Hovnanian Enterprises, Inc. — Q2 FY2015 10-Q
Reporting period: Three and six months ended April 30, 2015. The company builds and sells homes across six U.S. regions and provides mortgage and title services. Amounts below are in U.S. dollars; financial statement figures are converted from thousands to millions where appropriate.
Financial performance
- Revenue: Q2 revenue was $468.9 million, up 4.2% year over year; first-half revenue was $914.7 million, up 12.4%. Home-sale revenue rose 3.8% in Q2 and 12.0% for the first half. Average delivered home prices increased, mainly due to geographic and community mix; Q2 deliveries fell 1.0%, while first-half deliveries rose 4.4%.
- Profitability: Net loss was $19.6 million in Q2 versus $7.9 million a year earlier; first-half net loss was $33.9 million versus $32.4 million. Q2 and first-half pretax losses were $29.5 million and $49.2 million, respectively.
- Margins: Homebuilding gross margin before interest and land charges fell to 16.1% in Q2 from 20.2%, and to 17.1% for the first half from 19.5%. Management attributed the decline principally to incentives and discounts on older started unsold homes. Land charges were $4.3 million in Q2 and $6.5 million in the first half, versus $0.5 million and $1.2 million, respectively, in 2014.
- Segment results: Southwest remained the largest contributor, with first-half pretax income of $25.3 million. The West reported a first-half pretax loss of $11.3 million; Northeast and Southeast also reported first-half losses. Financial services pretax income increased to $8.8 million from $4.1 million for the first half.
- Cash flow and liquidity: First-half operating cash use was $256.1 million, compared with $186.1 million in 2014, largely reflecting inventory investment. Investing activities used $6.7 million; financing activities provided $262.5 million, including $250 million of proceeds from new notes. Cash and cash equivalents totaled $261.6 million at April 30, 2015, including $256.9 million in homebuilding and $4.7 million in financial services. Management said available cash, operating sources and the $75 million revolving facility should fund needs through FY2015.
- Debt and equity: Notes payable were $1.95 billion, up from $1.69 billion at October 31, 2014, principally reflecting issuance of $250 million of 8.0% senior notes due 2019. The notes carry a net balance of $840.9 million. Additional obligations included $118.9 million of nonrecourse community mortgages, $16.1 million of headquarters mortgages and $83.0 million of mortgage warehouse lines. Total liabilities were $2.66 billion, exceeding assets of $2.52 billion; stockholders’ equity was negative $146.3 million. The company reported compliance with debt covenants, but debt restrictions currently prevent preferred dividends.
Material changes and operating indicators
- Active selling communities increased to 207 from 196 a year earlier. The company opened 54 and closed 48 communities in the first half.
- Backlog at April 30, 2015 was 2,972 homes valued at $1.17 billion, versus 2,797 homes valued at $1.05 billion a year earlier. Q2 net contracts decreased 0.7% year over year; first-half net contracts increased 7.4%.
- Started or completed unsold homes and models declined to 921 from 993 at October 31, 2014. The company reported 45 mothballed communities with $105.2 million of net book value.
- Inventory excluding consolidated inventory not owned increased $202.5 million from October 31, 2014, reflecting land purchases and development, partly offset by deliveries. The company spent $334.4 million on land and land development in the first half.
Outlook, risks and unusual items
- Management expected stronger results in the second half, primarily Q4, supported by backlog and anticipated community growth, but did not expect Q4 pretax income to offset earlier fiscal-year losses. It characterized recent results as uneven and said mixed market performance could continue.
- Risks cited include economic weakness, uncertain oil prices and weather—particularly in Texas—restrictive mortgage lending, rising mortgage rates, competition, land and construction costs, and the availability of suitable land and financing. Management said national and company home sales remained below historical levels.
- The company recorded a $9.9 million Q2 income tax benefit and a $15.2 million first-half benefit, primarily from deferred taxes. It maintained a $642.5 million deferred-tax valuation allowance at April 30, 2015, while concluding that substantial deferred tax assets were more likely than not to be realized. That judgment is notable given the company’s three-year cumulative loss position; management expected to return to a three-year cumulative income position by FY2015-end.
- The company identified itself as a potentially responsible party in an EPA cleanup matter concerning a Newark, New Jersey redevelopment near a former lead smelter. It had begun preliminary discussions but could not estimate any obligation or rule out a material impact. The D’Andrea HVAC class action was settled for $21 million, with most of the settlement funded by insurers; the matter concluded in February 2015.
- Warranty and general-liability reserves were $161.3 million at April 30, 2015. Management noted high insurance deductibles and uncertainty in estimating claims. The filing also describes exposure to additional inventory impairments if community cash-flow or fair-value estimates deteriorate.
Key facts for investors to verify
- Whether backlog converts to deliveries and earnings as expected, and whether gross margins recover after the discounting of older spec homes.
- How operating cash use and land investment develop, and whether stated FY2015 liquidity remains adequate.
- Debt maturities, interest burden, covenant restrictions, and access to refinancing or additional capital.
- The support for deferred-tax-asset realizability and the potential effect of future losses on valuation allowances.
- Any estimated exposure or developments in the EPA matter, and changes in warranty claims, reserves or insurance recoveries.