KB Home — Q3 2015 Form 10-Q Summary
Reporting period: Fiscal quarter and nine months ended August 31, 2015. Comparisons are with the corresponding 2014 periods; balance-sheet comparisons are with November 30, 2014. Amounts below are in U.S. dollars.
Financial performance and position
| Metric | Three months ended Aug. 31, 2015 | Nine months ended Aug. 31, 2015 |
|---|---|---|
| Total revenue | $843.2 million, up 43% | $2.046 billion, up 27% |
| Pretax income | $34.0 million, up 18% | $57.1 million, down 14% |
| Net income | $23.3 million, down 18% | $40.6 million, down 38% |
| Diluted EPS | $0.23, versus $0.28 | $0.42, versus $0.68 |
| Homes delivered / average selling price | 2,236 / $357,200 | 5,616 / $343,400 |
| Housing gross profit margin | 16.2%, versus 18.8% | 15.9%, versus 18.5% |
Quarterly housing revenue growth reflected 25% more homes delivered and a 9% increase in average selling price. Nine-month deliveries rose 13% and average selling price rose 8%. Homebuilding operating income was $36.0 million for the quarter, compared with $33.9 million, but was $68.2 million year to date, compared with $85.9 million. The Southeast segment reported a nine-month pretax loss of $21.0 million; West Coast pretax income declined 19% year over year, while Southwest and Central improved.
Margins were pressured by product and geographic mix, higher land and construction costs, pricing pressure in some markets, greater amortization of previously capitalized interest, and inventory-related charges. Adjusted housing gross profit margin, a company-defined non-GAAP measure, was 21.1% for the quarter and 20.4% year to date, compared with 22.7% and 22.4%, respectively. SG&A as a percentage of housing revenue improved to 11.9% for the quarter and 12.7% year to date.
Net income comparisons were also affected by taxes: 2015 nine-month tax expense was $16.5 million, versus $0.8 million in 2014. The 2014 effective tax comparisons were not meaningful because of a full valuation allowance against deferred tax assets during those periods. In late 2014, KB Home reversed most of that allowance; at August 31, 2015, deferred tax assets were $851.2 million, partly offset by a $41.2 million valuation allowance.
Operating cash flow was negative $22.1 million for the nine months, compared with negative $716.7 million in 2014, primarily reflecting substantially lower cash investment in inventory. Investing cash flow was negative $9.1 million; financing cash flow was positive $27.3 million. Cash and cash equivalents were $353.0 million, and restricted cash was $25.0 million.
Total assets were $4.948 billion and stockholders’ equity was $1.640 billion at August 31, 2015. Notes payable totaled $2.631 billion, up $54.2 million from November 30, 2014. Debt-to-capital was 61.6%; net-debt-to-capital, a non-GAAP measure, was 57.9%. The amended revolving credit facility was increased to $275 million and extended to August 2019. There were no cash borrowings under it and $273.3 million was available for cash borrowings at quarter-end. KB Home reported compliance with its debt covenants.
Material changes and operating developments
- Net orders increased 19% in the quarter and 26% year to date. Ending backlog grew 36% by homes to 4,664 and 44% by value to $1.585 billion. Ending community count increased to 252 from 200.
- Land and land-development investment was $701.6 million in the first nine months, versus $1.19 billion a year earlier; about 70% of current-period investment was for land development.
- KB Home issued $250 million of 7.625% senior notes due 2023 and used part of the proceeds to repay $199.9 million of 6.25% notes at maturity. The 2015 debt balance therefore increased overall.
- A $3.2 million inventory impairment was recorded for a Florida community after a change in sales and marketing strategy. Land-option abandonment charges were $1.3 million year to date.
- Financial-services pretax income rose to $7.6 million year to date, mainly reflecting income from the Home Community Mortgage joint venture. Financial-services revenue fell to $7.4 million, partly because marketing-services fees ended after the prior-year period.
Outlook, risks and contingencies
Management’s 2015 outlook calls for land and land-development investment of $1.0–$1.1 billion; average community count growth of more than 20% versus 2014; fourth-quarter housing revenue of $1.04–$1.10 billion; and full-year housing revenue of $2.97–$3.03 billion. Management expects fourth-quarter housing gross margin to exceed 18% sequentially, while remaining below the year-earlier quarter and for full-year 2015. The anticipated sequential improvement depends on community mix, pricing and options revenue, cost control, and higher deliveries. Management cited generally favorable conditions in most served markets but noted the outlook depends on economic, financing, regulatory, and housing-market conditions.
- Florida warranty and regulatory matters: The company estimated $1.3 million of remaining repair costs for water-intrusion-affected homes and anticipated completing repairs by year-end 2015. It considered an additional loss of up to $3 million reasonably possible beyond the amount accrued. For the Florida Attorney General inquiry, an additional loss of up to $5 million beyond the accrual was considered reasonably possible.
- Litigation: In Nevada development-contract litigation, a loss beyond accrual of zero to approximately $55 million plus prejudgment interest was considered reasonably possible. In wage-and-hour cases, the company said an additional loss of zero to $6 million beyond accrual was reasonably possible; plaintiffs claimed $66 million in damages, penalties, and interest. KB Home disputed the claims and intended to defend them.
- Drought exposure: Severe, prolonged drought in Arizona, California, and Nevada could lead to water-use restrictions, permit delays, higher costs, lower land values, or reduced consumer demand, potentially affecting development, sales, and inventory valuations.
- Other risks: Housing demand and prices, mortgage availability, interest rates, labor and material costs, land availability, inventory impairments, warranty claims, deferred-tax-asset realization, credit-facility covenant compliance, and execution of growth plans.
Key facts for investors to verify
- Whether deliveries, backlog conversion, and community growth support the revenue targets and the forecast fourth-quarter margin recovery.
- Whether lower gross margins persist, especially in West Coast and Southeast operations, and whether construction, land, and interest-amortization costs stabilize.
- Cash generation and land investment relative to management’s stated capital priorities; quarter-end cash includes $25.0 million of restricted cash.
- Debt maturities, refinancing needs, covenant headroom, and the continued availability of the revolving credit facility.
- Developments in Florida water-intrusion repairs and the Attorney General inquiry, Nevada litigation, and wage-and-hour cases, including changes to accruals or recovery estimates.
- Effects of drought-related regulations on permits, development costs, and demand in key western markets.
- Realizability of deferred tax assets and the impact of tax items on reported earnings and comparability.