Beazer Homes USA Inc (BZH) 2012 Q1 法說會逐字稿

Good morning, and welcome to the Beazer Homes earnings conference call for the first quarter of fiscal year 2012. Today's call is being recorded and will be hosted by Allan Merrill, the Company's Chief Executive Officer. Joining him on the call today will be Bob Salomon, the Company's Chief Financial Officer. Before he begins, Carey Phelps, Director of Investor Relations, will give instructions on accessing the Company's slide presentation over the internet and will make comments regarding forward-looking information. Ms. Phelps?

Thanks, Jody. Good morning and welcome to the Beazer Homes' conference call discussing our results for the quarter ended December 31, 2011. During this call, we will webcast a synchronized presentation which can be found on the investor page of beazer. com.

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 that may cause actual results to differ materially. Such risks, uncertainties and other factors are described in our SEC filings, including our annual report on Form 10-K.

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. Following their prepared remarks, we will take the questions in the time remaining. I will now turn the call over to Allan.

Thanks, Carey. Thank you for joining us this morning. On our call this morning, we will recap our results for the first quarter, discuss the current homebuilding environment, and update you on our current operational objectives and goals for the year.

I am pleased with the results our team delivered to start out fiscal 2012. For the first quarter, we recorded 724 new homeowners, which is up 36% over the first quarter of fiscal 2011. The sales increase reflected a growth in communities of just under 10%, but more importantly, a better than 25% increase in sales per community or absorptions. This is a direct result of our efforts to be more competitive in every community through the no community left behind initiative we adopted in the fourth quarter.

We closed 867 new homes, up 67% over the first quarter of fiscal 2011, and we ended the quarter with a backlog that reflects a similar improvement over last year. We generated homebuilding gross margins of 20.2% compared with 17% a year ago. Excluding a significant warranty recovery, this quarter's margins were 14.3% as we made feature, pricing, and incentive adjustments to ensure that our sales pace was both faster and more broad-based.

We reported positive EBITDA and positive net income. The positive net income was a result of a non-cash $36 million tax benefit and the warranty recovery. While this does not reflect the commencement of sustainable profitability, we are not going to apologize for making a bit of money in the quarter.

Finally, we maintain substantial liquidity, ending the quarter with $273 million in unrestricted cash. These results were achieved despite persistently difficult market conditions characterized by a lack of urgency on the part of buyers and extremely inefficient mortgage origination conditions. We are clearly seeing an increase in traffic in our communities and we are confident that significant pent-up demand for new homes is forming in many of our markets. But this demand is not broadly translating into new home sales despite record affordability, very low interest rates, and steadily rising residential rental rates.

At the risk of oversimplifying the psychology of prospective homebuyers, we think there are three dominant reasons for the disconnect between the positive indicators and new home orders. First, fear of home prices falling further. Second, concern about the overall direction of the economy including job security, stock market volatility, and with some buyers, concern about the impact of potential changes in national housing policies. And third, a dysfunctional mortgage origination environment. Let me share our views on each of these.

On the issue of home prices, there is solid evidence of home price stability in most of our markets. In fact, even the most pessimistic housing experts now seem to believe that we are at, or very near the bottom for home prices, excluding the impact of distressed home transactions, which continue to overhang a handful of markets like the Sword of Damocles. For our part, prices have remained flat although we have tweaked incentives and certain of our communities to stimulate a more competitive posture in the market.

On fears about the economy, there is not a lot we can do for buyers other than to relentlessly point out the emergence of job growth and the truly historic levels of home prices and mortgage rates. The number one thing that propels housing is jobs so we draw encouragement from any and all signs of job growth.

It is the third leg of the stool, mortgage originations, where we have recently come to believe we can make a small dent in the problem. The mortgage origination environment is afflicted by a host of complex issues including unprecedented, confusing, and time-consuming underwriting processes created by changing, and still to be finalized, regulations.

Originators are acting in ways that I can only characterize as inconsistent, creating a significant customer service challenge for us and taxing our ability to convert today's increased level of traffic into increased sales and closings. So, in an effort to better assist our homebuyers with this unwieldy process, we have eliminated the exclusivity provision from our long-standing marketing services agreement with a national lender. Effective this quarter, we are making it easy for our buyers to consider a small number of carefully selected lenders at the earliest stage of their home financing process.

We want our prospective buyers to benefit from a level of competition among a short list of providers on the basis of program, service level, and of course, pricing. These lenders have been individually selected at the division level and include national, regional, and local lenders who have already demonstrated their ability to provide value to our customers.

Going forward, we are going to be extremely focused on our customers' feedback on the service level of these lenders and if they falter, we will replace them in a heartbeat. This new approach clearly is not a magic bullet that will solve the mortgage mess. But it is a way that we can differentiate ourselves from any of the other builders. Since we have no financial interest in which lender ultimately provides the loan, we are able to sit squarely on the customer side of the table.

We think offering choices to buyers with a feedback loop of customer experiences is one way that we can add to the value proposition of choosing to purchase a new Beazer home. Now let me turn to our goal of driving our return to profitability. This is, by far, priority number one. As I outlined last quarter, we have a four-point plan to reach this objective. I will comment on each of these in order.

First, we are totally focused on increasing sales per community in all of our communities. During the first quarter, our sales per community per month improved from just over 1 during the first quarter of last year to about 1.3 this quarter. That's a big improvement.

Continuing to make progress on this objective is a vital component to growing our top line and, in time, driving margin improvements. Second, we need to gradually increase our community count. We have added 13 net new communities since the first quarter of fiscal 2011 which represented order growth of under 10%.

Even though some builders seem to be in a bit of a frenzy to add locations, we are going to be cautious in the market until we feel we have really nailed down our own operations in our existing communities. Third, we know we have to get our gross margins up.

Of course, better sales per community and more new locations will help this over time. But we are not just about to sit still and hope things will pick up in our underperforming communities. Instead, we have chosen to be reasonably aggressive in creating momentum for any underperforming communities and on any old completed specs.

The consequence of this approach, which is clearly on me, is that our gross margin, excluding warranty recovery, was actually down about 150 basis points from last year. This is a price we are willing to pay right now to make all of our assets more competitive in their local marketplace. Over the balance of this year we are committed to competing for buyers on the basis of things other than just price.

We are working on the other P's in our 4P plans -- product, people and promotion to allow us to pullback or reverse most, if not all, of these incentives. Finally, we are committed to holding down and hopefully reducing our fixed costs so that increased unit activity and improved margins flow through to the bottom line. These fixed costs include both our overheads and larger than desirable interest costs. For the quarter, our G&A expenses were down 13% in dollar terms from the first quarter of last year, despite a much larger number of closings, reflecting the success of the cost-cutting initiatives we initiated last spring.

We intend to continue this tight watch on costs as we move forward. Accomplishing these four components should enable us to reach our goal of returning to profitability. It is admittedly hard work and not everything we try will work. But our level of liquidity, our debt maturity profile, and the flexibility in our capital structure provides us with the ability to work through this plan for a number of years if necessary. With that I will turn the call to Bob.

Thanks, Allan. We reported net income from continuing operations for the quarter of $700,000 or $0.01 per share, which included an $11 million benefit from warranty recovery, non-cash pretax charges of $3.5 million related to inventory impairment and a benefit from income taxes of $35.7 million. This compared to a loss from continuing operations of $48.3 million or $0.65 per share during the first quarter of fiscal 2011. The $35.7 million non-cash tax benefit accorded this quarter, which is higher than I previously estimated due to the addition of accrued interest, is a result of tax planning that created clarity and the recognition of some of our prior year unrecognized tax benefits. Please note that this is expected to be a one-time event.

As Allan indicated earlier, our first quarter sales and closings were quite strong despite an increase in our reported cancellation rate. This higher cancellation rate is attributable, in large part, to the challenges created by today's mortgage environment.

Facing changing qualification standards, as well as burdensome and time-consuming processes, many potential homebuyers are encountering loan qualification issues or having problems selling their existing homes. Yet despite these obstacles, our orders were up 36% and closings were up 67% for the quarter.

During the quarter, our backlog conversion was 60%, which was less than our conversion rate from the prior year of 67%, but roughly equivalent to our expectation for this quarter. As we have shown in this slide, there are a number of moving parts that impact this conversion ratio. First, in every quarter, we have homes in backlog whose closings are scheduled for future quarters due to build times and product times.

Second, cancellations occur in the normal course of business in a range between 10% and 15% of beginning backlog over the past five quarters. Third, we pushed 11% of our September 30 backlog into future quarters due to various reasons, ranging from credit repair and mortgage financing issues to construction-related delay.

At the beginning of fiscal 2011, we have pushed an average of 12% of our beginning backlog each quarter into future periods. Finally, we sell and close a number of spec homes within each quarter. During the quarter, the December quarter, we experienced stronger to-be-built sales than we did in the prior year, in part due to having fewer specs on the ground but also due to the fact of increasing number of our prospective buyers desire the flexibility of designing and choosing options for their own home. As a result, we experienced a smaller relative pickup from closings of homes that were sold and closed within the same quarter, as compared with the first quarter of fiscal 2011.

As I look toward the second quarter and the potential impact of the factors listed on the slide, I believe that our conversion will improve from this quarter 60%, but not be as high as the 75% conversion experienced in our fourth quarter. Let's turn now to our end-of-quarter backlog. Our solid sales results in the back half of fiscal 2011 continued into our first quarter this year generating a strong backlog as we entered January.

At December 31, we had 1,307 homes in backlog, seasonally lower than we had at the end of September, but up 66% in units as compared to the same time last year. The sales value of our backlog in December 31 was $315.8 million, up 59%, with a sales value of $198 million last year.

The ASP in our backlog at the end of December was $242,000, which compares to an ASP in the first-quarter's closings of $216,000 and a trailing 12-month average of $220,000. ASP and backlog is an aggregate of future closings at any given point in time that will in fact be spread over several quarters.

Therefore, the ASP and backlog can vary greatly in comparison to the ASP of closings that occurred within a specific quarter through the different mix of products and markets. On this slide you can see that there are many quarter-to-quarter variations in the backlog and reported ASPs. So, we suggest you look at the longer-term trailing four-quarter ASP shown on the right-side of the page to see the trends more clearly.

The trailing four-quarter ASP reflects a fairly stable trend and is nearly unchanged from a year ago. For the first quarter, our homebuilding gross margin, excluding impairments in interest, was 20.2% compared to 17% last year. Included in this quarter's margin was a warranty recovery of $11 million. In comparison, last year's margin benefited from $1.4 million warranty recovery. While the magnitude of the warranty recovery this quarter was notable, our results in 8 out of the last 12 quarters were impacted to some extent by warranty recoveries. Without these warranty related items, margins would have been 14.3% this quarter as compared with 15.8% for the same period last year. Two primary factors contributed to this variance.

First, the home sales environment remains highly competitive, and has resulted in some increases in incentives and discounts in several of our markets primarily Houston, Las Vegas, Maryland, and Virginia. Second, as part of our no community left behind mindset, during the quarter we targeted price incentives to drive some sales in our underperforming communities.

As we gain momentum in these communities to further improve our sales for community metrics, we expect some gradual margin improvement. I'm confident that by the end of the year, our efforts will improve our sales per community performance, and will have a positive impact on our margins, but it's unclear whether this improvement will start as soon as next quarter.

Let me now turn to our G&A expenses. As a reminder, beginning with the September quarter, we pulled commissions out as its own line item in our financial statement. Excluding any commissions, total general administrative expenses for the quarter decreased $4.3 million from the first quarter of fiscal 2011. This included $3.3 million decrease in compensation and benefits primarily related to reduced headcount.

A $1.3 million reduction in legal and professional fees and a $1.6 million reduction to stock-based compensation, partially offset by a $1 million increase in sales and marketing related expenses. As we mentioned last quarter, legal fees may be elevated and unpredictable for the next few quarters as a result of post trial motions and appeals in connection with the trial involving a former employee.

Operating G&A, which adjusts for items such as legal fees, severance, and stock compensations, among others, totalled $21.6 million, down from $23.5 million a year ago primarily due to the cost-cutting initiatives that we talked about. Importantly, our operating G&A totaled only 11.4% of revenues during the quarter, compared with 21.6% in the same period last year.

We are clearly benefiting from our cost-cutting initiatives implemented last year and gained additional leverage as our level of closings has increased. This has created a current trajectory in operating G&A costs that positions us for significant fixed cost leverage in future quarters, as we drive toward increased sales per community. For a detailed reconciliation of our operating G&A totals, please refer to the schedule in the appendix of our presentation.

Now let me turn to our inventory. We have the benefit of owning an ample supply of finished lots in most of our markets. At the end of the first quarter, we had over 6,800 finished lots with houses under construction or ready to begin construction. Another 7,800 lots were under development and could be ready for use in the near future.

At the end of the first quarter, we just had over 660 lots held for sale and approximately 6,500 lots in land held for future development. As we have said in previous quarters, because we have such an ample supply of lots in inventory, our level of additional land spending is largely discretionary in nature.

In the first quarter, we spent $58.2 million compared with $62.6 million during the same period last year. As Allan said earlier, while we intend to gradually grow our community count in the coming years, in the near term, you can expect us to essentially replace the land we are using. To that end we approved the acquisition of two new land deals during the quarter.

We will remain cautious with our land spending as we focus on improving the results of our existing communities. As a reminder, although there may be seasonal or other timing variations, our use of land during the year will typically equate to approximately 20% to 25% of the home building revenues. At December 31, we had 729 unsold homes under construction or completed, representing a decrease of 153 homes from a year ago.

We were pleased to have reduced unsold homes significantly from this time last year. As we look forward, we intend to control the level of spec homes very carefully. Our plentiful land supply and the recapitalization efforts we took in 2009 and 2010, provides us with a flexible capital structure and a comfortable level of liquidity. We ended the quarter for $273 million in unrestricted cash and have no significant debt maturities until mid-2015.

But reducing our interest expense and/or extending our maturities remains a priority. We are encouraged by the recent improvement in debt and equity valuations in this sector and anticipate future opportunities to enhance our liquidity and capital structure as marketing conditions evolve.

As you know, during fiscal 2011, we launched an initiative to buy and rent previously owned homes. To date, we have nearly reached our self-imposed investment limit of $20 million. We continue to believe that it is both desirable and possible to scale this business with external capital. I am hopeful that we will have a more detailed update on this effort prior to our next earnings call. With respect to our deferred tax asset, as we have previously discussed, the dollar value of the deferred tax assets is significant and total $465.8 million at the end of December. While we are unlikely to be able to use the entire DTA due to some IRS change-of-ownership limitations, our current expectation is that upon the resumption of sustained profitability we will be able to utilize approximately $395.8 million to offset future taxes. The tax planning that resulted in this quarter's $35.7 million non-cash, tax benefit directly reduced our deferred tax asset. With that I will turn the call back over to Allan.

Thanks, Bob. I would like to end our comments this morning by reiterating my confidence in our operational improvement plans. The positive order in closing trends in the first quarter confirm a clear pattern of recovery. After three solid quarters of new home order growth and two quarters of increases in closings, our trailing 12-month results are moving in the right direction.

It's obvious that we have a lot of work in front of us, that every one of my colleagues here at Beazer are committed to creating our own recovery, not simply waiting for a recovering economy to bail us out. We aren't going to try and provide line-item guidance for this year, but I can confirm that our goals are unchanged.

For fiscal 2012, we expect to sell and close more homes than we did last year, generate positive EBITDA for the first time in years, and preserve and protect our liquidity. While our visibility into the economic conditions for the remainder of the year is limited, I believe that we will benefit from a gradually improving housing market.

We are taking the steps necessary to drive improvement in our revenues while maintaining an efficient cost structure, looking for new opportunities to generate profits and investing in future growth, all with the objective of accelerating our return to profitability. I look forward to updating you during future calls on our progress as we work to implement these path-to-profitability strategies. With that I will turn the call back to the operator to lead us into the Q&A.

(Operator Instructions) Jay McCanless, you may ask your question.

The question I wanted to ask with the discussions right now about bulk foreclosure sales starting up, have you guys given any thought to what that might do to appraisals and/or impairments in some of the areas like Arizona and Florida that you own?

It's a good question, Jay. I think the a -- there's a lot we don't know about how these bulk foreclosures will take place. When you are into portfolio sales, trying to assign value to individual homes becomes very challenging. But I can tell you that those homes that have already worked through the foreclosure process have clearly had an effect on appraised values. But I think that the investor demand for those properties is high enough that we are now seeing increases in the prices for distressed homes even though they're priced below where the regular resale market is and clearly below where the new home market is, there is a lot of investor demand for those properties.

So I think a bigger issue that we want to work with the industry on is making sure that when appraisals come in on new homes that they take into account energy efficiency features, that they either eliminate the distressed transactions because they are not comparable or at least the appraiser has done a physical inspection of that distressed property so that they can make an appropriate adjustment based on the condition. But I would tell you that the bulk sales in and of itself, I don't think is going to prove to be a big issue on new home prices.

Thank you and then my second question just with so many of your markets now focused on the East Coast and east of the Mississippi, do you believe that you had some benefit in Q1 from warmer weather and do you think you may have stolen some demand that would normally show up in Q2 and Q3?

As I look at the mix of businesses that we've got, our west businesses and our southeast businesses did pretty well in the quarter, our, what we call our east segment, which for us is New Jersey, Maryland, Virginia, and Indianapolis, actually were down in orders year-over-year. I don't think we got any benefit and I sure hope that did not reflect feeling or pulling forward any demand. We really struggled in the period and I think a lot of it was self-imposed, but we had real issues with spec sales canning during the quarter in those markets which was one of the primary things that led us to make the changes in our mortgage program that we did.

Next question comes from David Goldberg.

Thanks. Good morning, everybody. My first question was about the new lender choice program that you are adding more lenders. I'm just wondering how that -- if it complicates the ability to be on top of the mortgage process as you sell homes and we have heard from other builders that have told us that for their clients, as an example, if they've used outside lenders they might have to push closings because when they got to the closing table, everything wasn't together. Now clearly you will be more on top of it than that because it is not like pure outside lender, but I would just imagine as you add more lenders to your program and you give people more choice, it is going to be more complicated for you to be on top of the situation. I was wondering if you could talk about your views on that and maybe what kind of controls you put in place to make sure that's not an issue?

It's a great question, and I can't tell you definitively it's not an issue, but let me give you some color around it because I think it is actually not quite as concerning as folks might think. First of all, we have limited the number of lenders in each division to three lenders that we are working with. It is not an unruly number. Now that number can change. But we have worked with that number and larger in recent years. Notwithstanding having an agreement with a particular lender where we created a specific incentive to use that lender, there were still outside lenders involved. What we found is that there was very little efficiency, even with a relatively high capture rate to one lender, we found that on a loan-by-loan basis, the effort, the pain, the trials and tribulations of the lender collecting documents, giving us a read on credit, and moving that through their respective process, whether we had 1 loan with that lender or 35 loans with that lender, it did not cut down the number of conversations we had, it did not make it any more efficient for us.

So I personally talk to our closing coordinators in our divisions, and this is a local thing, it's not a national thing. I think their view is that when you get a match of the right lender to the right borrower, actually the process gets a whole lot simpler. Where we spin our wheels and spend a lot of time is when you try to put a square peg in a round hole and you are trying to get a loan through a lender that's really not a good fit. And that is really where our biggest inefficiency is, so while I am very open to and accept the premise that more lenders does create a little different risk profile, I will tell you that trying to get everything to be kind of one-size-fits-all through one program and through one lender had its own inefficiencies and I like very much the position that we've got with buyers that we are on their side.

I think that makes sense. My follow-up question, I just want to make sure I understood in the commentary, but I think you mentioned and Allan, I think you mentioned before about some of these no communities left behind, and maybe some more price incentives in these communities to drive some volumes. Is the view that that is going to be kind of a consistent theme as you work through some of these underperforming communities or is it more, I think this is what you guys were trying to say, was that as you get the sales pace and start to ramp up through some of these targeted price incentives that eventually you will wean off of them as just the sales volumes go up and maybe that looks better to new buyers that are coming in. So if you can just comment on that I think it would be helpful.

That's a good point. The latter of what you said is what we were trying to say. There's no question that when I looked at, with our teams, a community that wasn't working, we needed a framework to have a discussion about that. What's not right about it? I can't move it. I can't make it someplace else. Well, is our price right? Is our product right? Do we have the right salesperson there and are we promoting it correctly, which leads to both, do you have enough traffic in the community and is it the right kind of traffic? Is it the right buyer profile?

Other than price, which you can snap your fingers and make a change on, or including features which is typically what we do rather than changing the base price, we'll typically include a feature. Maybe it's a granite countertop. That's a margin hit but it's not really a price change. That's easy, that's quick, that helps create immediate competitiveness. The other three, changing out new home counselors or changing product, different structural options or more efficient building so that we can take direct costs out or tweaking the marketing locally so we are getting more of the right people in the community, those are not quick fixes. Those aren't 30 to 60-day flip the switch and it happens. So that the discipline is really around analyzing all four of those parameters and having detailed written plans that I look at weekly, what are we doing in these communities. It's lazy and it's simple, but it's to some extent necessary to stimulate this with a little bit of price.

As I talked last quarter, we've created incentive plans at the division level that manages both velocity and margin. I promise there's a high degree of alignment and interest between what our investors want, what I want and what our divisions are striving for to use those other aspects of repositioning a community than just price to grow into the kind of volumes we want to do in each community.

Great. Thank you and thanks for the color.

The next question comes from Ivy Zelman.

Thanks. Good morning, guys. If I can start with two questions and then assuming I get any color or further questions, but first on cancellation rates. You talk about the challenges there and your cancellation rates at over 30% are much higher than your peers, so is it possible that maybe there's some -- when the person is in the door and applying that needs to be tighter, or some more levels of scrutiny because certainly you're significantly higher than the industry? Secondly, when you think about gross margins today at 14.3%, you are also significantly below the industry, let's call it 400 plus basis points on average.

Assuming that's the case and you talk about Allan, 20%, 25% of your average selling price is your lot cost, is that what you are buying today as opposed to what's running through the P&L? Because with incentives you didn't disclose what percent of your ASP is incentives today. There's some big factor that is causing your margins to be so substantially below everybody else, so how do you close that gap and maybe if you walked through the COGS and explained it to us I think we would be more clear on what the drivers going forward are going to be.

How about this? We'll have a division of labor. Let me talk about the can rates and let Bob talk a little bit about the gross margins and the compenents to that and then we'll see if there's a follow-up. On the can rates, I do think, Ivy, that the premise of your question is right. I think in terms of people coming in the door and getting prequalified, that needs to be tighter. But part of that was in a mono-lender kind of environment, we were getting, I think, some false positives. We were getting, hey we are entitled to this business and yes, we can make this work and then when push came to shove and we are working through a deeper credit analysis, it was challenging.

These were not decisions made by our folks, these were reliances that we had. I think, again, competition, we are going to have a better read on that buyer. The other thing though and I made this point in relation to one of the other questions. Our can rate was either flat or down in the west and southeast year-over-year. It was way up in the east and within the east, it was particularly up on specs. It was basically flat on dirt. So we have really isolated in the three divisions the product type where the can rate really got away from us and I can put my finger on some very specific loan lending origination process improvements that I think will allow us to pull that back down.

I don't know that, and I've always believed that comparing can rates across builders is a little bit tricky because the real risk in a high can rate is if you have got a ton of houses that you start, if you've got some discipline about when you release a home for construction, plus or minus a few hundred basis points in the can rate does not make that a big difference. We definitely want to capture that buyer and if we're prudent about how we outlay capital against that I'm okay with it. I'm not going to try and chase some mythical can rate down to a low number. But in this quarter we can tell you very clearly where the can rate flip came from and what we have done about it. I think next quarter we will have a different story on both dirt and spec sales and where our can rates were by division. So that's a little bit more on that and Bob will, I will flip the gross margin question to you.

When you think about gross margins, you think about 20% to 25% component of the land. That's a blended consolidated number. That -- every market is not created equal so some markets have a little bit higher and some markets have a little bit lower. When you look at the mix of closings and where they are generated in that impact on that margin has a big impact. So it's not so much the land cost, but it's -- I think if you go back to the 50% of our communities previously creating 20% of the sales or so and trying to improve those, improving some incentives to get some of those communities moving has really been probably the bigger driver than the land cost. Our land cost and our new pro-formas are in that same range of 20% to 25%. Again, we operate and underwrite those deals, not so much on a land costs as a percentage, but what is the return characteristic going to be for that new land deal.

I think the other piece of this, this is not really the right forum to try and deconstruct the entire income statement, but when we think about cost of goods sold, the land market is one that we don't control the pricing obviously. It is very competitive out there but I don't feel badly about our purchases in that 20% to 25% range. On the building products side and on the labor side, I think we are very competitive. I think having pushed purchasing back into the field last quarter allows us to be a little bit more competitive. I think we can find some nickels and dimes in that.

I'll tell you the area where we've killed ourselves is we don't get good leverage on our fixed portions of costs at the community level that you really can leverage with better sales for community. Having a bunch of laggard communities that are selling less than one per month in that community, that is a margin killer. That is an absolute margin killer. So the area for us for greatest improvement in gross margin actually is job number one on our path to profitability increased sales per community. You can extend your point about our gross margins relative to the peer group. You need to say also our sales per community have been lower than the peer group. I think that is really the relationship that I'm focused on.

That's all very helpful. Just one quick follow-up on the price incentives. Can you say what they were, the percent of sales, and what they were the last few quarters and what the trend is going forward in your view?

I'll tell you what, how about if we get back to you? I don't have it right in front of me, Ivy. Bob, I don't know if you have it.

I don't have it off the top of my head, but--.

Thank you, guys.

Our next question comes from Mike Rehaut.

Thanks. Good morning, everyone. First question on absorption pace, I believe you said earlier in the call it was up about 25% year-over-year. I was curious if you could give us just for reference the last couple of quarters, 4Q year-over-year and 3Q year-over-year and if you have seen any change in that pace as we've entered into January?

I would tell you for sure, it was not up 25% as much as that in our fourth quarter. We really got on this bandwagon hard in the July, August time period, so it had a limited ability to affect us in the fourth quarter. It was clearly up, I think my recollection, low double-digit kind of percentage in terms of sales per community. I know on a trailing 12-month basis on that metric, we are just under 1.9%, which is better. A year ago on a trailing 12-month basis, we were at 1.55%. So there is improvement that we've made during the year. And more improvement this last quarter. Bob?

I think those numbers are accurate. You definitely have seasonality in the numbers and the trailing 12-month is the way to look at it.

Any further improvement into January?

January is going to be an interesting comparator, I think for a lot of folks. We finished December very strong. We are very pleased with how we did in our first quarter. In our second quarter, we have traditionally run a fairly significant promotion. That promotion is really less about price than it is about interest in trying to create velocity of interest in prospect leads, traffic in our communities. It is pulled forward this year.

We launched it actually yesterday. It's the first two weeks of February rather than where it has been the last two years, which is the last two weeks of February. And I will tell you I think it had a little bit of effect. I don't have our January's sales numbers yet but I'll bet that our January was a little softer than some others will be because I have no doubt that that is a lead into our promo. I try and be a little careful about reading a January comp against last year, just because of what we did with the timing of our promo.

Great. Thanks. Just a second question to try and better understand the challenges you've had with the mortgage origination. Was there a particular profile of buyer that -- you were kind of mentioning, Allan, that you were trying to fit a round peg in a square hole. Was there a typical profile of buyer that really was not cutting it with the provider that you had in terms of either FICO scores or LTV and you had also said it was maybe limited to some geographies?

Unfortunately, it is very hard to generalize. I will use the opportunity to give you an example because it is something I've actually talked in DC about, tried to paint this picture for regulators and others that are interested in what's happening in housing finance. We had a 750 plus FICO borrower that was working with our preferred lender that was $50,000 plus in cash liquidity, better than 10% down. We were two days away from a closing. There was a requirement and a re-audit of an audit of the loan file to document a deposit that had occurred six months previously in an amount of $400 or $500.

Initially it was sort of ambiguous what the $400 was and you'd have to say, in a commonsense way, the reason people want to document sources of income and deposits is you want to be careful about where the deposit or the down payment for the home is coming from. I think we all get that. That's important. We are talking about $400 against a $15,000 or a $20,000 down payment. In any event, the borrower confessed that he won the NCAA basketball pool in his office. Well, that flagged the file. Checkmark, known gambler. Loan denied. Missed closing. Unhappy customer. That is not really a credit issue. It is not really a FICO score issue. It's an issue of everybody is so fearful about putback risks on their originations that there can't be any blemish or any question or any doubt because who knows, if you're a lender, whether 1, 2, 3, 4, 5 years down the road, somebody's going to come back and say you had active knowledge, you should not have originated that loan.

I am happy to say some number of weeks later, we were able to get that buyer approved with a different lender and closed, but those kinds of things, it is not as simple as the FICO was not there or the income history wasn't there. It is little nits and nats and I can't fault any lender for their specific processes. But it's why I think consumers are well served to have a couple lenders working their file and working with them because these are very personal and entity specific overlays.

The next question comes from Dan Oppenheim.

Thanks very much. I was wondering about the sales promotion that you were talking about getting started now. It seems as though you are talking about less of an emphasis on incentives with this. Are you basically going into the spring season with less of what is out there so that we are thinking that you will be able to get the sales with what's going on, but not using the incentives to get that as we go through fiscal 2Q?

Dan, I don't think that in year-over-year, the incentives are going to be particularly different. I really don't. They may be a little lower. They are certainly not, there's no concerted strategy that they need to be higher. Traffic is up materially, November, December, and January in our communities. Interest is pretty high. We had a self-created bottleneck on the originations side that we weren't as good as we needed to be with that. I think we've addressed that. I'm sure it's not perfect. I think we just need to use the things that we talked about, low rates, good affordability, tremendous energy efficiency which continues to be a big push for us to get people to commit. Candidly, I hope we jump the market a little bit by being a bit earlier in our promo to pull those buyers, even pre-Super Bowl, out of the market.

Got it. Thanks. In terms of the mortgage issues on the specs and such, how much of it was an issue with the buyers versus an issue in terms of homes at all? Where there's too much finish and the appraisal issues then? Is there anything that, aside from having more lenders in there that you're doing different in terms of how you're perceiving the specs?

I think on the specification levels, there are a couple of markets. Florida is really challenging on appraisals. We have got to be unbelievably careful putting anything in a home in Florida because of the appraisal problems. That's still true in Phoenix. It's a little less true than it was a year ago. I would say that broadly, the appraisal issues are diminishing in both frequency and in severity. So the issue really is more at the loan file level than it is at the house level.

The next question comes from Susan Berliner.

Hi, good morning. I was wondering if we could focus a little bit on the unrestricted cash. I know you guys have a lot of coupon payments this quarter. I guess I was trying to figure out where all the cash went. I do not know if some went to the rental program or if there is anything notable that you guys could address.

Susan, I think we can talk about them in bug buckets. We had about $50 million of interest payments this quarter. We paid our portion of our South Edge payment, which was about $16 million. We had about $8 million in CapEx, of which I think $6 million was related to the pre-owned. When you look at that, those are pretty much the lion's share of the cash decrease.

Going forward, a year ago you guys had kind of articulated where you expected unrestricted cash to end the year, which would obviously also kind of tie in to land spend. Are you guys going to provide those numbers?

We haven't talked about providing specific numbers but if you remember we talked about our interest burn is about $120 million a year. We are going to have positive EBITDA and we are going to run our land on a basic replacement level from what we use. So I think when you think about those, it kind of gives you some indication as to where cash will end up.

If I could sneak one more with regards to the balance sheet, the new issue market is quite strong. Any comments on what you guys see in terms of raising additional debt going forward?

I think we are pretty encouraged with what's been happening with the recent issuances in the market and we keep pretty close tabs on what's going on. As you know in the past we have been pretty creative with our willingness to issue debt as well as equity in the past and I think going forward, we're going to be continued to be flexible. We are going to watch the market. I think we will just continue to monitor.

The next question comes from Kristin McDuffy.

Just following on Susan's question, could you talk a little bit about how you think about what part of the structure you wish you would issue debt at? Would you consider secured debt or would you even consider a convertible? Also, could you talk a little bit about revolvers? It sounded like from some prior builder calls that things were becoming more amenable to revolvers? Thanks.

When we talk about, let's talk about the revolver first. If we see the markets really improve and we start leaning into our land acquisition in width buildup. We would look towards putting a revolver in place and we feel pretty comfortable right now. But when we think about debt, there are circumstances that might make some sense, as we move forward, we have no specific plans in place today. There could come a time where the opportunities would make sense for us.

Okay, let me just jump in. I also think Bob's exactly right. We have got to be quite opportunistic, but we worked hard a couple of years ago to be in a position where we had a nicely laddered maturity profile and we had a lot of drive power in the secured basket and I think we like the flexibility that those things present. We have got plenty of cash to run the business right now so we don't fill a particular urgency by any pressing matter. On the convertibles market, it's clear we've got a couple of converts out there already. I think we've got as complex a capital structure probably as a Company our size needs to have. I think we'd be a bit cautious about that right now.

Our next question comes from Alex Barron.

Good morning, guys. I guess I was listening to all your comments and strategies on the profitability or getting back to it. I think you guys are making progress in the right direction, but the one thing that I continue to struggle with is the level of debt and therefore the level of interest incurred. I'm just kind of wondering, how do you overcome that? Do you have any plans to maybe raise some equity or try to start paying down some debt or how are you thinking about that?

I've talked about the path to profitability, Alex. If we do the first. If we just execute our list. If we increase sales per community, against a gradually increasing community count number and we keep our fixed costs under control, and I've defined fixed costs to include the interest burden and the overhead expenses, we can get back to profitability. If there is a way to accelerate that on any one of those levers, we would certainly look at it, have looked at it, will continue to look at it, but I don't think there's a silver bullet that is going to get us there. We are going to have to do all four of those things.

Okay. My second question is something I have asked other builders. It's been about six years since the market turned down. It looks like it's finally bottomed. Obviously there's been several million people who have lost their home to foreclosure and short sales and have been out of the market for a while, renting houses. Are you starting to see any of those people qualify to be able to buy homes again? Are they coming back to your communities yet?

We have. In fact, some of the markets that went in early, Phoenix and Las Vegas, are among those. We are seeing people who had short sales or foreclosures in '07 or '08 who are back to a point with their FICO scores where they are prospective and eligible homebuyers. We are in the very earliest wave of that and I think we've still got a year or two to go before we see a significant number of those folks. But we are starting to see the early signs of it, yes.

Next question comes from Andrew Casella.

Hi, thanks for taking the question. Firstly, on your revolver. That matures I believe later this year. Have you entered in negotiations with your lenders yet on that and as far as when we talk about your liquidity and whatnot, would it be under management's consideration to expand the current revolver to, I believe, it's a $150 million basket and possibly tap incremental cash from that aspect?

We do have a basket of $150 million for first lane revolver. The revolver that's in place right now is primarily for letters of credit, which right now we have cash secured those letters of credit. We have not entered into any discussions at this point to extend that particular term. I'm sure that we will at the appropriate time. We do have plenty of liquidity today and no maturity. At the moment we are not very stressed about entering into a brand-new revolver.

So if you were to tap that $150 million basket, would that be under the same lenders or would you have to go to different banks on that?

I have no idea. I can't predict who would be interested in playing into a new revolver.

Just one follow-up. Regarding the warranty reversal, is that a cash inflow or is that just a reversal of an accrual?

It was a cash inflow. The accrual was put in place I think in 2004 and monies were spent over the years. This was a cash recovery.

Okay. As far as including that or excluding it from EBITDA just to get a clean number, would you consider that to be a deduction or do you think it is good to include that as far as just getting a cash EBITDA number?

I think it's good to include it in EBITDA. Again, in the past, the costs related to those reserves were deducted from EBITDA. I think that just because the timing of the recovery is several years in the future, I still think it belongs in EBITDA.

Our last question comes from Joel Lockery.

Hi guys. Just on your community count you mentioned it was up 13 year-over-year. What would it have been if you included the discontinued operation communities?

I don't have that. From a discontinued -- I actually don't even have that calculation.

I think the delta was like 10. (multiple speakers) But it would have been in both camps. Disco ops a year ago and disco ops this year would be, in both cases, a number under 10. The differential is pretty insignificant.

Do you have any communities open now that are discontinued or are all those closed? I didn't see any orders.

To be honest, we have less than five homes remaining in disco ops that are for sale. I don't think you could call that a community.

Right. Your interest expense of $19 million running through that line item, is that just going to be there for a while based on inventories being relatively flat?

I think it is based on a couple things. Inventories being flat, level of closings for where you relieve that interest expense. Given the incurreds level in relation to the inventory level, for a period of time, that is going to stay, it's going to be geography on the balance -- on the income statement as to whether it is in COGS or below. But I think you can expect that to happen.

Just the last question on your -- what -- do you have a finished spec count or total amount of dollars in customer deposits?

I don't have -- the customer deposit number I don't have off the top of my head. But the finished spec number is about 380 which is on slide 16.

Thank you for participating. This concludes today's conference call. You may disconnect at this time.