Jeff Mezger - President and Chief Executive Officer Jeff Kaminski - Executive Vice President and Chief Financial Officer Bill Hollinger - Senior Vice President and Chief Accounting Officer Thad Johnson - Senior Vice President and Corporate Treasurer.

Michael Dahl - Credit Suisse Robert Wetenhall - RBC Capital Markets Michael Rehaut - JPMorgan Stephen Kim - Barclays Megan McGrath - MKM Alan Ratner - Zelman & Associates Adam Rudiger - Wells Fargo Securities.

Good morning. My name is Rob and I will be your conference operator today. I would like to welcome everyone to the KB Home 2015 First Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Today's conference is being recorded and a live webcast is available on KB Home's Web site at kbhome.com.

Following the company's opening remarks, we will open the lines for questions. 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. At this time I will now turn the call over to Jeff Mezger, President and CEO for KB Home. Mr.

Mezger, you may begin..

Thank you, Rob. Thank you everyone for joining us on our call today as we review our first quarter results. With me are Jeff Kaminski, Executive Vice President and Chief Financial Officer; Bill Hollinger, Senior Vice President and Chief Accounting Officer; and Thad Johnson, Senior Vice President and Corporate Treasurer.

I will begin the call with an overview of our results and the solid progress we are making on many fronts as we position our company for accelerated growth in revenue and profits.

Next, I will provide some comments on our three key strategic initiative to grow our community count, expand revenue per community and enhance profitability per unit along with our increased focus on improving our return on investment.

Following this, I will share a few remarks on the macro environment after which Jeff Kaminski will provide specific details on our financial performance. Then, I will make some closing comments before opening up the call to your questions.

For our first quarter, our growth in revenue, net orders and backlog clearly illustrate that our investment and growth strategies are working.

We are entering the second quarter with momentum as we expect further growth in community count again this quarter which positions us well as we enter the spring selling season where the initial indications of demand have been encouraging.

We have remained diligent in driving community count growth which requires not just the investment in land and land development, but also the investment in additional field overhead necessary to open each community and commence selling homes.

These initial startup costs have a negative impact on both our gross profit margin and our SG&A expense ratio that will diminish over time as these communities convert orders into revenue.

Over the last two quarters we have celebrated 72 community grand openings and ended our first quarter with 235 communities opened for sale, a 25% increase from the 188 communities opened at the end of the first quarter of last year. As a result of this successful ramp up in community count, 2015 will be a tale of two halves.

With the first half focused on driving additional community openings and continued growth in orders and backlog and the second half focused on sustaining our momentum while realizing the substantial benefit of increased revenues from our expanded platform.

Looking ahead, we expect significant revenue growth creating leverage that will drive improved ratios and much higher earnings. For the year, we are now projecting housing revenue in the range of $2.8 billion to $3.1 billion. Turning now to highlights from the first quarter.

We generated $580 million in revenues, an increase of 29% over the prior year, including two land sales totaling $53 million.

We reported $525 million in housing revenue, reflecting an increase of 19% year-over-year, driven by 10% growth in the number of homes delivered and an 8% increase in our average selling price which came in at just under $330,000. Our pretax income of $10.5 million was roughly flat with the prior year and we reported net income of $7.8 million.

We were pleased with our net order value which increased 25% to $753 million on 2189 net orders. The net order increase of 24% was consistent with our growth in average community count which was up 22%. Net orders per community were on par with the prior year as we continue to balance price and pace at each community in order to optimize returns.

Our quarter end backlog value rose to $1.1 billion, a 30% increase over the prior year and is our highest first quarter backlog level since 2008. Our investment strategy is working and we have now achieved 14 consecutive quarters of year-over-year revenue growth.

Along the way, we remain diligent in our actions regarding our three key strategic initiatives of increasing our community count, expanding revenue per community and enhancing profitability per unit.

While we continue driving these three initiatives, we have expanded our strategic focus to also include an emphasis on improving our return on investment. We intend to fund our future growth through a more efficient use of our assets and also through the reinvestment of our growing profits.

Consistent with earlier guidance, our housing gross profit margin was tempered in the quarter, coming in at 15.1% versus 17.7% a year ago. We are very committed to raising our gross margin and expect to significantly narrow the year-over-year gap in gross margin percentage by the end of the year.

With the seasonal nature of home sales and our built to order approach, the first quarter is always our lowest revenue quarter and in turn our lower gross profit margin quarter, due to lost leverage on field overhead.

This year, our first quarter gross margins also reflected the softer market conditions we were experiencing when these sales were written last fall. We continue to take action on all of the revenue and cost levers available to improve this metric.

Since the first of the year, we have been successful in raising our selling prices in most of our markets. On the cost side, we have reduction targets in place in every division and we are measuring our progress on a weekly basis.

While we continue to take these steps to improve our gross margin, our efforts to contain overheard while growing our topline have been effective. Our SG&A expense ratio improved to 13.5% for the quarter and we expect sequential improvement over the balance of the year.

Taken together, our actions to improve our gross margin while containing our SG&A expenses and accelerating our revenue, will result in significant earnings growth in the second half of the year. Now moving on to land. We currently own or control all of the land and lots necessary to achieve our growth delivery targets for 2015 and 2016.

We will continue to invest in additional upside opportunities for 2016 and beyond while working on ways to enhance our returns. As part of this effort, we will from time to time identify opportunities to sell land or lots.

We have seasoned land teams in place that have the skills necessary to create value through the entitlement and development process. This allows us to acquire land parcels in desirable areas that maybe larger than we need, retain the portion necessary to support our growth targets and sell any excess.

This was the case in our first quarter during which we sold land in the Bay Area and in Austin. Our ability to identify unique opportunities like this has and will continue to be a core part of our business. We are also working on improving our returns through activating and opening communities previously held for future development.

Over the past two years, we have now opened 41 such communities which are producing incremental profit while generating cash, which we then in turn reinvest in our business. We are targeting at least 15 additional communities that we intend to activate later this year.

Now I would like to share a few comments regarding home community mortgage, our mortgage joint venture. HCM's execution continued to improve in the first quarter and as a result our deliveries were more predictable than they have been in quite some time.

The quality of our backlog management is also improving as a result of HCM's execution as evidenced by our lower cancellation rate in the quarter. These factors came into play in driving upside to our first quarter delivery projections and I am hopeful these trends will continue in the future.

HCM generated a profit for the second consecutive quarter and we expect further growth in profits as we work to increase our capture rate on our growing delivery volume. While it has taken time, HCM is starting to evolve into the business opportunity we envisioned when it was formed. Turning now to the economy and housing trends.

By most metrics, the national economy is continuing to strengthen, whether you consider job growth, the unemployment rate, GDP growth or consumer confidence. At the same time, mortgage rates and affordability remain favorable. Resale inventories levels are low, price appreciation continues and the share of home sales that are distressed has declined.

There have also been recent reports published regarding the acceleration of household formation as millennials are finding jobs in the improving economy and moving out on their own. This age group is also now entering their prime home buying years which could create significant demand going forward.

The housing recovery is gaining traction with plenty of runway before we reach normalized volume levels. Our increasing traffic is a strong indication that demand is on the rise. While our average community count was up 22% year-over-year in the first quarter, our traffic levels were up 46%.

We believe that this acceleration in traffic can be attributed to not only improved housing fundamentals but also the favorable response to our new community openings which feature the right products in the right locations.

As I often say, housing markets are very localized with each sub-market demonstrating its own strength or weakness and that is certainly the case in our business today. In California, the Bay Area is very strong with solid job and income growth occurring in an area with limited housing supply.

Our net orders in the Bay Area were the primary driver of our positive order comp in our West Coast region. In Southern California, the coastal area is showing a real uptick in demand after a soft fourth quarter and there are indications that the strengthening demand is starting to ripple inland once again.

We are particularly pleased with our strong order comp in our Southwest region. Las Vegas continues to be one of our best performers in net orders per community in a market demonstrating strong demand. We are also seeing encouraging signs in Phoenix, where we are working to expand our community count in a market that is stabilized and improving.

Our central region continues to perform well. There has been a lot of new coverage on the impact of declining oil prices on jobs and housing in Texas. At this time, we are not seeing any evidence of a slowdown in demand. While the central region was up a solid 15% in net orders, Houston's results actually exceeded the region's average.

Having said this, we remain cautious as we continue to gauge how things play out with oil and the local economies. In our southeast region, we also experienced improving traffic and order trends and we are encouraged by the 18% year-over-year growth in net orders.

In closing, we continue to build momentum in our business as we accelerate our growth in net orders and backlog which is being driven by our community count growth. We are very encouraged with the early indications of the strength of the spring selling season and are well positioned to capitalize on this demand.

Now, I will hand the call over to Jeff Kaminski for a detailed review of our financial results.

Jeff?.

Thank you, Jeff and good morning. During the first quarter we continued to execute on our key strategic initiatives. Our current quarter results, particularly our revenues, generally reflected improved operational performance and healthy market condition.

We believe we are well positioned for the spring selling season and to realize improvements in our financial metrics as the year progresses. We expect the improvements will be more pronounced in the latter part of the year leading to a strong second half.

Now I will provide more detail on our first quarter financial performance as well as our expectations for the remainder of the year. Our first quarter housing revenues of approximately $525 million grew 19% from the same quarter of last year, extending our track record of year-over-year revenue growth to 14 consecutive quarters.

The current quarter revenue performance exceeded our expectations due primarily to strong operational execution in completing and closing more homes than we anticipated which pulled forward certain deliveries that were previously forecasted for the second quarter.

Improved execution by Home Community Mortgage during the quarter also contributed to our revenue result. We delivered 1593 homes in the first quarter representing a conversion rate of 55% of beginning backlog.

For the second quarter, we anticipate a conversion rate in the low 50s on a beginning backlog of 3505 units and housing revenues in a range of $580 million to $615 million. We realized a $6 million gain on land sales of $53 million in the current quarter compared to a $1 million gain in land sales of $8 million in the prior year quarter.

We are actively pursuing opportunities to selectively monetize other land positions as part of our focus on improving asset efficiency. At this time, we are targeting land sales in the range of $100 million for the full year.

During the first quarter our overall average selling price increased to approximately $330,000, up 8% from the same quarter in 2014 reflecting a shift in our geographic mix of deliveries and generally favorable conditions in our served markets.

Going forward, we currently expect our average selling price to advance sequentially in each remaining quarter of 2015. We anticipate that on a year-over-year basis, both our quarterly and full year average selling prices will increase in the mid-to high single-digit range.

Our housing gross profit margin was 15.1% in the first quarter of 2015 as compared to 17.7% in the year earlier quarter.

Excluding the amortization of previously capitalized interest and land option contract abandonment charges in each period, our first quarter adjusted housing gross profit margin was 19.5% in 2015, down 230 basis points compared to 21.8% in 2014.

We continue to focus on enhancing our housing gross profit margin and expect to realize sequential improvement in each of the remaining quarters of 2015. For Q2, we are projecting a sequential increase of approximately 50 basis points.

For the second half of the year we anticipate stronger sequential improvements of approximately 100 basis points in the third quarter and 100 to 150 basis points in the fourth quarter. Our selling, general and administrative expense ratio for the quarter improved 40 basis points to 13.5% compared to 13.9% a year ago.

The favorable leverage impact of higher revenues in the quarter more than offset increased expenses that we incurred primarily to support community count growth, higher first quarter deliveries and our anticipated increase in homes delivered in the second half of 2015.

Historically, our first quarter expense ratio is higher than in other quarters during the year. We expect to see sequential improvement in our SG&A expense ratio for the remainder of this year, particularly in the third and fourth quarters.

Our first quarter average community count of 231 was up 22% from the same period a year ago, which held fuel double-digit year-over-year increases in our net orders and net order value. During the quarter we opened 32 new communities including seven communities previously held for future development.

As part of our asset efficiency initiatives, we plan to continue to evaluate our land held for future development in order to reactivate additional communities and we currently plan to open another 10 to 15 of these communities by the end of the year. In the first quarter we also closed out of 24 communities.

We ended the quarter with 235 communities open for sales, up 25% from 188 communities a year earlier. We continue to anticipate our full-year average community count will increase in the range of 15% to 20% versus 2014 depending on sales absorption rates and the resulting timing of community closeouts.

The increase in our average community count in the quarter reflects a strong inventory pipeline we have built through higher investments in land and land development over the past few years. During the quarter, we invested $202 million in land and land development.

Approximately 73% of our total investment in the quarter related to land development compared to about 37% a year ago, reflecting our emphasis on advancing the conversion of our own land into new home communities open for sales in 2015. Our total owned and controlled lot count at quarter end was 50,666.

Approximately 81% of these lots were owned compared to 69% owned lots in our portfolio a year ago. We are continuing to target $1.1 billion to $1.4 billion of land and land development investment in 2015 which we believe will support our revenue growth objectives. Turning now to our balance sheet.

We currently intend to retire the remaining $200 million of our June 2015 notes at their maturity during our third quarter. At this time, we believe this is the most effective way to handle this maturity due to the make-whole call provision and estimated administrative expenses associated with an early retirement.

With the public issuance of $250 million of senior notes in February, we already have the cash on hand for the retirement.

As a result of the incremental interest that will be incurred, our interest expense in the second quarter will increase sequentially by approximately $4 million before declining for the remaining quarters of the year following the debt retirement.

In conclusion, we are working toward a strong finish for 2015 as we continue to execute on our top strategic initiatives.

Looking ahead, we believe we will post improvements in most of our financial metrics, particularly during the second half of the year when we expect to begin realizing greater revenues from our recent and planned growth in community count. We expect housing revenues in the range of $2.8 billion to $3.1 billion for the full year.

This accelerated housing revenue growth is anticipated to provide favorable operating leverage for both our housing gross profit margin and SG&A expense ratio results and is also expected to drive strong improvements in our pretax earnings in the third and fourth quarters of 2015. Now I will turn the call back over to Jeff for his final remarks..

Thanks, Jeff. Before we conclude, I would like to take a moment to thank the employees at KB home who work diligently each day to advance our goals as a company. I would also like to highlight our key messages for today. The housing recovery is gaining traction with most major data points trending positive.

We are now seeing indications of increased household formation which has been at historically low levels for many years. If this trend holds, it will be a real driver of increased demand. We ended the first quarter with our highest first quarter backlog levels since 2008 at $1.1 billion and a community count that was up 25% year-over-year.

The early signs of spring selling season have been very encouraging and we are well positioned to take advantage of this demand. While the gross profit margin was tempered in the first quarter, we have action plans in place for improvement and expect to significantly narrow the year-over-year gap by the end of the year.

Our investment and product strategies are working as we sustain one of the highest absorption rates per community in the industry while continuing to raise our average selling prices.

The execution levels of Home Community Mortgage continued to improve resulting in a more predictable delivery cycle, a better quality backlog and the potential for profits as capture rates increase.

We are positioned for accelerated revenue growth in the second half of the year which will create additional leverage with our ratios and result in significant earnings growth. We are continuing to invest in our future growth and will support this initiative through improved asset efficiency and reinvesting our profits.

Finally, we are now projecting housing revenue for the year in the range of $2.8 billion to $3.1 billion. With our growth platform in place and with more community openings on the way, we have momentum and are well positioned for a strong finish to 2015. Now, let's open up the call to questions..

[Operator Instructions] Our first question is from the line of Michael Dahl with Credit Suisse. Please proceed with your question..

Jeff, Jeff M., wondering if you could elaborate a little bit more on some of the comments about formation and seeing signs of a pickup. I mean clearly we've all seen the census data but that's notoriously volatile and I think a lot of that's coming in, or all of it's coming in rental. So wondering if you can just talk to your own business this spring.

Are you seeing an increase in your first time buyer percentages? If so, how broad-based is it?.

Mike, I would say we see a slight uptick in some of our regions. It's not broad-based, it's incremental. I think our first time buyer percent in the quarter was 50% of our sales. So it's in the range of what we have been seeing. We are certainly seeing, with the traffic increase, a lot of people that are out for the first time, looking around.

I don’t know that we can share that we have seen a big swell in sales to the first time home buyers yet but it's an encouraging trend. And I agree, the data is always subject to revisions. The consistency and the uptick over the last couple of quarters would suggest that it's a real trend and we will see.

To me it's really the missing link in a fulsome and sustained housing recovery. And I think if you look at the statistics, it's been running at about 50% of historical levels for eight or nine years now, so it's an incredible pent up demand that seems to be starting to get unlocked..

Right. Okay. And if you look at or you listen to some of the feedback from your sales associates, are some of the changes in existing programs or some of the new programs, like the 97% down GSE stuff or the 50 basis point reduction in FHA premiums.

What type of feedback are you hearing on those?.

A little bit of feedback favorable on the 97%, more favorable feedback on the reduction in the mortgage insurance premium. That was a real payment reduction for the buyer that needs it the most. So it has helped our [business] [ph] line. I think good examples are central region where we do a higher percentage of FHA business..

Our next question comes from the line of Robert Wetenhall with RBC. Please proceed with your question..

Congratulations on what's undeniably a really good quarter and a great way to start the year. I like the momentum. The revenue guide is really a lot higher than we were looking for and thanks for the detail. Trying to understand two questions.

One, what are you thinking about your 20% gross margin target, when you can get there? What needs to happen and how should we think about that from timing? That's my first question..

Well, Bob, our number was a disappointment, as you know, in the fourth quarter and here in the first quarter. And we have got a lot of steps in place to improve on every sale and also we have got a lot of leverage coming.

We shared in our prepared comments we will close the gap on the prior year's gross margin by -- narrow the gap by the end of the year. But if you just do the math, if we are starting out of 15.1%, we are not going to hit 20% in 2015 and that’s why we gave the guidance we had.

Still our goal and we will see how things progress with the strength of demand and what we can do on the cost side..

Okay. I wanted to just think, understand a little bit better, taking some ideas from your Investor Day. Are you managing for return on invested capital and what are the right kind of milestones? You obviously have some nice momentum going on and it sounds like you are committed towards getting higher levels of profitability.

Is this a return on invested capital improvement story? And for Jeff Kaminski, how should we think about free cash flow? You're obviously investing heavily in communities but it sounds like you're pretty happy with the land position. Give us a better way to think about that. Thanks a lot..

Bob, let me make a few comments and then I will kick it to Jeff K. If you look at the journey we have been on over the last couple of years, you have to have profitability to have returns on investment.

And our top priority for a few years was to grow the top line back, grow into our balance sheet and our debt, get back to the scale that we are capable of in the markets we are in and restore and in turn grow profitability. We accomplished all that in '14.

Now as we move forward in '15, it's more of a balanced approach where we intend to keep growing the top line, keep providing more leverage, keep growing our profitability and use our balance sheet to mine the cash needed to support and fuel our future growth.

And if you think about it, it's not just the balance of your inventory turns in these communities that we are unlocking, it's the cash we will be generating not just from our earnings, but the shelter on the tax on the earnings. As we continue to grow profits, that’s a significant cash opportunity for us to fuel our future growth.

So we have a nice combination of many things working both on the P&L side and on the returns side. It's a dual approach for us..

Yes. In response to your question on the cash flow, you know basically echoing some of Jeff's comments, we are intending to fund our land investment with internally generated funds this year. We are serious about our capital targets that we talked to a lot last conference call, 40% to 50% leverage target that we are holding ourselves to.

And we believe we have land in place right now that can grow the business in line with our objectives. So we are in pretty good shape on cash. We are managing it closely and we like the outlook for the remainder of the year..

Does that mean you guys could be potentially cash flow neutral to positive?.

That means, yes, we intend to fund the land that we invest in this year with internally generated funds. So, yes, it means exactly that in that neighborhood..

Our next question comes from the line of Michael Rehaut with JPMorgan. Please proceed with your question..

First question I had was on, just kind of going back to the gross margins for a moment, if possible.

Now that the dust has settled after the 4Q results and the resetting of guidance and expectations around your trajectory for gross margins over the next year or so, I was hoping to get some more color or clarity around the investment process that occurred over the last couple years and some of the underwriting hurdles that you apply as you underwrote the land over the last couple years and how you are doing it going forward.

And specifically what I'm asking is around the fact that over the past year or two, when there was that guidance around achieving or even exceeding the 20% gross margin target, it appeared that the land that was underwritten was done with that in mind.

And as the land was converted into closing from more coastal areas or closer to, in the core where there was a higher price point let's say or scarcer demand, or just better-positioned community, that those would naturally lead to a mix shift into that 20% range.

So just want to understand, the land that was bought in '12 and '13, was that either not written to the 20% or were there other factors that just drove that number down as you're monetizing that land today? And how you think about underwriting with that 20% in mind going forward..

Michael, as you know there is a lot of moving parts to a gross profit margin, so you can't point to one event or one trend and say that’s what lifting it or that’s what's draining it. And I can tell you from an underwriting perspective, we have been very consistent in our underwriting with what we call a 20-20 rule.

20% gross, 20% IRR, and have continued that discipline throughout. As you look at our business we have -- one of the frustrations for me has been the delays in getting the new communities open. And a lot of the land we bought in '13 is just now, frankly, opening for sales and we will see how they perform in the first stage of deliveries whatever.

But you have a combination of -- in many of our markets our cost of build went up faster frankly, than we could move price. So we have some margin erosion on the cost of build. You have these activations that are on average probably a little less than our company average margin. So you have a little bit of that.

If you think of having 40 some communities open today with field overhead that you didn’t have year ago, that haven't produced deliveries, yes, you have another drain on your gross margin. And as we typically open a community, your first few sales will be a little below your hurdle.

So you are getting momentum going and then you get your backlog going and you lift margins and then the last half or last two-thirds of the community will be above your pro forma. So it depends on the timing of when communities open and hit first delivery. So you have all these different things influencing the gross profit margin.

And then in the sales we had in the fourth quarter, we saw some real pressure in some of our markets on the revenue side where things softened. And we will do the things we have to to optimize the asset and that played a little bit of a part in it. So together you have a confluence of things.

As this year unfolds, you will see us clear out and elevate and we have got plans in place, as I shared, in a lot of ways to continue to get back to our stated goal of the 20%. We are not going to get there in '15 but it's still our goal and we are committed to getting it.

Anything else you want to add to that, Jeff?.

Okay. No, I thank for that answer, Jeff. I appreciate it. And I guess the second question, you referred to in your answer just now some of the, perhaps, competitive activity in the fourth quarter or pressure on revenues and whatnot that colored your view of 2015 when you gave the guidance.

In your prepared remarks today, you referred to in 2015 that you were able to raise prices across most of your markets. I was hoping if you could give, and I'm sure the answer obviously varies by market, but if you have any sense of like a rough average or the majority percent increase in base prices that you were able to achieve.

And if you could also give any color directionally in terms of incentives or discounts on the order trends so far this year, how that's going..

Well, you are absolutely right Mike that it's hard to give you a percent. Because it will literally vary by community in the same sub-market, let alone the same cities, same state, same region. I can tell you in the Bay Area we have been able to push price more than we have in the Inland Empire in California.

And that’s a good [indiscernible] example of an incredibly strong market versus one that’s in recovery. And we keep maintain this approach of balancing price and pace to optimize the return. The worst thing you can do is stop selling.

So you try to identify what's the best sales pace to optimize that asset, get your money out, get your returns and at what price. And we are constantly toggling. You know if it's a softer submarket, we could take $500 or $1000 price increase and if we keep selling we will take another $500 or $1000.

In the Bay Area you can take significantly more than that on every phase that you release. Every handful of lots that you release. So as I shared, in most of our markets, we have been able to take price this year.

And at the same time we are not an incentive heavy company in the first place so, again, in our financials our incentives are a point or a point and half. We focus more on giving people the best price as opposed to more incentives and we don’t do a lot of that.

So our pricing as it moves around is a pretty good proxy of consumer demand because we don’t move up and down with incentives too much..

Thank you. The next question comes from the line of Stephen Kim with Barclays. Please proceed with your question..

Congratulations on a good quarter. Wanted to ask about a comment you made, Jeff Mezger, early on. I think you mentioned on the cost side, we have reduction targets in place in every division and we're measuring our progress on a weekly basis and I think you expressed some optimism about the way the cost control has been going.

So just wanted to see if we could get a little bit more color in terms of, sort of are you talking specific product? Do you have specific products in mind where you have been able to achieve some savings and if so, what general categories? I don't need names of companies or anything but just kind of names of categories would be helpful.

And if you could break out your comments there versus the land compared to the -- sorry, the labor versus the products, that would be great..

Well, Stephen, as you know, as you have watched our company for many years, we have a lot of standardized product series where the elevation may vary from city to city but the walls and the plumbing and the electrical are all identical. And as a result of that, you can get your purchasing teams in a room for all the divisions in Texas.

So for Arizona and Vegas and compare notes and you can always find best practices where one division does it better than another and in the meeting the divisions that recognize the opportunity can walk out of the meeting with an action item that will help them do a better job in their direct cost.

So through that best practice sharing where we have got some reporting and tracking, we know week to week where we are making progress. What we are seeing at a high level, some of the commodities like lumber have come down, others there is still pressure like sheet rock and concrete.

But I think lumber has been a little bit of a benefit compared to the other commodities. And in some markets we are seeing the benefit of more labor returning to the marketplace.

Whether it's a slowdown in apartments, a slowdown oil drilling, what it maybe, we are seeing more labor come back and you have this supply demand equilibrium where if there is more people who want to do your work, you can get a little better price.

And lastly, I would share that we are starting to see some benefit of gas prices going down in distribution or commute times, frankly, for contractors as well. So there is no one major drop that we are seeing but a lot of little things can turn to a point or two of margin over time if you are good.

And I would say on average, that we are seeing some softening in the cost pressures that we were experiencing in Q3 and Q4..

Yes, Stephen, just to add to that a little bit. The purchasing folks in the company are working pretty hard, like Jeff said, we are having these some of these combined meetings.

I was talking to our head of purchasing earlier this week and he described our first quarter as being sort of the best first quarter as far as cost containment goes in quite a few years. And what we typically see early part of the year is a lot of inflationary pressure on cost.

We have been able to play that quite effectively both because of the gasoline price drop which has allowed us to call back some of the surcharges that we were having, as well as some of the value engineering changes that have frankly taken some time to get in place and we are starting to see some results coming from that.

So we had a really nice first quarter and we are optimistic about continuing to maintain that throughout the year..

Great. Thanks for that. And Jeff Kaminski, I guess, that comment that you just made, that relates to things that are sort of in the pipeline, right? Not necessarily things that closed in the quarter, I assume..

It's correct. That’s correct..

Right. Okay. My next question relates to land. Did you have, by chance -- I missed it -- the land spend number broken out between acquisition and development? And then another housekeeping item, or sorry, and then also regarding land. You had land sales this quarter. You're talking about $100 million for the year profitability.

Should we look at this quarter and think that the profitability you saw is, give or take, not an unreasonable estimate going forward? Would that be reasonable?.

I would look at the land, the potential land sales for the remainder of the year as being closer to book value. You know we are looking -- it's not a -- we are not looking at it as a profit driver for the company at this point, we are looking at it as asset efficiency mechanism for us.

We are looking at, like Jeff said, larger lot positions where we could trim down in that asset price growth. If we get some gains, it will be a bonus for us but I would not probably forecast it out too aggressively. On the acquisition versus the development spend for the quarter, as I mentioned, the total is $202 million.

$55 million in the quarter we spend at land acquisition. We have pivoted more heavily towards the development side. Again, developing some of the land assets that we currently have on the balance sheet and taking them through to open communities. They continue to drive community count increases..

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

Just wanted a couple of clarification questions. First, Jeff, you talked a little bit in your previous answer about the Inland Empire. I think that was one of the regions that you cited last quarter as being one of the drivers for the lower margins as you had to incentivize or lower prices there.

So could you talk a little bit more specifically about that market and what you saw in the first quarter? You know is it looking any healthier or just sort of maintained from last quarter..

I would say it's looking healthier, Megan. You know the geography. The closer you get on the west side of the Inland Empire to Orange County right now, the better it is. Or the closer you get on the South End and South River side to San Diego, it's actually pretty good.

Most of the available land is out further inland and those markets are still softer than the areas that border coastal counties. But it is getting better..

Okay. Great. And then I wanted to ask -- you mentioned a little bit that there were some, potentially some pull forward units in to 1Q that you had expected to come in 2Q. Would that imply that 2Q might be a little bit lower in terms of growth or backlog conversion but I know it's usually a typically a higher quarter in terms of backlog conversion.

So could you just put a little bit of color around your expectations in 2Q for units..

Megan, yes, that’s right. As I talked about in the prepared remarks, we are looking at conversion in the low 50s and I actually even gave revenue guidance of $5.80 to $6.15 in the second quarter. So I think you are exactly right here in the analysis..

Our next question comes from the line of David Goldberg with UBS. Please proceed with your question..

It's actually [indiscernible]. My first question is a little bit bigger picture, in that can you talk about how you see change in the mortgage market coming and what role that will play on [shaking] [ph] some of this pent up demand that you talked about in your prepared remarks..

I certainly think the mortgage situation remains tight. And it is holding back the recovery. You know we have talked about things like the mortgage insurance premium came down and that’s a good thing.

I do feel that the big banks still have overlays and are still conservative in their underwriting because of the rules and the impact of Dodd-Frank are still getting clarified. So you have a recovery that’s occurring and demand is growing.

It's still a top shelf borrower, I will say, in that FICO scores that five years ago you could get a loan on you still can't get today. So we don’t bank on that getting better in order to achieve our delivery targets and our revenue targets.

I do think over time it will continue to ease and it does it will be a nice combination with the household formation occurring and the economy improving where you should see a real uptick in demand..

Okay. Thank you. And then our next question is, you mentioned that you think that you that you get [indiscernible] demand, but can you give us any indication of what early signs you are watching that you are keeping an eye on to determine if things do start to weaken there..

Well, certainly it will show up in your -- you have cancellations because of job loss. If traffic levels were to drop, if our conversion rates were to drop, if inventory levels really pushed hard, I think one of the keys to our success right now and our ability to hold sales is the price points that we are playing at.

I am hearing some anecdotes in the market in Houston that the higher price points have softened and most of our communities are right in the sweet spot of price points between 150 and 300. They are in the major employment corridors up north and out west and our communities continue to sell well.

In our higher price points, I think we have one community that tips up in the 400, Jeff, and that's a little bit softer. But on balance, how we are positioned there continues to be in the meat of the market. And as I shared, we are not seeing evidence of a slowdown in demand yet..

Thank you. Our next question is coming from the line of Alan Ratner with Zelman & Associates. Please proceed with your question..

Congrats on the quarter and thanks for all the detailed guidance. Firsts, Jeff K., just to clarify a couple of the guidance numbers, I just want to confirm.

The revenue number excludes land sales and the margin numbers include interest; is that correct?.

That's correct..

Okay, great. And Jeff M., just following on that Houston commentary. I think when we look at your land position it seems like you probably have a bit more exposure to the south and the east, the lower price points within Houston than some of your peers and I think you're probably a bit less exposed to some of the larger master plans there.

So I was also curious whether you think that you are seeing any different trends among those different submarkets there.

And then on the incentive front, are you seeing any increase in incentives in that market and have you become more competitive on your pricing there perhaps to capture some of those sales?.

I would tweak your comment, Alan, that we are most southwest and west than we are south in Houston. We have a lot of stores open along the energy corridor on the west side out in Katy that are all performing well today. And I would say in general we have been able to take some price in Houston this year.

Nothing big because it's a competitive market but we have been taking price and holding our sales. Our community count is up in Houston and that’s part of the sales lift that we saw. And I will say we will continue to balance price and pace and we are not seeing signs yet of incentivizing, heavy incentives or pressure on price. So we are comfortable.

We like the demand. We like the trends. But I remain cautious because there were a lot of rigs shut downs and you have to wait and see how it plays out..

Sure. I appreciate that. And then a final question, I know you have your leverage targets out there but curious, with your cash flow outlook and the focus on returns whether there is any contemplation of buying back stock with the trading below book value here..

Right now we are focused on growing our business..

And Alan, just to come back, I just want to make sure we are perfectly clear on the guidance. The revenue guidance we gave for both the second quarter and full year was housing revenues which excludes land sales. So that’s just to be clear on that.

On the gross margin guidance, because we gave sequential improvement in basis points of sequential improvement for each of the quarters, it really works either way. Whether you want to include or exclude the interest from the gross margin number.

As long as you are, whatever base you chose to come off of and you go with the sequential improvement in basis points, it should work for you either way..

Thank you. Our next question comes from the line of Adam Rudiger with Wells Fargo. Please proceed with your question..

Could you -- the Southwest saw a little bit different pricing trends than the rest of the regions.

Can you discuss what was going on there?.

It's mix, Adam. Our Arizona portion of the business is up from what it was a year ago. Vegas, we are seeing price. Vegas, the market is holding well there. But our ASP came down because of the mix..

Okay. The second question was, you referenced in an earlier question, I think, and in kind of your prepared remarks about competitive pressures in the fourth quarter. I was wondering in the regions that you saw that in the fourth quarter, if the trends had changed there, if there is any stabilization.

Gotten worse, gotten better? And if you saw any other regions that changed..

If you go back to my comment I made previously in the Q&A, we did see a softening in the market demand in the Inland Empire in the fourth quarter.

And you try to separate out the -- you are always going to see a better market in the first quarter than you saw in the fourth quarter just due to the seasonality of our business and we are seeing that and we are trying to gauge whether demand is improving.

Relatively in the Inland Empire though when you see the strength that’s starting to show up again in Orange County, it always will move Inland, it's a typical recovery. And I think we are starting to see some of this on the West End of the Inland Empire.

There were parts of Florida that we saw softening in Q4 and we are seeing an uptick in sales and traffic year-over-year. So I would say on average, across our footprint, we are seeing better market conditions today than we did in the fourth quarter..

Thank you. At this time we have reached the end of our Q&A session for today. I will turn the floor back to Mr. Jeff Mezger for closing comments..

Okay. Thanks, Rob, and thank you everyone for joining us today and we look forward to speaking with you all again in the near future. Have a great weekend..

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