KB Home — Q1 2016 Form 10-Q
Reporting period: Three months ended February 29, 2016; comparisons are to the three months ended February 28, 2015. KB Home builds and sells homes across four U.S. homebuilding segments and operates a financial services segment. Management cautions that quarterly results are seasonal and may not indicate full-year results.
Financial and operating performance
| Metric | Q1 2016 | Prior-year period | Change |
|---|---|---|---|
| Total revenue | $678.4 million | $580.1 million | +17% |
| Homebuilding revenue | $675.7 million | $577.9 million | +17% |
| Net income | $13.1 million | $7.8 million | +68% |
| Diluted EPS | $0.14 | $0.08 | +75% |
| Operating cash flow | $(143.3) million | $(48.9) million | Greater cash use |
| Notes payable | $2.653 billion | $2.626 billion at Nov. 30, 2015 | +$27.2 million |
- Housing revenue rose 28% to $672.6 million; deliveries increased 23% to 1,953 homes and average selling price rose 5% to $344,400. Land-sale revenue fell to $3.1 million from $53.0 million, which included a large northern California parcel sale in the prior-year quarter.
- Housing gross margin improved to 16.0% from 15.1%; management’s non-GAAP adjusted housing gross margin was 20.7% versus 19.5%. SG&A was 13.1% of housing revenue, down from 13.5%. Homebuilding operating margin was 2.8%, up from 2.5%.
- Net orders increased 4% to 2,272; cancellation rate rose to 27% from 25%. Backlog grew 22% to 4,285 homes, with value up 29% to $1.434 billion. Average community count increased 6% to 244.
- Cash and cash equivalents were $323.1 million and restricted cash $4.4 million at quarter-end, compared with $559.0 million and $9.3 million, respectively, at November 30, 2015. Cash declined mainly with land investment and share repurchases.
- Net debt to capital, a non-GAAP measure, increased to 59.0% from 54.9%; GAAP debt to capital rose to 62.1% from 60.8%. The $275 million revolver had no cash borrowings and $246.8 million available for cash borrowing; the company reported compliance with covenants.
Material changes and management commentary
- Land and land-development investment was $385.7 million, versus $201.6 million a year earlier; about 60% was for land acquisition. Inventory rose to $3.469 billion from $3.314 billion at November 30, 2015.
- Financing cash flow was an outflow of $90.5 million, versus an inflow of $241.2 million in the prior-year quarter, when KB Home issued $250 million of senior notes. Current-quarter financing use chiefly reflected $87.5 million of share repurchases.
- Financial services pretax income declined to $1.2 million from $1.7 million. The segment recorded a $0.6 million equity loss from its mortgage joint venture; 49% of homebuyers used HCM, down from 65%, amid a loan-system transition and staffing constraints.
- Management cited healthy supply and demand trends in served markets, supported by steady employment and economic growth. It said current backlog and community levels position the company to pursue its 2016 objectives.
Outlook, risks, and unusual items
- Q2 2016 outlook: Housing revenue of $710 million–$770 million; housing gross margin expected roughly flat sequentially; homebuilding operating margin expected to improve 50–100 basis points year over year; effective tax rate projected at about 37%.
- Full-year 2016 outlook: Housing revenue of $3.35–$3.65 billion; housing gross margin above 17%, with expansion in the second half; SG&A expected in the low 11% range of housing revenue; effective tax rate about 34%–35%. Management anticipated land and land-development investment capacity of up to $1.3 billion while remaining cash-flow neutral for the year, and average community count roughly even with 2015.
- Forecasts depend on housing demand, home prices, mortgage availability and interest rates, land costs, construction inputs, regulation, consumer confidence, and the company’s ability to convert backlog and control costs. Management warned that weaker markets or changed assumptions could prompt material inventory impairment or land-option abandonment charges.
- Q1 included $1.3 million of inventory impairment charges and $0.6 million of land-option abandonment charges. A $3.3 million federal energy tax credit reduced the effective tax rate to 18.1%; the credit was extended through 2016.
- The Florida Attorney General inquiry concerning water-intrusion issues was resolved by an agreement effective February 2016; management considered the accrual adequate. A tentative wage-and-hour settlement remained subject to court approval. In Nevada development-contract litigation, the company said a loss above the amount accrued was reasonably possible, potentially ranging from zero to approximately $55 million plus prejudgment interest. A California water-board notice remained under discussion; potential penalties and corrective measures were not expected to be material.
- Other notable exposure includes $566.8 million of performance bonds and $32.4 million of letters of credit. The company did not expect a material amount to be called. Land-option contracts covered land with an aggregate purchase price of $996.1 million and $42.9 million of cash deposits; the contracts generally allow the company not to exercise its purchase rights.
Investor verification priorities
- Check delivery, order, cancellation, and backlog trends against the assumptions underlying Q2 and full-year revenue and margin guidance.
- Assess cash consumption, planned land investment, share repurchases, and leverage against management’s cash-flow-neutral and liquidity expectations.
- Review margin improvement alongside land-sale mix, warranty adjustments, legal accruals, capitalized-interest amortization, and impairment or abandonment charges.
- Monitor the Nevada litigation, wage-and-hour settlement approval, self-insurance and warranty estimates, and the realization of deferred tax assets.
- Track mortgage-joint-venture operating recovery and the continued availability and cost of homebuyer financing.