Century Communities, Inc. (NYSE:CCS) Q4 2022 Earnings Call Transcript

Century Communities, Inc. (NYSE:CCS) Q4 2022 Earnings Call Transcript February 1, 2023

Operator: Hello and welcome to the Century Communities Fourth Quarter 2022 Earnings Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Senior Vice President of Investor Relations, Tyler Langton. Please go ahead.

Tyler Langton: Good afternoon. Thank you for joining us today for Century Communities earnings conference call for the fourth quarter and full year 2022. Before the call begins, I would like to remind everyone that certain statements made during this call may constitute forward-looking statements. These statements are based on management’s current expectations and are subject to a number of risks and uncertainties that could cause actual results to differ materially from those described or implied in the forward-looking statements. Certain of these risks and uncertainties can be found under the heading Risk Factors in the company’s latest 10-K as supplemented by our other SEC filings. We undertake no duty to update our forward-looking statements.

Additionally, certain non-GAAP financial measures will be discussed on this conference call. The company’s presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Hosting the call today are Dale Francescon, Chairman and Co-Chief Executive Officer; Rob Francescon, Co-Chief Executive Officer and President; and David Messenger, Chief Financial Officer. Following today’s prepared remarks, we will open the line up for questions. With that, I will turn the call over to Dale.

Dale Francescon: Thank you, Tyler, and good afternoon, everyone. During the fourth quarter, we focused our sales efforts and incentives towards available homes with near-term deliveries to monetize these homes, even though they carried lower margins due to inflated direct construction costs, given their start dates earlier in the year. The goals behind this strategy included increasing our cash position, reducing leverage metrics, and positioning us to start new and lower cost homes. As a result of the efforts, we generated $382 million of operating cash flow during the fourth quarter and reduced our net debt to net capital ratio down to 23.5%, the lowest year-end level in our history as a public company. Our solid results this quarter also included $102 million in pre-tax income, net income of $79 million, diluted earnings per share of $2.47 and EBITDA of $121 million.

In the fourth quarter, we delivered 2,903 homes, the second highest level of closings in our history, and only 12 homes off a record level of homes delivered in the fourth quarter of 2021. While supply chain pressures weighed on the pace at which we could deliver homes throughout most of 2022, these disruptions improved as the year progressed, helping us to achieve the strong level of closings in the fourth quarter. Revenues from home sales were $1.2 billion, the highest quarterly level in our history; while our average sales price increased by less than 1% on a year-over-year basis to $397,000 consistent with our goal of building affordable homes. Gross new contracts in the fourth quarter totaled 2,008 homes and net new contracts were 1,258, due to an elevated cancellation rate, mortgage rate volatility and overall economic uncertainty keeping many potential homebuyers on the sidelines.

Our quarter end backlog consisted of 1,810 sold homes valued at $671 million. While we expect home sales will continue to be pressured in the near-term as buyers adjust to higher mortgage rates and uncertainty in the economy, we also believe that underlying demographics remain favorable. Additionally, we think buyers are beginning to return to the market now that rates are stabilizing at levels below recent highs. An indication of this is that both our net and gross new contracts in November and December were well above October levels, leading us to believe that the decline in mortgage rates that started in November, led to an improvement in sales. During January, we’ve experienced further improvement in home buyer activity. Similar to the past several quarters, homebuyers are continuing to look for homes that are closer to completion in order to lock in their interest rates.

Consistent with our strategy, we intend to continue concentrating our sales efforts on homes with more near-term completions and are not focused at this point on building up a significant sold backlog of major term deliveries. Incentives on closed homes in the fourth quarter increased to about 900 basis points of average sales price from roughly 300 basis points in the third quarter. A significant amount of these incentives were in the form of forward commitments and rate buydowns that drove traffic and sales, especially when mortgage rates went above 7%. While we will continue to move inventory by finding the market clearing price on a community by community basis, we expect the average level of incentives that we’re offering to moderate a bit, especially with the recent retrenchment in interest rates.

In the fourth quarter, we generated adjusted gross margins of 20% with higher incentives being the largest driver of this expected decline compared to last quarter. These incentives applied not only to new sales with near-term closings, but also to many backlog homes that had been sold earlier in the year. Consistent with our strategy of prioritizing the sale of complete and completing inventory, we expect our margins in the first quarter of 2023 will be consistent with those of the fourth quarter of 2022 as the homes delivering will be burdened with similar elevated construction costs, given their start dates earlier last year and higher incentives than historical norms. Many of our planned starts in the second half of last year were postponed due to increased incentives and elevated input costs that had become commonplace in our industry.

Our corporate, regional and divisional purchasing teams rose to the challenge, and have made great strides in reducing costs across the board. As a result, we began starting homes at a greater pace in November and December, which has accelerated into this year. Due to the improvement in direct construction costs, reduced incentives and shorter cycle times, these homes are expected to carry a higher margin profile as they begin to close. As a result, beginning in the second quarter of 2023, we expect homebuilding gross margins to trend positively on a sequential basis through the balance of the year as they return to more normalized levels. Before turning the call over to Rob, I wanted to briefly recap our record setting performance for the full year 2022.

During the year, which was not only the company’s 20th anniversary but the 20th consecutive year of profitability, we delivered 10,594 homes, the second highest level in our history. Gross margins and adjusted gross margins for the year averaged 25% and 26% respectively, both company records. Net income increased 5% year-over-year to a company record $525 million and earnings per diluted share increased 10% to $15.92 per share, also a company record. Finally, our book value per share at year end increased to a record level of $67.67, with our total stockholders’ equity increasing to $2.2 billion, the highest in our history. We believe we have the right strategy to navigate the current headwinds in the housing market and one that positions us well as conditions normalize.

Buyers are currently looking for affordably priced homes with near-term completions and we intend to meet this demand. We will find the market clearing price for our homes nearing completion, knowing that it may weigh on margins in the near-term. We are also confident that we will be able to redeploy capital and start new homes from our current lot supply that will earn both better margins and higher returns going forward, due to lower direct costs, improved cycle times and reduced levels of incentives. In closing, on behalf of the entire senior management team, I want to thank our employees across our national footprint. Our achievements this year would not have been possible without their hard work and dedication, and we greatly appreciate their commitment to both Century and our valued customers.

I’ll now turn the call over to Rob to discuss our business and plans going forward in more detail.

Rob Francescon: Thank you, Dale, and good afternoon, everyone. Our strategy of concentrating sales efforts and incentives on inventory with near-term completions was very productive and enabled us to deliver 2,903 homes, representing 84% of beginning backlog, an approach we intend to continue. We have a strong presence within the affordable new home category with approximately 81% of fourth quarter deliveries coming from homes priced below FHA limits, allowing us to target the widest range of potential buyers in any given market. Additionally, back in December, the FHA announced higher loan limits for 2023. And with these higher limits, approximately 90% of our fourth quarter deliveries would have come from homes priced below FHA limits.

Our homebuyers continue to have a healthy financial profile. Century Communities and Century Complete’s homebuyers had respective average FICO scores of 737 and 711, consistent with levels experienced throughout the year. Our cancellation rate was 37% in the fourth quarter, with roughly equal rates at our Century Communities and Century Complete brands. Our cancellation rate declined as the quarter progress to a rate of 28% in December, with also roughly equal rates at both brands. The number of cancellations further declined in January. The homebuilding industry continues to be challenged by municipal and utility delays, supply chain issues and trade shortages. These pressures are starting to ease especially as housing starts have slowed and capacity has improved.

We have seen improvements in our direct costs throughout the construction cycle, which declined by roughly 9% in the fourth quarter, versus the high watermark in the second quarter of the year, an average of approximately 16,000 per home. Looking forward, we expect our direct costs to continue to decline and our cycle times to improve as supply chain and trade shortages further subside. We ended the quarter with approximately 53,000 owned and controlled lots, with roughly 60% owned and 40% controlled. This total lot pipeline was down from roughly 63,000 lots at the end of the third quarter 2022 and 80,000 lots at the beginning of the year. This decline was almost entirely within our bucket of controlled lots, as our own lots have remained relatively unchanged compared to the last quarter and the beginning of the year.

Our 32,000 owned lots provide approximately three years of deliveries based on 2022 volumes, which is consistent with past years. We continued to step away from land deals throughout the second half of 2022 that no longer met our investment standards and that were generally higher in price than our owned lots. Given the effectiveness of our land strategy, we were able in the fourth quarter to reduce our land pipeline by nearly 10,000 lots and our acquisition commitments by approximately $270 million, while incurring minimal abandonment costs of roughly $4 million. For the full year, we reduced our land pipeline by a total of nearly 27,000 lots and our acquisition commitments by over $650 million for only $12 million in abandonment costs. This strategy allows us to control significant amounts of land for future growth during periods of high sales absorptions for limited investment, and exit those positions at a reasonable cost in the event of a market downturn, all without adversely impacting our near-term need for lots on which to start homes.

Looking forward, we expect the recent decreases in our controlled lots to start leveling off. Century’s total community count at quarter end stood at 208, down from 217 in the previous quarter, but up from 202 in the year ago period. Our community count dropped sequentially in the fourth quarter due to closeout of various communities and our conscious decision to delay the opening of certain new communities in the second half of the year as market conditions deteriorated. Looking ahead, we expect to grow our community count at a measured pace as the recent declines in direct costs, moderation of incentives, and expected improvements in cycle times has given us increased confidence in our ability to generate solid margins and returns from the new communities we opened.

Given the extent of our existing land pipeline, our year end 2023 community count could be in the range of 250 to 260 communities if we elect to open all communities that we expect to be available. In the face of numerous market challenges, we are very pleased with our performance this quarter and for the full year. Going forward, our strategy remains consistent: Continue to find market prices for completed and completed homes that were started earlier last year with elevated costs, manage land spend and generate operating cash flow that will be reinvested in new homes with improving margin profiles that will be started in the first half of 2023 and beyond. I’ll now turn the call over to Dave to discuss our financial results in more detail.

David Messenger: Thank you, Rob. We met our objectives and delivered healthy results this quarter, which resulted in the generation of strong operating cash flow and meaningful reductions in our gross and net homebuilding debt ratios. During the fourth quarter of 2022, net income was $79.5 million compared to $165 million in the prior year quarter or earnings per diluted share of $2.47 compared to $4.78 in the year ago period. Full year net income increased to $525.1 million, while earnings per diluted share increased to $15.92, both company records. Fourth quarter pre-tax income was $102.4 million. And our full year pre-tax income increased to $676.9 million, the highest in the company’s history. Home sales revenues for the fourth quarter were $1.2 billion, slightly above last year’s levels.

Home deliveries of 2,903 homes were down less than 1% on a year-over-year basis, while our average sales price of $397,000 was up by less than 1%. Home sales revenues for the full year increased 9% to a company record of $4.4 billion driven by an 11% increase in our average sales price. Home deliveries of 10,594 homes were the second highest in our company history and nearly flat with last year’s record levels of 10,805. In the fourth quarter, net new contracts across our footprint were 1,258. Similar to last quarter, this year-over-year decline was primarily due to elevated cancellation rates and the impact that the sharp increase in interest rates had on potential homebuyers. New contracts before cancellations totaled 2,008 homes. At quarter end, our backlog of sold homes was 1,810 valued at $671 million, with an average price that had decreased by 8% year-over-year.

In the fourth quarter, adjusted homebuilding gross margin percentage was 19.8% compared to 27.3% in the prior year quarter. Homebuilding gross margin was 17.6% or 18.4% when excluding inventory impairments, compared to 25.9% for the same period last year. As we discussed on our last quarterly call, this reduction in margin percentage was expected and primarily resulted from our strategy of generating cash and reducing our leverage profile by focusing our sales efforts and incentives on near-term deliveries, even though they carried elevated construction costs due to their start dates earlier in the year. In the fourth quarter of 2022, we also recorded an inventory impairment charge of $10.1 million. For the full year, homebuilding gross margin percentage improved to 24.5% compared to 24.2% and adjusted homebuilding gross margin percentage improved to 26% from 25.9%.

SG&A as a percent of home sales revenue was 9.5% in the fourth quarter compared to 9.3% in the prior year. This minor increase was a result of higher commission costs year-over-year due to market conditions with the balance of the costs below the prior year levels. For the full year, SG&A as a percent of home sales revenue was 9.8% compared to 9.7% in 2021. Pre-tax income margin for the quarter was 8.7% compared to 17.6% in the prior year. For the full year, pre-tax income margin was essentially flat at 15% versus 15.2% in 2021. We incurred $5.1 million of other expense in the fourth quarter, including $4.2 million of expense from the abandonment of certain deposits and feasibility costs. For the full year, we incurred $11.6 million of expenses from the abandonment of deposits and feasibility costs.

As a reminder, our charge-off of these deposits and feasibility costs was a result of our deliberate decision to step away from land deals that no longer met our investment standards as a result of the market shift. During the fourth quarter, financial services captured 65% of the closings, generating $23.1 million in revenues compared to $31.2 million in the prior year quarter, primarily due to forward commitments entered into in prior quarters, fewer loan originations and increased competitive pressures. The business contributed $12 million in pre-tax income compared to $12.7 million in the prior year quarter, a significant accomplishment given the decline in revenues and volatility surrounding the mortgage market. During the quarter, we maintained our quarterly cash dividend of $0.20 per share and did not repurchase any shares of our common stock.

As a reminder, in the first three quarters of this year, we invested in repurchasing 2.3 million of our common stock at an average share price of approximately $52.32 or a roughly 23% discount to our year end 2022 book value of $67.67 per share. These share repurchases in 2022 reduced our share count by approximately 7% with approximately 1.5 million shares remaining available for repurchase under our current authorization. As a result of executing on our objectives, we generated $382 million in operating cash flow in the fourth quarter. Our net homebuilding debt to net capital ratio declined significantly to 23.5% compared to third quarter 2022 levels of 32.5% and the lowest year end level in our history as a public company. Our homebuilding debt-to-capital ratio declined to 32% at quarter end compared to 36.3% as of the end of the third quarter of 2022.

For the 12 months ending December 31, 2022, we generated a return on equity of 26.8%, which represented our seventh consecutive quarter with a return on equity above 25%. We ended the quarter with a strong financial position, including $2.2 billion in stockholders’ equity, a 22% year-over-year increased, and $1.2 billion in total liquidity, including $353.3 million in cash. In the fourth quarter, we paid off the $165 million outstanding on our revolving credit facility and have no borrowings outstanding on the $800 million facility that does not mature until April 2026. Additionally, we have no senior debt maturities for five years, providing us ample flexibility with our leverage management. Now turning to guidance, the homebuilding industry last year was impacted with increasing interest rates, rising costs, declining ASPs, and deteriorating demand.

We have begun to see mortgage rates stabilize and homebuyer traffic on sites increase. For the first and second quarters, we expect our deliveries to be below prior year levels. This expected decrease is due to the fact that we delayed community openings, started fewer homes in the second half of 2022 as the market softened and successfully executed in the fourth quarter on our strategy of prioritizing the sale of near-term deliveries, leaving us with a limited number of completed spec homes. As a result, we will simply have fewer homes available for delivery in the first two quarters of 2023, while we start new homes with lower input costs for delivery in the second half of 2023. For the full year 2023, we expect our deliveries to be in the range of 7,000 to 8,000 homes, and our home sales revenues to be in the range of $2.6 billion to $3.1 billion.

In closing, we believe that our spec based model, dedicated focused on our own more affordable homes, geographic footprint and solid balance sheet, positions us well to navigate the current market, as well as thrive in improved economic environments. With that, I’ll open the line for questions. Operator?

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Q&A Session

Operator: Today’s first question comes from Carl Reichardt with BTIG.

Carl Reichardt : I wanted to ask a regional question. Southeast orders came down quite a bit I think 70% and the store count was flat. Just curious, with the performance there, can you talk a little bit about what happened there? And then following on to that, from a West and Mountain Region perspective, you’ve got a lot of lots, backlogs pinned up in the West. So is the focus, especially in the first half of the year going to be on working through lots and houses in the West?

David Messenger: Hey, Carl. This is Dave. I’d say, the answer to your question on the Southeast community count was flat and sales were down, but that was really a function of the Southeast throughout the first half of the year was still strong on sales, leaving ’21 and the ’22 both strong on sales. We just didn’t have any product and so we just didn’t have enough near-term completing specs or completed specs really available in those markets for us to be selling in Q4. So we saw that drop off, even though we’ve got some open communities. On the West Coast, yes, the first half of this year, as sales have come down, you’re going to see us work through some of that existing inventory that was started earlier last year. And that’s something we started at higher direct costs, and we’ve seen those prices come down, and we’ll work through that inventory here the first half of 2023.

Carl Reichardt: Thanks, Dave. So Southeast then is a function more of product availability as opposed to an excessively elevated can rate compared to the rest of the company?

David Messenger: Correct, correct. We definitely still see the Southeast being a strong region. It’s been just more a function of homes under construction.

Carl Reichardt: And then one — when you talked a little bit about the trends continuing in January from the improvement as you saw through the quarter and 4Q, would you describe what you’re seeing in January as better than what you’d expect seasonally, worse than or about what you’d expect seasonally? Thanks.

Dale Francescon: Well, in terms of seasonal, I mean, we’re certainly seeing an improvement in sales traffic and overall sales. And so, whether you call it seasonally or just an improvement because of the lower interest rates that are now in the market, it’s hard to tell. But the easiest thing to say is, January is improving over December. And from what we can see, we expect that to continue as we go forward.

Operator: The next question comes from Alan Ratner with Zelman & Associates.

Alan Ratner: Thanks for all the great info. A lot of interesting comments there. First, I’d love to drill in a little bit on some of your comments on pricing and incentives. It sounds like if I’m interpreting the comments correctly that you think that pricing or net pricing has effectively bottomed here, given that you’re kind of guiding for incentives to decline as the year goes on. So first of all, I want to make sure I’m understanding that correctly. And as soon as I am, does that imply that you feel like among your cohort of buyers, that affordability is kind of where it needs to be to kind of generate volume growth in the business over obviously a longer time period?

Dale Francescon: Alan in the fourth quarter, we were really addressing affordability across all subdivisions. And we had forward commitments, we had rate buydown programs available. We don’t have any of those in place now. We obviously still help some of our buyers on a case by case basis, but has — as rates have come down, we don’t see the need that we have to do it across our entire portfolio.

Alan Ratner: And to that point, have there been any offsets to that, that we should think about as far as pricing, like have there been base price adjustments or anything? I’m just trying to think like, obviously incentives is one way you attack the affordability equation. But home prices have gone up quite a bit over the last several years. So are you keeping the base price flat even as you’re pulling back on those mortgage incentives that you had been offering?

Dale Francescon: Well, typically in an existing community, we won’t be dropping base prices. But as we’re opening new communities, it becomes far easier to adjust base prices. We don’t have any backlog. And more importantly, we’re bringing out homes that have lower input costs in them than something that would have been started quite some time ago. But in general, as we are seeing in our — in the fourth quarter, our incentives went up pretty significantly over what we had in the third quarter and what we would normally see. And a significant component of that related to really the company-wide mortgage programs that we were offering.

Alan Ratner: Okay. And I appreciate that. You brought up the input cost, which was kind of the second question I was going to throw at you guys. If I heard you correctly, I think you said that your direct costs are down about $16,000 from the peak. Correct me if I’m wrong on that. But, generally, I think your commentary, it sounds more bullish than I think a lot of other builders up to this point and a lot of them have been kind of highlighting their optimism that they will be able see some cost relief as ’23 goes on. But I think you guys are probably the first to kind of highlight significant reductions. And I’m curious if you could kind of split that out a little bit, like how much of that is lumber versus other inputs or labor that you have actually seen some relief on?

Dale Francescon: It’s around two-thirds of it on lumber, and the balance on some of the other areas. And it depends too. And some of the back end areas we got released, but really a lot more on the front end where things have slowed down on starts across the board and people are not nearly as busy as they were. So we are getting that potential reduction there, where people are more readily available to come and perform their work at the pricing. So it’s an ongoing focus of ours and not only in the division but regionally and then from the corporate team as well. And I think our team has done a really good job of getting the input costs down, because candidly, they were just way too high at the beginning and middle of last year.

Alan Ratner: Got it. That’s helpful. So that $16,000, if I just look at some rough math here, your average pricing backlog is about $370,000. So call it a 4% margin impact all else equal. Is that how we should think about your comments as far as once you get past the first half of the year, you see margins lifting sequentially. Is that 400 basis points kind of assuming all else equal pricing stays flat, everything else stays flat and what we should expect to see?

David Messenger: You hit it right on the head. You did the math and that’s exactly it. So yes.

Operator: The next question comes from Jay McCanless with Wedbush. Please go ahead.

Jay McCanless: Good afternoon. Just a couple of questions on the guidance for ’23. If you average out the community count to around 225, 230, and then the closings — the midpoint of the closings, it looks like you guys are expecting maybe less than three closings per month for fiscal ’23 versus being anywhere between three and four really since fiscal ’18. I guess it seems a bit cautious, a bit hesitant. Maybe talk us through why you are going to such a low closure — what we perceive to be a relatively low closing guidance to start the year?