Business Context and Reporting Period
Company: M/I Homes, Inc. (M/I Homes)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2007
Industry: Residential Homebuilding and Financial Services
M/I Homes is a leading builder of single-family homes, townhomes, and condominiums operating in the Midwest, Florida, and Mid-Atlantic regions. The company also provides mortgage financing, title, and insurance brokerage services through its financial services segment. In late 2007, the company announced its exit from the West Palm Beach, Florida market, classifying those operations as discontinued. The company also announced plans to enter the Chicago market in 2008.
Key Financial Metrics
| Metric | 2007 | 2006 |
|---|---|---|
| Total Revenue | $1,016.5 million | $1,274.1 million |
| Homes Delivered | 3,173 | 3,901 |
| Average Sales Price | $296,000 | $308,000 |
| Gross Margin | $35.5 million (3.5%) | $247.7 million (19.4%) |
| Net Loss from Continuing Operations | ($92.5 million) | $29.3 million |
| Net Loss (Including Discontinued Ops) | ($128.1 million) | $38.9 million |
| Backlog (Units) | 712 | 1,433 |
| Backlog (Sales Value) | $220 million | $484 million |
| Total Assets | $1,117.6 million | $1,477.1 million |
| Inventory | $797.3 million | $1,092.7 million |
| Debt (Notes & Mortgages Payable) | $162.1 million | $446.8 million |
| Senior Notes | $198.9 million | $198.7 million |
| Cash from Operating Activities | $202.2 million | ($104.0 million) |
Material Changes vs. Prior Period
- Revenue Decline: Total revenue decreased 20% to $1.0 billion, driven by a 19% drop in homes delivered and a 4% decrease in average sales price. Housing revenue fell from $1.2 billion to $939.5 million.
- Significant Impairment Charges: The company recorded $148.4 million in impairment charges related to inventory and investments in unconsolidated LLCs on continuing operations. An additional $58.9 million in impairments was recorded for the discontinued West Palm Beach operation.
- Margin Compression: Gross margin percentage collapsed from 19.4% in 2006 to 3.5% in 2007. Excluding impairment charges, the gross margin was 18.1% in 2007 compared to 24.7% in 2006.
- Backlog Reduction: Year-end backlog dropped 50% in units and 54% in sales value compared to 2006, reflecting reduced demand and higher cancellation rates.
- Debt Reduction: The company reduced its homebuilding net debt to capital ratio from 44% to 33% by issuing $100 million in preferred shares and utilizing cash from operations to pay down $284.5 million in revolving credit facility borrowings.
- Discontinued Operations: The West Palm Beach division was sold, resulting in a net loss of $35.6 million for the period, primarily due to inventory impairments.
Guidance, Outlook, and Risks
Management Outlook:
- 2008 Deliveries: Management estimates approximately 2,500 homes will be delivered in 2008 (50% Midwest, 20% Florida, 30% Mid-Atlantic).
- Cash Flow: The company expects to generate positive cash flow in 2008 and plans to completely pay off the debt under its homebuilding credit facility by the end of 2008.
- Market Recovery: Management generally assumes a gradual improvement in market conditions beginning in 2009 or 2010.
Key Risks and Contingencies:
- Inventory Impairment: Continued deterioration in market conditions could necessitate additional valuation adjustments and impairment charges, which would negatively impact earnings.
- Financing Covenants: The company must maintain specific interest coverage ratios and tangible net worth levels under its Credit Facility. While currently compliant, further impairments could trigger covenant violations.
- Deferred Tax Assets: The company holds $67.9 million in net deferred tax assets. If future taxable income is insufficient to realize these assets, a valuation allowance may be required, increasing tax expense.
- Joint Venture Default: One unconsolidated joint venture is in default on its loan agreement. Failure to renegotiate could result in a write-off of the company's $3.3 million investment.
Investor Verification Checklist
- Inventory Valuation: Verify the assumptions used for the $148.4 million impairment charge and assess the risk of further write-downs given the 50% drop in backlog.
- Covenant Compliance: Monitor the company's ability to meet the interest coverage ratio and tangible net worth covenants under the Credit Facility, especially if additional impairments occur.
- Deferred Tax Realization: Confirm the company's ability to generate sufficient taxable income in 2008 to utilize the $67.9 million deferred tax asset and avoid a valuation allowance.
- Land Inventory Strategy: Review the progress of land sales and the reduction of owned inventory, which was a primary driver of the positive operating cash flow in 2007.
- Discontinued Operations: Ensure the West Palm Beach exit is fully accounted for and that no residual liabilities remain from the sale.