KBH

KB Home (KBH) 10-Q Summary: Period Ended May 31, 2010

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended May 31, 2010, and the six months ended May 31, 2010. KB Home is a homebuilder operating in four geographic segments (West Coast, Southwest, Central, Southeast) and a financial services segment. The company operates in a challenging housing market characterized by weak economic conditions, high unemployment, and the expiration of the federal homebuyer tax credit on April 30, 2010.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Total revenues decreased 8% year-over-year for the six months ended May 31, 2010, and 3% for the three-month period. This was driven by lower average selling prices (down 5% and 4% respectively) and fewer homes delivered in the six-month period, though deliveries increased 1% in the quarter.
• Improved Loss Profile: Net loss narrowed significantly compared to the prior year periods ($85.4M vs. $136.5M for six months; $30.7M vs. $78.4M for three months). This improvement was primarily due to the absence of significant inventory impairment and land option contract abandonment charges in the current period, which totaled $81.8M in the prior year's six-month period.
• Margin Expansion: Housing gross margin improved to 17.7% in the quarter from 1.9% in the prior year quarter, driven by value-engineered product offerings and lower land cost bases from prior impairments.
• Backlog Reduction: Backlog decreased 17% year-over-year to 3,175 homes ($648.2M value), attributed to a 23% decline in net orders in the second quarter following the expiration of the federal tax credit.

Guidance, Outlook, and Risks

• Revised Guidance: Management revised its 2010 full-year delivery guidance to between 8,000 and 8,500 homes, down from the 8,488 homes delivered in 2009. The company now anticipates it may not achieve profitability until 2011, rather than the latter part of 2010 as previously forecasted.
• Strategic Focus: The company is pursuing a land acquisition strategy to secure a 3-to-4-year supply of lots, adding approximately 4,300 lots in the second quarter. The goal is to restore profitability through operational efficiency and revenue growth.
• Legal and Regulatory Risks:
  • SEC Investigation: The company is cooperating with an SEC investigation regarding possible accounting and disclosure issues related to inventory and joint venture impairments.
  • Drywall Litigation: The company faces lawsuits regarding allegedly defective drywall in homes delivered in Florida and Louisiana. A warranty liability of $17.7 million has been accrued for repairs.
  • ERISA Litigation: A settlement regarding a 401(k) plan fiduciary duty lawsuit was preliminarily approved by the court; the company deems it not material.
• Joint Venture Guarantees: The company has significant potential exposure under guarantees for unconsolidated joint ventures, including a "several guaranty" with a maximum potential responsibility of approximately $182.7 million if triggered by involuntary bankruptcy proceedings.

Investor Verification Checklist

• Impairment Charges: Verify the absence of inventory and land option abandonment charges in Q2 2010 compared to the significant charges in Q2 2009 to understand the volatility in net loss.
• Backlog Quality: Assess the 17% year-over-year decline in backlog and the 24% cancellation rate to gauge future revenue visibility.
• SEC Investigation Status: Monitor updates on the SEC investigation regarding accounting and disclosure issues, as the outcome remains uncertain.
• Joint Venture Exposure: Review the details of the $182.7 million potential liability under the several guaranty for unconsolidated joint ventures.
• Profitability Timeline: Note the management's shift in expectation regarding the return to profitability, now projected for 2011.