Larry Nicholson – President & CEO
Gordon Milne – EVP & CFO
Drew MacKintosh – VP Investor Relations & Corporate Communications
David Goldberg – UBS
Ryland Group, Inc. (RYL) UBS Building & Building Products Tenth Annual CEO Conference November 15, 2012 10:00 AM ET
David Goldberg – UBS
Okay. We’re going to get started here again if you guys are good to go. Okay. Great, well we’re going to get started here. It’s a pleasure to welcome our friends from Ryland. We have Larry Nicholson, Gordon Milne and Drew MacKintosh with us. Larry, I’ll turn it right over to you.
Okay. Thanks. Appreciate you having us. Well, good morning. It’s great to be here. Beautiful day in New York. We were talking couple of days ago about we were here a year ago and if we were to said to anybody a year ago that our sales would have been up 40% through the first three quarters of the year, you guys would have laughed us out of the room.
We saw – the recovery started to happen last year about this time and saw improvement throughout the markets. And obviously that’s continued and as Brad said earlier, there is a lot of good things happening. There is still some headwinds that we faced, but I think in general we feel real good about where we are, where the industry is and where it’s going.
I’ll skip the first and talk about markets first, because I think it’s important to understand that all the markets are recovered, we’re seeing positive signs in every market. Don’t see anything concerns us, some of the slower market today which will be Chicago have even picked up dramatically over the last 60 days. So we’re really comfortable, we see great activity in Vegas which is another place a lot of people are surprised, where we’ve had very good sales in Vegas and good margins. So we feel real good about everything.
As you know we entered Raleigh through the downturn, we finally got that up and running. We got five communities opened Raleigh today and sales are starting to flow through, so we’re excited about that. We have made a decision we will go back into Phoenix.
We left Phoenix probably three years ago, sold lot of our inventory when the market was rather distressed and have decided that long-term that market seems to got some legs again and so we’re going to make a move back into that market and I would expect over the next couple of years, we’ll continue to evaluate a few of the markets we are not in. As you can see, we are in most of the bigger markets in the country. So there is not a lot of opportunity to move in to – also you have top 20 building market floors. We were already geographically diverse, which has always been part of our strategy.
A little bit on the third quarter. Obviously, we feel like we had a real strong quarter. The unit closings were up. The big number was the sales, we’re up 56% and how did we do that? What contributed that? A couple of things I would say, is community count continued to grow which is really where we’ve been focused probably the last 24 months, buying lots, trying to get communities open. And I think we’ve executed on that obviously we did do the Timberstone acquisition, which picked us up about 138 sales in backlog. We closed that in the third quarter. So that did have some addition to our backlog.
But what we did with the communities that we bought there, we slowed them down for probably about 60 days to retool product, make changes and get them (inaudible) as we would call it. So from sales perspective they did not contribute a lot of sales as in the backlog we bought, but as of today, all those communities are up and running, we’re good activity in those. So we’re really excited about that.
Average closing price continued to move up a little bit. I think margins the only thing we got to 20%, which is always been a question that we had over the last probably six months from the investment communities. When do you get to a 20% margin, what’s normalized? Unfortunately we got 20%, what’s normal. We would say 22% is probably what we expect to be at a normalized margin on a go forward. And then the leverage from the SG&A side finally showed up and we would expect this continue to see that as we open more communities.
It doesn’t take us a lot of people to open those obviously a sales person and a supervisor in there, but from a staffing perspective, we really don’t need any more people. Our corporate staff is well intact and in the field we really don’t need anybody else. We think there is additional leverage there. So, all things look bright. From a forward-looking, obviously we got backlog that’s up quite a bit also and we have vision into that backlog. So, we would expect to see continued improvement across the board.
Next is just the sales and I think you can just see real quickly, obviously this year dramatically better than last. But the thing to look at is, it’s continued all the way through the third quarter. We saw good activity in September and we won’t talk much about October-November other than the say that it’s been consistent and we expect to finish the year in a real strong position. So, and I think you’ll probably hear that from most of the builders today that everybody is seeing a good fourth quarter so far. And again, I think its execution. It’s getting communities open. It’s been in the right locations and having good discipline on the financial side, which drives the bottom-line profit.
Geographic breakdown, you can see that this is a little bit different probably than it’s been in the past. A year ago, we had 2% of our inventory in California. We’re rebuilding our California inventory today, most of it is in Southern California and as you know that’s a very expensive market. We did make a big investment in the Mid-Atlantic and that those communities are starting to come online, actually this quarter and really the first half of next year. So, we see – expect to see a big improvement out of the Mid-Atlantic.
Elsewhere, I would say it’s pretty consistent with what we had a year ago. Texas continues to be a big part of our business and will continue to be a big part of the business. Don’t expect to see a tremendous amount of growth in Texas. Expect to see more growth elsewhere in the company. In Texas, as you know was the foothold during the downturn. So, we all had a lot of communities in Texas, continue to operate at good margins, but don’t expect Texas to be the main growth engine going forward.
This is the inventory breakdown and a couple of things I takeaway here that I would urge you to look at is basically most of the inventory we have is active and when I say that I mean we can build on it, 65% of our lots are developed today, so we don’t have a lot of expense to get a lot of lots to the finished line. But if you look at, we only have 6% of our inventory that’s inactive, mothballed or held for sale. And what that means is we have a very small portion which means our inventory returns are higher than most of our competition, that’s one of the things we stay focused on.
And all of that inventory that is inactive has been impaired and a lot of its communities that take development to get to the finish line and in those cities we can still buy lots that are developed instead of putting the development orders. We can buy a lots either on an option or buy small bulk takedowns to continue to put lots on the ground in those markets. So those lots will come to market over the next couple of years. They are all buildable, they’re do not dogs, I guess, is the best way of putting it. So, we’re really excited about that.
And as you can see obviously the sold inventory is 31% of our business, started unsold as our spec inventory. Our spec program really has not changed from the good times to the downturns of today. We run usually two to three specs per community, try to have at least 100% finish so the person that sells our home comes in, needs a home in a near term, we can accommodate them. So nothing really changes on the spec inventory side and then you can see land under development is about 45%. So, again we can build on everything we own for the most part.
Lot count, you can see it’s jumped up. I think the big focus there would be the option lots where you can see between the last couple of years, we’ve increased our option lots and a lot of people ask us, how we can do that, a lot of guys were saying there is not lots, Brad made the comment that A and B positions are getting very limited and I agree with him wholeheartedly.
Our guys in the field have done a tremendous job of negotiating deals and being able to get option opportunities. And that ranges the gamut across the country. I mean the West is a little bit harder to get an option deal done. I would say California, there is not much options, Denver there is not much options, Vegas there is not a lot, although we just did get one done so. But we continue to strive to increase that and I think that’s a bit part of our business. It allows us to turn that inventory again quicker, get our money back and reinvest it. So I think this is a slide that we’re probably one of few guys to say they increased operation positions and that’s a real important part of the business going forward.
Lots approved, you can see the last two quarters, lots approved and have increased dramatically. Obviously in Q2 we picked up the Timberstone acquisition, which was about 1,100 lots, but you can see in the third quarter again it was very active and these are all good quality deals that meet the hurdles rates and they’re across the country. They’re not in one market or we’re buying a lot of lots and they range from deals that are 40 lots to a couple of 100 lots.
I think one of the things that a lot of our guys have decided to do is look for those opportunities, those smaller opportunities that maybe some of the other guys pass over and take an opportunity to buy 20 or 30 lots in a good in-fill location, where we can maximize margin. Instead at doing bigger communities all the time. Twin cities is a good example of that. Gentlemen there has probably bought 10 deals over the last two years, that are probably less than 50 lots, but are in extremely good locations or development deals, but their high margin, good observation communities. Instead of focusing on trying to get bigger deals, it’s a little bit more work for their teams, but the returns are extremely good.
So, and again so far I would tell you in the fourth quarter on the lot side, we continue to see really good activity across the nation, everywhere there is still opportunities. I would say probably about half of what we’re doing we’ve been buying this quarter’s options, the other part is development and development is going to pick up, obviously in certain markets there is not a lot of lots that are left that are developed. So we’re going to have to increase our development share as we go forward.
But I think to look outside the box and find opportunities in the As and the Bs is really important and I think that As is a window obviously, you buy Bs, the C lots, there is lot of C lots available today. The guys are buying C lots in locations and we would expect to continue to see that as the As disappear, the Bs become As, So the Cs become Bs – but I don’t think that you’ll see a quick move to that because I think we all got hurt very bad with the Cs in the downturn. But I think you will start to see guys pick up some Cs in some of the stabilized markets in small bits and pieces.
Yearend community count, we’re on track to finish around 245, obviously that number is a function of what sales do in the fourth quarter because we have been closing out of some things quickly than we had anticipated. So, we’re on track for that and we think next year we can have the same kind of community count growth. So – and when I say that that stuff we have under contract or that we own today that’s in the pipeline, in the development pipeline. So we should be able to deliver continued community count growth which again should lead to good growth in the company.
So, sorry, this is John Burns slide, but it’s desirability index, but it’s just another third party, say, what we’ve been doing and what we’ve been buying. We think we’ve been buying good locations and this is kind of a just a little reflection of that. A couple of things we really focused on and when we learned through the downturn was, obviously we got hurt by some of our perimeter positions. So we really ask the guys and girls to focus on maybe less communities, better locations and I use Southern Cal as probably the best example.
We were predominantly an Inland Empire builder in the last, I’ll say 10-20 years and right now we have really one community in Inland Empire and everything else is an Orange County and San Diego County. And we’ve made a concerted effort to get into those markets, they’re more expensive, but the returns are better and if things were to slowdown again, we feel like our risks could be limited. But the opportunity therefore as we think is better than in the Inland Empire.
So, but we’re happy with our lot positions obviously, everybody can talk about lot positions. But we’ve tried to stay mainstream, we’ve tried to stay in the better markets, we’ve done more infield than we have ever in the past and that ranges from buying an acre and half site in downtown Houston to a couple of acres in Twin Cities. So we’re looking at all these opportunities on a one-by-one basis and if they make sense we need to be doing. Because we’re not going to be doing then somebody else is.
Debt maturities, balance sheet is in great shape. We ended the quarter with about $800 million in cash. No near term maturities, get a $126 due in 2015, so no issues or concerns there. Our cost of capital is about under 6%, which is great. We just – we did do it that deal back couple of months, which is the 2022 and lucky to be talking about that. But that’s the maturity and we took $250 million, and we took that as an opportunity to bolster the balance sheet in order to grow the business.
The rates were very favorable. We weren’t sure what ultimately they would be after the elections. So we thought it was an opportunity to go out and take money. Put it on the balance sheet and then we’ll try to get that employed as quickly as we can. So, no near-term issues there, so, good runway. Deferred tax in a way about $263 million deferred tax, we would expect at some time next year that probably comes across the line depending on when our auditors tell us we can take it. Obviously some builders have already taken portions or all of it. So, we would expect to see that come over which obviously will grow our equity. That should happen sometime next year.
The mortgage company and you all have a lot of questions on the mortgage business. The mortgage business continues to be challenging, I guess, is the best way of putting it. You can our average FICO score there is about 730, which tells you the quality of the buyer is really good. It is tough to get people with any kind of credit issues written. It’s hard to sell those loans, nobody wants to buy them. And you can talk about 580 all day long that you can write to 580. But – just the risk of all with that is something that – I don’t think most people are doing.
We haven’t seen a big change in any of the underwriting guidelines more overlays or anything such as that. Obviously our sales were up 56% so we’re getting people written. I think what’s happened through the downturn is a lot of people have figured out what their issues were and we’re going to fix them, because they know they can’t get a loan if they’re not clean.
So, I think that that’s a good indication. You can see FHA dropped a little bit. So, far year-to-date it’s trending down, would expect to continue to see that. The whole rhetoric on the mortgage business with QM, QRM all of that, where is that shakeout FHA announced their reserves this week. Don’t expect that to be good news. But I think ultimately you could see a little bit change in FHA maybe moving down payment up here, but I don’t see it exceeding 5%. I think where we end up is a mortgage industry that 10% is going to be more of the norm. I don’t think it’ll end at 20%, but I could be wrong.
I think it’s going to be real critical in the near-term that the administration doesn’t do anything to disrupt the mortgage market. I think that’s the biggest risk we’ve run in the industry and what I mean by that is, a) they don’t take FHA and try to change it dramatically too quickly. I think the Fannie and Freddie face outs have to be over time, no quick moves there.
And they need to think through everything that they due to make sure they don’t put any kind of pause in the market. I mean we have a little bit of momentum today, we’re creating jobs. For every house we built we create three jobs. So we’re starting to see job growth because of the industry and I think if you’ll watch TV or you listen to the news, everybody talks about the housing industry bring this out of this situation and making a positive commitment. So I think that we need to keep it moving in the right direction and I do think this is the single one thing.
I don’t think rates moving a little bit has much effect. I mean I think if rates go up over the next five years, people just buy a less house. I mean if I can afford a 2,500 square foot house and rates go up and my payment was 1,500, hey may be I got about a 2,300 square foot house. But I still have the opportunity to buy house and if you think back for those of us, we’re around when interest rates were 18% and we still had north of a 1 million starts. So people make adjustments in their lifestyle, what they want to do. So I think ultimately the people still want to own a house. And I think it’s still is the American dream and I think people figure out a way to do it.
So, rates don’t overly concerns, underwriting concerns to be more than rates do. And I think that – and I think Brad made a comment that I would agree with. I think you will see some loosening because there’s a lot of people out there as I said that have a good job, can make the payments, have all the research required, but they lost their job for 60 days they change jobs and unfortunately they can’t get written and we were talking this morning with a group of folks that in a story, which it said is a guy had a 40% down payment, had a good job, was in the financial world and the bank turned him down because they thought he was to be big in a risk.
I mean, that’s the kind of stuff you hear on a daily basis so or another one was a guy, was approved for loan, but he had like a an $800 deposit in his bank account that he had to prove what it was and he kept stone, stone, stone and finally he told the loan processor, well, I one won the office basketball pool last year, okay. So he won $800 bucks well, that put him in the gambling categories, so they denied the loan.
I mean, so we got some stupid things going on and we got to get over that. So, the pendulum’s got to fallback a little bit, but big part of our business so from a profit perspective, we capture just over 70% of our own loans today. At the peak we probably capture a little bit more, but today there’s a lot of programs that we can’t offer that we have to send people to the bank, because we can’t write the loan and then sell it. So we are seeing a little bit more outside business, but there are still good programs. There’s 97% no MI programs out there that some of the banks have. There’s still USDA, which is a free draw a lot along with lines, but I think overall you can still get people closer.
So in closing what I’d say is we’re really excited about what’s going on. We don’t see anything we think we’ll slow the business down. As I said the mortgage tax is the biggest issue. We expect to see a good trajectory on permits to continue. Our numbers would tell us that in 2015 we get back to about a 1 million permits, a good growth. We do expect the economy comment to continue to chug along. So we don’t see a whole lot that would prevent the business from moving forward. We think we’re well positioned, we’re well capitalized and we’re just excited to be able to stand up here and talk about making money and growing our business. For five years we’ve stood up here and pretty much talked about what was the next arm we had to cut off, right. So it’s exciting to be back, playing off and set a plan for us. With that I’ll take any questions.
David Goldberg – UBS
I’m going to start with one. Larry, I think the Timberstone deal, it seems like it was a great acquisition, it had some really good communities. Now, we have the verb to get Rylandized, we had Hortonized earlier in the week, so eventually we’re going to have all the builders who’re going to introduce new jargon into the Lexicon, but my question is how many Timberstone’s are out there, how many times can you find a private builder that’s going to sell, let’s assume it was a reasonable price that you like to land position, that you feel like, hey, this is a good deal for us?
Well, I would tell you for everyone we’ve gotten at the finish line, we’ve looked at a number and I think it goes to the gamut, it goes from – you find in – you find builders that are up in age, that don’t want to go through the aggravation and the hassle of trying to finance, sight personally to have equity in the business. And that’s what I would kind of categorize the Timberstone deal, more like they wanted to exit, they did keep part of their business in Indianapolis, but just we’re willing to exit those markets.
A lot of the other ones, you find, their balance sheets are not so good and you’re dealing with the bank more than you’re dealing with the builder. But I think the cost of capital, growth capital, and I heard Brad talk about capital being available to people and I think there is some capital available. But I think it’s still challenging and if you’re trying, if you’re a mid-sized private guy trying to grow your business, the cost of our capital is 6%, they’re probably in the mid-teens, it’s just tough to compete. And I don’t think we lose a lot of deals to private guys. So, I think there will be continued opportunities in that market. And everybody says, why would they sell now when the market is getting better? Well, because they got to go out and get your money.
David Goldberg – UBS
And I still think it’s hard. There are some small regional banks and local banks lending some money, but they’re not lending them a lot of money. They’re just – they’re growing at a very small pace.
David Goldberg – UBS
Yeah. Larry, is there any concern on your part that the pool of qualified buyers has been satisfied? And that everybody who – with good credit, who could get a mortgage has now bought a house and they’re gone and that your next batch of buyers maybe need a smaller and then just mean or take needs longer time to get their credit repaired and get your sales growing at the pace that you’ve had in the last nine months?
Well, I’m not overly concerned with that, because I think you got to remember where you’re starting from in the number of – I mean, while we had 60% sales growth, the numbers we’re still starting – and this is going to be the fast worst year in homebuilding. Okay. We’re not back at a million people or million two. So, I don’t think we were at a point where we don’t have room to run. I think a couple of things help you. I think a) I think as the resale markets have stabilized, a lot more people have the opportunity to move their existing house and move up.
And we have been predominantly a move-up builder through the year, so, I see that opportunity. You get a lot of people still sitting on the sidelines and whether that’s an entry-level buyer or first-time move-up buyer and you got household formations up, then again hopefully you get jobs to turnaround. Interest rates, affordability, rents are going up, I mean I don’t see anything that would tell me that it’s going to slowdown. And while we’re extremely happy with the numbers we’re seeing, it’s still a small number in comparison.
David Goldberg – UBS
When you think about where Ryland was at the last peak. And you think about the commitment to being in better locations, the better product, you obviously were very option focused. So that was a way to mitigate risk in the last up term, but do you think the potential size of the business is different this time around. It is smaller, higher quality?
Well. I mean I think it – at 17,000 is what we did at the peak. I don’t think we have visions that we’re going to get 17,000 at a time. I mean, I think, if we can 10,000, we can take what we have, we can leverage that overhead make a lot of money. So I think that while we want to continue to grow the business at a faster pace than our competition, I think that to have belief that we’re going to basically triple, I think it’s going to be tough.
And I don’t think any of us knows what this – when this thing settles up. What’s going to be the run rate on the permits on an annualized basis? Is it going to be a 1 million or is it going to be 900,000. It’s not going to be a 1.5 million in my opinion. So I think at some point you do – just you say, hey, I rather have profitable than size and I think you’re seeing that across the board. I don’t think we’re the only ones to talk about that. I think everybody is looking at, hey, it’s great to be bigger, but if you – you want to money.
David Goldberg – UBS
Maybe you can talk a little bit about cost side of the business right now. I think there’s been a lot of conversation about labor costs and labor shortages. We’ve kind of thought about this, my guess is different perspective, which is really about more about how your sub-contractor base is going to rebuild itself. There is working capital issues, certainly just growing – just growing the business is going to be very difficult. They’re having tough time accessing the market. What you think the solution is for that? Is Ryland a partner to the subs or is it kind of like the subs who don’t have to figure it out, will pay them and pay them on time?
Well. I always say, in an improving market, these are the kind of problems you have. I mean, you have labor issues, you have cost issues. And we have seen both and they vary by market. I think what we have to do is we have to go back to the vendors and we have to commit to them and they’ve got to commit to us. And there is a lot of different ways you can do that, you can commit units to them to make sure that they got – their crews are busy, payment terms are something that you can commit to. They are capital constrained. You can make sure that you keep their cash flow going, so they can pay their bills and they can pay their vendors.
The growth side, I think is the bigger concern, how do you grow it? Lot of our guys have told us that they’ve been slow to bring people back, just because they want to make sure it’s sustainable. So, I think that as we get through the end of the year in the fourth quarter, it should be pretty decent. I think as we head into the selling season next year, guys are willing to invest a little bit of capital and grow their business. There is going to be some issues. I think there is – Phoenix is probably the best example of it, because of their immigration laws.
I think a lot of people left the market now, will they come back, I don’t know. I think that’s going to be a bigger challenge for those states that have those kind of laws. But I think one of the things we got to focus on as an industry is getting kids into the trade. Kids that don’t want to go to a four school, get into trade, they can make a good living being electrician or a plumber. Hey, it’s hard work. But it’s a great opportunity for somebody and those are the people that create new businesses. They spin-off and they start their own business. That’s the other thing you’ll start to see too is, you’ll see guys spin-off and then start new business. So, it’ll be competitive. It’ll be tough, but I’d rather have that problems in the other side.
David Goldberg – UBS
High quality problem. Can we talk about the move back into Phoenix? One thing that seems to me that’s very important as Ryland as a company is, great land people. I mean that really the ability to go and get those option lots, where other people can’t find them to do the 40 lot deals and maybe other builders are going to pass over, that really requires a very tenacious land effort. When you’re out of a market three years ago, you’re back in the market today. How do you get the right land people for your position and how do you build the right land sessions at a reasonable price?
Well, I think when you back into a market you have to identify, you have to go find the best and the brightest and I would say we’ve done that with – in the last 30 days for the gentlemen we have chasing land for us. Its again, you got to meet hurdle rates, you got to do things, there is a little bit of price you pay sometimes to get up and running, but there is still opportunities. We left that market with a good name. We were there for a long-long time. We still have a lot of contacts in the market. It’s not like we’re going to Seattle where we’ve never done business. So, I think that helps us. We left that market on very good terms with all the land sellers.
David Goldberg – UBS
And I think that we’re talking to all those guys again, and again it’s like any other market, so that’s going to be competitive and we just got to get our piece of the pie. But we think long-term it’s a great market, it’s obviously stabilized and it’s a good long-term position for us. So hope to be open there sometime mid next year.
David Goldberg – UBS
Are there additional questions in the audience? It looks like not.
Thank you very much.
David Goldberg – UBS
Drew, Gordon, Larry, appreciate it for your presentation.
David Goldberg – UBS
We’re going to now lag in about two or three minutes here. Thank you so much.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: email@example.com. Thank you!