10-Q
 
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, 2015
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 x
 
Non-accelerated filer  o
 
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 2, 2015, there were 20,008,649 shares of the registrant’s common stock, par value $.01 per share, outstanding.


Table of Contents

TABLE OF CONTENTS
   



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


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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

LGI HOMES, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
 
 
 
September 30,
 
December 31,
 
 
2015
 
2014
ASSETS
 
(Unaudited)
 
 
Cash and cash equivalents
 
$
36,465

 
$
31,370

Accounts receivable
 
15,822

 
7,365

Real estate inventory
 
460,475

 
367,908

Pre-acquisition costs and deposits
 
7,879

 
9,878

Property and equipment, net
 
2,052

 
1,610

Other assets
 
11,977

 
7,515

Goodwill and intangible assets, net
 
12,296

 
12,481

Total assets
 
$
546,966

 
$
438,127

 
 
 
 
 
LIABILITIES AND EQUITY
 
 
 
 
Accounts payable
 
$
28,865

 
$
15,479

Accrued expenses and other liabilities
 
44,591

 
21,365

Deferred tax liabilities, net
 
1,478

 
2,685

Notes payable
 
247,809

 
216,099

Total liabilities
 
322,743

 
255,628

 
 
 
 
 
COMMITMENTS AND CONTINGENCIES
 

 

EQUITY
 
 
 
 
Common stock, par value $0.01, 250,000,000 shares authorized, 21,008,649 shares issued and 20,008,649 shares outstanding as of September 30, 2015 and 20,849,044 shares issued and 19,849,044 shares outstanding as of December 31, 2014
 
210

 
208

Additional paid-in capital
 
168,143

 
163,520

Retained earnings
 
72,420

 
35,321

Treasury stock, at cost, 1,000,000 shares
 
(16,550
)
 
(16,550
)
Total equity
 
224,223

 
182,499

Total liabilities and equity
 
$
546,966

 
$
438,127








See accompanying notes to the consolidated financial statements.

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

 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Revenues
 
$
173,956

 
$
92,516

 
$
453,472

 
$
274,848

 
 
 
 
 
 
 
 
 
Cost of sales
 
127,949

 
67,256

 
333,430

 
201,661

Selling expenses
 
14,057

 
9,239

 
39,032

 
25,788

General and administrative
 
8,902

 
6,115

 
25,050

 
16,557

Operating income
 
23,048

 
9,906

 
55,960

 
30,842

Other income, net
 
173

 
628

 
228

 
663

Net income before income taxes
 
23,221

 
10,534

 
56,188

 
31,505

Income tax provision
 
(7,801
)
 
(3,488
)
 
(19,089
)
 
(10,828
)
Net income
 
$
15,420

 
$
7,046

 
$
37,099

 
$
20,677

Basic and diluted earnings per share data:
 
 
 
 
 
 
 
 
Basic
 
$
0.77

 
$
0.34

 
$
1.86

 
$
1.00

Diluted
 
$
0.76

 
$
0.34

 
$
1.72

 
$
0.99

 
 

 
 
 
 
 
 
Weighted average number of shares of common stock:
 
 
 
 
 
 
 
 
Basic
 
19,923,079

 
20,763,449

 
19,894,859

 
20,763,449

Diluted
 
20,318,537

 
20,881,827

 
21,665,289

 
20,871,757




















See accompanying notes to the consolidated financial statements.

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

 
 
 
Common Stock
 
Additional Paid-In Capital
 
Retained Earnings
 
Treasury Stock
 
Total Equity
 
 
Shares
 
Amount
BALANCE—December 31, 2014
 
20,849,044

 
$
208

 
$
163,520

 
$
35,321

 
$
(16,550
)
 
$
182,499

Net income
 

 

 

 
37,099

 

 
37,099

Issuance of shares, net of offering costs
 
100,000

 
1

 
2,767

 

 

 
2,768

Issuance of equity awards in settlement of accrued bonuses
 

 

 
238

 

 

 
238

Compensation expense for equity awards
 

 

 
1,644

 

 

 
1,644

Stock issued under employee incentive plans
 
59,605

 
1

 
(26
)
 

 

 
(25
)
BALANCE—September 30, 2015
 
21,008,649

 
$
210

 
$
168,143

 
$
72,420

 
$
(16,550
)
 
$
224,223


























See accompanying notes to the consolidated financial statements.

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LGI HOMES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
 
 
Nine Months Ended
 
 
September 30,
 
 
2015
 
2014
Cash flows from operating activities:
 
 
 
 
Net income
 
$
37,099

 
$
20,677

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

 

Depreciation and amortization
 
647

 
471

Loss on disposal of assets
 

 
14

Compensation expense for equity awards
 
1,644

 
627

Excess tax deficiencies from equity awards
 
25

 

Deferred income taxes
 
(1,207
)
 
(179
)
Changes in assets and liabilities:
 
 
 
 
Accounts receivable
 
(8,458
)
 
(4,312
)
Real estate inventory
 
(85,399
)
 
(143,534
)
Pre-acquisition costs and deposits
 
1,999

 
(9,026
)
Other assets
 
(2,310
)
 
(589
)
Accounts payable
 
14,221

 
1,449

Accrued expenses and other liabilities
 
17,387

 
4,817

Net cash used in operating activities
 
(24,352
)
 
(129,585
)
Cash flows from investing activities:
 
 
 
 
Purchases of property and equipment
 
(892
)
 
(828
)
Net cash used in investing activities
 
(892
)

(828
)
Cash flows from financing activities:
 
 
 
 
Proceeds from notes payable
 
185,382

 
127,528

Payments on notes payable
 
(154,786
)
 
(2,875
)
Loan issuance costs
 
(1,839
)
 
(2,148
)
Payment for offering costs
 
(313
)
 

Payment for earnout obligation
 
(848
)
 

Excess tax deficiencies from equity awards
 
(25
)
 

Proceeds from sale of stock, net of offering expenses
 
2,768

 

Net cash provided by financing activities
 
30,339

 
122,505

Net increase (decrease) in cash and cash equivalents
 
5,095

 
(7,908
)
Cash and cash equivalents, beginning of period
 
31,370

 
54,069

Cash and cash equivalents, end of period
 
$
36,465

 
$
46,161





See accompanying notes to the consolidated financial statements.

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

1.     ORGANIZATION AND BASIS OF PRESENTATION
Organization and Description of the Business
LGI Homes, Inc., a Delaware corporation (the “Company”, “us,” “we,” or “our,”), is engaged in the development of communities and design, construction, marketing and sale of new homes. At September 30, 2015, we had operations in Texas, Arizona, Florida, Georgia, New Mexico, Colorado, North Carolina and South Carolina.

Basis of Presentation

The unaudited consolidated financial statements have been prepared in accordance with U.S. Generally Accepted Accounting Principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. These financial statements should be read in conjunction with the consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014. The accompanying unaudited consolidated financial statements include all adjustments that are of a normal recurring nature and necessary for the fair presentation of our results for the interim periods presented. Results for interim periods are not necessarily indicative of results to be expected for the full year.

The accompanying unaudited financial statements as of and for the three and nine months ended September 30, 2015 and 2014, include the accounts of the Company and its subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires us 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, the earnout liability for a completed homebuilder acquisition, performance-based compensation, and loss contingencies.

Recently Issued Accounting Pronouncements    

In August 2015, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (ASU)No. 2015-15, “Interest - Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements - Amendments to SEC Paragraphs Pursuant to Staff Announcement at June 18, 2015 EITF Meeting”(“ASU 2015-15”), which clarifies the treatment of debt issuance costs from line-of-credit arrangements after the adoption of ASU 2015-03 (as defined below). In particular, ASU 2015-15 clarifies that the Securities and Exchange Commission staff would not object to an entity deferring and presenting debt issuance costs related to a line-of-credit arrangement as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of such arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. The adoption of ASU 2015-15 is not expected to have a material effect on our consolidated financial statements and disclosures.

In April 2015, the FASB issued ASU No. 2015-03, “Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs” (ASU 2015-03) as part of its initiative to reduce complexity in accounting standards (the Simplification Initiative). ASU 2015-03 requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts and does not affect the recognition and measurement guidance for debt issuance costs. ASU 2015-03 will be effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. The adoption of ASU 2015-03 is not expected to have a material effect on our consolidated financial statements and disclosures.

In February 2015, the FASB issued ASU No. 2015-02, “Consolidation (Topic 810): Amendments to the Consolidation Analysis” (“ASU 2015-02”), which amends the consolidation requirements in ASC 810, primarily related to limited partnerships and variable interest entities (“VIEs”). ASU 2015-02 will be effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption is permitted. The adoption of ASU 2015-02 is not expected to have a material effect on our consolidated financial statements and disclosures.

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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 periods ending after December 15, 2016. The adoption of ASU 2014-15 is not expected to have any effect on our 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 beginning January 1, 2018 and, at that time, we may adopt the new standard under the full retrospective approach or the modified retrospective approach. Early adoption of this ASU is not permitted. We are currently evaluating the method and impact the adoption of ASU 2014-09 will have on our consolidated financial statements and disclosures.

2.     ACQUISITION
Oakmont Acquisition
On October 2, 2014, we acquired certain home building assets and liabilities of Oakmont Home Builders, Inc. (“Oakmont”) and certain land positions of EST Properties, LLC, an affiliate of Oakmont (the “Oakmont Acquisition”). As a result of the Oakmont Acquisition, we established an immediate presence in residential homebuilding in the Charlotte, North Carolina, market acquiring 150 homes under construction and more than 1,000 owned and controlled lots. The total purchase price for the Oakmont Acquisition was approximately $17.3 million, consisting of approximately $15.2 million in cash and a contingent earnout based on home closings through December 31, 2017. During the quarter ended September 30, 2015, we closed 65 homes attributable to the Oakmont Acquisition resulting in a $260,000 earnout obligation to be paid during the fourth quarter of 2015. The earnout liability is included in other liabilities on the consolidated balance sheet and will be subject to adjustment based on revisions to the forecasted absorption rate and the actual number of homes closed during the earnout period.

3.     REAL ESTATE INVENTORY
Our real estate inventory consists of the following (in thousands):
 
 
September 30,
 
December 31,
 
 
2015
 
2014
Land, land under development, and finished lots
 
$
282,226

 
$
244,658

Sales offices
 
8,166

 
6,978

Homes in progress
 
111,508

 
55,807

Completed homes
 
58,575

 
60,465

Total real estate inventory
 
$
460,475

 
$
367,908

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 and net of expected reimbursements of development costs, are capitalized to real estate inventory. Land development and other common costs that benefit the entire community, including field construction supervision and related direct overhead, are allocated to individual lots or homes, as appropriate. The costs of lots are transferred to homes in progress when home construction begins. Home construction costs and related carrying charges are allocated to the cost of individual homes using the specific identification method. Costs that are not specifically identifiable to a home are allocated on a pro rata basis using either the lot size or relative sales value. Inventory costs for completed homes are expensed to cost of sales as homes are sold. Changes

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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.
Interest and financing costs incurred under our debt obligations, as more fully discussed in Note 5, are capitalized to qualifying real estate projects under development and homes in progress.

4.     ACCRUED EXPENSES AND OTHER LIABILITIES
Accrued and other current liabilities consist of the following (in thousands):
 
 
September 30,
 
December 31,
 
 
2015
 
2014
Inventory related obligations
 
$
13,331

 
$
7,275

Retentions payable
 
2,339

 
2,696

Accrued compensation, bonuses and benefits
 
5,821

 
2,434

Earnout liability
 
1,884

 
2,196

Taxes payable
 
12,307

 
1,448

Warranty reserve
 
1,100

 
900

Other
 
7,809

 
4,416

Total accrued expenses and other liabilities
 
$
44,591

 
$
21,365


Inventory Related Obligations
We own 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.
Estimated Warranty Reserve
We typically provide homebuyers with a one-year warranty on the house and a ten-year limited warranty for major defects in structural elements such as framing components and foundation systems.

Changes to our warranty accrual are as follows (in thousands):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015

2014
Warranty reserves, beginning of period
 
$
1,000

 
$
825

 
$
900

 
$
630

Warranty provision
 
656

 
329

 
1,697

 
685

Warranty expenditures
 
(556
)
 
(279
)
 
(1,497
)
 
(440
)
Warranty reserves, end of period
 
$
1,100

 
$
875

 
$
1,100

 
$
875

 
5.     NOTES PAYABLE
Revolving Credit Agreement
In May 2015, we entered into a Credit Agreement (the “Credit Agreement”) with several financial institutions, and Wells Fargo Bank, National Association, as administrative agent. The Credit Agreement provides for a $225.0 million revolving credit facility, which can be increased upon our request up to $300.0 million, subject to the terms and conditions of the Credit Agreement. The revolving credit facility matures on May 26, 2018. Prior to each annual anniversary of the Credit Agreement, we may request a one-year extension of the maturity date. The Credit Agreement is guaranteed by each of our subsidiaries having gross assets

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equal to or greater than $500,000. Prior to the occurrence of a trigger event under the Credit Agreement, the revolving credit facility is unsecured except that the facility is secured by a first priority lien in land held for development, lots under development and/or finished lots with an aggregate land value of at least $35.0 million. As of September 30, 2015, the borrowing base was $225.0 million, of which $170.0 million was outstanding, $3.4 million represents letter of credit assurances, and $51.6 million was available to borrow.
Interest on borrowings under the Credit Agreement is paid monthly at LIBOR plus 3.50%. The Credit Agreement applicable margin for LIBOR loans ranges from 3.00% to 3.50% based on leverage ratio. At September 30, 2015, LIBOR was 0.20%.
The Credit Agreement contains various financial covenants, including a tangible net worth ratio, a leverage ratio, a minimum liquidity amount, and an EBITDA to interest expense ratio. The Credit Agreement also prohibits us from making any investments except as permitted under the Credit Agreement. In addition, the Credit Agreement contains various covenants that, among other restrictions, limit the amount of our additional debt. At September 30, 2015, we were in compliance with all of the covenants contained in the Credit Agreement.

Convertible Notes
In November 2014, we issued $85.0 million aggregate principal amount of our 4.25% Convertible Notes due 2019 (the “Convertible Notes”). The Convertible Notes mature on November 15, 2019 and bear interest at a rate of 4.25%, payable semiannually in May and November. Prior to May 15, 2019, the Convertible Notes are convertible only upon satisfaction of any of the specified conversion events. On or after May 15, 2019, note holders can convert their Convertible Notes at any time at their option.
When issued, the conversion of the Convertible Notes could only be settled in shares of our common stock. On April 30, 2015 at our 2015 Annual Meeting of Stockholders, our stockholders approved the flexible settlement provisions of the Convertible Notes which allows us to settle the conversion of our Convertible Notes using any combination of cash and shares of our common stock. The initial conversion rate of the Convertible Notes is 46.4792 shares of our common stock for each $1,000 principal amount of Convertible Notes, which represents an initial conversion price of approximately $21.52 per share of our common stock. The conversion rate is subject to adjustments upon the occurrence of specific events.
When the Convertible Notes were issued, the fair value of $76.5 million was recorded to notes payable. $5.5 million of the remaining proceeds was recorded to additional paid in capital to reflect the equity component and the remaining $3.0 million of debt issuance cost was recorded as a deferred tax liability. The carrying amount of the Convertible Notes is being accreted to face value over the term to maturity.
Notes payable consist of the following (in thousands):
 
 
September 30, 2015
 
December 31, 2014
 
 
 
LGI Homes, Inc.—Notes payable to Wells Fargo Bank, National Association and several financial institutions under the Credit Agreement ($225.0 million revolving credit facility) maturing on May 26, 2018; interest paid monthly at LIBOR plus 3.50%; collateralized by certain land, land under development, and finished lots (carrying value of $42.5 million at September 30, 2015)
 
$
170,000

 
$

LGI Homes, Inc.—Notes payable to Texas Capital Bank, National Association and a syndication of lenders under the Credit Agreement ($200.0 million secured revolving credit facility) repaid and terminated on May 27, 2015; interest paid monthly at LIBOR plus 2.75%, with a LIBOR floor of 1.00%
 

 
139,404

LGI Homes, Inc.— 4.25% Convertible Notes due November 15, 2019; interest paid semi-annually at 4.25%; net of approximately $7.2 million and $8.3 million in unamortized discount at September 30, 2015 and December 31, 2014, respectively
 
77,809

 
76,695

Total notes payable
 
$
247,809


$
216,099












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Capitalized Interest
Interest activity, including other financing costs and accretion of discount, for notes payable for the periods presented is as follows (in thousands):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Interest incurred
 
$
3,468

 
$
1,586

 
$
10,347

 
$
3,263

Less: Amounts capitalized
 
(3,468
)
 
(1,586
)
 
(10,347
)
 
(3,263
)
Interest expense
 
$

 
$

 
$

 
$

 
 
 
 
 
 
 
 
 
Cash paid for interest
 
$
1,554

 
$
1,085

 
$
6,193

 
$
2,520


Included in interest incurred was amortization of deferred financing costs for notes payable and amortization of Convertible Notes discount of $0.9 million and $0.3 million for the three months ended September 30, 2015 and 2014, respectively, and $3.0 million and $0.6 million for the nine months ended September 30, 2015 and 2014, respectively.

6.     INCOME TAXES

We utilize 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. Our ability to realize deferred tax assets is assessed throughout the year and a valuation allowance is established, if required. We recognize 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. We recognize potential interest and penalties related to uncertain tax positions in income tax expense.

We file U.S. federal and state income tax returns. As of September 30, 2015, we have no unrecognized tax benefits. We are not presently under exam for income tax by any taxing jurisdiction and we are no longer subject to exam for years before 2012 (2011 for Texas).

Our effective tax rate of 34.0% 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.

Income taxes paid were $1.8 million and $3.8 million for the three months ended September 30, 2015 and 2014, respectively. Income taxes paid were $10.2 million and $12.0 million for the nine months ended September 30, 2015 and 2014, respectively.


7.     EQUITY
Shelf Registration Statement and ATM Offering Program
We filed a shelf registration statement on Form S-3 (the “Registration Statement”) to sell from time to time various securities with a maximum offering price of $300.0 million. The Registration Statement was declared effective in August 2015. Under the Registration Statement, we established an at the market common stock offering program (the “ATM Program”) in August 2015 with Deutsche Bank Securities Inc., J.P. Morgan Securities LLC, JMP Securities LLC and Builder Advisor Group, LLC, as sales agents. Under the ATM Program, we may issue and sell from time to time shares of our common stock having an aggregate offering price of up to $30.0 million. During September 2015, we issued 100,000 shares of our common stock under the ATM Program and received net proceeds of approximately $2.8 million.


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8.     EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per share for the three and nine months ended September 30, 2015 and 2014:
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Numerator (in thousands):
 
 
 
 
 
 
 
 
Numerator for basic earnings per share
 
$
15,420

 
$
7,046

 
$
37,099

 
$
20,677

    Effect of dilutive securities:
 
 
 
 
 
 
 
 
Interest expense associated with Convertible Notes, net of taxes
 

 

 
190

 

    Numerator for diluted earnings per share
 
$
15,420

 
$
7,046

 
$
37,289

 
$
20,677

Denominator:
 
 
 
 
 
 
 
 
       Basic weighted average shares outstanding
 
19,923,079

 
20,763,449

 
19,894,859

 
20,763,449

       Effect of dilutive securities:
 
 
 
 
 
 
 
 
Convertible Notes - treasury stock method
 
346,625

 

 

 

Convertible Notes - if-converted method
 

 

 
1,736,585

 

         Restricted stock units
 
48,833

 
118,378

 
33,845

 
108,308

       Diluted weighted average shares outstanding
 
20,318,537

 
20,881,827

 
21,665,289

 
20,871,757

 
 
 
 
 
 
 
 
 
Basic earnings per share
 
$
0.77

 
$
0.34

 
$
1.86

 
$
1.00

Diluted earnings per share
 
$
0.76

 
$
0.34

 
$
1.72

 
$
0.99

Antidilutive non-vested restricted stock units excluded from calculation of diluted earning per share
 
970

 

 
4,300

 
3,030


In accordance with ASC 260-10, Earnings Per Share, we calculated the dilutive effect of the Convertible Notes using the “if-converted” method through April 30, 2015. The interest expense related to the Convertible Notes through April 30, 2015 is the amount included in cost of sales. On April 30, 2015, our stockholders approved the flexible settlement provisions of the Convertible Notes at our 2015 Annual Meeting of Stockholders which allows us to settle the conversion of the Convertible Notes using any combination of cash and shares of our common stock. Therefore, subsequent to April 30, 2015, the treasury stock method is used to calculate the dilutive effect of the Convertible Notes, since we have the intent and ability to settle the principal amount of the outstanding Convertible Notes in cash. Under the treasury stock method, the Convertible Notes have a dilutive impact on diluted earnings per share to the extent that the average market price of our common stock for a reporting period exceeds the conversion price of $21.52 per share.

During the three months ended September 30, 2015, the average market price of our common stock exceeded the conversion price of $21.52 per share, therefore the calculation of diluted earnings per share for the three months ended September 30, 2015 includes the effect of approximately 0.3 million common shares related to the conversion spread of the Convertible Notes.















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9.    STOCK-BASED COMPENSATION

Non-performance Based Restricted Stock Units
The following table summarizes the activity of our restricted stock units (“RSUs”):
 
 
Nine months ended September 30,
 
 
2015
 
2014
 
 
Shares
 
Weighted Average Grant Date Fair Value
 
Shares
 
Weighted Average Grant Date Fair Value
Beginning balance
 
102,786

 
$
15.43

 
140,222

 
$
11.00

   Granted
 
66,300

 
$
15.28

 
64,426

 
$
17.26

   Vested
 
(59,707
)
 
$
17.20

 

 
$

   Forfeited
 
(3,444
)
 
$
15.97

 
(2,806
)
 
$
11.00

Ending balance
 
105,935

 
$
14.31

 
201,842

 
$
13.00

In March 2015, we issued 56,611 RSUs for 2014 bonuses to certain officers and managers under the Annual Bonus Plan. The RSUs vest over three years and will be settled in shares of our common stock. In addition, during the nine months ended September 30, 2015, we issued 9,689 RSUs to certain employees and executives which vest on the third anniversary of the grant date. The RSUs will be settled in shares of our common stock.
We recognized $0.1 million and $0.2 million of stock-based compensation expense related to outstanding RSUs grants for the three months ended September 30, 2015 and 2014, respectively. We recognized $0.4 million of stock-based compensation expense related to outstanding RSUs grants for both the nine months ended September 30, 2015 and 2014. At September 30, 2015, we had unrecognized compensation cost of $1.0 million related to unvested RSUs, which is expected to be recognized over a weighted average period of 2.2 years.
Performance Based Restricted Stock Units
The Compensation Committee of our Board of Directors has granted awards of Performance-Based RSUs (“PSUs”) under the LGI Homes, Inc. Equity Incentive Plan to certain members of senior management for each of the three-year performance cycles: 2014 - 2016 and 2015 - 2017. The PSUs provide for shares of our common stock to be issued based on the attainment of certain performance metrics over a three-year period. The number of shares of our common stock that may be issued to the recipients for the PSUs range from 0% to 200% of the target amount depending on actual results as compared to the target performance metrics. The PSUs vest upon the determination date for the actual results at the end of the three-year period and require that the recipients continue to be employed by us through the determination date. The PSUs will be settled in shares of our common stock.
The following table summarizes the activity of our PSUs:
Period Granted
 
Target PSUs Outstanding December 31, 2014
 
Target PSUs Granted
 
Target PSUs Vested
 
Target PSUs Forfeited
 
Target PSUs Outstanding at September 30, 2015
 
Weighted Average Grant Date Fair Value
2014
 
62,906

 

 

 

 
62,906

 
$
17.09

2015
 

 
127,111

 

 

 
127,111

 
$
13.34

Total
 
62,906

 
127,111

 

 

 
190,017

 
 
At September 30, 2015, management estimates that the recipients will receive approximately 167% and 158% of the 2014 and 2015 target number of PSUs, respectively, at the end of the applicable three-year performance cycle based on projected performance compared to the target performance metrics. We recognized $0.9 million and $0.1 million of total stock-based compensation expense related to outstanding PSU grants for the three months ended September 30, 2015 and 2014, respectively. We recognized $1.3 million and $0.2 million of total stock-based compensation expense related to outstanding PSU grants for the nine months ended September 30, 2015 and 2014, respectively. At September 30, 2015, we had unrecognized compensation cost of $2.9 million related to PSUs, which is expected to be recognized over a weighted average period of 1.5 years.

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10.    FAIR VALUE DISCLOSURES

ASC Topic 820, Fair Value Measurements (“ASC 820”), defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date” within an entity’s principal market, if any. The principal market is the market in which the reporting entity would sell the asset or transfer the liability with the greatest volume and level of activity, regardless of whether it is the market in which the entity will ultimately transact for a particular asset or liability or if a different market is potentially more advantageous. Accordingly, this exit price concept may result in a fair value that differs from the transaction price or market price of the asset or liability.
ASC 820 provides a framework for measuring fair value under GAAP, expands disclosures about fair value measurements, and establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three levels of the fair value hierarchy are summarized as follows:
Level 1 - Fair value is based on quoted prices in active markets for identical assets or liabilities.
Level 2 - Fair value is determined using significant observable inputs, generally either quoted prices in active markets for
similar assets or liabilities, or quoted prices in markets that are not active.
Level 3 - Fair value is determined using one or more significant inputs that are unobservable in active markets at the
measurement date, such as a pricing model, discounted cash flow, or similar technique.
We utilize fair value measurements to account for certain items and account balances within our consolidated financial statements. Fair value measurements may also be utilized on a nonrecurring basis, such as for the impairment of long-lived assets. The fair value of financial instruments, including cash and cash equivalents and accounts receivable and accounts payable, approximate their carrying amounts due to the short term nature of these instruments. As of September 30, 2015, the revolving credit facility's carrying value approximates market value since it has a floating interest rate, which increases or decreases with market interest rates.
The Convertible Notes, as discussed in Note 5, were initially recorded at estimated fair value determined using Level 2 measurements. No significant changes occurred through December 31, 2014 and the recorded value of $76.7 million at December 31, 2014 approximated fair value. The fair value of the Convertible Notes was $75.9 million as of September 30, 2015 using Level 2 measurements compared to the carrying value of $77.8 million.
The fair value of the Oakmont Acquisition earnout, discussed in Note 2, is determined using Level 3 measurements based on the forecasted number of home closings adjusted to reflect probability weighted absorption scenarios and a 10% discount rate and has been estimated to be approximately $1.6 million and $2.2 million as of September 30, 2015 and December 31, 2014, respectively. Significant assumptions impacting our estimates of the fair value of the earnout include absorption rates, the timing of the completion of development activities and the discount rate.


11.    RELATED PARTY TRANSACTIONS

Magnolia Reserve
The Company has an option contract to purchase 106 finished lots in Montgomery County, Texas, from an affiliate of a family member of our chief executive officer for a total base purchase price of approximately $8.0 million. The lots will be purchased in takedowns of at least 21 lots during each 6 month period, subject to 5% annual price escalation and certain price protection terms. The Company had a $25,000 non-refundable deposit at September 30, 2015 related to this option contract. We expect the first closing of lots under the option contract will take place on or around December 31, 2015.

Consulting Fees
We have a three year consulting agreement with a family member of our chief executive officer for $100,000 per year payable on a monthly basis, which expires November 2016. Consulting fees were $25,000 for each of the three month periods ended September 30, 2015 and 2014 and $75,000 for each of the nine month periods ended September 30, 2015 and 2014.

12.     COMMITMENTS AND CONTINGENCIES
Contingencies
In the ordinary course of doing business, we become 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

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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 our consolidated financial position, results of operations or cash flows.
We have provided unsecured environmental indemnities to certain lenders. In each case, we have performed due diligence on the potential environmental risks including obtaining an independent environmental review from outside environmental consultants. These indemnities obligate us to reimburse the guaranteed parties for damages related to environmental matters. There is no term or damage limitation on these indemnities; however, if an environmental matter arises, we may have recourse against previous owners. Management is not aware of any environmental claims or occurrences and has recorded no reserves for environmental matters at September 30, 2015 and December 31, 2014.

Land Deposits
We have 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. Amounts paid for land options and deposits on land purchase contracts are capitalized and classified as deposits to purchase. Upon acquisition of the land, 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 deposit and related pre-acquisition costs 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 810”), a nonrefundable deposit paid to an entity is deemed to be a variable interest that will absorb some or all of the entitys expected losses if they occur. Non-refundable land purchase and lot option deposits generally represent our maximum exposure if we elect not to purchase the optioned property. In most instances, we will 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 we would have to absorb should the option not be exercised. Therefore, whenever we enter into a land option or purchase contract with an entity and make a nonrefundable deposit, we may have a variable interest in a VIE. In accordance with ASC 810, we perform ongoing reassessments of whether we are the primary beneficiary of a VIE and would consolidate the VIE if we are deemed to be the primary beneficiary. As of September 30, 2015 and December 31, 2014, we determined we were not the primary beneficiary for any VIEs associated with non-refundable land deposit and option contracts.
The table below presents a summary of our lots under option or contract (in thousands, except for lot count):
 
 
September 30, 2015
 
December 31, 2014
Land deposits and option payments
 
$
7,509

 
$
9,591

Commitments under the land purchase option and deposit contracts if the purchases are consummated
 
$
154,526

 
$
86,277

Lots under land options and land purchase contracts
 
6,729

 
3,921

As of September 30, 2015 and December 31, 2014, approximately $1.9 million and $7.4 million of the land deposits are related to purchase contracts to deliver finished lots that are secured by mortgages on the related property and refundable under certain circumstances.

Bonding and Letters of Credit
We have outstanding letters of credit and performance and surety bonds totaling $18.8 million (including $3.4 million under our revolving credit facility) and $7.7 million at September 30, 2015 and December 31, 2014, respectively, related to our obligations for site improvements at various projects. Management does not believe that draws upon the letters of credit or bonds, if any, will have a material effect on our consolidated financial position, results of operations, or cash flows.

13.     SEGMENT INFORMATION
We operate one principal homebuilding business which is organized and reports by division. We have five operating segments at September 30, 2015: the Texas division, the Southwest division, the Southeast division, the Florida division and the Northwest division. The recently formed Northwest division had only pre-construction operations as of September 30, 2015. The Texas division is the largest division and it comprised approximately 56% and 70% of total home sales revenues for the nine months ended September 30, 2015, and 2014, 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-

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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, we 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 and is managed by our management team. We have no inter-segment sales, as all sales are to external customers.





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ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For purposes of this Management’s Discussion and Analysis of Financial Condition and Results of Operation, references to “we,” “our,” “us” or similar terms refer to LGI Homes, Inc. and its subsidiaries.
Business Overview
We are one of the nation’s fastest growing public homebuilders in terms of percentage increase of home closings. We are engaged in the design, construction, marketing and sale of new homes in markets in Texas, Arizona, Florida, Georgia, New Mexico, Colorado, North Carolina and South Carolina. Our core markets include Houston, San Antonio, Dallas/Fort Worth, Austin, Phoenix, Tucson, Tampa, Orlando, Atlanta, Albuquerque, Denver and Charlotte. Our management team has been in the residential land development business since the mid-1990s. Since commencing home building operations in 2003, we have constructed and closed over 11,000 homes. During the nine months ended September 30, 2015, we had 2,458 home closings, compared to 1,704 home closings during the nine months ended September 30, 2014.
Recent Developments
Shelf Registration Statement and ATM Offering Program
We filed a shelf registration statement on Form S-3 (the “Registration Statement”) to sell from time to time various securities with a maximum offering price of $300.0 million. The Registration Statement was declared effective in August 2015. Under the Registration Statement, we established an at the market common stock offering program (the “ATM Program”) in August 2015 with Deutsche Bank Securities Inc., J.P. Morgan Securities LLC, JMP Securities LLC and Builder Advisor Group, LLC, as sales agents. Under the ATM Program, we may issue and sell from time to time shares of our common stock having an aggregate offering price of up to $30.0 million. During September 2015, we issued 100,000 shares of our common stock under the ATM Program and received net proceeds of approximately $2.8 million.

Key Results
Key financial results as of and for the three months ended September 30, 2015, as compared to the three months ended September 30, 2014, were as follows:
Homes closed increased 67.7% to 934 homes from 557 homes.
Average sales price of our homes increased 12.1% to $186,248 from $166,097.
Home sales revenues increased 88.0% to $174.0 million from $92.5 million.
Gross margin as a percentage of home sales revenues decreased to 26.4% from 27.3%.
Adjusted gross margin (non-GAAP) as a percentage of home sales revenues decreased to 27.5% from 28.3%.
Net income before income taxes increased 120.4% to $23.2 million from $10.5 million.
Adjusted EBITDA margin (non-GAAP) as a percentage of home sales revenues increased to 14.4% from 11.9%.
Active communities increased to 50 from 34.
Total owned and controlled lots increased to 23,419 lots at September 30, 2015 from 22,192 lots at June 30, 2015.
Key financial results as of and for the nine months ended September 30, 2015, as compared to the nine months ended September 30, 2014, were as follows:
Homes closed increased 44.2% to 2,458 homes from 1,704 homes.
Average sales price of our homes increased 14.4% to $184,488 from $161,296.
Home sales revenues increased 65.0% to $453.5 million from $274.8 million.
Gross margin as a percentage of home sales revenues decreased to 26.5% from 26.6%.
Adjusted gross margin (non-GAAP) as a percentage of home sales revenues decreased to 27.8% from 27.9%.
Net income before income taxes increased 78.3% to $56.2 million from $31.5 million.
Adjusted EBITDA margin (non-GAAP) as a percentage of home sales revenues increased to 13.9% from 12.7%.
Total owned and controlled lots increased to 23,419 lots at September 30, 2015 from 19,883 lots at December 31, 2014.
For a reconciliation of certain non-GAAP measures to the most directly comparable GAAP measure, please see
“—Non-GAAP Measures.”

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Results of Operations

The following table sets forth our results of operations for the periods indicated: 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
 
 
(dollars in thousands, except per share data and average home sales price)
Statement of Income Data:
 
 
 
 
 
 
 
 
Revenues
 
$
173,956

 
$
92,516

 
$
453,472

 
$
274,848

Expenses:
 
 
 
 
 
 
 
 
Cost of sales
 
127,949

 
67,256

 
333,430

 
201,661

Selling expenses
 
14,057

 
9,239

 
39,032

 
25,788

General and administrative
 
8,902

 
6,115

 
25,050

 
16,557

     Operating income
 
23,048

 
9,906

 
55,960

 
30,842

Other income, net
 
173

 
628

 
228

 
663

     Net income before income taxes
 
23,221

 
10,534

 
56,188


31,505

Income tax provision
 
(7,801
)
 
(3,488
)
 
(19,089
)
 
(10,828
)
     Net income
 
$
15,420

 
$
7,046

 
$
37,099

 
$
20,677

Basic earnings per share
 
$
0.77

 
$
0.34

 
$
1.86

 
$
1.00

Diluted earnings per share
 
$
0.76

 
$
0.34

 
$
1.72

 
$
0.99

Other Financial and Operating Data:
 
 
 
 
 

 

Active communities at end of period
 
50

 
34

 
50

 
34

Home closings
 
934

 
557

 
2,458

 
1,704

Average sales price of homes closed
 
$
186,248

 
$
166,097

 
$
184,488

 
$
161,296

Gross margin (1)
 
$
46,007

 
$
25,260

 
$
120,042

 
$
73,187

Gross margin % (2)
 
26.4
%
 
27.3
%
 
26.5
%
 
26.6
%
Adjusted gross margin (3)
 
$
47,870

 
$
26,167

 
$
126,277

 
$
76,782

Adjusted gross margin % (2)(3)
 
27.5
%
 
28.3
%
 
27.8
%
 
27.9
%
Adjusted EBITDA (4)
 
$
25,136

 
$
10,984

 
$
62,843

 
$
34,908

Adjusted EBITDA margin % (2)(4)
 
14.4
%
 
11.9
%
 
13.9
%
 
12.7
%
 
(1)
Gross margin is home sales revenues less cost of sales.

(2)
Calculated as a percentage of home sales revenues.

(3)
Adjusted gross margin is a non-GAAP financial measure used by management as a supplemental measure in evaluating operating performance. We define adjusted gross margin as gross margin less capitalized interest and adjustments resulting from the application of purchase accounting included in 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.

(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

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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, 2015 Compared to Three Months Ended September 30, 2014
Homes Sales. Our home sales revenues and closings by division for the three months ended September 30, 2015 and 2014 were as follows (dollars in thousands):
 
 
Three Months Ended September 30,
 
 
2015
 
2014
 
 
Revenues
 
Closings
 
Revenues
 
Closings
Texas
 
$
93,661

 
491

 
$
64,282

 
389

Southwest
 
30,333

 
158

 
11,277

 
67

Southeast
 
26,588

 
159

 
7,713

 
48

Florida
 
23,374

 
126

 
9,244

 
53

Total home sales
 
$
173,956

 
934

 
$
92,516

 
557


Home sales revenues for the three months ended September 30, 2015 were $174.0 million, an increase of $81.4 million, or 88.0%, from $92.5 million for the three months ended September 30, 2014. The increase in home sales revenues is primarily due to a 67.7% increase in homes closed and an increase in the average selling price per home during the three months ended September 30, 2015 as compared to the three months ended September 30, 2014. The increase in home closings was largely due to the increase in the number of active communities in the three months ended September 30, 2015. The average selling price per home closed during the three months ended September 30, 2015 was $186,248, an increase of $20,151, or 12.1%, from the average selling price per home of $166,097 for the three months ended September 30, 2014. The increase in average selling price per home is primarily due to changes in product mix, price points in new markets, and a favorable pricing environment.
Cost of Sales and Gross Margin (home sales revenues less cost of sales). Cost of sales increased for the three months ended September 30, 2015 to $127.9 million, an increase of $60.7 million, or 90.2%, from $67.3 million for the three months ended September 30, 2014. This increase is primarily due to a 67.7% increase in homes closed during the third quarter of 2015 as compared to the third quarter of 2014, and to a lesser degree, product mix. Gross margin for the three months ended September 30, 2015 was $46.0 million, an increase of $20.7 million, or 82.1%, from $25.3 million for the three months ended September 30, 2014. Gross margin as a percentage of home sales revenues was 26.4% for the three months ended September 30, 2015 and 27.3% for the three months ended September 30, 2014. The decrease in gross margin as a percentage of home sales revenues reflects increased construction costs, overall higher lot costs and higher carrying costs (including capitalized interest) attributed to closed homes partially offset by higher average home sales price for the three months ended September 30, 2015 as compared to the three months ended September 30, 2014.
Selling Expenses. Selling expenses for the three months ended September 30, 2015 were $14.1 million, an increase of $4.8 million, or 52.1%, from $9.2 million for the three months ended September 30, 2014. Sales commissions increased to $6.8 million for the three months ended September 30, 2015 from $3.6 million during the same period in the prior year, primarily due to a 88.0% increase in home sales revenue during the three months ended September 30, 2015 as compared to the three months ended September 30, 2014. Selling expenses as a percentage of home sales revenues were 8.1% and 10.0% for the three months ended September 30, 2015 and 2014, respectively, and reflect operating leverage realized related to advertising costs.
General and Administrative. General and administrative expenses for the three months ended September 30, 2015 were $8.9 million, an increase of $2.8 million, or 45.6%, from $6.1 million for the three months ended September 30, 2014. The increase in
general and administrative expenses is primarily due to the higher number of home closings and active communities during the third quarter of 2015 as compared to the third quarter of 2014. Additionally, the increase in the general and administrative expenses is also attributed to the performance based incentive plans. General and administrative expenses as a percentage of home sales revenues were 5.1% and 6.6% for the three months ended September 30, 2015 and 2014, respectively. The decrease in general

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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 2015 as compared to the third quarter of 2014.
Other Income. Other income, net of other expenses was $0.2 million for the three months ended September 30, 2015, a decrease of $0.5 million from $0.6 million for the three months ended September 30, 2014. The decrease 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, 2015 was $23.0 million, an increase of $13.1 million, or 132.7%, from $9.9 million for the three months ended September 30, 2014. Net income for the three months ended September 30, 2015, was $15.4 million, an increase of $8.4 million, or 118.8%, from $7.0 million for the three months ended September 30, 2014. The increases are primarily attributed to a 67.7% increase in homes closed, the increase in average home sales price during the third quarter of 2015 as compared to the third quarter of 2014, and operating leverage realized related to selling, general, and administrative expenses, net of increased expenses associated with new communities.

Nine Months Ended September 30, 2015 Compared to Nine Months Ended September 30, 2014
Homes Sales. Our home sales revenues and closings by division for the nine months ended September 30, 2015 and 2014 were as follows (dollars in thousands):
 
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
 
Revenues
 
Closings
 
Revenues
 
Closings
Texas
 
$
256,146

 
1,361

 
$
192,111

 
1,199

Southwest
 
74,006

 
380

 
31,211

 
188

Southeast
 
68,731

 
423

 
20,566

 
132

Florida
 
54,589

 
294

 
30,960

 
185

Total home sales
 
$
453,472

 
2,458

 
$
274,848

 
1,704


Home sales revenues for the nine months ended September 30, 2015 were $453.5 million, an increase of $178.6 million, or 65.0%, from $274.8 million for the nine months ended September 30, 2014. The increase in home sales revenues is primarily due to a 44.2% increase in homes closed and an increase in the average selling price per home during the nine months ended September 30, 2015 as compared to the nine months ended September 30, 2014. The increase in homes closings was largely due to the increase in the number of active communities in the nine months ended September 30, 2015. The average selling price per home closed during the nine months ended September 30, 2015 was $184,488, an increase of $23,192, or 14.4%, from the average selling price per home of $161,296 for the nine months ended September 30, 2014. The increase in average selling price per home is primarily due to changes in product mix, price points in new markets and a favorable pricing environment.
Cost of Sales and Gross Margin (home sales revenues less cost of sales). Cost of sales increased for the nine months ended September 30, 2015 to $333.4 million, an increase of $131.8 million, or 65.3%, from $201.7 million for the nine months ended September 30, 2014. This increase is primarily due to a 44.2% increase in homes closed during the first nine months of 2015 as compared to the first nine months of 2014, and to a lesser degree, product mix. Gross margin for the nine months ended September 30, 2015 was $120.0 million, an increase of $46.9 million or 64.0%, from $73.2 million for the nine months ended September 30, 2014. Gross margin as a percentage of home sales revenues was 26.5% for the nine months ended September 30, 2015 and 26.6% for the nine months ended September 30, 2014. The decrease in gross margin as a percentage of home sales revenues reflects increased construction costs, overall higher lot costs and higher carrying costs (including capitalized interest) attributed to closed homes partially offset by higher average home sales price for the nine months ended September 30, 2015 as compared to the nine months ended September 30, 2014.
Selling Expenses. Selling expenses for the nine months ended September 30, 2015 were $39.0 million, an increase of $13.2 million, or 51.4%, from $25.8 million for the nine months ended September 30, 2014. Sales commissions increased to $18.0 million for the nine months ended September 30, 2015 from $10.3 million during the same period in the prior year primarily due to a 65.0% increase in home sales revenue during the nine months ended September 30, 2015 as compared to the nine months ended September 30, 2014. Advertising and direct mail costs increased to $7.0 million during the nine months ended September 30, 2015 from $6.0 million for the nine months ended September 30, 2014 primarily due to the increase in the number of active communities. Selling expenses as a percentage of home sales revenues were 8.6% and 9.4% for the nine months ended September 30, 2015 and 2014, respectively, and reflect operating leverage realized related to advertising costs and operating leverage through increased communities count partially offset by an increase in outside broker expense in the first nine months of 2015.

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General and Administrative. General and administrative expenses for the nine months ended September 30, 2015 were $25.1 million, an increase of $8.5 million, or 51.3%, from $16.6 million for the nine months ended September 30, 2014. The increase in general and administrative expenses is primarily due to the higher number of home closings and active communities during the first nine months of 2015 as compared to the first nine months of 2014. The increase in general and administrative expenses is also attributed to the performance based incentive plans. We also incurred costs related to training events as a result of continued growth. General and administrative expenses as a percentage of home sales revenues were 5.5% and 6.0% for the nine months ended September 30, 2015 and 2014, 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, 2015 as compared to the nine months ended September 30, 2014. Additionally, accounting and professional services fees decreased for the nine months ended September 30, 2015 as compared to the nine months ended September 30, 2014.
Other Income. Other income, net of other expenses was $0.2 million for the nine months ended September 30, 2015, a decrease of $0.4 million from $0.7 million for the nine months ended September 30, 2014. The decrease 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, 2015 was $56.0 million, an increase of $25.1 million, or 81.4%, from $30.8 million for the nine months ended September 30, 2014. Net income for the nine months ended September 30, 2015 was $37.1 million, an increase of $16.4 million, or 79.4%, from $20.7 million for the nine months ended September 30, 2014. The increases are primarily attributed to a 44.2% increase in homes closed, the increase in average home sales price during the first nine months of 2015 as compared to the first nine months of 2014, and operating leverage realized to selling, general, and administrative expenses, net of increased expenses associated with new communities.
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 adjustments, which have real economic effects and could impact our results, the utility of adjusted gross margin information as a measure of our operating performance may be limited. In addition, other companies may not calculate adjusted gross margin information in the same manner that we do. Accordingly, adjusted gross margin information should be considered only as a supplement to gross margin information as a measure of our performance.
The following table reconciles adjusted gross margin to gross margin, which is the GAAP financial measure that our management believes to be most directly comparable (dollars in thousands):

 
Three Months Ended September 30,

Nine Months Ended September 30,

 
2015
 
2014

2015

2014
Home sales revenues
 
$
173,956

 
$
92,516


$
453,472

 
$
274,848

Cost of sales
 
127,949

 
67,256


333,430

 
201,661

Gross margin
 
46,007

 
25,260


120,042

 
73,187

Purchase accounting adjustments (a)
 
39

 
434


1,859

 
2,448

Capitalized interest charged to cost of sales
 
1,824

 
473


4,376

 
1,147

Adjusted gross margin
 
47,870

 
26,167


$
126,277

 
$
76,782

Gross margin % (b)
 
26.4
%
 
27.3
%

26.5
%
 
26.6
%
Adjusted gross margin % (b)
 
27.5
%
 
28.3
%

27.8
%
 
27.9
%
 

(a)
Adjustments result from the application of purchase accounting related to prior acquisitions and represent the amount of the fair value step-up adjustments for real estate inventory included in cost of sales.

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

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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 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;
adjusted EBITDA may vary significantly from EBITDA calculations under the terms of our revolving credit facility and should not be used for assessing compliance or non-compliance with financial covenants under our revolving credit facility; 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):

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Three Months Ended September 30,

Nine Months Ended September 30,

 
2015
 
2014

2015

2014
Net income
 
$
15,420

 
$
7,046

 
$
37,099

 
$
20,677

Income taxes
 
7,801

 
3,488

 
19,089

 
10,828

Depreciation and amortization (a)
 
225

 
171

 
647

 
471

Capitalized interest charged to cost of sales
 
1,824

 
473

 
4,376

 
1,147

Purchase accounting adjustments (b)
 
39

 
434

 
1,859

 
2,448

Other income, net
 
(173
)
 
(628
)
 
(227
)
 
(663
)
Adjusted EBITDA
 
$
25,136

 
$
10,984

 
$
62,843

 
$
34,908

Adjusted EBITDA margin % (c)
 
14.4
%
 
11.9
%
 
13.9
%
 
12.7
%
 

(a)
Depreciation and amortization expenses include amortization related to the marketing intangible asset.
(b)
Adjustments result from the application of purchase accounting related to prior acquisitions and represent the amount of the fair value step-up adjustments for real estate inventory included in cost of sales.
(c)
Calculated as a percentage of home sales revenues.


Backlog

We sell our homes under standard purchase contracts, which require a homebuyer to pay a deposit at the time of signing the purchase contract. The amount of the required deposit is minimal (generally $1,000 or less). The deposits are refundable if the homebuyer is unable to obtain mortgage financing. We permit our homebuyers to cancel the purchase contract and obtain a refund of their deposit in the event mortgage financing cannot be obtained within a certain period of time, as specified in their purchase contract. Typically our homebuyers provide documentation regarding their ability to obtain mortgage financing within 14 days after the purchase contract is signed. If we determine that the homebuyer is not qualified to obtain mortgage financing or is not otherwise financially able to purchase the home, we will terminate the purchase contract. If a purchase contract has not been cancelled or terminated within 14 days after the purchase contract has been signed, then the homebuyer has met the preliminary criteria to obtain mortgage financing. Only purchase contracts that are signed by homebuyers who have met the preliminary criteria to obtain mortgage financing are included in new (gross) orders.

Our “backlog” consists of homes that are under a purchase contract that are signed by homebuyers who have met the preliminary criteria to obtain mortgage financing but have not yet closed. Since our business model is based on building move-in ready homes before a purchase contract is signed, a significant number of our homes in backlog are substantially complete. Ending backlog represents the number of homes in backlog from the previous period plus the number of net orders (new orders for homes less cancellations) generated during the current period minus the number of homes closed during the current period. Our backlog at any given time will be affected by cancellations and the number of our active communities. Homes in backlog are generally closed within one to two months, although we may experience cancellations of purchase contracts at any time prior to closing. It is important to note that net orders, backlog and cancellation metrics are operational, rather than accounting data, and should be used only as a general gauge to evaluate performance. Backlog may be impacted by customer cancellations for various reasons that are beyond our control, and in light of our minimal required deposit, there is little negative impact to the potential homebuyer from the cancellation of the purchase contract. As of the dates set forth below, our net orders, cancellation rate, and ending backlog homes and value were as follows (dollars in thousands):
Backlog Data
 
Nine Months Ended September 30,
2015
 
2014
Net orders (1)
 
3,063

 
1,756

Cancellation rate (2)
 
25.1
%
 
31.6
%
Ending backlog – homes (3)
 
755

 
242

Ending backlog – value (3)
 
$
147,668

 
$
42,402


(1)
Net orders are new (gross) orders for the purchase of homes during the period, less cancellations of existing purchase contracts during the period.

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(2)
Cancellation rate for a period is the total number of purchase contracts cancelled during the period divided by the total new (gross) orders for the purchase of homes during the period.
(3)
Ending backlog consists of homes at the end of the period that are under a purchase contract that have met our preliminary financing criteria but have not yet closed. Ending backlog is valued at the contract amount.

Land Acquisition Policies and Development

We increased our active communities to 50 as of September 30, 2015 from 39 as of December 31, 2014. We also increased our lot inventory to 23,419 owned or controlled lots as of September 30, 2015 from 19,883 owned or controlled lots as of December 31, 2014.

The table below shows (i) home closings by division for the nine months ended September 30, 2015, and (ii) our owned or controlled lots by division as of September 30, 2015.
 
 
Nine Months Ended September 30, 2015
 
As of September 30, 2015
Division
 
Home Closings
 
Owned (1)
 
Controlled
 
Total
Texas
 
1,361
 
10,493
 
2,827
 
13,320
Southwest
 
380
 
1,598
 
917
 
2,515
Florida
 
423
 
1,254
 
1,015
 
2,269
Southeast
 
294
 
3,257
 
1,659
 
4,916
Northwest
 

 
88

 
311
 
399
Total
 
2,458
 
16,690
 
6,729
 
23,419

(1)
Of the 16,690 owned lots as of September 30, 2015, 10,958 were raw/under development lots and 5,732 were finished lots (including homes in progress, sales offices and completed homes).

Homes in Inventory

When entering a new community, we build a sufficient number of move-in ready homes to meet our budgets. We base future home starts on closings. As homes are closed, we start more homes to maintain our inventory levels. At September 30, 2015, we had a total of 428 completed homes, including sales offices, and 1,338 homes in progress in inventory.

Raw Materials

When constructing homes, we use various materials and components. We generally contract for our materials and labor at a fixed price for the anticipated construction period of our homes. This allows us to mitigate the risks associated with increases in building materials and labor costs between the time construction begins on a home and the time it is closed. Typically, the raw materials and most of the components used in our business are readily available in the United States. In addition, the majority of our raw materials is supplied to us by our subcontractors, and is included in the price of our contract with such contractors. Most of the raw materials necessary for our subcontractors are standard items carried by major suppliers. Substantially all of our construction work is done by third party subcontractors, most of whom are non-unionized. We continue to monitor the supply markets to achieve the best prices available. Typically, the price changes that most significantly influence our operations are price increases in commodities and lumber.

Seasonality

In all of our divisions, we have historically experienced similar variability in our results of operations and in capital requirements from quarter to quarter due to the seasonal nature of the homebuilding industry. We generally close more homes in our second, third and fourth quarters. Thus, our revenue may fluctuate on a quarterly basis and we may have higher capital requirements in our second, third and fourth quarters in order to maintain our inventory levels. Our revenue and capital requirements are generally similar across our second, third and fourth quarters.


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As a result of seasonal activity, our quarterly results of operation and financial position at the end of a particular quarter, especially the first quarter, are not necessarily representative of the results we expect at year end. We expect this seasonal pattern to continue in the long term.

Liquidity and Capital Resources

Overview
As of September 30, 2015, we had $36.5 million of cash and cash equivalents. Cash flows for each of our active communities depend on the status of the development cycle and can differ substantially from reported earnings. Early stages of development or expansion require significant cash outlays for land acquisitions, development, construction of sales offices and inventory, general landscaping and other amenities. Because these costs are a component of our inventory and are not recognized in our statement of operations until a home closes, we incur significant cash outflows prior to recognition of revenues. In the later stages of an active community, cash inflows may significantly exceed revenues reported for financial statement purposes, as the costs associated with home and land construction were previously incurred.
Our principal uses of capital are operating expenses, land and lot purchases, lot development, home construction, interest costs on our indebtedness and the payment of various liabilities. In addition, we may purchase land, lots, homes under construction or other assets as part of a business combination.
We generally rely on our ability to finance our operations by generating operating cash flows, borrowing under our revolving credit facility or the issuance and sale of shares of our common stock under our ATM Program. As needed, we will consider accessing the debt and equity capital markets as part of our ongoing strategy. We also rely on our ability to obtain performance, payment and completion surety bonds as well as letters of credit to finance our projects.

We believe that we will be able to fund our current and foreseeable liquidity needs for at least the next twelve months with our cash on hand, cash generated from operations, cash expected to be available from our revolving credit facility, including any future modifications and net proceeds from the issuance and sale of shares of our common stock under the ATM Program.

Revolving Credit Facility
In May 2015, we entered into a Credit Agreement (the “Credit Agreement”) with several financial institutions, and Wells Fargo Bank, National Association, as administrative agent. The Credit Agreement provides for a $225.0 million revolving credit facility, which can be increased upon our request up to $300.0 million, subject to the terms and conditions of the Credit Agreement. The revolving credit facility matures on May 26, 2018. Prior to each annual anniversary of the closing of the Credit Agreement, we may request a one year extension of the maturity date. The Credit Agreement is guaranteed by each of our subsidiaries having gross assets equal to or greater than $500,000. Prior to the occurrence of a trigger event under the Credit Agreement, the revolving credit facility is unsecured except that the facility is secured by a first priority lien in land held for development, lots under development and/or finished lots with an aggregate land value of at least $35.0 million. As of September 30, 2015, the borrowing base was $225.0 million, of which $170.0 million was outstanding, $3.4 million represents letter of credit assurances, and $51.6 million was available to borrow.
The Credit Agreement requires us to maintain a tangible net worth of not less than $160.5 million plus 75% of the net proceeds of any equity issuances plus 50% of the amount of our net income in any fiscal quarter after the date of the Credit Agreement, a leverage ratio of not greater than 67.5%, liquidity of at least $40.0 million and a ratio of EBITDA to interest expense for the most recent four quarters of at least 2.50 to 1.0. The Credit Agreement also prohibits us from making any investments as permitted under the Credit Agreement. In addition, the Credit Agreement contains various covenants that, among other restrictions, limit the amount of our additional debt. At September 30, 2015, we were in compliance with all of the covenants contained in the Credit Agreement.

Convertible Notes
In November 2014, we issued $85.0 million aggregate principal amount of our 4.25% Convertible Notes due 2019 (the “Convertible Notes”). The Convertible Notes mature on November 15, 2019 and bear interest at a rate of 4.25%, payable semiannually in May and November. Prior to May 15, 2019, the Convertible Notes will be convertible only upon satisfaction of any of the specified conversion events. On or after May 15, 2019, note holders can convert their Convertible Notes at any time at their option.
On April 30, 2015, our stockholders approved the flexible settlement provisions of the Convertible Notes at our 2015 Annual Meeting of Stockholders, which allows us to settle the conversion of the Convertible Notes using any combination of cash and shares of our common stock. The initial conversion rate of the Convertible Notes is 46.4792 shares of our common stock for each

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$1,000 principal amount of Convertible Notes, which represents an initial conversion price of approximately $21.52 per share of our common stock. The conversion rate is subject to adjustments upon the occurrence of specific events.

Letters of Credit and Surety Bonds
We are often required to provide letters of credit and surety bonds to secure our performance under construction contracts, development agreements and other arrangements. The amount of such obligations outstanding at any time varies in accordance with our pending development activities. In the event any such bonds or letters of credit are drawn upon, we would be obligated to reimburse the issuer of such bonds or letters of credit.
Under these letters of credit and surety bonds, we are committed to perform certain development and construction activities and provide certain guarantees in the normal course of business. Outstanding letters of credit and surety bonds, total $18.8 million as of September 30, 2015. Although significant development and construction activities have been completed related to the improvements at these sites, the letters of credit and surety bonds are not generally released until all development and construction activities are completed. We do not believe that it is likely that any outstanding letters of credit or surety bonds as of September 30, 2015 will be drawn upon.

Cash Flows

Nine Months Ended September 30, 2015 compared to Nine Months Ended September 30, 2014
Net cash used in operating activities during the nine months ended September 30, 2015 was $24.4 million as compared to $129.6 million during the nine months ended September 30, 2014. The $105.2 million decrease in net cash used in operating activities was primarily attributable to a $58.1 million decrease in the net change in real estate inventory year-over-year primarily related to the timing of our land acquisitions, and a corresponding $11.0 million decrease in cash paid for pre-acquisition costs and deposits. The decrease in net cash used in operating activities between periods also reflects a $16.4 million increase in net income, and a $25.3 million increase in accounts payable, accrued expenses and other liabilities during the nine months ended September 30, 2015, as a result of our continued growth and the increased number of our active communities.
Net cash used in investing activities was $0.9 million during the nine months ended September 30, 2015 as compared to $0.8 million during the nine months ended September 30, 2014 and reflects the purchase of property and equipment.
Net cash provided by financing activities totaled $30.3 million during the nine months ended September 30, 2015 as compared to $122.5 million during the nine months ended September 30, 2014. The $92.2 million decrease in net cash provided by financing activities is primarily due to the decrease in net borrowings in the nine months ended September 30, 2015 as compared to the nine months ended September 30, 2014 partially offset by the $2.8 million of net proceeds from the issuance and sale of shares of our common stock under the ATM Program is September 2015.
Off-Balance Sheet Arrangements
In the ordinary course of business, we enter into land option contracts in order to procure lots for the construction of our homes. We are subject to customary obligations associated with entering into contracts for the purchase of land and improved lots. These purchase contracts typically require cash deposits and the purchase of properties under these contracts is generally contingent upon satisfaction of certain requirements by the sellers, which may include obtaining applicable property and development entitlements or the completion of development activities and the delivery of finished lots. We also utilize option contracts with land sellers as a method of acquiring lots and land in staged takedowns, to help us manage the financial and market risk associated with land holdings, and to minimize the use of funds from our corporate financing sources. Option contracts generally require a non-refundable deposit for the right to acquire land or lots over a specified period of time at pre-determined prices. We generally have the right at our discretion to terminate our obligations under both purchase contracts and option contracts by forfeiting our cash deposit with no further financial obligations to the land seller. In addition, our deposit may also be refundable if the land seller does not satisfy all conditions precedent in the respective contract. As of September 30, 2015, we had $7.5 million of cash deposits pertaining to land option contracts and purchase contracts for 6,729 lots with an aggregate purchase price of $154.5 million. Approximately $1.9 million of the cash deposits as of September 30, 2015 are related to purchase contracts to deliver finished lots and these deposits are secured by indemnity mortgages on the related property and are refundable under certain circumstances.
Our utilization of land option contracts is dependent on, among other things, the availability of land sellers, willing to enter into option takedown arrangements, the availability of capital to financial intermediaries to finance the development of optioned lots, general housing conditions, and local market dynamics. Option contracts may be more difficult to procure from land sellers in strong housing markets and are more prevalent in certain markets.


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Inflation
Our business can be adversely impacted by inflation, primarily from higher land, financing, labor, material and construction, and carrying costs. In addition, inflation can lead to higher mortgage rates, which can significantly affect the affordability of mortgage financing to home buyers.
Contractual Obligations
Other than the Credit Agreement that we entered into in May 2015, at which time we repaid and terminated our prior secured revolving credit facility, there have been no material changes to our contractual obligations appearing in the Contractual Obligations section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014. Please see "—Liquidity and Capital Resources—Revolving Credit Facility" for a description of the Credit Agreement.


Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. On an ongoing basis, management evaluates such estimates and judgments and makes adjustments as deemed necessary. Actual results could differ from these estimates using different estimates and assumptions, or if conditions are significantly different in the future.

We believe that there have been no significant changes to our critical accounting policies during the nine months ended September 30, 2015 as compared to those disclosed in Managements Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014.

Cautionary Statement about Forward-Looking Statements

From time to time we make statements concerning our expectations, beliefs, plans, objectives, goals, strategies, future events or performance and underlying assumptions and other statements that are not historical facts. These statements are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those expressed or implied by these statements. You can generally identify our forward-looking statements by the words “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “forecast,” “goal,” “intend,” “may,” “objective,” “plan,” “potential,” “predict,” “projection,” “should,” “will” or other similar words.

We have based our forward-looking statements on our management’s beliefs and assumptions based on information available to our management at the time the statements are made. We caution you that assumptions, beliefs, expectations, intentions and projections about future events may, and often do, vary materially from actual results. Therefore, we cannot assure you that actual results will not differ materially from those expressed or implied by our forward-looking statements.

The following are some of the factors that could cause actual results to differ materially from those expressed or implied in forward-looking statements:
adverse economic changes either nationally or in the markets in which we operate, including, among other things, increases in unemployment, volatility of mortgage interest rates and inflation;
a slowdown in the homebuilding industry;
volatility and uncertainty in the credit markets and broader financial markets;
the cyclical and seasonal nature of our business;
our future operating results and financial condition;
our business operations;
changes in our business and investment strategy;
the success of our operations in recently opened new markets and our ability to expand into additional new markets;
our ability to successfully extend our business model to building homes with higher price points, developing larger communities and sales of acreage home sites;
an inability to develop our projects successfully or within expected timeframes;
our ability to identify potential acquisition candidates and close such acquisitions;

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our ability to successfully integrate any acquisitions with our existing operations;
availability of land to acquire and our ability to acquire such land on favorable terms or at all;
availability, terms and deployment of capital;
decisions of the lender group of our revolving credit facility;
the occurrence of the specific conversion events that enable early conversion of the Convertible Notes;
decline in the market value of our land portfolio;
continued or increased disruption in the terms or availability of mortgage financing or the number of foreclosures in our markets;
shortages of or increased prices for labor, land or raw materials used in housing construction;
delays in land development or home construction resulting from natural disasters, adverse weather conditions or other events outside our control;
uninsured losses in excess of insurance limits;
the cost and availability of insurance and surety bonds;
changes in, liabilities under, or the failure or inability to comply with, governmental laws and regulations;
the timing of receipt of regulatory approvals and the opening of projects;
the degree and nature of our competition;
increases in taxes or government fees;
poor relations with the residents of our projects;
future litigation, arbitration or other claims;
availability of qualified personnel and third party contractors and our ability to retain our key personnel;
our leverage and future debt service obligations;
the impact on our business of any future government shutdown similar to the one that occurred in October 2013;
other risks and uncertainties inherent in our business;
other factors we discuss under the section entitled “Managements Discussion and Analysis of Financial Condition and Results of Operations”; and
the risk factors set forth in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014.

You should not place undue reliance on forward-looking statements. Each forward-looking statement speaks only as of the date of the particular statement. We expressly disclaim any intent, obligation or undertaking to update or revise any forward-looking statements to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statements are based. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements contained in this Quarterly Report on Form 10-Q.

Implications of Being an Emerging Growth Company
    
We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. For as long as we are an emerging growth company, unlike other public companies, we will not be required to:

provide an attestation and report from our auditors on management’s assessment of the effectiveness of our system of internal control over financial reporting pursuant to Section 404(b) of the Sarbanes-Oxley Act;
comply with certain new requirements adopted by the PCAOB;
comply with certain new audit rules adopted by the PCAOB after April 5, 2012, unless the SEC determines otherwise;
provide disclosures regarding executive compensation required of larger public companies; and
obtain stockholder approval of any golden parachute payments not previously approved.

We intend to continue to take advantage of all of these exemptions.
    
We will cease to be an emerging growth company when any of the following conditions apply:

we have $1.0 billion or more in annual revenues;
at least $700 million in market value of our common stock are held by non-affiliates;
we issue more than $1.0 billion of non-convertible debt over a three-year period; or
the last day of the fiscal year following the fifth anniversary of our initial public offering has passed.

In addition, an emerging growth company can delay its adoption of certain accounting standards until those standards would otherwise apply to private companies. However, we have chosen to “opt out” of such extended transition period, and as a result, we will comply with any new or revised accounting standards on the relevant dates on which non-emerging growth companies

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must adopt such standards. Section 107 of the JOBS Act provides that our decision to opt out of the extended transition period for complying with new or revised accounting standards is irrevocable.

ITEM 3.         QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our operations are interest rate sensitive. As overall housing demand is adversely affected by increases in interest rates, a significant increase in mortgage interest rates may negatively affect the ability of homebuyers to secure adequate financing. Higher interest rates could adversely affect our revenues, gross margin and net income. We do not enter into, or intend to enter into, derivative financial instruments for trading or speculative purposes.
Quantitative and Qualitative Disclosures About Interest Rate Risk
We utilize both fixed-rate debt ($85.0 million aggregate principal amount of our 4.25% Convertible Notes due 2019 and certain inventory related obligations) and variable-rate debt, (our $225.0 million revolving credit facility) as part of financing our operations. On April 30, 2015, our stockholders approved the flexible settlement provisions of the Convertible Notes at our 2015 Annual Meeting of Stockholders, which allows us to settle the conversion of our Convertible Notes using any combination of cash and shares of our common stock. We do not have the obligation to prepay the Convertible Notes or our fixed-rate inventory related obligations prior to maturity, and, as a result, interest rate risk and changes in fair market value should not have a significant impact on our fixed-rate debt.
We are exposed to market risks related to fluctuations in interest rates on our outstanding variable rate indebtedness. We did not utilize swaps, forward or option contracts on interest rates or commodities, or other types of derivative financial instruments as of or during the nine months ended September 30, 2015. We have not entered into and currently do not hold derivatives for trading or speculative purposes, but we may do so in the future. Many of the statements contained in this section are forward looking and should be read in conjunction with our disclosures under the heading “Cautionary Statement about Forward-Looking Statements” above.
As of September 30, 2015, we had $170.0 million of variable rate indebtedness outstanding under the Credit Agreement. All of the outstanding borrowings under the Credit Agreement are at variable rates based on LIBOR. The interest rate for our variable rate indebtedness as of September 30, 2015 was LIBOR plus 3.50%. A hypothetical 100 basis point increase in the average interest rate on our variable rate indebtedness would increase our annual interest expense by approximately $1.7 million.
Based on the current interest rate management policies we have in place with respect to our outstanding indebtedness, we do not believe that the future interest rate risks related to our existing indebtedness will have a material adverse impact on our financial position, results of operations or liquidity.

ITEM 4.    CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, management has evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) of the Securities Exchange Act of 1934) as of September 30, 2015. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure information is recorded, processed, summarized and reported within the periods specified in the Securities and Exchange Commission’s rules and forms and is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error and mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of controls.
The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, a control may become inadequate because of changes in conditions or because the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and may not be detected.

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Changes in Internal Controls
No change in our internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f) occurred during the three months ended September 30, 2015 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

ITEM 6.         EXHIBITS

The exhibits filed or furnished as part of this Quarterly Report on Form 10-Q are listed in the Exhibit Index immediately preceding those exhibits, which Index is incorporated in this Item by reference.

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

 
   
LGI Homes, Inc.
 
 
 
Date:
November 4, 2015
/s/    Eric Lipar
 
   
Eric Lipar
 
   
Chief Executive Officer and Chairman of the Board
 
   
   
 
November 4, 2015
/s/    Charles Merdian
 
   
Charles Merdian
 
   
Chief Financial Officer, Secretary and Treasurer



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EXHIBIT INDEX
Exhibit No.
 
  Description  
31.1*
 
CEO Certification, Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2*
 
CFO Certification, Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1*
 
Certification Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2*
 
Certification Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS†
 
XBRL Instance Document.
101.SCH†
 
XBRL Taxonomy Extension Schema Document.
101.CAL†
 
XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF†
 
XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB†
 
XBRL Taxonomy Extension Label Linkbase Document.
101.PRE†
 
XBRL Taxonomy Extension Presentation Linkbase Document.
*
Filed herewith.
XBRL information is deemed not filed or a part of a registration statement or Annual Report for purposes of Sections 11 and 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under such sections.