KB Home F1Q10 (Qtr End 02/28/10) Earnings Call Transcript

Mar.23.10 | About: KB Home (KBH)

KB Home (NYSE:KBH)

F1Q10 (Qtr End 02/28/10) Earnings Call Transcript

March 23, 2010 11:30 am ET

Executives

Jeff Mezger – President and CEO

Bill Hollinger – SVP and Chief Accounting Officer

Kelly Masuda – SVP and Treasurer

Analysts

Dan Oppenheim – Credit Suisse

Michael Rehaut – J.P. Morgan

Carl Reichardt – Wells Fargo Securities

Dennis McGill – Zelman & Associates

Jonathan Ellis – Bank of America

David Goldberg – UBS

Stephen East – Ticonderoga Securities

Jim Wilson – JMP Securities

Matt Benzene [ph] – Barclays Capital

Joshua Pollard – Goldman Sachs

Nishu Sood – Deutsche Bank

Alex Barron – Housing Research Center

Joel Locker – FBN Securities

Operator

Please standby. Good day, everyone. And welcome to the KB Home First Quarter Earnings Conference Call. Today’s conference call is being recorded and webcast on KB Home’s website on kbhome.com. The recording will also be available via telephone replay until midnight on April 2nd. You can access the recording by dialing 719-457-0820 or 888-203-1112, entering the replay passcode of 5468882.

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 of the company’s business activities, prospects, strategies, and financial and operation results.

These statements are not guarantees to future performance and due to a number of risks, uncertainties and other factors outside its control, KB Home’s actual results could materially different from those expressed in, or implied by the forward-looking statements. Many of these risk factors are identified in KB Home’s filings with the SEC which the company urges you to read with care.

KB Home’s comments today will also include non-GAAP financial measures as defined in regulation G. The reconciliation of these non-GAAP financial measure to their most directly comparable GAAP financial measures and other information required by regulation G is provided in the company’s earnings release which is posted on the Investor Relations page of the company’s website and recent released, and through the financial information news releases link on the right side of the page.

And now at this time, I will turn the conference over to Mr. Jeff Mezger. Please go ahead sir.

Jeff Mezger

Thanks, Chelsea. Good morning, everyone. Thank you for joining us today for a discussion of our 2010 first 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.

Before we get started, I want to let you know that based on your feedback we have shorten our prepared remarks to allow more time for Q&A. After I share an overview of the quarter and outlook of the future, we will open it up to your questions. I will begin with a summary of the current market conditions, followed by some insight into KB Home first quarter performance. Then I will cover a strategic vision for the remainder of 2010, which we believe sets us up for a stronger 2011.

The housing market today is continuing to steadily work through excess inventory. In many regions, the supply/demand equilibrium that is essential to a healthy market is starting to take shape.

Record affordability is bringing both new and experienced home buyers back. Many buyers are finding that homeownership is within their reach for the first time, while others want to move up to a larger home or downsize to a smaller one.

The key drivers of housing affordability, compelling interest rates and lower prices are evident across our operating regions and should continue to help fuel this encouraging market trend going forward.

At the same time, short-term government stimulus in the form of federal tax credit for home buyers appears to be having the desired effect of getting buyers off the fence today and deciding that now is the time to buy.

In addition to greater affordability, the long-term demographics for the U.S. housing market are also strong. As a population grows, households are forming and demand for homes over the next 20 year is still expected to outpace demand of the last 20 years.

In other words, the life events that drive the need for a new home continue to unfold across the country. Of course, job growth and consumer confidence remain the foundation for any sustained housing recovery and a healthy overall economy.

The better than expected employment report in February was certainly a welcome step in the right direction. There was some mixed news out this morning with sales of existing homes down for the third consecutive month in February, some of which was attributed to weather conditions.

However, the sales decline was generally less than expected. While we cannot predict what lies ahead, the view from where we stand today has significantly improved over the last year and we remain bullish on our company’s ability to compete in the current environment.

We are not declaring that the overall health of the housing market is strong and robust. However, our relentless efforts to improve our business over the past few years has us well positioned to capitalize on future opportunities.

As we entered our new fiscal year in December, market conditions remain challenging, as the softness we experienced in the fall continued. In fact, our December orders were down significantly over the prior year.

The extension of the federal tax credit in November occurred just as we were entering the holiday season, but it was too late to have an impact during this typically slower period and the new expiration date was too far out to create any immediate urgency.

As a result of our many strategic and proactive actions, however, sales steadily grew over the reminder of the first quarter and we were able to make up the substantial initial shortfall. In particular, we had a very solid February with a notable increase in sales and traffic.

Overall, KB Home generated 1,913 net orders in the first quarter, up 5% over the same period last year. We are hopeful the momentum created by our marketing efforts, our well received product offerings and our new communities opening will carry into the second quarter.

However, the uncertainty surrounding what to expect following the tax credit expiration in April, will ultimately determine whether our year-over-year net orders will be favorable. Just as the month of February was critical to the outcome of our first quarter, the month of May will largely determine the outcome of our second quarter.

We grand opened 40 communities in the quarter, many of which occurred in the month of February, half of these communities were brand new neighborhoods, while the other half were existing communities in which we introduced new product offerings from The Open Series. These new home designs continue to meet today’s buyer preferences and resulting in a higher sales pace. In fact, on a per community basis, we are selling very well.

The challenge now is to grow our community count. In early 2006, as market conditions started to weaken, we embarked on a strategy of hording cash, reducing inventory levels and lower our cost-to-build and operate. At that time, we also made the decision to curtail investment in land and lots until the environment improved.

Our current cash position and owned and controlled lot count illustrate how well we executed on our strategy. A resulting outcome, however, is a lower community count, which we are now diligently working to increase.

With our markets beginning to stabilize and our open series product generating solid results, we think the time is right to once again reinvest in our future growth. We began this process in the second half of 2009 and it continues today. We have the liquidity and resource to ramp up our community count throughout this year and to position us for strong growth in 2011.

Although it will take some time before housing returns to a more normalized environment, we believe our strategy now and throughout the downturn is and has been the right one for our business.

Turning to our financial results, we delivered 1326 homes during the quarter, which represented a decrease of 8% from the prior year. With our average selling price of 197,700, down 6% year-over-year, we generated total housing revenues of the $262 million.

Despite our housing revenues declining 14% from a year ago, we narrowed our net loss for the seventh consecutive quarter and continued to make solid progress in many areas of our business. Our net loss for the first quarter was $55 million, a 6% improvement over the $58 million net loss we incurred last year.

I’m pleased to report that the first quarter marked KB Home sixth straight quarter of year-over-year margin growth. Our housing gross margin, excluding inventory related charges grew to 18.8%, from 13% a year ago. This 580-basis point improvement is especially notable, given the decline in our average selling price for the period.

Going forward, as a higher percentage of our deliveries come from our open series product line, along with new communities opening, we anticipate our gross margin for the year in 2010 to be higher than it was in 2009.

Our total inventory related charges decreased significantly from a year ago to approximately $13.4 million, the lowest level we have seen since the first quarter of 2007. At this point, we believe these charges are mostly behind us.

Our selling, general and administrative expenses increased by approximately $11 million over the prior year and represented 27.5% of housing revenue for quarter. While disappointing, it is important to keep in mind that the reduced volume we typically experience in the first quarter can cause expenses that are even relatively small in dollars to have a bigger impact on our SG&A percentage.

The quarterly increase primarily consisted of two non-operating items, the cost associated with long-term cash settled compensation tied to the company’s stock price and higher legal expenses. These two expenses are likely to continue at elevated levels in the second quarter.

For the full-year, we anticipate that SG&A will settle out in the 18.5% range, depending in part on where our stock price ends up. Increased volume will also be an important factor in improving this ratio. Of course, we remain committed to looking for ways to be more efficient in our business and reduce our cost, while being mindful of retaining and leveraging our growth platform.

KB Home strong and liquid balance sheet continues to be an advantage for our business. We had $1.3 billion in cash at the end of the quarter, roughly flat with our year-end level, despite having spending approximately $80 million on land acquisition to fuel future growth. We have given $6 million for land acquisition and development for the year, and we still expect to finish 2010 with a healthy cash position of well over $1 billion.

Our net debt to total capital remains below 45%. In short, we have a solid platform from which to grow our community count and position the company for higher revenue levels and profitability entering 2011.

We have also succeeded in strengthening our backlog and for the first time in four years, the number of homes and backlog increased year-over-year, setting up additional momentum going forward.

Moreover, we are converting our backlog at record levels, which speak to our business efficiency, compress cycle time and compelling value to this proposition we offer to our buyers. With our community count growing throughout 2010, we anticipate any miss year with the higher number of homes in backlog than at the end of 2009.

As we move into the second quarter, we are seeing more sales activity driven by the federal tax credit, which has become a really motivator for our home buyers. We have a targeted tax credit strategy to start inventory homes in select markets and communities, which we believe will be instrumental in allowing us to capitalize on the increased urgency as the April 30th deadline approaches. It goes without saying that we remain firmly dedicated to our KBnxt Built to Order business model for our buyers and for our company.

KB Home was the first national builder to apply this pre-sold, customize and approach on a large scale in the 1990s and it will continue to be a cornerstone of our business as we work to become a low risk, high performing company with strong returns on invested capital.

At the same time, KB Home has the defining characteristic of being able to move fast, to meet the rapidly changing demands of this marketplace. With the strategy of proactively starting more homes than we would under normal circumstances, our buyers can still benefit from the many personalization options that they truly value while qualifying for the limited time tax credit opportunity.

In terms of the number of homes we are building for this purpose, our general guideline is approximately one month sales in entry-level communities that have demonstrated consistent and predictable absorption rates.

If the housing market stabilize at the current levels and depending on where demand is after the tax credits expires, we believe KB Home is positioned to restore profitability at some point in the later part of 2010, and we intend to build on our momentum entering 2011. Our entire team has the tremendous sense of urgency and dedication to making this happen.

To that end, we are working to open new communities in all of our markets that fit our product strategy, while continuing to execute our proven KBnxt Built to Order business model.

Our hard work and reposition our balance sheet has result in one of the lowest lot position in the industry and we are now poised to reload at better prices. The snapshot of our current holdings and inventory balance underscore this strategy.

At the end of the first quarter, we owned or controlled 37,300 lots, roughly a four-year supply. However, more than 70% of our 1.6 billion of inventory was related to homes sold in back lots, finished lots or lots that over 50% finished. With this pipeline, we are very liquid and can be very opportunistic.

We are supplementing this pipeline by securing finish lots that will enable us to grow our community count and topline. Over the past two quarters, we have spent $140 million on land purchases, the more – majority of which was invested in the first quarter, as we are now seeing increased opportunities.

With the success of The Open Series, we have confidence in underwriting new acquisitions, as we now have more predictable, pricing and sales pace. We are also able to turn these newly acquired lots in the revenue producing communities much more quickly, which enhances returns.

Our average community count for the year is expected to be in the range of 145, roughly the same as 2009. However, we anticipate a higher community count in the second half of the year and that growth trajectory should accelerate into 2011.

We firmly believe we are on the right path to achieve our strategic objectives. We previously estimated our 2010 deliveries to be in the range of 8,000 to 9,000 homes for the year. We are now comfortable in raising the four of that range to 8,300 units. Following the spring selling season, we will have better clarity our expected annual deliveries.

Looking beyond this year to 2011, we believe the picture will become significantly better. We expect our volume of delivery in the 2011 too benefit from the increased pace of land acquisition and communities opening in 2010. In fact, we have set solid internal growth targets for homes delivered in 2011, while maintaining our discipline return requirements and strategic product alignment. Reaching our goal of profitability at some point in the latter part of this fiscal year will primarily be the results of gross margin improvement.

But we believe it will be the powerful combination of higher volume and operating leverage that will fuel our profitability in 2011 and beyond. This is not so much a prediction as it is a strategic vision for where we believe we can take the company as we continue to execute on our plan.

With operations in 30 of the top 75 markets from coast to coast, our balance and diversified geographic footprint is the right one. The markets we operate in, has favorable long-term projections for population and job growth. We are also in a market with substantially fewer builders as compared to a few years ago.

Additionally, many private builders today likely do not have access to capital which is critical to operating successfully. In the current competitive landscape, the opportunity for a financially sound builder, such as KB Home to quickly grow its business is clear.

Before I wrap up, I would like to take a moment to reiterate the attributes that differentiate KB Home from other builders and the strengths that we will continue to leverage going forward. The strict processes, controls and operational disciplines of our KBnxt Built to Order business model have generated solid results including improved margins, compressed cycle times and the effective use of cash.

Our business also benefits from the even flow production and greater visibility this model represents. Our land life position, transformed product offerings, substantial cash on hand and proven capacity for quickly turning new land purchases into viable communities should allow us to deliver superior returns on capital.

Our Built to Order experience is as important to our customers as it is to our business. As buyers develop a heightened emotional connection to a home they have customized, cancellations are reduced and customer satisfaction is increased. We were the first and are still the only home builder to adopt the rigorous 3rd party certification of our quality controls through the NAHB research centers national housing quality program.

In addition, as part of KB Homes' my home, my earth' initiative, we continue to be a leader in building earth friendly homes that reduce our home owner monthly utility bills without adding to cost of the home for us or for them. This again, we're again recognized by the U.S. Environmental Protection Agency as an excellence in ENERGY STAR promotion award winner.

Finally, our unique partnerships with global brands including Martha Stewart and Disney continue to drive traffic and distinguish KB Home from our competition. With all of these industry-leading initiatives, KB has been named to Fortune Magazine's 2010 list of the world's most admired companies for the 6th consecutive year. And KB Home ranked number one for innovation among home builders which is a source of great pride for our employees.

This honor shows our proactive efforts have been recognized and our producing results. In the almost 17 year that I have been with KB Home, I have never been more enthusiastic about the company's future. Our core values, our focus on the customer, our high performance culture, our passion for the business, it is these attributes that allowed us to successfully navigate through the market challenges and will once again take our company to new heights in the years ahead.

We will continue to strive to meet the needs of our customers and our stockholders by operating our business with efficiency, integrity and ingenuity. And now, we will open it up for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) We please ask that you limit yourself to one question and one follow-up. Our first question will come from Dan Oppenheim with Credit Suisse.

Dan Oppenheim – Credit Suisse

Thanks, very much. I was wondering, Jeff, if you can elaborate, you talked about how the environment now is better than the home building environment a year ago. At that point, the thought was to see sequential improvement throughout the course such as '09 and clearly with the tax credit there has been some impact. What is it you are seeing differently this year? What gives you the confidence in thinking that 2010 so that the overall outlook is better now than, what we had, a year ago?

Jeff Mezger

Sure, Dan. There are a few things going on. First off, in many if not most of the markets we operate in today, the resale housing prices have been stable for many months. We always share on these calls that we view our market imbalance when there is a six month supply of resales and that pricing is stabilized. In many of the markets we are in, inventory is below six months and pricing has been stable in some cases for as long as a year so that there is inventory clearing and the markets appear stable, while at the same time we continue to transform our business to have product in those market that competes favorably with the resale business at those price points. So market stability and transformation of our business continuing.

Dan Oppenheim – Credit Suisse

Okay. Thanks. I guess the second question, wondering about the SG&A, talking about that being 8 .5% for the full year, can you give a little clarification. How much of the hire cost came from legal? Is that from the SCC investigation or what is that relating too and do you have a goal in terms of once x business charges where SG&A should be?

Jeff Mezger

First off, I can tell you it is not due to any SCC investigation costs. As I indicated, Dan, in the prepaid remarks, the increase was primarily non-operating cost which will decrease overtime and be less impactful as our deliveries grow throughout the year. However, let me kick this over to Bill who can share more details on the first quarter SG&A.

Bill Hollinger

Yeah. Thanks Jeff. There were two factors that obviously gave rise to $11 million increase in our SG&A. And those two were, as we said in the press release and Jeff said on his openings comments, one being our cash settled stock awards and legal expenses. The cash level stock based awards are really primarily our stock appreciation rights and our phantom shares. And those were issued in place of stock options.

Those two awards really, the phantom and the stock appreciation rights, under the rules of accounting today, actually have a mark-to-market or type reevaluation that occurs every quarter. And so with our increase in our stock price during the quarter was about 20%, it actually threw off about six additional million worth of expenses in the quarter, whereas a year ago with our stock price having dropped during the quarter, it actually generated income of $3 million. So there is a $9 million Delta between last year and this year. That volatility will continue as the stock price changes and these instruments remain outstanding.

The other component to our increase in our SG&A and giving rights to 27.5% as a percent of revenues was also due to, as Jeff said, higher legal expenses. And those legal expenses really are about $3 million year-over-year as a result of defense costs that we are incurring on behalf of our former Chairman and chief executive officer in connection with his current litigation.

Under Delaware law, the company is required to pay such legal defense costs. And so if you combine those two of about $12 million and back that out of then our SG&A for this year, it would bring our SG&A ratio to just slightly under 23%. So, that is, again, the clear majority of both the absolute increase as well as the ratio.

Jeff Mezger

If I could add, Dan, as I shared in my comments, we are guiding that for the year we will be at 18.5% range of revenue. We do see these costs being elevated in the 2nd quarter, but dropping down from there, at the same time, our revenue will be going up later in the year.

Then the last comment I can make also to build and share with you is we have taken a conservative accounting approach on these legal costs, we are expensing as incurred and depending on the outcome of the process, we will get some recovery. It is just unclear at this time how much.

Operator

Our next question will come from Michael Rehaut with J.P. Morgan.

Michael Rehaut – J.P. Morgan

Hi, thanks. Good morning everyone.

Jeff Mezger

Good morning, Mike.

Michael Rehaut – J.P. Morgan

First question, I was wondering you mentioned December orders down significantly. I was wondering if you could give us – quantify that a little bit more specifically and also what the year-over-year trend was for January and February and as part of this question, before I hit my second question limit, just what the community count average was for the first quarter?

Jeff Mezger

Okay. I thought you would be happy, Mike, that we were actually sharing some month-to-month trends because we normally don't do that within the quarter.

Michael Rehaut – J.P. Morgan

It is never enough for us.

Jeff Mezger

Well we felt it was important to provide that color because we are in such fluid times with these extra ordinary influences like a tax credit coming and going. So in December, we were down significantly what the trend we saw in November continued, where it was soft both on traffic and sales activity.

January was about neutral and February, we picked up not only the shortfall in December, but ended up 5% up year-over-year. So the trajectory was favorable through the quarter. We won't give color on March, because we don't want to focus on a couple of week's activity either relative to trends, but it was encouraging how we saw the market conditions improve. I will refer the community comp side to Kelly.

Kelly Masuda

Mike, our community counts – our community count in Q1 was 109, down 9% year-over-year from 120. I think as Jeff indicated on his prepared remarks that we expect to be down slightly year-over-year for the first half of the year with growth in the second half of the year to be relatively flat at 145 for 2010. And then we expect community count growth to accelerate in 2011 as we reload our loss pipeline throughout 2010.

Michael Rehaut – J.P. Morgan

Okay. Thanks. And just a second question. Was interested in your commentary or thoughts on ordered friends and, I guess, relative market strength on a regional basis and with the 600 million in land-spend goal, if that is going to be concentrated in certain geographies and perhaps, you said, the 140 that you've already spent most was in the first quarter, where was that concentrated – excuse me– as well? So, another two partners. First, current trends in terms of regional strengths and second, plans and geographic focus for the land spend.

Jeff Mezger

Sure. That is three questions, Mike, but we will answer them for you.

Michael Rehaut – J.P. Morgan

Thank you.

Jeff Mezger

Clearly, California is performing well now for us. Inventory levels are way down in the state. In fact, we were told this morning that the simply incentive approved a new tax credit for California that, it is expected the governor would sign later this week. So that would be a nice boost to our California business. Nevada, interestingly, where some people call it a foreclosure capital of America, is one of our better performing divisions in terms of sales community. We are selling very well there. Still sluggish in Phoenix.

Texas has held well around the state. San Antonio and Austin, in particularly are doing well. Dallas not quite as strong, but not that larger business for us. When you get over to the east coast, it's fairly choppy. Parts of each city of Florida are doing well in the sub markets and others aren't doing so well. It is mixed in Florida. North Carolina not performing as well as Charleston, yet Charleston is doing well.

And we are encouraged also, we opened up again in D.C. with a town home community and Alexandria in February. And in spite of all the news about the winter weather and the impact there, we had actually had six net sales the first week and we were opened in DC. So we are very encouraged with the DC activity. And as if you go back up top from an investment strategy perspective, every market we are in has students today. There is a sub market in every city where supply is in balance, prices are stable and we can underwrite deals and go today.

So we have not restricted our investment anywhere in the company today. I don't know if you want to add any color to that to Kelly?

Kelly Masuda

No.

Jeff Mezger

Okay.

Operator

We will move on to Carl Reichardt with Wells Fargo Securities.

Carl Reichardt – Wells Fargo Securities

Good morning, guys. How are you?

Jeff Mezger

Good, Carl.

Carl Reichardt – Wells Fargo Securities

Hey, Jeff, I have one technical question and one bigger picture. The technical question is on gross margin, as you begin to deliver homes related to the tax credit, you have a little more spectrum will be normal for you. It sounds like that your fiscal quarter splits from tax delivery maintenance in June, so it's split tax rate, try to think if you are going to have a camel bump delivery in 2Q and Q3 and whether or not that will be positive for gross margins because you had more volume or whether or not the spec will creep in there and compress gross margins. So can you help me think a little bit about how your margin trend ought to be if it's antiseasonal in Q2 and Q3. Yeah. Thanks.

Jeff Mezger

Okay. That's the first time I have thought of our housing cycle at a camel bump. One bump or two, I don't – any way, the spec strategy and as I shared in my comments, we are a pre-sold built to order company. However, we were at a disadvantage last fall and we want to make sure we are protected from that disadvantage. And with our build times where they are, if we start one months' worth of sales in select communities, we are still expecting them to be sold before the homes even hit sheet rock. So we are continuing to offer choice to this consumer, which they value and as a result, we are not expecting any margin erosion, because it is not like we are loading up and have a bunch of standing inventory around.

With it having to be sold in April, closing in June, with a 90 to 105 day build time, these will be sold before they get to completion. So, the tax credit is creating some interesting dynamics. We don't know whether May and June demand is going to be pulled forward to April or not or whether post tax credit, the economy is better and the sales demand continues, our margin guidance, we will be able to give you more charity after this camel bump, as you called it, but overall as a company, we have always done better on margins than pre-sold than on inventory. But we are trying to bridge this without a big impact on margins. Kelly, do you have any other thoughts on it?

Kelly Masuda

Carl, nationally as a bigger percentage of our deliveries is open series, and secondly as new land starts coming online in new communities, you will have a natural expansion of our margin.

Carl Reichardt – Wells Fargo Securities

Okay. Great. Thanks guys. And then the bigger question, Jeff, I noticed your comment on return on capital in the release. I am curious, if you think a few years out and you are trying to manage the top line growth with free cash flows. Most builders generate fairly significant negative free cash as they going rapidly, are you thinking about managing the balancing between the two better, as you come out of this cycle trying to generate cash while still growing on a modest pace, or would you rather try to take advantage of the bottom in the cycle if you see it and grow real rapidly and have the same free cash flow dynamics, as the industry as historic we have. How do you think about that?

Jeff Mezger

We have a balance approach, Carl. We are going to grow as fast as we can, but we are going to stay disciplined on the return side. And I think in our business model, as quickly as we can turn from tie up a lot to get to revenue that we can have a superior return on invested capital and generate cash. You will not going to see us fallback to writing big checks for partially entitled land, and take two or three years to bring it to market. So, as solid our growth rate, as we can drive while adhering to the disciplines of our financial hurdles.

Carl Reichardt – Wells Fargo Securities

Terrific.

Kelly Masuda

Carl, I think with single family starts at around $0.5 million, you naturally, as the start number comes back, you will naturally going to see the higher growth rate coming out of the downturn, but when the housing markets stabilizes and starts to stabilize overall, you are going to see a more modest growth rate than you have seen in the past.

Carl Reichardt – Wells Fargo Securities

Thanks, Kelly. Thanks, guys.

Operator

Our next question comes from the line of with Dennis McGill with Zelman & Associates.

Dennis McGill – Zelman & Associates

Hello, guys. The first question is elaborating on the data that Bill gave us, appreciate all the color on the SG&A. I'm just trying to understand some of the underlying drivers, if we think about it year-over-year and based on the (inaudible) which is kind of flat on a dollar basis, yet revenues are down in that 15% range. So I am trying to understand what would be off setting the lower variable expenses that you have there like commissions and so forth, and how should we think about that big picture as sort of the fixed versus variable leverage opportunities that you have?

Kelly Masuda

Dennis, I am not sure I completely understand your question, but we recall what we said on our last call, year-end. We said, we thought, unlike, what we had done in 2009, where we had significantly brought down our overhead through all the various initiatives that took place. We said that our overhead for this year would remain relatively flat. And that's still the guidance that we are giving, expect for the fact that, what we are probably adding on to it is the fact that there are these two other issues that are going, non-operating expenses of the legal costs as well as the variable accounting to the cash settled based stock awards. So, we haven't really changed our view. And so, we really see an increase really coming only from those two things right now. Otherwise, relatively flat from where we were a year ago.

Dennis McGill – Zelman & Associates

Maybe we can follow-up offline but I guess the numbers based on what you talked about earlier, it seemed like you expensed around $60 million in each quarter this year and last year. But yet your revenues are down, so if you are holding your overhead counts that I am trying to understand on the variable side, what would offset that? And then we can follow-up offline if the numbers are wrong. The second question just had to do with – on the lots you said, I think you control about 37,000. Can you give us a sense of how much of that you put on the books over the last five quarters or so?

Jeff Mezger

Kelly?

Kelly Masuda

Well, we've spent $140 million over the last two quarters. That doesn't include loss, transactions that we have approved but have not yet closed. Now, I will tell you of the 30,200 lots that are owned, about 18,300 owned lots that are sold in backlogs, finished lots and lots that are majority finished.

Dennis McGill – Zelman & Associates

Okay. But there is no way for us to, for understand the opportunity based on what you have done over the last year?

Kelly Masuda

You mean in terms of number of lots that we have approved? Look, we have done transactions across all of our regions, and our sequential, our overall lot count is relatively flat.

Operator

We will move on to Jonathan Ellis with Bank of America.

Jonathan Ellis – Bank of America

Thanks. Good morning, guys.

Jeff Mezger

Good morning.

Jonathan Ellis – Bank of America

Wanted to, first question, with respect to open series, do you have a figure for what percentage of your deliveries this quarter were open series and also if you have, in the bag log, percentage of those products in the backlog?

Jeff Mezger

Jonathan, as we shared on our last quarterly call, our deliveries in the fourth quarter were over 50%. It has continued to grow, since then. We really – we got out of wanting to share that because it gets very blurry. There's communities where we have added one open series plan, where the city would let us but it is not really open series. I can tell you that almost 80% of our deliveries in the first quarter were to first time buyers. And good parentage of that was open series product, and we expect to continue to see open series become a higher percentage of our deliveries, as we transition into more new communities and close out existing.

Jonathan Ellis – Bank of America

Okay. Great. And then just, second question, I wanted to ask about upgrades. Both in terms of the first time market, which I understand is obviously 80% of your sale in the quarter, but also in the move-up market. Are you seeing any increase or change in terms of the mix of options or upgrade that the buyers are pursuing?

Jeff Mezger

Our studios, Jonathan, continue to perform well. Sales per unit are off slightly from the pick, but they are still running roughly 10% of the base price. One of the consumer trends, I would say we picked upon is, people are less about sizzle and more about value these days. They are putting the money in room options, construction options, cabinets and counters, instead of jacuzzis or upgraded plumbing trim in their bathrooms. It is all about value today. But our sales continue to hold well.

Jonathan Ellis – Bank of America

Okay. Thank you.

Operation

Moving on to David Goldberg with UBS.

David Goldberg – UBS

Thanks. Good morning, guys.

Jeff Mezger

Good morning, David.

David Goldberg – UBS

First question, I wanted to delve into the SG&A a little bit, but maybe from a different angle. I was hoping we can talk about how the opening of new communities is going to impact the SG&A through the year? And if you think it's going to be difficult maybe to bring that number down as percentage of revenue, if you're opening a lot of communities where you would not have as much leverage.

Jeff Mezger

Well, David, again, as I think I guided in my comments, we think will be in the range of 18.5% for year, which will be up a point over 2009 primarily attributable to these two things that Bill gave due detail on. Included in that number is our assumptions for the incremental costs to open up new communities, offset by communities we are closing out. I do think, at some point, as we cross over to growing the top line, there will be the natural increase in cost on the SG&A side, but we are comfortable with the 18.5 we are giving for this year.

David Goldberg – UBS

Got it. Follow-up question here, second question is. And I might know this might be difficult with the JV on the financial services side, but just trying to get an idea on how you think average FICO scores are looking. How – What is the kind of credit quality of your buyer, maybe? And how do you think if we look back past the camel humps in the next couple quarters, or whatever? And we just think about, maybe in June with the FHA changing seller finance concessions, how that impacts the first time buyer, the entry-level buyer for you guys?

Jeff Mezger

Sure. David, let me make a couple of comments and then I will refer to Kelly for specific answers. We continue to be very pleased with our joint venture with Bank of America. We have a high capture rate. The service levels are very good. Most importantly, deliveries are occurring when projected, so it helps us with our business. And with the FHA changes that were announced, for the most part, we were already operating at that level. We don't have a lot of incentives.

So if they drop a seller contribution to 3 points, we were already well under that. We actually think that is a good thing for the industry and competitively. They raised FICO to 620. We were already operating at that level. And the increase on the mortgage insurance premium was a small number. So we don't think it is going to have a significant impact on our business.

Interestingly and Kelly will give you the details here, our FICO scores have been very flat to slightly up for a few years now. We have a high quality buyer as evidenced by our Can rates being at the low side of our historical levels both as a percent of growth and as a percent of backlog. The buyers we are seeing today are very good quality. Do you want to share some of the specifics, Kelly?

Kelly Masuda

Sure. Dave, our capture rate in Q1 was 81%. The average FICO score was 706. And approximately 70% of our loans are FHA and VA loans, 61% being FHA loans and about 9% being VA. So the FHA and VA market remain one of the most and the conforming loans market, are the most liquid parts of the mortgage market today.

David Goldberg – UBS

Great. Thank you.

Operator

We will now hear from Stephen East with Ticonderoga Securities.

Stephen East – Ticonderoga Securities

Good morning, guys.

Jeff Mezger

Good morning, Stephen.

Stephen East – Ticonderoga Securities

Jeff, if you could talk a little bit, 80% of your sales are going to first time buyers. As this tax credit rolls off, how do you all get to a comfort level that, if we see first time buyers in a total percentage of the market going from 40% or 35%, or 30% or 25%, how do you get comfortable that your business doesn't follow suit?

Jeff Mezger

It is a good question, Stephen. And we are comfortable with the demand. This tax credit has been a motivation for people to buy. It is not creating buyers. The buyers are out there. And, what kind of got lost in the run up is there were a lot of people that elected not to buy and stay renters, because prices got so high they couldn't live in an area they wanted to live in or they just weren't comfortable making that decision.

So there is actually pent up demand in the rental sector today that passed the tax credit. I think you will continue to see demand hold. It is the normal process in what I call the resetting of the food chain. You see the first time buyer come back first. Slowly people build up equity, they move up. Then the first move-up buyer builds up equity and they move up, but it always starts in these cycles with the first time buyer. I think that is the case here. It's that we have this extraordinary influence that is motivating the buyer on a short term basis. I think in the long run you will continue to see a lot of demand in this niche. We are not even close to it happening.

Kelly Masuda

Steve, the other thing I would add is that the Open Series has been a strong seller for us at the entry level because the first time buyer doesn't have a home to sell. But this product, it also, we also have a 2,000 foot product that goes up to 3500 feet, so it really can address the move-up market as well. It is just that the entry-level is a stronger part of the market today.

Stephen East – Ticonderoga Securities

Okay. All right. And then if you could talk a little about what you are looking for, what you are doing on the land acquisition side, this $600 million. Are you going after distressed communities that have gone back to the banks primarily? Or are you looking for just finished lots? Or do you think – A lot of builders are saying now that, hey, we are going to have to buy lots and develop them because there just aren't enough A and B lots around for everybody who wants them.

Jeff Mezger

I agree with your comments, Steve. As always, it is a different story in each sub-market around the country. The banks still – while we are seeing more activity and more opportunity with the banks, they are still holding on to their portfolios. We are buying lots on the ground from developers, from landholders, from other builders, from banks. It is really a mixed bag out there. I can't reinforce strongly enough that you are only as good as your local team and their network and their relationships to find deals. The ones that keep the transactions or the offerings you see in the media, are where a realtor does a broadcast bid for some lot somewhere. But, frankly, we are not really pursuing those because the price gets bid up where it doesn't make sense and it is typically an investor that jumps in on a buy and hold, hoping for inflation to fix it. We are more strategic and disciplined and only buying things that we can turn into revenue right away.

Operator

Jim Wilson, with JMP Securities has the next question.

Jim Wilson – JMP Securities

Thanks. Good morning guys.

Jeff Mezger

Good Morning, Jim.

Jim Wilson – JMP Securities

I was wondering, drilling back into the local sale a bit, so should I assume, I guess, looking at just the net orders and California being down a bit, but your comments about them being strong at the community level and where your total community count is versus were you expect it to be for the year. Obviously California's community count must be down, a fair amount, at least, I assume year-over-year? Driven the lower total number?

Jeff Mezger

Kelly can answer that.

Kelly Masuda

The California community counts are down, relatively in line with our nationally.

Jim Wilson – JMP Securities

Okay. All right. So, then maybe another way to look at this is with that real big ramp you expect in the community count for the rest of the year, how geographically balanced or imbalanced might that look?

Kelly Masuda

It is up in the second half of the year, and regionally, it is not far off. There is no anomalies regionally. It is up across the board across all of our regions.

Jim Wilson – JMP Securities

Okay. And then, maybe, last question. What, as you get to the end of the year, what percentage of communities open do you expect to be Open Series?

Bill Hollinger

Well, we will see that year unfolds, Jim. Definitely, higher than the 50% that we were in the fourth quarter but it will – fourth quarter of 2009. It will depend on how many new communities we roll in and how successful we are in closing out existing, but it will be our deliveries will be up over the 50% in 4Q of '09.

Jim Wilson – JMP Securities

Okay. Good, thanks.

Operator

Moving on to Megan McGrath, Barclays Capital.

Matt Benzene – Barclays Capital

Hi, it's actually Matt Benzene [ph] for Megan. I have been trouble recently reconciling builder commentary with some other softness we have seen on the national macro side of things trends and you said that the operating environments and homebuilding industry is better today than last year at this time, yet new home sales data in January registered a new low. So I wonder if you believe this is kind of an anomaly or if you think that because you are taking share for instance, this trend is likely to continue?

Jeff Mezger

It's a good question. I don't get too caught up in one month trends, because I always seem to adjust them and…

Matt Benzene – Barclays Capital

Yeah.

Jeff Mezger

One month does not a trend make. When I say things are better, I am referring specifically to how our company has transformed. As I – answered another question earlier in this Q&A. Many of the markets we are in the resale side of things, where there are $5 million plus transactions a year. The resale size has stabilized. And that's where we are trying to take share. Whether new gnome activity is 300,000, 500,000, 600,000 whatever the number analyzes to we are more focused on our market shares specific to a submarket, targeting taking sales away from the larger resale business.

Matt Benzene – Barclays Capital

Got you. Okay. And then just two housekeeping questions. First, can we get your ending deferred tax asset and size of evaluation allowance? And second, I believe with regard to monthly order trends, you said December was down, January neutral and February with up about 5% yet for the whole quarter you average up 5%. Does that I missed here something?

Jeff Mezger

Yeah. February picked up the shortfall from December covered last February and pulled us positive 5%for the quarter.

Matt Benzene – Barclays Capital

Okay. I see. Okay. And your deferred tax asset?

Jeff Mezger

It is currently $771 million or just right around $10 per share.

Matt Benzene – Barclays Capital

All right. Thanks a lot.

Operator

Our next question will come from Joshua Pollard with Goldman Sachs.

Joshua Pollard – Goldman Sachs

Hi, thanks for taking my call. My first question is around margins. It looks like it came in at the high end before you guys got it history $0.02 that it would be above where 1Q, 2009 was but slightly below or somewhere below the 19 you reported in your November quarter. I am wondering what is going on there? Are incentives coming down drastically or was that right in line with what your internal targets were? And along those same lines, I am trying to understand between margin differential between specs and Built to Order for you will, I would assume that has come in pretty drastically over time now that home price seem to be stable in your markets?

Jeff Mezger

Sure. Josh, on the margin side, I would give credit to our Open Series product. As we continue to deliver more we have been – because the costs to build it versus the value to the consumer. We have been able to drop our prices and raise on margins. So it's a great combination and that’s those a key driver on why our margins are what they are relative to the past. I mean you do have previous impairments that improve your go forward margins as well.

Over time in our business, specs typically have a margin four to five points below Built to Order deliveries. So it's part to the reason that we like the Built to Order builder. Incentives come into play when you build specs and it gets completed and the consumer doesn't want it, so you increase incentive to make it more compelling. In our business model, where we pre-sold incentive don't play a big part our incentive side hasn't materially moved much over the last several years. Frankly, we always focus on best price to the consumer.

Kelly Masuda

Joshua, if there is one thing I would like to add too is that, unlike the trajectory we saw last year where we started out in the first in the quarter with a gross margin of about 13% and we ended the year with 19%. That's a pretty steep rate of climb. We don't see that really happening this year. We think the trajectory will be much flatter even though we still maintain though, year-over-year for the full year will be up. We are not going to see the same rate of climb like we saw last year.

Joshua Pollard – Goldman Sachs

Yeah. That makes a ton of sense. Jeff, another follow-up for you which is, you go on your website and you actually see a countdown for the tax credit. What is your marketing strategy post the ending of the tax credit? Do you think post the tax credit do you have a strategic advantage versus resale homes?

Jeff Mezger

Most definitely we do, Josh. Because it's a custom home in a competitive price to resales and with our cycle time in the most cities, we are turning from contract to close in 4.5 months, which is competitive how long it takes on – in many of the resale transactions. As we shared last fall, we were at this odd disadvantage when we were Built to Order in August and September and competing against a resale that had an 8,000 our tax credit that we didn't have.

We're going to put some houses on the ground, so we can offer the consumer choice and the tax credit here in the next 30 to 45 days. After the tax credit expires, I think there will be a settling down period and that's when our business model will really demonstrate value tied to the resale at the time. That the buyer would much rather, have a brand new energy efficient home than a 20-year old used home and we give them that choice.

Operator

We will now hear from Nishu Sood with Deutsche Bank.

Nishu Sood – Deutsche Bank

Thanks. I wanted to ask about the land spend environment and may be the competitive conditions out there. I think if you look at the top four builders, previous top five over the last couple of quarters. You have seen pretty aggressive behavior from some of them one is wrapped up in a merger. You folk haves taken what I describe as a little more cautious approach so far, but the $600 million land spend budget for this year implies obviously a ramping up.

Now, obviously as you described it, KB takes a balanced and disciplined approach. So I imagine that increased land spend is coming out of internal priorities, but how much of this is also the competitive environment. I mean obviously it's a real heated race in a lot of these markets to kind of secure the land right now. So I was just wondering if you could walk us through your thinking in terms of internal priorities versus the competitive landscape as you are picking up your land spend here?

Jeff Mezger

Nishu, Really they are one in the same for us in that we are staying very discipline and hitting our return hurdles with products that needs our strategy. So we are not going takes – if it doesn't align with those two components. And frankly, I would like to spend more than $600 if we could because it means we are finding more deal flow that aligns with those two opponents.

We are staying more prudent and disciplined, we are doing more options, we are going couple of bulk takes but they are small. I don't think see in major play unless we partner with somebody because we don't want to bleed off too much of our cash. But as I said before, you're only as good as your local team in every city. And there are deals getting done locally that make a lot of sense for us right now. And we will continue to load in as long as it hits our two criteria.

Kelly Masuda

And Nishu, you have to remember, although $600 million is up year-over-year. It's still down 80% of where we were at our pique. So when we end with more than five quarters of data from our encouraging results from our Open Series, whether more normalized sales pace. So we can better underwrite these new deals.

Nishu Sood – Deutsche Bank

Got it. Got it. Okay. So second question I wanted to ask, also kind of related to the land spend. Like a lot of the other builders, you are sitting on tremendous liquidity. I just wanted to get a sense of what type of feedback you get from your stakeholders, shareholders and bondholders on that liquidity. During more normal times there might be calls for debt repurchases or share repurchases. What is the message you get from your stakeholders?

Are they – it seems to be from judging from the behavior of the builders that stakeholders really want you folks to go out and aggressively spend on land. So I wondering if you could maybe talk through what kind of pressures or feedback you are getting from the stakeholders?

Kelly Masuda

Nishu, I think maintaining a strong balance sheet, especially in this type of housing environment is a real positive to all of our stakeholders. We are operating now with much smaller revolvers than we had in the past. So the bank and project finance availability is not what it used to be. The public debt markets are open today, but our access to capital is going to be different in the – when the cycle returns than it was in the past cycle.

So I think operating with more liquidity is something that's which you need to do in this type of environment. So we've maintained a lot of liquidity and we lettered out our maturities. So our next maturity is until $100 million in 2011 and that maturity after that until 2014.

Nishu Sood – Deutsche Bank

Okay. Thanks a lot.

Operator

And our next question will come from Alex Barron with Housing Research Center.

Alex Barron – Housing Research Center

Yeah. Thanks. Good morning.

Jeff Mezger

Hi.

Alex Barron – Housing Research Center

I wanted to ask you, I guess in some conversations I have had with land brokers and various private builders recently. It seems like the competitive landscape for the land has picked up I guess quite a bit in the last six months to the point where a lot of them are saying land prices are going up pretty substantially versus where they were six months ago. So I'm just trying to figure out if you guys are finding that is the case and is it much harder to find deals at 10 or 20% these days versus six months ago?

Bill Hollinger

Alex, I will take that. I will share an interesting anecdote that will provide the answer. We're actually while sellers may try to push land prices up, either hit your margin and your returns or you don't. So the market will tell you what they can get. And what the seller can get for a price. But in Southern Cali, I will use that as an example. We have actually are seeing more deal flow. There was a frenzy in the fall where you would get these scattered give us a bid deadline type sales and you would have multiple offers coming in.

We have actually seen that soften where they are doing the same approach, they'll put an asset on the market give us bids by March 1, then on March 1 they're extending the deadline, because they didn't get any bids. And I think you had a initial frenzy out there that has since softened a bit because markets are still stabilizing and people that were banking on inflation found out they made a mistake. So we are actually seeing more deal flow now than we were last August or September.

Alex Barron – Housing Research Center

Okay. That's helpful. My other question was with regards to the impairment that you guys showed this quarter. I wasn't sure if you mentioned where that happened or what specific region that might have happened? And what it was attributed to? Did you have to cut prices or was it just too low of a sales pace?

Kelly Masuda

Alex, it was basically four communities across three of our regions. So one region, our central region did not have any impairments, so it was in the other three. And I don't recall specifically what gave rise to the impairment. But obviously with the impairments being about $7 million and the abandonment being another $7 million. It's a pretty small number for those four projects. So it was – they were all minor.

Operator

And we have time for one more question with Joel Locker with FBN Securities.

Joel Locker – FBN Securities

Hi, guys. Just a couple of quick ones. Just on the – do you have a total amount of customers deposits at the end of the first quarter?

Jeff Mezger

We will look that up, Joel. Go ahead with your other question.

Joel Locker – FBN Securities

Okay. Then gross margin differential between Open Series and traditional in the first quarter. What was that roughly in basis points?

Jeff Mezger

I don't know that we even have that, Joel. Because we stopped differentiating.

Joel Locker – FBN Securities

And what – I guess, those were the only two I really had left?

Jeff Mezger

Hold it. Bill has the answer.

Bill Hollinger

$6.7 million at the end of the first quarter.

Joel Locker – FBN Securities

How much was it?

Bill Hollinger

$6.7 million.

Joel Locker – FBN Securities

$6.7 million in customer deposits. All right. Thanks a lot, guys.

Jeff Mezger

Okay. Thank you.

Operator

And gentlemen, I will turn it back to you for closing or additional remarks.

Jeff Mezger

Thank you everyone for your questions. As we shared today on the call, KB Home made solid progress during the quarter and we are well-positioned for the future. We look forward to sharing our results with all of you as the year progresses. Thanks for attending the call. And everyone have a great day.

Operator

Again, ladies and gentlemen that concludes our conference for today. We thank you all for your participation.

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