LGI Homes, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. LGI Homes develops communities and builds and sells homes across six operating divisions. Results are unaudited; amounts below are in U.S. dollars.
Financial and operating performance
- Revenue: Home sales revenue was $279.0 million, up 71.3% year over year. Closings rose 63.5% to 1,244, while average selling price increased 4.8% to $224,296. Active communities grew to 79 from 69.
- Profit: Gross margin was $69.3 million, up 59.2%, but gross margin rate declined to 24.8% from 26.7%. Adjusted gross margin, a company-defined non-GAAP measure, was $73.6 million, or 26.4% of revenue, versus $45.6 million, or 28.0%.
- Operating income rose 91.4% to $30.9 million; pretax income rose 85.4% to $31.2 million. Net income increased 131.8% to $27.3 million. Diluted EPS was $1.10, compared with $0.52. The effective tax rate was 12.6%; the filing attributes the lower rate primarily to share-based payment tax benefits, partly offset by other tax changes.
- Cash flow: Operating activities used $110.9 million, versus $47.2 million used in Q1 2017, principally reflecting investment in inventory and land as the business expanded and timing of tax and liability payments. Investing activities used $0.2 million; financing activities provided $95.5 million. Cash declined $15.5 million to $52.0 million.
- Balance sheet and debt: At March 31, cash was $52.0 million, real estate inventory $1.040 billion, total assets $1.171 billion, and total equity $518.9 million. Notes payable were $571.7 million, up from $475.2 million at year-end. The revolving facility had $510.0 million drawn, $6.0 million of letters of credit, and $84.0 million available; $70.0 million principal remained on 4.25% convertible notes due November 2019.
- Margins and costs: Management cited higher construction and lot costs, as well as product mix, as factors in lower gross margin percentage. Selling and G&A expenses rose in dollars but fell as percentages of revenue, to 8.2% and 5.5%, respectively.
Changes versus the prior comparable period
- Growth reflected more active communities and closings, higher average selling prices, and contributions from divisions outside Central. Central remained the largest division, generating 39% of revenue.
- Revenue and net income increased substantially, but gross margin percentage fell. The cancellation rate rose to 20.6% from 18.9%.
- Net operating cash use increased, while borrowings under the revolving credit facility expanded. Owned and controlled lots rose 14.1% from December 31, 2017, to 45,321.
Outlook, risks, and notable items
- The filing provides no specific full-year revenue or earnings guidance. Management said it believes cash, operating cash generation, and available financing will fund current and foreseeable liquidity needs for at least 12 months. Results are seasonal; the company generally closes more homes in Q2 through Q4, so Q1 may not represent full-year performance.
- The credit facility matures May 31, 2020, bears variable interest at LIBOR plus 3.15% at quarter-end, and includes financial covenants. LGI reported compliance with all covenants. A hypothetical 100-basis-point increase in the average rate on variable-rate debt would increase annual interest cost by approximately $5.1 million.
- Convertible notes were convertible during Q1 and remained convertible in Q2; $15.0 million principal was settled in Q1 with a $15.0 million cash payment and issuance of 486,679 shares. No additional conversion notices had been received as of the filing date.
- Land deposits were $23.0 million against contracts covering 22,063 lots with aggregate purchase commitments of $596.8 million. Outstanding letters of credit and performance/surety bonds totaled $52.4 million. Management did not expect material draws or material effects from disclosed ordinary-course claims and regulatory matters.
- Key risks include mortgage-rate increases and reduced buyer affordability, inflation in land, labor and construction costs, land and subcontractor availability, development delays, seasonality, and the execution and financing risks of growth and new markets. Backlog contracts may be cancelled before closing; buyer deposits are generally minimal and refundable if financing is unavailable.
- Topic 606 revenue-recognition guidance was adopted January 1, 2018, with no material financial-statement effect. The company was still refining certain Tax Act accounting estimates. Related-party land purchase arrangements were disclosed, including contracts with affiliates of the CEO’s family member and a director.
Important facts for investors to verify
- Whether sales growth and the 1,370-home backlog convert to closings, particularly given the higher cancellation rate and minimal buyer deposits.
- Whether home price and product mix can offset construction and lot-cost pressures and stabilize gross margin.
- How inventory investment, land commitments, and seasonal working-capital needs affect cash use and reliance on revolving borrowings.
- Remaining revolver capacity and covenant headroom, variable-rate exposure, and any further conversion or settlement of the 2019 notes.
- Execution and capital requirements of geographic expansion, including the newer Midwest and Oklahoma City markets, and the terms of related-party land transactions.