Beazer Homes USA Inc (BZH) 2015 Q1 法說會逐字稿

Good morning and welcome to the Beazer Homes earnings conference call for the quarter ended December 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 in the investor relations section of the Company's website at www.beazer.com. At this point, I will turn the meeting over to your host, Ms. Carey Phelps, Director of Investor Relations.

Thank you, Ella. Good morning and welcome to the Beazer Homes conference call discussing our results for the first quarter of fiscal year 2015.

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 the 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 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 for joining us. You have likely seen the press release that we issued this morning. In it we reported a larger-than-expected net loss of $22 million for our fiscal first quarter, which included $13.6 million of additional warranty reserves related to the stucco issues in Florida that we discussed last call, as well as a $4 million charge related to our discontinued operations.

Bob will talk in more detail about the reserves in a few minutes, but first I want to highlight the operational results for the quarter and comment on current market conditions. While losing money is disappointing, there were plenty of good things that happened in the quarter.

Orders rose 7.9%, with absorption rates in line with our expectations. Our ending community count was up 13%. We also saw further improvements in our ASP, which increased to $296,000, up 6% year over year.

Homebuilding gross margins, excluding the warranty charges, grew by 60 basis points over last year to a healthy 21.8%. And we ended the quarter with an ASP in backlog of $317,000, which was 11% higher than last year. This led to a dollar value of backlog of more than $560 million, the highest it has been on December 31 since 2007.

While these results demonstrated continued improvement in our core 2B-10 metrics, there were clearly two areas of disappointment in the quarter, as well. In addition to the nearly $18 million in reserves we took, our quarterly revenue fell short of our expectations. We expected revenue to be about even with last year, and we fell about 10% short of that level.

The shortfall related to a combination of a lower backlog conversion rate, which also reduce our ASP on the quarter's closings and about $5 million in land sales that were pushed into our second quarter. I expect us to overcome both of these issues both during the balance of the year, and Bob will discuss them more fully in his remarks.

This is always an interesting time of year. Every builder, supplier, shareholder, lender is wondering one thing: how will the spring selling season play out? It's understandable, because the next 100 days or so will largely determine if expectations for this year's new home sales and the industry's earnings objectives will be met. I can confirm that our demand patterns improved during the course of the first quarter and then have continued into January.

So as we said in the headline of our earnings release this morning, other than excluding the impact of the reserves we took, we are reiterating the full-year profitability expectation we established on our November call. While there are both marketwide and Company-specific risks in play, we still expect to improve adjusted EBITDA by at least $20 million as we track toward our 2B-10 goal by the end of next year.

Outside of Texas and Bakersfield, the macro picture is, if anything, slightly better than in November. Mortgage rates have moved lower; employment trends remain positive, especially for younger workers; lower gas prices have increased discretionary income; apartment rental rates have continued to move up; and changes to FHA and GSE loan programs have been adopted by regulators to encourage more first-time buyers. That is a lot of positive context for new home sales this year.

Of course, the drop in oil prices has certainly added a new risk in a number of our markets. In Texas, particularly in Houston, we are watching jobs, inventory, home prices, incentives, and land prices extremely carefully. While we now assume there will be some fallout in demand and/or prices, so far we haven't seen it.

For Beazer, our sales indicators are also positive. Visits to our websites have been up all year. Traffic levels to our communities were up in Q1 and so far in Q2; and January sales through last weekend are better than last year. Encouragingly, our December 31 margins in backlog were a few basis points better than they were in September. Despite all positive data points, I know there are valid concerns swirling around, many of which relate to either the growth in community counts or various headwinds on gross margins.

Specifically, there has been a lot of talk about risks related to higher land costs; higher construction costs; and, of course, the possibility of higher builder incentives. It is hard to know how much of that will come to pass -- and, in particular, if other builders will start to get aggressive in pricing their closeout communities or even their start-up communities.

All I can say for sure is if that starts to occur, our competitive market analysis process will tell us as it happens. And we will take steps to defend our communities vigorously and, hopefully, intelligently.

I will now turn the call over to Bob to dig into the details of the quarter's results. Bob?

Thanks, Allan. I want to start off with some more color on the $13.6 million of unexpected warranty charges that we recorded this quarter. You may recall that we first discussed some stucco issues in Florida last November. We believe that a number of our subcontractors failed to properly install stucco on some of the homes we built in Fort Myers and Tampa, resulting in water intrusion issues. The average age of the homes is more than eight years old.

In November, we believed that these issues were likely confined to certain house plans in several specific communities. However, since that time, the call volume from affected homeowners increased. We learned that more communities were impacted than we had thought. And we stepped up our own process to estimate our potential exposure for homes for which we have not yet received any claims.

As a result, we recorded additional warranty charges this quarter intended to cover both the repair costs for the homes that have already been identified as having water intrusion issues as well as an estimate related to potential future plans. We will aggressively pursue recoveries from a variety of sources, including our own insurers as well as the subcontractors and their insurers.

While we believe that some recoveries are likely, because the amount cannot be reasonably estimated at this time, we have not included any assumption of recoveries in our warranty charge calculations.

Now, while we're on the topic of legacy construction issues, we also took a $4 million reserve for the cost of resolving a construction defect issue in one of the markets we exited several years ago. This charge is in the discontinued operations line of our income statement.

When I get into the discussion of our 2B-10 progress, you will note the impact these charges had on the reported values of our gross margin and adjusted EBITDA. Now let's move on to our revenue for the quarter.

We recorded $265.8 million of total revenue, which was $27 million below last year's level and also below our expectations for the quarter. There were three big drivers.

First, about $5 million of land sales moved from Q1 to Q2. These assets are under contract and are expected to close this quarter. Second, our closings were below our expectations. And third, we had an unusual shift in the mix of closings compared to what we had anticipated. These last two points are intertwined, and it is a little bit easier to think about them separately.

On the spec side, we were happy with total orders in the quarter; and even though we closed more homes than were scheduled in backlog for the quarter, we expected to sell and close even more specs than we did. On the mix side, the closings that occurred carried a lower ASP than we anticipated.

In numeric terms, here is what happened. We had about 120 expected closings with an ASP above $320,000, which either shifted out of the quarter, or canceled, or were not available because a forecasted sale didn't occur. That was a slightly higher number than we usually have to deal with, but it was the very high ASP associated with these closings that hurt. Those missed closings represented $40 million in lost revenue.

As is typical in any quarter, we also generated a number of closings we hadn't expected from different specs and from homes that were available to close earlier than originally scheduled. This quarter the pickup was only 60 homes -- again, because we didn't sell as many specs as we planned.

Just as importantly, the ASP associated with these sales was only $280,000, representing about $17 million in revenue. When you put those two numbers together, you can see exactly what caused the rise to the revenue miss. This is the second quarter in a row where we have posted a revenue miss.

Despite reporting strong orders and improving margins, the consistent challenges have been a gradual increase in the percentage of our backlog scheduled to close in future quarters and the difficulty estimating which specs will sell and close in a particular quarter. Clearly, we need to do a better job of estimating the mix of closings that will occur, and I think we can.

With that mea culpa, perhaps the more important issue is what it all means for the next quarter and the rest of the year. Based on our new home order expectations for the full year, which is obviously not a guarantee, we think closings will be up in mid-single digit percentage over last year. In the second quarter, learning from the experience of the last two quarters, we will estimate that we can close more than the 857 that are scheduled to close in the quarter, but likely less than the 977 we closed last year.

At the midpoint, we would generate a 52% conversion ratio similar to this quarter. With those items out of the way, let's turn to our overriding priority -- achieving our 2B-10 plan. In November we updated our expected path to get there. We will likely meet or exceed some of our targets before reaching others, which may lead to further refinements of our expectations. But regardless of the exact path that takes us there, the expected outcome is the same: $2 billion in revenue with a 10% EBITDA margin by the end of fiscal 2016.

Our LTM revenue of $1.4 billion is about $100 million higher than at this time last year. And our LTM adjusted EBITDA is $128 million, up 28% since last year, excluding the $4 million charge in discontinued operations as well as the stucco charges taken in Q4 and this quarter.

We recorded 2.1 sales per community per month during the first quarter, just slightly behind last year's 2.2 absorption pace, but in line with our expectations for the quarter. On a trailing 12-month basis, our sales per community per month was 2.8, which we believe is among the strongest in the industry.

We currently expect each of the remaining quarters this year to hover around three sales per community per month. With sequential community count growth expected through Q3, our third-quarter new home orders are likely to exceed our second quarter.

Average selling prices rose 6% this quarter to $296,000, as both the East and Southeast segments experienced increases in their ASPs and grew as a percentage of our total closings. On an LTM basis, ASP rose to $288,000 compared with $262,000 a year ago. And ASP in backlog at December 31 was $317,000, providing visibility to further increases in our ASP. For Q2 we expect to record an ASP above $300,000 for the first time in the Company's history.

Extensive development efforts continue this quarter, as we prepare to open new communities ahead of and during the spring selling season. We ended December with 156 active communities, 13% higher than a year ago. Our average of 154 active communities during the quarter was 12% higher than last year. At December 31 we had 57 communities under development, and we expect to open at least eight net new communities by the end of March.

Turning now to our gross margins, while we were extremely pleased to generate year-over-year improvement in our gross margin from the operations of our business, our reported gross margin of 16.6% reflected the $13.6 million warranty charge. Excluding this charge, our homebuilding gross margin was 21.8%, up 60 basis points over last year's first quarter.

Looking ahead, Q2's gross margin will likely be similar to what we recorded this quarter and, therefore, a bit below last year's second quarter. For the full year we are still targeting 22%, though we acknowledge there are likely to be some margin and volume trade-offs that determine whether we get there.

In November, we told you that our G&A dollars would be between $32 million and $34 million for the quarter. We came in slightly better than that at $31.4 million, resulting in SG&A of 15.9% of total revenue for the quarter and 13.7% for the last 12 months.

Looking ahead to the remainder of fiscal 2015, each quarter we expect G&A dollars to be approximately $4 million to $5 million higher than the year-before quarter. Relative to our expected revenue growth for the year, this restrained pace of G&A spending will allow us to make considerable progress toward our 2B-10 target of 12%.

Moving now to our land investments, we spent $145 million on land and land development during the quarter -- up almost $22 million over the same time period last year. For the full year we expect to spend in excess of $500 million as we continue to grow inventory and invest for further community count growth in 2015 and beyond.

During the quarter we recorded $4 million in land sales. We continue to expect to record in excess of $50 million in land sale revenue and between $2 million and $3 million of gross profits from land sales for the year as we reduce our exposure in several larger land parcels that were purchased with this intent.

Essentially, all of the land sales we expect to occur this year are under contract at this point. Please note that any revenue related to land sales is included in our SG&A ratio.

With our increased land spending, our total inventory has continued to rise. At the end of December, we had almost 28,000 owned and controlled lots and nearly $1.7 billion of total inventory, up $296 million or 21% from last year.

At the end of December we had $312 million of land held for future development, which represented 19% of total inventory at December 31, down from 25% last year. We expect to bring some assets into active status over the next couple of quarters. The dollars that they return to the business will be a nice addition to our results, since further activations are not currently included in our 2B-10 targets.

Looking now at our capital structure, as we have said before, we are watching the market for opportunities to refinance our 2019 9 1/8% senior notes, which should enable us to save a substantial amount of interest. While long-term rates are attractive right now, the high-yield markets have been pretty tough for new issues.

With prospects for enhanced profitability in the quarters ahead, we are reasonably confident a refinancing will occur this year. In addition, this summer our TEUs will mandatorily convert to common shares, and our 2018 secured notes will be callable. While there is unlikely to be any interest savings in refinancing these notes, we do hope to eliminate secured debt from our capital structure when the opportunity arises.

Finally, we have a substantial amount of deferred tax assets that we hope to bring back onto our balance sheet when we report our full-year results. Given the larger-than-expected loss this quarter driven by the warranty charge, it may be difficult for us to remove portions of the valuation allowance prior to the end of the year. Currently, we estimate that we will be able to use approximately $449 million or about $13 per share in deferred tax assets to offset our future tax liabilities. Once we are able to bring this asset back onto our balance sheet, our book value and our debt-to-equity ratio will be substantially improved.

With that, let me turn the call back over to Allan for his conclusion.

Thanks, Bob. With the exception of my disappointment about the big charges and shortfall in revenue this quarter, I feel pretty good about we how we started off the year. We have got a robust backlog, improving sales trends, and more new communities coming this year; so we are well positioned for another year of progress in our 2B-10 objectives.

We know that we don't compete in a vacuum. Community counts are rising in most of our markets, and many of our competitors are talking about incentives. The oil price drop will likely also pose some new challenges.

But despite these complications, we continue to expect to increase our full-year adjusted EBITDA by at least $20 million to approximately $150 million, excluding the stucco and disco operations charges that we took this quarter. This quarter we have resisted the temptation to tweak each of our target metrics for the full year. While I am sure there will be some twists and turns throughout the year, at this point there aren't any specific changes we feel compelled to make.

This is exactly what we said in November. For the full year, we are targeting year-over-year percentage growth in our average active community count in the midteens; absorption rates that are flat with fiscal 2014; mid-teen order growth, in line with the community count growth that we expect; mid-single-digit percentage growth in closings, since we won't have a full year of closings from our larger expected community count; revenue growth that will be higher than closings growth; and ASPs likely approaching $320,000, up more than 10% over last year.

On the margin side, while acknowledging the risks in the market, we are still targeting around 22% for the full year, excluding the stucco costs. And the anticipated revenue growth will help us leverage our fixed costs, which should enable us to reach an SG&A ratio of about 12.5% of total revenue for the year. There is little doubt that we will end up exceeding some of these current targets and missing others, but we are determined to drive to the expected improvement in profitability, regardless of the mix of results in our operational metrics.

Our top priority is achieving 2B-10 in 2016, and we intend to make significant progress towards those objectives this year. Thanks for joining the call today. And at this point, I will open it up for Q&A.

(Operator Instructions) Michael Rehaut, JPMorgan.

First question I had was on the competitive backdrop. Allan, you made reference to some other builders so far this season, talking about perhaps incentives coming up a little bit. At the same time, we have heard from you and others that there has been some positive momentum in the marketplace recently, perhaps since Thanksgiving into January.

I was hoping maybe we could dial deeper and perhaps just cover if there is any particular markets on your footprint that stand out that either we can make sense of from the comments of competitive elements -- that perhaps there are some markets where you have seen a little bit of a pickup in incentives; or if there are any markets in particular, also, that -- you know, where it drives your comments about some positive momentum being seen in demand.

Okay. As we think about markets, obviously, where our stores are located are our communities; and the products that we offer -- it differs. And so we may have a really strong competitive position in a market that is a little softer, or we may be in a little weaker position in a market that is strong.

So I just caution listeners that the readthrough on our commentary about markets is what we are experiencing, but you kind of have to triangulate that with other data points to see it that is giving you a market read. And that is kind of obvious. But I wanted to make that point.

And I would tell you, for us there were a number of places that continued to be strong -- a couple that stood out as a little bit stronger, and a couple that were a little bit weaker. I will start on the weaker side; and it is not a great revelation, but it's Bakersfield, where we have one community -- actually, two communities in a single kind of master plan. We have got just over 100 lots.

Bakersfield is really, really tough. We actually impaired that asset in September, largely related to the FHA reduction in loan limits. And it hasn't gotten any easier. I am happy we have only got the two communities there, and I expect that to be a slog all year. And that really would stand out as a particularly difficult place.

On the other end of the spectrum, I would tell you that our coastal Carolina markets have been very strong. Charleston in particular has been very, very good for us, and incrementally good compared to last year.

I would say the same thing -- surprisingly, perhaps, to many -- about Dallas. Dallas has not only been strong, it has gotten stronger for us this year. We have seen continued strength in Orlando; and, again, maybe on the surprising side, we have seen a good, sustaining level of demand in Houston.

I would say that while we were down a little bit year over year, we still actually like our positions and feel good about Southern California and Vegas. Both of those markets are performing all right. And I try not to read too much into the first quarter in the East, because it just has a different rhythm to it. Our path of sales in Virginia, Maryland, New Jersey -- maybe it is whether; maybe it is psychology; maybe it is just in our heads, but we tend to not do as well in the first quarter in those markets.

And so I can't say that things have really changed, but they certainly didn't stand out in terms of over-performance. So I think, Michael, that gives you kind of an around the horn. And I am happy to go in deeper into any of those markets that you want.

But there isn't a market where we have gotten dramatically on incentives. I will anticipate a question. I think our incentive increase, if I look at the first quarter compared to the first quarter last year, is mostly driven by the change in the ASP. As a percentage of the ASP it moved 10 or 20 basis points. Maybe it was 25 basis points.

But the dollar increase was really just driven by the change in the ASP. So there is really not a measurable change in incentives, comparing Q1 of this year with Q1 of last year.

No, that is a great answer, very comprehensive. I appreciate it.

I guess just a second question to look at one of the components of your full-year expectations that you reiterated -- I guess you reiterated all the components. Just the ASP -- wanted to get perhaps a little bit additional level of clarity there.

Your ASP was $296,000 in the first quarter, and I understand it was hurt by some of the timing of the deliveries of some higher ASP product. But even with that being said, your backlog is $316,000. And you said that for the Q2 you expect to be over $300,000.

But it would seem that in the back half of the year, to do a full-year ASP nearing $320,000 -- let's say, $315,000 -- you would have to be solidly above $320,000 in the back half of the year, maybe closer to $330,000 or $325,000. Is that the right way to think about it? And is that what you had kind of see playing out based on your backlog and mix of priced communities throughout the year?

Uncharacteristically, I have a single-word answer. Yes.

All right. Short and sweet. That's good for me. Thanks.

David Goldberg, UBS.

My first question: I wanted to get a little bit more clarity on these 120 units that got pushed. And I really want to ask the question from two perspectives; Bob, I think you kind of went through in your part of the commentary that some of that was cancellations, and some of it was just things got delayed. So maybe just some more clarity on the breakout between those?

But then also with that, when I think about the guidance for second-quarter closings being down year over year, right, I mean, the backlog is up; you have these 120 units that pushed, some of which presumably aren't in backlog now because they were cancellations. And so what is driving that? Is it just a different mix of homes in the backlog now? Maybe if you could give us some color on that, I think that would be very helpful.

Yes. I looked forward to the question, David; and perhaps now, in contrast to the prior one, this one will be a little bit more than one word. I want to direct you to slide 7, which was the slide where we have the backlog activity. And there are a couple of things that we have pointed out differently -- and these are kernels of the answer, but I think they are important things to realize.

I think as we have been sustaining kind of low and mid-50s conversion rates in our backlog, there has been kind of a dynamic going on inside of that. On the one hand, the percentage of our backlog at quarter-end that was scheduled to close in the immediate -- in the following quarter has been declining pretty significantly as our mix of to-be-builts has grown over the last year or two.

So just as an example, at the beginning of this quarter, of the first quarter, about 50% of the backlog that we had was scheduled to close in the quarter. We actually close more than that. We closed 105% of that. And in fact, in the fourth quarter I think the ratio was about 110%.

Well, if you go back a year or two, what you would have seen is that more like 60% of the backlog was scheduled to close in the subsequent quarter, and our closings were at or below 100% of that number. So you have got a dynamic where the backlog is slightly longer-dated. The percentage has moved, as I said, from sort of 60% into 50s.

And I think for the quarter Bob gave you a number. Actually, only 48% of the backlog at December 31 is scheduled to close in the March quarter. So we are seeing that trend. And that's -- you know, 3 points here and 3 points there really eat into your backlog conversion ratio.

So how do you offset that? Well, you have got a slightly larger spec number, including some finished specs. And those finished specs become the source of the additional closings. And that worked pretty well. If we look back at 2003, or sorry -- at 2013, if I just analyzed -- of the units scheduled to close in backlog, what did we actually close? We closed just under 100% if you took the four quarters.

Last year we closed about 105%. And I think this year we will close more than 105%, because we kind of set ourselves up with slightly more specs.

Now, the trick to that is: our mix of spec sales isn't really changing very dramatically; but when we are selling the specs, we are intending to and have had some success in selling and closing them in the same quarter. And that is really at the heart of what is going on with the conversion rate.

Now, I will happily get to the 120. But let me just pause there for a second and see if I have still got you with me, or if I lost you with all that.

I think I understand.

Okay. So in terms of the 120, as Bob said, there really are three different things that go on. You do get some cans of homes that are expected to close; and I can tell you that two-thirds of the cans that we got on homes that were expected to close were resold during the quarter. But not very many of them were resold and closed during the quarter.

So that is a normal dynamic. A handful of them -- as always, nothing dramatic -- but a handful of them were delayed for construction permit, weather issues, or possibly lender or borrower issues. And then we do make -- every quarter as we think about, okay, what does this quarter look like -- we do make some assumptions about, well, which specs do we think are targeted, priced to sell, going to be in the mix?

And in the December quarter, we had lots of interest in and reasoned expectations for some spec sales on some pretty high ASP product. You follow us pretty closely; we have got a Gramercy townhome or condo project in Hollywood, where our ASP is at 700. We have got -- right next to the Under Armor campus in Baltimore on the Inner Harbor, we have got a community that is in the $500,000s and $600,000s.

We sold some homes in both of those communities in the quarter, but they didn't sell and close in the quarter. And that is the kind of nature of what happened with the 120.

And then in terms of the 60 that came back the other way, where we were able to either pull forward from a construction standpoint, or where we were able to sell other specs -- and that happens; we can't be exactly right about which specs we are going to sell -- the mix of those that sold were more the $280,000 variety, so that you get this crazy shift with 120 homes at $320,000 costing you $40 million and only 60 at $280,000, giving you back 17. It is only 60 units, but the net effect is about $360,000 if you just divided the 60 units into the $23 million.

So that dynamic was very unusual -- the size of it and the magnitude of the ASPs. I don't know. I guess we could spend hours on this, but I am trying to give you a little bit more understanding. And it is definitely something we are much more attuned to as we have sort of worked through this quarter, and it has influenced what we have said about Q2.

I think as we look at what we have done, it has been a long time since we haven't closed more than what was scheduled to close in the quarter. So we will beat that 857 number, but in order to get up to 977, which is where we were last year -- I think it is, like, 115% -- that would be at the high end of any range that we have had.

I think this is an important point. It relates to this issue. As I have been running the business, I have been very focused on two things and maybe not a third thing. The two things I've been focused on have been driving margin improvements and improving or sustaining pace. And I am really proud of the track record of our team over one years, two years, three years -- any benchmark you want, we have made most of those go up a lot.

But the third thing that I have paid less attention to is: within that, what mix of specs and to-be-builts are you selling? And maybe that is a failure, but my attitude has been, if we are getting the pace and the margin out of each community -- not on average, but out of each community, we are probably be better off letting the market tell us whether in that location at that moment in time it is a spec for a to-be-built sale. And that lack of direction or repetition on my part to our teams about that mix -- I think it kind of bit us in the butt.

Okay. Very thorough. I was hoping I could get a follow-up, although I have taken a lot of time. But real quick, I guess -- I was wondering if you could talk about the warranty charge. And I think in the comments there were more claims kind of as you went forward here than what you maybe had expected or what you had seen earlier.

Maybe you can just talk about the methodology for determining what your reserve would be, because I thought it would be based more on the subcontractor in the community as opposed to claims activity. In other words, if you had a stucco and water issue in one home, most builders would tell you you have to take a reserve against -- assuming it is in a lot of homes, even if there is no claims, because it was a similar contractor, it was the same sub or whatever, or is the same construction technique as opposed to the actual number of claims. So maybe you could just talk about how that varied and what changed in the assumption base.

No, it is a good question, Michael.

David.

Or David; I'm sorry.

It happens all the time; don't worry.

Actually, we took both of those things into account. The first time that you kind of are alerted to these things are through calls that you get from your homeowners.

And what happened this quarter was the call volume increased; we had more calls in additional communities than we had thought we had had. The problems were the subcontractors that had done the work in the original community that we had issues with in the fourth quarter. And so we had to broaden our methodology and look at, really, all of the communities that we had built homes in Fort Myers and Tampa, where the subcontractors worked; and we did make some estimations of potential claims in communities and on homes for which we had not yet received any customer calls.

Which were driven, David, exactly by your point, through the subs' work. If sub X had a 90% defect rate in a community that we knew about, and sub X was present in another community, even if we hadn't heard from them, we needed to make some allowance for the fact sub X probably didn't magically get better in a different community. And that absolutely was at the epicenter of this quarter's estimate.

Ivy Zelman, Zelman and Associates.

Maybe, Allan, you could start with: apples to apples, what right now would you see in price appreciation, roughly? Or maybe you can go by market, but just kind of getting an idea -- are you seeing flat, up a few percent? On the same house, same floor plan?

Yes. It is either up 1% to 3% apples to apples to apples. Not in Bakersfield.

Okay. (laughter) How about -- does that include Phoenix?

It does, actually.

Okay.

Yes, we are seeing a little bit of lift there. Now, it is not a lot. Boy, 1% feels pretty good, though, after the last two years.

And in Bakersfield, with the FHA loan limits coming down, are you optimistic that the new 97% LTV could actually help with the higher loan limits there?

I do, although now we have a jobs problem. So I think if oil hadn't fallen out, I think -- again, it is two communities, and we are obviously working on a much, much larger platform. But if I just think about that area, yes. That was a specific solution to an acute problem in Bakersfield -- that 97% down program -- or the 97% LTV program. And I think that was very responsive. And I think that will, frankly, be helpful, Ivy, in Vegas and in Phoenix.

Okay. And then, just because you have always been known as an entry-level builder, do you expect strategically to start to offer more product in competing against express homes in that $160,000, $170,000, given your average ASP is so much higher now? And, roughly, what percent of the market or percent of your offering would be at that low end, if at all?

It is a very low percentage. That is not -- I want to be first-time and first move-up, which has been our bread and butter, with a nice dollop of retirement business, particularly in a condo context in the Mid-Atlantic. Those have been the mainstay businesses for us, and they will stay that way.

Our mix has shifted a little bit to the Mid-Atlantic and California, so our ASP is drifting up. We are not trying to be something different. But I don't have a strategy right now to try and go way down.

From my perspective -- and, again, we are a small company compared to the folks that are executing that strategy. And the compromises -- and I don't mean it to sound pejorative, because I am respectful of what they are doing; but the things you have to do to hit those price points that relate to location and product selection, I think, are heightened in a downturn. And we really don't have the battleship here to absorb that if those things in a different economic environment are problematic.

So I don't see a lot of merit for us. Not for anybody else, but I don't see a lot of merit for us to try and get down there.

Are you worried, Allan -- there is a lot of competition in that first-time move-up segment of the market. It seems like there might be arguably some that would say that that market is being saturated with too much new community, and that is part of the problem: that there is not enough broader product offering for entry-level. So you don't ascribe to that?

Well, yes, but the definition -- as you know better than I do -- a move-up is a pretty wide range. I talked last quarter about 60-foot lots on the east side of Phoenix; and there were 100 new communities in Phoenix, and 80 of them were 60-foot lots in Gilbert, Chandler, and Mesa. We did exactly zero of those deals.

So yes, your thesis is right. There are areas where there are over-concentrations of homogenous product that have created supply imbalances. That is an absolutely accurate statement.

On the other hand, if I think about the distinction between first-time and first move-up is getting a little bit blurry, as you know. And your work has pointed out that the first-time buyers are more affluent and a little older than they were a generation ago. So I don't really feel like we have changed our stripes or that we are trying to change our stripes.

And we can list off all of our competitors; their ASPs are still between $50,000 and $100,000 higher than ours. So I still like our position. And I think with our choice options and our mortgage choices, we are doing some things to differentiate ourselves so that we are just not another box-on-box price-per-square-foot play.

Great. Good luck. Thank you.

Will Randow.

In terms of regional color on gross margin and mix that is provided on slide 23, how do you think about the key drivers of the changes in gross margin? It looks like, for example, the West compression may be rising land costs, potentially some negative mix on flat mix-neutral ASPs. But could you provide further details on the key drivers for the three segments and your directional expectations for trends in the second half?

Sure. The overall -- just to kind of set the table, we have said -- is we are targeting that 22%. And I think what you will see among this -- I do expect further lift in the East. One of the things that will happen seasonally -- and I know my East team is listening, so I am glad for that -- is we do get better pace in the back half of the year out of the East. And there are some fixed costs that get leveraged with pace.

I also think the new communities are -- there are a significant number of them that have been on our East segment in that Mid-Atlantic region. And I think the margins in those communities are going to be very attractive. I mean, these are assets that we bought a couple of years ago we have been working through the development issues on; we're going to start to get closings out of those in the back half of the year. And I think that those will be accretive to margins.

Honestly, I don't see a dramatic change in the Southeast. I think it can move up just a little bit. We are very well positioned in the markets that we are in there. I don't think that we have got a really unfavorable land cost/mix issue. And the labor issues are not particularly acute in any of those markets. So that feels to me like a market where we might see a little bit of lift, but I wouldn't expect too much.

The West is tricky for us, because it does cover both Houston/Dallas, Phoenix/Vegas, and California. And in California, we have got some very high-end product. We have got product out in the desert. We are -- as I talked about, being in Hollywood. And we have got Houston/Dallas, as I said.

So it is very hard for me to tell you prospectively, unless we go community by community, what's the mix of sales going to be. I don't see -- there isn't a single -- I wish there were. It would be easier to answer your question if I could say, look, here are the two things that are going to drive it down or drive it up. I would tell you, I expect our gross margins to have two handles on them out of the West segment, but whether or not it is closer to the 20% or the 22% has a huge -- it is a huge factor what that exact mix is.

And I realize it is a little frustrating answer, but I just can't tell you exactly what the Southern California versus Phoenix/Vegas versus Texas mix will be in our third and fourth quarter, because we haven't made those sales yet.

Got it. Thanks for that. Just a follow-up on the comments on mix-neutral price appreciation --

Yes.

-- being low single-digit.

Yes.

For the past month or two, it looks like the existing home sales -- call it prices -- are running at mid-single digit with a little bit tighter inventory. And in some ways I think about that as a leading indicator, but I am just kind of curious: do you think it is more incentives, builders closing the gap between the spread that has been created between new and existing homes? Or what do you think the key driver for differentiation is there?

Yes. The thing I always worry about -- and, I mean, it was a very precisely-asked question, which was absolutely apples to apples -- is the mix thing always is going to drive any of these home price indexes. New homes, used homes, distressed homes, whatever it is. It is virtually impossible to measure exactly apples to apples.

I think you made a good point that the gap in many markets between new and used homes has gotten historically wide. And I think that that probably has some effect on new homes relative to used homes. But I am not totally convinced that that isn't also a mix-driven issue by what is available on the market on the used side.

So I think that is at play a little bit. I think supply and demand is what is driving pricing, and there are clearly submarkets -- and you cover the industry closely, so you know this. There are submarkets where you got 10 builders; each of them has three communities trying to get at a single buyer profile. That is a tough context in which to drive price appreciation.

But on balance, even though there has been growth in community counts, we are not saying that is a consistent theme. Those are places, by and large, I am happy not to be. And I think that is why we can still see. Although I have not forecast any price appreciation, the question was, prospectively, what had we seen over the last couple of months? And that is kind of what we have seen.

Thanks. As always, appreciate the insightful comments.

Jay McCanless, Sterne, Agee.

The first question I had is on the deferred tax asset and also going to tie in the debt refinance. Could you reiterate, Bob, your comments about that the DTA and whether you guys will bring it back on balance sheet? And also, the interest expense -- it looks like it ran about $9.4 million this quarter. Should we expect that to trend down through the year, even with the 2019 notes not being refinanced yet?

Thanks, Jay. The DTA -- what we said and what we believe is that we will bring it back on our balance sheet at some point, or at least some portion of it, by the end of the yea; and that the charges we took this quarter will prove to be -- make it a little bit difficult to bring some of the DTA on the balance sheet sooner than the end of the year. But we still expect and hope that it will be -- at the end of the year we will bring the DTA back on the balance sheet.

As for interest expense, what we said last November and what we still believe is that the direct expense as the balance sheet continues to grow, regardless of the refinancing, should trend towards about $35 million for the year. Obviously, we refinanced the 2019 unsecured notes and have favorable interest coupon experience. That will also benefit a decline in that, more than maybe the $35 million over time.

Okay. Okay. And then, Allan, going back to the question about first-time buyers, some of your larger competitors seem to have a dichotomous view where either the entry-level buyer is back; they can get a mortgage, and the demand for the housing is there. Then you have others who are saying that, no, the demand does not seem like it is reappearing. What are you hearing from your mortgage contacts and the people who work with your Beazer mortgage program right now?

I think there is significant pent-up demand among a very wide group of first-time buyers. That would be anywhere from the mid-$100,000s up into the $300,000s, as geographic differences and incomes vary.

I still think there are a couple of impediments. So I believe it is there: I see it in our traffic; I hear it from our mortgage contacts. The household formations are there. The demand is there.

It isn't fully realized. Now, is that the customer? Is it the mortgage process? And that is where it is hard. It is both of those things. A lot of the folks -- and it is interesting; I mean, I have been on a whirlwind tour. I have been in 14 of our communities in the last six -- or 14 of our divisions in the last six weeks. And I have been in -- mostly, going to talk to new home counselors, because they are the ones who actually know what is happening in our business day to day.

And they will tell you: people have real concern about their income growth, which is a subtle issue, but it is different from being concerned about their job. Two years ago -- do I have a job? Can I get a job? Will I keep my job? -- was a pervasive fear. It feels different now. It is more about my income is not going up.

And so this is a long-term commitment, whether I intend to live here 3 years, 5 years, 10 years. People, notwithstanding 30-year mortgages, probably are not going to live there for 30 years, but they are worried about that income continuity.

I think the other thing is there is still tremendous ignorance about who can qualify and how. And probably the biggest part of handholding that we do with those first-time buyers -- and that's -- pardon the plug for Mortgage Choice, but it is one of the great attributes of having two or three lenders trying to get the same prospect qualified, competing to get that prospect qualified, is there is a way to get there.

But the ignorance on the customer side, thinking they need 20% down; thinking that they need a 700 FICO; thinking that because they had a short sale eight years ago or five years ago, they can't qualify. So I still think there is just a lot of that atmospheric headwind -- to mix my metaphors -- on those buyers. I am not sure we are going to get the V-shaped or the rocket launch here on that first-time buyer, but it is there; it is growing; it is building.

And I think, as I talked about GSE and FHA changes -- I think that there are some things that are starting to kind of matter now that are stimulating that. It will all depend on whether the lenders in some significant way will lead to those new standards. And I think the smaller the institution, the more likely they are to -- which is, again, one of the benefits of not being wedded to a bigger lender on an exclusive basis, because I do think that that is where -- and I have talked about the animal spirits of the lenders -- I think that is where you see some of it. But I think the narrative that the first-time buyers are important, that they are reemerging, is exactly true. It is slower than any of us would like, but it is absolutely there.

Okay. That's great. Thanks for the answer. And if I could sneak one more in, from a land development and community opening perspective, it seems like weather shouldn't be a hindrance to that this year like it was last year. Could you talk a little bit about how the comps are going to look from an order and from a community perspective? And then, also, are you seeing any relief on the local side, where more people are there to do permits; get plans approved; et cetera, et cetera?

Well, and the last part first. No, there isn't a lot of relief there. We have sort of reconciled ourselves to having short-staffed municipalities and utility companies, and we have kind of had to adjust our expectations. I'm sure there are some places that have staffed up, but I think the better answer is, there hasn't been much change.

We do expect a progression of communities. I think I said or Bob said in the script that we expect to add at least eight net new communities by the end of March. We will have an additional increment of new committees in the June quarter. We haven't given a number for that. But we have said we expect to have our average community count for the full year be up in the midteens. But the bulk of the growth in community count is going to happen from this point in Q2 and Q3.

Bob also said -- and I think it is important; it wasn't intended to be too subtle -- I don't know that the pace in Q2 or Q3 is going to be point this or point that. I think the expression that he used is that we expect the pace to hover around 3 in each of the remaining three quarters. We will have more communities active and selling in Q3 than Q2, and that has led us to have expectation that Q3 orders will exceed Q2 orders.

Adam Rudiger, Wells Fargo.

I wanted to ask two questions and some clarification from slide 5. One of the comments was -- you said January sales were better than last year. I was just curious if that was absorptions or just overall orders. And the second clarification I wanted is -- you said there is less pressure on margin versus peers.

Yes.

And I wanted you to elaborate a little bit on why that might be the case, or what you were really saying there.

Right. Let me take the second one first. In getting prepared for these calls, we are thinking about everything that we ought to try to talk about, and ultimately some things go to the cutting room floor because there are different points of emphasis.

But one of the things that I think has been lost a little bit in a lot of the hand-wringing over margins is, on a company-specific basis, what are the specific issues that individual companies have? And the narrative for one company may be exactly the same, or it could be really different.

I think, though it is not necessarily a point of pride, it is accurate that we were not significant participants in the distressed land market in 2011 and 2012. And the consequence to us has been that we have lagged, on a time-period basis, the margins of many of our peers. And I think that regression to the mean is a tough thing if you can't replace those distressed land deals.

And I think that is a significant headwind narrative pressure that they are facing. I have said boldly on this before: we get out to 2016, and we are on kind of apples to apples in terms of we are buying land, they are buying land in the 2013, 2014, 2015 time period. I think a lot of that sort of works its way out.

We have seen progression even as others have seen regression. And I think that that is what I mean. We have got to deal with incentives. We have got to deal with features and base pricing, like everybody else. We are not immune to that, but the comps for us are less weighted by things that we cannot replace. Does that make sense?

Absolutely. Thank you.

Okay. So the second question: through three weeks, which is not a month, but through three weeks, both orders and pace are a little better in -- orders are a lot better, and pace is a little better -- in January.

Okay. The second question was: some others have -- you know, just to allay or maybe even exaggerate fears of Houston; others have offered their exposure to clarify, because we all have our own numbers. But I just wondered if you'd care to offer what your either revenue or closing contribution from Houston was in 2014?

Yes. What I would say is -- because we don't breakout individual divisions, and it is a little bit of a slippery slope. But I am glad you asked me a specific Houston question, because there are a couple of things I do want to say.

I think that both Houston and Dallas represent on the order of 10% of our business. And you can look at that -- each. You can look at that -- you know, assets, orders, closings. Just a little above 10% on any of those metrics.

So you can kind of reconcile that to all the published reports of who sold how many homes, because there are plenty of third parties that do that. But there is a more subtle point that I wanted to make about Houston, which is: where you are in Houston really matters. And it is one of the largest metropolitan areas in the United States.

And I can tell you, having been there in the last two weeks, that to drive from one end to the other is a three-hour exercise; and that is assuming you don't have bad traffic. So the thing that I would encourage folks to do -- as you think about Houston, there will be different impacts of whatever the downturn looks like in Houston in different locations. There is an energy corridor that's North that is loaded with white-collar, high-end oil company executives.

There is a Western market; there are Southern markets. And one of the things I think you would see -- just pull up our website, look at where the pins in the maps are. We have a larger share than most South and Southeast now. So we are pretty heavily levered to transportation, healthcare, and petrochemicals.

We had an opening of a community this week in La Porte, which is a suburb or a submarket within the Houston market. And I don't report individual community sales, but let's just say we were really satisfied with the first couple of days of activity. Lots of pent-up demand, and the petrochemical plants that are within very short distance have multibillion-dollar expansion underway.

By the way, oil is their number-one input cost. So I feel pretty good about that spot. I feel pretty good about being levered to the port, to Hobby airport, to the healthcare complex. I think we have one community that is up North that I would put in that main-and-main corridor for white-collar energy jobs.

That will clearly be a tougher place, in my opinion. Now, I think we are a low-price leader in that submarket, and we have got very few lots. I don't want that to come across as: we have got our heads in the sand, and everybody knows that Houston is a problem, and we are pretending otherwise.

I would just tell you, as I look at the specific locations where we are, I think we have got some different job levers. And there will be, likely, a malaise that affects different submarkets differently; but on a relative basis, I think we are pretty well positioned.

Great. Thank you.

All right, Ella, I think -- if that was our last call, I want to thank everybody for participating. Thank you for the good questions. I look forward to talking to you in about 90 days.

And that concludes today's conference. Thank you all for participating.