Document
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
ý
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2018
OR
o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from                       to                      .
Commission file number 001-36126      

LGI HOMES, INC.

(Exact name of registrant as specified in its charter)

Delaware
 
46-3088013
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
1450 Lake Robbins Drive, Suite 430, The Woodlands, Texas
 
77380
(Address of principal executive offices)
 
(Zip code)
(281) 362-8998
(Registrants Telephone Number, Including Area Code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes  ý  No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ý
 
Accelerated filer ¨
Non-accelerated filer  ¨
 
Smaller reporting company  ¨

(Do not check if a smaller reporting company)

 
Emerging growth company ¨

 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  ¨    No  ý

As of May 4, 2018, there were 22,615,146 shares of the registrant’s common stock, par value $.01 per share, outstanding.


Table of Contents

TABLE OF CONTENTS
   



 
Page
 
Item 1.
 
 
 
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
 
Item 6.
 
 
 


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Table of Contents

PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LGI HOMES, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share data)
 
 
 
March 31,
 
December 31,
 
 
2018
 
2017
ASSETS
 

 
 
Cash and cash equivalents
 
$
52,024

 
$
67,571

Accounts receivable
 
21,660

 
44,706

Real estate inventory
 
1,040,351

 
918,933

Pre-acquisition costs and deposits
 
24,609

 
18,866

Property and equipment, net
 
1,647

 
1,674

Other assets
 
17,403

 
14,196

Deferred tax assets, net
 
1,142

 
1,928

Goodwill
 
12,018

 
12,018

Total assets
 
$
1,170,854

 
$
1,079,892

 
 
 
 
 
LIABILITIES AND EQUITY
 
 
 
 
Accounts payable
 
$
25,737

 
$
12,020

Accrued expenses and other liabilities
 
54,489

 
102,831

Notes payable
 
571,718

 
475,195

Total liabilities
 
651,944

 
590,046

 
 
 
 
 
COMMITMENTS AND CONTINGENCIES
 

 

EQUITY
 
 
 
 
Common stock, par value $0.01, 250,000,000 shares authorized, 23,615,146 shares issued and 22,615,146 shares outstanding as of March 31, 2018 and 22,845,580 shares issued and 21,845,580 shares outstanding as of December 31, 2017
 
236

 
228

Additional paid-in capital
 
231,434

 
229,680

Retained earnings
 
303,790

 
276,488

Treasury stock, at cost, 1,000,000 shares
 
(16,550
)
 
(16,550
)
Total equity
 
518,910

 
489,846

Total liabilities and equity
 
$
1,170,854

 
$
1,079,892








See accompanying notes to the consolidated financial statements.

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LGI HOMES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except share and per share data)

 
 
 
Three Months Ended March 31,
 
 
2018
 
2017
Home sales revenues
 
$
279,024

 
$
162,911

 
 
 
 
 
Cost of sales
 
209,765

 
119,412

Selling expenses
 
22,949

 
16,107

General and administrative
 
15,440

 
11,265

   Operating income
 
30,870

 
16,127

Other income, net
 
(357
)
 
(715
)
Net income before income taxes
 
31,227

 
16,842

Income tax provision
 
3,925

 
5,062

Net income
 
$
27,302

 
$
11,780

Earnings per share:
 
 
 
 
Basic
 
$
1.23

 
$
0.55

Diluted
 
$
1.10

 
$
0.52

 
 
 
 
 
Weighted average shares outstanding:
 
 
 
 
Basic
 
22,188,121

 
21,360,167

Diluted
 
24,772,027

 
22,787,652




















See accompanying notes to the consolidated financial statements.

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LGI HOMES, INC.
CONSOLIDATED STATEMENT OF EQUITY
(Unaudited)
(In thousands, except share data)

 
 
 
Common Stock
 
Additional Paid-In Capital
 
Retained Earnings
 
Treasury Stock
 
Total Equity
 
 
Shares
 
Amount
BALANCE—December 31, 2017
 
22,845,580

 
$
228

 
$
229,680

 
$
276,488

 
$
(16,550
)
 
$
489,846

Net income
 

 

 

 
27,302

 

 
27,302

Issuance of shares in settlement of Convertible Notes
 
486,679

 
5

 
(475
)
 

 

 
(470
)
Issuance of restricted stock units in settlement of accrued bonuses
 

 

 
181

 

 

 
181

Compensation expense for equity awards
 

 

 
1,351

 

 

 
1,351

Stock issued under employee incentive plans
 
282,887

 
3

 
697

 

 

 
700

BALANCE— March 31, 2018
 
23,615,146

 
$
236

 
$
231,434

 
$
303,790

 
$
(16,550
)
 
$
518,910


























See accompanying notes to the consolidated financial statements.

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LGI HOMES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
 
 
Three Months Ended March 31,
 
 
2018
 
2017
Cash flows from operating activities:
 
 
 
 
Net income
 
$
27,302

 
$
11,780

Adjustments to reconcile net income to net cash used in operating activities:
 
 
 
 
Depreciation and amortization
 
180

 
211

Loss on extinguishment of debt issuance costs
 
164

 

Compensation expense for equity awards
 
1,351

 
1,230

Deferred income taxes
 
932

 
977

Changes in assets and liabilities:
 
 
 
 
Accounts receivable
 
23,046

 
(95
)
Real estate inventory
 
(120,306
)
 
(70,263
)
Pre-acquisition costs and deposits
 
(5,743
)
 
(911
)
Other assets
 
(3,207
)
 
1,089

Accounts payable
 
13,717

 
7,643

Accrued expenses and other liabilities
 
(48,360
)
 
1,155

Net cash used in operating activities
 
(110,924
)
 
(47,184
)
Cash flows from investing activities:
 
 
 
 
Purchases of property and equipment
 
(153
)
 
(171
)
Net cash used in investing activities
 
(153
)
 
(171
)
Cash flows from financing activities:
 
 
 
 
Proceeds from notes payable
 
110,000

 
25,000

Payments on notes payable
 
(15,038
)
 

Loan issuance costs
 

 
(190
)
Proceeds from sale of stock, net of offering expenses
 
700

 
4,930

Payment for offering costs
 

 
(69
)
Payment for earnout obligation
 
(132
)
 
(186
)
Net cash provided by financing activities
 
95,530

 
29,485

Net decrease in cash and cash equivalents
 
(15,547
)
 
(17,870
)
Cash and cash equivalents, beginning of period
 
67,571

 
49,518

Cash and cash equivalents, end of period
 
$
52,024

 
$
31,648





See accompanying notes to the consolidated financial statements.

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LGI HOMES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1.     ORGANIZATION AND BASIS OF PRESENTATION
Organization and Description of the Business
LGI Homes, Inc., a Delaware corporation (the “Company”, “us,” “we,” or “our”), is engaged in the development of communities and the design, construction and sale of new homes in Texas, Arizona, Florida, Georgia, New Mexico, Colorado, North Carolina, South Carolina, Washington, Tennessee, Minnesota, Oklahoma and Oregon.
Basis of Presentation
The unaudited consolidated financial statements have been prepared in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. These financial statements should be read in conjunction with the consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017. The accompanying unaudited consolidated financial statements include all adjustments that are of a normal recurring nature and necessary for the fair presentation of our results for the interim periods presented. Results for interim periods are not necessarily indicative of results to be expected for the full year.
The accompanying unaudited financial statements as of March 31, 2018, and for the three months ended March 31, 2018 and 2017, include the accounts of the Company and its subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates, and these differences could have a significant impact on the financial statements.
Recently Adopted Accounting Standards
Effective January 1, 2018, we adopted the Financial Accounting Standards Board (the “FASB”) Accounting Standards Update (“ASU”) No. 2016-15, “Statement of Cash Flows - Classification of Certain Cash Receipts and Cash Payments” (“ASU 2016-15”), which addresses specific classification issues and is intended to reduce diversity in current practice regarding the manner in which certain cash receipts and cash payments are presented and classified in the consolidated statements of cash flows. The adoption of ASU 2016-15 did not have a material effect on our consolidated statements of cash flows or disclosures.
Effective January 1, 2018, we adopted the FASB ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“Topic 606”), which provides guidance for revenue recognition. Topic 606 affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets and supersedes the revenue recognition requirements in Topic 605, “Revenue Recognition” (“Topic 605”) and most industry-specific guidance. Topic 606 also supersedes certain cost guidance included in Subtopic 605-35, “Revenue Recognition—Construction-Type and Production-Type Contracts.” Topic 606’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which a company expects to be entitled in exchange for those goods or services. We adopted Topic 606 using the modified retrospective transition method only with respect to contracts not completed at the date of adoption. We have developed the additional expanded disclosures required; however, the adoption of Topic 606 did not have a material effect on our consolidated statements of operations, balance sheets or cash flows. See Note 2 for further details.
Recently Issued Accounting Pronouncements    
In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842)” (“ASU 2016-02”), which amends the existing accounting standards for lease accounting, including requiring lessees to recognize most leases on their balance sheets. ASU 2016-02 will be effective for annual reporting periods beginning after December 15, 2018, and early adoption is permitted. ASU 2016-02 requires a modified retrospective transition approach. As part of our assessment work-to-date, we have formed an implementation work team and we are currently evaluating the impact that the adoption of ASU 2016-02 will have on our consolidated financial statements and disclosures.

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2.     REVENUES
Adoption of Topic 606, "Revenue from Contracts with Customers"
On January 1, 2018, we adopted Topic 606 using the modified retrospective method. The results of applying Topic 606 did not affect our contracts as all contracts were completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts were not adjusted and continue to be reported in accordance with our historic accounting under Topic 605. We did not record any adjustments or net reductions to opening retained earnings as of January 1, 2018 in relation to the adoption of Topic 606.
Revenue Recognition
Revenues from home sales are recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. Revenues from home sales are recorded at the time each home sale is closed, title and possession are transferred to the customer and we have no significant continuing involvement with the home. Proceeds from home sales are generally received from the title company within a few business days after closing. Home sales discounts and incentives granted to customers, which are related to the customers’ closing costs that we pay on the customer’s behalf, are recorded as a reduction of revenue in our consolidated financial statements of operations.
The following table presents our home sales revenues disaggregated by revenue stream (in thousands):
 
 
Three Months Ended March 31,
 
 
2018
 
2017
Retail home sales revenues
 
$
272,038

 
$
161,495

Other
 
6,986

 
1,416

Total home sales revenues
 
$
279,024

 
$
162,911

The following table presents our home sales revenues disaggregated by geography, based on our determined operating segments in Note 13 (in thousands):
 
 
Three Months Ended March 31,
 
 
2018
 
2017
Central
 
$
107,498

 
$
64,918

Southwest
 
54,283

 
33,126

Southeast
 
45,108

 
27,847

Florida
 
42,443

 
24,200

Northwest
 
29,692

 
12,820

Midwest
 

 

Total home sales revenues
 
$
279,024

 
$
162,911

Home Sales Revenues
We generate revenues primarily by delivering move-in ready spec homes with our entry-level and move-up homes sold under our LGI Homes brand and our luxury series homes sold under our Terrata Homes brand.
Retail homes sold under both our LGI Homes brand and Terrata Homes brand focus on providing move-in ready homes with standardized features within favorable markets that meet certain demographic and economic conditions. Our LGI Homes brand primarily markets to entry-level or first-time homebuyers, while our Terrata Homes brand primarily markets to move-up homebuyers.
Our other revenues are composed of our wholesale home sales under our LGI Homes brand in existing communities where we are currently marketing and selling to targeted homebuyers. Wholesale homes are primarily sold under a bulk sales agreement and focus on providing move-in ready homes with standardized features to real estate investors that will ultimately use the single family homes as rental properties.
Performance Obligations
Our contracts with customers include a single performance obligation to transfer a completed home to the customer. We generally determine selling price per home on the expected cost plus margin. Our contracts contain no significant financing terms

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as customers who finance do so through a third party. Performance obligations are satisfied at a moment in time when the home is complete and control of the asset is transferred to the customer at closing. Home sales proceeds are generally received from the title company within a few business days after closing.
Sales and broker commissions are incremental costs incurred to obtain a contract with a customer that would not have been incurred if the contract had not been obtained. Sales and broker commissions are expensed upon fulfillment of a home closing. Advertising costs are costs to obtain a contract that would have been incurred regardless of whether the contract was obtained and are recognized as an expense when incurred. Sales and broker commissions and advertising costs are recorded within sales and marketing expense presented in our consolidated statements of operations as selling expenses.
3.     REAL ESTATE INVENTORY
Our real estate inventory consists of the following (in thousands):
 
 
March 31,
 
December 31,
 
 
2018
 
2017
Land, land under development and finished lots
 
$
542,230

 
$
494,552

Information centers
 
19,508

 
18,327

Homes in progress
 
226,760

 
191,659

Completed homes
 
251,853

 
214,395

Total real estate inventory
 
$
1,040,351

 
$
918,933

Inventory is stated at cost unless the carrying amount is determined not to be recoverable, in which case the affected inventory is written down to fair value.
Land, development and other project costs, including interest and property taxes incurred during development and home construction and net of expected reimbursements of development costs, are capitalized to real estate inventory. Land development and other common costs that benefit the entire community, including field construction supervision and related direct overhead, are allocated to individual lots or homes, as appropriate. The costs of lots are transferred to homes in progress when home construction begins. Home construction costs and related carrying charges are allocated to the cost of individual homes using the specific identification method. Costs that are not specifically identifiable to a home are allocated on a pro rata basis, which we believe approximates the costs that would be determined using an allocation method based on relative sales values since the individual lots or homes within a community are similar in value. Inventory costs for completed homes are expensed to cost of sales as homes are closed. Changes to estimated total development costs subsequent to initial home closings in a community are generally allocated to the remaining unsold lots and homes in the community on a pro rata basis.
The life cycle of a community generally ranges from two to five years, commencing with the acquisition of land, continuing through the land development phase and concluding with the construction and sale of homes. A constructed home is used as the community information center during the life of the community and then sold. Actual individual community lives will vary based on the size of the community, the sales absorption rate and whether the property was purchased as raw land or finished lots.
Interest and financing costs incurred under our debt obligations, as more fully discussed in Note 5, are capitalized to qualifying real estate projects under development and homes under construction.
4.     ACCRUED EXPENSES AND OTHER LIABILITIES
Accrued and other current liabilities consist of the following (in thousands):
 
 
March 31,
 
December 31,
 
 
2018
 
2017
Inventory related obligations
 
$
13,236

 
$
12,906

Taxes payable
 
8,712

 
48,733

Retentions and development payable
 
9,489

 
12,025

Accrued compensation, bonuses and benefits
 
8,559

 
14,462

Accrued interest
 
3,338

 
2,096

Warranty reserve
 
2,600

 
2,450

Other
 
8,555

 
10,159

Total accrued expenses and other liabilities
 
$
54,489

 
$
102,831


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Inventory Related Obligations
We own lots in certain communities in Arizona, California, Florida and Texas that have Community Development Districts (“CDD”) or similar utility and infrastructure development special assessment programs that allocate a fixed amount of debt service associated with development activities to each lot. This obligation for infrastructure development is attached to the land, is typically payable over a 30-year period and is ultimately assumed by the homebuyer when home sales are closed. Such obligations represent a non-cash cost of the lots.
Estimated Warranty Reserve
We typically provide homebuyers with a one-year warranty on the house and a ten-year limited warranty for major defects in structural elements such as framing components and foundation systems.
Changes to our warranty accrual are as follows (in thousands):
 
 
Three Months Ended March 31,
 
 
2018
 
2017
Warranty reserves, beginning of period
 
$
2,450

 
$
1,600

Warranty provision
 
988

 
352

Warranty expenditures
 
(838
)
 
(302
)
Warranty reserves, end of period
 
$
2,600

 
$
1,650

5.     NOTES PAYABLE
Revolving Credit Agreement
On May 25, 2017, we entered into that certain Second Amended and Restated Credit Agreement (the “Credit Agreement”) with several financial institutions, and Wells Fargo Bank, National Association, as administrative agent. The Credit Agreement provides for a $600.0 million revolving credit facility (subject to a borrowing base), which can be increased by our request up to $650.0 million, subject to the terms and conditions of the Credit Agreement.
The Credit Agreement matures on May 31, 2020. 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 equal to or greater than $0.5 million. Prior to nonperformance of certain financial covenants under the Credit Agreement, the revolving credit facility is unsecured. As of March 31, 2018, the borrowing base under the Credit Agreement was $600.0 million, of which borrowings of $510.0 million were outstanding, $6.0 million of letters of credit were outstanding and $84.0 million was available to borrow.
Interest is paid monthly on borrowings under the Credit Agreement at LIBOR plus 3.15%. The Credit Agreement applicable margin for LIBOR loans ranges from 3.00% to 3.50% based on our leverage ratio. At March 31, 2018, LIBOR was 1.80%.
The Credit Agreement contains various financial covenants, including a minimum tangible net worth, a leverage ratio, a minimum liquidity amount and an EBITDA to interest expense ratio. 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 March 31, 2018, we were in compliance with all of the covenants contained in 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. The Convertible Notes mature on November 15, 2019. Interest on the Convertible Notes is payable semiannually in May and November at a rate of 4.25%. Prior to May 15, 2019, the Convertible Notes are convertible only upon satisfaction of any of the specified conversion events. On or after May 15, 2019, the holders of the Convertible Notes can convert their Convertible Notes at any time at their option.
Upon the election of a holder of Convertible Notes to convert their Convertible Notes, we may settle the conversion of the Convertible Notes using any combination of cash and shares of our common stock. It is our intent and belief that we have the ability to settle in cash the conversion of any Convertible Notes that the holders elect to convert. 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.
During the fourth quarter of 2017, we received notice from holders of $15.0 million principal amount of the Convertible Notes to convert their Convertible Notes. The conversion of such Convertible Notes were settled in the first quarter of 2018,

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resulting in the issuance of 486,679 shares of our common stock, a $0.6 million reduction to debt discount and additional paid in capital, a $0.2 million loss on the extinguishment of debt issuance costs and a cash payment of $15.0 million for the principal amount of such Convertible Notes. As of March 31, 2018, we have $70.0 million aggregate principal amount of Convertible Notes outstanding.
During the first quarter of 2018, the Convertible Notes were convertible because the closing sale price of our common stock was greater than 130% of the $21.52 conversion price on at least 20 trading days during the 30 trading day period ending on December 31, 2017. As a result, the holders of the Convertible Notes could elect to convert some or all of their Convertible Notes in accordance with the terms and provisions of the indenture governing the Convertible Notes during the conversion period of January 1, 2018 through March 31, 2018 (inclusive). The Convertible Notes continue to be convertible during the second quarter of 2018. As of the date of the filing of this Quarterly Report on Form 10-Q, no other conversion notices have been received by us.
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.
Notes payable consist of the following (in thousands):
 
 
March 31, 2018
 
December 31, 2017
Notes payable under the Credit Agreement ($600.0 million revolving credit facility at March 31, 2018) maturing on May 31, 2020; interest paid monthly at LIBOR plus 3.15%; net of debt issuance costs of approximately $4.7 million and $5.3 million at March 31, 2018 and December 31, 2017, respectively.
 
$
505,277

 
$
394,714

4.25% Convertible Notes due November 15, 2019; interest paid semi-annually at 4.25%; net of debt issuance costs of approximately $0.7 million and $1.0 million at March 31, 2018 and December 31, 2017, respectively; and approximately $2.8 million and $3.5 million in unamortized discount at March 31, 2018 and December 31, 2017, respectively
 
66,441

 
80,481

Total notes payable
 
$
571,718


$
475,195

Capitalized Interest
Interest activity, including other financing costs, for notes payable for the periods presented is as follows (in thousands):
 
 
Three Months Ended March 31,
 
 
2018
 
2017
Interest incurred
 
$
7,193

 
$
5,074

Less: Amounts capitalized
 
(7,193
)
 
(5,074
)
Interest expense
 
$

 
$

 
 
 
 
 
Cash paid for interest
 
$
5,170

 
$
3,159

Included in interest incurred was amortization of deferred financing costs for notes payable and amortization of Convertible Notes discount of $0.8 million and $0.9 million for the three months ended March 31, 2018 and 2017, respectively.
6.     INCOME TAXES
We file U.S. federal and state income tax returns. As of March 31, 2018, we have no unrecognized tax benefits. We are no longer subject to exam for years before 2014 (2013 for Texas).
For the three months ended March 31, 2018, our effective tax rate of 12.6% is lower than the statutory rate primarily as a result of the deductions in excess of compensation cost (“windfalls”) for share-based payments, offset by the elimination of a credit for the federal Domestic Production Activity Deduction as a result of the newly enacted tax regulation and an increase in rate for state income taxes, net of the federal benefit.
The Securities Exchange Commission (the “SEC”) staff issued Staff Accounting Bulletin 118, which provides guidance on accounting for the tax effects of the U.S. federal income tax legislation signed into law on December 22, 2017, commonly known as the “Tax Cuts and Jobs Act of 2017” (the “Tax Act”) for which the accounting under Accounting Standards Codification (“ASC”) 740 is incomplete. To the extent that a company’s accounting for certain income tax effects of the Tax Act is incomplete but the

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company is able to determine a reasonable estimate, it must record a provisional estimate in the financial statements. If a company cannot determine a provisional estimate to be included in the financial statements, it should continue to apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before enactment of the Tax Act.
As of March 31, 2018, we have completed the majority of our accounting for the tax effects of the Tax Act. However, as there is some uncertainty around the grandfathering provisions related to performance-based executive compensation, we have estimated a provisional amount for deferred tax assets related to performance-based executive compensation. In addition, we also re-measured the applicable deferred tax assets and liabilities based on the rates at which they are expected to reverse. However, we are still analyzing certain aspects of the Tax Act and refining our calculations, which could potentially affect the measurement of these balances or potentially give rise to new deferred tax amounts.
Income taxes paid were $42.9 million and $0.0 million for the three months ended March 31, 2018 and 2017, respectively.
7.     EQUITY
Convertible Notes
During the forth quarter of 2017, we received notice from holders of $15.0 million principal amount of the Convertible Notes to convert their Convertible Notes. The conversion of such Convertible Notes was settled in the first quarter of 2018, resulting in the issuance of 486,679 shares of our common stock, a $0.5 million reduction to additional paid in capital, net of tax and a cash payment of $15.0 million for the principal amount of such Convertible Notes. See the “Convertible Notes” section within Note 5 for further details on this debt obligation.
Shelf Registration Statement and ATM Offering Program
We have an effective shelf registration statement on Form S-3 (the “Registration Statement”), to offer and sell from time to time various securities with a maximum offering price of $300.0 million. In November 2017, we concluded our prior $25.0 million at-the-market common stock offering program (the “2016 ATM Program”) under the Registration Statement. During the three months ended March 31, 2017, we issued and sold 150,000 shares of our common stock under the 2016 ATM Program and received net proceeds of approximately $4.7 million.

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8.     EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per share for the three months ended March 31, 2018 and 2017:
 
 
Three Months Ended March 31,
 
 
2018
 
2017
Numerator (in thousands):
 
 
 
 
Numerator for basic and dilutive earnings per share
 
$
27,302

 
$
11,780

Denominator:
 
 
 
 
       Basic weighted average shares outstanding
 
22,188,121

 
21,360,167

       Effect of dilutive securities:
 
 
 
 
Convertible Notes - treasury stock method
 
2,217,336

 
1,161,326

         Stock-based compensation units
 
366,570

 
266,159

       Diluted weighted average shares outstanding
 
24,772,027

 
22,787,652

 
 
 
 
 
Basic earnings per share
 
$
1.23

 
$
0.55

Diluted earnings per share
 
$
1.10

 
$
0.52

Antidilutive non-vested restricted stock units excluded from calculation of diluted earnings per share
 
25,106

 
49,392

In accordance with ASC 260-10, Earnings Per Share, we calculated the dilutive effect of the Convertible Notes using the treasury stock method, since we have the intent and ability to settle the principal amount of the outstanding Convertible Notes in cash. Under the treasury stock method, the Convertible Notes have a dilutive impact on diluted earnings per share to the extent that the average market price of our common stock for a reporting period exceeds the conversion price of $21.52 per share.
During the three months ended March 31, 2018 and 2017, the average market price of our common stock exceeded the conversion price of $21.52 per share; therefore, the calculation of diluted earnings per share for the three months ended March 31, 2018 and 2017 includes the effect of approximately 2.2 million and 1.2 million shares, respectively, of our common stock related to the conversion spread of the Convertible Notes.
9.    STOCK-BASED COMPENSATION
Non-performance Based Restricted Stock Units
The following table summarizes the activity of our time-vested restricted stock units (“RSUs”):
 
 
Three Months Ended March 31,
 
 
2018
 
2017
 
 
Shares
 
Weighted Average Grant Date Fair Value
 
Shares
 
Weighted Average Grant Date Fair Value
Beginning balance
 
175,100

 
$
27.66

 
133,853

 
$
20.13

   Granted
 
35,048

 
$
64.60

 
61,986

 
$
31.64

   Vested
 
(31,021
)
 
$
30.68

 
(10,719
)
 
$
15.17

   Forfeited
 
(2,611
)
 
$
14.75

 
(406
)
 
$
24.71

Ending balance
 
176,516

 
$
37.22

 
184,714

 
$
24.27

During the three months ended March 31, 2018, we issued 15,867 RSUs to senior management for the time based portion of our 2018 long-term incentive compensation program, 11,780 RSUs for 2017 bonuses to managers under our Annual Bonus Plan and 7,401 RSUs to other employees. Generally, the RSUs cliff vest on the third anniversary of the grant date and can only be settled in shares of our common stock.

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We recognized $0.4 million and $0.3 million of stock-based compensation expense related to outstanding RSUs for the three months ended March 31, 2018 and 2017, respectively. At March 31, 2018, we had unrecognized compensation cost of $4.5 million related to unvested RSUs, which is expected to be recognized over a weighted average period of 2.4 years.
Performance-Based Restricted Stock Units
The Compensation Committee of our Board of Directors has granted awards of Performance-Based RSUs (“PSUs”) under the Amended and Restated LGI Homes, Inc. 2013 Equity Incentive Plan to certain members of senior management based on the three-year performance cycles. The PSUs provide for shares of our common stock to be issued based on the attainment of certain performance metrics over the applicable three-year periods. The number of shares of our common stock that may be issued to the recipients for the PSUs range from 0% to 200% of the target amount depending on actual results as compared to the target performance metrics. The terms of the PSUs provide that the payouts will be capped at 100% of the target number of PSUs granted if absolute total stockholder return is negative during the performance period, regardless of EPS performance; this market condition applies for amounts recorded above target. The compensation expense associated with the PSU grants is determined using the derived grant date fair value, based on a third party valuation analysis, and expensed over the applicable period. The PSUs vest upon the determination date for the actual results at the end of the three-year period and require that the recipients continue to be employed by us through the determination date. The PSUs can only be settled in shares of our common stock.
The following table summarizes the activity of our PSUs for the three months ended March 31, 2018:
Period Granted
 
Performance Period
 
Target PSUs Outstanding at December 31, 2017
 
Target PSUs Granted
 
Target PSUs Vested
 
Target PSUs Forfeited
 
Target PSUs Outstanding at March 31, 2018
 
Weighted Average Grant Date Fair Value
2015
 
2015 - 2017
 
120,971

 

 
(120,971
)
 

 

 
$
13.34

2016
 
2016 - 2018
 
87,605

 

 

 

 
87,605

 
$
21.79

2017
 
2017 - 2019
 
111,035

 

 

 

 
111,035

 
$
31.64

2018
 
2018 - 2020
 

 
61,898

 

 

 
61,898

 
$
64.60

Total
 
 
 
319,611

 
61,898

 
(120,971
)
 

 
260,538

 
 
At March 31, 2018, management estimates that the recipients will receive approximately 141%, 167% and 200% of the 2018, 2017 and 2016 target number of PSUs, respectively, at the end of the applicable three-year performance cycle based on projected performance compared to the target performance metrics. We recognized $0.9 million and $1.0 million of total stock-based compensation expense related to outstanding PSUs for the three months ended March 31, 2018 and 2017, respectively. PSUs granted in 2015 vested on March 15, 2018 at 200% of the target amount, and 241,942 shares of our common stock were issued upon such vesting. At March 31, 2018, we had unrecognized compensation cost of $9.1 million, based on the target amount, related to unvested PSUs, which is expected to be recognized over a weighted average period of 1.2 years.
10.    FAIR VALUE DISCLOSURES
ASC Topic 820, Fair Value Measurements (“ASC 820”), defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date” within an entity’s principal market, if any. The principal market is the market in which the reporting entity would sell the asset or transfer the liability with the greatest volume and level of activity, regardless of whether it is the market in which the entity will ultimately transact for a particular asset or liability or if a different market is potentially more advantageous. Accordingly, this exit price concept may result in a fair value that differs from the transaction price or market price of the asset or liability.
ASC 820 provides a framework for measuring fair value under GAAP, expands disclosures about fair value measurements and establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three levels of the fair value hierarchy are summarized as follows:
Level 1 - Fair value is based on quoted prices in active markets for identical assets or liabilities.
Level 2 - Fair value is determined using significant observable inputs, generally either quoted prices in active markets for
similar assets or liabilities, or quoted prices in markets that are not active.
Level 3 - Fair value is determined using one or more significant inputs that are unobservable in active markets at the
measurement date, such as a pricing model, discounted cash flow or similar technique.
We utilize fair value measurements to account for certain items and account balances within our consolidated financial statements. Fair value measurements may also be utilized on a nonrecurring basis, such as for the impairment of long-lived assets. The fair value of financial instruments, including cash and cash equivalents, accounts receivable and accounts payable, approximate their carrying amounts due to the short term nature of these instruments. As of March 31, 2018, our revolving credit facility’s

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carrying value approximates market value since it has a floating interest rate, which increases or decreases with market interest rates and our leverage ratio.
In order to determine the fair value of the Convertible Notes listed below, the future contractual cash flows are discounted at our estimate of current market rates of interest, which were determined based upon the average interest rates of similar convertible notes within the homebuilding industry (Level 2 measurement).
The following table below shows the level and measurement of liabilities at March 31, 2018 and December 31, 2017 (in thousands):
 
 
 
 
March 31, 2018
 
December 31, 2017
 
 
Fair Value Hierarchy
 
Carrying Value
 
Estimated Fair Value (1)
 
Carrying Value
 
Estimated Fair Value (1)
Convertible Notes
 
Level 2
 
$
66,441

 
$
67,137

 
$
80,481

 
$
81,523

(1)
Excludes the fair value of the equity component of the Convertible Notes. See the “Convertible Notes” section within Note 5 for further details.
11.    RELATED PARTY TRANSACTIONS
Land Purchases from Affiliates
We have a land purchase contract to purchase 106 finished lots in Montgomery County, Texas from an affiliate of a family member of our chief executive officer for a total base purchase price of approximately $8.0 million. The lots are being purchased in takedowns of at least 21 lots during successive six-month periods, subject to 5% annual price escalation and certain price protection terms. We have a $100,000 non-refundable deposit at March 31, 2018 related to this land purchase contract. During the three months ended March 31, 2018 and 2017, the land purchase contract did not have any takedown activity. As of March 31, 2018, we have 22 finished lots remaining under the land purchase contract for a total base purchase price of approximately $1.6 million. The final takedown of 22 lots under this land purchase contract occurred on April 27, 2018 for $1.6 million.
As of March 31, 2018, we have two land purchase contracts to purchase a total of 194 finished lots in Pasco County and Manatee County, Florida from affiliates of one of our directors for a total base purchase price of approximately $6.8 million. The lots will be purchased in takedowns, subject to annual price escalation ranging from 3% to 6% per annum, and may provide for additional payments to the seller at the time of sale to the homebuyer. We have a $0.7 million non-refundable deposit at March 31, 2018 related to these land purchase contracts. We anticipate closing on these contracts in the fourth quarter of 2018.
Home Sales to Affiliates
We had no home closings to affiliates during the three months ended March 31, 2018. During the three months ended March 31, 2017, we closed on three homes sold to an affiliate of one of our directors for approximately $0.7 million.
12.     COMMITMENTS AND CONTINGENCIES
Contingencies
In the ordinary course of doing business, we are subject to claims or proceedings from time to time relating to the purchase, development and sale of real estate and homes and other aspects of our homebuilding operations. Management believes that these claims include usual obligations incurred by real estate developers and residential home builders in the normal course of business. In the opinion of management, these matters will not have a material effect on our consolidated financial position, results of operations or cash flows.
We have provided unsecured environmental indemnities to certain lenders and other counterparties. In each case, we have performed due diligence on the potential environmental risks including obtaining an independent environmental review from outside environmental consultants. These indemnities obligate us to reimburse the guaranteed parties for damages related to environmental matters. There is no term or damage limitation on these indemnities; however, if an environmental matter arises, we may have recourse against other previous owners. In the ordinary course of doing business, we are subject to regulatory proceedings from time to time related to environmental and other matters. In the opinion of management, these matters will not have a material effect on our consolidated financial position, results of operations or cash flows.
Land Deposits
We have land purchase contracts, generally through cash deposits, for the right to purchase land or lots at a future point in time with predetermined terms. We do not have title to the property, and obligations with respect to the land purchase contracts

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are generally limited to the forfeiture of the related nonrefundable cash deposits. The following is a summary of our land purchase deposits included in pre-acquisition costs and deposits (in thousands, except for lot count):
 
 
March 31, 2018
 
December 31, 2017
Land deposits and option payments
 
$
23,007

 
$
17,761

Commitments under the land purchase contracts if the purchases are consummated
 
$
596,770

 
$
460,714

Lots under land purchase contracts
 
22,063

 
18,758

As of March 31, 2018 and December 31, 2017, approximately $11.1 million and $8.4 million of the land deposits are related to purchase contracts to deliver finished lots that are refundable under certain circumstances and secured by mortgages, or letters of credit or guaranteed by the seller or its affiliates.
Bonding and Letters of Credit    
We have outstanding letters of credit and performance and surety bonds totaling $52.4 million (including $6.0 million of letters of credit issued under our revolving credit facility) and $49.7 million at March 31, 2018 and December 31, 2017, respectively, related to our obligations for site improvements at various projects. Management does not believe that draws upon the letters of credit, surety bonds or financial guarantees if any, will have a material effect on our consolidated financial position, results of operations or cash flows.
13.     SEGMENT INFORMATION
Beginning in the fourth quarter of 2017, we changed our reportable segment to Central, Southwest, Southeast, Florida, Northwest and Midwest. These segments reflect the way the Company evaluates its business performance and manages its operations. Prior year information has been restated for corresponding items of our segment information.
We operate one principal homebuilding business that is organized and reports by division. We have six operating segments at March 31, 2018: our Central, Southwest, Southeast, Florida, Northwest and Midwest divisions. The Central division is our largest division and comprised approximately 39% and 40% of total home sales revenues for the three months ended March 31, 2018 and 2017, respectively.
In accordance with ASC Topic 280, Segment Reporting, operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision-makers (“CODMs”) in deciding how to allocate resources and in assessing performance. The CODMs primarily evaluate performance based on the number of homes closed, gross margin and average sales price.
The operating segments qualify as our six reportable segments. In determining the most appropriate reportable segments, we consider operating segments’ economic and other characteristics, including home floor plans, average selling prices, gross margin percentage, geographical proximity, production construction processes, suppliers, subcontractors, regulatory environments, customer type and underlying demand and supply. Each operating segment follows the same accounting policies and is managed by our management team. We have no inter-segment sales, as all sales are to external customers. Operating results for each segment may not be indicative of the results for such segment had it been an independent, stand-alone entity for the periods presented.

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Financial information relating to our reportable segments was as follows (in thousands):
 
 
Three Months Ended March 31,
 
 
2018
 
2017
Revenues:
 
 
 
 
Central
 
$
107,498

 
$
64,918

Southwest
 
54,283

 
33,126

Southeast
 
45,108

 
27,847

Florida
 
42,443

 
24,200

Northwest
 
29,692

 
12,820

Midwest
 

 

Total home sales revenues
 
$
279,024

 
$
162,911

 
 
 
 
 
Net income (loss) before income taxes:
 
 
 
 
Central
 
$
15,818

 
$
8,421

Southwest
 
4,986

 
2,565

Southeast
 
4,327

 
2,314

Florida
 
3,972

 
2,298

Northwest
 
3,057

 
1,368

Midwest
 
(512
)
 
(104
)
Corporate (1)
 
(421
)
 
(20
)
Total net income (loss) before income taxes
 
$
31,227

 
$
16,842

(1)
Balance consists primarily of general and administration unallocated costs for various shared service functions, as well as our warranty reserve. Actual warranty expenses are reflected within the reportable segments.
 
 
March 31, 2018
 
December 31, 2017
Assets:
 
 
 
 
Central
 
$
474,294

 
$
439,833

Southwest
 
190,401

 
175,786

Southeast
 
185,559

 
155,928

Florida
 
115,015

 
119,257

Northwest
 
114,806

 
80,350

Midwest
 
18,679

 
15,066

Corporate (1)
 
72,100

 
93,672

Total assets
 
$
1,170,854

 
$
1,079,892

(1)
Balance consists primarily of cash, pre-acquisition costs, prepaid insurance, security deposits and prepaid expenses.

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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:
Central
 
Southwest
 
Southeast
 
Florida
 
Northwest
 
Midwest
Houston, TX
 
Phoenix, AZ
 
Atlanta, GA
 
Tampa, FL
 
Seattle, WA
 
Minneapolis, MN
Dallas/Ft. Worth, TX
 
Tucson, AZ
 
Charlotte, NC/SC
 
Orlando, FL
 
Portland, OR
 
 
San Antonio, TX
 
Albuquerque, NM
 
Nashville, TN
 
Fort Myers, FL
 
 
 
 
Austin, TX
 
Denver, CO
 
Raleigh, NC
 
Jacksonville, FL
 
 
 
 
Oklahoma City, OK
 
Colorado Springs, CO
 
Winston-Salem, NC
 
 
 
 
 
 
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 23,000 homes. During the three months ended March 31, 2018, we had 1,244 home closings, compared to 761 home closings during the three months ended March 31, 2017.
We sell homes under the LGI Homes and Terrata Homes brands. Our 79 active communities at March 31, 2018 included six Terrata Homes communities.
Recent Developments
During March 2018, we closed on our first home in the Oklahoma City, Oklahoma market.
Key Results
Key financial results as of and for the three months ended March 31, 2018, as compared to the three months ended March 31, 2017, were as follows:
Home sales revenues increased 71.3% to $279.0 million from $162.9 million.
Homes closed increased 63.5% to 1,244 homes from 761 homes.
Average sales price of our homes increased 4.8% to $224,296 from $214,075.
Gross margin as a percentage of home sales revenues decreased to 24.8% from 26.7%.
Adjusted gross margin (non-GAAP) as a percentage of home sales revenues decreased to 26.4% from 28.0%.
Net income before income taxes increased 85.4% to $31.2 million from $16.8 million.
Total owned and controlled lots increased 14.1% to 45,321 lots at March 31, 2018 from 39,709 lots at December 31, 2017.
For a reconciliation of adjusted gross margin (a non-GAAP financial measure) to gross margin, the most directly comparable GAAP financial measure, please see “—Non-GAAP Measures.”

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Results of Operations
The following table sets forth our results of operations for the periods indicated: 
 
 
Three Months Ended March 31,
 
 
2018
 
2017
 
 
(dollars in thousands, except per share data and average home sales price)
Statement of Income Data:
 
 
 
 
Home sales revenues
 
$
279,024

 
$
162,911

Expenses:
 
 
 
 
Cost of sales
 
209,765

 
119,412

Selling expenses
 
22,949

 
16,107

General and administrative
 
15,440

 
11,265

     Operating income
 
30,870

 
16,127

Other income, net
 
(357
)
 
(715
)
     Net income before income taxes
 
31,227

 
16,842

Income tax provision
 
3,925

 
5,062

     Net income
 
$
27,302

 
$
11,780

Basic earnings per share
 
$
1.23

 
$
0.55

Diluted earnings per share
 
$
1.10

 
$
0.52

Other Financial and Operating Data:
 

 

Active communities at end of period
 
79

 
69

Home closings
 
1,244

 
761

Average sales price of homes closed
 
$
224,296

 
$
214,075

Gross margin (1)
 
$
69,259

 
$
43,499

Gross margin % (2)
 
24.8
%
 
26.7
%
Adjusted gross margin (3)
 
$
73,568

 
$
45,609

Adjusted gross margin % (2)(3)
 
26.4
%
 
28.0
%
(1)
Gross margin is home sales revenues less cost of sales.
(2)
Calculated as a percentage of home sales revenues.
(3)
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 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 adjustment, 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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Three Months Ended March 31, 2018 Compared to Three Months Ended March 31, 2017
Homes Sales. Our home sales revenues, closings, average sales price (ASP) and ending community count by division for the three months ended March 31, 2018 and 2017 were as follows (revenues in thousands):
 
 
Three Months Ended March 31,
 
 
2018
 
2017
 
 
Revenues
 
Closings
 
ASP
 
Revenues
 
Closings
 
ASP
Central
 
$
107,498

 
521

 
$
206,330

 
$
64,918

 
315

 
$
206,089

Southwest
 
54,283

 
197

 
275,548

 
33,126

 
132

 
250,955

Southeast
 
45,108

 
229

 
196,978

 
27,847

 
151

 
184,417

Florida
 
42,443

 
209

 
203,077

 
24,200

 
123

 
196,748

Northwest
 
29,692

 
88

 
337,409

 
12,820

 
40

 
320,500

Midwest
 

 

 

 

 

 

Total home sales revenues
 
$
279,024

 
1,244

 
$
224,296

 
$
162,911

 
761

 
$
214,075

 
As of March 31,
Community count
2018
 
2017
Central
29

 
24

Southwest
14

 
17

Southeast
17

 
13

Florida
12

 
11

Northwest
6

 
4

Midwest
1

 

Total community count
79

 
69

Home sales revenues for the three months ended March 31, 2018 were $279.0 million, an increase of $116.1 million, or 71.3%, from $162.9 million for the three months ended March 31, 2017. The increase in home sales revenues is primarily due to a 63.5% increase in homes closed and an increase in the average sales price per home during the three months ended March 31, 2018 as compared to the three months ended March 31, 2017. This increase in home closings was largely due to the overall increase in the number of active communities in the three months ended March 31, 2018 as compared to the three months ended March 31, 2017. The average sales price per home closed during the three months ended March 31, 2018 was $224,296, an increase of $10,221, or 4.8%, from the average sales price per home of $214,075 for the three months ended March 31, 2017. 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 a favorable pricing environment. We continued to diversify our operations outside of our Central division during the first quarter of 2018.  We increased our home sales revenues in our divisions other than our Central division by $73.5 million during the three months ended March 31, 2018 as compared to the three months ended March 31, 2017, representing a 62.1% increase in the number of homes closed in these divisions during the three months ended March 31, 2018 as compared to the three months ended March 31, 2017.  Our active selling communities at March 31, 2018 increased to 79 from 69 at March 31, 2017Five of the ten active selling communities added between March 31, 2017 and March 31, 2018 were outside of our Central division, contributing to the further geographic diversification of our business. All divisions added communities by expanding into new markets or deepening existing markets with the exception of the Southwest division, which had three fewer active communities due to close out or transition between certain of its active communities.
Cost of Sales and Gross Margin (home sales revenues less cost of sales). Cost of sales increased for the three months ended March 31, 2018 to $209.8 million, an increase of $90.4 million, or 75.7%, from $119.4 million for the three months ended March 31, 2017. This increase is primarily due to a 63.5% increase in homes closed during the three months ended March 31, 2018 as compared to the three months ended March 31, 2017, and to a lesser degree, product mix. The increase in average cost of sales per home is primarily due to changes in construction costs associated with product mix and lot costs. Gross margin for the three months ended March 31, 2018 was $69.3 million, an increase of $25.8 million, or 59.2%, from $43.5 million for the three months ended March 31, 2017. Gross margin as a percentage of home sales revenues was 24.8% for the three months ended March 31, 2018 and 26.7% for the three months ended March 31, 2017. This decrease in gross margin as a percentage of home sales revenues is primarily due to a combination of higher construction costs and lot costs partially offset by higher average home sales price for the three months ended March 31, 2018 as compared to the three months ended March 31, 2017, and to a lesser extent due to 31

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wholesale home closings during the three months ended March 31, 2018 compared to seven wholesale home closings during the three months ended March 31, 2017.
Selling Expenses. Selling expenses for the three months ended March 31, 2018 were $22.9 million, an increase of $6.8 million, or 42.5%, from $16.1 million for the three months ended March 31, 2017. Sales commissions increased to $11.1 million for the three months ended March 31, 2018 from $6.5 million for the three months ended March 31, 2017, largely due to a 71.3% increase in home sales revenue during the three months ended March 31, 2018 as compared to the three months ended March 31, 2017. Selling expenses as a percentage of home sales revenues were 8.2% and 9.9% for the three months ended March 31, 2018 and 2017, respectively, and generally reflects operating leverage realized relating to advertising costs.
General and Administrative. General and administrative expenses for the three months ended March 31, 2018 were $15.4 million, an increase of $4.2 million, or 37.1%, from $11.3 million for the three months ended March 31, 2017. The increase in the amount of general and administrative expenses is primarily due to additional general and administrative compensation costs associated with an increase of active communities and home closings during the three months ended March 31, 2018 as compared to the three months ended March 31, 2017. General and administrative expenses as a percentage of home sales revenues were 5.5% and 6.9% for the three months ended March 31, 2018 and 2017, respectively. The decrease in general and administrative expenses as a percentage of home sales revenues reflects leverage realized from the increase in home sales revenues during the three months ended March 31, 2018 as compared to the three months ended March 31, 2017.
Operating Income, Net Income before Income Taxes and Net Income. Operating income for the three months ended March 31, 2018 was $30.9 million, an increase of $14.7 million, or 91.4%, from $16.1 million for the three months ended March 31, 2017. Net income before income taxes for the three months ended March 31, 2018 was $31.2 million, an increase of $14.4 million, or 85.4%, over the three months ended March 31, 2017. Our divisions contributed the following amounts and percentages of net income before income taxes during the three months ended March 31, 2018: Central - $15.8 million or 50.7%; Southwest - $5.0 million or 16.0%; Florida - $4.0 million or 12.7%; Southeast - $4.3 million or 13.9%; and Northwest - $3.1 million or 9.8%. Net income for the three months ended March 31, 2018 was $27.3 million, an increase of $15.5 million, or 131.8%, from $11.8 million for the three months ended March 31, 2017. The increases in operating income, net income before income taxes and net income are primarily attributed to a 63.5% increase in homes closed, a higher average sales price, a decrease in the effective tax rate and improved leverage realized during the three months ended March 31, 2018 as compared to three months ended March 31, 2017.
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.
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 March 31,

 
2018

2017
Home sales revenues
 
$
279,024

 
$
162,911

Cost of sales
 
209,765

 
119,412

Gross margin
 
69,259

 
43,499

Capitalized interest charged to cost of sales
 
4,312

 
2,075

Purchase accounting adjustments (a)
 
(3
)
 
35

Adjusted gross margin
 
$
73,568

 
$
45,609

Gross margin % (b)
 
24.8
%
 
26.7
%
Adjusted gross margin % (b)
 
26.4
%
 
28.0
%
 
(a)
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.

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(b)
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 or less). 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. 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
 
Three Months Ended March 31,
2018 (4)
 
2017 (5)
Net orders (1)
 
1,798

 
1,402

Cancellation rate (2)
 
20.6
%
 
18.9
%
Ending backlog – homes (3)
 
1,370

 
1,087

Ending backlog – value (3)
 
$
357,870

 
$
253,764

(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)
70 units and values related to bulk sales agreements are not included in the table above.
(5)
92 units and values related to bulk sales agreements are not included in the table above.

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Land Acquisition Policies and Development
We increased our active communities to 79 as of March 31, 2018 from 78 as of December 31, 2017. We also increased our lot inventory to 45,321 owned or controlled lots as of March 31, 2018 from 39,709 owned or controlled lots as of December 31, 2017.
The table below shows (i) home closings by division for the three months ended March 31, 2018 and (ii) our owned or controlled lots by division as of March 31, 2018.
 
 
Three Months Ended March 31, 2018
 
As of March 31, 2018
Division
 
Home Closings
 
Owned (1)
 
Controlled
 
Total
Central
 
521

 
12,708

 
9,614

 
22,322

Southwest
 
197

 
3,527

 
1,040

 
4,567

Southeast
 
229

 
3,673

 
8,304

 
11,977

Florida
 
209

 
2,050

 
1,702

 
3,752

Northwest
 
88

 
1,079

 
1,309

 
2,388

Midwest
 

 
221

 
94

 
315

Total
 
1,244

 
23,258

 
22,063

 
45,321

(1)
Of the 23,258 owned lots as of March 31, 2018, 13,229 were raw/under development lots and 10,029 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 March 31, 2018, we had a total of 1,547 completed homes, including information centers, and 1,900 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 regions, 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 of the year. 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 operation 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 March 31, 2018, we had $52.0 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

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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 a business combination.
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.
Under our $300.0 million shelf registration statement on Form S-3, which was declared effective in August 2015, we have the ability to access the debt and equity capital markets as needed as part of our ongoing financing strategy. At March 31, 2018, we have used approximately $55.0 million of the securities registered under the shelf registration statement.
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
In May 2017, we entered into that certain Second Amended and Restated Credit Agreement (the “Credit Agreement”) with several financial institutions, and Wells Fargo Bank, National Association, as administrative agent. The Credit Agreement provides for a revolving credit facility of $600.0 million (subject to a borrowing base), which can be increased upon our request up to $650.0 million in accordance with the terms and conditions of the Credit Agreement. The revolving credit facility matures on May 31, 2020. Before each anniversary of the closing of the Credit Agreement, we may request a one-year extension of the maturity date. Prior to nonperformance of certain financial covenants under the Credit Agreement, the revolving credit facility is unsecured. The Credit Agreement is guaranteed by each of our subsidiaries that have gross assets equal to or greater than $0.5 million.
As of March 31, 2018, the borrowing base under the Credit Agreement was $600.0 million, of which borrowings of $510.0 million were outstanding, $6.0 million of letters of credit were outstanding and the remaining $84.0 million was available to borrow.
The Credit Agreement requires us to maintain (i) a tangible net worth of not less than $300.0 million plus 75% of the net proceeds of all equity issuances after December 31, 2016 plus 50% of the amount of our net income in any fiscal quarter after December 31, 2016, (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 1.0. 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 March 31, 2018, we were in compliance with all of the covenants contained in the Credit Agreement.
Convertible Notes
In November 2014, we issued $85.0 million aggregate principal amount of our 4.25% Convertible Notes due 2019 (the “Convertible Notes”). The Convertible Notes mature on November 15, 2019 and bear interest at a rate of 4.25%, payable semiannually in May and November. Prior to May 15, 2019, the Convertible Notes are convertible only upon satisfaction of any of the specified conversion events. On or after May 15, 2019, the holders of Convertible Notes can convert their Convertible Notes at any time at their option.
Upon the election of a holder of Convertible Notes to convert their Convertible Notes, we may settle the conversion of the Convertible Notes using any combination of cash and shares of our common stock. It is our intent, and belief that we have the ability, to settle in cash the conversion of any Convertible Notes that the holders elect to convert. 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.
During the fourth quarter of 2017, we received notice from holders of $15.0 million principal amount of the Convertible Notes to convert their Convertible Notes. The conversion of such Convertible Notes was settled in the first quarter of 2018, resulting in the issuance of 486,679 shares of our common stock, a $0.6 million reduction to debt discount and additional paid in capital, a $0.2 million loss on the extinguishment of debt issuance costs and a cash payment of $15.0 million for the principal amount of such Convertible Notes. As of March 31, 2018, we have $70.0 million aggregate principal amount of Convertible Notes outstanding.
During the first quarter of 2018, the Convertible Notes were convertible because the closing sale price of our common stock was greater than 130% of the $21.52 conversion price on at least 20 trading days during the 30 trading day period ending on December 31, 2017. As a result, the holders of the Convertible Notes could elect to convert some or all of their Convertible Notes

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in accordance with the terms and provisions of the indenture governing the Convertible Notes during the conversion period of January 1, 2018 through March 31, 2018 (inclusive). The Convertible Notes continue to be convertible during the second quarter of 2018. As of the date of the filing of this Quarterly Report on Form 10-Q, no other conversion notices have been received by us.
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 $52.4 million as of March 31, 2018. 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 March 31, 2018 will be drawn upon.
Cash Flows
Three Months Ended March 31, 2018 Compared to Three Months Ended March 31, 2017
Net cash used in operating activities during the three months ended March 31, 2018 was $110.9 million as compared to $47.2 million during the three months ended March 31, 2017. The $63.7 million increase in net cash used in operating activities was primarily attributable to cash outlays for the $50.0 million increase in the net change in real estate inventory year-over-year, which was primarily related to our increased community count, additional homes under construction and land acquisitions, and to the $43.4 million decrease in accounts payable, accrued expenses and other liabilities, which was primarily related to payment of income taxes. Year-over-year change in net cash provided by working capital items were a $4.8 million increase in cash paid for pre-acquisition costs and deposits and a $4.3 million increase in other assets, offset by the $23.1 million decrease in accounts receivable and a $0.2 million increase in loss on extinguishment of debt issuance costs year-over-year . The increase in cash used in operating activities reflects our continued growth and, to a lesser extent, the timing of home sales and homebuilding activities.
Net cash used in investing activities was $0.2 million during both the three months ended March 31, 2018 and 2017 and reflects the purchase of property and equipment.
Net cash provided by financing activities totaled $95.5 million during the three months ended March 31, 2018, as compared to $29.5 million during the three months ended March 31, 2017. The $66.0 million increase in net cash provided by financing activities in the three months ended March 31, 2018 as compared to the three months ended March 31, 2017 consists primarily of the $70.0 million increase in net borrowings under our revolving credit facility, offset by the $4.2 million decrease in net proceeds realized from the issuance and sale of shares of our common stock.
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 March 31, 2018, we had $23.0 million of cash deposits pertaining to land purchase contracts for 22,063 lots with an aggregate purchase price of $596.8 million. Approximately $11.1 million of the cash deposits as of March 31, 2018 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.

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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
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, 2017.
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.
Revenue Recognition
Effective January 1, 2018, we adopted the FASB ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“Topic 606”), which provides guidance for revenue recognition. Topic 606 affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets and supersedes the revenue recognition requirements in Topic 605, “Revenue Recognition” (“Topic 605”) and most industry-specific guidance. Topic 606 also supersedes certain cost guidance included in Subtopic 605-35, “Revenue Recognition—Construction-Type and Production-Type Contracts.” Topic 606’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which a company expects to be entitled in exchange for those goods or services. We adopted Topic 606 using the modified retrospective transition method only with respect to contracts not completed at the date of adoption. We have developed the additional expanded disclosures required; however, the adoption of Topic 606 did not have a material effect on our consolidated statements of operations, balance sheets or cash flows.
We recognize revenue upon the transfer of promised goods to our customers in an amount that reflects the consideration to which we expect to be entitled by applying the following five-step process specified in Topic 606.
Identify the contract(s) with a customer
Identify the performance obligations
Determine the transaction price
Allocate the transaction price
Recognize revenue when the performance obligations are met
Our contracts with customers include a single performance obligation to transfer a completed home to the customer. We generally determine selling price per home on the expected cost plus margin. Our contracts contain no significant financing terms as customers who finance do so through a third party. Performance obligations are satisfied at a moment in time when the home is complete and control of the asset is transferred to the customer at closing. Home sales proceeds are generally received from the title company within a few business days after closing.
Sales and broker commissions are incremental costs incurred to obtain a contract with a customer that would not have been incurred if the contract had not been obtained. Sales and broker commissions are expensed upon fulfillment of a home closing. Advertising costs are costs to obtain a contract that would have been incurred regardless of whether the contract was obtained and are recognized as an expense when incurred. Sales and broker commissions and advertising costs are recorded within sales and marketing expense presented in our consolidated statements of operations as selling expenses.
With exception of the aforementioned, we believe that there have been no significant changes to our critical accounting policies during the three months ended March 31, 2018 as compared to those disclosed in Managements 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, 2017.

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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:
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;
a slowdown in the homebuilding industry;
volatility and uncertainty in the credit markets and broader financial markets;
the cyclical and seasonal nature of our business;
our future operating results and financial condition;
our business operations;
changes in our business and investment strategy;
the success of our operations in recently opened new markets and our ability to expand into additional new markets;
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;
our ability to develop our projects successfully or within expected timeframes;
our ability to identify potential acquisition targets and close such acquisitions;
our ability to successfully integrate any acquisitions with our existing operations;
availability of land to acquire and our ability to acquire such land on favorable terms or at all;
availability, terms and deployment of capital;
decisions of the lender group of our revolving credit facility;
the occurrence of the specific conversion events that enable early conversion of our 4.25% Convertible Notes due 2019;
decline in the market value of our land portfolio;
disruption in the terms or availability of mortgage financing or increase in the number of foreclosures in our markets;
shortages of or increased prices for labor, land or raw materials used in land development and housing construction;
delays in land development or home construction resulting from natural disasters, adverse weather conditions or other events outside our control;
uninsured losses in excess of insurance limits;
the cost and availability of insurance and surety bonds;
changes in, liabilities under, or the failure or inability to comply with, governmental laws and regulations;
the timing of receipt of regulatory approvals and the opening of projects;
the degree and nature of our competition;
increases in taxes or government fees;
poor relations with the residents of our projects;
future litigation, arbitration or other claims;
availability of qualified personnel and third-party contractors and subcontractors;
our ability to retain our key personnel;
our leverage and future debt service obligations;
the impact on our business of any future government shutdown;
other risks and uncertainties inherent in our business;
other factors we discuss under the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations”; and
the risk factors set forth in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017.
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

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acting on our behalf are expressly qualified in their entirety by the cautionary statements contained in this Quarterly Report on Form 10-Q.


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ITEM 3.         QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our operations are interest rate sensitive. As overall housing demand is adversely affected by increases in interest rates, a significant increase in mortgage interest rates may negatively affect the ability of homebuyers to secure adequate financing. Higher interest rates could adversely affect our revenues, gross margin and net income. We do not enter into, or intend to enter into, derivative financial instruments for trading or speculative purposes.
Quantitative and Qualitative Disclosures About Interest Rate Risk
We utilize both fixed-rate debt ($70.0 million aggregate principal amount of the Convertible Notes as of March 31, 2018 and certain inventory related obligations) and variable-rate debt (our $600.0 million revolving credit facility, which may be increased to $650.0 million in accordance with the terms and conditions of the Credit Agreement) as part of financing our operations. Upon the election of a holder of Convertible Notes to convert their Convertible Notes, we may settle the conversion of the Convertible Notes using any combination of cash and shares of our common stock. Other than as a result of an election of a holder of Convertible Notes to convert their Convertible Notes, we do not have the obligation to prepay the Convertible Notes or our fixed-rate inventory related obligations prior to maturity, and, as a result, interest rate risk and changes in fair market value should not have a significant impact on our fixed-rate debt.
We are exposed to market risks related to fluctuations in interest rates on our outstanding variable rate indebtedness. We did not utilize swaps, forward or option contracts on interest rates or commodities, or other types of derivative financial instruments as of or during the three months ended March 31, 2018. We have not entered into and currently do not hold derivatives for trading or speculative purposes, but we may do so in the future. Many of the statements contained in this section are forward looking and should be read in conjunction with our disclosures under the heading “Cautionary Statement about Forward-Looking Statements” above.
As of March 31, 2018, we had $510.0 million of variable rate indebtedness outstanding under the Credit Agreement. All of the outstanding borrowings under the Credit Agreement are at variable rates based on LIBOR. The interest rate for our variable rate indebtedness as of March 31, 2018 was LIBOR plus 3.15%. At March 31, 2018, LIBOR was 1.80%. A hypothetical 100 basis point increase in the average interest rate on our variable rate indebtedness would increase our annual interest cost by approximately $5.1 million.
Based on the current interest rate management policies we have in place with respect to our outstanding indebtedness, we do not believe that the future interest rate risks related to our existing indebtedness will have a material adverse impact on our financial position, results of operations or liquidity.


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ITEM 4.    CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, management has evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) of the Securities Exchange Act of 1934) as of March 31, 2018. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure information is recorded, processed, summarized and reported within the periods specified in the Securities and Exchange Commission’s rules and forms and is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error and mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management’s override of controls.
The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, a control may become inadequate because of changes in conditions or because the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and may not be detected.
Changes in Internal Controls
No change in our internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f) occurred during the three months ended March 31, 2018 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION
ITEM 6.         EXHIBITS
Exhibit No.
 
  Description  
3.1**
 
3.2**
 
31.1*
 
31.2*
 
32.1*
 
32.2*
 
101.INS†
 
XBRL Instance Document.
101.SCH†
 
XBRL Taxonomy Extension Schema Document.
101.CAL†
 
XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF†
 
XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB†
 
XBRL Taxonomy Extension Label Linkbase Document.
101.PRE†
 
XBRL Taxonomy Extension Presentation Linkbase Document.
*
Filed herewith.
**
Previously filed.
XBRL information is deemed not filed or a part of a registration statement or Annual Report for purposes of Sections 11 and 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under such sections.


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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 
 
LGI Homes, Inc.
 
 
 
Date:
May 8, 2018
/s/    Eric Lipar
 
 
Eric Lipar
 
 
Chief Executive Officer and Chairman of the Board
 
 
 
 
May 8, 2018
/s/    Charles Merdian
 
 
Charles Merdian
 
 
Chief Financial Officer and Treasurer



Exhibit


EXHIBIT 31.1
CEO CERTIFICATION
PURSUANT TO SECTION 302 OF THE
SARBANES - OXLEY ACT OF 2002
I, Eric Lipar, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q of LGI Homes, Inc. (the “Registrant”);
2. Based on my knowledge, this Quarterly Report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this Quarterly Report;
3. Based on my knowledge, the financial statements, and other financial information included in this Quarterly Report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this report;
4. The Registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in the Exchange Act Rules 13a-15(f) and 15(d)-15(f)) for the Registrant and have:
a.
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this Quarterly Report is being prepared;
b.
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c.
Evaluated the effectiveness of the Registrant’s disclosure controls and procedures and presented in this Quarterly Report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this Quarterly Report based on such evaluation; and
d.
Disclosed in this report any change in the Registrant’s internal control over financial reporting that occurred during the Registrant’s most recent fiscal quarter (the Registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Registrant’s internal control over financial reporting; and
5. The Registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant’s auditors and the audit committee of Registrant’s Board of Directors (or persons performing the equivalent functions):
a.
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant’s ability to record, process, summarize and report financial information; and
b.
Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant’s internal control over financial reporting.
Date: May 8, 2018
By: 
 /s/ Eric Lipar
   
Eric Lipar
   
Chief Executive Officer and Chairman of the Board
   
LGI Homes, Inc.


Exhibit


EXHIBIT 31.2
CFO CERTIFICATION
PURSUANT TO SECTION 302 OF THE
SARBANES - OXLEY ACT OF 2002
I, Charles Merdian, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q of LGI Homes, Inc. (the “Registrant”);
2. Based on my knowledge, this Quarterly Report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this Quarterly Report;
3. Based on my knowledge, the financial statements, and other financial information included in this Quarterly Report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this report;
4. The Registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in the Exchange Act Rules 13a-15(f) and 15(d)-15(f)) for the Registrant and have:
a.
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this Quarterly Report is being prepared;
b.
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c.
Evaluated the effectiveness of the Registrant’s disclosure controls and procedures and presented in this Quarterly Report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this Quarterly Report based on such evaluation; and
d.
Disclosed in this report any change in the Registrant’s internal control over financial reporting that occurred during the Registrant’s most recent fiscal quarter (the Registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Registrant’s internal control over financial reporting; and
5. The Registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant’s auditors and the audit committee of Registrant’s Board of Directors (or persons performing the equivalent functions):
a.
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant’s ability to record, process, summarize and report financial information; and
b.
Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant’s internal control over financial reporting.
Date: May 8, 2018
By: 
 /s/ Charles Merdian
   
Charles Merdian
   
Chief Financial Officer and Treasurer
   
LGI Homes, Inc.


Exhibit


EXHIBIT 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of LGI Homes, Inc. (the “Company”) on Form 10-Q for the quarterly period ended March 31, 2018 as filed with the Securities and Exchange Commission on the date hereof (the “Quarterly Report”), I, Eric Lipar, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:
1.
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and
2.
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
May 8, 2018
 /s/ Eric Lipar
   
Eric Lipar
   
Chief Executive Officer and Chairman of the Board
   
LGI Homes, Inc.



Exhibit


EXHIBIT 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of LGI Homes, Inc. (the “Company”) on Form 10-Q for the quarterly period ended March 31, 2018 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Charles Merdian, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:
1.
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and
2.
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
May 8, 2018
 /s/ Charles Merdian
   
Charles Merdian
   
Chief Financial Officer and Treasurer
   
LGI Homes, Inc.