Fitch Assigns `BB+' to KB Home's $350MM Debt; Outlook Positive

Business Wire, June 25, 2004

NEW YORK -- Fitch Ratings has assigned a 'BB ' rating to KB Home's (KBH) $350 million, 6.375% senior unsecured notes due 2011. The Rating Outlook is Positive. Proceeds from the new debt issue will be largely used to pay down bank debt in the short term and for other corporate purposes. Senior notes of $175 million at 7 3/4% will mature later in the year.

The current ratings and Outlook 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 approximately 17% of its deliveries from California, compared with 69% in fiscal 1995. 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 management has projected for 2004), approximately 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 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 cash and equivalents of $65.6 million and $655 million available under its $1 billion domestic unsecured credit facility (before adjusting for $174 million of letters of credit) as of May 31, 2004. In addition, liquid, primarily presold work-in-process inventory totaling an estimated $2.87 billion provides comfortable coverage for construction debt. As noted earlier, $175 million in senior notes mature in 2004, but the balance of debt is well laddered and the current $1 billion revolving credit facility matures in four years.

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 million (1 million shares) so far in fiscal 2004. At the end of May 2004, 1 million shares remain 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. The company has had a small dividend. In early December 2003, the board of directors sharply raised the annual dividend from $0.30 per share to $1.00 per share, a pay out of 9.3%, based on forecast earnings for fiscal 2004. However, the cash expenditures on dividends represent only about $39 million, based on the current share count.

KBH has lessened 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 markets in the north and in the south. During the 1990s, the company entered various major Western metropolitan markets, including Phoenix, Las Vegas, Denver, Dallas, Austin, and San Antonio and has risen to a top five 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, Georgia, and North and South Carolina. Recently, the company entered the Midwest (Chicago and Indianapolis) via acquisitions. 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.