LGI Homes, Inc. (LGIH) Q4 2014 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. Welcome to the LGI Homes Fourth Quarter and Year End Earnings 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 fourth quarter and full year 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 our IPO. Please refer to the unaudited pro forma statements of operations included in today's earnings release and our annual report on Form 10-K for the fiscal year ended December 31, 2014. 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 annual report on Form 10-K for 2014 which we expect to file with the SEC later today. This filing will be accessible on the SEC’s website and in our Investors section of our website at www.lgihomes.com. Joining me today are Eric Lipar, LGI Homes' 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 are joining us today and are very pleased to share our fourth quarter and full year results for 2014. On the call this morning, I will summarize the highlights from the fourth quarter and the full year. Then Charles will follow-up to 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 2015 before we open the call for questions. 2014 was momentous year for LGI Homes. It marked the completion of our first year as a public company and at this time I’d like to thank the team here at LGI Homes for your hard work and intense focus which helped us achieve these results. I am pleased to announce that for 2014, we drew home closings by 45%, increased home sales revenues by 59%, and increased pretax net income by 88%. Some additional highlights of 2014 include our first home closings in Tucson, Albuquerque, and Fort Myers, Florida. In addition, we entered the Denver, Colorado market with the LGI Homes brand and we acquired a homebuilder in Charlotte which was our first business acquisition. We also successfully accessed the capital markets to provide growth capital and we launched our new move-up brand, Terrata Homes. Our 2014 results were in line with our guidance to the market which we increased midway during the year. We committed to deliver 2,300 home closings and the year with 37 active communities and generate basic earnings per share in the range of $1.30 to $1.38. We are extremely proud that we ended the year achieving all of these goals. We ended the year with 2,356 home closings which represented a 45.7% increase over 1,617 homes closed in the previous year. This marched the fourth consecutive year that LGI has grown closings by more than 40%. We also ended the year with 39 active communities. This includes five additional communities in the Southeast division, four added in the Southwest, three added in Florida, and two additional communities in Texas. And lastly, we brought 2014 to a close with net income of $28.2 million or basic earnings per share of $1.37. In December, we closed 246 homes setting an all-time record for closings during a single month. This resulted in 652 homes closed during the fourth quarter of 2014, an increase of 29% over the same quarter in the previous year. We believe that our disciplined commitment to our systems including our customer centric sales process has enabled us to grow our top line. In addition, our focus on production building based upon including standardized features in all of our homes and building in affordable locations has enabled us to maintain our higher absorption rates as well as adjusted gross margin during 2014 within our target range of 27% to 29% which is at the high end of the range of adjusted gross margins reported by our homebuilding peers. These recording setting results were our first full year as a public company demonstrates our ability to execute on our growth plan and continue our trend of strong results and profitability that we have experienced since we began operations in 2003. Looking now at our division results, our operating strategy includes our goal to fully develop each of our four markets and to establish our presence in each of the key traffic corridors within the market. Texas continues to be our leading division because of its established presence and experienced sales and construction teams. During 2014, we had 1,575 home closings across our Texas markets compared to 1,358 in 2013, a 16% year-over-year increase. During 2014, we have continued to focus on our growth outside of Texas which has benefited us by diversifying our revenues. During the fourth quarter of 2014, approximately 42% of our total home closings were outside of Texas, up from just under 20% at the end of 2013. At December 31, 2014, we had 20 active selling communities in the five states outside of Texas. This includes two active selling communities from our acquisition of Oakmont Home Builders and its affiliate in Charlotte, North Carolina completed in October 2014 which provided us with an immediate foothold in this new market. Our operating models made effective respect to home sales in any geography and at various price points. We are continuing to prove this out. This past year, we began to further diversify our product mix and expand our range of price points with the introduction of our move-up brand, Terrata Homes. With this new brand, we include luxurious interior and exterior upgrades as a standard in every home. No matter the pure play in our community every Terrata Homes include stainless steel kitchen appliances, a covered outdoor kitchen, soaring ceilings and stateside lots. Leveraging our world-class sales system which has been perfected over the last 20 years, we launched Terrata Homes this past November in the gated community of Potranco Ranch San Antonio delivering move-in ready homes starting at $350,000. We ended the quarter with a portfolio of just under 20,000 lots that we own or control, of which approximately 7,200 are finished lots. We believe our lot inventory represents three year to five years of supply in our markets. We remain disciplined in our evaluation of our land acquisitions and expansion opportunities. As a result, we only move forward on deals that meet our underwriting criteria and our strategy. As discussed on previous calls, as we obtain the supply of readily available finished lots decline in our markets, we have been able to adjust to a development strategy leveraging our teams land development experience. During 2014, we had over 30 communities where we performed substantial development activities through sustainer homebuilding momentum. A 11 of these communities are active selling communities at December 31, 2014. By developing their own lots, not only can we control the pace of future sections, but we also can create a development margin as well as a homebuilding margin. In addition, we are starting to see some benefit from changes in the mortgage industry. We agree with the commentary from other homebuilders that the reduction in FHA mortgage insurance premiums will have a positive effect on the entry level buyer. The 50 basis points reduction in monthly mortgage insurance will save our average customer approximately $800 a year or more importantly approximately $70 in monthly payments. Overall, we believe the market conditions we have experienced this quarter have been favorable. Each of our market continues to experience strong momentum in housing demand drivers including nationally leading population and employment growth trends, general housing affordability and desirable lifestyle characteristics. For more detailed financial results, I will now turn it over to our Chief Financial Officer, Charles Merdian.

Thanks, Eric. Home sales revenues for the quarter were $108.4 million based on 652 homes closed which represents a 40.8% increase over the fourth quarter of 2013. Our average sales price was $166,288 for the fourth quarter, an increase of 9.1%. Adjusted gross margin was 28.9% for the quarter, 60 basis points higher than the third quarter. Adjusted gross margin excludes purchase accounting included in cost of sales for the quarter of $1.2 million, of which approximately $700,000 was related to the Oakmont acquisition and approximately $500,000 was from the GTIS acquisitions. In addition, adjusted gross margin excludes approximately $600,000 of capitalized interest charged to cost of sales during the quarter. Selling expenses were $10.9 million or 10% of home sales revenues, which is comparable with the third quarter of 2014. Selling expenses in the fourth quarter includes approximately $300,000 related to a higher percentage of outside broker commissions on home closings from the acquired Oakmont backlog. General and administrative expenses were $7.2 million in the fourth quarter or 6.6% of home sales revenues and included approximately $700,000 or approximately 60 basis points of legal, due diligence and other related acquisition cost attributable to the Oakmont acquisition. Pretax income for the quarter was $11.6 million or 10.7% of home sales revenue, an increase of 620 basis points over the same quarter in 2013. We had net income of $7.5 million or 6.9% of home sales revenue for the fourth quarter, which represents $0.37 per basic share. Fourth quarter net orders were 562 including contract assumed from the Oakmont homebuilders. Ending backlog for December was 152 units and the cancellation rate for the fourth quarter was 30.1%. Moving on to full year 2014 results, home sales revenue for the year increased 59.1% over the prior year to $383.3 million. We closed 2,356 homes as compared to 1,617 homes closed in the prior year. Increased average home sales prices have contributed to our strong revenue performance. Our average sales price was $162,677 for the year and represents a 9.2% increase over the previous year. This increase reflects price increases and communities that we added during the year which have higher price points, offset by an average sales price of approximately $141,000 for home sales attributable to the Oakmont acquisition. Sale prices realized from homes closed during 2014 range from 110 to 250s. Gross margin was 26.8% for 2014 compared to 25.4% for the prior year. Our 2014 adjusted gross margin was 28.2% and reflects $3.6 million of purchase accounting adjustments and $1.7 million of capitalized interest charged to cost of sales. The 2014 adjusted gross margin reflects an improvement of 90 basis points over the prior year primarily attributable to a decrease in purchase accounting charges as a percent of sales in 2014. Selling, general and administrative expenses were 15.8% in 2014 compared to 15.9% for the prior year. We believe that SG&A expense as a percentage of revenue for the full year of 2015 will normalize between 14.5% and 15.5%, and we expect the first half of the year to be higher decreasing as we increase the top line throughout the year. Pretax income of $43.1 million or 11.2% of home sales revenue was 170 basis points higher than the prior year. Net income was $28.2 million or 7.4% of revenues and $1.37 per basic share. As of December 31, we had $31.4 million in cash, $368 million of real estate inventory and total assets of $438 million. In November of 2014, we issued $85 million of our 4.25% convertible notes due in 2019 which under the terms of convertible into approximately 3.95 million shares of our common stock under certain circumstances. Our financial statements include $76.5 million which is a fair value of the notes at the date of issuance and $5.5 million of the remaining proceeds has been recorded to additional training capital to reflect the equity component of the convertible notes. $3 million has been recorded as the deferred tax liability. We will be accreting the notes to the face value over the term based on a rate of 6.63%. As issued, the conversion of the notes may only be settled in shares of our common stock. However, under the terms of the convertible notes, it’s the flexible settlement feature included in the notes is approved by our stock holders. We will have the option to settle the conversions in cash, shares of our common stock or through any combination thereof at our election. This proposal is expected to be included for vote at our upcoming 2015 annual shareholder meeting. Diluted earnings per share for the fourth quarter and the year reflect the effect of the convertible notes using the if converted method from the date of issuance. The underlying shares of approximately 3.95 million will be treated as dilutive until we obtain stockholder approval for the flexible settlement of the notes. And upon receipt of stockholder approval, the company may be able to use the treasury stock method for determining the impact of the conversion feature of the convertible notes on EPS. A portion of the proceeds from the convertible notes were used to reduce the amount outstanding under our secured credit facility. The outstanding debt on our secured bank facility was approximately $139 million resulting in approximately $216 million of total debt at December 31. Our gross debt to cap was 54% and net debt to cap of 50% at the end of the year. Concurrent with the issuance of the notes, we utilized approximately $15.6 million of the net proceeds to repurchase 1 million shares of our common stock which we have reported as treasury stock. Accordingly at December 31, 2014, we have 19.8 million common shares outstanding and total equity of $182.5 million. At this point, I’d like to turn it back over to Eric.

Thanks, Charles. In summary, we had an outstanding quarter to end to our first full year as a public company. Let me provide some guidance and thoughts on what we are seeing for this quarter and looking ahead into the remainder of 2015. We have started this quarter strong with 153 closings in January, up from 119 closings in January of 2014, representing a year-over-year growth of 28.6%. We closed 220 homes in February, up from 156 home closings in February of 2014, representing year-over-year growth of 41%. Sales have been strong during this first quarter and we continue to see the demand for homeownership remain high. Home closings in Texas continue to be very solid and important to us despite some concerns expressed regarding the impacts of the oil and gas sector on the Texas and Houston economies. Through the first two months of the year, our average closings per community in Houston have increased. We average 6.8 closings in our eight communities in January and February of 2015 as compared to 6.1 closings per community for January and February of 2014. Company-wide, we expect March will continue the momentum. We are expecting to close more homes this month than we did in February. At the end of February, we had 42 active selling communities. We expect to continue to grow our community count to between 50 and 55 by year end. We are also seeing our average sales price continue to rise in the first few months of the year. In addition to seeing favorable pricing power in our entry level communities, we have experienced a great start with our Terrata Homes community in San Antonio and the expansion of our LGI Homes brand into Denver. Year-to-date we have closed six homes in our first Terrata Homes community with an average sales price of approximately $400,000 and closed 8 homes in our first Denver community with an average sales price above $270,000. Based on this early momentum, we expect to see our average sales price in 2015 increase by as much as 12% over 2014. In addition, we expect our 2015 adjusted gross margins to be relatively consistent with what we experienced in 2014. Our adjusted gross margin after taking into account purchase accounting, interest cost and other non-recurring type items is expected to be in our target range of 27% to 29%. Based on these assumptions including 2,800 to 3,200 expected home closings, a likely increase in average sales price, consistent adjusted gross margins and expected improvement in our G&A leverage, we believe our basic earnings per share will be in the range of $1.85 to $2.25 this year. The midpoint of our EPS guidance will be $2.05 per share representing basic EPS growth of approximately 50% over 2014. Now, we will be happy to take any questions you may have.

Thank you. [Operator Instructions] Our first question comes from the line of Michael Rehaut from JPMorgan.

Thanks. Good morning, everyone. And thanks for the detailed guidance. I appreciate it. Congrats on the year and the momentum in the first quarter.

Thank you.

I guess in the never ending quest for more numbers other than the generous ones, the amount that you’ve given already, just to further understand the guidance for 2015, I was hoping Charles if you could give your expectations for the tax rate as well as for the convert which I guess would be about 3.6 million of interest for the year. If that would be in interest amortization, COGS or would it run through the interest expense line and what you think overall for the interest amortization number.

Sure. So starting with Texas, we ended the year approximately around 34.5%. We think we will be in that range, 34.5% to 35%. As far as interest and its impact, we’ve been running around 50 basis points historically and interest expense coming through the income statement. So we see that pushing up into around the 100 basis points up to 125 basis points incrementally throughout 2015.

So when you give the 27% to 29% is that before that interest expense.

Correct. That’s on adjusted gross margin basis, yes.

Okay. Alright, so that’s helpful. I think that kind of puts because if you are looking at, you said ASPs up around 12% in the midpoint of closings, 100 bips to 125 bips would put you around $6.5 million of interest amortization and that I guess you could work off at 2014 of 1.7, another 3.5 and then may be drifting up as you draw on revolvers and such.

Yeah, that’s in the range.

Okay, great. And then I was also hoping it was a good point that was discussed around the fact that your business outside of Texas continues to grow disproportionately and so hence while Texas remained strong, you are diversifying your geographic exposure. So 4Q got to 42% outside of Texas. Do you have any type of expectation or can you share with us of the closings range for ’15, would that 42% drift upwards to pass around 50% and how could you see that going over the next two to three years.

Yeah, for next year, we are forecasting roughly 50% of our closings coming from Texas, Mike. This is Eric speaking. And I think that’s going to continue to trend down as a percentage of overall closings over the next few years. Now I think that this will continue to be our strongest market and Houston will continue to be our strongest market. And there is no other market in United States I’d rather be right now than Houston, Texas but as a percentage it is certainly trending down.

Okay, great. Thanks so much.

You are welcome.

Thank you. Our next question comes from the line of Nishu Sood from Deutsche Bank.

Hi, guys. This is Rob Hansen on for Nishu. So I guess I just wanted to ask Mike’s question a little differently in terms of your Texas exposure right. So now on a community basis, it’s around 50%. I guess when you think about your community count growth like how much is going be coming from Texas, so at the end of next year right should it be more like 40% of your communities are in Texas, how that kind of look?

Yeah, our community count growth will be primarily outside of Texas, Rob. Oil-and-gas, 75% to 80% of our community count growth is going to be outside of the State of Texas in 2015, that would be a pretty accurate number.

Got it, okay. And then just on the – I appreciate all the guidance. When you set your original closings guidance right, that was beginning of this year we already have seen a pretty large impact from oil, right. So in terms of the price of oil declining a lot right, so how much was that a factor when you came up with 2,800 to 3,200 closings?

It wasn’t a factor in our mind. We are forecasting basically closings per community being flat especially at similar price points, no matter what the market is across the United States and then running that projection through our community account, so that’s how we came up with our closing numbers. But we haven’t changed our closing numbers for 2015 based on oil either positively or negatively. We’ve seen the demand of renters that are looking to move into home ownership. We’ve seen that demand remain strong in our opinion since we started doing this in 2003 and no matter what type of event over the last 11 years including 2008 and 2009. There seems to be always people as a percentage because there are so many renters in the Houston market. They’re always looking to take that next step in the homeownership.

And will you think about your conversion rates right in terms of the tracking of the data, sending our suppliers in the calls, has that improved over the last year-over-year, is that still improving, how does that kind of look?

It depends on a community. I would say it has been as strong as it’s always been if we are amortizing the same price point. As we get into more expensive homes and continue to raise prices of our entry level communities, the demand goes down but the quality of the buyer goes up. So it’s very similar demand as it’s always been. I can’t reiterate enough that the oil prices being low has not had a negative impact on our business certainly our customers in our entry level communities outside of Texas. Most of our communities are 30 miles to 50 miles from downtown Houston. They tend to be a little bit further out. Most of our customers when they go from a rental situation into home ownership, almost all of them are going to increase their commute to work and that lower gas price is very beneficial to our customers.

Alright, great. Well, that’s all I had for now. Thanks for the time.

Alright. Thanks, Bob.

Thank you. [Operator Instructions] Our next question comes from the line of Brendan Lynch from Sidoti.

Good morning guys. Thanks for taking my questions.

No problem. Good morning.

Eric, my first one is on your geographic expansion and as you are implementing your very differentiated and specific sales process, how personally involved are you in establishing the new sales offices and do you feel that you can effectively delegate that responsibility as the company continues to expand.

Great question, Brendan. I am very involved along with our President and Chief Operating Officer, Mike Snider. And we think that we can continue to expand the LGI brand and LGI processes across the country because we have a process. We have a very structured sales process, no matter if we are opening up Orlando, Florida or Tucson, Arizona. We have a national sales training that we put everyone through, we got national sales manuals, every person we hire comes to Texas for training. All of the Vice Presidents come to Texas or we get together with all of them at least once a quarter for training. Mike Snider or I have been in every market of the United States in the last 30 days and we do that every 30 days. So I think we take a very hands-on approach relative to our homebuilding peers and really emphasize the LGI way and make sure that’s operating in consistent manner across the country.

Great. That’s very helpful. And maybe just a quantitative approach that same issue, could you give us some color on your absorption pace at your various geographic locations and how it compares to how you have historically done in Texas?

Yes. I think Charles can give you some exact numbers, but I can say Texas is our strongest area. It’s got the highest absorption pace. The newer markets are less in Texas, most of them are in the three to four month range and we expect that to improve as our people get more experienced, as our managers get more experienced and as we get more of a presence in each one of our markets.

That’s great, that’s helpful. And then another question, I appreciate the detail on Terrata. Can you just give us a little more color on how the demand for the new product line has been? I know it’s active in San Antonio now, but where and when the product line will be expanded next?

Yes, great question. The demand has been strong. We like San Antonio as a market. We also obtain strong demand from the standpoint of having that $400,000 finished. I know we’ve already sold a few people that were transferring in to San Antonio and they wanted immediate homeownership and something that was complete in that price range. So that gives us a competitive advantage. Overall, Brendan, Terrata homes and that price points can be a small percentage of our closings. We don’t anticipate having another community outside of San Antonio open until the second half of the year. So we won’t have a huge impact on closings, but we certainly think it’s accretive. We’re going to open one in Charlotte in the second half of the year and then we’ll have a small section in one of our new communities in Houston that will have the Terrata Homes as a small section of a larger master plan which will also have our entry level product in it.

Great. And if I can sneak one more in, the increased delivery pace in Houston in the first two months is certainly encouraging given all the concerns about sitting in [ph] the market. Can you comment on the gross margin comparison year-over-year in January and February?

I don’t have those numbers in front of us. We can do a follow-up call on that, but I know they will be very similar, Brendan, to what they were last year.

Okay, very good. Thank you.

Yeah. You’re welcome.

Thank you. And our next question comes from the line of Barry Haimes from Sage Asset Management.

Thank you. Great quarter guys. Two questions, one is of the 39 communities at year end, how many were Texas, non-Texas and then of the 50 to 55 you anticipate at the end of ’15 what would that split look like? And then also – are there any new markets that you will be entering in 2015? Thank you.

At the end of 2014, Barry, we had 20 outside of Texas and 19 communities inside of Texas, so really a 50/50 split. We give community count guidance of 50 to 55 for 2015 and 70% to 80% of those communities will be outside of the Texas. As far as new markets go, I would say we are looking at new markets all the time especially those markets that are close to where we are doing business now like Jacksonville, Florida; Raleigh-Durham, North Carolina; Colorado Springs, those type of markets. And we will grow into those markets and other markets across the country as we have the people in place and as we are ready to handle it from a grow standpoint. So we are open minded to just about every market of size in the country and we think our process will work in every market of size anywhere in the country.

Great. Thanks very much.

You’re welcome.

Thank you. And we have a follow-up from the line of Michael Rehaut from JPMorgan.

Thanks. Just wanted to clarify Eric on your previous statement about 50 to 55 communities by ’15 and you said 75% to 80% of those outside of Texas. That’s just – the delta between 39 and 50 to 55, correct?

Yeah, that is correct. Yeah, I could have made it more clear on that Michael, that’s correct.

Okay. You answered that before I just wanted to – just to have that on record to make sure. And then also the gross margin in ’14 pre-interest you came in at 27.3%, but more or like 28X, some of the step up charges and the purchase accounting. In the most recent quarter, you are actually closer to the 28% reported in 29% without the charges. The midpoint, you’re getting a pretty strong gross margin even with some of those purchase and step-up charges, I would assume that it seems like you’re saying that you are being able to hit that midpoint of that range even with some of those purchase accounting and other types of charges. Is that a fair way to think about it and if those fade overtime could you see that gross margin get closer to the higher end or as part of this mix as well.

Yes. So this is Charles. I would say, so the adjusted gross margin guidance in that 27% to 29% put 28% at the midpoint. We had talked about the impact of [indiscernible] interest moving from 50 basis points up to 100 basis points or 125 basis points throughout the year. On the purchase accounting side, we have roughly about $3.1 million total of step up to bring in through the income statement, roughly about $1.4 million of that is related to GTIS acquisitions from 2013, and the balance related to Oakmont. So we see from a absolute dollar basis, we see the majority of that coming in through this year, which puts the purchase accounting adjustments somewhere in the 40 basis point to 50 plus basis point range for the year so that backing those out is how you would get back to the gross margin.

Okay. So the 27 to 29 excludes both the interest and those 40 to 50 bips?

That’s correct.

Okay. Fair enough. Thanks.

Yeah, you bet.

Thank you.

Thank you. And that concludes our question-and-answer session for today. I would like to turn the conference back over to Eric Lipar for closing comments.

Thank you and thanks everyone for listening in and also to end the call in a positive note. I like to congratulate everyone at LGI Homes and all of our customers. Yesterday afternoon, LGI Homes closed at 9,000 home in company history, so congratulations everybody.

Thank you. Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may now disconnect. Everyone, have a good day.