The New Home Company Inc.
Q2 2020 Earnings Call Transcript

Published: 1 Aug 2020

[Operator:]

Greetings, and welcome to The New Home Company Second Quarter 2020 Results Conference Call. [Operator Instructions] A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Drew Mackintosh with Mackintosh Investor Relations. Thank you, you may begin.

[Drew Mackintosh:]

Good morning. Welcome to The New Home Company's earnings conference call. Earlier today, the company released its financial results for the second quarter of 2020. Documents detailing these results are available in the Investor Relations section of the company's website at nwhm.com. Before the call begins, I would like to remind everyone that certain statements made in the course of this call, which are not historical facts, are forward-looking statements that involve risks and uncertainties. A discussion of such risks and uncertainties and other important factors that could cause actual operating results to differ materially from those in the forward-looking statements are detailed in the company's filings made with the SEC, including its most recent annual report on Form 10-K and in its quarterly reports on Form 10-Q. The company undertakes no duty to update these forward-looking statements that are made during the course of this call. Additionally, non-GAAP financial measures may be discussed on this conference call. Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP can be accessed through The New Home Company's website and in its filings with the SEC. Hosting the call today is Larry Webb, Executive Chairman, Leonard Miller, President and Chief Executive Officer and John Stephens, Chief Financial Officer. With that, I will now turn the call over to Larry.

[Larry Webb:]

As we go over our results for the second quarter of 2020, provide an update to our strategic outlook and give some additional color on our operations. The New Home Company made progress on a number of fronts in the second quarter of 2020 and proactively addressed some lingering issues that, whilst creating a significant loss in the quarter, put the company in a much better position to succeed over the long-term. Specifically, we took $39 million in impairment charges in the quarter, of which $20 million related to our Russell Ranch joint venture in Northern California and $19 million to address five underperforming wholly owned communities. With respect to Russell Ranch, we are planning to exit from the joint venture, following an extensive review of the project, weighing further investment and future returns against the tax benefits associated with leaving the project altogether. Ultimately, we believe that the future estimated returns and capital needed to move the joint venture forward do not outweigh the risk to stay in the venture with the current structure. In addition, we determined that five of our wholly owned communities required some level of impairment based on our future expectations and budgets for these communities. These communities are scattered throughout our footprint, with three in Southern California, one being a closeout, one in Northern California and another closeout community in Arizona. While the issues facing each of these projects are unique, the common theme was that these were either larger attached projects or luxury condominiums, where a combination of order activity at current pricing levels had not materialized as we had hoped or where direct construction costs were higher than original underwriting. The actions we took repositioned these assets which, we believe, will give us the flexibility to sell homes at a faster pace and generate improved financial performance. Aside from these issues, there were several very positive developments during the quarter. Following the halt in activity we experienced during the initial weeks of the pandemic. We began to see things pick up at the end of April and really start to accelerate as the quarter progressed, culminating in a 68% increase in net orders for the month of June. Our June net orders represented the highest monthly total in our company's history and contributed to a 14% year-over-year increase in unit backlog to end the quarter. We believe this pickup in demand stems from a heightened sense of urgency to own a home as a result of the pandemic; a trend we believe will continue for some time. Demand was also positively impacted by many of the drivers that were in place before the current health crisis hit, namely a very favorable mortgage rate environment, a lack of existing home supply and a demographic wave of new homebuyers, led by the millennial generation which is aging into their prime home-buying years. These tailwinds appear that they will remain in place for the foreseeable future. As the fed has indicated that they have no intention of raising rates anytime soon and the housing supply and demand issues this country faces will take years to solve. In addition to generating strong momentum on the order front, The New Home Company also made further progress improving its financial condition during the quarter. We generated our fifth consecutive quarter of positive cash flow from operations, bringing our cash on hand total to about $86 million. We ended the period with a net debt-to-capital ratio of 51.5%, a 620 basis point improvement from the second quarter of 2019. We also repurchased $5.8 million in principle of senior notes at a discount and successfully extended the maturity date of our company's bank credit facility to September 30, 2021. Improving our financial condition has been a focus of ours for several quarters. In summary, while the impairments we took in the quarter resulted in a significant loss, there were several positive developments during the period that are cause for optimism. Home sales gross margins and sales rates should improve as a result of the actions we took this quarter and the amount of capital required to fund large land development joint ventures is expected to decline significantly. Orders rebounded sharply following the initial stages of the pandemic, and we believe the drivers of this order improvement are part of a longer-term trend; not a temporary phenomenon. We also made great strides in improving our leverage ratios and maintaining our excess to capital, putting us on a much more solid financial foundation going forward. There is much more work to be done, but I am pleased with the progress we made and the strategic direction of the company. With that, I'd like to turn the call over to Leonard, who will provide more detail on our operations.

[Leonard Miller:]

I would like to echo Larry's optimism regarding the future of our industry and the outlook for The New Home Company. Starting around mid-April, we saw our order activity trough and then steadily improve; leading to June being the best sales month in our company's history at 89 net orders on an absorption pace of 3.6 homes per community. The solid order momentum has carried into July with orders up 136% year-over-year through July 28, and we have taken advantage of the improvement in demand by raising prices and scaling back incentives at select communities. While our operation has clearly benefited from the renewed sense of urgency to own a home, brought on by the pandemic and the strong underlying fundamentals for our industry, our sales success this quarter can also be attributed in part to the opening of seven new communities so far in 2020, which averaged 3.7 sales per month during the second quarter. These new communities were spread throughout our geographic footprint and should contribute nicely to our top line and margin profile over the next several quarters. One of our success stories this quarter was our Mosaic project in Arizona, which is our first medium density, more affordable community in the market, where we sold 24 homes across three product lines in the first six weeks since opening. This bodes well for operations in Arizona as we have five similar communities slated to open over the next two to three quarters. Another important factor contributing to our sales improvement was our successful migration to our enhanced virtual selling platform. During the quarter, we saw a significant shift in consumer behavior as the vast majority of our sales originated from our online sales tools, it is clear that the homebuyers are becoming increasingly comfortable shopping for a home online, which is great for our business because it allows us to more easily identify qualified, motivated buyers and convert those leads into sales. It is also a much more cost-efficient way to sell homes versus the traditional model. Despite the strong rebound in sales, we felt compelled to make additional reductions to our workforce during the quarter due to the lingering uncertainty surrounding the pandemic effects on our business and our ongoing need to improve our profitability. While these were difficult decisions to make, we realized that our current cost structure was unsustainable given our projected level of volume. Overall, we reduced our headcount by 20% since the start of the 2020 second quarter through now and by about 37% as compared to January of 2019. We continue to look for other ways to leverage our overhead and manage our costs as we strive to return to profitability. One area where we expect to pick up additional profits is through our fee building operations. During the quarter, we signed on to be a fee builder for Fivepoint at their Great park development in Irvine. Our fee business has been a steady, low market and capital risk contributor to our bottom line for years now. And the agreement with Fivepoint will allow us to grow this segment while giving us additional scale benefits in our Southern California markets. We are currently looking at other ways to potentially expand our fee building operations through similar arrangements with other large regional master plan developers, single-family rental companies and private landowners. In summary, The New Home Company made solid progress in many areas in the second quarter while continuing to shift the company's product focus to the more affordable segments of the market. Our long-term strategy of leveraging our premium brand centered around industry-leading customer experience. Quality and design remains a key differentiator for our business and we believe this emphasis will serve us well as homebuyers place a higher premium on where and how they live as a result of this pandemic. Now I'd like to turn it over to John, who will give you more detail on the numbers from the quarter.

[John Stephens:]

Thank you, Leonard, and good morning. For the 2020 second quarter, we realized a $41.2 million pretax loss compared to $2.6 million of pretax income in the year ago period. The pretax loss included $19 million in inventory impairment charges, a $20 million joint venture impairment charge and $1.1 million in severance charges. This translated to a net after-tax loss of $24.3 million or $1.32 per diluted share for the second quarter compared to net income of $1.6 million or $0.08 per diluted share in the prior year second quarter. Adjusted net loss for the quarter after excluding impairments, severance charges and a net deferred tax asset re-measurement benefit was $706,000 or $0.04 per diluted share. Our home sales revenue for the second quarter was $77.8 million compared to $140.5 million in the prior year period. Our home sales revenue exceeded our expectations we set in April at the onset of the pandemic. However, compared to the 2019 second quarter, the 45% drop was due to a 32% decrease in deliveries and a 19% decrease in average selling price to $755,000 from $930,000 a year ago. The lower delivery levels were driven by a lower beginning backlog, coupled with lower order activity and higher cancellations in the month of April, which limited the number of spec homes we were able to sell and deliver in the quarter. The decrease in our average selling price was a result of our continued pivot to more affordable product by generating approximately 50% of total home sales revenue in the Inland Empire and Sacramento regions, where the blended average selling price was $586,000. In the prior year second quarter, these two regions generated a combined 22% of our total home sales revenue. Assuming no material change in new housing demand in the near term, we estimate our 2020 third quarter home sales revenue to be between $100 million and $115 million, and our average selling price for the third quarter of approximately $725,000. Our gross margin for the 2020 second quarter was a negative 9.6%, versus 12.1% in the prior year period. The decrease in gross margin was primarily due to the previously noted $19 million of inventory impairment charges related to five communities. Excluding inventory impairment charges, the company's gross margin was 14.8% compared to 12.1% in the prior year period. The 270 basis point increase before impairments was primarily due to a $2.2 million benefit related to a profit participation true-up at two closed out communities in Southern California and, to a lesser extent, a product mix shift. The positive product mix shift was driven by a higher percentage of our total home sales revenue generated at lower-priced communities, which have higher gross margin percentages. These improvements were partially offset by a 160 basis point increase in interest included in cost of sales. Excluding interest in cost of sales and impairments, our gross margin from home sales was 20.8% as compared to 16.5% in the year ago period. For the 2020 third quarter, we estimate our gross margin to be between 12.0% and 12.5% based on the homes in backlog and homes we expect to sell and close next quarter. Our SG&A rate as a percentage of the home sales revenue for the second quarter was 17.1% versus 11.1% in the year ago period. The increase in the SG&A rate in 2020 was primarily the result of the 45% drop in home sales revenue. In addition, our 2020 second quarter G&A included approximately $900,000 in severance charges and a $700,000 reduction in G&A expenses allocated to the fee building cost of sales due to lower joint venture management fees. These items were partially offset by lower amortization of capitalized model costs and lower advertising expenses. Excluding the severance charges, our SG&A rate for the quarter was 15.9%. For the 2020 third quarter, we estimate our SG&A rate to be between 12.0% and 12.5%. We ended the quarter with 235 homes in backlog, up 14% from the 2019 second quarter. The dollar value of our backlog at the end of the second quarter was $169 million, down 16% due to a 26% decrease in our backlog ASP to $720,000 versus $974,000 a year ago, which was offset partially by the volume increase. We believe our backlog is solid with only 5% of buyers having a home to sell contingency, and the average FICO credit scores of buyers and backlog using our preferred lenders was in the 750 range. We ended the quarter with 25 active communities, which was a 25% increase compared to the prior year second quarter. For the balance of the year, we are planning to open approximately five new communities and expecting to sell-out of approximately six communities. We expect one new community to open towards the end of the third quarter and the remaining four are slated for the fourth quarter. Also, four of the five new communities are located in Phoenix. Our fee building revenue for the second quarter was nearly flat with the prior year at $21.2 million, while our fee building gross margin for the quarter was $208,000 or 1% versus $515,000 or 2.3% in the prior year. The 130 basis point reduction in the fee building gross margin was primarily related to approximately $200,000 of severance charges, including in fee building cost of sales due to a reduction in staff at our fee projects in Irvine, California due to a slowdown in production. For the 2020 third quarter, we estimate our fee building revenue to be between $10 million and $15 million. We incurred a $20 million loss from our joint ventures for the quarter compared to $185,000 of income for the prior year. The current quarter loss resulted from the $20 million impairment charge recognized in connection with our intent to exit the Russell Ranch land development joint venture in Folsom, California. Assuming we exit the joint venture this year, we anticipate a tax refund of approximately $13 million in the first half of next year. During the second quarter, we expensed $1.3 million of interest costs directly to interest expense due to lower qualified assets compared to our debt balance. For the third quarter, we estimate interest expense of approximately $1.7 million. Our effective tax rate for the second quarter was a 41% benefit compared to a 38% provision in the year ago period. The higher benefit rate for the 2020 second quarter was largely due to our ability to carry back net operating losses five years at the higher effective federal tax rate of 35% as a result of the Cares Act versus the current 21% rate, and to a lesser extent, the impact of energy tax credits. With respect to our liquidity and balance sheet, we generated $4.7 million in operating cash flow despite a 45% year-over-year drop in home sales revenue, and we ended the quarter with $86 million in cash and cash equivalents. We had no borrowings outstanding under our $60 million revolving credit facility at the end of the quarter and had $295 million in senior notes outstanding with an April 2022 maturity date. We also repurchased 817,300 shares of our common stock for $1.5 million or $1.80 per share; a price at which we believe was a tremendous value and a solid use of our capital. Lastly, we spent $7 million on land during the quarter as a result of being more cautious with the slowdown in demand at the outset of the second quarter and are focused on preserving liquidity. We remain focused on maintaining a proper balance between building liquidity, managing leverage and rebuilding our pipeline. I will now turn the call back to Larry for his concluding remarks.

[Larry Webb:]

In conclusion, The New Home Company took decisive action in the second quarter of 2020 to improve our sales efforts, streamline our cost structure and address several underperforming assets in our company. Our rapid response to the pandemic and our ability to shift to a more virtual sales model contributed to a remarkable rebound in order activity in the back half of the quarter, which continued into July. In addition, the impairments we took in both our joint venture and wholly owned segments will allow us to sell homes more quickly and redeploy capital into projects with better return profiles. We feel good about our existing projects and anticipate that the actions we took in the quarter will lead to better sales and higher margins over time. In addition, the improvements we made to our balance sheet have enhanced both our financial and operational flexibility. These positives, coupled with our continued shift to more affordable price points and our strong leadership team, give me confidence in the future of The New Home Company. Finally, I'd like to thank all of our team members for the way that they performed during the pandemic. This health crisis has upended nearly every aspect of our lives and I have been extremely impressed with their ability to stay focused on the task at hand despite all of the challenges. That concludes our prepared remarks, and now we'd be happy to take your questions.

[Operator:]

[Operator Instructions] Our first question comes from the line of Thomas Maguire with Zelman & Associates. Please proceed with your question.

[Thomas Maguire:]

Great job in the quarter and pushing things in the right direction here. Just to stick with the impairments, I know things change, and Larry, you alluded to feeling good, but where do we sit in terms of the current portfolio at the reset basis? And just how would you think about the remaining communities from the outside looking in? Is there a percentage that are maybe close or would be close to needing to be discounted to close out? Or just maybe broadly, can you talk about the risk to book if the environment softens here a little and incentives increase? And maybe even just coming at it another way, what percentage of communities are still at that higher end price point that you'd be worried about?

[Larry Webb:]

Well, Thomas, we've been looking at that really hard that -- and we felt like we've made, when I say decisive actions, we feel like we did do that, did the right thing. I'll turn it over to John for real detail. But overall, we feel very positive that we took our actions and we're not -- we don't have some big problem way into the future. But go ahead, John.

[John Stephens:]

Yes, obviously, we did a very thorough and comprehensive review of all of our projects during the quarter. I think with just the pandemic and what we saw at the outset of the quarter, we adjusted some of our assumptions in our business plan models and whatnot and some of our project pro formas. And as a result, we just thought it was the right thing to do with some of these communities that had very low margins. And in order to get through the communities at a more reasonable pace, we made the difficult decision to make these adjustments. I think we did a very thorough review. Again, I would say, with respect to higher-end communities where there is potential risk, I would say it's very limited. I think with the review we did and taking this deep stroke on these, really, three larger communities, I'd say. And then two are closed up communities. We just want to get through those two communities. So my thought is that with respect to the wholly owned business that we've -- we don't have much risk there left anymore. I think that we've made the hard decisions on some of these communities. And we feel pretty good going forward with everything that's actively selling today. And with respect to the joint venture, that's been a difficult process for us. And again, we just -- with where we're at from a capital standpoint and where we thought the future returns were on this relative to the market risk and the cost risk, we just thought it would be the best thing to move on from that joint venture going forward. And there will be a pretty significant tax benefit in connection with liquidating out of that partnership and exiting the venture. So again, we feel good about where we're at now. It was difficult to stomach those, but I feel very positive about that going forward.

[Thomas Maguire:]

Right. I think it makes sense to reset the base. And then just shifting gears, the June commentary was really encouraging in July, obviously; pretty remarkable bounce back. You guys mentioned balancing price or raising price here. Can you just talk about the magnitude of that in the thought process? Obviously, 100% plus growth is running really hot. But how do you think about the right optimization of pace here or growth? And are there any supplier delivery constraints that you're thinking about right now that make you want to slow the volume or just kind of what's the target? Or is there something we're managing to that's the right way to think about the trade off?

[Leonard Miller:]

Yes. Thomas, this is Leonard. I'll take a shot at that. I think when it comes to price versus pace, the company continues to focus on gross margins. So first and foremost, we want to capture whatever price increases we can and really work on improving our margins. Now it's community by community. And one thing that we're really focused on is with really all the strong activity, sales activity, we want to make sure that we match our sales pace to really what we can do on the construction side with our start. So we don't want to get too far out in front. What we're seeing and really anecdotally, one of the things you mentioned was cost. And I know you're aware of it, but since April, the cost of lumber is up over 30%, it's at all-time highs. And so we're making sure every time we do a release that we're not only capturing whatever that increase is. But adding to that to try to -- that incremental margin. We've increased prices over 60% of our communities and kind of recent increases there. One thing that we're hearing throughout the market is both labor and kind of supplier shortages, whether it's appliances, HVAC, we're hearing some of the -- our subcontractors being impacted by COVID-19 and getting people back to work. We haven't been impacted today, but I know when I talk to our peer group, certainly, you're starting to hear about it over the last two to three weeks.

[Operator:]

[Operator Instructions] Our next question comes from the line of [indiscernible]. Please proceed with your question.

[Unidentified Analyst:]

I hope you can hear me okay. And I hope you're all safe through everything that's going on. I wanted to ask about the community that you opened in Phoenix that I think you said had 20-something sales and three different, I guess, offerings. So is that considered one community and five that you have slated to open, are they of a similar nature, or are they just a single product type communities?

[Larry Webb:]

Well, let me go first, Alex. And you of all people, as the -- as an analyst who sees more communities than any human, right, know that it has taken us a while to get our footing in Arizona. And our initial forays were primarily in second, move-up and empty nester attached housing. But we feel as if these Mosaic communities, and there are three different product lines. It is really the beginning of us getting a strong foundation. And with the five new communities that are coming on that are different housing programs but have a lot of similarities in that they are higher density detached or maybe medium density attached housing programs and will be priced, I guess, below $400,000 that we're just beginning to finally hit our stride in Arizona. And I'll turn it over to Leonard for more color, but we really feel confident that our future in Arizona is extremely positive and extremely bright.

[Leonard Miller:]

Yes. Larry hit most of it, I would say, just to be really clear, so we counted as three communities. It's a mini master plan. So it's got an amenity. And one thing we believe with New Home when we look forward in the way that we want to compete, we think that's a real opportunity for us. I think one of the things that the company does really well is place-making and our focus on quality and design. So looking forward on those five new communities, we have another one slated to open in Chandler. And that would be similar, where it would be three different product segments, a mini master plan. We expect that to come online early in the fourth quarter. And then we have two stand-alone communities that are slated to open in master plants in the Phoenix area.

[Unidentified Analyst:]

Yes, it sounds really positive and like a really good move, especially for these times. I was curious about the impairments and the severance charge. I guess, two separate questions. John, is the severance charge included in your G&A? Sorry –

[John Stephens:]

Yes, about 9 –

[Unidentified Analyst:]

Going forward?

[John Stephens:]

About $900,000 is included in our G&A, and there's another couple of hundred thousand dollars that's included in our fee building cost of sales because it related to that personnel who works on those key projects in Irvine.

[Unidentified Analyst:]

Okay. And I guess my question was related to these impairments and the hard decisions that you guys made. Were those decisions made basically early on in the quarter when things were really slow in April? And do you think it would have had a different outcome if you guys had waited to see how June played out?

[John Stephens:]

No. They were -- typically, the impairment process is done in connection with the quarterly close. And when we sort of update all of our budgets and incentive budgets, cost budgets, things like that, pace -- And we made it kind of in connection with the close. So it wasn't made necessarily in April. But I think with where we're at with a few of these communities, we thought this definitely was the right thing to do. And then going forward, our margins should improve. We'll see that through the balance of this year. And I think we'll see it more as we head into 2021 and deliver more of those homes.

[Unidentified Analyst:]

Okay. And if I could just ask one more. I mean, I guess where I'm having trouble with the SG&A is, you said about $900,000. In the first quarter your G&A was about $6 million, and you said you laid off 20% of the people. So I'm just trying to kind of guesstimate a run rate for G&A going forward or [indiscernible].

[John Stephens:]

Really what the difference there is, you're saying, well, why didn't it go down more? But really, it has to do with the amount of G&A costs that were allocated to the fee business a year ago versus this year. So we allocated last year about $700,000 more to our fee business because we had a lot more activity with the joint ventures and the management fees we were earning. This year with the falloff in management fees from the joint ventures and the joint venture business really falling down, or pulling back significantly with the unwind of many of these joint ventures, we were not -- we did not allocate as much of our G&A cost. So it's about a $700,000 difference year-over-year. So if you factor that in, you will see our G&A decrease year-over-year.

[Operator:]

There are no other questions in the queue. I'd like to hand the call back to Mr. Webb for closing remarks.

[Larry Webb:]

So in conclusion, I would just like everyone on the call to understand that we have gotten through the initial stages of the pandemic. We took very decisive action in both staffing and on impairments. We have seen extremely positive results in June and July in our sales, and we believe we've reset the table for the company to grow and move forward. I am very enthusiastic about our opportunities and I believe that we are absolutely headed in the right direction under Leonard and John's leadership. And with that, I'll thank all of you.

[Operator:]

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.