LGI Homes, Inc. — Q2 2018 Form 10-Q
Business context and period. LGI Homes develops communities and builds and sells homes across six U.S. operating segments. This unaudited report covers the quarter and six months ended June 30, 2018; comparisons are with the corresponding 2017 periods.
Financial and operating performance
- Q2 revenue and earnings: Home sales revenue was $419.8 million, up 29.5%; 1,815 homes closed, up 20.1%, and average selling price rose 7.8% to $231,321. Net income increased 47.9% to $47.6 million; diluted EPS was $1.90 versus $1.39.
- Six-month results: Revenue rose 43.5% to $698.9 million on 3,059 closings, up 34.6%, and average selling price of $228,464, up 6.6%. Net income increased 70.3% to $74.9 million; diluted EPS was $3.01 versus $1.91.
- Margins: Q2 gross margin was 26.1%, down from 26.6%; six-month gross margin was 25.6%, down from 26.7%. Management attributed the contraction mainly to higher construction costs and, for the six-month period, higher lot costs; wholesale closings also weighed on margin. Q2 and six-month adjusted gross margins, a non-GAAP measure, were 27.7% and 27.2%, respectively. Q2 EBITDA margin was 16.4%, flat year over year; six-month EBITDA margin was 14.9%, versus 14.7%.
- Cash flow: Cash used in operating activities was $95.7 million for the six months, versus $67.7 million used in 2017. Increased inventory investment, land acquisitions and home construction, along with payments of taxes and other liabilities, were principal factors. Ending cash was $48.9 million, down from $67.6 million at year-end 2017.
- Balance sheet and liquidity: Total assets were $1.20 billion; real estate inventory was $1.06 billion. Notes payable were $554.5 million on the balance sheet. At June 30, revolver borrowings were $495.0 million, with $10.1 million of letters of credit and $172.3 million available under the borrowing base. The facility required at least $50 million of liquidity; the company reported covenant compliance.
- Debt developments after quarter-end: On July 6, the company issued $300 million of 6.875% senior notes due 2026 and used approximately $296.2 million of net proceeds to repay revolver borrowings. The revolving commitment was reduced from $750 million to $450 million, and approximately $3.1 million of debt extinguishment costs were expected in Q3. The company also had $70 million principal amount of 4.25% convertible notes due 2019 outstanding at June 30.
Changes, outlook and risks
- Growth reflected more active communities (79 versus 71 a year earlier), higher closings and selling prices, and expansion across markets. The Central segment remained the largest revenue contributor. Sacramento recorded its first home closing in June.
- Management provided no specific full-year financial guidance. It said cash, operating cash flows, revolver capacity and potential capital-market access were expected to meet current and foreseeable liquidity needs for at least 12 months.
- Backlog at June 30 was 1,184 homes valued at $296.9 million, versus 1,545 homes and $352.5 million a year earlier. Six-month net orders were 3,427 versus 3,371; the cancellation rate increased to 22.5% from 21.3%. The company cautioned that backlog can be cancelled and is not a revenue forecast.
- Land purchase contracts covered 22,296 lots with aggregate purchase commitments of $665.4 million; deposits were $27.9 million. The company generally may terminate contracts by forfeiting nonrefundable deposits, subject to contract terms.
- On August 2, the company acquired Wynn Homes assets for approximately $80 million, including about 200 homes under construction and 4,000 owned or controlled lots in North Carolina. The $74.3 million cash closing payment was funded with cash and revolver borrowings; purchase-price allocation was not yet practicable.
- Key risks identified include mortgage-rate increases and affordability, inflation and rising land, labor and construction costs, housing-market weakness, land and financing availability, development delays, and acquisition integration. A putative FLSA overtime class action was pending; management intended to defend it and did not expect additional plaintiffs. Management did not expect ordinary-course claims, environmental matters or outstanding bonds and letters of credit to have a material effect.
- The IRS began examining the company’s 2016 federal tax return; no adjustments had been proposed as of June 30. Tax Act accounting remained subject to refinement. Adoption of the new revenue standard had no material financial-statement effect.
Key facts for investors to verify
- Whether higher construction and lot costs continue to pressure gross margins as sales volumes grow.
- How backlog, cancellations and closings develop, given the lower backlog and higher cancellation rate.
- Post-quarter debt and liquidity after the senior-note repayment, the Wynn acquisition, and the reduction in revolving commitment.
- Land-contract takedowns, inventory growth and cash requirements, including the $665.4 million of land purchase commitments.
- Integration and returns from the Wynn Homes acquisition, including final purchase-price allocation and any contingent property payments.
- Resolution of the overtime lawsuit and the 2016 IRS examination; review the filing’s non-GAAP reconciliations alongside GAAP results.