Kb Home Q1 FY2020 Earnings Call

Good afternoon. My name is Devon, and I will be your conference operator today. I would like to welcome everyone to the KB Home 2020 First 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. Now, I would like to turn the call over to Jill Peters, Senior Vice President, Investor Relations. Jill, thank you. You may begin.

Thank you, Devon. Good afternoon, everyone, and thank you for joining us today to review our results for the first quarter of fiscal 2020. On the call are Jeff Mezger, Chairman, President, and Chief Executive Officer; Matt Mandino, Executive Vice President and Chief Operating 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 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 factors outside of the company's control, including those detailed in today's press release and in 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.

Thank you, Jill. And good afternoon, everyone. We are finding creative ways to adapt to changing conditions as the country deals with the COVID-19 outbreak. While Jeff and I are in the office today, practicing social distancing, the rest of our team is on this call from different locations. These are unprecedented times and our main priority continues to be the health and well-being of our community of employees, customers, business partners, and their families. While we are reporting excellent first quarter results today that showed strong momentum across our footprint, given current market conditions, we are withdrawing our guidance for this year. Rather than follow our standard approach for these quarterly earnings calls, my remarks today will focus on how we are responding to the COVID-19 related challenges, the actions we are taking to navigate this uncertain environment, and the strength of our positioning to manage through it. We began the process early last week of temporarily closing our sales centers, model homes, and design studios to the general public. During this time, we have shifted to appointment only, following appropriate protocols to help ensure the health and safety of our employees and customers. We are also leveraging our virtual sales tools including home video tours, interactive floor plans, and an online design studio to give customers the ability to shop for new homes from the comfort and safety of their mobile device or personal computer. In addition, we are actively engaging with customers by phone, email, FaceTime, Skype, and other online tools. We are seeing an increased response to our digital efforts. Month-to-date in March, visits to our website are up nearly 50% and conversions to sales leads are up over 20%, both as compared to their respective prior-year periods. In addition to the temporary changes we have made at our communities, we have also shifted our corporate and division office functions to working remotely. We will continue to monitor the situation and follow the guidance of the Centers for Disease Control and Prevention, as well as state and local authorities. In most of our markets, there are restrictions on activities commonly called shelter in place orders. But these orders usually exempt residential construction, categorizing it as an essential activity. Our company is better positioned than perhaps we have ever been to deal with this type of disruption. The tremendous progress we made over the past three years under our return-focused growth plan has truly transformed KB Home. We are now a larger, more profitable company with a higher gross margin, supported by a solid balance sheet which has no goodwill and over $1.2 billion in liquidity. Our leverage ratio has steadily improved in the past few years and continued to progress in the first quarter, both year-over-year and relative to year-end 2019. In addition, we have a better mix of assets as a result of both our discipline in acquiring land as well as the ongoing reduction in our inactive inventory. Our approach to land acquisition has primarily focused on communities that provide a roughly one to two year supply of lots in preferred submarkets with price points that are attainable by the median household income. Our lots owned at the end of the first quarter represented a 3.1 year supply, based on our last 12 months of deliveries. In these challenging times, housing is an even more essential need as homebuyers want a place of their own for many reasons including safety, security, and health. Throughout the first quarter, low mortgage interest rates and a strong economy, together with limited resale inventory, fueled homebuyer interest and demand, holding steady for the first two weeks of March with our net orders up 7% relative to the comparable prior-year period. As news of the Coronavirus intensified and we temporarily closed our sales centers, traffic and sales slowed in the third week of March, with net orders now down a cumulative 5% quarter-to-date as compared to the prior year period. Our cancellation rate is currently healthy at 17% quarter-to-date, although both our order and cancellation rates could change as we go forward depending on how conditions evolve from here. With our built-to-order business model, our buyers are invested in their purchases, when we start their homes given the time they have devoted to selecting their lot, floor plans, and structural options, then personalizing their home in our design studios, along with obtaining mortgage approval. We believe this process helps to reduce our risk of cancellations after start. At the end of the first quarter, our backlog increased year-over-year to 5,821 homes with a value of $2.1 billion, up 28% relative to the prior year period. We remain in regular contact with our buyers in backlog, and with its high capture rate, KBHS, our mortgage services joint venture, gives us both an additional avenue to support and communicate with our customers, as well as better predictability to manage through the closing process. Operationally, the built-to-order model allows us to align our business to demand and build to our sales pace and not to a targeted delivery goal, minimizing our spec starts and mitigating inventory risk. Under this model, we also scale our land acquisition and development spend to sales. In addition, having already reduced our product offerings down in square footage to promote affordability, we have expanded the choices buyers have in our communities. Our long-tenured leadership team has successfully managed the company through a variety of economic cycles. One of the many benefits of this experience is learning to quickly adapt to changing market conditions. Given the uncertainties surrounding the duration and extent to which COVID-19 will impact the US housing market, we are focused on being both prudent and strategic with our cash resources. We continue to close homes with our quarter-to-date deliveries ahead of the comparable period of last year, providing us with cash inflows, and we are closely monitoring cash outflows. As such, we have curtailed land acquisition and land development for now. This public health crisis has interrupted many businesses and government services, and we have found land sellers and developers to generally be accommodating in extending closing dates. We are also shifting to more targeted phases of land development aligned to our sales pace. We have long-standing relationships with many of our land sellers and developers and we are working collaboratively with them to carefully and thoughtfully manage our business. In closing, we had an excellent first quarter, and demand remained resilient in the early weeks of our second quarter. Although these data points are in the rearview mirror, they do provide a good sense of the strength of our business and the strong desire for homeownership. We believe we are well positioned with a solid balance sheet, strong liquidity, an experienced leadership team that is communicating daily across our organization to ensure that we are focused on the right priorities with consistency. In addition, we have an effective core business strategy and a built-to-order model that provides flexibility and mitigates risk. I would like to thank all of our employees for their dedication at KB Home and determination to support our customers and each other. I also want to thank our trade partners, who have responded to the call from our company and our industry colleagues who participated in national campaigns by contributing protective masks and eyewear for our heroic healthcare workers across the country who desperately need these supplies. I'm confident in our team's ability to lead our company through this period of uncertainty. We look forward to the eventual stabilization of market conditions and updating you on our progress along the way. With that, I'll now turn the call over to Jeff for the financial review.

Thank you, Jeff and good afternoon, everyone. I will now briefly cover highlights of our financial and operational performance for the first quarter followed by comments summarizing the strength of our significantly improved financial position and the solid liquidity supporting our planned strategies to navigate through these uncertain times. The abbreviated summary of our outstanding first quarter performance is a strong reminder of how well we have continued to execute our differentiated strategy. This same strategy and level of execution drove the tremendous improvements in our profitability, returns, financial position, liquidity, and capital structure generated under the returns-focused growth plan we launched in 2016. Our performance during the first quarter and for the past several years gives me great confidence in our ability to execute during this market disruption. During the first quarter, we generated improvements in virtually all of our key profitability measures and ended the quarter with a robust balance sheet and installed liquidity. In short, it was a very strong quarter of financial performance for the company. Our first quarter housing revenues were up 34% from a year ago to $1.1 billion, reflecting a 28% increase in homes delivered, and a 5% rise in overall average selling price. Housing revenues were favorably impacted by our sizable backlog at the beginning of the quarter, which was up 24% year-over-year, as well as strong market conditions and outstanding execution throughout the quarter with several of our divisions significantly outperforming forecast delivery results. Homebuilding operating income of $60.2 million for the quarter increased 92% year-over-year from $31.3 million, and our operating margin rose 170 basis points to 5.6%. Our housing gross profit margin improved 30 basis points to 17.4%, including total inventory-related charges of $5.7 million in the 2020 quarter and $3.6 million in the year earlier period. Excluding the impact of inventory-related charges, our gross margin for the quarter was 17.9% compared to 17.6% for the prior year quarter. This improvement reflected the favorable impacts of increased operating leverage due to higher housing revenues and lower amortization of previously capitalized interest. These favorable impacts were partly offset by a shift in the mix of homes delivered for the communities with lower gross profit margins. Our selling, general and administrative expense ratio of 11.8% improved by 160 basis points from last year's first quarter ratio, mainly as a result of the increased operating leverage from higher housing revenues and our continued focus on cost containment. Our net income for the quarter was up 99% year-over-year to $59.7 million and diluted earnings per share more than doubled to $0.63. We ended the quarter with stockholders' equity of over $2.4 billion and book value per share of $27. Against this backdrop of our strong first quarter performance, I will now provide an overview of our current financial position. During last quarter's earnings call, we described several initiatives that contributed to the success of our returns-focused growth plan in achieving our capital allocation and efficiency objectives and improving our financial risk profile. These included measurably growing our total inventory investment while reducing our inactive inventory, substantially deleveraging our capital structure, and meaningfully expanding the borrowing capacity under our revolving credit facility. We obviously appreciate even more the significant progress we've made in these areas, given the current uncertain market environment. We believe our strengthened financial position and liquidity profile produced through our focused execution of these initiatives will provide financial flexibility and support our ability to capitalize on opportunities as we operate through this period of uncertainty. At the end of the first quarter, our leverage ratio of 41.7% improved another 60 basis points from the end of our 2019 fiscal year. Our net debt to capital ratio finished the quarter at just over 35%. In addition to the favorable impact on our leverage ratio, the refinancing activities completed in 2019 lowered the expected amount of incurred interest in 2020 by nearly $14 million and extended the weighted average life of our senior notes to just under five years as of the end of the first quarter. In January 2020, Standard and Poor's financial services upgraded our credit rating to BB from BB- and changed the rating outlook to stable from positive. We ended the first quarter with $430 million of cash and total liquidity of over $1.2 billion, including available capacity under our unsecured revolving credit facility. In addition, we had no outstanding borrowings under our revolver at any point during the first quarter and we do not have any senior note maturities until December 2021. As we previously reported, we completed an amendment to our credit facility in the 2019 fourth quarter, increasing its borrowing capacity to $800 million from $500 million and extending its maturity by more than two years to October 2023. Given the current macro environment, we are pleased with the additional financial flexibility available to us with this enhanced liquidity. During the first quarter, after investing $405 million in land and land development, we utilized only $10 million of net operating cash. We have consistently generated positive net operating cash flow in each year since 2015 while funding an average annual land investment in excess of $1.4 billion over that period. Our ability to efficiently and effectively react to changes in the market environment and control our level of land investment is a significant lever available to us as we manage liquidity. We expect to continue to make selective investments as we implement the land-related actions Jeff outlined earlier. In conclusion, as this unprecedented health crisis continues to evolve, we believe we are well prepared to navigate through this volatile period. We also believe that the combined strength of our built-to-order business model, consistent operational execution, and focus on offering affordable products will enable us to capitalize on the eventual return of more normalized market activity. Our financial position and liquidity profile are stronger today than at any point over the past decade, and we are proud of the many successful initiatives we have implemented to reduce our financial risk and enhance the quality of our balance sheet. We will now take your questions. Devon, please open the lines.

Thank you. At this time, we will be conducting a question-and-answer session. Our first question comes from the line of Alan Ratner with Zelman and Associates. Please proceed with your question.

Hey guys, good afternoon. Thank you for the time and hope you're all doing well and the team is doing well. First, I guess questions here just digging in, thinking about the backlog, the 5800 homes there. Just curious if you could just talk a little bit about that. Obviously a lot of focus on getting those homes delivered, and it's encouraging to hear March closings up year-over-year. Can you talk a little bit about maybe the percentage of that backlog that was scheduled to deliver in the upcoming quarter and kind of what steps you're taking with those buyers and backlog to hopefully facilitate them getting to the closing line there? And on the homes that are newer, maybe haven't been started yet. Are you doing anything differently there as far as maybe putting off starting those homes or anything along those lines that might be mitigating some of the potential cancellation risk in the future?

Sure. A lot of questions, Alan. I'll do my best, really just give you a state of play on how we manage our backlog. As you know, our backlog is typically 5 months to 5.5 months' supply of deliveries and a portion of that is in the unstated bucket and the rest is scattered from foundation to final. We try to get into a rhythm of even flow deliveries, monitoring the backlog and starts. A couple of things for you. We are continuing to complete homes, and as I shared, our March closings are ahead of last year. The title companies, the mortgage companies, escrow companies, city finals, everyone's finding ways to creatively accomplish their tasks along the way. One thing I tried to communicate in my prepared comments, the buyers definitely want to close. We have a very motivated buyer right now that values home ownership and the safety and the security that goes with it. Because of the protocol and the social distancing, there are fewer subcontractors working in the homes today. So we are expecting that as we get deeper into the production cycle, build times will extend a little bit, in that you can't have three or four different contractors in the home at any one time. We're working right now to spread out the production capacity so that we don't have these chunks where you're just stuck, because you don't have the capacity with the subs being spread out. And so we're extending out the web cycle. Right now we're closing homes that were all within 30 days of completion as of March 1, and that'll be the first priority. As we extended out a little bit, then we will follow that up on the start side with the unstarted backlog. All of that is predicated on the quality of the backlog and what are the conditions that we're seeing on the ground. Frankly, you need the city situations all have a different story right now on what kind of shutdowns they have, how the economy is working, how the COVID-19 cases are, what level they are, and how it's impacting things. So, very fluid; it's a daily focus, and right now, our backlog is pretty stable.

All right. I appreciate that. That's very helpful. Related to this, I guess, but the mortgage market. That's obviously very important getting those homes closed. It seems like there's a lot of turmoil going on, especially in the secondary market and in the servicing side of things. I'm not sure if that's impacting your buyer's ability to get loans, but we have heard some originators are actually putting in some overlays to kind of mitigate their risk in terms of selling the loans. Just curious if you could talk about; I know it's changing every day, but how is the mortgage market right now in terms of your ability to get loans closed?

We are closing homes, so that’s not a concern right now. There has been some minor activity regarding new requirements from investors, servicers, and equity line mortgage companies, but none of these changes are significant. We are continuing to operate smoothly. It’s reassuring to have a business partner performing well. The Federal Reserve is clearly dedicated to maintaining liquidity in the mortgage market, actively buying mortgage-backed securities daily, with reported purchases of $50 billion just yesterday. There’s plenty of liquidity available, and the process is functioning effectively for us, so it’s not a problem at the moment.

Our next question comes from the line of Truman Patterson with Wells Fargo. Please proceed with your question.

Hi, good afternoon, guys, and thanks for taking my questions. First, I wanted to start off, thanks for giving March order trends. We've heard from contacts that orders have stayed fairly elevated due to prior backlog and prior contacts. But looking more near-term and maybe I'm splitting hairs. Could you maybe parse out how traffic has actually trended in the past couple of weeks on a year-over-year basis?

Yes, it's hard to compare that, Truman, because we closed our sales offices last week. So any walk-in traffic we may have seen, we didn't want to see to keep our employees safe. We'd love to be in the right conditions, but we shut our doors last week. The traffic in the leads that we're working right now are all internet-based and by appointment only once we get past the internet process. On the internet side, things are doing fine. I shared we're up year-over-year on internet leads, but we have closed the doors for walk-in traffic.

Any way you could net those out between the walk-in traffic and the internet traffic?

I mean, it's really hard to do that because it's corresponding to all that. It's a hard thing to...

Okay. And then positive, you all are managing your cash flows. Could you just discuss how you're pulling back on the land spend? Are you rotating more toward option land? Are you doing the land closing dates to purchase, or are you just really pulling back on land altogether?

Good question, Truman. For starters, for all the questions we get, I just want to remind everybody, it's very fluid and this hasn't been around that long. Our earnings release we just put out was based on results that ended 25 days ago. So we're 25 days at the end of a very successful quarter and now navigating through all this disruption. Our view right now has been to buy time. We're not going to people and negotiating discounts. We're not doing anything like that. Let's all work on this and buy some time, and in the process, we curtailed spend on entitlements, which can add up to a lot of money across the system in many cities; they've canceled the public hearings in the short run. So why spend money on an engineer if you can't get a map approved? We've stopped all that. But we're continuing to poke around on the land search side. But right now, we'll be a little more cautious with commitments and we're working with our partners on land selling and the land developers. Let's just pause, give us some time, and let's see how things settle out over the next 60 days. That's our primary focus right now. Through that process, you're going to spend less on land in the next 60 days.

Our next question comes from the line of Mike Dahl with RBC Capital. Please proceed with your question.

Hi, thanks for taking my questions. And first and foremost, I hope you all and your teams are staying safe and healthy. It's good to see you taking a proactive approach here. I guess, I just wanted to ask first a little more detail about how you are approaching the appointment process when it comes to new sales. Because on your website, it simply says that things are temporarily closed, but it sounds like maybe you're funneling then internet leads into still some in-person visits to the sales center. Can you just walk us through that a little more? What is the process to get someone into a model home at this point for an in-person visit? And likewise, give us a little insight into then the design center phase, which ends up being pretty crucial to your closing process?

Sure. What we're already finding, Mike, is this is making us a better company in that we're testing our brains and virtual selling and the internet far more than we did a couple of months ago. The buyer is responding. It's also changing the buyer's thought process on what it takes to acquire a home or go through the personalization process. So we've closed our sales offices to walk-in traffic. The first priority is the safety of our employees and in turn, our customers. So we're complying with everything, and we thought we'd move quickly and close to walk-in traffic. Past that, if we have a sales office with two sales consultants in it, they are actively working remotely right now through all the virtual tools we have, the online tools, communicating with people, demonstrating the product. Our criteria is, if you get through all that and the buyer expresses an interest in visiting the model park, and our sales team in that location is comfortable, we will go ahead and show them the models, complying with all the CDC protocols. Interestingly, on the studio side, people are very comfortable making their selections online that we actually finalized in our studio last week, 225 buyers that went through the process, and we're finding things we can do along the way, like our carpet supplier, a great partner, is willing to ship samples of what they selected. So there's a lot of things going on right now, but the studios are functioning well in a remote prospect.

Okay, that's really helpful. And then my second question, you've mentioned a handful of times now how fluid it is and I think we all understand that. With respect to the shelter in place order, it's good that initially largely construction was exempt. But we've heard a couple of instances where construction is initially exempt, but then there is some question of whether or not there has been some shift in that, where areas are going to rethink construction and whether that should be exempt. Have you seen in any large markets that have initially kind of exempt construction, but now you're hearing that may end up being more restrictive?

Yes, Mike, as you touched on, it is very fluid. Unfortunately, this process in many cases, whether it's a state order, a city order, or the federal order, is not clearly written. So there is a lot of interpretation. As the order comes down from the governors to the mayors or the county commissioners, it's all subject to some of these interpretations in a way the bills are written. There are cities where an order would come out and we would interpret the order and say that you can't work, and our industry would work with that governmental entity and they would clarify it. Now, it's okay, you can go to work. There's others where we thought it said you could work and they've come out and said no, you can't work. As we're sitting on this call, this is moving around by the hour. As we sit on this call, right now, the Seattle Metro, King County has shut down to construction. They made the decision there that it's not an essential business. For us, Seattle is not a very big part of our business. We would like to see it open so we can continue to advance our progress there. Other than those two anecdotes, I'm not aware of anything where there is a conflict today. We are open for business here in the State of California, where you can actually read the rules, and it suggests even to the customer that it's okay to visit the community, because it's an essential business. So it's pretty varied out there.

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

Thanks very much guys. Obviously, very unusual time. My question relates to how you're adjusting your pricing in this highly unusual time. Now in your case, because you've shut down your sales centers and that sort of thing. Maybe the answer is a two-stage answer. But my question is effectively, this demand drop-off is not really tied to price. Typically, when sales approach, division presidents modulate price and discounts to maintain a certain level of pace. As you move forward and hopefully get to a more normalized environment, are you going to continue to leave the pricing decisions up to the division presidents? Or are you preparing to address pricing in a more centralized manner so that you don't have price cuts or increased discounts, which would be done to try to raise traffic or volumes when that's not really the issue keeping volumes down?

Stephen, that's a good question. You're absolutely right; it is different right now. We're not slowing down in demand, because of subprime mortgages or a pop in pricing or lack of demand or anything like that. It's this terrible pandemic and a government decision. It would depend on the duration. Right now, in the short run, we're taking the view that we have a nice backlog to continue to generate revenue out of. We don't have a lot of inventory out there to liquidate. So we don't see an urgency to do anything with price today. If anything, the inventory has a higher value today, if there are people out there who want to move into a home very quickly, because of these health and safety concerns. Our view right now is, let's take our time, wait until there's clarity, continue to sell homes like we are, continue to monitor our backlog for deliveries, which we are, and depending on how things settle in each market will revisit it. Unless this thing is really extended, I don't see major price moves here. This is more about timing and the quality of the process with the customer.

Yes, that's encouraging. And certainly, we don't hear of anything suggesting that pricing industry-wide has been weakening. That's good to hear. Now you've said that cancellation rates have held steady; buyers are motivated to close. Assuming that's because in part, they see pricing is holding steady. My second question relates to how this may play out in terms of the existing home market influencing the new home market. Typically, the existing home market and the new home market tend to move somewhat together since they're both tied to similar economic factors and consumer confidence. But today is different. The new residential construction market is much better equipped to deal with social distancing than the resale market. It looks like, this could continue to depress existing home transactions and be a problem in the resale market much more so than the new market. Are you concerned, are you preparing in any way to educate your division presidents or your buyers not to be reactive if you see pricing from folks in the resale market, who really do need to sell cutting their prices? Are you worried at all about that bleeding over into the new market, or do you think that there is an ability to keep that separation, keep that somewhat quarantined to the resale market while the new market is able to retain pricing?

I'll actually add another one, Steve. I think you're going to see a shortage of listings because you have people that are content with the safety and security of their existing home. Whenever this settles and goes back in the other direction, I think you'll see a tighter resale market than you have even today, because people aren't necessarily putting their home on the market. On the other side, we're doing what we can to maintain the infrastructure and the subcontractor base and the momentum we have. Whenever it settles, I'm an optimist about the housing market. I expect that when you get out the other side of it, there is going to be strong demand from people really wanting to own their own home. So we want to be ready for that.

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

Hey, thanks, good afternoon. I wanted to first ask about the supply chain. Do you see anything on the horizon, whether it's imported materials from China or other markets? Anything that could be disruptive in terms of continuing to the cadence of home closings that may or may not extend out here in the coming weeks?

Yes, Buck, we're not seeing any disruptions right now. When this thing first hit in China and the ports were closed and they didn't have trucks to move the product to the ports, we quickly mobilized with all of our suppliers to understand their pipeline and product availability, and many of them have more than even a year of supply of their products. We didn't see any real signals that the supply chain was going to be too tight and that's certainly how it's playing out for us today. We're not seeing any issues whatsoever. If anything, if you think about it, with the drop in Chinese demand for product that may even help availability here in the US right now. Another soundbite— we'll see how it plays out. As China's growth stopped, their demand for lumber stopped with it. The Canadian lumber markets have a lot of inventory right now. So that pressure that we saw in lumber occurring in the first couple of months of this year may actually end up going the other way due to the inventory that's building up right now. It’s fluid as everything else we're dealing with, but right now, we're not seeing any real cost pressure on supply in the last month and product is readily available.

Okay. Very helpful, thank you. And second one, if you could parse out maybe kind of in the first few weeks of March. We're just hearing that the entry-level communities and further down price points seem to be holding up much better through the early weeks of this crisis. Is there still a lot of demand? Have you detected anything like that or have any corroborating evidence that the entry-level is doing better?

I do think it is interesting that we didn't comment on it in our prepared remarks, but our first-time buyer percentage did pick up in the first quarter. We're now at 57% of our deliveries, so it's slightly higher than it was. I would say that because it's always been a big part of our business and it could speak to why our sales have held steady in March. I was observing the other day to somebody here in the office, if I'm living in a one of those semi-downtown towers with a common hallway with 20 other renters, I'd much rather be in my own home in the suburbs right now. I think we will see more of that going forward.

Our next question comes from the line of Matthew Bouley with Barclays. Please proceed with your question.

Good afternoon and thanks everyone for all the details through this. I wanted to ask on the traffic side again. Just that strength in website traffic and reconversion, presumably a lot of that is just replacing the in-person traffic. But is there any scenario where you might consider building anymore spec to perhaps have some product available? If and when there is a recovery or kind of status quo and if this gap in sales however long it is kind of cleanly flows into closings in five months, how do you guys think about that?

Right now, Matthew, I'd like to stick to our business model. Our margins are higher on our built-to-order sales, have been for years, and we believe that's the right way to go. I'll never say never, because there could be some community somewhere where it makes sense to do that. But right now, we'll stick to our process and make as much money as we can for us.

Okay, got it. Thank you for that. I wanted to ask on the community side, presumably with sales and model closures and delays, are there any numbers you could put around that if there is a backlog of community openings that might emerge that perhaps would be available to open later in the year?

We don't know what the community openings will look like going forward. However, our process is continuing forward on the grand openings. We're not having big grand openings as in the past, where we're gathering hundreds of people around, balloons and hotdogs. But we're opening the communities; we're not opening up big community openings. There may be other external things that could prevent us from opening, but we're certainly trying to move ahead with the openings and keeping the business running.

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

Hey, guys. Thank you for taking my questions here as well. The first one is I'm just curious how much skin the typical KB buyer has in the game in the sense of what are they putting down for a down payment. Is that down payment generally refundable? In certain situations, if the down payment was not refundable in the past, are you guys making exceptions today given the extenuating circumstances and the pressure on the consumer?

If they can't qualify for a loan, we always refund the money if we haven't started the home and they changed their mind. We'd like to keep them for another day. So you'd refund the money and past that, our deposits vary by city. If the homes completed and the loans approved and they don't want to perform at this time, our first step would be the same pause that we're doing with land sellers. We're going to offer them a 30-day, 60-day window. Okay, let's call it a time out. Keep everything ready to go. Let's see how the world settles. Our first step right now is not managing the deposits, but managing our customers and keeping them in the game.

Okay, that's helpful. And then understanding that this is going to be project by project and community by community, but is there a rule of thumb that you guys think about where a margin based on gross margin, what pricing on a project would have to go in order to trigger an impairment on the land?

Look, on the impairment side, there are three big factors surrounding it. One is the macroeconomic situation and what we're seeing right now is completely different than what we saw probably in the last downturn. Big downturn for housing is not financial sector driven. We don't believe we'll see the same level of distressed inventory. We don't have the easy credit situation, and everything else. So, I think everything is pointing to much better conditions in the macro. If you look at our land portfolio and the quality of our land portfolio, that's also improved tremendously. We've been pretty cautious with land investments. We're still investing in the best submarkets, relatively modest lot counts, we're staying right down the middle of our strategy as far as setting up our communities to be at the low price points with shorter duration land positions. The second component is that our land portfolios looking very positive. And finally, kind of getting to your question, if you look back over the last 12-month period, our gross margins are right around the 19% range. At that level, there is still quite a bit of room before you start discounting to the cash flow becomes negative. We do have other levers available to us instead of just simply cutting price; we certainly look at the size of homes we're building and offering and cost reduction strategies. We think we're quite a ways away from that. We think there's a lot of room in our pricing. It's always at risk when there's market disruptions, but we believe we're much more favorably positioned than at any point in the last decade.

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

Thanks. I appreciate it and I hope everyone is healthy and safe. First question I had was maybe just kind of circling back and talking a little bit about the backlog from another perspective. Obviously over the next month or two, you know, there is going to be dramatic changes in the country with regards to unemployment, and I'm sure you might have seen the unemployment claims spike. I was just curious if you've talked about being proactive or working with different buyers; if there has been any initial efforts over the last week or two around reaching out to whatever percent of backlog it may be that might be more susceptible to some of the employment trends or some of the tougher industries being hit right now. If you have any early sense around what percent of the backlog might be in that susceptible or subject to those types of tougher to hit industries?

Yes, Michael. A few things come to mind. When considering the headline number, it's important to recognize that, not just in California, the figure was 87,000 in the state. While this is a significant number, it's a relatively small percentage. Regarding buyer behavior, we are often one of the first calls they make after losing their job. They may feel disappointed and are aware that they can't proceed, leading them to either advocate for themselves or seek another job while hanging in there. We quickly learn if people have lost their jobs or if their circumstances have drastically changed. One advantage we have from partnering with a mortgage company is a much higher capture rate. I haven't noticed any concerns regarding delays within the industry or in cities experiencing a lot of cancellations. If unemployment stays at this level for an extended time, we might expect higher cancellation rates, but we haven't observed that yet. We're monitoring the situation on a daily and weekly basis and approaching it logically.

Okay, understood. My second question was just kind of more around personnel management and kind of a tough question. But obviously, there's a lot of uncertainty in terms of length of this downturn and also the ability for the economy to bounce back. I was just curious if you look at your business, today it's pretty premature to think about adjusting staffing levels or anything of that nature or perhaps even furloughing or whatnot. But are there any thoughts around if this were to last for another three months, six months and the recovery might be at softer levels, given if there is persisting unemployment? I don't mean to be too gloomy of course, but I was just trying to get a sense for the flexibility that you might have in your personnel be it across the sales centers or the design studios or other parts of the fixed cost structure chain. If that's something you've started to give any thought towards.

Two opening thoughts. One I already shared is the safety and security of our employees is the top priority for us, and for me around here. The second top priority for me is a very strong desire to maintain the organization that was operating at such a high level 25 days ago. We have a very strong machine here, and it's a credit and a tribute to the employee base. We're going to do what we can do to retain and motivate and reward the employee base. If it's a short cycle, you just keep everybody and you go back to work. If this thing extends out for months and months, we have shared that our build pace then our land pace is tied to our sales pace. If your sales pace is six months or eight months out, you expect to be off dramatically. You have to do what you can unfortunately to preserve and protect your profitability in your organization. I think it's way too premature to go out there. Right now, our view is let's maintain this organization that's operating so well and cut our overhead where we can, and see how things go as they start to settle.

Our final question comes from the line of Susan Maklari with Goldman Sachs. Please proceed with your question.

Thank you. Good afternoon, everyone, and thanks for squeezing me in. My first question is just can you give us a little bit of color around what you're seeing in your Vegas communities? Has anything changed there significantly and how you're thinking about that market? Obviously, given its reliance on tourism and travel.

As you know, Susan, Vegas is a top-performing business for us. It's a big business and even in March had good sales. It's like the comments I just made to Michael; we're not seeing a big rush of unemployment yet. Our backlog is still relatively stable. We're closing a lot of houses in Vegas. It has been slack because of the industries that are there. It has the potential for more layoffs, but the steady state is more diversified than it was. So it's not just casinos anymore; we're monitoring it. It's too early to call right now, but that team is one of our best at reacting to market conditions. We will deal with it as it comes up.

Okay, thanks. And then my second question relates more broadly. Given the change in how you're communicating with buyers and trying to get buyers through the website and traffic such as that, have you made any changes to the marketing strategy or your marketing approach? How are you staying top of mind with potential buyers, especially as we think about new community openings and not having the same kind of event to attract them?

We have shifted almost totally to internet-based advertising and there is very little spend anymore on radio, newspaper, magazine, all the old traditional things that we did over the years. As we continue to refine and enhance, we know which vehicles online get us the most leads and sales. You're constantly refining your spend in online marketing to what you know works. You can geo-fence your traffic, so you know the buyer profiles of who is buying in that area, as you can target them with your most effective online outreach. It's working pretty well. It's an interesting process right now, and we're still learning from it. It's going to make the industry a lot better. Finally, we're able to use technology to promote our homes as opposed to a billboard in a newspaper.

Ladies and gentlemen, this concludes our question-and-answer session, as well as today's conference call. We thank you for your participation. You may now disconnect your lines and have a wonderful day.