KB HOME quarterly report, Q1 FY2019

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KB Home — Q1 2019 Form 10-Q

Reporting period: Three months ended February 28, 2019. Comparatives are for the three months ended February 28, 2018, except balance-sheet comparisons, which are to November 30, 2018. Amounts below are in U.S. dollars.

Financial performance

  • Revenue: $811.5 million, down 7% year over year. Homebuilding revenue was $808.8 million; financial services revenue was $2.7 million.
  • Profit: Pretax income was $34.5 million, down 25%. Net income was $30.0 million, or $0.34 basic and $0.31 diluted per share, versus a net loss of $71.3 million, or $0.82 per share, in Q1 2018. The prior-year loss included a $111.2 million noncash tax charge related mainly to the Tax Cuts and Jobs Act.
  • Homebuilding margins: Operating income fell 29% to $31.3 million; operating margin declined to 3.9% from 5.1%. Housing gross margin increased to 17.1% from 16.1%, while adjusted housing gross margin, a company-defined non-GAAP measure, edged down to 21.3% from 21.4%. SG&A rose to 13.4% of housing revenue from 11.0%.
  • Deliveries and orders: Homes delivered declined 3% to 2,152; average selling price fell 5% to $370,900. Net orders declined 4% to 2,675, and net order value fell 13% to $1.02 billion. Cancellation rate remained 20%. Ending backlog declined 7% to 4,631 homes and 16% in value to $1.66 billion. Average community count increased 10% to 244.
  • Cash flow: Operating activities used $198.2 million, compared with $141.7 million used in Q1 2018, mainly reflecting inventory investment and reductions in payables and accrued liabilities. Investing activities used $1.7 million; financing activities provided $137.2 million. Cash and cash equivalents were $511.7 million at quarter-end, down from $574.4 million at November 30.
  • Debt and liquidity: Notes payable totaled $2.20 billion, up from $2.06 billion. Debt-to-capital was 50.9%, versus 49.7%; net debt-to-capital was 44.3%, versus 41.6%. Total liquidity was $978.5 million, including $466.9 million available under the $500 million revolving facility. The company reported compliance with its debt covenants.
  • Other metrics: Inventories were $3.68 billion, up from $3.58 billion. The quarterly dividend was $0.025 per share.

Material changes and management commentary

  • Management attributed weaker year-over-year results chiefly to lower deliveries and selling prices, prior-year community-count and backlog levels, affordability concerns, and geographic/product mix. The West Coast was particularly weak; Southeast revenue grew 20%, while that segment recorded an operating loss.
  • Management said housing gross margin benefited from lower amortization of capitalized interest, adoption of ASC 606, and fewer inventory-related charges. SG&A increased partly due to ASC 606, marketing for new communities, and prior-year legal recoveries and favorable settlements.
  • KB Home adopted ASC 606 on December 1, 2018 using the modified retrospective method. It increased opening retained earnings by $11.6 million. For Q1 2019, the company estimated adoption reduced net income by $1.0 million and diluted EPS by $0.01 compared with results without adoption.
  • The company invested $384.2 million in land and land development, down from $465.0 million a year earlier, and described its Returns-Focused Growth Plan as focused on asset efficiency, reduced leverage, and improved returns.

Outlook, risks, and unusual items

  • Q2 2019 outlook: Housing revenue of $900–$950 million; average selling price of $375,000–$380,000; housing gross margin of 17.0%–17.6%, assuming no inventory-related charges; SG&A of 12.3%–12.9% of housing revenue; and homebuilding operating margin, excluding inventory-related charges, of 4.2%–5.2%. The company expects an effective tax rate of about 26%, excluding potential stock-based compensation and tax-credit effects, diluted weighted-average shares of about 92 million, and average community count 15%–20% above Q2 2018.
  • For full-year 2019, management expected average community count growth of 10%–15% and said continued improvement in demand and moderated mortgage rates could support second-half year-over-year revenue growth. It emphasized that the spring selling season would be important.
  • Management cited affordability pressures, home-price appreciation, mortgage rates, higher new-home inventories, labor constraints, volatile material costs, and tariffs as risks. It warned that sustained or worsening conditions could harm results and execution of its plan.
  • Legal and insurance exposures include a Northern California construction-defect matter with claims increased to $142 million and approximately 560 outstanding Florida Chapter 558 construction-defect notices. The company had recorded estimated probable losses and recoveries but said reasonably possible additional losses or recovery shortfalls could not be estimated. Self-insurance and other litigation liabilities totaled $297.4 million.
  • Debt actions: KB Home repaid $230 million of convertible notes at maturity in February, issued $300 million of 6.875% notes due 2027 and $100 million of additional 7.625% notes due 2023, then redeemed $400 million of 4.75% notes on March 8, 2019. The redemption occurred after quarter-end.
  • Inventory impairment charges were $3.2 million and land-option abandonment charges were $0.4 million. Management said the inventory carrying value was recoverable, but noted future market or strategy changes could lead to material additional charges.

Important facts for investors to verify

  • Whether order activity, backlog value, selling prices, and affordability trends improved through the spring selling season and support the stated revenue and community-count outlook.
  • Whether homebuilding margins and SG&A performance track the Q2 ranges, particularly as ASC 606 and sales incentives affect reported results.
  • Cash use, land investment, leverage, debt maturities, and continued access to the revolving credit facility and capital markets.
  • Developments in the Northern California and Florida construction-defect matters, including potential loss estimates and collectability of insurance recoveries.
  • Inventory impairment assumptions and the realization of deferred tax assets, both of which depend on estimates and future market conditions.