LGI Homes Inc (LGIH) 2018 Q1 法說會逐字稿

And welcome to the LGI Homes First Quarter 2018 Conference Call. Today's call is being recorded and a replay will be available on the company's website later today at www.lgihomes.com. (Operator Instructions) At this time, I would like to 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 first quarter of 2018. Today's conference call will contain forward-looking statements that include, among other things, statements regarding LGI's business strategy, outlook, plans, objectives and guidance for 2018. All such statements reflect current expectations. However, they do involve assumptions, estimates and other risks and uncertainties that could cause our expectations to prove to be incorrect. You should review our filings with the SEC, including our Risk Factors and Cautionary 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 and non-GAAP financial measure will be discussed on this conference call. The presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. A reconciliation of adjusted gross margin to gross 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 first quarter of 2018 that we expect to file with the SEC later today. This filing will be accessible on the SEC's website and in the Investor section of our website at lgihomes.com.

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

Thank you, Rachel, and welcome to everyone on this call. We appreciate your continued interest in LGI Homes. During today's call, I will summarize the highlights and results from the first quarter of 2018. Then Charles will follow-up to discuss our financial results in more detail. After he is done, we will conclude with comments on what we are seeing for the second quarter and our expectations for the remainder of 2018 before we open the call for questions.

For the first quarter, we closed 1,244 homes, a 63.5% increase in home closings compared to the 761 homes closed during the first quarter of last year. We also generated approximately $279 million in home sales revenue, which represents a 71.3% increase over the first quarter of 2017. Absorption in the first quarter averaged 5.4 closings per community per month company-wide. This was an increase over the first quarter of last year's absorption pace of 3.8 closings per month.

Our top market on a closings per community basis was Tampa at 7.7 closings per month; followed by Houston at 7.1; then Orlando and Seattle, both at 6.3 closings per month. Company-wide, we ended the first quarter with 79 active communities, which is a net increase of 10 over the 69 active communities that we had at the end of the first quarter last year.

During the first quarter of 2018, our Central Division added 5 communities, our Southeast Division added 4, our Northwest Division added 2 and our Florida Division and Midwest Division each added 1 community. These additions were offset by a decrease of 3 communities in our Southwest Division due to community closeouts and transitioning between projects.

Breaking it down, let's look at highlights from our Central Division operations. The price of results from Houston, San Antonio, Dallas/Fort Worth, Boston and now the Oklahoma City market, our Central Division generated 521 closings in the first quarter, representing approximately 42% of our total closings. These 521 closings also represent a 65% increase in closings for the Central Division over the first quarter of last year.

In addition, the absorption rate in the Central Division was one of the strongest across all divisions, averaging 6.1 closings per community per month. During March, we closed on our first home in the Oklahoma City market, expanding our Central Division outside of the state of Texas. Our concentration outside of Texas continue to increase during the first quarter, making up 58% of our closings.

The Southwest Division represented 16% of our home closings. The Southeast Division represented 18%. The Florida Division represented 17% and the Northwest Division represented 7%. As we have discussed on previous calls, we anticipate that our percentage of closings outside of Texas will continue to increase.

Another highlight of the first quarter was the results from our Northwest Division. We had strong absorption of 5.5 closings per community per month at an average sales price of $337,000, up from $321,000 in the first quarter of last year. In addition, the Northwest Division closed 88 homes compared to 40 homes closed in the first quarter of last year, which is an increase of 120% year-over-year.

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. As previously mentioned, home sales revenues for the quarter were $279 million based on 1,244 homes closed, which represents a 71.3% increase over the first quarter of 2017. Sales prices realized from homes closed during the first quarter range from the 140s to over $500,000 and averaged $224,296, a 4.8% year-over-year increase. The increase in average sales price year-over-year reflects changes in product mix, price points in certain new markets and a favorable pricing environment.

In the first quarter, approximate average sales prices by division were $206,000 in Central, $276,000 in the Southwest, $197,000 in the Southeast, $203,000 in Florida and $337,000 in the Northwest. Gross margin as a percentage of sales was 24.8% this quarter compared to 26.7% for the same quarter last year. Our adjusted gross margin was 26.4% this quarter compared to 28% for the first quarter of 2017, a 160 basis point decrease.

Sequentially, gross margins increased 40 basis points, and adjusted gross margins increased 60 basis points quarter-over-quarter. Adjusted gross margin excludes approximately $4.3 million of capitalized interest charged to cost of sales during the quarter, representing approximately 155 basis points, consistent with previous quarters.

Combined selling, general and administrative expenses for the first quarter were 13.8% of home sales revenue compared to 16.8% in the prior year. We believe that SG&A will vary quarter-to-quarter based on home sales revenue. And for the full year, we expect the SG&A as a percentage of revenue to be to be 20 to 50 basis points lower compared to our 2017 full year results.

Selling expenses for the quarter were $22.9 million or 8.2% of home sales revenue compared to $16.1 million or 9.9% of home sales revenues for the first quarter of 2017, which is 170 basis point decrease. The decrease in selling expenses as a percentage of home sales revenue is due to operating leverage realized related to advertising costs.

General and administrative expenses were 5.5% of home sales revenue compared to 6.9% for the first quarter of 2017, a 140 basis point decrease. The decrease in general and administrative expenses as a percentage of home sales revenue reflects operating leverage realized from the higher number of homes closed.

Pretax income for the quarter was $31.2 million or 11.2% of home sales revenue, an increase of 90 basis points over the same quarter in 2017, and this is the strongest first quarter earnings in LGI history and represents an 85% increase in pretax income dollars over the same quarter last year.

For the first quarter, our effective tax rate of 12.6% is lower than our annual expected effective tax rate, primarily due to the result of deductions in excess of compensation costs, or windfalls, for share-based payments. Excluding the windfall deduction, our effective tax rate would have been approximately 24%, and we would expect that the second through fourth quarter effective tax rate will be between 23.5% and 24.5%.

We generated net income in the quarter of $27.3 million or 9.8% of home sales revenue, which represents earnings per share of $1.23 per basic share and $1.10 per diluted share. Weighted shares outstanding for calculating diluted earnings per share are impacted by our outstanding convertible notes. In the first quarter of 2018, our average stock price was $67.65, exceeding the conversion price. And therefore, the convertible notes were determined to be dilutive. This resulted in an approximate 2.2 million share increase to the weighted average shares outstanding for the diluted EPS calculation for the quarter.

First quarter gross orders were 2,264 and net orders were 1,798. Ending backlog for the first quarter was 1,370 homes compared to 1,087 last year, and the cancellation rate for the first quarter of 2018 was 20.6%. We ended the first quarter with a portfolio of approximately 45,300 owned and controlled lots, up from approximately 39,700 at the end of last year.

As of March 31, we had approximately $52 million in cash, over $1 billion of real estate inventory and total assets over $1.2 billion. We had $510 million outstanding on our revolving credit facility and our borrowing capacity was approximately $84 million. In addition, we had $70 million in convertible notes outstanding. And as mentioned on last quarter's call, during the first quarter, we settled $15 million in principal and issued approximately 500,000 shares of our common stock related to these notes. Our gross debt to capitalization was approximately 52% and net debt to capitalization was approximately 50%.

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

Thanks, Charles. In summary, we had another outstanding quarter. Let me provide some guidance and thoughts on what we are seeing thus far in this quarter and looking ahead into the remainder of the year. The second quarter is off to a great start with 606 closings in April, up 66% from the 365 closings in April of last year. The 606 closings came from 79 active communities, resulting in a very solid absorption pace, averaging just over 7.7 closings per community per month.

We are also continuing our nationwide expansion, focusing on increasing our community count. As previously discussed, we believe we are on track to end the year between 85 and 90 active communities. We have started construction in our first communities in the Sacramento, California and Birmingham, Alabama markets. Most of these projects will start sales later this quarter, with closings expected in the third quarter of this year.

We also have closed on our first project in Las Vegas. Construction and sales will begin later this year, with closings expected in the fourth quarter of this year or the first quarter of next year. Based on the strength of our first quarter closings and our strong start to the second quarter, we offered the following guidance for the remainder of the year. We expect to close between 6,000 and 7,000 homes in 2018. We believe our average sales price in 2018 will end the year between $220,000 and $230,000.

We predict our gross margin will end the year between 24% and 26%. We expect adjusted gross margin, which excludes the effects of interest and purchase accounting, will continue to be strong, ending the year between 25.5% and 27.5%. Given our continued belief that we will close between 6,000 and 7,000 homes and our reaffirmed guidance of average sales price, gross margins and community count, we continue to believe our full year basic earnings per share will be between $6 and $7 per share.

Now we'll be happy to take your questions.

(Operator Instructions) And our first question comes from Nishu Sood of Deutsche Bank.

Eric, let me just start out, obviously, the results looked strong on the margins, the SG&A, especially. The stock reaction today runs counter that. I think that maybe because, despite the very strong closings pace you've had year-to-date, you're not taking your guidance ranges up. So I was wondering if you could walk through the dynamics and thinking around that, please?

Yes. Sure. Nishu, this is Eric. Appreciate those comments. And yes, we look at that every quarter and based on our history, we want to be conservative with our guidance and we've had a real strong first 4 months of the year. We had some pretty easy comps that we've had 4 straight months of 60% increases over last year. And looking at the rest of the year, we went over with our Board of Directors, and we want to make sure we hit our guidance. And historically, that 6 to 8 closings a month is really where we have been. And at 6,000 closings, our guidance on that, we'd have to average 6.3 closings per month for the rest of the year. And at 7,000, it's 7.9 based on an average community count. So our guidance, we feel, is right in line with that 6 to 8 historical averages. And we feel really good about the start of the second quarter. We averaged 7.7 closings per community. We think, May, based on what we're seeing in a couple of communities closing out, will still be strong but beyond the 6.3 to 6.5 closings per community. And we think we're going to stay in that range in that 6 to 8 closings per month range, just the math works out to 6,000 to 7,000 for the year. And we'll certainly look at that every quarter and very likely to tighten that guidance as we get further into the year. But for now, we thought it was best to continue with that guidance.

Got it. Yes, the range is pretty wide. So I guess, the way to characterize it is you may have moved up within the range a little bit, but the range is still good?

Yes. No, absolutely. The range is still good. We're very confident in the range. We always want to hit our guidance. And we're off to a great start and really positive about the business.

Got it. Got it. On SG&A, very strong performance this quarter. And so obviously, clearly, the -- it seems -- or I guess, as part of the question, it seems like you're benefiting from your continued investment in digital initiatives. And Charles, if I understood your guidance correctly, I think you actually are now a little less -- you're expecting a less improvement in the SG&A ratio this year. So I was just wondering if you could talk through the dynamics of that, please?

Sure. Yes. So this is Charles, I'll start and Eric can add on the digital and on the marketing spend. So what we're thinking, if you look back on a quarter-over-quarter basis between the second and fourth quarters, we're expecting the SG&A percentage to be similar. So in the range of where we were last year. We've got investments -- certainly, we have geographic investments and overhead that we're working through. The driver or the primary driver in the first quarter on selling expenses is really the advertising costs and the marketing costs, like you mentioned. And then putting that in context comparing the first quarter of 2017, the ratio was higher due to the overall lower closings and lower revenue driven by the inventory gaps that we had in some of our high-performing markets. So if you look at it quarter-over-quarter for the rest of the year, we think the SG&A ratio is going to be similar. That puts us somewhere in that 20 to 50 basis point range for the full year, depending on where we come in on the closing guidance.

And Nishu, I can add to that. As far as a little bit more on the digital marketing. Our marketing team here at corporate continues to do a great job of driving leads to our community. The first quarter, again, we had over 100,000 inquiries or 100,000 leads from customers, looking to purchase an LGI Home. So we have got oversized leverage, if you will, and have not needed to spend our full advertising budget in order to drive leads to our communities. And I'm sure there's going to be a question around rates and what we're seeing. And as rates continue to go up, and we're advertising a higher price point because of cost going up and advertising higher monthly payments, one of the things that we're forecasting is needing to spend a little bit more money on marketing. And we're certainly willing to do that since we've been so efficient to drive the number of leads we need to hit our closing numbers. So we're probably a little conservative on our guidance, giving us some room to spend more money, if needed, to come back to a higher rate -- interest rate environment.

Got you. Got you. Okay. And last one for me. Last year, your demand pace was so strong that your ramp-up and starts, I think, last year -- Charles, you gave the stats, I think, last time was somewhere at 60% plus in terms of starts, '17 versus '16. Where -- and that led to some inefficiencies on the gross margin line. Where are we now on that? Are you -- is the production machine caught up with demand, now that the demand environment has been at this level for some time? And therefore, could there be some benefit to gross margins, if that's the case, in the back half of the year?

Sure. So great question. So yes, so last year, we did see kind of into the first quarter and into the summer quite a bit of ramp-up, if you will, in terms of our inventory production. We ended the year close to around 3,000 units, either completed or in process. We ended the first quarter around 3,400 units so we still have been, overall, increasing our investment in our direct construction to give us the ability to hit the high end of the closings per community range that Eric mentioned. I think we have seen, overall, what I would refer to probably as a tapering. I think the production issue has, I guess a way to describe it, maybe stabilized in that sense. A lot more consistency on a month-over-month basis in terms of how many starts we're putting into the system on a monthly basis. So that has definitely helped on the cost side as well. I think what we're looking at from what we can see at this point is that materials and labor have really kind of -- both in the frequency and dollar amount of increases, have been less impactful over the last 3 or 4 months, which potentially could give us some upside. But as Eric mentioned, there's still are some headwinds for us in terms of affordability and how much pricing power we can really achieve. So I think we're looking, really, at more consistent gross margins through the first quarter than a significant ramp-up in the back end.

And our next question comes from Michael Rehaut of JPMorgan.

And this Neal BasuMullick, in for Mike. I guess I want to start on the gross margin performance relative to your guidance. What were some of the things you see is driving the upside? So really any comments on the puts and takes there?

Yes. Sure. This is Charles and Eric can add. I mean, following up on the earlier question, I think we definitely saw some pricing power. We mentioned on the last call that we are raising prices in January, so we were able to do that. I think some of the issues we were seeing in terms of rapid and significant price increases settled a little bit, so that work to our advantage as well. So I think a combination of those 2 factors led to the gross margin this quarter. Maybe being a little bit higher than what we guided to in the last call. But I think -- like I mentioned, I think we're maybe not expecting to see it increase so much as much on the back end as maybe we mentioned earlier as well.

Okay. That helps a lot. I want to ask a quick one on capital structure. Even though net debt to cap has ticked up a bit, it seems like you're pretty much in line with where you want to be from a leverage standpoint. So maybe could you update us on what you're thinking as far as capital structure to finance the growth you've been seeing?

Yes. Sure. So great question. So first of all, we've been focused on reinvesting our process. It's been -- one of our key components of our capital structure. We've earned over $300 million since our IPO, and been able to reinvest that into the business. We've also been very successful managing, like you mentioned, our debt to cap in that 50% range. We've done that through our credit facility through increases year-over-year. We have an annual renewal that's coming up this month as well. And then we continue to consider all of our options from our long-term capital structure, the convertible notes, which we mentioned, $15 million of which were converted this quarter. The maturity date on those convertible notes of November of 2019, so we're also thinking ahead in terms of making sure that we'll have the capacity to settle those convertible notes as well. And then we also believe our capital structure will continue to evolve looking at the other options available to us. Certainly, taking into account what's happening in the markets, availability, capital, the size of issuance, those types of factors. And we continue to believe that, over time, that our capital structure will kind of evolve as well.

And our next question comes from Stephen East of Wells Fargo.

Last quarter, Eric, you talked some about wholesale closings that you had in the quarter. Could you talk a little bit about what you had this quarter and what you think is the outlook for the rest of the year, if you all try to forecast that? And just the impact on gross margin and SG&A, so we know what was really going on.

Yes. Yes. Thanks, Stephen. Appreciate the question. Yes, from a wholesale standpoint, we had 31 closings in the first quarter, so that's about 2.5% of our closings, average sales prices at around $220,000. So pretty consistent with our average sales price of our LGI Homes retail business. And for the rest of the year, guidance would be the same as we mentioned previously. We expect to close 200 to 300 houses in the wholesale business this year, which puts us maybe a little bit higher percentage overall, more in the 3% to 4% range. So same impact to gross margin. The first quarter is about 20 basis points on gross margin and then maybe slightly higher than that, 30 to 50 basis points in the second, third and fourth quarter, just because the percentage probably slightly higher as a percentage of the wholesale business.

Got you. Okay. And one follow-on with that. How do you view those sales versus your normalized sales? Are you agnostic between the 2? And then the other question I had was, last quarter also, you talked about land market getting a bit more competitive. We've actually heard some move-up competitors say, hey, that market's maybe getting a little bit less competitive. Just any changes you're seeing as you go through the markets?

Yes. On the wholesale business, we underwrite to the same operating income or pretax income, if you will. So we're really indifferent on the financial aspect of it on a one-off basis. But we really like a lot about the wholesale business and why it's such a positive for our company is, we only sell the wholesale homes in communities where we have the supply to do it. Not necessarily underperforming communities, but performing communities where we have extra land or extra lots on the ground. So it's really a win-win situation where it helps move some inventory and creates a similar pretax net income. And then, overall, you're getting the additional leverage on your SG&A by adding those additional closings. And your second question, Stephen, was on the move-up business?

No. Well, just your land market. Last quarter, you talked about, yes, you were seeing it get a little bit more competitive and some of your peers are saying that the move-up market is getting a little bit less competitive because of the movement toward entry level. Just wondering if you're seeing that change any more than what you saw in the fourth quarter?

Yes. I don't think we've seen much of a change. I mean, we certainly have noticed other public builders and some privates talking about the strong demand for entry-level, and I think that's positive for LGI. I think everybody realized that the demand for the first-time homebuyer is there and a lot of demographics in our favor as far as renters getting into the first-time homebuyer markets. But I'd say the land business is similar. We've got a lot of deals in the pipeline. You saw our owned and controlled lots have increased since the last quarter, so underwriting to the same guidelines and we think we're in a good shape from a land position.

And our next question comes from Carl Reichardt of BTIG.

You've got some my questions, except for one. When you're looking at lot cost acceleration, I'm curious especially as you moved into new markets. Where are you seeing lot cost accelerate most significantly out of your markets? I'm operating under the assumption that the business model has continued to be to look at markets that are somewhat untrammeled by some of your larger peers, to some extent, to get to affordable price points. I'm just curious if you think around the country where you see the most inflation.

Yes. This is Charles. I'll start. I mean, I think, to your point, I mean lot cost as a percentage of revenue has definitely increased. We talked a little bit about that on the last call. Our average lot cost as a percentage of revenue is in the mid-18%, so roughly 18.5%, which is continuing to increase. It's one of those items that we believe were going to continue to be a factor in terms of increasing costs. I think you're right, it is more geographic, but even in the case in some of our longer-term markets, like Texas, the next replacement or the community that replaces, one that's being closed out, the cost to develop those lots or purchase those lots are going to be higher. And usually, a little bit further out as well. So even though we are in the tertiary submarkets compared to our peers, I think lot costs are definitely one of those factors that we expect to continue to increase.

Okay. And actually, I do have one other follow-up. If you look at your traffic conversion rates, which I know you don't disclose, how did they look in Q1, relative to Q1 last year?

I think very similar, Carl. We're still seeing strong demand like we talked about, still having all the leads coming in. The mortgage availability, I'd say, is consistent. It's more available than it was a couple of years ago, but I'd say consistent year-over-year. So certainly, a lot of training, constant, never-ending improvement as part of our culture here in LGI. And we've got a lot of new markets, a lot of new managers, a lot of new sales people coming to the systems. So we have to do -- continuously do a lot of training, but our conversion ratios are very similar.

(Operator Instructions) We do have a question from Alex Barrón of Housing Research Center.

I wanted to ask, I guess, in this rising rate environment. Do you foresee that as being more of a negative or more of a positive? Meaning that you'll lose more buyers who can't afford a home or you're gain more buyers who can't afford more expensive homes?

Well, right now, Alex -- this is Eric speaking. Right now, we're seeing it as a positive because when you're selling at a higher interest rate environment, and we have been for at least arguably the last 4 to 6 months, and we're continuing to see strong demand going along with the higher interest rates. You as well as others are seeing increased job growth. Tax reform has put a few more dollars in our customers' paycheck, which we see as positive. And right now, I think everybody's feeling pretty good. We're seeing strong demand. So, so far, interest rates have had, I'd say, a neutral to positive effect. Certainly, as rates increase and the monthly payment increases, some customers may not qualify. Some customers may have to buy a smaller square footage house to qualify. Some customers may have to come down into an LGI Homes from a potential move up. So right now, I'd say, neutral to positives outweighing the negatives in a high interest rate environment or rising interest rate environment. And we think this weekend is the best time in history to buy a house because rates are only going up from here, and we're seeing strong demand.

Okay. And how about as you're seeing more builders, I guess, moving in your direction in terms of price point. Do you feel that the environments become more competitive or not really due to your own kind of the way you guys market to people?

Yes. Well, there certainly are more builders coming into the entry-level space. So it'd be more competitive in that regard, but we don't think it will have a negative influence on our results. We're really focused on what we're doing here at LGI, and not focused on what everyone else is doing. But the fact that everyone is in agreements that the entry-level buyer is really in a strong position right now, like I said earlier, the demographics is on our side and we're seeing strong demand. I think it's a positive testament of what we believe in, that to say, very strong market right now. But we're not too worried about the competition. We're focused on what we're doing and it won't impact our results. But we, overall, we think it's a positive. Thereby, talking about the strength of the entry-level market.

Okay. One last one. I didn't see any deliveries from the Midwest region. Any reason for that?

No. Just because we're just getting started up there, so you'll see that coming next quarter.

And our last question comes from Jay McCanless of Wedbush.

I jumped on late, so apologies if you've already addressed this. But I wanted to find out what percentage of communities you raised price this quarter. And with input cost continue to go up, how much are you guys been able to cover on pricing to offset that?

Yes. I'll take it first, Jay, and then Charles can jump in if he wants. But we look at price increases and our prices, quite frequently, do a real deep analysis every quarter. And in January, we did a price increase in virtually all of our communities. And then, again, in April because we're still seeing prices and cost increase. In April, we did another price increase in virtually all of our communities. So 80%, 90% plus of our communities had a price increase in April because that was necessary because we're continuing to see cost increase. And we talked about it earlier on the call. We anticipate gross margins being similar. We anticipate cost continue to rise for the second, third and fourth quarter. And us continuing to have to raise prices to offset those costs to keep gross margin neutral.

Great. The second question I had, Freddie Mac announced that they're going to be starting a new 3% down mortgage program with no income restrictions beginning in July. I don't know if you guys had a chance to look at that program. What impact that might have on buyers who may be are knocked out of the FHA limit in certain areas?

Yes. I saw the headline. We have not done a lot of research on that. We'll rely on our preferred mortgage partners to really give us the details. Once that program has really confirmed and we can potentially roll it out to our customers, but if it's a program that would open up availability of mortgages to more people that, certainly, would be a positive for LGI.

And I'm showing no further questions over the phone lines at this time. I would like to turn the call back over to Eric Lipar for closing remarks.

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

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program, and you may now disconnect. Everyone, have a great day.