M/I Homes, Inc. — Q1 2013 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the three months ended March 31, 2013, with comparisons to Q1 2012. M/I Homes builds single-family homes in the Midwest, Southern and Mid-Atlantic regions and provides mortgage and title services. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless stated otherwise.
Financial and operating results
- Revenue: $190.7 million, up 45% from $131.1 million. Home deliveries rose 24% to 627, and average selling price increased 14% to $284,000. Financial services revenue increased 95% to $8.4 million.
- Profitability: Gross margin was $38.3 million versus $23.7 million. Operating income was $9.2 million versus $0.2 million; pretax income was $4.9 million versus a $4.4 million loss. Net income was $4.6 million versus a $3.2 million loss. Net income attributable to common shareholders was $2.4 million, or $0.11 per diluted share, compared with a $3.2 million loss, or $0.17 per share, in Q1 2012.
- Expenses and interest: Selling, general and administrative expense rose to $29.1 million from $23.5 million, but fell to 15.3% of revenue from 17.9%. Interest expense declined to $4.3 million from $4.6 million.
- Cash flow and liquidity: Operating cash flow was positive $8.6 million, versus negative $7.7 million. Investing used $12.7 million; financing provided $121.7 million. Cash and cash equivalents were $263.1 million at quarter-end, plus $9.5 million restricted cash. The company reported net debt to net capital of 38%, versus 39% at year-end 2012.
- Debt and capital: The balance sheet reported $53.1 million of bank borrowings for financial services, $10.3 million of other notes payable, $57.5 million of 2017 convertible notes, $86.3 million of 2018 convertible notes, and $227.8 million carrying value of senior notes. The company issued $86.3 million of 3.0% convertible notes and 2.461 million common shares in March, generating combined net proceeds of $137.3 million. It redeemed half its Series A preferred shares for $50.4 million cash on April 10, after quarter-end.
- Homebuilding indicators: Net new contracts increased 37% to 1,047; backlog rose 48% to 1,385 homes, with backlog sales value up 60% to $401.2 million. Average community absorption improved to 2.6 from 2.1. The cancellation rate was 14.7%, versus 14.4%.
Material changes versus Q1 2012
- Results returned to profitability, with stronger revenue, gross margin and operating income. Management attributed improvement to more deliveries, higher selling prices, a more favorable mix and market improvement; higher construction costs partly offset gains.
- All three homebuilding regions improved operating income. Southern and Mid-Atlantic results also benefited from third-party land sale profits.
- Inventory increased to $577.6 million from $556.8 million at year-end 2012. Investment in unconsolidated LLCs rose to $22.3 million from $11.7 million, primarily reflecting a Southern-region land-development investment.
- Share issuance increased common shares outstanding; the preferred-share redemption generated a $2.2 million non-cash charge reducing income available to common shareholders for Q1.
Outlook, risks and unusual items
- Management said it expects the homebuilding industry to continue improving and plans to focus on profitable growth, selective market investment, balance-sheet strength and customer service. It estimated 2013 land purchases and development spending of $275 million to $325 million; this is spending guidance, not an earnings forecast.
- Management believed cash, borrowing options and expected operating receipts would be adequate for anticipated needs for at least 12 months. At March 31, the homebuilding credit facility had $46.3 million of net remaining availability; the company said it was in compliance with its financial covenants.
- The mortgage warehousing agreement was amended to provide up to $80 million of borrowing availability, with an optional increase of up to $20 million, and expires March 28, 2014. The filing identifies inability to renew or replace it as a risk to financial-services operations and home sales.
- Key sensitivities include home prices and absorption, construction and land costs, interest rates, mortgage availability, inventory valuation and the company’s ability to satisfy debt covenants. Management’s inventory projections assume gradual market improvement; impairments depend on estimates and could recur. Q1 inventory impairment was $0.9 million.
- The company maintained a full valuation allowance against deferred tax assets ($134.0 million at March 31), including federal and state tax-loss carryforwards; realization depends on future taxable income.
- Potential obligations include $65.9 million of completion bonds and standby letters of credit, $301.7 million of contingent land and lot purchase agreements, and guarantees relating to mortgage loans. The Chinese drywall settlement obligation was described as immaterial and paid; routine other legal matters remain subject to uncertainty.
- Preferred shares redeemed after quarter-end reduced cash by $50.4 million. The filing also notes that senior-note covenants restrict dividends, repurchases and certain investments.
Important facts for investors to verify
- Whether the substantial increase in contracts and backlog converts into closings and sustained earnings, particularly given the 14.7% cancellation rate and normal seasonality.
- Whether higher home prices and improved absorption can continue to offset rising labor, material and development costs.
- Liquidity and covenant headroom after the April preferred-share redemption, including borrowing-base availability and the March 2014 mortgage warehouse maturity.
- The assumptions supporting inventory and unconsolidated-LLC valuations, the potential for further impairments, and the ability to use deferred tax assets.
- The effect of the equity and convertible-note issuances on dilution, leverage, debt service and future capital allocation.