Hovnanian Enterprises, Inc. — Q2 FY2014 Form 10-Q
Reporting period: Fiscal quarter and six months ended April 30, 2014. 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 rounded to millions.
Financial performance and position
| Metric | Three months ended April 30 | Six months ended April 30 |
|---|---|---|
| Total revenue | $449.9 million, up 6.4% from $423.0 million | $814.0 million, up 4.2% from $781.2 million |
| Net income (loss) | $(7.9) million, versus $1.3 million income | $(32.4) million, versus $(10.0) million |
| Basic loss per share | $(0.05), versus $0.01 income | $(0.22), versus $(0.07) |
| Homebuilding gross margin before interest and land charges | 20.2%, versus 18.9% | 19.5%, versus 18.0% |
| Operating cash flow | $(186.1) million for the six months, versus $(15.9) million |
Home sale revenue rose 7.0% in the quarter and 6.7% year to date, while deliveries fell 1.6% and 2.0%, respectively. Higher average selling prices—$355,000 for the quarter and $349,000 for the six months—more than offset lower delivery volumes. Financial services revenue declined 11.9% for the quarter and 21.6% year to date.
At April 30, cash and cash equivalents totaled $245.2 million, down from $329.2 million at October 31, 2013; restricted cash was $28.7 million. The company attributed the cash decline principally to $287.0 million of land and land-development spending. Inventories excluding inventory not owned increased $209.8 million during the six months.
Notes payable were $1.689 billion, versus $1.558 billion at October 31, 2013. Stockholders’ equity was a deficit of $463.0 million. A $75 million unsecured revolving credit facility had no borrowings and $20 million of letters of credit outstanding. Mortgage warehouse lines totaled $35.3 million outstanding. Management stated it believed available cash sources would cover fiscal 2014 working-capital and other needs.
Changes versus the prior comparable period
- Despite higher revenue, the company moved to a quarterly net loss and recorded a larger first-half net loss. Corporate and homebuilding costs, including interest, contributed to the deterioration.
- Homebuilding margin improved, reflecting delivery mix, lower-cost recently acquired land, and prior price increases. The six-month comparison also benefited from reversals of prior-period inventory impairments: $19.5 million in 2014 versus $27.6 million in 2013.
- Selling, general and administrative expense increased. Companywide SG&A as a percentage of revenue rose to 13.9% for the quarter from 12.2%, and to 15.1% for the six months from 12.9%.
- Backlog at April 30 was 2,797 homes valued at $1.046 billion, up 13.6% by units and 21.0% by value year over year. Quarterly net contracts increased 6.7%; six-month net contracts increased 0.4%. Contracts per average active selling community declined to 9.3 for the quarter and 15.0 for the six months.
- Active selling communities increased to 196 from 177 a year earlier. The company opened 55 communities and closed 51 in the first half.
Outlook, risks and unusual items
- Management described the housing market as uneven and the recovery as slower, expecting uneven improvement across markets. It cited the higher backlog value, improved margins and larger community count as factors supporting stronger results as the year progresses. No specific earnings or revenue guidance was provided.
- Management said new land acquisitions at prices supporting appropriate returns and operating efficiency are important to sustained profitability. It expected to open additional communities in the remainder of fiscal 2014.
- Key risks include mortgage availability and rates, economic weakness and unemployment, potential foreclosures, construction-cost inflation, land availability, regulation and permitting, and the company’s substantial indebtedness and related covenant restrictions. The company reported compliance with its debt covenants as of April 30.
- Operating cash use reflects investment in land and community growth; management noted positive operating cash flow may remain difficult until sustained profitability returns. The company is restricted from paying preferred-stock dividends for the foreseeable future under debt covenant provisions.
- On January 10, 2014, the company issued $150 million of 7.0% senior notes due 2019 and used part of the proceeds to redeem $21.4 million of 6.25% notes due 2015. The redemption produced a $1.2 million loss on extinguishment of debt. The settlement of tangible equity units resulted in issuance of 6.1 million Class A shares in February.
- After quarter-end, the company agreed to a $21 million settlement of a class action concerning HVAC systems in certain New Jersey homes; most of the settlement is expected to be funded by insurers, and court approval is pending. Separately, the EPA considers the company a potentially responsible party in a Newark-area lead-contamination matter. The company said the scope of any obligation is unknown and could not assure the matter would not have a material impact.
- Inventory impairment and land-option write-offs were $1.2 million for the six months, versus $2.9 million a year earlier. The company reported 47 mothballed communities with a net book value of $106.2 million.
Most important facts for investors to verify
- Whether backlog converts to deliveries and cash at expected prices and margins, particularly given lower contracts per community and mixed regional results.
- Liquidity and debt-service capacity as cash declines and operating cash flow remains significantly negative; review debt maturities, collateral and covenant terms.
- The actual insurer contribution, court approval and ultimate company exposure for the $21 million HVAC settlement, and developments in the EPA matter.
- Whether higher SG&A and land investment can be supported by community growth and a recovery in sales pace; monitor inventory impairments and land-option commitments.
- The effect of the large deferred-tax valuation allowance and continued restriction on preferred dividends.