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KB Home (KBH - Analyst Report) reported adjusted net loss per share (excluding inventory impairment charges) of 51 cents in the first quarter of fiscal 2012, wider than the adjusted loss (excluding inventory and impairment charges and a loss on loan guarantee) of 47 per share in the year-ago quarter. Lower revenues and gross margins led to the wider loss in the quarter. The loss was far more than the Zacks Consensus Estimate of a loss of 23 cents per share.

Total revenue increased 29% year over year to $254.6 million propelled by housing revenues. Total revenue was however much below the Zacks Consensus Estimate of $324.0 million as well as the prior-quarter revenue of $479.9 million due to declining net orders.

Homebuilding Revenue and Income

Housing revenue increased 29% over the prior-year quarter to $251.9 million due to a 21% increase in the number of homes delivered to 1,150 and a 6% rise in average selling price to $219,000. Housing revenues, homes delivered and average selling prices however declined significantly from prior-quarter levels.

Net orders declined 8% in the first quarter of 2012 to 1,197 homes from 1,302 homes a year ago due to a sharp increase in cancellations. As a percentage of gross orders, the company’s cancellation rate was 36% in the quarter compared with 29% in the prior-year period. Management blamed the increase in cancellation rates to a lack of performance by the mortgage companies. Further, shutdown of mortgage operations by KB Home’s preferred mortgage lender, MetLife also resulted in cancellations by buyers.

The company’s increased focus to improve margins and revamp geographic footprint (the company has exited South Carolina and Charlotte markets and downsized operations significantly in Arizona) also affected net orders. A decline in orders in the company’s operating segments of West Coast, South West and South East markets negated a 22% increase in the Central region.

The company’s backlog totaled 2,203 homes as of February 29, 2012, up 30% from 1,689 homes as of February 28, 2011. Potential housing revenues from backlog rose 30% to $460 million from $353.6 million, primarily due to increases in backlog revenue in all operating regions.

Housing SG&A expenses increased 12.3% to $55.7 million from $49.6 million a year ago. However, as a percentage of revenue, SG&A expenses were lower at 22.1% in the first quarter of 2012 from 25.4%in the prior-year quarter.

The company’s homebuilding business (including housing and land) posted a gross margin of 12.3% in the first quarter of 2012, down from 13.4% in the first quarter of 2011 and 15.1% in the fourth quarter of 2011. The closeout of the high-margin Redwood Shores community in the fourth quarter of 2011 in Northern California as well as lower leverage led to the decline in gross margins.

Financial Services Revenue and Income

The Financial Services business, which includes KB Home’s equity interest in an unconsolidated mortgage banking joint venture, registered a 62% rise in revenues to $2.7 million. The segment reported pre-tax income of $1.9 million in the quarter, including a gain of $0.14 million related to the unconsolidated mortgage banking joint venture.

Recently, KB Home announced that it has signed an agreement with Texas-based premier mortgage services provider Nationstar Mortgage. Per the terms of the agreement, Nationstar will become KB Home’s preferred mortgage lender for its customers.

Outlook

The housing market has been fragile since the last few years. The downturn in the housing industry aggravated by an overall weak economic condition, high unemployment rates, reduced credit availability, rising interest rates and lack of incentives like tax-credit for homebuyers has been weighing down on homebuilders like KB Home and its compatriots DR Horton, Inc. (DHI - Analyst Report), Pulte Group (PHM - Analyst Report) and Lennar Corporation (LEN - Analyst Report). Other than that, the housing market became extremely aggressive and KB Home’s new homes faced tough competition from housing alternatives, including resale homes, foreclosed homes, short sale homes and rental housing. Increased availability of housing alternatives has kept the company’s earnings under pressure.

Management believes that the housing market is slowly stabilizing with increase in employment rates and higher consumer confidence. Management believes that the housing recovery combined with the company’s strategic initiatives (like overhead reduction, margin expansion, and land investments towards higher priced, better located communities) and the Nationstar deal will help it to achieve profitability in 2012. The company expects its operating margin to improve by 500 basis points in 2012. The average selling price is also expected to increase throughout 2012, particularly in the second half, with an average for the year in excess of $240,000.

Our Recommendation

We currently have an Underperform recommendation on KB Home. The stock carries a Zacks #5 Rank (a short-term ‘Strong Sell’ rating).

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