KB HOME annual report, FY2012

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Business context and reporting period

KB Home’s Form 10-K covers the fiscal year ended November 30, 2012. The company builds and sells homes across four U.S. homebuilding segments—West Coast, Southwest, Central and Southeast—and provides related insurance, title and mortgage-marketing services. Homebuilding generated 99.3% of fiscal 2012 revenue.

Financial and operating results

  • Revenue: $1.560 billion, up 19% from $1.316 billion in fiscal 2011. Housing revenue was $1.548 billion.
  • Deliveries and pricing: 6,282 homes delivered, up 8%; average selling price was $246,500, up 10%.
  • Profit and margins: Full-year net loss was $59.0 million, or $0.76 per diluted share, versus a $178.8 million loss in 2011. Operating loss narrowed to $11.6 million from $96.3 million. Housing gross margin was 14.9%, compared with 13.4%; excluding inventory impairment and land-option abandonment charges, the company reported a non-GAAP margin of 16.8% versus 15.4%.
  • Fourth quarter: Revenue was $578.2 million; net income was $7.7 million, or $0.10 per share. KB Home also reported net income in the third quarter.
  • Cash flow and liquidity: Operating cash flow was positive $34.6 million, compared with cash use of $347.5 million in 2011. Cash, cash equivalents and restricted cash totaled $567.1 million, including $524.8 million unrestricted.
  • Debt and capital: Mortgages and notes payable were $1.723 billion, up from $1.584 billion; stockholders’ equity was $376.8 million. Debt-to-total-capital was 82.1%, versus 78.2%; net debt-to-total-capital was 75.4%, versus 71.4% (the latter measure is non-GAAP).
  • Backlog and orders: Year-end backlog was 2,577 homes, up 20%, with potential housing revenue of $618.6 million, up 35%. Net orders rose 1% to 6,703, while the cancellation rate increased to 31% from 29%. Ending community count fell to 191 from 234.

Material changes versus fiscal 2011

  • Higher deliveries and average selling prices drove the revenue increase and improved housing gross profit. Results also benefited from $26.5 million of insurance recoveries and favorable warranty adjustments; inventory impairment and land-option abandonment charges totaled $28.5 million.
  • The 2011 comparison included $53.7 million of impairment related to the South Edge joint venture and a $30.8 million loss on loan guaranty. Those items did not recur in 2012.
  • Operating cash flow improved substantially, while debt increased and equity declined, contributing to higher leverage.
  • KB Home issued $350 million of 8.00% notes due 2020 and $350 million of 7.50% notes due 2022, and used proceeds in part to tender for earlier-maturing notes. The transactions extended the maturity of $584.9 million of senior debt by more than five years.
  • The quarterly dividend was reduced from $0.0625 to $0.025 per share beginning in the second quarter of 2012.

Outlook, risks and unusual items

  • Management expected the company to be profitable in 2013 and projected community-count growth, additional land and land-development investment, and continued growth initiatives, conditional on improving housing markets. It cautioned that results depend on economic, credit and capital-market conditions and may fluctuate.
  • Key risks include a stalled housing recovery, tight mortgage credit and buyer cancellations; rising land, labor and building-material costs; inventory impairment; and the company’s high leverage and access to financing. Management highlighted the importance of California, which generated nearly half of 2012 revenue.
  • Nationstar became the preferred mortgage lender in 2012 after the prior provider exited forward mortgage lending. Mortgage-funding disruptions earlier in the year contributed to cancellations and delayed closings; approximately 58% of November deliveries used Nationstar. The company’s stated intention to establish a mortgage-banking joint venture remained prospective.
  • Warranty and legal matters warrant attention. Florida water-intrusion claims were under investigation, and the company said it could not yet determine whether additional repair charges would be needed. The Nevada development-contract case remained unresolved; management described a reasonably possible loss range from zero to claimed damages, plus prejudgment interest, and the trial was scheduled for October 2013. A separate California judgment led to an $8.8 million charge in 2012; the company appealed.
  • The 2012 tax benefit of $20.1 million primarily reflected resolution of tax audits. KB Home maintained a full valuation allowance against $880.1 million of net deferred tax assets, so realization depends on future taxable income.
  • The independent auditor issued an unqualified opinion on the financial statements and internal control over financial reporting.

Important facts for investors to verify

  1. Whether improving backlog and deliveries translate into sustained profitability and stronger operating cash flow, rather than relying on favorable mix or nonrecurring recoveries.
  2. Whether the 14.9% reported housing gross margin is sustainable after impairment charges, warranty adjustments and insurance recoveries.
  3. Debt maturities, interest costs and refinancing capacity, alongside leverage and unrestricted cash available for planned land investment.
  4. Cancellation trends and mortgage-funding performance, including Nationstar’s continued execution and the planned mortgage-banking joint venture.
  5. The eventual costs and outcomes of Florida water-intrusion claims, the Nevada litigation and the appealed California judgment.
  6. Whether the assumptions supporting inventory values and deferred tax assets remain reasonable as market conditions change.