Hovnanian Enterprises, Inc. — Q2 2021 10-Q
Reporting period: Quarter and six months ended April 30, 2021. Hovnanian is a U.S. homebuilder operating across six geographic segments, with a mortgage and title-services business. Amounts below are in U.S. dollars; financial statement amounts are converted from thousands to millions unless noted.
Financial performance and position
- Revenue: Q2 revenue was $703.2 million, up 30.6% year over year; home-sale revenue rose 29.8% to $679.5 million. Six-month revenue was $1.278 billion, up 23.8%. Home deliveries increased 22.1% in Q2 and 17.3% for the six months; average selling price rose 6.3% and 4.7%, respectively.
- Profit: Q2 pretax income was $31.0 million versus $4.2 million a year earlier; six-month pretax income was $50.6 million versus a $3.3 million loss. Reported net income was $488.7 million in Q2 and $507.6 million for six months, driven principally by a $457.6 million tax benefit from reversing most of the deferred-tax valuation allowance. These net income figures substantially overstate operating earnings. Basic/diluted EPS was $71.11/$69.65 in Q2 and $74.00/$72.71 for six months.
- Margins: Homebuilding gross margin was 18.1% in Q2 versus 14.5% and 17.7% for six months versus 13.7%. Excluding cost-of-sales interest and land charges, the respective margins were 21.3% versus 18.2% and 21.0% versus 17.8%. Management attributed improvement mainly to price increases across most markets and delivery mix.
- Costs: Total selling, general and administrative expense was $82.6 million in Q2, or 11.7% of revenue, versus $55.9 million, or 10.4%, a year earlier. Management cited $17.5 million of incremental Q2 phantom-stock expense tied to the rise in the share price; excluding this item, it said total SG&A would have been $65.1 million, or 9.3% of revenue.
- Cash flow and liquidity: Six-month operating cash flow was $15.5 million, down from $79.7 million; investing cash use was $12.4 million and financing cash use was $40.9 million. Cash and restricted cash totaled $271.6 million at April 30, 2021. Management reported total liquidity of $352.8 million, including $218.3 million of homebuilding cash and $125.0 million available on its revolving facility. It said liquidity should cover working capital needs through fiscal 2021.
- Debt and equity: Senior notes and credit facilities, net, were $1.429 billion, compared with $1.431 billion at October 31, 2020; nonrecourse inventory mortgages were another $113.9 million. The company also reported $110.5 million outstanding on mortgage warehouse facilities and $90.4 million of liabilities from inventory not owned. Most senior debt bears high fixed rates; the filing lists weighted-average interest of 9.48% on long-term debt. Total equity turned positive at $72.7 million from a $436.1 million deficit, mainly reflecting the tax-allowance reversal and reported earnings.
- Backlog and operations: Contract backlog was 3,897 homes valued at $1.8 billion, versus 2,383 homes and $958.1 million a year earlier. Net contracts rose 19.1% in Q2 and 26.3% for six months. Active selling communities declined to 97 from 116 at October 31, 2020, as strong sales accelerated community closeouts. The company controlled 28,077 lots, including lots held through options and joint ventures.
Changes versus comparable periods
- Operating results improved markedly year over year: higher deliveries and prices lifted revenue and margins, and all homebuilding segments except the Northeast reported higher six-month pretax income than in 2020.
- Six-month cash from operations fell despite the profit improvement, reflecting land and development investment, inventory growth and a $459.2 million deferred-tax asset increase.
- The tax benefit drove the sharp rise in net income and equity; pretax income provides a more useful comparison of underlying period performance.
- Q2 2020 included a $9.3 million debt-extinguishment gain for the six-month comparison; there were no debt transactions in the first half of fiscal 2021.
Outlook, risks and unusual items
- Management described demand as strong, citing low mortgage rates, limited existing-home inventory and consumer demand for more space. It reported improved sales pace and a $1.8 billion backlog, and said it was pursuing replacement communities as active community count fell.
- No specific revenue, earnings or delivery guidance was provided. Management stated that available cash and revolver capacity were expected to fund working capital through fiscal 2021. It also said liquidity was above its target range of $170 million to $245 million.
- On June 2, 2021, after quarter-end, the company announced redemption of all $111.2 million principal amount of 10.0% notes due 2022, at par plus accrued interest, with a July 30, 2021 redemption date.
- Debt covenants restrict dividends and certain financing and capital actions. The company was unable to pay dividends on its 7.625% preferred stock and anticipated that restriction would continue for the foreseeable future. Management said it was in compliance with debt covenants.
- Risks include high leverage and interest costs, housing-market and COVID-19 uncertainty, mortgage rates and financing availability, land and construction-cost inflation, labor and material supply, cancellations, regulatory and environmental requirements, and warranty and construction-defect claims.
- Notable contingencies include the Four Seasons at Great Notch construction-defect case, in which plaintiffs assert approximately $119.5 million in damages potentially subject to trebling, and the Hickory Manor environmental lawsuit seeking recovery of costs and other relief. The company intends to defend both. It also disclosed an EPA Newark cleanup reimbursement demand of $2.7 million and said it believes it has adequate reserves, while the ultimate obligation remains uncertain.
- The company recorded a $0.8 million inventory impairment and $1.2 million of land-option and related cost write-offs for the six months. It cautioned that lower prices or adverse changes in assumptions could require further impairments. COVID-19 effects and broader housing-market conditions remained uncertain.
Important facts for investors to verify
- How much of reported net income and the equity improvement reflects the noncash deferred-tax valuation-allowance reversal, and whether future taxable income supports realization of the remaining deferred tax assets.
- Whether backlog converts to deliveries at expected prices and margins, particularly as active selling communities decline and the company works to replenish them.
- Whether price gains can continue to offset land, labor, materials and other construction-cost inflation.
- Debt maturities, cash interest burden, covenant limitations and the funding and completion of the July 2021 note redemption.
- Actual cash generation after land investment, along with developments in the Great Notch, Hickory Manor and Newark environmental matters.