LGI Homes, Inc. — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. Financial statements are unaudited. LGI develops and builds entry-level homes; at quarter-end it operated in Texas, Arizona, Florida, Georgia and New Mexico. The company acquired the remaining interests in four LGI/GTIS joint ventures in November 2013, so reported comparisons with 2013 are not fully like-for-like. Where useful, management also presents pro forma comparisons assuming the acquisition had occurred earlier.
Financial and operating results
| Metric | Three months ended June 30, 2014 | Six months ended June 30, 2014 |
|---|---|---|
| Home sales revenue | $106.4 million | $182.3 million |
| Homes closed; average selling price | 662; $160,744 | 1,147; $158,964 |
| Gross margin; gross margin rate | $28.4 million; 26.7% | $47.9 million; 26.3% |
| Operating income | $13.9 million | $20.9 million |
| Net income | $9.0 million | $13.6 million |
| EPS | $0.44 basic; $0.43 diluted | $0.66 basic; $0.65 diluted |
| Adjusted EBITDA (non-GAAP) | $15.3 million; 14.4% margin | $23.9 million; 13.1% margin |
On management’s pro forma comparison with 2013, Q2 home sales revenue rose 76.7%, closings increased 61.1%, and net income increased 16.4%. For the first half, pro forma revenue rose 90.0%, closings increased 72.7%, and net income increased 21.5%. Pro forma gross margin rates declined year over year: 26.7% versus 28.3% in Q2 and 26.3% versus 27.7% for the half-year.
Cash and cash equivalents were $42.9 million at June 30, down from $54.1 million at year-end 2013. Six-month operating cash use was $67.5 million, principally reflecting increased real estate inventory and land deposits; investing cash use was $0.5 million. Financing provided $56.8 million. Real estate inventory was $220.6 million, up from $142.0 million at year-end.
Notes payable totaled $93.9 million, compared with $35.5 million at year-end. The new senior secured revolving facility had a $135 million commitment at June 30; its borrowing base was $107.3 million, with $13.4 million available to borrow. It bears interest at LIBOR plus 2.75%, subject to a 3.75% floor, and matures April 28, 2017. All borrowings were variable-rate; the company reported covenant compliance. Total liabilities were $125.1 million and total equity was $179.0 million.
Material changes and unusual items
- Scale expanded: active communities increased to 31 from 18 on a pro forma year-ago basis; owned and controlled lots reached 19,936, up 33.8% from year-end.
- Gross margin pressure reflected higher construction and lot costs and a $0.9 million Q2 ($2.0 million first-half) purchase-accounting inventory step-up charge. Management said higher selling prices partly offset these pressures.
- Reported first-half income tax provision was $7.3 million, versus $0.1 million in 2013. Management attributed the difference primarily to the post-reorganization corporate tax structure; the predecessor had been treated as pass-through entities.
- CDD and similar utility-development obligations of $3.3 million were recorded at June 30. The filing says these obligations and related lot costs should also have been recognized at December 31, 2013 and March 31, 2014, but management considered them not significant to those statements.
Outlook, risks and contingencies
Management said it sees opportunities to grow in existing markets and expand into new markets. It expected construction to start in Denver and Charlotte before year-end 2014. It anticipated that a higher-price product mix could modestly reduce absorption, while expecting adjusted gross margins to remain within its target range; no numeric earnings or revenue guidance was provided. Management expected 2014 cash outlays for land, development, construction and operating expenses to exceed operating cash generated, but believed available cash and credit would cover foreseeable needs for at least 12 months.
Backlog was 246 homes valued at $41.0 million at June 30; the first-half cancellation rate was 30.4%, up from 26.8% in 2013. Deposits are generally $1,000 or less and may be refundable if buyers cannot obtain financing. Land purchase and option agreements covered 10,127 lots with $158.9 million of potential remaining purchase commitments; the company’s obligations are generally limited to forfeiture of deposits if it terminates. Outstanding performance and surety bonds were $6.0 million. The company also provided environmental indemnities without stated term or damage limits, but reported no known claims and no related reserves. Management said ordinary-course claims were not expected to materially affect results.
Key risks include housing and mortgage-rate sensitivity, seasonality, land and construction-cost inflation, availability of financing and land, expansion execution, and variable-rate debt. A hypothetical 100-basis-point rate increase was estimated to raise annual interest expense by about $0.9 million. The company reported no derivative use during the quarter.
After quarter-end, the company acquired approximately 1,980 acres in South Carolina from a Family Principal-affiliated entity for about $15.4 million. On July 31, the revolving facility commitment was increased by $40 million to $175 million.
Investor verification priorities
- Assess underlying growth using pro forma comparisons, and distinguish it from the effect of consolidating the LGI/GTIS ventures.
- Monitor gross margin trends, construction and lot costs, and the remaining effect of the purchase-accounting inventory step-up.
- Track cash use, inventory and land commitments against borrowing-base availability, debt covenants and the expanded credit facility.
- Review cancellation rates, backlog conversion and the execution and funding needs of new markets and communities.
- Verify the accounting and materiality of previously unrecorded CDD obligations, and monitor land-related commitments, bonds and environmental indemnities.