Beazer Homes USA Inc (BZH) 2016 Q1 法說會逐字稿

Good morning and welcome to the Beazer Homes earnings conference call for the quarter ended December 31, 2015. 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 call over to David Goldberg, Vice President and Treasurer.

Thank you, Martha.

Good morning, and welcome to the Beazer Homes conference call discussing our results for the first quarter of FY16.

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 from our projections.

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 our prepared remarks, we will take questions in the time remaining.

I will now turn the call over to Allan.

Good morning, and thank you for joining us.

We're pleased to report our first-quarter results, which demonstrated progress toward both our 2B-10 target and our deleveraging goals. Specifically, we posted big increases in home closings, revenue, adjusted EBITDA, and net income. And we paid down more than $20 million in debt.

Here are the details: On the profitability front, we generated $1.2 million of net income from continuing operations. We reported $25.9 million of adjusted EBITDA, up almost 60% versus the prior year.

We closed 1,049 homes in the quarter, which was up almost 19%. This equated to a 51% backlog conversion ratio, as our efforts to manage labor constraints in several markets proved successful.

Better-than-expected top-line growth led to further improvements in our operating leverage, as SG&A as a percentage of revenue declined 270 basis points versus last year to 13.2%. We ended the quarter with nearly $635 million of future closings in backlog, which was up about 13% versus the prior year, and provides good visibility into revenue and profit growth in the next two quarters.

In line with our stated goal of reducing our financial leverage, we repurchased $23 million of our 2016 senior notes during the quarter, and another $5 million thereafter, helping us reduce the run rate of our cash interest expense by more than $2 million annually. At the same time, we had about $145 million of unrestricted cash at the end of the quarter, more than we had at this point last year.

There were a couple of challenges in the quarter as well, but none that lower our expectations for profit growth and debt reduction for the full year. You will note that we had a small reduction in new home orders, despite an increase in community count.

While we had a disappointing October, the steps we took contributed to a much better sales pace in November and December. And this improvement continued into January, leaving us cautiously optimistic about the spring selling season.

We anticipated that Q1 absorption rates would be a bit lower than last year due to tough comps in several of our divisions, but a variety of factors, primarily in our West segment, presented further challenges. Although we don't generally script comments on individual markets, given the absorption rates in the West, I thought an overview of the sales dynamics in each of these divisions would be helpful, and explain the basis for our confidence for the full year.

In Dallas, we decided to slow the sales pace, and stop selling into future phases in a handful of communities to allow us to shorten the length of our backlog. This will result in happier customers and higher margins in the quarters ahead. The market in Dallas remains exceptionally strong. And even with the reduced absorption rate in the quarter, this market ranks among our best.

In Houston, the market showed further signs of a slowdown, although our absorption rates there remain above the Company average. We're anticipating further challenges in Houston this year, but our locations, our lot sizes and our product are all highly competitive, and we're fortunate to have one of our most experienced management teams in place.

In southern California, our newer communities couldn't match the sales pace of the close-out communities we had in the Central Valley last year. Partially this was related to being in better locations with higher prices, which should contribute to improving profitability in that division going forward. I'm a lot happier with exposure to Santa Clarita and Pomona than Bakersfield.

In Sacramento, we just restarted Natomas after many years of biding our time while the levies were improved. This is a highly accessible and desirable location, and we are in the earliest stages of ramping up our activity there. In fact, our models aren't even open yet. Nonetheless, we didn't sell as well as we had hoped. But we will find the formula, and turn that division into a cash generator this year.

In Phoenix, demand is finally catching up with the growth in community count. Our performance in Phoenix in the quarter met our expectations, and this market is showing early signs of a particularly strong spring selling season.

Finally, there's no sugar-coating it, we had a weak quarter in Las Vegas. That market is still pretty fragile, but we didn't do a great job of opening two new communities in the Inspirada master plan. We retooled the 4-Ps that I've mentioned in the past, and I'm confident we will do better in the quarters ahead.

The West segment is exceptionally important for us, and is characterized by our largest number of communities, rising ASPs, and excellent gross margins. Apart from Houston, consumer demand patterns are stable or improving.

Now, before I turn the call over to Bob and David to review our results in greater depth, I want to discuss the coming maturity of our 2016 notes. At the beginning of the fiscal year, we added deleveraging to our list of financial objectives. At that time, we were planning to pay off at least $50 million of debt by the end of the fiscal year as a part of any refinancing. But, with the deterioration in credit markets since that time, we have adopted a more aggressive deleveraging plan that will enable us to reduce debt by at least $100 million, and fully repay the remaining balance of these notes without tapping the high-yield market.

This plan requires some near-term adjustments to our strategy. Specifically, we are selling more specs, increasing the use of land bank financing, and carefully managing the timing of our land spend. While selling a higher ratio of specs will temporarily create some gross margin pressure, we think it makes a lot more sense than taking on higher-cost debt that we will have to live with for years into the future.

Even as we adjusted to volatile capital markets, our first-quarter results demonstrated our willingness and ability to implement a balanced growth approach with higher profitability, better return on capital, and importantly, less debt.

With that, let me turn the call over to Bob to go through our results for the first quarter and our expectations moving forward.

Thanks, Allan.

We continue to focus on the metrics that drive the achievement of our 2B-10 plan. Although the path we take will evolve over time, the expectation that we will reach $2 billion in revenue with a 10% EBITDA margin remains unchanged. I will be reviewing first-quarter results, and providing some visibility into our operational expectations for the second quarter, and how those relate to our 2B-10 goals.

Looking at our progress today, our last 12-month revenue totaled $1.7 billion, up $270 million or 19% compared to last year. In addition, our LTM adjusted EBITDA of $154 million is up more than $25 million versus the prior year.

Our first-quarter absorption rate was in the range of our peer group, but a bit lower than our expectations. Allan touched on many of the issues, and as he said, we don't believe it provides a barometer for the housing market.

In the second quarter, we are targeting a sales pace in the low 3[%]s. Although this is down versus the prior year, we haven't viewed matching last year's pace as a critical metric in our plans.

There will be a number of factors at play, including two different dynamics in Texas. Specifically, in the second quarter of FY15, our operations in Texas, which represented about 20% of our Business, did a combined absorption pace of more than four sales per community per month. That pace created some unusually long delivery times for homebuyers, as land development and home production struggled to keep up.

This resulted in some margin deterioration and elongated backlog, which was compounded by weather issues that pinched labor. That's why we raised prices and stopped selling into future phases to slow our sales pace in Dallas.

Houston, our expectation for a slower sales pace is more a function of market conditions. Demand remains strong there, but absorptions are clearly lower than a year ago. For the full year, we're still targeting absorption rates similar to last year, with a modest improvement in pace in the second half of the year compared to last year.

Turning now to average sales price, our ASP in the first quarter rose 9% over last year to $321,000. Each of our regions experienced price improvement relative to last year, led by the West, where our prices were up 17%. On a trailing 12-month basis, ASPs rose 10.5% year over year to $318,000, up from $288,000.

Importantly, our ASP and backlog as of December 31 was $332,000, within our targeted 2B-10 range. We expect our average sales price in the second quarter to be around $330,000 and to increase modestly throughout the year based on mix.

Our backlog conversion ratio was 51% in the first quarter, which was ahead of our expectations. These results primarily related to our efforts to manage cycle times to drive closings per community more in line with our absorption base.

Additionally, our conversion ratio benefited from our decision to accelerate spec sales in some markets, particularly in the mid-Atlantic. In the second quarter, we are expecting a backlog conversion ratio of around 60%, up significantly from the same period last year, but more in line with our historical performance.

Our average community count during the quarter was 169, or 10% higher than last year. On a trailing12-month basis, our average community count was up 13%.

The size of the sequential increase was primarily related to a few communities not closing out in the quarter. With these closeouts pushed into the second quarter, we expect the Q2 average community count to be up low-single digits versus the prior year, but down from first-quarter levels. We continue to expect modest year-over-year growth in our full-year community count, though there will be some variability quarter to quarter based on the timing of new community activations.

Turning now to our gross margins, we generated a 20.4% gross margin for the quarter, fully excluding the $3.6 million recovery related to floor and stucco issues. Including the recovery, gross margins were 21.5%.

Gross margins were lower than our expectations, mainly because we decided to monetize finished specs in several of our highest ASP markets, led by our mid-Atlantic divisions. Given the continuing emphasis on spec sales as part of our more aggressive deleveraging plan, we now expect gross margins in the second quarter to be similar to the first quarter. This means full-year gross margins for FY16 likely won't get back to 21%.

As investors know, margins on specs are typically several points lower than to-be-built homes. So, as the spec percentage of our total closings increases, gross margins will be impacted proportionately.

It's impossible for us to predict the exact shift we will achieve in each market, and in any event, there is a potential offset as we are raising prices on to-be-built homes to create more perceived value in our specs. Ultimately, we decided reducing debt and increasing net income is more important, and will drive a higher return on capital, than capturing the incremental gross margins over the next few quarters.

SG&A was 13.2% of total revenue for the quarter, down 270 basis points compared to the prior year, as rising ASPs, better closing volumes, and our continual focus on managing overhead costs generated significant operating leverage. The results are similar for the trailing 12 months, as SG&A as a percentage of revenue was 12.3%, representing an improvement of about 140 basis points versus the comparable period last year.

We would like to remind investors that revenue related to land sales is included in our SG&A ratio calculation. We expect our SG&A ratio to improve throughout the year, with the second quarter flat sequentially, but down nicely on a year-over-year basis. As a reminder, the underlying goal of our 2B-10 plan is achieving a 10% EBITDA margin, and we are continuing to manage our overhead spend to a level that allows us to achieve this profitability goal.

Moving now to our land investments, shown on slide 14, we spent about $112 million on land and land development, including deposits associated with four new land banking deals we closed. In total, our commitments were about even with our expectations, although our mix was more heavily weighted toward land banking as we implemented our plan to repay the 2016s.

Looking forward, on-balance-sheet commitments are expected to be approximately $200 million over the next two quarters, roughly flat versus last year. For the full year, total land spend is still expected to be approximately $600 million, although the mix between on-balance-sheet spending and land bank deals will vary based on market conditions. In addition to this spending, we anticipate the activation of one or more land held assets, which will add to our community count in future periods.

Revenue from land sales during the quarter was about $8 million, slightly ahead of our guidance in November. As of the end of December, we had approximately $55 million of land held for sale, about half of which we expect to close before June 30. At the end of December, we had more than 25,000 owned and controlled lots, and about $1.7 billion of total inventory, up $50 million or 3% from last year. Based on our trailing 12-month closings, our active lot position represents about a four-year supply, which is more than sufficient to achieve our 2B-10 plan and allow ongoing deleveraging.

At this point, I will turn the call over to David to discuss our balance sheet and liquidity.

Thanks, Bob.

We ended the quarter with approximately $260 million of liquidity, consisting of $145 million of unrestricted cash and $115 million of availability on our credit revolver after adjusting for letters of credit. Taking advantage of the liquidity we generated in the quarter, we repurchased $23 million of our 2016 notes during the quarter, and an additional $5 million thereafter, above par, but below the make-whole price. Accordingly, we've now reduced the outstanding balance of these notes to $143 million. Since September of 2015, we have repurchased approximately $30 million of our 2016 notes, which will reduce our annual cash interest expense by more than $2.4 million.

Although our initial expectations were to reduce our financial leverage at a pace that corresponded to the normal seasonal cash generation of our Business, we're now prepared to pay off the 2016 senior notes at maturity through a combination of cash generated from operations, and available liquidity from our revolver. We view this strategy as more advantageous than borrowing at historically high credit spreads, and absorbing higher interest cost for the next 3 to 5 years.

If market conditions improve, and we have options for repaying our 2016 notes that are better aligned with our seasonality, we would consider doing so. Regardless, we're committed to retiring about $100 million of debt during 2016.

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

Thanks, David.

On slide 17, we've reiterated our main themes for 2016, and our accomplishments in the first quarter. We generated year-over-year EBITDA growth of almost 60%, and expect full-year improvements as we head toward 2B-10.

We grew our EBITDA at a dramatically faster pace than our inventory, allowing us to improve our return on capital. And finally, we implemented a plan to pay off our 2016 notes, and retired over $20 million of debt, demonstrating our commitment to reduce our leverage and interest expense as we continue to improve the health of our balance sheet.

We want to thank our team for their continued diligence and resiliency. With their support, we have both the willingness and the ability to do what is necessary to reach our profitability and balance sheet objectives.

With that, I will turn the call over to the operator to take us into Q&A.

(Operator Instructions)

Susan Berliner, JPMorgan.

Good morning. I want to start with Houston. If you could give us some color, I noticed your can rate was up year over year. So I guess starting with can rate and just color in the market, what are you seeing in terms of price points being impacted, incentives, et cetera?

I would tell you, I think the can rate was a function of not super gross sales in the quarter. There really isn't narrative that leads back to Houston, so let me be clear about that.

As it relates to the color commentary in Houston, and I have seen what some others have said, there is no question that the so-called energy corridors that are primarily due north and due west have been most adversely affected. Interestingly, there are quite a few sub markets where approximately a third of the permits are generated in Houston that are actually up year over year.

And it really gets into where are the job drivers in that market? Are they healthcare related, court related, petrochemical related?

Overall, it's easy to say and accurate that there is definitely headwind and pressure on pace in Houston. It's -- bifurcated is a simplification. It's more complicated than that by location.

We're definitely seeing it in prices down to that $300,000 level. Six months ago it was affecting $500,000 and $400,000. And so, I don't think -- we're not trying to argue that we are immune because of price points.

I do think our strategy has been for many years to be in slightly different locations. And looking at our map, we are more south, we're more southeast than our peers, and frankly that's where the jobs are.

I think it's not a reason that we won't have headwinds in Houston, but it's why I think we're pretty well positioned all things considered. I hope that's helpful.

Yes, that's great. My other question was with regards to land spend, I know you kept the total amount the same.

But I was wondering, should we be expecting there will be a bigger component from land banking? And if so, if you could help us with that.

You're absolutely correct to assume there's going to be a bigger component of land banking than what we had originally mapped out, but I think it's probably still too early for us to give you exact percentages. We had said 80%/20% last quarter, I think it's going to be a little bit more geared towards land banking. But we will have more visibility as we move through the year.

Okay, I will get back in queue. Thank you.

Alan Ratner, Zelman & Associates.

Good morning, thanks for all the information. Allan, given the decision to focus more on deleveraging, which I think is clearly prudent given the capital market conditions right now, it seems like in order to get the cash balance where you want it to be to fund the $100 million of deleveraging, you're banking on a pretty significant improvement in absorptions in the second quarter.

I was hoping you might give us a little bit of color on what you're seeing on the ground that gives you that comfort on guiding for that or expecting that. I don't know if you want to quantify the improvement you saw through the quarter or January activity, but I think it would be helpful for us. And I guess the follow-up to that would be, if the spring does not turn out to be strong or some of the weakness we have seen on Wall Street permeates into Main Street, what contingencies do you have in place to generate that cash to hit your deleverage targets?

Good question. First of all, at the risk of a shocking statement, we don't actually expect on a year-over-year basis an improvement in absorption rates. We have actually guided to a lower absorption rate in Q2 than we had a year ago.

We're more focused on the mix of specs versus to-be-builts. That played out in the first quarter as we started to adopt this, and it had real benefit for us in our mid-Atlantic divisions where sales paces were good. But we clearly were able to emphasize or shift the mix to homes that would close sooner.

What gives us confidence is that over the last three months, we've had some success doing that. We don't need a return of 2015 paces to achieve our objective.

In part, Alan, that is also because there are other elements to the plan. We are controlling our land spending, we guided to something on the order of $100 million in each of the next two quarters. That is a bit lower than it would have been six months ago or even three months ago.

We talked about more land banking. We telegraphed what our expectations are on our asset sales, things that are held on our balance sheet as held for sale and what we expect to close. I think there are enough levers within the mix of things we are doing that as sales paces prove inherently impossible to predict or control, there are other things that are available to us so we are in a very comfortable position without being in the high-yield market prior to June.

I appreciate that. The second question I have would be, you're maintaining the 2B-10, the targets on margin and volume are unchanged. I think intuitively, given the strategy shift, it would seem like there would have to be some type of potential offset assuming this becomes a longer-term decision to reduce that debt and not go out and refi or raise additional capital.

What metric when you look at that 2B-10 plan would be most at risk as we look into 2017 and 2018? Should we anticipate margin pressure because you're land banking more, or are you going to preserve the margin and potentially see lower volume if that comes to fruition?

It's a great question. Honestly, we try and be prepared for the questions we're going to be asked, and we clearly anticipated that. The hard part of the answer is there's a lot that has to happen between now and the end of the year for me to really tell you.

Right now, when we are underwriting deals, we have not changed our underwriting criteria for gross margins that would put us at or above the 2B-10 range. In terms of our communities and their performance at a pace level, I don't see a reason why we have to today accept a structural reduction in pace.

We telegraphed back in November that there would be a rising mix of both land bank and land held for future development assets. We have a chart, in the appendix this time, that really lays out there is a margin differential associated with the mix. And that was going to impose on us this year already, a 50 basis point headwind relative to last year. So I feel like we've built that in.

In the next couple of quarters, shifting 10%, 20% of the sales from 2B builts to specs, I think that is going to pull a little margin pressure into Q2 and Q3 as it did into Q1. I don't see that that is a permanent shift.

That's not a long-term strategy to become a spec builder. It's dealing with a situation that we have roughly six months or five months remaining, and it was within our control. Longer term, I don't think we're telling you -- in fact, we're not telling you that we expect to radically change or even materially change in 2017 and beyond, the mix of specs.

One of the things that's hidden in plain sight is if you watched our balance sheet over the last three or four years, our active lot number hasn't changed a lot. Our absorptions and our total deliveries have gone up.

We have shrunk the quantity where the years supply, and actually the ratio of lots controlled under option has increased over a period of time. And I think that will continue to be the case. There are more things to managing to a deleveraging strategy than a simple trade-off between pace and margin.

Thank you.

Michael Rehaut, JPMorgan.

Good morning everyone. Working off the last question and answer, and appreciate all the detailed thought processes on this. And certainly makes a lot of sense in terms of trying to pay off the debt sooner than later.

Just wanted to make sure I'm understanding, you mentioned that the spec strategy is not a long-term strategy, which I think also makes sense; that it's more of a temporary strategy to generate cash in 2016.

At the same time, looking at the balance sheet and the debt maturities, you do have maturity. You have a term loan in 2017, more coming due in 2018. Is this something that there are other steps that you intend to take to address those maturities as well? Because it could seem to be an ongoing problem. Or do you think that would be more dealt through maybe pulling back on the spec from the increased activity this year and then shifting next year or increasing, continue to increase the land banking and other alternative financing methods?

I think it's a good question, and thank you for it. I think we have to look a little bit at pieces as we move forward.

There's a lot of moving parts in terms of the overall environment, what's going to happen in credit markets, what's going to happen in housing market. It's very difficult to comment on the 2018 maturity or 2019 maturity other than to say we're dealing with the 2016 maturity. We're going to put it behind us, and we're going to continue to evaluate our strategy against what's happening in the macro environment and the housing market.

If things were to slow down a little bit, we might generate some more cash in the business, we might slow land spending, that might make it easier to deal with the 2018 to the 2019. We are very well aware of what the maturity structure looks like in front of us, and we are being very pragmatic in moving forward and continually being proactive in adjusting our strategy. We've developed this strategy for 2016, and we will move forward as we go.

I just want to add one thing to David's response because I agree with it. But I think the other thing to realize is that improving the efficiency of our assets is a longer-term strategy. And we have taken land held from over $400 million to under $300 million.

There is a portion of our capitalization that is clearly tied up, if you will, by assets that aren't generating revenue and profits. Getting Sacramento active and Natomas, and I intentionally said, turning that division into a cash generator is a big part of our strategy.

We will activate other assets in the coming quarters and years, and frankly that is something that we have had no benefit from for many years. As I look out into 2018 and 2019, I think there are more things on the table than simple trade-offs with the spec ratio.

Great, and then just also following up on some of the detailed regional commentary, and certainly appreciate that as well. I was hoping to get if possible a little more sense of when you look at the average absorption for the quarter down 13%, you highlighted the West.

I was hoping to get some type of rough quantification of what sales pace was on a regional basis year over year, just to get a better sense of what was going on. You had also said you took steps throughout the quarter to improve.

If you can give a sense of on a year-over-year basis, you obviously still expect 2Q to be down year over year, but how did things begin and end during the quarter? Regional color, quantification on the sales base, and then throughout the quarter as well.

We have put it in plain sight. The West had a big in [de sell] in absorption rates. It was over half a sale a month per community in the West, and that drove the outcome.

Actually the pace was up a little bit in the East, and down a little bit in the Southeast. But really, that was more of an available communities dynamic than any commentary I want to make.

I think one of our markets in the Southeast, and I think for competitive reasons I won't name it. One of our markets in the Southeast went from 4 something to 3 something in terms of pace, so it had a little bit of an effect. But honestly, we were contemplating that.

I am not trying to put the elephant behind that telephone pole. The story for us in pace was in the West. It was in the markets that we described.

As I said, I will be happy to get into a little bit of the details. Part of it was the market. Houston was softer than we expected, but we still had a decent sales pace there.

In Dallas, we made a decision. We suffered last year enormously by selling into future phases and then holding the backlog. You've got cost creep in that backlog, and you've got customers that get antsy when their delivery dates are being pushed out. And I don't blame them.

That was a self-inflicted issue, and it was tough because our sales team could have sold a lot more homes in Dallas in some of our communities where we held lots off the market because we don't have them at a stage of land development yet where we can predict exactly when their house is going to start and therefore their home could close. I feel it was the right thing to do, a little bit of a pain in the quarter, but that market is primed for a really strong 2016.

We talk about levers that we pull, things that we do. I probably bored investors with the 4-P plans that we always talk about. But four Ps: price, product, promotion, people.

What do we do? When we have a community that's under performing, and it is looked at every single week, if it's not performing, where is the 4-P plan? What are we doing differently?

In Las Vegas, the Inspirada master plan is one of the more important focal points for new home sales. We opened two new communities. As I like to tell our team, rarely will we receive a welcome to the neighborhood party from our competitors.

I think about it in a little bit more pugilistic fashion, which is: we're going to open, they're going to punch us, we better be ready to punch back. I think what happened is we had our product dialed in to where we saw market demand, our sales team was ready, our traffic generation and promotion was right. And we got there and we were surprised by the competitive response that our new product elicited.

We were flat-footed, and we had to adjust. We did it within a couple of weeks, we changed included features, we changed actually product in one instance. I think we saw by the time we got to December a very different sales pattern.

So intra-week, intra-month, intra-quarter, we are dealing with those issues. I would say that in total unit counts, I think Las Vegas probably missed more sales than anybody. It's not a huge division for us.

The good news is it was acute, it was focused in a month and in a couple of communities, and it's not any genius that I've got. I can tell you the division leadership, the area leadership, the sales management was all over it. And the level accountability they have for putting forward and implementing change didn't wait until we had to report our results.

Great to hear. Thanks very much.

Susan McClary, UBS.

Thank you and good morning. In terms of accelerating the spec sales, can you talk a little bit to what you are doing to make sure you maintain the proper levels that perhaps a certain market doesn't get too far ahead of you? Along with that, do you think as we hear more about this trend across the industry and a lot of your peers are moving in the same direction, do you think in certain markets there is any chance we could move from perhaps a situation where you're under supplied to be over supplied especially if things were to slow further?

Let me take a part of that, and I think Bob will talk a little bit more about the spec strategy. I don't see right now evidence in either the resale market which is much larger or the new home market of building inventories.

We are early in the spring selling season, and I certainly can't see the start releases that all of our peers are doing. The good news about the specs is they turn pretty quickly. I am not worried about it, but I am aware of it.

I definitely think we're going to make a bit more emphasis maybe than others because we have a June maturity that we're managing to as part of our motivation. If you're on a September year end or an October, November, December year end, you're going to have a little different sense of timing then we had. I don't mind being first. I would tell you that.

One other thing about the whole spec strategy, and Bob alluded to this, it will sound, I suspect, somewhat superficial to folks. The reality is when someone comes into our community, when a buyer comes into our community, in many instances they don't know whether a to-be-built home or a spec home is right for them. Some have timing issues that force a spec or a near-term delivery, others have designs on options and features selections that will require a to-be-built.

A big part of what we do in every community, and honestly the answer is different in every community, is how do you differentiate those homes that are available for quick delivery if not immediate delivery versus the ones that are to-be-builts? And we've talked about this.

What we tried to do, and actually I'm really pleased with what we did in the mid-Atlantic. We sold a lot more specs, but part of the way we did that was we re-featured and repriced the to-be-builts to open a gap to make a relative value very apparent without reducing the price of the spec. You create that gap.

It's not just a shell game of pricing because you have to do things with your offering on the to-be-built. But a sensible customer and their realtor are looking at that value proposition saying; gee, that's $10,000 or $15,000. Now there are some consequences in terms of maybe the feature level is a little bit different in the immediate delivery home, but those are the kinds of things we're doing to make sure that we are effecting a shift in emphasis.

Some markets aren't going to move very far. They are predominantly to-be-built markets, and the basis of our competitive position is going to remain weighted.

There are other markets, and the higher price point markets for us in the mid Atlantic and California, I think do lend themselves to our ability to influence that spec versus to-be-built. Bob, you can talk about what we do from a controlling spec strategy because Bob does control that personally.

Sue, we've talked about this before. In answer to your question about us not getting too long specs, I still continue to control it.

All spec starts run through May. It's a community by community discussion and decision. If you are selling specs you can get more specs.

If you have communities where you haven't demonstrated the ability to sell them, you can continue to ask for them. You just may not get additional spec starts.

We continue to do that, and again, looking at the pricing differentials between to-be-builts and specs is a very important component in addition to sales pace of, how many have you sold the last three months specs versus to-be-builts. So we keep a tight eye on that.

Thank you. That's very helpful. You have talked about how the beginning of this year has started off pretty well. Could you give us any details around January and perhaps how it's coming together?

January came together, well, closer to the end of the month. I would tell you, it's hard to know week to week in this business. You have a good week, a bad week and then you have to look at weather and what was somebody else doing from a promotion standpoint.

I'm going to wear a decidedly and admittedly, a bit of an optimistic hat here for second. The things that have happened most recently have been pretty positive.

A couple of our competitors launched their big promos of heavily promoted promotions in front of us this year starting in January. When they do those things, I pay them the respect of expecting that they're going to compete hard for sales at that point.

Our spring promo started February 1. We are in the middle of it beyond the spot savings. We're promoting it, and as in prior years, I expect it to be an important part of Q2 sales.

What was interesting, encouraging, happy-making was that our last week of September was absolutely spectacular. The whole month was very good, but that last week was really strong. And I look at that say, in the face of the fact that everyone in our Company knows that our Blitz promo starts February 1 and we were not out in promotional mode in January and some people we compete with were -- to have posted the week that we posted at the end of January now, it's one week. There are 52 of these little battles, so I always try to be balanced about it. But that's a very encouraging dynamic to have a strong week in the week before you actually start your promo and in the face of other people doing things that I expect to be successful for them.

Thank you. Best of luck this year.

Thank you.

Sam McGovern, Credit Suisse.

After the 2016 maturities were paid, if we see rates tighten later in the year, should we expect you to be back in the market opportunistically, both to target other maturities but also to add back the debt you paid off?

We're going to reduce debt and reduce cash interest expense this quarter, next quarter, and for the foreseeable future. That leaves open opportunities in the future to do refinancing. We want to be clear that regardless of the rate movement, we expect to have less debt at the end of the year and less debt next year.

Great, and then just with regard to the repayment, you mentioned both a mix of cash and revolver draw. Can you give us a sense in terms of the mix between the two?

No, we're not going to give you an exact sense because it will depend. There's a lot of levers that go into cash generation during the next two quarters.

I think Allan and Bob and I have talked about the different levers we have within the business. Certainly there will be some revolver, and we will look as we move to the end of the year how much of the revolver we end up paying back. No specifics on that, but we will see as we move through the year.

Got it, and just lastly, when you look at leverage longer term, can you remind us on your target -- you mentioned debts reduction, but how much of it was going to be a mix of debt reduction versus the growth of the business?

We're often asked in a slightly different context. 2B-10 is terrific -- what happens next? I went to tell investors or remind them that we try to hide in plain sight exact what we want to do with the business.

If you look at our proxy, maybe I'm cynical, but I think people try to do those things that they're compensated to do. And we have laid out our long-term comp objectives for the senior management team that frankly all of our division presidents are levered to.

And there are three components. One is growth of pre-tax income, one is improvement in return on assets, and the third one is to reduce debt to EBITDA. I can tell you that the target level is [six], and the opportunity to get paid is at [five] or below.

If you think about where we want to go and where our incentives reside, we put it in black and white. I will say as a little footnote on that, I think investors liked it. And the reason I say that is, we got the highest vote for our Say on Pay in the company's history 97% or 98%. So I think we're getting good feedback that we're focused on the right things.

Thank you. I will pass it along.

Jay McCanless, Sterne Agee.

First question I had on the order comp, could you talk about if New Jersey orders were in last year's numbers? And if you stripped those out, what the order comp would have looked like?

It's not material, Jay. There were more orders in New Jersey in Q1 of 2015 than Q1 of 2016. I think we're down to our last five homes in New Jersey actually.

But in terms of the quantum of difference, I might be able to move the second number right of the decimal point with that. But that was not a material component of the de sell. It was really the things I have talked about at some length in the West.

Got it. And then Bob, could you repeat the guidance you gave on land sales?

Sure. We've got about $55 million on the balance sheet right now in land held for sale. And we have said we expect to close about half of that between now and June 30.

The last question I had, with the acceleration in specs, what should we expect the can rate to start moving up as well? Is it -- maybe not 400 basis point of differential year over year, but should we expect can rates to be slightly elevated as you try to press the specs strategy?

It could move it a few points. As I said about Q1, I want to be really careful. I don't think the Q1 can rate bump, really, I can tie back to that or to Houston. We just didn't have the gross sales numbers we typically have and that we expect to have particular in October.

Over time, you're right. You've studied the industry, when you have a higher ratio of specs, you can see a slight increase. I don't think it's going to be a big narrative for the year. But probably caution would suggest a couple points may be right.

Jay, I would add to Allan's comments on the can rate in the quarter. We also look at can rates as a percentage of beginning backlog. If you look at it on a year-over-year basis, there was very little change, maybe 20 basis points between first quarter last year first quarter this year. So it really was the sales number.

Got it, thanks.

Alex Barron, Housing Research Center.

Thank you and good morning. I like your shift to delever, so I think that's a good move. I wanted to ask you on the gross margins, how much would you say the impact has been so far from an increase in labor costs year over year versus an increase in land costs? Is any way you can quantify that?

We don't break out the specifics. I can tell you in terms of labor and material costs, it wasn't that significant in terms of the overall impact in the business in the quarter.

And on a go-forward basis looking forward, we don't see a lot of significant change in the next three to six months. Not as much labor, more heavily weighted towards land cost, but again, we don't quantify the differences.

David, you say that, but we kind of do. We told investors, and I've said it once on this call already, the mix this year, Alex, that has more land held for future development and more land bank deals, that is essentially going to be reflected in the land component that is a bit of a headwind year over year on our gross margins. That is a piece of it.

We've always said we're between 20% and 25% of ASP in our land costs. With that change that Allan just noted, it's going to trend a little closer to the 25% than maybe it had in prior years.

Got it. Any thoughts as far as shifting into more affordable products over the next couple years? I know some other builders seem to be doing that, and you guys in the last few years have moved away from it. I'm wondering if you are changing your thoughts on that or not yet.

It's interesting Alex, I think they're coming to us as opposed to us shifting. Our ASP has moved up, there's no doubt about, and it's been important for the Company. But it has been a regional story more than it has been an in-market story as it relates to who we are.

When you look at the major master plans or in the markets that are highly competitive, you know who is on the 70- or 80-foot lots, you know who's on the 60-foot lots and you are going to find these are on the 50s or 45s or the 40s. I don't think we have abandoned our base at all in terms of who our buyer is. Our buyer is a little older, they are a little more affluent, they want a few more features in the home.

I don't feel any need to strategically reset the business. We're focused on those first-time homebuyers.

Thank you. Good luck.

Joel Locker, FBN Securities.

A question on your G&A and obviously, that was one of the highlights of the quarter. How do you expect that to trend going forward? It was only up 1% year over year. Do you think you can actually get it down year over year, or where there some one-timers in the G&A?

This is Bob. In the quarter, we were actually down 270 basis points year over year. The actual spend was pretty comparable as we controlled our costs.

On a go-forward basis, what we said earlier was we think it will be flat sequentially in Q2 on a percentage basis. But that will be about 170 basis points better than the prior year.

Now, dollar costs will be up as they normally are seasonally. We will get additional leverage from more closings and higher ASPs.

Thank you.

At this time, we have no further questions in the queue.

We would like to thank investors for participating on the call, and we look forward to talking to you and giving you an update on our results at the end of April. Thank you.

Thank you for joining today's conference call.