Fitch Affirms KBH Senior Unsecured Debt at 'BB+'; Outlook Positive

Business Wire, August 3, 2004

NEW YORK -- Fitch Ratings affirms KB Home's (KBH) 'BB ' senior unsecured debt and 'BB-' senior subordinated debt ratings. The Rating Outlook is Positive. The ratings reflect KB Home's solid, consistent profit performance in recent years and the expectation that the company's credit profile will continue to improve as it executes its business model and embarks on a new period of growth. The ratings also take into account the company's primary focus on entry-level and first-step trade-up housing (the deepest segments of the market), its conservative building practices, and effective utilization of return on invested capital criteria as a key element of its operating model. Over recent years the company has improved its capital structure and increased its geographic diversity and has better positioned itself to withstand a meaningful housing downturn. Fitch also has taken note of KB Home's role as an active consolidator within the industry. Risk factors also include the cyclical nature of the homebuilding industry. Fitch expects leverage (excluding financial services) to remain comfortably within KB Home's stated debt-to-capital target of 45%-55%.

The company has expanded EBITDA margins over the past several years on steady price increases, volume improvements and reductions in SG&A expenses. Also, KB Home has produced record levels of home closings, orders and backlog as the housing cycle extended its upward momentum. KB Home realizes a significant portion of its revenue from California, a region that has proved volatile in past cycles. But the company has reduced this exposure as it has implemented its growth strategy and currently sources 17% of its deliveries from California, compared with 69% in fiscal 1995 and 88% in fiscal 1993. Over recent years KB Home shifted toward a presale strategy, producing a higher backlog/delivery ratio and reducing the risk of excess inventory and debt accumulation in the event of a slowdown in new orders. The strategy has also served to enhance margins. The company maintains a 4.6 year supply of lots (based on deliveries projected for 2004), 50% of which are owned and the balance controlled through options. Inventory turnover has been consistently at or above 1.5 times (x) during the past seven and a half years.

Balance sheet liquidity has continued to improve as a result of efforts to reduce long-dated inventories, quicken inventory turns and improve returns on capital. Progress in these areas has allowed the company to accelerate deliveries without excessively burdening the balance sheet.

As the housing cycle progresses, creditors should benefit from KB Home's solid financial flexibility supported by $65.6 million in cash and equivalents and $480.5 million available under its $1 billion domestic unsecured credit facility, net of $174.5 million of outstanding letters of credit, as of 5/31/04. In addition, liquid, primarily pre-sold work-in-process inventory totaling $2.8 billion provides comfortable coverage for construction debt of $1.7 billion. $175 million in senior notes mature in 2004, but the balance of debt is well laddered and the revolving credit facility matures in October 2007.

Management's share repurchase strategy has been aggressive at times, but has not impaired the company's financial flexibility. KB Home repurchased $81.9 million of stock in fiscal 1999, $169.2 million in 2000, $190.8 million in 2002, $108.3 million (2 million shares) in fiscal 2003 and $66.1 million (1 million shares) so far in fiscal 2004. At the end of May 2004, 1 million shares remained under the board of directors' repurchase authorization. Notwithstanding these repurchases, book equity has increased $1,040.2 million since the end of 1999, while construction debt grew $763.1 million.

KBH has lowered its dependence on the state of California, but it is still the company's largest market in terms of investment. Operations are dispersed within multiple California markets in the north and in the south. During the 1990s the company entered various major Western metropolitan markets, including Phoenix, Denver, Dallas, Austin and San Antonio, and has risen to a top 5 ranking in each market except Dallas (number 10 ranking). In an effort to further broaden and enhance its growth prospects it has established operations (greenfield and by acquisition) in the southeastern U.S., including various markets in Florida, Atlanta and the Carolinas. Most recently, the company has entered the Midwest (Chicago and Indianapolis) via acquisition. Fitch recognizes the company as a consolidator in the industry, but expects future acquisitions will be moderate in size and largely funded through cash flow.

KB Home ranked as fifth largest homebuilder in the U.S. in 2001, 2002 and 2003. Its average home selling price through the first six months of fiscal 2004 is $215,900. It is on pace to construct more than 32,000 homes in fiscal 2004. The company operates homebuilding operations within the U.S. and France (57% ownership of Kaufman and Broad S.A.). Kaufman and Broad S.A. also does commercial construction in France and KB Home operates KB Home Mortgage Company domestically. Year-to-date the Western region (CA) accounts for 17.0% of corporate orders, the Southwest (AZ, NV, NM) represents 23.4% of orders, the Central region (CO, IL, IN, TX) accounts for 28.8% of orders, the Southeast (FL, GA, NC, SC) contributes 18.0% of orders and France represents 12.8% of total net new orders.