KB Home's Profit Tumbles 84%
Despite Lower Cancellation Rate

KB Home posted an 84% slide in fiscal first-quarter earnings as orders and prices for new homes dropped amid a slowdown in the housing market.

Chief Executive Jeffrey Mezger warned that the recent meltdown in the subprime mortgage sector now may exacerbate the trends. He provided a largely gloomy outlook even though the company's latest results managed to surpass Wall Street's expectations, and despite improvements in his company's order cancellation rate.

"We're not ready to say that the markets have stabilized" and prices have stopped eroding, Mr. Mezger said on a post-earnings conference call with analysts.

He said the difficult conditions "likely will continue for at least the remainder of 2007" -- crimping quarterly and full-year results relative to last year's levels -- although he also noted that signs of bottoming in certain regions could start showing up soon. "We are now in the peak selling season, and we'll have a much better feel in eight to 10 weeks" for the overall market, he said.

The Los Angeles-based home builder reported net income of $27.5 million, or 34 cents a share, for its first quarter ended Feb. 28, off from net income of $173.3 million, or $2.01 a share, a year earlier. Revenue fell 19% to $1.77 billion from $2.19 billion.

Wall Street expected KB Home to post a profit of 25 cents a share on $1.61 billion in revenue, according to analysts polled by Thomson Financial.

The company said its deliveries and its average selling price both fell in the first quarter, compared with the year-ago period. Deliveries were off 16%, at 6,655 homes, while the average selling price came in at $261,400, off 5%.

Meanwhile, first-quarter net orders decreased 12% to 7,677. But the company's cancellation rate came in at 31% in the first quarter, an improvement from 48% in the fourth quarter and from 53% in the third quarter.

A.G. Edwards & Sons analyst Gregory Gieber, who has a hold rating on KB Home, called the overall results solid amid what he characterized as a "horrendous" environment for home builders. He agreed with Mr. Mezger that conditions could get worse, noting that the subprime meltdown occurred in March, meaning the bulk of the fallout wasn't reflected in KB Home's fiscal first-quarter results.

Mr. Mezger warned that the improvement in his company's cancellation rate, as well as some recent indications of improvement in order rates, are trends that "should be viewed with caution." The company continues to see "instability" in the market early in the crucial spring selling season, he said.

KB Homes has estimated its subprime exposure at only about 13%. But Mr. Mezger said the company still must deal with the potential that the issue will further slow the housing market.

Climbing rates of delinquencies and foreclosures could increase the supply of homes on the market, at the same time that stricter lending requirements render fewer people eligible for mortgages. Regardless, Mr. Mezger maintained that KB Home's status as a presold builder, instead of one that builds on speculation, makes it well-positioned to weather the storm.

All but 17% of the estimated 10,000 homes that the company currently has under construction in the U.S. have already been sold, the company said. Still, the percentage is higher than the company's 10% traditional goal, a trend that KB Home chalked up to its relatively high cancellation rates late last year.

Meanwhile, executives acknowledged in response to an analyst's question Thursday that the company may have to take another impairment charge if home prices continue to fall.

A number of builders have written down their land values, or walked away from options, amid an oversupply of homes for sale and continued pressure on home prices. KB Home previously took an inventory-impairment charge of $255 million, as well as an $88 million charge from the abandonment of some land-option contracts.

KB's latest results come in the midst of a crisis in the subprime mortgage lending sector that has left U.S. builders assessing their exposure to home buyers with weak credit histories.

-- Mike Barris contributed to this article.

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