KB Home — Q1 2012 Form 10-Q
Business context and period. The filing covers the three months ended February 29, 2012, compared with the three months ended February 28, 2011. KB Home builds and sells homes across four U.S. reporting segments and provides related title, insurance, and mortgage-marketing services. Amounts below are in U.S. dollars; financial statement figures are generally in millions unless noted.
Key financial and operating metrics
| Metric | Q1 2012 | Q1 2011 / comparison |
|---|---|---|
| Total revenue | $254.6 million | $196.9 million; up 29% |
| Homes delivered / average selling price | 1,150 / $219,000 | 949 / $205,700 |
| Homebuilding operating loss | $31.1 million | $47.9 million loss |
| Pretax loss / net loss | $45.4 million / $45.8 million | $114.1 million / $114.5 million loss |
| Basic and diluted loss per share | $0.59 | $1.49 |
| Housing gross profit margin | 9.7%; 12.3% excluding impairment charges | 12.6%; 13.4% excluding impairment and land-option abandonment charges |
| SG&A as a percentage of housing revenue | 22.1% | 25.4% |
| Net cash used by operating activities | $109.6 million | $164.9 million |
| Cash and cash equivalents, including restricted cash | $368.1 million at Feb. 29 | $479.5 million at Nov. 30, 2011 |
| Mortgages and notes payable | $1.587 billion at Feb. 29 | $1.584 billion at Nov. 30, 2011 |
| Backlog | 2,203 homes; approximately $460.0 million | 1,689 homes; approximately $353.6 million at Feb. 28, 2011 |
Changes versus the prior comparable period
- Revenue rose 29%, reflecting 21% more deliveries and a 6% higher average selling price. Deliveries benefited from a substantially larger beginning-of-year backlog.
- Net orders fell 8% to 1,197; the cancellation rate increased to 36% from 29%. Management attributed much of the cancellation increase to mortgage-loan funding problems affecting some buyers. Backlog nevertheless increased 30% year over year.
- Housing gross profit margin declined, including on an adjusted basis, as fewer deliveries came from higher-margin communities and product mix changed. The $6.6 million of Q1 2012 inventory impairments also weighed on the reported margin.
- The net loss narrowed substantially. The prior-year quarter included a $53.7 million South Edge joint-venture impairment and a $22.8 million loan-guaranty loss; both were absent in Q1 2012. Q1 2012 instead included a $2.0 million loss on early debt extinguishment.
- Operating cash use improved year over year, primarily because less cash was invested in land and land development. Cash and cash equivalents plus restricted cash declined during the quarter.
Liquidity, debt, and unusual items
- Unrestricted cash was $304.2 million; restricted cash was $63.9 million, held as collateral for letters of credit. Stockholders’ equity was $393.9 million.
- Debt to total capital was 80.1%, up from 78.2% at November 30, 2011; net debt to total capital, a non-GAAP measure, was 75.6%, up from 71.4%.
- In February, KB Home issued $350 million of 8.00% senior notes due 2020 and used substantially all net proceeds to repurchase $340 million principal amount of notes due 2014 and 2015. Management said this extended the maturity of the repurchased debt by more than five years. The next scheduled public debt maturity was $193.4 million in 2014. The company reported compliance with applicable debt covenants.
- Q1 impairment charges were $6.6 million, associated with two communities. No land-option contract abandonment charges were recorded. Management said it expected generally stable or slightly improved sales pace for the remainder of 2012, but warned that adverse market changes could prompt further impairments.
- The company recorded an $18.3 million valuation allowance against deferred tax assets generated from the quarterly loss. The deferred-tax valuation allowance totaled $866.1 million; management stated realization of tax assets depends primarily on sustained profitability.
Outlook, management commentary, and risks
- Management expected gradual, uneven housing-market improvement, citing economic and consumer-confidence gains, high affordability, and low mortgage rates. It also highlighted oversupply, foreclosures and short sales, restrained demand, and tight mortgage lending standards.
- Management forecast year-over-year improvement in the second half of 2012 in deliveries, average selling price, gross margin, and SG&A ratio; it anticipated positive operating income for the year and profitability later in the year. These are forward-looking expectations, not guarantees.
- KB Home entered a preferred-lender agreement with Nationstar in March 2012 after MetLife announced it would stop offering forward mortgage banking. The transition was expected during Q2, with additional time needed for the relationship to mature. Management expected it to help address buyer loan-funding issues and cancellations.
- The company intended to manage fiscal 2012 toward a cash-neutral position and expected much of its land investment and community openings to be in California and Texas. It reported approximately $113 million of land and land-development investment in Q1.
- Material contingencies include Nevada development-contract litigation, for which plaintiffs seek rescission or, alternatively, $55 million plus unspecified punitive and other damages; KB Home said a loss could range from zero to the claimed damages and could be material. A separate California jury verdict was $9.8 million before legal fees and interest; the company accrued $2.9 million and estimated a possible loss range of $2.9 million to $13 million, including fees and interest.
- Construction-defect and other litigation liabilities totaled $99.6 million. The warranty liability was $64.6 million, including $3.9 million for remaining repairs on identified homes affected by allegedly defective Chinese drywall. The company had 11 related lawsuits and had not recorded potential recoveries from suppliers or insurers.
- Other risks include future inventory impairments, housing and credit-market weakness, debt-market access, construction costs and labor availability, warranty claims, litigation outcomes, and the ability to realize deferred tax assets. Management stated disclosure controls were effective and there were no material changes to internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether Nationstar’s transition improves mortgage funding outcomes and reduces cancellations from the reported 36% rate.
- Whether backlog converts into deliveries and revenue, and whether margins improve despite the lower Q1 adjusted gross margin.
- Whether operating cash use and land investment align with management’s cash-neutral objective and liquidity needs.
- Debt maturity, refinancing capacity, leverage trends, and compliance with debt restrictions as losses continue.
- Potential inventory write-downs and the assumptions supporting recoverability of the $1.748 billion inventory balance.
- Developments in the Nevada and California cases, drywall-related claims, and adequacy of recorded litigation and warranty reserves.
- Whether the company can generate sustained taxable profits to support realization of deferred tax assets.