News Column

BEAZER HOMES USA INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations Executive Overview and Outlook

July 31, 2014

Executive Overview and Outlook: During our fiscal third quarter, the homebuilding industry continued on its recovery path. The fundamentals in most markets remain favorable as new home ownership continues to provide value compared to renting and in relation to household incomes. We also expect to continue to benefit from improved consumer confidence, modest improvement in job growth, the impact of a constrained supply of new and existing homes for sale and the projected growth in the number of new households. Based on our current expectations of the housing market and general economic conditions, we continue to believe that fiscal 2014 will be the Company's first full year of profitability since fiscal 2006. For the quarter ended June 30, 2014, we reported a net loss from continuing operations of $13.2 million, which included a $19.8 million loss on extinguishment of debt. Excluding the loss on debt extinguishment, the Company reported net income from continuing operations of $6.6 million. The loss on debt extinguishment related to the successful refinancing of our 9.125% 2018 Senior Notes with 5.75% Senior Notes due June 2019. This transaction was completed in April and reduces annual cash interest expense by over $8 million. In November 2013, we introduced our multi-year "2B-10" plan, which provides our expected roadmap to achieve $2 billion in revenue with a 10% Adjusted EBITDA margin. Reaching these objectives depends primarily on our ability to increase sales per community per month, raise our average selling prices ("ASP"), expand homebuilding gross margins, keep a tight watch on costs as a percentage of revenue and grow our active community count. We anticipate achieving the objectives outlined in the "2B-10" plan in the next 2 to 3 years. Since introducing our "2B-10" plan, we have made significant strides toward achieving its objectives. For the 12 months ended June 30, 2014, our revenues are $1.356 billion, up 10% year-over-year. Adjusted EBITDA has increased $53.5 million or 90% for the same time period. These improvements are due to the intense focus we have placed on the operational drivers of this plan, and, in part, to improved market conditions.



Specifically, sales per community per month was 2.9 for the 12 months

ended June 30, 2014 versus 2.7 a year ago.



Our ASP for the same time period is up 13.3% year-over-year, and our ASP

in backlog at June 30, 2014 was approximately $300 thousand, pointing to

our expected future improvements in this area.



Homebuilding gross margins for the fiscal third quarter were the highest

they've been in the past several years, bringing the homebuilding gross

margin excluding impairments, abandonments and interest for the 12 months

ended June 30, 2014 to nearly 22 percent.



On the cost side, SG&A for the 12 months ended June 30, 2014 was 13.9% of

total revenues. As we increase revenues in future quarters, we expect to

move closer to our "2B-10" target of 12%. We ended the third quarter with 142 active communities. In order to further increase our active communities, we invested $129.1 million in land and land development during the quarter. This investment brings our



total spending for the trailing 12 month period to $542.3 million, up over

50% versus a year ago. A significant majority of this land requires

development and will become active either later in fiscal 2014, in fiscal

2015 or in fiscal 2016. As a result, although our average active community

count for the quarter ended June 30, 2014 was down slightly as compared

with a year ago, it is expected to compare favorably year-over-year in the

coming quarters.

We expect a continued focus on our "2B-10" plan in the quarters ahead. Critical Accounting Policies: Some of our critical accounting policies require the use of judgment in their application or require estimates of inherently uncertain matters. Although our accounting policies are in compliance with accounting principles generally accepted in the United States of America (GAAP), a change in the facts and circumstances of the underlying transactions could significantly change the application of the accounting policies and the resulting financial statement impact. As disclosed in our 2013 Annual Report, our most critical accounting policies relate to inventory valuation (inventory held for development and land held for sale), homebuilding revenues and costs, warranty reserves, investments in unconsolidated entities and income tax valuation allowances. Since September 30, 2013, there have been no significant changes to those critical accounting policies. Seasonal and Quarterly Variability: Our homebuilding operating cycle generally reflects escalating new order activity in the second and third fiscal quarters and increased closings in the third and fourth fiscal quarters. 29



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RESULTS OF CONTINUING OPERATIONS:

Three Months Ended Nine Months Ended June 30, June 30, ($ in thousands) 2014 2013 2014 2013 Revenues: Homebuilding $ 353,165$ 313,129$ 909,248$ 843,025 Land sales and other 1,506 1,310 8,614 6,218 Total $ 354,671$ 314,439$ 917,862$ 849,243 Gross profit: Homebuilding $ 68,672$ 53,588$ 174,777$ 132,471 Land sales and other 132 527 869 1,613 Total $ 68,804$ 54,115$ 175,646$ 134,084 Gross margin: Homebuilding 19.4 % 17.1 % 19.2 % 15.7 % Land sales and other 8.8 % 40.2 % 10.1 % 25.9 % Total 19.4 % 17.2 % 19.1 % 15.8 % Commissions $ 14,322$ 13,078$ 37,239$ 35,406 General and administrative expenses (G&A) $ 35,994$ 29,612$ 97,032$ 84,735 SG&A (commissions plus G&A) as a percentage of total revenue 14.2 % 13.6 % 14.6 % 14.1 % G&A as a percentage of total revenue 10.1 % 9.4 % 10.6 % 10.0 % Depreciation and amortization $ 3,400$ 2,953$ 9,138$ 8,761 Operating income $ 15,088$ 8,472$ 32,237$ 5,182 Operating income as a percentage of total revenue 4.3 % 2.7 % 3.5 % 0.6 % Effective Tax Rate 11.8 % 7.4 % 6.6 % 2.3 % Equity in (loss) income of unconsolidated entities $ (81 )$ (310 )$ 221$ (206 ) Loss on extinguishment of debt $ (19,764 ) $ - $



(19,917 ) $ (3,638 )

Homebuilding Operations Data

Three Months Ended June 30, New Orders, net Cancellation Rates 2014 2013 14 v 13 2014 2013 West 486 614 (20.8 )% 22.1 % 20.2 % East 418 389 7.5 % 19.8 % 23.6 % Southeast 386 378 2.1 % 20.9 % 15.6 % Total 1,290 1,381 (6.6 )% 21.0 % 20.0 % Nine Months Ended June 30, New Orders, net Cancellation Rates 2014 2013 14 v 13 2014 2013 West 1,387 1,696 (18.2 )% 20.4 % 22.1 % East 1,150 1,140 0.9 % 21.3 % 24.4 % Southeast 1,038 998 4.0 % 20.0 % 15.2 % Total 3,575 3,834 (6.8 )% 20.6 % 21.1 % 30



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Sales per active community per month were 3.1 for the quarter ended June 30, 2014 compared to 3.2 for the quarter ended June 30, 2013 contributing to the 6.6% decline in net new orders year-over-year. During the quarter, we opened 17 communities and closed out of 13. We still anticipate that our active community count will increase in the fourth quarter of fiscal 2014 and in fiscal 2015 as recently purchased land and communities under development become active. Our West segment was especially impacted by the lower average active communities for the quarter, experiencing a double-digit decline from the prior year due to accelerated absorptions which resulted in the close out of communities during fiscal 2014 in advance of new community openings. The West segment was also impacted by a softening homebuyer market in Las Vegas and Phoenix. As of June 30, 2014 2013 14 v 13 Backlog Units: West 723 982 (26.4 )% East 833 781 6.7 % Southeast 656 595 10.3 % Total 2,212 2,358 (6.2 )% Aggregate dollar value of homes in backlog (in millions) $ 663.2$ 646.1 2.6 % ASP in backlog (in thousands) $ 299.8$ 274.0 9.4 % Backlog above reflects the number of homes for which the Company has entered into a sales contract with a customer but has not yet delivered the home. Our backlog has been and may continue to be impacted in the short-term due to our reduced number of active communities or by increased development or home construction cycle times due to labor and/or supply shortages. The recent higher demand for trade labor has created shortages of certain skilled workers in certain markets, driving up costs and/or extending land development and home construction schedules. We expect new orders and backlog units to increase over time as our active communities increase. Homebuilding Revenues and Average Selling Price The table below summarizes homebuilding revenues, the average selling prices (ASP) of our homes and closings by reportable segment: Three Months Ended June 30, Homebuilding Revenues Average Selling Price Closings ($ in thousands) 2014 2013 14 v 13 2014 2013 14 v 13 2014 2013 14 v 13 West $ 136,775$ 132,803 3.0 % $ 266.1$ 241.5 10.2 % 514 550 (6.5 )% East 127,147 111,333 14.2 % 332.0 300.9 10.3 % 383 370 3.5 % Southeast 89,243 68,993 29.4 % 259.4 219.7 18.1 % 344 314 9.6 % Total $ 353,165$ 313,129 12.8 % $ 284.6$ 253.8 12.1 % 1,241 1,234 0.6 % Nine Months Ended June 30, Homebuilding Revenues Average Selling Price Closings ($ in thousands) 2014 2013 14 v 13 2014 2013 14 v 13 2014 2013 14 v 13 West $ 376,031$ 360,052 4.4 % $ 268.2$ 231.8 15.7 % 1,402 1,553 (9.7 )% East 316,392 324,334 (2.4 )% 323.5 293.2 10.3 % 978 1,106 (11.6 )% Southeast 216,825 158,639 36.7 % 247.5 214.4 15.4 % 876 740 18.4 % Total $ 909,248$ 843,025 7.9 % $ 279.3$ 248.0 12.6 % 3,256 3,399 (4.2 )% Generally, improved operational strategies, product mix and market conditions in certain of our markets enhanced our ability to generate higher ASP over the past year. This higher ASP drove our increase in homebuilding revenues for the quarter and year-to-date as compared to the prior year. During fiscal 2013, we were able to increase prices or reduce incentives in response to robust demand and improved market conditions in the majority of our markets in our West segment. These conditions in a majority of our West markets have moderated over the past few quarters. Recently, in select markets or communities in our East and Southeast segments, we have been able to increase prices or reduce incentives in concert with market conditions. The change in ASP for the 31



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three and nine months ended June 30, 2014 was also impacted by a change in mix in closings between products and among communities and markets as compared to the prior year. We anticipate that our average ASP will continue to increase in future quarters as indicated by our increase in ASP for homes in backlog. We also anticipate that our closings in future quarters will increase as our number of active communities increase. Homebuilding Gross Profit The following table sets forth our homebuilding gross profit and gross margin by reportable segment and total homebuilding gross profit and gross margin, and such amounts excluding inventory impairments and abandonments and interest amortized to cost of sales for the three and nine months ended June 30, 2014 and 2013. Homebuilding gross profit is defined as homebuilding revenues less home cost of sales (which includes land and land development costs, home construction costs, capitalized interest, indirect costs of construction, estimated warranty costs, closing costs and inventory impairment and lot option abandonment charges). ($ in thousands) Three Months Ended June 30, 2014 Impairments & HB Gross HB Gross Interest HB Gross Profit HB Gross Margin HB Gross HB Gross Abandonments Profit w/o Margin w/o Amortized to w/o I&A and w/o I&A and Profit (Loss) Margin (I&A) I&A I&A COS Interest Interest West $ 33,784 24.7 % $ - $ 33,784 24.7 % $ - $ 33,784 24.7 % East 23,118 18.2 % 357 23,475 18.5 % - 23,475 18.5 % Southeast 17,252 19.3 % 1,653 18,905 21.2 % - 18,905 21.2 % Corporate & unallocated (5,482 ) - (5,482 ) 9,430 3,948 Total homebuilding $ 68,672 19.4 % $ 2,010 $ 70,682 20.0 % $ 9,430 $ 80,112 22.7 % ($ in thousands) Three



Months Ended June 30, 2013

Impairments & HB Gross HB Gross Interest HB Gross Profit HB Gross Margin HB Gross HB Gross Abandonments Profit w/o Margin w/o Amortized to w/o I&A and w/o I&A and Profit (Loss) Margin (I&A) I&A I&A COS Interest Interest West $ 28,747 21.6 % $ - $ 28,747 21.6 % $ - $ 28,747 21.6 % East 19,115 17.2 % - 19,115 17.2 % - 19,115 17.2 % Southeast 13,979 20.3 % - 13,979 20.3 % - 13,979 20.3 % Corporate & unallocated (8,253 ) - (8,253 ) 9,996 1,743 Total homebuilding $ 53,588 17.1 % $ - $ 53,588 17.1 % $ 9,996 $ 63,584 20.3 % ($ in thousands) Nine Months Ended June 30, 2014 Impairments & HB Gross HB Gross Interest HB Gross Profit HB Gross Margin HB Gross HB Gross Abandonments Profit w/o Margin w/o Amortized to w/o I&A and w/o I&A and Profit (Loss) Margin (I&A) I&A I&A COS Interest Interest West $ 88,590 23.6 % $ - $ 88,590 23.6 % $ - $ 88,590 23.6 % East 56,231 17.8 % 388 56,619 17.9 % - 56,619 17.9 % Southeast 41,875 19.3 % 2,533 44,408 20.5 % - 44,408 20.5 % Corporate & unallocated (11,919 ) - (11,919 ) 23,944 12,025 Total homebuilding $ 174,777 19.2 % $ 2,921 $ 177,698 19.5 % $ 23,944 $ 201,642 22.2 % ($ in thousands) Nine Months Ended June 30, 2013 Impairments & HB Gross HB Gross Interest HB Gross Profit HB Gross Margin HB Gross HB Gross Abandonments Profit w/o Margin w/o Amortized to w/o I&A and w/o I&A and Profit (Loss) Margin (I&A) I&A I&A COS Interest Interest West $ 70,797 19.7 % $ 150 $ 70,947 19.7 % $ - $ 70,947 19.7 % East 57,776 17.8 % 33 57,809 17.8 % - 57,809 17.8 % Southeast 28,999 18.3 % 2,046 31,045 19.6 % - 31,045 19.6 % Corporate & unallocated (25,101 ) - (25,101 ) 27,823 2,722 Total homebuilding $ 132,471 15.7 % $ 2,229 $ 134,700 16.0 % $ 27,823 $ 162,523 19.3 % 32



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Our overall homebuilding gross profit increased to $68.7 million for the three months ended June 30, 2014 from $53.6 million in the prior year. This increase in homebuilding gross profit benefited from increased ASP's which more than offset the increases in direct material, labor and land costs as compared to the prior year. Combined, these changes drove the 240 bps improvement in homebuilding gross margins, excluding impairments, abandonment and interest. For the nine months ended June 30, 2014, the $42.3 million increase in homebuilding gross profit was due primarily to the 7.9% increase in homebuilding revenues, driven by a 12.6% increase in ASP tempered partially by increases in direct material and labor costs and a 4.2% decrease in closings compared to the prior year. Total homebuilding gross profit and gross margin excluding inventory impairments and abandonments and interest amortized to cost of sales are not GAAP financial measures. These measures should not be considered alternatives to homebuilding gross profit determined in accordance with GAAP as an indicator of operating performance. The magnitude and volatility of non-cash inventory impairment and abandonment charges for the Company, and for other home builders, have been significant in recent periods and, as such, have made financial analysis of our industry more difficult. Homebuilding metrics excluding these charges, and other similar presentations by analysts and other companies, is frequently used to assist investors in understanding and comparing the operating characteristics of home building activities by eliminating many of the differences in companies' respective level of impairments and levels of debt. Management believes these non-GAAP measures enable holders of our securities to better understand the cash implications of our operating performance and our ability to service our debt obligations as they currently exist and as additional indebtedness is incurred in the future. These measures are also useful internally, helping management compare operating results and as a measure of the level of cash which may be available for discretionary spending. In a given quarter, our reported gross margins arise from both communities previously impaired and communities not previously impaired. In addition as indicated above, certain gross margin amounts arise from recoveries of prior period costs, including warranty items that are not directly tied to communities generating revenue in the period. Home closings from communities previously impaired would, in most instances, generate very low or negative gross margins prior to the impact of the previously recognized impairment. Gross margins at each home closing are higher for a particular community after an impairment because the carrying value of the underlying land was previously reduced to the present value of future cash flows as a result of the impairment, leading to lower cost of sales at the home closing. This improvement in gross margin resulting from one or more prior impairments is frequently referred to in the aggregate as the "impairment turn" or "flow-back" of impairments within the reporting period. The amount of this impairment turn may exceed the gross margin for an individual impaired asset if the gross margin for that asset prior to the impairment would have been negative. The extent to which this impairment turn is greater than the reported gross margin for the individual asset is related to the specific historical cost basis of that individual asset. The asset valuations which result from our impairment calculations are based on discounted cash flow analyses and are not derived by simply applying prospective gross margins to individual communities. As such, impaired communities may have gross margins that are somewhat higher or lower than the gross margin for unimpaired communities. The mix of home closings in any particular quarter varies to such an extent that comparisons between previously impaired and never impaired communities would not be a reliable way to ascertain profitability trends or to assess the accuracy of previous valuation estimates. In addition, since any amount of impairment turn is tied to individual lots in specific communities it will vary considerably from period to period. As a result of these factors, we review the impairment turn impact on gross margins on a trailing 12-month basis rather than a quarterly basis as a way of considering whether our impairment calculations are resulting in gross margins for impaired communities that are comparable to our unimpaired communities. For the trailing 12-month period, the homebuilding gross margin from our continuing operations was 18.9% and excluding interest and inventory impairments, it was 21.9%. For the same trailing 12-month period, homebuilding gross margins were as follows in those communities that have previously been impaired and which represented 19.5% of total closings during this period: Homebuilding Gross Margin from previously impaired communities: Pre-impairment turn gross margin (1.6



)%

Impact of interest amortized to COS related to these communities 3.2 % Pre-impairment turn gross margin, excluding interest amortization 1.6 % Impact of impairment turns 19.3 %



Gross margin (post impairment turns), excluding interest amortization 20.9 %

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Land Sales and Other Revenues and Gross Profit (Loss). The table below summarizes land sales and other revenues and gross profit by reportable segment for the three and nine months ended June 30, 2014 and 2013:

Land Sales & Other Revenues



Land Sales and Other Gross Profit (Loss)

Three Months Ended June 30, Three Months Ended June 30, (In thousands) 2014 2013 14 v 13 2014 2013 14 v 13 West $ 131$ 716 (81.7 )% $ - $ 103 (100.0 )% East 1,211 223 443.0 % (32 ) 53 (160.4 )% Southeast 164 371 (55.8 )% 164 371 (55.8 )% Total $ 1,506$ 1,310 15.0 % $ 132 $ 527 (75.0 )% Land Sales & Other Revenues



Land Sales and Other Gross Profit (Loss)

Nine Months Ended June 30, Nine Months Ended June 30, 2014 2013 14 v 13 2014 2013 14 v 13 West $ 5,337$ 2,589 106.1 % $ 538 $ 291 84.9 % East 2,921 890 228.2 % (25 ) 190 (113.2 )% Southeast 356 2,739 (87.0 )% 356 1,132 (68.6 )% Total $ 8,614$ 6,218 38.5 % $ 869$ 1,613 (46.1 )% Land sales relate to land and lots sold that did not fit within our homebuilding programs and strategic plans in these markets. Other revenues in our Southeast segment include net fees we received for general contractor services we performed on behalf of a third party and broker fees. We currently have scheduled a number of land sales to close in the next few months. We anticipate recording between $10 million and $30 million of revenue related to these land sales in the fourth quarter of fiscal 2014. Operating Income. The table below summarizes operating income (loss) by reportable segment for the three and nine months ended June 30, 2014 and 2013: (In thousands) Three Months Ended June 30, Nine Months Ended June 30, 2014 2013 14 v 13 2014 2013 14 v 13 West $ 18,754$ 15,313$ 3,441$ 48,854$ 33,716$ 15,138 East 10,438 7,714 2,724 21,667 24,215 (2,548 ) Southeast 8,235 7,644 591 18,025 12,024 6,001 Corporate and Unallocated (22,339 ) (22,199 ) (140 ) (56,309 ) (64,773 ) 8,464 Operating income $ 15,088$ 8,472$ 6,616$ 32,237$ 5,182$ 27,055 Our operating income improved by $6.6 million to $15.1 million for the three months ended June 30, 2014, compared to $8.5 million in fiscal 2013. For the nine months ended June 30, 2014, our operating income was $32.2 million compared to $5.2 million in the prior year. These improvements reflect higher homebuilding gross profits. As a percentage of revenue, our operating income was 4.3% and 3.5% for the three and nine months ended June 30, 2014 compared to 2.7% and 0.6% for the comparable periods of fiscal 2013. Our third quarter SG&A (a component of operating income) as a percentage of total revenue was higher than last year as our selling, general and administrative expenses included costs incurred in anticipation of new community openings to promote sales and support operations in these communities before any revenues were generated. As a result, our SG&A as a percentage of total revenue was 14.2% this quarter compared to 13.6% last year. Income taxes. Our income tax assets and liabilities and related effective tax rate are affected by various factors, the most significant of which is the valuation allowance recorded against substantially all of our deferred tax assets. Due to the effect of our valuation allowance adjustments beginning in fiscal 2008, a comparison of our annual effective tax rates must consider the changes in our valuation allowance. Our overall effective tax rates from continuing operations were 11.8% and 6.6% for the three and nine months ended June 30, 2014, compared to 7.4% and 2.3% for the three and nine months ended June 30, 2013. 34



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Three months ended June 30, 2014 as compared to 2013 West Segment: Homebuilding revenues increased 3.0% for the three months ended June 30, 2014, compared to the prior year, due to an increase in ASP in the majority of our markets offset partially by decreased closings. The 6.5% decrease in the number of closings was primarily driven by lower year-to-date sales as evidenced by an 18% lower beginning backlog and a double-digit decline in average active communities for the quarter ended June 30, 2014. As compared to the prior year, our homebuilding gross profit increased $5.0 million and homebuilding gross margins increased from 21.6% to 24.7%. These increases were primarily due to decreased incentives, product mix and modest price appreciation in most of our submarkets in the West which enabled us to better absorb increases in direct material, labor and land costs. The increase in land costs is primarily attributable to product and community mix including a shift to newer communities in certain markets which have a higher land basis. The $3.4 million increase in operating income resulted from the aforementioned increase in homebuilding gross margins offset partially by increased SG&A costs in anticipation of community openings. East Segment: Homebuilding revenues increased 14.2% for the three months ended June 30, 2014, compared to the prior year, primarily due to a 10.3% increase in ASP. As compared to the prior year, our homebuilding gross profit increased $4.0 million related to the aforementioned increase in homebuilding revenues. As a result, homebuilding gross margins increased from 17.2% to 18.2%. The $2.7 million increase in operating income resulted from the aforementioned increase in homebuilding revenues offset partially by increased SG&A expenses including increased commissions related to the higher revenues. Southeast Segment: As compared to the prior year, our homebuilding gross profit in the Southeast segment increased $3.3 million driven primarily by a 29.4% increase in homebuilding revenues, offset partially by increases in material, labor and land costs and $1.7 million for the abandonment of certain lots related to wetlands permitting issues. A slight increase in average active communities and improving market conditions contributed to this increased revenue and closings. Including the aforementioned abandonment, homebuilding gross margins decreased from 20.3% to 19.3%. Excluding the abandonment charge, homebuilding gross margins increased 90 bps from 20.3% last year to 21.2% this quarter. Our fiscal 2014 and fiscal 2013 land sales and other revenue and gross profit in our Southeast segment include net fees received for general contractor services we performed on behalf of a third party. The slight increase in operating income resulted from the aforementioned increase in homebuilding gross profit offset by a $1.6 million increase in commissions, sales and marketing and general and administrative expenses related to the increase in homebuilding revenues and active communities. Corporate and Unallocated: Corporate and unallocated includes amortization of capitalized interest and indirects and numerous shared services functions that benefit all segments, including information technology, national sourcing and purchasing, treasury, corporate finance, legal, branding and other national marketing costs. The costs of these shared services are not allocated to the operating segments. Corporate and unallocated gross profit this quarter included an increase in the amount of capitalized indirect spending relative to the increase in inventory. Corporate and unallocated operating loss was impacted by the increase in capitalized indirects offset partially by increases in sales and marketing costs, personnel related expenses and variable compensation plans to grow the business. The slight decrease in interest amortized to cost of sales is the result of a decrease in inventory capitalized per unit. Nine months ended June 30, 2014 as compared to 2013 West Segment: Homebuilding revenues increased 4.4% for the nine months ended June 30, 2014, compared to the prior year, due to an increase in ASP in the majority of our markets offset partially by decreased closings related to the decrease in average active communities. As compared to the prior year, our homebuilding gross profit increased $17.8 million and homebuilding gross margins increased from 19.7% to 23.6% due to our increased revenues and our ability to absorb increases in direct construction costs per home related to increases in material, land and labor costs. The $15.1 million increase in operating income resulted from the aforementioned increase in homebuilding gross margins offset partially by increased commissions and other sales and marketing costs. East Segment: Homebuilding revenues decreased 2.4% for the nine months ended June 30, 2014, compared to the prior year, primarily due to an 11.6% decrease in closings driven by the year-over-year decrease in active communities. Homebuilding gross margins were relatively consistent between years on $7.9 million of lower homebuilding revenues. Operating income decreased by $2.5 million primarily due to the aforementioned factors and the increase in personnel in preparation for the opening of new communities. Southeast Segment: Homebuilding revenues increased $58.2 million for the nine months ended June 30, 2014. This increase in revenues drove a $12.9 million increase in homebuilding gross profit and a $6.0 million increase in operating income. For the nine months ended June 30, 2014, operating income was offset partially by increased commissions and sales and marketing and personnel-related expenses to support the revenue increase. 35



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Corporate and Unallocated: Corporate and unallocated charges included in operating income decreased from the prior year due to a $3.9 million decrease in interest amortized to cost of sales, an increase in the amount of indirect spending capitalized and a $1.4 million benefit related to the reduction of certain reserves offset partially by an increase in personnel related expenses including an increase in headcount and variable compensation plans related to our actual and anticipated revenue growth. The decrease in interest amortized to cost of sales is the result of a decrease in inventory capitalized per unit. Derivative Instruments and Hedging Activities. We are exposed to fluctuations in interest rates. From time to time, we enter into derivative agreements to manage interest costs and hedge against risks associated with fluctuating interest rates. As of June 30, 2014, we were not a party to any such derivative agreements. We do not enter into or hold derivatives for trading or speculative purposes. Liquidity and Capital Resources. Our sources of liquidity include, but are not limited to, cash from operations, proceeds from Senior Notes, our Secured Revolving Credit Facility, and other bank borrowings, the issuance of equity and equity-linked securities and other external sources of funds. Our short-term and long-term liquidity depends primarily upon our level of net income, working capital management (cash, accounts receivable, accounts payable and other liabilities) and available credit facilities. As of June 30, 2014, our liquidity position consisted of $206.5 million in cash and cash equivalents, $150 million of capacity under our Secured Revolving Credit Facility, plus $58.0 million of restricted cash, $22.4 million of which related to our cash secured term loans. We expect to be able to meet our liquidity needs in the remainder of fiscal 2014 and fiscal 2015 and to maintain a significant liquidity position, subject to changes in market conditions that would alter our expectations for land and land development expenditures or capital market transactions which could increase or decrease our cash balance on a quarterly basis. We spent $381.5 million on land and land development activities during the nine months ended June 30, 2014 as we continue to strive to replace close out communities and position the Company to increase our active community count. We spent $314.4 million on land and land development for the nine months ended June 30, 2013. This spending on land and land development had a significant impact on our net cash used in operating activities in both years bringing net cash used in operating activities to $289.6 million for the nine months ended June 30, 2014 and $198.2 million for the nine months ended June 30, 2013. Also impacting cash used in operations in both years were the payment of other liabilities including interest obligations. Net cash used in investing activities was $22.3 million for the nine months ended June 30, 2014 primarily related to capital expenditures for model homes, additional investments in unconsolidated entities and a net increase in restricted cash collateralizing our outstanding letters of credit. Net cash used in investing activities was $0.3 million for the nine months ended June 30, 2013 primarily related to capital expenditures for model homes offset by a net decrease in restricted cash. Net cash provided by financing activities was $14.0 million for the nine months ended June 30, 2014 primarily related to the net proceeds from the issuance of $325 million aggregate principal amount of 5.75% Senior Notes due June 2019 (the June 2019 Notes) at par (before underwriting and other issuance costs) through a private placement to qualified institutional buyers. The proceeds from the issuance of the June 2019 Notes were used to redeem all of our outstanding Senior Notes due June 2018 (the 2018 Notes), including the applicable $17.2 million call price and make-whole premiums provided for by the 2018 Notes. Net cash provided by financing activities was $9.0 million for the nine months ended June 30, 2013 primarily related to the proceeds from the issuance of the 2023 Notes offset by the repayment of the 2015 Notes and the repurchase of $2 million of our 9 1/8% Senior Notes due 2019 (see Note 7 to the unaudited condensed consolidated financial statements). In September 2013, Fitch reaffirmed the Company's long-term debt rating of B-. In April 2014, Moody's reaffirmed the Company's long-term debt rating of Caa1 and increased our rating outlook from stable to positive and S&P reaffirmed the Company's long-term debt rating for the Company of B-. These ratings and our current credit condition affect, among other things, our ability to access new capital. Negative changes to these ratings may result in more stringent covenants and higher interest rates under the terms of any new debt. Our credit ratings could be lowered or rating agencies could issue adverse commentaries in the future, which could have a material adverse effect on our business, results of operations, financial condition and liquidity. In particular, a weakening of our financial condition, including any further increase in our leverage or decrease in our profitability or cash flows, could adversely affect our ability to obtain necessary funds, could result in a credit rating downgrade or change in outlook, or could otherwise increase our cost of borrowing. We generally fulfill our short-term cash requirements with cash generated from our operations and available borrowings. While we believe we possess sufficient liquidity to participate in a housing recovery, we are mindful of potential short-term, or seasonal, requirements for enhanced liquidity that may arise, especially as we increase our land and land development spending to grow our business. To facilitate this objective, we maintain our Secured Revolving Credit Facility at $150 million. We have also entered into a number of stand-alone, cash secured letter of credit agreements with banks. These combined facilities will provide for letter of credit needs collateralized by either cash or assets of the Company. We currently have $33.7 million of 36



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outstanding letters of credit under these facilities, secured with cash collateral which is maintained in restricted accounts totaling $34.4 million. In the future, we may from time to time seek to continue to retire or purchase our outstanding debt through cash repurchases or in exchange for other debt securities, in open market purchases, privately negotiated transactions or otherwise. In an effort to accelerate our path to profitability, we may seek to expand our business through acquisition, which may be funded through cash, additional debt or equity. In addition, any material variance from our projected operating results could require us to obtain additional equity or debt financing. There can be no assurance that we will be able to complete any of these transactions in the future on favorable terms or at all. Stock Repurchases and Dividends Paid. The Company did not repurchase any shares in the open market during the nine months ended June 30, 2014 or 2013. Any future stock repurchases, as allowed by our debt covenants, must be approved by the Company's Board of Directors or its Finance Committee. The indentures under which our Senior Notes were issued contain certain restrictive covenants, including limitations on the payment of dividends. At June 30, 2014, under the most restrictive covenants of each indenture, none of our retained earnings was available for cash dividends. Hence, there were no dividends paid during the nine months ended June 30, 2014 or 2013. Off-Balance Sheet Arrangements and Aggregate Contractual Commitments. At June 30, 2014, we controlled 29,783 lots. We owned 79.4%, or 23,658 lots, and 6,125 lots, or 20.6%, were under option contracts which generally require the payment of cash or the posting of a letter of credit for the right to acquire lots during a specified period of time at a certain price. We historically have attempted to control a portion of our land supply through options. As a result of the flexibility that these options provide us, upon a change in market conditions we may renegotiate the terms of the options prior to exercise or terminate the agreement. Under option contracts, purchase of the properties is contingent upon satisfaction of certain requirements by us and the sellers and our liability is generally limited to forfeiture of the non-refundable deposits and other non-refundable amounts incurred, which aggregated approximately $42.6 million at June 30, 2014. The total remaining purchase price, net of cash deposits, committed under all options was $417.2 million as of June 30, 2014. We expect to exercise, subject to market conditions and seller satisfaction of contract terms, most of our option contracts. Various factors, some of which are beyond our control, such as market conditions, weather conditions and the timing of the completion of development activities, will have a significant impact on the timing of option exercises or whether lot options will be exercised. We have historically funded the exercise of lot options through operating cash flows. We expect these sources to continue to be adequate to fund anticipated future option exercises. Therefore, we do not anticipate that the exercise of our lot options will have a material adverse effect on our liquidity. We participate in several land development joint ventures and have investments in other entities in which we have less than a controlling interest. We enter into investments in joint ventures and other unconsolidated entities in order to acquire attractive land positions, to manage our risk profile and to leverage our capital base. Excluding our investment in a pre-owned rental homes REIT, the remainder of our investments in our unconsolidated entities have historically been entered into with developers, other homebuilders and financial partners to develop finished lots for sale to the unconsolidated entity's members and other third parties. We account for our interest in our unconsolidated entities under the equity method. Our unaudited condensed consolidated balance sheets include investments in unconsolidated entities totaling $34.2 million and $45.0 million at June 30, 2014 and September 30, 2013, respectively. Our unconsolidated entities periodically obtain secured acquisition and development financing. At June 30, 2014, our unconsolidated entities had borrowings outstanding totaling $124.3 million. Historically, we and our partners have provided varying levels of guarantees of debt or other obligations of our unconsolidated entities. At June 30, 2014, we had no repayment guarantees outstanding related to the debt of our unconsolidated entities. See Note 3 to the unaudited condensed consolidated financial statements for further information. We had outstanding performance bonds of approximately $200.3 million at June 30, 2014 related principally to our obligations to local governments to construct roads and other improvements in various developments.


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Source: Edgar Glimpses


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