KB Home — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended August 31, 2013; comparisons are with the corresponding 2012 periods unless noted. Amounts are in U.S. dollars.
Business context and operating results
KB Home builds and sells homes across four U.S. reporting segments—West Coast, Southwest, Central and Southeast—and operates a financial services segment. Management said the housing recovery continued, supported by steady demand and low inventories, while noting that higher mortgage rates and home prices had slowed sales activity in some markets.
- Third quarter: Revenue was $549.0 million, up 29%; homebuilding revenue was $545.8 million. The company delivered 1,825 homes, up 6%, at an average selling price of $299,100, up 22%.
- Homebuilding operating income was $36.0 million versus $10.9 million. GAAP housing gross margin was 18.2%, compared with 16.7%; adjusted housing gross margin, a non-GAAP measure, was 19.3% versus 14.3%.
- Net income was $27.3 million, or $0.30 per diluted share, versus $3.3 million, or $0.04. Results included a $5.9 million Florida water-intrusion warranty charge and a $0.7 million tax benefit. The 2012 quarter included $16.5 million of probable insurance recoveries, $6.4 million of inventory impairments, an $8.3 million debt-extinguishment loss and a $10.7 million tax benefit.
- Nine months: Revenue was $1.479 billion, up 51%; homes delivered were 5,107, up 23%, and average selling price was $287,900, up 23%. Net income was $11.8 million, or $0.14 per diluted share, versus a net loss of $66.7 million, or $0.86 per share.
- Nine-month GAAP housing gross margin was 16.2% versus 14.1%; adjusted margin was 17.8% versus 12.6%. Homebuilding operating income was $45.1 million, compared with an operating loss of $35.8 million.
Cash flow, balance sheet and capital
- Operating activities used $401.5 million of cash in the first nine months, compared with $75.8 million used in 2012, primarily reflecting a $491.0 million increase in inventories as the company invested in land and development.
- Cash, cash equivalents and restricted cash totaled $424.9 million at August 31, including $383.3 million unrestricted, versus $567.1 million and $524.8 million, respectively, at November 30, 2012. Financing activities provided $273.7 million.
- Inventories rose 31% to $2.230 billion. Land and land development investment was $889.2 million; owned or controlled lots increased to 55,877 from 44,752.
- Debt was $1.937 billion, up from $1.723 billion, principally reflecting $230 million of 1.375% convertible notes due 2019. Stockholders’ equity was $498.0 million, up from $376.8 million. Debt to total capital was 79.5% versus 82.1%; net debt to total capital, a non-GAAP measure, was 75.2% versus 75.4%.
- The company reported no borrowings on its $200 million revolving credit facility and was in compliance with its debt covenants. It had $41.1 million of letters of credit outstanding under separate facilities.
Orders, backlog and material changes
- Third-quarter net orders fell 9% to 1,736 homes, while net order value rose 7% to $528.9 million. The cancellation rate increased to 33% from 29%.
- Backlog at quarter-end was 3,039 homes, down 3%, with potential revenue of $808.5 million, up 9%, reflecting higher selling prices. Ending community count was 189 versus 166 a year earlier.
- Performance varied materially by segment. West Coast third-quarter net orders declined 35% year over year, while Southeast reported a $9.9 million pretax loss for the quarter and a $35.0 million loss for the nine months. Florida water-intrusion costs weighed on Southeast results.
- The company reported no inventory impairment charges in the first nine months of 2013, compared with $22.9 million in 2012. However, 2013 included $23.5 million of net water-intrusion warranty charges.
Outlook, risks and contingencies
- Management expected fourth-quarter 2013 sequential and year-over-year improvement in revenue, deliveries, average selling price, housing gross margin and homebuilding operating margin, and expected to be profitable in both the fourth quarter and full year.
- Full-year 2013 revenue guidance was $2.1–$2.2 billion; expected average selling price on homes delivered was $285,000–$290,000. Management expected approximately $1.2 billion of full-year land and land development investment and a roughly 15% year-over-year increase in year-end community count.
- Management cited higher mortgage rates and selling prices, rising construction labor and material costs, community-opening delays, and uncertainty in economic, credit and capital markets as risks to its outlook. It cautioned that future results could fluctuate.
- For Florida water intrusion issues, the company had identified 1,341 affected homes requiring more than minor repairs and resolved 583. The estimated total repair cost was $49.1 million; the warranty liability included $23.7 million for remaining costs and expected future identifications, before insurance and other recoveries. The company said losses could reasonably exceed the accrued amount by up to $10 million and anticipated completing repairs by the end of 2014.
- A Nevada development-contract case remained pending; the company estimated a reasonably possible loss range of zero to approximately $55 million plus prejudgment interest. Trial was scheduled for May 2014. Other litigation outcomes could also differ materially from accrual estimates.
- The filing highlighted potential home-sale delays or cancellations if federal agency activities—including tax-return verification and mortgage-loan approvals—were disrupted by a prolonged federal funding lapse.
Important facts for investors to verify
- Whether backlog converts into deliveries and revenue, particularly given lower quarterly orders and a higher cancellation rate.
- Whether margin gains persist after adjusting for unusual warranty charges, insurance recoveries and inventory impairments, and whether Southeast results recover.
- Progress, repair costs and recoveries related to the Florida water-intrusion claims, including the potential for costs above the recorded liability.
- Cash use and funding needs as land investment continues, alongside debt maturities and ongoing compliance with revolving-credit covenants.
- Whether management achieves its full-year revenue, average selling price, profitability, land-investment and community-count outlook.