Q4 2022 MDC Holdings Inc Earnings Call
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Good day and welcome to M. D. C Holdings 2022 fourth quarter earnings Conference call. All participants will be in listen only mode did you need assistance. Please signal a conference specialist by pressing star.
Zero on your telephone keypad. After today's presentation, there will be an opportunity to ask questions to ask a question. You May Press Star then one on your telephone keypad to withdraw your question. Please press Star then two please note. This event is being recorded I would now like to turn the conference.
Over to Derrick, Kimberly Vice President and Chief Accounting Officer. Please go ahead.
Thank you good morning, ladies and gentlemen, and welcome to M. D. C Holdings 2022 fourth quarter earnings Conference call.
On the call with me today, I have Larry Mizel, our executive Chairman.
David <unk>, Chief Executive Officer, and Bob Martin Chief Financial Officer.
At this time all participants are in a listen only mode.
After finishing our prepared remarks, we will conduct a question and answer session at which time, we request that participants limit themselves to one question and one follow up question. Please.
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 MDC Holdings Dot com.
Before turning the call over to Larry and David It should be noted that certain statements made 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 may contain forward looking statements within the meaning of the private securities.
Litigation Reform Act of 1095.
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 2020 to Form 10-K, which is expected 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 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. Michael for his opening remarks.
Thank you for joining us today.
For a review of our operating results for the fourth quarter and full year 2022 and then update of our strategy for navigating today's new home landscape.
M. D. C. We reported net income of $562 1 million for the 2022 full year or $7.67 per diluted share representing one of the most profitable years in our company's history.
We generated 5.6 billion and homebuilding revenues and produce a gross margin from home sales up 22.4%, which is a testament to the strong demand environment, we experienced earlier in the year and solid exit.
Houston by our homebuilding teams.
Despite persistent operational headwinds.
We are proud of these accomplishments and I want to thank all of our team members for their contributions in making 2022 such a profitable year.
As we turn our attention to 2023.
We face a much different housing environment than the one that was in place at the beginning of 2022.
Demand tail wins, we enjoyed in 2021 in the first half.
Of 2022, namely low mortgage rates and high consumer confidence turned against us in the second half of the year, creating a much more difficult selling environment.
<unk> became more cautious and the value proposition that home ownership presented became much less compelling.
Combination of rapid home price appreciation.
And higher financing costs.
These headwinds led to a sharp drop in new order activity and a big increase in cancellations in the third and fourth quarter.
Resulting in a much smaller backlog.
Start 2023 as compared to the beginning of 2022.
In response to these new market realities, we have taken decisive steps to adjust our business practices and stay competitive in our markets. We delivered a significant portion of our high margin backlog in the third and fourth quarters of 2022.
Allowing us to be more aggressive in our approach to pricing and incentives as we enter the spring selling seasons.
We realize that most home buyers are trying to solve for a monthly payment that meets their budget and.
And we have multiple levers that we can use to address their affordability needs.
In addition, we have increased and expect to continue to increase our spec home construction starts.
[noise] appeal to buyers, who are willing to forego some personalization with their homes in exchange for faster close.
This should keep our inventory turns moving in the right direction help.
Help reduce our cycle times and reduced the number of cancellations as compared to the previous two quarters.
Another way, we're bringing our cancellation rate down is through higher deposit requirements and our build to order homes buyers in general most now put down 5%.
Order for us to move forward and they new build versus the 2% we required and more favorable times. In addition, we have modified our deposit requirements on options and upgrades purchased at our home galleries Studios.
These changes should result in a more stable backlog and give us better visibility into our delivery schedules for a build to order homes.
Despite the near term challenges facing our industry.
We remain confident in the long term outlook for new home construction.
This thing home inventory remains at a historically low level on a national basis, and there continues to be a strong desire for home ownership by a large segment of the population.
We believe that comparisons made between this housing correction and the one we experienced during the Ah.
2007, and eight financial crisis are unwarranted.
U S households are in a much better shape today than they were 15 years ago.
Today's unemployment levels remain incredibly low despite the best efforts of the Federal reserve does slow the economy.
In addition, we have a much more stable and closely regulated mortgage finance system in place today, which has curtailed much of the speculative activity that led to the last downturn.
We also had the benefit of hindsight and wisdom.
Comes from weathering a difficult downturn.
Which has led to a more resilient and return focused industry. All of these factors give us confidence in the future of our industry and the outlook for our company.
Now I'd like to turn the call over to David who will provide more detail on our operating results this quarter.
Thank you Larry the soft demand trends, we experienced in the third quarter carried into the fourth quarter as buyers remain cautious about moving forward with their purchase.
However, we did see a pickup in demand starting in December once we reduced pricing and increased incentives.
We believe this is a good sign that the price elasticity exists in our markets and that the buyers remain active and engaged despite the higher interest rate environment.
Cycle times remain stubbornly long in the fourth quarter. Despite some improvements we've made in our internal processes.
Which reduce the time between sale to start and finish to close on a year over year basis.
Ongoing challenges related to municipal delays later and product availability to finish jobs continue to be headwinds for our industry.
We expect to see some relief on these fronts once the current slowdown in demand works its way through the system.
Another area in which we expect to see some relief is on the cost side.
Lumber prices have been moving down for some time and we expect to see the benefit of this down word movement in our results as we move through 2023.
We have been working closely with our trades suppliers and vendors to make sure the prices, we pay stay more competitive and reflect today's slowing market conditions.
We are also being very vigilant about our overhead costs and we will continue to look for ways to do more with less.
With respect to land, we have taken decisive action to adjust our lot position and renegotiate the terms of many option agreements.
We expect to see real opportunities for land investment is better terms and pricing.
Been recently.
Okay.
Overall, we expect 2023 and to be a year of continued adjustment for our industry, but I shared larry's enthusiasm for the future of our industry.
We remain committed to the markets, we're in and see a long runway for growth once the industry fundamentals stabilize.
MDC has been building homes for over 45 years, and it's been through numerous downturns.
We know how to navigate through difficult times and how they can.
Capitalize on opportunities that arise from market dislocations such as this.
We are well positioned both in a financial way and operational perspective, but to address the challenges of today and look forward to building on the legacy of MDC and Richmond American homes.
With that I'd like to turn it over to Bob who will provide more color on our financial performance.
Thanks, David and good morning, everyone.
During the fourth quarter, we generated net income of $79 $8 million or $1.08 per diluted share.
Representing a 51% decrease from the fourth quarter of 2021.
Pretax income from our homebuilding operations for the quarter were $94 $5 million.
Which represented a 51% decrease.
From the fourth quarter of 2021.
This decrease was primarily due to inventory impairments of $92 8 million recorded during the quarter impacting 10 communities within our West segment and six communities within our mountain segment.
The impairments mostly related to communities already opened for sale as well as a few communities scheduled for opening during the first quarter of 2023.
This decrease was partially offset by home sale revenues, which rose 4% year over year to $1.49 billion.
Our financial services pretax income increased during the fourth quarter of 2022 to $18 $7 million. This increase was primarily due to increased insurance premium revenue recognized by our captive insurance companies.
Our tax rate increased from 22, 2% to 29, 5% for the 2022 fourth quarter. The increase in our current quarter rate was driven by an increase in our estimated state tax rate, whereas the prior year benefited from the reversal of an uncertain tax position.
For 2023, I would roughly estimate.
And the effective tax rate of 25, 5%, which includes our current estimate of the anticipated benefit under the new 45 L energy efficient.
<unk> tax credit.
This estimate does not include any discrete items or any potential changes in tax rates or policies.
We delivered 2554 homes during the quarter, which represented a 4% decrease year over year, but exceeded the previously estimated range for the quarter of 2200 2500 closings.
Our backlog conversion rate in the fourth quarter was 48%, which represented a 300 basis point improvement from the fourth quarter of 2021.
This was due to an increase in the number of quick move in homes, we sold and closed during the fourth quarter, which accounted for nearly 500 closings or 19% of our total deliveries for the quarter.
These quick move in or spec homes were the result of cancellation activity during the second half of 2022 and to a lesser extent strategic spec construction starts from earlier in the year.
Our ability to convert these homes into closings played a big role in exceeding our closing guidance for the quarter.
The average selling price of homes delivered during the quarter increased 8% to $582000.
This was primarily the result of price increases implemented during 2021 and the first quarter of 2022, which were partially offset by an increase in incentives.
We currently anticipate home deliveries for the 2023 first quarter of between 500 600 units.
And we expect the average selling price of these units to be between 550005 hundred $60000.
There continues to be a heightened risk of underperformance relative to our forecast as we look forward to the first half of 2023 due to the increased volatility of economic and industry conditions.
Gross margin from home sales decreased by 850 basis points year over year to 15% excluding.
Excluding inventory impairments gross margin from home sales decreased only 230 basis points to 21, 3%.
The decrease was primarily due to increased incentives as well as increases in land and construction costs year over year.
These items were partially offset by higher base house pricing due to price increases implemented in the 2021 and the first quarter of 2022.
We are currently expecting gross margin from home sales for the 2023 first quarter of <unk>.
Between 18% and 19% assuming no impairments for warranty adjustments.
Our total dollar SG&A expense for the 2022 fourth quarter increased $1 $8 million from the 2021 fourth quarter driven by increased commission expenses as a result of an increase in home sale revenues.
As noted last quarter, we continue to take steps to reduce our general and administrative expenses and saw these expenses decrease during the fourth quarter of 2022, both sequentially from the third quarter as well as on a year over year basis, when compared to the fourth quarter of 2021, we.
We currently estimate that our general and administrative expenses for the first quarter of 2023 will be between 50, and $55 million, which represents a $19 $5 million or 27% decrease from the first quarter of 2022 at the midpoint.
The dollar value of our net orders decreased 95% year over year to $74 $4 million due to a 93% decrease in net unit orders yet.
Orders were negatively impacted by the number of cancellations during the quarter, which nearly doubled from the prior year to 1312 cancellations.
While our cancellation rate as a percentage of homes in backlog has been above our historical average during the second half of the year. These cancellations have provided us with a source of quick move in homes at a time when more buyers are looking for homes that can close quickly in order to provide certainty as to their ultimate mortgage rate at closing.
As Larry mentioned at the outset.
Due to this change in consumer preference and the ongoing uncertainty around mortgage rates that has negatively impacted the build to order market. We have pivoted our strategy to focus on more speculative construction starts to supplement build to order construction activity.
Before cancellations, our gross order activity for the fourth quarter was down 55% year over year and 4% from the third quarter of 2022.
74% of our fourth quarter gross order activity with respect to inventory with a sizeable portion of those orders contributing to fourth quarter closings.
Looking at our average selling price of new orders, we analyze this metric on a gross basis, given the magnitude and mix of cancellation activity during the quarter.
On a gross order basis, our average selling price of new orders decreased approximately 1% as compared to the prior year and approximately 6% as compared to the third quarter of this year.
The decrease in our average selling price from the third quarter of 2022 was due to an increased incentives as well as a decrease in base pricing across many of our communities.
Our active subdivision count was at 225 to end the quarter up 20% from 187 a year ago.
Looking at the graph on the right the number of students to be active communities significantly exceeded the number of soon to be inactive communities at December 31 2022.
This indicates a strong possibility that our active subdivision count will continue to increase as we enter the 2023 spring selling season.
During the fourth quarter, we acquired 258 lots, resulting in total land acquisition spend of $38 million.
Incurred $119 million of land development costs.
For the full year, we invested $1 billion in land acquisition and development, which represented a 46% decrease from the prior year.
As of yearend, we had $19 million in cash deposits $3 $7 million in letters of credit and $3 4 million of capital costs at risk associated with the 3703 lots remaining under option.
Our financial position remains among the best in the industry as of year end.
With our slowdown in land acquisition and development activity during the year operating cash flows increased to $905 $6 million for the full year 2022, compared with $208 million of cash used to fund operating activities during fiscal 2021.
We ended the year with one point to $8 billion of cash and short term investments.
Thanks to our opportunistic senior note issuances. During 2021, we entered 2023 with a very attractive capital structure highlighted by the fact that we have no senior note maturities until January 2030.
Our year end debt to capital ratio was 32, 6% and our net debt to capital ratio was just six 6% to end the year.
Our book value per share at December 31, 2022 was $42 60.
Which represented an increase of 23% year over year after adjusting for our industry, leading cash dividend.
We ended the year with 4770 homes under construction, which is a 34% decrease from the prior year end.
So that comes comprised 31% of our homes under construction at year end and we expect this percentage to increase in the near term as we continue to supplement our build to orders construction activity with the construction of spec homes.
In summary, we remain confident in the long term growth prospects for the industry given the underproduction of new homes over the past decade.
And the strong desire for home ownership in this country are.
Our strategic decision to build more spec inventory should provide us the inventory we need to satisfy current consumer preferences and give us the opportunity for another very profitable year in 2023.
Similar to past homebuilding cycles, we believe we are well positioned to navigate today's evolving market conditions, given our seasons leadership team and strong financial position.
That concludes our prepared remarks, we will now open up the line for questions.
We will now begin the question and answer session to ask a question you made press Star then one on your telephone keypad.
If youre using a speakerphone please pick up your handset before pressing the keys.
If at any time your question has been addressed and you'd like to withdraw. Your question. Please press Star then two please.
Please limit yourself to one question and one follow up question at.
At this time, we will pause momentarily to assemble our roster.
The first question comes from Stephen Kim with Evercore ISI. Please go ahead.
Yes, thanks, very much guys I appreciate the color I think you had even last quarter talked about maybe changing some.
Some of your policies regarding the deposits as a percent of the deposit earnest money that you were taken.
And it's interesting to hear Youre talking about making this change to your spec strategy. So you know obviously, we've seen your spec.
Count per community increasing in the back you made it sound in your prepared remarks at this time and also last quarter, but that was kind of unintentional, but that was really just due to cancellations.
So is it correct to think that this change to your spec strategy is something that you are really just starting to implement to be deliberately doing some more specs in January or was there. Some point in the fourth quarter, where you made that change and how many specs per community should we be anticipating.
That you'll run with for as long as the customer is behaving the way they are.
Okay.
Steve It's Dave Good morning, good afternoon in your case.
I think that we made we made some changes in the fourth quarter and.
And we did a little bit more changes yet this quarter and maybe Bob can kind of go through some of the numbers, but we.
We do think based on the consumer today is they want a house they want to close in three or four months. So we feel pretty good about the strategy of building some inventory houses plus as you well know today people want to know what their house payment is going to be and they're going to feel a lot better about buying a house that they can get a gig.
Closed in the 60 to 120 days and they will know what the mortgage payment as Bob what can you add to that.
I think really in terms of the starts intentionally starting the stacks youll see that more in earnest here in the first quarter.
The idea is to keep our production levels up and as David mentioned really make sure that we're meeting the needs of our customers.
At the same time, we are still offering a build to order.
As well.
So I don't think there is a long term target on the number of specs I think we're going to play that by ear and look at what the market is telling us, but we are committed.
To adding that spec strategy.
And maintaining here in the near future.
So you ran at $6 six specs per community I think this quarter you were five last quarter, you know historically, you've generally run around two and change some of your peers that are kind of hybrid I would say are kind of running close to 10.
So I'm I'm inclined to model that youre going to run at about 10 specs.
Per community in the near term so correct me, if I'm a little wrong on that maybe.
Maybe too high or too low and then in terms of gross margin I believe you had indicated previously the gross margin on specs is a little higher than on dirt dirt closings was curious if that's still the case or if I remember that and correct me. If you can just give us a sense for your gross margins on specs this quarter.
Quick move in homes, where they higher or lower than.
And then the Etfs.
Yes.
This quarter, they were about 100 basis points lower for closings.
Due to some of the incentives that we offered during the fourth quarter.
Okay, and then the 10 specs per community is that a reasonable level to be thinking.
Yes, I don't think it's unreasonable that that's the way the math would work out I think you calculated roughly.
<unk>.
Six per community at this point as you look at what is currently on balance sheet, so to see it migrate up or to a greater percentage.
Of the homes, we have under construction at any given point in time I think is a reasonable assumption.
Great well I appreciate the color thanks, very much guys.
The next question comes from Truman Patterson with Wolfe Research. Please go ahead.
Hey, good morning, everyone. Thanks for taking my questions and Larry.
Please please don't taunt the fed over the low unemployment rate so.
Bob.
Just hoping you can give us a little color on on January trends, you know when I'm looking at your fourth quarter orders clearly you had elevated cancellation rates, but now you're making changes to your spec strategy, you're pushing incremental incentives.
Clearly it's.
It kind of muddied right now so I'm, hoping you could just let us understand how January is trending regarding orders maybe on a year over year basis, and how you all are kind of thinking about <unk>.
Yes, so year over year, I think it's a little little confusing for them and because we were still in a period of time, where rates were really low so I'm not sure that.
That's a really fair comparison, but versus December and keep in mind.
December was our best orders month, both gross and net for.
For the fourth quarter.
So relative to December for January I expect both gross and net orders to exceed our December activity and that's with a lower number of cancellations in January relative to December .
So that's something.
Something that we've we've really liked to see.
Okay. Thank you and again.
Again, I realize seasonality is a little strange right now but.
Would you characterize January as you know above normal seasonality as we sit today.
It's tough to really.
Peg seasonality of January versus December when Youre coming off of a very tumultuous time, but I would say it certainly gives us a good bit of optimism going into spring.
Okay, Okay, perfect and then.
Any chance you could help us quantify the magnitude of any potential cost tail wins you're experiencing.
As of like today starts I realize lumbers.
Lumber is down meaningfully year over year might've pop back up you know some recently, but I'm hoping.
Hoping you can help us think through some of the potential cost savings outside of lumber.
So I think those are still.
Materializing, we might.
I think relative to the peak be in the 4% to 5% range outside of lumber.
But as you indicated really lumber is the biggest bucket of potential tailwind at this point.
Alright. Thank you all good luck in the upcoming quarter.
The next question comes from Michael Rehaut with Jpmorgan. Please go ahead.
Hi, This is Andrew <unk> on for Mike. Thanks for taking my question.
I wanted to ask if you would be able to get any color on that.
Initial for any future land impairments or how we should be thinking about that.
Yeah.
Land impairments isn't analysis, we do on a quarterly basis.
Really one of the biggest contributing factor is.
Is pricing and whether that's based pricing or incentives.
So to the extent that we have a decrease in base pricing or an increase in incentives.
That is <unk>.
Significant.
We could realize additional impairments just as we did in Q4, so not really much more to say about it than that and we tried to be very thorough every quarter going through our assets and making sure we do a very.
Thorough.
<unk> analysis.
And.
Take the impairments as appropriate.
Okay, I appreciate that and I apologize if I missed this did you ever breakout the incentives.
In the quarter as compared to last quarter.
Versus Q3, so Q3, we talked about.
800 basis points.
Of incentives and that's on sales.
In Q4.
That was closer to 200 basis points on sales.
On closings.
For Q4, it was about 800 basis points.
Yeah.
Okay, Alright, I really appreciate that.
That's all for me good luck in the next quarter.
Thank you.
The next question comes from Jesse Letterman with Zelman and Associates. Please go ahead.
Hi, Thanks for taking my questions.
So in the past you guys have really largely resisted doing more spec building for a number of reasons.
We agree with the interest rate dynamics. It makes it more attractive to homebuyers, having as quick moving product for your business. It seems really built upon built to order from your sales strategy and revenue generation with no options and upgrades to your overhead structure. So how confident are you in being able to execute this pivot compared to other homebuilders.
Who specialize in the sales model and how can you compete from a cost perspective.
This is David speaking I'd tell you, we're very encouraged over the last couple of months because.
We are getting a percentage of what I call a build order houses and I think this month, Bob will go through the numbers, but we're seeing a lot of customers that are coming in.
My lot in my House I'm going to give you a deposit I want to pay.
Whatever it is for upgrades at our home galleries.
We've got a number of customers that are looking at that kind of product.
In the past, we've done mainly that kind of product and so we're excited that there's customers out there that really.
Are willing to wait for that got announced but they want their house, they're locked with their options. So Bob you might kind of go through the numbers.
Yes, I think that was about.
Just go ahead had been hearing.
Just a second here and clarify.
Just curious about your ability to execute the spec strategy given you know that's kind of veering away from the.
The built to order model that you know your business is kind of built around so in terms of like selling specs, particularly how confident are you in being able to.
Again, some of your competitors, who specialize in this strategy the spec strategy.
I'd say, we're very confident I mean, we executed really well in fourth quarter.
Larry and I have been doing this for 46 years, so over and over time we've had.
Times, where we did inventory houses I think the last couple of years, we've just been build to order, but we're very confident on the execution.
And the product that we're putting out.
No I think that's absolutely right.
There is a lot of experienced during the periods of time, where it's much higher.
<unk> concentration.
What we saw as a percentage for now we're about 25% dirt for orders and about 75% spec.
So we have pivoted, we think that that makes sense, we think we can.
Executing.
And it's in line with consumer preferences. So.
So we definitely have the team to execute on that strategy.
Absolutely. Thanks for that and then just a quick follow up are you altering the product.
Given presumably you generate a fair amount of revenue through your design studio. So how are you thinking about creating these spec homes are you just trying to drive the price lower versus your built to order product.
Well I'll, just start off and Bob Bob could probably enhance that a little bit but essentially what we've done is we looked at customer preferences.
On.
On dirt starts we put those kind of preferences and our inventory of houses.
<unk>, what I call, some sun rooms, or patios or or cabinet types, but we think we've looked at the metrics and we feel really good about.
About what are what our inventory of houses will look like when they are finished.
And I think Thats, absolutely right, we basically looked at the take rate for both structural upgrades and design center upgrades and we're trying to emulate that see what's the most popular.
So as a result.
It really should.
Put us in the same range of options and upgrades that we had before it just so happens that a lot of them are now going to be pre selected for many of our consumers versus them selecting them.
Got it so is the asps.
Actually on par with your built to order product when all set and done or just lastly, what's kind of the variance there as it stands today.
Yes, I wouldn't see necessarily a a.
A huge.
The variance in ASP, just because of that.
I mean right now the metrics.
On spec versus dirt ASP could be a little bit.
Skewed just depending upon where the cancellations have come from and therefore, where the spec inventory is the highest.
But for now.
I think the intent is not to reduce the average selling price.
Because of the spec strategy.
Understood. Thanks for all the color I really appreciate it.
This concludes our question and answer session I would like to turn the conference back over to Bob Martin for any closing remarks.
Thank you all for joining the call today, we look forward to.
Hosting you again, when we announce our Q1 2023.
<unk>.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.
Okay.
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Okay.
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