Beazer Homes USA Inc Q4 FY2022 Earnings Call

Good afternoon, and welcome to the Beazer Homes Earnings Conference Call for the Quarter and Fiscal Year Ended September 30, 2022. 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, Senior Vice President and Chief Financial Officer.

Thank you. Good afternoon, and welcome to the Beazer Homes conference call discussing our results for the fourth quarter and full year of fiscal 2022. 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 is Allan Merrill, our Chairman and Chief Executive Officer. On our call today, Allan will discuss highlights of our fiscal 2022 performance, our thoughts on the current macroeconomic environment, fiscal 2023 operational initiatives and our competitive strategy. I'll then provide details on our full year results, our expectations for the first quarter and some additional operating priorities for the year. We will conclude with 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.

Thank you, Dave, and thank you for joining us on our call this afternoon. We finished fiscal 2022 with strong financial results, even as the environment for new home sales was under extraordinary pressure. During the course of the year, our team successfully navigated complex challenges with both customers and trade partners, which allowed us to generate historically strong financial results and exceed the strategic objectives we established at the beginning of the year. We grew EBITDA by nearly 41%, leading to more than $7 in earnings per share. We generated an average return on equity of 26.5% or 34%, excluding our deferred tax assets. We reached our long-standing leverage goal by reducing debt below $1 billion, and we increased our active lot position by almost 14%, primarily by securing option lots. Despite a fundamental shift in the environment for new home sales during the year, we did what we said we were going to do and then some. While it is clear to all of us that the magnitude of our financial results in fiscal 2022 were greatly aided by the enthusiasm for housing that developed during the COVID crisis, it is also clear that our results were directionally consistent with our performance over the past decade. As you can see on this slide, our long-standing balanced growth strategy has allowed us to dramatically improve profitability without growing our assets and at the same time, reduce leverage and enhance the efficiency of our balance sheet. Balanced growth has also created tremendous value for our shareholders. We've been able to improve both the quantity and composition of our book value, which positions us to be more resilient and opportunistic in the face of significant challenges. Over the past few years, we've consistently identified declining affordability as the greatest risk to our industry. In recent quarters, we've shown the graphic on this slide to illustrate the concern. As the COVID pandemic played out, rising demand for new homes and a constrained supply chain led to rapidly increasing home prices and rents. At the same time, inflation in other parts of the economy proved to be persistent, which, as we all know, has led to much higher interest rates. With 30-year mortgages now about 7%, affordability isn't a risk. It is the explanation for one of the sharpest drops in demand we've ever experienced. This has already pushed down both new and used home prices, and we anticipate continued weakness in both demand and pricing in the quarters ahead. As tough as this environment is right now, a positive longer-term thesis for housing and home ownership remains firmly in place. We've under-built the country's demographic growth for a decade, resulting in a multimillion home deficit. Employment conditions remain strong with work from home entrenched in many of the fastest-growing industries. And unlike the last serious housing downturn, the credit quality of the existing mortgage book is unlikely to contribute a wave of short sales or foreclosures to the housing supply. That's why we're confident that affordability will recover over time as prices, wages and interest rates find a new equilibrium. Entering fiscal 2023, we're not waiting on a recovery. We're proactively addressing the weak demand environment. Like other builders, we're adjusting prices, incentives and specification levels to enhance buyer affordability. Additionally, we're working on two other initiatives that should offset some of the pricing pressure we're facing. First, we expect to reduce our construction costs. Comparing our most recent quarter to fiscal 2019, our average sales price increased by more than $130,000, allowing gross profit to increase by nearly $60,000. That means our costs went up $70,000, the vast majority of which is related to vertical construction. We are intensely focused on recapturing those dollars. With lumber prices back to pre-COVID levels, we're already seeing reductions in the cost of our framing packages. We're now realizing about $15,000 in lumber savings on new starts, which will benefit future closings. Beyond lumber, we're targeting significant savings across our other direct cost categories. Second, we expect to reduce our construction cycle time. Prior to COVID, we were generally able to start homes as late as April and still close them before fiscal year-end. Over the last two years, construction cycle times have extended by about 120 days, meaning that last year, our construction cutoff dates were generally in January. Dramatic reductions in housing starts are beginning to release some of the pressure on the supply chain. That's why we're targeting at least an additional month of sales and closings in our current fiscal year. While affordability and availability are crucial elements in selling new homes in a challenging environment, they're not the only things that matter; the experience we provide and the home we build also matter. That's why we're vigorously emphasizing two strategies that differentiate us from our competitors. First, Mortgage Choice is an exceptional competitive advantage. Mortgage Choice is designed to ensure that a carefully selected group of lenders competes for our buyers' business. This means our customers have access to an array of loan programs, rate locks, and buy-downs that a typical in-house lender simply can't match. Second, our homes' surprising performance and the monthly savings it creates resonate with buyers. Our homes are built to energy efficiency standards that exceed current energy codes for new construction and are light-years ahead of used homes. That means our homes cost less to operate and are more likely to retain value against the energy-efficient homes that will inevitably be built in the future. With monthly costs of ownership and resale value at the center of most buyer conversations, our commitment to energy efficiency is a big advantage. We know that fiscal '23 is going to be intensely challenging. But we also know that we're positioned to emerge from this environment in strong shape. It's not just that our corporate and operating management teams are battle-tested from the last downturn. We're a fundamentally different company. We've got a sizable and efficiently controlled land position. We've massively reduced debt and interest expense. And perhaps most importantly, we've developed durable competitive strategies to compete for buyers. With that, I'll turn the call over to Dave.

Thanks, Alan. For the full fiscal year, adjusted EBITDA was $370 million, up nearly 41% versus the prior year. Net income was $221 million or $7.17 of earnings per share, inclusive of $12 million of energy efficiency tax credits. Our average community sales pace was 2.8 per month with a cancellation rate of 18%. Homebuilding revenue was $2.3 billion, up about 8% as the benefit from higher ASPs offset a modest decline in closings. Gross margin, excluding amortized interest, impairments and abandonments, was up 330 basis points to 26.3%. SG&A as a percentage of total revenue was down 50 basis points to 10.9% as we benefited from improved leverage from higher ASP. Interest amortized as a percentage of homebuilding revenue was 3.1%, down 100 basis points as we benefited from lower interest incurred and our GAAP tax expense was about $53 million for an effective tax rate of 19.4%. As a reminder, broadly speaking, we don't pay cash taxes as we continue to utilize our deferred tax assets. As it relates to our balance sheet, our liquidity at the end of the year stood at more than $450 million comprised of unrestricted cash and an undrawn revolver. As Allan mentioned in his opening comments, we achieved our goal of bringing debt below $1 billion. We ended the fourth quarter at about $980 million of debt, and we now have no maturities due until March 2025. Our net debt to cap was 45%, and our net debt-to-EBITDA was 2.1 times, in line with our expectations. And finally, after the end of the quarter, we replaced our secured revolver with a larger unsecured facility, which completely eliminates secured debt from our capital structure. As it relates to land spend, we're taking a more cautious approach until we see conditions stabilize. We continue to re-underwrite all of our land deals, and in many cases, we negotiate both the cost and structure of the deal. These efforts will likely continue to yield modest abandonment charges as we walk away from deals that don't meet our underwriting criteria in a higher rate and lower price environment. Even with our more cautious approach to new investments, we have a robust land pipeline in place with more than 24,000 active lots, a majority of which are controlled through options. Although conditions are likely to remain challenging in the near term, our land position enables modest community count growth in fiscal '23, accelerating in fiscal '24, allowing us to be very disciplined in the current environment. Moving back to the near term, we're providing the following expectations for the first quarter of this fiscal year. We expect average monthly sales pace to be less than two per community, reflecting both normal seasonal trends as well as the weakness we're experiencing in the current rate environment. Cancellation rates are unlikely to improve, contributing to the expectation for lower net sales. We anticipate backlog conversion to be up 400 basis points to 450 basis points versus the same period last year as cycle times continue to normalize from all-time highs. ASP should be about $535,000. We expect gross margin to be down 150 basis points to 200 basis points versus the same period last year. SG&A on an absolute dollar basis should be up approximately $4 million, most of which is related to employee cost of living increases from the past year. This should lead to EBITDA between $45 million and $50 million for the quarter. Interest amortized as a percentage of homebuilding revenue should be in the mid-3s and our tax rate to be approximately 17%. In addition to the cost reduction and cycle time initiatives that Allan discussed earlier, there are several other operational disciplines we are following as we continue to execute our balanced growth strategy. First, we will keep our production aligned with sales, maintaining a healthy balance of spec and to-be-built production as individual market conditions dictate. Second, we will keep our organizational structure aligned with the volume of our business, while allowing for future growth when demand returns. And third, we will remain cautious with our capital allocation, balancing opportunities for growth with expanding liquidity. As we enter fiscal 2023, our posture is cautious. We will respond as the market develops and won't sacrifice the progress we've made with our balanced growth strategy.

Thanks again, Dave. Our fiscal 2022 was very successful, but also very unusual. After beginning the year with demand for new homes at feverish levels, which we couldn't fully accommodate due to supply chain challenges, we ended the year in a decidedly weak sales environment brought about by an unprecedented increase in rates. Despite this shift, we were able to generate excellent financial results and improve our balance sheet in fiscal 2022. Taking a step back, our team has done an outstanding job executing our balanced growth strategy over many years. They've allowed us to improve both the operations and the financial position of the company, which should help us to withstand what we know will be a challenging environment in fiscal 2023. The long-term fundamentals for housing remain intact and robust. And our team is why I remain confident that we have the people, the strategy, and the resources to create durable value over the coming years. With that, I'll turn the call over to the operator to take us into Q&A.

Thank you. Our first question comes from Alan Ratner. You may go ahead.

Good afternoon, everyone. I appreciate the opportunity to ask a question and commend you on your performance in this challenging environment. I would like to inquire about your pricing strategy. It's a bit difficult to understand the situation based on the guidance and results. On one side, your Q1 margin guidance is roughly 600 basis points lower than the peak we saw two quarters ago, which seems to align with what many of your competitors are experiencing. However, it appears that your price expectations for the next quarter have increased significantly compared to the previous quarter, and it hasn't reached its peak yet. I assume this is influenced by homes that were sold prior to the recent slowdown. Could you clarify what the current net price reduction looks like for you? How is this impacting your numbers? Is it primarily driven by incentives like rate buydowns, or is it more related to mix impacts? Any insights you could share would be appreciated.

That's a complex but insightful question, Alan, and it's challenging to answer due to various factors involved. To break it down, I'm fairly confident that the first quarter will likely be our peak average selling price for fiscal 2023. This is mainly because of the backlog we are delivering in the December quarter, which was sold between 7 to 12 months ago. There are also some mix elements involved, and while these homes had some incentives, they weren't significant. Looking ahead, we've categorized our markets into two broad groups, which simplifies the situation but helps to clarify why it's difficult to pinpoint exact trends in the numbers. Some markets typically operate with high incentive dialogues, such as offering $30,000 or $40,000, without noticeable changes in base prices. Other markets, however, have a more straightforward pricing approach, focusing on the base price without many incentives. The tricky part is that markets can shift between these categories over time. Generally, when incentives become substantial, there can be downward pressure on base prices. When I consider our pricing strategy, it's more about regional dynamics—what's happening in Dallas, California, or the East Coast—than a national overview. Overall, base prices are decreasing and/or incentives are increasing. However, while the national context matters, it's the local market conditions and competitor actions that are more significant. Consequently, I expect average selling prices to drop throughout 2023, and we will face margin pressures. However, I believe there will be some mitigations on the incentive and pricing fronts, as I am confident we can achieve savings beyond just lumber costs. I wish I could provide a straightforward yes or no answer, but these are some factors that may help clarify our business situation.

Yes, no. That's really helpful, Alan, and I appreciate at least kind of just talking through the progression of price in 2023. I think kind of answers at least a good chunk of that question there. Second, I'd love to drill in a little bit on the cancellations. Obviously, it's not unique to you guys, but cancellations are accelerating. And can you talk a little bit about the main drivers of those cancellations? What stages are those cancellations occurring? And are you losing people at the closing table because you're not maybe as aggressive on willing to incentivize those buyers, or are these people that were only in backlog for a month? Any color you can give there to better understand what's causing the cancellations and at what stage they're occurring? And then I guess the final point on that is what the success rate looks like in reselling those cancellations?

Okay. So one sort of overarching comment about cancellations, and I have to make this comment, it's a bit redundant. But our cancellation rate consistently has included lot transfers. So, somebody moving within a community to a different home. It doesn't affect the net sales, but if they move from Lot 6 to Lot 8, that's a new sale and a new can. And I only point that out, because I want to be careful as anyone looks at our cancellation rate and compares it to anybody else's cancellation rates; I don't know what their math is and what they include or exclude. So we tend to be very focused on the trajectory within our own business, because we know that it's a comparable calculation. So with that out of the way, I would tell you that there really are two things that are happening in cancellations, either people chose to not lock and they find rates that either they can't or they don't want to afford, or in a few of our cities, and it really isn't in most of our cities, we've seen folks walk away from fairly significant earnest money deposits in order to buy a home that is ready right now before their home with us is ready at a giant discount. And I think that there is definitely a dynamic around fiscal year ends in the industry between September and December, where if you're sitting on finished specs and we see it every year, maybe more so this year than many, you're seeing giant incentives on those ready to move in homes as opposed to on to-be-built homes. And we've lost some of our buyers there. But in terms of what stage we're losing them, they are spread. There isn't a pattern where they're all two weeks out from closing or they're all two weeks after sale. I don't know that I can manufacture quickly as a statistic that would answer that in a precise way. But it doesn't feel like there is a particular emphasis at the front end or at the back end, but those are the two things. Folks that were not locked in on their rate and got to a place where they can't afford it, or just say, 'gosh, 7% is a lot, and I want to wait or there's a $50,000 offer, an $80,000 offer, and they're walking away from a significant earnest money with us in order to go capture that.' Now you ended the question with whether we're being successful or not successful; we're open for business. And we are talking to those buyers. I think we're as aware of the incentive structure that our peers are offering. So we tend to not be surprised when that happens. And in many instances, we're proactive with backlog. If we've done something in pricing in our community where we see what's happening around this, we'll reach out to the backlog and talk to them about what we can do to make sure that they're feeling great about closing. So I don't know with a 30-ish percent cancellation rate in the fourth quarter; I want to say it was super successful, but that's certainly the effort that we've got underway. And it's been fairly consistent at that level, I would tell you from kind of mid-summer through present day. So I haven't really seen it dramatically change over the last 30, 60 days. I mean it wasn't great in July, and it hasn't really been great since.

Allan, I would tell you, it's Dave, just to add to that, on Slide 27 in the presentation, we have spec homes and you can see the level of specs and specifically the level of finished specs still remains very, very low. So in terms of cancellations, pretty high success in being able to resell homes and not tendering a lot more specs from that perspective.

Great. All right, guys. Well, thanks a lot. Appreciate all the time.

You bet. Thanks, Allan.

Our next caller is Alex Rygiel with B. Riley. You may go ahead.

Thank you, gentlemen, nice quarter.

Thanks.

Thank you, sir.

Drilling into the $70,000 per home cost inflation, it's great to hear you've already sort of recaptured $15,000 of lumber savings. What are some of the other large buckets that you see opportunities to recapture in the near-term? And maybe if you can quantify that, that would be helpful.

I can't provide specific details yet regarding the individual categories. However, we are exploring major categories like mechanical systems, which include plumbing, electrical, and HVAC, where we see opportunities. Our manufacturers are aware of this, as are our peers. Other categories include windows, doors, and bricks. None of these categories are as significant as lumber, which we're targeting. Instead, we are focusing on more specific components rather than large categories like lumber, and while these involve substantial amounts, they are individual parts rather than big ticket items.

And then, congratulations on achieving your debt reduction target. Any chance you could point us in a direction for what a new target might look like for year-end fiscal 2023?

I believe we are in a good position. We aimed to reduce our leverage to below $1 billion, and I don't foresee any increase in debt. Currently, we have a satisfactory relationship between our equity and debt. As we continue to grow our book value, I expect the leverage ratio to decrease, but I don't anticipate significant changes in the total level of debt.

Thank you very much.

All right. Thank you.

And our next caller is Alex Barron with Housing Research Center. You may go ahead.

Yes. Thanks, gentlemen. And great job this year. I wanted to focus in on SG&A. I think, this year we saw an improvement in that ratio. But obviously, as being slowed down, that also kind of goes the other way. So my question is, do you have any thoughts or initiatives to try to, I guess, not allow that ratio to go up too much this year that you can discuss?

Well, Alex, the answer is Dave. We're clearly very focused on this area. You're correct that we've seen a lot of leverage as the average selling price has increased and selling, general, and administrative expenses have decreased as a percentage. We mentioned in our Q1 guidance that SG&A is projected to rise by around $4 million mainly due to cost-of-living adjustments. Wage pressures haven't significantly eased yet, but we remain hopeful that they might if the market conditions weaken. We're definitely concentrating on SG&A, reviewing overhead costs, volumes, and our efforts at the community level. It's crucial for us to carefully manage these aspects in relation to the size of our business.

Okay. And how about in terms of being able to deleverage further? And is there a plan to slow down or stop land spend this year to raise cash and keep paying down debt?

Well, look, we talked about in the script, Alex, very clearly that there's a level of caution in our land spend this year, renegotiating existing deals, focusing on liquidity. I wouldn't go so far as to say there's a specific desire, as Alan mentioned, to pay down debt further below the $1 billion where we've gotten so far. But the idea is to create liquidity in the business and gives ourselves a lot of financial flexibility as we look forward into a relatively uncertain 2023 and what we think is going to be better conditions in the future.

I'll just add to that, Alex. I think building a little cash is a good thing to do, obviously, in an uncertain environment. And honestly, I look at our fixed income instruments and say they're fairly attractively priced, no maintenance covenants and low coupons. So, I think we want to be a little bit careful. I don't think we need to go pay that off as much as being cautious. Having liquidity is a good thing. I don't know that structural reductions are the best intermediate and longer-term strategy.

Got it. And I don't know if it's here in your presentation. I'm just kind of scrolling through. But do you guys have a figure for what the starts were in the quarter and what your total homes under construction are, whether it's old or not sold?

Well, so I can tell you, Alex, that starts were down 50% year-over-year in Q4, and we expect a pretty meaningful decline in Q1 just given the overall environment and given the sales pace and given the focus on units under production. So, a pretty significant decline in terms of overall start spaces.

Okay. And do you have the overall homes under construction you guys have at this time?

We certainly. It's in the chaos, and you certainly can look at overall what's in backlog and spec starts in the K. I don't have it right in front of me, but the total volume is certainly in the K and disclosed in terms of specs and backlog under construction.

Okay. And if I could ask one more. What's your overall approach at this point? You guys mentioned about the anecdotal of people walking away, canceling because they can find a quick move-in somewhere else at a discounted price. I mean are you guys thinking of following that same approach of trying to have those specs and chasing that type of buyer or not necessarily?

That's not really us. We've always had a blend of to-be-built and spec homes. And in an environment where we had a hard time predicting what our build costs were going to be, it was difficult to sell to-be-built and then have your costs get away from you. And so we certainly moved more in the direction of specs over the last 18 months or two years. But I think things are reverting more to norm for us right now, Alex. And I think you'll see us back in a 60%-plus to-be-built context. We have individual communities, townhome communities and certain cities where specs have always been, for us, a slightly larger share, but we're not intending to go put a bunch of inventory in the air and then try and compete on the size of discounts we can get to sell them.

Got it. Okay. Gentlemen, that's luck for the year. Thank you.

Thanks Alex.

Our next caller is Julio Romero with Sidoti. You may go ahead.

Good afternoon, everyone. My name is Stefan, and I'm here for Julio Romero. How is everyone doing?

Good. How are you?

Good. I'm sorry if I missed this, but how are you thinking about land spend given the uncertain environment? And sorry if I missed it.

Go ahead, David.

Look, we did speak to it earlier, but no worries, happy to kind of go through it again. I would tell you we're taking a pretty cautious approach to land spend. We started to outline this as conditions slowed, but frankly, renegotiating every deal that we're involved in and trying to find opportunities to restructure price, takedowns, whatever we can in the deal to make it more attractive. So I would tell you, overall, the approach, especially with the lack of visibility into the market, is cautious and waiting to see more stability until we see more stability in the market.

Thank you so much. Can you also discuss the potential variability in community count at the end of fiscal 2023?

I think there are two things going on there. I mean we've got a great lot position today. And I think if we could all assume that absorption rates were going to be similar to or the average of what they've been in normal times, it would be a little easier to make a prediction. And that prediction would be our community count will be a little higher at the end of the year. I think when you overlay a very high degree of difficulty in predicting sales paces, certainly over the next three to six months. I think it's harder to know what the community closeouts are going to be. So, I think there'll be modest community count increase over the basis of the year or over the balance of the year. But the weaker sales are in Q1 and Q2, the higher the community count, at least temporarily, will be toward the end of the year. So that's kind of a two-part answer, but those are the elements that will make up the ending community count.

All right. Thank you. And on your debt, can you tell us how much is like fixed versus floating? And secondly, does the move-up in rates impact the interest expense dollars going through your cost of sales?

No, it doesn't. In terms of fixed versus floating, all the senior notes are fixed-rate debt. The revolver is a floating rate instrument when it's drawn, and there's a non-usage fee. At the end of the year, we had nothing drawn on the revolver. Additionally, we discussed the transition from the secured revolver to the unsecured revolver and the fully unsecured capital structure. Regarding the second debt, the sub-debt is LIBOR-based, but its impact is insignificant. It doesn't really matter what happens to rates since it's such a small amount, around $70 million, that it doesn't have any material effect on interest expense.

The second part of the question was about interest amortized through cost of goods sold. It won't really be affected by rate increases or changes. The primary consideration is the interest incurred, which is mainly from fixed-rate instruments. You can refer to the previously capitalized interest balance in our K. Inventory turnover plays a significant role in this. Therefore, higher rates or fluctuations in the treasury or Cypher rate won't have a meaningful impact.

Thank you so much. And the last one for me. With the expectation of lower volumes in fiscal 2023, how are you guys thinking about setting up fiscal 2024 and beyond upward earnings trajectory?

I believe we are in a good position with our land holdings and anticipate finishing this year with a slightly increased number of communities. Looking ahead to 2024, I expect our community count to grow even further. We also foresee growth in unit activity over the next few years, despite the current challenges we face. We are excited about the opportunities we've secured in recent years and look forward to bringing them to market. There should be a balance between wage growth, stable or declining prices, and more stable rates, potentially at lower levels in the next year or two. Given these factors, we are optimistic about increasing both our community count and home deliveries as we approach 2024.

Thank you, guys, so much for taking my questions.

Thank you.

You’re welcome.

And we have no additional questions at this time.

Okay. I want to thank everybody for joining us on our call. We look forward to talking in the next three months. Thank you so much. And this concludes today's call.

This concludes today's conference. Thank you for participating. You may disconnect at this time.