KB Home (KBH) — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended August 31, 2019; comparative periods ended August 31, 2018. KB Home builds homes across four U.S. regions and also provides title and insurance services. Results are unaudited and interim results may be affected by seasonality.
Financial and operating results
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Total revenue | $1.161 billion | $1.225 billion | $2.994 billion | $3.198 billion |
| Pretax income | $91.9 million | $114.7 million | $183.2 million | $239.0 million |
| Net income | $68.1 million | $87.5 million | $145.6 million | $73.5 million |
| Diluted EPS | $0.73 | $0.87 | $1.55 | $0.75 |
| Homebuilding operating margin | 7.4% | 8.6% | 5.7% | 7.0% |
- Q3 homebuilding revenue was $1.157 billion, down 5%; deliveries increased 1% to 3,022, while average selling price fell 7% to $381,400. Housing gross margin rose 50 basis points to 18.5%, but higher SG&A and lower revenue reduced operating margin.
- For the first nine months, homebuilding revenue fell 6% and operating income fell 25%. Housing deliveries were nearly flat at 7,942, while average selling price declined 7% to $373,800. The housing gross margin increased 50 basis points to 17.7%; SG&A as a percentage of housing revenue increased to 12.0% from 10.2%.
- Q3 orders strengthened: net orders rose 24% to 3,325, cancellation rate improved to 20% from 26%, and ending backlog grew 14% to 6,230 homes, valued at $2.297 billion. Average community count increased 18% to 255.
- Financial services pretax income rose 30% to $6.6 million in Q3 and 35% to $13.7 million for the nine months, helped by greater income from its mortgage joint venture.
Cash, debt and liquidity
- Operating cash flow was negative $152.1 million for the first nine months, versus negative $49.5 million in 2018, primarily reflecting $389.5 million invested in inventories. Investing cash flow was negative $29.1 million; financing cash flow was negative $209.1 million.
- Cash and cash equivalents were $183.8 million in homebuilding and $184.8 million consolidated at August 31, down from $574.4 million in homebuilding at November 30, 2018. Total liquidity, including available revolving credit, was $610.8 million, versus $1.046 billion.
- Notes payable totaled $1.860 billion, down from $2.060 billion at November 30, 2018. Debt-to-capital was 45.1% versus 49.7%; net debt-to-capital, a non-GAAP measure, was 42.6% versus 41.6%.
- The $500 million revolving facility had $50 million borrowed and $23 million of letters of credit outstanding, leaving $427 million available for cash borrowings. KB Home reported compliance with debt covenants.
- Debt transactions included repayment of the $230 million 1.375% convertible notes and redemption of $400 million of 4.75% notes, funded in part by issuance of $300 million of 6.875% notes due 2027 and $100 million additional 7.625% notes due 2023.
Material changes and unusual items
- Nine-month 2019 net income increased 98%, largely because 2018 included a noncash $111.2 million tax charge related primarily to the Tax Cuts and Jobs Act. Excluding that charge, 2018 adjusted net income was $184.7 million and adjusted diluted EPS was $1.84; these are company-defined non-GAAP measures.
- KB Home adopted ASC 606 on December 1, 2018 using the modified retrospective method, increasing opening retained earnings by $11.6 million. The filing says adoption reduced nine-month 2019 net income by $1.2 million versus the prior accounting method and affected cost classification and timing.
- Inventory impairment and land-option abandonment charges totaled $13.1 million for the first nine months, down from $19.9 million. Management stated that carrying values were recoverable under current assumptions but warned that deterioration in housing markets or strategy changes could lead to further material charges.
- In July 2019, the parent of Stearns, KB Home’s 50% partner in KBHS Home Loans, filed for bankruptcy; Stearns was included in the case, but KBHS was not. Management said KBHS was then able to operate, but the process could disrupt mortgage services and adversely affect future deliveries; the financial impact was not estimable.
- The company settled a Northern California homeowners-association claim in May within its prior accrual and paid it in August. In Florida, approximately 615 construction-defect notices remained outstanding; losses could exceed accruals and insurance recoveries could be lower than recorded, but any reasonably possible excess was not estimable.
Outlook and risks
Management expected Q4 2019 housing revenue of $1.56–$1.64 billion, average selling price of $400,000–$410,000, and housing gross margin of 18.9%–19.5%, assuming no inventory-related charges. It forecast full-year housing revenue of $4.53–$4.61 billion, average selling price of $382,000–$386,000, housing gross margin of 18.4%–18.6% assuming no inventory-related charges, and average community count approximately 12% above 2018. Full-year homebuilding operating margin excluding inventory charges was forecast at 7.3%–7.7%; debt-to-capital at 35%–45%; and return on equity above 12%.
Management cited generally healthy housing conditions, planned community openings and land investment as support for the outlook. It also highlighted labor constraints, volatile material costs and tariffs, housing and mortgage-market conditions, interest rates, land availability, legal and warranty exposures, and the Stearns bankruptcy process as risks. Guidance is forward-looking and subject to these and other uncertainties.
Most important facts for investors to verify
- Whether stronger orders and backlog translated into Q4 deliveries and revenue, particularly given the lower Q3 selling price and weaker West Coast results.
- Whether gross-margin improvement persists after separating ASC 606 and lower capitalized-interest amortization from underlying construction economics; review the company’s non-GAAP margin reconciliations.
- Cash conversion and inventory investment, including the decline in cash and liquidity and the execution and returns on land and community investments.
- Debt maturities and covenant headroom, including the company’s ability to refinance or repay upcoming obligations.
- Developments in Stearns/KBHS, Florida construction-defect claims and related insurance recoveries, and any resulting effect on mortgage availability, home deliveries, or recorded liabilities.
- Potential inventory impairments and exposure to labor, material-cost, tariff, housing-demand and interest-rate changes.