LGI Homes, Inc. (LGIH) Q1 2017 Earnings Report, Transcript and Summary

Welcome to LGI Homes First Quarter 2017 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, Sandra. Welcome to the LGI Homes conference call discussing our results for the first quarter of 2017. 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 2017. 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 in isolation or as a substitute for the financial information presented in accordance with 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 three months ended March 31, 2017 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 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 our performance from the first quarter of 2017. 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 for the second quarter and our expectations for the remainder of 2017 before we open the call for questions. To begin today, we’re pleased to announce that Builder Magazine has released their rankings for the 2017 Builder 100. We’ve come a long way over the past 10 years when we built exclusively in Texas and were ranked as the 151st largest builder in 2007. This year we held strong as the 15th largest builder for the second year in a row based on our 4,163 home closings in 2016 and I’d like to take a moment to extend a special thank you to our dedicated employees at LGI. Because of you we’ve been able to realize strong growth throughout the years. Looking at the first quarter of 2017, the year is off to a solid start. We closed 761 homes generating approximately $163 million in homes sales revenue which represent the slight increase in revenue over the first quarter of 2016. Year-over-year closings were lower than last year primarily driven by lack of finished home inventory and [indiscernible] but we saw an increase in average sales price which offset our lower volume. We continue to demonstrate our ability to expand our business to new markets. We ended the first quarter with 69 active communities which is an increase of 13 over the 56 active communities that we had at the end of the first quarter last year. These communities were spread throughout the nation with three in Seattle, two in Orlando, Denver and Nashville and one each in Austin, Albuquerque, Phoenix, Colorado Springs an our newest markets of Portland and Raleigh, net of two communities closing out on the Dallas Fort Worth market. Breaking it down by market, let’s first take a look at the results of our Texas operations. The fundamental of this division have remained solid generating 315 closings and representing approximately 41% of our total closings during the quarter. This compares to 410 closings or 49% of our total closings during the first quarter of last year. This year-over-year decrease is primarily due to lack of available inventory and the closeout of two communities in DFW. We continue to geographically diversify our operation, our presence outside of Texas increased during the first quarter to 59% of our closings compared to 52% of our closings in the first quarter of last year. The Southwest division represented 17% of our home closings. The Southeast division represented 20%. The Florida division represented 16% and the Northwest division represented 5%. Historically, we have seen lower absorption rates in the first quarter. This quarter our top market was Nashville leading the way with 5.4 closings per community per month, a direct result of our successful grand opening of our second Nashville community during December of 2016. Charlotte was our second leading community this quarter with 5.3 closings per community per month and Huston in third remain solid at 5.2. Our marketing folks on [indiscernible] are living in close proximity to our communities. We have seen continued increase in demand for home ownership with our advertising producing over 80,000 inquiries during the first quarter of 2017 reinforcing our belief that that there is strong demand in the first time home buyer segment. In addition housing demand drivers are alive and well in all of our markets including nationally leading population and employment growth trends, general housing affordability and desirable lifestyle characteristics. With that I would like to turn the call over to Charles Merdian, our Chief Financial Officer for more in-depth review of our financial results.

Thanks Eric. As mentioned earlier, homes sales revenues for the quarter were $162.9 million a slight increase over the first quarter of 2016. Sales prices realized from home closed during the first quarter range from 140s to $480,000. In the first quarter, approximate average sales prices were $206,000 in Texas, $251,000 in our Southwest division, $184,000 in our Southeast division, $197,000 in Florida and $321,000 in our Northwest division. Our overall companywide average sales price was $214,075 for the first quarter and a 11.2% year-over-year increase and approximately 3% increase over the average sales price for the fourth quarter of 2016 of approximately $208,000. This is largely attributable to changes in product mix, price points in new markets and favorable pricing environment. Gross margin as a percentage of sales was 26.7% this quarter compared to 25.5% for the same quarter last year. Our adjusted gross margin was 28% this quarter compared to 26.7% for the first quarter of 2016, a 130 basis points increase. Adjusted gross margin excludes approximately $2.1 million of capitalized interest charged across the sales during the quarter representing 127 basis points. Combined, selling, general and administrative expenses for the first quarter were 16.8% of home sales revenues, compared to 14.8% in the prior year. We typically expect the first quarter to have the highest SG&A ratio due to lower closings on our per community basis. We believe that SG&A will vary quarter to quarter based on home sales revenue and for the full year we expect SG&A as a percentage of revenue to be similar to our 2016 results. Selling expenses for the quarter were $16.1 million or 9.9% of home sales revenue compared to $14.1 million or 8.7% of home sales revenue for the first quarter of 2016, a 120 basis point increase. The increase in selling expenses as a percentage of home sales revenue is due to an increase in advertising related expenses in both new and existing markets. General and administrative expenses were 6.9% of home sales revenues compared to 6.1% for the first quarter of 2016, an 80 basis point increase. The increase in general and administrative expenses as a percentage of home sales revenue reflects an increase in overhead related to our ongoing expansion and lower closings on our per community basis. Pre-tax income for the quarter was $16.8 million or 10.3% of home sales revenue, a decrease of 70 basis points over the same quarter in 2016. As a result of the recently adapted accounting standard, our effective tax rate of 30.1% is lower than the statutory rate due to the tax benefit of deductions in excess of compensation cost or wind falls per share based payments that impact this quarter's tax rate. We expect our effective tax rate for the remainder of 2017 to be similar to the 2016 rate of approximately 34%. We generated net income in the quarter of $11.8 million or 7.2% of home sales revenue which represents earnings per share of $0.55 per basic share and $0.52 per diluted share. Weighted shares outstanding for calculating diluted earnings per share are impacted by our outstanding convertible notes. In the first quarter of 2017 our average stock price was approximately $30.50 exceeding the conversion price and therefore the convertible notes were determined to be dilutive under the treasury stock method. This resulted in approximate 1.2 million share increase to the weighted average shares outstanding for the diluted EPS calculation for the quarter. First quarter growth orders were 1,734 and net orders were 1,402. Coming off the record breaking quarter are the end of 2016 for homes closed, we began the year with the backlog at 446 which was lower than the prior year and a contributing factor to our year-over-year decrease in homes closed in the first quarter. Our backlog as of March 31 was 1,087 homes compared to 814 at the end of the first quarter of last year and the cancellation rate for the first quarter of 2017 was 18.9%. We ended the first quarter with a portfolio of approximately 29,300 owned and controlled lots and as of March 31, approximately 12,400 of our 20,800 owned lots are either raw or under development. Turning to the balance sheet, we ended the quarter with approximately $32 million of cash, $789 million of real estate inventory and total assets of $868 million. As of March 31, we had a total of approximately 2,150 homes complete and in progress compared to 1,560 as of December 31 increasing our investments in vertical construction by over $50 million this quarter in-line with our increase in backlog during the quarter. In February of this year we increased our revolving credit facility to 400 million in accordance with the accordion feature of the Credit Agreement. At March 31, we had $350 million outstanding under the facility as well as $85 million outstanding in convertible notes. Our gross debt capitalization was approximately 53% and net debt to capitalization was 51%. Also during the first quarter, we issued a 150,000 shares of our common stock under the 2016 ATM program, generating net proceeds of approximately $4.7 million. At this point, I would like to turn it back over to Eric.

Thanks, Charles. 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. Closings for the first four months of the year have a solid hold a -- which is 9.8% less than a 1185 closings that we start the last year with. The primary reason that our closings are down year-over-year as that we had strong closings in December 2016 and our inventory has completed homes during Q1 was not as high as we would have liked. As Charles mentioned, we entered 2016 with 1560 homes at various stages compared to 1710 homes at the end of 2015 giving us fewer homes to close in the first quarter. We believe the situation will correct itself for the next few months as we are bringing a new inventory online with additional homes under construction and the completion of new development sections. As we continue to build back our inventory, we are continued to sell homes. Sales over the last 90 days have been very strong. We have had over 500 net sales in each of the month of February, March and April. We currently have more homes under contract than we have had at any one time in our company history. We expect our inventory levels to increase in May, trending back to targeted levels over the second quarter and in line with our strong sale performance. Based on our backlog, we expect to close between 450 and 500 homes in the month of May, resulting in an absorption pace north of six closings perking in the current month and right on track to meet our goal of closing more than 4700 homes for the year. We ended April with 71 active communities continuing on pace to end the year between 75 and 80 communities. New projects will be introduced in both Minneapolis Minnesota and Winston-Salem North Carolina by the end of the year and we will have continued expansion in Nashville, Houston, Dallas, Charlotte, and the Seattle markets. We believe our average sales price will continue to increase during 2017 just as it had in the first quarter, ending the year with an average sales price between $210,000 and $220,000. We also expect our gross margin to be in the 25% to 27% for the remainder of the year and adjusted gross margin for the year will continue to be in our historical range between 26.5% and 28.5%. Given our guidance of delivering more than 4700 home closings along with an increase in average sales price and consistent gross margins, we continue to believe our basic earnings per share for the full-year 2017 will be between $4 and $4.50 per share. Now, will be happy to take your questions.

[Operator Instructions] Our first question comes from the line of Jay McCanless with Wedbush. Your line is now open.

Hi, good afternoon guys. Thanks for taking my questions. The first one, much better performance on gross margin than we expected. Could you talk about how much that was price versus mix?

Sure. This is Charles. So, predominantly mostly price but a combination with in the last quarter’s call we also talked about some cost initiatives that we implemented at the end of the summer and into the fall. So, we again got to see some those benefits that carried into the first quarter as well. And that's why we had a better than expected performance in the first quarter.

Yes. I mean, on a percentage basis, how many of your communities do you think you'll be able to raise prices right now if you look across your whole footprint?

Yes Jay, this is Eric. I think we're raising prices pretty much consistently in every project nationwide because we're continuing to see costs go up. And everybody's been talking about lumbar cost going up but we're finding that across the country whether it's the price of develop lot, the fees coming out from cities, the cost of lumbar, the cost of concrete. Generally it's more expensive to build a house today than it was 90 days ago. So, we're consistently raising prices, so we keep that gross margin consistent.

Okay. And then the last question I had, with the expansion to some of these geographies where Minneapolis you may have some weather issues or Winston-Salem, I mean, not Winston-Salem but some of the other North West geographies. Is it going to make your backlog run a little bit longer, you think your cycle times for the company are going to be moving out because you're going into some of these different areas where weather might push out closings?

Yes. I think that's going to happen be built in our schedule. I mean, we don’t talk about weather here at LGI very often but certainly in those markets where you have to deal with the climates more so than in Texas, our build schedules tend to be a little bit longer, well but we don’t anticipate the build schedule in those markets being any longer than five to 10 days longer than we're building in Texas.

Okay. Sounds great, thanks guys.

Okay.

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

Thanks. So Eric, you folks have had a month or two even here and there in your history where you've had inventory fall a little bit, impact closings and then the issue resolved itself usually pretty quickly. This is the most persistent inventory problem in my recollection that you have had since you've been a public company. What is the real cause of that? I mean, if I look back over time, your discussions of labor are far less frequent, I mean, if at all I think compared to most builders out there, weather has not been a factor and all of a sudden here at the beginning of 1Q, at the beginning of '17 it just seems to have become a persistent problem across more than a quarter. So, if it's possible, what is driving that at the end of the day?

Yes, sure. I think this year it was a combination of a few different factors. And you're correct. And we have room to improve on that. A couple of different things. One is we just flat out did not start enough houses, we dropped the ball, in some cases we just didn’t start enough houses to build up the inventory for the first quarter. Also, construction times we just had the question the construction times. We got room for improvement nationwide and reducing our construction times. The construction times in some of our newer markets are not where we want them today. And also from a development standpoint, getting plans and cities to approve our plans and getting new development sections on the ground especially in the Dallas Fort Worth market which is where we're really short of inventory and we closed out two separate communities. That had an influence. And the obviously we don’t want to not say sales, were an issue either, the inventory was predominant reason we were last year-over-year on closings, but we can only use more sales. I mean, January and we talked about this on last call, January sales were down year-over-year but February, March and April have been like I said over 500 net sales a month. So, I think is a combination of factors and issue, but anchor inventory is going to be in line and we're not going to be talking about inventory any more over the next couple of quarters.

Got it. As you addressed the issues, have there been any repercussion so far of this longer than typical inventory problem. Could there be any repercussion going forward? What I'm thinking about is did you lose sales from not having enough inventory as you catch up here, are you worried about cost creep. For example, are you worried about still being able to start enough homes from a labor perspective in the efforts to catch up on inventory? Do you think any quality issues might creep up? Are there any kind of secondary repercussions from a situation that’s risen here but have already happened or you're worried about for the rest of the year?

No. I think it's not material. I mean, we worry about those issues you talked about, I mean, certainly from a contract standpoint. The longer customers are under contract and I think this is the case with every builder. The longer it takes from the contract signing to closing, the better chance that life's going to get in the way and something happens and that deal has a higher percentage of not closing. Now, I don’t think that's going to be a material number for us but I do think we will probably lose more as that it's extended. And as far as the quality, I'm not concerned about quality, the cost, like I said earlier the cost will continue to grow up, so the longer takes us to start houses and get them close, I think the cost will go up. I think we've got that built into pricings. I think our margins are going to remain consistent.

Got it. Yes, your closings at 18% don’t look, they don’t look too bad for 1Q. So, I imagine you're talking about looking forward. I mean, 18% sounds like a pretty normalized public builder, I mean, we obviously not a typical builder. So, but that hasn’t happened to-date. So, that's just a potential you're talking about.

Correct. Yes, I just think based on our history of selling houses, it takes an average 30 days longer than it did to close houses. You will lose some percentage of those deals. So, our business model is converting renters and the home owners. And ideally we have the house finished so the customer can look at it and we can close in the next 30 to 45 days. And the longer that it gets it extended, there will be more deals that cancels. But like I said, I don’t think that's going to be a material amount. We need to do a good job of keep the customers engaged and keep them informed and keep them excited. So, but there will be situation where the customers life gets in the way and it will lead to some but not much.

Got it. And one final one on Houston. I can't remember another, Houston is thought as a very important market. I think it's maybe still one year within top markets. The closings pays, the closings absorptions there have always been eight plus. I mean, I think you're even exceeded nine a few times. This is the first time I think I can remember where it ranked third and nor first, basically. How should we think about that, is this the new norm going forward for Houston, it's kind of convergence of some of the other ones, I think you said Charlotte was number one, I can't remember but --.

Yes.

Or is that the closings or is this the inventory issue and Houston will be back up there again as the year progresses.

Yes. I think Houston's been in our top three in issue. I mean Charlotte's been strong for us, Dallas was actually a number one community last year in closings surpassing Houston. So, Houston for the first quarter of last year averaged 5.8 closings per community and this year we averaged 5.2. So, slightly down this year but Houston's going to continue to be a strong market for us. That number in the second quarter will certainly be over six closings per month per community. So, Houston feels good as it always has.

Okay. Thank you.

You're welcome.

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

Thank you. Actually this is Paul Przybylski on for Stephen East. First of all with respect to your gross margin guidance. I was kind of wondering how the progression, how that will progress through the year given the 26.7 in the first quarter that kind of imply the midpoint that it would might trend down some for the remaining quarters?

Yes. This is Charles, Paul. It definitely we believe that there's a wide range and there is a number of factors that come into play on a quarter-to-quarter basis on gross margin. Introduction of new markets, transition between communities within our existing markets. Eric mentioned and we talked a little bit about some of the labor and material headwinds that were constantly really kind of see on a regular basis, all of that offsetting with increased average sales prices. So, I think it's more of a function, 2015 and 2016 both came in at an adjusted gross margin at 27.8%. So, if we think we come in somewhere in and around that number is how we would define being consistent.

Okay. And then you've mentioned you had some increased advertising cost this quarter. Did you see an increase in customer enquiries from that spend?

Yes, we had. Yes, we had over 80,000 leads in the first quarter this year, sailed up at least 20% over last year. So, we spend additional dollars primarily as a result of having more communities. So, we keep it pretty consistent on per community basis. But we are definitely seeing the results of that additional spend.

Okay. And the final question, and is to Dallas Fort Worth community has been replaced or will they be coming on the replacements come online soon?

Yes. They're going to be coming online over the next 90 days and that's a big part of us talking about getting our inventory back in line Dallas Fort Worth is a big part of that so we are looking for pretty big numbers out of that market over the next 90 days.

Okay, great, thank you. I Appreciate it.

Thank you. And our next question comes from the line of Carl Reichardt with BTIG. Your line is now open.

Hi guys. How are you?

Great.

I have question, in Nishu’s about construction times, I just wanted to follow up. You talked Eric about reducing them, is that a function in new markets altering mix downstream a little bit within sub contractors or what's specifically do you do to get those construction times down on those houses up faster?

Yes, I think it's gaining, we entered new markets, our construction times in Texas has historically been quicker if you will than the new markets out of states and in the markets we have been in longer like a Florida market or Charlotte market. We are in pretty good shape there on our construction time lines and that on our newer markets like Nashville and Denver and even the Northwest we are still working again on that construction time line down and it really comes with lot of experience learning our systems, but also getting credibility in the market, getting access to the trades, as we open up more communities and can produce more volume that should come down as well building that relationship with our trade partners.

And Eric between the markets the sort of longer cycle time market versus shorter, what would be roughly the differential in days or weeks in your mind if you could give me some rough idea?

Yes, we are building to a schedule of 50 to 60 calendar days in the Texas markets from the time we started pushing dirt until the home is complete. And our out of state markets it's running 15 to 30 days longer than that and we think we can improve on that by 5 or 10 days.

Perfect. And then one last question just on community count for [indiscernible] so 71 at the end of April 75-80 at the end of the year is that ramp going to be relatively consistent to the balance of the year and then what number of those communities won't produce delivery/revenue in 2017?

Yes this is Charles. Yes it will pay [indiscernible] relatively even out for the remainder of the year. We will have net communities net of some other community close outs that we are expecting. And then you are also right in terms of the communities that we add in the late to back half part of the year generally tend to count as a community but don't contribute the significant number of closings until the following year.

And roughly how many of those Charles do you think that will be to 75-80 year end net of close outs what will have that won't be producing?

Yes probably around five of those I would say. Yes.

Perfect. Thanks a lot that was appreciated.

You are welcome.

Thank you. And our next question comes from the line of Michael Martin with Michael J Martin Associates, your line is now open.

Hi thanks for taking my call. Just little more on the inventory I believe I read that these is zero shortage of labor in the home building industry as a result of lot of people going out of it after the big disaster going back, is that a problem?

This is Eric speaking. It's not going to be a problem for us getting our inventory back in-line because we have already got that scheduled out and in progress. We are comfortable that we can deliver enough houses because labor, I think where labor does come into play and I think this is a challenge for the industry is, labor is tight and some markets and we have to pay up for it. So I think it’s more of a margin headwind than getting the houses built.

Great and then in terms of going forward over the last, next couple of years just the rough calculations you did about 759 homes in the 2015 and then so for 2016 strategy you’re look around plus 538 this year what kind of goals do you have over the next several years?

Yes we haven't given specific guidance or anything outside of 2017 so 4,700 homes in 2017, but we have talked about before on the call and will reiterate that we are going in the new markets we continue to grow obviously, continue to grow and our goal is to get into the top ten we talked about on the call today we are top 15 builders right now our goal is to get into top 10 over the next few years and eventually top five builders in the United States.

Great. Thanks so much.

You are welcome.

Thank you. [Operator Instruction] Our next question comes from the line of Michael Collins with Boston Advisors, your line is now open.

Thanks for taking my call guys. Just it relates to achieving guidance of 4,700 homes for the year some quick [indiscernible] you guys will need six closing per community with about 76 or 77 active communities on average. Do you see any issues hitting those numbers or what is the biggest kind of hiccup as the first four month of the year, your average closings per community were 2.6, 3.4, 5.3 and 5.1 just wanted to get a little guidance or clarity on that?

Yes good question Michael. I look at it from an absolute numbers but you are correct in your math on a per community basis. So to get to 4,700 we basically have closed 450 houses per month the rest of the way for May on and we said on the call that we are comfortable based on the division presidents and what they said we can count on the close this month between 450 and 500 closings in May. And also based on our pipeline the next 90 days of closing looks real clear to us so I am very comfortable saying in May, June and July we can average 450 closings per month which is where we need to be for the year so that's why we think we are right on track with that 4,700 number. Now once you get past July and get in August to December obviously not as confident of that although there are historical trends because we know the phones are going to keep ringing and we are going to have closings. But we just haven't got into a lot of sales that's going to impact the back half of the year yet. But the next 90 days averaging 450 closings a month and putting us right on track for the 4,700 gives us good confidence in that number.

Great. Just a quick follow-up to on the active community count, do you guys ever give guidance on the depletion level of those that could skew some of those numbers for example 25% of those active communities are like 85% sold if you could kind of give misleading number in terms of what – how many active communities there really are?

Yes, I mean the active communities is defined by information centers or sales team that are open and have closings but you are right transition and then that part of the inventory challenge in the first quarter we had a lot of communities transitioning from one community to other. They were still having closings, but closings definitely got bumpy if you will. So the goal is to stay in each sub market and stay consistent we mentioned on the call we had two communities in DFW close out, so it reduced our community count by two compared to last year to make some of that but we want to stay pretty consistent in each sub market and replace the communities that we are currently selling in.

Great. Thanks Eric.

You are welcome.

Thank you. And I am showing no further questions at this time. So I would like to return the call to Mr. Eric Lipar for any closing remarks.

Alright, thank you and thank you everyone for participating on today's call and your continued interest in LGI Homes. Everybody have a great day.

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