M/I Homes, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. M/I Homes is a U.S. single-family homebuilder with Midwest, Southern, Mid-Atlantic and financial services operations. Figures below are in U.S. dollars; financial statement amounts are generally in millions unless noted.
Financial and operating results
- Revenue: $437.9 million, up 8% from $407.0 million. Housing revenue was $418.4 million; land sales were $4.4 million; financial services revenue was $15.0 million.
- Profit: Net income was $18.1 million versus $16.9 million; diluted EPS was $0.60 versus $0.55. Pretax income declined 9% to $23.9 million from $26.3 million. The effective tax rate fell to 24.3% from 35.9%, largely reflecting the Tax Act’s lower corporate rate. Management’s non-GAAP adjusted net income was $20.0 million, excluding acquisition-related charges.
- Margins and costs: Housing gross margin was 17.6%, down from 18.6%; excluding $0.9 million of purchase-accounting adjustments, adjusted housing gross margin was 17.8%. Higher lot and construction costs and delivery mix weighed on margin. Total selling, general and administrative expense rose to $58.0 million, though it declined to 13.2% of revenue from 13.5%.
- Cash flow: Operating activities used $31.2 million, versus $23.3 million used in Q1 2017, primarily reflecting inventory growth and working-capital outflows. Investing activities used $97.7 million, including the $100.8 million Pinnacle Homes acquisition. Financing activities provided $30.7 million. Cash, cash equivalents and restricted cash ended at $53.6 million; unrestricted cash was $45.9 million.
- Liquidity and debt: Homebuilding revolving-facility borrowings were $162.3 million, with $268.4 million of net remaining availability. Financial-services borrowings were $102.7 million, with $3.9 million of reported availability. Senior notes included $300 million due 2021 at 6.75% and $250 million due 2025 at 5.625%. Homebuilding debt to capital was 48%, versus 46% at year-end. The company reported compliance with debt covenants.
- Operating indicators: New contracts rose 20% to a quarterly record 1,739; deliveries rose 8% to 1,122. Backlog increased 24% to 2,744 homes, with sales value up 31% to $1.09 billion and average backlog price up 6% to $398,000. Active communities reached a record 205. Total cancellation rate improved to 11.8% from 14.0%.
Material changes versus Q1 2017
- Revenue and deliveries grew, but pretax income declined due to $1.7 million of Pinnacle acquisition and integration costs, $0.9 million of purchase-accounting charges, higher interest expense and margin pressure. Excluding those acquisition-related charges, adjusted pretax income was $26.5 million, up about 1%.
- Performance varied by region: Southern revenue rose 27% and operating income increased to $14.9 million; Midwest revenue rose 8% but operating income declined to $12.2 million; Mid-Atlantic revenue fell 24% and operating income declined to $2.6 million.
- In March, the company acquired Detroit homebuilder Pinnacle Homes for approximately $100.8 million, adding 1,341 lots under control and 113 homes to backlog. The purchase-price allocation, including $16.4 million of goodwill, was provisional.
- The $86.3 million 3.0% convertible notes due 2018 were settled at maturity: approximately $20.3 million converted into about 629,000 common shares, and approximately $65.9 million was repaid in cash. The company had no remaining balance at March 31.
Outlook, risks and contingencies
- Management expected employment growth, wage gains, consumer confidence and constrained housing supply to support modestly improved new-home demand in 2018. It also expected the Tax Act to benefit the business. These are expectations, not earnings guidance; the filing provides no clear full-year revenue or EPS forecast.
- Management estimated 2018 land purchases and development spending of $550 million to $600 million, including $126.7 million spent in Q1 and excluding the Detroit acquisition. It expected cash outlays to exceed operating cash generation in some periods and anticipated continued use of the revolving credit facility, with peak borrowings estimated not to exceed $275 million. Management said available cash and credit were expected to fund anticipated needs for at least 12 months.
- Risks include higher interest rates, labor and materials costs, land costs, competition, changing homebuyer demand and the possibility that pricing cannot offset cost increases. The company also noted that credit-facility liquidity and mortgage-financing facilities depend on borrowing-base availability and lender extensions.
- Florida stucco claims remain a significant contingency. The company recorded $28.4 million of related warranty charges in 2015–2017 and reported a $7.9 million remaining reserve at March 31, 2018; no additional charge was recorded in Q1. The company said estimates could change materially and it had not recorded expected recoveries from insurers or subcontractors.
- Outstanding completion bonds and standby letters of credit totaled approximately $179.9 million. Land options and contingent purchase agreements covered land and lots with an aggregate purchase price of about $757.7 million. Other legal matters were reserved at $0.3 million; management said outcomes could differ from estimates.
- The mortgage warehouse facility was due to expire June 22, 2018; management expected to seek a one-year extension but gave no assurance it could obtain one. The company also expected to seek an extension of that facility in its liquidity discussion.
- ASC 606 was adopted January 1, 2018 using the modified retrospective method; management reported no material impact. Disclosure controls were assessed as effective, with no material change in internal control reported.
Important facts for investors to verify
- Whether backlog growth converts to closings and revenue, especially given regional differences and the seasonality of homebuilding.
- Whether housing margins stabilize as lot, labor and construction costs change, and how much purchase-accounting charges from Pinnacle affect 2018 results.
- Cash use, inventory investment, projected land spending and peak revolver borrowings, including the availability of borrowing-base capacity.
- Renewal of the mortgage warehouse facility before its June 2018 expiration and the status of the mortgage repurchase facility, due in October 2018.
- Changes in the stucco reserve, repair progress, litigation exposure and any potential insurance or subcontractor recoveries.
- Final purchase accounting for Pinnacle, performance of the Detroit operation and recoverability of the $16.4 million provisional goodwill balance.