KB Home — Form 10-Q Summary
Reporting period: Third quarter and nine months ended August 31, 2014; comparative periods ended August 31, 2013. Unaudited interim results. KB Home builds and sells homes across four U.S. homebuilding regions and operates a financial services segment.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Total revenue | $589.2 million | $549.0 million | $1.605 billion | $1.479 billion |
| Net income | $28.4 million | $27.3 million | $65.5 million | $11.8 million |
| Diluted EPS | $0.28 | $0.30 | $0.68 | $0.14 |
| Homebuilding operating income | $33.9 million | $36.0 million | $85.9 million | $45.1 million |
| Housing gross margin | 18.8% | 18.2% | 18.5% | 16.2% |
Q3 revenue rose 7% and net income rose 4%, while diluted EPS declined 7%, reflecting a higher diluted share count. For the first nine months, revenue increased 9% and net income increased substantially from the prior-year period, which included $23.5 million of water-intrusion-related warranty charges. Nine-month 2014 results included $5.2 million of inventory impairment and land-option abandonment charges, a $3.2 million gain on sale of a joint-venture interest, and $0.8 million of income tax expense.
Q3 home deliveries fell 2% to 1,793, but average selling price rose 9% to $327,000. Nine-month deliveries fell 2% to 4,986, while average selling price rose 10% to $318,100. Q3 reported housing gross margin improved year over year; adjusted margin, excluding specified abandonment and warranty charges, was 19.0% versus 19.3%. SG&A was $72.9 million in Q3, up from $63.5 million; its share of housing revenue increased to 12.4% from 11.6%, partly because the prior-year quarter had a $6.2 million compensation expense offset.
Cash, liquidity, debt and balance sheet
- Operating cash flow was negative $716.7 million for the nine months, compared with negative $401.5 million a year earlier, primarily as land and development investment drove inventory growth. Investing cash flow was negative $28.1 million; financing cash flow was positive $511.2 million.
- Cash and cash equivalents were $297.1 million at August 31, 2014, and restricted cash was $32.5 million. Combined cash and restricted cash was $329.5 million, down from $572.0 million at November 30, 2013.
- Inventory increased 41% to $3.24 billion from November 30, 2013. The company invested approximately $1.19 billion in land and land development during the nine months.
- Debt increased to $2.581 billion from $2.150 billion, principally following issuance of $400 million of 4.75% senior notes due 2019. Stockholders’ equity was $744.6 million. Debt-to-capital was 77.6%; net-debt-to-capital was 75.1%, versus 80.0% and 74.6%, respectively, at November 30, 2013.
- The $200 million revolving credit facility was undrawn and fully available for cash borrowing at quarter-end; up to $100 million could be used for letters of credit. The company reported compliance with applicable debt covenants. Its next scheduled senior-note maturity was approximately $199.9 million in 2015.
Material changes and operating trends
- Net orders rose 5% year over year to 1,827 in Q3 and 5% to 5,861 for the nine months. Net order value rose 19% in both comparisons. Backlog increased 13% to 3,432 homes, valued at $1.10 billion, up 37% from a year earlier.
- Management attributed Q3 delivery deferrals to construction delays, including subcontractor and municipal inspection capacity, utility energization delays, and mortgage-processing disruption during the transition from Nationstar to the company’s 49.9%-owned joint venture, Home Community Mortgage (HCM), launched July 21.
- Homebuilding pretax results improved across most regions year to date, but the Southeast remained loss-making: a $9.9 million nine-month pretax loss, improved from a $35.0 million loss. The Q3 included a $3.4 million impairment tied to a planned sale of the company’s last Atlanta parcel.
- Financial services pretax income declined to $1.8 million in Q3 from $2.4 million and to $5.2 million for nine months from $7.0 million. HCM-related transition costs contributed to joint-venture losses. Approximately 61% of nine-month homebuyers used HCM or Nationstar, compared with 58% using Nationstar a year earlier.
Outlook, risks and contingencies
Management expected generally favorable conditions in most served markets to continue, while noting dependence on employment and income growth, consumer confidence, mortgage availability and interest rates. It forecast Q4 2014 deliveries of approximately 2,200–2,400 homes, a 65%–70% backlog conversion rate, and full-year deliveries of 7,200–7,400 homes. For Q4, management expected year-over-year growth in average selling price, revenue, housing gross profit and net income, and sequential improvement in housing gross margin and SG&A as a percentage of housing revenue. It expected approximately $1.6 billion of full-year 2014 land and land-development investment, a Q4 average community count up 10% year over year, and year-end community count up approximately 15% from November 2013. These are forward-looking expectations, not guarantees.
- Tax assets: The company maintained a full valuation allowance against $832.4 million of deferred tax assets, with no net deferred tax assets recorded. Management said sustained profitability and favorable market conditions could support reducing a large portion of the allowance in Q4 2014; timing and amount were uncertain.
- Florida water-intrusion claims: The warranty liability included $14.7 million for estimated remaining repairs; management said the reasonably possible loss could exceed the accrued amount by up to $6 million. The company had identified 1,600 affected homes, resolved repairs on 1,237, and expected to finish by mid-2015. It estimated minimum probable recoveries of $27.0 million, subject to revision.
- Legal exposure: A Nevada development-contract case had remaining contract-damages and rescission claims. The company estimated a reasonably possible loss range of zero to approximately $55 million plus prejudgment interest; trial was scheduled for October 21, 2014. A Florida Attorney General inquiry related to water-intrusion issues was ongoing; the company said it could not estimate a reasonably possible loss range.
- Other risks: Housing-market weakness, inventory impairment, land-option abandonments, labor and material costs, mortgage financing conditions, HCM performance, warranty and construction-defect claims, litigation, and access to capital could affect results. Performance bonds outstanding were $500.7 million; letters of credit were $31.9 million. The company did not expect a material amount to be called.
Most important facts for investors to verify
- Whether Q3-delayed home deliveries converted in Q4 and whether stated delivery, backlog-conversion and community-count targets were achieved.
- Whether HCM’s mortgage operations stabilized and its transition costs, loan processing and buyer adoption developed as expected.
- How much of the deferred tax valuation allowance was subsequently released, and whether profits remained sustained.
- Actual costs, recoveries and resolution timing for Florida water-intrusion repairs, plus the outcome of the Attorney General inquiry.
- Outcome and financial impact of the Nevada litigation, including any damages or prejudgment interest.
- Whether cash use for land investment, inventory growth and the 2015 debt maturity remained manageable within covenant and liquidity capacity.