KB Home (KBH) 2003 Q3 法說會逐字稿

Good day and welcome to the KB Home third 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 the 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 reports on form 8-K filed with the SEC identify various factors that could actual cause results to differ from (inaudible) KB Home will be projecting in the forward looking statements made today and we urge you to read those.

I would like to remind everyone that this conference call is being Web cast on KB Home's Web site at http://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.

Good morning, everyone, and thank you for joining us today to discuss our record results for the third quarter. With me this morning are Jeff Mezger, our Executive Vice President and Chief Operating Officer, Dom Cecere, our Senior Vice President and CFO, 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, and then I'll turn it over to Dom to review our third quarter profitability and other key financial information and finally I will wrap it up with our business and market outlook for the remainder of the year and our EPS guidance for next year. At the conclusion of my remarks, we will, of course, be happy to address any questions you may have.

I am again very pleased with our record third quarter results. Our company-wide focus on returns on invested capital 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 strengthen our balance sheet. The third quarter was our 33rd consecutive quarter of meeting or beating analysts' expectations and our financial performance continued to set new records. Company-wide net orders for the third quarter increased 16% when compared to third quarter of 2002.

As a result of this solid net order growth, we ended the third quarter with the highest quarter-end backlog in our company's history. Our backlog of $3.4 billion on 16,572 units was up 29% in dollar value, 22% in units, from a year earlier.

Total revenues fort third quarter rose to a record $1.44 billion, up 12% from the year-earlier quarter. Revenues for the first nine months reached nearly $4 billion, increasing 19% from the first nine months of 2002.

Net income for the quarter totaled $97.8 million, increasing 17% from the year-earlier quarter, and for the first nine months of 2003, net income reached $232 million, up 22% from $190.6 million in the corresponding period of 2002.

Our diluted EPS rose 19% to a record $2.33 for the third quarter from $1.95 a year earlier. For the first nine months of this year, our diluted EPS was $5.51, up 28% from $4.29 a year earlier.

The company's after-tax return on invested capital for the trailing 12 months remained above 16%, well above our cost of capital, and almost triple the average for the S&P 500.

During the quarter, we repurchased 750 shares of our common stock, bringing our total repurchases for the year to 2 million shares. Our average shares outstanding for the third quarter were 41.9 million, down $1.1 million or 3% from the 43.1 million shares outstanding in the third quarter of 2002.

Over the last year and a half, we have repurchased 6 million shares of our common stock at an average price of just under $50 per share, representing approximately 14% of the shares outstanding at the beginning of the period.

Now I'd like to comment on business conditions in our various markets. Our overall average community count in the third quarter of this year was 396, an increase of 65 communities or 20% over third quarter of 2002.

The higher community count contributed to the 16% year-over-year increase in company-wide net orders in the third quarter. In our West Coast region, comprised of five California divisions, demand for housing remains strong in the third quarter, with an average sales price up 10% on a year-over-year basis.

We had 65 active selling communities in California, which was one less than a year ago, as strong demand caused us to sell out of existing communities earlier than expected and continued constraints on land development delayed new community openings.

Housing demand in our Southwest region which includes Arizona, Nevada and New Mexico, continues to remain strong led by solid Las Vegas housing market. The company's third quarter average selling price in the region rose 8% in 2003 as compared to the same quarter a year earlier.

Third quarter net orders in the Southwest were up 14%, driven solely by an expansion in community counts in the region. We expect the Southwest region to continue to provide solid top and bottom line growth for the company over the upcoming quarters.

Housing demand in our central region which includes Texas and Colorado still remains mixed with orders down 14% for the third quarter and 116 active communities. The decrease in central region net orders occurred primarily in Denver and Austin. While net orders in the other markets in the region remained relatively flat with year-earlier levels.

The overall average selling price in the third quarter was up less than 1% compared to a year earlier. We are limiting our expansion in the central region to select submarkets until pricing and demand warrant additional investment. However, we expect to see a turnaround in the central region next year.

I'm very pleased with our continued expansion into the Southeast. We currently operate in six major markets in Florida, Georgia, North Carolina, compared with having only one Southeast market in Jacksonville at this time last year.

Net orders of 1130 units from the Southeast region were up 459% on a year-over-year basis in the third quarter. We expect revenues in the region to increase fivefold to more than $600 million this year and contribute to both top and bottom line next year.

In summary, we had our 33rd consecutive quarter of meeting or beating expectations with orders up 16%, revenues up 12%, EPS up 19%, and our return on invested capital remaining solid.

Now I'll ask Dom to take you through some of the 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 12% from $1.27 billion in the same quarter of 2002. We delivered 6,850 homes in the third quarter, up 6% from 6,490 in the third quarter of 2002 with an average selling price up just over 5%.

Our construction operating income for the third quarter of 2003 rose 16% to $137.3 million from $118.8 million in 2002. The housing gross profit margin for the quarter was 22.8%, up 140 basis points year-over-year. For the first nine months of 2003, the housing gross profit margin was 22.1%, also up 140 basis points versus the same period in 2002.

Commercial and land sales for the third quarter of 2003 totaled $23.6 million and contributed $2.2 million in operating income compared with $2.9 million of operating income generated in the third quarter of 2002.

Our mortgage banking pre-tax income of $13.7 million in the third quarter of 2003 decreased from $16.6 million in the same quarter a year ago. We expect year-over-year profit comparisons in our mortgage business to turn positive next quarter and to continue to improve in 2004 due to higher unit deliveries and the contribution from our expansion into the Southeast. Our Southeast operations are now fully integrated into our mortgage operations.

Our selling, general and administrative expense ratio in the third quarter was up 90 basis points to 12.9% in 2003. The increase in SG&A expenses stem from additional expenditures related to new community additions and the initial investment required to expand our market presence and build brand awareness in the Southeast. We expect to see SG&A as a percentage of construction revenues improve in the fourth quarter and throughout 2004 as our investments in the Southeast deliver additional revenues and profits going forward.

Total pre-tax income for the quarter increased 17% to a third quarter record of $146 million from $125.2 million in the same quarter of 2002, driven primarily by improved pricing and operating performance in our construction business.

We ended the first nine months of 2003 with $346.3 million in total pre-tax income, up 22% from $284.5 million last year.

Net income increased 17% to a record $97.8 million in the third quarter, Up from $83.9 million in the same quarter of 2002. For first three quarters of 2003, net income rose to $232 million, increasing 22% from $190.6 million in the year-over-year period.

Third quarter 2003 EPS of 233 rose 19% from $1.95 posted in the year-earlier quarter due to a 22% increase in construction pre-tax income driven by both unit volume and housing gross margin improvement.

With our high returns on invested capital, KB Home continues to be a leader in after-tax returns on invested capital and in redeploying these returns in the best interest of our shareholders.

The company closed the quarter with approximately $70 million in cash. We continue to effectively manage our leverage ratios with the debt to total capital improving to 50.3% at August 31st, 2003 from 51% at August 31st, 2002 and 53.4% at August 31st, 2001. We are continuing to strengthen our balance sheet with interest coverage, debt EBITDA and debt to total debt-to-total-capital ratios improving over the last several years and now comparing favorably against a median of BBB investment grade-rated companies.

Our inventories at August 31st, 2003 totaled $2.9 billion, including both land and homes under construction. We had approximately 125,000 lots owned and controlled at the end of the quarter compared to 96,000 a year ago, approximately 49% of our lots are under option contract versus for the 42% at the end of third quarter in 2002.

At the end of the third quarter, as we continue to focus on build to order and minimal speculative home building, we had less than 500 completed unsold homes or 4% of homes under construction. We continue to maximize return on invested capital by turning 80% of our inventory dollars in five or six quarters with approximately 40% sold and in backlog to be delivered over the next six months.

Looking at the supplemental information provided with our earnings release, the average sales price in the U.S. for the third quarter of 2003 rose 3% to $203,900 from $197,700 in the year-earlier quarter. While average selling prices were you be is substantially on the West Coast and Southwest region, the company's overall average was tempered by a 1% price increase in the central region and a 4% decline in the Southeast due to lower average prices from the Colony acquisition.

With an average sales price of approximately $203,900 for the U.S. and $161,000 outside of California, KB Home still offers some of the highest quality, most affordable homes in America with a 10-year warranty backed by our strong brand and a financially solid Fortune 500 company.

Finally, we ended the quarter with a robust backlog of 16,572 units with a dollar value of approximately $3.40 billion, up $760 million or 29% from $2.64 billion in 2002.

With these record backlog levels at the end of our third quarter, our financial outlook remains favorable. Communities are in place and land is secured providing a foundation for capital investment to grow our business. Investments in the Southeast have been made to expand our platform for growth, and all key credit ratios continue to improve, warranting a credit rate upgrade. We now have a solid foundation for profitable growth as we enter the fourth quarter and prepare for 2004.

Thanks, Dom. Before I wrap up, I'd like to turn it over to Jeff for just a minute, who will comment on two recent operational developments.

Thanks, Bruce. Good morning, everyone. I share Bruce and Dom's enthusiasm about the third quarter. From an operational perspective, our home building business is thriving as we continue to successfully execute on the KB next business model.

In addition, our integration of recent acquisitions in the Southeast has gone very well, and we are presently working to integrate our latest acquisition, Zale Homes.

As you know, we completed the acquisition of Chicago-based Zale Homes just after the end of our third quarter. The Zale transaction is unique in that it takes our operations beyond the sun belt into the largest single-family housing market in the Midwest.

Zale is one of Chicago's premiere home builders, and is regularly listed on the nation's top 150. Zale operates primarily in the highly desirable North and Northwest suburbs. Their homes range from 1,600 to 4,200 square feet with prices from $170,000 to over $500,000.

While growing the business further in this very successful submarket, we will also be quickly expanding our product series. We acquired Zale for $33 million, which we believe is an excellent price for a successful established operation in a dynamic market such as Chicago.

For a nominal price, we have an ongoing business with a 50-plus-year history and an outstanding employee base that can bring tremendous upside for us.

Zale is on track to deliver 300 homes this year, and with KB Home's resources and access to capital, we believe that we can grow the business substantially going forward.

Our expectation for the Chicago business is to develop a growth trajectory similar to all of our other very successful acquisitions. We can also leverage this entry into the Midwest for further expansion into other Midwest markets in the future.

Both KB Home and Zale share a commitment to quality and seek to provide the best value to our home buyers. We believe Zale is an excellent addition to the KB Home team.

On another note, as we have consistently shared with the investment community, customer satisfaction is an absolute priority in our KB next business model. In fact, we are as proud of our accomplishments in customer satisfaction as we are with our accomplishments in financial measures. With internal customer satisfaction scores of 95%, we have shifted our focus to maximize in our rankings in the J.D. Power survey, an independent external source of customer satisfaction.

J.D. Power is a global marketing company that represents the voice of the customer. Their survey is most commonly associated with the automotive industry but is also recognized as one of the top measures of customer satisfaction in a number of industries, including home building. This year's study of the home-building industry was based on responses from over 71,000 buyers of newly constructed homes in 21 of the largest U.S. markets.

To qualify for the J.D. Power survey, builders in each market must have closed 150 or more homes in the calendar year of 2002. The study examined every builder in a number of categories, customer service, home readiness, sales staff, quality of workmanship of materials, price and value physical design elements, design center, recreational facilities and location.

These are the same key elements that we at KB Home focus on every day. That's why we are proud to announce the tremendous results attained by the company over the past year. This year's survey results, which were announced today by J.D. Power, reflect that the company moved up 16 points above last year in the overall customer satisfaction rating from a score of 95 up to 111, which represents the most dramatic year-over-year improvement among all major public builders.

In addition, our Las Vegas and Austin division secured the much coveted top three ranking for their markets. According to the study, KB Home performs above the major market average on most of the factors driving customer satisfaction. We scored above average in customer service, home readiness, sales staff, price value, design and location.

Of course there's always room to improve. We know that we can't be satisfied until every one of our customers is ultimately satisfied. That is the goal, and it is a goal that all the employees of KB Home in every function are firmly committed to. We are very proud of our results in customer satisfaction.

Now I'll turn it back to Bruce.

Thanks, Jeff. I might add that I met with Dave Power several weeks ago, and Dave, who is the creator of J.D. Power, mentioned to me something that surprised me and maybe some of you listening, that buyers of modest-priced product have higher expectations, are tougher to satisfy, than purchasers of higher-priced product, and he said it is true with automobiles as well as homes, and he said when talking about homes, the reason is quite simply that first-time buyers have nothing to relate to as to what to expect in terms of issues that they have to deal with, whether it's changing air filters or expecting to do normal maintenance in their home, so because of that fact, the results to us are even more satisfying.

Now let me finish up. The housing market continues to remain stronger than expected, leading some analysts to anticipate an overdue correction. Something that we've heard now for some time. Surprisingly, some of these same analysts also believe that low mortgage rates and liquidity increases have fueled the resiliency in the housing market over the last several years at the expense of demand.

While at first blush, these arguments may appear to have some validity. Consider the following. In its latest report, the Joint Center for Housing Studies at Harvard concludes that the stronger demand for homes is based on fundamental demographics driven by 25 million immigrants arriving in the U.S. since 1980, and based on its population and immigration projections, the study supports that housing is well positioned for another solid decade.

Using the Harvard housing studies report as a basis, we would go on to emphasize that for the large public home builders, it is actually market share gain built upon overall demand that is the dominant force behind our record growth. We continue to serve a highly fragmented market where the large public builders have a multitude of advantages over thousands of smaller private builders. As a result, both a fundamental demographic trends and the increases driven by gains in market share support our view that growth will be favorable for the next decade for large public home builders.

Regarding interest rates, according to the statistics from the U.S. Census Bureau and the Harvard study previously cited, since 1975, in no one year or even two-year period after an initial increase in interest rates do total housing starts ever decline. Of particular note, during the period from 1978-79, while average 30-year mortgage rates rose 235 basis points, total housing starts increased 7% over the same period.

More recently, while average 30-year mortgages rose 111 basis points during the 1999 through 2000 period, total housing stats still increased, albeit modestly, of 1%. The important underlying statistic during this period, we believe, is that despite this modest increase, single-family and condo starts rose materially, or 4%, at the expense of manufactured housing starts which declined 15%.

Consequently, we believe it is the nation's demographic trends and job growth in conjunction with the consolidation of the industry which will support the prospects of the large public builders. While the only period where interest rates and housing starts were negatively linked was during the 800 basis point upswing of the early 1980's, which we believe that kind of significant rise in rates is highly unlikely to reoccur.

With our continued focus on our KB Next operating model, controlled geographic expansion, share buybacks, and a stronger balance sheet, we believe KB Home is better situated than most to take advantage of the opportunities provided by a fragmented market with strong underlying prospects for continued growth. We now have nine months of record results behind us and a record third quarter backlog.

2003 is shaping up to be another record year for KB Home. Revenues are expected to approach $6 billion this year with unit deliveries in excess of 27,000, and our return on invested capital is anticipated to remain well above our overall cost of capital.

We are raising our earnings per share guidance for this year to approximately $8.50 per share, up 19% from the $7.15 posted last year.

In 2003, we benefited from strong pricing and improved operating performance in our construction business, which more than offset a weaker than expected central region, significant investments in the Southeast, and some one-time charges in Q1 related to mortgage accounting and early retirement of debt.

In 2004, we expect price increases to moderate. We believe we will benefit from our Southeastern region expansion, improving market conditions for KB Home in the central region, and lower SG&A expense as a percentage of construction revenues.

Assuming an improving economy and a flat to modest rise in interest rates, we expect diluted EPS for 2004 will approximate $9.40 to $9.50 a share.

This now concludes our formal remarks, and we'll open up the lines to your questions.

Thank you. The question and answer session will be conducted electronically. If you would like to ask a question, please do so by pressing the star key followed by the digit 1 on your touch-tone telephone. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. We will proceed in the order that you signal us, and we'll take as many questions as time permits. Once again, please press star 1 on your touch-tone telephone to ask a question. If you find at any time that your question has been answered, you may remove yourself from the queue by pressing the pound key.

We'll pause for just a moment to give everyone an opportunity to signal for questions. An we'll now take our first question from Stephen Kim with Smith Barney.

Hello, guys. Good quarter.

Thanks, Steve.

First question I had, Bruce, you talk about the $8.50 number and I think you said $9.49, $9.50 next year.

Yes.

The $8.50 this year, that's excluding the one-time charge or including the one-time charge?

Including.

OK. So that's the lower number. Got it. Was wondering if you could provide a little bit of color on the pricing. You may have said it but I missed it. Obviously it was dragged down this quarter by France. Is that a lingering drag that you anticipate or is that to 2004 that looks like you averaged this quarter in closing prices, you know, should we be using something a little higher than that in the fourth quarter and going forward?

No, it should stay that or slightly moderate.

OK, great. And inventory, Dom, can you provide a little bit of a breakdown on that? You give a couple of categories and I think in your press release, you didn't have a -- in progress on the land-to-land development. Do you have those numbers?

Wait one second.

OK

Steve, it's Bill. You were asking for the breakdown of our $2.8 million?

Yes.

The homes under production is 2.442 and the land under development is 425.

Great. Thanks a lot. And then the subcount. The subcount that you indicated was 396. That was, I guess, global or including France. What was it in just the U.S.? Ending subcount?

324.

Yes, 324.

And that's a little on the light side, isn't it? And do you still expect to end the year like around 4.25 or should we moderate that expectation?

Well had said last time that we would go from 4.25, went down to 400, we're now looking at about 380 with about 10 less in the central region as we're being more select and 10 less than the West Coast which is really delayed community count opening.

OK. Great. So, I mean, those numbers are basically coming down because you're running into, would you say, zoning issues or it's an issue of maybe selling out? I mean, are those communities that are going to fall out of this year, are they still expected to open next year? Could you provide a little color as to why we keep seeing that number trend down and provide some color on that?

Well, Steve, one is, it is difficult to predict exactly when communities open, and there can be lots of factors that affect that last ultimate date. I think in this case, while it's a mixture in of a lot of things, certainly in the West, we have sold through faster, and at the same time, opened up slower for a whole multitude of reasons. The other part that Dom mentioned is some of it is voluntary, where we have voluntarily cut back investment in certain submarkets, but overall, while it is less than previously guided, it is still a significant increase from where we were in the same period a year earlier.

OK. Great. And my last question, guys, is basically addressing what I'm sure you guys are all aware of, which is that many people have sort of, you know, had heightened concerns about the fact that you build to the affordable end of the market, and while I certainly agree the long-term demographics there are very strong, some people are concerned that near term, you're more susceptible to interest rates. There has been a lot of written about the low-down payments mortgages and the zero down payment FHA etc.

Can you just provide an update as to what your percentage of -- or participation in sort of the zero down payment or the gifting down payment is and your exposure to FHA, VA, and maybe if those numbers have trended more conservatively over the last quarter or so?

Remember on our down payment assistance programs in 2002, they were approximately 15% of our total deliveries, and when we looked at it market by market, they're trending down in 2003 overall.

Can you put some kind of magnitude on that? Should we expect something closer to 10 you think by the time the year is up?

When you look at market to market, 15% last year, it was under 10 this year.

In terms of FHA/VA, I think you said were you something around roughly 50%? Is that right? Is that coming down too?

I think it's around 45 and it's been staying fairly level.

OK, great. Thanks very much, guys. Strong quarter.

We'll take our next question from Ivy Zelman from Credit Suisse First Boston.

Good morning, gentlemen. It's actually Dennis on behalf of Ivy. You mentioned the attractive price that you got Zale at. Can you expand on why you were able to get it at such an attractive price? Was Zale looking to exit or having some difficulty there?

No, Dennis. We look at lots of acquisition opportunities, and Zale was a quality company. Most transactions are not heavily bid but rather negotiated on a one-off basis, and in this case, we feel we were able to acquire the company attractively.

Well, it looks like a great price and a great market. Will you be breaking that Midwest -- I guess will it be a new Midwest division or will that be included in, I guess the central?

It will be the central because it's only 300 units a year this year.

OK. Dom, could you give us an idea of why the interest expense was much lower recently? It looks like you capitalized a little bit more this quarter.

I certainly can. This was our largest quarter for land purchases, and so per GAAP, we capitalize interest on land, and that's -- we just followed GAAP.

So is it on a percentage of lots basis or a dollar basis?

It's on a dollar basis.

OK. And lastly, it looks like you had 59 deliveries from JV this quarter, yet there was no backlog in the JV's recent a quarter ago, and it looks like looking at the year ago third quarter, you had at the time zero backlog of JV and in the current press release that's 85.

Yes, we, if you recall, we usually in the past only broke out JV for our domestic operations in the U.S. and now we started to include France, so that's why. So right now we have the total company showing up or showing the JV's.

So the 59 delivered this quarter, that was all in France?

Yes.

All right. That's all. Thank you very much, guys.

Thanks, Dennis.

Moving on to Margaret Whelan with UBS.

Good morning, guys.

Hi, Margaret.

Couple of things. I guess the community count being lower is good because your sales base is higher, but then I'm wondering, how do you actually manage your average selling price? How often do you relook at those prices, maybe raise them if the demand pace is high and if you've got these delays in opening new communities?

Margaret, that's a good point. We look at pricing on a weekly basis, and even in some submarkets, more frequently than that. And there is a process that divisions go through, highly disappointing process, to attract what our competitors are doing, and as well as what we have actually done over the prior week or weeks to determine how aggressively we can increase prices.

And I think we continue to get better and better at that, and while increases are not possible throughout every submarket, they certainly have been, as I indicated, throughout almost all of California and Nevada over the past quarters.

Margaret, if I could just respond on it, part of the impact has clearly been in the central region, where our orders were down double digit, and we've continued to focus on not having sales for sales' sake, but on maintaining our returns on invested capital, and I would just say that our gross margins on our housing deliveries in the central region are the same as the company average and the same as we had last year, so rather than putting in concessions and reducing prices to drive volume, we've chose to be selective on our land deals and maintaining our housing gross margins and our returns.

The gross margins and returns are the same in the central even though your sales are down?

The gross margins are. It takes a little while to recover on the returns. As we said before, we work through land, 80% of our land in five or six quarters, so it recovers fairly quickly.

But in terms of EBIT margin, the SG&A has got to be up a little bit, right?

As far as the timing it takes you on SG&A to right-size the business to the market, you're right, we lost a little bit on the SG&A line, but as we said in our release, that will correct itself in the fourth quarter and be back to normal in 2004.

Got it. OK. And then just on this community count issue again, in the event that you do have these delays and they take a little bit longer than we're forecasting now, I mean, you've got to be carrying some excess SG&A just because of the salespeople that are not working if they sell out of one community and there's a gap between the time you move to the next one, right? So SG&A could be more volatile?

Remember our salespeople are 100% commissioned, so at least that follows the revenue stream.

OK. So there's no real fixed asset there or fixed cost?

No, there are some fixed costs, and that's what it does take a couple of quarters to correct.

OK. And then in terms of the closings, I mean, recognizing you didn't have the communities open that you expected, but your actual conversion ratios, sales from the backlog, was a lot lower than we expected, and it was lower than it's been in the last couple of quarters. Did you have weather delays or something that we were missing there?

Remember, our orders in the first quarter were only up 1.5%. 17% in the second quarter. And part time, it takes you maybe 30 days to qualify a first-time buyer and two to three months to build a home --

More than that.

More than a month. You're really looking at the impact on our housing delivery showing up in the fourth quarter, not the third quarter. So we thought we were right on target

OK. So it will just be back-end-loaded?

As we said in the second quarter, we knew that our order deliveries were back-end-loaded this year and there would be a modest increase in the third quarter.

OK. And then in terms of the mortgage capture rate, do you know what that was, or the percent of the homes you're selling, how many mortgages -

79%.

79%?

It was 90% last year.

And what was it last quarter? I know it was lower than we had expected.

About the same.

About 79 as well?

Yes.

OK. And just housekeeping, the average price on the shares you repurchased this quarter, do you have that handy?

I believe it was $55 for the 2 million that we've done this year.

OK. Oh, for the 2 million you've done this year.

Off the top of my head, I don't have it.

Just lastly on the hurricane in the Southeast, are you guys prepared for that?

Well, one is I'm unaware that we've had any damage, and this becomes rather a common occurrence in the Southeast, and as a new entry into the market, we do have experienced Floridians and North Carolinians, so I think we're doing everything one can do to minimize any loss.

OK. Thank you, guys.

You're welcome.

Joseph Sroka, Merrill Lynch has our next question.

Hi. Good morning, everyone.

Hi, Joe.

Bruce, in one of your television or radio interviews this morning, you talked about increased marketing costs, particularly in the central region. What actually are you doing? Is it advertising or incentives or what's going on there, and do you believe that stays flat, goes down or goes up as we move into the back half of the year?

Well, to repeat what Dom had just said was that although sales in the region were off, gross margins were not, so that should tell you that we have chosen the path of not discounting our product to encourage sales, but rather holding our pricing even in certain submarkets in a tougher environment, which I think bodes well for the future.

However, it does -- that lower sales activity does hit you on the SG&A line because there is a natural lag unfortunately between a sales decrease and a comparable decrease in fixed, and that is what we suffered from, so a higher percentage of SG&A caused by a lower sales delivery rate.

OK. So it's billboards and buses and everything else as opposed to home incentives?

Yes.

OK. And then just a follow-up on the JV and the France JV issue, those numbers that are now showing up in unconsolidated joint ventures, they were never anywhere else, like they were never in the French delivery count?

That is correct.

OK. Because that stayed consistent from your previous financial statements.

That is correct.

OK. So -- but there was revenue recognized from this in previous periods, so there's no income statement effect but you're just saying when you break out the home building numbers, you're disclosing that there were some more JV deliveries in France?

Yes, it's just an operating data metric that was disclosed. There's no impact on the financials at all. It's just -- yes, to your point, it was broken out where previously, we only disclosed the domestic side.

OK. And you'll get us restatements for all the previous periods?

Yes.

OK, gentlemen. Thank you very much.

Thanks Joe.

Our next question comes from Michael Rehaut with J.P. Morgan.

Good morning. A couple of questions. If you could provide an update on how the cancellation rates are going. You mentioned in the press release about August order trends still being double digit. I was wondering if that was in context to the prior two months, was that, you know, at a stable rate versus the other two months or was it slowing or how would you characterize the activity on that level?

Can rates (ph) have stayed about where they have been, and with respect to August, we outlined August because some people had written that they were concerned that August showed a negative trend and we didn't see that, so our August order rates were he very similar to June and July.

OK. And are you seeing any higher expenses right now in lumber costs or have you been mostly able to offset that with your pricing power at this point?

Michael, this is Jeff. We definitely have seen some lumber increases and it varies by market. Our backlog is covered so that there's no impact to our Q4 deliveries or going into Q1 of next year. We're going through some pricing strategies to cover any increases. The lumber market has been moving up and down, as you know, it changes day-to-day, so we just deal with that on a daily basis and think we have it covered.

Lumber costs are roughly 5% of our sales overall, and I'm pretty comfortable that we have enough cost savings generated by our efforts with the National Account Rebates that margins overall will not be materially impacted in 2004.

OK. Thanks a lot.

Thanks, Mike.

We'll take our next question from Steve Fockens with Lehman Brothers.

Good morning, guys. Two quick questions. On the community count in the central, I think you said it was 116 in the quarter. What was it a year ago, and then kind of what might be your plan a year from now?

It was 108 a year ago.

108?

108.

OK. And do you think it will stay in that 116 range or call it the 100-110 range --

We think the market is going to be covered so therefore, we think that community counts in central will be up a year from now.

Maybe I should put it this way. Any idea of the magnitude of the increase?

Going forward, it should be -- remember, we're going to have Chicago, and then again, when we talk about central, there are a number of markets that are doing very well for us like Houston is a market that's doing very well, and interestingly, the DFW Metroplex for us is also showing growth. Whereas San Antonio and Austin, we think might be, you know, more flat going forward. So overall, we would see probably an increase in community count -- I don't know if I can give you a real number, but -- close number, but it will be, you know, fairly significant.

And that, again, would probably be more Chicago and probably --

And those places --

And Houston and DFW?

Yes.

And I'm sorry, one other quick question to follow up on the lumber question. Is it fair to say that you guys generally think that any recent price spikes there are more a cyclical and not a secular issue?

Typically lumber spikes in September every year, as we've tracked it over the years, so you can never -- it's a commodity so it could go up, could go down going forward, and we just manage to that and cover our backlog.

But in terms of -- I mean, obviously over time that you've been doing this, maybe there have been spikes in the past, but I know that plywood and OSB have moved pretty dramatically recently. You don't expect the prices that you're seeing now to linger, you know, at that kind of level for an extended period?

Hard to say because it's a commodity, but we're not seeing -- we're not expecting it to go up in a real fast trajectory.

But I would tell you that we would not make any assumptions about which way those kinds of prices will go, but rather just manage through forward contracts and tied into our pricing of our product.

And lastly, have you guys thought about or already undertaken areas of actually improving efficiencies in your use of lumber, whether that's designing a house in a different way or anything along those lines?

We're constantly looking at those kind of things. We call it our path finder initiatives, and we are actually working on some regional and national initiatives in lumber that will give us better control of supply availability and also pricing going forward, so we're definitely focused on that.

OK. Great. Thank you very much.

David Weaver with Legg Mason has our next question.

Good morning. On the Zale acquisition, consistent with other acquisitions, do you intend to change the name over to KB and brand it as such?

The Monday after the closing, the phone was answered "KB Home, may I help you."

OK. And in terms of the pricing points sounds like they've got some product that's a little bit above your normal zone. Are you going to continue to grow that higher-end market for them or are you going to expand that more on the affordable product?

It's an interesting question. While their prices are higher, you have to recognize they also operate in the most expensive submarkets in Chicago, in Lake County, so that while the numbers are high relative to those submarkets, they're actually affordable, just like our business model in San Jose, for instance. Our strategy is to expand into the less pricey submarkets, if you will, but holding our niche and growing our niche in Lake County as well.

On the mortgage business, I think on prior calls, you've said you hold your mortgages for a month or so before you sell them. Are you changing your strategy there at all with the recent slight change in direction with rates?

Not at all. We still hold them 30 days. We have them hedged for the last 45.

OK. Thank you.

And Barbara Allen with Natexis Bleichroeder has our next question.

Thank you. Wanted to make sure I have the right number on the number of U.S. communities this quarter versus a year ago is -- I think I have it at 324?

Yes. Versus 249 a year ago.

Versus 250 was what I had. And that implies a decline in orders per community in the U.S.?

It implies a slower velocity, but a velocity we still think is acceptable.

OK. The second question that I have is through thank you for the number of completed and unsold number of houses in inventory. Could you give us the total of houses in each stage of construction in inventory and how many of those did not have a contract?

Less than 10% did not have a contract.

Total. Do we have a number for it? Why don't we look for it, Barbara, and then we'll give it to you. Do we have it, Dom?

Yes, we have about 12,000 homes in production.

In production?

Yes.

And of that, less than 10% --

Are unsold.

Are unsold. Ok. Thank you.

Our next question comes from Jim Wilson with JMP Securities.

Good morning, gentlemen. Bruce or Dom, looking forward in your $9.49, $9.50 guidance for next year, any other color like for community count assumptions or anything else that you could give us as color to your thought process on growth for next year?

Well, we're anticipating, you know, an increase in the delivery count level, you know, north of 30,000, and we anticipate that the Southeast, which has, as I indicated, we'll do over $600 million this year at very little contribution, will begin to be a real contributor on the bottom line in 2004. And we anticipate to do better in the central region in 2004, and moderating price increases in the Western region.

OK. So that could easily be possibly even in that mix improved margin next year, but with lower average sales prices due to the Southeast?

It could happen.

OK. That's what I was thinking. OK. That's really all I wanted to get at. Thanks.

Ok.

Our next question comes from Mike Kender with CitiGroup.

You talked earlier in the call about rating agencies and trying to get upgrades out of these guys. Can you just give us an update on kind of when is the last time you went through the rating agencies and is there any specific target that they've -- anything specifically they've singled out that's keeping you from investment grade?

Well, we've just visited with S&P and we'll be visiting with Moody's October 8th or 9th, and the feedback that we got -- of course they don't give you real clear, clarity on what they're thinking, but they were very impressed with all of our matrices and the fact that they were all better than 226 (inaudible) investment grade companies, so the indications we got back were positive that they thought the progress we had made was excellent, and that's the overall sector including us with moving towards investment grade.

Great. Thank you.

Actually when, I don't know, but we're moving in the right direction.

OK. Thank you.

Timothy Jones with Wasserman and Associates has our next question.

Good morning. Couple of questions. First of all, what percentage of your mortgages right now are fixed?

Plus 90%.

That's interesting because Ryland (ph) said 95%, so it obviously shows that even the low-cost buyers are not really being strained by the rise in interest rates. Would you agree with that?

Totally.

OK. Purchase accounting, what effect did that have on your gross margins?

We've never broken out purchased accounting's gross impact for the company.

OK. I've contacted most of the public builders, and over 85% including you said that there was no really slowdown in the last couple weeks versus the prior weeks. Can you explain this ISI survey which went down 14 points? I'm having a terrible time figuring it out.

You know what I think, Tim, I am puzzled as well. I think what's going on is that there is going to be a bifurcated business between the large publicly held builders and the smaller privately held builders, and I think we're going to continue to see as we move forward this consolidation, and quite commonly two points of view as to what's going on in markets, and right now that's what this latest survey indicated, and I wouldn't be surprised that there will be other times when it will be similar.

This week it was -- they were more strong on demand for housing, so I think it's very difficult to take a one-week look and interpret any long-term impact on the business.

I mean, if people are giving one month look, certainly one week is ridiculous, but there is, I think, 11 public builders and two private ones in that survey, so I'm not quite sure. But lastly, there has been a rise in delinquencies in FHA loans as opposed to VA's and certainly as opposed to conventionals. Do you have any idea what's going on there on delinquencies?

You know, I don't have the numbers in front of me, Tim, but it was something that was discussed at a conference that Steve Kim put on last week, and as I recall, the number we're talking about, 100th of 1% differences. I mean, very, very small. In my mind, it was something like --

The total number, yes, the total number was very, very small, like 10 basis points, but the FHA number seemed to be quite big. VA and conventional was very small.

Yes, right.

I remember there was a comment that FHA was losing some of their best buyers to other agencies, and therefore the mix in FHA's have changed.

Interestingly, of course, the Fannie and Freddies have moved into the FHA market, and so what is going on is really an expansion of mortgage availability to a wider range of buyers, which some people seem troubled with. I think it's a trend line that is going to continue because that's one -- the investor market is becoming much more comfortable with the risk-reward tradeoff, and politically, there is strong pressure to expand home ownership to a broader range of first-time and minority home buyers.

I actually felt the overall delinquency rates were probably right in line with the job recovery, which has not happened yet, and when you see job recovery, those numbers will probably improve.

And that does conclude today's question and answer session. Mr. Karatz, I'd like to turn the conference back to you for any additional or closing remarks.

Thank you very much for joining us, and I want to reiterate that our business remains very solid, business conditions remain very positive, and we continue to be optimistic about our future.

And on one last point, next month we will be holding an investor meeting and luncheon in Boston and New York on October 8th and 9th, and any of you who would like to attend, please contact Jim Gonzalez. We'd love to see you there. Have a great rest of the morning and day, and see you next month. Bye.

That concludes today's conference call. Thank you for your participation.