LGI Homes, Inc. (NASDAQ:LGIH) Q3 2023 Earnings Call Transcript

LGI Homes, Inc. (NASDAQ:LGIH) Q3 2023 Earnings Call Transcript October 31, 2023

Operator: Welcome to LGI Homes Third Quarter 2023 Conference Call. Today’s call is being recorded and a replay will be available on the company’s website at www.lgihomes.com. After management’s prepared comments, there will be an opportunity to ask questions. At this time, I’ll turn the call over to Joshua Fattor, Vice President of Investor Relations and Capital Markets.

Joshua Fattor: Thanks and good afternoon. I’ll remind listeners that this call contains forward-looking statements, including management’s views on the company’s business strategy, outlook, plans, objectives and guidance for future periods. 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 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 current viewpoints and are not guarantees of future performance.

On this call, we’ll discuss non-GAAP financial measures that are not intended to be considered in isolation or as substitutes 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 we issued this morning and in our quarterly report on Form 10-Q for the quarter ended September 30, 2023 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. I’m joined today by 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.

Eric Lipar: Thanks Josh. Good afternoon and welcome to our quarterly earnings call. I’m pleased to share our exceptional performance during the third quarter of 2023. Our strong results built upon the momentum generated in the first half of the year and the positive impact of decisions we made to align our business with the unique challenges of today’s affordability-constrained market. Demand remains healthy, supported by positive longer-term fundamentals, including strong demographic trends and a low supply of affordable homes. We believe that, once the Fed’s targets are met and we have a clear view of the economic landscape, interest rate volatility will subside and the market will likely exhibit more stability similar to what we experienced in the years prior to the pandemic.

However, there’s no consensus on whether that takes a couple of quarters or a couple of years. Therefore, we are laser focused on ensuring that any near-term decisions around pricing, incentives, investments, and community openings are weighed not only in the context of their impact to our company’s near-term success but also five, 10 and 20 years down the road. A great example of this is the 1,751 homes we closed in the third quarter. This was a 13.2% increase over the same period last year and represented a strong pace of 5.6 closings per community per month. It is possible that if we’d offered significantly more than our typical 2 to 3-points of rate buydown assistance, we may have pushed closings higher. But beating the closing guidance wasn’t the goal.

Hitting the guide while also protecting and expanding margins was our focus. And that’s exactly what we did, delivering adjusted gross margins of 27.2% representing a sequential improvement of 340 basis points and back within the pre-pandemic range we’ve been working towards. Additionally, our pretax profit margin of 14.5% was also up 340 basis points and was the highest third quarter result in our history outside of the pandemic. During the third quarter our top market on a closings per community basis was Dallas Fort Worth with 10.1 closings per month. Next was Charlotte with 9.5 closings followed by Northern California with 8.9. Rounding out the top five were Fort Pierce with 8.5 and Houston with 7.9. Congratulations to the teams in these markets for their strong performance last quarter.

To reiterate every decision currently being made is being considered within the context of our systems-based philosophy and represents a careful assessment of its potential to create sustainable long-term value for our shareholders. Along with margin expansion our continued community count growth is another highlight. At the end of the quarter, we reported 106 active communities a 14% increase from a year ago and a 4% increase from the prior quarter. Growing our community count remains a key focus and we still expect to be active in 115 to 125 communities by the end of 2023. Finally, I’ll share my thoughts on an additional highlight from the quarter, the land market. Early in 2020 deals for finished lots began to diminish. By the end of 2020 they were virtually non-existent.

However, we’ve started to see that shift. During the third quarter we approved a total of 23 new projects nine of which were composed entirely of finished lots, many of which will contribute to closings and community count in the back half of 2024. Though still in the early innings we’re encouraged by this recent trend and its potential to impact future returns. Along with attractive land opportunities, we’ve also seen a meaningful increase in M&A opportunities. The majority of these are small private builders looking to leverage longer-dated land pipelines to free up capital to continue to grow their operations. During the quarter we closed a deal to acquire substantially all of the land assets of Glenwood Homes in North Carolina. The transaction enabled us to acquire over 1,100 lots in one of our best-performing regions.

On the opposite side of the deal the seller retained their high-margin backlog and received an inflow of capital that has the potential to insulate them from turbulent credit markets and support their continued success as a homebuilder and developer. The win-win nature of this deal illustrates a positive upside of today’s uncertainty. Challenging times can create great opportunities that if structured thoughtfully hold real value for both parties. We expect similar opportunities to materialize in the future and plan to pursue those that work within our profitability focused long-term growth strategy. I’ll now turn the call over to Charles for more details on our financial results.

Charles Merdian: Thanks, Eric. Revenue in the third quarter was $617.5 million based on 1,751 homes closed. Revenue was up 12.9% and closings were up 13.2% over the same period last year as we benefited from continued demand and the momentum built during the first half of the year. Of our total closings, 139 were through our wholesale channel, representing 7.9% of total closings in line with the second quarter this year. Our average selling price of $352,678 was slightly lower year-over-year, but up 1.3% sequentially. Our third quarter gross margin was 25.7%, and adjusted gross margin was 27.2%. As Eric highlighted, adjusted gross margins improved 340 basis points sequentially compared to the 150 basis point improvement we guided to on our last call.

The outperformance was driven by our success in maintaining and where possible raising prices in many communities, as well as lower input costs and new and replacement community openings at normalized margin profiles. Adjusted gross margin excluded $8.6 million of capitalized interest charged to cost of sales and $767,000 related to purchase accounting together representing 150 basis points. Combined selling general and administrative expenses for the third quarter were $76.5 million or 12.4% of revenue. Selling expenses were $49.8 million, or 8.1% of revenue compared to 7.6% in the second quarter of this year. The 50 basis point sequential increase was primarily due to spending on advertising to drive leads and support new community openings.

General and administrative expenses totaled $26.7 million, or 4.3% of revenue a level that was in line with the second quarter of this year. We expect advertising and G&A dollars will remain consistent in the fourth quarter resulting in full year SG&A as a percentage of revenue of around 13%. Pre-tax net income for the quarter was $89.4 million, or 14.5% of revenue, a 340 basis point improvement over the prior quarter. Our effective tax rate was 25.1%, compared to 16.8% in the same quarter last year. The increase in the rate was primarily due to fewer federal energy efficient home tax credits recognized this quarter compared to the same period last year. We expect the rate in the fourth quarter to be similar to the third resulting in a full year effective tax rate of approximately 24%.

Third quarter reported net income was $67 million, or $2.85 per basic share and $2.84 per diluted share. Third quarter gross orders were 2,068 up 6% over the same period last year. Net orders were 1,490 a slight decrease compared to the third quarter of last year. Our cancellation rate during the quarter was 27.9%, compared to 21.3% in the same period last year. At September 30, our backlog consisted of 1,377 homes valued at $510 million. Of those homes 273 or 19.8% of our total backlog were related to wholesale contracts with single-family rental partners. Turning to our land position. At September 30, our portfolio consisted of 72,109 owned and controlled lots a decrease of 5.7% year-over-year, but an increase of 4.2% sequentially, driven by an increase in the availability of fairly valued land deals during the quarter.

Of those lots 56,301 or 78.1% were owned a decrease of 7.1% year over year and less than 1% sequentially. Of our owned lots 42,618 were raw land or land under development. Of the remaining 13,683 owned lots, 1,471 were completed homes, including our information centers and 3,009 were homes in progress and 9,203 were finished vacant lots. We controlled 15,808 lots at quarter end, essentially flat year-over-year, but an increase of 26.8% sequentially. With that, I’ll turn the call over to Josh, for a discussion of our capital position.

Joshua Fattor: Thanks Charles. As of September 30th, we had just under $1.2 billion of notes payable outstanding, including $904.2 million drawn on our credit facility. Our debt-to-capital ratio was 39.8% and our net debt-to-capital ratio was 38.8%. Total liquidity at the end of the quarter was $243.2 million including $47 million of cash on hand and $196.2 million of available capacity, under our credit facility. At September 30th our stockholders’ equity was over $1.8 billion and our book value per share was $76.50, an increase of 10.9%, over the same time last year. At this point, I’ll turn the call back over to Eric.

Eric Lipar: Thanks Josh. On Friday, we expect to report October closings of 567 homes, up 5% compared to last October, in 108 active communities. Based on those deliveries and the sales pace in October that was consistent with this time last year, we expect to achieve an increase in closings year-over-year in the fourth quarter. Based on this, we are tightening the range of our expected closings for the year. We now expect to close between 6,700 and 7,000 homes at an average selling price between $350,000 and $355,000 for the full year. Margins in the fourth quarter are expected to be similar to slightly lower, than what we’ve delivered in the third quarter depending on several factors including geographic, product and retail versus wholesale mix as well as incentive levels offered in the fourth quarter related to our Make Your Move National Sales Event.

Based on those variables, and our performance in the third quarter, we are raising the low end of our margin guidance by 150 basis points, while holding the top end steady. We now expect full year gross margins between 23% and 23.5% and adjusted gross margins between 24.5% and 25%. Community count is building. As I mentioned earlier, we continue to expect 115 to 125 active communities at year end. As a closing thought, I’ll add that, based on our existing land pipeline and views on development timing, we now expect to end 2024 with over 150 communities and to be operating in over 180 communities by the end of 2025. I’ll conclude by saying again, how proud I am of our strong third quarter results and our success at returning profitability metrics back to pre-pandemic levels.

Our continued success is a result of outstanding execution by our teams around the country. Despite volatile rate movements, market uncertainty and the occasional need to move between projects due to the timing of new openings our dedicated employees continue to construct, sell and close homes while delivering the best service in the industry. Thank you for continued commitment to our company and to our customers. We’ll now open the call for questions.

Operator: Certainly. [Operator Instructions] And our first question will come from Michael Rehaut of JPMorgan. Your line is open, Michael.

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Q&A Session

Andrew Azzi: Hi guys. This is Andrew Azzi on for Mike. Congrats on an impressive quarter. I just wanted to ask if maybe you can bucket out to maybe quantify more succinctly what drove the gross margin beat and maybe if there was a lean in one direction or the other.

Eric Lipar: I think Andrew — this is Eric. I can start and Charles can add if he’d like. I think the gross margin beat comes from a couple different factors. One is we held pricing strong. We’re still in a very strong demand environment, low supply of inventory out there and able to hold pricing and raise prices in a substantial number of communities. The other thing that happened during the quarter is when we guided to 25.3% and then beat that is we didn’t have a lot of wholesale closings or gave room for more wholesale closings to come through in the quarter, which didn’t happen. I’d point to those two as the two primary reasons.

Andrew Azzi: That’s really good color. And then maybe just one more. How maybe widespread were these price increases that you guys are seeing?

Eric Lipar: Yeah. I would say in October when we did our Q4 pricing, we probably raised prices in one-quarter to one-third of our communities.

Andrew Azzi: Okay. And maybe if you could quantify the magnitude or…?

Eric Lipar: Yeah. They’re very slight. Just to quantify the strong demand communities and also we did have some house cost increases, which we need to raise prices to maintain margins as well.

Andrew Azzi: Thanks so much. We’ll talk soon.

Eric Lipar: You’re welcome.

Operator: And one moment for our next question. Our next question will be coming from Truman Patterson of Wolfe. Your line is open, Truman.

Truman Patterson: Hey, good afternoon, everyone and thanks for taking my questions. First, Eric I’m hoping to understand how you’re balancing your historically elevated gross margin, which you all were able to rebuild back to normalized levels this quarter. By balancing that with the recent spike in rates and the affordability constraints, are you all going to continue to favor price a bit more at the sake of absorption pace given just all this community growth that you all have in the pipeline?

Eric Lipar: Yeah, it’s a great question Truman, and good afternoon. Starting again with very strong demand, but certainly affordability is getting constrained whether it’s raising prices to offset additional costs, which I should also mention the development costs are generally increasing as well, or the increasing in rates and we’re cautious about throwing too many incentive dollars with the customers because incentives are really short-term and there’s no question in our mind if we put a lot more dollars into large forward commitments or buying down rates that would improve sales temporarily. But we want to make sure we’re making good strategic long-term decisions. We’re protective of that gross margin because the financials as we just showed with this quarter at 5.6 absorption pace, creating a 14.5% pre-tax, the financials can handle a slower absorption pace.

But when you start discounting your houses tremendously and start throwing a lot of incentives into a short-term bucket to drive that absorption pace, that may or may not be the right long-term decision for the company, and that’s what we’re really focused on.

Truman Patterson: Okay, perfect. And then, I believe you mentioned, that you all were maintaining I think two to three points of financial incentives. Could you help us understand, what portion of your buyers are getting a mortgage rate buydown? And are you all doing any sort of forward commitments at all? Or is this just a case-by-case basis with incentives that the consumer can use based on their specific needs?