KB Home (KBH) 2003 Q2 法說會逐字稿

Good day everyone and welcome to the KB Home Second Quarter Earnings Conference Call. As a reminder, today's call is being recorded.

KB Homes' 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 form 10-K, quarterly reports on form 10-Q and current reports on form 8-K filed with the 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 during today's conference call. We urge you to read those. I would like to remind everyone that this conference will be webcast on KB Home's website at www.kbhome.com.

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

Thank you, and good morning, everyone. Thank you for joining us today to discuss our record results for the second quarter of 2003. With me this morning are Jeff Mezger, our EVP and Chief Operating Officer, Dom Cecere, Senior Vice President and Chief Financial Officer, Bill Hollinger, 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'll provide some highlights of our record financial performance for the second quarter, comment on the current state of our business, and then I'll turn it over to Dom, to review our second quarter profitability and other chief financial information. Finally, we'll wrap it up with questions and business and market outlook for the rest of the year and into 2004.

Let me begin. I am very pleased with our record second quarter results. Our company-wide focus on increasing shareholder value continues to drive our record financial performance and provide ample free cash flow to invest in all aspects of our business. Our balanced approach to cash management has enabled us to profitably grow our business, buy back our stock, and pay a dividend, while continuing to improve our leverage ratios.

In the second quarter, the company's financial performance continued to set new records, despite these less than certain economic times. Net orders for the quarter increased 20% in the U.S., 17% overall, when compared to Q2 a year ago. Unit net order growth also increased significantly to the 2% year over year growth experienced in the first quarter of 2003.

Net orders progressively strengthened during each month of the second quarter as a result of some 82 new community wide openings, 60 of which were in the U.S. We ended the second quarter with the highest quarter-end backlog in our history. Our dollar backlog of $3.4 billion on 16,103 units rose 29%, and 17% respectively from the same period a year ago.

Total revenues for the quarter rose to a record $1.44 billion, up 26% from a year earlier. For the six months, revenues totaled $2.54 billion, up 23% from the first six months last year. Our diluted EPS rose 37% to $1.94 for the quarter; up from $1.42 a year earlier, and for the six months, our diluted EPS was $3.19, up 35% from a year ago. The company's after tax return on invested capital for the trailing 12 months remained at 17%, well above our cost of capital, and almost triple the average for the S& P 500. In the second quarter, we repurchased 750,000 shares of our stock, bringing our total repurchases for the year to 1.25 million shares.

Our average shares outstanding for the quarter were $42 million, down $3.2 million or 7% from the 45.2 million shares outstanding second quarter a year ago. Over the last year and a half, we have repurchased $5.25 million shares of our common stock at an average price of just under $48 per share, representing approximately 12% of the shares outstanding at the beginning of the period.

Now, I'd like to comment on business conditions in our various markets. In the second quarter, with our new community grand openings and our expansion in the southeast, our community count in the U.S. averaged 300, up 23% from the second quarter last year. Our unit orders per community in the U.S. averaged a healthy 24 units for the quarter, roughly the same velocity that we had a year ago. We've expanded KB Home's national presence in six new markets, or by 38%, in the last 12 months and continue to geographically diversify our operations.

We currently operate in 22 major markets in the U.S. versus 16 markets this time last year. Our adaptability to changing market conditions and our flexibility to redeploy investments in land are critical to maintaining our high returns on invested capital. Continued focus on KB next operating principles and execution of our business strategy at the regional and national levels will ensure our continued success.

In our West Coast region, comprised of five California divisions, demand for housing remains strong with average sales prices up 19% in the second quarter despite a weaker economy and unemployment rising above the national average. The housing supply, demand and balance especially in our demographic segment continues to be the primary factor influencing the housing market in this region. Housing demand in our southwest region continues to remain strong led by strong Las Vegas housing market.

We are also gaining market share in Tucson as a result of the integration of the acquired assets of new world homes into our existing KB Home Tucson operations. Housing demand in our central region, which includes Texas and Colorado, remains mixed. The macroeconomics in the Denver market continue to be difficult. The inventory of homes in Denver is up 26% with a 9.4 months supply and closings are projected to be down 17% for the year. Market conditions in Denver have made us more cautious about land acquisitions in this market.

In Texas, our business is mixed with overall deliveries anticipated to be down approximately 10% for the year and profitability is expected to decrease even more. Unlike California, there is little price elasticity in Texas. I am very pleased with our continued expansion into the southeast. We currently operate in six major markets in Florida, Georgia and North Carolina, and have grown substantially since this time last year, when we operated only in Jacksonville.

Orders of 1346 units from the southeast region were up 587%. We expect revenues in the region to increase fivefold from last year and exceed $600 million this year. Today, we are investing heavily in our southeast business, advertising the KB Home brand, adding the KB Home product to our model parks, opening new design studios and investing in training and development of our people.

While 2003 is a year of integration for the region; we fully expect it to be a major contributor to both top and bottom line growth for our company next year. Our track record for acquisitions delivering solid returns on our initial investment is excellent. Acquisitions such as Esters Homes in Tucson, Dover Hallmark in Houston, Trademark in Jacksonville are all excellent examples of the shareholder benefits derived when we incorporate private builders into our KB next operating model and deploy our capital to expand our presence into new markets.

Our long track record of share repurchases, organic growth and targeted acquisitions has delivered a top line revenue cager of 22% for the last five years and 16% for the last 10 years. Our EPS compounded annual growth rate was 38% over the last five years and 25% growth per annum over the last 10 years. In summary, we had another great quarter with orders up 17%, revenues up 26%, EPS 37%, and continued solid returns on invested capital.

I'll now ask Dom to take you through some financial highlights 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 $1.42 billion, up 27% from the same quarter of 2002. We delivered 6,344 units in the second quarter, up 5% from 6,052 in the second quarter of 2002. The average sales price in the U.S. for the quarter rose 10% from the prior-year quarter to 208,400, driven primarily by a 19% increase in the average sales price in our West Coast region.

Revenue comparisons from our operations in France benefited from a much stronger Euro and $73 million in revenue from the sale of a commercial building. The sale of the building, after adjusting for minority ownership, impacted EPS for the quarter by 15 cents. With an average sales price of approximately 208,000 for the U.S., 163,000 outside of California, KB Homes still offers some of the highest quality, most affordable homes in America with a 10-year warranty backed by a strong brand and a financially solid Fortune 500 company.

For the last six years, our average sales price has increased by only 5% annually. Less than 3% of this was actual price increase, and the remainder came from buyers selecting more square footage and options from our design studios.

Our construction operating income for the second quarter of 2003 rose 40% to $122 million from $87 million in 2002. The housing growth profit margin for the quarter was 21.8%, up 140 basis points year over year, mainly due to improvement in our West Coast region. Our mortgage banking pre-tax income up $10.1 million was down the second quarter of 2003 from $14.8 million in the same quarter a year ago.

The recent refinancing surge has impacted staffing at our regional mortgage banking centers. Our retention rate has declined from 90% in the second quarter of 2002 to approximately 73% in the second quarter of 2003. While our short-term staffing issues have impacted our retention rate in mortgage banking profitability, we see this only as a temporary issue.

Going forward, our mortgage banking profitability should improve significantly, as we stabilize the work force in our regional centers and expand our mortgage banking operations fully into the southeast region. Integrating new businesses with our mortgage operations normally takes us 12 months.

Our selling, general and administrative expense ratio in the second quarter of 2003 was up 50 basis points to 13.2%. The increase in SG&A cost stemmed from additional up-front expenditures related to new community additions and the initial investments required to expand our market presence and build our brand awareness in the southeast.

Total pre-tax income for the quarter increased 27% to a record $121.5 million from $95.7 million in the same quarter of 2002, driven primarily by a group pricing and operating performance in our construction business. We ended the first half of 2003 with $203.3 million in pre-tax income, up 26% from $159.3 million in the first half of last year.

Net income increased 27% to a record $81.4 million in the second quarter, up from $64.1 million for the same quarter of 2002. For the first half of 2003, net income rose 26% to $134.2 million from the year earlier period. Second quarter EPS of $1.94 increased 37% from the year-earlier quarter EPS of $1.42 due to a 40% improvement in construction operating income, resulting from both volume and housing gross margin improvement and 7% fewer average diluted shares outstanding. With our high returns on invested capital, KB Homes continues to be a leader in creating shareholder value.

The company closed the quarter with approximately $80 million in cash and no amount outstanding under our revolver. We continue to effectively manage our leverage ratios with debt to total capital improving to 48.7% at May 31st, 2003 from 49.9% at May 31st, 2002 and 54.8% at May 31st, 2001. With respect to 1046, the accounting profession is having an ongoing dialog on the application of the new rule to the home building industry and practical issues surrounding its implementation.

We are in the process of reviewing all contracts entered into since January 31st, 2003 effective date and anticipate receiving clearer implementation guidance before we conclude our review. Nonetheless, we currently believe that 1046 will not have a significant impact on our balance sheet for the second quarter, and I can tell you with certainty that 1046 will not impact our profitability, our leverage ratios, or our free cash flow. We will comply fully with 1046 and will include a full balance sheet as part of our form 10-Q to be filed with the SEC in July.

However, let me provide you some specific balance sheet data for the second quarter. We ended the quarter with $80 million in cash. Our inventory balance at the end of the quarter was $2.67 billion. Total assets were $3.75 billion. Construction debt was $1.31 billion, about flat with a level of debt at the end of Q1, 2003. Stockholder equity was $1.38 billion, up 22% from a year ago. At May 31st, 2003, we had approximately 120,000 lots owned and controlled compared to 92,000 a year ago.

Approximately 50% of the lots are under option. We continue to focus on building homes against a six-month backlog and 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 and housing. At the end of the second quarter, we had less than 500 completed unsold homes or about 1.6 per community.

Finally, we ended the year with a robust backlog of 16,103 units with a dollar value of approximately $3.4 billion, up $800 million or 29% from $2.6 billion in 2002. Oh, for the quarter. Excuse me. For 2003, our revenue and profit outlook remains favorable. While we expect to continue delivering record results for the year, we do expect earnings growth to moderate in the second half as year over year comparisons become more difficult and as share count benefit narrows.

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

Thanks, Dom. The National Association of Realtors raised its forecast for U.S. home sales this year to 6.6 million units as falling mortgage rates make it possible for more people to buy homes. At the beginning of the year, the group had forecasted a drop of 4% in sales for the year.

Nationwide, home prices rose at an annual rate of 3.8% during the first three months of the year, down from 5.4% last year. New home sales are up 8% for the January through April period, and the home building sector has been stronger than anyone expected, and I anticipate that the major public builders will continue to gain market share and produce record results for the balance of this year and, most likely, throughout 2004.

Earlier this month, Alan Greenspan emphasized the importance of keeping the U.S. economy from sliding into deflation. While acknowledging that there's still little evidence of an economic rebound in the U.S., Greenspan said the economy did weaken in March and April but the data for May to date suggest that is it's stabilized. Certainly our sales performance mirrors that. Greenspan continues to signal that the Fed will not be raising rates any time soon, even if the economy begins to turn. The message is that interest rates will be on hold for a protracted period of time.

Meanwhile, U.S. senators Debbie Stabenow from Michigan and Gordon Smith from Oregon unveiled legislation this month to provide tax credits to first-time home buyers that could help as many as 17 million people get a new home over the next seven years. Realizing the dream of home ownership is one of the greatest moments in a lifetime, Smith said it provides safety and stability, not only to families, but to entire communities. Home ownership has strong emotional appeal as well as financial benefits.

The goal is to extend the dream of home ownership to more working families, Stabenow said. In summary, current macro economic demographic and competitive trends appear positive, and even the political environment seems to be favorable for homebuilders. Moreover, our balance sheet should continue to strengthen with strong operating earnings flowing through to stockholders' equity and key borrowing ratios improving. We expect moderate unit and revenue growth in the third quarter due to first quarter orders, which were up less than 1% in the U.S., flowing through to deliveries in the third quarter.

Unit deliveries for the year are expected to be around 28,000, up 10%, reflecting unit growth of 5% in the first half of the year and 17% in the second half. The second half unit deliveries will be heavily weighted towards the fourth quarter. Our southeast region will be a strong contributor to our second half unit and revenue growth as we build on the strong base provided by acquisition of Colony Homes. Profitability in the region, however, will be nominal as we absorb the impact of purchase accounting, integrate the systems, build design studios and invest for expansion. These investments are anticipated to drive significant improvements in profitability next year.

With the continued uncertain economy, we expect 2003 to deliver double-digit revenues and earnings growth. Revenues are expected to approach $6 billion this year and returns on invested capital will remain well above our overall cost of capital. With that said, we are raising our estimates per share guidance for the year to approximately $8.20, up 15% from the $7.15 posted last year.

We have set ourselves up for a record year in 2004 and we'll give further guidance on that at the end of next quarter. We plan to continue our focus on profitable growth and high returns on invested capital, generating substantial free cash flow. We'll maintain a balanced approach to the use of our cash to create shareholder value by expanding organically, entering new attractive markets for acquisitions, repurchasing our shares and paying a cash dividend.

Thank you for listening, and let me also thank the dedicated and committed professionals who led our company to these record results, and with that, I'll open up for questions.

Thank you, Mr. Karatz. Today's question and answer session will be conducted electronically. If you'd like to ask a question, you may ask it by pressing the 'star' key followed by the digit 1 on your touchtone telephone. If you're on a speakerphone, please turn off your mute function to allow your signal to reach our equipment. Again, that will be 'star' one for questions.

We'll go first to Joseph Sroka at Merrill Lynch.

Good morning everyone. Dom, Could you clear up the $73.1 million on the commercial revenue, you said that was from the sale of a building. Was that all from the sale of a building or extra sale of the building what was the sort of operating revenue in the commercial segment relative to like the about $9 million that you did last year?

It's Bruce. It wasn't just from the commercial building. The commercial building was a new transaction and then there was some follow-up revenues from some past transactions, but the impact for the quarter was because obviously we only own 53% of our French business, was 15 cents, which is a delta of about 10 cents over same quarter last year, which also had some commercial business.

Ok. Then with respect to the mortgage business, because you were short-handed, did the actual capture rate go down relative to the business?

Yes, it did.

Ok. Do you know what it was?

No, we don't have it with us.

Ok. I can follow up on it.

I thought we gave you its 73%.

I thought you were talking about units year over year.

Ok. That's fine. Thank you.

We'll go next to Ivy Zelman at Credit Suisse First Boston.

Good morning.

Hi, Ivy.

Just a quick question on what today versus last year was your loan-to-value for your originations at the mortgage company?

It was 90% in 2003 and 91% in 2002.

For the quarter? Or is that pretty much an annual number, Dom?

That was for the quarter, and I think it's pretty close to an annual number.

Ok. And with respect to the percent of originations roughly that are generated through relationships with nonprofit organizations, I know that it's been a moving number out there. I just wanted to clarify what it actually is.

The down payment assistance programs this quarter were approximately 9% of our business as compared to 2002, which was 13%. So it's down from last year, also down from Q1 of this year.

Thank you. And lastly, with respect to Colony, you mentioned purchase accounting, Bruce. Can you give us an indication of what the purchase accounting impact was for the quarter, and also what you expect it to be for the year?

No, Ivy, we don't provide that.

Ok. And you're still looking at the numbers for Colony? You did say that once you determined how much goodwill you were going to basically provide that to the street. Is that something that's still a work in progress?

No. I'll give it to you.

Ok.

At the end of the quarter, we had approximately $178 million of goodwill in the United States plus 40 million in France, which was less than 6% of our total assets, and with respect to Colony, added approximately $16 million of goodwill to our balance sheet.

Great. Thank you.

And we'll go next to Stephen Kim with Smith Barney.

Thanks very much. Strong quarter, guys.

Thanks.

I got on the call a little late, but I had a question for you about your margins. Looked like your gross margin was quite substantial, but your SG&A was also fairly substantial relative to what I had thought it might be. I was wondering whether or not you could talk about both in terms of the trajectory going forward and maybe what are the factors that may cause future periods to deviate from the percentages that we saw this quarter?

We've said in the second half; our gross margins on housing will remain about where they were in the second quarter, which was up 140 basis points. Our SG&A is going to come down, although remain high year over year because of our investments in the southeast. We should see an improvement in SG&A going into 2004.

In terms of the magnitude of the year over year increase, I think it was up about 110 basis points in the SG&A line, would you expect that to narrow to something more like, you know -

I think about half of that.

Half of that, Ok. Fine. I noticed your gross margin typically rises in the fourth quarter. Would you expect a similar phenomenon this year?

Yes, but narrowing.

Ok. Right. You sort of throw all those things in the hopper and I'm having trouble arriving at a number as low as your 820.

Let me give you a little help with that. One, when we gave that guidance which I want to remind everyone is still 15% up from last year, we had a lot of new community openings in Q2, some of which got delayed to the end of the quarter and some have gotten pushed into Q3.

Right.

This results in deliveries coming out in the latter part of Q4 and into Q1 next year, and when you look at the increases in deliveries in the Q4, we wanted to just moderate it in our guidance just in the event that it doesn't all has happen the way we'd like it. And, therefore, that's where the guidance is.

Got it. Right. Ok. Right. So in other words, your backlog conversion assumption in the fourth quarter is intentionally conservative because, heck, who knows?

That's fair.

Ok. Great. Thanks very much.

Ok.

And we'll go next to Margaret Whelan at UBS.

Good Morning guys. Just to follow up on a couple things again on Steve's questions on the guidance, this 820 number, I presume, is the floor?

It's the guidance, Margaret.

Ok. And did you say in your prepared comments 15 cents on the gain on the sale?

Yes.

1-5?

It's a 10-cent delta, but 15 cents for the quarter.

And you were including that in recurring earnings?

Yes.

Ok. I just wanted to be clear. Ok. And has anything changed with your cancellation rate over the last couple of weeks or month?

No, no --

Can you tell us what it is?

About 35%, 36%, about the same as we had last year.

Ok. Would you give us an idea of the 60 new communities in the U.S., of the timing of the rollout there?

In the quarter?

Yes. Were they all open by the end of May or have they been open since the end of the quarter?

They were really pushed into the -- not in March and April, but the majority were in May.

Ok. And has the response of those communities been as expected or better or worse?

It's been as expected.

Ok.

And we saw an order pattern, when we looked at March, April, and May. Order pattern, May was clearly a very strong month compared to April and March.

And has that trend accelerated through June?

I don't think we want to get into that, Margaret. You know, we disclose it once a quarter, so we want to stick with that.

Ok. What are you using for your share count for the earnings estimates? Are you expecting some creep as options are exercised?

Flat year over year.

The share count?

About 42 million shares.

Ok. And then in terms of use of the cash, are you going to raise the dividend at any point?

Well, our board has asked us to review our dividend policy in light of the current changes in tax legislation, and as you know, we currently pay a 7-1/2 cent per quarter dividend or 30 cents annually, which is a small yield of less than a half of one percent and costs us about $12 million. With the cash flow we have over $500 million. Clearly, while there has not been a decision by the Board, it's something that is going to be examined while still looking at maintaining our balance of buying back shares, growing our business, and reducing our leverage and yet still paying a cash dividend. So no decision has been made, but it is under consideration.

Ok. When would we get news on that?

Don't know. There's nothing to report, but if there were, you'd be the first one to know.

Ok. And just finally, Bruce, on your interview this morning, you seemed a lot more conservative than you've been on this conference call, and I guess the tone this morning isn't helping the group as a whole. Can you give us feedback on what you're thinking?

Well, maybe the early hour caused my personality to be different. I didn't think I said anything different. I guess the only thing in reflecting on it is that if I gave anybody an impression that somehow we didn't like our Texas business that would be a very wrong impression. We like our Texas business. It's a very strong leg of our company, and the community count growth that we anticipate going into 2004 gives us great optimism that Texas will have a very good year next year. But what is true is there is a mixed story on orders this year in Texas.

All right. Thank you.

We'll go next to Greg Nejmeh, Deutsche Bank.

Good morning. Just a quick question with regard to 2004, you commented that you expected most of the public builders to demonstrate continued earnings growth in 2004. Obviously given your fiscal year-end, I wonder if you could provide us with at least a preliminary glimpse of what you're thinking with respect to next fiscal year.

You know, I'd like to do it, but we've decided we're going to do that in our next call. But, I feel good that we will see record numbers and more specificity to come.

And when might that be?

Well, at the end of Q3.

Ok. Thanks.

We'll go next to Michael Rehaut at J.P. Morgan.

Good morning.

Hello, Michael.

Just a couple of questions. First, on the commercial and land sale gains, what are you looking for in terms of a normalized annual rate? In the last couple years, you had at least in terms of EBIT, $12 to $14 million a year in the last couple of years, and there's going to be a big jump-up this year. What can we expect in terms of sort of recurring versus non-recurring?

I think the premise is wrong, Michael. I don't think it's a tremendous bump up, so -

Well, you have this quarter, you know, with the -

I know, but this quarter it could have fallen into next quarter, you know? So we don't expect this quarter to be indicative of the next three quarters.

Ok. Second question on the gross margins, I was wondering if you could give us a little bit of color with the strength in California and the overall 15% ASP gain. I would have thought perhaps there would have been a little bit more strength in the gross margins, and I was wondering if you could comment on, you know, just how good the gross margins were in California versus perhaps some of the other regions and, you know -

No, we wouldn't break that down for you, Michael, but what tempers the strong California is the start-ups in the southeast, where we're dealing with margins pre-acquisition and where we are rather in the process of implementing KB Next. So we're not getting much benefit on the margin side this year in the southeast, and that does temper the strong California margins.

And Michael, the ASP was 15% including France. It was only 10% in the U.S.

Right. Right. Ok. And just lastly, in terms of land costs, could you make a comment about what they are today on a percent inflation versus a couple years ago and in a couple of the different regions, California and Texas in particular?

You know, don't have a number for you, but it's, again, a mixed bag. You know, in the west, land inflation has been, you know, certainly double-digit, but then as you start heading east, there's been very little. So it's a mixed situation.

Ok. Thanks a lot.

We'll go next to Todd Voigt at Cliffwood Partners.

Good morning. I think you gave us the 15 cents the office sale on the commercial portion of the income statement provided with minority interest. I'm trying to work backwards to get the true cost of goods for that office. I'm coming to like $60 million. Is that correct?

Yeah, Todd, it was $70 million of 401. I'm sorry, that's for the six months. For the three months, $57,143.

Ok. And then for the prior year, the cost of goods was -

$6185.

Ok. And what about land cost of goods as well?

This quarter, it was $1137. And last year, $505. So we had a gross profit in land this year of about $300,000, and slight loss last year of $50,000.

I appreciate that. And then also on the -- following up on the Colony question, the $15 million of goodwill, were there other intangibles? Did you allocate to indefinite life?

There were none.

What was the write-up of land to fair market value?

We don't disclose that.

Ok. Thank you all.

Ok.

We'll go to Timothy Jones at Wasserman and Associates.

Good morning. Couple of things. First of all, the flat orders in California, I know a lot of this has to do with the fact you just can't get the -- there's not demand certainly in Southern California, but just getting stuff online, but it was flat in both the six months and the three months. When are we going to see that these new communities coming on?

Well, remember, when we talk about new communities, we're really talking on a year-over-year basis more outside -- here, let me give you an idea. In California, essentially we're just simply resupplying our pipeline. There is, I mean, there is a slight community count increase in Q3, but essentially the community count growth occurs in the Southwest, Texas, and of course the southeast where we had a very small business a year ago.

Ok. Now, you gave a good breakdown of three of your markets. Actually you concentrated on two problem markets. We know that Southern California is very strong. Are you seeing a slowdown in Northern California again?

No.

Ok. Secondly, how about a little bit on Nevada and Phoenix?

Very strong.

Both of them?

Yep.

So it's --

Our order rate wouldn't be up 19% unless business was pretty good. Like I guess most $6 billion businesses, there are pieces that we wish were a little bit better.

Did you ever give the final number on what the EBITDA number was that you paid for Colony, the multiple?

No, you didn't miss it. No.

But you did say something that astounded me and that was actually very positive. You said you only incurred $13 million of goodwill..

It was 16.

Well, Ok, 16. I would say that that is dramatically lower than -- that implies that you put a substantial amount of goodwill or excess cross into either the inventories or intangibles that can be expense which is conservative, is that correct?

I thank you for that, but it can also mean that we bought it.

Would you like to tell me which one?

Well, it's a little bit of both.

Ok. And lastly, I listened to the -call on sin 46, and it sounded like the end of the world, and you guys said that you with assurance can say that this will not affect the balance sheet. I don't think anybody knows what's going on, to tell you the truth, and how can you say it with such certainty?

Tim, this is Bill. We have spent really a lot of time on this, and as Dom said in his remarks, we do feel we are far down the path, having gone through it in great detail looking at all the contracts, and working very closely with our auditors as they interpret it as they have --

And who's your auditors now?

Ernst and Young. Deloitte has taken a complete different tact, and secondly, the accounting standard board is not giving any exceptions, which I think, you know contracts that have no recourse should certainly be excluded. I think it's ridiculous. But they don't seem to be giving any Leeway. To your latter point on the FASB, Tim, that's our understanding also. As I understand, Ernst & Young did make a run at FASB and they were not open to hearing anything on this.

It's hard for me to comment on Deloitte, but what I'm hearing is just really rumors and I'm hearing that there is possibly some movement towards their Ernst & Young position, and so it's hard to say where they'll come out, but I think, again, it's just depending on what we're talking about here. This really kind of threw our industry into kind of a reaction that we're just going through now. But at the end of the day, I think that we can say again that we do believe and very confidently that it will have little impact, if any, on our balance sheet.

One last question. It is impossible for you or any other home builder to comply with this rule, if the people that you have the options with will not give you the amount of debt leverage they had, which before this was meaningless as long as you could walk away from the project. What's to stop somebody who has given you an extremely favorable option simply to refuse to give you that number?

That is true, and again, that's one of the big issues that the public accounting firms are grappling with, and all I've heard is that they haven't really come to any definitive resolution on that issue. I will tell you in our case, we have contacted those parties and have requested the information. So right now you just have to do the best you can. That is one area that is recognized as being problematic.

And we'll move next to Steve Fockens at Lehman Brothers.

Good morning. I apologize. I missed the interview this morning, so maybe this is redundant, but can you guys comment a little bit more on the decline in the deliveries in the central region in terms of how much is just directly related to the environment or the weak demand, how much is maybe a deliberate choice on your part to either slow communities or reinvestment, or how much is actual share changes versus other builders?

Steve, this is Jeff Mezger. Our deliveries or our unit rates that you see on the release are down about 10%. You have to go to each city to look at what's going on in that city. We feel really good about Texas today. Our community count is building through the rest of the year. As you can see, our backlog is actually pretty strong, about flat will last year. So we think we're past the trough and going up as we build out '03 and enter 2004. Our general sense is the markets in Texas are off. So I don't know if there's a huge swing in market share from builder to builder.

Am I reading the release right, you had 2400 deliveries in the central region in '02 and 1600 this year?

Yes. Year-to-date, yes.

Oh, so you're saying Texas as a part of that, that's only 10% decline?

Yes.

Ok. Ok. So as far as you can tell, it's more just the overall environment or current environment as opposed to any major shift among the builders?

Jeff Mezger Yeah, that's our view. And again, as we sit here today, we feel fairly good. Sales are strong. It's a great business for us, and we think it will continue to improve as we go through the rest of '03.

Ok. Great. Thanks. One other question, do you think it's possible in the future -- I know in your Q's, you tend to release the profitability by commercial and land. Do you guys have any intention of maybe including that in the press releases up front?

Jeff Mezger I don't think so. I think we'll just continue to put it in the Q.

Ok. Thanks much.

And we'll go next to Serena Shiller at JMP Securities.

Hi. This is Serena Shiller. Quick question about your guidance from you previously had indicated $8 per share and now it's going up to 8.20. With the $8 per share, have you included the commercial property sale?

Bruce Karatz Yes.

Ok. And then also, the relationship between your interest expense and your total revenues, it seems that it's declining but yet you had such a huge pop in revenue. Could you clarify that a little bit?

Bruce Karatz Yeah, our revenues have gone up, but our debt has really remained the same as I think Dom commented, our debt has remained flat and, thus, why our interest is not changing while our revenues are increasing.

Ok. Great. Thank you.

We'll go next to Alex Barron at Franklin Templeton.

Hi! Good morning. When you talked about your price increases in West Coast region as well as your France region, what's driving that, and as well as is it sustainable going forward?

Well, Alex, those increases are for the most part being driven by a lack of supply, and even though as you know, the economy is not strong at the present time in California. There is a strong imbalance between the number of homes for sale and the demand. The actual number was a year ago our average price in the West was 300. This quarter it moved to 356. Our guess would be that you wouldn't see as big an increase going forward as we've seen this quarter.

Ok. But, relative to your strategy of being low cost builder, is this still in line with -

Well, interestingly, 356 sounds like a big price except in California. And actually in all of the submarkets that we operate in, we tend to be at median or below those submarket median prices.

Ok. What about France?

Now France showed a big increase of which 25% was driven by currency. So, you know, if you were to take that out of the equation, it wouldn't look as dramatic as it does. And there, it's a mix issue. I mean, there's nothing fundamentally -- although there is an imbalance also in product, the difficulty in finding land is just as tight there as it is in California.

Ok. Can you talk about again a little bit more on your deliveries in the central region, just focusing on Steve's question? They were down 33%. I know they were only down in Texas versus the rest, pretty much just in Denver?

The balance is in Denver where the market is a little tougher for us than Texas.

You seem to have, roughly speaking, the same backlog. So why are the deliveries so much as compared to last year? Why are they so much lower this quarter?

The backlog is future deliveries, and we had a trough in sales early in the year in the central region as we reviewed on these calls, we think we're past the toughest time in Texas and things are improving. Denver continues to be soft.

Ok. And if I could just ask one more, what can we expect in terms of your deliveries for your southeast region given that it's a brand new region?

For the year, it's about approximately 1500.

I'm sorry, how many?

Were you asking for the year?

Right.

The whole southeast region?

Right.

That's about 3900 to 4,000.

Ok. Thank you very much.

We'll go next to Ari Choechek at Millennium Partners.

Good afternoon. I just want to find the 1046 issue, I mean Hovanian's [ph] auditors are also Ernst & Young and it seems odd why they would give you such different advice, unless your option structure is so differently -

I don't think there was any -let me see in case we got them -

So do you think with your discussions with the you auditors -is it fair for us to think that apply the standards uniformly across the home building companies that they audit or is there enough discretion that each company can choose to do it differently?

No, I think it's the former

Let's remember that it doesn't affect our cash flows. It doesn't affect our profitability for our company and it doesn't affect our leverage ratio. So the fundamentals of company, which is driving free cash flow to grow your business, isn't being affected by 1046.

I understand that. It's just from our standpoint, the companies that we cover, we just try to look at them apples to apples, and to have one company doing it one way and one company doing it another just makes it difficult for us.

I imagine it will be consistent when it's all said and done.

Great. Thank you.

And we'll take a follow-up from Ivy Zelman at Credit Suisse Credit Suisse First Boston.

It's actually Dennis, on behalf of Ivy. My additional question was answered, but Dom, would it be possible to get the breakout of the southeast for the third and fourth quarter of last year for orders and deliveries?

No. We don't provide that.

But you'll provide it going forward? When we have the year over year?

Yes.

Ok. All right. Thank you very much, guys.

And we'll be going to Michael Rehaut at J.P. Morgan for a follow-up.

I was just wondering, if you could give us an idea in terms of the community count growth year over year over the next couple of quarters in the west and central regions? What you expect that to be?

Well, in the west, it's going to be, give or take a couple of communities, basically flat.

And you were interested in the central or southwest?

I'll take both.

Well, the southwest, you will see about a 20-plus % increase in community count over the next couple of quarters in the southwest, and a little bit better towards the end of the year in central, and of course, a huge percentage increase in the southeast.

Ok. So the central will be, you know maybe in the 5% to 15% and then accelerating in the fourth quarter?

Well, it might be more. -Yeah, might be a bit more than that, yeah.

More than that in the third and in the fourth?

Yes.

Okay. Thank you.

This concludes today's question and answer session. I'll turn the call back over to Mr. Karatz for any additional or closing remarks.

Thank you all for joining us, and we look forward to updating you on our third quarter results. Have a great day, and I hope a nicer weekend in the east.

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