Hovnanian Enterprises(US:HOV)2023-12-17 16:00Business and Risk Factors Business Overview Hovnanian is a major US homebuilder operating in 13 states, focusing on QMI homes and a risk-averse land strategy - The company operates through two main divisions: homebuilding and financial services. The homebuilding operations are divided into three reportable segments: Northeast, Southeast, and West12 - In fiscal 2023, the company offered homes with base prices ranging from $135,000 to $1,770,000, with an average sales price of $539,00013 - The company employs a risk-averse land acquisition strategy, preferring to use land options to control lots, which limits financial exposure. In fiscal 2023, the company walked away from 3,838 lots under option, resulting in a pre-tax charge of $1.5 million4454 - In response to rising interest rates, the company shifted its focus to increasing the availability of quick-move-in (QMI) homes and executed "Build-For-Rent agreements" to supplement sales volume in fiscal 202338 FY 2023 Housing Deliveries and Revenue by Segment (Consolidated) | Segment | Housing Revenues (in thousands USD) | Homes Delivered | Average Sales Price | | :--- | :--- | :--- | :--- | | Northeast | $933,156 | 1,618 | $576,734 | | Southeast | $419,656 | 776 | $540,794 | | West | $1,277,645 | 2,484 | $514,350 | | Consolidated Total | $2,630,457 | 4,878 | $539,249 | - As of October 31, 2023, the company employed 1,715 full-time associates. The workforce is diverse, with 25.6% being non-white and 44.3% being women2730 Risk Factors The company faces significant cyclical homebuilding risks, high leverage, and potential NOL limitations - The homebuilding industry is highly cyclical and significantly affected by changes in economic conditions, including interest rates, employment levels, and consumer confidence, which can impact profitability and liquidity8384 - Substantial increases in interest rates, as seen in fiscal 2022 and 2023, can impair home affordability, lower demand, and reduce the company's ability to realize its sales backlog91 - The company has a significant amount of debt ($1.07 billion as of Oct 31, 2023, excluding certain items), which could limit future financing, require substantial cash flow for debt service, and place it at a competitive disadvantage127132133 - Restrictive covenants in debt instruments limit the company's ability to, among other things, incur more debt, pay dividends, repurchase stock, and make certain investments. Failure to comply could lead to default139140 - The company has a federal net operating loss (NOL) carryforward of $688.3 million. An "ownership change" as defined by Section 382 of the Internal Revenue Code could substantially limit the ability to utilize these NOLs155156157 - The company's operations are concentrated in Arizona, California, Florida, New Jersey, Texas, and Virginia, making it vulnerable to regional economic downturns or events in these specific markets106107 Financial Information Market for Common Equity and Share Repurchases Hovnanian's Class A common stock trades on NYSE; no public market for Class B or recent equity repurchases - The Class A Common Stock is traded on the New York Stock Exchange under the symbol "HOV"169 - The company reported no issuer purchases of its equity securities during the period171 Management's Discussion and Analysis (MD&A) FY23 saw revenue and net income decline due to high interest rates and lower margins, despite strong liquidity Overview and Market Conditions FY23 housing market faced rising interest rates, prompting incentives and QMI homes, which improved demand and liquidity - The company used its increased inventory of QMI homes and offered mortgage interest rate buydowns to combat the impact of rising interest rates and provide customers with more certainty on mortgage pricing183 - A low supply of existing homes for sale led to increased demand for new homes, allowing the company to increase net prices in approximately 54% of its communities during Q4 2023184 - In FY2023, the company spent $679.3 million on land and development, repurchased $245.0 million of senior secured notes, and ended the year with total liquidity of $564.2 million186 Results of Operations FY23 total revenues decreased 5.7% to $2.76 billion due to fewer deliveries and lower gross margins, partially offset by increased JV income Total Revenues Breakdown (FY2023 vs FY2022) | Revenue Source | 2023 (in thousands USD) | 2022 (in thousands USD) | Variance (in thousands USD) | | :--- | :--- | :--- | :--- | | Sale of homes | $2,630,457 | $2,840,454 | $(209,997) | | Land sales | $48,217 | $16,202 | $32,015 | | Other revenues | $17,254 | $4,035 | $13,219 | | Financial services | $60,088 | $61,540 | $(1,452) | | Total Revenues | $2,756,016 | $2,922,231 | $(166,215) | Homebuilding Gross Margin Analysis (FY2023 vs FY2022) | Metric | 2023 | 2022 | | :--- | :--- | :--- | | Homebuilding gross margin percentage | 19.6% | 21.5% | | Homebuilding gross margin %, before interest & land charges | 22.7% | 25.0% | - Inventory impairments and land option write-offs decreased significantly to $1.5 million in FY2023 from $14.1 million in FY2022209 - The company recorded a net loss on extinguishment of debt of $25.6 million in FY2023, primarily from redeeming and refinancing several series of senior secured notes191231232 Homebuilding Operations Analysis Homebuilding operations saw increased sales pace but volatile cancellation rates, leading to a 16.4% backlog value decline to $1.1 billion - Net contracts per average active selling community increased to 40.8 in FY2023 from 39.6 in FY2022, indicating a faster sales pace213 Quarterly Contract Cancellation Rates (as % of Gross Sales) | Quarter | 2023 | 2022 | | :--- | :--- | :--- | | First | 30% | 14% | | Second | 18% | 17% | | Third | 16% | 27% | | Fourth | 25% | 41% | Consolidated Contract Backlog (Year-End) | Metric | Oct 31, 2023 | Oct 31, 2022 | | :--- | :--- | :--- | | Total contract backlog (in thousands USD) | $1,060,614 thousand | $1,268,679 thousand | | Number of homes | 1,824 | 2,186 | Capital Resources and Liquidity The company maintained $564.2 million in liquidity in FY23, driven by debt refinancing and share repurchases - Total liquidity at October 31, 2023 was $564.2 million, comprising $434.1 million in homebuilding cash and $125.0 million available under its revolving credit facility242 - Cash provided by operating activities was $435.3 million in FY2023, a significant increase from $89.5 million in FY2022131244 - In FY2023, the company undertook several debt management actions, including redeeming $200.0 million of its 7.75% Notes, repurchasing $45.0 million of its 10.0% Notes, and refinancing several other notes with new issues due in 2028 and 2029231232233234 - The company repurchased 118,478 shares of its Class A common stock for $4.8 million during fiscal 2023. As of year-end, $33.0 million remained available under the repurchase authorization263502 Inventories and Land Position FY23 saw total inventory decrease by $86.2 million, with a strategic increase in QMI homes and stable controlled home sites Total Controlled Home Sites (Consolidated) | Date | Owned | Optioned | Total Home Sites | | :--- | :--- | :--- | :--- | | Oct 31, 2023 | 7,337 | 24,389 | 31,754 | | Oct 31, 2022 | 9,022 | 22,496 | 31,800 | - The number of started or completed unsold homes and models increased to 909 at the end of FY2023 from 739 at the end of FY2022, a strategic move to increase the availability of QMI homes274275 - The company utilizes land banking and model sale-leaseback arrangements, which are accounted for as financings. As of October 31, 2023, this "Consolidated inventory not owned" totaled $224.8 million270388 Market Risk Disclosures Market risk is primarily interest rate-related but limited due to fixed-rate long-term debt and short-term mortgage hedging - The company has limited exposure to variable interest rates as substantially all of its long-term debt requires fixed payments302 Long-Term Debt Maturity Schedule (as of Oct 31, 2023) | Maturity Year (Fiscal) | Principal (in thousands USD) | Weighted-Avg Interest Rate | | :--- | :--- | :--- | | 2026 | $204,092 | 11.55% | | 2027 | $39,551 | 5.00% | | 2028 | $306,498 | 8.53% | | Thereafter | $520,120 | 10.58% | | Total | $1,070,261 | 9.97% | Controls and Procedures Management and auditors concluded the company's disclosure controls and internal control over financial reporting were effective - Management concluded that the company's disclosure controls and procedures were effective as of October 31, 2023309 - Deloitte & Touche LLP audited and found the company's internal control over financial reporting to be effective as of October 31, 2023313350 Corporate Governance Directors, Executive Officers, Compensation, and Related Matters This section's detailed information is largely incorporated by reference from the company's definitive proxy statement - Information required by Items 10, 11, 12, 13, and 14 is largely incorporated by reference from the company's definitive proxy statement to be filed for its annual meeting on March 21, 2024317325326327328 - The company has adopted a Code of Ethics applicable to all associates and directors, as well as Corporate Governance Guidelines, which are available on its website321322323 Financial Statements and Notes Auditor's Report The auditor issued an unqualified opinion on financial statements and internal controls, identifying warranty and construction defect reserves as a Critical Audit Matter - The auditor issued an unqualified (clean) opinion on both the financial statements and the effectiveness of internal control over financial reporting350 - A Critical Audit Matter was identified concerning the estimation of reserves for warranty costs and construction defects. This was due to the high degree of complexity, subjectivity, and judgment required by management in determining the liability, which necessitated increased audit effort and the use of actuarial specialists358359 Consolidated Financial Statements FY23 financial highlights include $2.49 billion total assets, $581.8 million equity, $2.76 billion revenues, $205.9 million net income, and $435.3 million operating cash flow Consolidated Balance Sheet Highlights | (In thousands USD) | Oct 31, 2023 | Oct 31, 2022 | | :--- | :--- | :--- | | Total Inventories | $1,349,186 | $1,519,184 | | Total Assets | $2,492,940 | $2,562,030 | | Senior notes and credit facilities, net | $1,051,491 | $1,146,547 | | Total Liabilities | $1,911,151 | $2,178,979 | | Total Equity | $581,789 | $383,051 | Consolidated Statement of Operations Highlights | (In thousands USD) | FY 2023 | FY 2022 | FY 2021 | | :--- | :--- | :--- | :--- | | Total Revenues | $2,756,016 | $2,922,231 | $2,782,857 | | Income before income taxes | $255,951 | $319,753 | $189,861 | | Net Income | $205,891 | $225,490 | $607,817 | | Diluted EPS | $26.88 | $29.00 | $85.86 | Consolidated Statement of Cash Flows Highlights | (In thousands USD) | FY 2023 | FY 2022 | FY 2021 | | :--- | :--- | :--- | :--- | | Net cash provided by operating activities | $435,275 | $89,466 | $210,213 | | Net cash (used in) provided by investing activities | $(78,235) | $(2,152) | $8,996 | | Net cash used in financing activities | $(261,711) | $(16,520) | $(217,273) | Notes to Financial Statements The notes provide critical details on accounting policies, debt, segment performance, NOLs, joint ventures, and litigation matters - (Note 9) The company executed a major refinancing in October 2023, issuing $225.0 million of 8.0% Notes due 2028 and $430.0 million of 11.75% Notes due 2029 to redeem several series of notes maturing in 2026455456 - (Note 11) The company has remaining federal Net Operating Loss (NOL) carryforwards of $688.3 million. A valuation allowance of $71.9 million is maintained against certain state NOLs and tax credits that are not expected to be realized486487 - (Note 12) The company recorded no inventory impairments in FY2023, compared to $8.4 million in FY2022. Write-offs for abandoned land options and other costs were $1.5 million, down from $5.7 million in the prior year491493 - (Note 16) Warranty and construction defect reserves stood at $89.6 million at year-end. In fiscal 2023, an additional $10.1 million was added to reserves due to an updated assessment of claims history520522 - (Note 18) The company reached a settlement in the Four Seasons at Great Notch case in December 2023. The settlement amount was not materially different from what had been reserved530 - (Note 20) The company actively uses unconsolidated joint ventures. In FY2023, it contributed numerous communities to new and existing JVs, generating significant cash, and also consolidated the assets of other JVs537538539