HOVNANIAN ENTERPRISES INC quarterly report, Q3 FY2021

Hovnanian Enterprises, Inc. — Q3 FY2021 Form 10-Q

Reporting period: Three and nine months ended July 31, 2021; financial statements are unaudited. Hovnanian builds homes across six U.S. regions and provides mortgage and title services.

Key financial results

Metric	Three months ended July 31, 2021	Nine months ended July 31, 2021
Total revenue	$690.7 million (+10.0% year over year)	$1,968.5 million (+18.5%)
Income before taxes	$61.8 million, versus $16.2 million	$112.4 million, versus $13.0 million
Net income	$47.7 million, versus $15.4 million	$555.3 million, versus $10.3 million
Basic / diluted EPS	$6.85 / $6.72	$80.02 / $78.51
Homebuilding gross margin	19.2%, versus 13.6%	18.3%, versus 13.7%
Net cash from operating activities	$82.3 million for nine months, versus $192.8 million

All dollar amounts are U.S. dollars. Homebuilding revenue from home sales rose 9.5% in the quarter and 17.8% for nine months. Average selling price increased 13.5% and 7.6%, respectively; nine-month deliveries rose 9.4% to 4,501 homes. Higher selling prices and community mix were the main drivers of stronger margins.

The nine-month net income surge is not solely operating growth: it includes a $442.9 million income tax benefit, mainly from reversing the federal deferred-tax valuation allowance and part of the state allowance. The resulting net deferred tax asset was $447.5 million at July 31, 2021. Quarterly income tax expense was $14.1 million.

Balance sheet, liquidity and debt

• Cash and cash equivalents were $172.7 million at July 31, 2021, down from $262.5 million at October 31, 2020. Cash, cash equivalents and restricted cash totaled $235.1 million, versus $309.5 million at fiscal year-end.
• Management reported total liquidity of $307.7 million: $172.7 million of homebuilding cash and $125.0 million of available capacity under its revolving credit facility. This was above its stated target range of $170 million to $245 million.
• Senior notes and credit facilities, net, were $1.318 billion, down from $1.431 billion. Separately, nonrecourse inventory mortgages were $118.0 million. Total liabilities were $2.191 billion. The company reported positive equity of $120.7 million, versus a $436.1 million deficit at October 31, 2020, largely reflecting accumulated earnings and the deferred tax asset.
• Operating cash flow was lower year over year despite higher earnings, reflecting, among other items, increased inventory investment and the $447.5 million increase in deferred tax assets. The company spent $531.2 million on land purchases and development during the nine months. Cash and restricted cash declined by $74.4 million overall.
• On July 30, 2021, the company redeemed $111.2 million principal amount of 10.0% notes due 2022 for $111.7 million including accrued interest, funded with cash. On August 2, it redeemed $69.7 million principal amount of 10.5% notes due 2024 for $71.9 million including accrued interest. Management said the two redemptions reduce annual interest incurred by approximately $19 million; the August redemption was expected to produce a $3.4 million extinguishment loss in Q4.
• Debt agreements restrict dividends and other capital actions. The company could not pay dividends on its 7.625% Series A preferred stock due to covenant restrictions. It said it was in compliance with debt covenants at July 31.

Operating trends and changes from prior year

• Backlog rose to 3,673 homes valued at $1.75 billion at July 31, from 3,056 homes valued at $1.23 billion a year earlier; dollar value increased 41.8%. Customer deposits increased to $76.7 million from $48.3 million at October 31, 2020.
• Quarterly net contracts fell 45.6% year over year; nine-month net contracts declined 5.5%. Management attributed the quarterly decline partly to deliberately limiting sales in many communities and comparison with unusually strong COVID-era demand in Q3 FY2020. Nine-month sales pace per average active community increased to 44.9 from 38.1.
• Active selling communities numbered 104, down 11.1% from a year earlier. The company was pursuing replacement communities, and total controlled lots had increased each quarter since July 2020. Inventory excluding consolidated inventory not owned increased $201.7 million from October 31, 2020, largely due to land purchases and development.
• Financial-services pretax profit was $8.6 million in the quarter, down from $10.8 million, but $28.1 million for nine months, up from $20.0 million. Corporate and general administrative expense rose to $81.1 million for nine months from $54.3 million, largely due to cash-settled phantom stock awards whose expense increased with the company’s share price.

Outlook, risks and contingencies

• Management said cash and available revolver borrowings were expected to be sufficient to fund working capital requirements through FY2021. The filing provides no specific revenue or earnings guidance.
• Management described strong housing demand, citing low mortgage rates, limited existing-home supply and demand for more space. However, COVID-related supply-chain disruption had increased construction cycle times by about 45 days in many markets; further delays and cost increases could affect deliveries and margins.
• Key risks include a housing downturn, high leverage and restrictive debt covenants, availability and cost of land, labor and materials, mortgage rates and financing availability, weather, regulatory and environmental requirements, and warranty, construction-defect and other legal claims. Management noted that rising building costs could outpace buyers’ incomes and limit pricing power.
• The Great Notch construction-defect case includes remaining claimed damages of approximately $119.5 million, potentially subject to treble damages; defendants intend to contest the claims. The EPA has demanded $2.7 million for cleanup costs at a Newark-area site; the company stated it believes reserves are adequate but cannot assure the matter will not have a material impact. A separate New Jersey environmental suit concerning Hickory Manor seeks recovery of costs, further remediation and other relief; the complaint alleges more than $5.3 million in investigation and mitigation costs.
• The company recorded $3.3 million of inventory impairment losses and land-option write-offs for the first nine months. It cautioned that additional impairments may be needed if expected cash flows or land values decline. It also reported warranty and general-liability reserves of $95.4 million at July 31.

Important facts for investors to verify

• How much of reported earnings and improved equity reflects the deferred-tax valuation-allowance reversal, and whether future taxable income supports realizing the remaining deferred tax assets.
• Whether the backlog converts into timely closings given supply-chain delays, construction cycle times and the reduced active-community count.
• Cash generation after substantial land and development investment, and liquidity after the two note redemptions and ongoing operating needs.
• Debt maturities, interest burden, covenant restrictions and the practical availability of refinancing or additional capital.
• Developments in the Great Notch, Newark EPA and Hickory Manor matters, including potential exposure beyond recorded reserves.