KB Home — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended August 31, 2017; comparisons are with the corresponding 2016 periods. KB Home builds and sells homes across four U.S. homebuilding segments and operates a smaller financial-services business.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Total revenue | $1.144 billion | $913.3 million | $2.965 billion | $2.403 billion |
| Pretax income | $79.2 million | $53.5 million | $152.6 million | $94.3 million |
| Net income | $50.2 million | $39.4 million | $96.2 million | $68.1 million |
| Diluted EPS | $0.51 | $0.42 | $1.00 | $0.72 |
- Homebuilding revenue increased 25% in Q3 and 24% year to date. Q3 deliveries rose 11% to 2,765 homes, while average selling price increased 12% to $411,400. For nine months, deliveries rose 12% to 7,569 and average selling price rose 10% to $389,000.
- Q3 housing gross margin was 16.2%, down 0.2 percentage points year over year; nine-month margin was 15.5%, down 0.5 points. Management’s non-GAAP adjusted housing gross margin was 21.7% in Q3 and 21.0% year to date. Q3 homebuilding operating margin rose to 6.7% from 5.7%; year-to-date it was 5.1% versus 4.0%.
- SG&A was 9.6% of housing revenue in Q3, improving from 10.8%, and 10.4% year to date, versus 11.7%. Q3 inventory impairment and land-option abandonment charges totaled $8.1 million, compared with $3.1 million; nine-month charges were $18.1 million versus $16.8 million.
- Operating cash flow was $103.3 million for nine months, compared with a $102.6 million outflow in 2016. Investing used $13.6 million and financing used $187.8 million; cash declined $98.2 million. Cash and equivalents were $494.1 million on the balance sheet at August 31.
- Notes payable were $2.502 billion and stockholders’ equity was $1.841 billion. Debt-to-capital was 57.6% and net-debt-to-capital was 52.2%, compared with 60.5% and 54.3% at November 30, 2016. The $500 million revolver had no cash borrowings and $467 million available after outstanding letters of credit.
Changes and operating trends
- Net orders rose 4% in Q3 to 2,608 and 7% year to date to 8,604; cancellation rates improved to 25% and 23%, respectively. Backlog increased 4% to 5,455 homes, with value up 14% to $2.116 billion.
- Growth was strongest in the West Coast segment, which generated 47% higher Q3 revenue. Southeast revenue fell 13% in Q3, amid fewer deliveries and the wind-down of Metro Washington, D.C. operations. Southwest Q3 operating results improved, though its housing margin declined.
- On July 27, KB Home increased its unsecured revolving-credit commitment from $275 million to $500 million and extended maturity to July 2021. It redeemed $100 million of 9.10% notes in January and repaid the remaining $165 million at maturity on September 15, after quarter-end. Nine-month interest expense included a $5.7 million early-extinguishment charge.
- The company invested $1.12 billion in land and development during the first nine months. It launched KBHS mortgage banking joint-venture operations across served markets by June 2017; the prior HCM venture was being wound down.
Outlook, risks and unusual items
- Management expected Q4 2017 housing revenue of $1.3–$1.4 billion, average selling price of $425,000–$430,000, housing gross margin of 18.0%–18.3% assuming no inventory charges, and SG&A of 9.2%–9.4% of housing revenue. Full-year 2017 housing revenue was projected at about $4.3 billion. For 2018, housing revenue guidance was $4.5–$4.9 billion; average community count was expected flat to slightly lower than 2017.
- Management cited favorable housing demand, employment, household formation and low existing-home supply. It cautioned that hurricanes affecting Houston and Florida could reduce Q4 orders by a mid-single-digit percentage and cause construction delays, higher material and labor costs, warranty claims or weaker sales activity. Those markets represented 15% of housing revenue over the prior 12 months.
- A Q3 actuarial review increased self-insurance liabilities by $21.7 million due to higher claim frequency and, to a lesser extent, severity. The company also received $23.5 million of insurance recoveries, exceeding $11.6 million of previously estimated recoverables. These items affected SG&A.
- A Northern California homeowners association alleged approximately $100 million of construction-defect damages. KB Home had accrued an estimated probable loss, but said it could not yet estimate any reasonably possible amount above the accrual. The filing also reports $557.5 million in performance bonds and $33.0 million in letters of credit; the company did not expect a material amount to be called.
- The effective tax rate rose to 36.6% in Q3 and 36.9% year to date, partly reflecting the reduced benefit from federal energy-efficient-home credits, which were not extended beyond 2016. Management said it believed deferred tax assets were largely realizable. No material changes to previously disclosed risk factors were reported.
Investor verification priorities
- Track order growth, cancellations, backlog conversion, average selling prices and community counts against guidance, especially in Southeast and hurricane-affected markets.
- Assess whether gross-margin improvement can continue after inventory charges, capitalized-interest amortization and construction-cost pressures.
- Monitor self-insurance estimates, insurance recoveries and the Northern California construction-defect claim, including any change in the accrued loss estimate.
- Review debt maturities, revolver covenant headroom, cash use for land investment and progress in reducing leverage.
- Compare actual Q4 and 2018 results with management’s revenue and margin outlook; guidance is subject to housing, labor, materials, financing and regulatory conditions.