Hovnanian Enterprises, Inc. — Q3 FY2014 Form 10-Q
Reporting period: Three and nine months ended July 31, 2014. Financial amounts below are in millions unless stated otherwise. The company builds homes across six U.S. regions and provides mortgage and title services.
Financial results and liquidity
- Third-quarter revenue: $551.0, up 15.2% year over year. Home sales revenue was $538.0, up 16.4%; 1,464 homes were delivered, up 9.2%, and average selling price rose 6.6% to $367,000.
- Third-quarter earnings: Net income was $17.1, or $0.11 per diluted share, versus $8.5, or $0.06, a year earlier. Pretax income was $15.4. Homebuilding gross margin was 21.3% before cost-of-sales interest and land charges, compared with 20.3% a year earlier; after those items, margin was 18.2% versus 17.2%.
- Nine-month results: Revenue was $1,365.0, up 8.4%; net loss was $15.3, or $0.10 per share, versus a $1.5 loss. Pretax loss was $15.8. Homebuilding gross margin before cost-of-sales interest and land charges improved to 20.2% from 18.9%.
- Cash flow: Operating activities used $259.5 in the first nine months, compared with $47.4 used a year earlier. Inventory investment used $299.3. Investing activities used $9.3; financing activities provided $123.4.
- Cash and liquidity: Cash was $183.7 at July 31, down from $329.2 at October 31, 2013; restricted cash was $25.9. Management stated that available sources were expected to fund working capital and other needs through fiscal 2015. The $75.0 revolving facility had no borrowings and $25.5 of letters of credit outstanding.
- Debt and equity: Notes payable totaled $1,683.2; additional homebuilding nonrecourse mortgages were $115.2, and financial-services warehouse lines were $54.0. Total liabilities were $2,336.8, exceeding assets of $1,893.7; stockholders’ equity deficit was $443.1. The company issued $150.0 of 7.0% notes due 2019 and used part of the proceeds to redeem $21.4 of 6.25% notes due 2015.
Changes versus the prior comparable period
- Homebuilding deliveries and average selling prices increased, supporting revenue and gross-margin improvement. The company attributed margin gains partly to delivery mix, prior price increases, and lower-cost land in newer communities.
- Demand indicators were mixed: net contract home counts fell 6.3% in the quarter and 1.8% year to date; contracts per average active selling community declined to 6.9 from 7.8 for the quarter and to 21.9 from 24.4 year to date. The quarter-end backlog value was $1,025.6, up 14.3% year over year.
- SG&A, including corporate costs, rose to 12.2% of revenue from 11.8% in the quarter and to 13.9% from 12.5% year to date. Homebuilding SG&A increased with community growth, compensation, advertising and architectural costs, while joint-venture management fees declined.
- Financial-services pretax profit fell to $3.9 from $6.2 in the quarter and to $8.0 from $14.0 year to date, chiefly reflecting fewer mortgage settlements. Joint-venture income also declined, to $0.2 from $3.7 in the quarter and $3.8 from $6.8 year to date.
Outlook, risks and unusual items
- Management described the housing recovery as slower and uneven, citing high unemployment, economic uncertainty, restrictive mortgage lending, higher mortgage rates and possible foreclosures. It expected uneven improvement by market and provided no specific numerical earnings or revenue guidance.
- The company opened 77 communities and closed 73 in the first nine months, ending with 196 active selling communities. It acquired or optioned approximately 7,400 lots and planned further land purchases and community growth, while saying sustained profitability remained a goal and positive operating cash flow could remain difficult until then.
- Inventory impairment and land-option write-offs were $1.9 year to date, down from $3.5. Management cautioned that weaker prices or cash-flow assumptions could require further impairments. Inventory excluding consolidated inventory not owned increased $272.0 during the period, primarily due to land purchases and development.
- A $21.0 class-action settlement concerning HVAC systems in certain New Jersey homes was agreed with plaintiffs and insurers, subject to court approval; the company said its share was fully reserved. The EPA identified the company as a potentially responsible party in a Newark-area lead-contamination matter; the company said the scope of any obligation was unknown and could not assure the matter would not have a material impact.
- Debt covenants restrict cash dividends, including on the 7.625% Series A preferred stock; management expected the restriction to continue for the foreseeable future. The company reported compliance with its debt and credit-facility covenants at quarter end.
- Deferred-tax valuation allowance was $933.3. Management noted a three-year cumulative loss position, but said improving profitability could lead to a future allowance reversal with a material effect on reported income and equity.
Key facts for investors to verify
- Whether contract activity, cancellations and backlog convert into deliveries and cash, particularly given the lower contract pace and quarter cancellation rate of 22% versus 17% a year earlier.
- Cash runway and funding needs as land investment and inventory growth continue; reconcile the $183.7 cash balance, restricted cash, secured cash collateral and substantial operating cash use.
- Debt maturities, refinancing options, collateral coverage and covenant restrictions, including the company’s ability to maintain liquidity through fiscal 2015.
- Potential exposure from the EPA matter and the final court approval, insurance contribution and company-funded portion of the $21.0 HVAC settlement.
- Assumptions behind inventory valuations and the $933.3 deferred-tax valuation allowance, including any future impairment or tax-benefit reversals.