Q3 2019 Earnings Call

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Jason Hormann, H O R and a and <unk>.

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A.I.E.R.A.

Okay.

Thank you.

[noise] spec closings in the quarter and improved cycle times.

Our third quarter gross margin, excluding amortized interest impairments and abandonments was 19.4% ahead of our expectation by about a quarter of a point aided by some warranty pickups.

SGN as a percentage of total revenue was 12.2% down in absolute dollars and in line with our expectations.

This led to adjusted EBITDA of $38.7 million.

Finally, we benefited from $4.4 billion of energy tax credits, which brought our net income for the quarter to $11.6 million.

Turning now to our expectations for the fourth quarter.

Our sales were up double digits in July and we are working to take advantage of the improved environment to drive higher margins.

Accordingly orders should be up 5% to 10% year over year with an average community count around 170.

We expect closings to be relatively flat versus last year with a modest improvement in the backlog conversion ratio as specs will remain slightly elevated.

Our ASP should be about $385000 up versus the prior year and the third quarter.

Our gross margin should be roughly flat sequentially as demand for specs has been higher than anticipated.

We expect margins to improve next fiscal year as our mix of specs and to be built homes normalizes.

SGN areas should be around 10% down as a percentage in about flat on an absolute dollar basis relative to last year.

And finally, the cash component of land spend should be around $100 million.

At this point I will turn it over to David.

Thanks, Bob.

The objective of our balanced growth strategy is to deliver it to drive higher returns on our assets by improving our EBITDA and by using our balance sheet more efficiently.

Slide eight illustrates our active asset as a percentage of the total and the returns we're generating.

You can see that we've been successful in activating non earning assets while increasing returns.

In the coming quarters, we expect that virtually all the former land held assets that are non earning today will start producing revenue contributing to better returns in the future.

In the third quarter, we spent a $103 million on land and development in line with our expectations.

Going forward, we are focused on increasing use of options and targeting smaller purchases with shorter durations.

On slide 10, we outline the components of our expected community count for the coming quarters.

We expect to end fiscal 2019 with around 170 active communities. So forecast an exact quarterly trend is challenging.

The majority of the new communities, we are bringing online have lower asps relative to our existing communities as we remain focused on delivering extraordinary value at an affordable price for millennials and baby boomers.

In terms of the rollout of gatherings across our footprint as in the third quarter, we have gatherings buildings under construction in Orlando, Dallas and Nashville, with additional sites under development in Dallas and Houston. We have also approved projects in various stages of entitlement that will result in having gathering sites in nearly half of our markets by the end of this fiscal year.

We've made a great deal of progress returning capital to investors.

During the third quarter, we continued our debt reduction retiring approximately $17 million, bringing our year to date total to $22 million, we expect to retire more than $50 million of debt this fiscal year.

In May we entered into a second MSR program and repurchased shares in the open market, bringing our total buybacks for the fiscal year to nearly $35 million or 3.3 million shares.

This represents more than 10% of the company acquired at a blended price of approximately 60% of current book value.

Over the last 11 years, we've made significant strides in improving our leverage have introduced total indebtedness by more than $500 million over the next several years, we plan to reduce debt by an additional $200 million to achieve our target of getting under $1 billion of total debt.

This reduction will bring our net debt to EBITDA into the fours before accounting for any growth in earnings.

With that let me turn the call back over down for his conclusion.

Thanks, David.

The demand environment has improved this year, which should allow a strong finish to the fiscal year.

Looking forward to next year, we expect EBITDA growth as we benefit from higher revenue improved gross margin and further overhead efficiency.

Longer term, our balanced growth strategy should allow us to continue to grow book value and earnings per share, while bringing debt below $1 billion.

I want to thank our team for their ongoing efforts I'm confident that we have the people the strategy and the resources to execute our plan over the coming years.

And with that I will turn the call over to the operator to take us into Q in AG.

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Our first question comes from Jay Mccanless with Wedbush You May go ahead.

Hey, good afternoon, everyone.

Yes, it did.

The first question I had on the order growth.

It was definitely within the guidance, we gave but a little lower than we were looking for did you all have any issues with getting communities open or yes. We've heard some other builders talk about weather delays, forcing communities to the openings to the end of the quarter.

No Jay I think for us it really it was as we had talked about in May and started to benefit from in June we've really use the stronger environment to try and reduce incentives and drive margin and that progression for the quarter.

For us showed the effects of that I have no doubt that had we not been.

Pursuing that we would've had a different order number but we felt like this was sort of the right balance of order growth and and incentive reduction.

Got it and.

And I apologize if you said already but could you quantify where at what has happened with incentives and on closings and also whats haven't incentives on orders, maybe this year versus last year.

Yeah, we don't have a consistent metric that we publicly disclosed around that so its a little bit tricky.

What I can tell you is that every day every week and in some.

In most cases, it's more frequent than that each of our divisions in each of their communities has got a pricing strategy that they are following and directionally across the board, but particularly as it related to specs. We were we're moving incentives and those may have been modest initially you know whether it's your removing a thousand dollars or $500 or changing a set of included features but it's more the direction than it is the precision and I think we want to leave you with because it's not an exact science and it's not terribly reliable because the things that you do to change that mix in incentives over time.

Makes the comparisons difficult.

And then just looking to the fourth quarter guidance.

Closings, that's flat year over year, certainly better than we were expecting.

But I would have thought the additional volume would have produced a gross margin a little bit better than flat quarter over quarter can you talk about what's happening there.

Well.

I think Bob made the point that in the third quarter. The gross margin was at the high end of the range that we had kind of anticipated that got up to 19 in a quarter and then beyond that we benefited from some warranty pickups.

We won't have those in the fourth quarter I don't think.

So we still see a positive progression from Q3 into Q4 ex that.

I will say that I think as we started to remove incentives.

In the third quarter toward the specs it actually stimulated more spec sales than we expected and so I think we'll still have a slightly higher share of homes closed in the fourth quarter that are specs and that's another factor, but looking out into Q1, I think that mix starts to normalize.

Yeah, Jay I think Alan was pretty clear in his comments about kind of expectations for higher margin as you move into 20 on any kind of lifted the reasons behind it.

But certainly we feel like there is some margin improvement with reducing spat reducing incentives.

There is little to mix in Q4, though.

But its still a positive progression.

Yeah absolutely.

And then the last one I had.

Just any any kind of color or insight you can give us about community count growth in 2000, and what we should be modeling.

Yeah, Jay So obviously, it's difficult to predict quarterly trends.

Let alone try to go a couple of quarters out and tell you. What we think is going to happen.

We've clearly said, we're going to benefit from the community count growth, we've already experienced we've already achieved.

And that's going to drive higher sales and topline growth next year.

I would tell you pretty early in the planning process and we'll have more to talk about next quarter about kind of full year community count guidance, but at this point just kind of kind of the higher in the first half as we kind of talked about and we've already experienced.

I would just add look at slide 10 jazz decide we typically provide or have for years I think it'll give you kind of the components. The timing within that is tough, but I think you and others can see that there's there's a lot of activity.

The the pipelines pretty good.

Okay, great. Thanks for taking my questions.

Thanks, Jeff.

Thank you. The next question comes from Thomas Maguire with Zelman and Associates you May go ahead.

Hey, guys, good afternoon, and nice job on the quarter.

Just to see what the demand side can you can you talk about just trends I price point, maybe and understand the market has improved broadly, but any any relative for differences you would call out or pockets of weakness or strength.

You know for us the strength was pretty well across the board price point and and markets.

You know the there there is no question that the focus that we have as a company in the first time first move up on the on the one side and then the active adult side.

Both benefited.

We don't have a huge exposure to the to the second third move up market. So I wouldn't take a lot of read through from our experience in that category, but in the two segments that we really serve we saw strength in both.

Got it that makes sense and then just to shift gears to the capital allocation side and I know you guys touched on earlier, but.

Maybe just some more thoughts about how you guys prioritize and specifically with the buyback first further debt reduction maybe beyond the target you talked about and just from a high level, what's kind of the discussion that you guys have when you're weighing those moving pieces.

Well I mean in terms of the high level, we want to get total debt below $1 billion.

It'll take a period of time to get there. We've said that we expect to reduce at least $50 million of debt. This year and we said today that we expect to reduce debt in dollar terms next year by even more.

So that's kind of the Breadcrumb trail if you will from where we are through this year into next year with a goal in mind.

And that's that's a pretty well I think articulated I mean within the capital structure in terms of individual components. As you know, we're obviously not going to speculate on that but you know we've got a pretty favorable maturity structure. So I think we have a lot of flexibility in how we pursue that reduction in indebtedness.

Makes sense, thanks, guys have a good day.

All right. Thanks.

Thank you and just as a reminder to the parties on the phone line. If you would like to ask a question. Please press star followed by one.

Our next question comes from Alex Barron with housing Research Center you May go ahead.

Yes. Thank you.

Yes, I was hoping you guys could comment on.

What you've seen.

You know in the California market I guess last quarter I think you guys had a.

Have you given the impairments, but I'm wondering how the market has progressed since that time.

It's good question Alex. The fact is this spring, California has participated in the improvement in demand that we've seen across our footprint. We are competitively better positioned with the price adjustments that we took and we saw a pretty significant improvement in.

Sales pace in California.

Owing both to our better positioning and the fact that I believe that each of the sub markets that we participate in showed greater strength.

So I am glad we took the steps we took to become more competitive and we are benefiting from a a improvement in demand.

Got it and then.

Also I guess, we've been to Vegas recently and it seems you guys are doing pretty well based on your price points there.

You feel like there's more that would enable you to keep.

Going once you know you finish some of their current projects.

We do we've got a terrific land pipeline in Las Vegas, and we've got a great position.

I mean, it's as good an example of what we do well extraordinary value at an affordable price.

Are there lower price points available in some of the Submarkets absolutely.

But I can tell you in terms of Bang for the Buck and and value to the customer we have a phenomenal position and.

It's an interesting market as you know there is there is a kind of a quite a concentration of land ownership, but weve got positions in.

A couple of the Master plans and we've gotta capacity and have executed on self development deals. So we've got multiple ways of participating in that market.

I have to say that I'm really.

Kinda shout out to our team.

In Las Vegas, they've executed exceptionally well.

And one last question on the billion dollar debt target by when do you expect that.

[laughter] well that's a good question too we said over the next several years.

Look I think over time that will become more and more clear to us and obviously to the market, but if we reduced debt by at least 50. This year more than that next year and we've sort of talked about $1 billion that gives you kind of a 200 and change quantum that we're working toward that you can kind of see the breadcrumb trail as I said, but I'd be reluctant to go much further than that and precision of the timing.

Okay Best of luck. Thank you.

Thanks, Alex.

Thank you and our next question comes from Jay Mccanless with Wedbush You May go ahead.

Hey, just a couple more.

Bob tax rate for the fourth quarter will we see a repeat of this credit we saw in Threeq.

Oh I don't think so its possible we were always looking to.

Maximize our ability for tax credits, but you know at this point I don't I don't see any in the fourth quarter. So the tax rate should be in the 25.

Percentage.

And then was going to ask now that july's completed any color or commentary you guys could give us on on July would be helpful.

Yeah.

So obviously the the pain has still dry with a month, just ending yesterday, but I'm pretty pleased are one month.

On a year over year basis performed better than any month in the third quarter.

And better than the third quarter as a whole, obviously and as Dave said it was up double digits or maybe Bob said that so that was that was encouraging I mean, a year ago. There were signs of weakness starting to emerge in the middle of the summer and I would say this year July has felt very very different from a year ago.

Do you say to your question related to your question Hey, Jay give me once like it's Dave just to your point, though and Alan talked about this before we've guided 5%, 10% order growth for the quarter or any kind of compares that double digit and it's to alan's point about taking incentives back and rebuild the margin. It's very clear this quarter to kind of what the game plan is for us.

Got it and then just on them on pricing power.

I mean.

I don't ever remember you guys breaking it out by a percentage of communities or something like that but if you could talk about.

What type of pricing power do you have you feel like you can accelerate it in certain communities are certain markets.

Yeah, I mean, I will tell you that each market has it and individual you know there are specified mix of the community. So it's so hard to talk about but let me talk about one market talk about actually Alex asked about Las Vegas, Las Vegas is kind of interesting.

There there are two.

Facts about Las Vegas that kind of get to your question. The first is Las Vegas for us in the quarter.

Pad.

The highest sales pace and it was the sales pace per community per month.

A little above five.

That was the highest in the company for US what's interesting as a year ago. It was actually quite a bit higher.

And the difference while it was still a great number and a company leading number for US. The difference was that we've used the better environment to really be much more.

Aggressive on.

Finding the price in the market and I think that's it.

A combination of base price included features and incentive structure. So you know that's an example of a market where there was an explicit and clear tradeoff in pace versus margin and yet.

Still resulting in a really healthy margin.

Not every market obviously is isn't that characteristic but you know a majority of our markets had increases in pace in the third quarter. In fact, a significant majority had year over year increases in pace and when you see those kind of increases in pace. That's a good indicator that we are able to.

To drive some margin to drive some price so I would say.

You're right, we don't break it out by percentage, but it's fairly broad based our ability to even if its at the margins and I'm much more interested than the direction than the Ics specific number at a moment in time, because once you sort of turn that corner and you started to move in a direction you know that begets, a certain momentum and that's kind of what we've seen over the last two months.

Sounds great. Thanks, guys.

Thank you and at this point.

At this time there are no further questions.

Okay I want to thank every phone call for joining the call this quarter and we will talk again in three months. Thank you very much. This concludes today's call.

Thank you that does conclude today's conference all participants may disconnect.