KB Home — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended May 31, 2014. KB Home builds homes across four U.S. regions and provides related insurance, title and mortgage-marketing services. Comparisons are with the corresponding 2013 periods; balance-sheet comparisons are with November 30, 2013.
Financial performance and position
- Quarter: Revenue was $565.0 million, up 8%. Net income was $26.6 million, or $0.27 diluted EPS, versus a $3.0 million loss, or $0.04 loss per diluted share, in Q2 2013. Homebuilding pretax income was $25.2 million versus a $6.2 million loss.
- First half: Revenue was $1.016 billion, up 9%. Net income was $37.2 million, or $0.40 diluted EPS, versus a $15.4 million loss, or $0.19 loss per diluted share. Homebuilding pretax income was $34.4 million versus a $21.2 million loss.
- Homebuilding margins: Q2 housing gross margin was 18.9%, compared with 15.1%; adjusted housing gross margin, a non-GAAP measure, was 18.9% versus 18.2%. First-half housing gross margin was 18.4% versus 15.0%; adjusted margin was 18.5% versus 16.9%. Homebuilding operating margin was 6.1% for Q2 and 5.1% for the first half, compared with 1.7% and 1.0%, respectively.
- Deliveries and pricing: Q2 homes delivered fell 3% to 1,751, while average selling price rose 10% to $319,700. First-half deliveries fell 3% to 3,193, while average selling price increased 11% to $313,200.
- Orders and backlog: Q2 net orders rose 5% to 2,269; net order value increased 19% to $763.2 million. At May 31, backlog was 3,398 homes valued at $1.026 billion, up 9% in units and 24% in value year over year. The Q2 cancellation rate was 28%, versus 27%.
- Cash flow and liquidity: Operating activities used $554.5 million in the first half, versus $267.6 million used in 2013, primarily reflecting land and development investment. Cash, cash equivalents and restricted cash totaled $528.7 million, including $484.5 million unrestricted. The company had $200 million available under its revolving credit facility and reported compliance with its covenants.
- Debt and capital: Debt was $2.574 billion, up $423.5 million from November 30, 2013, mainly following issuance of $400 million of 4.75% senior notes due 2019. Debt-to-capital was 78.4%, versus 80.0%; net debt-to-capital was 74.2%, versus 74.6%. Stockholders’ equity rose to $709.7 million from $536.1 million.
- Inventory: Inventory increased 31% to $3.006 billion, reflecting land and development investment and land received from a joint venture. No inventory impairment charges were recorded in either comparable period.
Material changes and management commentary
- Management attributed improved earnings primarily to higher selling prices, better housing gross margins, lower interest expense recognized in earnings, and improved SG&A as a percentage of housing revenue. The prior-year comparison included $15.9 million of Q2 and $17.5 million of first-half water-intrusion warranty charges; 2014 included $0.4 million and $0.8 million of land-option abandonment charges, respectively.
- Community positioning and land investment remained central to the growth strategy. Average community count was 191 in Q2, up 7% year over year; management expected it to continue increasing as new communities opened. The first-half results included a $3.2 million gain on sale of a Maryland joint-venture interest.
- Regional results varied: Central and West Coast generated the largest homebuilding pretax profits in the first half, while Southeast remained loss-making, with a $1.9 million first-half pretax loss.
- Financial-services pretax income declined to $1.8 million for Q2 from $2.0 million, and to $3.3 million for the first half from $4.6 million. Home Community Mortgage, the company’s 49.9%-owned venture with Nationstar, was expected to begin offering mortgage services in Q3 2014.
Outlook, risks and contingencies
- Management expected generally favorable conditions in most served markets and said it expected to be profitable for fiscal 2014. It projected full-year land and land-development investment of approximately $1.6 billion, year-over-year ending community-count growth of 15%–20%, and full-year average selling-price growth in the high-single-digit to low-double-digit range. Management expected all four homebuilding segments to increase deliveries, average selling prices and revenue year over year.
- Outlook depends on economic and employment growth, consumer confidence, mortgage availability and rates, construction labor and material costs, land availability, and housing-market conditions. Management cautioned that quarterly results may fluctuate and that weaker markets could lead to future inventory impairments or land-option abandonments.
- Florida water-intrusion matters: The warranty liability included $19.8 million for estimated remaining repairs involving identified and potentially affected homes. The company had identified 1,590 affected homes and resolved repairs on 1,125 by May 31; it expected to complete repairs by mid-2015. Estimated minimum probable recoveries were $25.4 million. Management said the overall warranty liability was adequate but that losses could reasonably exceed the accrued amount by up to $6 million. A Florida Attorney General inquiry was ongoing; the company accrued an estimated minimum probable loss but could not estimate a reasonably possible range.
- Nevada litigation: Plaintiffs seek rescission or damages in a development-contract dispute. The company said a reasonably possible loss ranged from zero to approximately $55 million plus prejudgment interest. A non-jury trial was scheduled for October 21, 2014.
- Taxes: The company maintained a full valuation allowance against deferred tax assets of $844.0 million and had no net deferred tax assets. Management said sustained profitability and favorable housing conditions could support reducing a large portion of the allowance in Q4 2014; this was conditional, not a commitment.
Important facts for investors to verify
- Whether order and backlog growth converts into deliveries and cash generation, particularly given the elevated cancellation rate and first-half operating cash outflow.
- Whether planned land investment and community expansion achieve targeted margins and returns, and whether higher labor and material costs pressure gross margins.
- Progress, repair costs and recoveries related to Florida water-intrusion claims, including the Attorney General inquiry and the possible additional loss estimate.
- Developments and potential exposure in the Nevada litigation, including the scheduled trial.
- Debt maturities, covenant headroom and refinancing needs, especially the $199.9 million of senior notes due in 2015; also verify continued access to financing markets.
- Whether sustained profitability supports a deferred-tax-valuation-allowance reduction; verify the timing and amount before treating it as an earnings benefit.