KB Home — FY2010 Form 10-K Summary
Business context and reporting period
KB Home is a U.S. homebuilder operating in nine states through four homebuilding segments, with a small financial-services business providing title and insurance services and mortgage banking through a joint venture. This filing covers the fiscal year ended November 30, 2010; comparisons are primarily with FY2009. Homebuilding contributed 99.5% of revenue.
Financial and operating metrics
| Metric | FY2010 | FY2009 |
|---|---|---|
| Total revenue | $1.590 billion | $1.825 billion |
| Net loss | $69.4 million; $0.90 per diluted share | $101.8 million; $1.33 per diluted share |
| Homebuilding operating loss | $16.0 million | $236.5 million |
| Housing gross margin | 17.4% | 6.5% |
| Housing gross margin excluding impairment and land-option abandonment charges (non-GAAP) | 18.6% | 15.5% |
| Homes delivered / average selling price | 7,346 / $214,500 | 8,488 / $207,100 |
| Net orders / cancellation rate | 6,556 / 28% | 8,341 / 25% |
| Year-end backlog | 1,336 homes; $263.8 million potential housing revenue | 2,126 homes; $422.5 million |
| Cash, cash equivalents and restricted cash | $1.020 billion | $1.289 billion |
| Debt / stockholders’ equity | $1.776 billion / $631.9 million | $1.820 billion / $707.2 million |
Operating activities used $134.0 million of cash in FY2010, versus providing $349.9 million in FY2009. The 2010 use reflected inventory investment and reductions in payables and accrued liabilities; cash from a $190.7 million federal tax refund partly offset these uses. Investing activities used $16.1 million and financing activities used $119.5 million. Debt-to-total-capital was 73.8% (72.0% in 2009); net-debt-to-total-capital, a non-GAAP measure, was 54.5% (42.9%). The company terminated its $650 million revolving credit facility in March 2010; it reported $87.5 million of letters of credit outstanding, collateralized by $88.7 million of restricted cash.
Material changes versus FY2009
- Revenue declined 13%, principally as deliveries fell 13%; a 4% rise in average selling price partly offset lower volume.
- Net loss narrowed 32%, and homebuilding operating loss improved substantially. Homebuilding generated operating income in each of the final two quarters; Q4 pretax income was $15.4 million and net income was $17.4 million.
- Gross margin rose markedly, supported by lower direct construction costs, operating efficiencies, improved product mix, and reduced inventory impairment and land-option abandonment charges. Those charges totaled $19.9 million in 2010 versus $168.1 million in 2009.
- Orders fell 21%; year-end backlog declined 37%. The fourth-quarter cancellation rate increased to 37% from 31% a year earlier.
- Inventory increased 13% to $1.697 billion amid targeted land acquisitions; owned or controlled lots rose to 39,540 from 37,465. Cash declined, and net leverage increased despite lower reported debt.
Outlook, commentary, risks and unusual items
Management expected housing markets to remain weak and results uneven in 2011, and cautioned that FY2010 margin and earnings improvement might not continue. Its priorities were restoring homebuilding profitability, generating cash and maintaining a strong balance sheet, and positioning for growth. Plans included increasing owned or controlled lots, opening approximately 70 communities in the first half of 2011, and targeting an approximately 25% increase in average active communities versus FY2010. These plans were subject to market conditions, land availability and sales performance; the filing did not provide earnings or revenue guidance.
- Management cited oversupply, foreclosures and short sales, weak employment and consumer confidence, tighter mortgage standards, reduced credit availability, intense competition, and expiration of the federal homebuyer tax credit as continuing headwinds.
- South Edge litigation is a significant contingency. KB Home disclosed a potential maximum responsibility of approximately $180 million of principal under a springing repayment guaranty, plus potentially significant interest and legal fees; defenses, offsets and the ultimate outcome were uncertain. South Edge’s loan principal was about $328 million at year-end.
- The company had $1.1 million of net deferred tax assets after a $771.1 million valuation allowance; realization depends on future taxable income. Potential Section 382 ownership-change limits could restrict use of tax benefits.
- Warranty exposure included $11.3 million accrued for approximately 296 Florida homes identified or suspected of containing allegedly defective Chinese drywall. The company faced nine related lawsuits and said further costs were possible.
- Other significant exposures include inventory impairment, land-option abandonment, warranty and construction-defect claims, joint-venture guarantees, regulatory and environmental requirements, and refinancing or liquidity risk. Total debt maturities included $204.3 million due in 2011; the company reported compliance with debt covenants at year-end.
- The 2010 tax benefit was $7.0 million; the FY2009 comparison included a $209.4 million benefit, primarily related to NOL carrybacks. These tax effects make year-to-year net-loss comparisons less representative of operating performance.
Most important facts for investors to verify
- Whether FY2011 community openings, lot additions and the targeted 25% increase in average active communities translated into orders, deliveries and cash generation.
- Whether margin gains persist after separating underlying housing margins from impairment charges, prior write-down effects and product or geographic mix.
- Backlog quality and conversion, cancellation trends, mortgage availability, and the impact of foreclosure and short-sale competition.
- Cash needs, debt maturities and refinancing access following termination of the revolving facility; also monitor restricted cash and rising net leverage.
- Developments in South Edge proceedings and any resulting guaranty payments, additional litigation exposure or joint-venture funding requirements.
- Future inventory write-downs and land-option charges, and the support for management’s assumptions in valuing inventory and deferred tax assets.