LGI Homes, Inc. (LGIH) Q1 2014 Earnings Report, Transcript and Summary

Good morning, and welcome to the LGI Homes 2014 First Quarter Conference Call. Today's call is being recorded. And a replay will be available on the company's website later today at www.lgihomes.com. We have allocated an hour for prepared remarks and Q&A. [Operator Instructions] At this time, I will turn the call over to Rachel Eaton, Chief Marketing Officer at LGI Homes. Ms. Eaton, you may begin.

Thank you. Good morning, and welcome to the LGI Homes conference call discussing our results for the first quarter of 2014. Today's conference call will contain forward-looking statements that include, among other things, statements regarding LGI's business strategy, outlook, plans and objectives. All such statements reflect current expectations. However, they do involve assumptions, estimates and other risks and uncertainties that could cause our expectations to prove to be incorrect. You should review our filings with the SEC, including our risk factors for a discussion of the risks, uncertainties and other factors that could cause our actual results to differ materially from those anticipated in these forward-looking statements. These forward-looking statements are not guarantees of future performance. You should consider these forward-looking statements in light of the related risks, and you should not place undue reliance on these forward-looking statements, which speak only as of the date of this conference call. The pro forma financial information discussed on this call gives effect to the acquisitions completed on November 13, 2013 of certain joint venture interests that we did not previously own prior to the IPO. Please refer to the unaudited pro forma statements of operations included in today's release and our previously filed 10-K. Additionally, certain non-GAAP financial measures will be discussed on this conference call. The presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP are included in the earnings press release that we issued this morning and in our quarterly report on Form 10-Q for the first quarter of 2014 that will be filed with the SEC later today. This filing will be accessible on the SEC's website or in the Investor section of our website at www.lgihomes.com. Joining me today are Eric Lipar, LGI's Chief Executive Officer and Chairman of the Board; Charles Merdian, the company's Chief Financial Officer, Secretary and Treasurer; and Meg Britton, the company's Chief Administrative Officer. With that, I will now turn the call over to Eric.

Thank you, Rachel, and good morning, everyone. We appreciate you joining us today. First of all, I want to thank the entire team at LGI Homes for all their hard work contributing to our success. We just got back from the Housing Leadership Summit where we were named the 24th largest builder in the United States according to BUILDER magazine. This year, our ranking increased 8 spots, which is the largest jump among the top 40 builders. On the call this morning, I'll summarize the highlights from the first quarter of 2014, then Charles will discuss our financial results in more detail. After he is done, I will conclude with comments on what we are seeing this quarter and our expectations for the remainder of 2014, then we will open up the call for questions. At LGI Homes, we had a phenomenal start to the year. I am pleased to say that we wrapped up the first quarter of 2014 well exceeding our expectations. Home closings during this quarter increased approximately 92% to 485. Home sales revenues for the first quarter of 2014 increased a 112% to $75.9 million compared to the first quarter of 2013. The increase in home sales revenues is primarily due to the increase of number of homes closed and a 10.8% increase in the average home sales price to $156,535. Adjusted gross margin as a percentage of home sales revenues for the first quarter of 2014 increased to 27.5% from 26.9% for the first quarter of '13, which is within our target range. Active selling communities increased approximately 65% to 28, as compared to the first quarter of last year. Furthermore, we ended this quarter with a portfolio of finished lots, land under development and raw land that represent approximately 17,000 owned or controlled lots. Throughout the quarter, we saw success across all of our divisions. Our Texas division averaged approximately 6 closings per community per month. Similarly, Florida and Southwest divisions averaged approximately 5 closings per community. And the Southwest, our newest division, averaged approximately 4 closings per community. The results reflect that we had new communities coming online during the quarter, particularly in our markets outside of Texas. In addition, the first quarter marked the first closings in our Tucson, Arizona and Albuquerque, New Mexico markets. In our newest market, Albuquerque, we were able to quickly establish ourselves by hiring and training 4 new sales people in January, opening the community sales office in February and closing our first home in March. In addition, we moved in another 5 homeowners in the month of April. We have also seen a positive response to our new product line, the Great Lakes series, which ranges in price from the 160s to the 220s. Our Presidential Glen community in Austin, Texas is the first community where we have offered this product, and we had a great start in the first quarter. We have seen strong demand from our customers for this product line with its higher-end finishes. During the first quarter of 2014, we closed 19 homes in this community with an average sales price of approximately $170,000, which represents more than a 25% increase in homes closed and more than a 15% increase in average sales price over the same period in the prior year. These results indicate that we can increase price point with an upgraded product and improve our absorption. During the first quarter, we closed on an acquisition in San Antonio, where we are planning to introduce our Hall of Fame series, which will have an average price point of $350,000. We believe that our plan for move-up product aligns with our expectation to be able to grow our business by increasing the number of price points in some of our existing markets. We see opportunities to develop properties with multiple product lines and price points in the same communities, and to deliver move-in-ready homes at a higher price point. With that, I'd like to turn the call over to Charles for a more in-depth review of our financial results.

Thanks, Eric. Over the quarter, we recorded $7.1 million in pretax net income, which was a 99.9% increase over the same quarter in the prior year, and we reported earnings of $4.6 million or $0.22 per share. As Eric mentioned, home sales revenues for the quarter were $75.9 million, an increase of approximately 112% from the first quarter of 2013. Adjusted gross margin of 27.5% was 60 basis points higher from the first quarter of '13 and 160 basis points higher than the fourth quarter of '13. This primarily reflects the net impact of higher average home sale prices. Adjusted gross margins for this quarter excludes $1.1 million of cost of sales related to the step-up adjustment for real estate inventory acquired in the GTIS acquisitions that were closed during the quarter. Selling expenses were $7.4 million or 9.7% of home sales revenue this quarter compared to 10.8% in the same quarter in the prior year and 10.2% in the fourth quarter of 2013. General and administrative expenses were $5.1 million in the first quarter of this year or 6.7% of home sales revenue. This was a 40 basis point -- this was 40 basis points higher than the fourth quarter of 2013. The increase was primarily due to approximately $600,000 of incremental costs incurred during this quarter related to legal and accounting costs that we believe are nonrecurring. Income taxes totaled approximately $2.5 million, representing an effective tax rate of 35%. First quarter net orders were $619 million and ending backlog was 324 units. As of March 31, we had $25.7 million in cash, $177.5 million in real estate inventory and total assets of $239.6 million. Our outstanding debt was $48.8 million, an increase of approximately $13 million over the previous quarter. In April, we entered into an agreement with a syndicate of lenders to provide $135 million senior secured credit facility that can be increased to $200 million. Interest is LIBOR-based with a floor of 3.75. At this point, I'll turn it back over to Eric.

Thanks, Charles. In summary, we had a very positive quarter and expect the momentum to continue into the second quarter. Next, I'd like to provide some guidance and thoughts on what we are currently seeing and looking ahead into 2014. We started the second quarter strong with a 191 homes closed in April of 2014, up from 132 homes closed in the same period of 2013. At the end of April, we have 29 active selling communities compared to 18 active selling communities at the same point of the prior year. As of April 30, we have 676 year-to-date home closings, a 75% increase in homes closed during the same period in 2013. Based on the success we have experienced so far this year and the continued demand for homeownership in our markets, we are increasing our previously released 2014 guidance from at least 2,200 homes closed to at least 2,300 homes closed, which represents a 42% increase over the 1,617 homes closed in 2013. We are also raising our expected community count from 36 to a minimum of 37 active selling communities at the end of 2014. As noted on our year-end earnings call, we have been evaluating the Denver, Colorado and Charlotte, North Carolina markets and are moving forward. We have hired our first employee in Denver, and we have our first acquisition in each market under contract. Once we complete due diligence and close on these projects, we expect to start home construction by the end of the year and have closings in the first half of 2015. As we continue to expand into new markets and deliver some upgraded products at higher price points, we will still remain focused on serving the entry-level buyer. We anticipate that only a small part of our revenue will come from closings greater than $300,000. Our strategy is to remain focused on not only our absorption rate, but also on margins. As previously mentioned, adjusted gross margin as a percentage of home sales revenues for the first quarter of 2014 increased to 27.5% from 25.9% for the fourth quarter of 2013. We believe that through the quality of our homes, our unique sales process and the superior customer experience, we will be able to maintain similar gross margins in the future. Our industry-leading closings per community, in combination with strong operating margins, will continue to drive profitability. Assuming that home sales prices, construction costs, overall absorption rate and mortgage availability are generally consistent with our recent experience, we expect earnings per share for 2014 to be between $1.22 and $1.30 per share. In conclusion, we are extremely optimistic on the remainder of 2014. We expect the demand for homeownership to remain strong, in a combination with our LGI process, we can capitalize on these favorable conditions. We believe we will continue to generate industry-leading margins and the best absorption rates. Now Charles and I will be happy to take any questions you may have.

[Operator Instructions] And our first question comes from Nishu Sood from Deutsche Bank.

This is Rob Hansen on for Nishu. So the first question I had for you guys was kind of around the guidance. We really appreciate you guys providing EPS guidance. I think you're one of the only builders at this point doing that. So obviously we just wanted to kind of ask a little bit more about the parameters around how you arrived at the $1.22 to $1.30 in terms of the top line. And I realized you said gross margins are kind of in a -- remaining at current levels, is I think what you said, so. And how do you think about SG&A? So just some kind of parameters around your guidance.

Sure, Rob. This is Eric, I'll address the top line. First of all, we were comfortable raising our closing guidance to 2,300 units and expect top line revenue average sales price to increase closings. On the last call, we said 2% to 4% per quarter. That was consistent with what we saw on the first quarter, and we expect that to continue the -- throughout the remainder of the year. And I'll let Charles address the SG&A question.

Sure. On SG&A, so we had mentioned 16.4% in the first quarter for SG&A. We see us taking advantage of operating leverage over the remainder part of the year looking to target 14% SG&A by the fourth quarter. So yielding an additional 200 to 220 basis points in SG&A leverage.

One other area that we wanted to ask about was you guys put out an 8-K the other day about a pretty large land purchase in South Carolina. So I wanted to ask about how that opportunity came about and what your plans are for the land. It looks like a pretty big portion of your cash that you have right now and what this means for how much more land you'll be buying in the future.

Yes. This is Eric, I'll address that. That came about because of our relationship with Woodforest Bank and also LGI Land, which we knew, and we're very similar with that piece of property. I was personally involved with it back when we bought it in approximately 2006. We think it's a phenomenal piece of property. We think it's great value. We are very experienced in developing those sites. That site is approximately 2,000 acres, 30 miles south of Charlotte with 2 miles of frontage on the Catawba River. It's forecasted to have approximately 1,000 units of approximately 1-acre home sites, and we plan on going in there. We think we got a great value in the buy, and building product in the $300,000 to $400,000 range and also have the ability to burn through the land pretty quickly, if we need to through the selling of acreage home sites to the consumers or possibly other builders. So we're really excited about that project.

Our next question comes from Michael Rehaut from JPMorgan.

It's actually Will Wong on for Mike. My first question is with regards to your focus on the first-time buyer. There's been some recent commentary about some other builders focusing on that, as well, on those recent transaction in the Atlanta market by one of your competitors. So just wondering if you could share with us maybe what's your -- thoughts are regarding the competition in that market. It sounds like there's going to be, just going forward, some more focus by some of the other public builders on that entry-level buyer. Just how are you guys positioning yourself against that competition?

Yes, well, this is Eric. Great question. First of all, I think the focus on the entry level really validates our business model. So we're excited about that. We would agree that the entry-level market is coming back. There's lots of opportunities in that space, and we're very optimistic on that in the future. As far as the competition goes, we really don't focus on the competition, specifically to the Atlanta market. We are very happy with the positions that we have. We are still able to buy finished lots below replacement costs. The demand that we track through the incoming lease that we're receiving in each office is extremely high, and we believe we have the best sales process in the industry that we can take a customer through regardless of the competition and creates the margins, the absorption rates that LGI has historically created.

Okay, great. And then with regards to gross margin. Charles, maybe you can help us with this. But -- the -- I think there's about $2.8 million left in terms of the purchase accounting amortization through COGS. Can you just walk us through with the timing of that would be? Is it mostly going to be in the second quarter?

Sure. So what we're seeing is, we mentioned this on the last call, is an allocated portion of the step-up ended up in land and lots. So we're seeing it pace out a little bit longer and we'll see it pace out over the year. We're looking at about $750,000 to $900,000 in the second quarter and about $500,000 each quarter thereafter, which puts it on pace to finish out in the second quarter of 2015.

Our next question comes from Mike Roxland from Bank of America Merrill Lynch.

Can you just talk about the pace of sales in your business and whether you witnessed any acceleration toward the end of 1Q? The reason I asked that question is that on your last earnings call back in late March, you were guiding to around 475 total deliveries, and you wound up at 485. On top of that, you're obviously now increasing your 2014 delivery guidance. So did you really see any type of acceleration toward the end of 1Q that's persisted into April and May?

I'll explain it like this, Mike. When we said 475 for the first quarter, we were -- wanted to be pretty conservative and make sure we hit that number and make sure the people showed up for closing in that last week. So we're wanting to make sure we hit that, so we ended up with 485. And what we have seen in the office is very consistent with what we've seen over the years. As the year goes on, closings get better. We are comfortable raising guidance from 2,200 to 2,300. Our pipeline looks very strong. We closed 101 in April, which is February and March sales. And since that point, sales have also remained very strong, and we're very optimistic on how the months of May and June are going to end up as well.

Got it. Additionally, on the sales pace, though it seems like it's a little bit lighter than certainly in some of -- I think you guided to 6 sales per community in Texas, and I think some of your new areas were 5, and that compares with what -- it had been a company average of around 7, even at times higher than that, maybe approaching 8. So I just wanted to get your thoughts on the sales pace, and is it just -- what's really driving it? Why is it lower than what it has been historically? I can understand maybe being lower to some of your new areas that you're -- where you're expanding, but can you just provide probably some color around what's happening with the actual sales pace?

Yes, we're really happy with our sales pace in all markets across the country, Mike. And we put that in there, we had actually forecasted 5 closings per month per community in the first quarter because that is primarily driven by sales in the fourth quarter, which is our slowest time of the year, and the first quarter traditionally has the slowest per community closing numbers. So we actually are very happy with all markets and closings for the first quarter, and we expect that to increase. And 6 closings per community is a good average for all markets for the entire year.

Got it. And last question and I'll turn it over. Gross margin performance in 1Q was solid, and it's certainly better than we were expecting. Was there anything that actually occurred in the quarter that resulted in gross margins on being higher? Have you seen -- gross margins were about 100, 150 bps higher than we were expecting. Was it a matter of cost? Was it a matter of -- do you think you'll be able to close on more homes? Just trying to get a sense of why gross margins accelerated as much as they did?

Well, I would say we just focused on a lot more. We missed the last quarter of 25.9%. We weren't happy with, and we had talked about that and really focused on gross margin. And we were able to push pricing higher than costs were increasing. And that's what led to that greater gross margin, and we continue -- we believe we're going to be able to continue push pricing ahead of costs. So gross margin is going to be at least similar through the rest of the year.

Our next question comes from Brendan Lynch of Sidoti.

I wanted to get a little deeper onto South Carolina. Can you give us a little color on the time line of when you think you might be delivering homes there? And also, give us some color on what you see as driving demand in that market.

Sure. The time line is -- we're buying in -- as part of that purchase, 66 finished lots. So we can get started fairly quickly. We're scheduled to close on that property in July. I would say, we'd start construction by the end of the year and open up for sales towards the first quarter of next year and have closings around mid of 2015, would be a pretty accurate time line on that. And we believe the demand because of the value we're creating through this property. So being 30 minutes from the Charlotte proper and to be able to offer acreage home sites and the value proposition, we feel real strongly that demand is going to be there. Also, I was involved in this project back in the late 2000s, in 2007, 2008 before the downturn, and we saw a very strong demand for this particular project. So we just need to get it restarted again at the value and the basis we're going to be into this property. It's going to be a great value to the consumer.

Great. And then just another question on your ASP growth. It was pretty strong year-over-year and just wanted to get the color on the pricing power you're seeing and whether that ASP growth was truly pricing power or is that more geographic mix and product mix?

Well, it's both. It's certainly product mix, but there's certainly some pricing power there because you saw our gross margins have increased. So it's certainly a combination, and we feel very comfortable that's going to continue in the future.

[Operator Instructions] Our next question comes from Jordan Hymowitz from Philadelphia Financial.

If you only outsell your competition by 100%, I promise I won't be disappointed as an investor.

Thanks, Jordan.

I have 2 questions. One, I mean, as the other person alluded to, D.R. Horton has kind of entered your market and someone -- some analysts are presenting that as a negative, but I would throw the opposite. Don't you think it's a validation of the huge opportunity of a company like D.R. Horton? Saying what we see, this as a missed opportunity. And might there even be a potential they could look to acquire you or something like that?

This is Eric, Jordan. I certainly think D.R. Horton being the largest builder in the country, a great company, certainly validates our business model and the focus on the entry levels. We took that as a very positive news that they're rolling out there express homes. And we agree with them that the entry level is underserved. We agree with them that's there's -- that's a huge market. And the opportunity for all of us exists. And no comment on them acquiring us, but that's probably very unlikely.

Okay. And my other question is, yesterday Mel Watt in his FHA speech talked about loosening of credit standards. I mean, it's a small step backward, but it's the first step back of tightening credit regulations for the past 4 or 5 years. And I guess, my question is, as a person that's a credit-based lender for lack of -- home builder, for lack of a better term, the easing of credit standards, specifically for entry-level people has got to be a big positive for you, is it not?

It would be substantially positive, Jordan. I mean, any easing of credit for the first-time homebuyer will directly result in increased closings for LGI. There's no question about that, and we are excited to see that. We have seen slight easing in credit over the last quarter or 2, but nothing substantial. But if it gets to be material in the future, it certainly will help LGI and all of us that focus on the entry-level part of the segment.

And then the biggest pullback from quadrupling your competitors versus just doubling is the availability of credit, correct?

That is correct. These -- back pre-2006, we were averaging double-digit closings per community per month. And if credit scores ease, minimum requirements went down. No question it would benefit LGI. Just like tightening is going to make it more challenging.

Our next question comes from Michael Rehaut of JPMorgan.

It's Will, again. I just had a quick housekeeping question. Can you tell us what your cancellation rate was as well as what the orders were for the quarter?

Sure. Yes, cancellation rate was 29%. And what was the second part of your question, orders?

Orders, yes.

Yes. So net orders were 619.

And our next question comes from Nishu Sood from Deutsche Bank.

It's Rob Hansen again. One quick question I had was on the closings in April, I just wanted to ask about the placement of Easter in April this year. Did that have a material impact? Were you guys open on Easter Sunday? Was that maybe part of the factor in the closings down a little bit from March?

No, it wasn't a factor. We closed 191 houses in April. And yes, we were open on Easter Sunday, Rob. We're only closed 4 days for the year. We're open 361 days. We're always open on Easter. But that had no bearing on our closings. I mean, it was very positive. We had about 30 sales on Easter Sunday. So it's definitely worth being open that day.

And there are no further questions. I'd like to turn it back to Sir Eric Lipar for closing remarks.

Thank you, Eric. I want to thank, everyone, for joining us here today. We look forward to sharing our success as 2014 unfolds.

Ladies and gentlemen, that concludes today's conference. Thank you for your attendance. You may now disconnect. Everyone, have a great day.