Harbor Custom Homes: HCDI: UPDATE: Diversified and pioneering real estate development company reports 3rd quarter earnings which were below expectations due to a difficult real estate market and project sales timing.

By Thomas Kerr, CFA NASDAQ:HCDI READ THE FULL HCDI RESEARCH REPORT Harbor Custom Development Inc. (NASDAQ:HCDI) reported 3rd quarter results and updated investors on the current state of the real estate market. Sales for the 3 rd quarter of 2022 decreased by 34.8% to $11.7 million, compared to sales of $18.0 million for the 3rd quarter of 2021. This decrease was largely due to a lower level of entitled land sales of $7.0 million, partially offset by an increase in home sales of $0.8 million and fee build revenues of $0.8 million. Gross profit for quarter decreased to $0.4 million compared to $7.1 million in the prior year period. Gross margin decreased to 3.7% compared to 39.7% for the 3 rd quarter of 2021. The $(6.7) million decrease in gross profit and (35.9)% decrease in gross margin were primarily due to the non-recurrence of higher margin entitled land sales in 2022 and a decrease in fee build gross profit due to significant cost overruns. The entitled land sales in the 3rd quarter of 2021 provided $5.9 million gross profit dollars at a gross margin of 57.0% that did not recur in the 3 rd quarter of 2022. Operating expenses during the quarter were $4.5 million compared to $3.3 million for the 3 rd quarter of 2021. The increase in operating expenses was primarily due to $0.9 million of bad debt expense related to the sale of Winding Lane's developed lots in March 2022. Additionally, there was $0.5 million in pre-acquisition due diligence costs associated with the cancelation of the Westry Village project. These unusual project charges were partially offset by a reduction in 2022 incentive bonus compensation of $0.6 million. In addition, the company saw less significant increases in payroll expenses, marketing and advertising, right-of-use expense for a new corporate office, and depreciation expense. EBITDA for the quarter decreased to a loss of ($3.2) million compared to positive EBITDA of $4.3 million in the prior year period. Adjusted EBITDA, which excludes the impact of stock compensation and other non-recurring items, decreased to a loss of ($3.1) million compared to adjusted EBITDA of $4.5 million for the third quarter of 2021. The company's liquidity position remains stable with unrestricted cash of $13.7 million and $0.2 million available on the line of credit. Stockholders equity was $88.1 million, or $2.40 per share. Based on construction related loans of $92.2 million and total real estate values of $179.9 million, the company real estate leverage ratio was 51.2%. Based on the 3 rd quarter financial results, the company failed to meet a financial covenant on its senior secured revolving credit facility with BankUnited. The covenant requires the company to maintain an interest coverage ratio of 2.5x and based on the 3 rd quarter financial results, that ratio stands at 1.4x. The company is working with the bank on this issue and there is no indication at this time the bank will call the loan. On October 20 th , the company announced it has contracted to sell 56.6 acres of land in Punta Gorda, Florida for $7,250,000. The property transaction is scheduled to close on or before December 20, 2022. Harbor Custom Development chief operating officer Jeff Habersetzer stated, " The potential sale of our Punta Gorda property reinforces our stated business plan to monetize our assets at the most opportune time in the development cycle by taking into account current market dynamics and our planned capital allocation strategy. " On October 31 st , the company announced it has executed a letter of intent for the acquisition of 15 acres of land in Stanwood, Washington for $4,590,000. Located 53 miles north of Seattle in Snohomish County, the Stanwood site is suited for garden-style apartments. The property is located with easy access to the I-5 corridor, retail services, and approximately 20 minutes from the Cascade Industrial Center. Commencement of construction on the multi-family project is estimated to begin in the first quarter of 2024 following the completion of entitlements. The company reiterated its strategic focus on developing and marketing multi-family housing projects which began in 2021. Multi-family properties have historically fared well in economic downturns and in addition, multi-family properties are usually a more affordable alternative for housing needs than purchasing a single-family home. This is more pronounced now due to high home prices, a slower economy, higher mortgage rates and low levels of single-family housing inventory in the company geographic markets. Multi-family housing projects comprise approximately 60% of real estate assets as of September 30, 2022 During the 2 nd quarter, Harbor announced the listing of six multi-family properties in Western Washington. Those projects include Pacific Ridge, Mills Crossing, Belfair View, Wyndstone, Meadowscape (formally known as Tanglewilde) and Bridgeview Trails. The company's initial target was to have Mills Crossing, Pacific Ridge, Wyndstone and Belfair Phase 1 sold during the fourth quarter of 2022, but the closing of most of these projects will likely occur in 2023. As of August 2022, the company announced it was in the process of developing additional multi-family projects which could total approximately 283 units. These will be located in the Puget Sound region of Washington in the cities of Silverdale, Port Orchard, Poulsbo, Bremerton, Tacoma and Edmonds. These projects are in various stages of the permitting and entitlement and should be completed during the 2024 calendar year. Due to the items mentioned above, Harbor revised its annual 2022 guidance. Revenues for the year are now expected to be between $61 million and $65 million compared to previous guidance of $80 million to $90 million in revenues. Adjusted EBITDA is expected to be a loss of ($5.0) to ($7.0) million. CEO Sterling Griffin stated, "While our third quarter results were impacted by lower sales and higher operating expenses, we continued to make progress on our strategic initiatives to support future growth. I am pleased with the development we made in our transition to focus on multi-family projects and believe this strategy will enable us to drive additional value for our shareholders. Today's market environment remains unstable. The increases in interest rates to combat inflation, combined with affordability challenges and lower buyer sentiment, have weakened demand, particularly for land, lots, and single-family homes. These dynamics, along with their resultant uncertainty and inability to obtain cost-effective financing, as well as delays in the closing of certain multi-family projects and home sales, have caused us to revise our financial guidance downwards for the full year 2022. We continue to believe our unique portfolio positions us to deliver future financial growth through our multi-family offerings in 2023 and remain confident that the team we have in place will enable us to manage the changing market conditions and position us for long-term success." We are adjusting our revenue and earnings numbers for the 4 th quarter of 2022 and full year 2022 based on the year-to-date operating results, the current housing market environment and the timing of multi-family project closings. Our revenue estimate for 2022 is lowered to $63.2 million and EPS is lowered to ($1.02). Adjusted EBITDA is now estimated to be a loss of ($5.4) million. 2023 revenue estimates have been raised to $271.9 million as we expect many of multi-family projects currently listed for sale to close during the year. Based on this level of sales, EBITDA is estimated to be approximately $38.6 million and we expect annual EPS of $1.34. These estimates assume a normalized housing market, receding inflationary pressures, and the absence of any unusual cost overruns. SUBSCRIBE TO ZACKS SMALL CAP RESEARCH to receive our articles and reports emailed directly to you each morning. Please visit our website for additional information on Zacks SCR. DISCLOSURE: Zacks SCR has received compensation from the issuer directly, from an investment manager, or from an investor relations consulting firm, engaged by the issuer, for providing research coverage for a period of no less than one year. 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