KB Home — Q2 2017 Form 10-Q
Reporting period: Three and six months ended May 31, 2017. KB Home builds and sells homes across four reporting regions—West Coast, Southwest, Central and Southeast—and operates a smaller financial services business.
Financial and operating performance
| Metric | Three months ended May 31, 2017 | Six months ended May 31, 2017 |
|---|---|---|
| Total revenue | $1.003 billion, up 24% year over year | $1.821 billion, up 22% |
| Pretax income | $52.0 million, up 110% | $73.4 million, up 80% |
| Net income | $31.8 million, up 104% | $46.0 million, up 60% |
| Diluted EPS | $0.33, versus $0.17 | $0.49, versus $0.31 |
| Homebuilding operating income | $49.6 million; 5.0% of homebuilding revenue | $74.8 million; 4.1% |
| Homes delivered / average selling price | 2,580 / $385,900 | 4,804 / $376,100 |
- Q2 housing gross margin was 15.4%, down 0.1 percentage point year over year; adjusted margin, a company-defined non-GAAP measure excluding inventory-related charges and previously capitalized interest, was 21.0%, up 0.3 point.
- SG&A was 10.4% of housing revenue in Q2, improving 1.2 points year over year. Six-month housing gross margin was 15.0%, down 0.7 point, while SG&A was 10.9%, improving 1.4 points.
- Q2 net orders rose 5% to 3,416; cancellation rate was 21%, unchanged. Backlog grew 8% to 5,612 homes, with value up 19% to $2.181 billion. West Coast and Southwest order activity was strong; Southeast backlog fell 22%.
- Six-month operating cash flow was negative $64.6 million, versus negative $167.5 million a year earlier. Investing cash flow was negative $8.2 million and financing cash flow negative $170.8 million. Cash and cash equivalents totaled $349.4 million at period end, down from $593.0 million at the start of the fiscal year.
- At May 31, notes payable were $2.510 billion and stockholders’ equity was $1.772 billion. Debt-to-capital was 58.6%; net debt-to-capital, a non-GAAP measure, was 54.9%, versus 54.3% at November 30, 2016. The $275 million revolving credit facility had no cash borrowings and $242.6 million available for cash borrowing after letters of credit.
Changes, outlook and management commentary
Management attributed growth to more deliveries, higher average selling prices and favorable housing-market demand, alongside operating leverage and cost containment. Q2 deliveries rose 11% and average selling price rose 11%. Six-month land and land-development investment was $706.6 million, close to $702.6 million a year earlier. Housing gross margin faced pressure from higher construction and land costs and more amortization of capitalized interest, particularly in certain West Coast communities.
KB Home redeemed $100 million of 9.10% senior notes in January using internally generated cash, paying $105.3 million and recording a $5.7 million early-extinguishment charge. Total debt declined by $130.0 million from November 30, 2016, although cash also decreased. The company reported compliance with applicable debt covenants.
For Q3 2017, management projected housing revenue of $1.08–$1.15 billion, average selling price of $405,000–$410,000, housing gross margin of 16.4%–16.7% assuming no inventory-related charges, and SG&A of about 10.1% of housing revenue. For full-year 2017, it forecast housing revenue of $4.2–$4.4 billion, average selling price of $390,000–$400,000, operating margin of 6.0%–6.6%, housing gross margin of 16.3%–16.7%, and SG&A of 10.0%–10.3%; margin forecasts assume no inventory-related charges.
Risks, contingencies and unusual items
- Housing demand, home prices, interest rates, employment, land availability and construction-material costs could affect orders, margins and inventory values. Management cautioned that weaker market conditions or changes in strategy could prompt additional impairments or land-option abandonments.
- Inventory impairment and land-option abandonment charges were $6.0 million in Q2 and $10.0 million for six months, below prior-year comparable charges. Management’s estimates of inventory recoverability and remaining selling periods involve judgment.
- Self-insurance, construction-defect, warranty and litigation estimates are uncertain. Warranty liability was $60.0 million and self-insurance liability $156.5 million at May 31; the company notes actual claims and recoveries may differ materially from estimates.
- A Nevada development-contract dispute was settled and dismissed with prejudice; a future land purchase may be required if specified conditions are met, or a nonmaterial cash payment may be due. A California water-board matter was subject to a proposed $0.3 million settlement and land-development procedure changes, pending public comment and approval.
- Deferred tax assets were $736.7 million, partly offset by a $24.8 million valuation allowance. Their realization depends on future taxable income. Federal energy tax credits were lower in the first half, and the cited credit authorization had not been extended beyond 2016.
- KBHS, a 50%-owned mortgage joint venture with Stearns Lending, was operating in served markets outside California at quarter end and began California operations in June 2017. KB Home also continued winding down its former HCM joint venture and said further losses were possible, though not expected to be material.
Key facts for investors to verify
- Whether Q3 and full-year revenue, pricing and margin guidance is achieved, particularly given its assumption of no inventory-related charges.
- Whether margin pressure from construction costs and capitalized-interest amortization persists, and whether Southeast and Southwest performance improves.
- Cash generation relative to land investment, debt repayments and the scheduled debt maturities, including $195.8 million in 2017 and $630.0 million in 2019.
- Developments in warranty, self-insurance, inventory valuation, deferred-tax-asset realization and the pending California administrative order.