KB Home (KBH) Q2 2013 Earnings Report, Transcript and Summary

Good morning. My name is Michelle, and I will be your conference operator today. And I would like to welcome everyone to the KB Home 2013 Second Quarter Earnings Conference Call. [Operator Instructions] Today's conference is being recorded, and a live webcast is available on KB Home's website at kbhome.com. The company will make a presentation and then open the line for questions. [Operator Instructions] KB Home's discussion today may include forward-looking statements that reflect management's current views and expectations of market conditions, future events and the company's business performance. These statements are not guarantees of future results, and the company does not undertake any obligation to update them. Due to a number of factors outside of its control, including those identified in the SEC filings, the company's actual results could be materially different from those expressed and/or implied by the forward-looking statements. A reconciliation of non-GAAP measures referenced during today's discussion to their most directly comparable GAAP measures can be found in the company's earning release issued earlier today and/or on the Investor Relations page of the company's website. I will now turn the conference over to the company's Chief Executive Officer, Mr. Jeff Mezger. Sir, you may begin.

Thank you, Michelle, and good morning, everyone. Thank you for joining us today for a review of our second quarter financial results. With me this morning are Jeff Kaminski, our Executive Vice President and Chief Financial Officer; and Bill Hollinger, our Senior Vice President and Chief Accounting Officer. I'd like to start today's call with an overview of our substantially improved operating results during the quarter, which illustrates the dramatic progress we are making in our business. I'll then provide an update on the status of our 2 strategic priorities for the year: accelerating top line growth and enhancing profitability per unit. Following this, Jeff Kaminski will take you through the details of our financial results. After which, I will conclude our prepared comments with a few remarks about how we have positioned KB Home for even stronger results heading into 2014. As always, after the prepared remarks, we will open the call up to your questions. We are very pleased with the meaningful improvement we achieved across most of our financial and operational metrics in the second quarter. Between our enhanced company performance and the continued advancement of a sustained housing recovery, we are well positioned to achieve meaningful profits in both the third and fourth quarters, leading to solid profits for this fiscal year and accelerating profits and growth going forward. Some of the significant accomplishments during the quarter are: Revenues increased by 73% year-over-year to $524 million. Our average selling price rose 25% to $290,000, our 12th consecutive quarter of year-over-year increases. The primary driver of this increase was our ongoing land investment and product positioning strategy, which is working successfully across all of our regions. Of note, we reported operating income of $8.7 million, our fourth consecutive quarter of operating income and our first operating income reported for second quarter since 2006. We dramatically improved our adjusted growth housing margin to 18.2%, which represents over a 600-basis-point increase over last year's adjusted gross margin of 12.1% and an approximately 300-basis-point sequential increase compared to our first quarter of this year. We lowered our SG&A ratio by 760 basis points to 13.4%, the lowest second quarter SG&A ratio since 2006. Our net order value of $640 million was up 27% from a year ago, while net orders were up 6%, consistent with the guidance we've provided at our Analyst Day. We continue to fuel our growth with land and land development investment of $230 million. For the first half of 2013 we invested $575 million in land and land development, nearly triple our investment for the first 6 months of last year. As a result, we have increased our lot count, owned and controlled, to almost 53,000. We continue to identify attractive investment opportunities across all of our regions that are aligned with our strategy, and we have now again increased our estimated spend, now planning to invest up to $1.2 billion for the year. Finally, even with the unusual charge, which I will discuss in more detail in a moment, we're basically breakeven for the quarter. Excluding this charge, we would have reported a profit of approximately $13 million. These results, taken together with a quarter-end backlog value of $827 million and our expectations for continued ASP growth, additional margin expansion and further improvement in our SG&A leverage, are strong support for accelerating profits going forward. Before discussing our strategic priorities for the year, let me address the recent concerns many have raised regarding the recent uptick in mortgage rates and its potential impact on housing. In my view, there is no question that housing dynamics are significantly better than they were a year ago. At the same time, in my view, we are still in the early innings of a recovery that is continuing to accelerate. The positive factors underpinning the current housing recovery remain fully in place and will continue to drive favorable market fundamentals. There is substantial pent-up demand driven by population growth, job growth, an increase in household formation and record affordability. At the same time, in most areas of the country, there is a shortage of supply and monthly mortgage payments for a typical home are lower than rent; further reinforcing the appeal of homeownership. Despite the recent rise in rates, affordability is still at extraordinary levels, and demand is significantly outpacing supply in every market we serve. Anecdotally, we are hearing from the sales floor that the uptick in rates has actually created an increased sense of urgency, as buyers don't want to miss out on this incredible opportunity. Having said all of this, if you get past the pure economics of interest rates and payments, I have always maintained that consumer confidence is far more important to home sales than interest rates are. The desire to live in the American dream is strong, and if a consumer feels good about their personal situation, they will always work through any obstacles and find a way to become a homeowner. With job growth accelerating and consumer confidence hitting a 5-year high last month, I expect the housing recovery will continue with solid advance, especially in the attractive submarkets that we serve. Turning back to our results, during the second quarter, we recorded a $15.9 million charge for estimated repair costs associated with water intrusion-related issues affecting certain of our communities in Central and Southwest Florida. The charge reflects the results of a progressive assessment of these issues over the past several months, and we believe it encompasses the full scope and the likely overall cost of the repair effort. We believe this charge puts this matter behind us financially. We became aware in the latter part of 2012 that certain homes in these Florida communities, both attached and detached, have not been built to our standards and required repair. The problems involved framing, stucco, roofing, and in some instances, sealant on homes that were delivered to our customers in some instances almost 10 years ago, and which resulted in more recent water intrusion-related issues. An important fact in this situation is that we are pursuing recoveries from various sources, including our subcontractors and their insurers. Because we rely on our trade partners to build our homes, we also expect them to stand behind the work they do and to respond when problems arise. We fully intend to hold all responsible trade partners accountable for defective construction or materials, and we are aggressively and diligently taking action, including litigation, to recover the cost of the repairs. Although the scope and scale of these issues in the affected communities is quite unusual, our response to them reflects our commitment to customer service and to taking care of our homeowners. Jeff will provide more details on this topic later during the call. Let me reiterate that even with this unusual charge, which we feel puts the financial impact of this issue behind us, we remain on track to achieve solid profits for the year. One of the primary reasons for our improved financial performance is the land investment and product repositioning we have been executing for the past few years. This strategy of repositioning into more desirable submarkets and featuring larger homes where demand is strong and price points are higher is working across our entire system. This initiative has now achieved a powerful combination of significant growth in our average selling price and higher gross margins, while maintaining one of the leading sales rates per community in the industry. The net result has been a year-over-year increase in average selling price of 25% to $290,000; an advance that is well above market averages. At the same time, we remain committed to serving our core first-time and first move-up homebuyers. Even at this higher price in the quarter, first-time homebuyers still represented approximately 60% of the homes we delivered. We've been highlighting the strategy on these calls over the last 2 years, and it's gratifying to now see the results starting to play out. I am really proud of the progress we have made with this effort. We're a different company today with a much more dynamic submarket and community mix as compared to just a few years ago. Additionally, we have a backlog value in place that supports our expectation for continued increases in average selling price and higher gross margins going forward. As I outlined on last quarter's call and as we reviewed in detail at our recent Analyst Day, we have 2 strategic priorities for 2013: accelerating top line growth and enhancing profit per unit. I'd like to again highlight these initiatives at a high level as they both provide significant upside to our results. I will start with accelerating top line growth where our primary objective is to continue to gain share in each of our 33 served markets. We have significant upside in our geographic footprint and don't need to expand in the new markets to achieve exponential growth rates. To give you some perspective, in our peak year of 2006, we delivered more than 28,000 homes out of this current footprint. As I mentioned at the opening of today's call, we are pleased with the investments we made in the first half of the year. While it takes time for all of these investments to convert to actively selling communities, we remain on track to open more than 120 new communities this year and have the expectation for continued community count expansion in 2014. We have been finding attractive investment opportunities across our markets, and as a result, we're planning to invest up to $1.2 billion in 2013. Our second strategic priority is to drive enhanced profitability per unit. KBnxt and its Built to Order approach provide multiple levers to enhance profit per unit, and we're diligently utilizing all of them. In a market that is normalizing, our Built to Order approach provides incremental revenue opportunities that are simply not available with a one-size-fits-all Speculative Start approach. When the consumer is able to select their home and their lot of choice, you can maximize the full value of premiums they are willing to pay, such as lot premiums, elevation premiums and premiums for structural options. We think there is real opportunity to capture more of these premiums, especially in the higher-income submarkets we are now serving. In addition to these types of premiums, we have additional opportunities for revenue enhancements in our KB Home design studios. When it comes to offering consumers ultimate choice in value, our studios have always been a strong driver of sales. Today's consumers who are buying with the intent of living in their homes for a longer timeframe, are leveraging their buying power to design the home of their dreams. Our consumer surveys and local market knowledge continue to help us find additional options that we can offer in our studios that appeal to today's buyers. In Southern California, for example, buyers are attracted to an outdoor lifestyle and are spending more in this area. In response to this trend, in some of our higher-priced coastal communities, we are now offering fully retractable glass walls that open to the outside, and landscape and hard-scape packages that maximize their outdoor living space. In these examples, we have seen some buyers spend more than $200,000 in the Studio, truly personalizing their home for their lifestyle. This is a great example of how we can use the Studio to drive more revenue and profit per unit. At the same time, our Studios are also a great place to educate consumers on home buying, home features and the benefits of homeownership. We utilize the Studios and our proprietary Energy Performance guide to demonstrate the material financial benefit of our industry-leading energy-efficient construction, which can result in estimated monthly savings of as much as $200 on utility bills. We also offer additional energy options in our Studio that can lower utility bills even further, all the way down to a net-0 home if that is the buyer's preference. As consumer trends emerge in our Studios, we continue to quickly share best practices across our system through our common business model. With our KBnxt Built to Order approach, I feel we have significant upside profit opportunity in this area. While continuing to seek out revenue enhancements, we're also focused on our cost. Our business model drives efficiencies through operational excellence and provides many opportunities to reduce cost through scale. Relative to our cost of construction, our healthier backlog is enabling us to leverage the benefit of even flow production. And with standardized product lines, we're working to get cost reductions through our increasing volume. Relative to overhead, our primary focus is containing cost at these levels while utilizing the tools and processes in our business model to grow our top line. As our improvement in SG&A this quarter clearly illustrates, there is significant opportunity through continuing to unlock the spring coil in our growth platform. Finally, our high-performing mortgage partner, Nationstar, is enabling us to run a more predictable and successful Built to Order business by providing reliable loan approvals, high levels of customer satisfaction and faster turns on closing. Nationstar gained traction during the quarter, continued to decrease their time from completion of the home to closing, and was a major contributor to our strong closing performance. We expect continued improvement as our relationship matures. By year end, we also expect our Home Community Mortgage joint venture with Nationstar to be operational, which should provide a new earnings stream in the future. As to sales, we have shared with you on previous calls that we remain committed to optimizing the return on each asset through carefully balancing the maximum price and targeted sales pace at each community. Our current absorption rates support our 2013 revenue goals. Having said that, we are still working to improve our sales rates, in particular in those communities that are performing below their target. In the short run, we expect sales value growth will continue to significantly outpace unit growth. As our community count continues to grow, our strong sales pace per community will enable us to generate even more robust sales value growth. In the meantime, the revenue and profit growth from this strategy is driving meaningful results for our business. To summarize, as we continue to enhance the execution on our strategic initiative for 2013, we see a very bright future ahead. Our backlog supports our accelerating revenue and profit trajectory for the remainder of this year. We expect to see continued improvements in ASP, higher gross margin and a lower SG&A ratio, along with sustained growth in community count. Through our efforts, we have momentum, a strategic growth platform in place, and with a housing recovery that is still in the early innings, we expect to not only achieve our growth and profit targets for the year but also to continue our earnings growth and momentum into 2014 and beyond. Now I'll turn the call over to Jeff Kaminski who will offer the specific details on our margins and overall financials in the quarter. Jeff?

Thank you, Jeff. And good morning, everyone. We are once again pleased with the tremendous progress we have made in many areas across our operations, as reflected in the second quarter financial results. Most of our financial metrics for the quarter were considerably better on both the sequential and year-over-year basis. At the same time and more importantly, we remain committed to further improvements as we lead the company to full year profitability in 2013, as well as drive enhanced profitability and accelerated growth for fiscal 2014 and beyond. For the second quarter 2013, we narrowed our net loss by $21.1 million or $0.27 per share as compared to the second quarter of the prior year. Higher revenues combined with an expansion in our housing gross profit margin and an improved SG&A expense ratio drove the better bottom line results, which approached breakeven. Second quarter total revenues increased 73% over the same period a year ago to $524 million. During the quarter, our backlog conversion ratio improved to 65%, helped by the continuous performance improvement of Nationstar, as Jeff mentioned earlier. Our West Coast region once again accounted for the majority of the revenue increase, with revenues in the region up nearly $141 million or 106% from the second quarter of 2012. Year-over-year revenue improvements in the Southwest, Southeast and Central regions were 69%, 54% and 37%, respectively. We believe the continued combination of increased average selling price and higher deliveries in the third and fourth quarters of this year will drive our total revenue for 2013 to the range of $2.1 billion to $2.2 billion. The value of net orders generated and our net order pace during the second quarter, as well as our quarter-end backlog, strongly support this revenue forecast. Our overall average selling price for homes delivered during the second quarter was approximately $290,000. The strategic strength and favorable market position of the operations in our West Coast region were once again a tailwind for our consolidated performance during the quarter. While average selling prices were higher in all 4 regions, with year-over-year increases ranging from 15% to 26%, the shift in mix towards a higher proportion of deliveries from our West Coast region, which had an ASP of over $460,000 for the quarter, accounted for an incremental 7 percentage points of the overall average selling price increase. As a result of the continued success of our land investment and community management strategies, we expect our overall average selling price to continue to trend higher with both year-over-year and sequential improvements for the remaining quarters of the year. We now anticipate that our ASP for the full 2013 fiscal year will be in the range of $285,000 to $290,000 as compared to $246,500 for 2012. Enhancing profit per unit by continuously improving our housing gross profit margin is one of our key priorities, and the second quarter marked another quarter of steady progress. On an as-reported basis, our second quarter housing gross profit margin was 15.1% as compared to 15.8% in the same quarter of 2012. However, the current quarter gross margin included the $15.9 million charge we took in Florida, as well as a land option abandonment of approximately $300,000. Excluding these items, the current quarter adjusted gross profit margin was 18.2%. Adding to Jeff's earlier comments on the charge, I want to point out that we initiated an intensive on-the-ground investigation relating to this item in an effort to accomplish 3 things: to identify the scope of the issues; to fully understand the causes; and to address them as quickly and completely as possible for our home buyers. While the assessment process has been unfolding since the fourth quarter of 2012 and has been somewhat slower than we had initially hoped, we believe we now have a clear path to resolution. The unusual charge we recognized in the second quarter includes our estimate of cost associated with homes that have already been identified as having issues, as well as potentially affected homes that have not yet been identified. Prior to this quarter, we had been unable to estimate the number of homes not yet identified and the repair costs associated with those homes. That being said, repairs will continue for some time, and we will, of course, continue to assess and reassess our reserves each quarter under our normal process. Nonetheless, we believe this charge represents the culmination and conclusion of this issue from a financial perspective. More information about this subject will be included in our Form 10-Q that we will file in the next couple of weeks. Now back to our margin discussion. In the second quarter 2012, the housing gross profit margin included favorable warranty adjustments and insurance recoveries, partially offset by inventory impairment charges. Excluding the $11.2 million net favorable impact of these items, the adjusted housing gross profit margin was 12.1% in 2012. On an adjusted basis, we realized an impressive year-over-year improvement of more than 600 basis points in our gross profit margin, as well as a meaningful and sequential increase as compared to our first quarter. The main drivers of our strong margin improvement included a higher mix of housing revenues from our West Coast region, our actions to optimize pricing, greater operating efficiencies and the rotation to higher-performing land positions as we continue to open new communities and close out older ones. For the remainder of the year, we expect to see continued year-over-year and sequential improvement in our quarterly housing gross profit margin. To complement our efforts in growing our top line and expanding our gross margin, we remain disciplined in controlling our overhead costs. We continue to be well positioned to leverage our strategic growth platform as we ramp up delivery volumes, driving further enhancements to our bottom line profit performance. Our selling, general and administrative expenses for the quarter were $70 million, or 13.4% of housing revenue. This percentage represented the lowest second quarter level since 2006 and a substantial improvement as compared to the 21% ratio for the same period of the prior year. Our SG&A expense in the second quarter of 2012 included the charge for a legal judgment that we are appealing. For the 6 months of 2013 -- the first 6 months -- we increased our year-over-year housing revenues by over $370 million while holding our SG&A expense increase to less than $15 million. As we have discussed, we believe we have continued upside from operating leverage opportunities, and we expect further improvement in our overall SG&A expense ratio as we continue to contain costs while growing our quarterly housing revenues through the remainder of the fiscal year. Substantial improvement in our second quarter adjusted housing gross profit margin, which was offset by the unusual charge and a reduction in our SG&A expense ratio, drove nearly 700 basis points of improvement in our year-over-year operating income margin for the quarter. We reported $8.7 million of operating income in Q2 of 2013 as compared to an operating loss of $15.5 million in the same period in 2012. As with other performance metrics, we expect to realize continued year-over-year improvement, as well as better sequential comparisons in our operating income margin for the remainder of 2013. Turning now to our community count, we opened 37 new communities during the second quarter and closed out of 23. The average for the second quarter was 178 open communities, as compared to an average of 183 communities for the same period of the prior year. Despite the 3% decline in our quarterly average community count, our net orders were up 6% year-over-year. Our sales absorption rate for the quarter was just over 12 net orders per community, an increase of 8.5%; as compared to net orders per community of just over 11 during the second quarter of 2012. This improvement reflects the positive effects of our community repositioning as we opened 81 new communities over the past 4 quarters, partially offset by our moderation of sales pace as we continued to focus on margin improvement and maximizing the value of our land assets. Our plan for the end of 2013 is to accelerate our community count growth and to meet our sales pace to improve gross margins while maintaining one of the highest sales rates per community in the industry. Our strategy is to generate sales and backlog values high enough to achieve our current year revenue targets and open the new communities required to support our future revenue growth expectations. We will continue to place a much lower emphasis on unit sales comparisons while we balance pace and price and focus on driving top line revenue, improving margins and maximizing the value realized from our open communities. Strategic land investment is critical to expanding our community count and growing our top line, and we intend to continue to aggressively invest in attractive land assets. As we are continuing to find solid opportunities that align with our strategy, we now expect, as Jeff referenced earlier, that our total investment for the 2013 fiscal year will range from $1.1 billion to $1.2 billion. We remain on track to increase our fourth quarter community count in the range of 15% compared to the prior year as we continue to convert our land acquisition development activities into open communities. We still plan to open a total of more than 120 new communities during the fiscal year. We used net cash of $56.6 million from operating activities during the second quarter as compared to $19.7 million of cash provided for the same period of 2012. However, excluding cash used for land acquisition and development activity from both periods, we generated $173 million of operating cash during the second quarter 2013; an improvement of more than $70 million or 68%, as compared to the $103 million generated in the same period of last year. Before I wrap up my comments, 1 accounting housekeeping item. Our diluted EPS calculation for the quarter utilized a share count of 83.6 million shares outstanding. As we expect to generate net income in the third and fourth quarters, we will need to include the impact of our convertible senior notes and stock awards in the calculation to the extent they are dilutive. Therefore, for the remaining quarters of the fiscal year, we believe the share count for the calculation to be in the range of $95 million. In conclusion, while we were disappointed with the unusual charge that we recorded in the quarter, virtually all of the underlying operating and financial metrics reflected significant improvement as compared to the second quarter of 2012 and the first quarter 2013. These favorable trends bode well for a potential to deliver strong performance through the end of 2013 and beyond. Now I will turn the call back over to Jeff Mezger for some final remarks.

Thanks, Jeff. Before I make my concluding comments, let me first take a moment to thank our dedicated team of KB Home employees who do the heavy lifting every day that enables us to maximize shareholder value and drive our business forward. It's through their efforts that we elevated our business to a new level in the second quarter, delivering significant year-over-year improvements across most of our financial and operational metrics. We grew our revenue an impressive 73%, increased our ASP by 25%, improved our adjusted gross margin by 610 basis points and reduced our SG&A ratio by 760 basis points. As pleased as we are with our accomplishments during the quarter, we believe we can do even better going forward. We are aggressively pursuing our growth targets and now expect to invest up to $1.2 billion this year. If over the balance of the year, we identify opportunities that exceed this number, we have the confidence and ability to invest further. In my experience as markets normalize, differentiated performance levels among the peer group will emerge at a regional or local market level, and success will be driven by a homebuilder's track record and expertise in each of its served markets. We're the biggest builder in California, and we see tremendous upside in our home state. California currently accounts for more than 50% of revenues and is the primary area for our land investment strategy. Our leading presence, long-standing experience, strong and well-recognized brand and network of relationships in the state make us a preferred land buyer, and enable us to grow share in the most coveted and land-constrained submarkets. The Golden State is the largest and strongest housing market in the country, with solid job growth and record-low inventory that is being pursued by an enormous and growing population. KB Home is the leader in this market, and we are well positioned to drive significant results as this market continues to rebound from the early stages of recovery. The other very large market opportunity for us is Texas where strong job growth and an expanding economy offer tremendous upside in an area where we have historically done well. We're quickly growing share in both states at this time, and I expect them to continue to be the bookends of our growth strategy. Having specifically called out these 2 significant regions for our company, I'd also like to reiterate that our strategy is working everywhere and that we are investing across our systems. Our actions over the last few years to reposition the company, combined with a rapidly accelerating housing recovery, give us confidence that the best is yet to come. We expect to deliver meaningful profits for both the third and fourth quarters, a solid profit for the full fiscal year, and anticipate accelerating our results in 2014. We're excited about our future and look forward to sharing our progress with you as you continue on our journey back to normalized profit levels. With that, we'll open up the call to your questions.

[Operator Instructions] Your first question comes from Michael Rehaut from JPMorgan. Michael Jason Rehaut - JP Morgan Chase & Co, Research Division: On that topic, my first question: When you discussed your expectation for further improvement in the back half of the year, recognizing that you haven't given specific guidance, but you did have a pretty material improvement, obviously, sequentially in year-over-year in this current quarter. Given the pricing trends that you've been able to realize and the fact that we are still off from mid-cycle 18% -- I'm sorry, 19%, 20% or better that you saw in late '90s time period, when could we expect to get back to that 20% or better type of level? Would it be in the next couple of quarters? Or would that be more of a fiscal '14 event?

As you already said, Mike, we haven't given guidance on where we think our margins are headed. Having said that, we did share that we expect continued sequential growth in our gross margins. But we have a lot of things in play, many of which I shared in my comments and we shared at the Investor Day, relative to opportunities in the Studio and the premiums and our Built to Order model. We also have a nice mix of product rotation as we open up new communities and close out older ones. So I can't give you the date when we'll hit the 20% you've referenced, but we're continuing to actually sequentially improve, and at this time, we're already north of 18%. So we've moved pretty significantly in the last year. I'm not saying, we'll -- you'll see that kind of significance going forward, but we think we'll continue to improve. And at some point, we'll get there. Michael Jason Rehaut - JP Morgan Chase & Co, Research Division: No, I mean -- I appreciate that, and certainly, to be able to hold onto a 300-plus sequential improvement is impressive in itself. And certainly the outlook for expansion is encouraging. The second question, just on the ASP guidance of $285,000 to $290,000 for the year; that kind of implies more of a flattish outlook for the back half. I know you said that ASP should improve throughout the rest of the year. But I would think the numbers -- the way we're looking at them -- would only bear just a very modest sequential improvement for here. So I was wondering if you could elaborate on that a little bit, if our math is correct. And if there's some mix shift items going on? Because certainly, as you mentioned before, you do have positive pricing momentum, and everything else equal, that would imply perhaps a more material improvement in the back half.

Sure, Mike. Yes, I can respond to that. The -- during the quarter, we had a nice mix shift. It helped us about 7 percentage points, actually, the mix shift to the West. So we're using a little bit of caution on our forward forecasting, of where those delivery numbers will be and where the revenue will come from in the third and fourth quarter. And that is moderating, I'd say, the pace of improvement, but nonetheless, we still see sequential improvement both in the third and in the fourth quarter of this year. We've had some pretty high comps the last 2 quarters. The first quarter is up 24%. Of course, this more recent quarter is up 25%. Full year last year is up about 10%. So we're enjoying the increases. The strategy is working, continues to work. We're seeing everything ranging from increasing average square footage in our communities, to community placements, to regional shift helping us. But we stand by the guidance for the full year of $285,000 to $290,000 for ASP.

Your next question comes from Adam Rudiger from Wells Fargo Securities.

I had a question about your product repositioning. This is actually Joey on for Adam. How far do you think you are in your product repositioning strategy? And if you're halfway there or 3/4 of the way there, how much longer -- how many more quarters until you kind of get to your goal?

Joey, that's an interesting question because we really haven't looked at it that way. Certainly, the new communities we're opening are aligned with our strategy and are successful, for the most part. And until we get to our maximum market potential in our 33 markets, I would say that we're -- we have a lot of upside still. But it's a nice combination as we close 1 of our older communities and open a new one. And we think, through the things we've already identified in this call, we'll continue to have a positive impact from all these initiatives for some time going forward.

Great. And a question on kind of current trends in June. If you could help us with kind of what you're hearing from the field -- real-time feedback from your communities on what's been going on with recent trends and traffic in orders -- that would be really helpful.

Right. We typically don't give a lot of detail on intra-quarter. But I can tell you, as far as traffic trends, it's going to be holding up. I think with all the noise that you're reading in the media and the press and everything else on interest rates and what it's doing, in my opinion, at least in the short term, I think it's going to create more urgency; and buyers that want to get to the table and get to the closing table quicker. We're seeing it in a lot of anecdotal, I guess, stories from the field at this point, and we're really not seeing any negative impact so far from the headlines.

Your next question comes from Bob Wetenhall from Zelman -- I'm sorry, from RBC.

What a quarter. Really delivering, too, on what you guys said at the Investor Day about Going on Offense, and that's showing up in the numbers. I just wanted to understand in your guidance of top line. How do you see new -- how do you see the pace of orders during the balance of the year unfolding? Is it more towards like high single-digits? Is that realistic to use?

Bob, again, we don't typically guide order comps going forward. A lot of it depends on how many communities open and how many communities close out. Sales and demand are strong and -- but we expect community count growth, so that I would suggest if you just hold your order track you'll have positive sales comp. And we're continuing to work on these communities we have that are not hitting their sales targets. So we're trying to push our order growth per community a little bit and we are trying to open more communities. We keep reiterating whatever that unit comp is, it is, but we expect continued exponential increases at sales value just like we did in the second quarter.

Got it.

And I -- just to add to that a little bit, Bob, just like we messaged during the script. I mean, we're really focused on margin improvement and supporting our revenue targets. So to the extent we're seeing nice improvement in pricing and in our average selling price for multiple factors, mainly strategic and things that we've done, that's providing the revenue juice that we need to hit our targets for the year, and we're going to continue to emphasize that, particularly seeing such nice improvement in the margins that we've not only seen in the actual results but in our backlog numbers.

Got it. And just keying off your comment about the huge focus on expanding margins and keeping them 600 basis points better on the gross -- which is really a pretty important accomplishment -- could you give us some insight on why ASPs, particularly in California, are so strong and robust? I think you said added 7% overall ASPs with a high 400s number. What are you seeing in the California market? And is it just outpacing other regions by that much of a force? And also, do you expect to continue?

Bob, if you look specific to Q2, we had a great quarter in California, and it was a real driver in our results. It actually tilted to a little stronger mix than it had been, and as Jeff shared, it was 7% of the ASP increase with the regional mix. In my comments I shared, I think California is the best housing market in the country. The coastal areas are incredibly strong, and they continue to push price up. It is now rippling inland, and I've been sharing that trend for over a year. And you have to drive around the area to appreciate how strong demand is, how many people are looking to buy a home, and there's just no supply. So we're finding communities where there's great demand. We're positioning with bigger homes. And the consumer is responding favorably. You have millions and millions of people pursuing 25,000 or 30,000 housing starts a year with -- and there's no supply. So prices are continuing to move quickly. You're seeing it in the headlines. We're opening communities that are performing very well, and you don't have any inventory yet. So we're in this economic recovery in the state that's still early, yet you've already got these incredible dynamics at play. And I think that will continue for a while. And you'll continue to see our California presence grow. But that's just one of the bookends. We think we'll see -- though not at this level because it's such a strong demand today -- you'll continue to see the similar trends in our other regions as well.

Your next question comes from Ivy Zelman from Zelman & Associates. Alan Ratner - Zelman & Associates, LLC: Hey guys, it's Alan on for Ivy. Jeff, just in terms of your backlog, given your presale model and that you generally sell very few specs, I was hoping you might give us a little bit of insight into the percentage of your backlog, where they have already locked in their mortgage rates. And kind of adding on to that, any anecdotal commentary you could provide in terms of what your salespeople are doing to reach out to people in backlog and assure them as far as there is an increase in rates? Any color you could provide there would be helpful as well.

Okay. We leave it up to our consumer to lock the rate. We're not really influencing that. And most of them like to have confidence when we start the home that they have a rate in place that they'll close with. So for the most part, and this has been the case for years, our consumer will lock to cover through delivery at some point whether it's the start -- and in some cases, with home lenders, you have to pay a little fee to lock it if it's 3 or 4 months out. In a little shorter window, you can lock it for free, and they do. And to no surprise, the consumers understand when rates are moving. So they track it daily, and they'll make their call on whether to lock at that point or not. And so in our backlog, we manage to it and it's a motivator, actually, to close. If people have a rate lock that's expired and their home's done and something has to happen to get their approval or their documentation, they'll move faster and want to preserve and protect their rate. And as we've looked at it here, in particular, in the submarkets we're in and the price points we're playing at, our consumer's not that impacted on the ratio side, the income-to-debt -- it is more of a credit challenge for us. So if rates tick up a little and payments tick up a little. It's really not moving the consumer that much in terms of their payment and their ability to qualify for that payment. Our bigger challenge is still underwriting the credit, and if that unlocks, you'd see incredible demand. Alan Ratner - Zelman & Associates, LLC: And I guess, on that thing. We heard from Lennar earlier this week that they've seen some modest improvement on credit overlays and a little bit of loosening from that standpoint. Is that something similar to you're seeing on the credit front? Any improvement?

Well, we're certainly seeing that anecdotally in the media, and there's reports of it. We're probably seeing some incremental. As I'd say, that it is nowhere near more normal underwriting standards today, even relative to the government standards that are out there that they -- the mortgage companies can underwrite to. And it's a classic push and pull where through a downturn, underwriting tightens up. There's been jokes running around for a few years that mortgage companies never make a bad loan at the bottom of a cycle, which is when it's the best risk because prices are running up. And markets are firming. If the economy continues to expand like it is, I think you'll see the banks loosen up. And if sort of rates go up a little bit but underwriting loosens up a bit, I think you'll see similar demand, if not more. That's why we're not troubled by a little uptick in interest rates right now.

Your next question comes from Dan Oppenheim from Crédit Suisse. Daniel Oppenheim - Crédit Suisse AG, Research Division: You're talking about the land investment taking place in California, and also about the benefit of the community in coastal California in terms of the -- what people are paying for options, and the doors opening up and such. As you think about sort of the land spending, which would be a few years out, how much of that is now being focused a bit more inland? I was thinking about the recovery as it broadens across all of the state into more areas versus coastal. How are you thinking about the investment there?

I don't know that we break it out, Dan, between a coastal region and an inland region. We break it up Southern Cal versus Northern Cal. And it's obviously a larger dollar-per-lot play in the more expensive coastal region than it is inland. But as these markets recover and we track inventory and utilize our surveys, there's inland areas that are performing well that we're investing in heavily. And in -- on the coast, it's a land constraint. You have to really mine it and get ahead of the curve, and you'll take everyone you can get. So it's -- both sides are working well. So we're encouraging investment throughout the state, not trying to balance it just in the coast today. Daniel Oppenheim - Crédit Suisse AG, Research Division: Great. And then in terms of the comments on the options, what are you seeing in terms of just with the spending on -- in the design centers and options overall? And so what has that ended up making in terms of difference to the margins in the homes?

Well, our dollar spend in the Studios per sale does continue to track up. It's not huge. It's not the main driver in our ASP increase. In the past call, or even at our investor day, I shared that I think over time there's a point or 2 of margin between all these premiums we talked about, things we can do on the Studio, frequency pricing, leveraging our best practices. That certainly isn't in our numbers today. That's what we would hope to get someday. And it will be a little bit here and a little bit there. But with today's consumer, where they intend to stay in their home longer and they're buying it as a residence, not just an investment or something to flip in a year or 2, they're making it their home. And they're spending on whatever is of value to them. I think you'll see that trend continue for a while.

The next question comes from Alex Barrón from Housing Research Center. Alex Barrón - Housing Research Center, LLC: I wanted to ask if you can comment on your process of managing the sales pace versus the price increases? And I guess, now that we've seen the -- that move in rates in the last few weeks, whether that's impacting your ability to continue to raise prices?

Well, Alex, it -- that you may have -- I think we presented this or walked through it at our Investor Day, which I know you were at. But every community has a targeted balance of margin and pace. We say we want to optimize the return on the asset, and it's turn your inventory and maximize your margin at the same time. And there's a different balance. And on a weekly basis, we will review every community for: That week's results in a 4-week track; and what's the margin in backlog; and where's your price at; and we will make decisions each week to ensure a balance. And if a division for a community is ahead of their goal, they'll raise price. If it's behind in their goal, they won't raise price. They're not going to cut price but we will come up with different ways to try and stimulate sales to get it back on the goal. And it's a fairly intensive review that actually starts with participation here in Westwood from senior management and goes all the way down through to the sales manager. So it's manage your inventory on a weekly basis. And as I shared in the prepared comments, rates have ticked up. We haven't seen it impact sales. I don't think they'd moved enough to offset all of the housing fundamentals that are in place today. So we're continuing to run the business like we did a month ago or 6 months ago at this time. Alex Barrón - Housing Research Center, LLC: Okay. And as far as the community count in California, I guess that's probably been whether it's been more challenging to keep up with the demand because it seems like buyers, or communities, are closing out faster than your ability to open them. So do you think we've reached the point where the community count will start trending up? Or do you think we'll -- that will take another quarter or 2 from here?

Well, like we've been guiding, Alex, we did expect the community count increase to be really back-end loaded this year. We're talking about 15% up in the fourth quarter. The trend is similar in California. We're working hard to acquire land on a year-to-date basis. 64% of our spend between land acquisition and development was here in our West Coast region. So we are really aggressively looking, and as Jeff mentioned earlier, it's throughout the state and the best submarkets, whether they be inland or coastal. So we do believe that we can expand community count, not only across the company, but here in the West Coast region this year.

Your next question comes from Jack Micenko from SIG.

Trying to look at the back half and some of the embedded opportunities you talked about: West sales, Southwest sales down percentage basis; ASP is up, so definitely, the pace/price offset makes sense there. With the community count growth in the back end and kind of the flattish ASP guidance, does that mean that the centrums in the other areas that haven't seen as much ASP increase will see that? I'm just trying to get some sense of where the mix shift will take place on a more pronounced basis in the back half given that the West has been -- and the Southwest have been real price leaders in the last couple of quarters.

Jack, I'll let Jeff give you the percentages by region. In the prepared comments, we shared that every region's price was up. And every region's price is up more than that market's average. And it reinforces that our strategy is working. And as we've also already shared, if your mix shifted 1 or 2 points to California versus 1 or 2 points to Houston, it can move your ASP big time because a home in Houston could be $180,000 or $230,000 and a home in California could be $800,000 or $900,000. That's why at our current scale, your ASP can move around a bit on a little bit of a mix shift. So we're not -- this guidance is not suggesting that pricing has stopped or that markets have changed or anything like that. It's where -- the improvement relative to whatever happens with a little bit of mix shift over the next quarter or 2. But this trajectory is firmly in place by region right now. Want to share the...

Sure, yes. The -- I think Jeff said it right. I mean, the trend is there, and we believe the trend will continue. We had a 24% improvement in sales value year-over-year in our West Coast region. So although the units were more or less flat year-over-year, we still saw a 24% value jump. Our lowest ASP increase of any of the regions, I think, was 15%. So we're seeing nice improvement across the business, and some of those numbers, even at -- with our lowest region -- are better than we're seeing across the industry with some of the peers. So we've been pretty pleased with the progress we've made and with the land repositioning and the strategic moves on our product and community placement throughout the business. So we're trying to be a little bit cautious, I guess, with the rest of the year on the ASP estimate. We do have some upside potential, we believe, and we'll continue with the same strategy. We like the results we've seen. We plan to continue with the same strategy, and that's what we're trying to emphasize during the prepared remarks. You're not seeing a shift in strategy from us, just continued same strategy and hopefully, continued very positive results.

And then just trying to make -- trying to figure out if a mix may be more pronounced outside of the West is all I was sort of thinking there. On the mortgage side, you talked about days to close improving, and the new home community business coming online. Can you throw out some numbers in terms of what that closing time did? What the can rate was? And then are you looking in the new partnership to do non-capture rate business, third-party origination as well?

Jack, I can't speak to the strategy with the venture because we didn't get into too much detail on this call. I shared it's -- we're still in the process of getting the approvals from the agencies, and we still feel we're on track to have it up and running by the end of the year. As we shared on the last call or at our analyst day, it's kind of a seamless transition here in that the team's already in place. They're already working on our business. Our divisions are well linked and communicating with Nationstar's people. And the venture, when it's created, the Nationstar people would become employees of that venture. And through that, we'll manage it just like we -- any other mortgage operation would be managed, and we expect it to -- as the venture is formed, you have further alignment between the teams. I think you'll continue to see better execution as these relationships mature. And over time, I think we can see profits come out of the venture just like we did in the past with our previous venture.

Right, as far as some of the specific numbers, I believe the final to close cycle time for Nationstar came down 3 days. The can rate for the quarter was about 27%; about the same as last year's second quarter, which was about 26%. And I think that covers everything else you asked.

Your next question comes from Michael Roxland from Bank of America.

Just want to go through the rates again. If rates hold at these levels or even rise from here, how do think about your pricing strategy? I mean, are you willing to continue with the strategy of slowing down the pace through price? Just trying to help us frame how are you thinking about rising rates or even rates that are maintained at these elevated levels relative to where they were about 4 or 6 weeks ago?

Yes. Well, it's very interesting, Michael, because a lot of people are thinking elevated levels and what's happened -- rates are still at incredibly attractive levels. And while I think it came off from the peak, affordability levels are like the second best in the history of tracking affordability. So are payments going up with the rate increase? Yes. Is it going up enough to slow down all the underpinnings right now? No. And to us, if you tie that to our price and pace strategy, whether it's a good market or a bad, we're going to have a strategy in place to optimize that asset. And if demand were to soften, you'll do things to stimulate the sales pace to ensure that you hit your target to move through the asset. But it's not something we're expecting. And if it does happen, another thing that's good for us in our business model, if this trend of the consumer buying a bigger home in these more affluent areas, if they selected a 3,000-foot home and their purchasing power gets cramped a little bit by an interest rate, they'll go by the 2,800-foot home instead. They'll still going to buy a home. They want a home. So we can flex with this thing, and we're not troubled with the rates today. There's incredible demand outpacing supply in all of our markets right now. If it were to hit a point at some time where rates were to crimp the demand, then we'll react to that. But we have a lot of different ways to be fluid and flex with whatever market dynamics we have, and right now, they're very strong.

Got you. Last question. You continue to target the more creditworthy homebuyer and improving the over-all mix, and as your land base for those buyers diminishes both as you sell out of communities -- I know there's a given diminishing land availability for prime land -- can you help us think about your strategy and how you continue to plan to serve that segment?

Absolutely. Right now, we're growing our position in those areas and investing heavily as we shared with our prepared comments. So one of the beauties of the land-constrained markets we're operating in is that they're also where our best land teams are on the ground. And we're able to get deals done whether it's California or in Texas. We're getting deals done that others may scratch their head at because they don't have the relationship or the entitlement expertise or the understanding of the market. And not only is the strategy working, I think the fact that we grew our lot count owned and controlled by 8,000 this quarter tells you that we're continuing to find real opportunity even in these more desirable submarkets. If they run out of lots, that demand gets pushed to an adjacent submarket. So this isn't something that will go away because the zip code runs out of lots. It will go to a neighboring zip code. It just won't go to a zip code 20 or 30 miles away right now.

And your final question for today comes from David Goldberg from UBS.

I want to ask a bit of a theoretical question. I know we've hit on rates quite a bit and Jeff I agree with the assessment that rates really aren't crimping buyers today, and it's certainly not going to slow down the upturn at this point. But I guess what I want to think about is, in your experience as you look out and you look at the Studio business and you look at when affordability gets constrained, is that a place where buyers change their preferences? So if we think about moving to somebody's peripheral areas in the future -- I know it's not a 2013, I know, or even a 2014 story -- but as you look into the future, do you think we're going to see if rates come up and affordability gets less attractive or I want to think about it more constrained, do you think buyers are going to take less -- have less take from the Studio?

Well, this is theoretical, David. You and I have these debates over time, but the -- you're only telling part of the story. If rates go up, it's because the economy is better, for the most part. I mean, they may move up a little bit here and there with some of these other influences. But if rates go up, it's because price inflation's occurring, and that inflation's incurring because there's job growth. And if there's job growth, there's a better economy. So if rates go up, I think you'll see it's the result of a better economy, and you'll still have strong demand. If the economy is better, I think you'll see underwriting loosen up. And I've shared on this call now, qualifying from an income perspective and not the issue for a lot of the first-time buyers in particular today. They've been blocked out because the mortgage companies have elected to really tighten up on their underwriting until there's clarity on the direction of things. So if you unlock all that demand and rates go up a little bit, you're going to see even more demand than we have here today. And underneath all that, you have no supply, large demographics, a lot of demand and affordability that's still at incredible levels. And when I say the strategy is working, it's not just in Orange County for $800 million to $1 million. It's out in the Inland Empire for $400,000 or $500,000; and it's a Texas at $180,000; and it it's in Florida at $180,000 or $200,000. And with our business model, if they get maxed on their payment, they have the choice of a different-sized home, which a lot of them will do. Or instead of the granite, they'll take the extra bedroom. Or instead of the -- whatever, a separate tub and shower, they'll take a kitchen option for a bigger kitchen. And that's why our business model works so well, because we can move with the trends of the consumer, the demands of the consumer, the needs and continue to meet their lifestyle. I just said a mouthful. But there's a lot of things that play here, and they're -- there's a lot of push and pull and offsetting things. But underneath it, there's the underpinnings of a real recovery going on that I think is going to go on for some time. So we'll continue to navigate and pull the levers and work through it with the consumer.

And I appreciate the color, and it's good insight, I think, into the business model. The last question I had is something we've been thinking about, and I just want to get your view on this as effect to the industry and as effect to KB. I think we've had great home price appreciation. I think that's obvious in your numbers, and certainly, some of it's mix shift, some of it's real price appreciation. But if the rate of home price appreciation were to stabilize or even decline -- still stay positive, still have growing prices but not at the same rate -- how would that impact margins on a go-forward basis?

Well, it would soften whatever percentage of our margin expansion is, is tied to opportunistic price increases. But the biggest chunk of our margin expansion right now is what we're doing that because prices in a city are increasing. So if prices actually stabilize right here today and then go up further, we would love that opportunity. We'll continue to grow our margin and continue to grow share.

This concludes today's question-and-answer session. I would now like to turn the call over to Mr. Jeff Mezger for closing remarks. Please go ahead, sir.

Okay. Thanks, everyone, for joining us today, and we look forward to talking with you again soon in the future. Have a great day.

Thank you, everyone. This concludes today's conference call. You may now disconnect.