Overall it was a fairly solid fiscal third quarter for KB Home. The company posted higher revenues, better margins, and lower SG&A levels, which helped narrow its losses to just a couple pennies per share shy of breakeven. (For complete earnings results, please click here.) However, several operating metrics point to a very challenging fourth quarter if the company fails to make adjustments to its operating model.

Potential red flags were the company's weak orders, which fell 39% year over year, and backlog numbers, which also were off 42% from the same period a year ago.

During the company related conference call, CEO Jeffrey Mezger acknowledged these weak points and their future impact on revenues, telling analysts that management was lowering its revenue projections. He also said the company will veer away, at least temporarily, from its pre-sale, built-to-order model toward higher levels of spec building in an attempt to set the company up for better success going into 2011.

Calling it a "bridge" strategy, Mezger said, "We hope to reload unstarted backlog and go."

Currently, roughly 70% of the homes the company has under construction are sold. The company counted 413 finished and unsold specs on its books, which Mezger said was slightly overstated because of the opening of a low-rise condo project in California. Moreover, he added, most of the inventory that the divisions have started are tried-and-true best selling plans.

But the shift to selling more inventory homes is likely to pressure margins. For that reason, KB management remains focused on further reducing SG&A costs. During the call, Mezger announced the company would be winding down its Charleston, S.C., operations and also that he expected about $5 million in annual savings to come from a consolidation of administrative positions in the company's southeast region, which includes North and South Carolina; Jacksonville, Fla.; and Washington, D.C.

Mezger said that despite the significant SG&A reduction the company already has undergone, he believed there were probably more efficiencies to be had. "With technology we can combine [more] back-office functions," he said.

In addition to a weak backlog, pricing may also negatively affect the company's revenues next quarter. Although average selling price during the company's first quarter was up 27%, which management attributed to a shift in both geographic and product mix, Mezger indicated there could be pricing softness ahead given some of the upticks in for-sale inventory he's been seeing.

"We may need to get more aggressive," he said. "[But] our first priority is margin."

Management also expected new communities, the bulk of them slotted to open between now and the second quarter of next year, should help drive revenues and volume. Whereas the company's community count has been shrinking, Mezger said he expected to open roughly 100 new communities in the year ahead. One analyst estimated the increase would net an increase of between 25 and 40 in total community count when closeouts are factored in. Currently KB has 138 actively selling communities, compared to 147 at the end of fiscal 3Q2009.

Learn more about markets featured in this article: Charleston, SC.