Good day, ladies and gentlemen, and thank you for standing by. Welcome to the LGI Homes 2022 Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker’s presentation there will be a question-and-answer session. [Operator Instructions] At this time, I would like to turn the conference over to Mr.

Josh Fattor. Sir, please begin..

Thank you and good afternoon. Before we begin, I will remind listeners that this call will contain forward-looking statements that includes management views on LGI Homes’ business strategy, outlook, plans, objectives and guidance for 2022.

Such statements reflect management’s current expectations and involve assumptions and estimates that are subject to risks and uncertainties that could cause management’s expectations to prove to be incorrect.

You should review our filings with the SEC including the Risk Factors and cautionary statements about forward-looking statements sections for discussion of the risks, uncertainties and other factors that could cause actual results to differ from those presented today.

All forward-looking statements must be considered in light of those related risks and you should not place undue reliance on such statements, which reflect management’s viewpoints as of the date of this conference call and are not guarantees of future performance.

Additionally, on today’s call, we will discuss non-GAAP financial measures that are not intended to be considered in isolation or as a substitute for financial information presented in accordance with GAAP.

Reconciliations of non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP can be found in the press release that we issued this morning and in our quarterly report on Form 10-Q for the quarter ended June 30, 2022, that we expect to file with the SEC later today.

This filing will be accessible on the SEC’s website and in the Investor Relations section of our website. Our hosts today are Eric Lipar, LGI Homes’ Chief Executive Officer and Chairman of the Board; and Charles Merdian, Chief Financial Officer and Treasurer. I will now turn the call over to Eric..

Thanks, Josh. Good afternoon, everyone, and welcome to our earnings call. I will open with highlights from our second quarter, and then, Charles, will provide details on our financial results. Finally, I will provide an update on our performance to-date in the third quarter and our outlook for the rest of the year.

I am pleased to share the record results delivered by the LGI team in the second quarter, continuing our track record of operational excellence and industry-leading profitability. We closed 2027 homes at an average selling price of over $356,000, resulting in over $723 million in revenue.

Absorptions for the quarter came in at 7.4 closings per community per month above our historical second quarter average of 7.1. Houston was our top market with 13.6 closings per community per month. Charlotte was second with 12, followed by Dallas Fort Worth with 11.8, San Antonio with 10.7 and Tucson routed out the top five with 10.3.

Congratulations to these teams to their outstanding performance last quarter. I am also pleased to announce that in June we had our first closing in the State of Maryland and are now operating in 35 markets across 20 states.

Despite fewer closings compared to last year, our commitment to our systems, combined with continued pricing power allowed us to deliver our most profitable second quarter ever and we set new company records in every profitability metric we track including gross margins, EBITDA, pretax income and net income.

While the housing market outlook is uncertain, we are confident in our positioning and path going forward. We enter the remainder of the year with a solid balance sheet and attractive land pipeline, our proven expertise in land development and marketing, and the most experienced, well trained sales force in the industry.

Regardless of what the market does in the near-term, LGI is on solid footing and well positioned to succeed. Now I will turn the call over to Charles for more details on our financial results..

Thanks, Eric. During the quarter, we closed 2027 homes. Of our total closings, 146 homes were sold through our wholesale business, representing 7.2% of our total closings, compared to 430 homes or 15.1% of our total closings in the same quarter last year.

The year-over-year decline in wholesale closings was driven by our decision to write fewer wholesale contracts in the second half of 2021 when cost inputs were at their most volatile, our prioritization of retail sales and the timing of closing.

Revenue in the second quarter was $723.1 million, a decline of only 8.6% from last year, as the decrease in home closings was offset by 28.7% increase in average selling prices to a record $356,719. Selling prices increased in all of our reportable segments, primarily driven by continued strong demand that enabled us to pass-through cost increases.

Gross margin this quarter was a new company record at 32%, a 500-basis-point improvement over the same period last year and a 300-basis-point improvement over our prior record. The increase resulted from our success at passing through costs increases, lower capitalized interest expense and lower lot costs as a percentage of average sales price.

Adjusted gross margin this quarter was also a new company record at 33.1%, a 460-basis-point improvement over the same period last year and a 280-basis-point improvement over our prior record.

Adjusted gross margin excludes $5.7 million of capitalized interest charged cost to sales during the quarter and approximately $2 million related to purchase accounting together representing 110 basis points.

Combined selling, general and administrative expenses for the second quarter were 10% of revenue, compared to 8.6% during the same period last year and 11.5% in the first quarter of this year. Selling expenses for the quarter were $43.3 million or 6% of revenue, compared to 5.7% for the second quarter of 2021.

General and administrative expenses totaled $29.1 million or 4% of revenue, compared to 2.9% last year. The 110-basis-point increase was driven by lower overall revenue, increased overhead and other personnel costs.

EBITDA for the quarter was $169.1 million or a record setting 23.4% of revenue, a 320-basis-point improvement over the same period last year, which was also our previous record. Adjusted EBITDA was $167.1 million or 23.1% of revenue, a 310-basis-point increase from the same period last year and also a new record.

Adjusted EBITDA excludes $4 million of other income and $2 million related to purchase accounting, together representing approximately 30 basis points. Pretax net income was $163 million, a record setting 22.5% of revenue and a 370-basis-point improvement over the same period last year, which was also our previous record.

Our effective tax rate in the second quarter was 24.3%, compared to 20.8% last year. The increase was primarily due to the expiration of benefits related to the 45L Tax Credits. Our second quarter reported net income was $123.4 million or 17.1% of revenue, also a new company record.

Finally, earnings in the second quarter were $5.24 per basic share and $5.20 per diluted share, both representing year-over-year increases of 10.3%. Second quarter gross orders were 1,244 and net orders were 864.

The 57.3% decrease in net orders was primarily due to last year strong comp, as well as our decision to divert sales to later in the construction process.

Our cancellation rate for the second quarter was 30.5%, compared to 24.4% last year, primarily due to the moderation in demand experienced in June, as mortgage rates increased and some buyers chose to cancel their contracts. We finished the second quarter with a backlog of 1,266 homes, representing over $445 million in value.

As of June 30th, our land portfolio consisted of at 9,984 owned and controlled lots, an 18.5% increase year-over-year and a 3.5% decrease sequentially. We added over 4,800 new lots to our owned inventory and ended the quarter with 61,893 owned lots, an increase of 45.7% year-over-year and 4.8%, sequentially.

Of our owned lots, 49,595 were either raw land or land under development and only a third of those lots were inactive development. The remaining 12,298 of our owned lots were finished lots, of which 7481 were vacant lots.

During the quarter, we started over 2,400 homes, and at June 30th, we had 4,817 completed homes, information centers or homes in process. Excluding information centers, we had just 603 completed homes. And finally, at the end of the quarter, we controlled 28,091 lots, a decrease of 15.9% year-over-year and 17.8%, sequentially.

Turning to the balance sheet, we ended the quarter with $42 million in cash, over $2.6 billion in real estate inventory and total assets of nearly $2.9 billion. Total debt at quarter end was $1.2 billion, resulting in a debt-to-capitalization ratio of 43.3% and a net debt to capitalization ratio of 42.4%.

We expect our leverage ratio will remain in the range between 35% and 45%. As of June 30th, we had total liquidity of $245.7 million, consisting of the $42 million of cash on hand and $203.7 million available to borrow under our credit facility.

In the last year, our shareholders equity is increased by $228 million to over $1.5 billion and we delivered a return on equity of 29.6%. During the second quarter, we repurchased 417,861 shares of our common stock for $37.4 million and we ended the quarter with 23.3 million shares outstanding.

Since 2020, we have repurchased approximately 12% of our common stock, and as of June 30th, we had $211.5 million remaining on our stock repurchase program. At this point, I will turn the call back over to Eric..

Thanks, Charles. As highlighted in our press release, we are adjusting our full year guidance to reflect our current outlook for the rest of 2022. Pending verifications of fundings, we expect to report that we close 470 homes in July. We now expect to close between 7,500 and 8,300 homes for the full year.

While lower than our original guidance, this new range assumes the closing pace of 7.5 to 8 closings per community per month for the rest of the year, which is in line with our strong performance during the back half of 2019 and we had a similar number of communities.

We continue to experience headwinds on the development side and now expect 100 to 110 active communities at year end. Additionally, we still expect community count growth of 20% to 30% next year. Based on our results to-date and current backlog, we expect an average selling price between $345,000 and $360,000 for the full year.

Additionally, we now expect our SG&A expense will range between 10% and 11%. We maintain our guidance for gross margins in the range between 27% and 29%, and adjusted gross margins between 28.5% and 30.5%. After a two-year boom market unlike any other in history, the new home market is at a crossroads.

From a short-term perspective, homes are more expensive, consumer prices are up and move the curb inflation nearly doubled mortgage rates. However, the longer term outlook reveals a solid foundation for multiyear growth.

Demographic Trends remain supportive of demand, strong labor markets are fueling wage growth, tight rental supply is pushing up rents and the inventory of homes available for sale remains historically low. At LGI, we are taking the long-term view and remain optimistic about our business for several reasons.

For the first half of the year, we were mainly focused on closing the homes in our backlog. Now we are back to focusing on sales and closings, and our marketing faucet is turned on. While others may be cutting expenses, we have been increasing our advertising spend with favorable results.

In July alone, nearly 20,000 people inquired about moving from renting to homeownership, a 54% increase over last year. Additionally, our orders have been up for four consecutive months.

These results give us confidence that there is still a large pool of qualified buyers for our homes and we expect these numbers to grow as we connect with more of those target buyers. We have removed the governor from our sales process. For the last few months, we have only sold homes that are within 60 days of closing.

That was the right decision at the time given the supply chain disruptions. However, with supply chains now normalizing, we are adjusting accordingly. This weekend, we will start selling homes that are within 90 days of closing.

These homes will be at a phase of construction, where we can have confidence in our delivery times, a clearer view of costs and certainty that we can provide a great experience for our homebuyers. Prices are normalizing.

While we are proud of the 33% adjusted gross margin we just delivered is not a sustainable expectation and that’s not our target moving forward. As we bring new communities online, we are offering them at prices that will deliver normalized margins in the 25% to 28% range.

Additionally, we are seeing input cost decrease in almost all of our communities, which will enable us to offer homes at monthly payments that are more affordable for our buyers.

Finally, as we right-size our inventory to meet current levels of demand, we expect to generate additional cash flow that will position us to capitalize on opportunities to accelerate our growth. To conclude, I want to congratulate our employees on our record setting quarter and thank them for their commitment to our continued success.

The days of retail investor demand, shifts in housing premises, work-from-home migration and low interest rates filling sales offices are behind us.

What matters now is an unwavering focus on connecting directly with customers, educating buyers on the benefits of ownership, building homes that offer a compelling value compared to renting and delivering the industry’s best customer experience.

LGI homes was built to thrive in challenging markets and we believe our people, systems, culture and 100% spec focus model will continue to differentiate our company as we navigate this dynamic period. We will now open the call for questions..

[Operator Instructions] Our first question or comment comes from the line of Trevor Allinson from Wolfe Research. Your line is open..

Hi. Good morning. Thank you for taking my questions. First question I just want, you touch on what you would ended with there on your gross margin outlooks in the back half of the year. It sounds like the main driver there is going to be new communities coming online at lower margins.

Are there any other factors that are major drivers of that, maybe increased wholesale closings or still higher costs flowing through in the back of the year, it’s going to drag that sequential decrease from Q2 strong level?.

Yeah. It’s a great question. This is Eric. I can start. I point to three things talking about our margin guidance and also with the caveat that our gross margin guidance midpoint will be the best year in company history. So still a very strong margin for the year.

But the margin that we just came off, our adjusted gross margin on how we priced our house, 33.1% in Q2 and 31.9% year-to-date is phenomenal. It really shows how strong the market dynamics were and phenomenal results. I think going forward the three things I’d point to is, one, new communities coming online.

We are pricing at normalized margins, 25% to 28% and we have seen those communities get off the fast starts with more normalized orders and sales pace, which is very positive. I’d also point to the wholesale business. Wholesale is only 7% of our closings last quarter.

We expect that to get normal, probably, 10% to 15% of our closings in the back half of the year. And then also, as we have closed out the pipeline, our costs are going down.

So even in our existing community, we are going to be able to adjust our pricing to normalize margins, in addition with the costs coming down and to offer a more affordable payment to our customers..

Okay. Great. Thanks. That’s very helpful.

And then, second, looking at your option lots, they took a step down sequentially, I was hoping to get an update with what you are seeing as a landmark in general and then with your option agreements, given the slower demand environment, have you seen sellers become more willing to negotiate on terms or pricing? Have you seen any actual price declines? And then, with your option lots moving lower sequentially, have you actually walked away from any of those option deals?.

Yeah. I think it’s a great question. I think what we are seeing in land market, it is probably consistent with whatever else has been saying, haven’t seen a lot of price decreases on land yet, when I say land, I mean, raw land or paper lots per se. But it’s early.

I was in Colorado last week for a Board meeting and spent some time in the field with our acquisitions team. And for the first time, in a couple years, we had a couple of finished lot opportunities we were looking at.

So there’s a lot of developments going on across the United States and we are pretty excited about the potential opportunities that may come about with a more normal market.

For the last couple of years it’s just been an unbelievable market where all the builders are taking orders, everybody is having phenomenal success, everybody is having phenomenal margins.

But a lot of the land coming to mark and a lot of developments that’s going on has been financed with more expensive debt, more expensive land banking, and those communities come online, we will see. We are starting to see some of those opportunities, but it’s early.

So I think rather than focusing on raw land, we may see some opportunities for finished lots..

Okay. Great. Thanks for taking my questions. Good luck in the next couple of quarters..

Thank you..

Thank you. Our next question or comment comes from the line of Trevor Allinson from Wolfe Research. Mr. Allinson, your line is open. Mr. Allinson from Wolfe Research, your line is open..

I think we got Trevor’s first question..

Yeah. I guess I will hop in with one quick one then we can move on. I am just hoping you guys could discuss demand by geography here. Your West region was really strong and I got some community account growth there. So I will just ask one quick one there and I will hop back out..

Yeah. Yeah. I think I can take this, again, the demand question in general, Charles, can add to it if he wants to see that. I think demand is consistent across the country. And what I mean by that is, really our focus on the first half of the year was really focused on our backlog and getting that close.

We made a decision in March to only sell houses within 60 days of closing, because supply chain challenge, we weren’t having great experiences with the customers, because we were missing closing dates, which is not good for us, not good for the customer.

So we really focused through Q2 closing out our backlog and did not focus on sales, because we did not have a lot of finished inventory to sell within a 60-day period. That has started to change.

In fact, that’s one of the things in the scripted remarks we talked about, our orders are up four consecutive months, because we are bringing more houses on that are within that 60-day period and gave us more inventory to sell in four consecutive months and we are confident, August will be an increase over July and that will make five consecutive months of order increase.

Also, like we talked about in our remarks, we decided to with construction and pipeline and supply chain easing starting this weekend, we are going to start selling houses within 90 days of closing. And we also think that’s going to add to our orders and produce a really good solid month of orders as well.

So that’s pretty consistent nationwide, Trevor, what we are seeing and our focus is now entirely shifted to started -- start selling more houses. We are going to have more available inventory. We are going to spend more money on marketing. And we are going to be hiring a lot of salespeople and opening up these new communities at normalize margins.

So we are real optimistic about the second half of the year..

Trevor, this is Charles. I just add specifically to the West. You are correct. It was increasing community count, specifically in our Phoenix and Northern California markets..

All right. Thanks, guys..

Thank you. Our next question or comment comes from the line of Michael Rehaut from JPMorgan. Just a second. Mr. Rehaut, your line is open..

Thanks. Thank you. Good afternoon. Thanks for taking my questions..

Good afternoon..

I just want to circle back and make sure I am understanding the gross margin comments well, as it relates to the back half.

You are talking about opening up new communities in a 25% to 28% range and just want to be clear, that is pre or post-interest?.

Pre, that’s adjusted gross margin..

Okay. So, with the guidance that you have pre-interest currently, it looks like, you would have to get to around the closer to like 28% or less, that’s coming off of the 33%. So, still at the high end of that range. So number one, I just wanted to make sure, my math is roughly correct.

If it’s going to be all of us step down in the third quarter or if it could go even below that 28% average in the fourth quarter and how quickly might we see the 25% to 28% range flow through, because obviously, there’s a certain element of community count turnover?.

Yeah. I think, the only clarification, Mike, I’d make is, the adjusted gross margin, what we are saying, new communities, it’s not only new, that community added a community count, it’s also our replacement community.

So we have got a lot of communities nationwide that are in the process of closing out and that we are bringing the quote replacement online, which is an additive to community count, but does have an impact on this gross margin discussion.

Charles can weigh in, but I personally think gross margins in the third quarter, probably, higher than the fourth quarter, because our backlog percentage gross margin is still really strong and we think that’s going to gradually go back to normalization and then we factor that in when we provide at the year-end range that we did..

Yeah. I would just -- I would agree, Mike, with Eric’s comment that, it’s likely that the third quarter will be higher than the fourth quarter. So we are thinking the step down would likely happen in the fourth quarter..

Right. Right. Okay.

Also, if you kind of run some of the math on the absorption for the back half of the year, your comments around absorption 7.5 to 8 and getting to a midpoint of the community count with a kind of stepped that up gradually over the next several months, even keeping sale closings pace between 7.5 and 8 or even at the lower end of that, get you actually towards the higher end of your closings range.

So just curious any thoughts on that, if there’s anything we are missing here, because it does seem like, based on, again, a gradual move towards community count getting to the middle of the 100 to 110 by the end of the year and 7.5 to 8 seems like you are coming up at the higher end.

So just any thoughts?.

Yeah. I think that’s, my comment on that is really, that’s why we get ranges, anywhere in that 7.5 to 8 a month range in the second half is going to put us in our guidance range.

And it really depends, a lot of it’s going to depend on, what happens in the economy the next three months or four months, a lot of it’s going to depend on getting these new communities open, where we are at in the range of community count, high end versus low end. So that’s still a challenge for us.

How many houses we can deliver? What the supply chain looks like? So I don’t know if I have any more comments other than, that’s why we give the range. We are confident in our new closing guidance range.

We had to adjust that down based on where we were and what we are seeing on construction, development and sales, but we are confident of being in that range..

Okay. One last one, if I could, you gave the 10% to 11% for the SG&A for the year.

Is that something that all else equal, we should expect going forward into 2023 or if the market remained soft, you are not kind of getting the results that you would want, would we see that come up a little bit more or can we see further adjustments on the gross margin side?.

Yeah. It’s great question, Mike. This is Charles. Not necessarily giving specific guidance on 2023. But I think what we have been talking about as it refers to SG&A is that we generally think that our increase in marketing and advertising is going to return back to normal.

So we have seen over the last year and a half or so just the benefits of not having to spend as a bunch of money. So I think I’d break it into the selling portion. We are expecting it to increase as a percentage of revenue over time to get back to normal ranges. And then the G&A portion in our income statement is generally more fixed.

So I would say, depending on where our closings end up in 2023 and how the pace that community count goes, is there some opportunity for leverage there to offset some of the increase in selling expenses. But I think, overall, I think, we are kind of trending back to this 10% to 11% range for the near-term..

Right.

So selling expenses were 7% to 7.5% from 2017 to 2019 is that a good reference point?.

I don’t know that I would go quite necessarily that high, but probably the lower end of the range is what I would say..

Great. Thanks so much. Appreciate it..

You bet..

Thank you. Our next question or comment comes from the line of Jay McCanless from Wedbush. Mr. McCanless, your line is open..

Hey. Good afternoon guys.

Can you remind us on the community growth that you are expecting for fiscal 2023, when is the bulk of those communities coming up?.

Yeah. That is a great question, Jay. And after the last couple years the probably the correct answer is I am not sure. But we are confident that 23%, 30% number, I mean, those communities are just getting delayed, they will be there, so we are confident community count is going to grow - grow next year.

For modeling purposes, yeah, I think, an equal amount coming through the year would probably be appropriate..

Okay. And that was actually going to be my next question.

If you could talk about what type of delays you are seeing on horizontal development and have the supply chain issues gotten any better for that side of the business?.

It doesn’t seem to be getting any better yet. We are still having challenges electrical transformers, some other supply chain, getting the start of the development process, getting the plants recorded, getting the necessary approvals from the city, all the engineers are still busy.

So supply chain on the development side, I would say, is similarly challenged. Now we do expect that to get better, because we believe and other builders have said, as well as us, probably not doing as much developments near-term, probably adjusting development sizes of the sections for today’s normalizing market.

So just like on the construction side, we do see that improving but we have not seen that yet the development side..

Okay. And then on this new or not new but going back towards a more historical gross margin range, it would imply, I think, some pretty steep price cuts maybe to what you had originally intended to bring these communities out.

Is that thinking for that line of thinking correct and how much of it is -- how much are we talking about in percentage, have you marked down what you think your initial base prices are going to be on these communities?.

Yeah. It’s a great question. I don’t think we are looking at it as having a lot of price cuts Jay, because we increase prices so rapidly over the last couple years we are just going back to normal.

And we have not been focused on price cuts because we haven’t had a lot of finished inventory and I think our reaction is probably similar to a lot of a lot of builders and so you have a lot of standing inventory. There’s not going to be a lot of discussion, about price cuts per se.

But that’s changing and we are looking at our pricing on a community-by-community basis nationwide and all -- everybody can tell by our backlog, and the fact, we have only been selling 60 days in advance, we describe it as we do need to normalize our pricing.

Some of our communities had unbelievable gross margins, we are able to increase pricing a lot like in markets like Austin. While markets like Austin, we are not going to be able to keep selling, we don’t believe that 35% plus gross margins and we have seen some pushback on those type of pricing. We will normalize our pricing.

Yes, we will probably be selling the same floor plans in the future for less money than we were over the last 24 months. But it’s going to be similar to what it was two years and three years ago, because the last couple years have just, they are just going to be an outlier as far as pricing goes.

I mean, a 33%, adjusted gross margin, we are very unlikely never to post that, again, in our history. It’s such an outlier in gross margin. And we are just going back to normal and in a normal market, we believe we are going to thrive and there’s going to be great tremendous opportunities for LGI and we are pretty excited about it..

Got it.

And then one more quick one, it’s interesting that you are starting to see finished lot deals again, do you think with the pace of what you are seeing that you could potentially buy enough of those communities to make up for some of the shortfall that you are expecting relative to your previous guidance for this year?.

Yeah. Not necessarily this year, because I mean, even they are just starting to see opportunities. I mean close them, it certainly wouldn’t relate in any home closings in 2022. We think it may create opportunities for community count growth and closing growth in 2023.

And I gave a couple of examples, but it just really depends on what happens with the industry.

The more challenging the industry becomes, whether it’s a recession, whether rates pricing, supply chain, any of the headwinds that we potentially face as an industry, our attitude and what we are talking about internally, the more challenging environment it is, the more opportunities it’s going to create thrill.

Yeah, you have to remember our company and we haven’t talked about this last couple of years. But we have never lost money in any year, including the greatest downturn anyone’s ever seen in 2006, 2007, 2008. We have never taken an inventory impairment in the company history.

So if it’s a more challenging environment, going forward, it’s going to create more opportunities for finish lots. If it’s a more normalized market or things get really good and rates stay down or whatever the tailwinds may be, then that’s fine as well and LGI will thrive in that market..

Okay. Sounds great. Thank you..

You are welcome..

Thank you. Our next question or comment comes from the line of Carl Reichardt from BTIG. Standby..

Thanks for taking the questions. One question I had Eric is just on cancellations. Your rate was up, although, your unit counts weren’t up much.

Did you see an alteration and why folks were cancelling over the course of the quarter? Is it still more affordability related or would you say it’s more sort of psychological and fear of the future? I just kind of like your take on if that’s changed and how it’s changed?.

Yeah. I think for us, it’s still primarily affordability related. Our pipeline got very large in Q2 of last year. We have been working on getting that closed out, rates are certainly higher. Not all our customers have rate locks, usually were blocking the rate to within 60 days to 90 days of closing. So, some of the customers didn’t qualify anymore.

Certainly that cancellation rate and we have talked about on calls before we don’t think it’s as relevant for us as maybe other companies being a spec builder, but we didn’t have enough orders either. If we had had more orders, the cancellation rate would have been normal. We did see Carl, and I appreciate you asking the question our cancellations.

We have seen some of our retail investors cancel.

But we have also closed a lot of those homes over the last couple quarters and first part of the year, which has been very, very good for us as a company and they are -- we just think we are going back to a normalized market where our customers are predominantly going to be customers that are currently paying rent.

I mean LGI we offer an affordable alternative to renting. Rents are off across the country and we are going back to catering to that customer. We have sold a lot of houses to investors over the last couple years and we believe that was the right decision, but in a more normal market. We think that we will get back to normal activity as well..

Okay. Thanks, Eric. And then, Charles….

You are welcome..

… the line of credit and you are about I think I got this right 75% capacity utilization at this point. And if I did this right, more typically, you are sort of back at a year, third quarter, fourth quarter is your peak utilization.

So I am curious, are you planning on being operating cash flow positive fourth quarter, can we expect to see a diminished utilization of the capacity as we move into the next couple of quarters?.

Yeah. Great question, Carl. So, yeah, we had mentioned in the script as we right-size inventory. So one of the things we are focused on with 4,700 units in inventory, we would expect our vertical inventory to work its way down throughout the year.

We are also focused on just inventory management in general and keeping an eye on what we need in terms of from acquisitions and development. And then we also evaluate what we have available for share repurchases as well. So that’s kind of a function that goes into that, all keeping in mind our 35% to 45% target leverage ratio.

So, yes, we should generate some positive cash flow based on right-sizing the inventory, and stay within our targeted ranges..

Charles, with the dollars in inventory, a little bit stuck in the field, just because things have slowed down, because it’s taken longer to build stuff.

Is that forcing you then to divert dollars to finish that inventory as opposed to doing development spend?.

No. No. I don’t think so. I think it’s balanced between all categories between acquisitions, development and vertical construction. So I think it shifts between whether we have heavily weighted towards complete versus WIP comes into play. We will see that shift continued throughout the year only having 600 completed homes.

At the end of June, we would expect completed homes to increase, getting back to as Eric mentioned, kind of a more normal selling cycle where we are selling spec. We would expect completed homes to increase, but the WIP number would come down as kind of supply chain works itself out.

And then we just look at all those combined to really see what our targeted inventory number is to make sure we are managing that accordingly..

Okay. All right. I appreciate the help. Thanks so much, guys..

Thank you. Our next question or comment comes from the line of Deepa Raghavan from Wells Fargo. Your line is open..

Good afternoon, everyone. Thanks for taking my question.

Eric, can you talk through how you are assessing demand deterioration at your end if you are only accepting orders selectively? Anywhere to provide color on demand fall out versus how many you might have done away with a new audit performance? I mean, as we have talked through this, can you talk about traffic trends at your communities as well?.

Yeah. I could probably measure how many we would have sold, Deepa, it’s a good question. And I think we don’t want to diminish that, we are in the affordable housing business and with ASP up 27% year-over-year, interest rates higher. We -- our affordability does matter and rates do matter.

I think we are calling on more of our experience in the business, because we did believe -- we do believe is the right decision to turn off sales if you will, make sure the customer has great experience, focus on our backlog, folks’ kind of getting homes closed and now that we have closed the majority of our backlog focus on orders.

So we are not sure how many we missed, but orders have went out for four straight months. We are confident in our sales team, we are confident in our ability to spend marketing, over 20,000 people inquired about homeownership in July. We know and got all kinds of data behind it.

We know that if we spend dollars on marketing that’s going to result in leads we know what percentage of those leads are going to make an appointment, show up for their appointment and be qualified, contracts and close, and that’s just -- those are mathematical facts that we have been doing since 2003 and our teams on top of it.

Our salespeople have to be on their game, we have to be trained, we have to execute on our systems. But all that math always works and our guidance and our confidence in our numbers, that’s because of our experience and went through this before. So, yes, we are going to be dealing with higher rates, we may dealing with higher prices.

There will be no spending on marketing with our trained sales force works. And unlike a lot of companies that are cutting back on expenses, laying off employees, we are ramping up. Now’s the time to spend more money on marketing.

I got with our recruiting department before the call and we are hiring to make sure we hit our numbers and hiring to ramp up and staff our existing office to normal capacity and also ramping up hiring to staff all of our communities that are coming online.

Because we are hiring, we have got 67 open positions, including 51 new sales positions that we are hiring for, for our October training class. And we add 50 salespeople to the LGI mix for getting our staffing up to current levels and new communities and that will have an impact..

Okay. Okay.

How many starts did you do last quarter?.

Around -- just over 2,400..

And your construction site though is how many days now?.

Still pushing us in fact ahead, it depends on the markets, still pushing 85 to 120 in there. We have seen some relief, but I think we still have some ways to go to get back to a normal construction cycle..

Yeah..

Okay.

So 2,400 kind of the starts in order pace roughly that we can experience near-term?.

Well, I think, the way we think about it Deepa is, four months to six months inventory is what we are targeting. So, I would expect us to start fewer than what we close in the short run and then future starts in the back half of the year will be, based on what we think outlook for the next three months to six months are going to look like.

So we will likely start fewer than what we close in the third quarter as part of right-sizing that inventory getting down from, 4,700 to say something like 4,000 units, which would be, six months at an 8,000 a year pace. So that’s how we are thinking about it..

That’s very helpful. Thanks very much and good luck..

Thank you..

Thank you..

Thank you. Our next question or comment comes from the follow-up from Mr. Michael Rehaut from JPMorgan. Your line is open..

Thanks. Appreciate the follow-up. I just wanted to actually a little more of a technical clarification. But the difference between adjusted and reported gross margin guidance is still 150 bps and I know that the difference between their interest amortization and purchase accounting, purchase accounting has been a 30 -- roughly 30 bps.

So you are talking about 120 bps from interest amortization and we have only been doing by 80 bps so far in the first half and on the $1 basis, it’s been about half as much as a year ago.

To get that one 1.2 you would be more like 1.5% range in the back half and that would be up nicely year-over-year on a 40 bps, 50 bps and up a few -- several million year-over-year on $1 basis.

So just wanted to be sure if that’s correct, I mean, I would think all else equal, it would still be relatively low, but not just not sure, if we are missing something?.

Yeah. Great question, Mike. I mean, I think, from our guidance standpoint, we use 150 years as the range, that doesn’t necessarily mean we are seeing specifically that interest in purchase accounting, will be 150 I think it will range in between the 110, we just saw and slightly tick up as.

Over the last couple of years, we have been capitalizing interest on development deals, a lot of those communities are now coming online. So there’s a potential that it will tick up a little bit.

We also saw an increase in average sales price, fairly rapid increase in average sales price, which will kind of minimize the percentage just in terms of percentage of revenue. And then our credit facility is also floating rate debt as well.

So as interest rates are rising, we will expect to see, all things equal slightly higher dollars related to floating rates increasing..

Right. But so maybe increasing a little bit, but if you are at $4 million, $5 million or $5 million, $6 million in the first half per quarter, I mean, we shouldn’t be doubling that in the back half.

Is that fair?.

Yeah. I think that’s fair, somewhere in between..

Great. All right. Thanks very much. Appreciate it..

You bet..

Thank you. Our next question or comment comes from the line of Kenneth Zener from Key. Your line is open..

Good afternoon, gentlemen..

Good afternoon..

One second, so with your product mix more tied to first time and obviously you have a spec for still the order approach.

Can you contrast your experience or what you are seeing, relative to the trade up buyers or anybody that really has to sell their house, given the kind of choke up that we are seeing on the existing side? Could you just offer us your thoughts on how that the demand dynamic varies within the process that you guys have?.

Yeah. And Ken, I will take it a shot. This is Eric. If I understand your question is, it’s really, I think we have an advantage focused on the first time homebuyer focusing on that monthly payment. 90% of our -- 90% plus of our customers are currently in a rental situation.

And what triggers their inquiry about LGI homes and they get our marketing in pieces, whether it’s mail or digital in the world we live in today, is their lease is expiring or their lease is coming up and almost exclusively, now everybody’s rents are increasing, and most of them are increasing a pretty material amount.

So we -- so we are confident we are going to have the demand there, because we are very, pro homeownership, where a lot of the existing, customers are existing homeowners and a lot of people probably listening to scholar in the same boat, we all have very low fixed rate mortgages on our homes.

I think that’s a headwind for the for the move up builders, which we don’t have to deal with as much dealing with the entry level builder. I think is where your question was going. But affordability does matter and we are still solving for that monthly payment..

Right. That was the direction where I was going. And then, with the challenges you face developing, considering you do develop more of your land, high gross margins.

Are you -- how do you look at your growth, because as these communities come on with 30% plus gross margins, you have a lot of leeway to grow and offer price up right to attract those renters? How wedded are you to kind of the gross margins, as you bring on new products? I mean, I think, you talked about 4,000 units and inventory at the end of the year.

Are there any other metrics, like, that you are going to be targeting in terms of the turnover, that your margins would be part of the solution to or how should we think about that?.

Yeah. A little bit what you talked about earlier, Ken. I think, it’s a shifting dynamic. We were never one to talk about a lot about price versus pace, but certainly the first half a year is all about capturing price.

We had all kinds of unbelievable waitlist, people wanting, waiting in line to buy our houses and every time a house went on the price list, it sold and we kept raising prices and it didn’t matter everyone’s still wanting to buy our houses. And that was the environment that we have been living in for a lot of the last few years and that’s changed.

Now it’s about normalized margins and pace. And I think it’s important though, and I think, we have done a good job of that.

If everybody looks at our gross margins over time, compared to the industry, that if you are doing development, if we are spending the upfront capital, we are taking the development risks we are taking the timing risks was certainly has been a challenge.

We have to price the homes accordingly to where we capture both the development profits, and the homebuilder profit. I think we have done. So we don’t want to forget that.

But certainly, I do think we have an advantage in the pricing and the gross margin when you are doing your own development and we are doing the development where our expense -- our debt expense, because we are using our credit facilities, significant less -- significantly less than the builders that used land banking and then buy the lots from land bankers at a very expensive interest rate.

So we do have that advantage as well and that’s why I think you are going to continue to see elevated margins from LGI compared to the industry..

Thank you very much..

You are welcome..

Thank you. I am showing no additional questions in the queue at this time. I’d like to turn the conference back over to management for any closing remarks..

Thank you. And thanks everyone for participating on today’s call and for your continued interest and LGI homes. Have a great day..

Ladies and gentlemen, thank you for participating in today’s conference. This concludes the program. You may now disconnect and have a wonderful day. Speakers standby..