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Beazer Homes USA Inc  (NYSE:BZH)
Q2 2019 Earnings Call
May. 02, 2019, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon, and welcome to the Beazer Homes Earnings Conference Call for the Quarter Ended March 31, 2019. Today's call is being recorded, and a replay will be available on the Company's website later today. In addition, the 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 time, I will turn the call over to David Goldberg, Vice President and Treasurer.

David Goldberg -- Vice President and Treasurer

Thank you, Michelle. Good afternoon and welcome to the Beazer Homes Conference Call discussing our results for the Second Quarter of fiscal 2019.

Before we begin, you should be aware that during this call, we will be making forward-looking statements. Such statements involve known and unknown risks, uncertainties and other factors, which are described in our SEC filings, including our Form 10-Q for the quarter, 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. And we do not undertake any obligation to update or revise any forward-looking statement whether as a result of new information, future events or otherwise. New factors emerge from time-to-time and it is simply not possible to predict all such factors. Joining me today are Allan Merrill, our President and Chief Executive Officer; and Bob Salomon, our Executive Vice President and Chief Financial Officer.

On our call today, Allan will review highlights from the second quarter and provide insights into the impairments we took this quarter. Bob will cover our second quarter results in greater depth, as well as our expectations for the third quarter of fiscal 2019. I will then come back to provide more details about our land spend, community account and our updated capital allocation priorities followed by a wrap-up by Allan.

After our prepared remarks, we will take questions in the time remaining.

I will now turn the call over to Allan.

Allan P. Merrill -- President and Chief Executive Officer

Thanks David, and thank you for joining us on our call this afternoon. Our second quarter results were at or above the expectations we expressed on last quarter's earnings call. This reflected better conditions for sales across our markets, as well as the benefit of our quick response to the demand weakness we experienced in the first quarter. The improvement in the sales environment resulted from a combination of lower mortgage rates, accelerating wage growth and more competitive home pricing. At the same time, our strategy to deliver extraordinary value at an affordable price led to changes in our product and pricing that enhanced affordability.

Encouragingly, the sequential sales improvements that occurred during the quarter continued into April. In terms of operational and financial metrics, in the second quarter, we did what we said we were going to do. Orders declined less than we'd expected as our growing community count offset a decline in our sales pace. Sales per community per month rebounded nicely from the first quarter and reflected a healthy pace in line with our second quarter results in recent years.

Home Building revenue also surpassed our expectation, driven by higher closings. Our operating margin was better than we anticipated, as we benefited from a higher gross margin and lower SG&A, as a percentage of revenue. And finally, land spending was nearly identical to last year, just as we guided. As it relates to capital allocation, we returned more than $10 million to investors during the quarter with $7.5 million of share buybacks and $5 million in debt retirement. As a reminder, our Board has authorized a $50 million of share repurchase program.

To date, we have completed approximately $24 million. We have also said that by year-end our debt retirements will exceed our share buybacks and that continues to be our expectation. In short, operationally and financially, we have continued to execute our balanced growth strategy, which targets improving returns and less leverage. Of course, the other big news in the second quarter was the impairments on certain California assets. These non-cash impairments totaled $148 million on a pre-tax basis and $107 million on an after-tax basis.

The impairments related to 15 assets, all of which were currently or previously classified as land held for future development. 14 of these assets were acquired before 2007. The impairments occurred in two categories. The first related to nine projects that are under development or/are actively selling. Assets that fell into this category contributed $109 million of the pre-tax impairment and were spread across Southern California. The second category related to six communities that we have decided to sell that were still classified as land held for future development. The pre-tax impairment related to these assets was $39 million, split between Northern and Southern California.

After these adjustments, we have no remaining land held for future development in California. We have discussed the underlying characteristics of our land held assets many times. We have consistently said that when these assets began delivering homes, they would carry margins below the Company's average. Nonetheless as market conditions improved over the past several years, we've been gradually activating them, allowing us to begin to recover the capital that was previously tied up.

As has been widely noted, demand for new homes slowed considerably in the last three months of calendar 2018. This was especially true in California where affordability is particularly challenging. As we assess the underlying reasons for the slowdown, and observed the market reactions of competitors, we concluded that we needed to lower prices to achieve acceptable sales momentum. The pricing actions we took brought us in line with a broader market and have stimulated a higher level of demand for those communities that are open for sale. From an accounting standpoint, these price reductions had the effect of flipping certain assets below the impairment line.

Slide 7 is an illustration of how this impairment process works. The easiest way to think about this impairment line is do the undiscounted future cash flow for our community add up to its current book value. If they do, even if the margins are below market norms the asset is above the impairment line and no accounting adjustment is allowed. However, if those cash flows add up to an amount below its current book value, the asset must be impaired. The price reductions we took to align with the market led to aggregate cash flows below the line for the assets we impaired. At that point, the accounting is straightforward.

We have to record a loss for the difference between the present value of those same cash flows and the current book value. The present value of those cash flows ended up averaging just under 50% of the previous book value but varied considerably based on the duration of each community. The second category of the impairments related to the assets that we decided to sell instead of develop. This decision was based on the market condition for each asset, our longer-term California strategy and our intent to improve ROA. These assets are now carried at their expected realizable value.

With these impairments behind us, we are positioned to accelerate our recovery of cash, allowing us to reallocate capital in ways to benefit shareholders. Whether that is into new communities, debt reduction or share repurchases, this capital can be put to better use. And with a lower cost basis, these communities will generate better gross margins, leading to higher EBITDA and EPS in the next few years.

At this point, I'll turn the call over to Bob to walk through the results in more detail.

Robert L. Salomon -- Executive Vice President, Chief Financial Officer and Chief Accounting Officer

Thanks Allan, and good afternoon, everyone. Looking at our second quarter results compared to the prior year, new home orders decreased 4.8% to 1,598. With sales per community per month of 3.3. Homebuilding revenue dropped 5% to $421 million driven by 10% decrease in closings, partially offset by 7% increase in ASP to $371,000. Our backlog conversion ratio was over 74%, up nearly 800 basis points as the number of homes sold and closed in the quarter increased.

Our average community count rose to 163, an increase of 12 communities from the previous year, and we entered the quarter with a 166 active communities. Our second quarter gross margin excluding amortized interest impairments and abandonment was 19.8% which is ahead of our expectations, primarily related to non-recurring benefits which added about 60 basis points to our results. SG&A as a percentage of total revenue was 12.7%, an improvement of 10 basis points. This led to adjusted EBITDA of $33 million. Finally, driven by the impairments taken on certain California assets, our net loss for continuing operations was $101 million. Excluding these impairments, we were profitable on an operating basis.

Turning now to our expectations for the third quarter. Our sales were up strongly in April and we're continuing to take advantage of this improvement to drive higher margins. Accordingly, we expect orders to be up 5% to 10% year-over-year, offer similar increase in our average community count. Speaking of gross margin, based on what we've closed thus far in the third quarter and the margins in backlog, we expect gross margin to be about 19%. Of course, the mix of our additional sales that closed in the quarter could influence that by a quarter point in either direction. Regardless, the third quarter gross margin should represent a trough for the year. As we work through the heightened incentives from earlier in the year and because to be built homes will represent a higher percentage of closings in the fourth quarter.

Our ASP should be above $375,000 up versus the prior year and the second quarter. We expect backlog conversion ratio above 60%. SG&A expense should be below last year on a dollar basis. And finally, the cash component of land spend should be above a $100 million.

At this point, I'll turn it over to David.

David Goldberg -- Vice President and Treasurer

Thanks, Bob. In the quarter, we spent $140 million on land and development relatively flat versus the prior year, following our change in strategy with respect to our long-held California assets, we have now reduced our land held for future development balance to less than $29 million. This is down from a peak of $420 million in 2009 and as Allan noted, we no longer have any land held for future development in California.

Looking to the second half of this fiscal year, we expect our land spending to be down approximately $100 million to $150 million versus the prior year, driven by two factors. First, we're continuing to improve the efficiency of our balance sheet through increasing our use of options and discouraging large bulk purchases. Second, our land spending in the second half of last year included our Venture Homes acquisition.

On Slide 11, we outline the components of our expected community count growth for the coming quarters. Our land spending over the past 18 months has positioned us for a growing community count. The majority of these new communities will have ASPs below our current average selling price. We continue to expect to end the fiscal 2019 with more than 170 active communities though forecasting exact quarterly trends is challenging. The objective of our balanced growth strategy is to drive higher returns on our assets by improving our EBITDA, without inefficiently increasing our asset base.

You can see the success we've achieved thus far at the top of Slide 12. In previous quarters, we've discussed the continued improvement we expected in ROA as non-earning assets on our balance sheet started producing revenue. While the impairment we took this quarter reduced the carrying value of these assets, the underlying story is unchanged. Over the next 12 months, we expect that virtually all of the former land held assets that are non-earning today, will start producing revenue contributing to better returns.

We have made a great deal of progress with the execution of our share and debt repurchase programs following their announcement in November. Since completing our ASR in the first quarter, we have continued to repurchase shares bringing our total buybacks to more than $24 million or 2.2 million shares, representing more than 6% of the Company. In addition, during the second quarter, we began our debt repurchases and through March 31, we retired more than $5 million of our outstanding 2023 and 2025 senior notes.

Over the last 11 years, we've made significant strides in improving our leverage, having reduced our total indebtedness by more than $500 million. Since fiscal 2015, our net debt to adjusted EBITDA has declined to 6.2x and we're targeting a net debt to adjusted EBITDA on the floors (ph) by improving our profitability, including through the monetization of previously non-earning capital and further reducing debt.

With that, let me turn the call back over to Allan for his conclusion.

Allan P. Merrill -- President and Chief Executive Officer

Thanks David. We're encouraged by the resumption of healthier demand trends this spring, and we remain confident that our balanced growth strategy is right for this environment. Over the next quarter, our activities in support of this strategy will include growing our community count with more affordably priced homes, extending our mortgage choice platform and technology and expanding our gatherings footprint. In terms of allocating capital, we'll continue to invest in our business, accelerate our debt repurchases and opportunistically repurchase shares. I want to thank our team for their ongoing efforts. I'm confident that we have the people, the strategy and the resources to execute on our plan over the coming years.

And with that, I'll turn the call over to the operator to take us into Q&A.

Questions and Answers:

Operator

Thank you. At this time we would like to begin the question-and-answer session of the conference. (Operator Instructions) Our first question will come from Jay McCanless with Wedbush. Your line is now open.

Jay McCanless -- Wedbush Securities -- Analyst

Hey, good afternoon. Thanks for taking my questions. I guess the first one I had is with the six asset that you guys are looking to sell. Do you have any of that under contract, any timing when that cash is going to hit the balance sheet?

David Goldberg -- Vice President and Treasurer

No Jay, none of it's under contract yet. The decision we've just made in this quarter but it will be a high priority for us to convert it to cash, but I can't commit to a timing at this point.

Jay McCanless -- Wedbush Securities -- Analyst

Okay. I guess maybe was it just slower sales pace, was it maybe some price deceleration in those markets. Could you maybe walk through some of the factors? First you ought to go ahead and do it this quarter.

David Goldberg -- Vice President and Treasurer

Sure. So we're not breaking any news by remembering and pointing out that October, November, December time period was pretty uneven. And that's a nice euphemism for tough sledding from a new home sales perspective, and particularly in California. And it really led us to deep dive each of our communities, what our competitors were doing, the structural issues in the market. And I think we have all benefited from a level of price appreciation in that market over the last number of years. And we realized that we were at a point where that was over. Affordability is paramount and in any context of rising rates home prices simply we're too high to sustain an acceptable level of sales. So we made a reset decision about those active communities and the ones that we are bringing active, but it also gave us a chance, Jay, to think about geography and within the markets Northern and Southern California where is our power ally. What are we good at? Which sub-markets do we really want to be committed to? Which products? Which buyer profiles?

And as I pointed out in my comments, 14 of the 15 assets we dealt with here have been on the books for more than 12 years. So we said, we've had these assets, we really going to go to those locations to build these assets out or is now the time to acknowledge that we've got a focused strategy, we can build a growing business in California, but let's build it on our terms in the places we want to be. And really it all kind of came together like that and we said, well, this is the time, the trigger was clearly the reduction in prices and velocity in that first fiscal quarter, but it led to this bigger deeper analysis that we did.

Jay McCanless -- Wedbush Securities -- Analyst

And I was impressed to see that the gross margin looks like it's going to be up a little bit sequentially from Q2 to Q3 which is not in line, I think that's what we've seen from some of your competitors. Maybe can you talk about the levels of discounting in Q2 this year versus last year? And how our discounts moved as you've gone into April?

David Goldberg -- Vice President and Treasurer

So a couple of things, just clarification. Our Q2 gross margin of 19.8%, we acknowledge that we had some benefits in that, and it was really more like 19.2%. We have said based on backlog and based on what we've already closed in the quarter 19%-ish looks about right. We're still in the heat of the spring selling season. We've got specs, we're going to sell them. Depending on the mix of those specs that are sold and closed, we think the margin in the third quarter will oscillate around that 19% and we gave a bracketed range up or down 25 basis points around 19%. So I would say, it's fair to characterize flatness kind of from Q3 or Q2 to Q3.

Let me get to the more structural part of your question though. If you think about, not if you think about, if we talk about what happened from a selling perspective, January was better than December in the sense that it was down less year-over-year. And February was better than January because it was almost but not quite flat year-over-year. March was flat year-over-year and April was frankly up double digits. So what you would reasonably expect and in fact what has happened is that selling environment has manifested itself is a reduction in incentives over that period of time. But we're going to deal with. We dealt in the second quarter and we'll deal in the third quarter with some of the heightened incentives that we pushed in January and February to stimulate activity. I think we have largely work through that in that third quarter, but that's kind of the dynamic of what's going on with incentives.

Jay McCanless -- Wedbush Securities -- Analyst

Yeah. Thank you for straighteningout on the gross margin.

David Goldberg -- Vice President and Treasurer

Yeah, Jay, to be clear and I want to make sure we get this out properly. We also said the third quarter would be the trough for margins. Now we see improvement in Q4 and so maybe that's where the confusion was but clearly Q3 as Allan said and Q4 some improvement as we head into next year.

Allan P. Merrill -- President and Chief Executive Officer

Thanks David. And I guess the only other question I had was if you guys could talk, I think you Allan, you said double-digit growth for April. Was that -- can you talk more about that? And also we heard from other builders that the active adult buyer all of a sudden came back to life at March and April. So if you guys could comment on those two things and that'll be it for me.

Well, I don't really have a segment differentiation comment for you. I would say we've seen strength across our footprint at every price point and in each market as February turned into March and March turned into April. So I wouldn't try and distinguish so much particular buyer profiles that hasn't been our experience.

Jay McCanless -- Wedbush Securities -- Analyst

Okay. And then orders for April versus last year?

Yes. So they were up more than community count was up. We had an actual increase in pace for one month, but I think Bob correctly established the thing that we want to do in the face of that strength is regain margin. So it's one month, one month is helpful but we've guided up 5% or 10% in orders because we're going to be using that environment that better environment we're in, we've already been using it. We used it in April and we'll keep doing it in May to push margins. And I'm interested in driving both margins and order improvements not just one or the other.

Sounds good. Thanks for taking my questions.

David Goldberg -- Vice President and Treasurer

Thanks Jay.

Our next question will come from Michael Rehaut from J.P. Morgan. Your line is now open.

Maggie McGrath -- J.P. Morgan -- Analyst

Hey. This is actually Maggie on for Mike. Just to kind of follow up to the last question. You said that orders trended better throughout the quarter and that April was up double digits, and that you saw strength at every price point in that new market but are there any specific markets that you'd like to call out or get some more color on?

David Goldberg -- Vice President and Treasurer

I'm sure. I mean there were a few places that for us and let me, I will answer your question pretty directly, but let me just make sure that the record is clear. Any time we or any other builder talks about strength in a market, it's always a little bit dangerous because you may be looking at macro data at a market and say, well, gee that's not what others are saying. So oftentimes the mix of communities between one year and another can be a little bit distorting. And I'll give you a quick example. Our highest sales pace division is Las Vegas in the second quarter.

We're really proud of what they did in big numbers, but guess what, it was down in pace 20% year-over-year. So is the story it was down or is the story it's the best in the country for us and so that's where I just want to be careful as we comment about individual markets. That is an area of great strength. We saw strength in the mid-Atlantic and in Raleigh to pick some examples of places where year-over-year we saw a nice tick-up in sales pace.

Maggie McGrath -- J.P. Morgan -- Analyst

Okay. Thank you.

Operator

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

Alan Ratner -- Zelman & Associates -- Analyst

Hey guys. Good afternoon. Thanks for taking my questions.

David Goldberg -- Vice President and Treasurer

Hi Alan. Of course.

Alan Ratner -- Zelman & Associates -- Analyst

So on the impaired projects it sounds like they've been on the books for a while. Have they been previously impaired during the downturn or was just the first charge that you took on them?

David Goldberg -- Vice President and Treasurer

I would be a little reluctant to answer it definitively. One or more of them may have had an impairment, but they have not been impaired since 2007 or 2008 because once they went into the land held category, where the assessment was that they could be recovered, they were annually tested for impairment in the same way. So it's reasonably fair to assume they were largely untouched.

Alan Ratner -- Zelman & Associates -- Analyst

Got it, OK. So we shouldn't necessarily extrapolate that to other California assets that might have been purchased over the last several years as an indication that there could be some risk there?

David Goldberg -- Vice President and Treasurer

I agree with you, you should not make that extrapolation. That's why we were careful to point out the duration of these assets.

Alan Ratner -- Zelman & Associates -- Analyst

And I guess just more broadly when I know the bucket of land held for future development is small from a company standpoint. But I think you guys and others in the past have kind of -- in the past said given an indicator or a number of communities that had potential indicators of impairment. So I'm just curious if maybe you could just talk about for the company. Are there other assets, other communities where maybe they're getting close to that ledge that you kind of walked us through?

David Goldberg -- Vice President and Treasurer

So a couple of things and Bob and I'll will kind of split this up. I think you're asking a question about communities that we are watching closely and we have a process for that. The land held is such a small number of communities, they're really not in there from an impairment standpoint. They're there because there is some reason that it is not in our strategy to develop that asset. It may be entitlement related; it may be infrastructure related; it may be product or buyer profile related. So there are typically a variety of reasons why we don't have a current intention to develop. And those set in a different bucket that land held bucket that's down to $29 million bucks and that's really around intent. I think your question gets to the rest of the business and Bob can do a better job than I can talking about our process with those assets.

Robert L. Salomon -- Executive Vice President, Chief Financial Officer and Chief Accounting Officer

Yeah, we had a watch list process where communities that have margins either actual or expected margins below a certain level go on we call watch list. And as you -- when you get our 10-Q, you'll notice that we had about 13 communities that we reviewed and nine of them got impaired. And the other three were review before either mathematical reasons or other reasons they did not fall into that category where we had to run it undiscounted cash flow or discounted.

Alan Ratner -- Zelman & Associates -- Analyst

That's very helpful. If I could sneak in one last one just here in California. I guess, Allan, maybe just give a quick comment, you mentioned you're going to kind of recycle the capital and into deals that make more sense today but what's your longer-term commitment to California? We've heard a lot about just from the general environment there. And it's certainly a high-cost area for you guys, requires a lot of investments. So is that -- is that still a market that you guys are committed to your longer-term?

Allan P. Merrill -- President and Chief Executive Officer

I'm glad you asked because there are a lot of people who listen to this call, and some are investors and some are employees and some are land sellers. So I appreciate very much you asking that. We took the chance or the opportunity through this assessment to ask really the fundamental questions about why be in California. And if so, to what extent and in which sub-markets. And we concluded that the demand imbalance is so great that it is a market that warrants our capital.

Now your points about our scale relative to others means we have to pick our spots. We have to know which sub-markets, which product types, which buyer profiles we want to excel at, and I think we can do that. Our ambition in the market will have a least $200 million invested and probably more through cycles. And I think we can have a 1,000 unit business out there. We don't right now, but we've got a very strong presence in the Sacramento market, and we're going to be there for a long time. We've got the biggest master plan in Sacramento coming online this year. In Southern California, we're in I215, I10, I5 builder in Oceanside. We like those sub-markets. There is a whole bunch of real estate in Southern California that's not our buyer profile, not our appetite and I think being disciplined about knowing who we are gives us a really good chance to have California be important and a high return on asset business for us.

Alan Ratner -- Zelman & Associates -- Analyst

Great. Thanks a lot for that. Good luck.

David Goldberg -- Vice President and Treasurer

Thanks Alan.

Operator

(Operator Instructions) Our next question will come from Alex Barron with Housing Research Center. Your line is now open.

Alex Barron -- Housing Research Center -- Analyst

Yes, thank you. So I head you mentioned these assets that (inaudible) in California but I was hoping to get a bit more color on where these more higher price move up type communities into level or can you comment on the more specific locations?

David Goldberg -- Vice President and Treasurer

Well, Alex, we don't talk about individual assets in this context. We said about the communities and the category of nine that they were spread around Southern California. And they were in a variety of product types, variety of locations, and again all but one of which was more than 12 years old. So I wouldn't say they really reflected some particular strategy, but I think a thing that they had in common is B locations. And what we've recognized is that we know for us what an A location is and we've kept the A and the B locations and we're going to sell the other ones.

Alex Barron -- Housing Research Center -- Analyst

Yeah. And that was going to be my next question. So going forward when you said you're going to pick your spots what are you guys -- I guess identifying the more your strategies going forward in California? What are you going to be doing there?

David Goldberg -- Vice President and Treasurer

Yeah. We're an EVAP builder and I'm sorry to use that acronym, Extraordinary Value and Affordable Price. We're not going to get down as very, very lowest price point. There are things that we want to put in a home that we believe are important in terms of construction quality and materials and long-term livability and comfort and energy. That we just don't compromise on, and that means we can't be the absolute lowest price. But we think the decisions that we've made about the things that we include have demonstrable value for buyers.

Having said that, we are definitely not chasing into the first, second third move-up market because there are other builders for whom that's really what their expertise is. So we're in that first time, first move-up buyer profile with an awful lot of single-story product just for what it's worth. That is value oriented but isn't competing exclusively on the base of the price. And there are a handful of zip codes, a handful of school districts where we've got good DNA. We've been in California very long time. We've got a legacy of a lot of successful communities. And we really studied what we've been good at and that's what we're going to keep doing.

Alex Barron -- Housing Research Center -- Analyst

Got it. And then I thought I heard you say that next quarter you expect the margin to be the low like I don't know if I missed like if you give any basis points or is it roughly down a couple point of basis points or like did you give any sense of range where the margins might be this quarter?

Robert L. Salomon -- Executive Vice President, Chief Financial Officer and Chief Accounting Officer

Yeah. Alex, what we said in the in the script was I think we'd be about 19 but as we sell additional specs in the quarter that could oscillate 25 basis points up or down, but that would be the trough after the year we would expect margins to improve in the fourth quarter as well.

And Alex to make sure that you heard, we did put a 19 point up, 8% gross margin up this quarter, but it had some non-recurring items. So on a more regular basis about 19.2. So relatively flat was what we talked about 19 and then that range is the guidance that we gave.

Alex Barron -- Housing Research Center -- Analyst

Okay. I appreciate that. Thank you.

David Goldberg -- Vice President and Treasurer

Thank you, Alex.

Operator

We have no further questions at this time.

David Goldberg -- Vice President and Treasurer

Okay, all right. Well, we want to thank everyone participating in our second quarter earnings call. We look forward to talking to you in about 90 days. Thank you.

Operator

This concludes today's conference. Thank you so much for your participation in today's call. All participants may disconnect at this time.

Duration: 33 minutes

Call participants:

David Goldberg -- Vice President and Treasurer

Allan P. Merrill -- President and Chief Executive Officer

Robert L. Salomon -- Executive Vice President, Chief Financial Officer and Chief Accounting Officer

Jay McCanless -- Wedbush Securities -- Analyst

Maggie McGrath -- J.P. Morgan -- Analyst

Alan Ratner -- Zelman & Associates -- Analyst

Alex Barron -- Housing Research Center -- Analyst

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