KB Home (KBH) 2016 Q1 法說會逐字稿

Good morning. My name is Shea, and I'll be your conference operator today. I would now like to welcome everybody to KB Home's 2016 first quarter earnings conference call.

(Operator Instructions)

Today's conference call is being recorded, and will be available for a replay at the Company's website, KBHome.com through April 23. Now I would now like to turn the conference over to Jill Peters, Senior Vice President of Investor Relations. Jill, you may now begin.

Thank you, Shea. Good afternoon, everyone, and thank you for joining us today to review our first-quarter results. With me are Jeff Mezger, President and Chief Executive Officer; Jeff Kaminski, Executive Vice President and Chief Financial Officer; Bill Hollinger, Senior Vice President and Chief Accounting Officer; and Thad Johnson, Senior Vice President and Corporate Treasurer.

Before we begin, let me quickly note that during this call, items will be discussed that are considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. 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 the Company's control, including those details in today's press release and in our filings with the Securities and Exchange Commission, actual results could be materially different from those stated or implied in the forward-looking statements.

In addition, a reconciliation of the non-GAAP measures referenced during today's discussion to their most directly comparable GAAP measures can be found in today's press release, and/or on the Investor Relations page of our website at KBHome.com. And with that, I will turn the call over to Jeff Mezger.

Thank you, Jill. Good afternoon, everyone. Going to start with a brief overview of our first-quarter performance, followed by a business update. Then Jeff Kaminski will take you through our financial results in greater detail, after which we will open the call for your questions.

We were well-positioned entering 2016, with a sizable year end backlog from which we delivered strong results in the first quarter. We generated $678 million in total revenues, driven by substantial growth in deliveries which were up 23% year-over-year. This in turn helped fuel a 53% increase in pre-tax income to $16 million.

Our home-building operating margin excluding the impact from land sales improved 140 basis points, driven by healthy improvement in both our gross margin and SG&A. The value of our net orders increased 9% to $825 million, against a strong comparison in last year's first quarter, which was up 25% over the prior year. Our net order growth of 4% was basically in line with the 6% year-over-year increase in our average community count, and we are now into our third year of producing quarterly net order growth on a year-over-year basis. Overall, we experienced solid traffic levels and favorable demand trends during the quarter.

The value of our backlog at the end of the first quarter was $1.4 billion, up 29%, providing a solid foundation for continued revenue and profit growth, as we enter the second quarter. While it's still early in the spring selling season, we are encouraged by the traffic levels and steady demand we are seeing, and are optimistic as we continue to build backlog, in support of our delivery targets for the latter part of this year.

On a regional basis, California demand remained strong in the first quarter, particularly in the coastal regions where supply is very limited. And with prices continuing to climb along the Coast, we are once again seeing demand move to the inland areas as well. While we did generate positive comparable sales for the quarter in the West Coast region, in the Bay area, our net orders actually decreased, as we continue to transition out of many of our existing communities, and work to open the replacement communities.

We successfully opened four communities late in the first quarter, and have an additional six communities with grand openings scheduled for the second quarter. The Bay area continues to be one of the strongest housing markets in the country, and our division there is also our most profitable per unit. We expect these 10 new community openings in the first half of the year to drive a favorable sales comparison for the division, with the Bay area overall being a key contributor to our gross margin projections for the year.

In our Southwest region, Las Vegas continued to perform well, once again producing among the highest sales per community in the Company. We did have a slight negative sales comp for the region, primarily related to the timing and the number of community openings in Phoenix, as we had several very successful grand openings in Phoenix in the first quarter of last year.

In our Central region, our largest in terms of units, we were pleased to generate a positive order comparable, in spite of the softer market conditions in Houston. As we have shared with you, we purposely began limiting our investment in Houston about a year ago, given the severe contraction in the price of oil, and its impact on the local economy. As a result, our community count in Houston is down about 20% year-over-year, and sales in the first quarter were down about 18%, basically flat on a per community basis.

Houston continues to be a price-sensitive market, with weak demand in the price bands above $250,000, while price points below $250,000 continue to perform reasonably well. We believe we are strategically well-positioned in Houston, operating in the most desirable and active submarkets, with a first quarter ASP on deliveries of approximately $230,000.

Our other markets within the region all continue to perform well, with solid sales and steady demand in Austin, Dallas, and San Antonio, as well as in Denver. We also gained momentum in our Southeast region, which had the highest order growth, with sales soundly up across all divisions.

Before I turn the call over to Jeff, I want to spend a few minutes on our capital allocation plans for 2016. We have a balanced approach to prioritizing our use of capital, in order to support our growth, strengthen our balance sheet, and improve shareholder value.

During the first quarter, we repurchased approximately 8.4 million shares of our common stock, representing about 9% of our shares then outstanding. At the time of the repurchases, our stock was trading between 55% and 60% of book value, providing a significant opportunity to drive shareholder value. As a result of these repurchases, we increased our book value per share by nearly $1 to $19.22. We have about 1.6 million shares remaining in our existing authorization, and we will evaluate future repurchases relative to market conditions, and our overall capital allocation plans.

Even with this measured investment in share repurchases, we have the capacity to allocate up to $1.3 billion towards land acquisition and development in 2016, and remain cash flow neutral for the year. We will continue to be thoughtful about investment opportunities, based on local market conditions, and the return potential of each individual project. For the year, we anticipate that about one-half of our land spend will be in development costs and fees, as we continue to drive revenue growth and profitability from our existing assets. While we own all the lots necessary to achieve our 2016 delivery targets, as well as the majority of the lots we need for 2017, we are working to identify additional investment opportunities in support of our community count growth targets for 2017 and beyond.

In closing, we made meaningful progress with our results in the first quarter. The early indications for the spring selling season are favorable, as we continue to see steady job growth and household formations creating demand, while inventory levels remain low, and new home affordability remains compelling.

We are well-positioned entering our second quarter, with a backlog value of $1.4 billion, and we are committed to driving continued improvement in our performance. We look forward to sharing our results with you, as the year unfolds. With that, I'll now turn the call over to Jeff for the financial review. Jeff?

Thank you, Jeff, and good afternoon, everyone. Our solid results for the first quarter that Jeff covered in his opening remarks, reflected strong operational execution which generated improvement in all of our key financial metrics. I will now provide some additional detail on our first-quarter performance, as well as our outlook for the second quarter and full-year.

In the first quarter, housing revenues grew 28% from a year ago to $673 million. This growth was driven by a 23% increase in homes delivered, and a 5% rise in our overall average selling price. Each of our four regions reported double-digit increases in deliveries, as well as higher ASPs.

We were particularly pleased with the delivery execution in the quarter, given ongoing challenges with labor constraints in our trade base, and the fact that the majority of the closings were subject to the new TRID regulations. The strong year-over-year revenue increase was the primary catalyst for the improvements in both our operating income and bottom line.

For the second quarter, we expect to generate housing revenues in a range of $710 million to $770 million. And for the full year, we are maintaining our housing revenue guidance of $3.35 billion to $3.65 billion. We expect housing revenue growth for both the second quarter and the full year to be driven by the conversion of our robust backlog in homes delivered, as well as continued year-over-year improvement in our overall average selling price.

The 5% year-over-year increase in our average selling price of homes delivered to $344,400 for the quarter, reflected increases in all four of our home-building regions. For the second quarter of 2016, we expect an ASP of approximately $360,000, which would represent a 6% increase on a year-over-year basis. We expect community mix and a shift of deliveries towards the West Coast region to drive our average selling price even higher during the second half of the year, resulting in a full-year increase of between 6% and 8% as compared to 2015.

Our housing gross profit margin of 16% for the first quarter was up 90 basis points year-over-year, with each of our four regions generating improvement. The first quarter gross margin included $1.2 million of inventory impairment in land option contract abandonment charges, which had a roughly 20 basis point impact. Excluding the inventory-related charges and the amortization of previously capitalized interest, our adjusted housing gross profit margin was 20.7%, representing an increase of 120 basis points from the first quarter of 2015.

For the second quarter, we believe our gross margin will be relatively flat on a sequential basis, before expanding during the second half of the year. We have a number of higher-margin communities with first deliveries scheduled for the third and fourth quarters, particularly in our West Coast region. In light of this, and the favorable leverage impact from higher housing revenues expected in the second half of the year, we are maintaining our outlook for full-year gross margin improvement. Therefore, assuming no further inventory impairment or land option contract abandonment charges, we continue to expect to generate a housing gross profit margin above 17% for the full-year.

Our selling, general, and administrative expense ratio of 13.1% for the first quarter improved 40 basis points versus the year earlier quarter. This is our lowest first quarter ratio in 10 years, despite an unfavorable impact of approximately 50 basis points from a legal accrual during the quarter. We believe we will continue to produce sequential and year-over-year improvements in our SG&A expense ratio throughout 2016, through our cost containment efforts, and improved operating leverage. We still expect our full year SG&A expense ratio to be in the low 11% range, as discussed during our previous earnings call.

Our first quarter home building operating income margin improved by 140 basis points from the year earlier quarter to 3%, after excluding land sales results from both periods. On an unadjusted basis, our operating margin increased 30 basis points. For the second quarter, we expect to generate year-over-year home building operating income margin improvement in a range of 50 to 100 basis points.

Income tax expense for the quarter was favorably impacted by $3.3 million of federal energy tax credits we earned from building energy-efficient homes, resulting in an effective tax rate of 18.1%. We recognized $1.4 million of such credits in the same quarter of 2015. The favorable impact from these energy credits reflects a significant financial benefit directly related to our sustainability and energy efficiency initiatives. We expect recognize more of these tax credits during the second half of 2016, and project an effective tax rate of approximately 37% for the second quarter, and in the range of 34% to 35% for the full-year.

The expansion of our housing gross profits and improved SG&A expense ratio, together with the favorable tax credit impact, drove a 68% year-over-year increase in our first-quarter net income to $13 million or $0.14 per diluted share. The per diluted share result includes less than a $0.01 benefit from our lower share count.

Our first quarter average community count rose 6% year-over-year to 244, which drove the increases in our net orders, and net order value that Jeff mentioned earlier. During the quarter, we opened 15 new communities, and closed out of 21. We ended the quarter with 241 communities, up 3% from a year ago.

Included in the 15 community openings for the quarter were four communities that were previously classified as land held for future development. Our balance of land held for future development at the end of the quarter decreased by approximately $40 million from year end, as we activated land parcels and continued our efforts to monetize these properties, and redeploy the capital into assets with higher income producing potential. We expect our average community count to be relatively flat in the second quarter of 2016, as compared to the same quarter of 2015, which had increased 30% from the previous year.

For the full year of 2016, we still expect our average community count to be relatively flat compared to 2015, which had expanded 22% from 2014. Looking out past the current year, we believe our planned community openings will drive increased community count, beginning in the first quarter of 2017.

During the first quarter, we invested approximately $386 million in land and land development, with $230 million or 60% of the total representing new land acquisitions, and the remainder spent on development to convert owned parcels into new communities.

As Jeff mentioned, we are taking a measured approach in our capital investment and allocation planning. We are focused on growing the business in a balanced manner, and we'll remain flexible as to land-related investments as the year progresses, assessing among other things, general housing market conditions, the return potential and risk profile of specific land acquisition opportunities, and our operating cash flow available to fund the investments. Even if we decide to use the full land investment capacity that Jeff noted, we expect to be at least cash flow neutral for the year.

We ended the quarter with unrestricted cash of $323 million, and total liquidity of approximately $570 million, including the unused capacity under our unsecured revolving credit facility. Our fully diluted share count at the end of the first quarter of 99.4 million shares reflected the impact of the 8.4 million shares that were repurchased pursuant to our Board authorized plan that was announced earlier in the quarter. Considering the share repurchases to date, we anticipate that our fully diluted share count will approximate 94.5 million for the remaining quarters of 2016, and roughly 96 million for the full year diluted earnings per share calculation.

In conclusion, we feel good about our first-quarter performance, and we are optimistic about our ability to deliver continued improvements over the course of the year. With that said, we will now take your questions. Shea?

Thank you.

(Operator Instructions)

Bob Wetenhall, RBC Capital Markets.

Hi, this is actually Collin filling in for Bob. Thank you for taking my question.

In terms of new order growth, in the quarter, it was definitely skewed towards the southeast region. And it sounds like that there was a lot of ins and outs, with community count. But can you talk about what you are seeing in terms of organic growth in the different markets, and how you expect this mix shift towards that Southeast region to impact profitability and pricing going forward?

Collin, I can say a few comments toward that. Yes, the Southeast was our largest in terms of growth, it's still a small segment relative to the business we have in the central region, or certainly the West Coast. So I don't know that it has a meaningful impact on our margins one way or the other. It's good to see the momentum in the sales in that segment.

As we go from quarter-to-quarter, any given quarter, we can be up a little or down a little. But I think if you listened to the comments, what we are trying to communicate is central and West, which are our largest region in profits and units, there were some things going on, and overall, we still had a positive comp. To meet with the softness in Houston, and the fact the region continues to have a favorable sales comp each quarter, it speaks to the strength of the overall region, and we're actually encouraged with the sales in Houston.

If you go to the West, we had a positive comp even with a negative sales for the quarter in the Bay area. And as we shared, we have a lot of community openings that are hitting right now in the Bay area, and expect that come back very strongly, with deliveries in the second half of the year. So it will all sync together, and on a blended basis, we'll continue to improve our margins.

Great. And then, just in terms of the tightness that you are seeing in the labor market, what trades are you specifically seeing that in? And how is that impacting your costs going forward and profitability?

Well, the pressure is more -- on the cost side, the pressure is more on labor, then it is material right now, and there definitely still is a shortage of labor, and it varies. Around the system, there's different shortages in each city. But it starts on the left, with land development subs were short a year ago. And then, it works through the framing and concrete, and on into the finished subs through the year.

I think the worst of it's over. It was pretty tight, and we had a lot of cost pressures in the fourth quarter. They're still out there, but they don't seem as impactful as they were in the fourth quarter. So we'll continue to sort through things, and we think it's getting better right now in the labor front.

Megan McGrath, MKM Partners.

Good afternoon. A couple of questions here.

I wanted to -- was interested to hear your commentary on a couple of markets, that we've heard from others are getting kind of hard to invest that because of land. You mentioned the Bay area of San Francisco, and I know you have some coming on line. But thinking about future investment, would love to hear your thoughts on, is it possible any more to underwrite land in that market?

And I would love to hear your comments on Dallas as well. A lot of talk there about how land bases have gone up significantly, the past year or so?

Okay. Good questions, Megan, and you know our business pretty well. We have a unique advantage in the Bay area, in that we have a very tenured seasoned land team that's been together for quite some time.

Most of the deals that we bring to market up there, never get into the bidding wars, or the broker shopping. There are parcels that we tie up due to relationships, and we're actually the ones that are creating the entitlement value. So we'll tie the deal up, spend the dollars on the entitlements, and then close, once we get it fully entitled.

Some of the communities that we're bringing to market right now, we've eventually had controlled for five, six, seven years. It just takes that long to bring them to market. If we were to enter the Bay area today, and try to buy land just through the open market, I think it would be tough to get it to underwrite.

And frankly, we don't like to play in that, because you don't make margin. We'd rather create the value, with the confidence we have in our team up there.

In terms of Dallas, I would agree, that the land market is pretty frenzied still. We don't have a large business in Dallas. I think we have two communities open for sale today.

We're trying to grow our business, but we are being patient with it. And we have not jumped in, and chased these prices up, because there is a disconnect right now between home price and land, with the land sellers. So I would agree with that on Dallas.

Thank you. That's really helpful.

And then, just if you could give us of commentary on the pace throughout the quarter? My sense was that February, at least optically, should have been a nice month with the four weekends. But I'm not sure -- weather can always be an issue in February. So if you could talk us through the cadence through the quarter, and if you have any commentary on how margins are looking?

Yes. What we try to understand -- get through the noise of how many days in the month, and where the weekend falls, which is also a big driver since most of the sales activity occurs on weekends. This year in February, you actually had an extra day, so we probably picked up a few sales, as it was 29 days, not 28 days. But if you just look at the high-level trends, we were experiencing good sales coming out of the quarter. February was a good month for us.

So it's very early here in the spring selling season. So it's hard to call after couple of weeks of March, but we're encouraged with the trends we're seeing right now in traffic and demand.

Thank you.

Michael Rehaut, JPMorgan.

Thanks. Good afternoon, everyone. First question, I had was on the balance sheet.

Obviously, great to see you take advantage of some of the low prices, and attractive valuation from a share repurchase standpoint. But I was hoping you could also remind us what your goals are, in terms of your leverage, which during the volatility in the market so far year-to-date, some of the more highly levered builders got hurt that much more.

So maybe Jeff Kaminski, can talk to how you're thinking about leverage target ratios, target ratios for leverage over the next year or two? And to the extent that share repurchase may or may not be able to continue to be a part of those plans?

Right. Sure, Mike. Yes.

I guess, to start with, just looking at our ratios, our debt-to-capital ratio was actually a little bit lower than it was after the first quarter of last year. We ended it at about 62% versus 64% last year. On a net basis, it was about the same. So over the last year, we maintained the leverage that we had experienced in 2015 at the end of the quarter.

As far as forward targets go, our targets remain intact. We talked about, at the time being in that 40% to 50% range on a net basis, and that the target is still intact for us. The share repurchase, we thought it was actually a home run, from the point of view of the value it created for the Company shareholders.

We clearly bought at the right time. And I think it had really nice impact, that you don't see very often, where you're able to take a company with liquidity, buy back shares, and actually increase the book value per share as a result of the buyback. So we were very pleased with that, but it was opportunistic.

We remain focused on the leverage targets. It's a -- I'd just call it a medium-term goal. I think as we look out for the year, what we did with the share repurchase in the first quarter, basically just brought forward, basically the net income add to retained earnings that we're going to see for the full year. So it really didn't impact the full year, as far as moving as backward, and it was really nice opportunity for us.

No, no, I'd certainly agree with that.

I guess, a second question, shifting to community count growth. I believe you reiterated your outlook for FY16, in terms of being roughly flat, and anticipating some growth beginning in the first quarter of 2017. But just hoping for a little more detail around that, from the standpoint that, I guess, the way that the math would work -- and correct me if I'm wrong -- I'm away from my desk, in a (inaudible) road. But you had some growth year-over-year this quarter. It would seem to imply, maybe a little bit of year-over-year decline in the back half.

And so, when you talk about growth in the first, and coming out of the back half of this year, maybe down a little bit year-over-year, and you're saying growth in the first -- beginning of the first quarter, would that be sequential, or would it be year-over-year? And if you can give us any sense of, should we be thinking that 2017 overall, as a type of a mid single-digit community count growth, or would it be above -- more in the double-digit flip side?

Right. I guess, I'll start with the last part of your question on 2017. We're basically indicating right now, we're looking to start growing community count, early part of the year. That would be coming off the fourth quarter. I believe there's good potential we'll be higher than the first quarter of this year, although it's quite a ways out at this point.

We're really not guiding full year, either single-digit, double-digit, or whatever as we go, because a lot will depend on market conditions, and what we see as far as land acquisition opportunities this year, as well as development timing. So our intention is to obviously get that back on a growth trajectory, as we get into 2017.

And as we talked about last call, it's a little bit of a stair step on community count growth. We had outsized growth in 2015, 22% for the full-year which we're pretty happy about. We've maintained, and intend to maintain that community count as we go through this year, and hopefully see another step up next year, subject to market conditions on the land side.

If you're looking at just overall math, if you look at the second quarter as being flattish on an average basis versus last year, it means we have to more or less maintain our quarter end community count, and grow it slightly, in order to have that average be about level with last year, because we had pretty large acceleration between Q1 and Q2 in 2015. We had 261 communities at the end of the quarter -- of the second quarter of last year, versus 235 to start the quarter. So we'll have to have a little bit of growth in absolute terms sequentially in Q2 to basically hit that average.

Thank you.

Susan Maklari, UBS.

Hello, good afternoon. You've talked a lot about the pricing power that you saw in the quarter, and that you expect to see as we continue to go through 2016. But in some of your markets, and specifically California, you've already realized a lot of pricing power in general, as the market has. How much further do you think that can go, and how are you thinking about, how that could trend in terms of volume versus price perhaps?

Susan, let me take a crack at it, and qualify some of your comment, because a lot of the pricing power we're seeing, I guess, you'd say is pricing power, but it's really mix. And if we close out of a community in inland California, and replace it with a higher priced city of San Francisco condo at $1.5 million, it will look like we're getting a lot of price. But it's really just a relocation of the product, where you're at a higher priced submarket, but still an attractive price for that place.

So I think we're seeing some price. We'll take price where the market will give it to us, but most of the pricing is still due to the products shifts that are going on within our business.

In terms of that, if you look in the Bay Area, it's so underserved as an example, there is such good demand and so little supply, I don't think you're anywhere near a bubble price. It's certainly not at the price points we're playing at. We're -- sad to say, but a $1.5 million is an affordable home in the Bay Area right now, or city of San Francisco, I'll say.

So I think you'll see the price come here, due to mix this year, not that the market is letting us raise prices 6% to 8%. I don't think we're seeing that right now.

Okay, okay. And then, you mentioned in your comments to that -- obviously you've got some significant closings of the quarter, despite the issues with the trades and TRID as well. Can you just talk about bit about TRID, are you seeing that become any kind of significant impediment? I mean, obviously, it was okay in this quarter, but anything that's changing out there?

I certainly haven't heard much. I think there was a few speed bumps as the process rolled out. They're continuing to refining it, to make it as consumer-friendly as possible. So I think as things settled, you'll see it be less of an issue, or we're hopeful that it is.

But I don't think it was a material impact at all of this quarter, just kind of powered through it. It was actually far better than -- we were expecting the worst, and it came out pretty well.

Yes. Okay, thank you.

Stephen Kim, Barclays.

Yes. Thanks very much, guys.

I guess, my first question related to your land spend in the quarter. It was fairly robust, and particularly on the acquisition side. It looked like your development spend was running sort of the low 20%s of revs, which is about consistent with what it was running at last year. It looks like you've kind of guided to a figure that's around high 30% of revenues for a total spend.

And if I'm trying to figure out, if you're going to continue for the year, to have development spend running around that low 20%, of revenues, if that seems reasonable, kind of like what you did last year. Because that number seems a little high, actually relative to peers. And so, I wanted to know if maybe I am overestimating what your development spend might be this year? And then if not, if I have it correct, maybe what's driving your development spend to run a little higher, than maybe what we see for other builders, if you had a guess?

Right. Yes, I'll take a shot at it, and give you a few facts.

First of all, typically for us, we spend a little bit less on the development side earlier in the year, and more in later quarters. So I think the percentage, being 60/40 in the first quarter is not all that unusual.

It also -- you have a lot of ups and downs in acquisition and timing of acquisitions, as well as development. So it tends to blend, and even out as you travel through the year.

We are seeing a lot of opportunities right now that require development. Frankly, you're not seeing a lot of A lot -- or A location finished lot deals right now, that you can just pick up and start building on. And a lot of the land that we are seeing is requiring development. So I think those are two factors that we're looking at.

The other thing I think I just mentioned is, we are really in many respects, trying to stay away from a point guidance on land spend, or even land development spend for the year. And instead, really wanted to indicate for everyone where we saw our capacity. So that's why Jeff talked about a $1.3 billion capacity to spend.

And we're watching market conditions as we go, and we'll guide the land investment in, as we and tune it in as we go through the year based on that. So I really don't want to look at it as a guidance number, although it's an indication of what we think we have the capacity for. And if the opportunities are out there, and they make sense, and they hit our hurdle rates, and they're good opportunities, we'll -- we'd like to be able to invest at that level.

And Stephen -- (multiple speakers) If you are asking what may be a little different in our dev numbers and fees, as you know in California, when you start development, you pay a lot of impact fees. And in the higher-priced markets, it can be [$750,000] a lot that you pay in fees when you start grading. So if in a quarter, we pull the trigger on a couple of communities in California, it looks like a big number, but it's on 75 lots, as opposed to a finished lot in Houston, that would be one-third the price of those fees. So we can get skewed at any given quarter, depending on the timing of the type of development, or acquisition we're doing.

Got it. Yes, that's very helpful. Thanks for that, Jeff. That may be the answer I was looking for.

Okay. And then, with respect to these higher-margin communities that you're opening up in the back half of the year, which I guess you were just eluding to, I guess, many of these are going to be in the West Coast area. I was curious if you could share with us when -- what roughly the vintage of those lots was, like when they were sort of purchase and negotiated?

Because I know that you were all fairly active in 2013 and parts of 2014, as you were looking to reposition your portfolio a bit. I'm curious, is that we are starting to see here in the back of this year, or do they reflect perhaps earlier acquisitions or even later acquisitions? If you could just talk about the age of those deals?

What -- we're constantly rolling through them, Stephen. And my hunch would be, the things we're opening now in the Bay Area were probably acquired in 2013 to 2014, because it's taking us over a year to bring them to market. That we may have tied them up much earlier than that at a much lower basis and entitled them. But these aren't parcels that for the most part that we're buying, in late 2014 or early 2015, and now we are open. We don't get that open quickly in the Bay area.

Alan Ratner, Zelman & Associates.

Hey, guys. Good afternoon. A nice quarter, and a nice job on the buybacks.

Jeff, I was hoping to get your updated thinking, just in terms of what you're seeing across your price points? You've made a mix shift up towards move-up over the last few years. Historically, you guys have done a good job at the entry level, and I know in certain markets, you still have a fair amount of entry-level exposure.

So just curious, how you're thinking about really on the current land buys, and really where you see the strength in the market? And if there is any notable geographic differences, to talk about that? And I guess, just in general how you see the mix of the business evolving over the next few years? Thanks.

Good question, Alan. You've followed us a long time, so you've seen our movement back and forth in the different buyer segments. We like to call it moving with demand, we'll go where the demand is. Demand is not just income and activity levels, it's ability to get a mortgage.

And if you look back over the last few years, in 2008, 2009, even into 2010, I think our first time buyer business was 60%, even 70%. Over the last three years, it's kind of interesting, our first time buyer mix has ranged right around 50% for the last three years. And if you put that in the context of how much our average selling price has lifted -- I think it is over $100,000 in that period, it shows you how we have been able to flex, and find a first-time buyer in these higher income, more desirable submarkets, where they have an easier time getting a mortgage.

And underwriting is getting easier, but it is not easy yet. And our choice right now is to continue to target those areas that are more land-constrained. So it's harder to bring things to market, but it's also where the higher income, more likely to get a mortgage first-time buyer is today.

And depending on the market, as they've each recovered at their own pace, you'll see us go a little further out from the job core, because demand is stronger out in the ring around the jobs. A good example would be the Texas cities, where the economy has recovered pretty nicely, and you have a fairly typical housing recovery, where our first-time buyer percentage is higher. It's easier to get land, because you're out in the B locations, and you can run your normal business.

Because many cities we are in, where the recovery is still restricted to only a few select submarkets, and we're encouraged with the inland areas of California, but they're is still nowhere near as strong as the coast. So our tilt will be to stay as close as we can to the coast, until you're really comfortable that the more peripheral areas have firmly recovered. And there is real demand and a real capability for that buyer to get a mortgage.

So I think you'll see us over time slowly migrate out. We're not pushing out right now. We're continuing to stay in high quality locations, and moving with that demand for now.

Thanks. That's very helpful.

So I guess, just if you think about where the B and C locations if you will, that a lot of people are talking about, some other builders have had success there, you wouldn't expect that -- it sounds like from your comments, you wouldn't expect that to represent a much greater share of your land purchases this year, than it has over the last year or two?

Yes, definitely would not. We have ample opportunities closer in.

As I said, at some point you will see a start to migrate a little more further out, and go after the lower price products. But it will be an evolution in each market, and it will be incremental business, not a replacement business. We're going to hold -- we like this business we're developing in the urban cores, and near the employment centers. So whatever we do, would be accretive to the current business.

Nishu Sood, Deutsche Bank.

Hello. This is actually Tim Dolan on for Nishu. Great quarter, guys.

Thanks.

So my first question is in regards to land spend guidance. I understand, you obviously gave a caveat that this wasn't particularly guidance. But you have -- of the $3 billion of the ([$100 million] It came down from $1.5 billion to $1.3 billion. Just curious if this is due to the share repurchases?

And then if so, what does that mean for volume going forward in the out years? Especially just noting the fact that when you said that you're going to focus more on development than acquisition? Obviously, a little more intensive there, and time-dependent.

Right. I think if you look to our 10-K that was filed after we announced the share repurchase plan, we did revise and refine some of the capital allocation decisions that we had made for the year, and disclosed them in the 10-K, and we talked about, probably be at a maximum about $1.3 billion for the year. And it did reflect anticipating $100 million or so of investment and reinvestment back into the Company in the form of repurchasing shares.

So it is dynamic. Our land spend and investment decisions are dynamic, and we made that decision early part of the year.

As far as impacting future years, I mean, we're very well-covered. 2016 is a non-issue. The communities we have open and we're selling out of, and delivering out of, really will have absolutely no impact on our delivery or revenue forecast for the current year.

I would say, the relatively modest amount that we've invested to date in the share repurchases, would have very little impact on future years as well. So we're gaining more comfort in the coverage for 2017 deliveries, and actually starting to work out beyond that. And we'll continue to search for those opportunities, and try to grow to business in a balanced fashion, as we talked about during the prepared comments.

Understood. All right, great. Thank you.

Michael Dall, Credit Suisse.

Hi, this is Anthony Trainor filling in for Mike this afternoon.

So my question today is, I want to try and understand the cadence of gross margin, excluding some of these regional mix shifts? So it seems like the mix is definitely driving some of the margin growth expectations.

So what about the trends within the region? So you're saying West Coast is lifting the overall, but are margins going to be up, down, or flat within California?

We really haven't guided, and don't intend to guide at this point on regional margins. The margins move -- predominantly, the number one movement in our margin as a company is community mix. And it's openings and close out communities that we're seeing, and not just on really on the delivery side, as opposed to the selling community side, and that can move the margins quite significantly, even within a region.

So the number one determining factor for us is community mix, and then the second one is level of revenues. We do typically earn higher margins in the back half of the year, when we have a higher revenue number and greater leverage on our fixed costs, that's included in our cost of sales. And those are the two primary determining factors on our margin.

Great, thanks. And then shifting to Houston real quick. Any comments on recent trends there, both pricing and margins?

As we shared in the prepared comments, we like our position in Houston. I don't know what the new home median price is today. Last one I saw was around $310,000, $320,000 for Houston. So we are literally $80,000 to $90,000 under the median price.

So we are well-positioned at a price point where there is still steady demand in the market. We're watchful, because of the ripple with the price of oil, what does it really mean to the economy? I think that's still playing out.

What are the major oil companies that were creating all those campuses there, what do they do with their staff and their teams? And I would say that things, if anything, have probably stabilized. I don't hear anecdotally anything that tells us it's getting any softer than it was in the fall.

So I'd say it's stabilized, and it's a large market, with a lot more diversification in the economy, than it had in the last oil crisis, frankly. So we'll see how it goes. But we like what where are prices are, and we're seeing good demand at those price points.

John Lovallo, Merrill Lynch.

Hi, guys. Thanks for taking my call as well.

The first question, on the guide for the second quarter gross margin being flat sequentially. And Jeff, I think that you just mentioned that the two biggest drivers of the margin would be higher revenue and mix. And it looks like you are calling for higher revenue, and the ASP looks like it going to be higher as well, which I'm assuming is better mix. Can you maybe just help flesh out, why the margin would be flattish sequentially?

It's really just what we're seeing coming out of the backlog, and where the deliveries we see, delivering out in the second quarter are at. I mean, it's -- the communities of coming from -- and right now most of the deliveries we have scheduled for Q2 are known to us. So we do a bottoms-up roll-up of it, and look at it house by house, and community by community, and that's where is coming out of at this point.

Okay. And then (multiple speakers) yes.

As we shared in our comments, we're going through a trough in community count in the Bay area. And we talked about it on our last call, that the delays that we've experienced in getting these things opened, also delay deliveries.

And we've had some -- I'll call it dilution to margin, because the Bay area has been less of our business than it typically is. And that's why we were sharing the number of communities that are opening, pretty significant, and it gets us right back on track, second half of the year.

Okay. And then, I guess, the next question would be, by our calculations absorptions were down about 2% year-over-year. And it looks like the order growth is really driven by community count growth of around 6% call it. So if you're thinking -- if you are calling for community count growth to be kind of flattish for the full-year, what are you implying in terms of absorptions?

Want to give him the numbers on the --?

No, I mean, we've been talking pretty consistently for the past couple of years on -- looking at absorbing communities, or absorbing sales at about equal to our community count rate. One of the reasons for that is, we have one of the highest absorption paces in the industry, and we're certainly in the top quartile with our current profile, and what we have been seeing.

So we're not interested in artificially pushing absorptions at the expense of margin, as we move forward. And for guidance purposes, we don't have a crystal ball anymore than any of you do. We basically look at, what's happening with the community count, and we think that's a good proxy for what will happen with our net sales rate.

I would also say in my opinion, if you are plus or minus 5% on absorption, it's a relatively flat number year-over-year. There's a lot of ins and outs in the community count. It's -- number one, it's only a 2 point average, beginning of quarter, end of quarter, it doesn't take into account timing of close outs, timing of openings. And it's not an exact science.

So I haven't scientifically calculated what's statistically significant, but I don't think anything within that band is terribly significant, as far as the change year-over-year. So that's just the way we look at it.

We're optimistic about the spring. We're well-positioned with communities on the ground right now, going into, and as we just started the spring selling season. And we'll see what the second quarter holds for us.

Jack Macenko, SIG.

Thank you. Good afternoon.

Jeff K., you talked about bringing the leverage numbers down, or getting closer to the target, as somewhat of a near-term focus. Looking at your owned versus options mix, some of your peers have moved a little more towards option in the last four to six quarters, and you guys have sort of stayed at that 80/20. And I guess, the question is, are you focusing on the owned more still, because you're really trying to push on that margin side? Or is it more function, hey, the land market is going to give you, what it gives you, and sellers are going to determine terms, and where we operate, that's just the way it is?

Right. I'd certainly say, it's more the latter. We love to see more option land on the balance sheet, and control land. The opportunities dictates it, and we're heavily into, obviously the West Coast region for us, which is California, probably less opportunities here, than perhaps other parts of the country, that you might may be seeing with other builders.

So that's the primary driver. It's not like we don't have a preference as a Company to put out a lot of cash and own all of our land. It's just really coming down to the opportunities, the rates of return that we're seeing on the various opportunities, and the margin potential associated with them.

Jack, I would actually reiterate that even stronger. We'd love to option every lot, because it helps your returns. But when you're trying to focus on A location land-constrained markets, like the Bay area or Orange County or San Diego, it's very, very difficult to see any option activity, because the demand is still strong for the lots.

Yes, that's helpful.

We'll get options wherever we can. They're just hard to come by in A locations.

Okay. And then your can rate -- sorry, cancellation rate showed some nice improvement year-over-year. Is the mortgage company partnership, is that hitting on all cylinders? Is it maybe mix up, maybe a more experienced homebuyer? What do you think drove that year-over-year improvement in the cancellation rate?

I'd say our mortgage company is an eight cylinder engine that's on five or six, and a year ago, it was on two or three, so we're making progress. They're a nice business partner, and they definitely continue to elevate their execution. So it's part of the reason our deliveries were better during Q1, was the conversion rate through HCM.

I also -- I noticed an interesting tidbit -- and I don't know what it means -- but within our closings in the quarter, the government loans ticked up. There was more FHA and VA business than we've seen in the previous quarters, yet FICO scores held high, and first-time buyer was the same ratio. So it could suggest that there's a little loosening in FHA underwriting -- I don't know.

The FHA did lower their mortgage insurance premium about six months ago, and that may have brought some FHA business back. But our buyer mix is about the same. The FICO scores are about the same. The income levels are about the same.

So I'd say, it's a fairly typical buyer out there. I think they want to be a homeowner, and we're seeing our can rate come down.

Ryan Gilbert, Morgan Stanley.

Thanks, guys. Just a quick question on the California communities that are anticipated to open in the second quarter of 2016. What's the average selling price on those projects? And then, I guess, also are you anticipating closing out on communities in the West Coast?

Ryan, the communities we referenced are all in the Bay area. And the Bay area is higher priced than any of the other areas we operate in frankly, in the state. I don't know that we have the pricing with us, but it will be above the average for the region.

And that's -- we're reloading in the Bay area. As I've shared, we've been through a trough in community count, and now we're quickly going to get it right back. I think, overall for the state, we're still on track to continue grow community count, but it's a much bigger impact in the Bay area right now.

And I think to clarify -- just to clarify, Ryan, just so you have a good understanding. Jeff's comments were really focused on northern California and the Bay Area, and not the whole state, or the whole region.

Got it. And are you anticipating -- well, I guess, what level of close outs, are you anticipating in the second quarter?

On an overall basis, like I said earlier, we're anticipating a flat community count on an average basis, year-over-year. So the grand openings will inch the ending count up a bit, from the end of the first quarter, relative to 2016 period. And that should line up about the same, on an average basis with the prior year. So little bit of balance, but I think on balance, we'll have more openings than we do close outs in total.

Jade Rahmani, KBW.

Thanks for taking my question. Can you just provide some additional color on how you think about long-term capital structure, and weighing the trade-off between stock repurchases and potential debt repayment?

What Jade, as we shared, it's a balanced approach. And we wanted to walk through with the share repurchase, and the land act capability that we shared, we'd be cash neutral for the year.

We are mindful of future debt. And if we are cash neutral, we're positioned to take care of that debt at maturity, and we'll see what our strategy is at that time. But over time, what we're looking to support the growth of the Company, and improve shareholder value like we did with the share buyback, and continue to strengthen our balance sheet. And we think we have the capacity right now to do all three.

Regarding spring selling season, have you detected any change in sentiment, or softening in sentiment from buyers, as a result of recent market volatility?

We didn't see that at all. As I shared, we ended February with some good momentum. And that's the month that there was all the volatility in the marketplace.

And I think if you look at a couple, who are both gainfully employed, and you now have a child, and you have the need to get out of your apartment, and move into a home, you're not worried about Wall Street volatility, you're worried about the second bedroom, or third bedroom that you need. And on the street, out on Main Street, the consumer right now is favorably looking at home ownership.

Thank you. I will now turn the floor back over to Management for closing comments.

Okay, everyone. Thanks for joining us on the call this afternoon, and we look forward to sharing our results with you in the future. Thanks.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.