Beazer Homes USA Inc (BZH) 2014 Q1 法說會逐字稿

Good morning and welcome to the Beazer Homes earnings conference call for the quarter ended December 31, 2013. Today's call is being recorded and a replay will be available on the Company's website later today. In addition Power Point slides intended to accompany this call are available on the website -- on the Investor Relations section of the Company's website at www.beazer.com. At this point I will turn the call over to Carey Phelps, director of Investor Relations.

Thank you, Pat. Good morning and welcome to the Beazer Homes conference call discussing our results for the first quarter of fiscal 2014. Before we begin, you should be aware that during this call we will be making forward-looking statements. Such statements involve known and unknown risks, uncertainties, and other factors which are described in our SEC filings including our Form 10-K which may cause actual results to differ materially.

Any forward-looking statements speak 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 statement 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 or 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.

Thank you, Carey and thank you for joining us. We are sorry about delaying the call by a day but weather and road conditions here in Atlanta required us to do so. And after the last three days, we should probably consider moving our corporate headquarters to Detroit where they seem to be able to handle an inch of snow.

As most of you know, in November we introduced the 2B-10 plan, a new multi-year overarching objective to reach at least $2 billion in revenue with 10% EBITDA margins. Our team has quickly embraced this new plan and produced results for our fiscal first quarter that keep us on track to attain these milestones within the next two to three years. Specifically during the quarter we increased adjusted EBITDA to $21.6 million from $7.7 million last year. This is especially notable in light of the fact that coincidentally we closed exactly the same number of homes this quarter as we did last year. We sold 895 homes during the quarter or 4% less than last year with 9% fewer active communities. Contrary to most of our peers we were able to improve sales per community slightly on a year-over-year basis. We grew our ASPs by $44,000 to $279,000.

Expanded gross margins by 310 basis points to 21.2%, decreased our cancellation rate by 460 basis points, and improved SG&A as a percentage of revenue from nearly 50-- 15% last year to 13.7% this year. Finally, we ended the quarter with $383 million in unrestricted cash and spent $124 million on land and land development compared to only $90 million last year. Overall we're pleased with these results particularly because they were accomplished in a selling environment that lacked consistency and sustained buyer enthusiasm. As in past years, we were prepared for the adverse seasonality typical of the December quarter as well as the more aggressive selling tactics of many of our peers with fiscal years that end during this particular quarter.

But beyond those factors we successfully weathered the government shutdown in October, and to use a flying analogy, we powered through a few air pockets characterized by very low traffic and buyer engagement in certain weeks in particular markets. On an overall basis, buyer demand in the first quarter could be called tepid, or lukewarm, or half hearted. I think you get the idea. Before giving you our take on January and the balance of 2014, I will turn the call over to Bob to provide a bit more detail on the quarter and then come back on to discuss our expectations for the remainder of the year. Bob?

Thanks, Allan. First I would like to talk about our 2B-10 plan and the progress we made this quarter. As a reminder, there are a number of different combinations that can lead us to $2 billion in revenue with a 10% EBITDA margin. In November we provided some specific targets that could get us there. During the first quarter, we recorded improvements for each of the metrics included in our 2B-10 targets. Total revenues for the last 12 months are in excess of $1.3 billion, up 25% versus a year ago. Let's look at each of the components that drove this increase. Sales per community per month continued to improve this quarter to 2.9 in a trailing 12 month basis compared with 2.5 a year ago. Looking at the first quarter, the improvement was more modest rising from 2.1 to 2.2. ASPs also continued to rise during the quarter to $279,300 from $235,500 a year ago up 19%.

For the 12 months ended December 31, our ASP $262,000, up $33,000 or 14% from a year ago. Similarly, our ASP in backlog at the end of the quarter was $286,000 versus $263,000 last year. We opened 14 new communities and closed down ten during the quarter. This led to our first sequential increase in community count in a long time although we were down 9% compared with a year ago. During the first quarter we spent $124 million in land and land development, up 37% and for the full year we expect to spend in excess of $500 million on land and land development exclusive of any potential land sales. With the increase in land spending our lock counts and inventory totals have been on the rise.

At the end of December we had nearly $1.4 billion of total inventory, up over $200 million from last year and we had 29,000 owned and controlled lots at the end of our first fiscal quarter, up 15% from last year. In addition to our 138 active communities at the end of December, we also had 54 communities under development and 27 communities whose purchases had been approved but had not yet closed. Subsequent to the end of the quarter, we approved the purchase of eight more communities and are now in active negotiations on many others, all in support of our drive to grow our active community count. Our projected 2014 community counts have not changed since November when we outlined our fiscal year expectations. We still anticipate an average of approximately 150 active communities for the year and expect to end September around 160.

Over the course of the year, we expect to see sequential active community count growth of approximately 5% for each of the next three quarters give or take a couple of percentage points. You can see on the slide that our year-over-year average active community counts are expected to be approximately down 5% for the second quarter, up 5% for the third quarter and up approximately 20% for the fourth quarter. Because we aren't expecting big changes in absorption rates the rest of the year compared to last year, the change in community counts is a pretty good starting place for estimates of future orders. On the cost side, we need to continue to improve gross margins and leverage our overheads.

Specifically, as part of our 2B-10 plan we are targeting at least 22% in home building gross margins and SG&A as a percentage of revenue of 12% or less. Taken together, these improvements should create a 10% EBITDA margin. Gross margin on a trailing 12-month basis was 20.6%. Up 320 basis points from last year. And our gross profit dollars increased to $53,200 per home closed during the last 12 months from $39,000 last year. Representing a 36% year-over-year improvement. During the quarter, gross margins expanded nicely. Up 310 basis points year-over-year to 21.2% with improvements in all three of our operating segments. And our gross profit dollars per closing increased to $57,600 for the quarter, up $15,400, or 37% from last year.

In addition to achieving improved gross margins, keeping our costs in line is a key component of our plan to reach our 2B-10 objectives. On a trailing 12-month basis, SG&A totaled 13.3% of revenue, an improvement of 120 basis points versus a year-ago and for the first quarter our SG&A improved 130 basis points to 13.7% of revenue. As we ramp our community count we will incur operating costs for our new communities before generating revenues. As a result, we expect our Q2 SG&A ratio to be above Q1 and likely the highest of the year. However, we continue to expect that the full year SG&A as a percentage of revenue will be between 12.5% and 13%. Because we have a lower ASP than our peers we also look at SG&A per closing. By our estimates, we are among the lowest cost operators in the industry.

As a result of the progress we recorded in our first quarter, adjusted EBITDA improved $14 million over last year and reached $100 million on a trailing 12 month basis. Turning to our balance sheet, with no significant debt maturities until 2016, $383 million in unrestricted cash and an undrawn $150 million revolver, we have sufficient liquidity to meet our 2B-10 objectives. Looking ahead, our unsecured notes due in 2018 and 2019 become callable later this year and we will consider refinancing them if and when it makes sense. Finally, we currently estimate that we will be able to use approximately $443 million or $14 per share in deferred tax assets to offset future tax liabilities. While the exact timing is not known, we currently expect to start bringing a portion of the tax asset back on to our balance sheet sometime during fiscal 2015. With that, let me turn the call back over to Allan to review our expectations for the remainder of fiscal 2014.

Thanks, Bob. Our operational expectations for our 2B-10 drivers for full year fiscal 2014 have not changed. Specifically, we expect sales per community per month of 3 to 3.1, an average active community count of approximately 150 for the year, with the year-end active community count around 160, an average sales price of $275,000 to $285,000, home building gross margins between 21% and 22%, which should allow us to achieve approximately $60,000 of gross profit per closing. And finally, SG&A between 12.5% and 13% of revenues. Achieving these results will allow us to report our first full year of profitability since 2006. And in fact, our expectations for EBITDA for the year have actually gone up. We now expect year-over-year EBITDA growth of $40 million, $10 million more than we suggested last quarter.

In order to achieve these results, we need to continue to execute. And we do need a decent spring selling season. While there are a number of headwinds here is why I'm cautiously but decidedly optimistic. First, while housing isn't the screaming bargain that it was a year ago, it is still highly affordable in relation to household incomes and to alternative rental payments. We add the monthly payment benefits of the energy efficiency features of newly built homes, this is still a terrific time to be a new home buyer and I think buyers recognize that the market isn't likely to revert to last year's affordability any time soon. Second, household formations are occurring and they drive new construction. After half a decade of waiting, young adults are getting on with their lives and moving out of their parents' basement. This leads to rising rents and increased turnover in rental properties which in turn stimulates demand for both new and used homes.

Third, let's face it, mortgages are a pain to get if the buyer has any blemishes or complications. But, the enormous mortgage lending industry is starved for business now that the refi boom is over, and I believe these lenders' competitive instincts and desire for origination income will drive both process and underwriting improvements. Admittedly those are all macro trends. On a Company-specific basis I'm excited about our coming-soon communities. We going to open more than 50 new communities in the next six months. I think they will be very well received allowing us to create momentum of our own, not just benefit from industry trends.

Finally, a few words about January. The weather in many of our markets has been awful this month. It has adversely impacted land development schedules, traffic to certain communities, sales, and construction starts. But despite these issues on an overall basis we are absolutely seeing more traffic and enthusiasm than we have seen in many, many months. While I don't think demand is as pent up as it was a year ago we have strung together a number of positive sales weeks with absorption rates about where they were last January. Based on traffic levels and buyer engagement our team senses that February has the potential to be quite strong.

There is always risk and uncertainty lurking in our business but we certainly prefer the current environment and our positioning to just about every period of time in the last seven years. I look forward to bringing you the early spring selling results on our next call in May. Thanks for joining us today. At this time I will turn the call over to the operator to take us into Q&A.

Thank you. (Operator Instructions). And our first question comes from David Goldberg with UBS. Your line is open.

Thanks, good morning. Great quarter and good to hear everybody is safe from the storm.

Thanks, David.

My first question, I think Allan, you guys did a great job last quarter getting ahead and maybe some of the peers, and maybe revamping your promotions, maybe not increasing promotional activity but revamping them and drawing some interest in what was a tough environment last quarter and even into this quarter into December, and maybe you could talk a little bit about as you are looking out to the selling season how you are trying to get a jump on the competition especially if demand it good but not great or great but not fantastic. How is Beazer positioning themselves from a sales perspective as we head into February?

I think -- and I appreciate the compliment. We did talk in November about what we did in the September quarter and kept doing it in the first quarter which was, we call them competitive market analysis or CMA's, it is doing those on a weekly basis at the community level to really figure out where we position, where the opportunities between included features and incentives or the mix of incentives. You can spend a dollar a lot of different ways and the question is really to figure out how to spend less than a dollar and put it in the right place where it has maximum effect.

I try to look at trends but I get really nervous, cautious about trying to say that there is a silver bullet, that there is a corporate strategy that is pervasive because it is a street fight. It's a street fight in every community every week, and we are trying to teach the team to react to and be aggressive in the context of their market and do what is necessary to hit both the velocity numbers and the margin targets that they have got. It's a thought process more than it is a silver bullet. I would tell you that included features, and I think all builders would tell you this, included features have crept up over the last couple of years so we are not seeing quite as much in design center incentives as we might have seen in prior periods because the feature levels are pretty good. So we are really focused on some internal initiatives.

We talked a lot in this forum about mortgage choice. We haven't talked as much about something we call plan choice, which is the ability for consumers to make structural changes to the floor plan inside the envelope of the home at no cost. It is a disruptive strategy because most of our peers charge an arm and a leg for structural options. If we are adding square footages, if we're adding a third car garage or a covered lanai, we charge for that. But if we're changing the way the living room lives or the way the great room and the kitchen are laid out, the shape and size of the counter or of the island in the kitchen, I mean those kinds of things really are impactful in causing people to feel like they found the right home for them because it lives the right way. It is a hard thing to do, it's a hard thing to design, but it actually, from an implementation standpoint once you get over the hump of understanding how to do it, it reduces the total number of options which I think improves both our build costs and our cycle times.

Is a much longer and more detailed answer than you probably cared to have and I didn't really tell you something specific about incentives but that is what we are doing to make sure that we are competing strong in this quarter.

Actually, it is very interesting. And not that we hear from a lot of builders. Like you said a lot of builders charge for structural options. Very interesting. My second quick follow-up question was on the cancellation rate. Interesting to see it decline year-over-year and decline also sequentially. Is that the mortgage choice program kicking into place that you feel like you are better able to keep buyers that pre-qualified in the process? Is that just the benefit from home price appreciation, a more stable economy? What do you think you would attribute that to?

I think psychology is better. I think home prices rising clearly helps make your backlog stick. I'm really proud of the mortgage choice program, too, I think it makes a difference. I think lenders get less persnickety during the underwriting, approval and documentation stage when they know our sales team is trained at the first sign of trouble -- frankly they're trained at the time of sale and thereafter to make sure that the customer knows they have got choices. That check and balance is really crucial. No one feels entitled to our customers' mortgage business. And I think entitlement is at the root of evil in terms of customer service. I think it plays a role. But I would be delusional if I didn't admit that the improvement in home prices wasn't also a pretty important factor.

Do you think there is further room to grow on the cancellation rate or are we at a normal comfortable level?

It is a funny thing and I probably have said this on earnings calls before. The can rate that we have as a Company that is reported is obviously the sum of all of our divisions. And we have markets that have high single digit can rates and have markets that are closer to 30. I think that on a weighted average basis we are in a place where I'm pretty comfortable. I heard others say and I agree with it you need to have a level of cancellation rate because you are not pushing hard enough on sales, I believe, if you are not making sales that may can. Now, is 20% the magic number? I don't know.

But I think something in the low 20s feels good. There are certain markets where buyers have legal rights of recission for seven days where we don't record the sale until after that seven days. Those markets structurally have lower can rates. I also think that the can rates are a function of the buyer profile and of home prices. Our home prices are moving up a little bit but our buyer profile isn't really changing. I don't think it is really that, that is driving the can rates. So again, arguably a long-winded answer but I feel like we are in a zone plus or minus where we are pretty comfortable. I think we are being appropriately aggressive. If it ticked up or down a point or two one way or the other I have to tell you I wouldn't be looking for ghosts or shadows. I think we are in that zone now.

Thank you for the color.

Sure.

Thank you. Dan Oppenheim, with Credit Suisse.

This is Patrick Murray for Dan. Thanks for taking my question. Was looking to get some commentary on the closeouts you are expecting in coming quarters versus the new openings with respect to geography or ASPs.

I think ASPs on the new communities, and I don't have that stat right at my finger tips but our anticipated ASPs from the new communities are slightly higher than for the closeout communities. Part of that is geography. We will be opening quite a few communities in our east segment, Maryland in particular. And we have just opened in this quarter, a couple in California which have higher ASPs. Our Houston and Dallas markets also are looking at some significant openings, and Orlando. In those markets, while those are not high relative to our Company average within the respective markets the communities that we are opening are slightly higher than the ASP of the communities that are closing out in those markets. I think there is a mix between markets a little bit. We are a little bit more coastal, I think, in 90 days than we are today and that affects price. And I think within markets you will see a little movement as well.

Okay. Thank you. And then just another question. Could you talk about how the no community left behind mindset works with or against any of the 2B-10 initiatives?

Sure. It is a good question and at some point I will be at risk of tripping myself up on my own acronyms and buzzwords. No community left behind is really the core philosophy of the Company. You can't have underperforming communities, it is not okay. You have to fix it. And sure, price is a lever but people and promotion and the four P's that I have talked about before. You have to have accountability to fix those things. I think what we have seen in the last two years is gross margins going up and velocities going up. Not just because the best stores, the best communities do better, but because we really made it cultural to not let stores get left behind. So, having gone from a third or more of our communities that were woeful so something more like 10% that are underperforming where we would like them to be, I don't think it is coincidence that we have more confidence in having 2B-10 metrics at an aggregate level because we have a much higher proportion of the communities performing. So I think one leads to the other. I don't think they are in any way in conflict.

Okay, thank you.

Thank you. Ivy Zelman with Zelman and associates.

Thank you. Good afternoon everyone, and again, glad you didn't have to pull out your ice skates and you are back in the office.

Allan, when you talk about the market, you indicate a lot of new openings in the 50 communities you plan on bringing online. Are those communities from your perspective and I know that you have been focused on buying the right assets, and not just buying assets to make sure you have land. Do you feel that the gross margins on the new communities are going to be at the current levels that you're at today, or are they likely higher? And just talk about pricing with respect to your full year outlook as you think about your ability on an apples to apples basis, do you think you will have pricing power or do you think the market will be more flattish given the strength we had this year?

I will take the second part first in terms of pricing. When we did our 2B-10 targeting and when we do our business planning, we try really hard to not let price appreciation thinking creep into the numbers. We are forecasting every community on a monthly and quarterly basis and we roll that up and that is really the basis of our annual plan on our 2B-10. There is not an overlay or underlay of pricing assumption. If, and I think I answered this question this way before, if you ask me what I think is going to happen, I do think that when we get done if we could have an absolutely apples to apples comparison which isn't possible because the mix is constantly changing, I think we could absolutely go apples to apples, I think we'd see very low price depreciation this year. That's my guidance. I think it will be a little better in a couple of markets, I think it'll be flat in a couple of markets.

But if you told me it was 3% or 5% or something on that order, I'm guessing that is what is going to happen. That should be incrementally helpful for us if it does occur because we are not counting on it. On the question of the new communities there is 50 communities speak -- I have to speak in generalities. I'm very confident that those communities are contributing to our outlook that margins this fiscal year are going to be higher than last fiscal year. They are helping. They are in the range of current margins. They are not going to represent a headwind on our margin trajectory.

Well, that's very helpful Allan. If we can now move into thinking about your I guess consumer who you are focused on, you're still focused on entry level although you are also benefiting from moving up the price point and there is a lot of concern about the entry level market, and getting your perception on whether or not you think that that sentiment being so negative towards the entry level buyer not participating in the upturn is legitimate or do you think there is more entry level buyers coming to the market now that we are seeing stabilization in rates and maybe the credit box is easing slightly? What is your big picture view as an entry level builder?

I think it has been surprising that that group of buyers has not led the recovery like they typically do. We know the reasons why. I think they are there. I think that they will reassert themselves albeit at a lower level than in prior cycles. We are not abandoning that first time buyer market at all. It is hard to serve them because land prices have gotten to places in certain markets where it is hard to get to that price and that first-time buyer might have to buy a used home because we can't get lots on the ground at a level that allow us to serve that buyer. That is really more the dynamic. I think as a group, though smaller in contribution or distribution of the total buyer mix so far this cycle I think they are reremerging, Ivy, and I think we will see benefit from that this year into next year.

Part of it is psychology. Part of it is the credit box that you talked about. I think, and you have done work and others have on the household formations, I mean we suppressed household formations and primarily the household formations that were suppressed were those of younger adults who though they may transit through rentership before home ownership I think they will be disproportionately weighted, these newer households, and push factor of household formation is going to be at lower price points, not higher price points. There aren't a lot of millionaires living in their mother's basements.

You mentioned about rents moving up and people looking at the turnover is going to be increasing and move out to buy and all those factors which we concur with. How about on the credit box? Are you seeing some of the improvements that I spoke about or still exceptionally tight in your opinion, or has there been some benefit from refis going away as you mentioned in your opening comments?

I think it is still historically tight. Less historically tight I believe than it was 90 or 120 days ago. The difference is very hard to measure. You would need a microscope. I can tell you that the insight that I get about this is really when we talk to our divisions about at the community level who are the lenders that we are allowing to have the opportunity to interact with our buyers. And that list is a dynamic list at the community level. If there is somebody who has essentially a zero percent capture rate they are demonstrating they are not very competitive either on price or service or rate so we take them off the list and put somebody else there. We have been surprised and happily so at the waiting list if you will of lenders who want to be on the preferred list. It's a really unique proposition with us because they don't have to pay us anything. I don't want their money. I want them to give that money to the buyer.

So it's a unique sales pitch for us on a B to B basis with the lenders because we are not trying to stick our hand in their pocket. We said hey, you got extra change jangling around in there, give it to our buyer, don't give it to me. That is very appealing to those lenders. And then you have the discussion with about hey, that is the good news. The rest of the story is you got to compete because somebody else is going to see that same loan app and if they make a better first impression you are not going to write that business. What I can tell you about the credit box is I think what we are experiencing is a microcosm of a broader trend, this desire for loan volume growth is driving more lenders to our doors to say we would like to be on the list and I think as we talked a little bit on the other question the can rate is demonstrating that they are working hard to keep those buyers and get them closed.

Great. Thank you very much.

Sure.

Thank you. Michael Rehaut with JPMC.

Hi. Jack Slade (Inaudible) for Mike. How are you guys?

Good.

Regarding the absorption in your fourth quarter you guys it a pretty substantial year-over-year increase in the absorption pace, it was up about 30%. And we saw a little bit of deceleration in the first quarter. Wondering how that stacked up relative to your expectations? I know you guys in fiscal fourth quarter did a lot of things with repackaging incentives. Wondering if that 2.1, 2.2 rate this quarter really stacked up to your expectations. I know you guys kept the full year outlook the same but do you think that will be more back half weighted now in terms of getting to that goal?

It was always going to be back half weighted, right? Because I expect--

More so now than --

I'm sorry?

No, sorry. Go ahead.

It was always back half weighted or back three quarters weighted. Regardless of the level of improvement in our fiscal first quarter, Q2, Q3 in particular and Q4 with new community openings over that period of time were always going to be the bigger factor in being able to sustain well, to achieve and then sustain 2.9 to 3.0 and then to 3.1 sales per month per community. It was never really going to be positively influenced that average by Q1. Back to the nub of your question, yes, I was a little disappointed. We would like to have sold more homes in the first quarter. Being down 9% in community count and we were really clear about that, was always going to be a significant headwind. There was no way we or rationally anybody would have assumed we would have the same kinds of absorption rates we had in Q3 or Q4. You talk about the year-over-year change. I think that we didn't have a huge year-over-year change for some of the reasons I talked about but I'm pretty damn proud of the fact that we did have a positive year-over-year change.

And I think on an absolute level our absorptions were top tier. I don't know if they were number one because I don't think all of the numbers are in yet. So far, I haven't seen anybody else actually increase absorptions. I would certainly love to have sold another 50 homes. Some number like that would have been terrific. It wasn't there. As one of our compatriots said, there was not a lot of elasticity in demand so we didn't feel any desire to go chase it with incentives. We took what was there and I think we did a little better than getting our share.

Okay, great. Thank you. And the second question he regarding gross margin. You guys were up about 500 basis points on the west. Just wondering if you could talk a little bit about what the drivers of that was as well as in the east you guys were up about 60 basis points and that continues to be below some of the southeast and the west. Just wondering if you are seeing any changes in that region or expecting any significant improvement in that region going forward?

I mean as we look at the full year, I think the west will be under some pressure because there are some legacy communities in that mix in the west that got the benefit of all of the price appreciation that at the very highest margins. A couple of communities in the high 20s and low 30s. Those will be impossible to replace. We won't be able to buy new deals there. So while I think the west has historically had higher margins than most other segments for us and for other builders, I think we will be hard pressed to drive that segment's margins much higher over the course of the year. I will tell you that I'm disappointed still with our margins in the east, but part of our reinvestment strategy has been to be in better locations with better product so I think that the prospects for margin improvement in our Company as I look out 12 and 24 months, I think the improvements in the east will be a big part of the answer.

Great. Thank you. And then just last one, if could, in terms of the orders throughout the quarter if you have those numbers available?

Orders throughout the quarter? You mean October, November, December?

Yes.

Yeah, it was odd. I talked a little bit about air pockets. We had individual divisions where in one week it is like where did everybody go and then the next week was back to normal and no one asked, I expected that they might. That happened to us in Phoenix , it happened to us in Raleigh. Just odd in those two instances. As I look at it overall, though, it was pretty consistent. Our gross and net orders in October, November and December were within spitting distance of each other month-to-month to month. I didn't really see a dramatic change. December was the lowest this year.

A year ago, December was a little bit stronger. We had just a phenomenal last week of the year or last week of the calendar year in 2013 that we didn't replicate. It was an anomaly last year and probably I should have been smarter and realized that that was not likely to recur. Because had it, I think, , we would have been a little better positioned on the orders. But as I looked at it month to month to month it was pretty consistent in number but it didn't feel consistent underneath at the market level.

Okay. Thanks so much.

Thank you. Jay McCanless with Sterne Agee. Your line is open.

Good morning, everyone. First question I had, can you give us some commentary from what you are hearing from the field and your mortgage partners about the lowered FHA limits and what affect it is having on business?

Yes. It is not a good thing in markets like Las Vegas and Bakersfield. It is not helpful. And it is affecting us and others. Interestingly, our FHA share, my estimate based on what we are hearing from the lenders, and this is different from having a mortgage company, so comes with a little different health warning, but our-- a year ago, I would have told you that we were well above a third of our business with FHA. I think your backlog right now is between 20% and 25% FHA. We've seen a pretty significant mix shift towards conventional. Part of that I'm sure is driven by the loan limits. Part of that is driven by the fact that FHA -- and this was an intentional strategy, it was a policy matter, jacking up guarantee and fees and expense premium. They have been trying to shrink that pool and they did. I think they have thrown another log on the fire by lowering the loan limits and so far buyers have moved to the conventional market as a consequence.

Okay. And then wanted to ask next about the other expense line. That ticked up to a negative $15.8 million in the first quarter versus negative $12.3 million in the fourth quarter. Is there any one-time items in that number or should we expect this as a quarterly run rate going forward?

Bob was feeling like the may tag repairman here. So Bob, that seems like it is right up your alley.

Yes, Jay, if you recall the end of September we issued the 2021, $200 million notes, so our interest incurred for 2014 will be higher than 2013. So basically the disallowed interest in the first quarter went up, call it $3 million, which is really the basis of the difference. I think on a run rate standpoint, it will trend down, that difference will trend down as we go forward depending upon how we layer in additional inventory as we buy the land in excess of what we run through cost of sales.

And then just the other question that I had, just any preview for what you all are going to be doing for the annual February sales event?

Well, I wouldn't want to give our competitors that much of a headstart. I will simply tell you that we feel good about the packaging and promotion that we will be doing both in its ability to drive traffic and sales and the lack of adverse impact on margins.

Okay. Thanks.

Thank you. Adam Rudiger with Wells Fargo Securities.

Hi, thank you. I wanted to go back to something Bob said in his prepared remarks when he talked about community counts. You mentioned, I think, that you were not expecting a big change in absorptions for 2014. I was wondering if that was based upon your view of the market or if that was more something -- a pace that you were planning on managing to?

I think my memory our fiscal year 2013 sales per month per community was 2.9 and we guided to 3.0 to 3.1. We were hoping what happened and, of course, plans and hopes are different from reality, but what we were trying to manage to was a little pickup in Q1 which we had, and it was maybe a little littler than we would have liked. And then it was going be all right with us if Q2 or Q3 ran a little less hot. I said last year, 3.4 felt pretty warm in the second quarter. And so if we had had it perfectly to control we would have seen a weighted average increase in that sales per month per community up from 2.9 into the very low 3's, shifting just a little bit into Q1 and it was okay with us, is okay with us if it was off a point, a decimal point or two or three in Q2 and Q3. That mix would lead to the outcome that we were trying to get to.

So, that was our thinking at the time. I think with Q1 being on the lower end still up year-over-year, we are not going to try and micro manage the rate. I want to make sure that we are not winning false prizes, trying to win a specific sales per month metric at the expense of maximizing profitability. Doesn't make a lot of sense. But I think Bob's comments were intentional that we don't expect if I look at Q2 through Q4 we don't expect that those absorption rates this year will be a lot different. Could they be point one different? Yeah. And that would get us to where we expect to be for the full year.

Okay. Thank you. When I look at the words that you used in the beginning, tepid, lukewarm, half-hearted for the quarter, and then your commentary on January, it sounded to me like a different level of excitement or tone. Is that a correct interpretation that January to you felt a lot better than the December quarter?

That is absolutely intentional.

Okay. And then last question, when you think about your aside from market improvements when you think about your Company specific opportunities, done a lot already. What single area do you still think you have the most room or if there is such a thing as low-hanging fruit, where would that be?

It was obvious to see but hard to execute against and that was owning better land. We were out of the land market, we didn't get some of the low-hanging fruit in 2010 and 2011 that our peers did. They've been blowin' and going through that for the last three years and we didn't get to have any punch out of that punch bowl. The last two years we've been much more on the gas on the land side and starting to see the benefit of those new communities is really something. We have been fighting that headwind for two-and-a-half years. That turns into a tailwind at some point this year and I like the locations we are in. Also given us a chance to revise and update refresh our product. So I think having fresher looking better elevations, really current floor plans in better dirt, we haven't had any of that. It has been behavioral. It's been being more competitive, being more attuned with the market, just expecting and holding people accountable for better performance. When you get the dirt better and you get the houses better that will be a nice benefit that we haven't had so far.

Great. Thanks for taking my questions.

Yep.

Thank you. Eli Hackel with Goldman Sachs.

Thanks. Good morning. Just one question quickly on January. Not to state the obvious, but rates have been moving decently lower. Is it your view that that is really not at all behind the increase in January and it is not seasonal, it is really some type of change in buyer sentiment?

Well, it is clearly partially seasonal. There is no question about it being partially seasonal. I think it is more than that. So I think it is complicated. I don't know that consumers really know what rates are when they come into your model. When they are in the process of qualifying and looking at loan product, that is when they know what rates are and they are doing the affordability calculations. But to get up off the couch to get in the car and drive out and look at a community, particularly in adverse weather, I don't think that behavior is motivated by a 20 basis point change in the tenure.

That is helpful. One follow-up questions. Going back to lending standards. You have a good chart from CoreLogic talking about where current standards are difficult and the biggest one is really on the FICO score. It sounds like you thought maybe some things were starting to ease. Do you think -- does that number need to ease materially to get back to what some people call some type of normalized selling environment, or do you think a slow ease is good enough and can get you to the 2B-10 plan over the next two to three years?

I think over the next couple of years a slow ease will be fine. I would love it to snap back to that historical line. It's not going to. It is just not going to happen. I think that if it moves out on that axis a little bit at a time, a little bit at a time that is just incrementally helpful and I think frankly relative to a lot of builders we benefit disproportionately because of our profile of buyers. Get any easing there, that should help us.

That is great. Thank you so much.

And by the way, thank you for raising the spider graph. There was not a small amount of controversy with my colleagues here about putting that in the deck. So I get a gold star --

Thanks, Eli. Appreciate it.

Well, -played but you. Thank you.

You're welcome. Thank you very much.

Thank you. And our last question from Sean Wondrack with Deutsche Bank.

Hi, good morning. This is Sean Wondrack on for Phil Volpicelli. Not to beat a dead horse. Another quick question on new orders. You said the cadence was pretty normal throughout the quarter, wasn't any real major market stall. But you also noted that towards the end of last year's comparison that that had a big influence on why orders came in shorter. I was curious if you could quantify of that 4% new orders being down what percentage was from that last week?

Yeah, it is tough because we are selling out of different communities. The mix changes and so it is a little bit hard. Like I said, I had designs in the beginning of the year on another 50 to 100 orders for the quarter that would have been optimal and that is probably 1% of the total number for the year, kind of number. So it was hard to get too worked up over it. But I would have said if you told me there were 50 sales roughly spread over the quarter but maybe a larger share of those that very last week of 20 or 30 of them in that last week of December, that would have made the difference.

Right. Right. And in a related question, when you look at some of your markets you operate in, you have obviously been in very hot markets, some of these markets have had a lot of growth over the past year or two and look at Texas, Florida, California. Have you seen on a market to market basis have you seen any trends changing or maybe an acceleration in certain markets and a cool down in others?

Phoenix was tough in the first quarter and in December in particular. I don't know if our peers have talked a lot about that but we found Phoenix to be pretty tough. It felt substantially, eye openingly better in January. So it is not like they turned off the lights in Phoenix. It turns out that December wasn't very good. I mentioned Raleigh. I was disappointed in Raleigh and I don't think it was just us. We looked at the market carefully. Some of the big master plans there really stopped marketing. People were feeling fat and happy in that market after September and it was a wait until next year, that is my observation. You talk about Texas being hot. Texas is hot for a lot of reasons.

It is not I don't think real estate speculation. I think it is jobs. I don't have the job number in Houston at my fingertips, but it is in the six digits, it's in the 100,000 plus category. When you are creating that kind of job growth it is absolutely a powerful driver for housing. So I -- that trend I think continues. I think the recovery in Orlando is well underway. I was down there last week for a couple of days looking at our new communities. That is going to be a big part of our 2014 getting some new communities open in Orlando. We really like that market. I like the fact that they have taken very intelligent steps to work on the infrastructure. Opened new toll roads and Highways that make new affordable markets accessible and they've had a concerted region-wide effort to create job growth in the health care complex which you can see not just the cranes but the occupied buildings basically at the end of the runways there in Orlando. Those are jobs and those are home buyers. That is a place where I think there is still very good things to come.

All right. Great. Thank you for the color. Appreciate it.

You bet.

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