Hovnanian Enterprises, Inc. — Q1 FY2019 10-Q
Reporting period: Three months ended January 31, 2019. Hovnanian is a residential homebuilder operating across six U.S. regions, with mortgage and title services for homebuyers. Comparisons below are with the three months ended January 31, 2018, unless noted. Dollar amounts are in millions except per-share data.
Financial results and position
| Metric | Q1 FY2019 | Q1 FY2018 |
|---|---|---|
| Total revenue | $380.6 | $417.2 |
| Home sales revenue | $362.1 | $401.6 |
| Net loss | $(17.5) | $(30.8) |
| Basic loss per share | $(0.12) | $(0.21) |
| Homebuilding gross margin | 14.8% | 14.8% |
| Operating cash flow | $(122.2) | $(87.6) |
- Revenue fell 8.8%; home deliveries declined 5.7% to 967 and average selling price fell 4.4% to $374,493. Net contracts declined 9.1%; contracts per average active selling community were 6.8 versus 7.3.
- Gross margin before cost-of-sales interest and land charges was 17.8%, slightly below 17.9%. SG&A, including corporate costs, decreased to $60.4 million from $62.4 million, but rose to 15.9% of revenue from 14.9%.
- Loss before tax improved to $17.1 million from $30.5 million. A $9.6 million contribution from unconsolidated joint ventures compared with a $5.2 million loss a year earlier was a key factor. Other interest expense declined to $22.3 million from $29.1 million.
- Investing cash flow was positive $3.4 million and financing cash flow was positive $39.0 million. Cash, cash equivalents and restricted cash totaled $153.2 million at quarter-end; homebuilding cash was $113.3 million. Management reported total liquidity of $215.0 million, including $89.0 million of availability under the secured revolving facility.
- Total assets were $1.624 billion and total liabilities were $2.094 billion at January 31, 2019; stockholders’ equity was a deficit of $470.4 million. Balance-sheet notes payable, including accrued interest, were $1.278 billion; revolving and term loan facilities were $237.4 million, and nonrecourse mortgages were $121.5 million. The company also reported $82.1 million of liabilities related to inventory not owned, principally financing arrangements.
Changes, outlook and management commentary
- Homebuilding revenue declined, mainly reflecting fewer deliveries and lower average selling prices. The decrease in deliveries was attributed primarily to fewer active communities than in the prior-year quarter. Active selling communities were 137 at January 31, up from 123 at October 31, 2018, but down 2.1% year over year.
- Backlog was 1,793 homes valued at $749.8 million, down 7.9% in value from the prior-year quarter. The cancellation rate was 24%, compared with 18%; management said cancellations had recently been at the high end of its normal range amid a housing-market slowdown.
- Management said community count was expected to continue growing in Q2 FY2019 and that higher lot control could support future delivery and revenue growth, subject to market conditions and the time needed to open communities. It invested $141.3 million in land purchases and development in the quarter and said available cash and the secured facility were expected to fund working capital through FY2019. It cautioned that it was evaluating land acquisitions carefully.
- During the quarter, Hovnanian issued $25 million principal amount of additional 10.5% senior secured notes for $21.3 million cash proceeds and borrowed $36 million under its secured revolving facility. The facility’s availability terminates December 28, 2019; outstanding borrowings then convert to secured term loans due December 28, 2022.
- Debt covenants restrict dividends and certain additional borrowing; preferred dividends were suspended and management expected the restriction to continue for the foreseeable future. The company reported compliance with debt covenants at quarter-end. Its $640.1 million deferred-tax valuation allowance continued to fully reserve deferred tax assets, citing cumulative losses and housing-market uncertainty.
- In February 2019, the company entered a majority-owned joint venture involving ten communities; it expected consolidation to add $54.0 million cash, $53.5 million debt and $0.5 million minority interest.
Risks, contingencies and unusual items
- A New Jersey condominium association asserts approximately $119.5 million in remaining construction, design and geotechnical defect claims, potentially subject to treble damages. A partial settlement was described as immaterial; the company’s summary-judgment motion was pending and trial was scheduled for September 2019.
- The EPA demanded $2.7 million from a company entity for cleanup costs at a Newark-area site. The company disputed the demand, said it had adequate reserves, and was negotiating under a tolling agreement extending to December 20, 2019; it could not assure the matter would not have a material impact.
- Land-option walk-aways rose to 1,490 lots from 627 a year earlier. Land-option write-offs and inventory impairment charges totaled $0.7 million; management warned further impairments could arise if market conditions or estimates weaken.
- Homebuilding insurance availability and cost remain concerns. The warranty and general-liability reserve was $93.4 million at quarter-end, down from $95.1 million at the prior fiscal year-end.
- Other disclosed risks include high leverage and restrictive debt terms, housing-market and mortgage-rate changes, cancellations, land and construction cost inflation, financing availability, regulatory and environmental requirements, and litigation. Management noted rising construction costs could outpace buyers’ incomes and constrain pricing and margins.
Investor verification priorities
- Track orders, cancellation rates, backlog conversion, deliveries and average selling prices to assess whether the housing slowdown is continuing.
- Verify liquidity and cash use against land investment plans, debt maturities, borrowing availability and restrictive covenants.
- Review the status and potential exposure of the Great Notch litigation and EPA cleanup demand, including any changes to reserves or settlement discussions.
- Monitor gross margins, land-option walk-aways, inventory impairments and the company’s fully reserved deferred-tax assets.
- Assess the economics and financing effects of the February 2019 joint venture and the company’s high-cost secured and unsecured debt.