Beazer Homes USA Inc (BZH) 2004 Q2 法說會逐字稿

Good morning and welcome to the Beazer Homes second quarter fiscal 2004 earnings conference call. This call is being recorded and will be hosted by Ian McCarthy, the company's Chief Executive Officer.

Before he begins, Leslie Kratcoski, Director of Investor Relations will give instructions on accessing the slide presentation over the Internet and make comments regarding forward-looking information. Ms. Kratcoski you may begin.

Welcome to the Beazer Homes conference call on our results for the quarter ended March 31, 2004.

During this call, we will web cast the synchronized slide presentation. To access the slide presentation, go to the investor home page of www.beazer.com and click on the web cast link in the center of the screen. From this site, you may submit questions to us electronically.

Before we begin, you should be aware that during this call we will be making forward-looking statements, which are subject to factors that could cause actual results to differ materially from the results discussed in the forward-looking statements.

Please refer to our recent SEC filings including Form-S4A, filed on April 9, 2004 and annual report in 10-K, for the year-end September 30, 2003 for details. Ian McCarthy our president and Chief Executive Officer and Jim O'Leary our Executive Vice President and Chief Financial Officer will give a brief presentation after which they will address any questions you may have I would now like to turn the call over to Ian McCarthy.

Thank you Leslie. Before we get started I'd like to apologize to anyone who may have had difficulty contacting us this morning the building in which our corporate office is located remains closed this morning after a gas leak and we have had to relocate to an alternative location. Notwithstanding that, today we are pleased to announce record financial results for the March quarter. Our second quarter fiscal quarter of 2004.

Home closing and revenues increased 12% and 32% respectively, indicating continued strength and favorable conditions in the housing industry, and our strong position in the market. At the same time, gross profit and operating income were up 29% and 27% respectively, from the prior year, and we achieved record March quarter net income of 29% with EPS of $3.52, up 24%. This illustrates our ongoing commitment to achieving profitable growth by leveraging our size, scale, and geographic reach and continuing to exercise our specific growth and profitability initiative. In the March quarter, new orders for the first time exceeded 5,000, in a single quarter, representing an increase of 10% year over year.

In terms of our respective geographic markets, new order growth for the quarter was very strong across the board in the West, with double-digit increases in all the states in that region. Orders were also up in central region, driven by strong performance in Houston.

In total, southeast orders were relatively flat with continued strong performance in Florida, offset by slight decreases in other markets. Despite a decrease in orders in the mid-Atlantic in the second quarter, these markets remain very strong, with closings up 57% year over year, and a continued healthy level of backlog. We're carefully managing our releases in these markets in order to maximize sales prices and not let backlog extend beyond the current 12 months. Midwest orders were down 14% compared to the prior year.

Last quarter we announced a strategic and financial review with an aim to improve performance in this region and have made progress. To date, we've initiated specific actions on several fronts including the completion of a three-year financial plan. Organizational alignment including management changes where appropriate, consolidation of some office facilities, eliminating redundant costs, introducing a new product in the region, enhancing price point diversification and leveraging our significant land holdings. And enhanced realtor programs and other marketing initiatives, including a coordinated media campaign centered on the new Beazer brand. We continue to take proactive steps to improve performance in these markets, which we continue to maintain, hold long-term strategic advantages for us.

Our backlog now stands at 8,470 homes with a sales value of over $2 billion, up 14% and 37% respectively, from the unit and sales value at March 31, 2003. The sizable backlog increase provides excellent visibility as we move into the second half of fiscal 2004. Our increases in new orders and backlog levels were achieved on an increase of 6% in our number of active communities during the quarter, relative to the same quarter of the prior year, illustrating better penetration on a community basis. I'll now turn it over to Jim O'Leary to address in more detail our financial results. Jim.

Thank you Ian and thank you all for joining us today. As Ian mentioned we're out of our normal habitat this morning. We'll be back in this afternoon. If you have questions we can't get to you quickly here on the call, or follow-up questions afterwards, just leave voice mails we'll get back to you as quickly as possible. We expect to be back in our offices later this afternoon. Thank you for your patience and thank you for joining us this morning.

For the quarter ended March 31, 2003, revenues totaled 877 million, a March quarter record. And a 32% increase over last year's March quarter. This revenue increase was achieved on unit closing increase of 12%, with revenues continuing to increase at greater rate than units due to continued pricing power, we see in most of our major markets, as well as mix with strong closings in markets and higher average sales price such as the West and the Mid-Atlantic.

Net income for the quarter was 49 million, a 29% increase over last year, with diluted EPS for the quarter totaling $3.52, up 24% over 2002, both figures representing March quarter records. Turning to the balance sheet, our financial position remains strong during the second quarter, debt to total capitalization and net debt to total capitalization stood at 46% and 44% respectively, representing continued improvement from the December quarter and similar year to year levels. We're continuing to prudently and conservatively manage our balance sheet while growing the business and we're encouraged by Moody's recent announcement they're reviewing us for upgrade.

Total inventory of 2.27 billion at March 31 included 238 million net of cash deposits of consolidated inventory not owned, reflecting full application of FIN 46. Our land position as of March 31st totaled 85,591 lots, representing a 5.4-year land supply based on our last 12 months closings. At March 31, 49% of our lots were owned and 51% were under option, consistent with our general desire to be at about 50-50.

During the second quarter, gross profit and operating income in dollars increased 29% and 27% respectively. In terms of margins we increased our home sales gross margin by 10 basis points, or a total gross in operating margin slightly compared to prior year. We're continuing to realize benefits from strong pricing in the execution of our profit improvement initiative. For example, in the most recent six months, rebates collected per home increased 20% before consideration to direct cost savings which have been significant in several categories.

Unfortunately, these gains are offset somewhat by ongoing warranty costs associated with construction defect claims from water intrusion at one of our Midwest subdivision divisions, and - which are included in gross sales representing about 130 basis points of deleterious impact on gross margins I just quoted. In addition, we continue to incur incremental marketing expenses associated with the branding initiative of approximately $3.5 million this quarter, which are included in SG&A and that represents an additional 40 basis points of deleterious impact on our net margin included in SG&A. While the branding expenditures are depressing income in the short-term we believe it's strategically important investment for the long-term. At the end of this fiscal year, at the end of 9/30 we expect all of the one-time sales and marketing expenses to be gone.

Our performance for the first six months of the fiscal year combined with the significant level of existing backlog, and expectations of continued strength in the housing market, provide us with great confidence in our continued growth. After getting unanticipated adverse changes, we're raising our outlook for diluted EPS to be in the range of $15.75 to $16 fiscal 2004, representing approximately 25% growth over last year. This target assumes approximately 10% increase in closings with the balance coming from margin improvement and price appreciation realized to date in backlog. Now I'll turn it back to Ian to conclude our remarks.

Thanks, Jim. In conclusion a strong overall performance continues in 2004 reflecting our commitment to improved profitability and focused growth. As we move into the second half of fiscal 2004, our strong backlog of 37% in dollar value coupled with expectations of continued strength in the housing market provide us confidence in our future growth opportunities resulting in increased outlook of approximately 25% EPS growth for the year. As pointed out our margins have been positively impacted by both price appreciation and property value appreciation although these continues begins were offset approximately 15 million or 170 basis points in additional warranty costs and investment in the brand.

As I discussed earlier, we initiated an improvement plan in the Midwest and are taking specific actions on several fronts to proactively address and improve operational performance in this region. We believe strong demographic trends combined with constraints on housing supply and continued industry consolidation will continue to provide growth opportunities for large public homebuilders such as Beazer Homes. In addition, our continued focus on strategic initiatives that leverage our national brand, capsulize on our broad geographic profile through focussed product expansion and price point diversification and drive best practices to achieve optimal efficiencies will place us in a strong position for continued growth.

As evidenced by our increase in our earnings per share outlook to $15.75 to $16 growth of approximately 25% over fiscal 2003. So with that confident outlook for the future, I'd like to open it up for questions and invite your questions to the operator.

Thank you.

(OPERATOR-INSTRUCTIONS)

Stephen Kim from Smith Barney, you may ask a question

Thank you very much. Strong quarter, guys. Good job.

Thanks, Steve

I missed some of what you said in the beginning so I hope I'm not repeating but if I am, apologies. I thought I heard you mention something about changing the product mix. I assume that may have been applying to Crossmann. Are you looking to move into some higher price points with your mix as you go forward?

Let me address that. As we said we're out of our office today. If there's problems with the telephone lines we apologize and we'll surely back fill with anyone later on. The point we were making is that we've undertaken a strong review in the Midwest in this quarter and one of the things we're doing there is we've looked at our very strong land holdings and we've decided that we have a lot of opportunities there to split some of our land holdings and put different communities in there, different product in there, differentiate the product lines that we have in there, bring products in from other markets so we'll be able to drive through that and enhance the flow of sales through those communities. So that process is well under way now, obviously we may have to go back in for some rezoning.

Typically, the Midwest region has our lowest price point there, so we're going it continue with, that we want to what we call our economy product, that is obviously going to drive the business forward, but we're going to bring in our next product line out which is our value product which is a very traditional Beazer product throughout the country we are bringing that in. We will have to go back for rezoning in cases but often that's up zoning, getting slight less density, putting different products in there. We feel very confident we'll be able to get that. That's something we're doing. We've talked about for a long time in many of our other regions we've been bringing the economy product, the Midwest type of product; we've been bringing that into those regions as well. That's been going on for some time but we've enhanced that process, driven that process harder in the Midwest in this quarter.

This all fits into the strategy behind our brand at this time, is we recognize that our price point was fairly tight in the past that we've always been an entry-level first move up builder and what we see now is the opportunities to incrementally move both down in some of the traditional Beazer markets and then move up, particularly in some of those Midwest markets to broaden our product offering there, give ourselves a slightly wider spread. We're not doing this randomly, we're doing it incrementally from the base we have in every market but I think its is something you're going to see, as we talk about it's focused growth. Focusing in on where we want to grow, deciding how we're going to apply that and it fits under the brand umbrella

It sounds like those are initiative that will play but over the next three quarters, three to four quarters. So you had a very nice ramp here in your average price over the last four quarters. That sounds like it's not so much mix shift, but maybe also some substantial sales prices increases.

I think the answer is yes. If there is a mix shift, we had a hard contribution from the west, which is California, Las Vegas, places we really enjoy great price power and our closings in the Mid-Atlantic where we're working down our backlog, we talked about, slowing the sales pace to get our production line in with our backlog. We are enjoying sales price increases obviously the magnitude of California doesn't compare to a Columbus but on average it's 3 to 4% in the smaller more moderate markets and obviously into the teens, and that's reflected in our backlog.

I want to backtrack one second to your question on the product review. If you remember when we acquired Crossmann, when the company acquired Crossmann, it was very focused on entry level and had a big land bank and the strategic plan was never to chew through the land bank selling one type of product. And if you recall, your conference, other conferences for the last year, we have been talking about Plan Fest, which at its most crass level is SKU rationalization. We went through every single division, reviewed every single plan with the objective of getting anything a non-performer out of the product offering.

That way we weren't supporting, it weren't selling things that weren't selling at acceptable growth margins and only focusing on the old 80-20 rules. Only the 20% that were carrying the highest margins best offerings.

The adjunct to that we identified the debt best selling plans of the entry level and identified the debt best selling plans at the value-orientated buyer, first time move up, second time move up and what we're doing now is taking product lines that have been successful elsewhere and comparable markets to a Columbus, a Cincinnati, Indianapolis, where it was always focused on entry level, and we're broadening the price point, product opportunity and I think we'll see that probably not in the next three or four quarters because we'll get some of it this year, but I think it's next selling season and the future we'll be able to ramp up the growth potential in the markets like Columbus, Cincinnati and Indianapolis where we know we can do a lot better

And Ian or Jim, can you explain for us, what you anticipate the dynamic to be if and when rates were to rise, let's say 200 basis points, and I guess specifically what I'm getting at because we've all fielded these questions over the last few years, and I guess what I'm trying to understand, in your view do you anticipate that the buyer will generally be less willing to spend on options but still buy the house?

Do you see needing to increase density, or what kind of changes do you think you're going to need to make as a result of changes you anticipate in your buyer demand, if and when rates rise about 200 to 250 basis points?

OK, so Steve, that's a multi-layered questioned there. We can look back just for history to say back in 1999, 2000, rates did raise 200 basis points before the fed lowered the rates, you probably remember they raised them quite substantially almost choking the economy, and during that period we and the other large builders just drove through that, we drove through it both at the top line with increased orders, increased revenue, and at the bottom level with increased profits. The fact is, industries normally consolidate in tougher times; we've been able to do it in this these excellent times.

What I see happening is, one, we continue to consolidate, we take other substantially private builders out of the equation and it gets more difficult for them, so we have the opportunity there, we have the land holdings, we have the access to capital, we have the balance sheet to do, that but on a more tactical level, I think that what the great thing about this industry is, we don't just have one product, and we don't just have one product that we sell or one series of products.

We have multi-layers of products; the buyers at the end of the day are looking at a payment. We will be able to either give them an adjustable rate and it's interesting to say that currently our adjustable rate mortgage percentage of our business has actually gone up quite substantially already. I think people, even though rates in this quarter have been historically low, people are anticipating higher rates and the number of people taking adjustable rates is actually for us doubled from last year, from about 12% to about 24%.

So people are already recognizing that they can get a similar payment by using adjustable rate. We can also adjust the product line. We can either squeeze our product line or as you say, take a few of the options out there, we can move people down from say a 2200 square foot to a 2100-foot house at the end of the day, particularly for the first-time buyers they're really not going to notice the difference there. Those large toys that we service they're not going to see a lot of difference there.

They can move down the product line very slightly or take some of the options out. So I think we've got a lot of flexibility in the product offerings we have, I think we have a lot of flexibility in the financing that we can give to these buyers, and I see for us and the larger builders, over this period of somewhat enhanced increased interest rates, but in a better economic environment, and that's always the flip side here, we've got a much better environment if rates are going up. I see us really taking more and more market share and driving us through this period.

Steve, if you look at the 10 to 15 top public builders and I know this is a thesis and you other analysts subscribe, to they have long-term capital, we're sitting there with $89 million of cash on our balance sheet, we have very little short-term variable rate, if interest rates go up 200 basis points, X. those 15 or 10 to 15 guys who tapped the capital markets who have access, only a handful of which have substantial cash holdings. If you're a smaller mid-sized building very dependent on banks and short-term capital, that 200 basis points is going to change the math on a lot of your projects and profitability metrics. That's when we'll continue to grow and drive right through a downturn.

Got it, thanks very much.

Thank you, Steve.

The next question comes from Ivy Zelman from Credit Suisse First Boston.

Good morning gentlemen. It's Carlos Ribera (ph) on behalf of Ivy.

Hi, how are you?

Good, how are you doing?

Good, Thank you.

On the Midwest initiatives you guys are going over right now, when do you expect to start seeing some of the beneficial impact here hit the P&L?

Well, the companies are still profitable, we're making money in these regions, we're not making as much as we would like, but we're seeing positives already. We're seeing up sales in Ohio in this quarter. We're seeing improvements there, we've got a very strong business in Cincinnati, we've talked about that before, they've been able to implement some of these changes, they're probably the furthest ahead on the curve, we're now doing that in Columbus and Indianapolis, so it's not as though we're coming from a totally negative position, we're still making money in these markets, we'd just like to be making more.

The land holdings that we have there say we should make substantially more, and I think these initiatives we've been taking over time but we really have driven them hard center this quarter, we've set expectations higher, I think the balance of this year we're going to semi improvement, but I think the real upside comes into next year and the years beyond, as we really add and spread our product mix in those markets, so I think that 2005 will be a substantial improvement there, although we are looking for improvement in the balance of 2004.

Carlos, I wouldn't dispute or debate the Midwest performance. We know it's sub par, not up to our expectations but I think if you look at Midwest overall plus the operations that aren't disclosed, because they've been included into Beazer operations, Crossmann has a big position in Charlotte, Raleigh, very profitable operation in Myrtle Beach, Lexington, Kentucky, some of which we're looking to grow. And it brought us, in addition, we talked before about the pricing power that we're able to enjoy now over our subcontractors, will probably double our rebate revenue and substantially increase -- decrease, excuse me, hard costs in a number of categories like appliances, like faucetry, like cabinets.

All of, which were deals inked in the last 12 to 18 months, which could not have been inked without the additional contribution from not just the Midwest but all the acquired operations, which you have to look at in total, to really assess the profitability. So we'd like to seat sales trends and now see the profitability improve visibly in the Midwest because they're obviously out there, easy to see. But there's a lot of things that aren't easy to see that should be factored in more holistically.

Fair enough. Ian you mentioned in the southeast, Florida obviously was one of your strongest markets but also alluded to some slight decreases in other markets, would you care to elaborate?

Really just a timing issue. We had a down quarter in Georgia, and in Nashville, those were he two markets that were down somewhat and the Carolinas were quite strong. We talked about them being down somewhat in this period, they were actually up. We had -- but we had a very strong quarter in Georgia, last year, which set us back a little bit here. In five year the Atlanta market has picked up, we're very confident. We look at those just as timing issues. We're certainly pleased after a number of years of investing in Florida, Florida is coming through strongly. We see that as a strong market for the future. I'm not worried about the slight offset in those couple of markets in the southeast

OK. With respect to your gross margins, do you expect this warranty costs to see impact to gross margin for the remainder Of the year?

No for the remainder of the year they will continue to come through, and I don't know if you know much of the background of the issue, we inherited an issue in the Midwest, where a number of unhappy customers with an issue in a couple of particular subdivisions, where today we're wrestling through trying to keep the customers as happy as possible, and honor really put Beazer behind some of these claims, which we inherited. It's caused substantial spike over the last two quarters in warranty costs, we don't know about the situation enough about the situation and a lot is because each situation is different, a lot of people have been organized by homeowners associations, you know, potential class actions, which is described in painful detail in our last couple quarter 10Q.

We hope this is not the issue that it purports to be. We're standing behind the homes. We've been accruing. We don't know enough to put it behind us. So my expectation is we'll continue to incur claims sometime in the next few quarters. Hopefully we'll be able to put it behind us and settle with the homeowners and stand behind the claims and address the problems that they have. What that number is, I couldn't tell you today because we just don't know. But on the sales and marketing side, that's been about three and a half over the last two quarters, it will probably be something comparable going forward and that will be done by 930.

Can you quantify the impact this quarter with respect to high era material costs, obviously we're all aware of the higher lumber costs that are out there?

I would say for this quarter probably not a lot because we've done a good job on backlog protection. Yesterday I had a conference call with our divisional purchasing leaders and what we're seeing in terms of prospective price increases, anywhere between 5% and 10% hard house costs, very little of which is come through so far because we did a good job of protecting backlog but in the key categories, lumber being a big one, copper, steel, you know, you're seeing on average between 5% and 10%, and that wouldn't impact us probably until last quarter, first quarter of next year, and I think something I want to point out, while we are seeing increases in the hard house costs, we have been able to pass those price increases through. We're seeing some of the biggest increases our markets where the price appreciation has stayed ahead of that, so I don't expect any deleterious impact on gross margins, definitely not in the near term

Two cleanup items and I'll let someone else ask questions. Your community town growth expectations by year-end?

We haven't been forecasting that, Carlos, but that 5% growth probably wouldn't be far off.

And I missed your lot count at quarter end?

It was 86,000?

OK. Great, thanks, guys.

You're welcome.

The next question comes from Tony Campbell from North Partners.

Good morning, it's Tony Campbell on behalf of North partners. Good quarters, fellows.

Thanks, Tony.

I'm wondering if you can -- getting back to the Midwest and hate to beat a dead horse here but what quarter do you think you could see positive sales gains there?

Well, Tony, we would like to see some ups through the rest of this year, through the next couple of quarters obviously we were still down somewhat this quarter but catching a nice here but less than previous quarter so we're seeing turnaround.

As I told you, the higher markets have turned positive constantly so that's a positive for us. We'd like to see the Indiana market turn around. Jim made a good point just now that the whole of the acquisition, we've got some very strong growth in our Southeast markets from some of the Crossmann operations there, so really what we're talking about here is a higher in Indiana and bringing those markets around, that represents our Midwest market here so I would hope through the rest -- the balance of the fiscal year, the next two quarters we see improvement in the sales and ace said in as we go into 2005 and add these new product lines in place, effectively adding some communities within communities, I think you will definitely see some improvement.

OK, and I guess -- I hate to beat again, sort of come back to Steve Kim's question, but -- because obviously this is an issue that kind of worries the market and it's one of the reasons that we cant see that the multiples of the homebuilders where they are, but could you address the affordability issue because you guys, as a percentage of your business, have sort of a -- are at the lower end have a higher percentage at the lower end, so could you talk a bit about affordability as you see it, if I guess my question is say rates go up 200 to 250, how do you see the affordability of your houses for the first time buyers?

I think it's, for the first-time buyer, really they can be almost interest rate blind. What they're looking at is a payment, they want to see what they can afford in terms of a payment, what we can do there is move them from a fixed.

We really -- most first time buyers shouldn't take a fixed rate mortgage rate. I've been saying that the fact that the chairman of the Federal Reserve said that, they're saying taking too much to take 30-year security for a first time buyer. We should do a better job in promoting the range of adjustable rate mortgages that are out there and now that -- if we do see rates going up and we've seen it, the bond market is ahead of the fed here, and we'll do a better job promoting adjustable rates.

I said also to Steve Kim, we've doubled the number of adjustable rates in our portfolio, but our origination here in this quarter over the previous year. So the buyer has flexibility in terms of where they are in the yield curve and we can get them a payment there to suit their pocket book. As far as we're concerned on our side, we can also change the product line. They can move down the product line, they won't get the home that they could have got at the lower interest rates, but we can still move them into a home.

We have probably one of the broadest ranges of products for buyers, particularly at the lower end there, that we've got the economy models, that came out of the Midwest that we've got in nearly all of our markets now so we'll be able to move those first-time buyers down the product range.

Obviously, most of our homes now are fairly well stripped of options, we followed the model for a number of years and having design centers in all of our markets so the basic home is very affordable.

The fact is they may not be able to put in as many of the options as we would like them to buy, but I think getting them into affordable home is something that we can achieve. So both through the financing and through the product that we offer them.

So I'm very comfortable that we've got plenty of product options there, we haven't been -- even though we are looking to increase what we call style product at the higher ends of the market we see opportunities for us there, we haven't gone very far in that, our average price has gone up a lot, but it's really due, as Jim mentioned earlier to mix in California, the mid-Atlantic, mid-Atlantic closing up 57% in this quarter, those are very high-priced units coming in.

Our mix of product throughout the whole of the country, we've still got a lot of very affordable homes there. So I'm very confident that we will be able to address the buyer' needs back as back in a 1999, 2000 we'll be able to address it through product and financing alternatives for them.

What we were talking about a couple minutes ago, Tony, about moving newspaper price points in a few markets. It's not just addressing the buyers' needs today, if you'll remember a mortgage rates are in quarter of couple minutes ago when we went from 12.5% arms this year or last year towards about 24, 25 now, that was greater in some of the markets where we go to the more affordable sensitivity buyer that's probably gone up 60%, 70% so people are getting educated or doing a good job getting them into the right mortgage products.

The situation didn't exist a few years ago. What you he we talked about plan fest and the Midwest product review, we don't want to be telling only the affordable buyer, the guy 100% sensitivity to interest rates a lot of our growths and pick a market like Columbia, we don't want to be the leading entry level buyer, we want to be one of the leading builders and that's by getting into the value orientated, and pricing under the big guys and we think there's a boat load of share we can take

If I might just -- thank you. If I might just one sort of for follow-up. Down payments, any change there, and has there been any change in your cancellation rate?

In fact, our cancellation rate has come down somewhat from a year ago. So we're seeing something like 22% low 20s, this period compared to last year, it was 26%. So we've had some improvement there.

And down payments?

We currently run about 86% LDV, so that's pretty normal for us, that's pretty consistent for us that's across the board.

And it's dipped a percentage, went from 86% last year to about 85, and while the cancellation rate has gone down -- I don't want people out there changing their models and doing too much on it, part of that is mix. Part of that is mix. I'd love for the cancellation rate to be up to 25% again but the Midwest to double, but right now the number is 22, good part of that improvement is mix.

OK, thank you very much, good luck.

You're welcome, Tony, thank you.

Next question comes from Margaret Whelan from UBS.

Good morning.

Hi, Margaret.

I didn't catch everything, you kind of rushed through the prepared comments. But in terms of this issue in the Midwest with the water, did you say that cost you 130 basis points in the quarter?

That's right.

OK. And can you give us more detail on that, when it's going to be resolved?

We answered that previously, but 11.5 million is for warranty costs, spike we've had with a couple communities in the Indianapolis area, they are individual claims, but a lot of them are claims that are coming in en masse as homeowners in a few particular subdivisions have kind of banded together. There is no -- like today we can't quantify it otherwise we would take a final accrual and put it behind us. Three and a half million of sales and marketing associated with the Beazer branding development

In terms of the 11.5, where are you in terms of the potential opportunity for that? Are you halfway through it?

Could you repeat you question, I couldn't hear you.

The warranty costs so far is 11.5 million but when is it going to end?

If I knew that, we would accrue for it and put it behind us unfortunately, we don't have the full basis of information and don't know what the full potential of claims could be.

What's the average size of the claim?

That will be in our 10Q, and we're still sorting through the math.

We'll get the average size and absolute number so sonar.

That are the range of claims and the full claims to date will be in there.

OK. And you have no idea when it's going taper off?

I would expect over the next few quarters but I couldn't promise you it will be next quarter.

OK. And then you said $3.5 million for the branding?

That's right.

How much do you expect to spend on that in total?

About to date and you could double that for the rest of the year and that brand development cost training, ambassador training internally, that will run off by the end of the year.

And then when we start see the benefit?

I think we're starting to see the benefit now

Can you quantify it?

I can't tell you how many more homes we've sold in Las Vegas because of the brand. I can tell that you internally people have re charged up about it, our sales force has the wind in their sails and been very motivated. It's been a big part of the momentum I think we've gotten every other market except the Midwest and I think in future quarters it will be a big part of the momentum we get in the Midwest. Helping us establish the brand where Crossmann had taken some knocks over the years is not a brand with tremendous brand equity. Putting Beazer in there I think will be a big part of the growth we expect there in the future

And given the fact you're saying Crossmann doesn't have this great equity you have a couple hundred million of goodwill on the balance sheet for the acquisition are you going to writing that down at some point?

At the present, we don't think so. We're going through that review right now and it is a comprehensive rigorous review. We did a three-year financial review for the Crossmann businesses, first time it's been done, and I'm sure you know SAS 42 better than I do we employed valuation experts. They go through account and cash flow, comparable company analysis cash flow, look at the various discount rates, do a lot sensitivity analysis, and while that's an ongoing exercise, as of today, if we felt we had an impairment we would be talking about it. We don't.

OK. And then, in terms of the balance sheet, you were saying that the cash flow is positive, but the share kind of crept up a little bit, was that just options?

Yes.

Have you been repurchasing any stock?

No, we have not.

Do you have any plans to?

Not at the present.

OK, what about splitting the stock, I know you talked about that recently. We don't have plans right at this time to split the stock, we've certainly been looking at that and we will consider that throughout the year.

Let me comment on a couple things Jim said, when we talked about Crossmann didn't have brand equity. The fact is that Crossmann used many different brands in their marketing throughout the Midwest. They had acquired a number of companies and they use different brand names there. What we've done now is put everything under the Beazer name and we can leverage that and as I said in the remarks at the beginning, that we have a very - a coordinated media campaign at CV-radio, print throughout the country but we've started that in the Midwest so we've piloted a lot of that in the Midwest markets, obviously we recognize that we need to see the benefits there in that market so the TV campaigns are running out there now.

This is where we've put this incremental investment into branding but as we go forward, as we're able to do that on a central basis and then distribute it out to our markets we're going to see the benefit of that. So I think the benefit now everyone can stand behind the Beazer brand. And I would comment also on the warranty claims we're getting Beazer Homes that were built a number of years ago, not built by us, built by others, we are going to stand behind those customers, those are now our customers, for us being responsive to the customers' needs and recognizing that is something that we want to do and we do that across the country. we're going to take care of this, make sure those customers are satisfied and I think that actually give us a benefit in the markets we're in because I think they'll see and we're starting to see some really positive reaction there now, seeing the positive reaction of us addressing those issues.

But it would be positive for us if you could try to quantify it to some degree.

As Jim said, it's difficult to know where all those claims are going to come from. We are work on quantifying that and we put good disclosure in our filings and so I think you can see that. We would like to get it behind us but at this stage we're satisfying the homeowners' claims, we have a procedure there, we have an expert, a forensic expert in working on these claims, we've done everything in the right way here and we're going to address all those claims, and as we think over the next few quarters, we should be able to put this behind us. So as we get more and more information, we'll give that to you.

In the overall scheme, you know, it's a modest amount compared to the size of the company now, but obviously when you isolate it and look at it, it it's something that stands out and we want to give full disclosure here on this, but as far as I'm concerned we're going to take care of it, it is quantifiable but not today. It's going to be something over the next few quarters we think we'll be able to manage and understand exactly what that number is.

We certainly appreciate -- we wish we could quantify it today but I think it's worth point pointing out in spite of it, we beat our guidance substantially, we're 24% ahead of last year guidance and expect to be 24, 25% for the full year. So I wouldn't -

Okay, just one last question. What's the spread in the margin between the price points you're targeting right now?

As you move up at entry level, and I'll get some exact numbers for you but it's at least 2, 300 basis points. A lot of it, as you go from entry level, who are in many cases getting their selections out of a garage next to the model, it's really pick your colors, pick options amongst the most basic product line, you go into value orientated buyers who do have money to spend, have a little bit more room in their mortgage and will look to do real upgrades. This year, this quarter, I think we did $70 million of design center revenue. None of that was in, or very little was in the true 3entry-level buyer focus area. That usually carries 48% plus gross margins. An example, a market like Columbia where the former Crossman divisions only sold entry level or predominantly, as we start to move up and get that next level of buyer, we'd like to tap into those margins and in the option center that are again 48% plus across the board.

That's 40% gross margin.

Yes, but most of that drops to the bottom line, you're not carrying a lot of incremental overhead on that.

Great stuff, thank you.

Thank you, Margaret.

Nick Hiber (ph) from AG Edwards, you may ask your question.

Yes, part of it was just answered with Margaret's question, goes back to Steve's question on the rise in interest rates. I have no doubt that can you blow through with better unit numbers, but have you attempted any sort of quantification in just what sort of pressure your margins might come under if you do have to move people down from, example you gave, 2200 square foot to a 2000 square foot home, and there are fewer options being sold currently in your average home, what percentage are options and upgrades right now that you might lose in a higher mortgage market environment?

Total options run about 6 to 8%, say 7, and I don't think you're going to lose that in a market. Could you lose some of it on the margin? Sure. Have we gone through the exercise of quantifying it down to the level of our price point? No. I think we've been more focused on getting the balance sheet in the best shape we can and we're sitting here 44% debt to cap with $90 million of cash, we're focused on broadening the price points and we're foes cussed on get our backlog and collecting every dollar on the table today. That's an exercise that we will do and are doing as part of our overall financial planning, but there are other things to focus on the last couple quarters.

OK. You said that the percentage of market that are arms doubled. What are the current volume of ARMs are what is the average adjustment period for these? How many are yearly, how many are five years? Any idea there?

Greg, we don't have our own mortgage finance company, we have an origination company, so we pass that through, we don't collect that data to hand. We collect the data between conventional and government loans, we collect the number of ARMs and fixed-rate mortgages but we don't collect the three, five, seven-year, we don't collect that. But I've advocated most of the buyers should be in those products and we'll be doing a better job selling that to our customers going forward.

OK. Was the increase in ARMs pretty much across all your regions or was it concentrated say in the mid-Atlantic and the west coast?

It was across all regions, but it was more heavily weighted, and this is a rough answer because we do have two centers, I can't tell you exactly which division, which price point today generated it, but you had almost a tripling that centers on our Midwest operations which would really be the economy buyer. We went from 5% up to 14%, and something less going from about 20 to 27 in the balance of the company, and the balance of the company would actually be the market you just cited where I don't think people are going to arms. You are buyer in the mid-Atlantic and Midwest they're probably trying to lock in the best rate today. And those are the two markets where our cancellation rates are nil or very de minimus.

I think the other point for everyone's benefit is the interest rates are only going to go up if the economy improves and if you're a home buyer or considering buying a home, the state of the economy, the state of your employment is very, very important, and I think particularly for our Midwest market, we'd love to see some improvement in the economy, does that mean we've got to take a hike in suspect rates? So be it, as far as I'm concerned Ki think I'd rather see the economy pick up, I'd rather see job growth come back, that's a real -- really strong factor for people considering buying a home or moving up in their home lifestyle. So for us, I think that we are very confident going forward, the scenario that's going to play out over these next few years with slightly higher interest rates but with an improved economy is what we all expect I think is a good environment for us. It's particularly a good environment for the large public builders because we're going to be positioned to take that opportunity; the smaller more diversified private builders are not going to have the capacity to take that market share. As Jim explained earlier, the increase in rates is going to affect them more, I think it's going to somewhat affect their banking relationship, et cetera going forward as there is this caution out there. I see a great opportunity for us and I'm looking forward to a better economy for us. That's good for us

One last question if you have numbers. Is there any way you could break out your lot inventory by regions and how it's changed?

We can certainly get that to you. We have those numbers, but its -- the good thing now is we have five and a half years across the board, we have pretty much.

Pretty much the same in all regions, five and a half years.

It's slightly stronger still in the Midwest. The Midwest where we acquired our very large land bank is slightly stronger there but in every market we're around four-plus in every market, in every region, so we've got a good strong land bank in every region with a slightly more in the Midwest. We can certainly afford those -- forward those numbers to you at the appropriate time

Appreciate that, very nice quarter, gentlemen.

Thank you.

Annette Lindenbaum from Basswood Partners, you may ask your question.

I wanted to clarify, the 11 and a half million of warranty costs, does that flow through the gross margin line?

Yes, that's included in cost of sales.

And once you're past that particular problem, is there some normalized level that you would -- in other words, does it go from 11 and a half million to zero, would one expect that just over time you'd tend to have problems creep up?

This is a discrete unique situation -

So should I understand the 11 and a half million being above some normalized -

That's right

OK, fine. And my other question is you raised the guidance very dramatically and I'm sitting here trying to think, what is the source of that enormous increase until guidance? Where did that all of a sudden come from?

I think two things. Firstly, performance year to date we feel we've beat the numbers we had out there internally and externally and we have to factor that in. Second is with backlog up and dollar values up 30% we know those are homes that will be delivered over these next two to three quarters, so we have very good visibility there. We can see right through this year, we've got over 8,000 homes in backlog, which we're working through to deliver so we've got great visibility. The great thing about this industry is we that really can't forecast very accurately, so we feel very confident raising that guidance at this time.

So even, I'm not even a cell-phone analyst and I'm focused on guidance, but going back to the prior quarter, wasn't it something you could have already have seen? It's just that sales all of a sudden were dramatically higher than what you had been expecting?

OK, no. Otherwise we would have done it.

Right.

And the principal driver, and we've talked about on a couple issues, but if you look at mix, much higher price point than we anticipated it.

Right.

Offset - you know, I don't want to say it would be a positive to have fewer west coast units, Midwest units. I'd rather have more west coast and Midwest units. As played out now has been a big impact on guidance, you know, our mix in the west, where we really knocked the lights out in almost every region, and this big shift in price point, you know, it's obviously high double digits, in teens, in the western markets, where the mix real shifted, if you look at our backlog. But even in other markets it's 4 to 5% and we historically, and I don't think many people, are factoring big price improvements going forward. So I wouldn't say it's a surprise but it wasn't something I would have been comfortable forecasting out six months ago

And given what you described, I would have expected a big increase in the margin and the reason we didn't see that flow through because of the costs.

We would have been another 130 basis points plus absent those issues, but looking at them in isolation, we're seeing a lot of benefit not just from the mix but issues in place. Natural purchasing, plan fest, we call it spec fest which is getting our specifications in line across the company. A lot of productivity initiatives under way as well. Regrettably it's keeping us you up to flat with last year once we work through these issues, one is investment in terms of the sales and marketing expenditure and one is those unpleasant things when you're in business, which is the warranty cost. Once we chew through those we'll have more revenue drop to the bottom line

When will you start talking about expectations for the next year?

Probably the fourth quarter, our fourth quarter call, if we're far enough along with our planning process it could be next quarter

All right, thank you very much.

You're welcome.

The next question comes from Timothy Jones (ph) from Wasserman & Associates.

Good morning, Tim

A couple questions. First of all, why weren't these water damages covered by warranty cost? Are you self-insured or what?

No, there is insurance, as I explained before, these are homes built a number of years ago that we acquired in the acquisition of Crossmann. They were built many -- a few years ago. There is some insurance there and we're going through that process with the insurance carriers, but this is something that we -- we have to make sure we cover our costs on this. So some of it is expenditure already and some is a provision for future costs we know we're going to incur.

Is there a limit on the insurance, do you have warranty insurance --

Tim? I don't want to comment about insurance because obviously we're working with our carriers on it, however, do not allow to accrue insurance recoveries. So nobody who has an issue like this does anything other than what we're doing. You're not allowed to accrue insurance proceeds.

Oh, OK, so that could be a reversal in every respect.

There could be a pickup

I understand you're sensitive about that. You said it's about 11 and a half million mid this quarter and you said use that number for the next two quarters. About 44 million for the year.

I don't think it's prudent to forecast warranty costs. If we knew what the number would be we'd have accrued it

But you implied it would still be going on through this year.

There's still some going on but we don't have the basis to accrue the full amount

I understand. But if you take those -- and what's your biggest cost on this branding? Is it the advertising, I mean you say training, it can't be that much training cost if you're selling a house understand a different name, I mean continuing doesn't take too much rocket science to change the name.

We've only changed the name in a few markets, far more in that we've given some information about this on our annual report talks about it. But basically it's the way we're addressing the customer, we're really working on the experience the customer has, and there is a lot of training. We're putting a lot of training into this, everyone in the company is going through training, to understand the relationship, we're making sure that we deliver to the customer in every single one of our markets, a standard that we're going to be proud of and that we think will give us referrals going forward. This is far more than a name or new logo

What percentage will be under the Beazer name, of the markets?

All the markets are under the Beazer name now

The rest is the training ping and the advertising?

And we're putting substantial media dollars into this to reinforce that, we've got some changes in terms of -- you know, there is a new logo here, that's the visual side of this. But underneath it is the whole experience we're providing to every one of our customers to be consistent across every market from west coast to east coast and everything in between. You're going it see a consistent product from Beazer, you're going to see that consistent relationship with the customer, this is something that we're spending incrementally at this time, we do think there will be benefit in terms of national purchasing, national media campaigns, as I said, we've launched in the Midwest to TV campaign that will be used throughout west of the country as well. We've got to invest in it right now but this is something we think over the next few years is really going to benefit the company. We want to differentiate the service that we give to our customers and we want to get recognition from that from our customers going forward

Are you training these people with the Internet, with the advanced Internet that you have, campaign?

That's one of the factors here, is that our customers, whichever market they're in, can get access to all of the other markets through the Internet. You're not now dealing with discrete buyers and discrete markets. You're dealing with a buy their can access everything across the country, so we have to make sure that we're giving consistent service to each of those customers, we're making sure that we're giving consistent product guidance and the like. So this is something that I think we feel very strongly is the right way forward and for a large national builder is the right way going forward

Two quick questions. California, up 10% and subdivisions up almost 50% in orders, I know it's as strong as anything. You think you might be leaving something on the table, I mean a lot of people have -- they don't have the subdivisions or they're parceling them out because the price appreciation is so strong.

We are being very judicial in the mid-Atlantic markets where our backlog is now around 12 months. We don't want it to get any further than that. In California it's well under that. We're getting every dollar we possibly there. We've got a good land supply going forward. We feel very comfortable with that but again -

You'll cut -- you'll slow down at the 12 months?

That's where -- we don't want to go much beyond 12 months. We can get price locks for materials that extend to up to 12 months in certain markets but much beyond that we don't --

I agree 100% with that. And lastly, the question on the Crossmann, I mean about a write-up, I mean I remember when you picked Crossmann, or did -- earn the dollar share the following year, and then you never expected the 50% decline in Indianapolis, I'm sure. I mean, why wouldn't you, under the current economy, you know, allow you not to amortize the cost anymore of goodwill, take a write-off on Crossmann?

Because within-year performance doesn't drive the rolls, Tim. If it did, every company in homebuilders chemical industry, auto industry, anyone when ever did a deal in a cyclical business, you know, from what you just said, would be saying we had a bad year, write it off. This is a long-term proposition; you acquired a lot of hard assets, a lot of things that bring benefit to the rest of the company. I can assure you we just went through a rigorous process with outside valuation experts using every metric that I think you guys probably use.

The basic metric would be the value of the lapped. I went through this with Champion Home Builders and their retails of outlets worth 20 cents on the dollar and they argued and there was a 50% write-off. I think manufacturing -

I think manufactured housing might not be the direct --

I understand it's not but basically what you're saying is that the land is -- was six years of land is - has held up or appreciated and so forth. I mean that should be a major factor, correct?

The land and the positioning it bring us in the market. Now, we acquired a long land bank with Crossmann that was being use only to sell entry-level homes. Or predominantly. Now the opportunity to tap into that land bank, increase the pace and really get more out of every lot we sell than Crossmann might have otherwise, that has pretty substantial value but is part of the underpinnings of the exercise we're going through. OK?

Lastly, and I don't know if any municipality that would not be delighted to have you upgrade the zoning. Is that correct?

They certainly would. That's not going to be an issue. We feel that we've got great grandfathered zoning there for the very affordable product. In some of the land holdings if we put more upscale, we will get that through. We're very comfortable getting that through

I would agree.

Thanks, Tim. I hope none of our sales people were listening to the rocket science comment

Next is Gale Alexander from Darfill Associates.

Nice quarter.

Thanks

On affordability, I'm sorry to go back to this but could you give us an idea of the average payment and what percentage that is of the -- of your client' disposable income.

I don't think we have that to hand, Gale. As we said, what we're doing is we're putting our buyers and our -- and the mortgage companies together. We can track certain parts there, but we don't go through that in detail. That's underwritten by the mortgage company. We only have an origination company here, so we can see learn to value, ARMs versus conventional, government, but we don't see all of that other detail. Don't track that here

I thank you. One last question, if I may. You know, people have been talking about your warranty cost issues. But if there was to be a slow-down, it would seem your margins don't necessarily have to come down because you're absorbing all those costs this year is that a fair comment?

Yes, it is.

Thank you very much, and good luck.

You're welcome, Gale, thank you very much.

Our last question comes from David Nott (ph) from Nott Partners.

Hi. I hate to belabor this warranty issue, but what is the nature of the problem that has occurred? Is it the basement, the roof, or what?

It's a number of issues, David. I mean, basically, as I said before, these were homes built a number of years ago and there has been some water intrusion, and it's through many different issues there, whether it's a flashing issue or window, a chimney issue, we just have to address it one by one, and it's quite a large number and there's been quite a bit of publicity so it's a pulled a number of other people in. We've got a testing company there, a forensic company, handling the re-mediation, so I think we're going to get through that, but it's not one isolated item that you can say if we solve this it will be finished. We have to take each house one at a time.

Poorly built in general.

Yeah, the way they were built

How many communities has this affected so far?

I don't think we're giving all these details here, Tony, I mean we've got details on, that we've got an overall number of claims, but it's certainly something, we're going to work it through. It's a finite number; it's not something that's spread across every one of our markets. There's just a finite discrete area within one market.

Could you give us how many homes would be in that universe?

That will be in our 10-Q, Dave, we're still working through those numbers

By the way, do you have any recourse against the seller?

They're public sellers so you wouldn't have recourse typically. As we mentioned before, we're working with our carriers about potential coverage, we're looking at the subcontract base, for potential coverage, but recourse against the sellers, public company deal, and you don't -

Got you.

Thanks, David.

At this time there are no further questions.

OK, well, thank you, operator and we would like to take this opportunity to thanks everyone for joining us today. We apologize again if you've had difficulty contacting us.

We should be back in the office later this afternoon and as a reminder there will be a recording of this conference call with a slide presentation and it will be available on Investor Relations section of our web site, Beazer.com and we look forward to talking to you after our June quarter.

Goodbye.