M annual report, FY2016

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M/I Homes, Inc. (NYSE: MHO) — FY 2016 Form 10-K

Business context and reporting period. The filing covers the fiscal year ended December 31, 2016; quarterly figures below refer to the three months ended December 31, 2016. M/I Homes builds and sells single-family homes and townhomes across the Midwest, Southern and Mid-Atlantic regions, with a mortgage and title-services segment. Homebuilding generated 98% of consolidated revenue. At year-end, the company operated in 15 markets across nine states and had 178 active communities.

Financial and operating performance

  • Revenue and earnings: FY revenue was $1.691 billion, up 19% from $1.418 billion in 2015. Net income was $56.6 million versus $51.8 million; net income to common shareholders was $51.7 million, or $1.84 diluted EPS, versus $46.9 million, or $1.68. Pretax income increased 6% to $91.8 million.
  • Q4 results: Revenue was $523.2 million, compared with $468.9 million in Q4 2015. Gross margin was $104.6 million; net income to common shareholders was $19.3 million, or $0.67 diluted EPS. Q4 2016 included $4.0 million of inventory impairment charges.
  • Deliveries and backlog: Homes delivered rose 15% to 4,482; net new contracts increased 16% to a record 4,755. Average delivered price rose 4% to $359,000. Year-end backlog was 1,804 homes valued at $685.5 million, up 18% in units and 20% in value year over year; average backlog price was $380,000.
  • Margins and expenses: GAAP housing gross margin was 17.6%, down from 19.2%. Excluding stucco-related charges and impairments, adjusted housing gross margin was 19.0% versus 19.5% (company-reported non-GAAP measure). SG&A was 13.0% of revenue, improving from 13.3%.
  • Cash flow and liquidity: Operating cash flow was positive $34.2 million, compared with $82.4 million used in 2015. Investing activities used $31.6 million and financing activities provided $18.8 million. Year-end cash, cash equivalents and restricted cash totaled $34.4 million, including $33.4 million unrestricted cash. The company had $322.6 million available under its $400 million homebuilding revolver.
  • Debt and capital: Homebuilding debt to capital was 43%, down from 45%. Reported total indebtedness was approximately $484.9 million excluding mortgage warehouse and repurchase facilities; balance-sheet debt also included $152.9 million of financial-services borrowings. Debt includes $57.5 million of 3.25% convertible notes due September 2017, $86.3 million of 3.0% convertible notes due March 2018 and $300 million of 6.75% senior notes due 2021. No common dividends were paid; preferred dividends totaled $4.9 million.
  • Financial services: Revenue increased 17% to $42.0 million. Mortgage originations rose to 3,286 loans valued at $969.7 million; approximately 84% of homes delivered were financed through M/I Financial.

Material changes versus 2015

  • Sales, deliveries, revenue and backlog all reached company records, supported by greater volume, higher average selling prices and favorable demand in most markets.
  • Pretax income growth was limited by a $19.4 million charge for known and estimated future Florida stucco repairs, $4.0 million of inventory impairments, and lower land-sale profit. Management’s adjusted pretax income measure rose 21% to $111.1 million, excluding specified items.
  • Southern-region operating income fell to $20.4 million from $47.3 million, principally due to stucco and impairment charges and higher SG&A. Midwest and Mid-Atlantic operating income improved.
  • Inventory rose to $1.216 billion from $1.112 billion, reflecting investment in land, development and homes. The company controlled more than 23,000 lots, a 5.1-year supply based on 2016 deliveries.
  • Debt-to-capital improved, while operating cash flow returned to positive territory. Interest expense was essentially flat at $17.6 million.

Outlook, risks and unusual items

  • Management expected modest improvement in housing demand and new-home sales in 2017, despite forecast interest-rate increases. It targeted profitable growth, higher community counts, customer service and product quality, and maintaining a strong balance sheet; these expectations are not guarantees.
  • Planned 2017 land purchase and development spending was approximately $500–$550 million. Average active communities were expected to increase 5%–10% from the 2016 average of 176. The company anticipated continued revolver use and estimated peak 2017 homebuilding revolver borrowings would not exceed $200 million.
  • The $125 million mortgage warehouse agreement was due to expire June 23, 2017. Management expected an extension but provided no assurance it could secure one. The $57.5 million convertible notes mature in September 2017.
  • Stucco claims: Claims and litigation concern stucco installation in certain Tampa and Orlando communities. The company recorded a $19.4 million 2016 charge and had $11.9 million remaining in warranty reserves for known and estimated future repairs at year-end. The review continued; actual costs could exceed estimates, and no recovery from insurers or subcontractors was recorded.
  • Other key risks include housing-market and mortgage-rate shifts, construction labor and material shortages, land valuation and impairment, regulations, severe weather, warranty and legal claims, and access to capital. The company reported modest construction delays from labor or material shortages in 2015 and 2016.
  • The 2016 financial statements received an unqualified audit opinion, and management and the auditor reported effective internal control over financial reporting.

Investor verification priorities

  • Track stucco repair progress, the adequacy of the $11.9 million reserve, any additional claims, and potential recoveries.
  • Verify renewal or replacement of the mortgage warehouse facility before its June 2017 expiration and the plan to repay or convert 2017 notes.
  • Assess whether backlog converts to closings at planned prices and margins, and monitor cancellation rates, which were 14.4% overall in 2016.
  • Compare actual land spending and community growth with the $500–$550 million spending plan and 5%–10% community-count outlook.
  • Monitor margin pressure from construction and lot costs, impairments, cash use, revolver borrowings and compliance with debt covenants.
  • Review the company’s adjusted performance measures alongside GAAP results; adjusted housing margin and pretax income exclude specified charges and land-sale profits.