LGI Homes, Inc. (LGIH) Q3 2016 Earnings Report, Transcript and Summary

Welcome to LGI Homes Third Quarter 2016 Conference Call. Today's call is being recorded and a replay will be available on the company's website later today at www.LGIHomes.com. We have allocated an hour for prepared remarks and Q&A. [Operator Instructions]. At this time, I will turn the call over to Rachel Eaton, Chief Marketing Officer at LGI Homes. Ms. Eaton, you may begin.

Thank you and welcome to the LGI Homes conference call discussing our results for the third quarter of 2016. Today's conference call will contain forward-looking statements that include among other things, statements regarding LGI's business strategy, outlook, guidance, plans, and objectives. All such statements reflect current expectations. However, they do involve assumptions, estimates, and other risks and uncertainties that could cause our expectations to prove to be incorrect. You should review our filings with the SEC, including our Risk Factors 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 speaks only as of the date of this conference call. Additionally, adjusted gross margins and non-GAAP financial measures will be discussed on this conference call. The presentation of this information is not intended to be considered an isolation or as a substitute for the financial information presented in accordance to the GAAP. A reconciliation of adjusted gross margin to gross margins, the most comparable measures prepared in accordance with GAAP is included in the earnings press release that we issued this morning and in our Quarterly Report on Form 10-Q for the third 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 Investor Relations section of our website at www.LGIHomes.com. Joining me today are Eric Lipar, LGI Home's 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 third 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 on what we are seeing so far during the fourth quarter and our expectations for the remainder of 2016. Then we will open the call for questions. First I would like to acknowledge that this week we are celebrating our third anniversary as a public company. At the time of the IPO, our objective was to access capital to fuel our growth and replicate our business model across the country. In the past three years, we have expanded into nine new markets in six states and nearly tripled the size of our organization, while maintaining our culture and demonstrating that our unique operating model is sustainable. We would 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 for the third quarter of 2016, LGI Homes closed at 15,000 homes and delivered impressive results highlighted by strong year-over-year growth in closings revenue, average sales price, net income, and earnings per share. For the second time in company history, we closed more than 1,000 homes in a single quarter delivering 1,052 closings and generating over $216 million in home sales revenue. This represents a 12.6% increase in closings and a 24% increase in revenue over the third quarter of 2015. For the first nine months of the year, we closed a total of 3,024 homes achieving a 23% increase in closings and a 40% increase in revenue over the third quarter of 2015. We ended the third quarter at 59 active communities which is an increase of nine communities over the same quarter last year. The increase in active community count reflects our continued expansion outside of Texas. Year-over-year, we added four new communities in Colorado, four in Florida, and two in Washington, offset by the closeout of one community in Texas. Absorption during the quarter remained consistent with our previous performance averaging 6 closings per community per month companywide. This is a slight decrease from the 6.3 closings per community per month for the third quarter of last year however our average sales price increased by 10.4% year-over-year. Based on abortion, our top three markets for this quarter were all in Texas. Our absorption pace in Dallas Fort Worth was 9.9 closings per community per month, Houston was 8.6, and Austin was 8.1. As our leading division, Texas generated 553 closings which represents approximately 53% of our total closings during the quarter. We saw an increase in closings of approximately 13% in Texas during this quarter as compared to the third quarter of last year with one less active community. Year-over-year closings that came from market outside of Texas remains steady at 47% for both the three months ended September 30, 2016, and 2015. The Florida division and the Southwest division both experienced strong growth during the quarter. The Florida division increased closings 23% over last year and the Southwest division increased closings 18% over the same period last year. Our Northwest division now has two active communities. We closed 20 homes in the division for the quarter with an average sales price of over $325,000. This is a very strong start given that we first opened for sales in the Greater Seattle area in March and closed our first homes in June of this year. With that, I would 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 $216.3 million based on 1,052 homes closed, which represents a 24.3% increase over the third quarter of 2015. Our average sales price was $205,613 for the third quarter, an increase of $19,365 or 10.4% year-over-year. This increase is largely attributable to higher price points in some of our new markets that continued favorable pricing environment and our product mix. For example our newest markets Denver, Colorado Springs, and Seattle have average sales prices over $300,000. Our gross margin was 26.3% this quarter compared to 26.5% in the second quarter of this year bringing our year-to-date gross margin to 26.1%. Our adjusted gross margin was 27.7% this quarter compared to 27.8% in the second quarter of this year resulting in year-to-date adjusted gross margin of 27.5%. Adjusted gross margin for the quarter excludes approximately $3 million of capitalized interest charged to cost of sales during the quarter representing 138 basis points which was slightly above our previous guidance due to current sales activity in some projects with significant development. We expect capitalized interest charged to cost of sales to vary quarter-to-quarter based primarily on mix of closings and the relative capitalized interest balance from previous quarters, with an expected normalized range of 110 to 150 basis points. Combined selling, general, and administrative expenses for the third quarter were 12.8% of home sales revenue compared to 13.2% for the same quarter in the prior year. Selling expenses for the quarter were $17 million or 7.9% of home sales revenues compared to $14.1 million or 8.1% of home sales revenue for the third quarter of 2015 which is a 20 basis point improvement attributable to leverage resulting from our higher home sales revenue. General and administrative expenses were 5% of home sales revenue compared to 5.1% for the third quarter of 2015, a 10 basis point improvement. We saw our strong closings and higher ASP positively impact our bottom-line. Pretax income for the quarter was $29.5 million or 13.6% of home sales revenue an increase of 30 basis points over the same quarter in 2015. Our year-to-date pretax income of $78.7 million was 13.1% of home sales revenue, an improvement of 70 basis points over 12.4% for the year-to-date 2015. We generated net income in the quarter of $19.5 million or 9% of home sales revenue which represents earnings per share of $0.92 per basic share and $0.86 per diluted share. Third quarter gross orders were 1,295 and net orders were 942. Ending backlog for the third quarter was 777 homes and the cancellation rate for the third quarter was 27.3%. We ended the third quarter with a portfolio of 29,856 owned and controlled lots. As of September 30, 11,847 of our 18,768 owned lots were either raw or underdevelopment. Turning to the balance sheet, we ended the quarter with approximately $45.9 million of cash, $676.9 million of real estate inventory, and $330.6 million in equity. At September 30, we had $280 million outstanding under our credit facility as well as $85 million of convertible notes outstanding. Our gross debt to capitalization was 51.8% and net debt to capitalization was 48.3%. We also had approximately $73 million of additional capacity available to borrow under our credit facility at September 30. Utilizing our universal shelf registration statement, we established our second aftermarket common stock offering program during September. Under this program, we may issue and sell up to $25 million of our common stock from time to time. During September 2016, we issued 250,000 shares of our common stock under this program at an average price of $36.78 and received net proceeds of approximately $9 million. At this point, I would like to turn it back over to Eric.

Thanks, Charles. In summary, we had another impressive quarter. Now looking forward I will share our observations on what we are seeing thus far for the fourth quarter and the remainder of the year. The final quarter of 2016 has started strong with 351 closings in October, a 33% increase over the 264 closings in October of last year. These 351 closings came from 61 active communities resulting in an absorption pace of 5.7 closings per community per month. The two additional communities added during October reflect our continued expansion across the country. October marked our first month of closings in the Nashville market. We're off to a great start in this new market closing four homes in our first month. We also added our third project in the Seattle market during October. This project had a solid start with three closings in October with an average sales price of over $285,000. During October, we closed on our first project in the Portland market further expanding our operation in the Northwest. We're planning our grand opening next month with closings expected during the first quarter of next year. We're also making progress in the Raleigh-Durham market where we have started construction in our first community. We are looking forward to the grand opening in December and expect our first closings in this new market to take place in the first quarter of next year. Based on our results today, we believe we will close a similar number of homes in November as we did in October 2016 and end the year strong with closings between 4,000 and 4,300 homes right in line with our previously stated guidance. We expect to add one or two new activity communities during the remainder of the year ending with 62 or 63 active communities. Quarter-over-quarter our average sales price increased over 4%. We believe our average sales price for the remainder of the year will continue to increase as a result of product and geographic mix as well as favorable market conditions ending the year with an overall average sales price between $195,000 and $205,000. Additionally we expect our adjusted gross margin which excludes the effects of interest and purchase accounting will continue to be strong. We expect adjusted gross margin for the fourth quarter to be similar to the first three quarters of the year. Given our results today, we continue to believe basic earnings per share will be in the range of $3.20 to $3.70 for the year. Looking ahead to the future, we believe LGI will one day have a presence in the majority of the top 50 markets in the United States. As we make progress toward achieving this goal, I'm excited to announce that we've our first project under contract in Minneapolis. We are currently in the test marketing phase and the results are looking great. We plan to continue to look at acquisitions in this new market and we anticipate our first home closing in late 2017 or early 2018. In addition, we are actively looking for opportunities to begin operations in the Las Vegas market in 2017 as well. Finally, with our continued planned expansion in both new markets and existing markets and assuming other market factors remain comparable to our experience in 2016, we believe, we'll increase our community count by at least 20% during 2017. In addition, we believe our gross margin, overall absorptions, and SG&A as a percent of revenue will generally remain consistent into the next year. We plan to provide more specific and expanded guidance on our next call. In summary, we believe we will end the year strong and continue our growth and momentum into 2017. Now we'll be happy to take your questions.

[Operator Instructions]. And our first question comes from the line of Michael Rehaut from JPMorgan. Your line is now open.

Hi, it's actually Jason Marcus on for Mike. First question just on the solid ASP increases that you're seeing across the company. Just want to get a sense of -- if for you what percentage of that is a true price versus mix? And then as you look across your footprint, have you encountered any affordability issues among your buyers as your price point has increased?

Yes, I think most of that, Jason thanks for the call. This is Eric. Thanks for the question. Most of it is new geographic expansion, certainly getting more closings in the Colorado market as well as expanding into Seattle and having closings up there in the Northwest, this quarter certainly added to our price point, average price point increasing 4% over the quarter. Like we said in our scripts that that price increase, average sales price is going to continue to increase as a percentage of out of states closings outside of Texas continues to increase. That being said we also on apples-to-apples comparison, we do believe that our average sales price will continue to increase because we believe that cost will continue to increase, well there is the cost of land, the cost of fees, the cost of labor, forward-looking we believe possible and continue to increase and we will need to adjust our pricing to reflect that.

Okay. That's helpful. Next question just on the competitive environment, you heard a lot of other builders talking about an increased focus on first-time buyer, just wanted to see, what you guys are seeing on the ground and sort of continuing to increasing competition and I guess generally how incentives have trended across the markets that you operate in?

Yes, I think that's real positive for us. The entry level buyer is getting a lot of positive news coming back, moving out of their parent's house. We are seeing continued strong leads coming in for people that want to get out of the rental situation and get into home ownership. So we're very optimistic on the first-time homebuyer and I think a lot of other builders are seeing that as well and wanting to get into this space. Increased competition, we do not believe is going to have an effect on LGI operationally. We won't be changing our closing forecast or absorption paces based on increased competition because we think it's very favorable market out there. So it's all positive for us.

Okay, great. And then lastly just on the gross margin, you had a pretty consistent track record over the last couple of years of having a stable gross margin, wanted to get a sense of when you're underwriting your new land deals particularly when you're looking at some of the newer markets, how should we be thinking about the underwriting criteria that you're underwriting to?

Look we underwrite the same criteria as we always have since 2003 and I think that's one of the reasons our gross margins have always been consistent. So no matter what the market we underwrite with same adjusted gross margin of at least 25% and every region in the country this last quarter had a gross -- adjusted gross margin above 25%. So we're right on track.

Thank you. And our next question comes from the line of Nishu Sood from Deutsche Bank. Your line is now open.

Hi this is actually Tim Daley on for Nishu. Thanks for the question. So first I would like to dig a bit into the community count guidance. So obviously the top-end of the range is a bit lower at 67 from or sorry 63 from 67. But I just wanted to get a little bit of color on to what is the -- what's kind of behind that lower number and then as well is the 20% year-over-year growth that you're guiding to 2017 is that based on ending or average community count?

That's based on average community count. So we believe we will end the year 2016 at 62 or 63 and then end the year 2017 with community count at least 20% above that number. Going from 67 at the high end of a range last quarter to pulling down to 63 combination of a couple of things, one is our grand openings are scheduled in December, so in Portland and Raleigh. So likely those closings are going to fall into January or February and that's when they will count as a community rather than December, so one or two months make a difference in community count. So the communities that would have resulted in 67 are still going to happen, they are just going to get delayed into the first quarter of next year and we also had a community in Houston because of great sales pace closeouts that we thought may have been around till the end of year but it actually is closed out in October so that no longer counts as a community as well and that's a subtraction of one.

All right. And then just kind of digging into the absorption pace and then to the closeout of 2016 and then just kind of starting next year, last there were some period of strength in December and then as well now that you're kind of guiding to a lower count with the same closing range, I just wanted to understand how absorptions will the year-over-year comps and absorptions will react to this. And then as well since you're opening up a lot of communities in early in the year would that imply that weaker absorptions in start of the year or is the strength that you're seeing able to offset that? Thank you.

Yes, we said it on the earlier remarks that we expect November to be similar absorption and similar closings to October, and December is traditionally a very strong month for us. Last year the numbers were a little bit more heavily weighted to December than November. Some of you may remember implementation of TRID last November pushed some of our November closings into December. So we closed 249 last November which is going to make for a very easy comp in this year's closings in November. And then 433 in December which was the best month we ever had and a very strong month, it's going to be tougher comp. And then in the first quarter as it's always the case for us, January and February closings will be substantially lower compared to other months because that is based on sales between November 15 and through the holidays and the first of the year. So historically December is very strong for us and then January and February are weaker as far as closings go.

All right, that's very helpful. And then just my second question is when comparing to new markets that you're entering particularly in the Pacific Northwest, is there any change in kind of the ratio of flyers to call and call to appointment that traditionally you guys have the system set up and very calibrated specifically for a meeting set absorption paces. Just kind of talking about the markets do they come in as you expect or you kind of initiating at the same level. Thank you.

Sure, sure. From a revenue per community standpoint that would be very similar, most of our underwriting is based on around $1 million per community per month in revenue. So what we're seeing in the more expensive markets like a Denver market or a Seattle market we're seeing absorptions being more in the three to four range but with the average sales price in the high 2s if not the low to mid three's. So you get less volume of homes at that price point as a response to the mailer but usually you're getting more qualified buyers at that price point as well. So less abortion higher average sales price, similar gross margin, similar SG&A expenses as a percentage and operating margins are very similar in every market across the country.

Thank you. And our next question comes from the line of Stephen East from Wells Fargo. Your line is now open.

Thank you. First of all, I was wondering if you could give us any update on what's happening in the mortgage market and if you're seeing any easing in trends?

Sure. Stephen this is Eric. Thanks for the question. Yes we're seeing out there slight easing but not a big material difference. So I would classify the mortgage availability for the consumer as very similar as it's been over the last year or two. We predominately are focused on FHA as a source for our customers. FHA makes up approximately 70% to 80% of our business and slight easing I would say but generally very similar conditions.

Okay. And then can you give us some color on what caused that during the quarter versus your kind of on a square foot basis versus your price increase?

Sure this is Charles. It was relatively flat for us quarter-over-quarter. So not a lot of change nothing of significance that we couldn't absorb in our normal practice of kind of evaluating sales prices and looking at the fit and finish in houses, so.

Okay. And then can I get an update on the rollout of your townhouse strategy, if you have any of those communities in place yet?

We've got a couple of communities nationwide where we're selling attached products, not necessarily a strategy other than we think we will be doing more attached products in the future just because of affordability. So we have attached product that we're currently selling in Florida, in Charlotte, currently it's going well because it's affordable product, which usually generate higher volumes. We do have attached product coming online in New Mexico and Colorado really soon.

Thank you. [Operator Instructions]. And our next question comes from the line of Daniel Jacome with Sidoti. Your line is now open.

Couple of quick housekeeping questions, I think Charles you broke out the backlog units, do you have the dollar value I'm just trying to get a sense of the backlog ASP?

Sure. Give me just one second.

Yes.

Great, thank you. Yes, ending backlog value at the end of September was $165 million approximately on 777 units.

Right, okay. And then on leads, I know it's been a while since you guys gave that to us on the conference call. Historically you've been I think 65,000 per quarter, do you have that or you guys still in that range or doing better, where do you stand on that, I'm curious.

Yes, we’re still in that range, we're approximately 60,000 leads in the third quarter. That is people that either called or emailed regarding home ownerships, so very similar number.

Okay. So and then on November obviously just a week but off to a pretty good start, is that I know it's only a week but is it across the entire portfolio was it one or two reasons that was driving that?

No, I think across the entire portfolio everything. Everybody is excited about the end of the year and sales are strong. A lot of people are shooting for end of the year bonuses and recognition, so end of the year strong.

Thank you. And I do have another question from the line of Barry Haimes from Sage Asset Management. Your line is now open.

Thanks guys. Great quarter. I have two questions one is you talked about the up 20% community count next year, is it fair to say SG&A would be up smaller percentage than that and then I have one follow-up question.

Sure, Barry. This is Charles. Couple of things as we mentioned, we'll give a little bit more specifics in the next call on 27 SG&A but couple of factors we've got our Sarbanes-Oxley coming in next year. We also did a system implementation this year, so that will factor in as well, so there is a potential but we'll give a little bit more detail on the next call.

Got it. And second question your larger competitor has come out or they on sort of derivative product aimed at the active adult market and I'm wondering if that's something that you looked at and if you've any thoughts about that. Thanks.

Yes, we've looked at a little bit. We actually have one community in Phoenix that's focused on the active adult buyer and that was a position that came up that was an opportunity to buy finished lots at a competitive price that we took advantage of. So we're just building houses and selling in a big master plans, it's a got a golf course and menu center. So I think we will look at those opportunities in the future, if there is an opportunity to buy lots that are finished whether it's not huge capital investment, we go on there and build and sell, we'll be successful selling to the active adult clients. I do not believe we will get into a community where we're going to put a ton of upfront capital into infrastructure and build golf courses or big clubhouses or anything like that.

Thank you. And I'm showing no further questions at this time. I'd like to turn the call back over to Mr. Eric Lipar for closing remarks.

Thank you everyone for participating on the call. If you're interested in LGI Homes, we look forward to speaking with you on our next call as we reveal how the rest of the year unfolds. Thanks.

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