KB Home closed out its fiscal year 2010 with a bang rather than the whimper analysts expected. The company reported a profit of $17.4 million, or $0.23 per share, for its fourth quarter, handily beating analysts' expectations of a $0.17 per share loss. (For full financial results, click here.) The outperformance was mostly driven by higher margins and lower overhead costs.
"We're very pleased with how we've transformed and repositioned the company," CEO Jeffrey Mezger told analysts during the company's earnings call Friday. "We now have the capability to generate profits on lower revenues."
Analysts' take-aways were more mixed. UBS analyst David Goldberg called the results "impressive" in a related research note, but other analysts were more reserved in their assessment. Credit Suisse analyst Dan Oppenheim, for example, called the company "poorly positioned" for the year ahead.
Most of the uncertainty over the company's future performance stems from its ability to replicate its performance quarter to quarter in 2011. The big question marks are whether the company can reverse its negative order trends and rebuild its backlog, sustain its 19.7% gross margins (excluding charges), and keep its cancellations in check.
New orders for the quarter fell 25% from the same period a year ago, which did little to help the company reload its already thin backlog of 1,336 homes, which marks a falloff of 37% from 4Q2009. Mezger acknowledged that the company's backlog did little to boost the company's revenue projections for the next quarter, going so far as to indicate the company would likely be unprofitable in its fiscal first quarter of 2011. However, assuming no major changes in the market, the company should come out in the black for the whole fiscal year.
Mezger said it wouldn't take much for the company to make up lost ground on new orders, given the new communities and product it would be selling in 2011 and the increases in traffic the divisions saw in November and December. He confirmed the company was still on track to grow its community count by 25% in 2011, saying roughly 70 new communities, the bulk of which are in California and Texas, will come online in the next six months. The company ended the year with 132 actively selling communities.
"It's not a big number to catch up and pass," he said. "We elected not to chase sales in November and get aggressive on pricing because there aren't a lot of buyers who want to close in three weeks."
Moreover, Mezger defended management's so-called "bridge" strategy, which some analysts feared may have backfired given the company's weak orders and spike in cancellations. The strategy moved the company away from its built-to-order business model in favor of increasing its spec levels in an effort to convert sales to deliveries quickly, preserving revenue.
Mezger said while the decision to follow the new spec strategy "broke his heart"--he was an original champion of KB's built-to-order model--it was "successful in covering revenue." However, he noted that the company would not be starting much spec inventory going forward. During the quarter, the company reduced its spec inventory, including both under construction and finished, from roughly 1,000 units to about 700 at the end of its fourth quarter. Approximately 200 of those spec units are attributed to two low-rise condo projects in California.
Although some analysts remain concerned that this speculative inventory will lead to margin erosion as the builder tries to move the units as quickly as possible, Mezger said future margin fluctuations would likely reflect more product mix. For example, he noted some margin improvement during the quarter was due to a greater number of deliveries coming from higher-priced communities in California.
However, additional margin improvement came from yet another reduction in SG&A. During its fiscal fourth quarter, the company realized savings of $12 million in salaries, rent, compensation, and insurance; $3 million in professional services and fees; and $3 million in legal recoveries.
But the biggest shock to company management during the quarter was the company's cancellation rate, which shot up to 37% of gross sales. Mezger pointed to tighter and ever-changing underwriting standards in the mortgage industry as an issue, which was creating problems for some buyers even as they were pre-qualified and their homes were under construction.
"It's an odd dynamic, and we're trying to get our arms around it," said Mezger, noting that he expected cancellation rates to normalize going forward.
The other X factor for KB in the year ahead is the continuing saga with its joint venture behind the Inspirada community in Las Vegas. Recently, the venture's lenders, led by J.P.Morgan, moved to force it into involuntary bankruptcy. When asked about the issue, KB management said the venture has requested the bankruptcy court judge to dismiss the filing and should have a ruling by early February.
Mezger added that Inspirada is an important community to the company. Not only does the company have a 48% ownership stake in the community, but it continues to be one of the local division's best-selling communities. Mezger said the company has delivered 534 homes since opening up shop in the community, 40 of which were delivered in its most recent quarter. Given the sales velocity, Mezger added the company would be introducing a new product line to the community.
"We have a real stake in the success of the community," Mezger said.