll continue to monitor spring selling conditions and hopefully we'll start capturing back some of that margin improvement as we go.

Susan Berliner, JPMorgan.

Hi, good morning. Just wanted to I guess speak about the spec strategy with the marketplace, if you're contemplating changing and I guess in Houston, since it's such a big relocation market, if you can I guess just discuss where your specs are in the Houston market and where you see that trending over the year?

Susan, we remain committed to our Built to Order model and we're heavily weighted to a sold WIP, I'll say. We always have some inventory that's hanging around whether it's a cancellation after start, a multifamily community or if we have sold out of a cul-de-sac except for three lots, we may start those three just to clean it up. So there's always some level of inventory in our business and as we go through the year, our inventory sales are our most difficult sales. Our sales team, our management teams, everybody's, we take the view that building a home of the customer's choice is the way to go and there's a lot of value to that. And if it's in Houston and you can build a home there pretty quickly, it's one of our faster build times, we will retain the value of the Build to Order over the risk of a spec every time. In our fourth quarter, I shared that we did have some margin compression on inventory sales that we had achieved in order to deliver what we did, but it's not a large component of our business. We're going to stick to our strategy of Built to Order.

Regarding your question on specs, Susan, we're maintaining right now about two finished specs per community across the business. I don't think the Houston division varies significantly from that. I don't have that information in front of me, but I think it's right around that same metric.

Great. And I just had a follow-up I guess on the Inland Empire. I guess what was the change? Was it the Chinese buyer? Was there anything else that you could discern from the slowdown there?

Well, there's a ripple that occurs when Orange County softened a little and it did and I do think it was in part the Chinese buyer demand softened. It ripples inland and the further inland you go, the more the ripple is felt. So we had -- there are some areas in the far Eastern end I'll say of the Inland Empire, not to Palm Springs, but say 60, 70 miles from the coast where there's been price pressure, new and used, on the magnitude of 8% or 10% in the last six months where prices went down that much. So it hit pretty hard out there. It's not where you have a big business, it's not where you're investing today, but if you have communities open that you're working through, it had an impact. It's the typical ebb and flow. As Orange County settles, it will slowly settle back inland and I don't know that it's a fundamental structural shift; it's just some short-term market dynamics that we're facing.

Coming back to your question, we did just check the number. We're actually a little bit below the Company average in Houston. The Company average being two per community. We're a bit below that in the Houston market with finished specs.

Nishu Sood, Deutsche Bank.

Thanks. On the impairments, I think investors think of it as normal if you have a few, call it, fine-tuning impairments, maybe $1 million to $3 million per quarter. Obviously, this quarter, you mentioned the drivers of the more significant impairments, but you also mentioned that with the return on capital strategy, there could be future impairments. So saying that in a quarter or drawing that out in a quarter where the impairments rose to more than $30 million I think probably has some people thinking that there could be large amounts like we had this quarter in future quarters as well. I know it's difficult to tell obviously. You do the project evaluations and you figure it out as you go, but maybe if you could just give us some sense of what you meant by that. Do you mean that there will be significant impairments in the ballpark of what we saw this quarter in future quarters or what exactly did you mean by that statement?

What we meant, Stephen, is that we'll evaluate it on a community by community basis and we want to put the proper, I guess, framework around it for the street. We are very serious about improving our return on invested capital. We will be looking at monetization of various assets on the balance sheet. As Jeff mentioned, we activated over 30 communities over the past couple years and had a very low level of impairment. We did have a higher impairment quarter this quarter, but we did not mean to imply that that would be normal on a go-forward basis. I think it was just a cautionary statement that there could be additional impairments in the future as we pursue that strategy, but not necessarily saying you should model, certainly not model in impairments to the level that we saw in this most recent quarter.

Okay, thanks. That's very helpful. Second question, there have been a lot of questions about Texas already. I wanted to dig in in a little more detail. I am sure you're keeping a very close pulse on it. Forward-looking indicators, so you wouldn't have expected just because oil prices fell in the headlines that you would have seen demand fall apart already, but maybe forward-looking indicators, as you talk to your folks on the ground in Houston and in other parts of Texas as well, traffic anecdotally sentiment maybe in the moveup segment, which might be expected to see more of a hit, more of a headline awareness. Anything forward-looking that you have gathered in terms of the pulse you're keeping on the market that leads you to lean one way or the other for the next couple quarters?

We're always watchful of traffic trends and if some company had a round of layoffs, we hear about that pretty quickly. And that's a data point that you don't want to ignore. As I looked at our book of business in preparation of the call, I would say that our first-time buyer communities, our lower priced, our more value-oriented products, are selling better in Houston today and that it could be that the higher priced buyer has softened a little bit. I don't know. But as we shared, right now, the consumer performance is pretty typical. We're not seeing any signs that they are pulling back.

Right, and I think the best forward indicators that we have right now is quarter-to-date sales performance in Houston and in Texas and in the central region in general has been pretty strong. It's tracking right along our community count growth and the traffic in the fourth quarter in the central region was up nicely versus prior year both on a per community basis and an overall basis. So we're not seeing the indications right now although with all the news and the concerns that everyone has economically on the state, I'd like to say that we're facing and looking at evaluating it on a measured basis. We're not overly bullish on it, but up to this point we really haven't seen much impact from all the headline news that you've been seeing.

Michael Rehaut, JPMorgan.

Thanks. Most of my questions have been answered. I guess I just wanted to circle back to some comments that you've made over the last 12, 18 months about some of the asset purchases and overall portfolio shift that you've kind of referred to in terms of the land investment strategy that you've done. And in particular I'm thinking about some of the asset purchases that you've highlighted in California, Plum Creek, for example, also the reactivation of Inspirada and some of the Vegas properties there, which you've referred to as a good cost basis. And what I'm trying to get to is with this kind of pushing out of the 20% gross margin goal, it would have seemed that before, and you kind of walked through what the drivers were in terms of the gross margin outlook for the next few quarters and the fact that you are being caught right now by a little bit of softer pricing relative to costs, but it would seem that at the same time you would have had some positive momentum in this portfolio shift from some of these purchases again that I mentioned.

I guess the question here is are those -- were those assets generating a 20% gross margin or better? Have things changed and was the goal of achieving 20% in some ways dependent on price inflation because it appears that there's something a little bit off relative to the expectations 12 months ago?

Mike, as we always share with this group, we don't underwrite with inflation. We don't -- I always take the view that if your price goes up, your costs go up with it and if you link this to the comments we've made on the pressure on directs, if we acquired a community, we underwrite a community, develop the lots, open them for sale on the western side of the Inland Empire, as an example and you get a point of price pressure and a point or two of cost pressure, you are not at a 20% margin. It's not that you underwrote it; you've had some changes in the input data, I'll say, from when you acquired it.

The other thing that goes on, and Jeff touched on it, we had a couple of communities close out in the fourth quarter that were acquisitions in California that we made back in 2012 where in some cases they were finished lots and you build through those and in the typical lifecycle of a quarter, it will open up at or below the 20% as you get momentum in the community and it will close out well above 20% and that's what happened with those that closed out in the fourth quarter and we have this turnover going on where a lot of communities are closing out and the new ones that are opening up are at lower margins and we expect as they mature and we get into the year and they are open longer that you will see the margin lift.

Well, I appreciate that. I guess with some of those, the Plum Creek and the others that you had highlighted at the last Analyst Day, are the margin expectations intact as we sit here today in terms of I would assume being above 20% and perhaps if you can also talk about Las Vegas and what the contribution might be there over the next couple of years? As that business perhaps grows relative to the overall mix of closings, would that also be a positive contributor to your margin mix?

Mike, when you touched on Plum Creek and you said is it over 20%, we just opened it in the fourth quarter and we never said when we bought it it was over 20%. So I can tell you it is not over 20% today, but for the most part, our new acquisitions are performing within a range. Some are better, some are not as good as when we underwrote them and that's part of your portfolio of business and you keep flogging things where you are below and capitalize on when you are above. When it comes to Las Vegas, as I mentioned in a comment before, the market is holding well for us. Inspirada, in particular, is selling very well right now and if you think of Vegas relative to my comment on the seasoning of communities and how they will open a little under, but they will exceed over time and that happened with some that closed out in the fourth quarter. If you go to Vegas, we closed out a lot of communities in the first quarter of last year where we had previously had a lot of price run-up on assets that we had purchased opportunistically below cost of replacement. And we had some very, very strong margins in Vegas Q1 of last year well above 20%. As you watch Inspirada, which is now open and I think we're now just getting into deliveries out there, it will become a big part of that business and you will see it lift our margin in Las Vegas, if not for the Company.

At this time, I will turn the floor back to management for closing comments.

Okay, I'd again like to thank everyone for joining us on the call today and we look forward to sharing our success in the future as the year unfolds. Thank you.

Thank you. This concludes today's teleconference. You may now disconnect your lines at this time and we thank you for your participation.