HOVNANIAN ENTERPRISES INC quarterly report, Q1 FY2015

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Hovnanian Enterprises, Inc. — Q1 FY2015 Form 10-Q

Business context and period. Homebuilder and mortgage/title services provider. The unaudited quarter ended January 31, 2015; comparisons are with the three months ended January 31, 2014 unless otherwise noted. Amounts below are in U.S. dollars.

Financial performance and position

  • Revenue: $445.7 million, up 22.4%. Homebuilding revenue was $434.6 million; financial services revenue was $11.1 million.
  • Home sales and activity: 1,149 homes delivered, up 10.9%; average selling price was $377,259, up 10.0%. Net contracts rose 20.8% to 1,319 homes. Backlog was 2,399 homes worth $925.5 million, up 7.9% in units and 13.5% in value year over year.
  • Profit and margins: Pretax loss was $19.7 million versus $23.9 million; net loss was $14.4 million versus $24.5 million. Basic and diluted loss per share was $0.10 versus $0.17. Homebuilding gross margin before interest and land charges was 18.2%, down from 18.8%; after interest and land charges it was 15.1%, down from 15.9%. Selling, general and administrative expense, including corporate G&A, declined to 14.5% of revenue from 16.6%.
  • Segment results: Homebuilding pretax income was $13.5 million versus $9.7 million, while corporate and unallocated costs were $37.0 million versus $35.0 million. Financial services pretax income increased to $3.8 million from $1.4 million. Southwest was the largest homebuilding contributor, with $11.3 million pretax income; Southeast and West reported pretax losses.
  • Cash flow: Operating activities used $195.6 million, compared with $131.1 million used a year earlier, mainly reflecting inventory investment. Investing activities used $11.4 million. Financing activities provided $218.5 million, including proceeds from a $250 million notes issuance. Cash and cash equivalents ended at $273.3 million, up from $261.9 million at the start of the quarter; restricted cash was $24.5 million.
  • Debt and liquidity: Notes payable totaled $1.938 billion at January 31, 2015, versus $1.690 billion at October 31, 2014. The increase principally reflects $250 million of 8.0% senior notes due 2019 issued in November 2014. Homebuilding nonrecourse mortgages were $100.6 million; mortgage warehouse lines were $68.8 million. The $75 million unsecured revolver had no borrowings and $24.0 million of letters of credit outstanding. Total liabilities were $2.591 billion and stockholders’ equity was a deficit of $130.0 million.
  • Other metrics: Inventory, excluding consolidated inventory not owned, increased $156.4 million from October 31, 2014, largely due to land purchases and development. Inventory impairment and land-option write-offs totaled $2.2 million, including a $0.9 million impairment. Warranty and general liability reserves were $181.8 million.

Material changes and management commentary

  • Management attributed higher revenue to increased deliveries and average selling prices, supported by community growth and mix. Active selling communities were 199, compared with 193 a year earlier. First-quarter net contracts per average active community improved to 6.6 from 5.7.
  • Despite year-over-year improvement, gross margin before interest and land charges fell 0.6 percentage point, primarily because of increased incentives and competitive pricing pressure. Sequentially, that margin fell from 19.3% in Q4 FY2014 to 18.2% in Q1 FY2015; management cited lower seasonal deliveries and fixed costs.
  • Management said backlog growth and expected community-count increases positioned the company for stronger results as the fiscal year progressed, particularly in the second half. It also cautioned that results may remain mixed across markets and that positive operating trends do not ensure sustained profitability.
  • Management expected available cash, operating sources, financing and the revolver to fund fiscal 2015 working-capital and other needs, including community growth. It also anticipated continued difficulty generating positive operating cash flow until full-year profitability improves.
  • Management reported a three-year cumulative loss position for deferred-tax accounting, but concluded substantial deferred tax assets were more likely than not to be realized, citing recent operating profitability and housing-market recovery. The valuation allowance was $642.5 million at January 31, 2015. This assessment depends on estimates and future results.

Guidance, risks, contingencies, and unusual items

  • No quantified revenue, earnings, delivery, or margin guidance was provided. The outlook was conditional on backlog conversion, community growth, and continued housing-market recovery.
  • Management identified economic uncertainty, declining oil prices that could affect Texas, restrictive mortgage lending, rising mortgage rates, land and construction costs, labor and materials availability, competition, seasonality, regulation, and access to financing as risks.
  • The company reported negative operating cash flow and substantial debt, restrictive debt covenants, and limits on additional indebtedness and restricted payments. It said it was in compliance with relevant covenants at January 31, 2015, but expected to remain unable to pay preferred dividends for the foreseeable future.
  • The EPA identified the company as a potentially responsible party regarding lead contamination near a former smelter and proposed that it fund or contribute to cleanup. The company said the scope of any obligation was unknown and could not assure the matter would not have a material impact.
  • A New Jersey HVAC class action involving a potential class of 1,065 homes settled for $21 million, primarily funded by insurers; the company had previously reserved for its share. The settlement judgment became final February 20, 2015, and the matter was concluded.
  • The quarter included a $5.3 million income tax benefit, primarily from deferred taxes, and $2.2 million of inventory impairment and option-related write-offs. One community impairment used a 19% discount rate. Management warned that changed estimates, pricing, or projected cash flows could lead to further impairments.

Important facts for investors to verify

  1. Whether backlog growth converts into deliveries and sustained profitable margins, especially given pricing incentives and market-specific weakness.
  2. How the company funds ongoing land investment and operating cash outflows, and whether debt maturities, financing access, and covenant restrictions constrain liquidity.
  3. The assumptions supporting realization of deferred tax assets and the potential earnings or balance-sheet effect if those assumptions change.
  4. The possible financial exposure and timing of the EPA cleanup matter, and whether warranty, construction-defect, or mortgage repurchase claims exceed reserves.
  5. Whether the reported improvement in contracts, deliveries, and financial-services results persists across regions and through the remainder of FY2015.