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

Alan Ratner - Zelman & Associates Paul Przybylski - Wells Fargo Securities Mike Reinhart - JP Morgan Nishu Sood - Deutsche Bank James "Trey" Morrish - Evercore ISI Will Randow - Citigroup Susan McClary - Credit Suisse Mike Dahl - Barclays Jay McCanless - Wedbush Securities Bob Wetenhall - RBC Capital Markets John Lovallo - BofA Merrill Lynch Buck Horne - Raymond James John Micenko - Susquehanna Financial.

Good afternoon. My name is Darren and I will be your conference operator today. I would like to welcome everyone to the KB Home 2017 Second Quarter 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 July 27. Now I would like to turn the call over to Jill Peters, Senior Vice President, Investor Relations. Jill, you may begin..

Thank you. Good afternoon everyone and thank you for joining us today to review our second 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 good afternoon everyone. We delivered another quarter of strong results in the second quarter with 24% growth in total revenues and expansion of our operating income margin driving earnings per share of $0.33. Reviewing the specifics of our performance, we increased our housing revenues to just under $1 billion.

We are realizing the benefits of investments we have made, especially in our West Coast region as our mix is positively influencing our revenue growth. We delivered over 25,000 homes during the quarter, and a 11% increase. We converted this revenue growth and the higher profitability substantially increasing our operating margins.

This was largely accomplished through our continuing trend of driving greater leverage from our growing scale, while simultaneously containing costs. The strength of both our top-line performance and operating margin expansion was the primary factor in our increase in pretax income to over $50 million.

As we discussed on our last earnings call, with the backlog in place to support our revenue growth goals, along with favorable market conditions, our objective as the start of the spring selling season was to maintain our sales pace and capture more price.

We were successful in executing this plan producing an increase in net order value in the second quarter of 15% to $1.4 billion on a 5% increase in net order. The majority of these orders will deliver during the fourth quarter, which we expect will positively benefit both revenues and gross margins for that quarter and for the full year.

Our absorption was 7% in the second quarter to 4.8 net orders per community per month as demand to our Built to Order product remained strong. Home buyers continue to demonstrate a preference for choice and personalization of their homes. We build the homes that customer wants with features that they value.

In our view, our built to order approach is the biggest factor in our ability to drive industry-leading absorption rates. On a regional basis, the majority of our markets are performing well with the most desirable areas of each city remaining strong with limited inventory. As a result, demand is moving out to adjacent and more affordable suburbs.

The West Coast provides a good example of this ripple effect. Prices continue to move up along the coast and demand is expanding further inland. Our West Coast region, our largest in terms of revenue generated a 23% increase in net order value on a 7% increase to net orders.

These results are notable considering this region’s strength in the last year’s second quarter when we reported a 31% increase in net order value on a 29% increase in net orders. We again held our pace at a healthy 5.4 net orders per community per month in this region while capturing price. The Bay area in particular produced strong net order results.

This is our most land constrained market where we have a long tenured management team with the relationship essential to driving community count growth. This was a key factor in driving net order growth in this division during the quarter.

In addition here at Los Angeles, we had a very successful grand opening at our Hayden community in Playa Vista that contributed to our net order results as well. Our Southwest region grew some 19% increase in net order value on a 16% net order comparison led by continued momentum in Arizona.

The performance in Las Vegas also remains solid with an increase in absorption to over 6 per month. This division continues to produce one of the highest order rates per community across our company. Net order value in our central region was up 12% on a 5% increase to net orders.

For the past year, Houston has consistently produced positive net order comparisons each quarter and did so again in the second quarter.

In Austin, we grand opened North Ridge, a community in a great infill location, it was made possible through the skill and experience of our local teams in successfully getting the lots entitled despite numerous complexities. The community opened very successfully in the second quarter helping to drive Austin’s positive net order results.

Colorado was also a solid contributor with net order growth driven by strong demand in a market that features one of the lowest resell inventory levels in the nation.

Wrapping up the regional updates, absorption per community in the Southeast region continued its improving trends in the second quarter despite net orders being down primarily due to the wind down of our metro DC division.

Orlando has demonstrated solid improvement in growing net orders over the past year and Jacksonville produced another quarter of positive order comparison.

With our growth in net order value in the second quarter and the 19% increase in ending backlog value to $2.2 billion, on over 5600 homes, we believe we are well positioned to achieve a higher revenue target this year.

In addition, the visibility of future revenues, the larger backlog also allow for a higher volume of even flow production which helps us manage our construction costs and build time. During the second quarter, we held average build times versus the prior year at about four months.

This is a positive outcome considering the labor shortages our industry has been facing and the rainy weather we experienced earlier this year.

Our even slow production approach is attractive to our subcontractors in that we commit to a certain start space each week in a community or sub-market, and this commitment in turn provides our subcontractors with a level of predictability that helps them manage their labor and materials.

In most of our divisions, we benefit from the longstanding relationships we developed with our subcontractor base, and we have also realized benefits from actions we have taken to increase our qualified subcontractor base.

As part of our efforts to improve returns, our goal is to further compress build times and we have focused on simplifying and standardizing areas of our business to positively influence build times going forward.

Over the past 18 months, we have streamlined our product series reducing the number of plans in our core business by about 60%, while retaining a broad array of the highest frequency plans.

Similarly, beginning about a year ago, we reduced the number of SKUs in our studio by roughly 50% eliminating low preference options while preserving ample choice. This simplifies the decision-making process for our customers and allows us to negotiate better pricing from our suppliers and the options we continue to offer.

Looking ahead, we maintain our outlook for favorable housing market conditions with job growth increasing in first time buyers, a segment that continues to comprise one half of our deliveries during the second quarter fueling demand for new homes. What remains especially striking is the extremely low levels of resale inventory available.

At 4.2 months nationally, and well below that in many our submarkets, resale inventory is insufficient to meet demand. It is one of the key factors underlying pricing power in most of our markets, and we plan to continue maintaining price or pace – sorry – continue maintaining pace while increasing price when appropriate.

And while we will always opportunistically take price when market conditions allow, we are also driving price through the many revenue enhancements that our built to order approach provides on an ongoing basis through lot premiums, exterior elevations and structural options and studio revenue.

Although our ASP was up significantly in the second quarter, our product remains competitively priced relative to new and resale homes. This is true even in higher priced markets such as California where resale inventory is extremely low at 3.3 months supply.

Before I wrap up my comments, a brief update on KBHS Home Loans, our mortgage joint venture with Stearns Lending. As planned, the JV is now operational in each of our divisions. Stearns executed well during the second quarter which contributed to our ability to exceed the top 10 of our delivery range and they posted a modest profit.

As the KBHS business matures, and execution continues to improve, we expect the JV to achieve higher levels of customer service for our home buyers resulting in a higher capture rate more predictable deliveries and a growing income stream.

In closing, our second quarter results reflect the continuation of our strong and consistent performance and excellent progress on the return focused growth plans we shared at our investor conference last October.

We are executing in each of the areas that form our roadmap, increasing our scale within our current footprint, expanding our operating margins, monetizing our deferred tax assets, and improving asset efficiency.

As a result, our revenue base is strong and growing, our profitability and returns are increasing and we are generating a healthy level of cash all of which position us well for the future.

Our second quarter results, favorable market conditions and substantial backlog support an increase our outlook for this year and we are raising our guidance for revenues in both operating and gross margins. This progression in our results puts us firmly on track for our 2019 goals. With that, I’ll now turn the call over to Jeff for review.

Jeff?.

Thank you, Jeff and good afternoon everyone. As Jeff mentioned, we are pleased with the second quarter performance and the positive trends we are seeing in the business resulting from consistent execution on our return to focused growth plans.

I will now review the highlights of the measurable improvements we generated across our key financial metrics in this quarter and provide details of our improved outlook for the third quarter and full year.

In the second quarter, housing revenues grew 23% from a year ago to $996 million reflecting increases of 11% in both homes delivered and the overall average selling price of those homes.

This significant growth in our housing revenues was largely driven by a 25% higher beginning backlog value in the current quarter as compared to the same quarter of 2016 in combination with solid operational execution.

Three of our four homebuilding regions generated double-digit year-over-year increases in housing revenues ranging from 13% in the Southwest to 39% in the West Coast. Housing revenues in the Southeast region declined mainly due to the wind down of our metro Washington D.C operations that we announced last year.

We ended the quarter with a backlog value of $2.2 billion which increased 19% in the year earlier period. Based on this strong backlog value, we believe we are well positioned for accelerated top-line growth in the second half of the year and are raising our full year housing revenue expectations.

For the full year, we expect housing revenues to range between $4.2 billion and $4.4 billion with the midpoint up $150 million as compared to our prior guidance and up 20% as compared to 2016. We currently anticipate third quarter housing revenues in the range of $1.08 billion to $1.15 billion.

In the second quarter, the overall average selling price of homes delivered increased to approximately $386,000 driven by increases in all four of our homebuilding regions as well as an increased proportion of deliveries from our West Coast region.

For the 2017 third quarter, we are projecting an overall average selling price in the range of $405,000 to $410,000, year-over-year increase of 11% to 12%.

Reflecting the targeted pricing actions we implemented across the majority of our communities during the spring selling season, and the strength of our West Coast region’s second quarter net order value, we have raised our full year overall average selling price forecast relative to prior guidance.

We anticipate our overall average selling price for 2017 will be in the range of $390,000 to $400,000 representing a year-over-year increase of 7% to 10%.

This is the result of the changing mix of communities within our regions and expected full year mix shift towards the West Coast region and the successful implementation of targeted plan-specific price increases.

Homebuilding operating income in the current quarter increased 91% from the year earlier quarter to $49.6 million including inventory-related charges of $6 million compared to $11.7 million in the prior year period. Excluding inventory-related charges for both periods, our second quarter homebuilding operating margin improved 90 basis points to 5.6%.

For the full year 2017, we are increasing our homebuilding operating income margin expectations to a range of 6.0% to 6.6% excluding the impact of any inventory-related charges.

Our housing gross profit margin was 16% for the second quarter excluding $6 million or 60 basis points of inventory impairment and land option contract abandonment charges, excluding both inventory-related charges and the amortization of previously capitalized interest, our adjusted housing gross profit margin was 21%, up 30 basis points compared to the same period of 2016.

We expect to continue to generate sequential gross margin expansion during the remainder of 2017 from multiple contributing factors including improved leverage on fixed costs from higher quarterly housing revenues, deliveries from recently opened higher margin communities, a favorable regional mix of deliveries, and community-specific gross margin improvement action plans.

Assuming no inventory-related charges, we expect our housing gross profit margins for the 2017 third quarter to improve to approximately 16.4% to 16.7%.

During the spring selling season, we successfully balanced absorption pace as price increases in our communities driving a meaningful year-over-year increase in our anticipated gross margins for the fourth quarter in addition to the improved full year housing revenue outlook mentioned earlier.

We now anticipate our fourth quarter gross margins will be in the range of 17.6% to 18%, up 50 basis points at the midpoint compared to our prior expectations.

With the strength of our second quarter performance and higher expectations for each of the remaining two quarters, we are increasing our projected 2017 full year housing gross profit margin to a range of 16.3% to 16.7%.

Our selling, general and administrative expense ratio of 10.4% for the second quarter improved 120 basis points from the year earlier quarter. This significant improvement reflects our ongoing cost control initiatives and the favorable leverage impact from higher housing revenues.

In the second quarter, our SG&A expenses were up only $10 million year-over-year on a $188 million increase in housing revenues. We believe there are opportunities for further progress and expect to extend the favorable year-over-year trend into our third quarter with a projected ratio of about 10.1%.

We currently anticipate that our full year SG&A expense ratio will be in the range of 10.0% to 10.3%. Income tax expense for the quarter of $20.2 million which is a predominantly non-cash charge against earnings, due to our deferred tax assets represented an effective tax rate of approximately 38.9%.

We still expect our effective tax rate for the remaining two quarters of 2017 to be approximately 39%. Turning now to community count, our second quarter average is 238 which is flat with the first quarter and down 2% from 242 in the same quarter 2016.

The year-over-year decrease in our overall average community count was attributable to a 26% decline in our Southeast region, due to fewer community opening relative to closeouts and the wind down of our Metro DC operations. Our other three homebuilding regions posted a higher average community count compared to the year earlier quarter.

We anticipate that both the third quarter and full year average community counts will be approximately flat as compared to the corresponding prior year period. During the second quarter, to drive future community openings, we invested $405 million in land, land developments and fees with $204 million of that amount representing new land acquisitions.

We continue to make progress in reducing our land held for future development for sale through community activations and land sales. At the end of the second quarter, we had a balance of $396 million in this inventory category representing a decrease of $36 million or 8% from last quarter.

In the 2017 second quarter, approximately 12% of our housing revenues were generated from reactivated communities. We ended the second quarter with total liquidity of over $590 million including $349 million of cash and $242 million available under our unsecured revolving credit facility.

In addition, our net debt to capital ratio of 54.9% reflected 390 basis points of improvement versus May 31, 2016. We believe we are firmly on track to be within the range of our stated goal of 40% to 50% in the near to mid-term.

In summary, we delivered a strong second quarter financial performance, particularly the 24% year-over-year increase in total revenues, the 90 basis point improvement in homebuilding operating income margins, and growth in diluted earnings per share of $0.33.

We made measureable progress across our key financial metrics in the quarter, as we continued to execute on our roadmap for returns focused growth.

Based on the successful community level management of pace and price during the quarter leading to a 15% year-over-year increase in our net order value, and a robust quarter and backlog of $2.2 billion we have increased both our midpoint full year housing revenue forecast by approximately $150 million and our midpoint fourth quarter housing gross profit margin expectations by 50 basis points.

In addition, at the midpoint of our forecasted guidance for the second half of the year, we estimate that our full year return on equity will reflect the year-over-year improvement of approximately 300 basis points.

With our strong and consistent execution within our operating divisions and current favorable market conditions, we are confident that we can deliver improved results for the remainder of this year and maintain the strong momentum into 2018. We will now take your questions. Operator, please open the lines..

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

Hey guys, good afternoon and congrats on another very strong quarter. Great to see the guidance moving higher.

I was hoping to dig in a bit more to the pricing trends you guys are seeing, the ASP growth both on closings and orders, very strong and I know there is some mix going on there, but at the same time I know you guys are raising price and focused on driving the margin higher.

So, one of the questions or concerns we get from investors a lot relates to how far can pricing go before it starts to impact both affordability and also confidence, so I was curious if maybe you can parse out those price gains and maybe you can give an indication of what actual apples-to-apples pricing is doing on the community basis ? And within that, what type of feedback are you getting from this deal thus far as buyers reaction to those price increases? Is there still a pretty decent runway to go before affordability becomes a constraint? Thank you..

I’ll try to hit most of those Alan and what I miss though, turn over to Jeff. For starters, we know we raised prices in the quarter on about 200 communities, for most of our communities that see a price increase and we are rotating through communities fairly quickly so it’s very difficult to have apples-to-apples on a year-over-year basis.

There is no question we have a mix shift going on where the West Coast is growing the revenue little faster than the other regions, but even within the West Coast closing a community in Sacramento and opening one up in San Jose can move your ASP pretty significantly.

As we position our communities, we try to – we call bracket in the median income, we stay very focused on a product that’s affordable for the median income in that sub-market or in that zip code or in that area. So when we open for sale, typically it’s a very compelling value.

We get momentum and from there we will monitor price and pace to hold whatever our stated absorption rate is and then take whatever price we can get above that, and make sure we optimize the returns.

With the limited inventory that’s out in the marketplace today, there is incredible demand for the products we offer at our price points, and at the same time you have job growth and wage growth going on, so demand is growing while inventory is shrinking.

So it’s a pretty typical – it’s not a balance, there is not enough supply to meet today’s demand, and within each community we are navigating to that kind of dynamic. .

I mean, the only thing I’d add is, we are very watchful on the absorption pace and making sure the sales keep progressing and we had a good quarter from point of view pace where we are up 7%, overall, we are actually up 8% in our core communities during the quarter in absorptions.

And in addition to that, we are able to work on some margin improvement that actually which we believe will manifest in the fourth quarter with our improved guidance on our gross margin by 50 basis points.

So we like the balance right now -- as Jeff said the resale inventory is in short supply and it does provide a little more pricing power on the new home side and we are taking advantage of that. But certainly we don’t think we are moving out past what the market will bear, again as evidenced by our improving absorption pace..

Okay. I appreciate that. Thank you. And Jeff K, if I can, just on the absorption commentary, just want to clarify, so it sounds like community count is going to be flat in the back half of the year, it’s been, maybe down a point or two so far. And I know you’ve been signaling this push on maybe price over driving absorption growth.

So, just to be clear, are you actually assuming absorptions flat line on a year-over-year basis as well and the growth on the order side will come more on the dollars in terms of the price as opposed to units or do you still think you can drive the absorption rate a little bit higher similar to what we saw in the second quarter? Thank you..

What typically – I mean, we target to maintain pace, particularly of the strong comps on absorption increases last year. So we had some very outsized comp and absorption terms last year, but it doesn’t mean we are not looking for upside.

We had a similar target this quarter to sort of maintain price or maintain pace and work on price, and we ended up actually improving both. We’d hope to do the same in the third and fourth quarter, but we’ll see where market conditions take us and everything else.

We don’t have very many weeks or days of data points so far in the third quarter to know anything more than that. We have no crystal ball on that side of it..

Our next question comes from Stephen East with Wells Fargo. Please proceed with your question. .

Actually this is Paul Przybylski on for Stephen. I guess, first question, your incremental SG&A increased to 5.4 from 3.6 in the first quarter.

What drove that sequential increase and how should we look at that on a go-forward basis?.

I think the incremental increase is pretty much right in line with what we talk about every quarter. We always say somewhere between 5% and 6% of top-line – of the difference on top-line revenue is what we expect to see there.

I think it was well controlled in the second quarter given the revenue jump both on a sequential basis as well as on a year-over-year basis and we actually did much better than we thought we were going to on our guidance and our internal forecast. So, we are actually quite pleased with the leverage.

That 5% to 6% number is what we continue to suggest people use as modeling, and it’s typically where we are coming at the first quarter. I don’t recall exactly, but there may have been some ups and downs to the other factors and a few million dollars one way or another on adjustments here and they can really change things.

But I think going forward, that 5% to 6% is about the right number..

Okay.

And then, orders in the west were a little bit lower than what we were expecting, and was community count flat there and then if you could give any color amongst the region and what’s the status of the international demand in Orange County and the Bay Area versus a year ago?.

Yes, on top of state of demand….

Yes, Paul, Orange County is very strong right now. It’s very good for us, the whole – fills on north and south. There is very limited inventory and demand is very strong. So it’s very good conditions right now. .

And as far as community count goes, as you know we were down a couple percent total company, we were up a little bit in the west but not significantly. So, more of it came from just the management that we put into to the business during the quarter of trying to improve the margins and we were successful doing that.

So we are pleased with forming to the West Coast..

Our next question comes from Mike Reinhart of JP Morgan. Please proceed with your question..

Hi, thanks. Good afternoon everyone and nice quarter. The first question I had was on gross margin guidance. The 50 BIP raise, Jeff that you alluded to, Jeff K a couple times and obviously it’s very encouraging.

I was wondering if you could kind of break that down if possible what the big drivers of that in terms of, do you feel that it’s more – if you kind of think about it in three buckets of mix versus price, versus you’ve alluded to other types of gross margin improvement initiatives that you have in place?.

Yes, specifically the lifts that you see, now the 50 basis points that we talked about this quarter is more related to what we saw going through the spring selling season on the pricing side as far as price outpacing and cost increases.

So, if you recall from last quarter’s conference call, we talked a fair amount and we were very optimistic about being able to expand our operating margin for the year, but we did say we wanted to see what the spring selling season was going to bring us and we wanted to watch the management of our communities on pace price basis as we went to spring to drive some of that improved operating margin and we were successful doing that.

So, the incremental change versus last quarter came mostly from that. When you look at on a year-over-year basis, or sequentially as we go through this year, there were other factors involved and those include better leverage on fixed costs that are included in cost of goods sold. You are seeing new communities that are performing very, very well.

So we’ve been very pleased with some of our new community openings and we are getting those opened up in the first half of the year, we are getting better visibility and what that means in the back half as far as margins go and impact out into the first quarter of next year as well.

Regional mix is certainly helping us on the edges and as well as really in every single one of our communities the company in total is focused on community-specific action plans to improve margins.

We know that’s real key to success of the business not only for the remainder of 2017 but as we enter into 2018 and we want to enter with strong momentum on operating margin improvement and particularly in gross margin improvement as we get into next year. So it’s really a combination of all those tactics Mike..

Right, but, Jeff, before I go into my second question, just to be clear, because you started talking about the 50 basis point improvement in guidance and then you started talking about the year-over-year improvement.

I just want to be clear that the raising of the fourth quarter guidance from 17.8 to 17.3 that the driving of that raising of guidance, if I heard you right, is more because of getting price even greater than your cost inflation.

So that – I just wanted to clarify that that was the driver of the guidance, it sounded like that’s what you said just the spring selling season being better, being able to capture and more than offset even better than you expect that price over cost inflation.

So that – just wanted to clarify that that’s the case and then, my second question is on the SG&A side, I’ve seen there has been a couple quarters in a row where I believe you’ve had a nice upside relative to guidance and notice that you essentially only – you effectively reiterated your full year SG&A guidance, lowered the high end of the range only down by 10 BPS, is that’s something where there is still bit more upside to go there and I noticed that you are only looking for about 70 BIP year-over-year leverage in the third quarter versus 120 in the second quarter.

So, again just clarifying the raising of the 4Q gross margin guidance and then is there is still an element of conservatism in the full year for SG&A?.

Sure, sure. Starting with the gross margin side, one of the main drivers was the strength of spring selling season just as we talked about last quarter, we definitely had better visibility now because that most of the sales are now in our backlog relating to the fourth quarter. So that’s definitely helped us.

But in addition to that, we were successful with the new community openings which until you get them opened, everything is on paper, once you get them opened you start selling and start seeing your gross margins for sale. It’s reassuring and adds confidence to the back half margin guidance. So those two factors and mix played a role in it as well.

So, I think you said it more or less right on that adding those other couple factors. On the SG&A side, we have been very successful. We had a very in line quarter this quarter on SG&A. We had some ups and downs and that basically netted out. So we didn’t have really any unusual one-time positives or unusual one-time negatives.

A few million dollars moves SG&A. We are always a little bit cautious on SG&A partially for that reason. We like the trend that we are seeing and we like basically the acknowledgement a lot of people had about the cost control on that side of the business. But we want to stay – we don’t want to get out of our skies on the improvement side.

I think we can continue to leverage it. We said that consistently price mix for the past several years and we have done that and I think you’ll start continue to see good progress and our forecast right now indicate that as well a nice progress on a year-over-year and sequential basis.

So, I think we will stay with our guidance on that and hopefully we can be at the lower end of it. .

Our next question comes from Nishu Sood of Deutsche Bank. Please proceed with your question..

Thank you. I wanted to follow-up on the pricing question and, Jeff, you mentioned 200 of your communities where you are able to raise prices. So, focusing on this comment, but taking a little bit more on price, little bit less in absorptions, it seems that that comment applies more to California than maybe the other regions.

Is that the right way to think about it? I mean, the 200 is pretty broad.

Just wanted to understand specifically by region how you are thinking about that dynamic?.

I would say, very broad Nishu. I comment with this with years to optimize the asset and there is a certain pace that’s the minimum and when you get above that minimum we will try to hold above that and take more price.

So the market commentary I gave where I observed that the most desirable areas remains strong in every city and it’s rippling to the adjacent submarkets across out footprint. So, we have pricing power in the close in locations and the same time as it ripples out we are seeing some price lift out on the peripheral.

So, while we raised in 200, it wasn’t just in California or the South West, it’s broad based..

Good it. Thanks and I think Jeff K mentioned over – just over $400 million in land spend in the quarter, that would mark a cycle high. Your lot count on the other hand I think only increased by about 500 or so keeping you are probably actually even dropping your supply metric a little bit.

How should we think about that? Maybe if you could give us the developed versus buy versus new acquisitions? Does that reflects a lot of these California projects coming through the pipeline where there is probably more intensity of dollars on the land development spend? Or how should we think about that number and as well as reflecting your ability to grow now that you’ve got a pretty nice gross margin trajectory, the SG&A is going well, your absorptions are improving as well.

So, sorry, two questions in there..

No worries. On the split, it was about 50-50, it was about $204 million was land ac and roughly $200 million or so was developments and skies. You are right in talking about California.

I mean, there is heavy development dollars in California and a lot of the deals and also when you look at where we are investing, in California land is a higher percentage of total revenue.

So to the extent as everyone understands our business, where we have a high percentage of our revenues coming from the West Coast region it drives a high percentage of land spend into that same region if you want to reinvest to grow the business.

We were actually quite pleased with the investment level in the quarter as our goal is to continue to drive community count growth as we get out into 2018 and we want to continue to reinvest in the business for growth in the top-line.

So, we thought we had a pretty successful quarter and what we had done and we hope to continue more of that as we travel through the year. .

Our next question comes from Stephen Kim of Evercore ISI. Please proceed with your question..

Hey guys. This is actually Trey on for Steve. Thanks for taking our question. So first one, talk a little bit about California. It’s definitely been quite a nice tailwind for you guys so far and probably will be at least for rest of the year maybe going forward some more.

But we are just wondering how much of a greater mix improvement? Can you guys really out to your West Coast and into California, because we can’t really see it within the West Coast itself what’s going on in that division?.

I can speak to that. If you look at our California business, the community development and opening is a little more lumpy in the Coastal areas because of the time it takes to get things approved and it’s tougher to mine the deals, get them entitled, develop and open them up and in the second quarter, we had some nice momentum.

Out in the Bay Area, where we opened a few more communities that are closing.

As the markets had strengthened and the demand has moved inland it’s now out to areas where there is more buildable land available and it doesn’t take us much effort to identify entitle develop and get things opened and if you look at the central region from Sacramento, south of Fresno or you look at the Inland Empire, there is still running at 20% or 30% in normal volume levels and a lot of those areas are just now starting to hit their strides.

We think within the region that there is a lot of upside still in California where we will hold our scale and hopefully grow some on the coast, but it’s the land constrain and therefore our growth engine will move inland and that’s what you are seeing right now..

Got it. Thanks.

And then, secondly, just taking a step back, thinking about your 2019 targets that you guys laid out late last year, could you talk a little bit about how after raise your guidance for full year this year two quarters in a row how you are thinking incrementally about that longer term outlook for the company?.

I stated in my comments, we feel we are right on track to hit the goals we laid out for 2019..

Our next question comes from Will Randow – Citigroup. Please proceed with your question..

Hey, good afternoon and thanks for taking my questions.

I guess in terms of input cost inflation as mentioned previously you are more than able to cover that, are you seeing the full impact of lumbar inflation and are there any other factors that we should be conscious of course land, but any other cost pressures that we should be focused on?.

There is always various commodities that are either hot or cold in price. As you may have seen the announcement today on the tariff that came out of the Commerce Department that really has been priced into our products for 90 to 120 days that actually was more of a confirmation of the range that have been set many months ago.

So, that’s been priced into our lumber now for a while. And there is still pressure on lumber prices, but it’s not significant and as we shared we are – right now we are able to take more price than we are seeing in our input cost.

On the labor side, there is still – pockets around the country where a few lockers here maybe tighter but for people over here paying in that city you do what you have to, to keep your production going, but I think right now, I’d say that the cost side is very manageable. That’s impart why we are raising our margin guidance for the year. .

Makes sense.

And then just secondly, in terms of your strong progress on pace and price, outside of just typical consumer confidence, is there anything you can specifically point to, have you seen mortgage credit ease or any other factors that are notable?.

Certainly there has been employment growth and employment growth creates demand and don’t forget the millennials moving out of the parent’s house. There is a lot of demand being generated right now as millennials move on with their life and get married and dual incomes and all of those things.

On the mortgage side, again there was an announcement today out of Fannie on encouraging lenders to loosen up their guidelines a bit. We are seeing little bits around the edges, but no major shifts in the quality of the underwriting..

Our next question comes from Susan McClary of Credit Suisse. Please proceed with your question..

Thank you. Good afternoon. The first question is really around the design studios.

It certainly sounds like you are seeing some pretty good pricing power out there, are you seeing any changes in how people are approaching the options out there choosing?.

I would – at a high level and it’s anecdotal. I would say that our customers are still looking for a value in their products over sizzle. So it’s, give me a little bigger kitchen, get me more counter space and they’ll take that or convert this open area to a bed room as opposed to level five granite and acoustic top.

It’s still a fire that in terms lit there a while and they are staying with more functional options..

Okay.

And then, in terms of the new mortgage operations, would you say that there was any levels of backlog that you kind of came through this quarter especially as Stearns really sort of this new kind of new model came into place and was firmly in there?.

We’ve been working with Stearns since last fall. They actually were quite helpful. We didn’t have the JV up and running yet and when we wound down Home Community Mortgage, our previous JV Stearns stepped in and helped us with our deliveries in the fourth quarter at a small pipeline they maintain the loans in the first quarter.

And then here in the second quarter, they started taking on us as a JV as we turned it on and now they are building their pipeline for future originations.

So we see this as a real opportunity as go forward over the next couple of years to really capture a big percentage of our business and make deliveries more predictable and generate another income stream. They are doing a very good job right now. .

Our next question comes from Mike Dahl of Barclays. Please proceed with your question..

Hi, thanks for taking my questions. I had a couple of questions on the community count. I think first one, there was comment around some of the churn just given obviously the absorption has been strong and the flip side of absorption being strong as you kind of sell through some communities pretty quickly.

So, could you give us a sense of, if we look at the full year guide for flat year-on-year, how many close outs are you going to have versus opens?.

I don’t really have that number in front of me, but I mean, overall, the community count last year on average for the five quarters was 238, I think we are going at somewhere near that number this year and we have a number of openings scheduled obviously in the third and fourth quarters.

Again, I don’t have the number in front of me, but it’s going to hopefully more openings and close outs to be able to grow our community counts between now and the end of the year and keep that number relatively flat year-over-year.

And ultimately, as we get into 2018, I mean, we’d like to continue to obviously grow top-line and we’ve done a great job the last couple years with our top-line housing revenue growth on very flat community count.

Right now at the midpoint of our guidance up 20% year-over-year, last year housing revenues were up 23% year-over-year and in both of the years 2016 and 2017 or 2017’s expectations as points of 2016 we were relatively flat well. So, we’d like to have that additional driver to top-line revenue and building community counts as we go forward.

But again the guidance for this year is relatively flat for the full year on an average basis. .

Right, got it, and I guess as a second part to that question, have you – is there any sort of math you can give us of I think pace was a little ahead as you said relative to your expectations and so then it seems like maybe community count was a little bit light of where we and some others were thinking? So, anything you can give us as far as kind of the algorithm if pace continues to run up 5% or 10% what the impact on your community count would be?.

It’s really difficult when you get into that because it’s really at the community-by-community level. It depends where the pace is up. I mean, if your pace is up at a community where you have few hundred lots and three more phases to go through and everything else it doesn’t change your community count at all.

If you end up selling out quicker, quicker sell out, out of a community that maybe at 10 or 15 lots left, it impacts. So, I mean, it’s very, very difficult to tell.

In this particular quarter, we came in a couple communities shy of where we thought we might end the quarter due to some stronger sales, those are communities and more close outs, but you are talking about three or four communities and on a base on in excess of 200 it gets pretty finite when – detailed when you are trying to forecast down to that level.

So, overall, again just to reemphasize we are pleased with the absorption pace pick up in both our core communities and overall and we are pleased with the management, particularly again have to lift their operating margin and gross margin guidance for the year.

So we saw that is all being pretty successful in the quarter, but to get any more details on the community count, it’s really difficult..

Our next question comes from Jay McCanless with Wedbush. Please proceed with your questions..

Hey, thanks for taking my questions.

The first one, I just want to follow on some more the community counts, are you guys thinking about net community count growth for 2018 versus 2017 and if so, should we expect SG&A to flex higher either at the end of this year as we move into the first half of 2018?.

Jay, we are definitely trying to grow our community count in 2018 that’s our goal and our strategy and I don’t think you will see a big spike in SG&A as we ramp up the community count. That occurred a few years ago when we aggressively ramped up. But I think at our scale, it will be less of an impact, we will be able to manage through that. .

Okay.

And then just as the second question, any commentary on June orders or traffic what you are seeing so far this month?.

Jay, we typically don’t comment within the quarter, because we are so early into it. We did in the first quarter because we do our earnings release half way through the quarters, but we feel we can give you the color I can say in general but the trends remain good just like March, April and May and that’s some specific..

Our next question comes from Bob Wetenhall of RBC Capital Markets. Please proceed with your question..

Hi, good afternoon gentlemen. This is actually [Indiscernible] on for Bob. Thanks for taking my questions. I’d like to go back to the gross margin.

What you expect in terms of contribution from reactivated communities and think about deliveries and how should we think about the impact of these communities on gross margins? You already gave us our – you already gave us guidance for gross margins, but I was just curious on what your thoughts were on that?.

Right, what we are seeing on the reactivated communities is, actually a lot of stability in terms of percentage of total revenues.

Last quarter it spiked up a little bit, I think it was 15% of total revenues but if you look back throughout 2016, look at the second quarter 2017 and really our expectation for the rest of the year, it’s right in there around the 12% level of our total.

So, it is a headwind, it remains the headwind to the company but not an incremental headwind either on a year-over-year basis or getting worse sequentially as we go through the year.

We think we will just continue to be maintaining at around the same level of revenue and it is a drag of up to four basis point on our margins depending on the quarter on – excuse me you are right. But it’s not something that we see a lot of variability or variation as we look forward..

Thank you. And as a follow-up jumping to capital allocation. In the first half of fiscal 2017, your investments and land acquisition were around $700 million. How should we think about land spend and capital allocation in general for the second half of the year? Thank you and good luck..

Yes, thanks. I think capital allocation in general, it’s just in line with what we’ve been saying publicly for a while. I mean, we want to reinvest in the business, so land investments and development of land already owned is very important to us to continue the acceleration of top-line revenues. That’s first and foremost.

We are looking to delever the business and we made some moves earlier in the year towards that with our pay down of debt. We have other maturities coming up and we will see where market conditions are and capital markets as well as housing markets and make decisions on that.

But those are two primary – basically the focus areas for capital allocation in addition to our regular dividend which is relatively modest, but we obviously continue to plan to maintain that.

So that’s really where we are coming from and at the same time, we are seeing positive cash flow coming out of the business despite some pretty good levels of investment back and as part of land investment goes.

So, that’s a positive and that allows us to do both to grow the business through community counts relative to delever the business as we move forward, it’s worked up to this point and we don’t see any reason to believe that it won’t continue to work until we could get basically our ratios in line with our medium term goals and our community count and investment in land in line with our goals as well.

.

Our next question comes from John Lovallo of Bank of America. Please proceed with your question..

Hey guys. Thanks for shooting me in here.

The first question I have is, if you could just remind us of your exposure to Houston, maybe what you’ve seen – what you are seeing there and if that has changed at all throughout the quarter given kind of the pullback in oil?.

John, Houston is about 7% of our business and as we keep sharing on the calls, we are priced at the lower price points for Houston. Our ASP there today is around 230.

I think when you get up in the 3s and definitely the 4s, there is some danger there and that’s the area that see the softening in demand but when oil prices tracked down last time, we powered through it pretty well because of the price points that we played at and we’ve stuck to that discipline, as I shared in the comments, Houston had a very good quarter at a solid run all of last year and we expect good things in that business..

Okay, and then, maybe on the labor front, we’ve heard some other folks that they are seeing some incremental labor, green shoots of incremental labor coming back to the market whether some other industries or maybe even from the multi-family side.

Are you guys seeing any of that?.

Definitely. Most of that and it’s the combination of things and some of the cities, apartment starts are down and that labor is coming back to the residential side.

So that’s encouraging and as always the case in the lots to find demand we’ve taken some pretty big increases over the last few years in labor in some of our cities and found to get to a point where it starts to attract more people coming back into the market. So I think you do have both those going on right now..

Our next question comes from Buck Horne of Raymond James. Please proceed with your question..

Hey, thanks good afternoon. Jeff, couple of quick ones, most of mine have been answered. But do you have the quarter ending that home count and I guess my other question just is still what out there, have you worked with any of these single-family rental companies recently to build some built for rent homes that they are targeting.

There is a few of them that are trying to ramp that up and I was wondering if you might have been working with any of them in particular?.

I can speak to the rentals, Buck, we are really not looking at that right now.

We are pleased with taking our assets then working our for sale business model, back several years ago when we are trying to figure out what to do with some assets we explored it and we always came back to we can create the best returns through building our products and selling our homes. .

Yes, and as far as spec count goes, we have about 1.5 finished spec per community. We ended the quarter with 362 finished unsold. .

Our final question comes from John Micenko of Susquehanna Financial Group. Please proceed with your question. .

Hey, good afternoon. Kind of related question to Buck’s question. Your revenue beat pretty big upside to your conversion rate and looking at our math it looks like you are looking for further acceleration in backlog conversion in 3Q and 4Q.

So I guess the question is, are you doing something strategically different going forward? I know your built to order and by definition less spec, but I was curious as to what was driving some of that improvement both in the quarter and then on a go forward?.

I can take the crack at couple of comments, that one, our cycle time in our company is from contract to close and built to order business that’s 5.5, 6, 6.6 months depending on the cities. Well, I talked in my prepared comments about things we are doing to simplify the build side of things.

We are also working to compress what we call the paper side from contract to start and from completion to close and one of the things that we are seeing already in our joint venture is a partner that is very good at pushing the paper, getting buyers prepared for their loan approval and final upon their start and the compress time also after loans completed to get it closed quicker with a better and more efficient paper process.

So, we are shrinking our cycle time from a year ago and I also think we have a better distribution of whips now where our backlog is bigger or unstarted backlog is bigger and it’s feeling better even flow production than a year ago.

So it’s lot lumpy in the second quarter marks with a very good delivery month for us which tells you that you have your – the right balance of whip, you don’t just jump it on February, you build through and it’s a more even flow spread. So, we have better whip distribution and we are also working on ways to compress the cycle time..

And as far as the numbers go, I mean when you look at it year-over-year, our backlog conversion was the same this year in the second quarter as last year we were at 54%.

At the midpoint of our guidance range, if you look at the midpoint of our revenue and the midpoint of our ASP could imply a backlog conversion rate in the third quarter a little bit better than last year. I think it was 48% last year and this implies about a 49% backlog conversion.

So, and really what’s happening there is in the third quarter, with your second quarter ending backlog, you have a higher percentage of sales that were made more recently because through spring selling season and as a result of that, your conversion, typically for us moves down a little bit in the third quarter just because of the strong spring and to the backlog and adding more recent sales to your backlog.

So, I think it’s pretty much in line with the trend that we’ve had and as Jeff had mentioned, we are pretty focused on and looking for improvements as we move forward. .

Okay, that’s helpful.

And then, the 40 to 50 net debt to cap target, Jeff K, does that contemplate, you got some high cost money coming due in September, does that contemplate redeeming that for cash or are you still undecided there?.

We are still looking at market conditions and what we want to do both on the capital market side as well as on the housing market side things like when and that’s been where we will move the business. But it remains firmly a part of our three year plan to have the business back within that range as quickly as possible.

We talked last fall about a delivering of at least $250 million over that period. So it’s very much still in cross years to the business. But we don’t like making too many decisions too far out ahead a time especially publicly on capital structure.

So we will evaluate that as we go through the quarter and then make some decisions by the time talk to you guys during the third quarter call. .

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