Business context and reporting period
Hovnanian Enterprises, Inc. is a homebuilder operating across six U.S. regions, with mortgage banking and title services. This unaudited Form 10-Q covers the three and six months ended April 30, 2017; balance-sheet comparisons are with October 31, 2016. Amounts below are in U.S. dollars.
Financial performance and position
| Metric | Q2 FY2017 | Q2 FY2016 | Six months FY2017 | Six months FY2016 |
|---|---|---|---|---|
| Total revenue | $585.9m | $654.7m | $1,137.9m | $1,230.3m |
| Net loss | $6.7m | $8.5m | $6.8m | $24.6m |
| Loss per common share | $0.05 | $0.06 | $0.05 | $0.17 |
| Operating cash flow | Not separately provided | Not separately provided | $117.2m | $(31.2)m |
- Homebuilding gross margin was 12.6% in Q2 and 13.0% for the first half, versus 11.1% and 11.3% a year earlier. Before cost-of-sales interest and land charges, margins were 16.5% and 16.8%, respectively.
- Q2 home-sale revenue fell 9.4%; deliveries declined 15.0% to 1,358, partly offset by average selling price increasing to $418,000 from $392,000. First-half home-sale revenue decreased 7.1% as deliveries declined 12.3% and average price rose to $415,000.
- Cash and cash equivalents were $280.8m, including $275.0m in homebuilding, down from $346.8m total at October 31, 2016. Restricted cash was $24.7m. Total assets were $2.134bn, total liabilities $2.267bn, and stockholders’ equity deficit $133.9m.
- Notes payable and term loan, net, were $1.569bn; the revolving facility had $52.0m drawn, and nonrecourse mortgages totaled about $80.0m. Mortgage warehouse borrowings were $70.1m. The filing reports substantial fixed-rate debt; weighted-average interest on long-term debt shown in its market-risk table was 7.21%.
- Six-month cash flow included $19.8m used in investing and $163.4m used in financing. The company spent $290.1m on land purchases and development, repurchased debt for $30.8m, and ended the period with $280.8m cash and equivalents.
Material changes versus the prior comparable period
- Revenue declined 10.5% for Q2 and 7.5% for the first half; the principal driver was fewer deliveries, reflecting a smaller community base. Active selling communities were 146 at April 30, down from 196 a year earlier, and management cited a 25.5% year-over-year community-count decline.
- Net losses narrowed year over year. Lower land impairments and option write-offs supported margins: first-half land charges were $5.1m versus $21.4m in 2016. Management also said higher-margin delivery mix and reduced incentives helped, while labor and material cost increases were a partial offset.
- First-half operating cash flow improved to $117.2m from an outflow of $31.2m, which management attributed in part to lower land spending than in the prior-year period. Financing cash outflow was larger, including debt reduction and lower mortgage warehouse balances.
- Financial services pretax profit declined to $7.1m for Q2 and $13.1m for the first half, from $7.4m and $17.4m, respectively, principally reflecting lower mortgage originations and capture rates.
- The company repurchased $38.4m aggregate principal/stated amount of certain 2019 notes and exchangeable units for $30.8m, recording a $7.8m debt-extinguishment gain before $0.4m of related costs.
Outlook, risks, contingencies and unusual items
- Management said existing sources of cash should be sufficient to meet working-capital needs through fiscal 2017. It expects community-count growth no earlier than the second half of fiscal 2018, with revenue and delivery growth potentially following, absent adverse market factors. This is forward-looking, not a guarantee.
- Backlog at April 30 was 2,504 homes valued at $1.1bn, down 23.6% in dollar value year over year. Net contracts fell 12.3% in Q2 and 17.3% in the first half, though contracts per average active community improved. The company invested in land and expects new land purchases to support future growth, but development-to-opening timing may range from months to years.
- Debt and liquidity remain key risks. Debt covenants restrict additional borrowing and dividends; preferred dividends were suspended and management expected restrictions to continue. Nearer maturities include exchangeable and amortizing notes due in 2017, 10.0% second-lien notes due in 2018, and senior notes due in 2019. The company reported compliance with its debt covenants at April 30.
- Management’s deferred-tax assessment relies on future taxable income; the valuation allowance was $628m, and about $275m of taxable income over 19 years is needed to support realization of deferred tax assets without an allowance. State NOLs of $2.2bn have expirations beginning in 2017.
- Construction-defect litigation: a June 1, 2017 jury verdict—after quarter-end—awarded $3m, trebled to $9m, against a subsidiary, plus undetermined attorneys’ fees. A veil-piercing finding leaves potential parent liability to be decided; the company reserved its estimated probable loss and intends to seek post-trial relief and appeal. A separate nearby condominium suit alleges about $70m in damages, potentially subject to trebling; loss was not yet estimable.
- The EPA has identified the company as a potentially responsible party concerning a former Newark lead-smelter site; the scope of any obligation is unknown, and the filing gives no clear estimate of potential loss.
- Other risks include housing-market weakness, interest rates and mortgage availability, land and construction-cost inflation, labor and materials availability, regulatory and environmental requirements, warranty and product-liability claims, and joint-venture performance. Management reported effective disclosure controls and no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- How quickly land investment converts into new active communities, contracts, deliveries and revenue, given the reduced community count and backlog.
- Whether margin gains persist as older, higher-cost land is worked through and labor and material costs rise; also assess the impact of prior impairment reversals on reported margins.
- Cash availability and refinancing capacity against the 2017–2020 maturity schedule, covenant limitations, restricted cash and reliance on land-bank, joint-venture and other financing arrangements.
- Developments in both condominium lawsuits, including the veil-piercing determination, attorneys’ fees, appeals and the still-unquantified second case; monitor EPA exposure as well.
- Whether forecast taxable income supports deferred-tax-asset realization and whether any further valuation allowance is required.