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Executives

Jeffrey T. Mezger - President, Chief Executive Officer, Director

William R. Hollinger - Senior Vice President, Chief Accounting Officer

Kelly K. Masuda - Senior Vice President, Treasurer

Analysts

Steven East - Pali Capital

Ivy Zelman - Zelman & Associates

Daniel Oppenheim - Credit Suisse

Michael Rehaut - JP Morgan

David Goldberg - UBS

Buck Horne - Raymond James

Michael Smith - JMP Securities

Josh Levin - Citi Investment Research

Megan Talbott McGrath - Barclays Capital

Kenneth Zener - Macquarie Research

Timothy Jones - Wasserman & Associates

Nishu Sood - Deutsche Bank

Joshua Pollard - Goldman Sachs

Alex Barron - Agency Trading Group

Joel Locker - FTN Midwest Securities

Susan Berliner - J.P. Morgan

Eric Landry - The Morning Star

KB Home (KBH) Q2 2009 Earnings Call June 26, 2009 11:30 PM ET

Operator

Good day, everyone and welcome to the KB Home second quarter earnings conference call. As a reminder, today’s conference is being recorded and the webcast on KB Home's website at kbhome.com. The recording will also be available via telephone replay until midnight on July 6, 2009. You can access this recording by dialing 719-457-0820, or 1-888-203-1112 and entering the replay pass code of 4252012.

KB Home's discussion today may include certain predictions and other forward-looking statements that reflect management’s current expectations or forecasts of market and economic conditions and the company’s business activities, prospects, strategies, and financial and operational results. These statements are not guarantees of the future performance and due to the number of risks, uncertainties, and other factors outside its control, KB Home's actual results could be materially different from those expressed in or implied by the forward-looking statements. Many of these risk factors are identified in the company’s filings with the SEC, which the company urges you to read with care.

For opening remarks and introductions, I would now like to turn the call over to KB Home's President and Chief Executive Officer, Mr. Jeffrey Mezger. Please go ahead, sir.

Jeffrey T. Mezger

Thank you, Michelle. Good morning. Thank you for joining us today for a review of our 2009 second quarter results. With me this morning are Bill Hollinger, our Senior Vice President and Chief Accounting Officer, and Kelly Masuda, our Senior Vice President and Treasurer.

During this call, I will discuss our performance for the quarter, share some observations on the current housing environment, and provide an update on the transformation of our business through the open series home designs. After Bill gives his review of our financial performance, I will have some closing comments and then we will open it up for your questions.

Our second quarter results reflect the persistent challenges in today’s housing environment. While I am pleased with our steady progress, we are still short of our ultimate goal of restoring profitability. Through solid execution, however, we were able to significantly narrow our loss, compared with the second quarter a year ago. We are encouraged with our net orders of 2,910 homes which exceeded our internal expectations at the beginning of the quarter. This represents a 59% sequential improvement over the first quarter net orders.

As we discussed on our last call, we faced a difficult year-over-year comparison in the second quarter. Compared to the prior year, our second quarter net orders fell 31%. Going forward, we believe we will have year-over-year net order growth in the third quarter, fourth quarter, and for the full year 2009, assuming economic conditions do not materially deteriorate.

Because of the significant improvement in our net orders from the previous quarter, we have once again increased our backlog. At the end of the quarter, our backlog stood at approximately 3,800 homes, representing future housing revenues of close to $800 million. This is the first time since 2007 that we achieved two consecutive quarters of backlog growth in both units and dollars, and we expect it will continue in the third quarter as well.

We remain firmly committed to our build-to-order model and given our reduced cycle times, we see no rationale for building and selling speculative inventory. In Las Vegas, for example, we have reduced the time from contract to close to just over four months. In many cases, that represents less time than it would take for a buyer to complete a bank-owned resale transaction. And through their build-to-order experience, our buyers in the end will have a ready-to-move-in, energy efficient new home customized to their preferences. This combination of choice and value, available within a short timeframe, represents the heart of our market positioning and differentiates us from resales, foreclosures, and other builders.

In spite of the turbulent economy, what we have seen so far in our results for 2009 is what we hope represents a return to the normal rhythm of our business, something we have not experienced since the market began turning in 2006.

If you look at our historical results, we generally show seasonal increases in net orders and backlog during the first half of the year. Then in the fourth quarter we increasingly convert our sales in backlog into revenue and reset for the following year. Our results through the first half of 2009 are pointing toward a strong fourth quarter and we anticipate that this momentum will carry into the first quarter of 2010 and beyond.

We expect to enter next year with a larger backlog compared to the start of this year and also expect to increasingly realize financial benefits from our ongoing product transformation.

We remain committed to our four interconnected strategic principles, designed to manage our downside risk while maximizing future opportunities. They are generate cash and maintain a strong balance sheet; introduce new products that can compete with resales and foreclosures; restore profitability by fine-tuning our business model, reducing overhead, and lowering our cost-to-build; and prepare to be opportunistic as housing markets stabilize.

To reach a point where we can sustain profitability, we must first effectively compete in the current housing environment which is marked by the heavy presence of resale and foreclosure inventory, ongoing pricing pressure, and general economic weakness. In communities across the country where we have introduced the open series, our sales rates are typically running at historical levels. The sales consistency of the open series in this challenging housing market is validating our strategy on the ground.

We do not expect a sustained rebound in the overall U.S. housing market in the near-term. Unemployment is rising and may continue to persist at high levels long after an economic recovery is underway. Foreclosures continue inflating inventory levels and we recognize that additional waves of foreclosures will impact the market over the next few years, adding to the uncertainty in predicting the housing recovery. These market dynamics are combining to produce steady downward pressure on prices in most markets.

On the brighter side, however, the existing home sales report released by the national association of realtors earlier this week confirms that the combination of historically low prices and low interest rates is having a positive impact and the new home sales data from the U.S. Census Bureau showed a sales pace that is stabilizing, albeit at low levels. Affordability is at an all-time high and inventory of available homes has trended much lower in many key markets despite the steady influx of foreclosures.

The $10,000 California new home tax credit contributed to our California sales activity by helping draw already interested buyers off the fence. But from what we have seen, the more fundamental driver has been affordability. In May, we stopped promoting the tax credit because it was increasingly likely that it would be exhausted before our buyers could close on their build-to-order homes.

Our California sales, nevertheless, remain fairly consistent even without the credit being promoted or readily available. That being said, because this program creates a tangible benefit for new homeowners and provides a stimulus to the California economy, we are hopeful that the legislature will extend it.

While I do not want to minimize just how challenging it is to operate in today’s housing market, I believe there are real opportunities we are beginning to capture by offering a compelling alternative to resales and foreclosures. The open series is a product that is right for these times.

We provide a tremendous opportunity for first-time buyers who want the benefits of new home ownership but have had limited choices in their price range until now. First-time buyers remain the most attractive segment of the market. As a result of our focus on first-time buyers, they represented 72% of our deliveries in the quarter, up from 58% in the second quarter of 2008. Furthermore, 79% of our homes in backlog at the end of the quarter were to first-time buyers.

Homebuyers are rethinking what they value in their home and family experience. We position our pricing to be very competitive with resales and foreclosures, which encourages buyers to make a side-by-side comparison. The key attributes of the open series, affordability, functionality, smart design, and energy efficiency, all backed by a 10-year limited warranty, create a significant competitive advantage. And the business impact of our new home designs is considerable. To help illustrate our strategic opportunity, let me walk you through an example from one community in Texas.

When the market began turning in 2006, we found that our product offering was not in lie with what buyers could afford. With weakening sales performance and a desire to conserve cash, we eventually chose to suspend sales until we could develop the strategy to make the community successful again. Now with the open series, we have been able to reduce prices by $60,000 while lower our cost to build by $80,000, offering a much more affordable product while effectively increasing our gross margin. Because of the positive buyer response to the open series, we have also reestablished a consistent sales pace.

We are experiencing the same success throughout the company as we continue our nationwide rollout of the open series. In certain regions, the portion of net orders from the open series now exceeds 50% of all our net orders in the region, in some cases double or even triple the share of net orders in the first quarter.

There are those whose opinions are that the advantages we have created for ourselves in certain markets are temporary and other builders will eventually match our prices and value proposition. I disagree. We believe that the open series gives us a real first mover advantage. While other builders may match us on price, they cannot match the full build-to-order experience we offer. Delivering that experience requires an infrastructure, business processes, and expertise that can take years to develop. The behind-the-scenes work that enables us to understand homebuyer preferences through detailed surveys, value engineer our homes, drive down costs, and capitalize on market opportunities requires considerable discipline and experience. We have steadily built on and refined these capabilities over the years and they form the backbone of our process driven KB Next business model.

We are also committed to ensuring that KB Home remains differentiated in the marketplace. We continue to offer more high value studio options, deliver world-class customer service, and increase energy efficiency through our commitment to building energy star qualified homes.

The U.S. environmental protection agency recently recognized our efforts by awarding us eight 2009 energy star leadership in housing awards. During the quarter, we also released our 2009 sustainability report. Our commitment to sustainability not only appeals to today’s homebuyers, it generates cost-saving opportunities for both ourselves and for our customers and lessens the environmental impact of our operations.

Part of my optimism about our future comes from seeing the KB Home team continued dedication to innovation and operational excellence and I would like to thank them for their performance during the quarter. Even though housing markets have not substantially improved, I believe we have. That kind of determination and focus is essential in today’s market and will continue guiding us in the coming months.

I will turn it over to Bill for the financial recap. Bill.

William R. Hollinger

Thank you, Jeff. Good morning, everyone. As Jeff mentioned, we remain steadfast in executing on our key initiatives of maintaining a strong financial position, restoring profitability in our homebuilding operations, innovating new products, and positioning the company to capitalize on an eventual market recovery.

During the second quarter, we continued to operate in a recessionary economy and a turbulent housing market with elevate home foreclosure rates and high unemployment prolong even downturns that began in 2006.

Despite these challenging conditions, and our substantially lower revenues, we narrowed our net loss considerably from the year earlier quarter by remaining focused on our goals. For the quarter ended May 31, 2009, we reported a net loss of $78 million, or $1.03 per diluted share. That compared to a net loss of $256 million or $3.30 per diluted share a year ago. In addition to expanding our gross profit margin and lowering our overhead costs from the year earlier quarter, we realized improvement from a significant reduction in asset valuation charges. These charges consisting of pretax non-cash charges for inventory and joint venture impairments and abandonment of land option contracts totaled $50 million in the second quarter. That is down 72% from $177 million of similar charges a year ago. The decrease was principally due to our lower inventory base and the significant impairment charges we have incurred over the past several quarters, along with the favorable impact of our open series product transformation.

At this point, we believe the majority of our impairments are behind us, although if market conditions appreciably worsen, we could incur additional charges in the future.

Excluding inventory and joint venture related valuation charges and the $24 million goodwill impairment charge in the last year second quarter, our pretax losses would have been $34 million in the second quarter of 2009 versus $54 million a year ago. That is a 37% improvement year over year. After factoring in related tax benefits, our current quarter net loss would have been $19 million, or $0.25 per diluted share compared to $33 million, or $0.43 per diluted share in the year earlier quarter. Turning to our top line, home building revenues in the second quarter totaled $383 million, down 40% from a year ago due to lower housing revenues. Our housing revenues for the quarter fell to $381 million, the result of a 37% decrease in the number of new homes delivered and a 5% decline in our average selling price.

We delivered fewer homes in the quarter, largely due to a 38% decrease in our overall active community count from a year ago. The decline in our average selling price reflected the downward pricing pressure that persists in most of our markets as well as our ongoing rollout of more affordable value-engineered homes. That includes, as Jeff mentioned, the open series, our newest line of homes specifically designed to appeal to today’s cost-conscious, first-time buyers.

On a sequential basis, our average selling price increased 3% from the first quarter of 2009 as a by-product of offsetting changes in geographic and product mix. Looking ahead, however, we expect our average selling price to resume its downward trend in the third and fourth quarters as we continue the rollout of more affordable homes.

Our housing gross profit margin improved to 1.9% in the second quarter from a negative 17.5% a year ago. Excluding inventory valuation charges, the gross profit margin improved by 400 basis points to 12.7% from 8.7% a year ago and was roughly comparable to the 13.0% we achieved in the first quarter of 2009.

The year-over-year increase in our gross profit margin reflected our success in executing on our strategic initiatives, rolling out value-engineered homes, reducing direct construction costs, and improving our overall operating efficiency, as well as the benefit of impairments taken in prior quarters. We expect to generate similar year-over-year and sequential gross profit margins comparisons through the remainder of 2009 with the most pronounced impact in the fourth quarter when close-outs of older, discontinued products are likely to be behind us and homes delivered from the open series reach their peak for the year.

Our selling, general, and administrative expenses totaled $73 million in the second quarter of 2009, a $46 million or 39% reduction from the year earlier quarter. The savings were across the board and in large part attributed to lower salary costs and other payroll related expenses. Our total headcount declined 42% from a year ago, reflecting division consolidations and other operational adjustments we have made to realign our cost structure to lower revenue levels.

Reduction of overhead costs remains a high priority and we continue to evaluate all opportunities for further savings. We are mindful, however, of the need to maintain a strong talent base and infrastructure platform so we can respond quickly to the prospects that will arise as housing markets stabilize.

As a percent of housing revenues, our SG&A expenses increased slightly to 19.1% in the second quarter from 18.7% a year ago, mainly because the steep year-over-year decline in our housing revenues outpaced our cost reductions. Compared to the first quarter of 2009, however, our SG&A percentage improved by 100 basis points. We will continue to focus on reducing this percentage but expect it to remain above historical levels for some time, largely because we believe it is essential to preserve a core strategic footprint that can rapidly mobilize when business conditions eventually improve.

Overall, our home building business generated an operating loss of $66 million in the second quarter, including $42 million of charges for inventory impairments and land option contract abandonment. In last year’s second quarter, our home-building operations generated an operating loss of $262 million, including $174 million of inventory related charges and a $24 million goodwill impairment. Excluding these charges in both periods, our homebuilding operating loss narrowed to $24 million in the current quarter, which is an improvement of $39 million, or 62% from the $63 million loss a year ago. We achieved this improvement in spite of a substantial drop in our revenues from a year ago. This illustrates how we are transforming our business and getting more with less today.

Before turning to the balance sheet, I want to highlight that the substantial progress we made in reducing our overall net losses so far was achieved even with the adverse trends in our interest income and interest expense. In the second quarter of this year, our interest income fell by $8 million from a year earlier quarter, largely due to a shift to safer government guaranteed investments that delivered lower yields. At the same time, we expensed $11 million of interest to a reduction in our assets qualifying for capitalization while a year ago, all such interest was capitalized.

These two items are likely to have a similar adverse impact in our year-over-year comparisons for the remainder of 2009. I point this out to underscore that improvements in our bottom line are being driven by real progress in our operations and despite the headwind of these two non-operating items.

As we have mentioned on previous calls, maintaining a strong financial position and ample liquidity is one of our top priorities. This was evident as we ended the quarter with balances of $1.1 billion in cash and cash equivalents and $1.6 billion in total liquidity. As expected, we used approximately $20 million of cash flow from operations in the second quarter. While we again expect to use cash in the third quarter, we anticipate this will be more than offset by positive operating cash flows in the fourth quarter. As a result, we expect to produce overall positive cash flows for the second half and full year ending 2009 with more than $1.1 billion in cash and cash equivalents. Having said that, our ability to generate positive cash flows remains highly dependent on economic conditions and the behavior of housing markets, which will influence our future land acquisition decisions.

Generating and preserving cash remains a high priority for us, both because of today’s highly uncertain economic and market conditions and because we will be better situated to capitalize on new opportunities. As Jeff will discuss in his closing remarks, we are beginning to see some attractive land acquisitions emerge along with an increase in actual deal flow. Currently it is our plan to spend less than $350 million on land purchases and land development in 2009. That is about $200 million below last year. We are and we want to remain well-positioned to replenish our land pipeline when the time and opportunity are right. As such, we have begun to opportunistically reload our land pipeline on a limited basis using options whenever possible to minimize cash outflow.

Our inventories total $1.9 billion at the end of the second quarter, down from $2.6 billion a year ago. We continued to trim our inventory holdings in the quarter exclusive of impairments and land option contract abandonment. Our total lot count is currently about 42,100, down 5% from the first quarter of 2009 and down 26% from a year ago. As of May 31, 2009, we own 78% of our lot total, approximately 33,000 lots, and controlled 22%, or about 9,100 lots via land option contracts. Our total lot count represents about a four-year supply.

We ended the second quarter with 3,033 homes in production, down 35% from last year’s second quarter. About 12% of those homes, some 366, remain unsold. That number has been reduced substantially from the first quarter of 2009 when 618, or 25% of our homes in production were unsold. We also reduced the number of finished, unsold homes in inventory to 142 at the end of the second quarter from 282 at the end of the first quarter.

With regard to our unconsolidated joint ventures, we had approximately $171 million invested in 19 joint ventures at quarter end. Our investment in these ventures is significantly lower than the $295 million we reported a year ago. At May 31, 2009, our unconsolidated joint ventures held total assets of $1.1 billion and had total debt of $740 million. Both the assets and the debt are down more than 50% from a year ago.

For added perspective, six of our 19 unconsolidated joint ventures accounted for 76% of the total assets and 80% of the total debt at May 31, 2009. We remain committed to evaluating and eliminating those ventures that are no longer a good, strategic fit.

While we will continue to reduce the joint ventures, we still believe they play a constructive role in our business. However, the evaluation and dissolution process takes time and each joint venture operates within a unique set of facts and circumstances. Nevertheless, we are determined to reduce further exposure to these ventures and importantly to their debt obligation. During the second quarter, we pared our joint venture account by five. We have a goal to unwind up to an additional seven joint ventures over the remainder of the year. Those seven joint ventures comprise about 40% of the total joint venture debt at May 31, 2009.

Now let me give you a look into our capital structure. We ended the second quarter with no borrowings outstanding under our revolving credit facility. Our total debt at the end of the quarter was $1.7 billion, roughly flat with the first quarter of 2009 and down nearly $450 million from a year ago. Most of our debt balance, $1.6 billion, is made up of [inaudible] senior notes with maturities extending through 2018. Our next debt maturity does not occur until August 2011.

Our debt net of cash totaled $612 million at the end of the second quarter. That is roughly flat with the first quarter and down by $244 million from a year ago. Our net debt to total capital ratio was 47% at May 31st, up from 44% at the end of the first quarter and 40% a year ago. Our liquidity at quarter end totaled $1.6 billion, which included $1.1 billion of cash and cash equivalents and the amount of credit available under our bank revolver. We ended the second quarter in compliance with all covenants associated with the revolver.

With anticipated positive cash flow from operations in the second half of 2009, $1.1 billion of cash and no debt maturities until 2011, we do not expect to borrow against our bank revolver for the remainder of the year.

Before turning back to Jeff, I have a couple of points on our outlook.

Having reached the halfway mark for 2009, we are financially sound, strategically positioned, and on track to achieve our key initiatives of maintaining a strong financial position, restoring profitability in our home building operations, and positioning the company to capitalize on an eventual market recovery. Furthermore, we remain totally committed to the interests of our customers and our shareholders.

In the second half of 2009, we expect to deliver fewer homes than we did a year ago but with higher year-over-year gross profit margins as a result of greater operating efficiencies in our business. We also intend to emphasize further overhead cost reductions while preserving a platform for sustainable future growth in the longer term. As we continue our product transformation and cost reductions, we have reasonable expectations that we will gain momentum to end the year with a strong fourth quarter marked by year-over-year improvements in net orders, backlog, and operating margin.

From an overall balance sheet perspective, we have strength and flexibility. Our substantial cash and liquidity, conservative lot count, and [well-lettered] debt maturities provide a strong foundation for us to navigate the current turbulent conditions and support future growth. We anticipate generating significant positive operating cash flows in the fourth quarter that we hope will drive our cash and cash equivalents above the $1.1 billion level at year-end. Although the market indicators remain mixed and uncertainty shadows most of our markets, we are squarely focused on executing on our proven strategies to improve our financial performance. We are confident that the many factors that differentiate KB Home in the marketplace and our diligent adherence to our proven business disciplines will be the keys to our success as we move ahead. As we are gaining ground every quarter and identifying opportunities to grow our top line and restore profitability, we are building toward a strong finish for the year and anticipate this performance will lead to even better results in 2010.

Now let me turn the call back to Jeff for some closing thoughts.

Jeffrey T. Mezger

Thanks, Bill. Our financial results from the second quarter demonstrate that we have moved closer toward restoring profitability, yet we still have more work to do. To reach profitability, not only will we have to continue achieving cost-savings in what we build and how we operate but we will also have to grow our top line. We recognize that you cannot simply save your way to profitability, which is why we have been careful to preserve our growth platform, even as we streamline our operations.

Now, in large measure because of the work we have done with our product transformation, we have an opportunity to leverage our operations and grow our business. We believe we are in a good position to restart our deal flow and have begun rejuvenating our land acquisition activity. Where we have introduced the open series, sales results have yielded more predictable absorption rates, which gives us confidence in underwriting new land acquisitions. We have not had this level of predictability in our business since the downturn began more than three years ago. As a result, I am pleased to say that during the second quarter, we optioned five attractive finished lot deals with minimal deposits, touching every region we operate in and representing more than 600 lots. While we now see opportunities in every market, we will continue to be conservative with our cash and carefully choose only those deals that meet both our market strategy and financial hurdles.

Because the open series product is already designed and the cost to build contracted, we can move quickly once we acquire new lots. In Florida, for example, we approved a lot option purchase in April and by May we were building our model complex and generating an interest list. We conducted a successful grand opening in June, less than 60 days after deal approval, and expect the first homes to be delivered by early November. That means we will be generating revenue less than seven months after making the investment decision while staying disciplined with our build-to-order model.

We continue working to shape our own future and are not simply relying on the uncertain timing of the broader housing market recovery. Our responsibility is to continue executing with speed and discipline, identify and act on targeted new growth opportunities, and remain focused and committed to the strategic principles that have steadily produced positive results.

Thank you and now, Michelle, let’s open up the line to questions.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll take our first question from Steven East with Pali Capital.

Steven East - Pali Capital

If you look at the orders, you talked about orders being up for the full year, 3Q, 4Q and the full year. I guess broadly speaking, that seems a little bit optimistic to me. Obviously it’s got to be more driven by open series. Can you sort of walk us through how you get there and also sort of blend in what happened in the Southeast? And can that be corrected very easily?

Jeffrey T. Mezger

Sure. Steven, as I mentioned in the prepared comments, we actually exceeded our expectations in Q2 and that occurred because of the strength of the sales rates where we’ve rolled out the open series and we continue to introduce the product in more locations across the country, so we have good sales momentum and at the same time in Q3 and Q4 last year, we had poor sales results. That was the time when we decided to shut down communities and start retooling. So you have this inflection occurring where we have good momentum in all the markets where we’ve opened up and introduced the open series, it’s selling at historical sales rates so we have confidence in the sales pace going forward. At the same time, we now have a very soft comp in Q3 and Q4.

As to the Southeast, a few things are going on. As you know, we pulled out of Atlanta. We’ve significantly reduced our footprint in Florida. We had a lot of sales last year in both Atlanta, parts of Fort Myers and the treasure coast that we no longer operate in, and the markets have remained a little difficult. Frankly, the Carolinas have turned soft from where they were last year at this time and our community count is down.

So I think it will take some time to close the gap in the Southeast. While I say that, in every one of those markets where we’ve introduced the open series, it’s selling very well.

Steven East - Pali Capital

Okay, and along those lines, how many communities do you have now that are open series and what should we expect in Q3 and Q4?

Jeffrey T. Mezger

Well, it’s starting to blur for us, Steven. I didn’t share the percentage because we now have -- I’ll call it a grey area of community where we have existing models and existing product and we’ve now introduced open series into the product line that’s selling well without building models. So to give you an exact count going forward, it’s going to get blurry and it’s going to get difficult, so what we would prefer to share again is that we are continuing to introduce it across the system. Any new acquisitions we do would be open series product and we continue to hold that coming out of the fourth quarter that 50% of our deliveries will be open series product.

Steven East - Pali Capital

Okay and just one other question, on the gross margin, you talked about the project that you bought in April, built in May, et cetera. Can you compare the gross margin you are getting there on that product versus the rest of your business? And when do you sequentially -- when do you see a step change in your gross margins?

Jeffrey T. Mezger

Great question, Steven. I was hopeful that people got that message out what we shared in Florida. Part of the reason that we are going out on these soft options and moving quickly is we can raise our returns and our margins and if this community hits pro forma and the initial sales rate suggest it’s well on its way, the margins will be north of 20 and the IRR is north of 30, so it will help to lift margins over time.

We haven’t done that many new deals at the higher margin yet and it’s going to take some time to broadly lift the margin back to the good old days. But in the meantime, as Bill shared in his comments, we expect a margin lift in the fourth quarter as we close out a lot of the older product lines that weren’t performing that well and a higher percentage is the new open series mix.

Steven East - Pali Capital

All right, thanks a lot, guys.

Operator

We’ll take our next question from Ivy Zelman with Zelman & Associates.

Ivy Zelman - Zelman & Associates

Good morning. Great quarter, guys. Happy to see your progress. Just a few things just to continue on the questions Steve was asking -- if we look at the open series margins, it sounds very promising about your community there but realizing that’s also on land you just locked up at what would clearly be better returns and the legacy asset, so just kind of thinking about your gross margins I the second half of the year. If I understand you correctly, they are definitely going to be obviously higher than the 14.3 and the 18.7 that you reported in the last year and two quarters respectively. Should we assume that this roughly 19.7 you did this quarter is a sustainable margin going forward sequentially or would you expect that normal discounting, mortgage rate buy-downs, closing costs -- whatever you are doing, which I would love to know the percent of the total discounting as a percent of ASP you are averaging right now, kind of help us understand what our though projections look like for the second half?

Jeffrey T. Mezger

The numbers that you shared on margin, I believe you model it a little different than us in that you take out cap interest and some other things. But if you look at our track for the year here, it was roughly 13 in Q1, it was 12.7 in Q2, basically flat. We expect it to be flat in Q3 and then there will be a lift from there in Q4.

Along the way, our allowances and incentives have all held at historical levels, as you know in our business model we focus on the best price for the consumer and don’t rely too much on incentives. And when we don’t have any inventory to sell, you don’t have to take steps to flush inventory. So our incentives will remain low and we feel that our margins with our backlog are now fairly predictable again.

Ivy Zelman - Zelman & Associates

So is that -- I guess my number then would assume that you can hold margins sequentially from 2Q to 3Q and you are saying up from there?

Jeffrey T. Mezger

Yes.

Ivy Zelman - Zelman & Associates

Okay. Also, just realizing that you did no longer have the mortgage company but did you have any loans that you were required to repurchase?

Jeffrey T. Mezger

No. Again, sometimes you are lucky but part of the move to sell our mortgage company back in ’05 and create debenture significantly lowered any go-forward risk for us, so we have not had to do some of the things you are hearing where there’s major loan purchases coming back at the builders.

Ivy Zelman - Zelman & Associates

Great. And if I can keep going, cut me off, but SG&A obviously seeing some improvement as a percent of revenue. Assuming you actually benefit from the strength of the orders that you took this quarter and that your more predictability in terms of the ability to sell, what would SG&A kind of look like under the closings that these orders would bring in eventually? Are you going to see a material improvement or do you expect that SG&A is still going to be even on a higher revenue base still challenged?

Jeffrey T. Mezger

It won’t be back to historical levels but it will be below the 19 or 20 we’ve run for the last few quarters. Definitely if you help the top line, it helps your percentage and we are continuing to pursue actions and initiatives to reduce our overhead, our fixed costs, but they are somewhat limited because we are retaining a growth platform now. So you will see the cost side go down and the top line go up and hopefully a much better percentage result.

Operator

Your next question comes from the line of Daniel Oppenheim with Credit Suisse.

Daniel Oppenheim - Credit Suisse

Thanks very much. Jeff, just wondering, with your comments in terms of the order trend here, the positive trend continuing into the third and fourth quarter and the start of next year, I heard a lot of optimism there, which is good with the open series. What is it that you are more worried about these days? We’ve certainly heard from others about appraisal issues, foreclosures -- do you think that you’ve solved the issues of appraisals now? I guess looking at the Southeast and Southwest, have some concern that some of those markets were still very foreclosure heavy that it might still be challenging for some time.

Jeffrey T. Mezger

Well, let me make a few comments, Dan. We are more confident in our sales pace in that we’ve been introducing the product in some markets that are pretty challenged, frankly, on inventory levels and foreclosure levels and we are still seeing good sales pace. And the sales pace is achieved because we’ve dropped our prices down where they are above foreclosure and resale but they are close enough where there’s a compelling value when you throw in all the other attributes of new homes.

While I say that we’re confident, I also am concerned, I’ll say, in that interest rates have gone up a little bit. We don’t think that’s going to continue but if it does, it will put pressure on affordability. You have unemployment going up, which always impacts consumer demand, so that’s somewhat uncertain. You have consumer confidence that’s improved, yet is still at low levels. And you just have this cloud over the general economy.

So we’re I’d say cautiously optimistic in that our sales results on the ground are reinforcing that we’re doing the right thing but you have all these variables that we don’t control and that are independent that will impact consumer demand going forward.

Relative to appraisals, every appraisal has its own story and I’ve read a lot about the change in the appraisal process. Within our business, and our JV with Banc of America, the protocol and procedures that were raised with this change in May were already in place with Banc of America, so that didn’t really impact our business at all.

If you get to a specific value on a specific home, you always have the push and pull of what are the comps that are used around it and is the foreclosure an appropriate comp to a brand new home or not? And we just deal with those one at a time. But there’s nothing that’s happened on the appraisal side that would impact our confidence on the ability to sell homes today.

Daniel Oppenheim - Credit Suisse

Okay, thanks and then just follow-up, wondering about California, you talked about not advertising the credit there, the tax credit in May. As it’s continued and there’s been more talk in the press there about that running out, what have you seen in terms of the trends there in California into June?

Jeffrey T. Mezger

Well, we don’t comment intra-quarter, Dan, but through May as we shared, we stopped emphasizing the California credit because we knew the build-to-order consumer won’t be able to take advantage of it and I think what happened here is as this credit was rolled out, the government, the state government was making a statement to the consumer that it’s a good time to buy a home and there’s a little financial benefit and it got some people off the fence to come in to our sales offices that were contemplating a home purchase and once they looked into it, whether it’s the resales and foreclosures or our product, they are discovering incredible opportunity and incredible affordability. So we think the prices are driving it as much as, or more than the credit. Credit definitely had an impact because it stirred some activity but we saw our activity levels hold through May.

I think in addition to that, if you’ve seen the data in California, resale prices have now ticked up for at least two months in a row and with our sales success, we’ve actually been able to raise our prices some in California. So you have the get-them-off-the-fence-because-prices-are-going-up phenomenon, which again we haven’t seen in years.

Operator

Your next question comes from the line of Michael Rehaut with JP Morgan.

Michael Rehaut - JP Morgan

Thanks. Good morning, everyone. On the open series, appreciate the detail and the improvement that you expect on the gross margins. I just wanted to get a sense, you said that 50% of deliveries you expect in 4Q to be open series, I just wanted to make sure when you talk about further improvement in gross margins from 3Q, which you expect to be flattish, relative to 3Q, would the 4Q margin actually be up year-over-year versus 4Q08 or when you kind of said that in the second half it will be up, was that more on a second half blended basis?

Jeffrey T. Mezger

Fourth quarter will be up sequentially and year over year.

Michael Rehaut - JP Morgan

And year over year -- okay, and looking forward into 2010, could you give us an idea in terms of mix of communities and deliveries that would be open series? Would it be higher than the 4Q number or would it be around 50% throughout the year?

Jeffrey T. Mezger

We think it will continue to have an upward trajectory, Michael. It depends on how much reload we do with options like I shared. We are also using the series now to open up some communities like the Texas story I shared, where we would shut it down and preserve cash and now it’s tensing again because of our new product line, and that will help the percentage.

On the other hand, we have communities where you can’t change the product. We have town home communities where you can’t really do it as well, which is a percentage of our business. We don’t think we would get to a pure open series business for a few years but it will be higher than 50 and we won’t -- we can give you more guidance later in the year, depending on all the things I just shared.

Operator

Your next question comes from the line of David Goldberg with UBS.

David Goldberg - UBS

Thanks. Good morning, everybody. First question is about the land deals that you talked about, Jeff. I’m just wondering, how many deals did you guys bid on to -- I think you said you completed six of them. I’m just trying to get an idea of how many -- what that fixed hit rate is against and how much you think the land market has really adjusted versus kind of being one-off deals here?

Jeffrey T. Mezger

I could not tell you how many the team has bid on. We always encourage our land teams in each division to -- I call it the hang around the rim strategy. You always -- you have to be out in the market. You have to know what’s going on and you can throw an offer out to pencils and it may stick or it may not but the response will tell you what’s going on in the marketplace.

What the phenomenon that’s happening now, there are -- we are starting to see some opening up of term deals at favorable pricing, which is certainly encouraging and also an opportunity for us. We are mindful of the fact it has to be product that is aligned with our strategy, so we wouldn’t go do second move-up lots in an expensive location, and it has to hit our returns. We think that what we saw in the second quarter will probably grow going forward, in part because the open series is allowing us to under-write transactions on lots that in the past wouldn’t have penciled for us and are in a higher price than these bottom-feeding investment funds are willing to pay. So there is an opportunity there for us and we’ll see how it goes over the rest of the year.

David Goldberg - UBS

Got it. The follow-up question is just on the open series product, I’m wondering how the open series product works with the design studios and really to understand better what kind of options people who are buying the open series are taking magnitude wise. Are they taking as much as your traditional buyer? And margin wise, are they taking things that yield similar margins?

Jeffrey T. Mezger

With the open series, Dave, we have not see a big drop-off in our studio sales at all. In fact, one of the things I do like to share, since the peak in ’06, our per unit revenue hasn’t moved significantly. Our overall sales prices are down a bunch but the studio revenue has held very well.

What we have seen, however, is a shift to more practical things. People aren’t buying Jacuzzi tubs and the more exotic things that they may have bought in ’06. They are buying flex options to move walls around, convert a bedroom to an office or a den or visa versa. And kitchen options to make the kitchen a little bigger or -- they are not going to granite, they are going to more cabinet and counter space. So I’d say it’s more functional items as opposed to some of the sizzle we saw a few years ago.

Operator

Your next question comes from the line of Buck Horne with Raymond James.

Buck Horne - Raymond James

Good morning. I just wonder if you could put a little housekeeping detail around your community count -- what your average active communities were in the quarter, what you project that to be at for year-end and just how many other communities you currently have either mothballed or still in development?

Jeffrey T. Mezger

Do you want to handle that, Kelly?

Kelly K. Masuda

Buck, we had 134 communities in Q2. We expect that to be relatively flat in Q3 and the average for the year will be somewhere around 140.

Buck Horne - Raymond James

Okay, great. And I just -- just circling back to the appraisal issues. I’m just wondering, how are you guys instructing your sales force to act when an appraisal comes back on a contract and it’s below the buyer’s original contract price or below a level where a lender is willing to finance it? How aggressively are you continuing to pursue that sale?

Jeffrey T. Mezger

Well, the sales people aren’t involved at all, Buck, so we don’t control the process. So it’s between the lender and the consumer and they may contact us to get more data in the market place but we are out of that discussion. So the sales people aren’t instructed to do anything other than to hold the consumer’s hand through the process from sale to close.

Buck Horne - Raymond James

Okay. All right, thank you.

Operator

Your next question comes from the line of Michael Smith with JMP Securities.

Michael Smith - JMP Securities

Just a quick question about the impairments. I wonder if you could give some color on where you took them regionally and if you want to break it down maybe by -- just by region and where you took them, that would be really helpful. Thanks.

William R. Hollinger

Yeah, if you just give me a second.

Michael Smith - JMP Securities

Sure.

William R. Hollinger

All right, for the quarter, we -- and this will obviously all be disclosed in greater detail in the Q that we’ll file here in the first part of July but basically impairments we had was about $5.7 million and it was spread across the -- basically all our regions -- $1.4 million in the West Coast; $1.3 million in Southwest region; our Central had $1.6 million; and the Southeast had $1.4 million.

Inventory abandonments basically were in two regions -- about $27 million in the West Coast region and $9 million in the Southeast region. And on our joint ventures, the impairments of $7 million was all in our West Coast region.

Michael Smith - JMP Securities

Can you give some color on specifically where on the West Coast that $27 million inventory abandonment was? That seems -- that’s the one that sticks out to me.

Jeffrey T. Mezger

It’s California, Michael.

Michael Smith - JMP Securities

Thanks.

Operator

Your next question comes from the line of Josh Levin with Citi.

Josh Levin - Citi Investment Research

I wanted to ask, you said that you think the majority of our impairments are behind us unless market conditions are appreciably worse. Can you sort of quantify that? How much would they have to worsen, maybe in terms of the price drops or absorptions before we saw our impairments really start to kick up again?

Jeffrey T. Mezger

Josh, that’s a hard question to answer because every asset has a different story and it’s in a different sub-market of a different market. We like the move we’ve made with the open series and that has provided more cushion for impairments, whether it’s the margin side or the fact we now have a run-rate. As you know, impairments are driven by an internal rate of return and you are not selling houses, it can trigger an impairment just like if you have no margins.

So as we shared on the last few calls, the open series has provided a cushion for impairments and we review it every quarter and we are comfortable with where we are at today and if prices drop severely in any given city, it may trigger more impairments.

Josh Levin - Citi Investment Research

Okay. I wanted to ask more of a high level strategy question -- you know, you said [inaudible] that we may be approaching a point of relative stability. [inaudible] in a few quarters, you really believe we have achieved stability? What do you think about M&A and what do you think KB’s role might be in M&A in the industry?

Jeffrey T. Mezger

I don’t know if I said we are approaching economic stability, Josh. I told you in many of our markets, we are seeing a bottom form on price and we are seeing typical sales rates. So it’s encouraging but I’m not calling stability yet.

If you look at the growth platform we have, the markets we are in today in the peak delivered 28,000 houses. We are obviously nowhere near that level today in any city that we are in, so we can grow our business a significant amount just by opportunistic land purchases. If our stock currency created an opportunity or there was some distress out there and we could use our balance sheet to take advantage of an opportunity that way, we’d be open to it but our view right now is let’s just go rebuild the lot pipeline while we continue to manage our current assets and do it organically.

Operator

Your next question comes from the line of Megan Talbott McGrath with Barclays Capital.

Megan Talbott McGrath - Barclays Capital

I wanted to follow-up on a couple of comments that you made. First in regard to open series, you mentioned at one point that you had raised prices in California. I don’t know if that was the open series there. And just generally, now that you are about half-a-year into the opening of those communities, how have they faired versus your original expectations in terms of pricing, or have there been any other surprises, either positive or negative around the open series, things that you’ve had to tweak?

Jeffrey T. Mezger

A good question, Megan. The price increases are open series related and it was frankly throughout California, not just the Southern California. We’ve been pleased and encouraged with the sales response. If I had a surprise, it’s that we’ve actually been able to move our prices up above not just foreclosures but actual resales that aren’t foreclosure sales in many of the sub-markets, so the old traditional value equation from foreclosure up to resale up to our product has started to emerge in many of the sub-markets, so it’s a -- I call it a pleasant surprise. And sales rates have -- after we opened the first year, we had confidence so we are no longer surprised. We expect it and it’s continuing to deliver on that expectation.

Megan Talbott McGrath - Barclays Capital

Great, thanks. And then I just wanted to get a little bit more general color -- you talked about your operating margins and improving SG&A but keeping a certain level of folks on board to be efficient. How do you think about that generally in a -- let’s say by community by community basis? Is there a point where at a certain velocity, you need to start hiring more? Are you at that point already with the open series? If you could give us any sort of thought or numbers around that, that would be great.

Jeffrey T. Mezger

Well, as we manage each community, Megan, we look at the P&L and the cash flow after overhead, so it’s definitely part of the equation. It would be a nice problem to have to hire more people because of growth in the business. Our current view is we’ll continue to try to find more efficiencies and off the bottom like this, we want to lever this overhead structure and grow as much as we can before we load any additional overhead back in.

But if the volume supports it, obviously we’d go hire a couple of superintendents and ramp it up from there. But we’re not at that point right now.

Operator

Your next question comes from the line of Kenneth Zener with Macquarie Research.

Kenneth Zener - Macquarie Research

Realizing you are positioning yourself with unique product, open series, which we are all talking about here, can you highlight perhaps how much just market share gains have been assisting higher absorption rates? Because we saw higher absorption rates from a builder yesterday as well.

Jeffrey T. Mezger

I think the fact that we are selling at the pace we are where we are open is telling us that we are growing market share, Ken. The numbers are so volatile on sales and closings and starts that it’s hard to try to pin down market share. We do know that this thing has continued, the economic cycle. A lot of the competitors have fallen to the wayside so naturally we’re growing market share.

But we don’t -- we’re not really at this time -- we’re not looking at it from a market share point of view as much as we are how do we get returns out of that asset and that community?

Kenneth Zener - Macquarie Research

Right, and I guess given your confidence in what sounds to be 10 to 12 orders per community, you know, more traditional levels, is that what really gives you the confidence when you are going to bid on land and do you see that as obviously a relative advantage? Could you quantify that relative to other builders that might be using six orders a quarter?

Jeffrey T. Mezger

Every city has a different assumption in run-rate, Ken and depending on the price point in the sub-market, we’re not up at 10 or 12. It’s more like six, seven, or eight. If we were running 10 or 12, we’d push prices and bring it down.

Kenneth Zener - Macquarie Research

Oh, you would? Okay. And what was your -- last question, what was the FHA share this quarter at your closing?

Jeffrey T. Mezger

Kelly has that.

Kelly K. Masuda

Government loans increased year over year from 57% in Q208 to 75% in Q209.

Operator

Your next question comes from the line of Timothy Jones with Wasserman & Associates.

Timothy Jones - Wasserman & Associates

A couple of questions -- on the open series, I don’t know if I got it -- can you give me the percentage -- I think you track it by deliveries but it was -- there were of your deliveries or sales in the first quarter, the second quarter? The estimated third and then you had the 50% for the fourth, right?

Jeffrey T. Mezger

We really haven’t shared it, Tim, per quarter. I can tell you that it wasn’t much at all in Q1, it was more in Q2 and it will ramp up -- and we’re still holding to the 50% in Q4.

Timothy Jones - Wasserman & Associates

Okay and related to that question, you said you had a bunch of certain areas that are already over 50%. Would you like to share that with us?

Jeffrey T. Mezger

Well, there’s divisions within every region that --

Timothy Jones - Wasserman & Associates

Yeah, could you just name a couple of the larger ones, or areas where it -- just kind of flavor [of the area where it’s been successful].

Kelly K. Masuda

Southern Cal would be one, Houston is one, Orlando -- I mean, it’s across the system. It’s not just in one sub-market.

Timothy Jones - Wasserman & Associates

Okay, and the second -- I know you still I’m sure market your product just to compare with rentals. What -- how does your average or however you track it, how does your average monthly payment for your average house related to the average rental or how do you market now, or maybe if it’s more of a by-market area, but can you give me some flavor on that?

Jeffrey T. Mezger

It is by market, Tim, and if you look at the statistic where in our backlog 78% of our backlog is first-time buyers, we’re pulling people out of apartments. If I just gave you an example, in Southern Cal, there are many sub-markets we are in where the PITI payment is lower than rent today. So we have again reached this inflection where ignore the benefits of home ownership and interest deductions and whether you build equity over time, the out-of-pocket every month is lower for the ownership than it is for the rental.

Operator

Your next question comes from the line of Nishu Sood with Deutsche Bank.

Nishu Sood - Deutsche Bank

Thanks. First question, headed into the second quarter you had a pretty lean inventory, spec inventory position. Also the spring selling season, your order momentum has picked up a little bit, so I would have thought you would have come out of the quarter with a closing -- you know, a modest percentage of your backlog but the number was actually pretty strong, you know, I think 66% or so above your historical average, you know, better than last quarter and last year. So I was wondering, was that -- did you close more specs than you might have expected or planned or was that related to perhaps the lower construction times you were citing for your new products? What explains that?

Jeffrey T. Mezger

Good question. We actually closed 66% of our backlog I think was the number in the quarter, which was the highest second quarter number we’ve had in years. And I would attribute it to a high quality backlog, so people are -- there’s a higher degree that close when it’s time to close and also the fact that our cycle times have dropped significantly from a year ago.

You know, I shared the Las Vegas story where in the month of May, they were a little over four months from contract to close, so we are able to turn our inventory much faster than we were previously, so it’s encouraging.

Nishu Sood - Deutsche Bank

Yeah, but --

Jeffrey T. Mezger

We didn’t have a lot of inventory at the start of the quarter. We only had -- I think the number was 300-and some standing unsold, and now we’re at 140-some, so it’s come down significantly but it’s not a big contributor to deliveries.

Our go-forward revenue stream will come from delivering our backlog.

Nishu Sood - Deutsche Bank

Okay, so second question I wanted to ask was about your central division. During the years of the boom, your central division typically ran at about 25% of your orders. In the last couple of quarters, its out performance meant it’s headed back up to 35% or so, which is where it was before the boom years. So I just wanted to get your sense of whether, you know, considering your strategic direction, the new products you are introducing, the places you are making land investments, is that a temporary trend or is that something you think might persist?

Jeffrey T. Mezger

I think it’s temporary, Nishu. You have to wait for the markets to really settle down before we’d have a clear investment and growth strategy. When you are in opportunistic mode like we are today, you manage your current holdings and you go find opportunities where you can. The central region -- Houston -- actually, all the cities in Texas are doing pretty well in sales, so that’s encouraging but compare that to the comment I shared, okay, we’re out of Atlanta, we pulled back in Florida so you might have an aberration for a while but we are comfortable with all the cities we are in today and we want to be opportunistic in all the cities we are in. So the market shares will play out as they do once everything settles.

Operator

Your next question comes from the line of Joshua Pollard with Goldman Sachs.

Joshua Pollard - Goldman Sachs

I hope everyone is doing well. I am trying to mirror a couple of comments that you made -- first, you have lowered your land spend projections for the year and you’ve also lowered your expected year-end community count. I am trying to marry that with your very positive comments on order growth. Are you expecting even better absorption basis for the rest of the year, and if so, why?

Jeffrey T. Mezger

I wouldn’t say that we are expecting better absorption pace where we’ve opened up the open series. We shared that it’s selling at typical levels. If the sales pace were to go up, we would raise prices and go capture margin. We are continuing to introduce more product which we think will increase our overall sales as a company but as I shared, in every market we’ve rolled out the open series, its hit the sales pace we would expect. So we have some confidence there that we didn’t have before.

Joshua Pollard - Goldman Sachs

So when you think about lowering your land spend, at least the top-end of the range and also lowering the expected year-end community count, if things are hitting your ranges, why wouldn’t you guys actually spend a little bit more on land or keep the same pace on a year-end community count?

Jeffrey T. Mezger

If opportunities were out there where we can tie up lots that are aligned with our strategy and hit our hurdles and we’ve got reduced risk where it’s an easy term deal, we would absolutely chase them. But we’d have to hit all those.

But we don’t feel the pressure to go do deals now. We have plenty of lots on our books to manage through.

Joshua Pollard - Goldman Sachs

Okay, and then --

Jeffrey T. Mezger

We’ll be opportunistic.

Joshua Pollard - Goldman Sachs

Okay, a quick follow-up, and this probably goes back to a question that hasn’t been asked since Bruce was running the company but do you guys know what percentage of your buyers are investors today versus actual owners, specifically in the California market?

Jeffrey T. Mezger

Josh, it’s such a small number, we don’t pay much attention to it. We shared that 78% or 79% of our backlog is first-time, so there’s not a lot left for investors and we do have a buyer group that’s the move-down buyer in the sun-belt cities where the open series product is perfect for them as well.

I don’t think it’s much of a factor right now at all.

Operator

Your next question comes from the line of Alex Barron with Agency Trading Group. Mr. Barron.

Alex Barron - Agency Trading Group

Hello?

Operator

Your next question comes from the line of Joel Locker with FTN Midwest Securities.

Joel Locker - FTN Midwest Securities

Just I was curious on the amount of customer deposits you have versus your backlog currently.

Jeffrey T. Mezger

Give us a minute. We need to look that up.

Joel Locker - FTN Midwest Securities

All right, I can follow-up with that. And the other thing, on the SG&A, I guess it went up sequentially on a dollar basis and I was wondering if there were any one-time charges like severance or divisions close downs or something that affected the second quarter SG&A versus the first quarter?

Jeffrey T. Mezger

Not really, Joel. It didn’t go up significantly and you have the timing of things, when we shut down our division and consolidate and you walk on a lease and you have one-time costs but I wouldn’t take that as a trend. We expect it to go down a little bit in Q3.

Joel Locker - FTN Midwest Securities

All right, and the --

William R. Hollinger

To answer your customer deposits, we only had about $8 million worth at the end of May.

Joel Locker - FTN Midwest Securities

$8 million or so -- all right, guys. Thanks a lot.

Operator

Your next question comes from the line of Susan Berliner with J.P. Morgan.

Susan Berliner - J.P. Morgan

Thanks. Just a couple of quick questions -- one was on your total debt. It looked like it went down sequentially by about $26 million and I was wondering if that was any bond repurchases or just maturity of non-recourse mortgages?

Jeffrey T. Mezger

No, Susan, it was tied to a couple of JVs we unwound and the debt came on our books and we are closing through the -- it’s a condo project or two and we’re closing through those so as units close, your debt comes down.

Susan Berliner - J.P. Morgan

Okay, and then secondly, I was wondering if you could comment on your comfort with your leverage ratio and how you are looking to get that down over the next, you know, foreseeable period?

Jeffrey T. Mezger

It’s an interesting mix right now in that we are holding to our cash position but every time you book a little bit of loss, it hits your equity so it affects our debt-to-equity ratio and we keep sharing that we are absolutely focused on restoring profitability and if we are not there yet, we can see it. We are very close to getting the profits. When we get to profits, we start to unlock our deferred tax allowance, which today is --

William R. Hollinger

$911 million, Susan, almost $12 a share.

Jeffrey T. Mezger

So that’s one way to restore book, plus profits restore book.

Susan Berliner - J.P. Morgan

Okay, great. Thanks so much.

Operator

We’ll take our final question from Eric Landry with The Morning Star.

Eric Landry - The Morning Star

Great, thanks. A question about land [inaudible] -- I assume that the five option deals that you did in the quarter were from someone other than banks, is that correct?

Jeffrey T. Mezger

A mix of everything, Eric.

Eric Landry - The Morning Star

Okay. Is it true that the stuff from the banks is finally starting to come to market?

Jeffrey T. Mezger

It’s coming very slowly. There is a lot of land that these banks own and control in their portfolios that they haven’t really put to market and you’ve heard the noise on the street about some of the portfolios but a lot of what’s been shopped is C-minus locations where you just wouldn’t go build today if the lot was free. They have yet to unlock a lot of the A and the B locations and I think they are still trying to get their arms around it.

I do know anecdotally that the banks are starting to get more aggressive on taking property back from developers and builders where it’s just not performing today and over time, it’s naturally got to flow back out into the market. We view that as a real opportunity at some point in the future.

Eric Landry - The Morning Star

Jeff, real quick -- how much aid do you think is out there in these bank portfolios? I mean, relative to the junk that’s been dribbled out over the past, is there a significant amount of A-stuff out there so that the big builders can go rebuild their land banks?

Jeffrey T. Mezger

Well, there’s probably not as much -- there’s definitely not as much A as there is B. There’s a lot of B and Bs when markets settle are As. What you don’t want is the C-minus that when the market settles is still a C. And when we come across that, we’ll talk to the banks about them in very good locations, in very solid sub-markets and they are just not ready to put them on the market yet or to recognize the value. So we’ll keep working on that.

Operator

And at this point, there are no further questions and I would like to turn the call back over to Mr. Mezger.

Jeffrey T. Mezger

Thanks, Michelle. Thanks again, everyone, for joining us and we look forward to seeing you over the next few months. Have a great day.

Operator

That does conclude today’s conference. Have a wonderful day.

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Source: KB Home Q2 2009 Earnings Call Transcript
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