Beazer Homes USA Inc (BZH) Q2 2023 Earnings Call Transcript

Good afternoon, and welcome to the Beazer Homes Earnings Conference Call for the Second Quarter Ended March 31, 2023. 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 second 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 second quarter, the current environment for new homes, and an update on our company's strategy and the primary goals we have for the future. I'll then provide details on our second quarter results, expectations for the third quarter and full year, updates on our cycle time and cost reduction initiatives, and end with a look at our balance sheet and capital allocation priorities. 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. Our team delivered strong operational performance in the second quarter, which allowed us to exceed the expectations we outlined in January. On sales, we generated a pace of 3.2 homes per community per month, as a strong start to the spring selling season enabled us to more than double the pace we saw in the first quarter. And on profitability, adjusted EBITDA was over $62 million with better than expected operating margins and closings, lifting results. We also celebrated an important balance sheet milestone. For the first time since 2005, the dollar value of our total shareholders' equity exceeded our outstanding debt at the end of the quarter, with book value now in excess of $32 per share. During the second quarter, we were also pleased to be recognized for the homes we deliver in the culture we have created among customers and employees. For the eighth straight year, we received a sustained excellence award from the U.S. Department of Energy and the EPA. This is their highest honor among ENERGY STAR awards granted for delivering homes that exceed their stringent requirements. For the second consecutive year, we were named by Newsweek as one of America's most trustworthy companies, as determined through extensive polling of employees, customers, and investors. And for the first time, we were recognized as a 2023 top 100 workplace by Energage. These awards speak to the commitment we've made to delivering exceptional homes, building trust with our customers, and becoming an employer of choice. Those are all outcomes that should contribute to growing shareholder value in the years ahead. Turning to the new home sales environment. The momentum we experienced in January continued through the quarter. In fact, I was a bit surprised by the strength of demand during the quarter, especially because affordability remains quite challenging. While I know our team did a terrific job marketing and selling our homes, there were clearly some other macro factors that helped. First, the economy weathered the rapid increase in rates better than many feared. Employment remained strong and wages have continued to grow. With home prices modestly lower and incentives somewhat higher than this time last year, wage gains have contributed to an improvement in affordability. Second, homebuyers seem to be adjusting to higher mortgage rates, particularly as they consider the cost of renting. They may buy a smaller home or one with fewer design options, but buying a home still represents a way to cap a family's housing costs in an inflationary environment. And third, the supply of existing homes for sale is incredibly constrained because owners with low mortgage rates have little incentive to trade in or trade up. This has led to share gains for new homes compared to existing homes this spring with no signs of excess inventory in any of our markets. The structural housing shortage in this country is very real. So even as we acknowledge that it is a challenge for many consumers to attain home ownership, we are confident in the durability of demand for well-priced new homes. To that end, we remain committed to our balance growth strategy. This strategy is designed to deliver profitable growth from an efficient and less leveraged balance sheet resulting in returns above our cost of capital over a housing cycle. Of course, doing these things in a competitive environment is not easy, which is why we created and have embraced three pillars to differentiate our homes and home buying experience. During the second quarter, we commissioned an investor perception study to help us better understand what investors and analysts thought about our strategy and how we could improve our investor communication. We were encouraged that there was broad support for both growing our business and improving our balance sheet, a clear validation of balanced growth. But we also heard that we could do a better job describing our longer-term goals. So today we'll outline three multi-year goals that should help investors track our progress. As it relates to growth, starting in the fourth quarter, we expect a double-digit annual growth rate in our community count for the next several years with a target of exceeding 200 active communities by the end of 2026. The growth in our lot position, particularly through options, provides early evidence we're on this path. As it relates to our balance sheet, we will continue to reduce leverage, and we're targeting a net debt to net capital ratio below 30% by the end of 2026. Investors noted the significant progress we've made reducing this ratio in the past several years, and should take comfort that we intend to continue this journey. And finally, as it relates to the homes we build. We are the only national homebuilder who is fully committed to the Department of Energy's Net Zero Energy Ready program. More specifically in our ESG report, we pledged that by the end of 2025, every home we start will meet this DoE standard. In Q2, 4% of our starts were Net Zero Energy Ready, and we expect this to ramp quickly in the years ahead. In fact, we now have Net Zero Energy Ready homes under production in 14 of our 16 markets. While there are technical and financial challenges associated with attaining this goal, we are well on our way. The fact is we are building tomorrow's home today, and we are excited to explain the benefits of our homes to buyers. As the past few years have clearly demonstrated, it is hard to predict market dynamics and even harder to translate those kinds of predictions into precise financial guidance. What's remained constant is our commitment to improving our profitability, our balance sheet, and our returns. As I've outlined today, we believe we have the strategy that will allow us to make further progress in the years ahead. With that, I'll turn the call over to Dave.

Thanks Allan. For the second quarter of fiscal 2023, we closed 1,063 homes, generating homebuilding revenue of $542 million with an average sales price of about $510,000. Gross margin, excluding amortized interest impairments and abandonments was 22%. SG&A as a percentage of total revenue was 11.2% for the quarter and below 11% on a last twelve months basis. Adjusted EBITDA was $62.1 million. Interest amortized as a percentage of homebuilding revenue was 3.2%. GAAP tax expense was $5.1 million for an effective tax rate of 12.8%, reflecting the benefit of energy efficiency tax credits from homes closed in the current quarter and prior years. As a reminder, broadly speaking, we don't currently pay cash taxes as we continue to utilize our deferred tax assets. Net income was $34.7 million or $1.13 per share. Looking forward to the third quarter, we're providing the following expectations. We anticipate a sales pace approaching three sales per community per month. Average community count is expected to be relatively flat year-over-year. We expect to close around 1,000 homes reflecting a backlog conversion ratio between 50% and 55%, up around 20 points versus the same period last year. Average sales price should remain around $510,000. We expect gross margin, excluding interest to be in a 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 adjusted EBITDA above $50 million. Interest amortized as a percentage of homebuilding revenue should be in the low threes, and our effective tax rate should be at or below second quarter levels as we continue to realize the benefit of our energy efficiency tax credits. Finally, we expect diluted earnings per share of approximately $0.90. Last quarter we outlined our expectation for delivering at least 4,000 homes and generating revenue in excess of $2 billion this fiscal year. The initial strength of the spring selling season underscores our confidence in achieving these targets. With the visibility provided from our backlog, we now expect to earn approximately $4 per share in fiscal 2023 based on an effective tax rate of approximately 14% for the full year. I'd also like to provide an update on our cycle time and cost reduction initiatives. Over the last two years, supply chain challenges extended our average cycle times by nearly four months. This pushed our starts cutoff update from April back into January. At the beginning of the year, we projected we'll be able to recover at least 30 of those days in fiscal 2023. Thanks to a tremendous effort by our field operations teams, we've been able to recapture about 90 days on average. This means that in many of our markets, we will be able to close homes by September that started in April, allowing us to offset some of the sales weakness from the first quarter. We also had success reducing direct construction costs in the second quarter. We expect to see more meaningful benefits in the fourth quarter when the mix of closings will more heavily reflect homes started with these lower costs. On to the balance sheet. We ended the quarter with more than $500 million of liquidity. Our net debt to net capital was 42.7%, and our net debt to last twelve months EBITDA was 2.2 times. Our shareholders' equity now exceeds our total debt, and we have no maturities until March, 2025. As we think about capital allocation, we are committed to investing for organic growth and further deleveraging. Deleveraging will occur through growth in retained earnings and debt repurchases, with the goal of bringing our net debt to net capitalization below 30% by the end of 2026. With the work we've done over the past several years, we have the flexibility to achieve both of these objectives. We continue to grow both the quantity and quality of our book value. We ended the quarter with a book value per share over $32, up more than $6 from the prior year. Despite near-term challenges, we expect to grow book value and generate returns above our cost of capital through the cycle. With that, I'll turn the call back over to Allan.

Thanks again, Dave. The second quarter reflected strong operational performance in an improving sales and production environment. Despite our ongoing affordability concerns, we did what we said we were going to do and are now well positioned to have a solidly profitable fiscal year. Looking further out, we remain confident in the durability of demand for new homes and committed to both growth and balance sheet improvements. And we believe our three pillars, particularly our leadership in energy efficiency, have created a compelling opportunity for us with homebuyers. With this differentiated value proposition and a dedicated and highly engaged team, I remain confident we have the ingredients to create growing and durable value for shareholders in the years ahead. And today, we've provided a roadmap for investors to measure exactly where we're going and how fast we're getting there. 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 is from Julio Romero with Sidoti & Company. You may go ahead.

Thanks. Good afternoon, Allan and Dave. To start with the April trends, can you discuss that? I know there was a time when mortgage rates decreased briefly before rising again. I'm curious if you noticed any impact on buyer traffic, website clicks, or overall activity from that.

Really nothing that drew attention. A given day, a given week, there could be a little bit of volatility, but I have to say that the buyer has been more resilient to the puts and takes with mortgage rates over the last couple of months than I expected they would be. And that includes in April.

Okay. That's helpful. And then on your quarterly results, the cancellation rate of 18% is pretty improved from the 37% in the December quarter. Can you maybe speak to how that rate is trending in April at least directionally?

Yeah. I mean, we're not to the end of the month yet. So I really don't have like an intramonth number, but there's no pattern that we see that is troubling or concerning. That first quarter was super tough, right? That was buyer concerns were prevalent. There was a big backlog number. And we struggled a little bit and we talked a lot about it. It's why we provided, and talked about the cancellations as a percentage of sales and a backlog in that quarter to sort of put it in some context. But things have normalized and we're really not seeing unusual cancellation activities anywhere.

Got it. And then just last one for me is, very exciting on the multi-year goal announcement, and the rollout here. Just thinking about the capital allocation portion of that. I know last quarter you talked about wanting to maintain financial flexibility. Has market conditions changed that approach in the near-term at all? Like, in terms of how much financial flexibility you want to keep in the near-term?

Julio, I wouldn't say that it's changed the amount of flexibility that we have. And we talked about the importance of balancing both growth in the business, organic growth in the business, and reinvestment, with debt repurchases. We're definitely going to remain very focused on flexibility. I guess what has probably changed, there's been some more stability in the market, which helps when you try to underwrite deals, and I think you'll see some growth in the land position in the back half of the year accordingly. But look, there's still a very clear focus on flexibility, maintaining very strong liquidity as we move forward. So no change from that perspective.

Helpful. I'll hop back into queue. Thanks very much.

Thank you.

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

Hey, guys. Good evening, I guess now, and great quarter and appreciate the longer term visibility there in terms of the target. So, that's where I want to start the question. So 200 communities, the last time you guys were there was about 13, 14 years ago obviously a much different time. But at that point you controlled about 30,000 lots, maybe a little bit north of that. And I'm just curious, is that kind of the number in mind that we should keep as far as where the lot count needs to go over the next year or two to achieve that target? And if so, what does that look like from a cash flow perspective? I mean, even if you option a good chunk of those lots, I would imagine there's still a decent amount of cash that needs to be invested to drive that type of growth.

We are optimistic about the cash generation and profitability of the business, which positions us well to achieve our goals. As you've been in this industry for a long time, you understand that predicting the exact size and structure of future deals is challenging. The 30,000 figure you mentioned seems appropriate; it's not too high or too low considering our profitability and the capital we are able to recycle within the business. We are confident that we can manage both the necessary operations and secure enough land to deliver homes across 200 communities. Additionally, as Dave noted, through growth, retained earnings, and some selective debt repurchases, we expect to reduce our leverage below 30%. While our focus remains on the capital side, I am confident that we have the resources to reach these targets.

All right. Perfect. Second question on pricing. So, a few of your competitors have indicated, given the strong spring, they've started to either dial back incentives or even raise base prices. And Allan, I know you kind of share our view as far as the affordability challenges right now. And obviously, we've also been surprised at how strong the demand has been in spite of that. But I'm curious if you could talk a little bit about what you guys are doing on the pricing side right now. And how much runway do you think there is to drive growth if we don't meaningfully kind of fix the affordability equation either through lower rates or significantly higher wages or lower home prices?

I wish I had a clear answer for you, Alan. One of the biggest challenges in understanding affordability is the time lag in certain data elements. While we have seen decent wage growth in the last year across various sectors, the publicly available data we rely on doesn't reflect that growth. I do believe that ongoing wage increases are a positive factor. Additionally, prices have stabilized and we're currently offering lower prices than a year ago. These two factors have contributed to the current situation. However, it's uncertain how much potential growth remains. If unemployment stays stable and there's a significant difference between the new mortgage rates and those of existing homeowners, that could create pressure on the supply of resale homes. Demographics and life events will continue to drive the demand for housing. There’s also a segment of renters realizing it's time to buy a home and manage their costs by doing so, hoping to refinance later if rates decrease. This sentiment is supporting demand. Looking ahead to next year, I believe our average sales prices will be lower, mainly due to strategic changes in our mix and some consumers opting for smaller homes. If people buy slightly smaller homes, combined with wage growth and flat home prices, we may see gradual improvements in affordability. While other factors could emerge, this appears to be a reasonable outlook from my perspective.

I think that makes a lot of sense. And I'm wondering based on your comments about the disincentive to give up that low rate, are you seeing stronger activity on a relative basis at your lower price points entry level, however you kind of classify it versus move up at this point?

We are, but we don't do a lot of move up business, so it's challenging for me to think that what we see is a great read through to broader trends. I can tell you that the active adult buyers who have either no mortgage or very low principal amounts, they have been quite active this spring as well. So, it isn't just that first time buyer and maybe a first-time buyer who is deferred to home purchase, but there are also empty nesters that form a good chunk of our business both in age-restricted and a non-age-restricted context. But in some of our markets like Indianapolis, that empty nester is a really meaningful part of our buyer profile.

Got it. And I'll just wrap up with a comment more than a question. But kudos on the SG&A leverage because I know in a disinflationary environment it's tough to keep those costs under control, and a lot of your competitors I think have kind of moved in the opposite direction there. So, nice job with the leverage there.

Thank you Alan.

Thanks Alan.

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

Yeah. Thanks guys. Nice job in the quarter. David, I wanted to ask about the margin guidance. I think I heard 21% to 22%. Was that for next quarter? And was that before interest or after interest?

That was excluding interest and remains the same. I know it was a bit unclear during the reading, but it's 21% to 22% excluding the interest.

Got it. Okay. And then I wanted to ask about share buybacks. Do you guys have an authorization in place? And if so, how much, and what are the general thoughts around buying back the share kind of given the disconnect between your equity and where the market is pricing?

Well, look, Alex, we do have an authorization. It's in the $30 million remaining to do. I can tell you that our view on share purchases, it clearly can be an attractive use of our capital depending on the share price. But right now, and I think we've made it pretty clear in the script, the focus is clearly on growing the business and doing some modest deleveraging, as Allan mentioned. And of course, we're always focused on risk-adjusted, maximizing risk-adjusted returns in the business, and positioning the business for future growth. So, we watch it very, very carefully as you'd imagine. And there are times when it's extremely appropriate.

Okay. And in terms of growing the business, and I heard you say you plan double-digit community account growth. Does that require you to get more active on the land front right now, or do you feel like you already have enough runway to achieve those goals with the land you're already controlling?

We're in great shape for 2024, and well into 2025. So the activity that we're engaged in right now is to sustain that growth rate into 2026 and beyond. And the good news is with the control of lots that we've got and have accumulated over the last three years, we're not having to be in a particular panic to chase deals that can open next year. We know what deals are going to open next year. So, we're really being quite selective about opportunities for 2025 and 2026. I think there is a little bit of a frenzy around finish lots out there and folks trying to capitalize in a better environment than anticipated. And I would say we've looked at some deals and it was kind of silly season pricing. I'm happier with where we are with the growth in the land position over the last few years, creating the runway for our near-term community count growth, allowing us to be more strategic in deploying capital for a couple of years out.

And given that several builders cancel deals and stuff like that in the last two, three quarters, have you found anything in that that's attractive or not really, or not yet?

A little bit. What really happened over the last nine months, and it started last summer through the fall. I mean, we were very transparent about the fact that we were renegotiating everything and relooking, reunderwriting everything. We didn't walk on very many deals, but we were quite successful in reducing either deposits or pricing or timing or risk shifting. We'll close at a further stage of entitlement rather than an earlier stage. So, I mean, we did a number of things across the deals that we were working on, and I'm really proud of what we did. I think the truth is a number of our competitors were doing similar things, and that's why there weren't that many deals that fell out. There are some, and we had tied up a few. But I want to be clear, it's not as if in the last six months we found some magic solution to community count growth with other deals that got dropped. We've added a few here and there that way. But most of what we will be opening into 2024 are deals that we started circling in 2021, and not things that we've identified in the last six or nine months.

Okay. Great. Well, best of luck with the new goals. Thanks.

Thanks Alex.

Thank you. And at this time there are no further questions.

Okay. And I want to thank everybody for dialing into our second quarter earnings call. And this concludes today's call. Thank you for your time. And we'll see you for our third quarter's call.

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