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Beazer Homes USA Inc (BZH 1.03%)
Q3Â 2020 Earnings Call
Jul 30, 2020, 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 June 30th, 2020. 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'll turn the call over to David Goldberg, Vice President and Treasurer. Thank you, sir. You may begin.
David Goldberg -- Vice President, Treasury and Investor Relations
Thank you, Mishy. Good afternoon, and welcome to the Beazer Homes conference call discussing our results for the third quarter of fiscal 2020. 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, which may cause actual results to differ materially from our projections.
Any forward-looking statement speaks only as the date the 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's simply not possible to predict all such factors.
Joining me today are Allan Merrill, our Chairman 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 third quarter, our response to the pandemic and the strength of the new home market, and then recap our strategic objectives for the coming quarters. Bob will cover our third quarter results in greater detail as well as our expectations for the fourth quarter and the full year. I will then come back to provide an update on our land spending and balance sheet, 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.
Operator
Thanks, David, and thank you for joining us on our call this afternoon. We generated very strong financial results in the third quarter with increases in both home closings and gross margins leading to nearly 40% growth in adjusted EBITDA. We also reported our highest third quarter net income in over 10 years. From a sales perspective, after weathering a very difficult environment in April, we experienced improved demand in May, which accelerated in June, leading to the best June sales pace we have generated in a decade. Together, these results have positioned us for a strong finish to our fiscal year.
As David outlined, the balance of my comments this afternoon are organized around three topics: our ongoing and evolving response to the pandemic, the environment for new home demand and a quick review of our strategic objectives. Last quarter, we outlined our initial response to the pandemic, highlighted by the priority we place on the health and safety of our employees, customers and trade partners. This continues to be our highest priority, with ongoing implications for every aspect of our business. In addition to our safety protocols, over the course of the third quarter, we reviewed and revised numerous operational and financial practices.
There were three primary outcomes from these adjustments. First, we preserve liquidity by maintaining a full draw on our revolver until the end of the quarter. While this increased interest expense in the quarter, it ensured that we had substantial cash to deal with any potential disruption and closings. With strong sales and greater clarity around the operational environment, we fully repaid the revolver and do not currently intend to have it drawn other than for seasonal liquidity needs.
Second, we paused land spending to apply new COVID-related risk criteria to our underwriting. Temporarily slowing land spending contributed to an increase in liquidity during the quarter. But more importantly, it allowed us to review every proposed transaction against new risks to employment, household income and supply. While our review resulted in us exiting a handful of positions, in the vast majority of cases, we were able to validate and renegotiate pending transactions. Going forward, we are confident we have a lot pipeline that supports our growth ambitions.
And third, we improved the cost structure of the business. As we adapted to a new working environment, we realized there were opportunities for us to improve our cost structure without reducing our ability to sell and build a growing number of homes in the quarters ahead. That was important to us because we saw the demand was rebounding quite quickly.
Prior to the COVID-19 pandemic, the new home market was very strong supported by wage growth, low unemployment, low mortgage rates, low housing supply and high consumer confidence. In late March, that momentum gave way to the pandemic. And in April, industrywide demand plummeted. But as you've heard and read, housing demand began recovering very quickly, and by June, was arguably better than prior to the pandemic. For you and for us, that raises two crucial questions. Where did this surge in demand come from? And is this sustainable? Only time will reveal the answers. But here is what we think is driving it and why it may last.
First, low mortgage rates have gotten even lower. This is a real plus for buyers as it improves affordability, increasing access to new homes for all buyer segments, especially first-time buyers. Second, working from home and schooling from home have led to a massive reappraisal of shelter needs. Our buyers are telling us that new homes offer crucial advantages over most apartments and used homes, including more space, more flexible floor plans and better outdoor living features, plus they're move-in ready and don't require costly cleaning or time-consuming improvements.
Third, the shift to remote work appears to be durable. Despite some challenges posed by remote work, both employees and employers have experienced an enormous boost to productivity arising from the elimination of commutes. Knowledge workers in particular are capable of working from completely different places, which can only benefit demand for new homes. And fourth, this may be the tipping point demographers have predicted for a decade, reflecting the moment that ownership-reluctant millennials embrace the inevitability and desirability of homeownership. This is our most speculative observation, but millennials represent about a quarter of the US population, so their housing preferences have to be watched very closely.
Despite the many challenges presented by the pandemic, we see no reason to deviate from our longer-term balanced growth strategy, which targets a double-digit return on assets by growing EBITDA faster than revenue from a more efficient and less leveraged balance sheet. As we monetize our longer-term assets and increase the share of lots controlled by option, we will generate plenty of liquidity to both grow the business and remain on course to reduce our long-term debt below $1 billion.
Finally, I want to express our corporate support for the elimination of prejudice, discrimination and injustice in our country. We have shared on social media a letter I wrote to our employees expressing both my personal views and our corporate commitment to addressing these issues in our company and our communities. I am extraordinarily pleased with the enthusiasm our team has shown to learn about and honestly discuss these issues. We are taking steps that will allow us to share the benefits of greater inclusion and diversity with our employees, customers, trade partners and shareholders. I know our efforts can make a difference.
With that, I'm going to turn the call over to Bob.
Robert L. Salomon -- Executive Vice President, Chief Financial Officer and Chief Accounting Officer
Thanks, Allan, and good afternoon, everyone. As Allan highlighted earlier, adjusted EBITDA in the quarter was up nearly 40% versus the prior year to $54 million. This performance was driven by strong results across our core metrics. Specifically, compared to last year, we grew homebuilding revenue by 10% to $532.5 million as we benefited from an 8% increase in closings combined with a 3% increase in our ASP.
Our gross margin, excluding amortized interest, impairments and abandonments, was up approximately 180 basis points to 21.2%, driven by increased margins on spec homes and our ongoing efforts to simplify product and reduce incentives. This margin excludes impairments and abandonments associated with our reunderwriting process totaling $2.3 million. SG&A as a percentage of total revenue was 11.7%, down 50 basis points, even with $1.4 million in one-time charges associated with improving our ongoing cost structure.
Total GAAP interest expense was up around $2.1 million, primarily due to our decision to carry a fully drawn revolver through nearly the entire quarter for liquidity purposes. Even with that, however, our cash interest expense was down $3.7 million as a result of our prior debt retirements and refinancing activities. Our tax expense in the quarter was about $5 million for an average tax rate of 24%. Taken together, we owned $15.3 million of net income from continuing operations or $0.51 in EPS this quarter, up $3.6 million versus the prior year.
As clarity into market conditions has improved, we are comfortable offering the following guidance into our expectations for the full year and the fourth quarter. For the full year of fiscal 2020, we expect adjusted EBITDA to be up 5% to 10% compared to last year with a big improvement in gross margin more than offsetting the impact of fewer home closings. This would represent the second highest level of EBITDA we've produced in a decade.
For the fourth quarter, the pandemic has impacted a variety of our operational metrics, particularly timing. For example, our beginning backlog is essentially flat to the level we had last year, but the stage of completion is very different. The COVID outbreak impacted the timing of both orders and spec starts during the quarter such that a larger than usual share of this backlog will deliver in the first quarter of fiscal '21 rather than the fourth quarter of this year. Accordingly, we expect our backlog conversion ratio will be in the low-70% range rather than the high-80%s like last year.
Our margin expectations reflect the strength in demand that occurred during the third quarter and our cost improvement efforts. Specifically, we expect gross margins will be up at least 100 basis points to around 21% and SG&A will be down more than 5% on an absolute dollar basis. Finally, with our reunderwriting complete, a cash component of land spend will accelerate, likely exceeding $100 million.
At this point, I'll turn it over to David.
David Goldberg -- Vice President, Treasury and Investor Relations
Thanks, Bob. At the beginning of the third quarter, we owned or controlled more than a three-year supply of land based on our trailing 12-month closings. This position allowed us to pause land spending, assess the demand environment and reunderwrite land deals that were in process. This process resulted in modest land acquisition and development spending during the quarter totaling just under $56 million.
With our reunderwriting process complete and demand improvements evident, we have resumed our regular land acquisition and development activity and expect to return to more normalized spending levels in our fiscal fourth quarter and into fiscal 2021. Of course, we'll take a disciplined approach given the ongoing spread of the coronavirus and the long-term impacts the pandemic may have on the economy. Strategically, we expect to sustain a lot position representing at least three years' supply with a growing share controlled by options, allowing us to better leverage our spend, improve return on assets and reduce risk.
We ended the third quarter with over $400 million of liquidity, more than double this point last year. This reflected more than $150 million of unrestricted cash and no outstandings on our revolver. With a durable business model that mixes to be built and spec homes and a growing land positions supported by larger share of options, we expect to generate sufficient liquidity to both reduce borrowings and grow our business in the years ahead.
We have no significant maturities until 2025 and our clearly defined deleveraging path includes $50 million term loan repayments in each of the next three years. After our upcoming September repayment, we will have just over $100 million remaining on our goal of bringing our total debt below $1 billion.
With that, let me turn the call back over to Allan for his conclusion.
Allan P. Merrill -- Chairman, President and Chief Executive Officer
Thanks, David. The third quarter of fiscal 2020 was very successful. We increased closings and improved margins, driving both revenue and profitability growth. We also took steps to improve our business and ongoing cost structure. These results, coupled with the tremendous sales momentum that we experienced in the back half of the quarter, position us to realize the objectives of our balanced growth strategy.
While there have been and will continue to be many challenges associated with operating during the pandemic, I'm very proud of our team for taking decisive steps to improve long-term shareholder value. It is because of them that I'm confident we have the people, the strategy, and the resources to navigate this fluid environment and execute our plan over the coming years.
With that let me turn the call over to the operator to take us into Q&A.
Questions and Answers:
Operator
Thank you. We will now begin the question-and-answer session of today's call. [Operator Instructions] First question comes from Alan Ratner from Zelman & Associates. Your line is open, sir.
Alan Ratner -- Zelman & Associates -- Analyst
Hey, guys. Good afternoon. First off, congrats to Bob on the upcoming retirement and to David on the promotion. Great to see both. Good luck.
David Goldberg -- Vice President, Treasury and Investor Relations
Thank you.
Alan Ratner -- Zelman & Associates -- Analyst
So, I guess, the first question, I guess, I'd love to just drill in a little bit on Slide 10 of your deck here on community count. If I'm reading this right, it looks like community count is probably going to pull back fairly meaningfully over the next couple of quarters. And first, I'd love to just get a little bit of a better understanding of exactly what the cadence of that looks like, how quickly that might occur based on obviously the strong sales environment right now. And I guess, more broadly, is there any way to accelerate community count growth to offset those declines? Have you looked into potential M&A in this environment similar to the deal you did in Atlanta a couple of years ago just thinking if there's a way to prevent that magnitude of a drop-off in the next few quarters?
David Goldberg -- Vice President, Treasury and Investor Relations
Yeah. Alan, it's Dave. Let me try to address it. So, if you look on Slide 10, you can see that in the aggregate, I would say, you have enough openings, enough communities in the pipeline to offset the closeouts and get to a more neutral number. But I think you're right in saying that we're going to have some community count. Now, the magnitude, we're not guiding to the magnitude. We're not talking about the specifics. As you know, it's quite difficult to predict the timing. But I think you are correct to think that there's going to be some communities where we have down community count.
But look, I think the plus side of it is, and what we really want to focus on, there's a lot of levers to pull in the business. There's margin, there's sales pace, right? There's a lot of -- there's the deleveraging that we're doing -- driving profitability. So, it's not just the community count that we're looking at. But certainly, you've identified a trend and we are out there trying to figure it out.
So, I don't know if you want talk about the -- I'm happy to kind of talk about M&A. The answer is kind of the same thing that we talked about M&A for a while, right? We look at all the deals that come through. We think of them as they're probably more likely than not going to be in our existing markets. We think of them as land acquisitions. And as we did previously, we signed deals that make sense and pencil from that perspective. We're always interested in looking. So, yeah, look, we're very focused on community count. But again, there's a lot of leverage to pull to drive profitability and drive higher EBITDA. And that certainly is our focus with our balanced growth strategy.
Alan Ratner -- Zelman & Associates -- Analyst
Got it. That's helpful, Dave. And then, I guess, I'm sorry if I missed it, but any commentary you can give us on July? How that's been tracking? And I guess, more broadly tying it back to the prior question, how are you thinking about the pace versus price dynamic here with all those communities approaching close-out?
Allan P. Merrill -- Chairman, President and Chief Executive Officer
Alan, t's Allan. The acceleration that we saw through the last quarter was really remarkable. And I mean, we were up almost 50% in pace in June. July has been up year-over-year in pace, but not by the same amount, it felt very good. But I think there are a few reasons for that. And you put your finger on the main one, which is margin. I think we have clearly been emphasizing in all of our markets -- I call it the and, I want pace and margin and not one or the other. And so, that's very much in our mind. And that's definitely playing a role. I think, the other thing is that the areas where the price or where the volume action has been the greatest are really price-only or price-driven buyers. In the value area where we play, I think we have a better opportunity to do both, right, get some pace and margin.
Alan Ratner -- Zelman & Associates -- Analyst
Got it. All right. Thanks a lot. Good luck.
Allan P. Merrill -- Chairman, President and Chief Executive Officer
Thank you, Alan.
Operator
Thank you. Next question comes from Susan Maklari from Goldman Sachs. Your line is open.
Susan Maklari -- Goldman Sachs -- Analyst
Thank you. And congratulations to both Bob and Dave, very exciting news.
Robert L. Salomon -- Executive Vice President, Chief Financial Officer and Chief Accounting Officer
Thanks.
David Goldberg -- Vice President, Treasury and Investor Relations
Thanks, Sue.
Susan Maklari -- Goldman Sachs -- Analyst
My first question is, what we've seen over the last few months is that builders that have really focused on spec seem to have outperformed, given their ability to close buyers quickly. Are you thinking about any changes in terms of your inventory position or strategy as it relates to spec given that? And how are you thinking about the sustainability maybe of that trend?
Allan P. Merrill -- Chairman, President and Chief Executive Officer
Sue, we've been in the 60-40, 55-45 range over the last couple of years. And I think, as we look out into the next year, that's probably where we're going to be. In a given quarter, it may oscillate a little bit, but I think we really have an equation in our mind for the value that we provide not just the number of units. And so, I don't think just an extravagant increase in specs is really on strategy for us in particular, because I think we're going to see some competitive response in the marketplace. We're already starting to see it, where there's going to be a fair bit of that happening. And I think we want to make sure that we protect our value proposition, and we don't wade into an eyesight in certain submarkets.
So, I like our position. It's really -- we've always said this. It's at the community level. Some communities operate with a spec-heavier model. Some operate really almost exclusively on a to-be-built basis, but our blend in that slight preference or slight majority to to-be-built, I think, is pretty durable.
Susan Maklari -- Goldman Sachs -- Analyst
Okay. Thanks for that, Allan. And then, following up, you made some comments earlier about some of the long-term tailwinds that seem to be moving in housings' favor, low rates, and some of the work-from-home trends and such, but do you get the sense that in the near-term, we have pulled forward demand, or do you think that this has been -- this growth we've seen over the last few months have been more a sense of maybe some pent-up demand that's now coming through and that we should still see some pretty nice growth levels over the next few quarters?
Allan P. Merrill -- Chairman, President and Chief Executive Officer
So, I think, during this third quarter, our fiscal third quarter, we saw two different things happen. I was pretty convinced in May and into June that as good as it felt, we were likely just catching up on what had been pent up from March and April. By the time we got further deeper into June, and certainly into July, my thinking shifted a little bit as we talk to our sales teams. I think what's happened is that the demand that we were going to have is there. And I don't think about it as pulling forward, I think about it as kind of awakening the sleeping giant. That cohort of people who have been dissatisfied with their housing, who say, gosh, now it really matters, less time in the car or less time in the office, more time in the house or apartment, and I got to go.
And I look at the aggregate occupancy in apartments in our markets over the last five or six years. And if we had seen the normal bleed off of those folks into the new home space, we would have had a much bigger industry over the last few years. I think we've awakened that giant and I think there's a group of occupants in used homes as well who are looking at the opportunities presented by having more space -- more flexible space.
So, I want to be a little careful. I was very intentional in my comments that whether or not this is the proverbial tipping point in that millennial kind of awaken the sleeping giant, I'm not absolutely sure. But I don't feel like we're just robbing next quarter. I mean, we look at the trends in our markets. We talk to the buyers. They've been thinking about this for a while, but the pandemic has really stirred that up. And I feel pretty optimistic that the environment over the next number of quarters is very constructive.
I do want to say, and this is the other side of it, we can't for long be disconnected from the macro economy. And I saw the GDP numbers today. We know what the temporary unemployment is. We need to get those people back to work, right. For this to be sustainable, with this kind of enthusiasm, we need to see the employment numbers continue to improve. And so, that's clearly an overhang. But I think when we look at total aggregate demand that is latent in our society for new homes, we haven't begun to serve that for nearly a decade, and I think that's in front of us now.
Susan Maklari -- Goldman Sachs -- Analyst
All right. Good, Allan. That's very encouraging. Best of luck with everything.
Allan P. Merrill -- Chairman, President and Chief Executive Officer
Thanks, Sue.
Operator
Thank you. Next question comes from Jay McCanless from Wedbush. Your line is open.
Jay McCanless -- Wedbush Securities -- Analyst
Hey. Good afternoon, everyone. Congrats, Dave and Bob. Very good news.
David Goldberg -- Vice President, Treasury and Investor Relations
Thanks, Jay.
Robert L. Salomon -- Executive Vice President, Chief Financial Officer and Chief Accounting Officer
Thanks, Jay.
Jay McCanless -- Wedbush Securities -- Analyst
The first question -- yeah. Absolutely. First question I had, what was your spec channel at the end of the quarter? How did that compare to last year?
Robert L. Salomon -- Executive Vice President, Chief Financial Officer and Chief Accounting Officer
Yeah. Jay, we had 714 specs at the end of the quarter. And it was about -- it's a couple of hundred, almost 300 less than last year.
Jay McCanless -- Wedbush Securities -- Analyst
And it looks like the sales absorbtion [Phonetic], the monthly sales was down year-over-year. I know the community count was down. But was that also a function of you guys trying to get more price in the quarter we're on or there are some things you'll need to do to address that shortfall versus last year [Phonetic]?
Allan P. Merrill -- Chairman, President and Chief Executive Officer
Well, the pace coming for the quarter was 2.7, which was a little off of last year, which was 3. But what happened over the course of the quarter was pretty remarkable. I think we talked about having the highest June pace we've had in recorded history, I don't know, of 10 years. We were over 4 in June. So, I think the pace is in pretty good shape. I mean, frankly it was into that kind of a number that we were very confident on the price side.
David Goldberg -- Vice President, Treasury and Investor Relations
Jay, I would tell you on the spec side, the original question, there was nothing to that. It was just some timing, March and April specs and the slowdown that we had. There is no deliberate, hey, let's shrink specs. I think, as Allan kind of mentioned earlier, it will be a pretty similar kind of specs to to-be-built company on a go-forward basis. They are just some timing given how strong demand was for specs. And frankly, again, kind of the March and April slowing down some spend and seeing how the environment was in assessing the situation.
Jay McCanless -- Wedbush Securities -- Analyst
And then, on the can rate, I mean, it's not surprising given everything that's happening. But can you talk about how the can rate progressed through the quarter. I'm just wondering if April is skewing the number, the 21.1%, a lot higher than it really was.
David Goldberg -- Vice President, Treasury and Investor Relations
It absolutely is, Jay. I can tell you by the time that we got to June, especially with the strong gross sales rate in June, the numbers were pretty flat to last year to even down a little bit. So, you had a little bit from the April and the gross sales number being down in April. But by June, things were pretty normalized, even it's better than usual.
Jay McCanless -- Wedbush Securities -- Analyst
Sounds great. Thanks for taking my questions.
David Goldberg -- Vice President, Treasury and Investor Relations
Absolutely, Jay.
Allan P. Merrill -- Chairman, President and Chief Executive Officer
Thanks, Jay.
Operator
[Operator Instructions] Next question comes from Alex Barron from Housing Research Center. Your line is open, sir.
Alex Barron -- Housing Research Center -- Analyst
Thank you. And congratulations again also on the retirement and the promotion. I wanted to focus, I guess, a little bit on the sleeping giant you talked about and just kind of wondering if you can remind us again what percentage of your sales this quarter, I guess, were to first-time or entry-level buyers and where do you see that going next year if current trends kind of persist?
Allan P. Merrill -- Chairman, President and Chief Executive Officer
Yeah. It's always a tricky thing to try and be exactly precise about first-time buyers. But if you look at our product portfolio, the width and the square footages and the price points that we serve, which clearly skew low within our peer group, it is -- within the realm of sort of the right range, Alex, to think about, probably about half of our business is in that first-time buyer. And then, you've got two other components that are competing for the other half, and that's that first move-up buyer for whom a little more square footage is important, but they're not at the mansion level.
And then, we've got the move-down buyer in the last category. And that move-down buyer is typically either buying a ranch plan, single-story living, three-bedrooms, kind of around 2,000, 2,100 square feet, or they're buying a gatherings unit. So that's kind of the distribution of our business. And as we've talked about, it's really about aging boomers and millennials.
David Goldberg -- Vice President, Treasury and Investor Relations
Alex, did you have a follow-up question?
Operator
There are no further questions in queue at this time.
David Goldberg -- Vice President, Treasury and Investor Relations
Okay. Well, look, I want to thank everybody for joining us on the call. We'll talk again in three months at the end of the fiscal year. Thank you very much for your time. This concludes today's call.
Operator
[Operator Closing Remarks]
Duration: 29 minutes
Call participants:
David Goldberg -- Vice President, Treasury and Investor Relations
Robert L. Salomon -- Executive Vice President, Chief Financial Officer and Chief Accounting Officer
Allan P. Merrill -- Chairman, President and Chief Executive Officer
Alan Ratner -- Zelman & Associates -- Analyst
Susan Maklari -- Goldman Sachs -- Analyst
Jay McCanless -- Wedbush Securities -- Analyst
Alex Barron -- Housing Research Center -- Analyst
