Jeff Mezger - CEO Jeff Kaminski - EVP and CFO.

Michael Rehaut - JPMorgan David Goldberg - UBS Megan McGrath - MKM Steve Kim - Barclays Stephen East - Evercore Michael Dahl - Credit Suisse Group Ivy Zelman - Zelman and Associates Susan Berliner - JPMorgan.

Good morning. My name is Rob and I will be your conference operator today. I like to welcome everyone to the KB Home 2014 Fourth Quarter Year End Earnings Conference Call. At this time, all participants will be in a listen-only mode. Today's conference is being recorded and a live webcast is available on KB Home's website at kbhome.com.

Following the Company's opening remarks, we will open the lines for questions [Operator Instructions]. KB Home's discussion today may include forward-looking statements that reflect management's current views and expectations of market conditions, future events and the Company's business performance.

These statements are not guarantees of future results and the Company does not undertake any obligation to update them. Due to a number of factors outside of its control, including those identified in its SEC filings, the Company's actual results could be materially different from those expressed and/or implied by the forward-looking statements.

A reconciliation of non-GAAP measures referenced during today's discussion to their most directly comparable GAAP measures can be found in the Company's earnings release issued earlier today and/or on the Investor Relations page of the Company's Web site. It is now my pleasure to introduce your host, Chief Executive Officer for KB Home, Mr.

Jeff Mezger. Mr. Mezger, you may begin..

Thank you, Rob. Good morning, everyone. Thank you everyone for joining us today for a review of our fourth quarter and full year 2014 results. With me today are Jeff Kaminski, Executive Vice President and Chief Financial Officer, Bill Hollinger, Senior Vice President and Chief Accounting Officer; and Thad Johnson, Vice President and Treasurer.

I will begin with a summary of our fourth quarter performance and provide some color on our accomplishments and some challenges we encountered during the period.

Then, I will share our key areas of focus for 2015 as we continue to pursue top line growth and improvement in profitability while also now working to enhance our recurrence through improving our capital efficiency. Following this Jeff Kaminski will provide greater detail on our financial results.

After which, I will offer some concluding remarks before opening the call up to your questions. During the fourth quarter, we achieved continued progress across many of our core financial metrics. We reported 796 million in revenues, an increase of 29% over the prior year, on 2229 deliveries.

Our average selling price, up 351,500, which increased by 17% year-over-year, was a key contributor to our top line growth as our investment and product strategies continue to drive results. Our adjusted gross margin was 18.7%. I am disappointed with this result as we expect it to perform better.

And I’ll provide additional detail around this topic in a moment. During the quarter, our SG&A ratio continued to improve coming in at 10.5% as we work to contain overhead cost while growing our revenue.

Net income for the quarter rose to 853 million, or $8.36 per diluted share, reflecting both our operational results and the positive impact of our DTA reversal. With this result, we now have 1.6 billion in book equity, nearly three times our equity, at the prior year end.

While we continue to make progress in many areas of our business during the quarter, we also recognize there is still much work to be done to achieve our financial goals going forward. Now, I’d like to address our fourth quarter housing gross margin performance.

The time of our last earnings call with our expectation that the housing market would continue at slow yet steady recovery, we indicated that we believed our housing gross profit margin for the fourth quarter will improve sequentially from the third quarter.

Unfortunately we experienced the softening in demand in some of our served markets as the quarter progressed with increased pricing pressure while at the same time we continue to face cost pressure among other things.

As a result we generated a disappointing fourth quarter adjusted housing gross margin of 18.7% which was down 30 basis points from the third quarter.

While regionally, results in the inland markets of our West Coast operations had the most significant effect, several factors contributed to the difference between our actual and projected gross margin results.

First, we were impacted as a result of delivering fewer homes than we had previously expected, consequently we lost some operating leverage on our indirect construction costs. These costs have been increasing ahead of deliveries as we continue to staff our operations in support of our current and future community account growth.

Second, against the back drop of tighter market conditions, we had an increased use of sales incentives and price reductions and spec home deliveries in the quarter. Third, we continue to experience cost pressures with our construction labor and material cost.

We believe that all of these factors taking together had about an 80 basis point impact on our gross profit margin for the quarter. Looking to 2015 with this lower fourth quarter gross margin comparable to the prior year as a starting point, we know that our gross margin will continue to lag the prior year comp for some time.

As a result we are projecting our first quarter 2015 gross margin will drop significantly from the first quarter of 2014 hitting the low point for the year before improving sequentially for the remaining three quarters of 2014. As we often observe, there is no one item that will drive an improvement in gross margin.

There is a menu of many actions in both revenue and cost and we are aggressively addressing all of them. Although at this time we do not expect to reach our housing gross profit margin goal of 20% in 2015 as we have hoped, this remains the target level we are working toward for the near future.

Moving on to the sales and traffic trends for the quarter, our net order value increased to 587 million up 22% on a unit increase of 10%. This increase in net orders is consistent with our average community count growth for the quarter of 13%.

As we shared, we will continue to balance price and pace to optimize each asset and expect our sales rate per community will not increase until we achieve our targeted gross margins. In the mean time we do expect that our future order growth will coincide within the range of our community count growth.

Our traffic levels per community remain strong up 15% over the prior year. This data point reinforces that there continues to be strong interest in home ownership. Our year-end backlog value rose to 940 million a 34% increase over the prior year and our highest year-end backlog value since 2007.

Between our backlog position, our growing community count and our product mix continuing to generate a higher ASP, we are well positioned to drive unit and revenue growth entering 2015. The priorities looking forward I’d like to revisit the journey we have been on over the past few years.

As we entered 2012, we knew that we would need to further accelerate revenue growth in order to achieve and sustain profitability. We announced at that time that we are going on offence and it was rallying cry within our organization.

We made significant investments in land and lots to grow community count and repositioned our locations and products within our current business footprint while at the same time minimizing overhead increases as we supported this growth strategy.

Our 2014 results reflect the culmination of these actions and with these profits, we achieved our short term goal of recognizing the DTA reversal. Now that we have established the larger scale and sustained profitability we will be expanding our focus to not only growing our revenues and enhancing profitability but also to improving our returns.

Due to the investments we have made, we own and control all the lots needed for our 2015 business and substantially all the lots needed for 2016.

Having now made significant progress with our land pipeline and in profitability in late 2014 we began augmenting this focus with a greater emphasis on enhancing our asset efficiency and improving our returns on invested capital.

As part of these efforts, we have been evaluating potential opportunities to more quickly monetize certain and long term development assets in order to redeploy the capital in the more productive assets that have a shorter life cycle.

In that regard in October we sold our last remaining land position in Atlanta, a market where we no longer have ongoing operations. In addition we have increased our efforts to reactivate properties previously held for future development in various markets where we continue to operate.

Reflecting this change in our corporate strategy to more quickly monetize certain long held development assets, we recorded inventory impairment charges of $34 million in Q4 related to seven properties.

The majority were 23 million of these impairment charges related to an 80 acre land parcel located in Coachella Valley area of Southern California, a sub market that has not recovered as quickly as we had anticipated. Similar to Atlanta, this is a market where we no longer actively participate.

This particular property which was earmarked as an active adult community is not aligned with our core business and will require significant additional investment dollars in land development and infrastructure for an extended period of time to build out.

Taking all of this into account, we decided to better optimize as non-strategic asset by monetizing it in the short-term through a plan future land sale and redeploying the cash to generate healthier returns rather than building and selling homes on the property as we have previously intended.

The remainder or $11 million of the fourth quarter impairment charges related to six communities primarily located in inland California and Arizona.

Based on our evaluation of the markets where these assets are located, we decided to monetize these land positions sooner by opening for sales more quickly than anticipated and accelerating our overall timing and pace for building and delivering homes.

In addition, sum of the Q4 impairment charges related to certain active communities where housing market conditions have softened.

In 2015, as we plan to continue to work to improve our asset efficiency and generate a greater return on invested capital, we may identify and evaluate other opportunities to more quickly monetize assets, particularly those with longer-term horizons or that would require a significant additional cash outlay for development and infrastructure before the first home would be delivered.

It is important to note that in the two-year period prior to this quarter, we have activated 34 communities, of these only three communities have impairment charges as time of their activation or in a subsequent period. To the extent we change our strategy on any given asset, it is possible that we may have additional impairments in the future.

As a result from our growing profitability and our actions to enhance our capital efficiency, we believe that we can support our current growth strategy without having to access to capital markets for equity. I’d also like to briefly comment on the status of Home Community Mortgage, our mortgage joint venture.

In its first full quarter of operations after the roll out in July this team continued to elevate their execution, while still not optimal, we’re pleased with the steady progress being demonstrated each month and look forward to the increasingly positive impact the venture will have on the predictability of our business as 2015 unfolds.

As service levels continue to improve and our capture rate increases, we’re also looking forward to the added benefits of the additional income strength. In closing, while many of our served market remains sluggish in their pace of recovery with our larger scale and expectation for continued community comp growth, we believe we have momentum.

We will continue to drive our top-line growth while taking every action possible to enhance our profitability, while also now working diligently to improve our return on invested capital. With that I’ll hand the call over to Jeff Kaminski for a more detailed discussion of our financial results.

Jeff?.

Thank you, Jeff and good morning. We continued our profitable growth trajectory in the fourth quarter largely through the successful execution of our three strategic initiatives. Perhaps most notably during the quarter we reversed $825 million of our deferred tax asset valuation allowance.

The steady operational improvements and expected future performance that's supported the reversal also set the stage for the introduction of our fourth strategic initiative improving asset efficiency and increasing our return on invested capital.

Since Jeff has just covered the headline results for the quarter, I will focus on providing more details surrounding some of our key financial metrics for the period and our expectations heading into 2015. Certainly one highlight for the quarter was the increase in our overall average selling price to $351,500, representing a 17% rise from year ago.

Double-digit increases in three of our four home building regions combined with the expected favorable mix shift toward higher priced substantial markets within our Northern California division were the main drivers of this improvement.

For the first quarter of 2015, we currently expect to experience a sequential decline in our average selling price, due to the changing mix of deliveries within our home building regions as well as a relative shift of deliveries away from our higher priced West Coast region to our other home building regions.

We also anticipate selling price growth to moderate in 2015 given the higher price levels we have reached after 18 consecutive quarters of year-over-year increases. We expect the first quarter ASP to be in a range of $325,000, which is closer to what we reported in the second and third quarters of 2014.

Our housing gross profit margin for the fourth quarter was 17.3% versus 17.9% for the same quarter of 2013. The current quarter included $34.2 million of inventory impairment charges of which $11 million were housing inventory related.

The 2013 fourth quarter included $8.5 million of warranty related charges and 3.3 million of housing inventory impairment in land option contract abandonment charges. Excluding these housing impairment and warranty charges, our fourth quarter adjusted housing gross profit margin decreased to 18.7% in 2014 from 19.8% in 2013.

While our goal of achieving a minimum 20% housing gross profit margin remains intact, we believe our timing to achieve this goal will be extended largely due to the current headwinds discussed earlier. During the fourth quarter, our selling, general and administrative expense ratio increased by 20 basis points from a year ago to 10.5%.

This slightly higher ratio was mainly due to the reversal of an $8.2 million accrual in the 2013 fourth quarter following a favorable court decision. Excluding this reversal, our ratio would have improved by 110 basis points year over year.

Sequentially, the fourth quarter ratio improved by 190 basis points as compared to Q3 of 2014 reflecting the continued success of our cost containment efforts and the favorable leverage impact of increasing revenues. We ended the fourth quarter with 227 communities open for sales up 19% from 191 communities a year earlier.

During the fourth quarter, we opened 40 new communities and closed out 13. Our fourth quarter average community count of 214 was up 13% as compared to the same period of last year. During the quarter we invested $272 million in land bringing our total owned and controlled log count at year end to 52,198.

We expect further community count growth in 2015 with the full year average projected to increase in the range of 15% to 20% versus 2014 depending of course on sales absorption rates and the resulting timing of community close outs.

Our net order performance during the quarter was consistent with our stated strategy of maintaining pace on a per community basis roughly in line with the year earlier quarter and increasing overall net orders in line with community count growth.

Fourth quarter 2014 net orders increased 10% to 1,706 or 2.7 orders per average community per month approximately the same rate that we experienced in Q4 of 2013. Our net order value for the quarter increased 22% from a year ago to $587.4 million due to higher net orders and average selling prices.

Turning now to our balance sheet and capital structure, we were able to achieve our goal of reversing a significant portion of our deferred tax asset valuation allowance during the fourth quarter and we ended the year with a net debt to capital ratio of 57.9%.

At year end we had over $550 million of liquidity and our strategic prioritization of asset efficiency will place additional focus on asset monetization opportunities as well as balancing land investment and managing growth within our capital structured goals.

We are targeting a lower rate of land investment in 2015 in the range of $1.1 billion to $1.4 billion which we believe will support our revenue growth objectives.

Other than in connection with the planned refinancing of our senior notes due in June of this year, we have no anticipated capital raises for the foreseeable future and have no plans to issue equity. In addition, our target net debt to capital ratio in the 40% to 50% range remains consistent with past comments.

We are pleased with the progress we made during the 2014 fiscal year. Our focused operational and investment strategies yielded broad improvements across most of our core financial metrics demonstrating the success of our strategic initiatives.

However, we believe the headwinds that have developed will likely create a pause in this progress and we have moderated our expectations for the first quarter of 2015. We currently expect housing revenues of between $440 million and 490 million in Q1.

With this anticipated significant decrease in the housing gross profit margin mentioned earlier and the inclusion of a projected land sale gain of approximately $7 million, we believe our first quarter bottom line will be approximately break-even. Now, I will turn the call back over to Jeff for his final remarks..

Thanks Jeff. In closing, I would like to review some highlights of our full year results. Revenues increased to 2.4 billion or 14% year over year. Most of this revenue growth can be attributed to our higher average selling price as the geographic and product mix of our investments over the last few years continues to gain traction.

Growing our top-line and improving our profitability allowed us to achieve our goal of reversing the DTA valuation allowance. As a result, of both our operational earnings and this reversal, our net income for the year was 918 million or $9.25 per diluted share.

Our reported book equity at year end was 1.6 billion up substantially over the prior year and is now at a value of approximately $16 per fully diluted share. We enter the year with a strong backlog in place and with the year ending community count that is up 19% over last year.

This leaves us in a much better position to capitalize on this year’s spring selling season. Looking ahead we expect to sustain our community count growth which combined with an increase in ASP year-over-year will continue to drive real topline growth.

At the same time we will be diligently working to enhance profitability with a particular focus on improving gross margins. With our increasing revenue and improving profitability, we believe we are positioned to support our growth target while placing a greater emphasis and also improving our return on invested capital.

Thank you all for joining us this morning. Rob let’s open up the call to questions. .

Thank you. We will now be conducting a question and answer session. [Operator Instructions]. Our first question is from the line of Michael Rehaut with JPMorgan. Please proceed with your question. .

Thanks. Good morning everyone. First question I had was on I guess the gross margins obviously an area of concern and you have talked about it a bit already.

But just wanted to clarify when you talk about your expectation for first quarter gross margins to be down materially, sequentially it would appear that given the outlook for breakeven net income that would also be down materially on a year-over-year basis.

Is that correct? And also for the outlook for the full year, are you expecting gross margins to on a full year basis improve, be flat or even be down year-over-year?.

On a year-over-year basis we do expect the first quarter margin to be down. There is really two I would say maybe two or three main impacts affecting the margins in the first quarter.

The first one is what we typically see every year in the first quarter which is the leverage impact or the loss of leverage impact on the fixed cost that we have included in our construction cost. And we think there could be up to 2 to 4 percentage points of margin impact just in that.

We have the conditions and the items discussed during the script on the market pricing higher incentives that we are seeing in the marketplace, price, the ability to increase price not equal to some of the cost increases that we are seeing that we think will affect it.

And we also have a couple of very high value, very high margin communities in our West Coast region that are posed out now in the fourth quarter and we won’t enjoy the benefit from those coming in the first quarter.

And I think it is important to note that we do believe that first quarter will be a low point for the year and that will have sequential improvement going further into that.

As far as the full year estimate on gross margin, right now I'd say it really depends on market conditions through the spring and our ability to raise price and offset some of the cost increases that we have been experiencing. But I would say that the 20% target is not likely in 2015. .

The next question is from the line of David Goldberg with UBS. Please go ahead with your question. .

I was wondering if you guys can give some more clarity on the return on capital focus and specifically what does that translate to? I mean I assume it means greater free cash flow generation. Is it just the way that you invest another capital maybe on a market basis? Or is it thinking maybe a little bit paying down some debt or maybe start buyback.

So I just wondered if you could give us some focus on kind of how you are seeing about maximizing return on capital, if it is going to become more efficient within the business..

David, as I shared in the, my look back on history, we have to get to a higher scale to be able to sustain profits. And we have done that. So your first priority is to create a return and we have now done that and we are going to pull every lever to continue to improve our profitability so improve the return.

On the other side of the equation, we think we can drive our growth with our own cash generation.

And whether it’s some of the things we talked about monetizing all the assets whether it’s selling some lots where lots [indiscernible] location, just a general review every month of our balance sheet, where our assets are, what the status is and what can we do to monetize things while continuing to grow our business.

And we know that overtime we want to get to an inventory turnover 2x, we are not there today. But I think where you started with the comment on generating more cash that’s where we are starting, we want to drive our business with our balance sheet and not have to go access the markets anymore..

Our next question is from the line of Megan McGrath with MKM. Please proceed with your question. .

Wanted to ask a little bit about your expectations for community count growth, among what sounds like a relatively cautious outlook for the year in terms of the soft demand continuing. And if you could comment specifically, you talked a little bit about inland California.

Could you talk a little bit about if you are seeing anything in Texas now specifically in Houston as we started to see some layoffs there and also has the expectations that Houston could be soft this year impacted your growth plans in that region. Sorry, long question..

It's okay. Megan let me help cover as many as I can recall from your question. Let me start up talks with a couple of comments. We entered the year with a community count of 19%.

We normally don’t like talking about trends within a quarter but in this case because we’re half way through our first quarter, we can share that our sales are tracking within range this quarter of our community count growth. Traffic levels remains solid, sales per community are pretty consistent with what we saw in Q4.

So we like how we’re positioned and my comments on the growths are more relative to in some locations we’re seeing some pressure on pricing, while we’re also seeing some pressure on cost. So we’re selling homes but in some cases we have to do some things to hold to the sales rate strategy in that community.

And if you go specific to Texas, our trends there are very similar to what we’re seeing around the rest of the system, our sales per community are holding fine, traffic is up, its tracking with community council. We’re seeing no indication of any pull back by the consumer at this time.

We’re sensitive with the Houston situation, we are very watchful right now, in fact we actually pulled out of a couple of land transactions in the fourth quarter because of our sensitivity there.

So we’re going to keep an eye on it and see how things develop as there is more clarity on the economy there and having said all that, I like to kick it to Jeff to give some clarity to what our Houston business really means to our Texas business relative to the whole company. So it’s been a lot of different number spinning out there..

Relating to Houston I want to clarify a few of the facts that we are seeing some analyst reports trying to estimate the percentage of our business et cetera that’s associated with it. For 2014 as a percentage of our total housing revenues Houston represented about 8.5% of the total company’s revenues.

So again like many things with the company because of the higher ASP in our West Coast operations although the delivery and the community count in the Houston market were higher it was really only an 8.5% total mix on revenue. In terms of deliveries it was about 14% and in terms of year end community count it was about 16%.

So that’s one thing we wanted to clarify I think in relation to that business.

So Megan did you have a follow-up?.

I do. I just wanted to ask a little bit about your 1Q guidance on revenues 440 to 490 that also sounds like you might have a lower backlog conversion rate in the quarter. And you talked a little bit about closings coming in lower than expected this quarter. So is it the same issues impacting you next quarter that did this quarter.

And if you could talk a little bit about that?.

Well Megan, our backlog rotation right now as we looked at it entering the year, what our backlog is up its weighted a little more too early stage construction or homes that are about or have now been started but won’t be completed till the second quarter. So we do expect our backlog conversion to go down relative to prior year.

It’s the way the backlog's positioned and over time you’ll see it get it into a better balance..

Yes I guess I'll just add to that a little bit on the bill times have also seen a slight expansion to bill times which is due what I would say due primarily to the higher price point product that we’re building right now today and to a tighter labor market condition.

So I think the combination of the two factors has impacted our expectations on first quarter backlog conversion..

Our next question is coming from the line of Robert Wetenhall with RBC. Please go with your question..

Hi guys this is actually Collin filling in for Bob. So quick question on your long term guidance for your 20% gross margin, you said that this is going to be achievable in 2015.

But what would you think your timing expectations for achieving this goal would be?.

A lot of it Collin will be impacted by market conditions. From time to time we'll review all the different things that we’re addressing to improve our gross margin and what the message we want to make sure everyone heard is with the -- we’re starting out of the gate lower than we did a year ago.

And with that it makes the 20% a much higher hurdle to get to if your first half is well under that means you have to well over the second half to average 20. We just don’t think we can do that today. We assure that we’ll continue to have sequential improvement that remains our near term goal, we just don’t think we [can get to 15] [ph]..

Our next question comes from the line of Steve Kim with Barclays. Please go ahead with your question..

Thanks very much guys. Was wondering first if you could talk a little bit about your comment of reactivating some previously mothball communities and bringing them online.

At around the same time you were saying that you were talking about possibly taking additional impairments and I just wanted to understand a little bit, are those two things related in your mind as you reactivate some of these parcels that have been sitting idle for a while and maybe require some longer term investments, are you looking sort of reactivate them and sell them or are these completely different parcels that you are referring to for the impairments?.

Steven in my prepared comments I walked through why we decided to sell the community out in the Palm Springs area.

It would be very cash intensive to develop the market out there is extremely volatile and we could not see ourselves in the near future based on where we’re at today and our strategy to utilize our own cash to grow our business we wouldn’t want to put the kind of dollars that one would have required in the ground and the long term it would take to get it back so it wasn’t consistent with improving our capital efficiencies.

As we look at each asset, some could be sold though typically that’s a harder financial hit, it will create more value through building things but we may sell something we may build something it’s one phase, two phase every asset has its own strategy and each quarter we look at the timing and the potential and the market conditions and how much cash would it take to activate this.

We want to keep [indiscernible] so we can take those dollars and grow our business with higher returns offering..

Right.

I think that strategy Steven is most closely associated with our new initiative of really focusing on asset efficiency as we go into 2015 and I think as Jeff mentioned in the prepared remarks, we have been activated communities over the last couple of years and have had very few impairments relating to those activations and we’ll continue to review our balance sheet for monetization opportunities whether they be in build out or in sales as we move forward..

I guess my next question relates to anything you might be seeing in terms of the entry level of the market and sort of what you’re telling your folks there, obviously we’re seeing this FHA fee action which would be in effect I guess at the end of the month, what are you telling your folks in the field with respect to how to position around that or how to react to any move in demand that would happen, do you expect something to happen, just if you could talk a little bit about that and the entry level and then one housekeeping thing, can I get the homes under construction number for the quarter?.

Steven within the quarter our first time buyer percentage ticked up a point I think, it was basically consistent with what we've seen, its higher in Texas than it is in most of our other regions because there's been job growth there and there is population growth and all the things that unlocked the first time buyer.

The FHA insurance premium reduction, I’m sure you’ve seen the reports, they’re estimating it unlocked another 250,000 buyers both new and used that otherwise wouldn’t have qualified so it’s a meaningful boost to the overall housing market and each city it will have a different impact.

Our current FHA backlog does get the benefit of this reduction and so we have some communication out in the field on how to manage to that, so that goes into effect here at the end of January so it helps your current backlog and it clearly changes the payments to qualify on future sales.

So, time will tell how big an impact it has today our FHA business is about 30%, it’s not much lower than it used to be and I think as you see the first time buyer unlock that will probably go up again but right now it’s less than the a third..

Right, on the housekeeping items Steven, total net production at the end of the quarter was 3,002..

Thank you. The next question comes from the line of Stephen East with Evercore, please go ahead with your question..

Thank you, good morning guys. Jeff, I appreciate you’re walking through what sort of driving it and how you all think this plays out.

If you look at the 1Q where you say, you think this will be the bottom, I guess what gives you confidence there that 1Q is the bottom and then you grind off of that level?.

Well, for starters Steven, you have the leverage side and our first quarter is always our lowest revenue quarter so we have the biggest leverage impact on the fixed portion of our gross margin and as I shared in my comments we’ve been growing in this area so you have a double hit net revenues down while your cost is up.

If you go back to our community count guidance, your community count is going to be year-over-year, 40 or 50 communities whatever the number is and there is cost associated with that in many cases without the revenue tied to it until the second, third or fourth quarter.

So, we had this inflexion point where our cost are being hit by overhead and we don’t have the revenue pull through yet. Yes, so you will see that come through as quarters play out over the year.

And on top of that it’s -- the other side that we know as we look at it is the mix of our business in communities opening and communities closing, so that’s how we see it today and we’re hopeful of finding upside in the cost areas and the revenue where it's going forward but those two certainly are driving the support for our comments..

Okay and that makes sense, and the second question sort of a combined question, if you look at your markets, let’s take leverage out of the picture for a minute.

When you look at your pricing and incentives versus your cost which would be the bigger driver of reducing gross margins or putting pressure on gross margin? And then historically if just looked between your California margins and the rest of you regions, what type of magnitude did you historically see there?.

I think it’s hard to differentiate between price and cost because we have both going on in any given location. It’s hard to say it’s just one or the other.

And if you’re in the Bay area and prices are continuing to move up quickly cost are probably, hopefully they’re not but they’re probably going up right with it then we have other areas where you have this crossover where costs have increased while pricing in the short run has softened, so you have that component going on with it as well.

And if you go back to my prepared comments where we did see in the quarter the inland areas of California were quite a bit softer than they have been while the coastal areas held very well, so you have this, this dislocation that built up where within the same reporting region for us you have areas like the Bay area where it's as good as it’s ever been while the inland region softened quite a bit..

Our next question comes from the line of Michael Dahl with Credit Suisse Group. Please go ahead with you question..

Just I guess with respect to margins, it’s an environment that you’ve acknowledged is increasingly difficult to hit the 20% gross margin and you’ve introduced the new focus on return on capital which isn't necessarily gross margin dependent.

So what makes 20% the right long-term target for KPH, I guess, what I am getting at is, so if you were able to hit your two times [indiscernible] with 18% margin, how do you view that trade off right now?.

Well it’s balanced certainly, Mike, and we refer to our bottom line and all the components as a property equation and if you can hit an 18% gross but your SG&a is 8 or 9 that’s the same thing as a 20% gross and the higher SG&A.

So with any city we have a balance of those two and we continue to chase leverage we can pull on all of those areas not just one or the other. Typically in the past in order to achieve our return on invested capital targets, you have to have a bottom line around 8% to 10% so it’s how do you get to that bottom line and then play into the return.

Our message is if you go back and think of the components I walk through we had to get to scale because of our cost structure, debt structure everything in it, we had to get to a higher scale in order to achieve profitability.

And now that we’ve done that and we can mind the cash out of this scale our message is that we can drive our growth through cash generation in our current business. And therefore we think we can grow our returns while at the same improving our profitability going forward..

Okay thanks and then second question, I think Jeff K.

you mentioned that Texas is 16% of communities today, if you think about the growth plans for Houston was 16%, if you think about the growth plans for 2015, would that number current -- would that percentage currently be expected to increase, if so I guess with some of those communities if you were to see any issues, how many of them are early on and [indiscernible] amount of dollars in the ground that you could turn it off quickly in response? Thank you..

Right, on the community count growth expectations for 2015, Jeff mentioned earlier that we’ve been pretty measured with continued investment in Texas and while we intend to continue to invest in open communities, I think on a net basis we’ll see a relatively flat community count in Texas in total and Houston in particular in 2015, so we’re taking a measured approach.

We’ll see what happens and develops in the market. I certainly won't expect our exposure there to increase into 2015 and hold right around that 8% or 9% of total company revenues as we go into the year..

Our next question is coming from the line of Ivy Zelman of Zelman and Associates. Please proceed with your question..

I think it would helpful if you could maybe dive a little bit deeper, you talked about some of the market differentiation with the Inland flowing, there has been some discussion that the Phoenix market is improving and the Bay Area remains really red hot maybe with respect to the trends, do you expect home prices on an apple-to-apple basis? Do you still show increases and are you concerning about coastal California, Southern California where we’re hearing that Asian buyers are starting to pull back as it's harder to pull money out of China.

Are you hearing anything that would confirm that? And how do we think about the trajectory given markets like southern [indiscernible] have been so strong in the coastal areas. Just an overall kind of sense of the market specific might be really helpful for everyone..

One of the things that we’ve seen the trend we’ve picked up on I think relative to Orange County, there has been a pull back on the new home side with the Chinese buyer and these people are heavily controlled by realtors that they’re comfortable doing business with.

Where the realtors are taking them today is the resale side in that the new home pricing in ’14 increased pretty significantly in those areas and retail became a more attractive opportunity in the eyes of the realtor and the consumer.

So I don’t know if that’s the typical push pull in the market and as resale pricing goes up which it has now in the last 60 days in Orange County it’s been moving up. So it could just be the competitive push pull and at some point they'll come back to the new home side.

It’s hard to say whether it’s a short term move or the competitive pressure from other builders, but in the Inland Empire or Central Valley up Northern California we saw a big increase incentives and price pressures.

And I don’t know if there is people closing out their year, closing out communities and we’re watchful we’ll see how the New Year unfolds here. And relative to Phoenix we are seeing improved demand in Phoenix. We’re not that large there, but we’re seeing improved demand there.

I think you will see activity levels go up before you will see a lot of price in Phoenix. Those people need to work through their assets. Vegas I'd say is okay, demand is good. We don’t see prices moving but there is demand there.

So it’s a mixed bag, interestingly in Texas our pricing is favorable right now, we’re not seeing any price pressures in our Texas business here. So if you go around the country it’s a mixed bag and the good areas are still good and the bad areas had a little tougher..

Just as a follow up on really appreciating the dynamics of what’s happening in certain Texas areas concerned about the headwinds. Your same store sales per community were down in the Central region just modestly and you indicated that you expect growth to be just really driven by the new stores and new communities [indiscernible].

So when you're thinking about level of same store being where it is right now, how much [indiscernible] same store in order to resume margin expansion or you said that you will not select for strategically trying to increase same store if it means negatively impacting the margin.

So that relationship strategically how should we think about it?.

I think as we look at it, as always we look at it on a community by community basis across the business and we currently have communities that are running very well and running above pace or above forecasted pace of those communities and we’re taking pricing actions within those communities.

And we’ve had communities on the other side of that spectrum as well. So, I think it’s important to understand how we’re running the business and it's really done at the division level and even more detailed at the community level beyond that.

The pace so far in the first quarter we’re pretty happy with as Jeff mentioned it’s tracking very closely back to little of our community count growth expectations for the quarter. So there's good signs for the spring and we’ll continue to monitor spring selling conditions and hopefully start capturing back some of that margin improvement as we go..

The next question is from the line of Susan Berliner of JPMorgan. Please proceed with your question..

Just wanted to I guess speak about the spec strategy with the marketplace if you’re contemplating changing.

And I guess in Houston since it’s such a big relocation market, if you can I guess just discuss where your specs are in the Houston market and where you see that trending over the year?.

Susan, we remain committed to our built to order model. And we’re heavily weighted to [indiscernible]. We always have some inventory that’s hanging around whether it’s a cancellation after start, a multifamily community or if we have sold out of a colder sack except for three lives we may start those three just to clean it up.

So there is always some level of inventory in our business. And as we cope through the year our inventory sales are our most difficult sales. Our sales, team our management teams, everybody's, we take the view that building a home of the customer’s choice is the way to go. And there is a lot of value to that.

And if it's in Houston and you can build a home there pretty quickly it’s one of our faster build times we will retain the value of the built to order over the risk of a spec every time.

In our fourth quarter I shared that we did have some margin compression on inventory sales that we had achieved in order to deliver what we did but it’s not a large component of our business, we’re going to stick to our strategy of built to order..

And regarding your question on specs Susan, we’re maintaining right now about two finished specs per community across the business. I don’t think the Houston division varies significantly from that. I don’t have the information in front of me but I think its right around the same metric..

Great.

And I just had a follow up I guess on the inland empire, I guess what was the change, was it the Chinese buyer, was there anything else that you could discern from the slow down there?.

Well there is a repeal that occurs when Orange County softened a little and it did and I do think it was in part the Chinese buyer demand soften, it ripples inland and the further inland you go the more the ripple is felt.

So we have -- there are some areas in the far eastern and I’d say of the inland empire not to Palm Springs but say 60-70 miles from the coast where there has been price pressure new and used on the magnitude of 8% or 10% in the last six months where prices went down that much so it hit pretty hard out there, it’s not where you have a big business, it’s not where you’re investing today but if you have communities open that you’re working through it have an impact and it’s the typical ebb and flow, as Orange County settles, it will slowly settle back inland and I don’t know that it’s a fundamental structural shift.

It's just some short term market dynamics that we’re facing..

And coming back to your question, we did just check the number. We're actually a little bit below the company average in Houston, the company average being two per community, we're a bit below that in in the Houston market was finished specs..

Thank you. Next question is coming from the line of [indiscernible] of Deutsche Bank. Please proceed with your question..

Thanks. On the impairments I think investors think of it as normal if you have a few call it fine tuning impairments maybe 1 million, 2 million, 3 million per quarter, obviously this quarter you mentioned the drivers of the more significant impairments but you also mentioned that with the return on capital strategy there could be future impairment.

So saying that in a quarter or drawing that out in a quarter where the impairments rose to more than 30 million I think probably has some people thinking that there could be large amounts like we have this quarter and future quarters as well. I know it’s difficult to tell.

Obviously you do the project evaluation then you figured out as you go but maybe if you could just give us some sense of what you mean by that, do you mean that there will be significant impairments in the ball park of what we saw this quarter, in future quarters or what exactly did you mean by that statement?.

What we meant Steven is that we’ll evaluate it on a community by community basis and we want to put the proper I guess framework around it for the street. We are very serious about improving our return on invested capital. We’ll be looking at modernization of various assets on the balance sheet.

As Jeff mentioned we activated over 30 communities over the past couple of years and had a very low level of impairment. We did have a higher impairment quarter this quarter but we did not mean to imply that that would be normal on a go forward basis.

I think it was just a cautionary statement that there could be additional impairments in the future as we pursue that strategy but not necessarily saying you should model, certainly not model in impairments at level that we saw in this most recent quarter..

Okay, thanks. That’s very helpful. And second question, there have been a lot of questions about the Texas already. I wanted to dig-in in the little more detail, I’m sure you’re keeping a very close pulse on it, forward looking indicator.

So you wouldn’t have expected just because oil prices going headline instead, you would have seen demand fall apart already but maybe forward looking indicators as you talk to your folks on the ground in Houston and in other parts of Texas as well, traffic anecdotally sentiment maybe in the move up segment which might be expected to see more of a headline awareness, anything forward looking that you have gathered in terms of the pulse you’re keeping in the market that leads you to lean one way or the other for the next couple of quarters..

We’re always watchful the issue of traffic trends and if some company had a round of layoffs we hear about that pretty quickly and that’s a data point that you don’t want to ignore.

As I looked at our book of business in preparation of the call, I would say that our first time buyer communities are lower priced, are more value oriented products are selling better in Houston today and it could be that the higher priced buyer is often a little bit I don’t know, but as we shared right now the consumer performance is pretty typical, we’re not seeing any signs that they’re pulling back..

Right. And I think the best forward indictors that we have right now is sort of quarter to date sales performance in Houston and Texas and in the central region in general has been pretty strong. I mean it’s tracking right along our community count growth.

And the traffic in the first quarter in the central region was up nicely versus prior year both on a per community basis and overall basis.

So we’re not seeing the indications right now although with all the news and the concerns that [indiscernible] economically on the state, I’d like to say that we’re facing and looking at a evaluating it in on a measured basis.

We’re not overly bullish on it but up to this point we really haven’t seen much impact from all the headline news that you would think..

The next question comes from the line of Michael Rehaut, JPMorgan. Please go with your question..

Most of my questions have been answered.

I guess just wanted to circle back to some comments that you have made over the last 12, 18 months about some of the asset purchases and overall portfolio shift that you’ve kind of work referred to in terms of the land investment strategy that you’ve done and in particular I am thinking about some of the asset purchases that you’ve highlighted in California, Plum Creek for example also the reactivation of Inspirada and some of the Vegas properties there which you’ve referred to has a good cost basis and what I am trying to get to is with this kind of pushing out of the 20% gross margin goal it would have seen that before and you kind us walk through what the drivers were in terms of the gross margin outlook for the next few quarters and the fact that you are behind caught right now by a little bit of softer pricing relative to cost but it would have seen that at the same time you would have had some positive momentum in this portfolio shift from some of these purchases again that I mentioned, I guess the question here is are those -- were those assets generating a 20% gross margin or better, have things changed or -- and was the goal of achieving 20% in some ways dependent on price inflation? Because it appears that there is something a little bit off relative to the expectations 12 months ago?.

Mike as we’ve always share with this group, we don’t underwrite with inflation, we don’t -- I always take the view, if your price goes up, your cost go up with it and if you link this to the comments we’ve made on the pressure in [duress] [ph] if we acquired community, we underwrite a community developed the last, open it for sale on the western side of the inland empire as an example.

And you get a point of price pressure and a point or two of cost pressure, you're not at the 20% margin, it's not that you underwrote, you’ve had some changes in the input data I’ll say from when you acquired it.

And the other thing that goes on and Jeff touched on it, we had a couple of communities close out in the fourth quarter that were acquisitions in California that we made back in ’12, where in some cases that were finished lots and you build through those and in the typical life cycle of a quarter it will open up at or below the 20% as you get momentum in the community and it will close out well above 20% that’s what happened with those that closed out in the fourth quarter.

And we have this turnover going on where a lot of communities are closing out and the new ones are opening up at lower margins and we expect that they mature and we get into the year and they are open longer that you’ll see the margin with..

Well I appreciate that, I guess with some of those the Plum Creek and the others that you had highlighted until last Analyst Day, are the margins expectations are intact as we sit here today in terms of I would assume being above 20% and perhaps if you can also talk about Las Vegas and what the contribution might be there over the next couple of years if that, as that business perhaps grows relative to the overall mix of closings would that also be a positive contributor to your margin mix?.

Mike, when you touched on Plum Creek and you said is it over 20%, we just opened it in the fourth quarter and we never said when we bought it, it was over 20%.

So, I can tell you it's not over 20% today, but for the most part our new acquisitions are performing within a range, some are better, some are not as good as when we underwrote them and that’s part of your portfolio of business and you are keep flagging things when you are below and capitalize on when you're above.

When it comes to Las Vegas as I mentioned in a comment before, the market is holding well for us, Inspirada in particular is selling very well right now.

And if you think of Vegas and relative to what my comment on the seasoning of communities and how they are open a little under but they'll exceed overtime and that happened with some that closed out in the fourth quarter.

If you go to Vegas, we closed out a lot of communities in the first quarter of last year where we had previously had a lot of price run up on assets that we had purchased opportunistically below cost of replacement and we had some very, very strong margins in Vegas Q1 of last year well above 20%.

And as you watch Inspirada which is now open and I think we’re just now getting into deliveries out there it will become a big part of that business you’ll see it, lift our margin in Las Vegas if not for the company. .

Thank you. At this time, I will turn the floor back to management for closing comments..

Okay. I'd again like to thank everyone for joining us on the call today. And we look forward to sharing our success in the future as the year unfolds. Thank you..

Thank you. And this concludes today's teleconference. You may now disconnect your lines at this time. And we thank you for your participation..