LGI Homes, Inc. (LGIH) Q2 2016 Earnings Report, Transcript and Summary

Good day ladies and gentlemen and welcome to the LGI Homes 2016 Second 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. Welcome to the LGI Homes conference call discussing our results for the second 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 the remainder of 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 other 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 quarterly report on Form 10-Q for the second quarter of 2016 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 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 and results from our exceptional second quarter and year-to-date. 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 third quarter and our expectations for the remainder of 2016 and then open the call for questions. Before we discuss our results today, I would like to take a few moments to tell you about one of our 2016 initiatives LGI Giving which we launched earlier this year. Through LGI Giving, we are committed to support and benefit our local communities, through volunteerism and service. On May 26th, we held our inaugural service impact day where we closed all of our LGI offices nationwide in order to perform service projects and give back to our communities. We held 20 events across United States from Seattle, Washington to Jacksonville, Florida, ranging from constructing homes in partnership with Habitat for Humanity to building sustainable gardens, to helping communities recover from recent heavy rains and flooding. Through these events our employees donating over 3,300 employee service hours and LGI contributed over a $120,000 to local organizations. It was a great success and we thank all of our employees for dedicating their time and talents to these worthwhile causes. We'd also like to thank all of our employees for their hard work, dedication and loyalty to LGI. Because of your outstanding performance, we are proud to announce that LGI delivered an impressive quarter highlighted by record setting, closings, revenues, average sales price, net income and earnings per share. For the first time in company history, we closed more than 1,000 homes in a single quarter ending the quarter with 1,128 closings. This generated over $222 million in home sales revenue, which represents a 32% increase in closings and a 40% increase in revenue over the second quarter of 2015. For the first six months of the year, we closed a total of 1972 homes, which represents a 29% increase over the first six months of 2015. We ended the second quarter with 56 active communities, an increase of 24% over the same quarter last year. The increase in active community count reflects our continued expansion outside of Texas. Year-over-year, we added three new communities in Colorado, three in Florida, two in the Carolinas and one each in Arizona, Georgia and Washington. Absorption during the quarter was very strong, averaging 6.8 closings per community per month companywide. This was an increase over the 6.4 closings per month for the second quarter of last year; all while increasing our average sale price by 6% and adding 11 communities outside the State of Texas. Based on absorption, our top market for the quarter were Houston, Fort Myers, Dallas/Fort Worth and Charlotte. Our absorption pace in Houston was 10 closings per community, per month and Fort Myers, DFW and Charlotte each had an average of approximately nine closings per community per month. Texas continues to be our leading division, generating 585 closings, which represented approximately 52% of our total closings during the quarter. We saw a 20% increase in closings in Texas during this quarter as compared to the second quarter of last year with the same number of active communities. 48% of our closings this quarter came from markets outside of Texas, compared to 43% for the same quarter last year. Year-over-year, the Florida division increased closings 57%, the Southeast division increased 50% and the Southwest division increased 34%. This growth was driven by our new communities, which enabled us to increase closings while maintaining similar closings per communities for each of these divisions. Our Northwest division is off to a solid start. The first closings occurred in May and we ended our first quarter in this division closing 11 homes with an average sales price above $275,000. Seattle is the most recent market that validates our belief that we can enter new markets effectively using our established and disciplined processes and our proven sale system. Our marketing strategy continues to be focused on directing marketing to renters living within close proximity to our communities. Based on responses to our direct consumer strategy, we maintained our belief that there are strong demand in the first time home buyer segment. In addition, our markets continue to have strong housing demand drivers including nationally 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. And as previously mentioned, home sales revenues for the quarter were $222.7 million based on 1,128 homes closed, which represent a 40.2% increase over the second quarter of 2015. Our average sales price was $197,450 for the second quarter, a 6% year-over-year increase. This increase is largely attributable to higher price points in some of our new markets, a continued favorable pricing environment and our product mix. For example our newest markets, Denver, Colorado, Springs and Seattle all averaged home sale prices over $275,000. Our adjusted gross margin was 27.8% this quarter, compared to 26.7% in the first quarter of 2016 bringing our year-to-date adjusted gross margin to 27.3%. Margins improved 110 basis sequentially as a result of increasing sales prices and leverage due to increased closings per community over the first quarter. Adjusted gross margin for the quarter excludes approximately $2.7 million of capitalized interest charged to cost-to-sales during the quarter representing 120 basis points and in-line with expectations. Combined selling general and administrative expenses for the second quarter were 12.7% of home sales revenues compared to 13.4% for the same quarter in the prior year. As a percentage of home sales revenue we believe that SG&A will vary quarter-to-quarter based on home sales revenue and we expect the remainder of the year to be at the lower end or slightly below our previous guidance of 13% to 14%. Selling expenses for the quarter were $17.9 million or 8% of home sales revenues compared to $13.4 million or 8.4% of home sales revenue for the second quarter of 2015, a 40 basis point improvement. Selling 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 4.7% of home sales revenues compared to 5% for the second quarter of 2015, a 30 basis point improvement. This decrease reflects leverage realized from the increase in home sales revenues during the second quarter of 2016 as compared to the second quarter of 2015. Pretax income for the quarter was $31.4 million or 14.1% of home sales revenue, an increase of 70 basis points over the same quarter in 2015. Our year-to-date pretax income was 12.8% of home sales revenue, an improvement of 100 basis points over the prior year. We generated net income in the quarter of $20.7 million or 9.3% of home sales revenue which represents earnings per share of $1.01 per basic share and $0.96 per diluted share. Second quarter gross orders were 1,535 and net orders were 1,201. Ending backlog for the second quarter was 887 homes compared to 783 last year. And the cancellation rate for the second quarter of 2016 was 21.8%. We ended the second quarter with a portfolio of approximately 28,000 owned and controlled lots. As of June 30 approximately 11,400 of our 18,100 owned lots were either raw or under development. Turning to the balance sheet, we ended the quarter with approximately $50 million in cash, $610 million of real estate inventory and $301 million in book equity. On May 27 we entered into an amended and restated credit agreement that has substantially similar terms to our previous credit agreement but increased our available revolving credit facility to $360 million which can be further increased to $400 million. At June 30 we had $260 million outstanding under the facility as well as $85 million of convertible notes outstanding. Our gross debt-to-capitalization was 52.6% and net debt-to-capitalization was 48.6%. We had approximately $92 million of capacity available to borrow under our credit facility at June 30. During the second quarter, we sold and issued approximately 594,000 shares of our common stock which generated $16.3 million in net proceeds and completed our ATM program. Since the ATM program was initiated in September 2015 we sold and issued approximately 1.1 million shares of our common stock generating total net proceeds of approximately $29.4 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 first half of 2016. Let me provide some guidance and thoughts on what we are seeing thus far in the third quarter and looking ahead into the remainder of the year. The third quarter started off with 306 closings in July compared to 311 closings in July of last year. The 306 closings came from 55 active communities, resulting in an absorption pace of 5.2 closings per community per month. Month-to-month variability is expected throughout the year. Primary factors that contribute to monthly variances, our inventory availability of both lots and homes and the timing of community openings. We continue to see strong leads and demand which were the key metrics that we monitor. Based on our current backlog, we believe we’ll close between 350 and 380 homes in August. Additional highlights of our growth and expansion across the nation include our evolving presence in Nashville, where we have started construction on our first homes. In this new market we expect to open for sales during this quarter and close our first homes by the end of the year. During July we closed five homes in our second community in the Seattle market exceeding our expectations and have started construction in our third community where we expect to begin filling later this quarter. We have also closed down our first project in the Portland market further expanding our operation in the Northwest. We anticipate closing homes in this new market and the first or second quarter of 2017. We're also making progress in Raleigh, North Carolina and have our first two projects under contract. We expect construction to start later this quarter, sales to begin in the fourth quarter and our first closings in Raleigh to take place in the first quarter of 2017. We are still expecting our community count at the end of the year to range between 62 and 67 active communities. In the second quarter we saw a nearly a 3% increase in average sales price over the first quarter. We believe our average sales price for the remainder of 2016 will continue to increase as a result of product and geographic mix as well as the favorable market conditions ending the year with an overall average sales price between $195,000 and $205,000. Our average home sales price in July was above $200,000, a new high for us and largely the results of higher entry level price points in our new markets. We expect adjusted gross margins, which excludes the effects of interest and purchase accounting, will continue to be strong. We believe that our adjusted gross margin for the year will be in our target range of 26.5% to 28.5%. Based on 2,278 closings through July and our estimate for August we believe we will close on average 340 to 400 homes per month for the remainder of the year, resulting in closings between 4,043 homes during 2016. Given our increased guidance on every sales price, our confidence in producing adjusted gross margins in the 26.5% to 298.5% range and continued strong SG&A leverage, we are raising our whole year earnings per share guidance from $3 to $3.50 per basic share to a new range of $3.20 to $3.70 per basic share. 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 revenue, community count and earnings in line with our guidance allowing LGI Homes to achieve our long-term goals and objectives. Now, we'll be happy to take your questions.

[Operator Instructions] Our first question comes from the line of Nishu Sood from Deutsche Bank. Your question please.

Thank you and congratulations on the launch of the LGI Giving, sounds really nice. So I wanted to start out just thinking about this ASP creep upwards as we talked about recently, my grading [ph] to new markets were the entry-level rental conversion prices just higher because of cost than because of land considerations. So that puts a greater pressure on LGI in terms of making sure that your cost profile stay in line. There not much you can do about land. But particularly on the sticks and bricks and labor side of things that puts particular pressure on that side. Can you describe a little bit about the initiatives that you have underway to manage your construction costs to make sure the price points stay affordable as possible?

Sure. Nishu, this is Eric. I can start with and I think Seattle is a good example of higher price points market for LGI. Our three bedroom, two bath, two car garage, 1,500-1,600 square foot home in Seattle market is about $100,000 higher than those on the Texas market. That $270,000 to $300,000 range rather than $170,000-$200,000 range. And that's a component of land cost and construction cost, primarily fees and permit. So just more expensive to do business in Seattle. How we control cost is make sure we remember that our business model is focused on being an affordable alternative to renting and one of the positive things about these new markets they are more expensive to get into an entry-level home but they are also significantly more expensive for rents. And we have found in Seattle as an example in the same way in Denver which will be another one of our higher priced markets. We are still able to offer an affordable alternative renting and then certainly from a construction cost standpoint and having access to trades we really rely on local expertise. When we go to a new market for example in Seattle we transferred two of our top managers from Phoenix and from Houston to get that area started. But we hired local construction expertise that has all the access to trades. The other factor is we are expecting lower absorption paces in these new markets as well to get started and also with that average sales price. So we're conservative in our underwriting assumptions. But that average sales price is really accretive to earnings as well.

Got it. That's helpful and you have a much broader footprint now, of course then you did when you launch the IPO. And so if you were to - and you obviously run a very, very different business model than most public builders with much more skill and focus on the sales process. So on the construction cost side now that you have a broader footprint and probably more data points to compare, more people spread out across the country, how do you believe your per square foot construction cost would compare with the other public builders based on what you see in the field?

I think from a construction cost standpoint compared to the other large public builders if we're building the same product it would be very similar from a construction cost standpoint. One of the advantages we have in our model is building spec inventory in all of our markets no matter if it's Houston or Seattle or Denver or Florida we don't offer any options at all and that consistency that we can offer trades, and that consistency in building the same floor plans over and over, and consistency with the upgrade that we offer in home. I think drives cost savings for us. And certainly, I think we got an advantage over the small, smaller private builders that don't have the observations per community or the scale that we have. So I think the large publics were certainly in line with and probably have an advantage over the smaller builders.

And given your volume now, and especially as you build presence in these local markets, you should, with no options and a 100% spec building, you should ultimately, as these operations mature have even a lower per square foot cost, I would think as your operations continue to mature. Have you quantified that? And you how much further, we know what percent could you get your per square foot cost 10% below the other builders, 5%, have you began to map that out or is that still too early given you the rapid pace of expansion?

Yes. I think. That's too early Nishu. There is no question, we go into a new market, as we add communities, as we add scale and as we get some depth in that market, we’re going to see more efficiencies from the trades. Even though, people that listen this call have an idea of LGI on a national scale or public builder have success in the markets. When you go to a new market, we still have to prove to local trade base that we can drive the absorption that we say we're going to drive. And that we're going to build the houses with no option, because it is different and they're not used to seeing that. But as we get in and add more communities improve that it to the local trades, we will get the efficiencies, no question about it.

Got it. Thanks for the color.

You’re welcome.

Thank you. Our next question comes from the line of Dan Jacome from Sidoti. Your question please.

Good morning.

Good morning.

Nice to see the Northwest finally impacting the P&L. I was just wondering the 11 closings, is that kind of in line what you were expecting internally six months ago, or this tracking ahead?

Yes. It's tracking head, if you look at our budget, probably budgeted 10 for the very first quarter of closings in the Seattle market ramping up, so we didn't have our first closing to later in the quarter. So I think it's exceeded expectations. Remember we also mentioned that in July, our second community Summerwood Park had five closings, and it's very first month of closings. We’re going to model that probably at 2, and the average sales price in that second community would have been in the $325,000 range. So five of that community really strong start. So I’d say exceeding expectations, we have our third community opening at Seattle. We're going to have grand opening next month, and have closing in the fourth quarter. And has projects 4 and 5 shortly after that. So excited about the Northwest, excited about getting Portland started, and exceeding expectations is how I would describe to start with.

Okay. Excellent. And then sorry, if I missed it, did you call out an ASP for Portland that you're thinking about?

We did not mention that on the call. But I can tell you to be very similar to Seattle and be in that $275,000 to $300,000 range.

All right. Thanks a lot. Nice job.

You’re welcome. Thank you.

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

Thanks. Good afternoon, everyone. How are you?

Very good. Thanks.

So first question I was hoping just to get a little color on the July closings. You obviously, clearly laid out your expectations for August to pick up. You said 350 to 380, and for the remainder year to be between 348 to 400, if I heard that right per month. So the dip in July, is that more attributable to just inventory availability over there any let's say markets that experienced a temporary dip in demand?

This is Eric, Mike. I appreciate the question, I would so, no, we didn't have a temporary dip in demand from a market standpoint. The second quarter absorptions per community at 6.8 was an outstanding quarter, like we talked about, we left from 6.4 the year earlier to 6.8 while adding 11 communities. Going down to 5.2, in July, closings per community, it was disappointing, month-to-month volatility had a great May with 432 closings, wiped out some inventory. So in our top performing markets like North Carolina market, Charlotte, Texas certainly had some supply issues, as far as running out of homes to sell and not having the next section of developments ready. Certainly we can always use more sales. I don’t want to mitigate that. If we had more sales, we’d more closings. But you’re correct, we project 350 to 380 closings for the month of August, and then the range we gave was really a range around six closings per month for community, more of our historical range over last couple of years, not as strong as the second quarter, but six a month per community sounds inline for the rest of the year.

Okay. And, I mean I guess just following on this before, I moved to another question if I'm able, is the 6.8 obviously was a very strong number and the strongest in a while. Do you think that’s more of a function of some of your, let’s say communities in Florida, you mentioned the strength of Fort Myers; some of the expansion that you hit on, let’s say beginning two, three years ago that are now maturing; those markets kind of coming into its own and therefore a mid-six range. As you’ve got greater percentage of your markets that are little more seasoned, is that something that you feel is possible? Or were again sort of one kind of factors that really droves that 6.8 that you think may be is not sustainable?

Well, I’d answer it in a couple of different ways. One is, as markets mature and starts grow and community count, I think it is more likely that absorptions per community increase. Because if you look at the Texas market, if you look at the Charlotte, if you look at Fort Myers we have not been adding a lot of new communities in those markets. They’ve been more stable and those are our top performing areas. We did mention, I have got the list in front of me, but Albuquerque averaged 7.8 closings per community per month in the second quarter and that was in two communities and we’ve had two communities in Albuquerque. So we’re not adding community count in Albuquerque market right now. And comparing it to some of the newer markets, like Seattle, like Colorado Springs, like Jacksonville, like Orlando, which are all down in the three, four, five closings per community, we’ve been adding a lot of community count in those markets. So we do expect as markets mature and get more stable that closings per community would go up.

Okay, that’s helpful and then just also looking at the raised guidance, just trying to dissect the drivers of that. Obviously you highlighted a higher ASP expectation. What were the other key drivers of that raise by $0.20 to 320 to 370? It appears that you reiterated the gross margin range and actually slightly reduced the high end of the closings range. So the only other thing I was looking at was possibly SG&A coming in at the lower end of your $13 million to $14 million, but any help there would be helpful?

Sure Mike, it’s Charles. So yeah you’re right on raising the ASP guidance, certainly the performance of the second quarter, as far as gross margin; even though the range overall range stayed the same. I think we have a lot more confidence in where we stand in terms of actual performance. And then exactly right on SG&A coming in below $13 million in this quarter with 6.8 closings per community. Certainly see the reminder of the year now, heading towards the lower end of that range or may be slightly below. The other factors, tax rates and everything else stays essentially the same.

Okay so, and then just last lastly on that idea. Given that you’re at 13.2 and 13.1 in the back half of '15, would you say that you expect the SG&A to be at the lower end or slightly below the 13% mark? If it were at the 13% mark, that would imply minimal leverage relative to what you’ve been able to achieve so far. Is that just based on a - kind of a 10% to 20% type of a growth rate on the top line? Or why wouldn’t we expect, as long as you continue to perform and hit your numbers that it would be a little bit below 13.

Sure. If we believe or end up in the higher end of the closing range, we definitely should be, should have some opportunity to show some operating leverage year-over-year. So there is some variability there, depending on where the top line comes into play. We’ve also have the new markets as Eric mentioned coming on in the back half of this year. So, we'll have Portland and establishing ourselves with the infrastructure we need as we go into 2017. So some of those expenses will start to come into play before we actually see results in those markets. So that’s coming into play as well.

Great, thank you.

You bet.

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

All right. Thanks everyone for participating on the call and your interest in LGI Homes. We look forward to getting back to you in next quarter sharing our achievements for the rest of 2016. Everybody have a great afternoon.

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