Beazer Homes USA Inc (BZH) Q1 2023 Earnings Call Transcript

Good afternoon, and welcome to the Beazer Homes Earnings Conference Call for the First Quarter Ended December 31, 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 first quarter of fiscal 2023. 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 this 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 from our first quarter, the current environment for new homes and an update to our balanced growth strategy. I'll then provide details on our first quarter results and second expectations, updates on our cycle time and cost savings initiatives, a review of our land activity and future community count and end with a look at our balance sheet and book value. 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. In our first quarter, we were pleased to generate financial results and profitability in line with the expectations we outlined in November. This translated into adjusted EBITDA of $47 million and $0.80 of earnings per share. Having said that, the new home sales and cancellation environment proved to be even more difficult than we had anticipated. As we will discuss, however, more recent traffic and sales results have been much improved. Beyond the selling environment, we are continuing to pursue and make progress with each of the operational priorities we set out for the year. This includes accelerating cycle times, reducing construction costs and re-underwriting all pending land transactions. These efforts will generate benefits in the coming quarters. In the meantime, thanks to our significant backlog and the deleveraging we accomplished in recent years, we're in a strong position from a balance sheet perspective. We have an ample supply of lots, plenty of liquidity and no near-term maturities, so we expect to remain both resilient and opportunistic over the course of the year. Let's dive into the sales and cancellation environment in the first quarter with an update on more recent trends. Early in the quarter, mortgage rates continued their relentless move higher, which together with elevated home prices and other macro concerns, effectively froze the market for most discretionary homebuyers. The sales activity that was taking place was primarily for specs or quick move-in homes, many of which were being offered with big incentives as most of our peers were completing their fiscal years. That presented a tough environment for us for two main reasons. First, we had just completed our fiscal year end, so our finished spec position was extremely low. We entered the quarter with fewer than 100 quick move-in homes, leaving us with few opportunities for buyers with serious time constraints. Second, we experienced an increase in cancellations. As a percentage of beginning backlog, our first quarter cancellation rate was about 14%, which was in line with prior years but a lot higher than the 5% to 10% we had experienced in the preceding quarters. And there was one other factor at play improving cycle times. On our last call, we outlined our efforts to accelerate cycle times to extend our window for making fiscal ’23 starts and closings. Fortunately, we saw a lot of progress during the quarter, which limited our enthusiasm to offer to-be-built homes at finished inventory prices. In December, as mortgage rates drifted lower, we started to see a nice uptick in online and in-person visits. This translated into a January sales pace more than double our quarter results. While we've adjusted prices, features and incentives to align with the market, overall, we have not had to make drastic changes and we are slowly capturing lower construction costs for future closings. There remains a lot of uncertainty about the trajectory of demand and pricing for new homes, largely because of affordability. But the wage growth, home price reductions, and rate relief that have already occurred are gradually improving affordability. This, along with new and limited new and used home supply, leads us to be cautiously optimistic about the spring selling season. Looking further out, we remain confident in the strength of the new home market and our ability to create shareholder value. For quite a few years, we have described our financial strategy with a phrase 'balanced growth.' The objectives of our results that arise from this strategy have been straightforward. Profitability growth and a less leveraged and more efficient balance sheet have led to higher returns. Our long-term commitment to all three elements of balanced growth remains in place. In order to consistently deliver these balanced growth results, we know we need to successfully execute differentiated and customer-oriented operational strategies. To date, our positioning has been to deliver what we call extraordinary value at an affordable price through our three pillars. But to continue to win with customers, we know we need to continue to innovate. Over a year ago, we became the first and so far the only public builder to commit that 100% of our homes would be built to the U.S. Department of Energy's Net Zero Energy Ready standard. While we set the end of fiscal ’25 as our deadline, we're using the current slowdown to move even faster. In fact, we expect to have Net Zero Energy Ready homes under production in each of our markets by the end of this year. While there are obviously some additional costs associated with building to this higher standard, we believe that further differentiating our home creates an opportunity for driving both sales paces and prices. Energy efficient homes cost less to operate, are more durable over time, and deliver higher customer satisfaction. And it's worth noting that the recently adopted Inflation Reduction Act provides meaningful financial incentives to attain the Net Zero Energy Ready standard. Companies have to make choices about how to pursue the creation of shareholder value. Our path is to execute against balanced growth objectives by delivering differentiated energy-efficient homes with a truly unique mortgage experience. With that, I'll turn the call over to Dave.

Thanks, Allan. For the first quarter of fiscal year 2023, homebuilding revenue was $444.1 million, with an average sales price of more than $533,000. Gross margin, excluding amortized interest, impairment and abandonments was 22.3%. SG&A as a percent of total revenue was 12.3%. Adjusted EBITDA was $47.1 million. Interest amortized as a percentage of homebuilding revenue was 3.1%. Net income was $24.4 million, or $0.80 per share. Our GAAP tax expense was about $4 million for an effective tax rate of 14.5%, reflecting the benefit of energy efficiency tax credits from homes closed in prior years. As a reminder, broadly speaking, we don't currently pay cash taxes as we continue to utilize our deferred tax assets. Looking forward to the second quarter, we're providing the following expectations. We are anticipating a sales pace of over 2.5 per community per month, which is comparable to what we did in January. While this remains somewhat lower than normal seasonal levels, it is significantly better than the first quarter pace of 1.3. Average community count is expected to be up 5% year-over-year. We expect to close around 1,000 homes, reflecting the backlog conversion between 55% and 60%. While this is up around 20 points versus the same period last year, it's still quite a bit lower than our historical norms. Average sales price should be about $515,000, well above our Q1 ASP and more in line with what we expect for the rest of the year, as we continue to emphasize affordability in an elevated interest rate environment. We expect gross margin excluding interest to be in the 21% to 22% range. SG&A as a percentage of revenue should be relatively flat versus the same quarter last year. We expect this to lead to both adjusted EBITDA and earnings per share very similar to the first quarter. Interest amortized as a percentage of homebuilding revenue should be in the mid-3s, and our effective tax rate should be at or below first quarter levels as we continue to reflect the benefit of our energy efficiency tax credits. While there's too much uncertainty around future sales prices to provide profitability expectations for the full year, with our large backlog and available production universe, we believe we can deliver at least 4,000 homes in fiscal 2023, which should again lead to total homebuilding revenue in excess of $2 billion. In November, we highlighted a number of operational priorities for the year, including accelerating cycle times, reducing construction costs and re-underwriting pending land deals. I'll review these one at a time. The supply chain challenges we faced over the last few years have extended our cycle times by nearly four months, pushing our traditional April cutoff dates for starts back into January. Our efforts to recoup at least 30 days on average across our markets have been successful. So we are now looking to recoup additional time above and beyond the initial goal. On the direct cost side, the evidence of success is not apparent yet. Our first quarter closings had even higher construction costs than the prior quarter, which wasn't surprising given the cost environment that existed when these homes were started. We're working in every market with nearly every trade to recapture those dollars. We expect meaningful improvements in construction costs to materialize in the fourth quarter when the mix of closings will more heavily reflect homes started with lower costs. At the same time, we continue to re-underwrite land deals using lower home prices, slower sales paces, and higher mortgage rates. In many cases, we've been able to renegotiate the costs and/or the structures of our pending deals. Even with these efforts underway, we remain confident in our expectations for community count growth moving forward through fiscal 2023 and accelerating in fiscal ’24. As it relates to our balance sheet, we ended the quarter with about $386 million of liquidity. Our net debt to cap was 47.3%, and our net debt to EBITDA was 2.4 times. We ended the first quarter at about $984 million of total debt and have no maturities until March 2025. Our focus on liquidity and a supportive maturity schedule provides flexibility for us to allocate capital in ways that best support our balanced growth objectives. We continue to grow both the quantity and quality of our book value. We ended the quarter with a book value per share above $31, up $7 from last year. Despite near-term challenges, the ultimate goal of our balanced growth strategy continues to be earning returns that are above our cost of capital while growing book value per share. With that, I'll turn the call back over to Allan.

Thanks again, Dave. Despite a tough sales environment, we were able to deliver positive first quarter financial results. Just as importantly, our backlog of sold homes, improved sales momentum, and our cycle time and cost reduction initiatives have favorably positioned us to generate full year results that grow book value and are consistent with our balanced growth objectives. Longer-term fundamentals for housing remain intact and robust. We're confident our differentiated consumer strategies, including our Net Zero Energy Ready initiative, will allow us to compete for homebuyers on a basis other than just price. Finally, our team is why I remain convinced 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. We will now start the question-and-answer session. Our first question is from Julio Romero with Sidoti & Company. Please go ahead.

Hey, good afternoon, Allan and David.

Hey, Julio.

I wanted to maybe start on your goal of accelerating cycle times. You've been successful in recouping, I guess, 30 days. How much more do you think you can achieve on that front?

It will depend on the city. There are different characteristics in different markets. A couple of weeks, I would say overall, some places a little more, some places a little less. But that's kind of what we try to depict on the slide, is that we've moved that cutoff date out another couple of weeks.

Okay. And maybe just talk about obviously on the demand side, I think January and the move-in mortgage rates have caused a little bit more optimism. Just talk about what you're seeing there and how that's maybe changed the strategic outlook for you guys?

In December, we noticed a significant increase in website activity and engagement in our communities. It wasn't really due to favorable weather; it felt different, and interest rates played a part in this shift. Additionally, some of the concerns regarding the economy and housing seemed to ease a bit. We must remember that there is a housing shortage in this country, which led to renewed attention from potential buyers. In January, we observed a strong interest in speculative homes, and we are now more assured of a shorter cycle time, making it easier to sell homes that are to be built. This was quite challenging for much of last year since we struggled to provide customers with completion dates for their homes. Now, we find ourselves in a much better position. There are several factors at play, including the macroeconomic environment and interest rates, along with improvements in the supply chain that offer customers better visibility on delivery timelines for homes under construction. Collectively, as mentioned in the script, January was significantly better for us, more than double what we achieved in the entire first quarter on a monthly basis. It felt much more positive.

Yeah. No, I appreciate the color. And I guess, if you could just touch on your other initiative of cost reductions. You talked about not there yet, but expecting meaningful improvements by the fourth quarter. How is the trajectory of lumber prices maybe impacted the way you're thinking about the flow through of cost reductions as we progress throughout the year?

Yeah. I mean, with cycle time still stuck above six months, as you saw prices down in the fall, you'll start to get the benefit of some of those this spring. But it really starts that have occurred in November, December, and into January and February where we're seeing those lower lumber costs, and that's where we get into our fourth quarter. I think that there will be improvement in our direct costs in the second and third quarters, but I think it's going to be pretty modest honestly. So weighted average as much as anything, where the weighted average of homes with lower costs will be far better by the time we get to the fourth quarter. The lumber part will play a big role in that, but it's certainly not the only category where we are seeking and achieving cost reductions.

Understood. Thanks very much for taking my questions.

Of course. Thank you.

Thank you. Our next question is from Alan Ratner with Zelman & Associates. You may go ahead.

Good afternoon, everyone. Thank you for the valuable information as always. My first question is about the trends from January and how they influence your thoughts on pricing, incentives, and the overall environment. It's encouraging to see the improvement in sales activity, but you mentioned the sales pace of 2.5 to 2.6 that you observed in January and expect for the quarter. Historically, your fiscal second quarter absorption pace was around 3.3 each year, showing little volatility. Currently, you are approximately 25% below what is considered normal, even with the recent increase. How do you approach pricing in this situation? Are you still providing discounts, increasing incentives, or adjusting base prices to reach the long-run average? Or are you contemplating the sequential improvement and considering it a positive development from a weaker fourth quarter, deciding to wait and see if the momentum carries into February and March before becoming more aggressive with pricing?

Alan, that's a great question and quite complex. The straightforward answer is that it's both. To elaborate, we're actively engaging in discussions with our division and sales leaders about individual communities. Our goal is to improve sales numbers, ideally to seasonal levels in the 3s, which could happen this year, but I can’t be certain. A single good month doesn't define an entire quarter, and we've noticed that the market has been quite inconsistent over the past six months. We’re being cautious about assuming a quick recovery or that this momentum will automatically carry into February and March. We feel reasonably confident about achieving at least 2.5 for the quarter, but, as you've noted, that isn't where we want to be—it’s not our target. One insight from the first quarter was that merely raising prices doesn't drive buyer interest. Adjusting incentives to encourage buyers to purchase a home is important, but it's not the only factor. We're trying to carefully manage that aspect. We are competing for buyers, and if community conditions call for different pricing, incentives, or feature packages, we're ready to adapt. However, we've seen enough buyer interest and confidence to eliminate some special incentives that effectively act as price increases. Right now, we’re focused on maintaining activity levels instead of chasing after buyers with more incentives. Depending on the community and city, we might take either approach, but overall, we prefer to gradually increase the sales pace rather than aggressively pursuing it. I understand this is a lengthy response, but it's a nuanced issue.

No, that's really helpful. I think it certainly walks through the way you guys are approaching the business, which is probably a little bit different than some others right now. So it's helpful to hear how you're thinking about it. Second question on the land market. So you guys were a bit later than others to kind of really ramp your lot count, I think early in the pandemic, rightfully so, you were focusing more on the balance sheet and liquidity. If I look at your growth and loss, it really all came in '22, maybe the tail on '21. And you haven't walked away or it doesn't look like you walked away from any meaningful amount of lots right now, but at least what we're hearing is that while sellers are willing to adjust take-down terms and things like that, we haven't really seen any capitulation either from some landowners on the options or land sellers on price. Assuming that doesn't happen, that kind of puts you in a little bit of a tricky situation I guess if these deals that you tied up later in the pandemic no longer pencil or maybe they pencil at subpar margins. So how are you thinking about the land market? How are you thinking about what opportunities there might be? Do you think there will be capitulation on price or do you envision a stalemate potentially impacting your growth in ‘24 and beyond if you don't see pricing come down?

There's a book in that question, Alan. Here's kind of my take. First of all, and I don’t want to be argumentative, mathematically where the control lot showed up does appear to be in ‘22. But remember those deals would have been identified six, nine, and twelve months before they were approved and contracted. So there was an awful lot of euphoria in the market on the pricing side that happened after we achieved deal terms with the underlying sellers, whether it was on a purchase or on an option contract. The fact that something showed up in our reported control in '22 isn't necessarily indicative of the point at which we tracked it. We didn't change our underwriting process. We still have the same documentation required, the same turn requirements, and it's burdensome and it takes a while. So there is no exaggeration that those deals on average were more than six months and oftentimes as much as twelve months earlier when they were identified. A lot of the price activity that happened after we tied them up has either been given back or might be given back. So I don't dispute that, but I'm not so worried about that generation of deals having subpar margins. Now, the experience that we've had so far, we did walk away from one deal in the quarter and it was about a $150,000 abandoned charge approximately. So we had one where we just couldn't see a path, and we walked away from it. But we've had pretty good success, as you pointed out, with takedowns. We've also had some of the land banking relationships where we've renegotiated the rate, which affects the carrying cost, which ultimately is a part of what our finished lot cost will be. So I think we've had a measure of success on terms. On other deals, we have been able to renegotiate prices downward by millions of dollars. Is it capitulation? No. But if you take a $6 million asset for $4 million, it's only $2 million, but it's a third off. I would tell you, I think there is a little bit of price that is available in the market. It's not dramatic, it's not 30%, 50%, and obviously it depends on cities. I think some markets that are a little more challenging right now from a sales and pricing perspective, I do expect there to be more price movement ultimately on the land side and I would call out Phoenix. I think Phoenix is a market where there needs to be. There was a fever in Phoenix. We did not participate. Our lot position in Phoenix diminished in ‘21, ‘22. Frankly, people are trying to get $3,000 a front foot for lots. We just didn't see it. It wasn't real. A lot of people contracted at those prices. Some closed, some didn't close. I don't think that's where value is. So I think if we sort of peel the onion a little bit deeper and sort of go market by market, it's going to be different outcomes. But I'm not very concerned about having subpar margins from the deals that we tied up in ‘21.

Well, thank you. That was certainly a nice epilogue to my book question. So thank you.

Well, I feel like I've got to keep up on the page count.

There you go. Thanks a lot guys. I appreciate it.

All right. Thanks Alan.

Thank you. Our next question is from Alex Barron with Housing Research Center. You may go ahead.

Yeah. Thanks, gentlemen. I wanted to, I guess, better understand the guidance of 1,000 closings for next quarter and just kind of the acceleration on the backlog conversion rate. Does that imply you guys have a lot of, I guess, canceled houses on the sidelines that are going to be able to get delivered that quickly? And going forward, my second question is, what was the starts in the quarter and how are you guys thinking about shifting towards specs and what the market seems to want right now?

So Alex, let me kind of handle the first question. We've talked about a conversion ratio, a backlog conversion ratio in Q2 in the kind of 55% to 60% range. It's not, as you said, predominantly just from the specs that were canceled that are sitting there. There are some specs frankly that will close. But frankly that 55% to 60% is more in line with historical levels and still below where we have been in '18 and '19. So we're just kind of seeing some normalization in the backlog conversion ratio, and frankly not back to levels where we've been at historically, and a lot of that cycle time. Picking up a month makes a big difference in converting your backlog. So I think it is way more of that than any mix issue associated with formerly sold homes that became specs. Second question on the production universe, Dave, maybe has the number immediately at hand, but interesting fun fact, Alex. In the last 20 quarters, we've only had four quarters where specs represented more than half of our closes over five years. The first quarter happened to be slightly one of those quarters. I don't really see us trying to do what everybody else is doing. One of the challenges in the last year with buyers has been, can you tell me when my home is going to be ready? We feel a lot better about being able to answer that question in a really competitive way with yes, we can tell you and here's when it's going to be available, and we have confidence in that. There are some markets, and we have some buyer profiles within our footprint where specs have been and will continue to be a part of it. But I don't think you should expect us to become something that we haven't traditionally been: build huge numbers of specs and then try and engage in price discovery. We're selling a different home. We've got a different buyer experience, a different mortgage experience. I really don't feel like playing in other people's sandbox is our best strategy.

Got it. Now, I guess a month ago or two months ago, builders were talking about getting inbound calls from people looking for new starts, new work, and that seemed to present an opportunity to potentially get better costs on those new starts. But at that timeframe, it seemed like prices were still heading downward. Right now, it would seem from other commentary from builders that given the momentum in new sales and stuff like that, that maybe prices won't be heading downward anymore. So do you think there's still going to be that opportunity to get better costs?

I do. The costs that we have gotten aren't in the P&L yet because those homes haven't reached the delivery stage. I also think it's important to understand that just because home prices may not fall as far from here as was feared, I think we're going to get to a point where we do have year-over-year price reductions because of the action that occurred in the first quarter really started last summer. We've got to get to the other side where we've got a one-year anniversary. As it becomes more evident what closing prices are, that actually is going to be valuable in those negotiations because we're a good example. We just reported a $533,000 ASP and guided down almost $20,000. Well, guess what? That reflects changes that occurred six and nine months ago. I think some more of that data being in the market actually helped the case with the trades for why costs have to keep coming down.

Alex, I think the other part of that is not just the price side, but also the volume side. We see some pullback in volume, and it clearly appears that starts volumes are down as an industry. There'll be some excess labor out there that we think we can go get some cost savings from.

Okay. Very helpful. Thanks a lot.

Thank you. And our next question is from Jay McCanless with Wedbush. You may go ahead.

Hey. What was the spec count at the end of the quarter?

Jay, it's about 840 specs. It's in the queue, and I can get you the number.

Now that you have the unsecured credit facility and the senior maturities, with 29 still trading below par, why not consider addressing some of those? Given that the community count is likely to remain flat for the next few quarters, it may be a good opportunity to lower some of that future leverage.

Well, let's talk about that, Jay. First of all, the spec number was 840, just so you know. In terms of the capital allocation, we talked about it last quarter and the story is pretty consistent. We're building some liquidity. We're kind of looking to 2025 for being fully thoughtful on the capital allocation as we're going to make it. We want to see if there's more stability in the market, and if we see some improvement in demand. We're certainly committed to growing the business. So we're being pretty thoughtful with how we spend capital. And again, it's a little bit of a wait-and-see perspective, and we have some time on the 2025s. I don't know if you had another question on top of that, but…

No. Just trying to understand when you have the opportunity to go out and take some of these future maturities out below par, especially given how fast things went from good to bad in '22? Just trying to get a little more insight as to how you're thinking about capital allocation right now?

Alternative uses of capital and rates of return on a risk-adjusted basis. I mean, certainly, we're underwriting land deals even in this environment with conservative assumptions and return profiles that are vastly better than retiring debt with single-digit yields. And are those assumptions valid? Are they durable? Well, that's why Dave says, we’re being a little bit cautious. But I think the opportunity for those kinds of returns, certainly for returns that greatly exceed de-levering, are good enough, and the probabilities are good enough that it sort of discourages us from being in a big hurry using the liquidity for deleveraging.

Okay. I think the other thing is, and I want to make sure we're clear, and we said in the script, and I just want to make sure we have excellent visibility in the community count growth in 2023 and 2024 from the land position that we already have. Allan talked about it earlier in the Q&A. Clearly, we're very comfortable with the land position and the community count growth that's coming in our business.

Okay. All right. Thanks for taking my questions.

Thank you. At this time, there are no further questions.

All right. I want to thank everybody for joining us for our call. We'll see everybody in our second quarter earnings call, and we appreciate your participation. And this concludes today's call.

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