The New Home Company Inc.
Q2 2017 Earnings Call Transcript

Published: 27 Jul 2017

[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 2017. Documents detailing these results are available in the Investor Relations section of the company's Web site 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 uncertainty. 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 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 Web site and in its filings with the SEC. Hosting the call today is Larry Webb, Chief Executive Officer; and John Stephens, Chief Financial Officer. With that, I will now turn the call over to Larry.

[Larry Webb:]

Thanks, Drew, and good morning to everyone joining us on the call today. I'm very pleased to report that The New Home Company delivered solid results for the second quarter of 2017, highlighted by net [indiscernible] quarter growth of 53%, home sale revenue growth of 23%, and earnings of $1.5 million or $0.07 per diluted share. We also ended the period with a backlog dollar value of $339 million, which is a 22% increase over the second quarter of 2016, and represents the highest quarter in backlog in value in our company's history. These results are a testament to the fundamental strength of the markets in which we build, the quality of our home offerings, and our intense focus on execution. We are in a great position to achieve the goals we set forth for ourselves in the back half of the year. Our transformation continues from a capital-constrained builder relying on fee building and joint venture arrangements to a company with a solid financial position, and a focus on wholly owned projects. We've opened two new wholly owned communities this year, and anticipate opening nine more wholly owned communities before the end of the year. In May, we successfully completed a tack-on offering of $75 million in senior notes providing a significant [indiscernible] at the end of the quarter, with a cash balance of over $150 million, and no outstandings under our credit facility. This enhanced liquidity position will allow us to make additional investments in wholly owned projects, thereby giving us and our investors better visibility and confidence in the future of our business. As we had previously discussed, we are also in the midst of a product transformation [indiscernible] average sales price profile of our company, but will also give us exposure to additional buyer segments, and will likely improve our return profile moving forward. This transition begins in earnest as six of the nine communities to open over the next two quarters will initially be priced at $750,000 or lower. These communities are slated to open late third quarter or early fourth quarter, and will really begin to impact our results next year. Given the kind of demand that we've seen in our markets for more affordable housing options, we are excited about this new phase in our company's evolution. In general, the strong sales momentum we've experienced in the first quarter carried over into the second quarter, as sustained job growth and limited existing home inventory have created a very favorable backdrop for our business. We averaged 3.3 sales per community per month during the quarter, a 74% increase over the second quarter of 2016. Similar to the first quarter, our operations in Northern California led the way with a sales pace of 3.9 homes per community per month. The strong demand trends were evident in both the Bay Area and Sacramento, with a handful of communities selling at over one homer per week in both markets. Sales activity was also solid at a number of our seven California communities, where we averaged 2.8 sales per community per month. The two communities that contributed the largest number of sales in the region were Cressa and the Portola Springs master plan, and Amethyst at Great Park, both of which are located in Irvine. Since quarter end, sales activity in Southern California has remained solid and on pace with absorption rates seen during the second quarter. In Northern California, our net orders thus far enjoy -- are a little lower due to the sellout of three successful communities during the second quarter. However all three of these successful communities will be replaced with similar offerings by the end of the year. We are also on the verge of expanding our operations into the Inland Empire in Southern California, where we expect to purchase our first community in a master plan during the third quarter. In addition, we will further expand in this submarket with [indiscernible] opportunities from our new 1,600 lot Bedford master plan in South Corona, which we anticipate grand opening in the spring of 2018. In light of our successful first-half of the year and our record backlog value I feel very good about where The New Home Company's path as we head into the back half of the year. Now, I'd like to turn it over to John for a more in-depth look at our results this quarter.

[John Stephens:]

Thank you, Larry, and good morning. Our net income for the 2017 second quarter was $1.5 million or $0.07 per diluted share compared to $2.5 million or $0.12 per diluted share in the prior year period. The 2017 second quarter include a $1.3 million pretax inventory permit charge related to one home building community in Southern California which represented $0.04 per diluted share on an after tax basis. The year-over-year decrease in our net income was primarily due to a $3.7 million reduction in joint venture income, a $1.3 million decrease in joint venture management fees, and the inventory permit previously noted. These decreases were largely offset by improvements in our wholly owned operating margin. The improvements in our wholly owned operating margin was driven by a 23% increase in home sales revenue, a 290 basis point increase in home sales gross margin before impairments, and a 140 basis point improvement in our SG&A from operating leverage efficiencies. Home sales revenue for the quarter was up 23% to $97 million. The increase was largely due to a 49% increase in deliveries, and was partially offset by a 17% decrease in our average selling price to $1.5 million. The decrease in our average selling price was primarily attributable to a mix shift to a more lower-priced product primarily in Northern California. Based on the homes in our backlog and that are scheduled to deliver in the third quarter, we expect our average selling price to dip by about 10% to approximately $1.3 million for the 2017 third quarter, and jump back up in the fourth quarter to around $1.8 million to $1.9 million as we deliver the last of our luxury product in Crystal Cove. For the full year of 2017, we expect our average selling price to be around $1.5 million, which would represent about a 25% year-over-year decline due to a shift in delivery mix. As we move into 2018 we expect our full-year ASPs to be below $1 million as we expand our product and price diversification, which is a key component of our long-term strategy. Our gross margin from home sales for the second quarter improved 160 basis points over the prior year, at 13.6%. Excluding inventory impairments, our home sales gross margin was 14.9% versus 12.0% in the prior year period. The improvement in gross margin before impairments is primarily due to a change in mix, including the favorable impact of higher margins from our Crystal Cove communities Newport Coast, California. Excluding impairments and interest in cost of sales, our gross margin from home sales for the 2017 second quarter was 16.7% versus 13.3% in the prior year period. For the third quarter and the full year of 2017, we estimate our GAAP gross margin from home sales including capitalized interest to be in the mid 14% range. Our SG&A rate as a percentage of home sales revenue for the second quarter was 12.4% as compared to 13.8% in the prior year period. The year-over-year improvement was driven by the strong operating leverage resulting from increase in home sales revenue, which was driven by strong delivery growth, combined with a modest reduction in our G&A spend. We expect our SG&A rate to be in the mid 11% range for the third quarter and low 10% range of the full year. Our share of joint venture income for the 2017 second quarter was $200,000, compared to $3.9 million in the prior year period. In the 2017 second quarter included $400,000 of income related to the unwinding of our large [indiscernible] joint venture in the Bay area. The year-over-year decrease in JV income for the third quarter was consistent with the shift emphasis to our wholly owned operations and was largely due to a reduction in deliveries and revenues and lower gross margin from home sales. The lower JV gross margin in 2017 are largely due to a mix shift as the deliveries in the 2015 second quarter were from high margin Orchard Park community in San Jose. In addition, the 2016 second quarter benefited from $1.6 million gain from the unwinding of our Lambert Ranch joint venture. Net new orders for the second quarter were up 53% and represented $122 million in aggregate sales value. Our multi-sales absorption rate was up 74% over the prior year, 3.3 sales per community versus 1.9 per community in the 2016 second quarter. As Larry mentioned, our Northern California division led the way with a 117% increase in monthly absorption rate at 3.9 sales per community, while Southern California turned in a solid 33% increase in monthly sales absorption pace at 2.8 sales per community. We ended the third quarter with a record backlog value of $339 million which was up 22% over last year. Our fee building revenue from the third quarter was up 57% to $47 million, due to increased construction activity and fee delivery and included $1.2 million in JV management fee compared to $2.5 million in the prior third quarter. The lower JV management fees is consistent with the lower JV volumes due to a shift in emphasis to our wholly owned operations. Our fee building gross margin for the third quarter was $1.3 million or 2.7% compared to $1.7 million or 5.7% in the prior year period. The lower year-over-year fee building gross margin percentage was due to a reduction in JV management fees. As of June 30, 2017 we owned or controlled approximately 5,800 lots, which included over 1,800 lots from our wholly owned business. Nearly 3,000 lots through joint ventures and about a 1,000 fee building lots. And of the 1,800 lots owned or controlled through our wholly owned operations, 62% were controlled through option contracts. Controlling a substantial portion of our lots through options and take down structures allows for strong asset turnover and a more efficient utilization of our capital. Moving to our balance sheet, we ended the third quarter with $154 million in cash, $365 million in real estate inventories and $318 million in debt. The components of our inventory at third quarter end consisted of $212 million in work in process and completed homes, $108 million in land and land under development and $35 million in land deposits and pre-acquisition cost. These land deposits controlled approximately $442 million in future land purchases inclusive of the deposits that are scheduled to be purchased over the next few years. Also in May we issued an additional $75 million of 7.25% senior notes, unsecured notes due 2042, at a premium to yield 6.44%. Net proceeds from this tack-on offering will be used for working capital purposes including land acquisition. We had no borrowings outstanding under our $260 million unsecured revolving credit facility as of June 30, 2017 and had a gross debt to capital ratio of 56.2% and a net debt to capital ratio of 39.8%. Now, I'd like to update our full year guidance for 2017 along with some additional third quarterly color. You are estimating home sales revenues of between $540 million and $570 million. Our home sale revenues will be heavily backend loaded with approximately 70% of our full year revenues to be delivered in the second half of the year with between 45% to 50% in the total home sale revenues to be generated in the fourth quarter. Based on the strong first half of the year we are increasing our fee building revenue estimate to between $145 million to $165 million. We expect our full year fee building gross margin to be between 3.5% to 4% and they fluctuate from quarter-to-quarter based on the timing of JV management fee recognized. We are lowering our full year joint venture income to between $2 million to $3 million; the decrease in estimated JV from this largely a result of fewer expected deliveries from our Mountain Shadows and Paradise Valley, Arizona. We believe that $2 million of the change in estimate from the prior third quarter is temporary and we expect it to be recognized in subsequent years. We expect to end the year with 17 wholly owned communities. The decrease in wholly owned community capital that be reported last third quarter is due to one Southern California community open late until Q1 of 2018. And as a result of the anticipated decrease in our Q2 ending community count coupled with the timing of opening 9 new communities in late Q3 and early Q4. We expect to see a dip in our third quarter order activity. With respect to our JVs, we expect to end the year with nine active communities. I'll now turn the call back to Larry for his concluding remarks.

[Larry Webb:]

Thank you, John. In conclusion, I'm very pleased with our performance in the second quarter. We turned in another profitable third quarter. We generated healthy order phase and we enhanced our liquidity position. We also made further progress in transitioning our company and to becoming a more affordable and diversified builder with several new wholly owned projects in the pipeline. These achievements have given us a great platform from which to grow and put us in a solid position to deliver on our goals for this year and beyond. Finally, I'd also thank our hardworking team members for another job well done. We've come a long way since our home [indiscernible] and I am very appreciative of their efforts. We have a lot of moment as we head into the second half of the year, which gives me confident that the future of the new home company looks as great as ever. That concludes our prepared remarks and now, I'd like to open the call up for questions.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from the line Alan Ratner with Zelman Associates. Please proceed with your questions.

[Alan Ratner:]

Hey, Larry. Hey, gentlemen. Good morning. Nice third quarter. Appreciate the guidance here. As you look at your community count, obviously there has been a lot of churn and I got a lot of opening coming up here. When you look at the 17 communities, you expect to have opened at the end of this year. How many of those are going to be, that the profit sharing master plan types? I know a year ago when you had 15 at the end of the year, it probably was a pretty meaningful chunk of your business. So curious, how you expect this to compare when you and this year having went to 18. And then if you could talk a little bit just about the difference in margins between those projects, I know the - obviously the master plans are very high return projects, but their lower margins. So curious how it compares to your self-developed field?

[John Stephens:]

Hey Alan, it's John. In terms of the communities we're opening, it looks like most of them will be master plans, which will have some form of [indiscernible] to the land seller, probably 10 out of 12 parts sort of fit into that category, albeit each of the master plans have different structures, so Irvine versus [indiscernible] different as well as the new communities we're going to be opening down in San Diego. In terms of the margins, we would expect higher gross margin percentages as we move forward and open in these new communities, albeit they'll be at lower price points as we've talked about many times in the previous quarter remarks that they will be at lower price points.

[Alan Ratner:]

Got it. Okay, that's helpful. Then just on the price point conversation and just curious if you could just give a little bit of an update on what you're seeing on pricing power across your markets. We heard from some other builders, maybe Northern Cap was hitting a bit of a resistance point especially at the higher end. But at the same time, as you open up more lower priced communities it seems like there's probably more pricing power there. So any thoughts across the portfolio how you see the ability to push price and whether it's hitting any resistance?

[Larry Webb:]

Sure. Every market is really a little different. What we found is that Sacramento is the most, I would say, resistant to price increases. We've been modest when we're in the affordable areas. And I would say $600,000 and below there's uplift. Above that you do get some resistance in Sacramento. Bay Area, the market is strong, but above $1 million it starts getting harder to significantly raise prices. In Southern California we've been primarily consistent in having modest increases between every one of our sales releases, but again under $1 million is a lot easier. And then what we found at the very top of the market, you do have the ability, and when I say that most of you or many of you have seen our Crystal Cove projects. We had the ability there to be able to raise prices significantly, starting out at $3 million to $5 million, and ending up in the $6 million to $9 million range. So the very top of the market there's more flexibility. And big picture though, there's still room for uplift I think. And our new strategy of getting into more affordable housing will be beneficial in that area for us.

[John Stephens:]

Yes, and Alan, just to kind of quantify it, the top 60% of our communities that we're selling on a week we raised prices during the quarter. And I think that Larry's point is a good one. As we move into some of these new communities at lower price points I think there's an opportunity there if the demand is real strong.

[Alan Ratner:]

Got it, thanks a lot guys. And one last clarification question, John, just on the guidance for orders to dip in the third quarter. Is that in relation to the second quarter number or on a year-over-year basis?

[John Stephens:]

Sequential. I mean really just…

[Alan Ratner:]

Okay, yes, and you're referring to absolute number of orders?

[John Stephens:]

Correct, yes. And the absorption rate, probably we do see some seasonality as we move into the summer months. And a lot of the really strong communities we sold out of or are selling out of here very shortly. So then we're just waiting for the new ones to open as we move to the back half of the quarter.

[Larry Webb:]

And, Alan, the one point that we didn't emphasize is, on this call was, that this plan of having a solid third quarter and building through and opening the new projects in the third quarter and fourth quarter has been our strategic plan from day one. This isn't anything new. And if anything, the first and second quarters beat our forecasts, and made us feel more optimistic about the second half of the year, as opposed to the first. This quarter-to-quarter sort of chasing your tail thing it isn't in my mind a good way to be strategic. And we're really on a solid path moving forward. So we just wanted people to be aware of it, third quarter will probably be a little slower because we have fewer communities right now.

[Alan Ratner:]

Understood. All right, thanks guys. Good luck.

[Larry Webb:]

Thanks.

[Operator:]

Thank you. [Operator Instructions] Our next question comes from Michael Rehaut with J.P. Morgan. Please proceed with your question.

[Unidentified Analyst:]

Good morning, it's Jason in for Mike. So first question just wanted to hit on sales pace for a minute, it seems to be very solid, and I think especially in Northern California you're seeing a lot of improvement. Just wanted to get a sense as to a little bit more color on what you're seeing across the footprint. And I appreciate the commentary that you just gave on pricing power. But just want to understand how you're thinking weighing price versus [indiscernible] across your different communities. And then as you look into the back half of the year how would you think about the year-over-year improvement in sales pace relative [indiscernible] in the first half?

[John Stephens:]

I think in the back half of the year sales pace will be lower. Our sales pace will be lower as expected, which is seasonality. But in terms of price versus pace it really is going to boil down to communities where there is very strong demand we are raising prices. But it's obviously a delicate balance of how you sort of manage the momentum or not in those types of communities. And obviously if projects where there's not as much demand we're obviously not laying off the pricing quite a bit. We want to make sure we manage to have reasonable absorption pace so we can meet our revenue and business plan targets.

[Larry Webb:]

Jason, if we could take a step back for everyone one second, we have made a conscious commitment to get into more affordable pricing. And we've done that strategically for a series of reasons that we think make a lot of sense. One is there are no more Ocean View lots left in Southern California. Second, we want to always be at the deepest part of the market. And in most cases that's in the more affordable ranges. Third, we want to continually improve our operational expertise. So we want to build our houses faster, we want to turn our inventory, we want to focus on returns. And along with that, we want to consistently raise our prices wherever we can, and we watch that. John is very adamant and very, I would say, he's the watchdog in our company about that. One of the reasons we had the lowest cancellation rate or one of the two lowest cancellation rates in the industry is because when people go in escrow in our company they are confident that they've made a good investment.

[Unidentified Analyst:]

Okay, great. And then moving on to deliveries, came in nicely ahead of what we were looking for in the quarter. So just wanted to get an update on what you're seeing in the labor market, if you've maybe gotten some more efficiencies over the last quarter or so? And then just in terms of the material cost perspective, I want to understand that as well.

[Larry Webb:]

I'll take the labor, and I'll let John handle the cost. It again is a market-by-market situation. Southern California, because of our size, we really are in a pretty strong position regarding labor, both of cost and availability. The Bay Area has consistently been more of a problem on both cost and availability of workers. And we've adjusted our schedules and have continued to do that. Sacramento, I think we are more comfortable with cost, but it still is a challenge. And Arizona we're pretty new. But when I look at Arizona it seems to me that the labor market will continue to be a challenge.

[John Stephens:]

Yes, and then in terms of specifics, certain trades we've seen sort of a 1% to 2% sort of increase there, concrete, lumber framing, roofing have been sort of an -- well, what we've seen in some of our markets. But again on a much higher ASP it's not as big of a component as you might see for some of the other builders.

[Unidentified Analyst:]

Okay, great. Thanks.

[Operator:]

Thank you. [Operator Instructions] There are no further questions at this time. I'd like to turn the floor back to management for closing comments.

[Larry Webb:]

Thank you very much. We are on a journey, and one that we're really proud of. And I feel as if the foundation is set for us to continue to improve, and to continue to, not just beat our projections, but really create a company that does the right thing at the right always. I'm very pleased with the quarter, and I am excited about the future. Thank you.

[Operator:]

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.