Hello, welcome to the LGI Homes second quarter 2018 conference call. Today's call is being recorded, and a replay will be available on the company's website later today at lgihomes.com. We have allocated an hour for prepared remarks and Q&A. If anyone should require operator assistance during the conference call, please press star then zero. At this time, I will turn the call over to Rachel Eaton, Chief Marketing Officer at LGI Homes. Mrs. Eaton, you may begin.
Thank you. Welcome to the LGI Homes conference call discussing our results for the second quarter of 2018 and the six months ended June 30th, 2018. Today's conference call will contain forward-looking statements that include, among other things, statements regarding LGI's business strategy, outlook, plans, objectives, and guidance for 2018. All such statements reflect current expectations. They do involve assumptions, estimates, and other risks and uncertainties that could cause our expectations to prove to be incorrect. You should review our filings with the SEC, including our risk factors and cautionary statement about forward-looking statements sections for a discussion of the risks, uncertainties, and other factors that could cause our actual results to differ materially from those anticipated in these forward-looking statements. These forward-looking statements are not guarantees of future performance.
You should consider these forward-looking statements in light of the related risks, you should not place undue reliance on these forward-looking statements, which speak only as of the date of this conference call. Adjusted gross margin, a non-GAAP financial measure, will be discussed on this conference call. The presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. A reconciliation of adjusted gross margin to gross margin, the most comparable measure prepared in accordance with GAAP, is included in the earnings press release that we issued this morning and in our quarterly report on Form 10-Q for the quarter ended June 30th of 2018 that we expect to file with the SEC later today. This filing will be accessible on the SEC's website and in the investor section of our website at lgihomes.com.
Joining me today are Eric Lipar, LGI Homes' Chief Executive Officer, and Charles Merdian, the company's Chief Financial Officer. I will now turn the call over to Eric.
Thank you, Rachel, and welcome to everyone on this call. We appreciate your continued interest in LGI Homes. During today's call, I will summarize the highlights and results from our record-breaking second quarter and for the first six months of 2018. Charles will follow up to discuss our financial results in more detail. After he is done, we will conclude with comments on what we are seeing for the third quarter and our expectations for the remainder of 2018 before we open the call for questions. First, I'd like to thank all of our employees for their hard work, dedication, and loyalty to LGI. Because of your outstanding performance, we are proud to announce that we delivered a very impressive quarter, highlighted by record-setting revenue. This quarter, we also set new company records for average sales price, active community count, net income, and earnings per share.
We would also like to thank all of our employees and outside partners that helped in our acquisition of Wynn Homes, the 129th largest builder in the country. In 2017, Wynn Homes closed 312 homes across Central and Eastern North Carolina. We believe this acquisition will give us a strong foothold in the Raleigh-Durham market, where we currently only have one active community. With the acquisition, LGI Homes gained 4,000 owned and controlled lots in prime locations, primarily throughout the Raleigh-Durham market. These lots and communities increase our exposure to first-time homebuyers in this market and will expand our footprint to Coastal Carolina. As part of the purchase, three communities that were focused on the move-up buyer, along with the real estate assets located in the Fayetteville market, were excluded.
We believe this to be an opportunistic purchase for LGI Homes, Charles and I will provide more color on this transaction and what it means for LGI later in the call. For the quarter, we closed 1,815 homes, generating approximately $420 million in home sales revenue. This brings us to a record 3,059 closings through the first two quarters, more than a 34% increase over the first six months of last year. For the second quarter, we averaged an industry-leading 7.8 closings per community per month company-wide. This absorption pace of 7.8 closings per community per month was an increase from the second quarter of last year and is the highest absorption pace of any quarter since we became a public company.
Our top market on a closings per community basis was Dallas-Fort Worth at 12.4 closings per month, followed by Charlotte at 10.6, Seattle at 9.9, and Houston at 9.8 closings per month. It is also worth mentioning that our one community in Raleigh averaged nine closings per month in the second quarter. We ended the second quarter with a total of 79 active communities, which is a net increase of eight over the 71 active communities that we had at the end of the second quarter last year. In addition to adding more communities, we also began sales in three new states during the second quarter. We held grand opening events in our first communities in Alabama, California, and Oregon. All three openings exceeded expectations and are already producing closings for the company. Another highlight of the second quarter was an increase in closings in our Northwest division.
This quarter, we closed 145 homes in this division compared to 64 homes closed in the second quarter of last year, which is an increase of more than 125% year-over-year. Another highlight of our record-breaking second quarter was the strength of our wholesale business. We closed 103 homes this quarter with three different investment groups at an average sales price over $260,000. This included 30 of the 47 homes that make up our first community, located in the Seattle market, that was sold exclusively through our wholesale channel. We believe opportunities like this are accretive to our business and offer us an avenue for potential growth. Our markets continue to have strong housing demand drivers, including nationally leading population and employment growth trends, general housing affordability, and desirable lifestyle characteristics.
We continue to see solid demand across all of our markets as we continue our focus marketing directly to renters living within close proximity to our communities. Our advertising produced nearly 100,000 inquiries in the second quarter, strengthening our belief that there remains a strong demand in the first-time homebuyer segment. With that, I'd like to turn the call over to Charles Merdian, our Chief Financial Officer, for a more in-depth review of our financial results.
Thanks, Eric. Home sales revenues for the quarter were $419.8 million based on 1,815 homes closed, which represents a 29.5% increase over the second quarter of 2017. Sales prices realized from homes closed during the second quarter ranged from the 140s to over $550,000, and averaged $231,321, a 7.8% year-over-year increase. The increase in average sales price year-over-year reflects changes in product mix, favorable pricing environment, and newer replacement communities added that have higher price points. In the second quarter by division, approximate average sales prices were $213,000 in our Central division, $279,000 in the Southwest, $203,000 in the Southeast, $214,000 in Florida, and $341,000 in the Northwest. Gross margin as a percentage of sales was 26.1% this quarter, compared to 26.6% for the same quarter last year. Our adjusted gross margin was 27.7% this quarter, compared to 28% for the second quarter of 2017, a 30-basis-point decrease.
However, both gross margin and adjusted gross margin increased 130 basis points over the first quarter of this year. Adjusted gross margin excludes approximately $6.6 million of capitalized interest charged to cost of sales during the quarter, representing approximately 160 basis points and consistent with previous quarters. Combined selling general and administrative expenses for the second quarter were 11.3% of home sales revenue, compared to 11.7% in the prior year. Year-to-date, our SG&A expenses of 12.3% of home sales revenue represents 110 basis points improvement over the first six months of last year. We believe that SG&A will vary [inaudible]. We generated net income in the quarter of $47.6 million, or 11.3% of home sales revenue, which represents earnings per share of $2.11 per basic share and a $1.90 per diluted
Ladies and gentlemen, your conference call will begin momentarily. Please remain on the line. Again, your conference call will resume momentarily. Please remain on the line. Thank you. You are now connected.
All right. We apologize. Apparently, we had a technical difficulty. I will begin where we believe we dropped off, which is on gross margin as a percentage of our sales, was 26.1% this quarter compared to 26.6% for the same quarter last year. Our adjusted gross margin was 27.7% this quarter, compared to 28% for the second quarter of 2017, a 30-basis-point decrease. Both gross margin and adjusted gross margin, however, increased 130 basis points over the first quarter of this year. Adjusted gross margin excludes approximately $6.6 million of capitalized interest charged to cost of sales during the quarter, representing approximately 160 basis points and consistent with previous quarters. Combined selling general and administrative expenses for the second quarter were 11.3% of home sales revenues, compared to 11.7% in the prior year.
Year-to-date, our SG&A expense of 12.3% of home sales revenue represents 110 basis points improvement over the first six months of last year. We believe that SG&A will vary quarter-to-quarter based on home sales revenue. We expect SG&A as a percentage of revenue for the third and fourth quarters of this year to be similar to the second quarter, resulting in 2018 SG&A as a percentage of sales of approximately 20 to 40 basis points lower compared to our 2017 full-year results. Selling expenses for the quarter were $29.3 million or 7% of home sales revenue, compared to $24.2 million or 7.5% of home sales revenue for the second quarter of 2017, a 50-basis-point decrease. The decrease in selling expenses as a percentage of home sales revenue is primarily due to operating leverage realized from the increase in home sales revenues.
General and administrative expenses were 4.4% of home sales revenue, compared to 4.2% for the second quarter of 2017, a 20-basis-point increase. The increase in general and administrative expenses as a percentage of home sales revenue is primarily due to professional fees and additional compensation costs associated with our geographic expansion, increase in active communities, and additional home closings. Pre-tax income from the quarter was $62.7 million or 14.9% of home sales revenue, an increase of 10 basis points over the same quarter in 2017. Year-to-date pre-tax income of $93.9 million represents a 43.4% increase over the six months in the prior year. Second quarter effective tax rate was 24%, and we expect our effective tax rate for the back half of the year to range between 23.5% and 24.5%.
We generated net income in the quarter of $47.6 million or 11.3% of home sales revenue, which represents earnings per share of $2.11 per basic share and $1.90 per diluted share. Weighted shares outstanding for calculating diluted earnings per share are impacted by our outstanding convertible notes. In the second quarter of 2018, our average stock price was $64.47, exceeding the conversion price, and therefore the convertible notes were determined to be dilutive. This resulted in approximately 2.2 million share increase to the weighted average shares outstanding for the diluted EPS calculation for the quarter. Second quarter gross orders were 2,158, net orders were 1,629. Ending backlog for the second quarter was 1,184 homes compared to 1,545 last year. The cancellation rate for the second quarter of 2018 was 24.5%. We ended the second quarter with a portfolio of approximately 46,800 owned and controlled lots.
As of June 30th, 14,823 of our 24,559 owned lots were either raw or under development. 6,433 were finished lots, 1,522 were completed homes, including our information centers, and 1,781 were homes in process. In May of this year, we increased our revolving credit facility from $600 million to $750 million with a $50 million accordion on our third amended and restated credit agreement. As of June 30th, we had approximately $49 million in cash, over $1 billion of real estate inventory, and total assets of over $1.2 billion. At June 30th, we had $495 million outstanding under our revolving credit facility. Our borrowing capacity was approximately $172.3 million. In addition, we had $70 million in convertible notes outstanding. In July of this year, we issued $300 million in aggregate principal amount of our 6-7/8% senior notes.
We received net proceeds of approximately $296 million after deducting initial purchasers discounts, commissions, and offering expenses, and we used these proceeds to repay a portion of the borrowings under our revolving credit facility. In connection with the issuance of the senior notes, we reduced the revolving commitment under the credit agreement from $750 million to $450 million, and we expect to record approximately $3.1 million in debt extinguishment costs related to the credit agreement during the third quarter of 2018. Our gross debt to capitalization was approximately 50%, and net debt to capitalization was approximately 47%. As Eric mentioned, on August 2nd, we acquired the majority of the assets of Wynn Homes and its affiliates for a purchase price of approximately $80 million, which is subject to certain post-closing adjustments.
We paid the cash closing payment of $74.3 million using cash on hand and borrowings under our revolving credit facility. In addition, as a portion of the purchase price, we will issue $4 million of our common stock. We acquired approximately 200 homes under construction and approximately 4,000 owned and controlled lots. We assumed certain land acquisition and land development contracts of Wynn Homes and acquired certain tangible and intangible assets. Of the 4,000 owned and controlled lots, approximately 2,600, or 65%, are controlled. At this point, I would like to turn it back over to Eric.
Thanks, Charles. In summary, we had another outstanding quarter and a great first half of the year. Let me provide some guidance and thoughts on what we are seeing thus far in the third quarter and looking ahead into the remainder of the year, along with more information on the integration of Wynn Homes into the LGI processes and systems. The third quarter is off to a solid start with 538 closings in July. These 538 closings span across 82 active communities, resulting in a very solid absorption pace, averaging just over 6.5 closings per community per month, and brings our year-to-date closings to 3,597, up more than 25% over the first seven months of last year. Although July closings were down 9% year-over-year, these results were in line with expectations and consistent with our historical July absorption paces.
With the Wynn Homes transaction we recently closed, we acquired approximately 200 homes under various stages of construction, of which approximately 60 of these homes are under contract. We expect to average between 20 and 25 closings per month for the rest of 2018, and at the same time, begin implementing the LGI systems and processes. This will result in 100 to 125 closings, generating revenue of $25 million to $35 million for the year. We expect to be fully operational the LGI way in all departments in the first quarter of 2019 and believe the greatest benefit to LGI and our shareholders will be realized in 2019 and beyond. This acquisition in Raleigh will take LGI from one active community that we have currently to six to eight active communities in the Raleigh market and an additional one or two communities in the Wilmington market by the end of 2019.
We expect to close more than 500 homes between these two markets in 2019 with similar adjusted gross margins as our other regions, with an average sales price above $250,000. As a result of this acquisition and our focus on expansion in new and existing markets, we are expecting our community count to grow between 20% and 30% in 2019, continuing on the path to our goal of becoming a top five builder. Given our record-breaking performance in the second quarter, our solid start to the third quarter, and our recent acquisition of Wynn Homes, we are increasing our guidance for the year. We now expect to close between 6,400 and 7,000 homes in 2018. We believe our average sales price in 2018 will continue to increase, and we are increasing our guidance for our average sales price for the year to a new range of $225,000 to $235,000.
As Charles mentioned earlier, we had a very strong gross margin in the second quarter of this year. As a result, we are increasing our full-year gross margin guidance by 50 basis points on the low and high end of the range. Guidance for gross margin for the full year will be between 24.5% and 26.5%. This includes the expected impacts of purchase accounting related to the Wynn acquisition. We expect adjusted gross margin, which excludes the effects of interest and purchase accounting, will continue to be strong, ending the year between 26% and 28%. Due to increasing the lower end of our closing range, along with an increase in our guidance for average sales price and gross margins, we are increasing our full-year basic earnings per share guidance from $6 to $7 per share to a new range of $6.50 to $7.25 per share.
Now we'll be happy to take your questions
Thank you. Ladies and gentlemen, if you have a question at this time, please press star then one on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Due to time constraints, we ask that you please limit yourself to one question and one follow-up. If time permits, you may reenter the queue with any additional questions. Our first question comes from the line of Stephen East with Wells Fargo. Your line is now open. Pardon me, Mr. East, please check your mute button. All right. Our next question comes from the line of Nishu Sood with Deutsche Bank. Your line is now open.
Thank you. Eric, I wanted to ask first about the 20%-30% community count guidance that you're thinking about for next year. At the size that you've gotten to, you've been kind of growing 10-15 communities, I think, a year. 20%-30% community count growth is a real step up. Obviously, fueled by this acquisition, very exciting to see. Wanted to break it down, though. How much of that is going to be driven by the acquisition and rolling that out fully, and how much of it will be driven by the existing operation?
Sure. Great question, Nishu. 20%-30% growth, just really factoring in our guidance for this year of 85-90 active communities. 20%-30% growth on that is 17-27, depending on the high end of the range, 20%, 30% on 85-90. The acquisition factors into that, like we talked about for 2019, it's probably about five active communities for the acquisition. All of the other growth is what we've been working on for the last couple of years, as far as going deeper in our existing markets. All of the markets that we've recently expanded to, a lot of new communities coming from those markets as well.
We haven't given a lot of guidance on 2019 yet, but we thought it was important to get out there, because when you're talking about active community counts, that takes the most preparation and planning. We really need to have those ready to go right now. We're very confident in that number because of all the planning it takes place to get those ready, whether it's us developing the lots, or third-party developers developing for them. We're very confident in that 20%-30% number for next year.
Got it. You're not seeing any Wynn communities this year because you didn't take your community count guidance up for this year?
No, I think Wynn will add two or three active communities for this year. I think it probably takes us from the low end of the range to the high end of the range. We thought since it was two or three in a range of five, we'd just leave it the same. It will add to community count this year, and then an additional five next year.
Got it. Second question I wanted to ask was, you're in, I think, 15 states now, 30 plus markets. When you started the business, you were in one market, one state. Where are we in the growth trajectory as you kind of Obviously, you laid out the top five builder goal, but just wanted to understand your thoughts on areas of potential growth or untapped markets as you see them still. Is it just more penetration of existing markets? Wanted to get a sense of what's going to get us there.
Great question, Nishu. I think we've done a great job over the last few years, and we've certainly grown. Looking at our average community count, 2014, our average community count was at 30. Now we're at 82 as of last month with an average sales price of $160,000, and now we're north of $230,000. At the same time, we've been able to keep absorption paces in line or even exceed, as I was talking about, the best quarter in LGI history with the 7.8 number. The team has done a great job. We have the systems and processes in place that allow us to grow and experience that growth while maintaining the margins and consistency. That's a big benefit for us, and the team's done a great job of executing on that. We think that's going to continue.
We believe in order to be a top five builder, we're going to need about 240 communities across the U.S. We've actually already got the plan laid out. That plan will no doubt change, but looking at the markets that we're already in, looking at the corridors around those markets, and where LGI Community centers fit in into those markets. We got the plan in place. Really, it's just a question of how long it's going to take to get there. What we talk about with our leadership team is it's up to us. If we keep producing results like we have been producing over the last five years, then we're going to be right on track and keep running, and we'll get there quicker. That's going to be depending upon us.
We think top five builder is very realistic and shooting for 240 communities nationwide.
Okay, thanks for your thoughts.
Thank you. Our next question comes from the line of Jay McCanless with Wedbush. Your line is now open.
Hey, good afternoon, everyone. Couple housekeeping items first. Charles, what was the actual dollar value and the number on the backlog at the end of 2Q?
Let's see. Give me one second.
Thank you.
Apologize. One second. The value at the end of June, $296.9 million.
1,184 homes, is that right?
Correct.
Okay, great. The next question I had, in terms of the regions that carried the football this quarter, it looks like the Southwest, the Southeast, and Florida all had unit sales growth, unit closing growth well below the company average. Especially as you guys put out a pretty impressive growth target for 2019, can you talk about what you're doing to improve sales performance in those regions right now, as well as you think about the expansion, is it going to be more organic focused, or is this Wynn deal kind of the first of many larger deals that will help you vault yourself up to that 20%-30% community growth?
Yeah. A couple of good questions, Jay. I'll take it. This is Eric. On the first question, we believe it's going to be primarily organic growth from here. M&A activity for us, I think, is going to be fairly limited. This is the first acquisition we've done since the fall of 2014, what appealed to us about this particular transaction was it's 80% focused on the first-time home buyer, the lots of land that we're acquiring. It's 80% focused in Raleigh-Durham, which is a market that we only have one active community. We have very strong leadership from a sales and construction standpoint in that market. We obviously like the price and the value that we were getting in the lots of land.
All those have to work in any potential acquisitions, and I think it's going to be pretty rare that we find a good fit for LGI. As far as the growth, absolute numbers in some of our markets were not growing as fast because we're not adding community count growth. Most of our community count growth is coming from our newer markets that we've recently expanded. That will result in the absolute numbers increasing. In some of the markets that you mentioned, still very strong absorptions per community. We're happy with the performance in the second quarter of those markets. We just haven't been adding as many communities in those particular markets.
Okay. On Wynn, just two, three housekeeping questions there. On the consideration, I think you guys said it was $74 million cash and $4 million worth of stock for that, correct?
That's correct.
Okay. In terms of one-time charges, I know you talked about the debt extinguishment charge for 3Q, but is there going to be a one-time charge for the Wynn deal that also shows up in the financials?
There will not be a one-time charge, but there will be purchase accounting that'll come through. Since the acquisition just closed, we're still working on our schedules and the fair value analysis. We'll have a better update for you after next quarter's results. We do expect there to be an impact for purchase accounting, going forward, related to Wynn.
Okay. Then, in terms of a target leverage ratio, what are you guys thinking now that you've taken the facility down a little bit, you got some debt priced, and you brought Wynn on board. What should we think about as the longer-term leverage target or net leverage target for you guys?
Yeah, sure. This is Charles. I think, obviously, the second quarter, we paid down $15 million this quarter. A lot of that is driven by our investments in inventory. We saw our net debt to cap decline from the first quarter. I think you'll see long term, you'll see us in that low 50% range, which is where we've historically operated, that still is our target leverage.
Okay. That's all I had. Thanks for taking my questions.
You're welcome.
Thank you. Our next question comes from the line of Michael Rehaut with JP Morgan. Your line is now open.
Thanks. Good afternoon, everyone. First question, I just wanted to drill down a little bit on the monthly closings pace, in particular, you mentioned that July was kind of in line with expectations, although down year-over-year. Obviously, you kind of gave the updated closings guidance, I was just curious how much of that is reflective of your expectations around Wynn, I believe you said 20-25 closings a month, but I just wanted to make sure I heard that right. What does that mean in terms of the core legacy or organic business from a closings expectation standpoint? I'll start there, I just have one or perhaps two others.
Okay. Thanks, Mike. Great question. First of all, yes, that's what we talked about with Wynn. Consistent with what they had been closing and consistent with the 300 closings that they had last year, 20-25 a month for the last five months of the year, starting in August. 100-125 total is what we're forecasting because of the acquisition. Outside of that, yeah, we talked about July and historical averages, raising the guidance from 6,000-6,400 means we're going to have to close between 6.5 and 8 closings per month from this point forward. We did 7.8 in the second quarter, which was an unbelievable quarter and the highest absorption that we've ever had. It's tough for us to say that we don't expect things to be as good as they have been. Certainly, demand is there.
We're seeing strong demand from the first-time home buyer to get into homeownership. That hasn't changed. Forecasting out, I think our historical averages of 6.5-7.5 a month from this point forward through the end of the year, we'd be happy with that. It's a little less than the absorption pace of the second quarter, still very strong, and also in an environment where we're going to be not taking a hit to gross margin and also keep increasing our average sales price, as well.
I appreciate that, Eric. I guess just secondly, around pricing power, you said not taking the hit to gross margin, if anything, you raised it. Maybe you could speak to pricing power in your given markets. I think that's been an area where perhaps more an issue at higher price points or move-up price points, at the same time, there has been, I would say, somewhat of a mixed set of commentary around, even on the entry level, the ability to push through price, fully and different markets maybe have different ability to absorb price increases. I was hoping to hear from you guys what your pricing trends have been and the level of success that you've had over the past quarter with pricing.
Yeah, great question, Mike. I think we look at pricing the same way we've always looked at it, we've been dealing with, since we've been a public company, a market that has seen increasing costs, whether it's on lots or land development or labor and materials. That has caused our average sales price, like we talked about earlier, go from $160,000 in 2014 to $186 to $197 to $214 to $231 last quarter. We've consistently seen average sales prices increase because we keep our pricing strategy pretty simple. As costs increase, we're able to, and need to, raise our prices to keep our gross margins consistent. Our Q2 adjusted gross margins for the last five years in the Q2 have been between 27.7% and 28.2%.
We've been in a 50 basis points range for the last five years on adjusted gross margin in the second quarter, I think that's a testament to our pricing strategy. In the market that we're in, which I'd characterize as a good, solid, strong demand market with a tight supply of houses and the labor challenges and material challenges that we all face, we see at least for the next couple of quarters, that trend continuing. Prices are going to have to increase on a same-store basis, if you will, in order to offset increased costs.
Great. Thank you.
You're welcome.
Thank you. As a reminder, ladies and gentlemen, if you have a question, please press star then one. Our next question comes from the line of Ryan Gilbert with BTIG. Your line is now open.
Actually, it's Carl Reichardt on with Ryan. Hi, guys. I wanted to ask about California and Rio Vista, whether or not there are any closings this quarter. I think it sounds like there weren't. What the plan is for the next couple of quarters. Any more new stores in California in 2018?
Yeah, great question, Carl. Yeah, there actually was. We are off to a fast start in California. We had a great grand opening event. In fact, we took more customers and sold more houses at that grand opening event than at any grand opening in LGI history. That community had an average sales price of $370,000. It's in Rio Vista, California, a project called Liberty. We could not be more pleased with that start. The grand opening was the second weekend of June, and we were actually able to get one closing in the month of June. It happened on the last day of the month. It actually counted in our active community count for June.
In July, which is our first month of closings, primarily based on the available houses that we had to close, we closed an additional eight more, again, with an average sales price somewhere around $370,000. Just a fantastic start. We would expect that community in California, based on the pipeline, continue to average seven or eight closings per month from now to the end of the year.
Okay. Yeah, you guys tried to sell us a house when we were out there, so good job in that regard. Two more quick ones. Is Terrata planned to be continually sort of small, 5% or so of mix on a go forward into 2019? Can you talk a little bit about the wholesale closing side over the course of 2019 within that guide? Are you expecting any communities that are going to be largely or solely single-family rentals? Thanks.
Great question, Carl. Taking the Terrata one first. Terrata, we only have five active communities with Terrata. It's only a percentage or two of our business right now. Between the wholesale business and our LGI Homes retail business, that has really outgrown faster than Terrata. We haven't added a lot of new active communities with the Terrata brand. We think that's going to continue. We'll be opportunistic with that brand. We're excited about it. The five active communities have been accretive this year, but a very small percentage of our business going forward. On the wholesale business, the wholesale business was between 5% and 6% of our closings in the second quarter. We think that trend is going to continue. We provided and built and sold our first community that was solely to the investors, and we see opportunities for that in the future.
Our acquisition team is looking for 30, 40, 50 lot parcels that we can sell to the retail wholesale investor groups, and also looking at various sections of our own communities. Obviously, we wouldn't go forward on that unless it made sense to do LGI and was accretive to our earnings for our shareholders. We think there's opportunity there. Certainly, 5 or 6% of our business is very realistic.
Great. Thanks so much, Eric.
You're welcome.
Thank you. Our next question comes from the line of Kenneth Zener with JP Morgan. Your line is now open.
Hi, thanks for taking my call. A lot of my questions were already answered. I was wondering if you could comment on whether or not you've done any stress testing for the interest rate environment and how that's affecting your homebuyer client. I'm curious if there's a rate level at which you start to have to give up some margin in order to keep the home at an affordable price and compare a attractive trade-off from someone who would potentially be a renter rather than a homeowner.
Yeah. This is Eric. I can start with that. We have looked at the different scenarios and stress tested from standpoint of looking as interest rates increase and what that results see for the monthly payment for the buyer. Certainly, we're dealing with a higher monthly payment for the buyer now because of the rise in interest rates from nine months ago. Demand seems to be there. I'd describe it as consistent, and we're comfortable where we're at now. Certainly keep an eye on it. I think as rates continue to rise, every builder is going to have to face decisions on how to deal with that. LGI would not be in the camp as suggested where we would take a margin haircut and lower price in order to deal with that.
I think we'd be in the camp of absorptions may slow, but gross margins would still be there, and our average sales price may have to increase as well, because we're still planning on dealing with a higher cost environment. Average sales price being higher is a positive for us. Also look at alternatives for our product to deal with the higher interest rates rather than reducing the price. We may have to look at smaller square footages. The buyer may have to choose a smaller square footage. We're continuously looking at our fit and finishes. We'll continuously look at our land development opportunities and look at lot size and efficiencies in land development. I think there's other avenues that we would look at instead of just sacrificing gross margin.
Got it. Thank you. That's helpful. I guess, along the similar lines, are you seeing any kind of break in the trend of rising input costs at all? Do you expect that to be a persistent environment, at least as far out as the next 12 months as you're forecasting out?
Yeah, this is Charles. We have a fundamental belief that costs will always be rising. Eric mentioned the trend in our average sales price since 2014 has been going up and primarily due to rising land and both labor and materials. We mentioned on our last call that we saw cost taper in a way that wasn't quite as dramatic as what we saw in 2017. Certainly, following up on the pricing power discussion, that really resulted in a positive benefit to us this quarter compared to the first quarter. We believe that costs will continue to rise. To what degree? Our goal is to just increase prices to keep up, maintain our consistent margins, which over time, we've been able to do very successfully.
Are there any particular materials that you are more concerned about than others? I've recently seen things like hardwood suddenly being included in China's counter-tariffs. Any material in particular that you're worried may have a spike from where we are today?
I would say no. I think, at all times, there's different components at any one point in time becomes the predominant one. Lumbers, historically, over the last short term, has been kind of the number 1 driver for cost increases. It ebbs and flows every quarter, and we'll just continue to monitor it.
Okay. Thank you.
You bet.
Thank you. Our next question comes from the line of Stephen East with Wells Fargo. Your line is now open.
Thank you. This is Paul on for Stephen. Eric, going back to the Wynn acquisition, looking at the website, it looks like it's a little bit of a break from your traditional focus in a particular market on the highway arteries, more the communities clustered together. Is that a change in thinking or will you, after you deplete their assets, move back more towards your traditional model?
Yeah. We're going to be operating the LGI way by the first of the year. Yes, they were a builder that operates probably more like a traditional builder outside of LGI, where their communities, they had about eight model homes, if you will, set up in eight locations, doing 20-25 a month, consistent 2-3 a month. Very typical of a home builder in the industry. What we'll do is take those different corridors around town, as you can see from their websites, and we'll actually combine them and set up LGI information centers. Like I talked about, a couple new active communities this year, another five or so next year, and just combine their communities. We'll definitely switch it to the LGI model.
Okay. Charles, can you add some color on the year-over decline in your gross margin? How much of that was attributed to material and land inflation versus the wholesale closings or your lower margins in your new markets?
Yeah, you're referring to 26.6 in gross margin last year, this quarter compared to 26.1?
Right.
Yeah, I think, included in last year's number, we had a one-time benefit. We had mentioned in the call last year, it was about 80 basis points related to a community reimbursement. That certainly comes into play this year, when you're looking at the year-over-year comparison. We're very happy with where we ended up this quarter. We're very pleased that we're in the range and consistent with our historical results.
Given the range that you gave, what would be the driver to hit that lower end of that guidance?
Well, in terms of the gross margins guidance range, I think, obviously, there's uncertainty around costs and inputs. Mix certainly comes into play as we shift. Generally, most of our divisions are pretty close in terms of their results that they generate in terms of the overall gross margin percentage. The mix and our community mix certainly comes into play in volatility within the margins. 50 basis points swing either way, or 100 basis points swing either way, that's kind of why we speak to that, is because, just like our monthly closings volatility is going to vary month-to-month, our gross margin quarter-to-quarter is going to vary. In the long run, we feel like we can deliver consistent gross margin results.
One last one, if I could. I think the last couple of quarters, your direct marketing expense had been under budget. Is that still the case, or have you had to increase that to combat the higher rate environment?
Go ahead.
Yeah, I'll just add it there. We haven't had to increase it yet. We're still seeing strong demand, that is something that we could also use as a tool to combat higher interest rates in the last few months of this year.
Okay. Thank you.
Thank you. Our next question comes from the line of Jay McCanless with Wedbush. Your line is now open.
Thanks for taking my follow-up. Just two, three quick questions. Number one, you talked about pricing growth earlier. What was your same-store price growth this quarter versus last year, and maybe for the first six months as well?
I don't think we have that information in front of us, Jay. There's so much volatility with new community counts and sellouts and new floor plans. Our average sales price is certainly up from last year. I think it's around 9%, maybe about half in inflation and half because of mix and new markets would be a pretty accurate estimate.
Okay. Then on the investor homes versus direct-to-consumer homes, are you guys still seeing a similar operating margin on one versus the other? Do you have a target or a limit of the amount of investor homes you want to sell this year?
It is a similar operating margin for sure. Not only is it a similar operating margin, but in the case of most of these sales are coming from communities that you accelerate the closing. It's very accretive, not only from an operating margin, but also return on equity, return on assets, those type of metrics as well. We are limited on how many we could sell this year from a standpoint of we need to have lots finished and available to go. We don't have an excess supply of lots, it takes planning and really working with the investors and getting deals under contract. It's a little bit more of a lead time in order to produce wholesale closings.
Got it. Then the last one I had, just wanted to ask the unit closing growth and maybe in a little bit different way. Should we think about as you guys work towards 240 communities, how much of your sales growth do you think is going to come from organic versus new markets and acquisitions? Have you guys even split it out that way? Then also, for the next, call it 12 to 18 months, how many communities on average do you want to have in each of your markets?
Well, a couple of things there. Mostly organic growth because M&A activity, especially since we need to integrate Wynn into this acquisition, we think that's very accretive in helping us with community count growth. Our plan to get to 240 communities, we're not assuming that we're going to go out and make any acquisitions in that plan. That's all organic growth. Most of the markets we've at least talked about previously, we're just getting started, whether it's California, whether it's Las Vegas, Birmingham. We're up and running in the Mid-Atlantic region right now. We got our first project we just closed on in that market. We got at least one or two other projects under contract in that market, but they're not included in community count yet because we're not open for sales, we haven't had closings in those markets.
We're focused on the markets that I mentioned in all of our existing markets for now. In order to get to 240, we'll definitely add markets to that. Primarily focused on going deeper in our existing markets.
Thanks again. Appreciate it.
Thank you. I'm showing no further questions at this time. With that, I'd like to turn the call back over to CEO and Chairman of the Board, Mr. Eric Lipar, for closing remarks.
Sure. Thank you, and thank you for everyone for participating on today's call and continued interest in LGI Homes. Have a great day.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program.