LGI Homes [LGIH] Conference call transcript for 2022 q1
2022-05-03 17:54:09
Fiscal: 2022 q1
Operator: Welcome to LGI Homes' First Quarter 2022 Conference Call. Today's call is being recorded, and a replay will be available on the company's website later today at www.lgihomes.com. We have allocated an hour for prepared remarks and Q&A. At this time, I will turn the call over to Josh Fattor, Vice President of Investor Relations at LGI Homes.
Josh Fattor: Thank you. Good afternoon and welcome to our conference call to discuss our results for the first quarter of 2022. I'll remind listeners that this call will contain forward-looking statements that include statements regarding LGI Homes' business strategy, outlook, plans, objectives and guidance for 2022. All such statements reflect management's current expectations. However, these statements involve assumptions and estimates and are, therefore, subject to risks and uncertainties that could cause management's expectations to prove to be incorrect. You should review our filings with the SEC, including our risk factors and cautionary statement about forward-looking statements sections for a discussion of the risks, uncertainties and other factors that could cause our actual results to differ from those presented in these forward-looking statements. You should consider all forward-looking statements in light of the related risks and not place undue reliance on these forward-looking statements, which speak only as of the date of this conference call, and are not guarantees of future performance. Additionally, we will discuss non-GAAP financial measures on today's call. Such information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Reconciliations of non-GAAP financial measures to the most comparable measures, prepared in accordance with GAAP, can be found in the earnings release that we issued this morning and in our quarterly report on Form 10-Q for the quarter ended March 31, 2022, that we expect to file with the SEC later today. This filing will be accessible on the SEC's website and in the Investor Relations section of our website. Our hosts for today's call are Eric Lipar, LGI Homes' Chief Executive Officer and Chairman of the Board; and Charles Merdian, Chief Financial Officer and Treasurer. I will now turn the call over to Eric.
Eric Lipar: Thanks, Josh. Good afternoon and welcome to our earnings call. I'll open with highlights on our first quarter, and then Charles will provide more details on our financial results. Finally, I'll close with an update on our performance so far in the second quarter, and our outlook for the rest of the year. Despite ongoing supply chain headwinds, we delivered strong first quarter operational results. Our average selling price was over $341,000, an increase of 24% over the same period last year. Absorptions for the quarter came in at 6 closings per community per month, well above our eight year first quarter average of 5.5. Dallas-Fort Worth was our top market with 13 closings per community per month; Houston was second with 11.3 followed by San Antonio with 11.2. Rounding out the top five were Nashville with 9.7 and Las Vegas with 8.7 closings per community per month. Congratulations to the teams in these markets on an impressive first quarter performance. During the quarter, cycle times continued to lengthen as we navigated supply shortages, labor constraints and inspection delays. Despite the impact these headwinds had on first quarter deliveries, our systems-based processes and continued pricing power enabled us to deliver record results in virtually all our profitability metrics. Gross margin and adjusted gross margin were up significantly, coming in at all-time highs of 29% and over 30%, respectively. EBITDA margins were also a first quarter record at over 19%. Finally, continued demand-driven efficiencies and disciplined cost controls helped deliver our pretax net income margin of over 18% and net income margin of over 14%, both of which were first quarter records. As part of our commitment to providing exceptional customer service, we are releasing homes for sale when they are within 60 days of closing. Doing so provides the clearest view of costs, improves the accuracy of estimating closing dates, limits customers' time and backlog and eliminates interest rate risk while they prepare to close. Despite rising rates and a metering of our sales pace, our orders were up 32% over last quarter and we ended March with more than 2,400 homes in backlog. Given the attention on rising interest rates, we're closely monitoring the sales in our backlog and can report that over 96% of our backlog has no interest rate exposure. Demand during the quarter was strong, supported by positive underlying fundamentals, including favorable demographics, low unemployment, a strong economy, tight inventory, rising rents, and the increased preference for homeownership born out of the pandemic. Nevertheless, prices of new and existing homes are up significantly and mortgage rates are expected to move higher. As a result, we are seeing signs that demand is normalizing from the unprecedented levels witnessed throughout 2021. We carefully monitor demand in each of our markets and while certainly not as hot as last year, we haven't seen the need to adjust our current course. In fact, with only 450 completed homes at quarter end and very few of those homes unsold, the primary constraint to closings continues to be longer cycle times and the opening of new communities. With that, I'll turn the call over to Charles for more details on our financial results.
Charles Merdian: Thanks, Eric. During the quarter, we closed 1,599 homes, a 37.6% decrease year-over-year as a result of fewer active communities. As noted, our pace of absorptions in those active communities remained above historical averages. Of our total closings during the quarter, 213 homes were sold through our wholesale business, representing 13.3% of our total closings, compared to 283 homes or 11.1% of our total closings in the same quarter last year. Our revenue in the first quarter was $546.1 million, a decline of 22.7% resulting from fewer closings and partially offset by higher average selling prices, compared to the same period last year. As Eric highlighted, our average sales price increased 23.9% over the same period last year and 7.7% sequentially, to a record $341,495. Price increases were primarily driven by a favorable demand environment that allowed us to pass through cost increases in all of our markets. Gross margin this quarter came in at 29%, a 210 basis point improvement over the same period last year and a new company record. The improvement resulted from our success in passing through cost increases, lower capitalized interest expense, and lower lot costs as a percentage of average selling price, partially offset by a larger percentage of wholesale closings. Our adjusted gross margin this quarter was also a new company record at 30.3%, a 180 basis point improvement over the same period last year. Adjusted gross margin excludes approximately $4.5 million of capitalized interest charged cost of sales during the quarter and $2.3 million related to purchase accounting together representing 130 basis points. Combined selling, general and administrative expenses for the quarter were 11.5% of revenue compared to 9.6% during the same period last year. Selling expenses for the quarter were $34.4 million or 6.3% of revenue compared to $42.8 million or 6.1% of revenue for the first quarter of 2021. General and administrative expenses totaled $28.3 million or 5.2% of revenue compared to $24.7 million or 3.5% of revenue for the same quarter last year. The 170 basis point increase was driven primarily by lower overall revenue compared to the same time last year, as well as investments in our people, including additional headcount in our construction and land acquisition and development departments to support our continued community count growth. EBITDA for the quarter was $104.4 million or 19.1% of revenue, a 10 basis point improvement over the same period last year and a new first quarter record. Adjusted EBITDA was $102.9 million or 18.8% of revenue, a 20 basis point decrease from the same period last year. Adjusted EBITDA excludes approximately $3.8 million of other income, and $2.3 million related to purchase accounting together representing approximately 30 basis points. Pretax net income was $99.6 million or 18.2% of revenue, a 70 basis point improvement over the first quarter of 2021 and a new first quarter record. Our effective tax rate in the first quarter was 21% compared to 19.2% in the same period last year. And our first quarter reported net income was $78.7 million or 14.4% of revenue. A first quarter of record and our earnings were $3.30 per basic share and $3.25 per diluted share. First quarter gross orders were 2,339, a decrease of 59.9% and net orders were 1,973, a decrease of 62.3% year-over-year. As we noted last quarter, the expected decline in our orders is primarily due to record prior year comps and our decision to defer sales to later in the construction process and limit our customer's time and backlog. Our cancellation rate for the first quarter was 15.6%. We finished the first quarter with a backlog of 2,429 homes representing over $849 million in value. As of March 31, our land portfolio consisted of 93,270 owned and controlled lots, a 38.6% increase year-over-year, and a 1.6% increase sequentially. We added over 5,800 new lots to our owned inventory and ended the quarter with 59,079 owned lots, an increase of 53.4% year-over-year and 7.7% sequentially. Of our owned lots, only 7,419 were finished vacant lots and 47,222 were either raw land or land under development. During the quarter, we started over 2,300 homes and as of March 31 had 4,438 completed homes, information centers or homes in process. Excluding information centers and homes related to our leasing initiative, only 450 homes were complete, a decline of 30.6% compared to the 648 complete homes at the end of the first quarter last year and significantly less than the 1,648 complete homes at the end of the first quarter in 2020. Finally, at quarter end, we had 34,191 controlled lots, an increase of 18.8% year-over-year, and a decrease of 7.5% sequentially as more of those lots were converted to owned. I'll conclude with an update on our capital position. We ended the quarter with $53.3 million in cash over $2.3 billion in real estate inventory and total assets of nearly $2.6 billion. Total debt at quarter end was $1 billion resulting in debt capitalization ratio of 41.4% and a net debt to capitalization ratio of 40%. We expect our leverage ratio will remain in the range between 35% and 45%. As of March 31, we had total liquidity of $161.6 million consisting of the $53.3 million of cash on hand and approximately $108 million available to borrow under our credit facility. On April 29, we successfully increased our liquidity through an amendment of our existing credit agreement that increases total commitments by $250 million, bringing the total facility size to $1.1 billion. In the last year, our shareholders equity increased by $204 million to over $1.4 billion. And we delivered a return on equity of 30.9% over the same period. During the first quarter, we returned $57.7 million to shareholders through the repurchase of 475,055 shares of our common stock. And we ended the quarter with 23.7 million shares. Since 2018, we have now repurchased over 2.5 million shares of our common stock and as of March 31 had approximately $249 million remaining on our stock repurchase program. At this point, I'll turn the call back over to Eric.
Eric Lipar: Thanks, Charles. During April, cost pressures and supply chain bottlenecks continue to impact our operation, slowing construction cycle times and delaying the openings of new communities. We expect these challenges to continue for the foreseeable future and are working closely with our trade partners and the municipalities where we operate to limit impacts on our customers. Despite these headwinds, our second quarter is off to a solid start and pending verifications of fundings, we expect to report that we close 703 homes in 91 active communities in April. Though absolute closings were down due to the lower community count, the absorption pace of 7.7 closings per community exceeded our eight-year historical average for fourth straight month this year. As highlighted in our press release this morning, we are revising upward our pricing and margin guidance. Based on our results to date, visibility into our backlog and outlook for the rest of the year, we now expect selling prices for the full year to be in a range between $335,000 and $350,000, gross margins between 27% and 29%, and adjusted gross margins between 28.5% and 30.5%. Our other guidance metrics for the full year are unchanged. To conclude, I want to thank our employees for their hard work, loyalty to our company, and commitment to our customers. LGI Homes was recently named as one of America's most trusted companies, a distinction that recognizes our employees' commitment to our core values of exceptional customer service, integrity and ethical behavior. Your dedication has enabled us to manage through numerous industry challenges and consistently deliver outstanding results and the first quarter was no exception. We'll now open the call for questions.
Operator: Thank you. Our first question comes from the line of Deepa Raghavan with Wells Fargo.
Deepa Raghavan: Hi. Good afternoon everyone. Thanks for taking the questions. Eric, you kept your original closings guidance, 9 to 10, but just given the slower start – 9,000 to 10,000 closing. But just given the slower start, should we think about risks to the high-end year? Or are you assuming anything within your supply chain that actually still keeps the higher end of guide pretty much in the works?
Eric Lipar: Yes, Deepa, great question. Yes. No, the closing guidance remains unchanged, 9,000 to 10,000 closings for the year. We think we're off to a solid start. But because of the way we're selling houses within 60 days of closing, demand remains solid. I think it's just a question of where we end up in the range is really what the back half of the year looks like. Still seeing solid demand even though rates are up and our costs are up, but it really depends on getting the houses built. We have a number of new communities opening in the third and fourth quarters that will impact that closing number, still seeing really solid demand from the single-family rental industry to buy our houses. So the range is still in play for sure.
Deepa Raghavan: Great. How should – Charles, this one is probably for you. How should we think about your cash flow this year? Your inventory stepped up a little bit more than I would have expected, maybe not a big surprise, but at the same time, you're calling for some demand moderation. Should we assume you're starting to take some defensive measures here and start to see your cash flow turn strongly positive by end of the year?
Charles Merdian: Yes. Thanks, Deepa. Great question. I think the way we're thinking about it from an inventory standpoint is that we still expect to increase our community count. So we see increases to community count. We're factoring in how we think about our inventory management in terms of vertical construction, based on what we're seeing in terms of expected absorption, so we kind of adjust accordingly, if you will. So as we move inventory into owned, we are still predominantly seeing, if not all of our deals that are coming to acquisitions committee, are raw land deal, so they're taking time if you will to spend that cash to get those sections ready, as we've been talking about delivering community count into 2023 and 2024. So I think I'd describe it as we're right in line with our expectations in terms of what we're investing in terms of land, land under development, and then as we mentioned on the call, just managing vertical inventory, completed inventory is significantly below where it normally would be. So we should see as things normalize, completed inventory start to move up into its normal ranges
Deepa Raghavan: Understood. Thanks for the color. I will pass it on. Good luck.
Eric Lipar: Thank you.
Charles Merdian: Thank you.
Operator: Thank you. And our next question comes from the line of Mike Rehaut with J.P. Morgan.
Doug Wardlaw: Hi. Doug Wardlaw on for Mike. I was wondering if you could give some further color on kind of your outlook for lumber inflation and just the cost – or potential for cost of grow throughout the remainder of the year? And how much of that is already embedded in the guidance?
Eric Lipar: Yes, Doug, great question. This is Eric. We're expecting cost to increase, continue to increase. That's been the trend so far this year. Our most recent starts costs were still up, and that was often all time high. So we're expecting cost to continue to increase, and we're expecting to pass on those costs to consumers and maintain our gross margins in a very strong area like we did by raising our gross margin guidance by 50 basis points, but we expect costs to continue to go up.
Doug Wardlaw: Awesome. Thank you. And then just in terms of your current level of incentives, I'm just curious on if that has changed or you envision that changing especially on rise – rates continue to rise, maybe there is a kind of tapering in demand? Is that something that you guys have thought about or come across to implement in the future?
Eric Lipar: Yes. No change in that at all. Right now, still seeing a very strong demand environment and we have very few houses to sell. And when we do put houses on the price list, they are generally still selling. Not quite as strong as it was, but coming off the comparisons of the best all time sales environment in history. So still solid. No reason to increase incentives. Right now, we're doing discounting at all. So we have no houses and no inventory finished and our costs are still increasing. So we're still raising prices to offset costs.
Doug Wardlaw: Awesome. Thank you guys.
Eric Lipar: You're welcome.
Operator: Thank you. And our next question comes from the line of Jay McCanless with Wedbush Securities.
Jay McCanless: Hi. All right, good afternoon everyone. Thanks for taking my questions. I guess, Eric, my first question, I think you said in your prepared comments that 96% of the backlog has no interest rate risk. Did I hear that correct?
Eric Lipar: That is correct.
Jay McCanless: So is that mortgage locks on consumers as well as some institutional buyers in the mix. Is that the way to think about it?
Eric Lipar: Correct. Yes, that's a great way to think about it. And also because of our – the way that we're selling, to make sure the customer has a great experience and make sure we're hitting our closing dates and not having interest rate exposure and make sure we understand our costs. We are not putting any houses on our price list for sale until we are within 60 days of closing, which is around the first day of sheet rock in our construction cycle and by doing that we can limit our interest rate exposure. So we sell a house within 60 days of closing. We are confident in the closing date delivering, when we're that close we take out a lot of the supply chain risk. The customer has a better experience. We have a better experience and have no interest rate exposure. So our backlog at the end of Q1 was 2,429 homes. And our assumption is that all of those or most of those are all scheduled to close in the second quarter. So, everything is locked and then those that aren't locked, going into the third quarter, the majority of those are cash buyers investors.
Jay McCanless: You stole my second question, and thank you for answering it before I asked it. I guess my follow-up to that is, with the unpredictability we've seen on the supply chain, et cetera, have you talked with your mortgage partner about potentially extending some locks, whether they're willing to do so? I mean we heard on another call last week that most lenders are coming with one year locks and have those types of programs available. So just any discussions you've had with your mortgage partner in case the supply chain and/or municipal issues get away from you?
Eric Lipar: Yes. We've had those discussions, Jay, but we came to the conclusion the best approach was just to shorten the cycle time, and not have to worry about interest rate exposure. And I think that's where our selling house within 60 days of closing really helps us, because we don't have those customers out there, like most builders that have longer cycle times. We don't have the customers out there that are scheduled to close in the third and fourth quarter right now that have to worry about where rates are going. We're just going to sell them and write a contract at the current rate, we'll lock them in. They're going to be within 60 days of closing, and we'll feel really good about our pipeline or that situation.
Jay McCanless: Okay. That sounds great. I will turn it over. Thank you.
Eric Lipar: Thank you, Jay.
Operator: Thank you. And our next question comes from the line of Truman Patterson with Wolfe Research.
Truman Patterson: Hi. Good morning every – or good afternoon everyone and thanks for taking my questions. Just for clarity, Eric, on those interest rate locks that you were talking about, could you just – I don't think I heard the cost on the prior answer.
Eric Lipar: Yes. No cost, normal operating business. We are not paying a fee for forward commitments or locking interest rates, and we don't need to, because going back to the comment that we expect our entire pipeline to close within 60 days or 96% of it, very little interest rate risk in our pipeline and no additional expense.
Truman Patterson: Okay. Okay. And then just on your target buyer. Mortgage rates continue moving higher, so do home prices, but we also have a heavy degree of rental inflation as well. I'm just trying to understand what your monthly mortgage payment spread is compared to that of some of the median rents of the buyers that you're targeting?
Eric Lipar: Yes. I think both have been going up. You're right on. Our monthly payments on our most value-oriented house and all of our communities is higher. There's no question. And we're in the affordable housing business and focused on that first-time homebuyer. And with the combination of rates going up and ASPs going up, it's not as affordable as it used to be. But I do believe that it's being offset and why we're still seeing strong demand is, because rental rates are also increasing and the single-family rental operators demand by houses from us is very strong and there's still a very low supply of finished inventory out there. So as of now, when we put houses on the price list, they are selling very quickly. We do believe that demand is going to moderate, because we're coming off such a strong demand environment, and eventually – I'm not sure the timing of it, but eventually the word we used in our prepared remarks in the press release and what we talk about internally is going back to a normalized demand environment. And from 2014 to 2020, for us, that was six to seven closings per community per month. It's just the last couple of years have been higher than that, but we do expect it to return to normalized at some point.
Truman Patterson: Okay. Okay. And then on the SG&A line, I noticed that your selling expenses ticked up, I think it was like 20 basis points year-over-year. Is that's simply due to, I don't know, if lost closings leverage might impact that? Or are you actively increasing your ad and marketing spend? Just trying to understand how we should view your strategy there and maybe some guidance around the metrics moving through 2022.
Charles Merdian: Yes. Sure, Truman. This is Charles. Not an increase in advertising spend, our advertising spend in terms of direct advertising, as a percentage of revenue, was very similar year-over-year. We did see a slight increase in co-broker. As we continue to have limited inventory, we see brokers on deals more frequently than we used to or historically. So we think – so also some delevering there in terms of the revenue being down year-over-year. And then pacing out through the rest of the year, I think selling certainly kind of demonstrates that it's predominantly variable whereas G&A is predominantly more fixed. So I think as revenue increases throughout the year, we'll see some leverage there to get us into our original guidance range of 9% to 10% expected for the full year.
Truman Patterson: All right. Thanks for taking my questions and good luck in the coming year.
Charles Merdian: Thanks, Truman.
Eric Lipar: Thanks, Truman.
Operator: Thank you. Your next question comes from the line of Carl Reichardt with BTIG.
Carl Reichardt: Hey guys. Thanks for taking my question. Have you seen any shift at all, Eric, in the consumers who are looking to go to arms as opposed to fixed rate right now?
Eric Lipar: We haven’t – we – our mortgage company doesn’t even offer arms at this point. We’re just focused on fixed rates.
Carl Reichardt: Okay. And then just as a housekeeping – as the percentage of backlog, the 24, 29, how much of that is bulk wholesale to single family rental operators?
Eric Lipar: About 10%. That’s still our guidance for the year is approximately 10% of the closings this year, we come from the single family rental space.
Carl Reichardt: And am I right that the stuff that’s in backlog now, it’s in backlog, but I think, you – it’s six to 12 months before you begin vertical construction on that, or is that accelerated right now? I’m just wondering if that 10% closes this year based on the footnote in the release.
Eric Lipar: Yes. Yes. No, every everything under backlog we’d expect to close this year.
Carl Reichardt: This year. Okay.
Eric Lipar: Yes.
Carl Reichardt: Okay. And then last question is when you talk about the change from sort of what has been frenzy to more moderation and more normalization, and you’ve said that before, in terms of what you think normalized pace is. What are the actual signs of that you’re seeing? Is it related to traffic or conversion rates of traffic or some other element that’s giving you the sense that things are slowing given that the orders themselves seem to be much more a function of just not having the product to move?
Eric Lipar: Yes. I think it’s similar to what the other builders have said, Carl, as well. It has been such unbelievably hot market that is just cooled from there, but still solid demand. When we release houses for sale, maybe we don’t sell every single one of them, but we sell most of them. But we end up selling them all before they’re complete. Our waitlists are not as robust as they used to be, because we’re going through our waitlists. We’re still not spending a lot of money on advertising because we don’t have the houses for sale. So we’ve got our advertising right to go and it can turn on the faucet when necessary. But we’re not there yet. We still don’t have any finished houses done. So just signs that it’s slowing off peak, but still very solid market.
Carl Reichardt: And the new community openings that you’ve done in the last sort of say quarter or so, I’m guessing that you’re still seeing really good traffic, really good demand for those opening phases, yes?
Eric Lipar: We are. And we are opening three new communities this week and we expect to see solid results as well.
Carl Reichardt: Super. Okay. Thanks, Eric. Appreciate it.
Eric Lipar: All right. Thanks, Carl. Thank you. And our next question comes from the line of Alex Barron with Housing Research.
Alex Barron: Yes. Thank you, gentlemen. I know historically you guys used to target a lot of rental communities and send mailers and stuff, given the jump in pricing and interest rates, you feel that your basic client base is changing. Is it now more, maybe buyers from coming from other builders or what has changed in your client base and in your marketing?
Eric Lipar: Yes, great question, Alex. We not doing much marketing right now and haven’t since the pandemic started because sales have been so robust. We haven’t even before the pandemic, we wasn’t doing nearly as much as direct mail because everything has went to the digital space if you will. So a lot more social media, internet, digital marketing, and I think that trend will continue once we ramp up our marketing spend. But I got buyers exactly the same buyers someone that’s currently paying rent, but at today’s prices and rates that customers just have to be able to afford a higher monthly payment. Maybe they’re going to select a smaller floor plan to get keep that monthly payment as affordable as possible. But we still view ourselves as an affordable alternative to renting. And with rental rates increasing and the number of renters increasing across the country, we think we’re well positioned for the future.
Alex Barron: Got it. And I think somebody else sort to ask this next question, but I’ll try to ask in a different way. So right now, obviously, the closings were 1,599 and I don’t know if you’ll stay at the 700 pace for the next couple of months, but let’s say that’s the case. It seems like a pretty big ramp up in the back half to hit the deliveries guide. So are you guys starting a lot more spec homes to get there or do you expect a lot more closings to come from institutional buyers in the back half or what gets us there, I guess, is what I’m trying to ask.
Eric Lipar: Yes. I think what’s going to get us there is the increased community account, increased inventory. We’re still seeing strong demand. So yes, we are starting construction on as many houses as we can nationwide because we want to get some inventory built. We need to get some inventory built because the demand we’re seeing both from the wholesale and our investors and also the retail side. So it’s really the ramp up of inventory community count is going to push us past that 9,000 number to get to the high end of the range. I think we’re going to need some relief on construction cycle times and supply chain disruption, maybe that happens in the back half of the year. Maybe it doesn’t, but I think that’s the difference between 9,000 and 10,000.
Alex Barron: Got it. All right. Thanks a lot. Best of luck.
Eric Lipar: Thank you.
Operator: Thank you. Your next question comes from the line of Ken Zener with KeyBanc.
Ken Zener: Afternoon, everybody.
Eric Lipar: Good afternoon.
Charles Merdian: Good afternoon.
Ken Zener: I just want to give you some metrics and maybe you could kind of respond to how you think it’ll unfold, because I've all become public, the larger public companies you guys have had. I think, the highest growth rate in terms of units market cap, et cetera. So your inventory is up about 2% year-over-year, about 20% from March 2020. Let’s call that right before COVID. The industry’s inventory overall, the public builders is up about 25% and about 65% in units since that same March 2020 backlog period, and rates are going up, I know demand is very strong and deep as it relates to institutional investors. But how do you think this kind of plays out given, I think Black Knight put out the fact that affordability is almost at, an all time low, clearly you’re at the lower end and farther out, which I think is historically provided you very good dynamics, but the whole industry building more units because of the slower cycle time, how are you going to manage that? What are you looking for to see deceleration since you’re building homes in order to release them because the construction cycle times had been delayed? Like what are you looking at that would moderate the outlook you have right now for the industry?
Eric Lipar: Yes, it’s a great question. I think we’re looking at everything is the answer we’re looking at every community nationwide week by week, we’re monitoring traffic, we’re monitoring sales, cancellations closings, and we don’t know what the future holds. We’re optimistic about future. And I think a lot has to do with our people and the systems that we have in place, no matter what happens over the next couple quarters with rates in supply chain. We think we have the systems in place to deal with that. We do believe that demand will normalize just because it’s been so really strong over the last couple years. But if closing slow down, we will adjust our inventory accordingly. We believe that prices will remain high because our costs are going to remain high. And that’s really just a question of absorptions. We’ll adjust our inventory accordingly. And if things slow down considerably how we look at that as it creates opportunity for LGI, whether it’s M&A opportunity, buying more finished lots or land acquisitions opportunity or stock buyback opportunities. So we’re optimistic under any scenario that’s thrown at us and we have the systems in place to succeed at anything that’s thrown at us.
Ken Zener: And when you talk about normal, we could talk about construction cycle times. We could talk about, the kind of six order pace or the industries closer to four. We could talk about gross margins at 20. I mean, do all those things really make sense to you, sooner versus later in terms of how you’re managing your risk, because you’re obviously more than other builders, you’re self-developing your land, which gives you hypothetically a lot of embedded equity.
Eric Lipar: Yes, no. I think that’s accurate. We think everything’s going to normalize, gross margin being above adjusted gross margin north of 30. We don’t think that’s – that will continue long term either because our adjusted gross margin every year, pre-pandemic and pre last quarters between 25% and 28%. I think the key thing we’re also looking at is on land acquisitions. When we make a decision to go forward on a piece of property we’re buying is making sure we are underwriting that at normalized absorptions, the costs are elevated when we’re looking at deals to buy. We’re not underwriting, the costs are going to come down. We’re not estimating that the ever sales price are going to come down either, but the absorption we are looking closely at and the deals we are proving to proceed to closing are based on historical absorptions, not absorptions over the last 12 to 18 months.
Ken Zener: Thank you very much, gentlemen.
Eric Lipar: You’re welcome. Thank you.
Operator: Thank you. And our next question comes from the line of Jay McCanless with Wedbush.
Jay McCanless: Hey, thanks for taking my follow-ups. The first one I had when I look at your gross margin guidance for the full year, are you all expecting like some of your competitors we’ve heard from earlier in this earnings cycle that potentially incentives and or competition picks up and you might see back half gross margins to be a little bit lower than what you’re seeing in the front half, or just maybe how you all are thinking about gross margin trajectory through the rest of the year?
Charles Merdian: Yes. Great question, Jay. This is Charles. I think you’re right. I think for us, it really is just the back half of the year is just a little bit more unknown. So we feel very confident in terms of what we see in the existing backlog. But the third and fourth quarter are just yet to be determined. So I think it implies that we’re moving towards that normalization that Eric was talking about and just we’re going to evolve back into that normal range and it seems likely or reasonable that may occur in the back half.
Jay McCanless: Okay. And then just wanted to ask follow-up Carl’s question. Why – I guess, why isn’t your mortgage partner willing to offer arm? Is it something to do with your buyer base or just not wanting to take that type of risk in a moving rate environment?
Eric Lipar: Yes, I probably should have said we don’t offer arms. I think if the customer wanted to really look at in that, but we’ve just always ran it as a company that the borrowers are better off getting a fixed rate mortgage. Rates are still in the historical realms still very good. Most of our customers are getting interest rates in the fives on a fixed rate. So it’s just, we think it’s a better option for most of our customers. But if there’s someone that was passionate about it, our mortgage company certainly has the ability to offer arms if necessary.
Jay McCanless: Okay. Okay, great. Thanks again for taking the follow-up.
Eric Lipar: You’re welcome.
Operator: Thank you. At this time, I’m not showing any further questions.
Eric Lipar: Okay. Well, we appreciate everybody’s time today and thanks for participating and have a great day.
Operator: This concludes LGI Homes’ first quarter 2022 conference call. Have a great day.
