LGI Homes, Inc. quarterly report, Q3 FY2019

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LGI Homes, Inc. — Q3 2019 Form 10-Q

Business context and period: Unaudited results for the quarter and nine months ended September 30, 2019, compared with the corresponding 2018 periods. LGI Homes develops, builds and sells homes across U.S. markets under the LGI Homes and Terrata Homes brands. It had 103 active communities at quarter-end, versus 81 a year earlier, and expanded into Riverside, California and Columbia, South Carolina.

Financial and operating results

  • Q3 revenue: Home sales revenue was $483.1 million, up 27.0%; closings rose 25.1% to 2,003 and average selling price increased 1.5% to $241,179.
  • Q3 profit and margins: Net income was $49.3 million, up 30.8%; diluted EPS was $1.93 versus $1.52. Operating income was $64.0 million. Gross margin was 24.1%, down from 25.6%; adjusted gross margin, a non-GAAP measure, was 26.3% versus 27.4%.
  • Nine-month results: Revenue was $1.23 billion, up 14.2%, on 5,175 closings, up 11.1%, and average selling price of $238,165, up 2.8%. Net income was $113.7 million, up 1.0%; diluted EPS was $4.49 versus $4.57. Operating income declined 0.8% to $143.5 million. Gross margin fell to 23.9% from 25.6%; adjusted gross margin was 26.0% versus 27.3%.
  • Cash flow: Operating activities used $104.2 million in the first nine months, compared with $102.0 million used in 2018, primarily reflecting a $249.9 million increase in real estate inventory. Investing activities used $1.6 million; financing activities provided $96.2 million. Cash declined $9.6 million to $37.0 million.
  • Balance sheet and debt: At September 30, cash was $37.0 million, real estate inventory $1.48 billion, total assets $1.64 billion and notes payable $751.4 million, versus $653.7 million at year-end 2018. Equity was $777.0 million. The $550 million revolving facility had $145.1 million available after outstanding borrowings, letters of credit and deferred purchase price obligations. The company reported compliance with all facility covenants.
  • Interest and liquidity: Interest incurred was capitalized to qualifying inventory; the income statement reported no interest expense. Cash interest paid was $35.7 million for the nine months. Management said cash on hand, operating cash generation and expected revolver or capital-market access should fund current and foreseeable needs for at least 12 months.

Material changes and management commentary

  • Q3 revenue growth reflected higher closings, expanded community count and a modestly higher average selling price. Selling and general and administrative expenses grew more slowly than revenue, improving operating leverage.
  • Gross margin percentage declined in Q3 and year to date, primarily due to higher lot, construction and capitalized interest costs; year-to-date results also reflected construction overhead and purchase-accounting effects. Management cited higher prices and other income as partial offsets.
  • Year-to-date closings and revenue grew, but results varied by market: West, Central and Southeast revenue increased, while Northwest and Florida revenue declined, with community transitions and close-outs among the cited factors.
  • Owned and controlled lots totaled 48,803, down 5.1% from year-end 2018. Inventory included 1,518 completed homes (including information centers) and 3,111 homes in progress.
  • No specific earnings or revenue guidance was provided in the supplied filing text. Management expects the homebuilding business’s seasonal pattern to continue, with generally more closings in the second, third and fourth quarters.

Risks, contingencies and notable items

  • Approximately $70 million principal amount of 4.25% convertible notes matured November 15, 2019. LGI elected to pay principal in cash and settle conversion value, if applicable, in shares; it expected to use operating cash and revolver borrowings to meet the obligation.
  • The $300 million 6.875% senior notes mature in 2026. Revolver borrowings bear variable LIBOR-based rates; a hypothetical 100-basis-point increase was estimated to add about $3.9 million to annual interest cost. The company was evaluating the transition away from LIBOR.
  • Land purchase contracts covered 17,044 lots with aggregate commitments of $550.4 million; related deposits were $37.7 million. Most contracts allow termination subject to forfeiture of nonrefundable deposits. Outstanding letters of credit, surety bonds and financial guarantees totaled $100.8 million.
  • The company committed up to $30 million to a real estate investment fund and had contributed $1.1 million by quarter-end. It also disclosed land contracts with affiliates of a director, with a base purchase price of approximately $6.9 million for 198 lots.
  • Management said ordinary-course legal and regulatory matters and potential draws on bonds or letters of credit were not expected to have a material financial effect. Key stated risks include housing and mortgage-rate conditions, land and construction cost inflation, labor and materials availability, development delays, leverage, market expansion and access to capital.
  • Disclosure controls were assessed as effective; no material change in internal control over financial reporting was reported for the quarter.

Important facts for investors to verify

  1. Whether margin pressure from land, construction and interest costs persists, and how it affects GAAP gross margin and earnings.
  2. How the November 2019 convertible-note maturity was settled and its effect on cash, debt and share dilution.
  3. Whether operating cash flow improves as inventory investment and community expansion evolve, given negative operating cash flow year to date.
  4. Revolver availability, covenant headroom and refinancing or LIBOR-transition implications.
  5. Lot inventory, land-contract commitments and sales/backlog conversion, including market-level performance and cancellation exposure.
  6. How the $30 million fund commitment, related-party land transactions and outstanding development guarantees progress.