BZH

Business Context and Reporting Period

Company: Beazer Homes USA, Inc.
Filing Type: Form 10-K (Annual Report)
Period Ended: September 30, 2004
Business Overview: Beazer Homes designs, builds, and sells primarily single-family homes across geographically diverse markets in the United States, including the Southeast, West, Central, Mid-Atlantic, and Midwest regions. The company operates through a decentralized structure with centralized corporate management. Ancillary businesses include mortgage origination (Beazer Mortgage), design studios, and title services.

Key Financial Metrics

Operational Highlights:

• Homes Closed: 16,451 (up 6.8% from 2003).
• Average Sales Price: $232,200 (up 15.4% from 2003).
• Backlog (Units): 8,456 homes valued at $2.24 billion (up 13.9% in units).
• New Orders: 17,481 (up 7.1% from 2003).

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 23.2% year-over-year, driven by a 6.8% increase in closings and a 15.4% increase in average sales prices. Strong demand in the West and Mid-Atlantic regions contributed significantly.
• Profitability: Net income rose 36.5% to $235.8 million. Gross margin improved to 20.7% due to strong pricing power and cost-saving initiatives, despite $43.9 million in warranty expenses related to construction defects in the Midwest.
• Liquidity and Debt: Cash on hand increased significantly to $320.9 million, funded by the issuance of $200 million in 6.5% Senior Notes (2013) and $180 million in 4.625% Convertible Senior Notes (2024). Total debt increased to $1.14 billion.
• Inventory Build: Inventory increased by $620.6 million to $2.34 billion, reflecting higher year-end backlog and land acquisition for future growth. This resulted in a net cash outflow of $73.7 million from operating activities.
• Dividends: The company initiated quarterly cash dividends of $0.10 per share in fiscal 2004, totaling $5.5 million, whereas no dividends were paid in fiscal 2003.

Guidance, Outlook, and Risks

Outlook: Management forecasts fiscal 2005 diluted earnings per share in the range of $20.00 to $21.00. This guidance incorporates the impact of EITF 04-8, which requires the inclusion of shares issuable upon conversion of the company's convertible senior notes in diluted EPS calculations.

Management Commentary:

• Strong demand continues in the West and Southeast regions, while the Midwest (specifically Indiana and Kentucky) and Central (Dallas) regions face economic weakness.
• The company is executing a national branding strategy and focusing on price point diversification.
• Land supply is robust, with 90,571 lots controlled (47% owned, 53% optioned), representing a 5.5-year supply based on 2004 closings.

Risks and Contingencies:

• Trinity Homes Litigation: A class action lawsuit regarding moisture intrusion and mold in Trinity Homes (acquired via Crossmann) was settled in October 2004. The settlement covers homes with brick veneer sold between 1998 and 2002. The company accrued $42.2 million for warranty reserves related to these issues as of September 30, 2004, but notes that actual costs could differ materially.
• Environmental Compliance: The EPA has issued Administrative Orders for 20 sites regarding storm water discharge practices. While no monetary penalties have been imposed yet, the EPA has reserved the right to impose them later.
• Market Risks: The company is exposed to interest rate fluctuations, though it uses swap agreements to hedge $100 million of floating-rate debt. Other risks include labor/material shortages, insurance availability, and changes in consumer confidence.

Investor Verification Checklist

• Warranty Reserve Adequacy: Verify the sufficiency of the $42.2 million accrual for Trinity Homes moisture intrusion claims, as the company states the ultimate cost is uncertain and could materially impact future earnings.
• Midwest Performance: Monitor the turnaround plan for the Midwest region (Indiana/Kentucky), which saw a 22.4% decline in closings and continued weakness in new orders.
• Convertible Note Dilution: Confirm the impact of the $180 million Convertible Senior Notes on future diluted EPS, particularly under the new EITF 04-8 rules effective in fiscal 2005.
• Land Option Exercise: Assess the company's ability to fund the exercise of $1.79 billion in land options over the next few years, given the significant increase in inventory and debt.
• Interest Rate Sensitivity: Review the maturity schedule of the $1.14 billion debt portfolio and the effectiveness of current hedging strategies against rising interest rates.