Business context and reporting period
Hovnanian Enterprises, Inc. is a U.S. homebuilder operating across six geographic segments, with a mortgage and title services business. This unaudited Form 10-Q covers the quarter and nine months ended July 31, 2020; comparisons are with the corresponding 2019 periods. Amounts below are in millions of dollars unless stated otherwise.
Financial and operating results
| Metric | Three months ended July 31 | Nine months ended July 31 |
|---|---|---|
| Total revenue | $628.1, up 30.3% from $482.0 | $1,660.5, up 27.4% from $1,303.3 |
| Net income (loss) | $15.4 vs. $(7.6) | $10.3 vs. $(40.3) |
| Diluted earnings (loss) per share | $2.16 vs. $(1.27) | $1.44 vs. $(6.76) |
| Homebuilding gross margin | 13.6% vs. 14.0% | 13.7% vs. 14.0% |
| Operating cash flow | $192.8 for nine months, versus $(258.1) in 2019 |
- Home deliveries rose 31.1% to 1,553 in the quarter and 27.1% to 4,114 year to date. Average selling price was $390,169 in the quarter and $390,985 year to date.
- Net contracts increased 46.9% for the quarter and 26.0% year to date. Quarter sales pace reached 17.8 contracts per average active selling community, up from 11.0. Backlog at July 31 was 3,056 homes valued at $1.2 billion, up 17.1% in value year over year.
- Quarter financial services pretax profit was $10.8, versus $3.8; nine-month profit was $20.0, versus $8.6. The company attributed improvement to higher deliveries, loan values, and mortgage-sale spreads.
- Quarter gross margin before cost-of-sales interest and land charges was 17.5%, down from 18.4%; the comparable nine-month measure was 17.7% in both years. Management cited product mix and incentives on unsold homes.
- Cash, cash equivalents and restricted cash totaled $246.3 at July 31. Homebuilding cash was $198.1; total liquidity, including $125.0 of undrawn revolving-credit capacity, was $334.3.
- Net senior notes and credit facilities were $1,432.1; nonrecourse inventory mortgages were $179.8. Total equity remained in deficit at $479.5. The filing reports high leverage and restrictive debt covenants.
Material changes versus prior comparable periods
- Revenue and deliveries increased substantially, with particularly strong sales activity late in the quarter. Active selling communities declined to 117 from 141 a year earlier.
- The company moved from losses to profits in both comparison periods. Year-to-date operating cash flow also improved markedly, reflecting operating results and inventory and working-capital movements.
- Homebuilding gross margin percentage fell despite higher revenue. Land-option and related write-offs were $6.2 year to date, versus $2.5 in 2019; no inventory impairment losses were recorded in the 2020 period.
- Debt transactions included exchanges that reduced or refinanced certain obligations and extended maturities. The company repurchased $25.5 principal amount of 10.0% notes for $21.4, recognizing a $4.1 gain. Debt extinguishment gains totaled $13.3 year to date.
Outlook, commentary, risks and unusual items
- COVID-19 caused lower traffic and sales pace and higher cancellations in the second quarter. Management said conditions improved from late April through the third quarter, but cautioned that pandemic effects and future business conditions remain uncertain and could materially affect sales, deliveries, cash flow and profitability.
- The company said available cash and revolver capacity should be sufficient to fund working-capital needs through fiscal 2020. It provided no specific revenue or earnings guidance.
- Restructuring measures include consolidating operations, reducing offices, phasing out the Chicago market as existing communities sell through, and reducing overhead. Management expects approximately $20 million of annualized overhead savings beginning in fiscal 2021; third-quarter severance and related costs were $2.9.
- Management reported increased demand in June and July and began raising home prices, which it believes may offset higher material and labor costs and could improve future margins. This is an expectation, not a guarantee.
- Debt covenants currently restrict dividends, including dividends on the 7.625% preferred stock; management expects the restriction to continue for the foreseeable future. The company reported compliance with debt covenants as of July 31.
- The company maintained a full valuation allowance against deferred tax assets of $592.9. It cited cumulative GAAP losses and housing-market uncertainty among the negative evidence considered.
- Contingencies include an EPA cleanup-cost demand of $2.7 related to a New Jersey site, with settlement discussions ongoing; the company says it has adequate reserves. In the Great Notch construction-defect case, plaintiffs assert approximately $119.5 in damages, potentially subject to treble damages; the company intends to defend the claims.
- Other risks include high debt and limited ability to incur additional debt, mortgage availability and interest rates, land and construction costs, labor and materials supply, regulatory and environmental requirements, and potential future inventory impairments. The company noted that COVID-19 could contribute to additional impairment or reorganization charges.
Most important facts for investors to verify
- Whether strong contract activity and backlog convert into deliveries and cash generation, and how cancellation rates develop; quarter cancellations were 18% of gross contracts, while cancellations equaled 21% of beginning backlog.
- Whether home-price increases offset labor, materials, land-development and incentive costs, particularly given lower reported gross margins and weaker West-segment results.
- Liquidity, debt maturities, interest burden and covenant restrictions, including the availability and terms of refinancing and the continued inability to pay preferred dividends.
- Execution and timing of the planned $20 million annualized overhead savings, along with restructuring costs and the Chicago market wind-down.
- Developments in the EPA and Great Notch matters, and whether reserves remain adequate as proceedings progress.