Hovnanian Enterprises, Inc. — FY2013 Form 10-K
Business context and reporting period. The company designs, builds and sells homes across six U.S. homebuilding segments and provides mortgage and title services. This annual report covers the fiscal year ended October 31, 2013; quarterly figures below refer to the fourth quarter ended that date.
Financial and operating performance
| Metric | FY2013 | FY2012 |
|---|---|---|
| Revenue | $1.851 billion | $1.485 billion |
| Net income (loss) | $31.3 million | $(66.2) million |
| Diluted earnings (loss) per share | $0.22 | $(0.52) |
| Operating cash flow | $9.3 million | $(67.0) million |
| Homebuilding gross margin, before cost-of-sales interest and land charges | 20.1% | 17.8% |
| Homebuilding gross margin, after cost-of-sales interest and land charges | 16.9% | 13.4% |
- Home deliveries rose 12.6% to 5,266 consolidated homes; average selling price increased to $338,839 from $300,595. Including unconsolidated joint ventures, deliveries totaled 5,930.
- Net sales contracts increased 7.9% by number; contract value rose 19.8% to $1.914 billion. Active selling communities increased to 192 from 172, and net contracts per average active community rose to 30.7 from 28.1.
- At October 31, backlog excluding joint ventures was 2,167 homes valued at $762.4 million, versus 1,889 homes and $632.3 million a year earlier. Including joint ventures, backlog was 2,392 homes valued at $848.4 million.
- Fourth-quarter revenue was $591.7 million and net income was $32.8 million, compared with revenue of $487.0 million and a net loss of $84.4 million in the year-earlier quarter. The prior-year quarter included an $87.0 million debt-extinguishment loss.
Liquidity, debt and balance sheet
- Cash and cash equivalents were $329.2 million at year-end; separately reported restricted cash was $31.8 million. Homebuilding cash increased $60.8 million from the prior year. The company spent $503.0 million on land and land development.
- Notes payable totaled $1.558 billion on the balance sheet. The filing cites $1.544 billion of debt excluding nonrecourse secured debt and financial-subsidiary debt; debt service for FY2013 was $121.2 million, substantially all interest. Total equity deficit was $432.8 million.
- Mortgage warehouse borrowings were $91.7 million. Nonrecourse mortgages were $62.9 million, with a further $17.7 million secured by operating properties. The $75 million unsecured revolving facility had no borrowings and $25.8 million of letters of credit outstanding at year-end.
- Management said available cash and expected sources should fund working capital and other needs through FY2014, while warning that cash flow could remain slightly positive or negative after land purchases. Operating cash flow was positive in FY2013, but negative in each of the preceding two years.
- Debt agreements restrict dividends and certain other activities; common and preferred dividends were prohibited, and the company expected the restriction to continue for the foreseeable future. The company reported compliance with debt and credit-facility covenants at October 31, 2013.
Material changes, outlook and risks
- Results improved with higher deliveries and prices, better sales pace and a greater contribution from newer communities, whose land costs generally support higher margins. SG&A fell to 11.9% of total revenue from 12.8%, although homebuilding SG&A dollars increased with activity.
- Homebuilding segment income before tax was $135.5 million, versus $47.0 million in FY2012. The Southwest contributed $76.5 million. The Northeast returned to a modest profit of $1.5 million; all six segments reported positive FY2013 income before tax.
- The company recorded $5.0 million of inventory impairment and land-option write-offs, down from $12.5 million. It walked away from 1,611 option lots, incurring $2.6 million in charges; 50 mothballed communities had $115.9 million of net book value.
- Management described demand as improved but still below historical levels, with uneven recovery across markets. It cited higher mortgage rates, unemployment, tight mortgage underwriting, foreclosures and economic uncertainty. Fourth-quarter net contracts were 6.4% below the prior-year quarter, partly attributed to higher mortgage rates, the sequester and government shutdown; management said contracts improved slightly year over year in October and November 2013.
- Land investment is a central part of the strategy: during FY2013 the company opened 91 communities, purchased about 6,200 lots and optioned about 12,100 lots in newly identified communities. Returns depend on land costs, sales pace, pricing and construction costs.
- The $9.4 million income-tax benefit reflected releases of tax reserves and a favorable state audit settlement. The company maintained a $927.1 million valuation allowance against deferred tax assets and disclosed $1.5 billion of federal NOLs; use may be limited by an ownership change.
- Material contingencies include an EPA matter concerning possible lead contamination near a Newark redevelopment site, for which the company’s potential obligations were unknown, and a New Jersey HVAC class action involving a potential class of 1,065 homes. The company could not estimate a loss range for the class action.
- Other principal risks include substantial leverage, refinancing and liquidity needs, interest-rate and mortgage-availability changes, construction labor and material cost increases, inventory valuation, warranty and mortgage-loan repurchase claims, regulation, weather, and seasonality. The filing reports an unqualified audit opinion and effective internal control over financial reporting.
Most important facts for investors to verify
- Whether improved sales, pricing and margins persisted after FY2013, particularly following the reported late-summer slowdown and mortgage-rate increase.
- Whether operating cash generation can support land purchases, debt service and obligations as the company pursues growth; review cash flow against the $503 million FY2013 land and development spend.
- Debt maturities, covenant restrictions, secured collateral and refinancing options, including the company’s ability to preserve liquidity and access letters of credit.
- Potential dilution and settlement terms for the remaining tangible equity unit purchase contracts scheduled to settle in February 2014, and any further conversions of exchangeable notes.
- The eventual scope and cost, if any, of the Newark EPA matter and HVAC class action, as well as adequacy of warranty, insurance and mortgage repurchase reserves.
- Assumptions supporting inventory recoverability, mothballed-community values and the realizability of tax attributes subject to the large valuation allowance and Section 382 ownership-change limits.