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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
   

ý
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2014.
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
(Registrant’s Telephone Number, Including Area Code)
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes  ý  No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o
 
Accelerated filer o
 
Non-accelerated filer  x
 
Smaller reporting company  o
 
 
 
 
(Do not check if a smaller reporting company)
 
 
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 10, 2014, there were 20,763,449 shares of the registrant’s common stock, par value $.01 per share, issued and outstanding.




TABLE OF CONTENTS
   



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


2


PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

LGI HOMES, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
 
 
 
September 30,
 
December 31,
 
 
2014
 
2013
ASSETS
 
(Unaudited)
 
 
Cash and cash equivalents
 
$
46,161

 
$
54,069

Accounts receivable
 
9,713

 
5,402

Real estate inventory
 
291,988

 
141,983

Pre-acquisition costs and deposits
 
12,729

 
3,703

Deferred taxes, net
 
467

 
288

Property and equipment, net
 
1,373

 
845

Other assets
 
4,730

 
1,992

Goodwill and intangible assets, net
 
12,543

 
12,728

Total assets
 
$
379,704

 
$
221,010

 
 
 
 
 
LIABILITIES AND EQUITY
 
 
 
 
Accounts payable
 
$
15,449

 
$
14,001

Accrued expenses and other liabilities
 
17,747

 
7,100

Notes payable
 
160,188

 
35,535

Total liabilities
 
193,384

 
56,636

 
 
 
 
 
COMMITMENTS AND CONTINGENCIES
 

 

EQUITY
 
 
 
 
Common stock, par value $0.01, 250,000,000 shares authorized, 20,763,449 issued and outstanding
 
208

 
208

Additional paid-in capital
 
158,325

 
157,056

Retained earnings
 
27,787

 
7,110

Total equity
 
186,320

 
164,374

Total liabilities and equity
 
$
379,704

 
$
221,010














See accompanying notes to the consolidated financial statements.

3


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,
 
 
2014
 
2013
 
2014
 
2013
Revenues:
 
 
 
 
 

 

Home sales
 
$
92,516

 
$
37,035

 
$
274,848

 
$
95,033

Management and warranty fees
 

 
1,007

 

 
2,309

Total revenues
 
92,516

 
38,042

 
274,848

 
97,342

Cost of sales
 
67,256

 
27,083

 
201,661

 
69,225

Selling expenses
 
9,239

 
3,589

 
25,788

 
9,082

General and administrative
 
6,115

 
4,052

 
16,557

 
9,078

Income from unconsolidated LGI/GTIS Joint Ventures
 

 
(1,976
)
 

 
(2,920
)
Operating income
 
9,906

 
5,294

 
30,842

 
12,877

Interest expense, net
 

 
(41
)
 

 
(47
)
Other income, net
 
628

 
34

 
663

 
56

Net income before income taxes
 
10,534

 
5,287

 
31,505

 
12,886

Income tax provision
 
(3,488
)
 
(137
)
 
(10,828
)
 
(273
)
Net income
 
7,046

 
5,150

 
20,677

 
12,613

Loss attributable to non-controlling interests
 

 
437

 

 
583

Net income attributable to owners
 
$
7,046

 
$
5,587

 
$
20,677

 
$
13,196

Basic and diluted earnings per share data:
 
 
 
 
 

 

Basic
 
$
0.34

 
 
 
$
1.00

 

Diluted
 
$
0.34

 
 
 
$
0.99

 


 

 
 
 

 

Weighted average number of shares of common stock:
 
 
 
 
 

 

Basic
 
20,763,449

 
 
 
20,763,449

 

Diluted
 
20,881,827

 
 
 
20,871,757

 
















See accompanying notes to the consolidated financial statements.

4


LGI HOMES, INC.
CONSOLIDATED STATEMENTS OF EQUITY
(Unaudited)
(In thousands, except share data)
 
 
 
Common Stock
 
Additional Paid-In Capital
 
Retained Earnings
 
Total Equity
 
 
Shares
 
Amount
BALANCE—December 31, 2013
 
20,763,449

 
$
208

 
$
157,056

 
$
7,110

 
$
164,374

Net income
 

 

 

 
20,677

 
20,677

Issuance of restricted stock units in settlement of accrued bonuses
 

 

 
642

 

 
642

Compensation expense for equity awards
 

 

 
627

 

 
627

BALANCE—September 30, 2014
 
20,763,449

 
$
208

 
$
158,325

 
$
27,787

 
$
186,320






































See accompanying notes to the consolidated financial statements.

5


LGI HOMES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
 
 
Nine Months Ended
 
 
September 30,

 
 
2014
 
2013
Cash flows from operating activities:
 
 
 
 
Net income
 
$
20,677

 
$
12,613

Adjustments to reconcile net income to net cash used in operating activities:
 

 

Income from unconsolidated LGI/GTIS Joint Ventures
 

 
(2,920
)
Distributions from unconsolidated LGI/GTIS Joint Ventures
 

 
3,027

Depreciation and amortization
 
471

 
199

Gain on settlement of participation fee obligation
 

 
(9
)
Loss on disposal of assets
 
14

 
61

Compensation expense for equity awards
 
627

 

Deferred income taxes
 
(179
)
 

Changes in assets and liabilities:
 
 
 
 
Accounts receivable
 
(4,312
)
 
(682
)
Real estate inventory
 
(143,534
)
 
(38,311
)
Pre-acquisition costs and deposits
 
(9,026
)
 
(2,674
)
Other assets
 
(589
)
 
(1,843
)
Accounts payable
 
1,449

 
3,257

Accrued expenses and other liabilities
 
4,817

 
3,001

Net cash used in operating activities
 
(129,585
)
 
(24,281
)
Cash flows from investing activities:
 
 
 
 
Capital investments in unconsolidated LGI/GTIS Joint Ventures
 

 
(928
)
Capital distributions from unconsolidated LGI/GTIS Joint Ventures
 

 
148

Proceeds from disposal of assets
 

 
35

Purchases of property and equipment
 
(828
)
 
(533
)
Net cash used in investing activities
 
(828
)
 
(1,278
)
Cash flows from financing activities:
 
 
 
 
Proceeds from notes payable
 
127,528

 
64,151

Payments on notes payable
 
(2,875
)
 
(51,362
)
Loan issuance costs
 
(2,148
)
 

Contributions from owners
 

 
2,535

Distributions to owners
 

 
(3,240
)
Contributions from non-controlling interests
 

 
15,797

Net cash provided by financing activities
 
122,505

 
27,881

Net increase (decrease) in cash and cash equivalents
 
(7,908
)
 
2,322

Cash and cash equivalents, beginning of period
 
54,069

 
7,069

Cash and cash equivalents, end of period
 
$
46,161

 
$
9,391





See accompanying notes to the consolidated financial statements.

6


LGI HOMES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.     ORGANIZATION AND BUSINESS
Organization and Description of the Business
LGI Homes, Inc., a Delaware corporation (the ''Company''), was organized on July 9, 2013 as a holding company for the purpose of facilitating the initial public offering (the "IPO") of its common stock in November 2013.
The Company's principal business is the development of communities and the design and construction of homes. At September 30, 2014, the Company had operations in Texas, Arizona, Florida, Georgia, New Mexico, Colorado, and South Carolina.
Initial Public Offering and Reorganization Transactions
On November 13, 2013, the Company completed the IPO and received net proceeds of $102.6 million. In conjunction with the IPO, the Company completed the reorganization of LGI Homes Group, LLC and LGI Homes Corporate, LLC and their consolidated subsidiaries and variable interest entities, as well as LGI Homes II, LLC, LGI Homes - Sunrise Meadow, LLC, LGI Homes - Canyon Crossing, LLC, and LGI Homes - Deer Creek, LLC, (collectively, the "Predecessor") into LGI Homes, Inc. (the "Reorganization Transactions").
Immediate family members, a father and son (the "Family Principals"), individually or jointly owned more than 50% of the voting ownership interest of each entity comprising the Predecessor. The Predecessor entities and the Company were under common management, operated in the same business, and were controlled by the Family Principals immediately before and after the Reorganization Transactions. Following the Reorganization Transactions, the entities that comprised the Predecessor are wholly-owned subsidiaries of the Company. The Reorganization Transactions were accounted for at the transaction date as a consolidation of entities under common control. In addition, since the Predecessor controlled LGI Fund III Holdings, LLC before and after the IPO, the Company accounted for the acquisition of the non-controlling interests as an equity transaction. The accompanying unaudited statements of operations for the three and nine months ended September 30, 2013 and the statement of cash flows for the nine months ended September 30, 2013 present the historical combined financial statements of the Predecessor.

2.     ACQUISITION OF LGI/GTIS JOINT VENTURE PARTNERS' INTERESTS
Concurrent with the IPO, the Company acquired from GTIS Partners, LP and its affiliated entities (''GTIS'') all of GTIS’ equity interests in four unconsolidated joint ventures with the Predecessor, namely LGI-JV Holdings, LLC (formerly LGI-GTIS Holdings, LLC), LGI-JV Holdings II, LLC (formerly LGI-GTIS Holdings II, LLC), LGI-JV Holdings III, LLC (formerly LGI-GTIS Holdings III, LLC) and LGI-JV Holdings IV, LLC (formerly LGI-GTIS Holdings IV, LLC) (collectively, the ''LGI/GTIS Joint Ventures''), in exchange for aggregate consideration of $41.3 million, consisting of cash of approximately $36.8 million and 409,091 shares of the Company’s common stock valued at $4.5 million on the IPO date (the "GTIS Acquisitions"). As discussed at Note 6, the LGI/GTIS Joint Ventures were historically accounted for as unconsolidated joint ventures under the equity method of accounting. As a result of the GTIS Acquisitions, the Company consolidated these entities. As required by ASC Topic 805, Business Combinations ("ASC Topic 805"), the acquired assets and assumed liabilities were accounted for at fair value and the Predecessor’s historical interests in the joint ventures were remeasured at fair value.
In connection with the purchase accounting, the Company recorded a gain of $6.4 million on the re-measurement of the Predecessor’s equity interest in the LGI/GTIS Joint Ventures and $12.7 million of goodwill and other intangibles. In addition, there was a $7.9 million step-up adjustment to record the acquisition date real estate inventory and lot option contracts at fair value. Approximately $0.4 million and $2.4 million of the $7.9 million fair value step-up adjustment is included in cost of sales for the three and nine month periods ended September 30, 2014, respectively, related to real estate inventory and lot option contracts at November 13, 2013 that were sold during the respective periods. As of September 30, 2014, a total of $5.8 million of the step-up adjustment has been amortized to cost of sales.

Supplemental Pro-Forma Information
The supplemental pro forma information presented below presents the home sales revenues, cost of sales, and net income before income taxes of the Company as if the GTIS Acquisitions had been completed on January 1, 2012.
The pro forma adjustments are based upon available information and certain assumptions that the Company believes are reasonable under the circumstances. The pro forma consolidated financial data is presented for informational purposes only. The pro forma consolidated financial data does not purport to represent what the Company's results of operations would have been

7


had the GTIS Acquisitions actually occurred on January 1, 2012 and does not purport to project the Company's results of operations for any future period.

 
 
Three Months Ended September 30,

Nine Months Ended September 30,
Pro Forma Financial Information

2013
 
2013
 
 
(in thousands)
Home sales revenues

$
67,997

 
$
163,966

Cost of sales

$
49,429

 
$
118,856

Net income before income taxes

$
7,996

 
$
19,450

The pro forma results have been adjusted to reflect the elimination of the Predecessor's equity in earnings of the LGI/GTIS Joint Ventures. The pro forma results also reflect $0.1 million and $0.2 million for the three and nine months ended September 30, 2013, respectively for the amortization expense related to the marketing intangible asset. The pro forma financial information excludes the impact of the gain on re-measurement and the incremental impact of the fair value step-up adjustment of real estate inventory and lot option contracts as these are considered to be non-recurring items.

3.     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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 the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2013. The accompanying unaudited consolidated financial statements include all adjustments that are of a normal recurring nature and necessary for the fair presentation of the Company’s 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 and for the three and nine months ended September 30, 2014 include the accounts of LGI Homes, Inc. and its subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.

The accompanying unaudited financial statements for the three and nine months ended September 30, 2013 include the Predecessor's historical combined accounts and results of operations. All intercompany and intracompany balances and transactions have been eliminated.

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. The significant accounting estimates include real estate inventory and cost of sales, impairment of real estate inventory and property and equipment, warranty reserves and loss contingencies.

Cash and Cash Equivalents and Concentration of Credit Risk

Cash and cash equivalents are defined as cash on hand, demand deposits with financial institutions, and short-term liquid investments with an initial maturity date of less than three months. The Company’s cash in demand deposit accounts may exceed federally insured limits and could be negatively impacted if the underlying financial institutions fail or are subject to other adverse conditions in the financial markets. To date, the Company has experienced no loss or diminished access to cash in their demand deposit accounts.




8


Accounts Receivable

Accounts receivable consist primarily of proceeds due from title companies for sales closed prior to period end and are generally collected within a few days from closing.

Real Estate Inventory

Inventory consists of land, land under development, finished lots, sales offices, homes in progress, and completed homes. 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, 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 (principally capitalized interest and property taxes) 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 using the total number of lots in the community. Management believes the allocation of land development costs on a pro rata basis approximates an allocation using a relative sales value method. Inventory costs for completed homes are expensed to cost of sales as homes are sold. 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 sales office 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.
In accordance with the provisions of ASC Topic 360, Property, Plant, and Equipment ("ASC Topic 360"), real estate inventory is evaluated for indicators of impairment by each community during each reporting period. In conducting its review for indicators of impairment on a community level, management evaluates, among other things, the margins on homes that have been sold, communities with slow moving inventory, projected margins on future home sales over the life of the community, and the estimated fair value of the land. For individual communities with indicators of impairment, additional analysis is performed to estimate the community’s undiscounted future cash flows. If the estimated undiscounted future cash flows are greater than the carrying value of the community group of assets, no impairment adjustment is required. If the estimated undiscounted future cash flows are less than the community’s carrying value, the asset group is impaired and is written down to its fair value. The Company estimates the fair value of communities using a discounted future cash flow model. As of September 30, 2014 and December 31, 2013, the real estate inventory is stated at cost; there were no inventory impairment indicators noted for the nine months ended September 30, 2014 and 2013.

Capitalized Interest

Interest and other financing costs are capitalized as cost of inventory during community development and home construction activities, in accordance with ASC Topic 835, Interest (''ASC Topic 835'') and expensed in cost of sales as homes in the community are sold. To the extent the debt exceeds qualified assets, a portion of the interest incurred is expensed.

Pre-Acquisition Costs and Deposits

Amounts paid for land options, deposits on land purchase contracts, and other pre-acquisition costs are capitalized and classified as deposits to purchase. Upon execution of the purchase, these deposits are applied to the acquisition price of the land and recorded as a cost component of the land in real estate inventory. To the extent that any deposits are nonrefundable and the associated land acquisition process is terminated or no longer determined probable, the related deposits are charged to general and administrative expense. Management reviews the likelihood of the acquisition of contracted lots in conjunction with its periodic real estate impairment analysis.

Under ASC Topic 810, Consolidation ("ASC Topic 810"), a nonrefundable deposit paid to an entity is deemed to be a variable interest that will absorb some or all of the entity's expected losses if they occur. Non-refundable land purchase and lot option deposits generally represent the Company's maximum exposure if it elects not to purchase the optioned property. In some instances, the Company may also expend funds for due diligence, development and construction activities with respect to optioned land prior to close. Such costs are classified as preacquisition costs, which the Company would have to absorb should

9


the option not be exercised. Therefore, whenever the Company enters into a land option or purchase contract with an entity and makes a nonrefundable deposit, it may have a variable interest in a variable interest entity ("VIE"). In accordance with ASC Topic 810, the Company performs ongoing reassessments of whether it is the primary beneficiary of a VIE and would consolidate the VIE if the Company is deemed to be the primary beneficiary. As of September 30, 2014 and December 31, 2013, the Company was not deemed to be the primary beneficiary for any VIEs associated with non-refundable land deposit and option contracts.

Deferred Loan Costs

Deferred loan costs represent debt issuance costs and, depending on the nature and purpose of the loan, are capitalized to real estate inventory or amortized to interest expense using the straight-line method which approximates the effective interest method.

Property and Equipment

Property, equipment and leasehold improvements are stated at cost, less accumulated depreciation. Depreciation expense is recorded in general and administrative expenses. Upon sale or retirement, the costs and related accumulated depreciation are eliminated from the respective accounts and any resulting gain or loss is included in other income, net. Depreciation is generally computed using the straight-line method over the estimated useful lives of the assets, ranging from 3 to 7 years for property and equipment. Leasehold improvements are depreciated over the shorter of the asset life or the term of the lease. Maintenance and repair costs are expensed as incurred.

Impairments of long-lived assets are determined periodically when indicators of impairment are present. If such indicators are present, the determination of the amount of impairment is based on judgments as to the future undiscounted operating cash flows to be generated from these assets throughout their remaining estimated useful lives. If these undiscounted cash flows are less than the carrying amount of the related asset, impairment is recognized for the excess of the carrying value over its fair value. There were no indicators of impairments noted for property, equipment and leasehold improvements for the nine months ended September 30, 2014 and 2013.

Investments in Joint Ventures and Unconsolidated Variable Interest Entities (VIEs)

The Predecessor functioned as the managing member of several joint ventures conducting homebuilding activities; these joint ventures became wholly-owned subsidiaries of the Company as a result of the Reorganization Transactions and the GTIS Acquisitions.

In accordance with ASC Topic 810, management had assessed whether these entities were VIEs. The Predecessor had variable interests in the joint venture arrangements that it managed, and these joint ventures were determined to be VIEs because the members of the joint ventures, as a group, had insufficient equity at risk without further capital contributions. The Predecessor’s rights as well as the rights held by the other joint venture members had been evaluated to determine the primary beneficiary of the VIE, including the extent of substantive participating rights and control of activities that most significantly affected its economic performance. Such activities included, but were not limited to, the ability to determine the budget and scope of land development work, if any; the ability to control financing decisions for the VIE; and the ability to acquire additional land into the VIE. If the Predecessor was not able to control the significant decisions, the Predecessor was not considered the primary beneficiary of the VIE. If the Predecessor was determined to be the primary beneficiary of the VIE, the entity was consolidated in the Predecessor's financial statements.

The Predecessor had investments in four joint ventures where the Predecessor and the other joint venture members were deemed to have joint control and the Predecessor was not the primary beneficiary since all major decisions required both parties’ consent. Accordingly, the Predecessor’s interests in these joint ventures were accounted for using the equity method and its share of the joint ventures’ net earnings was included in income from unconsolidated joint ventures and investments in unconsolidated joint ventures. Distributions received were credited against the related investment in the joint venture.

During the nine months ended September 30, 2013, the Predecessor formed one VIE, LGI Fund III Holdings, LLC, where it had been determined that the Predecessor was the primary beneficiary. In addition to the Predecessor serving as the managing member of this entity, a Family Principal of the Predecessor also held the general partner controlling interest in the non-managing member of the VIE. As a result, the Predecessor combined with the Family Principal’s related party interest had the power to direct all significant activities of the VIE, and had exposure to the risks and rewards of the VIE, based on the division of income and loss pursuant to the joint venture agreement and the Predecessor’s ownership in the joint venture. This

10


VIE is consolidated in the accompanying unaudited financial statements for the three and nine months ended September 30, 2013.

Management evaluated the Company’s investments in unconsolidated entities for indicators of impairment during each reporting period. No impairment charges were recorded related to investments in unconsolidated entities as of September 30, 2013.

Goodwill and Intangible Assets

The excess of the purchase price of a business acquisition over the net fair value of assets acquired and liabilities assumed is capitalized as goodwill in accordance with ASC Topic 805. ASC Topic 805 requires that goodwill and intangible assets that do not have finite lives are not amortized, but are assessed for impairment at least annually or more frequently if certain impairment indicators are present. The Company recorded $12.0 million of goodwill related to the GTIS Acquisitions. No goodwill impairment indicators were noted for the nine months ended September 30, 2014.

The cost of a marketing intangible asset acquired valued at $0.7 million related to the GTIS Acquisitions is being amortized over its estimated useful life of 3 years. When certain events or changes in operating conditions occur, the estimated future undiscounted cash flows associated with the asset are compared to the asset’s carrying amount to determine if an impairment of such asset is necessary. For intangible assets that are amortized, a review is performed of their estimated useful lives to evaluate whether events and circumstances warrant a revision to the remaining useful life. No impairment indicators were present during the nine months ended September 30, 2014 associated with this intangible asset.

Warranty Reserves

Future direct warranty costs are accrued and charged to cost of sales in the period when the related home is sold. The Company’s warranty liability is based upon historical warranty cost experience and is adjusted as appropriate to reflect qualitative risks associated with the types of homes built, the geographic areas in which they are built, and potential impacts of the Company's continued expansion.

Warranty reserves are reviewed quarterly to assess the reasonableness and adequacy and to make adjustments to the balance of the pre-existing reserves, as needed, to reflect changes in trends and historical data as information becomes available.

Customer Deposits

Customer deposits are received upon signing a purchase contract and are typically $500 - $1,000. Deposits are generally refundable if the customer is unable to obtain financing. Forfeited buyer deposits related to home sales are recognized in other income in the period in which it is determined that the buyer will not complete the purchase of the property and the deposit is nonrefundable to the buyer.

Home Sales

In accordance with ASC Topic 360 – 20, Real Estate Sales ("ASC Topic 360 – 20"), revenues from home sales are recorded at the time each home sale is closed, title and possession are transferred to the buyer, and the Company has no significant continuing involvement with the home. Home sales proceeds are generally received from the title company within a few days after closing. Home sales are reported net of sales discounts and incentives granted to home buyers, which are primarily seller-paid closing costs.

Cost of Sales

As discussed under Real Estate Inventory above, cost of sales for homes closed include the construction costs of each home and allocable land acquisition and land development costs, capitalized interest, and other related common costs (both incurred and estimated to be incurred).

Selling and Commission Costs

Sales commissions are paid and expensed based on homes closed. Other selling costs are expensed in the period incurred.

11


Advertising Costs

Advertising and direct mail costs are expensed as incurred. Advertising and direct mail costs were $2.3 million and $0.8 million for the three months ended September 30, 2014 and 2013, respectively. Advertising and direct mail costs were $6.0 million and $1.9 million for the nine months ended September 30, 2014 and 2013, respectively.

Income Taxes

The Company utilizes the liability method of accounting for income taxes. Under the liability method, deferred tax assets and liabilities are recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that some portion or all of the net deferred tax assets will not be realized. The Company’s ability to realize deferred tax assets is assessed throughout the year and a valuation allowance is established, if required. The Company recognizes the impact of a tax position only if it is more likely than not to be sustained upon examination based on the technical merits of the position. The Company recognizes potential interest and penalties related to uncertain tax positions in income tax expense.

The Company's effective tax rate of 34.4% is lower than the statutory rate primarily as a result of a decrease in the rate for the federal Domestic Production Activity Deduction offset by an increase in rate for state income taxes, net of the federal benefit. The current year rate of 34.4% is greater than the prior year rate of 2.1% because prior to the Reorganization Transactions, the Predecessor consisted of limited liability companies and limited partnerships, all of which were treated as partnerships for income tax purposes and as such, the federal income taxes were the obligation of the individual members or partners. Federal and state income taxes of approximately $3.8 million and $0.1 million were paid during the three months ended September 30, 2014 and 2013, respectively. Federal and state income taxes of approximately $12.0 million and $0.3 million were paid during the nine months ended September 30, 2014 and 2013, respectively.

Earnings Per Share

Basic earnings per share is based on the weighted average number of shares of common stock outstanding. Diluted earnings per share is based on the weighted average number of shares of common stock and dilutive securities outstanding. Non-vested grants of restricted stock awards were the only potentially dilutive share equivalents the Company had outstanding at September 30, 2014.

Stock-Based Compensation

Compensation costs for non-performance-based restricted stock awards are measured using the closing price on the date of grant and are expensed on a straight-line basis over the vesting period of the award. Compensation costs for performance-based restricted stock awards are also measured using the closing price on the date of grant but are expensed in accordance with ASC 718-10-25-20, Compensation - Stock Compensation ("ASC 718-10-25-20"), which requires an assessment of probability of attainment of the performance target. Once the performance target outcome is determined to be probable, the year-to-date expense is recorded and the remaining expense is recorded on a straight-line basis through the end of the award's vesting period.

Fair Value Measurement of Financial Instruments

ASC Topic 820, Fair Value Measurements (“ASC Topic 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 Topic 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.

12


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.

The fair value of financial instruments, including cash and cash equivalents, accounts receivable and notes payable, approximate their carrying amounts due to the short term nature of these instruments. In addition, the notes payable have a floating interest rate, which increases or decreases with market interest rates, and are subject to an interest rate floor. Fair value measurements may be utilized on a nonrecurring basis, such as for the impairment of long-lived assets.

As described in Note 2, the Predecessor’s historical interests in the LGI/GTIS Joint Ventures were adjusted to fair value at November 13, 2013. The assets and liabilities of the LGI/GTIS Joint Ventures were recorded at fair value based on Level 2 or Level 3 assumptions and valuation inputs.

Recently Issued Accounting Pronouncements    

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”), which requires management to evaluate, at each reporting period, whether there are conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date the financial statements are issued and provide related disclosures. This ASU applies to all entities and is effective for period ending after December 15, 2016. The adoption of ASU 2014-15 is not expected to have a material effect on the Company's consolidated financial statements or disclosures.

In June 2014, the FASB issued ASU No. 2014-12, Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period (“ASU 2014-12”). ASU 2014-12 requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. A reporting entity should apply existing guidance in Accounting Standards Codification Topic No. 718, “Compensation - Stock Compensation” (“ASC Topic 718”), as it relates to awards with performance conditions that affect vesting to account for such awards. ASU 2014-12 is effective for periods beginning after December 15, 2015. The adoption of ASU 2014-12 is not expected to have a material effect on the Company’s consolidated financial statements or disclosures.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which provides guidance for revenue recognition. ASU 2014-09 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,” and most industry-specific guidance. This ASU also supersedes some cost guidance included in Subtopic 605-35, “Revenue Recognition-Construction-Type and Production-Type Contracts.” ASU 2014-09’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. In doing so, companies will need to use more judgment and make more estimates than under today’s guidance, including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. ASU 2014-09 is effective for the Company beginning January 1, 2017 and, at that time, the Company may adopt the new standard under the full retrospective approach or the modified retrospective approach. Early adoption of this ASU is not permitted.  The Company is currently evaluating the method and impact the adoption of ASU 2014-09 will have on the Company's consolidated financial statements and disclosures.

4.     REAL ESTATE INVENTORY
The Company's real estate inventory consists of the following (in thousands):   
 
 
September 30,
 
December 31,
   
 
2014
 
2013
Land, land under development, and finished lots
 
$
190,738

 
$
82,006

Sales offices
 
8,110

 
3,784

Homes in progress
 
34,322

 
27,723

Completed homes
 
58,818

 
28,470

Total real estate inventory
 
$
291,988

 
$
141,983

Interest and financing costs incurred under the Company's debt obligations, as more fully discussed in Note 8, are capitalized to qualifying real estate projects under development and homes in progress.


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5.     PROPERTY AND EQUIPMENT
Property and equipment consist of the following (in thousands):
 
 
 
 
September 30,
 
December 31,
   
 
Asset Life
 
2014
 
2013
   
 
(years)
 
 
 
   
Computer equipment
 
3-5
 
$
677

 
$
499

Machinery and equipment
 
4-5
 
49

 
169

Furniture and fixtures
 
5-7
 
1,358

 
745

Leasehold improvements
 
various
 
124

 
108

  Total property and equipment
 
   
 
2,208

 
1,521

Less: Accumulated depreciation
 
   
 
(835
)
 
(676
)
Property and equipment, net
 
   
 
$
1,373

 
$
845

Depreciation expense was $0.1 million for each of the three months ended September 30, 2014 and 2013 and $0.3 million and $0.2 million for the nine months ended September 30, 2014 and 2013, respectively. Equipment was sold to the LGI/GTIS Joint Ventures at net book value of approximately $0 and $0.03 million during the three and nine months ended September 30, 2013, respectively.

6.     INVESTMENTS IN JOINT VENTURES, VARIABLE INTEREST ENTITIES AND NON-CONTROLLING INTERESTS
Unconsolidated Joint Ventures
Prior to the GTIS Acquisitions, the Predecessor's interests in four LGI/GTIS Joint Ventures were accounted for using the equity method of accounting since the Predecessor was not deemed to be the primary beneficiaries of these variable interest entities.   
The LGI/GTIS Joint Ventures were each engaged in homebuilding and land development activities. GTIS was the joint venture member in these entities. Management of each of the LGI/GTIS Joint Ventures was vested in the members, being the Predecessor and GTIS. The Predecessor was considered the managing members of these entities. The managing member had the responsibility and authority to operate the LGI/GTIS Joint Ventures on a day-to-day basis subject to the operating budget and business plan, which were approved by both members. The Predecessor used their sales, development and operations teams to support operations and had significant influence even though the respective joint venture members had been deemed to have joint control under ASC Topic 810. All major decisions required both members’ consent. Major decisions included, but were not limited to: the acquisition or disposition of a project; capital contributions; and changes, and updates or amendments to the operating budget or business plan. Generally, the LGI/GTIS Joint Ventures did not obtain construction financing from outside lenders, but financed their activities primarily through equity contributions from each of the joint venture members.
Profits were allocated to the members of the LGI/GTIS Joint Ventures based on the predetermined formulas specified in the joint venture agreements for the allocation of distributable cash. The GTIS member and the Predecessor were allocated 85% and 15% of the profits, respectively, (the “Sharing Percentages”) until such time as the members received cash distributions equal to their initial capital investment plus, generally, a 15% internal rate of return (“First Tier Return”). Subsequent allocations of distributable cash and profits included a priority allocation of approximately 20% to 40% to the Predecessor, depending on the amount of cash distributions achieved over the life of the joint venture.
Since the internal rates of return necessary to receive a higher proportion of distributions were calculated over the life of each LGI/GTIS Joint Venture and both the timing and amount of future contributions and distributions would affect the Predecessor’s share of distributions, there was no certainty that the Predecessor would receive greater than 15% of the LGI/GTIS Joint Ventures’ distributions. Therefore, the Predecessor recorded its investments in the LGI/GTIS Joint Ventures at 15% of each venture’s capital balance and recognized the incremental amounts due to the Predecessor as a result of reaching the higher distribution tiers only when received.
As of September 30, 2013, three of the four joint ventures had yet to achieve the First-Tier Return; the fourth joint venture was paying a 30% priority allocation to the Predecessor’s member. During the three and nine months ended September 30, 2013, the Predecessor recognized $1.3 million and $1.5 million in priority distributions from the LGI/GTIS Joint Ventures. GTIS' interests in the LGI/GTIS Joint Ventures were acquired on November 13, 2013, and as a result, the LGI/GTIS Joint Ventures became wholly-owned subsidiaries of the Company.

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Summarized condensed combined financial information of the LGI/GTIS Joint Ventures accounted for using the equity method is presented below for the three and nine months ended September 30, 2013 (in thousands):  
   
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2013
 
2013
Home sales
 
$
30,962

 
$
68,933

Cost of sales
 
$
22,415

 
$
49,805

Net earnings of unconsolidated entities
 
$
4,674

 
$
9,502

Predecessor's share in net earnings of unconsolidated entities
 
$
1,976

 
$
2,920


Consolidated Joint Venture
LGI Fund III Holdings, LLC, a consolidated joint venture, was formed March 31, 2013, and LGI Homes Group, LLC was the managing member of this VIE; this entity became a wholly-owned subsidiary of the Company on November 13, 2013, as a result of the Company’s acquisition of the non-controlling interests in the joint venture as part of the Reorganization Transactions (See Note 1).
Historically, profits were allocated to the members of the consolidated joint ventures based on the predetermined formulas specified in the joint venture agreements for the allocation of distributable cash. The non-managing members and the Predecessor were allocated 85% and 15% of the profits, respectively, (the “Sharing Percentages”) until such time as the members received cash distributions equal to their initial capital investment plus, generally, a 15% internal rate of return (“First Tier Return”). Subsequent allocations of distributable cash and profits included a priority allocation of approximately 20% to 40% to the Predecessor’s member, depending on the amount of cash distributions achieved over the life of the joint venture.

7.     ACCRUED EXPENSES AND OTHER LIABILITIES
Accrued and other current liabilities consist of the following (in thousands):
   
 
 
September 30,
 
December 31,
   
 
2014
 
2013
Inventory related obligations
 
$
6,471

 
$

Retentions payable
 
2,292

 
867

Accrued compensation, bonuses and benefits
 
3,394

 
2,693

Taxes payable
 
1,187

 
1,554

Other
 
4,403

 
1,986

Total accrued expenses and other liabilities
 
$
17,747


$
7,100


Community Development and other Utility Development District Obligations
The Company owns lots in certain communities that have Community Development Districts ("CDD") or similar utility and infrastructure development special assessment programs that allocate a fixed amount of debt service associated with development activities to each lot. This obligation for infrastructure development is attached to the land, is typically payable over a 30 year period, and is ultimately assumed by the homebuyer when home sales are closed. Such obligations represent a non-cash cost of the lots.
At September 30, 2014, the Company had CDD and other utility development obligations of approximately $6.5 million. Approximately $2.7 million of CDD and other utility development costs and the related increase to finished lots should have been recognized in the Company's balance sheets as of December 31, 2013; the Company believes these obligations are not significant to its consolidated balance sheet as of December 31, 2013.
Estimated Warranty Reserve
The Company typically provides homebuyers with a ten-year limited warranty for major defects in structural elements such as framing components and foundation systems, a two-year limited warranty on major mechanical systems, and a one-year

15


limited warranty on other construction components. The Predecessor provided similar warranty services for homes sold by the LGI/GTIS Joint Ventures prior to the GTIS Acquisitions (see Note 11).

Changes to the Company's warranty accrual (included in Accrued expenses and other liabilities) are as follows (in thousands):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2014
 
2013
 
2014

2013
Warranty reserves, beginning of period
 
$
825

 
$
475

 
$
630

 
$
450

Warranty provision
 
329

 
357

 
685

 
475

Warranty expenditures
 
(279
)
 
(282
)
 
(440
)
 
(375
)
Warranty reserves, end of period
 
$
875

 
$
550

 
$
875

 
$
550

 
8.     NOTES PAYABLE
Secured Revolving Credit Agreement
On April 28, 2014, the Company entered into a credit agreement with Texas Capital Bank, N.A. and a syndication of lenders (the “Credit Agreement”) to provide a $135.0 million senior secured revolving credit facility, which could be increased by request of the Company, to $200.0 million, subject to the terms and provisions of the Credit Agreement. On July 31, 2014, amounts available to the Company under the Credit Agreement were increased by $40.0 million to $175.0 million, and on September 30, 2014, amounts available to the Company under the Credit Agreement were increased from $175.0 million to $200.0 million, in each case, in accordance with the accordion feature of the Credit Agreement.
The Credit Agreement matures on April 28, 2017. Borrowings under the credit facility are limited to the borrowing base, which is based on the loan value of the pool of collateral in which the lenders have a security interest. The Company may add houses, vacant lots, land, and acquisition and development projects to its pool of collateral through April 28, 2015. The loan value of speculative houses, pre-sold houses, model houses, vacant lots, land, and acquisition and development projects is adjusted based on formulas with respect to each of those categories of collateral; the loan value of the collateral decreases based on the amount of time such collateral is in the borrowing base. During the period May 1, 2015 to April 28, 2016, advances will continue to be made for assets previously included in the pool of collateral as they move into higher funding categories. Speculative homes may remain in the borrowing base for up to 18 months. Vacant lots, land and acquisition and development projects may remain in the borrowing base for up to three years. As of September 30, 2014, the borrowing base was $175.4 million, of which $160.2 million was outstanding and the remaining $15.2 million was available to borrow.
The Credit Agreement contains various financial covenants including a minimum EBITDA to debt service payments ratio; a debt to capitalization ratio; a leverage ratio; liquidity ratio and ratio of value of all land, lots, and acquisition and development projects to net worth; and a net worth ratio. In addition, the Credit Agreement contains various covenants that, among other restrictions, limit the amount of the Company's additional debt.
On September 30, 2014, certain provisions of the Credit Agreement were modified and supplemented. The modification of the Credit Agreement increased each of the Combined Acquisition and Development ("A&D") and Entitled Land Subfacility, the Combined A&D, Entitled Land and Lot Inventory Subfacility, and the Entitled Land Subfacility; modified certain of the Credit Agreement financial covenants, which are generally tested on a quarterly basis; and allows the Company to incur up to $85.0 million of unsecured subordinated indebtedness. In addition, the debt to capitalization ratio, leverage ratio, EBITDA ratio and liquidity rate were also modified. At September 30, 2014, the Company was in compliance with all of the covenants contained in the Credit Agreement.

16


 
 
September 30,
 
December 31,
   
 
2014
 
 2013
 
 
(in thousands)
LGI Homes, Inc.—Notes payable to Texas Capital Bank, N.A. and a syndication of lenders under the Credit Agreement ($200 million line at September 30, 2014) maturing through April 28, 2017; interest paid monthly at LIBOR plus 2.75%, with a 3.75% floor; collateralized by the Company and its subsidiaries' land, development and home construction costs
 
$
160,188

 
$

LGI Homes Group, LLC—Notes payable to Texas Capital Bank, N.A. under a credit facility ($35 million line at December 31, 2013) expiring June 30, 2015; interest at LIBOR plus 3.0%, with a 4.0% floor; collateralized by borrower's land, development and home construction costs (carrying value of $106.1 million at December 31, 2013); guaranteed by a Family Principal, the managing member, and non-managing members as joint and several guarantors at December 31, 2013; the credit facility was paid in full in April 2014
 

 
34,078

LGI Homes—Sunrise Meadow, LLC—Notes payable to Texas Capital Bank, N.A. under a credit facility ($2 million at December 31, 2013) expiring December 31, 2013; interest at LIBOR plus 3.9%, with a 4.0% floor; collateralized by borrower's land, development and home construction costs (carrying value of $5.1 million at December 31, 2013); guaranteed by a Family Principal; the credit facility was paid in full in April 2014
 

 
1,457

Total notes payable
 
$
160,188

 
$
35,535


At September 30, 2014 and December 31, 2013, LIBOR was 0.23% and 0.24%, respectively. Based on the terms of the variable rate notes payable, the interest rates as of September 30, 2014 and December 31, 2013, were based on the interest rate floor terms.
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,
   
 
2014
 
2013
 
2014
 
2013
Interest incurred
 
$
1,586

 
$
385

 
$
3,263

 
$
923

Less: Amounts capitalized
 
(1,586
)
 
(344
)
 
$
(3,263
)
 
$
(876
)
Interest expense
 
$

 
$
41

 
$

 
$
47

 
 
 
 
 
 
 
 
 
Cash paid for interest
 
$
1,085

 
$
281

 
$
2,520

 
$
769


Included in interest incurred was amortization of deferred financing costs of $0.3 million and $0.6 million for the three and nine months ended September 30, 2014, 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, 2014. Earnings per share is not computed for the three and nine months ended September 30, 2013 because the Predecessor consisted of limited liability companies and limited partnerships.

17


 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2014
 
2014
Net income (in thousands)
 
$
7,046

 
$
20,677

 
 
 
 
 
Basic weighted average shares outstanding
 
20,763,449

 
20,763,449

 
 
 
 
 
   Add: Dilutive effect of restricted stock units
 
118,378

 
108,308

Diluted weighted average shares outstanding
 
20,881,827

 
20,871,757

 
 
 
 
 
Basic earnings per share
 
$
0.34

 
$
1.00

Diluted earnings per share
 
$
0.34

 
$
0.99


3,030 non-vested restricted stock units were excluded from the computation of diluted earnings per share for the nine months ended September 30, 2014, because their effect was antidilutive. No shares were antidilutive for the three months ended September 30, 2014.

10.    STOCK-BASED COMPENSATION
Non-performance Based Restricted Stock Units
The following table summarizes the activity of the Company's restricted stock units ("RSUs"):
 
 
Shares
 
Weighted Average Grant Date Fair Value
Balance at January 1, 2014
 
140,222

 
$
11.00

   Granted
 
64,426

 
17.26

   Vested
 

 

   Forfeited
 
(2,806
)
 
11.00

Balance at September 30, 2014
 
201,842

 
$
13.00

In March 2014, the Company issued 37,307 RSUs to certain officers in settlement of approximately $0.6 million of bonuses that were earned under the 2013 performance-based cash bonus plan and accrued at December 31, 2013. The RSUs have a one-year vesting period and will be settled in shares of the Company's common stock.
In addition, during the nine months ended September 30, 2014, the Company issued 27,119 RSUs to certain employees and executives which vest over periods ranging from one to three years. The RSUs will be settled in shares of the Company’s common stock. The fair value of the RSUs was determined to be equal to the number of shares of the Company's common stock to be issued pursuant to the RSUs, multiplied by the closing price of the Company's common stock on the date the RSUs were awarded. The weighted average fair value on the grant dates was $18.99 for the three months ended September 30, 2014. The Company recognized $0.2 million and $0.4 million of stock-based compensation expense related to outstanding RSUs grants for the three and nine months ended September 30, 2014, respectively. At September 30, 2014, the Company had unrecognized compensation cost of $0.5 million related to unvested RSUs, which is expected to be recognized over a weighted average period of 1.4 years.
Performance Based Restricted Stock Units
In February 2014, the Compensation Committee approved a target of 62,906 performance-based restricted stock units (“Performance-Based RSUs”) for certain members of senior management of the Company. The Performance-Based RSUs provide for shares of the Company's common stock to be issued based on the attainment of certain performance metrics of the Company over the three year period, January 1, 2014 to December 31, 2016. The number of shares of the Company's common stock that may be issued to the recipients for the Performance-Based RSUs range from 0% to 200% of the target amount depending on actual results as compared to the target performance metrics. The Performance-Based RSUs vest upon the determination date for the actual results at the end of the three-year period and require the recipients continue to be employed

18


by the Company through the determination date. The Performance-Based RSUs will be settled in shares of the Company's common stock.
The fair value of the Performance-Based RSUs was determined to be equal to the number of shares of the Company’s common stock to be issued based on the target amount multiplied by the closing price of the Company’s common stock of $17.09 on the date the Performance-Based RSU awards were approved by the Compensation Committee. As of September 30, 2014, the target amount represents management's best estimate of the number of shares of the Company's common stock expected to be issued at the end of the three-year performance cycle. The Company recognized $0.1 million and $0.2 million of total stock-based compensation expense related to outstanding Performance-Based RSUs grants for the three and nine months ended September 30, 2014, respectively. At September 30, 2014, the Company had unrecognized compensation cost of $0.8 million, based on the target amount, related to unvested Performance-Based RSUs, which is expected to be recognized over a weighted average period of 1.6 years.

11.    RELATED PARTY TRANSACTIONS
From time to time, the Company may engage in transactions with entities that are affiliated with the Company. Transactions with related parties are in the normal course of operations.

Consulting Fees
Concurrent with the IPO, the Company entered into a three-year consulting agreement with a Family Principal for $100,000 per year payable on a monthly basis. Consulting fees were approximately $25,000 and $75,000 for the three and nine months ended September 30, 2014, respectively.

Management and Warranty Fees
The Predecessor had a Management Services Agreement with each of the LGI/GTIS Joint Ventures. The Predecessor provided administration, supervision, marketing, and various other services for the joint ventures. The Predecessor charged the joint ventures a management fee of approximately 3% of home sale revenues and 3% of construction costs for the development of land, as applicable. The management and construction fees were in addition to direct costs charged to the joint ventures. Management fees earned under the agreements were $1.0 million and $2.2 million for the three and nine months ended September 30, 2013, respectively.
The Predecessor collected a warranty fee of $250 from the LGI/GTIS Joint Ventures upon the closing of the sale of each home. The Predecessor provided a Home Builder’s Limited Warranty to the buyer of each home. The Predecessor was responsible for the performance and discharge of any warranty claims asserted against the joint ventures or the GTIS member. Warranty fees earned were approximately $52,000 and $119,000 for the three and nine months ended September 30, 2013, respectively.
Riverchase Acquisition

On July 11, 2014, the Company acquired approximately 1,902 acres of land located in Lancaster County, South Carolina, from an entity owned and managed by a Family Principal, for an aggregate purchase price of approximately $15.4 million.

12.     COMMITMENTS AND CONTINGENCIES
Contingencies
In the ordinary course of doing business, the Company becomes subject to claims or proceedings from time to time relating to the purchase, development, and sale of real estate. Management believes that these claims include usual obligations incurred by real estate developers and home builders in the normal course of business. In the opinion of management, these matters will not have a material effect on the Company’s consolidated financial position, results of operations or cash flows.
The Company has provided unsecured environmental indemnities to certain lenders. In each case, the Company has performed due diligence on the potential environmental risks including obtaining an independent environmental review from outside environmental consultants. These indemnities obligate the Company 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, the Company may have recourse against other previous owners. Management is not aware of any environmental claims or occurrences and has recorded no reserves for environmental matters at September 30, 2014 and December 31, 2013.



19


Land Deposits

The Company has land purchase option contracts, generally through cash deposits, for the right to purchase land or lots at a future point in time with predetermined terms. The Company does not have title to the property and obligations with respect to the option contracts are generally limited to the forfeiture of any related nonrefundable cash deposits.
The table below presents a summary of the Company's lots under option or contract (in thousands, except for lot count):
 
 
September 30, 2014
 
December 31, 2013
 
 
 
Land deposits and option payments
 
$11,927
 
$2,977
Commitments under the land purchase option and deposit contracts if the purchases are consummated
 
$125,063
 
$111,115
Lots under land options and land purchase contracts

 
8,538

 
8,214


As of September 30, 2014, approximately $8.7 million of the deposits are related to purchase contracts to deliver finished lots and these deposits are refundable under certain circumstances and secured by indemnity mortgages on the related property.
Bonding
The Company has outstanding performance and surety bonds of $6.5 million and $0.4 million at September 30, 2014 and December 31, 2013, respectively, related to the Company’s obligations for site improvements at various projects. Certain of the 2013 surety bonds are guaranteed by one of the Family Principals. Management does not believe that draws upon these bonds, if any, will have a material effect on the Company’s consolidated financial position, results of operations, or cash flows.

13.     SEGMENT INFORMATION
The Company operates one principal homebuilding business which is organized and reports by division. The Company has four operating segments at September 30, 2014: the Texas division, the Southwest division, the Southeast division and the Florida division. The Texas division is the largest division and it comprised approximately 70% and 86% of total home sales revenues for the nine months ended September 30, 2014, and 2013, respectively.
In accordance with ASC Topic 280, Segment Reporting ("ASC Topic 280"), 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-maker ("CODM") in deciding how to allocate resources and in assessing performance. The CODM primarily evaluates performance based on the number of homes sold, gross margin and net income.
The operating segments qualify for aggregation as one reporting segment. In determining the reportable segment, the Company concluded that all operating segments have similar economic and other characteristics, including similar home floor plans, average selling prices, gross margin, production construction processes, suppliers, subcontractors, regulatory environments, customer type, and underlying demand and supply. Each operating segment follows the same accounting policies as the Company and is managed by the Company’ management team. The Company has no inter-segment sales, as all sales are to external customers.

14.     SUBSEQUENT EVENT
 
Oakmont Acquisition    

On October 2, 2014, the Company acquired certain real estate assets owned by Oakmont Home Builders, Inc. and its affiliate for a purchase price of approximately $15.0 million, subject to adjustment and, net of approximately $1.0 million of assumed liabilities. In addition, Oakmont will receive an earn-out to be paid based on home closings through December 31, 2017.

20


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 when used in a historical context refer to LGI Homes, Inc. and its subsidiaries. See Note 1 “Organization and BusinessInitial Public Offering and Reorganization Transactions” and “Note 2 Acquisition of LGI/GTIS Joint Venture Partners’ Interests” to our unaudited consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information regarding the reorganization transactions, the initial public offering and our acquisitions of our joint venture partners' interests in the LGI/GTIS Joint Ventures (the “GTIS Acquisitions”).
Business Overview
We are one of the nation's fastest growing residential homebuilders in terms of percentage of home closings. We are engaged in the design and construction of homes in Texas, Arizona, Florida, Georgia New Mexico, Colorado, North Carolina and South Carolina. Our management team has been in the residential land development business since the mid-1990s.
In 2003, we commenced homebuilding operations targeting the entry-level market. Since commencing operations in 2003, we have constructed and closed approximately 8,000 homes. During the nine months ended September 30, 2014, we had 1,704 home closings, compared to 1,112 home closings, including home closings by the LGI/GTIS Joint Ventures, during the nine months ended September 30, 2013.
On November 13, 2013, we completed an initial public offering (the “IPO”) of 10,350,000 shares of our common stock. For accounting purposes, the assets, liabilities and results of operations prior to the completion of the IPO relate to LGI Homes Group, LLC, LGI Homes Corporate, LLC, LGI Homes II, LLC (formerly LGI Homes, Ltd.), LGI Homes-Sunrise Meadow, LLC (formerly LGI Homes - Sunrise Meadow, Ltd.), LGI Homes-Canyon Crossing (LGI Homes - Canyon Crossing, Ltd.), LLC, LGI Homes-Deer Creek, LLC and their direct and indirect subsidiaries (collectively, our “Predecessor”).
Prior to the completion of the IPO, our Predecessor owned a 15% equity interest in and managed the day-to-day operations of the LGI/GTIS Joint Ventures. Concurrent with the IPO, we acquired all of the equity interests in the LGI/GTIS Joint Ventures that we did not own immediately prior to the IPO. In our historical financial statements, our Predecessor’s interest in the LGI/GTIS Joint Ventures were accounted for using the equity method and our Predecessor’s share of the LGI/GTIS Joint Ventures’ net earnings are included in income from unconsolidated joint ventures. Effective November 13, 2013, we own all of the equity interests in the LGI/GTIS Joint Ventures and we began to account for them on a consolidated basis. For discussion of pro forma financial information for the three and nine months ended September 30, 2013, please see "—Supplemental Management's Discussion and Analysis—Pro Forma Financial Information."
Recent Developments

On October 2, 2014, we acquired certain real estate assets owned by Oakmont Home Builders, Inc. and its affiliate for a purchase price of approximately $15.0 million, subject to adjustment and, net of approximately $1.0 million of assumed liabilities. In addition, Oakmont will receive an earn-out to be paid based on home closings through December 31, 2017. Through this acquisition, we acquired approximately 150 homes under construction and approximately 1,000 owned and controlled lots in the Charlotte, North Carolina market.
On July 31, 2014, the amounts available to us under our credit agreement with Texas Capital Bank, N.A. and a syndication of lenders (the"Credit Agreement") increased by $40.0 million to $175.0 million, and on September 30, 2014, the amount was further increased from $175.0 million to $200.0 million, in each case, in accordance with the accordion feature of the Credit Agreement.
On September 30, 2014, certain provisions of the Credit Agreement were modified and supplemented. The modification of the Credit Agreement increased each of the Combined Acquisition and Development ("A&D") and Entitled Land Subfacility, the Combined A&D, Entitled Land and Lot Inventory Subfacility, and the Entitled Land Subfacility; modified certain of the Credit Agreement financial covenants, which are generally tested on a quarterly basis; and allows us to incur up to $85.0 million of unsecured subordinated indebtedness. In addition, the debt to capitalization ratio, leverage ratio, EBITDA ratio and liquidity rate were also modified. At September 30, 2014, we were in compliance with all of the covenants contained in the Credit Agreement.

Key Results
Key financial results as of and for the three months ended September 30, 2014, as compared to the three months ended September 30, 2013, were as follows:

21


Homes closed increased 132.1% to 557 homes from 240 homes with an increase in the average sales price of our homes of 7.6% to $166,097. On a pro forma basis, homes closed increased 24.3% to 557 homes from 448 homes with an increase in the average sales price of our homes of 9.4%.
Home sales revenues increased 149.8% to $92.5 million from $37.0 million. On a pro forma basis, home sales revenues increased 36.1% from $68.0 million.
Gross margin as a percentage of home sales revenues increased to 27.3% from 26.9%. On a pro forma basis, gross margin as a percentage of home sales revenues remained the same at 27.3%.
Adjusted gross margin as a percentage of home sales revenues increased to 28.3% from 27.2%. On a pro forma basis, adjusted gross margin as a percentage of home sales revenues increased to 28.3% from 27.5%.1 
Net income before income taxes increased 99.3% to $10.5 million from $5.3 million. On a pro forma basis, net income before income taxes increased 31.8% to $10.5 million from $8.0 million.
Adjusted EBITDA margin as a percentage of home sales revenues decreased to 11.9% from 14.8% and decreased from adjusted EBITDA margin as a percentage of home sales revenues on a pro forma basis of 12.1%.2 
Active communities as of September 30, 2014 increased to 34 from 22, on a pro forma basis. Our expansion with our Florida and Southeast divisions is reflected in this increase.
Total owned and controlled lots increased 8.5% to 21,638 lots at September 30, 2014 from 19,936 lots at June 30, 2014.
Key financial results as of and for the nine months ended September 30, 2014, as compared to the nine months ended September 30, 2013, were as follows:
Homes closed increased 167.5% to 1,704 homes from 637 homes with an increase in the average sales price of our homes of 8.1% to $161,296. On a pro forma basis, homes closed increased 53.2% to 1,704 homes from 1,112 homes with an increase in the average sales price of our homes of 9.4%.
Home sales revenues increased 189.2% to $274.8 million from $95.0 million. On a pro forma basis, home sales revenues increased 67.6% from $164.0 million.
Gross margin as a percentage of home sales revenues decreased to 26.6% from 27.2%. On a pro forma basis, gross margin as a percentage of home sales revenues decreased to 26.6% from 27.5%.
Adjusted gross margin as a percentage of home sales revenues remained the same at 27.9%. On a pro forma basis, adjusted gross margin as a percentage of home sales revenues remained the same at 27.9%.
Net income before income taxes increased 144.5% to $31.5 million from $12.9 million. On a pro forma basis, net income before income taxes increased 62.0% to $31.5 million from $19.4 million.
Adjusted EBITDA margin as a percentage of home sales revenues decreased to 12.7% from 14.5% and increased from adjusted EBITDA margin as a percentage of home sales revenues on a pro forma basis of 12.5%.2 
Total owned and controlled lots increased 33.8% to 21,638 lots at September 30, 2014 from 14,895 lots at December 31, 2013.
______________________
1 Adjusted gross margin is a non-GAAP financial measure used by management as a supplemental measure in evaluating operating performance. Please see “—Non-GAAP Measures—Adjusted Gross Margin” 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.
2 Adjusted EBITDA is a non-GAAP financial measure used by management as a supplemental measure in evaluating operating performance. Please see “—Non-GAAP Measures—Adjusted EBITDA” for a reconciliation of adjusted EBITDA to net income, which is the GAAP financial measure that our management believes to be most directly comparable.

 

22


Outlook

We believe there continues to be opportunities to grow our share of sales in our existing markets. Given our familiarity with each of our existing markets and the favorable demographic and economic trends that are forecasted in our markets, we expect to continue to see growth in these markets.

We also believe that we will be able to grow our business by increasing the number of price points in our existing markets. We are seeing opportunities to develop properties with multiple price points and product lines in the same communities. As our average sale price continues to increase and we begin to sell our higher price point product, we expect that we may see a slightly lower absorption rate from product mix but believe we will continue to realize adjusted gross margins within our target range.

We intend to expand into new markets where we identify opportunities to build homes and develop communities that meet our profit and return objectives. During the three months ended September 30, 2014, we began home construction in Denver, Colorado. We recently entered into the Charlotte, North Carolina market through the acquisition of land in Lancaster County, South Carolina in July 2014 and the acquisition of certain real estate assets owned by Oakmont Home Builders, Inc. and its affiliate in October 2014. We have employees in each market as of September 30, 2014. We will continue to analyze other potential markets as we continue our efforts to expand into new geographical markets.


23


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,
 
 
2014
 
2013
 
2014
 
2013
 
 
(dollars in thousands, except per share data and average home sales price)
Statement of Income Data:
 
 
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
 
Home sales
 
$
92,516

 
$
37,035

 
$
274,848

 
$
95,033

Management and warranty fees
 

 
1,007

 

 
2,309

     Total revenues
 
$
92,516

 
$
38,042

 
$
274,848

 
$
97,342

Expenses:
 
 
 
 
 
 
 
 
Cost of sales
 
67,256

 
27,083

 
201,661

 
69,225

Selling expenses
 
9,239

 
3,589

 
25,788

 
9,082

General and administrative
 
6,115

 
4,052

 
16,557

 
9,078

Income from unconsolidated joint ventures
 

 
(1,976
)
 

 
(2,920
)
     Operating income
 
$
9,906

 
$
5,294

 
$
30,842

 
$
12,877

Interest expense, net
 

 
(41
)
 

 
(47
)
Other income, net
 
628

 
34

 
663

 
56

     Net income before income taxes
 
$
10,534

 
$
5,287

 
$
31,505


$
12,886

Income tax provision
 
(3,488
)
 
(137
)
 
(10,828
)
 
(273
)
     Net income
 
$
7,046

 
$
5,150

 
$
20,677

 
$
12,613

Loss attributable to non-controlling interests
 

 
437

 

 
583

Net income attributable to owners
 
$
7,046

 
$
5,587

 
$
20,677

 
$
13,196

Basic earnings per share
 
$
0.34

 
 
 
$
1.00

 
 
Diluted earnings per share
 
$
0.34

 
 
 
$
0.99

 
 
Other Financial and Operating Data:
 
 
 
 
 

 

Active communities at end of period
 
34

 
14

 
34

 
14

Home closings
 
557

 
240

 
1,704

 
637

Average sales price of homes closed
 
$
166,097

 
$
154,313

 
$
161,296

 
$
149,188

Gross margin (1)
 
$
25,260

 
$
9,952

 
$
73,187

 
$
25,808

Gross margin % (2)
 
27.3
%
 
26.9
%
 
26.6
%
 
27.2
%
Adjusted gross margin (3)
 
$
26,167

 
$
10,065

 
$
76,782

 
$
26,508

Adjusted gross margin % (2)(3)
 
28.3
%
 
27.2
%
 
27.9
%
 
27.9
%
Adjusted EBITDA (4)
 
$
10,984

 
$
5,475

 
$
34,908

 
$
13,776

Adjusted EBITDA margin % (2)(4)
 
11.9
%
 
14.8
%
 
12.7
%
 
14.5
%
 
(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 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 adjustment, which have real economic effects and could impact our results, the utility of adjusted gross margin information as a measure of our operating performance may be limited. In addition, other companies may not calculate adjusted gross margin information in the same manner that we do. Accordingly, adjusted gross margin information should be considered only as a supplement to gross margin information as a measure of our performance. Please see “—Non-GAAP Measures—Adjusted Gross Margin” 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.


24


(4)
Adjusted EBITDA is a non-GAAP financial measure used by management as a supplemental measure in evaluating operating performance. We define adjusted EBITDA as net income before (i) interest expense, (ii) income taxes, (iii) depreciation and amortization, (iv) capitalized interest charged to the cost of sales, (v) other income, net and (vi) adjustments resulting from the application of purchase accounting. Our management believes that the presentation of 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. Adjusted EBITDA provides an indicator of general economic performance that is not affected by fluctuations in interest rates or effective tax rates, levels of depreciation or amortization and items considered to be non-recurring. Accordingly, our management believes that this measurement is useful for comparing general operating performance from period to period. Other companies may define adjusted EBITDA differently and, as a result, our measure of adjusted EBITDA may not be directly comparable to adjusted EBITDA of other companies. Although we use adjusted EBITDA as a financial measure to assess the performance of our business, the use of adjusted EBITDA is limited because it does not include certain costs, such as interest and taxes, necessary to operate our business. 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 adjusted EBITDA should not be construed as an indication that our future results will be unaffected by unusual or nonrecurring items. Our adjusted EBITDA is limited as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Please see “—Non-GAAP Measures—Adjusted EBITDA” for a reconciliation of adjusted EBITDA to net income, which is the GAAP financial measure that our management believes to be most directly comparable.


Three Months Ended September 30, 2014 Compared to Three Months Ended September 30, 2013
Homes Sales.  Our home sales revenues and closings by division for the three months ended September 30, 2014 and 2013 were as follows (dollars in thousands):
 
 
Three Months Ended September 30,
 
 
2014
 
2013
  
 
Revenues
 
Closings
 
Revenues
 
Closings
Texas
 
$
64,282

 
389

 
$
30,834

 
200

Southwest
 
11,277

 
67

 
5,469

 
35

Florida
 
9,244

 
53

 
732

 
5

Southeast
 
7,713

 
48

 

 

Total home sales
 
$
92,516

 
557

 
$
37,035

 
240


Home sales revenues for the three months ended September 30, 2014 were $92.5 million, an increase of $55.5 million, or 149.8%, from $37.0 million for the three months ended September 30, 2013. The increase in home sales revenues is primarily due to a 132.1% increase in homes closed and an increase in the average selling price per home during the three months ended September 30, 2014 as compared to the three months ended September 30, 2013. The increase in home closings for the three months ended September 30, 2014 is partially attributable to the GTIS Acquisitions completed in November 2013 (see the Supplemental Management Discussion and Analysis - Pro Forma Financial Information below). The average selling price per home closed during the three months ended September 30, 2014 was $166,097, an increase of $11,784, or 7.6%, from the average selling price per home of $154,313 for the three months ended September 30, 2013.
Management and Warranty Fees.  Management and warranty fees were $1.0 million for the three months ended September 30, 2013. Management and warranty fees were received from the LGI/GTIS Joint Ventures through November 2013 when the joint ventures were acquired. Total home closings on a combined basis for the LGI/GTIS Joint Ventures were 208 for the three months ended September 30, 2013. There were no management and warranty fees for the three months ended September 30, 2014 as the LGI/GTIS Joint Ventures have been consolidated since the GTIS Acquisitions.
Cost of Sales and Gross Margin (home sales revenues less cost of sales).  Cost of sales increased for the three months ended September 30, 2014 to $67.3 million, an increase of $40.2 million, or 148.3%, from $27.1 million for the three months ended September 30, 2013. This increase is primarily due to a 132.1% increase in homes closed during the third quarter of 2014 as compared to the third quarter of 2013. In addition, cost of sales for the three months ended September 30, 2014, include $0.4 million related to the fair value step-up adjustment for real estate inventory and lot option contracts acquired from the LGI/GTIS Joint Ventures and that resulted in home sales closed during the three months ended September 30, 2014. Gross margin for the three months ended September 30, 2014 was $25.3 million, an increase of $15.3 million, or 153.8%, from $10.0 million for the three months ended September 30, 2013. Gross margin as a percentage of home sales revenues was 27.3% for the three months ended September 30, 2014 and 26.9% for the three months ended September 30, 2013. The increase in gross margin as a percentage of home sales revenues reflects the higher average homes sales prices offset by increased construction

25


costs and higher lot costs for the third quarter of 2014 as compared to the third quarter of 2013, and the impact of the amortization of the step-up adjustment related to real estate inventory and the lot option contracts.
Selling Expenses.  Selling expenses as a percentage of home sales revenues were 10.0% and 9.7% for the three months ended September 30, 2014 and 2013, respectively. The increase in selling expenses as a percentage of home sales revenues was primarily due to start up expenses related to new community openings. Selling expenses for the three months ended September 30, 2014 were $9.2 million, an increase of $5.6 million, or 157.4%, from $3.6 million for the three months ended September 30, 2013. Sales commissions increased to $3.6 million for the three months ended September 30, 2014 from $1.4 million during that same period in the prior year primarily due to a 132.1% increase in homes closed during the third quarter of 2014 as compared to the third quarter of 2013. Advertising and direct mail costs increased to $2.3 million during the three months ended September 30, 2014 from $0.8 million for the same period in the prior year primarily due to the increase in the number of active communities for the third quarter of 2014 as compared to the third quarter of 2013.
General and Administrative.  General and administrative expenses as a percentage of home sales revenues were 6.6% and 10.9% for the three months ended September 30, 2014 and 2013, respectively. The decrease in general and administrative expenses as a percentage of home sales revenues reflects leverage realized from the increase in home sales revenues during the current quarter and less accounting and professional expenses incurred during the current quarter as compared to the same period in the prior year when we were preparing for our initial public offering. General and administrative expenses for the three months ended September 30, 2014 were $6.1 million, an increase of $2.1 million, or 50.9%, from $4.1 million for the three months ended September 30, 2013. The increase in the amount of general and administrative expenses in the third quarter of 2014 as compared to the third quarter of 2013 is attributable to additional employees and office space added to support the increased number of active communities and higher number of home closings.
Income from unconsolidated joint ventures.  Our share of income from the LGI/GTIS Joint Ventures for the three months ended September 30, 2013 was $2.0 million. We acquired our joint venture partner's interests in the LGI/GTIS Joint Ventures on November 13, 2013 in the GTIS Acquisitions.
Other Income.  Other income, net of other expenses was $0.6 million for the three months ended September 30, 2014, an increase of $0.6 million from $0.03 million for the three months ended September 30, 2013. The increase in other income reflects the gain realized from the sale of land not directly associated with our core homebuilding operations.
Operating Income and Net Income.  Operating income for the three months ended September 30, 2014 was $9.9 million, an increase of $4.6 million, or 87.1%, from $5.3 million for the three months ended September 30, 2013. Net income for the three months ended September 30, 2014 was $7.0 million, an increase of $1.9 million, or 36.8%, from $5.2 million for the three months ended September 30, 2013. The increases are primarily attributed to a 132.1% increase in homes closed and the 7.6% increase in average home sales price during the third quarter of 2014 as compared to the third quarter of 2013, net of the amortization of the step-up adjustment and increased expenses associated with new communities.

Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013
Homes Sales.  Our home sales revenues and closings by division for the nine months ended September 30, 2014 and 2013 were as follows (dollars in thousands):
 
 
Nine Months Ended September 30,
 
 
2014
 
2013
  
 
Revenues
 
Closings
 
Revenues
 
Closings
Texas
 
$
192,111

 
1,199

 
$
82,036

 
552

Southwest
 
31,211

 
188

 
12,266

 
80

Florida
 
30,960

 
185

 
731

 
5

Southeast
 
20,566

 
132

 

 

Total home sales
 
$
274,848

 
1,704

 
$
95,033

 
637


Home sales revenues for the nine months ended September 30, 2014 were $274.8 million, an increase of $179.8 million, or 189.2%, from $95.0 million for the nine months ended September 30, 2013. The increase in home sales revenues is primarily due to a 167.5% increase in homes closed and an increase in the average selling price per home during the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013. The increase in home closings for the nine months ended September 30, 2014 is partially attributable to the GTIS Acquisitions completed in November 2013 (see the Supplemental

26


Management Discussion and Analysis - Pro Forma Financial Information below). The average selling price per home closed during the nine months ended September 30, 2014 was $161,296, an increase of $12,108, or 8.1%, from the average selling price per home of $149,188 for the nine months ended September 30, 2013.
Management and Warranty Fees.  Management and warranty fees were $2.3 million for the nine months ended September 30, 2013. Management and warranty fees were received from the LGI/GTIS Joint Ventures through November 2013 when the joint ventures were acquired. Total home closings on a combined basis for the LGI/GTIS Joint Ventures were 475 for the nine months ended September 30, 2013. There were no management and warranty fees for the nine months ended September 30, 2014 as the LGI/GTIS Joint Ventures have been consolidated since the GTIS Acquisitions.
Cost of Sales and Gross Margin (home sales revenues less cost of sales).  Cost of sales increased for the nine months ended September 30, 2014 to $201.7 million, an increase of $132.4 million, or 191.3%, from $69.2 million for the nine months ended September, 30 2013. This increase is primarily due to a 167.5% increase in homes closed during the first nine months of 2014 as compared to the first nine months of 2013. In addition, cost of sales for the nine months ended September 30, 2014, include $2.4 million related to the fair value step-up adjustment for real estate inventory acquired from the LGI/GTIS Joint Ventures and sold in the nine months ended September 30, 2014. Gross margin for the nine months ended September 30, 2014 was $73.2 million, an increase of $47.4 million, or 183.6%, from $25.8 million for the nine months ended September 30, 2013. Gross margin as a percentage of home sales revenues was 26.6% for the nine months ended September 30, 2014 and 27.2% for the nine months ended September 30, 2013. The decrease in gross margin as a percentage of home sales revenues reflects the $2.4 million amortization of the step-up adjustment plus increased construction costs and higher lot costs for the first nine months of 2014 as compared to the first nine months of 2013; these construction and lot costs were partially offset by higher average homes sales prices.
Selling Expenses.  Selling expenses as a percentage of home sales revenues were 9.4% and 9.6% for the nine months ended September 30, 2014 and 2013, respectively. The decrease of selling expenses as a percentage of home sales revenues was primarily due to the operating leverage realized from our salaried sales and marketing personnel in the first nine months of 2014. Selling expenses for the nine months ended September 30, 2014 were $25.8 million, an increase of $16.7 million, or 183.9%, from $9.1 million for the nine months ended September 30, 2013. Sales commissions increased to $10.3 million for the nine months ended September 30, 2014 from $3.5 million during that same period in the prior year primarily due to a 167.5% increase in homes closed during the nine months of 2014 as compared to the nine months of 2013. Advertising and direct mail costs increased to $6.0 million during the nine months ended September 30, 2014 from $1.9 million for the same period in the prior year primarily due the increase in the number of active communities for the first nine months of 2014 as compared to the first nine months of 2013.
General and Administrative.  General and administrative expenses as a percentage of home sales revenues were 6.0% and 9.6% for the nine months ended September 30, 2014 and 2013, respectively. The decrease in general and administrative expenses as a percentage of home sales revenues reflects leverage realized from the increase in home sales revenues during the nine months ended September 30, 2014. General and administrative expenses for the nine months ended September 30, 2014 were $16.6 million, an increase of $7.5 million, or 82.4%, from $9.1 million for the nine months ended September 30, 2013. The increase in general and administrative expenses is primarily due to the higher number of home closings and active communities in the first nine months of 2014 as compared to the first nine months of 2013. To support the increased number of active communities, we hired more employees and acquired additional office space.
Income from unconsolidated joint ventures.  Our share of income from the LGI/GTIS Joint Ventures for the nine months ended September 30, 2013 was $2.9 million. We acquired our joint venture partners' interests in the LGI/GTIS Joint Ventures on November 13, 2013.
Other Income.  Other income, net of other expenses was $0.6 million for the nine months ended September 30, 2014, an increase of $0.6 million from $0.06 million for the nine months ended September 30, 2013. The increase in other income reflects the gain realized from the sale of land not directly associated with our core homebuilding operations.
Operating Income and Net Income.  Operating income for the nine months ended September 30, 2014 was $30.8 million, an increase of $18.0 million, or 139.5%, from $12.9 million for the nine months ended September 30, 2013. Net income for the nine months ended September 30, 2014 was $20.7 million, an increase of $8.1 million, or 63.9%, from $12.6 million for the nine months ended September 30, 2013. The increases are primarily attributed to a 167.5% increase in homes closed and the increase in average home sale prices during the first nine months of 2014 as compared to the first nine months of 2013, net of the amortization of the step-up adjustment and increased expenses associated with new communities.


27


Supplemental Management's Discussion and Analysis

Pro Forma Financial Information

The following pro forma statement of operations has been developed by applying pro forma adjustments to our statements of operations for the three and nine months ended September 30, 2013 included elsewhere in this Quarterly Report and the combined financial statements of the LGI/GTIS Joint Ventures. The pro forma statement of operations for the three and nine months ended September 30, 2013 gives effect to the GTIS Acquisitions as if they had occurred on January 1, 2012.

The pro forma adjustments are based upon available information and certain assumptions that we believe are reasonable under the circumstances. The pro forma financial data is presented for informational purposes only. The pro forma financial data does not purport to represent what our results of operations would have been had the GTIS Acquisitions actually occurred on the date indicated and does not purport to project our results of operations for any future period. The pro forma financial statements should be read in conjunction with the information contained in other sections of this Quarterly Report including our historical financial statements and related notes thereto, and other sections of this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this Quarterly Report. All pro forma adjustments and their underlying assumptions are described more fully in the notes to our pro forma statements of operations.

The pro forma financial information has been prepared to give effect to the GTIS Acquisitions in accordance with ASC Topic 805, “Business Combinations.” A fair value step-up adjustment of approximately $7.9 million was recorded to the real estate inventory and certain lot option contracts in connection with the GTIS Acquisitions. The pro forma adjustments do not reflect cost of sales related to the step-up adjustment since the step-up does not have a continuing impact on our results of operations due to the short-term impact on our financial performance.


28



Unaudited Pro Forma Statement of Operations
for the Three Months Ended September 30, 2013
 
 
LGI Homes, Inc.
 
LGI/GTIS Joint Ventures (1)
 
Adjustments
 
LGI Homes, Inc. Pro Forma
 
 
(In thousands)
Revenues:
 
 
 
 
 
 
 
 
Home sales
 
$
37,035

 
$
30,962

 
$


$
67,997

Management and warranty fees
 
1,007

 

 
(1,007
)
(c)

Total revenues
 
38,042

 
30,962

 
(1,007
)

67,997

Cost of sales
 
27,083

 
22,415

 
(69
)
(c)
49,429

Selling expenses
 
3,589

 
2,464

 


6,053

General and administrative
 
4,052

 
1,352

 
(877
)
(b)(c)
4,527

Income from unconsolidated LGI/GTIS Joint Ventures
 
(1,976
)
 

 
1,976

(a)

Operating income
 
5,294

 
4,731

 
(2,037
)

7,988

Interest expense
 
(41
)
 

 


(41
)
Other income, net
 
34

 
15

 


49

Net income before income taxes
 
5,287

 
4,746

 
(2,037
)

7,996

Income tax provision
 
(137
)
 
(72
)
 


(209
)
Net income
 
5,150

 
4,674

 
(2,037
)

7,787

Loss attributable to non-controlling interests
 
437

 

 


437

Net income attributable to owners
 
$
5,587

 
$
4,674

 
$
(2,037
)

$
8,224


(1)
This column is a combination of the unaudited financial statements of LGI-GTIS Holdings, LLC, LGI-GTIS Holdings II, LLC, LGI-GTIS Holdings III, LLC and LGI-GTIS Holdings IV, LLC, for the three months ended September 30, 2013.

Notes to Unaudited Pro Forma Statement of Operations for the Three Months Ended September 30, 2013

(a) Eliminates our Predecessor’s equity in the income of the LGI/GTIS Joint Ventures.

(b) Reflects amortization of the $0.7 million marketing related intangible asset (i.e., trade name rights) recorded in the GTIS Acquisitions. The trade name rights have an estimated useful life of three years based upon the timing of the majority of the forecasted revenues to be earned over the remaining development cycle of the LGI/GTIS Joint Ventures’ communities. Amortization is recorded on a straight-line basis. Pro forma amortization expense was $0.1 million for the three months ended September 30, 2013.

(c) Reflects the elimination of $1.0 million of management and warranty fees our Predecessor charged to the LGI/GTIS Joint Ventures during the period pursuant to certain management services agreements. The applicable management services agreements were terminated in connection with the GTIS Acquisitions. The corresponding charges were recorded to general and administrative expense and cost of sales by the LGI/GTIS Joint Ventures.









29



Unaudited Pro Forma Statement of Operations
for the Nine Months Ended September 30, 2013
 
 
LGI Homes, Inc.
 
LGI/GTIS Joint Ventures (1)
 
Adjustments
 
LGI Homes, Inc. Pro Forma
 
 
(In thousands)
Revenues:
 
 
 
 
 
 
 
 
Home sales
 
$
95,033

 
$
68,933

 
$


$
163,966

Management and warranty fees
 
2,309

 

 
(2,309
)
(c)

Total revenues
 
97,342

 
68,933

 
(2,309
)

163,966

Cost of sales
 
69,225

 
49,805

 
(174
)
(c)
118,856

Selling expenses
 
9,082

 
6,135

 


15,217

General and administrative
 
9,078

 
3,401

 
(1,985
)
(b)(c)
10,494

Income from unconsolidated LGI/GTIS Joint Ventures
 
(2,920
)
 

 
2,920

(a)

Operating income
 
12,877

 
9,592

 
(3,070
)

19,399

Interest expense
 
(47
)
 

 


(47
)
Other income, net
 
56

 
77

 
(35
)
(c)
98

Net income before income taxes
 
12,886

 
9,669

 
(3,105
)

19,450

Income tax provision
 
(273
)
 
(167
)
 


(440
)
Net income
 
12,613

 
9,502

 
(3,105
)

19,010

Loss attributable to non-controlling interests
 
583

 

 


583

Net income attributable to owners
 
$
13,196

 
$
9,502

 
$
(3,105
)

$
19,593


(1)
This column is a combination of the unaudited financial statements of LGI-GTIS Holdings, LLC, LGI-GTIS Holdings II, LLC, LGI-GTIS Holdings III, LLC and LGI-GTIS Holdings IV, LLC, for the nine months ended September 30, 2013.

Notes to Unaudited Pro Forma Statement of Operations for the Nine Months Ended September 30, 2013

(a) Eliminates our Predecessor’s equity in the income of the LGI/GTIS Joint Ventures.

(b) Reflects amortization of the $0.7 million marketing related intangible asset (i.e., trade name rights) recorded in the GTIS Acquisitions. The trade name rights have an estimated useful life of three years based upon the timing of the majority of the forecasted revenues to be earned over the remaining development cycle of the LGI/GTIS Joint Ventures’ communities. Amortization is recorded on a straight-line basis. Pro forma amortization expense was $0.2 million for the nine months ended September 30, 2013.

(c) Reflects the elimination of $2.3 million of management and warranty fees our Predecessor charged to the LGI/GTIS Joint Ventures during the period pursuant to certain management services agreements. The applicable management services agreements were terminated in connection with the GTIS Acquisitions. The corresponding charges of were recorded to general and administrative expense, cost of sales and other income by the LGI/GTIS Joint Ventures.


30


Three Months Ended September 30, 2014 Compared to Pro Forma Three Months Ended September 30, 2013
Pro forma Homes Sales.  Our home sales revenues and closings by division for the three months ended September 30, 2014 and pro forma home sales revenues and closings by division for the three months ended September 30, 2013 were as follows (dollars in thousands, unless otherwise stated):
 
 
Three Months Ended September 30,
 
Pro Forma Three Months Ended September 30,
 
 
2014
 
2013
  
 
Revenues
 
Closings
 
Revenues
 
Closings
Texas
 
$
64,282

 
389

 
56,165

 
372

Southwest
 
11,277

 
67

 
9,225

 
59

Florida
 
9,244

 
53

 
2,607

 
17

Southeast
 
7,713

 
48

 

 

Total home sales
 
$
92,516

 
557

 
$
67,997

 
448


Other Financial and Operating Data:
 
2014
 
2013
Active communities at end of period
 
34

 
22

Average sales price of homes closed
 
$
166,097

 
$
151,779

Gross margin (1)
 
$
25,260

 
$
18,568

Gross margin % (2)
 
27.3
%
 
27.3
%

(1)
Gross margin is home sales revenues less cost of sales.
(2)
Calculated as a percentage of home sales revenues.


Home sales revenues for the three months ended September 30, 2014 were $92.5 million, an increase of $24.5 million, or 36.1%, from pro forma home sales revenues of $68.0 million for the three months ended September 30, 2013. The increase in home sales revenues is primarily due to a 24.3% increase in homes closed and an increase in the average home sales price per home during the third quarter of 2014 as compared to the third quarter of 2013, on a pro forma basis. The average home sales price for the third quarter of 2014 was $166,097, an increase of $14,318, or 9.4%, from the pro forma average home sales price of $151,779 for the third quarter of 2013.
Pro forma Cost of Sales and Gross Margin (pro forma home sales revenues less pro forma cost of sales).  Cost of sales for the three months ended September 30, 2014 was $67.3 million, an increase of $17.8 million, or 36.1%, from pro forma cost of sales of $49.4 million for the three months ended September 30, 2013. This increase is primarily due to a 109-unit, or 24.3%, increase in homes closed for the three months ended September 30, 2014 as compared to homes closed on a pro forma basis for the three months ended September 30, 2013. In addition, cost of sales for the three months ended September 30, 2014 includes $0.4 million related to the fair value step-up adjustment for real estate inventory and lot option contracts acquired from the LGI/GTIS Joint Ventures and sold in the third quarter of 2014. Gross margin for the third quarter of 2014 was $25.3 million, an increase of $6.7 million, or 36.0%, from pro forma gross margin of $18.6 million for the third quarter of 2013. Gross margin as a percentage of sales was 27.3% for the third quarter of 2014 as compared to 27.3% for the third quarter of 2013, on a pro forma basis.
Pro forma Selling Expenses.  Selling expenses as a percentage of home sales revenues were 10.0% and pro forma selling expenses as a percentage of home sales revenues were 8.9% for the three months ended September 30, 2014 and 2013, respectively. The increase in selling expenses as a percentage of home sales revenues was primarily due to start up expenses related to new community openings and increased sales bonuses. Selling expenses for the third quarter of 2014 were $9.2 million, an increase of $3.2 million, or 52.6%, from pro forma selling expenses of $6.1 million for the third quarter of 2013. This increase is largely due to the higher number of home closings and the growth in active communities for the three months ended September 30, 2014 as compared to the three months ended September 30, 2013 on a pro forma basis. Sales commissions increased to $3.6 million from $1.4 million and advertising and direct mail costs increased to $2.3 million for the three months ended September 30, 2014 from $1.3 million for the three months ended September 30, 2013, on a pro forma basis.

31


Pro forma General and Administrative.  General and administrative expenses as a percentage of home sales revenues were 6.6% and pro forma general and administrative expenses as a percentage of home sales revenues were 6.7% for the three months ended September 30, 2014 and 2013, respectively. The decrease in general and administrative expenses as a percentage of home sales revenues reflects leverage realized from the increase in home sales revenues during the third quarter of 2014 and less accounting and professional expenses incurred during the third quarter of 2013, on a pro forma basis. General and administrative expenses for the third quarter of 2014 were $6.1 million, an increase of $1.6 million, or 35.1%, from pro forma general and administrative expenses of $4.5 million for the third quarter of 2013. The increase in the amount of general and administrative expenses in the third quarter of 2014 as compared to the pro forma amount for the third quarter of 2013 is attributable to additional employees and office space added to support the increased number of active communities and higher number of home closings.
Pro forma Operating Income and Pro forma Net Income.  Operating income for the three months ended September 30, 2014 was $9.9 million, an increase of $1.9 million, or 24.0%, from pro forma operating income of $8.0 million for the three months ended September 30, 2013. Net income for the three months ended September 30, 2014 was $7.0 million, a decrease of $0.7 million, or 9.5%, from pro forma net income of $7.8 million for the three months ended September 30, 2013. The decrease in net income during the third quarter of 2014 as compared to the third quarter of 2013, on a pro forma basis is primarily attributed to income taxes recorded during the third quarter of 2014. Prior to the Reorganization Transactions, the Predecessor consisted of limited liability companies and limited partnerships, all of which were treated as partnerships for income tax purposes and as such, the federal income taxes were the obligation of the individual members or partners.

Nine Months Ended September 30, 2014 Compared to Pro Forma Nine Months Ended September 30, 2013
Pro forma Homes Sales.  Our home sales revenues and closings by division for the nine months ended September 30, 2014 and pro forma home sales revenues and closings by division for the nine months ended September 30, 2013 were as follows (dollars in thousands, unless otherwise stated):
 
 
 
 
 
 
Pro Forma
 
 
Nine Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2014
 
2013
  
 
Revenues
 
Closings
 
Revenues
 
Closings
Texas
 
$
192,111

 
1,199

 
$
139,787

 
954

Southwest
 
31,211

 
188

 
19,382

 
126

Florida
 
30,960

 
185

 
4,797

 
32

Southeast
 
20,566

 
132

 

 

Total home sales
 
$
274,848

 
1,704

 
$
163,966

 
1,112


Other Financial and Operating Data:
 
2014
 
2013
Active communities at end of period
 
34

 
22

Average sales price of homes closed
 
$
161,296

 
$
147,452

Gross margin (1)
 
$
73,187

 
$
45,110

Gross margin % (2)
 
26.6
%
 
27.5
%

(1)
Gross margin is home sales revenues less cost of sales.
(2)
Calculated as a percentage of home sales revenues.


Home sales revenues for the nine months ended September 30, 2014 were $274.8 million, an increase of $110.9 million, or 67.6%, from pro forma home sales revenues of $164.0 million for the nine months ended September 30, 2013. The increase in home sales revenues is primarily due to a 53.2% increase in homes closed and an increase in the average home sales price per home during the first nine months of 2014 as compared to the first nine months of 2013, on a pro forma basis. The average home sales price for the first nine months of 2014 was $161,296, an increase of $13,844, or 9.4%, from the pro forma average home sales price of $147,452 for the first nine months of 2013.
Pro forma Cost of Sales and Gross Margin (pro forma home sales revenues less pro forma cost of sales).  Cost of sales for the nine months ended September 30, 2014 was $201.7 million, an increase of $82.8 million, or 69.7%, from pro forma cost

32


of sales of $118.9 million for the nine months ended September 30, 2013. This increase is primarily due to a 592-unit, or 53.2%, increase in homes closed for the nine months ended September 30, 2014 as compared to homes closed on a pro forma basis for the nine months ended September 30, 2013. In addition, cost of sales for the nine months ended September 30, 2014 includes $2.4 million of amortization related to the fair value step-up adjustment for real estate inventory and lot option contracts acquired from the LGI/GTIS Joint Ventures and sold in the first nine months of 2014. Gross margin for the first nine months of 2014 was $73.2 million, an increase of $28.1 million, or 62.2%, from pro forma gross margin of $45.1 million for the first nine months of 2013. Gross margin as a percentage of sales was 26.6% for the first nine months of 2014 as compared to 27.5% for the first nine months of 2013, on a pro forma basis. The decrease in gross margin as a percentage of sales reflects the impact of the step-up adjustment plus increased construction costs and higher lot costs partially offset by higher average home sales prices for the first nine months of 2014 as compared to the first nine months of 2013.
Pro forma Selling Expenses.  Selling expenses as a percentage of home sales revenues were 9.4% and pro forma selling expenses as a percentage of home sales revenues were 9.3% for the nine months ended September 30, 2014 and 2013, respectively. The increase in selling expenses as a percentage of home sales revenues was primarily due to start up expenses related to new community openings and increased sales bonuses. Selling expenses for the first nine months of 2014 were $25.8 million, an increase of $10.6 million, or 69.5%, from pro forma selling expenses of $15.2 million for the first nine months of 2013. This increase is largely due to the higher number of home closings and the growth in active communities for the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013 on a pro forma basis. Sales commissions increased to $10.3 million from $6.1 million and advertising and direct mail costs increased to $6.0 million for the nine months ended September 30, 2014 from $3.3 million for the nine months ended September 30, 2013, on a pro forma basis.
Pro forma General and Administrative.  General and administrative expenses as a percentage of home sales revenues were 6.0% and pro forma general and administrative expenses as a percentage of home sales revenues were 6.4% for the nine months ended September 30, 2014 and 2013, respectively. The decrease in general and administrative expenses as a percentage of home sales revenues reflects leverage from the increase in home sales revenues during the nine months ended September 30, 2014 and less accounting and professional fees during the first nine months of 2014 as compared to the first nine months of 2013 when we were preparing for our initial public offering. General and administrative expenses for the first nine months of 2014 were $16.6 million, an increase of $6.1 million, or 57.8%, from pro forma general and administrative expenses of $10.5 million for the first nine months of 2013. The increase in general and administrative expenses for the nine months ended September 30, 2014 as compared to the pro forma amount for the same period in the prior year is primarily due to the higher number of home closings and active communities for the first nine months of 2014. To support the increased number of active communities, we hired more employees and acquired additional office space.
Pro forma Operating Income and Pro forma Net Income.  Operating income for the nine months ended September 30, 2014 was $30.8 million, an increase of $11.4 million, or 59.0%, from pro forma operating income of $19.4 million for the nine months ended September 30, 2013. Net income for the nine months ended September 30, 2014 was $20.7 million, an increase of $1.7 million, or 8.8%, from pro forma net income of $19.0 million for the nine months ended September 30, 2013. The increase in net income is primarily attributed to a 592-unit increase in homes closed and the increase in average home sales prices during the first nine months of 2014 as compared to the first nine months of 2013, on a pro forma basis, net of the amortization of the step-up adjustment and income tax expense recorded in the first nine months of 2014, increased expenses associated with new communities and higher professional service fees and expenses.

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,” 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 adjustment, which have real economic effects and could impact our results, the utility of adjusted gross margin information as a measure of our operating performance may be limited. In addition, other companies may not calculate adjusted gross margin information in the same manner that we do. Accordingly, adjusted gross margin information should be considered only as a supplement to gross margin information as a measure of our performance.

33



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):
 
 
 
 
 
 
Pro Forma
 
 
Three Months Ended September 30,

Three Months Ended September 30,
  
 
2014

2013

2013
Home sales revenues
 
$
92,516


$
37,035


$
67,997

Cost of sales
 
67,256


27,083


49,429

Gross margin
 
25,260


9,952


18,568

Purchase accounting adjustment (a)
 
434





Capitalized interest charged to cost of sales
 
473


114


114

Adjusted gross margin
 
$
26,167


$
10,066


$
18,682

Gross margin % (b)
 
27.3
%

26.9
%

27.3
%
Adjusted gross margin % (b)
 
28.3
%

27.2
%

27.5
%
 







Pro Forma
 

Nine Months Ended September 30,

Nine Months Ended September 30,
  

2014

2013

2013
Home sales revenues

$
274,848


$
95,033


$
163,966

Cost of sales

201,661


69,225


118,856

Gross margin

73,187


25,808


45,110

Purchase accounting adjustment (a)

2,448





Capitalized interest charged to cost of sales

1,147


700


700

Adjusted gross margin

$
76,782


$
26,508


$
45,810

Gross margin % (b)

26.6
%

27.2
%

27.5
%
Adjusted gross margin % (b)

27.9
%

27.9
%

27.9
%
 

(a)
This adjustment results from the application of purchase accounting in connection with the GTIS Acquisitions and represents the amount of the fair value step-up adjustment to real estate inventory and lot option contracts sold during the three and nine months ended September 30, 2014, as applicable.

(b)
Calculated as a percentage of home sales revenues.

Adjusted EBITDA

Adjusted EBITDA is a non-GAAP financial measure used by management as a supplemental measure in evaluating operating performance. We define adjusted EBITDA as net income before (i) interest expense, (ii) income taxes, (iii) depreciation and amortization, (iv) capitalized interest charged to cost of sales, (v) other income, net and (vi) adjustments resulting from the application of purchase accounting. Our management believes that the presentation of 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. Adjusted EBITDA provides an indicator of general economic performance that is not affected by fluctuations in interest rates or effective tax rates, levels of depreciation or amortization and items considered to be non-recurring. Accordingly, our management believes that this measurement is useful for comparing general operating performance from period to period. Other companies may define adjusted EBITDA differently and, as a result, our measure of adjusted EBITDA may not be directly comparable to adjusted EBITDA of other companies. Although we use adjusted EBITDA as a financial measure to assess the performance of our business, the use of adjusted EBITDA is limited because it does not include certain material costs, such as interest and taxes, necessary to operate our business. 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 adjusted EBITDA should not be construed as an indication that our future results will be

34


unaffected by unusual or nonrecurring items. Our adjusted EBITDA is limited as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:

it does not reflect every cash expenditure, future requirements for capital expenditures or contractual commitments, including for the purchase of land;

it does not reflect the interest expense or the cash requirements necessary to service interest or principal payments on our debt;

although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced or require improvements in the future, and adjusted EBITDA does not reflect any cash requirements for such replacements or improvements;

it is not adjusted for all non-cash income or expense items that are reflected in our statements of cash flows;

it does not reflect the impact of earnings or charges resulting from matters we consider not to be indicative of our ongoing operations; and

other companies in our industry may calculate it differently than we do, limiting its usefulness as a comparative measure.

Because of these limitations, our adjusted EBITDA should not be considered a measure of discretionary cash available to us to invest in the growth of our business or as a measure of cash that will be available to us to meet our obligations. We compensate for these limitations by using our adjusted EBITDA along with other comparative tools, together with GAAP measurements, to assist in the evaluation of operating performance. These GAAP measurements include operating income, net income and cash flow data. We have significant uses of cash flows, including capital expenditures, interest payments and other non-recurring charges, which are not reflected in our adjusted EBITDA.

Adjusted EBITDA is not intended as an alternative to net income as an indicator of our operating performance, as an alternative to any other measure of performance in conformity with GAAP or as an alternative to cash flows as a measure of liquidity. You should therefore not place undue reliance on our adjusted EBITDA calculated using this measure. Our GAAP-based measures can be found in our unaudited consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q.

The following table reconciles adjusted EBITDA to net income, which is the GAAP financial measure that our management believes to be most directly comparable (dollars in thousands):
 
 
 
 
 
 
Pro Forma