Business context and reporting period
LGI Homes, Inc. filed this Form 10-K for the fiscal year ended December 31, 2014. The company builds and sells primarily entry-level homes across markets in Texas, Arizona, Florida, Georgia, New Mexico, Colorado, North Carolina and South Carolina. It reports one aggregated homebuilding segment. Comparisons with 2013 require care: LGI acquired the remaining interests in its GTIS joint ventures in November 2013, changing them from equity-method investments to consolidated operations. The filing also provides pro forma comparisons that treat the acquisition as if completed at the start of 2013.
Financial and operating performance
| Metric | 2014 | 2013 comparison |
|---|---|---|
| Home sales revenue | $383.3 million | $160.1 million reported; $241.0 million pro forma |
| Home closings | 2,356 | 1,062 reported; 1,617 pro forma |
| Average selling price | $162,677 | $150,722 reported; $149,018 pro forma |
| Gross margin | $102.8 million; 26.8% | $38.7 million; 24.2% reported; 25.4% pro forma |
| Net income | $28.2 million | $21.7 million reported; $21.7 million pro forma |
| Adjusted EBITDA | $48.4 million; 12.6% margin | $21.3 million; 13.3% reported margin; $28.3 million; 11.8% pro forma margin |
On a pro forma basis, closings increased 45.7%, home sales revenue rose 59.1%, and gross margin rate improved from 25.4% to 26.8%. Management attributed higher gross margin primarily to increased selling prices, partly offset by construction and lot-cost inflation. Selling and general and administrative expenses were $36.7 million and $23.7 million, respectively. Net income growth was lower than revenue growth, partly reflecting increased income tax expense; reported 2013 results included a $6.4 million nonrecurring gain on remeasurement of the GTIS interests.
For fourth-quarter 2014, home sales revenue was $108.4 million, gross margin was $29.6 million, pretax income was $11.6 million, and net income was $7.5 million. Diluted EPS was $0.34.
Cash flow, balance sheet and liquidity
Cash and cash equivalents were $31.4 million at year-end, down from $54.1 million. Operating cash flow was negative $173.2 million, compared with negative $54.5 million in 2013, principally because of investment in real estate inventory. Investing cash flow was negative $16.4 million, including the Oakmont acquisition; financing cash flow was positive $166.9 million.
Real estate inventory rose to $367.9 million from $142.0 million. Total assets were $438.1 million and total liabilities were $255.6 million. Notes payable were $216.1 million on the balance sheet, including $139.4 million drawn on the revolving credit facility and the convertible notes at their discounted carrying value. The facility had $60.6 million available at year-end, subject to borrowing-base terms. LGI reported compliance with its credit covenants and stated it expected available cash, operating cash flow and facility capacity to meet foreseeable needs for at least twelve months.
In November, the company issued $85.0 million of 4.25% convertible notes due 2019, repurchased 1.0 million shares for $16.6 million, and used remaining proceeds in part for land and lot purchases and general corporate purposes. The $200.0 million secured revolver matures in April 2017. A hypothetical 100-basis-point increase in the variable-rate borrowing cost was estimated to add approximately $1.4 million in annual interest expense at the year-end balance.
Material changes and unusual items
- Active communities increased from 25 to 39; owned or controlled lots increased 33.5% to 19,883.
- LGI acquired Oakmont-related homebuilding assets and liabilities in Charlotte for approximately $17.3 million, including an estimated $2.2 million contingent earnout. The earnout depends on closings through 2017.
- The company launched its Terrata Homes move-up brand in San Antonio and closed its first Terrata home in January 2015.
- Net orders were 2,259, while the cancellation rate rose to 31.3% from 23.5%. Year-end backlog was 152 homes valued at $27.1 million, versus 190 homes valued at $30.1 million.
- No inventory impairment charges were recorded in 2014, 2013 or 2012. The filing says ordinary-course legal matters were not expected to materially affect financial position, results or cash flows; it also discloses unsecured environmental indemnities and no related reserves.
Outlook, management commentary and risks
Management expects to continue focusing on entry-level buyers, growing in existing and new markets, and using its move-in-ready, standardized-home operating model. Terrata homes and closings in higher-priced communities or communities involving home-site sales were each expected to represent less than 10% of annual closings through 2016. A second Terrata community was expected to open in South Carolina in mid-2015. The filing gives no specific numerical earnings or revenue guidance.
Key risks include mortgage availability and interest rates, homebuyer qualification and cancellations, rising land, labor and material costs, the carrying and impairment risk of substantial inventory, development and permitting delays, subcontractor availability, and competition. Operations are geographically concentrated: Texas generated 66.6% of 2014 home sales revenue. The company also flagged exposure to weather and natural disasters, environmental and warranty claims, insurance availability in Texas and Florida, and the possibility that credit-facility covenant breaches could restrict funding or accelerate repayment. The business is seasonal, with typically more closings in the second through fourth quarters. Management reported effective disclosure controls and internal control over financial reporting as of year-end.
Important facts for investors to verify
- Reconcile reported 2013 results with the pro forma GTIS comparison when assessing growth and margins.
- Track whether inventory expansion converts into closings and operating cash flow; 2014 operating cash use was substantial and the cancellation rate increased.
- Review borrowing-base availability, covenant headroom, debt maturities and the effect of variable interest rates.
- Assess potential dilution and settlement terms for the convertible notes, including the status of stockholder approval for flexible settlement provisions.
- Monitor Texas concentration, new-market execution, Terrata adoption, and the Oakmont earnout and related development assumptions.
- Consider that adjusted gross margin and adjusted EBITDA are non-GAAP measures and should be evaluated alongside GAAP results and cash flows.