KB Home Q1 Earnings Call Transcript

123jump.com Staff
13 Apr, 2009
New York City

The homebuilder first quarter revenue slid 61% to $307.4 million. Net loss fell 78.3% to $58.1 million and earnings per share were loss of 75 cents against a loss of $3.47 a share in the year ago quarter. The company ended the quarter with $1.1 billion in cash.

KB Home ((KBH))
Q1 2009 Earnings Call Transcript
March 27, 2009 8:30 a.m. PT

Executives

Kelly Masuda – Senior VP & Treasurer
Jeffrey Mezger – President & Chief Executive Officer
William Hollinger – Senior VP & Chief Accounting Officer

Analysts

Carl Reichardt – Wachovia Securities
Dennis McGill – Zelman & Associates
Dan Oppenheim – Credit Suisse
Michael Rehaut – JP Morgan
Jim Wilson -- JMP Securities
David Goldberg – UBS Securities
Stephen East – Pali Capital
Josh Levin -- Citigroup
Kenneth Zener – Macquarie Research
Megan McGrath – Barclay’s Capital
Joshua Pollard -- Goldman Sachs
Nishu Sood – Deutsche Bank
Joel Locker - FBN Securities

Presentation

Operator

Good day everyone and welcome to the KB Home first quarter earnings conference call. (Operator Instructions) As a reminder today’s conference call is being recorded and webcast from KB Home’s website at kbhome.com. The recording will also be available via telephone replay until midnight April 6th 2009. You can access this recording by dialing 719-457-0820 or 888-203-1112 and entering replay pass code of 7081455. KB Home''s discussion today may include certain predictions and other forward-looking statements. These statements may cover market or economic conditions, KB Home''s business and prospects, its future financial and operational performance and/or future actions or strategies and their expected results. They are based on management’s current expectations and projections about future events and business conditions but are not guarantees of future performance. Due to a number of risks, assumptions, uncertainties and events outside its control, KB Home''s actual results could differ materially from those expressed in, or implied by the forward-looking statements. Many of these risk factors are identified in the company’s periodic reports and other 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 Mezger – Chief Executive Officer

Thank you, Darrell. Good morning and thank you for joining us for a review of our results from the first quarter of 2009. With me this morning are Bill Hollinger our Senior Vice President and Chief Accounting Officer and Kelly Masuda our Senior Vice President and Treasurer. This morning I’d like to share with you my thoughts on the current housing markets our net order performance and our progress towards restoring profitability. I’ll also talk about how KB Home’s strategy is different than others in our industry and how we are executing on our strategy. After Bill provides you with the financial update I’ll have some closing comments about the status of our roll out of the open series array of new home designs where our initial buyer response has been encouraging. Since our last earnings call in January we’ve continued to experience a difficult national housing environment still burdened by an over supply of homes and declining sales prices. The recessionary economic environment punctuated by rising unemployment and falling consumer confidence has only added to these difficulties. Yet in the middle of these ongoing economic challenges we are seeing some signs that the housing market is functioning according to fundamental economic principles. The median home sales price is now less relative to income levels than has been at any time in the past forty years. In addition to these low prices, mortgage rates have fallen to all time lows increasing affordability even further. As a result of this combination of low prices and low interest rates, buyers have become more active. Data released earlier this week from the National Association of Realtors shows that February existing home sales bounced sharply off their lows. Resale inventory picked up slightly as foreclosures continued adding to the housing supply. But the current inventory of unsold homes should begin clearing if the sales rates continue their current trend. While the median resale price in February declined 15% year-over-year the NAR reports reflects that sales prices stabilized sequentially from January levels, an event that has not happened quite sometime. While one month does not establish a sustainable trend these early indicators are encouraging and the federal government has made it clear that it remains committed to reducing foreclosures keeping mortgage rates low and ensuring that homes remained affordable. We see a great deal of buyer awareness about the $8,000 federal tax credit for qualified first time homebuyers in all our markets. But at this point we do not believe that tax credit alone is having a material impact on traffic or sales.

In California however the additional $10,000 tax credit for buyers of new homes has created a significant $18,000 total combined tax credit which we believe is helping contribute to increased sales activity in the state. Lastly, we are hopeful that the unprecedented amount of federal stimulus money being injected into the economy would have its intended affect of creating jobs and building consumer confidence which are prerequisites for housing market recovery. All that being said I want to repeat what I have shared over the past few earning calls. We are now relying on outside intervention for help and our strategy is not based on unrealistic assumptions about the future of the housing markets. Instead we continue to identify and implement actions that enable us to operate successfully no matter the economic climate. We’ve consistently focused on a set of core strategic objectives that include generating cash and strengthening our balance sheet, developing innovative new products that help us to compete with resales and foreclosures, restoring profitability by executing our KB Next business model, reducing overhead, and lowering our cost to build and provision ourselves to be opportunistic when the housing market stabilizes. While it is till early, our progress toward these objectives confirms that we are on the right track. Turning to first quarter net orders are 26% year-over-year increase is certainly a positive development. This is the first time in 13 quarters that our net orders were up on year-over-year basis. These results were due in large part to a combination of product positioning that enabled us to compete effectively with resales and foreclosures, favorable buyer response to the open series array of new home designs and the intensity with which our sales team executed on our sales strategy.

built-to-order KB Home offers.

As I have noted on previous calls, and consistent with the NAR data release this week, we believe first-time buyers represent the most attractive segment of the market and that they do not have to sell a home before purchasing and can access readily available FHA& VA financing. Our strategy of targeting these buyers continues to generate results. Not only did our net orders grow this quarter, we also increased the number of homes delivered to first-time buyers to 70% of our deliveries. This is a significant increase from 53% in the first quarter of 2008 and 65% in the fourth quarter of 2008. While we expect our second quarter ''09 net orders to fall below their year earlier levels, primarily due to a more difficult comparison against 2008, we do expect sequential growth in net orders in the second quarter and through the remainder of 2009. We believe we can sustain increased sales even with a lower community count due to higher absorption rates per community. We also expect our year-over-year net order comparisons to be positive for both the third and fourth quarters. Our backlog increased during the first quarter as net orders exceeded the number of homes we delivered by approximately 400 units. Looking out over the next two quarters our goal is to continue to build our backlog as net orders should outpace deliveries. Of course our overriding objective is to position ourselves to restore profitability. And a growing number of performance indicators confirm that we are on the right strategic path. While we are not there yet, we are approaching break even. Once we achieve break even we can advance toward our goal of turning sustainable net profit.

Our SG&A expenditures were down more than 50% year-over-year and we constantly look to identify additional opportunities to reduce overhead further. While SG&A as a percentage of revenue increased during the quarter due to the sharp decrease in our revenue, we believe we have both the right framework and urgency to drive additional cost reductions over the balance of 2009. Our KB Next operational business model will continue to be the centerpiece of our cost reduction efforts. By continuing enhancing our execution of the model and implementing our new product strategy we are developing a long-term capability to build and deliver homes profitably at much lower price points. Our objective is to ensure that KB Home will be the low-cost producer of quality homes for the first time, first move up and active adult buyers. We are in an extremely competitive housing market where buyers face an abundance of inventory from resales, foreclosures and other builders. That is why we believe it is essential to relentlessly differentiate ourselves in the marketplace. And while we are aggressively developing and promoting KB Homes product and brand attributes to potential homebuyers, our most important differentiator is the built-to-order experience we offer. That experience becomes especially attractive to buyers when they compare a KB Home to a resale or foreclosure. A home purchase is a deeply personal decision and the aspiration of buyers is for their new home to be their dream home. By offering choice on location and floor plan and then on the options available at our KB home studios we create a personalized home buying experience that is simply not available elsewhere. While other builders have been deemphasizing choice and closing their studios we are offering our buyers more choices to customize their homes and our studio sales have been consistently strong. And not only does our built-to-order experience deliver high customer satisfaction, the homes we build meet a high standard of quality. With the NAHB research center this week we are firming our position as the only builder to earn the rigorous National Housing Quantity Certified Builder designation for our nationwide operations.

We also associate the KB Home brand with some of the world''s leading brands such as Disney and Marcus stores. Our latest collaboration with Disney to create personalized Disney themed bedroom designs which are exclusively available at every KB home community is just one example of how we differentiate ourselves in a competitive market. As I have asserted for sometime now we believe buyers want their new home to be environmentally friendly and energy-efficient. That is why we have made a long-standing commitment to Energy Star and to educating buyers about how energy efficient, environmentally friendly homes can save their money on energy costs while promoting sustainability. We were recently recognized by the US Environmental Protection Agency as the only national home builder honored with its 2009 excellence in Energy Star Promotion Award. Beginning this year, all of our new home communities are fully Energy Star qualified, another differentiator in the marketplace. Homes that are fully Energy Star qualified have been shown to be as much as 45% more energy efficient than homes built as recently as a decade ago saving our home buyer''s money and energy costs for years to come. I believe that our commitment to innovation and continuous improvement is a big reason why we were honored on Fortune Magazine 2009 list of the world’s most admired companies as the #1 home builder. It is the second year in a row we topped the Fortune list and the third time in four years. These rankings are based on voting by our peers in the home building industry and the financial analyst community and we are proud to join other industry leaders such as Google, Nike, IBM and Wal-Mart. This recognition reflects the dedication and commitment of the entire KB Home team and I’d like to thank them for their hard work and congratulate them on their performance during the quarter. So, before I turn it over to Bill, let me recap our position. To begin with despite the challenging economic environment we were able to generate positive sales momentum and look to continue sequential net order grow. This growth should also enable us to continue to increase our backlog over the next few quarters. We are positioning ourselves to restore profitability by keeping pressure on overheads and driving a disciplined execution of our KB Next operational business model. We continue to focus on generating cash and strengthen our balance sheet and maintain our commitment to managing the positive cash flow from operations for the full year 2009. And we are aggressively differentiating KB Home in the market versus resales, foreclosures and other builders, a strategy that we believe is already paying dividend. There is much more work to do but I believe we have energy and momentum. We are well positioned to make the most of today’s housing market and seize new opportunities as they arise. Now, I’ll turn it over to Bill for more detailed recap of our first quarter. Bill?

William Hollinger – Chief Accounting Officer

Thank you Jeff and good morning everyone. Our first quarter financial result demonstrated the progress we have made towards restoring the profitability of our operations through sound strategy and strong execution. Compared to a year ago we significantly reduced asset valuation charges, improved our gross profit margin and lowered our overhead costs. As a result we reduced our net loss considerably in the quarter despite delivering fewer homes. For the first quarter of 2009 we reported a net loss of $58 million or $.75 per diluted share compared to a net loss of $268 million or $3.40 per diluted share a year ago. Our first quarter results included pre tax non-cash charges of $32 million for inventory and joint venture impairment and land option contract abandonment. That is an 86% decrease from 223 million impairment charges last year. Our inventory impairment charges decreased substantially from both a year earlier quarter and from the fourth quarter of 2008 despite our overall average selling price dropping 15% year-over-year and 9% from the fourth quarter of 2008. Our impairments are more closely tied to the prices on orders we are taking than they are on current delivery. For the most part we experienced no significant decline in prices on orders in the first quarter versus the level we had anticipated in our impairment analysis in the fourth quarter. As a result we did not have sizeable impairments this quarter. However, while our impairments have dropped considerably, we recognize that if market conditions deteriorate from here it is possible we will have additional impairments charges in the future. Adjusting for the asset valuation charges our first-quarter pretax loss would have been $27 million versus $44 million a year ago, that is a 38% improvement year-over-year. With similar adjustments, our current quarter net loss would have been $16 million or $0.21 per diluted share compared to a $27 million or $0.35 per diluted share in the first quarter of 2008.

Home building revenues in the first quarter totaled $306 million down 61% from a year ago, primarily due to lower housing revenues. Housing revenues for the quarter were $304 million down 58% year-over-year, the result of a 51% decrease in new homes delivered and a 15% decline in our average selling price. The reduction in the homes delivered was primarily driven by a 46% decline in our community count. The lower average selling price reflected both the state of our housing market which continued to absorb downward pressure on prices and our continued roll out of more affordable value-engineered homes designed to attract today''s cost-conscious first-time buyers. Our housing gross profit margin improved to 4.9% in the first quarter up 11.1 percentage points from a -6.2% a year ago. If we exclude inventory-related valuation charges from both periods, this margin increased by 400 basis points to 13.0%. Furthermore, our gross profit margin was nearly flat with the fourth quarter of 2008, despite a 9% decline in average selling price. We are pleased and encouraged by our progress to date and are improving our housing gross profit margin particularly with our average selling price having decreased. Some of the year-over-year gross profit margin improvement was due to reductions in our comps to build homes. Out home building business is now seeing real benefits from the execution of our strategic initiatives to value engineer our products, reduced direct construction costs and increase operating efficiencies, all of which are shaped by the discipline of our KB Next operational business model as Jeff mentioned earlier.

Our year-over-year improved gross profit margins also reflected the benefits of impairments taken in prior quarters. Selling, general and administrative expenses totaled $61 million in the first quarter, down 52% from a year earlier period. Significant savings in the first quarter came out of marketing expenses, salaries and other payroll related expenses and compensation plan. We‘ve curbed our advertising print media by shifting even more to the Internet, an outlet we’ve found very effective in the reaching our buyers. Our savings in the payroll area reflects the dramatically reduced headcount which was driven largely by division consolidations. During the quarter we made additional consolidations in Arizona, Florida, North Carolina and Texas. The savings realized from these consolidations should become more apparent as the year unfolds. Meanwhile overhead cost reductions remain our top priority. We will continue to scrutinize expenditures, challenge our organizational structure and look for new opportunities to achieve further cost savings but always with an eye toward preserving our ability to respond quickly when the markets stabilize.

Our SG&A expense ratio was elevated in the first quarter even with the major steps we have taken to streamline our organizational structure. As a percent of housing revenues the SG&A expenses were 20.1% in the quarter versus 17.6% a year ago primarily due to the sharp decrease in our housing revenues. While we will continue to take actions to reduce this percentage it will run on the high side relative to historical levels due to our conscious choice to maintain a strategic platform for growth and markets that have generated delivery volumes that are more than triple our current levels. The combined effects of our gross profit and SG&A expenses resulted in our home building business generating an operating loss of $46 million in the first quarter. That includes charges of $25 million for inventory impairments and land option contract abandonments which are reflected in cost of sales. Most of these impairments occurred in our West Coast and South West regions where selling prices fell. By comparison our business generated an operating loss of $249 million a year ago including a $188 million of consumer valuation charges. Adjusting for these charges our home building business generated a first quarter operating loss of $22 million in 2009 and $61 million in 2008.

Now let’s turn to a review of our balance sheet. Our focus on strengthening and enhancing our financial position as we navigate the current downturn has provided stability to our company. We ended the first quarter with cash and cash equivalents of $1.1 billion and liquidity of approximately $1.6 billion. These amounts reflect the impact of $221 million federal income tax refund we received and the maturity of our $200 million senior subordinated notes. But the tax refund and the reduction in our inventories we generated $105 million in cash flow from operations in the first quarter. Our substantial liquidity should provide valuable financial flexibility going forward. For the next couple of quarters we expect to use cash flow from operations to build our work and process inventory as well as support our transition to new value engineered product. Our ability to generate positive cash flows will also be affected by overall market conditions and behavior of housing markets as the government stimulates the economy and housing in particular. As with past years we expect operating cash flow to turn positive again in the fourth quarter. Overall, we currently anticipate that we will generate positive cash flows from operations for the full year ending 2009 with more of than $1.1 billion in cash and cash equivalents on the balance sheet. A healthy balance sheet will be essential to capitalizing quickly on new opportunities so our focus on preserving or generating cash will remain a key priority.

Our inventories totaled $2 billion at the end of the quarter down from $2.9 billion a year ago. We continue to bring down inventories in the first quarter exclusive of impairments and abandonments. Our last count was 44300 at the end of the first quarter down 6% from year end 2008 and 26% from last year’s quarter end. As of February 20, 2009 we owned 77% of our total lots, about 34300 lots and controlled 23% or approximately 10000 lots via land option contracts. The total lot count represented about four year’s supply based on our trailing 12 month deliveries. Our current inventory supply is one of the lowest in the industry and there will be further reductions as we continue to align our inventory holdings with our forecast of homes to be delivered. Our land acquisition standing continues to be limited as we remain selective and disciplined in our land investments in order to preserve cash and wait for the right opportunities. We currently expect to spend less than $400 million on land purchases and land development in 2009. This is about a $150 million less than 2008. Similar to last year we will continue to review and adjust our land investments throughout the year based on market conditions. We entered the quarter with 2518 homes in production, a figure that is down 86% from the peak in the second quarter 2006 and 46% below the first quarter of 2008. Some 618 on these homes, about 25% remain unsold. We also have approximately 282 finished unsold homes in our inventory at the end of the first quarter. Added for the tax assets of $881 million at February 28, 2009 were almost entirely offset by evaluation allowance. We are taking steps to preserve the long-term value of our net operating losses under section 382 of the Internal Revenue Code. We have proposed a protective amendment to our restated certificate of incorporation and a successive rights plan both of which are up for the stock holder vote at the annual meeting scheduled for April 2, 2009.

Our balance sheet at the end of the quarter was $1.7 billion down $204 million from year end 2008 and $424 million from a year ago. Our debt decreased in the first quarter with the maturity of our $200 million of senior subordinated notes on December 15, 2008. We had no cash borrowings outstanding under our unsecured credit facility at the end of the first quarter and our next debt maturity is not until August 2011. The remaining $1.6 million of senior notes on our balance sheet are well laundered with maturities extending to 2018. Our debt net of cash totaled $606 million at the end of the first quarter. That is down $85 million from year end 2008 and down $239 million from last year''s first quarter. Our net debt to total capital ratio was 44% at the end of the quarter compared to 45% at year-end 2008. Our liquidity at quarter end totaled $1.6 billion including $1.1 billion of cash and cash equivalents plus the amount of credit available under our bank revolver. This reflects the capacity under our revolving credit facility being reduced from $800 million to $650 million due to our consolidated tangible net worth falling below $800 million as of February 28, 2009. Nonetheless we believe we have sufficient liquidity and financial flexibility to navigate the current environment as we anticipate generating positive cash flow from operations. With no additional debt maturities in 2009, we do not expect to borrow again from our bank revolving credit agreements. We ended up first quarter in compliance with all covenants associated with our revolving credit facility.

With regard to unconsolidated joint ventures we reduced our count by 1 in the quarter. We had approximately $175 million invested in 24 joint ventures at quarter end. That is down 38% from $281 million at the end of last year’s first quarter and slightly below the $178 million at year-end 2008. The debt of our unconsolidated joint ventures totaled $859 million at February 28, 2009 representing a slight decrease from year-end 2008 and 43% decline from a year ago. While our unconsolidated joint venture numbers did not change significantly from year end 2008 we continued to make every reasonable effort to reduce both our joint ventures investment and their individual job debt levels that joint ventures typically have by their nature added complexity because of the involvement of other parties that often have different objectives, it is taking time to work through these arrangements. Nevertheless we are unrelenting and expect to show measurable progress in the next few quarters as we continue to focus on negotiations with banks and partners and look for opportunistic buy outs.

Looking at our business more broadly, we expect to deliver reduced volumes of new homes on a year-over-year basis throughout 2009. However as we move beyond 2009 our deliveries may begin to improve if current positive sales and buy plot trends persist. We continue to monitor market conditions carefully and we are ready to adjust to new accounts if market conditions warrant. In the meantime, our highest priority remains generating positive operating cash flows, maintaining a strong financial position, restoring our profitability and making prudent investments that will allow us to capitalize on a market turn when it comes. We made progress on each of these goals during the quarter and our efforts to date have produced better financial results. We gained momentum from the reductions from impairments and we made headway in reducing our cost structure and improving our gross profit margins. All three contributed to a significant reduction in our net loss for the quarter. We are determined to improve on that performance as we move through the year. While we cannot predict when the housing market will rebound, we can assure you that we will work long and hard to effectively execute on our strategies to maximize our financial and operating results no matter what conditions we face. As Jeff noted we have more work ahead of us. But with the improvement in our financial metrics in the first quarter including the 26% increase in our net orders which represented the first increase in 13 quarters and what we hope will be a growing backlog we are all energized to accomplish more and are prepared for the opportunities yet to come. Now let me turn the call back to Jeff who will provide some closing comments.

Jeffrey Mezger

Thanks Bill. Before we begin taking your questions I want to give you an update on our progress with our open series, our new array of value engineered home designs we are introducing across the country. At the end of February we had approximately 30 communities offering the open series. In every community where we transitioned to the new product line, sales of the open series exceeded previous sales rates often by a significant order of magnitude. Results have been consistent wherever we have introduced the new product, whether in Southern Cal, Tucson, Houston, Orlando, North Carolina or the other regions where we have launched. The new home designs contributed 20% of our built-to-order sales of the month of February and that percentage has been steadily rising in the opening weeks of our second quarter. This performance confirms our belief that our new product is very compelling to homebuyers. By designing the open series to compete directly with resales and foreclosures we have given homebuyers a quality, new, built-to-order alternative to depreciate homes. They are responding to the affordability, energy efficiency, smart design, flexibility and choice offered by the open series. Because of smart design and value engineering we have dramatically lowered our cost to build and even while pricing these homes more competitively we have still improved our gross margin. In addition, we build the open series much faster enabling us to convert our backlog to revenue more quickly. Our roll out of the open series nationwide remains on schedule and we continue to believe that deliveries of the new products should constitute approximately 50% of all deliveries by the end of 2009. As I said before, the worst decision a builder could make in the current economic climate is to keep building what they have built in the past and stay purely defensive while waiting for the market to rebound. Instead we believe homes must change with the times. We have developed a differentiated product that is the foundation of our differentiated strategy. It is not simply about reducing prices. It is about increasing value to the consumer, providing them innovative features and a built-to-order purchase experience that they cannot find elsewhere. That is the philosophy behind the open series and while we are still early in the roll out, we are all very excited about the early response from our homebuyers. Thank you and now Darrell, let’s open up the line for questions.

Operator

Alright, thank you sir. The question-and-answer session will be conducted electronically. If you would like to ask a question please do so by pressing “*1” on your telephone keypad. If you are using a speakerphone please be sure that the mute function is turned off to allow your signal to reach our equipment. We''ll take as many questions as time permits. We ask that you limit yourself to one question and one follow-up question only. Once again, please press “*1” on your telephone keypad to ask a question. We’ll take our first question from Carl Reichardt with Wachovia Securities.

Carl Reichardt – Wachovia Securities

Good morning guys. How are you? Jeff, congratulations on your orders and I’m curious if you look at your deliveries this quarter in Excel your corporate allocation of expense. Do you have a sense of on a community level or per home level, how many homes that you are delivering that are actually operating profitable and how would you think about that for the rest of the year? What percentage of homes can you deliver that are actually making money?

Jeffrey Mezger

Carl I don’t know how I can answer the question because we don’t look at it per house. We definitely have financial statements per community and what we first look at from a cash flow point of view and then convert once we are positive cash, how do we make profits as well. And our goal over the year is to continue to increase our revenue at the top line, improve margin and hopefully lower our SG&A along the way. But we don’t break it out per home.

Carl Reichardt – Wachovia Securities

Okay great, thanks Jeff. I appreciate and I’ll get back in queue, thanks.

Operator

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

Dennis McGill – Zelman & Associates

Good morning guys and thanks for the info. Jeff I was hoping you could go into open series, particularly what you are seeing in California because I’d think that’d be an area where foreclosures are high, that you have an opportunity to take some share, but orders were down there. So, why don’t you give a little color behind that?

Jeffrey Mezger

Yeah, orders Dennis were down in large part because our community count was down. As we shared on previous calls some of our first introductions of the open series actually occurred in Southern California and actually have sold as well or better than any other part of the country. I had the opportunity last week to visit one of our communities in the middle of the week and at that time there was a lot of traffic, there was a lot of interest. There was actually a sale occurring there and it was a very exciting experience.

Dennis McGill – Zelman & Associates

What did you say were the absolute level of communities for the first quarter relative to the numbers from last year?

William Hollinger

The average for the quarter was 120, which is down 46% from 224 a year ago.

Dennis McGill – Zelman & Associates

So how do you think you will go from 260 communities in the fourth quarter to 120 in the first quarter when you are opening communities related to the open series, right?

Jeffrey Mezger

Many of those communities Den had just opened at the end of February. So, we are the average for the quarter was low. We always have a spike in community count at the end of the year as we deliver through and close out communities. So, if you go back over our history our highest community counts have always been in the fourth quarter as we transition through closings on the old and we start to introduce the new. As I have shared on the last few calls we shut down many communities and are re-tolling to this new product and they are now coming on line and you’ll continue to see our community count grow as we work through the rest of ’09.

Operator

We take our next question from Dan Oppenheimer with Credit Suisse.

Dan Oppenheimer – Credit Suisse

Thanks very much. I was wondering if we can talk about the margins in the open series for builders on newly purchased land as well as land they have always had there and just re-tolling. What margins would you be targeting on that versus margins on traditional communities?

Jeffrey Mezger

That’s a great question Dan. We are not…I’m not aware of any open series that we have opened on new acquisition of lots because we still don’t think it is the right time to acquire more lots. Going forward we would underwrite any acquisition pretty conservatively whether the margin is 20 or above in our format and more importantly an IRR of 30 above. So, we are conservative on the go forward acquisitions. But the beauty of the open series, because of the costs we build it for it will allow us to acquire lots at an acceptable margin and return that we may not have previously been able to.

Dan Oppenheimer – Credit Suisse

Okay thanks. I was wondering about early on you talked about the essential increase are in pricing. Given what you are saying in terms of the goals for the orders and the cash flow, should we assume that your strategy is still going to be focused on the orders and that we should not expect to be a price leader in the market here?

Jeffrey Mezger

I don’t know Dan that we observed increased sales prices. We are sequentially talking about our sales pace that we think we can grow sales in Q2 over Q1 and sequentially.

Dan Oppenheimer – Credit Suisse

You just mentioned about the NAR status and I just wanted to make sure that you are talking about those as an aside to your strategy inn terms of push your strategy will be to push volumes.

Jeffrey Mezger

Yeah, the balance of top line to overhead to margin like we have been doing for years and our primary priorities are to continue to strengthen our balance sheet and restore profitability. So, we’ll be attacking on both sides but I don’t expect pricing to go up through the year.

Dan Oppenheimer – Credit Suisse

Okay thanks.

Operator

We’ll take our next question from Michael Rehaut with JP Morgan.

Michael Rehaut – JP Morgan

Thanks. Good morning everyone.

Jeffrey Mezger

Hello Michael.

Michael Rehaut – JP Morgan

First question Jeff on trying to get more granularity on the orders there and looking at the different segments that you report you had a lot of strength coming out of the central region whereas the west coast was still down 15%, South West and southeast were up but not on the overall corporate average numbers. So, I was wondering if you could just kind of walk through perhaps how if it was the open series communities that really expected relative performance on a regional basis, perhaps you can give us some color in terms of pockets of relative strength and weakness across your different major markets.

Jeffrey Mezger

Sure Michael, I’ll take a stab at that. There is a lot to your question. In Central specifically our Houston market in particular is performing well. We’ve been introducing this product in several communities in Houston and it was big driver in the year-over-year comp for the central region. If you go to a national perspective as we shared on the call we compete with resales. The only market where resale we feel were in imbalance for us is a six months supply would be southern Cal and Denver. Every other market we are in continues to have an excess inventory position on the resale front. So, my color overall would be that the majority of the markets are still challenged and the open series as we roll it out is working well because we are competing with foreclosures. I think on a quarterly basis the community count does drive some of the comp. Where we have opened the open series in California, it is working extremely well and we have more on the boards to open in the future. So, I wouldn’t jump to one region that’s working better than others. We have to get it open more broad based across our country.

Michael Rehaut – JP Morgan

Okay I appreciate that Jeff. And Jeff as a follow up I guess does the community count where do you see that getting up to by the end of the year and I’m sorry I’ve one quick follow up after that.

William Hollinger

Again we had 120 in the first quarter on average. For the year we expect about 150 with community count, a lot of that growth coming in the second half of the year.

Michael Rehaut – JP Morgan

Okay the second question really is just on pricing and you had mentioned before that you don’t see pricing necessarily strengthening throughout the year and that overall as you said in your prepared comments you don’t expect material improvement in the housing market but what we have observed over the last couple of years is that when one company sort of puts the stake in the ground and really resets the pricing and the way you are doing is much more structural than that with the open communities but it takes a quarter or sometimes two quarters for other builders to react to that and try and get some of the orders and traffic back in their backyards. So, I was just wondering if you are starting to see that in the regions where your communities have been open for a couple of months and if you have the ability to further lower price and cost a couple of quarters from now in reaction to the competition making their moves?

Jeffrey Mezger

Michael, as I said in the comments we are focused on competing with foreclosures and resales. It’s a much bigger market if you look at this week’s data. 4.7 million resales annualized and 330,000 new home sales annualized. So, your market prices will come from resale, not necessarily your new home builder. Every builder has a strategy. We think ours is different and we are setting our price to compete with what we feel is the true competition, resales and foreclosures. We are seeing markets like Southern Cal where resales are picking up and turning and price has stabilized. So, it could be that you have a fall around pricing in Southern Cal if this trend continues and we are priced right where we want to be relative to that floor. Past that any pricing pressure we see it is going to be based on resale inventory in that market.

William Hollinger

I would say Mike as we said in our opening remark, it is encouraging that although our pricing is down 15% year-over-year our gross margin is up 400 basis points.

Operator

We take our next question from Jim Wilson with JMP Securities.

Jim Wilson – JMP Securities

Hi thanks good morning guys. So, my two questions, first one is on the open series, if you are thinking that it could be 50% of your sales by year end. Is it compared to sub-divisions count do you think it will be 50% of your sub-building account, also by year end or more or less than that?

Jeffrey Mezger

The comment was type of the delivery site Jim.

Jim Wilson – JMP Securities

Oh okay.

Jeffrey Mezger

But we are seeing higher absorption rate out of this product than our previous product and as you know out here in many of the states in the west you don’t have the ability to flat out change product like we are trying to, so it is taking time. And as we work through and open more communities we are getting higher sales rates and I wouldn’t say I wouldn’t jump to half our communities will be open series at the end of the year.

Jim Wilson – JMP Securities

Okay fair enough and in the same question can you give any more color on sort of how sales trends have been going so far in the month of March either in general by area or even just even within the open series and its impact to sales, home sales.

Jeffrey Mezger

Jim we don’t, we don’t share our data intra-quarter and as I said in my prepared remarks we are seeing continued strength in sales in the open series communities.

Jim Wilson – JMP Securities

Okay. Right, thanks.

Operator

We take our next question from David Goldberg with UBS.

David Goldberg – UBS Securities

Thanks good morning.

Jeffrey Mezger

Good morning David.

David Goldberg – UBS Securities

Jeff I was wondering if you can clarify and give us a little bit more color and maybe a little bit more details, I know you said a couple of times that the sales pace in the open series communities is greater than in kind of the normal communities and what I’m trying to get a handle on is kind of on a per month kind of basis what do you think in term of sales you are looking at in order to be comfortable with the idea that sales are going to increase sequentially through the year?

Jeffrey Mezger

It ties to the if we look to our first quarter results and what we generated in sales and the fact that we are opening more of the open series communities so our community count will be going up through the year and it is a logical progression that that sales will go up with it and that we are seeing strong sales due to how each of these communities are positioned. So, it is sales growth tied to the success of the product and the expected community count growth through the year.

David Goldberg – UBS Securities

Let me ask the try that in a different way, if you are looking at open series communities that you had opened, do you see when you first grand opened that there is a higher sales statement and sales offer over time or you have been able to keep the sales pace pretty consistent after the opening and then I know it is pretty early in the process but generally speaking.

Jeffrey Mezger

Any grand opening David, our view is you can only grand open once and so you do it right and will take the time to properly promote the community and we always see as a spike in sales above our intended run rate I’ll call it at the grand opening period. That said we have been able to sustain sales rates past the opening at fairly historical levels, the 6, 7, 8 a month kind of a track versus a 1, 2, 3 a month that we were seeing on the old product. We have been able to sustain sales after the opening period.

David Goldberg – UBS Securities

That’s great. I guess a follow up question would be about the benefits from higher impairments in this quarter and how much that helped margins?

William Hollinger

We don’t really disclose the profit component but on proportionate deliveries of the quarter was just slightly over 70% were from deliveries that had previous impairments.

David Goldberg – UBS Securities

Is that up though as a percentage sequentially?

William Hollinger

Yes it is.

David Goldberg – UBS Securities

Okay.

Operator

Our next question comes from Stephen East with Pali Capital.


Stephen East – Pali Capital

Hi good morning guys. If you look at the profitability in the open series Jeff, and also looking at land, you talked in the past that you have a mismatch in land where you said you historically purchase land with much bigger houses etc and you started to work through that. If you look at that in conjunction with the profitability of the open series when will you go through and see profitability throughout and where land is at the right percentage of ASP?

Jeffrey Mezger

Well if I reflect on that process Steve, what we were doing before was keeping the same product out there which was out of alignment with the consumers today. You’d lower your price, you’d impair it, you get your cash out and you wouldn’t have any margin really to speak of it at the end of the day. As we’ve put the open series out there on lots that we acquired in some cases years ago, intended for a much larger product we have dropped our cost enough where we have ended with a product that’s aligned with what the consumer today wants where we have been able to slow the impairments, drop the price and raise margin all at the same time. So, it is a good combo as you go forward. I call it the property equation balance, how much revenue can you get, at what margin, relative to your overhead and our strategic goals right now would be to get up volumes, to get up margins and ideally over time you get your margins above 15 and get your SG&A below 15. Our sales rate and our margin performance for the next couple of quarters will tell us whether we are going to get there or not. I don’t see margins losing north of that range where we are at today until we acquire more land.

Stephen East – Pali Capital

Okay, so how long do you think it takes for you to work through that mismatch on land if you will?

Jeffrey Mezger

It is market specific. Some markets are pretty lean on lots where we will be reloading earlier if the opportunities are there. It’s a difficult thing to peg as a company but we will get there over time.

Stephen East – Pali Capital

Okay and on your SG&A since you are bringing absolute sales dollars down, what do you need to do to bring that back into alignment?

Jeffrey Mezger

It’s a function of our revenue and hard costs and as we shared we drafted 50% year-over-year. Unfortunately our revenue through the unit count and the average price drop 60%. So, we are still chasing it down. As Bill mentioned in his comments we did some more organizational realignment in the first quarter. It takes time for the savings to flow through. You’ll see more of it as we move on through the year but we remain committed and dedicated to getting our SG&A back in line with our top line.

Stephen East – Pali Capital

Okay thanks.

Operator

Next question is from Josh Levin with Citi.

Josh Levin – Citigroup

Hey good afternoon everybody. I have a question regarding orders during the first quarter. I think in May 2008, particularly October, November which would have been your fourth quarter it is probably sad to say that the world certainly was falling apart, consumer confidence wasn’t in a very good stage. Do you have any sense of the material sense of the order you got in the first quarter or pent up demands in the fourth quarter of last year meaning people who were going to buy in October, November had backed off and then came back in the first quarter?

Jeffrey Mezger

I don’t know that it’s that simple, Josh. We actually did share at our year end call our sequential sales in the fourth quarter and I don’t know if November was actually was up over October and our October was up over September. So, sequentially through the quarter our sales improved. I think what we are seeing in our sales results here in the first quarter is directly linked to the continued effort to realign our product to be more compelling. I don’t think it is consumer psyche that was on the fence and has now come back.

Josh Levin – Citigroup

Okay one more question, you talked about 70% of your deliveries were first time home buyers. Given the down payment requirements now, and then FICO score requirements, do you have a sense, have you done any research about how big the pool is, the potential the buyers out there, who actually qualify?

Jeffrey Mezger

I know the pool is very large Josh. Along with that 70% first time we are focused heavily on price points that offer FHA financing. On an FHA loan the requirement down is 3.5% today and they don’t use FICO scores. They use other criteria, so it’s still a readily available loan instrument. You just have to document your income and your job and your credit. The financing is out there. It is not a roadblock to the first time buyer.

Josh Levin – Citigroup

Okay thank you.

Operator

We’ll go to Ken Zener with Macquarie capital.

Kenneth Zener – Macquarie Capital

Morning.

Jeffrey Mezger

Morning Ken.

Kenneth Zener – Macquarie Capital

The order rate that you guys are getting in the 120 communities in the first quarter was pretty high. How do you guys think about when you talk about order rates, obviously the second quarter is a tougher but as you think about it really are you thinking that you can sell 4, 5 homes at our community?

Jeffrey Mezger

That was our experience in the first quarter Ken. It is well worth now modeling now as we roll out this new product going forward.

Kenneth Zener – Macquarie Capital

That’s obviously a very solid rate. I mean if you go back to a more normalized rate of absorptions per month there. What do you think are the risk assumptions given that you are not trying necessarily send off other community kind buyers here. You are really targeting that entry level, competing with the resale. What do you think are some of the risks to that assumption?

Jeffrey Mezger

The risk would be if sales continue to fall dramatically there is a point in time we are not going to chase the sales. As we have opened this product up and positioned it to compete head on with foreclosures, in places like Southern Cal where prices have actually stabilized on the resale front it is encouraging because perhaps there is a floor now in Southern Cal and if you are selling well and inventory is clearing you get little more predictable result. In the other markets we are in whereas resale inventory is 20, 25 months, prices are still going down we’ve priced aggressively to compete in that environment. If price were to continue to go down we may not have the appetite to chase it but as we sit here today we are comfortable with sales rate we are seeing.

Kenneth Zener – Macquarie Capital

Right and I guess given that absorption pace internally in your forecast can you give I mean you didn’t give an explicit order rate or closings for the year. I assume there will be a pretty wide variance if you are looking at first quarter, 5 orders per community when you were doing 2 in the second half of ’08. How do you kind of balance the potential upside given the first quarter’s rate versus what we saw in the latter half of ’08?

William Hollinger

Right it speaks volumes to the new product we are rolling out. We are basing it on our current experience and I tempered my comments about where the markets are headed because I am concerned about the overall economy and the job loss and a lot of the media is jumping okay about we are calling about it and we are not yet calling about that yet. We think it is going to be difficult for a while. So, we are being prudent, yet we are also trying to recognize the experience we are now seeing where we have effectively rolled out and introduced the open series.

Operator

We’ll take our next question from Megan McGrath from Barclays Capital.

Megan McGrath – Barclay’s Capital

Hi thanks. I have just got another quick follow up on the order growth. Can you give us any color even if it is not specific numbers on how the order growth trended in the quarter and as a follow up to that, how sustainable do you think this cancellation rate is going forward?

William Hollinger

Well we showed that in the month of February the open series accounted for 20% of our built-to-order sales. We qualify built-to-order because we don’t have an inventory of open series product. There are new communities opening and what we are seeing good momentum that we can carry going forward. The cancellation rates, we now report both ways. When your gross sales are declining your can rate will grow up as a percent of sales even if your can rate as a percent of beginning backlog holds. Our can rate improved as a percent of sales because our gross went up. Our can rate as a percent of backlog was actually in the historical range that we have seen for last few years. So, we think the can rate was fairly typical.

Megan McGrath – Barclay’s Capital

Okay that’s helpful, thanks. Looking a little bit for clarification on the forward looking order growth you talked about net orders going up sequentially although historically the second quarter has been from a seasonal perspective a lot higher. So, because you are increasing community count can you think that the August and November quarter can actually be higher than 2Q?

Jeffrey Mezger

We do.

Megan McGrath – Barclay’s Capital

Okay, thank you.

Jeffrey Mezger

And we wanted to clarify the guidance because we know we are not going to achieve the sales that we generated in the second quarter of last year because our community count was so much higher. However we do think we can build on our sales rate through the year.

Megan McGrath – Barclay’s Capital

Great, thank you very much.

Operator

Next question is from Joshua Pollard with Goldman Sachs.

Joshua Pollard – Goldman Sachs

Hi most of my questions have been answered but I do have two. One is could you give us a sense of how much square footage pricing has changed? How much is your pricing down year-on-year on a square footage basis and my second question is, what are your thoughts on issuing equity here, given where your stock price is?

Jeffrey Mezger

I don’t know Josh that we have the price per foot on the call and we can probably take a stab at it. Don’t confuse price per foot with absolute price. The consumer can only afford so much and if you are building a much smaller home albeit your price per foot could be higher, the price could be still down 100 grand to the consumer. So, my hunch is since we are offering lots of smaller products the absolute price is way down but price per foot actually could be up a little bit. I’m sorry I can’t remember your second question. Oh equity. No, our equity is too cheap right now. We think that there is a lot of up side so why give it away.

William Hollinger

And give our liquidity position with 1.1 billion of cash and 1.6 billion of liquidity and the maturity not till August 2011 our balance sheet is in pretty good shape right now.

Operator

We move to Nishu Sood with Deutsche bank.

Nishu Sood – Deutsche Bank

Thanks. I also wanted to ask couple of questions about the new open series plan given how important it is going to be. I can really understand the appeal of it in markets like Florida and California where there is much more intense competition with the resale market and where prices have fallen a lot more significantly. I am trying to understand especially also relative to your competitors, other builders, you are probably more differentiated, I am trying to understand the kind of basis for success in a market lets say like Texas where there isn’t as much competition from foreclosures, the 1200 sq foot for box, for entry level buyers is a much more typical product and prices haven’t fallen as much. So, can you just give me a sense of how it plays in a place like Texas?

Jeffrey Mezger

Well Texas certainly hasn’t seen the deflation that the coastal markets have. Its still very competitive there and there is still excess inventory on the resale side and inventory levels continue to climb. So, there is a lot of competitive pressure in Texas and Nishu right now one of our best stories in sales is Houston where we rolled out this product and has been received extremely well. Income levels overall in Texas are a little lower than they are out here in California for instance and affordability is absolutely critical. So, it’s a key strategy for us and I think it’s a differentiator in Texas just like it is in California, Florida.

Nishu Sood – Deutsche Bank

Got it and it sounds like a great principle to be able to offer the customer the flexibility to decide on their own house. Some of them will take in a sense make it tailored to their own level of affordability, whatever they can afford, and I can imagine it introduces a lot more uncertainty to your revenue stream. So, like what do you model as you are looking at an open series community in term of revenues? Are you expecting that everyone is just going to pick the most basic option and I guess a related question would be, how does that factor into your impairments as well?

Jeffrey Mezger

We have years and years now Nishu of experience with the studio results and what we are seeing even with these lower priced products, the results at the studio as percent of revenue are fairly typical like what we have been generating over the years. We’ll take a historical track on the studio results and factored in with the base price to do our revenue projections. As to impairments the price is the price. Where we have a business model, we understand what the studio expectation would be and that’s all factored in as we would book any impairments.

Nishu Sood – Deutsche Bank

Got it okay. Thanks a lot.

Operator

We take a question from Larry Taylor with Credit Suisse.

Larry Taylor – Credit Suisse

Thanks very much. We talked about pricing in a number of different forms. I want you like ask you in a slightly different way or clarify it. It is possible you gave that information I didn’t catch it. As a finished product what the difference in pricing might be if the backlog or new orders currently relative to your closing status.

Jeffrey Mezger

The guidance that we gave on the call, Larry is that we don’t expect our pricing to move much through the year. It is down a little bit from the end of the year but our expectation is that pricing is in the range.

Larry Taylor – Credit Suisse

Okay so you are not seeing a significant difference on the new orders or current orders in terms of pricing to the pricing on the closing stock in the quarter.

Jeffrey Mezger

That’s correct.

Larry Taylor – Credit Suisse

Right, thank you.

Operator

We take our final question from Joel Locker with FBN Securities.

Joel Locker - FBN Securities

Hi guys just I was wondering on competition to your open series you are obviously the first one or one of them just like recently you have been saying you are seeing some type houses being built by your competitors.

Jeffrey Mezger

Joel, somebody asked a question similar to yours and I keep reiterating our biggest competitor today is resale. Other builders are doing things obviously to lower their prices when everybody had a different strategy on how they are going to compete with resale and foreclosure. I can’t speak to those but I can speak to, we feel strongly that our strategy is the right one and is a differentiator in that it is not only an affordable product it is designed with the consumer in mind, a product that appeals to their needs today and we are the builder of choice because they can go to the studio and customize it and its more than just price, it’s the whole package.

Joel Locker - FBN Securities

Right and just a follow up on communities, if you include all communities even your homes with home flush or flush with high homes what would it be? Would it still be 12o or would it be higher? And if so what would be your number?

Jeffrey Mezger

Joel the number is the number. There is probably communities with 1 or 2 lots to close that wouldn’t be in that but its not a material impact.

Joel Locker - FBN Securities

Not material impact, all right thanks a lot.

Operator

This does conclude our question-and-answer session for today. Mr. Mezger I’ll turn things back to you for any closing remarks.

Jeffrey Mezger

Thank you Darrell and thank you everyone for joining us and we look forward to seeing you over the next few months. Have a great day.

Operator

This does conclude today’s conference. Thank you for participating. Have a great weekend.