Hovnanian Enterprises, Inc. — FY2014 Form 10-K
Reporting period: Fiscal year ended October 31, 2014; fourth-quarter figures are for the three months ended October 31, 2014. The company builds and sells homes across six U.S. regions and provides mortgage and title services.
Financial and operating performance
- Revenue: $2.063 billion, up 11.5% from $1.851 billion. Home-sale revenue rose 12.8% to $2.013 billion, reflecting 4.4% more deliveries and an 8.1% increase in average selling price to $366,202. Financial-services revenue fell to $42.4 million from $47.7 million.
- Profit: Net income was $307.1 million versus $31.3 million; diluted EPS was $1.87 versus $0.22. Pretax income declined to $20.2 million from $21.9 million. The net result was dominated by a $287.0 million income-tax benefit, including a $285.1 million partial reversal of the deferred-tax-asset valuation allowance. The filing reports a remaining valuation allowance of $642.0 million.
- Margins and expenses: Homebuilding gross margin before cost-of-sales interest and land charges was 19.9%, down from 20.1%; after interest and land charges it was 17.0%, versus 16.9%. SG&A as a percentage of revenue rose to 12.4% from 11.9%. Prior-period impairment reversals benefited gross margin by $48.0 million in FY2014.
- Cash flow and liquidity: Operating activities used $190.6 million, compared with $9.3 million provided in FY2013. The company spent $585.8 million on land and land development. Year-end cash and cash equivalents were $261.9 million, down from $329.2 million; this includes $255.1 million in homebuilding cash and $6.8 million in financial-services cash. Management said available sources should fund requirements through FY2015, while cautioning that operating cash flow could remain negative or only slightly positive after land purchases.
- Debt and equity: Notes payable totaled $1.690 billion, including $979.9 million of senior secured notes and $590.5 million of senior notes, net of discounts. Separately, mortgage warehouse lines were $76.9 million and nonrecourse mortgages were $103.9 million. The company reported a $117.8 million equity deficit, improved from $432.8 million. It reported compliance with debt covenants; dividend payments remained restricted.
- Fourth quarter: Revenue was $698.4 million versus $591.7 million a year earlier; pretax income was $36.0 million. Net income of $322.5 million principally reflected a $286.5 million tax benefit. Gross margin before interest and land charges fell sequentially to 19.3% from 21.3%, while SG&A as a share of revenue improved to 9.3% from 12.2%.
Material changes versus FY2013
- Consolidated deliveries increased to 5,497 from 5,266; including unconsolidated joint ventures, deliveries were 5,934 versus 5,930. Active selling communities rose to 201 from 192.
- Net home contracts were nearly flat by count: 5,559 versus 5,544. Contract value increased 10.0% to $2.106 billion, but contracts per average active community declined to 28.4 from 30.7, reflecting slower sales pace.
- Year-end backlog including joint ventures was 2,341 homes valued at $905.0 million, compared with 2,392 homes and $848.4 million. Excluding joint ventures, backlog value was $855.8 million, up from $762.4 million.
- Regional results were uneven: the Northeast recorded a $7.5 million pretax loss, while the Southwest generated $74.5 million of pretax income. Financial-services pretax profit declined to $13.8 million from $18.7 million.
- Inventory impairment and land-option write-off charges totaled $5.2 million, versus $5.0 million. The company walked away from 5,148 optioned lots and recorded $4.0 million of related pretax charges.
Outlook, risks and unusual items
- Management viewed the company as positioned for FY2015 based on higher backlog value and community count, but expected uneven results across markets. It cited persistent unemployment in some markets, economic uncertainty, declining oil prices, restrictive mortgage lending and rising mortgage rates. Its strategy remains to expand community count and acquire land at prices expected to support acceptable returns.
- Liquidity and leverage are significant risks: management disclosed substantial debt service needs, negative FY2014 operating cash flow after land purchases, and dependence on cash, operations and financing access. Debt covenants constrain dividends and other actions.
- The large FY2014 tax benefit arose from management’s reassessment of deferred tax asset realizability. The company noted cumulative losses over the three-year period despite recent operating profitability; realization depends on future taxable income. Federal NOL carryforwards were $1.5 billion and state NOLs approximately $2.2 billion.
- After year-end, on November 5, 2014, the company issued $250 million of 8.0% senior notes due 2019, receiving $245.7 million net proceeds for general corporate purposes, including land acquisition and development.
- A New Jersey HVAC class action settlement provides for $21 million to the plaintiff class, with most funded by insurers; it was fully reserved for the company’s share and remained subject to court approval. The EPA identified the company as a potentially responsible party for a Newark lead-contamination cleanup; the scope of any obligation was unclear and could not be estimated.
- Other exposures include warranty and construction-defect claims, mortgage-loan repurchase representations and warranties, land impairment, regulatory and environmental requirements, and weather, labor and material-cost fluctuations. The filing states the financial statements received an unqualified audit opinion and internal control over financial reporting was effective.
Investor facts to verify
- Whether the deferred tax assets and NOLs are ultimately usable, and how future taxable income supports the valuation-allowance release.
- Cash generation after land and development spending, financing access, debt maturities and covenant headroom.
- Whether slower sales pace, pricing pressure and incentives affect backlog conversion and gross margins in FY2015.
- The eventual cost and timing of the Newark EPA matter and court approval and insurance funding of the $21 million class settlement.
- Whether inventory carrying values, option walk-aways and warranty/insurance reserves remain adequate as market conditions change.