Beazer Homes USA Inc (BZH) Q2 2021 Earnings Call Transcript

Good afternoon, and welcome to the Beazer Homes Earnings Conference Call for the Quarter Ended March 31, 2021. 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. Now, I’ll turn over the conference call to David Goldberg, Senior Vice President and Chief Financial Officer. Thank you.

Thank you. Good afternoon and welcome to the Beazer Homes conference call, discussing our results for the second quarter of fiscal ’21. 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 described in our SEC filings, 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; 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 is Allan Merrill, our Chairman and Chief Executive Officer. On our call today, Allan will review highlights from the second quarter and discuss the supportive macro environment. He’ll then provide a preview for the remainder of the year and outline our expectations for growth in fiscal ’22. I'll then provide more details on our results, projections and balance sheet. We will conclude with a wrap up by Allan. After our prepared remarks, we will take questions in the time remaining. I’ll now turn the call over to Allan.

Thanks, Dave. And thank you for joining us on our call this afternoon. We had an extraordinary quarter, highlighted by an unprecedented increase in our sales pace, and significant growth in our gross margin, EBITDA and net income. At the same time, we invested for the future, grew our share of lots controlled by options and continued to reduce debt. In sum, we had a nearly perfect balanced growth quarter, with profitability growing faster than revenue, while operating from a less leveraged and more efficient balance sheet. Perhaps the best news is that our team is poised to translate continuing strength in market conditions into even better results in the quarters ahead. As I'm sure you've heard, the strength in new home demand has contributed to both longer cycle times and higher construction costs. To date, we have successfully adapted to this environment by raising prices, limiting sales paces and extending delivery dates on sold homes. As we work through these issues, our objectives remain the same. We expect to create value for customers, partners, employees and shareholders by delivering great homes on time and at the margin we intended when we made the sale. Our commitment to creating value for our stakeholders can also be seen in our recent accomplishments and goals on the ESG front as summarized on Slide 5. This quarter's highlights included being named an ENERGY STAR Partner of the Year for the sixth consecutive year, representing another significant step toward our goal of having every home we build Net Zero Energy Ready by 2025. We believe the strength in the housing market will prove to be durable. And the reasons are simple: strong demographic demand, exceptionally limited supply and the recovering economy. On the demand side, we expect many of the COVID housing norms to be persistent, namely the desire for more space, better space and outdoor space. Even as we return to offices and schools, our homes have clearly taken on new roles in our lives. Couple that with a great awakening of Millennials to the benefits of homeownership and the desire of many boomers to simplify, and you have a recipe for depth and breadth of demand that isn't likely to disappear anytime soon. On the supply side, the shortage of owner-occupied homes we described on our call in January turns out to be even more acute than we suggested. On that call, we conservatively estimated that the deficit was more than 1 million homes. In recent weeks, Freddie Mac published a deep research report which demonstrated the housing shortage is closer to 4 million homes. There's simply no way for our industry to accelerate entitlement, development and construction to make a serious dent in that number anytime soon. Finally, on the economy, while there are still many COVID-related challenges, there's ample evidence about job growth and wage growth, which bode well for consumer spending and housing. In sum, our industry is in a highly advantageous position, with demographically driven demand in a recovering economy, faced with seriously constrained supply beyond 2021. Turning now to our expectations, with our sold and already started backlog up more than 50% and continuing strength in lead and traffic trends, our visibility and confidence in fiscal ’21 results is quite high. Dave will provide details on our outlook for the third quarter and full year, but I'm happy to share that we’re raising our expectations again. The headline is that we now expect full-year earnings per share to be above $3. Looking beyond this year, our balanced growth strategy is a longer-term approach to generating shareholder value while carefully managing risk. Over the past several years, our strategy has yielded a big jump in profitability, even bigger improvements in our returns and a meaningful reduction in debt. And we're not done. While it's too early for us to give any type of detailed guidance for next year, there are three factors that give us confidence that we can again improve profitability and returns in fiscal ’22. First, our current backlog already contains nearly 700 homes scheduled to close in the first quarter of next year; that's more than half of our typical first quarter closings. With our normal cycle times, most of these homes would have closed this year. But these aren't normal times, so instead, we have a great start on next year. Second, community count growth is coming. Credibly strong sales over the past six months mean the depth in our community count arrived a little sooner than we previously anticipated. But next year, the positive progression in our community count will be evident. And remember, these communities were tied up six to 12 months ago, before the recent run-up in home prices. And third, we’ll finally see real interest savings. We have dramatically deleveraged our balance sheet in recent years but haven't really benefited from a reduction in interest expense in our earnings. That's because of the timing difference between the immediate cash benefit of much lower interest costs and the non-cash GAAP expense that arises from previously capitalized interest. Next year, we expect to realize a multimillion dollar reduction in our GAAP interest expense based on actions we have already taken. These factors and our confidence in the industry supply and demand equation should yield another successful year for our balanced growth strategy. Before closing, I’d like to again express our appreciation for the scientists, doctors, first responders and essential workers who saw us through what appears to be the worst of the pandemic and put our country in a position to begin to recover. With that, I'll turn the call over to Dave.

Thanks, Allan. Looking at the second quarter compared to the prior year, new home orders increased approximately 12% to 1,854 as our sales pace was up more than 40% to 4.7 sales per community per month. Homebuilding revenue increased about 12% to $547 million on 9% higher closings. Our gross margin, excluding amortized interest, impairment and abandonment, was 22.2%—up approximately 140 basis points. SG&A was down 100 basis points as a percentage of total revenue to 11% as we benefited from improved overhead leverage. Adjusted EBITDA was $64.2 million, up over 45%. Our EBITDA margin was 11.7%, the highest second quarter level in the past 10 years. Interest amortized as a percentage of homebuilding revenue was 4.4%, down 20 basis points, and that led to net income from continuing operations of $24.6 million, yielding earnings per share of $0.81, more than double the same period last year. With the strength of our current backlog and positive macro outlook, we’re in a position to once again increase our financial expectations for fiscal ’21. We now expect EBITDA to be up over 20% or more versus the prior year, a significant increase from the previous guidance. This level of improvement implies EBITDA growth of more than 10% in the second half of this year, with greater year-over-year growth expected in the third quarter. Our full-year EBITDA guidance equates to earnings per share above $3, up from last quarter’s guidance of at least $2.50. We now expect our return on average equity for the full year to be approximately 14%. If you exclude our deferred tax asset, which doesn't generate profits, our ROE would be over 20%. The current production environment is going to impact both sales and closings in the third quarter. As the second quarter progressed, in the face of elongating cycle times, we deliberately slowed home sales to provide a better experience for customers and increase the value of our communities. Many of these restrictions remain in place and as such, we anticipate new orders to be down 10% to 20%. On the closing side, because of the challenging production environment, it is difficult for us to predict the timing and mix of closings between the third and fourth quarter of this year. We’re focused on delivering great homes, not maximizing third quarter closings. Even with this caution, we still expect closings to be up in the high single digits in the third quarter year-over-year. Our ASP should be above $400,000 for the first time ever, gross margin should be up over 100 basis points, SG&A as a percentage of total revenue should be down at least 20 basis points, our interest amortized as a percentage of homebuilding revenue should be around 4% and our tax rate will be about 25%. Combined, this should drive a sequential increase in quarterly earnings per share. We ended the second quarter with over $600 million of liquidity—more than double this point last year—with unrestricted cash in excess of $350 million and no outstanding draws on our revolver. During the quarter, we retired approximately $10 million of our senior notes. And with two remaining term repayments, we’re on a clear path to achieve our goal of bringing our total debt below $1 billion by the end of fiscal ’22. During the quarter, we spent almost $100 million on land acquisition and development. Based on our land pipeline and approvals, we expect our land spend to accelerate in the remaining quarters of fiscal ’21, resulting in over $600 million of total land spend for the year. We also increased our option percentage in the second quarter and now control more than 45% of our active lots via options, up from less than 30% in the same period last year. We still anticipate community count troughing around 120 later this year, but we expect to grow steadily from there in fiscal 2022 as we benefit from our increased land spending. I’ll now turn the call over to Allan for his conclusion.

Thanks, Dave. The second quarter of fiscal ’21 was very successful for us as we maintained the momentum of the last several quarters, highlighted by very strong new home orders and substantially improved margins, while also improving the efficiency of our balance sheet. These results and continued strength in the market have enabled us to raise our expectations for the year. Perhaps more importantly, our performance should help investors understand the longer-term opportunity for value creation embedded in our balanced growth strategy and our ESG leadership. I want to thank our team for their ongoing efforts. I'm confident that we have the people, the strategy and the resources to create durable value over the coming years. And with that, I'll turn the call over to the operator to take us into Q&A.

Thank you. Our first question will come from Alan Ratner from Zelman & Associates. Your line is now open.

So, we’ve heard from a lot of builders over the last couple of days and it seems there are two somewhat differing views on the best way to approach the market these days. You've got some builders that are sticking to a kind of a 'to-be-built' strategy and feel like that's what the consumer really desires today to design and pick their perfect dream home. And then you've got other builders that, for a multitude of reasons, feel like it makes more sense to wait until the home is started and further along in the construction process perhaps to sell. I think at least those builders in the near term are probably seeing a little bit of a greater lift in gross margin; they're benefiting from those extra months of pricing power as well as maybe some increased visibility on their cost structure. I know you guys historically have had a balanced sales approach. So I'm curious if you have a view one way or another, or if you've kind of shifted your sales strategy one way or another to reflect all the various trends and dynamics in the market today—uncertainty on costs, pricing, significant price appreciation, etc.

Great question, Alan. I think my starting position is that in an environment where you have near absolute cost certainty, our value proposition for buyers tilts toward a larger share of our sales being 'to be built.' But in the current environment, we’re doing a couple of things because of pockets of uncertainty around costs: either slowing the rate of those to-be-built sales or starting homes, so that we have that certainty on cost and then selling them. So unfortunately, I don't have a red-or-blue, yes-or-no answer for you. It's navigating through it, but the pivot for us is that where we have cost certainty, we have more confidence; therefore the to-be-built model allows us to capture value for our choices and our product. But I totally understand the point that it's tough to sell a home, not know what your costs are, lock the price, and then end up with costs that you didn't anticipate. We're managing that problem at a community level.

Got it. Your response, Allan, makes a lot of sense and it’s helpful. And I guess on that note, it seems like at this point, really the only limitation on sales is production; maybe for you guys community count is a factor as well. But what is your production pace look like right now? How many homes are you starting per month per community if you look at it that way, or on an annualized basis, how many homes do you feel like your production machine is capable of starting? And is there any flex point on that where you can potentially drive that higher, assuming demand continues to be as robust as it is, if not accelerate even further?

I think it can go up over time. But it's not simply a capacity switch you can flip in the next 30, 60 or 90 days. That's why you saw, when I was talking about a meaningful part of our backlog delivering in Q1, I meant we looked at the capacity for throughput where we could have price certainty and deliver the right home the way we wanted, and we realized that the reality of that production environment is that we won't have the backlog conversion that we've historically had in the third and fourth quarter. It is going to get better in terms of the production capacity for us and for the industry, because I think this structural deficit is an undercurrent that is going to force the industry to expand capacity. We need to, and the trick of course is to keep it affordable. But I do think that capacity will increase over time.

Great, thanks a lot. Good luck.

Thanks, Alan.

Our next question will come from Julio Romero, your line is now open.

Hey, good afternoon, Allan and David.

Hi, Julio, how are you?

I’m good. So you're obviously seeing a very strong price environment. ASP is expected above $400K next quarter. Can you speak to maybe how much more price can be driven in this environment and how you see that unfolding? Is there a breaking point eventually?

Well, I know the answer to the last part of the question for sure: there is a breaking point—it’s affordability. One of the things that is different about this environment now compared to other times that have felt quite euphoric from a new home construction perspective is I'm comforted by the fact that mortgage underwriting has remained really disciplined. So qualification income levels are going to ultimately have a big effect on how much pricing power we have. And of course, changes in interest rates will factor into that as well. I think that there is more room, and I'm not panicked about some of the pressures on the cost side of the supply chain. I think we've got the ability to make changes to the product and accommodate those in a mix. But I don't think that if I looked at macro numbers, the level of price appreciation we've seen across all new and used homes in the last year is a run rate that we're going to see sustained over multiple years. We're in a bit of a short squeeze right now for the next few months or quarters. There's quite a bit of pricing power.

Got it. And with the strong demand for these being built, are consumers looking for certain amenities, or has there been any change in consumer preferences in regards to configurations or floor plans at all, and has that affected your product mix?

It has a little bit, and it will come as absolutely no surprise when I tell you that a place to home office and home school comes up in almost every sales conversation. I don't think it's a cynical view that forever we're going to work from home and teach from home, but when you realize you don't have that flexibility, it feels like your product is functionally obsolete. That is a big part of what we've seen over the last year, and I think it's got legs. We’re very focused on having opportunities for people to work from home, and that affects the architecture and layout of the home. In many of our communities and many of our floor plans we're intentionally designing more spaces so you've got the opportunity for quieter spaces and more of them. I mentioned last quarter that there's an interesting development in interior architecture: open floor plans, high ceilings and great rooms look and feel great, but they're not ideal for working from home or teaching from home. So there's a challenge of how you create nooks and purpose-built spaces and still have these gathering places and a sense of place within your floor plans. It's actually an exciting thing to figure out, and that is definitely a major theme in our product everywhere in the country.

Understood. And I guess just one last one for me: could you speak to any progress updates with your commitment to having all your homes be Net Zero Energy Ready by 2025? Does the current unique demand backdrop accelerate that at all or change it at all?

I don't know that it changes the commitment. The opportunity to accelerate is really a function of community and new community count. It's tough to go into a community that you're two-thirds of the way through in entitlement and permitting and with let contracts with subs and fundamentally change how the home is built. So what will happen—and what will play a big role in our rate of achievement—is as we open new communities, our capacity to bring those features into homes within that community. There are some larger communities where we’re making changes in real time, and those are incremental changes. I was thrilled to have the company recognized again as an ENERGY STAR Partner of the Year. Six years in a row is a big deal. Testing every single home for 10 years is a big deal. I feel confident we'll remain a leader in this category. We're disciplined about it, our team is excited about it, and I think it's the future we're driving toward.

Great, appreciate you taking the questions and best of luck in the third quarter.

Thanks, Julio.

Our next question will come from Jay McCanless from Wedbush. Your line is now open.

Hi, good afternoon, everyone. Just wanted to walk through the math: if your backlog is 3,300 with nearly 700 homes that are going to close in 1Q ’22, and you're looking at high single digits for Q3, you're talking somewhere around 1,400 to 1,500 closings for the third quarter. Are you thinking right now that your fourth quarter is going to be in line or maybe slightly higher on total closings than what you're seeing in Q3, or do you feel like you can deliver those homes and potentially deliver a few more homes than what you're going to close in Q3?

So Jay, we're not going to give specific fourth quarter guidance. You can kind of back into it given what we said and what's in backlog and the spec level, but we're not going to give specific guidance. As I mentioned in my comments, there's a bit of uncertainty between Q3 and Q4 with production and movement in between. So high single digits for Q3, and you can kind of back into Q4 based on what's in backlog and the spec count.

Right, well, and that's going to be my next question on the spec. Are the homes you are starting now mainly to meet the backlog, or are you trying to rebuild that spec count at all?

We are trying to rebuild spec, and in some places we've got the throughput to do that. In other places, the backlog of sold and started homes limits the throughput for additional specs. So the answer differs by community. We want to have a larger spec number; we're a little off our traditional specs per community and that is mostly attributable to selling the specs. But we want to take care of customers, and we've gotten backlog. The balance there is how we got to where we think the second half of this year will be from a total perspective. That's why we focused more on the earnings side than on the unit side, because I think there's going to be some movement, as Dave said, between Q3 and Q4 in both specs and backlog.

Okay. The communities that you're planning to start growing in ’22: is there any geographic specificity to those? And when you think about underwriting now, what type of monthly absorption pace are you underwriting these newer communities to?

I'm glad you asked both questions. On the first, there's no real asymmetric distribution of new communities—we've got growth in every market. As part of the discipline of staying in our footprint instead of getting excited by new markets, we've got great teams and long histories in the markets we're in, and we want to invest with our teams in markets we know. In terms of underwriting: these are exciting, frothy sales times but these are not the sales paces we use in our underwriting. We're using sales paces that look like our last three, four or five years, not the last six or seven months.

Okay, it's good to hear. Okay, that's all I had. Congrats on the great quarter. Thanks.

Thanks, Jay.

Thanks, Jay.

Our next question will come from Alex Barron from Housing Research. Your line is now open.

Yes, hi guys. Thanks. I was hoping you could comment on your interest expense versus interest incurred. Obviously, interest incurred has been going down because you guys have been paying down your debt. But this quarter we saw a jump in the interest that went through cost of goods sold. Roughly when can we expect those two numbers to be more in line? Is it maybe until next year?

We've talked about this in the past. Allan mentioned in his commentary that we think we'll see a benefit from the interest perspective flowing through cost of goods sold. Overall in the income statement, we expect a reduction as we look to next year, but it's a little bit further off in the distance. There are factors that go into it—inventory turnover, beginning balances and timing—but certainly the reduction is in next year's plan and we'll see a benefit from an earnings perspective as Allan referred to.

Okay, great. And then as I think about capital allocation, and I looked at your balance sheet, obviously you don't have any debt maturing near term. So I'm assuming you probably won't be delevering in the near term. What are the uses of cash at this point? Is it more to buy land? Is there potential for share buybacks? How are you thinking about that?

Let me correct one thing: we are going to get debt below $1 billion; we've committed to do that by the end of fiscal ’22. We structured a term loan a few years ago with $50 million principal payments so we could balance deleveraging with our growth ambitions, and we've been executing against that. We'll have a term loan payment at the end of this year and another next year, and we'll pick up a few other bonds in the market so that the aggregate gets below $1 billion. That will be one of our allocations. Beyond that, the much larger dollar amount is investing in the business. The market is strong, we're seeing lots of opportunities. We're excited about the commitments we've made and the deals we've tied up. We've given pretty bullish guidance related to land spending in the back half of this year and for the total year. A lot of the deals that we’re doing will have takedowns and other uses of capital in ’22 and beyond. So at this point, I'm excited about the returns we can make investing in the business. So that, plus paying down debt to get below $1 billion—that's really where our focus is from a capital allocation perspective.

Got it. If I could ask another one: your land balance didn't seem to go up year-over-year. Is that something that is in the works to line up more with the growth you are seeing in orders?

There are a lot of cross currents in the land balance. We had some formerly land held for future development assets that were pretty big, and as those have been sold through, our debt and lot needs have changed. Also, you've seen our option percentage go from 30% to over 45%. We constantly talk about balance sheet efficiency; we want to have no bigger an investment than we need to drive higher returns. That's been a big focus of our strategy: growing return on unlevered assets and return on equity. So actually, the limited growth in land dollars while we drive EBITDA growth is a positive—it shows prudence. But we are definitely growing assets; we're more focused on growing returns than growing assets. That's what balanced growth is for us.

Okay, great. Well keep up the good work. Thanks.

Thank you, Alex.

And I'm currently showing no additional questions at this time.

All right, I want to thank everybody for tuning into our second quarter call and look forward to talking to everybody again in 90 days. Thank you very much. This concludes today’s call.

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