Business context and reporting period
Hovnanian Enterprises, Inc. filed this unaudited Form 10-Q for the quarter and six months ended April 30, 2018. The company builds and sells homes across six U.S. regions and provides mortgage and title services. Comparisons below are with the corresponding 2017 periods unless noted.
Key financial metrics
Amounts are in millions of dollars except per-share data, percentages, and home counts.
| Metric | Three months ended Apr. 30, 2018 | Six months ended Apr. 30, 2018 |
|---|---|---|
| Total revenue | $502.5 | $919.7 |
| Net loss | $9.8; $0.07 per share | $40.6; $0.27 per share |
| Homebuilding gross margin | $64.8; 13.8% | $124.2; 14.3% |
| Gross margin before cost-of-sales interest and land charges | 17.7% | 17.8% |
| Operating cash flow | $(72.6) for the six months | |
| Cash and cash equivalents | $253.8 total at Apr. 30, including $248.8 homebuilding cash | |
| Total assets / total liabilities | $1,642.5 / $2,142.5 at Apr. 30 | |
| Stockholders’ equity | $500.0 deficit at Apr. 30 |
At April 30, listed long-term debt obligations were approximately $1.616 billion, excluding $70.6 million of nonrecourse inventory mortgages and mortgage warehouse borrowings. The company reported $52.0 million drawn on its unsecured revolving facility, alongside $11.6 million of letters of credit. Debt carrying amounts and scheduled obligations vary by instrument and include accrued interest in certain balance-sheet lines.
Material changes versus the prior comparable periods
- Revenue declined 14.2% in the quarter and 19.2% in the first half. Home-sale revenue fell 17.5% and 20.9%, respectively, reflecting fewer deliveries and lower average selling prices. Deliveries fell 10.5% in the quarter and 15.4% for the half; average selling price fell to $385,281 and $388,256, respectively, largely due to geographic and community mix.
- Net loss widened to $9.8 million for the quarter from $6.7 million and to $40.6 million for the half from $6.8 million. The first-half comparison also reflects higher interest expense and a $7.4 million prior-year gain on debt extinguishment versus a $1.4 million loss in 2018.
- Gross margin percentage improved from 12.6% to 13.8% for the quarter and from 13.0% to 14.3% for the half, primarily because of community mix; lower land charges also benefited the half-year comparison. Gross margin dollars declined with lower home-sale revenue.
- Cash from operations shifted to a $72.6 million use from $117.2 million provided in the first half of 2017. Management attributed the cash use in part to increased land and development spending, which totaled $284.8 million.
- Active selling communities were 132 versus 146 a year earlier. Backlog at April 30 was 2,193 homes valued at $900.7 million, down 17.6% in value year over year.
Outlook, management commentary, risks, and unusual items
- Management said prior debt repayments had constrained land purchases in fiscal 2016 and 2017, reducing community count and revenue. It reported two consecutive quarters of year-over-year growth in lots controlled and expects substantial community-count growth to begin in early fiscal 2019, with deliveries and revenue expected to follow, absent adverse market conditions. The filing gives no specific earnings or revenue guidance.
- Management believed cash on hand and refinancing transactions would be sufficient to fund working capital through fiscal 2018. It also said increasing land investment will reduce operating cash flow and that debt covenants limit additional borrowing and restrict preferred dividends for the foreseeable future.
- In February 2018, the company borrowed $132.5 million under a new 5.0% unsecured term loan to redeem its 7.0% notes. It exchanged $170.2 million of 8.0% notes for $90.6 million of 13.5% notes due 2026 and $90.1 million of 5.0% notes due 2040, and purchased $26.0 million principal amount of 8.0% notes for $26.5 million cash. In May, it redeemed a further $65.7 million principal amount of 8.0% notes using delayed-draw term loans. The exchange and related transactions resulted in a $1.4 million debt-extinguishment loss for the first half.
- S&P downgraded the corporate credit rating to CC in April. The company said ratings changes could make capital access more difficult or costly. It reported compliance with debt covenants at April 30; however, the filing describes restrictive covenants, default provisions, and limited capacity for non-refinancing debt.
- The Grandview litigation judgment was approximately $10.4 million; execution was stayed pending appeal with an approximately $11.1 million bond posted. Management considered a loss probable and reserved its estimated probable loss; the disclosed loss range was $0 to $11.1 million. In a separate Newark environmental matter, the EPA demanded $2.7 million for cleanup-cost reimbursement; the company said it had adequate reserves but could not assure the matter would not be material.
- The Grandview II construction-defect case was settled and paid in March 2018. The Solus litigation was dismissed with prejudice in May without a settlement payment or admission of wrongdoing; the company paid overdue interest on certain 8.0% notes, curing the stated default. It was seeking insurance coverage for Solus litigation costs.
- The Tax Cuts and Jobs Act reduced the federal corporate rate to 21%. The company recorded no net tax benefit or expense from remeasurement after adjusting its valuation allowance and continued to fully reserve deferred tax assets; the valuation allowance was $661.8 million. It cited cumulative losses as significant negative evidence.
- Other risks include housing-market and mortgage-rate volatility, land and construction-cost inflation, regulatory and environmental requirements, warranty and construction-defect claims, and the possibility of further inventory impairments. First-half inventory impairments and land-option write-offs were $3.1 million; management cautioned that additional impairments may be required if estimates or market conditions worsen.
Important facts for investors to verify
- Whether land investment translates into the forecast community-count growth in early fiscal 2019, and whether backlog and deliveries stabilize.
- Liquidity after land spending and debt repayments, including access to refinancing and compliance with debt covenants and payment obligations.
- The cost and terms of refinanced debt, including the high-coupon 13.5% notes and the status of remaining 8.0% notes.
- Final outcomes and reserve adequacy for the Grandview appeal and EPA cleanup demand, as well as insurance recovery for litigation costs.
- Whether improved gross-margin percentages persist as community and regional delivery mix changes, and whether the full valuation allowance on deferred tax assets remains appropriate.