Hovnanian Enterprises, Inc. — Q1 FY2018 10-Q
Reporting period: Three months ended January 31, 2018; unaudited. Hovnanian is a residential homebuilder operating across six U.S. regions, with a mortgage and title services business.
Financial performance and position
| Metric | Q1 FY2018 | Q1 FY2017 / comparator |
|---|---|---|
| Total revenue | $417.2 million | $552.0 million; down 24.4% |
| Home sales revenue | $401.6 million | $531.4 million; down 24.4% |
| Net loss | $30.8 million; $0.21 per share | $0.1 million loss; approximately break-even per share |
| Operating cash flow | -$82.5 million | $25.9 million provided |
| Cash and equivalents | $282.3 million, including $278.2 million in homebuilding | $469.3 million at October 31, 2017 |
| Gross margin on home sales | 14.8% | 13.5% |
| Backlog | 2,004 homes; $814.4 million | $1,020.2 million a year earlier; down 20.2% in value |
Deliveries declined 20.5% to 1,025 homes, while average selling price fell 4.9% to $391,782, primarily reflecting geographic and community mix. Net contracts fell 12.4% to 1,027 homes. Active selling communities were 140, versus 157 a year earlier. Gross margin improvement reflected community mix and lower land charges; margin before cost-of-sales interest and land charges rose to 17.9% from 17.2%.
Total assets were $1.646 billion and total liabilities were $2.137 billion at January 31, 2018; stockholders’ equity was a deficit of $491.2 million. The balance sheet included $1.545 billion of notes and term-loan obligations, net of specified discounts and costs and including accrued interest. The company also had $52.0 million drawn on its revolving facility and $64.5 million of nonrecourse inventory mortgages. The filing reports substantial additional mortgage warehouse and inventory-related financing balances separately.
Cash declined during the quarter as the company used $82.5 million in operations, invested $158.8 million in land purchases and development, and made debt payments. Investing activities provided $41.1 million, largely from the sale of its headquarters and joint-venture distributions; financing activities used $145.6 million. Homebuilding cash fell $185.5 million from October 31, 2017.
Changes, outlook, and management commentary
- Management attributed lower revenue and deliveries mainly to a smaller community base following reduced land investment in fiscal 2016–2017. Lots controlled increased sequentially and year over year in Q1 FY2018.
- Management expects improved results over the remainder of FY2018 and believes cash and refinancing transactions will fund working-capital needs through FY2018. It now expects sustainable community-count growth in early FY2019, later than its prior expectation of the second half of FY2018; revenue and delivery growth are expected to follow, absent adverse market conditions. No numerical earnings or revenue guidance was provided.
- Homebuilding and corporate SG&A as a percentage of revenue increased to 14.9% from 10.9%, driven in part by legal and financing-related fees, higher stock compensation, and rent after the headquarters sale-and-leaseback. Other interest expense rose to $29.1 million from $22.6 million. Cash interest paid, net of capitalized interest, was $56.5 million versus $24.0 million.
- On February 1, 2018, after quarter-end, the company borrowed $132.5 million under a new 5.0% term loan due 2027 and used the proceeds with cash to redeem its $132.5 million 7.0% notes due 2019. It also exchanged $170.2 million principal amount of tendered 8.0% notes, issuing $90.6 million of 13.5% notes due 2026 and $90.1 million of 5.0% notes due 2040, and bought back $26.0 million principal amount of 8.0% notes for $26.5 million cash. These transactions extend maturities but include high-cost debt and are subject to restrictive covenants.
- The company reported no inventory impairment charges in Q1, versus $2.7 million in Q1 FY2017; it recorded $0.4 million of land-option and related write-offs. A $3.6 million gain on the headquarters sale was included in other revenue. The Tax Cuts and Jobs Act reduced the federal rate to 21%; the company recorded no net tax benefit or expense from the tax-law remeasurement because it maintained a full valuation allowance on deferred tax assets.
Risks, contingencies, and other items
- Debt agreements restrict additional borrowing, dividends, asset sales, and other actions. The company was unable to pay preferred dividends and expected that restriction to continue. It reported compliance with debt covenants at January 31, 2018, but liquidity and access to financing remain sensitive to covenants and market conditions.
- In the Grandview at Riverwalk construction-defect case, a final judgment of approximately $10.4 million was entered in January 2018. The company appealed; execution was stayed subject to an approximately $11.1 million bond. Management considered a loss probable and said it had reserved its estimated probable loss. The stated potential loss range was $0–$11.1 million.
- A separate Grandview II case, with claimed damages of approximately $69–$79 million potentially subject to trebling, was settled with Hovnanian-affiliated defendants; the company said it had fully reserved the settlement amount as of October 31, 2017.
- Solus sued in connection with the proposed exchange transactions, alleging improper structuring and other claims. Its motion for a preliminary injunction was denied; defendants moved to dismiss the amended complaint. Hovnanian said it considered the claims meritless and intended to defend them.
- The company is an EPA-designated potentially responsible party concerning a Newark redevelopment near a former lead smelter. It said the scope of any obligation was unknown and could not assure the matter would not have a material impact. Development faces environmental, permitting, construction-cost, labor, weather, housing-market, mortgage-rate, and litigation risks.
Most important facts for investors to verify
- Cash availability and operating cash use as land spending increases, including restricted cash and financing needs.
- Execution and economic impact of the post-quarter refinancing and exchange, including interest expense, covenant terms, and remaining 2019 maturities.
- Whether the projected early FY2019 community-count growth and subsequent delivery recovery materialize; monitor backlog, net contracts, and active communities.
- Final outcomes and reserve adequacy for the Grandview matters, Solus litigation, and Newark EPA matter.
- Impact of the full deferred-tax valuation allowance, NOL limitations, and inability to pay preferred dividends.