Harbor Custom Development, Inc. (NASDAQ:HCDI) Q2 2022 Earnings Conference Call August 15, 2022 12:30 PM ET
Company Participants
Sterling Griffin – CEO, President and Chairman of the Board
Lance Brown – Chief Financial Officer
Operator
Thank you for standing by. And welcome to the Harbor Custom Development Incorporated Second Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session from previously submitted questions will follow the formal presentation. As a reminder, this conference is being recorded.
I would now like to introduce today’s presenters, Sterling Griffin, CEO, President and Chairman of the Board; and Lance Brown, Chief Financial Officer.
I will now turn the conference over to Mr. Brown.
Lance Brown
Thank you, Operator. Thank you all for joining us today. Welcome to Harbor Custom Development’s second quarter 2022 earnings conference call. During our discussion today, we will be referring to our earnings press release and presentation that were made available prior to the call. The release and presentation can be found in the Investor Relations section of the Harbor Web site at www.harborcustomhomes.com. Before we begin, I would like to remind everyone that today’s call includes forward-looking statements. Any forward-looking statements contained in the earnings release or discussed today are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially from these forward-looking statements. Specifically included are statements regarding our industry and our outlook for 2022. Please see our recent SEC filings, which identify the principal risks and uncertainties, which could affect future performance. We assume no obligation to update any forward-looking statements. In addition, we will be discussing or providing certain non-GAAP financial measures today, including EBITDA, adjusted EBITDA and adjusted EBITDA margin. Please see the appendix of our earnings presentation for a reconciliation of these non-GAAP measures to their most direct comparable GAAP measure.
I would now like to turn the call over to Sterling.
Sterling Griffin
Thank you, Lance. And thanks to everyone for joining the call today. We appreciate your interest in Harbor Custom Development. I am thankful for our team’s hard work and dedication during the second quarter despite results coming in below internal expectations. The primary drivers impacting Q2 results were the significant cost overruns on our fee build projects, primarily due to increase in material costs and record setting rainfall in Western Washington, which caused substantial delays. In addition, the cancellation of a high margin entitled land sale in our Horizon subdivision that was previously under contract also had a substantial impact to our financial results. While these events impacted our financial results for the quarter, we made a number of accomplishments that positioned us well for the remainder of the year and into 2023. These accomplishments include the listing of six multi-family projects, totaling 278 million with Kidder Mathews, significantly progressing the construction of those projects and continuing to close more Texas home sales at attractive prices and margins.
As we enter a challenging macroeconomic environment, including a slowing economy, weakened consumer buying behavior, higher interest rates and inflation, we are staged and ready for the future. We expect that our distinct business plan, which is focused on serving multiple segments of the residential market within a 20 to 60 minute commute in some of the nation’s fastest growing regions, will continue to provide us with a consistent stream of revenue generated from multi-family apartments, single family homes, land and lot sales. Our diversified product portfolio enables us to build to the demands of the different communities. As we continue to navigate a challenging and dynamic market environment, our unique model will allow us to meet the needs of our diverse customers. As we previously communicated, we began a strategic transition of our inventory to multi-family housing in 2021. We believe this transition occurred at the opportune time as multi-family properties have historically fared very well in economic downturns. Furthermore, multi-family properties are a more affordable alternative than purchasing a single-family home particularly now, as the economy takes on inflation, rising mortgage rates and continued low levels of housing inventory in our geographic markets. During Q2, we announced the listing of six multi-family properties in Western Washington. Those projects are: Pacific Ridge, Mills Crossing, Belfair View, Windstone, Meadowscape, formally known as Tanglewilde and Bridgy Trails. Our initial target was to have Mills Crossing, Pacific Ridge, Windstone and Belfair Phase 1 sold during the fourth quarter of 2022, but one or more of these properties may close in 2023.
Now I would like to transition the commentary to our single family home segment. In Q2 of 2022, we closed on the sale of our final two homes in Soundview Estate. This was the last of our single family home projects in Washington. We also sold five single family homes in the Austin, Texas, MSA. Texas home sale prices ranges from 1.3 million to 1.6 million or approximately 400 per square foot with average margins of approximately 23%. Although the second quarter did not meet our expectations, we have continued our growth story for the first half of the year, recognizing $38.9 million of revenues for the six months ended June 30, 2022. This is an increase of $10.9 million compared to the prior year period. As of June 30, 2022, our backlog of fully executed contracts for the sale of developed residential lots and single family homes was $15 million compared to $14.2 million as of June 30, 2021. Our fee build backlog as of June 30, 2022 was $5.8 million compared to $5.5 million as of June 30, 2021. Our financial condition remains stable and we continue to take a prudent approach in managing our financial health. We ended the second quarter with $22 million of unrestricted cash, an increase compared to the $12.8 million at the end of the second quarter of 2021. We continue to invest in our business. We’ve grown our real estate assets to $154.6 million as of June 30, 2022. The majority of our investment during the second quarter was allocated to the development and construction of our multi-family properties.
Before I turn the call back to Lance, I want to address the timing of projects. As I mentioned earlier, at the end of the quarter, we had a customer withdraw from a previously contracted entitled land sales during the final stages, which impacted our revenue for the second quarter by approximately $5 million. It is worth remembering that the realization of revenue and gross profit related to unrealized sales has not disappeared, rather the property remains in our inventory for future sale and monetization. We will continue to take a diligent approach to our guidance practices and maintain open communication sharing any key changes to our expected targets.
I will now turn the conference call back to Lance Brown, our Chief Financial Officer, to further discuss our financial details.
Lance Brown
Thank you, Sterling. During the second quarter, sales decreased by 27.2% to $10.3 million as compared to $14.1 million for the prior year period. The decrease in sales was mostly driven by a decrease in entitled land sales of $9.3 million, primarily offset by an increase in home sales of $5.3 million. The entitled land sales in Q2 2021 did not recur in Q2 2022. Our gross loss for the second quarter 2022 was $1.9 million compared to gross profit of $3.3 million for the second quarter of 2021. We had a gross margin loss of 18.8% for the three months ended June 30, 2022 compared to 23.5% gross margin for the three months ended June 30, 2021. The $5.3 million decrease in gross profit and 42.3% decrease in gross margin was primarily due to significant cost overruns on our fee build projects and the nonrecurrence of higher margin entitled land sales. Our fee build cost overruns, which were primarily attributable to inflation and record setting rainfall in Western Washington, resulted in a $3.2 million gross loss and 212.9% gross margin loss in the second quarter of 2022 as compared to $0.2 million gross profit and 11.8% gross margin in the second quarter 2021. The entitled land sales in the second quarter 2021 provided $2.4 million gross profit dollars at a gross margin of 25.5% that did not recur in the second quarter 2022.
Our operating expenses increased to $3.7 million for the three months ended June 30, 2022 as compared to $2.3 million for the three months ended June 30, 2021. This anticipated increase in total operating expenses is primarily attributable to increases associated with our continued investment in public company infrastructure and our future growth plans. $0.8 million increase in payroll related cost was the largest contributor of our operating expense increases. Less significant increases in professional fees, marketing and advertising, insurance expense, investor relations, right of use expense for a new corporate office and depreciation expense, also contributed to the increase over the prior year period. In the second quarter of 2022, operating expenses as a percentage of sales increased to 35.5% compared to 16% for the second quarter of 2021. The increase in operating expenses as a percentage of sales is primarily due to the increase in public company infrastructure expenses and cost to support our growth plans that were previously mentioned and lower sales in Q2 2022 compared to Q2 2021. We believe we are now sufficiently staffed to fully support our public company reporting requirements and meet our near term growth plans. We expect operating expenses as a percentage of sales to decline as sales increase from selling our multi-family properties.
Net loss was $4.5 million for the three months ended June 30, 2022 as compared to net income of $1.1 million for the three months ended June 30, 2021. The decrease in net income was primarily attributable to decreases in sales, cost of sales overruns, and increased operating expenses in the second quarter of 2022. For the three months ended June 30, 2022, we had a loss per share of $0.46 compared to earnings per share of $0.06 for the three months ending June 30, 2021. EBITDA loss for the second quarter of 2022 was $4.9 million compared to $2 million of EBITDA income in the second quarter of 2021. Adjusted EBITDA loss in the second quarter of 2022 was $4.8 million compared to $2.1 million of adjusted EBITDA income in the second quarter of 2021. Adjusted EBITDA loss as a percentage of sales was negative 46.5% for the second quarter of 2022 compared to 14.7% for the second quarter of 2021. Net cash used in operating activities for the quarter ended June 30, 2022 was $26.1 million compared to cash used by operating activities of $44.6 million for the quarter ended June 30, 2021. The primary use of cash during the quarter were related to the development of construction of our real estate assets, the majority of which were focused on our multifamily projects. Our real estate assets have continued to increase to $154.6 million as of June 30, 2022 from $122.1 million as of December 31, 2021. As of June 30, 2022, our real estate assets were levered approximately 45%.
Now turning to year-to-date results. Sales for the first half of 2022 increased by 38.8% to $38.9 million compared to $28 million for the first half of 2021. Sales improvement in 2022 was primarily due to increases in home sales of $10.7 million, fee build revenues of $2.9 million and developed lot sales of $2.1 million, partially offset by a decrease in entitled land sales of $4.8 million. Gross profit for the first half of 2022 was $4.1 million compared to $3.9 million for the first half of 2021. Gross margin for the first half of 2022 was 10.6% compared to 14% for the first half of 2021. The $0.2 million increase in gross profit in 2022 was primarily due to increases in home gross profit of $1.8 million and entitled land gross profit of $1.6 million, which was partially offset by the decrease in fee build gross profit of $3.2 million. The 3.4% decrease in gross margin was primarily driven by the significant cost overruns with our fee build projects and was partially offset by the margins attained with the sale of entitled land in the first quarter of 2022.
Our operating expenses for the first half of 2022 were $7.5 million compared to $4.3 million for the first half of 2021. This expected increase is primarily attributable to increases in the continued investment of public company infrastructure and personnel to support our future growth plans. Payroll related cost and professional fees were the largest contributors to the increase in operating expenses at $1.6 million and $0.5 million respectively. Right of use expense for a new corporate office, depreciation expense, marketing and advertising, stock compensation and director fees, also contributed to the increase over the prior year period. Operating expenses as a percentage of sales for the first half of 2022 were 19.3% compared to 15.4% for the first half of 2021. The increase in operating expenses as a percentage of sales is primarily due to the increase in operating expenses as described earlier, which have increased faster than the increase in sales.
Net loss for the first half of 2022 was $2.9 million compared to net loss of $0.5 million for the first half of 2021. The decline in net income was primarily attributable to cost of sales overruns with our fee build projects and increased operating expenses in the first half of 2022. For the first half of 2022, we had a loss per share of $0.50 compared to a loss per share of $0.04 for the first half of 2021. EBITDA loss for the first half of 2022 was $1.4 million compared to EBITDA of $2.3 million for the first half of 2021. Adjusted EBITDA loss for the first half of 2022 was $0.9 million compared to $2.5 million of adjusted EBITDA for the first half of 2021. Adjusted EBITDA as a percentage of sales was negative 2.3% for the first half of 2022 compared to 8.9% for the first half of 2021.
I will now turn the call back to Sterling.
Sterling Griffin
Thank you, Lance. Looking forward to the remainder of 2022, we are confident in the momentum we have generated during the first six months of the year. As discussed earlier, we believe that the timing of certain multi-family projects factored into our prior full year 2022 outlook could move from Q4 2022 into 2023. Because of these factors, along with the previously mentioned headwinds, we are adjusting our outlook for the full year of December 31, 2022 to assume the following: Full year revenue in the range of $80 million to $90 million and adjusted EBITDA, which is expected to be at or around break even; while our outlook assumes a degree of near-term uncertainty, primarily related to timing, we believe this updated guidance has room for upside; while the sales timing of our listed multifamily properties is uncertain, we are confident the monetization of these assets will drive future shareholder value.
With that, I will turn it back to the operator.
Question-and-Answer Session
A – Unidentified Company Representative
We will now switch to the question-and-answer session. Prior to the call, inquiries were submitted to ir@harborcustomdev.com. I will now read the previously submitted questions for Mr. Griffin and Mr. Brown to respond to. Thank you to everyone who submitted questions.
What is the construction pipeline of multi-family units and what are the cap rate trends for those projects?
Sterling Griffin
We previously announced the listing of six properties with Kidder Mathews for $278 million. In our pipeline behind those listed properties, we have approximately 600 units in various stages of the due diligence process. Regarding cap rates, we’ve seen them rise from the 4% range for new construction in our target markets to 4.5% to 5%. Fortunately, we have also seen corresponding rises in rental rates that have helped offset the cap rate increases.
Unidentified Company Representative
Do you still expect the sale of apartment units to contribute to a substantial portion of your top-line for 2022 and 2023?
Sterling Griffin
Based on our updated guidance, we do not expect the sale of our multi-family projects to contribute a substantial portion of our 2022 revenues, as we think several of those projects could slide into 2023. For 2023, we expect our multi-family segment to be the largest contributor to our top line sales.
Unidentified Company Representative
What is the anticipated full year mix of developed lots, entitled land, fee build and home sales and the resulting gross margins?
Sterling Griffin
It is hard to predict the exact sales mix that each of the segments will contribute to 2022 due to the unknown timing of the closings. However, we have a pipeline for all of our segments and expect each segment to further contribute to overall sales during the remainder of the year. As far as margins go, they tend to be project specific. In general, margins are declining based on current marketing conditions. We expect entitled land sales to provide the highest gross margins of all of our segments. Our multi-family property sales in Washington and single family home sales in Texas could generate gross margins on average in the low to mid 20% range. As we discussed on the call, we have incurred cost overruns on the fee build projects and as a result, we expect future margins to be at or near break even for that segment.
Unidentified Company Representative
What is your forecasted normalized annual operating expenses for 2022?
Sterling Griffin
We are estimating operating expenses for 2022 to be in the $16 million to $17 million range. We believe that we are now sufficiently staffed to fully support our public company reporting requirements and meet our near term growth plans. We expect operating expenses as a percentage of sales to decline in future years.
Unidentified Company Representative
For the multifamily projects listed, are they; one, under construction; two, completed but unoccupied; or three, occupied to some degree? Which do you prefer in a sale or do all three stages work?
Sterling Griffin
For the six multifamily projects, we have listed with Kidder Mathews for $278 million, all are under construction at this time. One of those projects, Mills Crossing, is currently in the rent up stage. Our objective is to sell each multi-family project at the earliest possible opportunity. In the current market newly constructed projects typically need to achieve a certain level of occupancy ranging from 70% to 90% before a buyer will close.
Unidentified Company Representative
Would it ever be a viable plan or option to hold/own the multifamily properties for the rental income revenue stream?
Sterling Griffin
Yes. In the future, it is our objective to hold some of our multifamily projects. The company would benefit both from the monthly revenue created by the project while adding an appreciating asset to the balance sheet.
Unidentified Company Representative
What does site work mean exactly for the Florida condo project?
Sterling Griffin
Site work typically refers to horizontal development. Regarding Punta Gorda when we refer to site work, it is the beginning of construction and refers to the clearing of the land, installation of roads, underground utilities and building pad preparation.
Unidentified Company Representative
Can you give an update on the Austin area real estate market, which some say has become very difficult?
Sterling Griffin
Like most single family markets in the US, the Austin market has also slowed down. We will continue to assess the Austin market dynamics and use our unique business model to monetize our real estate assets at the most opportune stage.
Unidentified Company Representative
Since there still appears to be a nationwide housing shortage, is there still going to be a focus on single family home development over the long term?
Sterling Griffin
There does continue to be a nationwide housing shortage. Our focus today is on multifamily housing, which also has a significant shortage across the US, and we believe multifamily housing provides better opportunities for the company long term.
Unidentified Company Representative
Will you please provide an update on your Darkhorse property in California and your plan for that project?
Sterling Griffin
We are currently working to sell the remaining 63 lots in the Darkhorse development. And at this time, we do not plan on building any single family homes in the subdivision.
Unidentified Company Representative
This concludes the question-and-answer session. I will now turn the call back to Mr. Griffin for closing remarks.
Sterling Griffin
Thank you everyone for participating on today’s call. We look forward to providing additional updates soon. You can find more information about the presentation and future events on our investor relations page under the tab events on our Web site, harborcustomhomes.com. For the most recent updates on company news, we encourage you to sign up for email notifications on the investor resources tab of our Web site. If anyone has further questions, we can be reached at 866-744-0974 or at ir@harborcustomdev.com. Thank you again for joining us today. We appreciate your time.
Operator
This does conclude today’s conference call. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.
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