M.D.C. Holdings, Inc.
Q1 2017 Earnings Call Transcript

Published: 10 May 2017

[Operator:]

Good afternoon. We are ready to begin the MDC Holdings Inc. First Quarter Earnings Conference Call. I will now turn it over to Kevin McCarty, Vice President of Finance and Corporate Controller. Sir, you may begin your call.

[Kevin McCarty:]

Thank you. Good morning ladies and gentlemen and welcome to the MDC Holdings' 2017 first quarter earnings conference call. On the call with me today I have Larry Mizel, Chairman and Chief Executive Officer; and Bob Martin, Chief Financial Officer. At this time, all participants are in a listen-only mode. After finishing our prepared remarks, we will conduct a question-and-answer session, at which time, we request that participants limit themselves to one question and one follow-up question. Please note that this conference is being recorded and will be available for replay. For information on how to access the replay, please visit our website at MDCHoldings.com. Before turning the call over to Larry, it should be noted that certain statements made during this conference call, including those related to M.D.C.'s business, financial condition, results of operations, cash flows, strategies and prospects and responses to questions may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve known and unknown risks, uncertainties and other factors that may cause the Company's actual results, performance or achievements to be materially different from the results, performance or achievements expressed or implied by the forward-looking statements. These and other factors that could impact the Company's actual performance are set forth in the Company's first quarter 2017 Form 10-Q which is scheduled to be filed at the SEC today. It should also be noted that SEC Regulation G requires that certain information accompany the use of non-GAAP financial measures. Any information required by Regulation G is posted on our website and our webcast slides. And now, I will turn the call over to Mr. Mizel for his opening remarks.

[Larry Mizel:]

Thank you. In 2017, we are celebrating 40 years in the homebuilding industry. We have delivered more than 190,000 homes since we started in 1977. As we recognized this anniversary we are pleased to announce a strong start to the year with first quarter net income reaching 22.2 million or $0.43 per share, which was more than doubled the level from the same quarter a year ago. The robust income growth was driven by a 43% improvement in the top line results of our homebuilding operations based on increased home deliveries. This allowed us to achieve significant gains and operating leverage as well as a 350 basis points of improvement to our last 12 months returns on equity. Throughout much of the past three years, we saw a downward trend in our backlog conversion rate, because of our increased focus on built-to-order production model and decreased labor availability. However, in the first quarter we saw backlog conversion improved year-over-year for the first time in 11 quarter. Though we continue to battle elevated cycle times in many markets, this achievement is a promising sign as we look forward to the rest of 2017. As our Company grows, our balance sheet remains a top priority. We continue to operate with a unique combination of low leverage, carefully managed exposure to home building assets and liquidity of nearly $1 billion. Just last month, we were pleased see the strength of our financial position publicly recognized by Standard & Poor’s which upgraded our rating outlook. With both our operating results and our financial positions showing signs of strength, we continue to have the confident to reward shareholders with a strong dividend unsurpassed in the industry in both yield and consistency of payment. Our new affordable product offering continues to be well received by buyers. The season series is targeted towards a first time home buyer, who has often been priced out of the current market and is steadily becoming a more significant part of our unit orders and closing volume. We believe that part of the appeal of the Seasons series is that we provide the buyer with a personalization opportunity that are often not available at this relatively low price. Based in part on our more affordable offerings and a solid macroeconomic environment the 2017 spring selling season has started off strong. We continue to experience growth in our monthly sales absorption pace, which reached a 10 year high in the 2017 first quarter. The improved demand across most of our markets has given us confidence to reinvest capital into new homebuilding projects. This is evidenced by a sizable year-over-year increase in the number a new lots we acquired and approved in the first quarter. We believe that the industry remains poised for continued market strength as the spring selling season draws to closed in the second quarter. Some uncertainties remains such as the impact of potential policy changes adopted by the new administration. However, given our strong financial performance in the first quarter, we remain optimistic for the top and bottom line growth for 2017 full year. I want thank our employees, board members, trades and financial partners both past and present for what they have done to make MDC a successful homebuilder over the past 40 years. I will now turn the call over to Bob Martin for more specific financial highlights of the 2017 first quarter. Bob.

[Robert Martin:]

Thank you Larry. Our home sale revenues increase 43% from the prior year to $563 million primarily due to 38% increase in closings. We achieved our highest number of first quarter closings in 10 years with the improvement mostly explained by 24% increase in our beginning backlog. Also, our first quarter backlog conversion rate was up year-over-year from 39% to 44%. The increase was driven primarily by the stabilization of our overall construction cycle time, led by year-over-year improvements in Colorado and California, which together comprised half of our beginning backlog. However, the improvements in these two markets were offset year higher construction cycle times in other markets. The year-over-year increase in our conversion rate was the first we have seen in 11 quarters and it exceeded our expectations. While this is encouraging, cycle times continue to be at elevated levels in many of our large markets. As a result, we believe there is risk for volatility in our backlog conversion rate. So as we look forward second quarter, we believe a reasonable goal for our backlog conversion rate is 40% just shy of as the rate we experienced in the second quarter of 2016. Our average selling price for the quarter of $449,000 was up the modest 3% year-over-year. The increase would have been more significant without our season's product which comprised about 5% of closings during the first quarter of 2017. In the same quarter of last year, we do not close any Seasons homes. Our gross margin from home sales percentage was down year-over-year from 16.3% to 15.9%. The 2017 first quarter included $4.9 million of inventory impairment while our 2016 first quarter included $3 million of expense to adjust our warranty accrual. The $4.9 million of impairments we took during the quarter is related to two assets one each in South California and South Florida. We were pleased to see improved operating leverage for the quarter as our SG&A rate fell by 250 basis points and 14.3% to 11.8% due in large part to our significant year-over-year increase in home sale revenues. Our total dollar SG&A expense was up for the quarter, driven by a $6 million increase in commission and a $3.1 million increase in marketing. These increases were primarily due to the growth in our closings unit volume and home sales revenues. The dollar value of our orders increased 3% year over year to $750 million. The increase was almost entirely due to a 3% increase year-over-year in the number of units, which was driven by an 8% increase in our absorption rate to 3.5. This was our highest first quarter absorption rate since 2006. Our Seasons collection accounted for roughly 8% of total orders for the quarter, up 300 basis points sequentially, and 600 basis points year-over-year. The rollout of this product continues to be a key focus for the Company. However, as I noted last quarter, the increase in unit volume, will be gradual as many of the communities we have recently purchased for the Seasons product need to completed through development activities and community set-up procedures during the coming quarters. We ended the year with an estimated sales value for our homes and backlog of $1.59 billion, which was up 11% year over year. The increase was mostly the result of an 8% increase in the number of units in backlog to 3,324 homes. While we are optimistic about backlog driving a year-over-year increase in closings for the second quarter, our optimism is somewhat tempered by a risk with regard to our cycle trends, which remained elevated in many of markets across the country. Our cancellation rate was flat year over year at 18% for both the 2017 and 2016 first quarters. As a percentage of beginning backlog, our cancellation rate was down 200 basis points year over year to 13%. Active subdivision account decreased to 160 at the end of the 2017 first quarter from a 169 a year ago. To end the quarter, we had roughly 14 fewer subdivisions in the category we call soon to be active than in the soon to be inactive category. In other words, we continue to be little heavier on subdivisions that are on the verge of sell out relative to those that are just opening. That tells us that our active subdivisions trajectory may continue to decrease in the second quarter relative to where we ended the first quarter consistent with what I shared with you during our call last quarter. For the 2017 first quarter, we acquired 1,313 lots for $77 million, up substantially from a year ago. This was also the highest number of lots that we have acquired since the fourth quarter 2015. The first quarter activity occurred largely in Arizona and Colorado, but we also acquired Boston and six other states as well. We spent additional $53 million on development expenditures, bringing our total land spend for the quarter to $130 million. The lots we acquired in the first quarter were in 30 subdivisions, with just under 50% of those subdivisions requiring some level of development. For the third consecutive quarter, approximately 20% of all lots acquired were for Seasons product. Furthermore, we acquired lots specifically designated for Seasons product for the first time in three location, Jacksonville, Las Vegas and Tucson. At the end of the quarter, we owned or controlled 14,875 lots up 2% year-over-year. This represents about 2.8 year supply on a trailing 12-month delivery basis, which is within our strategic range. And with liquidity approaching $1 billion at March 31, we have more than enough resources to react quickly to land acquisition opportunities as find them. Our key production metrics continue to improve year-over-year. Our first quarter home starts were up 5%, marking sixth consecutive quarter of year-over-year increases. Our homes completed around construction excluding models at the end of the quarter increased 2% from the same period in the prior year. Continued progress here is important as these units make up a big part of what we can close for much of the remainder of 2017. In addition, consistent with our built-to-order strategy, 89% of the work-in-process units you see here at the end of the first quarter are already sold compared to 84% a year ago. We believe the high percentage sold also speaks the quality of our balance sheet with limited speculation in unsold unit. Our last 12 months return on equity is up 350 basis points year-over-year and 80 basis points sequentially for the first quarter of 2017 to 8.9% this demonstrates the strong impact of the operating leverage that we have established starting the back half of 2016. It is also note worthy that the increase in our return in equity occurred without changing our risk profile. In fact, we have seen improvements in some of our key risk measures, this includes net debt-to-capital, which decreased by 860 basis points year-over-year to 24.7% and our overall investment unsold homes, which is down 29% to approximately $90 million. That concludes our prepared remarks. At this time, we would like to open up the call for questions.

[Operator:]

[Operator Instructions]. Your first question comes from the line of Stephen Kim with Evercore ISI. Stephen, your line is open.

[Christopher Shook:]

Hi, this is actually Christopher Shook on to Steve. So we are looking at your east division and on a year-over-year basis outside Florida, we continue to see new order growth in community count declined. I just wondering whether you can give any color as to whether you have any plans to increase investment in the area?

[Robert Martin:]

Yes, the East coast in particularly in the Mid-Atlantic that's one area we talked about as not having seen a good at returns as we would have like to seen over the past couple of years. And that's one of the reasons why we haven't invested as much in that particular area. it's still the mid-Atlantic region, it’s still an area we are committed to and we continue to look for opportunities in that market to invest in.

[Christopher Shook:]

Okay great. In regards to the Seasons products, so you mentioned that you are waiting some of the community development tools at the end of the year to roll out the product. Do you need to see any means in which you can accelerate that?

[Robert Martin:]

Well we always try to look for communities that have finished lots. We do that across products spectrums and to the extent that we find those that might accelerate what we are able to do. But developments inherently is tricky thing, we try to predict how it's going to go, it doesn’t always work out as we wanted to. So that's why we don't put too fine point on exactly where the level of Seasons’ activity will be in the future.

[Christopher Shook:]

Well thanks very much.

[Robert Martin:]

Thank you.

[Operator:]

Your next question comes from the line of Truman Patterson with Wells Fargo. Truman, your line is open.

[Truman Patterson:]

Hey guys nice quarter. This is Truman as she said for Stephen East. So good quarter. First question I just wanted to touch on gross margins, sequentially being in a jumping 20 bps quarter-over-quarter, which is a little unusual whenever you compared against the seasonally high fourth quarter, typically you would expect margin to deteriorate a good amount just due to the loss leverage. What is really driving the improvements sequentially and how should we think about this going forward? Should this be a spring board, where it continues improving sequentially throughout the year?

[Robert Martin:]

I think what I would say for our gross margins is as we have seen stability over the last eight quarters, there is only been 70 basis points separating the high from the low, I made a similar at the disclosure last quarter. I think what you saw on the first quarter we don’t really have much kind of the expense if you will sitting in - rolling through our gross profit margin, in other words, there are some other builders who run expense through their cost of goods sold regardless, what closings are rolling through. Most of our expense is directly buy into the closing. So I don’t know that you get as much of a seasonal bump for us as you referred to. So for us when we look at 20 basis point sequentially or 10 basis point year-over-year. It's really a non-event and really the name of the game for us is stable, first breath of marking.

[Truman Patterson:]

Okay, thanks and then just quickly the follow-up on the gross margin, the inventory impairment. I believe that you said it, it was in [indiscernible] that I might have miss heard, what vintage land was that?

[Robert Martin:]

It was two assets actually there, smaller impairment was an asset in south Florida and the other asset was in our southern California market. And those assets - I don’t know if I know the exact year, but I think the Florida one was probably right around 2012, the California one was probably right around 2013. So it’s a couple of years old and of course in a shorter land supply builder we are always find land somewhat real time.

[Truman Patterson:]

Okay, okay. I’ll hop back in queue. I don’t want to take up too many questions.

[Robert Martin:]

Thank you.

[Operator:]

The next question comes from the line of John Lovallo with Bank of America. John your line is open.

[John Lovallo:]

Hey guys, thanks for taking my call. The first question I guess on community count, I know that you had indicated last quarter that you expected it to be down slightly year-over-year in the first half of 2017, and if I heard you correctly, it may be down a little bit in the second quarter than you previously thought. But can you give us any thoughts on the back half of the year and how we should be thinking kind of an exit rate?

[Robert Martin:]

I mean it's tough to predict what is going to happen in the second half of the year, so we always cautious about that what we stay on it, but given where we have talked about being for the first half of the year, I think it's reasonable for us to have a goal to get back to where we were at the start of the year by the end of the year. So that’s where we are focused on, certainly if we see as we did in the first quarter increased absorption rates, i.e. we can still do more with less and that was the case in the first quarter. And that’s really what is most important to us is that the efficiency of the subdivision that we do have.

[John Lovallo:]

Okay, got it, it’s helpful. And then I guess the second question would be on order ASP, it looks like it was down a little bit sequentially and year-over-year. Just curious how much of that maybe is attributable to mix in the Seasons brand.

[Robert Martin:]

Yes I think given that 8% of our orders were attributable to Seasons. I believe that was up 300 basis points sequentially and 600 basis points year-over-year. So that there certainly was an impact. I don't know if I have the exact number, but I think it could have been as much as to $10,000 kind a difference between the two. If it didn't have Seasons equation.

[John Lovallo:]

Okay. that’s perfect, thanks a lot.

[Robert Martin:]

Sure.

[Operator:]

Your next question comes from the line of Nishu Sood with Deutsche Bank. Nishu, your line is open.

[Unidentified Analyst:]

Hi this is [Tim Bailey] (Ph) on for Nishu, so Bob I just wanted to quickly touch on the absorption. So very solid first quarter, 8% annual growth, but then your commentary about how more communities are mature and will be closing soon than those will be opening up. obviously more mature communities tend to have a better absorption pace . but, if there is any risk as you kind a trade new community for old community that there could be a sequential decline in absorption pace in 2Q, because I know just the comp gets pretty tough in the second and third quarter of this year.

[Robert Martin:]

I mean there is always a risk. I think we like the position that we are in right now simply because we do have new product that we have put on online and we have got a focus on that new product that needs to be performing well. So that works in our favor, but it's really hard for us to predict exactly what happens in the second quarter or any period of time not with regard to orders.

[Unidentified Analyst:]

Alright that's helpful. And then I guess the follow up on that, what were the April absorptions year-over-year comparison.

[Robert Martin:]

Absorptions, absorptions were flat year-over-year.

[Unidentified Analyst:]

Alright thank you. And then my second question just quickly around I guess land investment that was made in the quarter. So typically you are around a little bit above to two times two year zone. As you move into the later into the cycle, last cycle you have got down about 1.5 year zone is that something that you are shooting for kind of work that lands to buy down to or are you comfortable with the two year range through this cycle. Thank you.

[Robert Martin:]

One and a half that sounds pretty low figure, but we talked about two to three years supply of land so 2.8 is well within that range and something we are very comfortable with.

[Unidentified Analyst:]

Alright great. thank you.

[Robert Martin:]

Sure. Thanks.

[Operator:]

Your next question comes from the line of Thomas Maguire with Zelman & Associates. Thomas, your line is open.

[Thomas Maguire:]

Hey guys good afternoon and nice job on continued improvement in returns. I just had a quick one the tax rate was higher than expected this quarter and we know part of that you guys called out was evaluation allowance being created against some state NOLs, so one-time in nature there. But any sense for what the run-rate will be going forward, I know we have uncertainty around energy tax credits, but I believe you guys stopped the benefits from the manufacturing deduction. So just kind a what is the right way to think about it over the near-term here or are how you guys thinking about it.

[Robert Martin:]

I think the impact of the state NOLs was roughly 420 basis points somewhere right in there. And the impact of the lack of inner peak credit was about 85 basis points, reflect that we have got 500 basis points worth of downward pressure there, increasing at from what was 30% to at over 38%. So I think you would expect that delta to come out to some degree for the state NOLs. We are still of course not going to have - remains to be seem what happens with the energy credit unless the Federal government does something about that we are not going to see that benefit come back online for us.

[Thomas Maguire:]

Got it and then just one more on the SG&A side on the corporate expense. Those up what we expected sequentially and up slightly year-over-year, just any thoughts on the right way to think that going forward. I know there has been some noise with the stock and expense, but anything that should roll off going forward or just kind of a good run rate to support the growth plan in place now for the rest of the year just on the corporate side? Thanks.

[Robert Martin:]

I think we had a couple of things that happened during the first quarter. First, of all the increases that we did the annual increases in salaries from across in part in the first quarter, so you have got some of that rolling through there, we also had a contribution to our foundation that will through that number as well. I think what you stall in the first quarter that is probably and as good to run rate as any going forward that you could look at right now. There is risk to that obviously, to the extent that we have to change accruals. You can see that number increase or decrease. And we also have, you mentioned the stock option expense, we do have something called performance share unit and the way we expense those. Without being too technical and just really a quarter-by-quarter assessment as to where you are at and the probability of those actually vesting. And that can cause the volatility in the number as well, but I can't peg it to a number that really depends on where we are at the end of each quarter.

[Thomas Maguire:]

Got it. Thanks guys.

[Operator:]

Your next question comes from the line of Alex Barron with Housing Research Center. Alex your line is open.

[Alex Barron:]

Hey guys good job in the quarter. I wanted to talk about the Seasons product so if you can comment on how your build time differ versus your traditional product let's say in a market line Denver, how much shorter is the build time? I know you guys have shifted more towards built-to-order as oppose to spec building, but does the Seasons brand lend itself through more like spec building or are you guys still doing entry levels? And also what is the differential in margin roughly between the Seasons versus a traditional product?

[Robert Martin:]

Yes that’s a lot of questions, I’ll try to make sure I get them all. First of all, we are not really tweaking our built-to-order policy for Seasons in fact. We think it’s one of this distinguishing characteristics in our first time product versus some of our competition is the fact that we do to allow a customization to degree in our Seasons products. So we think that's something that's special and that’s something that we are going to continue to have. So first one, in terms of gross profit margin, I think we are seeing roughly the same gross profit margins on Seasons versus other products, it kind a depends where it is in cases where you are building it where previously you built larger products that might be different, because the lots weren't actually purchased for the Seasons, but the advantage to get is increased velocity. So there is that factor. As far as the cycle times go, it is significantly better as you might expect especially in Colorado. in Colorado you typically build the basement but for Seasons you don't build the basement. So looking at in order of magnitude, you are talking about 30% lower cycle times for Seasons versus for traditional products in Colorado. In other market it's not quite as dramatic of an improvement, but Colorado is one of the bigger places where we felt that thus far.

[Alex Barron:]

Yes. And in terms of the communities or percentage of communities right now, what percentage is Seasons versus compared to the total company?

[Robert Martin:]

Of the 160 that we had at end of the quarter roughly 6% was Seasons.

[Alex Barron:]

Got it. Okay, thanks a lot best of luck.

[Robert Martin:]

Sure thanks .

[Operator:]

[Operator Instructions]. your next question comes from the line of Andrew Berg with Post Advisory Group. Andrew, your line is open.

[Andrew Berg:]

Yes just a question regarding working capital. if you look at last quarter excluding mortgages held for sale, working capital was about $66 million, this year it look like there is actually a little bit of benefit. Is there a timing issues associated with the working capital and how should we think about that as we get into 2Q.

[Robert Martin:]

Yes, I think we don't always think about working capital the same way other companies might think about it. Really our capital and cash flow surrounds inventory levels, we did purchase a little bit more inventory at this quarter than we did year ago back - quite a bit more this quarter than a year ago. And we would expect if business remains strong and we continue to increase our inventories, so that we can make possible growth top-line for our company in the future. So that's really what is going to hinge on our capital concern is the inventories.

[Andrew Berg:]

So you think it's safe to say 2Q looks like 1Q which we see something continue to run about $130 million a quarter for [indiscernible].

[Robert Martin:]

It's really not, it's hard to predict exactly when the timing of the cash flows occur, because we have delays in developments or you have delays even if we are not doing the development, we may see that one of our sellers is delayed in delivering lots, because they haven't been able to do the development as quickly as they would like to. So it's really a timing game, but we see the trajectory overall of investment in inventory going up and unless we see a potential change in the market.

[Andrew Berg:]

Okay. Thank you.

[Robert Martin:]

Thank you.

[Operator:]

This concludes our question and answer session. I would now like to turn the call back over to Mr. Martin for closing remarks.

[Robert Martin:]

Great, thank you very much to everyone for being on the call. And we look forward to having you again on our second quarter earnings conference call.

[Operator:]

This concludes our meeting, and you may now disconnect.