1. KB HOME
KB Home
Accounting Project
Group 6 (Gold/Thurs)
Rajeev Kalavar, Delia Chavarria, Prentiss Douglass, Herman Ng, and Ganesh Vasudeva
2. 2
Agenda
The KB Story
• Pre 2005 – The Growth Years
•Macro Economic Conditions
• Post 2005 – The Bubble Bursts
•Macro Economic Conditions
Financial Statements
• B/S, I/S, Cashflow Analysis
• Strategic Analysis - Ratios
The Future
• Observations
• Recommendations
Overview
• History and Background
• Products & Strategy
3. 3
Overview
History/Background
- Headquartered in Los Angeles, California
- Mission to serve entry-level housing market with affordable homes
- Expanded into international markets, but currently now only serves the US
- Market Capitalization: ~$1.3B; Working Capital: ~($454)M as of Q3’08
- Q2’07 is the beginning of 6 straight quarters of net losses
F/S Analysis Strategic Analysis RecommendationsOverview
1957
KBH Founded
1961
IPO
1989
Phases out of
IL & NJ
2000
Becomes Fortune
500 Company
2005
Partnership with
Martha Stewart Living;
Sells KBHMC to
Countrywide
2008
#1 Admired
homebuilder - Fortune
2007
Sale of French
subsidiary
4. 4
Overview
Products
- Attached and detached single family homes, townhomes, and condominiums
- Financial services: mortgage banking, title, and insurance services
F/S Analysis Strategic Analysis RecommendationsOverview
5. 5
Pre-2005: Economic Conditions
F/S Analysis Strategic Analysis RecommendationsOverview
• Index measures the residential housing
market.
• It tracks changes in the value of the
residential real estate market
• Since the late 90s, home prices
increase and continue through 2005
• Home price increases In turn drive
home ownership to record levels (and
vice versa)
• Since late 90’s, home ownership
continues to increase through 2005
RECORD HOME PRICES
RECORD HOME OWNERSHIP
6. 6
Pre-2005: Economic Conditions
F/S Analysis Strategic Analysis RecommendationsOverview
• Sub-prime loans dramatically increase
affordability
• Ownership now possible with 0 down
payment, loans available to individuals
with bad credit
• Affordability increases as a result of
taking on more debt
• Avg income remains stagnant, leading
to highly leveraged, but VERY
SATISFIED home owners!
AFFORDABILITY ON THE RISE
HIGHLY LEVERAGED OWNERSHIP
7. 7
KB’s Expansion through 2005
Flourishing environment for Home builders
Aggressive growth strategy
F/S Analysis Strategic Analysis RecommendationsOverview
19601963
1965
1973
1992
1998 2001
2003
2004
2005
- Acquisitions to enter new markets
- Partnership with Martha Stewart Living
- Partnership with Disney
- Built to Order Homes
10. 10
KB Homes 2003-2008
The KB Story
F/S Analysis Strategic Analysis RecommendationsOverview
0
10
20
30
40
50
60
70
80
90
11/30/20022/28/20035/30/20038/30/2003
11/30/20032/29/20045/30/20048/30/2004
11/30/20042/28/20055/30/20058/30/2005
11/30/20052/28/20065/30/20068/30/2006
11/30/20062/28/20075/30/20078/30/2007
11/30/20072/29/20085/30/20088/30/2008
Source: finance.google.com
StockPrice($)
Date
01/16/03-Raises FY 2003
Guidance($8.00)-DJ
06/19/03-Raises FY 2003
Guidance($8.25)-DJ
03/10/03-acquires
Colony Homes
09/05/03-acquires
Zale Homes
01/06/04-acquires
Palmetto Homes
06/08/04-acquires
Dura Builders
12/16/04-Raises FY EPS
Guidance($14.50)
06/30/05-CountryWide to
acquire Mortgage
subsidiary of KB Homes
10/12/05-Announces
collaboration with
Martha Steward Living
12/06/05-Joint
Venture with Shaw
03/22/06-Reiterates FY
2006 outlook ($11.25)
06/15/06-Lowers FY
2006 EPS ($10.25)
08/24/08-SEC inquiry
into stock option grants
11/14/06-CEO
Karatz resigns
03/27/07-Lawsuit,
backdating options
02/07/08-Lawsuit,
appraisals propping value
06/11/08-settles
lawsuit, water polution
07/16/08- Lawsuit, arms-
length conflict of interest
9/15/08-Lehman files for
bankcruptcy, Financial crisis hits
KB Home Acquisitions
Lawsuits and Settlements
11. 11
Key Accounting Standards
Homebuilding Revenue Recognition: SFAS 66
“Accounting for Sales of Real Estate”
Inventory and Cost of Sales: SFAS 144
“Accounting for the Impairment or Disposal of Long-Lived Assets”
Goodwill: SFAS 142
“Accounting for Goodwill and Other Intangible Assets”
Fair Value: SFAS 157
“Fair Value Measurements”
F/S Analysis Strategic Analysis RecommendationsOverview
13. 13
(2,000)
(1,750)
(1,500)
(1,250)
(1,000)
(750)
(500)
(250)
-
250
500
750
1,000
1,250
1,500
11/30/03 11/30/04 11/30/05 11/30/06 11/30/07 8/31/08
$Millions
Cash and Short Term Investments Receivables
Accounts payable Accrued expenses and other liabilities
Current Portion of mortgages and notes payable Working Capital
Balance Sheet Analysis
Working Capital Trend
Note: Inventory is excluded from Working Capital as it primarily consists of land
F/S Analysis Strategic Analysis RecommendationsOverview
14. 14
2003 2004 2005 2006 2007 2008
USD Millions FY 2003 FY 2004 FY 2005 FY 2006 FY 2007 YTD Q3'08
Total Revenues 5,851 7,053 8,155 9,380 6,417 2,115
Homebuilding
Revenues 5,775 7,008 8,123 9,360 6,401 2,108
Construction and land costs (4,479) (5,326) (5,955) (7,666) (6,826) (2,322)
Selling, general and administrative expenses (734) (910) (980) (1,124) (825) (380)
Goodwill impairment - - - - (108) (25)
Operating income (loss) 563 772 1,189 570 (1,358) (619)
Interest income 3 4 4 6 29 29
Loss on early redemption/interest expense (24) (18) (16) (17) (13) -
Minority Interests (27) (69) - - - (10)
Equity income (loss) of unconsolidated joint ventures 3 18 14 (21) (152) (92)
Homebuilding pretax income (loss) 518 707 1,190 538 (1,495) (692)
Financial Services
Revenues 75 44 31 20 16 7
Expenses (39) (36) (20) (6) (5) (3)
Equity in income of unconsolidated joint venture - - 0 19 23 13
Financial services pretax income 36 9 11 34 34 17
Income (loss) from continuing operations 554 715 1,202 572 (1,461) (675)
Income tax benefit (expense) (183) (241) (447) (179) 46 6
Income (loss) from continuing operations 371 474 755 393 (1,415) (669)
Income from discontinued operations, net of tax - - 69 89 47 -
Gain on sale of discontinued operations net of tax - - - - 438 -
Net income (loss) 371 474 824 482 (929) (669)
KB HOME - Income Statements
Financial Results
Income Statement Analysis
F/S Analysis Strategic Analysis RecommendationsOverview
15. 15
Percent Change in Homes Delivered by Market Segment
9%
4%
-31% -31%
-8%
-5% -3%
16%
-35%-34%
-40%
-30%
-20%
-10%
0%
10%
20%
W
est
Southw
est
C
entral
Southeast
Total
Market Segment
PercentChange
% change 05-06
% change 06-07
Percent Change in Revenues by Market Segment
15%
-39%
-31%
10%
16%
31%
0%
-42%
-32%
-14%
-50%
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
W
est
Southw
est
Central
Southeast
Total
Market Segment
PercentChange
% change 05-06
% change 06-07
Revenue by Segment
Income Statement Analysis
F/S Analysis Strategic Analysis RecommendationsOverview
West Coast
Southwest
Central
Southeast
Revenue Breakdown by
Segment - 2007
16. 16
USD Millions 11/30/03 11/30/04 11/30/05 11/30/06 11/30/07
Cash flows from operating activities
Net income (loss) 371 474 824 482 (929)
Income from discontinued operations, net of income taxes - - (69) (89) (47)
Gain on sale of discontinued operations, net of income taxes - - - - (438)
Adjustments to reconcile net income (loss) to net cash provided (used) by operating activities:
Equity in (income) loss of unconsolidated joint ventures (3) (18) (14) 2 129
Distributions of earnings from unconsolidated joint ventures 0 11 12 14 42
Gain on sale of investment in unconsolidated joint venture - - - (28) -
Gain on sale of mortgage banking assets - - (27) - -
Amortization of discounts and issuance costs 2 2 2 2 2
Depreciation and amortization 22 22 18 18 17
Provision for deferred income taxes 12 (51) 3 (189) 208
Excess tax benefit associated with exercise of stock options 7 - - (15) (1)
Stock option income tax benefits - 11 37 - -
Stock-based compensation expense - 2 6 19 9
Inventory and joint venture impairments and land option contract abandonments - 37 43 431 1,410
Goodwill impairment - - - - 108
Changes in assets and liabilities:
Receivables 340 (1) 50 (24) (71)
Inventories (465) (989) (1,808) (356) 780
Accounts payable, accrued expenses and other liabilities 122 328 697 206 (341)
Minority Interest 27 69 - - -
Other, net 34 24 56 7 17
Net cash provided (used) by operating activities — continuing operations 470 (79) (171) 480 897
Net cash provided by operating activities — discontinued operations - - 87 230 297
Net cash provided (used) by operating activities 470 (79) (84) 710 1,194
KB HOME - Cash Flow Statements
Cash Flow Statement Analysis
Cash Flow from Operating Activities
F/S Analysis Strategic Analysis RecommendationsOverview
17. 17
Cash Flow Statement Analysis
Cash Flow from Investing and Financing Activities
F/S Analysis Strategic Analysis RecommendationsOverview
USD Millions 11/30/03 11/30/04 11/30/05 11/30/06 11/30/07
Cash flows from investing activities
Sale of discontinued operations, net of cash divested - - - - 740
Acqusitions of companies (106) (122) - - -
Sale of investment in unconsolidated joint venture - - - 58 -
Purchase of mortgage banking assets 6 (0) - - -
Sale of mortgage banking assets 8 6 42 - -
Investments in unconsolidated joint ventures (10) (129) (118) (238) (242)
Purchases of property and equipment, net (13) (23) (22) (18) 1
Other, net - - 1 1 -
Net cash provided (used) by investing activities — continuing operations (115) (268) (96) (197) 499
Net cash used by investing activities — discontinued operations - - (2) (4) (12)
Net cash provided (used) by investing activities (115) (268) (98) (201) 487
Cash flows from financing activities
Net payments on credit agreements and other short-term borrowings (516) 179 (379) (84) -
Proceeds from (redemption of) term loan 166 - - 400 (400)
Redemption of senior subordinated notes - (175) - - (250)
Proceeds from issuance of senior notes - 596 748 298 -
Payment of collateral mortgage (7) (6) - - -
Payments on mortgages, land contracts and other loans (87) (56) (39) (37) (114)
Issuance of common stock under employee stock plans 30 42 102 65 12
Excess tax benefit associated with exercise of stock options - - - 15 1
Payments of cash dividends (12) (39) (62) (78) (77)
Repurchases of common stock (108) (66) (135) (394) (7)
Minority Interest (12) (32) - - -
Net cash provided (used) by financing activities — continuing operations (546) 443 235 186 (835)
Net cash used by financing activities — discontinued operations - - (119) (215) (307)
Net cash provided (used) by financing activities (546) 443 116 (29) (1,142)
Net increase (decrease) in cash and cash equivalents (661) 175 18 (231) (655)
KB HOME - Cash Flow Statements
20. 20
Liabilities to Equity Ratio
Ratio Analysis
F/S Analysis Strategic Analysis RecommendationsOverview
2003 2004 2005 2006 2007
KB Home 1.66 1.84 1.79 2.17 2.08
Pulte 1.34 1.30 1.19 1.00 1.37
Centex 4.27 3.67 3.26 1.58 2.54
Toll Brothers 1.56 1.56 1.30 1.22 1.05
Liabilities to Equity Ratio
Comparative Debt Ratios
21. 21
Strategic Analysis
F/S Analysis Strategic Analysis RecommendationsOverview
Strengths Weaknesses
Well-positioned in areas expected to
experience the strongest long-term population
and job growth.
Huge growth potential in the industry (top 10
publicly owned homebuilders only have 24%
market share).
Very familiar with the process to acquire other
companies to expand into other markets if
needed.
Distressed housing market due to tighter
lending standards, oversupply of homes,
increased foreclosure activities, poor economic
conditions.
Purchases land before plans are approved
leads to impairment charges.
Moody's Bond rating 11/26/08 (recent
downgrade from Ba3 to Ba2 → speculative
grade)
Opportunities Threats
Diversification in attractive markets that exhibit
growth potential through the acquisition of
companies or land at distressed prices.
Exit from markets that no longer have growth
potential.
Potential for bankruptcy if KBH becomes too
highly leveraged.
Outflow of cash if KBH does not modify the
payment schedule for many of the loans that are
due to be repaid within the next 5 years.
Outflow of cash due to expenses associated
with government investigations and other
litigation.
22. 22
Management of Working Capital
Accounts Payable
- Action Item: Decrease spending and seek favorable payment terms
- Example: Taking 5 additional days to pay Accounts Payable would equate to
$100M in cash
Shift to Debt to Long-Term
- Action Item: Shift short-term notes payable to long-term notes payable.
Issuance of Equity
- If additional financing is needed, issue equity rather than debt.
“Last Resort” for cash
- Liquidate land
Recommendation 1
F/S Analysis Strategic Analysis RecommendationsOverview
23. 23
Expand in Other High Potential Markets
- A perfect time to acquire small struggling public homebuilders
- Purchase high potential land cheaply
Recommendation 2
F/S Analysis Strategic Analysis RecommendationsOverview
24. 24
Develop partnerships with rental/timeshare companies
- Generate a positive revenue stream by renting out homes until the company can
start building again.
- For example: Turn Condominium Complexes Apartments
Recommendation 3
F/S Analysis Strategic Analysis RecommendationsOverview
33. 33
Post-2005: Economic Conditions
F/S Analysis Strategic Analysis RecommendationsOverview
• Foreclosures rise across the US, many
in regions KB has expanded in.
• Inventories rise, severe downward
pressure on price of new homes
• Recessionary market, falling home
prices – a perfect storm on the horizon for
Home Builders
• 1,3 ARMs start resetting; highly leveraged
owners cannot afford new payments
• Some paying more than house is worth
• The housing bust has started snowballing
HOME PRICES CRASH
RECORD FORECLOSURES
34. 34
Balance Sheet Analysis
F/S Analysis Strategic Analysis RecommendationsOverview
4% 1%
12%7%
23%
19%
44% 16% 0%
60%
69%
44%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
November 2006 November 2007 August 2008
Greater than Five Years
Three to Five Years
One to Three Years
Less than One Year
Mortgages and Notes Payable – Maturity Schedule
$1,296M
$232M
$349M
$348M
$498M
$19M
$1,296M
$129M
$200M
$1,296M
$1,295M
35. 35
Operating Activities
- Net decrease in inventories due to curtailment of inventory investments in light of
challenging housing market conditions and our diminished future sales expectations.
-Discontinued Operations are results from the French subsidiary that was sold in 2007.
- Inventory and joint venture impairments and land option contract abandonments are
related to West Coast and Southwest reporting segments.
Investing Activities
- Sale of Discontinued Operations see above.
- Investments in Unconsolidated Joint Ventures refer to balance sheet notes.
Financing Activities
- Primary activity relates to redemption and proceeds from notes to operate the company.
In light of the deteriorating market conditions in 2007, KBH took several decisive actions
during the year to generate cash flow, reduce debt levels and strengthen its balance
sheet.
Cash Flow Statement Analysis
F/S Analysis Strategic Analysis RecommendationsOverview
Notas do Editor
Market cap as of 11/29/08 Working capital as of 8/31/08 Q207 = 5/31/07
Homebuilding Revenue Recognition. As discussed in Note 1. Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements in this Form 10-K, revenues from housing and other real estate sales are recognized in accordance with Statement of Financial Accounting Standards No. 66, “Accounting for Sales of Real Estate” (“SFAS No. 66”), when sales are closed and title passes to the buyer. Sales are closed when all of the following conditions are met: a sale is consummated, a significant down payment is received, the earnings process is complete and the collection of any remaining receivables is reasonably assured. Inventories and Cost of Sales. As discussed in Note 1. Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements in this Form 10-K, inventories are stated at cost, unless the carrying amount of the parcel or community is determined not to be recoverable, in which case the inventories are written down to fair value in accordance with SFAS No. 144. Fair value is determined based on estimated future cash flows discounted for inherent risks associated with the real estate assets, or other valuation techniques. Due to uncertainties in the estimation process, it is possible that actual results could differ from those estimates. Our inventories typically do not consist of completed projects.
Inventory - Changes due to less homes and lots in production and less land under development. Inventory includes land and land development costs, direct construction costs, capitalized interest, and real estate taxes Goodwill - Changes due to impairment charges of $107.9M. Goodwill relates to the acquisitions that KBH made in prior years to enter new markets. Discontinued Operations - Associated with KBH’s French subsidiary. Previously presented as a separate reporting segment. Total Liabilities - Changes due to the increased acquisition of mortgages and notes payable. This capital is primarily used to operate KBH’s business. Retained Earnings - Changes due to inventory impairment charges, abandonment of option contracts write-off, goodwill impairment, and joint venture impairment.
Revenue - Decrease due to year-over-year decrease in net orders, decrease in average selling prices, and decrease in number of homes delivered. Construction Costs - $1.1B in write-down of land value and $144M write-down for the abandonment of land option contracts in West and Southwest segments – reflected as part of construction costs. Operating Income - Affected by abandonment of option contracts write-offs, inventory, goodwill, and joint venture impairment charges. Equity Loss of Unconsolidated Joint Ventures - Reflects impairment charges of $156M, including $123.4M of valuation adjustments related to the KBH’s investments in certain unconsolidated joint ventures. Gain on Sale of Discontinued Operations - On July 10, 2007, KBH sold its 49% equity interest in its French subsidiary, KBSA.
RNOA = NOPAT/ Avg. NOA. Which is the net operating asset profit after tax divided by average net operating assets. RNOA is also broken out into profitability and asset productivity. The operating profit after tax is decreasing at a faster rate than the operating assets. ROE = Profit Margin x Asset Turnover x Leverage Factor. This is a reflection of how much profit is generate with invested shareholder dollars. over time, the Profit margin is decreasing rapidly while both asset turnover and leverage are increasing NOPM: NOPAT/Rev Without revenues coming in, our denominator is decreasing. Worse still is that KBH’s costs and expenses are exceeding their revenues thus showing a negative gross profit. In years previous, the profit had been decreasing due to decreasing revenue while land costs and expenses have been fairly consistent. NOAT: Net operating asset turnover ratio: Revenues / net operating assets How many sales dollars are generate by invested assets. Decreasing, but better than some of the competitors. By disaggregating this, we may find that while sales are decreasing, but not as quickly as net operating assets.
Current Ratio is made up of Current Assets over current Liabilities. This has not changed much over the past few years. Investments due to unconsolidated joint ventures is not part of their core business, so this was excluded from core assets. As was deferred taxes, goodwill and other assets. Current liabilities excluded notes and mortgages payable from the calculation. Quick Ratio has increased because KBH has increased their cash holding. This might be seen as a wildly positive, but Quick is made up of Cash + MS + AR. They are likely not increasing their land holding, so they are sitting on their cash right now waiting for the right time. In previous years, they might have been too quick to purchase land for future development which is why their quick ratio < 1.0 DSO is days sales outstanding (receivable mgmt) which is AR/ Sales. KBH is doing a good job managing its income assets by have a short number of days for purchasers to pay them. DPO is days payable outstanding (AP management) which is AP/COGS. In this case, they are able to delay payment to vendors longer than any of the other manufacturers that we looked at. While KBH was consistently around 27 days during the earlier part of the time period, they were able to cut that by two thirds in 2006 but appear to be heading in the wrong direction by nearly doubling to 17 days in 07.
Liabitilies to Equity are twice as high as the current leader in the field: Toll Brothers. In the case of KB as well as all the others, they are financing more on credit than they are with equity. Further disaggregation of the figures reveals that while KBH has decreased their liabilities from 2006, the equity has not kept pace. In particular, the retained earnings are 2/3 of what they were in 2006. From our experience looking at the figures, KBH is not in a good position in several areas, but they are not in as dire straights as Centex. Looking at market leader: Toll Brothers, they have have to L to E ratio as KB.
Accounts Payable Rationale: Stretching out payables will allow the company to more effectively utilize their funds. Taking 5 additional days to pay A/P = $100M + in cash. Getting back to their 2005 DPO figures of 55 days would equate to a little over $300M in additional cash. Debt Debt – Almost $600M is due within the next three years. Refinancing is key to turning. Equity Equity – Raise a round of equity, similar to CB Richard Ellis’ announcement of raising 50M Land Land – Not recommended - due to historical cycles of the business, land will increases in value over time
Two companies with low market capitalizations (cheap acquisitions) are CCC (homes along the CA coast) and K Hovnanian and Beazer (who operates in virtually the same states as KBH and has a similar first time home buyer operating model) Purchase quality tracts of land cheaply for development. In a market where homes prices are small, price and location will play a big factor in value Assess the need to remain in those markets that have declined the most in terms of revenues and exit those markets in order to focus the company’s efforts in entering other markets that have a solid growth potential.
This would likely only work in their vacation-type markets for timeshares, but would work elsewhere for rentals.
Inventory - Changes due to less homes and lots in production and less land under development. Inventory includes land and land development costs, direct construction costs, capitalized interest, and real estate taxes Goodwill - Changes due to impairment charges of $107.9M. Goodwill relates to the acquisitions that KBH made in prior years to enter new markets. Discontinued Operations - Associated with KBH’s French subsidiary. Previously presented as a separate reporting segment. Total Liabilities - Changes due to the increased acquisition of mortgages and notes payable. This capital is primarily used to operate KBH’s business. Retained Earnings Changes due to inventory impairment charges, abandonment of option contracts write-off, goodwill impairment, and joint venture impairment.
This would likely only work in their vacation-type markets for timeshares, but would work elsewhere for rentals.
This would likely only work in their vacation-type markets for timeshares, but would work elsewhere for rentals.
Revenue - Decrease due to year-over-year decrease in net orders, decrease in average selling prices, and decrease in number of homes delivered. Construction Costs - $1.1B in write-down of land value and $144M write-down for the abandonment of land option contracts in West and Southwest segments – reflected as part of construction costs. Operating Income - Affected by abandonment of option contracts write-offs, inventory, goodwill, and joint venture impairment charges. Equity Loss of Unconsolidated Joint Ventures - Reflects impairment charges of $156M, including $123.4M of valuation adjustments related to the KBH’s investments in certain unconsolidated joint ventures. Gain on Sale of Discontinued Operations - On July 10, 2007, KBH sold its 49% equity interest in its French subsidiary, KBSA.
Fed cuts rates to 1% on October 29, 2008 - US new-home sales hit lowest level in 17 years in October 2008 (Census Bureau) - Oversupply of new and resale homes - Rising foreclosure activity - Heightened competition - Reduced home affordability - Turmoil in the mortgage finance and credit markets - Decreased real estate speculation - Decreased consumer confidence