Beazer Homes USA Inc (BZH) 2018 Q3 法說會逐字稿

Good afternoon, and welcome to the Beazer Homes Earnings Conference Call for the quarter ended June 30, 2018. 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, Lisa. Good afternoon, and welcome to the Beazer Homes conference call discussing our results for the third quarter of fiscal year 2018.

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-Q, which may cause actual results to differ materially from our projections. Any forward-looking statements speaks only as of the date the statement is made, and 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 simply not possible 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. On our call today, Allan will briefly review our results for the third quarter of fiscal 2018, discuss our recent acquisition and provide our perspective on the broader housing market and our positioning heading to next year. Bob will cover our third quarter results in greater depth, where we stand relative to other 2B-10 goals and our expectations for the fourth quarter of this year. I will then come back to provide more details about our land spend this quarter and provide an update on our balance sheet, followed by a wrap-up by Allan. After our prepared remarks, we will take questions in the time remaining.

I will now turn the call over to Allan.

Thanks, David, and thank you for joining us on our call this afternoon. We had a productive third quarter, generating benefits for this year and laying groundwork for the future. Improvements in revenue and profitability brought us closer to achieving 2B-10 and our debt retirement goals in fiscal 2018. At the same time, our elevated land development spending and the expansion of Gatherings, combined with our acquisition of Venture Homes, positions us for substantial growth in both earnings and return on assets in the coming quarters. Since Bob and Dave will delve into the numbers in some detail, I'm going to concentrate my comments on 3 higher level topics. First, I'll discuss our third quarter orders and how they relate to our positive view of housing market conditions. Second, I'll talk in a little more detail about the acquisition of Venture Homes and why we're confident we can drive improvements in these communities. And finally, I want to discuss our expectations beyond achieving 2B-10.

As we've previously reported, we generated an absorption pace of 3.1 sales per community per month in the third quarter. This was a little bit lower than we expected and lower than last year's unusually robust sales pace of 3.4. At the same time, 3.1 is a pretty strong number, matching the industry leading pace we've achieved in the third quarter in prior years. Although, peer results aren't all disclosed yet, this pace is likely to remain nicely above the average of the national builders.

Looking at absorptions by month, April orders were a bit lower than anticipated, but it was May when we experienced greater difficulty converting solid traffic into sales. Then June showed a nice lift in virtually every market with essentially no change in incentives. It's hard to know the exact mix of reasons for these sales patterns, but one factor was likely rising mortgage rates, and more specifically, the timing of this year's increases. Rates rose sharply in the March quarter before flattening out in the June quarter. It's likely that this pattern helped earlier in the year as buyers tried to get in front of further increases and then worked against demand as rates flattened. In June and so far this month, it appears that buyers are adjusting, and we have seen improvements in our conversion rates.

But just looking at monthly order trend risks missing in the bigger picture. Current conditions in the housing market are quite positive. Demand for new homes remains healthy, as rising consumer confidence, favorable demographics and strong job and wage growth continue to encounter a limited supply of new and used homes. The challenge is to be able to provide homes that are affordable despite mortgage rate increases and the cost pressures that are inevitable in a strong housing market. With our longstanding consumer-facing strategy of providing an exceptional value at an affordable price, we believe we're well positioned to manage this affordability challenge.

Earlier in July, we announced the acquisition of Venture Homes, one of the largest private builders in Atlanta. In our announcement, we highlighted some of the advantages of the transaction, including doubling the size of our Atlanta operations and improving next year's profitability. What we haven't talked about is how we expect to improve the performance of these acquired communities? Venture's historical success was driven by offering attractive homes in well-located communities at affordable prices. But they did this with essentially no marketing and without an on-site sales presence 7 days a week. Venture sales pace over the last 12 months was 1.7 homes per community per month. As we drive leads and traffic with our online marketing expertise and fully staff the communities, we expect to increase the sales pace quite significantly.

Over the past year, investors and analysts have repeatedly asked us about our expectations for what comes after 2B-10. With 2B-10 in sight, we decided it was time to address that question. Based on the investments we've been making in community count, incremental contributions from the Venture transaction and our confidence in the underlying strength of the housing market, we expect to generate at least $2.50 in earnings per share in fiscal '19, driven by a double-digit growth in EBITDA and leading to a return on assets above 10%.

While we have to manage both headwinds and tailwinds, here's how we plan to get there. First, we're going to significantly grow our top line as we benefit from both a mix-driven improvement in average selling price and the community count growth we've been investing in. Second, we expect to improve our operating margin as top line growth will generate greater overhead leverage. And finally, interest expense will become an even smaller percentage of revenue as we benefit from the debt reductions we've undertaken.

Setting expectations isn't the same thing as guaranteeing results. We still have to go out and execute, but we're confident in our prospects because these goals arise from strategies and activities we've been working on for several years. With that, I'll turn the call over to Bob to discuss our results in more detail.

Thanks, Allan, and good afternoon, everyone.

Homebuilding revenue rose more than 7% versus the prior year to $507 million. This was driven by a 7% increase in the average selling price, which reached nearly $365,000. We generated a backlog conversion ratio of over 60%, in line with our expectations. Average community count for the quarter rose to 157, an increase of 2 communities from the previous year. We ended the quarter with 158 active communities. And we'll see community count begin to rise in the fourth quarter, largely as a result of the Venture acquisition earlier this month. Our third quarter gross margin, excluding amortized interest, impairments and abandonments, was 20.8%, right in line with our guidance. SG&A as a percentage of total revenue, including both homebuilding revenue and land sales, was 12.1%, down 30 basis points year-over-year. Taking to -- this led to third quarter adjusted EBITDA of $46.6 million, up more than $2 million compared to the same period last year.

Total GAAP interest expense, which includes both interest amortized from cost of goods sold and the interest included in other expense was $22.7 million for the quarter, down more than $2 million versus the prior year. As a percentage of total revenue, our interest expense for the quarter was down 80 basis points year-over-year, and we expect further improvements moving forward.

Tax expense in the quarter was about $4 million with an average tax rate of 24% as we benefited from additional energy tax credits in the quarter. We expect our average tax rate to be approximately 27% in the fourth quarter and around 24% next year. All this led to net income from continuing operations of $13.4 million, an increase of 89% year-over-year.

We continue to make progress toward achieving 2B-10, our goal to get to $2 billion in revenue and a 10% EBITDA margin.

On this slide, we have provided details on our performance relative to our 2B-10 metrics. For the trailing 12 months, our total revenue was $2 billion, up more than 50% from when we introduced our 2B-10 plan. Over the same period, our adjusted EBITDA has grown more than 120% to $191 million. This accelerated growth in EBITDA was achieved without growing our total assets, driving a significant improvement in our ROA.

Before we get into the fourth quarter guidance, we thought it might be helpful to review the mechanics of the allocations of the purchase price related to Venture. The methodology we're employing is very similar to what our peers have used in their acquisitions. In allocating purchase price to the assets and liabilities in Venture, we are required to separately fair value portions of the inventory, consisting of homes in backlog, specs and model homes to eliminate some of the built-in gains associated with these assets. This will produce lower than normal gross margins on these when they close, and therefore, impact our overall company gross margin. This impact will be most pronounced in the fourth quarter of this year and the first quarter of fiscal 2019. While we're still going through the valuation process, we expect to record a modest amount of goodwill as a result of the transaction.

Moving on to our expectations for the fourth quarter compared to the prior year. Our guidance includes the impacts from Venture, though it's important to note that the acquisition is likely to contribute virtually no EBITDA in the fourth quarter because of purchase price allocations.

Orders are expected to be up low single digits, driven by a higher community count. Closings should be up versus the prior year with a backlog conversion ratio around 85%. Our ASP should be around $380,000, up significantly versus the prior year. Gross margin should be between 20.5% and 21%, including the impact of purchase price allocations from Venture. SG&A as a percentage of total revenue should be 10%, down significantly versus the fourth quarter of last year. We expect EBITDA to be up with the full year total surpassing our 2B-10 goal of $200 million. And finally, the cash component of land spend will be up significantly.

At this point, I'll turn it over to David.

Thanks, Bob.

In the quarter, we spent about $156 million on land and development with acquisition spending up more than 55% and development spending up more than 40% versus the prior year. Our land development spending has been elevated throughout this year as we've invested in both new communities and activating our formerly land-held assets. Since peaking in 2009, our total land held for future development has declined from $420 million to less than $85 million with further reductions expected in coming quarters. As depicted on Slide 12, more than $500 million of our $2.2 billion in total assets are currently nonearning. This includes $226 million of formerly land-held assets that are under development. We think this is important to point out because it means that our trailing 12-month EBITDA of $191 million was earned on only $1.7 billion in assets. This 11.5% return on active assets is more reflective of our operational capabilities than our 8.8% ROA on total assets. As we begin to monetize these nonearning assets in fiscal year '19, we expect to surpass a 10% ROA on total assets with further improvements over time.

On Slide 13, we outline the components of our expected community count growth for the coming quarters, including the breakout of organic versus Venture growth. While it's always challenging to predict the exact timing of community activations and closeouts, we currently expect to end fiscal 2019 with more than 170 communities, driven not only by the Venture acquisition, but also from our increased land spend and our activation of previously land-held assets.

As a result of our debt reduction and refinancing activities, our balance sheet is positioned to support our growth ambitions. We ended the quarter with $136 million in unrestricted cash and more than $330 million in total liquidity. As we have stated previously, we will complete our $250 million debt repurchase program this fiscal year with retirement of the remaining $96 million of our 2019 senior notes. This will generate approximately $5 million of additional annual cash interest saving, resulting in an aggregate cash interest reduction of about $21 million since the beginning of fiscal 2016. After that repayment, we will have no debt due before 2022, although we expect to incrementally reduce debt moving forward.

With the improvement in profitability and our reduction of debt, our net debt to adjusted EBITDA has declined to 6.2x, down from 6.9x at the end of the third quarter last year and down from more than 11x just 4 years ago. We are targeting a net debt to adjusted EBITDA below 5x as we continue to improve our profitability and redeploy formerly nonearning capital.

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

Thanks, David.

As we enter the final quarter of fiscal 2018, we are on track to achieve 2B-10 and our debt reduction goals. Looking forward to fiscal 2019, our actions over the past few years have positioned us to generate significant improvements in earnings and return on assets.

I'd like to thank our team for their ongoing efforts. I'm confident that we have the people, the strategy and the resources to execute our plan over the coming years.

And with that, I'd like to turn the call over to the operator to take us to Q&A.

(Operator Instructions) And our first question does come from Alan Ratner from Zelman & Associates.

So appreciate all the guidance that you've given in the slides here. It's very helpful. I was hoping that, if possible, to dig in a little bit more on the '19 outlook and the $2.50 of EPS. It obviously implies very strong growth. And I think you touched on, I guess, the levers that you expect to be most impactful. It sounds like top line, SG&A and interest. But I'm looking at the order activity recently. Obviously, 3Q was a little bit of a tougher quarter than expected, and it sounds like 4Q low single-digit growth, a little bit of an improvement. But I would honestly have expected a little bit something stronger than that given that you've had -- you'll have Venture for the full quarter. So I guess, what I'm trying to figure out is what's embedded in that expectation specifically on the volume side? We could see your community count is going to be up, call it, high single digits. But do you expect to drive further absorption growth? And if so, what's really going to be driving that given the recent order activity?

You bet. So I think when we get to November, we'll dial into more detail around 2019. But I can -- I think I can help kind of with your question by reminding you that we're really focused on community count and a mix-driven shift in ASP as the primary top line growers for next year. At this point, I don't see a significant change, one way or the other in pace. Month-to-month, quarter-to-quarter, as you know as well as anyone, it's very tough to call, but we are not assuming that we have substantially higher paces next year.

So if I look at your backlog price, it's up about 10% year-over-year. Is that a reasonable guide for what you expect that mix-driven ASP growth to be? Or as you look your new communities that you're opening, are those priced significantly above what you're currently selling today?

They're not. I guess, the way -- and I know this ultimately comes down to how do you -- what do you put in a model. A couple of things, Alan. I think it's instructive to go back in time, at least for us, and look at the latency between the ASP in backlog and how 1, 2, 3 quarters out that translates into ASP in the quarter at hand. I mean, you can sort of see how that transitions. I think 2 other factors, the small amount of backlog that we brought in from Venture and their price point is lower. So I would suggest that the mix-driven shift will be slightly different than it would have been to the downside because the ASP in Venture is just a little bit lower. As it relates to the Beazer communities that we're opening, they match very nicely with the existing footprint that we have, the existing price points that we have. So those are really the factors that I would give you. There is not a dramatic change in new openings. There's a little bit of downward pressure because of Venture. But it's really -- you can see in the backlog, what's going to happen.

Got it. I appreciate that, Allan. If I could just maybe step away from the model for a second, just to ask a bit of a higher-level question on the current demand environment. You're not the only ones that have reported some deceleration in orders in the most recent quarter. Sounds like most builders are pretty optimistic that growth will pick back up here, and some have even pointed to June and July, like you guys have. I guess, the question is, as you move into the seasonally slower months, at what point if growth does not significantly pick up from here do you start to think about that price versus volume equation and prioritize volume perhaps instead of maybe the -- where the focus has been on driving price and margin at this point?

Yes, it's a very good question. And obviously, the kinds of things that we're talking about all the time. And boy, I wish there were an easily distillable answer to it. One just point of maybe correction, the idea of growth we're assuming, I will tell you that there's no question, when we were sitting in May, we thought that the second -- our fiscal third quarter was going to be a little stronger pace. But there's not a lot to apologize for at 3.1. That's a very good pace for the industry. And frankly, as we've talked about, that's a very good pace for us. So it's not like it completely went away. It didn't stay quite as enthusiastic as it was in the second quarter, no question about it. I don't think we're looking for it having to rebound to that level. That's not the expectation. I think there's kind of, at least on our side, more of a maintenance, but it will be potentially lumpy for month-to-month. Now the real -- the thrust to your question was more in the pace versus price. And we've always said we like to point out that when we've tended to have better paces, we've tended to have better margins. So it isn't obvious that that's a trade-off. But clearly, there are individual communities, where based on the competitive environment around that community, particularly if we had older-dated specs or we are in closeout mode, that would be the point where we’d say, "Okay, it's time to look at the price lever." As we look at our business overall, though, I think there are enough other things and we keep proving this to ourselves and our 4-P plans that with product and people and the way that we are promoting and advertising, there are a lot of other levers to pull before we get to price. So I don't think we're in an environment now and I don't think we're particularly close to an environment where we adopt kind of a price-driven volume mindset. Those market conditions could arise in the future, but I don't think that's where we are right now.

The next question comes from Susan Maklari from Crédit Suisse.

This is Chris on for Susan. The first question is just on the Venture Home acquisition, understanding you're still very early on in the process, but can you just give us an update on how the integration's come along and what benefits you expect to realize through the year and into 2019?

Sure. So they were doing a lot of things well. And one thing that's nice about buying a business that has a 30-plus-year operating history is we didn't have to teach them homebuilding, and we didn't have the arrogance to think that we could. There are definitely things that they were doing really well. But I touched on the thing that we saw was the most direct opportunity, which is 2 sales counselors in each community 7 days a week and an online marketing program that we're pretty good at. We think we do very well with that. We are confident it's going to drive both traffic and sales in those communities. And I think that's the thing we're the most confident in. And I can tell you, in the first week of our ownership, a week ago, we sold more homes on that side of our Atlanta business than, frankly, they had sold in the prior month. So I really do feel like that it is the sales side where we can add the most value. Clearly, we are bringing some of our national account relationships into the Venture family, so there'll be some change-outs in some of the products. And we're also having an opportunity to talk to trades about having a bigger scope of business. And I'll be honest, in the environment we're in, that's a little less about price and it's a little bit more about certainty and cycle time and quality and our safety protocols. But I think that footprint scale is quite helpful for us.

Got it. And then my second question is just on the 2019 guidance. We're seeing a lot of pricing action come through in the building product side of things, the manufacturer side of things. So I was wondering how much pressure you have baked into 2019 guidance on the margin side.

We are fortunate that in many of our product categories, we have longstanding and longer-duration agreements with major partners. And I think for competitive reasons, it's probably not wildly advisable for me to go through the terms of each of those, but there are an awful lot of the categories in which we have multiyear price protection in our relationships. So I would just say, as you're seeing things and hearing things on a day-to-day basis, understand that when we've got a long-term partnering relationship with a major product provider, we don't do that lightly, neither do they. But there is an awful lot of price certainty built into the tenor of that relationship.

(Operator Instructions) And our next question comes from Jay McCanless from Wedbush.

Just looking at the regional comps, it looks like the West was your best performer. And was just wondering if things are slowing out West because we're hearing different stories about California, how does that affect your ability to convert some of the land held into active assets? And what type of impact do you think they could have on the '19 guidance?

So they're -- for us, Jay, the West includes Texas, Arizona, Nevada and California. So it certainly, for us, is a broader segment than I think it may be for others. The largest portion of our formerly land-held assets are in Northern California and, in particular, in the Sacramento area. We operate in that market with a price point generally in the 3s. That's a very attractive price point to be at anywhere in California, particularly in a place with record-low MLS listings, good job and wage growth. So as we look at that submarket and where we have the most formerly land-held assets that are yet to generate revenue, we feel okay about how we're set up for 2019.

And then, Bob, the other expense was almost negligible this quarter. Should we expect that going forward, especially with you guys returning that $96 million in debt at the end of the year?

Yes. I think we won't be talking too much about direct interest expense going forward.

And then just was going to see if you guys could quantify what you're seeing for sales pace in July versus what you saw in 3Q?

No, we don't do it week to week. I mean, it's hard enough on a quarterly or an annual basis, Jay. I think our comments in the script were we've seen that the buyers have adjusted after what we really described as May being a little bit tougher for us and conversion rates have improved, and that's really as far as I want to go.

I am showing no additional questions in the queue. I will turn the call back over to the speakers.

Okay. Well, hey, thank you all for joining us on our third quarter earnings call. We look forward to reporting our full year results in a few months. Thank you very much.

That does conclude today's call. Thank you for participating. You may disconnect at this time.