Beazer Homes USA's (BZH) Allan Merrill on Q4 2016 Results - Earnings Call Transcript

| About: Beazer Homes (BZH)

Beazer Homes USA, Inc. (NYSE:BZH)

Q4 2016 Earnings Conference Call

November 15, 2016 10:00 AM ET


David Goldberg – Vice President and Treasurer

Allan Merrill – President and Chief Executive Officer

Bob Salomon – Executive Vice President and Chief Financial Officer


Alan Ratner – Zelman & Associates

Yaman Tasdivar – Private Investment Management


Good morning and welcome to the Beazer Homes’ Earnings Conference Call for the Quarter Ended September 30, 2016. Today’s call is being recorded and a replay will be available on the company’s website later today. In addition, PowerPoint slides intended to accompany this call are available in the Investor Relations section of the company’s website at

At this point, I will turn the call over to David Goldberg, Vice President and Treasurer.

David Goldberg

Thank you, Nicole. Good morning and welcome to the Beazer Homes conference call discussing our results for the fourth quarter of fiscal year 2016 and the full year.

Before we begin, you should be aware that during this call we will be making forward-looking statements. Such statements involve known and unknown risks, uncertainties and other factors, which are described in our SEC filings including our Form 10-K, which may cause actual results to differ materially from our projections.

Any forward-looking statements speaks only as of the date on which such statement is made, and except as required by law, we do not undertake any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. New factors emerge from time-to-time and it is not possible for management to predict all such factors.

Joining me today are Allan Merrill, our President and Chief Executive Officer; and Bob Salomon, our Executive Vice President and Chief Financial Officer. Allan will start by providing our perspective on market conditions and then review to our current positioning and strategic plan. Bob will then discuss fourth quarter highlights where we stand relative to our 2B-10 goals and our expectations for the first quarter of fiscal 2017.

I will come back on the line to review the capital market transactions we completed during the quarter and provide an update on our balance sheet and liquidity, followed by warp up by Allan. After our prepared remarks, we will take questions in the time remaining.

I will now turn the call over to Allan.

Allan Merrill

Thanks, David and thank you for joining us on our call this morning. Our fourth quarter and fiscal 2016 results reflected the initial implementation of our balanced growth strategy, which we introduce to investors at this time last year. For the full year, we generated both revenue growth and higher EBITDA while substantially reducing our debt and improving our return on capital.

This represented progress on each of the goals we established and we expect further improvements in each of these areas in 2017. The broader environment for housing remains supportive, underscored by consistent job growth, low interest rates and a limited supply of new and used homes. And healthfully, wage growth seems to be accelerating a factor that has been notably absent so far this recovery.

Although there are hurdles that may prevent the industry from meeting the underlying demand for new homes, we remain fundamentally bullish about the prospects for our sector and especially our company over the next several years. Before I turn the call over to Bob and Dave, I want to expand on our operational expectations for 2017, and explain how these connect with our longer term strategic objectives.

In 2017, we expect another year of top line growth driven by an improving sales pace and higher average selling prices more than compensating for a lack of community count growth.

At the same time, we expect to grow EBITDA even faster than revenue arising from both an uptick and gross margin and a lower SG&A ratio moving us toward our 2B-10 profitability target. While we are well aware of the various cost pressures on the industry’s gross margins, the improvements we’ve made to our balance sheet mean we won’t have the same focus on selling lower margin specs that we did in 2016.

On the SG& A side, in addition to benefiting from revenue leverage, for the first time in seven years, we won’t be making any payments related to legacy litigation issues. That’s a run rate savings of more than $5 million by itself. Following the success of our efforts to reduce debt last year, our capital allocation priorities have flipped for 2017. We still plan on reducing our debt by a $100 million over the next two years. But our priority has shifted toward growing community count for fiscal year 2018 and beyond.

Now let’s connect those near-term expectations with our longer term strategic objectives. In allocating capital, our primary focus is to invest where demographics are propelling demand and where we’ve possessed clear operational expertise. By doing so, we can maximize returns, while reducing execution risks. So what does that look like an action?

We are predominantly known as a first time and first time move up builder, with one of the lowest ASP’s among our peers that positioning seems pretty clear. But looking at average price doesn’t really tell our story, since we aren’t principally a price driven builder. We’re targeting home buyers who define value through location factors like high quality schools and easily accessible employment centers, construction quality, including energy efficiency features and choice, including the ability to customize their home at no additional cost and pick their own lender.

More simply, we’re targeting buyers that demand exceptional value at an affordable price. This positioning is just right for the current environment, because many households have delayed homeownership these consumers largely millennials, have come to expect the location, quality and choice we provide, all at an affordable price.

However, first time buyers aren’t the only consumers who appreciate our definition of value. We know that most investors are aware of the compelling demographics behind the active adult segment, or home buyers over the age of 55, which you may not know is the importance of this buyer to Beazer.

In fact our sales of baby boomers are growing rapidly and represented about 20% of our business last year. Our success with this segment is driven by the same value equation we have with first time buyers, offering exceptional value at an affordable price.

And if anything, this buyer understands those characteristics even better than first time buyers. We address this opportunity in two ways. First, we sell a lot of one-story ranch homes and two-story master on main homes to downsizing boomers. These buyers choose traditional communities for many reasons, but they still need homes that match their lifestyle. This is a vibrant growing part of our business and will remain so in the future.

But it’s the second way we address the boomer market that is highly differentiated and is poised to become a significant growth driver for us over the next several years. For more than a decade, we have been developing higher density age restricted communities in our mid-Atlantic market under the gatherings brands. To benefit from economies of scale, we only build one type of building a four-story, 27-unit condominium.

With four different floor plans and a variety of exteriors elevations, the building is proven to be very versatile. And we must be doing something right, as we have built this building more than 50 times across 10 communities with great financial success. In fact, our gatherings communities consistently generate faster sales paces and higher gross margins in our traditional single-family business. The economics of this building and the sites, it allows us to acquire enable us to target customers in or near where they live.

Our buyers are typically selling an existing home and using a portion of the proceeds to buy a Gatherings home while maintaining their lifestyles. To these buyers the convenience, safety and low cost maintenance of a Gatherings home represents enormous value compared to other alternatives. That’s why this opportunity fits our strategy so well. A Gatherings home represents the same exceptional value to a boomer that our single-family homes do to first time buyers. And because of the products density, we can offer this exceptional value at an affordable price.

To accelerate our company’s growth trajectory, we are exporting our deep understanding of active adult buyers and our Gatherings building across the Beazer footprint. In fact, we already have 10 Gathering sites controlled in five new markets beyond our original mid-Atlantic focus with a lengthy pipeline of land opportunities in front of us. To ensure that we take advantage of our expertise and control overheads, we’ve organized a small Gatherings team to execute our expansion in partnership with our local land acquisition and new home sales professionals.

During fiscal 2017, we will incur some startup costs in the range of a couple million dollars, which will reduce the SG&A leverage, we would otherwise expect this year. But those upfront costs are small potatoes compared to the size of this opportunity, although it’s still too early to put numbers around it. We’re confident the Gatherings will become a bigger part of our results in the next few years.

I hope my comments this morning have helped you connect the dots, while delivering continued growth in revenue and EBITDA in fiscal 2017, we will be busy expanding our investments in both single-family and Gatherings communities that are linked by our mission to provide exceptional value at an affordable price to the two largest demographic cohorts in U.S. history millennials and baby boomers.

With that, I’ll turn the call over to Bob to discuss our result in more detail and update you on our 2B-10 progress.

Bob Salomon

Thanks, Allan and good morning, everyone. In the fourth quarter, our sales absorption rate was 2.8 sales per community per month up more than 16% year-over-year, and ahead of our expectation leading to 15% growth in orders. Importantly, our sales pace remained balanced across our markets with notable improvements in Phoenix, Charleston, Las Vegas and Maryland.

Homebuilding revenue grew 1.4% year-over-year to $620 million, our highest fourth quarter since 2007. Although closings declined slightly compared to the fourth quarter of 2015, this was more than offset by a 3.5% increase in the average selling price. Our backlog conversion ratio of 77% was in line with our expectations and significantly higher year-over-year.

Our ASP for the quarter was $334,000, up 3.5% versus the same time last year. Each of our regions experienced price improvement on a year-over-year basis. Nevertheless, the prices were up 6%. Our average price in backlog as of September 30 was more than $340,000 suggesting further ASP growth moving forward.

On our second quarter call, we explain how we intended to expand our gross margins by rebalancing our mix of to be built in spec sales. The fourth quarter showed further results from these efforts with a gross margin of 20.8%, up 10 basis points sequentially and 60 basis points from the second quarter.

SG&A as a percentage of total revenue including both homebuilding revenue and land sales was 10.6%. Our fourth quarter adjusted EBITDA was $66 million. Our total GAAP interest expense which includes both direct interest expense and interest amortized through cost of goods sold was $34.3 million in the fourth quarter, $3.7 million higher than last year.

Although retiring debt leads to an immediate reduction in our cash interest expense. It takes time for this benefit to materialize on our income statement as we worked through previously capitalized interest.

Our fourth quarter net loss from continuing operations was $789,000, which included $11.4 million of losses related to the early extinguishment of debt and $8.6 million in a non-cash tax related charge. While we have a large deferred tax asset, those futures benefits primarily relate to federal taxes, and as such, we pay state taxes in many jurisdictions. To reduce these obligations in the future, we completed a legal entity restructuring that will generate significant state cash tax savings moving forward.

As a result, we recorded a valuation allowance against our state deferred tax assets in the fourth quarter. From the GAAP perspective, we expect our future effective tax rate, including both federal and state taxes, to be reduced to approximately 38%. We continue to make progress toward achieving 2B-10, our multi-year goal to get to $2 billion in revenue and a 10% operating margin.

As reminder, our 2B-10 objectives are measured against our last 12-month performance. Total revenue was $1.8 billion, up nearly $200 million or 12% compared to last year. We closed 5,419 homes in fiscal 2016, more than 8% higher than the prior year. Our sales pace was 2.7 sales per community per month, slightly below our 2B-10 range but up sequentially as projected.

We expect to move into our target range as we progress through the calendar year, reflecting a higher sales pace in the first quarter of fiscal 2017 compared to last year. Our average selling price was $329,000, up more than 5% versus last year and nearly at our targeted level of $330,000 to $340,000.

Our average community count for the last 12 months was 166 and we ended the year with 161 active communities. As we’ve noted, we prioritized deleveraging in 2016 which will lead to gradual declines in community count through March. However, as Dave will discuss in more detail, we have visibility into community count growth in the back half of fiscal 2017 from communities we already have under development.

As we will move toward our 2B-10 range in 2018, as we opened communities we’ve already approved. Our gross margin over the past year came in at 20.6%, which was down about 90 basis points versus last year, for the reasons we have discussed. With two quarters of sequential improvement, we expect gross margin to be higher in fiscal 2017.

SG&A as a percentage of total revenue declined to 12.3%, down 50 basis points relative to the same period last year. For fiscal 2017, we expect to achieve additional SG&A improvement despite the incremental investment in our Gathering business and lower land sales.

What this all leads EBITDA of $156 million, up approximately $12 million from the prior year and up more than $180 million over the past five years. We have made significant progress to date toward achieving 2B-10 and the path forward remains clear.

Moving on to our expectations for the first quarter of 2017. We expect orders to grow about 10% over the first quarter of 2016, driven entirely by a better sales absorption pace because we – our average community count is likely to be around 5% lower than the average fourth-quarter level.

We had a strong start to the quarter in October, as our sales rose 20% versus the same month last year. We expect our backlog conversion rate to be in the low 50s, similar to last year. Our ASP is expected to be in the $330,000s, up relative to the first quarter of 2016.

Our gross margin should be higher than last year’s first quarter and similar to the September quarter. Our SG&A on a percentage basis will likely be up slightly year-over-year but well below where it was in the first quarter of fiscal 2015. We expect our land spend to be similar to last year where we spent more than $100 million.

At this point, I’ll turn the call over to David to discuss our balance sheet and liquidity.

David Goldberg

Thanks, Bob. In the fourth quarter, we spent $70 million on land and land development, which was below our expectations. The difference was attributable to two factors, both of which are positive. First, we were able to accelerate the recovery of a $14 million reimbursement from a utility district, which we treat as an offset to our net land spending figures.

Second, we ended up land banking two extra transactions, which meant we only contributed a deposit instead of spending the entire purchase price. For the full year, our land spending also came in below our expectations from the beginning of the year in part because we elected to triple our deleveraging goal from $50 million to $150 million. But that isn’t the whole story with our land spending.

We also shipped a higher percentage of our purchases into option arrangements with our ratio of option lots up to 35% of the total and we were able to activate nearly $60 million in land held for future development bringing that category down to 14% of our total inventory. As we’ve touched on in our comments this morning, we expect a decline in our community count through March, with growth returning in the balance of the year and into 2018.

As you can see on the slide, we have 30 near-term closeout communities and 32 under active development. While we managed through the timing differences this year, you can see that we also have 46 communities under contract providing visibility into community count growth in 2018 even before considering our investment activities this year.

From a strategic perspective, when planning for land spending, we have three objectives. First, to ensure that the transactions we consummate individually meet our unleveraged return criteria. Second, to continue driving improvements in our return on capital and return on inventory, and finally, to expand our community count so that we can reach and then exceed our 2B-10 goals.

With our balance sheet much improved, a modest deleveraging target through 2018, ready access to land bank financing and expectations for additional land held activations, we have significant fire power and flexibility to grow our community count in the years ahead while continuing to drive improving returns.

Demonstrating the progress we’ve made to date in improving our profitability and more efficiently using capital, our trailing 12-month EBITDA-to-inventory ratio rose to 10%, representing the dramatic improvement relative to prior years. Driving higher returns remains a focus moving forward.

During the fourth quarter, we significantly improved our balance sheet by retiring debt, extending maturities, reducing cash interest expense and moving toward a fully unsecured capital structure. We repurchased or retired nearly $86 million of debt in the quarter, bringing our year-to-date total to $157 million in excess of our $150 million target.

With our lower debt and improved profitability, our net debt-to-EBITDA ratio declined to 7.1 times down from 8.8 times last year. The improvement in our balance sheet resulted in positive actions from each of the rating agencies during the quarter.

In September, we issued $500 million of unsecured notes due 2022 using the proceeds to refinance all of our 2018 secured notes and our 2019 nine and eight unsecured notes. Our annual cash interest savings, including the impact from the refinancings and repurchases, will be approximately $8 million.

Even after reducing our debt by more than more than we’d expected, we ended the year with almost $230 million in unrestricted cash and total liquidity of $336 million, including availability on our revolver. Subsequent to the end of the quarter, we amended our credit facility to increase facility to $180 million and extend the maturity to February 2019.

Following the actions we undertook during fiscal 2016, we now have no debt coming due until 2019 outside of our scheduled term loan amortization payments of $55 million, which we will repay as part of our planned $100 million reduction over the next few years.

With that, let me turn the call back over to Allan for his conclusion.

Allan Merrill

Thanks, David. I want to conclude the call by summarizing what we accomplished last year and what we are planning to do this year. In 2016, we generated significant EBITDA growth for the fifth consecutive year. We reduced both debt and interest expense while extending our maturity schedule and eliminating most of our secured debt and we greatly improved our return on assets.

In 2017, we’re focused on delivering top-line growth, an improved operating margin and larger investments to accelerate our growth in 2018 and beyond. I’d like to thank our team for their continued efforts. With their talent, I’m confident we have the people, the strategy and the resources to reach our goals.

And with that, I’ll turn the call over to the operator to take us into Q&A.

Question-and-Answer Session


Thank you. We will now being the question-and-answer session. [Operator Instructions] Our first question is coming from the line of Michael Rehaut of JPMorgan. Your line is now open.

Unidentified Analyst

This is Neal on for Mike. I guess, could you review the regions a bit? I mean what’s trending better than expected and are you seeing continued growth in the east with your move up price points or where else?

Allan Merrill

Good morning and, by the way, thank you. The year-over-year improvement for us in the fourth quarter was pretty broad-based. It was interesting. I mean we had divisions in each of the segments that showed real progress and we did well in the Carolinas including in Charleston. In the west, both Phoenix and Las Vegas were up and we did see a tick-up in activity in Maryland as well. So, I wouldn’t say it was really price-point driven as much as in each of our regions, there were areas where we saw strength.

Unidentified Analyst

Okay. That’s helpful. And I guess you mentioned, in the southeast, is that kind of where you see winning the incremental investment dollar, I guess aside from deleveraging?

Bob Salomon

Well, I actually expect our land spending over the course of this year will, in fact, be allocated into each of our markets, obviously to varying degrees. That competition for capital is ongoing. I do see a lot of opportunity to grow in the southeast. But adding Gatherings communities is something that has allowed us to target locations and markets as well. So I think I wouldn’t be too geographically focused in thinking about our land spending.

Unidentified Analyst

Okay. That’s helpful.


Thank you. Our question is coming from the line of Alan Ratner of Zelman & Associates. Your line is now open.

Alan Ratner

Hey, guys. Good morning and nice job with all the balance sheet actions taken during the quarter. Allan, you guys are the first builder that we’ve heard from since the election and it sounds like you still have a pretty optimistic view of the world and increasing your land spend and gearing up for community count growth in 2018 and beyond.

But just curious if the move in mortgage rates since the election and just the general uncertainty about the mortgage market and what the Republican sweep has in store for the housing market in general. Has that changed your view, in terms of underwriting standards, criteria, which segments of the market you are looking to gain exposure to, which markets, et cetera? Or from your perspective, is it all kind of status quo as it was before the election?

Allan Merrill

Good moring, Alan. It’s obviously early to say. But let’s break it into kind of a regulatory piece and an interest rate piece. On the regulatory side, we are clearly in favor of common sense regulations. We value safety at the absolute highest possible level, so don’t take this the wrong way. I do think that there will be an opportunity for relief in a number of areas, at least the rate of tightening or the expansion of the regulatory regimen in lots of different ways that I think have had an impact on pushing affordability or creating affordability challenges and, frankly, restricting the supply side, which obviously contributes to affordability.

I don’t have explicit and specific policy expectations, but I do think that we are likely to see, over the next couple of years, some change in the direction of that regulatory environment. And I think that may be positive. That hasn’t changed our underwriting and, clearly, we intend to comply and are complying with all of those. On the interest rate side, I don’t think you’ll get anyone to say that they’ve embraced or are super excited about higher rates. But, the point we tried to make is we are not principally a price-driven builder and I think there is a big message in that.

We believe that, on that price-only or price-focused price segment, or market segment, there are location risks, there are construction risks, and clearly, there are some interest rate or payment risks. That’s why being focused on the value oriented first-time buyer and the value oriented move-down buyer I think gives us a little bit of insulation from that rise in rates.

But let’s see how it shakes out. I mean it’s been a week and, obviously, we are not going to try and dramatically spend our land allocation in the first 30 or 60 days. So, we’ll go through this year and we’ll watch closely. But I think our view is that the underlying demand characteristics remain intact. Supply remains constrained and affordability for our buyers remains very, very good.

Alan Ratner

That’s very helpful, Allan. Thank you for that. And a second question, if I could. You guys have had some nice success in finding option deals out there, as well as land banking. And I guess, generally, we think about those deals as being higher return, higher turn assets, but perhaps lower gross margin and I know you are guiding for margin expansion next year.

But presumably, a lot of these deals are probably 2018 and beyond opening. So is the way to think about the long-term trajectory that maybe you see some slippage on the margin excluding interest, but that offset as the benefits from the deleveraging begin to filter through on the P&L in 2018 and beyond?

Allan Merrill

Well, it’s complicated. There are a lot of moving parts. You’re absolutely right. Option deals typically do generate higher return on invested capital by turning faster and generating a little lower gross margin. But our options are a result of land banking and, I guess, traditional option arrangements with land developers. And I don’t think that the percentage of those is dramatically increasing from here.

We really had to absorb in 2016 both that step-up in options and our activation of our land-held assets and we’ve done that. And I think that’s kind of reflected in our numbers now. So we don’t see that as an incremental headwind in 2017. We don’t give full-year guidance, so I sure can’t go out to 2018. But I would tell you we’re looking at that mix balancing risk and returns to our shareholder benefit.

Alan Ratner

Great. I appreciate that. Thanks and good luck.

Allan Merrill



Thank you. Our next question coming from Yaman Tasdivar of Private [ph] Investment Management. Your line is now open.

Yaman Tasdivar

Thank you very much. Good morning, everyone. Congrats on your continued progress on your 2B-10 goals. Looks like it’s down today a little bit but I think the market has more so much foresighted for usual and I’d like to focus on my question on the longer-term. I expect home prices to continue to increase in the coming years at an increasing rate and to that effect, I would like to understand how does that trend affect your income statement and balance sheet? My first look at it, I would expect the balance sheet – your inventories to be understated because the GAAP rules do not allow for adjustment upward. First of all, is that correct?

Allan Merrill


Yaman Tasdivar

And secondly, on the income statement, I would expect your gross margin, if the home prices let’s say, go up 5% in 2017, I would expect the gross margin, all else equal, to increase. But I would like to understand, is that a one-to-one increase? I’m not saying a 5% increase in gross margin, but if you could just talk us through how that flows through an income statement and balance sheet, I would appreciate that. Thank you.

Allan Merrill

Okay. Well, I appreciate your positive sentiment. We don’t make price projections. But in the context of rising home prices, which was your premise, you are right about that accounting for assets on the balance sheet. They do not get written up. As it relates to the income statement, I think your question – it was a sophisticated question and it touches the income statement a lot of different ways.

Clearly, there is a revenue benefit from higher home prices, but we would expect in that environment, that labor rates in our construction would also be somewhat higher. And we would clearly expect to see commissions, which are variable in relation to revenue, be higher. So, there would be some offsets that the price appreciation wouldn’t flow directly through to the bottom line.

There are no structural reasons why overheads would go up with higher home prices. So if we really look at the variable cost like commissions and you look at some of the inputs that are labor or wage related, I think those would be areas where you would see some offset to the price gains.

Yaman Tasdivar

Thank you. And just a quick follow-up. Could you maybe talk about the percentage offset from labor cost and sales commission? Sales commission, especially. Is that a one-to-one relationship to revenues? And then labor, I would think it would be more of an indirect impact. So overall, is it 100% offset or 50% offset or 20%? Just, I’m talking more longer-term trends, not quarter-by-quarter.

Allan Merrill

It’s really hard. I can’t predict labor rates. But let’s try and get at it this way. Commissions are in the range of 4% of revenue. And so when I say it goes up, if our revenue goes up, you are going see that commission expense go up. I don’t think that commissions as a percentage of revenue would decline.

Those are going to be purely variable. I think when you look at the labor side, labor and materials are obviously in our cost of goods sold. It depends on the trade market conditions, how much wage rate gain they could claim. Where there are areas that have shortages of particular labor at particular times of year, you would clearly expect to see more wage pressure.

There are other trade categories, and at different times of the year, where you wouldn’t necessarily expect to see much, if any, wage because of the supply and demand characteristics of the labor. And I’m sorry, it’s a very hard question to answer. I think that the fact is that there would be some offsets over time, but it’s almost impossible to estimate what that would be.

Yaman Tasdivar

Okay. Thank you very much and good luck with the coming years.

Allan Merrill

Thank you.


Thank you. Our next question is coming from Alex Barron of Housing Research. Barron your line is now open.

Allan Merrill

Good morning, Alex. Nicole, can we skip to the next question? We will let Alex get back in the queue and maybe something’s – he might be on mute maybe.


At this time, there are no further questions in queue.

Allan Merrill

All right. Well, Nicole, thank you and thank you to those that dialed in this morning. We appreciate your support and we will look forward to talking to you next quarter. Thank you.


Thank you. That concludes today’s conference. Thank you for participating. You may now disconnect.

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