BEAZER HOMES USA INC quarterly report, Q3 FY2011

Beazer Homes USA, Inc. — Fiscal 2011 Third-Quarter Form 10-Q

Business context and reporting period

Beazer Homes is a residential homebuilder operating through West, East and Southeast segments across 16 states. The filing covers the three and nine months ended June 30, 2011, compared with the corresponding periods of 2010. Mortgage origination, title services and certain exited markets are reported as discontinued operations.

During the quarter, the Company discontinued homebuilding operations in Northwest Florida and continued to emphasize cost reductions, limited speculative-home construction, reduced land spending and preservation of liquidity. It also expanded its newly launched Pre-Owned Homes rental and resale division, with a stated plan to limit Company investment in that division to $20 million.

Financial performance and key metrics

Metric	Three months ended June 30, 2011	Three months ended June 30, 2010	Nine months ended June 30, 2011	Nine months ended June 30, 2010
Total revenue	$172.8 million	$321.8 million	$407.5 million	$722.4 million
Gross profit	$13.8 million	$36.8 million	$23.8 million	$79.6 million
Gross margin	8.0%	11.4%	5.8%	11.0%
Operating loss	$(35.2) million	$(19.4) million	$(108.1) million	$(70.5) million
Net income (loss)	$(59.1) million	$(27.8) million	$(161.7) million	$25.5 million
Basic EPS	$(0.80)	$(0.41)	$(2.19)	$0.46

Homebuilding revenue declined 47.6% in the quarter and 44.4% year to date, primarily because closings declined 49.2% and 43.3%, respectively. The prior-year quarter benefited from accelerated closings associated with the expiration of the federal homebuyer tax credit.
Average selling price was $213,000 in the quarter, up 3.2%, but declined 1.9% year to date to $213,000, reflecting product and community mix, discounting and incentives.
Net new orders increased 23.7% in the quarter to 1,215 units but declined 11.2% year to date to 2,921 units. Backlog increased to 1,820 homes, valued at $431.2 million, versus 1,134 homes and $279.3 million at June 30, 2010.
SG&A declined to $46.4 million from $52.9 million in the quarter and to $125.2 million from $140.9 million year to date; however, SG&A as a percentage of revenue increased to 26.9% and 30.7%, respectively, because of lower revenue. The quarter included approximately $7.3 million of severance-related costs.
Inventory impairments and option abandonments were $6.9 million in the quarter and $25.3 million year to date, compared with $5.0 million and $23.3 million in the prior-year periods.
Net cash used in operating activities was $277.6 million for the nine months, versus $0.8 million provided in the prior year. The use of cash primarily reflected a $150.6 million increase in inventory and the absence of the prior-year $102.1 million of federal tax refunds.
Net cash used in investing activities was $259.0 million, principally due to $250.1 million of increases in restricted cash. Net cash provided by financing activities was $274.2 million.
Cash and cash equivalents were $274.6 million at June 30, 2011, and restricted cash was $284.3 million, for combined cash and restricted cash of approximately $559.0 million.
Total debt, net of discounts, increased to $1.489 billion from $1.212 billion at September 30, 2010. The increase primarily reflected cash-secured borrowings and a new $250 million senior-note issuance, partly offset by debt repayments and repurchases.
There were no borrowings under the secured revolving credit facility. The facility was subsequently amended to extend its maturity to August 2, 2012.

Material changes versus the prior comparable period

Revenue, gross profit and operating results deteriorated substantially because of lower closings, weak housing demand and the prior-year tax-credit comparison.
The Company moved from $25.5 million of net income in the first nine months of 2010 to a $161.7 million net loss in 2011. The prior year benefited from a $43.9 million gain on debt extinguishment; 2011 included a $2.9 million loss.
Backlog improved materially despite lower year-to-date orders, but management cautioned that backlog is subject to cancellations and may not translate into comparable future revenue.
Owned inventory increased to $1.291 billion from $1.154 billion, while completed unsold homes declined to 252 from 423. Total stockholders’ equity declined to $241.0 million from $397.1 million, and accumulated deficit increased to $383.3 million.
Management adopted revised variable-interest-entity guidance and deconsolidated land under four lot-option agreements, reducing land not owned under option agreements and related obligations by $12.9 million.
In June 2011, the Company entered into a settlement relating to the defaulted South Edge joint venture. It recorded a $15.7 million liability at June 30, 2011, net of $1.5 million placed in escrow, and recognized a $4.0 million impairment of future land purchase rights during the nine months.

Guidance, outlook, risks and unusual items

Management did not provide quantitative revenue or earnings guidance. It expects housing demand and starts to improve over time but stated that visibility into the remainder of fiscal 2011 and fiscal 2012 was limited. The Company expects to preserve a significant liquidity position, maintain a disciplined operating approach and invest selectively in new opportunities, including Pre-Owned Homes.

Housing demand remains pressured by high unemployment, low consumer confidence, distressed-home inventory, falling or volatile home prices and limited mortgage availability.
Further price reductions, higher incentives or slower absorption could result in additional material inventory impairments. The nine-month impairment review included $24.5 million of development-project and land-held-for-sale impairments, including discontinued operations.
The Company had a $505.8 million valuation allowance against deferred tax assets. Utilization of certain pre-ownership-change tax attributes is limited by Section 382.
South Edge’s joint venture debt totaled approximately $327.9 million, and the Company’s estimated maximum repayment-guarantee exposure for all unconsolidated joint ventures was $17.9 million. The South Edge reorganization and settlement remained subject to contingencies and bankruptcy-court processes.
Other contingencies include construction-defect and Chinese-drywall claims, mortgage-loan repurchase demands, environmental matters, litigation and obligations under a deferred prosecution agreement. The Company had accrued $29.9 million for litigation and related matters, including South Edge.
The deferred prosecution agreement and related settlements could require additional payments based on adjusted EBITDA, subject to a stated maximum liability of $55.0 million; $16.0 million had been paid by June 30, 2011.
Outstanding performance bonds were approximately $175.8 million and outstanding letters of credit were approximately $34.4 million at June 30, 2011.
Management stated that cash, restricted cash, operating cash flow and potential financing sources were expected to be adequate for liquidity needs through the remainder of fiscal 2011 and into fiscal 2012, but access to capital depends on credit quality, covenant compliance and market conditions.

Most important facts for investors to verify

Whether the increased backlog converts into closings without elevated cancellation rates or additional incentives.
The sustainability of cash resources given negative operating cash flow, rising inventory and approximately $1.489 billion of debt.
Compliance with debt covenants and the impact of the 2012 revolving-facility maturity and future debt maturities.
The final resolution and cash cost of the South Edge settlement, including the value of land rights received.
Potential additional inventory impairments under weaker home prices or absorption assumptions.
Exposure from Chinese-drywall claims, construction defects, mortgage repurchase demands and other litigation.
The extent to which the deferred tax valuation allowance and Section 382 limitations affect future tax benefits.
Whether the Pre-Owned Homes division can scale while remaining within the stated $20 million Company investment limit.