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 September 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 November 2, 2018, there were 22,717,096 shares of the registrant’s common stock, par value $.01 per share, outstanding.


Table of Contents

TABLE OF CONTENTS
   



 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2

Table of Contents

PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LGI HOMES, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share data)
 
 
 
September 30,
 
December 31,
 
 
2018
 
2017
ASSETS
 

 
 
Cash and cash equivalents
 
$
37,969

 
$
67,571

Accounts receivable
 
31,379

 
44,706

Real estate inventory
 
1,187,994

 
918,933

Pre-acquisition costs and deposits
 
40,055

 
18,866

Property and equipment, net
 
1,520

 
1,674

Other assets
 
11,033

 
14,196

Deferred tax assets, net
 
3,858

 
1,928

Goodwill and intangible assets, net
 
19,979

 
12,018

Total assets
 
$
1,333,787

 
$
1,079,892

 
 
 
 
 
LIABILITIES AND EQUITY
 
 
 
 
Accounts payable
 
$
17,891

 
$
12,020

Accrued expenses and other liabilities
 
75,782

 
102,831

Notes payable
 
627,695

 
475,195

Total liabilities
 
721,368

 
590,046

 
 
 
 
 
COMMITMENTS AND CONTINGENCIES
 

 

EQUITY
 
 
 
 
Common stock, par value $0.01, 250,000,000 shares authorized, 23,717,153 shares issued and 22,717,153 shares outstanding as of September 30, 2018 and 22,845,580 shares issued and 21,845,580 shares outstanding as of December 31, 2017
 
237

 
228

Additional paid-in capital
 
239,611

 
229,680

Retained earnings
 
389,121

 
276,488

Treasury stock, at cost, 1,000,000 shares
 
(16,550
)
 
(16,550
)
Total equity
 
612,419

 
489,846

Total liabilities and equity
 
$
1,333,787

 
$
1,079,892








See accompanying notes to the consolidated financial statements.

3

Table of Contents


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

 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Home sales revenues
 
$
380,369

 
$
365,896

 
$
1,079,240

 
$
852,985

 
 
 
 
 
 
 
 
 
Cost of sales
 
283,035

 
274,000

 
802,882

 
631,242

Selling expenses
 
27,890

 
26,018

 
80,140

 
66,318

General and administrative
 
17,794

 
15,431

 
51,536

 
40,376

   Operating income
 
51,650

 
50,447

 
144,682

 
115,049

Loss on extinguishment of debt
 
3,058

 

 
3,599

 

Other income, net
 
(399
)
 
(430
)
 
(1,806
)
 
(1,312
)
Net income before income taxes
 
48,991

 
50,877

 
142,889

 
116,361

Income tax provision
 
11,268

 
17,190

 
30,256

 
38,695

Net income
 
$
37,723

 
$
33,687

 
$
112,633

 
$
77,666

Earnings per share:
 
 
 
 
 
 
 
 
Basic
 
$
1.66

 
$
1.55

 
$
5.07

 
$
3.60

Diluted
 
$
1.52

 
$
1.40

 
$
4.57

 
$
3.32

 
 

 
 
 
 
 
 
Weighted average shares outstanding:
 
 
 
 
 
 
 
 
Basic
 
22,658,457

 
21,668,585

 
22,236,018

 
21,544,747

Diluted
 
24,896,569

 
24,050,385

 
24,642,882

 
23,413,467




















See accompanying notes to the consolidated financial statements.

4

Table of Contents


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
 

 

 

 
112,633

 

 
112,633

Issuance of shares in settlement of Convertible Notes
 
486,679

 
5

 
(475
)
 

 

 
(470
)
Issuance of shares, Wynn Homes Acquisition
 
70,746

 
1

 
3,999

 

 

 
4,000

Issuance of restricted stock units in settlement of accrued bonuses
 

 

 
181

 

 

 
181

Compensation expense for equity awards
 

 

 
4,172

 

 

 
4,172

Stock issued under employee incentive plans
 
314,148

 
3

 
2,054

 

 

 
2,057

BALANCE— September 30, 2018
 
23,717,153

 
$
237

 
$
239,611

 
$
389,121

 
$
(16,550
)
 
$
612,419


























See accompanying notes to the consolidated financial statements.

5

Table of Contents


LGI HOMES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
 
 
Nine Months Ended September 30,
 
 
2018
 
2017
Cash flows from operating activities:
 
 
 
 
Net income
 
$
112,633

 
$
77,666

Adjustments to reconcile net income to net cash used in operating activities:
 
 
 
 
Depreciation and amortization
 
543

 
600

Loss on extinguishment of debt
 
3,588

 

Loss on disposal of assets
 
6

 

Compensation expense for equity awards
 
4,172

 
2,677

Deferred income taxes
 
(1,784
)
 
(2,353
)
Changes in assets and liabilities:
 
 
 
 
Accounts receivable
 
13,327

 
(15,661
)
Real estate inventory
 
(194,387
)
 
(183,666
)
Pre-acquisition costs and deposits
 
(19,938
)
 
(3,508
)
Other assets
 
3,347

 
(3,858
)
Accounts payable
 
5,871

 
13,794

Accrued expenses and other liabilities
 
(29,394
)
 
42,136

Net cash used in operating activities
 
(102,016
)
 
(72,173
)
Cash flows from investing activities:
 
 
 
 
Purchases of property and equipment
 
(395
)
 
(502
)
Payment for business acquisition
 
(73,829
)
 

Net cash used in investing activities
 
(74,224
)
 
(502
)
Cash flows from financing activities:
 
 
 
 
Proceeds from notes payable
 
537,717

 
80,000

Payments on notes payable
 
(386,238
)
 
(15,000
)
Loan issuance costs
 
(6,690
)
 
(4,375
)
Proceeds from sale of stock, net of offering expenses
 
2,057

 
11,049

Payment for offering costs
 
(76
)
 
(69
)
Payment for earnout obligation
 
(132
)
 
(480
)
Net cash provided by financing activities
 
146,638

 
71,125

Net decrease in cash and cash equivalents
 
(29,602
)
 
(1,550
)
Cash and cash equivalents, beginning of period
 
67,571

 
49,518

Cash and cash equivalents, end of period
 
$
37,969

 
$
47,968





See accompanying notes to the consolidated financial statements.

6

Table of Contents

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, Oregon and Nevada.
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 September 30, 2018, and for the three and nine months ended September 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 3 for further details.
Effective January 1 2018, we adopted the FASB ASU No. 2017-01, “Business Combinations - Clarifying the Definition of a Business” (“ASU 2017-01”). ASU 2017-01 provides additional guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The adoption of ASU 2017-01 was applied prospectively and had no effect on our consolidated financial statements.
Recently Issued Accounting Pronouncements
In August 2018, the FASB issued ASU No. 2018-13, “Fair Value Measurement (Topic 820) Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement” (“ASU 2018-13”), which modifies the disclosure requirements of fair value measurements. ASU 2018-13 is effective for us beginning January 1, 2020. Certain disclosures are required to be applied

7

Table of Contents

on a retrospective basis and others on a prospective basis. We are currently evaluating the impact that adoption of this guidance will have on our financial statement disclosures.
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 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.     ACQUISITION
On August 2, 2018, we acquired certain homebuilding assets owned by Crosswind Properties, LLC, Wynn Construction, Inc., Crosswind Development, Inc., Crosswind Investments, Inc., First Continental Communities, Inc. and William Wynn (collectively, “Wynn Homes”), and assumed certain related liabilities. As a result of the Wynn Homes acquisition, we expanded our North Carolina presence in the Raleigh market, as well as established an immediate presence in the Wilmington market. We acquired approximately 200 homes under construction and more than 4,000 owned and controlled lots. The total purchase price for the Wynn Homes acquisition was approximately $77.8 million, consisting of approximately $73.8 million in cash and $4.0 million in shares of our common stock.
The acquisition was accounted for in accordance with Accounting Standards Codification (“ASC”) Topic 805, Business Combinations (“ASC 805”). The preliminary allocation of the purchase price to the tangible and intangible assets acquired and liabilities assumed may change for a period of up to one year from the date of the acquisition. Our purchase accounting for Wynn Homes as of September 30, 2018 was incomplete and we expect to complete the working capital adjustment and valuation of the tangible assets, intangible assets and liabilities assumed as of the acquisition date within one year from the acquisition date. Accordingly, we may adjust the amounts recorded as of September 30, 2018 to reflect the final valuations of assets acquired or liabilities assumed. At September 30, 2018, the acquired assets and assumed liabilities have been recorded at their estimated fair values at the acquisition date as noted below (amounts in thousands):
Purchase Consideration:
 
Total
Cash paid for net assets
 
$
73,829

Common Stock
 
4,000

            Total consideration
 
77,829

Assets acquired and liabilities assumed:
 
 
Real estate inventory
 
74,359

Pre-acquisition costs, deposits and other assets
 
1,360

Intangible assets
 
7,961

            Total assets
 
83,680

Accounts payable and accrued liabilities
 
(5,851
)
            Total liabilities
 
(5,851
)
 
 
 
          Net assets acquired
 
$
77,829

Pre-acquisition costs, deposits and other assets, accounts payable and accrued liabilities, and customer deposits are stated at historical carrying values given the short-term nature of these assets and liabilities. Real estate inventory was adjusted to reflect fair value. Intangible assets acquired in connection with the Wynn Homes acquisition consist of contracts to purchase controlled properties previously controlled by Wynn Homes that are at varying stages of completion from third-party sellers, and are amortized as homes are sold on these properties.
The Company determined the estimated fair values of the real estate inventory with the assistance of appraisals performed by independent third-party specialists and estimates by management.
Significant assumptions included in our estimates of the fair value of the assets acquired include future development costs and the timing of the completion of development activities, absorption rates, and mix of products sold in each community. Based

8

Table of Contents

on the estimated purchase consideration, management believes that the purchase price for the Wynn Homes acquisition was at market value and there was no excess of purchase price over the net fair value of assets acquired and liabilities assumed.
The Company has expensed approximately $0.8 million of acquisition related costs for legal and due diligence services; these costs are included in the general and administrative expenses in the accompanying consolidated statements of operations.
3.     REVENUES
Adoption of Topic 606, “Revenue from Contracts with Customers”
On January 1, 2018, we adopted Topic 606 using the modified retrospective method. 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 September 30,
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Retail home sales revenues
 
$
353,594

 
$
347,626

 
$
1,017,952

 
$
819,309

Other
 
26,775

 
18,270

 
61,288

 
33,676

Total home sales revenues
 
$
380,369

 
$
365,896

 
$
1,079,240

 
$
852,985

The following table presents our home sales revenues disaggregated by geography, based on our determined operating segments in Note 14 (in thousands):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Central
 
$
150,045

 
$
165,870

 
$
438,811

 
$
370,550

Southwest
 
65,742

 
66,002

 
193,055

 
162,386

Southeast
 
73,507

 
54,331

 
178,984

 
133,665

Florida
 
38,750

 
56,171

 
136,211

 
129,345

Northwest
 
50,697

 
23,522

 
129,852

 
57,039

Midwest
 
1,628

 

 
2,327

 

Total home sales revenues
 
$
380,369

 
$
365,896

 
$
1,079,240

 
$
852,985

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.

9

Table of Contents

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.
4.     REAL ESTATE INVENTORY
Our real estate inventory consists of the following (in thousands):
 
 
September 30,
 
December 31,
 
 
2018
 
2017
Land, land under development and finished lots
 
$
647,580

 
$
494,552

Information centers
 
21,796

 
18,327

Homes in progress
 
242,286

 
191,659

Completed homes
 
276,332

 
214,395

Total real estate inventory
 
$
1,187,994

 
$
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 6, are capitalized to qualifying real estate projects under development and homes under construction.

10

Table of Contents

5.     ACCRUED EXPENSES AND OTHER LIABILITIES
Accrued and other current liabilities consist of the following (in thousands):
 
 
September 30,
 
December 31,
 
 
2018
 
2017
Inventory related obligations
 
$
9,714

 
$
12,906

Taxes payable
 
4,107

 
48,733

Retentions and development payable
 
23,544

 
12,025

Accrued compensation, bonuses and benefits
 
12,811

 
14,462

Accrued interest
 
7,607

 
2,096

Warranty reserve
 
2,850

 
2,450

Other
 
15,149

 
10,159

Total accrued expenses and other liabilities
 
$
75,782

 
$
102,831

Inventory Related Obligations
We own lots in certain communities in Arizona, California, Florida and Texas that have Community Development Districts 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 September 30,
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Warranty reserves, beginning of period
 
$
2,800

 
$
1,850

 
$
2,450

 
$
1,600

Warranty provision
 
1,240

 
1,990

 
2,923

 
3,189

Warranty expenditures
 
(1,190
)
 
(1,840
)
 
(2,523
)
 
(2,789
)
Warranty reserves, end of period
 
$
2,850

 
$
2,000

 
$
2,850

 
$
2,000

6.     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, provided for, as of September 30, 2018, a revolving credit facility of $450.0 million, 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 (which was requested and approved in October 2018); see Note 15 for further details.
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 September 30, 2018, the borrowing base under the Credit Agreement was $743.9 million, of which borrowings, including the Convertible Notes (as defined below) and the Senior Notes (as defined below), of $638.8 million were outstanding, $5.3 million of letters of credit were outstanding and $99.8 million was available to borrow under the Credit Agreement.

11

Table of Contents

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 September 30, 2018, LIBOR was 2.18%.
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 September 30, 2018, we were in compliance with all of the covenants contained in the Credit Agreement.
In connection with the issuance of our 6.875% Senior Notes due 2026 (the “Senior Notes”) in July 2018, we reduced the revolving commitment under the Credit Agreement from $750.0 million to $450.0 million pursuant to the First Amendment. During the three months ended September 30, 2018, we recognized on our consolidated statements of operations $3.1 million in debt extinguishment costs related to 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 was settled in the first quarter of 2018, resulting in the issuance of 486,679 shares of our common stock, a $0.6 million reduction to debt discount and additional paid in capital, a $0.2 million loss on the extinguishment of debt and a cash payment of $15.0 million for the principal amount of such Convertible Notes. As of September 30, 2018, we have $70.0 million aggregate principal amount of Convertible Notes outstanding.
During the third 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 June 30, 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 July 1, 2018 through September 30, 2018 (inclusive). The Convertible Notes continue to be convertible during the fourth 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.
Senior Notes Offering
On July 6, 2018, we issued $300.0 million aggregate principal amount of the Senior Notes in an offering to persons reasonably believed to be qualified institutional buyers in the United States pursuant to Rule 144A under the Securities Act and to certain non-U.S. persons in transactions outside the United States pursuant to Regulation S under the Securities Act. Interest on the Senior Notes accrues at a rate of 6.875% per annum, payable semi-annually in arrears on January 15 and July 15 of each year, commencing on January 15, 2019, and the Senior Notes mature on July 15, 2026. Terms of the Senior Notes are governed by an indenture and

12

Table of Contents

supplemental indenture, each dated as of July 6, 2018, among us, the Subsidiary Guarantors and Wilmington Trust, National Association, as trustee.
We received net proceeds from the offering of the Senior Notes of approximately $296.2 million, after deducting the initial purchasers’ discounts of $2.3 million and commissions and offering expenses of $1.5 million. The net proceeds from the offering were used to repay a portion of the borrowings under the Credit Agreement.
Notes payable consist of the following (in thousands):
 
 
September 30, 2018
 
December 31, 2017
Notes payable under the Credit Agreement ($450.0 million revolving credit facility at September 30, 2018) maturing on May 31, 2021; interest paid monthly at LIBOR plus 2.90%; net of debt issuance costs of approximately $4.1 million and $5.3 million at September 30, 2018 and December 31, 2017, respectively
 
$
264,747

 
$
394,714

4.25% Convertible Notes due November 15, 2019; interest paid semi-annually at 4.25%; net of debt issuance costs of approximately $0.5 million and $1.0 million at September 30, 2018 and December 31, 2017, respectively; and approximately $1.7 million and $3.5 million in unamortized discount at September 30, 2018 and December 31, 2017, respectively
 
67,759

 
80,481

Senior Notes due July 15, 2026; interest paid semi-annually at 6.875%; net of debt issuance costs of approximately $2.6 million at September 30, 2018 and approximately $2.2 million in unamortized discount at September 30, 2018
 
295,189

 

Total notes payable
 
$
627,695

 
$
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 September 30,
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Interest incurred
 
$
10,823

 
$
6,526

 
$
26,803

 
$
17,628

Less: Amounts capitalized
 
(10,823
)
 
(6,526
)
 
(26,803
)
 
(17,628
)
Interest expense
 
$

 
$

 
$

 
$

 
 
 
 
 
 
 
 
 
Cash paid for interest
 
$
4,517

 
$
4,361

 
$
17,786

 
$
13,272

Included in interest incurred was amortization of deferred financing costs for notes payable and amortization of Convertible Notes and Senior Notes discounts of $1.3 million and $1.0 million for the three months ended September 30, 2018 and 2017, respectively, and $3.5 million and $3.0 million for the nine months ended September 30, 2018 and 2017, respectively.
7.     INCOME TAXES
We file U.S. federal and state income tax returns. As of September 30, 2018, we have no unrecognized tax benefits. We are no longer subject to exam for years before 2014 (2013 for Texas).
For the nine months ended September 30, 2018, our effective tax rate of 21.2% is higher 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 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 September 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 and their applicability to our 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

13

Table of Contents

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.
In June 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 September 30, 2018, the IRS has not proposed any adjustments to our tax positions.
During the three months ended September 30, 2018, we received notice from the State of Texas that an examination of the Company’s Texas Franchise tax report for 2015 will be conducted.  As of September 30, 2018, the examination has not commenced.
Income taxes paid were $12.8 million and $2.0 million for the three months ended September 30, 2018 and 2017, respectively. Income taxes paid were $76.5 million and $16.7 million for the nine months ended September 30, 2018 and 2017, respectively.
8.     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 6 for further details on this debt obligation.
Shelf Registration Statement and ATM Offering Program
On August 24, 2018, we and certain of our subsidiaries filed an automatic shelf registration statement on Form S-3 (Registration No. 333-227012), registering the offering and sale of an indeterminate amount of debt securities, guarantees of debt securities, preferred stock, common stock, warrants, depositary shares, purchase contracts and units that include any of these securities. In November 2017, we concluded our $25.0 million at-the-market common stock offering program (the “2016 ATM Program”) under our prior shelf registration statement. During the three and nine months ended September 30, 2017, we issued and sold 112,798 and 267,788 shares of our common stock, respectively, under the 2016 ATM Program and received net proceeds of approximately $5.1 million and $10.0 million, respectively.
9.     EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per share for the three and nine months ended September 30, 2018 and 2017:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Numerator (in thousands):
 
 
 
 
 
 
 
 
Numerator for basic and dilutive earnings per share
 
$
37,723

 
$
33,687

 
$
112,633

 
$
77,666

Denominator:
 
 
 
 
 
 
 
 
       Basic weighted average shares outstanding
 
22,658,457

 
21,668,585

 
22,236,018

 
21,544,747

       Effect of dilutive securities:
 
 
 
 
 
 
 
 
Convertible Notes - treasury stock method
 
1,978,770

 
2,037,665

 
2,128,854

 
1,601,450

         Stock-based compensation units
 
259,342

 
344,135

 
278,010

 
267,270

       Diluted weighted average shares outstanding
 
24,896,569

 
24,050,385

 
24,642,882

 
23,413,467

 
 
 
 
 
 
 
 
 
Basic earnings per share
 
$
1.66

 
$
1.55

 
$
5.07

 
$
3.60

Diluted earnings per share
 
$
1.52

 
$
1.40

 
$
4.57

 
$
3.32

Antidilutive non-vested restricted stock units excluded from calculation of diluted earnings per share
 
2,245

 
1,873

 
9,744

 
7,801

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

14

Table of Contents

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 nine months ended September 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 2.0 million shares of our common stock related to the conversion spread of the Convertible Notes for both the three months ended September 30, 2018 and 2017, and 2.1 million and 1.6 million shares of our common stock related to the conversion spread of the Convertible Notes for the nine months ended September 30, 2018 and 2017, respectively.
10.    STOCK-BASED COMPENSATION
Non-performance Based Restricted Stock Units
The following table summarizes the activity of our time-vested restricted stock units (“RSUs”):
 
 
Nine Months Ended September 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
 
40,844

 
$
63.30

 
68,109

 
$
32.38

   Vested
 
(36,486
)
 
$
15.70

 
(12,323
)
 
$
15.63

   Forfeited
 
(5,941
)
 
$
34.31

 
(9,219
)
 
$
20.09

Ending balance
 
173,517

 
$
38.34

 
180,420

 
$
25.06

During the nine months ended September 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 13,197 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 September 30, 2018 and 2017, respectively. We recognized $1.5 million and $0.9 million of stock-based compensation expense related to outstanding RSUs for the nine months ended September 30, 2018 and 2017, respectively. At September 30, 2018, we had unrecognized compensation cost of $3.6 million related to unvested RSUs, which is expected to be recognized over a weighted average period of 2.1 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.

15

Table of Contents

The following table summarizes the activity of our PSUs for the nine months ended September 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 September 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 September 30, 2018, management estimates that the recipients will receive approximately 100%, 200% 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 $0.7 million of total stock-based compensation expense related to outstanding PSUs for the three months ended September 30, 2018 and 2017, respectively. We recognized $2.7 million and $2.6 million of total stock-based compensation expense related to outstanding PSUs for the nine months ended September 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 September 30, 2018, we had unrecognized compensation cost of $6.4 million, based on the probable amount, related to unvested PSUs, which is expected to be recognized over a weighted average period of 0.8 years.
11.    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 September 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 and the Senior 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 and senior notes within the homebuilding industry (Level 2 measurement).

16

Table of Contents

The following table below shows the level and measurement of liabilities at September 30, 2018 and December 31, 2017 (in thousands):
 
 
 
 
September 30, 2018
 
December 31, 2017
 
 
Fair Value Hierarchy
 
Carrying Value
 
Estimated Fair Value (1)
 
Carrying Value
 
Estimated Fair Value (1)
Convertible Notes
 
Level 2
 
$
67,759

 
$
68,149

 
$
80,481

 
$
81,523

Senior Notes
 
Level 2
 
$
295,189

 
$
297,895

 
$

 
$

(1)
Excludes the fair value of the equity component of the Convertible Notes. See the “Convertible Notes” section within Note 6 for further details.
12.    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 nine months ended September 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 nine months ended September 30, 2017, we purchased 21 lots under this land purchase contract for $1.7 million.
As of September 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 September 30, 2018 related to these land purchase contracts. We anticipate closing on these contracts in the first quarter of 2019.
Home Sales to Affiliates
We had no home closings to affiliates during the three and nine months ended September 30, 2018 or the three months ended September 30, 2017. During the nine months ended September 30, 2017, we closed on three homes sold to an affiliate of one of our directors for approximately $0.7 million.
13.     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.

17

Table of Contents

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):
 
 
September 30, 2018
 
December 31, 2017
Land deposits and option payments
 
$
38,263

 
$
17,761

Commitments under the land purchase contracts if the purchases are consummated
 
$
778,264

 
$
460,714

Lots under land purchase contracts
 
26,836

 
18,758

As of September 30, 2018 and December 31, 2017, approximately $22.3 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 $56.0 million (including $5.3 million of letters of credit issued under our revolving credit facility) and $49.7 million at September 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.
14.     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 September 30, 2018: our Central, Southwest, Southeast, Florida, Northwest and Midwest divisions. The Central division is our largest division and comprised approximately 41% and 43% of total home sales revenues for the nine months ended September 30, 2018 and 2017, respectively.
In accordance with ASC Topic 280, Segment Reporting, operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision-makers (“CODMs”) in deciding how to allocate resources and in assessing performance. The CODMs primarily evaluate performance based on the number of homes closed, gross margin and average sales price.
The operating segments qualify as our six reportable segments. In determining the most appropriate reportable segments, we consider operating segments’ economic and other characteristics, including home floor plans, average selling prices, gross margin percentage, geographical proximity, production construction processes, suppliers, subcontractors, regulatory environments, customer type and underlying demand and supply. Each operating segment follows the same accounting policies and is managed by our management team. We have no inter-segment sales, as all sales are to external customers. Operating results for each segment may not be indicative of the results for such segment had it been an independent, stand-alone entity for the periods presented.

18

Table of Contents

Financial information relating to our reportable segments was as follows (in thousands):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Revenues:
 
 
 
 
 
 
 
 
Central
 
$
150,045

 
$
165,870

 
$
438,811

 
$
370,550

Southwest
 
65,742

 
66,002

 
193,055

 
162,386

Southeast
 
73,507

 
54,331

 
178,984

 
133,665

Florida
 
38,750

 
56,171

 
136,211

 
129,345

Northwest
 
50,697

 
23,522

 
129,852

 
57,039

Midwest
 
1,628

 

 
2,327

 

Total home sales revenues
 
$
380,369

 
$
365,896

 
$
1,079,240

 
$
852,985

 
 
 
 
 
 
 
 
 
Net income (loss) before income taxes:
 
 
 
 
 
 
 
 
Central
 
$
25,571

 
$
28,824

 
$
75,614

 
$
63,245

Southwest
 
8,824

 
7,170

 
23,999

 
18,347

Southeast
 
7,512

 
6,225

 
19,438

 
15,145

Florida
 
4,522

 
7,430

 
16,079

 
16,222

Northwest
 
7,051

 
2,524

 
15,901

 
6,336

Midwest
 
(600
)
 
(393
)
 
(1,800
)
 
(620
)
Corporate (1)
 
(3,889
)
 
(903
)
 
(6,342
)
 
(2,314
)
Total net income (loss) before income taxes
 
$
48,991

 
$
50,877

 
$
142,889

 
$
116,361

(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.
 
 
September 30, 2018
 
December 31, 2017
Assets:
 
 
 
 
Central
 
$
518,225

 
$
439,833

Southwest
 
186,204

 
175,786

Southeast
 
304,916

 
155,928

Florida
 
104,006

 
119,257

Northwest
 
152,390

 
80,350

Midwest
 
22,718

 
15,066

Corporate (1)
 
45,328

 
93,672

Total assets
 
$
1,333,787

 
$
1,079,892

(1)
As of September 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. As of December 31, 2017, $18.9 million of deposits and pre-acquisition costs were reported at Corporate and balances as of September 30, 2018 were allocated to the six reportable segments.
15.     SUBSEQUENT EVENT
Revolving Credit Agreement
On October 18, 2018, we entered into a Lender Acknowledgement Agreement with certain lenders and Wells Fargo Bank, National Association, as administrative agent, whereby the aggregate revolving commitments under our revolving credit facility increased by $50.0 million from $450.0 million to $500.0 million in accordance with the relevant provisions of the Credit Agreement.
 


19

Table of Contents

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
 
Wilmington, NC
 
 
 
 
 
 
 
 
Las Vegas, NV
 
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 26,000 homes. During the nine months ended September 30, 2018, we had 4,660 home closings, compared to 4,001 home closings during the nine months ended September 30, 2017.
We sell homes under the LGI Homes and Terrata Homes brands. Our 81 active communities at September 30, 2018 included five Terrata Homes communities.
Recent Developments
As a result of the August 2, 2018 Wynn Homes acquisition in our Southeast division, we closed on 49 homes in the Raleigh and Wilmington markets during the months of August and September 2018.
On October 18, 2018, we entered into a Lender Acknowledgement Agreement with certain lenders and Wells Fargo Bank, National Association, as administrative agent, whereby the aggregate revolving commitments under our revolving credit facility increased by $50.0 million from $450.0 million to $500.0 million in accordance with the relevant provisions of the Credit Agreement.
On August 24, 2018, we and certain of our subsidiaries filed an automatic shelf registration statement on Form S-3 (Registration No. 333-227012), registering the offering and sale of an indeterminate amount of debt securities, guarantees of debt securities, preferred stock, common stock, warrants, depositary shares, purchase contracts and units that include any of these securities.
On July 6, 2018, we issued $300.0 million aggregate principal amount of the Senior Notes in an offering to persons reasonably believed to be qualified institutional buyers in the United States pursuant to Rule 144A under the Securities Act and to certain non-U.S. persons in transactions outside the United States pursuant to Regulation S under the Securities Act.

20

Table of Contents

Key Results
Key financial results as of and for the three months ended September 30, 2018, as compared to the three months ended September 30, 2017, were as follows:
Home sales revenues increased 4.0% to $380.4 million from $365.9 million.
Homes closed decreased 7.4% to 1,601 homes from 1,729 homes.
Average sales price of our homes increased 12.3% to $237,582 from $211,623.
Gross margin as a percentage of home sales revenues increased to 25.6% from 25.1%.
Adjusted gross margin (non-GAAP) as a percentage of home sales revenues increased to 27.4% from 26.5%.
Net income before income taxes decreased 3.7% to $49.0 million from $50.9 million.
Net income increased 12.0% to $37.7 million from $33.7 million.
EBITDA (non-GAAP) as a percentage of home sales revenues decreased to 14.6% from 15.4%.
Adjusted EBITDA (non-GAAP) as a percentage of home sales revenues increased to 15.5% from 15.3%.
Total owned and controlled lots increased 14.5% to 53,647 lots at September 30, 2018 from 46,855 lots at June 30, 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.”
Key financial results as of and for the nine months ended September 30, 2018, as compared to the nine months ended September 30, 2017, were as follows:
Home sales revenues increased 26.5% to $1,079.2 million from $853.0 million.
Homes closed increased 16.5% to 4,660 homes from 4,001 homes.
Average sales price of our homes increased 8.6% to $231,597 from $213,193.
Gross margin as a percentage of home sales revenues decreased to 25.6% from 26.0%.
Adjusted gross margin (non-GAAP) as a percentage of home sales revenues decreased to 27.3% from 27.4%.
Net income before income taxes increased 22.8% to $142.9 million from $116.4 million.
Net income increased 45.0% to $112.6 million from $77.7 million.
EBITDA (non-GAAP) as a percentage of home sales revenues decreased to 14.9% from 15.1%.
Adjusted EBITDA (non-GAAP) as a percentage of home sales revenues increased to 15.1% from 14.9%.
Total owned and controlled lots increased 35.1% to 53,647 lots at September 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.”

21

Table of Contents

Results of Operations
The following table sets forth our results of operations for the periods indicated: 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
 
 
(dollars in thousands, except per share data and average home sales price)
Statement of Income Data:
 
 
 
 
 
 
 
 
Home sales revenues
 
$
380,369

 
$
365,896

 
$
1,079,240

 
$
852,985

Expenses:
 
 
 
 
 
 
 
 
Cost of sales
 
283,035

 
274,000

 
802,882

 
631,242

Selling expenses
 
27,890

 
26,018

 
80,140

 
66,318

General and administrative
 
17,794

 
15,431

 
51,536

 
40,376

     Operating income
 
51,650

 
50,447

 
144,682

 
115,049

Loss on extinguishment of debt
 
3,058

 

 
3,599

 

Other income, net
 
(399
)
 
(430
)
 
(1,806
)
 
(1,312
)
     Net income before income taxes
 
48,991

 
50,877

 
142,889

 
116,361

Income tax provision
 
11,268

 
17,190

 
30,256

 
38,695

     Net income
 
$
37,723

 
$
33,687

 
$
112,633

 
$
77,666

Basic earnings per share
 
$
1.66

 
$
1.55

 
$
5.07

 
$
3.60

Diluted earnings per share
 
$
1.52

 
$
1.40

 
$
4.57

 
$
3.32

Other Financial and Operating Data:
 
 
 
 
 

 

Active communities at end of period
 
81

 
77

 
81

 
77

Home closings
 
1,601

 
1,729

 
4,660

 
4,001

Average sales price of homes closed
 
$
237,582

 
$
211,623

 
$
231,597

 
$
213,193

Gross margin (1)
 
$
97,334

 
$
91,896

 
$
276,358

 
$
221,743

Gross margin % (2)
 
25.6
%
 
25.1
%
 
25.6
%
 
26.0
%
Adjusted gross margin (3)
 
$
104,369

 
$
97,085

 
$
294,290

 
$
233,517

Adjusted gross margin % (2)(3)
 
27.4
%
 
26.5
%
 
27.3
%
 
27.4
%
EBITDA (4)
 
$
55,353

 
$
56,206

 
$
160,517

 
$
128,509

EBITDA margin % (2)(4)
 
14.6
%
 
15.4
%
 
14.9
%
 
15.1
%
Adjusted EBITDA (4)
 
$
58,862

 
$
55,830

 
$
163,157

 
$
127,423

Adjusted EBITDA margin % (2)(4)
 
15.5
%
 
15.3
%
 
15.1
%
 
14.9
%
(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) loss on extinguishment of debt, (vi) other income, net and (vii) adjustments resulting from the application of purchase accounting. Our management believes that the presentation of EBITDA and adjusted EBITDA provides useful information to investors regarding our results of operations because it assists both investors and management in analyzing and benchmarking the performance and value of our business. EBITDA and adjusted

22

Table of Contents

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

23

Table of Contents

Three Months Ended September 30, 2018 Compared to Three Months Ended September 30, 2017
Homes Sales. Our home sales revenues, closings, average sales price (ASP), average community count, average monthly, absorption rate and ending community count by division for the three months ended September 30, 2018 and 2017 were as follows (revenues in thousands):
 
 
Three Months Ended September 30, 2018
 
 
Revenues
 
Closings
 
ASP
 
Average Community Count
 
Average
Monthly
Absorption Rate
Central
 
$
150,045

 
691

 
$
217,142

 
29.3

 
7.9

Southwest
 
65,742

 
229

 
287,083

 
15.0

 
5.1

Southeast
 
73,507

 
352

 
208,827

 
19.7

 
6.0

Florida
 
38,750

 
183

 
211,749

 
10.7

 
5.7

Northwest
 
50,697

 
139

 
364,727

 
5.3

 
8.7

Midwest
 
1,628

 
7

 
232,571

 
2.0

 
1.2

Total
 
$
380,369

 
1,601

 
$
237,582

 
82.0

 
6.5

 
 
Three Months Ended September 30, 2017
 
 
Revenues
 
Closings
 
ASP
 
Average Community Count
 
Average
Monthly
Absorption Rate
Central
 
$
165,870

 
830

 
$
199,843

 
28.0

 
9.9

Southwest
 
66,002

 
255

 
258,831

 
16.0

 
5.3

Southeast
 
54,331

 
284

 
191,306

 
16.0

 
5.9

Florida
 
56,171

 
288

 
195,038

 
12.0

 
8.0

Northwest
 
23,522

 
72

 
326,694

 
4.3

 
5.6

Midwest
 

 

 

 

 

Total
 
$
365,896

 
1,729

 
$
211,623

 
76.3

 
7.6

 
As of September 30,
Community count
2018
 
2017
Central
28

 
28

Southwest
15

 
16

Southeast
21

 
16

Florida
10

 
12

Northwest
5

 
5

Midwest
2

 

Total community count
81

 
77

Home sales revenues for the three months ended September 30, 2018 were $380.4 million, an increase of $14.5 million, or 4.0%, from $365.9 million for the three months ended September 30, 2017. The increase in home sales revenues is primarily due to the increase in the average sales price per home during the three months ended September 30, 2018 as compared to the three months ended September 30, 2017, partially offset by a decrease in home closings by 7.4%. The average sales price per home closed during the three months ended September 30, 2018 was $237,582, an increase of $25,959, or 12.3%, from the average sales price per home of $211,623 for the three months ended September 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. The decrease in home closings was largely due to decreases in our Central and Florida divisions, partially offset by increases in our Southeast and Northwest divisions during the three months ended September 30, 2018 as compared to the three months ended September 30, 2017. The decreases in our Central and Florida divisions were mainly due to close out of or transition between, and to a lesser extent available inventory in, certain of their respective active communities.

24

Table of Contents

Our home sales revenues in our Central division decreased by $15.8 million, or 9.5% of home sales revenues, during the three months ended September 30, 2018 as compared to the three months ended September 30, 2017, representing a 16.7% decrease in the number of homes closed in this division during the three months ended September 30, 2018 as compared to the three months ended September 30, 2017. Our home sales revenues outside of the Central division increased by $30.3 million, or 15.1% of home sales revenues, during the three months ended September 30, 2018 as compared to the three months ended September 30, 2017, representing a 1.2% increase in the number of homes closed in these divisions during the three months ended September 30, 2018 as compared to the three months ended September 30, 2017. Our active selling communities at September 30, 2018 increased to 81 from 77 at September 30, 2017. All of the active selling communities added between September 30, 2017 and September 30, 2018 were outside of our Central division. All divisions maintained or added communities by expanding into new markets or deepening existing markets with the exception of the Southwest division, which had one fewer active community, and our Florida division, which had two fewer active communities due to close out or transition between certain of its active communities for the three months ended September 30, 2018 as compared to the three months ended September 30, 2017.
Cost of Sales and Gross Margin (home sales revenues less cost of sales). Cost of sales increased for the three months ended September 30, 2018 to $283.0 million, an increase of $9.0 million, or 3.3%, from $274.0 million for the three months ended September 30, 2017. This increase is primarily due to higher land costs and to a lesser extent, increased construction costs for homes closed during the three months ended September 30, 2018 as compared to the three months ended September 30, 2017, and, to a lesser degree, product mix, offset by a decrease in home closings during the three months ended September 30, 2018 as compared to the three months ended September 30, 2017. Gross margin for the three months ended September 30, 2018 was $97.3 million, an increase of $5.4 million, or 5.9%, from $91.9 million for the three months ended September 30, 2017. Gross margin as a percentage of home sales revenues was 25.6% for the three months ended September 30, 2018 and 25.1% for the three months ended September 30, 2017. This increase in gross margin as a percentage of home sales revenues is primarily due to a higher average home sales price, offset by a combination of higher land costs and construction costs.
Selling Expenses. Selling expenses for the three months ended September 30, 2018 were $27.9 million, an increase of $1.9 million, or 7.2%, from $26.0 million for the three months ended September 30, 2017. Sales commissions increased to $14.7 million for the three months ended September 30, 2018 from $14.4 million for the three months ended September 30, 2017, primarily due to a 4.0% increase in home sales revenues during the three months ended September 30, 2018 as compared to the three months ended September 30, 2017. Selling expenses as a percentage of home sales revenues were 7.3% and 7.1% for the three months ended September 30, 2018 and 2017, respectively. The increase in selling expenses as a percentage of home sales revenues reflects additional operating expenses associated with advertising and broker commissions.
General and Administrative. General and administrative expenses for the three months ended September 30, 2018 were $17.8 million, an increase of $2.4 million, or 15.3%, from $15.4 million for the three months ended September 30, 2017. General and administrative expenses as a percentage of home sales revenues were 4.7% and 4.2% for the three months ended September 30, 2018 and 2017, respectively. The increase in general and administrative expenses as a percentage of home sales revenues is primarily due to one-time acquisition related transaction expenses associated with the acquisition of Wynn Homes during the three months ended September 30, 2018 as compared to the three months ended September 30, 2017.
Loss on extinguishment of debt. Loss on extinguishment of debt for the three months ended September 30, 2018 was $3.1 million, due to debt issuance costs previously capitalized that were associated with our Credit Agreement. There was no loss on extinguishment of debt for the three months ended September 30, 2017.
Operating Income, Net Income before Taxes and Net Income. Operating income for the three months ended September 30, 2018 was $51.7 million, an increase of $1.2 million, or 2.4%, from $50.4 million for the three months ended September 30, 2017. Net income before income taxes for the three months ended September 30, 2018 was $49.0 million, a decrease of $1.9 million, or 3.7%, from $50.9 million for the three months ended September 30, 2017. The following divisions contributed to net income before income taxes during the three months ended September 30, 2018: Central - $25.6 million or 52.2%; Southwest - $8.8 million or 18.0%; Florida - $4.5 million or 9.2%; Southeast - $7.5 million or 15.3%; and Northwest - $7.1 million or 14.4%. Net income for the three months ended September 30, 2018 was $37.7 million, an increase of $4.0 million, or 12.0%, from $33.7 million for the three months ended September 30, 2017. The increases in operating income is a result of the 12.3% increase in average home sales price, partially offset by higher construction costs and a decrease in home closings. The decreases in net income before income taxes is primarily attributed to overall higher community count, the extinguishment of debt, one-time acquisition related expenses, and higher operating costs realized related to selling expenses for the three months ended September 30, 2018 as compared to the three months ended September 30, 2017. The increase in net income is primarily due to the decrease in the effective tax rate during the three months ended September 30, 2018 as compared to the three months ended September 30, 2017.

25

Table of Contents

Nine Months Ended September 30, 2018 Compared to Nine Months Ended September 30, 2017
Homes Sales. Our home sales revenues, closings, average sales price (ASP), average community count and average monthly absorption rate by division for the nine months ended September 30, 2018 and 2017 were as follows (revenues in thousands):
 
 
Nine Months Ended September 30, 2018
 
 
Revenues
 
Closings
 
ASP
 
Average Community Count
 
Average
Monthly
Absorption Rate
Central
 
$
438,811

 
2,062

 
$
212,808

 
28.8

 
8.0

Southwest
 
193,055

 
688

 
280,603

 
14.1

 
5.4

Southeast
 
178,984

 
879

 
203,622

 
17.9

 
5.5

Florida
 
136,211

 
649

 
209,878

 
11.2

 
6.4

Northwest
 
129,852

 
372

 
349,065

 
5.3

 
7.8

Midwest
 
2,327

 
10

 
232,700

 
1.7

 
0.7

Total
 
$
1,079,240

 
4,660

 
$
231,597

 
79.0

 
6.6

 
 
Nine Months Ended September 30, 2017
 
 
Revenues
 
Closings
 
ASP
 
Average Community Count
 
Average Monthly
Absorption Rate
Central
 
$
370,550

 
1,824

 
$
203,152

 
25.4

 
8.0

Southwest
 
162,386

 
635

 
255,726

 
16.1

 
4.4

Southeast
 
133,665

 
710

 
188,261

 
14.3

 
5.5

Florida
 
129,345

 
656

 
197,172

 
11.4

 
6.4

Northwest
 
57,039

 
176

 
324,085

 
4.1

 
4.8

Midwest
 

 

 

 

 

Total
 
$
852,985

 
4,001

 
$
213,193

 
71.3

 
6.2

Home sales revenues for the nine months ended September 30, 2018 were $1,079.2 million, an increase of $226.3 million, or 26.5%, from $853.0 million for the nine months ended September 30, 2017. The increase in home sales revenues is primarily due to a 16.5% increase in homes closed and an increase in the average sales price per home during the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017. This increase in home closings was largely due to the overall increase in the number of active communities in the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017. The average sales price per home closed during the nine months ended September 30, 2018 was $231,597, an increase of $18,404, or 8.6%, from the average sales price per home of $213,193 for the nine months ended September 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 $68.3 million, or 18.4% of home sales revenues, during the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017, representing a 13.0% increase in the number of homes closed in this division during the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017. We increased our home sales revenues in our divisions other than our Central division by $158.0 million, or 32.7% of home sales revenues, during the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017, representing a 19.3% increase in the number of homes closed in these divisions during the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017. Our active selling communities at September 30, 2018 increased to 81 from 77 at September 30, 2017.  All of the active selling communities added between September 30, 2017 and September 30, 2018 were outside of our Central division, contributing to the further geographic diversification of our business. All divisions maintained or added communities by expanding into new markets or deepening existing markets with the exception of the Southwest division, which had one fewer active community, and our Florida division, which had two fewer active communities due to close out or transition between certain of its active communities for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017.

26

Table of Contents

Cost of Sales and Gross Margin (home sales revenues less cost of sales). Cost of sales increased for the nine months ended September 30, 2018 to $802.9 million, an increase of $171.6 million, or 27.2%, from $631.2 million for the nine months ended September 30, 2017. This increase is primarily due to a 16.5% increase in homes closed during the nine months ended September 30, 2018 as compared to the nine months ended September 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 nine months ended September 30, 2018 was $276.4 million, an increase of $54.6 million, or 24.6%, from $221.7 million for the nine months ended September 30, 2017. Gross margin as a percentage of home sales revenues was 25.6% for the nine months ended September 30, 2018 and 26.0% for the nine months ended September 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 nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017, and to a lesser extent due to 238 wholesale home closings during the nine months ended September 30, 2018 compared to 168 wholesale home closings during the nine months ended September 30, 2017.
Selling Expenses. Selling expenses for the nine months ended September 30, 2018 were $80.1 million, an increase of $13.8 million, or 20.8%, from $66.3 million for the nine months ended September 30, 2017. Sales commissions increased to $42.2 million for the nine months ended September 30, 2018 from $33.5 million for the nine months ended September 30, 2017, largely due to a 26.5% increase in home sales revenues during the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017. Selling expenses as a percentage of home sales revenues were 7.4% and 7.8% for the nine months ended September 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 nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017.
General and Administrative. General and administrative expenses for the nine months ended September 30, 2018 were $51.5 million, an increase of $11.2 million, or 27.6%, from $40.4 million for the nine months ended September 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 nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017. General and administrative expenses as a percentage of home sales revenues were 4.8% and 4.7% for the nine months ended September 30, 2018 and 2017, respectively. The increase in general and administrative expenses as a percentage of home sales revenues reflects additional costs realized from the increase in community count and one-time acquisition related transaction expenses associated with the Wynn Homes acquisition during the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017.
Loss on extinguishment of debt. Loss on extinguishment of debt for the nine months ended September 30, 2018 was $3.6 million, due to debt issuance costs previously capitalized that were associated with our Credit Agreement. There was no loss on extinguishment of debt for the nine months ended September 30, 2017.
Operating Income, Net Income before Income Taxes and Net Income. Operating income for the nine months ended September 30, 2018 was $144.7 million, an increase of $29.6 million, or 25.8%, from $115.0 million for the nine months ended September 30, 2017. Net income before income taxes for the nine months ended September 30, 2018 was $142.9 million, an increase of $26.5 million, or 22.8%, from $116.4 million for the nine months ended September 30, 2017. The following divisions contributed to net income before income taxes during the nine months ended September 30, 2018: Central - $75.6 million or 52.9%; Southwest - $24.0 million or 16.8%; Florida - $16.1 million or 11.3%; Southeast - $19.4 million or 13.6%; and Northwest - $15.9 million or 11.1%. Net income for the nine months ended September 30, 2018 was $112.6 million, an increase of $35.0 million, or 45.0%, from $77.7 million for the nine months ended September 30, 2017. The increases in operating income, net income before income taxes and net income are primarily attributed to a 16.5% increase in homes closed, a higher average sales price, a decrease in the effective tax rate, and improved leverage realized during the nine months ended September 30, 2018 as compared to nine months ended September 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,

27

Table of Contents

other companies may not calculate adjusted gross margin information in the same manner that we do. Accordingly, adjusted gross margin information should be considered only as a supplement to gross margin information as a measure of our performance.
The following table reconciles adjusted gross margin to gross margin, which is the GAAP financial measure that our management believes to be most directly comparable (dollars in thousands):

 
Three Months Ended September 30,

Nine Months Ended September 30,

 
2018
 
2017

2018

2017
Home sales revenues
 
$
380,369

 
$
365,896


$
1,079,240

 
$
852,985

Cost of sales
 
283,035

 
274,000


802,882

 
631,242

Gross margin
 
97,334

 
91,896


276,358

 
221,743

Capitalized interest charged to cost of sales
 
6,185

 
5,135


17,085

 
11,548

Purchase accounting adjustments (1)
 
850

 
54


847

 
226

Adjusted gross margin
 
$
104,369

 
$
97,085