Hovnanian Enterprises, Inc. — Q1 FY2014 Form 10-Q
Reporting period: Three months ended January 31, 2014. The company builds and sells homes across six U.S. regions and provides mortgage and title services. Financial amounts below are in U.S. dollars; balance-sheet and cash-flow figures are as of or for the stated period.
Financial performance and liquidity
| Metric | Q1 FY2014 | Prior-year period |
|---|---|---|
| Total revenue | $364.0 million | $358.2 million |
| Homebuilding revenue | $356.0 million | $346.6 million |
| Financial services revenue | $8.1 million | $11.7 million |
| Loss before income taxes | $23.9 million | $20.8 million |
| Net loss | $24.5 million | $11.3 million |
| Basic loss per share | $0.17 | $0.08 |
| Net cash from operating activities | $(131.1) million | $5.8 million |
| Cash and cash equivalents, period-end | $288.9 million | $329.2 million at October 31, 2013 |
- Homebuilding gross margin before cost-of-sales interest and land charges was 18.8%, up from 17.0% year over year. After interest and land charges, it was 15.9%, versus 13.7%.
- SG&A, including corporate expense, rose to 16.6% of total revenue from 13.8%. Homebuilding SG&A increased to $44.0 million from $36.8 million; corporate G&A increased to $16.4 million from $12.5 million.
- Home deliveries fell 2.4% to 1,036, while average selling price increased 8.9% to $343,000. Net contracts declined 8.6% to 1,092 homes; backlog increased 10% in units to 2,223 homes.
- Operating cash use principally reflected a $131.8 million inventory increase as the company invested in land and development. Management reported $181.7 million of spending on land and land development during the quarter.
- Total notes payable were $1.705 billion, up from $1.558 billion at October 31, 2013. The company issued $150 million of 7.0% senior notes due 2019. Total equity remained in deficit at $456.1 million.
- Homebuilding cash was $282.5 million and financial-services cash was $6.4 million. Restricted cash totaled $23.9 million. The $75 million revolving facility had no borrowings and $24.2 million of letters of credit outstanding.
Changes versus the prior period
- Revenue increased 1.6%, mainly because higher average home prices more than offset lower deliveries and a sharp decline in land-sale revenue.
- Net loss more than doubled. The prior-year period included a $9.5 million income-tax benefit, while the current period had $0.6 million of tax expense; current-quarter losses also reflected higher selling and corporate costs.
- Homebuilding income before tax improved to $9.7 million from $4.8 million, but financial-services income before tax fell to $1.4 million from $4.2 million and corporate/unallocated losses widened.
- Active selling communities increased to 193 from 175 a year earlier. Sales pace per average active community declined to 5.7 from 6.9. The cancellation rate was 18%, compared with 16% a year earlier.
Outlook, commentary, and risks
- Management said the housing recovery was slower than expected and results were mixed. It cited poor weather, labor and material shortages, higher mortgage rates, restrictive mortgage lending, and slower sales as factors affecting deliveries and demand.
- Management pointed to a 10% increase in backlog units, higher gross margin, and a larger community count as support for its expectation of stronger results as the year progresses. It gave no specific revenue, earnings, or delivery guidance.
- Management said available cash and financing sources should be sufficient through FY2014 for working capital and other needs, while acknowledging that sustained positive operating cash flow may be difficult until profitability improves.
- The company recorded no inventory impairment in the quarter, but wrote off $0.7 million of option, approval, and engineering costs and walked away from 1,536 lots. Two tested communities had projected undiscounted cash flows less than 20% above carrying value. Fifty mothballed communities had a $116.3 million net book value.
- Hovnanian was identified by the EPA as a potentially responsible party regarding alleged lead contamination near a Newark redevelopment site. The company said the scope of any obligations was unknown and could not assure the matter would not have a material impact.
- A New Jersey class action concerning HVAC systems in a potential class of 1,065 homes is proceeding; damages are unspecified, and the company said it could not estimate a loss range. Management stated ordinary-course litigation was not expected to materially adversely affect results or financial position.
- Debt covenants restrict dividends; the company anticipated it would remain unable to pay preferred dividends for the foreseeable future. In February 2014, it redeemed $21.4 million of 6.25% notes due 2015, recording a $1.2 million loss on extinguishment in the next quarter. Settlement of tangible equity unit purchase contracts also resulted in 6.1 million Class A shares issued after quarter-end.
- Other risks include housing-market and home-price weakness, mortgage availability and interest rates, land and construction costs, labor or material shortages, regulatory and environmental matters, warranty claims, and the company’s substantial debt and liquidity needs.
Investor verification priorities
- Track whether backlog converts into closings and whether contracts, cancellation rates, sales pace, and deliveries improve.
- Test the sustainability of gross-margin improvement against pricing pressure, incentives, community mix, and inventory impairment risk.
- Reconcile operating cash use with land investment plans, cash availability, restricted cash, and debt-service needs.
- Review debt maturities, refinancing and covenant constraints, collateral supporting secured notes, and the impact of the 2019-note issuance and 2015-note redemption.
- Monitor the EPA Newark matter and the HVAC class action for developments, potential exposure, and insurance coverage.
- Confirm the effect of the February 2014 equity-unit settlement and resulting share issuance on dilution.