KB Home, the industry's fifth-largest builder, lost $268.2 million in the three months ended Feb. 29, compared to a $27.5 million gain in the comparable quarter last year. The builder's revenue from its home building operations fell 47.1 percent to $794.2 million in the quarter, when its deliveries declined by nearly 43 percent, to 2,928 units.
The company's profitability was negatively impacted by $224 million in impairment charges it took in the quarter, which were triggered primarily by declining prices for land and homes in various markets. Those impairments helped drag down KB's quarterly gross margin to negative 6.2 percent, compared to a positive 15.5 percent in the comparable three months a year ago. KB also took a $100 million tax asset valuation deferral charge to reserve its benefits from pretax losses. The company currently has more than $600 million in tax allowances that are fully reserved, which it can apply to prior losses at a future date.
Like other large production builders, KB is scaling back its presence by consolidating divisions or exiting underperforming markets. It cut its community count to 224, a 38 percent decline compared to the same quarter a year ago. "We believe [this] is the most significant store count reduction among the builders we follow," writes Carl Reichardt, Wachovia's housing analyst. The drop in communities contributed to a 75 percent reduction in KB's new orders, to 1,449 units. The builder's backlog was also down 56.7 percent, to 4,843, whose $1.23 billion value was off 59.4 percent.
KB has also reduced the number of lots it owns and controls by 68 percent from its peak in the first quarter of 2006 to 59,500. KB has been winding down its construction activities in Washington, Chicago, and Albuquerque, N.M., although Jeff Mezger, KB's president and CEO, hinted during the webcast presentation to analysts this morning that KB might consider re-entering the first two metros once the housing market recovers.
"Our top priorities at KB Home are to maintain a strong balance sheet and position the company for the long-term," says Mezger. However, both he and Dom Cecere, KB's CFO, admit that by focusing on maintaining profitability and holding the line on prices (KB lowered its prices in the first quarter an average of 7 percent to $248,000), "we let the market get away from us a little bit," says Cecere, vis a vis competitors' marketing. In addition, KB continues to be plagued by cancellations, which in the quarter were 53 percent, versus 34 percent in the first quarter of 2007.
Still, KB ended the quarter with $1.3 billion in cash, and Mezger says the company expects to generate positive cash flow through the remainder of this year. KB ended the quarter with $35 million in free cash flow, "significantly better than our projection of negative $140 million," wrote Ivy Zelman of Zelman & Associates, who nevertheless cautioned that KB's lower community count and orders "suggest that cash flows likely will be challenged in the coming quarters."
As he looks forward, Mezger says that "we see no reason to believe that resale absorption rates are going to improve over the next few months," which means that KB's margins and sales will continue to be challenged. However, he's buoyed by recent indications that existing-home prices have been falling a bit, and that the interest rate for 30-year fixed-rate mortgages is below 6 percent. "These could be precursors to the market's recovery." He also expresses confidence in KB's business model, which emphasizes its strong brand and product quality, and is focused on presales and affordability; 90 percent of its deliveries in the first quarter sold at prices that fell within FHA, VA, and conforming loan limits.
Learn more about markets featured in this article: Los Angeles, CA.