KB Home Q2 2012 Form 10-Q Summary
Business context and reporting period
KB Home filed this unaudited quarterly report for the three and six months ended May 31, 2012. The company builds homes in four U.S. regions and provides related title, insurance and mortgage-lender marketing services. Comparisons below are with the corresponding 2011 periods, unless stated otherwise.
Financial and operating performance
| Metric | Q2 2012 | Six months 2012 |
|---|---|---|
| Total revenue | $302.9 million, up 11% | $557.4 million, up 19% |
| Net loss | $24.1 million; $0.31 per diluted share | $69.9 million; $0.91 per diluted share |
| Homes delivered | 1,290, up 2% | 2,440, up 10% |
| Average selling price | $233,000, up 9% | $226,400, up 8% |
| Housing gross profit margin | 16.9%, versus 7.3% | 13.7%, versus 9.5% |
| Housing gross profit margin excluding impairment and land-option abandonment charges (non-GAAP) | 20.3%, versus 14.9% | 16.6%, versus 14.3% |
| Homebuilding operating loss | $15.5 million | $46.7 million |
| Operating cash flow | Not provided for the quarter | Cash used of $89.9 million, versus $271.3 million used |
At May 31, cash and cash equivalents were $318.0 million, including $314.3 million of unrestricted homebuilding cash; restricted cash was $63.2 million. Debt was $1.583 billion, approximately unchanged from November 30, 2011. Debt-to-total-capital was 81.1%, up from 78.2%; net-debt-to-total-capital was 76.5%, up from 71.4%. Stockholders’ equity declined to $369.5 million from $442.7 million. Total assets were $2.394 billion and inventory was $1.728 billion.
Backlog at May 31 rose 22% year over year to 2,962 homes, with potential future housing revenue of $693.4 million, up 38%. Q2 net orders increased 3% to 2,049; their value increased 18% to $503.1 million. The cancellation rate was 26%, versus 25% a year earlier and 36% in Q1 2012.
Material changes versus the prior period
- Q2 revenue growth reflected 2% more homes delivered and a 9% higher average selling price. For the six-month period, deliveries rose 10% and average selling price rose 8%.
- Losses narrowed substantially year over year. The 2011 comparison included South Edge joint-venture impairment and loan-guaranty charges totaling $91.0 million for the six-month period; those obligations had been eliminated or resolved by late 2011.
- Q2 gross margin improvement included $11.2 million of favorable warranty adjustments and a $10.0 million insurance recovery, partly offset by $9.9 million of inventory impairments. The quarter also included an $8.8 million charge related to an adverse court decision.
- The company issued $350 million of 8.00% senior notes due 2020 and used most proceeds to repurchase $340 million principal amount of notes due 2014 and 2015, extending maturities. The transaction generated a $2.0 million early-extinguishment loss.
- Cash and cash equivalents declined by $100.1 million in the first half. The company reduced its quarterly dividend from $0.0625 to $0.025 per share in Q2.
- Regional performance was mixed: West Coast’s six-month pretax result shifted to a $33.5 million loss from $6.6 million income; Southeast returned to slight six-month pretax income; Central and Southwest remained loss-making.
Outlook, commentary, risks and contingencies
- Management described housing conditions as stabilizing but uneven, with distressed-home supply, tight mortgage lending, uncertain employment and consumer confidence continuing to constrain recovery.
- Management expected year-over-year second-half improvement in deliveries, average selling price, gross margin and SG&A as a percentage of housing revenue. It anticipated positive operating income for fiscal 2012 and profitability in Q4, while cautioning that Q1 cancellations could weigh on Q3 results.
- KB Home planned approximately $350 million of land and land-development investment in the second half of 2012, primarily in California and Texas. It expected to open about 25 communities in that period but anticipated ending 2012 with fewer open communities than a year earlier. Management intended to manage to a cash-neutral position for fiscal 2012.
- Mortgage funding disruption during the transition from MetLife Home Loans contributed to elevated cancellations, particularly in Q1. Nationstar began accepting applications on May 1, 2012; management expected the transition to improve loan-origination execution, but results were not assured.
- Inventory impairment charges were $16.5 million for the first half. Management expected a steady, slightly improved sales pace for the remainder of 2012, but noted that weaker markets, pricing or cost assumptions could require material future inventory impairments or land-option abandonment charges. About 34% of inventory was estimated to have a six-year-or-longer realization horizon.
- Contingencies include Nevada development-contract litigation for which plaintiffs seek rescission or damages including $55 million plus more than $41 million in interest; the company said a loss could be material and the non-jury trial was set for September 2012. A separate California matter resulted in an $11.7 million accrual at May 31, including the estimated judgment and fees, and was being appealed.
- Warranty and construction-defect exposure remains relevant. The warranty liability was $50.9 million; estimated self-insurance liabilities were $93.9 million. The company had 11 lawsuits relating to allegedly defective drywall and had not recognized potential future recoveries from suppliers or insurers.
- The company reported compliance with debt covenants and effective disclosure controls. Management cautioned that market, financing, litigation, warranty and tax outcomes could differ materially from estimates; the large deferred-tax-asset valuation allowance also reflects uncertainty about future profitability.
Most important facts for investors to verify
- Whether Nationstar’s mortgage-lending transition reduces cancellations and supports orders, backlog conversion and deliveries.
- Whether reported margin gains persist after separating the $11.2 million warranty adjustment and $10.0 million insurance recovery from ordinary homebuilding results.
- Whether management achieves its stated fiscal-year operating-income and Q4 profitability expectations while maintaining liquidity and its cash-neutral objective.
- Whether the planned land investment and community openings generate adequate returns without increasing inventory impairment risk or leverage pressure.
- Developments in the Nevada litigation, California appeal, warranty claims and potential recoveries, including any change to accruals or cash exposure.
- Debt maturities and refinancing capacity, including the effects of the 2020 notes and the company’s elevated debt-to-capital ratios.