Jill Peters - SVP, Investor Relations Jeff Mezger - Chairman, President and CEO Jeff Kaminski - EVP and CFO.

Alan Ratner - Zelman & Associates Stephen East - Wells Fargo Stephen Kim - Evercore ISI Michael Rehaut - JP Morgan Nishu Sood - Deutsche Bank Megan McGrath - MKM Partners Will Randow - Citigroup Mike Dahl - Barclays.

Good afternoon. My name is Darren and I'll be your conference operator today. I would like to welcome everyone to the KB Home 2016 Fourth Quarter and Year-End Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the Company’s opening remarks we will open the lines for questions.

Today's conference call is being recorded and will be available for replay at the Company's website kbhomes.com through February 11. Now I would like to turn the call over to Jill Peters, Senior Vice President, Investor Relations. Jill, you may begin..

Thank you Darren. Good afternoon everyone and thank you for joining us today to review our fourth quarter results.

With me are Jeff Mezger, Chairman, President and Chief Executive Officer; 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.

Before we begin, let me note that during this call, items will be discussed that are considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. 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 the Company's control, including those detailed in today's press release and in our filings with the Securities and Exchange Commission, actual results could be materially different from those stated or implied in the forward-looking statements.

In addition, a reconciliation of the non-GAAP measures referenced during today's discussion to their most directly comparable GAAP measures can be found in today's press release and/or on the Investor Relations page of our website at kbhome.com. And with that, I will turn the call over to Jeff Mezger..

Thank you, Jill and happy New Year to everyone. We're going to start with a brief overview of our fourth quarter results followed by a business update.

Then Jeff Kaminski will take you through our financial results in greater detail and discuss our guidance for the first quarter of 2017 as well as the full year after which we will open the call for your questions.

The fourth quarter marked a meaningful conclusion to 2016, with strong results and significant progress in our operational and financial performance. In addition, at our investor conference in October, we articulated our framework for returns focused growth and outlined a three-year roadmap that will guide us toward achieving our objectives.

Central to our plan is our core KB2020 business strategy. A key component of this is to increase our scale within our existing geographic footprint. As we grow, we remain focused on improving our profitability per unit and increasing our operating margin which in turn will drive earnings growth.

When you couple expanding earnings with better asset efficiency it produces both improved returns and a healthy level of positive cash flow that we can then redeploy to both fuel our growth and reduce our debt. Moving on to a review of the quarter, there are a few key points that I want to highlight.

We generated a 21% increase in housing revenues driven by increases in delivery across all four of our regions, with the most pronounced growth coming from our West Coast region.

We leverage this growing revenue base while effectively managing our overhead costs to drive an 80 basis point improvement in our SG&A ratio to the lowest fourth quarter percentage in our company's history.

Our revenue growth and increased operating income together with a minimal amount of interest expense resulted in a nearly 30% increase in homebuilding pretax income excluding inventory related charges.

While the inventory charges are real, the majority of the charges in the fourth quarter were specific to the particular group of non-core assets that we have identified for sale in alignment with our returns focus growth plan.

We ended the year with almost 600 million in cash, the results of our operations generating strong cash flows and our balanced approach to allocating our capital. Over the course of the year, we invested almost 1.4 billion in land and development, and repurchased 86 million of our common stock.

Since our fiscal year end, we took the first step toward reducing our debt balance with an early optional redemption of 100 million of our 2017 maturity which will be completed this week. These actions taken together demonstrate the execution of our balanced approach to returns focused growth.

In the fourth quarter, we increased our net order value by 27% to 856 million. We reported a 20% increase in net orders. On an average community count that was down about 8%. This result reinforces the strength of our strategy, which is grounded in offering consumers a compelling combination of affordability, choice and personalization.

We build the home the customer wants and values. This approach is a primary reason that we sustain one of the highest absorption rates per community in the industry. During the fourth quarter, we achieved 3.3 net orders per community per month reflecting an increase of 30% year-over-year with improvement in each of our four regions.

The West Coast delivered a strong net order comparison in the fourth quarter at 32%, with every division in the region posting a positive comp on a modest overall increase in community count.

While our coastal business remains solid, we continue to see accelerating demand in the inland areas of California as buyers seek affordable alternatives to the higher prices along the coast. Our Southwest region produced a 47% net order comparison.

We maintain our strength in Las Vegas which continued to generate one of the highest sales rates per community company-wide. We were pleased to see the rankings report issued last week where Inspirada ranked seventh on the 2016 of top selling master planned communities in the US.

With our 75% ownership position and five distinct communities open for sale today, Inspirada continues to contribute strong and consistent performance for the company. Arizona also delivered substantial growth in net orders in part due to an easy comparison relative to last year and in part due to improving market conditions.

While Arizona showed some signs of softness earlier in the year, we saw stronger demand return during the second half of 2016. Net orders in our central region were up 25% in the fourth quarter, which is significant as it is already our largest region in terms of units.

Our San Antonio division which holds a number two ranking in the market generated a significant increase in net orders further strengthening our position. Our Austin division where we are also a solid number two had among the highest absorption rates per community in the region.

Our Houston division once again produced a positive order comparison in spite of a lower community count, a reflection of demand holding at the more affordable price points that we target.

We are well positioned in Houston today with an average selling price of about 240,000 and we remain encouraged by the growth prospects for this market at these price points. Wrapping up the regional commentary, while absorption per community improved in the Southeast, net orders were down due to a substantial decline in community count.

The wind down of our Metro DC division was a factor. And we've also been more selective in making new investments in the Southeast as the region works to improve its execution. Our strong net order growth contributed to the expansion of our year-end backlog by 19% to 1.5 billion, our highest year-end backlog in a decade.

As we enter 2017, we recognized that we have work to do in lifting our operating margin. We have many initiatives in place to drive higher gross margins, while we also work to contain our SG&A cost and leverage the economies of scale that come with being a larger company.

The industry continues to face cost pressures due to a shortage of labor within a subcontractor base. For 2016, our cost to build increased about 4.8% versus the prior year, roughly $5,000 per house. And we were able to cover most of these cost increases with higher prices.

As part of improving our asset efficiency, we continue to activate communities that were previously held for future development. Over the past two years, we've made significant progress on this initiative for both the fourth quarter and the full year. Deliveries from reactivated communities represented about 15% of total deliveries.

While these reactivations are accretive to earnings and generate cash that we can then reinvest for higher returns, they are another headwind to our gross margin. We continue our weekly review of the balance between price and pace in every community as we work to optimize the returns for each asset.

We will always take price where the market allows, but we know we cannot rely on price alone to lift our margins.

With the strengthening of demand that we are experiencing and now that we are approaching our targeted community absorption rates, we are looking at how we can further leverage our build to order approach to enhance incremental revenue opportunities such as lot and exterior elevation premiums or to tweak pricing in a planned series based on frequencies.

On the cost side, in addition to our ongoing value engineering efforts, we are refining our product specification levels to ensure we only include the standard items those that are essential to making the sale. In essence, lowering our cost to build without adjusting price.

With an increasing backlog per community, we feel that we are in a stronger position with the sub-contractor base either to expand availability or help us better manage our cost to build and also to compress our build time. These are examples of the initiatives we are working on that over time will help us drive higher gross margins.

And finally, a brief update on our financial services business. We're off to a good start with Stearns Lending, as the initial phase of the transition during the fourth quarter, transferring HCM's loan pipeline and operations to Stearns went very well.

Our ability to reach the top end of our delivery range for the quarter is indicative of the solid execution on the part of Stearns and its commitment to our customers. Our joint venture with Sterns has been established and we expect it to be operational in most of our markets by the end of the second quarter.

As this relationship matures and our capture rate grows, it should provide improved customer service and better consistency in backlog management and eventually an additional income stream for our company. All in all 2016 was a solid year, we generated over 3.5 billion in revenue and delivered almost 10,000 homes.

We also grew our earnings per share 32% and we exited the year with a backlog of 1.5 billion setting ourselves with momentum as we enter 2017. We remain encouraged by the steady recovery of the housing market with solid underlying fundamentals supporting continued demand.

Although interest rates are rising, these moves are accompanied by higher consumer confidence, wage growth and continued steady improvement in employment levels. Together with increasing household formation and the broader availability of credit, these factors should help sustain a healthy degree of demand.

On the supply side, single family housing starts remain well below historically normal levels and the inventory of existing homes is insufficient. As a result, we believe that the increasing activity we witnessed from first time buyers last year in the more affordable some markets that we serve will continue.

With about 55% of our deliveries to first time buyers during the fourth quarter we're well positioned to continue to benefit from this growing market segment. Since the end of our fiscal year, we’ve continued to experience solid demand. On a quarter-to-date basis through the first five weeks, our net orders are up 11% year over year.

In 2017, we celebrate our 60th anniversary have expanded from our start in Detroit, Michigan to operations in 36 markets across seven states with a rich history and an enduring brand. We expect 2017 to mark another year of growth in revenues, profitability and returns.

Along the way we also intend to enhance the execution of our core business strategy and improve our asset efficiency. These actions will strengthen our company paving the way toward achieving our mid-term net leverage target of 40% to 50%, improving our return and continuing to drive shareholder value for the long term.

With that I'll now turn the call over to Jeff for the financial review.

Jeff?.

Thank you, Jeff and good afternoon everyone. I will now review key components of our financial and operational performance for the 2016 fourth quarter and full year as well as provider outlook for 2017.

As Jeff mentioned we are pleased with the strong finish to our 2016 fiscal year with considerable topline growth and improvement in many key financial metrics. In the fourth quarter, our housing revenues grew 21% from a year ago to nearly $1.2 billion reflecting 19% increase in homes delivered and a slight rise in our overall average selling price.

All four of our homebuilding regions generated year over year increases in housing revenues with three of our regions posting double digit growth. The largest year-over-year increase occurred in our West Coast region where housing revenues were up 30%.

Overall the significant growth was largely driven by our increased border absorption pace over the prior two quarters and solid operational execution during the current quarter.

In addition, we completed the effective transfer of our previous mortgage banking joint ventures operations to Stearns Lending with relatively minimal disruptions to our deliveries. For the 2017 first quarter, we expect to generate housing revenues in the range of $760 million to $820 million.

For the full-year, we anticipate housing revenues in the range of $3.8 billion to $4.2 billion which is in line with the guidance provided at our Investor Conference in October. Having ended our 2016 fiscal year with a backlog value up 19% from a year ago, we believe we are well positioned to achieve these expectations.

In the fourth quarter, our overall average selling price of homes delivered increased to approximately $387,000. This improvement was mainly driven by the increased proportional deliveries from our West Coast region. For the 2017 first quarter, we are projecting our overall average selling price to be in the range of $360,000 to $365,000.

We believe our overall ASP for 2017 will be in the range of $370,000 to $385,000 representing an increase in a range of 2% to 6% as compared to 2016.

Our housing gross profit margin was 16.5% for the fourth quarter and included $5.5 million of inventory impairment in land option contract abandonment charges that negatively impacted the gross margin by about 50 basis points.

Excluding both the inventory-related charges and the amortization of previously capitalized interest, our adjusted housing gross profit margin was 21.6%, up forty basis points sequentially from the third quarter but down 60 basis point compared to the same period of 2015.

The year over year decline was primarily due to increased land costs and trade labor cost inflation.

Assuming no inventory related charges, we are forecasting a housing gross profit margin for the first quarter of 2017 of about 15% reflecting the typical seasonal decrease in operating leverage from lower revenues and a continuation of the increased land cost and trade labor cost inflation trends partially offset by selling price increases.

Our selling, general and administrative expense ratio of 9.2% for the fourth quarter improved 80 basis points from the year earlier quarter and represented the lowest fourth quarter level in the company's history.

We are pleased with the considerable improvement we have seen in our SG&A ratio over the past five years and we believe there is room for further progress. We expect to extend the favorable year over year trend into 2017 with our first quarter ratio projected to be about 12% which would represent a full percentage point of year-over-year improvement.

Homebuilding operating income for the quarter decreased 20% from the year earlier quarter to $56 million reflecting total inventory related charges of $36.1 million compared to $5.1 million in the prior-year period.

Excluding inventory related charges from both periods, our fourth quarter homebuilding operating income increased to $92.1 million, a 22% increase as compared to 2015 and our operating margin was flat at 7.7% as improvement in our SG&A expense ratio due to operating leverage offset the decline in the housing gross profit margin.

The current quarter inventory related charges were primarily related to our decision to sell certain land parcels that no longer fit into our future business plans with the majority of these land parcels located in our Southeast region.

As discussed at our October Investor Conference, we made this decision in connection with our introduction of a roadmap for returns focused growth and the refinement of our core business strategy.

For full-year 2017, we expect our homebuilding operating income margin excluding the impact of any inventory-related charges to be in the range of 5.7% to 6.3% which is consistent with prior guidance. We expect that 2017 full-year gross margin to be in the range of 16% to 16.5%, down slightly as compared to the 2016.

We anticipate that our SG&A expense ratio will be in the range of 10% to 10.5% which represents a year-over-year improvement of 40 to 90 basis points as we continue our cost containment efforts and gain greater efficiencies from generating higher revenues.

Income tax expense for the quarter of $17.5 million which is predominantly non-cash charge against earnings do our deferred tax asset represented an effective tax rate of approximately 32% and included the favorable impact of $4.8 million of federal energy tax credits from building energy efficient new homes.

Assuming these tax credits are not renewed and statutory tax rates remain unchanged, we expect our effective tax rate for 2017 to be approximately 39%. Given recent tax policy discussions in Washington DC, we have analyzed the potential impacts from changes in the federal corporate tax rate.

While the specifics of any corporate income tax reform are still unknown, we would like to provide our current perspective in response to numerous inquiries we have received and hopefully clarify a couple of items in this area.

As a starting point, lower tax rates drive higher future cash flows and therefore should result in a higher enterprise value. While we have some complexity associated with our net deferred tax asset position, we have found that it really does not impact this core concept.

Until we exhaust the federal net operating loss carryforwards and tax credits that comprise of deferred tax asset, our income tax provision will continue to be a largely non-cash charge against earnings with virtually no cash taxes paid.

In addition, our DTA will continue to shield at least the same level of pretax earnings as it does under today's statutory income tax rate. Although a reduction in the federal rate would reduce the book value of our deferred tax asset.

At the end of the day, we believe a lower tax rate will be accretive to our overall valuation due to the resulting increases in both net income and returns. Turning now to community count, our fourth quarter average of 231 was down 8% from 250 in the same quarter of 2015.

We ended the year with 235 communities, down 5% from a year ago and up 4% or eight communities from the end of the third quarter. Of the 235 communities, 43 communities or 18% were previously classified as land held for future development.

The majority of the year over year decrease in our fourth quarter average community count occurred within our Southeast region which was down 17 communities or 27% due to both the wind down of our Metro DC division as well as fewer community openings during 2016.

As a result of additional community activations and reclassification of certain inactive assets for land held for sale, we reduced our balance of land held for future development by $55 million during the fourth quarter.

The remaining balance of land held for future development represented a 11% of our total inventory at year end, down from 16% at the end of 2015. As part of the roadmap we communicated in October, we plan to continue to unlock our investments in these inactive properties and redeploy the capital into assets with expected higher return prospects.

We currently expect a small sequential increase in our first quarter ending community count as compared to year-end 2016. However, on a year over year basis, we anticipate our first quarter average community count will decline in the range of 2% to 4%.

For 2017, we expect our average community count to remain relatively flat as compared to full-year 2016. During the fourth quarter to drive future community openings we invested approximately $300 million in land, land development and fees with approximately $180 million of the total representing new land acquisitions.

We ended the year with $592 million of unrestricted cash which was up $33 million from year-end 2015 and had total liquidity of $836 million including availability under our unsecured revolving credit facility.

We exceeded our stated target of remaining cash neutral for the year despite the buyback of nearly 8.4 million shares of our common stock in the first quarter. Additionally, our book value for share at November 30, 2016 was $20.25, up 11% from a year ago.

In December, we announced that we had elected to redeem $100 million in aggregate principal amount of our 9.1% senior notes, our most expensive debt.

As Jeff mentioned, our growing scale and favorable operating results in 2016 positioned us to support both our future growth through land investments and an initial step toward deleveraging our balance sheet.

We will record a charge of approximately $5.4 million in our first quarter results reflecting the make-whole provision associated with this redemption. As we reflect on 2016, we are pleased with the progress we made, with solid financial results we delivered and the trajectory of our business into 2017.

For the full-year we increased our total revenues to $3.6 billion and grew our housing revenues by 23% on a 20% increase in deliveries. Our net orders per community were up 14% in 2016 driving a 17% increase in net order value and a 19% increase in value of our year-end backlog.

With strong operational execution and favorable market conditions, we increased net income by 25% year-over-year to $106 million and diluted earnings per share by 32% to $1.12.

In addition, despite the elevated level of inventory related impairments in 2016, our return on invested capital improved by 70 basis points and our return on equity improved by 113 basis points.

We expect 2017 to mark another solid year as we intend to continue executing on our roadmap for returns focused growth and work to expand our revenues within our served markets, increased returns, improve our net debt to capital ratio and deliver higher stockholder value. We will now take your questions. Operator, please open the line..

[Operator Instructions] Our first question comes from Alan Ratner of Zelman & Associates..

I think the order results are probably would jump out the most and I know there is a lot of concern over the increase in mortgage rates we've seen since the election and there is some debate on what impact if any that might have on demand.

But you guys actually showed some acceleration in the back half of the quarter from what you updated us on at your Analyst Day. So just curious if you just give us a little bit more qualitative commentary about what you saw from buyers in that November and December time period.

Was that acceleration do you think maybe a little bit of a pull forward and within your kind of more lower price point entry level buyer, I think that additionally the can rate coming down is quite notable unimpressive as well, so it doesn't appear like you had any credit issues with buyers qualifying with the higher rates.

So, any commentary you can give there that would just give us a little bit of an update on what you're saying would be helpful. Thank you..

I can touch on a few of those and Jeff can pile on. For starters, in our business model, our buyers typically lock their loans partly through the construction process. They want certainty of their payment of close.

So if rates went up in November, it wouldn't have impacted most of our backlog that’s under construction because they already locked their loans. Rates did pick up in November, they’ve kind of paused right now from that initial 50 basis point. And I heard some anecdotes about buyers moving to lock quickly that hadn't locked.

I've heard one story of a buyer who purchased now because of concerns that rates would go up. But in terms of our overall backlog and the quality buyer demand and whatnot, we really haven't seen or heard anything yet on the rates having an impact yet.

And what we're - we always say, hey if rates go up, it does raise payments and that affects buying power, but if jobs are strong and confidence is favorable they have to go up more than fifty basis points to have real impacts. We’ll wait and see what happens after things settle down here and we get a lot more clarity as the year unfolds.

In December, we shared because we're halfway through the quarter now, we shared our December and first week of January sales were still favorable on a year over year basis so that would suggest we're still seeing solid demand but it’s the softest five weeks of the year, so it's not a big number relative to how the rest of the quarter will play out but I think in general things are holding very well and we’re seeing solid demand right now..

I appreciate that Jeff that's very helpful.

And then second question if I could on the mortgage side as well, we're hearing some chatter about appraisal delays in certain markets and Colorado is one that was mentioned but I think several of the western markets maybe, it doesn't look like you had any issues closing homes at year end but is that something you're experiencing at all on the appraisal side and what can be done to kind of offset those challenges.

Thanks and good luck..

Appraisal timing has been spotty for a few years now and we've heard some of that during the quarter but again it really didn't get in the way. There's a timing issue with TRID where you have to get the final before you can do the TRID notice.

The final appraisal sign-off sometimes costs you a day or two, but if you manage to do it and get ahead of it, it really didn't get in the way of our delivery cycle..

Our next question comes from Stephen East of Wells Fargo..

Jeff Mezger I guess I'll ask you, absorptions up 30% and obviously your markets are not up that much, so you're taking the share.

Can you talk to what do you think the two or three drivers of that performance is and I'm not just thinking about what's going on right now but I'm also thinking about how your business has changed how you all have changed internally versus a year ago.

So you know sort of and you mentioned that the 44 per community – you had 44 per community and you’re nearly done with that.

Where do you ultimately want to get to that level and hold?.

Good question Steven and we've been sharing, we try to optimize each asset and there's a balance of margin and absorption that will get you the highest return on the investment that you've made. And in our modeling it typically settles around for a month in some cases a larger law position could be five a month.

So I share that we're at our targeted we're approaching our target absorption in that a seasonal slower quarter like we just reported. If you're at 3.3 that'll be quite tough, 4.5 probably in the February, March, April May period.

So we're basically running where our targets are and therefore can now hold pace and work on improving our margins which is what we're doing. Within the business, there was an interesting shift that's occurred. Jeff shared the regional community count and how it moves some, our community count was up in California and it's down in the southeast.

And within California the community count is up in the inland areas which is also where the demand is strengthening right now as we've been sharing for a couple of calls. So we had a nice lift in our sales because of the strength in California frankly for starters.

And then as you go around our business, the strength in demand we continue to see in the first time buyers is hitting right in our wheel house, so we're taking advantage of the demand that’s now emerged with first time buyer..

And then, as you look at your business, is the first time buyer you know they’re always working to a monthly payment if you will. What do you think typically happens with your buyer, do they more often go smaller or do they more often start to skew away from putting as much in upgrades into the product..

It’s another good question. We haven't seen any big shifts in our studio performance as our first time buyer percentages picked up, our percent in revenue coming out of the studio has been pretty constant. One of the things I didn't mention with the question before on interest rates are tied to payment.

What we saw develop when mortgage insurance premiums were spiked up with FHA, if our buyers could put 10% down they were because the payment on a conventional loan with 10% down was actually lower because the mortgage insurance was lower.

Now with FHA mortgage insurance coming down, it’s actually a nice offset to the interest rate uptick that we've seen and my hunch is we’ll see our buyers tilt more to FHA probably now than they have been. Our FHA business I think at the low point was down to about 30% of our business.

I expect we'll see that tick back up now with FHA premiums coming down..

Our next question comes from Stephen Kim of Evercore ISI. Mr. Kim, your line is now live..

Hey, guys. This is actually Tray on for Steve. I think he’s having some technical difficulties. Thanks really and thanks for taking our questions. So first thing we wanted to ask you is, in terms of cadence in the quarter, entering your first five weeks, you said orders were up, I think it was low double digits.

Then obviously you had an acceleration in the back half of the quarter. So obviously, there's a pick up post-election. So we were wondering if you could talk a little bit about, if you indeed saw a pickup in demand and activity and traffic and anecdotes of positive buyer outlooks as the election finished up..

Yeah. I don't know if we can say it was tied to the election. That's unclear. I didn't hear any stories or get any feedback that people bought homes because of the election, but there's no question that our demand actually was a little higher in November. We had better sales in November than we did in October, which is not a normal seasonal shift.

Normally, October is stronger than November for us this year, it flipped..

Yeah. Okay. Sorry guys, it’s Steve Kim. I had some technical issues, but okay so that would be consistent with the thought that maybe there was a little bit of holding of breath ahead of the election and then post-election, we had a little bit of an exhaling and that's what we've kind of been hearing in a little bit in the market too, which is great.

I guess my follow-up question really relates to what you're watching, we had an, you'd already addressed a little bit about the cancellation rates and it sounded like you sort of indicated that what you reported in 4Q is kind of too early to really be able to see any, you wouldn’t really have expected to see an increase in rate, in cancellation rates from higher mortgage rates.

As we go forward, is it, would you agree that an increase in cancellation rates is probably the first sign that we would see of maybe people having reduced demand in the face of higher rates and would you furthermore expect that to be more visible at the entry level price points or do you think that it would be more visible already or do you not or do you think you'd be more sort of evenly distributed across the price spectrum as we go forward?.

Stephen, I would flip it in that, I think our interest rates will affect growth contracts coming in more than cancellation rates. We don't write the contract, so we've done a prequel with the customer which will tell you whether they can afford to buy the home or not before we write the contract.

And as I travel around and talk with our divisions, the income needed and the payment and debt ratio is not the issue, it’s as credit. Or do they have the down payment to close.

And if you think about and you’ve covered our history for a long time, we don't even track now what percentage of our loans were adjustable rate because it’s next to nothing and every year is when rates were much higher, the consumer with telco or to an adjustable rate because you still want to be a homeowner.

And the rates have been so low for so long, that's really not that active of mortgage product out there. So I think, well, my hunch is we'd see it in the level of growth contracts we’re writing, not necessarily the rate..

Our next question comes from Michael Rehaut of JP Morgan..

Thanks. Good afternoon, everyone. The first question I had was just looking at the SG&A expectation for ‘17, so I guess for Jeff K, expecting continued nice leverage there and I was curious what's driving that aside from the housing revenue growth? In other words, is there anything structural going on there or is it largely just fixed cost leverage.

It looks like if you take the midpoint of revenue and the midpoint of the SG&A, maybe you're looking at a plus or minus 6% variable on the SG&A.

So just curious if it's just all leverage or if there's any structural reductions as well?.

Yeah. Good question, Mike. On the fixed portion of that or overall, I guess, typically what we usually guide to is about a 5% to 6% differential on revenue increases.

So at the higher end of that range and that takes into account both the variable piece and our SG&A as well as some cost creep on fixed, because as we all know, I mean fixed isn't an absolute fixed number as you're driving higher deliveries and higher community count, et cetera. You're seeing it happen.

I would say from a structural point of view, what you're seeing within the company is really an excellent discipline on cost containment number one and number two, I think you're seeing very efficient revenues being driven off higher absorption paced in our current open communities and also a focus on our current markets in line with Jeff’s strategy of improving market share and increasing scale of our businesses in our current served markets.

That is a way we believe is the quickest path to increase returns and more profitability in the business. So very efficient growth I would say is the predominant reason for the improved SG&A leverage..

It’s great. I appreciate that Jeff and I guess secondly just some housekeeping items.

I was hoping if we could get what your total land spend was for fiscal 16 as well as where your spec count is, total and finished maybe this year versus a year ago?.

Sure, sure. As far as the total land spend, I think the number was 1.365. I mean we are rounding the 1.4 billion on a land spend number for the 12 months and as far as specs go, we’re still a little bit over one finished spec per community. We were at 378 at the end of the fourth quarter. That’s been our specs. .

Your next question comes from Nishu Sood of Deutsche Bank..

Thanks. So you described being at the absorption targets that you intend, just thinking about the regular weekly valuations, just talking about price versus pace, how should we think about the implications of that that you are at the absorption paces, you’ve targeted.

I mean that would typically imply maybe the pricing trends would start to look better, but you also in you know some of the other comments, Jeff were kind of advising a little more caution on that given the environment.

So how should we think about that given you’ve reached that and especially with the rate movement, the impact that might have on your pricing power?.

The rate move is something that will certainly keep our nature. That's why I believe if rates do start to affect demand or confidence, we'll see it on the growth side. And if growth was down, if the sales are down in that community, we won't be as quick to push price.

And I think what we're trying to paint was a picture where we're now, we're approaching the optimal run rate in our assets.

So we can, we want to hold that rate and see if there's ways that we can get our margins up without just pure pushing price because there is an affordability side to things, but I would expect going forward, our hope is that we'll be able to hold our run rates at our targets and continue to work on ways to improve our margin.

As the year unfolds and we get into the spring selling season, we’ll be sharing our progress..

Got it. And in October, you gave three year targets.

The world has obviously changed quite a bit since and I was wondering if you can give your updated thoughts on those targets, particularly on the revenue and the margin side and your expectation, your ability to meet those?.

Right. Yes, good question. I would say we're basically tracking right along with what we thought in October. There have been obviously changes in the country, in the political atmosphere and potential tax legislation et cetera. Our jury is still a lot of what impact it will have on the economy.

I mean, the initial indications have been pretty favorable, but I would say we're still in line with those. You would have noticed that our 2017 guidance across all the other points that we talked about today was pretty much right in line with what we talked about in October.

Our fourth quarter performance came in actually a little bit better in most of the metrics than what we expected for the fourth quarter. So that was a good indication and our first quarter was, as we saw internally, about at the same levels as what we expected back at that point in time as well. So I don't see any really significant changes from that.

We’re pretty committed to the three year strategy, very committed to three year strategy from top to bottom in the company, those are the numbers we’re shooting for, but importantly we're very, very focused on 2017. I mean, three years is fine, but it's one year at a time, one quarter at a time.

And we want to keep progressing down that path and not get too far ahead of ourselves on that. So our focus is on achieving the guidance points that we outlined again for you in 2017 and we'll see how this year progresses..

Our next question comes from Megan McGrath of MKM Partners..

Good afternoon. Thanks for taking my question. Wanted to follow up a little bit on your gross margin guide, it looks like you're forecasting down about 100 basis points in the first quarter, but ending the year flat.

So can you talk a little bit about what you're expecting for the trajectory throughout the year and is it just volume or is there anything else going on in terms of your expectations for margin as we progress throughout the year?.

Right. I can cover a few points on that, Megan. In fact, obviously we expected and always expect questions on margin, so I'll go through a few thoughts that I have on it.

I would like to start with a discussion about what we're doing at the operating margin guidance and like I said earlier, consistent with our comments in October, we're still right in line with what we expected for the total year, 5.7% to 6.3%. We believe that range is very solid and we're very comfortable with the range.

Embedded in that, you obviously have two main drivers here, the SG&A expense ratio and what you can do on that piece. We are looking at a 40 to 90 basis point improvement in that. I commented in response to a question earlier on why and where that’s coming from.

So I'll leave that one, but in terms of the gross margin piece which is more relevant to your question and that component of operating margin, we do believe we will see improvement in community margins, both from community specific action plans that we're putting in place and many of those Jeff outlined in his prepared remarks, but in addition to that, we also believe we'll see some improvement from deliveries in communities that we plan to open in the first half of the year.

We do believe we will see a community improvement actions from those new communities that will result in margin improvement. Both of those we think will generate incremental benefit to gross margins.

On the other side of the equation however, based on recent experience in market conditions and it's been very widely discussed, what's been happening in the industry in association with trade labor cost, land cost inflation, et cetera, we are anticipating some of that and believe it may continue to offset many of the gains from the operating initiatives.

So we're being, I’d say, careful right now in trying to stay grounded in the facts and how we guide. We will be looking at all those factors over the next few months.

As we get in to the spring selling season, we’ll obviously be much better informed and have more facts related to that back end of the year as we sell into backlog and then deliver out that backlog in the back half of 2017 and we'll have a much better idea how market conditions actually may impact both things like sales prices as well as costs.

But for now, we're sticking with our previously communicated operating margin guidance. And I think just to leave you with one point, just reflecting back on 2016, personally I believe we really accomplished a lot in relation to rest of the peer group over the past 12 months and in relation to success at this company.

We had I think one of the highest increases in orders per community over the past year and at the same time, we achieved that, we were able to offset about 20 basis points of headwind from an increasing mix of reactivated communities, all at the same time while holding our overall consolidated gross margin basically flat and in normal cases, you wouldn’t be too proud of holding margins flat, but in light of what's happened throughout the industry, in light of our absorption increase, we thought that was a pretty good accomplishment.

And we would like to build on that in 2017. So at this point, we don't have a crystal ball on costs and what we’ll be able to do with prices and items like that, but we are pushing very hard and it's a huge goal for the company to try to improve the operating side of the equation as it relates to gross margin..

Great. Thanks for that color. And then a quick follow up, a couple folks have mentioned that a pretty meaningful decline that you thought in cancellations rates year-over-year.

Just wanted your opinion on really what's driving that and if there's something structural within your business or your mix that drove that big decline and is it sustainable do you think going forward?.

Yes. There's a couple of impacts on that. One, we do believe we're attracting a better quality buyer at this point and people that are credit worthy I would say and able to kind of get through the financing process a little bit easier.

We have also improved I would say the operational side of it as far as when we're recording a growth sale, we're making sure we have good solid buyers in the pipeline who are very interested in improving the quality of our backlog, which we believe gives us better visibility to future quarter deliveries.

So it's really I think a combination of several factors, the process improvement, the buyers that are being attracted and I also believe improving market conditions and the improving economy is also helping. So it's really two or three things. .

Our next question comes from Will Randow of Citigroup..

Hi, guys. And thanks for taking my questions. I guess I just tried to visit one of the previous questions on potential changes in terms of tax policy.

Can you discuss how you think about that if it is a cash flow metric, how would that impact your decisions on planned buy and growth? And if you have any details on how you think that may impact you outside of the DTA, love to hear it?.

I'm not just, maybe you could clarify what you mean, what I heard was planned buy and growth, oh land buy..

Yeah.

So in terms of if it’s a more cash flow base as opposed to a GAAP based metrics, driving corporate taxes would? Would that impact the way you think about land buy and if so could you talk about any details and how you think about how that tax policy may look?.

Right. So okay, let me take you through a few things and I think there is still some level of interest from the analyst community and what's happening with this tax rate change and how it could impact this.

So I’ll give you a little more color than we did in the prepared remarks on it, but fundamentally I think the bottom line, I hope everyone walks away and has the same concept that we do that lower taxes are definitely a good thing in relation to our company and the valuation of our company.

The base concept that a higher or sorry the lower tax rates drive higher future net income and enhance cash flows is a very solid concept and should lead to an increase in value. So we're very convinced that’s the case and our internal analysis proves that out.

As far as how that relates to our land buy going forward, it's really, there's really no change with or without the tax decrease in the short term, because currently we're paying zero cash taxes and with the cash, with the sorry the statutory rate decrease, the potential statutory rate decrease, we’ll still be paying zero cash taxes.

So there's very little impact on our planning from a cash flow point of view because the cash flow was there in the first place. On the upside however, there are a couple of positive things that will result out of this decrease for us beyond the obvious that once we do start paying taxes, we’ll be paying lower taxes.

For one, embedded in our DTA, we have about $200 million of tax credits that are embedded in there. Those tax credits would not be subject to revaluation, if the rates are lowered and in addition, those tax credits will actually show a higher level of pretax income.

So it's a big benefit for us to have that $200 million and just by way of example, at a 35% tax rate, the shield from the $200 million of tax credit is about $575 million of pretax income.

At a 25% rate, it's about $800 million of pretax income and at a 20% tax rate, those same tax credits would shield about $1 billion or exactly $1 billion of pretax income. So just based on the math, we would be able to shield about $425 million of additional pretax if the rate ends up at 20%. So that's a strong positive for us.

I guess the last one, I'll leave you with on this is if the expected rate reduction were to happen, it will also for us have a very significant positive impact on a return on equity.

And in fact, as we’ve calculated, we believe in the year, the fiscal year following the potential change, so we have a full year impact, we can see an improvement of over 300 points in our OE, just from the tax rate decline and what that does to the profitability of the company as well as rolling slightly the equity value as a result of ETA revaluation.

So all in all, it's a really, really positive factor for us. We hope it happens. We're very watchful on what's happening on that side and we’ll continue to be and until we have kind of final details, it's kind of the best we could do in our preliminary analysis right now..

And I guess on a similar note and I apologize if I missed it, but in terms of energy credits, are there any hinging issues on 2017 to make you feel like you won't receive those, if you could just basically discuss any of the details there? I’d love to hear it..

Right, yes. As we've seen, I mean this has been a continuing case for the past several years anyway, where the credits are typically renewed early in the following fiscal year. There's always a bit of uncertainty around the energy credits. I would say this year there's probably even more uncertainty with perhaps a total tax review this year.

So I'm not really sure when we’ll have more clarity on that. At this point, right now, we're assuming very simply no energy credit and the current 35% federal rate in our estimate, which we provided, which was 39% for the full year. I think that's unlikely to be the case to be honest with you because there's been so much discussion about tax reform.

But without just guessing on things that’s kind of currently what we're planning..

Our next question comes from Mike Dahl of Barclays. .

Thanks for taking my questions and thanks for all the helpful color on some of these issues. First question, I did want to dig in a little bit on the operating margin guidance and I think on the Analyst Day, we didn't necessarily get the components of that guide.

So while it's holding steady, I'm curious if you could just give us a little color on if either gross margin or SG&A thoughts internally have evolved differently since October.

I know you've outlined some of the SG&A improvement and some of the steps that you're taking around really trying to drive that and drive some efficiencies, while mentioning some of the margin pressures that aren’t really abating.

So is this just a better sense of, is it in line with what you were thinking three months ago or has something changed within that?.

No. It’s definitely in line with our thoughts from three months ago. I would say the only change and I think it's fairly significant was, we had another quarter of really nice absorption growth. And as Jeff highlighted, we're getting very close, if not at our targets for community absorptions.

We also had another quarter where we were able to improve the, what I call, the underperforming communities and not just reactivated communities, but our basic what we call our core communities and we had a number of communities where we would deliver or excuse me, where we had orders that were less than five sales in the quarter last year and we reduced that number of communities by 31% year-over-year.

So a lot of the absorption pace increase we've seen is just by improving those underperforming communities. And as we continue to improve in that area, I think it does provide more opportunities for gross margin improvement as we move forward.

Again, just holding gross margins in a very tough environment in 2016 I think was quite an accomplishment, but at this point in time, there's been nothing that's really changed from the October operating margin guidance that we gave you as far as split between gross margin or SG&A or anything else, but we're I'd say slightly more bullish on what’s happened as a result of our absorption increase to perhaps some additional opportunities for improvement as we go in to next year on the gross margin side..

Okay. That's helpful. And then I guess as a follow-on specifically, as it relates to the reactivated communities, could you give us a sense of what portion of deliveries you expect that to represent in 2017 and just I guess similar to some of the improvement you just talked about on the, getting the underperforming communities up towards line average.

How's your experience been recently on sales pace in the reactivated communities relative to your company average?.

Right. Really good questions. On the reactivated side, we're pretty happy with what's been happening on that. We've really increased the pace on the reactivated side where in the fourth quarter, there was almost no difference between core communities and reactivated community as far as pace per community.

We were right around the corporate average of 3.3 in each of those categories. In the fourth quarter, the percentage that we had coming from reactivated communities was right at about 15%, which was about 5 percentage points higher than it was a year ago.

So we did, that reflects the improvement in pace that you saw because the community count didn't really change. If you look at our full year 2016, pretty much every quarter, we were in the teens, somewhere, 16%, 17%, 18% of total communities were reactivated. That's about where we're at right now.

We don't really anticipate that driving much higher than that.

We think we're going to stay in that same range and in fact for the full year 2017, what we anticipate now is that we're going to see a pretty similar mix to what we saw in 2016 as far as the mix between poor communities and reactivated communities and I think the pressure of the year-over-year detriment in gross margin could subside a little bit as a result of that.

I think the big year for that was really ’16 where we drove, number one, the number of reactivated communities up in 2016 as well as the absorption pace up. So there was a little more of a gap between ‘16 and ‘15 that I think we'll see in between ’17 and ’18. At the same time, it’s still a headwind for us.

I mean, at the base gross margin level, it’s 70 or 80 basis points of headwind versus what we would experience with Alpha's reactivated communities, but keeping in mind all the discussion we had in October about it, it’s a very, very good thing for the company in terms of returns, cash flow, incremental net income, incremental EPS, et cetera.

So we're very happy to be monetizing those assets and as Jeff just pointed out, and utilization of the DTA and all really good positives.

And like I said before, the only real negative is what it does to consolidated gross margins, but as long as investors and analysts understand those dynamics, we're very comfortable internally that it's a really good business decision to continue to drive it..

Ladies and gentlemen, this concludes today's teleconference. Thank you for your participation. You may now disconnect your lines..