Hovnanian Enterprises, Inc. — FY2016 Form 10-K
Reporting period: Fiscal year ended October 31, 2016. The filing also reports fourth-quarter results for the three months ended October 31, 2016. Hovnanian builds and sells homes across six U.S. segments and provides mortgage and title services to homebuyers.
Financial performance and liquidity
| Metric | FY2016 | FY2015 |
|---|---|---|
| Total revenue | $2.752 billion | $2.148 billion |
| Home sales revenue | $2.601 billion | $2.088 billion |
| Income (loss) before income taxes | $2.4 million | $(21.8) million |
| Net income (loss) | $(2.8) million | $(16.1) million |
| Operating cash flow | $387.7 million | $(320.5) million |
| Cash and cash equivalents, year-end | $346.8 million total; $339.8 million homebuilding cash | $253.7 million total |
| Notes payable | $1.678 billion | $1.936 billion |
| Stockholders’ equity | $(128.5) million | $(128.1) million |
Home sales revenue rose 24.6%, reflecting 17.4% more deliveries and a higher average selling price ($402,350 versus $379,177). Gross margin before cost-of-sales interest and land charges fell to 16.9% from 17.6%; after cost-of-sales interest and land charges, it was 12.2% versus 14.1%. Annual selling, general and administrative expense was 9.2% of total revenue, down from 11.7%.
In Q4, revenue was $805.1 million and net income was $22.3 million, compared with revenue of $693.2 million and net income of $25.5 million in Q4 FY2015. Q4 pretax income was $32.1 million. Gross margin before cost-of-sales interest and land charges improved to 17.6% from 16.9% in Q3 FY2016.
Reported debt figures require care: $1.678 billion of notes payable excludes nonrecourse mortgages and financial-services warehouse borrowings. Separately, the company reported $83.5 million of nonrecourse mortgages secured by inventory, $14.3 million secured by its headquarters, and $145.6 million of mortgage warehouse lines. The $75 million revolving facility had $52 million borrowed and $17.9 million of letters of credit outstanding, leaving $5.1 million available. Total equity remained in deficit.
Changes versus the prior year
- Operating cash flow swung to $387.7 million provided from $320.5 million used in FY2015, while year-end cash increased by $93.0 million.
- Notes payable declined by $257.7 million. The company paid approximately $260 million of bonds at maturity and redeemed $121 million of notes, while completing new secured financings.
- Active selling communities fell 23.7%, from 219 to 167. Net contracts declined 1.2% to 6,109, although net contracts per average active community increased 4.3% to 31.3.
- Backlog excluding unconsolidated joint ventures declined 12.1% in value to $1.069 billion and 17.5% in homes to 2,398.
- Land charges rose to $33.4 million from $12.0 million, including $24.5 million of inventory impairments and $8.9 million of land-option and related write-offs.
- Financial-services pretax profit increased to $35.5 million from $24.7 million; income from unconsolidated joint ventures shifted to a $4.3 million loss from $4.2 million of income.
Outlook, management commentary, risks and unusual items
- Management said year-end homebuilding cash and the absence of significant scheduled debt maturities in FY2017 should support more land investment and community growth. It expects adequate FY2017 liquidity for working capital, but noted that future land investment and cash generation depend on market conditions and its ability to refinance debt.
- The company exited Minneapolis and Raleigh by selling land portfolios and plans to wind down San Francisco Bay Area and Tampa operations by completing homes on existing land. These actions, along with land-banking transactions and joint ventures, were part of a liquidity-focused shift away from growth during FY2016.
- Management cited an uneven housing recovery, restrictive mortgage lending, rising mortgage rates, economic uncertainty, lower oil prices affecting Texas, labor and construction-cost pressures, and the possibility of continued mixed operating results. Housing sales remain below historical levels.
- Debt and liquidity are significant risks. Credit agencies downgraded the company or its debt during FY2016; management warned that further downgrades could make capital more difficult or costly to obtain. Debt covenants restrict additional borrowing, asset transactions and dividends. Common and preferred dividends were prohibited, and management expected that restriction to continue.
- FY2016 financing included a $75 million term loan, $75 million of 10% second-lien notes due 2018, and $75 million of 9.5% secured exchange notes due 2020. The term loan and new notes are secured by substantially all applicable assets; the term loan’s maturity may accelerate to October 2018 under specified conditions. The refinancing helped fund redemption of 8.625% notes due 2017. The company reported covenant compliance at year-end.
- Other notable items: a $3.2 million debt-extinguishment loss; a $9.2 million Q4 reduction in construction-defect reserves following an actuarial review; and a $5.3 million income-tax expense. The company reported a $627.9 million deferred-tax valuation allowance and federal and state net operating loss carryforwards of $1.5 billion and $2.2 billion, respectively.
- The EPA identified the company as a potentially responsible party for a Newark, New Jersey redevelopment site near a former lead smelter and proposed that it contribute to cleanup costs. The company said the scope of any obligation was unknown and could not assure the matter would not have a material impact.
- Management reported effective disclosure controls and internal control over financial reporting; Deloitte issued unqualified opinions on the financial statements and internal control.
Important facts for investors to verify
- Whether the company can sustain operating cash generation while increasing land purchases and community count, given the decline in backlog and active communities.
- The full debt and liquidity position, including maturities, interest costs, collateral priorities, covenant limits, refinancing conditions and availability under credit and letter-of-credit facilities.
- Whether margins can stabilize amid higher land and construction costs, incentives, impairments and the effects of market and geographic mix.
- The recoverability of inventory and deferred tax assets, including the assumptions behind community cash-flow estimates and the potential effect of any ownership change on NOL utilization.
- The eventual scope and cost, if any, of the Newark EPA matter, as well as exposure to warranty, construction-defect and mortgage repurchase claims.