Beazer Homes USA Inc (BZH) 2014 Q2 法說會逐字稿

Good morning and welcome to the Beazer Homes earnings conference call for quarter ended March 31, 2014. Today's call is being recorded and a replay will be available on the Company's website later today. In addition, PowerPoint slides intended to accompany this call are available 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. Good morning, and welcome to the Beazer Homes conference call discussing our results for the second quarter of FY14.

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

Joining me today are Allan Merrill, our President and Chief Executive Officer, and Bob Salomon, our Executive Vice President and Chief Financial Officer. Following their prepared remarks, we will take questions in the time remaining.

I will now turn the call over to Allan.

Thank you, Carey, and thank you all for joining us.

As one of the last home builders to report this spring, we know that there have been mixed reports about the strength and durability of the housing recovery. While it is clear the industry is not enjoying a so-called V-shaped recovery, affordability remains healthy, rental rates keep rising, new and used home supply is limited, and crucially, lenders seem to be tiptoeing back into the purchase money mortgage origination basis.

And, after a long period of dormancy, we are seeing encouraging signs in the first-time buyers segment. Overall, our sense is that, as long as mortgage rates don't spike again like they did last May, new home sales should continue on a slow but deliberate improvement path, with home prices inching up in most markets.

At Beazer, with our operational turnaround in full swing, we have a number of achievements to be pleased about this quarter. Our sales absorption rates were ahead of our expectation, home pricing was a bit better than expected, and gross margins were stronger than we anticipated.

Specifically, for the second quarter, we increased adjusted EBITDA to $18.5 million, up from $15.2 million last year. We sold 3.3 homes per community per month, higher than we have recorded for any of the previous three quarters. We expanded gross margins by 340 basis points to 22.5%. We grew ASPs by 7.5%. We ended the quarter with $300 million in unrestricted cash, and we spent $129 million on land and land development, compared to only $63 million last year.

We also activated one of our largest land-held-for-future-development assets, located in California, creating more opportunity for unit and profitability growth next year. In addition, just after the end of the quarter, we successfully completed a bond refinancing, which will save the Company over $8 million in annual interest expense.

Of course, not everything went our way during the quarter. As we reported in early April, orders and closings for the quarter were impacted by both a decline in our active community count, which we expected, and by severe winter weather, which we didn't. Overall, orders were down 9% and closings were down 13% versus last year.

This contributed to SG&A as a percentage of sales being higher than we expected in the quarter, and as I will discuss in detail in a minute, the weather has contributed to some delays in opening new communities. But even with the challenges, our confidence in making money this year is undiminished, and in fact, we are modestly increasing our expectations for full-year EBITDA.

Last November, we introduced our 2B-10 plan to reach $2 billion in revenue with a 10% EBITDA margin over the next 2 to 3 years. This plan calls for improvement in five key metrics, including sales per community, ASP, average community count, gross margin, and SG&A. While there are a number of different combinations that can lead us to $2 billion in revenue with a 10% EBITDA margin, at that time, we provided some specific targets that could get us there.

Bob will go through our progress against these metrics in just a minute, but first, I want to address a topic you've heard a lot about recently, and that's the weather. On the sales front, it's tough to quantify how many potential buyers stayed indoors due to the frigid conditions. Surprisingly, we actually saw a small uptick in absorption rates in our East segment this quarter, allowing us to record that 3.3 sales per community per month for the Company, one of the strongest paces we have reported in years.

We weren't so fortunate dodging the weather with closings. We have identified 44 closings in our East segment, which got pushed into the third quarter as a result of harsh weather conditions. Missing these closings obviously reduced revenue. It also decreased our SG&A leverage, and slightly shifted our geographic mix of closings, which impacted both ASPs and gross margins.

So yes, mother nature impacted our income statement in a few different ways, but in the context of our full-year results, we don't expect that deferring the closings into the third quarter will make a very big difference.

Where the weather really hurt us was in land development. In Maryland, where we have 13 communities under active development, schools were closed as many as 15 days in some districts. That's nearly an entire school month. On many of those days, local governments followed suit, by either shutting down early or not opening at all. In those areas, no permits were issues, no inspections were performed, and no one at the municipal reviewed any site plans. Just as importantly, we didn't dig any trenches, lay pipes, grade lots, or pave streets on those days either.

Beyond Maryland, we experienced some version of these issues in New Jersey, northern Virginia, Indianapolis, Raleigh, Nashville, and even here in Atlanta. Just in those markets, we have 30 communities slated to open still this year, and while our folks in the field fought valiantly to not lose any time on our development schedules, we were not totally successful. In all, we had five expected community openings slip from Q2 to Q3, and another eight move from Q3 to Q4 due to weather.

So where do we stand on our active community count? During the second quarter, we opened 17 communities, but we had expected to be a little higher on our community count by the end of the quarter. Year over year, our average active community count was down 6.7%, compared to the 5% we had anticipated. In addition to our 138 active communities at the end of March, we also had 62 communities under development, 50 of which are expected to go active by year end, and 23 whose purchases had been approved but had not yet closed.

In recent quarters, we have acknowledged that one of the biggest risks in our forecast was accurately predicting the timing of our land development efforts. Between delays due to short-staffed municipalities, shortages of specialized trades or equipment, and the extended windows required to schedule utility providers, we expected to have a few hiccups along the way, which is why we gave ranges on our quarterly community count estimate. And all of that was before we had to deal with the worst winter weather in memory.

Between the weather issues and a few other challenges, the bottom line is this. We are having to adjust modestly our previously communicated forecast for our average active community count. We are moving our Q3 expected average active community count to a range of 140 to 150. That means we'll be essentially flat year over year in the third quarter.

For our fiscal fourth quarter, we now expect an average approximately 155 active communities, an increase of approximately 15% over last year, but five communities fewer than the prior estimate. And for the full year, we expect our average active community count to be approximately 145 or flat with last year.

I realize that's a lot of detail about the weather and our community counts, but we want to be accountable for what we told you, and community count is one area where we came up a little short this quarter. Yes, I'm disappointed by the change, but I'm actually pleased with how modest the adjustments are in light of the massive number of developments we have underway.

More broadly, these issues shouldn't detract from the sales and margin results we've recorded or our improving EBITDA expect for the year.

With that I am, I'm going to turn the call over to Bob to provide more detail on the quarter and the progress we've made on our 2B-10 plan. Bob?

Thank, Allan.

[Up for] the community count, which Allan just covered, I'm going to take you through both our quarterly results, and more importantly, the LTM results on each driver of our 2B-10 plan. Starting with revenues, for the quarter, our total revenue was lower than expected at $270 million. On a trailing 12-month basis, total revenues are in excess of $1.3 billion, up 13% versus a year ago.

We sold 3.3 homes per community per month during the quarter, without sacrificing margin dollars. This compares with a number well below three sales per community per month reported by most of our peers. On a trailing 12-month basis, our sales per community per month held steady at 2.9 and compares favorably to 2.7 a year ago.

Our ASP was $272,000 for the quarter, up 7.5% versus last year. On a trailing 12-month basis, our ASP was $266,000, 13% higher than the year ago. Usually it doesn't make much sense to look at sequential trends in ASP, however, because there was a sequential decline, we wanted to illustrate that mix between segments, and within segments was the reason.

You can see that our East segment and its higher ASPs comprised a much lower portion, call it 6% less, of our closings this quarter than last, some of which was due to weather. You can also see that our West segment, where prices have risen steadily, was impacted by a different mix this quarter. Our Texas business, and one very affordable townhome community in Las Vegas, played a much larger role in our closings this quarter than in California, which contributed to decline in ASPs within that segment.

On a year-over-year basis, the trend in higher prices is intact. In fact, our ASP and backlog is the highest it's been in recent memory at $295,000, up $30,000, or 11% over last year. As a result, we expect our third-quarter ASP to return to a level above what we reported in either of our first two quarters this year.

The primary reason for our revenue decrease this quarter was lower backlog conversion, driven by several factors. We had more homes scheduled to close in future quarters this year versus last year, a higher percentage of closings pushed in future quarters, in part, due to weather issues that impacted 44 expected closings in our East segment, and we had fewer spec sales within the quarter that closed by March 31.

If I look to the third quarter, and composition of our backlog, I believe that our conversion rate will be within the range of 55% to 60%. For the quarter, our home building gross margin was 22.5%, up 340 basis points from last year. Our gross profit dollars per closing increased to $54.9 thousand for the quarter, up $6.8 thousand or 14% from last year. The margins were definitely above our internal expectations and we are, of course, very pleased by them, but before any of us get too carried away by this one quarter, let me point out a few things that benefited our Q2 margins.

First, our mix of closings featured fewer East segment closing than expected. My estimate is that missing the closings due to weather added about 30 basis points to our margin. Second, we benefited from a credit on an outstanding warranty matter of $1.4 million, which added another 50 basis points. As a result of these factors, we do not expect quarterly margins in the back half of the year to be quite as high as they were in Q2.

But for the full year, we do expect home buildings gross margins to be at the high end of the range we previously reported, somewhere between 21.5%, and 22%. Achieving this level of margin would represent great progress this year, and will leave room for further improvement in FY15, as we benefit from the new communities we are preparing to open. While other builders may be fighting the headwind of not being able to sustain their high gross margins, we think we still got room to grow.

As relates to our 2B-10 plan, gross margin on a trailing 12-month basis was 21.3%, up 350 basis points from last year, and gross profit dollars increased to $54.7 thousand for homes closed on trailing 12-month basis, from $41.5 thousand last year, representing the 32% year-over-year improvement.

SG&A was 16.2% of revenues this quarter. While we expected the second quarter's SG&A ratio to be the highest of the year, we did not expect for it to be quite that high. However, we could easily determine the reasons for the large ratio this quarter. First, as expected, we had increased spending related to our coming soon communities, as well as our normal seasonal promotions at the start of the spring selling season.

Second, the piece that was unexpected, were our lower closings, in part due to weather. Because that second piece is only temporary, it has no impact on our full view of the full year. We still believe that our full-year FY14 SG&A will be between 12.5% and 13%. On a trailing 12-month basis, SG&A as a percentage of revenue was 13.7%, which was slightly improved over last year's despite our results this quarter.

Looking at the graph on the right, on a per closing basis, we continue to be among the lowest cost operators in the industry. With our year-over-year LTM improvements in both gross margin and SG&A, our LTM adjusted EBITDA reached $103.5 million this quarter. And as we increase our closings in the back half of the fiscal year, we expect to see further improvements.

In the second quarter, we spent $128.6 million on land and land development, more than double last year's second-quarter spend. Included in this year's number is $11 million of non-cash acquisitions, primarily related to land in Las Vegas that we received from the Inspirada joint venture [settlement]. Also on this slide, we've included a couple of photos to provide a sense of the equipment required to complete -- to compete land development efforts at our larger sites.

By doubling up the crews on site, we are trying to cut into the delays created by weather or municipal issues. For the full year, we still expect to spend in excess of $500 million on land and land development, exclusive of any potential land deals.

With our increased land spending, our inventory levels have continued to rise. At the end of March, we had nearly $1.5 billion of total inventory, up over $300 million from last year. Our lot count is up over 18%, with over 29,000 owned and controlled lots at March 31.

During the quarter, we activated a $30 million asset out of land held for future development. This community located outside of Sacramento in Rancho Cordova, is expected to open in the summer of 2015. As we've grown our total inventory in recent quarters, and activated several large parcels, our land held for future development has declined as a percentage of total inventory from 31% a year ago to 21% this year, improving the ratio of our assets working for our shareholders.

At the end of March, we had a total of $306 million of land held for future development, all of which we hope to bring active in the next several years. Approximately 80% of this land is located in California, equally divided between northern and southern California. Most of the land in the north is impacted by the moratorium on permits related to repairs needed on levees in Sacramento.

I should note that our 2B-10 plan and its related targets were developed without any assumed benefit from these assets. And while margins from these land held future development properties will likely be below our current Company average, any EBITDA generated from these assets will be additive to our results and will generate significant cash for reinvestment.

In early April, we refinanced our 9 1/8% senior notes due 2018 with new $325 million 5.75% unsecured senior notes due 2019. As a result, we expect to save $8.4 million in cash interest per year. Because this transaction occurred after the end of the quarter, the one-time cost of refinancing will show up in our Q3 results. We will take a non-cash loss of about $20 million to redeem the higher cost debt, but with an immediate earnings improvement, and pay back of about two years, we think that it was a prudent move.

Looking at the remainder of our capital structure on a pro-forma basis with our new 2019 notes, we have no significant debt maturities until 2016, $300 million in unrestricted cash, and an undrawn $150 million revolver, all providing us with sufficient liquidity to meet our 2B-10 objectives.

Finally, we currently estimate that we will be able to use approximately $445 million, or $14 per share, in deferred tax assets to offset our 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 some time during FY15.

With that, let me turn the call back over to Allan to review our expectations for the remainder of the fiscal year.

Thank you, Bob.

With the exception of the modest reduction in community counts, which I discussed earlier, our other full-year expectations are all unchanged or improved. We still expect to report positive net income, obviously a major milestone for the Company, and in fact, we are again raising our expectations for full-year adjusted EBITDA. We now expect EBITDA growth of $45 million over last year, a more than 50% year-over-year improvement. That's a $5 million increase since our last call.

We are also increasing the expected range of our ASPs to $280,000 to $290,000 and focusing our expectations for gross margins at the high end of our prior range, likely between 21.5% and 22%. We continue to expect 3 to 3.1 sales per community per month, with a significant contribution from our soon-to-open communities, and SG&A as a percentage of revenue between 12.5% and 13%, despite the higher ratio this quarter. All in all, things are progressing well for us.

I'd like to take just a minute to acknowledge our team's efforts. They are the ones who have put this Company on their backs and carried to us a better place. They have been consistently generating better results with no excuses for legacy assets or the legacy debt load. They have demonstrated that we can outperform on absorption rates, while improving gross margins, reducing SG&A ratios, and investing for the future.

This has led to three straight years of large-scale increases in EBITDA, which will soon translate into GAAP profitability for our shareholders. So to my Beazer colleagues, thank you for your focus, your intensity, and your accountability.

For those of you on the call, thank you for joining us today, and thank you for your patience as we execute our improvement plans. We look forward to sharing our continuing progress in the quarters ahead.

At this point, I'll turn the call over to the operator to take us into Q&A.

(Operator Instructions)

Our first question comes from the line of Michael Rehaut from JPMC. Sir, your line is now open.

Thanks, good morning, everyone, and nice quarter. The first question I had was on sales pace, and, you continued to make good progress given the challenges of the weather, and in comparison to many of your peers, that several of them have had sales pace down 10%, 15% or so. Just wanted to focus on that for a moment.

Certainly, part of it is, if I can put words in here, improvement off of levels that you weren't satisfied with, and that you saw a lot of improvement opportunity over the last couple of years, but as you go forward, is that something that you would expect to improve a little bit further? Certainly, it's in the range of your goals, but would you want that to be more in a three to four sales per month, or how do you see that changing from here on in?

Well, Mike, you've hit a couple different points there. If we just start with the 2B-10 plan, which isn't the be all and end all, it's our current focal point for financial outcomes, we have used 3.2 as a target there. On a trailing 12-month basis, we're at 2.9, so I do think that there is an opportunity for us to make incremental improvements over the next year or two.

Longer term, it depends on the environment we're in. There are clearly -- there had been in the past environments where 3.2 would be an immodest objective. In the current environment, it's a very healthy, if not industry-leading objective, so I'd like to reserve the right to adjust that based on broader market conditions, but for where we are right now, the modest pace of the recovery, being in that low three range is a pretty good place to be.

Okay. Also, looking at the gross margins by region, the East, it was a 200 bp decline year over year. Part of that was due to a warranty charge, but was the other part either just due to the higher operational costs in the quarter related to weather or if you can go into that a little bit more?

There was a warranty charge in the East of about $1 million in the quarter and we're really in the midst of a significant repositioning of our divisions in the east segment. We have got a few close-out communities, we had costs associated with start-ups, so we are in the midst of a significant transition in the east.

There is no reason structurally, longer term, why the east margins will be an order of magnitude less than in the rest of the Company. We wouldn't be making the investments there that we are making if we thought that was the case.

So I would say there's a little transitional noise. I can't say that there's a ton of weather noise in there, but clearly some close-out and start-up costs.

Just one other quick one, if I could. Interest not qualified for capitalization ran about $16 million in the quarter, it was [$16 million] last year? Does that run rate change at all with the debt issuance and refinancing?

Yes, Mike it, will change a bit, but also, if you remember, it's highly dependent upon how many new assets we bring on to the balance sheet as we continue to invest. Over the next several quarters, that should trend downward.

Thank you.

[Provided] pre-financing as well.

Thank you.

Next question comes from Ivy Zelman from Zelman and Associates. Your line is now open.

Good morning, guys, it's actually Alan on for Ivy. Nice job with dealing with tough weather in the quarter. Allan, you gave us obviously great detail as far as how the weather impacted the development side of the Business. Just curious if you can give us some commentary how the sales and also pricing environment progressed through the quarter?

We've heard from some other builders that they have seen a significant snap back in activity in March, once the weather headwind subsided a bit. It doesn't look like you faced as much of a headwind as some of your peers, given your commentary on absorptions being stronger than you were expecting, but curious to see how that progressed through the quarter and also where you see the incentive environment today, both from a Company standpoint, as well as what you're seeing in the industry.

Okay. That was a two-for. We got absorption rates and incentives, and I'll try and deal with both those. On the progression during the quarter, there's no question January was not a huge number, it was fairly similar to where we were last year in January. February was a good step up.

We always admit that in February, we expect and create a step up because we run one of our big national promos during that period of time. We've gotten very disciplined on not using that as an opportunity or an excuse to lower prices, but it rallies enthusiasm, and it's our kick-off to the sales season. It's disappointing that we've been copied and more and more folks are pulling those spring selling events forward, but the fact is it still has effect on our results.

And we did see broader-based, less promotionally driven traffic activity and sales activity in March. One thing I'm a little cautious about, and it's not a big negative, but it is the case that Easter was in March last year, and it was in April this year. As I've had a chance to look at partial April data, which let me anticipate the question, I would tell you, March was a lot better than last year, and April is a little softer than last year, as I look at traffic level.

I don't know what the April sales are yet, but I do think part of that March pick-up that you're hearing about was a little bit of a year over year difference in the holiday calendar. I can't speak for others, but I sense a bit of that.

So I don't see that things have become different in April. There are some comparative differentials that we're dealing with, because as I say, of where Easter and Passover were.

In terms of the incentive environment, it's interesting, we have got a variety of strategies around the Company on incentives, and I anticipated this question, so I pulled some things that I thought I would share. On an overall basis, our incentives are down about 1 percentage point from where they were a year ago. And you can look at the gross margin improvement and say, aha, I see it, you've reduced incentives and there it is in your margin and there's a lot of truth in that.

But at the risk of making everybody's heads explode, I'm going to give you the longer form answer, which is a little bit more complicated. We have divisions where our incentives are below 3% of sales prices, and we have divisions where our incentives are north of 10% of sales prices. It would be easy to assume that there is a strict correlation between the level of the incentive and how robust the market is, but interestingly, the divisions in our Company with the highest gross margins in the quarter were also at the higher end of our incentives and conversely, one of our divisions with really low incentives is one of the ones where we still have a lot of opportunity for improvement in margin.

So, as investors, and we as managers need to be careful, that there are a couple other things going on when you look at incentives. I am pleased they're down, but it's important that we look at base pricing. I also think it's crucial you look at included feature because as base pricing, included features, and option pricing changes, you've then got to -- a richer context in which to think about the incentives.

So all of that was not meant to obfuscate; it's just to be careful with simple sound bites on incentives. They are modestly down, but I would tell you that I wouldn't be unhappy if I had to tell you they were up, because it fit into an included features, option pricing, base price strategy that was increasing absorption rates and margins. I would be very pleased in that context for incentives to go up.

So we try and compete in every community every single day, and there is not some overarching, we must reduce incentive. We want to get our paces up to the levels that we've talked about, we want to drive gross margins.

We expect and have been benefited from letting our local presidents make decisions at the community level how to dial that in. So I know, Alan, that's not exactly the context of answer maybe that you were looking for, but I was anxious for somebody to ask the incentive question, because I wanted to make sure that we didn't just let the simple answer suffice.

And that's really helpful, and we certainly appreciate the mix between base price and incentives. What I was really hoping to get at with the question, which you touched on, was just the idea that we've heard from some builders talking about -- Phoenix, for an example -- where builders are at, right, cutting price. And what I'm really curious on your thought is, just directionally, is price across your footprint, would you call it still showing upward momentum when you take into account all of those factors, or are you seeing markets where all those pieces together account to either maybe some net price reductions?

That's an easier question, and I would say that we look across the footprint, I do think that prices are inching, and I use that word advisedly, inching upward across our footprint. I would tell you there are certain product types and lot widths where we have seen a substantial change in the number of competing communities. Just as a specific example, if you were to look at community counts in Phoenix, which I'm sure most of the folks on this call have done, they are up over 100 communities year over year on a base of about 300. You got 100 more communities in Phoenix.

What's interesting is if you break it down to what are the home sizes that are being sold and the lot widths that are available, there's clearly been a dramatic bunching up in certain lot widths and certain home sizes, and you get too many new communities too quickly attacking exactly the buyer profile, those can create the dynamics that you are describing. Speaking for us, broadly and specifically about Phoenix, we have not seen an environment of net price reductions, but I can -- I just described for you the circumstances that might be culpable for what you've heard.

Great. Thanks a lot.

Next question come from David Goldberg from UBS. Your line is now open.

Thanks. Good morning, everybody, and congrats on the progress you made in the quarter towards the 2B-10 goals. Very solid.

Thank you, David.

Wanted to start by asking a question, you guys did an excellent job talking about some of the delays in terms of entitlements from the weather, and even on the development side, but I was thinking about build cycles, and where build cycles are now, laying foundations to actually closing homes, and how that was affected by weather, and how long that really takes to normalize and what that does to return assumptions if it gets extended 10 or 15 days in a 100-day build cycle?

There's a really rich question in terms of build cycles because it's broader than just the context of weather. I would tell you that if the only thing going on in any of our markets were adverse weather, the good news is that you can, quote, catch up relatively quickly, and it doesn't become a lingering problem.

Land development is different; there's a linearity to the progression of land development where X has to come before Y, which has to come before Z. In the home construction process, you can multi-task and you can be doing multiple things at the same time to try and catch up some of those days. So we did lose closings, because we weren't able to complete the homes during the period.

I couldn't give you an exact metric on what that did to cycle time, but clearly, it elongated, as we just weren't able to be on the job site safely or get our get our contractors on the job sites safely. I don't think that, that issue, weather specifically, as we think about cycle times, is a go-forward issue, although I could tell you, I was talking to my guys in Maryland yesterday and six inches of rain made for a decidedly tough day in the market.

But the bigger question is cycles times more broadly and there are a couple of markets for us, Houston and Dallas just jump off the page, where we're struggling a little bit to sustain our cycle times because of labor availability issues. And we have seen 5-day, 8-day, 10-day expansions in our cycle times in those markets. It's particularly acute on the framing side of the business right now, and it is the spring selling season, and so you've got different builders, particularly in Houston, with different spec strategy.

It's definitely created a bottleneck, and we've tried to deal with it by doing a better job at setting expectations with buyers upfront, because it's one thing to be 10 days late, it's another thing to be a lot more than 10 days late, and not have communicated that to the buyer. I'm worried about it from a customer experience and perspective, not just the return criteria.

I haven't calculated it. It's I'm sure just a simple algorithm to add 10 days to cycle time in a handful of markets. At this point, that doesn't feel to us like it's not changing our margin progression in either of those markets. There are some cost side pressures there.

I'm happy to say that the pricing environment has been sufficiently strong. We have been able to absorb that. I will be worried if our cycle times across the country expand like that, but it really has been for us at least pretty isolated to those two markets.

That's great color. Allan, just want to follow up on the comment you made about starting to see some first-time buyers come back in the market. Clearly, mortgage market liquidity loosening, we're hearing signs of that, too, but I'm wondering if you think there's any aspect to first-time -- the limited amount of first-time buyers in the market, coming from a lack of supply.

It feel like a lot of builders, when you talked about Phoenix, and you can buy a 3,500-square foot home on a number of different lots in Phoenix today, that you maybe, you had a lot less choice last year at this time. But I'm wondering how much of the issue, if any, do you think, from the lack of first-time buyers is coming from lack of supply in that the builders just have not built the product, but demand might be there. Certainly not the levels that we saw in the last cycle, but better than completely absent, as some builders seem to indicate?

The death of the first-time buyer has been greatly exaggerated, to paraphrase Mark Twain, and I do think part of responsibility is ours as an industry. A larger portion relates to the legacy of the mortgage crisis and the housing crisis, but what we're observing is that this first-time buyer population, prospective first-time buyer population, is older and more affluent than prior first-time buyer cohorts.

And they bifurcating in some interesting ways. There's a larger portion single-only buyers, and there are a larger portion of, what I would call, purely location buyers, and that is putting some pressure on us as an industry to understand and execute infill.

So we have some responsibility for that, but the good thing is we haven't tried to solve the problem by building dozens of tracts of moderately-priced and smaller, affordable units in the desert on a build-it-and-they-will-come basis, because I do think these buyers are a little different. The amenity feature, in the house, the access to transportation -- I do think that the locations have to change.

So I would say that if the focus was purely on price, that would be a mistake, and frankly, we've seen some successful examples of folks using either remote locations or dramatically reduced optionality to drive at price, and they can have it. Our view is let's be in the places where people want to be, these first-time buyers, but accepting the burden, those are harder to find and the product is not a cookie-cutter. We have got to be right for each market in those locations.

Because of that being my view, I don't think we, Beazer, can solve that problem by putting sticks in the air. There is a portion of the market that others could probably address by putting sticks in the air. We want to be very selective.

We want to be on great real estate, no matter what, not just have units for units' sake. Your question is nuanced and interesting; what our reaction is, is a little different from what you've heard from some others about how to attack the first-time buyer opportunity.

That's very interesting. Thank you.

Next question comes from Dan Oppenheim from Credit Suisse. Your line is now open.

Thanks, very much, and good quarter, despite the weather and everything going on, even the rain yesterday you were describing. Wondering if you can talk a little bit more about SG&A. You were talking about some of the increase in costs with the community opening costs there and how we'll see seasonal incentives.

You described the season year as delivering a modest recovery, and also in terms of plans for potentially using incentives strategically. Do you think, as we look at SG&A over the coming quarter or two, we should being a bit more from the incentives coming in there, understanding that it may be for some strategic reason there or be it the modest recovery?

Our incentives are in cost of goods sold, so they would be up above, not there. The simple answer, Dan, is you should look for our SG&A in dollar terms to be higher in the third and fourth quarter than it was in the second quarter, but keep an eye on full year between 12.5% and 13%.

Okay. Thank you very much.

Next question comes from Eli Hackel from Goldman Sachs. Your line is now open.

Thanks, good morning. Allan, just want to go back to some of the comments you made about credit loosening. Clearly it's been slow so far this recovery.

I wondered if you could just go into a little bit more detail about what you're seeing. Is it more from the non-bank originators than the bank originators, is it on the FICO, or is there some debt level reduction that they're taking? A little bit more detail that would be appreciative?

It's been interesting, with the big money center banks have seen their share start to erode, and I think it's because there are still these legacy issues. I can't image the dozens, if not hundreds or thousands of lawyers and folks they had working on legacy problems.

So the folks that are a little bit more nimble, working within the QM rules, and not writing crazy loans, are aggressive, they're hungry. I called it last quarter, the animal spirits. I see it every day with our mortgage source lenders, they want to lend.

One of the things that is going on now, and it's frustrating to me -- I wish I had a perfect answer for it, I don't -- but I genuinely believe this. A lot of buyers, particularly first-time buyers, and first move-up buyers, who were first-time buyer more than five years ago have a different view of what is required than what is actually required.

People believe they have got to have 20% down. I'd love to have a dollar for every news article about having 20% down, somebody spouting off about how that's what's going to make America great again. It's gotten in people's heads.

It doesn't take 20% down. You and I know that. And so it is an ongoing challenge for us to communicate to buyers that you have a great opportunity to qualify, you're well-employed, you don't have a recent bankruptcy or a significant default -- and even if you have those things, but they have seasoned, and you have repaired your credit, you have an opportunity to qualify.

And I do think that banks have to be better salespeople, builders have to be better hand holders, and the narrative will shift here. I don't know if there's going to be a tipping point moment when the light bulb goes off, and everybody says, aha, I get it. I doubt that. That's not our view. But there's a really significant disconnect between what banks are willing to do within this much stricter confines of the current lending environment, than what consumers think they'll do. And that's a hard problem to solve with a silver bullet.

One of the things that we do with mortgage choice pretty well is we can say to a prospect, we have got a couple of lenders that we picked for this community, both of whom would like to earn your business. Why don't you talk to both of them? It is the case, and it is -- I'm sorry to be in my sales soap box, again -- it is the case that we're going to see better rates, better fees, better service as a result of that competition.

But there's a different aspect to it that I haven't talked a lot about, which is if it changes the buyer's belief set as to the likelihood that they'll actually qualify, that's a big deal. And that's really a main theme for us as we try and refine connecting mortgage choice with these first-time buyers. That yes, you're going to get a better rate, but you also -- it may be a gaiting issue -- you got a better chance of qualifying.

I talked, Eli, before, and I won't repeat the whole anecdote, there were tons of tons of structural overlays the banks had put in place around the purchase money business because the refi business was more profitable. That boom you heard a year ago was the refi business dying and it has taken time for the banks and their regulators to remove some of those impediments. They are doing that. I still thing it's sticky because buyers don't believe it.

And just one quick one. Just on the land held for future development, it sounded like you wanted to develop that over the next couple of years. Is there an opportunity, understanding maybe sell it sooner versus later to a third party and reinvest that capital elsewhere within the Company or you really want to hold on to it for the next couple of years and develop it yourself?

There are different answers for different parcels. The Sacramento stuff, we like that market. I've been there a lot lately. We have activated a big asset, we've got other assets up there that are levy constrained.

I like our position very much. I've talked a little bit about it before, but if you look at an aerial photo of Sacramento, you find across in the middle of the city where I-5 and I-80 intersect, we own essentially the northeast quadrant, the southwest quadrant of the busiest interchange in Northern California.

I like that land a lot. We need the levies repaired so we can go back to building in those locations, but those are excellent sites. We have other sites around the Company where the right answer may be to sell them.

Our issue is let's be good stewards of our investor capital, and we'll make that decision, asset by asset, but I don't think there's a stubbornness on our part, or an unwillingness to monetize them where it makes sense. Without making a specific prediction, that is not a thought process far removed from ours in real-time.

Thank you very much.

Next question comes from Jay McCanless from Sterne Agee. Your line is now open.

Good morning, everyone. First question I had, the guidance for positive net income for the year, does that exclude the one-time charge for the debt refinancing or does it include it?

We believe we will be positive GAAP net income, including that charge.

Okay. And then if you could repeat the gross margin detail for the back half of the year? I missed that?

What Bob said about that is that because we did have the benefit of a little mix shift and a warranty recovery in that 22.5%, we think that the back half will be below that, and we believe that the full year will be between 21.5% and 22%.

Okay. And then just one other quick one. It sounds like M&A, at least public to private, is starting to pick up again. Can you talk about the deal flow you're seeing there, and where it compares to this time last year?

The deal flow is certainly up. We've seen a lot of different deals, we continue to be very focused on our existing footprint and opportunities to derive more value from that footprint. Obviously we haven't bought anything. You'd know about it if we had.

We look at it like other builders would -- some cases it's an opportunity to replenish or add to a land supply, in others it may represent something more strategic as to a buyer profile, or a product expertise. But I would say that there are several opportunities a month that we become aware of. Maybe it's higher than that.

There's a lot of drama and a lot of complexity associated with M&A. We try and only spend time thinking about those where we think we're really the likely or right buyer for it. There are a lot of shiny objects that go floating by, and we wish others well, but we don't feel compelled to chase them all.

Okay. Thank you.

Next question comes from Adam Rudiger from Wells Fargo. Your line is now open.

Good morning, thanks for taking my question. In your prepared remarks, Allan, you talked about an opportunity to grow gross margins a bit more in contrast to some peers who have talked about more stable ones. And I was wondering what you think the biggest levers for that continued expansion?

I admit, it's not really natural for us to beat our chest, but one of the things that's missing is we've got pounded, and appropriately so, because our margins have been below our peers, but a lot of them had the great luxury and the foresight in -- they're all geniuses, but they loaded up on land in 2010, 2011 and 2012. I wish we had. I would love to have the problem of my margins are too high.

But we don't, so we've suffered by that comparison over the last couple of years, but there's a regression [the mean] problem that they've gotten that we have different sizes of. We're out competing with them in the market every day and have been for the last 18 months or so and so the deals that we're putting on for 2015 and 2016 are the same deals they are looking at for 2015 and 2016.

From where we sit, we see opportunity. If we had been burning off of legacy positions, which were extraordinary purchases, it would be harder to sustain. So it's -- I'd love to tell you it's a lot more complicated than that, and the thousand things that we're doing to raise gross margins, and that's all true, but the bigger picture, simpler answer is we just don't have the benefit of some of those well-timed legacy purchases.

Okay. And does that suggest that the deals you're putting under for purchase agreements now have higher margins than current margins?

We're buying deals that are supportive of our ambition to grow gross margins.

Okay. And then secondly, on margins, when I look at your 2B-10 plan, you talk about 22% growth, 12% SG&A, that gets you to a 10% margin, although -- and that's normally what people talk about as maybe a normal margin for the builders, but usually that's an operating margin, not an EBITDA one. I was wondering if you threw the interest in there, that reduces that goal a bit. So I was wondering if that was what you think is the appropriate normal for Beazer, or is that just more of an interim goal?

When you're hiking across the desert, you identify a point on the horizon and you set your sights on that, it doesn't mean it's the end goal and that's what 2B-10 for us was. $2 billion, people can relate to that, and 10% is a round number.

I wouldn't interpret it a lot more deeply than that. Our ambition extends beyond both of those numbers, but at least it became specific and actionable, stretch but not insane on both the revenue and on the margin side, so it has served that purpose, but our opportunities and our ambitions will exceed both those numbers during the cycle.

Okay. Makes sense. Thanks for all the metaphors. It makes it a lot easier to understand.

The team here is not as enthusiastic about all of my metaphors and analogies. Some of them work better than others, but thank you.

Thank you.

Next question comes from Joel Locker from FBN Securities. Your line is now open.

Just was curious about your cost per square foot in the second quarter. What was it, and maybe if you have it for a year ago also?

Joel, we don't break that out, because I always wonder about what's included and what's not included, but if you use direct costs of around $40 a foot, you're in the right range. It's up a little bit in the last year, primarily in framing and materials and labor, but that is not a metric that we have tried to wrap our hands around and communicate externally because if our mix changes, then all of a sudden, my cost of square foot changes, and I can't tell you whether it was labor and materials, or whether it's because we're building attached product instead of detached or two stories instead of one story. But $40 is still a pretty good number.

Thanks and on your underwriting, do you include any appreciation on the home price or the cost side?

We don't. And that's a stubbornness on my part. My view is I'd rather know what return I'm bargaining for. If everything stays the same, rather than at this point in the cycle, trying to be smart enough to guesstimate what might happen to prices at this location at specific dates in the future, and what might happen with labor, materials, costs by trade, at this location in the future. Those end up being opportunities to make lots and lots of assumptions, and adding up more and more assumptions doesn't make the analysis more accurate.

Right, and what about hurdle rates? Do you have a minimum IRR -- just?

We do, Joel. And others are probably going to hang up now because they're tired of me talking about it, but we use what we call modified internal rate of returns. It's actually an Excel thing, we didn't invent it. But we force the reinvestment rate in our cash flows to 15%, which is a rough proxy for an unlevered cost of capital and that, therefore, compresses a lot of IRRs with a 15% reinvestment rate, are really dramatically reduced in an MIRR math, but we target a 20% MIRR.

All right. And you're still finding deals at those rates?

We are, and we've done deals above that, and we've done a few below that. My view is, is 19% okay? It might be in a particular location were a specific risk profile, but I'd rather consciously make that bet and convince myself it was a 20% because we were smart enough to guess by how much prices were going to increase in March of 2016.

All right. Thanks a lot, guys.

Next question comes from Alex Barron from Housing Research Center. Your line is now open.

Sounds like maybe --

Hello?

There we go.

Sorry about that. I had the mute on. I was just saying that I'm trying to get my arms around the SG&A this quarter, and how it relates to the remainder of the year. I was just trying to figure out if there's anything that's one-time in nature. I know you mentioned you're opening new communities, but I'm assuming that's going to continue to happen every quarter?

Look, let me help you with it, Alex. SG&A in dollar terms will be higher in the third and fourth quarter than it was this quarter, but lower in percentage of revenue terms. And focus on 12.5% to 13% for the full year.

Got it. Okay. Thanks a lot.

Our last question comes from Michael Rehaut from JPMorgan. Your line is now open.

Thanks. Just circling back to a couple things, I just wanted to make sure I understood, a little clarifications, if you will. First, Allan, at risk of going back on the incentives question, and I appreciate all the additional detail and thoughts around that, but I was hoping also to get a sense, you mentioned the pricing was inching upwards across the footprint, incentives down 1% year over year, and again understanding incentives aren't the end all and be all, but just directionally, what do you see in incentives as well on a sequential basis this past quarter versus the previous quarter?

Boy. When you go from October, the first day of the previous quarter, to March, the last day of the most recent quarter, obviously you're covering from tip-to-tip really different environments, seasonal patterns and otherwise. So I have to tell you, the sequential change for the quarters was pretty modest, certainly less than 1 point in terms of improvement.

It was modest improvement. But I just don't spend a lot of time thinking about that, and I'm sorry, I don't have a metric for you. It didn't feel like we did things very differently, and so when we end up looking at numbers at the end of the quarter, the weighted average moves a little bit, but there was no enduring or searing message that comes through there. I'm sorry, I don't have something better for you.

That's fine. Basically what you're saying is, you think it's essentially stable more or less?

Yes, it's essentially stable.

Okay. And then also, again, just clarification, Bob, on that interest question, in terms of the savings from the actions you did on the debt side, given where your inventory levels are, all of else equal, in other words, not assuming any changes going forward, that wouldn't have any type of at least immediate impact on that, let's say, the $16 million that you did in the first quarter, that was not qualified? That's more of -- it's still relates more to the direction of the inventory balance?

It's absolutely true, Michael, that our interest expense going forward will be less, so therefore, all things being equal, we will drop a bit less into the income statement because of that. As inventory improves and continues to grow, that will ratably also decrease the interest expense below the line as we move forward.

But the simple way to thing about it is if you kept inventory exactly flat, that savings would, dollar for dollar, show up in the disqualified interest. That's the only place it would go. What Bob was trying to give you, Michael, was a little more nuanced view that we expect the inventory balance is going to grow, so there are going to be a couple things reducing the interest below the line in subsequent quarters.

Right, right. That's what I was getting at, in that, you already had that first driver of, as inventory balance grows, but aside from that, with this action, you did [$16 million] last year, you're going to expect roughly $8 million in savings, so inventory balance aside, you're starting from an $8 million lower base.

Yes. Figure about $2 million a quarter.

Okay, perfect. Thank you.

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