KB Home (KBH) 2003 Q1 法說會逐字稿

Please stand by.

Good day, everyone. Welcome to the KB Home first quarter earnings conference call. As a reminder, today's call is being recorded.

KB Home's discussion today will include certain projections and forward-looking statements in order to help investors better understand KB Home's business prospects. These are based on their assessment of current business and operating conditions. Please be aware that actual results may differ from those that may be expressed or implied by the projections and forward-looking statements, and the differences may be material.

These discussions in the company's annual report on the from 10-K, quarterly reports on from 10-K, and current reports on form 8-K filed with SEC identify various factors that could cause actual results to differ from those that KB Home will be projecting in the forward-looking statements that will be made today, and we urge you to read those.

I would like to remind everyone that this conference call is being Webcast on KB Home's Web site at http://www.kbhome.com. Again, that URL is http://www.kbhome.com.

For opening remarks and introductions, I'd now like to turn the conference over to KB Home's Chairman and Chief Executive Officer, Mr. Bruce Karatz. Please go ahead, sir.

Thank you. Good morning to everyone and thank you for joining us today to discuss our record results for the first quarter of '03. With me this morning are Jeff Mezger, our Executive Vice President and Chief Operating Officer; Dom Cecere, our Senior Vice President and Chief Financial Officer; Bill Hollinger, our Senior Vice President and Controller; and Jim Gonzalez, our Vice President of Investor Relations.

Our agenda this morning will cover the following topics: First, I will provide some highlights of our record financial performance for the quarter and comment on the current state of our business. Then I will turn it over to Dom to review our first quarter profitability and other key financial information. And, finally, I will be back to wrap up with our business and market outlook for the rest of the year. At the conclusion, of course, we'd be happy to address any questions you may have.

2003 has started out as an exciting year for KB Home. Our strong first quarter results set new company records and contributed to KB Home, achieving 31 consecutive quarters of meeting or beating analysts' expectations. In addition, just after the end of the first quarter we expanded our operations in the Southeast with the acquisition of Colony Homes. We now operate in nine U.S. states, comprising 22 of the highest growth markets in our country.

As we continue to pursue expansion in new and existing markets, our KB Next operating model continues to guide our business at all levels of the enterprise. With KB Next, we have continued to improve the quality of our business and post new records of achievements on our financial scorecard quarter after quarter.

The first quarter of '03 was no exception. Total revenues for the quarter rose to $1.09 billion, up 20 percent from $916 million a year earlier, driven by a four-percent increase in unit deliveries and a 13-percent increase in our average selling price. The company's operating income for the quarter increased 27 percent to a record $90 million from $71 million in the same quarter last year. This increase was fueled solely by improved operating performance in our construction business.

Net income for the first quarter of '03 rose 24 percent to $53 million from $43 million in the first quarter of '02, despite a $2.9 million after-tax charge for the early retirement of high cost debt and a negative after-tax impact of $3.1 million due to an accounting change in our mortgage banking operations. Our diluted EPS rose 32 percent to $1.25 for the first quarter from 95 cents a year earlier, feeding consensus [Inaudible] estimates, which were at $1.16.

Our backlog at the end of the quarter of over 13,000 units was valued at $2.6 billion, up 14 percent from $2.3 billion in the same period last year. This was a record for any first quarter in our history. Our after-tax return on invested capital remains well above our cost of capital at 17 percent, almost triple the average for the S&P 500.

Our financial liquidity remains solid, with a net debt to total cap ratio of 45 percent and a 12-month rolling interest coverage ratio of nearly six times. The issue of 7.75 percent, $300 million of senior subordinated notes during the quarter, enabled us to redeem our $125 million nine and five-eighths senior subordinated notes, reducing our cost of debt by approximately 200 basis points and extending our maturity by four years. And in the first quarter, we repurchased 500,000 shares of our common stock at an aggregate price of $23.8 million.

Our average diluted shares outstanding for the quarter were 42.3 million, down 2.7 million, or six percent, from 44.9 million shares in the first quarter last year. We still have a board authorization to repurchase an additional 1.5 million shares.

Now I'd like to comment on business conditions in the various markets in which we operate. First of all, housing is a regional basis; I might say a local business, in which KB Home operates primarily in the growth regions of the United States. While there may at times be regional weakness, we believe this would be mitigated by our geographic diversity and the fact that we primarily target growth markets.

We anticipate demand for our homes to continue to be healthy for the foreseeable future, driven by population growth, employment growth, and the strength of new [Inaudible] formations in these markets in particular. In the first quarter, our U.S. net orders of 5,686 were up only one percent over the first quarter a year earlier, causing pause for concern by some industry spectators. While some regional markets may have slowed a bit, there are no apparent signs of a significant industry slowdown.

Indicators such as excess inventories, a change in the competitive landscape, changes in consumer preferences, increased interest rates, a shortage of demand or an issue with affordability all remain favorable for large public builders. In the first quarter of 2003, our community counts in the U.S. averaged 263, up about 17 percent from our average community count of 225 last year. Our sales per community, which is one of the highest in the industry, averaged seven units per month in the first quarter of this year and eight units per month in the same period last year.

This apparent slowdown in sales per community was driven by a 16-percent rise in the average selling price in our West Coast region, resulting from strategic price increases made to intentionally slow down demand and maximize returns in a land-constrained market. In addition, we saw some softening in demand in our central region, which encompasses Texas and Colorado.

Net orders in the Southwest, which includes Arizona, Nevada, New Mexico, were up 28 percent, driven primarily by higher community counts, which were up 18 percent, averaging 72 sales per quarter. Averaging 72 community count per quarter.

As I previously mentioned, we continue to pursue our expansion program in the Southeast. This week, we announced our acquisition of Colony Homes, one of the largest privately owned homebuilders in Georgia and North Carolina. Last year, Colony generated revenues of $244 million and delivered approximately 1,900 homes. At the time of the acquisition, Colony controlled over 8,000 lots across its three markets.

Colony, along with our Florida acquisition of American Heritage Homes last year, gives us a strong foothold in the Southeast. This time last year, KB Home's presence in the Southeast was only in Jacksonville, where we delivered 565 homes for the full year. We fully expect unit deliveries in the Southeast to exceed 3,500 units this year and approach 5,000 units next year.

In summary, business remains good in the homebuilding sector, where growth continues to be driven by market share of the large public builders in a still highly-fragmented $230 billion market. And we had another great quarter with revenues up 28 percent, EPS up 32 percent, and our return on invested capital remaining solid. Our construction business delivered outstanding results, beating street expectations, even after absorbing the impact of an accounting change in our mortgage banking operations and a charge relating to the early extinguishment of debt.

I'd now like to ask Dom to take you through some of the financial results of the quarter.

Thank you, Bruce.

If you would please turn to our exhibit labeled "Consolidated Statements of Income." The company's construction revenues for the quarter reached $1.08 billion, up 20 percent from the same quarter of 2002. We delivered 5,263 units in the first quarter, up four percent from 2002. The overall average selling price for the quarter rose 13 percent to $201,700 driven primarily by a 16-percent increase in the West Coast region, where we implemented strategic price increases a 14-percent increase in France , primarily resulting from currency translation effects.

Our construction operating income for the first quarter of 2003 rose nearly 38 percent to $87 million. The housing gross profit margin for the quarter was 21.5 percent, up 150 basis points year over year. Our Selling, General and Administrative expense ratio in the first quarter was up 70 basis points to 13.6 percent in 2003. The increase in SG&A cost came from up-front expenses related to new community openings and investments to expand our market presence in the Southeast.

Mortgage banking pre-tax income of $3.7 million was down in the first quarter of 2003 from $8.2 million in the same quarter of 2002. This decrease resulted from a negative impact of $4.6 million in the first quarter related to the adoption of Statement of Position No. 01-6. SOP 01-6 requires that servicing rights income be recognized when the related loan is sold rather than upon the loan closing, as was permitted under previous accounting guidance.

This [Inaudible] the mortgage banking operations and recognition of income from the sale of these servicing rights for loans. Then it originates into the following month, when the loan is sold.

Net income increased 24 percent to a record $53 million in the first quarter, up from $43 million for the same quarter of 2002. Included in 2003 net income was an after-tax charge of $2.9 million related to the early retirement of $125 million, of nine and five-eighths senior subordinated notes, and the negative impact of $3.1 million resulting from the adoption of SOP 01-6 just mentioned.

First quarter EPS of $1.25 increased 32 percent from the year earlier quoted EPS of 95 cents due to improved performance in our construction business and six percent fewer average diluted shares outstanding. The early retirement of debt and the accounting change in mortgage banking impacted the EPS by 14 cents, reducing the reported EPS from $1.39 to $1.25 in the quarter.

Turning to our balance sheet, the company closed the quarter with approximately $254 million in cash, versus approximately $196 million at the end of the first quarter of 2002. Inventories of $2.31 billion were up 16 percent over the prior year quarter. Included in inventories were 113,700 lots, up 31 percent from 86,573 lots this time last year. Approximately 48 percent of our lots are now under option contract. We continue to focus on a just in time land development to maximize the number of lots under our control and at the same time minimize the capital invested in land.

Now if you would please turn to our exhibit of "Supplemental Information."

During the first quarter, the average selling price for our U.S. operations rose 14 percent on a year-over-year basis to $209,000. The continued shortage of housing in California drove prices in the West Coast region up 16 percent, while prices outside California remained relatively flat.

Finally, we ended the quarter with a healthy total company backlog of 13,309 units, with a dollar value of approximately $2.63 billion, up 14 percent. For 2003, our revenue and profit outlook remain favorable. We had a strong first quarter, with revenues up 20 percent and a quarter end backlog at a robust $2.63 billion. In the remainder of 2003, we expect to see top-line growth from the AHH acquisition completed last year and the recently acquired Colony Homes. Our profitability will continue to be driven by our adherence to the disciplines of the KB Next operating model.

We are currently completing the purchase accounting for Colony, which we acquired for approximately $142 million, including the assumption of debt, and are now focused on integrating the business and converting it into KB Next in 2003. While 2003 will be a transitional year, we expect Colony and American Heritage Homes to contributed significantly to our results in future years, due to expected synergies, once we integrate their local marketing knowledge and land positions with the strength of our KB Next operating model and uniform approach to market.

Now I will turn it back to Bruce for the wrap-up of our first quarter conference call.

Thanks, Dom.

Over the last 10 years, KB Home in the U.S. has transformed itself from a small cap regional builder with operations only in California to a national builder operating under one brand and one business model in Arizona, California, Colorado, Florida, Georgia, Nevada, New Mexico, North Carolina and Texas. Our company-wide revenues have grown from $1.1 billion in 1992, with $45 million in pre-tax profits back then, to projected revenues approaching $6 billion, with projected pre-tax profits of approximately $500 million this year.

Ten years ago, we had 39 million fully diluted outstanding shares, and today the count stands at just over 42 million. We have been able to grow our company five-fold in revenues, driven by our focus on high returns and the best deployment of our free operating cash flow.

Today, we are in an economy that has been coping with uncertainty, as a quarter of strength has been followed by a quarter of weakness. Business has been struggling to try and gauge demand for goods during these uncertain economic times. The biggest factor holding back the economy's recovery is the reluctance of businesses to make big commitments and [Inaudible] capital spending, due in part on the uneasiness about war and the general uncertain business environment.

Federal Reserve Chairman Alan Greenspan says he's hopeful that once geopolitical uncertainties lift this factor will be resolved. Even with a weak economic front, the housing market remains in relatively good shape. While sales of new homes in the U.S. fell by 15 percent in January to an adjusted annual rate of $914,000, the sales of previously owned homes, the biggest chunk of the housing market, hit a monthly record high.

If interest rates rise, it would probably be due to improvement in business activity in a resurgent economy which would offset any dampening effect of slightly higher mortgage rates. The net effect on housing, I believe, will be relatively limited. In the meantime, our balance sheet should continue to strengthen, with strong operating earnings flowing through to shareholders' equity and key borrowing ratios improving.

It's only a matter of time before the rating agencies realize the investment grade performance ratios we have already achieved are sustainable and our competitive advantages in the marketplace are real. Despite the weaker economic outlook, we are confirming our 2003 guidance to deliver double-digit revenue and earnings growth this year. Revenues are expected to approach $6 billion in 2003, and our earnings per share is forecasted to grow to approximately $8 per share, up 12 percent from the $7.15 posted last year.

We expect to continue our focus on profitable growth and high returns on invested capital, generating substantial free cash flow. We plan to maintain a balanced approach to the use of our cash. Repurchasing shares of our undervalued stock, expanding organically to increase market share, and opportunistically acquiring other builders to expand our footprint and add to the continuing industry consolidation.

With that, our formal remarks are concluded, and I'd be happy to open up the lines to your questions.

Thank you, Mr. Karatz. The question-and-answer session will be conducted electronically today. To ask a question, simply press your star key followed by the digit one on your touch-tone telephone. Please keep in mind if your mute button is on, please turn that off to make sure that your signal does allow our equipment.

Again, it is star, one at this time, if you do have any questions or comments. And we'll pause for just a moment.

Our first question will come from Ivy Zelman with Credit Suisse First Boston.

Good morning, everybody.

Hi, Ivy.

Great quarter, Bruce.

Thank you.

I actually had a few questions. But one easy one, I hope, is that you obviously had a much better quarter than what the consensus was. And yet you didn't raise the guidance. If you look at the operating earnings of $1.39, shouldn't we be raising for the full-year expectations as a result of this quarter? That's the first question.

You know one is - I wouldn't get carried away. We're talking about, what, a dime or something like that. So, you know should this continue, I think that's a reasonable expectation. But we are sitting in an uncertain economy. So I think today, to be prudent, to keep the guidance where we've given it.

OK. The second question relates to your options. You have 48 percent options. There's been some speculation that a lot of builders are using what is called specific performance options, where there is a contingency. Does KB use any specific performance options?

Ivy, this is Jeff Mezger. If you're referring to a specific performance guarantee, we do not structure our land deals that way. There are options where we will put a deposit up, and if things change and we decide to walk, we have the flexibility to do that.

OK. And, Jeff, roughly, what do you think the deposit and what premium do you think you'd pay for those options, roughly?

I couldn't give you a number here, Ivy. It's deals-specific.

I mean is it five percent, 10 percent...

You're saying paying a premium to get an option, as opposed to going in and buying the property?

Correct.

You know, first of all, the option business is very much location-oriented. There are certain places where it's common to operate like that. And we, along with others, do that. We don't believe that the prices that we're acquiring in [Inaudible] under option contracts is above market. You know we wouldn't do that.

But - so I think it's really one having your whole acquisition team focused on the fact that we are a return on capital oriented company. And we've gotten that message across. Which means, you know, people selling land, it's transaction by transaction. But unless you ask, you don't get. And we want to try to use the least amount of capital in acquiring our land and turning those assets the fastest.

I do not think - and it would be almost impossible to calculate - I do not believe you pay any more when you pay on an option contract than you would if you were just to write them a check. And it might sound curious to Wall Street, but I think that's the way it works in the real world.

OK. And then, lastly, Bruce, you know one of the things that, you know, some markets in especially west of the Mississippi, it looks like, and many of the markets that you're in, Austin, San Antonio, Denver, are, you know, showing, as you indicated, [Inaudible] softness. If you could just kind of give us your thoughts on this subject of markets that already have a lot of public builders that have consolidated a market like Austin. And realizing that, therefore, maybe the market is more rational and there is not as much speculative inventory as a positive.

But what do you think about all of the public builders therefore having all the same attributes, access to capital, synergies of purchasing? Though Austin is probably an extreme example. But how do you sustain your market share in Austin and keep your margins from being diluted when your competition is your other public homebuilders?

One, I think it's a - you're delving into a very interesting topic. Let me just make a few comments.

One, I believe as the large public builders continue to gain market share in the biggest housing markets in the U.S., that that is a good thing for margins among the large builders operating, because the biggest risk you have competitively - it has been my experience - is when markets go soft, it is the small under-capitalized that do crazy things that adversely effect the larger, more well-capitalized builders. So I think that, generally speaking, as the consolidation continues, we will have much more rational pricing, even in softer markets.

And remember on the largely variable cost structure of the building industry, when you're well capitalized, and since you're building to order, if you don't sell, you don't build. And so I think we're going to see - you know obviously in a competitive environment anything is possible. But I think we're going to see people maintaining their market share and, most importantly, their margins.

Now from my standpoint, I don't think every builder is [Inaudible] . And I do believe that the KB Next operating model is a model which can sustain us better than others in both up and down market positions. But obviously I don't want to dominate this call to go over all that again. But I do think we have examples in Austin, since you focused on Austin.

You know in a market where permits were down, what, 40 percent, we were able to grow our market share and have in excess of 20 percent return in capital during a major disruption in the market. And I think that's an example, I think, that our system works.

Well that's pretty impressive, Bruce. But you know, on the other hand, just to play devil's advocate, if you look at San Antonio, since you purchased Ricco, what has your market share done there?

Well, it's very different. I would look at it this way. One, it hasn't dramatically decreased.

We've continued to deliver approximately 3,000 homes in San Antonio from 1996 to the present time. And you know the folks in San Antonio whom we acquired the business from believed that that was the right number to protect you on downturns, when the percentage market share might go up as much as 50 percent. And in good times, it might go down to 30 percent. I still think the market share we have in San Antonio is the largest market share of any builder in any market in the United States.

Right. But it has been nearly cut in half since you bought it...

No. No, no, no. I don't know - you know one of my competitors must be giving you some numbers. But it's - to be cut in half would mean that the market would have had to double. I don't think the market has doubled. I think the market has been up about, what 30 percent, 40 - yes.

OK. Well I'll leave it with...

All right. But, you know, call us afterwards. We'll give you the right numbers.

And we'll now hear from Stephen Kim with Salomon Smith Barney.

Thanks. Bruce, I'm much more interested in what your returns on capital from - you're getting in San Antonio are. What are those looking like?

Well, one is, our returns on capital in San Antonio are in excess of 20 percent - weigh in excess of 20 percent. And, in fact, most of Texas, even in the softness, continues to drive very high returns on capital.

Sounds pretty good to me. My next question relates to your sub count. I didn't see it in the release, but I know that was something that we were hoping to get an update on. Can you give us an idea of sort of where you stood at the end of February in terms of U.S. versus total sub count and where you sort of think you're going to be at the end of the year? And whether these numbers include Colony, by the way.

Yes. Well, what I'm going to give you - the end of Q1, we had 263 U.S. communities versus 225 a year ago. And that does not include Colony.

Right.

If you take it out to year end, Q4 - and you know some of these things can shift around. So don't hold be yet to the - but it's going to - the difference is going to become much greater because partially we're going to add about 30 communities from Colony. But the total number ought to be somewhere around 425, something like that, versus 288 a year earlier.

OK, right. And total company?

It would be about 540 versus 386.

Yes. OK, great. And then, I wanted to - the last question I had relates to your return on capital, because I think that, at the end of the day, that's really what I think is becoming increasingly - well, it's become the primary consideration for you, as well as many other builders. And I guess, according to my calculations, the last 12 months, you're running at something like 18 percent return on capital, which is - you know you've been at kind of those levels now for a few years.

And I know that clearly what's in people's minds is the issue of sustainability. You know, can you sort of maintain levels anywhere near that? And I think that Ivy's point was sort of touching into that. That, you know, as you get increased competition in these markets with other large builders, what's the likelihood that you see returns on capital dramatically diminish?

Now I've always sort of felt like you, that I'd rather have a competitor that has shareholders and return on capital thresholds. But would you feel comfortable for us sort of giving us an idea where you think - where you target your return on capital to be over the next, let's say three or four years?

One is, I believe that these levels of returns are sustainable. At our presentation that we made at your conference this week, we laid out for investors a chart in which we showed specifically the areas where we thought we could increase pre-tax margins by 600 basis points. Now we don't believe - realistically believe - that we can we hit that, because that would be too beautiful, everything would have to happen. But the taskforce in the divisions that are working on it, we think any one of them can happen and together could add as much as 300 basis points to get us to where we would like to be, which is 12 percent pre-tax profits.

If we obtain that, you will see returns on total capital invested increase into the low 20s, which would be a significant improvement and increase from our already quite desirable levels. So the bottom line is we still think there's a lot of work to be done. And if we're successful in achieving it, we ought to see our returns increase.

Stephen, this is Dom. Another comment would be that, you know, we're making investments in the Southeast. And as those investments turn into profits in future years, we're funding those investments with profits in the quarter [Inaudible] . So we'll get a pickup there.

OK - thanks very much.

And our next question will come from Michael Rehaut from J.P. Morgan.

Hi - good morning. I just wanted to hit on a couple of things. Can you go into a little more detail in the central region, what's going on there currently with pricing and incentives? And then I had another quick question.

Well, as I indicated, some of the markets in Texas and definitely in Denver have gone softer. I think Denver starts our off - what is 27 percent or something like that over the last three years? And from market to market, week to week, builder to builder, you see a certain amount of incentives advertised. In fact, what I indicated to Ivy's question I believe is true even in these softer markets, which is the better capitalized better operators are more restrained in offering those kinds of incentives and feeling like you have to give away the product.

The inventory levels are still very reasonable even in the soft markets. And so, while it's tough sledding and highly competitive, it's something that we feel we can still operate in nicely and profitably.

So you feel then that in some of those softer markets the incentives aren't up year over year or aren't getting out of control, where...

Yes. You know one is - it's just a qualitative comment. I think there are more incentives. But I don't think it's something that is troublesome. What you'd like to see is a pickup in demand. And the incentives that say we've seen it before, we'll see it again. You know?

And the important thing is it's not something that we're seeing across all of our markets. One of the advantages, all of a sudden we're beginning to feel [Inaudible] .

OK. On the inventory side, I was wondering if you could - perhaps, Dom, you have this information - break out the - of that inventory number, what is the land position of that? And, also, if it's possible to sort of give us an idea over the last year, year over year, what the average cost basis per lot owned has been doing? You know, has it been steady rising or decreasing?

Mike, we don't have that with us at this point. And what we've always said is land prices continue to rise. But land is only 10 percent of the cost of a house [Inaudible] itself. So it's a material input to us.

Land development is an area that really triples the price of land. And land development is an area where we think as a large public builder we're actually able to have an advantage being [Inaudible] in markets and having the ability to have better land development costs than other builders. So that's the best record answer. And it's a very regional-marketed local business. So it's hard to ask that question [Inaudible] .

Is most of the land that you own on your balance sheet raw, then, versus finished?

In the unit counts, the majority of our land is optioned land. You know 50 percent of our lots are optioned. So the answer would be yes. In dollar terms, the majority of our land is finished lots which turn in five quarters.

So when you look at it from a dollar perspective, we've turned the land very quickly. When you look at it from a unit perspective, it's raw land or optioned lots.

Right - right, OK. But the lots that you actually own, that's on the balance sheet, most of that is finished when you buy it?

No. We develop lots, Mike, as [Inaudible] .

OK. That was my question.

Yes, OK.

Yes, we do both.

OK, thank you.

Yes.

And we'll next hear from Armando Lopez with Morgan Stanley.

Yes, hi. Good morning, everyone.

Hi, Armando.

A quick question, Bruce, in terms of the subdivisions. I mean the subdivision openings seem to be opening slower than we would have expected. Could you talk a little bit about what you're seeing there by market? I mean is - and how it compares today relative to, you know, two months ago, when we were talking in the fourth quarter?

No. I can't be that specific, because I don't remember exactly. I think, you know, on the community count, new openings, you know there's always some jockeying around and pushback from a date to another date. What I can tell you is that we have a very strong community count opening schedule over the next three months. And you know we're going to open approximately 90 communities in the next 90 days.

And the effect of that will be more heavily felt in Q3 and Q4 to the order rights. But we're at as strong a new community opening schedule right now as we speak as we have ever been in the history of our company.

OK. And then, second, you know back on a return on - a follow-up question kind of on return on invested capital. You talked about the opportunity on margins, and when I think about returns and return on capita, you can really, there's like two levers, right? There's operating margins and then there's capital turns. So does that imply -- saying that these returns at this level is sustainable, does that imply capital turns either stay flat or decline here?

Yes, what we believe is, as we continue to expand our footprint east, the opportunities to have just in time lat deliveries that you're not carrying for quarters or longer on your balance sheet become more do-able. And so, if we achieve our margin expectations in our new businesses, or as we achieve it, the opportunities that we have to efficiently acquire land through options and extended takedowns we think will be -- have good effect on the ROIC calculation.

You know, California is the most difficult place to do that. And so as a greater and greater percentage of our business is created outside of California, it should help our returns.

OK, and then one last...

If you look at last year, you really see it because we increased our inventory count of lots by I think at the end of this quarter by almost 30 percent, and the inventory dollars went up 16 percent. So we're controlling more land with less capital invested and that will improve turns.

OK, and then one last one. I was just wondering if you could comment what you're seeing in terms of cancellation rates currently, and then also, I mean, on a national basis, inventory levels, based on the census data, and I know it's revised and stuff, but it looks like inventory levels overall are rising. Can you just talk a little bit about what you're seeing in your different regions, where you see -- maybe if you rank the regions, where you see inventory going up the most?

On the first cancellation rates, it stayed about the same. They're flat. There's no real movement up or down. With respect to inventories, I can't give you any kind of -- I mean, Jeff, you ...

It's a market-specific number I'm on, though, and there's really no markets we operate in today that have a -- that we see an inventory issue. They're all sold at all very healthy levels.

Armando, remember, the norm is considered to be six, so it's still significantly below the norm. So although it's risen from historical lows below four, being slightly above four is still very, very healthy.

But that's on a month supply basis, right? So, I mean, on an absolute basis, these things continue to go up. And we're getting close to level that we were at the early '90s.

Well, that's because the population has expanded, and the number of households has expanded.

Armando, if you go back to our business model and the price points that we target, the inventory buildup's occurring at higher price points than we're selling.

OK. All right, great. Thanks a lot, guys.

And we'll now hear from Timothy Jones with Wasserman & Associates.

Good morning. First of all, on the Colony Homes, how did the debt assumed to cash payment break out on the 142?

You know, Tim, we're going to give that out in due time, but since a few of my friends push me to give the price, we're giving the price today. But we'll break out after we go through all the purchase accounting how it all breaks down.

Was the price -- I mean, looking at it, to me, it looks like five and a half times EBITDA -- is that a rough number or not, or is it higher?

You know, I don't want to give any color. I think what you can start believing is it's probably less than that.

OK.

And I was encouraged to really give this out because there were some numbers being thrown around by the Street that were significantly higher than what we paid ...

Yes, and there's numbers being thrown out around on the very high price to book, too. Do you want to put some color on that?

No, don't want to do that, but I wanted to put enough on it that people didn't get the impression that we had a hole in our pocket or something.

Well, a 12 multiple gives you 27 million EBITDA, so you can get a pretty good idea from that level. But it was less than 5.5, that's good to know. OK, secondly, I happened to be talking to one of your major competitors, and we had it this morning. We happened to get on the subject of Denver versus Texas, two of their biggest markets and two of yours. And they said that metaphysically, unconditionally, that Texas was dramatically weaker market, more competitive and so forth than Denver. Could you throw some color, since you're in both of those markets, pretty major, could you give me an idea there?

I would be very slow to start generalizing about Texas as one market...

I'm talking Dallas specifically.

OK, well, wait a minute, now you're...

Dallas versus Denver.

If you want to talk about Dallas versus Denver.

That's what I want to talk.

I think Dallas has historically been a much more competitive market where land is much more plentiful. And it's one of the handful of markets in the United States where there's easy access and people can get into the business with very little capital. And so, while there continues to be consolidation in the market, it still is extremely fragmented.

Denver is a land-constrained market. Not as much as California, but nevertheless very much land constrained. Land development challenges, and obviously zoning challenges. And therefore, it plays to the strengths of the well-capitalized, more professional, bigger builders. And once you achieve a buildable parcel, you've got something special. So I would agree with that conclusion between those two markets.

OK, so yours -- and lastly ...

But I would also tell you those are not two of our biggest markets.

No, but I mean they're sizable, but you agree, and OK. And the last question is, I'm a little surprised on you going into Atlanta. I know you were going into the East Coast, only because I know it's the biggest market. But it is a lagging market that until recently also had the characteristics of Dallas and not being particularly land constrained. That has changed in the last four or five years. Is that the reason why you're doing it? Five years or ten years ago, it was exactly like Dallas?

One, I think things are changing in Atlanta. The fact is, it is the largest single market in the United States. No builder has yet been able to put together a dominant market position there. Colony, which is highly respected, very strong team, not only Atlanta but also into the Carolinas, we think are going to form the core of a super company there, and with our capital, we think that they're going to sort of have their shackles released and are really going to be able to go to down. Now, it will take us some time, but when you're our size, I think we've got to play in the biggest ballfields. And it may take us some time to achieve our objectives, but we think we ought to be able to do it in the U.S.'s largest market.

Yes, and lastly, the average price in Dallas, what is it? I mean, assuming in Atlanta and how does that -- the rate ...

Well, I think their average price company-wide was 130.

That low?

Is that representative of Atlanta? No, we're talking Colony, aren't we?

Yes, Colony.

Yes, 130.

Well, of course I would suspect North Carolina would be a little lower, but that's a very low price.

Yes, they -- it's a I think very good marriage, because they're used to building quality homes for the first-time move-up. It's strictly KB Home type of philosophy.

Oh, it fits beautifully as far as product line and geographic. The question is the Atlanta market, the competition, which you've addressed.

We're going to show you.

OK, thank you.

And we'll now here from Margaret Whelan with UBS Warburg.

Morning, folks.

Hi, Margaret.

Congratulations on the quarter, and a couple of wrap-up questions, I guess. The first thing is, some of your larger public competitors have mentioned that using options to secure land cost them about 200 basis points of EBIT margin. Would you say that you're in that range?

You know, somebody asked that at the beginning. No, I wouldn't agree with that, and I don't know exactly -- you know, we may be talking about apples and oranges here, because in certain markets, large publicly held builders can enter into option contract, and take down lots over a period of time. If we're talking about that, I don't believe that you're paying more to get that. Now, if some people are talking about OBS financing and letting someone carry that property for them rather than put it on their balance sheet, that I think does relate to about 200 basis points.

OK.

So, and there's been different periods of time. Presently, we do not access that kind of financing. But when we did in the past, the 200 basis points was probably about right.

OK, and thanks for clearing that up. And the second question I have, it's kind of an observation. To the degree that we are in a cyclical industry and it's unlikely to get much better from here, wouldn't it be wiser for you to be spending money making acquisitions similar to the one of Colony Homes than to be opening 19 new communities and putting new supply out into the market, given how spotty sales are right now?

Your supposition is because there's great uncertainty, why wouldn't we go and buy another company as opposed to opening up, organically, new communities?

Well, yeah. Just creating to the degree that we might be creating oversupply in the market.

Well, one is, we wouldn't agree with your premise.

OK.

We don't think there's anything that would indicate that there ought to be a significant fall off in housing demand. People refuse to accept the fact that ever family unit has to live somewhere, and that owning a home in the United States is considered a very smart thing to do. Everybody believes that. It's not some of the people, everybody believes that. So when you have affordability, and even in today's environment, where all we're seeing is war and conflict and economic problems and Greenspan and the stock market, why is traffic virtually running at historic highs at our homebuilding sites? And the reason is, still being able to become is considered probably the most important event in a family's life.

So we don't think, in spite of all the uncertainties, that there's going to be a dramatic fall off. Now, we may go through 30 days a la 9/11 tragedy where people just stay glued to the TV to watch the war, but we think that would be very short-lived, and we would come back to the reality, which is you have to live somewhere. You want to pay $1300 a month in rent, or would you like to have an after-tax cost and be a homeowner less than that?

And people still worry about themselves first and the world second, and so we wouldn't agree with that. Now, as far as what we do, given our view of the future, we need both, because in order to continue to push KB Home forward, we need organic growth, and we need acquisition growth. And each of our divisions and their management teams are in those individual marketplaces looking for land acquisition opportunities and ways to route their community count.

And we here in Los Angeles are looking for acquisition opportunities, particularly in new markets to again continue to push the needle higher. So we think both make sense.

OK, let me put the question to you a little differently then. If you look, for example, in the central region, where your order backlog is slowing, what are the early warning signs that you're looking for that might curtail some of the spending.

OK, now, if you want -- we don't just push the metal or the foot is the expression, pedal to the metal, everywhere all the time. So in markets where you do see softening in demand, you now start becoming much pickier with respect to your investments, and you may even end up delaying investing in new land until you feel a little more confident where the demand level might pick up. But generally speaking, and I think you've seen our charts on Denver and Austin, two of the most adversely affected markets, large markets in the United States, to date, KB Home has done very well through that softening.

And we believe it is in part due to the price range that we operate in, and in part to execution by our teams on the ground.

And are you seeing any slowdown whatsoever then that would lead you to maybe slow down the number of communities, or no?

Well, to date, with the exception, again, of those two markets, where we're obviously watching very closely, where we might be less enthusiastic about increasing community count -- we certainly like to maintain our position, virtually throughout the company, our challenge is, is to find what we think are the opportunities that meet our screening and criteria for returns in order to increase our community count. So we are continuing to look at every opportunity and would like to see increasing community counts, and do not believe that we're going to see a significant fall off in demand.

And to the degree that you could increase or maintain market share, would you choose that over return on capital?

No, no, no. I mean, the earlier on the question asked about that -- yes, market share is nice. Return on capital is what we're focused on.

OK. Sorry, I missed some of the comments earlier.

Well, somebody was making a comment about was our market share down somewhere, and I think the real focus for is, well, yeah, we're proud of our market share, but return on capital is where the money is.

OK, and then to the degree that you can give us more details on the acquisition, I think that'll be very useful.

Yes. Good.

Just finally, Dom, did you address the gross margin expansion and where that came from? I know you had better pricing because of the acquisition, but was some of it organic?

The margin?

The gross margin expansion, the 150 basis points.

Certainly it was California contributed to a [Inaudible] , and also our KB next offering that will cause of our businesses to continue to improve margins.

OK, thanks very much.

And we'll now here from Jim Wilson of JMP Securities.

Bruce, could you give a little color. With the 90 communities opening, give or take, over the next 90 days, geographic concentration of those openings, is it a lot? Florida I would imagine, but where's sort of the mix of those openings.

It actually is pretty evenly spread, Jim. It's -- there's a lot going on in -- well, all over. Las Vegas, there's a lot going on, Tucson, Phoenix, New Mexico, Houston, San Antonio.

What about California.

California also.

California also, OK. And can you also give any color -- I know you have repurchased 500,000 shares in Q1 and your thoughts -- obviously, you're deploying a fair amount of capital into opening new communities, any thoughts on that?

I think what I said earlier is where we stand, which is we're going to do a balance of share buyback, internal expansion, and opportunistic acquisitions.

OK, and then finally, I know you talked about the G&A at the corporate level. It also jumped up a lot at the mortgage company. Is that just opening new offices geographically and preparing for expansion there, or is there anything else in there?

You know, I don't think there's anything there. I can't give you much more precision, but no, we're not opening up new offices, and I think you might see it next quarter evening out.

OK. All right, good, thanks.

And our next question will come from Steve Fockens with Lehman Brothers.

Hey, good morning. Two questions. The first would be, could you comment on what you think about the sustainability of the kind of price increases you're seeing in California, i.e., is there a certain point where consistent quarterly double-digit increases in pricing start to have an impact on demand?

I will tell you, we wouldn't think it would continue, Steve. All right, I mean, we get concerned when you start seeing that on any kind of sustained basis.

So I guess that probably answers my second question, which is, over time, would you rather see five percent unit increases and 10 percent pricing, or the reverse?

Well, on a sustained basis, you'd probably like to see unit growth, but the pricing increases definitely gooses your earnings and returns during that period. So it's quite seductive. The problem is is that it's not probably sustainable, and if it led to generally inflationary pressures, then it would push interest rates, and higher interest rates, lower supportability, so somewhere down the line you'd get squeezed.

So is it fair to say then that perhaps over the next six to 12 months we should see those pricing numbers in the West start to moderate somewhat?

Yes, yes.

Thank you very much.

And moving along, we'll now hear from David Weaver wit Legg Mason.

Good morning.

Hi, David.

On the Colony Homes acquisition, could you let us know roughly what percentage of their sales price is in options, and I guess if you're going to be opening your studio in Atlanta within this year?

They have been successful in getting about five percent of base pricing options. And they are very excited about expanding that program the way we do it, and so the integration period, everybody's moving very fast. I mean, obviously the transaction just closed, but I think we'll probably -- Jeff, would you say six months away from really maximizing the option business?

To have an impact, it'll take some time. They do have a studio in Atlanta, David, that's much smaller than we would typically do, and the product offerings are more limited than we offer in our business model, so we're pretty comfortable there's a good upside opportunity as we roll out the studios and implement our business model.

Could you give us an idea where your options company-wide stood for the first quarter?

Over nine percent.

That's a sharp -- a nice improvement from the end of the year, at least.

Yes. It's one of our major initiatives to increase our returns.

And what type of mass, in terms of units, would you need to put a studio in either Raleigh or Charlotte?

Well, we've -- even our smallest divisions have some size studio today, so as we integrate the Colony acquisition, we'll be opening a studio in all three markets.

OK, great. Thank you.

And if you find that your question has been answered, you may remove yourself from the queue by pressing pound. We'll now hear from Barbara Allen with Bleichroder.

Thank you. Good morning, y'all.

Good morning.

I was wondering, in your central division, with the economic weakness in some of those markets, what has happened to your pre-tax margin, overall, in the past year?

We're looking at all of Texas, Barbara?

Whatever you'd like to give me.

Well, because we don't break out, you know--if you would look at one of the things that we did give at the conference this week was we looked at Austin and while we didn't give margins, we did show how that market was severely hit with--you know my memory and, guys, please correct me, but where permits were off more than 40 percent, KB Homes business was up very nicely, but most importantly our profits during that three years was up about 200 percent, all of which weighed (ph) into a return on capital well in excess of 20 percent. So that example, I think it would--I can't tell you on a Texas wide basis, but our overall Texas business continues to evolve very favorably.

So the margins are not being negatively affected by economic weakness?

No, I would--I don't want to--that would be a conclusion that I wouldn't want to stand behind because, obviously, where there are weaknesses, you know, strong weaknesses, it has, obviously, some affect on margins. You have to remember our Texas business is relatively new. We didn't deliver one home in Texas until the Raco acquisition in mid-'96 and now we're the largest builder in Texas. So everything has happened over the last, essentially five years, but our business in Texas remains very healthy.

And you said that Denver is a little different because of the land and development constraints.

Yes.

Has there been pressure on margins there in the last year or two? Margin per house.

You know, we don't--we don't break it out if somebody--I actually think, for lots of different reasons I think our margins have maintained themselves even during the softening in Denver.

OK. And the 26 percent increase in SG&A expenses quarter, given the heavy opening schedule that you've got, should we assume that kind of an increase for the year?

Barbara, it's Bill. While it--it got a little boost here in the first quarter, we do think by the time we end the year, we'll be on about the same level as we were last year. I think at about that 12.4 percent around for the full year.

So probably the second quarter would be the peak in it, sounds like?

I think actually the first quarter is, but second quarter could be, yes, and then the back end declining significantly.

And one last question there; have you--in the central region overall where you have seen economic weakness but your profits are up, are you writing off some option deposits? In other words, are you cutting back on land in--where it seems appropriate?

Barbara, at this time we haven't written anything off in Texas. As Bruce alluded to, we're new to the state and we stayed very focused on our strategy. Each land deal is underwritten by Land Committee; they're selling to expectations. We probably lost some of the opportunity to raise prices the way we have in California, obviously, but the returns are fine and we're comfortable with our business.

OK, good.

Barbara, we look--this is Dom. We look at, you know, we look at every community end of every quarter to make sure that there's no issues and there were none.

Good. And lastly, in California your price that you delivered this quarter is now about $10 thousand above the median resale price in California in January and a year ago it was about $20 thousand below it. Have you shifted your product strategy upwards or are you going to--are you adding more entry-level projects to bring that down or what's going on there?

At this time the product mix is very similar to last year. Some of the price increase is due to significant expansion on studio sales. We've also been very successful in expanding our lot premium activities in the state. So it's not just pure price increase on the base home.

OK. But the strategy has been, I thought, to stay below the median resale price, so is that something that is...

Well, you know, part of it--you know, part of it I think is just mix and what Jeff's point about the studio, we have communities and divisions where we're selling, you know, 12, 13 percent of base...

Yes.

... so that does cause a consequent increase in RASP, but not to the ASP to the customer.

OK. Thanks very much.

Moving along, we'll now hear from Robert Manowitz with UBS Warburg.

Hi, got a real quick question. As I listen to everything you're saying and looking at your inventory balance at the end of the most recent quarter, which was up 16 percent, it sounds like we should expect that year-over-year comparison to continue through the next three quarters and end 2003 up about 15 to 20 percent. Is that fair?

Yes, that's fair.

OK, great. Thank you.

And moving along, we'll now hear from Chris Bauders with Raymond James.

Great quarter, guys.

Thanks.

Just real quickly, a couple of housekeeping items. Could you just give interest included in the cost of sales and then D&A in the quarter?

Yes, Chris, the amortized interest for the--for 2003 first quarter was 14.461 and for 2002 12.613.

OK, and then also D&A?

Just give me a second. First quarter again for 2003, 4969 and 2002, 4216.

Thank you very much.

And our next question will come from Mike Kender with Salomon Smith Barney.

Hi. Just one more number, interest incurred in the quarter?

30768 and for last year, 23788.

Great, thank you.

And just real quick, keep in mind that that does also include where we included the one-time charge on the redemption of our notes of about 4 million 303.

And now we hear from Alex Barron with Franklin Templeton.

congratulations on the quarter. I had a couple of questions regarding Colonies. I was hoping you could give us some idea of how their margins compare to yours, as well as what we can expect for deliveries coming from them this next quarter.

Yes, the--their margins most recently were lower than ours and they, as well as us, believe that some of it was probably just taking their mind off the ball during the whole acquisition process. And the Colony team believes that in relatively short order we can make tremendous improvement in the margins because over their history they had done much better than they did most recently.

So, I think that's a, you know, very nice opportunity for us going forward.

OK. How about some guidance as far as ...

I think we're counting on an annualized basis of approaching, what -- 2000 units out of Colony on an annualized basis? You know, before ramping up any of their activities.

I guess I'm trying to get at sort of what the seasonal pattern, you know, over the four quarters that they have.

Is there any seasonal pattern? You know, we don't think so. Obviously, we're just starting, but if you were to -- I don't know if you're building a model or something ...

Right.

If you just sort of counted 500 a quarter you wouldn't be too far off.

OK. How about the backlog that that acquisition came with in terms of dollars?

I think the number was around 740.

OK. And I guess I can just assume the ...

... ASP, yes.

OK.

Yes.

Any other guidance in terms of next quarter in terms of EPS or revenues or ...

No ...

... units for the Company?

Nothing other than what we've already said.

Could you repeat what you said?

Well, the guidance I gave was we still believe the $8.00 EPS for '03. Revenues probably a little, you know, greater than what we've said. And the revenues should be approaching 6 billion.

OK. So, you don't want to give anything for Q2?

For -- no. We don't do quarter by quarter.

OK. Great. Thank you.

And our next question will come from Chris Windham with SAC Capital.

Hey, Bruce.

Hi, Chris.

Just a question on the community count.

Yes?

We were up 17 percent for this quarter, but the orders were up just one percent.

Yes.

So, I kind of want to reconcile that.

Well, I think we gave you some guidance. I mean, California the absorption per community was down. However, before someone gets excited about it, we wanted to say that one, we have the highest absorption per community, we believe, in the industry within California.

Last year we were at something like -- oh, go ahead, yes.

Yes, in California when you looked at a monthly basis we were at 12 a month in California. And now it's gone back to a normal level of seven per month. So, part of what you're seeing is the fact that we've slowed down our absorption in California by increasing our prices, which is what we've said in our [Inaudible] .

OK. And then ...

And then the southwest was way off. You know, actually, it was -- if you look at it on a monthly basis, we were selling nine per month in the southwest versus eight last year for community.

And then in the central last year we were selling seven. Now we're about six, which is still acceptable in our model.

OK, and then with the 90 that are coming on in the next 90 days netting that against what will roll off -- what will the year over year change in the community count look like by the time we get to the end of this Q2?

Well, you know, again, adjusting for, you know, because the 90 days where now part of that is going into June. So, that's already Q3, but we think when you include -- when you include Colony that we ought to be looking at by the end of Q2 about 297 U.S. communities versus 244 a year ago.

Anything further, Mr. Windham?

Yes, so that's going to put us about -- so we'll be up over 20 percent for Q2.

Yes.

And ...

The big difference, really, will flow into Q3.

So will we still have the same kind of community absorption issue in California that we had in the first quarter.

You could. I mean, we're only, you know, two weeks into the quarter.

Sure.

But, yes, you could.

That's what I'm trying to figure out. When, you know, I understand -- when we will see kind of the commiserate ramp up in the order growth tied to follow the community.

Yes, I think you'll really be looking at Q3.

OK, thanks Bruce.

Yes.

And we'll take a followup question from Stephen Kim with Salomon Smith Barney.

Hi, It's Alex Barron for Steve Kim. Just one last quick followup. Could you give us the contribution -- the profit contribution from commercial and land in the quarter?

Yes, on the commercial for the first quarter it was 4,025,000 and last year it was 662,000. And for land it was 598,000 versus a year ago of 211 -- 211,000.

Great, thanks very much.

Actually, it's Steve Kim also. If I could jump in one quick thing. Bruce, did you say the 297 at the end of the second quarter included the 30 from Colony or did not include the 30 from Colony?

It does.

It does include. So, excluding Colony, the sub count ramp is really going to show up, you know, after May?

Yes.

And we'll now take another followup question from Ivy Zelman with Credit Suisse First Boston.

Hi, Dennis McGill for Ivy. Just a couple of things that you guys talked about earlier. You mentioned land as a percent of the cost was around 10 percent. What would that number be if you were going to include the development as well?

... 30?

I'm sorry?

Closer to 30.

Closer to 30, OK. And just to clarify, the 142 million included the debt you assumed. Is that correct?

Yes.

And you mentioned you might -- you were obviously interested in entering other markets in the near term. Are there any -- assuming you could enter at a reasonable price -- that are at the top of the list for you guys?

Nothing that we would care to discuss.

OK. Lastly, we've heard some rumblings, specifically in Texas, that the quality of the buyer is marginally perhaps being stretched. Are you guys seeing anything in your operations that would indicate that?

You know, there's always, you know, that's an issue as old as the hills. If you've ever gone through the home buying process, you would personally know that you start the process figuring that there's no way that you're going to be able to get enough money to put the down payment or qualify for the loan.

You squeeze it. You try to buy something a little bit more than you can really afford. And it's always, you know, trying to shoehorn your pocketbook into the demand. So, there's nothing, I mean, it's a continual issue. I don't think there's anything substantively different today from, you know, a year ago.

Is there any point where the squeezing there -- the working around it -- would become concerning to you?

Well, no. I mean, there's -- as interest rates remain very low, you now start expanding afford ability to a whole group of buyers who never could afford to buy before. So, there's a lot of education that goes into it.

And obviously, you know, you're dealing with, you know, tight credit issues. You know, I'd always rather be in that position than in a position where somebody walking through the door couldn't possibly come close to buying.

If you look at on a broader base, all of the studies indicate that the demographics should remain very strong for at least the rest of the decade for home buying. Primarily driven the biggest single segment is going to be immigration.

Immigration remains very strong in spite of 9/11. In spite of a softer U.S. economy we're still seeing a million plus new immigrants a year in the United States. We know from all the surveys that it takes about 10 years for these immigrant families to save up enough money to buy.

We've figured out that as we get better and better in communicating with realtors, these buyers rely on realtors for advice in finding homes. If we can get to them to show them a new home, rather than what they think they can afford, which is a used home, we've got a leg up in convincing them to buy.

A lot of opportunity within this group and in the general household formation group for future home buyers.

OK. Very good. Thank you, guys.

And that concludes the question and answer session. Mr. Karatz, I'll turn it back over to you for any closing or additional remarks, sir.

Thank you all for joining us and we look forward to talking with you in June at our Q2 earnings conference call. Have a great day and weekend. Bye.

And that concludes today's conference. We do appreciate your participation. You may now disconnect and have a great day.