KB Home Tuesday reported a net loss of $772.7 million, -$9.99 per diluted share, in the fourth quarter of 2007, which ended November 30. The loss, which included a $399-million loss from continuing operations and $403 million in write-downs and impairments related to owned land and options.
"These are not the financial results that any CEO wants to report to shareholders," said KB president and CEO Jeffrey Mezger during a midday conference call with analysts. He added, "We see no indication that markets are stabilizing."
During the conference call, Mezger and his team pointed out the positives in the financial results, including a reduction of owned and controlled lots from 186,000 early last year to 66,000 at the close of the fourth quarter, with fewer than 45,000 of those lots owned. It converted 68% of its backlog into revenue. And, as one analyst pointed out during the call, the company has cash on hand of $1.3 billion, which is roughly equivalent to $17 per outstanding share, which is the range in which the company's stock is trading.
Mezger said the market was too unpredictable for the company to provide guidance for 2008 at this time. However, he said that the company's first-time buyer product was selling better than its move-up product. KB execs also pointed out that there is ample liquidity in the government-backed mortgage market for buyers who have the necessary down payments and that, as a result of that, the company will continue to pursue a strategy of building smaller homes at lower price points. One in three buyers has a government-backed loan, the execs said. They also said the company plans to cut its community count by 25% to 30% during 2008. The count in the fourth quarter was up to 418 but shrank to 380 as the 2008 fiscal year began and will decline to "just under 300" by year end.
The strategy for 2008 will be to continue to focus on the balance sheet and to maintain positive cash flow, the KB execs said. Mezger said the company would "selectively reload our land pipeline," adding later that "we think we are well positioned to acquire new lots" if prices are attractive.
In response to a question, Mezger said the company had seen a shift in the buyer profile. "The days of flipping...are over," he said. "This is a truly normal-housing-climate buyer," a buyer "that views owning the home as a lifestyle for the long term."
Mezger also noted that the average option package chosen by buyers in the fourth quarter from KB's design studio totalled $31,500, with the mix of options moving away from "sizzle" luxury items to more traditional options such as cabinets and flooring.
"The challenging market conditions we experienced through the first three quarters of 2007 continued during the fourth quarter," said Mezger in a statement prepared for the earnings release. "Several factors weighed on the entire housing industry this year, including a persistent oversupply of new and resale homes available for sale, increased foreclosure activity, heightened competition for home sales, reduced home affordability, turmoil in the mortgage and credit markets, and decreased consumer confidence in purchasing homes."
The company also took an after-tax, non-cash charge of $514.2 million to fourth-quarter income tax expense and a reduction to the company's deferred income tax assets. The net effect of the charge is to lower current book value of the company, but the charges should be recaptured as the company returns to profitability. During the conference call, KB execs noted that the value of those deferred tax assets going forward would add another $9 per share to the $17 represented by cash on hand, bringing the value of hard liquid assets up to $26 per share.
Said Mezger of the charge, "As a result of the continued downturn in the housing market and the uncertainty as to its length and magnitude, we recorded a valuation allowance on certain deferred tax assets. This resulted in a substantial non-cash charge in the fourth quarter. To the extent that we generate sufficient taxable income in the future to utilize the tax benefits of the related deferred tax assets, we expect to see a reduction in our effective tax rate as the valuation allowance is reversed."
Revenues fell 31.2% to $2.07 billion from $3.01 billion in fourth quarter, 2006. Fourth quarter 2007 housing revenues of $2.02 billion were 31% lower than in the year-earlier period. This decline reflected a 22% year-over-year decrease in new home deliveries to 8,132 in the fourth quarter of 2007 from10,386 in the 2006 fourth quarter, and a 12% year-over-year decrease in the average selling price to $247,800 in 2007 from $280,000 in 2006.
For the fiscal year, KB said it delivered 23,743 new homes, down 26% from32,124 in fiscal 2006. Revenues were off 32% to $6.42 billion, down from$9.38 billion in fiscal year 2006. KB also reported a 9% year-over-year decline in the average selling price to $261,600 from $287,700. The loss from continuing operations in fiscal 2007 was $1.41 billion; including the results of its French discontinued operations, KB posted a net loss of$929.4 million, -$12.04 per diluted share, in fiscal year 2007, compared to net income of $482.4 million or $5.82 per diluted share in fiscal year 2006.
KB said it generated positive cash flow in the fourth quarter and that it ended the fiscal year with a cash balance of $1.33 billion, an increase of$625.2 million from November 30, 2006. It also said it reduced debt by$758.5 million during the year and that it had no borrowings outstanding under its $1.5 billion revolving credit facility as of November 30, 2007.KB's debt-to-capital ratio was 53.9% at the end of the fourth quarter, compared to 50.0% at November 30, 2006. Net of cash, the ratio of debt to total capital improved 12.1 percentage points to 31.1% at November 30, 2007 from 43.2% at November 30, 2006.
During the fourth quarter, KB took 2,574 net orders, down 32% from 3,763 net orders in in the prior year's comparable quarter. All regions generated negative results compared to 2006. The company attributed the drop to a decrease in its community count as well as market conditions. The cancellation rate moved up to 58% from 50% in the third quarter. Backlog totaled 6,322 units, valused at $1.50 billion. The backlog was down 40% from fiscal year-end 2006. The company's housing gross margin fell to a negative 4.3% in the fourth quarter.
The company also disclosed that it has been in violation of it loan covenants. Said Mezger,"Notwithstanding our current cash and capital resources, the impact of the impairments and deferred tax assets valuation allowance required us to obtain a waiver under our revolving credit facility relating to a consolidated tangible net worth covenant," said Mezger. "To address our covenant compliance for future periods, we are currently working with our bank partners to amend our credit facility covenants. We have a long-standing and positive working relationship with our bank group and, based on preliminary discussions, we expect to enter into an amendment by the end of the first quarter of 2008."
The KB earnings release, coupled with a decline in the National Association of Realtors' Pending Home Sales Index, drove builder stocks down. KB stock (NYSE:KBH) was off 4.55% to $17.64 in heavy trading shortly after 1 p.m., and the S&P home builder exchange-traded fund ((AMEX:XHB) was off nearly 4% at $16.18.
Carl Reichardt, home building analyst at Wachovia Securities, said in a research note that even though the loss far exceeded his estimate of -$1.39 per share, KB's balance sheet "improved, with cash at the end of the quarter of $1.3 billion, up over 100% sequentially. Furthermore, there are no borrowings under the revolver and net debt/total cap is healthy in our view at 31%." He also said, "Orders were well below our forecast, however, we believe community count is down 20-25% year over year, part of the company's strategy to shrink out of non-core markets--a strategy of which we approve."
Reichardt also noted that the tax charge, similar to a charge taken earlier by Hovnanian Enterprises, would "distort and lower current book value but that valuation allowances are reversed through a lower tax rate when builders return to profitability."
Likewise, David Goldberg at UBS said the losses were greater than expected and that he was lowering his earnings estimates for fiscal 2008 from $2 per share to $1.85. "Despite this, we still believe KB is well positioned," he wrote in a note to investors.
Michael Rehaut at J.P. Morgan Securities said in a research note, "Orders of -32% were highly disappointing against an easy -61% year-ago comp -- despite ASPs down 21% sequentially -- in part due to the can rate worsening to 58% from 50% in 3Q. Accordingly, we believe this points to continued pain and continued significant impairment charges for the industry in the upcoming earnings season, and thus we reiterate our negative sector stance."