KB Home — Q3 2012 Form 10-Q
Reporting period: Three and nine months ended August 31, 2012. Amounts are in U.S. dollars; financial figures are generally in millions unless stated otherwise. Results are unaudited.
Business context and performance
KB Home builds and sells homes across four U.S. homebuilding regions and provides title, insurance, and mortgage-lender marketing services. Management described housing recovery as improving but uneven, with tight mortgage credit and economic uncertainty still limiting demand. The company continued shifting investment toward stronger, land-constrained markets, particularly in California and Texas.
Q3 housing activity improved year over year: 1,720 homes delivered, up 7%, at an average selling price of $245,100, up 8%. Net orders rose 3% to 1,900 despite 13% fewer communities open for sale. Quarter-end backlog increased 18% to 3,142 homes, with potential housing revenue up 33% to $744.7 million. The cancellation rate was 29%, unchanged year over year.
Key financial metrics
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Total revenue | $424.5 | $367.3 | $981.9 | $836.0 |
| Homebuilding operating income (loss) | $10.9 | $1.4 | $(35.8) | $(103.9) |
| Pretax income (loss) | $(7.4) | $(9.6) | $(81.5) | $(192.6) |
| Net income (loss) | $3.3 | $(9.6) | $(66.7) | $(192.7) |
| Diluted earnings (loss) per share | $0.04 | $(0.13) | $(0.86) | $(2.50) |
| Housing gross profit margin | 17.5% | 16.9% | 15.3% | 12.7% |
Q3 housing revenue rose 16%, reflecting more deliveries and higher average selling prices. The reported Q3 margin included a $16.5 million insurance recovery and $6.4 million of inventory impairments; excluding inventory impairments, the company reported a non-GAAP margin of 19.0%. Nine-month housing gross profit margin excluding impairment and land-option abandonment charges was 17.7%, versus 15.6% a year earlier.
For the first nine months, operating cash flow was negative $75.8 million, compared with negative $309.9 million a year earlier. Investing activities provided $1.8 million and financing activities provided $79.0 million; cash and cash equivalents increased $5.1 million. At quarter-end, unrestricted cash was $420.4 million and restricted cash was $46.1 million. Debt was $1.73 billion, up from $1.58 billion at November 30, 2011. Debt-to-total-capital was 82.3%, versus 78.2%; net debt-to-total-capital was 77.2%, versus 71.4% (the latter is non-GAAP). Stockholders’ equity was $372.4 million.
Material changes and unusual items
- Nine-month net loss narrowed substantially from 2011, when results included $53.7 million of South Edge joint-venture impairment and $37.3 million of loan-guaranty losses. Those items did not recur in 2012.
- 2012 results included $26.5 million of insurance recoveries over nine months, $11.2 million of favorable warranty adjustments, $22.9 million of inventory impairments, and an $8.8 million charge for an adverse court decision under appeal.
- Q3 net income included a $10.7 million tax benefit, primarily from resolution of a federal tax audit, and a $2.1 million gain related to the wind-down of KBA Mortgage. These helped offset an $8.3 million loss on early debt extinguishment.
- The company issued $350 million of 8.00% notes due 2020 and $350 million of 7.50% notes due 2022, using proceeds in part to repurchase earlier-maturing notes. It said the transactions extended maturities on $584.9 million of senior debt by more than five years. The next scheduled senior-note maturity was $76.0 million in 2014.
- The quarterly dividend was reduced from $0.0625 to $0.025 per share in 2012. No shares were repurchased during the nine-month period.
Outlook, risks, and contingencies
Management expected year-over-year improvement in Q4 deliveries, average selling price, housing gross margin, and SG&A as a percentage of housing revenue; it anticipated positive operating income for fiscal 2012 and profitability in Q4. These are expectations, not guarantees. The company expected 2012 land and land-development spending of approximately $550 million, after spending approximately $337 million in the first nine months, and expected community count to begin increasing in 2013. Management cited rising labor and materials costs, tight mortgage standards, distressed-home competition, uneven local markets, and constrained availability of desirable land as risks to recovery and margins.
Nationstar became the preferred mortgage lender and began accepting applications May 1, 2012. Management said this improved loan execution and backlog stability; it expected Nationstar to handle 70% of net-order buyers’ mortgage financing by fiscal year-end. The company said its longer-term intention was to establish a more integrated mortgage-banking joint venture.
Notable contingencies include Nevada development litigation, in which plaintiffs sought rescission or damages of $55 million plus unspecified punitive damages and more than $41 million in interest; KB Home said a possible loss could range from zero to the claimed damages, and trial was continued to January 2013. A global settlement concerning allegedly defective Chinese drywall had preliminary approval, with a fairness hearing scheduled for November 13, 2012; final approval and participation remained outstanding. The company also reported an $11.7 million accrual for the Estancia Coastal matter and said it had appealed the judgment.
Important facts for investors to verify
- Whether Q4 profitability and positive full-year operating income were achieved, and how much Q3 and nine-month earnings depended on insurance recoveries, tax benefits, and warranty adjustments.
- Whether backlog converts into deliveries and revenue, particularly given mortgage availability, cancellation levels, and the planned reliance on Nationstar.
- Whether projected land spending and community openings are realized without increasing leverage or impairments; inventory carrying values depend on uncertain market and sales assumptions.
- Debt maturity, refinancing capacity, and leverage: debt reached $1.73 billion and debt-to-total-capital rose to 82.3%.
- Developments in the Nevada and drywall litigation, insurance recoveries, and other warranty or construction-defect exposures.