KB Home (KBH) 2004 Q3 法說會逐字稿

Good day, everyone, and welcome to KB Home's third quarter conference call. As a reminder, today's call is being recorded. KB Home discussion today will include certain projections and forward-looking statements in order to help investors better understand KB Home's business prospects. These are based on their assessment of current business and operating conditions. Please be aware that actual results may differ from those that may be expressed or implied by the projections and forward-looking statements and the difference may be material These discussions are in the Company's annual reports on 10-K, quarterly reports on 10-Q, and current reports on form 8-K filed with the SEC identify as 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 website 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. Good morning everyone, and thank you for joining us today. With me are Jeff Mezger, our Executive Vice President and Chief Operator Officer, Dom Cecere, our Senior Vice President and Chief Financial Officer, Bill Hollinger our Senior Vice President and Controller and Kelly Masuda, our Vice President of Investor Relations and Treasurer. I'll begin the call today with an overview of the quarter and current market conditions. Dom will review our financial results with you, and then I'll finish with an overview of our earnings outlook for the remainder of the year and 2005, and then we'll be happy to take your questions. I'm please to report that KB Home delivered another excellent quarter in financial performance our shareholders, fully diluted earnings per share rose to $2.84 this quarter a 22% increase over the third quarter of 2003. Our financial and operating results in the third quarter underscore the importance of our KBNEX disciplines to our continued success as a national homebuilder. Let me share some of the quarter's highlights with you. In the third quarter, we averaged 491 active selling communities, up about 24% from 396 active communities at this time last year.

Companywide net orders for new homes rose 23% in the third quarter, on the heels of a 28% increase in the second quarter of this year. We ended the year with a solid order backlog of approximately 21,900 homes, with a future revenue value of more than $4.8 billion, up 42% from our dollar backlog this time last year. We posted sold top line revenue growth in the third quarter, with Companywide unit deliveries up over 17% on a year-over-year basis. And housing revenues up 24% to $1.7 billion. Our housing gross margin improved by 130 basis points to 24.1% in the third quarter, with improvements in price and productivity more than offsetting higher material and subcontractor costs. And our return on equity for the last 12 months was a solid 27%. We are also very pleased with the recent survey results from JD Power reflecting our continued focus on the quality of our homes and on customer satisfaction. According to the JD Power survey, KB Home ranked third among national homebuilders, and was only one point behind the second place ranking.

Our continued focus on delivering solid financial results and delighting our customers strengthens our national brand and has earned us independent recognition as one of the best in the business with our customers, our shareholders, our employees, and our suppliers. Let's now take a brief look at how each of our geographic regions is performing today. In our West Coast region net orders were up 8% in the third quarter with 58 active selling communities. Demand remains healthy in all of our California markets, and our community counts are expanding, providing a solid foundation for continued profitable growth if this land constrained region of the U.S. In our Southwest region net orders rose 6% quarter over quarter with 90 active selling communities. In both Las Vegas and Phoenix, we have slowed our order growth to allow construction of homes to catch up with our order backlog. Our backlog of sold homes has now extended out to 8 months, representing nearly 4,000 homes with a revenue value in excess of 800 million.

Demand in our central region continued to remain strong with 15% order growth in the quarter, following a breakaway second quarter where orders were up 59% from the previous year. And in the Southeast, net orders rose 58%, and 67% quarter over quarter in the second and third quarters respectively, illustrating the strong performance that we've achieved with our expansion through both acquisitions and de novo growth in the region. We now have 86 active selling communities in the Southeast, and an order backlog of approximately 4200 homes with a revenue value slightly over $750 million and solid gross margins. As always, we continue to be guided in our pursuit of Companywide topline growth by the KBNEX disciplines that have delivered 37 consecutive quarters of meeting or beating analysts' expectations. In particular, the balanced approach we have taken to capital redeployment has allowed to us maintain a strong balance sheet, pay an industry leading dividend, and enhance shareholder value through repurchases of our common stroke. With that, let me turn it over to Dom who will walk you through the financial results for the quarter.

Thank you, Bruce. We began the quarter with 20,636 units in backlog and converted 8,041 units, or 39% of our backlog to revenues in the quarter. Deliveries in the third quarter were impacted by labor and material shortages in several of our Southwest markets and weather related delayed closings in the Southeast. These external factors reduced our unit deliveries by approximately 500 units for the quarter, pushing about 100 million of expected revenues into the fourth quarter. Housing gross margins improved by 130 basis points quarter over quarter to a solid 21.4%, and our Companywide SG&A ratio rose slightly to 3.3% for the quarter - - 13.3% for the quarter compared to 13.1% at this time last year. Our SG&A ratio was negatively impacted by the 500 home closings that moved out of Q3. However, we expect an improvement in our SG&A ratio for 2005 as we continue to benefit from our expansion in community counts and maturing business units in the Southeast. Our mortgage banking operations delivered 1.2 million in pretax income for the quarter, compared to 13.7 million in pretax income in the year earlier quarter.

Third quarter profits were hampered mainly by lower retention rates and the increased use of variable rate mortgages. We recently redeployed our loan officers from our regional centers into the field to improve customer service and drive higher retention rates in this highly competitive environment. However, we see only upside in our mortgage business going forward, ask we are optimistic it will provide upside opportunity to Companywide earnings in 2005. Our third quarter 2004 mortgage retention rate was 60% versus 71% in 2003. And the average loan to value ratio was approximately 87% versus 89% in the year earlier quarter. The percentage of fixed rate mortgages was 64% in the third quarter of 2004, compared to 92% in the third quarter of 2003, and our average FICO scores are were 690 compared to 687 for Q3 of 2003. Our balance sheet remained healthy, with construction debt to total capital of 52.7% and interest coverage for the last 12 months at 6.2 times. Our third quarter leverage ratios were slightly higher than expected, due to the weather related delays in home closings in Florida, and the shortages in the Southeast impacting our bill cycle times. Both of which will correct themselves in the fourth quarter of this year.

We expect our debt to total capital to close out the year at a ratio that continues to warrant an investment grade rating. Total inventories of land and homes under construction at August 31, 2004, totaled 4.1 billion, up from 2.9 billion in the third quarter of 2003. We expanded our investment in land and land development from 20 to 35 markets to the U.S., and our Companywide community counts are up 24% to approximately 491 communities in the third quarter. With strong net orders for new homes in these communities, our Companywide orders were up 23% in the third quarter, and 28% last quarter, inline with our investments in land and the growth in active number of communities. Companywide we we had over 160,000 lots owned or controlled at August 31, 2004, compared to approximately 125,000 lots a year ago. Approximately 51% of those lots were under option contract. We are very happy with the strategic land position across all of our strategic - - all of of our geographic markets. And have the pipeline in place for a very successful 2005. Bringing us one step closer to meeting or even exceeding our 2000 objectives of 50,000 unit deliveries, 10 billion in revenues, and $20 in earnings per share. With our continued focus on even flow production and build to order, we had approximately 355 completed unsold homes in the U.S. at August 31, 2004, less than 1 unsold finished home per active selling community. Spec inventory of finished unsold homes was only 2.5% of the more than 14,400 homes we currently have under construction in the U.S.

To summarize, the financial score card for our business continues to improve and profiles are an ongoing success. Our community counts are up 24%, order growth in the third quarter was up 23%. Our backlog of 21,928 sold homes was up 32%. Our gross margin was up 130 basis points to a solid 24.1%, and our construction pretax margin rose 70 basis points to 10%. We have a strong high quality backlog with a revenue value of 4.8 billion, a strong and liquid balance sheet, a lower volume cost, improving margins, and a national footprint. This puts KB Home in an excellent financial position to continue to deliver solid financial results for stakeholders going forward. Now I'll return the call to Bruce for an update on our earnings guidance for the year.

Thanks Dom. With our strong financial results including a strong order back log of 4.8 billion, up 42% year-over-year, and our housing gross margin improving to 24.1%, we are raising our earnings per share guidance for 2004. We now expect diluted EPS of $11, up from the 10.75 we provided during our last conference call. The new estimate represents a 25% increase from the 8.80 reported in 2003. I'm proud of what our people have accomplished over the last 3 years, and honored to tell our stakeholders that 2005 has KB Home dead on course in achieving or even exceeding the bold financial objectives for 2007 we internally targeted for ourselves 3 years ago. For the first 9 months of this year, we had, on average, 455 active selling communities. Based on the investments made in land and land development over the last several quarters, we fully expect to average over 575 active selling communities in 2005. An increase of 26% over the 455 communities.

Our growth in community counts across all of our geographic regions provides the foundation to deliver 38,000 homes in 2005, a 19% increase over the 32,000 we are forecasting for 2004. In looking at our historical order growth since 1990, we noted a direct correlation between growth in community counts and the growth in orders. Regardless of the interest rate environment. Specifically, throughout the last 14 years, we sold on average between 6 and 7 homes per community, per month, in each year. In fact, the statistical correlation between order growth and community count growth was 1.0, while the correlation between order growth and the change in interest rates was .76. The bottom line is that community growth will drive order growth. And we have the communities in place to deliver our forecasted results for 2005. The Southeast region will be a major contributor to our 2005 results. The backlog of sold homes at the end of this quarter was approximately 4200 units, up 79% when compared to backlog at the end of the third quarter last year. And our margins and backlog were substantially better than they were one year ago. With an average price per home in backlog of approximately $220,000, revenues in 2005 are expected to reach 8.6 billion, including mortgage revenues and modest land sales, up 23% over 2004. The average number of diluted shares outstanding are expected to remain at approximately 42,500,000 shares in 2005. And our forecasted EPS for 2005 is $14, a 27% increase over the $11 now forecasted for this year. This now concludes our remarks this morning and we'd be happy to answer your questions.

Thank you. The question-and-answer session will be handled electronically today. 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 that your mute function is turned off to allow your signal to reach our equipment. Once again, that is star 1 on your touch-tone telephone, if you do have any questions. And we'll pause for just a moment to give everyone the opportunity to signal for questions. Our first question will come from Margaret Whelan with UBS.

Good morning, guys.

Yeah, hi Margaret.

Well done.

Thanks

What a great result. And a couple of things could you break out maybe the gross margin expansion? We were very impressed that it rose to a record for KB. Would you just break down where the improvement is coming from, maybe how much is in pricing and mix versus that sustainable permanent cost reduction?

Well, I think Margaret there's certainly price and productivity that's helping. But one of the big benefits that we had year-over-year was in the Southeast where our margins were up 300 base points in Q3 of '04 versus Q3 of '03, and we'll see that improvement again I think again in '05. So I think that would be one of the drivers that helped us.

And is that just because your getting bigger, the sale advantage?

It's because of the scale advantage.

And how do they care compare to your margins on the West Coast?

Well, you'd have to look on the West Coast and say that's a much more capital intensive business. So it has to drive a higher margin. So they're clearly not the West Coast margins. But they close in gap in a much more closer to our overall margins going into '05.

And if you think about the returns in the individual markets, you're probably committing less land up front, or less cash up front for land in the Southeast, so are the returns comparable versus the West Coast?

As you move forward, they will be. I would say the returns in the West Coast are a little higher now, because it's a hotter market than the Southeast.

Okay.

But they'll be attractive.

Okay. And the second thing is the '04 guidance, is that all organic growth you're assuming there? Or are you factoring in any acquisitions.

You're talking '05 now?

Or '05, I'm sorry yeah.

No, it's all organic.

Okay. And what do you think the community count might be?

The community count in '05 we said was 575 selling communities.

Okay. That's the average?

That's the average.

And can you just give us an idea of what markets they might be in, where you're going to focus?

All markets are up. The largest growth is in the Southeast, because of just the growth in the Southeast. Second, I believe, is the West Coast, and then up equally in both the Southwest and Central.

Okay. Good stuff. Thanks, guys. Well done.

Okay. Thanks, Margaret.

Up next from Smith Barney we'll hear from Stephen Kim.

Thanks. Yeah really, just a great job, guys. Congratulations.

Thanks.

A couple of questions. One, let's start with the price. You're giving a guidance, I thought I heard for 220,000 for next year?

Yes.

Seems a little low, given what we're seeing in the backlog, and what you've historically done relative to your backlog. Typically, we would see prices usually a little higher in the following year. Just wondering whether that's just conservatism on your part, or is there some significant mix shift that might be coming down the pipe here that maybe we would not have seen in previous years?

Yeah, it is a little conservative for next year. And we don't ever assume any additional pipe going into '05. So you're right Stephen it is a little conservative.

That's good. That's fair. Okay. And then let's talk about the SG&A. You indicated that 500 units sort of, you know, fell out of the delivery this year, this quarter, and that was a little bit of a drag. What was the dollar value? You gave a revenue number associated with those 500 deliveries. What was that again.

100 million.

About a 100 million.

Approximately.

I'm sorry?

Approximately.

Yeah. Okay so approximately, an average price of 200. So the marginal SG&A that you would get, you know, the variable SG&A component, what would you assume that is? Should we assume 5%, 6% type?

No, no, I've would have said it would be maybe - - the impact on the Company may have been 30 basis points.

Oh, that's it?

So we would have seen a slight improvement year-over-year.

Okay. So it would have been 30 basis points. Okay. I was trying to back into that number. Okay. Fine. And then can we just talk about your conversion ratios here? I understand you said - - you cited a couple of issues, labor, material, shortages, etc., weather related, hurt about 500 units. But can you - - was there anything else? Are you maybe doing more vertical construction? Are you doing maybe because you opened up a lot of communities, you're doing maybe presales out of trailers, something that would sort of prevent your conversion ratios from getting a little closer back to where they once were? I would much rather see a 39% conversion ratio than the 120 that KB used to do like back in the dark ages. But still I mean it seems--

Steve, if you go back the last several quarters, we've been running about - - except for towards the end of the year 42.5%. This is 39. The difference between that is the 500 units. Otherwise we would have been up at 42.5. And if you look at the fourth, it's much closer to 48 and so I think overall it's pretty good.

Okay. Well, that's fine. I'll requeue back in and let other people ask some questions. Thanks a lot, though.

Moving on, we'll hear from Carl Reichardt with Wachovia Securities.

Hi, guys, how you doing. Bruce, as per the recent interview with you in Business Week I think, and per some comments you've made in the pass, how is the strategy of moving the mix of product away from entry level and towards somewhat higher end product, and also, I guess potentially the active adult side going? Can you give us an update on what you're doing specifically to move that mix, if that's part of your core focus? And how it's going to affect earnings and ASPs in '05 and beyond?

One, we are - - have definitely begun the shift to broaden our product line. We have introduced product at a greater frequency that is larger and more expensive relative to the medium prices in various submarkets. It has started primarily on the West Coast. And if you look at some of our more recent openings of what we now refer to as the KB Home Luxury Series, I think you will see that the style design of these homes matches up with the best in the marketplace. How it's going to affect the P&L and ASP, we - - because of the size of the overall Company, it ought not to have a dramatic effect on ASP in '05. And it is not something that because of the you know, the delays that it takes to get more communities opening. But I think over time it will have a upward impact of ASP. We are putting these communities online and underwrite them the same way as we do any other community. And therefore, we believe that in terms of return on capital invested, we ought to meet the same standards as we do in our more moderate priced product. And we think it's something that we can do well and will allow us to grow in markets that we know very well through the broader product offering.

Okay. Great. Thanks for that, Bruce. And then just one follow-up. On the quarter, Dom I think you mentioned Southwest and materials and labor shortages. Can you elaborate a little bit on that, particularly with relation to the labor?

Yeah, Carl, this is Jeff. It's much more labor than it is material. We had some issues early in the year with concrete and lumber but it was not a big issue for us at all. If you look at Vegas or Phoenix, both of those markets continue to run at very high levels of production, and the subcontractors are getting pushed and pulled around a bit. So we're working hard to partner with our subs to expand their labor pool. And we've worked through most of the issues, so it was a short term impact on delivery. And it will come right back here in Q4.

Okay. Were there particular trades, Jeff?

Framing contractors.

Okay. So it's framing. And if you guys are having those issues given your size in those markets you have to assume that other builders are having them just as much if not worse.

Absolutely. That's probably far worse than us due to our size.

From JMP Securities, we'll hear from Jim Wilson.

Yeah hi Jim.

Hi. Good quarter. I was wondering with the community count expansion, either Bruce or Jeff, you could color the margin differences that you're seeing in the Southeast compared to obviously, particularly, California, Southwest California, Arizona, Nevada, are they lower and coming up, and is that - - you might help the mix next year as you move forward? Because obviously you're expect some margin expansion in your numbers?

Yeah, clearly the - - one of the positive drivers on our earnings outlook for '05 is the fact that what I have said earlier, the Southeast was up 300 basis points in margins year-over-year versus '03. And will improve again, we know from our backlog going into '05. And you'll probably see the Southeast, you know, up closer to the 20% DCs than where they are today. And it's clearly as we said earlier slightly lower than what you would see in the Southwest or on the West Coast, but improving. And nowhere near as capital intensive as the West Coast, or even the Southwest.

And I would assume terms turns are each faster out there?

Absolutely.

Given timing, so it helps your return on capital?

That's exactly right.

And just finally so if the upturn in basis points are roughly what they are now, they would have the potential to add to 20% next year? or is it like 18 or somewhere in that range?

Yeah. In that range.

In that range. Okay. All right. Great. Good job, thanks.

Thanks.

Moving on, we'll here from Michael Rehaut with J.P. Morgan.

Hi, good morning.

Hi.

Wondering if you could give us a little color in the West and the Southwest, which, you know, you still had nice order growth, considering the growth the last couple of years, but which reasons you felt were stronger in terms of demand versus, you know, a little bit softer, and if there are any markets that you know you consider are soft regarding your operations?

Michael, this is Jeff. The - - really, across the Company, our sales are were up in every region. So on a regional basis, our sales performed quite nicely. We continue to have a little bit softer environment in parts of Texas. Austin in particular, and some of the Dallas submarkets are still challenged, where demand is a little soft. But overall the Southwest, the West, Florida, Colorado is improving, so our sales environment is favorable for us right now.

And across California, you've seen that, you know, Southern Cal versus Northern Cal, any areas that, you know, perhaps are showing greater degrees of deceleration in demand or growth versus others?

We're not seeing a deceleration today at the price points we sell at, there continues to be far more demand than there is supply. So our sales and backlog are right where we want them to hit our '05 targets.

Right. And one last question on the Southeast margins, Dom, you had mentioned that you estimated the Southeast region had about 300 basis points of improvement. Are you looking for - - what type of improvement overall would you say are you looking for '05, incremental margin improvement over, you know, '04 at this point?

I would guess 200 to 300 basis points better.

And is that - - given that, you know, you have, you know, revenue growth of about 23%, and earnings growth of about 27% in terms of your guidance --

No, that was just for the Southeast we were talking about, not the total Company.

Right, right. But, you know, what the overall guidance would imply is that, you know, you're going to have some marginal margin improvement Companywide.

Correct.

If you're getting still that type of a bump in the Southeast, are you just being conservative for the other areas of your Company? Or are there - - would there be -- or is it something else that, you know, perhaps one or two regions you're looking for a little bit of margin contraction?

Yeah, we're not assuming any price, so you see a slight margin contraction on the West Coast, Southwest. But not large.

Okay. Slight in the West and the Southwest, you said?

Unless you see additional price.

Right. Okay. And the other regions, the Central, you would be looking for flattish margins, or up margins?

Flattish margins.

Great. Thanks, Dom. Thank you.

You're welcome.

Anyone else?

Yes, just one moment, please.

Okay.

Moving on, we'll here from Timothy Jones with Wiseman and Associates.

Good morning.

Tim, good morning.

Actually, a very good quarter. This conference call versus the one yesterday, I didn't realize you were in the same business, but a couple of questions. First of all, your 13% SG&A, where do you guys put commissions to outside realtors and warranty? Do you put it in SG&A, or do you put it in cost of sales?

SG&A.

Okay. So that's why your SG&A is a little higher than some.

Right.

Because it runs about, you know, 50/50, or half of them put it in SG&A, and half put it in - - you put both of them in SG&A.

Sounds like an SG&A to me.

Well, it - - you know, it -- you know, it's 50/50, and I just want to know. That probably is accounting for about a 2 percentage difference, those 2 items right there what from other builders show in the roughly 11%? Would you say that's about right?

I truthfully don't know what the other builders have and so I can't answer that.

Well, the outside, the one cost is like 3%, right, of your outside - - what percentage of your sales are done through outside realtors?

I don't know, Tim, that we have the exact number.

I mean roughly.

1/3.

About a 1/3? Okay. The - - you mentioned in - - you said that you - - we know you improved the margins in the Southeast. You mentioned that you leveraged your margins by managing your costs. Is there anything that's really stands out, or is it just blocking and tackling and a lot of little things?

It's really blocking and tackling across all of our businesses.

Across all the businesses? Now, the return on assets, you're talking about the Southeast next year getting roughly about the Company average margin. Will the turnover be roughly equal to the Company? Obviously it's going to a lot faster than California, and a lot slower in the other markets, but will it be -- the return on assets be roughly comparable too?

I don't think it will be quite at the level of the total Company. But significantly improved from '04.

And what - - a 300 basis points is pretty impressive. Can you give us a couple of main things that you did? Obviously to bring the margins up this much in one year, in a difficult environment, certainly with rising interest rates, and certainly rising costs and labor shortages and certainly cement problems in Florida. What specific things, one or two things that really helped the margins?

Tim, there's a few things. And if you look across the region, it's Florida through the Carolinas. In the first place, when we did acquisitions, there was purchase accounting, which would hold the margin.

Obviously. Could you give me what that - - how much that benefited you?

It's different per state, Tim, so we don't have that detail. But on top of that, we rolled out our business model, introduced studios, we've grown our community count, we've changed to our product line. Now we're getting to a size where we're getting more efficiencies due to size. So it's a logical progression just like we've illustrated over and over as we enter markets. So it's a fairly typical track course.

A lot of builders continue to have problems in the Carolinas. How are you doing there?

Our sales are tracking just fine. The buildings are coming along nicely.

Really? You're one of the few. Thank you.

Thanks, Tim.

Up next from Parker/Hunter we'll he here from Larry Horan.

What would you estimate is your average community count for the current fiscal year? I mean, three quarters actual --

487.

487. Thanks, go doing a great job.

Thanks, Larry.

Moving on from Lehman Brothers, we'll hear from Steve Fockens.

Hi, good morning. Bruce, when you had made the comment earlier about the very strong correlation between total order growth and community growth, is it fair to assume that your average community size over time has been fairly consistent? And if that's true, do you expect that to continue in the future?

I don't know that we have the number on average size, but my inclination would be to say yes, that it would about the same going forward. And where we buy larger parcels of land, we're opening up multiple product lines. So I would think community size would about the same.

Okay. And then - -

Unless, Bill, do you have anything different? Okay. Yes.

And then secondly the JD Power, where you did show place to improvement year-over-year, what were the things in your mind that drove the improvement within the Company? Was it - - did you change local management incentives? Did you change specific building practices or customer service practices? Kind of what are the things that drove that improvement?

Well, what's driving it is like everything else in business, one, you need to set objectives. And Companywide, every one of the more than 6,000 persons who are part of KB Home understand how important our delighting customers is. So we have focused on JD Power over the last 3 years. It was about 3 years ago we decided to simply instead of fighting the survey, accepting the survey, and using that as a reference point for us. And we have developed policies such as our "Say Yes Policy" throughout the Company, which is - - would be too long to describe to you right here. But essentially the persons in the business who have the most contact with the customer are often your lowest compensated people. And what we want is if someone is going to say no to a customer, that it has to move up the ladder. As opposed to someone at the - - at the field level who is making that judgment. So we prefer to just say yes. We think it's better business, and of course it avoids conflict. And we think will result in higher customer satisfaction. There are a number of other programs including every week Jeff shares with our entire team nationwide specific examples of best practices, good stories. We continue to highlight it at management meetings. You know, if I go back 10 or 15 years, we focused first and foremost on P&L, and then, you know, we would get around to how are we doing on quality and customers? And today it is just the opposite. Our business model is customer focused. As you know, we're very proud of the fact that we offer choice, a number of other of our competitors are going another way. We think this is what customers want. And we think in a more competitive environment that it will give us a leg up. And all of this adds to better results. I can tell you throughout the Company last week, when we got the results, there was a lot of celebration and continued focus to continue to continued improvement. And the whole industry is doing a better job. And the competition on quality is getting tougher. And we think this is something that's very good for the home building industry. And as the industry leaders continue to get larger and larger, we think this is something that is a sign of leadership and at the same time maturity.

Great. Thanks much for the call, Bruce. And one last question. In a couple of markets where you did very well, like Houston or Vegas, is it possible to tell, all other factors being equal, that doing well in this survey actually allows you to generate better margins whether it's through price, whether it's through lower warranties, anything like that? Can you tell that already?

You know, if we wanted to make the argument, I'm sure we could make the argument. I don't know that it's easy to do that. I think that our view it's just smart business. And we're dealing with the most important consumer purchase that a family will make during their lifetime. And you know, this, we think, is something that will make good sense longer term. And whether you know, we're not really spending the time to go through the mathematics of it, but I'm sure there is some positive benefit to the P&L.

Okay. Great. Thank you so much.

Moving up from CS First Boston we'll here from Ivy Zelman.

Actually, this is mark Herbach on behalf of Ivy Zelman man. Good morning gentlemen. A very strong quarter. Just a couple of cleanup items, and obviously apologize if you have already discussed them, but could you give some color on the cancellation rates for the quarter?

Yeah. Our cancellation rates for the quarter were 28% versus 36% in 2003, so they improved by 8 points

Okay. Great. How about did you repurchase any shares during the quarter?

No, we did not.

Okay. And finally, any color on September traffic thus far?

Everything seems to be going along well in the month.

Okay. Thanks gentlemen. I appreciate it.

Yeah.

From Friedman, Billings and Ramsey, we'll hear from Craig Kucera.

Yes, hi. Good morning.

Good morning.

I had a question about your community count growth that you anticipate for next year. Are you essentially anticipating that you will be operating in the same kind of geographic footprint, or are you anticipating any expansion into any new markets?

No, we're not. No, we're not. We're anticipating the business to stay in the markets we're in, and continuing to grow in those markets.

Now, are you seeing any - - obviously you guys have been very successful at integrating acquisitions, and have been somewhat aggressive. Are you continuing to see pretty good deal flow? And can you comment maybe on the pricing expectations that some of the sellers are looking for right now?

Well, we actually have not been active recently. And while we look at several opportunities, the internal growth opportunities are so compelling that we think that that's the right place to be spending our capital, and our human resources. So frankly, that's where we're focused.

Okay. And I guess finally, along those lines, you know, you guys do pay a nice dividend. And it's certainly helpful to the shareholders. Do you have any anticipation of reviewing your dividend in the short term, or do you think $1 is probably where you're going to stay for some time?

Well, it's a Board decision, and it will be something that will be discussed by the board at upcoming Board meeting. And it's something that the Board when we made the decision to pay $1 said that that's something we have to look at on an annual basis. So I think that's coming up in the next few months and so at that time, it will be discussed and considered.

Okay. Great. Congrats again.

Uh-huh.

Up next from Natexis Bleichroeder we'll hear from Barbara Allen.

Thank you.

Yeah, hi Barbara.

Hi, I have a couple of questions. The first one is, could you give us the U.S. community count this year and last year?

In the U.S., we had 402 active selling communities, this year, and last year was 324. That's year-over-year for the year.

Thank you. And then the other question is I wondered if you could review for us what your expectations for France are? You didn't mention it in your guidance for 2005. Looks like they're doing very well this year. Could you expand on that a bit?

Well, they are doing well. And you know France has nicely integrated some regional acquisitions that is driving their growth. They've found some excellent opportunities to expand in the regions at what we would, in the United States, think are very attract effect acquisition prices. In terms of - - and I might add they're doing it with their own cash, not with U.S. balance sheet. I can't give you communities, but if you look at what they're anticipating, you know, this year, they're looking at delivering about 4700 units, and next year something north of you know, 6200, 6300.

And anything on the commercial side that is --

No, no.

Interesting? Okay.

No, always talking, looking, but nothing is in the plan for them. Okay.

Are you seeing any regions that the land prices are just excessive, and that you're holding back in any areas?

We're talking now the United States?

I'm sorry, in the U.S., yes.

You know, we always think prices are excessive when you're buying.

Of course. You want them lower, right?

Yeah. Of course, of course. You know, in the markets where we have substantial businesses, we think we understand market dynamics well enough we believe that the constraint of land will continue to push land values and prices at varying degrees, at varying times. And it's unlikely and we would not subscribe to continued price inflation in the West as we've had it over the last couple of years. But by the same token, I would never bet very much that there won't be, simply because there's so much constraint with growth in population. Constraint in supply. So even though it seems prices have in some sectors gone way too fast, the other side is, you know, where do you find available housing? So the area may come - - become less and less affordable but you've got a bigger and bigger population group. The other point is, you know, as you know, Barbara, in most of the hotter housing markets, our price ranges still remain relatively, and I put this in quotes, "relatively affordable". And, you know, there's just a shortage of that kind of product in almost all of these submarkets.

Thank you very much.

Uh-huh.

Moving on from Atlanta we'll hear from William Nobler. There hi, congratulations on a great quarter and a great call.

Thank you. You mentioned that you're not assuming any price changes in your '05 guidance. Is this because you always do it that way on or do you see the change in mix impacting it, or finally do you see a change in the marketplace?

No, we always do it that way. That's the way we build our plans.

Can you give us some feel, say, if prices were to go up, oh, I don't know, 4%, how much of that might fall to the pretax margin?

Well, it depends on how much costs might go up next year, also. So you have both sides of the coin to address.

Okay. You talked about the mortgage banging, which I guess the pretax for the 9 months is down 22 million, although it didn't seem to really kill your bottom line that much. But at any rate, you seem fairly confident of an improvement there, and a contribution to the Company. Could you just give us some color on that?

Well, the you know, the main reason is that we have redeployed the loan officers back into the field. We think that will help significantly with handling our first time buyers and other buyers that we have. And we're starting to see some semblance of a turnaround of the business.

Okay. And last question on use of cash, Bruce referred to reviewing the dividend but you know, despite enormously strong earnings and prospects, and the stock selling at 5.5 times your forecast in '05, you've been - - I don't want to say quiet in the purchase of stock, but you certainly haven't been as aggressive as you have been been in prior years. So how do you see going forward the uses of the cash that you're generating?

Can I just say one thing. In the last 3 years we did repurchase 7 million shares of our stock at an average price of $52. So we have been a pretty big repurchaser of our stock.

I think to just complete the answer, we want to have a balanced approach. We are determined to get an upgrade from S&P and Moody's and Fitch, and with that comes, you know, certain natural constraints. The increase in the dividend would frankly be a very small - - because of the small number of shares that we have, the increase in the dividend would have a I might say a deminimus effect on our free cash flow. And so leverage is really the primary constraint. And I think if everything falls into place as we believe it will in '05, we could probably do, you know, a little bit of everything. Grow our business. And I'm not saying we're going to increase the dividend, but certainly could consider that, as well as repurchasing some shares. And, at the same time, reducing our leverage ratio.

Thanks again, and keep up the great work.

Thanks.

Up next we'll hear from Jeff Feinstein with JLS Asset Management.

It's actually Jeff Feinberg, all of my questions have been answered. Thank you, and congratulations.

Thanks Jeff.

Thank you. And moving on, we'll take a follow up question from Margaret Whelan with UBS.

Hi Bruce. Could I ask you a big further question? When you go through the - - your order backlog is so strong right now, your community count is going to be higher and you make a very valid point that the correlation on order growth in communities is perfect at 1. And then I look at your earnings guidance, and brow provide a lot of visibility area which are appreciate for '05. But if you put in the two together, it actually quite low. And and I hate to say that because I know you're do doing a super job but I also that investors some of the investors worry that maybe the builders don't have great controls in place. Because it's not like it's an impulse purchase. It's a home it's not like buying a cup of coffee. And you have this great visibility yet you don't necessarily see it in that your own confidence when you gave these numbers. Can you just kind of think about that?

Margaret, can I just give you - - one thing you have to be careful is, the 575 communities are the communities that we're going to be selling out of '05 not delivering out of. So when you look at community count and you use the formulations in the past years, you've got to look what we were selling out of in the last half '04 and the first half of '05 to determine deliveries. If you do that it fit fairly well.

It's at least 15% higher right, including France?

What, deliveries year-over-year?

No, your communities.

Oh, the communities, absolutely. As far as deliveries.

And then you get a little pricing, you're doing a good job on the margins, you're buying in stock?

I think it ought to all fit together. I mean --

It fits together to a higher number.

Oh, well, Margaret, always something happens that's unexpected, and that's the part that you always miss. So - - I mean, if everything went perfect, I would totally agree with you, but things don't always go perfectly.

You mean maybe on the cost side?

Maybe on any side. It could be costs, it could be just one of the operations, it could be a market condition. There's always something.

I mean, we got the nice diversity now in markets. Which I think can balance off one being softer, another being better. I mean, we think we're extremely well positioned in terms of our land investment.

Uh-huh.

And as you said, the backlog is very strong, which is why because of those two factors we felt confident in giving the '05 guidance.

Uh-huh.

And you know, it's still - - you know, it's very strong growth, and if we exceed it, we will certainly update you and everyone else as the year unfold.

But you have always done a very good job of buying in stock aggression effect when the opportunity presents itself. Like in 2000, you bought in nearly 20% of your shares in 12 months. So you do still have control there in the event that a market was just slow, or you decide not to reinvest in land.

What can I say?

All right. It's just a big picture question. Thanks. Good job.

Okay.

Up next we'll hear from Smith Barney's Steve Kim for a follow-up question.

Yeah, thanks. Dom, did you give guidance on the gross margin and the SG&A in '05? Because if so, I didn't quite catch it.

No I didn't Steve. But if I was to give guidance, it would be the margins would be around 24%, slightly better than they were in '04, and SG&A will improve slightly.

SG&A will improve --

We still have to firm that up with our '05 plan.

Fine. With respect to your gross margin, typically it rises in your fourth quarter but give your guidance of $11for the year for '04, I would assume that that number does not include an increase in the gross margin from third quarter levels. Is that - - first of all, is that right?

That's pretty accurate. It's better year-over-year, but about the same as it is in the third quarter, but still a fairly nice margin.

Uh-huh. And as we go forward on that 24% in '05, do you similarly expect that to sort of break out from your typical seasonal pattern and be kind of more 24 throughout the year? Or is that going to be - - you going to see a typical dip in the first quarter, and then sort of a rise throughout the year?

Yeah. Because of your fixed variable costs it will be less in Q1 and Q2, and better in Q3 and Q4.

Oh okay. So you would expect to be higher a year from now year-over-year, and what do you anticipate driving that, if it's not price? It's I assume productivity, efficiencies and so forth?

Well like I said, the reason you said quarter to quarter was because the seasonality of the business. When you do more volume in a quarter, you do have some fixed costs in the business.

Right. What I'm saying is in you're saying 24% for the year as the average, you're going to be below that, and then you're obviously going to be above it in the back half of the year which is going to put you above where you are in the fourth.

Yeah, it's a continued improvement in the Southeast, mainly.

I see. Okay. Can you give us an idea of what the margins look like in France?

Less than, but north of 20.

Less than the Company average, but more than 20.

Yeah.

So not way off the map or anything?

No.

Great. And I guess one last question. Bruce, have you done any more work in terms of figuring out whether or not the JD Power, and maybe your positioning in terms of price points, how you expect to sort of tie all of that together with an enhanced brand. I know you guys are one of the few builders that really has sort of focused on that in the past. Is that something that's sort of very much sort of the end gain here from some of these initiatives, or is that something that you're not really spending a tremendous amount of time focusing on at that point?

We - - as you know, we do believe that the KB Home brand is growing, and is of value, and continuing to grow our business. We think that, you know, traffic drives sales, brand drives traffic. Signage is the single most important driver of traffic. And I think we have the best signage in the business, and at least one of the strongest logos in the business. JP Power I would put as a parallel, but equally important initiative in the Company. It's important because - - for the reasons - - many of the reasons that I talked about before, Steve. The product is the single most important consumer product. Satisfied delighted customers is what's going to drive us to the leadership position that we're seeking. And JD Power just happens to be here with an independent survey so that we can grade ourselves on how well we're doing. Our internal customer satisfaction numbers are at the highest level since we began independently surveying. This is now our internal numbers are north of 95% Companywide, which, to our knowledge, is as high as anyone in the business, and higher than almost all of others. So we like all of this. But it's a blocking and tackling every day. And as we continue to develop our product line, which, as I indicated, we are now introducing KB Home Luxury Series, we think it all helps. Whether it links together from a marketing point of view, we're not there yet.

Right. Okay. Thanks.

Yeah.

And our final question will come from Tony Campbell with Knott Partners.

Hi, Tony.

Hi, Bruce. Great numbers. I wondered - - I hate to bring this up again, but I will. Have you looked at monetizing France? I mean --

Yeah, of course.

I mean, and obviously, you could buy back a boat load of stock if you did something there. Is that something that comes up again on the radar screen, or no?

Well --

I know your tax space low, et cetera, et cetera, but --

I mean I would just say yes we have looked at it. Two, we continue to get a nice hunk of cash flow from France each year. We don't send money there, they send money here. And lastly we may be consummating a transaction soon in which we would - - it wouldn't affect our balance sheet, but it in effect they would would be reacquiring the royalty stream for a single cash payment. Which would again send money from France to the U.S., which would be a you know, a significant event if that were to happen. Okay.

Okay. Well, I urge you to - - because I think that would really break you out of the mold, if you know what I mean.

Okay.

Anyway, just my idea.

Thanks, Tony.

Have a nice one.

Okay. All right. That was the last question, wasn't it?

Yes, sir.

Okay. Thank you, ma'am. Thank you all for joining us this morning. We hope to see some of you next Thursday. Next Thursday, September 30 we're going to be in Boston for our investor luncheon. And on Friday, the 1 of October, we'll be in New York for an investor breakfast. And then also as long as you're marking your calendars for our 2005 annual investor day or days - we're going to be here in Los Angeles on March 23 and 24. And for any further information you would like about any of those events, please contact our Investor Relations Department at 310-231-4033. And we would love to see all of you, or as many of you as we can at one of those events. Have a great day, and again thank your you for listening to our third quarter financial update. Have a nice day.

That does conclude our teleconference for today. We would like to thank you all for your participation. You may now all disconnect.