Beazer Homes USA Inc (BZH) Q1 2020 Earnings Call Transcript

Good afternoon, and welcome to the Beazer Homes Earnings Conference Call for the Quarter Ended December 31, 2019. 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. Good afternoon, and welcome to the Beazer Homes’ conference call discussing our results for the first quarter of fiscal 2020. 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 statement speaks only as of the date the statement is made. And 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 simply not possible to predict all such factors. Joining me today are Allan Merrill, our Chairman and Chief Executive Officer; and Bob Salomon, our Executive Vice President and Chief Financial Officer. On our call today, Allan will review highlights from the first quarter and then discuss our progress towards our goals for fiscal 2020. Bob will cover our first quarter results in greater depth, as well as our expectations for second quarter. I will then come back to provide an update on our balance sheet and more detail about our land spend 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 first quarter as we met or exceeded our expectations on each of our core metrics. First quarter orders were the highest they’ve been in a decade, up nearly 30% year-over-year, as we benefited from both the healthy demand environment and community count growth. And importantly, gross margins ticked up, reflecting the improvement efforts we adopted last year once demand stabilized. This strong performance drove a large increase in our backlog, enhancing our visibility and adding to our confidence for the full-year. It’s fair to acknowledge that sales comparisons with the prior year were relatively easy in the first quarter. But that doesn’t diminish the fact that there are both market and company-specific factors supporting our expectations for future improvement. At the market level, fundamentals remain strong across the board. Continued wage growth, low unemployment and high consumer confidence all support robust demand, and the supply of both new and used homes remains quite low. Of course, sustaining home affordability remains a challenge, but the reduction in interest rates over the last year has directly benefited homebuyers. Inside the company, we are using the strong economic backdrop to reduce incentives as one part of our effort to drive gross margins back into the 2020s. The first quarter reflected early results of these efforts, with higher margins in backlog providing further evidence of the opportunity in front of us. With absorption rates at current levels, we are laser-focused on delivering year-over-year margin improvement in each quarter this year. At the beginning of the fiscal year, we outlined three main goals for 2020. These goals arise from our longstanding balanced growth strategy, which targets a double-digit return on assets by growing EBITDA faster than revenue from a more efficient and less leveraged balance sheet. In the first quarter, we made progress on all of these goals. First, EBITDA was up 9.4%, marking the first year-over-year improvement we’ve generated in five quarters and providing momentum toward our full-year goal of more than 10% EBITDA growth. Second, strong sales and improving margins, together with the continued monetization of previously non-earning assets are pushing us toward our double-digit ROA goal by year-end. And finally, growth in closings and profitability will generate sufficient cash flow to allow us to retire more than $50 million of debt while we invest for future growth. This should allow us to achieve a net debt-to-EBITDA ratio below five times. Achieving these goals will lead to higher earnings per share, growth in book value and further growth in our return on equity, all from a less leveraged balance sheet. With that, I’ll turn the call over to Bob.

Thanks, Allan, and good afternoon, everyone. Looking at our first quarter results compared to last year, new home orders increased over 28% to 1,251, as our average community account rose 5% and our sales pace rose more than 20%. Our pace was 2.5 sales per community per month, the highest first quarter level we generated in the last 10 years. Homebuilding revenue increased 4% to $417 million, driven by a 3% increase in closings and a 1% increase in our ASP. Our gross margins, excluding amortized interest, impairments and abandonments, was up 10 basis points year-over-year, driven by our ongoing efforts to reduce incentives and simplify our product offerings. As we’ve previously noted, avoiding a significant drop off in gross margins sequentially from the fourth quarter should bode well for the year, as our first quarter gross margins have typically been well below the prior quarter. SG&A as a percentage of total revenue was 13.3%, down 20 basis points. This led to adjusted EBITDA of $29.4 million, up over 9% versus the prior year. Total GAAP interest expense was up around $3.5 million. However, our cash interest expense was actually down $3.3 million due to our debt retirements and refinancing activity. We recorded an income tax benefit of $200,000 in the quarter. This was driven by energy efficiency tax credits of $700,000, which compared to $5.3 million of credits in the prior year. And finally, net income from continuing operations was $2.8 million. Before we move on to our second quarter expectations, I wanted to provide additional details on the difference between our GAAP and cash interest expense. On Slide 7, you can see the relationship between the two measures over the past several years. As we’ve explained on prior calls, the amount of interest that we amortized through cost of goods sold is a function of both our capitalized interest and our inventory turnover, while our cash interest expense reflects what we are actually paying. In line with our balanced growth strategy, we’re improving our return on assets with a less leveraged balance sheet by successfully growing our EBITDA even faster than our assets, which is leading to higher inventory turnover. But by doing so, we’re also accelerating the expensing of previously capitalized interest. This has occurred even as we have dramatically reduced our cash interest expense. Over time, we expect that our GAAP interest expense will converge with our cash interest expense, which will fall further as we payoff additional debt. Turning now to our expectations for the second quarter of fiscal 2020. Relative to the same quarter last year, we are targeting the sales pace comparable to last year and we expect our community account to grow slightly. Taken together, this shows a modest increase in orders as we have prioritized driving higher gross margins. Gross margin should be up at least 20 basis points year-over-year, back about 20%. We expect our backlog conversion ratio to be around 70%. Our ASP should be in the high-370s. We expect SG&A as a percent of total revenue to be roughly flat with last year. Total GAAP interest expense should be around $23 million comprised of both interest included in cost of sales and direct interest expense. Cash interest expense will be approximately $21 million, down $4 million compared to last year. Our annualized effective income tax rate for the full-year is expected to be about 26%, though we may experience fluctuations on a quarterly basis. Finally, the cash component of land spend should be around $135 million. At this point, I’ll turn it over to David.

Thanks, Bob. Reflecting the goals of our balanced growth strategy, we have structured our balance in a way that allows us to invest in our business, while continuing to reduce borrowings toward our goal of bringing debt below $1 billion. With our defined deleveraging path and without any significant maturities until 2025, we have substantial runway to focus on operations and growing the business. In the first quarter, we spent $146 million on land and development, in line with our expectations. Looking forward, we continue to expect land spending for the full-year to be significantly higher than the prior year. At the end of the first quarter, we owned or control nearly 19,000 active lots, representing a 3.5-year supply of land based on our fiscal 2019 closings. This level supports our growth goals as we continue to invest in our business. The table on the right side of Slide 10 details our expectations for future community openings and close-outs. Finally, we continue to allocate a component of our land spend to the roll out of gatherings across our footprint. As of the first quarter, we are open for sale in Orlando and Dallas. We are under construction in Nashville and expect to start selling soon. And later this spring, we expect to break ground in Houston. Finally, we own or have approved the acquisition of additional sites in Atlanta, Charleston, Dallas, Maryland and Orlando. On Slide 11, you can see the success we’ve had in executing our balanced growth strategy over the last few years, as our first quarter EBITDA has grown by 80%, while our assets have declined by 13%. And we believe we can drive additional balance sheet efficiency, as we focus on buying shorter duration deals, increasing our use of options and generating cash from assets that were previously inactive. Our improved balance sheet efficiency has enabled us to grow our business, while substantially reducing debt and decreasing our cash interest expense. This is reflected on the right-hand side of the slide, where we compare the improvement in our first quarter EBITDA versus the reduction in first quarter cash interest expense over the last five years. Given our expectation for further debt reduction, we expect this trend to continue moving forward. With that, let me turn the call back over to Allan for his conclusion.

Thank you, David. The first quarter of fiscal 2020 was very productive for Beazer, as we exceeded our sales targets, improved margins and invested for future growth. These results gave us momentum heading into the spring, providing confidence in our efforts to reach our goals for this year and positioning us for higher earnings and improved returns in the years ahead. I want 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’ll turn the call over to the operator to take us into Q&A.

Thank you. We will now begin the question-and-answer session. Our first question comes from Alan Ratner with Zelman & Associates. Your line is open.

Hey, guys, good afternoon. Nice quarter. Congrats. First question, just on the 2Q guide on orders. Obviously, really strong order growth this quarter. And it looks like you expect that to pull back quite a bit in 2Q just up modestly year-over-year. I’m curious how you’re thinking about that, because it looks like the comp is fairly similar and at least up to this point, other builders have been pretty positive in January. So is there something specific that might be driving that pullback in growth?

Well, Alan, a couple of things going on there. Last year in our second quarter, we actually had a pretty good number. This year, we’d like to do that again, but with better margins, and that’s really the focus for us. The environment is constructive, and I think the opportunity is there to do better. But we really focus this year on driving margins back into the 20s, and that has an effect on our enthusiasm for leaning into the absorption rate.

That’s helpful, Allan. On that point, can you talk a little bit about what’s getting you there on the margin? Have you been actively raising prices over the last several weeks given the strong order activity? Is that why you’re so confident on the margin, and at the same time do you expect to see that pullback in growth or is there something else driving costs or anything?

There are a few levers. Bob talked in the script a little bit about reducing incentives. If we pivot back to last June, once it became clear that the market had regained footing, we competed aggressively at this time last year to make home sales. We’ve been removing incentives and pursuing simplification. That takes a little bit of time, but we’ve been working simplification strategies through our product lineup, while adjusting incentives and raising prices where we can. It’s a combination of those activities that give us the visibility into not just this next quarter, but a real belief that we can have year-over-year increases in gross margin all year.

Got it. I appreciate that. Thanks, guys.

Thanks, Alan.

Next, we will hear from Alex Barron with Housing Research Center. Your line is open.

Yes. Thanks, guys. I appreciate the comments on the interest expense versus interest going through the cost of goods sold. I was curious if you would expect that the interest going through the P&L for the whole year will be similar to last year’s amount?

We haven’t given full-year guidance on that specific split. What we’re trying to do is give a guide towards what the expense will be in total on a go-forward basis. If you look at the percentage of revenue this quarter, you’ll see that percentage of revenue should tick down as we get through the periods where we have much higher closing velocity and we’ll get some leverage out of the interest expense number in cost of goods sold.

Okay. I guess that’s what I was getting at. The order growth has been much stronger for yourselves and others than probably expected, and it seems like the year is off to a great start. I’m trying to understand your priorities. You mentioned focusing on debt reduction, but what is your appetite for growing versus maintaining or generating cash and not growing as much to focus on debt reduction? What’s the greater priority at this point?

We’ve taken a balanced approach. We’re going to pay off at least $50 million this year. The way we set up our term loan last year gives us a graduated path to show what debt reduction would look like. That leaves us plenty of firepower to grow the land bank where appropriate. Just because we can doesn’t mean we should, so we want to be careful in our underwriting. The market is quite constructive. We’re seeing opportunities to put money to work and I think we can do both: grow our lot count and at least pay off $50 million. We’ve committed to a minimum debt reduction this year.

Frankly, Alex, that’s really the hallmark of balanced growth. It’s the ability to pay down debt and grow the business that we’ve been doing for a while, and we’ll continue to do so if the market is warranted and the opportunities are there.

Okay, great. If I could ask one last one: can you give us a sense of where you think the tax rate will fall this year? Also, are you able to take advantage of the energy efficiency tax credit renewal or extension?

Yes. Our effective tax rate is expected to be about 26%, and yes, we’re looking at opportunities to take advantage of the energy efficiency tax credit renewal as well, as we have in prior years.

Okay, great. Thanks. Best of luck for this year.

Thanks, Alex.

Thanks, Alex.

Thank you. Our next question comes from Jay McCanless with Wedbush. Your line is open.

Hey, guys, thanks for taking my questions. I wanted to ask on spec homes versus to-be-built: how’s the gross margin spread looking on that right now?

With the constructive environment we’ve had, that spread has been narrowing and we’re pretty positive about that. You’ve seen the increase in margin and the margin guide going forward; we’re constructive about the margin differential.

On the flattish order growth, could you talk about how much you drove orders in the first quarter? Maybe elaborate on the strength out West — was it new openings, better demand than last year, or anything behind the scenes?

Last year the West was more adversely affected than other markets; California in particular was really tough in the fiscal first quarter, so that is part of the year-over-year improvement. We had strong results in all three reporting segments and in essentially all of our divisions, and the quarter built during the period — December was better than November, which was better than October. We did achieve a strong pace last year by being competitive; this year we can be in that range, but we are very focused on achieving margin improvement.

On Slide 10, if the community count will be up slightly for Q2 versus last year, should we expect a flat to slightly down community count for the back half of the year? What’s the cadence going to be as you see it?

It’s too early to give a prediction of what the back half of the year will look like. We try to give you the table to provide a sense of what’s in the pipeline. For now, modest community count growth in Q2 is the guidance we’ve provided, and as we move through the year we’ll discuss cadence in more detail.

As you think about the spring, we don’t know exactly which communities will sell at which paces. In a context where we are trying to improve margins and not just chase pace, that adds uncertainty as to the rate at which 55 to 75 communities will close out. It makes it hard to precisely time new openings and close-outs. We have good visibility into March, and in aggregate we have the firepower of communities to still have some community count growth, but being precise for Q3 and Q4 before our biggest selling quarters of the year is difficult.

Any quantitative description you’d like to give about January? That number in the West was large, and I’d love to hear anything further about January.

We’re not going to give a monthly number. We look at the business over quarters, not days and weeks. January has certainly been good, and we continue to see strength in the market across the footprint.

Thanks, guys. I appreciate it.

Yes. Thank you, Jay.

Next, we have a follow-up question from Alex Barron with Housing Research Center. Your line is open.

Thank you. I was curious if you guys were seeing any noticeable changes in the commissions you’re paying out to brokers? Also, what are your thoughts or appetite as far as share buybacks at this point?

On the commission side, we haven’t really seen a change in realtor payout behavior. On share repurchases, we’ve always been opportunistic with capital. We evaluate returns and risk in our capital allocation. If there are opportunities to buy the stock back at an attractive return, that makes sense. We have some firepower to do it, so everything is open for business and we’ll see where we go.

And we are showing no further questions at this time.

All right. Thank you very much, everybody, for joining us on our call, and we will talk again in three months. This concludes today’s call.

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