Harbor Custom Development, Inc. (NASDAQ:HCDI) Q3 2022 Results Conference Call November 14, 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 Third 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. Please go ahead.
Lance Brown
Thank you, Operator, and thank you all for joining us today. Welcome to Harbor Custom Development’s third 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 would like to begin by saying that our team performed at a high level during the third quarter. While our team’s performance during the quarter may not be reflected in our financial results, throughout the quarter, we made progress from a strategic and operational standpoint. Efforts to shift our inventory and focus more heavily on multifamily housing continued to advance. Multifamily projects now represent approximately 60% of our total real estate assets. We continue to advance work on each of the six projects highlighted during the second quarter earnings call, the construction of those projects remains on track with the first three scheduled for substantial completion by the end of the fourth quarter. We also monetized a smaller entitled land sale during the quarter and continued to earn additional fee build revenues. These lower gross margin sales were partially offset by several higher margin single family home sales in our Texas market.
As we continue to refocus our portfolio on more multi-family opportunities, we expect the revenue contribution from multi family projects to account for more than 50% of total annual revenues for 2023. Rising interest rates, continued inflation and broader market uncertainty continued to pose legitimate threats to the economy and have had a negative impact on home buyer confidence and affordability. The housing market has continued to weaken in response to the rapid increase in mortgage rates, which has substantially slowed the single family home sales market nationally. As a result and to recover loss momentum, we implemented certain market adjustments, including new pricing strategies and increased incentives across the majority of our markets. We believe our calculated move into the multi-family housing market puts us in a unique position to grow our business during this slowing economy as multi-family properties are traditionally a more affordable alternative to purchasing single-family homes and have historically fared better during economic downturn. For more information on the performance of multi-family in down markets, please see our White Paper on multi-family housing, which can be found in the presentations section of our Web site.
As of September 30, 2022, our backlog of fully executed contracts for the sales of developed residential lots and single family homes was $6.9 million, an increase of 81% from the prior year. Our fee build backlog as of September 30, 2022 was $2.1 million compared to $12.6 million in the prior year. The decrease in fee build backlog is primarily due to the progress we have made towards completion of our fee build projects previously under contract. While inventory varies across each market, we have deployed price reductions and/or increased incentives to begin rebuilding the lot sales momentum. While the size of the reduction or incentive varies community-to-community, we believe these proactive measures will help us regain volume and momentum of sales. Our management team continues to monitor the market environment for changes to interest rates, pricing or demand. We will address any significant changes in the market and make strategic decisions and/or adjustments as necessary.
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 third quarter, sales decreased by 34.8% to $11.7 million as compared to $18 million for the prior year period. The decrease in sales was mostly driven by a decrease in entitled land sales of $7 million and developed lot sales of $0.8 million, partially offset by increases in home sales of $0.8 million and fee build revenues of $0.8 million. Our gross profit for the third quarter 2022 was $0.4 million compared to gross profit of $7.1 million for the third quarter of 2021. We had a gross margin of 3.7% for the three months ended September 30, 2022 compared to a gross margin of 39.7% for the three months ended September 30, 2021. The $6.7 million decrease in gross profit and 35.9% decrease in gross margin was primarily due to the non-recurrence of higher margin entitled land sales in the third quarter of 2022 and a decrease in fee build gross margin due to cost overrun disclosed during the second quarter.
Our operating expenses increased to $4.5 million for the three months ended September 30, 2022 as compared to $3.3 million for the three months ended September 30, 2021. The increase in total operating expenses is primarily attributable to the recording of a bad debt expense for the Rocklin Winding Lane 22 LLC note receivable and preacquisition expenses associated with the Westry Village project that we decided not to purchase, which were partially offset by reduction in payroll expense attributable to the release of our annual short term incentive plan accrual. In the third quarter of 2022, operating expenses as a percentage of sales increased to 38.5% compared to 18.4% for the third quarter of 2021. The increase in operating expenses as a percentage of sales is primarily due to the increased expenses previously mentioned and the decline in sales over the comparable periods. Not considering the bad debt expense and the Westry Village cancellation costs, we believe our run rate operating expenses should remain relatively stable going forward, meeting our public company infrastructure requirements and setting us up for our near term growth objectives. Our operating expenses as a percentage of sales should decline, especially as sales from our multi family projects begin to monetize, which we expect to occur in 2023.
Net loss for three months ended September 30, 2022 was $3.4 million as compared to net income of $3.7 million for the three months ended September 30, 2021. The decrease in net income was primarily attributable to the decrease in sales and increase in cost of sales and operating expenses in the third quarter of 2022. For the three months ended September 30, 2022, we had a basic loss per share of $0.37 compared to basic earnings per share of $0.21 for the three months ended September 30, 2021. EBITDA loss for the third quarter of 2022 was $3.2 million compared to $4.3 million EBITDA income in the third quarter of 2021. Adjusted EBITDA loss in the third quarter of 2022 was $3.1 million compared to $4.5 million of adjusted EBITDA income in the third quarter of 2021. Adjusted EBITDA loss as a percentage of sales was negative 26.2% for the third quarter of 2022 compared to 25.1% for the third quarter of 2021. Net cash used in operating activities for the quarter ended September 30, 2022 was $32.6 million compared to cash used by operating activities of $18 million for the quarter ended September 30, 2021. The primary uses of cash during the quarter were related to the development and construction of our real estate assets, the majority of which were focused on our multifamily projects. The majority of our multi family home projects are fully financed. Our real estate assets have continued to increase to $179.9 million as of September 30, 2022 from $122.1 million as of December 31, 2021. As of September 30, 2022, our real estate assets were levered approximately 51.2%.
Now turning to year-to-date results. Sales for the first nine months of 2022 increased by 10% to $50.6 million compared to $46 million for the first nine months of 2021. The sales improvement in 2022 was primarily due to increases in home sales of $11.5 million, fee build revenues of $3.6 million and developed lot sales of $1.3 million, partially offset by a decrease in entitled land sales of $11.9 million. Gross profit for the first nine months of 2022 was $4.6 million compared to $11.1 million for the first nine months of 2021. Gross margin for the first nine months of 2022 was 9% compared to 24.1% for the first nine months of 2021. The $6.5 million decrease in gross profit in 2022 was primarily due to the decrease of entitled land gross profit of $4.5 million and fee build gross profit of $3.8 million, partially offset by $2.4 million increase in gross profit from home sales. The decline in fee build gross profit was a result of significant cost overruns that were previously disclosed. The decrease in entitled land gross profit relates to a volume decline for the first nine months of 2022 as compared to the first nine months of 2021. The 15.1% decrease in gross margin was primarily driven by significant cost overruns with our fee build projects resulting in a 56.1% gross margin decline. The fee build gross margin decline was partially offset by the gross margin increases from homes, developed lots and entitled land.
Our operating expenses for the first nine months of 2022 were $12 million compared to $7.6 million for the first nine months of 2021. This increase is primarily attributable to the investment we made in our public company infrastructure and personnel to support our future growth plans. Bad debt expense associated with the Rocklin Winding Lane 22 LLC note receivable and preacquisition expenses associated with the Westry Village project that we decided not to purchase. Payroll related costs, bad debt expense, professional fees and project cancellation costs were the largest contributors to the increase in operating expenses at $1.2 million, $0.9 million, $0.5 million and $0.5 million respectively. Right of use expense for the new corporate office, depreciation expense, marketing and advertising and insurance also contributed to the increase over the prior year period. Operating expenses as a percentage of sales for the first nine months of 2022 were 23.7% compared to 16.6% for the first nine months of 2021. The increase in operating expenses as a percentage of sales is primarily due to the increase in operating expenses previously stated, which increased more rapidly due to the investments in our business to build our public company infrastructure and support our growth and unexpected costs incurred related to a bad debt expense and canceled projects.
Net loss for the first nine months of 2022 was $6.3 million compared to net income of $3.2 million for the first nine months of 2021. The decline in net income was primarily attributable to cost of sales overruns with our fee build projects, less volume of high margin entitled land sales and increased operating expenses in the first nine months of 2022. For the first nine months of 2022, we had a loss per share of $0.88 compared to basic earnings per share of $0.17 for the first nine months of 2021. EBITDA loss for the first nine months of 2022 was $4.6 million compared to EBITDA income of $6.6 million for the first nine months of 2021. Adjusted EBITDA loss for the first nine months of 2022 was $4 million compared to $7 million adjusted EBITDA income for the first nine months of 2021. Adjusted EBITDA as a percentage of sales was negative 7.8% for the first nine months of 2022 compared to 15.2% for the first nine months of 2021.
I will now turn the call back to Sterling.
Sterling Griffin
Thank you, Lance. During the third quarter, we experienced certain supply chain constraints, including shortages of block wall masonry, appliances and electrical components. In most of these instances, the company was able to reduce or eliminate construction delays through thoughtful redesign or alternative selections. At times, however, these challenges resulted in construction delays within both our single family and multi-family divisions. As we look forward, certain industry trends continue to suggest prolonged headwinds, including continued inflation, affordability issues, increased mortgage rates and slower and less attractive financing options for customers. Due to these dynamics, along with the further uncertainty related to timing of certain multi-family projects and home sales, we are reducing our full-year financial targets for the 12 months end of December 31, 2022. Our full year financial outlook for the 12 months ended December 31, 2022 now includes the following: Revenue in the range of approximately $61 million to $65 million compared to our previous range of $80 million to $90 million; adjusted EBITDA between a loss of approximately $5 million and a loss of $7 million compared to our previous expectation, which was at or around breakeven. This updated guidance is based solely on real estate that is under contract and is scheduled to be completed and sold in 2022. While our results for the third quarter fell short of expectations, we believe Harbor Custom Development is in a stable position. As the landscape surrounding us remains very dynamic, we will continue to manage the business diligently and remain focused on creating shareholder value.
With that, I will turn it back to the operator.
Question-and-Answer Session
Operator
[Operator Instructions] I will now read the previously submitted questions from Mr. Griffin and Mr. Brown to respond to. Thank you to everyone who submitted questions. Does the pending Punta Gorda sale get the company completely out of the Florida market?
Sterling Griffin
Yes. Punta Gorda is the only property we currently have in Florida. However, we like the Florida market and we will continue to evaluate opportunities there in the future.
Operator
Are there any new markets that the company is looking to enter into at this time?
Sterling Griffin
Yes. We really like markets within migration, no or low state income tax and strong economic conditions. We will evaluate any opportunity that meets one or more of these criteria.
Operator
Will you please provide an update on the BankUnited loan default?
Lance Brown
As we disclosed in our 8-K filing on October 28th, Harbor failed to meet the BankUnited minimum interest coverage ratio debt covenant as of September 30, 2022, and this was considered an event of default under the loan agreement. The covenant requires us to maintain a ratio of at least 2.5. But as of September 30th, we had an interest coverage ratio of 1.4. We submitted the covenant calculations to the bank and they informed us that they are sending the loan to their restructuring department for potential restructuring. To-date, the bank has not provided us with a notice of default or their intention to accelerate payment of any amounts due under the loan. We are waiting for the restructuring analysis and we will provide future material updates as appropriate.
Operator
What is the plan to get back into good standing with BankUnited and the 2.5 interest coverage ratio?
Lance Brown
We are actively seeking a resolution with BankUnited, which has sent the loan to its restructuring department. Additionally, we are continuing to progress market and monetize our real estate assets to generate EBITDA, which is a key component to the interest coverage ratio.
Operator
What is the plan or what will Harbor do if BankUnited calls the loan?
Sterling Griffin
Harbor values our relationship with BankUnited. The support they provided has allowed us to pivot to multifamily at the opportune time. We do not believe it’s in BankUnited’s best interest to call the loan, because we have consistently paid all debt services costs when due, have significant real estate assets nearing completion that will generate cash when monetized and intend to pay the loan in full and on time. We have not received any indication that BankUnited will call the loan. But as Lance commented, it’s being analyzed for potential restructuring.
Operator
How much is left on the 5 million share buyback authorized on May 10, 2022, and can the remainder be used for preferred shares to lower future cash needs?
Lance Brown
At this time, Harbor has spent 0.4 million of the 5 million Board approved share repurchase program, so there is $4.6 million remaining. This authorization includes all of Harbor’s equity securities, including preferred shares, so purchasing preferred stock is an option for the company. However, due to difficult and changing market conditions and the uncertainty regarding the timing of sales and availability of future financing, we are closely monitoring our cash reserves to ensure our longevity. As our financial condition evolves, whether through real estate monetization, additional financing or other cash generators, we will reevaluate the best use for our capital, which may include continuing the Board approved stock repurchase program.
Operator
What is the expected gross profit and gross margin associated with the pending $7.25 million Punta Gorda sale that was recently announced?
Sterling Griffin
Punta Gorda is under PSA for $7.25 million. We are expecting gross profit margins of approximately 20% associated with this pending sale.
Operator
What is the status of the three multi-family and total land tracks at Horizon at Semiahmoo that were previously under contract for sale for $5.4 million, but the buyer chose to walk?
Sterling Griffin
We are currently permitting these three multi-family tracks referred to as RS&T for Town Home Rentals. We will evaluate market conditions at the time of approval and determine if it’s in our best interest to build the town homes or sell the permitted projects.
Operator
What is management doing to ensure the preferred shareholders continue to receive dividend payments?
Lance Brown
Previously mentioned, we are closely monitoring our cash position to ensure we can meet all of our financial commitments, including the preferred dividend payment. We have made all payments to date and although the preferred dividend payment is subject to monthly board approval, there are no immediate plans to defer payments at this time.
Operator
Harbor’s common stock has fallen under $1, so what is the company going to do to avoid [B&D] listed?
Lance Brown
The company is currently in compliance with the NASDAQ listing rules. In the future, if we do have a closing bid under $1 for 30 consecutive trading days and NASDAQ issues a deficiency notice, the company has at least 180 days to return to compliance and possibly an additional 180 day grace period if our market cap exceeds $1 million and shares held by non-affiliates. If we are still non-compliant after such time, there are additional avenues we can take to remain listed, which we would aggressively pursue. In the meantime, management’s focus is on the execution of our business plan, which if executed successfully should alleviate this concern.
Operator
Given the current state of the company and industry, what actions are being taken to immediately reduce expenses?
Lance Brown
The company constantly looks for opportunities to reduce expenses. We have recently taken a number of actions, including significantly reducing the cost of our D&O insurance, while increasing the coverage. On an annualized basis, these costs are being reduced by approximately $0.9 million. Another action we have recently taken is we have reduced our headcount since announcing second quarter results by approximately 20%, which will save roughly $3.3 million in annualized salary and benefits. Additionally, we’ve enacted other recent cost savings measures, including reducing and/or eliminating certain investor relations, marketing and professional services costs associated with third party service providers. We will continue to investigate other cost savings opportunities in an effort to become a leaner organization.
Operator
What is the current status of Darkhorse and surplus lots in Texas?
Sterling Griffin
Darkhorse listings have been recently transferred to a new real estate broker. We are looking to monetize this asset through individual or bulk lot sales. We recently signed a purchase and sale agreement to sell a lot in this community and expect more in the coming months. As for Texas, we’ll have an announcement about our surplus lots in the coming weeks.
Operator
What is the current plan and schedule for Grandis Pond?
Sterling Griffin
We are working with our civil engineers and the governing jurisdiction to determine the most cost effective way to serve the property with utilities while moving forward on the first couple of neighborhoods in the master plan. If all goes well, we hope to have approval to begin site work on the initial lots by mid-2023.
Operator
You recently announced properties for almost 1,000 new apartments. What is the timeline for this?
Sterling Griffin
I believe you’re referring to our six multi-family projects in Washington. We recently put out a brief update video about the status of the projects, which we encourage our shareholders to watch. This video can be found on our company Web site. In addition to these six projects, we also have several other projects under our control or in the pipeline.
Operator
With revenue projections being missed this year and last year, what is management doing to increase their credibility amidst shareholders?
Sterling Griffin
This is a good question, and one that we don’t take lightly. Our goal in providing guidance is to paint a financial picture of what we think is the most likely outcome based on the best information available at the time. We, like all the companies, are subject to rapidly changing market conditions. As was mentioned in the earnings release and 10-Q, we have missed guidance primarily as a result of revenues we expected to receive in 2022, but are now pushed into 2023.
Operator
How much cash is roughly projected to be needed for operations on current projects, and how does Harbor plan to raise money for said projects?
Lance Brown
Of our six listed multifamily projects, four are fully funded, which includes construction financing and the company’s equity requirement and one project has construction financing in place for phase one and has met the equity requirement. We are actively working on financing for the sixth project, and we’ll update the market when that occurs.
Operator
And finally, have you considered transitioning the multifamily strategy to grow the business in the build for rent sector?
Sterling Griffin
The plan for the six multifamily projects currently under construction continues to be build to sell. Our business is capital intensive and the immediate horizon necessitates us monetizing through sales. However, we are open to the idea of some build to rent projects in the future. We will provide further commentary if and when our strategy shifts.
Operator
This concludes the question and answer section of our conference. I will now pass it back to Sterling for closing remarks. Thank you.
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 irharborcustomdev.com. Thank you again for joining us today. We appreciate your time.
Operator
That concludes today’s call. At this time, you may now disconnect. Thank you.
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