The New Home Company Inc.
Q3 2014 Earnings Call Transcript

Published: 7 Nov 2014

[Operator:]

Greetings and welcome to The New Home Company Third Quarter 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief 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, Rodny Nacier, Investor Relations. Thank you, sir. You may begin.

[Rodny Nacier:]

Good morning. We would like to thank you for joining us today for The New Home Company's third quarter 2014 earnings conference call. Today's conference call is hosted by Larry Webb, the Company’s Chief Executive Officer, and Wayne Stelmar, the Company’s Chief Financial Officer, and the Company's Chief Operating Officer, Tom Redwitz. This morning we distributed a press release detailing our third quarter financial results which can be found in the Investor Relations section of our Web-site at thenewhomecompany.com. We expect to file our Form 10-Q after the close of the market. During our call today, management's remarks and answers to your questions may contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements address matters that are subject to risks and uncertainties that may cause actual results to differ from those discussed today. Examples of forward-looking statements includes statements regarding expected performance, especially expectations with respect to revenue, gross margins, operating income and expenses, cash flow and liquidity as well as non-GAAP financial measures, operational expectations including community count, number of new community openings and home deliveries and the role of fee building in our overall business plan. These statements which may occur during our prepared remarks or during the question-and-answer session maybe identified with words such as expect, should, anticipate, intend, estimates, believes or similar expressions that are used in connection with any discussion of future financial and operating performance. As a reminder, forward-looking statements represent management’s current estimates and the Company assumes no obligation to update any forward-looking statements in the future. We encourage you to review the Company’s past and future filings with the SEC including, without limitation, the Company’s Form 10-K which identifies the specific factors that may cause actual results to differ materially from those described in these forward looking statements. Now, I will turn the call over to Larry.

[H. Lawrence Webb:]

Thank you for joining us today for our third quarter 2014 earnings conference. I will provide a summary of our operating and financial highlights for the quarter, and Wayne will then discuss additional details on our financial results and balance sheet. After our prepared remarks, we will be joined by our Chief Operating Officer, Tom Redwitz, and open the call to your questions. During the third quarter of 2014, we continued to expand our operations, increase our backlog, strengthen our capital base and invest in our business for further expansion. We are pleased with our continued growth during the quarter which builds on the progress we have made since our founding in 2009 to accomplish our simple but ambitious goal, to create a company that is recognized as one of the country's best homebuilders. In September, The New Home Company celebrated its fifth anniversary, and today we are one of California's fastest growing homebuilders. We have a leadership team that has to proven track record of creating value and a strong financial alignment with the Company's shareholders. Our strategic operating platform focuses on wholly owned, JV and fee building activities to grow our business. This unique business approach has allowed us to scale up our operations through a disciplined allocation of capital and maximize our return on equity. Together with our unconsolidated joint ventures or JVs, we finished the quarter with over 6,500 lots owned or controlled in premier locations, providing us the lots for all projected deliveries through 2016. We have a specific focus on coastal Southern California, the Bay Area, Silicon Valley and targeted submarkets in metro Sacramento and the western portion of the Inland Empire. We offer a wide range of homes across all price points that result from extensive marketing and consumer research designed to ensure we deliver the most innovative housing programs in our markets. This strategic consumer driven approach and the impact we are making on neighborhood is being recognized throughout our marketplace. In September we were pleased to announce that our Company received 21 homebuilding awards and top recognition in a variety of categories, including Community of the Year. Moving to our operating results, in the third quarter total revenues increased 35%, but more importantly our backlog dollar value increased a combined 147% at our wholly-owned and JV communities. We grew our new home deliveries by 45% to 125 homes across all project activities. We opened three communities in our JV operations to end the quarter with 14 active selling projects, including four wholly-owned communities and 10 communities owned by our JVs. In addition, we expanded our fee building operation significantly, and at present we have over 360 homes under construction. Overall, the expansion of our wholly-owned and JV backlog to 189 homes totaling approximately $280 million in revenue bodes very well for our future. During 2014, from our IPO in January to our ongoing expansion in all areas, our focus has been to lay the groundwork for solid financial results in 2015 and beyond. We look forward to continuing our progress with our experienced team, unique strategy and solid foundation to further expand our operations. Our coastal and infield California homebuilding markets remain strong and the opportunities to execute our growth strategy are exciting. I'd now like to briefly highlight several of our new and ongoing project activities. In late May, we opened two highly popular communities, Amelia and Trevi, in the Orchard Hills master-plan located in Irvine, California. These two wholly-owned communities have experienced excellent demand and account for 84 million or 93% of our owned backlog. In our JVs, we continue to participate in the ownership of larger more unique sites in some of the strongest markets in the United States. This is especially true of our Meridian and Rose Lane communities, which were significant drivers of the $96 million increase in homes in our JV backlog compared to a year ago. In addition, Meridian, a luxury oriented coastal community located in Newport Beach is scheduled to grand opening in late 2014 but has already sold 34 homes as of the end of October, representing over 40% of the total community. In September, we announced the opening of three communities within our Orchard Park master plan, three weeks ahead of schedule due to strong demand in the vibrant San Jose market. Our planned acquisition of Bedford Ranch by our Arantine Hills JV is on track to close in December 2014. Located in Corona, California, Bedford Ranch will feature over 1,300 lots within the upscale master-planned community. As we are doing at The Cannery in Vegas, we will develop and sell improved lots to other homebuilders as well as build on lots we acquire. The community, which is expected to begin selling lots in mid-2016, further highlights the strengths of our land development expertise and strategic relationships with landowners and capital providers. Through our fee building activity, we create increased visibility in our core markets and gain access to the best trading partners, enhance our purchasing power as well as generate meaningful earnings. Our fee building revenue increased 111% in the third quarter compared to a year ago, as a result of an increase in communities combined with significant home starts and a variety of Irvine Pacific sites. As a result, our fee building business has a strong base of activity to continue growing into 2015. As I mentioned, at present we have over 360 homes under construction in eight communities. As you can tell, the third quarter was a busy time for The New Home Company on all fronts. Our Californian markets continue to see favorable traffic across their communities. We have a strong balance sheet to support our pursuit of opportunities to increase our community count. While wholly-owned communities are the primary focus of the Company's future growth, communities owned by our JVs and fee building activities allow us to generate significant homebuilding activity as well as further enhance our returns. Quite simply, our future is very bright. I will now turn the call over to our CFO, Wayne Stelmar, to provide additional details on our financial results.

[Wayne Stelmar:]

Thank you, Larry, and good morning. During the third quarter of 2014, we continued to increase our backlog and strengthen our balance sheet. There are four highlights in the quarter I'd like to emphasize. Number one, we achieved strong sales at two recently opened owned communities in Irvine which drove the increase in backlog dollar value to $91 million from 42 homes. Number two, we continued to execute our housing JV strategy with a 62% increase in backlog to 147 homes and a doubling of our backlog dollar value to $189 million. Number three, we had 111% increase in fee building revenues to $20.4 million resulting from an increase in homes under construction to over 360 compared to 60 homes in the prior year quarter. And finally, we ended the quarter with a strong balance sheet with $109.6 million of total liquidity to invest in our growth. We are pleased with our progress and results as we continue to accomplish our strategic plan. Probably now our quarterly results may be impacted by near-term timing factors and shifting market dynamics. Revenue in the third quarter, which includes our communities and fee billing activities, increased 35% to $28.6 million from $21.2 million in the prior year period. We reported a net loss of $1.1 million or $0.06 per share, largely as a result of reduced deliveries of home communities and a reduction in our share of income from JVs. Additionally, sales and marketing expenses were accelerated at several communities opened in the second quarter but we saw opportunities to increase orders and grow backlog. I'll now provide an overview of our third quarter operating results. Home sales revenue from our communities was $8.2 million from 10 deliveries in the quarter, compared to $11.5 million from 25 deliveries in the prior year period. The impact from the reduced deliveries was partially offset by a significant increase in the average selling price of homes delivered to $820,000 compared to $461,000 in the prior year period. This increase in ASP reflects a change in mix of homes delivered to a community with a higher average sales price. As we mentioned last quarter, we expect average selling price to vary from period to period as we bring new communities to market. Our four actively selling communities currently have base prices that range from $430,000 to $2.9 million. Our homebuilding gross margin in the third quarter was 15.6% compared to 17% in the prior year quarter, largely due to higher costs of homes delivered at our two Sacramento communities. In our fee building business, revenue increased 111% to $20.4 million for the third quarter, compared to $9.7 million in the prior year quarter, primarily due to an increase in number of fee building communities and related construction activity. Our fee building revenue included management fees collected from our JVs which were $2.2 million for the third quarter of 2014 compared to $1.9 million in the prior year period. We are pleased by the increased activity which should continue to produce strong results into the fourth quarter of 2014 and beyond. For the quarter, we reported fee building gross margin of $1 million compared to $1.8 million in the prior year period. The lower margin resulted from the reduction in management fees from JVs as a percentage of total fee building revenue. As a reminder, we expect fee building margin to vary from quarter to quarter as the amount of management fees from JVs increase or decrease. The fee build business remains attractive as we continue to expand strategic relationships and activities in our core markets. Our SG&A increased to $4.1 million in the third quarter, representing roughly 50% of home sales revenue, compared to $2.4 million or 20.7% for the same period a year ago. Selling and marketing expense increased $442,000 due to activity related to opening new communities in the second quarter. Such activity resulted in an increase in orders of these communities. G&A expense was higher than in the prior year period as a result of increased personnel and public company costs. As deliveries and revenue increase from wholly-owned communities, we expect our SG&A as a percentage of home sales revenue to normalize. Moving on to our JVs, the JV structure continues to provide us an opportunity to earn an economic return in excess of our capital percentage as well as significant management fees. As a reminder, the results of our JVs are not consolidated and are reported in equity and net income from unconsolidated joint ventures in our financial statements. At the end of the quarter, we had ownership interests in 12 JVs with capital percentages ranging from 5% to 35%. The JVs reported third quarter revenue of $35.7 million from 72 home deliveries, compared to $39.4 million from 26 home deliveries a year ago. The average selling price of homes in JV communities was $496,000 compared to $1.5 million in the prior year period and was impacted by the lower priced homes in newer communities. Our share of net income from JVs for the third quarter was $0.1 million compared to $1 million in the prior year period, largely due to the mix of homes delivered and the specific income allocation percentage from each of the JVs. Homebuilding gross margin from JVs was 17.9% compared to 27.7% in the prior year period, primarily due to the mix of homes delivered which included deliveries of the low market rate homes in one of our JVs. Additionally, the 2013 comparison period consist of deliveries exclusively from our highly successful Lambert Ranch community. The backlog of homes in JV communities continues to grow at a strong pace. At the end of the third quarter, there were 147 homes in backlog from 10 communities representing $189 million of backlog dollar value, compared to 91 homes from four communities and the end of the prior year period representing $93.5 million of backlog dollar value. This growth arose from the increase in average selling communities from 2.5 to 8.3 communities which produced 79 new home orders compared to 47 in the prior year period. This growth in backlog and community count positions us to recognize increased revenue and earnings in the fourth quarter and well into 2015. Our land pipeline remained strong and well positioned to support our growing operations across all our activities. At the end of the third quarter, together with our JVs, we owned or controlled over 6,500 lots representing a 37% increase from a year ago. [Indiscernible] in our JVs owned 2,782 lots and controlled an additional 3,742 lots. In October, we acquired 404 lots in our Foster City JV for $30 million. We are currently developing this site and expect to begin selling parcels in the near-term. Now moving on to balance sheet and liquidity, we ended the quarter with $109.6 million of total liquidity including $59.9 million in cash and $49.7 million available under our loan commitments. We had $94.3 million in outstanding debt which represented a net debt-to-capital ratio of 19%. We believe our balance sheet is strong and expect to continue to invest in attractive growth opportunities, currently controlled or in our acquisition pipeline. Additionally, we expect cash flow from existing JV communities to accelerate in 2015, which will also be reinvested in our business. Our outlook for 2014 and coming years remains very positive. We now expect to end the year with 13 actively selling communities consisting of four wholly-owned communities and nine JV communities. The reduction of one JV community resulted from the sell-out of one community in Rose Lane ahead of schedule. We continue to expect to report revenue from our owned communities of $50 million to $55 million. In our fee building activities, we now expect revenue of $75 million to $85 million for the full year 2014. We continue to expect our equity and net income from unconsolidated joint ventures of $7 million to $8 million for the full year 2014. As we mentioned last quarter, the significant fourth quarter activity anticipated in our results are in line with our expectations. As we enter 2015, we continue to expect the growth in our community count to be primarily driven by wholly-owned communities. We have an attractive strategy in place and are focused on our growth objectives but we do expect our results to vary from quarter to quarter as we continue to increase our project activity and position ourselves for further expansion. I'll now turn the call back to Larry for his concluding remarks.

[H. Lawrence Webb:]

Since our founding in 2009, we continue to expand our operating strategy and capitalize on attractive growth opportunities. It is clear to see that we are a company on the rise. At present, we have five communities, three owned and two JV, with models under construction that will open in the first half of 2015. In addition, we have site development taking place in over 1,400 lots under development in a number of communities in Northern California. Finally, we have over 360 homes presently under construction within our Irvine Pacific fee building operation. We are excited to continue pursuing our goals and strengthening our operations in some of the strongest housing markets in the nation. We remain focused on enhancing our operations, acquiring land, opening new communities and generating value for shareholders. Thank you for joining us today. Operator, we are now ready to open up the line for questions.

[Operator:]

(Operator Instructions) Our first question comes from the line of Michael Dahl with Credit Suisse. Please proceed with your question.

[Michael Dahl:]

Wanted to start out, I guess maybe expand a little bit on the comment about shifting market dynamics, I mean clearly industry going through some choppy times but you guys have better locations than those, so any color on what you're seeing in your markets on both the sales and pricing side?

[H. Lawrence Webb:]

This is Larry. We had very positive results in the end of, let's just say, July and August and we've seen some slowing in September and early October in particular I would say in the Sacramento area. In the Bay Area and the coastal Southern California markets, we still have been pretty solid. Now when I look at the industry as a whole, it seems to me the market has slowed, but our feeling is it's much more seasonal than anything else, and what we're really seeing is the demographics in our markets are still very strong. We are getting three to four jobs being created for every house permit that's pulled in. Long-term we're still very positive.

[Michael Dahl:]

Got it, thanks. And, Wayne, on the margin side, it's obviously mix plays a big role for you guys, if you look at the backlog that's out of Amelia and Trevi delivering over the coming periods, how should we think about the margin in wholly-owned communities over the next couple of quarters?

[Wayne Stelmar:]

Michael, the Q4 for us is really a transitional quarter. Q3 as we all know was impacted by deliveries from two communities in Sacramento, one of which closed out. So we are very positive that in Q4 we'll be able to see the results from both the top line revenue and certainly bottom line profit from the activity at Trevi and Amelia in Orchard Hills.

[Michael Dahl:]

Any quantification of just margin that we should be thinking about?

[Wayne Stelmar:]

Again as we've spoken before, the Irvine Company margins, because of the profit participation are typically lower than those communities in which we develop lots. So we would expect possibly a reduction of gross margin of maybe up to a couple of hundred basis points. But that said, we look to the underwriting of those communities based on underwriting on an IRR concept where we are more interested in our returns on invested capital rather than our gross margin.

[Michael Dahl:]

Right, okay. And then one last one, I guess given the success that you've had at Irvine and the fee building relationship, any visibility into next year in terms of how many new programs might be coming out that you'd be competing for?

[Wayne Stelmar:]

We provided full year guidance for 2014 and it's premature for us to provide at this point guidance in 2015. I know Larry alluded to new model homes, there are model communities that are under construction today, we have also made mention of lots and significant number of lots under development in Northern California. So we have a lot of things going on for guidance for 2015 at this point in time.

[Michael Dahl:]

Got it. Okay, thanks.

[Operator:]

Our next question comes from the line of Michael Rehaut with JP Morgan. Please proceed with your question.

[Michael Rehaut:]

First question I just had was looking at the – kind of a forward-looking question as well and I know, Wayne, you just said you're going to defer real guidance for '15, but just trying to get a sense of, at least from a geographic standpoint, how you expect the mix of closings and revenues to play out in '15 in terms of roughly speaking Sacramento versus Bay Area versus Orange County, any sense of kind of like a mix from those different geographies which would certainly kind of help us in thinking about perhaps margins and things of that nature?

[Wayne Stelmar:]

Certainly our focus even through 2014 was on coastal Southern California, primarily Orange County, and then secondarily the Bay Area. Sacramento, again because it's a softer market and has been that way for some time, it's been less of a focus for us. So I would suggest that we're going to see significant and rapid increases in our own communities in Orange County, primarily given our relationships with the Irvine Company, and then secondarily new communities that we would expect to open in the Bay Area.

[Michael Rehaut:]

Okay. I guess also I just wanted to hit on the previous question about gross margins on kind of a shorter-term basis directionally, particularly kind of thinking about the fourth quarter where you expect a material bump up in revenues, and Wayne, you kind of alluded to the fact that you'd expect in the next quarter to more closings and revenue from the Irvine Company which comes with a lower gross margin. At the same time, this past quarter your gross margin after interest was around 15.5%. That's down couple of hundred bps from 2Q, down even more from the first quarter. And I guess using 3Q as a base, because you said that that was impacted by Sacramento, I understand certainly that Irvine has a lower gross margin than your own developed projects, but is my understanding that that gross margin was still kind of in the high-teens, mid to high-teens at least, and comping or comparing against 3Q where you were at 15.5%, I guess that's where, I just want to make sure when you said, down a couple of hundred basis points, I wouldn't expect still 4Q to necessarily be down sequentially versus 3Q, I just want to make sure I understand kind of your comments and when you talked about that because 3Q feels like it's kind of a, I would think a little bit of a low watermark in terms of margins for you guys?

[Wayne Stelmar:]

Certainly Q3 was impacted by Sacramento to a large extent but the revenue that comes out of the Sacramento market for us is relatively minor compared to the revenue that will be coming from home sales in both Amelia and Trevi. Now for those of you who are not familiar with the Irvine Company deal structure, effectively builders have the ability to achieve a 9% net margin before a profit participation agreement kicks in, and that profit participation agreement provides $0.70 of every dollar above that 9% margin to the Irvine Company. So 12% to 14% gross margin is pretty normal for an Irvine Company deal.

[Michael Rehaut:]

So in fact you are expecting maybe a couple of hundred bps down from 3Q?

[Wayne Stelmar:]

That's correct. But on a positive side, the amount of revenue that's generated from the home sales of Amelia and Trevi with average sale prices into the $2 million and the profit that flows from that revenue is significant, as are the IRR from those communities because of our takedown structure.

[Michael Rehaut:]

Right. And do you have any sense for next year on what the Irvine Company mix will be for the wholly-owned business?

[Wayne Stelmar:]

It will certainly dominate.

[Michael Rehaut:]

Okay. Alright, thank you.

[Operator:]

Our next question comes from the line of Ivy Zelman with Zelman and Associates. Please proceed with your question.

[Ivy Zelman:]

With respect to I think Michael's question and really everyone is drilling in on this gross margin issue, Wayne, is really related to what we've modelled and everyone that modelled right now are thinking, now I got to take my gross margins down pretty significantly, so I don't think any of us were modeling a 12% to 14% gross margin for looking at the impact of the Irvine Company, so when we're thinking about it, just to make sure that's GAAP, that's our first question, that we're talking about the same apples to apples of how we model. And then really looking at one of the other points within the joint venture operations, you mentioned that you had below market rate homes which had an impact given the mix from that. Is that something that we should see every quarter, because I don't remember you saying if you were required to have so many below market rates within every JV and therefore that should be something that we have to consider going forward? So that's my first question. I do have another one. Thank you.

[Wayne Stelmar:]

That's really two questions, so let's go back to the owned question, but I'll give you credit in 1A and 1B. Let's go back to the Irvine. The Irvine margins are as I said we would love to pay the Irvine Company their profit participation as historically we've achieved significantly higher gross margin in our prior [lives] (ph) because the Irvine communities typically perform well regardless of market. So from a GAAP perspective, you're going to see a 12% to 14%. Now on the joint venture margins, we only have one joint venture community in which we had BMR units and most of those BMR units, effectively all of those BMR units, flushed out by the end of the third quarter. Absent that, the margin in that community, the gross margin in that community would have been above, well above 20%.

[Ivy Zelman:]

Okay, that was very helpful. I guess in my second question really maybe Larry you can comment with respect to the going around with fundamental Sacramento being weaker. Can you talk a little bit about incentives and what you see competitively? I know those markets near-term have been choppy. It's part of the margin weakness. How much of that is coming from selling incentives and do you think that it's stabilizing or is there a risk it's going to go down further with more incentives building as inventory in new communities come online?

[H. Lawrence Webb:]

The good news for us is, at present we only have two actively selling projects in Sacramento, and that is the weakest of the three markets we're in. But the incentives we're using today in Sacramento are still relatively low, I mean under 5% in most cases. But big picture, it's very minor in the scheme of the rest of our business. I mean it really is a small part and we have not seen incentives at all in the Bay Area or in Southern California. So is there some incentive giving in Sacramento? Yes, and some people are doing more than that, competitors, but kind of big picture, it's just such a small part of our business right now and we are monitoring it, that's all.

[Operator:]

Our next question comes from the line of Brendan Lynch with Sidoti. Please proceed with your question.

[Brendan Lynch:]

I wanted to dig in a little bit further on the JVs. As you just discussed, gross margin [protracted] (ph) a bit and revenue was down, but you also received a small percentage of the JV net income. I was hoping you could give us some color on what we should expect into '15 and '16 just based on the lifecycle of these joint ventures.

[Wayne Stelmar:]

Brendan, it is premature for us to give that guidance at this point in time. And as you know we've got 12 joint ventures. Each joint venture has a different gross margin embedded in it and it depends on whether it's housing or whether it's land, and they are really dependent upon where we are in the lifecycle of the specific joint venture.

[Brendan Lynch:]

Okay. And can you comment on how that mix will be changing going forward at this point?

[Wayne Stelmar:]

I think it's premature.

[Brendan Lynch:]

Okay, fair enough. And just my other question was on your inventory increase in the quarter. Can you just give us some color on whether you're acquiring raw or partially developed or more finished lots and the timing of when this increase in inventory might be new open communities?

[Wayne Stelmar:]

So again for the quarter, our focus, if we're talking specifically about third quarter, our focus – the impact of our acquisition activity was really the finished lots, and that was with the Irvine Company.

[Brendan Lynch:]

Okay, very good. Thank you.

[Operator:]

(Operator Instructions) Our next question comes from the line of Alex Barron with Housing Research Center. Please proceed with your question.

[Alex Barron:]

Not sure if you commented on the timing of Meridian, when do you expect to see the first closings there?

[Thomas Redwitz:]

This is Tom. Fourth quarter, so the quarter we're in right now.

[Alex Barron:]

Okay, got it. And then you said the big targets that you just have in Sacramento, I'm sorry in [indiscernible], that one is not going to be coming online till 2016?

[H. Lawrence Webb:]

This is Larry, Alex. We are grading as we sit here today and we are on schedule and moving forward and we expect to have a big grand opening on the project sometime the summer of next year.

[Alex Barron:]

Okay. What about the one in Foster City?

[H. Lawrence Webb:]

Foster City, again we're moving dirt and doing site development. We are excited about that and we expect sticks to be in the air next year.

[Alex Barron:]

Okay. And on Amelia and Trevi, how are you guys thinking about the space versus price, are you still seeing sufficient demand post the grand opening to keep pushing prices or you guys just rather keep the pace steady?

[Thomas Redwitz:]

This is Tom again. The absorption has remained even effectively since our opening, and as I think I commented last call with you, we have an eye towards conservatively increasing pricing going forward, and we'll continue to monitor it obviously based on absorption, but the trend is very positive right now.

[Alex Barron:]

Excellent. Thank you.

[Operator:]

It appears we have no further questions at this time. I would now like to turn the floor back over to the management for closing comments.

[H. Lawrence Webb:]

I'd like to thank everyone for your questions and we look forward to updating you on future quarterly calls. Thanks.

[Operator:]

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