MHO

Business Context and Reporting Period

Company: M/I Homes, Inc. (M/I Homes)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2008
Industry: Residential Homebuilding and Financial Services

M/I Homes is a leading builder of single-family homes, townhomes, and condominiums operating in nine markets across the Midwest, Florida, and Mid-Atlantic regions. The company also operates a financial services segment providing mortgage, title, and insurance brokerage services. The 2008 fiscal year was characterized by an unprecedented economic downturn, severe credit market turmoil, and a significant decline in consumer confidence, leading to a strategic shift toward a defensive posture focused on liquidity preservation and cost reduction.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Total revenue decreased 40% to $607.7 million, driven by a 36% drop in homes delivered and a 7% decrease in average sales price.
• Significant Losses: The company reported a net loss of $245.4 million, compared to a loss of $128.1 million in 2007. This was primarily due to a $158.6 million charge for inventory and investment impairments and a $108.6 million non-cash valuation allowance on deferred tax assets.
• Inventory Write-downs: Impairment charges totaled $158.6 million in 2008 (up from $152.0 million in 2007), reflecting the inability to recover land costs in declining markets.
• Backlog Contraction: Year-end backlog fell 21% in value to $139 million, with average backlog sales prices dropping from $308,000 in 2007 to $247,000 in 2008.
• Discontinued Operations: The West Palm Beach, Florida division was sold in late 2007; its results are reported as discontinued operations.

Guidance, Outlook, and Risks

Management Commentary: Management maintains a defensive strategy focused on generating cash and preserving liquidity. Key initiatives include curtailing land purchases, transitioning to finished lots, reducing production volumes, and cutting overhead expenses. The company anticipates minimal investment in new land parcels in the near term.

Outlook: Visibility on future earnings is limited due to weak market conditions. Management expects a gradual improvement in market conditions beginning in 2010 but warns that further deterioration could necessitate additional impairment charges.

Key Risks and Contingencies:

• Liquidity and Covenants: The company is restricted from paying dividends or repurchasing shares due to a negative "consolidated restricted payments basket" of ($146.8) million under its senior notes indenture. Compliance with the Credit Facility's minimum tangible net worth covenant is critical; failure could trigger a default.
• Inventory Impairment: Continued market weakness may require further valuation adjustments to land and inventory, which could be significant.
• Financing: The financial services credit agreement expires in May 2009. The company must secure replacement financing to continue mortgage origination activities.
• Regulatory: A proposed HUD rule change regarding affiliated business arrangements could negatively impact operations if implemented.

Investor Verification Checklist

• Covenant Compliance: Verify the company's continued compliance with the "Minimum Tangible Net Worth" and leverage ratio covenants in its Credit Facility, as a breach could accelerate debt.
• Inventory Valuation: Assess the assumptions used for inventory impairment testing (discount rates, sales pace, pricing) given the high degree of judgment involved and the risk of future write-downs.
• Deferred Tax Assets: Confirm the realizability of deferred tax assets and the potential for future adjustments to the $108.6 million valuation allowance.
• Financing Renewal: Monitor the status of the M/I Financial credit agreement renewal prior to its May 2009 expiration.
• Backlog Quality: Analyze the cancellation rate (27% in 2008) and the pricing of homes in backlog to gauge future revenue realization.