LGI Homes, Inc. (LGIH) Q4 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the LGI Homes 2015 Fourth Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, today’s program is being recorded. I would now like to introduce your host for today’s program, Rachel Eaton, Chief Marketing Officer at LGI Homes. Please go ahead.

Thank you. And welcome to the LGI Homes conference call discussing our results for the fourth quarter and full year 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 guidance for 2016. 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 section 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. 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 annual report on Form 10-Q for the fiscal year ended December 31, 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 Charles Merdian, the company’s Chief Financial Officer, Secretary and Treasurer. With that, I will now turn the call over to Eric.

Thank you, Rachel, and welcome everyone to this call. We appreciate your continued interest in LGI Homes. 2015 marked our second full year as a public company. Our primary objective, when we went public in 2013 was to access the capital markets to fuel our growth by replicating our business model, across the country. Over the past two years, we have more than doubled the size of our organization and today LGI Homes is selling across eight states, in 14 markets, and we have start-up operations in four additional new markets. As we have continued to grow, we have maintained the LGI culture, demonstrating that our unique operating model is sustainable. Our employees are our most vital assets in continue to make the difference. It is only through and with the voluntary cooperation of our employees that we can leverage our systems and processes, execute our model of constant and never ending improvement, and embrace our focus on sales and closings. So to all of our LGI employees, we appreciate and thank you for your commitments, loyalty and hard work, which have produced another year of record setting results. During today’s call, 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, we will conclude with comments and what we are seeing this quarter and our expectations for 2016 before we open the call for questions. At the start of 2015, we provided guidance announcing our expectations to deliver between 2,800 and 3,200 home closings. In addition to having 50 to 55 active communities by the end of the year and to deliver earnings per share to our investors in the range of $1.85 to $2.25, all while maintaining our adjusted gross margin at or near industry leading levels between 27% and 29%. And as we continue throughout the year with an intense focus on results, we increased and refine our guidance. Today I am pleased to announce that for 2015 we met or exceed our guidance in all areas. With 52 active communities at year-end and 946 homes closed during the fourth quarter, we closed a record setting 3,404 homes during 2015. This year-over-year increase marks the fifth consecutive year, we have grown closings by more than 40%. During 2015, we generated home sales revenue of just over $630 million, which represented a 64% increase in revenue over 2014. This was driven by a 45% increase in home closings combined with 13.8% increase in average sales price for the year. These strong results have enabled us to deliver basic earnings per share of $2.65, which is 29% above the midpoint of our original market guidance of $1.85 to $2.25 and nearly doubled our basic earnings per share of $1.37 for 2014. Additional highlights include our expansion in the Colorado. We closed our first home in the Denver market in January of 2015 building momentum throughout the year to generate a total of 138 closings in our two communities. 2015 also completed our first full year operating in the Albuquerque, Fort Myers and Charlotte markets. These three markets all exceeded our expectations and proved again that we have the processes and systems in place to enter new market and create positive results quickly. During the fourth quarter, we had 495 closings in Texas. This is a 32% increase over the 376 homes closed in Texas during the fourth quarter of 2014 and consistent with the number of closings in the previous quarter. Our eight active selling communities in Houston closed 207 homes during the fourth quarter. Our absorption pace for the fourth quarter was 8.6 closings per community per month in line with our absorption pace in number of homes closed in the previous quarter. Houston, our home market had a strong year in 2015 with 847 home closings. The driver of our growth this year in Texas was in our DFW in Central Texas regions. We added two active communities in DFW during 2015 to bring our total active communities in this market to nine. We closed the total of 475 homes in DFW in 2015, a 59% increase over 2014. Our Central Texas region also experienced strong results with the addition of three new communities ending the year with 534 homes closed a 42% increase. Consistent with our stated strategy, we continue to diversify our operations outside of Texas. Out non-Texas divisions continue to gain ground and demonstrate success. For the fiscal year, the share of our home closings in our markets outside of Texas increased from 33% of our home closings in 2014 to 45% in 2015. During the fourth quarter, we closed a total of 451 homes in our divisions outside of Texas. Our Southwest and Southeast divisions contributed 20% and 17% of home closings this quarter, and the Florida division generated 11% of our home closings. Each of these divisions experienced a year-over-year increase of more than 30% in the number of homes closed during the fourth quarter. For the quarter, we averaged 6.1 closings per community per month company-wide. On closings per community per month basis, we closed an average of 6.9 homes in Texas, 5.6 in our Southwest division, 5.5 in our Southeast division and 4.9 in Florida. For the year, we averaged six closings per community per month company-wide consistent with our average closings per community in 2014, demonstrating our ability to maintain absorption rates as we have expanded into new markets. 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 $177 million based on 946 homes close, which represents a 63% increase over the fourth quarter of 2014. Our average sales price was $186,855 for the fourth quarter, a 12.4% year-over-year increase and consistent with the third quarter. The increase in average sales price year-over-year reflects changes in product mix, a favorable pricing environment in new or replacement communities added during 2015 that have higher price points. Sales prices realized from homes closed during the fourth quarter range from the 120s to the 460s. This includes 10 homes in our Toronto communities, which had an average net sales price of approximately $404,000. For the year, we closed 33 homes in our Toronto communities representing less than 1% of our overall closings. Going forward, we expect closings from our Toronto communities to be less than 5% of our overall business. Our adjusted gross margin was 27.6% this quarter compared to 28.9% for the fourth quarter of 2014, which is within our expected range and consistent with the previous quarter. For the year, adjusted gross margin was 27.8% compared to 28.2% for the full year 2014. Adjusted gross margin excludes approximately $1.7 million of capitalized interest charges cost of sales during the quarter representing 95 basis points and we expect this to remain in that range between 90 and 125 basis points for the upcoming year. Combined selling, general and administrative expenses for the fourth quarter were 13.1% of revenues and 13.8% for the full year. As a percentage of revenues, we believe that SG&A will be between 13% and 14% for the full year 2016. Varying quarter-to-quarter based on home sales revenue. We typically expect the first quarter to have the highest SG&A ratio as our first quarter generally results in the lowest closings on a per community basis during the year. Selling expenses were $14 million or 7.9% of home sales revenue compared to $10.9 million or 10% of home sales revenue for the fourth quarter of 2014, a 210 basis point improvement. Selling expenses as a percentage of home sales revenues improved 20 basis points from the previous quarter, primarily as a result of operating leverage realized related to advertising costs. General and administrative expenses were 5.2% of home sales revenues compared to 6.6% of homes sales revenues for the fourth quarter of 2014, a 140 basis point improvement and consistent with the second and third quarters of this year. Pre-tax income from the quarter was $24.1 million or 13.6% of home sales revenue, an increase of 290 basis points over the same quarter in 2014. We generated net income of $15.7 million or 8.9% of home sales revenue for the fourth quarter of this year representing basic earnings per share of $0.79 and $0.75 on a diluted share. For the year, we generated net income of $52.8 million or $42.65 basic earnings per share and $2.44 diluted earnings per share. As mentioned on previous calls, weighted shares outstanding for the purpose of calculating diluted earnings per share are impacted by the convertible notes. Prior to April 30, we used the, if converted method, and subsequently we have been able to use the treasury stock method to calculate the dilutive of effect of these notes. In the first four months of the year, prior to our shareholder meeting the convertible notes were treated as fully diluted under the, if converted method, resulting in approximately 1.3 million shares computed in the dilution calculation. Under the treasury stock method the convertible notes are dilutive, if the market price of our stock exceed the $21.52 per share conversion price of the convertible notes. In the fourth quarter of 2015, our average stock price was approximately $29 a share, exceeding the conversion price and therefore, the convertible notes were determined to be dilutive. This resulted in approximately one million shares increased to the weighted average shares outstanding for the diluted EPS calculation for the quarter. Since, May of 2015, approximately 463,000 shares were considered dilutive, based on the average share price from May through December. The dilutive effect in future quarters will be determined based on the average share price above the conversion price of $21.52. Fourth quarter gross orders were 1,096, net orders were 714. Ending backlog for the year was 523 homes and the cancellation rate for the fourth quarter was 34.9%. For the year, our cancellation rate was 27.2%. We ended the quarter with a portfolio of approximately 23,900 owned and controlled lots, as of December 31, approximately 11,900 of our 17,600 owned lots were either raw or under development. As of December 31, we had approximately $38 million in cash, $531 million of real estate inventory and total assets of $622 million. In addition, we had $230 million outstanding under our revolving credit facility, which was increased by $45 million in January 2016 to total $300 million. Our gross debt to capitalization was approximately 55%. And net debt to capitalization approximately 52%. In September, we issued perspectives under our $300 million self-registration statement to issue up to $30 million of our common stock from time-to-time in an aftermarket program. During the fourth quarter we issued approximately 246,000 shares of our common stock under the program. And an average price of approximately $28 per share and received net proceeds of approximately $6.8 million. To-date we have sold approximately 346,000 shares resulting in net proceeds of approximately $9.6 million. Going forward we expect to utilize the aftermarket program and our self-registration statement, as needed to manage our balance sheet. At this point, I’d like to turn it back over to Eric.

Thanks Charles. In summary, we had another impressive quarter and a phenomenal 2015. Let me provide some guidance and thoughts on what we are seeing for the upcoming year. The first quarter of 2016 is off to a solid start with 477 closings through February, representing year-over-year growth of 28%. Based on our strong performance today and assuming a continuation of today’s housing market conditions for the remainder of this year, we offer the following guidance. We expect to close between 4,000 and 4,400 homes in two 2016. We expect Texas to close 40% to 45% of our homes for the year, with the Houston market representing between 15% and 20% of our closings. As mentioned on previous calls, we plan to expand into five new markets this year, because we are systems based company with proven 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, produce results consistent with our existing communities. And all will be accretive to our operations. To update you on the new markets, we had our first home closing in Jacksonville, Florida in January. Our expansion in the Seattle market is underway. I will be in Olympia with some of our leadership team this weekend for our grand opening event. The following weekend March 19, we will hold our first grand opening event in the Colorado Springs market. The initial response from customers at both locations has been positive and we believe we’ll have very successful openings. We’re on track for our first community in Nashville and Riley to open later this year and we anticipate closings in the third or fourth quarter. In each of these five new markets we are primarily buying finished lots. We believe this is a wide strategy allowing us to reduce our development risk and increase the return on our equity. Getting back to more specifics, we ended February with 55 active communities with the addition of two communities in our Florida division and one in the Southwest. We believe by the end of 2016, we will have between 62 and 67 active selling communities. We saw a very slight increase in average sales price over this past quarter. We believe our average sales price in 2016 will generally continue to be flat increasing an average of 1% to 2% per quarter, ending the year with an overall average sales price between $190 and $200,000. We expect adjusted gross margin, which excludes the effects of interest and purchase accounting, will continue to be strong and consistent with our results in 2015. We believe in 2016 our adjusted gross margin will be between 26.5% and 28.5%. Given our guidance of delivering between 4,000 and 4,400 home closings, along with an increase in average sales price, consistent gross margins and realized SG&A leverage, we believe our basic earnings per share for the full year 2016 will be between $3 and $3.50 per share. In summary, we are very pleased with our results for the fourth quarter and the full year of 2015. We are poised to take advantage of continued growth opportunities in existing and new markets, and believe we are well positioned to continue to grow our revenues, community account and earnings allowing LGI Homes to achieve our long-term goals and objectives of market leading returns for our shareholders. Now I will be happy to take your questions.

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

Thanks, good morning everyone, and congrats on the quarter and the year.

Thank you. Good Morning.

First question I had was, the Houston market specifically in Texas. Obviously, you continue to put out good results there. And you kind of gave your expectation for Houston to be 15% to 20% of your closings in 2016 and Texas 40% to 45%. I apologize, I’m away from my desk, I’m calling from out of the office, and wasn’t able to run all the numbers on my computer. But maybe could you just give us a sense what that implies, in terms of growth for those for Houston and Texas more broadly? And if that is reflecting either any of macro concerns that a lot of people continue to be top of mind for a lot of people?

Yes, thanks, Michael. This is Eric, great, great question. Yes, the Houston market had a really strong year in 2015 exceeding our expectations as most of our markets did, averaging over eight closings per community per month, and that was above our budget. So a couple of things going to happen in Houston in 2016. We expect to close more absolute homes because we’re going to go down by two in the community count. Our sales were so good in 2015 that we sold out of a couple of communities and the replacement projects are not ready to go yet. So we’re going to go down by a couple in community count, but the absorption pace in Houston, that’s going to be modeled less than our year, last year because the year was a phenomenal year. But it’ll be modeled at the same absorption pace about six closings per month, consistent with what we had margined and budgeted in 2015. And I can also say, our guidance that we’re putting out there for 2016, as far as closings between 4,000 homes, 4,400 homes, we are comfortable with that guidance regardless of what happens in the Houston market, regardless of where oil prices are at.

Right. That’s helpful. Thank you for that Eric. And I guess, just secondarily, obviously, you exceeded a lot of your goals handily in 2015 as compared to the original guidance given at the beginning of the year. I would think that that was – and I believe you kind of alluded to this, due to better than expected performance in your non-Texas markets, as well as probably Houston that you just said. Could you give us a sense for what could drive performance in 2016 towards the higher end of the range both from closings and also a gross margin standpoint? Would it be – some of the continued better than expected performance in some of your new markets or your non-Texas markets? Or do you feel that there’s perhaps also any upside relative to expectations around Houston and Texas as well?

Yes, great question, Mike. We certainly had a great year in 2015 and exceeded our guidance that we gave to the market and us as a leadership team, discussed with our board of directors a lot on providing guidance to the market and we want to make sure that we’re building a reputation for making sure if we put numbers out there and we put a lot of numbers out there that we’re hitting those targets. And when we are forecasting for 2015, we far exceed our guidance because what we did as we expanded into a whole lot of new markets, we hired a lot of new people, we had a lot of new managers. But we were able to maintain gross margins, we were able to maintain our absorption paces and grow revenues by over 60%, and that was a great year. In 2016, how we hit the upside the guidance, to answer your question, yes, we do the same thing again. If we can continue to expand into new markets and continue to create similar absorption rates and similar gross margins and not be dilutive, that would certainly put us at the high end of the range. And, is that the best way to provide guidance where it’s assuming that we’re going to be able to maintain absorption rates even though we’re adding 20% to 25% more communities and adding new markets and adding a lot of people. We want to provide a little bit more conservative guidance from that because we think it would be a great year if we hit our guidance in 2016. But I would not argue with the fact there is some upside in those numbers if you we do in 2016 what we did in 2015.

So, I appreciate that. And just lastly on that answer I mean – will there be any, and I apologize if this sounds repetitive or if you don’t want to go into too much detail, but where there any reasons that might exceed the – I don’t think conservative guidance because I think what you’re giving is not conservative per se but there is certainly still some upside. Do you think that would be more likely coming from your non-Texas markets or your Texas markets? And on the gross margin side are there anything baking in from a cost inflation standpoint that maybe you’re not seeing today, but you expect, like for example further, labor inflation, just throw one of those out there.

Yes, I think it’s relative to time into this as well if you want but I think the upside is really the new communities outside the state of Texas, because we gave a range of our community count of 62 to 67. And certainly they’re – when you’re forecasting new communities and new markets and dealing with finishing development or relying on other developers to finish development; that should create some upside if we got to the high end of the community count range. Gross margin-wise, one of the things that also was very positive in 2015 is all of our regions had adjusted gross margins of 25% or above. So, how we look at gross margin, as we think in our existing communities that are underway, most of those will have higher gross margins in 2016, and 2015 offset by some of the new communities and new markets having a little bit lower gross margin, more towards the 25% range, and offsetting and be consistent in 2016 like 2015.

Great. Thanks so much.

Yes, I appreciate it, Mike. Great questions.

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

Thanks, and congrats on the terrific year and the growth.

Thank you.

I wanted to – Houston is the number one thing everyone likes to think about, especially when it comes to you folks. I just want to dig into these numbers a little bit. 15% to 20% of your 4,000 to 4,400 closings at Houston that works simply about 7.35 or so.

Yes.

You have eight communities in Houston at the moment, and you’re going to drop down. So I used 7.25. That gets me to a sales pace of about 8.5 a month, which is pretty similar to the pace of the fourth quarter, I think for 2015 as well. There has been some concern about the monthly numbers that obviously December, a blowout number, February a little bit slow on a year-over year-basis. So the concern is that Houston that the weakness will continue to filter down the price points and that will affect you folks at some stage. So, I was wondering so your outlook is for there to be a little change in absorption pace. I was wondering, if you could get real reason in terms of your experiences in Houston. What you’re seeing in terms of the success rate on the flyers, the conversion rates, the flow through of the pipeline specifically January and February, clearly December was a terrific month. And what gives you the confidence for your forecast for absorption for this year out of Houston?

Yes, great question, Nishu. The primary thing that we’re looking at in the Houston market – we’re looking at past results. But the most important thing we’re looking at what this year is going to bring, as we’re looking at the lease that are coming in the office and we’ve got information on that on a week to week basis. And I can tell everyone on the call that through the first eight, nine, ten weeks of this year, we have not seen a drop off in demand. The number of customers that are calling us, the number of customers that are calling out as a percentage of the direct mail pieces that we mail. We have not seen a drop off at all. So converting those leads to appointments and tours and contracts and closings both a lot of people and lot of management but we have not seen the drop off in Houston relative to comparing at year-over-year or our experience that we’ve seen. So we’re – we in our modeling, we’re modeling a slightly lower absorption rate and then we’re going to lose a community or two depending on throughout the year, but all is good here in Houston.

Got it, and I appreciate it. The mortgage lending environment especially with the way that your folks model works. As things ease, it should provide a tailwind for you folks. There was a little bit of easing at the entry level of the market and easing at some return of subprime. I know you guys didn’t use subprime before and I don’t think you and that continues to be the case. But what are you seeing out there on the mortgage lending environment? Is it providing a tailwind in a market like Houston where their economic headwinds, well, oil is – for the low end consumer there are some tailwinds. But are you seeing it as a tailwind or you seeing it as more stable. How is it impacting your pipeline conversion on the ground across your communities?

Yes. First of all, we don’t do any subprime lending at all. Government based lending FHA, VA and USDA just like other builders, that’s our primary driver and focus. As far as mortgage underwriting requirements as far as credit score, debt to income ratios, I would characterize those as very similar sort of last quarter, very similar over the last 12 months. One thing that is helping Houston and helping all of our customers is this $40, $50 price of gasoline. That is certainly helping our customers have a little bit more money at the end of the month. But as far as mortgage underwriting guidelines, I would say they’ve been fairly stable.

Got it. Got it, that’s great. And then, just one last one, if I could, the community count, another 13 this year, that’s pretty similar to the 12 to 15 range you’ve had over the past few years. Is that the sustainable phase of healthy expansion. And then I guess one way to look at it is, is opening that same number getting easier because you have a larger base and more talent to drew from, is it getting harder because the enterprise has gone so much larger. So if you could just give us your thoughts on that continued growth path, please.

Well, I’m not sure it’s easier or harder. But that 20% growth of the community count for the next few years, that feels about right, Nishu. We’ve expanded into a lot of the what I consider really good markets and the next set, the Raleigh, the Nashville, the Seattle’s, but we have a lot of room to go deeper in these markets as well rather than just keep expanding into new markets. So, I think we’re in pretty good shape for our continued expansion of the 20% a year for the next few years. I will get back to you after that.

Great. Thanks for the thoughts.

You’re welcome.

Thank you. [Operator Instructions] Our next question comes from the line of Barry Haimes from Sage Asset Management. Your question please. Barry, you might have your phone on mute, looks like. Looks like he just removed himself from the queue. Our next question comes from the line of [indiscernible] from Sidoti. Your question please.

Hey, good morning, how are you?

Great.

Great.

Good. I appreciate the time. Just staying on the Nishu’s question, I know in the past you guys have detailed a number of leads you got in the quarter. I was just wondering if you had that for this quarter, fourth quarter?

I don’t have that right in front of me, Daniel. We could certainly get you that information. But I can tell you, what I’ve been looking at consistent with years past, 70 to 100 leads per week per community. So we’re running 5,000 or so leads per week. 60,000 to 80,000 leads for the quarter would be a very good estimated lead, so demand for home ownership is still there.

Great. That seams in line with the last few quarters where I think you actually saw an acceleration. And then, I guess a larger picture question, if I am not mistaken, the absorption rate in the metropolise kind of DFW area is lagging, the Houston – is there anything you guys, if I’m correct, is there anything you guys are doing internally or taking any initiatives to potentially narrow the gap?

Yes, I think we’ve made some changes in DFW as that team up there gets more experience. We’re excited about everything we got going on in DFW. New communities are off to a good start. So we averaged 6.2 closings per community in the DFW region in last quarter, which is very strong. But Houston is a tough comp, Houston is our home base, we’ve got great managers in the Houston region. So that’s a very high standard to compete with Houston. But at six closings per month, we’re happy with the absorption in DFW and look forward to a great 2016.

Okay. It’s all that takes. And then, last one, you mentioned and congrats on finally, I think you had a closing in Jacksonville, your first one.

Thank you.

Yes. Can you just remind us again, what drew you to that market to begin with? And if there’s any parallels with some of your kind of core markets?

Yes, I think what got us in the Jacksonville market is really our success in Orlando and Tampa, we’re having good success in the Florida markets. Jacksonville is obviously closely geographically close to the Orlando market. We have a lot of confidence in our Florida leadership team and came across individual deal and add potential acquisitions from a seller in a matter hurdles, we did our test marketing, the demand was there. So we bought it, and we’re off to a great start.

All right, thanks a lot, appreciate it.

All right, appreciate it.

Thank you. And this does conclude the question-and-answer session of today’s program. I’d like to hand the program back to Eric Lipar for any further remarks.

Thank you 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.

Thank you, ladies and gentlemen for your participation in today’s conference. This does conclude the program. You may now disconnect. Good day.