LGI Homes, Inc. — 2017 Form 10-K Summary
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2017. LGI Homes designs, builds and sells primarily entry-level homes, with move-up and luxury offerings, across 16 states. It ended the year with 78 active communities and reported six operating and reportable divisions beginning in the fourth quarter; comparative segment information was restated.
Financial and operating performance
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Home sales revenue | $1,258.0 million | $838.3 million | +50.1% |
| Closings | 5,845 | 4,163 | +40.4% |
| Average selling price | $215,220 | $201,374 | +6.9% |
| Gross margin | $320.4 million; 25.5% | $221.6 million; 26.4% | Margin down 0.9 percentage points |
| Operating income | $169.8 million | $111.5 million | +52.3% |
| Net income | $113.3 million | $75.0 million | +51.0% |
| Diluted EPS | $4.73 | $3.41 | +38.7% |
| Cash from operating activities | $(68.5) million | $(108.2) million | Cash use narrowed |
Fourth-quarter 2017 home sales revenue was $405.0 million, gross margin was $98.7 million, and net income was $35.6 million; diluted EPS was $1.43. For the full year, adjusted gross margin, a non-GAAP measure, was $338.1 million, or 26.9%, versus $232.8 million, or 27.8%, in 2016.
Balance sheet and liquidity. At year-end, cash and cash equivalents were $67.6 million, real estate inventory was $918.9 million, total assets were $1.080 billion, total liabilities were $590.0 million and equity was $489.8 million. Notes payable totaled $475.2 million, including $400.0 million of gross revolving-facility borrowings and $85.0 million principal amount of convertible notes. The $600.0 million revolving facility had $161.3 million available to borrow after outstanding letters of credit; the company reported covenant compliance. Operating cash use reflected inventory and working-capital investment, despite higher earnings.
Material changes versus 2016
- Growth in revenue came from more closings and higher average selling prices, supported by expansion from 63 to 78 active communities.
- Gross margin percentage declined, which management attributed principally to higher construction and lot costs, with some effect from 201 wholesale closings versus none in 2016.
- Owned or controlled lots increased 34.8% to 39,709. The company reported 1,378 completed homes and 1,630 homes in progress at year-end.
- Central division represented 42.3% of 2017 home sales revenue, down from 51.2% in 2016, reflecting continued geographic diversification.
- Operating cash use improved year over year, while financing activities provided $87.0 million; cash increased by $18.1 million to $67.6 million.
Outlook, commentary, risks and unusual items
- Management expected 2018 closings from new markets to begin in Oklahoma City in the second quarter and Sacramento and Birmingham in the third quarter; Las Vegas construction and sales were expected to begin by year-end. Management also expected luxury homes to remain below 5% of annual closings and wholesale closings to be approximately 5%.
- Management cited growth opportunities in existing and new markets, multiple product lines and flexible land acquisition. The company had started construction in Oklahoma City, Sacramento and Birmingham.
- Key risks include mortgage availability and rising interest rates, affordability and homebuyer demand, land acquisition and development costs, labor and materials shortages, margin pressure, inventory impairment, weather and natural disasters, and geographic concentration. Management noted 2017 hurricanes and natural disasters contributed to labor, material and construction-cost pressures.
- The $600.0 million revolving facility matures in May 2020 and bears interest at LIBOR plus 3.15% at year-end. A hypothetical 100-basis-point increase in rates was estimated to add about $4.0 million in annual interest cost. The company had no interest-rate hedges.
- Holders elected to convert $15.0 million principal amount of convertible notes in late 2017; settlement in January and February 2018 involved $15.0 million cash repayment and issuance of 486,679 shares. The notes remained convertible during the first quarter of 2018.
- The Tax Cuts and Jobs Act reduced the federal corporate tax rate to 21%. LGI recorded an estimated $1.1 million reduction in deferred tax assets in 2017 and expected a lower 2018 effective tax rate, excluding excess stock-compensation tax benefits; some tax accounting remained provisional.
- No real estate inventory impairment charges were recorded in 2015–2017. Management said ordinary-course legal and regulatory matters were not expected to have a material effect, but the filing describes unsecured environmental indemnities without stated term or damage limits. Outstanding letters of credit, surety bonds and guarantees totaled $49.7 million; management did not believe draws would be material.
- Independent auditors issued unqualified opinions on the financial statements and internal control over financial reporting. Management also concluded disclosure controls and internal financial controls were effective as of year-end.
Important facts for investors to verify
- Whether closings and average selling prices can continue to grow while construction and land costs weigh on gross margin.
- Whether negative operating cash flow and the large inventory and lot position are manageable as community expansion continues.
- Current revolver availability, covenant headroom, floating-rate exposure and the status of remaining convertible notes after the 2018 conversions.
- Actual 2018 performance in new markets, and whether the stated wholesale and luxury mix expectations were achieved.
- The final tax effects of the Tax Act, including any revisions to provisional estimates and the effect of stock-based compensation.
- Potential exposure from environmental indemnities, warranty claims, development commitments and uninsured weather-related losses.