Hovnanian Enterprises, Inc. — FY2018 Form 10-K
Reporting period: Fiscal year ended October 31, 2018. This is an annual filing; fourth-quarter results are identified separately where relevant. Hovnanian builds and sells homes across six U.S. regions and provides mortgage and title services to its homebuyers.
Financial results and operating metrics
| Metric | FY2018 | Prior comparable period |
|---|---|---|
| Total revenue | $1.991 billion | $2.452 billion; down 18.8% |
| Net income (loss) | $4.5 million | $(332.2) million |
| Income (loss) before taxes | $8.1 million | $(45.2) million |
| Homebuilding gross margin | 15.2% | 13.2% |
| Operating cash flow | $(66.8) million | $301.6 million provided |
| Home deliveries, consolidated | 4,847 | 5,602; down 13.5% |
| Average delivered home price | $393,280 | $417,714; down 5.8% |
Housing revenue was $1.906 billion, down 18.5%. Management attributed the decline chiefly to fewer deliveries as the community base contracted, and lower average selling prices reflecting geographic and community mix. The non-GAAP gross margin before cost-of-sales interest and land charges was 18.4%, versus 17.2% in FY2017.
FY2018 net income followed a large FY2017 loss, which included a $286.9 million tax provision, primarily from establishing a full valuation allowance against deferred tax assets. The FY2018 result also included $7.5 million of debt-extinguishment losses and $24.0 million of income from unconsolidated joint ventures, compared with a $7.0 million joint-venture loss in FY2017. Fourth-quarter FY2018 net income was $46.2 million, including $48.1 million pretax income.
Liquidity, debt and balance sheet
- Homebuilding cash and cash equivalents were $187.9 million at year-end. Management reported total liquidity of $325.6 million, including $125.0 million available under the secured revolving facility; $12.7 million of cash was collateralized for letters of credit.
- Cash used in operations was $66.8 million. The company spent $566.8 million on land purchases and development and used $211.4 million for net debt repayments. Cash and cash equivalents declined from $463.7 million to $187.9 million in homebuilding operations.
- Debt excluding nonrecourse secured debt and financial-subsidiary debt was reported at $1.493 billion face amount ($1.453 billion net of discounts and premiums). Total equity remained in deficit at $453.5 million; total assets were $1.662 billion.
- The company reported $322.8 million of FY2018 debt service, defined to include interest incurred and principal payments, with specified debt categories excluded. It reported no borrowings under its $125.0 million secured revolving facility at year-end and said it was in compliance with debt covenants.
- FY2018 financing transactions refinanced or exchanged maturing debt, including issuance of term loans bearing 5.0% interest and new notes bearing 13.5% and 5.0%. Outstanding senior secured notes include 10.0% notes due 2022 and 10.5% notes due 2024. Debt covenants restrict additional borrowing, asset sales and dividends; preferred dividends were unpaid and management expected restrictions to continue.
Changes, outlook and notable items
- Net sales contracts fell 10.1% to 4,671 homes; contract value decreased 11.9% to $1.835 billion. Backlog excluding unconsolidated joint ventures was 1,826 homes valued at $745.6 million, down 7.7% in value year over year.
- Active selling communities declined from 130 to 123. Management said land investment was constrained by debt maturities in earlier years, but controlled lots increased year over year for four consecutive quarters. After investing $566.8 million in land and development during FY2018, management expected community-count growth to begin in the first half of FY2019; growth in deliveries and revenue would follow with a lag. No quantified earnings or revenue guidance was provided.
- Management said it believed available cash, operating cash flows and the secured credit facility would be sufficient to fund working-capital needs through FY2019. It remained cautious about market conditions and land acquisitions. Fourth-quarter contracts per community declined year over year, and management noted rising mortgage rates and a potentially slowing housing market.
- Gross margin improvement reflected delivery mix, a one-time $6.3 million California municipal land-development reimbursement and lower warranty reserves. The company also reported $51.7 million of reversals of prior-period inventory impairments benefiting FY2018 gross margin; these items make reported margin less indicative of recurring performance.
- Key risks include high leverage and refinancing needs, housing-market and mortgage-rate sensitivity, labor and material cost increases, land availability, regulation, weather and construction defects. Southern California wildfires after year-end had not directly affected communities, but management warned of possible labor, construction and utility delays in FY2019.
- Contingencies include an EPA demand for $2.7 million related to a Newark, New Jersey site; the company disputed responsibility and said it had adequate reserves. A separate New Jersey condominium lawsuit asserted approximately $119.5 million in remaining damages, potentially subject to treble damages; summary judgment and mediation were pending, with trial scheduled for March 2019. The company said it would defend the claims vigorously.
Investor verification priorities
- Review the debt maturity schedule, refinancing restrictions, interest burden and covenant terms, including the status and terms of the committed $25 million additional 10.5% notes purchase scheduled for January 2019.
- Assess whether liquidity can support planned land investment while operating cash flow is negative, and verify the timing and economics of anticipated FY2019 community growth.
- Separate recurring margin performance from the $6.3 million reimbursement, warranty-reserve changes and impairment reversals; check whether those benefits recur.
- Track sales pace, cancellations, backlog conversion, average selling prices and mortgage affordability amid higher rates and slower market conditions.
- Monitor the Great Notch litigation, EPA matter, warranty reserves and any other construction-defect or mortgage-loan repurchase exposures.