LGI Homes, Inc. (LGIH) Q2 2018 Earnings Report, Transcript and Summary

Hello and welcome to the LGI Homes Second Quarter 2018 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. Mrs. Eaton, you may begin.

Thank you. Welcome to the LGI Homes conference call discussing our results for the second quarter of 2018 and the six months ended June 30, 2018. 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 2018. All such statements reflect current expectations. However, they do involve assumptions, estimates and other risks and uncertainties that could cause our expectations to prove to be incorrect. You should review our filings with the SEC, including our risk factors and cautionary statements about forward-looking statements section for a discussion of the risks, uncertainties, and other factors that could cause our actual results to differ materially from those anticipated in these forward-looking statements. These forward-looking statements are not guarantees of future performance. You should consider these forward-looking statements in light of the related risks and you should not place undue reliance on these forward-looking statements, which speak only as of the date of this conference call. Additionally, 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 measure 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 quarter ended June 30, 2018 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 cal, I will summarize the highlights and results from our record breakeven second quarter and for the first six months of 2018, then Charles will follow-up to discuss our financial results in more detail. After he has done, we will conclude with comments and what we are seeing for the third quarter and our expectations for the remainder of 2018 before we open the call for questions. First, I would like to thanks all of our employees for their hard work, dedication and loyalty to LGI, because of your outstanding performance, we are proud to announce that we delivered a very impressive quarter highlighted by record setting revenue. This quarter, we also set new Company records for average sales price, active community balance, net income and earnings per share. We would also like to thank all of our employees and outside partners that helped in our acquisition of Wynn Homes the 129th largest builder in the country. In 2017 Wynn Homes sold 312 homes across Central and Eastern North Carolina. We believe this acquisition will give us a strong foothold in the Raleigh-Durham market where we currently only have one active community. With the acquisition LGI Homes getting a 4000 owned and controlled lots in prime locations primarily throughout the Raleigh-Durham markets. These lots and communities increased our exposure to first-time homebuyers and will expand our footprint to costal Carolina. As part of the purchase, three communities that were focused on the move up buyer along with the real estate assets located in the FayetteVille market were excluded. We believe this to be an opportunistic purchase for LGI Homes and Charles and I will provide more color on this transaction and what it means for LGI later in the call. For the quarter, we closed 1815 homes generating approximately $420 million in home sales revenue. This bring us to a record 3059 closings through the first two quarters more than 34% increase over the first six months of last year. For the second quarter, we average an industry-leading 7.8 per closings per community per month Company wide. This absorption pace of 7.8 closings per community per month was an increase from the second quarter of last year and is the highest absorption pace of any quarter since we became a public Company. Our top market on the closings per community basis was Dallas Fort Worth, at 12.4 closings per month, followed by Charlotte at 10.6, Seattle at 9.9 and Huston at 9.8 closings per month. It is also worth mentioning that our one community in Raleigh average 9 closings per month in the second quarter. We ended the second quarter with a total of 79 active communities, which is a net increase of eight over the 71 active communities that we had at the end of the second quarter last year. In addition to adding more communities we also began sales in three new states during the second quarter. We held grand opening events in our first communities in Alabama, California, and Oregon. All three opening exceeded expectations and are already producing closings for the Company. Another highlight of the second quarter was an increase in closings in our North West division. This quarter we closed the 145 homes in this division compared to 64 homes closed in the second quarter of last year which is an increase of more than 125% year-over-year. Another highlight of our record-breaking second quarter was the strength of our wholesale business. We closed the 103 homes this quarter with three different investment groups at an average sales price over $260,000. This included 30 of the 47 homes that make up our first community located in the Seattle market that was sold exclusively through our wholesale channel. We believe opportunities like this are accretive to our business and offer us an avenue for potential growth. Our markets continue to have strong housing demand drivers, including nationally leading population and employment growth trends, general housing affordability and desirable lifestyle characteristics. We continue to see solid demand across all of our markets as we continue our focus marketing directly to renters living within close proximity to our communities. Our advertising produced nearly 100,000 inquiries in the second quarter strengthening our belief that there remains a strong in the first-time home buyer segment. 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. Home sales revenues for the quarter were $419.8 million based on 1815 homes closed, which represents a 29.5% increase over the second quarter of 2017. Sales prices realized from homes closed during the second quarter range from the 140 to over 550,000 and averaged 231,000, $321 a 7.8% year-over-year increase. The increase in average sales price year-over-year reflects changes in product mix, favorable pricing environment, and new or replacement communities added that have higher price points. In the same quarter by division approximate average sales prices were 213,000 in our Central division 279,000 in the South West, 203,000 in the South East, 214,000 in Florida and 341,000 in the Northwest. Gross margin as a percentage of sales was 26.1% this quarter compared to 26.6% for the same quarter last year and our adjusted gross margin was 27.7% this quarter compared to 28% of second quarter of 2017 a 30 basis point decrease. However both gross margins and adjusted gross margin increased 130 basis points over the first quarter of this year. Adjusted gross margin excludes approximately $6.6 million of Capitalized interest charged to cost of sales during the quarter, representing approximately 160 basis points and consistent with previous quarters. Combined selling, general and administrative expenses for the second quarter were 11.3% of home sales revenue, compared to 11.7% in the prior year. And year-to-date our SG&A expenses of 12.3% of home sales revenue, represents a 110 basis points improvement over the first six months of last year. We believe that SG&A will vary [Audio Gap from 12:41 to 14:25]. To range between 23.5% and 24.5%. We generated net income in the quarter of $47.6 million, or 11.3% of home sales revenue, which represents earnings per share of $2.11 per basic share and $1.90 per diluted share. [Technical Difficulty] Alright we apologize, apparently we had a technical difficulty, so I will begin where we believe we dropped off which is on gross margin. As a percentage of our sales was 26.1% this quarter compared to 26.6% for the same quarter last year. Our adjusted gross margin was 27.7% this quarter compared to 28% for the second quarter of 2017, a 30 basis point decrease. Both gross margin and adjusted gross margin, however increased 130 basis points over the first quarter of this year. Adjusted gross margin excludes approximately $6.6 million of capitalized interest charge to cost of sales during the quarter, representing approximately 160 basis point and consistent with previous quarters. Combined selling, general and administrative expenses for the second quarter were 11.3% of home sales revenue, compared to 11.7% in the prior year. Year-to-date, our SG&A expense was 12.3% of home sales revenue represents 110 basis point improvement over the first six months of last year. We believe that SG&A will vary quarter-to-quarter based on home sales revenue. We expect SG&A as a percentage of revenue for the third and fourth quarters of this year to be similar to the second quarter, resulting in 2018 SG&A as a percentage of sales of approximately 20 to 40 basis points lower compared to our 2017 full-year results. Selling expenses for the quarter were $29.3 million or 7% of home sales revenue, compared to $24.2 million or 7.5% of home sales revenue for the second quarter of 2017, a 50 basis point decrease. The decrease in selling expenses as a percentage of home sales revenue is primarily due to operating leverage realized from the increase in home sales revenues. General and administrative expenses were 4.4% of home sales revenue, compared to 4.2% for the second quarter of 2017, a 20 basis point increase. The increase in general and administrative expenses as a percentage of home sales revenue is primarily due to professional fees and additional compensation costs associated with our geographic expansion increase in active communities and additional home closings. Pretax income from the quarter was $62.7 million or 14.9% of home sales revenue an increase of 10 basis points over the same quarter in 2017. Year-to-date pretax income of $93.9 million represents a 43.4% increase over the six months in the prior year. Second quarter effective tax rate was 24% and we expect our effective tax rate for the back half of the year to range between 23.5% to 24.5%. We generated net income in the quarter of $47.6 million or 11.3% of home sales revenue, which represents earnings per share of $2.11 per basic share and $1.90 per diluted share. Weighted shares outstanding for calculating diluted earnings per share impacted by our outstanding convertible notes. In the second quarter of 2018 our average stock price was $64.47, exceeding the conversion price and therefore the convertible notes were determined to be dilutive. This resulted in approximately 2.2 million share increase to the weighted average shares outstanding for the diluted EPS calculations for the quarter. Second quarter gross orders were 2,158 and net orders were 1,629. Ending backlog for the second quarter was 1,184 homes, compared to 1,545 last year and the cancellation rate for the second quarter of 2018 was 24.5%. We ended the second quarter with a portfolio of approximately 46,800 owned and controlled lots, as of June 30th 14,823 of our 24,559 owned lots were either raw or under development. 6,433 were finished lots, 1,522 was completed homes including our information centers and 1,781 were homes and process. In May of this year, we increased our revolving credit facility from $600 million to $750 million with the $50 million accordion on our third amended and restated credit agreement. As of June 30th, we had approximately $49 million in cash over $1 billion of real estate inventory and total assets of over $1.2 billion. At June 30th, we had $495 million outstanding under our revolving credit facility and our borrowing capacity was approximately $172.3 million. In addition, we had $70 million in convertible notes outstanding. In July of this year, we issued $300 million in the aggregate principle amount of our 6% and 7% to 8% senior notes. We received net proceeds of approximately $296 million after deducting initial purchasers discounts commitments and operating expenses and we use these proceeds to repay a portion of the borrowings under our revolving credit facility. In connection with the issuance to the senior notes, we reduced the revolving commitment under the credit agreement from $750 million to $450 million and we expect to record approximately $3.1 million in debt extinguishment cost related to the credit agreement during the third quarter of 2018. Our gross debt-to-capitalization was approximately 50% and net debt-to-capitalization was approximately 47%. As Eric mentioned, on August 2nd, we acquired the majority of the asset of Wynn Homes and its affiliates for a purchase price of approximately $80 million which is subject to certain post closing adjustments. We paid the cash closing payment of $74.3 million using cash on hand and borrowings under our revolving credit facility. In addition as a portion of the purchase price, we will issue $4 million of our common stock. We acquire approximately 200 homes under construction and approximately 4,000 owned and controlled lots. We assume certain land acquisition and land development contracts of Wynn Homes and acquired certain tangible and intangible assets. Of the 4,000 owned and controlled lots approximately 2,600 or 65% are controlled. At this point, I would like to turn back over to Eric.

Thanks, Charles. In summary, we had another outstanding quarter and a great first half of the year. 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 along with more information on the integration of Wynn Homes into the LGI processes and systems. The third quarter is off to a solid start with 538 closings in July. These 538 closings span across 82 active communities, resulting in a very solid absorption pace, averaging just over 6.5 closings per community per month and bring our year-to-date closings to 3,597 up more than 25% over the first seven months of last year. Although July closings were down 9% year-over-year, these results were in line with expectations and consistent with our historical July absorption paces. With the Wynn Homes transaction we recently closed, we acquired approximately 200 homes under various stages of construction of which approximately 60 of these homes are under contract. We expect to average between 20 and 25 closings per month for the rest of 2018 and at the same time, begin implementing the LGI systems and processes. This will result in 100 to 125 closings generating revenue of $25 million to $35 million for the year. We expect to be fully operational the LGI way in all departments in the first quarter of 2019 and believe the greatest benefit to LGI and our shareholders will be realized in 2019 and beyond. This acquisition in Raleigh will LGI from one active community where we have currently six to eight active communities in the Raleigh market and an additional one or two communities in the Wilmington market by the end of 2019. We expect to close more than 500 homes between these two markets in 2019 with similar adjusted gross margins as our other reasons, with an average sales price above $250,000. As a result of this acquisition and our focus on expansion in new and existing markets, we are expecting our community count to grow between 20% and 30% in 2019, continuing on the path to our goal of becoming a top five builder. Given our record-breaking performance in the second quarter, our solid start to the third quarter and our recent acquisition of Wynn Homes, we are increasing our guidance for the year. We now expect to close between 6400 and 7000 homes in 2018. We believe our average sales price in 2018 will continue to increase, and we are increasing our guidance for our average sales price for the year to a new range of $225,000 to $235,000. As Charles mentioned earlier, we had a very strong gross margin in the second quarter of this year. As a result, we are increasing our full-year gross margin guidance by 50 basis points on the low and high end of the range. Guidance for gross margin for the full-year will be between 24.5% and 26.5%, this include the expected impacts of purchase accounting related to Wynn acquisition. We expect adjusted gross margin, which excludes the effects of interest and purchase accounting will continue to be strong ending the year between 26% and 28%. Due to increase in the lower end of our closing range, along with an increase in our guidance for average sales price and gross margins, we are increasing our full-year basic earnings per share guidance from $6 to $7 per share to a new range of $6.50 to $7.25 per share. Now, we will be happy to take your questions.

[Operator Instructions] Our first question comes from the line of with Stephen East with Wells Fargo. Your line is now open.

Alright. Our next question comes from the line of Nishu Sood with Deutsche Bank. Your line is now open.

Thank you. So Eric I wanted to ask first about the 20% to 30% community comp guidance that you are thinking about for next year. At the size that you have gotten to I think kind of growing 10 to 15 communities I think a year 20% to 30% community comp on growth is a real step-up. Obviously you know fueled by this acquisition very exciting to see, wanted to break it down though how much of that is going to be driven by the acquisition and rolling that out fully and how much of it will be driven by the existing operations.

Sure, great question Nishu. So 20% to 30% of growth just really factoring in our guidance for this year of 85 to 90 active community so 20% to 30% on that is 17 to 27 on the high end of the range 20% to 30% on 85 to 90 and you know the acquisition factor is into that like we talked about for 2019 its probably about five active communities for the acquisition. And then all of the other growl is what we have been working on for the last couple of years, as far as going deeper on our existing markets and then all of the markets that we have recently expand to, a lot of new communities coming from those markets as well. And we haven’t given lot of guidance on 2019 yet, but we thought it's important to get out there because when you talk about asset community counts that takes the most preparation and planning and we really need to have those ready to go right now. So we are very confident in that number, because of all the planning it takes place to get those ready whether it's us developing the lots or third-party developers developing for them. So we are very confident in that 20% to 30% number for next year.

Got it. And you are not seeing any Wynn communities this year, because you didn’t your community guidance for this year?

Yes. No, I think when we will add two or three assets communities for this year, I think it probably takes us from the low end of the range to the high end of the range, so we thought since it was two or three in a range of five, we just leave it the same, but it will add to the community count this year. And then additional five next year.

Got it. And then so second question I were to ask was on the you are in I think 15 states now 30 plus markets, when you started to the business you were in one market, one state. Where are we in the growth trajectory as you kind of - I mean obviously you laid out the top five builder goal, but just wanted to understand your thoughts on areas of potential growth or like kind of untapped markets as we see it and still or is it just more penetration of existing markets. We wanted to get a sense of what is going to get us there?

Yes, great question Nishu. I think we have done a great job over the last few years and we have certainly grown just looking at our average community count, in 2014 our average community count was that 30 and now we are at 82 as of last month with an average sales price of 160,000 and now we are north of 230,000 and at the same time we have been able to keep absorption places in line or even exceed as I have talked about the best quarter in LGI history of 7.8 number. So the team has done a great job, we have the systems and processes in place that allow us to grow and experience that growth while maintaining the margins and consistency. So I think that is a big benefit for us and the team has done a great job of executing on that and we think that is going to continue. We believe in order to be a top five builder, we are going to need about 240 communities across the United States. We have actually already got the plan laid out. That plan will no doubt change, but looking at the market that we are already in, looking at the corridors around those markets and where LGI community centers fit in into those markets. So we have got the plan in place, really it’s just a question of how long it’s going to take to get there and what we talk about withy our leadership team is up to us. If we see producing result like we have been producing over the last five years, then we are going to be right on track and keep running and we will get there quicker, but that is going to depending upon. So we think top five builders were realistic and shooting for 240 communities nationwide.

Okay. Thanks for your thoughts.

Thank you. And our next question comes from the line of Jay McCanless with Wedbush. Your line is now open.

Hey good afternoon everyone. A couple of housekeeping items. First Charles what was the actual dollar value in the number on the backlog at the end of 2Q?

Let's see, give me one second. The value at the end of June $296.9 million.

And if the 1184 is that right?

Correct.

Okay great. And then the next question I had in terms of the regions that carried the football this quarter, it looks like Southwest and Southeastern Florida all had unit sales for a unit closing growth well below the Company average, and especially if you guys put out a pretty impressive growth target for 2019. Can you talk about what you are doing to improve sales performance in those regions right now as well as you think about the expansion is it going to be more organic growth rate where is this Wynn deal kind of the first of many larger deals that will help yourself up to that 20% to 30% community growth?

Yes, couple of good questions Jay, I will take this is Eric. So on the first question, we believe that’s going to be primarily organic growth from here. M&A activity for us I think can be fairly limited. This is the first acquisition we have done since the fall of 2014, and what it feels to us about this particular transaction was 80% focus on the first-time homebuyer, the lots and land that we are acquiring, its 80% focused and Raleigh-Durham, which is a market that we only have one active community. We have very strong leadership from the sales and construction standpoint in that market. And then we obviously like the price and the value that we are getting in the lots of land. So all those have to work in any potential acquisitions and I think it’s going to be pretty rate that we have seen a fit - find a good fit for LGI. As far as the growth, absolute numbers in some of our markets were not growing as fast, because we are not adding community count growth. Most of our community count growth is coming from our newer markets that we have recently expanded. So that will result in the absolute numbers increasing. And some of the markets that you mentioned, still very strong abortions per community, so we are happy with the performance in the second quarter of those markets. We just have been adding as many communities in those particular markets.

Okay. And then on Wynn, just two or three housekeeping questions there. On the consideration I think you guys said it was $74 million cash and 4 million worth of stock for that correct?

That's correct.

Okay, and then in terms of one-time charges, I know you talked about the debt extinguishment charge for 3Q, was there going to be a one-time charge for the Wynn deals that also shows up in the financials?

There will now be a one-time charge, but there will be purchase accounting that will come through, so since the acquisition just closed we are still working on our schedules in the fair value analysis, so we will have a better update for you after next quarter's results, but we do expect there to be an impact of purchase accounting going forward related to Wynn.

Okay. And then in terms of a target leverage ratio what are you guys thinking now that you have taken the facility down a little bit, you got some debt priced and you brought Wynn on board, what should we think about as the longer-term leverage target or net leverage target for you guys?

Yes sure. This is Charles. I think obviously the second quarter we paid down 15 million this quarter while it is driven by our investments and inventory, so we saw our net-debt-to-cap decline from the first quarter. I think long-term you will see us in that low 50% range which is where we have historically operated and that still is our target leverage.

Okay. That is all I had. Thanks for taking my questions.

Thank you. And our next question comes from the line of Michael Rehaut with JPMorgan. Your line is now open.

Thanks, good afternoon everyone. The first question I just wanted to drill down a little bit on the monthly closings pace and in particular, you mentioned that July you know was kind of in-line with those expectations although down year-over-year, obviously, you kind of gave the updated closing guidance and I was just curious how much of that is reflective of your expectations around Wynn. I believe you said 20 to 25 closings a month, but I just wanted to make sure I heard that right and what does that mean in terms of the core you know legacy or organic business from a closings expectations standpoint and with now, I will stop there and I just have one or perhaps two others.

Okay, thanks Mike. Great question. First of all yes that is what we talk about was Wynn, consistent was they have in closing and consistent with the 300 closings that they had last years, 20 to 25 a month for the last five months of the year starting in August, so 100 to 125 total is what we are forecasting, because of the acquisition. Outside of that, yes we talked about July and historical averages and our guidance from 6000 or raising the guidance from 6400 means we are going to have to close between 6.5 and eight closings per month from this point forward. So we did 7.8 in the second quarter, which was an unbelievable quarter and the highest absorption that we have ever had. So it's tough for us to say that that we don't expect things to be as good as they have been. Certainly demand is there, we are seeing strong demand from the first time home buyer to get into home ownership. So that hasn’t changed. But forecasting out, I think our historical averages of 6.5% to 7.5% a month from this point forward through the end of the year. We would be happy with that. It’s a little less than the absorption pace of the second quarter, but still very strong and also in an environment where we are going to be not taking a hit to gross margin and also dealing and keep increasing our average sales price as well.

I appreciate that Eric. I guess secondly around pricing power and you said you are not taking the hit the gross margin if anything you raised it. Maybe you could speak to pricing power in your given markets, I mean I think that has been an area where perhaps more an issue at higher price points and move up price points, but at the same time there has been I would say somewhat of a mix set of commentary around even on the entry-level the ability there to push through price, you know fully in different market maybe have different ability to absorb price increases? So I was hoping to hear from you guys what your pricing trends have been and the level of success that you have had over the past quarter with pricing?

Yes, great question Mike. I think we look at pricing the same way we always look at it and we have been dealing with since we have been a public company a market that seen increasing cost whether it’s on lots or land development or labor and materials that has caused our average sales price like we talked about earlier ago from 160,000 in 2014 to 186,000 to 197,000 to 214,000 to 231,000 last quarter. So we have consistently seen average sales prices increase, because we keep our pricing strategy pretty simple and its cost increase we are able to and need to raise our prices to keep our gross margins consistent. And our Q2 adjusted gross margins for the last five years in the Q2 have been between 27.7 and 28.2. So we have been in 50 basis points range for the last five years on adjusted gross margin in the second quarter. And I think that’s a testament to our pricing strategy. And in the market that we are in, which I would characterize is a good solid, strong, demand market with a tight supply of houses and the labor challenges the material challenges that we all face, we see at least for the next couple of quarters that trend continuing. Prices are going to have to increase on a same store basis if you will in order to offset increased costs.

Thank you.

You are welcome.

[Operator Instructions] And our next question come from the line of Ryan Gilbert with BTIG. Your line is now open.

Actually its Carl Reichardt with Ryan. Hi guys. I wanted to ask about the California and just whether or not there any closings this quarter. I think it sounds like there weren’t. what the plan is for the next couple of quarters? Anymore new stories in California in 2018?

Yes, great question Carl. Yes there actually was. We are off to a fast start in California, we had a great grand opening events. In fact we took more customers and sold more houses at that grand opening events and at any grand opening in LGI history. That community had an average sales price of 370,000 that's been [indiscernible] to California a project called Liberty. So we could not be more pleased with that starts, the grand opening was the second week end of June and we are actually able to get one closing in the month of June and again happened on the last day of the month, so it actually pounded in our active community count for June. In July which is our first month of closing, primarily based on available houses that we had to close, we closed an additional eight more again with an average sales price somewhere around $370,000 so just a fantastic start. We would expect that community in California based on the pipeline continue to average seven or eight closings per month from now to the end of the year.

Okay, and you guys tried to sell it there house when you were out there so a good job in that regard. Two more quick ones, is [Toronto] (Ph) planned to be continually they are small right now 5% or so a mix on a go forward into 2019. And then can you talk a little bit about the wholesale closing side over the course of 2019 with the net guide, are you expecting any communities that are going to be largely or solely single family rentals. Thanks.

Great question Carl. Taking the Toronto one first. Toronto we only have five active communities with Toronto, it's only a percentage or two of our business right now, so the between the wholesale business and our LGI Homes retail business that is really outgrown faster in Toronto we haven't added a lot of new active communities with the Toronto brand. We think that is going to be continue, we will be opportunistic with that brand and we are excited about it and the five active communities have been accretive this year, but a very small percentage of our business going forward. On the wholesale business, the whole business was between 5% and 6% of our closings in the second quarter. We think that trend is going to continue, we provided and built and sold our first community that was solely to the investors and we see opportunities for that in the future. Our acquisition team is looking for 30, 40, 50 lots parcels that we can sell to the retail, wholesale investor groups and also looking at various sections of our own communities. Obviously, we would go forward on that unless it made sense to LGI and was accretive to our earnings for our shareholders, but we think there is opportunity there, but currently 5% or 6% of our business is very realistic.

Great. Thanks so much Eric.

You are welcome.

Thank you. And our next question comes from the line of Kenneth Williamson with J.P. Morgan. Your line is now open.

Hi thanks for taking my call, one of my questions were already answered. But I was wondering if you could comment on whether or not you have done any stress testing for the interest rate environment, and kind of how that is affecting your homebuyer client. I'm curious if there is a rate level at which you start to have to give out some margin in order to keep the home at an affordable price and attractive trade-off from some that would potentially be a renter rather than a homeowner.

Yes this is Eric, I can start with that. We have looked at the different scenarios and stress tester from standpoint of looking at interest rates increase and what that results see for the monthly payment for the buyer. You know certainly we are dealing with a higher monthly payments for the buyer now, because of the rise in interest rates nine-month ago. Demand seems to be there, I mean I describe it as consistent and were comfortable where we are at now, but certainly keep an eye on it. I think as rates continue to rise you know every builder is going to have to face decisions on how to deal with that. LGI would not be in the camp as suggested where we would take a margin haircut in lower price in order to deal with that. I think we would be in the camp of absorptions may slow, the gross margins would still be there and our average sales price may have to increase as well, because we are still planning on dealing with the higher cost environment so average sales pricing higher as a positive for us. And then we also look at alternatives for our products to deal with the higher interest rates rather than reducing the price, we may have to look at smaller square footages, the buyer may have to chose the smaller square footage. We are continuously looking at our finishes. We will continuously look at our land development opportunities and look at lots size and efficiencies in land development. So I think there is other avenues that we would look at instead of just sacrificing gross margin.

Got it. Thank you, that is helpful. And I guess kind of along with similar lines. Are you seeing any kind of break in the trend of rising input cost at all? Or do you expect that to be kind of persistent environment at least as far as out next 12 months as you are forecasting out?

This is Charles. We have a fundamental belief that cost will always be rising. Eric mentioned the trend in our average sales price since 2014 has been going up and primarily due to rising land and both labor and materials. But we mentioned on our last call that we saw cost taper in a way that wasn't quite as dramatic as what we saw in 2017 and certainly following up on the pricing power discussion that really resulted in a positive benefit to us this quarter compared to the first quarter. So, we believe the cost will continue to rise to what degree our goal is then to increase prices to keep up maintain our consistent margins, which overtime we have been able to do very successfully.

Are there any particular materials that you are more concerned about? I know recently you have seen things like hardwoods maybe included in China counter tariffs, anything like any material in particular that you are worried may have a spike from where we are today?

I would say no. I think at all times there is different components than any one point in time becomes the predominant one, lumbers historically over the last short-term has been the number one driver for cost increases. But it hasn’t closed every quarter and we will just continue to monitor it.

Okay. Thank you.

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

Thank you. Just to follow on for Steven. Eric I guess the first going back to Wynn acquisition you are looking at the - or looks like it’s a little bit of a break from your traditional focus particularly market on high rate arteries more - can you cluster together. Is that a change in thinking? Or would you after you defeat the assets move back more towards your traditional model?

Yes, we are going to be operating the LGI way by the first-year. So yes, they were a builder that operates probably more like a additional builder outside of LGI where their communities may had about eight model homes if you will and set up in eight locations doing 20 to 25 a month consistent two to three a month very difficult to home builder in the industry. And what we will do is take those different corridors around town as you can see from their websites and we will actually combine on LGI Information Centers, like I talked about a couple of new active communities this year another five or so next year and just combined that communities. So will definitely switch it to the LGI model.

And Charles, can you add some color on the year-over-year decline in your gross margin, how that was attributed to material and land inflation versus the wholesale closings or lower margins in your new markets.

Yes. And you are referring to 26.6 in gross margin last year, this quarter compared to 26.1.

Right.

Yes. I think included in last year's number, we had a one-time benefit, we had mentioned in the call last year it's about 80 basis points or related to a community reimbursement. So that certainly comes into play this year when you are looking at the year-over-year comparison, but we are very happy with where we ended up this quarter, we believe that we are in the range and consistent with our historical results.

Given the range that you gave what would be driver toward to hit that lower end of that guidance?

Well in terms of the gross margin guidance range, I mean I think you know obviously there is uncertainty around cost and inputs mix, certainly comes in the play as we shift. Generally, most of our divisions are pretty close in terms of their results that they generated in terms of the overall gross margin percentage. But the mix and our community mix certainly comes into play and volatility within the margin 50 basis points, we either way or a 100 basis points swing either way that is kind of why we see to that is because just like our monthly closings volatility is going to vary month-to-month, our gross margin quarter-to-quarter is going to vary, but in the long run, we feel like we can deliver consistent gross margin results.

And one last one if I could. I think in the last couple of quarters your direct marketing expense had been under budget, is that still the case or do you have the increased that compared to higher rate environment?

Yes, I will just add it there. We haven't had to increase yet, we are still seeing strong demand, but that is something that we could also use as a tool to combat higher interest rates last few months of this year.

Okay. Thank you.

Thank you. And our next question comes from the line of Jay McCanless with Wedbush. Your line is now open.

Thanks for taking my follow-up. Just two or three quick questions. Number one, you talked about pricing growth earlier. What was your same-store price growth this quarter versus last year and maybe for the first six months as well?

Yes. I don’t know if we have that information in front of us Jay, there is so much volatility of new community accounts and sell out and new floor plans. You know our average sales price was certainly up from last year, I guess around 9% maybe about half inflation and half because of mix and new markets would be a pretty accurate estimate.

Okay and then on the investor homes versus direct to consumer homes. Are you guys still seeing a similar operating margin on one versus the other and do you have a target or limit of the amount of investor homes you want to sell this year?

It is a similar operating margin for sure and then not only is a similar operating margin, but in the case of most of these sales are coming from communities that you accelerate the closing, so it's very accretive not only from operating margin, but also return on equity, return on assets, those type of metrics as well. We are limited how many we could sell this year from a standpoint of we need to have lots finished and available to go. We don’t have an excess supply of lots, so it takes planning and really work with the investors and getting deals under a contract. So it’s a little bit more of a lead time in order to produce wholesale closings.

Got it. And then the last one I had. Just wanted to ask the unit closing growth and maybe in a little bit different way. Should we think about as you guys work towards 240 communities how much of your sales growth do you think is going to come from organic versus new markets and acquisitions? Have you guys even split it out that way? And then also what for the next call it 12 to 18 months how many communities on average do you want have in each of your markets?

Well a couple of things there. Mostly all - growth because M&A activity especially as we just - we need to integrate Wynn into this acquisition and we think that is very accretive in helping us with community count growth. Our plan to get to 240 communities, we are not assuming that we are going to go out and make any acquisitions in that plan that is all organic growth. Most of the markets we have at least talked about previously we are just getting started whether its California, whether its Las Vegas, Birmingham, we are up and running in the mid-Atlantic region right now. We got our first project we disclosed on in that market. We got at least one or two other projects under contract in that market. But they are not included in community count yet, because we are not open for sales and we haven’t had closings in those markets. So we are focused on the markets that I mentioned in our existing markets for now. In order to get to 240 we will definitely add markets to that, but primarily focused on going deeper in our existing markets.

Thanks again. I appreciate it.

Thank you. And I’m showing no further questions at this time. So with that I would like to turn the call back over to CEO and Chairman of the board Mr. Eric Lipar for closing remarks.

Sure. Thank you and thank you for everyone for participating on today's call and continued interest in LGI Homes. 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 wonderful day.