Welcome to the LGI Homes Third Quarter 2019 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. Welcome to the LGI Homes conference call discussing our results for the third quarter of 2019 and the 9 months ended September 30, 2019. Today’s conference call will contain certain forward-looking statements that include, among other things, statements regarding LGI’s business strategy, outlook, plans, objectives and guidance for 2019.

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 statement 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 margin, a non-GAAP financial measure, will be discussed on this 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 margin, 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 September 30, 2019, 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 www.lgihomes.com. Joining me today are Eric Lipar, LGI Homes’ Chief Executive Officer and Charles Merdian, LGI Homes’ 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 highlights and results from the third quarter of 2019. Then Charles will follow up to discuss our financial results in more detail.

After he is done, we will conclude with comments and open the call for questions. Before we get started, I want to recognize that this week marks the sixth 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 6 years, we have expanded into more than a dozen new markets, quadrupled the size of our organization and seen 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 preserving our culture and demonstrating that our unique operating model is sustainable.

Over these past 6 years we have maintained our intense focus on delivering strong results, breaking many LGI records along the way and the third quarter was no different.

For the third quarter of 2019, we produced record-setting closings, record-setting revenue, record-setting average home sales price, record-setting community count and record-setting net income dollars.

This quarter, we closed 2,003 homes, generating approximately $483 million in home sales revenue which represented a 27% increase in revenue over the third quarter of 2018. Bringing us to a total of 5,175 homes closed through the first 9 months of the year, generating over $1.2 billion in home sales revenue.

For the third quarter, we averaged 6.6 closings per community per month companywide. This was an increase from the third quarter of last year of 6.5 closings per month.

This increase was primarily due to an increase in closings per community per month in our Central division, which increased from 7.4 to 8.6 closings per community per month for the quarter and an increase in our West division from 5.8 to 6.2 for the quarter.

Absorption for the quarter was highlighted by performance in our San Antonio, Dallas/Fort Worth and Houston markets. For the quarter, our top performing market on a closing per community basis was San Antonio, averaging 10 closings per community per month followed by Dallas/Fort Worth at 9.7 and Houston at 9.5.

Companywide, we ended the third quarter with 103 active communities, more than a 27% increase over the 81 active communities that we had at the end of Q3 last year. Breaking it down, let’s first look at highlights from our Central Division operations.

Comprised of results from the San Antonio, Dallas/Fort Worth, Houston, Austin, Oklahoma City and Minneapolis markets, our Central operations generated 876 closings in the third quarter which represented approximately 44% of our total closings.

Of the remaining 56% of closings, which took place outside the Central Division, a highlight of the third quarter was an increase in closings in our Southeast Division. This quarter, we closed 420 homes, an increase of 19% in the Southeast compared to 352 homes closed in this division during the third quarter of last year.

Our Southeast Division also had an increase in community count of 6 communities, primarily located in Raleigh with 4 new communities resulting from our acquisition of Wynn Homes. August 2 marked our 1 year anniversary of the Wynn Homes acquisition.

This acquisition was instrumental in our community count growth for 2019, expanding our footprint in one of the top housing markets in the southeast. Our West division closed 240 homes compared to 173 in the third quarter last year.

This 39% increase in homes closed year-over-year was primarily driven by the increase of 3 new active communities which includes the addition of the Sacramento and Las Vegas markets. In addition, we continued to develop the wholesale side of our business.

This quarter, we closed 127 homes with three different investment groups, generating $26 million in revenue. Overall, throughout the third quarter, we saw a continuous demand for affordable homes coupled with community count expansion and a positive response from buyers to lower interest rates.

With that, I would like to turn the call over to Charles Merdian, our Chief Financial Officer, for a more in-depth review of our financial results..

Thanks, Eric. As mentioned earlier, home sales revenue for the quarter were $483.1 million based on 2,003 homes closed, a 27% increase over the third quarter of 2018. Sales prices realized from homes closed during the third quarter range from the $140,000s to over $600,000 and averaged $241,179, a 1.5% year-over-year increase.

In the third quarter by segment, approximate average sales prices were $221,000 in the Central, $363,000 in the Northwest, $218,000 in the Southeast, $207,000 in Florida and $256,000 in the West.

Gross margin as a percentage of sales was 24.1% this quarter compared to 25.6% for the same quarter last year, a decrease of 150 basis points primarily as a result of higher land, construction and capitalized interest cost. Sequentially, gross margins were consistent compared to the second quarter of this year.

Our adjusted gross margin was 26.3% this quarter compared to 27.4% for the third quarter of 2018 and consistent with the second quarter of this year.

Adjusted gross margin for the third quarter excludes approximately $9.5 million of capitalized interest charged to cost of sales during the quarter, representing 197 basis points and consistent with the previous quarter. We currently expect our gross margin and adjusted gross margin to be similar in the fourth quarter.

Combined selling, general and administrative expenses for the third quarter were 10.9% of home sales revenue compared to 12% in the prior year, reflecting operating leverage from more homes closed and higher average sales prices.

Selling expenses for the quarter were $33.5 million or 6.9% of home sales revenues compared to $27.9 million or 7.3% of home sales revenue for the third quarter of 2018, which is a 40 basis point decrease.

The decrease in selling expenses as a percentage of home sales revenue reflects operating leverage realized from the increase in home sales revenue. General and administrative expenses were $19.1 million or 4% of home sales revenue compared to 4.7% for the third quarter of 2018, a 70 basis point decrease.

The decrease in general and administrative expenses as a percentage of home sales revenues reflects operational leverage realized from the increase in home sales revenues. We expect fourth quarter SG&A expenses as a percentage of revenue to be similar to the third quarter.

Pre-tax income for the quarter was $64.7 million or 13.4% of home sales revenue. We generated net income in the quarter of $49.3 million or 10.2% of home sales revenue, which represents earnings per share of $2.15 per basic share and $1.93 per diluted share.

Third quarter gross orders were 2,625 and net orders were 1,990, a 22.3% increase over the prior year third quarter. Ending backlog for the third quarter was 1,635 homes compared to 1,212 last year and the cancellation rate for the third quarter of 2019 was 24%. We ended the third quarter with a portfolio of 48,803 owned and controlled lots.

As of September 30, 31,759 or 65% were owned. And of this amount, 6,974 were finished vacant lots, 20,156 were either raw or under development and 4,629 were either completed homes, information centers or homes in process.

Weighted shares outstanding for calculating diluted earnings per share are impacted by our outstanding convertible notes maturing this month.

In the third quarter of 2019, our average stock price was $76.42, resulting in an approximate 2.3 million share increase to the weighted average shares outstanding for the diluted EPS calculation for the quarter.

With respect to the conversion of the convertible notes, we have elected to settle the notes using a combination of cash to pay the principal amount and shares of our common stock. We expect that our average stock price through conversion could be slightly higher than the third quarter treasury stock method calculation.

We would then expect to issue approximately 2.5 million shares in November, increasing our basic shares outstanding to approximately 25.5 million shares. As of September 30, we had approximately $37 million in cash, approximately $1.5 billion of real estate inventory and total assets of $1.6 billion.

Also at the end of September, we had roughly $760 million in total debt outstanding under our revolving credit facility, convertible notes and senior notes. Our available borrowing capacity was approximately $145 million. Our gross debt to capitalization was 49.5% and net debt to capitalization was 47.9%.

At this point, I would like to turn the call back over to Eric..

Thanks, Charles. Let me provide some guidance and thoughts on what we are seeing thus far in the fourth quarter and looking ahead into the remainder of the year. So far in the fourth quarter, we are seeing sustained demand and positive response to lower interest rates.

We just wrapped up our national sales event, promoting the idea that now is the time for consumers to make their move. And as a result, we are able to drive more leads to our communities resulting in increased sales. October results were positive and we expect the momentum we are experiencing now to carry throughout the remainder of the year.

We expect to publish our October monthly closings after the market closes later today. We had a strong month and will report 718 closings for the month of October. This final number is subject to our normal review and verification of fundings.

718 closings would result in a year-over-year increase of more than 50% from the 468 closings in October of last year. The first 10 months have put us on track to hit all of our key metrics.

For the remainder of 2019, we expect our community count to end the year between 105 and 115 active-selling communities and are updating our guidance to reflect our expectation to close between 7,100 to 7,600 homes for the full year. In addition, we believe our average sales price for the year will be between $235,000 to $240,000.

We expect our gross margin for the year to be similar to our year-to-date results through September and end the year between 23.5% and 24.5%. We expect adjusted gross margin, which excludes the effects of interest and purchase accounting, to end the year between 26% and 27%.

Given our guidance for home closings, average sales price, gross margins and active community count, we believe our full year basic earnings per share will be between $7 and $7.60 per share. Now we will be happy to take your questions..

Thank you. [Operator Instructions] And our first question comes from Truman Patterson from Wells Fargo. Your line is open..

Thanks. Actually, this is Paul. I was wondering the interest rate spike in the first half of September and then we have seen that again kind of repeat itself in October.

Did you notice any – did that have any impact on either your traffic or your orders when those rates were elevated?.

Yes, I don’t think so, Paul. This is Eric speaking. It seems like we had a real positive October. I think historically, we are still talking about really low interest rates. So we haven’t been talking a lot about interest rates spiking. It’s more of how low they are and how great an environment we are in.

October, like we talked about in the scripted presentation, October was our make your move national sales event and really talked about, historically speaking, how great rates are and how that leads to a more affordable payment. So October was a good, solid, strong month and similar to the third quarter..

Speaking of the national sales event, should we expect may be an even higher than seasonal bump in December closings as those closed before year end?.

Yes, I think we look at the event as very positive. It was really to get out our – get the information out to the consumer. It’s a great time to move because of interest rates and also because of the inventory that we had on the ground. We did the national event last year as well.

So I think as far as the fourth quarter and December closings, we gave guidance for our full year. So I think everybody should expect that we will be inside that guidance..

Okay. And then on the gross margin decline, you mentioned that’s due in part to higher land cost.

Is that really just due to increased land pricing in your core markets or is that more towards option lot mix and some of your newer geographies?.

Yes, Paul. This is Charles. Yes, so our finished lot cost averaged this past quarter about 19.5% of our average sales price. So that was up year-over-year just over 100 basis points and just up slightly sequentially. So I think the comparable that we referenced in the earnings call and in the script is really more on the year-over-year comp.

But we do continue to price our houses based and account for both just land cost and increasing construction cost. We expect that land and construction costs will continue to rise over time and there is competition in the entry level, which certainly, we see in the market right now..

Okay, I appreciate it. Thank you very much..

You are welcome..

Our next question comes from Jay McCanless from Wedbush. Your line is open..

Hey, thanks for taking my questions. Charles, if I could pick up on the competition statement.

I wanted to find out are you guys seeing an elevated level of incentives from some of your entry level competitors and/or are you expecting that you guys are going to have to be running some type of incentives as the rates start to move up to drive volume?.

Jay, this is Eric. I’ll take a shot at this question. I think from the competition incentives, we really haven’t seen that and incentives isn’t a big part of our program as well. Maybe some incentives that’s on older houses that are still in inventory to finish out the year.

But we still think it’s a very positive environment out there with us and all the other builders and are seeing a lot of incentives because rates are still really good, demand is good, supply is low. So it feels pretty good out there with us and the other builders..

Got it.

And then on the 127 wholesale homes this quarter, how does that compare to last year? And do you guys still believe that the net – or the operating margin I guess from those wholesale homes is still in line with the home that you sell to a retail customer?.

Yes, that is correct. Yes, we know that for a fact that the margins are similar to selling it to a retail customer. Gross margins overall are less, but we makeup that and reduce commissions, advertising, etcetera. So, operating margins are very similar.

And compared to last year, last year was about 104 wholesale homes in the third quarter, so very similar percentage, this year 6.3% and very similar percentage to that last year..

Okay.

So that increase in wholesale probably didn’t have a big impact on the gross margin? It was more the land cost which you just talked about – you guys just talked about land cost?.

Correct and getting more closings coming from outside the state of Texas which also tends to lead to a lower gross margin compared to Texas..

And then I wanted on the October 718 closings, it is a great number, what was the ending community count for the month or the average community count for October?.

Yes, we are still tying all the numbers out for October and going through our normal processes and make sure everything is funded and all the paperwork is complete. Normally going through that process, 1, 2 or 3 closings may fall into the next month.

But at this point, when we release the numbers later today, we are very confident our closing number is going to be between 715 and 718 and very likely on a community count of 104..

Okay, great. Thanks for taking my questions..

You are welcome..

Our next question comes from Michael Rehaut from JPMorgan. Your line is open..

Hi, thanks. Good morning or good afternoon, everyone. I appreciate you taking my questions. First, I just wanted to get a little bit of kind of drilling down on some of the guidance for the year given obviously three quarters in.

With the particular – on the ASP – on the adjusted gross margin and reported – or post interest gross margin, you said you expect 4Q to be similar to 3Q. That would put your full year right around 26 on the adjusted side, 24 even on the post interest. So I was just curious.

Those numbers, could you obviously towards the lower end o the adjusted for the full year range and kind of towards the middle? Just want to make sure I’m thinking about that right because you are pretty specific on 4Q.

And to get something a little different on the full year, you know you would have to be a bit more – there would have to be a bit more movement relative to 3Q.

So I just want to make sure I’m thinking about that right and I’m doing the numbers right?.

Yes, this is Charles. You are right on. That is accurate.

If the fourth quarter margins come in similar, that would weight the actual results for the full year to trend towards the bottom of the adjusted gross margin range and more towards the midpoint on the gross margin range and we go into every quarter in our outlook for every year evaluating a number of factors that go into the gross margin.

Certainly, there is variability between introducing new communities, transitioning between communities, geographic mix and certainly wholesale all come into play and really, adjusting the top end of the margin down was as you may have done is that it would have to take an exceptional quarter to really push past to get to the top end of the range..

Right, okay. And then similarly, Charles, on the ASP side, I would assume to get to the low end of the range, you’d have to plug in a number for 4Q on the ASP side, something around 230 or even a little less which is you haven’t done that in three quarters and you’ve been trending pretty consistently upwards.

So just want to make sure again that I’m thinking about that right that all else equal, it would seem like it would be towards the high end of the ASP range?.

Yes. I mean, year-to-date, we are at 238 in terms of an ASP. I mean, our strongest markets is, we mentioned in the script, here in Texas, which generally tend to be on the lower end of the average ASP companywide, also Carolinas which we have done a lot of expanding this year tends to be on the lower end of the ASP.

So if we take into account that geographic mix that certainly we feel comfortable with the range that we republished, but you are right, it would definitely seems to be, that we would likely kind of stay where we are at or just within that range just tightening up the range a little bit..

Okay, appreciate that. And then I was just thinking about that – I know obviously you are not giving out 2020 guidance, but directionally when you think about community count, in 2018, by the end of the year, year-over-year, you are up about 10%.

If you kind of hit the midpoint of your guidance this year, you are going to be up around 25%, so a very big difference there.

How should we think directionally? When you look at those two types of numbers over the last couple of years, this year and last, how should we think about directionally where that community count could be by the end of 2020? And as part of that question, maybe perhaps you could review how you’re thinking about your geographic expansion plans to the extent there in new communities, new markets, areas that you feel like you have better penetration opportunities such as possibly like a California, so maybe you can kind of overlay some comments around your geographic expansion strategy into that as well?.

Thanks, Michael. This is Eric. Yes, great year for community count growth this year. We have invested a lot last year. A lot of community count growth this year aided by the Wynn Homes acquisition that we made last year at this time.

So it’s been a very strong year and I think we are going to see the dividends pay off from all the community count growth and the openings this year is really in the closings next year and getting these community open and experiencing closings for the full year 2020. You are correct we haven’t given guidance for 2020 yet.

Certainly, it should be another year of community count growth. But really depends also on how we end the year. Our guidance remains the same at 105 to 115 and the difference there is really getting a lot of our new communities open by the end of the year.

And if they don’t open by the end of the year, they certainly will open in the first quarter of next year. So it could be at the low end of the range and that’s going to result in more positive community count growth next year or if it’s in the high end of the range, probably more muted growth for next year.

But we will really end up at the same place and we are positive about that. As far as the new markets go, the new markets we have talked about on calls previously, I don’t think there is anything new to add.

The markets we are focused on getting open for the next couple of quarters and getting in the sales and closings tend to be the smaller markets, that’s run out of our hubs.

Some examples are Sarasota, Florida, Daytona, Florida, Greenville, we are going into Southern California, should have our first closings in the Riverside area over the next couple of months. First community is getting ready to open in Richmond, Virginia here over the next quarter or two.

So a lot of growth continuing, a lot of new markets, but it also depends on the market and what we are seeing out there from prices for land sellers. We will be diligent in protecting our gross margin and diligent in acquisitions. We are not going to grow just to grow. We are going to make good decisions on underwriting of our land parcels.

And right now, it’s a pretty positive environment for the sellers and asking prices are high..

Great. And then one last quick question on the modeling side.

Charles, how should I think about tax rate for fourth quarter?.

Yes, it should be similar to third..

Great. Thank you..

You bet..

Our next question comes from Carl Reichardt from BTIG. Your line is open..

Thanks. Hi, guys.

Eric, could you talk about CompleteHome and the rollout to this point? And then may be just chat a little about what has surprised you positively and what challenges you may have had, if any during that transition?.

Yes. CompleteHome, the rollout has been very positive. I think from the results that everyone has seen this year, that’s one of our 2019 initiatives.

And certainly from our order growth, including this past quarter, our closings being up more than 50% in October very positive response from our employees at LGI, our sales personnel and people on the field, very positive response from the buyers that are seeing it, really positive response from the marketing team and those of us at our corporate that support field operations.

Because it really was done to provide a lot of consistency in the product that we offer to the field.

We think with the consistency of upgrading the appliances going to hard surface countertops nationwide, ceiling fans, garage door openers, those are all what customers are starting to expect when their average sales price is getting into the mid 200s.

So, overall, very positive, it wasn’t meant to necessarily increase margins, but put a nicer product on the ground and everybody can be proud of selling, more appealing to the consumer and keep our sales elevated and I think it’s done exactly that..

Okay. Thanks. I appreciate that. And then just on your lot count, I think it’s down 9% year-on-year if I got it right.

And what’s your perspective again knowing that there is competition for lots and peers are out there looking, is the expectation over the course of the next say, two or three quarters that we will see it kind of flatten year-over-year or would you expect some type of an increase in spend there to get the lot count growing again?.

Yes, I think it will be flattish or even down possibly because the market we are in. And also on the year-over-year comps, we had the Wynn acquisition last year so I think that artificially inflated it temporarily to the higher side. So we are down but on an artificially high comp I think.

And then during this quarter, just had some larger projects fall out during the feasibility period. So a lot of it has to do with what’s in the pipeline and what ends up not getting through our acquisitions committee or getting through the due diligence period as much as new projects under contract.

But generally speaking, I do think right now we are going to be cautious with new projects under contracts and this market would lead to us not being aggressive or not putting as many new deals under contract and being patient because the deals will come again as we all know..

Great. I appreciate it. Thanks, Eric..

You are welcome..

[Operator Instructions] And our next question comes from Alex Barron from Housing Research Center. Your line is open..

Yes, thanks. I guess given all the positive things going on in the market right now, low interest rates, demand for entry-level, so forth, and the number you just gave us for October. I am trying to figure out under what scenario, would you hit the low end of your closings guidance, because that implies about 600 closings for the next 2 months.

So what could possibly cause you guys to be on the low end?.

Yes, I think, Alex, we normally don’t think about the low end of the guidance. That is kind of a worst case scenario and I think the biggest unknown because we have already reported October closings. We obviously know what October closings are going to be.

It’s really what our sales looking like in the next 6 weeks and we think they are going to be very positive and no reason to think otherwise. But when you’re putting guidance out to the market we always want to have a little bit of consciousness to that.

So that would be under scenario that sales are not very good over the next 6 weeks which is not what we expect..

Okay, got it.

So just being conservative?.

Correct..

And then Charles, you have the backlog dollar number at the end of the quarter?.

Let’s see. I still have it handy with me. Just give me one second, I apologize, just one second..

I guess while you are finding that, I heard you mentioned I think it was Riverside in Southern California.

Is there any other submarkets within Southern California cities that you guys are targeting in the next 12 months?.

We do have some in the pipeline. California is a big expansion area for us. Not necessarily in Southern California, but I know we have a project in Stockton that’s on the horizon for the next couple of quarters as an example of that..

Got it..

And Alex, the ending backlog value is $410.5 million..

Alright. Appreciate it. Thanks..

You bet..

Thank you. And I am showing no additional questions from our phone lines..

Okay. Thanks everyone for participating on today’s call and for your continued interest in LGI Homes. Have a great afternoon..

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