Hovnanian Enterprises, Inc. — Q3 FY2012 Form 10-Q
Business context and period. Hovnanian is a U.S. homebuilder operating across six geographic segments, with mortgage banking and title services. This filing covers the three and nine months ended July 31, 2012; comparisons are with the same periods in 2011. Financial figures below are in millions unless noted.
Financial performance and position
| Metric | Q3 FY2012 | Nine months FY2012 | Comparable FY2011 |
|---|---|---|---|
| Total revenue | $387.0; +35.5% | $998.3; +25.8% | $285.6 Q3; $793.3 nine months |
| Net income (loss) | $34.7 | $18.2 | $(50.9) Q3; $(187.7) nine months |
| Income (loss) before taxes | $(1.8) | $(17.0) | $(55.6) Q3; $(193.8) nine months |
| Operating cash flow | Not reported separately | $(62.1) | $(179.2) nine months |
- Home-sale revenue was $371.5 million in Q3 and $936.3 million for nine months. Deliveries rose 22.1% and 14.9%, respectively; average selling prices increased to $307,000 in Q3 and $298,000 for nine months.
- Homebuilding gross margin before interest and land charges was 18.2% in Q3 and 17.5% year to date, versus 15.3% and 15.6%. After cost-of-sales interest and land charges, margins were 14.2% and 13.0%, versus 6.0% and 4.6%.
- Financial Services pretax profit improved to $4.7 million in Q3 and $9.3 million for nine months, from $2.3 million and $4.1 million.
- At July 31, cash and cash equivalents totaled $234.0 million, including $219.3 million in homebuilding and $14.6 million in financial services. Restricted cash was $57.2 million. The company reported no revolving credit facility.
- Notes payable were $1.465 billion, net of discounts, including $967.9 million of senior secured notes, $458.6 million of senior notes and $7.0 million of amortizing notes. Additional homebuilding nonrecourse mortgages were $63.6 million; the financial-services mortgage warehouse line balance was $78.2 million. Total equity was a deficit of $404.2 million.
Material changes versus prior period
- Revenue growth reflected more deliveries and stronger sales pace: net contracts rose 28% year over year for the nine-month period, and contracts per average active selling community increased to 20.8 from 16.1. Backlog grew to 2,132 homes worth $674.2 million, from 1,469 homes worth $467.6 million.
- Management reported a 20% Q3 cancellation rate, which it viewed as closer to a normalized level. Active selling communities declined to 175 from 184 a year earlier.
- Q3 net income despite a pretax loss principally reflected a $36.5 million income-tax benefit. The nine-month $35.3 million tax benefit primarily came from reversing reserves for uncertain state tax positions. Debt-extinguishment gains were $6.2 million in Q3 and $58.0 million year to date, contributing materially to reported results.
- Inventory impairment losses and land-option write-offs fell to $0.7 million in Q3 and $7.2 million year to date, from $11.4 million and $41.9 million. Selling, general and administrative expenses as a share of revenue also declined.
- Financing and capital actions included a $47.3 million net common-stock issuance, debt repurchases and exchanges for equity, model-home sale-leasebacks, and a land-banking arrangement with GSO. The GSO arrangement and model-home transactions are accounted for as financings, not sales.
Outlook, commentary, risks and unusual items
- Management cited improving sales, margins and cancellations from Q2 onward, but warned that high unemployment, economic uncertainty, foreclosures and tighter mortgage availability could impede housing recovery. It gave no specific earnings or revenue guidance.
- Management believed available cash sources would fund working-capital and other needs through fiscal 2012. Potential additional liquidity measures included joint ventures, land banking, equity or debt issuance, excess-land sales, further model-home sale-leasebacks, and reduced starts, land purchases or development spending.
- Operating cash use reflects investment in land and development; management said positive operating cash flow may remain difficult until sustained profitability returns. Nine-month uses included approximately $235.9 million for land and land development.
- Inventory was approximately $1.0 billion, net of $702.7 million in impairments. The company reported 54 mothballed communities with $128.0 million net book value and noted that further impairments may be required if estimates or market conditions weaken.
- Key risks include substantial indebtedness, restrictive debt covenants, no homebuilding revolver, and debt maturities including senior notes due 2014–2017. The company said it was covenant-compliant, but its fixed-charge coverage restriction barred preferred dividends; it expected that restriction to persist.
- A New Jersey class action concerning HVAC systems in potentially 1,065 homes had been certified; plaintiffs seek unspecified damages and treble damages. The company said a loss was not probable, but it could not estimate a possible loss range. Warranty and general-liability reserves totaled $122.1 million.
- Credit ratings remained speculative grade; S&P revised its outlook to positive in July 2012 while affirming a CCC- corporate rating. Other uncertainties include mortgage repurchase claims, construction-defect litigation, regulation, environmental obligations and joint-venture exposure.
Important facts for investors to verify
- How much of reported earnings depended on the tax-reserve reversal and debt-extinguishment gains, and what recurring profitability looks like excluding those items.
- Whether improving contracts, backlog, cancellation rates and gross margins persist, particularly by segment; Q3 cancellation rates were elevated in several regions.
- Cash availability after restricted cash, collateral requirements, land spending and upcoming debt maturities; also confirm the terms and renewal status of mortgage warehouse facilities.
- Potential inventory impairments, land-option exposure and the economics and repurchase obligations of the GSO land-bank and model-home financing arrangements.
- Developments in the HVAC class action, warranty and construction-defect claims, mortgage repurchase exposure, and compliance with debt covenants.