KB Home — Q2 2016 Form 10-Q
Reporting period: Three and six months ended May 31, 2016. Comparisons are with the corresponding 2015 periods unless otherwise noted. KB Home builds and sells homes across four reporting segments and also provides insurance and title services.
Financial and operating performance
- Second-quarter revenue and earnings: Total revenue was $811.1 million, up 30%; net income was $15.6 million, up 63%; diluted EPS was $0.17 versus $0.10. Pretax income increased 96% to $24.8 million.
- First-half performance: Revenue was $1.489 billion, up 24%; net income was $28.7 million, up 65%; diluted EPS was $0.31 versus $0.18.
- Homebuilding: Q2 housing revenue rose 33% to $807.4 million, with deliveries up 30% to 2,329 homes and average selling price up 2% to $346,700. Homebuilding operating income was $25.9 million, up 45%. GAAP housing gross margin was 15.5%, down from 16.0%; adjusted margin, a non-GAAP measure excluding capitalized-interest amortization and inventory-related charges, was 20.7% versus 20.3%.
- Orders and backlog: Q2 net orders increased 8% to 3,249; cancellation rate was 21% versus 22%. Backlog at May 31 was 5,205 homes valued at $1.829 billion, up 10% by homes and 14% by value. Ending community count was 242 versus 261.
- Cash flow and investment: First-half operating cash use was $167.5 million, compared with $135.9 million used in 2015, primarily reflecting higher inventory investment. Investing cash use was $3.6 million. The company invested $702.6 million in land and land development, versus $454.7 million a year earlier.
- Liquidity and debt: May 31 unrestricted cash and cash equivalents were $274.8 million and restricted cash was $3.5 million. Notes payable totaled $2.632 billion, compared with $2.626 billion at November 30, 2015. Debt-to-capital was 61.7% versus 60.8%; net debt-to-capital, a non-GAAP measure, was 59.0% versus 54.9%. The $275 million revolving facility had no cash borrowings and $243.4 million available for cash borrowing after letters of credit. The company reported compliance with its debt covenants.
- Dividends and repurchases: The company paid $0.05 per share in dividends during the first half and spent $87.5 million on stock repurchases.
Material changes and management commentary
- Management cited healthy supply and demand in most served markets, stronger home deliveries and improved operating leverage. Higher volume supported revenue and earnings growth, while inventory charges, higher costs and greater amortization of previously capitalized interest weighed on reported Q2 housing margin.
- KB Home began transitioning out of the Metro Washington, D.C. market, with completion expected within 12 months, to redeploy resources toward markets management believes can generate stronger returns. The market represented 2% of Q2 homebuilding revenue. Related Q2 inventory impairment and land-option abandonment charges totaled approximately $6.8 million.
- Financial services pretax income fell to $1.5 million in Q2 from $3.2 million, mainly because the mortgage joint venture, HCM, moved from equity income to a loss. Management cited fewer originations, higher overhead, a new loan system and staffing constraints. The share of homebuyers using HCM declined to 47% from 66%.
- First-half inventory impairment and land-option abandonment charges were $13.7 million, versus $1.0 million in 2015. The filing notes that changes in housing conditions, strategy or estimates could result in additional material charges.
Outlook and risks
- Q3 2016 outlook: Housing revenue of $900 million to $960 million; average selling price of $375,000 to $380,000; housing gross margin of approximately 16.5%, assuming no inventory impairment or land-option abandonment charges; SG&A at approximately 10.8% of housing revenue; and an effective tax rate of approximately 31%.
- Full-year 2016 outlook: Housing revenue of $3.45 billion to $3.70 billion; average selling price growth of 4% to 6%; housing gross margin of 16.7% to 16.9%, assuming no inventory-related charges; SG&A just below 11% of housing revenue; and housing operating margin of 5.8% to 6.0%, assuming no inventory-related charges. Expected effective tax rate is 32% to 34%.
- Management said it could invest up to $1.3 billion in land and land development in 2016 and remain cash-flow neutral, but investment could exceed that amount and leave year-end cash below the prior-year level. Average community count was expected to decline about 7% year over year in Q3 and be relatively flat for the full year.
- Contingencies: In Nevada development-contract litigation, the company said a loss beyond its accrual could range from zero to approximately $55 million plus prejudgment interest; it believes it has meritorious defenses. A $7.5 million wage-and-hour settlement received court approval for one case and preliminary approval for another, with final approval expected in September 2016. A California water-board proceeding could result in penalties and corrective measures exceeding $100,000, but management did not expect a material financial impact. The Florida Attorney General inquiry was resolved in February 2016, with the accrued amount adequate under the agreement.
- Principal risks cited include housing demand and consumer confidence, interest rates and financing access, land and construction costs, concentrated California exposure, inventory valuation, mortgage availability and HCM performance, warranty and construction-defect claims, litigation and regulatory matters, and the company’s ability to convert backlog into deliveries and cash.
Most important facts for investors to verify
- Whether backlog converts into forecast deliveries and whether Q3 and full-year revenue, pricing and margin guidance is achieved.
- Underlying profitability after inventory charges and capitalized-interest effects, alongside ongoing operating cash use and land investment.
- Progress and costs of the Metro Washington, D.C. exit, and any further inventory impairments or land-option abandonments.
- Liquidity, leverage, covenant headroom and refinancing needs, including scheduled principal payments of $630 million in 2019.
- Outcomes of the Nevada litigation and wage settlement, and developments in warranty, self-insurance and regulatory exposures.
- Whether HCM resolves its system and staffing constraints and improves mortgage activity and financial-services results.