KB Home (KBH) 2005 Q2 法說會逐字稿

Good day everyone and welcome to KB Home second quarter earnings conference call. As a reminder today's conference is being recorded.

KB Home's discussion today will include certain projections and forward-looking statements intended to help investors better understand KB Home's business prospects. These are based on management's assessment of the Company's current business and operating conditions.

Please be aware that KB Home's actual results may differ from those that may be expressed or implied by the projections and forward-looking statements that will be made today and that the differences may be material. Similar forward-looking discussions in the Company's annual report on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K filed with the SEC identify various factors that could cause KB Home's actual results to differ from those that the Company will be projecting in the forward-looking statements that it will be making today and the Company urges you to read those.

I would like to remind everyone that this conference call is being webcast on KB Home's Web site at KBHome.com.

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

Good morning everyone. Thank you for joining us today to discuss the results of our second quarter.

With me this morning are Jeff Mezger, our Executive Vice President and Chief Operating Officer, Dom Cecere, our Senior vice President and Chief Financial Officer, Bill Hollinger, our Senior Vice President and Controller, and Kelly Masuda, our Senior Vice President Investor Relations and Treasurer.

We are again pleased to report strong second quarter and first half results that mark ten years of KB Home meeting or beating analyst expectations. Our financial performance in the first half reflects our expansive geographic footprint, continued focus on superior customer service, and refinement of our KB Next operating model to improve all aspects of our business

Let me share with you some of the second quarter financial highlights.

Companywide net orders in the second quarter of 12,290 new homes increased by 15% when compared to a strong second quarter of last year which was up 28% over the previous year. Order growth was particularly strong on both costs with unit orders in the West Coast up 30% and unit orders in the Southeast up more than 18% compared to a year ago.

We are entering the second half of the year with a solid order backlog of 27,089 sold homes with a revenue value of approximately $6.8 billion. Our backlog value entering the second half is up approximately 2.3 billion or 52%, compared to nearly 4.5 billion at the end of the second quarter last year.

We posted solid top line revenue growth in the second quarter with companywide unit deliveries up 20% on a year-over-year basis, and revenues up 36% to 2.1 billion.

Construction pretax income for the second quarter was 275 million, up 83% from 150 million second quarter last year. Construction pretax margin as a percentage of revenue improved by 3.4 percentage points to 13% this quarter from 9.6% in the second quarter of last year.

Diluted earnings per share for the quarter was $2.06, up 72% from $1.20 in the second quarter of last year, with 88 million diluted average shares outstanding this quarter compared to 85.2 million shares a year ago. These EPS figures and share counts reflect our two for one stock split which we affected in April.

It was a terrific quarter, a terrific first half in every aspect solidifying a very strong financial outlook for 2005. Let me just take a minute and look at our market outlook in each of our geographic regions.

In our West Coast region demand for housing remains strong. The population growth in California has exceeded 450,000 people annually for the last five years, while single-family housing permits have averaged around 125,000.

The continued growth in Californias' population, spurred by immigration, combined with a decade of new housing construction lagging household formation growth, continues to drive overall demand in this supply constrained market. Demand for KB Home remains robust in California with unit orders for homes up 30% in the second quarter.

Our unit backlog of sold homes in the region now stands at 4837 units, with a revenue value of approximately 2.2 billion, up 52% over the dollar backlog end of second quarter last year.

In our Southwest region demand for housing also remains strong driven by population growth in the desert states of Nevada, Arizona and New Mexico. Net unit orders for new KB homes were up 3% in the second quarter with fewer selling communities, primarily in Arizona, where we sold through existing communities ahead of planned new community openings.

We enter the second half with 5444 sold homes in backlog, having a revenue value of more than 1.4 billion, up 50% over the dollar backlog a year ago.

In our Central region net orders for new homes were nearly flat for the quarter against a very strong second quarter a year ago. In Texas and Colorado we continued to place a higher priority on improving our returns on invested capital and have slowed order and community count growth until demand in these markets catches up with excess supply.

We enter the second half with 5810 sold homes in backlog, valued at approximately $904 million, up 11% from this time last year.

In the Southeast region net orders for new homes were up 18% for the quarter reflecting strong organic growth that we're achieving in these markets. The Southeast region is now on par with our other regions with 5665 sold homes in backlog.

The Southeast dollar backlog at quarter end nearly doubled from the prior year to about 1.2 billion with solid gross margins.

And in France, demand for housing continues to remain very strong as we actively pursue our strategy of developing in regions outside of Paris. Net orders for new homes in the quarter were up 44% to 2,084 units from the previous year quarter.

There are now 5233 sold homes in backlog in France at the end of the quarter, with a revenue value of approximately 1.1 billion, up 60% from the 688 million at the end of the second quarter '04.

We are very well-positioned both geographically and financially entering the second half of this year with pretax income of 461 million in the first half, up 75%, driven by top line revenue growth and higher housing gross margins. The backlog of sold homes at the end of Q2 was well-balanced geographically, up 31% year-over-year to 27,089 units, with the average price in backlog up 19% in the U.S.

Now I'll ask Dom to take you through some of the financial highlights for the quarter.

Thank you, Bruce.

We began the quarter with 23,334 homes in backlog and converted 8,535 homes, or 37% of our unit backlog to revenues in the quarter.

Our conversion ratio improved by 3 percentage points over the first quarter with the deliveries of new homes up 20% this quarter, compared to 11% in the first quarter of the year, and we began to recover from the weather-related delays in our coastal regions with unit deliveries up 18% in the West Coast and 48% in the Southeast.

The average sales price of homes in the U.S. delivered in the second quarter increased 17% to 254,500 from 218,200 in the second quarter of 2004. The average sales price in backlog in the U.S. entering the second half is 261,000, up 19% from 219,000 one year ago.

The average sales price of our homes benefited from favorable regional mix, price improvement, and the continued diversification of our product mix to reach a broader array of move up buyers in the market.

Our housing gross margins strengthened again, reaching 26.8% for the quarter, up 3 percentage points from 23.8% in the second quarter of 2004, and 1.3 percentage points better than the 25.5% we achieved in the first quarter of this year.

SG&A expenses as a ratio to housing revenues improved to 12.9% this quarter, compared to 13.6% in the first quarter of 2005, and 13% in the second quarter of 2004. We are on track to deliver solid improvements in SG&A in the second half of 2005 and into 2006.

Our mortgage banking operations delivered .4 million of pretax income for the quarter compared to 2.5 million in the second quarter of 2004. The second quarter mortgage retention rate improved to 53% from 49% in the first quarter of 2005, and the average loan to value ratio improved slightly at approximately 85% versus the prior year.

Average FICO scores for fixed rate loans were 684 and for ARMs, 704. Of the loans processed in the quarter, 61% were fixed rate loans and 39% ARMs, consisting primarily of hybrid mortgages where rates are fixed for three, five, or seven years.

The Company closed the quarter with approximately 76 million in cash related to our construction operations.

Our net debt to total capital at the end of the quarter net of cash was 49.2%, which improved by 180 basis points over 51% in the first quarter of this year and by 60 basis points over this time last year. We fully expect this improvement to continue and we are targeting 47% in debt to total cap by year-end.

We continue to be committed to an investment grade balance sheet and expect to conclude the year with debt to total capital, interest coverage and our debt to EBITDA ratios continue to be at investment grade levels.

Inventories at quarter end totaled 5.1 billion including both land and home center construction. Our inventory supports our community count and unit delivery growth, both of which are forecasted to increase by over 20% in the second half of 2005 versus the second half of 2004.

We continue to have a very liquid balance sheet with over 70% of our inventory flowing through the income statement over the next six quarters.

Companywide we had a four-year supply of land with approximately 180,000 lots owned and controlled at May 31, 2005, compared to approximately 149,000 lots at this time last year. Approximately 52% of these lots are under option contract.

Included in inventory are unsold homes and homes under construction. With our continued focus on build to order we had only 507 completed unsold homes in inventory at quarter end which approximated 1.3 unsold homes per active selling community, or only 3% of the total units under construction.

Our investment in inventory continues to be guided by our detailed analysis of each sub market where we sell homes and our overall focus on after-tax returns on invested capital, which for last several years has ranged between 16 and 16.5%, well above our cost to capital delivering real economic value to our shareholders.

At 2005 we returns on invested capital are forecasted to exceed 17% as we begin to reap the expected benefits of having expanded our community counts in California and Florida. Today we have a very geographically balanced backlog with between 4800 and 5800 homes sold and in backlog in each of our five geographic regions.

Our first half financial performance was truly excellent setting the stage for another great year in 2005 for our shareholders.

First half revenues were up 29%, pretax profits in the first half were up 75% with a diluted EPS up 67%. We enter the second half with s very strong and geographically diverse backlog of over 27,000 sold homes with revenue value of 6.8 billion, up 52%, returns on invested capital are improving and we are expected to exceed 17% in 2005. SG&A improvements are now taking hold and we are on course to strengthen our balance sheet as the year progresses.

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

Thanks, Dom.

We continue to be excited about the prospects for long-term profitable growth at KB Home. In 2002 we developed a strategic plan to expand our geographic footprint and expand the breadth of our product offering to provide a broader foundation to profitably grow our business.

We established aggressive five-year goals at that time to become a $10 billion company by 2007, generating 1.2 billion in pretax profits and earning $10 in EPS after our two for one stock split. We also continued to focus on quality, driving to be one of the top three national homebuilders and customer service as measured by J.D. Power.

This year we will have completed year three of the five-year plan outlined in 2002, and we have either achieved or are well ahead of schedule on every one of the five-year goals. While 2005 is clearly a banner year for KBH, it is still one year of our strategic plan to build homes in long-term attractive housing markets, with a strong balance sheet and clear competitive advantages driven by our KB Next operating model.

Considering the quality of our first half earnings with EPS up 67% and a robust dollar backlog at quarter end up 52%, we are revising our guidance for the year. Revenues in 2005 are now expected to exceed 9.5 billion, up 35% over last year on approximately 38,000 unit deliveries.

Housing gross margins are expected to remain above 26% in the second half, and our SG&A ratio as a percentage of revenues is expected to continue to improve as the year progresses.

We are raising our earnings per share guidance for the year from $7.88 to $9 per diluted share, up 58% from the $5.70 we delivered last year. This is $1.04 higher than the current consensus estimates for the year of $7.96. Furthermore, the current consensus estimates of $9 for 2006 will be achieved one year ahead of expectations.

We continue to maintain a land pipeline and community count projection that supports the market strategy and three-year plans within each of our operating divisions. We're well-positioned for 2006 with average community counts up over 20% in the second half of 2005 and projected to be up by approximately 15% on average in 2006.

Again, it was a terrific first half. Our outlook for the year is favorable. I'm very pleased with our results which have been driven by a well-defined business model, world-class training, and very good people.

I'll now open up the lines to take your questions.

Thank you. [Caller instructions] We'll take our first question from Margaret Whelan with UBS.

Hey, guys, it's actually Dave.

Hello, Dave.

How are you doing? Great quarter. Congratulations. Just a quick question here. With pricing up in the backlog and we're looking at a total 14% how can we think about that in terms of gross margins? I mean is it every kind of 5% you get a 100 point improvement in gross margin or what's the kind of follow through?

Dave, this is Dom. You have to realize that part of the price improvement is that our growth has come on both coastal areas where the average price of the homes are higher than they are in the central part of the U.S. So part of it is mix.

You also have to realize that on average I would say the land cost, per lot cost, are up over 10%. So that will have an impact on margins. And overall cost, direct cost to construct a home were up about 3% of total sales price.

So what we're looking at still is that margins will be over 29% in the second half of the year. Which, as you know, is very strong within the industry and as a business.

Definitely. And then one just quick follow-up. Should we be expecting some share creep moving forward with the share rising so rapidly?

Yeah, you will see some slight share creep in the second half of the year.

Okay. Thanks a lot, guys. Congratulations again.

Moving on to Stephen Kim with Smith Barney. Hello guys, can you hear me?

Yeah, hi, Steve, we do. We got cut off for a second.

Okay. Sorry about that. Well, congratulations on a strong quarter. Okay. Well, I guess basically I was wondering whether or not you could comment a little bit more on your delivery cycle times? I mean you obviously had a pretty strong performance here in an area that builders have been complaining about for the last three to six months. Can you elaborate? Are the delays that you're seeing in Florida in the market overall sort of abating somewhat or is it in elsewhere in the country where you're turning your inventory faster?

Dave, this is Jeff. As you know our business is regional and there's different dynamics in each of the regions.

In California where the market remains very strong our build times on average are around five months, which they have been for the last few years. We're seeing some lengthening in the desert, whether it's Nevada or Arizona, due to the sub-base being [stretched].

The demands and the supply are so strong that the subs are really working hard to keep up and we're seeing some of that so our build time's lengthened a little bit out in the desert probably to 4.5 to 5 months from 3.5 to 4 a year ago. We're seeing some creep in the West.

In Florida we're actually seeing some improvement as the after effects of the hurricane settled down but still on average probably a five-month build time there.

Okay. So Florida's getting better, California has never really been that much of a problem, and the desert is continuing to worsen or has the situation in the desert has worsened and is stabilizing?

It's stretched a little and it's now stabilizing.

Okay. Got it.

And also remember in the Southeast because we're still developing our business we're getting better at what we do. So we're striving to be best-in-class and we're not there yet so that helps it on a year-over-year basis.

And Steve as a comment, in the Southeast our divisions, deliveries were up 48% in the second quarter. So for them they delivered a lot of homes year-over-year.

Right. Well, that's good. Good to hear that the delays are starting to perhaps lighten up as we go forward.

Regarding Florida's margins, I know that was an area that earlier on you had articulated that you had a mix of regional margin that was going to start accruing to your benefit because Florida was improving and becoming a bigger part of your story. Can you talk about how much the margins in Florida, or at least how they're looking, how they improving, are you been pleased with the rate of improvement there, has it been on track?

I haven't, Steve as I was thinking about it, I have it for the Southeast overall and Florida would be the primary contributor to this. But yes, the margins are up around 300, or 3 percentage points or 300 basis points year-over-year and still have in the backlog some improvement to go. So it looks very good for us.

Yeah, the margins in Florida, are they still below your Company average?

Yes.

Right. So that's actually, okay. Great. Good. And lastly, on your income statement, equity and unconsolidated joint ventures, any visibility on what that number might look like over the next couple of years on an annual basis, profits?

The actual profits in the equity joint ventures?

Correct.

I don't, it will be modest over the next couple of years. Both of the JVs we have are really be land JVs and we'll be delivering lots but not profits.

Okay. Good. Great. Thanks very much. Great quarter.

Once again, that is star one if you would like to ask a question. We'll take our next question from Greg Gieber with A.G. Edwards.

I wonder, Dom, perhaps when you look at the increase in margins on your average selling price if you could, I know it's hard to do, but if you could give us an approximate idea how much of that increase came from improvements from the KB model better margins on the East Coast, selling more through the design centers, et cetera versus simply, and selling higher valued homes or larger homes, versus just pure plain price appreciation in markets like California and the Southwest.

Greg, that's complicated to do, kind of a mix analysis, but let me say this, overall we did see that design studio revenues are up year-over-year significantly and so that was a solid contribution for us. We did that see in our emerging new businesses in the Southeast that margins are up so this is all quality improvement in operations.

And then we also benefited from price which was offset by the fact that land costs are rising and the cost to construct is rising. But really, we benefited this quarter from everything.

I saw the new divisions were providing more profits than they did year-over-year and we saw some of the KB Next operating model providing more profits than we saw year-over-year. So it's been good.

Okay. So it's just not all price appreciation.

Not all price appreciation.

The second question, I want to take a look at your community count. Can you tell me what your actual community count was during the quarter and then kind of your best guess for the third quarter, fourth quarter and sort of an average for where it might be in '06?

In the second quarter in the United States we had approximately 415 active communities in the U.S. which was up 14% from 363 a year ago. For the year 2005 we'll average about 451 communities in the U.S. which is up 17% from 386 in 2004. The community counts in the second half were up about 20% year-over-year in the U.S.

And more importantly, if you look at community counts, they'll be up over 20% on the West Coast and 50% on the East Coast and relatively flat in the middle part of the country. So it's a good favorable mix on community counts for us, also.

Any idea where you, what you're planning for for next year as you look, because you do plan three years out?

Bruce had said that in 2006 on average community counts will be up 15% year-over-year.

15% year-over-year in '06. Thank you very much.

Moving on to Carl Reichardt with Wachovia Securities.

Good morning, guys. How are you? What's your attached/detach ed mix right now, Dom or Jeff or Bruce?

It's in here. I thought it was 13%, if I remember, is our detached mix as the total company right now.

13 attached.

13 detached. No, attached.

That would be quite a change. And then second, Dom, going back to the analyst day a few months ago and some conversations we've had about initiatives to improve fixed cost leverage, SG&A in particular. Can you kind of update us as to some specific things you guys are doing to get that SG&A down besides just leveraging off with a higher revenue number?

Yeah, Carl. The COO, Jeff and I, we actually went through division by division and we looked at SG&A by cost element. And as a result of that and looking at best practices from division to division, and based on that we were able to engage all of the VPs in finance in each division to come back with action plans to improve the per unit SG&A cost and put a program in place that we think over the next 18 months will improve SG&A b 100 basis points year-over-year.

100 bips year-over-year.

That is our goal. We hope everybody achieves it, but clearly, everybody is working out and are focused on it and we think the benefit's there.

Okay. Terrific. Thanks a lot, guys.

And we'll take our next question from Ivy Zelman with Credit Suisse First Boston.

Good morning, guys. Actually it's Dennis McGill on for Ivy. I was wondering if you could just run through some of your bigger markets, what you're seeing on the price side of things, if we are looking on an annualized basis here over the last quarter or so?

It's in there, but the average selling prices in our markets, if you look on the West Coast, it was up 13% in the second quarter year-over-year.

No, not the selling price. I'm speaking on orders and if you could even get a little bit more granular than just the region just to give us a sense.

No, we don't [inaudible] that but you do have the regional look. But again, I would say the flavor, when you looked at the community counts, was the solid growth is coming from the coastal regions, the West Coast and Southwest.

So we should assume that you're pushing price 30% in the Southwest right now?

Pushing price?

You're increasing prices 30% today in the Southwest?

No, I didn't say that. I said community counts are off. Now you've just asked me about price. You said you didn't want to talk about price you wanted to talk about community counts so.

No, no, I was asking on price.

Oh, on price.

If you could just give us a sense of how prices are trending in some of the bigger markets today versus just the reported sales price?

Oh. I mean how they're trending for the future?

Are you seeing double-digit price increases in some of the markets, is it single digits?

They seem to be but I'd say they're moderating from where they were in the first half of the year.

Okay. And particularly in the Southeast, where you're getting a lot of growth there, can you give us an idea of where you're modeling for the year or where you expect that average price to be for the year?

In the Southeast?

Yes.

Well, the current price in the Southeast is $206,000. I would guess it will be up 5, 6% from there.

Okay. And I might have missed this earlier, I apologize, but did you give the ARM breakout for the quarter?

We did give the ARM breakout and I believe the ARM was 39%, 61 fixed, 39 ARM.

Okay. And how much of that would be interest only?

They're almost all hybrid mortgage which are three, five, seven year, and of those hybrids I think the majority do go for interest only loans which is pretty much what the market is today.

Thanks a lot.

Okay.

Next we'll hear from Jim Wilson with JMP Securities.

Thanks, guys. Great quarter. I was wondering, in your land positions that you've build up and obviously Florida is from, significantly from all the acquisitions and I would assume fairly well geographically spread across Florida, but my question is for both Florida and California, where have you been finding and adding to the land inventory and can you characterize pricing and what kind of yields you're seeing compared to what you've seen in the last two or three years?

Well if I understand the import of the question, Jim, one, as evidenced by where we see our community count growth we're investing in land in areas that we think are showing the strongest growth which is in terms of dollars is both coasts as opposed to the central.

And as far as trending, you would see if you were to go through transaction by transaction we continue to be interested in expanding the breadth of our product line so we're growing both ends of the product line from higher priced detached to higher density attached on the other side, particularly in the biggest demand markets. And, is that helpful?

It is and I was just even thinking California is it's in now much heavier than it might have been in the past two or three years towards Riverside, San Bernardino as well, particularly on the detached side.

Well, I would tell you the answer in California is, yes, to all of that. I mean we have, over the last several years, invested a lot in people to grow our community count. As you know, as well as anyone, California, very competitive land environment and you want to participate on the smart side.

And to do that you've got to have the teams in place and be the first ones there, not the last ones. And so we've done a very nice job of setting ourselves up. It's one of the reasons it takes time but it's one of the reasons that you've seen our order growth so strong in California and we expect it to continue into '06.

Okay. And then just one final thing on the lot count growth in the Southeast, could you contrast a little bit what kind of those percentage numbers would be between Florida, Atlanta, and the Carolinas or are they all somewhat similar in terms of growth?

In a lot of position growth in the Southeast and it goes up about 30, over 30% year-over-year and I think it's pretty balanced.

I think it's heavier in Florida, much heavier in Florida.

Much heavier in Florida. Okay. Great. Thanks.

We'll take our next question from Dan Oppenheim with Banc of America Securities.

Thanks very much. Was wondering given your comments earlier about the concentrating the sales efforts on the two coasts given through the focus on returns in the central region. You talked about margins staying above 26% for the remainder of this year. Can's we also look out to '06 and expect to see some margin expansion just given a greater presence on the coasts and less in the central region?

Well, we're building backlog now, Dan, for '06. And I think we already have 5,000 units of our backlog is all ready for '06 production so it's, it's something that we'll have a better feel for as we go through the next three or four months and that's why we always wait to give you kind of our outlook for '06 until September when we build some backlog. But things look good year-over-year.

Okay. Great. A related question to that. At the conference in March you talked about the land investment, 2005, with I think, over three-quarters of the land investment being in either California, Florida, or Nevada. So clearly not so much outside of that, but is there even less now going to the central region and more being focused on those three states?

Yeah. If you look at our lot positions it's actually, they're up only 6% in the central region but they're up 40% on the West Coast and over 30% in the Southeast. So the answer is yes. Even up 30% in the Southwest when you included joint venture and the BLM transactions. So, yes, the answer is yes.

Great. Fantastic. Thanks very much.

We'll take our next question from Michael Rehaut with JP Morgan.

Thank you. Just a question on margin expansion which was impressive this quarter. I was wondering if you could kind of give us an idea how that broke down in terms of perhaps mix versus price versus construction efficiencies? And over the next couple of years how you expect those different factor to play out and potentially, again I think as Dan mentioned, potentially even drive margins further from here?

Well, Mike, as I've commented earlier the mix has been favorable for us because our growth has been in the coastal areas. So we've had a favorable mix with a slow down in the Midwest.

We also got significant increases in design studio revenues which were at higher margins so that's been favorable and we've gotten price. And we've seen improvements in margin as a result of our expansion businesses, the margins improving year-over-year.

So we've kind of hit on all cylinders and truthfully, it still looks good going forward. And the difference is, is you've got higher direct costs going up and you've got higher lands costs that you're replacing. So on balance we're sitting here saying that boy, if you could run a business at 26% plus margins that generate 15% pretax and 17% returns you have a great business and that's how we see it today.

And just in terms of maybe a better level of granularity in terms of perhaps how much mix helped versus price versus the design studio, any direction there in terms of maybe 30% for mix or 20%?

We just closed the quarter but I haven't tried to do, which would be a community by community complicated mix analysis. But like you would you do in the manufacturing world but we haven't done that for this quarter.

And just lastly on the design studio revenues that you mentioned, where is that right now as a percent of the ASP versus a year ago?

Yeah, let me just say on design studio revenues, in the first half there were 316 million which was up 35% year-over-year. On a per house basis it was around $24,000 per house which was up 17%, and then as a percent of the base price of the house design studio revenues were at 11%, which was up 30 basis points from 2004.

Great. Thank you.

You're welcome.

Moving on to with Steven Fockens with Lehman Brothers.

Hi, good morning. Just one question.

As, I'm presuming, and correct me if I'm wrong, that the returns and margins you've been generating over the past year are probably better than would you have priced into your land deals in the past. So as you look at your land deals today, have you been raising hurdle rates and margins or is it possible over time that even though you would be earning very nice economic returns on the projects today that they may not be as good as what you are actually earning today?

No, we haven't changed our 20% in total rate of return on free cash flow for land deals because that's exceptional. And, but you are right in the fact that the lands deals that we've done in the past we would have seen improved margins from where they are, because of where we are today.

So over time you're keeping things where they are and you're just looking to keep doing the good things that you're doing now?

Because we don't allow the divisions to assume price improvement on the houses going forward. So they have to make sense of today's market price.

Okay. Thank you.

Moving on to Craig Kucera with FBR.

Good morning. I just have one question also. I just wanted to know if we can get a little bit more of an update on France? I mean I know you said the demand was strong and that your order growth certainly looks good, but are you planning on growing that business further and are you seeing any mix shift that would account for the lower prices we're seeing in backlog?

Well, there's a number of thing going on in France. One, we're moving more into the provinces. We are finding opportunities to acquire businesses in regions at very attractive prices unattainable in the United States. They're using their own cash to do it, we're not sending anything from here.

The average price is being driven even though the market is good is flat because of the regional nature as well as stronger condo as opposed to single-family. But I will tell you anecdotally, we just opened up a community in the outskirts of Paris last weekend and sold homes to a waiting line at 800,000 euro a house in a community that I can remember back in the old days when we were happy to be getting 150,000. And in spite of a sluggish economy real estate housing remains very strong in the country.

Great. Thank you.

Next we will hear from Larry Horan with Parker Hunter.

Yes. You had mentioned that Texas was an area where you were slowing releases to improve your return on invested capital. Are there any other markets where you're doing that?

Well, Colorado I think you put into that category, Larry.

Okay.

Although there are signs of improvement. And our business is improving. Some of the things that happened were market-driven, some were our own fault and we think we're on the right path and both from a management as well as a market point of view.

Okay. And in Texas it's strictly market.

And it's mix. I mean we have some good businesses in Texas. If you put Texas as a region, the answer is yes.

Okay. Thanks a lot.

And as our final reminder, that is star one to ask a question. Moving on to Timothy Jones with Wasserman and Associates.

Good morning. A question. Going back to your ARMs, you said 79% of the business was basically ARMs and most of that was interest only. Would you explain, let's say, a three-year ARM, what the danger, what do the change, when does the interest only affect it and when does it change to go to a fixed mortgage effective?

It was 39%.

Oh, 39. Good.

And remember that's only [on] 50% of the buyers because only 53% of our buyers go through our mortgage operations.

Why is that so low? Why is that capture rate so low?

Actually it improved quarter-over-quarter.

Yeah, but I mean most builders are 70 to 80%.

You know, that's a long story, Tim, but the basic line is, part of it is as we move up higher price they are going outside and too, we haven't done as good a job as we could in capturing it.

Okay. Let's go back, but the ARMs, is one of the things that's bothering me, the interest only. What I'm really concerned about is, thank God you said 39 instead of 79, is I listened to the Chairman of the FDIC on the TV about two days ago and he basically said he was going to go after lenders for lax lending practices and especially interest only loans. Do you have any comment on that and how it would affect you?

You know, no, as the bottom line, remember that of the ARMs, so of the loans originated, so 39% were ARMs. Of those, almost 60% were fixed five years or more.

Okay, good.

Okay? And another 28% were three years, or three year. So I don't think our experience mirrors what he was referring to or you're concerned about.

Oh, no, once you said 39 instead of 79 it made quite a difference. Just want to give you a compliment. Bruce, don't have a heart attack.

No, I'm fine.

But I did have two people that went to Jacksonville, one bought two spec homes, they're direct, one went around to different builders, some who'd talked to them, some wouldn't, but the one customer that went down and said I would like to rent a home from Kaufman and Broad, the guy said, absolutely not, handed him a sheet or an affidavit or something, says we are not allowed and we had to stop the conversation right now. So I congratulate you on that.

Thanks, Tim.

We'll take our next question moving on to Susan Berlinger with Bear Stearns.

Thank you. Just had a question on leverage. I know you guys are talking about bringing it down and I was wondering if you can just give us some color what if the rating agency has been talking about with regards to bringing it down especially in light of your bond deal subsequent to quarter end?

Sue, this is Kelly. As you know, in terms of our covenants that we've been getting from the capital markets we've been getting investment grade money. We've had terrific meetings with the rating agency. I think it's just a matter of time. It's not if it's when. And we keep them posted and updated on our business and how well we're doing.

Did they give you any specific targets that you need to achieve? Do you think these ratios right now are within their comfort zone?

I don't believe that financially I think we're there. I don't think any of the rating agencies have an issue with us financially. It's just a matter of time and in a market where they're downgrading more companies than upgrading?

Okay. Great. Thanks very much.

We'll take our next question from Daniel Richardson with Argus Research.

Oh, good morning.

Good morning.

Just to revisit the mix issue a little bit. When you talk about mix earlier you talked about geographical mix, and I was wondering about the mix in terms of whether or not any of it was due to selling more in a higher home brackets like more towards the luxury bracket?

Daniel, we're just now rolling out our true luxury programs so they haven't been too much of an impact on mix. We are doing more product in California, for instance, in a second move up, not quite to the luxury but certainly higher priced than we've done in the past. So some of it is mix but it would vary by region.

Okay. So most it was really just geographical as opposed to the second move up buyer class?

Right.

Okay. Just one more question. There was mention that your conversion ratio went up from 34% in the first quarter to 37% in this quarter. Is any of that seasonal and how do you see your conversion ratios going forward this year?

It was somewhat seasonal because the first quarter we were impacted by the weather on both coasts. In the second half of the year, if you looked at our backlog, just over what we have today, about 83% of that will convert to deliveries in the second half based on 38,000 unit deliveries. So it does improve in the second half of the year.

Okay. Thank you.

We'll take our next question from Gary Freeman with Gem Realty Capital.

Thanks. Jeff or Bruce, in some of the land replenishment on the coast today, can you give us a sense for some of the land price appreciation that you're experiencing on a year-over-year basis? And also give us a sense of that accelerated more recently? You stayed stable kind of a trend line?

I can't be that specific. I would say this that points that you might find interesting.

One, in the most competitive markets, what we're seeing is the large, most highest capitalized builders, are the ones competing for the best parcels of land. So something that we have talked about for years and years has finally arrived which is, there are fewer people competing for land rather than more.

The other development is we're seeing continued momentum with large builders joining together to buy large, expensive parcels of land which further makes it uncompetitive for smaller players to participate at initial levels.

Pricing I think is generally a little lighter on the increases than we might have said a year ago. But I'm feeling that we are, have a stronger team, a larger team, and because of our breadth of product offering, which is much broader than it was, allows to us participate and be interested in parcels of land that formerly we might not have been as interested in.

So it gives us more opportunities to participate and I think in the end we will fuel our growth even in the most competitive land environment.

Those are interesting comments. I don't want to put words in your mouth but should we imply from that that in terms of making land deals [cancel] on the coast today you're seeing it somewhat, it's somewhat like an easier environment than you would have maybe a year ago?

I don't think I would characterize it like that. I think it's still very competitive but I think there are fewer players at these, at certain of the most parcels because if you're at one financial players have a tougher time playing against builders, users.

You know they've got to have to have a certain margin that we know what we're going to do with the lands, all they're doing is speculating. So I think it's still just as competitive. I wouldn't say it's easier. I think we're doing a better job.

And I would assume you're obviously pushing density a lot more on the coast to make it work.

We are.

Right. Okay. Thank you, Bruce.

Um-hum.

We'll take our next question moving on to Greg Gieber with A.G. Edwards.

I want to go back to you mentioned you're increasing density on your entry level product. I was just wondering when you look at the increased density that you've achieved so far, is that enough to really offset the sort of 10% increase in land that you're seeing or are you, generally how is the density, increased density affecting pricing or your margins?

Greg, that's something that again is a region specific topic. I don't know that we had the data here to tell you how much the higher density product is part of our mix to move our prices up or down.

I would point out in some of our more urban attached product it is not just first time home buyer. When you get into the L.A. basin for instance, condos, townhomes, they're being purchased by move downs, first move up second move up as well, so it's per region.

We are continuing to expand our higher density initiative so you'll see more of it outside even California, but today, it's hard to give you an answer on what it's done to price.

Okay. But you don't, any sense that it can offset say a 10% rate of price appreciation in land costs for those particular lots?

No, I don't believe it, no, density is not offsetting the rising cost of land. It is helping but not offsetting it totally.

Okay. Just wanted to ask about it. Thank you.

We'll take our next question from Margaret Whelan with UBS.

Good morning everyone.

Hi, Margaret.

Tough quarter, very well done and my question is a bit of a ramp up really just in terms of your business in France, the performance while [inaudible] your [inaudible] prices in the U.S., the opportunities in the U.S., and also potentially the opportunities for M&A and at what point would we see more of a focus just on the U.S. business and would you think of divesting that before the euro goes any lower and maybe buying more assets in the U.S.?

You know you're not coming through clearly but is the question related to M&A activity?

In terms of maybe liquidating or monetizing the France?

Ah, the France business?

Yeah.

I don't think there's any compelling reason to do it now. I think that frankly the cash flow is adequate right now I think to drive our business at the growth levels that we believe is prudent and doable.

And France is, it's a cash cow and they're doing fine. If something were to happen that we think is particularly opportunistic we'd probably look at it, but right now there's not a real driver to do something.

And then how are you thinking about M&A opportunity right now? You said land might be.

You know, I tell you, our land pipeline looks so good as we speak that we just don't see a compelling opportunities to by stuff, companies at premiums.

Okay.

So that's what our thinking is today.

Okay. Thank you very much.

That does conclude the question-and-answer session. I'll turn the conference back over to your host for any additional or closing remarks.

Thank you all for participating. Let me just close by reiterating the solid state of our current business and the conditions in which we're operating. And just to emphasize our optimism that we have for the rest of the year.

Look forward to talking to you at the end of Q3. Have a nice afternoon and a nice weekend. Good bye.

That does conclude today's teleconference. Thank you for your participation