Hovnanian Enterprises, Inc. — Q2 FY2019 Form 10-Q
Reporting period: Three and six months ended April 30, 2019. Unaudited consolidated results; dollar amounts below are in millions unless noted.
Financial performance and position
- Q2 revenue was $440.7, down 12.3% year over year. Home sales revenue fell 8.7% to $427.6, mainly as deliveries declined 10.7% to 1,085 homes. Six-month revenue was $821.3, down 10.7%.
- Net loss was $15.3 for Q2 versus $9.8 a year earlier; six-month net loss narrowed to $32.7 from $40.6. Q2 diluted loss per share was $2.56, versus $1.65. The six-month loss per share was $5.49, versus $6.85.
- Homebuilding gross margin was 13.3% in Q2 versus 13.8% a year earlier; six-month margin was 14.0% versus 14.3%. Management cited community mix and increased incentives, especially on spec homes. SG&A as a share of total revenue rose to 13.7% in Q2 from 12.3%.
- Joint ventures contributed $7.3 of Q2 income and $16.8 for six months, versus $1.3 and a $3.8 loss, respectively, a year earlier. This improvement helped reduce the six-month net loss.
- Cash flow and liquidity: Cash used in operating activities was $198.9 for the six months, versus $70.0 used in the prior-year period; investing used $3.9, while financing provided $138.4. Homebuilding cash was $124.0 at April 30. Management reported total liquidity of $266.0, including $125.0 available under the secured revolver, above its $170–$245 target range.
- Debt and equity: Notes payable and accrued interest totaled $1,298.9; revolving/term facilities were $201.5 net, and nonrecourse mortgages were $190.7 net. Stockholders’ equity was in deficit by $485.0. The company reported no secured-revolver borrowings and said it was in compliance with debt covenants. Debt agreements restrict dividends; preferred dividends are expected to remain suspended for the foreseeable future.
- Balance sheet changes: Total assets were $1,755.3, versus $1,662.0 at October 31, 2018. Inventory, excluding inventory not owned, increased $123.4; consolidated inventory not owned increased $66.5, largely reflecting land-bank and model-home financing transactions.
Changes, outlook and management commentary
- Active selling communities rose to 147 from 132 a year earlier; controlled lots also increased year over year for the sixth consecutive quarter. Net contracts increased 10.1% in Q2 and 2.0% for six months, while backlog rose to 2,254 homes valued at $949.9, up 5.5% in value year over year.
- Management expected community count to continue growing in Q3 FY2019 and said increased lots and communities should support future delivery and revenue growth, subject to market conditions. It stated that available cash and the secured facility should cover working-capital needs through FY2019. No quantified earnings or revenue guidance was provided.
- The company spent $252.6 on land purchases and development in the first half, while remaining cautious about slower absorption in certain periods and carefully evaluating new land investments. Tariffs had not materially affected results to date, but future tariffs could affect costs and customer budgets.
- Unusual and estimation-sensitive items include inventory impairment and land-option write-offs of $2.2 for six months, and prior-period impairment reversals that benefited six-month gross margin by $18.3, versus $33.5 a year earlier. A 1-for-25 reverse stock split took effect March 29, 2019; share and per-share data are retrospectively adjusted.
Risks and contingencies
- The company identified high leverage, restrictive debt covenants, limited debt-incurrence capacity, liquidity and financing availability, housing-market cyclicality, mortgage rates, cancellations, land and construction costs, labor and material availability, regulation, environmental obligations, and tariffs as material risks.
- An EPA matter concerning a Newark redevelopment site includes a $2.7 demand for reimbursement of cleanup costs. The company disputed the demand, entered a tolling agreement through December 20, 2019, and stated it had adequate reserves, while noting the ultimate obligation was uncertain.
- In the Great Notch construction-defect litigation, the plaintiff asserted approximately $119.5 in damages, potentially subject to treble damages. Mediation was scheduled for July and August 2019, with trial scheduled for September 9, 2019. The company said it intended to defend the claims vigorously.
- The company also disclosed ordinary-course litigation and environmental and permitting risks. It said ordinary-course litigation was not expected to materially adversely affect its financial position, results or cash flows, but could not assure that the EPA matter would not have a material impact.
Important facts for investors to verify
- Whether delivery volumes, sales absorption, cancellations and incentives support the expected growth in communities and future revenue.
- How operating cash use and land investment affect liquidity, and whether the reported revolver availability and total-liquidity position are sustained.
- Debt maturities, interest burden, covenant constraints, and the basis for continued suspension of preferred dividends.
- Potential exposure and reserve adequacy for the Great Notch litigation and Newark EPA cleanup demand.
- Inventory valuations, impairment assumptions and the sustainability of joint-venture income and prior-period impairment reversals.