Business context and reporting period
Hovnanian Enterprises, Inc. is a U.S. homebuilder with six regional homebuilding segments and a mortgage and title-services business. This unaudited Form 10-Q covers the three and nine months ended July 31, 2017; balance-sheet comparisons are to October 31, 2016. Amounts below are in U.S. dollars.
Financial performance and liquidity
| Metric | Three months ended July 31, 2017 | Nine months ended July 31, 2017 |
|---|---|---|
| Total revenue | $592.0 million, down 17.4% | $1,730.0 million, down 11.2% |
| Net loss | $337.2 million; $2.28 per share | $344.0 million; $2.33 per share |
| Pre-tax result | $50.2 million loss | $57.5 million loss |
| Homebuilding gross margin | 12.8%, versus 13.1% | 12.9%, versus 11.9% |
| Operating cash flow | Not separately presented | $145.5 million, versus $194.6 million |
- Home-sale revenue was $574.3 million in Q3 and $1,673.3 million for nine months. Home deliveries fell 14.2% and 13.0%, respectively; average selling prices rose to $425,000 and $419,000.
- The Q3 tax expense was $287.0 million, largely from raising the deferred-tax-asset valuation allowance. The company established a full valuation allowance; the reported allowance was $922 million at July 31.
- Cash and cash equivalents were $285.7 million, including $278.5 million in homebuilding cash, down from $346.8 million total at October 31. Homebuilding cash remained above management’s stated $170–$245 million target range. Restricted cash was $25.4 million.
- Net cash used in investing activities was $22.6 million and net cash used in financing activities was $183.9 million for nine months. The company said it spent $439.9 million on land purchases and development.
- Balance-sheet notes payable and term loan were $1.599 billion, net of discounts and issuance costs; the revolving facility had $52.0 million drawn. Stockholders’ equity deficit widened to $471.2 million from $128.5 million.
Material changes versus the prior comparable period
- Revenue declined mainly because the company had 19% fewer active selling communities year over year, following reduced land investment and market exits. Q3 net contracts fell 10.0%, and nine-month net contracts fell 15.1%; contracts per average active selling community improved to 9.4 in Q3 from 8.4 and to 26.7 for nine months from 23.9.
- The July refinancing issued $440 million of 10.0% senior secured notes due 2022 and $400 million of 10.5% senior secured notes due 2024. Proceeds and cash were used to tender for and discharge specified secured notes due 2018 and 2020. The transactions generated a $42.3 million debt-extinguishment loss; earlier open-market repurchases generated a $7.8 million gain.
- Management said the refinancing increases annual interest expense by about $23.4 million from fiscal 2018 onward. Nine-month cash interest paid, net of capitalized interest, rose to $88.9 million from $80.5 million.
- Financial-services pre-tax profit declined to $6.1 million in Q3 and $19.3 million for nine months, from $7.6 million and $25.0 million, respectively, reflecting fewer mortgage originations and a lower capture rate.
Outlook, commentary, risks and contingencies
- Management expected strong sales and backlog to support a profitable fiscal fourth quarter, but warned that Hurricane Harvey would reduce deliveries. Fewer than ten homes in two of its 45 Houston communities were reported to have flood damage.
- The company identified a fire-resistant coating issue affecting I-joists in 63 homes in Delaware and New Jersey. It anticipated delayed closings and/or cancellations, but did not expect material costs or charges; remediation was still being evaluated.
- Management expected community-count growth in the second half of fiscal 2018, following land investment and subject to the time needed for approvals and community openings. It stated that available cash and other sources should fund working-capital needs through fiscal 2017 and 2018.
- Debt covenants restrict dividends and certain additional borrowing; management expected the preferred-stock dividend restriction to continue for the foreseeable future. It reported compliance with applicable debt covenants at July 31, 2017.
- Homebuilding risks include construction-cost and labor increases, interest rates and mortgage availability, housing-market conditions, land access, weather, regulation, and the company’s high debt and covenant limits. Additional inventory impairments may be required if expected cash flows or property values weaken.
- In a New Jersey condominium case, a jury verdict against a subsidiary totaled $9 million after statutory trebling, plus undetermined attorneys’ fees. Management considered a loss probable and estimable and recorded a reserve; post-trial motions and potential appeals were pending. A separate nearby condominium lawsuit alleged about $70 million in damages, potentially subject to trebling; loss could not yet be assessed. The EPA’s Newark-area lead-contamination inquiry also remained unresolved, and the company could not estimate its potential obligation.
- The company reported a three-year cumulative loss, prompting its full deferred-tax-asset valuation allowance. Management cited the debt refinancing and market recovery as positive factors, but noted continuing housing-market uncertainty, increased future interest costs, and risks to recovery.
Important facts for investors to verify
- Whether home deliveries, backlog conversion, and community openings recover as management anticipated, especially after the Harvey and I-joist disruptions.
- The refinancing’s final cash costs, higher interest burden, remaining maturities, and the company’s ability to meet debt obligations within covenant restrictions.
- Whether the full deferred-tax valuation allowance remains appropriate and whether the company can generate taxable income to realize its tax assets.
- Developments, reserves, and potential exposure in the Port Imperial litigation and EPA matter, as well as outcomes in the second condominium lawsuit.
- Cash generation as land and development spending increases, and the quality and expected returns of land, option, and joint-venture investments.