Business context and reporting period
LGI Homes, Inc. develops, builds, markets and sells homes across multiple U.S. markets. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2016, compared with the same 2015 periods. At quarter-end, the company had 56 active communities and 28,040 owned or controlled lots.
Financial and operating results
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Home sales revenue | $222.7 million | $158.8 million | $385.2 million | $279.5 million |
| Home closings | 1,128 | 853 | 1,972 | 1,524 |
| Average selling price | $197,450 | $186,197 | $195,328 | $183,409 |
| Gross margin | $59.1 million; 26.5% | $42.6 million; 26.8% | $100.5 million; 26.1% | $74.0 million; 26.5% |
| Operating income | $30.7 million | $21.2 million | $48.1 million | $32.9 million |
| Net income | $20.7 million | $14.0 million | $32.4 million | $21.7 million |
| Diluted EPS | $0.96 | $0.66 | $1.54 | $0.97 |
Revenue rose 40.2% in Q2 and 37.8% in the first half, reflecting more closings and higher average selling prices. Gross margin percentage declined in both periods; management cited geographic/product mix and higher construction and lot costs, partly offset by pricing. Adjusted gross margin, a non-GAAP measure, was 27.8% in Q2 and 27.3% for the first half, versus 28.2% and 28.1%, respectively.
For the six months, operating cash flow was negative $34.5 million, compared with negative $1.8 million in 2015, primarily due to increased real estate inventory and land-related deposits as the business expanded. Investing cash outflow was $0.4 million; financing provided $46.9 million, including net debt proceeds and stock issuance. Cash ended at $49.7 million, up from $37.6 million at year-end 2015.
At June 30, 2016, total notes payable were $334.2 million, including $260.0 million drawn on the revolving facility and $85.0 million principal of 4.25% convertible notes due 2019 (carrying value $77.1 million). The $360.0 million revolver had $92.4 million available after borrowings and letters of credit. Total liabilities were $406.5 million and equity was $300.9 million. The company reported compliance with credit covenants. Interest incurred was fully capitalized to qualifying inventory, so reported interest expense was zero for the periods shown.
Material changes versus prior comparable periods
- Q2 closings increased 32.2%; first-half closings rose 29.4%. Active communities grew to 56 from 45 a year earlier.
- Average selling price increased 6.0% in Q2 and 6.5% for the first half. Despite higher gross profit dollars, gross margin rates narrowed by 0.3 and 0.4 percentage points, respectively.
- First-half operating cash use increased as inventory and pre-acquisition investment expanded; real estate inventory reached $609.9 million, from $531.2 million at December 31, 2015.
- The company amended and expanded its revolving credit facility from $300 million to $360 million, with an option to request an increase to $400 million and maturity in May 2019.
- The completed ATM program raised approximately $19.8 million net in the first half; cumulative net proceeds were approximately $29.4 million.
Outlook, risks and unusual items
No specific earnings or revenue guidance is provided. Management said it believes cash, operating cash generation, revolver availability and potential capital-market access will fund foreseeable liquidity needs for at least 12 months. It expects seasonal patterns to continue, with generally more closings in the second, third and fourth quarters.
Risks highlighted include housing and mortgage-rate sensitivity, inflation and increases in land, labor and material costs, development and construction delays, land availability, financing access, competition, and execution in new markets. A hypothetical 100-basis-point increase in variable borrowing rates would increase annual interest expense by approximately $2.6 million. The company reported $26.4 million of letters of credit, surety bonds and financial guarantees, and $247.7 million of potential purchases under land option and purchase contracts covering 9,972 lots; deposits were $11.7 million. Management did not expect material draws or material effects from ordinary-course claims, and recorded no environmental reserves.
Other items to note: a CEO-family-affiliate lot option involved 106 finished lots at a base price of approximately $8.0 million; 21 lots closed in Q2, with 85 remaining. A consulting agreement with a CEO family member was terminated by mutual agreement in June 2016. Warranty reserves were $1.4 million at quarter-end.
Important facts for investors to verify
- Whether growth in closings and communities can be sustained while gross margin rates face construction-cost, lot-cost and mix pressure.
- How inventory investment and land commitments affect operating cash flow, revolver usage and liquidity as the company expands.
- Revolver covenant headroom and the effect of higher LIBOR or mortgage rates on financing costs, buyer demand and affordability.
- Backlog quality and conversion: 887 homes valued at $187.6 million at June 30; the filing reports a 22.2% first-half cancellation rate and notes deposits are generally minimal and refundable if financing is unavailable.
- Execution and capital requirements for the 9,972 optioned or contracted lots, and terms and oversight of the related-party lot arrangement.