Beazer Homes USA Inc (BZH) 2012 Q2 法說會逐字稿

Good morning and welcome to the Beazer Homes earnings conference call for the second 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.

Thank you, Cathy. Good morning and welcome to the Beazer Homes conference call discussing our results for the quarter-ended March 31, 2012. During this call, we webcast a synchronized presentation which can be found on the Investor Page of beazer.com. Before we begin we 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 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 questions in the time remaining. I will now turn the call over to Allan.

Thanks, Carey, and thank you for joining us. On our call this morning we will recap our results for the second quarter, discuss the current homebuilding environment, and update you on the progress we've made to date on our operational objectives and financial goals for the year. I was very pleased with our second-quarter results. Compared to last year, we generated substantially higher new home orders and closings with improvements in every geographic segment. At the same time, we were able to push up gross margins from last quarter. While these results leave us plenty of work left to do to reach our profitability objectives, the across-the-board improvements were encouraging.

The results this quarter were driven by two primary factors. Improving conditions for new home sales, including a return of a more normal seasonal uptick, and the progress we're making in our path to profitability strategy as we make numerous operational enhancements intended to drive improved results in every one of our communities. There were several operational highlights of our second-quarter results. Among them, we reported 1,512 new home orders, which was up 29% over the second quarter of fiscal 2011. This was driven by a substantial improvement in sales per community per month, which grew from 2.2 last year to about 2.7 this year, as our No Community Left Behind efforts showed results.

We closed 844 new homes, up 50% over the second quarter of fiscal 2011. This meant we ended the quarter with a backlog that is 41% higher than the same time last year. We generated unlevered homebuilding gross margins of 17.5%, or 15.8% excluding warranty recoveries and bond reimbursement, up a 1.5 points from last year. And importantly, we maintained substantial liquidity ending the quarter with $257 million in unrestricted cash. In addition to these operational achievements, since our last call, we completed an important capitalization transaction. In March, we successfully exchanged common stock for the substantial majority of our mandatory convertible notes and tangible equity units, adding $54 million in shareholders' equity and eliminating approximately $4 million in annual interest expense.

Now that we've covered the highlights since our last call, let's discuss the broader topics of the housing market. It is clear that we have rediscovered some semblance of a spring selling season this year, although without a crystal ball in hand, it is hard to tell whether a sustainable recovery is here. There are reasons for optimism. First, as we have been telling our customers for some time and the media is now reporting almost daily, it is an excellent time to buy a new home. There is significant pent-up demand in many of our markets and home buyers today can enjoy record home price affordability, low interest rates, and excellent energy cost savings all while avoiding rapidly increasing rental rates.

Second, although national job growth numbers have been uneven and a bit disappointing over the past few months, we are seeing much improved employment trends in many of our markets. In fact in our communities, we are seeing many currently employed consumers who appear to be gaining confidence and are voluntarily changing jobs to improve their employment circumstances. This isn't necessarily picked up in the job growth statistics, but we believe it is a positive sign. Third, traffic levels have been much more consistent so far this calendar year, with far fewer wild week-to-week swings than we saw during the last several years. And finally, pricing has either stabilized or is ticking up slightly across most of our markets.

Now, as encouraging as these factors are, there is still nagging headwinds impeding a more robust recovery in the housing industry. These start with what remains a truly inefficient and difficult mortgage origination environment for most borrowers. Add to this, a housing policy narrative which can only be described as chaotic. While it is unlikely that any of the array of housing policy issues will be solved this year, including the fates of Fannie and Freddie, the appraisal mess, the role of the FHA, and critically, the extent of any changes to the mortgage interest discussion. The bickering among policy makers and politicians is not a helpful backdrop for home buyers.

We can't add much to the housing policy dialogue, but on the mortgage front we are doing what we can to minimize the hassles of the process. On our last call we announced our decision to end our exclusive arrangement with our largest mortgage provider. In February, we adopted a practice of enabling our buyers to consider a small number of carefully selected lenders at the earliest stage of their home financing process. Unlike many of our peers, we have no interest in any one lender and are able to promote real competition among lenders on behalf of our customers. While we are still working through some of the operational complexities inherent with a change of this nature, we are pleased with our ability to provide buyers with an open and competitive mortgage origination platform. We think this is one of the ways we can demonstrate a durable and differentiated home buying experience to our customers.

Now, returning to the question of sustainability of the housing recovery, it appears we may have turned the proverbial corner. For the first time in many years, the reasons for optimism about housing seemed to be outweighing the headwinds with prospective home buyers. While the trajectory isn't awe-inspiring, the direction is becoming clearer. If this momentum is sustained, it will represent a very welcome change for our long-suffering shareholders, our trade partners and our employees.

Now let me turn to our goal of driving our return to profitability. As we've said before, this is our top priority and we have a four-point plan to reach this objective. I will comment on each of these in order. First, our primary focus is on increasing sales per community in all of our communities. During the second quarter, our sales per community per month improved from 2.2 during the second quarter of last year to about 2.7 this quarter. In fact, in the 12 months ended March 31, we averaged just over 2 sales per month per community, which was an important milestone. Continuing to make progress on this objective is a vital component of growing our top line and in time driving margin improvements.

Second, we intend to gradually increase our community count. We've added 10 net new communities since the second quarter of fiscal 2011, which represented growth of approximately 6%. Expanding this number is important to the growth and profitability prospects of the Company longer term, especially now that we are feeling a bit better about our operations in existing communities.

Third, we have to continue to increase our gross margins. When we implemented our efforts to drive sales momentum in our underperforming communities, our margins suffered somewhat. While they improved this quarter, they have not yet returned to the levels we recorded last year, let alone to the levels we are targeting. This effort will take time as we fully apply our four P -- product, people, promotion, and pricing tactics to every community. And as with other builders, we expect margins to benefit slightly as we add new communities.

Finally, the first three steps are only useful if we continue to hold down our fixed costs so that the increased contribution dollars created by more unit activity and better margins actually flow through to the bottom line. These fixed costs include both our overheads and our interest costs. While I'm encouraged that our total G&A expenses were down 27% in dollar terms from last year, despite a much larger number of closings, I realize we have to be extremely vigilant about cost creep as the business expands.

On the interest expense front, we will find ways to chip away at this line item as we did in the second quarter with the successful exchange offers that converted the majority of our equity linked securities to common stock ahead of their originally scheduled conversion base. Getting back to profitability is our overriding objective, and we believe that consistently and urgently working on these four components is what we need to do to get there. With that I'll turn the call over to Bob.

Thanks, Allan. We reported a net loss from continuing operations for the quarter of $37.9 million, or $0.48 per share, which included non-cash pretax charges of $1.2 million for inventory impairments and a loss on debt extinguishment of $2.7 million. This compared to a loss from continuing operations of $53.8 million, or $0.73 per share, during the second quarter of fiscal 2011, which included non-cash pretax charges of $17.8 million for inventory impairments and a cash benefit of approximately $6.8 million related to a return of compensation.

Exchange orders we completed during the quarter resulted in the acceleration of a conversion to common stock of 84% of our mandatory convertible notes, and 94% of our tangible equity notes. Given today's total outstanding share count, of approximately 101 million shares following these transactions, the average share count expected for all of fiscal 2012 would be approximately 88 million. As Allan indicated earlier, we recorded another solid growth quarter in both new home orders and closings, providing further evidence of stabilization in the market. Despite the continuing challenges our buyers face today, due to the mortgage environment, our orders were up 29% for the quarter and closings were up 50%.

During the quarter, our backlog conversion was 65%, which is within the expected range that we provided on our last call. This slide shows the various 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 and have ranged between 10% and 15% of beginning backlog over the past six quarters. For the second quarter, the cancellation rate of our units in backlog was 12%, or just under what we saw during the first quarter and the same as we saw last year.

Third, we pushed 12% of our December 31 backlog into future quarters, consistent with the average we sustained during fiscal 2011. And finally, we sell and close a number of spec homes within each quarter. This quarter, the number of homes sold and closed during the quarter was 296. As I look toward the third quarter and potential impact of the factors listed on this slide, I believe that our conversion will be similar to the rates we've reported in the first two quarters of this year.

Looking at our end of quarter backlog, we have seen solid sales results for several consecutive quarters, therefore generating the strong backlog as we entered April. At March 31, we had 1,975 homes in backlog, up 41% in units as compared with the same time last year. The sales value of our backlog at March 31 was $465 million, up 39%, from a sales value of $335.2 million last year. The ASP in our backlog at the end of March was $235,500, which compares to an ASP in the second quarter's closings of $224,700, and a trailing 12-month average of $221,400. The trailing four-quarter ASP reflects clearly stable trend and is up slightly from a year ago.

For the second quarter, our homebuilding gross margins, excluding impairments and interest of 17.5%, compared to 19.2% last year. This quarter's margin benefited from several nonrecurring items, including bond reimbursements and product litigation warranty recoveries. Without these items, margins would have been 15.8%. As we pointed out during our last two calls, our No Community Left Behind objective which is intended to drive sales in our underperforming communities has resulted in a short-term negative impact on margins, that you can see reflected in our year-over-year comparison. I was pleased, however, that we had sequential improvement in margins from 14.3% last quarter to 15.8% this quarter.

As is typically the case in our second quarter, margins benefited from a more favorable mix in closings, weighted toward higher margin markets than in the prior quarters. In addition, we closed a higher percentage of to be built homes this quarter, which generally carry higher margins in spec sales. We will continue to experience quarter-to-quarter variations in margins. In fact, if history is our guide, we'll see some pressure next quarter. However, I expect the full-year gross margins, excluding any adjustments, will be similar to what we reported last year.

Let me now turn to our G&A expenses. As a reminder beginning with the September quarter, we pulled the commissions out as its own line item in our financial statement. Excluding any commissions, total general and administrative expenses for the quarter decreased $9.7 million from the second quarter of fiscal 2011 and decreased from 29% of revenue to 14%. Comparing our G&A expenses to last year, this quarter we saw a $4.4 million decrease in compensation and benefits primarily related to a reduced headcount. The elimination of a $4 million accrual adjustment related to the South Edge joint venture that was recorded in the second quarter of fiscal 2011 and a $1.7 million reduction in legal and professional fees related to legacy legal issues. These decreases were partially offset by smaller swings in various cost items.

Operating G&A, which adjusts for items such as legal fees, severance, and stock compensation among others, totaled $22.3 million this quarter, down 9.7% from $24.7 million a year ago primarily due to the cost-cutting initiatives we undertook last spring. Importantly, our operating G&A totaled only 12% of revenues during the quarter, compared with 20% in the same period last year. In fact, our trailing 12-month operating G&A is now below 10% of revenues. Our current trajectory of operating G&A costs positions us well for significant fixed cost leverage in future quarters as we drive 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.

We had the benefit of owning an ample supply of finished lots in most of our markets. At the end of the second quarter, we had over 7,200 finished lots with homes under construction or ready to begin construction. Another 7,000 lots are under development and could be ready for use in the near future. Also at March 31, we had 644 lots held for sale, and approximately 6,600 lots in land held for future development. As we've said in previous quarters, because we have such an ample supply of lots and inventory, our level of additional land spending is largely discretionary in nature. The second quarter we spent $41.9 million, compared to the $61.1 million during the same period last year.

One of our strategies is to gradually grow our community count. With the benefit of recent sales momentum, we now expect that our land spend fiscal 2012 will be slightly exceeding our use of land. As a reminder, although there may be seasonal or other timing variations, our use of land during the year typically equates to approximately 20% to 25% of homebuilding revenues.

We are controlling our level of spec homes very carefully and ended the quarter down substantially from last year. At March 31, we had 579 unsold homes under construction or completed, down from 789 homes a year ago. Within this, we've reduced the number of finished unsold homes under construction to 210 homes from 380 in the prior quarter. We will continue to carry a number of specs in most of our communities, but we've made a conscious effort to reduce the overall number and age of our specs. Both because spec margins are typically lower end and because they tie up working capital.

To address these objectives, we've improved the mix of to be built sales versus spec sales in many of our markets and sold through a considerable number of older completed spec homes, which unlike fine wines do not gain value with age. This strategy has contributed to our near-term margin pressure; however, we will be in a position to more efficiently deploy our capital as we move forward. Our plentiful land supply and the recapitalization actions we took in 2009 and 2010 provide us with a flexible capital structure and a comfortable level of liquidity.

During the quarter, we reduced our annual interest expense by approximately $4 million, including approximately $2 million in savings for fiscal 2012 through the successful completion of our exchange offers. In addition, the early conversion of the TEUs will reduced our cash debt repayments to be made between now and August 2013 by $4.7 million.

We entered the quarter with $257 million in unrestricted cash and have no significant debt maturities until mid-2015. But we will continue to look for opportunities to reduce our interest expense and/or extend our maturities before then should they arise. With respect to our deferred tax assets, as we have previously discussed, the dollar value of deferred tax assets is significant and total $480.1 million at the end of March. While we are unlikely to be able to you use the entire DTA due to some IRS change of ownership limitations, our current expectation is that upon the resumption of a sustained profitability, we will be able to utilize approximately $410 million, or approximately $4 per share, to offset future taxes. With that, I will turn the call back over to Allan.

Thanks, Bob. As I said I'm very pleased with the direction of our results so far. While we are clearly benefiting from improvements in the overall housing market, our operational strategies also are making a positive difference. Obviously we have a long way to go in reaching our profitability objective, but we now have momentum in both orders and closings to help push us toward that goal in the quarters ahead.

Turning to our expectations for the full year, based on where we are today, all of the objectives we have communicated to you in the last quarters remain in place. We continue to expect to sell and close more homes in fiscal 2012 than we did last year; generate positive EBITDA for the first time in years; preserve and protect our liquidity. Our results so far this year have improved our confidence that we will achieve these goals and in fact internally, we are modestly increasing our expectations on all of these measures. With that, I'll turn the call over to the Operator to lead us into Q &A.

Thank you.

(Operator Instructions)

David Goldberg, UBS.

The first question I wanted to ask was on the slide where you talked about the conversion rates in the backlog. When you talked about the homes that are getting pushed, that were scheduled to get closed in the current quarter and got pushed to future quarters, I had gotten the impression that when we started to see that that had more to do with mortgage underwriting and complications around getting people the right documentation and that that was something that would -- the percentage of homes that were essentially getting pushed was going to come down. Am I wrong to think that? Is that kind of a normal historical average for you guys? Or would we expect to see that over time as the mortgage market at least becomes stabilized if not getting more complicated, is that something that would kind of stay where it is in terms of percentages?

It's a great question, David. I think that number will come down over time. I think in this quarter in particular, we changed our mortgage process radically during the quarter. We went from having a single sourced exclusive relationship to on February 1, opening it up. And while that formerly exclusive provider is still important to us, we have a much larger percentage of our business now with other lenders that are within our list that we provide to each community to borrowers.

And I think that has imposed on us a little bit more work to make sure that we're tracking the borrower through their various processes at those different lenders, and I think it's going to mean that we can't today tighten very much the predictive ability we've got in calling for when the closing can occur from a more mortgage process perspective. I do think we'll refine that. The level that it's at right now isn't alarming. It isn't dramatically up as you can see in percentage terms, but I think we can operationally drive that down, which will effectively drive up the conversion rate over time.

Got it. My follow-up question. We didn't talk about it much in the prepared remarks, but the buy to rent business, and what I'm trying to think about now is with the housing market improving and maybe prices are going to start to go up at some point, does your strategy relative to that business change? In other words, if you've invested in foreclosures, you fix them up, you rent them out now, prices start to go up, what kind of returns do you look for before you start maybe looking to monetize some of those of investments, maybe reinvest them with that capital versus holding it as a rental unit for a period of time? And so just trying to get an update on that business and how you're thinking about it in an improving housing market.

Okay. Well, it's a good question. And there are some constraints on what I can say, but let me try to fill in some basic facts. At March 31, we owned just under 200 homes, concentrated in Phoenix and Las Vegas. We have reached our self-imposed $20 million investment limit, with respect to that business.

I'm happy to say that the homes are 98% leased, and I'm happy to say that we have experienced great success in the initial renewals of the tenants that we had in place last year in the first purchased homes. So at an operational level, there's a lot of good things going on. Now, we have said in the past and I need to say again, we fully expect to scale this business with external capital. And as soon as I can say more than that, I promised to say a lot more than that, but today that's as far as I can go.

Thank you very much.

Alan Ratner, Zelman & Associates.

Nice work on the improvement in executing your strategy there. I had two quick housekeeping questions and then was hoping to just ask a follow-up to that afterwards. Bob, on the gross margin guidance, to be roughly on par with '11, 2011 levels, I just wanted to confirm that that includes the one-time benefits you guys have seen in the first half of this year, the warranty adjustments and the bond reimbursements this quarter?

Yes. That's right, Alan.

Okay. And then on the share count, that 101 million is that a basic number, or is that fully diluted?

Yes. That's a basic fully diluted number.

That's a fully diluted number?

I'm sorry. It's a fully diluted number.

Fully diluted. So what would the basic number be? Is that closer to 98%?

I don't have that right at my fingertips, Alan. I think we're going to have -- obviously our disclosures will be filed later today. So, it will be more information there.

Got it. And then Allan, I was just hoping for an update on the no community left behind strategy. And I know last quarter you had some comments that there was a pretty meaningful percentage of your total communities that were underperforming. I believe is the way you put it. And those were ones that either weren't hitting your absorption targets or your margin targets. So was just curious if you can give an update there and maybe kind of tell us how that has progressed through the quarter and whether you've seen a reduction in your total number of communities that are not meeting your thresholds?

Sure. Be happy to. I think the -- just for people listening, I think one of the things to realize when we talked about no community left behind, there really are kind of two components to that. One of the components is there are better performing and worse performing communities and we want the worse performing committees to get going and that's where we talk about the four P plans. Let's look at the product, let's look at the pricing, let's look at the promotion, and let's look at the new home counselor that we have for the people side and make sure we are making every possible refinement to the market to help those communities perform.

The second part of it that kind of falls under the umbrella is with respect to both sets of communities, those that were better performing and those that were worse performing. We want to drive sales per community up in all of them. So what goes on when we see the 2.2 sales per community per month jump up to 2.7 is we've got both sides of that improving. We do have a larger share of our communities and I would have said half of our communities I would have put in a category of not meeting threshold levels a year ago. I would put that ratio at quarter or so today.

So I feel like we have moved a meaningful number back into kind of the middle of the fairway in terms of the kinds of performance that we want. And at the same time, we have seen improvements in sales per community even in the better selling committees. It's not like we're putting a restrictor plate on the best selling communities. It's just that we didn't want to be solely reliant on milking, if you will, those very, very best selling communities and then sort of wake up in a year with those sold out and a bunch of underperforming committees left behind.

Thanks. That's really helpful. And if I can just sneak one more in there. Just on the land spending, I know you guys are guiding for community count to grow, but you've seen a decline now in your land spend, and at some point if the market keeps chugging the way it is, you probably see it become a little bit more difficult for you to grow community counts. So was just curious when you expect that might flat line and if you are at all concerned about the ability to continue growing as you look out over the next couple of years?

Well, I think we start with 14,000 lots that are active and under development that represent several years of supply that we already have. And as market conditions improved dramatically, we start to put in play a significant number of the 6600 lots that are in the land held for future development. So we are not starting with the [bare] covered. We did say, Bob in fact said, that we now think, and this is a slight change, we now think that our land spending this year will probably be just above the level of land that we use during the year. We've been in a harvest mode in land relative to what we've used with the reinvestment rates been below what we've used in I think the last six years.

This is going to be a year where we've said it's like it was targeted at the beginning of the year to be roughly flat. It could go either way based on sales momentum and market trends. And I think what you've heard us say today is that is going to tip a little bit into more of an investment mode. Not dramatic, but I can definitely see that. Taking a step back, we've got a decent capital structure.

Is it ideal? Clearly not. We've got a lot of liquidity. We have no near-term debt maturities. And so the simple answer is we don't feel overly constrained in terms of being able to grow the community count to reach our objectives.

Thanks a lot.

Susan Berliner, JPMorgan.

I guess I wanted to start with your markets. I was wondering if you could go through the various regions and just touch upon the markets that are I guess doing a lot better and the markets that are still lagging?

Sure. Well, we had kind of a role reversal this quarter, Sue. I mean for years, the East has been just an engine for us. Indy and Maryland and Virginia have been very, very strong. And what we saw this quarter was really the West led. And that was Phoenix. That was Las Vegas. That was Houston.

And the Southeast contributed quite a bit as well. And for us that was really Orlando and Raleigh. So I feel very good about the fact that some places that had not been contributors to growth kicked in in a big way. In terms of markets that didn't perform as well in terms of percentage growth, we actually were pretty pleased in Nashville, which is part of our East business, but we were pretty flat in Indy and Maryland and Virginia. We found the going a little bit tougher in those and so we didn't see the big pop. But again, it's off of a higher base, and so maybe that's to be expected.

The biggest factor, though, in the East segment for us, and I actually meant to mention it at some point this morning is we really took New Jersey off the rails and retooled that business really down to the studs, if you will. We ripped that apart. We changed management and we took a significant number of cans in the quarter as we really scrubbed that backlog and look at house to sell contingencies and other things and decided that we want a much more reliable and rigorous process. And so that impeded what would have otherwise been I think better growth in our East segment, because on a net sale basis, we really hurt ourselves in New Jersey with what we did to cleaning out the backlog. So that's a little commentary touching on most of our markets.

Great. And I was wondering if you could talk at all about what you have seen. Most of the other builders have talked about what they had seen in April. And also if you can touch on the direction of incentives.

Sure. So for the quarter we were up 29%, and I think within the quarter it's interesting. January was up a little bit. It wasn't super exciting. February was up a little bit more. It wasn't super exciting. February is always the a bit of a tricky month for us because we do run a very big promo every month in February and so that comp is intentionally kind of always a tough comp for us. But March was spectacular. March really was a very, very big month.

So you add that all together and you get to 29%. Again, it would have been a little bit better but for the retooling we did in New Jersey. In April, I would say I feel like we're in a range that is similar to what the quarter as a hole was, as opposed to necessarily being just a follow on or a repeat of March. I don't see that.

I don't have as of this morning yet our April final sales numbers. Obviously, that was Monday. So I will have those at the end of the day today, but I'm guessing as I look through and talk to our Team, our April will feel good, feel very good in fact, but it's not going to be like March.

Dan Oppenheim, Credit Suisse.

Was wondering if you could talk a little bit about -- you talked today some about adding communities and sales opportunities. What about the communities per market in the sense that still have a lot of area, especially in the West where you have relatively few open communities, which be a real drag in terms of overhead and such? How do you look at that in terms of the overall efforts to bring down the overhead and get the margins up?

First of all, I agree with you. I think the density of community count at the market level is critical and we've had to take a view as we've looked at the overheads. Is it a market where we are likely to see significant growth in community count? Or, is it one where we expect to make our incremental profitability off of a smaller base? And obviously, you'd take a very different approach to the overheads and the structure of the division based on that.

What I would tell you about community count growth is, it will not be proportional across our markets. And I will say it clearly. I expect that we will see disproportionate growth in Florida, Texas, California, and probably some continued growth in the mid-Atlantic markets for us. And for those folks in our Company who listen to this call, we're going to grow in all of our markets, but I definitely think you will see over the next couple of years a greater emphasis in those three primary Southern markets; California, Florida and Texas that I mentioned.

Thank you.

Michael Rehaut, JPMorgan.

First question, I was hoping to get a little better detail on pricing during the quarter. You mentioned that it was stabilizing or ticking up slightly across most markets. I was hoping to get a sense of is that just generally you're looking at maybe up 1% on average, or 1% or 2% on average company-wide, or is it maybe a little less than that? It's half flat and half up slightly. And if that's also inclusive of a decline in incentive levels as well?

Yes. That's a good question. Michael, one of the things I want to be real cautious about is we did find ourselves in a spring selling season and that give us some levers to pull. That allowed us to take prices up and remove incentives, particularly in those markets that I highlighted have really excellent sales results. I mean into that rising tide, you've got the ability to tweak the incentives and adjust price.

I think one of the core questions, and it's the caution that we continue to have about the magnitude of the recovery is as we get into this, our fiscal third and then into our fiscal fourth quarter, does that settle back a little bit, or are those levels sustainable? And I don't know the answer to that. So I think that's why we haven't tried to be too buoyant about pricing.

I can tell you that there are markets in the West where we took more than three price increases at the community level during the quarter. And it didn't seem to impede selling activity. If anything, it might have added to selling activity. But I think that's an exciting anecdote. It's truthful, but is it scalable? Is it durable? I don't know yet.

But if I look across the business, there is no market in which our incentives were higher at the end of the quarter than they were at the beginning of the quarter, which is a very positive sign. I couldn't have said that I don't think at any time in the last number of years. And in almost all of our markets, at least one and usually many more of our communities did get at least some level of price increase. It may have been $500. It may have been $1000. But actually those price increases are a little bit like tick ups in interest rates. They have the effect of stimulating buyer demand.

Great. Just a couple of additional quick questions. You mentioned New Jersey. The reorg hurt orders in the March quarter. Can you give us a sense of the degree of magnitude there?

Sure. We took enough cans that our can rate in New Jersey in the quarter was 50%. We've never had a can rate in New Jersey above about 20%. And it really was new management, really to take it apart down to the studs, and say, okay, how much risk do we want to have in our backlog relative to house to sales, how real are these buyers in terms of setting prices correctly on their homes.

And in terms of credit process, one of the advantages frankly of changing the way we did mortgages, instead of having an exclusive partner and you sit in a backlog meeting and they say, oh it's good, it's good, it's good, but then you put the screws to them and say, well when is a good? What day can it close? We frankly lost confidence in our ability to just sort of take to the bank that it's good.

So having opened up that mortgage process and having multiple lenders competing, I actually feel a lot better as I look at the business broadly and say, if I've got a borrower who is double apped, and we are tracking where they are with those, we are going to have a much better read on which ones actually are going to get to the finish line and get them out of backlog quickly if they're not going to get to the finish line. And I think that in terms of magnitude in New Jersey for whatever reason, and it's our fault, it's a local management issue.

We did not do that very well. And we stripped the thing down, changed management, and I have looked closely at our other markets, I don't feel like there's any parallel dynamic going on. It was a bad egg. Had to fix it.

Well Allan, I guess I appreciate that detail. I guess I was just -- when I said degree of magnitude I meant the impact on the overall order numbers. Was it 20 orders, 40 orders in terms of the cans?

25 to 50. That kind of order of magnitude.

Okay. And just lastly, community count, you mentioned progress you are making there. Can you give us a sense of where you expect year-over-year? Where you expect to be 4Q '12 over 4Q '11? And any thoughts on potential growth for fiscal '13?

Yes. I think the community count will be up a little bit. I think we're up 6% this quarter. I don't know that we're going to be up as much as 6% at end of the year honestly. One of the good news features of increasing sales per community is it's possible we'll chase ourselves down in the sense that we'll have more communities dropping off than we are able to add. I don't feel governed by trying to hit a community count number because that makes you a bad land buyer. We'll be up a little bit. I think we'll be up somewhat less than 6%.

And that's on a year-over-year?

And that's on a year-over-year basis.

All right. Great. Thanks, Allan.

Kristin McDuffy, Goldman Sachs.

You indicated that you wanted to further reduce interest costs. I know you have a little stub piece of your convertible left but outside of that, what actions could you guys take to reduce your interest costs further?

Kristin, I think if you remember, when you think about the flexibility we have in our cap structure, we've shown over the years we've been creative. We've been diligent in dealing with it. I think we'll continue to do that in the future. We have considerable ability and no constraints to repurchase debt. We have a significant secured debt capacity as well. We have seen significant appreciation in the high-yield markets and we don't have any immediate plans, but we are going to continue to watch the market and believe that it will be open to us when we see that there will be something opportunistic for us to do.

Do you -- would you guys consider refinancing some of your unsecured notes at possibly the second priority level and possibly looking at those [12s] as well?

The [12s] have a big premium associated with them in October at the call price and I've been pretty reluctant to go blow a hole in tangible net worth, so that is a challenge. It interesting on the one hand. It's challenging on the other. I think we've been reluctant to use all of the basket available to us in the second lien. It's like having bullets in the chamber that you don't have to fire.

And I think our view has been, Kristin, let's get our operations performing as well as we can. Let's show progress on orders and closings and margins and overhead and see how the market rates us as opposed to letting the balance sheet drive the Company and just taking what the market will give us a moment in time before we've had a chance to prove what we can do as operators.

Okay. Thanks. And just one last quick one. Could you give us a sense for time horizon on the no committee left behind initiative? At what point do you think you could get through those underperforming communities and start to see some return to normal senior gross margins?

Well, this may strike you as strange, but I don't intend for no community left behind to ever end. I want to constantly have the focus on the performance of every single community. One of the lazy habits that we can get into as a company, as an industry, is the best-performing stories or communities sort of carry the underperformers. I have a sales call every week with every Sales VP and every Division President and we talk about all those committees that are underperforming. That is not a call you want to get called out on. And I don't have any plans to change that.

So the hurdles bar for what performance means is going to change over time. So we have -- if before 1.5 was a threshold, we wanted to get to 2. We are now on a trailing 12-month basis over 2, going to move the hurdle. But there's going to be somebody at the back of the pack and we are going to focus on do we need to do to make that one perform better. So I think that is an ongoing initiative.

Now, the startup process of that, where, as I said last quarter, the first lever to go grab is price. That's the first lever. Because changing your promotion strategy, changing the product, and even changing out your sales counselors, those things will need to be done deliberately, thoughtfully, and there are timelines associated with them. So I know that the first thing we did to go find out how to make a community work was grab the price lever. I could tell you our teams are not reaching for that price lever as we're sort of six months, nine months into it.

We have changed out sales counselors, we've tweaked product and we've clearly changed the way we're promoting individual communities. We've seen much less division level marketing out of us and much, much more community level marketing out of us. That has taken time, but it has taken some of the pressure off of the pricing peak, so I feel like even though no community left behind is likely to be a permanent condition in our Company, the impact that it has on margins because of changes in price to stimulate activity are nearly played out.

Okay. Thank you.

Jay McCanless, Guggenheim.

First question, on shifting from your preferred mortgage lender to local lenders, is that part of the reason that the ex impairment gross margin was down year-over-year?

I don't think I'd make that linkage. No. We had a number of things. Bob talked about a bunch of them, but frankly, we had a much bigger base of closings in the quarter and the mix was not quite as favorable in terms of the ratio from our higher-margin markets. That's a little bit of it. And then the no community left behind that we've talked a lot about. And then Bob also mentioned selling [eight specs] was a little bit of it, but I don't think the mortgage thing really had much to do with it.

Okay. And then that leads into my second question with looks like the West is a higher percentage of the backlog going into 3Q than it was last year. Should we take any negative perceptions on gross margin away from that shift?

I think Bob give you a pretty good --

I think if you look -- if you go back to our script when we talked about the fact that margins will be variable. And I think if you look at historically, our margins in the third quarter have been lower than in the second quarter. So I think mix will play a part in it, but I think it will be variable and it's not something that when you look at conversion rates, that is as easily maybe to peg as you would like.

Okay. Thank you.

I think the takeaway is we're going to get --

The takeaway is at the end of the year, though, we're going to be comparable to last year.

In terms of I think it was what, 10.7% ex impairment for fiscal '11?

If you look at the unlevered margin, prior to interest and impairments and abandonments, the margin will be comparable at the end of the full year to last year's standing number. I think that that slide is number 12.

Okay. Great. Thank you.

Adam Rudiger, Wells Fargo.

I wanted to ask two questions on no community left behind. You kind of answered some of them already, but the first was on the move from half of the communities underperforming to a quarter, what has been the most common, I think you might have just talked about price, but what's been the most common success story or theme maybe exclude New Jersey too that has enabled you to make, take the half to a quarter? And then conversely on the supporting, the really strong communities, how much are you thinking about, if at all, really slowing the sales pace there and trying to focus more on price appreciation and grow the margins there?

So, I'll take the second part first. In terms of growing the margins, as I said there's not a restrictor plate on those best selling communities. But that's clearly where we're feeling a little bit more confident and where you will see us taking price increases and/or removing incentives. As I mentioned in one of our Western markets, we had more than three price increases during the quarter, in communities that were selling at a very rapid pace. And so we're not at all embarrassed to do that and will do that.

That may mean that the improvement trajectory of those best selling communities on a sales per community per month basis will flatten out a little bit. That's okay. You're right. We do want to try to profit optimize.

In terms of the first part of your question, moving underperforming communities into performing status, it really is sometimes we've had the wrong product. There is one of our markets we're competing on a two-story context with no master on the main. All of our competitors have a master on main plan. Damn it, why don't we have one? So you get in the market and all of a sudden we are competing more effectively.

We've had other cases and in fact probably the most common is we stopped holding ourselves accountable for traffic from our marketing efforts at the division level, and started looking at traffic at the individual community level. That's -- I mentioned to Kristin, that's a big deal when you stop doing display advertising online or otherwise at the division level and you start holding people accountable for how much traffic did we get to that neighborhood in a period of time. I think the biggest success we've had is micro- targeting the drive traffic to those underperforming communities.

So there's a direct correlation. If we get more people over the threshold into the community, we're going to generate more sales. And so if your focus is sales per community, your marketing focus has to be traffic per community.

Yes. Thank you.

Joel Locker, FBN Securities.

Just talking about your balance sheet, just capitalization. Have you reached out to some of your debt holders and looked for maybe debt for equity exchanges? Just to lower interest rates and obviously get more towards probability.

Joel, I don't know that reaching out is maybe a fair statement. We've -- we look at all different types of transactions throughout every month and every quarter. And when something is interesting down the road, we certainly may think of something.

Joel, I will just tag on to that. I think if you look at the relationship between appreciation and our fixed income complex and depreciation in the equity, you have to look at both sides of it for something like that to make sense. And I'm pleased that the market has taken a view as to our viability that is reflected pretty clearly in our cap structure on the debt side. It's not as clear that our operational acumen has been recognized and we haven't earned it yet on the equity side. We've got to keep working at that. And that's why I say I think before you see really dramatic things happen on the balance sheet, we want a chance to prove that we can improve the operations, because I think that helps with the equity side and that frankly makes any type of transaction, the one you mentioned or others more interesting.

Right. And just to follow up on gross margins ex one-time items. It looked like they are 9.2% or so. It just seemed like some of the bottom performing communities would have to be I guess in line for some kind of impairment, just basing -- if you're doing mid-singles or I know that's before and/or after interest amortized, but just want to get your take on why we're not seeing at least some more impairments with gross margins still hanging around 9% I guess on a -- without any one-time items?

I think, Joel, we've got pretty fulsome disclosure on what our impairment process is in our 10-K and our 10-Qs. And it is a community level analysis. We have a watch list that we disclosed how many communities are on that watch list, and at the margin, in predicted margin that those characteristics where those communities will appear on that watch list, we have been very, very diligent over the years in how we run that process. We retooled the entire process during the restatement, and I think that that's not something that we're really concerned about from a long-term perspective. Our communities continue to have the rigor every quarter. And as margins continue to improve as we've seen, and in the no community left behind thing, continues to improve as we sell more communities, I think that's going to become less and less of an issue.

Right. And I just --

And the other thing, Jay -- or Joel, excuse me, when you analyze community issues, there is a permanence to a pricing situation or a margin situation in a temporary condition. You have to analyze which one is permanent and which one is temporary. And I think in many cases, we've seen temporary issues with older specs. We've reduced them significantly over the last several quarters. Obviously with those, you'll have a little bit lower margins. I think on a go forward basis as we control our specs, you will see improvements.

Right. And just the last question on net community count growth sequentially, what -- you said it was up 10 year-over-year, but what was it --

6%.

Just up from the last -- the third quarter's -- I mean up from the first quarter it was up 6%?

Year-over-year it was up 6%.

Right, but I'm saying from the December quarter.

No. It was up a couple of communities.

A couple of communities.

A couple communities. All right. Thanks a lot, guys.

Alex Barron, Housing Research Center.

In terms of your interest incurred and interest expense, either through cost of goods sold or below the operating line, could we expect that number for this year to be those two things to be roughly the same and also flowing into next year?

Well, if you remember, Alex, we continued or completed the successful exchange of the mandatory convertibles of a significant portion and the TEUs, so from an annualized perspective we've taken about $4 million out of that number. So if you compare year-to-year, I think that be a way to look at it.

Right. But I'm saying is the -- I'm guessing the absolute number is going to be closer to $125 million, $126 million interest incurred, so is that roughly the ballpark of what we should expect for interest that flows through the cost of goods sold plus interest below the operating line?

Yes. I think the total interest incurred will roughly equal the interest expense, with the addition of the amortization of capitalized costs and OID from the 2017s.

Okay. Thanks. And my second question has to do with I guess what you're seeing on the land front I guess given sort of the increase in sales activity. We heard at least in the Phoenix market that land sellers are starting to raise their asking prices. Are you starting to see something like that in other markets? And what -- how are you guys approaching your land acquisition from that perspective?

Clearly the land sellers pay attention to all these earnings conference calls, and they can see the sticks in the air. So they are not immune to trying to raise prices. That's clearly the case. I think a couple things. In all of these markets, there are lots of different kinds of land available, so finished lots, if somebody prices themselves out of the market, we'll take a look at something that needs still some development activity. It's not as if you are constrained unless you don't have some development capability, and we do in all of our markets. So I think that helps mitigate that a bit.

We're continuing to be very patient, focus on our MIRR hurdles that we require for new deals. I'm confident we can find them. But again, sort of and I know I'm a broken record, I want to come back to operational improvements is we're saying improvement in sales prices and increases in sales per community, that gives us a capacity to be more competitive in buying land. I mean it's awfully tough to buy land if you can't operate your communities at a market or better level. So I think part of the answer to being able to buy land is make sure you are a good operator.

Okay. Thanks.

Okay. Well I think that was the last question. I want to thank everyone for participating in this quarter's call. We'll talk to you in a couple of months. Thanks.