LGI Homes Inc (LGIH) 2022 Q2 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the LGI Homes 2022 Second Quarter Earnings Conference Call. (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'll remind listeners that this call will contain forward-looking statements that include management's views on LGI Home's 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 statement about forward-looking statements sections for a 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 host today are Eric Lipar, LGI Homes' Chief Executive Officer and Chairman of the Board; and Charles Merdian, Chief Financial Officer and Treasurer. I'll now turn the call over to Eric.

Thanks, Josh. Good afternoon, everyone, and welcome to our earnings call. I'll open with highlights from our second quarter, and then Charles will provide details on our financial results. Finally, I'll provide an update on our performance to date in the third quarter and our outlook for the rest of the year. I'm 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 2,027 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 of 12, followed by Dallas/Fort Worth with 11.8. San Antonio was 10.7% and Tucson rounded out the top 5 with 10.3. Congratulations to these teams on outstanding performance last quarter. I'm 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're confident in our positioning and path going forward.

We entered the remainder of the year with a solid balance sheet and attractive land pipeline, a 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'll turn the call over to Charles for more details on our financial results.

Thanks, Eric. During the quarter, we closed 2,027 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 closings. 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 a 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 in passing through cost 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 to cost of 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.

Pre-tax 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's strong comp as well as our decision to defer 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 30, our land portfolio consisted of 89,984 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 1/3 of those lots were in active development. The remaining 12,298 of our owned lots were finished lots, of which 7,481 were vacant lots. During the quarter, we started over 2,400 homes.

And at June 30, 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 30, 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 has 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 30, we had $211.5 million remaining on our stock repurchase program. At this point, I'll turn the call back over to Eric.

Thanks, Charles. As highlighted in our press release, we're adjusting our full year guidance to reflect our current outlook for the rest of 2022. Pending verification of fundings, we expect to report that we closed 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 when 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 a range between 27% and 29% and adjusted gross margins between 28.5% and 30.5%. After a 2-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 moved to curve inflation nearly doubled mortgage rates. However, the longer-term outlook reveals a solid foundation for multi-year 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're taking a long-term view and remain optimistic about our business for several reasons. For the first half of the year, we are mainly focused on closing the homes in our backlog.

Now we're back to focusing on sales and closings and our marketing faucet is turned on. While others may be cutting expenses, we've 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 4 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've only sold homes that are within 60 days of closings. 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 clear view of costs and certainty that we can provide a great experience for our homebuyers. Prices are normalizing. While we're proud of the 33% adjusted gross margin we just delivered, it's not a sustainable expectation and it's not our target moving forward. As we bring new communities online, we're offering them at prices that will deliver normalized margins in the 25% to 28% range. Additionally, we're seeing input costs 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 rightsize 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 purposes, work from home migration and low interest rates filling sales offers 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 compelling value compared to running 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-focused model will continue to differentiate our company as we navigate this dynamic period. We'll now open the call for questions.

Our first question or comment comes from the line of Trevor Allinson from Wolfe Research.

First question, I just wanted to touch on what you had ended with there on your gross margin outlook for 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 half of the year, it's going to drive that sequential decrease from Q2 strong level?

Yes, it's a great question. This is Eric. I can start. I'd point to 3 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 are adjusted gross margin on how we price 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. And I think going forward, the 3 things I'd point to is, one, new communities coming online. We're pricing at normalized margins, 25% to 28%. And we've seen those communities get off to 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're going to be able to adjust our pricing to normalize margins in addition with the cost coming down and offer a more affordable payment to our customers.

And then second, looking at your option lots, they took a step down sequentially. I was hoping to get an update with what you're seeing in the land market in general and then with your option agreements, just 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?

Yes. I think it's a great question. I think what we're seeing in the land market is probably consistent with whatever else has been saying. I 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 of years, we had a couple of finished mid opportunities we were looking at. So there's a lot of developments going on across United States, and we're 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's having phenomenal success, everybody's having phenomenal margins.

But a lot of the land coming to market, a lot of development that's going on has been financed with more expensive debt, more expensive land banking. And then those communities come online, we'll see. We're starting to see some of those opportunities but it's early yet. So I think rather than focusing on raw land, we may see some opportunities for finished lots.

Our next question or comment comes from the line of Trevor Allinson from Wolfe Research.

I guess I'll hop in with one quick one, then we can move on. Just hoping you guys could discuss the demand by geography here. Your West region was really strong and you've got some community count growth there. So I'll just ask one quick one there and I'll hop back out.

Yes. Yes, I think I can take this. And again, the demand question, in general, Charles can add to it if he wants to see fed. 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 is challenge. We weren't having great experiences with the customers as we were missing closing dates, which is not good for us, not good for the customer. So we really focused, through Q2, on 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 for consecutive months because we are bringing more houses on that are within that 60-day period and gave us more inventory to sell in 4 consecutive months, and we are confident August will be an increase over July, and that will make 5 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're 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're seeing. And our focus is now entirely shifted to start selling more houses. We're going to have more available inventory.

We're going to spend more money on marketing, and we're going to be hiring a lot of salespeople and opening up these new communities at normalized margins. So we're real optimistic about the second half of the year.

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

Our next question comment comes from the line of Michael Rehaut from JPMorgan.

I just want to circle back and make sure I'm understanding the gross margin comments well as it relates to the back half. You're talking about opening up new communities in a 25% to 28% range. And just wanted 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'd have to get to around 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 a 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?

Yes. I think the only clarification, Mike, I'd make is the adjusted gross margin when we're seeing new communities, it's not only new net communities, additive community count, it's also our replacement communities. So we've got a lot of communities nationwide that are in the process of closing out and that we're bringing the 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 margin in the third quarter is 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 provided the year-end range that we did.

Yes. I would agree, Mike, with Eric's comment that it's likely that the third quarter will be higher than the fourth. So we're thinking to step down would likely happen in the fourth quarter.

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, we kind of step that up gradually over the next several months, even keeping sales closings pace between 7.5% and 8% or even at the lower end of that, gets you actually towards the higher end of your closings range. So just curious any thoughts on that, if there's anything we're 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%, it seems like you're coming up at the higher end, so just any thoughts?

Yes. I think that 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 that's going to depend on what happens in the economy in the next 3 or 4 months. A lot of it is going to depend on getting these new communities open, where we're 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're confident in our new closing guidance range. We had to adjust that down based on where we were and what we're seeing on construction, development and sales, but we're confident of being in that range.

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 '23 or if the market remains soft, you're not kind of getting the results that you want, would we see that come up a little bit more or can we see further adjustments on the gross margin side?

Yes, it's a great question, Mike. This is Charles. Not necessarily giving specific guidance on '23 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've seen over the last 1.5 years 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 of community count goes is there's some opportunity for leverage there to offset some of the increase in selling expenses. But I think overall, I think we're kind of trending back to this 10% to 11% range for the near term.

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.

Our next question or comment comes from the line of Jay McCanless from Wedbush.

Can you remind us on the community growth that you're expecting for fiscal '23? When is the bulk of those communities going to hit?

Yes. That is a great question, Jay. And after the last couple of years, probably the correct answer ism I'm not sure. But we are confident in that 20%, 30% number. I mean those communities are just getting delayed. They will be there. So we're confident community count is going to grow next year. For modeling purposes, I think an equal amount coming through the year would probably be appropriate.

And that was actually going to be my next question. If you could talk about what type of delays you're 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're still having challenges electrical transformers and some other supply chain, getting the start of the development process, getting the past 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 development 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 on the development side.

And then, 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 or that line of thinking correct and if 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?

Yes, it's a great question. I don't think we're looking at it as having a lot of price cuts, Jay, because we increased prices so rapidly over the last couple of years of 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 builders, until 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've 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're able to increase pricing a lot like in markets like Austin. While markets like Austin, we're not going to be able to keep selling.

We don't believe that 35% plus gross margins. And we've seen some pushback on those type of pricing. We will normalize our pricing. Yes, we'll 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 2 and 3 years ago because the last couple of years, they're just going to be an outlier as far as pricing goes. I mean a 33% adjusted gross margin, we are very likely never to post that again in our history. It's such an outlier in gross margin. And we're just going back to normal. And in a normal market, we believe we're going to thrive and there's going to be great tremendous opportunities for LGI, and we're pretty excited about it.

And then one more quick one. It's interesting that you're starting to see finished light deals again. Do you think with the pace of what you're seeing that you could potentially buy enough of those communities to make up for some of the shortfall that you're expecting relative to your previous guidance for this year?

Not necessarily this year because, I mean, even they're just starting to see opportunities and in closing. I mean 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. 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're talking about internally, the more challenging environment it is, the more opportunity that's going to create for LGI.

You have to remember, our company, and we haven't talked about this in the last couple of years, but we've never lost money in any year, including the greatest downturn anyone's ever seen in '06, '07 and '08, 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 finished lots. If it is 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.

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

One question I had, Eric, is just on cancellations. Your rate was up, although your unit cans weren't up much. Did you see an alteration in why folks were canceling 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'd just kind of like your take on if that's changed and how it's changed?

Yes. I think for us, it's still primarily affordability related. Our pipeline got very large in Q2 of last year. We've been working on getting that closed out. Rates are certainly higher. Not all our customers had rate loss. Usually, we're locking the rate within 60, 90 days of closing, so some of the customers just didn't qualify anymore. Certainly, that cancellation rate, and we've 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 more orders, the cancellation rate would have been normal. We did see, Carl, and I appreciate you asking the question on cancellations, we have seen some of our retail investors cancel but we've also closed a lot of those homes over the last couple of quarters in first part of the year, which has been very, very good for us as a company.

And there, we just think we're 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're going back to catering to that customer. We've sold a lot of houses to investors over the last couple of years, and we believe that was the right decision. But in a more normal market, we think that will get back to normal activity as well.

And then Charles, the line of credit, you're about, I think I got this right, 75% capacity utilization at this point and if I did this right, more typically, you're sort of back of the year, third quarter, fourth quarter is your peak utilization. So I'm 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?

Yes. Great question, Carl. So yes, we had mentioned in the script as we rightsize inventory. So one of the things we're focused on with 4,700 units in inventory, we would expect our vertical inventory to work its way down throughout the year. We're 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 rightsizing 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 a balance 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'll see that shift continue 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're 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're managing that accordingly.

Our next question comment comes from the line of Deepa Raghavan from Wells Fargo.

Eric, can you talk through how you're assessing demand deterioration at your end, if you're only accepting orders selectively? Any way to provide color on demand fallout versus how many you might have turned away within your order performance? I mean, as you talked through this, can you talk about traffic trends at your communities as well?

Yes. I think it's hard to measure how many we would have sold, Deepa, it's a good question. And I think we don't want to diminish that we're in the affordable housing business and with ASP up 27% year-over-year interest rates higher, affordability does matter and rates do matter. I think we're calling on more of our experience in the business because we do believe it's the right decision to turn off sales, if you will, make sure the customer has great experience, focus on our backlog, focus on getting homes closed and now that we've closed the majority of our backlog, focus on orders. So we're not sure how many we miss but orders have went up for 4 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 point, be qualified contracts and close. Those are mathematical facts that we've been doing since 2003 and our team is 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 been through this before. So yes, we're going to be dealing with higher rates, we're going to be dealing with higher prices, but we know spending on marketing with a trained salesforce works. And unlike a lot of companies that are cutting back on expenses, laying off employees, we are ramping up. Now is the time to spend more money on marketing.

I got with our recruiting department before the call and we're 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've got 67 open positions, including 51 new sales positions that we're hiring for our October training class. And we had 50 salespeople to the LGI mix for getting our staffing up to current levels in new communities, and that will have an impact.

How many starts did you start last quarter?

Around just over 2,400.

And your production cycle is how many days now?

Still pushing... It depends on the market of pushing 85% to 120% in there. We've seen some relief but I think we still have some ways to go be to get back to a normal construction cycle.

So it's 2,400 kind of the starts in order pace roughly that we can expect in near term?

Well, I think the way we think about it, Deepa, is 4 to 6 months inventory is what we're targeting. So I would expect us to start fewer than what we closed 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 3 to 6 months are going to look like. So we will likely start fewer than what we closed in the third quarter. That's part of rightsizing that inventory getting down from 4,700 to say something like 4,000 units, which would be 6 months at an $8,000 a year pace. So that's how we're thinking about it.

Our next question or comment comes from the line from Michael Rehaut from JPMorgan.

I appreciate the follow-up. Just wanted 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's the difference between there interest amortization and purchase accounting. Purchase accounting has been at roughly 30 bps. So you're talking about 120 bps from interest amortization and we've only been doing about 80 bps so far in the first half. And on a dollar basis, it's been about half as much as a year ago. To get that $1.2 million, it'd be more like a 1.5% range in the back half and that would be up nicely year-over-year on a 40, 50 bps and up a several million year-over-year on a dollar basis. So I just wanted to be sure if that's correct? I mean I would think all else equal would still be relatively low but just not sure if we're missing something?

Yes. Great question, Mike. I mean I think from our guidance standpoint, we used $150 million as the range. That doesn't necessarily mean we're saying specifically that interest and purchase accounting will be 150, I think, in a range in between the $110 million we just saw and slightly tick up as over the last couple of years, we've 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, a fairly rapid increase in average sales price, which will kind of minimize the percentage 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'll expect to see, all things equal, slightly higher dollars related to floating rates increasing.

So maybe increasing a little bit but if you're at $4 million or $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?

Yes, I think that's fair, somewhere in between.

Our next question or comment comes from the line of Kenneth Zener from Key.

So let's see, with your product mix more tied to first time and obviously, you have a spec first build-to-order approach, can you contrast your experience or what you're seeing relative to the trade-up buyers or anybody that really has to sell their house given the kind of choke-ups that we're seeing on the existing side? Could you just offer us your thoughts on how that demand dynamic varies within the process that you guys have?

Yes, Ken, I'll take it a shot. This is Eric. If I understand your question, I think we have an advantage focused on the first-time homebuyer focusing on that monthly payment. 90% plus of our customers are currently in a rental situation. And what triggers their inquiry about LGI Homes and they get our marketing 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 at pretty material amount. So we're confident we're going to have the demand there because we're very pro homeownership. Where a lot of the existing customers or existing homeowners and a lot of people probably listening to this call are in the same boat, we all have very low fixed rate mortgages on our homes.

And I think that's a headwind 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're still solving for that monthly payment.

Right, that was the direction of where I was going. And then with the challenges you faced developing, considering you do develop more of your own land, high gross margins, 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, 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 in inventory at the end of the year, are there any other metrics like that you're 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?

Yes. A little bit of what we talked about earlier, Ken. I think it's a shifting dynamic. We were never one to talk a lot about price versus pace but certainly, the first half of the year is all about capturing price. We had all kinds of unbelievable waitlist people waiting in line to buy our houses. And every time a house went on the price list, it's sold and we kept raising prices, and it didn't matter, everyone still wanted to buy our houses. And that was the environment that we've been living in for the last years and that's changed. Now it's about normalized margins and pace. And I think it's important, though, and I think we've done a good job of that, if everybody looks at our gross margins over time compared to the industry that if you're doing development, if we're spending the upfront capital, we are taking the development risk, we're taking the timing risk, which certainly has been a challenge.

We have to price the homes accordingly to where we capture both the development profits and the homebuilder profit. And I think we've done it. 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're doing your own development, and we're doing the development where our debt expense because we're using our credit facility is significantly less than the builders that use 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're going to continue to see elevated margins from LGI compared to the industry.

Thank you. I'm 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 in 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, have a wonderful day.