KB Home — Q2 2011 Form 10-Q
Business context and period. This unaudited quarterly report covers the three and six months ended May 31, 2011, compared with the corresponding 2010 periods. KB Home builds homes across four U.S. regions and provides title and insurance services. Management described housing conditions as difficult, with weak demand, excess resale and foreclosed-home supply, tighter mortgage credit, and intense competition.
Key financial results
Amounts below are in millions, except per-share figures and percentages.
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Total revenue | $271.7 | $374.1 | $468.7 | $638.0 |
| Net loss | $(68.5) | $(30.7) | $(183.0) | $(85.4) |
| Basic and diluted loss per share | $(0.89) | $(0.40) | $(2.38) | $(1.11) |
| Homes delivered | 1,265 | 1,782 | 2,214 | 3,108 |
| Average selling price | $213,400 | $207,900 | $210,100 | $203,500 |
| Housing gross margin | 7.3% | 17.7% | 9.5% | 16.1% |
- Q2 revenue fell 27%, principally because deliveries declined 29%; the higher average selling price partly offset the volume decline. Excluding inventory impairment and land-option abandonment charges, Q2 housing gross margin was 14.9%, versus 17.7% a year earlier. This is a company-reported non-GAAP measure.
- Q2 selling, general and administrative expense fell 25% to $62.5 million, though it rose to 23.2% of housing revenue from 22.4%. Six-month SG&A declined 28% to $112.1 million.
- Q2 included $20.6 million of noncash inventory impairment and land-option abandonment charges and a $14.6 million South Edge loan-guaranty loss. The six-month results also included a $53.7 million noncash write-off of the South Edge joint-venture investment and total South Edge loan-guaranty losses of $37.3 million.
- Financial-services pretax income was $1.6 million in Q2 and $2.3 million for the six months, down from $4.2 million and $6.1 million, respectively, primarily reflecting lower KBA Mortgage joint-venture income.
Cash, debt and liquidity
- At May 31, 2011, cash and cash equivalents were $627.2 million, including $621.3 million in homebuilding and $5.9 million in financial services; restricted cash was $114.0 million. Combined cash and restricted cash was $735.3 million, compared with $1.02 billion at November 30, 2010.
- Six-month operating cash flow was a use of $271.3 million, versus a $112.6 million use in 2010. The comparison was affected by a $190.7 million federal tax refund received in the 2010 period and not in 2011. Investing activities provided $78.6 million, largely from a property sale; financing activities used $88.5 million.
- Debt was $1.692 billion at May 31, down from $1.776 billion at November 30, 2010. Debt-to-total-capital increased to 79.2% from 73.8%; net-debt-to-total-capital increased to 68.3% from 54.5%.
- The remaining $100 million of 6⅜% senior notes was due August 15, 2011. Management forecast more than $500 million of cash and restricted cash at fiscal year-end after anticipated operating needs, while noting the debt maturity and potential South Edge payment. It expected positive operating cash flow in the second half excluding South Edge.
- The company reported compliance with its debt covenants at May 31, 2011. It had $86.2 million of letters of credit outstanding, collateralized by $87.2 million of restricted cash.
Changes, outlook and material risks
- Demand and backlog: Q2 net orders were 1,998, down 11% year over year but up 53% sequentially from Q1. The cancellation rate was 25%, versus 24%. May 31 backlog declined 24% year over year to 2,422 homes valued at about $501.5 million.
- Management outlook: KB Home expected challenging markets to continue, but anticipated improved sales pace, sequentially higher deliveries and revenue, and stronger operating leverage in the second half. It expected no full-year 2011 net profit, but believed it could be profitable in Q4 if housing markets remained at or near then-current activity levels.
- Investment plans: The company had invested about $300 million in land and land development in the first half and expected full-year investment of approximately $560 million, similar to 2010. It opened over 60 communities in the first half and expected 45–50 additional openings in the second half.
- South Edge contingency: A consensual restructuring plan was subject to bankruptcy court approval and other conditions. KB Home estimated a probable net payment obligation of $226.4 million, with an estimated range of approximately $214–$240 million, and had deposited about $21 million in escrow. The estimate includes a $75.2 million estimated fair-value offset for the land it expects to acquire; failure to realize that value could cause additional expense of up to $75 million. A separate arbitration appeal could expose the company to an estimated maximum share of about $25.5 million.
- Mortgage-services transition: KBA Mortgage stopped accepting applications effective June 27 and ceased services after June 30, 2011. The MetLife Home Loans marketing agreement provides fair-market-value compensation for services, not mortgage-joint-venture earnings; management expected KBA-related equity income to decline substantially and then cease.
- Other risks and unusual items: The company reported $21.1 million of six-month inventory impairments and $1.3 million of land-option abandonment charges. It also reported $129.9 million of construction-defect and other litigation liabilities, $82.6 million of warranty liabilities, and $97.0 million of estimated self-insurance liabilities. Warranty estimates include Chinese drywall repair obligations; KB Home had identified 456 affected homes and had 10 related lawsuits pending. Management warned that market deterioration, mortgage-credit constraints, litigation outcomes, and estimates of inventory and South Edge land values could materially affect results and liquidity.
Most important facts for investors to verify
- Progress and court approval of the South Edge plan, ultimate payment amount, escrow treatment, land acquisition, and any separate arbitration exposure.
- Ability to meet the August 2011 $100 million note maturity and maintain the projected year-end liquidity level after South Edge and operating cash needs.
- Whether second-half deliveries, margins, order trends, and the conditional Q4 profitability outlook materialize.
- Assumptions supporting inventory impairment valuations and the $75.2 million South Edge land-value offset.
- Impact of ending KBA Mortgage’s services on homebuyer financing access and financial-services earnings, and adequacy of warranty, litigation, and self-insurance reserves.