Business context and reporting period
Hovnanian Enterprises, Inc. is a U.S. homebuilder operating across six geographic homebuilding segments, with a mortgage and title-services business. This unaudited Form 10-Q covers the third quarter and nine months ended July 31, 2016; comparisons are to the same 2015 periods unless noted.
Key financial metrics
| Metric | Three months ended July 31, 2016 | Nine months ended July 31, 2016 |
|---|---|---|
| Total revenue | $716.9 million | $1,947.2 million |
| Net loss | $0.5 million | $25.1 million |
| Loss per common share | $0.00 | $0.17 |
| Operating cash flow | Not shown separately in the statements; management reported $225.7 million for the quarter | $194.6 million provided |
- Revenue and deliveries: Home-sale revenue rose 21.7% in the quarter and 28.9% year to date, alongside delivery growth of 11.8% and 21.5%. Average home-sale price was $407,000 for the quarter and $397,000 year to date. Land sales and other revenue was $60.0 million in the quarter and $72.1 million year to date, largely reflecting market exits.
- Profitability and margins: Third-quarter pretax income was $1.1 million, versus a $10.0 million pretax loss in 2015. Year-to-date pretax loss was $29.7 million, compared with $59.2 million. Homebuilding gross margin before cost-of-sales interest and land charges was 16.9% for the quarter and 16.5% year to date, down from 17.8% and 17.4%. After interest and land charges, the respective margins were 13.1% and 11.9%, versus 14.5% and 14.0%.
- Cash flow: Nine-month operating cash flow improved from $332.7 million used in 2015 to $194.6 million provided in 2016, with inventory reductions a significant contributor. Investing used $36.2 million; financing used $222.1 million, including repayment of 2016 notes. Cash and cash equivalents were $190.0 million at July 31, 2016, down from $253.7 million at October 31, 2015. Restricted cash was $21.2 million.
- Balance sheet and debt: Total assets were $2.389 billion and stockholders’ equity was a deficit of $151.9 million. Notes payable totaled $1.671 billion, including $982.5 million of senior secured notes and $521.0 million of senior notes. Separately, homebuilding liabilities included $91.3 million of nonrecourse inventory mortgages; financial-services mortgage warehouse lines were $115.7 million. The filing does not provide a single total-debt figure combining these categories.
- Liquidity: The $75 million revolving facility had $52.0 million drawn and $18.5 million of letters of credit outstanding at quarter-end. Management said available cash sources were expected to fund fiscal 2016 and 2017 working-capital requirements, while noting refinancing risks and covenant limits.
Material changes versus the prior comparable period
- Quarterly and year-to-date total revenue increased 32.6% and 33.8%, respectively; home deliveries and average prices both contributed.
- SG&A, including corporate costs, fell as a share of revenue, while homebuilding gross margin percentages declined, reflecting higher land and development costs in certain new communities and increased construction labor costs.
- Year-to-date inventory impairment losses and land-option write-offs rose to $22.9 million from $7.6 million. This included $16.4 million of inventory impairments and $6.5 million of option, approval and engineering-cost write-offs.
- Operating cash flow turned positive year over year, while cash balances fell after debt repayments and land and development spending. Notes payable declined from $1.936 billion at October 31, 2015 to $1.671 billion at July 31, 2016, principally reflecting payment of the 2016 maturities.
- Active selling communities fell to 174 from 206 a year earlier. The company exited Minneapolis and Raleigh through land-portfolio sales and planned to wind down operations in the San Francisco Bay area and Tampa.
Outlook, commentary, risks and unusual items
- Management cited a 3.8% increase in the dollar value of backlog year over year and improved sales per community as support for expecting strong fourth-quarter fiscal 2016 results versus the prior year. This was not formal numerical guidance. Backlog was $1.312 billion for 2,969 homes, compared with $1.264 billion for 3,097 homes a year earlier.
- Quarterly net contracts declined 4.3% year over year, while nine-month net contracts rose 3.5%. Management cautioned that results could remain mixed by market and identified economic uncertainty, lower oil prices affecting Texas, restrictive mortgage lending and rising mortgage rates as challenges. It said national and company new-home sales remained below historical levels.
- Subsequent financing: On September 8, 2016, after quarter-end, the company completed a $75 million term loan and issued $75 million of new 10% second-lien notes, while exchanging $75 million of existing second-lien notes for 9.5% notes. Gross cash proceeds were approximately $146.3 million before expenses. Approximately $126.1 million was used to fund redemption of the January 2017 notes; remaining proceeds were restricted for debt retirement or other agreed indebtedness. The new facilities carry restrictive covenants and pledged collateral.
- Credit ratings were downgraded during 2016; management said downgrades do not change scheduled maturities but could make future capital access more difficult or costly. Debt covenants restrict additional borrowing and dividends; preferred dividends were not being paid and were expected to remain restricted for the foreseeable future.
- The company is an EPA-designated potentially responsible party concerning lead contamination near a former smelter and a Newark, New Jersey redevelopment project. It could not estimate the scope or extent of any obligation and gave no assurance the matter would not have a material impact. Management said ordinary-course litigation was not expected to have a material adverse effect.
- Additional risks include possible future inventory impairments, construction and warranty claims, regulatory and environmental costs, land availability and costs, cancellations, interest rates, and the ability to refinance debt. The warranty and general-liability reserve was $139.4 million at July 31, 2016.
Important facts for investors to verify
- Whether home deliveries, backlog conversion and sales pace support management’s fourth-quarter outlook, particularly with fewer active communities.
- Whether homebuilding margins recover, given higher land, development and labor costs and increased year-to-date impairments and land-option write-offs.
- The company’s post-quarter liquidity and debt maturity profile after the September financing and January 2017 notes redemption, including the new covenants, collateral priorities and restrictions on use of remaining proceeds.
- Whether operating cash generation is sustainable and how land banking, inventory levels and joint-venture funding affect cash needs and reported liabilities.
- Developments in the Newark EPA matter, warranty and construction-defect claims, and the valuation assumptions underlying deferred tax assets and inventory.