Beazer Homes USA Inc (BZH) 2014 Q3 法說會逐字稿

Good morning, and welcome to the Beazer Homes earnings conference call for the quarter ending June 30th, 2014. The 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, Brian. Good morning, and welcome to the Beazer Homes conference call discussing our results for the third 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 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, 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 for joining us. We were pleased to report profitable results for our fiscal third quarter, excluding the loss related to our bond refinancing.

This is the first time we have made money from operations in the third quarter since 2006. The gratifying part is, we made more than $6 million, while closing nearly the same number of homes as last year, when we lost just over $5 million. You might be wondering how did that $12 million turnaround happen? Well, there are a number of things that we can point to, including higher average sales prices driven by both an improving mix of communities and higher prices nationally. Higher gross margins, resulting from our initiatives to manage every community aggressively, and a tight leash on overheads.

In terms of numbers, in the third quarter we improved revenue by 13% to $355 million, grew ASPs by $31,000 or 12% and expanded gross margins by 240 basis points to 22.7%, which together allowed us to increase adjusted EBITDA by 45% to $32 million. We also invested $129 million in land and land development, to grow our community count.

The results reported today largely reflect home sales from prior quarters, so they aren't necessarily representative of the current selling environment. For that, we have to look to our new home orders, which are a function of both absorption rates and community count. Our orders were down about 6.5% versus last year, as a result of slightly lower absorption rates, and slightly fewer communities.

The absorption rate of 3.1 sales per community per month was fractionally lower than last year's 3.2. We think this absorption rate reflects a very good outcome in what is still a challenging new home sales environment. In fact, I'll be surprised if 3.1 doesn't turn out to be very near the top of our peer group, when all the results for the quarter are published. Of course we would like to sell more homes, but if we can sustain this pace while holding or improving prices and margins, we will be very happy.

On the community count side, we increased our end of period number of active communities sequentially by four, and got to the low end of our expected range of average selling communities for the quarter, but we had hoped to do better. We ended up selling in a slightly different mix of communities than we expected, and some of the new communities became active later in the quarter than we had estimated. I will give you a little more fulsome description of the community count numbers in a minute. For now, let me just say that averaging fewer active communities than we had hoped for isn't a reflection of any long-term operational or market issue.

Taken together, I'm proud of our accomplishments this quarter, and of the relentless efforts by our team to improve the aspects of the business that are within our control, and to make the best of the housing recovery, such as it is. These efforts have put us in a position to be confident we will record a GAAP profit for the full fiscal year, with momentum for even better results in the years ahead. Last November, we introduced our 2B10 plan, to reach $2 billion in revenue with a 10% EBITDA margin over the next two to three years. This plan calls for improvements in five key metrics, including sales per community, average selling price, average community count, gross margin, and SG&A.

I will spend a few minutes on community counts, and then turn the call over to Bob to go through our results, and the other 2B10 items. We ended the quarter with 142 active communities, and averaged 140 for the quarter. The average was down 3% versus last year, and as I said earlier, at the low end of the range of 140 to 150 active communities that we expected to have for our fiscal third quarter.

During the third quarter, we opened or made active 17 communities, and closed out of 13. In order for us to count a community as active, we have to sell the first two homes. Our challenge this quarter was twofold. We expected to get the first two sales in five to ten more communities than we did, and we expected many of the 17 communities to get active a month or two sooner during the quarter than they did.

That's not a sign that these communities are destined to be losers. It was mostly a sign that we were too optimistic in assuming we could make sales before we opened their respective model homes. While that does happen sometimes, particularly when we are selling out of a nearby community, making a lot of sales without a full sales presence is a tough thing to count on.

Taking a step back, for the full year we have added 48 communities and closed out of 40, leaving us up eight. With what we have under development and soon to open, we're poised for great year-over-year community count growth in the quarters ahead. Here's where we think community counts are growing. Yes, I think we can agree we haven't covered ourselves in glory trying to predict community counts, but hope springs eternal, so I'll take another shot.

In addition to the 142 active communities that we had on June 30th, we now have 57 communities under development, and 33 communities whose purchases have been approved, but have not yet closed. We expect 45 of these 90 communities to go active in the next six months. On the other side, at the end of June, we also had 33 communities with fewer than 20 homes left to sell. Think of these as the near-term close-outs. So if you just follow the math, 45 minus 33, we would add 12 new communities by December 31st.

One fact about making community count estimates that has become painfully clear is that it is easier for us to reach end-of- period targets than to precisely estimate the average counts during the quarter. That's because it is very hard to predict the month in which each community will go active, or close out during a quarter. The fourth quarter offers us a good example of this. We think that we will end September with 150 or more communities, which will be up 12% year-over-year.

But even if we prove to be exactly right about this, the average number could vary quite a bit. If each new community goes active, and the potential close-outs sell out, in the exact month predicted in our internal forecast, we will have 150 communities, on average. On the other hand, if the new communities only become active in the last month of the quarter, the average would be closer to 140.

My educated guess is that it will end up somewhere in between, but higher than last year in all events. Assuming you have now heard enough about community counts, I'm going to turn the call over to Bob, to provide more details on the quarter, and the progress we've made on the other parts of our 2B10 plan. Bob?

Thanks, Allan. Starting with revenue, for the quarter, our total revenue was $355 million, up 13% versus a year ago. On a trailing 12-month basis, total revenue was $1.36 billion, up 10% versus the prior 12-month period, as we continue to make progress toward our 2B10 objectives. We continue to sell and sell at pace this quarter, recording 3.1 sales per community per month, versus 3.2 last year.

There are many variables that impact sales per community when comparing one year to another, including regional differences. This year we had increases in absorptions compared to last year in Houston, Indianapolis and Charleston, and slight decreases in Phoenix, Las Vegas and Tampa, all of which still sold at least three homes per community per month. The only division that had lower absorption rates and fell far below our expectations was New Jersey, where we have eight communities.

On a trailing 12-month basis, our sales per community per month held steady at 2.9, very favorably to 2.7 last year. Increases in all three segments, our ASP rose to $285,000 for the quarter, up 12% versus last year, while our ASP of backlog grew to $300,000, providing evidence that we are on track to reach the target for this portion of our 2B10 metrics in the coming quarters.

The increases in our ASPs are not simply a reflection of improving market conditions, but also a direct result of the operational improvements we began several years ago. For example, the 18% growth in ASPs in the southeast segment was driven by contributions from newer communities, with updated plans that are located in better school districts. Our backlog conversion rate of 57% for the quarter was in the middle of the range we provided on our last call, and in line with last year.

As in prior years, we expect our fourth-quarter conversion rate to be considerably higher, likely more than 75%, and as we anticipate ending the year with around 5,000 closings. This significant portion of our backlog is scheduled to close during the fourth quarter, and an ample supply of specs in our newly-active and soon to be active communities, we're in position to reach this goal.

Turning now to EBITDA. At the end of June, our LTM adjusted EBITDA grew to $113 million, up almost 90% versus last year. Our EBITDA margin on an LTM basis is 8.4%, up substantially from last year, when it was 4.9%. As we increase our closings in our fiscal fourth quarter, we will see further improvement in adjusted EBITDA and our adjusted EBITDA margin.

The third quarter, our home building gross margin was 22.7%, which was up 240 basis points versus last year. All three of our operating segments reported year-over-year growth in margins, and our gross profit exceeded $61,000 per closing, up more than $11,000, or 22%, as compared with a year ago.

As it relates to our 2B10 plan, gross margin on a trailing 12-month basis was 21.9%, up 330 basis points from last year, and nearly reaching our 2B10 target of 22%. Gross profit increased to $57,500 per home closed on a trailing 12-month basis, from $44,800 last year, representing a 28% year-over-year improvement. For the fourth quarter, we expect our gross margin to be above last year's 21.4%, but not quite as high as the 22.7% reported this quarter.

As with every quarter, we expect a different mix of closing by geography and by product type, both of which impact gross margin. Specifically, we expect our [East] segment to contribute larger share of closings than it did either this quarter or during last year's fourth quarter. While we're encouraged by improvements in our East segment's gross margins, they remain slightly lower than in our other segments.

SG&A was 14.2% of revenue this quarter, an increase from 13.6% last year, but down from 16.2% last quarter, as we had expected. In dollar terms, excluding commissions, our G&A went up by $6 million to $36 million, driven by several factors. First, last year, we benefited from $1.4 million in insurance reimbursables, which we didn't have this year. Second, we increased our advertising spend by just over $1 million to support new community openings and to generate interest in our coming-soon communities. Finally, our headcount was up about 10%, as we prepare for our community count growth.

Looking ahead to the fourth quarter, we anticipate our G&A dollars will increase modestly compared to last year, up less than $5 million, resulting in SG&A as a percentage of total revenue below last year's fourth quarter, which was 12.3%. This leads us to estimate that full-year SG&A should be around 13% of total revenue, down from 13.5% last year. Looking at SG&A on a per homes closed basis, we continue to be among the lowest cost operators in the industry.

During the quarter, we spent $129 million on land and land development, in line with the amounts we've spent every quarter this fiscal year. Based on our investments to date and the land transactions that we have in the works, we now anticipate spending in excess of $520 million for all of FY14. With our increased land spending, our inventory levels have continued to rise.

At the end of June, we had nearly $1.6 billion of total inventory, up $323 million or 25% from last year. This increase in inventory has allowed us to add approximately 2,800 lots to our portfolio since last year, bringing our total owned and controlled lots to nearly 30,000 lots at June 30.

Looking at our capital structure, in April we successfully refinanced our 9 1/8% senior notes, due 2018, with 5.75% senior notes in 2019, and reduced our annual cash interest expense by over $8 million. As we have said before, our next capital markets activity is likely to be a refinancing of our 2019 notes, which at current yields, could result in more than $5 million in annual interest savings. We ended the third quarter with no significant debt maturities until 2016, [$260] million in unrestricted cash, and an undrawn $150 million revolver, all providing us with sufficient liquidity to meet our 2B10 objectives.

Finally, we currently estimate that we will be able to use approximately $479 million, or about $15 a share, in deferred tax assets, to offset our future tax liabilities. This estimate is about $1 per share higher than in previous quarters, due primarily to a favorable tax appeal ruling that we received earlier this month. This appeal related to a carry-back for certain tax items, which will be recorded as a tax benefit during our fiscal fourth quarter. We expect to receive $26 million of cash plus interest, hopefully by September 30th. After accounting for this tax benefit, we expect that we will be able to use the remaining $453 million in deferred tax assets to offset cash tax liabilities of the future. As we discussed in the past, the exact timing for bringing our deferred tax asset back onto our balance sheet is not known, but we do expect to start the process during FY15.

Before turning the call back over to Allan, I would like to mention one other item that will impact our fourth-quarter financial results. On July 1st, Beazer Pre-Owned Rental Homes, which was founded in 2011, was sold to American Homes 4 Rent. As a result of this transaction, we received Class A common stock in AMH, and we will record a gain of approximately $6 million during our fiscal fourth quarter. With that, let me turn the call back over to Allan for his closing remarks.

Thank you, Bob. When our Management team took over three years ago, we were near the end of the year, in which we lost $200 million. We made it our overarching financial goal to return to sustainable profitability as soon as possible. You have seen that phrase in many of our press releases, and heard it on these earnings calls.

The good news is that we expect to accomplish that objective this year. Specifically, we expect full-year adjusted EBITDA to be at least $45 million above last year, and net income, excluding the bond loss, the gain on the sale of pre-owned homes and the tax pick-up, to be above $20 million.

Including all of those items, we expect our full-year GAAP net income to be above $30 million. So with or without the one-time items, we expect to make money this year. Now, there won't be any confetti or champagne, because we know how much more work we have to do, but we will be very pleased to deliver those results.

In terms of our more detailed operational metrics for the full year of FY14, we now expect sales per community per month of about three. ASPs pushing toward $290,000, an end of year community count of approximately 150, homebuilding gross margin slightly above 22%, and SG&A as a percentage of total revenue of approximately 13%. Achieving all of those objectives will represent excellent progress in year one of our 2B10 plan.

I would like to end with a few comments about the housing market and our stock pricing. Investor and media sentiment regarding for sale housing in the home building industry has turned very negative in recent months, and our stock has fallen 30% this year. Both reactions seem overdone, in my opinion. In terms of the overall housing market, I don't pretend to know more than the economists, the analysts and the demographers who study housing.

It is clear that the home sales environment remains softer this year than most of the experts predicted, but there's still a lot to like about the housing market right now. We have improving employment conditions, stronger household formation, very low mortgage rates, steadily rising apartment rental rates, and limited new and resale inventory. Yes, the lending environment is still overly restricted for certain borrowers, despite serious efforts by lenders to reestablish more traditional mortgage underwriting practices. But taken together, the underlying fundamentals for new home sales have rarely been as favorable as they are today.

As it relates to Beazer and our share price, I know our best defense of the stock price over time is to improve profitability, and the evidence will show that we've already improved LTM EBITDA by $140 million in the past three years. Despite all the challenges facing us, and before we have had the assistance of a growing community count. But it is also my job to make the case for a higher share price, so here's my pitch.

We have radically changed our divisional leadership and our culture. That has allowed us to become a very sound operator. Our sales absorption rates are at the top of our industry. Our overheads are among the lowest. We are now generating gross margins in line with our peers, and we're about to get help from a growing community count.

With our capital structure, we have the liquidity to reach our 2B10 goals, and a lot of earnings leverage from future operational and market improvements. We've also got $300 million in legacy assets that will add to future profitability as we bring them on-line. Finally, once we remove the valuation allowance on our DTA, which we expect to begin doing during FY15, we will have a book value above $20 a share. With our earnings potential, it seems illogical to me that we would be the only builder to trade below book value.

The bottom line is that we're excited about the future, and we look forward to reporting even stronger results in future quarters. Thanks for joining the call today. At this point, I will ask the operator to take us into Q&A.

(Operator Instructions)

David Goldberg, UBS, your line is open.

Good quarter. The first question I wanted to talk about was with community counts, and trying to get an idea -- Allan, I know it's difficult to predict the timing of when communities are going to open. But I also know that, as a corporate management team, you want to make sure that you have -- that you're keeping people in the field -- very, very diligent in terms of moving the process along, going as quickly as possible.

I was wondering if you can talk about how the timing for community count openings is controlled, or the oversight at corporate, and is that part of your division people's pay and compensation packages? Maybe you can just talk about how you keep control of it, when obviously it's a difficult thing to predict?

There are two primary elements to that, David. The first one -- maybe there are three. There's an entitlement and approvals part. Once you own a piece of raw ground, you have got to make sure that you have got all of the permits and approvals in place to actually move.

You can be zoned for a certain property type, but you have to get your final map approved before you start moving dirt. So, tightening that up -- making sure that we've got that dialed in -- that's the first challenge. And I would tell you: Not this quarter so much, but earlier this year, I think there were a few communities where we were surprised that it took longer to get maps processed than we expected.

The second part of it is clearly: You actually have to do the physical on-site land development. You have to put in roads and pipes and curbs and gutters. And I would tell you that part of the overhead that we talked about hiring this year, and have hired, is to beef up our land development capability -- the senior guy here at our corporate office with 20-plus years of experience -- more people in the divisions to manage those schedules.

The challenge with land development -- it's a little bit different than I think other industries -- that there is a sequencing. So, if you get behind, it's hard to put more equipment on a site to catch up. So, managing it through each of the stages and understanding day by day, week by week, where we are, is clearly a discipline.

Two or three years ago, we weren't opening a lot of new communities, and if we were, we weren't doing a lot of land development. We've had to adopt a much more rigorous scheduling system for those communities. Those report up to us at corporate monthly. And if there is a variation week to week, that is by more than a couple of weeks, we will see it in for a month.

I think if I gave a report card across 16 divisions, I think probably we've only got three divisions that are still in the C category in managing those timelines; the rest are on the A/B. And we're working hard on it.

What I talked about this week, or this quarter, is the third leg of it, which is: You start to get the land development under control, you are moving towards having finished lots on the ground, and now you've got a race. You're starting a model home, you need a building permit to do that, you want to get it built, and then you need to get it furnished and grand-opened.

Where do you start trying to take sales? You can put a gal with a card table and an umbrella out on a site before you start moving dirt; that's not likely to work very well. You can put a trailer on a site; sometimes that works. You can sell the community from an adjacent community, and sometimes that works. But the fail-safe -- the go-to normal course of events is you've got to fully complete it and decorate a model, and staff, and that's really when you start trying to make sales.

I think if I look back to the May quarter, and I think about where our expectations were versus -- or the June quarter, where our expectations were versus what actually happened, there were too many instances where we were hopeful about making sales either from sales trailers or from adjacent communities, but when I went back and looked at it, and studied more closely, when the grand opening of the models was, that's really where our disappointment came from in the community count. As I now look at Q4, and look beyond, you can be assured that I've got a little tighter visibility or a closer visibility into when models are opening.

Now, let's be clear: I'm not letting our team off the hook to start making sales as soon as they can. In many cases, we can sell out of a trailer, or we can sell from an adjacent community. We want to try and do that, but I think our estimating of that, and the optimism embedded in that bit us this quarter, as it related to the average active community count.

That was great color. Thank you. Just as a follow-up, Bob mentioned that you increased some of the marketing expenses for the new communities, and some of the grand openings. I was wondering if you can talk about how your marketing expenditures are changing, in terms of media that you're using to try to hit clients, and what you're seeing in terms of trying to gain some extra excitement from clients, and draw some traffic away from other builders? Is there any change, and what kind of marketing techniques are you using on the sales side to try to drum up some interest in what feels like a stagnant housing market?

There are a couple of different things there. I won't, in one category, go into a lot of detail, because there are very few competitive advantages in this industry. And I'm not arguing that we have one, but if we did, I wouldn't want to give it all away.

The thing I'm alluding to is online marketing and social media marketing; there's no question that is the lion's share of the working ad budget for our Company. That's, I'm guessing, true for most of our peers, but the ways in which one does that are -- there are lots of options.

Some things work better for events, other things work better on a drip basis, to sustain a level of visibility. But we have continued to increase in dollar amount, and refine in application, our online spending. I spent seven years in the Internet, running an online advertising platform in the real estate industry, so this is an area that I personally spend a lot of time. I want to make sure that we're not stuck.

And it's funny: You can think about getting left behind by being in the newspaper instead of being online. As the consumer profiles change, and buyer profiles change online, we have to be in different places and in different ways.

What's become increasingly challenging is: You really have to have earned online media presence, not just paid online media presence. Finding organic ways to do that, involving customers in the buy process and having them talk about us, there's some infrastructure that we can put in place to do that, but those references, those experiences, are frankly incredibly valuable, and you can't just pay for them. So, that's a big part of what we're doing.

But around new communities, there really are two things. You've got to get your signage right, and you have got to get integrated into the realtor community.

So, we've thrown every manner of party/event for realtors in local markets that you can imagine. We've rented movie theaters. We've done hot air balloon rides. We've had carnivals. We've got to make sure that the people who are in touch with -- two-thirds to three-quarters of our buyers -- that they know we're coming, they know what our value proposition is, and they know what will be available and when. So, that realtor relations is a very big part of it.

Then, the signage is key. Being on the right billboards, being in the right locations -- that's one area of the so-called old media that hasn't changed. In fact, if anything, it's become more important. That's what we're doing in the category of media spend and behavior spending.

The other side of it is what we've done inside the models. And we have really changed our sales centers. Some of our peers have done some really creative things. What we've tried to do is to make the experience with picking a floor plan and an elevation a little bit more tactile.

There's a lot of brouhaha about digital sales centers and fancy iPads and everything; that's okay. But honestly, the experience of having a magnetized board where you can sort of look at, and touch and feel how a floor plan can change with our choice options, we have found that has been very effective. So, we spent a little bit of money updating our sales centers to create a different experience; not just more screens and more media, but also things that you can touch and play with. Those are the categories both outside and then inside our models, where we're spending money to create enthusiasm, in what you're right to describe as a tepid environment.

Thank you. That's great color.

Next question: Alan Ratner, Zelman & Associates.

Thanks again for all the disclosures and guidance. Allan or Bob, on your absorption guidance to hit three sales per month for the full year, if you look at where you have run through the first three quarters of the year, I think you are at about 2.85 sales per community. To hit that number would imply an actual acceleration in absorptions in the back half or in the fourth quarter, or at least maintaining the 3Q level, and that's counter to what normal seasonality is. I was hoping you might give us a little bit of read on July, or give us some insight into why you are optimistic the absorptions in 4Q can be actually above that three level?

Optimistic wouldn't be exactly the word that I would use. Let me frame it this way, for you, Alan. I will start with the quarter, and then I'll give you a couple of comments about July. I think about the fourth quarter as being framed by what's a low-end expectation that's reasonable, and what's a high-end expectation that's reasonable.

There obviously are two variables. One is the absorption rate; the other is the community count. As I have talked about, the average community count is in question. I gave a simplistic example of how it could be 140 or how it could be 150, and you can figure out, that makes a big difference.

Let me say, from a boundary condition standpoint, if we talk about what would be a very disappointing outcome, it would be to be at or below the level where we were last year in the fourth quarter, which was, I think from memory, 1,190 or 1,192 orders. That would translate into an absorption rate of about 2.8 on 140 communities. And we clearly expect to do better than that.

If you look at the other side and say: Okay, well, if we were at three sales in the fourth quarter on 150 communities -- again, optimistic and a little optimistic -- that would be 1,350 orders. And I think that our bias within that range is slightly higher, but not all the way to the top. And that's why I said in our wrap-up: We expect the full-year sales per month per community to be about three. If I told you at the end of the year it was 2.95, that's certainly inside a range I think we would be very happy with at this point.

We were probably 1/10 light in the third quarter and 1/10 light in the second quarter. So, the math is what the math is, which is obviously what your question is getting at.

But we've got these 45 communities, many of which are going to get active in the first and second months of the quarter. Typically, when we get a community active, and we get that first sale, we get the second and the third and the fourth sale pretty quickly. So, that's an element of the -- I guess, if we were going to use the word optimistic, the optimism that I've got.

All of that said, I've tried to frame for you an expectation for the quarter that dovetails up with where we expect to be for the year. I don't have all of the July results, but the first few weeks in July have not been stellar. So, you would say: Well, gee, if you have got two or three weeks that don't feel great, why not further reduce your expectations? I think part of it is: We looked at our own intra-quarter patterns, and we've typically done better in August and September than in July. I think that will persist as I look at our new home communities or our new openings coming down the pipe.

The other thing is -- and you didn't ask, but I want to put this in context. If I think about the third quarter, April was pretty slow relative to expectations and, frankly, year over year. May was better, and June was quite a bit better. So, I'm glad we didn't panic in the middle of April or the beginning of May and say: Gosh, April wasn't what we wanted, so we need to go pull a bunch of levers and do radical things.

I think we're executing well. We're driving the right traffic. The demographics and the income levels of the traffic we're driving are good.

We're making conversions; it is taking a little bit longer. I really feel like that's the environment that we're in. So, I'm not too worried about two or three weeks' worth of sales in July. But I want to be clear: The first few weeks have not been great.

That's very helpful. Thank you very much.

And the second question on the margin guidance: Your 22% target on the 2B-10 -- you're there now. Given some of the recent chatter in the industry from some other builders about incentives creeping higher, and I think you guys might have had a sales event in June as well, just curious: In the near term, is the current level of margins you're at, now that you are at that target, should we think about you now focusing more on the volume side, and looking to either maintain the margins here, or do you think that there's some potential upside further from here?

I know that mix is always going to play a real role in this. And in the next quarter, Bob talked about the east segment, where we've made some big investments, we've got better communities and better-located communities coming soon, so I'm pretty optimistic that our east margins are moving up.

There are challenges, as you know, out west, where margins could be under some pressure. I think we were just under 25% in our gross margins this quarter out west. I think those are going to be under some pressure.

The mix is really the trick for us to try and dial in quarter to quarter to quarter. And so, we've tried to be clear about that for the fourth quarter. I think, as I think about the Business over a slightly longer period of time, that low-20%s range, 22%-ish plus or minus, up a little bit we hope, is what we're shooting for. But we've never tried to pretend that we're an upper-20%s margin builder. That's not the positioning that we have. That's not the land position that we have.

So, I don't see any signs on the horizon that we've got some great risk to where we are. We have withstood others' incentive strategies before with new product and our 4P plans that we're dialing in every single week. We know how to compete. But I don't think there's tons of upside from here -- from where we are.

And then, that pivots to the other part of your question, which -- is it more volume? Damn right. That's where the community count is going to, I think, be the next wave of operational improvement for us. I don't think anybody will argue that we've improved absorption rates to a pretty darn good level. We've improved gross margins to a pretty darn good level. I think we bring the community count to bear now, and that's where the volume growth comes from.

Thanks a lot.

Next question: Michael Rehaut, JPMorgan.

First question I had was on -- actually the interest expense -- came down nicely in the quarter, in terms of the -- what was not qualified for amortization. And you also had some leverage on a year-over-year basis, in terms of what was in COGS. Particularly on the not-qualified front, but maybe you could also talk to COGS, as well as a percent of sales, how are you thinking about that in the fourth quarter? And given the trends that you're seeing in terms of how you are thinking about land investment and potential for some revenue growth next year, how should we think about 2015 -- if you could give us any directional sense? I know guidance probably is a little premature right now.

Sure, Michael. As you know, this is a pretty complicated area, so I'm going to try to keep it at a 10,000-foot level and hopefully answer your questions. Our total interest incurred on a go-forward basis, from a cash perspective, is about $115 million.

If you think about the direct expense -- we talked about qualified assets versus unqualified assets. And if you do a simple formula where you subtract your debt -- you take your debt and you subtract your eligible assets for capitalization, and if you looked at our inventory total today, the eligible assets are just over $1 billion or so, when you back out land held for future development, held for sale, and those things where you can't capitalize interest. You leave about 30% of the interest incurred that you have will go directly to the bottom -- to the interest expense line below cost.

So, that leaves about 70% to be capitalized. And when you think about how you relieve that capitalized portion in any year, obviously there's an impact of what's happening to your eligible assets. If it's increasing, you probably will relieve a little bit less on a go-forward basis. If it is decreasing, you will relieve a little bit more, as you lead into not only what you capitalized this year, but also some of that beginning balance of capitalized interest.

So, I think, we haven't given guidance about what's going to happen with inventory next year in land spend, which is going to be the big driver of our inventory. But I think that might be a way for you to think about it on a go-forward basis.

I appreciate the mechanics in terms of how you are getting there. I don't know if I missed in that answer, because, again, the interest did come down nicely -- has been coming down nicely, particularly in the third quarter did it come down nicely. And I know, obviously, like you said, it involves some view on the inventory balances. But I mean, is it safe to say at this point, given the directional trends in terms of your spending plans, that the -- at least the not-qualified interest as a percent of incurred should continue to come down, as you perhaps work through some of the non-qualified assets or build the qualified assets?

Absolutely. That's exactly what we would expect to happen.

Okay. Second question -- just on the SG&A -- certainly appreciate you guys pointing out obviously then on a per-closing basis, you're very competitive or at the better end of the range within the industry. But obviously still as a percent of sales, still runs a little high, and that has to do with some of the, I guess, just basic math of the revenue and fixed overhead perhaps. But you have come down over the past couple of years.

How do you guys think about SG&A, in general, as a steady state? In the past cycle, actually the Company was very, very consistent at like about a 10.5% ratio, and I mean, is that something where we could -- obviously not for 2015, but over time, is that the goal for the Company?

Let me address it -- a couple of points, Michael. I'm not going to take it from the perspective of what the Company used to do, because unfortunately some of what the Company used to do in absorption rates and margins wasn't so good. So, I don't want to go there.

But I would tell you, with revenue growth, we clearly have an ambition to drive that SG&A. As we talked about in our 2B-10 plan, on a full-year basis initially to 12%, and then lower than that. And we can do that, and we will do that.

But one thing, and I haven't spent a lot of time talking about it, because it is frankly irritating to have to talk about, but it is a fact. I want to put it out there. We signed an agreement with the government a number of years ago related to our behaviors. Included in that was a restitution fund and a penalty which relates to approximately 4% of our adjusted EBITDA. We're going to be paying it for a couple more years.

As we have turned the corner and started making money, we're now spending money on that agreement. This year, we will spend on the order of $6 million, which is flowing through G&A, on that deferred prosecution agreement. We have two more years of that. That's going to be almost 0.5 points in our SG&A number this year.

And it is what it is. It's an agreement we signed. It's an obligation we have; we honor our obligations. But I just think, when we look at: Are we being competitive? That's a per-unit thing on a percentage basis -- does the number make some sense?

I think we haven't done a good job of necessarily explaining all of the things that are in there, and that's frankly a pretty lumpy one that we're going to have for a couple of years. It will go away. We will, and have, lived up to all of our obligations, but that's a headwind, if you want to call it that, inside that number that I don't think folks have really focused on.

No, that's certainly very helpful, Allan. Just to clarify on that: That's something that is expected to be paid through FY15 or FY16?

Through FY16. It's a very complicated formula, but if you take our adjusted EBITDA number and take 4%, it is pretty close. In the agreement itself, there are some pluses and minuses to the definition of EBITDA, but that's sort of a rough order of magnitude to think about, that will continue to exist for a couple more years, and then it will go away.

Appreciate it.

Next question: Adam Rudiger, Wells Fargo Securities.

Going back to your pitch at the end of your prepared remarks about the stock price, if I were to play devil's advocate or think about the things that maybe would be the offsets to that, one of them is just interest incurred. It's well above peers. So, that's another significant headwind that you're carrying. What are your thoughts on that?

You mentioned some potential to refinance some additional debt, but any expectation when that might normalize? I think it's about 9% on a run-rate basis. Peers are on a 2% to 3% as a percentage of sales.

So, we certainly started life with a lot more debt than we had eligible assets. It's an awful tough thing to get profitable when you have $1.5 billion of debt. And at the time, I think we had about $600 million of working assets.

As Bob said, so-called eligible assets are up to $1 billion, so we have been growing that nicely, and we're going to continue to grow that. At the same time, we've been attacking the cash interest expense with refinancing transactions, including the one in April. What I don't think makes any sense is to try and equitize -- to sell really cheap stock to pay off bonds that are yielding in the low-single digits. I want to be clear that I don't see that happening. We are going to have to grow into this balance sheet.

The good news, Adam, is this is the year where our EBITDA exceeds our cash interest expense; and so, all growth from this point, in EBITDA, gets us to the bottom line. So, it has been a mountain to climb. It is the reason that we are, if not last, among the last to get profitable. That's a fact.

But going forward, having covered the nut, we don't see any occasion to increase the nut. And in fact, there will be incremental opportunities to reduce it. Bob telegraphed one: the 2019s that have a coupon in the 9% category. And I know that the high-yield market is in some disarray right now, but I don't think our refi rate on that is going to be 9. I think it is going to be lower than that. Every point is $2.5 million of cash interest savings.

Then we're going to go after other parts of the capital structure, and it is why we only have two bonds in our entire cap structure that are non-call light. I like having that call protection, so that as we improve the credit characteristics of the Business, we're able to refinance and lower our costs.

The last thing on this, and I know it was in my pitch, and it's in your devil's advocacy is: What's the right credit rating for this Company? What's the right interest cost for this Company? I can't tell you. The market will tell us. But I am sure that when we have the benefit of that deferred tax asset on our books, people start looking at debt to equity, not at 6 or 7 times, but at 2 or 3 times, I have a feeling that will be well received in the bond market, which is an additional benefit that we are going to use to try and drive further savings out of that cash interest cost.

Okay. Thank you. And then, you also mentioned in your prepared remarks you still think you have a lot of work to do. If you have gross margins where they should be or where they are going to be for a while, so that's -- heavy lifting's done there, maybe the same thing on costs. You just talked about some of the heavy lifting -- or lifting still on interest. Where else do you see then -- what's the biggest hard work still that you have left? What's the next area?

The next area is getting communities open. I tried to be realistic and not funny, but we haven't covered ourselves in glory in our ability to predict these openings. I'm embarrassed by that. It is a fact.

But we've been spending the money on land and land development for the last year and a half. Those communities are coming. We didn't lose them. Nobody else has them. They will open, and I think that is -- we've got to get them open, and then they need to perform at or above the levels of the existing communities when they do. So, opening on time, or opening as soon as possible, and opening well is crucial.

I think the other area for us, and it's not a next quarter or even next two quarter kind of thing, we've got $300 million in land held for future development. Working on the land plans, and the highest and best use of some of those assets, I'm really confident that we can create EBIT and earnings per share from those assets, that aren't in anybody's estimates right now. We've got to do that. Those are two big areas that we're working on.

Makes sense. Thanks for taking my questions.

Next question: Eli Hackel, Goldman Sachs.

Just wanted to touch on absorptions and community count growth, in the context of what is a moderate overall housing environment. Just wanted to focus, Allan, on your ability to keep absorptions flat with growing community count, at the same time demand isn't growing very much. Many builders are aggressively growing their community count at a time where demand doesn't seem to be growing at the same pace. So, what's the confidence that absorptions can stay at these levels over the next 12 months or so?

I can't give you my 2015 forecast, because we're not doing that on this call. I appreciate your question, Eli.

I think we have been slower to buy new communities, and slower to open them, in part, because we've tried to be selective. It is sort of tough.

There was a window in the market where we could have bought a lot of communities. I'm not sure how well they would have performed, but we would have checked a box on community count. What we've tried to do is be a little bit more patient, and buy communities where, when we open, they're going to open right. And by right, I mean not be dilutive to our objective metric targets. So, that has been part of our underwriting.

The scoring that we use on our existing communities in terms of absorption rates and contribution margins, we use on all perspective deals. If they aren't equal to, and moving beyond where we are on our 2B-10 metrics, we don't want to do those deals.

So, you are right: one of the things -- and I'm going to sidebar for a second because it is actually something we talk about all the time. We're going to open a new community, and we're going to open it typically in a context where there are existing competitors. This is important.

When we know we're going to be opening a community, we're not the only ones who know it. So, I joke with our team, but it is true: It's not like our competitors are going to throw a welcome-to-the-neighborhood party for us. What they're going to try and do is get as much intelligence as they can about how we're going to open, what's our product, what are our elevations, what's our value proposition. And just as soon as we open, they're going to counterpunch us. That's the nature of this industry. So, we know that.

So, the question is: What's our response to the counterpunch, not just how are we going to open. And it's that second dimension, anticipating, and we won't get it right every time, but our thought process is: We've got to open in the context of what the current competitive environment is. We have to anticipate that someone is going to react to that, and we want to be almost instantaneously ready to react to that.

Now, this is not just a price lever game. I always talk about 4Ps: the product, and the way we're marketing. And the price, which, by the way, is inclusive of base price and options and lot premiums, and all of those things. We have a very sophisticated open strategy for every community based on initial open, reaction to response, et cetera.

So, I can't tell you that every community is going to open and be perfect. It won't. But I can tell you the thought process and the work that goes into getting ready to open -- it's probably one of the things that if my Division Presidents were on this call, they would say all the trouble we give them about being ready is one of the things that gets in the way of getting open fast. That's been an unfortunate headwind to date. I hope that puts us in good stead or better stead than would otherwise be the case, as we look out the next 12 months.

Okay. So, then just to clarify, just on that point, if you are going to open a community, and there's one competitor right now, but by the time you open, maybe there's going to be four competitors, because everyone is opening those communities in a similar area, you're taking that into account?

Boy, if we get surprised by a new competitor -- and it has happened one time. We have opened one community this year where the rain of tears was: Well, we didn't know that XYZ was going to happen, and we missed it. It was knowable. These communities aren't stealth bombers; you can see them coming a mile away. We missed one. That was an object lesson on our Friday sales call that I promise nobody enjoyed. We won't make that mistake again.

Great. Thanks very much.

Next question comes from Jay McCanless, Sterne Agee.

First question: Just to clarify, the $26 million cash plus interest, if you receive it by the end of the fourth quarter, that's going to appear on the income statement?

Jay, it is going to appear on the income statement regardless of whether we receive the cash by the end of September.

Okay. Just want to clarify that. (multiple speakers)

If we don't get the cash, it will be in accounts receivable.

Perfect. Second question, and it's on page 29 of the debt. You have done a good job of bringing the inventory held for future development down. Just wanted to find out what progress you have made on the assets in northern California that you have referenced on past calls? And if bringing those back on would be any help, in terms of lowering the interest expense on the income statement?

And the answer is yes. We did make active one of the northern Cal assets that was outside of the Natomas flood basin, I think, last quarter. And talking with our team out there, we are working on having plans to get approved in that municipality, and we expect to be open in that market in our fiscal first quarter of 2015. So that we are getting a little benefit to the interest of that. The other communities in northern California, and there are two very large ones that are affected by that Natomas flood basin, I think will be active in FY15, but probably second or third quarter.

Just for those that have been paying attention to Sacramento, the President signed the WRRDA Act, I think, in June. We're about 12 months away, we believe, from being able to pull building permits in Sacramento. But there is work on the land plan and work on the building plans that will take place prior to that.

It's a very highly choreographed deal with FEMA, the Corps of Engineers, the City and the County, on both the land plan and the building plans. But I think there will be, in 2015, assets in northern California that get activated, though we won't have any closings from those incremental assets in 2015. They will start to affect what the eligible asset pool looks like, which will have an effect on interest expense.

Great. Thank you for that color. And then one other question -- just talking about the competitive environment and what you have said so far about July sales. If you had to pin it on one thing or the other, would you say that the weakness in July is attributable to actions by your competitors, or does it just seem to be a slacker demand pace than what you saw in July of 2013?

I'm not good enough, to be honest, to tell you July of this year versus July of last year, and sort of how it feels. Because so many things have happened in the meantime.

I will tell you that I don't think that there is a specific competitive activity by one or more peers that have changed the market dynamic. I just don't get that feedback. I talk to our guys at least once a week, and their sales Vice Presidents. That's not what I'm hearing.

There's a lack of urgency, and we have to manufacture it. Somebody referred to the fact that we had a June sales event. We did. By the way, we're going to have an August sales event. We're going to be like Toyota and have a sell-a-thon every month, if we have to. The fact is: We did it in February, we did it in June, we'll do it again in August.

The good news is that having events focuses the mind, creates attention; it creates a little momentum. It hasn't been deleterious to margins. I think that's one of the things people assume: Hey, you are going to have an event, you are going to go crush your margins. That's not been the pattern.

So, I can't tell you that we won't be aggressive if we have to. Absolutely, we're going sell some homes, but I do feel like the market is requiring us and our peers to manufacture urgency or events or enthusiasm, and either we or they didn't do it very well this month. So, we'll do better next month.

Great. Thank you.

Our last question today comes from Alex Barron, Housing Research Center.

I wanted to ask you about the sale of the rental homes, and the AMH shares that you got. Are you going to hang on to those, or are you going to sell them?

Right now, we're under a restriction because they don't have an effective registration statement; and after that, the Board and we will decide. I don't think, in the long term, we are likely to be shareholders. We don't have a specific date by which we will or won't sell.

But I will tell you: I think the considered decision by the Board of the pre-owned homes company, of which I was Chair, to take AMH's stock, reflected a lot of confidence that AMH is an exceptionally well-run company and frankly had, we thought, the best match of assets with the pristine assets that we had. I like that single family rental space. I like the assets that we and that they have. I like their scale. So, I think that's a very attractive asset for us.

But long term, it's not a strategic asset, and it's clearly not one that investors should expect we'll hold forever. I just don't have, at the moment, a timeline by which we will sell it. We would like to redeploy that money in our core business, but at the moment, that extra $26 million isn't the thing that's going to make a difference in our growth trajectory. And I still think that things are ahead for that single family rental category, and from AMH in particular.

Got it. And my other question is: I guess one of the larger competitors last week signaled that they intend to increase their sales pace, and that they were willing to sacrifice margin. You guys seem to be willing to, or signaling you are going to increase your sales pace, but you don't think your margin is going to go down, or am I wrong? Are you just compared -- prepared to compete head to head to just hit your sales pace?

We're talking about trying to hold serve on our sales pace. We start to get into these fine-tuned discussions with the difference between 3.01 and 3.1, and it's very hard. But at the 3-ish level -- we want to stay there. We would love it to go up. I'm not going to do things though, to drive it up. We will try and protect it at around that level.

There will be seasonality. One of the other questions was about that. The first quarter won't be at that level; it never is. But in the near term, I think our objective is to try, as I said in the opening, to hold our pace and price and margin, and I think we're well positioned to do that.

Great, thank you.

All right. Well, I want to thank everybody for joining the call. I know that I made you indulge me, and let me make my pitch for our share price, and I also know that we've got to go out and earn it, but I appreciate your attention, your questions, and look forward to talking to you next quarter. Thank you.

Thank you. And, once again, that does conclude the call for today. You may disconnect your phone lines at this time.