UNITED STATES SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
For the quarterly period ended August 31, 2004.
or
For the transition period from [ ] to [ ].
Commission File No. 1-9195
KB HOME
10990 Wilshire BoulevardLos Angeles, California 90024(310) 231-4000
(Address and telephone number of principal executive offices)
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.
INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS DEFINED IN RULE 12b-2 OF THE EXCHANGE ACT).
INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE REGISTRANT’S CLASSES OF COMMON STOCK AS OF AUGUST 31, 2004.
Common stock, par value $1.00 per share, 46,319,110 shares outstanding, including 7,391,920 shares held by the Registrant’s Grantor Stock Ownership Trust and excluding 8,448,100 shares held in treasury.
KB HOMEFORM 10-QINDEX
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
See accompanying notes.
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KB HOMENOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)
Comprehensive Income
The following table presents the components of comprehensive income (in thousands):
The accumulated balances of other comprehensive income in the balance sheets as of August 31, 2004 and November 30, 2003 are comprised solely of cumulative foreign currency translation adjustments of $40.6 million and $38.5 million, respectively.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Results of Operations
OVERVIEW
Total revenues for the quarter ended August 31, 2004 rose $306.0 million, or 21.2%, to a third quarter record of $1.75 billion from $1.44 billion for the corresponding quarter of 2003. For the nine months ended August 31, 2004, total revenues increased $694.8 million, or 17.5%, to $4.67 billion from $3.98 billion in the year-earlier period. The increases in total revenues for the three-month and nine-month periods of 2004 compared to 2003 resulted primarily from higher housing revenues. Net income for the third quarter of 2004 increased 20.5% to $117.9 million, or $2.84 per diluted share, from $97.8 million, or $2.33 per diluted share, for the third quarter of 2003. Net income for the nine months ended August 31, 2004 rose 26.8% to $294.2 million, or $6.98 per diluted share, compared to $232.0 million, or $5.51 per diluted share, for the nine months ended August 31, 2003. The increases in net income in the third quarter and first nine months of 2004 were primarily driven by higher revenues and improved operating income margins.
CONSTRUCTION
Revenues increased by $321.5 million, or 22.7%, to $1.74 billion for the three months ended August 31, 2004 from $1.42 billion for the three months ended August 31, 2003 primarily due to an increase in housing revenues. The Company’s construction revenues are generated from operations in the United States and France. The Company’s U.S. operating divisions are grouped into four regions: “West Coast” — California; “Southwest” — Arizona, Nevada and New Mexico; “Central” — Colorado, Illinois, Indiana and Texas; and “Southeast” - Florida, Georgia, North Carolina and South Carolina.
Housing revenues for the third quarter of 2004 increased by 23.6%, or $329.4 million, to $1.72 billion from $1.39 billion in the year-earlier period, reflecting a 17.4% increase in unit deliveries and a 5.3% increase in the Company’s average selling price. Housing revenues in the United States increased 23.8% to $1.50 billion on 6,912 unit deliveries in the three months ended August 31, 2004 from $1.21 billion on 5,938 units in the corresponding period of 2003. Housing revenues from the West Coast region for the third quarter of 2004 totaled $543.7 million, up 15.6% from $470.5 million in the year-earlier period. The Company’s 1,333 West Coast region unit deliveries in the third quarter of 2004 were nearly even with the 1,339 deliveries posted in the third quarter of 2003. In the Southwest region, third quarter housing revenues rose 20.7% to $376.1 million in 2004 from $311.7 million in 2003. Unit deliveries in the Southwest region increased 8.8% to 1,884 in the third quarter of 2004 from 1,731 in the third quarter of 2003. Housing revenues in the Central region increased 33.7% to $362.0 million in the three months ended August 31, 2004 from $270.8 million in the three months ended August 31, 2003, as deliveries rose 31.4% to 2,432 units from 1,851 units in the prior year’s quarter partly due to the acquisition of Indiana-based Dura in the third quarter of 2004. In the Southeast region, housing revenues rose 37.7% to $217.2 million in the third quarter of 2004 from $157.8 million in the same quarter of 2003. Unit deliveries in the region increased 24.2% to 1,263 units in the third quarter of 2004 from 1,017 units in the year-earlier quarter as a result of the Company’s expansion in the southeastern United States, including its acquisition of South Carolina-based Palmetto in the first quarter of 2004. Revenues from French housing operations for the three months ended August 31, 2004 totaled $224.9 million, up 22.4% from $183.7 million in the year-earlier period. The Company’s unit deliveries in France rose 23.8% to 1,129 in the third quarter of 2004 from 912 in the third quarter of 2003.
During the third quarter of 2004, the Company’s overall average selling price increased 5.3% to $214,400 from $203,600 in the same quarter a year ago. The Company’s average selling price in the United States rose 6.4% to $216,900 in the three months ended August 31, 2004 from $203,900 in the same period of 2003, reflecting increases in all of the Company’s domestic regions. For the quarter ended August 31, 2004, the average selling price in the Company’s West Coast region increased 16.1% to $407,900 from $351,400 for the same period a year ago. The average selling price in the Southwest region rose 10.9% to $199,600 in the three months ended August 31, 2004 from $180,000 for the same period of 2003. In both the West Coast and Southwest regions, high demand for housing combined with constrained supply continued to support higher prices. In the Central region, the average selling price increased 1.7% to $148,800 from $146,300. In the Southeast region, the average selling price increased 10.9% to $172,000 in the third quarter of 2004 from $155,100 in the same quarter of 2003. In France, the average selling price for the three months ended August 31, 2004 decreased by 1.1% to $199,200 from $201,400 in the year-earlier quarter.
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The Company’s revenues from commercial activities decreased to $7.6 million in the third quarter of 2004 from $15.2 million in the third quarter of 2003. Revenues from Company-wide land sales totaled $8.1 million in the third quarter of 2004 and $8.4 million in the third quarter of 2003. Generally, land sale revenues fluctuate with management decisions to maintain or decrease the Company’s land ownership position in a particular market or markets based upon the volume of its holdings, the strength and number of competing developers entering the particular market at given points in time, the availability of land in the particular market served by the Company and prevailing market conditions.
For the first nine months of 2004, construction revenues increased by $719.1 million, or 18.3%, to $4.64 billion, from $3.92 billion for the same period a year ago mainly as a result of higher housing revenues. Housing revenues totaled $4.60 billion on 21,361 units in the first nine months of 2004 compared to $3.80 billion on 18,457 units for the same period a year ago. Revenues from housing operations in the United States increased 20.9% to $3.96 billion on 18,262 units in the first nine months of 2004 from $3.28 billion on 15,835 units in the comparable period of 2003. During the first nine months of 2004, housing revenues from the West Coast region increased 9.8% to $1.46 billion from $1.33 billion in the first nine months of 2003, despite unit deliveries decreasing 3.2% during the period to 3,643 from 3,763 in 2003. Housing revenues from the Southwest region rose 27.3% to $1.06 billion from $830.5 million, as unit deliveries in the region increased 13.9% to 5,337 from 4,685. In the Central region, housing revenues increased 17.2% to $886.8 million in the first nine months of 2004 from $756.8 million in the same period of 2003 with unit deliveries in the region increasing 17.7% to 5,974 from 5,075. Housing revenues from the Southeast region increased 54.2% to $559.8 million in the first nine months of 2004 from $363.0 million in the same period a year ago as unit deliveries rose 43.1% to 3,308 from 2,312. French housing revenues totaled $640.8 million on 3,099 unit deliveries in the first nine months of 2004 compared to $526.6 million on 2,622 unit deliveries in the corresponding period of 2003.
The Company-wide average new home price increased 4.6% to $215,400 in the first nine months of 2004 from $206,000 in the year-earlier period. For the first nine months of 2004, the average selling price in the West Coast region rose 13.4% to $399,500 from $352,200 for the first nine months of 2003 and the average selling price in the Southwest region rose 11.7% to $198,100 from $177,300, as the continued shortage of housing in both regions drove prices up. In the Central region, the average selling price decreased slightly in the first nine months of 2004 to $148,400 from $149,100 in the same period of 2003. The average selling price in the Southeast region increased 7.8% to $169,200 from $157,000 in the first nine months of 2003. In France, the average selling price for the nine-month period increased 2.9% to $206,800 in 2004 from $200,900 in 2003, primarily due to favorable foreign exchange rates in the first nine months of 2004.
The Company’s commercial activities in France generated revenues of $16.7 million in the first nine months of 2004 compared with revenues of $105.6 million in the first nine months of 2003. Commercial revenues in the first nine months of 2003 were substantially higher than in the corresponding 2004 period due to the sale of an office building by the French commercial operations in 2003. Company-wide revenues from land sales totaled $22.6 million in the nine months ended August 31, 2004 compared to $12.3 million in the nine months ended August 31, 2003.
Operating income increased by $53.4 million to $190.8 million in the third quarter of 2004 from $137.3 million in the third quarter of 2003. The improvement was largely due to higher unit volume and an expanding operating margin. As a percentage of construction revenues, operating income increased 1.3 percentage points to 11.0% for the three months ended August 31, 2004 compared to 9.7% in the same period a year ago, due to a higher housing gross margin and increased operating margins from land sales and commercial activities. Gross profits increased by $99.5 million, or 31.0%, to $420.2 million in the third quarter of 2004 from $320.7 million in the prior year’s period. Gross profits as a percentage of construction revenues rose 1.6 percentage points to 24.2% in the third quarter of 2004 from 22.6% in the same quarter of 2003 primarily due to an increase in the housing gross margin. During the same period, housing gross profits increased by $96.9 million to $415.4 million from $318.5 million. The housing gross margin increased 1.3 percentage points to 24.1% in the third quarter of 2004 from 22.8% in the year-earlier quarter as the combination of improved productivity and higher average selling prices more than offset higher material costs. Commercial activities in France generated profits of $1.8 million during the three months ended August 31, 2004, compared with $2.0 million generated during the three months ended August 31, 2003. Land sales generated profits of $2.9 million during the third quarter of 2004 compared with profits of $.2 million posted in the third quarter of 2003.
Selling, general and administrative expenses totaled $229.4 million in the three-month period ended August 31, 2004 compared to $183.3 million in the three months ended August 31, 2003. As a percentage of housing revenues,
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selling, general and administrative expenses rose to 13.3% in the third quarter of 2004 from 13.1% in the same period a year ago.
For the first nine months of 2004, operating income increased by $130.8 million to $477.1 million from $346.3 million in the corresponding period of 2003. As a percentage of construction revenues, operating income increased 1.5 percentage points to 10.3% in the first nine months of 2004 from 8.8% in the first nine months of 2003 due to a higher housing gross margin. Housing gross profits increased by $238.4 million, or 28.4%, to $1.08 billion in the first nine months of 2004 from $841.0 million in the first nine months of 2003 with the housing gross margin increasing to 23.5% from 22.1%. This 1.4 percentage point increase in the Company’s housing gross margin for the nine months ended August 31, 2004 reflected enhanced operating efficiencies and higher average selling prices. Commercial activities in France produced profits of $3.8 million in the first nine months of 2004 compared with $22.0 million in the first nine months of 2003, as the 2003 period included profits from the sale of an office building. Company-wide land sales generated profits of $3.5 million and $1.1 million in the first nine months of 2004 and 2003, respectively.
Selling, general and administrative expenses increased by $91.9 million to $609.7 million for the first nine months of 2004 from $517.8 million for the same period of 2003. As a percentage of housing revenues, selling, general and administrative expenses improved to 13.3% for the first nine months of 2004 from 13.6% in the corresponding period of 2003.
Interest income totaled $.8 million in the third quarter of 2004 and $.6 million in the third quarter of 2003. For the first nine months, interest income totaled $3.0 million in 2004 and $2.0 million in 2003. Generally, increases and decreases in interest income are attributable to changes in the interest-bearing average balances of short-term investments and mortgages receivable as well as fluctuations in interest rates.
Interest expense (net of amounts capitalized) increased by $1.4 million to $3.8 million in the third quarter of 2004 from $2.4 million in the third quarter of 2003. For the nine months ended August 31, 2004, interest expense decreased by $3.8 million to $14.6 million from $18.4 million. Gross interest incurred in the three months and nine months ended August 31, 2004 was higher than that incurred in the corresponding year-ago periods by $8.8 million and $11.9 million, respectively, due to higher debt levels in 2004. Gross interest incurred in the first nine months of 2003 also included a pretax charge of $4.3 million associated with the Company’s early extinguishment of its 9 5/8% senior subordinated notes. Excluding this charge, gross interest expense increased by $16.2 million in the first nine months of 2004 compared to the same period of 2003. The percentage of interest capitalized during the three months ended August 31, 2004 decreased slightly to 89.7% from 91.6% in the same period of 2003. For the nine months ended August 31, 2004, this percentage increased to 85.6% from 79.5% for the nine months ended August 31, 2003 excluding the early extinguishment charge. The increase in the percentage of interest capitalized during the nine months ended August 31, 2004 resulted from a higher proportion of land under development compared to the corresponding period of 2003.
Minority interests totaled $18.5 million in the third quarter of 2004 and $4.0 million in the third quarter of 2003. For the first nine months of 2004, minority interests totaled $41.2 million compared with $12.7 million in the first nine months of 2003. Minority interests for the three months and nine months ended August 31, 2004 and 2003 were comprised of the minority ownership portion of income from consolidated subsidiaries and joint ventures related to residential and commercial activities. The increases in minority interests in the three-month and nine-month periods ended August 31, 2004 primarily relate to increased activity from a consolidated joint venture in Northern California.
Equity in pretax income of unconsolidated joint ventures totaled $5.6 million in the third quarter of 2004 and $.8 million in the third quarter of 2003. The Company’s joint ventures generated combined revenues of $84.4 million during the three months ended August 31, 2004 compared with $14.8 million in the corresponding period of 2003. For the first nine months of 2004, the Company’s equity in pretax income of unconsolidated joint ventures totaled $9.3 million compared to $1.5 million for the same period of 2003. Combined revenues from these joint ventures totaled $169.9 million in the first nine months of 2004 and $30.8 million in the first nine months of 2003. All of the joint venture revenues in the 2004 and 2003 periods were generated from residential properties. The increased results from joint ventures in the third quarter and first nine months of 2004 primarily reflected additional joint venture activity in France.
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MORTGAGE BANKING
Interest income and interest expense totaled $2.9 million and $1.1 million, respectively, in the third quarter of 2004. Interest income for the quarter ended August 31, 2004 decreased $.1 million from the year-earlier quarter, and interest expense decreased $.2 million. For the first nine months of 2004, interest income from mortgage banking activities decreased by $3.2 million to $7.9 million and related interest expense decreased by $2.0 million to $3.1 million from the same period of 2003. Interest income for the three-month and nine-month periods ended August 31, 2004 decreased primarily due to a lower average balance of first mortgages held under commitments of sale and other receivables outstanding in 2004 as a result of a decrease in the mortgage banking subsidiary’s retention rate and a reduced holding period for loans held for sale. The term “retention” refers to the percentage of the Company’s domestic homebuyers using its mortgage banking subsidiary as a loan originator. Interest expense decreased in the three-month and nine-month periods of 2004 mainly due to a lower balance of notes payable outstanding and lower interest rates on such notes as compared to the year-earlier periods.
The following table presents mortgage loan origination and sales data, including loans brokered to wholesale mortgage bankers, for the Company’s mortgage banking operations (dollars in thousands):
The mortgage banking subsidiary’s retention rate decreased to 60% in the third quarter of 2004 from 71% in the third quarter of 2003 due to several factors, including efforts to build a mortgage pipeline in the Company’s recently expanded Southeast region, increased referrals by real estate brokers to retail mortgage bankers and increased competition in the mortgage banking marketplace.
Other mortgage banking revenues, which principally consist of gains on sales of mortgages and servicing rights and, to a lesser extent, mortgage loan origination fees and mortgage servicing income, decreased by $15.4 million to $5.8 million in the third quarter of 2004 from $21.2 million in the prior year’s third quarter. For the nine months ended August 31, 2004, other mortgage banking revenues decreased by $21.2 million to $24.6 million in 2004 from $45.8 million in 2003. The decreases in the three-month and nine-month periods of 2004 compared to the corresponding periods of 2003 were mainly due to a rising interest rate environment, a shift towards adjustable rate products from fixed rate and lower retention.
General and administrative expenses associated with mortgage banking activities totaled $6.5 million in the third quarter of 2004 and $9.2 million for the same period of 2003. For the nine-month periods, these expenses totaled $23.9 million in 2004 and $24.2 million in 2003. General and administrative expenses decreased in the three-month and nine-month periods ended August 31, 2004 primarily as a result of the lower level of activity.
INCOME TAXES
Income tax expense totaled $58.1 million and $48.2 million in the third quarters of 2004 and 2003, respectively. For the first nine months of 2004, income tax expense totaled $145.0 million compared to $114.3 million in the same period of 2003. The income tax amounts represented effective income tax rates of approximately 33% in both 2004 and 2003.
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Liquidity and Capital Resources
The Company assesses its liquidity in terms of its ability to generate cash to fund its operating and investing activities. Historically, the Company has funded its construction and mortgage banking activities with internally generated cash flows and external sources of debt and equity financing. In the nine-month period ended August 31, 2004, operating, investing and financing activities used net cash of $99.4 million compared to $259.5 million used in the nine-month period ended August 31, 2003.
Operating activities used $447.5 million of cash during the first nine months of 2004 and provided $115.3 million of cash during the corresponding period of 2003. The Company’s uses of operating cash in the first nine months of 2004 included net investments in inventories of $913.5 million (excluding the effect of the Palmetto, Groupe Avantis, Foncier and Dura acquisitions, $51.0 million of inventories acquired through seller financing and $43.2 million of inventory of consolidated variable interest entities (“VIEs”)), and other operating uses of $18.5 million. The uses of cash in the first nine months of 2004 were partially offset by nine months’ earnings of $294.2 million, a decrease in receivables of $75.9 million, an increase in accounts payable, accrued expenses and other liabilities of $55.4 million, and various noncash items deducted from net income.
In the first nine months of 2003, sources of operating cash included a decrease in receivables of $358.4 million, nine months’ earnings of $232.0 million, other operating sources of $9.8 million and various noncash items deducted from net income. Partially offsetting these sources were investments in inventories of $532.1 million (excluding the effect of the Colony acquisition and $26.1 million of inventories acquired through seller financing) and a decrease in accounts payable, accrued expenses and other liabilities of $1.4 million.
Investing activities used $213.6 million of cash in the first nine months of 2004 compared to $78.7 million used in the year-earlier period. In the first nine months of 2004, $121.6 million, net of cash acquired, was used for the acquisitions of Palmetto, Groupe Avantis, Foncier and Dura, $80.0 million was used for investments in unconsolidated joint ventures, and $14.3 million was used for net purchases of property and equipment. The cash used was partially offset by proceeds of $2.0 million received from mortgage-backed securities, which were principally used to pay down the collateralized mortgage obligations for which the mortgage-backed securities had served as collateral, and net sales of $.3 million of mortgages held for long-term investment. In the first nine months of 2003, $72.7 million, net of cash acquired, was used for the acquisition of Colony, $11.2 million was used for net purchases of property and equipment and $6.7 million was used for investments in unconsolidated joint ventures. The cash used in 2003 was partly offset by proceeds of $6.3 million received from mortgage-backed securities and net sales of $5.6 million of mortgages held for long term investment.
Financing activities provided cash of $561.7 million in the first nine months of 2004 compared to $296.0 million used in the first nine months of 2003. In the first nine months of 2004, sources of cash included total proceeds of $596.2 million from the issuance of the $250 Million Senior Notes and the $350 Million Senior Notes, $47.9 million in net proceeds from borrowings and $30.4 million from the issuance of common stock under employee stock plans. Partially offsetting the cash provided were repurchases of common stock of $66.1 million, cash dividend payments of $29.4 million, payments to minority interests of $15.5 million and payments on collateralized mortgage obligations of $1.7 million. On January 28, 2004, the Company issued the $250 Million Senior Notes at 99.474% of the principal amount of the notes in a private placement. The notes, which are due February 1, 2014, with interest payable semi-annually, represent senior unsecured obligations of the Company and rank equally in right of payment with all of the Company’s existing and future senior unsecured indebtedness. The $250 Million Senior Notes may be redeemed, in whole at any time or from time to time in part, at a price equal to 100% of their principal amount, plus a premium, plus accrued and unpaid interest to the applicable redemption date. The $250 Million Senior Notes are unconditionally guaranteed jointly and severally by the Company’s Guarantor Subsidiaries, on a senior unsecured basis. The Company used all of the net proceeds from the issuance of the $250 Million Senior Notes to repay borrowings outstanding under its $1 Billion Credit Facility. On June 16, 2004, the Company exchanged all of the privately placed $250 Million Senior Notes for notes that are substantially identical except that the new notes are registered under the Securities Act of 1933.
On June 30, 2004, the Company issued the $350 Million Senior Notes at 99.3% of the principal amount of the notes in a private placement. The notes, which are due August 15, 2011, with interest payable semi-annually, represent senior unsecured obligations of the Company and rank equally in right of payment with all of the Company’s existing and future senior unsecured indebtedness. The $350 Million Senior Notes may be redeemed, in whole at any time or from time to time in part, at a price equal to 100% of their principal amount, plus a premium, plus accrued and
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unpaid interest to the applicable redemption date. The $350 Million Senior Notes are unconditionally guaranteed jointly and severally by the Company’s Guarantor Subsidiaries, on a senior unsecured basis. The Company used all of the net proceeds from the issuance of the $350 Million Senior Notes to repay borrowings outstanding under its $1 Billion Credit Facility. On September 24, 2004, the Company filed a registration statement with the Securities and Exchange Commission pursuant to which the Company would exchange its outstanding $350 Million Senior Notes, which were issued in a private placement on June 30, 2004, for notes that are substantially identical except that the new notes will be registered under the Securities Act of 1933.
Financing activities in the first nine months of 2003 resulted in net cash outflows due to net payments on borrowings of $351.7 million, redemption of the Company’s 9 5/8% senior subordinated notes of $129.0 million, repurchases of common stock of $108.3 million, payments to minority interests of $9.5 million, cash dividend payments of $8.9 million and payments on collateralized mortgage obligations of $5.5 million. Partially offsetting these uses were $295.3 million in proceeds from the sale of 7 3/4% senior subordinated notes and $21.6 million from the issuance of common stock under employee stock plans.
As of August 31, 2004, the Company had $583.6 million available under its $1 Billion Credit Facility, net of $135.4 million of outstanding letters of credit. The Company’s French unsecured financing agreements, totaling $156.0 million, had in the aggregate $148.5 million available at August 31, 2004. In addition, the Company’s mortgage banking operation had $308.3 million available under its $400.0 million master loan and security agreement and $144.4 million available under its $150.0 million master loan and security agreement at quarter-end. The Company’s mortgage banking subsidiary also has two purchase and sale agreements totaling $300.0 million, which allow it to accelerate the sale of its mortgage loan inventory resulting in a more effective use of the warehouse facilities. These agreements are not committed and may be terminated at the discretion of the counterparties. The debt of the Company’s mortgage banking subsidiary is non-recourse to the Company’s construction business.
On June 29, 2004, the Company’s mortgage banking subsidiary entered into a $150.0 Million Mortgage Warehouse Facility. The $150 Million Mortgage Warehouse Facility, which expires on June 30, 2006, provides for an annual fee based on the committed balance and provides for interest to be paid monthly at the London Interbank Offered Rate plus an applicable spread on amounts borrowed. The $150 Million Mortgage Warehouse Facility replaced the mortgage banking subsidiary’s $180.0 million revolving mortgage warehouse agreement, which was scheduled to expire on June 30, 2005.
The Company’s financial leverage, as measured by the ratio of construction debt to total capital, was 52.7% at August 31, 2004 compared to 50.3% at August 31, 2003. Construction debt to total capital is not a financial measure in accordance with GAAP. However, the Company believes this ratio is preferable to total debt to total capital, the most comparable GAAP measure, in order to maintain comparability with other publicly traded homebuilders for stockholders, investors and analysts. A reconciliation of the non-GAAP measure, construction debt to total capital, to the most comparable GAAP measure, total debt to total capital, follows (in thousands):
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The Company believes it has adequate resources and sufficient credit line facilities to satisfy its current and reasonably anticipated future requirements for funds to acquire capital assets and land, to construct homes, to fund its mortgage banking operations and to meet any other needs of its business, both on a short and long-term basis.
Off-Balance Sheet Arrangements
In the ordinary course of its business, the Company enters into land option contracts in order to procure land for the construction of homes. The use of such option arrangements allows the Company to reduce the risks associated with land ownership and development; reduce its financial commitments, including interest and other carrying costs; and minimize land inventories. As of August 31, 2004, excluding consolidated VIEs, the Company had cash deposits and/or letters of credit totaling $120.0 million which were associated with land option contracts having an aggregate purchase price of $2.32 billion.
The Company is often required to obtain bonds and letters of credit in support of its related obligations with respect to subdivision improvement, homeowners’ association dues, start-up expenses, warranty work, contractors’ license fees and earnest money deposits, among other things. At August 31, 2004, the Company had outstanding approximately $801.8 million and $135.4 million of performance bonds and letters of credit, respectively. In the event any such bonds or letters of credit are called, the Company would be obligated to reimburse the issuer of the bond or letter of credit. However, the Company does not believe that any currently outstanding bonds or letters of credit are likely to be called.
Subsequent Events
On September 24, 2004, the Company filed a registration statement with the Securities and Exchange Commission pursuant to which the Company would exchange its outstanding $350 Million Senior Notes, which were issued in a private placement on June 30, 2004, for notes that are substantially identical except that the new notes will be registered under the Securities Act of 1933.
Recent Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board issued FASB Interpretation No. 46, which is intended to clarify the application of ARB No. 51, to certain entities (VIEs) in which equity investors do not have the characteristics of a controlling interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. Pursuant to FASB Interpretation No. 46, an enterprise that absorbs a majority of the VIE’s expected losses, receives a majority of the VIE’s expected residual returns, or both, is determined to be the primary beneficiary of the VIE and must consolidate the entity. FASB Interpretation No. 46 applied immediately to VIEs created after January 31, 2003 and was effective no later than the first interim or annual period ending after March 15, 2004 for VIEs created on or before January 31, 2003.
In the ordinary course of its business, the Company enters into land option contracts in order to procure land for the construction of homes. Under such land option contracts, the Company will fund a specified option deposit or earnest money deposit in consideration for the right to purchase land in the future, usually at a predetermined price. Under the requirements of FASB Interpretation No. 46, certain of the Company’s land option contracts may create a variable interest for the Company, with the land seller being identified as a VIE.
In compliance with FASB Interpretation No. 46, the Company analyzed its land option contracts and other contractual arrangements and has consolidated the fair value of certain VIEs from which the Company is purchasing land under option contracts. The consolidation of these VIEs, where the Company was determined to be the primary beneficiary, added $70.6 million to inventory and other liabilities in the Company’s consolidated balance sheet at August 31, 2004. The Company’s cash deposits related to these land option contracts totaled $15.4 million at August 31, 2004. Creditors, if any, of these VIEs have no recourse against the Company.
On March 9, 2004, the Securities and Exchange Commission issued SAB No. 105, which provides guidance regarding IRLCs that are accounted for as derivative instruments under SFAS No. 133. In SAB No. 105, the
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Securities and Exchange Commission stated that the value of expected future cash flows related to servicing rights and other intangible components should be excluded when determining the fair value of derivative IRLCs and such value should not be recognized until the underlying loans are sold. This guidance must be applied to IRLCs initiated after March 31, 2004. The Company’s accounting policy for fair value determination of IRLCs requires consideration of the terms of the individual IRLCs in comparison to available market rates. The value of servicing rights and other intangible components representing potential economic gains the Company expects to receive upon disposition of its funded loans is not included in the determination of the fair value of IRLCs throughout the period IRLCs are outstanding. Accordingly, the implementation of SAB No. 105 did not have a material impact on its results of operations.
Critical Accounting Policies
There have been no significant changes to the Company’s critical accounting policies and estimates during the three months and nine months ended August 31, 2004 compared to those disclosed in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s Annual Report on Form 10-K for the year ended November 30, 2003.
Outlook
The value of the Company’s residential backlog at August 31, 2004 totaled approximately $4.82 billion, up 41.7% from approximately $3.40 billion a year earlier. The Company’s backlog units as of August 31, 2004 stood at 21,928, increasing by 5,356 units or 32.3% from 16,572 units at August 31, 2003, as all geographic regions posted double-digit backlog growth. Company-wide net orders for the third quarter of 2004 rose 22.7% to 8,982 from the 7,319 net orders generated in the third quarter of 2003. Year-over-year net order growth was driven by higher net orders in each of the Company’s geographic regions partly due to recent acquisitions and de novo growth.
The Company’s domestic operations accounted for approximately $4.08 billion of backlog value on 18,232 units at August 31, 2004, up from $2.90 billion on 14,097 units at August 31, 2003. Backlog in the West Coast region totaled approximately $1.52 billion on 3,718 units at August 31, 2004 compared to approximately $1.14 billion on 3,280 units at August 31, 2003. Net orders in the West Coast region increased 8.2% to 1,526 in the third quarter of 2004 from 1,410 in the same quarter a year ago. In the Company’s Southwest region, backlog value increased to approximately $987.6 million on 4,956 units from approximately $729.2 million on 3,991 units at August 31, 2003, while net orders of 2,025 in the third quarter of 2004 rose 5.9% from 1,912 net orders in the year-earlier quarter. Order growth in the Southwest was tempered by shortages of materials and subcontractor labor in Las Vegas and Phoenix. In both of these markets, the Company has slowed order growth to allow construction of homes to catch up with order backlog. Backlog in the Company’s Central region totaled approximately $806.9 million on 5,357 units at the end of the third quarter of 2004, up from approximately $643.4 million on 4,473 units a year earlier, partly due to the Company’s continued expansion in Texas and its acquisitions of Indiana-based Dura in June 2004 and Chicago-based Zale in September 2003. Central region net orders for the third quarter of 2004 increased 15.2% to 2,204 from 1,913 net orders in the same period of 2003. In the Company’s Southeast region, the backlog value totaled approximately $765.7 million on 4,201 units at August 31, 2004 compared to approximately $389.4 million on 2,353 units at August 31, 2003. The region’s net orders rose 67.4% to 1,892 units in the third quarter of 2004 from 1,130 units for the same period a year ago, reflecting the Company’s continued expansion in Florida and its entry into South Carolina through the acquisition of Palmetto in January 2004.
In France, the value of residential backlog at August 31, 2004 was approximately $735.5 million on 3,696 units, up from approximately $497.5 million on 2,475 units a year earlier, partly due to the acquisitions of Groupe Avantis on March 1, 2004 and Foncier on June 1, 2004. Net orders generated by the Company’s French operations increased 39.9% to 1,335 in the third quarter of 2004 from the 954 net orders posted in the third quarter of 2003. The value of backlog associated with the Company’s French commercial development activities totaled approximately $5.7 million at August 31, 2004 compared to $1.2 million at August 31, 2003.
Substantially all of the homes included in residential backlog are expected to be delivered; however, cancellation
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rates could increase, particularly if market conditions deteriorate, or mortgage interest rates increase, thereby decreasing backlog and related future revenues.
The Company expects to achieve strong results in 2004. Specifically, the Company anticipates unit deliveries, revenues and diluted earnings per share in 2004 to exceed 2003 levels. However, this expectation could be materially affected by various risk factors such as the impact of future domestic and international terrorist activities; U.S. military commitment in the Middle East; accelerating recessionary trends and other adverse changes in general economic conditions either nationally, in the United States or France, or in the localized regions in which the Company operates; diminution in domestic jobs or employment levels; an increase in home mortgage interest rates; decreases in consumer confidence; the upcoming national election; or a downturn in the economy’s pace, among other things. With such risk factors as background, the Company currently expects its 2004 unit deliveries to increase to approximately 32,000 or 17.0% over 2003 results, mainly due to growth in the average number of active communities planned for 2004 as a result of organic expansion and recent acquisitions. The Company projects earnings will grow in 2004 as a result of the increased unit delivery volume, a slightly higher housing gross margin and improvement in its selling, general and administrative expense ratio. The Company currently believes it is well-positioned to meet its financial goals for 2004 due to its cash position and borrowing capacity, the backlog of homes in place at August 31, 2004 and its commitment to adhere to the disciplines of its KBnxt operational business model. The Company plans to maintain its balanced approach to cash management to create shareholder value by expanding organically, entering attractive new markets through acquisitions, periodically repurchasing its shares and paying a higher cash dividend.
The Company expects the rate at which new home prices have been increasing to moderate towards the end of 2004 and into 2005, particularly in the West Coast and France regions. Nonetheless, the Company believes it will benefit from the expansion within its Central and Southeast regions, and lower selling, general and administrative expenses as a percentage of construction revenues. Assuming an improving economy and a flat to moderate rise in interest rates, the Company expects to achieve record diluted earnings per share in 2004.
Safe Harbor Statement
Investors are cautioned that certain statements contained in this document, as well as some statements by the Company in periodic press releases and some oral statements by Company officials to securities analysts and stockholders during presentations about the Company are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Act”). Statements which are predictive in nature, which depend upon or refer to future events or conditions, or which include words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates,” “hopes,” and similar expressions constitute forward-looking statements. In addition, any statements concerning future financial performance (including future revenues, earnings or growth rates), ongoing business strategies or prospects, and possible future Company actions, which may be provided by management, are also forward-looking statements as defined by the Act. Forward-looking statements are based on current expectations and projections about future events and are subject to risks, uncertainties, and assumptions about the Company, economic and market factors and the homebuilding industry, among other things. These statements are not guarantees of future performance, and the Company has no specific intention to update these statements.
Actual events and results may differ materially from those expressed or forecasted in the forward-looking statements made by the Company or Company officials due to a number of factors. The principal important risk factors that could cause the Company’s actual performance and future events and actions to differ materially from such forward-looking statements include, but are not limited to, changes in general economic conditions, material prices, labor costs, interest rates, the continued impact of terrorist activities and U.S. response, accelerating recessionary trends and other adverse changes in general economic conditions, the secondary market for loans, consumer confidence, competition, currency exchange rates (insofar as they affect the Company’s operations in France), environmental factors, government regulations affecting the Company’s operations, the availability and cost of land in desirable areas, unanticipated violations of Company policy, unanticipated legal proceedings, and conditions in the capital, credit and homebuilding markets. See the Company’s Annual Report on Form 10-K for the year ended November 30, 2003 and other Company filings with the Securities and Exchange Commission for a further discussion of risks and uncertainties applicable to the Company’s business.
The Company undertakes no obligation to update any forward-looking statements in this Report on Form 10-Q or elsewhere.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company enters into debt obligations primarily to support general corporate purposes, including acquisitions and the operations of its divisions. The primary market risk the Company faces is the interest rate risk on its senior and senior subordinated notes. The Company has no cash flow exposure due to interest rate changes for these notes. In connection with the Company’s mortgage banking operations, mortgage loans held for sale and the master loan and security agreements are subject to interest rate risk; however, such obligations reprice frequently and are short-term in duration and accordingly the risk is not material.
The following table sets forth as of August 31, 2004, the Company’s long-term debt obligations, principal cash flows by scheduled maturity, weighted average interest rates and estimated market value (in thousands):
For additional information regarding the Company’s market risk, refer to Item 7A, Quantitative and Qualitative Disclosures About Market Risk, in the Company’s Annual Report on Form 10-K for the fiscal year ended November 30, 2003.
Item 4. Controls and Procedures
The Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chairman and Chief Executive Officer (Principal Executive Officer) and Chief Financial Officer (Principal Financial Officer), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of August 31, 2004. Based upon, and as of the date of that evaluation, the Company’s Chairman and Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic Securities and Exchange Commission filings. There was no significant change in the Company’s internal control over financial reporting that occurred during the most recent fiscal quarter that materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
In January 2003, the Company received a request for information from the United States Environmental Protection Agency (“EPA”) pursuant to Section 308 of the Clean Water Act. The request sought information about storm water discharge practices at certain of the Company’s construction sites, and the Company provided information pursuant to the request. In May 2004, on behalf of the EPA, the United States Department of Justice (“DOJ”) tentatively asserted that certain regulatory requirements applicable to storm water discharges were violated at certain of the Company’s construction sites, and civil penalties and injunctive relief might be warranted. The DOJ has also proposed certain steps it would expect the Company to take in the future relating to compliance with the EPA’s requirements applicable to storm water discharges. The Company has defenses to the claims that have been asserted and is exploring methods of resolving the matter. While the costs associated with the claims cannot be determined at this time, the Company believes that such costs are not likely to be material to its consolidated financial position or results of operations.
Item 5. Other Information
The following table presents residential information in terms of unit deliveries to home buyers and net orders taken by geographical region for the three months and nine months ended August 31, 2004 and 2003, together with backlog data in terms of units and value by geographical region as of August 31, 2004 and 2003.
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Item 6. Exhibits and Reports on Form 8-K
Exhibits
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Reports on Form 8-K
On June 2, 2004, the Company filed a Current Report on Form 8-K (Item 9 and Item 12), which included the Company’s press release dated June 1, 2004, announcing its preliminary net new home orders for the quarter and six months ended May 31, 2004.
On June 14, 2004, the Company filed a Current Report on Form 8-K (Item 5), which included the Company’s press release dated June 11, 2004, announcing that it extended the expiration date of its offer to exchange up to $250.0 million aggregate principal amount of its 5 3/4% senior notes due 2014 registered pursuant to Registration Statement No. 333-114761 for a like principal amount of its privately placed 5 3/4% Senior Notes due 2014.
On June 17, 2004, the Company filed a Current Report on Form 8-K (Item 9 and Item 12), which included the Company’s press release dated June 16, 2004, announcing its results of operations for the three and six months ended May 31, 2004.
On June 24, 2004, the Company filed a Current Report on Form 8-K (Item 5), which included the Company’s press release dated June 23, 2004, announcing that it had priced $350.0 million aggregate principal amount of its 6 3/8% senior notes due 2011 in a private placement.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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INDEX OF EXHIBITS
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