Home builder KB Home today reported a net loss of $49.6 million, or 64 cents per diluted share in the fourth quarter, compared with net income of $304.4 million, or $3.44 per diluted share, in fourth-quarter 2005.

For the full year in 2006, KB Home reported a net income of $482.4 million, down 41 percent compared with $823.7 million in 2005.

On Nov. 12, 2006, the company reported the preliminary findings of an independent review of its stock-option grant practices, and the company is restating prior-period financial statements as a result of this stock-option review. The company announced that it will file its third-quarter report and final year report today with the Securities and Exchange Commission. “Both reports include restated financial statements for prior periods,” according to the announcement.

In November, KB Home announced the resignation of CEO Bruce Karatz, who had led the building company for 34 years. Karatz agreed to pay $13 million to KB Home after an investigation found that the company had incorrectly reported stock-option grants from 1998-2005.

Jeffrey T. Mezger has since replaced Karatz as president, CEO and a director. KB Home’s board also terminated Gary A. Ray, the company’s head of human resources, and announced the resignation of Richard B. Hirst, who served as executive vice president and chief legal officer. The investigation found that Karatz and Ray selected grant dates under the company’s stock-option plans.

Mezger said in a statement, “Last year was clearly a turning point for the U.S. housing market compared to the record growth of the past several years. Although our company’s revenues increased to record levels in 2006, net income and earnings per share dropped sharply in the face of increasingly difficult market conditions and the actions we took in response.”

He added, “During the second half of the year, an oversupply of unsold new and resale homes, reduced affordability, and greater caution among potential home buyers heightened competition among home builders and sellers of existing homes, prompting the aggressive use of price concessions and sales incentives. All these factors pressured our operating margins. Our results were further affected by declining land values and the resulting charges we recorded in the fourth quarter to reflect lower land values.”

Company revenues totaled $3.55 billion in fourth-quarter 2006, up 13 percent from $3.15 billion in the year-earlier quarter. This increase reflects a 9 percent increase in housing revenues driven by 5 percent growth in unit delivery volume and a 4 percent increase in the average selling price. The company’s fourth-quarter results reflect pretax noncash charges of $343.3 million related to inventory and joint venture impairments, and the abandonment of land-option contracts, KB Home reported.

For the year ending Nov. 30, 2006, the company reported a 17 percent increase in total revenues to $11 billion, up from $9.44 billion in 2005. New home deliveries rose 5 percent to 39,013 units in 2006, up from 37,140 units in 2005. The company recorded pretax noncash impairment charges and land-option contract write-offs totaling $431.2 million in 2006. Diluted earnings per share decreased 38 percent to $5.82 in 2006 from $9.32 per diluted share in 2005.

“Deteriorating market conditions during 2006 prompted the company to reduce its inventory positions, adopt a selective approach to potential new land acquisitions, and preserve resources to position itself strategically for an eventual housing market recovery,” the company reported.

“As a result of these measures, the company generated substantial cash flow from operations during the second half of 2006.”

Backlog totaled 17,384 units as of Nov. 30, 2006, which represents potential future housing revenues of $4.43 billion. The backlog value dropped 34 percent from the $6.76 billion backlog value a year earlier. Net orders decreased 38 percent in the fourth quarter to 6,059 compared with 9,747 in fourth-quarter 2005, “primarily due to higher contract cancellations by buyers,” the company reported. The cancellation rate in the fourth quarter was 48 percent, compared with 31 percent in fourth-quarter 2005 but down from 53 percent in third-quarter 2006.

Companywide revenues totaled $3.55 billion for the fourth quarter, increasing by $395.5 million or 13 percent compared to the same quarter in 2005, “primarily due to growth in revenues from the company’s home-building operations.”

Fourth-quarter housing revenues increased 9 percent to $3.42 billion, up from $3.14 billion in the year-earlier period, reflecting a 5 percent increase in unit deliveries to 12,553 from 11,946 and a 4 percent increase in the overall average selling price to $272,400 from $262,700, according to the report.

Revenues from land sales rose to $101.9 million in the fourth quarter from $7 million in fourth-quarter 2005.

The company’s construction business generated an operating loss of $96.4 million in the fourth quarter, down $587.9 million compared to fourth-quarter 2005.

“This decrease resulted primarily from lower housing gross profits and losses on land sales,” according to the report. The company’s housing gross margin decreased to 11.7 percent in the fourth quarter from 27.1 percent in the fourth-quarter 2005, “in large part due to pretax noncash charges of $152.7 million for inventory impairments and $88.3 million for land option contract abandonments, as well as an increased use of price concessions and sales incentives.”

The loss on land sales of $92.6 million in the fourth quarter included $63.1 million of impairment charges that relate to future land sales. The company reported that impairments in joint ventures and abandonment of land options “arose where market conditions became challenging, causing a decline in the value of certain land positions and prompting changes in the company’s strategy concerning projects that no longer meet internal investment standards.”

The company responded to declining market conditions in 2006 by reducing the number of lots it owns and controls by nearly one-third in alignment with expectations for lower 2007 deliveries, according to the report.

The company ended 2006 with $639.2 million in cash and no borrowings outstanding under its $1.5 billion revolving credit facility. Including the year-end cash balance, the company’s leverage ratio as of Nov. 30, 2006, was comparable to the year-earlier level.

“We began 2006 with a strong backlog that produced record deliveries. However, as the year progressed, market conditions worsened, cancellations increased, net orders declined and margins came under pressure,” Mezger stated. “The result was a 2006 year-end backlog substantially below the year-earlier level. At a minimum, this will likely result in a year-over-year decrease in our unit deliveries through the first half of 2007 and potentially longer. It will take time for individual markets to work through the current oversupply of housing and for buyers to regain their confidence in price stability.”

The company generated 6,059 net orders in the fourth quarter, down 38 percent from 9,747 net orders in fourth-quarter 2005. Unit backlog totaled 17,384 units at as of Nov. 30 versus 25,722 units in the previous year. The company’s backlog value fell 34 percent to approximately $4.43 billion at Nov. 30, 2006, down from approximately $6.76 billion at Nov. 30, 2005. Backlog units and values decreased in each of the company’s domestic homebuilding regions, according to the report.

“We are focused on improving execution and leveraging the disciplines of our operational business model to manage through this downturn and are working to further align the organization and inventory investment levels with an anticipated lower unit volume in 2007,” said Mezger. “We have successfully operated in a range of market environments over the years and believe our business model and strong financial position will allow us to compete effectively as the housing market recovers. In light of uncertain future market conditions, we anticipate that our unit deliveries, revenues, gross margins and earnings per share in 2007 will be below 2006 levels.”

During the year ended Nov. 30, 2006, the company delivered 39,013 new homes, a 5 percent increase from 37,140 homes delivered in 2005.

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Send tips or a Letter to the Editor to glenn@inman.com or call (510) 658-9252, ext. 137.

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