Business Context and Reporting Period
Company: M/I Homes, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2006
Business Overview: M/I Homes is a leading single-family homebuilder operating in Ohio, Indiana, Florida, North Carolina, Delaware, and the Washington, D.C. suburbs. The company operates two primary segments: Homebuilding (land acquisition, development, and home construction) and Financial Services (mortgage origination and title services).
Key Financial Metrics
| Metric (in thousands, except per share) | Q1 2006 | Q1 2005 |
|---|---|---|
| Revenue | $259,055 | $241,399 |
| Net Income | $16,378 | $16,746 |
| Earnings Per Share (Diluted) | $1.14 | $1.16 |
| Operating Cash Flow | $(97,405) | $(3,804) |
| Total Assets | $1,420,373 | $1,329,678 |
| Total Liabilities | $823,220 | $737,110 |
| Shareholders' Equity | $597,153 | $592,568 |
| Debt (Notes Payable & Senior Notes) | $609,965 | $504,465 |
| Cash and Cash Equivalents | $10,283 | $25,085 |
Margins: Total gross margin was 27.3% (up from 25.2% in Q1 2005). Total operating margin was 11.4% (down from 12.1% in Q1 2005). The effective tax rate was 38.0%.
Material Changes vs. Prior Period
- Revenue Growth: Revenue increased 7.3% year-over-year, driven by a 7% increase in homes delivered (832 vs. 775) and a 7% increase in average sales price ($298,000 vs. $278,000). This was partially offset by an 81% decline in land sales revenue to third parties.
- Profitability Decline: Net income decreased 2.2% despite higher revenue. Income before taxes dropped 4% due to significant increases in Selling, General, and Administrative (SG&A) expenses and interest costs.
- Expense Increases:
- SG&A: Increased by $5.7 million. Drivers included $1.1M in higher land taxes/fees, $1.8M in personnel/infrastructure costs, $0.9M in stock-based compensation (due to new SFAS 123(R) adoption), and $0.9M in amortization related to the Shamrock Homes acquisition.
- Selling Expenses: Increased $4.0 million due to higher advertising, model home spending, and realtor co-op participation.
- Interest Expense: Doubled from $1.9 million to $3.2 million due to higher borrowing levels and interest rates.
- Cash Flow: Operating cash flow turned significantly negative ($97.4M outflow) compared to a minor outflow in 2005, primarily due to a $148.4M increase in inventory (land purchases) and payment of prior year incentive compensation.
- Backlog: Backlog increased 4% in units to 3,112 homes, with an 18% increase in aggregate sales value to $1.1 billion.
Guidance, Outlook, and Risks
- Outlook: Management estimates approximately 4,750 homes will be delivered in 2006, with the second half expected to be substantially higher than the first half. The company plans to purchase approximately $200 million of land in 2006.
- Market Conditions: New contracts increased 5% in Q1 but declined 22% in March compared to the prior year. Cancellation rates rose to 24.9% (from 18.6% in 2005) due to increased inventory and competitor discounting, particularly in the Midwest and Washington, D.C. markets.
- Financial Services: Mortgage capture rate declined to 76% (from 82%) due to increased competition and lower refinance volume. Management expects continued downward pressure on capture rates and margins.
- Accounting Changes: The company adopted SFAS 123(R) on Jan 1, 2006, resulting in $0.9 million of stock-based compensation expense for the quarter.
- Risks:
- Interest Rates: Higher rates could reduce affordability and demand.
- Competition: Increased competition from resale markets and other builders is driving discounting and cancellations.
- Land Availability: Dependence on acquiring suitable land at favorable prices.
- Regional Exposure: Significant operations in Florida and North Carolina expose the company to natural disaster risks (hurricanes).
Investor Verification Checklist
- Inventory Valuation: Verify the $1.23 billion inventory balance, specifically the $862 million in land and land development costs, given the high cancellation rates and potential for impairment in soft markets.
- Debt Covenants: Confirm compliance with the $735 million Credit Facility covenants, particularly tangible net worth requirements, given the increased leverage.
- Backlog Quality: Assess the stability of the $1.1 billion backlog in light of the 24.9% cancellation rate and competitive discounting in key markets (DC, Florida, Midwest).
- Stock-Based Compensation: Review the impact of the new SFAS 123(R) standard on future earnings, noting $12.4 million of unrecognized expense remaining.
- Off-Balance Sheet Exposure: Evaluate the $176.4 million in letters of credit and completion bonds, and the $50.7 million investment in unconsolidated LLCs.