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 June 30, 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 every Interactive Data File required to be submitted 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 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  ¨


 
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 August 3, 2018, there were 22,632,991 shares of the registrant’s common stock, par value $.01 per share, outstanding.


Table of Contents

TABLE OF CONTENTS
   



 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


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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)
 
 
 
June 30,
 
December 31,
 
 
2018
 
2017
ASSETS
 

 
 
Cash and cash equivalents
 
$
48,886

 
$
67,571

Accounts receivable
 
31,746

 
44,706

Real estate inventory
 
1,062,696

 
918,933

Pre-acquisition costs and deposits
 
29,562

 
18,866

Property and equipment, net
 
1,675

 
1,674

Other assets
 
11,168

 
14,196

Deferred tax assets, net
 
2,168

 
1,928

Goodwill
 
12,018

 
12,018

Total assets
 
$
1,199,919

 
$
1,079,892

 
 
 
 
 
LIABILITIES AND EQUITY
 
 
 
 
Accounts payable
 
$
19,893

 
$
12,020

Accrued expenses and other liabilities
 
56,805

 
102,831

Notes payable
 
554,539

 
475,195

Total liabilities
 
631,237

 
590,046

 
 
 
 
 
COMMITMENTS AND CONTINGENCIES
 

 

EQUITY
 
 
 
 
Common stock, par value $0.01, 250,000,000 shares authorized, 23,632,991 shares issued and 22,632,991 shares outstanding as of June 30, 2018 and 22,845,580 shares issued and 21,845,580 shares outstanding as of December 31, 2017
 
236

 
228

Additional paid-in capital
 
233,598

 
229,680

Retained earnings
 
351,398

 
276,488

Treasury stock, at cost, 1,000,000 shares
 
(16,550
)
 
(16,550
)
Total equity
 
568,682

 
489,846

Total liabilities and equity
 
$
1,199,919

 
$
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 June 30,
 
Six Months Ended June 30,
 
 
2018
 
2017
 
2018
 
2017
Home sales revenues
 
$
419,847

 
$
324,178

 
$
698,871

 
$
487,089

 
 
 
 
 
 
 
 
 
Cost of sales
 
310,082

 
237,830

 
519,847

 
357,242

Selling expenses
 
29,301

 
24,193

 
52,250

 
40,300

General and administrative
 
18,302

 
13,680

 
33,742

 
24,945

   Operating income
 
62,162

 
48,475

 
93,032

 
64,602

Other income, net
 
(509
)
 
(167
)
 
(866
)
 
(882
)
Net income before income taxes
 
62,671

 
48,642

 
93,898

 
65,484

Income tax provision
 
15,063

 
16,443

 
18,988

 
21,505

Net income
 
$
47,608

 
$
32,199

 
$
74,910

 
$
43,979

Earnings per share:
 
 
 
 
 
 
 
 
Basic
 
$
2.11

 
$
1.49

 
$
3.34

 
$
2.05

Diluted
 
$
1.90

 
$
1.39

 
$
3.01

 
$
1.91

 
 

 
 
 
 
 
 
Weighted average shares outstanding:
 
 
 
 
 
 
 
 
Basic
 
22,616,085

 
21,602,261

 
22,403,266

 
21,481,842

Diluted
 
25,000,647

 
23,242,589

 
24,884,628

 
23,032,648




















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
 

 

 

 
74,910

 

 
74,910

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
 

 

 
2,770

 

 

 
2,770

Stock issued under employee incentive plans
 
300,732

 
3

 
1,442

 

 

 
1,445

BALANCE— June 30, 2018
 
23,632,991

 
$
236

 
$
233,598

 
$
351,398

 
$
(16,550
)
 
$
568,682


























See accompanying notes to the consolidated financial statements.

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LGI HOMES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
 
 
Six Months Ended June 30,
 
 
2018
 
2017
Cash flows from operating activities:
 
 
 
 
Net income
 
$
74,910

 
$
43,979

Adjustments to reconcile net income to net cash used in operating activities:
 
 
 
 
Depreciation and amortization
 
366

 
406

Loss on extinguishment of debt
 
530

 

Compensation expense for equity awards
 
2,770

 
1,580

Deferred income taxes
 
(95
)
 
(631
)
Changes in assets and liabilities:
 
 
 
 
Accounts receivable
 
12,960

 
(17,082
)
Real estate inventory
 
(143,449
)
 
(116,654
)
Pre-acquisition costs and deposits
 
(10,696
)
 
(2,793
)
Other assets
 
3,028

 
(822
)
Accounts payable
 
7,873

 
6,730

Accrued expenses and other liabilities
 
(43,867
)
 
17,625

Net cash used in operating activities
 
(95,670
)
 
(67,662
)
Cash flows from investing activities:
 
 
 
 
Purchases of property and equipment
 
(367
)
 
(323
)
Net cash used in investing activities
 
(367
)
 
(323
)
Cash flows from financing activities:
 
 
 
 
Proceeds from notes payable
 
120,000

 
60,000

Payments on notes payable
 
(40,038
)
 
(15,000
)
Loan issuance costs
 
(3,923
)
 
(4,359
)
Proceeds from sale of stock, net of offering expenses
 
1,445

 
5,503

Payment for offering costs
 

 
(69
)
Payment for earnout obligation
 
(132
)
 
(308
)
Net cash provided by financing activities
 
77,352

 
45,767

Net decrease in cash and cash equivalents
 
(18,685
)
 
(22,218
)
Cash and cash equivalents, beginning of period
 
67,571

 
49,518

Cash and cash equivalents, end of period
 
$
48,886

 
$
27,300





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, Alabama, California 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 June 30, 2018, and for the three and six months ended June 30, 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. Under ASU 2016-02, a lessee will be required to recognize assets and liabilities for leases with lease terms of more than twelve months. Lessor accounting remains substantially similar to current GAAP. In addition, disclosures of leasing activities will be expanded to include qualitative and specific quantitative information. 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 identified non-cancelable operating leases primarily associated with office facilities, real estate and office equipment. We believe the recognition of new right-of-use assets

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and lease liabilities will be the most significant change for us under ASU 2016-02. We are in the process of identifying and implementing appropriate changes to our business processes, systems and controls to support the adoption and disclosures required under ASU 2016-02.
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 June 30,
 
Six Months Ended June 30,
 
 
2018
 
2017
 
2018
 
2017
Retail home sales revenues
 
$
392,320

 
$
310,188

 
$
664,358

 
$
471,683

Other
 
27,527

 
13,990

 
34,513

 
15,406

Total home sales revenues
 
$
419,847

 
$
324,178

 
$
698,871

 
$
487,089

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 June 30,
 
Six Months Ended June 30,
 
 
2018
 
2017
 
2018
 
2017
Central
 
$
181,268

 
$
139,762

 
$
288,766

 
$
204,680

Southwest
 
73,030

 
63,258

 
127,313

 
96,384

Southeast
 
60,369

 
51,487

 
105,477

 
79,334

Florida
 
55,018

 
48,974

 
97,461

 
73,174

Northwest
 
49,463

 
20,697

 
79,155

 
33,517

Midwest
 
699

 

 
699

 

Total home sales revenues
 
$
419,847

 
$
324,178

 
$
698,871

 
$
487,089

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 markets. 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.

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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 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):
 
 
June 30,
 
December 31,
 
 
2018
 
2017
Land, land under development and finished lots
 
$
582,872

 
$
494,552

Information centers
 
19,974

 
18,327

Homes in progress
 
212,674

 
191,659

Completed homes
 
247,176

 
214,395

Total real estate inventory
 
$
1,062,696

 
$
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.

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4.     ACCRUED EXPENSES AND OTHER LIABILITIES
Accrued and other current liabilities consist of the following (in thousands):
 
 
June 30,
 
December 31,
 
 
2018
 
2017
Inventory related obligations
 
$
11,060

 
$
12,906

Taxes payable
 
3,917

 
48,733

Retentions and development payable
 
16,092

 
12,025

Accrued compensation, bonuses and benefits
 
9,771

 
14,462

Accrued interest
 
2,647

 
2,096

Warranty reserve
 
2,800

 
2,450

Other
 
10,518

 
10,159

Total accrued expenses and other liabilities
 
$
56,805

 
$
102,831

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 June 30,
 
Six Months Ended June 30,
 
 
2018
 
2017
 
2018
 
2017
Warranty reserves, beginning of period
 
$
2,600

 
$
1,650

 
$
2,450

 
$
1,600

Warranty provision
 
695

 
847

 
1,683

 
1,199

Warranty expenditures
 
(495
)
 
(647
)
 
(1,333
)
 
(949
)
Warranty reserves, end of period
 
$
2,800

 
$
1,850

 
$
2,800

 
$
1,850

5.     NOTES PAYABLE
Revolving Credit Agreement
On May 25, 2018, we entered into that certain Third Amended and Restated Credit Agreement with several financial institutions, and Wells Fargo Bank, National Association, as administrative agent, which was amended as of June 19, 2018 by that certain First Amendment thereto (the “First Amendment”; such credit agreement, as amended by the First Amendment, the “Credit Agreement”). The Credit Agreement has substantially similar terms and provisions to our second amended and restated credit agreement entered into in May 2017 with several financial institutions, and Wells Fargo Bank, National Association, as administrative agent (the “2017 Credit Agreement”) but, among other things, provides for an increase of the revolving credit facility from $600.0 million to $750.0 million (which was reduced in July 2018 upon issuance of the Senior Notes (as defined herein) to $450.0 million; see Note 14 for further details), which could be increased at our request by up to $50.0 million if the lenders make additional commitments, subject to the terms and conditions of the Credit Agreement.
The Credit Agreement matures on May 31, 2021. 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. The revolving credit facility is currently unsecured, but we have agreed to provide collateral if we fail to meet certain financial conditions in the future. As of June 30, 2018, the borrowing base under the Credit Agreement was $677.4 million, of which borrowings of $495.0 million were outstanding, $10.1 million of letters of credit were outstanding and $172.3 million was available to borrow.

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Interest is paid monthly on borrowings under the Credit Agreement at LIBOR plus 2.90%. The Credit Agreement applicable margin for LIBOR loans ranges from 2.65% to 3.25% based on our leverage ratio. At June 30, 2018, LIBOR was 2.07%.
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 June 30, 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 pursuant to an exemption from the registration requirements afforded by Section 4(a)(2) of the Securities Act of 1933, as amended (the “Securities Act”). The Convertible Notes mature on November 15, 2019. Interest on the Convertible Notes is payable semi-annually in arrears on May 15 and November 15 of each year at a rate of 4.25%. When the Convertible Notes were issued, the fair value of $76.5 million was recorded to notes payable. $5.5 million of the remaining proceeds was recorded to additional paid in capital to reflect the equity component and the remaining $3.0 million was recorded as a deferred tax liability. The carrying amount of the Convertible Notes is being accreted to face value over the term to maturity.
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, 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 and a cash payment of $15.0 million for the principal amount of such Convertible Notes. As of June 30, 2018, we have $70.0 million aggregate principal amount of Convertible Notes outstanding.
During the second 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 March 31, 2018. 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 April 1, 2018 through June 30, 2018 (inclusive). The Convertible Notes continue to be convertible during the third 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.
On July 6, 2018, concurrently with the offering of the Senior Notes, we entered into that certain First Supplemental Indenture, dated as of July 6, 2018, among us, our subsidiaries that guarantee our obligations under our revolving credit facility (the “Subsidiary Guarantors”) and Wilmington Trust, National Association, as trustee, which supplements the indenture governing the Convertible Notes, pursuant to which (i) the subordination provisions in the indenture governing the Convertible Notes were eliminated, (ii) each Subsidiary Guarantor agreed (A) to, concurrently with the issuance of the Senior Notes, fully and unconditionally guarantee the Convertible Notes to the same extent that such Subsidiary Guarantor is guaranteeing the Senior Notes and (B) that such Subsidiary Guarantor’s guarantee of the Convertible Notes ranks equally with such Subsidiary Guarantor’s guarantee of the Senior Notes and (iii) the Company agreed to not, directly or indirectly, incur any indebtedness in the form of, or otherwise become liable in respect of, any notes or other debt securities issued pursuant to an indenture or note purchase agreement (including the Senior Notes) unless such indebtedness is equal with or contractually subordinated to the Convertible Notes in right of payment.

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Notes payable consist of the following (in thousands):
 
 
June 30, 2018
 
December 31, 2017
Notes payable under the Credit Agreement ($750.0 million revolving credit facility at June 30, 2018) maturing on May 31, 2021; interest paid monthly at LIBOR plus 2.90%; net of debt issuance costs of approximately $7.7 million and $5.3 million at June 30, 2018 and December 31, 2017, respectively
 
$
487,304

 
$
394,714

4.25% Convertible Notes due November 15, 2019; interest paid semi-annually at 4.25%; net of debt issuance costs of approximately $0.6 million and $1.0 million at June 30, 2018 and December 31, 2017, respectively; and approximately $2.1 million and $3.5 million in unamortized discount at June 30, 2018 and December 31, 2017, respectively
 
67,235

 
80,481

Total notes payable
 
$
554,539


$
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 June 30,
 
Six Months Ended June 30,
 
 
2018
 
2017
 
2018
 
2017
Interest incurred
 
$
8,787

 
$
6,028

 
$
15,980

 
$
11,102

Less: Amounts capitalized
 
(8,787
)
 
(6,028
)
 
(15,980
)
 
(11,102
)
Interest expense
 
$

 
$

 
$

 
$

 
 
 
 
 
 
 
 
 
Cash paid for interest
 
$
8,100

 
$
5,752

 
$
13,269

 
$
8,911

Included in interest incurred was amortization of deferred financing costs for notes payable and amortization of Convertible Notes discount of $1.4 million and $1.0 million for the three months ended June 30, 2018 and 2017, respectively, and $2.2 million and $1.8 million for the six months ended June 30, 2018 and 2017, respectively.
6.     INCOME TAXES
We file U.S. federal and state income tax returns. As of June 30, 2018, we have no unrecognized tax benefits. We are no longer subject to exam for years before 2014 (2013 for Texas).
For the six months ended June 30, 2018, our effective tax rate of 20.2% is lower than the Federal statutory rate primarily as a result of the deductions in excess of compensation cost (“windfalls”) for share-based payments, offset by an increase in rate for state income taxes, net of the federal benefit payments.
The Securities and 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 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 June 30, 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.
During the three months ended June 30, 2018, the Internal Revenue Service (“IRS”) commenced an examination of the Company’s U.S. income tax return for 2016 that is anticipated to be completed in early 2019. As of June 30, 2018, the IRS has not proposed any adjustments to our tax positions.
Income taxes paid were $20.8 million and $14.7 million for the three months ended June 30, 2018 and 2017, respectively. Income taxes paid were $63.7 million and $14.7 million for the six months ended June 30, 2018 and 2017, respectively.

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7.     EQUITY
Convertible Notes
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 $0.5 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. As of the date of the filing of this Quarterly Report on Form 10-Q, no other conversion notices have been received by us. 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 and six months ended June 30, 2017, we issued and sold 4,990 and 154,990 shares of our common stock, respectively, under the 2016 ATM Program and received net proceeds of approximately $0.2 million and $4.8 million, respectively.
8.     EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per share for the three and six months ended June 30, 2018 and 2017:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2018
 
2017
 
2018
 
2017
Numerator (in thousands):
 
 
 
 
 
 
 
 
Numerator for basic and dilutive earnings per share
 
$
47,608

 
$
32,199

 
$
74,910

 
$
43,979

Denominator:
 
 
 
 
 
 
 
 
       Basic weighted average shares outstanding
 
22,616,085

 
21,602,261

 
22,403,266

 
21,481,842

       Effect of dilutive securities:
 
 
 
 
 
 
 
 
Convertible Notes - treasury stock method
 
2,166,333

 
1,417,163

 
2,191,836

 
1,296,413

         Stock-based compensation units
 
218,229

 
223,165

 
289,526

 
254,393

       Diluted weighted average shares outstanding
 
25,000,647

 
23,242,589

 
24,884,628

 
23,032,648

 
 
 
 
 
 
 
 
 
Basic earnings per share
 
$
2.11

 
$
1.49

 
$
3.34

 
$
2.05

Diluted earnings per share
 
$
1.90

 
$
1.39

 
$
3.01

 
$
1.91

Antidilutive non-vested restricted stock units excluded from calculation of diluted earnings per share
 
2,871

 
3,758

 
13,118

 
23,089

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 and six months ended June 30, 2018 and 2017, the average market price of our common stock exceeded the conversion price of $21.52 per share. Included in the calculation of diluted earnings per share was the effect of approximately 2.2 million and 1.4 million shares of our common stock related to the conversion spread of the Convertible Notes for the three months ended June 30, 2018 and 2017, respectively, and 2.2 million and 1.3 million shares of our common stock related to the conversion spread of the Convertible Notes for the six months ended June 30, 2018 and 2017, respectively.

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9.    STOCK-BASED COMPENSATION
Non-performance Based Restricted Stock Units
The following table summarizes the activity of our time-vested restricted stock units (“RSUs”):
 
 
Six Months Ended June 30,
 
 
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
 
38,546

 
$
64.06

 
65,869

 
$
31.96

   Vested
 
(35,968
)
 
$
15.51

 
(11,269
)
 
$
15.32

   Forfeited
 
(4,993
)
 
$
33.79

 
(6,419
)
 
$
20.28

Ending balance
 
172,685

 
$
38.14

 
182,034

 
$
24.70

During the six months ended June 30, 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 10,899 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.
We recognized $0.5 million and $0.3 million of stock-based compensation expense related to outstanding RSUs for the three months ended June 30, 2018 and 2017, respectively. We recognized $0.9 million and $0.6 million of stock-based compensation expense related to outstanding RSUs for the six months ended June 30, 2018 and 2017, respectively. At June 30, 2018, we had unrecognized compensation cost of $4.1 million related to unvested RSUs, which is expected to be recognized over a weighted average period of 2.2 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 six months ended June 30, 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 June 30, 2018
 
Weighted Average Grant Date Fair Value
2015
 
2015 - 2017
 
120,971

 

 
(120,971
)
 

 

 
$
13.34

2016
 
2016 - 2018
 
87,605

 

 

 
(3,929
)
 
83,676

 
$
21.79

2017
 
2017 - 2019
 
111,035

 

 

 
(2,788
)
 
108,247

 
$
31.64

2018
 
2018 - 2020
 

 
61,898

 

 

 
61,898

 
$
64.60

Total
 
 
 
319,611

 
61,898

 
(120,971
)
 
(6,717
)
 
253,821

 
 
At June 30, 2018, management estimates that the recipients will receive approximately 139%, 179% 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 $0.1 million of total stock-based compensation expense related to outstanding PSUs for the three months ended June 30, 2018 and 2017, respectively. We recognized

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$1.8 million and $1.9 million of total stock-based compensation expense related to outstanding PSUs for the six months ended June 30, 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 June 30, 2018, we had unrecognized compensation cost of $8.0 million, based on the target amount, related to unvested PSUs, which is expected to be recognized over a weighted average period of 1.0 year.
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 June 30, 2018, our revolving credit facility’s 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 June 30, 2018 and December 31, 2017 (in thousands):
 
 
 
 
June 30, 2018
 
December 31, 2017
 
 
Fair Value Hierarchy
 
Carrying Value
 
Estimated Fair Value (1)
 
Carrying Value
 
Estimated Fair Value (1)
Convertible Notes
 
Level 2
 
$
67,235

 
$
67,785

 
$
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
In April 2018, we completed our commitments under 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 were purchased in takedowns of at least 21 lots during successive six-month periods, subject to 5% annual price escalation and certain price protection terms. During the three and six months ended June 30, 2018, we purchased the final takedown of 22 lots under this land purchase contract for $1.8 million and a $100,000 non-refundable deposit related to this land purchase contract was applied to this takedown. During the three and six months ended June 30, 2017, we purchased 21 lots under this land purchase contract for $1.7 million.
As of June 30, 2018, we have two land purchase contracts to purchase a total of 198 finished lots in Pasco County and Manatee County, Florida from affiliates of one of our directors for a total base purchase price of approximately $6.9 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 June 30,

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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 and six months ended June 30, 2018 or the three months ended June 30, 2017. During the six months ended June 30, 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 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):
 
 
June 30, 2018
 
December 31, 2017
Land deposits and option payments
 
$
27,870

 
$
17,761

Commitments under the land purchase contracts if the purchases are consummated
 
$
665,398

 
$
460,714

Lots under land purchase contracts
 
22,296

 
18,758

As of June 30, 2018 and December 31, 2017, approximately $12.7 million and $8.4 million, respectively, 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 $60.7 million (including $10.1 million of letters of credit issued under our revolving credit facility) and $49.7 million at June 30, 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 June 30, 2018: our Central, Southwest, Southeast, Florida, Northwest and Midwest divisions. The Central division is our largest division and comprised approximately 41% and 42% of total home sales revenues for the six months ended June 30, 2018 and 2017, respectively.

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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.
Financial information relating to our reportable segments was as follows (in thousands):
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2018
 
2017
 
2018
 
2017
Revenues:
 
 
 
 
 
 
 
 
Central
 
$
181,268

 
$
139,762

 
$
288,766

 
$
204,680

Southwest
 
73,030

 
63,258

 
127,313

 
96,384

Southeast
 
60,369

 
51,487

 
105,477

 
79,334

Florida
 
55,018

 
48,974

 
97,461

 
73,174

Northwest
 
49,463

 
20,697

 
79,155

 
33,517

Midwest
 
699

 

 
699

 

Total home sales revenues
 
$
419,847

 
$
324,178

 
$
698,871

 
$
487,089

 
 
 
 
 
 
 
 
 
Net income (loss) before income taxes:
 
 
 
 
 
 
 
 
Central
 
$
34,225

 
$
26,000

 
$
50,043

 
$
34,421

Southwest
 
10,189

 
8,612

 
15,175

 
11,177

Southeast
 
7,599

 
6,606

 
11,926

 
8,920

Florida
 
7,585

 
6,494

 
11,557

 
8,792

Northwest
 
5,793

 
2,444

 
8,850

 
3,812

Midwest
 
(688
)
 
(123
)
 
(1,200
)
 
(227
)
Corporate (1)
 
(2,032
)
 
(1,391
)
 
(2,453
)
 
(1,411
)
Total net income (loss) before income taxes
 
$
62,671

 
$
48,642

 
$
93,898

 
$
65,484

(1)
The Corporate 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.
 
 
June 30, 2018
 
December 31, 2017
Assets:
 
 
 
 
Central
 
$
495,185

 
$
439,833

Southwest
 
188,939

 
175,786

Southeast
 
204,101

 
155,928

Florida
 
105,883

 
119,257

Northwest
 
130,574

 
80,350

Midwest
 
20,749

 
15,066

Corporate (1)
 
54,488

 
93,672

Total assets
 
$
1,199,919

 
$
1,079,892

(1)
As of June 30, 2018, the Corporate balance consists primarily of cash, prepaid insurance, and prepaid expenses. As of December 31, 2017, the Corporate balance consists primarily of cash, deposits and pre-acquisition costs, prepaid insurance, and prepaid expenses. $18.9 million of deposits and pre-acquisition costs were reported at Corporate as of December 31,2017 and balances as of June 30, 2018 were allocated to the six reportable segments.

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14.     SUBSEQUENT EVENTS
Senior Notes Offering
On July 6, 2018, we issued $300.0 million aggregate principal amount of our 6.875% Senior Notes due 2026 (the “Senior Notes”) in an offering to persons reasonably believed to be qualified institutional buyers in the United States pursuant to Rule 144A under the Securities Act and to certain non-U.S. persons in transactions outside the United States pursuant to Regulation S under the Securities Act. Interest on the Senior Notes accrues at a rate of 6.875% per annum, payable semi-annually in arrears on January 15 and July 15 of each year, commencing on January 15, 2019 and maturing on July 15, 2026. Terms of the Senior Notes are governed by an indenture, dated July 6, 2018, among us, the Subsidiary Guarantors and Wilmington Trust, National Association, as trustee.
We received net proceeds from the offering of the Senior Notes of approximately $296.2 million, after deducting the initial purchasers’ discounts and commissions and offering expenses. The net proceeds from the offering were used to repay a portion of the borrowings under the Credit Agreement. The impact of the offering of the Senior Notes will be recorded in the third quarter of 2018.
In connection with the issuance of the Senior Notes, we reduced the revolving commitment under the Credit Agreement from $750.0 million to $450.0 million pursuant to the First Amendment. We expect to record approximately $3.1 million in debt extinguishment costs related to the Credit Agreement during the third quarter of 2018.
Wynn Acquisition
On August 2, 2018, we acquired certain real estate assets owned by Wynn Homes and its affiliates for a purchase price of approximately $80.0 million, subject to certain post-closing adjustments. We paid the cash closing payment of $74.3 million using cash on hand and borrowings under our revolving credit facility. We acquired approximately 200 homes under construction and approximately 4,000 owned and controlled lots in central and eastern North Carolina, assumed certain land acquisition and land development contracts of Wynn Homes and acquired certain tangible and intangible assets. As a portion of the purchase price, we will issue to the owner of Wynn Homes, within 30 days after August 2, 2018, subject to the owner of Wynn Homes meeting certain requirements, a number of unregistered shares of our common stock equal to (i) $4,000,000 divided by (ii) the lesser of (a) the average of the closing sale price of our common stock for each of the ten trading days immediately prior to the date of August 2, 2018, or (b) the average of the closing sale price of our common stock for each of the five trading days immediately following August 7, 2018. Additionally, the acquisition provides that, in the event that we acquire certain specified developed or undeveloped real property following the August 2, 2018 acquisition date, we shall pay to the the owner of Wynn Homes an agreed cash amount for such property on the date of such acquisition, subject to certain restrictions. Due to the closing of this acquisition subsequent to the period end, we are currently determining the fair value of assets acquired and liabilities assumed necessary to develop the purchase price allocation. Therefore, disclosure of the purchase price allocation to the tangible and intangible assets acquired and liabilities assumed is not practicable. 


 


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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
 
Sacramento, CA
 
 
Austin, TX
 
Denver, CO
 
Raleigh, NC
 
Jacksonville, FL
 
 
 
 
Oklahoma City, OK
 
Colorado Springs, CO
 
Winston-Salem, NC
 
 
 
 
 
 
 
 
 
 
Birmingham, AL
 
 
 
 
 
 
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 25,000 homes. During the six months ended June 30, 2018, we had 3,059 home closings, compared to 2,272 home closings during the six months ended June 30, 2017.
We sell homes under the LGI Homes and Terrata Homes brands. Our 79 active communities at June 30, 2018 included five Terrata Homes communities.
Recent Developments
During June 2018, we closed on our first home in the Sacramento, California market.
On July 6, 2018, we completed an offering of $300.0 million aggregate principal amount of our 6.875% Senior Notes due 2026 (the “Senior Notes”). We received net proceeds from the offering of the Senior Notes of approximately $296.2 million, after deducting the initial purchasers’ discounts and commissions and offering expenses. The net proceeds from the offering were used to repay a portion of the borrowings under the Credit Agreement.
On August 2, 2018, we acquired certain real estate assets owned by Wynn Homes and its affiliates for a purchase price of approximately $80.0 million, subject to certain post-closing adjustments. As a portion of the purchase price, we will issue to the owner of Wynn Homes, unregistered shares of our common stock, with the actual number of shares to be determined based on the lower of (i) the average stock price over a period of time prior to the acquisition or (ii) the average closing price of our common stock over a period of time occurring after the filing of this Quarterly Report on Form 10-Q.
Key Results
Key financial results as of and for the three months ended June 30, 2018, as compared to the three months ended June 30, 2017, were as follows:
Home sales revenues increased 29.5% to $419.8 million from $324.2 million.
Homes closed increased 20.1% to 1,815 homes from 1,511 homes.
Average sales price of our homes increased 7.8% to $231,321 from $214,545.
Gross margin as a percentage of home sales revenues decreased to 26.1% from 26.6%.
Adjusted gross margin (non-GAAP) as a percentage of home sales revenues decreased to 27.7% from 28.0%.
Net income before income taxes increased 28.8% to $62.7 million from $48.6 million.
Net income increased 47.9% to $47.6 million from $32.2 million.
EBITDA (non-GAAP) as a percentage of home sales revenues remained flat at 16.4%.
Adjusted EBITDA (non-GAAP) as a percentage of home sales revenues remained flat at 16.4%.
Total owned and controlled lots increased 3.4% to 46,855 lots at June 30, 2018 from 45,321 lots at March 31, 2018.
For reconciliations of the non-GAAP financial measures of adjusted gross margin, EBITDA and adjusted EBITDA to the most directly comparable GAAP financial measures, please see “—Non-GAAP Measures.”

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Key financial results as of and for the six months ended June 30, 2018, as compared to the six months ended June 30, 2017, were as follows:
Home sales revenues increased 43.5% to $698.9 million from $487.1 million.
Homes closed increased 34.6% to 3,059 homes from 2,272 homes.
Average sales price of our homes increased 6.6% to $228,464 from $214,388.
Gross margin as a percentage of home sales revenues decreased to 25.6% from 26.7%.
Adjusted gross margin (non-GAAP) as a percentage of home sales revenues decreased to 27.2% from 28.0%.
Net income before income taxes increased 43.4% to $93.9 million from $65.5 million.
Net income increased 70.3% to $74.9 million from $44.0 million.
EBITDA (non-GAAP) as a percentage of home sales revenues increased to 14.9% from 14.7%.
Adjusted EBITDA (non-GAAP) as a percentage of home sales revenues increased to 14.9% from 14.7%.
Total owned and controlled lots increased 18.0% to 46,855 lots at June 30, 2018 from 39,709 lots at December 31, 2017.
For reconciliations of the non-GAAP financial measures of adjusted gross margin, EBITDA and adjusted EBITDA to the most directly comparable GAAP financial measures, please see “—Non-GAAP Measures.”

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Results of Operations
The following table sets forth our results of operations for the periods indicated: 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2018
 
2017
 
2018
 
2017
 
 
(dollars in thousands, except per share data and average home sales price)
Statement of Income Data:
 
 
 
 
 
 
 
 
Home sales revenues
 
$
419,847

 
$
324,178

 
$
698,871

 
$
487,089

Expenses:
 
 
 
 
 
 
 
 
Cost of sales
 
310,082

 
237,830

 
519,847

 
357,242

Selling expenses
 
29,301

 
24,193

 
52,250

 
40,300

General and administrative
 
18,302

 
13,680

 
33,742

 
24,945

     Operating income
 
62,162

 
48,475

 
93,032

 
64,602

Other income, net
 
(509
)
 
(167
)
 
(866
)
 
(882
)
     Net income before income taxes
 
62,671

 
48,642

 
93,898

 
65,484

Income tax provision
 
15,063

 
16,443

 
18,988

 
21,505

     Net income
 
$
47,608

 
$
32,199

 
$
74,910

 
$
43,979

Basic earnings per share
 
$
2.11

 
$
1.49

 
$
3.34

 
$
2.05

Diluted earnings per share
 
$
1.90

 
$
1.39

 
$
3.01

 
$
1.91

Other Financial and Operating Data:
 
 
 
 
 

 

Active communities at end of period
 
79

 
71

 
79

 
71

Home closings
 
1,815

 
1,511

 
3,059

 
2,272

Average sales price of homes closed
 
$
231,321

 
$
214,545

 
$
228,464

 
$
214,388

Gross margin (1)
 
$
109,765

 
$
86,348

 
$
179,024

 
$
129,847

Gross margin % (2)
 
26.1
%
 
26.6
%
 
25.6
%
 
26.7
%
Adjusted gross margin (3)
 
$
116,353

 
$
90,823

 
$
189,921

 
$
136,432

Adjusted gross margin % (2)(3)
 
27.7
%
 
28.0
%
 
27.2
%
 
28.0
%
EBITDA (4)
 
$
69,445

 
$
53,175

 
$
105,164

 
$
72,303

EBITDA margin % (2)(4)
 
16.4
%
 
16.4
%
 
14.9
%
 
14.7
%
Adjusted EBITDA (4)
 
$
68,936

 
$
53,145

 
$
104,295

 
$
71,593

Adjusted EBITDA margin % (2)(4)
 
16.4
%
 
16.4
%
 
14.9
%
 
14.7
%
(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 adjustments, which have real economic effects and could impact our results, the utility of adjusted gross margin information as a measure of our operating performance may be limited. In addition, other companies may not calculate adjusted gross margin information in the same manner that we do. Accordingly, adjusted gross margin information should be considered only as a supplement to gross margin information as a measure of our performance. Please see “—Non-GAAP Measures” for a reconciliation of adjusted gross margin to gross margin, which is the GAAP financial measure that our management believes to be most directly comparable.
(4)
EBITDA and adjusted EBITDA are non-GAAP financial measures used by management as supplemental measures in evaluating operating performance. We define EBITDA as net income before (i) interest expense, (ii) income taxes, (iii) depreciation and amortization and (iv) capitalized interest charged to the cost of sales. We define adjusted EBITDA as net income before (i) interest expense, (ii) income taxes, (iii) depreciation and amortization, (iv) capitalized interest charged to the cost of sales, (v) other income, net and (vi) adjustments resulting from the application of purchase accounting. Our management believes that the presentation of EBITDA and adjusted EBITDA provides useful information to investors regarding our results of operations because it assists both investors and management in analyzing and benchmarking the performance and value of our business. EBITDA and adjusted EBITDA provide indicators of general economic performance that are not affected by fluctuations in interest rates or effective tax rates, levels of depreciation or amortization and items

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considered to be unusual or non-recurring. Accordingly, our management believes that these measures are useful for comparing general operating performance from period to period. Other companies may define these measures differently and, as a result, our measures of EBITDA and adjusted EBITDA may not be directly comparable to the measures of other companies. Although we use EBITDA and adjusted EBITDA as financial measures to assess the performance of our business, the use of these measures is limited because they do not include certain material costs, such as interest and taxes, necessary to operate our business. EBITDA and adjusted EBITDA should be considered in addition to, and not as a substitute for, net income in accordance with GAAP as a measure of performance. Our presentation of EBITDA and adjusted EBITDA should not be construed as an indication that our future results will be unaffected by unusual or non-recurring items. Our use of EBITDA and adjusted EBITDA is limited as an analytical tool, and you should not consider these measures in isolation or as substitutes for analysis of our results as reported under GAAP. Please see “—Non-GAAP Measures” for a reconciliations of EBITDA and adjusted EBITDA to net income, which is the GAAP financial measure that our management believes to be most directly comparable.

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Three Months Ended June 30, 2018 Compared to Three Months Ended June 30, 2017
Homes Sales. Our home sales revenues, closings, average sales price (ASP) and ending community count by division for the three months ended June 30, 2018 and 2017 were as follows (revenues in thousands):
 
 
Three Months Ended June 30,
 
 
2018
 
2017
 
 
Revenues
 
Closings
 
ASP
 
Revenues
 
Closings
 
ASP
Central
 
$
181,268

 
850

 
$
213,256

 
$
139,762

 
679

 
$
205,835

Southwest
 
73,030

 
262

 
278,740

 
63,258

 
248

 
255,073

Southeast
 
60,369

 
298

 
202,581

 
51,487

 
275

 
187,225

Florida
 
55,018

 
257

 
214,078

 
48,974

 
245

 
199,894

Northwest
 
49,463

 
145

 
341,124

 
20,697

 
64

 
323,391

Midwest
 
699

 
3

 
233,000

 

 

 

Total home sales revenues
 
$
419,847

 
1,815

 
$
231,321

 
$
324,178

 
1,511

 
$
214,545

 
As of June 30,
Community count
2018
 
2017
Central
29

 
25

Southwest
14

 
16

Southeast
17

 
14

Florida
12

 
12

Northwest
5

 
4

Midwest
2

 

Total community count
79

 
71

Home sales revenues for the three months ended June 30, 2018 were $419.8 million, an increase of $95.7 million, or 29.5%, from $324.2 million for the three months ended June 30, 2017. The increase in home sales revenues is primarily due to a 20.1% increase in homes closed and an increase in the average sales price per home during the three months ended June 30, 2018 as compared to the three months ended June 30, 2017. The increase in home closings was largely due to the increase in the number of active communities in the three months ended June 30, 2018 as compared to the three months ended June 30, 2017. The average sales price per home closed during the three months ended June 30, 2018 was $231,321, an increase of $16,776, or 7.8%, from the average sales price per home of $214,545 for the three months ended June 30, 2017. The increase in the average sales price per home is primarily due to changes in product mix, price points in new markets and a favorable pricing environment. We increased our home sales revenues in our Central division by $41.5 million, or 29.7% of home sales revenues, during the three months ended June 30, 2018 as compared to the three months ended June 30, 2017, representing a 25.2% increase in the number of homes closed in this division during the three months ended June 30, 2018 as compared to the three months ended June 30, 2017. We increased our home sales revenues outside of the Central division by $54.2 million, or 29.4% of home sales revenues, during the three months ended June 30, 2018 as compared to the three months ended June 30, 2017, representing a 16.0% increase in the number of homes closed in these divisions during the three months ended June 30, 2018 as compared to the three months ended June 30, 2017. Our active selling communities at June 30, 2018 increased to 79 from 71 at June 30, 2017Four of the eight active selling communities added between June 30, 2017 and June 30, 2018 were outside of our Central division. All divisions added communities by expanding into new markets or deepening existing markets with the exception of the Southwest division, which had two fewer active communities due to close out or transition between certain of its active communities, and our Florida division, which maintained the same level of active communities for the three months ended June 30, 2018 as compared to the three months ended June 30, 2017.
Cost of Sales and Gross Margin (home sales revenues less cost of sales). Cost of sales increased for the three months ended June 30, 2018 to $310.1 million, an increase of $72.3 million, or 30.4%, from $237.8 million for the three months ended June 30, 2017. This increase is primarily due to a 20.1% increase in homes closed during the three months ended June 30, 2018 as compared to the three months ended June 30, 2017, and, to a lesser degree, product mix and higher construction costs. Gross margin for the three months ended June 30, 2018 was $109.8 million, an increase of $23.4 million, or 27.1%, from $86.3 million for the three months ended June 30, 2017. Gross margin as a percentage of home sales revenues was 26.1% for the three months ended June 30, 2018 and 26.6% for the three months ended June 30, 2017. This decrease in gross margin as a percentage of home sales revenues is primarily due to a combination of higher construction costs and to a lesser extent due to 103 wholesale home closings during

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the three months ended June 30, 2018 compared to 65 wholesale home closings during the three months ended June 30, 2017, partially offset by higher average home sales prices.
Selling Expenses. Selling expenses for the three months ended June 30, 2018 were $29.3 million, an increase of $5.1 million, or 21.1%, from $24.2 million for the three months ended June 30, 2017. Sales commissions increased to $16.3 million for the three months ended June 30, 2018 from $12.6 million for the three months ended June 30, 2017, primarily due to a 29.5% increase in home sales revenues during the three months ended June 30, 2018 as compared to the three months ended June 30, 2017. Selling expenses as a percentage of home sales revenues were 7.0% and 7.5% for the three months ended June 30, 2018 and 2017, respectively. The decrease in selling expenses as a percentage of home sales revenues reflects operating leverage realized from the increase in home sales revenues.
General and Administrative. General and administrative expenses for the three months ended June 30, 2018 were $18.3 million, an increase of $4.6 million, or 33.8%, from $13.7 million for the three months ended June 30, 2017. The increase in general and administrative expenses as a percentage of home sales revenues is 4.4% and 4.2% for the three months ended June 30, 2018 and 2017, respectively. The increases are primarily due to professional fees and additional compensation costs associated with an increase of active communities and home closings during the three months ended June 30, 2018 as compared to the three months ended June 30, 2017.
Operating Income, Net Income before Taxes and Net Income. Operating income for the three months ended June 30, 2018 was $62.2 million, an increase of $13.7 million, or 28.2%, from $48.5 million for the three months ended June 30, 2017. Net income before income taxes for the three months ended June 30, 2018 was $62.7 million, an increase of $14.0 million, or 28.8%, from $48.6 million for the three months ended June 30, 2017. The following divisions contributed to net income before income taxes during the three months ended June 30, 2018: Central - $34.2 million or 54.6%; Southwest - $10.2 million or 16.3%; Florida - $7.6 million or 12.1%; Southeast - $7.6 million or 12.1%; and Northwest - $5.8 million or 9.2%. Net income for the three months ended June 30, 2018 was $47.6 million, an increase of $15.4 million, or 47.9%, from $32.2 million for the three months ended June 30, 2017. The increases in operating income, net income before taxes and net income are primarily attributed to a 20.1% increase in homes closed, the 7.8% increase in average home sales price, a decrease in the effective tax rate, and operating leverage realized related to selling expenses during the three months ended June 30, 2018 as compared to the three months ended June 30, 2017.
Six Months Ended June 30, 2018 Compared to Six Months Ended June 30, 2017
Homes Sales. Our home sales revenues, closings and average sales price (ASP) by division for the six months ended June 30, 2018 and 2017 were as follows (revenues in thousands):
 
 
Six Months Ended June 30,
 
 
2018
 
2017
 
 
Revenues
 
Closings
 
ASP
 
Revenues
 
Closings
 
ASP
Central
 
$
288,766

 
1,371

 
$
210,624

 
$
204,680

 
994

 
$
205,915

Southwest
 
127,313

 
459

 
277,370

 
96,384

 
380

 
253,642

Southeast
 
105,477

 
527

 
200,146

 
79,334

 
426

 
186,230

Florida
 
97,461

 
466

 
209,144

 
73,174

 
368

 
198,842

Northwest
 
79,155

 
233

 
339,721

 
33,517

 
104

 
322,279

Midwest
 
699

 
3

 
233,000

 

 

 

Total home sales revenues
 
$
698,871

 
3,059

 
$
228,464

 
$
487,089

 
2,272

 
$
214,388

Home sales revenues for the six months ended June 30, 2018 were $698.9 million, an increase of $211.8 million, or 43.5%, from $487.1 million for the six months ended June 30, 2017. The increase in home sales revenues is primarily due to a 34.6% increase in homes closed and an increase in the average sales price per home during the six months ended June 30, 2018 as compared to the six months ended June 30, 2017. This increase in home closings was largely due to the overall increase in the number of active communities in the six months ended June 30, 2018 as compared to the six months ended June 30, 2017. The average sales price per home closed during the six months ended June 30, 2018 was $228,464, an increase of $14,076, or 6.6%, from the average sales price per home of $214,388 for the six months ended June 30, 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 increased our home sales revenues in our Central division by $84.1 million, or 41.1% of home sales revenues, during the six months ended June 30, 2018 as compared to the six months ended June 30, 2017, representing a 37.9% increase in the number of homes closed in this division during the six months ended June 30, 2018 as compared to the six months ended June 30, 2017. We increased our home sales revenues in our divisions other than our Central division by $127.7 million, or 45.2% of home sales revenues, during the six months ended June 30, 2018 as compared to the six months ended June 30, 2017, representing

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a 32.1% increase in the number of homes closed in these divisions during the six months ended June 30, 2018 as compared to the six months ended June 30, 2017. Our active selling communities at June 30, 2018 increased to 79 from 71 at June 30, 2017Four of the eight active selling communities added between June 30, 2017 and June 30, 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 two fewer active communities due to close out or transition between certain of its active communities, and our Florida division, which maintained the same level of active communities for the six months ended June 30, 2018 as compared to the six months ended June 30, 2017.
Cost of Sales and Gross Margin (home sales revenues less cost of sales). Cost of sales increased for the six months ended June 30, 2018 to $519.8 million, an increase of $162.6 million, or 45.5%, from $357.2 million for the six months ended June 30, 2017. This increase is primarily due to a 34.6% increase in homes closed during the six months ended June 30, 2018 as compared to the six months ended June 30, 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 six months ended June 30, 2018 was $179.0 million, an increase of $49.2 million, or 37.9%, from $129.8 million for the six months ended June 30, 2017. Gross margin as a percentage of home sales revenues was 25.6% for the six months ended June 30, 2018 and 26.7% for the six months ended June 30, 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 six months ended June 30, 2018 as compared to the six months ended June 30, 2017, and to a lesser extent due to 134 wholesale home closings during the six months ended June 30, 2018 compared to 72 wholesale home closings during the six months ended June 30, 2017.
Selling Expenses. Selling expenses for the six months ended June 30, 2018 were $52.3 million, an increase of $12.0 million, or 29.7%, from $40.3 million for the six months ended June 30, 2017. Sales commissions increased to $27.4 million for the six months ended June 30, 2018 from $19.1 million for the six months ended June 30, 2017, largely due to a 43.5% increase in home sales revenues during the six months ended June 30, 2018 as compared to the six months ended June 30, 2017. Selling expenses as a percentage of home sales revenues were 7.5% and 8.3% for the six months ended June 30, 2018 and 2017, respectively. The decrease in selling expenses as a percentage of home sales revenues reflects operating leverage realized from the increase in home sales revenues during the six months ended June 30, 2018 as compared to the six months ended June 30, 2017.
General and Administrative. General and administrative expenses for the six months ended June 30, 2018 were $33.7 million, an increase of $8.8 million, or 35.3%, from $24.9 million for the six months ended June 30, 2017. The increase in the amount of general and administrative expenses is primarily due to professional fees and additional compensation costs associated with an increase of active communities and home closings during the six months ended June 30, 2018 as compared to the six months ended June 30, 2017. General and administrative expenses as a percentage of home sales revenues were 4.8% and 5.1% for the six months ended June 30, 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 six months ended June 30, 2018 as compared to the six months ended June 30, 2017.
Operating Income, Net Income before Income Taxes and Net Income. Operating income for the six months ended June 30, 2018 was $93.0 million, an increase of $28.4 million, or 44.0%, from $64.6 million for the six months ended June 30, 2017. Net income before income taxes for the six months ended June 30, 2018 was $93.9 million, an increase of $28.4 million, or 43.4%, from $65.5 million for the six months ended June 30, 2017. The following divisions contributed to net income before income taxes during the six months ended June 30, 2018: Central - $50.0 million or 53.3%; Southwest - $15.2 million or 16.2%; Florida - $11.6 million or 12.3%; Southeast - $11.9 million or 12.7%; and Northwest - $8.9 million or 9.4%. Net income for the six months ended June 30, 2018 was $74.9 million, an increase of $30.9 million, or 70.3%, from $44.0 million for the six months ended June 30, 2017. The increases in operating income, net income before income taxes and net income are primarily attributed to a 34.6% increase in homes closed, a higher average sales price, a decrease in the effective tax rate, and improved leverage realized during the six months ended June 30, 2018 as compared to six months ended June 30, 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, EBITDA and adjusted EBITDA.
Adjusted Gross Margin
Adjusted gross margin is a non-GAAP financial measure used by management as a supplemental measure in evaluating operating performance. We define adjusted gross margin as gross margin less capitalized interest and adjustments resulting from the application of purchase accounting included in the cost of sales. Our management believes this information is useful because it isolates the impact that capitalized interest and purchase accounting adjustments have on gross margin. However, because adjusted gross margin information excludes capitalized interest and purchase accounting adjustments, which have real economic effects and could impact our results, the utility of adjusted gross margin information as a measure of our operating performance may be limited. In addition,

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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 June 30,

Six Months Ended June 30,

 
2018
 
2017

2018

2017
Home sales revenues
 
$
419,847

 
$
324,178


$
698,871

 
$
487,089

Cost of sales
 
310,082

 
237,830


519,847

 
357,242

Gross margin
 
109,765

 
86,348


179,024

 
129,847

Capitalized interest charged to cost of sales
 
6,588

 
4,338


10,900

 
6,413

Purchase accounting adjustments (1)
 

 
137


(3
)
 
172

Adjusted gross margin
 
$
116,353

 
$
90,823


$
189,921

 
$
136,432

Gross margin % (2)
 
26.1
%
 
26.6
%

25.6
%
 
26.7
%
Adjusted gross margin % (2)
 
27.7
%
 
28.0
%

27.2
%
 
28.0
%
 
(1)
Adjustments result from the application of purchase accounting for acquisitions and represent the amount of the fair value step-up adjustments included in cost of sales for real estate inventory sold after the acquisition dates.
(2)
Calculated as a percentage of home sales revenues.
EBITDA and Adjusted EBITDA
EBITDA and adjusted EBITDA are non-GAAP financial measures used by management as supplemental measures in evaluating operating performance. We define EBITDA as net income before (i) interest expense, (ii) income taxes, (iii) depreciation and amortization and (iv) capitalized interest charged to the cost of sales. We define adjusted EBITDA as net income before (i) interest expense, (ii) income taxes, (iii) depreciation and amortization, (iv) capitalized interest charged to the cost of sales, (v) other income, net and (vi) adjustments resulting from the application of purchase accounting included in the cost of sales. Our management believes that the presentation of EBITDA and adjusted EBITDA provides useful information to investors regarding our results of operations because it assists both investors and management in analyzing and benchmarking the performance and value of our business. EBITDA and adjusted EBITDA provide indicators of general economic performance that are not affected by fluctuations in interest rates or effective tax rates, levels of depreciation or amortization and items considered to be unusual or non-recurring. Accordingly, our management believes that these measures are useful for comparing general operating performance from period to period. Other companies may define these measures differently and, as a result, our measures of EBITDA and adjusted EBITDA may not be directly comparable to the measures of other companies. Although we use EBITDA and adjusted EBITDA as financial measures to assess the performance of our business, the use of these measures is limited because they do not include certain material costs, such as interest and taxes, necessary to operate our business. EBITDA and adjusted EBITDA should be considered in addition to, and not as a substitute for, net income in accordance with GAAP as a measure of performance. Our presentation of EBITDA and adjusted EBITDA should not be construed as an indication that our future results will be unaffected by unusual or non-recurring items. Our use of EBITDA and adjusted EBITDA is limited as an analytical tool, and you should not consider these measures in isolation or as substitutes for analysis of our results as reported under GAAP. Some of these limitations are:
(i) they do not reflect every cash expenditure, future requirements for capital expenditures or contractual commitments, including for purchase of land;
(ii) they do not reflect the interest expense or the cash requirements necessary to service interest or principal payments on our debt;
(iii) although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced or require improvements in the future, and EBITDA and adjusted EBITDA do not reflect any cash requirements for such replacements or improvements;
(iv) they are not adjusted for all non-cash income or expense items that are reflected in our statements of cash flows;
(v) they do not reflect the impact of earnings or charges resulting from matters we consider not to be indicative of our ongoing operations; and
(vi) other companies in our industry may calculate them differently than we do, limiting their usefulness as a comparative measure.
Because of these limitations, our EBITDA and adjusted EBITDA should not be considered as measures of discretionary cash available to us to invest in the growth of our business or as measures of cash that will be available to us to meet our obligations. We compensate for these limitations by using our EBITDA and adjusted EBITDA along with other comparative tools, together with

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GAAP measures, to assist in the evaluation of operating performance. These GAAP measures include operating income, net income and cash flow data. We have significant uses of cash flows, including capital expenditures, interest payments and other non-recurring charges, which are not reflected in our EBITDA or adjusted EBITDA. EBITDA and adjusted EBITDA are not intended as alternatives to net income as indicators of our operating performance, as alternatives to any other measure of performance in conformity with GAAP or as alternatives to cash flows as a measure of liquidity. You should therefore not place undue reliance on our EBITDA or adjusted EBITDA calculated using these measures.
The following table reconciles EBITDA and adjusted EBITDA to net income, which is the GAAP measure that our management believes to be most directly comparable (dollars in thousands):
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2018
 
2017
 
2018
 
2017
Net income
 
$
47,608

 
$
32,199

 
$
74,910

 
$
43,979

Income taxes
 
15,063

 
16,443

 
18,988

 
21,505

Depreciation and amortization
 
186

 
195

 
366

 
406

Capitalized interest charged to cost of sales
 
6,588

 
4,338

 
10,900

 
6,413

EBITDA
 
69,445

 
53,175

 
105,164

 
72,303

Purchase accounting adjustments(1)
 

 
137

 
(3
)
 
172

Other income, net
 
(509
)
 
(167
)
 
(866
)
 
(882
)
Adjusted EBITDA
 
$
68,936

 
$
53,145

 
$
104,295

 
$
71,593

EBITDA margin %(2)
 
16.4
%
 
16.4
%
 
14.9
%
 
14.7
%
Adjusted EBITDA margin %(2)
 
16.4
%
 
16.4
%
 
14.9
%
 
14.7
%
 
(1)
Adjustments result from the application of purchase accounting related to prior acquisitions and represent the amount of the fair value step-up adjustments for real estate inventory included in cost of sales.
(2)
Calculated as a percentage of home sales revenues.
Backlog
We sell our homes under standard purchase contracts, which generally require a homebuyer to pay a deposit at the time of signing the purchase contract. The amount of the required deposit is minimal (generally $1,000 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.

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Table of Contents

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
 
Six Months Ended June 30,
2018 (4)
 
2017 (5)
Net orders (1)
 
3,427

 
3,371

Cancellation rate (2)
 
22.5
%
 
21.3
%
Ending backlog – homes (3)
 
1,184

 
1,545

Ending backlog – value (3)
 
$
296,904

 
$
352,543

(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)
41 units and values related to bulk sales agreements are not included in the table above.
(5)
59 units and values related to bulk sales agreements are not included in the table above.
Land Acquisition Policies and Development
We increased our active communities to 79 as of June 30, 2018 from 78 as of December 31, 2017. We also increased our lot inventory to 46,855 owned or controlled lots as of June 30, 2018 from 39,709 owned or controlled lots as of December 31, 2017.
The table below shows (i) home closings by division for the six months ended June 30, 2018 and (ii) our owned or controlled lots by division as of June 30, 2018.
 
 
Six Months Ended June 30, 2018
 
As of June 30, 2018
Division
 
Home Closings
 
Owned (1)
 
Controlled
 
Total
Central
 
1,371

 
13,656

 
10,190

 
23,846

Southwest
 
459

 
2,445

 
1,672

 
4,117

Southeast
 
527

 
5,010

 
7,535

 
12,545

Florida
 
466

 
2,034

 
1,566

 
3,600

Northwest
 
233

 
1,143

 
1,292

 
2,435