Hovnanian Enterprises, Inc. — Q1 FY2020 10-Q
Reporting period: Three months ended January 31, 2020; balance-sheet comparisons are to October 31, 2019. The company builds homes across six U.S. regions and provides mortgage and title services. Figures below are in millions of dollars unless noted.
Financial performance
| Metric | Q1 FY2020 | Q1 FY2019 / comparison |
|---|---|---|
| Total revenue | $494.1 | $380.6; up 29.8% |
| Home sales revenue | $479.2 | $362.1; up 32.3% |
| Home deliveries | 1,236 | 967; up 27.8% |
| Average home selling price | $387,729 | $374,493; up 3.5% |
| Net loss | $(9.1) | $(17.5) |
| Net loss per common share | $(1.49) | $(2.93) |
| Cash from operating activities | $27.6 provided | $(122.2) used |
| Cash, cash equivalents and restricted cash | $127.9 | $153.2 at January 31, 2019 |
- Homebuilding gross margin was 12.9%, down from 14.8%. Before cost-of-sales interest and land charges, it was 17.3%, versus 17.8%. Management attributed the decline principally to higher interest included in cost of sales, greater incentives on unsold homes, and delivery mix.
- SG&A, including corporate SG&A, was $60.4, broadly flat year over year; it fell to 12.2% of revenue from 15.9%.
- Financial services pretax income increased to $4.5 from $1.1. Income from unconsolidated joint ventures fell to $1.5 from $9.6.
- Reported pretax loss was $7.4, compared with $17.1. Q1 FY2020 included a $9.5 debt-extinguishment gain from debt exchanges; the filing says its per-share effect was $0.65 before taxes.
Balance sheet, debt and liquidity
- Total assets were $1.790 billion and total liabilities $2.289 billion at January 31, 2020. Total equity remained in deficit at $(499.1) million.
- Senior notes and credit facilities, net, totaled $1.460 billion, down from $1.480 billion at October 31, 2019. Nonrecourse mortgages secured by inventory were $205.8 million; these carried an 8.2% weighted-average interest rate. Additional short-term mortgage warehouse borrowings were $73.0 million.
- Cash and cash equivalents reported in homebuilding were $81.4 million; homebuilding restricted cash was $19.9 million. Management reported total liquidity of $224.9 million, including $125.0 million available under the revolving facility, and said liquidity was within its $170–245 million target range.
- Cash and restricted cash decreased $54.3 million during the quarter. Investing used $16.8 million and financing used $65.2 million, including a $67.2 million reduction in mortgage warehouse borrowings. The cash-flow statement reports $27.6 million provided by operations.
- Debt exchanges reduced $163.0 million of unsecured term loans to $81.5 million of new secured term loans due 2028, and exchanged $164.9 million principal of existing secured notes for $158.5 million of new 10.0% secured 1.75-lien notes due 2025. The transactions involved no cash consideration. The debt structure includes multiple lien priorities and restrictive covenants.
Material changes and operating trends
- Net contracts increased 41.5% year over year to 1,322 homes; contracts per average active selling community rose to 9.7 from 6.8. Backlog grew to 2,221 homes valued at $899.6 million, up 20.0% in value year over year. First-quarter cancellation rate was 19%, versus 24%.
- Active selling communities were 136, down from 141 at October 31, 2019 and 137 a year earlier. Management cited faster-than-expected sell-through and the contribution of four communities to a new unconsolidated joint venture.
- Regional results were mixed: Southwest pretax income rose to $8.6 million from $2.4 million; Mid-Atlantic improved to $4.1 million income from near breakeven; Midwest and Southeast reported losses of $3.4 million and $4.3 million. West pretax income declined to $1.6 million from $11.7 million.
- Land and land development spending was $117.9 million. Inventory excluding consolidated inventory not owned decreased $11.7 million from fiscal year-end. Land option and related cost write-offs were $2.8 million, versus $0.7 million.
- The company contributed eight communities, including four active communities, to a new joint venture and received $29.8 million cash after its investment. Its investment in unconsolidated joint ventures rose to $135.3 million.
Outlook, risks and unusual items
- Management said available cash, operating sources and revolving-credit availability should be sufficient to fund working-capital needs through fiscal 2020. It intends to pursue land acquisitions selectively, balancing expected returns against market conditions, and expects recently opened communities to support future deliveries and revenue absent adverse market factors. No numerical earnings or revenue guidance was provided.
- Management expects to remain unable to pay dividends for the foreseeable future due to debt-covenant restrictions. The company was in compliance with debt covenants at January 31, 2020, but covenant limits constrain additional borrowing and other corporate actions.
- The company recorded a $596.0 million valuation allowance that fully reserves its deferred tax assets, including substantial federal and state net operating loss carryforwards. Management cited cumulative GAAP losses and housing-market uncertainty among the negative evidence.
- Litigation includes a New Jersey construction-defect case in which the plaintiff asserts approximately $119.5 million in damages, potentially subject to treble damages; trial was scheduled for September 2020. The company intends to defend the claims. In an EPA cleanup matter, the agency demanded $2.7 million; settlement discussions were ongoing and the company said it believed reserves were adequate.
- Other principal exposures include housing-market cyclicality, interest rates and mortgage availability, high leverage and financing access, land and construction costs, labor and subcontractor availability, cancellations, environmental and regulatory requirements, warranty and construction-defect claims, and natural disasters or severe public-health events. Management cautioned that actual results may differ materially from forward-looking statements.
- Operating leases were recognized on adoption of the new lease accounting standard: at January 31, 2020, right-of-use assets were $22.3 million and lease liabilities $23.3 million. The adoption had no material impact on reported operations or cash flows.
Most important facts for investors to verify
- Whether backlog growth and stronger net contracts convert to deliveries while cancellations remain controlled.
- Whether homebuilding margins recover from 12.9%, given incentives, interest costs, delivery mix and land charges.
- Cash availability and the company’s reported $224.9 million liquidity calculation, alongside restricted cash, warehouse financing and ongoing land investment.
- Debt maturities, interest burden, lien priorities and covenant restrictions, including the continuing suspension of preferred dividends.
- Potential exposure and reserve adequacy for the Great Notch litigation and EPA cleanup matter, as well as warranty and construction-defect claims.
- Regional profitability, particularly continued weakness in Midwest and Southeast and the decline in West earnings.