LGI Homes, Inc. (LGIH) Q1 2016 Earnings Report, Transcript and Summary

Welcome to the LGI Homes First Quarter 2016 Conference Call. Today's call is being recorded and a replay will be available on the Company’s Web site 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. And welcome to the LGI Homes conference call discussing our results for the first quarter of 2016. 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 statement 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 quarterly report on Form 10-Q for the three months ended March 31, 2016 that we expect to file with the SEC later today. This filing will be accessible on the SEC’s Web site and in the Investors section of our Web site at www.lgihomes.com. Joining me today are Eric Lipar, LGI Homes’ Chief Executive Officer; and Charles Merdian, the Company’s Chief Financial Officer. With that, I will now turn the call over to Eric.

Thank you, Rachel, and welcome to everyone on this call. We appreciate your continued interest in LGI Homes. During today's call I will summarize the highlights from the first quarter of 2016. Then Charles will follow-up to discuss our financial results in more detail. After he is done, we will conclude with comments of what we're seeing for the second quarter and our expectations for the remainder of 2016 before we open the call for questions. To begin today we are pleased to announce that LGI Homes was recently named as the 15th largest builder in the United States according to Builder Magazine based on our 3,404 home closings in 2015. This considerable jump of six spots on the Builder 100 rating would not have been possible without the commitment and dedication of our loyal LGI employees. I'd like to take a moment to extend a special thank you to everyone at LGI. Because of you we've been able to realize strong growth throughout the year and have great momentum to build on as we continue to deliver results and move up the Builder 100 list. Looking at the first quarter of 2016, the year is off to a solid start, we closed 844 homes, generating just over $162 million in home sales revenues which represents a 26% increase in homes closed and a 35% increase in revenues over the first quarter of 2015. As we enter the New Year we continue to demonstrate our ability to expand our business to new markets. We ended the first quarter with 56 active communities which is an increase of 12 over the 44 active communities that we had at the end of the first quarter last year. These 12 communities were spread throughout the country with three in Dallas, two in Charlotte and one each in San Antonia, Fort Myers, Tampa, Atlanta, Phoenix, Denver and our newest market Jacksonville. Breaking it down by market let's first take a look at highlights in our Texas operations. The fundamentals of this division have remained solid generating 410 closings and representing approximately 49% of our total closings during the quarter. This represents a 7.3% increase in closings in Texas over the first quarter of last year. In addition the absorption rate in Texas averaged 4.6 closings per community per month, which is right in line with our past experience and expectations. We continue to geographically diversify our operation. Our concentration outside of Texas increased during the first quarter and was 51% of our closings compared to 43% of our closings in the first quarter of last year. This was the first quarter in our history in which the majority of our closings came from outside the State of Texas. The Southwest division represented 20% of our home closings, the Southeast division represented 19% and the Florida division represented 12%. As we have discussed on previous calls we anticipate our percentage of closings outside of Texas will continue to increase. Absorption remained strong in the first quarter averaging 5.1 closings per community per month consistent with 5.3 closings per month for the first quarter of last year, our top three markets for the quarter including Charlotte leading the way with 6.8 closings per community per month and Houston and DFW remaining solid at 5.8 closings per community per month. Home ownership demand is alive and well in our markets across the country. We continue to market directly to renters living within close proximity to our communities. Our advertising produced over 66,000 enquiries in the first quarter, strengthening our belief that there remains a strong demand in the first time home buyer segment. In addition our markets continue to have strong housing demand drivers, including national leading population and employment growth trends, general housing affordability and desirable lifestyle characteristics. With that I'd like to turn the call over to Charles Merdian, our Chief Financial Officer for a more in-depth review of our financial results.

Thanks, Eric. As previously mentioned home sales revenues for the quarter were $162.5 million based on 844 homes closed which represents a 35% increase over the first quarter of 2015. Our average sales price was 192,491 for the first quarter, a 7% year-over-year increase and approximately 4% increase over the average sales price for the fourth quarter of 2015. This is largely attributable to changes in product mix, price points in new markets and a favorable pricing environment. For example our comparable entry level product in Denver had an average sales price of over $300,000. Our adjusted gross margin was 26.7% this quarter compared to 27.8% for the first quarter of 2015, 110 basis points decline. The decrease in adjusted gross margin is primarily due to a shift in geographic mix as Houston declined from 29% of our overall closings in the first quarter of last to 17% in the first quarter of this year as a result of closing out of two high volume communities in the market. Houston historically has been one of our highest gross margin markets and the close out of these communities directly impacted the overall margins. In addition, we experienced higher indirect overhead charges in the first quarter of 2016 primarily due to timing and cost related to our expansion. Adjusted gross margin excludes approximately $1.8 million capitalized interest charged as cost of sales during the quarter, representing 110 basis points. Combined selling, general and administrative expenses for the first quarter were 14.8% of home sales revenue compared to 16.4% in the prior year. We typically expect the first quarter to have the highest SG&A ratio as it generally results in the lowest closings on a per community basis during the year. As a percentage of home sales revenues, we believe that SG&A will vary quarter-to-quarter based on home sales revenue and remain within our previous guidance of 13% to 14% for the full year. Selling expenses for the quarter were $14.1 million or 8.7% of home sales revenue compared to $11.6 million or 9.6% of home sales revenues for the first quarter of 2015, which is a 90 basis point improvement. Selling and expenses as a percentage of home sales revenue improved primarily as a result of operating leverage realized related to advertising costs. General and administrative expenses were 6.1% of home sales revenues compared to 6.8% for the first quarter of 2015, a 70 basis point improvement. This decrease reflects leverage realized from the increase in home sales revenue during the first quarter of 2016 as compared to the first quarter of 2015. Pretax income from the quarter was $17.8 million or 11% of home sales revenue, an increase of 130 basis points over the same quarter in 2015. We generated net income in the quarter of $11.7 million or 7.2% of home sales revenue which represents earnings per share of $0.58 per basic share and $0.57 per diluted share. First quarter gross orders were 1,468 and net orders were 1,135. Ending backlog for the first quarter was 814 homes compared to 601 last year, and the cancellation rate for the first quarter of 2016 was 22.8%. We ended the first quarter with a portfolio of approximately 25,500 owned and controlled lots, and as of March 31st, approximately 11,700 of our 17,800 owned lots were either raw or under development. Turning to the balance sheet, we ended the quarter with approximately 48 million of cash, 561 million of real estate inventory, and total assets of 653 million. On January 6, 2016, we increased our revolving credit facility to $300 million in accordance with the accordion feature of the credit agreement. At March 31 we had $248 million outstanding under the facility as well as $85 million in convertible notes. Our gross debt to capitalization was approximately 55% and our net debt to capitalization was 51%. During the first quarter, we issued 150,000 shares of our common stock under our ATM program, generating net proceeds of approximately $3.5 million. At this point, I would like to turn it back over to Eric.

Thanks Charles. In summary, we had another successful quarter and a great start to 2016. Let me provide some guidance and thoughts on what we are seeing thus far in the second quarter and looking ahead into the remainder of the year. The second quarter is off to a strong start with 341 closings in April, up 28% from 267 closings in April of last year. The 341 closings came from 55 active communities, resulting in a very solid absorption base of just over six closings per community per month. Based on our backlog, we expect to close more homes in the month of May than in April, keeping our absorption pace north of six closings per community per month, and right on track to meet our goal of closing between 4,000 and 4,400 homes for the year. We expect to see continued demand for our new homes in Houston. As Charles noted earlier, some of our Houston communities sold out earlier than originally expected reducing our community count from eight to six. We expect to close more than 60 homes in these six active communities in May of 2016 averaging more than 10 closings per community for the month demonstrating continued strength in the Houston market. Our expansion efforts are already generating closings for the second quarter of 2016. Our first project in the State of Washington, Evergreen Point in Olympia had a very successful brand opening in March which generated five closings for the month of April, producing five closings in a new market in our first months that’s a great accomplishment by our team in the northwest and again proves that we have the systems, and processes in place to get off to a fast start in new markets. We expect to have closings in at least two other projects in the Seattle area before the end of 2016. Additional highlights of our growth and expansion across the nation include our presence in Nashville where we have started construction on our first five homes. In this new market we expect to open for sales in the third quarter and close on our first homes in the fourth quarter. We're also making progress in Raleigh, North Carolina and have our first two projects under contract. We expect construction to start in the third quarter, sales to begin in the fourth quarter and our first closings in Raleigh to take place in the first quarter of 2017. Our Acquisitions Committee has also approved our first deal in the Portland market. We anticipate closing homes in this new market in the first or second quarter of 2017. We expect community count at the end of the year to be between 62 and 67 active communities. This quarter we saw a nearly a 4% increase than average sales price over Q4 of 2015. We believe our average sales price in 2016 will continue to increase as a result of product and geographic mix as well as the market conditions increasing on average by 1% to 2% per quarter ending the year with an overall average sales price between $190,000 and $200,000. Although we continue to expand into new markets and deliver homes at higher price points we will remain focused on serving the entry level buyer. We expect adjusted gross margins which excludes the effects of interest and purchase accounting, will continue to be strong. Although the first quarter adjusted gross margin of 26.7 was near the low end of our guidance, we believe that our year-end adjusted gross margin will be in our target range of 26.5% to 28.5%. Based on our expectation of delivering between 4,000 and 4,400 home closings along with an increase in average sales price, consistent gross margin and realized SG&A leverage, we believe our first quarter results and our strong start to the second quarter keep us on track to deliver basic earnings per share for the full year 2016 between $3 and $3.50 per share. These expectations are based on the general economic conditions and our experience for the remainder of the year being similar to 2015 and our results to-date in 2016. In summary, we are very pleased with our results and are poised to take advantage of continued growth opportunities in existing and new markets. We believe we are well positioned to continue to grow our revenues, community count and earnings in line with our guidance allowing LGI Homes to achieve our long-term goals and objectives of market leading returns for our shareholders. Now we'll be happy to take your questions.

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

The investor community is clearly concerned and probably about the gross margin coming in towards the lower end of your range in 1Q, so wanted to spend a question or two just looking at that. You mentioned some of the factors, let's start with the Houston factor, that's been obviously the real base and anchor for your success overtime. And you mentioned closing out of some very high gross margin communities. Now in the past you've talked about gross margins can stay within the range because as you have maturing communities those gross margins rise, whereas that would offset some dilution from entering new markets, so in this first quarter it seemed to be more tilted towards loss of some of the legacy communities. So, how should we think about that effect going forward, is this like you've had earlier quarters where gross margins will fall for a quarter and then rebound or is it the case that your expansion is getting to the stage where it could drive down gross margins going forward?

This is Charles, I'll start, so as far as Houston goes, so as we mentioned in our remarks Houston coming in at 17% of the overall closing total compared to 29% last year. And you are right historically Houston has been at or near or above our stated gross margin guidance range. So, we did have a couple of communities that were nearing the end of their cycle closeout, so mathematically replacing those closings with other markets that had slightly less gross margins, had an impact on the overall gross margins. So, we believe that it's somewhere in the 30 basis point range related to the impact of the Houston mix falling off. So, that's how we see the Houston impact.

This is Eric I can add a couple of things to that, first of all we're comfortable in our range 26 to 28.5 was what we thought about the last quarter, we came in obviously on the low end of that range at 26.7. But we put a pretty good size range out there because we're comfortable even under the scenario of mix, and not sure exactly what markets these closings are coming from and every market gets a little -- slightly different to gross margin, we're comfortable we would be in that range. And the bottom line is we just really didn’t raise prices fast enough to keep up with cost. We always raise price on a quarterly basis and look at our cost. The costs have been going up for us as well as other builders. So we implemented in a lot of our communities somewhat of a mid quarter price increase over the last three weeks and we’re comfortable we’ve looked at preliminary numbers for April and we’re comfortable that the second quarter is going to be higher than the first quarter and the additional volume is going to help that as well. So, I think we’re in good shape in gross margins going forward and very comfortable in our range for the year.

And then the so the other aspect was indirect overhead charges having poor leverage in the first quarter. Can you just walk us through the dynamics of that? As your volumes increase in the remaining quarters of the year, does that effect dissipate, Charles the 30 bps quantification of Houston was helpful. So if you have some numbers around that it would be helpful, and whether that effect should dissipate as well?

Sure, yes so typically the first quarter there is a greater proportionate share of indirect overhead as a percentage of revenues due to the fact that the closing volume is historically the lowest for the quarter, for the year. So this particular quarter we saw about a 20 basis point increase in the indirect overhead, this quarter over first quarter of last year and just primarily due to timing on how new markets come in. We opened Jacksonville this first quarter. We also opened up an additional community in Colorado. And Eric has went through in his comments on some of the other markets that we went through. So it's really more directed towards just timing getting our primarily superintendents on boarded, getting trained as we get them on and working in our communities as we work to open other communities throughout the rest of the year.

And just going back to the follow up on that Houston comment, so your Q2 communities went from eight to six I think you mentioned. We’ve previously talked about how LGI’s positioned in Houston at the entry level, pretty much covers the entire MSA. Would you be, I am sorry if I missed this, you may have mentioned this. But would you be looking to add back communities to cover areas that are now not covered by an LGI community with the 25 mile radius? Is that in the works, or is six kind of the new level for communities in Houston? How is that trend in your home base market going to look from here going forward?

No, we’ll be increasing our community count Nishu, and the reason we want to make six is really positive. We just had a very strong in 2015 in the Houston market as well as a lot of markets in the country. But the replacement projects for those two that sold out were just not ready yet, because we increased the absorption above what was expected. So, we’re down to six communities right now that’s going to ramp-up by the end of the year to at least seven and possibly eight before we get in the closings. But we’ll start construction on project seven and eight before the end of the year, but probably seven or eight by the end of the year. And the next session you may have is Houston as a percentage of overall and we expect Houston to be about 15% to 20% of our closings for this year.

Our next question comes from the line of Michael Rehaut with JPMorgan. Your line is now open.

So, covered a lot of ground on the gross margin question, just one more there and then I had also a question on SG&A. Helpful that you kind of pointed to again not only reiterating the full year gross margin guidance but also that you expect 2Q to be better than 1Q. It seems like that’s mostly being driven by the price increase that you instituted mid quarter that you’re already seeing traction with. Do you have any sense and this is might be a little too challenging to answer. But does that get your back to the middle of the range, or anyway to give a sense of what that impact might be? And I assume also you’ll get a little better leverage on the indirects as well. But between the two of those factors, maybe you could give us a sense of what the price increase might be from a basis point standpoint and should we be expecting kind of mid range of that 26.5 to 28.5, any guidance there as well?

Yes, I mean that’s getting real specific on guidance on Michael, but we absolutely expect the second quarter to be higher than first quarter. The mid quarter price increase that’s not going to have a big effect on the second quarter since our pipeline is pretty full for the second quarter already, but sales over the last couple of weeks, we’ll get some of those closings in June but certainly relative to the third quarter of this year. So I think our adjusted gross margin what I would believe is it's going to continue to go up throughout the year, getting 80 to 100 basis points in one quarter might be at the high-end of what I would suggest but Charles and I both are comfortable that we’re heading in the right direction in gross margins, the second quarter should be higher than the first quarter.

And then just looking at the SG&A, I believe you reiterated the 13% to 14% range for the full year, at the same time obviously you had great improvement in the first quarter of 160 basis points so how -- in terms of 2Q I mean I think you kind of said, and I don't know if that was just a broad statement but you expect the remainder of the year to be similar to 2015, I don't know if that applies specifically to the SG&A line as well that we should look at more of a flattish type of improvement because otherwise it would seem like maybe you're on track to do, or to have some a little more improvement than may be the midpoint of the 13 to 14 range would suggest?

Yes this is Charles. That's fair, I mean what we're saying really is that the first quarter is typically on the highest end of the range, and that's why 14.8 came in above the full year guidance of 13 to 14. But I think as we go throughout the year, it's going to be primarily driven on where we land in the closing guidance range, obviously on the lower end of the closing guidance, the full year SG&A will likely be on the higher end of the 13 to 14 and on the high end of the closing guidance it'll likely end up down at the lower end of the range.

Okay. So, just in terms of the improvement though that we saw in 1Q at this point is the way you're modeling it that the rest of the year should be more flattish year-over-year because again certainly there was some nice year-over-year improvement in the first quarter?

I think we'll definitely see on a quarter-over-quarter basis I would say that that's fair. That is more flattish, more -- it'll be more dramatic in the first quarter as we've seen than it would be in the quarter-over-quarter comparisons for the remainder of the year.

[Operator Instructions] Our next question comes from the line of Dan Jacome with Sidoti & Company. Your line is now open.

I wanted to ask you first, like do you say that May closings are going to be above April's level?

Yes.

Okay.

Yes, that's what we talked about and it's going to be on a lower comp so close 255 homes in May. So, as a percentage increase it's going to be dramatically higher.

Okay, yes that was my question, because I think last year May was below April, so, is it just kind of a dynamic of tightening the comp and maybe the change in geographies?

Yes, it's month-to-month volatility based on last year's comp but I can tell you that sales have been extremely strong over the last couple of months and we are very positive about the second quarter and very comfortable telling everyone that closings in the month of the May are going to be higher than April.

Yes, I was impressed by the last two months given the weather in that region, it sounds like you didn't see any impact from weather related?

No, no impact from weather on closings of LGI and also very happy to report most of the people heard about some big storms that we have in the Houston market and no LGI Homes or community see their past or present at any flooding or any damage to the homes at all.

I wanted to ask you also do you have any level of thoughts on kind of the infrastructure changes that you're seeing in Houston with the, I guess expansion of what is it, State Highway 99 is that impacting your business at all and generating any incremental traffic I think most of the changes were in The Woodlands?

Yes, I think it's very positive for LGI as most of everyone on the call knows we tend to be in a little bit further out locations and the Grand Parkway is adding another ring of highway to the Houston market, so, one of our projects Bauer Landing for exit off the Grand Parkway to the front entrance of that project is about three or four miles and it's just created a more convenient access point for our customers and sales are very strong there and continue to be. So the Grand Parkway opening in Houston is certainly positive for LGI and those of us developed a little bit further out.

And then last question I know, you talked a lot about the gross margins and maybe I could ask it another way, do you guys -- you guys have always had kind of like an ROE that's well above other builders, do you see kind of to where is that now, do you think that could be sustainable as Texas becomes a smaller part of your business, longer term, even if you have gross margins kind of normalizing but you have maybe other levers to pull to sustain that or how do you guys think about that if you do?

I'll start, Charles you can add to it if you like to, yes, so I absolutely believe our return on equities can be sustainable. We're going to be diligent in our Acquisitions Committee, that's one of the metrics that we look at. And also and it does impact gross margin as we've been expanding outside of Texas, we have been more likely developed to buy finished lots from a developer. And in that case that development risk and all of the upfront capital in these new markets and our gross margin hurdle is lower on a finished lot deals and in the development deal we take but it certainly is accretive to the return on equity metric.

Our next question comes from the line of Jordan Haimowitz with Philadelphia Financial. Your line is now open.

90% of my questions have been answered, just a small clarification. If you would say what your average gross margins in Houston per se versus a more recent community you can pick it, whether it's Charlotte or Seattle where the average cost is higher. What would be that difference just on a like for like basis? In other words what the [Multiple Speakers]?

Yes good question Jordan, I appreciate the question. Houston has traditionally run at the high end of our range at 28.9% and these new markets, when going to a market we’re modeling those at closer to 25% gross margin and then increasing prices and increasing our gross margin as we develop.

So objectively if we were in a market where there was no Houston or no Texas let’s say you would have 25% gross but your average price point would probably be 20% higher as well as the net dollars you would end up in the same place?

That would be accurate. It depends on a little bit of market, but yes Colorado is 50% higher than the Houston market, so it is a little bit market specific but generally speaking most other markets are higher average sales price than Houston and the gross margin dollars you are correct would be higher even if the percentage is lower.

And no one has asked about capital at this point, so are there changes to your thoughts in that regard?

No, it's Charles. No we just increased our credit facility as we mentioned 300, we continue to work with our lenders as we evaluate our capital needs, same approach in terms of evaluating our acquisitions and our acquisitions pipeline we also have our ATM program cumulatively we have used about 13 million total of the 30 million so we have about 16 million or 17 million left available to us in that program and then have the shelf registration filed as well.

So it sounds like orders are up 28% plus for the first two months for the year and margins are better in the second quarter. Thank you very much.

Thanks Jordan, I appreciate it.

At this time, I am showing no further questions. I would like to turn the call back over to Eric Lipar for closing remarks.

Thank you everyone for participating on the call and for your interest in LGI Homes. We look forward to sharing the achievements of 2016 throughout the year. Have a great day.

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