Hovnanian Enterprises, Inc. — Q1 FY2013 10-Q
Reporting period: Three months ended January 31, 2013. Amounts below are in U.S. dollars; financial statement figures are converted from thousands to millions unless otherwise noted.
Business context and results
Hovnanian builds and sells homes across six U.S. regions and provides mortgage and title services. Management reported continued improvement in housing demand compared with the prior-year quarter, while noting that home sales remain below historical levels and recovery varies by market.
- Revenue: $358.2 million, up 32.9% from $269.6 million. Homebuilding revenue was $346.6 million; financial services revenue was $11.7 million.
- Home sales: 1,062 consolidated deliveries, up 19.5%; average selling price rose to approximately $315,000 from $284,000. Home-sale revenue increased 32.5%.
- Profitability: Net loss was $11.3 million, or $0.08 per share, versus a $18.3 million loss, or $0.17 per share, a year earlier. Pretax loss was $20.8 million versus $17.6 million. The current quarter included a $9.5 million income tax benefit, primarily from settling an uncertain federal tax position with the IRS.
- Margins and expenses: Homebuilding gross margin before cost-of-sales interest and land charges was 17.0%, up from 16.5%. After interest and land charges, it was 13.7%, versus 10.9%. Selling, general and administrative expense, including corporate expense, was 13.8% of revenue versus 17.1%.
- Cash flow: Operating cash flow was positive $5.8 million versus negative $43.1 million. Investing activities provided $9.7 million, including $12.5 million of joint-venture capital distributions. Financing used $50.6 million, and cash and cash equivalents declined $35.1 million to $238.2 million.
- Liquidity: At January 31, homebuilding cash was $232.8 million and financial-services cash was $5.4 million. Restricted cash totaled $51.5 million. The company has no revolving credit facility.
- Debt and equity: Notes payable totaled $1.557 billion, net of discounts, and included $977.7 million of senior secured notes and $458.9 million of senior notes. Total liabilities were $2.062 billion; stockholders’ equity remained in deficit at $481.5 million. Mortgage warehouse borrowings were $52.0 million.
Material changes versus the prior-year quarter
- Net contracts increased 27.1% to 1,195 homes; contract backlog rose to 2,022 homes valued at $695.0 million, from 1,438 homes valued at $457.4 million. The cancellation rate declined to 16% from 21%.
- Homebuilding pretax results improved to $4.8 million income from a $3.5 million loss. Financial-services pretax income rose to $4.2 million from $1.5 million. Corporate and unallocated pretax loss widened to $29.9 million from $15.6 million.
- Inventory impairment losses and land-option write-offs fell to $0.7 million from $3.3 million. The prior-year quarter included a $24.7 million gain on debt extinguishment; there was no such gain in Q1 FY2013.
- During the quarter, $18.3 million of senior exchangeable notes were exchanged for 3.4 million Class A shares. Class A shares issued also reflected settlement of prepaid stock purchase contracts.
Outlook, risks, and unusual items
- Management expects full-year FY2013 gross margin percentage to improve and SG&A as a percentage of revenue to decline versus FY2012 as deliveries and revenue rise from the seasonally low first quarter. Sequentially, however, gross margin declined from 18.3% in Q4 FY2012 to 17.0%, and SG&A as a percentage of revenue increased from 10.0% to 13.8%.
- Management believes available cash, home and land sales, and financial-services revenue will fund working-capital and other needs through FY2013. It cautioned that positive operating cash flow may remain difficult until sustained profitability returns; land purchases and development consume cash.
- Key business risks include weak or uneven housing demand, restrictive mortgage underwriting, unemployment and economic uncertainty, interest rates, construction-cost inflation, land availability, and access to financing. Management warned that additional inventory impairments may be needed if prices or projected cash flows weaken.
- At January 31, 52 mothballed communities carried $124.2 million of net book value after $465.9 million of prior impairments. The company reactivated one community during the quarter.
- Preferred dividends are restricted under debt covenants; no Series A preferred dividends were paid in the quarter. The company reported compliance with note indentures and mortgage repurchase facility covenants at January 31.
- Litigation is described as ordinary-course and not expected to materially affect financial position or results, but a New Jersey HVAC class action involving a potential 1,065 homes remains unresolved; loss could not be estimated. EPA matters included $120,000 of previously assessed penalties paid and a further $130,000 penalty under a February 2013 order, alongside compliance requirements.
Most important facts for investors to verify
- Whether contract growth, backlog conversion, cancellation rates, and home-price gains persist across regions.
- Whether margin improvement and management’s FY2013 outlook are achieved despite sequential first-quarter margin and SG&A deterioration.
- Cash needs from land investment and debt service, and the adequacy of liquidity given the absence of a revolving credit facility.
- Debt maturities, covenant limits on borrowing and dividends, and potential dilution from exchangeable notes and equity purchase contracts.
- Potential additional inventory impairments, warranty and construction-defect exposure, and developments in the HVAC class action and environmental matters.
- The sustainability of reported losses and tax benefits: the quarter’s $9.5 million tax benefit arose mainly from an IRS settlement, while the company remained in a three-year cumulative loss position and carried a $943.9 million deferred-tax valuation allowance.