UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
ý ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended November 30, 2013
or
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .
Commission File No. 001-09195
KB HOME
(Exact name of registrant as specified in its charter)
Delaware | 95-3666267 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
10990 Wilshire Boulevard, Los Angeles, California 90024
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code: (310) 231-4000
Securities Registered Pursuant to Section 12(b) of the Act:
Title of each class | Name of each exchange on which registered |
Common Stock (par value $1.00 per share) | New York Stock Exchange |
Rights to Purchase Series A Participating Cumulative Preferred Stock | New York Stock Exchange |
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ý No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No ý
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ý Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ý
The aggregate market value of voting stock held by non-affiliates of the registrant on May 31, 2013 was $2,089,096,838, including 10,559,844 shares held by the registrant’s grantor stock ownership trust and excluding 21,017,450 shares held in treasury.
There were 83,744,528 shares of the registrant’s common stock, par value $1.00 per share, outstanding on December 31, 2013. The registrant’s grantor stock ownership trust held an additional 10,501,844 shares of the registrant’s common stock on that date.
Documents Incorporated by Reference
Portions of the registrant’s definitive Proxy Statement for the 2014 Annual Meeting of Stockholders (incorporated into Part III).
KB HOME
FORM 10-K
FOR THE YEAR ENDED NOVEMBER 30, 2013
TABLE OF CONTENTS
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Item 1. | ||
Item 1A. | ||
Item 1B. | ||
Item 2. | ||
Item 3. | ||
Item 4. | ||
Item 5. | ||
Item 6. | ||
Item 7. | ||
Item 7A. | ||
Item 8. | ||
Item 9. | ||
Item 9A. | ||
Item 9B. | ||
Item 10. | ||
Item 11. | ||
Item 12. | ||
Item 13. | ||
Item 14. | ||
Item 15. | ||
PART I
Item 1. | BUSINESS |
General
KB Home is one of the largest and most recognized homebuilding companies in the U.S. and has been building homes for more than 50 years. We construct and sell homes through our operating divisions under the name KB Home. Unless the context indicates otherwise, the terms “we,” “our” and “us” used in this report refer to KB Home, a Delaware corporation, and its predecessors and subsidiaries.
Beginning in 1957 and continuing until 1986, our business was conducted by various subsidiaries of Kaufman and Broad, Inc. (“KBI”) and its predecessors. In 1986, KBI transferred all of its homebuilding and mortgage banking operations to us. Shortly after the transfer, we completed an initial public offering of 8% of our common stock and began operating under the name Kaufman and Broad Home Corporation. In 1989, we were spun-off from KBI, which then changed its name to Broad Inc., and we became an independent public company, operating primarily in California and France. In 2001, we changed our name to KB Home. Today, having sold our French operations in 2007, we operate a homebuilding and financial services business serving homebuyers in various markets across the U.S.
Our homebuilding operations offer a variety of new homes designed primarily for first-time, move-up and active adult homebuyers, including attached and detached single-family residential homes, townhomes and condominiums. We offer homes in development communities, at urban in-fill locations and as part of mixed-use projects. In this report, we use the term “home” to refer to a single-family residence, whether it is a single-family home or other type of residential property, and we use the term “community” to refer to a single development in which homes are constructed as part of an integrated plan.
Through our four homebuilding reporting segments, we delivered 7,145 homes at an average selling price of $291,700 during the year ended November 30, 2013, compared to 6,282 homes delivered at an average selling price of $246,500 during the year ended November 30, 2012. Our homebuilding operations represent most of our business, accounting for 99.4% of our total revenues in 2013 and 99.3% of our total revenues in 2012.
Our financial services reporting segment offers property and casualty insurance and, in certain instances, earthquake, flood and personal property insurance to our homebuyers in the same markets where we build homes and provides title services in the majority of our markets located within our Central and Southeast homebuilding reporting segments. In addition, since the third quarter of 2011, this segment has earned revenues pursuant to the terms of a marketing services agreement with a preferred mortgage lender that offers mortgage banking services, including mortgage loan originations, to our homebuyers. Our financial services operations accounted for .6% of our total revenues in 2013 and .7% of our total revenues in 2012.
In the year ended November 30, 2013, we generated total revenues of $2.10 billion and net income of $40.0 million, compared to total revenues of $1.56 billion and a net loss of $59.0 million in the year ended November 30, 2012.
Our principal executive offices are located at 10990 Wilshire Boulevard, Los Angeles, California 90024. The telephone number of our corporate headquarters is (310) 231-4000 and our primary website address is www.kbhome.com. In addition, community location and information is available at (888) KB-HOMES.
Markets
Reflecting the geographic reach of our homebuilding business, as of the date of this report, our ongoing principal operations are in the 10 states and 40 major markets presented below. We also operate in various submarkets within these major markets. From time to time, we refer to these markets and submarkets collectively as our “served markets.” For reporting purposes, we organize our homebuilding operations into four segments — West Coast, Southwest, Central and Southeast.
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Segment | State(s) | Major Market(s) | ||
West Coast | California | Contra Costa County, Fresno, Los Angeles, Madera, Oakland, Orange County, Riverside, Sacramento, San Bernardino, San Diego, San Francisco, San Jose, Santa Rosa-Petaluma, Stockton, Vallejo, Ventura and Yuba City | ||
Southwest | Arizona | Phoenix and Tucson | ||
Nevada | Las Vegas and Reno | |||
New Mexico | Albuquerque | |||
Central | Colorado | Denver | ||
Texas | Austin, Dallas, Fort Worth, Houston and San Antonio | |||
Southeast | Florida | Daytona Beach, Jacksonville, Lakeland, Orlando, Palm Coast, Punta Gorda, Sarasota, Sebastian-Vero Beach and Tampa | ||
Maryland | Rockville | |||
North Carolina | Raleigh | |||
Virginia | Washington, D.C. | |||
Segment Operating Information. The following table presents certain operating information for our homebuilding reporting segments for the years ended November 30, 2013, 2012 and 2011:
Years Ended November 30, | |||||||||||
2013 | 2012 | 2011 | |||||||||
West Coast: | |||||||||||
Homes delivered | 2,179 | 1,945 | 1,757 | ||||||||
Percentage of total homes delivered | 31 | % | 31 | % | 30 | % | |||||
Average selling price | $ | 467,800 | $ | 388,300 | $ | 335,500 | |||||
Total revenues (in millions) (a) | $ | 1,020.2 | $ | 755.3 | $ | 589.4 | |||||
Southwest: | |||||||||||
Homes delivered | 738 | 683 | 843 | ||||||||
Percentage of total homes delivered | 10 | % | 11 | % | 15 | % | |||||
Average selling price | $ | 237,500 | $ | 193,900 | $ | 165,800 | |||||
Total revenues (in millions) (a) | $ | 175.3 | $ | 132.4 | $ | 139.9 | |||||
Central: | |||||||||||
Homes delivered | 2,841 | 2,566 | 2,155 | ||||||||
Percentage of total homes delivered | 40 | % | 41 | % | 37 | % | |||||
Average selling price | $ | 198,900 | $ | 170,100 | $ | 171,500 | |||||
Total revenues (in millions) (a) | $ | 565.1 | $ | 436.4 | $ | 369.7 | |||||
Southeast: | |||||||||||
Homes delivered | 1,387 | 1,088 | 1,057 | ||||||||
Percentage of total homes delivered | 19 | % | 17 | % | 18 | % | |||||
Average selling price | $ | 233,900 | $ | 206,200 | $ | 195,500 | |||||
Total revenues (in millions) | $ | 324.4 | $ | 224.3 | $ | 206.6 | |||||
Total: | |||||||||||
Homes delivered | 7,145 | 6,282 | 5,812 | ||||||||
Average selling price | $ | 291,700 | $ | 246,500 | $ | 224,600 | |||||
Total revenues (in millions) (a) | $ | 2,085.0 | $ | 1,548.4 | $ | 1,305.6 | |||||
(a) | Total revenues include revenues from housing and land sales. |
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Unconsolidated Joint Ventures. The above table does not include homes delivered or revenues from unconsolidated joint ventures in which we participate. These unconsolidated joint ventures acquire and develop land in various markets where our homebuilding operations are located and, in some cases, build and deliver homes on the land developed.
Strategy
Since 1997, we have followed the principles of an operational business model that we call KBnxt. KBnxt provides the core framework under which we have established the primary operational and strategic goals for our homebuilding business. We believe the principles of KBnxt set us apart from other large-production homebuilders and provide the foundation for our long-term growth.
KBnxt. With KBnxt, we seek to generate improved operating efficiencies and return on investment through a disciplined, fact-based and process-driven approach to homebuilding that is founded on a constant and systematic assessment of consumer preferences and market opportunities. The key principles of KBnxt include the following:
• | gaining a detailed understanding of consumer location and home design and interior/exterior design option preferences through regular surveys and research. In this report and elsewhere, we refer to our home designs and design options as our “products;” |
• | managing our working capital and reducing our operating risks by acquiring primarily developed and entitled land at reasonable prices in preferred markets and submarkets that meet our investment return standards and market positioning (or “marketing”) strategy; |
• | using our knowledge of consumer preferences to design, offer, construct and deliver products that meet the desires of the largest demographic of homebuyers in our served markets. Historically, this demographic has been comprised of first-time and move-up buyers; |
• | in general, commencing construction of a home only after a purchase contract has been signed and preliminary credit approval or other evidence of financial ability to purchase the home has been obtained; |
• | building a backlog of orders and minimizing the cycle time from initial construction to delivery of homes to customers; |
• | establishing an even flow production of high-quality homes at the lowest possible cost; and |
• | offering customers affordable base prices and the opportunity to customize their homes through the choice of lot location within a community, as well as choices of various elevations and floor plans and numerous design options available at our KB Home Studios. |
While we consider KBnxt to be integral to our success in the homebuilding industry, there can be market-driven circumstances where we believe it is necessary or appropriate to temporarily deviate from certain of its principles. For example, at times we may be unable to maintain an even flow production of homes in a particular area because of slow net order activity. Also, in specific targeted communities with strong demand, we may start construction on a small number of homes before a corresponding purchase contract is signed to more quickly meet the delivery expectations of homebuyers and generate revenues. In some land constrained submarkets, or in submarkets experiencing significant homebuilding activity, we may acquire undeveloped or unentitled land parcels that otherwise fit with our marketing strategy and meet our investment return standards. Other circumstances may arise in the future that lead us to make specific short-term shifts from the principles of KBnxt.
Strategic and Operational Focus. Guided by KBnxt, over the last few years we have broadly transformed the scope, scale and orientation of our business both geographically and operationally, compared to where it stood prior to the severe and prolonged housing market downturn that began in mid-2006. We did this largely by focusing on three integrated strategic goals:
• | achieving and maintaining profitability at the scale of prevailing market conditions; |
• | generating cash and strengthening our balance sheet; and |
• | positioning our business to capitalize on future growth opportunities. |
In executing on these strategic goals, we shifted resources from underperforming areas to markets and submarkets offering perceived higher growth prospects, particularly land constrained locations in coastal areas of California, in order to maintain a solid growth platform; implemented measures to generate and conserve cash and bolster our balance sheet, including reduced spending, asset sales, opportunistic capital market transactions, and continuous efforts to improve our operating efficiencies and lower our overhead costs; and redesigned and re-engineered our products. Although we generally experienced declines in net
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orders and revenues, and generated losses during this period, we believe our actions since the onset of the housing downturn have strengthened our ability to adapt to changing housing market dynamics and positioned us well for future growth.
In 2013, we saw continued progress in the housing recovery that had begun to take shape in 2012, and we shifted our priorities to focus on improving profitability per home delivered and generating revenue growth within our current operational footprint through a number of strategic growth initiatives that are discussed below under “Part II — Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” As in 2012, we aggressively invested in land and land development and continued to evolve our community mix toward higher-performing, desirable locations in land constrained growth markets and our product offerings to meet changing consumer preferences. Increasing profitability per home delivered and executing on operational measures to grow revenues will continue to be our top priorities in 2014 as we seek to improve on our performance for 2013.
Based on our expectation that the healthier housing environment of the past two years will generally continue in 2014, we intend to pursue the following operational objectives, subject to conditions in the housing markets, the overall economy and the capital, credit and financial markets:
• | Active and Targeted Land Investment: Owning or controlling a forecasted three-to-five year base supply of developed or developable land subject to our investment return and marketing standards, and accelerating our land development activities, predominantly in high-performing, choice locations. We invested approximately $1.14 billion in land and land development in 2013 and approximately $565 million in 2012. This investment orientation yielded improved year-over-year results in 2013, contributing to higher revenues, average selling prices and housing gross profit margins. This was particularly the case in our West Coast homebuilding reporting segment, where our ongoing investment concentration toward coastal submarkets in California has positioned us to open new home communities for sales in 2014 in areas and with products that we believe will appeal to more affluent buyers who desire larger homes and purchase more design options and features at our KB Home Studios. |
In addition, we are pursuing opportunities to activate certain inventory previously held for future development in markets where improved conditions support such action. In 2012, we identified 21 communities for activation, primarily in Florida and Arizona, representing more than 1,000 lots, and delivered 293 homes from these communities in 2013. In 2013, we identified 20 communities for activation, primarily in California and Texas, representing approximately 1,700 lots. We expect to deliver homes and to realize the associated revenues from these activated assets in 2014.
Our community count at November 30, 2013 increased to 191 from 172 at November 30, 2012, largely as a result of the investments in land and land development we have made over the last few years. We use the term “community count” to refer to the number of new home communities with at least five homes/lots left to sell at the end of a reporting period.
• | Net Order Growth: Optimizing our assets by increasing revenues per new home community open for sales through an intense focus on balancing sales pace and selling prices. In addition, expanding our overall average selling price with, among other things, incremental gains from lot location, floor plan, home exterior elevation, structural and other premiums and additional sales of design options. Our approach is simple — provide the best combination of value, quality and choice in homes and design options in attractive locations along with attentive service to our customers — and is at the core of our distinct Built to Order™ homebuying experience. With Built to Order, we offer homebuyers affordable base prices and, unlike many other large-production homebuilders, the opportunity to significantly customize the floor plans and design options for their new home. |
• | Organizational and Production Efficiency: Continuously enhancing our performance and taking steps to improve our housing gross profit margins by aligning our management resources, personnel levels and overhead costs with our growth platform, home delivery expectations and business needs, and by streamlining and constantly improving, to the extent possible, our home construction process and operational activities. In addition to even flow production scheduling, our home construction process includes developing and refining a set of value-engineered home designs in ways that allow us to meet the needs of our primary customer base in a variety of different markets, shorten cycle times and lower direct construction costs. It also includes taking advantage of economies of scale in contracting for building materials and skilled trade labor, and leveraging our organizational infrastructure in our served markets. |
Promotional Marketing Strategy. Our promotional marketing efforts are centered on differentiating the KB Home brand in the minds of our primary customer base from resale homes and from new homes sold by other homebuilders. These efforts increasingly involve using interactive Internet-based applications, social media outlets and other evolving communications technologies. We believe that our Built to Order message and experience generate a high perceived value for our products and our company among consumers and real estate professionals, and are unique among large-production homebuilders. In marketing our Built to Order approach, we emphasize how we partner with our homebuyers to create a home built to their individual preferences in design, floor plan, elevation, square footage and lot location, and give them the ability to significantly customize their home
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with structural and design options that suit their needs and interests. In essence, Built to Order serves as the consumer face of core elements of KBnxt and is designed to ensure that our promotional marketing strategy and advertising campaigns are closely aligned with our overall operational focus. For greater consistency within our promotional marketing messages and in the execution of our Built to Order approach, the selling of our homes is carried out by in-house teams of sales representatives, design consultants and other personnel who work personally with each homebuyer to create a home that meets the homebuyer’s preferences and budget. In 2013, to further enhance our sales process, we began implementing a new design for our sales offices at communities we opened for sales during the year, reflecting a more contemporary look and technology to better engage with our homebuyers. We plan to continue to implement the new design for our sales offices in 2014.
Our KB Home Studios are a key component of the Built to Order experience we offer to our homebuyers and help increase the revenues we generate from home sales. These showrooms, which are generally centrally located within our market geographies, allow our homebuyers to customize their home by selecting from a wide variety of design options that are available at no-cost or for purchase as part of the original construction of their home. The coordinated efforts of our sales representatives and KB Home Studio consultants are intended to generate higher customer satisfaction and lead to enhanced customer retention and referrals.
Sustainability. We have made a dedicated effort to further differentiate ourselves from other homebuilders and resale homes through our ongoing commitment to become a leading national company in environmental sustainability. Under this commitment, we:
• | refine our products and construction process to limit the materials needed to build our homes, and continuously look at ways to reduce construction and office waste; |
• | build all of our new homes to the U.S. Environmental Protection Agency’s (“EPA”) ENERGY STAR® Version 3 standards; |
• | build an increasing percentage of our homes to meet the U.S. EPA’s Watersense® specifications for water use efficiency; |
• | build our homes with Watersense labeled fixtures; |
• | seek out and utilize innovative technologies and systems to further improve the energy and water efficiency of our homes; |
• | engage in campaigns and other educational efforts, sometimes together with other organizations and groups, to increase consumer awareness of the importance and impact of sustainability in selecting a home and the products within a home; |
• | developed an Energy Performance Guide®, or EPG®, that informs our homebuyers of the relative energy efficiency and the related estimated monthly energy costs and potential energy cost savings of each of our homes as designed, compared to typical new and existing homes; and |
• | created and are adding more net-zero energy design options, under a program called ZeroHouse 2.0™, that are available in select markets. |
This commitment and the related initiatives we have implemented stem, in part, from growing sensitivities and regulatory attention to the potential impact that the construction and use of homes can have on the environment, including on the consumption of energy and water resources. They also reflect our efforts to balance these concerns with our homebuyers’ interest in affordable homes and in lowering their utility bills and total cost of homeownership on a long-term basis. More information about our sustainability commitment can be found in our annual sustainability reports, which we have published on our website since 2008. To date, we are the only national homebuilder to publish a comprehensive annual sustainability report. As we see environmental issues related to housing becoming increasingly important to consumers and government authorities at all levels, we intend to continue to research, evaluate and utilize new or improved products and construction and business practices consistent with our commitment. In addition to making good business sense, we believe our sustainability initiatives can help put us in a better position, compared to resale homes and homebuilders with less-developed programs, to comply with evolving local, state and federal rules and regulations intended to protect natural resources and to address climate change and similar environmental concerns.
Customer Service and Quality Control
Our goal is for our customers to be 100% satisfied with their new homes. Our on-site construction supervisors perform regular pre-closing quality checks and our sales representatives maintain regular contact with our homebuyers during the home construction process in an effort to ensure our homes meet our standards and our homebuyers’ expectations. We believe our prompt and courteous responses to homebuyers’ needs throughout the homebuying process help reduce post-closing repair costs, enhance our reputation for quality and service, and help encourage repeat and referral business from homebuyers and the real estate community. We also have employees who are responsible for responding to homebuyers’ post-closing needs, including warranty claims.
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We provide a limited warranty on all of our homes. The specific terms and conditions vary depending on the markets where we do business. We generally provide a structural warranty of 10 years, a warranty on electrical, heating, cooling, plumbing and certain other building systems each varying from two to five years based on geographic market and state law, and a warranty of one year for other components of a home.
Local Expertise
To maximize KBnxt’s effectiveness and help ensure its consistent execution, our employees are continuously trained on KBnxt principles and are evaluated, in part, based on their achievement of relevant operational objectives. We also believe that our business requires in-depth knowledge of local markets in order to acquire land in preferred locations consistent with our investment return and marketing standards and on favorable terms, to engage subcontractors, to develop new home communities and offer products that meet local demand, to anticipate consumer tastes in specific markets, and to assess local regulatory environments. Accordingly, we operate our business through divisions with experienced management teams and trained personnel who have local market expertise. Though we centralize certain functions (such as promotional marketing, legal, purchasing administration, product development, architecture and accounting) to benefit from economies of scale, our local management exercises considerable autonomy in identifying land acquisition opportunities, developing and implementing product and sales strategies, and controlling costs.
Community Development and Land Inventory Management
Our community development process generally consists of four phases: land acquisition, land development, home construction and delivery of completed homes. Historically, our community development process has ranged from six to 24 months in our West Coast homebuilding reporting segment, with a somewhat shorter duration in our other homebuilding reporting segments. The community development process varies based on, among other things, the extent of government approvals required, the overall size of a particular community, necessary site preparation activities, the type of product(s) that will be offered, weather conditions, promotional marketing results, consumer demand and local and general economic and housing market conditions.
Although they vary significantly in size and complexity, our new home communities typically consist of 30 to 250 lots ranging in size from 1,900 to 20,000 square feet. In our communities, we typically offer from three to 15 home design choices. We also generally build one to three model homes at each community so that prospective buyers can preview various products available. Depending on the community, we may offer premium lots containing more square footage, better views and/or location benefits. A few of our communities consist of a single multiple-story structure that encompasses several attached condominium-style units.
The following table summarizes our average community count by homebuilding reporting segment:
For the Years Ended November 30, | West Coast | Southwest | Central | Southeast | Total | ||||||||||
2013 | 41 | 18 | 82 | 41 | 182 | ||||||||||
2012 | 53 | 14 | 81 | 32 | 180 | ||||||||||
Land Acquisition and Land Development. We continuously evaluate land acquisition opportunities against our investment return and marketing standards, balancing competing needs for financial strength, liquidity and land inventory for future growth. In many cases, we are able to leverage our long-standing business relationships and reputation with local land sellers, our financial resources and our steady operating history to secure opportunities ahead of other homebuilders, developers or investors. When we acquire land, we generally focus on land parcels containing fewer than 250 lots that are fully entitled for residential construction and are either physically developed to start home construction (referred to as “finished lots”) or partially finished. Acquiring finished or partially finished lots enables us to construct and deliver homes with minimal additional development work or expenditures. We believe this is a more efficient way to use our working capital and reduces the operating risks associated with having to develop and/or entitle land, such as unforeseen improvement costs and/or changes in market conditions. However, depending on market conditions and available opportunities, including opportunities to secure certain finished lots or property in land constrained or very active submarkets, we may acquire undeveloped and/or unentitled land. We may also invest in projects that require us to re-purpose and re-entitle property for residential use, such as in-fill developments. We expect that the overall balance of undeveloped, unentitled, entitled, partially finished and finished lots in our inventory will vary over time, and in implementing our strategic growth initiatives, we may acquire a greater proportion of undeveloped or unentitled land in the future.
Consistent with KBnxt, we target geographic areas for potential land acquisitions and community development based on the results of periodic surveys of both new and resale homebuyers in particular markets, prevailing local economic conditions, the supply and type of homes available for sale, and other research activities. Local, in-house land acquisition specialists analyze specific geographic areas to identify desirable land acquisition targets or to evaluate whether to dispose of an existing land interest.
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We also use studies performed by third-party specialists. Using this internal and external data, some of the factors we consider in evaluating land acquisition targets are consumer preferences; general economic conditions; prevailing and expected home sales activity and the selling prices and pricing trends of comparable new and resale homes in the subject submarket; proximity to metropolitan areas and employment centers; population, household formation, demographic, and employment and commercial growth patterns; household income levels; availability of developable land parcels at reasonable cost, including estimated costs of completing land development and selling homes; our operational scale and experience in the subject submarket; and regulatory and environmental compliance matters.
We generally structure our land acquisition and land development activities to minimize, or to defer the timing of, expenditures, which improves our returns associated with land-related investments. While we use a variety of techniques to accomplish this, we typically use contracts that give us an option or similar right to acquire land at a future date, usually at a pre-determined price and for a small initial option or earnest money deposit payment. These contracts may also permit us to partially develop the underlying land prior to our acquisition and/or condition our acquisition obligation on our satisfaction with the feasibility of developing the subject land and selling homes on the land by a certain future date. We refer to land subject to such option or similar rights as being “controlled.” Our decision to exercise a particular land option or similar right is based on the results of due diligence and continued market viability analysis we conduct after entering into such a contract. In some cases, our decision to exercise a land option or similar right may be conditioned on the land seller obtaining necessary entitlements, such as zoning rights and environmental and development approvals, and/or physically developing the underlying land by a pre-determined date.
Our land option contracts and other similar contracts may also allow us to phase our land acquisitions and/or land development over a period of time and/or upon the satisfaction of certain conditions. We may also acquire land with seller financing that is non-recourse to us, or by working in conjunction with third-party land developers or other parties. The use of these land option contracts and other similar contracts generally allows us to reduce the market risks associated with direct land ownership and development, and to reduce our capital and financial commitments, including interest and other carrying costs.
Our land option contracts and other similar contracts generally do not contain provisions requiring our specific performance. However, depending on the circumstances, our initial option or earnest money deposit may or may not be refundable to us if we abandon the related land option contract or other similar contract and do not complete the acquisition of the underlying land. In addition, if we abandon a land option contract or other similar contract, we usually cannot recover the pre-acquisition costs we incurred after we entered into the contract, including those related to our due diligence and other evaluation activities and/or partial development of the subject land, if any.
Before we commit to any land acquisition, our senior corporate and regional management evaluate the asset based on the results of our local specialists’ due diligence, third-party data and a set of defined financial measures, including, but not limited to, housing gross profit margin analyses and specific discounted, after-tax cash flow internal rate of return requirements. The criteria guiding our land acquisition and disposition decisions have resulted in our maintaining inventory in areas that we believe generally offer better returns for lower risk and lower our upfront investment in inventory.
Our inventories include land we are holding for future development, which is comprised of land where we have suspended development activity or development has not yet begun but is expected to occur in the future. These assets held for future development are located in various submarkets where conditions do not presently support further investment or development, or are subject to a building permit moratorium or regulatory restrictions, or are portions of larger land parcels that we plan to build out over several years and/or that have not yet been entitled and, therefore, have an extended development timeline. We may also suspend development activity if we believe it will result in greater returns and/or maximize the economic performance of a community by delaying improvements for a period of time to allow earlier phases of a long-term, multi-phase community or a neighboring community to generate sales momentum or for market conditions to improve. We resume development activity when we believe our investment in this inventory will be optimized or, in some instances, to accelerate sales pace and/or our return on investment, and we have activated assets previously held for future development in certain markets as part of our strategic growth initiatives.
The following table presents the number of inventory lots we owned, in various stages of development, or controlled under land option contracts or other similar contracts by homebuilding reporting segment as of November 30, 2013 and 2012. The table does not include approximately 10 acres we owned as of November 30, 2013 and approximately 326 acres we owned as of November 30, 2012 that were not expected to be approved for subdivision into lots in the respective period.
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Homes Under Construction and Land Under Development | Land Held for Future Development | Land Under Option | Total Land Owned or Under Option | ||||||||||||||||||||
2013 | 2012 | 2013 | 2012 | 2013 | 2012 | 2013 | 2012 | ||||||||||||||||
West Coast | 4,414 | 2,899 | 3,348 | 3,936 | 4,850 | 3,613 | 12,612 | 10,448 | |||||||||||||||
Southwest | 2,318 | 1,275 | 7,552 | 7,743 | 2,347 | 534 | 12,217 | 9,552 | |||||||||||||||
Central | 10,873 | 7,859 | 1,451 | 2,055 | 10,482 | 4,612 | 22,806 | 14,526 | |||||||||||||||
Southeast | 3,734 | 1,922 | 4,665 | 4,934 | 5,061 | 3,370 | 13,460 | 10,226 | |||||||||||||||
Total | 21,339 | 13,955 | 17,016 | 18,668 | 22,740 | 12,129 | 61,095 | 44,752 | |||||||||||||||
Reflecting our geographic diversity and relatively balanced operational footprint, as of November 30, 2013, 21% of the inventory lots we owned or controlled were located in our West Coast homebuilding reporting segment, 20% were in our Southwest homebuilding reporting segment, 37% were in our Central homebuilding reporting segment and 22% were in our Southeast homebuilding reporting segment.
The following table presents the carrying value of inventory we owned, in various stages of development, or controlled under land option contracts or other similar contracts by homebuilding reporting segment as of November 30, 2013 and 2012 (in thousands):
Homes Under Construction and Land Under Development | Land Held for Future Development | Land Under Option | Total Land Owned or Under Option | ||||||||||||||||||||||||||||
2013 | 2012 | 2013 | 2012 | 2013 | 2012 | 2013 | 2012 | ||||||||||||||||||||||||
West Coast | $ | 797,540 | $ | 471,650 | $ | 297,420 | $ | 337,229 | $ | 49,224 | $ | 33,718 | $ | 1,144,184 | $ | 842,597 | |||||||||||||||
Southwest | 141,153 | 63,456 | 157,924 | 156,159 | 5,162 | 1,830 | 304,239 | 221,445 | |||||||||||||||||||||||
Central | 383,210 | 292,475 | 15,193 | 21,806 | 12,673 | 5,443 | 411,076 | 319,724 | |||||||||||||||||||||||
Southeast | 265,708 | 154,992 | 158,992 | 153,661 | 14,378 | 14,152 | 439,078 | 322,805 | |||||||||||||||||||||||
Total | $ | 1,587,611 | $ | 982,573 | $ | 629,529 | $ | 668,855 | $ | 81,437 | $ | 55,143 | $ | 2,298,577 | $ | 1,706,571 | |||||||||||||||
Home Construction and Deliveries. Following the acquisition of land and, if necessary, the development of the land into finished lots, we typically begin constructing model homes and marketing homes for sale. The time required for construction of our homes depends on the weather, time of year, availability of local skilled trade labor and building materials and other factors. To minimize the costs and risks of unsold homes in production, we generally begin construction of a home only when we have a signed purchase contract with a homebuyer and have obtained preliminary credit approval or other evidence of a homebuyer’s financial ability to purchase the home. However, cancellations of home purchase contracts prior to the delivery of the underlying homes, the construction of attached products with some unsold units, or specific strategic considerations will result in our having unsold homes in production.
We act as the general contractor for the majority of our communities and hire experienced subcontractors to supply the skilled trade labor and to procure some of the building materials required for all production activities. Our contracts with our subcontractors require that they comply with all laws applicable to their work, including labor laws, meet performance standards, and follow local building codes and permits. We have established national and regional purchasing programs for certain building materials, appliances, fixtures and other items to take advantage of economies of scale and garner better pricing and more reliable supply and, where available, participate in manufacturer or supplier rebate programs. At all stages of production, our administrative and on-site supervisory personnel oversee and coordinate the activities of subcontractors to meet our production schedules and quality standards.
Backlog
We sell our homes under standard purchase contracts, which generally require a homebuyer to pay a deposit at the time of signing. The amount of the deposit required varies among markets and communities. Homebuyers also may be required to pay additional deposits when they select design options for their homes. Most of our home purchase contracts stipulate that if a homebuyer cancels a contract with us, we have the right to retain the homebuyer’s deposits. However, we generally permit our homebuyers to cancel their obligations and obtain refunds of all or a portion of their deposits in the event mortgage financing cannot be obtained within a certain period of time, as specified in their contract. We define our cancellation rate for a given period as the total number of contracts for new homes canceled divided by the total new (gross) orders for homes during the same period. Our cancellation rate for the year was 32% in 2013, compared to a cancellation rate of 31% in 2012. Our cancellation rate was
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36% in the fourth quarter of 2013, compared to 35% in the fourth quarter of 2012. Our cancellation rates and the factors affecting our cancellation rates are further discussed below under “Item 1A. Risk Factors” and “Part II — Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Our “backlog” consists of homes that are under a home purchase contract but have not yet been delivered to a homebuyer. Ending backlog represents the number of homes in backlog from the previous period plus the number of net orders (new orders for homes less cancellations) generated during the current period minus the number of homes delivered during the current period. Our backlog at any given time will be affected by cancellations and by our community count. The number of homes we deliver has historically increased from the first to the fourth quarter in any year.
Our backlog at November 30, 2013 consisted of 2,557 homes, essentially flat with the 2,577 homes in backlog at November 30, 2012. Our backlog at November 30, 2013 represented potential future housing revenues of approximately $682.5 million, a 10% increase from potential future housing revenues of approximately $618.6 million at November 30, 2012, primarily due to a higher overall average selling price. Our backlog conversion ratio, defined as homes delivered in a quarter as a percentage of backlog at the beginning of that quarter, will vary from quarter to quarter, depending on the number of homes in our backlog that are under construction, home construction pace, cancellations and the number of homes we sell and deliver within a quarter.
Our net orders for the year ended November 30, 2013 increased to 7,125 from 6,703 for the year ended November 30, 2012, marking the third consecutive year that full-year net orders have increased from the previous year. The value of the net orders we generated for the year ended November 30, 2013 increased 24% to $2.16 billion from $1.73 billion for the prior year. Our net order value for a given period represents the potential future housing revenues associated with net orders and homebuyers’ design option choices for homes in backlog during the same period. Our net order value may be further impacted by changes related to cancellations and change orders between periods.
The following tables present homes delivered, net orders (number of net orders and value) and cancellation rates by homebuilding reporting segment for each quarter during the years ended November 30, 2013 and 2012, and our ending backlog (number of homes and value) at the end of each quarter within those years:
West Coast | Southwest | Central | Southeast | Total | |||||||||||||||
Homes delivered | |||||||||||||||||||
2013 | |||||||||||||||||||
First | 509 | 140 | 571 | 265 | 1,485 | ||||||||||||||
Second | 594 | 211 | 637 | 355 | 1,797 | ||||||||||||||
Third | 555 | 194 | 757 | 319 | 1,825 | ||||||||||||||
Fourth | 521 | 193 | 876 | 448 | 2,038 | ||||||||||||||
Total | 2,179 | 738 | 2,841 | 1,387 | 7,145 | ||||||||||||||
2012 | |||||||||||||||||||
First | 309 | 170 | 487 | 184 | 1,150 | ||||||||||||||
Second | 330 | 157 | 536 | 267 | 1,290 | ||||||||||||||
Third | 541 | 186 | 700 | 293 | 1,720 | ||||||||||||||
Fourth | 765 | 170 | 843 | 344 | 2,122 | ||||||||||||||
Total | 1,945 | 683 | 2,566 | 1,088 | 6,282 | ||||||||||||||
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West Coast | Southwest | Central | Southeast | Total | |||||||||||||||
Net orders | |||||||||||||||||||
2013 | |||||||||||||||||||
First | 530 | 199 | 653 | 289 | 1,671 | ||||||||||||||
Second | 587 | 189 | 968 | 418 | 2,162 | ||||||||||||||
Third | 427 | 180 | 743 | 386 | 1,736 | ||||||||||||||
Fourth | 371 | 188 | 663 | 334 | 1,556 | ||||||||||||||
Total | 1,915 | 756 | 3,027 | 1,427 | 7,125 | ||||||||||||||
2012 | |||||||||||||||||||
First | 289 | 140 | 547 | 221 | 1,197 | ||||||||||||||
Second | 600 | 229 | 900 | 320 | 2,049 | ||||||||||||||
Third | 658 | 154 | 765 | 323 | 1,900 | ||||||||||||||
Fourth | 619 | 140 | 485 | 313 | 1,557 | ||||||||||||||
Total | 2,166 | 663 | 2,697 | 1,177 | 6,703 | ||||||||||||||
Net orders — value, in thousands | |||||||||||||||||||
2013 | |||||||||||||||||||
First | $ | 261,342 | $ | 43,706 | $ | 133,492 | $ | 68,263 | $ | 506,803 | |||||||||
Second | 292,769 | 49,246 | 198,621 | 99,002 | 639,638 | ||||||||||||||
Third | 227,119 | 44,885 | 160,566 | 96,352 | 528,922 | ||||||||||||||
Fourth | 194,888 | 53,248 | 144,255 | 89,311 | 481,702 | ||||||||||||||
Total | $ | 976,118 | $ | 191,085 | $ | 636,934 | $ | 352,928 | $ | 2,157,065 | |||||||||
2012 | |||||||||||||||||||
First | $ | 112,232 | $ | 24,907 | $ | 94,452 | $ | 45,938 | $ | 277,529 | |||||||||
Second | 235,299 | 44,577 | 155,521 | 67,673 | 503,070 | ||||||||||||||
Third | 252,566 | 34,536 | 135,934 | 70,241 | 493,277 | ||||||||||||||
Fourth | 259,159 | 30,986 | 98,738 | 70,387 | 459,270 | ||||||||||||||
Total | $ | 859,256 | $ | 135,006 | $ | 484,645 | $ | 254,239 | $ | 1,733,146 | |||||||||
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West Coast | Southwest | Central | Southeast | Total | |||||||||||||||
Cancellation rates | |||||||||||||||||||
2013 | |||||||||||||||||||
First | 23 | % | 22 | % | 39 | % | 34 | % | 32 | % | |||||||||
Second | 20 | 23 | 32 | 22 | 27 | ||||||||||||||
Third | 25 | 24 | 41 | 27 | 33 | ||||||||||||||
Fourth | 29 | 25 | 44 | 31 | 36 | ||||||||||||||
Total | 24 | % | 24 | % | 39 | % | 28 | % | 32 | % | |||||||||
2012 | |||||||||||||||||||
First | 34 | % | 24 | % | 39 | % | 37 | % | 36 | % | |||||||||
Second | 24 | 17 | 28 | 28 | 26 | ||||||||||||||
Third | 23 | 16 | 35 | 27 | 29 | ||||||||||||||
Fourth | 25 | 21 | 47 | 31 | 35 | ||||||||||||||
Total | 26 | % | 19 | % | 37 | % | 30 | % | 31 | % | |||||||||
Ending backlog — homes | |||||||||||||||||||
2013 | |||||||||||||||||||
First | 705 | 242 | 1,231 | 585 | 2,763 | ||||||||||||||
Second | 698 | 220 | 1,562 | 648 | 3,128 | ||||||||||||||
Third | 570 | 206 | 1,548 | 715 | 3,039 | ||||||||||||||
Fourth | 420 | 201 | 1,335 | 601 | 2,557 | ||||||||||||||
2012 | |||||||||||||||||||
First | 443 | 173 | 1,078 | 509 | 2,203 | ||||||||||||||
Second | 713 | 245 | 1,442 | 562 | 2,962 | ||||||||||||||
Third | 830 | 213 | 1,507 | 592 | 3,142 | ||||||||||||||
Fourth | 684 | 183 | 1,149 | 561 | 2,577 | ||||||||||||||
Ending backlog — value, in thousands | |||||||||||||||||||
2013 | |||||||||||||||||||
First | $ | 287,970 | $ | 54,604 | $ | 235,759 | $ | 125,560 | $ | 703,893 | |||||||||
Second | 337,878 | 48,524 | 296,949 | 143,262 | 826,613 | ||||||||||||||
Third | 276,031 | 48,646 | 315,900 | 167,906 | 808,483 | ||||||||||||||
Fourth | 206,308 | 50,858 | 279,424 | 145,899 | 682,489 | ||||||||||||||
2012 | |||||||||||||||||||
First | $ | 150,638 | $ | 32,139 | $ | 177,998 | $ | 99,176 | $ | 459,951 | |||||||||
Second | 301,652 | 43,518 | 237,558 | 110,680 | 693,408 | ||||||||||||||
Third | 327,528 | 40,727 | 251,900 | 124,589 | 744,744 | ||||||||||||||
Fourth | 248,790 | 40,206 | 204,473 | 125,157 | 618,626 | ||||||||||||||
Land and Raw Materials
Based on our current strategic plans, we strive to own or control land sufficient to meet our forecasted production goals for the next three to five years. As discussed above under “Strategy,” in 2014 we intend to acquire additional land subject to conditions in housing markets, the overall economy and the capital, credit and financial markets. However, we may also decide to sell certain land or land interests as part of our marketing strategy or for other reasons.
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The principal raw materials used in the construction of our homes are concrete and forest products. In addition, we use a variety of other construction materials in the homebuilding process, including drywall and plumbing and electrical items. We attempt to enhance the efficiency of our operations by using, where practical, standardized materials that are commercially available on competitive terms from a variety of sources. In addition, our national and regional purchasing programs for certain building materials, appliances, fixtures and other items allow us to benefit from large quantity purchase discounts and, where available, manufacturer or supplier rebates. When possible, we arrange for bulk purchases of these products at favorable prices from manufacturers and suppliers. Although our purchasing strategies have helped us in negotiating favorable prices for raw materials, in 2013, we encountered higher prices for lumber, drywall, concrete and other materials and for skilled trade labor, and we expect to see additional cost increases if and as the present housing recovery progresses, as discussed further below under “Competition, Seasonality, Delivery Mix and Other Factors.”
Customer Financing
Our homebuyers may obtain mortgage financing to purchase our homes from any lender or other provider of their choice. We do not directly offer mortgage banking services or originate residential consumer mortgage loans (“mortgage loans”) for our customers. Prior to late June 2011, KBA Mortgage, LLC (“KBA Mortgage”), an unconsolidated mortgage banking joint venture of a subsidiary of ours and a subsidiary of Bank of America, N.A., provided mortgage banking services to a significant proportion of our homebuyers. KBA Mortgage ceased offering mortgage banking services after June 30, 2011.
Since mid-2011, we have had a marketing services agreement with a preferred mortgage lender that offers mortgage banking services, including mortgage loan originations, to our homebuyers who elect to use the lender. The mortgage banking services are described further under “Part II — Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Financial Services Reporting Segment.” At no time has our preferred mortgage lender or its respective parent company been an affiliate of ours or any of our subsidiaries. Except as discussed below, we have not had any ownership, joint venture or other interests in or with our preferred mortgage lender or its respective parent company or with respect to the revenues or income that may be generated from our preferred mortgage lender providing mortgage banking services to, or originating mortgage loans for, our homebuyers. Until the first quarter of 2012, our preferred mortgage lender was MetLife Home Loans, a division of MetLife Bank, N.A., which announced in January 2012 that it was ceasing to offer forward mortgage banking services as part of its business. In March 2012, Nationstar Mortgage LLC (“Nationstar”) became our preferred mortgage lender. Nationstar began accepting new mortgage loan applications from our homebuyers on May 1, 2012.
On January 21, 2013, we entered into an agreement with Nationstar to form Home Community Mortgage, LLC (“Home Community Mortgage”), a mortgage banking company that will offer an array of mortgage banking services to our homebuyers. Nationstar will continue as our preferred mortgage lender until Home Community Mortgage begins offering mortgage banking services, which is expected in the first quarter of 2014. Home Community Mortgage is accounted for as an unconsolidated joint venture within our financial services reporting segment.
Employees
We employ a trained staff of land acquisition specialists, architects, planners, engineers, construction supervisors, marketing and sales personnel, and finance and accounting personnel, supplemented as necessary by outside consultants, who guide the development of our communities from their conception through the promotional marketing and delivery of completed homes.
At December 31, 2013 and 2012, we had approximately 1,430 and 1,200 full-time employees, respectively. None of our employees are represented by a collective bargaining agreement.
Competition, Seasonality, Delivery Mix and Other Factors
The homebuilding industry and housing market are highly competitive with respect to selling homes; hiring skilled trade labor, such as carpenters, roofers, electricians and plumbers; and acquiring attractive developable land. We compete for homebuyers, skilled trade workers, management talent and desirable land against numerous homebuilders, ranging from regional and national firms to small local enterprises. As to homebuyers, we primarily compete with other homebuilders on the basis of selling price, community location and amenities, availability of financing options, home designs, reputation, home construction quality and cycle time, and the design options and features that can be included in a home. In some cases, this competition occurs within larger residential development projects containing separate sections designed, planned and developed by other homebuilders. In addition, we compete for homebuyers against housing alternatives other than new homes, including resale homes, apartments, single-family rentals and other rental housing. In certain markets and at times when housing demand is high, we also compete with other homebuilders and commercial and remodeling contractors to hire skilled trade labor, primarily on the basis of pre-existing relationships, contract price and volume and consistency of available work. During the housing downturn, many skilled workers left construction for other industries. As a result, in 2013 and 2012, in markets experiencing increased residential
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construction activity due to improved housing market conditions, the relatively smaller workforce combined with higher demand for trade labor created shortages of certain skilled workers, driving up costs and/or extending land development and home construction schedules. This elevated residential construction activity also contributed to notable increases in the cost of certain building materials, such as lumber, drywall and concrete, reflecting in part a smaller supplier base and lower production capacity than existed before the housing downturn. In 2013, we also saw higher prices for desirable land amid heightened competition with homebuilders and other developers and investors, particularly in the land constrained areas we are strategically targeting. We expect these upward trends in construction labor, building materials and land costs to continue, and possibly intensify, in 2014 if and as the present housing recovery progresses and there is greater competition for these resources.
Our performance is affected by seasonal demand trends for housing. Traditionally, there has been more consumer demand for home purchases and we tend to generate more net orders in the mid- to late-spring and early summer months (corresponding to most of our second and part of our third quarters) than at other times of the year. With our Built to Order approach and typical home construction cycle times, this “selling season” demand results in our delivering more homes and generating higher revenues from late summer through the fall months (corresponding to part of our third and our fourth quarters). On a relative basis, the winter and early spring months within our first and part of our second quarters usually produce the fewest net orders, homes delivered and revenues, and the sequential difference from our fourth quarter to our first quarter can be significant.
In addition to the overall volume of homes we sell and deliver, our results in a given period are significantly affected by the geographic mix of markets and submarkets in which we operate; the number and characteristics of the new home communities we have open for sales in those markets and submarkets; and the products we sell from those communities during the period. While there are some similarities, there are differences within and between our served markets in terms of the quantity, size and nature of the new home communities we operate and the products we offer to consumers. These differences reflect, among other things, local homebuyer preferences; household demographics (e.g., large families or working professionals; income levels); geographic context (e.g., urban or suburban; availability of reasonably priced finished lots; development constraints; residential density); and the shifts that can occur in these factors over time. These structural factors in each of our served markets will affect the costs we incur and the time it takes to locate, acquire rights to and develop land, open new home communities for sales, and market and build homes; the size of our homes; our selling prices (including the contribution from homebuyers’ purchases of design options); and the pace at which we sell and deliver homes and close out communities. Therefore, our results in any given period will fluctuate compared to other periods based on the proportion of homes delivered from areas with higher or lower selling prices and on the corresponding land and overhead costs incurred to generate those deliveries, as well as from our overall community count. In 2013, we targeted opening more of our new home communities for sales in higher-performing, choice locations — predominately in land constrained areas that have customers with higher household incomes who desire larger homes and purchase more design options, key drivers for our home selling prices and housing gross profit margins. Due in part to this focused approach, in 2013, we posted favorable year-over-year results in revenues as we delivered more homes from these areas, and generated higher housing gross profits for the year compared to 2012. At the same time, we had modest year-over-year growth in net orders. In 2014, we plan to continue our approach of opening new home communities for sales in locations with the above-described demand characteristics, and we anticipate that we will have more new home communities open for sales than we did in 2013.
Financing
We do not generally finance the development of our communities with project financing. By “project financing,” we mean loans from parties other than land sellers that are specifically obtained for, or secured by, particular communities or other inventory assets. Instead, our operations have historically been funded by results of operations, public debt and equity financing. We also have the ability to borrow funds under our unsecured revolving credit facility with various banks (as amended, the “Credit Facility”). Depending on market conditions in 2014, we may obtain project financing, or secure external financing with community or other inventory assets that we own or control. We may also arrange or engage in capital markets, bank loan, project debt or other financial transactions and/or expand the capacity of the Credit Facility or our cash-collateralized letter of credit facilities with various financial institutions (the “LOC Facilities”) or enter into additional such facilities. These transactions may include repurchases from time to time of our outstanding senior notes or other debt through redemptions, tender offers, exchange offers, private exchanges, open market purchases or other means, and may include potential new issuances of equity or senior or convertible senior notes or other debt through public offerings, private placements or other arrangements to raise new capital to support our current land and land development investment targets, and for other business purposes and/or to effect repurchases or redemptions of our outstanding senior notes or other debt. Our ability to engage in such financial transactions, however, may be constrained by economic, capital, credit and/or financial market conditions, investor interest and/or our current leverage ratios, and we can provide no assurance of the success or costs of any such transactions.
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Environmental Compliance Matters
As part of our due diligence process for land acquisitions, we often use third-party environmental consultants to investigate potential environmental risks, and we require disclosures, representations and warranties from land sellers regarding environmental risks. Despite these efforts, there can be no assurance that we will avoid material liabilities relating to the existence or removal of toxic wastes, site restoration, monitoring or other environmental matters affecting properties currently or previously owned or controlled by us. No estimate of any potential liabilities can be made although we may, from time to time, acquire property that requires us to incur environmental clean-up costs after conducting appropriate due diligence, including, but not limited to, using detailed investigations performed by environmental consultants. In such instances, we take steps prior to our acquisition of the land to gain reasonable assurance as to the precise scope of work required and the costs associated with removal, site restoration and/or monitoring. To the extent contamination or other environmental issues have occurred in the past, we will attempt to recover restoration costs from third parties, such as the generators of hazardous waste, land sellers or others in the prior chain of title and/or their insurers. Based on these practices, we anticipate that it is unlikely that environmental clean-up costs will have a material effect on our consolidated financial statements. We have not been notified by any governmental agency of any claim that any of the properties owned or formerly owned by us are identified by the EPA (or similar state or local agency) as being a “Superfund” (or similar state or local) clean-up site requiring remediation, which could have a material effect on our future consolidated financial statements. Costs associated with the use of environmental consultants are not material to our consolidated financial statements.
Access to Our Information
We file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (“SEC”). We make our public SEC filings available, at no cost, through our investor relations website at www.investor.kbhome.com, as soon as reasonably practicable after the report is electronically filed with, or furnished to, the SEC. We will also provide these reports in electronic or paper format free of charge upon request made to our investor relations department at investorrelations@kbhome.com or at our principal executive offices. We intend for our investor relations website to be the primary location where investors and the general public can obtain announcements regarding and can learn more about our financial and operational performance, business plans and prospects, and our board of directors, our senior executive management team, and our corporate governance policies, including our articles of incorporation, by-laws, corporate governance principles, board committee charters, and ethics policy. We may from time to time choose to disclose or post important information about our business on or through our investor relations website, and/or through other electronic channels, including social media outlets and other evolving communications technologies. We webcast and archive quarterly earnings calls and other investor events in which we participate or host, and post related materials, on our investor relations website. Interested persons can register on our investor relations website to receive prompt notifications of new SEC filings, press releases and other information posted there. However, the content available on or through our primary website at www.kbhome.com or our investor relations website, including our sustainability reports, is not incorporated by reference in this report or in any other filing we make with the SEC. Our references in our SEC filings or otherwise to materials posted on or to any content available on or through our websites and/or through other electronic channels, including social media outlets and other evolving communications technologies, are intended to be inactive textual or oral references only. Our SEC filings are also available to the public over the Internet at the SEC’s website at www.sec.gov. The public may also read and copy any document we file at the SEC’s public reference room located at 100 F Street N.E., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the operation of the public reference room.
Item 1A. | RISK FACTORS |
The following important factors could adversely impact our business. These factors could cause our actual results to differ materially from the forward-looking and other statements that (a) we make in registration statements, periodic reports and other filings with the SEC and from time to time in our news releases, annual reports and other written reports or communications, (b) we post on or make available through our primary website at www.kbhome.com or our investor relations website at www.investor.kbhome.com and/or through other electronic channels, including social media outlets and other evolving communications technologies, and (c) our personnel and representatives make orally from time to time.
The recent improvement in housing market conditions following a severe and prolonged housing downturn may not continue, and any slowing or reversal of the present housing recovery generally, or in our served markets, or for the homebuilding industry may materially and adversely affect our business and consolidated financial statements.
In 2013, the housing recovery continued to advance after several years of weak demand and excess supply during the housing downturn. The present recovery, which began to take shape in 2012, has been fueled primarily by sustained demand for homes, low inventories of homes available for sale, and generally favorable economic and demographic trends. Housing demand has been supported by population growth, household formations, favorable housing affordability largely due to relatively low interest
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rates for mortgage loans, and positive consumer confidence. However, the performance of housing markets varied throughout the year. Further, in mid-2013, a sudden rise in mortgage loan interest rates, combined with steadily increasing home prices, tempered a relatively heated sales pace seen earlier in the year, and an extended legislative impasse during federal government budget and debt ceiling negotiations in October 2013 negatively affected consumer confidence and net orders in our fourth quarter.
Despite the changing environment during the year, with the present housing recovery, we and other homebuilders for the most part reported higher orders and homes delivered and better financial results in 2013 than in 2012. However, the improved conditions did not extend to a number of housing markets we serve, and some markets and submarkets have been stronger than others. We expect that such unevenness will continue in 2014 and beyond whether or not the present housing recovery progresses, and that prevailing conditions in various housing markets and submarkets will fluctuate. These fluctuations may be significant and unfavorable in future periods. In addition, while some of the many negative factors that contributed to the housing downturn may have moderated, several remain, and they could return and/or intensify to inhibit any future improvement in housing market conditions in 2014. These negative factors include (a) weak general economic and employment growth that, among other things, restrains consumer incomes, consumer confidence and demand for homes; (b) delinquencies, defaults and foreclosures on mortgage loans that could add to a “shadow inventory” of lender-owned homes that may be sold in competition with new homes, including our homes, and resale homes at low “distressed” prices or that generate short sales activity at such price levels; (c) a significant number of homeowners whose outstanding principal balance on their mortgage loan exceeds the market value of their home, which undermines their ability to purchase another home that they otherwise might desire and be able to afford, and also cause lenders to curb mortgage loan origination activity; (d) volatility and uncertainty in domestic and international financial, credit and consumer lending markets amid slow growth or recessionary conditions in various regions around the world; and (e) tight lending standards and practices for mortgage loans, which may be driven by regulatory requirements, that limit consumers’ ability to qualify for mortgage financing to purchase a home, including increased minimum credit score requirements, credit risk/mortgage loan insurance premiums and/or other fees and required down payment amounts, more conservative appraisals of home values, lower loan-to-value ratios and extensive buyer income and asset documentation requirements. Additional headwinds may come from the efforts and proposals of lawmakers to reduce the debt of the federal government through tax increases and/or spending cuts, or the failure of lawmakers to timely agree on a budget or appropriation legislation to fund the operations of the federal government, and financial markets’ and businesses’ reactions to those efforts, proposals or failure, which could impair economic growth. Since these factors may persist or recur, we can provide no assurance that the present housing recovery will continue or gain further momentum, whether overall or in our served markets.
If, on an overall basis or in our served markets, the present housing recovery stalls or does not continue at the same pace, or any or all of the negative factors described above persist or worsen, particularly if there is limited economic growth or a decline, low growth or decreases in employment and consumer incomes, and/or continued tight mortgage lending standards and practices, there would likely be a corresponding adverse effect on our business and our consolidated financial statements, including, but not limited to, the number of homes we deliver, our average selling prices, the amount of revenues we generate and our ability to operate profitably, and the effect may be material. Even if the present housing recovery continues for an extended period, our and the homebuilding industry’s orders, homes delivered, revenues and profitability remain well below, and may not return to, the peak levels reached shortly before the housing downturn began.
Continued or additional tightening of mortgage lending standards and practices or mortgage financing requirements or volatility in financial, credit and consumer lending markets could adversely affect the availability of mortgage loans for potential purchasers of our homes and thereby reduce our net orders.
Since 2008, the mortgage lending and mortgage finance industries have experienced significant instability due to, among other things, relatively high rates of delinquencies, defaults and foreclosures on mortgage loans and a corresponding decline in their market value and the market value of securities backed by such loans, although there has been some improvement in these areas amid a general lift in housing prices over the past two years. With the instability, a number of providers, purchasers and insurers of mortgage loans and mortgage loan-backed securities have exited the market, and most mortgage loans are currently being originated under programs offered or supported by government agencies or government-sponsored enterprises — principally, the Federal Housing Administration (“FHA”), the Veterans Administration (“VA”), the Federal National Mortgage Association (also known as “Fannie Mae”), Federal Home Loan Mortgage Corporation (also known as “Freddie Mac”) and the U.S. Department of Agriculture. Compared to prior periods, these developments have led to reduced availability of mortgage loan products (particularly subprime and nonconforming loans), and tighter lending standards and practices for mortgage loans. As a result, it is generally more difficult for some categories of borrowers to finance the purchase of homes, which is restraining the housing market’s recovery, causing volatility in and elevating cancellation rates for us and other homebuilders, and reducing demand for homes, including our homes. If these factors continue, or if mortgage lending standards and practices further tighten, we expect that there would be a material adverse effect on our business and our consolidated financial statements, particularly since we depend on third-party lenders (including our preferred mortgage lender Nationstar) to provide mortgage loans to our homebuyers.
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Further tightening of mortgage lending standards and practices and/or reduced credit availability for mortgages may also result from the implementation of regulations under the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). Among other things, the Dodd-Frank Act established several requirements (including risk retention obligations) relating to the origination, securitizing and servicing of, and consumer disclosures for, mortgage loans. In addition, U.S. and international banking regulators have proposed or enacted higher capital standards and requirements for financial institutions. These standards and requirements, as and when implemented, may further reduce the availability of and/or increase the costs to borrowers to obtain mortgage loans, including by reducing allowable debt-to-income ratios, imposing restrictions on mortgage origination fees and lowering maximum conforming mortgage loan amounts. Federal regulators and lawmakers are also considering steps that may significantly reduce the ability or authority of the FHA, Fannie Mae and Freddie Mac to purchase or insure mortgage loans under their respective programs, including proposals to gradually wind down Fannie Mae and Freddie Mac. Further, since 2010, lenders and other mortgage banking services providers, brokers and other institutions, and their agents, have been under intense regulatory scrutiny and the targets of several civil actions by investors and government agencies regarding mortgage loan underwriting practices and/or representations made in connection with selling mortgage loans into private or Fannie Mae- or Freddie Mac-backed securitized pools. If such scrutiny and civil actions result in lenders and other mortgage banking services providers and brokers having to adjust their operations and/or pay significant amounts in damages or fines, they may further curtail or cease their mortgage loan origination activities due to reduced liquidity or to mitigate perceived risks.
Since 2012, the Federal Reserve has been purchasing billions of dollars of longer-term U.S. Treasury securities and mortgage loan-backed securities of Fannie Mae, Freddie Mac and the Government National Mortgage Association (or “Ginnie Mae,” which guarantees securities composed of FHA- and VA-qualified mortgage loans). It expects this asset purchase program to maintain downward pressure on longer-term interest rates, support mortgage markets and help make broader financial conditions more accommodative. However, in mid-2013, when the Federal Reserve Chairman announced that the program could be scaled back, or “tapered,” there was a measurable spike in mortgage loan interest rates and they have remained elevated compared to the first half of the year. If the Federal Reserve does taper or end its asset purchase program, and it announced in December 2013 a reduction in its monthly purchases from $85 billion to $75 billion, it is likely that mortgage loan interest rates will rise, subject to prevailing economic and financial market conditions. Even if the Federal Reserve’s asset purchase program does keep mortgage loan interest rates at relatively low levels, many potential homebuyers may still be unable to obtain mortgage loans to purchase homes, including our homes, if mortgage lending standards and practices remain tight or tighten further, or if lenders curtail or cease mortgage loan origination activity due to regulatory requirements and/or liquidity or risk concerns.
Interest rate increases or changes in federal lending programs or regulations could lower demand for our homes.
Nearly all of our customers finance the purchase of their homes. Before the housing downturn began, historically low interest rates and the increased availability of specialized mortgage loan products, including products requiring no or low down payments, and interest-only and adjustable-rate mortgage loans, made purchasing a home more affordable for a number of customers and more available to customers with lower credit scores. Increases in interest rates and/or decreases in the availability of mortgage financing or of certain mortgage loan products or programs may lead to fewer mortgage loans being provided, higher credit risk/mortgage loan insurance premiums and/or other fees, increased down payment and extensive buyer income and asset documentation requirements, or a combination of the foregoing, and, as a result, reduce demand for our homes and increase our cancellation rates.
Due to the volatility and uncertainty in the credit markets and in the mortgage lending and mortgage finance industries since 2008, the federal government has taken on a significant role in supporting mortgage lending through its conservatorship of Fannie Mae and Freddie Mac, and its insurance of mortgage loans through the FHA and the VA. FHA backing of mortgage loans has been particularly important to the mortgage finance industry and to our business. The availability and affordability of mortgage loans, including interest rates for such loans, could be adversely affected by a scaling back or termination of the federal government’s mortgage loan-related programs or policies. The FHA, for instance, increased its annual mortgage insurance premiums in 2013 and, among other actions, extended the period that such premiums are charged to borrowers, increased down payment requirements and raised its standards on the loans it will insure in order to address a significant cash reserve deficit (relative to its projected losses from delinquent loans). In addition, federal regulators significantly lowered the FHA’s maximum single-family forward mortgage loan limits in 650 “high-cost” counties effective January 1, 2014, including counties in California and in other of our served markets. These steps, whether individually or collectively, could prevent some homebuyers from qualifying for mortgage loans to purchase homes, including our homes. In addition, given growing federal budget deficits, the U.S. Treasury may not be able to continue, or may be required by future legislation or regulation to cease, supporting the mortgage loan-related activities of Fannie Mae, Freddie Mac, the FHA and the VA at present levels.
Because Fannie Mae-, Freddie Mac-, FHA- and VA-backed mortgage loans have been an important factor in marketing and selling many of our homes, any limitations or restrictions in the availability of, or higher consumer costs for, such government-backed financing could reduce our net orders, particularly in our coastal submarkets in California, and adversely affect our consolidated financial statements, and the effect could be material.
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Third-party lenders may not complete mortgage loan originations for our homebuyers in a timely manner or at all, which can lead to cancellations and a lower backlog of orders, or to significant delays in our delivering homes and recognizing revenues from those homes.
Our homebuyers may obtain mortgage financing for their home purchases from any lender or other provider of their choice. If, due to credit or consumer lending market conditions, reduced liquidity, increased risk retention or minimum capital level obligations and/or regulatory restrictions related to the Dodd-Frank Act or other laws, or other factors or business decisions, these lenders refuse or are unable to provide mortgage loans to our homebuyers, the number of homes we deliver and our consolidated financial statements may be materially and adversely affected. For instance, tight mortgage lending standards and practices for mortgage loans have in recent periods led to significant delays in our delivering homes and/or have caused some potential homebuyers to cancel their home purchase contracts with us. We can provide no assurance that these tight mortgage lending conditions will relax or reverse in the foreseeable future.
In addition, as we were transitioning to Nationstar as our preferred mortgage lender in the first half of 2012, we experienced significant disruptions to our business due to the inability or unwillingness of several independent third-party lenders to complete in a timely fashion or at all the mortgage loan originations they had started for our homebuyers. Nationstar began accepting new mortgage loan applications from our homebuyers on May 1, 2012, and compared to other lenders has been providing more consistent execution and completion of mortgage loan originations for our homebuyers who choose to use Nationstar. Based on the number of homes delivered in 2013, approximately 59% of our homebuyers used Nationstar to finance the purchase of their home. In January 2013, we entered into an agreement with Nationstar to form Home Community Mortgage, a mortgage banking company that will offer an array of mortgage banking services to our homebuyers. Nationstar will provide management oversight of Home Community Mortgage’s operations, which are expected to begin in the first quarter of 2014. Although we expect an increasing percentage of our homebuyers will choose to use Nationstar/Home Community Mortgage, many of our homebuyers will continue to seek mortgage loans from other lenders and potentially be subject to the performance of such lenders, as well as the general mortgage financing industry issues described above. In addition, we can provide no assurance as to Nationstar’s ability or willingness, as our preferred mortgage provider or as the manager of Home Community Mortgage, to provide mortgage loans and other mortgage banking services to our homebuyers in future periods (whether due to the factors discussed above or otherwise), or as to its performance in doing so. Furthermore, the mortgage banking operations of Home Community Mortgage will be heavily regulated and subject to the rules and regulations promulgated by a number of governmental and quasi-governmental agencies. If Nationstar’s performance declines or Nationstar decides to end, or we decide to terminate, our relationship, or there is a finding that Home Community Mortgage materially violated any applicable rules or regulations and as a result is restricted from or unable to originate mortgage loans, we may experience mortgage loan funding issues similar to those we encountered in 2012, which would likely have a material adverse impact on our business and our consolidated financial statements.
Our current strategies may not generate improved financial and operational performance, and the continued implementation of these and other strategies may not be successful.
We believe our strategic actions during the housing downturn strengthened our overall business and that our current strategies and initiatives will enable us to profitably grow our business in 2014. However, our strategies, including, but not limited to, our strategic growth initiatives intended to improve our profitability and increase our revenues, such as our significant investments in land and land development, our plans to open more new home communities, our ongoing repositioning of our homebuilding activities and investments toward higher-performing, desirable locations in land constrained growth markets, and our efforts to optimize our sales pace at our new home communities, may prove to be unsuitable for some or all of our served markets. We can provide no guarantee that these strategies will be successfully or productively implemented or, even if they are implemented as designed, that they will generate growth and earnings, or that we will achieve in 2014 or beyond positive operational or financial results or results in any particular metric or measure equal to or better than our 2013 performance, or perform in any period as well as other homebuilders. In particular, our strategic effort to activate certain inventory that was previously held for future development may not generate positive results as many of these assets are generally located in submarkets that have only recently begun to stabilize. In addition, although we believe our new home communities and products will appeal to our primary customer base, we can provide no assurance that our new home community locations and product designs (or any refining of those designs) will successfully attract consumers or generate orders and revenues at the levels we have experienced in the past or anticipate in future periods, or at levels higher than other homebuilders. We also cannot provide any assurance that we will be able to maintain these strategies in 2014 and, due to unexpectedly favorable or unfavorable market conditions or other factors, we may determine that we need to adjust, refine or abandon all or portions of these strategies, although we cannot guarantee that any such changes will be successful. For instance, with the heightened land acquisition and development activities of homebuilders and other developers since 2012, there are significantly fewer well-located developable land parcels available at reasonable prices in several of our submarkets, making our land acquisition and development strategies more challenging to implement successfully, and we may not be able to achieve our land-related investment and community count growth goals. The failure of any one or more of our present strategies, or the failure of any adjustments or alternative strategies that we may pursue or implement, to be successful
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will likely have an adverse effect on our ability to grow and increase the value and profitability of our business and on our consolidated financial statements, as well as on our overall liquidity, and the effect in each case could be material.
The success of our present strategies, growth initiatives and our long-term performance depends on the availability of finished and partially finished lots and undeveloped land that meet our investment return and marketing standards.
The availability of finished and partially finished lots and undeveloped land that meet our investment return and marketing standards depends on a number of factors outside of our control, including land availability in general, geographical/topographical constraints, land sellers’ business relationships with other homebuilders, developers or investors, climate conditions, competition with other homebuilders and land buyers for desirable property, financial and credit market conditions, legal or government agency processes, inflation in land prices, zoning, allowable housing density, our ability and the costs to obtain building permits, the amount of environmental impact fees, real estate tax rates and other regulatory requirements. Should suitable lots or land become less available, which is increasingly the case, the number of homes that we may be able to build and sell could be reduced, and the cost of attractive land could increase, perhaps substantially, which could adversely impact our consolidated financial statements including, but not limited to, our housing gross profit margins, and our ability to maintain ownership or control of a sufficient supply of developed or developable land inventory. The availability of suitable land could also affect the success of our current strategies and growth initiatives, and if we decide to reduce our land acquisition activity in 2014 due to a lack of available assets that meet our standards, our ability to increase our community count, to grow our revenues and housing gross profit margins, and to maintain or increase our profitability, would likely be constrained and could have a material adverse effect on our consolidated financial statements.
The value of the land and housing inventory we own or control may fall significantly.
The value of the inventory we currently own or control depends on market conditions, including estimates of future demand for, and the revenues that can be generated from, this inventory. The market value of our inventory can vary considerably because there is often a significant amount of time between our acquiring control or taking ownership of land and the delivery of homes on that land. The negative conditions of the housing downturn, which generally depressed home sales and selling prices, caused the fair value of certain of our owned or controlled inventory to fall, in some cases well below the estimated fair value at the time we acquired ownership or control. Even with the improved housing market conditions we saw in 2013, local submarket-specific or other factors could lead to a decrease in the fair value of certain of our inventory in 2014 whether or not the present housing recovery progresses. Based on our periodic assessments of inventory for recoverability, during the housing downturn, we wrote down the carrying value of certain of our inventory to its estimated fair value, including inventory that we had previously written down, and recorded corresponding charges against our earnings to reflect the impaired value. We also recorded charges in connection with abandoning our interests in certain land controlled under land option contracts and other similar contracts that no longer met our investment return or marketing standards. In 2013, we recorded $.4 million of inventory impairment charges and $3.2 million of land option contract abandonment charges. However, if in 2014 the present housing recovery slows or reverses, or if particular markets or submarkets experience challenging or unfavorable changes in prevailing conditions, we may need to take additional charges against our earnings for inventory impairments or land option contract abandonments, or both, to reflect changes in fair value of land or land interests in our inventory, including assets we have previously written down. Any such charges could have a material adverse effect on our consolidated financial statements, including our ability to maintain or increase our profitability.
Our business is cyclical and is significantly affected by changes in general and local economic conditions.
Our operations and consolidated financial statements can be substantially affected by adverse changes in general economic or business conditions that are outside of our control, including changes in, among other factors:
• | short- and long-term interest rates; |
• | employment levels and job and personal income growth; |
• | housing demand from population growth, household formation and other demographic changes; |
• | availability and pricing of mortgage financing for homebuyers; |
• | consumer confidence generally and the confidence of potential homebuyers in particular; |
• | U.S. and global financial system and credit market stability; |
• | private party and government mortgage loan programs (including changes in FHA, Fannie Mae- and Freddie Mac-conforming mortgage loan limits, credit risk/mortgage loan insurance premiums and/or other fees, down payment |
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requirements and underwriting standards), and federal and state regulation, oversight and legal action regarding lending, home value appraisal, foreclosure and short sale practices;
• | federal and state personal income tax rates and provisions, including provisions for the deduction of mortgage loan interest payments, real estate taxes and other expenses; |
• | supply of and prices for available new or resale homes (including lender-owned homes) and other housing alternatives, such as apartments, single-family rentals and other rental housing; |
• | homebuyer interest in our current or new product designs and new home community locations, and general consumer interest in purchasing a home compared to choosing other housing alternatives; and |
• | real estate taxes. |
Adverse changes in these conditions may affect our business nationally or may be more prevalent or concentrated in particular markets or submarkets in which we operate.
Inclement weather, natural disasters (such as earthquakes, hurricanes, tornadoes, floods, droughts and fires), and other environmental conditions can delay the delivery of our homes and/or increase our costs. Civil unrest or acts of terrorism can also have a negative effect on our business.
The potential difficulties described above can cause demand and prices for our homes to fall or cause us to take longer and incur more costs to develop land and build our homes. We may not be able to recover these increased costs by raising prices because of market conditions and because the price of each home we sell is usually set several months before the home is delivered, as our customers typically sign their home purchase contracts before home construction begins. The potential difficulties could also lead some homebuyers to cancel or refuse to honor their home purchase contracts altogether. Reflecting the difficult conditions in our served markets during the housing downturn, we have experienced volatility in our net orders and cancellation rates in recent years, and if the present housing recovery slows or reverses, we may experience similar or increased volatility in 2014. If we do, there could be a material adverse effect on our consolidated financial statements.
Home prices and sales activity in the particular markets and regions in which we do business materially affect our consolidated financial statements because our business is concentrated in these markets.
Home selling prices and sales activity in some of our key served markets have declined from time to time for market-specific reasons, including adverse weather, high levels of foreclosures, short sales and sales of lender-owned homes, and lack of affordability or economic contraction due to, among other things, the departure or decline of key industries and employers that could effectively price potential homebuyers out of purchasing homes, including our homes. If home selling prices or sales activity decline in one or more of our key served markets, including California, Florida, Nevada or Texas, our costs may not decline at all or at the same rate and, as a result, our consolidated financial statements may be materially and adversely affected. Adverse conditions in California would have a particularly material effect on our consolidated financial statements as our average selling price in the state is higher than in our other homebuilding reporting segments; a large percentage of our housing revenues is generated from California; and a significant proportion of our investments in land and land development since late 2009 was made, and in 2014 is expected to be made, in that state. In recent years, California’s state government and many of its regional and local governments have struggled to balance their budgets due to a number of factors, although the state’s budget outlook for its current fiscal year has improved slightly. These include lower tax revenues; higher debt service, public employee pension and social welfare obligations; lower federal government support; and, for regional and local governments and redevelopment agencies, various reductions, eliminations or reversals of state government support. As a result, there have been, and lawmakers have proposed making additional, significant cuts to government departments, subsidies, programs and public employee staffing levels, and taxes and fees have been raised, and lawmakers have proposed additional tax and fee increases, in an effort to balance governmental budgets. A few municipalities have declared bankruptcy, and others are reportedly considering such a step. California lawmakers’ efforts at all governmental levels to address ongoing and/or projected budget deficits through spending cuts and/or efforts to increase governmental revenues, could, among other things, cause businesses and residents to leave the state, or discourage businesses or households from coming to the state, which would limit economic growth; cause significant delays in obtaining required inspections, permits or approvals with respect to residential development at our new home communities located in the state, which we encountered in 2013, or result in higher costs for such permits or approvals; and could delay or prevent the release or repayment by applicable municipalities and other government agencies of performance bonds, letters of credit and/or similar deposits we have made in connection with our residential development activities. These negative impacts could adversely affect our ability to generate net orders and revenues and/or to maintain or increase our housing gross profit margins from our California operations, and the impact could be material and adverse to our consolidated financial statements.
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Supply shortages and other risks related to demand for building materials and/or skilled trade labor could increase costs and delay deliveries.
As discussed above under “Item 1. Business — Competition, Seasonality, Delivery Mix and Other Factors,” there is a high level of competition in the homebuilding industry and the housing market for skilled trade labor and building materials that can, among other things, cause increases in land development and home construction costs, and development and construction delays. Also, in 2013, a smaller pool of skilled trade labor due to the housing downturn led to shortages in some markets that experienced increased residential construction activity, and such shortages could recur in 2014 if and as the present housing recovery progresses. Shortages or upward price fluctuations in lumber, drywall, concrete and other building materials, and labor, whether due to a small supplier base or supplier capacity constraints, increased residential construction activity, international demand, the occurrence of or rebuilding after natural disasters or other reasons, can also have an adverse effect on our business. We generally are unable to pass on increases in land development and home construction costs to homebuyers who have already entered into home purchase contracts, as the purchase contracts generally fix the price of the home at the time the contract is signed, and may be signed well in advance of when home construction commences. We also may not be able to raise our selling prices to cover such increases in land development and home construction costs because of market conditions, including competition for homebuyers with other homebuilders and resale homes. Sustained increases in land development and home construction costs due to higher skilled trade labor rates or elevated lumber, drywall, concrete and other building materials prices and/or our limited ability to successfully contain these costs may, among other things, decrease our housing gross profit margins, while shortages of skilled trade labor or building materials due to competition or other factors may delay deliveries of homes and our recognition of revenues. As a result, these negative items, individually or together, can have a material and adverse impact on our consolidated financial statements.
Inflation may adversely affect us by increasing costs that we may not be able to recover, particularly if home selling prices decrease, and the impact on our performance and our consolidated financial statements could be material.
Inflation can have an adverse impact on our consolidated financial statements because increasing costs for land, skilled trade labor or building materials could require us to increase our home selling prices in an effort to maintain satisfactory housing gross profit margins. In 2010 and 2011, worldwide demand for certain commodities and monetary policy actions led to price increases and price volatility for raw materials that are used in land development and home construction, including lumber and metals. Additionally, increased residential construction activity in 2012 and 2013 in combination with a relatively small supplier base further boosted prices and pricing volatility for lumber, drywall, concrete and other raw materials, and these trends are expected to continue, and possibly intensify, in 2014 if and as the present housing recovery progresses. These pricing trends, taken together with U.S. and international central bank and governmental policies and programs designed to boost economic growth, may lead to a general increase in inflation. However, we may not be able to increase our home selling prices to cover cost inflation due to market conditions, and may need to hold or reduce our selling prices in order to compete for home sales. If determined necessary, our lowering of home selling prices, in addition to impacting our housing gross profit margins, may also reduce the value of our land inventory, including the assets we have purchased in recent years, and make it more difficult for us to fully recover the costs of our land and any related land development through our home selling prices or, if we choose, through land sales. In addition, depressed land values may cause us to abandon and forfeit deposits on land option contracts and other similar contracts if we cannot satisfactorily renegotiate the purchase price of the subject land. We may incur charges against our earnings for inventory impairments if the value of our owned inventory is reduced or for land option contract abandonments if we choose not to exercise land option contracts or other similar contracts, and these charges may be substantial, as we experienced in certain periods during the housing downturn. Inflation may also increase interest rates for mortgage loans and thereby reduce demand for our homes and lead to lower revenues, as well as increase the interest rates we may need to accept to obtain external financing.
Reduced home sales may impair our ability to recoup development costs or force us to absorb additional costs.
We incur many costs before we begin to build homes in a community. Depending on the stage of development a land parcel is in when acquired, such costs may include costs of preparing land, finishing and entitling lots, and installing roads, sewers, water systems and other utilities; taxes and other costs related to ownership of the land on which we plan to build homes; constructing model homes; and promotional marketing and overhead expenses to prepare for the opening of a new home community for sales. In addition, local municipalities may impose requirements resulting in additional costs. If the rate at which we sell and deliver homes slows or falls, or if we delay the opening of new home communities for sales due to adjustments in our marketing strategy or other reasons, each of which has occurred throughout the housing downturn and in 2012 and 2013, we may incur additional costs and it will take a longer period of time for us to recover our costs, including the costs we incurred in acquiring and developing land in recent years. Furthermore, if the present housing recovery slows or reverses in 2014, we may decide to abandon certain land option contracts and other similar contracts, and sell certain land at a loss, and the costs of doing so may be adverse and material to our consolidated financial statements.
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Some homebuyers may cancel their home purchases because the required deposits are small and sometimes refundable.
Our backlog at a given point in time reflects the number of homes under a home purchase contract that have not yet been delivered to a homebuyer. Our home purchase contracts typically require only a small deposit, some or all of which is refundable prior to closing. If the prices for new homes decline, competitors increase their use of sales incentives, lenders and others increase their efforts to sell resale homes, skilled trade labor or building materials shortages delay our home construction cycle times, mortgage loan interest rates increase, the availability of mortgage financing further diminishes or there is continued weakness or a downturn in local or regional economies or the national economy and in consumer confidence, customers may cancel their existing home purchase contracts with us because they have been unable to finalize their mortgage financing for the purchase, they desire to move into a home earlier than we can deliver it, or in order to attempt to negotiate for a lower price or explore other options or for other reasons they are unable or unwilling to complete the purchase. In recent years, we have experienced volatile cancellation rates, in part due to these reasons and in part due to the mortgage loan funding issues arising from the 2012 transition of our preferred mortgage lending relationship. To the extent they continue, volatile cancellation rates resulting from these conditions, or otherwise, could have a material adverse effect on our business and our consolidated financial statements.
Tax law changes could make home ownership more expensive or less attractive.
Under current tax law and policy, significant expenses of owning a home, including mortgage loan interest costs and real estate taxes, generally are deductible expenses for the purpose of calculating an individual’s or household’s federal, and in some cases state, taxable income subject to various limitations. For instance, under the American Taxpayer Relief Act of 2012 signed into law in January 2013, the federal government enacted higher income tax rates and limits on the value of tax deductions for certain high-income individuals and households. If the federal government or a state government changes or further changes its income tax laws, as some lawmakers have proposed, by eliminating, limiting or substantially reducing these income tax benefits, the after-tax cost of owning a home could increase substantially. Any additional increases in personal income tax rates and/or additional tax deduction limits or restrictions enacted at the federal or state levels could adversely impact demand for and/or selling prices of new homes, including our homes, and the effect on our consolidated financial statements could be material.
We are subject to substantial legal and regulatory requirements regarding the development of land, the homebuilding process and protection of the environment, which can cause us to suffer delays and incur costs associated with compliance and which can prohibit or restrict homebuilding activity in some regions or areas. The impact of such requirements, individually or collectively, could be adverse and material to the implementation of our strategic growth initiatives and our consolidated financial statements.
Our homebuilding business is heavily regulated and subject to a significant amount of local, state and federal regulation concerning zoning, allowable housing density, natural and other resource protection, building designs, land development and home construction methods, worksite safety and similar matters, as well as governmental taxes, fees and levies on the acquisition and development of land parcels. These regulations often provide broad discretion to government authorities that oversee these matters, which can result in unanticipated delays or increases in the cost of a specified development project or a number of projects in particular markets. We may also experience delays due to a building permit moratorium or regulatory restrictions in any of the locations in which we operate, which can affect the balance of land held for future development in our inventory.
In addition, we are subject to a variety of local, state and federal statutes, ordinances, rules and regulations concerning the environment, including requirements to manage and/or mitigate storm water runoff, dust particles and other environmental impacts of our land development and home construction activities at our new home communities. As discussed below with respect to potential climate change impacts, these laws and regulations, and/or evolving interpretations thereof, may cause delays in our land development and in our construction and delivery of homes, may cause us to incur substantial compliance and other costs, and can prohibit or restrict homebuilding activity in certain regions or areas.
As discussed above under “Item 1. Business — Environmental Compliance Matters,” environmental laws may also impose liability for the costs of removal or remediation of hazardous or toxic substances whether or not the developer or owner of the property knew of, or was responsible for, the presence of those substances. The presence of those substances on our properties may prevent us from selling our homes and we may also be liable, under applicable laws and regulations or lawsuits brought by private parties, for hazardous or toxic substances on land that we have sold in the past.
Further, a significant portion of our business is conducted in California, one of the most highly regulated and litigious states in the country. Therefore, our potential exposure to losses and expenses due to new laws, regulations or litigation may be greater than other homebuilders with a less significant California presence.
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The homebuilding industry and housing market are very competitive, and competitive conditions could adversely affect our business or our consolidated financial statements.
As discussed above under “Item 1. Business — Competition, Seasonality, Delivery Mix and Other Factors,” we face significant competition in several areas of our business from other homebuilders and participants in the overall housing industry. These competitive conditions can result in:
• | our delivering fewer homes; |
• | our selling homes at lower prices; |
• | our offering or increasing sales incentives, discounts or price concessions for our homes; |
• | our experiencing lower housing gross profit margins, particularly if we cannot raise our selling prices to cover increased land acquisition and development, home construction or overhead costs; |
• | our selling fewer homes or experiencing a higher number of cancellations by homebuyers; |
• | impairments in the value of our inventory and other assets; |
• | difficulty in acquiring desirable land that meets our investment return or marketing standards, and in selling our interests in land that no longer meet such standards on favorable terms; |
• | difficulty in our acquiring raw materials and skilled management and trade labor at acceptable prices; |
• | delays in the development of land and/or the construction of our homes; and/or |
• | difficulty in securing external financing, performance bonds or letter of credit facilities on favorable terms. |
These competitive conditions may have a material adverse effect on our business and consolidated financial statements by decreasing our revenues, impairing our ability to successfully implement our current strategies, increasing our costs and/or diminishing growth in our local or regional homebuilding businesses. During the housing downturn in particular, actions taken by our new home and housing alternative competitors reduced the effectiveness of our efforts to achieve stability or increases in home selling prices, to generate higher deliveries of homes, revenues and housing gross profit margins, and to maintain or increase our profitability.
Homebuilding is subject to warranty and liability claims in the ordinary course of business that can be significant.
In the ordinary course of our homebuilding business, we are subject to home warranty and construction defect claims. We record warranty and other liabilities for the homes we deliver based primarily on historical experience in our served markets and our judgment of the risks associated with the types of homes we build. As further described in Note 15. Commitments and Contingencies in the Notes to Consolidated Financial Statements in this report, we maintain, and require the majority of our subcontractors to maintain, general liability insurance (including construction defect and bodily injury coverage) and workers’ compensation insurance. These insurance policies protect us against a portion of our risk of loss from claims related to our homebuilding activities, subject to certain self-insured retentions, deductibles and other coverage limits. We self-insure a portion of our overall risk through the use of a captive insurance subsidiary. We also maintain certain other insurance policies. In Arizona, California, Colorado and Nevada, our subcontractors’ general liability insurance primarily takes the form of a wrap-up policy, where eligible subcontractors are enrolled as insureds on each project. Enrolled subcontractors contribute toward the cost of the insurance and agree to pay a contractual amount in the future in the event of a claim related to their work. For those enrolled subcontractors, we absorb their general liability associated with the work performed on our homes within the applicable projects as part of our overall general liability insurance and our self-insurance through our captive insurance subsidiary. Because of the uncertainties inherent to these matters, we cannot provide any assurance that our various insurance arrangements and our liabilities will be adequate to address all our warranty and construction defect claims in the future, or that any potential inadequacies will not have an adverse effect on our consolidated financial statements. Additionally, the coverage offered by and the availability of general liability insurance for construction defects are currently limited and costly. There can be no assurance that coverage will not be further restricted, increasing our risks and financial exposure to claims, and/or become more costly and to a material degree.
We engage subcontractors to perform the actual construction of our homes, and in many cases, to obtain the necessary building materials. Our contracts with our subcontractors require that they comply with all laws applicable to their work, including labor laws, meet performance standards, and follow local building codes and permits. However, we may encounter improper construction practices or the installation of defective materials in our homes, among other things. When we discover these issues, we will evaluate and if necessary, repair the homes in accordance with our new home limited warranty and as required by law. For instance,
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in late 2012 and during 2013, we undertook a significant effort to repair homes in certain of our communities in central and southwest Florida affected by various problems that resulted in water intrusion-related issues. The adverse costs of satisfying our warranty and other legal obligations in these instances may be significant and we may need to record charges to reflect an increased overall warranty liability, as has been the case with our repair efforts in central and southwest Florida. Although we will pursue recoveries from potentially responsible parties, we may be unable to recover the costs of warranty-related repairs from subcontractors, suppliers or insurers, which could have a material impact on our consolidated financial statements. We can provide no assurance that in 2014 we will not face more warranty-related claims and/or incur higher costs to satisfy repair or other obligations related to our new home limited warranty and customer service activities, or not need to record charges to adjust our overall warranty liability, or be successful in obtaining any recoveries for warranty-related costs we incur from responsible parties.
Because of the seasonal nature of our business, our quarterly operating results fluctuate.
As discussed above under “Item 1. Business — Competition, Seasonality, Delivery Mix and Other Factors,” we have experienced seasonal fluctuations in our quarterly operating results that can have a material impact on our results and our consolidated financial statements. Historically, a significant percentage of our home purchase contracts are entered into in the spring and early summer months, and we deliver a corresponding significant percentage of our homes in the late summer and fall months. As a result, we historically have experienced uneven quarterly results, with lower revenues and operating income generally during the first and second quarters of our fiscal year. We currently expect to experience the traditional seasonality cycle and its impact on our results as the present housing recovery progresses, but we can make no assurances as to the degree to which our historical seasonal patterns will occur in 2014 and beyond, if at all.
We may be restricted in accessing external capital, and to the extent we can access external capital, it may increase our costs of capital or result in stockholder dilution.
We have historically funded our homebuilding and financial services activities with internally generated cash flows and external sources of debt and equity financing. However, during the housing downturn, we relied primarily on the positive operating cash flow we generated, principally through the receipt of federal income tax refunds, and from home and land sales and our efforts to reduce our overhead costs, to meet our working capital needs and to repay outstanding indebtedness. In recent years, the impact of the housing downturn in reducing our stockholders’ equity and increasing our debt-to-capital ratio and volatility in the financial and credit markets made external sources of liquidity less available and more costly to us. In 2013, relatively favorable housing and credit market conditions enabled us to refinance and extend the maturity of our outstanding senior notes due in 2014 and certain of our outstanding senior notes due in 2015 through the issuance of new senior notes, albeit at somewhat higher interest rates than the refinanced debt, and to raise unrestricted cash for general business purposes. We also entered into the Credit Facility. We can provide no assurances, however, that we will be able to access external credit or equity markets in 2014 at favorable terms or at all.
Market conditions in 2014 and beyond may significantly limit our ability to replace or refinance indebtedness, particularly given the ratings of our senior notes by the three principal nationally recognized registered credit rating agencies, as discussed further below. The terms of potential future issuances of indebtedness by us may be more restrictive than the terms governing our current indebtedness, and the issuance, interest and debt service expenses are likely to be higher, as was the case with the new senior notes we issued in 2013. In addition, our lower stock price and unrestricted cash balance compared to the level reached before the housing downturn began and volatility in the stock markets could also impede our access to the equity markets or increase the amount of dilution our stockholders would experience should we seek to raise capital through the issuance of new equity or convertible securities.
While we believe we can meet our forecasted capital requirements from our cash resources, expected future cash flow, capital markets access and the external financing sources that we anticipate will be available to us, we can provide no assurance that we will be able to do so, or do so without incurring substantially higher costs or significantly diluting existing stockholders’ equity interests. The adverse effects of these conditions on our business, liquidity and consolidated financial statements could be material to us.
We have a substantial amount of indebtedness in relation to our tangible net worth and unrestricted cash balance, which may restrict our ability to meet our operational and strategic goals.
As of November 30, 2013, we had total outstanding debt of $2.15 billion, total stockholders’ equity of $536.1 million, and an unrestricted cash balance of $530.1 million. The amount of our debt overall and relative to our total stockholders’ equity and unrestricted cash balance could have important consequences. For example, it could:
• | limit our ability to obtain future financing for working capital, capital expenditures, acquisitions, debt service requirements or other business needs, including, but not limited to, supporting our strategic growth initiatives; |
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• | limit our ability to maintain compliance with the financial covenants of the Credit Facility or to renew or, if necessary or desirable, expand the capacity of the Credit Facility; |
• | limit our ability to renew or, if necessary or desirable, expand the capacity of any letter of credit facilities, and to obtain performance bonds in the ordinary course of our business; |
• | require us to dedicate a substantial portion of our cash flow from operations to the collateralization or payment of our debt and reduce our ability to use our cash flow for other purposes; |
• | impact our flexibility in planning for, or reacting to, changes in our business; |
• | limit our ability to implement our present strategies, particularly our land acquisition and development plans and asset activation initiatives, in part due to competition from other homebuilders, developers and investors with greater available liquidity or balance sheet strength; |
• | place us at a competitive disadvantage because we have more debt or debt-related restrictions than some of our competitors; and |
• | make us more vulnerable in the event of weakness or a downturn in our business or in general economic or housing market conditions. |
Our ability to meet our debt service and other obligations will depend on our future performance. Our business is substantially affected by changes in economic cycles. Our revenues, earnings and cash flows vary with the level of general economic activity and competition in the markets in which we operate. They could also be affected by financial, political, regulatory, environmental and other factors, many of which are beyond our control. A higher interest rate on our debt could materially and adversely affect our consolidated financial statements.
Our business may not generate sufficient cash flow from operations and external financing at a reasonable cost may not be available to us in an amount sufficient to meet our debt service obligations, fulfill the financial or operational obligations we may have under certain unconsolidated joint venture transactions, support our letter of credit facilities (including the LOC Facilities), or to fund our other liquidity or operational needs. Further, if a change of control were to occur as defined in the instrument governing our senior notes, we would be required to offer to purchase all of our outstanding senior notes (with the exception of the amounts outstanding related to our 6 1/4% senior notes due 2015 (the “6 1/4% Senior Notes due 2015”) and our 7 1/4% senior notes due 2018 (the “7 1/4% Senior Notes due 2018”)) at 101% of their principal amount, together with all accrued and unpaid interest, if any. If a fundamental change under the terms of our 1.375% convertible senior notes due 2019 (the “1.375% Convertible Senior Notes due 2019”), which includes a change of control, occurs prior to their stated maturity date, the holders may require us to purchase for cash all or any portion of their notes at 100% of the principal amount of the notes, plus accrued and unpaid interest to, but not including, the fundamental change purchase date. In such circumstances of an applicable change of control and/or fundamental change, if we are unable to generate sufficient cash flow from operations, we may, given our unrestricted cash balance, need to refinance and/or restructure with our lenders or other creditors all or a portion of our outstanding debt obligations on or before their maturity, which we may not be able to do on favorable terms or at all, or raise capital through equity or convertible security issuances that would dilute existing stockholders’ interests, and the impact on our consolidated financial statements would be material and adverse.
Failure to comply with the restrictions and covenants imposed by the Credit Facility could restrict future borrowing or cause any outstanding indebtedness to become immediately due and payable.
Under the terms of the Credit Facility, we are required, among other things, to maintain compliance with various covenants, including financial covenants relating to our tangible net worth, leverage, and interest coverage or liquidity. The Credit Facility is also governed by a borrowing base test and includes a limitation on investments in joint ventures and non-guarantor subsidiaries. In addition, the existence of these restrictions and covenants may influence our operating decisions to enter into or structure certain transactions in order to maintain compliance. If we fail to comply, the participating financial institutions could terminate the Credit Facility, cause borrowings under the Credit Facility, if any, to become immediately due and payable and/or could demand that we compensate them for waiving instances of noncompliance. In addition, under certain circumstances, a default under the Credit Facility could cause a default with respect to our senior or convertible senior notes and result in the acceleration of the maturity of our senior or convertible senior notes and our inability to borrow under the Credit Facility, which would have a material adverse impact on our liquidity and on our consolidated financial statements. Moreover, we may need to curtail our investment activities and other uses of cash to maintain compliance with the restrictions and covenants under the Credit Facility.
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Our ability to obtain external financing could be adversely affected by a negative change in our credit rating by a third-party rating agency.
Our ability to access the capital markets and external financing sources on favorable terms is a key factor in our ability to fund our operations and to grow our business. As of the date of this report, our credit rating by Fitch Ratings is B+, with a stable outlook, our credit rating by Moody’s Investor Services is B2, with a stable outlook, and our credit rating by Standard and Poor’s Financial Services is B, with a stable outlook. Downgrades of our credit rating by any of these principal nationally recognized registered credit rating agencies may make it more difficult and costly for us to access the capital markets and external financing sources, and could have a material adverse effect on our consolidated financial statements.
We may have difficulty in continuing to obtain the additional financing required to operate and develop our business.
Our homebuilding operations and our present strategies require significant amounts of cash and/or the availability of external financing. We have entered into the Credit Facility and the LOC Facilities in order to support certain aspects of our operations in the ordinary course of our business, including our acquisition of land and our development of new home communities and other of our strategic growth initiatives. We anticipate that we will need to maintain the Credit Facility and the LOC Facilities in 2014, and, if necessary or desirable, we may seek to expand their capacities or enter into additional such facilities, or other similar facility arrangements with the same or other financial institutions. It is not possible to predict the future terms or availability of additional external capital or for maintaining or, if necessary or desirable, expanding the capacity of the Credit Facility or the LOC Facilities or entering into additional such facilities. Moreover, our outstanding senior notes and convertible senior notes contain provisions that may restrict the amount and nature of debt we may incur in the future. As the financial and credit markets worldwide have been experiencing and may continue to experience volatility, there can be no assurance that we can at reasonable cost actually borrow additional funds, raise additional capital through other means, or successfully maintain or, if necessary or desirable, expand the capacity of the Credit Facility or the LOC Facilities or enter into additional such facilities, each of which depends, among other factors, on conditions in the capital markets and our perceived credit worthiness, as discussed above. If conditions in the financial and credit markets continue to be volatile or worsen, whether generally, or for homebuilders or us in particular, it could reduce our ability to generate home sales and may hinder our future growth and materially impact our consolidated financial statements. Potential federal and state regulations limiting the investment activities of financial institutions, including regulations that have been or may be issued under the Dodd-Frank Act, could also impact our ability to access the capital markets, to obtain additional external financing and to maintain or, if necessary or desirable, expand the Credit Facility or the LOC Facilities or enter into additional such facilities, in each case on acceptable terms or at all.
Failure to comply with the covenants and conditions imposed by the agreements governing our indebtedness could restrict future borrowing or cause our debt to become immediately due and payable.
The indenture governing our outstanding senior notes and convertible senior notes imposes restrictions on our business operations and activities. Though it does not contain any financial maintenance covenants, the indenture contains certain restrictive covenants that, among other things, limit our ability to incur secured indebtedness, to engage in sale-leaseback transactions involving property or assets above a specified value, and, as in the case of four of our outstanding senior notes and our convertible senior notes, to engage in mergers, consolidations, and sales of assets. Due to financial and credit market conditions, we may also need to include additional covenants, obligations or restrictions in our indenture or with respect to a specific issuance of securities or to our currently outstanding securities. If we fail to comply with these covenants, obligations or restrictions, the holders of our senior notes or convertible senior notes could cause our debt to become due and payable prior to maturity or could demand that we compensate them for waiving instances of noncompliance, and, if they are successful in doing so, the impact on our consolidated financial statements would be material and adverse. In addition, a default under any series of our senior notes or convertible senior notes could cause a default with respect to our other senior notes and result in the acceleration of the maturity of all such defaulted indebtedness and other debt obligations, as well as penalties or additional fees, which would have a material adverse impact on our consolidated financial statements.
We may not realize our deferred income tax assets. In addition, our net operating loss carryforwards could be substantially limited if we experience an ownership change as defined in the Internal Revenue Code.
Since the end of our 2007 fiscal year, we have generated a significant deferred tax asset as a result of our net operating losses (“NOL”). Under federal tax laws, we can use our NOL (and certain related tax credits) to reduce our future taxable income for up to 20 years, after which they expire for such purposes. In 2013, we were able to use a portion of our deferred tax assets to offset the taxable income we generated for the year. Until they expire, we can carry forward our NOL (and certain related tax credits) that we do not use in any particular year to reduce our taxable income in future years, and we have recorded a valuation allowance against our net deferred tax assets that include the NOL (and certain related tax credits) that we have generated but have not yet realized. At November 30, 2013, we had deferred tax assets, net of deferred tax liabilities, totaling $859.4 million
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against which we have provided a full valuation allowance. Our ability to realize our net deferred tax assets is based on the extent to which we generate sustained profits and we cannot provide any assurances as to when and to what extent we will generate sufficient future taxable income to realize our net deferred tax assets, whether in whole or in part.
The majority of our net deferred tax asset is federal related and is valued at a 35% corporate income tax rate. If, as some lawmakers have proposed, the U.S. corporate income tax rate is lowered, we would be required to write down a roughly proportionate amount of the value of our federal net deferred tax asset to account for this lower rate. We would also need to record a corresponding write down of our valuation allowance. The lower tax rate would reduce our future federal taxes, which may put a portion of our tax credits at risk of expiring before we could use them.
In addition, the benefits of our NOL, built-in losses and tax credits would be reduced or potentially eliminated if we experienced an “ownership change,” as determined under Internal Revenue Code Section 382 (“Section 382”). A Section 382 ownership change occurs if a stockholder or a group of stockholders who are deemed to own at least 5% of our common stock increase their ownership by more than 50 percentage points over their lowest ownership percentage within a rolling three-year period. If an ownership change were to occur, Section 382 would impose an annual limit on the amount of NOL we could use to reduce our taxable income equal to the product of the total value of our outstanding equity immediately prior to the ownership change (reduced by certain items specified in Section 382) and the federal long-term tax-exempt interest rate in effect for the month of the ownership change. A number of complex rules apply in calculating this annual limit.
While the complexity of Section 382’s provisions and the limited knowledge any public company has about the ownership of its publicly-traded stock make it difficult to determine whether an ownership change has occurred, we currently believe that an ownership change has not occurred. However, if an ownership change were to occur, the annual limit Section 382 may impose could result in a material amount of our NOL expiring unused. This would significantly impair the value of our NOL and, as a result, have a material negative impact on our consolidated financial statements.
In 2009, our stockholders approved an amendment to our restated certificate of incorporation that is designed to block transfers of our common stock that could result in an ownership change, and a rights agreement pursuant to which we have issued certain stock purchase rights with terms designed to deter transfers of our common stock that could result in an ownership change. However, these measures cannot guarantee complete protection against an ownership change and it remains possible that one may occur.
Our consolidated financial statements could be materially and adversely affected if we are unable to obtain performance bonds and/or letters of credit.
In the course of developing our communities, we are often required to provide to various municipalities and other government agencies performance bonds and/or letters of credit to secure the completion of our projects and/or in support of obligations to build community improvements such as roads, sewers, water systems and other utilities, and to support similar development activities by certain of our unconsolidated joint ventures. We may also be required to provide performance bonds and/or letters of credit to secure our performance under various escrow agreements, financial guarantees and other arrangements. Our ability to obtain such bonds or letters of credit and the cost to do so depend on our credit rating, overall market capitalization, available capital, past operational and financial performance, management expertise and other factors, including prevailing surety market conditions, and the underwriting practices and resources of performance bond and/or letter of credit issuers. If we are unable to obtain performance bonds and/or letters of credit when required or the cost or operational restrictions or conditions imposed by issuers to obtain them increases significantly in 2014 or later, we may not be able to develop or we may be significantly delayed in developing a community or communities and/or we may incur significant additional expenses, and, as a result, our consolidated financial statements, cash flows and/or liquidity could be materially and adversely affected.
Our ability to attract and retain talent is critical to the success of our business and a failure to do so may materially and adversely affect our performance.
Our officers and employees are an important resource, and we see attracting and retaining a dedicated and talented team to execute our KBnxt operational business model as crucial to our ability to achieve and maintain an advantage over other homebuilders. We face intense competition for qualified personnel, particularly at senior management levels, from other homebuilders, from other companies in the housing and real estate industries, particularly with the increased residential construction activity in 2012 and 2013, and from companies in various other industries with respect to certain roles or functions. Moreover, the prolonged housing downturn and the decline in the market value of our common stock during the housing downturn have made it difficult for us to attract and retain talent, even as we are making a targeted effort to strengthen and expand certain of our local field management teams and talent as part of our strategic growth initiatives. If we are unable to continue to retain and attract qualified employees, or if we need to significantly increase compensation and benefits to do so (including as a result of complying with pending health care coverage requirements of the federal Patient Protection and Affordable Care Act and the Health Care
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Education Reconciliation Act of 2010), or, alternatively, if we are required or believe it is appropriate to reduce our overhead expenses through significant personnel reductions or adjustments to compensation and benefits, our performance, our ability to achieve and maintain a competitive advantage and our consolidated financial statements could be materially and adversely affected.
Changes in global or regional environmental conditions and governmental actions in response to such changes may adversely affect us by increasing the costs of or restricting our planned or future growth activities.
There is growing concern from members of the scientific community and the general public that an increase in global average temperatures due to emissions of greenhouse gases and other human activities have caused or will cause significant changes in weather patterns and increase the frequency and severity of natural disasters. An increased frequency or duration of extreme weather conditions and environmental events could limit, delay and/or increase the costs to develop land and build new homes and reduce the value of our land and housing inventory in locations that become less desirable to consumers or blocked to development. Projected climate change, if it occurs, may exacerbate the scarcity of water and other natural resources in affected regions, which could limit, prevent or increase the costs of residential development in certain areas. In addition, government mandates, standards or regulations intended to mitigate or reduce greenhouse gas emissions or projected climate change impacts could result in prohibitions or severe restrictions on land development in certain areas, increase energy, transportation and raw material costs that make building materials less available or more expensive, or cause us to incur compliance expenses and other financial obligations to meet permitting or land development- or home construction-related requirements that we will be unable to fully recover (due to market conditions or other factors), and reduce our housing gross profit margins and adversely affect our consolidated financial statements, potentially to a material degree. As a result, climate change impacts, and laws and land development and home construction standards, and/or the manner in which they are interpreted or implemented, to address potential climate change impacts, could increase our costs and have a long-term adverse impact on our business and our consolidated financial statements. This is a particular concern with respect to our key West Coast homebuilding reporting segment, as California has instituted some of the most extensive and stringent environmental laws and residential building construction standards in the country.
Information technology failures and data security breaches could harm our business.
We use information technology, digital telecommunications and other computer resources to carry out important operational and promotional marketing activities and to maintain our business records. Many of these resources are provided to us and/or maintained on our behalf by third-party service providers pursuant to agreements that specify to varying degrees certain security and service level standards. Although we and our service providers employ what we believe are adequate security, disaster recovery and other preventative and corrective measures, our ability to conduct our business may be impaired if these resources, including our primary website, are compromised, degraded, damaged or fail, whether due to a virus or other harmful circumstance, intentional penetration or disruption of our information technology resources by a third party, natural disaster, hardware or software corruption or failure or error (including a failure of security controls incorporated into or applied to such hardware or software), telecommunications system failure, service provider error or failure, intentional or unintentional personnel actions (including the failure to follow our security protocols), or lost connectivity to our networked resources. A significant and extended disruption in the functioning of these resources, including our primary website, could damage our reputation and cause us to lose customers, orders, deliveries of homes and revenues, result in the unintended and/or unauthorized public disclosure or the misappropriation of proprietary, personal identifying and confidential information (including information about our homebuyers and business partners), and require us to incur significant expense to address and remediate or otherwise resolve these kinds of issues. The release of confidential information may also lead to litigation or other proceedings against us by affected individuals and/or business partners and/or by regulators, and the outcome of such proceedings, which could include penalties or fines and cause reputational harm, could have a material and adverse effect on our consolidated financial statements. In addition, the costs of maintaining adequate protection against such threats, depending on their evolution, pervasiveness and frequency and/or government-mandated standards or obligations regarding protective efforts, could be material to our consolidated financial statements in a particular period or over various periods.
Item 1B. | UNRESOLVED STAFF COMMENTS |
None.
Item 2. | PROPERTIES |
We lease our corporate headquarters in Los Angeles, California. Our homebuilding division offices (except for our San Antonio, Texas office) and our KB Home Studios are located in leased space in the markets where we conduct business. We own the premises for our San Antonio office.
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We believe that such properties, including the equipment located therein, are suitable and adequate to meet the needs of our businesses.
Item 3. | LEGAL PROCEEDINGS |
Nevada Development Contract Litigation
KB HOME Nevada Inc., a wholly owned subsidiary of ours (“KB Nevada”), is a defendant in a case in the Eighth Judicial District Court in Clark County, Nevada entitled Las Vegas Development Associates, LLC, Essex Real Estate Partners, LLC, et al. v. KB HOME Nevada Inc. In 2007, Las Vegas Development Associates, LLC (“LVDA”) agreed to purchase from KB Nevada approximately 83 acres of land located near Las Vegas, Nevada. LVDA subsequently assigned its rights to Essex Real Estate Partners, LLC (“Essex”). KB Nevada and Essex entered into a development agreement relating to certain major infrastructure improvements. LVDA’s and Essex’s complaint, initially filed in 2008, alleged that KB Nevada breached the development agreement, and also alleged that KB Nevada fraudulently induced them to enter into the purchase and development agreements. LVDA’s and Essex’s lenders subsequently filed related actions that were consolidated into the LVDA/Essex matter. The consolidated plaintiffs sought rescission of the agreements or, in the alternative, compensatory damages of $55 million plus unspecified punitive damages and other damages, and interest charges in excess of $41 million (the “Claimed Damages”). KB Nevada has denied the allegations, and believes it has meritorious defenses to the consolidated plaintiffs’ claims. At a November 19, 2012 hearing, the court denied all of the consolidated plaintiffs’ motions for summary judgment on their claims. In addition, the court granted several of KB Nevada's motions for summary judgment, eliminating, among other of the consolidated plaintiffs’ claims, all claims for fraud, negligent misrepresentation, and punitive damages. With the court’s decisions, the only remaining claims against KB Nevada are for contract damages and rescission. In August 2013, the court granted motions that further narrowed the scope of the Claimed Damages. While the ultimate outcome is uncertain — we believe it is reasonably possible that the loss in this matter could range from zero to approximately $55 million plus pre-judgment interest, which could be material to our consolidated financial statements — KB Nevada believes it will be successful in defending against the consolidated plaintiffs’ remaining claims and that the consolidated plaintiffs will not be awarded rescission or damages. The non-jury trial, originally set for September 2012, was recently continued again until May 20, 2014.
Other Matters
In addition to the specific proceeding described above, we are involved in other litigation and regulatory proceedings incidental to our business that are in various procedural stages. We believe that the accruals we have recorded for probable and reasonably estimable losses with respect to these proceedings are adequate and that, as of November 30, 2013, it was not reasonably possible that an additional material loss had been incurred in an amount in excess of the estimated amounts already recognized on our consolidated financial statements. We evaluate our accruals for litigation and regulatory proceedings at least quarterly and, as appropriate, adjust them to reflect (a) the facts and circumstances known to us at the time, including information regarding negotiations, settlements, rulings and other relevant events and developments; (b) the advice and analyses of counsel; and (c) the assumptions and judgment of management. Similar factors and considerations are used in establishing new accruals for proceedings as to which losses have become probable and reasonably estimable at the time an evaluation is made. Based on our experience, we believe that the amounts that may be claimed or alleged against us in these proceedings are not a meaningful indicator of our potential liability. The outcome of any of these proceedings, including the defense and other litigation-related costs and expenses we may incur, however, is inherently uncertain and could differ significantly from the estimate reflected in a related accrual, if made. Therefore, it is possible that the ultimate outcome of any proceeding, if in excess of a related accrual or if no accrual had been made, could be material to our consolidated financial statements.
Item 4. | MINE SAFETY DISCLOSURES |
Not applicable.
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EXECUTIVE OFFICERS OF THE REGISTRANT
The following table presents certain information regarding our executive officers as of December 31, 2013:
Name | Age | Present Position | Year Assumed Present Position | Years at KB Home | Other Positions and Other Business Experience within the Last Five Years (a) | From – To | ||||||
Jeffrey T. Mezger | 58 | President and Chief Executive Officer (b) | 2006 | 20 | ||||||||
Jeff J. Kaminski | 52 | Executive Vice President and Chief Financial Officer | 2010 | 3 | Senior Vice President, Chief Financial Officer and Strategy Board member, Federal-Mogul Corporation (a global supplier of component parts and systems to the automotive, heavy-duty, industrial and transport markets) | 2008-2010 | ||||||
Albert Z. Praw | 65 | Executive Vice President, Real Estate and Business Development | 2011 | 17 (c) | Chief Executive Officer, Landstone Communities, LLC (a real estate development company) | 2006-2011 | ||||||
Brian J. Woram | 53 | Executive Vice President and General Counsel | 2010 | 3 | Senior Vice President and Chief Legal Officer, H&R Block, Inc. (a provider of tax, banking and business and consulting services) | 2009-2010 | ||||||
Senior Vice President, Chief Legal Officer and Chief Compliance Officer, Centex Corporation (a homebuilder and provider of mortgage banking services) | 2005-2009 | |||||||||||
William R. Hollinger | 55 | Senior Vice President and Chief Accounting Officer | 2007 | 26 | ||||||||
Thomas F. Norton | 43 | Senior Vice President, Human Resources | 2009 | 5 | Chief Human Resources Officer, BJ’s Restaurants, Inc. (an owner and operator of national full service restaurants) | 2006-2009 | ||||||
Tom Silk | 45 | Senior Vice President, Marketing and Communications | 2011 | 2 | Vice President of Marketing for Hydration and Juice Brands, PepsiCo Beverages Americas (a beverage marketing and distribution company) | 2009-2011 | ||||||
Senior Director, Global Brand Management, Activision Blizzard, Inc. (a game publisher of interactive entertainment software) | 2006-2009 | |||||||||||
(a) | All positions described were with us, unless otherwise indicated. |
(b) | Mr. Mezger has served as a director since 2006. |
(c) | Mr. Praw was employed by us from 1989-1992 and from 1994-2006. He was elected to his present position in October 2011. |
There is no family relationship between any of our executive officers or between any of our executive officers and any of our directors.
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PART II
Item 5. | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
As of December 31, 2013, there were 704 holders of record of our common stock. Our common stock is traded on the New York Stock Exchange under the ticker symbol “KBH.” The following table presents, for the periods indicated, the price ranges of our common stock, and cash dividends declared and paid per share:
Year Ended November 30, 2013 | Year Ended November 30, 2012 | ||||||||||||||||||||||||||||||
High | Low | Dividends Declared | Dividends Paid | High | Low | Dividends Declared | Dividends Paid | ||||||||||||||||||||||||
First Quarter | $ | 20.04 | $ | 13.86 | $ | .0250 | $ | .0250 | $ | 12.91 | $ | 6.17 | $ | .0625 | $ | .0625 | |||||||||||||||
Second Quarter | 25.14 | 18.21 | .0250 | .0250 | 13.12 | 6.77 | .0250 | .0250 | |||||||||||||||||||||||
Third Quarter | 22.49 | 15.57 | .0250 | .0250 | 11.25 | 6.46 | .0250 | .0250 | |||||||||||||||||||||||
Fourth Quarter | 18.98 | 15.48 | .0250 | .0250 | 17.30 | 10.89 | .0250 | .0250 | |||||||||||||||||||||||
The declaration and payment of cash dividends on shares of our common stock, whether at current levels or at all, are at the discretion of our board of directors, and depend upon, among other things, our expected future earnings, cash flows, capital requirements, debt structure and adjustments thereto, operational and financial investment strategy and general financial condition, as well as general business conditions.
The description of our equity compensation plans required by Item 201(d) of Regulation S-K is incorporated herein by reference to “Part III — Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” of this report.
We did not repurchase any of our equity securities during the fourth quarter of 2013.
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Stock Performance Graph
The graph below compares the five-year cumulative total return of KB Home common stock, the S&P 500 Index, the S&P Homebuilding Index and the Dow Jones Home Construction Index for the periods ended November 30.
Comparison of Five-Year Cumulative Total Return
Among KB Home, S&P 500 Index, S&P Homebuilding
Index and Dow Jones Home Construction Index
2008 | 2009 | 2010 | 2011 | 2012 | 2013 | ||||||||||||
KB Home | 100 | 118 | 101 | 67 | 133 | 163 | |||||||||||
S & P 500 Index | 100 | 125 | 138 | 149 | 173 | 225 | |||||||||||
S & P Homebuilding Index | 100 | 123 | 114 | 130 | 270 | 278 | |||||||||||
Dow Jones Home Construction Index | 100 | 120 | 109 | 118 | 207 | 216 | |||||||||||
The above graph is based on the KB Home common stock and index prices calculated as of the last trading day before December 1 of the year-end periods presented. The closing price of KB Home common stock on the New York Stock Exchange was $17.53 per share on November 30, 2013 and $14.36 per share on November 30, 2012. The performance of our common stock depicted in the graphs above represents past performance only and is not indicative of future performance. Total return assumes $100 invested at market close on November 30, 2008 in KB Home common stock, the S&P 500 Index, the S&P Homebuilding Index and the Dow Jones Home Construction Index including reinvestment of dividends.
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Item 6. | SELECTED FINANCIAL DATA |
The data in this table should be read in conjunction with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our Consolidated Financial Statements and the Notes thereto, which are included in “Item 8. Financial Statements and Supplementary Data.” Both are included in this report.
KB HOME
SELECTED FINANCIAL INFORMATION
(Dollars In Thousands, Except Per Share Amounts)
Years Ended November 30, | |||||||||||||||||||
2013 | 2012 | 2011 | 2010 | 2009 | |||||||||||||||
Statement of Operations Data: | |||||||||||||||||||
Revenues: | |||||||||||||||||||
Homebuilding | $ | 2,084,978 | $ | 1,548,432 | $ | 1,305,562 | $ | 1,581,763 | $ | 1,816,415 | |||||||||
Financial services | 12,152 | 11,683 | 10,304 | 8,233 | 8,435 | ||||||||||||||
Total | $ | 2,097,130 | $ | 1,560,115 | $ | 1,315,866 | $ | 1,589,996 | $ | 1,824,850 | |||||||||
Operating income (loss): | |||||||||||||||||||
Homebuilding | $ | 92,084 | $ | (20,256 | ) | $ | (103,074 | ) | $ | (16,045 | ) | $ | (236,520 | ) | |||||
Financial services | 9,110 | 8,692 | 6,792 | 5,114 | 5,184 | ||||||||||||||
Total | $ | 101,194 | $ | (11,564 | ) | $ | (96,282 | ) | $ | (10,931 | ) | $ | (231,336 | ) | |||||
Pretax income (loss) | $ | 38,363 | $ | (79,053 | ) | $ | (181,168 | ) | $ | (76,368 | ) | $ | (311,184 | ) | |||||
Net income (loss) | $ | 39,963 | $ | (58,953 | ) | $ | (178,768 | ) | $ | (69,368 | ) | $ | (101,784 | ) | |||||
Earnings (loss) per share: | |||||||||||||||||||
Basic | $ | .48 | $ | (.76 | ) | $ | (2.32 | ) | $ | (.90 | ) | $ | (1.33 | ) | |||||
Diluted | $ | .46 | $ | (.76 | ) | $ | (2.32 | ) | $ | (.90 | ) | $ | (1.33 | ) | |||||
Cash dividends declared per common share | $ | .1000 | $ | .1375 | $ | .2500 | $ | .2500 | $ | .2500 | |||||||||
Balance Sheet Data: | |||||||||||||||||||
Assets: | |||||||||||||||||||
Homebuilding | $ | 3,183,595 | $ | 2,557,243 | $ | 2,480,369 | $ | 3,080,306 | $ | 3,402,565 | |||||||||
Financial services | 10,040 | 4,455 | 32,173 | 29,443 | 33,424 | ||||||||||||||
Total | $ | 3,193,635 | $ | 2,561,698 | $ | 2,512,542 | $ | 3,109,749 | $ | 3,435,989 | |||||||||
Mortgages and notes payable | $ | 2,150,498 | $ | 1,722,815 | $ | 1,583,571 | $ | 1,775,529 | $ | 1,820,370 | |||||||||
Stockholders’ equity | $ | 536,086 | $ | 376,806 | $ | 442,657 | $ | 631,878 | $ | 707,224 | |||||||||
Homebuilding Data: | |||||||||||||||||||
Net orders | 7,125 | 6,703 | 6,632 | 6,556 | 8,341 | ||||||||||||||
Unit backlog | 2,557 | 2,577 | 2,156 | 1,336 | 2,126 | ||||||||||||||
Homes delivered | 7,145 | 6,282 | 5,812 | 7,346 | 8,488 | ||||||||||||||
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Item 7. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
RESULTS OF OPERATIONS
Overview. Revenues are generated from our homebuilding and financial services operations. The following table presents a summary of our consolidated results of operations for the years ended November 30, 2013, 2012 and 2011 (in thousands, except per share amounts):
Years Ended November 30, | Variance | ||||||||||||||||
2013 | 2012 | 2011 | 2013 vs 2012 | 2012 vs 2011 | |||||||||||||
Revenues: | |||||||||||||||||
Homebuilding | $ | 2,084,978 | $ | 1,548,432 | $ | 1,305,562 | 35 | % | 19 | % | |||||||
Financial services | 12,152 | 11,683 | 10,304 | 4 | 13 | ||||||||||||
Total | $ | 2,097,130 | $ | 1,560,115 | $ | 1,315,866 | 34 | % | 19 | % | |||||||
Pretax income (loss): | |||||||||||||||||
Homebuilding | $ | 28,179 | $ | (89,936 | ) | $ | (207,246 | ) | (a) | 57 | % | ||||||
Financial services | 10,184 | 10,883 | 26,078 | (6 | ) | (58 | ) | ||||||||||
Total pretax income (loss) | 38,363 | (79,053 | ) | (181,168 | ) | (a) | 56 | ||||||||||
Income tax benefit | 1,600 | 20,100 | 2,400 | (92 | ) | 738 | |||||||||||
Net income (loss) | $ | 39,963 | $ | (58,953 | ) | $ | (178,768 | ) | (a) | 67 | % | ||||||
Earnings (loss) per share: | |||||||||||||||||
Basic | $ | .48 | $ | (.76 | ) | $ | (2.32 | ) | (a) | 67 | % | ||||||
Diluted | $ | .46 | $ | (.76 | ) | $ | (2.32 | ) | (a) | 67 | % | ||||||
(a) Percentage not meaningful.
The U.S. housing market continued to improve in 2013, supported by steady demand, low inventories of homes available for sale, relatively high housing affordability, and a generally favorable economic environment. However, the performance of individual housing markets varied over the course of 2013, and rising mortgage loan interest rates and home price levels, and a decline in consumer confidence in the fall, tempered home sales activity in the second half of the year. We believe this recent moderation in activity, which has slowed the rate of increases in home selling prices, may provide a healthier foundation for a strong, sustainable housing recovery, and that additional progress will be made in many housing markets and by the overall homebuilding industry in 2014.
We achieved measurably improved financial performance on key metrics in our business in each quarter of 2013, including year-over-year growth in revenues, expansion of our housing gross profit margin and improvement in our bottom line results, and generated full-year profitability for the first time in several years. We believe these improvements largely resulted from the various ongoing strategic initiatives we have implemented over the past few years to reposition our homebuilding activities and investments toward higher-performing, desirable locations in land constrained growth markets, refine our products to meet consumer preferences, and sharpen our focus on reaching our profitability and growth goals. We also benefited from the overall improvement in housing markets. Our success in implementing these initiatives was particularly evident in our West Coast homebuilding reporting segment, which generated nearly half of our revenues in 2013. This segment’s average selling price rose 20% and its housing gross profit margin improved 840 basis points in 2013 compared to results in the prior year.
We took a number of steps in 2013 to further strengthen our business and to support our strategic growth initiatives. We raised capital in both public equity and debt markets, generating total net proceeds of $775.5 million through the concurrent underwritten public issuance of the 1.375% Convertible Senior Notes due 2019 and the underwritten public offering of 6,325,000 shares of our common stock, par value $1.00 per share, at a price of $18.25 per share (the “Common Stock Offering”), and the underwritten public issuance of our 7.00% senior notes due 2021 (the “7.00% Senior Notes due 2021”); entered into the Credit Facility; retired $215.1 million in aggregate principal amount of certain of our senior notes due 2014 and 2015 through a combination of purchases made pursuant to the terms of the applicable tender offers that were initially made on October 15, 2013 (the “October 2013 Tender Offers”) and redemptions; used the net proceeds from the equity and senior notes issuances and positive cash flows from operations
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to invest $1.14 billion in land and land development; and formed a mortgage banking company in partnership with Nationstar to offer mortgage banking services to our homebuyers.
We believe these actions enabled us to generate positive year-over-year results in 2013 in several key metrics:
• | Revenues. Total revenues of $2.10 billion for the year ended November 30, 2013 rose 34% from $1.56 billion for 2012. This increase was primarily due to a 35% rise in housing revenues to $2.08 billion from $1.55 billion for 2012, reflecting increases in both the number of homes delivered and the overall average selling price of those homes. For 2013, our total revenues included land sale revenues of $.9 million, compared to no land sale revenues for 2012. Also included in our total revenues were financial services revenues of $12.2 million for 2013 and $11.7 million for 2012. |
◦ | Homes Delivered. We delivered 7,145 homes in 2013, up 14% from 6,282 homes delivered in 2012, partly due to our relatively higher backlog at the beginning of the year, which was up 20% on a year-over-year basis, and the strategic positioning of our communities in locations with relatively strong demand. |
◦ | Average Selling Price. The overall average selling price of our homes delivered increased 18% in 2013 (and 10% in 2012 compared to 2011). This year-over-year increase reflected our efforts over the past few years to strategically position our new home communities in submarkets where buyers have higher household income levels and stronger credit profiles, are choosing to purchase larger homes at higher price points and are spending more on design options and features at our KB Home Studios. The increase also reflected our emphasis on pricing discipline to balance sales pace and the selling prices of our homes in our communities open for sales; our leveraging of our KBnxt operational business model to generate incremental revenues from lot location, floor plan, home exterior elevation, structural and other premiums; and general market increases in home prices as the housing recovery has progressed. |
• | Operating Income (Loss). Our homebuilding operating income improved by $112.4 million to $92.1 million in 2013, compared to an operating loss of $20.3 million in 2012, reflecting higher housing gross profits, partly offset by higher selling, general and administrative expenses largely incurred to support our strategic growth initiatives. As a percentage of homebuilding revenues, our operating income was 4.4% in 2013, compared to an operating loss of 1.3% in 2012. |
◦ | Housing Gross Profits. Housing gross profits of $347.8 million in 2013 increased by $131.4 million, or 61%, from $216.4 million in 2012, primarily due to the higher volume of homes delivered and a higher housing gross profit margin. Our housing gross profit margin improved by 270 basis points to 16.7% in 2013 from 14.0% in 2012. Our housing gross profits for 2013 included a net charge of $32.0 million for water intrusion-related repairs at certain of our communities in central and southwest Florida, and $3.6 million of inventory impairment and land option contract abandonment charges. In 2012, our housing gross profits included insurance recoveries of $26.5 million related to repair costs and costs to handle claims with respect to previously delivered homes, including homes affected by allegedly defective drywall manufactured in China, and favorable net warranty adjustments of $8.6 million that reflected trends in our overall warranty claims experience. The insurance recoveries and favorable warranty adjustments were mostly offset by inventory impairment and land option contract abandonment charges of $28.5 million. Our adjusted housing gross profit margin improved by 490 basis points to 18.4% in 2013 from 13.5% in 2012. The calculation of adjusted housing gross profit margin, which we believe provides a clearer measure of the performance of our business, is described below under “Non-GAAP Financial Measures.” The year-over-year improvement in our adjusted housing gross profit margin primarily reflected our sharpened focus on reaching our growth and profitability goals and our actions to generate greater operating efficiencies, partly offset by the impact of higher direct construction labor and material costs in 2013. |
◦ | Selling, General and Administrative Expenses. Selling, general and administrative expenses increased by $19.2 million, or 8%, to $255.8 million in 2013 from $236.6 million in 2012, reflecting, among other things, the increased volume of homes delivered and higher housing revenues generated in 2013. Selling, general and administrative expenses for 2013 included the reversal of a previously established accrual of $8.2 million due to a favorable court decision. In 2012, selling, general and administrative expenses included an $8.8 million charge related to an unfavorable court decision in the same matter. As a percentage of housing revenues, to which these expenses are most closely correlated, selling, general and administrative expenses improved to 12.3% in 2013, compared to 15.3% in 2012, mainly due to the 35% year-over-year increase in housing revenues and our ongoing focus on containing our overhead costs to the extent possible. |
◦ | Interest Expense. Interest expense of $62.7 million for 2013 decreased from $69.8 million for 2012, reflecting an increase in the amount of our inventory qualifying for interest capitalization in 2013. Interest expense in 2013 included a $10.4 million loss on the early extinguishment of debt associated with the retirement of certain of our senior notes due in 2014 and 2015, as discussed above. In 2012, interest expense included a $10.3 million loss on the early extinguishment of debt associated with the purchase of certain of our senior notes due 2014 and 2015 pursuant to the |
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applicable tender offers that were initially made on January 19, 2012 (the “January 2012 Tender Offers”) and on July 11, 2012 (the “July 2012 Tender Offers”).
• | Net Income (Loss). We generated net income of $40.0 million, or $.46 per diluted share, in 2013, compared to a net loss of $59.0 million, or $.76 per diluted share, in 2012. Our net income for 2013 included net water intrusion-related charges, a loss on the early extinguishment of debt, inventory impairment and land option contract abandonment charges, and the reversal of a previously established accrual, all as described above. Our 2013 net income also included an income tax benefit of $1.6 million, reflecting the resolution of a state tax audit. Our net loss for 2012 included inventory impairment and land option contract abandonment charges of $28.5 million, a loss on the early extinguishment of debt of $10.3 million, and an unfavorable court decision charge of $8.8 million, which were partly offset by insurance recoveries of $26.5 million and favorable net warranty adjustments of $8.6 million, all as described above. The net loss in 2012 also included an income tax benefit of $20.1 million, reflecting the resolution of federal and state tax audits. |
Balance Sheet
• | Cash, Cash Equivalents and Restricted Cash. Our cash, cash equivalents and restricted cash totaled $572.0 million at November 30, 2013, compared to $567.1 million at November 30, 2012. Of our total cash, cash equivalents and restricted cash at November 30, 2013 and 2012, $530.1 million and $524.8 million, respectively, were unrestricted. In 2013, our operating activities used net cash of $443.5 million, compared to $34.6 million of net cash provided in 2012, largely due to investment in land and land development that drove our inventories higher at November 30, 2013 compared to the level at November 30, 2012. |
• | Inventories. Reflecting our investment in land and land development of $1.14 billion in 2013, our inventory balance at November 30, 2013 grew to $2.30 billion compared to the $1.71 billion balance at November 30, 2012. We made investments in land and land development in each of our homebuilding reporting segments in 2013, with the majority made in our West Coast homebuilding reporting segment. We ended 2013 with a land inventory portfolio comprised of 61,095 lots owned or controlled, representing an increase of 37% from the 44,752 lots owned or controlled at November 30, 2012. |
• | Mortgages and Notes Payable. Our debt balance was $2.15 billion at November 30, 2013, up from $1.72 billion at November 30, 2012. This increase reflected the underwritten public issuances of the 1.375% Convertible Senior Notes due 2019 and the 7.00% Senior Notes due 2021, partly offset by the retirement of $215.1 million in aggregate principal amount of certain of our senior notes due in 2014 and 2015. Our ratio of debt to total capital was 80.0% at November 30, 2013, compared to 82.1% at November 30, 2012. Our ratio of net debt to total capital (a calculation that is described below under “Non-GAAP Financial Measures”) was 74.6% at November 30, 2013 and 75.4% at November 30, 2012. |
• | Stockholders’ Equity. Our stockholders’ equity increased to $536.1 million at November 30, 2013 from $376.8 million at November 30, 2012, primarily due to the Common Stock Offering and net income we generated in 2013, partly offset by the cash dividends we paid on our common stock. |
Net Orders and Backlog
• | Net Orders. Net orders from our homebuilding operations increased 6% to 7,125 in 2013 from 6,703 in 2012. This growth in our overall net orders reflected increases of 14%, 12% and 21% in our Southwest, Central and Southeast homebuilding reporting segments, respectively, partly offset by a 12% decrease in our West Coast homebuilding reporting segment. |
◦ | The year-over-year decline in net orders from our West Coast homebuilding reporting segment was largely due to a 23% decrease in the average community count in this segment, as we sold through older communities and shifted our investment strategy to favor coastal California submarkets. We also experienced delays in opening new communities, which in some cases were due to extended municipal processing times from increased construction activity and reduced local government budget and staffing levels. In addition, we deliberately managed our sales pace in 2013 in certain higher-margin, higher-demand communities in California to drive profitability. |
◦ | Rising mortgage loan interest rates and home price levels, and a drop in consumer confidence leading up to and during the federal government shutdown in the fall of 2013, slowed net order activity somewhat in all of our homebuilding reporting segments in the second half of the year as compared to the first half. |
◦ | The overall value of the net orders we generated in 2013 increased 24% to $2.16 billion from $1.73 billion in 2012, largely due to higher average selling prices in each of our homebuilding reporting segments. Each of our homebuilding reporting segments generated year-over-year increases in net order value in 2013, with our West Coast homebuilding reporting segment up 14% to $976.1 million, our Southwest homebuilding reporting segment up 42% to $191.1 |
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million, our Central homebuilding reporting segment up 31% to $636.9 million, and our Southeast homebuilding reporting segment up 39% to $352.9 million.
◦ | Our cancellation rate was 32% in 2013, compared to 31% in 2012. |
• | Backlog. Our backlog was comprised of 2,557 homes, representing potential future housing revenues of $682.5 million, at November 30, 2013, and 2,577 homes, representing potential future housing revenues of $618.6 million, at November 30, 2012. The number of homes in our ending backlog was essentially flat year over year, reflecting a 39% decrease in our West Coast homebuilding reporting segment that was offset by increases of 10%, 16%, and 7% in our Southwest, Central and Southeast homebuilding reporting segments, respectively. In our West Coast homebuilding reporting segment, the number of homes in backlog at November 30, 2013 decreased from the previous year due to a year-over-year decline in net orders, as described above. The potential future housing revenues in our backlog at November 30, 2013 increased 10% from the prior year, primarily reflecting the higher overall average selling price of the homes in backlog. Backlog value increased in each of our homebuilding reporting segments, except for the West Coast homebuilding reporting segment, where the backlog value decreased by 17% year over year reflecting the lower number of homes in backlog, partly offset by a higher average selling price. Substantially all of the homes in our backlog at November 30, 2013 are expected to be delivered during the year ended November 30, 2014. |
The following table presents information concerning our net orders, cancellation rate, ending backlog, and community count for the years ended November 30, 2013 and 2012 (dollars in thousands):
Years Ended November 30, | ||||||||
2013 | 2012 | |||||||
Net orders | 7,125 | 6,703 | ||||||
Net order value | $ | 2,157,065 | $ | 1,733,146 | ||||
Cancellation rate | 32 | % | 31 | % | ||||
Ending backlog — homes | 2,557 | 2,577 | ||||||
Ending backlog — value | $ | 682,489 | $ | 618,626 | ||||
Ending community count | 191 | 172 | ||||||
Average community count | 182 | 180 | ||||||
Effective December 1, 2012, we revised the methodology for determining our community count. Based on our current methodology, an approach used by many other public homebuilders, our community count represents the number of new home communities with at least five homes/lots left to sell at the end of a reporting period. Previously, our community count represented the number of new home communities with at least one home/lot left to sell at the end of a reporting period. Community count information for all periods presented in this report reflects our current methodology.
Our higher average community count in 2013 compared to 2012 reflected the impact of our increased investment in land and land development during 2013. Our average community count increased on a year-over-year basis in each of our homebuilding reporting segments, except for our West Coast homebuilding reporting segment, where there was a 23% decrease in the average community count for the reasons discussed above. However, the ending community count in our West Coast homebuilding reporting segment as of November 30, 2013 increased 5% from the prior year. Overall, our ending community count as of November 30, 2013 increased 11% to 191 from 172 as of November 30, 2012. With the substantial inventory-related investments we made in 2013, and the investments we are planning to make in 2014, we expect that our overall community count will increase in 2014.
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HOMEBUILDING
We have grouped our homebuilding activities into four reportable segments, which we refer to as West Coast, Southwest, Central and Southeast. As of November 30, 2013, our homebuilding reporting segments consisted of ongoing operations located in the following states: West Coast — California; Southwest — Arizona, Nevada and New Mexico; Central — Colorado and Texas; and Southeast — Florida, Maryland, North Carolina and Virginia.
The following table presents a summary of certain financial and operational data for our homebuilding operations (dollars in thousands, except average selling price):
Years Ended November 30, | |||||||||||
2013 | 2012 | 2011 | |||||||||
Revenues: | |||||||||||
Housing | $ | 2,084,103 | $ | 1,548,432 | $ | 1,305,299 | |||||
Land | 875 | — | 263 | ||||||||
Total | 2,084,978 | 1,548,432 | 1,305,562 | ||||||||
Costs and expenses: | |||||||||||
Construction and land costs | |||||||||||
Housing | (1,736,320 | ) | (1,332,045 | ) | (1,157,080 | ) | |||||
Land | (766 | ) | — | (200 | ) | ||||||
Total | (1,737,086 | ) | (1,332,045 | ) | (1,157,280 | ) | |||||
Selling, general and administrative expenses | (255,808 | ) | (236,643 | ) | (220,591 | ) | |||||
Loss on loan guaranty | — | — | (30,765 | ) | |||||||
Total | (1,992,894 | ) | (1,568,688 | ) | (1,408,636 | ) | |||||
Operating income (loss) | $ | 92,084 | $ | (20,256 | ) | $ | (103,074 | ) | |||
Homes delivered | 7,145 | 6,282 | 5,812 | ||||||||
Average selling price | $ | 291,700 | $ | 246,500 | $ | 224,600 | |||||
Housing gross profit margin as a percentage of housing revenues | 16.7 | % | 14.0 | % | 11.4 | % | |||||
Adjusted housing gross profit margin as a percentage of housing revenues | 18.4 | % | 13.5 | % | 12.8 | % | |||||
Selling, general and administrative expenses as a percentage of housing revenues | 12.3 | % | 15.3 | % | 16.9 | % | |||||
Operating income (loss) as a percentage of homebuilding revenues | 4.4 | % | (1.3 | )% | (7.9 | )% | |||||
Revenues. Homebuilding revenues totaled $2.08 billion in 2013, increasing 35% from $1.55 billion in 2012, which had increased 19% from $1.31 billion in 2011. In 2013 and 2011, nearly all of our homebuilding revenues were generated from housing operations, with a nominal amount of revenues produced from land sales in each year. Our homebuilding revenues in 2012 were generated entirely from housing operations.
The year-over-year increase in housing revenues in 2013 reflected a 14% increase in the number of homes delivered and an 18% increase in the overall average selling price of those homes. In 2012, housing revenues increased from 2011 due to an 8% increase in homes delivered and a 10% increase in the overall average selling price.
We delivered a total of 7,145 homes in 2013, up from 6,282 homes delivered in the previous year. The increase in the number of homes delivered was largely due to our higher backlog at the beginning of the year, which was up 20% on a year-over-year basis. Within our homebuilding reporting segments, the number of homes delivered in 2013 increased by 12%, 8%, 11% and 27% in our West Coast, Southwest, Central and Southeast homebuilding reporting segments, respectively, in each case as compared to the year-earlier period.
In 2012, we delivered 6,282 homes, up from 5,812 homes delivered in 2011. The increase in the number of homes delivered was partly due to our relatively higher backlog at the beginning of 2012, which was up 61% on a year-over-year basis largely as
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a result of a 39% increase in net orders in the latter half of 2011. Within our homebuilding reporting segments, the number of homes delivered in 2012 increased by 11%, 19% and 3% in our West Coast, Central and Southeast homebuilding reporting segments, respectively, and decreased by 19% in our Southwest homebuilding reporting segment, in each case as compared to the year-earlier period. The decrease in homes delivered in our Southwest homebuilding reporting segment reflected a reduction in our investments in certain underperforming locations in the segment and the significant downsizing of our business in Arizona during 2011 and into 2012, each part of an overall strategic repositioning of our operations to focus on better-performing markets.
The overall average selling price of homes delivered increased to $291,700 in 2013, up $45,200, or 18%, from $246,500 in 2012. The higher average selling price in 2013 reflected our efforts over the past few years to strategically position our new home communities in submarkets where buyers have higher household income levels and stronger credit profiles, are choosing to purchase larger homes at higher price points and are spending more on design options and features at our KB Home Studios. The increase also reflected our emphasis on pricing discipline to balance sales pace and the selling prices of our homes in our communities open for sales; our leveraging of our KBnxt operational business model to generate incremental revenues from lot, floor plan, home exterior elevation, structural and other premiums; and general market increases in home prices as the housing recovery has progressed. Compared to the previous year, each of our homebuilding reporting segments posted a double-digit increase in average selling price for 2013, with increases ranging from 13% in our Southeast homebuilding reporting segment to 22% in our Southwest homebuilding reporting segment. In our West Coast homebuilding reporting segment, the average selling price increased 20% year over year largely due to a shift in our geographic mix toward communities located in coastal submarkets in California, which feature generally higher selling prices and demand for homes as compared to inland submarkets in the state.
In 2012, our overall average selling price of homes delivered increased to $246,500 from $224,600 in 2011, primarily due to changes in community and product mix, as we delivered more homes from markets with economic and consumer demand dynamics that supported larger homes and higher average selling prices. Our higher average selling prices of homes delivered reflected year-over-year increases of 16%, 17% and 5% in our West Coast, Southwest and Southeast homebuilding reporting segments, respectively. In our Central homebuilding reporting segment, the average selling price of homes delivered in 2012 remained essentially even with 2011.
Land sale revenues totaled $.9 million in 2013 and $.3 million in 2011. We had no land sales in 2012. Generally, land sale revenues fluctuate with our decisions to maintain or decrease our land ownership position in certain markets based upon the volume of our holdings, our marketing strategy, the strength and number of competing developers entering particular markets at given points in time, the availability of land at reasonable prices and prevailing market conditions.
Operating Income (Loss). Our homebuilding business generated operating income of $92.1 million in 2013, an improvement from operating losses of $20.3 million in 2012 and $103.1 million in 2011. Our homebuilding operating income as a percentage of homebuilding revenues was 4.4% in 2013. Our homebuilding operating loss as a percentage of homebuilding revenues was 1.3% in 2012 and 7.9% in 2011.
The following table presents a summary of charges and other items included in our operating income (loss) (in thousands):