KB Home (KBH) 2006 Q1 法說會逐字稿

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

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

Please be aware that KB Homes' actual results may differ from those that may be express 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 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 Homes' actual results to differ from those that the Company will be projecting in the forward-looking statements that we 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 Web site at KBHome.com.

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

Thank you. Good morning, everyone, and thanks for joining us today to discuss the financial results for our first 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, Senior Vice President and Controller, and Kelly Masuda, our Senior Vice President Investor Relations and our Treasurer.

We are pleased to report strong profitability in the first quarter to commence another excellent year for our shareholders. Our financial performance this quarter reflects our continued focus on superior customer service and refinement of our disciplined KB next operating model to improve all aspects of our business.

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

We posted solid top line revenue growth in the first quarter with company-wide unit deliveries up 15% on a year-over-year basis and revenues up 34% to 2.2 billion. Total company pretax income for the quarter was 268 million, up 44% from the 186 million of a year ago.

Diluted EPS for the quarter was $2.02, up 43% from $1.41 in the first quarter of last year, with 86.2 million diluted shares outstanding compared to 87.1 a year earlier. We repurchased 2 million shares of our common stock this quarter, following the 2 million shares repurchased in the fourth quarter of last year.

We concluded the first quarter with a solid order backlog of 26,536 sold homes with a revenue value of approximately 7.2 billion. Our backlog value of sold homes entering the second quarter is up $1.4 billion, or 25% compared to a year ago.

Gross unit orders for new homes in the quarter were down 4% and net unit orders were down 12% from a strong first quarter of last year. First quarter net unit orders were up 23% on a year-over-year basis in both 2005 and the year before, 2004.

The average sales price homes delivered this quarter in the U.S. was 291,200, an increase of 22% from the 238,000 in the first quarter of last year.

It was a solid quarter with 2.2 billion in revenues, up 34%, $2.02 in earnings per share, up 43% and a backlog entering the second quarter valued at 7.2 million, up 25%. In fact, our six-month backlog of sold homes at quarter end, combined with our first quarter actual revenues, totals 9.4 billion, about equal to the total revenues for the full-year last year.

We are still optimistic about long-term demand for housing in our served markets and the benefits of our disciplined operating model and solid order backlog of sold homes. The fundamental drivers for housing remain intact. The economic outlook remains healthy.

Mortgage rates are still attractive. Demographics are favorable. Job growth and growth in personal income continue to rise, all supporting a healthy environment for new housing.

Dom and Kelly just returned from a short investor trip to London. They learned while they were there of a compelling analogy. We think a compelling analogy between current U.S. home building stock valuations and the U.K. home building stock performance.

After a five-year boom, the U.K. housing market slowed dramatically last year in 2005. This surprised many bulls as house price growth declined, sales volumes declined and real estate investors began fleeing the market despite the fact that there was healthy job growth and an attractive interest rate environment.

In fact one of the leading U.K. homebuilders saw flat unit deliveries and housing gross margins erode from 27% to 24%. After a challenging 2005 for this home builder, deliveries are now forecast to be up 16% this year and U.K. home construction sector stocks have rallied up over 50% in the last six months.

This increase was driven by PE multiples expanding to ten times current year earnings. U.K. homebuilders demonstrated their ability to manage effectively in a moderating housing market and their stocks have performed accordingly. So there appears to have been a soft landing in the U.K.

And as another data point, our own home building operation in France is currently trading at a PE of 12 times current year earnings.

While returning to our world here in the U.S., demand for housing slowed in the first quarter as speculators exited the market and homebuyers took longer in the decision process to purchase a home. In the meantime, our focus is to profitably grow our business while delivering sustainable long-term value for our shareholders.

This focus translates into several operating strategies. One, we are being more selective on land purchases and more demanding on terms. We continue to buy land based on a 20% internal rate of return.

Two, we are focused on reducing the cycle time from the sale of our homes to close. This includes improving even flow production and turning our inventory faster.

This in turn will improve the productivity of our subcontractors and additionally, we will continue to benefit from productivity improvements in our newer divisions as they achieve economies of scale in their respective markets.

Third, we repurchased 2 million shares of our common stock in the fourth quarter of last year plus another 2 million shares in the first quarter of this year. With 8 million shares remaining under our current board authorization we anticipate the repurchase of 2 million shares of our common stock in the second quarter of this year.

Fourth, we continue to deploy cash in a disciplined manner while maintaining a healthy investment grade caliber balance sheet.

And lastly we are resisting the use of short-term sales incentives to drive orders. Instead, we are maintaining our focus on selling the value of our brand, our sense of community, our customer service, our quality product and the full array of design options that make buying a KB Home a value buy, not a purchase based on sales incentives.

I'm thrilled that KB Home was named the number one home builder in Fortune Magazine's 2006 list of America's Most Admired Companies. This prestigious position is a tribute to all of our employees who work hard every day to fill the dream home ownership for KB Home buyers.

And now let me ask Dom to take you through the financial highlights of the quarter.

Thank you, Bruce.

The average U.S. sales price of homes delivered in the first quarter of 2006 increased 22% to $291,200 from 238,100 in the first quarter of 2005. The average sales price of our homes benefited from both price improvement and the continued diversification of our product and geographic mix.

The average sales price for a new home was favorably impacted by year-end deliveries being up 32% on the West coast, at an average price of approximately $486,000 for a new home, while unit deliveries in our central region, down 2%, had a lower average new home price of around 157,000. Also positively impacting pricing was demand for design studio options where the average revenue per home increased 37% to 31,400 this quarter from 23,000 per home one year ago.

Our cancellation rate increased to 32% this quarter compared to 25% in the first quarter of 2005, which was the primary driver of the overall decline in net orders for new homes.

The average price related to new home orders was up approximately 15% in the first quarter. The higher average sales price for new orders in the quarter more than offset the decline in unit orders and contributed favorably to the value of our quarter-end backlog reaching 7.2 billion, up 25% from the previous year.

U.S. community counts were up 10% this quarter with 409 active selling communities compared to 373 in the first quarter of 2005.

Our housing gross margin was 26% this quarter, up 50 basis points over the 25.5% housing gross margin in the first quarter of 2005 and our SG&A as a percentage of housing revenues improved by 10 basis points including the expensing of stock options. Excluding these costs SG&A on a comparable basis improved by 30 basis points.

Our construction pretax income for the quarter of 265 million improved by 43% over the 185 million in the first quarter of 2005 which was up 71% over the first quarter of 2004. Debt to total capital at quarter-end was 51.8% which was a slight improvement over debt to total capital at this time last year.

Company-wide we had approximately 197,000 lots owned and controlled at February 28, 2006 compared to approximately 166,000 lots at this time last year.

Our land positions have become more geographical diverse as we have expanded our business. Approximately 53% of these lots are under option contract.

With our continued focus as a risk adverse build to order home builder we had only 460 completed unsold homes in inventory at quarter-end which approximated only 3% of the 15,600 homes under construction. Our investment in inventory continues to be guided by our detailed analysis of each submarket where we sell homes and our overall focus on aftertax returns on invested capital, which in 2005, was a solid 20%.

We have a very geographically balanced business today with 4,207 homes sold and in backlog in our West coast region, 5,368 in the Southwest, 5,405 in the Central region and 5,857 in our Southeast, and 5,699 in France. You can also see the revenue contribution going forward from our Southeast region, which at quarter-end had $1.5 billion of sold homes in backlog compared to 2.1 billion in the West coast region and 1.7 billion in the Southwest region.

In summary revenues for the first quarter were up 34%, pretax profits were up 44%, housing gross margins improved, our SG&A ratio improved, and we reduced the average number of diluted shares outstanding. This contributed to an EPS of $2.02, up 43% over a very strong 2005 first quarter.

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

Thanks, Dom.

KBH is currently growing in 40 of the fastest growing major U.S. markets and in France. Our overall market share is around 5% of our served markets and we believe there is ample opportunity to further penetrate these markets by expanding our price points and broadening our product offerings.

We have entered over a dozen new markets de novo in the past year including Fresno, Bakersfield, Reno, Colorado Springs, New Orleans, Daytona Beach, Fort Myers, Sarasota, Lakeland, Melbourne, Port St. Lucie, Washington, D.C. and Baltimore. We believe this capital efficient and risk adverse organic expansion of our geographic footprint into these attractive housing markets supports our three-year business plan to grow our business in a cost and capital effective manner.

We continue to have a balanced approach in the use of our available cash. This includes paying the highest cash dividends of the large builders and repurchasing shares of our common stock while at the same time profitably growing our business.

I'm very excited about our co-branding with Martha Stewart. On March 6th KB Home unveiled the first Martha Stewart community just outside Raleigh, North Carolina.

The community known as Twin Lakes encompasses 650 lots with eight model homes and price points ranging from 200 to over $500,000.

On opening day our Twin Lakes community had more than 3500 families visit our models. We took commitments for 100 homes and are now attempting to accelerate land development on the remaining lots.

To quote Trish Hanchette, our Raleigh Division President, she said, quote, "I really don't have anything else to say but incredible."

Twin Lakes is the first of several communities that the two companies will design and build across the U.S. A second community is due in Atlanta in the late Spring of this year while additional developments are planned for Houston, Charlotte, Las Vegas, Southern California, Orlando and Daytona Beach.

With our first quarter EPS up 43%, our $7.2 billion backlog of sold homes at the end of the quarter up 25%, the double-digit growth in community counts going forward, and our share repurchase program, we are maintaining our EPS guidance of $11.25 for this year, up 18% over last year. We now expect revenues to reach $12 billion, up 27% over last year on approximately 42,000 unit deliveries.

I will now open up the lines to your questions.

[OPERATOR INSTRUCTIONS] We will take our first question from Margaret Whelan with UBS.

Good morning, guys. Nice quarter.

Two things. The first one is just in terms of the community count, did Dom say it was 409?

I did say it was 409 in the first quarter in the U.S.

Oh, for the U.S. What was the total?

You know, we've just gone to straight U.S. market. I mean there's probably about 124 in France but really it's more a function of U.S. for community count than it is France.

Am I wrong or did you have 487 open in November?

Did we have, how many open back in November?

I have 487.

487 was the U.S. and it will be roughly up 10, 12% from that in the fourth quarter of 2006, also. Our lowest community count since we ended the year.

Okay. So you saw a big drop off of 80 communities.

We do every year. If you'll look at the fourth quarter of '05 it was 47, but we ended the year with 373, so it's no different from the previous years.

Can you give us a sense for the orders for community by markets and into March? By region even, Bruce?

Have we done that before? I don't think we've broken that out, Margaret, so I don't want to start right this morning.

Would you be able to give maybe a little color on what's going on?

Well, what we've said is the two coasts are off of their highs and there's definitely been a resettling down and the center of the country has been stable. Places like Texas generally is better today than it was a year ago.

And the question for us for you and everyone else connected in one way or the other with the industry is exactly where it settles out and I think we're going to know a lot more in June after this quarter.

Margaret, I would say one thing, we're probably in much better position than the other large public builders in that we've already delivered 7900 homes and have over 26,000 homes in backlog.

So to make our 42,000 approximately unit delivery plan we only need to sell and close 7600 homes. This is probably the least amount of selling close in the whole industry.

And you brought that 42 down from 44 in September, right?

We did bring it down from 42 but we held our revenue number.

I saw that. You're getting better pricing than you expected.

Which is, I think, what everybody wants us to do which is maintain your prices and not sell just to get volume.

I agree. Would you give us an update on your cost structure and what's going on there given that demand is kind of slowing overall in the industry?

Margaret, this is Jeff. I can answer that.

Before I do, let me go back to community count and share something with you that we really haven't communicated a lot. We did underestimate the time impact of the hurricanes last Fall in getting communities opened.

And in part as we've gone into '06 whether it's Houston or Florida, we have a lot of communities we thought would be open by now that were delayed because we couldn't get city approvals, we couldn't get utilities in the ground, and we assume going into '06 we could power right through that, but with those delays you'll see our community count, as Dom shared, is going to increase at a faster rate again coming out of '06 as we get these open later this year.

In terms of cost structure I can address two things. It's been pretty interesting.

Most of the markets where demand has slowed the construction pace has not. And we're still, in the Southwest for instance, subs are still pretty tight in Las Vegas and in Phoenix because everything that was under construction is still coming through the system.

We're starting to see some improvement in, on the labor side as we lever our business model and our scale in those markets, but it hasn't been significant yet. We do have some strategies in place company-wide, what we called our Pathfinder Project every year after the JPL program from years ago.

But within our Pathfinder program we have targets per division and we share our successes and our progress and we are starting to see some improvement already in directs.

On the land side, we are yet to see prices come down on land. The land sellers are always the last to figure out that the markets are softer. So we're not seeing prices come down, however, we are already benefiting from getting better terms whether new deals or existing deals where they're more willing to do phase takedowns, extend takedowns, go deeper into the titlement process before you have to close.

We're taking less risk, we're seeing a lot of benefit in that area right now.

In the meantime, you know, our price and backlog is up 15% year-over-year.

Is that mix or is it all pricing power?

Well, it's of course, it's both because of our growth on both coasts.

So your margins should be going up?

Margins should be doing what?

Going up if your costs are flat and your prices--

No, in September, Margaret we -- Thank you. That was a nice lead in.

We said in September the margins would moderate but our increase in price and our increase in volume has more than offset that and the fact that we've seen an improvement in SG&A and we've taken, we have fewer shares outstanding today than we had said we would have in 2006 when we put together our plan. As a matter of fact, if you remember the 2006 outlook that we gave in September, we had said we'd have 91 million shares outstanding and we're actually going to be under 86 million now.

And you said you'll buy back another two in May as well?

We did in the second quarter.

Okay. Thank you, guys.

Our next question comes from Carl Reichardt with Wachovia Securities.

Morning, guys. How are you?

I just have one question really on cancellation rates. I'm operating under the assumption that traditionally cancellation rates, the largest reason for them is due to the inability of the buyer to get financing after they placed a deposit.

Is that still effectively correct? Is that basically the reason? Is that basically, the cancellation rates, that's the bulk of the reason why people cancel, is that true?

Carl, it's Jeff.

That's the primary reason. One of the things that caught us a little by surprise in Q1, we had some buyers cancel where the loans were approved, which we hadn't seen before and I think they're, whether it was consumer confidence or some of the media noise that's been out there for so long, some people were questioning whether to go forward and we've now powered through that, as Dom already referenced on this call, our gross contracts weren't really off that much year-over-year, it was the cans that impacted our net comp, and as we go into Q2 we think we've stabilized that.

We review our and scrub our backlog every week so we're comfortable with the quality of the backlog. And if you look at the can rate it really just came back to what our historical rate's been for the last five or six years.

Right and that's really my follow-up, Jeff.

The incremental increase in cancellations relative to last year, if you just look at those, you're saying that there's a greater portion of those are people who are walking away due to some reason other than an ability to get financing?

It was an additional factor that we had not seen before. In '05 our can rate was the lowest it had been in six or seven years.

We started operating below where we had historically been and now it's come right back to historical and it takes us a month or two to react and raise the gross targets to cover a little bit higher can right, and we think we've got it right back in balance now.

And the good news, Carl, is that the vast majority of our cans were dirt sales, they were not homes under construction, so the cancellations did not have a negative impact on our inventory in production which is why at the end of the quarter we had only 450 unsold homes finished, which is actually low compared to historical levels for us.

And you just answered my second question, too. Great. Thanks a lot, guys. Appreciate it.

Our next question comes from Greg Gieber with A.G. Edwards.

I want to follow-up on the previous questions.

First of all, since gross sales is not something you don't normally toss out, could you tell us what gross sales were by your various regions?

No, we have never given that out. We just wanted to give some exact color on what sales were overall and the mix so that people understood that this was driven primarily by cancellation rates and not by net orders. That's why we provided it this time.

Do I prorate that based upon weights across the regions or might I assume that there was a much higher jump in your can rates, say, in California and the Southwest?

You could assume that California, Southwest may have come up from where they were in the past, but not significantly higher than other regions.

I'm looking at the incremental changes what we have to get out here. Now is any of this coming because you are not willing to match price decreases or promotions by other builders? I mean in California it's only 3% down payment or deposit. I'm seeing sales run by others where as much as 10% of the posted price of a house, in which case it makes sense to abandon yours, walk away.

Greg, that's exactly right. You can see other projections where someone may have had stronger orders but prices only up single digits, low single digits. We prefer to have lower orders and to keep our prices up 15%. We believe that's a quality, a stronger quality business.

So you're doing really no more discounting than you were, say, in the fourth quarter?

We're not, as Bruce mentioned in his comments, Greg, we don't focus on incentives.

Okay.

We stay focused on providing the buyer value and choice. There's a lot of strength to the value of our studios to the customer so we're not having to play the incentive game. Let me talk a couple more comments--

And I'll just, excuse me, Jeff, let me just add one thing. And it's one of the advantages of being around a long time.

In markets where we're leaders to play the incentive game only brings everyone else down the same hole. And it's smarter business for us to take a leadership role and I think we'll see everybody pretty much falling into place other than perhaps somebody who's an overhang on some inventory and that's got to work through a quarter or something.

Okay. Last question.

If you could just talk about your, what the, what happened in sales over the course of the quarter? Did it deteriorate or improve, about the same and what do you know about the current month-to-date?

During Q1 sales trends improved over the quarter. This quarter it's frankly just too early to give you any color on it.

Okay. Thank you much.

Our next question comes from Ivy Zelman with Credit Suisse.

Good morning, everybody.

With respect to your comments, Dom, that you would be better served in not discounting because obviously you're saying that that would be a negative in terms what if the impact would have on the market, but the way I understand the volume game or the volume machine that you guys have, you have an infrastructure that supports so much volume so realizing orders down domestically 16%, you have a infrastructure in place to accommodate 40,000 plus units, so at what point doesn't it make more sense to sell incremental units?

If a manufacturing plant is left idle aren't you better off having a higher utilization even if it's at a discount rather than not selling homes? It doesn't make a lot of sense to me? I have a follow- up then, please.

I'll let Dom, since he came from a manufacturing environment, but you're bringing up a very important point that we think demonstrates the difference between the home building industry and manufacturing with plants and bricks and mortar which is an advantage that we have but they don't. But go ahead, Dom.

Ivy, I fully understand your point because having come out of that world, unfortunately, when you have bricks and mortar and manufacturing plants you have to run what we call 80 to 85% capacity utilization of the plant in order to make money and if you lose volume you're not only bleeding cash but you're bleeding profits so you cut your prices and therefore you run into this vicious circle that happens when demand slows down.

But we're a variable cost business, as you know, with over 90% of our cost being variable and only 10% fixed. So we're in pretty good shape as far as not having an issue with the bottom line by maintaining margins because of that 90/ 10 versus in the manufacturing world we're at 60/40 fixed variable.

Wow, I didn't realize 90% was variable when you've told us that 25% of ASP is land. Land is variable?

We see land as variable.

If you have options that have been exercised and you're sitting on land inventory that you now own and you're building on those units as you open new communities, that's variable?

It's a variable cost. It's absolutely a variable cost.

And you have to remember, if you take a look at our inventory versus what you look at in other industries, that if you look at the total inventory of $6 billion that we had, say, going into the year, $3 billion of that flows through the P&L in the first four quarters and we have two quarters already sold in the backlog. So our inventory turns very quickly.

Let me ask you another question on a different line of questioning with respect to incentives. So you guys are not offering incentives at all or what is it as a percent of your base and what was it last quarter?

Ivy, we can't say we don't offer any incentives. If we have a home where a buyer cancels and it's standing inventory we may wave a studio option, the price on that or something along those lines to move that specific home.

But our broad-based company philosophy and approach is offer the best price, offer choice through the studio, let the buyers pick the home they want and we'll build it so we don't have a lot of inventory that we have to go liquidate. While a lot of our brethren, and you can see it in the paper where there's huge incentives out there right now, if you were to look at our advertising and our marketing campaigns, we're not offering incentives.

No, I realize you're not offering incentives, what I'm asking, though, as a percent of your base if you look at those select deals that you're, you know, where you may have to incentivize and if you look at it as a percent of your base, what do you think roughly that would be right now?

I mean we don't track it but I would, and Bill, just correct me, if we said 1%, is that in the ballpark?

I think, what it's always been.

I mean it's always run somewhere around that.

So if you have, Bruce, if you have a competitor, you're in Orlando right now and you've competitors that are willing to chase volume and you're opening a lot more new communities, and you're saying to us as analysts, that you're going to grow revenues and you're going to get to 42,000 units and your order are down domestically 16% going into second quarter, if you're not willing to do the incentives that others are doing, and realistically, your product doesn't look that much different from the neighboring products that's a adjacent community and Horton's willing to give a 10% off, why should I understand that you're going to be hitting the unit growth that you're anticipating based on new community openings?

Ivy, it's a very good question. And what it goes to is, one, let me say because Orlando, you mentioned Orlando I happen to have been there last week saw all of the adds in the paper and I was very proud to see us selling value and styling and location and quality. If you looked at the paper a week ago Sunday.

I think the truth of the matter is, A, when people, competitors are offering incentives, it's very selectively. Adds might look, people believe, some people believe if you offer in an ad a big incentive that somehow that's going to drive traffic and sell more homes. When you get out to the community and you start looking at it you find out that most of it is on selective lots.

It's very similar to car advertising. When they advertise a number and when you go out to actually buy it's a different number. Personally, I do not think that drives traffic or sales. But that's a different opinion.

Now, with respect to new community openings, if we have the right product, and I do not agree that all product is similar, because if it were and if it were fungible I think we would be in a much worse position going forward. And I think the perfect proof of that is what happened in North Carolina with Martha Stewart.

We did something very different from everybody else and, guess what? 3500 families showed up in a relatively small town and they continue to show up by the thousands interested in buying one of Martha's homes.

So we can't do that every time, unfortunately, but it shows that where you do something different and it strikes a cord people respond. Just like in other consumer products.

Now on a macro level, if the marketplace in a particular submarket starts seeing values, pricing, go down somewhere down the line we are going to have to adjust just like the market. I mean, we cannot sell a value at prices above market.

So far, as a general, rule submarkets in all of the good markets pricing has not dropped. Now it's stabilized. If it were you would have to see us also with new community openings adjust to values. I mean we have to offer value.

Can I just give a couple of facts? Our price in the first quarter overall is up 17%. Our price in backlog is up 15%.

If you look at our backlog of sold homes in our first quarter deliveries, the 34,000 units, so we only have to sell and deliver 7,000 more units to make our plan. So we're in pretty darn good shape for --

Dom, Dom, are you saying, Dom, that if you look at the current order orders that you guys are taking that they are going to be at the same operating margins as the ones that you just closed and delivered in the first quarter so that margins, because you're not willing to incentive and you continue to believe that you're going to retain pricing in environments where we're seeing price sequentially decline in almost every city, that your margins are going to be equal to the margins you just delivered?

Absolutely not, Ivy. We actually have said.

So why are margins going to go down? I don't understand if you're not willing to incentivize.

No, we've said that our margins are going to normalize.

Why, though? Why? If everything is variable.

Ivy, just relax. The reason is because as you replace lots the new lots are coming in at a higher basis than the old lots. So that will have a depressive effect in certain markets on margins.

And realistically those margins are going to be how much lower do you guys forecast? In other words if EPS at $11.25 is going to be retained as guidance will operating income still be up in accordance with EPS growth?

We have said that our margins for the remainder of the year, we had the first quarter of 26%, our margins will be between 25, 25.5% for the next three quarters. And with that in 42,000 unit deliveries and a slight improvement in SG&A and fewer shares outstanding you can deliver $11.25. Just do the math.

Thank you. We will now move on to Dan Oppenheim with Banc of America Securities.

I wondered if you can talk about the trends over the course of the quarter in terms of cancellations? Was there any dissipation, the cancellation rate as we went through February?

And then in both cancellations and orders, know that we don't have a clear read on the second quarter but what are you seeing through the first couple of weeks of March?

Dan, we've already said, it's way too early to the give you any color on the second quarter.

When I look back on our Q1 trends, I'd have to say that our gross improved through the quarter to cover the higher can rate.

I don't know if the can rate really spiked as a percentage at any given month. But here in Q2 it's way too early to give you any color on what's going on.

In terms of cancellations that are resulting from people not being able to sell existing homes, are you seeing that as an issue as well?

No, Dan. In our business model we don't take contingent sales. We won't start the home unless the buyer waives any contingency and demonstrates the financial ability to close even if they haven't sold their home. We don't have contingent sales in our backlog.

And then I wanted to touch on the share repurchase, what sort of leverage are you comfortable with, how aggressive would you be with the share repurchase?

Well, I think what we've said is that, that's where we are. We've an authorization that allows us to repurchase 8 million more shares. It's a balance act between maintaining a strong balance sheet and paying a strong dividend and still growing our business.

So we've indicated that we bought 2 million this past quarter, that we anticipate purchasing another 2 million and after that we'll have to see how the business goes and market conditions.

Remember, Dan, in the fourth quarter we purchased 2 million shares and our debt to total capital ratio was better year-over-year. In the first quarter we purchased 2 million shares and our debt to total capital was better year-over-year.

And it does improve as it goes through the year because when we generate all our cash is in the last two quarters. So we're going to maintain investment grade caliber balance sheet but we're are also going to continue to buy back shares when we think it's appropriate. Like we've done for seven straight years.

And then finally, just wondering in terms of describing cancellations at more normalized levels, if we assume that sort of gross orders continue where they are then we should, you're not saying that we have a spike in cancellation so with them being normalized, we should see sort of the net order trends continue along the lines of what we saw in the first quarter. Is that fair?

We don't know. First of all remember, we only report net orders. The only reason we talked about gross is to give you some color on the quarter and to highlight that we've returned to a more normalized rate of cancellations. But none of that gives you any indication of where we're going to come out three months from now.

But we do know this, we've said this and everyone understands this I think it's a very healthy overall environment for housing. We may be going through a quarter or two of corrections but demand [inaudible] and the fundamentals are very strong in the U.S. and in the markets we're in, even better. So we're comfortable about the market.

Okay. Thanks very much.

Our next question comes from Jim Wilson with JMP Securities.

Hello. Thanks.

I won't focus on anything in the future because I know none of us can predict it too well. So can I just ask a little more color question on Q1 as it related to regions?

I would assume in the ones where you have multiple states like the Southeast, is it safe to assume that like the Carolina's, Atlanta sales pace was better and up and Florida may be down but contributed to the mix and then maybe the same thing in the Central region, that your general Texas patterns were all up compared to other parts of the Central?

Jim, this is Jeff.

Like Bruce mentioned before, there's a lot of factors to our trends. If you go within Florida, some divisions are up, some divisions are down. It's tied to community openings, things that would impact your numbers like that.

Overall we can tell you that Texas continues to rebound for us and gain traction and the market is stronger. We're actually seeing Denver improve in Central from the sales rates we had through 2005.

If you go over to the Southeast, you're absolutely right, Atlanta, Raleigh, Charlotte all show a lot of strength. Those markets never ran up in price like some of the other coastal markets and they continue to sell well.

Okay. Makes sense.

And then, so I would assume in part in the margin trends and what you're expecting for the future, or for the rest of the year, Dom, I mean obviously there's different margin levels in some of those markets compared to the California and parts of Florida and maybe Las Vegas and that's probably as big an impact as anything on the gross margin trends?

Absolutely. I mean we've said this in the past that our margins are coming back to normal in California. They're coming back to normal in Las Vegas.

They're continuing to improve in Florida from where we were because of the strong pricing in '05 and then we're starting to improve in the Midwest. So that's all a positive, I think.

Okay. That's good. Thanks.

Our next question comes from Steve Fockens with Lehman Brothers.

Hi, guys. Just one quick question.

If you look over the long-term what has been the variability in cancellation rates in the past? If someone wanted to be skeptical and you're returning to the historical 30% range, have there been periods in the past when you've been much higher than that?

All right.

I was just going to say when you look over really the last ten years they range from a range of basically from a low of 25% to a high of about 38%.

But the average over that time has been in the low 30s.

They're at 32%.

32%. And then the 25% that you saw in the year ago first quarter, was that similar through the rest of last year?

It was.

Okay. Thanks very much.

Steve, let me clarify one thing for you.

Sure.

We shared over the years. We have a filtering process before we start homes but we won't report the contract until we have a preapproval and know that the buyers more likely than not close a transaction. But before we start the home they finalized their options in the studio, finalize the lot premiums, everything else. We wrap up the full price and gain a full loan approval before we start the home.

So when we talk about can rates, one way that we're different than a lot of our peer group, the majority of our cans occur before the home starts. So our can rate is not 32% on homes under construction. It's less than ten.

Great. Thanks for the color.

Our next question comes from Michael Rehaut with JPMorgan.

Hi. Good morning.

On the, you had the statement about cautious optimism in the press release and I was wondering, it's very helpful to give us color that you felt that sales trends improved throughout the quarter. A couple of questions on that. One, was March still -- I'm sorry, was February still down year-over-year in terms of net orders?

And second, you also refer to the economic conditions still being strong. I was wondering if you also saw any improvement in inventory levels in terms of resale listings or whatnot as you've worked through the first quarter? And then I have a follow-up.

Mike, in February orders were, and I just want to make sure that we [inaudible] with something, orders were flat year-over-year but we over time look month-to-month and there's been huge variability. So the reason we quit reporting orders by month is because you can't really read into orders being flat any month or up in a month or down in a month as to what the quarter will finally end up but they were flat in the month of February versus the last two months.

Right. And so therefore, I mean you've talked about the trend improving throughout the quarter, but obviously, that's where you're getting at but the underlying economic conditions, you're pointing to being positive. Has that resulted in inventories in the sort of moderating markets being reduced throughout the quarter I mean as the positive demand supply dynamics take effect or?

We look at the same inventories of unsold homes that you do and they're still significantly below norms. So we think it's still fairly controlled and overall in the housing market.

I think what's it at now 4.8, or 5.2 months of which a fourth of that are just permits that have been pulled but homes not started. [Inaudible] inventory.

That's the national number. I was referring more to some of the markets that you're in that have slowed like a Phoenix or if the inventory, the resale listings have started to come down in some of those markets.

Michael, even in Phoenix you can't compare Scottsdale to surprise to Casa Grande. It's a very localized business.

And then the next question, I guess, perhaps slightly a bit of a comment, but talking about land as a variable cost or a fixed cost, it certainly would be more on the side of Ivy where it appears to us that you buy land a year or two in advance of opening up that community basically that's a fixed cost and so I think it's a little strange to kind of consider it a variable cost given that when you open up the community, the land is there, it's bought and it's paid for and it's fixed.

Well I mean you would say the same thing in the manufacturing world that if you bought material it's fixed. But in that world we consider material input to be a variable cost and what is fixed is bricks and mortar that stay there whether you sell more material or not.

That's the way to look at fixed variable costs in industry. We're doing it the same way that all industry looks at it.

Right. But the land that you've bought is already paid for and there's no change to the cost of that land whether or not you sell the homes there.

And the material you buy in industry is bought whether sell that material or not. But what you don't have is 40% fixed cost sitting there then go through the P&L even if you don't sell that material. That's the difference. It's the same way it's calculated in the manufacturing world versus our world.

Now if you want me to say in housing we're going to say some costs are fixed that other industries say are not fixed, I guess I could, you know, we could do it a different way. But it's to me land is a material cost and it's a material input. And by the way, it turns a lot faster than material input in other industries.

In other industries when there's a slowdown, they end up having inventory, material as you would put it, which they consider to be a variable cost sitting in the manufacturing plants, in distribution and on retail shelves, and it takes them 12 months to get rid of it. And we don't have that issue.

I mean it's a big plus in this industry and I don't know why people try to turn it into a negative. But our fixed variable cost structure is a big plus in this industry, significantly better than would you see in other industries that you might consider to be cyclical. No one will argue that with you. Hello?

We will now take our next question from Larry Horan with Janney Montgomery Scott.

Great quarter, guys.

On a more positive note, would you mind sharing with us the sort of pace of new community openings over the course of this fiscal year as you see it? Obviously they can get pushed from one quarter to the next because of all sorts of reasons, but I'd just like to get a sense of how that might affect orders?

Well, I mean it's really not different than last year. I think we're going to be somewhere between 10 to 15% community count growth year-over-year in the second quarter, third quarter and fourth quarter. We were up 10% in the first quarter.

Usually we're looking at a net number and maybe you don't have the ins and outs in front of you, but you closed on a lot as you obviously sell the last home and sometimes the openings are front end loaded or back-end loaded, I mean any sense of that or is it on a pretty even flow of new communities coming on stream over the course of the year?

It's pretty even flow but as it does every year, you'll see it stronger in the third and fourth quarter than you saw in the first and second quarter, builds through the year. Just like it's done for the last two years.

Okay. Thanks.

That concludes today's question-and-answer session. I would now like to turn the conference back over to our presenters for any additional or closing remarks.

Thank you for joining us today for our first quarter earnings conference call.

I'd like to remind everyone that our 2006 annual Investor Day will take place in New York on Wednesday, May 10. We're doing it at the Mandarin Oriental Hotel at Time Warner Center and anyone who would like information regarding that please call our Investor Relations department at 310-893-7446.

Thank you. And look forward to talking to you at the end of our second quarter. Have a great day.

This concludes today's presentation. Thank you for your participation and have a wonderful day.