KB Home — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended May 31, 2019. Amounts are in U.S. dollars; financial figures are rounded to millions unless stated otherwise.
Business context and results
KB Home builds and sells homes across four U.S. regions and provides title and insurance services. Management said housing fundamentals were generally healthy in the first half, while Q2 results still reflected weaker demand in late 2018 and early 2019, a smaller prior-year community base, and lower home selling prices. Improved demand and lower mortgage rates during Q2 supported higher orders.
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Total revenue | $1,021.8M | $1,101.4M | $1,833.3M | $1,973.0M |
| Homebuilding pretax income | $52.2M | $75.2M | $84.2M | $119.3M |
| Total pretax income | $56.8M | $78.3M | $91.3M | $124.4M |
| Net income (loss) | $47.5M | $57.3M | $77.5M | $(13.9)M |
| Diluted EPS | $0.51 | $0.57 | $0.82 | $(0.16) |
Key financial metrics and changes
- Homebuilding: Q2 homebuilding revenue fell 7% to $1.019B. The company delivered 2,768 homes, up 2%, but average selling price fell 8% to $367,700. Homebuilding operating income declined 30% to $52.1M; operating margin fell to 5.1% from 6.8%.
- Margins: Q2 housing gross margin was 17.2%, versus 17.1%; excluding inventory-related charges it was 17.6%, versus 17.7%. Adjusted housing gross margin, excluding inventory charges and previously capitalized interest amortization, was 21.3%, down from 22.2%. SG&A was 12.1% of housing revenue, up from 10.4%.
- Orders and backlog: Q2 net orders rose 15% to 4,064; net order value increased 13% to $1.533B. Cancellation rate improved to 15% from 18%. Ending backlog increased 2% to 5,927 homes, while backlog value fell 3% to $2.173B. Average community count rose 17% to 252.
- Cash flow: First-half operating cash flow was negative $180.3M, compared with negative $19.4M in 2018, principally reflecting $253.5M invested in inventories and lower accrued liabilities. Investing cash outflow was $15.7M; financing cash outflow was $199.3M. Cash and cash equivalents were $178.9M on the balance sheet, down from $574.4M at November 30, 2018.
- Liquidity and debt: Total liquidity was $597.3M, versus $1.046B at November 30, 2018, including $418.5M available under the $500M revolving facility. Notes payable were $1.855B, down from $2.060B. Debt-to-capital improved to 45.8% from 49.7%; net debt-to-capital increased to 43.3% from 41.6% as cash declined. The company reported compliance with debt covenants.
- Tax and prior-period comparability: The six-month 2018 net loss included a $111.2M noncash tax charge related primarily to remeasurement of deferred tax assets following U.S. tax reform. Excluding that charge, 2018 adjusted net income was $97.3M and adjusted diluted EPS was $0.97; therefore, the reported year-over-year improvement in first-half net income is not directly comparable to underlying operating performance.
Outlook, commentary, and risks
Management expected year-over-year revenue growth in the second half of 2019, citing stronger orders, lower mortgage rates, and expanding community count. Its outlook was:
- Q3 2019: Housing revenue of $1.10B–$1.18B; average selling price of $395,000–$400,000; housing gross margin of 17.9%–18.5%, assuming no inventory charges; SG&A of 11.3%–11.9% of housing revenue; and homebuilding operating margin of 6.4%–7.0%, excluding inventory charges. Expected average community count growth was 15%–18% year over year.
- Full-year 2019: Housing revenue of $4.45B–$4.60B and average selling price of $385,000–$390,000; housing gross margin of 17.9%–18.5%, assuming no inventory charges; SG&A of 11.0%–11.6%; homebuilding operating margin of 6.7%–7.3%, excluding inventory charges; average community count growth of 10%–15%; and debt-to-capital within a 35%–45% target range.
- Management cautioned that prolonged or worsening demand and inventory pressures, labor constraints, volatile material costs and trade tariffs could adversely affect results. Other disclosed risks include interest rates, affordability, competition, land availability, legal and warranty claims, tax-asset realization, and the ability of buyers to obtain mortgages.
Unusual items, contingencies, and accounting
- KB Home adopted ASC 606 on December 1, 2018 using the modified retrospective method, increasing opening retained earnings by $11.6M. It changed the classification and timing of certain marketing/model-home costs and insurance renewal commissions. The company said the standard reduced first-half 2019 net income by $1.2M, or $0.01 per diluted share, compared with the former accounting method.
- First-half inventory impairment and land-option abandonment charges totaled $7.9M, down from $11.5M a year earlier. Management warned that weaker market conditions or changed plans could lead to further charges.
- A Northern California construction-defect matter with claims raised to $142M was settled on May 24, 2019; the settlement accrual was within the amount previously accrued. In Florida, approximately 580 Chapter 558 construction-defect claims were outstanding. The company said loss could exceed its accrual and recoveries could be lower, but it could not estimate a reasonably possible excess.
- Performance bonds and letters of credit outstanding were $737.5M and $33.6M, respectively; management did not expect a material amount to be called.
- On July 9, 2019, the parent of Stearns, KB Home’s 50% partner in mortgage joint venture KBHS, filed for bankruptcy with Stearns included. KBHS was not included in the filing; management believed it could continue operating, but warned disruption could affect future home deliveries. The financial impact was not estimable at filing.
- In January 2019, KB Home repaid $230M of convertible notes at maturity, issued $400M of senior notes, and used the proceeds to redeem $400M of 4.75% notes. First-half land and land-development investment was $782.8M.
Most important facts for investors to verify
- Whether stronger Q2 orders and community growth convert into the forecast second-half revenue and full-year results.
- Whether selling prices, incentives, housing margins, and SG&A track management’s outlook, particularly in the West Coast segment.
- Cash use, liquidity, debt maturities, and progress toward the stated debt-to-capital target.
- Developments in the Stearns bankruptcy and any effect on KBHS mortgage services or home deliveries.
- Changes in Florida defect claims, the Northern California settlement and recoveries, and any additional inventory impairment charges.
- The effect of ASC 606 and other non-GAAP adjustments when comparing reported margins and earnings across periods.