Hovnanian Enterprises, Inc. — Q2 FY2013 Form 10-Q
Reporting period: Three and six months ended April 30, 2013; balance-sheet comparisons are with October 31, 2012. Amounts are in U.S. dollars; financial figures are rounded to millions unless noted.
Business context and operating results
Hovnanian is a residential homebuilder operating across six U.S. regions, with mortgage and title services for homebuyers. Management reported a strengthening housing market and higher sales activity, while cautioning that demand remained below historical levels.
- Revenue: Q2 revenue rose 23.8% to $423.0 million; six-month revenue rose 27.8% to $781.2 million. Home sales revenue increased 31.1% and 31.7%, respectively, while land sales and other revenue declined.
- Home deliveries and prices: Consolidated deliveries increased 20.3% to 1,255 in Q2 and 19.9% to 2,317 for six months. Average sale price rose to $326,000 in Q2 from $300,000 and to $321,000 for six months from $292,000.
- Contracts and backlog: Net contracts increased 11.1% in Q2 and 17.2% for six months. At April 30, backlog was 2,462 homes valued at $865.0 million, versus 1,921 homes and $599.0 million a year earlier. The Q2 cancellation rate was 15%.
- Profitability: Q2 net income was $1.3 million ($0.01 per share), versus $1.8 million ($0.02 per share). Six-month net loss narrowed to $10.0 million ($0.07 per share) from $16.5 million ($0.15 per share). Q2 pretax loss was $1.3 million; six-month pretax loss was $22.1 million.
- Margins: Homebuilding gross margin before cost-of-sales interest and land charges improved to 18.9% in Q2 from 17.4%, and to 18.0% for six months from 17.0%. After cost-of-sales interest and land charges, margins were 15.6% and 14.8%, respectively. Management attributed improvement to delivery mix, higher prices, sales volume and newer communities.
- Cash flow and liquidity: Six-month operating cash use was $15.9 million, compared with $39.9 million in 2012. Cash and cash equivalents were $244.9 million at April 30, excluding $49.5 million of restricted cash. The company spent $229.9 million on land and land development in the first half. It has no homebuilding revolving credit facility.
- Debt and capital: Notes payable were $1.559 billion, including accrued interest; total liabilities were $2.097 billion. Stockholders’ equity remained in deficit at $478.8 million. The company was restricted from paying dividends on its Series A preferred stock under debt covenant provisions.
Material changes versus the prior comparable period
- Higher home deliveries, selling prices and sales pace drove homebuilding revenue growth. Net contracts per average active community increased to 9.6 in Q2 from 8.2, and to 16.5 for six months from 13.1.
- Homebuilding income before taxes was $22.7 million in Q2 and $27.5 million for six months, compared with $6.3 million and $2.8 million. Corporate and unallocated pretax costs increased to $27.5 million in Q2 and $57.3 million for six months, including interest and corporate costs.
- Reported consolidated earnings benefited less from debt transactions than in 2012: there were no debt repurchases or exchanges in the first half of 2013, compared with a $51.7 million debt-extinguishment gain in the first half of 2012. The Q2 2012 comparison included a $27.0 million gain.
- Six-month results included a $12.1 million income tax benefit, primarily from release of federal tax reserves following an IRS settlement and a favorable state tax audit settlement. The deferred-tax valuation allowance was $941.8 million.
- Cash and cash equivalents declined $28.4 million from the beginning of the fiscal year. Homebuilding inventory excluding inventory not owned increased $38.3 million, reflecting land purchases and development, partly offset by deliveries.
Outlook, risks and unusual items
- Management expects full-year FY2013 gross margin to increase and SG&A as a percentage of revenue to decrease versus FY2012, provided market conditions remain stable. It believes available cash, sales and financial-services cash flows will meet requirements through FY2013; this is a management expectation, not a guarantee.
- Management cited unemployment, economic uncertainty, restrictive mortgage lending, potential foreclosures, uneven regional recovery, construction-cost inflation, land availability and access to financing as risks. It noted that operating cash flow may remain negative until sustained profitability returns.
- Inventory impairment and land-option write-offs totaled $2.9 million for six months, versus $6.5 million a year earlier. Prior-period impairment reversals also benefited reported gross margin; management cautioned that further impairments could be required if forecasts or market conditions weaken. Fifty-two mothballed communities carried $125.2 million of net book value.
- Land banking and model-home sale-leaseback arrangements are treated as financings for accounting purposes. At April 30, inventory not owned was $106.1 million, with related liabilities of $91.2 million.
- Outstanding note obligations included $992.0 million of senior secured notes and $460.6 million of senior notes, in addition to amortizing and exchangeable notes. The company reported compliance with note covenants. S&P raised its corporate credit rating to B- on April 23, 2013; the filing cautions that ratings changes can affect access to capital.
- Legal and regulatory matters include an early-stage EPA information request concerning a Newark redevelopment near a former lead smelter; the company said potential obligations beyond responding to requests were unknown. A New Jersey class action involving HVAC systems covers a potential class of 1,065 homes; loss was not considered probable, but an estimate could not be made. The filing also describes EPA stormwater matters, including penalties paid and compliance obligations.
- Warranty and general-liability reserves were $125.3 million. The company described higher insurance costs and substantial deductibles, as well as possible mortgage repurchase or make-whole claims.
Important facts for investors to verify
- Whether home-price, delivery and backlog growth persist, and how sales pace and cancellations develop across regions.
- Whether management’s FY2013 margin and liquidity expectations are met given land-development spending, negative operating cash flow and the absence of a homebuilding revolver.
- Debt maturities, interest burden, collateral and covenant restrictions, including the impact of restricted cash and preferred-dividend limits.
- The sustainability of gross-margin gains, including the effect of delivery mix, prior impairment reversals, and potential future inventory write-downs.
- Developments in the EPA Newark inquiry, the HVAC class action, warranty claims and mortgage-related repurchase exposures.