KB Home (KBH) 2004 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 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 differences may be material. These discussions (ph) 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 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 www.KBHome.com.

For opening remarks and introductions, I would 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 to everyone. I appreciate your joining us this morning. 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 Kelly Masuda, our Vice President of Investor Relations and Treasurer.

I will begin the call with an overview of the quarter and current market conditions. Dom will review our financial results. And then I'll finish up with an update on our earnings outlook, and then I will be happy to take your questions.

I'm pleased to report that KB Home delivered another excellent performance for our shareholders in the second quarter. Fully diluted earnings per share rose to $2.40, a 24-percent increase over the second quarter of '03. The disciplines of our powerful KB Next (ph) operating model continue to guide our business decisions at KB Home as we refine our existing operations, enter new markets, diversify our product offerings, and continually strengthen our financial position. Our financial and operating results in the second quarter and first half of 2004 underscore the importance of these disciplines to our continued success as a national homebuilder.

Let me share some of the quarter's highlights with you. We now have 360 active selling communities in the United States, up 20 percent from approximately 300 active communities at this time last year. Companywide net orders rose 28 percent in the second quarter on the heels of a 23-percent increase in Q1. We ended the first half with an order backlog exceeding 20,600 homes, with a future revenue value of nearly 4.5 billion, up 32 percent from our dollar backlog this time last year.

We posted solid topline revenue growth in the second quarter, with companywide unit deliveries up 12 percent on a year-over-year basis, and housing revenues up 15 percent to 1.54 billion. Our housing gross margin improved by 200 basis points to 23.8 percent in the second quarter, with price and productivity advances more than offsetting higher material cost. Our strong earnings performance in the second quarter contributed to a 30-percent increase in diluted earnings per share for the first half of 2004, to $4.15 from $3.19 in the first half last year. And our return on equity for the last 12 months was a solid 24 percent.

Additionally, we have a terrific land pipeline, owned or controlling approximately 149,000 lots, which will support our disciplined growth objectives. Given the compelling value of KBH common stock at a recent price of just 6 times the consensus estimate for 2004 earnings per share, we repurchased 1 million shares during the second quarter at an average price of $66 per share.

With these results, KB Home has now met or exceeded earnings expectations for our company for 36 consecutive quarters, and we are working hard to extend our track record of consistently strong financial performance. During the second quarter our majority-owned French subsidiary, Kaufman & Broad, S.A., acquired Groupe Avantis, one of the leading developer-builders in the Midi Pyrénées region of France, southwestern France. Groupe Avantis is currently developing 14 communities and holds a land portfolio representing more than 2,800 housing units. Revenues for 2005 are estimated at $120 million.

In the U.S., we acquired Dura Builders, expanding our position in the Midwestern United States. Dura is one of the top 10 builders in the Indianapolis market, which ranks as the 17th largest market in the nation based on housing permits, according to Builder magazine. Last year, Dura delivered over 500 homes and generated revenues of approximately $75 million. With the addition of Dura to KB Home's domestic operations, our geographic footprint now extends to 35 major markets in the United States, up from just 20 at the beginning of 2003. Last year, those markets generated approximately 475,000 new housing permits, one-third of the U.S. total, and represents a very interesting growth opportunity for our company.

In fact, I believe that KB Home now stands in the best strategic position of our over 45-year history. We believe that population and job growth, the key drivers of housing demand, will continue to trend positively in the markets we are in and mitigate the potential impact that rising interest rates can have on housing demand going forward. I'm confident in our ability to maintain financial performance that will compare favorably to that of the S&P 500.

There are ample marketshare growth opportunities available to KBH in the markets we now serve. Put more directly, I believe we have some of the best home design and marketing capabilities in the industry. And KB Home competes in the marketplace for new homes with a set of advantages largely confined to the biggest public builders in an industry that is still very fragmented, despite the consolidation we have seen over the past decade. In a rising interest rate environment, those advantages become even more apparent as smaller builders struggle with rising borrowing costs and shrinking capacity to finance their businesses.

Investors are concerned about the performance of home builders in a rising interest rate environment. The last real spike in interest rates was in the year 2000, when 30-year mortgage rates peaked at 8.5 percent. In 2000, our unit deliveries and revenues grew modestly. Margins improved, and we repurchased 10.7 million shares of our common stock. Our stock price recovered from being down 28 percent from January to May 2000 to being up 40 percent by the end of the calendar year. Certainly, I can't predict where our stock price will be at year end. But I do believe that financial markets ultimately will value our company based on business fundamentals, the financial results we deliver, and our sustainable competitive advantages.

And the fundamentals of our business bode well for the future. We now stand to benefit from a strengthening economy; accelerating job growth; and an expanding, geographically diverse footprint for our new homes in many of the nation's most attractive markets.

Let's take a brief look at how those markets are performing today. In our West Coast region, net orders were down 18 percent in the second quarter, due only to a shortage of active selling communities. As you know, housing demand on the West Coast today is at very high levels, and while we continue to make significant investments to expand our West Coast community counts, demand so far this year has outstripped our ability to replace sold-out communities. However, we do expect community counts to exceed last year's numbers by the end of 2004.

In our Southwest region, net orders rose 18 percent over a very strong second quarter 2003, which in turn, had risen 32 percent over 2002. Our dollar backlog in the Southwest is now close to $1 billion, up 39 percent from a year ago.

Demand in our central region continued to build momentum in the second quarter on the heels of a strong first-quarter recovery. Net orders were up 59 percent from a weak 2003 second quarter.

In the Southeast, roughly a year since our expansion into Florida, Georgia, and the Carolinas began, net orders rose 58 percent in the second quarter, illustrating the strong performance that we can achieve through a well-executed mix of private builder acquisitions and de novo expansion.

Overall, we achieved a 28-percent increase in companywide net orders during the quarter, and we remain confident in our ability to achieve continued growth in the second half of the year. As always, we will be guided in our pursuit of company growth by the disciplines that have brought us this far -- in particular, the financial prudence and balanced approach to capital redeployment that have allowed us to maintain an investment-grade balance sheet, pay an industry-leading dividend, and enhance shareholder value through timely repurchases of our common stock.

With that, let me turn it over to Dom, who will walk you through some of the financial results for the quarter.

Thank you, Bruce. We delivered 7,124 homes during the second quarter, up 12 percent from 6,344 in the second quarter of 2003. For the first half, we delivered 15,320 homes, up 15 percent year over year. And we entered the second half with a backlog of 20,636 homes, up 28 percent in units and 32 percent in dollar value from our May 31, 2003 quarter-end backlog.

Housing revenues for the quarter reached 1.54 billion, up 15 percent from the second quarter of 2003, driven primarily by a 12-percent growth in new home delivery and an overall two-percent increase in our company-wide average selling price.

Housing gross margins continued to improve during the second quarter, despite higher material costs for lumber, cement, insulation, plumbing, and Sheetrock. The gross margin on housing revenues was up 200 basis points year over year, which drove our gross profit dollars up 25 percent year over year.

Revenues from commercial activities and land sales in the second quarter totaled approximately 14 million and generated approximately 0.9 million in profits. This compares to revenues of 75 million and profits of 16 million in 2003.

Our construction pretax income for the second quarter rose 35 percent to 150 million, up from 111 million in 2003. This increase was mainly driven by growth in our revenues and a 200-basis-point improvement to 23.8 percent in our overall housing gross profit margin, as well as a significant improvement in our SG&A ratio.

In the second quarter, SG&A expenses as a percentage of housing revenues improved by 90 basis points to 13 percent from 13.9 percent in the second quarter of 2003. As we have mentioned several times this year, we expect our annualized SG&A expense ratio to improve in 2004. With our result to date, we are well on track to accomplish that fact.

Minority interest in the quarter increased to 13.9 (ph) million compared to 6.6 million in the second quarter of 2003. The main reason for this increase is our very successful Seaside community outside (ph) in Monterey, California. We expect to deliver over 200 homes at Seaside this year at an average price point above $750,000. Consequently, you should expect to see minority interest increase significantly by around 35 million in 2004.

Our mortgage banking operations posted second-quarter pretax profits of 2.5 million compared to 10.1 million in the year-earlier quarter. Second-quarter profits were hampered by lower retention rates and the increased use of variable rate mortgages, primarily by move-up buyers capitalizing on the wealth of attractive variable rate mortgage products now available in the market.

Our second quarter 2004 retention rate was 63 percent versus 79 percent in 2003, and average loan-to-value ratio was approximately 86 percent versus 85 percent in the year-earlier quarter. The percentage of fixed-rate mortgages was 72 percent in the second quarter of 2004 compared to 90 percent in 2003, while the percentage of FHA/VA loans for the second quarter was 22 percent of a dollar origination (ph) of loans, which was 23 percent in 2003.

Companywide, our total pretax income for our construction and mortgage banking segments for the second quarter of 2004 increased 26 percent to $153 million from 121 million in the same quarter of 2003. For the first half, our pretax profits totaled 263 million, up 31 percent from 200 million in the first half of 2003. So year-over-year growth in second-quarter pretax profits was excellent, despite the tough 2003 comparison that included the sale and proceeds of a commercial building in France.

The company's second-quarter EPS of $2.40 represents a 24-percent increase from year-earlier EPS of $1.94, and was 30 cents ahead of the $2.10 consensus estimate for the quarter. We had 42.6 million average diluted shares outstanding during the quarter, which was slightly higher than the number of shares outstanding in the second quarter of 2003.

The company closed the quarter with 66 (ph) million in cash related to our construction operations. Our financial position remained healthy, with net construction debt to total capital at 49.8 percent and interest coverage for the last 12 months at 6.3 times. We believe that our overall credit ratios, coupled with the liquidity of our balance sheet, provide investors with a risk-averse balance sheet of investment-grade caliber.

Total inventories of land and homes under construction at May 31, 2004 totaled 3.6 billion, up 33 percent from 2.7 billion in the second quarter of 2003. We expanded our investment in land and land development from 20 to 35 markets in the U.S., and our community counts were up about 20 percent to approximately 360 U.S. communities in the second quarter. With strong net orders for new homes in these communities, our companywide orders were up 28 percent in the second quarter, in line with our investment in land inventory and in the growth of number of active selling communities.

Companywide, we had 149,000 (ph) lots owned or controlled at May 31, 2004, compared to 120,000 lots a year ago. Approximately 50 percent of these lots were under option contract. We are happy with the strategic position of these lots across all of our geographic markets, and believe we have a pipeline in place to support our goals through 2007, which we reviewed at our investor meeting in New York, of 50,000 unit deliveries, 10 billion in revenues, and $20 in EPS for 2007. Included in inventory are unsold homes and homes under construction. With our continued focus on even-flow production and build-to-order, we had less than 300 completed unsold homes at May 31, 2004, less than one unsold finished home per active selling community. Spec inventory of finished unsold homes was less than 3 percent of the more than 11,000 homes we currently have under construction.

We continue to maximize our return on invested capital by turning more than 70 percent of our inventory dollars in five to six quarters and maintaining a strict focus on our build cycle times. The Company's inventory turn of 1.6 times is one of the highest in the industry while maintaining a four-year pipeline of land either owned or controlled.

Our U.S. orders in the second quarter grew by 27 percent. One of the important contributing factors was the progress we have made in lowering cancellation rates. During the second quarter, the rate improved to 25 percent from 29 percent in the first quarter and 36 percent in the second quarter of 2003. One reason is that we raised the FICO score level required to record an initial sale and set aside more credit-challenged borrowers until we'd had full documentation for loan qualification. Our companywide FICO scores averaged 689 in the second quarter of this year, which was up 10 points from the second quarter of 2003.

With the strong sales momentum so far this year, we ended the second quarter with the backlog of 20,663 units, up 28 percent on a year-over-year basis. The dollar value of backlog at May 31, 2004 was approximately 4.5 billion, up more than 1 billion or 32 percent from 3.4 billion at May 31, 2003. Our backlog was up in all geographic regions, setting the stage for another solid performance in the second half of the year.

As Bruce mentioned earlier, we repurchased 1 million shares of our common stock in the second quarter. We have now repurchased a total of 7 million shares over the last 2.5 years, and entering the third quarter, we have an average of just over 42 million diluted shares outstanding, roughly the same number outstanding in the third quarter of 2003 and in 1993, when our company was a regional builder delivering 7,000 homes with annual revenues of just over 1.2 billion.

To summarize, the financial scorecard for our business continues to improve and profiles our success. Our community counts in the U.S. are up 20 percent. Order growth in the second quarter was up 28 percent. Our backlog of 20,636 homes was up 28 percent. Our housing gross margin is up 200 basis points to 23.8 percent, and the ratio for expenditures for SG&A improved by 90 basis points in the quarter. We have a strong, high-quality backlog, an investment-grade balance sheet, good liquidity, a lower borrowing cost, improving margins, and expanding national footprint. This puts KB Home in an excellent financial position to continue to deliver solid financial results for our stakeholders going forward.

Now I will turn this back to Bruce for an update on our earnings guidance for the year.

Thanks, Dom. During our first-quarter conference call, I told you we would need a solid second-quarter performance in new orders to guarantee the year. Well, our division teams delivered on that challenge. We now expect KB Home to deliver more than 32,000 homes this year, which is an additional 1,000 homes from our earlier first-quarter guidance. We are also comfortable raising our revenue guidance for 2004 to 7 billion, up from the 6.8 billion guidance we provided in March. At that level, revenue will be up approximately 20 percent this year from the 5.9 billion achieved in 2003, with all regions contributing to topline growth.

We are also raising our earnings per share guidance for this year. We now expect diluted earnings per share to reach $10.75, up from the $10.25 we provided during our last conference call. The new figure represents an increase of approximately 22 percent from the $8.80 cents we reported last year.

More broadly, I would like to finish by reminding you once more of the unique competitive strengths and strong fundamentals that accompany KB Home into the second half of 2004. Against the backdrop of a growing economy and a now strongly expanding job market, we are well-positioned in more of the nation's best housing markets than ever before. We have a broader range of products to offer an increasingly sophisticated buyer. We have the financial strength to underwrite our continued growth and a competitive advantage in the cost of our capital, labor, and materials to achieve that growth. More importantly, we have a proven business model that reminds us every day of the wisdom of disciplined planning and careful execution. We work hard every day to deliver value to our homeowners and our stockholders, and we will continue to do this in the future.

That now concludes our remarks this morning, and would be happy to answer any of your questions.

(OPERATOR INSTRUCTIONS). Margaret Whelan, UBS.

Good (ph) quarter. And I guess, Bruce, you mentioned in your prepared comments how much your geographic footprint has expanded in the last couple years, which is important. But can you give us an idea of how you keep controls in place for so many different groups?

Well, Margaret, it's a longer story then probably we have time for on the Q&A. But we have established regional supervision, so -- we have a number of things going for us. Let me start first of all by reminding you and everyone else that we have a business model that is the same in Tampa as it is in Sacramento. So as we continue to develop new divisions, we are applying the same tools everywhere. The product development is done through our own design center, with almost 100 architects and technicians here in California that adopt housing plans that we know work with local architecture and local planning.

We also have invested heavily in training -- education for all KB Home employees. We just finished two weeks ago what we call Land 501 (ph), which is the fifth year that we all come together, some 300 persons involved in land acquisition and land development all coming together for a two-day meeting in which we go over best practices, issues, things that we didn't do so well that we can do better, and things where we have developed new product densities that have been proven successful. On top of all of that fundamental base, which is the most important, we have layered in a regional general manager who then reports in to Jeff here in Los Angeles.

And I think that, when you put it all together, coupled with the fact that a number of years ago -- I think you remember we set up two regional accounting centers. So all of our financial controls, regardless of the number of divisions, all funnel into two regional accounting centers which report back to Bill here in Los Angeles. So all checks are cut through our regional accounting centers; financial statements are prepared by regional accounting centers, and these are independent centers reporting to corporate as opposed to divisional management. And we think that's very important; we are very happy we did it.

And you couple that all together, and both Jeff and I feel very good about how the new businesses have developed. They, businesses that we have acquired -- we are seeing how owners who have become now presidents within the KB system have reacted positively to all of the tools and aids that we have given them to run their business better and bigger. And so, for the moment, we don't feel any of the pressures that one might think about growing this number of new businesses.

How often do you hear from them in terms of monitoring and the orders and the margin embedded in the order?

Well, remember, every week, we get what is called VC backlog, which is a report, again, generated by the accounting centers that put in all sales prices, and therefore very close to what the gross margin is in their backlog. It's all part of the same common system. And to date, we think we have as good a view on margins going forward as one can have.

Can you just give us an idea, maybe, if at all possible -- on a same-store basis versus last year the absolute dollar number of expenses because of higher costs right now -- because of timber and labor, energy, whatever it is?

Well, you're shifting now to direct costs?

Yes.

Okay. Direct construction costs are up. We estimate that it's about $3,000 a house for us, which is about a 4-percent increase in our construction material cost, which equates to about 1.5 percent of the total price of a home. (multiple speakers) And we're seeing some positive trends on the lumber front, but basically these costs -- I think we're probably going to have to eat for at least the next six months.

Yes -- but it's embedded in your backlog and in your (multiple speakers) guidance --

Yes. And you know, let me say for the most part, it is embedded. There are always some contracts that have shorter tails on them. So to the extent that prices continue going up, you might get nicked a little bit. But for the most part, it's embedded.

Good job. Thank you very much.

Steve Kim, Smith Barney.

The question I had for you guys relates to your land strategy. Can you walk us through what percentage of the land that you have on your inventory is land in which you were actively or are actively engaged in the entitlement process?

So we're talking about raw land that we do not own?

Correct. I would assume you don't own any unentitled land, so it would be land that you maybe have optioned, and is unentitled, and you are working through the entitlement process right now.

And your question is -- what do we have invested in that land?

Yes, percentage-wise, either in terms of number of units or in terms of dollar value.

Well, Steve, remember that 75 percent of our inventories are finished lots and homes under construction. So the option contracts, I think, on all of our land, inventory-wise, is only 500 million.

(multiple speakers) Plus (ph) the units?

Well, on units, our options are 50 percent of our total units. (multiple speakers) It's a very small dollar amount.

So it's about 75,000 units, more or less.

Probably (ph) right.

Which are optioned?

Yes.

And how many of those are unentitled?

I can't give you a good number. I think it's fair to say most.

Most are unentitled?

Yes. Would you agree, Jeff?

No, I'd go the other way, Bruce. Most of the lots we control are entitled. It's a small part that were unentitled (ph).

No, no -- of the optioned lots, of the 75,000 that we do not own that are optioned, your take is you think most of them --

Most of them are long-term takes (ph) that are (ph) entitled.

Okay. So if the majority of them are entitled, then that means that -- could you say maybe like 20, 25 percent of them maybe are unentitled? Would that be a fair guess, do you think?

Well, on this question, obviously I'm not giving you the good answer. But that's what Jeff believes.

Well, if you guys could maybe call me back or something like that with that information, that would be great. Thanks very much; good quarter.

Greg Gieber, A.G. Edwards.

Let me rephrased Steve's question in a slightly different manner. On a forward-going basis, of the homes that you sell, what percentage of those lots will you actually take through the entitlement process, and what percentage will you buy where somebody else has taken through the entitlement process? Do you have some sort of desired mix?

I think, if it's helpful to you, in the most competitive land environments, we take virtually all of them through the entitlement process. And in the areas where land is less rare and more available, there are many opportunities to buy lots from others who have done that.

That does help. Could you talk a bit on your home building revenue, on your average revenue per house -- what is happening to the percent that is coming from the design centers, and is that changing any in the most recent month or two as interest rates start to rise?

It's been averaging right around 10.7 to 11 percent. It really hasn't changed in the last several quarters.

If you could turn to -- I'd like to ask you about your acquisition strategy going forward. I mean, you've expanded very rapidly in the past six quarters. If I look forward another 12, 24 months, how many more markets do you think you might be in?

As I have said before, arbitrarily we think we could do three or four acquisitions in a year. There is a limit to proper integration, although I will have to say that the last two that we have acquired is integrating much better than prior, which seems to indicate to me that we have just gotten better at the transition of a new company into KB Home team.

The most recent example with Dura is that after I sent an e-mail to every Dura person and during the whole negotiation, we met very few, because that was the owner's desire, to keep it very quiet until the deal closed. I received personally an e-mail from over 40 employees at Dura, and I think the total count is something north of 60, each one offering their own words of why they are excited to be part of KB Home, and what Dura meant to them and their respect to the owner and so forth. That I see as a very positive sign.

Now, going forward, you can talk and look now at the footprint of those markets which are significant that we are not present in, and assume that if we had an appropriate opportunity to enter those markets that we're not in, that we would do it. But you have to wait for the right opportunities. So it's very difficult to predict future acquisition activity.

How much of your $20 is contingent upon acquisition activity?

None.

So you are saying there is upside to that $20, obviously. If I could ask you on Dura Builders -- they built 500 homes last year. How large do you think you can take them to in '05?

Well, '05 is around the corner. And you need a pipeline in place to significantly increase it. I wouldn't want to make a prediction for '05, but I --

How about '06?

Well, I frankly -- because its new, I don't want to openly put any undue pressure on those folks right now. But I think that the whole team, from what I know the owner expressed his reason for doing this transaction and from what I have already seen in the e-mail communications from the Dura team that this is a group very excited to grow the business. The owner admitted that he was a very conservative builder and knew that he was signing on the line very often for the debt he was undertaking, and he is looking forward to taking full advantage of his human resources and now with our capital to become a bigger force within the market. He thinks there's lots of opportunities.

I just wanted to get -- and I know you don't want to put pressure on anybody to deliver a given set of closings or orders; I'm just trying to get a sense that, when you take a private builder, just kind of a broad sense of what your, if -- I think Dom's term is to "supersize" them -- just what that means quantitatively.

Well, one thing you can look at is in the Southeast, our sales for the quarter were up almost 60 percent. So year over year, with that (ph) -- on, in effect, a same-store basis --

Greg, this is Jeff. If you look back over our track record on acquisitions, there's a fairly similar cycle that occurs. It takes about 18 months for the business to fully integrate to our business model, get their product lines up and running, get the studio open, get comfortable with our even-flow approach. And from there, we have a great track record. Every acquisition we have done has gone on a growth trajectory from that point. We have not yet finalized our market strategy for Indy. It's a great opportunity for us, and I would expect a growth trajectory will start to occur 18 months out. But we can't sit here today and tell you how large it will be, but we're comfortable we can be larger than we are today.

Okay, just final question, gentlemen. What is happening when you look at the private builders? Has there been any changes in sort of their expectations of what they think they can be taken out at?

It's a mixed bag. It's tough to generalize. I would say that there is a continual building of consensus among private builders that, one way or another, they are going to become part of a big builder. And I think, generally speaking, the view is it's going to be sooner rather than later.

Ivy Zelman, CSFB.

Actually, Dennis McGill (ph) on behalf of Ivy. A couple of quick questions kind of following on with the acquisition. Can you talk about -- and you can use Indianapolis as an example maybe -- the specific components of a market that you look at that will draw your attractiveness there as one that you would like to grow in? Maybe it's some job growth coming into the city or specific parts of the demographic trends. But just give us an idea of what maybe the top two or three drivers are that you focus on when you consider a market as one that you may expand into.

Well, first, Dennis, you look at what is the overall size of the market, how many homes are built there. And in the case of Indianapolis, it's, what, the 17th-largest market in the United States. So by that definition, it's interesting.

The other is whether or not you can find an opportunity that you believe that meets our criteria. And that becomes very opportunistic and unpredictable when that will happen. We do look at job growth, we look at population growth. But in a number of Midwest markets, we see a lot of stability, and that becomes very attractive. We have essentially been a Sun Belt builder, but as you look to grow the business, there were a number of Midwestern markets that have continually been solid homebuilding markets and that is getting consolidated by and large by the large public builders. And we think that's a great environment for us to be in.

Do you view that more as a stable, lower-growth market that you're able to gain share at to the (ph) high-growth markets for yourself -- but the market in general would be a lower-growth in sales (multiple speakers) --

I think that's right. Now, remember that when you start from a low base, you are able to grow your business, gaining market share. And then there's some point where it becomes more maturing and you don't want to force it. So fortunately, in most of the markets we are in, we still believe we have got opportunities to grow our businesses prudently.

Just two quick follow-ups. In the past, on your private deals, you guys have been kind enough to provide us purchase price. I was just wondering if you could give us that number to model in. And then, secondly, do we have to consider obviously some purchase price impacts here for the next couple of quarters? Can you give us the magnitude, maybe, that we should consider?

No -- all we have ever said is that on this transaction, it's actually a modest price with a minimal amount of goodwill.

Carl Reichardt, Wachovia Securities.

I have two questions. First, you'd spent some time over the last few months, Bruce, talking a little bit about a mix shift. And you really didn't mention it much today. And I'm curious -- as you look at your -- not your geographic mix, but your product mix and historic focus on entry-level, first-time move-up, do you continue to expect that to change? As you look at how deep your market share is in certain cities, especially at the entry-level, perhaps it's a good way for you to grow in other price segments. I'm just curious what your thoughts are there and what your strategy would be for expansion or not over the next couple of years.

I think you'll see us continually expanding the product mix on both ends. We're looking for opportunities that we feel comfortable with to move up in price, as well as opportunities to build higher-density attached product in more of the competitive markets that would, on a relative basis, move down in price. So we do think that's a way to grow our business in places that we think are very attractive and yet very competitive.

Okay. And then my second question is on France. As you look over the last three years, have the returns on capital that you earn in France generally compared to the U.S. returns started to diverge significantly one way or the other? And would you consider maybe monetizing the remainder of the France investment somehow? Do you think there's an opportunity to do that? And if so, what would you do with the cash you might generate?

One, their returns have not changed -- their margins are up very nicely, actually, in this quarter over a year ago. And they have done a super job in accelerating cash flow because, as you know, in France you sell on a percentage of completion, and you transfer title at foundation. And so, in essence, the customer is paying for construction of their home or condo, so it's quite attractive from a cash flow standpoint.

And frankly, it's a cash cow for us. The stock is trading at a multiple that is approaching 10 X this year's earnings. I think ours is less, if I'm not mistaken.

I think so too, yes.

And it's trading at EUR32, which is approaching $40 a share. We sold our initial stake at, I think, 23. And so we think it's monetized from the standpoint that it's a publicly traded security on the New York Stock Exchange of France (ph) that is providing cash.

Now, if there were some compelling opportunity in which we felt we didn't have other ways to finance it, obviously that would be an opportunity. But right now we don't think that we have something that we can't finance otherwise. And we have a franchise business that is very, very difficult to replace.

But as I understand it, if returns overall in France are flat while margins are up, but returns are flat in the U.S., returns have been growing apace -- the French returns, I'm assuming, are lower and are diluting your overall returns.

That is very true. That's true. And you're right about that.

Timothy Jones (ph), Lockerman (ph) and Associates.

First of all, the same question I asked Lennar yesterday. The shortage in cement (ph) and ready-mix is pretty severe in certain markets, certainly here in Florida. What are you experiencing -- and if you have your needs covered?

Yes. Certain materials, namely cement -- the supply has tightened. We have, anecdotally, evidence from a number of divisions of that. We have not experienced any delays to speak of with respect to our supply. And frankly, on the cement issue -- and you might go to insulation or Sheetrock -- I think that, if the problem were to exacerbate, the one conclusion I would reach is you wouldn't want to be a smaller builder because, to the extent that there is construction material available, it's going to go to the big builders first and the smaller builders second.

Okay, well, that's clear. It took a month for the city of Boca Raton to get one yard of ready-mix, one tugboat (ph).

The second question is -- there's a report of one of your competitors down the road suggesting that the builders have started to take substantial increases in incentives. I checked with that builder; they said only in one market out of 25 or 30. And I checked with three other large builders, and they said they have not seen that. First of all, most builders take like 2 to 4 percent of their price range cost (ph) for incentives. What do you allocate for that, and what has been your experience in your markets?

One -- incentives, to one degree or another, are very common in the industry. (multiple speakers) And it's more common in some markets than others. With respect to KBH, we are not in the camp that likes incentives. So from a directional standpoint, we discourage incentives. And if you look at what we are doing and have done, what we find is we spend something under 1 percent. And that has been the case -- I asked Dom to look at it. He said it's been the case for the last five years.

No change?

No change.

That's what I wanted to hear. Thank you.

Well, glad to give it to you.

Larry Horan, Parker Hunter.

Just one detail question. I just wanted to make sure that when you talked about less than 300 unsold finished homes in inventory that that was excluding models?

It was excluding models.

I thought it would be, but thanks. That's all I needed.

Michael Rehaut, J.P. Morgan.

Just on the gross margins, you had an impressive expansion this quarter which was much more than the first quarter's expansion of roughly 80 basis points. And I was wondering if you could identify the drivers in the acceleration this quarter and the expansion. One of the things we thought it might have been was the anniversarying of the Colony acquisition, which had a higher cost of inventory. But I was wondering if you could also shed some light -- if pricing or productivity also stepped up and what could we expect going forward in terms of year over year?

Let me answer it in a couple of ways. First of all, if you remember, last year our deliveries were down 20 percent in Central. We are now up in deliveries. So that's the first improvement. The second -- as we said, the Southeast margins would be more depressed in year one, improve in year two; and as Jeff said, you'd see the significant improvement in year three, which would be our 2005. So it is (ph) that we have got still continue to have good price and material shortages or product shortages on the West Coast. So all of those contributed to a very strong second quarter gross margin year over year.

Going forward, I would say that the margins we're seeing today in this quarter are probably going to be pretty similar in the third quarter, fourth quarter. The improvements are going to be hampered somewhat by the fact that you would have the material cost increases for the period of time impacting our third and fourth quarter more than they did in the first and the second quarter. That's one. And there is a mix change that we have to deal with. And the mix is that, as you remember, our orders were down because of communities in the West Coast and very strong in the Southeast and in Central. So there is a mix change in margins that will have an impact on us. But all in all, what we should end up with is a very strong year, year-over-year improvement in margins for the first half -- year over year looking better (ph) in the second half.

So then you're looking for -- again, to repeat, in the second half high 23-percent range --

(multiple speakers) say high 23-percent range. But if we can do 23 percent in the second half, we'd be thrilled. And that's a very good margin, in any business.

So you're actually saying it might go down from the 23.8 that we saw in the second quarter?

Absolutely; I would expect for a period of time.

And then in terms of SG&A, are you looking for -- continue to be roughly around 13 percent over the next two quarters, or would you also see a similar drop down to below 12 percent in the fourth quarter?

(multiple speakers) Yes. I don't believe -- first of all, I would tell you that the second-quarter SG&A was better than we thought it would be, and part of that was because we had actually had lower advertising cost. So we had a good quarter; we had strong orders, but we actually spent less year over year on advertising. In the third quarter and the fourth quarter, I would say flat to down. And --

Year over year?

Not (ph) -- 90 percent -- (indiscernible) that's not seeing a 90-basis point improvement, no. But by the end of the year, it will be better than last year. And '05 should be better than '04.

So last year, with the below-12-percent margin, obviously you get a seasonal jump in revenues. So that could be expected as well?

Right, that could be expected.

Steve Fockens, Lehman Brothers.

Just a little bit more color on the cancellation rates. I know, Dom, last quarter you said that you had hoped to end the year in that 25 to 29 range and since you actually got there nicely this quarter, where do you think you're going to end up in cancellations for the rest of the year? And maybe thinking beyond this year, where would you really like to end up, and what is a realistic level, say, over the next couple of years?

I would say 25 percent is a very realistic level. So if we could keep it in this range of somewhere between 20 and 30, we are pretty happy with the business.

So you wouldn't expect this to drop another of sequential four points in the next quarter or the quarter after that?

I would not.

Okay. And then to go along with that, what would your orders have been this quarter, roughly, if cancellation rates had been at the same rate as last year?

You know, I don't know. You can --

I mean, if it's a roughly -- what is that, an improvement of a third year over year? Would you say orders would have been roughly a third lower without that improvement?

I do not how -- it's kind of a theoretical question.

It's like what would the Lakers have done if Malone had been healthy?

They still would have lost.

Probably.

Tony Campbell (ph), Knot (ph) Partners.

Congratulations. I'm wondering if you could just -- because builders don't get any respect in the market at the moment -- just give us some sense of what's happened to traffic in some of your main areas recently. Is it up, down, or flat --?

You know, Tony, no changes. We are not seeing any -- nothing that we can point to from a trend point of view.

Okay. And then secondarily --

Now, you ought to keep in mind, though, that as Dom said, we spent less money on advertising in the quarter. So had we spent more, would we have seen greater traffic generation? That's another conundrum. But we have not seen anything in what I would say sort of the basic things you look at to indicate trends changing.

Okay. And I wondered if you could comment on the article that was in the Wall Street Journal about Fannie and Freddie and the Republican proposals, because I guess you guys are trying to change them?

You know, I saw the article this morning. Personally, I'm not familiar with the political implications that was being discussed. This is where there are a number of groups supporting the GSEs against the HUD proposal to increase low-end, moderate-income funding of mortgages. Is that what you're referring to?

Yes.

I don't know. I guess I'm not familiar enough to add anything other than what I read. So your ideas would be as good as mine.

I guess one final question, if I might. Do you -- since you have been in the market and acquiring some of these smaller private companies -- is the mentality kind of changed a little bit, or is it changing? Because my guess is that we ought to see that this consolidation should start speeding up, and in fact it has been quite a few -- there's been five or six of these smaller acquisitions quite recently.

I would think so. I'm a little surprised there have not been more transactions.

Jim Wilson, JMP Securities.

It's been a long call, so I'll make this a short, quick question. As you look at all the markets you're in now, and obviously, you've entered the Florida/Southeast through acquisitions. And I imagine (ph), compared to how well you operate and how efficient you are, there are certainly lower returns on capital there. But what I rather look at is -- can you characterize your opportunity or your biggest opportunities for improving returns on capital and where, whether it's Florida, due to where they stood when you bought them, or Texas, due to the market having (ph) been weaker than the Southwest, for instance?

Well, certainly, as we said, the biggest return on invested capital opportunities is, as Jeff said, after 18 months you start to see the full benefit of the investment. So I think the biggest opportunity is the Southeast, which we should start to see in 2005, and continuing to recover in Central from orders being weaker last year and now picking up steam this year. So those are the two biggest opportunities.

Okay. And maybe just your thoughts, then, on California, where it stands? Obviously, demand is still very strong, but any reason to think with all the moving parts and the land constraints that maybe it's actually -- return on capital could decline, or are you thinking it will sort of hold steady?

I don't see anything in the California market that would indicate any real significant changes. You have to believe the price appreciation, which just continues in the mid-20 range, has got to slow down. But I wouldn't bet a lot of money on when that's going to be. I think it could continue to defy smart people's analysis for many quarters to come.

William Nodler (ph), Atalanta Sognoff (ph).

Congratulations on a great quarter. By the way, the quarter -- am I correct that if you exclude the sale of the commercial property, that your EPS would have been up over 40 percent?

No; you have to adjust it for minority interest. It would be up over 30 percent.

Up over 30 percent adjusting. And on California you mentioned -- of course, you stated that by year end, the community count will be up over a year ago in the West, and orders were down 18 percent in the quarter. With the prices so firm and the market so firm out there, doesn't it give you are real kick, a real positive impact in 2005?

Yes.

Okay. And if you're going to earn at least 10.75 with a $1 dividend, would you comment on your attitude on sharing the dividend and cash flow with shareholders?

When we raised -- the Board raised the dividend from 30 cents to $1, we didn't come out with any elaborate thought on what will happen in the future. And the reason was that, frankly, we wanted to see -- we were the first ones to significantly raise the dividend. And we wanted to see what -- in the sector, and wanted to see how people reacted to it.

I wouldn't want to speak for our Board on this, because this is a subject that we do talk about often. But I think it's reasonable to think that we would continue with dividend increases along with share buyback and balance sheet strengthening and growing inventory to grow our business. And I think, as we see it now, there's probably opportunities to do it all to some degree.

And the last question, on the retention and the earnings on the mortgage side of the business -- that was, of course, down a fair amount -- I think 2.5 million versus 10.1?

Yes.

Do you see that recovering, or do you think in the new environment going toward variables that will remain under year-earlier levels?

I think the variables will continue to have a negative impact on the mortgage. But we do see our mortgage business turning, certainly in the fourth quarter and definitely in 2005, from a pure pre-tax profit perspective, year over year and quarter over quarter.

Wayne Cooperman, Cobalt Capital.

I'm curious if you could kind of walk us how you get from 10.75 to $20. How much of it is pricing, how much is units, how much is margins, how much is share repurchase?

Certainly, everything -- in order to get from 10 to 20, you do all of the above. And we can give you a copy, kind of, of what we showed on investor day in New York that to some degree walks you through it.

But clearly, one of the biggest contributors to it is topline growth going to 10 billion in sales, combined with improving pretax margins to 12 percent. If you do those two items and maintain your share counts outstanding maybe slightly below where they are today, you're quite close to $20. So if we can hit at least the 50,000 units, which would probably be larger than 10 million, make 1.2 billion in pretax profits, you're just about there.

And you think the 12-percent pretax profit -- can you get there if prices kind of stay flat? Can you take it all on the cost side?

Well, and our assumption is that prices will continue (ph) to like what they do (ph), what they have done for the last 30 years, which is move up slightly higher than inflation. And with that case, I think yes.

And that concludes our question-and-answer session for today. At this time, I would like to turn the call back over to Mr. Karatz for closing or additional remarks.

Thank you all for joining us this morning. I know it's a busy time of year for everyone. Have a great day, and we will talk to you, if not before, in September with our Q3. Thanks.

And that concludes today's conference. Thank you for your participation and have a wonderful day.