Hovnanian Enterprises, Inc. — Q3 FY2019 Form 10-Q
Reporting period: Fiscal quarter and nine months ended July 31, 2019. The company builds and sells homes across six U.S. regions and provides mortgage and title services. Figures below are in U.S. dollars; financial statement amounts are generally in millions.
Financial performance
| Metric | Three months ended July 31, 2019 | Nine months ended July 31, 2019 | Prior-year comparison |
|---|---|---|---|
| Total revenue | $482.0 | $1,303.3 | +5.5% and -5.3%, respectively |
| Net loss | $(7.6) | $(40.3) | $(1.0) and $(41.7), respectively |
| Net loss per common share | $(1.27) | $(6.76) | $(0.18) and $(7.03), respectively |
| Homebuilding gross margin | 14.0% | 14.0% | 15.4% and 14.6%, respectively |
| Operating cash flow | $(258.1) for the nine months | $(96.6) in prior-year period |
- Q3 home sales revenue rose 5.6% as deliveries increased 3.8% to 1,185 homes; average selling price rose to $394,809. For the nine months, deliveries fell 4.3% to 3,237 and home sales revenue declined 4.2%.
- Gross margin before cost-of-sales interest and land charges, a non-GAAP measure, was 18.4% in Q3 and 17.7% for the nine months. Management attributed the reported margin decline mainly to higher interest allocated to home costs and delivery mix, with some impact from direct costs and financing concessions.
- Financial services pretax profit was $3.8 million in Q3 and $8.6 million for the nine months, down from $4.0 million and $10.8 million. Management cited narrower mortgage origination spreads and, for the nine-month period, fewer home deliveries.
- Cash and cash equivalents were $83.6 million in homebuilding at July 31, down from $187.9 million at October 31, 2018. Total cash, cash equivalents and restricted cash across the company was $124.8 million.
- Nine-month investing cash flow was $(9.5) million and financing cash flow was $159.4 million. The company reported $225.1 million of total liquidity, including $125.0 million available under its secured revolving facility; it described this as within its $170–245 million target range.
Debt, balance sheet and operating changes
- Total liabilities were $2.288 billion and equity deficit was $493.1 million at July 31, 2019. Homebuilding notes payable, including accrued interest, were $1.285 billion; the senior unsecured term loan was $201.5 million net of issuance costs. Nonrecourse mortgages secured by inventory were $207.2 million net, up from $95.6 million at October 31, 2018.
- Senior secured notes carried stated annual rates from 2.0% to 10.5%; the senior notes included 13.5% notes due 2026 and 5.0% notes due 2040. The company had no borrowings under its $125 million secured revolving facility at quarter end. The facility’s availability was scheduled to end December 28, 2019, with any outstanding loans converting to term loans.
- Inventory excluding consolidated inventory not owned increased $185.1 million from October 31, 2018, reflecting land purchases and development. Consolidated inventory not owned increased $91.7 million, primarily because of land banking and model-home sale-leaseback financing arrangements.
- Active selling communities increased 12.2% year over year to 138, though down sequentially from 147; faster-than-expected sales led to more community sellouts than planned. Lots controlled increased year over year for a seventh consecutive quarter.
- Net contracts rose 22.6% in Q3 and 8.9% for the nine months year over year. Backlog rose to 2,555 homes valued at $1.1 billion, an 11.4% increase in dollar value.
Outlook, risks and unusual items
- No specific earnings or revenue guidance was provided. Management expected community count to continue growing in Q4 FY2019 and said it believed liquidity sources, including the secured facility, would be sufficient for working capital through fiscal 2019. It cautioned that new community openings and resulting deliveries depend on market conditions and can lag land control by months or years.
- Management said it would continue pursuing land acquisitions selectively, while monitoring market conditions, construction costs, and trade and tariff developments. It noted that tariffs had not materially affected results to date but could affect the business and customers’ budgets in the future.
- Cash used in operations reflected, in part, $400 million spent on land purchases and development. Management said further land investment is important to returning to sustained profitability, while emphasizing continued attention to liquidity.
- Debt covenants restrict additional borrowing and distributions. The company was unable to pay dividends on its 7.625% Series A Preferred Stock and expected that restriction to continue for the foreseeable future. It reported compliance with debt covenants at July 31.
- The company recorded $3.6 million of inventory impairment losses and land-option write-offs for the nine months. Management warned that lower prices or weaker cash-flow and fair-value estimates could require further impairments. Three tested communities had projected undiscounted cash flows less than 20% above carrying value.
- Material contingencies include a Great Notch construction-defect lawsuit with approximately $119.5 million in asserted damages, potentially subject to treble damages; the company intends to defend the claims. The EPA demanded $2.7 million for cleanup costs related to a Newark redevelopment site; the company said it had adequate reserves but could not assure the matter would not have a material impact.
- Other risks include high leverage, refinancing and liquidity constraints, housing-market cyclicality, mortgage rates and availability, labor and material costs, cancellations, environmental and land-use regulation, litigation, and joint-venture performance. Management said disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Key facts for investors to verify
- Whether backlog and contract growth convert into deliveries, revenue and improved margins, particularly as community count grows.
- Cash burn, land-investment pace, borrowing capacity and the December 2019 secured-facility availability transition.
- Debt maturities, interest burden, covenant restrictions and the continuing suspension of preferred dividends.
- Potential additional inventory impairments and the outcome, timing and financial exposure of the Great Notch and EPA matters.
- Regional performance: Q3 pretax losses persisted in the Southeast, while several segments had lower profits despite revenue or delivery growth.