KB Home — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended August 31, 2016; comparisons are with the corresponding 2015 periods unless noted. Amounts are in U.S. dollars.
Business context and performance
KB Home operates homebuilding divisions across the West Coast, Southwest, Central and Southeast, plus a financial services segment. Management said housing conditions remained favorable in most served markets, citing steady demand and generally positive economic and employment trends. The company began winding down its Metro Washington, D.C. operations, a process expected to finish within 12 months.
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Total revenue | $913.3m | $843.2m | $2,402.7m | $2,046.2m |
| Pretax income | $53.5m | $34.0m | $94.3m | $57.1m |
| Net income | $39.4m | $23.3m | $68.1m | $40.6m |
| Diluted EPS | $0.42 | $0.23 | $0.72 | $0.42 |
| Homebuilding operating income | $51.5m | $36.0m | $96.4m | $68.2m |
Quarterly housing revenue increased 14% to $910.1m as deliveries rose 11% to 2,487 homes and average selling price grew 2% to $365,900. Total homebuilding revenue grew 8%, partly because there were no Q3 2016 land sales versus $41.6m in the prior-year quarter. Nine-month homebuilding revenue increased 17%; deliveries were up 21% to 6,769 and average selling price rose 3% to $353,100.
Margins, cash flow, debt and liquidity
- Margins: Q3 housing gross margin was 16.4%, up 20 basis points; adjusted housing gross margin, a non-GAAP measure excluding capitalized-interest amortization and inventory-related charges, was 21.2%, up 10 basis points. SG&A was 10.8% of housing revenue, improving 110 basis points. Nine-month GAAP housing gross margin was 16.0% and adjusted margin was 20.9%.
- Cash flow: Operating activities used $102.6m in the first nine months, versus $22.1m used a year earlier. Inventory investment used $265.5m. Investing activities used $0.2m and financing activities used $119.8m. Cash and cash equivalents fell to $334.7m from $559.0m at November 30, 2015; including restricted cash, period-end cash was $335.3m.
- Debt and leverage: Notes payable were $2.675bn, up $49.3m from November 30, 2015. Debt-to-capital was 61.4% versus 60.8%; net debt-to-capital, a non-GAAP measure, was 58.2% versus 54.9%. Senior notes and convertible notes make up most debt.
- Liquidity: The $275m revolving facility had no cash borrowings and $32.5m of letters of credit outstanding, leaving $242.5m available for cash borrowings. KB Home reported compliance with its covenants; reported liquidity of $334.7m exceeded the $183m minimum covenant level.
- Capital allocation: Land and land-development investment was approximately $1.06bn for the nine months, up from $701.6m. The company spent $87.5m on share repurchases and paid $6.5m in dividends during the period.
Material changes and management commentary
Quarterly net orders rose 16% to 2,508 despite a 9% decline in average community count; order value increased 20% to $929.6m. Backlog grew 12% to 5,226 homes, valued at $1.849bn, up 17%. The cancellation rate improved to 29% from 30%. Central segment pretax income increased to $27.6m; Southeast returned to quarterly pretax income of $2.3m from a $4.8m loss. Southwest quarterly pretax income declined 27% to $8.6m, while West Coast pretax income was broadly stable at $36.9m.
Management attributed improved results mainly to higher delivery volume, operating leverage and stronger housing gross profits. Nine-month results included $13.9m of inventory impairment charges and $2.9m of land-option abandonment charges, versus $3.2m and $1.3m, respectively, in 2015. The charges included decisions to accelerate sales at selected communities and the Metro Washington, D.C. wind-down. Q3 charges totaled $3.1m versus $3.5m in the prior-year quarter.
Outlook, risks and contingencies
- Q4 2016 outlook: Housing revenue of $1.1bn–$1.2bn; average selling price of $385,000–$390,000; housing gross margin in the low 17% range assuming no inventory or land-option charges; SG&A ratio in the low-to-mid 9% range; effective tax rate approximately 36%; average community count expected to be about 8% lower year over year.
- Full-year outlook: Housing revenue of $3.5bn–$3.6bn; housing gross margin approximately 16.7%, excluding inventory impairment and land-option abandonment charges; SG&A ratio just below 11%. Management said it could invest up to $1.3bn in land and land development in 2016 and expected to remain cash-flow neutral under its current capital allocation plan, though year-end cash could be below the prior year.
- Tax: Federal energy tax credits reduced the effective rate; Q3 2016 credits were $6.7m. Management expected a higher Q4 tax rate as credits decreased.
- Mortgage joint venture: In September 2016, KB Home and Nationstar began winding down HCM and transferring its assets and operations to Stearns Lending. KB Home expected $1m–$3m of equity losses from unconsolidated ventures in Q4 due to the transition.
- Legal and warranty exposure: The Nevada development-contract case remained unresolved; management said a reasonably possible loss could exceed the accrual by zero to approximately $55m plus prejudgment interest, while expressing confidence in its defenses. A $7.5m wage-and-hour settlement was approved in 2016. The Florida Attorney General inquiry over water-intrusion issues was resolved under an agreement, with payment made in March 2016. Warranty and self-insurance liabilities were $52.1m and $77.8m, respectively.
- Other risks: Management cited housing-market and financing conditions, interest rates, land and construction costs, California concentration, mortgage availability, regulatory changes, warranty claims, litigation, and potential future inventory impairments. It warned that weaker markets or changed sales strategies could lead to additional material charges.
Important facts for investors to verify
- Whether Q4 deliveries and average selling prices support the $1.1bn–$1.2bn housing-revenue outlook and the projected margin improvement.
- Whether cash generation improves as inventory investment continues, and whether leverage and covenant headroom remain acceptable.
- Whether order and backlog growth converts into completed home deliveries, particularly given lower community counts and the delayed delivery of some higher-priced Northern California homes.
- The final costs and operational impact of the Metro Washington, D.C. exit and the HCM transition, including the projected Q4 joint-venture loss.
- Developments in the Nevada litigation and whether warranty, self-insurance or inventory impairment estimates require revision.