LGI Homes, Inc. (LGIH) Q2 2015 Earnings Report, Transcript and Summary

Good morning and welcome to the LGI Homes Second Quarter 2015 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 would like turn the call over to Rachel Eaton, Chief Marketing Officer at LGI Homes. Ms. Eaton, you may begin.

Thank you. Hello and welcome to the LGI Homes conference call discussing our results for the second quarter of 2015. Today's conference call will contain forward-looking statements that include among other things, statements regarding LGI's business strategy, outlook, plans, objectives and updated guidance for 2015 home closings and basic earnings per share. 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 and cautionary statements about forward-looking statements for a discussion of the risks, uncertainties and other factors that could cause our actual results to differ materially from those anticipated. 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. Additionally, certain non-GAAP financial measures will be discussed. 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 second quarter of 2015 that we expect to file with the SEC later today. This filing will be accessible on the SEC’s website and in the 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 hello everyone. We appreciate you joining us today. At LGI Homes, we have had an exceptional first half of the year. During our call, I’ll discuss highlights from our second quarter and 2015 year-to-date. Then Charles with follow-up to discuss our financial results in more detail. After he is done, I will conclude with comments on how the third quarter is unfolding and our expectations for the remainder of 2015 and then we will open the call for questions. LGI Homes delivered outstanding results with another record setting quarter for closings and revenue, paving the way for 2015 to be another year of solid growth and performance. We set a new quarterly record with 853 homes closed and $158.8 million of homes sales revenue which represents a 29% increase in closings and 49% increase in revenue over the second quarter of 2014. Contributing to this record breaking quarter was an all-time record for home closings during a single month with 331 closings in June of 2015. We finished the first six months of the year with a total of 1,524 homes closed, which represents 33% increase over the first six months of 2014. For the quarter, our average sales price reached a new high at $186,200. We ended the quarter with 45 active communities, which is an increase of 14 communities or 45% over the second quarter of 2014. Looking now at some of our market highlights. We are excited to announce that we moved in our 10,000th LGI family during the second quarter. This home closing milestone occurred at our Trails at Seabourne Parke community, one of our top performing projects in the Houston market. Overall, our presence in Texas is very strong and that’s our leading division representing approximately 57% of our closings. During the second quarter, we had 488 closings across the state; this is a 5% increase over [ph] 465 homes closed in Texas during the second quarter of 2014. The Houston market in particular remained strong. Four of our top five communities in the Company this past quarter were located in Houston. With eight active selling communities; we closed 238 homes during the second quarter and absorption rate of approximately ten closings per community per month. In addition, our average sales price in Houston was $180,700 for the second quarter of 2015. This represents more than a $27,000 increase in average sales price year-over-year. We have continued to diversify our geographic footprint during the second quarter of 2015. A total of 43% of our second quarter closings were generated outside of Texas, of which, 17% of the closings were in our Southwest division, 14% in our Southeast division and 12% in our Florida division. This represents 85% increase in the home closings outside of our home state of Texas over the same quarter in the prior year. Demand for homeownership remained high throughout the second quarter. We received over 54,000 leads during the second quarter from potential customers enquiring about homeownership. This represents an average of 100 leads per community per week. We consistently saw strong and steady traffic, with some of our information centers experiencing standing room only on the weekends. Our unique and highly successful marketing fuels our world-class sales systems. For the quarter, we averaged 6.4 closings per community, per month companywide. On closings per community per month basis, we closed an average of 4.8 in our Southwest division, 5.6 in Florida, 5.9 in our Southeast division and 7.6 in Texas. Our divisional results demonstrate the strength of our system to produce above average absorption rates in existing and new markets. Our diversification outside of Texas has been effective at generating strong margins as well as strong absorption rates. Every division in LGI reported adjusted gross margins, north of 25% for the second quarter. Our systems and processes have enabled us to generate momentum quickly and replicate our success, meeting our profitability objectives for these new markets. Maintaining our culture as we grow is important to us. This strategy is supported by our trading philosophy. Each of our new home consultants and management across every division is emerged in our culture through our in-depth in-house 100-day training program, which has enabled us to continue to prove our ability to expand the LGI brand, leverage our systems and maintain our focus on a great customer experience. Charlotte and Denver are two new markets added in the last 12 months. Both of these markets have demonstrated great momentum, becoming two of our top producing markets outside of Texas this past quarter. We closed 60 homes in Charlotte this quarter. Our two Denver communities are off to a fast start. Between Legacy Park and Bella Vista, we closed 47 entry-level homes during the second quarter with an average sales price of approximately $262,700 at an average of 1800 square feet. Overall, the market conditions experienced this quarter have been favorable. Each of our markets has continued to experience strong demand for homeownership, including nationally leading population and employment growth trends and general housing affordability. 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 $158.8 million, based on 853 homes closed, which represented a 49.3% increase over the second quarter of 2014. Our average sales price was $186,200 for the second quarter, a 15.8% year-over-year increase. Increased average home sale prices have contributed to our strong revenue performance. Average sales prices have increased in each of our divisions and companywide, we realized a 3.5% increase compared to the previous quarter. This increase in average sales price reflects changes in product mix, a favorable pricing environment and new or replacement communities, added during 2014 and the first six months of 2015 that have higher price points. Sales prices realized from homes closed during the second quarter of 2015 range from the low 100s to the 440s. This includes the closings of seven Toronto brand homes during the second quarter, which had an average net sales price of approximately $410,000. Excluding Toronto homes, we experienced a second quarter year-over-year price appreciation of 14.7%. Adjusted gross margin was 28.2% for the quarter, 30 basis points higher than the second quarter of 2014. Adjusted gross margin excludes $760,000 of purchase accounting included in cost of sales for the quarter, of which approximately $310,000 was related to Oakmont acquisition and approximately $450,000 was from the GTIS Acquisitions. On the balance sheet, we have approximately $1.3 million of step up remaining, primarily on land and land under development, which we expect to come through the income statement gradually over the next couple of years. In addition, adjusted gross margin excludes approximately $1.5 million of capitalized interest charged to cost of sales during the quarter, representing 94 basis points and we expect this to range between 90 to 125 basis points over the remainder of the year. Our financial gross margin for the quarter was 26.8%, a 10 basis point increase over the 26.7% gross margin reported in the second quarter of last year. Selling expenses were $13.4 million or 8.4% of home sales revenue, compared to $9.2 million or 8.6% of home sales revenue for the second quarter of 2014, a 20 basis point improvement. Selling expenses, as a percentage of home sales revenue, improved 120 basis points from the previous quarter. General and administrative expenses were 5% of home sales revenue for both the second quarter of 2015 and 2014. General and administrative expenses, as a percentage of revenues, decreased by 180 basis points from the first quarter of this year. SG&A for the second quarter was 13.4% of revenues and for the six months ended June 30, it was 14.7% of revenues. We believe we will continue to see the benefits of SG&A leverage through the rest of 2015. As a percentage of revenues, we believe that SG&A will be between 13% and 14.5% in the third and fourth quarters of this year. Pre-tax income for the quarter was $21.2 million or 13.4% of home sales revenue, an increase of 30 basis points over the same quarter in 2014 and 370 basis points over the first quarter of this year. We had net income of $14 million or 8.8% of home sales revenue for the second quarter of 2014, which represents earnings per share of $0.70 per basic share and $0.66 per diluted share. Second quarter net orders were 1187, ending backlog for June was 783 units and the cancellation rate for the second quarter was 24.2%. We ended the quarter with a portfolio of approximately 22,200 owned and controlled lots. We believe our lot inventory generally represents 3 to 5 years of supply in our current markets and 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 strict underwriting criteria and enable us to position the people and implement the processes to execute our systems-based strategy. At June 30, 2015, approximately 10,950 of our 16,400 owned lots are either raw or under development. As of June 30, we had approximately $50 [ph] million in cash, $407 million of real estate inventory and total assets of $503 million. In November 2014, we had issued $85 million of our 4.25% convertible notes due in 2019. At our annual stockholders' meeting in April, our stockholders approved the flexible settlement provisions of the convertible notes, which enables us to choose whether we will settle the conversion of notes with cash, shares of our common stock or any combination of cash and stock. Diluted earnings per share for the second quarter reflects the impact of the convertible notes using the, if converted method for the month of April and the underlying 3.95 million shares were treated as dilutive. Subsequent to April, the treasury stock method has been used to calculate the dilutive effect of the convertible notes. And under the treasury stock method, the convertible notes will not be dilutive unless the market price exceeds the $21.52 per share conversion price of our common stock. In May of 2015, we entered into a credit agreement with several financial institutions led by Wells Fargo Bank. The credit agreement provides for the $225 million revolving credit facility, which can be increased to $300 million subject to the terms and conditions of the agreement. The revolving credit facility matures in 2018 and is unsecured with the exception of a first priority lean in land with an aggregate minimum value of $35 million. As of June 30, $162.5 million was outstanding and $58.8 million was available to borrow. Interest under the credit agreement is LIBOR plus 350 and our previous secured credit facility was repaid in full with funds from this new facility. In July, we filed a universal shelf registration statement for up to $300 million of certain types of securities. Once effective, this shelf is expected to provide us with flexibility for addressing our future capital needs. At June 30, our gross debt to capitalization was approximately 54% and net debt to capitalization was 48%. With this point, I’d like to turn it back over to Eric.

Thanks, Charles. In summary, we had another impressive quarter. Let me provide some guidance and thoughts on what we are seeing for this quarter and looking ahead into the remainder of 2015. The third quarter is off to a strong start with 311 closings, up from 174 closings in July of 2014, which is a 79% year-over-year increase. As we are looking back at July of 2014, we reflected back on how far we have come in the last five years. In July of 2010, we closed 18 homes and five communities compared to 311 homes closed this year in 49 communities. As previously discussed home closings were strong in Texas during the first half of 2015 and have continued to be solid thus far in the third quarter. Our performance has now been impacted negatively by the weak oil and gas sector in the Texas and Houston economies or the weather during the May and June. In fact, July absorption in Houston was very strong averaging 9 closings per community with 72 closings spread throughout our 8 active communities. We increased our community count by 4 in July, bringing our total active community count to 49. The 6.3 closings per community in July compared very favorable to the 5.3 closings per community in July of 2014. We are still expecting to end 2015 with between 50 and 55 active communities. In early July, we are able to dramatically increase our land position in the Denver, Colorado market. We acquired approximately 400 lots including finished lots in undeveloped land from Jack Fisher Homes. On previous calls, we mentioned our plan to expand into the Seattle, Nashville, Jacksonville and Raleigh-Durham markets. Our expansion into Seattle is underway. We plan to close the acquisition of our first project in August and start construction in the fourth quarter. We have been working on our first acquisition in the Nashville market and plan on acquiring our first project before the end of the year. Our first project in Jacksonville is now closed and construction of our sales office has begun. We plan on opening sales by the end of the year and moving our first customers into their new homes in the first quarter of 2016. We are fortunate that in all three markets, Seattle, Nashville, and Jacksonville, we are relocating existing LGI management to oversee sales. We believe this will help to ensure a fast starts in these new markets. We also have a contract for our first Raleigh project, which we intend to open in mid-2016 and manage as an extension of our Charlotte operations. In addition to the previously mentioned markets, we have also made progress with our expansion into Colorado Springs. We have our first project under contract and expect to start construction near the end of this year. Because we are a systems-based company and have processes in place, we believe our expansions into these new markets are well-positioned for success. Our goal is to simply duplicate what we have accomplished thus far in our current markets. Our expectation is that each of these markets will perform at a high level and produce results consistent with our existing community. Looking ahead to the rest of the year, we offer the following items. We have committed to deliver 2,800 to 3,200 home closings for the year. Based on our solid start to the third quarter and the success we have seen during the first half of 2015, we are raising our home closing guidance. Assuming a continuation of today’s housing market conditions for the remainder of this year, we now expect to close between 3,000 and 3,300 homes in 2015. We saw a slight increase in average sales price over this past quarter. We believe our average sales price in the third and fourth quarter will be relatively flat and consistent with the second quarter. Based on our pipeline in the communities we are opening, we anticipate in both the third and fourth quarter that our average sales price will be between $185,000 and $190,000. We expect our adjusted gross margin, which excludes the effects of interest and purchase accounting to be similar to the first half of the year and believe it will be – it will continue to be in our target range of 27% to 29% of home sales revenue. In previous quarters, we indicated our basic earnings per share for 2015 was expected to be in the range of $1.85 to $2.25. Due to increased guidance of delivering 3,000 to 3,300 home closings, consistent average sales price, consistent cost and adjusted gross margins and SG&A leverage, we believe our basic earnings per share for the full year 2015 will be in the range of $2.15 to $2.50. The midpoint of our EPS guidance of $2.32 per share represents basic EPS growth of approximately 75% over 2014. We are very pleased with our results this quarter and I’ll like to thank all of our employees for their dedication and talent to produce these notable results. Now, we’ll be happy to take your questions.

Thank you. [Operator Instructions] Our first question comes from Nishu Sood of Deutsche Bank. Your line is now open.

Thanks and terrific quarter and July news guys.

Thanks.

Thanks.

So, I think what is probably most surprising about your results is that from the vast majority of builders, investors have been hearing about inability to get homes started, even having to curtail releases and sales and particularly just the backup on the trade side of things. So, I guess my first question is you folks are more exposed to Texas and you’re average builder and with the spec-based model, more exposed to construction schedules as well. So, my first question is, how have you been managing through that, why isn’t that showing up in your results? You’re actually taking up your closings guidance on the terrific pace in the last month or two. So, if you can just shed some light on that and whether there are any implications for the remainder of the year that would be very helpful.

Yeah. Nishu, this is Eric, I’ll comment on that and Charles can add to if he like to, but from getting the houses complete, the strength of the sales is really made up for any challenges we’ve had in that area. Our closings would have actually been better if we could have built the houses faster. Now, that being said, I do think LGI has an advantage on finding trade partners and finding the subcontractors to build their houses, because in our experience, the trade partners are looking for consistent work and with our spec approach and our absorption rates of consistently being in that five, six closings a month, that means we can give the subs on average five to six, seven starts per month and they like that consistency of having work. Also, LGI since 2003, we have never and not paid a trade partner. We never negotiated on their terms. We paid consistently on every two weeks when the work is complete. So, I do think we have an advantage when it comes to working with subcontractors.

Got it. Now, that’s helpful. And it doesn’t sound like it from your gross margin guidance, but it doesn’t sound like there would be any potential pricing pressure from the trades constraint that is being seen in some of the key Texas markets?

That is correct.

Okay, got it. And my second question I wanted to ask was the -- I think after last month, you mentioned that June was a big -- I think was a record closings month for you folks and you may have ended June with a little bit less inventory in the ground because of the strong sales base, but July looks like there was really strong as well and you mentioned it might have even been stronger. So, can you just walk us through that a little bit? I mean, July was very strong on a year-over-year basis. Didn’t show any let down from the lack of inventory. So, it really almost seem like you saw an acceleration in demand. So, any color on that would be helpful as well.

Yeah. I think we just reiterated an issue that demand has been very strong. [Technical Difficulty] we closed 331 homes in June, 311 in July. July was an easier comp. So, the percentage was greater on our increase. And in August of last year, we only closed 183. So, it’s going to be a very strong comp in August again this year. But like we said, and the reason we increased our guidance is sales, demand, everything has been very strong and we see that continuing through the end of the year.

Got it. Just a real quick clarification question. Charles, you said, for SG&A that would be 13% to 14.5%. Is that for the entire year, because last time you talked about the entire year being 14.5% or 15.5%, or is it just the second half?

Right, that’s just each quarter on the second half. So, that would put the year somewhere down in just south of 14% to just north of 14% for the year.

Great. Thanks for the color guys.

You bet.

Thank you. Our next question comes from Michael Rehaut of JPMorgan. Your line is now open.

Thanks. Good morning everyone and nice results.

Thank you.

First question, I just wanted to make sure I fully understood in terms of the raised guidance. It appears that given that you reiterated the community count outlook that the raised closings obviously more driven by better sales per month or closings per month outlook and that that’s really also what’s flowing through and resulting in the raised EPS guidance. Is that the right way to think of it that there is no other drivers at work?

Yeah, that’s how we’re thinking about it and we got a very good visibility on the pipeline for 2015. So, we just get them built and close to finish the year strong.

Right. And so, no real change obviously then from an EPS perspective in terms of the gross margin or SG&A outlook?

Now, the ranges are still consistent. I mean, we’re seeing consistent gross margins. I think we’re seeing some performance. Eric had mentioned in his comments about the performance out of state. So, I think we’re getting some depth in those newer markets. We’re starting to realize some of that performance in our closings per community.

Okay. So then, that kind of drives me to the second line of questioning. In terms of the improved closings per community, I guess, you started to say in terms of the delta of closings, is it -- we’re talking about better performance or better than expected performance in the non-Texas communities or a bit of both and if we can get more granular perhaps in terms of if outside of Texas if that’s the driver, what’s coming along faster than expected?

This is Eric, Mike. Definitely the increased absorption is getting the out-of-state markets up to speed and that’s what we expected and Texas remaining strong, but the increased absorption pace has really come from Texas or excuse me outside of Texas and we pointed out Charlotte and Denver because we averaged now 10 closings per month per community in the Charlotte market in the second quarter and a very solid absorption rate of about six in the Denver market. So those two markets really stood out as driving the overall absorption rate.

And I guess longer term when you think about the non-Texas markets, is there anything then to think that aside from perhaps ASP driven mix related issues that you shouldn’t be able to continue to bridge the gap between Texas and non-Texas?

I think that will continue to bridge the gap as we get more experience in our communities that we are in now. So Charlotte, Denver, Albuquerque, Phoenix, the Florida markets, they should continue to improve with everything else being equal. And then we will add the new markets of Seattle and Raleigh and Colorado Springs. In those markets, we are modeling a little bit more conservative and then they would ramp up into full production, if you will.

Okay. Just one last one if I could. The ASP you mentioned would be similar to – in the back half would be similar to 2Q. You also said 185 to 190, so maybe the midpoint just being a hair above 2Q. In terms of thinking about ’16, given the different growth rates, the different regions and I’d assume you still pursue obviously a more aggressive expansion out of Texas. How would that affect the trajectory of ASP growth? Would it perhaps continue to moderate given the mix of geographies or maybe we get back to that more typical 1% to 2% sequential improvement that I think you talked about previously?

This is Eric again. Yeah, we saw a big drop in the second quarter in year-over-year price increases really to be added throughout our homes and got into Denver with its average sales price being higher. For 2016 we haven’t given average sales price guidance but my feel is that it’s really going to be dependent on the markets, what drives that. We are anticipating Seattle and Colorado Springs being higher priced markets, Nashville not so much. So it’s really -- I don’t want to be vague, but I would say real unclear on 2016, but the third and fourth quarter, because the pipeline we got very good visibility and that’s going to be pretty flat from average sales price standpoint.

Great. Thanks, guys.

You are welcome.

[Operator Instructions] Our next question comes from Sam Doctor of Fundstrat. Your line is now open.

Thanks and congrats on a really good quarter. I had a couple of questions that I wanted to dive into on the Southeast. Sequentially Southeast closings were down, so I just wanted to understand that a little bit more and also the ASP growth in that market was single digits year-on-year compared to mid-to-high double digits for the other markets. So I just wanted a little more color on that.

Yeah, I will take the first part on the Southeast being down. Charlotte didn’t close quite as many homes in the second quarter as the first quarter, working through the Oakmont acquisition. But certainly close to 60 in the second quarter in Charlotte is really good production. And then you have to repeat the second part of your question.

I was just wondering about the ASP mix as well, because the Southeast ASPs were up 5% year-on-year, your other markets were all up 11% to almost 20%.

Yeah, I think the other markets, the reasons vary. They are Terrata Homes in the Texas market with an average sales price above $400,000. Denver is influencing the Southwest market with their high average sales price. So Southeast meaning, Charlotte, Atlanta really didn’t have anything to propel that other than just natural price appreciation.

Okay. Another question I would have on the communities, last year, I think 36% of your new communities were in the Southeast, which is obviously in terms of new communities the largest new market for you last year. How does your land inventory look relative to the mix of sales you are getting right now? Is the absorption rate in that market comparable or are you sort of -- I am just trying to understand the sort of discrepancy between the rate of new community openings and overall closings.

Yeah, I think I would describe it to as all of our – most of our growth is going to come from out of the state of Texas. Texas is going to be very strong market for us and I think we commented during the script that over 80% of our increase in home closings came from outside of Texas. So as we are opening up new communities in the future, I mean looking at our boarding and all the deals we got coming online, we believe that trend is going to continue and most of our new community openings will be outside of the state of Texas.

Okay. Great, thank you.

Thank you.

Thank you. And at this time, I am showing there are no further questions in the queue. I would like to turn the call over to CEO and Chairman of the Board, Mr. Eric Lipar.

Thanks everyone for participating on the call and for your interest in LGI Homes. We look forward to sharing our achievements as we finish out the rest of the year. Have a great day.

Ladies and gentlemen, thank you for your participation on today’s conference. This concludes your program. You may now disconnect. Everyone have a great day.