KB Home — Q1 FY2020 Form 10-Q
Reporting period: Three months ended February 29, 2020; comparison is the three months ended February 28, 2019. Results are unaudited. KB Home builds and sells homes across four U.S. regions and provides insurance and title services; mortgage services are offered through an unconsolidated joint venture.
Financial and operating performance
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Total revenue | $1.076 billion | $811.5 million | +33% |
| Pretax income | $68.8 million | $34.5 million | +99% |
| Net income | $59.7 million | $30.0 million | +99% |
| Diluted EPS | $0.63 | $0.31 | +103% |
| Operating cash flow | $(9.9) million | $(198.2) million | Less cash used |
- Homebuilding revenue was $1.072 billion, up 33%. Deliveries increased 28% to 2,752 homes, and average selling price rose 5% to $389,500.
- Homebuilding operating income increased 92% to $60.2 million; operating margin improved to 5.6% from 3.9%. Housing gross margin was 17.4%, up 30 basis points; excluding inventory-related charges it was 17.9%. The company’s adjusted, non-GAAP housing gross margin was 21.1%, versus 21.3%.
- Net orders rose 31% to 3,495; cancellation rate improved to 14% from 20%. Backlog increased 26% to 5,821 homes, with value up 28% to $2.125 billion. Average community count grew 3% to 251.
- Financial services pretax income rose to $5.8 million from $2.5 million, primarily reflecting higher joint-venture income. Seventy-one percent of homebuyers used KBHS, versus 64% a year earlier.
- Income tax expense was $9.1 million, with a 13.2% effective tax rate. Q1 included $5.6 million of excess stock-compensation tax benefits and $4.0 million of federal energy tax credits.
Balance sheet, liquidity and cash flow
- At February 29, cash and cash equivalents were $429.7 million in homebuilding and $430.9 million consolidated, including financial services cash. Notes payable totaled $1.749 billion; stockholders’ equity was $2.443 billion.
- Debt-to-capital was 41.7%, down from 42.3% at November 30, 2019; net debt-to-capital, a non-GAAP measure, was 35.1%, compared with 35.2%.
- Total reported liquidity was $1.217 billion, comprising $429.7 million cash and $787.6 million available under the $800 million revolving facility. There were no revolver borrowings; $12.4 million of facility capacity was committed to letters of credit. The company reported compliance with debt covenants.
- Operating cash use was $9.9 million, mainly from a $61.0 million decline in accounts payable, accrued expenses and other liabilities, partly offset by net income. Investing cash use was $7.8 million; financing cash use was $6.2 million. Cash declined $23.9 million during the quarter.
- The company declared and paid a quarterly dividend of $0.09 per share, versus $0.025 a year earlier. Capital investment in land and land development was $405 million, up 5% year over year.
Material changes and unusual items
- Q1 performance improved substantially versus the prior-year quarter, with stronger deliveries, orders, backlog, earnings and operating margins. Results benefited from higher housing revenue and operating leverage. Adjusted housing gross margin nevertheless declined 20 basis points.
- Inventory impairment and land-option abandonment charges totaled $5.7 million, up from $3.6 million. The charges reflected decisions to accelerate sales, construction and delivery in selected communities.
- Adoption of lease accounting standards added about $31.2 million of right-of-use assets and lease liabilities at December 1, 2019 and increased opening retained earnings by $1.5 million. The adoption did not materially affect reported operations or cash flows.
- Q1’s year-over-year cash-flow comparison also reflects prior-year financing transactions, including debt issuance and repayment of $230 million of convertible notes.
Outlook, risks and contingencies
- COVID-19: The pandemic and government restrictions arose after the reporting period. In mid-March, KB Home temporarily closed sales centers, model homes and design studios to the public, shifted to appointment-based and virtual sales where permitted, limited construction largely to authorized work and prioritized emergency warranty service. Management said these developments had already tempered sales pace and delayed deliveries.
- The company expected COVID-19 to negatively affect Q2 and later 2020 results, potentially materially, but could not estimate the full impact. It warned of possible declines in orders, deliveries, selling prices, revenue, cash flow and profitability, and withdrew its FY2020 guidance.
- Management planned to curtail land and development investment, discuss delayed land purchases with sellers and target development phases to slower expected sales and construction. These actions could reduce lot counts and future deliveries. The company stated it believed it had adequate capital resources and financing access at the report date, while cautioning that markets and liquidity conditions could deteriorate.
- Key disclosed exposures include about 480 outstanding Florida Chapter 558 construction-defect notices, with some trials expected in coming quarters; the company could not estimate reasonably possible losses above its accrual or any recovery shortfall. For a Northern California townhome construction-defect matter, a further loss of $0–$8 million was reasonably possible above the accrued amount.
- Outstanding performance bonds were $817.5 million and letters of credit were $45.8 million. Management did not expect a material amount to be called. Land-option deposits were $75.6 million against aggregate purchase prices of $1.39 billion; contracts generally allow the company not to exercise options and forfeit deposits without further penalty.
- Management cited potential inventory impairments, land-option abandonments, construction and materials constraints, mortgage availability, consumer demand, and access to capital as risks. The company reported no material change in market risk and said disclosure controls were effective.
Most important facts for investors to verify
- How COVID-19 affected subsequent-quarter net orders, cancellations, deliveries, pricing, margins and cash flows, and whether management reinstated or revised guidance.
- Whether reported backlog converted to deliveries and revenue, especially across regions, and whether the quarter’s margin improvement proved sustainable.
- Liquidity and covenant headroom, debt maturities, and the effect of reduced land investment on future lot supply and delivery capacity.
- Updates to Florida and California construction-defect matters, insurance recoveries, warranty and self-insurance estimates, and inventory impairment charges.
- The sustainability of earnings and tax benefits, including energy credits and stock-compensation tax benefits, and the basis for non-GAAP adjusted margin and leverage measures.