Q1 2013 Earnings Call Transcript
Transcript Call Date 03/21/2013

Operator: Good morning. My name is Sara. And I'll be your conference operator today. I would like to welcome everyone to the KB Home's 2013 First Quarter Earnings Conference Call. At this time all participants will be in a listen-only mode. Today's conference is being recorded and a live webcast is available on KB Home's website at kbhome.com.

The Company will make a presentation and then open the line for questions. We ask that you please limit yourself to one question and one follow-up.

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.

I will now turn the conference over to the Company's Chief Executive Officer Mr. Jeff Mezger. Sir, you may begin.

Jeffrey T. Mezger - President, CEO and Director: Thanks Sara and good morning, everyone. Thank you for joining us today for a review of our first quarter financial results. With me this morning are Jeff Kaminski, our Executive Vice President and Chief Financial Officer; and Bill Hollinger, our Senior Vice President and Chief Accounting Officer. I will start today's call with an overview of our first quarter results followed by a more detailed discussion on many of the operational drivers behind our performance and then provide an outline of the key priorities we have set for 2013.

Next, Jeff Kaminski will take you through the details of our financial results after which I will conclude our prepared comments with a few remarks before we once again open up the call to your questions.

Over the past few years, we have worked diligently to reposition our communities with a focus on two primary components; we prioritized our investments in select, more dynamic housing markets, and optimized our product designs and model offerings for today's consumer preferences with the expectation that these two moves would accelerate our progress towards our goal of sustained profitability.

Our hard work on all fronts is now paying off and we are pleased that our first quarter results reflect meaningful improvement in our financial and operational metrics. While we recognize we still have work to do in achieving normalized profit levels, our actions have now positioned us for profitability and growth.

Some of the highlights of the quarter that illustrate our progress include; our revenues increased 59% year-over-year in the first quarter and we substantially reduced our net loss. We improved our operating margin by 12.5 percentage points and reported operating income for the third straight quarter. Our net order value increased by 83%. The year-over-year increase in our backlog value of 53% has us well-positioned with future revenues of more than $700 million in backlog at the end of February.

We intensified our land acquisition and development activities during the quarter, nearly doubling our sizable fourth quarter spend by investing approximately $350 million in land and land development. Additionally, we strengthened our liquidity position by more than $0.5 billion through both our very successful capital raise and our recently announced revolving credit facility which further support our accelerated growth strategy.

We are confident that we will be profitable for 2013 and with the backdrop of the housing recovery that is now accelerating, we feel it is the right time to step up our investment and growth.

Our KBnxt business model remains our guide that drives our key strategies, actions and results. Our fact based approach to land acquisition enables us to identify the right land and market opportunities. Over the past few years, we have proactively focused our land investment on key states, that feature high economic and demographic growth projections and in highly desirable cities with strong existing demand. And within sub-markets of these cities that have strong consumer preference, a land constraint and which feature higher household income.

Our communities are then properly positioned with the right floor plans, square footage and features to appeal to the income levels of our core first time and first move up home buyers in these robust locations. Our first quarter results demonstrate that this strategy is paying off. As 2013 progresses, more and more of our land investments over the past 12 months will convert to open communities, supporting our expectation for a continuing trend over the balance of the year.

While our strategy is to invest in these higher priced more desirable sub markets, we remain committed to our core first-time home buyer segment. The difference is, in these higher preference locations, first-time home buyers have higher incomes and more importantly, are better able to qualify for a mortgage in today's financing environment. These buyers are responding to our built to order process and larger model offerings and after selecting from these larger square footage plans, are also adding more structural options and design features that our studious which further contributes to higher total revenue per sale.

This strategy is playing out nationally, as our average square footage continues to grow, and is reflected in the fact that our year-over-year average selling price is up significantly in all four of our regions. In the first quarter, our average price was $271,000 which represents an increase of nearly 25% over the same period in 2012. This marks the 11th consecutive quarter of year-over-year increases in average selling price and even at these higher ASPs, first time home buyers represented 60% of the homes we delivered.

In addition to the actions we have taken to change our product positioning, we opportunistically increased pricing as the market allows to control the pace of sales on valuable assets that are not easily replaceable. We monitor sales pace and price on a weekly basis at every community to optimize each assets profitability. As further proved of the success of our location and product strategy, we are achieving this significant increase in our average selling price while maintaining strong sales per community.

Our year-over-year sales per community improved dramatically with approximately 10 sales per community this quarter. While I'm pleased with our 40% year-over-year increase in unit sales I'm even more pleased with our sales value increase of 83%. Revenue growth is far more meaningful to our business than unit growth and its value results is the best illustration of the momentum our repositioning is now creating for our Company's future financial results.

As I've shared on previous calls one of the key strength of KB Home is our leading market position in California. We continue to be the largest builder in the state and have plans in place for significant growth. As you can see from our regional breakdown California is a major contributor to our improved results this quarter. This state features a large and diverse population and economy and due to the inherent land constrains and entitlement process even in the peak years of the last cycle housing demand was still not met.

Additionally, California is the largest U.S. gateway to the international community and has historically attracted in migration from other countries. As a result of this significant demand in place just as in previous cycles the market upturns are more dramatic here when the recovery takes hold. You may have heard within the industry that it's difficult to find lives in California and it is however our large presence and longstanding track record in the state makes us the land buyer of choice and we are successfully closing on significant opportunities.

In just the first quarter we acquired several communities in the choicest locations throughout the state from the Bay area in the North to San Diego in the South. Many of these transactions came to us first, in that sellers know we can and will perform because we understand the markets, can navigate the entitlement challenges, know our products and costs, and have the financial wherewithal to move quickly. Our reputation and relationships are valuable assets that we will continue to leverage as we tap this large vibrant housing market.

Another key driver in our improving results is our successful and maturing relationship with Nationstar, our preferred lender. As I've mentioned on previous calls, the past 24 months underscored the tremendous impact that not having a true mortgage partner can have on our built-to-order business. Our relationship with Nationstar is gaining traction and we continue to be very pleased with the results we are seeing, higher levels of customer satisfaction, quicker and more consistent loan approvals, and more predictable deliveries.

As one example of their favorable impact on our business during the first quarter Nationstar averaged 15 days for final documentation and closing after completion of the home, whereas other outside lenders averaged 24 days. This nine-day reduction in cycle time to closing is significant for our business and we expect that these times will compress even further as the working relationship between the teams becomes more established.

In January we announced the formation of Home Community Mortgage with Nationstar, creating a new mortgage company that will offer mortgage banking services to KB Home customers. This venture is a natural progression of our relationship further aligning our two companies' common goals of customer satisfaction and optimal performance. We expected this new company should be operational by the end of the year, once our licensing and agency approvals have been completed. At that time, in addition to the benefits of improved backlog management and reduced cycle time, this business should also provide an attractive new earning stream to KB Home. We also feel that our industry-leading position in energy efficiency enhances our sales results and as an important competitive differentiator for KB Home.

Our strategy is to lower the total cost of homeownership by adding standard energy features that lower monthly utility bills while not materially adding to the cost of a home. We have made significant progress in this area over the past few years. While our studios offer many additional energy options for the consumer as well, they also allow us to offer pilot programs for new options, where we can gauge consumer interest at various price levels for new energy products.

When the buyer reaction is strong, we will work to leverage our scale and to reduce our cost for the item due to a national commitment with that supplier to include its standard. This allows us to really zero-in on what the consumer feels is important and as critical what they are willing to pay for in this dynamic and critical area of our industry.

As a prime example of our leadership, we have a very successful program with solar power options particularly in California, where state and local rebates make it even more attractive for consumers. You may have seen our recent media coverage, where we celebrated the delivery of our 1,000 Solar Home in Southern California in a program that was introduced just 18 months ago. We have received numerous awards for our sustainability initiatives and energy efficient homes. In fact, earlier this month we were honored with the ENERGY STAR Partner of the Year - Sustained Excellence Award by the EPA.

We are the only builder to win this most prestigious award for three years in a row, while we appreciate the recognition, the real win is with our home buyers who are responding to the compelling value of our energy efficient homes. It is our goal to continually introduce new energy efficient features and options and we have plans to unveil many more products over the balance of this year.

As I shared in my opening comments the results of our actions give us confidence that KB Home will be profitable for 2013. Looking ahead, we have established our top Company priorities for this year to capitalize on our momentum. At high level these priorities are first, enhancing profitability and second, accelerating top line growth.

First, I'll share some comments on enhancing our profitability. Although there are always opportunities to reduce overhead, much of the heavy lifting has been done. The more impactful way to improve profit per unit going forward is by attacking key areas in both revenue and cost of build.

As I mentioned, we will increase base prices wherever the market allows. But this is not our core strategy as we know it is not sustainable in the long run. Therefore, we rely on our KBnxt business model with its build to order approach to maximize the profit margin of these sales. Our ability to continuously improve our product offerings, to streamline our processes, increase premiums and option revenue per home and share these best practices across all of our divisions is a real competitive advantage. We have held to our built to order discipline through the downturn and will now play a large role in margin expansion as the markets normalize.

Examples of revenue opportunities we have identified include increasing the premiums we can command for lots, pricing the plan and elevation frequencies, as well as enhancing our studio revenues. We know through our build to order experience that we can achieve higher lot premiums due to our customers selecting a lot of their choice for their personalized home.

We track lot premiums as a percent of revenue and our lot premiums today are almost a full percentage point below our average performance in a normal housing environment. When managing in turbulent times, lot premiums are one of the first things to get negotiated and compromised, with the ongoing recovery and as we have increased focus on capturing more of this opportunity we're already seeing a positive impact on our results.

Another opportunity for pricing is in optimizing plan frequency premiums. We know from our database, which floor plans and features each consumer segment prefers, and most importantly what they're willing to pay for. An example of frequency premiums would be single stories in Nevada and Arizona where these designs are very desirable. In tougher times when you're trying to get the sale you accept an average margin on the single-story and move on.

In today's environment it is not uncommon in some markets to get a 5% or 10% premium for the single-story plan as compared to a similar sized two-story home in the same neighborhood. The same holds true for pricing new exterior elevation frequencies. On all of these items we have reports that track results and are visible companywide so we can act, react and share best practices very quickly.

We're also going on offense to drive more profit from our studios. I've always maintained that the studio strategy is primarily to help us sell homes. Now that markets are recovering, there are refinements we are making in additional product offerings and our pricing strategy on these offerings to drive more gross margin. This is particularly the case on options that are not easily installed after the home is completed, such as structural options like room additions, bay windows, and covered patios. Our strategy remains the same, but we have ways to expand and leverage this unique element of our business. We're also identifying ways to improve our studio results by reviewing the size of our retail spaces and staffing levels to maximize products on display and ensuring optimal studio experience for our customers. We know the consumer places a high value on the customization of their home. We also know that it offers a great opportunity to enhance profitability today. I believe we have as much as an additional 1% to 2% margin left over time in our studios.

While we are concentrating our efforts on these revenue opportunities, at the same time, we're also working to identify ways to lower our cost to build through actions such as best practice sharing and procurement, evenflow production efficiencies, and value engineering in our product. Our purchasing effort is one of the core strengths of our business model. There is no question that as construction activity levels have increased, there has been pressure on labor and material costs. While we've been able to raise prices to offset these costs to date, we know there is a limit to this strategy and we are constantly looking for ways to lower our cost to build. We rely on our vendor relationships, many of which have been in existence for as long as 25 years to help us identify and realize savings.

In addition, most of the purchasing for a home is still performed at a local level, and with our standardized processes and product series we can compare budgets for the same floor plans from across the system, identify gaps, and share best practices to capture real savings in every plan. In essence, while purchasing is local, our teams benefit from the opportunity to tap the resources of a large national group of experts focused on the same task.

With our sales types now more predictable, we also now have an adequate backlog of sold and unstarted homes, and as a result we're doing a far better job of evenflow starts and deliveries. At the end of the first quarter, we were positioned with the best distribution of units per construction stage that we have experienced in many years. This is another area where through partnering with our contractor base, we're able to fend off increases or actually realized decreases as we ramp up our activity levels and improve our evenflow rhythm.

Our contractors understand the benefits of evenflow production, and in many cases they are able to improve their profitability while also offering us a lower price for their services. In addition, as our activity levels increase across the system, there are cost savings realized due to economies of scale.

Over the years, we have been zealous in our efforts to be the low-cost producer of new homes. We have an in-house architecture group that does a great job of creating standardize product series design to our surveys, to balance cost efficient construction designs with floor plans and features, we know our consumers want and that have great curve appeal. With standardize product series, design with standardize components we're very efficient in taking out cost and recognizing the savings.

Whether it's cost reduction or revenue enhancement, these are only a few of the opportunities we have as a result of our company wide KBnxt business model. None of these offer major impact in the short run, but overtime through many actions, we can favorably impact our margins in a material way.

As we entered the second quarter, we already have the expectations that our gross profit margins will improve sequentially each quarter for the remainder of the year. As a result of increased focused on these type of initiatives, we have a lot of opportunity for further improvement. And equally important priority for the company this year is pushing our top line growth.

We have created momentum on our growth trajectory and we now want to take it up even further. With markets now recovering at an accelerated pace it is the right time to really push the accelerated on growth. Let me outline a few of the key areas we are concentrating on. Significantly increasing our land and land development investment, capturing market share in our served markets through community count growth and driving further improvement in our sales pace per community.

As we have reported, we invested approximately $350 million in land and land development in the first quarter which is a significant increase over previous quarters. While I've already spoken about our strength in California, we have seasoned land teams on the ground around the system that are finding investment opportunities that are aligned with our location and price point strategies.

With our successful equity raise and recently announced revolver, we have the firepower to support our accelerated growth targets. In fact, we are now projecting that for the year, we will invest in excess of $1 billion on land acquisition and development depending on market conditions and acquisition opportunities.

We are comfortable with our current geographic footprint. We have proven expertise in our land teams and strategies in place to drive increased market share. A core tenant of our business model is to sustain a large presence in each of our served markets and we know that there is still significant upside before we would come close to competing with ourselves.

To give you a sense of this opportunity, we delivered approximately 25,000 homes in our peak year from our current footprint. We also see opportunity to drive increased sales pace per community. While we are disciplined in our effort to not let communities run too fast, not every community has this issue. We will continue to monitor pace in our winners and at the same time worked to raise the sales pace of those communities that are underperforming today.

I'm personally committed to driving this year's profit and growth initiatives and we have set specific measurable goals for each division in every component. I look forward to updating you on our progress in these areas as the year unfolds.

Now, I'll turn the call over to Jeff Kaminski, who will offer the details on our financials in the quarter.

Jeff Kaminski - EVP and CFO: Thank you, Jeff, and good morning. Our results clearly reflect another quarter of progress in improving our operating performance as most of our financial metrics are considerably better than the first quarter of 2012. For the first quarter of 2013, we reduced our net loss by over $33 million or $0.43 per share as compared to the same period of the prior year. Higher top line revenues combined with significant improvements in our housing gross margin percentage and SG&A expense ratio accounted for the majority of the improvement. As a result of the 29% increase in homes delivered and 24% higher average selling price, our first quarter total revenues of $405 million increased by 59% versus Q1 of the prior year.

All four of our geographic regions reported increased housing revenues for the first quarter with the strength of our West Coast region continuing to account for the majority of the increase. In the West Coast region our revenues were up more than $100 million or 96% from the first quarter of 2012 with the Southeast and Central regions up 68% and 33%, respectively.

As Jeff described earlier, our strategic land investment and highly desirable land constrained submarkets combined with our trend of increasing square footage and a general market price lift has extended our streak of year-over-year average selling price increases to 11 consecutive quarters. Our overall average selling price for homes delivered during the first quarter was approximately $271,000. This represents a significant year-over-year increase of over $52,000 or 24% and is also slightly higher on a sequential basis as compared to the fourth quarter of 2012. Average selling prices were higher in all four regions, with year-over-year increases ranging from 13% to 22%.

We expect to see a continuation of the trend in our overall average selling price with both year-over-year and sequential improvements in each of the remaining quarters of 2013. We anticipate that our ASP for the full 2013 fiscal year will be over $280,000 an improvement of at least 14% as compared to $246,500 for 2012.

Moving now to housing gross profit margin; we reported the first quarter result of 14.8% as compared to 8% in the same quarter of 2012. Excluding the $6.6 million impairment charge in the prior year quarter, we realized a 420 basis point improvement driven by community mix, pricing actions, improved leverage on fixed costs and lower closing cost allowances partially offset by the impact of higher direct construction costs. The current quarter gross profit margin also reflected a slight sequential improvement as compared to the fourth quarter of 2012 despite the negative impact from the loss of fixed cost leverage due to lower revenues.

As noted in our press release, we reclassified the expense relating to closing cost allowances provided to certain homebuyers from SG&A expense to construction and land costs in order to be more consistent with the practice of other public homebuilders. Prior period amounts have been reclassified to conform to the current treatment. We will include a schedule in the first quarter Investor Presentation that we will post on our website later today that summarizes the 2012 quarterly gross margin and SG&A results reflecting this reclassification.

For the remainder of the year, we expect to see sequential improvement in our quarterly housing gross profit margins. While we are focused on top line gross and gross margin expansion, we also maintain a close watch on controlling our overhead costs as a key component of our plan to continue to improve our operating margins. As a result of our ongoing efforts over the last few years to reduce overhead expenses, we are well-positioned to leverage our lower cost platform at higher delivery volumes which will further improve our bottom line.

This can be seen in our first quarter results. Even as our revenues increased significantly during the quarter and we implemented accelerated profitable growth initiatives, we continued our cost containment discipline and realized a meaningful improvement in our SG&A ratio. Our selling, general and administrative expenses for the quarter were $59 million, or 14.7% of housing revenues, as compared to $51 million or 20.4% of housing revenues in the first quarter of 2012. This represents the lowest first quarter levels since 2007 and reflects a year-over-year improvement of nearly 600 basis points.

For the first quarter of 2013, we increased our year-over-year housing revenues by over $150 million, while holding our SG&A expense increase to less than $8 million. We expect further improvement in our overall SG&A expense ratio as we continue to contain costs while growing our quarterly housing revenues through the remainder of the fiscal year. In addition, as a result of expense reclassification that I explained earlier and other previously implemented cost reduction initiatives, the variable component of our SG&A expense is now running at approximately 5% of housing revenue.

The significant improvements in both our housing gross margin and SG&A expense ratio drove a 12.5 percentage point increase in our operating income margin as we reported $0.5 million of operating income in the first quarter of 2013 as compared to an operating loss of approximately $31 million in the same period of the prior year. We expect to realize continued year-over-year improvement as well as better sequential performance in our operating income margin for the remainder of the year.

On fourth quarter 2012 earnings call, we told you that we were considering a revision to our community count definition. We have completed the review of our methodology and have raised the threshold for an open selling community to five lots left to sell in order to improve consistency with the rest of the peer group when comparing absorption rates. As you may recall, our community count previously represented communities with one or more lots left to sell. We're reporting our community count results for all periods using the revised methodology and will continue to do so in the future. Later today on our website we will include a schedule that summarizes our community count for each quarter of 2011 and 2012, reflecting this methodology.

Our community count was relatively flat for the fourth quarter of 2013 as we opened 15 new communities and closed out 16. As of February 28, 2013, we had 171 communities open for sale. The average for the first quarter was about 172 communities as compared to an average of 193 communities for the first quarter of 2012. Despite the 11% decline in average community count our net orders were 40% year-over-year reflecting an increase in our absorption rate of 56% from 6.2 net orders per community in the first quarter of 2012 to 9.7 in the same period of this year. This improvement reflects both the positive effects of our community repositioning as we opened 60 new communities over the past fourth quarters, as well as the strengthening housing markets in the cities where we operate.

We anticipate that our community count will increase sequentially for each of the remaining quarters during 2013, more heavily weighted towards the second half of the year as our land acquisitions and development activities convert into open communities. We still plan to open a total of more than 120 new communities during the fiscal year. We believe we can increase our fourth quarter average community count in a range of 15% as compared to the prior year period depending on absorption rates and the resulting pace of close outs. We invested approximately $345 million in land acquisitions and developments during the first quarter, including land acquisitions partially funded by seller financing. This brings our total investment over the past four quarters to almost $800 million driving our planned community count expansion, a key component of our profitable growth strategy.

We plan to continue to aggressively invest in land assets that meet or exceed our return expectations and anticipate that our total investment for the 2013 fiscal year will exceed $1 billion. To continue to fuel this driver of community count growth and in turn top line revenues, we added over $500 million of liquidity since the end of the fiscal year. During the first quarter, we enhanced our balance sheet and better aligned our capital structure for accelerated growth through the execution of concurrent public offerings of common stock and convertible senior notes. These offerings were heavily oversubscribed with full exercises of overallotment options for both issuances. We raised net proceeds of $333 million from these two transactions.

Following the success of the capital market transactions, we recently finalized an unsecured revolving credit facility in an initial principal amount of $200 million with an option to potentially increase the principal amount to $300 million. We obviously are extremely pleased with the success of these transactions and the meaningful impact they will have on driving future profitable growth for KB Home.

During the first quarter we had a net cash usage of $211 million from operating activities as compared to a net usage of $109 million for the same period of 2012. However, excluding cash used for land and development investments from both periods, we generated $110 million of operating cash in Q1 2013, a solid improvement of almost $107 million and closer to $3 million generated in the first quarter of last year. We ended the quarter with $669 million in total cash to support our community expansion plans and profitable growth strategy.

Now, I will turn the call back over to Jeff Mezger for some final remarks.

Jeffrey T. Mezger - President, CEO and Director: Thanks Jeff. Before I make my concluding comments, let me first take a moment to thank the talented KB Home employees, who continue to work hard every day to maximize shareholder value, drive our business forward and help deliver the dream of homeownership to our customers.

I would also like to underscore today's key messages. We have momentum in our business and expect to continue to generate improved quarterly financial results as the year unfolds. The pace of the market recovery is accelerating providing a tailwind to our actions. While we are pleased with the significant progress we've made in our financial metrics, we know that we have more work to do to achieve normalized profit levels.

Our investment and product strategies are working, and as a result, we are experiencing higher sales rates per community while also driving significant growth in our average selling price. Even though we were investing in higher priced submarkets, we remain committed to the core first time and first move up homebuyers. We have rolled out our 2013 priorities of enhancing profitability and accelerating top line growth. As part of these initiatives, we have specific actions with goals in place for revenue enhancement, direct cost reduction and community count growth with every division and our progress against these goals is tracked monthly.

We will capitalize on our build-to-order business model to continue to capture additional opportunities for improvement in our operational and financial results. We intend to accelerate our top line growth by investing more than $1 billion on land acquisition and development during 2013.

Finally, although the pace of the housing market recovery is gaining momentum, it is important to keep in mind that we are still in the early stages of the recovery. And there is a long way to go before the industry reaches normalized activity levels. Between the market recovery, our business momentum and our go forward strategies. We have confidence that we will not only achieve profitability this year, we will leverage the spring coil and our growth platform to drive profitable growth going forward.

Now we will be glad to take your questions.

Transcript Call Date 03/21/2013

Operator: Michael Rehaut, JPMorgan.

Michael Rehaut - JPMorgan: First question, I just wanted to focus on the gross margin, we had nice improvements there and I know you pointed to several areas that could drive further improvement and of course also guided to sequential improvement throughout the year. So, in terms of the gross margins, can you give us any sense of where you think you might be able to end the year given what you already have in backlog and some of the trends? And when you talk about option or lot premiums, I believe you said 1% below and studio revenue is another point or two of margins, just want to make sure I understand those are longer term opportunities that in aggregate would be another 200 to 300 bps to the gross margin?

Jeffrey T. Mezger - President, CEO and Director: Mike, I'll tell you those numbers and they are over the long-term and that would be closer to what we've achieved and what I confirm to as a normalized market. I wanted to walk through those items and frankly they may not be available to all the other builders. Our business model provides some real opportunity to pull levers that are visible to us and in working with a built to order consumer, you know where you can push a little bit here or a little bit there on price and you can also lever a little bit differently on the cost. You didn't hear me talk about banging on contractors on the cost side, because they will just go run to another community somewhere. So, I think there are differentiators and I think they'll start to illustrate real benefit moving forward. I think the same holds true on lot premium side, and everything I talked about because most of those are tied to experiences in our past overt the last 15 years of running the business model. At this time, we're not going to give you a specific guidance on the gross profit for the rest of the year other than that we expect sequential improvement. We'll see how the spring market unfolds and how things work out for the rest of the year.

Michael Rehaut - JPMorgan: No I appreciate that Jeff. I guess the second question is around your land spend and your community count growth that would result from the acceleration your putting in place right now. With the guidance which is appreciated for 4Q average being up roughly 15% year-over-year it would seem that there's still a lot more runway looking into fiscal '14 in terms of additional community count growth and if you know – obviously you haven’t given guidance for fiscal '14, but it would seem to me that given the material increase in land spend, it would be safe to assume at least double-digit or at least a 10% incremental growth on average for fiscal '14. Is that fair to say Jeff and I guess I'm talking not to Jeff Mezger but Jeff Kaminski as you're looking at some of those acquisition outlays.

Jeffrey T. Mezger - President, CEO and Director: Sure. Mike, there is no question. We expect to continue a strong growth trajectory. That's our goal and shared the (high site) number we've already delivered in these markets in the past. There isn't a single market we're in that's even close to the maximum market share that we're comfortable with. So we have a lot of upside in every market that we're in, and they're now all are recovering and there is opportunities in every city to push community count growth. One of the things that slows it down a little is that the more desirable locations don't typically have a lot of finished lots on the ground. So that's why I referred to as when '13 unfolds you will see us open more communities because we're having to do some development or all the development to get them opened. And as we continue to increase our spend, we expect to continue to grow our community count and what moves around a little bit about is how fast you sell out of the existing, but Jeff shared the number for the year and we're certainly not going to stop there. We want to keep pushing the envelope because we think it's the right time.

Michael Rehaut - JPMorgan: Okay. Any thoughts around that 10% minimum number for fiscal '14 or are you not going to go there at this point?

Jeff Kaminski - EVP and CFO: Mike, I think at this point, we're still really focused on profits and setting up a growth trajectory going forward out in the future years and prefer probably not to guide in '14 right now, but your overall assumptions and the way you're thinking about it, I think, are correct. I mean we spent $800 million over the last four quarters. We just sort of talked about today a $1 billion target for the current year, and we hope to drive our community count growth moving forward as a result of that. I think it'd be hard not to if we achieve with those land spend goals. Now all at the same time upholding our discipline on returns, et cetera, and making sure we're making wise investments with the funds available, but, yeah, that's the goal of the Company is to continue to drive the top line with community count increases.

Operator: Robert Wetenhall, RBC.

Desi Dipierro - RBC Capital Markets: This is Desi filling in for Bob. So, I just had a question about backlog conversion rates. It looked like this quarter sort of bucked the trend of declining rates on a year-over-year basis. So, I was hoping to get more color more on that along with what you're seeing in terms of labor availability and cycle times and how that will impact the conversion rates going forward?

Jeff Kaminski - EVP and CFO: I guess just to start with the conversion rates and I don’t know, Jeff, if you want to go after that, but on the conversion rate, yeah, we came in at what we call more or less normalized, I mean the high-50s. We are looking at right around 60% as being normalized. I think second quarter last year, third quarter last year, first quarter this year, we are all right in that range. Fourth quarter is typically a little bit higher. We had a bit lower conversion rate in the first quarter last year, but I'd say that 60% run rate is more or less normal for us.

Jeffrey T. Mezger - President, CEO and Director: Really in our business model, if it gets higher than that because we didn’t have enough backlog in the earlier stages for the future quarters deliveries. So, in our normal rhythm we'll typically range either side of 60%. So, it is a fairly typical expectation for us going forward. On the sub-contractor side, there is definitely some issues dependent on which city and which trade you talk about. And I think it's one of the strength that we have due to our long standing relationships or the benefits of our business model that we have an opportunity to do a better job in retaining contractors. It comes and goes, there is nothing that’s holding us up from really slowing down our construction cycle, you just – you move through it and deal with it. And if I'd say it's a much nicer problem to have then having too many subs and not enough houses under construction. So, it's just part of the challenge of an industry that's recovering. But we are able to successfully navigate it and deliver on our expectations.

Operator: Megan McGrath, MKM Partners.

Megan McGrath - MKM Partners: Wanted to follow-up a little bit on your conversation about your shift in strategy to these higher income sub-markets. Going forward let's go another year or so we're (into recovery) sort of volume higher, do you imagine that you would sort of prefer to pursue that strategy in new geographies. And target those kind of buyer let's say in a new city or do you see yourself rather moving outward to perhaps a lower income lower price consumer but taking advantage of the fact that you are already in a particular geography?

Jeffrey T. Mezger - President, CEO and Director: Megan as I shared in the prepared comments I mention that in previous question. We have significant upside in the markets that we're in whether it's our market share and frankly even at today's scale in those markets and the activity level in the cities where they could head to and you're always going to make more money staying in markets you know and leveraging your current team and platform as opposed to going into a new city. At some point in time to keep your growth trajectory you have to go in the additional cities and there were some that we've been in before, we don't see that some time as a requirement if there is the right opportunity we may consider it, but we think there is a lot of upside where we're at and as these recoveries continue to mature and accelerate what it does is open up more submarkets where there is a nice balance of supply and demand and there is an adequate fire pool to fuel growth at a little bit lower price point. Then lastly, I think if mortgage underwriting were to stabilize and normalize you'll see a lot of demand unleashed as well. So we're in – at (this moment) we have the ability to react and be nimble and fluid and go where the opportunities are and right now for the rest of this year, we see this as an incredible opportunity of how our position stays.

Megan McGrath - MKM Partners: Then I wanted to follow up a little bit on your comments around value engineering and there is a lot of focus talking about this, it's a little bit surprising that we're honestly that we're still hearing about it now I mean I would assume that during the deep part of the downturn everyone was trying to squeeze every possible cost out of construction that they could. So I guess and could you tell us a little bit about what's new to this process now versus the couple of years ago and what are you be able to kind of get out now I would assume this maybe I'm wrong but would have been a big part of what you were trying to do over the past five years or so.

Jeffrey T. Mezger - President, CEO and Director: It's a never-ending process Maggie, and as your business evolves and your product evolves, we keep shifting in our product line whether to smaller footage or larger footage and at different price points you think you need to have different features, and then you find out maybe you didn’t, and you are constantly testing it. And along the way there is always something in the house that you fail to recognize before that you can go back and deal with and lower your cost, whether it's a spec level item or a structural item, we never compromise structure, but there's things you can do in framing all the time in the way things are framed where there's little opportunities here and there. So I'm not looking for major, major reductions in cost. Right now we're trying to hold cost because there's a lot of pressure on that side. And we think there's opportunities through our approach to do that. In the long run I think there is opportunities I walked through, whether it's leveraging our scale or you take this out over here, but keep in mind if we have a home that we built a couple thousand around the system or floor plan and you save a $1000, it's a meaningful number when you can leverage it across your company. So that's why I said, none of these on their own are going to be major impact to the bottom line, but over time a little bit here, a little bit there starts to add up, but it’s an ongoing process.

Operator: Daniel Oppenheim, Credit Suisse.

Daniel Oppenheim - Credit Suisse: I was wondering you talked about some of the initiatives and priorities for 2013 in terms of maximizing revenues and such. But then when you talked about the absorption here at the start of the year, I guess wondering do these priorities get really in full swing at the start of the year or is it more here in the second quarter as it is now. I guess thinking about the absorption levels, I won't think that you can potentially be pushing the pricing even a bit more than you are?

Jeffrey T. Mezger - President, CEO and Director: Maybe I wasn't clear in my comments, but we have a lot of communities that are in great situations, where there is incredible demand, strong price and it’s a land constraint situation and you will meter these sales out to optimize pricing, but not all your communities are absolute screaming homeruns, and we are not going to push the pace higher in the winners. You go there to keep it in balance and I keep saying optimize the asset, but in every city, we have communities that are not performing at the level you would like, so those are the ones you go attack, and if something is doing two a month and you can get it to four a month where you have a lot of lots, and it's not selling like you would wanted to, that's where you go. You hold the winners and you monitor your success, which is why we've been doing for a year – year and a half, and on the desirable ones and on the underperformers, well those are the ones will go attack and figure out ways to make them sell better.

Daniel Oppenheim - Credit Suisse: Then my second question, just wondering about land, I think at the end of the last fiscal year about half of the land investment was in the West Coast, and then talking about it in the first quarter, the majority in California to the West Coast. As you think about the $1.04 billion for this year, will it be similar or majority in the west or what balance are you thinking for (indiscernible) targeting that?

Jeffrey T. Mezger - President, CEO and Director: It will continue to be the majority in West and in part the lot cost is much higher than many of our other states, but we are looking to push growth in all of our states, but California is more capital intensive. I don't know if you want to give in percentage in the quarter.

Jeff Kaminski - EVP and CFO: Yeah, in the quarter we invested about 75% in the total acquisition development dollars into the West region. And as Jeff said we see that trend more or less continuing, the mix of the business as you know our revenue is just like over 50% in California and the land cost are higher. So, just naturally if we were just going to replicate our current mix we would be up over the other regions in investment in the state.

Operator: Stephen Kim, Barclays Capital.

John Coyle - Barclays Capital: It's John filling in for Steve. I wanted to address volumes really quick. Back when you guys preannounced the volumes through January 18, things were running up 54%, but since then it seems like things have slowed been up 30% year-over-year. With the tougher comp in 2Q, how do you feel about your order trends heading into the second quarter? And could you give any color as to early read on spring selling season?

Jeff Kaminski - EVP and CFO: I think first of all you should probably (spec) a little bit on the quarter. the absorption rate is actually in the second half as the quarter accelerated versus the first seven weeks was changed with the year-over-year comparison and that was the guidance actually we put into that original lease, that where we said the increase would moderate, the variance would moderate year-over-year but not the order. So, the orders did accelerate for the second half of the quarter. But you know as Jeff has mentioned a couple of times, we are watching the pace versus price trade off. We do know most of our community count increase will be in the second half of the year, so we are being careful in how we are managing our communities and what we have opened in the face of sales and as long as we sell strong to this spring we are going to be well setup to hit our business plan top line revenues for the year and therefore our profit objectives.

John Coyle - Barclays Capital: Switching gears just to the home community JV can you maybe give us any color like the or any impact at the recent QM regs pertaining to the affiliated mortgage services and the proposed 3% cap how that's affecting, how you're looking at structuring the JV and what businesses you may or may not be involved in or are you looking to be involved in title insurance, appraisals or is it more going to be strictly mortgage origination?

Jeffrey T. Mezger - President, CEO and Director: For starters QM is in review mode I'll call it. The regs don't know kick in until next January and a few of them are actually still being written. So our industry group is working on all that first to understand it so you can then link it to each companies buys and they can see how it impacts them. In our venture with Nationstar, we're going into this purely as a mortgage originators to service our customers and possibly some outside business depending on the strategy down the road. We do have a small business in title insurance and home owners insurance that we operate under KB and if you just took the 3% and we're still trying to understand which of those regs will apply to a venture and whatever the regs are we'll comply with them but as we've said here we don't see a big impact to our business combined with this venture because of the three point cap.

Operator: Buck Horne, Raymond James.

Buck Horne - Raymond James & Associates: Quickly I was wondering could you give an idea how many mothball communities you have and maybe with the dollar value on the balance sheet of inventory associated with mothball communities?

Jeff Kaminski - EVP and CFO: We have right around 100 communities, about $650 million I think. It will be in the Q in the details.

Buck Horne - Raymond James & Associates: And any idea of that how many are coming back this year or next, any schedule there?

Jeff Kaminski - EVP and CFO: We were reporting last year I mean we activated about 21 communities fairly recently over the last few months. Some are still in the process of being activated. We review the communities on a very regular basis, monthly and at least and every community. And as the market conditions continue to improve and as our current portfolio shifts, we will continue to activate communities. And what I mean by that, if we have a community down the road that's already open, obviously we will wait for that to close out or approach close out and transition over to some of the new one. So there are in various states of development and analysis and it's a focus area for the Company and we'll continue to focus there.

Buck Horne - Raymond James & Associates: And I know this may be a little bit hard to do, but how much of the ASP increase that you're seeing right now is there a way that you can estimate how much of that is product mix or geography mix versus core same plan type price increases, do you have an idea of kind of what same product price increases you are putting through are right now?

Jeff Kaminski - EVP and CFO: It's a little difficult because as you can imagine with (churn of) communities in and out, it's never same for two periods in a row, but we would say about two thirds of the increase is really result of the strategy of the repositioning of the communities, of the increase in the square footage, which is coming from things like modeling larger models, offering larger plans, et cetera., so we think fully two-thirds of it is coming from that area. Obviously, we are going and achieving and enjoying actually, since sales price increases in various markets, but we think two-thirds of it is actually coming from the strategy.

Buck Horne - Raymond James & Associates: So, maybe like 7%, 8% kind of core price increase, like true price increase?

Jeff Kaminski - EVP and CFO: It could be in that range. I mean we think I would say it's probably in the 5% to 10% range.

Operator: David Goldberg, UBS.

Susan Maklari - UBS: It's actually Susan for David today. I'm looking at your energy efficient products in some of the solar home programs and things that you talked about around those. As you move into these better located markets where you have a stronger first-time buyer or move-up buyers, are you seeing any change in how the buyers value that and maybe in the sort of benefit that that can be longer-term to improving your profitability?

Jeffrey T. Mezger - President, CEO and Director: Sure. As I've mentioned it, we have a great consumer laboratory in this area because of the way we can test products with various consumer segments and run it all through a studio, so we can see how the buyer respond. One of the things I didn't mention, is that a big part of this educating the buyer. First-time buyers in particular don't spend a lot of time thinking about their utility costs, until they live in a home and get the first bill. My general summary would be, all consumers are interested in lowering their utility bills. The higher up you go in the income levels, the more they are willing to pay for it, because it will take a little longer time to the payback, but they'll make that investment to get the payback over time. A great example is this, our solar programs in California have rebates where you can actually upsize your solar all the way to a net zero house, and the more you go up in kilowatts, the bigger the rebate from the federal government for the upgrade. And in an odd way the upgrades are basically offset, the costs of the upgrades are offset by the amount of the rebate. So, you pay for it now and you get it back three year tax benefit and in the first time buyer communities, there is not a lot of upgrading going on, because it maybe just too complex or they don't have the tax structure to see the benefit. As you go up in the income levels, it becomes a more popular option. So, that’s a great example of the different consumer behaviors and today there is not a lot of inventory out there, our biggest competitor in normal kinds is resell, and with the age of much of the resell stock in the most desirable areas it's an even bigger compelling reason, we have examples around the system where peoples you feel those are down $300, $400, $500 a month from what they were paying in their reselling that they moved out of sight. I think the more the consumer understands it, and the more technology advances and cost continue to come up for the products. I think you will see this become a very significant and integral part of home building.

Susan Maklari - UBS: And then in terms of the sort of the premiums the kind of options that people are taking, generally speaking as the homes are getting bigger and maybe people are willing to take on a little bit more. Are you seeing any general changes in those trends and whether choosing for options and upgrades?

Jeffrey T. Mezger - President, CEO and Director: A little bit, it varies by city. My summary comment would be, that people buying the homes today are buying them to live in them and as we went throughout recycle it started becoming viewed as an investment. So, back approaching the peak people are buying the biggest house because they could, not because they wanted it needed is, intended to live in it and today, we're seeing more money spent on kitchen upgrade and things like or room additions and structural things to cater to their preferences because they're going to live there. In the past it was more about give me the biggest home and put more frozen. So it's more of a value-oriented play today for the consumer.

Operator: Alan Ratner, Zelman & Associates.

Alan Ratner - Zelman & Associates: My first question is on the SG&A, So if we take the 5% variable that you gave and kind of back that out, that assumes that the fixed component there is running kind of somewhere in the $39 million to $40 million per quarter range which I think it's pretty flat with where you were for 2012, but obviously well down from where you are a few years ago. So question is I guess as we go forward and the community count ramps and understanding 15% growth this year. Should we be thinking about that number creeping higher as community account grows or is that something you can keep at the current levels for a while?

Jeffrey T. Mezger - President, CEO and Director: Well our goal is to keep it at the current levels. We are putting a lot of pressure on cost and like Jeff's mentioned it's coat containment really right now as a gain. We don't think there's a lot of huge benefits to accrue to the company from trying to rip out more cost at this point in a cycle. Bur we do want to enjoy the leverage benefits of an increasing revenue line and holding our costs as fixed as we can keep them. So, that is certainly the objective. In certain cases, we have made some strategic investments and expenses as a resource. We talked about at a fair amount in the last couple quarters of last year where the growth drivers and things very associated with construction and customer facing functions where we see stress in those functions, we may put some resources back in, spend a little bit more money, but only to improve the bottom line. So we're being very cautious on it. We are going to continue to keep a very heavy discipline on the SG&A side. Of course, as revenues continue to tick up the way they have been, it becomes more and more difficult to do it, but we've been very successful over the last three or four quarters especially where we've seen nice revenue increases and been able to keep the cost down.

Jeffrey T. Mezger - President, CEO and Director: Alan, if you break it down a little more by component, we can do significantly more volume with our management structure today, and when I say management that will be a corporate or down at a division level. Many of our divisions delivered 3x, 4x, 5x in units from where they are today with the same teams. So if we ramp up community count, you are not adding to your management fixed, you have the community fixed tied to the model cost, a superintendent, things utility builds in the models, but with the way our communities are performing as we open them, the revenue is far outpacing and the margin is far outpacing any of the community-specific overhead that you have to add. So we're very solid, as Jeff said, in cost containment. There is a strategic element here or there where we incur a little bit of cost, but our plan here is to continue to push revenue and very incremental at best fixed cost increase.

Alan Ratner - Zelman & Associates: And my second question on the California orders this quarter, year-over-year gain was very strong and that was on a pretty easy comp and when I look at it sequentially, your California orders were actually down about 15%, and I think if you go back in your first quarter, you generally see a little bit of a lift there. So, given the strengths you're seeing in that market, is there something else going on there, either kind of timing of getting communities open or maybe pushing price intentionally to slow that volume that would've caused that sequential drop in orders?

Jeffrey T. Mezger - President, CEO and Director: Well, you hit on a lot of it. The timing in California in and out of communities and when you grand open, we had a few grand openings late in the fourth quarter and then they carried over early in the first quarter, but we've been applying the discipline of don't let the sales run too hard and keep pushing the price where you can without giving up any of your sales pace. So, we have a nice balance. I wouldn't overreact to one quarter of comps, because there is too many things that can influence. And I'm very bullish on California in general. Right now, I would say the housing markets here the recovery is far outpacing what we're seeing in most of the markets. So, there is no sales issue here. It's how much money can we make.

Operator: Michael Roxland, Bank of America.

Michael Roxland - Bank of America: Congrats on a good quarter. Just really one question. I'm wondering, if you can just comment more on the land market and competitive environment you are particularly seeing for land in California. On this call or on past calls, it seemed like, you guys were able to acquire some really interesting properties and maybe if you could just expand on how you're finding those opportunities?

Jeffrey T. Mezger - President, CEO and Director: A lot of it has to do of what I referenced in our prepared comments. When you have a land team on the ground for a couple of decades in the same market and yes, the Company that’s headquartered here and those all the nuances, you do become the buyer of choice for land sellers and there were things that came to us just in the first quarter that were somewhat opportunistic but right in the wheel house of product price and geography strategy. And I keep raising it because these markets continue their recovery. I think you will start to see differentiation among the builders where people have more expertise and want to stay connected to in another. And the example, I always use is while we have a strong hold in California, we really like our business here and we have great land teams were new to DC and there is others that can do in DC what we couldn't dream of doing, because we don't have the expertise or the seasoning that we will have at some point in time in our land departments. And I could name a bunch of other cities and every builder has a different profile, but here in California we continue to success in finding real opportunities to continue to acquire in very high demand, very valuable location.

Michael Roxland - Bank of America: Are there any other opportunities or regions that you are particularly interested in expanding into at this point?

Jeffrey T. Mezger - President, CEO and Director: We are going to push the envelope in cities that we are at and with that we are in and there isn't a city we are in today that doesn't have a lot of opportunity. The California recovery had become strong enough and I've been talking about it for the last probably six earnings calls. But every city we are in has a similar recovery occurring where there is a desirable area with no inventory, a lot of price movement upward and then the recovery will repel out to the other area adjacent and so on and so on. So, it were hard at seeking growth opportunities in every one of the 33 cities we are in today.

Jeffrey T. Mezger - President, CEO and Director: I guess that's it for now and once again I'd like to thank all of you for joining us this morning. Have a great day and we look forward to talking to you again soon. Thank you.

Operator: And this concludes today's conference call. You may now disconnect.