MDC Holdings Inc (MDC) 2015 Q2 法說會逐字稿

Good afternoon. We are ready to begin the MDC. Holdings, Inc. second-quarter earnings conference call. I'll now turn it over to Kevin McCarty, Vice President and Corporate Controller. Sir, you may begin your call.

Thank you. Good morning ladies and gentlemen, and welcome to MDC Holdings 2015 second-quarter earnings conference call. On the call with me today I have Larry Mizel, Chairman and Chief Executive Officer; and Bob Martin, Chief Financial Officer.

(Caller Instructions)

Please note that this conference is being recorded and will be available for replay. For information on how to access the replay, please visit our website at Mdcholdings.com.

Before turning the call over to Larry, certain statements during this conference call including those related to MDC's business, financial condition, results of operation, cash flows, strategies, and prospects and responses to questions which may contain forward-looking statements within the meaning of Private Securities Litigation Reform Act of 1995. These statements involve known and unknown risks, uncertainties, and other factors that may cause the Company's actual results, performance or achievements to be materially different from the results, performance, or achievements expressed or implied by the forward-looking statements. These and other factors that could impact the Company's actual performance are set forth in the Company's second-quarter 2015 form 10-Q which is scheduled to be filed with the SEC today.

It should also be noted that the SEC Regulation G requires that certain information accompany the use of non-GAAP financial measures. Any information required by regulation G is posted on our website within our webcast slides. And now I will turn the call over to Mr. Mizel for his opening remarks.

We are pleased to announce 2015 second-quarter net income of $20 million, or $0.41 per share. The quarter was highlighted by a rebound in our gross profit margin percentages, which improved by 120 basis points from the 2015 first quarter. The improvement is almost entirely the result of our effort to reduce spec inventory, which has been a key focus for us over the prior few quarters. As a result of this effort, we are now seeing a higher percentage of our total deliveries coming from dirt sales. In addition we have seen sequential improvement in the margin on the specs we did deliver.

Microeconomic environment continues to provide support for the homebuilding industry during the second quarter. For the most part, information on key indicators such as employment levels and consumer confidence remain positive. Additionally, interest rates remain low during the quarter. There does not appear to be much pressure to raise rates significantly in the near term because of the impact of global economic concerns and other factors remain unclear.

Again this backdrop we have seen stable demand, as our second-quarter absorption rates for new home sales was unchanged from a year ago. We are pleased to see this steady pace of sales, especially considering that we have reduced the availability of spec inventory per subdivision by almost 40% year over year and have increased prices in most of our subdivisions since the start of the year. Both of these actions should provide support of our gross profit margins in the future periods, which continue to be a priority for us.

Our backlog at the end of the quarter had a sales volume of $1.1 billion, up 48% year over year, the highest we have seen since 2007. Given our recent focus on dirt sales, our backlog is converting more slowly than last year. Because of this, we anticipate that our closings for the balance of the year may be weighed more heavily towards the fourth-quarter closings than normal.

Our active community count declined modestly during the second quarter, driven by delays in the opening of new communities in some markets. However, we expect to see our community count grow in the second half of 2015. Furthermore, we have seen strong deal flow in most of our markets, which has the potential to add to the more than 14,500 lots we had under our control at the end of the quarter. With one of the strongest balance sheets in the industry, and liquidity exceeding $840 million, we remain well-positioned to consider these opportunities in support of our future growth.

Thank you for your interest and attention. I will now turn the call over to Bob Martin for more specific financial highlights of our 2015 second quarter. Bob?

Thank you, Larry. We delivered 1126 new homes during the quarter, down 3% versus 1158 and the prior year. Our second-quarter backlog conversion rate came in at 51%, which was in line with the information we provided last quarter. However, it was down significant we from 71% a year ago. The lower conversion rate was largely the result of our previously announced initiative to reduce our overall investment in spec inventory.

With our reduced spec supply, the number of specs we sold and closed during the quarter decreased by 37% year over year. And overall, specs accounted for only 50% of deliveries compared to 67% in the 2014 second quarter. We have also seen some delays in our construction process, due to limited subcontractor availability in various markets and wetter than normal conditions in Colorado, which is our largest market.

Looking forward, we expect our third-quarter backlog conversion rate to decrease sequentially to the mid- to high 40% range before rebounding in Q4, consistent with our typical seasonal trend. The expected third-quarter conversion rate is moderately below our long-term historical average as we continue to transition our focus back to a higher proportion of dirt sales.

Our average price increased by 10%, or $38,000 per home, to $410,000, primarily the result of the mix shift to higher priced submarkets, but also due to our efforts to increase prices since the start of the year. Year over year, most of our divisions experienced increases in average home price. Some of the larger price increases include Florida at 45% and Nevada at 17%, largely due to higher price product or submarkets. On the other hand, we saw 16% increase in Colorado that we attribute more to price increases, with some impact from mix.

The increase in average price more than offset our decline in closings. And as a result, our second-quarter home sale revenues were up 7% year over year, to $462 million. Our gross margin from home sales excluding impairments was 16.6%, which was 70 basis points lower than the 2014 second quarter but 110 basis points higher than the 2015 first quarter. The year-over-year decline in gross margin was largely the result of increased land and construction costs, which was partially offset by a decrease in our interest and cost of sales as a percentage of home sales revenue. The sequential increase in our gross margin was primarily driven by the reduced percentage of our deliveries coming from spec homes, which typically have a higher incentive than dirt sales, combined with a decline in incentives on the spec homes we did deliver during the quarter.

Our estimated gross margin in backlog at the end of the second quarter again moved slightly higher on a sequential basis. We are encouraged by the continued improvement and we'll continue to work on striking an appropriate balance between maintaining sales velocity and increasing prices for the balance of the year. The impact of the sequential increase in backlog margin on Q3 closings will depend on, among other things, the mix of units that pull through and the impact of specs that sell and close during the quarter.

On the SG&A and operating leverage front, our home building SG&A expense rate experienced a 30 basis point increase, driven partly by $2.5 million in higher net legal expenses, as the second quarter of 2014 benefited from a sizable settlement. We also saw an increase in marketing costs, driven partly by higher costs associated with our models. As a percentage of home sales revenues, our sales commissions remained consistent, both year over year and sequentially at 3.3%.

Our net new orders for the quarter were up a modest 4% over the prior year, which represented our fifth consecutive quarter of year-over-year order growth and our highest second-quarter order level since 2007. The growth was driven mostly by an increase in our average active community count, which increased 3% year over year.

Our monthly absorption rate of 3% was virtually unchanged from the prior-year period, which we believe shows evidence of continued solid demand, given that we increased prices in 79% of active communities in the first quarter and 64% of active communities in the second quarter. Because of our reduced supply of specs, only about 25% of gross orders came from specs for Q2 compared to 46% a year ago.

The dollar value of our orders increased 16% year over year to $630 million. The increase in dollar value is the result of an 11% increase in our average order price to $425,000 due to the price increases I mentioned in most of our active subdivisions during the first half of the year coupled with a shift in the mix of net new orders to higher price communities.

From a regional perspective, we experienced the most strength in our Nevada, California and Colorado operations with monthly sales absorption rates of 4.6%, 4.4%, and 3.2% respectively for the quarter. These also were the division that showed some of our largest average price movement, with increases of 17%, 18% and 10% respectively.

As a result of the higher quarterly order activity we have achieved over the last year, our homes in backlog to end the second quarter were up 36% year over year on a unit basis to 2558 homes, with a value of over $1.1 billion, which was up 48% year over year. With respect to our spec inventory, after reducing our supply significantly during the first quarter, our overall spec level was stable in the second quarter at 4.4 units per active subdivisions. The number of finished specs per active subdivision, however, continued to decrease in the second quarter. Our total specs were down 456 units year over year, or 40%, to 688 units. And as I mentioned earlier, we believe that our lower supply of specs is positively influencing our gross profit margin.

Our ending active community count was at 156, down slightly year over year. You can see from the chart we've included on the left that this number has been up and down over the last five quarters. On the chart to the right, note that our soon-to-be-active subdivisions now exceeds our soon-to-be-inactive subdivisions by 17, a big jump from the end of the first quarter, and an indicator that we may see growth in our active community count as early as the third quarter. And while new community openings and project closeouts can be somewhat unpredictable, we still expect to see our year-end community count up compared to the count at the end of 2014.

During the quarter we acquired 719 lots and spent approximately $134 million total on land and developing costs. At the end of the quarter, we under-controlled 14,670 lots, which represented about a 3.4 year supply on a trailing 12-month delivery basis. We believe this land supply gives us the potential for continued growth as we look forward to 2016. However, land acquisition remains a priority for us as we work through the third quarter. We continue to see a good pipeline of deals coming in for review, and we are carefully evaluating each one for the appropriate balance between risk and return.

That concludes our prepared remarks. At this time, we would like to open up the call for questions.

(Operator Instructions)

Will Randow, Citigroup.

Hi, guys. And thanks for taking my questions. And congrats, Bob, on the promotion.

Thank you. I appreciate that.

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

Well, we, over the past 40 years have only done a very few M&A. We've basically -- we're in the business of acquiring assets, not legacy liabilities. And the mergers, I think, are good. The stronger the industry, the better the discipline that companies exemplify since this has become a more sophisticated business and you need to have access to the capital markets. And the larger companies continue to have more efficient access through better pricing and less restrictive covenants.

So I was glad to see the transaction take place. I'm sure they'll be highly successful. And throughout the period of time that we've been in the business, we've seen most of these transactions go kind of through a gestation. They take a little period of time of usually a year or two to kind of get it all sorted out, and I think it's good. Our direction is consistent, as it always is, is we look for the opportunity to acquire quality land at a competitive price. And that's the direction we will continue to follow.

Thanks for that. And just as a follow-up, is there any chance you guys could provide some color around if similar to other builders, your July 2015 orders held in flat to up single-digit rate? And how much improvement you're seeing in gross margins in your backlog versus what you were seeing last quarter?

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

Alan Ratner, Zelman and Associates.

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

I would say that people that have bought our homes have a compelling value and they're not looking to -- the conversion factor -- we've had some rain in some parts of the country. So we've had some slowdowns caused by weather. And, of course, it affects both sales and construction. And we're dealing with it. And the good thing is we have a healthy backlog. And some of the performance we expect to see in the fourth quarter versus the third quarter, and maybe some will roll over. But we are focused in moving forward, and we have not had the issue of holding people into the backlog because of construction.

And Alan, I would just add a little bit onto that. I mean, clearly as I mentioned in my comments outline, we have been a little bit more biased on increasing price for the past quarter. I would also say in terms of lot releases, that has been something that we have implemented in Colorado, limiting our lot releases to help try to let production catch back up.

Thanks for that, Bob. Second follow-up question, there, I guess separate. On the land pipeline comments, I think you have had similar comments in recent quarters as well. And the lot acquisition slide, it looks like you are continuing to lag behind what you're delivering every quarter. I think your lot count's down about 12% year over year. Where specifically are you seeing these deals? What type of deals are they?

I mean, are they skewed more towards entry-level lots, or are they more in the B and C locations? Or are you seeing more capital to the developers returning to the market, which is allowing you to get more just-in-time option type takedowns? Just curious if you can give us some color there because I think the land acquisition now has really lagged behind your deliveries for several quarters now.

Well, one thing, just going back a little bit in history, our basic guideline was two to three years. Just-in-time is very efficient, and that's what we've done through the various cycles. And what we see now is a little bit more deal flow. And some of the other builders have a full balance sheet of land.

You can certainly see, if you model how many years of land everybody has, some of them, their cup runneth over, as they say. And we're only interested in what we believe are A locations. And so therefore, we are very discriminating in how we approach it. We are very, very active, And we will transact when the economics are correct. And we also have a lot of discipline. And as you can see, we have an adequate land supply for what we need for the immediate future. And that's consistent with how we operate.

Michael Rehaut, JPMorgan.

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

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

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

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

Great. Thanks a lot.

Sure thing.

Stephen East, Evercore ISI.

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

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

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

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

Ken Zener, KeyBanc

Afternoon, gentlemen.

Afternoon.

With the decline in the lot count, Bob, you said the best way to look at it is stabilizing. But Larry, I wonder if you could expand on -- I think you said the cuppeth flow -- full cups of land for some other builders. Given your liquidity position, what is your kind of outlook? Do you think you're in that range in terms of land supply that you want? But obviously if you are able to perhaps pick up some land, as other people's cups are full and they are not looking to do it, is that, as you look to the back half of the year, something that you're more positive about now versus, let's say, three, four, or five months ago in terms of perhaps land deals?

Or are you already [ex-positions] that you're comfortable in? You've obviously increasing a lot of Nevada. In the mid-Atlantic it looks like you're decreasing your community count. If you could just expand, because you're liquid and because you're stabling, then you could perhaps improve your owned lot position and, importantly, your cost. Thank you.

I think that as we look at the markets that we're in, we're pretty and clearly identified markets of where we want to be. I believe that we have the ability and the desire to grow. And we will look at the opportunities that come in on the land. And I would say that we're absolutely open for business for the right kinds of transactions. And I'm comfortable where the market is. You probably read the same thing we read where household formations are at 3 times what they were five years ago. And I think that's a pretty hot deal with wage growth going and employment looking strong and kids finally being thrown out of their homes and have to go to work and get married and decide that owning apartments is not really cool because they don't end up with anything except a rent receipt. I'm optimistic, cautiously optimistic, very cautiously.

I'm looking at our General Counsellor. He is looking at me, what do you mean, you're cautious? Okay. So the point being is the basic elements in the economy are slow but steady in the growth of our economy. And I think housing is slow but steady. But we have this growth in household formations that's pretty unusual. And this has continued, now, I think this was the third quarter in a row that there's been this growth in household formations. And I see that as the potential in the housing market in general. And so that's kind of a longer answer to say that we're looking for good land deals, and we hope to continue to acquire them on favorable basis.

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

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

Nishu Sood, Deutsche Bank.

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

Nishu, I'll take that one first. I think generally we, as I said before, we have been biased towards increasing prices where appropriate versus driving the pace. So price increases have definitely had some impact in most of our markets. I would also say the decrease in our spec inventory has had some impact as well.

As I listen to your comment about the sequential change, the most impactful decrease across our markets was in Colorado. That was down 15% on a sequential basis for our absorption pace. And I already mentioned that weather has been an issue in this market with the rainfall totals for the first half of the year nearly double what the average is for Colorado. That rain slows our production and gives us really an incentive to slow down our absorption pace. And we did that in two ways during the second quarter in Colorado. First, the price increases that I already mentioned. And then second, we also did limited lot releases, as I had mentioned earlier on the call. I think it's probably likely that we could have done some incremental sales in Colorado if we had not limited those lot releases. So hopefully that provides you a little bit of color about one of our major markets.

No. That's very helpful. Bob, I wanted to ask you also about the backlog conversion ratio, which you indicated would drop, I think you said, to the high 40%s in the third quarter as you transition away from specs and more towards a to-be-built. So would that transition happen mostly during the third quarter? So we should be returning more to a normalized turnover ratio for 4Q, which I think would be probably around 60%? Or is that transition going to extend into 1Q of next year?

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

Jay McCanless, Sterne Agee.

Good morning, guys. First on the weather issues in Colorado, are you past most of those now? Or do think some closings or some community openings are going to be pushed into 2016? And if so, could you give us some numbers around that?

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

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

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

It may have been 2006?

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

(Operator Instructions)

Alex Barron, Housing Research Center.

Thanks. Good morning, guys. Going back to the issue of the lowered delivery guidance for third quarter, was any of that related to any kind of labor-related shortages? And also do you expect that to be pretty much across the board, or is there any one state that's going to be more impacted, the lower conversion rate than other?

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

Okay. And as far as SG&A leverage, it looks to me like this quarter you didn't get much. Do you expect in the second half you will see some more SG&A leverage?

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

Okay. Appreciate it. Thanks.

There are no further questions at this time.

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

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