Rachel Eaton - Chief Marketing Officer Eric Lipar - Chief Executive Officer Charles Merdian - Chief Financial Officer.

Nishu Sood - Deutsche Bank Securities Elad Hillman - JPMorgan Paul Przybylski - Wells Fargo Securities, LLC Carl Reichardt - BTIG Alex Barron - Housing Research Center, LLC Jay McCanless - Wedbush Securities.

Welcome to the LGI Homes Third 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..

Eric Lipar, LGI Homes' Chief Executive Officer; and Charles Merdian, the Company's Chief Financial Officer. With that, I will now turn the call over to Eric..

Thank you, Rachel, and welcome to everyone on this call. We appreciate your continued interest in LGI Homes. During today's call, I will summarize the highlights and results from the third quarter and year-to-date 2018. And 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 fourth quarter of 2018 before we open the call for questions. Before we get started, I want to recognize that tomorrow marks our fifth anniversary of LGI Homes becoming a public company.

At the time of our IPO, our objective was to fuel our growth and replicate our business model across the country. In the past five years, we have expanded into more than a dozen new markets tripled the size of our organization and seeing tremendous appreciation in our stock price since our IPO at $11 per share in 2013.

We have accomplished all of this and more all while maintaining our culture and demonstrating that our unique operating model is sustainable. And other notable accomplishment for everyone on the call is it LGI Homes was recently listed number 10, unfortunate magazine's list of 100 fastest growing companies.

This list ranks performance and revenue, profit and stock returns over the past three years and we were featured among global companies like Facebook and Amazon. This is a huge achievement and I'd like to thank all of our employees for their hard work, dedication and loyalty to LGI. The third quarter of 2018 was a solid quarter for LGI Homes.

For the quarter, we closed 1,601 homes, generating approximately $380 million in home sales revenue, which represents a 4% increase over the third quarter of 2017 and the best third quarter for revenue and Company history. We ended the third quarter with 81 active communities, which is a net increase of 4 over the 77 active communities.

Now we had at the end of the third quarter last year. Absorption in the third quarter average 6.5 closings per community per month company-wide. This was they decreased from the third quarter of last year with 7.6 closings per month, which was the highest absorption recorded in our third quarter history.

In comparison, our third quarter performance since our IPO generated 5.5 closings per community in 2014, 6.3 in 2015, and 6.0 in 2016. This quarter, our top division on the closings per community basis was the Northwest at 8.7 closings per month, followed by the Central Division at 7.9 and the Southeast division at 6.0.

Breaking it down, let us first look at highlights from our Central Division operations. Comprised the results with Houston, San Antonio, Dallas/Fort Worth, Boston and Oklahoma City markets, our Central operations generated 691 closings in the third quarter representing approximately 43% of our total closings for the quarter.

As mentioned earlier, the absorption rates in the Central Division was one of the strongest across all divisions, averaging 7.9 closings per community per month. Of the 57% of closings that took place outside the Central Division, a highlight of the third quarter was an increase in closings in our Northwest Division.

This quarter we closed 139 homes in this division compared to 72 homes closed in the third quarter of last year, which is an increase of 93% year-over-year with our active community count remaining flat. One of the primary drivers of this increase is our fast start in the State of California.

Our first project in the Sacramento market closed 33 homes in the first full quarter of being open for business. This made Sacramento our number one market this quarter, averaging 11 closings per month per community with an average sales price of over $370,000.

Our Southeast Division also had a strong quarter highlighted by our acquisition of Wynn Homes on August 2 for $78 million. The Wynn acquisition is allowing us to expand our presence in the Raleigh market while also giving us an entry into the Wilmington market.

As a result of this transaction, we acquired approximately 200 homes under construction and 4,000 owned and controlled lots of which 85% were in the Raleigh Durham market moving LGI from the 15th largest builder in the market to within reach of the top five according to builder.com.

The primary focus of our leadership team since August 2 has been integrating the Wynn employees into the LGI processes and systems, including sales and construction training and converting everyone to the LGI way.

We are pleased with the results so far closing 49 homes in the third quarter right on track with the expected 20 to 25 closings per month that we announced on our last call. In our wholesale business, we closed 104 homes this quarter with three different investment groups generating $26.8 million in revenue.

We believe opportunities like this are accretive to our business and offer us an avenue for potential growth. With that, I'd like to turn the call over to Charles Merdian, our Chief Financial Officer, for a more in-depth review of our financial results..

Thanks, Eric. Home sales revenues for the quarter were $380.4 million based on 1,601 homes closed, which represents a 4% increase over the third quarter of 2017.

Sales prices realized from homes closed during the third quarter range from the 140s to over $500,000 and averaged $237,582, a 12.3% year-over-year increase, and the highest ASP in our history.

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. All of our divisions experienced an increase in average sales price ranging from 8.6% to 11.6%.

In the third quarter by division, approximate average sales prices were $217,000 in our Central Division, $287,000 in the Southwest, $209,000 in the Southeast, $212,000 in Florida, $365,000 in the Northwest, and $233,000 in the Midwest.

Gross margin as a percentage of sales was 25.6% this quarter compared to 25.1% for the same quarter last year, a 50 basis points increase. Our adjusted gross margin was 27.4% this quarter compared to 26.5% for the third quarter of 2017, a 90 basis point increase.

Adjusted gross margin excludes approximately $6.2 million of capitalized interest, charged to cost of sales during the quarter, representing 163 basis points and $850,000 of purchase accounting adjustments associated with Wynn Homes acquisition.

Combined selling, general and administrative expenses for the third quarter were 12% of home sales revenue compared to 11.3% in the prior year. Selling expenses for the quarter were $27.9 million or 7.3% of home sales revenue, compared to $26 million or 7.1% of home sales revenue for the third quarter of 2017, a 20 basis point increase.

The increase in selling expenses as a percentage of home sales revenues reflects additional operating expenses primarily associated with increase in advertising expenses. General and administrative expenses were 4.7% of home sales revenue compared to 4.2% for the third quarter of 2017, a 50 basis point increase.

The increase in general and administrative expenses as a percentage of home sales revenue is primarily due to one-time acquisition related transaction expenses associated with the acquisition of Wynn Homes.

In connection with the issuance of the senior notes, we reduced the revolving commitment under the credit agreement from $750 million to $450 million. And this quarter we’ve recorded $3.1 million in debt extinguishment cost related to the credit agreement. Pre-tax income for the quarter was $49 million or 12.9% of home sales revenue.

We generated net income in the quarter of $37.7 million, a 12% increase over the prior year third quarter. Net income was 9.9% of home sales revenue, the highest percentage in the third quarter as a public company and represents earnings per share of $1.66 per basic share and $1.52 per diluted share.

Weighted shares outstanding for calculating diluted earnings per share impacted by our outstanding convertible notes. In the third quarter of 2018, our average stock price was $54.97, exceeding the conversion price, and therefore the convertible notes were determined to be dilutive.

This resulted in approximately 2 million share increase to the weighted-average shares outstanding for the diluted EPS calculation for the quarter. Third quarter gross orders were 2,157 and net orders were 1,629, similar to the second quarter.

Ending backlog for the third quarter was 1,212 homes compared to 1,328 last year, and slightly up from the 1,184 at the end of second quarter. The total dollar value in backlog was $292.6 million. The cancellation rate for the third quarter was 24.5%.

We ended the third quarter with a portfolio of approximately 53,600 owned and controlled lots, up from approximately 46,800 at the end of the second quarter was partly attributable to the Wynn acquisition.

As of September 30, approximately 26,800 were owned and of this amount, 7,500 we're finished vacant lots, 15,500 were either raw or under development. 1,700 were completed homes including information centers in 2,000 were homes and process.

As of September 30, we had approximately $38 million in cash, approximately $1.2 billion of real estate inventory consisting of $648 million of land, land under development and finished lots and $540 million in completed homes, homes in progress and information centers.

At September 30, we had $638.8 million in total debt outstanding under our revolving credit facility, convertible notes and senior notes in our available borrowing capacity was approximately $100 million. Our gross debt capitalization was approximately 51% and net debt capitalization was 49%. At this point, I'd like to turn it back over to Eric..

Thanks Charles. In summary, we had another outstanding quarter. Now let me provide some thoughts and what we are seeing thus far in the fourth quarter and some guidance for the rest of 2018. As reported in our monthly press release, we closed 468 homes in October down 12% from the 531 closings in October of last year.

The 468 closings came from 83 active communities resulting in absorption pace, averaging 5.6 closings per community per month. Although this absorption pace was not as strong as last year and represent a slower sales pace in 2017.

We are still seeing strong demand and based on our pipeline, we are still confident and closing more than 6,400 homes in 2018. Closings for the year through October total 5,128 we recognize that will need strong results for the last two months of the year to achieve more than the 6,400.

We expect closing to be heavily weighted in December, which is historically our strongest month. Affordability continues to remain a focus as mentioned in prior calls. We expect our absorption rates to normalize off the record breaking results from the prior year. Interest rates and higher prices have begun to stretch affordability.

Historically, we have seen buyers in this type of environment shift down and size of homes purchased and we would expect similar results in the near-term and believe we will be in a position to capitalize.

As Charles mentioned, our net orders were similar in the third quarter this year compared to the second quarter and we continue to see strong demand in traffic and our information centers from renters wanting to convert to homeownership, proving that buyer interest levels are still high.

As we have said all year, we are on track to end 2018 between 85 and 90 communities continuing to expand our footprint in our current markets and adding new ones. One of these new markets is Las Vegas where we expect to have our first closings in November and as the year between 25 and 30 closings making Las Vegas another successful launch for LGI.

This expansion will continue in 2019. We are on track to meet our goal of 20% to 30% community count to grow next year. We're also on track to meet our average sales price guidance in 2018 between $220,000 and $230,000 and to meet our previous margin guidance.

We believe we will end the year with gross margins between 24.5% and 26.5%, and adjusted gross margins which excludes the effects of interest and purchase accounting will continue to be strong ending the year between 26% and 28%.

Closing more than 6,400 homes with consistent margins average sales price and SG&A leverage leads us to believe that our full-year basic earnings per share will be between $6.50 and $7.25 per share. Now I'll be happy to take your questions..

[Operator Instructions] And our first question comes from the line of Nishu Sood from Deutsche Bank. You may begin..

Thanks. So first question I wanted to ask was just in terms of the response to the slow down and pace. Charles, you mentioned that you have increased the rate of marketing spend.

And so what is typically the flow through, when did you, increase the marketing expand in response to the, the slow down in sales pace and when would that begin to show up in terms of closings normally?.

Yes, I mean, I'll take that an issue. This is Eric. We started really returned to spending the money in August as interest rates continue to rise and advertising monthly payment and really looking and appealing to the renters that are looking to get into home ownership. We increased our marketing spend to deal with the higher rate.

So certainly over the last 90 days or so. And I think it’s also a good reminder that over the last couple years the demand has been so strong that we haven't spent our full marketing budget and nor have we needed to.

So we think it's just getting back to more of a normalized spend when it comes to advertising and what LGI does to drive leads to our information centers more so than, than we're spending an excess amount over budget..

Got it. Okay and in terms of you mentioned that another response that buyers typically have when there is an affordability constraints is to shift down to a lower price model, which, given your, the spec-oriented nature of your business would be a simple as looking at a different unit.

As that already begun to occur? Is there some response that is necessary on your part? For example, if you have a community that used to be with the starting model at 200 and the highest one at 250, do now need to shift it so that to adjust for it to shift what you're putting up or how is that going to work and has that begun to provide some offset as well today?.

Yes. I think we're already seeing that issue and I think a general comment is we’re always looking at affordability, we're always looking at all of our floor plans on a per community basis.

So if we have the ability to build a smaller square footage plan, we will do that and somewhat limited based on HRA requirements, city and county requirements in some cases, but generally we have four or five floor plans per community and the customer will have options on which one that they choose.

Obviously, the customers always liked the larger homes better, but they may have to select based on qualifications and where interest rates they’re paying today. They may have to elect to get into a smaller square footage plan.

But even in that scenario, we are very optimistic about the business and also strongly believe that getting into a smaller square foot home and owning it is a lot better than running. .

Got it. And final one, the Pacific Northwest comments are pretty notable given that, that has been an area that most other builders have cited as being at the front end of the slow down. Was it just Sacramento? How did the rest of the Pacific Northwest look and is that start in Sacramento, which just sounds I mean at a fantastic rate.

Is that sustainable?.

Well, it's sustainable from a demand standpoint. I mean, we’ve seen extremely strong demand in Seattle. The wholesale business has really helped out the Northwest Division as well. So we've seen strong demand up there.

I think one thing that's helping us in comparison with what the other builders have talked about on their calls, is our average sales price in Seattle is still in the 350 to 380 range and that's still a very affordable, very appealing price point in the Seattle market. So we're still continuing to see strong demand..

Got it. Thank you..

You’re welcome..

And our next question comes from the line of Michael Rehaut from JPMorgan. You may begin..

Hi. This is Elad on for Mike. This is Elad on for Mike. Just first, it sounds like demand is still fairly strong at your price point but there was that – about a 15% decline absorption in 3Q.

And I just wanted to break out, any particular regions where you're seeing some slower demand trends?.

Sure. This is Eric. Yes, it was slower than last year, but historically right in line with our averages, and based on the third quarter of 2018 compared to the 2017, of our six divisions, three were higher and three were lower.

We highlighted a few on the call, but the Northwest Division closings per community was higher this year as well as the Southeast Division and the Midwest, and then the Central Southwest and Florida were lower than last year. So it was mixed..

Okay.

And those regions that had the slowdowns, were there any particular drivers that you want to call out outside from some of the affordability, things that you mentioned? And in response to those things, have you found incentives or any particular type of incentive, maybe helping to pay for the rate increase, more helpful? And lastly, just when you look at – you mentioned that December tends to have higher waiting when it comes to the closings.

I'm just wondering if that also included some form of incentive that you're planning on boosting to more SG&A in the 4Q or kind of what you have built into that closings guidance? Thanks..

Yes. There's a few questions there. But Florida as an example, one the areas are slower. A lot of community-by- community transition and closed out. And like I said, a little bit slower compared to last year, which was a record breaking quarter that’s little bit expected with the higher rates.

But certainly no big drop-off in demand or what we're seeing from marketing standpoint in any of the markets. And then as far as incentives go, we're not a big incentive type of company. We priced the gross margin. So we expect our adjusted gross margin, like we talked about on the call to be consistent.

In fact, the first nine months of this year compared to last year, a 27.3 compared to 27.4 or so another year of very consistent gross margins for LGI and we expect that to continue to the fourth quarter..

Okay, great. And just lastly on the gross margins. The increase in gross margin this quarter and the strongest margin, how much of that also has to do with higher mix? It seems like just mentioned the higher price community in Sacramento.

How much of the gross margin is being helped by higher mix versus – or maybe underlying pricing power in the market?.

Yes. So this is Charles. Not so much as a percentage, you mean the higher mix or the higher price points, we underwrite to similar gross margins. So our expectations are similar despite where the ASP may come into play.

And I think this quarter certainly from the financial gross margin aspect was impacted by the wind acquisition, so relatively consistent as Eric would say. I think our results this quarter relatively consistent or similar and that's where we would expect them to continue to be..

Okay, great. Thank you..

You bet..

And our next question comes the line of Stephen East from Wells Fargo. You may begin..

Thanks. This is actually Przybylski on our Stephen. First of all, Eric, I noticed that you guys do have a national sales promotion going on, on your website right now.

Can you talk about the magnitude of incentive or the type that you're offering and is that targeted specific inventory and on a limited basis or more broad-based and I'm not – I can't recall it, but first time you've had a national sales promotion?.

It is the first time we’ve had a promotion on a national band? And that is really just our marketing team really staying on the business and really coming up with new ideas on how to promote LGI across the country and drive more sales and leads to our respective communities and we thought it was a great idea for the end of the year and make sure that we hit our 6,400 plus closings and do everything that we say we're going to do.

So our marketing team is on top of the business, always looking at great ideas. The national sales event is not so much of incentive is really letting people know to look into home ownership and get a hold of our sales representatives that are information centers. We have finished inventory that we can move customers in by the end of the year.

That's pretty unique in the home building industry. We can get them in before Christmas. We can get them in before the holidays. Enjoy their new house and really promoting the fact that we can make that happen and get them out of their rental situation and into their new home..

Okay. Other than your press release talked about some community friction in Florida and the central region, is there any way to break apart maybe the lower demand.

We're seeing lower mailer responses or just overall traffic or decline and qualifications, any kind of color around, what happened in the quarter with the respect to closings?.

Yes, I think it’s the tough question happened – what happened in the quarter because overall we have 6.5% closings for community. We that’s a very positive results. So we had a lot of positive things happened in the quarter.

Demand by no means a slow down, we're still seeing strong demand when you're dealing with higher interest rates and an average sales price that last year was 211,000, – this year is 237,000. So 26,000 increase in average sales price.

Obviously that drives the monthly payment higher and makes it more challenging for customers to qualify on the same home. But offset buy a lot of positive things happening in the economy, like job growth, wage growth, et cetera.

So it's hard for us to say it's slowing because we're comparing it to the best quarter in LGI history and the best year in LGI history and just a strong above absorption as we had a few years ago with an average sales price $50,000 to $70,000 less. So we look at all the metrics were on top of that.

Certainly our conversion rates aren't as strong as they were last year. But overall very positive.

Given the reduced affordability and the change in monthly payment, have you had to maybe alter your sales strategy or for the patient that you do in sales center?.

No, no. Our presentation to our customers is the same and it says not at the same was out since 2003. And really talking about the value of homeownership and making sure the customers have had a great experience.

And I think for our managers and our employees and our sales and for customers, what is different this time as over the last few years we've had a few interest rate bumps and then they go down again and they go back up and they go down again. This time I think we all agree.

Interest rates are higher and we're selling 30-year fixed rates and the plus 5% range or even 5.5% and that's going to continue. We don't, we don't believe they're going to go back down into the force and may likely given to the sixes and we need to be explaining that to customers.

We think it's a great time to buy, prices and interest rates are likely to continue to go higher..

Okay. Thank you. Appreciate it..

Thank you. And our next question comes from line of Carl Reichardt from BTIG. You may begin..

Thanks very much. Hi guys. I wanted to ask Charles or Eric about the community ramp for 2019. And you've talked about the 20% to 30% growth.

When we're looking at modeling that is that sort of a gradual growth rate through the year? Is there a back end or front end load and implied there?.

I think it’s to be more gradual Carl, throughout the year consistent 20%, 30% based on end of the year number to end of the year number..

Okay. All right, thanks. And then, lumber prices have come in quite a bit and then the last four to six months or so. And so I'm assuming that that will start to flow through and help a little bit on the cost side.

Can you talk about sort of the timing of that, of how that will help you assuming that now that trend stays safe flat from here?.

Sure. This is Charles. So I think for the most part what we're seeing in our construction budgets is that costs are being, are stabilizing and anything where we're seeing an opportunity where costs are coming in. We're taking a look at our finish as well, making sure that we're looking at the right product and building the right product.

So that we can flow that into our pricing model that we can stay mindful, if you will, of affordability.

So I think what we'll see is some of those savings will get offset with some changes that will make our plans and our expectations is that we'll see moderate increases to our construction budgets and we feel that's manageable from a pricing standpoint to maintain our adjusted gross margins and our guidance range..

Okay, great.

And then last question, look at your can rate, has the mix of those cans changed? Are you seeing still the majority of those being sort of inability to get financing or are you seeing more dropouts of existing orders due to other reasons?.

No, it's similar. It's still very heavily weighted towards not being able to get mortgage approval..

All right. Thanks Eric. Thanks Charles..

You’re welcome..

Thank you. And our next question comes from the line of Eric Barron from Housing Research. You may begin..

Okay. Sorry about that. Yes, this is Alex. I had a question, obviously a lot of builders have been talking about affordability and that they are making moves to open more affordable communities.

I'm kind of wondering if you guys have started to feel, you know, the effect of more competition and a lot of these other guys were also pretty promotional with discounts and incentives and just kind of what the plan is to compete against that?.

Yes. This is Eric. I'd say we haven't seen the effects of that yet. I think it's positive that all the builders are talking about getting into the entry level and that's where the demand is going to be. That's where the demographics point too. That's a very positive sentiment towards the primary market that LGI is focused on.

There are certainly places where we're competing with them to new deals to buy new deals, but with 53,000 owned are controlled lots. We think we're really in good shape there.

We're still focused on move in ready homes, converting renters into homeowners, I think the other builders are still have their different options and design center plan, so I think we'll keep folks and what LGI is doing. It's working really well so far and I that we’ll continue to grow regardless of what the other builders are focused on. .

Got it. And then Charles, I don't know if you had like how many homes, how many orders came from Wynn this quarter both in orders and in backlog. .

Sorry, I don't Alex, we don't have that in front of us..

Okay. And last question, I think I heard you right. You said you had like 100 something homes sold to investors.

Do you guys see that as being a larger part of your business going forward and if you have a number for last year, did you sell any last year?.

Yes. We think it's going to be a good part of our business going forward, probably consistent as a percentage of where it's been. This third quarter of 2018, we closed 104 homes through our wholesale channel. The second quarter is 103 and the third quarter of 2017 was 96, so pretty consistent. .

Got it. Thank you so much..

You’re welcome..

And our next question comes from the line of Jay McCanless from Wedbush. You may begin..

Hey, thanks for taking my questions. The first one I wanted to touch back on the wholesale, and you guys said that Northwest wholesale played a role there. How much of your closing this quarter in the Northwest came from wholesale..

31 closing, Charles had to look at it out..

31. Okay, great. And then the second question, touching on something you all discussed in the release about growing the community count to make up for slower absorptions, and I know I'm paraphrasing it badly.

My question is why if the absorptions are slowing down, does it make sense to look at a rehash of the product to maybe take some more floor plans down to smaller sizes? Do you have to do the 20% to 30% growth in the face of what seems to be a pretty steep fall-off in absorptions?.

Yes, I can take that Jay. Well, first of all I'll start with the 20% or 30% growth and community count. That's really been there all year, no matter what interest rates are doing. Those are communities that are coming online that we've already planned on and agreed to and then your severity and absorptions, similar to how we answer to the four.

Yes, we are coming off, last year being a very strong year, a very strong quarter. We grazed raised guidance three times, but at 6.5 closings per month that we just produced in the quarter. And to hit our goal of 6,400 closings for the year, we're going to need the average 6.8 closings in the fourth quarter.

And if we continue at that north of six closings per month pace, which we believe we can continuing to buy deals, grow the company, continuing to expand, that's to be great, and really creative to our shareholders.

The goal is to be three times of that size, we are now and be a top five builder, closed to six closing amounts and this 20% to 30% community count growth is just the next phase of that plan..

Got it. And then the other question I had, and apologize for you have already touched on this.

Wynn Homes, how many communities do you expect that it will contribute to that 20% to 30% growth next year?.

4 or 5 net communities additional in Raleigh..

Okay. And was that brings up one other question, I had.

Was there any storm delays for you guys getting some homes closed or were there's some closings that pushed into Q4 because of the weather?.

No, weather impact to those yet..

Okay, great. Thank you..

Thanks. End of Q&A.

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

Thank you everyone for participating on today's call and for your 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 great day..