Business context and reporting period
Hovnanian Enterprises, Inc. is a homebuilder operating across six U.S. regions, with a mortgage and title-services business. This unaudited Form 10-Q covers the three months ended January 31, 2016, the first quarter of fiscal 2016; comparisons are with the first quarter of fiscal 2015 unless noted. Interim results may not indicate full-year performance.
Financial performance and condition
- Revenue: Total revenue rose 29.1% to $575.6 million. Home sales revenue increased 28.4% to $556.8 million, reflecting 23.8% more deliveries (1,422) and a 3.8% increase in average selling price to $391,543. Financial-services revenue rose 63.9% to $18.2 million.
- Profit and margins: Net loss widened to $16.2 million from $14.4 million; loss per share was $0.11 versus $0.10. Homebuilding gross margin before cost-of-sales interest and land charges fell to 16.6% from 18.2%; after interest and land charges it was 11.5% versus 15.1%. The company recorded $11.7 million of inventory impairments and land-option write-offs, compared with $2.2 million.
- Operating costs and segments: Homebuilding SG&A was nearly flat at $47.5 million, while combined homebuilding and corporate SG&A declined to 11.1% of revenue from 14.5%. Financial services generated $10.0 million of pretax income, up from $3.8 million. Southwest was the largest profitable homebuilding segment ($16.4 million pretax); Midwest and West reported pretax losses of $5.6 million and $6.0 million, respectively.
- Cash flow and liquidity: Operating cash use was $65.1 million, improving from $195.6 million used a year earlier. Investing used $10.6 million and financing used $25.5 million. Cash and cash equivalents ended at $152.6 million, down $101.2 million during the quarter; this includes $147.1 million of homebuilding cash and $5.5 million of financial-services cash. Restricted cash was $26.9 million. The company spent $116.6 million on land and development and paid $172.7 million of notes that matured in January.
- Debt and equity: Notes payable totaled $1.751 billion, including $981.7 million of senior secured notes and $607.6 million of senior notes. Separately, homebuilding nonrecourse mortgages were $143.9 million and mortgage warehouse lines were $140.4 million. Stockholders’ equity was a deficit of $143.1 million. The $75 million revolving facility had $47.0 million drawn and $25.5 million of letters of credit outstanding.
- Balance sheet and other measures: Total assets were $2.553 billion. Inventory excluding consolidated inventory not owned declined $208.4 million from October 31, 2015; consolidated inventory not owned increased $215.8 million, mainly reflecting land-bank financing. Contract backlog was 3,014 homes worth $1.288 billion, up 25.6% by homes and 39.1% by value year over year.
Material changes versus the prior period
- Home deliveries, active selling communities and net contracts increased; active communities were 217 versus 199 a year earlier. Net contracts rose 16.1%, while the first-quarter cancellation rate increased to 20% from 16%.
- Revenue growth did not translate into improved net results: gross margin percentages declined, impairment charges increased, and the company moved from $1.5 million of joint-venture income to a $1.5 million loss.
- Cash used in operations improved substantially year over year, but quarter-end cash fell after debt repayment and land investment. Total notes payable declined from $1.936 billion at October 31, 2015, largely reflecting the January maturity payment.
- The company formed a joint venture in November 2015, contributed a mothballed parcel and received $25.7 million; it also increased use of land-bank financing.
Outlook, commentary, risks and contingencies
- Management said higher backlog and community count support expectations for stronger results as the fiscal year progresses, particularly in the latter half, while emphasizing uneven market performance and no guarantee of improvement. It expects cash sources to cover fiscal 2016 working-capital needs.
- The company prefers to refinance $86.5 million of 7.5% notes due May 15, 2016 and $121.0 million of 8.625% notes due January 15, 2017, but says refinancing may be unavailable or unattractive. Management believes operations and planned footprint reductions can provide liquidity to repay them; it may also delay investments or pursue land banking, joint ventures, project financing or model-home sale-leasebacks.
- Management is exiting Minneapolis and Raleigh by selling land portfolios, and winding down San Francisco Bay Area and Tampa operations through delivery and sale of homes on existing land. It says debt covenants limit additional borrowing and currently prevent preferred-stock dividends; the restriction is expected to continue for the foreseeable future.
- Risks cited include economic uncertainty, lower oil prices potentially affecting Texas, restrictive mortgage lending, rising mortgage rates, construction and land costs, cancellations, and regulatory or environmental requirements. Management noted national and company home sales remain below historical levels.
- The company recorded $9.7 million of impairments for six communities held for sale, mainly in the Midwest. It cautioned that further impairments may be needed if prices or cash-flow assumptions weaken. An EPA matter concerning elevated lead levels near a former Newark smelter remains unresolved; the company has been identified as a potentially responsible party, does not know the scope of any obligation, and cannot rule out a material impact. Ordinary-course litigation is not expected by management to materially affect results.
- Management concluded that a full valuation allowance against deferred tax assets was not necessary; the reported valuation allowance was $635.3 million. This assessment depends in part on expectations of long-term profitability.
Important facts for investors to verify
- Whether the May 2016 and January 2017 maturities are refinanced or repaid from available cash, and the resulting liquidity and financing costs.
- Whether backlog converts to deliveries and cash as anticipated, particularly given the higher cancellation rate and seasonal first-quarter results.
- Whether gross margins stabilize and further inventory impairments or land-option write-offs arise, especially in markets being exited.
- Progress, timing and proceeds from the Minneapolis and Raleigh land sales and the planned wind-downs in California and Tampa.
- Developments in the EPA Newark matter, warranty and construction-defect claims, and the assumptions supporting deferred-tax-asset realization.
- Use and availability of land-bank and other financing arrangements, covenant compliance, and continued restrictions on dividends and additional borrowing.