MDC Holdings Inc (MDC) 2018 Q1 法說會逐字稿

Good morning or afternoon. My name is Michelle, and I will be your conference operator today. At this time, I would like to welcome everyone to the M.D.C. Holdings First Quarter Earnings Call. (Operator Instructions)

I'd now like to turn the call over to Mr. Ken McCarty, Vice President and Corporate Controller. Please go ahead.

Thank you, Michelle. Good morning, ladies and gentlemen, and welcome to the M.D.C. Holdings 2018 First 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.

(Operator Instructions) After finishing our prepared remarks, we will conduct a question-and-answer session (Operator Instructions) Please note that this conference is being recorded and will be available for replay. More -- for information on how to access this replay, please visit our website at mdcholdings.com.

Before turning the call over to Larry, it should be noted that certain statements made during this conference call, including those related to MDC's business, financial condition, results of operations, cash flows, strategies and prospects and responses to questions may contain forward-looking statements within the meaning of the 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 first quarter 2018 Form 10-Q, which is scheduled to be filed with the SEC today.

It should also be noted that SEC Regulation G requires that certain information accompany the use of non-GAAP financial information measures. Any information required by Regulation G is posted on our website with our webcast slides.

And now, I will turn the call over to Mr. Mizel for his opening remarks.

Thank you. I'm pleased to announce a strong start to 2018, with first quarter net income up 74% to $38.8 million or $0.68 per diluted share. The robust income growth was driven by an 8% improvement in our home sales revenues, along with a 230 basis point expansion of our home sales gross margin. We also saw a significant reduction in our tax rate following the passage of Tax Cuts and Jobs Act in late 2017.

Our industry continues to see very strong demand for affordable housing, and we have increasingly focused our land acquisition efforts on this segment of the housing market during the past 2 years. During the first quarter of 2018, almost 50% of the lots we approved were for our affordability focused Seasons brand. This market -- this marked the highest number of lots approved for our Seasons product since it was introduced. Furthermore, an additional 25% of the lots we approved were for other affordable products, including our duplex homes, our Landmark Collection and our Cityscape Collection.

It is important to note that even for our more affordable products, we continue to offer the benefits of a build-to-order model, where our customers can personalize their homes to match their own unique preferences. We believe that this approach provides us with a competitive advantage as we continue to pursue growth through this important homebuyers' segment.

The more than 4,000 total lots we approved for purchase during the quarter was our highest quarterly total in well over a decade. This reflects our continued confidence in this housing market. Given this robust land approval activity, we continue to believe that we can achieve at least a 10% year-over-year increase in our ending active community count by the end of 2018.

We are seeing favorable supply-demand dynamics in all of our markets, and our 2018 spring selling season has kicked off strongly. Our monthly sales absorption pace increased by nearly 20% year-over-year to a level that ranks as the highest we've had since the -- we've had in the first quarter since 2006.

As our company grows, our balance sheet remains a top priority. We continue to operate with a unique combination of low leverage, carefully managed exposure to homebuilding assets and liquidity in excess of $1.1 billion. Our solid financial position and strong operating results gives us the confidence to reward shareholders with a strong dividend, which effectively increased in the first quarter by 30% year-over-year to $0.30 per share. Our dividend remains unsurpassed in the homebuilding industry, both in terms of yield and consistency of payment.

With our ending backlog value up nearly 20% from a year ago, we see an opportunity for more significant year-over-year growth in revenues for the balance of the year. This also gives us the opportunity to drive enhanced operating leverage to complement our already significantly expanded gross margin percentage. As such, we are optimistic about our prospects for continued growth of the company's core pretax operating margin and return on equity in 2018.

We appreciate the support of our board and many other stakeholders as we have taken further steps to grow our business to start 2018. And as always, we are grateful to our employees for what they do every day to make MDC a successful company.

I'll now turn the call over to Bob Martin for more specific financial highlights of our 2018 first quarter. Bob?

Thank you, Larry, and good morning. As Larry mentioned, our net income increased by 74% year-over-year to $38.8 million. On a pretax basis, income improved by 39% to $50.5 million for the quarter.

Mostly due to the recent enactment of the Tax Cuts and Jobs Act, our tax rate dropped from 38.8% to 23.3% for the 2018 first quarter, which was a big factor in our net income increase. The 23.3% rate was below the estimated 25% to 27% range we provided during our last earnings cycle, primarily due to the Section 45L energy-efficient home credit, which was retroactively extended earlier this year to include qualifying homes that closed in 2017. Based on our current estimates, this item resulted in a discrete tax benefit of $1.2 million or 240 basis points for the 2018 first quarter. For the full year, we are now estimating a lower range for our effective tax rate, between 24% and 26%. This estimated range assumes no additional discrete items during 2018.

Our home sale revenues for the 2018 first quarter were up 8% to $607.7 million, primarily due to a 6% increase in our average selling price. Our backlog conversion rate was 40%, which was on the top end of the expected range for Q1 that we discussed on our previous call. Looking forward to the second quarter, we estimate that our backlog conversion rate will be in the 39% to 40% range, lower than the 42% backlog conversion rate we achieved in the second quarter of 2017. The potential for a lower conversion rate is primarily a result of the strong sales we experienced at the end of the 2018 first quarter as these homes are in our quarter-end backlog, but most are not likely to close in the second quarter.

Our overall average cycle time, defined as days from start to finish, was almost unchanged year-over-year for build-to-order closings. Our West segment improved, but was offset by longer cycle times in our Mountain and East segments. In the case of our Mountain segment, the increased cycle time was mostly the result of the previously disclosed Weyerhaeuser issue in Colorado, which impacted 71 of the closings we had in Colorado during the quarter. On that note, we had 51 homes remaining to close at the end of the first quarter related to the Weyerhaeuser issue. Most of these homes should close in the second quarter.

As for product mix, 11% of closings for the quarter were from our Seasons Collection versus only 5% a year ago. We had Seasons closings in our Colorado, Arizona, Florida, Nevada and mid-Atlantic markets. Furthermore, 2 additional product lines that we have recently developed with affordability in mind, our Cityscape and Landmark Collections, contributed an additional 10% of Q1 closings.

Our gross margin from home sales was up 230 basis points year-over-year to 18.2%. This represents our highest level since 2010 as well as our largest year-over-year improvement since 2013. It was also 90 basis points higher than the gross margin for home sales that we realized in the fourth quarter of 2017. The impairments included in our cost of sales were $600,000 for the quarter, down from $4.9 million in the same quarter a year ago. All of our segments realized an improvement in the gross margin from home sales, with the West segment showing the largest improvement.

Because supply-versus-demand dynamics were favorable in our markets, we were able to increase pricing in nearly 80% of the communities that were active to start the quarter. With our higher gross margin and the increase in our overall average selling price, the amount of gross profit dollars that we have generated per closing rose by about $15,400 to $86,700 in the 2018 first quarter, our highest level since 2006.

We continue to have a positive bias with regard to our gross margin from home sales, with our quarter-end backlog indicating the potential for further improvement from the Q1 2018 closing level of 18.2%. However, it should be noted that the gross margin level we actually realize from our backlog in future periods could be impacted by cost increases, cancellations, impairments, reserve adjustments and other factors.

Our total dollar SG&A expense for the 2018 first quarter was up $5 million from the 2017 first quarter. This was driven mostly by the hiring we did last year to plan for the growth we are now experiencing. As a result of that hiring, our general and administrative headcount to start the quarter was up by 14%. However, with home sales revenue increasing 8% year-over-year, our SG&A rate was virtually unchanged at 11.7%. With many key positions already filled in 2017, our rate of hiring slowed during the first quarter as we added only 1% to our general and administrative headcount. However, we believe there could be some upward pressure on wages given the tight labor market overall.

The $35.8 million of general and administrative expense recognized during the quarter is a reasonable estimate for our run rates as we did not recognize any significant infrequent charges or benefits during the quarter. However, this amount is nonetheless subject to variation from quarter-to-quarter based on the timing and expense of any additional reserves or accruals that may be required in future periods. I encourage you to review our 10-Qs and 10-Ks to find additional detail about certain known items that could cause variability in the general and administrative expense we recognize in future periods.

The dollar value of our net orders increased 15% year-over-year to $863.7 million, driven by a 19% increase in our monthly absorption rate as we saw solid demand in most of our markets across the country. The acceleration of our absorption rate was offset somewhat by a 7% decrease in our average active subdivision count. The average price of our net orders was $453,600 for the quarter, up 3% from the same quarter a year ago.

We continue to be successful in marketing our Seasons product to buyers looking for affordable homes. For the 2018 first quarter, Seasons accounted for 15% of net new orders, up from 8% a year ago. Certain of our other new collections, which are also designed to address affordability in different ways, contributed an additional 11% of all net orders for the quarter compared to only 6% a year ago. We ended the quarter with an estimated sales value for our homes in backlog of $1.88 billion, which was up 18% year-over-year, based on an increase in units and, to a lesser extent, average selling price.

Overall, our cancellations were up slightly year-over-year, from 13% to 14% as a percentage of our beginning backlog. I will add that we have seen continued strength in April, with a year-over-year increase in unit net orders that exceeded the 12% increase we saw for unit net orders in the first quarter.

Active subdivision count was at 155 at the end of the 2018 first quarter, up slightly from 151 at the end of the 2017 fourth quarter but down 3% from 160 a year ago. We continue to see the largest decreases in the mid-Atlantic market in our East segment, where we previously disclosed a lower level of investment due to returns that did not meet our expectations. Our Mountain segment had a 21% increase in active community count as a result of our significant investment into the Colorado market over the past 2 years.

Looking at the graph on the right, we have one more subdivision in the category we call soon-to-be-inactive than in the soon-to-be active category to end the quarter. This tells us that our active community count is not likely to change much during the second quarter as compared with the end of the 2018 first quarter, though this analysis is far from a perfect indicator. Nevertheless, we continue to target at least a 10% year-over-year increase in active subdivision count from the 151 active subdivisions at the end of 2017 to the end of 2018.

For the 2018 first quarter, we acquired 2,504 lots, up 91% from a year ago. We acquired lots in almost every state in which we operate, with the heaviest concentration in our West segment, which accounted for 60% of the acquired lots. Approximately 47% of the lots were -- acquired in the first quarter were finished lots. Acquisition spend for the lots was $192 million. After accounting for an additional $64 million of development costs, our total land spend for the quarter was $256 million, the highest level of quarterly land spend we have seen in over a decade and nearly twice the level from a year ago.

The lots we acquired in the first quarter covered 49 communities, including 36 new communities. From a product mix standpoint, 23% of the lots acquired during the 2018 first quarter are intended for our Seasons Collection, and an additional 23% of the lots we acquired are intended for other affordable product that has been developed in recent years.

We approved 4,072 lots for acquisition during the quarter, with each state represented in the total. This was more than double the lots approved for acquisition in the first quarter of 2017.

Looking at product mix. Our Seasons Collection represented 47% of these lot approvals, which was the most Seasons lots approved in a quarter since approving our first Seasons community in the first quarter of 2016. And our other new affordable products accounted for about 25% of the total lots approved.

At the end of the quarter, we owned or controlled 21,453 lots, up 44% year-over-year. This represents about a 3.9-year supply on a trailing 12-month delivery basis, which is up from 2.8 at the end of the same quarter a year ago. Given the growth in absorption rates that we have already seen as a company, on a forward-looking basis, we believe that this lot supply is shorter than a 3.9-year supply.

With a significant amount of lot approvals during the quarter, the percentage of our lots controlled via option increased to 34% at the end of the 2018 first quarter from 20% at the same point a year ago.

Our last 12 months core pretax return on equity is up 40 basis points year-over-year to 13.8% at the end of the first quarter of 2018 after excluding a onetime $52 million gain recorded in the third quarter of 2017 related to the sale of investments.

With the expansion of our gross margin, our homebuilding operating margin, defined as our gross margin for home sales minus our SG&A rate, grew by 220 basis points year-over-year. With our backlog value up 18% year-over-year and backlog gross margin showing continued strength, we are optimistic about further improvement for both our core homebuilding operating margin and return on equity in 2018.

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

(Operator Instructions) The first question comes from Michael Rehaut from JPMorgan.

This is Neal BasuMullick in for Mike. So I guess starting on gross margins, looking at the last few quarters and then the strong result this quarter, what do you see as the big drivers of your improvement? And which pieces do you think are sustainable? Recognizing that your gross margins and backlog are above this quarter.

Yes. I think it's a focus on pricing. I think we're doing a good job of balancing absorption rate and increasing prices. As I indicated, we increased prices on about 80% of our communities during the first quarter of 2018. And if you look out there in the environment, across just about every one of our markets, I think there really is a positive supply-demand dynamic that we have out there. And that's really giving us an indication that we can continue to maintain these kinds of margins. Also, you see that in our backlog, as you just referenced, as that level is higher than what we closed in Q1 of 2018.

Okay, that's helpful. And then, I guess, looking at the accelerated investment toward Seasons this quarter, do you see the community mix next year changing a bit? And then do you see a little bit of gross margin lift associated with that?

Yes. I do see Seasons becoming an increasing percentage of our overall closings as we move into 2019. And in the first quarter of 2018, the margin on the Seasons product remained higher than our gross profit margins overall. So we certainly could see that play out because of the mix of product, further enhancements to our gross profit margin. And that's something I probably should have mentioned in the first part of my response.

And your next question comes from John Lovallo from Bank of America.

The first question is, although interest rates are at very low levels here, historically, there's obviously a fair amount of investor concern that order growth is going to stall here across the industry. So in your opinion, is this kind of an overblown stock market concern? Or are you sensing any hesitation on the part of buyers given the move in rates?

Well, I don't know if you caught it in my remarks, but as we looked into April, the year-over-year increase in our orders was bigger than for Q1. So that's really the latest data point that we have. We don't see that resistance at this point. As I think about it, from a high level, I think about periods of time in our history, in our country's history, where interest rates have been much, much higher, and yet volumes have also been higher. So I don't think interest rates necessarily correlate directly with how much demand is out there. And then I guess the other thing I would put out there is there's not a whole lot of supply out there as well, so that is certainly helpful in our efforts.

Okay, that's very encouraging. And then now that we're kind of in the middle here of the spring selling season, any better sense of how we should think about kind of the cadence of community count as we go through the remainder of the year?

Well, I provided that graphic on the soon-to-be active versus soon-to-be inactive. It's almost a dead even, those 2 metrics. And that tells us that over the next quarter, there's not a whole lot of likelihood that that's going to pop in the second quarter. We're still holding firm with our notion that by the end of the year, it's going to be up 10% year-over-year, at least. It's really tough to tell exactly how that shakes out quarter-by-quarter, because it can be an issue of getting the community count -- the communities open on time, but it can also be an issue, which we've seen to some extent recently, of selling out of communities too quickly. And sometimes that happens literally on the last day of the quarter that you sell out a community. So the timing is a little bit difficult, but that's kind of the color I can share at this point.

And your next question comes from Alan Ratner from Zelman Associates (sic) [Zelman & Associates].

So first question. You guys are obviously making a big push at entry level, and it looks like it's paying some dividends here. Given your strategy is more of a build-to-order approach, which means that your buyers sit in backlog for several months before closing, I was curious if you might have some maybe analysis or statistics on the mortgage side of the business related to your entry-level buyers in terms of how much, can they absorb if rates were to go up higher? Can you share anything on their debt-to-income ratios, how much they're putting down as far as a down payment, FICO scores, anything that gives you some comfort that if we do see a sudden burst in rates before they have to close, assuming they're not locked in, that you won't see cancellations spike?

Yes. I don't have it broken down like that at this point. I will tell you, we do have programs out there to try to make sure people who are sensitive to rate can, in fact, close if there is an increase in rate. An example of that would be interest rate lock programs that we have out there regularly. And I think you hit it on the head talking about interest rate shock. I mean, truly, if there is a big burst in interest rates in any given period, that's more of a concern than a gradual rise in interest rates, which seems to be more of what we're experiencing right now, although I know that's really a new thing over the last 6 months or so that rates are starting to come up. So we're comforted by the fact that rates don't seem to be out of control at this point, but those are some of the things that we have in our pockets to try to manage that risk.

Got it. And then second question, a big pickup in your land activity the last few quarters. We're hearing there is increased competition on the land side at the entry-level segment as more builders are making a push there. Can you talk a little bit about the dynamics you're seeing in the land market today? What type of inflation are you seeing for finished lots, which I presume you're primarily buying finished? And then just in terms of the land sellers' willingness to operate those deals on terms, rolling takedowns, et cetera, any commentary you can give us on the land market would be great.

Yes. I think that, first of all, we do try to buy finished, but only 40% of what we -- 47% of what we bought in the quarter was finished. And of those lots that we approved during the quarter, only 25% of those were finished. So I think that's absolutely right, the finished lot market is very competitive, if it's even present in certain markets. There are certain of our markets where there's just no supply of finished lots, and you have to develop. So it is competitive, and it's tough to say exactly what a kind of a year-over-year inflation in lock price is, simply because of the mix of houses out there. It goes somewhat in line with how home prices increase, as I think you know. So I think the good news is we've been -- we've got a very good land team that is set up in each of our markets that's been able to capitalize. I wouldn't say necessarily, we're getting rolling option deals. Typically, most deals are happening in bulk or maybe phased, phased purchases, so not a whole lot new to report on that front.

And your next question comes from Stephen Kim from Evercore.

This is actually Chris on for Steve. Just piggybacking off of the question about community count earlier, so given your difficulties in increasing community count for the past 5 quarters, and now that you expect community count to be flat next quarter, I guess what's driving your confidence in achieving this year-end target?

Well, there's a couple of things. First of all, it goes without saying, I mean, we have a great team on the ground. We increased our employee count last year by about 14%, and that helps us to have more boots on the ground to get those communities open. Second, you've seen the lot approval activity over the last few quarters, so it's not just this quarter. It's been the last few quarters before that, too, where this land activity has been happening. So this has been in process for a while. So as we sit here at the end of the first quarter, we have about double the number of communities than we did a year ago that are kind of in that category where they haven't even gotten to the soon-to-be-active phase. So we're working hard on those. We think we've got a great process for getting those open, and we're confident in this kind of market that we can increase by about -- by at least 10% by the end of this year.

Yes. It's Steve Kim, actually, also. So that sounds like it's a little bit of a pig and a python kind of a situation, which should carry over into 2019. Just want to make sure that we kind of understood the dynamics, although I know you're not giving guidance into 2019. And then my second question, lest I get cut off, is related to the comment that you raised prices at 80% of your communities. Obviously, a great stat, but probably, you also saw some cost inflation, I would gather, too. So I was curious if you could take a stab at what percent of your communities you saw that were open in the -- well, that you saw in the quarter were able to see margin improvement, gross margin improvement or raise price ahead of costs in the quarter. How broad-based was that?

I -- we don't track it like that, Steve, on a, I guess, community by community, how much price increases offset cost increases. I think the evidence speaks for itself when you talk about 230 basis points of margin expansion and a backlog even higher still as evidence that our focus on pricing is working. And no doubt about it, whether you talk about community count or you talk about margins, what happens in the future, what happens with labor, subcontractors, municipalities to get communities open, to be clear, all of those are risks, whether it be to our community count or to margins. But what we saw in the first quarter was an ability to overcome those risks and really a very strongly operating unit at this point.

Your next question comes from Dan Oppenheim from UBS.

I was wondering if you can talk a little bit about the backlog conversion. You talked about 2Q being a little bit lower based on the orders coming late in the quarter. I guess I'm wondering how the orders were spread out during the quarter relative to 2017. And also, any benefit from Seasons with those taking a little bit less time in terms of held payments?

Yes. I think in terms of Seasons, we do see that having a benefit over time. I think it ends up being maybe a little bit more towards the end of the year, the fourth quarter, that it becomes notably bigger as a percentage of closings and, therefore, notably accretive to our backlog conversion rate. So that is a positive benefit from that product. But remember, it's still only about 11% of our closings right now. As far as the monthly -- let's just go look up that really quick. I believe the month of March was our biggest year-over-year increase during the quarter. That was our biggest year-over-year increase during the quarter, the month of March relative to February and January.

And was that both in terms of the absorption -- and it looks as though the -- since the community count will be up sequentially in 2Q or thereabouts. Is that a function of just the -- some communities starting to open up? Or was it just the absorption per community?

I think the absorption per community was the strongest in March as well.

Your next question comes from Stephen East from Wells Fargo.

This is Paul Przybylski on for Stephen. Subsequent to us moving through the 18% gross margin in backlog, is it fair to assume that the land coming to market over the next 12 to 18 months has a pro forma gross margin at a similar or better level?

Yes. Pro forma, we're keeping our same disciplines as we approve these new deals. Of course, as you know, the margins we get on any individual deal depends upon the risks involved, are they finished lots versus lots to be developed and things of that nature.

Okay. And I'm not really familiar with the Cityscape and Landmark product. Can you tell us how that differs from Seasons?

Yes. So first of all, Landmark product, essentially what we did with Landmark is we took some of our historical series, and we did a little bit of redesign and reengineering, took out costs, and it allowed us to decrease prices as well, say, by $15,000, $20,000 on those kind of communities. So you're talking in the kind of 5% to 10% range. So it's not as extreme a price drop as Seasons is. It's closer to our traditional product, but it still gives you that opportunity to reach additional consumers who may be trying to stretch to that, somewhere between the first-time and move-up part of the market. The Cityscape Collection is a more modern, contemporary type of product. You might almost mistake it for a townhome if you look at it on first glance. But really, the thing about Cityscapes is it's a much denser product. You can build more of them per acre and therefore drive your price down that way. So in the case of the Cityscapes, we've been able to do that a little bit more in areas that would be considered infill, areas that may not want just the same old single-family detached house, wants something a little bit newer, a little bit more affordable for their area. And that's been highly successful for us as well. The third leg of the stool is duplexes, which is much more in its infancy for us, but we're starting to implement that product here in Colorado, first and foremost. Just had a few sales of that during this last quarter.

(Operator Instructions) Your next question comes from Nishu Sood from Deutsche Bank.

This is actually Tim on for Nishu. So I guess quickly, on the gross margin, so another strong, strong quarter, and I guess that's kind of what you're expecting to carry over to next quarter. Just curious, some of the guidance that you provided last time obviously is discussing -- discussions of the backlog gross margin. But just curious, was there anything that happened in the quarter that maybe improved that throughout the quarter? Obviously, you're moving away from specs, but maybe was there a bit of a tailwind from additional pricing power that you had in that aspect of the business?

Well, I mean, I think the additional pricing power you would have been talking about what we realized a couple of quarters ago since we're a build-to-order model, not what we have during the quarter. I mean it -- the backlog buildup, we reported on that last quarter, we reported that the backlog was -- the gross margin was higher than what we had experienced in the fourth quarter. So really, that was the first point at which we gave the indicator that the gross margin had room to move, in our opinion.

All right, understood. And then I guess thinking about April. So obviously, you've gone through it. March was up substantially, very strong. So I was just curious, could you provide some color on how April was trending relative to last year and, I guess, relative to what you see in the first quarter -- or what you saw in the first quarter?

Yes. And I made a comment on it earlier that you may have missed. So the year-over-year increase in net orders for April was bigger than the year-over-year increase we had for net orders in the first quarter. So we viewed that as a positive indicator, although it is just one month worth of data. And we'll see how the rest of the quarter progresses.

I have no further questions in queue. I'll turn the call back over to the presenters for closing remarks.

Great. Well, I appreciate everyone for being on the call today. And I look forward to having you again on our call when we report results for our second quarter.

Thank you, everyone. This will conclude today's conference call. You may now disconnect.