LGI Homes Inc (LGIH) 2017 Q3 法說會逐字稿

Welcome to the LGI Homes Third Quarter 2017 Conference Call. Today's call is being recorded, and a replay will be available on the company's website later today at www.lgihomes.com. We have allocated an hour for prepared remarks and Q&A. (Operator Instructions) At this time, I will turn the call over to Rachel Eaton, Chief Marketing Officer at LGI Homes. Ms. Eaton, you may begin.

Thank you. Welcome to the LGI Homes conference call, discussing our results for the third quarter of 2017.

Today's conference call will contain forward-looking statements that include, among other things, statements regarding LGI's business strategy, outlook, plans, objectives and guidance for 2017. All such statements reflect current expectations. However, they do involve assumptions, estimates and other risks and uncertainties that could cause our expectations to prove to be incorrect. You should review our filings with the SEC, including our Risk Factors and Cautionary Statement about Forward-Looking Statements section for a discussion of these 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 and non-GAAP financial measure will be presented on this conference call. The presentation of this information is intended to be considered in isolation -- 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 third quarter of 2017 that we expect to file with the SEC later today. This filing will be accessible on the SEC's website and in our Investor Relations section of our website at www.lgihomes.com.

Joining me today are Eric Lipar, LGI Homes' Chief Executive Officer; and Charles Merdian, the company's Chief Financial Officer. With that, I'll 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.

As we celebrate the success for our hometown Houston Astros winning the World Series, we recognize that Houston is strong, but not done rebuilding. We continue to keep the people of Southeast Texas and Florida in our thoughts and prayers. As a company, the impact of Hurricane Harvey and Irma had on our operations in Houston and Florida was minimal and most importantly, all of our employees and homeowners are safe. Physical damages directly related to both storms total less than $200,000, and as a company, we lost just 1 week of sales in the affected areas and experienced only minimal construction delays generally limited to a week.

Harvey and Irma caused some of our August closings in Houston to push to September and delayed some September closings in Florida to October. Overall, we expect these events to have no impact on our annual 2017 closings. However, we are anticipating increased pressure on labor and material costs, which will be a headwind to gross margin, but the overall impacts to the company are expected to be minimal.

Today marks our fourth anniversary of 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 4 years, we have expanded into more than a dozen new markets, tripled the size of our organization and seen more than a 400% increase in our stock price since our IPO at $11 per share in 2013. We have done all of this while maintaining our culture and demonstrating that our unique operating model is sustainable.

With that, I would like to thank all of our employees for their hard work, dedication and loyalty to LGI. Because of your outstanding performance, we are proud to announce that we delivered another impressive quarter, highlighted by record-setting closings, revenue and net income.

For the quarter, we closed 1,729 homes, generating approximately $366 million in home sales revenue, which represents a 69% increase over the third quarter of 2016. Breaking it down, let's first take a look at highlights from our operations in Texas. Comprised the results from Houston, San Antonio, Dallas/Fort Worth and Austin, our Texas operations generated 830 closings in the third quarter, representing approximately 48% of our total closings for the quarter. These 830 closings also represent a 50% increase in closings for Texas over the third quarter of last year.

In addition, the absorption rate in Texas was the strongest across all divisions, averaging 9.9 closings per community per month. Our concentration outside of Texas increased during the third quarter to 52% of our closings compared to 47% of our closings in the third quarter of last year. The Southwest Division provided 15% of our home closings, the Southeast Division provided 16%, the Florida Division provided 17% and the Northwest Division contributed 4%. As we have discussed on previous calls, we anticipate our percentage of closings outside of Texas will continue to increase, further diversifying our operations.

Our company-wide absorption in the third quarter averaged 7.6 closings per community per month, an increase from the third quarter of last year, with 6 closings per month. Our top 5 markets for the quarter were Fort Myers leading the way, with 13.2 closings per community per month; Dallas/Fort Worth with 11.3; Austin with 9.8; San Antonio with 9.6; and Houston with 8.8 closings per community per month.

For the past 7 years, LGI Homes has been and continues to focus on growth. We ended the third quarter with 77 active communities, which is an increase of 18 over the 59 active communities that we had at the end of the third quarter last year. These 18 communities were spread throughout the country, with 4 in Houston, 3 in Nashville, 2 in Seattle and 1 each in Phoenix, Portland, Orlando, Jacksonville, Atlanta, Charlotte, Raleigh, Austin and Dallas.

In addition to growth through community count, we are seeing success with what we are referring to as our wholesale business. Over the past 12 to 18 months, we have experienced increased interest from the single-family rental sector to purchase homes. We have been working with these investment groups on identifying mutually beneficial communities where we can deliver homes for them. After closing 72 of these homes in the first half of 2017, we delivered an additional 96 homes in the third quarter. These closings come at a lower gross margin, but similar net margins because of the savings on SG&A expense. Although wholesale closings still represent a small percentage of our 1,729 closings for the quarter, we are excited about future revenue in closings that can come as a result of these relationships.

We received mortgage statistics from certain preferred lenders, which provide financing to approximately 70% of our business nationwide. Based on these stats, our buyer profile this quarter had an average credit score in the 650s, with an annual household income of approximately $60,000 per year. 75% of our customers utilized FHA financing, 15% obtained a VA loan, 5% used USDA and another 5% used conventional financing.

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 $365.9 million based on 1,729 homes closed, which represents a 69.2% increase over the third quarter of 2016. Sales prices realized from homes closed during the third quarter range from the 150s to over $500,000, and averaged $211,623, a 2.9% year-over-year increase, and slightly below the previous quarter. This decrease from the prior quarter was primarily due to a higher percentage of our closings in lower-priced markets. By division, our average sales prices for the third quarter were approximately $200,000 in Texas, $259,000 in the Southwest, $191,000 in the Southeast, $195,000 in Florida and $327,000 in the Northwest.

Gross margin as a percentage of sales was 25.1% this quarter compared to 26.3% for the same quarter last year. As Eric mentioned earlier, included in this quarter's closings were 96 wholesale units closed at lower gross margins, reducing our overall margin by 50 basis points. Gross margin varies quarter-to-quarter, primarily based on higher construction costs, offset by increases in sales prices and mix. Construction cost as a percentage of home sales increased on homes closed, in part due to labor and material increases, but also as a result of increased overall production volumes, which has required us to expand our labor base to sustain the higher production rates. Increases in sales prices were not sufficient to offset these increased costs.

We also introduced a number of new or replacement communities that realized slightly lower margins, and this is generally expected for our new communities, and we expect to see margins gradually increase as the community matures and improves its leverage. Our adjusted gross margin was 26.5% this quarter compared to 27.7% for the third quarter of 2016, a 120 basis point decrease. Adjusted gross margin excludes approximately $5.1 million of capitalized interest, charged to cost of sales during the quarter, representing 140 basis points and consistent with previous quarters. For the year-to-date, gross margin was 26% compared to 26.1% for the same period in 2016 and adjusted gross margin was 27.4% compared to 27.5% for year-to-date '16.

Combined selling, general and administrative expenses for the third quarter were 11.3% of home sales revenue compared to 12.8% in the prior year. Selling expenses for the quarter were $26 million or 7.1% of home sales revenue compared to $17 million or 7.9% of home sales revenue for the third quarter of '16, an 80 basis point decrease, primarily due to operating leverage realized related to advertising costs.

General and administrative expenses were 4.2% of home sales revenue compared to 5% for the third quarter of 2016, an 80 basis point decrease, attributable to operating leverage realized from a higher number of homes closed. Pretax income for the quarter was $50.9 million or 13.9% of home sales revenue, an increase of 30 basis points over the same quarter in 2016. We generated net income in the quarter of $33.7 million or 9.2% of home sales revenue, which represents earnings per share of $1.55 per basic share and $1.40 per diluted share. Weighted shares outstanding for calculating diluted earnings per share include the impact of our outstanding convertible notes. In the third quarter of 2017, our average stock price was $44.44, exceeding the conversion price of $21.52, and therefore, the convertible notes were dilutive. Our strong stock price performance this quarter resulted in an approximately 2 million share increase to the weighted average shares outstanding for the diluted EPS calculation for the quarter.

Since our inception, one of our objectives has been to deliver an excellent return to our investors. And since our IPO, we have now generated over $240 million in earnings, which we have reinvested in growing our business, enabling us to deliver returns on average equity in the mid-20s. Third quarter gross orders were 2,152. Net orders were 1,512. Ending backlog for the third quarter was 1,328 homes compared to 777 last year, and the cancellation rate for the third quarter of 2017 was 29.7%.

We ended the third quarter with a portfolio of approximately 37,000 owned and controlled lots. As we've mentioned in previous calls, our objective is to build a sufficient number of move-in ready homes to meet our expected closings. And at the end of September, we had approximately 3,300 homes complete or in progress compared to 1,600 at December of 2016. In addition, as of September 30, we reported over $1 billion in assets for the very first time. In May of this year, we increased our revolving credit facility to $600 million, with a $50 million -- with $50 million of additional capacity available under an accordion option. At September 30, we had $390 million outstanding under the facility, and our borrowing capacity was approximately $203 million. In addition, we have $85 million in convertible notes outstanding. At September 30, our gross debt to capitalization was approximately 51%, and net debt to capitalization was 48%, down 240 basis points from the previous quarter.

And at this point, I would like to turn it back over to Eric.

Thanks, Charles. In summary, the third quarter was another outstanding quarter for us, contributing to a great first 9 months of 2017. Let me provide some guidance and thoughts on October and looking ahead to the remainder of the year.

The fourth quarter is off to a great start, with 531 closings in October, up more than 50% from the 351 closings in October of last year. The 531 closings came from 79 active communities, resulting in a very solid absorption pace, averaging just over 6.7 closings per community. This brings our total, through the first 10 months of the year, to 4,532 closings. Based on the strength of our October closings and the continued demand from customers to move from their rental situation to home ownership, we are raising our current closing guidance for 2017 from more than 5,000 homes closed to more than 5,400 homes closed. We continue to believe our community count will end the year between 75 and 80 active communities.

As we close out 2017, our focus is also on continuing our nationwide expansion. Last quarter, we provided the update that we had started construction and sales in both the Minneapolis and Winston-Salem markets. We have now had our first closings in these markets and expect to continue to expand community count in these markets during 2018 and 2019.

We have also started home construction in the Oklahoma City market. We expect to be open for sales in the second quarter of 2018, with closings during the second half of 2018. The Oklahoma City market will be managed by our leadership team out of Dallas/Fort Worth and is now combined with our Texas Division to form our new Central Division.

In addition, our entry into California continues to move forward. Since our last call, we have closed on finished lots in the Sacramento market, and we expect to start home construction during the next 90 days to allow us to open for sales in the spring and have closings in the second half of 2018. As Charles mentioned, our average sales price in the third quarter was nearly flat with the second quarter. We expect to see this trend continuing in the fourth quarter, resulting in our average sales price for the year remaining within our previous guidance of $210,000 to $220,000.

We expect gross margin for the fourth quarter to be similar to the third quarter and the full year 2017 to remain within our historical range of 25% to 27%, and adjusted gross margin to be within our historical range of 26.5% to 28.5%. Given our increased closing guidance and assuming similar average sales prices, gross margins, SG&A and taxes within our expected ranges and the overall continued strength in market conditions that we have seen in the housing market during 2017, we are raising our full year basic earnings per share guidance from $4.25 to $4.75 per share to a new range of $4.75 to $5.15 per share.

Now I'll be happy to take your questions.

(Operator Instructions) Our first question comes from Michael Rehaut of JPMorgan.

Congrats on the quarter and great results obviously coming out of Texas. I guess, just on the performance in Texas, and obviously it remains a core strength of yours doing nearly 10 a month in the quarter. Just wanted your thoughts on the sustainability of that rate, I guess. I think in the past, Eric, you've talked about the biggest influence on sales pace being more credit availability and lending standard -- driven by lending standards rather than interest rates. Obviously, we've seen, over the last couple of years, what I'd consider to be a modest easing of those standards. But how should we think about the Texas business at that type of a rate going forward? Do you think there's further upside to that? Do you think that perhaps this quarter benefited from some communities more hitting their stride? I'd love to hear your thoughts around the Texas pace.

Yes, Mike, this is Eric. Thanks for the question. And yes, Texas continues to be strong. I mentioned during the call, but all 4 markets for us, DFW, Austin, San Antonio and Houston, all had at least 8.8 closings per month per community. And right now, we look at it nationwide as a very strong market for us. Demand for customers looking to go from a rental situation to home ownership, we think is very strong. We're seeing strong demand across all our markets, particularly in Texas. We're dealing with a low supply market of new homes. So I think that helps us. Ability -- the rates have maintained lower, which obviously when customers are looking at affordability and qualifications, the lower the monthly payment, the more people are going to be able to get qualified. And we've also got our inventory in line. The demand has been there since the first quarter, but our absorptions per community, even in Texas, were low and below average for us in the first quarter, so we had to get some inventory built through houses and even more so on the development side. So we have improved in that area. Our sections and our lots and our deliveries to build houses on is in a lot better shape, obviously, and these absorptions say that. So, is there upside to these absorptions? I'm not sure because these are very strong absorptions for our community. One of our challenges going forward is going to be affordability. We anticipate home prices going up, and that may lead to slightly lower absorption as price increases, but certainly remaining strong. We got a great leadership team in all the Texas markets. It's where we've been the longest. We got a lot of experience, sales reps and construction management now. So we think Texas will remain strong.

That's great, Eric. I guess, secondly, moving on to the gross margins. Appreciate all the detail there and how to think about fourth quarter margins, which you said you expect to be similar to 3Q. So you kind of, in part, anticipated, I guess, one of my questions. But just around this topic, I mean, perhaps even going into next year. Obviously, the labor, material cost, we would expect them to continue in terms of seeing some inflation. Obviously, you're still going to have somewhat of, at least in the first half of the year, as that business continues to grow a little bit, the wholesale impact. So just kind of your thoughts on, if you're talking about a couple of quarters in a row of gross margins being at the lower end of the range, what's the likelihood of, perhaps, that continuing into the first half of '18? And would there be any drivers to maybe alleviate some of that pressure. You also mentioned increased production volumes with perhaps some newer crews coming online and new and replacement communities that maybe are starting out a little bit lower. So I don't know if either of those could burn off, but should we be thinking about more in 2018 the lower end of this gross margin range? Or again, could some of these factors help out that are also depressing 3Q?

Yes, Mike, this is Charles. I'll start and Eric can add. But I think you summarized it pretty well. I mean, that's what we wanted to cover is, really, the 2 components of increasing costs are, one, related to inflation. We're certainly seeing material and labor pressures. Certainly lumber has been one of the ones that we've highlighted as increasing significantly. The other piece, in terms of ramping up our production, creating a need for additional labor. And typically, and we've mentioned it on the last call, that typically that next laborer, the next guy is going to be a little bit more expensive than the first one. So those 2 are definitely coming into play. The wholesale business is going to add a little bit more volatility than I think what we've historically seen in our gross margin, just given the fact this was a decent quarter with 96 closings, depending on where the wholesale units come in on a quarter-to-quarter basis. But the 50 basis points seems to be kind of the number when there's roughly 5% of the business is going to end up being about 50 basis points. So we feel pretty comfortable there. And I think we're really more so focused in the short term. And then when we get back to you in March is when we'll be able to add a little bit more detail and talk a little bit more about what we see in 2018.

Okay. And just one quick one. You mentioned the 50-bp impact on gross margins from the wholesale business. Is it safe to assume kind of a similar benefit on the SG&A line, given that you're talking about a similar operating margin?

No, it is. That's a great point, yes.

Our next question comes from Carl Reichardt of BTIG.

I wanted to ask just a little more on wholesale. Where specifically has that activity been? And as you think about that business, do you intend to try to keep it at sort of a 5% type of number? Or would that grow as you expand into new markets?

Great question, Carl. This is Eric. I'll take it to start with and Charles can add to it. So 96 closings in the third quarter. Those were closings in 10 different markets, in 15 different communities spread throughout 4 states so -- and the states, if you want to get to that specific a level, were Georgia, Florida, Texas and the State of Washington. So that's where the closings came in the third quarter. The biggest challenge we have on the wholesale business is just really lack of inventory. Sales on the retail side, if you will, are extremely strong as you can see in the results. So there's not a lot of excess inventory or excess lots in order to create more sales in the wholesale business. But certainly, demand's there. And as a percentage of our closings, I would think it remains similar in the next year. But the absolute number of them should be increasing. And we look forward to growing that business in 2018.

Okay. Great. That's helpful. And then you've got I think you said 3,300 homes finished or under construction unsold, double last year. And I assume that, that's in part because you want to get a head start on the sales process, so you're not short inventory as you head into what for others would be a slow winter month but -- winter months period, but for you, hasn't been. And I'm assuming that, that's also the issue with an unabsorbed overheard and the directs right construction supers. Those folks are building those houses, managing those houses, they haven't been sold yet. So shouldn't you get some gross margin leverage off of that as you move into the first quarter to sort of help offset some of the pressure this quarter?

Sure. This is Charles. Just to clarify, the 3,300 are not necessarily all unsold. That's total completed or work in process. And then, as far as from a production standpoint, I mean, one of our focuses this year has been to build more efficiently. So we've actually seen the ability this year to produce more houses with similar construction. So I think your point is valid. There's an opportunity there to take advantage of spreading that overhead, which could have a positive impact to gross margins. But I think going back to our earlier comment about increasing costs, whether they end up being relatively neutral, it will certainly help mute some of the inflationary costs that we're seeing on the labor and material side.

Okay. And then one more -- last one just in terms of that. As you've grown larger now, how are you working with national contracts with building materials, suppliers? What progress have you made? And with what subsets?

Yes, sure. So we do have a handful of national contracts that we work with, primarily more of your items like appliances and those type of things. I mean, I think construction for us, I mean, it's still a local business. I mean, we focus on getting local expertise and local knowledge. So I think the answer really is it's case by case and really more market specific. As far as whether we have an opportunity to really accentuate or improve margins based on national contracts alone, I would probably describe it as relatively minimal and within the margin of error in terms of what we see on a quarter-to-quarter basis for margins.

Our next question comes from Stephen East of Wells Fargo.

Quick question on the communities as you look to '18. Just trying to understand how quickly do you reach saturation when you move into new markets. How much headroom do you have? I guess, if you're looking at your current markets that you're in, what type of growth would you expect from those current markets? And then, you've got 3 new markets that you've already talked about, Oklahoma City, and et cetera. More to come in '18? Anything you can share with us there?

Yes. Thanks, Stephen, great question. I mean, as far as getting deeper in the markets, we really focus on kind of the major arteries going out of major cities. So every city has got a range. And there's going to be fluctuations based on community count. Our Houston market, we went down for a while there and got as low as 6 in community count, and now we're back up to 10. But the Texas communities, in general, won't experience a lot of growth in community count. Our community count growth is going to be going deeper in our newer markets. For example, we're just getting started in Minneapolis. Only have one community in Portland. So we'll be going deeper in those 2 markets. The Carolinas, Raleigh and Winston-Salem are fairly new for us. So that's an opportunity to go deeper. And then like we also talked about on the call, California, will be additive to community count. We got our first community already ready to go, and then Oklahoma City. We're starting the process of getting going in Las Vegas. So that has a chance getting in a community count in 2018, but probably more 2019 as far as being meaningful communities. So we continue to expand but most of the depth will be in our recently expanded into cities.

Okay. That helps me a lot there. And then, one follow-on quickly on that. Do you have any major communities that you see burning off in the fourth quarter into the first quarter on that? And then, the other question I had was, Charles, would you mind -- could you bridge the gap for us a little bit more on the gross margin? You had about 50 bps from wholesale. You talked a lot about incremental cost, that some of them are true inflationary cost in the housing cycle, but some are from Florida and Houston. And then, you had a mix shift toward lower profit margin -- or markets, if you will, is what it sounded like a little bit. Could you maybe bridge the gap for us on that?

Stephen, this is Eric. I'll take the first part of the question. I mean, we're continuously -- just like every other builder replacing communities, then we do have some top-performing communities selling out that we're replacing right now. But that being said, we don't anticipate a situation like last year, where we had 4 or 5 of our top communities really closing out at the same time or being between sections. So we don't anticipate that first quarter bump like we had last year, other than the first quarter is always historically, from a closing standpoint, our lowest quarter because of sales through the holidays.

Yes, okay. I got you.

Yes. And then following up on gross margin. So we're really talking about 120 basis points. I mean, probably the year-over-year comp, and then the last 2 years, both full year 2015 and 2016, adjusted gross margins were about 27.8%. So when you put that into perspective, if you account for -- of the 120 basis points, 50 basis points in wholesale. And then a combination of not only the 2 factors that we talked about in terms of inflationary costs and ramping up production or increasing production but also just the general volatility that we experience when we introduce new communities, replace communities, kind of the timing of those and how they ultimately fall in. So of the 70 basis points remaining of the 120 basis points really that we're accounting for, if you will, maybe 1/2 to 2/3 is related to the cost issue, and then the other part is just the mix, the replacements and timing.

And just one last question. Land spend, as you look out in 2018, if you're not ready to give a full number, just relative to this year, where you -- what direction you think it's going?

Yes. So this quarter was relatively light. It's one of our lighter quarters, so you can see that as a result in our lower net debt to cap as a function of that, it's inventory is what really drives our capital needs. It'll be lumpy, I guess, is probably the best way to describe it. We don't necessarily have a number yet for 2018. Certainly, we'd be able to talk a little bit to it on the March call. But I think our goal is to have enough inventory in front of us, average size of anywhere between 2 to 5 years supply, depending on the submarket. So to make sure that we're ahead of both production and sales. So I think a lot of it will depend on where we see the community count falling out for '18 and what the needs are going to be are going to be a direct result of how far in advance if we're buying raw land and having to develop it versus taking advantage of finished lots and being able to time our lot inventory based on acquiring finished lots rather than the time it takes to develop. So...

Our next question comes from Nishu Sood of Deutsche Bank.

So Eric, I wanted to hear your thoughts about the capacity -- I'm sorry, the constraints that you would be seeing on your ability to grow closings. I mean, clearly, your pace of closings has picked up really nicely in the past 4 or 5 months. Where is the biggest constraint as you see it on kind of maintaining that growth trajectory? Is it the construction pace getting the spec units up? Is it opening the new communities? Where is the biggest constraint as you see it at the moment?

Yes. I think, Nishu, we have people constraints like we're focused on so we got to make sure we have the right people in the right places and growing and we've been growing a lot. So we need to make sure we're training everyone on our LGI processes because we're a systems-based company and that will ensure that we can grow consistently and take advantage of this market that we're in. And then also, I think it's the development community count. When we had above-average absorption pace, we talked a lot about this during the first quarter this year, at these absorption levels, you have to get new communities, new sections, new developments on the ground quicker. And that's a lengthier time line. We're doing a lot at development right now. And it's not getting any easier to get new sections on the ground and dealing with the different municipalities. So I think that's probably the biggest headwind and continuing to increase absorption and closings overall is just the growth and getting developments and sections, then obviously, once that happens, you got to get the houses built.

Got it. And as you've kind of compounded your growth here, obviously, a much larger organization now. I mean, should we naturally be -- I think you've kind of -- each year, you've kind of opening about -- you've thought about opening 10 to 15 new communities. Should -- is the -- as the organization scales up, is it going to be harder to kind of sustain or compound the growth rates that you've seen? Or are you building up enough people capacity, regional presence, et cetera, to kind of be able to keep up the growth pace?

Yes, I think we're planning on growing. I mean, our goal is to be a top 5 builder in the country and being into every market of size in the country. So we've got a lot of room to grow, but you have to have the people in place. And I think the size, it gets harder to keep the percentages of growth increasing for sure. But as far as the absolute numbers of growth, I think we can continue growing community count and closings for years to come.

Got it. Got it. And on the cost pressures and the margins, your business has had the power -- there's obviously fluctuations in gross margins from quarter-to-quarter. But your business has had the -- your business model has had the power obviously to respond with pricing, to get back to your targeted gross margins over the course of, call it, 2 to 3 quarters when you have a fluctuation like that. Now is in weaker pricing environments, it's not a pricing environment is stronger. Just wanted to make sure, because obviously there's a lot of questions clearly about the gross margins this quarter and then continuing into the fourth quarter. Has that changed in your opinion? Or does your business model still retain the ability to keep you within your target range longer term?

Yes. No, I don't think that's changed at all. I mean, I think one of the strengths of our company and we pride ourselves on having consistent gross margins since we went public and really, the 10 years prior to that in homebuilding. And we would put this quarter up, especially factoring in hurricane events and wholesale business is still being in our consistent gross margin range. And that's what we talked about our historical averages, adjusted gross margin, 26.5% to 28.5% and we think that trend is going to continue. Prices are going up, so we need to make sure we're making diligent land decisions and not just buying just for growth's sake because you can't maintain those margins and make bad decisions on the land buy. So we need to be diligent and make sure we're continuing to make good decisions. But we see that gross margin being consistent also in the future.

Got it. And just final one, the mortgaged data that you laid out, very interesting shift over time. You were pretty heavily USDA when you were more in Texas and that you could open your communities in those USDA boundaries. Now has shifted quite a bit mostly to FHA. Is there -- I mean, how has that impacted the business? Or how -- what does that reflect about the business? Clearly, you wanted to get that information out there. So just wanted to make sure that we're understanding properly what that shift is meant for your business, if anything.

Yes. Nishu, I think we wanted to get those numbers out there just so everybody had a clear understanding that we weren't 100% reliant on the USDA financing. It was a greater percentage of our business, somewhere around 40% of our closings, when we went public. And that's because we were primarily in Texas and we're a little further out in our entry-level communities. And a lot of communities qualified for USDA financing. And it's a better -- because of the mortgage insurance, if the customer can qualify for USDA, we put the customer, the mortgage company's going to give them the best loan that they possibly can. But what's happened over the last couple of years is the map that shows what communities are eligible for USDA financing has tightened as the population in the United States has grown. And also, we've gotten into a lot of other markets outside of Texas, including some higher-priced markets, like Denver and the Northwest, which basically we don't do -- 0 USDA business in those markets. And FHA financing, along with VA financing, the mortgage requirements be a credit score or debt-to-income ratios have loosened more than USDA has. So all of that together has just created the shift where USDA is now a very small percentage of our business. And FHA is about 75% of our business, which is obviously a very large portion.

Our next question comes from Alex Barrón of Housing Research Center.

I wanted to ask about the wholesale business. Was those homes sold to just like one of those type of investors? Or was it across multiple?

There was at least 2 in the third quarter, if not 3. But it wasn't a singular investor in the third quarter.

Okay. And then, I'm wondering if, obviously, those homes have lower margin, is there basically a corresponding savings in the SG&A, so that the operating margin basically the same?

Yes, that is correct. I mean, you nailed it. They get a discount off the retail price and then we do not pay sales commissions or obviously have to spend the money on advertising and allow the SG&A expense to get more corporate leverage. So we underwrite and the results show that a wholesale closing results in a very similar net margin as a retail closing.

Got it. And then, just on the diluted share count, I guess it's been going up a little bit. Is that just -- I guess, stock option issuance?

No, it's more related to the convertible notes. So as the stock price rises, the dilutive effect of the convertible notes is more impactful.

We have a follow-up question from Michael Rehaut of JPMorgan.

Just wanted to circle back on a couple of smaller line items here, if it's okay. The tax rate has been a touch under 38% -- 34% the last couple of quarters. If that's something we should roughly model in for 4Q and next year? And also, if you could just remind us of the basic share count outstanding and the implied, if the stock were to continue at this level, what that means for the fully diluted?

Sure. This is Charles. So yes, I would think the -- I don't see any reason or we don't have anything on the radar that would change the effective tax rate in the short term, pending any tax policy changes that ultimately get through, which obviously would be any changes. So the corporate tax rate would be positive for us next year, but...

Michael, you're not modeling at 20% corporate tax rate next year?

We did put out a note.

So more to come. We'll see what happens there, but obviously that would be positive for us. And then, on the basic share count, we had approximately 21.7 million shares outstanding on the basic shares outstanding at the end of the quarter. And then, on the dilutive effect, so the math would work out that you would take the difference between the average stock price at the delta between the average stock price and the conversion rate is at 21.52 and do the math to calculate how many shares you would have to issue to cover that premium, if you will. So 2 million shares at outstanding impact on a $44 stock price, so you can kind of ramp it up based on where you think the stock price is going to be for the full fourth quarter.

(Operator Instructions) Our next question comes from Michael Martin of Michael J. Martin & Associates.

In your introductory remarks, you talked about maintaining the culture. And I was just wondering if that becomes more challenging as you grow and you get far away from your home office and so on. Could you give us a little color on that?

Sure, Michael. I appreciate the question and I would say, generally, yes, it does become more challenging. We have over 700 employees now and we're in 20-plus markets across the country. And as we spread out farther away from the Houston office and open up new communities, I think it does get more challenging. And I think, as a company, we've done a good job of mitigating that risk and stepping up to that challenge. We have a lot of systems in place, and we train on the culture continuously to make sure we minimize that risk as much as possible because it's important. So we've done a good job so far and I think we could continue doing a good job of maintaining that culture as we continue to grow.

We do have another follow-up question from Michael Rehaut of JPMorgan.

One thing I just failed to ask on my last follow-up was following up on a community count question from before where in the past couple of years, you've been able to increase community count anywhere from -- in '15 and '16, it was 12, 13, kind of like a little bit over 10 a year. This year, it looks like it'll be more closer to a 15 improvement. How should we think over the next couple of years? I mean, obviously, you have more markets from which to grow and expand, so you could argue at -- in some sense that perhaps you could increase slightly the absolute number of communities that are added per year. But on the same time, to some degree, it gets more challenging and you have certain constraints, perhaps, on the top of the organization. So how should we -- is it still kind of more of a 10 to 15 community count addition type of business? Or could there be upside to that? Or even downside?

Yes, Mike. This is Eric. Similar to how I answered Stephen's question. We're not ready to give specific community count guidance yet. We'll get back with everybody on our February call, but we're definitely going to be growing community count and if you stay in California, Oklahoma City, Minneapolis, Portland, additional depth in Raleigh, Winston-Salem and the Carolinas, not to mention Las Vegas, I mean, those communities alone can certainly handle 20 to 30 additional communities that aren't there now. Now we still have the challenge of replacing every community that we have, and that's going to cause a little bit of fluctuation. So adding 20 to 30 communities over the next few years is certainly reasonable. But the timing is going to fluctuate a little bit whether it's '18 or '19 and quarter-to-quarter.

All right. So that 20 to 30 is more of not a 1-year goal, but a 2 -- like a 2 plus?

Correct, yes. It's just the ramp-up time of these new markets, especially California and Portland, Minneapolis. So I'm just giving you an example, just in the markets we talked about, 4 or 5 communities in those markets, even more so in California, is certainly realistic. So 20 to 30 over the next couple of years, for sure.

And ladies and gentlemen, this does conclude our question-and-answer session. I would now like to turn the call back over to Mr. Lipar for any closing remarks.

Yes. Thanks, everyone, for participating on today's call and your continued interest in LGI Homes. Have a great afternoon. Thank you.

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