The New Home Company Inc.
Q2 2019 Earnings Call Transcript

Published: 31 Jul 2019

[Operator:]

Greetings. Welcome to the New Home Group Company Second Quarter 2019 Results Conference Call. [Operator Instructions].Please note, this conference is being recorded. I will now turn the conference over to your host, Drew 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 2019. 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 in its most recent annual report on Form 10-K and in its quarterly report 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 The New Home Company's website and in its filings with the SEC. Hosting the call today is Larry Webb, Chief Executive Officer; Leonard Miller, President and Chief Operating Officer; and John Stephens, Chief Financial Officer.With that, I will now turn the call over to Larry.

[Lawrence Webb:]

Thanks, Drew, and good morning to everyone joining us on the call today. I'd like to start out by giving some high-level commentary about the housing market. Leonard will then give some additional color about current events in each of our markets, and John will provide more detail on the numbers.The New Home Company delivered solid results in the second quarter of 2019, generating net income of $1.6 million or $0.08 per diluted share. Our operating teams did an excellent job with executing in the quarter as we met or exceeded our previously stated guidance for revenues, margins and JV income. Order activity accelerated from the first quarter of 2019, resulting in a 41% increase to our sales pace on a sequential basis. We also improved our leverage ratios in the quarter by repurchasing $7 million of our senior notes and paying down our revolving credit facility by $18 million.These highlights represent significant progress for our company in our efforts to strengthen our balance sheet and transition our product mix to the more affordable segments of the market. We remain optimistic about the future of our markets as we head into the second half of 2019. California and Arizona continue to be solid markets to be a builder, though these markets have definitely shifted as new home buyers are increasingly looking for more affordable in response to the recent run-up in home prices.This trend was evident in our results this quarter as sales from our communities with average selling prices below $675,000 had an absorption pace of 2.9 homes per community and comprise 60% of our total net new home orders. We identified this change in market dynamics several years ago and have been aggressively repositioning our company ever since to bring more affordable product to market. Our company's profile is much different than it was just one year ago, and it will continue to evolve as we bring more affordable communities online over the next 12 to 18 months. These communities will have the same distinct New Home company look and feel as our higher-end projects, but at a much more reasonable price point. We have the relationships, experience and expertise to be successful at these price points. And the success we've had in a number of affordable communities we've opened so far is a testament to that.We are optimistic that this transition will result in a more diversified, stable and profitable business profile for our company.With that, I'd like to turn the call over to Leonard, who will provide more color on each of our markets.

[Leonard Miller:]

Thanks, Larry, and good morning to everyone on the call. In general, we were pleased with how the second quarter played out, with order activity accelerating from earlier in the year and also improving as the quarter progressed. Net new orders for 2019 second quarter were down 21% as compared to the prior year but were up 38% sequentially from the first quarter. Our monthly sales absorption rate for the second quarter was 2.4 per community compared to 3.2 per community in the prior year but was up 41% sequentially from the first quarter.As Larry mentioned, we experienced better demand trends at our more affordable projects in the quarter. In California, New Home sales in the coastal markets continue to lag the inland parts of the state as buyers are increasingly looking for value with their home purchase. In Southern California, we have seen migration of demand from higher-cost areas like Irvine in the Inland Empire, where our newly opened Parson project generated a sales pace of 5.7 homes per month in a quarter at margins well above the company average. This success bodes well for our future in the market as we plan to open six new communities in the Inland Empire over the next one to two years, with prices starting below FHA loan limits. While we continue to have a presence in markets closer to the coast in Southern California, we no longer have any wholly-owned active projects in the Irvine market.The market dynamics in Northern California were similar to those in the southern parts of the state as the lack of demand in the Bay Area has prompted several builders to use incentives and, in some cases, cut prices to find the market. While the local economy continues to produce great high-paying jobs in the area, more buyers are choosing value over location when it comes to their new home preferences. Fortunately, we have one community in the Bay Area that is actively selling, and we've sold 3/4 of that project to date, and we are slated to open two more affordably priced communities in Vacaville later this year.Demand trends in Sacramento were healthy in the quarter, continuing the sales stability we experienced earlier in the year. Incentives have remained in check as the market never really experienced a downturn that would require a more aggressive prices. Given the stability we've seen over the last several quarters, we are optimistic about our future in this market. We have two communities opened in Arizona, and similar to other markets, our more traditional Belmont communities bears much better than our luxury condominium ICON project in the quarter.Our presence in Arizona will scale dramatically over the next 12 to 18 months as we have eight new communities scheduled to open, all at prices between $275,000 and $425,000.Now, I'd like to turn it over to John for more detail on our financial results this quarter.

[John Stephens:]

Thank you, Leonard, and good morning. Our pre-tax income for the second quarter was $2.6 million versus $182,000 a year ago. While our net income was $1.6 million or $0.08 per diluted share compared to $115,000 or $0.01 per diluted share in the prior year. The year-over-year increase in net income was primarily driven by a 20% increase in home sales revenue, a 200-basis-point increase in our SG&A expense ratio, a $300,000 increase in joint venture income and a $550,000 gain on the early extinguishment of debt. These improvements were partially offset by a 50 basis point decrease in our home sales gross margin resulting from our focused on sales pace and cash flow generation and, to a lesser extent, a decrease in our fee building revenue and fee margin.Home sales revenue for the second quarter was $140 million as compared to $117 million in the prior year and was up 8% over the top end of our guidance. The year-over-year increase was largely driven by a 56% increase in deliveries, which was partially offset by a 23% lower average selling price that came in at $930,000 per delivery for the quarter. The lower ASP versus our guidance was due to accelerating deliveries from lower-priced communities into the second quarter. We expect a dip in the third quarter home sales revenue due to a pull-forward of spec deliveries into the second quarter and a smaller population of specs available for delivery in the third quarter.As a result, we are currently estimating third quarter home sales revenue of between $100 million and $120 million. And for the full year 2019, we are estimating between $480 million and $510 million in home sales revenue. We estimate that our average selling price for the third quarter and full year 2019 to be between $900,000 and $950,000. Our backlog conversion rate for the quarter was 74% as compared to 46% in the prior-year period as a result of our concerted effort to move down price point and our success of converting spec homes into revenues more quickly.As a result of the higher 2019 second quarter backlog conversion rate, coupled with a slower year-over-year sales absorption rate, the number of homes in our backlog at the end of the second quarter was down 33% from the prior year, and we ended the quarter with a backlog dollar value of $202 million. In addition, with our focus on more affordable product segments that tend to turn quicker as well as our focus on generating cash flow through selling specs, we expect to have a higher backlog conversion rate in both the 2019 third and fourth quarters as compared to our historical averages.Our gross margin for the 2019 second quarter was 12.1% versus 12.6% in the prior-year period. The 50-basis-point decrease in gross margin was primarily related to higher interest costs and incentives, partially offset by a product mix shift. Excluding interest in cost sales, our gross margin from home sales for the 2019 second quarter was up 70 basis points to 16.5% as compared to 15.8% in the year-ago period.For the third quarter and full year 2019, we are projecting home sales gross margins, including interest, of between 12.0% and 12.5%. Our SG&A rate as a percentage of home sales revenue for the second quarter was 11.1% versus 13.1% in the prior year. The 200-basis-point decrease in SG&A rate was primarily due to better leverage from higher home sales revenue, reduced marketing and advertising spend and, to a lesser extent, lower personnel expenses related to rightsizing our business. These decreases were partially offset by higher amortization of capitalized selling and marketing costs.For the 2019 third quarter, we expect our SG&A rate to be in the mid-12% range, and for the full year 2019, to be in the high 11% range, excluding Q1 severance charges. Our share of joint venture activity for the 2019 second quarter resulted in pre-tax income of $185,000 as compared to a $120,000 pre-tax loss in the prior-year period. The JV income for the quarter was driven largely by our Mountain Shadows venture in the Phoenix market. For the 2019 third quarter, we are projecting about a breakeven from our joint ventures and approximately $500,000 of income for the full year. Our fee building revenue for the second quarter was $22 million as compared to $38 million in the year-ago period. Our fee building gross margin for the 2019 second quarter was $515,000 or 2.3% versus $1.1 million or 2.8% in the prior year. The lower fee revenue and margin for the quarter was due to less construction activity at our Irvine fee communities, resulting from lower demand in this submarket.For the third quarter, we are estimating fee building revenue of between $10 million and $15 million, and between $65 million and $75 million for the full year. Our effective tax rate, including discrete items, for the second quarter was 38.7% compared to 36.8% in the year-ago period. The increase was due to discrete items related to stock-based compensation expense and deduction limitations for certain severance payments. We estimate an effective income tax rate, including discrete items, of 38% for the third quarter and 44% for the full year.We ended the 2019 second quarter with 20 active communities even with the 2018 second quarter. Our ending community count was slightly below our prior-quarter guidance due to our decision to not pre-sell two new communities in Northern California. We expect our third quarter end community count to be flat with the second quarter and an increase to 22 by year end. We ended the quarter with $48 million in cash, $542 million in real estate inventories and $375 million in debt. We spent $21 million on land during the second quarter and are targeting between $90 million to $100 million in land spend for the full year 2019.We also are anticipating approximately $40 million in land sales for 2019, which are currently scheduled to close by the end of the third quarter. In addition, we repurchased approximately $7 million in principal amount of our 7.25% senior notes due 2022. We ended the quarter with a net debt to capital ratio of 57.7%, a 240-basis-point sequential improvement from the 2019 first quarter, and we expect our 2019 third quarter net leverage to decline further, with a goal of being in a low to mid-50% net leverage range by the end of the year.I'll now turn the call back to Larry for his concluding remarks.

[Lawrence Webb:]

Thanks, John. In conclusion, I'm pleased with the progress we made in the second quarter. We met or exceeded our stated guidance for several key metrics, strengthened our balance sheet and made further strides towards repositioning our company to address the ongoing affordability trends in our markets. We've seen great results at many of our recently opened affordably priced communities, and we have confidence that we can achieve similar success with our comparable projects that are currently in the pipeline.Finally, as most of you know, we recently announced some changes to our leadership structure here at The New Home Company. I will transition from my position as CEO into an Executive Chairman role, effective August 30, and Leonard will succeed me as CEO. This has been something we have planned for many months, and I believe, it is the right time in our company's evolution to make this change. As Executive Chairman, I will maintain an active role in the strategic management of the company and in our interaction with the investment community.I also remain heavily invested in the future success of the company and actually increased my equity ownership in the company last quarter. It has been my sincere honor to lead The New Home Company from its inception 10 years ago to where we are today. Over that span, we have established our company as an innovator in new home design, a builder of choice for our trade partners, a market leader in customer satisfaction and an organization that values its people. I have the utmost confidence in Leonard, John and the rest of the leadership team to carry forward this legacy and take our company to the next level.That concludes our prepared remarks, and now we'll be happy to take your questions.

[Operator:]

[Operator Instructions]. Our first question is from Ivy Zelman with Zelman & Associates.

[Ivy Zelman:]

I don't even know what to say to Larry's announcement other than a legend moving to a new role. Congrats on that decision and glad that you're going to be part of the journey for New Home going forward, but excited to chat with you about that. Larry, you're the first private builder I ever met in the market when you were private back in the day.In any case, digging into some questions for you guys. We're excited to see the improvement in the cash flow generation and continuing to delever. We also like to push into entry levels. The first question is really, what percent of your company can you see in the future really being more focused on entry level? I'll give you the easy one first.

[Lawrence Webb:]

Well, Ivy, first of all, I should -- I was going to interrupt you, but I know no one is allowed to interrupt Ivy Zelman, right? If I could just say thank you for all you've done for not just me, but for, really, the industry. We've known each other an awfully long time, and I've always felt that you were, above all else, have been incredibly honorable in the way you've assessed and made calls to -- tough ones as well as not so tough ones. But you've always spoken your mind and you've done it with an incredible amount of dignity. And I think you've made the industry a better place because of that. So -- and by the way, you're not getting rid of me quite yet. Okay? So I'm still going to be very involved with the company, a company I love and a company that I love working with. I'll let Leonard handle this, but if he messes up at all, I'm going to criticize him right in front of the whole world. How's that?

[Ivy Zelman:]

Thank you for your kind words, Larry. Thank you, very much.

[Leonard Miller:]

Thanks, Larry. Really good question. If you look at kind of those communities that we either own, control or currently are in some form of due diligence, 85% of those are targeted over the next two years to be at FHA or below pricing. So we've really made a big move there. It's higher density, well located, good schools. So we're really excited about that future.

[Ivy Zelman:]

It's very helpful. Great to hear that. One other things, Larry, in opening comments and just to think about the market, getting your industry hat on or putting your industry hat on, sorry, with respect to the challenges, and the move up luxury, price points where builders are seen and they need to increase incentives and even cut prices, is that a function of several things, an aging population, or aging in place, lack of confidence that home prices will continue to move higher, the SALT changes in the tax basis and deductibility? Maybe just give us your thoughts high-level. It feels like that market can continue to be pressured downward and doesn't have a lot of, I think, tailwinds, especially, as you think about rates where they are and it's not really reacting to the rates having come back down. So really any high-level perspective and what you think the outcome over the next 1 to 2, 3 years will look like for that market?

[Lawrence Webb:]

It's a good question and a good comment, Ivy. This has been a pretty unusual recovery in that it hasn't been across-the-board everywhere, every place. And when we look at the move-up market and, particularly, second move up, at least through the California area, what we see is coastal projects or very well-located communities can still be quite successful. We have a project in Covenant Hills in South Orange County named Sky Ranch that by -- is really a very good community. But anything that doesn't fit A+ across-the-board has definitely been vulnerable.One thing you didn't mention, but is something that we all have to deal with is that the, clearly, reduction in demand from the Chinese buyer has also impacted the move-up sentiment within, I would say, Coastal California. Long term, there's always going to be demand for move-up housing. But clearly, it's facing a headwind today, and we started this transition towards doing both entry and first move-up about three years ago. It's taken us quite a long time because of the nature of political entitlements and just jurisdictional pushback to turn the ship around. But I feel The New Home Company is really looking forward very well-positioned towards hitting that depth of the market, which is, again, it's entry, but it's also first move up. There's demand there too.

[Ivy Zelman:]

One quick follow up just to ask about land prices for that maybe second time move up price point. Would you anticipate that there will be pressure that the land developers are going to have to lower land prices and maybe that creates the value that you alluded to earlier that's missing?

[Lawrence Webb:]

In this recovery as well as in the recession, I don't believe we saw land prices go down as low as they should have. And I definitely know land prices came back faster than we expected. I don't know if prices will go down, but I do believe that land prices and landowners are now, I believe, going to be looking at their property differently. So what do I mean by that? I mean that there may now be a chance for landholders to, for the first time in my career, be looking at builders as potentially partners, whether it's in a fee operation or some other kind of JV, where in order to get their land price, they have to stay in longer with home builders.And for a company like ours, there's a potential that they could really be beneficial because we really are viewed as leaders in design and quality. Clearly, second-move-up housing in California is -- the land prices are not accelerating. They're basically remaining stable.

[Operator:]

Our next question is from Alex Barrón with Housing Research Center.

[Alex Barrón:]

Well, Larry, I was surprise to hear the news, but congratulations, and also for you, Leonard, for the promotion. I wanted to, I guess, focus on Phoenix. I thought that was an interesting news that you just delivered about the eight new communities. So wanted to ask, in terms of, kind of, location and timing, are those -- I am assuming those, I guess, are already on your balance sheet? And roughly, what part of the metro are those going to be in? And when can we start, I guess, getting orders from those communities? Can you expound on the rollout of those communities?

[Leonard Miller:]

Sure. I'll take that, Alex, and thank you. I'll start with, six of those communities are in the Gilbert-Chandler area. So really well-positioned, three of which should open for sale in Q3 -- I'm sorry, three of which will be Q1 of 2020. The other three we'll bring on Q3 of 2020. So all eight communities are slated at some point during 2020. Again, six of those in Gilbert-Chandler, and then we have one in Eastmark and one in Estrella. As far as ownership of those go, we own three of the eight, and then it's -- there's typical closing conditions and terms on those deals. In some cases, the lots will be delivered finished. In others, it will be blue topped or entitled. So it's a mix.

[Alex Barrón:]

When you say you own three of the eight, you mean the others are in some form of joint venture?

[Leonard Miller:]

Not in joint venture, but we negotiated deal terms basically to take it down at more of a just-in-time or at certain closing conditions that were more favorable to us. So we will own those wholly-owned within The New Home Company in the future.

[Alex Barrón:]

Oh, okay, great. So it's basically some type of option deal, but the community itself will be wholly-owned and will be reflected in your income statement as wholly-owned?

[Lawrence Webb:]

You said that better than we did, Alex.

[Alex Barrón:]

Great. Okay. And then in terms of the debt situation, so obviously, you guys made good progress this quarter in bringing down the balance and the line of credit, and on the senior notes, you took advantage of the discount and bought some back. Can you just give us some idea of kind of how you guys are looking at that as you move forward? Is there plans to continue to repurchase some of those senior notes if they continue to trade at a discount? And at what points are you guys looking to maybe refinance those?

[John Stephens:]

Alex, it's John Stephens. First and foremost, our goal is to continue to pay down the line of credit. That's something that we've been focused on, and obviously, our line sort of moves up during the middle of the year, during when we kind of increase our WIP. We just thought that with the bonds trading where they were earlier in the quarter that they were at pretty attractive price, and we wanted to be opportunistic on that front too, because, again, our thought is now to continue to deleverage, with the goal of bringing our net debt to cap down in the low-50% range by the end of the year.So I think that there still is an opportunity for us to pick up some bonds over the next couple years as they become available. Now they don't trade as widely as you might expect. So the opportunities do come and go. So we will evaluate those, but again, first and foremost, we're focused on paying down the revolver and moving forward on that front. But again, deleveraging is a real important part of the story here for us for the next, I'd say, six months or so. And then part of that will be kind of touched on. We have a couple of land sales that are scheduled for Q3, and those are proceeding forward nicely, and we look forward to having those sort of happen and continue with our deleveraging story.

[Alex Barrón:]

Great. I guess as far as your margin expectations as those Phoenix communities come on, would you expect that those would have margins that are at average, I mean, at your company average or better than that?

[John Stephens:]

Better than company-wide averages. I think all the new communities that we're bringing online, whether they're kind of in Phoenix or these more affordable projects that Leonard referred to in some of the Inland Empire or Sacramento area, they have better margins than our company-wide average. I think we've also seen better absorption pace and demand from those. So I think that's been encouraging with this pivot we've been going through. Now, Leonard, do you have anything to add to that?

[Leonard Miller:]

Yes. I think you hit it.

[Alex Barrón:]

And if I could ask one last one and then I'll jump off. As far as your California exposure and community counts, are you guys thinking of it's going to remain roughly somewhere to where it is? It's going to trend a little bit up or little bit down? Just kind of some directional guidance as far as kind of community counts and overall exposure in California? On an absolute basis, not relative basis.

[Lawrence Webb:]

I think we're looking moving forward to remain about where it is. But you should be aware that our newer communities are going to be in more affordable price ranges as a whole. So some of our geographic shifts will be more towards the Western side of the Inland Empire as well as they'll be more in the Sacramento market than what we have today. But we still see opportunities in California, and I also think we'll be looking at other markets as well. We believe that there are other Western United States cities that would be really good opportunities for us. But everyone should be aware, our primary focus for this year is to bring cash in and to lower our leverage, and we are well on our way to doing that.Thanks, everybody, and we really appreciate your patience. We believe The New Home Company is really headed in the right direction. As I transition into a different role, I have the utmost confidence in both Leonard and John, and we're going to remain a three person team. And we hope to continue to give you positive news as The New Home Company grows. So thank you so much.

[Operator:]

Thank you. This concludes today's conference. You may disconnect your lines at this time, and have a pleasant day.