KB Home — Q3 2018 Form 10-Q Summary
Business context and reporting period
KB Home is a U.S. homebuilder with four homebuilding segments—West Coast, Southwest, Central and Southeast—and a financial services segment. This unaudited Form 10-Q covers the three and nine months ended August 31, 2018; balance-sheet comparisons are with November 30, 2017. The company entered the Seattle market during the quarter and expanded its Jacksonville operations.
Financial and operating results
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $1.225bn | $1.144bn | $3.198bn | $2.965bn |
| Pretax income | $114.7m | $79.2m | $239.0m | $152.6m |
| Net income | $87.5m | $50.2m | $73.5m | $96.2m |
| Diluted EPS | $0.87 | $0.51 | $0.75 | $1.00 |
| Homebuilding operating margin | 8.6% | 6.7% | 7.0% | 5.1% |
| Housing gross profit margin | 18.0% | 16.2% | 17.2% | 15.5% |
- Q3 performance: Homebuilding revenue rose 7%; deliveries increased 8% to 2,988 homes. Average selling price slipped 1% to $408,200. Housing gross margin expanded 180 basis points, while SG&A fell to 9.4% of housing revenue, a third-quarter record low, per management.
- Orders and backlog: Q3 net orders rose 3% to 2,685, but net order value decreased 5% to $1.018bn. Cancellation rate was 26%, compared with 25%. Backlog increased 1% to 5,484 homes, while its value fell 4% to $2.035bn, primarily reflecting lower average selling prices and geographic mix.
- Nine-month earnings: Pretax income rose 57%, but reported net income fell 24% and diluted EPS fell 25%. Results included a $111.2m noncash tax charge related to the 2017 Tax Cuts and Jobs Act (TCJA). Excluding that charge, the company reported non-GAAP adjusted net income of $184.7m and adjusted diluted EPS of $1.84.
- Cash flow and liquidity: Nine-month operating cash flow was negative $49.5m, versus positive $103.3m in 2017, mainly reflecting $370.0m invested in inventories and a $36.0m increase in receivables. Investing cash use was $9.8m; financing cash use was $306.5m, including repayment of $300m senior notes at maturity. Cash and equivalents were $355.0m consolidated at August 31 ($354.4m in homebuilding), versus $720.9m consolidated at fiscal-year start.
- Debt and capital: Notes payable totaled $2.063bn, down $261.7m from November 30, 2017. Debt-to-capital was 50.6%, versus 54.7%; net-debt-to-capital was 45.9%, versus 45.4%. The $500m revolving facility had no cash borrowings and $462.3m available for cash borrowing after letters of credit. The company said it was compliant with applicable covenants.
- Other: The quarterly dividend remained $0.025 per share. Financial services pretax income rose to $5.1m from $3.0m for Q3, mainly reflecting income from the KBHS mortgage joint venture.
Material changes, outlook and management commentary
Management attributed stronger Q3 profitability to improved housing gross margins, community-specific actions, a greater contribution from higher-margin communities and more deliveries. These benefits were partly offset by higher land, labor and material costs. The company invested $1.44bn in land and land development over nine months, up 29% year over year, and said its Returns-Focused Growth Plan was on track to reach many 2019 targets a year early.
- Q4 2018 outlook: Housing revenue of $1.39bn–$1.45bn; average selling price of $400,000–$405,000; housing gross margin of 18.3%–18.7% assuming no inventory-related charges; SG&A of 8.8%–9.2% of housing revenue; homebuilding operating margin of 9.3%–9.7% excluding inventory-related charges; effective tax rate of about 27%; average community count flat year over year.
- Full-year 2018 outlook: Housing revenue of about $4.60bn; housing gross margin of about 18.0% excluding inventory-related charges; SG&A of about 9.8%; homebuilding operating margin of about 8.2% excluding inventory-related charges; ending community count up about 4% year over year, including about 15% growth in West Coast.
- 2019 outlook: Housing revenue of $5.00bn–$5.30bn and average community count growth of 10%–15% versus 2018. These are forward-looking estimates, not guarantees.
Risks, contingencies and unusual items
- The $111.2m TCJA charge drove the unusually high nine-month effective tax rate of 69.2%; management’s adjusted rate was 22.7%. TCJA accounting remained provisional, and the company was still refining its analysis. Deferred tax assets were $495.9m, partly offset by a $26.9m valuation allowance.
- Inventory impairment and land-option abandonment charges totaled $19.9m in the first nine months, versus $18.1m a year earlier. Management cautioned that changes in housing conditions, strategy or assumptions could cause further material charges.
- Construction-defect exposures include a Northern California homeowners’ association claim alleging approximately $100m in damages and about 500 outstanding Florida Chapter 558 noticed claims. The company had accrued estimated probable losses but could not estimate reasonably possible losses above those accruals.
- Warranty liability was $80.0m and self-insurance liability was $178.8m at quarter-end. Estimates and insurance recoveries are subject to uncertainty; claims can take many years to resolve.
- Land-option contracts covered land with an aggregate purchase price of $1.38bn, supported by $48.8m in deposits and $42.3m in pre-acquisition costs. The company generally may forfeit deposits rather than exercise options, but acquisition decisions and land commitments expose it to market and execution risk.
- Key risks cited include housing demand and consumer confidence, mortgage availability and interest rates, land and construction costs, tariffs, regulation and tax changes, California market concentration, litigation, deferred-tax-asset realization and execution of the growth plan. Management said there had been no material changes to previously disclosed risk factors.
Important facts for investors to verify
- Whether Q4 and full-year guidance was achieved, particularly housing margin, deliveries, community count and selling-price assumptions.
- How much reported nine-month earnings weakness reflects the one-time TCJA charge versus underlying operating performance, and whether the provisional tax accounting was finalized.
- Whether higher land investment and inventory growth convert into deliveries, cash generation and targeted returns without additional impairments.
- Developments in the Northern California and Florida construction-defect matters, related accruals, insurance recoveries and potential exposure beyond recorded amounts.
- Cash, debt maturities and revolver availability as the company continues land investment and manages its 2019 maturities.