KB Home — Q1 FY2011 Form 10-Q
Reporting period: Three months ended February 28, 2011; comparisons are with the three months ended February 28, 2010 unless otherwise noted. Balance-sheet comparisons are with November 30, 2010. Amounts below are in millions except per-share data and operating statistics.
Business context
KB Home builds and sells homes across four U.S. regions and provides title and insurance services, with mortgage banking offered through a 50%-owned joint venture. Management described housing markets as persistently weak, citing oversupply, restrained demand, tighter mortgage credit, low consumer confidence and foreclosure competition.
Financial results and key metrics
| Metric | Q1 2011 | Q1 2010 / comparison |
|---|---|---|
| Total revenue | $196.9 | $264.0; down 25% |
| Homebuilding revenue | $195.3 | $262.5; down 26% |
| Net loss | $(114.5) | $(54.7) |
| Loss per diluted share | $(1.49) | $(0.71) |
| Homebuilding operating loss | $(47.9) | $(36.2) |
| Housing gross margin | 12.6% | 13.7%; excluding inventory and land-option charges, 13.4% vs. 18.8% |
| SG&A | $49.6; 25.4% of housing revenue | $72.2; 27.5% |
| Operating cash flow | $(164.9) | $18.3 |
| Cash and cash equivalents | $742.5 at February 28 | $908.4 at November 30 |
| Cash plus restricted cash | $857.0 at February 28 | $1,019.9 at November 30 |
| Debt | $1,701.7 | $1,775.5 at November 30 |
| Debt / total capital | 76.8% | 73.8% at November 30 |
| Net debt / total capital | 62.1% | 54.5% at November 30 |
Home deliveries fell 28% to 949, while average selling price rose 4% to $205,700. Net orders declined 32% to 1,302; cancellations rose to 29% of gross orders from 22%. Backlog fell 38% year over year to 1,689 homes, representing approximately $353.6 of projected revenue.
Investing activities generated $79.9 of cash, principally from the $80.6 sale of a rental property. Financing activities used $80.9, including $70.5 of debt repayments. Operating cash use reflected the net loss, inventory investment and lower accrued liabilities. The prior-year operating cash inflow included a $190.7 federal tax refund, making the year-over-year cash flow comparison less favorable.
Material changes and unusual items
- South Edge-related charges drove much of the increased loss: a $53.7 noncash write-off of the remaining joint-venture investment and a $22.8 loss on loan guaranty.
- Following a court order for relief in South Edge’s involuntary bankruptcy, KB Home considered its Springing Guaranty obligation probable. The company estimated a potential payment of $211.8, including unpaid interest, and recognized a liability partly offset by an estimated $75.2 fair value for its share of South Edge land. The recorded accrued-liability line for the guaranty was $136.6. A further expense of up to $75 could arise if the company cannot realize value from its land interest.
- Inventory impairment and land-option abandonment charges totaled $1.8, versus $13.4 in Q1 2010. The company also recognized an $8.8 gain on sale of a rental property and a $3.6 gain from early extinguishment of secured debt.
- Financial-services pretax income decreased to $0.6 from $1.9, including a shift in the mortgage joint venture’s equity result from $1.3 income to $0.1 loss. Mortgage originations through KBA Mortgage declined to 598 loans from 1,042, and its share of KB Home buyers fell to 68% from 81%.
Outlook, risks and contingencies
Management expected challenging market conditions to continue through 2011. It anticipated sequentially higher deliveries, planned to expand community count and open new communities across its regions, and cited improving March traffic and orders. Management expected a negative year-over-year net-order comparison in April, but forecast positive monthly comparisons from May and a favorable full-year net-order comparison. These are expectations, not guaranteed results.
Management said it did not anticipate a net profit for fiscal 2011 because of the first-quarter impact, while stating that its operating strategy positioned it to achieve profitability at some point later in the year. No specific numeric revenue, delivery or earnings guidance was provided.
- The South Edge bankruptcy, guaranty demand, related lender litigation and appeal of a separate $36.8 arbitration award remain uncertain; outcomes could materially affect liquidity. The company said it would contest a guaranty demand but could not assure that defenses or offsets would succeed.
- KB Home reported $735.8 of cash and cash equivalents and said it believed liquidity would remain adequate even if it paid the estimated maximum guaranty amount. Restricted cash included $94.4 collateral for letter-of-credit facilities and $26.8 for a surety bond.
- Outstanding performance bonds were $440.6 and letters of credit were $93.4. Management did not expect a material amount of outstanding bonds or letters of credit to be called.
- Risks include weak employment and consumer confidence, unsold-home and foreclosure competition, mortgage-credit constraints, further price pressure, potential impairments, and changing land availability and costs. Management said it was in compliance with debt covenants; senior-note indentures had no financial maintenance covenants.
- The Bank of America partner sought to change its relationship in KBA Mortgage; discussions and alternative strategies were ongoing, while the venture continued to serve buyers.
- The company’s deferred-tax valuation allowance increased by $45.1 to $816.2; net deferred tax assets were $1.1. Management said its tax-loss benefits were not then subject to a Section 382 ownership-change limitation.
Most important facts for investors to verify
- Progress and final cash impact of the South Edge bankruptcy and Springing Guaranty, including the recoverable value of the land, possible additional expense and related litigation outcomes.
- Whether order trends, cancellation rates and backlog improve as management anticipated, and whether planned community openings translate into deliveries and stronger margins.
- Cash use, debt and leverage trends, and liquidity after restricted cash, debt maturities and any South Edge payment.
- Mortgage-service continuity and the financial and operational effect of any change to the KBA Mortgage relationship.
- Potential changes in warranty, construction-defect, drywall-related and other legal liabilities, as estimates and outcomes remain uncertain.