M.D.C. Holdings, Inc.
Q2 2015 Earnings Call Transcript

Published: 4 Aug 2015

[Operator:]

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

[Kevin McCarty:]

Thank you. Good morning, ladies and gentlemen, and welcome to M.D.C. Holdings 2015 second 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 and which time we will 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, certain statements made during this conference call, including those related to MDC’s business, financial condition, results of operation, 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 second quarter 2015 Form 10-Q, which is scheduled to be filed with the SEC today. It should also be noted that the 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 with our webcast slides. And now, I will turn the call over to Mr. Mizel for his opening remarks. Larry?

[Larry Mizel:]

We were pleased to announce 2015 second quarter net income of $20 million or $0.41 per share. The quarter was highlighted by a rebound in our gross profit margin percentages, which improved by 120 basis points from the 2015 first quarter. The improvement is almost entirely the result of our effort to reduce spec inventory which has been a key focus for us over the prior few quarters. As a result of this effort, we are now seeing a higher percentage of our total deliveries coming from dirt sales. In addition, we have seen sequential improvement in the margin on the specs we did deliver. Microeconomic environment continues to provide support for the homebuilding industry during the second quarter. For the most part, information on key indicator such as employment levels and consumer confidence remain positive. Additionally interest rates remain low during the quarter. It does not appear to be much pressure to raise rate significantly in the near-term because of the impact of global economic concerns and other factors remain unclear. Again this backdrop, we have seen stable demand as our second quarter absorption rate for new home sales was unchanged from a year ago. We were please to see the steady pace of sales especially considering that we have reduced the availability of spec inventory per sub division by almost 40% year-over-year and have increased prices in most of our sub-division since start of the year. Both of these actions should provide support of our gross profit margins in the future periods, which continue to be a priority for us. Our backlog at the end of the quarter had a sales value of $1.1 billion, up 48% year-over-year, the highest we have seen since 2007. Given our recent focus on dirt sales, our backlog is converting more slowing than last year. Because of this, we anticipate that our closings for the balance of the year maybe weighed more heavily towards the fourth quarter closings than normal. Our active community count decline modestly during the second quarter driven by delays in the opening of new communities in some markets. However, we expect to see our community counts grow in the second half of 2015. Furthermore, we have seen strong deal flow in most of our markets, which has the potential to add to the more than 14,500 lots we had under our control at the end of the quarter. With one of the strongest balance sheets in the industry and liquidity exceeding $840 million, we remain well positioned to consider these opportunities in support of our future growth. Thank you for your interest and attention, I will now turn the call over to Bob Martin for more specific financial highlights of our 2015 second quarter. Bob?

[Bob Martin:]

Thank you Larry. We delivered 1,126 new homes during the quarter, down 3% versus 1,158 in the prior year. Our second quarter backlog conversion rate came in at 51% which was in line with the information we provided last quarter. However, it was down significantly from 71% a year ago. The lower conversion rate was largely the result of our previously announced initiative to reduce our overall investment in spec inventory. With our reduced spec supply, the number of specs we sold and closed during the quarter decreased by 37% year-over-year and overall specs accounted for only 50% of deliveries compared to 67% in the 2014 second quarter. We have also seen some delays in our construction process due to limited subcontractor availability in various markets and rather than normal conditions in Colorado which is our largest market. Looking forward we expect our third quarter backlog conversion rate to decrease sequentially to the mid to high 40% range before rebounding in Q4, consistent with our typical seasonal trend. The expected third quarter conversion rate is moderately below our long-term historical average as we continue to transition our focus back to a higher proportion of dirt sales. Our average price increased by 10% or $38,000 per home to $410,000, primarily the result of a mixshift to higher priced submarkets, but also due to our efforts to increase prices since the start of the year. Year-over-year most of our divisions experienced increases in average home price. Some of the larger price increases include Florida at 45% and Nevada at 17% largely due to higher price products or submarkets. On the other hand we saw a 16% increase in Colorado that we attribute more to price increases with some impact from mix. The increase in average price more than offset our decline in closings. And as a result our second quarter home sale revenues were up 7% year-over-year to $462 million. Our gross margin from home sales excluding impairments was 16.6% which was 70 basis points lower than the 2014 second quarter but 110 basis points higher than the 2015 first quarter. The year-over-year decline in gross margin was largely the result of increased land and construction cost which was partially offset by a decrease in our interest and cost of sales as a percentage of home sales revenue. The sequential increase in our gross margin was primarily driven by the reduced percentage of our deliveries coming from spec homes which typically have a higher incentive than dirt sales combined with the decline in incentives on the spec homes we did deliver during the quarter. Our estimated gross margin in backlog at the end of the second quarter again moved slightly higher on a sequentially basis. We are encouraged by the continued improvement and will continue to work on striking an appropriate balance between maintaining sales velocities and increasing prices for the balance of the year. The impact of the sequential increase in backlog margin on Q3 closings will depend on among other things the mix of units that pulled through and the impact of specs that sell and close during the quarter. On the SG&A and operating leverage front, our home building SG&A expense rate experienced 30 basis points increase driven partly by $2.5 million in higher net legal expenses at the second quarter of 2014 benefitted from a sizeable settlement. We also saw an increase in marketing costs, driven partly by higher costs associated with our models. As observed in home sales revenues our sales commissions remained consistent both year-over-year and sequentially at 3.3%. Our net new orders for the quarter were up a modest 4% over the prior year, which represented our fifth consecutive quarter of year-over-year order growth and our high second quarter order levels since 2007. The growth was driven mostly by an increase in our average active community count which increased 3% year-over-year. Our monthly absorption rate of 3.0 was virtually unchanged from the prior year period which we believe shows evidence of continued solid demand given that we increased prices in 79% of active communities in the first quarter and 64% of active communities in the second quarter. Because of our reduced supply specs only about 25% of gross orders came from specs for Q2 compared to 46% a year ago. The dollar value of our orders increased 16% year-over-year to $630 million. The increase in dollar value is the result of an 11% increase in our average order price $425,000 due to the price increases I mentioned in most of our active subdivisions during the first half for the year, coupled with a shift in the mix of net new orders to higher price communities. From a regional perspective, we experienced the most strength in our Nevada, California and Colorado operations with monthly sales absorption rates of 4.6, 4.4 and 3.2 respectively for the quarter. These also were the divisions that showed some of our largest average price movement with increases of 17%, 18% and 10% respectively. As a result of the higher quarterly order activity we have achieved over the last year, our homes in backlog to end the second quarter, were up 36% year-over-year on a unit basis to 2558 homes with a value of over $1.1 billion which was up 48% year-over-year. With respect to our stack inventory, after reducing our supply significantly during the first quarter, our overall spec level was stable in the second quarter at 4.4 units per active subdivisions. The number of finished specs per active subdivision however continued to decrease in the second quarter. Our total specs were down 456 units, year-over-year or 40% to 688 units. And as I mentioned earlier, we believe that our lower supply of specs is positively influencing our gross profit margins. Our ending active community count was at 156, down slightly year-over-year. You can see from the chart we’ve included on the left that this number has been up and down over the last five quarters. On the chart to the right, note that are soon to be active subdivisions now exceeds our soon to be inactive subdivisions by 17; a big jump from the end of the first quarter and an indicator that we may see growth in our active community count as early as the third quarter. And while new community openings and project close outs can be somewhat unpredictable. We still expect to see our year-end community count up compared to the count at the end of 2014. During the quarter we acquired 719 lots and spend approximately $134 million total on land and development cost. At the end of the quarter, we owned or controlled 14,670 lots which represented about a 3.4 years supply on a trailing 12 month delivery basis. We believe this land supply gives us the potential for continued growth as we look forward to 2016. However land acquisition remains a priority for us as we work through the third quarter. We continue to see a good pipeline of deals coming in for review and we’re carefully evaluating each one for the appropriate balance between risk and return. 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 Will Randall from Citigroup. Your line is open.

[Will Randall:]

Hi guys and thanks for taking my questions and congrats both on the promotion.

[Larry Mizel:]

Thank you I appreciate that.

[Will Randall:]

Larry, I guess that the recent Ryland and Standard Pacific merger in news, seemingly reducing negative stigma, these five investors are associated with large public-to-public builder M&A, what are your thoughts around the benefits and risks associated with large public-to-public builder M&A? And secondly given a lot of mid-cap regional builders have high sub market overlap and founder ownership, what’s kind of your forecast going forward for future M&A?

[Larry Mizel:]

We over the past 40 years have only done a very few M&A. Basically were in the business of acquiring assets, not legacy liabilities. And the mergers, I think are good. The stronger the industry is better the discipline of that company’s exim [indiscernible] since this has become a more sophisticated business and you need to have access to the capital markets and the larger companies continue to have more efficient access through better pricing and less restrictive covenants. So I was glad to see the transaction take place, sure they will be a highly successful and throughout the period of time that we’ve been in the business, we’ve seen most of these trends actions go kind of few gestation. They take a little period of time, of usually a year or two to kind of get it all sorted out. And I think it's good. Our direction is consistent as it always is, as we look for the opportunity to acquire quality land at a competitive price. That's the direction we will continue to follow.

[Will Randall:]

Thanks for that and just as a follow-up, is there any chance you guys could provide some color around of some of the other builders, your July 2015 orders have been flat up single-digit rate and how much improvement you are seeing in gross margin in your backlog versus what you have seen in last quarter?

[Larry Mizel:]

We think that we’re in a positive environment. You can see from our published, our recently released information that there is a solid tone in the market and as I look at the other builders, there is always a trade-off between absorptions and pricing and sometimes builders get a little ahead of themselves that they have sell homes that they can’t deliver for a year or more and we think it's important to manage the process because of the way, cost removing, that it's best not to go long in sales. And so we’re being very careful, and I expect that to continue with other builders also. And the pace on the street is kind of like the GDP in our country. It's a strong but steady and from time-to-time has some market fluctuations.

[Operator:]

Your next question comes from the line Alan Ratner from Zelman & Associates. Your line is open.

[Alan Ratner:]

Larry just on that similar topic on not looking to extend the backlog too much, I think the mid 40% guidance you gave for the third quarter, that would be the lowest conversion rate you’ve seen in the pace was since last peak. And we’ve heard from one of your competitors this morning that they are actually having to accommodate, or maybe even incentivize is the better word, buyers in their backlog to kind of keep them in their backlog because their delivery dates have been pushed out. So, was curious is that something that you’re experiencing as well. If so how do you expect that to impact on the margin over the next two quarters? And you maybe give a few details on what exactly you are doing to prevent backlog from becoming too extended? Are you limiting your lot releases or you are raising prices more aggressively, any color there would be helpful?

[Larry Mizel:]

I would say that people that buy their homes have a compelling value and they've been not looking to the conversion factor. We’ve had some rain in some parts of the country and so we’ve had some slowdowns caused by weather and of course it affects both sales and construction and we’re dealing with it. And the good thing is that we have a healthy backlog and some of the performance we expect to see in the fourth quarter versus the third quarter and maybe some more rollover; but we’re focused in moving forward and we have not had the issue of holding people into the backlog because of construction.

[Bob Martin:]

Alan, I would just add it a little bit on that, clearly as I mentioned in my comment outlined, we have been a little bit more biased on increasing price for the past quarter. I would also say in terms of lot releases that has been something that we have implemented in Colorado eliminating our lot releases to help try to let production catch backup.

[Alan Ratner:]

Second follow-up question I guess separate on the land type point comments. I think you had similar comments in recent quarters as well in the lot acquisition side. It looks like you are continuing to lag behind what you’re delivering every quarter, I think your lot counts down about 12% year-over-year. Where specifically are you seeing these deals? What type of deals are they? Are they skewed more towards entry level lots or more in the B&C locations or are you seeing more capital to the developer to return to the market which is allowing you to get more just in time option type take down. Just curious if you can give some color there, because I think the land acquisition now has really lagged behind your deliveries for several quarters now?

[Larry Mizel:]

Well one thing just going back a little bit history. Our basic guideline was two to three years, just in time as very efficient, and that’s what we’ve done through the various cycles. And what we see now is a little bit more deal flow and some of the other builders have a full balance sheet of land. Certainly see if you model, how many years of land everybody has. Some having their cups run as over as they say. And we’re only interested in what we believe are A locations. And so therefore we’re very discriminating and how we approach it. We are very-very active and we will transact when the economics are correct. And we also have a lot of discipline and as you can see we have in adequate land supply for what we need for the community at the future and that’s consistent with how we operate.

[Operator:]

Your next question comes from the line of Michael Rehaut from JP Morgan. Your line is open.

[Michael Rehaut:]

First question I had was on the specs and just wanted to make sure I heard you right, that I’ve wrote it down as you spoke through that. Specs represented 50% of closing this quarter versus 67 in the prior year; and kind of looking forward in terms of this spec contribution, is that something where you expect 2Q levels to roughly level out? And this help on the gross margin side from the reduced specs, a lot of that's more or less occurred; is that the right way to think of it?

[Bob Martin:]

Well Mike I think we talked about it a little bit on the last call as well, and indicated that Q2 is likely to come down a little bit, you might see some more coming in the back half of the year in terms of the decrease. And I think that’s still true, you’re likely to see a lower percentage of our closings in the last half of year, come from specs than you did in Q2. And you are correct, it was 50% in Q2, the percentage or spec deliveries in year ago, it was 67%.

[Michael Rehaut:]

And just also on the community count. I believe you mentioned the words used were that, 3Q may grow a little bit and you expect the year-end still be up, year-over-year. I believe last quarter you talked about 5% to 10% growth that you hope to achieve at 4Q end year-over-year. Is that still a number that we should hold by or are you maybe becoming a little more conservative, or should we think about that perhaps closure to the 5% or even a little less than that?

[Bob Martin:]

I think we’re pretty consistent with that prior disclosure Mike, by the end of 2015, we believe the number can be between 5% and 10% above where we were to start the year as you indicated. With the caveat that the number is always susceptible to be impact of delayed community openings or early close outs, update if a finicky number but we’re still holding by that guidance that we gave last quarter.

[Operator:]

Your next question comes from the line of Stephen East from Evercore ISI. Your line is open.

[Stephen East:]

Bob maybe this is directed at you. On the option side of the land you are down 12% on lots controlled year-over-year, but your options was up about 29% quarter-over-quarter by our calculation. I guess, what’s the strategy here are you, Larry mentioned that you are finding some land deals, but are you able to tie this up at the 20% type of underwriting gross margin in as you look forward for the next few quarters, we expect that options to ramp up pretty usefully?

[Bob Martin:]

The option per said, when I look at it, I don't think we’ve changed our underwriting criteria first of all. We’ve been consistent in what we’ve done I wouldn’t read too much into the option, piece of things, I think more importantly as I look at it. Yes, we’re down 12% year-over-year in terms of what's controlled. However it's stabilizing a little bit. Sequentially you are seeing the number stabilizing and you can start to nose up a little bit. So that's really what I think the story is there.

[Stephen East:]

Okay. All right that's helpful and then on your gross margin in the past you have given us on the specs, why that delta was versus your build to order; do you have that for us this quarter and maybe what it was in the second quarter of last year?

[Bob Martin:]

Yes, sure, I do. The difference between the third spec margins for closing was about 240 basis points for our Q2 of ‘15 and that is compared to a 170 basis points differential in the second quarter of 2014. And I think we gave it to you last quarter as well for Q1 of 2015 and it was 420 basis points in Q1 ‘15.

[Operator:]

Your next question comes from the line of Ken Zener from KeyBanc. Your line is open.

[Ken Zener:]

With the decline in the lot count, and Bob you said you had a best way to look at, it is stabilizing, But Larry I wonder if you could expand on -- I think you said, the forecast of land for some other builders, given your liquidity position, what is your kind of outlook? Do you think that -- you are in that range in terms of land supply that you want, but obviously if you are able to perhaps pickup some land as other peoples cups are full and they are not looking to do it. Is that as you look to the back half for the year something that you are more positive about now versus let's say three, four, five months ago in terms of perhaps land user you already ex-positions that you comfortable in. You’ve obviously increasing a lot in Nevada in the mid and like it looks like you are decreasing your community count. Do you get [indiscernible] like and because you're stabilizing and then you can perhaps improve your own lot position and importantly your cost? Thank you.

[Larry Mizel:]

I think that as we look at the markets that were in, we’re pretty in clearly identified markets of where we want to be. I believe that we have the ability and the desire to grow and we will look at the opportunities that come in on the land. And I would say that we’re absolutely open for business for the right kinds of transactions. And I’m comfortable where the market is. You probably read same thing we read, where household formations are at three times what they were five years ago. And I think that's a pretty hot deal with wage growth going and employment looking strong, kids finally being thrown out of their homes and have to go to work and get married and decide that owning apartments is not really cool, because they do not end up with anything except a rent receipt. I am optimistic; cautiously optimistic, very cautiously, I am looking at our general counsel, he is looking at me; really we’re cautious. Okay. So the point being is the basic elements in the economy are slow but steady in the growth of our economy. And I think housing is slow but steady, but we have this growth and household formations that's pretty unusual and this has continued now. I think this was the third quarter in a row that there's been this growth in household formations. And I see that as the potential in the housing market in general. And so that's kind of a longer answer to say that we are looking for good land deals and we hope to continue to acquire them on favorable basis.

[Ken Zener:]

Thank you. If I can ask one more, because your location in Colorado and your concentration there, as I look at your order pace there, you obviously brought price up nicely. Absorptions came down a little bit. Given that Denver, the gas market energy, could you comment on what you are seeing there? Are you seeing a price points that does look lower levels that your product has just shifted up dramatically or, if you could just give us a little flavor for Denver and/or Colorado?

[Larry Mizel:]

Actually Denver in the front range excluding Colorado Springs which seems to be in a different market. Business is good. Employment is growing and migration is growing. And as the dominant player in the Metropolitan Denver area, we are adjusting to the order flow and we are very aggressive in Denver market, and it happens to be good at this time. The energy fallout hasn’t been as noticeable as certainly it is in other parts of the country like Texas where we don’t build. So we have a highly diversified economy in Colorado. And this is a great place to live and we are providing part of that for the market in a way that seems to be well received.

[Operator:]

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

[Nishu Sood:]

Larry in your commentary you talked about trading-off, the builders constant trying to calibrate trading-off pricing versus absorptions. So my question for you is with the amount that you have raised prices so far this year, are you basically trading-off some absorption for pricing? And the reason I asked that is because your tone sounds like you are seeing continued steady demand. I know you mentioned it. However, but you mentioned that absorptions are kind of flat year-over-year, but I am down slightly from the first quarter, certainly less than what I think most people had expected. So was that a factor depressing your absorptions, because you do seems to be a little more focused on pricing this year so far compared to the other builders.

[Bob Martin:]

Nishu I will take that one first. I think as I said before, we have been bias towards increasing prices where appropriate versus driving the pace. So price increases have definitely had some impact in most of our markets. I would also say the decrease in our spec inventories had some impact as well. As I listen to your comment about the sequentially change, the most impactful decrease across our markets was in Colorado that was down 15% on a sequential basis for our absorption pace. And I already mentioned that weather has been an issue in this market with the rainfall totals for the first half of the year nearly double what the average is for Colorado. That rain slows our production and gives us really an incentive to slowdown our absorption pace. And we did that in two ways during the second quarter in Colorado. First the price increases, I already mentioned, and then second we also did limited lot releases as I had mentioned earlier on the call. I think it’s probably likely that we could have gotten some incremental sales in Colorado, if we'd not limited those lot releases. So hopefully that provide you a little bit of color about one of our major markets.

[Nishu Sood:]

Bob, I wanted to ask you also about the backlog conversion ratio, which you indicated would drop, I think you said to the high-40s in the third quarter as you transition away from specs and of more to a to-be-built. So would that transition happen mostly during the third quarter, so we should be returning more to a normalized turnover ratio for 4Q, which I think will be probably around 60% or is that transition going to extent into 1Q of next year?

[Bob Martin:]

First of all for third quarter, what I mentioned was mid to high 40%, so just wanted to clarify that. I think there is, as I indicated in my prepared remarks, a potential bounce back. We should bounce back from that in Q4. That’s the normal seasonal trend. It is still a little bit early at this point, so I don’t know that it will get all the way back to the level that you indicated. And if that’s the case we would see a little bit of lead through into Q1 for the benefit of that period.

[Operator:]

Your next question comes from the line of Jay McCanless from Sterne, Agee. Your line is open.

[Jay McCanless:]

First on the weather issues in Colorado; are you past most of those now devour, do you think some closings or some community openings are going to be push into ’16 and if so could you give us the numbers around that?

[Bob Martin:]

Well, we really haven’t provided guidance for the full year specifically. Actually I can't predict with the weather does going forward, but I think that’s really what we’re talking about partially, when we talk about a mid-40% to high-40% conversion rate in Q3. Part of the reason for that is not only our transition back to the dirt model, but also a function of some of the production delays we’ve seen in Colorado and that could impact to Q4 as well.

[Jay McCanless:]

And then the second question I had in terms of stock repurchase, your stock still trading just above our estimated of book value. Any more thoughts about repurchasing shares and when you judge repurchasing shares versus buying land at this point, can you walk us through the decision metrics on that?

[Larry Mizel:]

I think quite a few years ago, we announced that we had a stock buyback authorization and I think it was 4 million shares. That was many years ago?.

[Bob Martin:]

Maybe in 2006.

[Larry Mizel:]

So it’s about nine years ago and we haven’t acquired any yet. And when we do everyone will know that’s kind of where we’re going at this point.

[Operator:]

[Operator Instructions] Your next question comes from the line of Alex Barrón from Housing Research Center. Your line is open.

[Alex Barrón:]

Going back to the issue of the lower delivery guidance for third quarter; was any of that related to any kind of labor related shortages and also do you expect that’s pretty much across the border or is there any one today that’s going to be more impacted, in the lower conversion rate than other?

[Bob Martin:]

Well, I already mentioned Colorado with double the range. So that’s really the localized impact that I would call out. And naturally when you have the wetter weather it is going to push more activity into a shorter period of time, not only for us but for our competition as well. And I think that puts further pressure on our subcontractor base. So that is at play as well in Colorado. I think there is some issue of subcontractor availability in other markets, but it's not nearly as pronounced as it is in Colorado.

[Alex Barrón:]

Okay. And as far as SG&A leverage, looked to me like this quarter you did not get much, do you expect in the second half, you will see some more SG&A leverage?

[Bob Martin:]

Well, I think that the volume will help, we do expect for our closing volume to be weighted towards the back half of the year. So depending upon what you assume there, I do think that you will be helped by that additional volume. Just looking at G&A specifically, our G&A expense for the second quarter was $26.4 million. And we do expect some compensation related items to impact the third quarter, including our previously disclosed annual brand of options to our directors and option grant to senior management. Overall we think the impact to G&A could be in the $2 million to $3 million range for Q3, compared to the 2015 second quarter. So you should take note of that.

[Operator:]

There are no further questions at this time.

[Bob Martin:]

Thank you very much for being on the call today. And we look forward to having you again for our third quarter conference call.

[Operator:]

This concludes today's conference call you may now disconnect.