ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For purposes of this Management’s Discussion and Analysis of Financial Condition and Results of Operation, references to “we,” “our,” “us” or similar terms refer to LGI Homes, Inc. and its subsidiaries.
Business Overview
We are engaged in the design, construction and sale of new homes in the following markets:
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West
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Northwest
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Central
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Midwest
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Florida
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Southeast
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Mid-Atlantic
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Phoenix, AZ
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Seattle, WA
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Houston, TX
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Minneapolis, MN
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Tampa, FL
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Atlanta, GA
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Washington, D.C.
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Tucson, AZ
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Portland, OR
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Dallas/Ft. Worth, TX
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Orlando, FL
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Charlotte, NC/SC
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Albuquerque, NM
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Denver, CO
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San Antonio, TX
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Fort Myers, FL
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Columbia, SC
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Las Vegas, NV
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Colorado Springs, CO
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Austin, TX
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Jacksonville, FL
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Raleigh, NC
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Sacramento, CA
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Oklahoma City, OK
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Fort Pierce, FL
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Wilmington, NC
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Riverside, CA
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Winston-Salem, NC
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Birmingham, AL
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Nashville, TN
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Our management team has been in the residential land development business since the mid-1990s. Since commencing home building operations in 2003, we have constructed and closed over 34,000 homes. During the nine months ended September 30, 2019, we had 5,175 home closings, compared to 4,660 home closings during the nine months ended September 30, 2018.
We sell homes under the LGI Homes and Terrata Homes brands. Our 103 active communities at September 30, 2019 included three Terrata Homes communities.
Recent Developments
During the three months ended September 30, 2019, we expanded our geographic presence in the West and Southeast with the addition of the Riverside, California and Columbia, South Carolina markets.
In September 2019, we elected to settle the repayment of the Convertible Notes using a combination of cash (to pay the principal amount) and shares of our common stock at the maturity date.
Key Results
Key financial results as of and for the three months ended September 30, 2019, as compared to the three months ended September 30, 2018, were as follows:
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•
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Home sales revenues increased 27.0% to $483.1 million from $380.4 million.
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•
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Homes closed increased 25.1% to 2,003 homes from 1,601 homes.
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•
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Average sales price of our homes increased 1.5% to $241,179 from $237,582.
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•
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Gross margin as a percentage of home sales revenues decreased to 24.1% from 25.6%.
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•
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Adjusted gross margin (non-GAAP) as a percentage of home sales revenues decreased to 26.3% from 27.4%.
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•
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Net income before income taxes increased 32.1% to $64.7 million from $49.0 million.
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•
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Net income increased 30.8% to $49.3 million from $37.7 million.
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•
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EBITDA (non-GAAP) as a percentage of home sales revenues increased to 15.4% from 14.6%.
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•
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Adjusted EBITDA (non-GAAP) as a percentage of home sales revenues decreased to 15.4% from 15.5%.
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•
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Total owned and controlled lots decreased 9.9% to 48,803 lots at September 30, 2019 from 54,191 lots at June 30, 2019.
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For reconciliations of the non-GAAP financial measures of adjusted gross margin, EBITDA and adjusted EBITDA to the most directly comparable GAAP financial measures, please see “—Non-GAAP Measures.”
Key financial results as of and for the nine months ended September 30, 2019, as compared to the nine months ended September 30, 2018, were as follows:
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•
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Home sales revenues increased 14.2% to $1.2 billion from $1.1 billion.
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•
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Homes closed increased 11.1% to 5,175 homes from 4,660 homes.
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•
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Average sales price of our homes increased 2.8% to $238,165 from $231,597.
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•
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Gross margin as a percentage of home sales revenues decreased to 23.9% from 25.6%.
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•
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Adjusted gross margin (non-GAAP) as a percentage of home sales revenues decreased to 26.0% from 27.3%.
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•
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Net income before income taxes increased 2.8% to $147.0 million from $142.9 million.
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•
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Net income increased 1.0% to $113.7 million from $112.6 million.
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•
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EBITDA (non-GAAP) as a percentage of home sales revenues decreased to 13.9% from 14.9%.
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•
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Adjusted EBITDA (non-GAAP) as a percentage of home sales revenues decreased to 13.8% from 15.1%.
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•
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Total owned and controlled lots decreased 5.1% to 48,803 lots at September 30, 2019 from 51,442 lots at December 31, 2018.
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For reconciliations of the non-GAAP financial measures of adjusted gross margin, EBITDA and adjusted EBITDA to the most directly comparable GAAP financial measures, please see “—Non-GAAP Measures.”
Results of Operations
The following table sets forth our results of operations for the periods indicated:
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Three Months Ended September 30,
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Nine Months Ended September 30,
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2019
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2018
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2019
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2018
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(dollars in thousands, except per share data and average home sales price)
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Statement of Income Data:
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Home sales revenues
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$
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483,081
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$
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380,369
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$
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1,232,505
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$
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1,079,240
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Expenses:
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Cost of sales
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366,431
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283,035
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938,240
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802,882
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Selling expenses
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33,485
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27,890
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94,166
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80,140
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General and administrative
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19,140
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17,794
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56,558
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51,536
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Operating income
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64,025
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51,650
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143,541
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144,682
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Loss on extinguishment of debt
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—
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3,058
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169
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3,599
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Other income, net
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(707
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)
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(399
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)
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(3,589
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)
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(1,806
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)
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Net income before income taxes
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64,732
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48,991
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146,961
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142,889
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Income tax provision
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15,383
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11,268
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33,223
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30,256
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Net income
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$
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49,349
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$
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37,723
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$
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113,738
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$
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112,633
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Basic earnings per share
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$
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2.15
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$
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1.66
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$
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4.97
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$
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5.07
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Diluted earnings per share
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$
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1.93
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$
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1.52
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$
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4.49
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$
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4.57
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Other Financial and Operating Data:
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Active communities at end of period
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103
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81
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103
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81
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Home closings
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2,003
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1,601
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5,175
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4,660
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Average sales price of homes closed
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$
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241,179
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$
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237,582
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$
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238,165
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$
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231,597
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Gross margin (1)
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$
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116,650
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$
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97,334
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$
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294,265
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$
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276,358
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Gross margin % (2)
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24.1
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%
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25.6
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%
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23.9
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%
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25.6
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%
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Adjusted gross margin (3)
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$
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126,832
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$
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104,369
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$
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320,416
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$
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294,290
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Adjusted gross margin % (2)(3)
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26.3
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%
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27.4
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%
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26.0
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%
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27.3
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%
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EBITDA (4)
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$
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74,404
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$
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55,353
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$
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171,342
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$
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160,517
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EBITDA margin % (2)(4)
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15.4
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%
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14.6
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%
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13.9
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%
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14.9
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%
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Adjusted EBITDA (4)
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$
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74,368
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$
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58,862
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$
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170,179
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$
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163,157
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Adjusted EBITDA margin % (2)(4)
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15.4
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%
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15.5
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%
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13.8
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%
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15.1
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%
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(1)
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Gross margin is home sales revenues less cost of sales.
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(2)
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Calculated as a percentage of home sales revenues.
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(3)
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Adjusted gross margin is a non-GAAP financial measure used by management as a supplemental measure in evaluating operating performance. We define adjusted gross margin as gross margin less capitalized interest and adjustments resulting from the application of purchase accounting included in the cost of sales. Our management believes this information is useful because it isolates the impact that capitalized interest and purchase accounting adjustments have on gross margin. However, because adjusted gross margin information excludes capitalized interest and purchase accounting adjustments, which have real economic effects and could impact our results, the utility of adjusted gross margin information as a measure of our operating performance may be limited. In addition, other companies may not calculate adjusted gross margin information in the same manner that we do. Accordingly, adjusted gross margin information should be considered only as a supplement to gross margin information as a measure of our performance. Please see “—Non-GAAP Measures” for a reconciliation of adjusted gross margin to gross margin, which is the GAAP financial measure that our management believes to be most directly comparable.
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(4)
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EBITDA and adjusted EBITDA are non-GAAP financial measures used by management as supplemental measures in evaluating operating performance. We define EBITDA as net income before (i) interest expense, (ii) income taxes, (iii) depreciation and amortization and (iv) capitalized interest charged to the cost of sales. We define adjusted EBITDA as net income before (i) interest expense, (ii) income taxes, (iii) depreciation and amortization, (iv) capitalized interest charged to the cost of sales, (v) loss on extinguishment of debt, (vi) other income, net and (vii) adjustments resulting from the application of purchase accounting. Our management believes that the presentation of EBITDA and adjusted EBITDA provides useful information to investors regarding our results of operations because it assists both investors and management in analyzing and benchmarking the performance and value of our business. EBITDA and adjusted
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EBITDA provide indicators of general economic performance that are not affected by fluctuations in interest rates or effective tax rates, levels of depreciation or amortization and items considered to be unusual or non-recurring. Accordingly, our management believes that these measures are useful for comparing general operating performance from period to period. Other companies may define these measures differently and, as a result, our measures of EBITDA and adjusted EBITDA may not be directly comparable to the measures of other companies. Although we use EBITDA and adjusted EBITDA as financial measures to assess the performance of our business, the use of these measures is limited because they do not include certain material costs, such as interest and taxes, necessary to operate our business. EBITDA and adjusted EBITDA should be considered in addition to, and not as a substitute for, net income in accordance with GAAP as a measure of performance. Our presentation of EBITDA and adjusted EBITDA should not be construed as an indication that our future results will be unaffected by unusual or non-recurring items. Our use of EBITDA and adjusted EBITDA is limited as an analytical tool, and you should not consider these measures in isolation or as substitutes for analysis of our results as reported under GAAP. Please see “—Non-GAAP Measures” for reconciliations of EBITDA and adjusted EBITDA to net income, which is the GAAP financial measure that our management believes to be most directly comparable.
Three Months Ended September 30, 2019 Compared to Three Months Ended September 30, 2018
Homes Sales. Our home sales revenues, home closings, average sales price (ASP), average community count, average monthly absorption rate and closing community count by reportable segment for the three months ended September 30, 2019 and 2018 were as follows (revenues in thousands):
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Three Months Ended September 30, 2019
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Revenues
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Home Closings
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ASP
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Average Community Count
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Average
Monthly
Absorption Rate
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Central
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$
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193,860
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876
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$
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221,301
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34.0
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8.6
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Northwest
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92,242
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254
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363,157
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14.0
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6.0
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Southeast
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91,452
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420
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217,743
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26.3
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5.3
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Florida
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44,084
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213
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206,967
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14.0
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5.1
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West
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61,443
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240
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256,013
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13.0
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6.2
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Total
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$
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483,081
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2,003
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$
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241,179
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101.3
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6.6
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Three Months Ended September 30, 2018
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Revenues
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Home Closings
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ASP
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Average Community Count
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Average
Monthly
Absorption Rate
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Central
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$
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151,673
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|
698
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$
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217,297
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31.3
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7.4
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Northwest
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72,485
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|
195
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|
371,718
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|
10.3
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6.3
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Southeast
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73,507
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|
352
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208,827
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19.7
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6.0
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Florida
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38,750
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183
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211,749
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10.7
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|
5.7
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West
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43,954
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|
173
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254,069
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|
10.0
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|
5.8
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Total
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$
|
380,369
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|
1,601
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$
|
237,582
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82.0
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6.5
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As of September 30,
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Community count
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2019
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2018
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Central
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34
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|
30
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Northwest
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14
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|
10
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Southeast
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27
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|
21
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Florida
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15
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|
|
10
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|
West
|
13
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|
|
10
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|
Total community count
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103
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|
|
81
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|
Home sales revenues for the three months ended September 30, 2019 were $483.1 million, an increase of $102.7 million, or 27.0%, from $380.4 million for the three months ended September 30, 2018. The increase in home sales revenues is primarily due to a 25.1% increase in homes closed and an increase in the average sales price per home during the three months ended September 30, 2019 as compared to the three months ended September 30, 2018. The average sales price per home closed during the three months ended September 30, 2019 was $241,179, an increase of $3,597, or 1.5%, from the average sales price per home of $237,582 for the three months ended September 30, 2018. This increase in the average sales price per home is primarily due to changes in product mix, higher price points in new markets and a favorable pricing environment. The increase in homes closed was largely due to our geographic expansion in the West reportable segment and by deepening our presence within certain markets in the Northwest, Southeast, and Central reportable segments during the three months ended September 30, 2019 as compared to the three months ended September 30, 2018.
Home sales revenues in our West reportable segment increased by $17.5 million, or 39.8%, primarily due to an increase in community count associated with our geographic expansion into our California and Nevada markets. Home sales revenues in our Northwest reportable segment increased by $19.8 million or 27.3%, primarily due to an increase in the number of homes closed and an increase in community count for the three months ended September 30, 2019 as compared to the three months ended September 30, 2018. Home sales revenues in our Central reportable segment increased by $42.2 million, or 27.8%, during the
three months ended September 30, 2019 as compared to the three months ended September 30, 2018, primarily due to a 25.5% increase in the number of homes closed in this segment. Home sales revenues in our Southeast reportable segment increased by $17.9 million, or 24.4%, during the three months ended September 30, 2019 as compared to the three months ended September 30, 2018, primarily due to a 19.3% increase in the number of homes closed in this segment and partially due to the Wynn Homes acquisition. Home sales revenues in our Florida reportable segment increased by $5.3 million, or 13.8%, largely due to an increase in the number of homes closed and an increase in community count for the three months ended September 30, 2019 as compared to the three months ended September 30, 2018. Our active selling communities at September 30, 2019 increased to 103 from 81 at September 30, 2018. All reportable segments added communities by expanding into new markets or deepening existing markets during the three months ended September 30, 2019.
Cost of Sales and Gross Margin (home sales revenues less cost of sales). Cost of sales increased for the three months ended September 30, 2019 to $366.4 million, an increase of $83.4 million, or 29.5%, from $283.0 million for the three months ended September 30, 2018. This overall increase is primarily due to an increase in homes closed, higher lot costs recognized and to a lesser extent, increased capitalized interest costs for homes closed during the three months ended September 30, 2019 as compared to the three months ended September 30, 2018. Gross margin for the three months ended September 30, 2019 was $116.7 million, an increase of $19.3 million, or 19.8%, from $97.3 million for the three months ended September 30, 2018. Gross margin as a percentage of home sales revenues was 24.1% for the three months ended September 30, 2019 and 25.6% for the three months ended September 30, 2018. This decrease in gross margin as a percentage of home sales revenues is primarily due to higher lot costs and higher capitalized interest costs recognized for the three months ended September 30, 2019 as compared to the three months ended September 30, 2018.
Selling Expenses. Selling expenses for the three months ended September 30, 2019 were $33.5 million, an increase of $5.6 million, or 20.1%, from $27.9 million for the three months ended September 30, 2018. Sales commissions increased to $17.7 million for the three months ended September 30, 2019 from $14.7 million for the three months ended September 30, 2018, partially due to a 27.0% increase in home sales revenues during the three months ended September 30, 2019 as compared to the three months ended September 30, 2018. Selling expenses as a percentage of home sales revenues were 6.9% and 7.3% for the three months ended September 30, 2019 and 2018, respectively. The decrease in selling expenses as a percentage of home sales revenues reflects operating leverage realized from the increase in home sales revenues during the three months ended September 30, 2019 as compared to the three months ended September 30, 2018.
General and Administrative. General and administrative expenses for the three months ended September 30, 2019 were $19.1 million, an increase of $1.3 million, or 7.6%, from $17.8 million for the three months ended September 30, 2018. The increase in the amount of general and administrative expenses is primarily due to increased personnel associated with an increase of active communities during the three months ended September 30, 2019 as compared to the three months ended September 30, 2018. General and administrative expenses as a percentage of home sales revenues were 4.0% and 4.7% for the three months ended September 30, 2019 and 2018, respectively. The decrease in general and administrative expenses as a percentage of home sales revenues reflects operating leverage realized from the increase in home sales revenues during the three months ended September 30, 2019 as compared to the three months ended September 30, 2018.
Loss on extinguishment of debt. There was no loss on extinguishment of debt for the three months ended September 30, 2019. Loss on extinguishment of debt for the three months ended September 30, 2018 was $3.1 million, due to debt issuance costs previously capitalized that were associated with the Credit Agreement (as defined herein).
Operating Income, Net Income before Taxes and Net Income. Operating income for the three months ended September 30, 2019 was $64.0 million, an increase of $12.4 million, or 24.0%, from $51.7 million for the three months ended September 30, 2018. Net income before income taxes for the three months ended September 30, 2019 was $64.7 million, an increase of $15.7 million, or 32.1%, from $49.0 million for the three months ended September 30, 2018. All reportable segments contributed to net income before income taxes during the three months ended September 30, 2019 as follows: Central - $33.1 million or 51.2%; Northwest - $15.1 million or 23.3%; Southeast - $8.7 million or 13.5%; West - $6.5 million or 10.1%; and Florida - $3.2 million or 4.9%. Net income for the three months ended September 30, 2019 was $49.3 million, an increase of $11.6 million, or 30.8%, from $37.7 million for the three months ended September 30, 2018. The increases in operating income, net income before income taxes and net income are primarily attributed to operating leverage realized from the increase in home sales revenues and higher average sales price, partially offset by lower gross margin percentage and higher capitalized interest costs recognized for the three months ended September 30, 2019 as compared to the three months ended September 30, 2018.
Nine Months Ended September 30, 2019 Compared to Nine Months Ended September 30, 2018
Homes Sales. Our home sales revenues, home closings, average sales price (ASP), average community count and average monthly absorption rate by reportable segment for the nine months ended September 30, 2019 and 2018 were as follows (revenues in thousands):
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2019
|
|
|
Revenues
|
|
Home Closings
|
|
ASP
|
|
Average Community Count
|
|
Average
Monthly
Absorption Rate
|
Central
|
|
$
|
507,951
|
|
|
2,342
|
|
|
$
|
216,888
|
|
|
33.1
|
|
|
7.9
|
|
Northwest
|
|
207,492
|
|
|
567
|
|
|
365,947
|
|
|
12.0
|
|
|
5.3
|
|
Southeast
|
|
221,686
|
|
|
1,010
|
|
|
219,491
|
|
|
23.1
|
|
|
4.9
|
|
Florida
|
|
121,183
|
|
|
589
|
|
|
205,744
|
|
|
12.2
|
|
|
5.4
|
|
West
|
|
174,193
|
|
|
667
|
|
|
261,159
|
|
|
12.4
|
|
|
6.0
|
|
Total
|
|
$
|
1,232,505
|
|
|
5,175
|
|
|
$
|
238,165
|
|
|
92.8
|
|
|
6.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2018
|
|
|
Revenues
|
|
Home Closings
|
|
ASP
|
|
Average Community Count
|
|
Average Monthly
Absorption Rate
|
Central
|
|
$
|
441,138
|
|
|
2,072
|
|
|
$
|
212,904
|
|
|
30.5
|
|
|
7.5
|
|
Northwest
|
|
214,891
|
|
|
589
|
|
|
364,840
|
|
|
10.0
|
|
|
6.5
|
|
Southeast
|
|
178,984
|
|
|
879
|
|
|
203,622
|
|
|
17.9
|
|
|
5.5
|
|
Florida
|
|
136,211
|
|
|
649
|
|
|
209,878
|
|
|
11.2
|
|
|
6.4
|
|
West
|
|
108,016
|
|
|
471
|
|
|
229,333
|
|
|
9.4
|
|
|
5.6
|
|
Total
|
|
$
|
1,079,240
|
|
|
4,660
|
|
|
$
|
231,597
|
|
|
79.0
|
|
|
6.6
|
|
Home sales revenues for the nine months ended September 30, 2019 were $1,232.5 million, an increase of $153.3 million, or 14.2%, from $1,079.2 million for the nine months ended September 30, 2018. The increase in home sales revenues is primarily due to an 11.1% increase in homes closed, and an increase in the average sales price per home during the nine months ended September 30, 2019 as compared to the nine months ended September 30, 2018. The average sales price per home closed during the nine months ended September 30, 2019 was $238,165, an increase of $6,568, or 2.8%, from the average sales price per home of $231,597 for the nine months ended September 30, 2018. This increase in the average sales price per home was primarily due to changes in product mix, higher price points in certain new markets and increases in sales prices in existing communities. The increase in home closings was largely due to increased home closings in our West, Central and Southeast reportable segments, partially offset by decreased home closings in our Northwest and Florida reportable segments during the nine months ended September 30, 2019 as compared to the nine months ended September 30, 2018. The decreased home closings in our Northwest and Florida reportable segments were largely due to close out of or transition between, and to a lesser extent available inventory in, certain of their respective active communities.
Home sales revenues in our West reportable segment increased by $66.2 million, or 61.3%, primarily due to an increase in community count associated with our geographic expansion into our California and Nevada markets. Home sales revenues in our Southeast reportable segment increased by $42.7 million, or 23.9%, primarily due to an increase in community count associated with the Wynn Homes acquisition. Home sales revenues in our Central reportable segment increased by $66.8 million, or 15.1%, during the nine months ended September 30, 2019 as compared to the nine months ended September 30, 2018, primarily due to a 13.0% increase in the number of homes closed in this reportable segment. Home sales revenues in our Northwest and Florida reportable segments decreased by $7.4 million and $15.0 million, or 3.4% and 11.0%, respectively, largely due to close out or transition between certain of their respective active communities. Our active selling communities at September 30, 2019 increased to 103 from 81 at September 30, 2018. All reportable segments added communities by expanding into new markets or deepening existing markets during the nine months ended September 30, 2019.
Cost of Sales and Gross Margin (home sales revenues less cost of sales). Cost of sales increased for the nine months ended September 30, 2019 to $938.2 million, an increase of $135.4 million, or 16.9%, from $802.9 million for the nine months ended September 30, 2018. This overall increase is primarily due to an increase in homes closed, higher lot costs recognized, product mix, increased capitalized interest costs, purchase accounting and higher construction costs, during the nine months ended
September 30, 2019 as compared to the nine months ended September 30, 2018. In addition, there was an increase in construction overhead due to additional personnel and costs associated with geographic and community count expansion during the nine months ended September 30, 2019 as compared to the nine months ended September 30, 2018. Gross margin for the nine months ended September 30, 2019 was $294.3 million, an increase of $17.9 million, or 6.5%, from $276.4 million for the nine months ended September 30, 2018. Gross margin as a percentage of home sales revenues was 23.9% for the nine months ended September 30, 2019 and 25.6% for the nine months ended September 30, 2018. This decrease in gross margin as a percentage of home sales revenues is primarily due to a combination of higher construction costs, construction overhead, lot costs, capitalized interest and to a lesser degree purchase accounting, partially offset by higher average home sales price for the nine months ended September 30, 2019 as compared to the nine months ended September 30, 2018.
Selling Expenses. Selling expenses for the nine months ended September 30, 2019 were $94.2 million, an increase of $14.0 million, or 17.5%, from $80.1 million for the nine months ended September 30, 2018. Sales commissions increased to $47.4 million for the nine months ended September 30, 2019 from $42.2 million for the nine months ended September 30, 2018, partially due to a 14.2% increase in home sales revenues during the nine months ended September 30, 2019 as compared to the nine months ended September 30, 2018. Other increases include advertising and other personnel costs. Selling expenses as a percentage of home sales revenues were 7.6% and 7.4% for the nine months ended September 30, 2019 and 2018, respectively. The increase in selling expenses as a percentage of home sales revenues reflects increased personnel, advertising, and selling expenses primarily associated with new communities during the nine months ended September 30, 2019 as compared to the nine months ended September 30, 2018.
General and Administrative. General and administrative expenses for the nine months ended September 30, 2019 were $56.6 million, an increase of $5.1 million, or 9.7%, from $51.5 million for the nine months ended September 30, 2018. The increase in the amount of general and administrative expenses is primarily due to increased personnel associated with an increase of active communities during the nine months ended September 30, 2019 as compared to the nine months ended September 30, 2018. General and administrative expenses as a percentage of home sales revenues were 4.6% and 4.8% for the nine months ended September 30, 2019 and 2018, respectively. The decrease in general and administrative expenses as a percentage of home sales revenues reflects operating leverage realized from the increase in home sales revenues during the nine months ended September 30, 2019 as compared to the nine months ended September 30, 2018.
Loss on extinguishment of debt. Loss on extinguishment of debt for the nine months ended September 30, 2019 was $0.2 million. Loss on extinguishment of debt for the nine months ended September 30, 2018 was $3.6 million, due to debt issuance costs previously capitalized that were associated with the Credit Agreement.
Other Income. Other income, net of other expenses was $3.6 million for the nine months ended September 30, 2019, an increase of $1.8 million from $1.8 million for the nine months ended September 30, 2018. The increase in other income primarily reflects the gain realized from the sale of land not directly associated with our core homebuilding operations.
Operating Income, Net Income before Income Taxes and Net Income. Operating income for the nine months ended September 30, 2019 was $143.5 million, a decrease of $1.1 million, or 0.8%, from $144.7 million for the nine months ended September 30, 2018. Net income before income taxes for the nine months ended September 30, 2019 was $147.0 million, an increase of $4.1 million, or 2.8%, from $142.9 million for the nine months ended September 30, 2018. All reportable segments contributed to net income before income taxes during the nine months ended September 30, 2019 as follows: Central - $80.4 million or 54.7%; Northwest - $30.3 million or 20.6%; West - $16.9 million or 11.5%; Southeast - $14.9 million or 10.1%; and Florida - $8.9 million or 6.1%. Net income for the nine months ended September 30, 2019 was $113.7 million, an increase of $1.1 million, or 1.0%, from $112.6 million for the nine months ended September 30, 2018. The decrease in operating income is primarily attributed to lower gross margin percentage, increased advertising and additional costs realized from the increase of personnel associated with the increase of community count, higher capitalized interest costs recognized, purchase accounting and start-up costs in the Southeast reportable segment, partially offset by a higher average sales price realized during the nine months ended September 30, 2019 as compared to the nine months ended September 30, 2018. The increases in net income before income taxes and net income are primarily attributed to an increase in other income, net of loss on debt extinguishment, during the nine months ended September 30, 2019 as compared to the nine months ended September 30, 2018.
Non-GAAP Measures
In addition to the results reported in accordance with U.S. GAAP, we have provided information in this Quarterly Report on Form 10-Q relating to adjusted gross margin, EBITDA and adjusted EBITDA.
Adjusted Gross Margin
Adjusted gross margin is a non-GAAP financial measure used by management as a supplemental measure in evaluating operating performance. We define adjusted gross margin as gross margin less capitalized interest and adjustments resulting from the application of purchase accounting included in the cost of sales. Our management believes this information is useful because it isolates the impact that capitalized interest and purchase accounting adjustments have on gross margin. However, because adjusted gross margin
information excludes capitalized interest and purchase accounting adjustments, which have real economic effects and could impact our results, the utility of adjusted gross margin information as a measure of our operating performance may be limited. In addition, other companies may not calculate adjusted gross margin information in the same manner that we do. Accordingly, adjusted gross margin information should be considered only as a supplement to gross margin information as a measure of our performance.
The following table reconciles adjusted gross margin to gross margin, which is the GAAP financial measure that our management believes to be most directly comparable (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
Home sales revenues
|
|
$
|
483,081
|
|
|
$
|
380,369
|
|
|
$
|
1,232,505
|
|
|
$
|
1,079,240
|
|
Cost of sales
|
|
366,431
|
|
|
283,035
|
|
|
938,240
|
|
|
802,882
|
|
Gross margin
|
|
116,650
|
|
|
97,334
|
|
|
294,265
|
|
|
276,358
|
|
Capitalized interest charged to cost of sales
|
|
9,511
|
|
|
6,185
|
|
|
23,894
|
|
|
17,085
|
|
Purchase accounting adjustments (1)
|
|
671
|
|
|
850
|
|
|
2,257
|
|
|
847
|
|
Adjusted gross margin
|
|
$
|
126,832
|
|
|
$
|
104,369
|
|
|
$
|
320,416
|
|
|
$
|
294,290
|
|
Gross margin % (2)
|
|
24.1
|
%
|
|
25.6
|
%
|
|
23.9
|
%
|
|
25.6
|
%
|
Adjusted gross margin % (2)
|
|
26.3
|
%
|
|
27.4
|
%
|
|
26.0
|
%
|
|
27.3
|
%
|
|
|
(1)
|
Adjustments result from the application of purchase accounting for acquisitions and represent the amount of the fair value step-up adjustments included in cost of sales for real estate inventory sold after the acquisition dates.
|
|
|
(2)
|
Calculated as a percentage of home sales revenues.
|
EBITDA and Adjusted EBITDA
EBITDA and adjusted EBITDA are non-GAAP financial measures used by management as supplemental measures in evaluating operating performance. We define EBITDA as net income before (i) interest expense, (ii) income taxes, (iii) depreciation and amortization and (iv) capitalized interest charged to the cost of sales. We define adjusted EBITDA as net income before (i) interest expense, (ii) income taxes, (iii) depreciation and amortization, (iv) capitalized interest charged to the cost of sales, (v) loss on extinguishment of debt, (vi) other income, net and (vii) adjustments resulting from the application of purchase accounting included in the cost of sales. Our management believes that the presentation of EBITDA and adjusted EBITDA provides useful information to investors regarding our results of operations because it assists both investors and management in analyzing and benchmarking the performance and value of our business. EBITDA and adjusted EBITDA provide indicators of general economic performance that are not affected by fluctuations in interest rates or effective tax rates, levels of depreciation or amortization and items considered to be unusual or non-recurring. Accordingly, our management believes that these measures are useful for comparing general operating performance from period to period. Other companies may define these measures differently and, as a result, our measures of EBITDA and adjusted EBITDA may not be directly comparable to the measures of other companies. Although we use EBITDA and adjusted EBITDA as financial measures to assess the performance of our business, the use of these measures is limited because they do not include certain material costs, such as interest and taxes, necessary to operate our business. EBITDA and adjusted EBITDA should be considered in addition to, and not as a substitute for, net income in accordance with GAAP as a measure of performance. Our presentation of EBITDA and adjusted EBITDA should not be construed as an indication that our future results will be unaffected by unusual or non-recurring items. Our use of EBITDA and adjusted EBITDA is limited as an analytical tool, and you should not consider these measures in isolation or as substitutes for analysis of our results as reported under GAAP. Some of these limitations are:
(i) they do not reflect every cash expenditure, future requirements for capital expenditures or contractual commitments, including for purchase of land;
(ii) they do not reflect the interest expense or the cash requirements necessary to service interest or principal payments on our debt;
(iii) although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced or require improvements in the future, and EBITDA and adjusted EBITDA do not reflect any cash requirements for such replacements or improvements;
(iv) they are not adjusted for all non-cash income or expense items that are reflected in our statements of cash flows;
(v) they do not reflect the impact of earnings or charges resulting from matters we consider not to be indicative of our ongoing operations; and
(vi) other companies in our industry may calculate them differently than we do, limiting their usefulness as a comparative measure.
Because of these limitations, our EBITDA and adjusted EBITDA should not be considered as measures of discretionary cash available to us to invest in the growth of our business or as measures of cash that will be available to us to meet our obligations. We compensate for these limitations by using our EBITDA and adjusted EBITDA along with other comparative tools, together with GAAP measures, to assist in the evaluation of operating performance. These GAAP measures include operating income, net income and cash flow data. We have significant uses of cash flows, including capital expenditures, interest payments and other non-recurring charges, which are not reflected in our EBITDA or adjusted EBITDA. EBITDA and adjusted EBITDA are not intended as alternatives to net income as indicators of our operating performance, as alternatives to any other measure of performance in conformity with GAAP or as alternatives to cash flows as a measure of liquidity. You should therefore not place undue reliance on our EBITDA or adjusted EBITDA calculated using these measures.
The following table reconciles EBITDA and adjusted EBITDA to net income, which is the GAAP measure that our management believes to be most directly comparable (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
Net income
|
|
$
|
49,349
|
|
|
$
|
37,723
|
|
|
$
|
113,738
|
|
|
$
|
112,633
|
|
Income taxes
|
|
15,383
|
|
|
11,268
|
|
|
33,223
|
|
|
30,256
|
|
Depreciation and amortization
|
|
161
|
|
|
177
|
|
|
487
|
|
|
543
|
|
Capitalized interest charged to cost of sales
|
|
9,511
|
|
|
6,185
|
|
|
23,894
|
|
|
17,085
|
|
EBITDA
|
|
74,404
|
|
|
55,353
|
|
|
171,342
|
|
|
160,517
|
|
Purchase accounting adjustments(1)
|
|
671
|
|
|
850
|
|
|
2,257
|
|
|
847
|
|
Loss on extinguishment of debt
|
|
—
|
|
|
3,058
|
|
|
169
|
|
|
3,599
|
|
Other income, net
|
|
(707
|
)
|
|
(399
|
)
|
|
(3,589
|
)
|
|
(1,806
|
)
|
Adjusted EBITDA
|
|
$
|
74,368
|
|
|
$
|
58,862
|
|
|
$
|
170,179
|
|
|
$
|
163,157
|
|
EBITDA margin %(2)
|
|
15.4
|
%
|
|
14.6
|
%
|
|
13.9
|
%
|
|
14.9
|
%
|
Adjusted EBITDA margin %(2)
|
|
15.4
|
%
|
|
15.5
|
%
|
|
13.8
|
%
|
|
15.1
|
%
|
|
|
(1)
|
Adjustments result from the application of purchase accounting related to prior acquisitions and represent the amount of the fair value step-up adjustments for real estate inventory included in cost of sales.
|
|
|
(2)
|
Calculated as a percentage of home sales revenues.
|
Backlog
We sell our homes under standard purchase contracts, which generally require a homebuyer to pay a deposit at the time of signing the purchase contract. The amount of the required deposit is minimal (generally $1,000). The deposits are refundable if the retail homebuyer is unable to obtain mortgage financing. We permit our retail homebuyers to cancel the purchase contract and obtain a refund of their deposit in the event mortgage financing cannot be obtained within a certain period of time, as specified in their purchase contract. Typically, our retail homebuyers provide documentation regarding their ability to obtain mortgage financing within 14 days after the purchase contract is signed. If we determine that the homebuyer is not qualified to obtain mortgage financing or is not otherwise financially able to purchase the home, we will terminate the purchase contract. If a purchase contract has not been cancelled or terminated within 14 days after the purchase contract has been signed, then the homebuyer has met the preliminary criteria to obtain mortgage financing. Only purchase contracts that are signed by homebuyers who have met the preliminary criteria to obtain mortgage financing are included in new (gross) orders.
Our “backlog” consists of homes that are under a purchase contract that has been signed by homebuyers who have met the preliminary criteria to obtain mortgage financing but have not yet closed and wholesale contracts for which the required deposit has been made. Since our business model is generally based on building move-in ready homes before a purchase contract is signed, the majority of our homes in backlog are currently under construction or complete. Ending backlog represents the number of homes in backlog from the previous period plus the number of net orders (new orders for homes less cancellations) generated during the current period minus the number of homes closed during the current period. Our backlog at any given time will be affected by cancellations, the number of our active communities and the timing of home closings. Homes in backlog are generally closed within one to two months, although we may experience cancellations of purchase contracts at any time prior to closing. It is important to note that net orders, backlog and cancellation metrics are operational, rather than accounting data, and should be used only as a general gauge to evaluate performance. Backlog may be impacted by customer cancellations for various reasons that are beyond our control, and in light of our minimal required deposit, there is little negative impact to the potential homebuyer from the cancellation of the purchase contract.
As of the dates set forth below, our net orders, cancellation rate and ending backlog homes and value were as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
Backlog Data
|
|
Nine Months Ended September 30,
|
2019 (4)
|
|
2018 (5)
|
Net orders (1)
|
|
6,186
|
|
|
5,056
|
|
Cancellation rate (2)
|
|
20.0
|
%
|
|
23.1
|
%
|
Ending backlog – homes (3)
|
|
1,635
|
|
|
1,212
|
|
Ending backlog – value (3)
|
|
$
|
410,524
|
|
|
$
|
292,594
|
|
|
|
(1)
|
Net orders are new (gross) orders for the purchase of homes during the period, less cancellations of existing purchase contracts during the period.
|
|
|
(2)
|
Cancellation rate for a period is the total number of purchase contracts cancelled during the period divided by the total new (gross) orders for the purchase of homes during the period.
|
|
|
(3)
|
Ending backlog consists of homes at the end of the period that are under a purchase contract that has been signed by homebuyers who have met our preliminary financing criteria but have not yet closed and wholesale contracts for which the required deposit has been made. Ending backlog is valued at the contract amount.
|
|
|
(4)
|
16 units and values related to bulk sales agreements are not included in the table above.
|
|
|
(5)
|
Two units and values related to bulk sales agreements are not included in the table above.
|
Land Acquisition Policies and Development
We increased our active communities to 103 as of September 30, 2019 from 88 as of December 31, 2018. However, our lot inventory decreased to 48,803 owned or controlled lots as of September 30, 2019 from 51,442 owned or controlled lots as of December 31, 2018. This decrease is primarily related to controlled lots that were purchased or terminated during the acquisition process within our Southeast and West reportable segments.
The table below shows (i) home closings by reportable segment for the nine months ended September 30, 2019 and (ii) our owned or controlled lots by reportable segment as of September 30, 2019.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2019
|
|
As of September 30, 2019
|
Reportable Segment
|
|
Home Closings
|
|
Owned (1)
|
|
Controlled
|
|
Total
|
Central
|
|
2,342
|
|
|
14,692
|
|
|
8,507
|
|
|
23,199
|
|
Northwest
|
|
567
|
|
|
2,425
|
|
|
1,263
|
|
|
3,688
|
|
Southeast
|
|
1,010
|
|
|
9,769
|
|
|
5,122
|
|
|
14,891
|
|
Florida
|
|
589
|
|
|
2,779
|
|
|
1,341
|
|
|
4,120
|
|
West
|
|
667
|
|
|
2,094
|
|
|
811
|
|
|
2,905
|
|
Total
|
|
5,175
|
|
|
31,759
|
|
|
17,044
|
|
|
48,803
|
|
|
|
(1)
|
Of the 31,759 owned lots as of September 30, 2019, 20,156 were raw/under development lots and 11,603 were finished lots.
|
Homes in Inventory
When entering a new community, we build a sufficient number of move-in ready homes to meet our budgets. We base future home starts on closings. As homes are closed, we start more homes to maintain our inventory. As of September 30, 2019, we had a total of 1,518 completed homes, including information centers, and 3,111 homes in progress.
Raw Materials and Labor
When constructing homes, we use various materials and components. We generally contract for our materials and labor at a fixed price for the anticipated construction period of our homes. This allows us to mitigate the risks associated with increases in building materials and labor costs between the time construction begins on a home and the time it is closed. Typically, the raw materials and most of the components used in our business are readily available in the United States. In addition, the majority of our raw materials is supplied to us by our subcontractors, and is included in the price of our contract with such subcontractors. Most of the raw materials necessary for our subcontractors are standard items carried by major suppliers. Substantially all of our construction work is done by third-party subcontractors, most of whom are non-unionized. We continue to monitor the supply markets to achieve the best prices available. Typically, the price changes that most significantly influence our operations are price increases in labor, commodities and lumber.
Seasonality
In all of our reportable segments, we have historically experienced similar variability in our results of operations and in capital requirements from quarter to quarter due to the seasonal nature of the homebuilding industry. We generally close more homes in our second, third and fourth quarters. Thus, our revenue may fluctuate on a quarterly basis and we may have higher capital requirements in our second, third and fourth quarters in order to maintain our inventory levels. Our revenue and capital requirements are generally similar across our second, third and fourth quarters.
As a result of seasonal activity, our quarterly results of operations and financial position at the end of a particular quarter, especially the first quarter, are not necessarily representative of the results we expect at year end. We expect this seasonal pattern to continue in the long term.
Liquidity and Capital Resources
Overview
As of September 30, 2019, we had $37.0 million of cash and cash equivalents. Cash flows for each of our active communities depend on the status of the development cycle and can differ substantially from reported earnings. Early stages of development or expansion require significant cash outlays for land acquisitions, land development, plats, vertical development, construction of information centers, general landscaping and other amenities. Because these costs are a component of our inventory and are not recognized in our statement of operations until a home closes, we incur significant cash outflows prior to recognition of home sales revenues. In the later stages of an active community, cash inflows may exceed home sales revenues reported for financial statement purposes, as the costs associated with home and land construction were previously incurred.
Our principal uses of capital are operating expenses, land and lot purchases, lot development, home construction, interest costs on our indebtedness and the payment of various liabilities. In addition, we may purchase land, lots, homes under construction or other assets as part of an acquisition.
We generally rely on our ability to finance our operations by generating operating cash flows, borrowing under our revolving credit facility or the issuance and sale of shares of our common stock. As needed, we will consider accessing the debt and equity capital markets as part of our ongoing financing strategy. We also rely on our ability to obtain performance, payment and completion surety bonds as well as letters of credit to finance our projects.
We have an effective shelf registration statement on Form S-3 (Registration No. 333-227012), registering the offering and sale of an indeterminate amount of debt securities, guarantees of debt securities, preferred stock, common stock, warrants, depositary shares, purchase contracts and units that include any of these securities, that was filed on August 24, 2018 with the Securities and Exchange Commission. Under the shelf registration statement, we have the ability to access the debt and equity capital markets as needed as part of our ongoing financing strategy.
We believe that we will be able to fund our current and foreseeable liquidity needs for at least the next twelve months with our cash on hand, cash generated from operations and cash expected to be available from our revolving credit facility or through accessing debt or equity capital, as needed.
Revolving Credit Facility
On May 6, 2019, we entered into that certain Fourth Amended and Restated Credit Agreement (the “Credit Agreement”) with several financial institutions, and Wells Fargo Bank, National Association, as administrative agent. The Credit Agreement has substantially similar terms and provisions to our third amended and restated credit agreement entered into in May 2018 with several financial institutions, and Wells Fargo Bank, National Association, as administrative agent (the “2018 Credit Agreement”) but, among other things, provides for, a revolving credit facility of $550.0 million, which can be increased at our request by up to $100.0 million if the lenders make additional commitments, subject to the terms and conditions of the Credit Agreement.
The Credit Agreement matures on May 31, 2022. Before each anniversary of the Credit Agreement, we may request a one-year extension of the maturity date. The Credit Agreement is guaranteed by each of our subsidiaries that have gross assets of $0.5 million or more. As of September 30, 2019, the borrowing base under the Credit Agreement was $920.0 million, of which borrowings, including the Convertible Notes (as defined below) and the Senior Notes (as defined below), of $760.3 million were outstanding, $13.2 million of letters of credit were outstanding and $145.1 million was available to borrow under the 2018 Credit Agreement, net of deferred purchase price obligations.
Interest is paid monthly on borrowings under the Credit Agreement at LIBOR plus 2.50%. The Credit Agreement applicable margin for LIBOR loans ranges from 2.35% to 2.75% based on our leverage ratio. At September 30, 2019, LIBOR was 2.04%.
The Credit Agreement requires us to maintain (i) a tangible net worth of not less than $486.9 million plus 75% of the net proceeds of all equity issuances plus 50.0% of the amount of our positive net income in any fiscal quarter after December 31, 2018, (ii) a leverage ratio of not greater than 60.0%, (iii) liquidity of at least $50.0 million and (iv) a ratio of EBITDA to interest expense for the most recent four quarters of at least 2.50 to 1.00. The Credit Agreement contains various covenants that, among other restrictions, limit the amount of our additional debt and our ability to make certain investments. At September 30, 2019, we were in compliance with all of the covenants contained in the Credit Agreement.
In July 2017, the U.K.’s Financial Conduct Authority, which regulates LIBOR, announced that it intends to phase out LIBOR as a benchmark by the end of 2021. At the present time, our revolving credit facility has a term that extends beyond 2021, and borrowings under the Credit Agreement bear interest at LIBOR plus an applicable margin. The Credit Agreement provides for a mechanism to amend the facility to reflect the establishment of an alternate rate of interest upon the occurrence of certain events related to the phase-out of any applicable interest rate. However, we have not yet pursued any technical amendment or other contractual alternative to address this matter. We are currently evaluating the potential impact of the eventual replacement of the LIBOR interest rate on the Credit Agreement.
Convertible Notes
We issued $85.0 million aggregate principal amount of our 4.25% Convertible Notes due 2019 (the “Convertible Notes”) in November 2014 pursuant to an exemption from the registration requirements afforded by Section 4(a)(2) of the Securities Act of 1933, as amended (the “Securities Act”). The Convertible Notes mature on November 15, 2019. Interest on the Convertible Notes is payable semi-annually in arrears on May 15 and November 15 of each year at a rate of 4.25%. When the Convertible Notes were issued, the fair value of $76.5 million was recorded to notes payable. $5.5 million of the remaining proceeds was recorded to additional paid in capital to reflect the equity component and the remaining $3.0 million was recorded as a deferred tax liability. The carrying amount of the Convertible Notes is being accreted to face value over the term to maturity. As of September 30, 2019, we have $70.0 million aggregate principal amount of Convertible Notes outstanding.
Prior to May 15, 2019, the Convertible Notes were convertible only upon satisfaction of any of the specified conversion events. On or after May 15, 2019 and until the close of business on November 14, 2019 (the business day immediately preceding the stated maturity date of the Convertible Notes), the holders of the Convertible Notes can convert their Convertible Notes at any time at their option. With respect to the conversion of the Convertible Notes (i) between the date of this Quarterly Report on Form 10-Q and the maturity date of the Convertible Notes and (ii) on such maturity date, we have elected to settle the conversion of the Convertible Notes using a combination of cash (to pay the principal amount) and shares of our common stock. The initial conversion rate of the Convertible Notes is 46.4792 shares of our common stock for each $1,000 principal amount of Convertible Notes, which represents an initial conversion price of approximately $21.52 per share of our common stock. The conversion rate is subject to adjustments upon the occurrence of certain specified events. We expect to use a combination of cash received from operations and from borrowings under the Credit Agreement to satisfy the Convertible Notes at maturity.
On July 6, 2018, concurrently with the offering of the Senior Notes, we entered into that certain First Supplemental Indenture, dated as of July 6, 2018, among us, our subsidiaries that guarantee our obligations under the 2018 Credit Agreement (the “Subsidiary Guarantors”) and Wilmington Trust, National Association, as trustee, which supplements the indenture governing the Convertible Notes, pursuant to which (i) the subordination provisions in the indenture governing the Convertible Notes were eliminated, (ii) each Subsidiary Guarantor agreed (A) to, concurrently with the issuance of the Senior Notes, fully and unconditionally guarantee the Convertible Notes to the same extent that such Subsidiary Guarantor is guaranteeing the Senior Notes and (B) that such Subsidiary Guarantor’s guarantee of the Convertible Notes ranks equally with such Subsidiary Guarantor’s guarantee of the Senior Notes and (iii) the Company agreed to not, directly or indirectly, incur any indebtedness in the form of, or otherwise become liable in respect of, any notes or other debt securities issued pursuant to an indenture or note purchase agreement (including the Senior Notes) unless such indebtedness is equal with or contractually subordinated to the Convertible Notes in right of payment.
Senior Notes Offering
On July 6, 2018, we issued $300.0 million aggregate principal amount of the Senior Notes in an offering to persons reasonably believed to be qualified institutional buyers in the United States pursuant to Rule 144A under the Securities Act and to certain non-U.S. persons in transactions outside the United States pursuant to Regulation S under the Securities Act. Interest on the Senior
Notes accrues at a rate of 6.875% per annum, payable semi-annually in arrears on January 15 and July 15 of each year, commencing on January 15, 2019, and the Senior Notes mature on July 15, 2026. Terms of the Senior Notes are governed by an indenture and supplemental indenture, each dated as of July 6, 2018, among us, the Subsidiary Guarantors and Wilmington Trust, National Association, as trustee.
We received net proceeds from the offering of the Senior Notes of approximately $296.2 million, after deducting the initial purchasers’ discounts of $2.3 million and commissions and offering expenses of $1.5 million. The net proceeds from the offering were used to repay a portion of the borrowings under the 2018 Credit Agreement.
Letters of Credit, Surety Bonds and Financial Guarantees
We are often required to provide letters of credit and surety bonds to secure our performance under construction contracts, development agreements and other arrangements. The amount of such obligations outstanding at any time varies in accordance with our pending development activities. In the event any such bonds or letters of credit are drawn upon, we would be obligated to reimburse the issuer of such bonds or letters of credit.
Under these letters of credit, surety bonds and financial guarantees, we are committed to perform certain development and construction activities and provide certain guarantees in the normal course of business. Outstanding letters of credit, surety bonds and financial guarantees under these arrangements, totaled $100.8 million as of September 30, 2019. Although significant development and construction activities have been completed related to the improvements at these sites, the letters of credit and surety bonds are not generally released until all development and construction activities are completed. We do not believe that it is probable that any outstanding letters of credit, surety bonds or financial guarantees as of September 30, 2019 will be drawn upon.
Cash Flows
Operating Activities
Net cash used in operating activities was $104.2 million for the nine months ended September 30, 2019. The primary drivers of operating cash flows are typically cash earnings and changes in inventory levels, including land acquisition and development. Net cash used in operating activities during the nine months ended September 30, 2019 was primarily driven by net income of $113.7 million, and included cash outlays for the $249.9 million increase in the net change in real estate inventory, which was primarily related to our homes under construction and land acquisitions and development level of activity offset by changes in non-inventory balances of $32.0 million.
Net cash used in operating activities was $102.0 million for the nine months ended September 30, 2018, primarily driven by net income of $112.6 million, and included cash outlays for the $194.4 million increase in the net change in real estate inventory, which was primarily related to our homes under construction and land acquisitions and development level of activity and additional cash outlays due to changes in non-inventory balances of $20.3 million.
Investing Activities
Net cash used in investing activities for the nine months ended September 30, 2019 and September 30, 2018 was $1.6 million and $74.2 million, respectively, primarily due to the acquisition of Wynn Homes in 2018.
Financing Activities
Net cash provided by financing activities for the nine months ended September 30, 2019 and September 30, 2018, was $96.2 million and $146.6 million, respectively, primarily driven by net borrowings under the Credit Agreement and to a lesser extent proceeds from the issuance of stock, partially offset by loan issuance costs.
Off-Balance Sheet Arrangements
In the ordinary course of business, we enter into land purchase contracts in order to procure land and lots for the construction of our homes. We are subject to customary obligations associated with entering into contracts for the purchase of land and improved lots. These contracts typically require cash deposits and the purchase of properties under these contracts is generally contingent upon satisfaction of certain requirements by the sellers, which may include obtaining applicable property and development entitlements or the completion of development activities and the delivery of finished lots. We also utilize contracts with land sellers as a method of acquiring lots and land in staged takedowns, which helps us manage the financial and market risk associated with land holdings and minimize the use of funds from our corporate financing sources. Such contracts generally require a non-refundable deposit for the right to acquire land or lots over a specified period of time at pre-determined prices. We generally have the right at our discretion to terminate our obligations under purchase contracts during the initial feasibility period and receive a refund of our deposit, or we may terminate the contracts after the end of the feasibility period by forfeiting our cash deposit with no further financial obligations to the land seller. In addition, our deposit may also be refundable if the land seller does not satisfy all conditions precedent in the respective contract. As of September 30, 2019, we had $37.7 million of cash deposits pertaining to land purchase
contracts for 17,044 lots with an aggregate purchase price of $550.4 million. Approximately $28.5 million of the cash deposits as of September 30, 2019 are secured by third-party guarantees or indemnity mortgages on the related property.
Our utilization of land purchase contracts is dependent on, among other things, the availability of land sellers willing to enter into contracts at acceptable terms, which may include option takedown arrangements, the availability of capital to financial intermediaries to finance the development of optioned lots, general housing conditions and local market dynamics. Land purchase contracts may be more difficult to procure from land sellers in strong housing markets and are more prevalent in certain markets.
Inflation
Our business can be adversely impacted by inflation, primarily from higher land, financing, labor, material and construction costs. In addition, inflation can lead to higher mortgage rates, which can significantly affect the affordability of mortgage financing to homebuyers.
Contractual Obligations
As of September 30, 2019, there have been no material changes to our contractual obligations appearing in the “Contractual Obligations” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018.
Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. On an ongoing basis, management evaluates such estimates and judgments and makes adjustments as deemed necessary. Actual results could differ from these estimates using different estimates and assumptions, or if conditions are significantly different in the future.
We believe that there have been no significant changes to our critical accounting policies during the nine months ended September 30, 2019 as compared to those disclosed in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018.
Cautionary Statement about Forward-Looking Statements
From time to time we make statements concerning our expectations, beliefs, plans, objectives, goals, strategies, future events or performance and underlying assumptions and other statements that are not historical facts. These statements are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those expressed or implied by these statements. You can generally identify our forward-looking statements by the words “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “forecast,” “goal,” “intend,” “may,” “objective,” “plan,” “potential,” “predict,” “projection,” “should,” “will” or other similar words.
We have based our forward-looking statements on our management’s beliefs and assumptions based on information available to our management at the time the statements are made. We caution you that assumptions, beliefs, expectations, intentions and projections about future events may, and often do, vary materially from actual results. Therefore, we cannot assure you that actual results will not differ materially from those expressed or implied by our forward-looking statements.
The following are some of the factors that could cause actual results to differ materially from those expressed or implied in forward-looking statements:
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adverse economic changes either nationally or in the markets in which we operate, including, among other things, increases in unemployment, volatility of mortgage interest rates and inflation and decreases in housing prices;
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a slowdown in the homebuilding industry;
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volatility and uncertainty in the credit markets and broader financial markets;
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the cyclical and seasonal nature of our business;
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our future operating results and financial condition;
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our business operations;
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changes in our business and investment strategy;
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the success of our operations in recently opened new markets and our ability to expand into additional new markets;
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our ability to successfully extend our business model to building homes with higher price points, developing larger communities and producing and selling multi-unit products, townhouses, wholesale products, and acreage home sites;
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our ability to develop our projects successfully or within expected timeframes;
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our ability to identify potential acquisition targets and close such acquisitions;
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our ability to successfully integrate any acquisition with our existing operations;
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availability of land to acquire and our ability to acquire such land on favorable terms or at all;
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availability, terms and deployment of capital;
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decisions of the lender group of our revolving credit facility;
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decline in the market value of our land portfolio;
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disruption in the terms or availability of mortgage financing or increase in the number of foreclosures in our markets;
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shortages of or increased prices for labor, land, or raw materials used in land development and housing construction;
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delays in land development or home construction resulting from natural disasters, adverse weather conditions or other events outside our control;
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uninsured losses in excess of insurance limits;
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the cost and availability of insurance and surety bonds;
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changes in, liabilities under, or the failure or inability to comply with, governmental laws and regulations;
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the timing of receipt of regulatory approvals and the opening of projects;
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the degree and nature of our competition;
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increases in taxes or government fees;
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poor relations with the residents of our projects;
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existing and future litigation, arbitration or other claims;
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availability of qualified personnel and third-party contractors and subcontractors;
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information system interruptions or breaches in security;
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our ability to retain our key personnel;
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our leverage and future debt service obligations;
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the impact on our business of any future government shutdown;
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other risks and uncertainties inherent in our business;
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You should not place undue reliance on forward-looking statements. Each forward-looking statement speaks only as of the date of the particular statement. We expressly disclaim any intent, obligation or undertaking to update or revise any forward-looking statements to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statements are based. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements contained in this Quarterly Report on Form 10-Q.