KB Home — Q1 2017 Form 10-Q
Reporting period: Three months ended February 28, 2017; comparable period ended February 29, 2016. KB Home is a U.S. homebuilder operating in four homebuilding regions, with a financial services segment. Management described most served housing markets as favorable, supported by generally positive economic and employment trends and constrained supply.
Key financial results
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Total revenue | $818.6 million | $678.4 million | +21% |
| Homebuilding revenue | $816.2 million | $675.7 million | +21% |
| Pretax income | $21.5 million | $16.0 million | +34% |
| Net income | $14.3 million | $13.1 million | +9% |
| Diluted EPS | $0.15 | $0.14 | +7% |
| Homes delivered | 2,224 | 1,953 | +14% |
| Average selling price | $364,600 | $344,400 | +6% |
- Housing gross profit was $118.2 million, up from $107.8 million, while GAAP housing gross margin fell 140 basis points to 14.6%. Adjusted margin, excluding previously capitalized interest amortization and inventory-related charges, declined 80 basis points to 19.9%.
- SG&A was $92.9 million; as a share of housing revenue, it improved 160 basis points to 11.5%. Homebuilding operating income rose 33% to $25.3 million, and operating margin on homebuilding revenue was 3.1%, versus 2.8%.
- Operating cash flow was negative $77.0 million, compared with negative $143.3 million. Investing cash flow was negative $8.7 million and financing cash flow negative $154.9 million. Cash declined $240.6 million during the quarter.
- At February 28, cash and cash equivalents were $351.9 million on the balance sheet (the cash-flow statement reports $352.5 million including financial services). Notes payable totaled $2.50 billion, down $135.7 million from November 30, 2016. Debt-to-capital was 59.1%, versus 60.5%; net debt-to-capital was 55.3%, versus 54.3%.
- The $275 million unsecured revolving facility had no cash borrowings and $31 million of letters of credit outstanding, leaving $244 million available for cash borrowings. The company reported compliance with its debt covenants.
- Quarterly dividend declared was $0.025 per share. The effective tax rate was 33.6%, up from 18.1%; energy tax credits were $1.1 million versus $3.3 million a year earlier.
Material changes and operating trends
- Net orders increased 14% to 2,580; net order value rose 32% to $1.09 billion. The cancellation rate improved to 23% from 27%.
- Ending backlog rose 11% to 4,776 homes and 25% in value to $1.79 billion; average backlog selling price increased 12%. Average community count decreased 2% to 238.
- Regional performance was uneven. Central pretax income increased to $19.7 million from $10.6 million; West Coast pretax income was $22.9 million, slightly higher. Southwest pretax income fell to $8.7 million from $12.5 million. Southeast remained loss-making at $2.2 million, improving from a $7.6 million loss.
- Inventory impairment and land-option abandonment charges totaled $4.0 million, versus $2.0 million. The company attributed lower gross margin mainly to higher construction and land costs, mix, higher inventory-related charges, and greater amortization of capitalized interest.
- Land and land-development investment was $302.1 million, compared with $385.7 million; approximately 44% was for land acquisition, versus 60% the prior year.
Outlook, commentary, and risks
- Q2 2017 outlook: Housing revenue of $880 million–$940 million; average selling price of $387,000–$392,000; housing gross margin of approximately 15.6%, assuming no inventory impairment or land-option abandonment charges; SG&A of about 11.2% of housing revenue; and an effective tax rate of approximately 39%. Average community count was expected to be essentially flat year over year.
- Full-year 2017 outlook: Housing revenue of $4.0 billion–$4.3 billion; average selling price of $385,000–$395,000; operating margin of 5.8%–6.4% and housing gross margin of 16.1%–16.5%, both assuming no inventory-related charges; SG&A of 10.0%–10.4% of housing revenue; effective tax rate of approximately 38.5%; and average community count essentially flat versus 2016.
- Management cited its returns-focused growth plan and stronger backlog as support for its 2017 objectives. It expected 2017 land-sale revenue to increase year over year as it monetized non-strategic parcels and redeployed proceeds.
- Key risks include housing-market, consumer-confidence, interest-rate and financing conditions; construction costs and land availability; California market concentration; ability to convert orders and backlog into deliveries; inventory valuation and impairment assumptions; warranty, construction-defect and other litigation exposure; and realization of deferred tax assets. Management said actual inventory impairment outcomes could differ substantially from estimates.
- A Nevada development-contract case was settled effective March 3, 2017, after the quarter. KB Nevada agreed to purchase land by February 15, 2020, subject to conditions, or make a cash payment described as not material. A California water-board matter remained pending; potential penalties and corrective measures could exceed $100,000 but were not expected to be material. The filing reported no material change in previously disclosed risk factors.
- The HCM mortgage joint venture was being wound down; management said further losses were possible but not expected to be material. The new 50%-owned KBHS mortgage joint venture was expected to begin operating in most served markets by the end of Q2, subject to regulatory approvals.
Investor verification priorities
- Track conversion of the $1.79 billion backlog into deliveries and revenue, especially given the company’s Q2 and full-year selling-price and margin assumptions.
- Check whether gross-margin pressure from construction and land costs, mix, and interest amortization persists, and whether inventory-related charges remain within outlook assumptions.
- Reconcile cash use, land investment, debt repayments, and net debt: reported debt fell, but net debt-to-capital increased as cash declined.
- Assess regional execution, particularly continued Southeast losses and the Southwest profit decline, against stronger Central and West Coast results.
- Monitor the effective tax rate and the expiration of energy tax credits, alongside assumptions supporting deferred tax asset realization.
- Review developments in the HCM wind-down, KBHS launch, Nevada settlement conditions, California water-board proceeding, and warranty/self-insurance estimates.