Hovnanian Enterprises, Inc. — Q3 FY2013 Form 10-Q
Reporting period: Three and nine months ended July 31, 2013. The company builds and sells homes across six U.S. regions and provides mortgage and title services. Financial statements are unaudited.
Financial performance and position
| Metric | Q3 FY2013 | Q3 FY2012 | Nine months FY2013 | Nine months FY2012 |
|---|---|---|---|---|
| Total revenue | $478.4 million | $387.0 million | $1,259.6 million | $998.3 million |
| Income (loss) before taxes | $10.4 million | $(1.8) million | $(11.7) million | $(17.0) million |
| Net income (loss) | $8.5 million | $34.7 million | $(1.5) million | $18.2 million |
| Diluted earnings (loss) per share | $0.06 | $0.25 | $(0.01) | $0.15 |
- Revenue and volume: Home-sale revenue increased 24.5% in Q3 and 28.8% year to date. Deliveries rose 10.6% and 16.3%, respectively; average home prices increased to $345,000 from $307,000 in Q3 and to $330,000 from $298,000 year to date.
- Margins and expenses: Homebuilding gross margin before cost-of-sales interest and land charges was 20.3% in Q3 versus 18.2%, and 18.9% year to date versus 17.5%. After cost-of-sales interest and land charges, margins were 17.2% versus 14.2% and 15.7% versus 13.0%, respectively. SG&A including corporate costs was 11.8% of revenue in Q3 versus 12.4%, and 12.5% year to date versus 14.2%.
- Cash flow: Operating cash use was $47.4 million for the nine months, versus $62.1 million in the prior year. Investing provided $18.8 million; financing used $17.4 million. Cash and cash equivalents ended at $227.3 million, down $46.0 million from the start of the period. Management cited $377.6 million spent on land and development.
- Liquidity and debt: At July 31, cash was $227.3 million and restricted cash was $24.0 million. Notes payable were $1.552 billion, including $978.3 million of senior secured notes and $459.1 million of senior notes, net of discounts. Total liabilities were $2.131 billion; equity was in deficit by $467.2 million. A new five-year $75 million unsecured revolver had no borrowings and $22.8 million of letters of credit outstanding. Mortgage warehouse lines totaled $57.5 million outstanding.
- Inventory and land: Inventory excluding consolidated inventory not owned increased $117.5 million from October 31, 2012, principally from land purchases and development. Total inventory was $1.118 billion. There were 186 active selling communities and 30,003 controlled home sites.
Material changes versus prior period
- Operating trends improved: net contracts increased 4.8% in Q3 and 12.7% year to date; deliveries, average selling prices, gross margins and SG&A ratios also improved.
- Q3 net income fell from $34.7 million to $8.5 million despite improved pretax results, primarily because Q3 2012 included a $36.5 million tax benefit. Year-to-date earnings moved from $18.2 million income to a $1.5 million loss; the prior-year period included a $58.0 million debt-extinguishment gain, and the current year had no such gain.
- Homebuilding pretax results improved substantially, but corporate and unallocated expenses remained significant. Southwest was the largest homebuilding contributor to pretax income in both reported periods.
- Debt declined modestly on the balance sheet, while cash also fell as the company expanded land investment. The company issued 6.25 million Class A shares through equity-related transactions during the nine-month period, including shares issued upon exchange of senior exchangeable notes.
Outlook, risks and unusual items
- Management expected full-year FY2013 gross margin to increase and SG&A as a percentage of revenue to decrease versus FY2012, assuming market conditions remained stable. It stated available cash sources should fund working-capital and other needs through FY2013.
- Management cautioned that unemployment, economic uncertainty, restrictive mortgage lending, higher mortgage rates and possible foreclosures could impede recovery. New-home demand and company sales remained below historical levels, with uneven regional improvement.
- Q3 contract cancellation rate was 17%; management described approximately 20% as normalized, but said it was uncertain whether recent lower cancellation levels would continue.
- Dividend payments on the 7.625% Series A preferred stock are restricted by debt covenants; management expected the restriction to continue for the foreseeable future. Common dividends are also restricted.
- Deferred-tax valuation allowance was $941.1 million. The company remained in a three-year cumulative-loss position, which it identified as negative evidence regarding realization of deferred tax assets.
- Environmental contingency: EPA notified the company in August 2013 that it considers the company a potentially responsible party regarding lead contamination near a former Newark, New Jersey smelter and proposed that it address contamination. The company said the scope of any obligations was unknown and could not assure the matter would not have a material impact. Other disclosed EPA penalties and orders were paid or described as not expected to materially affect the company; the consent decree remains in effect and could lead to further penalties.
- Litigation: A New Jersey class action concerning HVAC systems potentially covers 1,065 homes and seeks unspecified damages, including possible treble damages. Class certification was affirmed; the company appealed. Management said a loss was not probable but a loss estimate could not be made.
- Inventory impairments and land-option write-offs totaled $3.5 million year to date, down from $7.2 million. Prior-period impairment reversals also benefited reported gross margins; additional impairments could be required if market expectations weaken.
- The company had 51 mothballed communities with $124.9 million net book value, after $442.9 million of prior impairments. Land banking and model-home sale-leaseback arrangements are accounted for as financing, not sales.
Important facts for investors to verify
- Whether sales pace, pricing and margin gains persist, particularly amid higher mortgage rates and tighter borrower financing.
- Cash requirements for land investment, operating losses and debt service, including upcoming maturities; the filing’s debt maturity schedule reports $56.6 million in FY2013 and $43.7 million in FY2014.
- The potential cost, timing and materiality of the Newark EPA matter, and developments in the HVAC class action.
- Whether inventory values, mothballed communities and land-option commitments remain supportable as markets change.
- How equity issuance, exchangeable notes and TEU purchase contracts may affect future share count and dilution.
- Whether covenant restrictions continue to bar preferred dividends and limit financing or other corporate actions.