M annual report, FY2018

Full document

M/I Homes, Inc. (NYSE: MHO) — 2018 Form 10-K Summary

Business context and reporting period

This annual report covers the fiscal year ended December 31, 2018; it is not a standalone fourth-quarter filing. M/I Homes builds and sells single-family homes and townhomes across 16 markets in 10 states, with homebuilding generating 98% of 2018 revenue. Its mortgage and title operations support home sales.

Financial and operating performance

  • Revenue: $2.286 billion, up 17% from $1.962 billion in 2017. Housing revenue was $2.217 billion; land-sale revenue was $16.9 million; financial-services revenue was $52.2 million.
  • Profit: Income before taxes was $141.3 million, up 17%; net income was $107.7 million versus $72.1 million. Diluted EPS was $3.70 versus $2.26. Adjusted net income available to common shareholders, a non-GAAP measure, was $117.3 million versus $85.3 million.
  • Fourth quarter: Revenue was $722.5 million and net income available to common shareholders was $32.4 million; diluted EPS was $1.15. The comparable 2017 quarter reported revenue of $621.7 million, common net income of $15.9 million, and diluted EPS of $0.53.
  • Margins and expenses: Housing gross margin was 17.6%, down from 18.1%; management attributed pressure to higher construction and lot costs and product mix. SG&A was $280.6 million, or 12.3% of revenue, versus 13.0%. The filing’s non-GAAP housing-margin disclosures are inconsistent: narrative discussion gives adjusted margin of 18.1%, while the reconciliation table labels it 17.8%.
  • Cash flow and liquidity: Operating cash use was $2.6 million, compared with $53.2 million used in 2017; investing cash use was $134.0 million, including the Pinnacle acquisition; financing provided $6.4 million. Year-end cash, cash equivalents and restricted cash were $21.5 million, including $20.9 million unrestricted, down $129.9 million in unrestricted cash year over year. The company said available cash and credit were expected to cover anticipated needs for at least 12 months.
  • Debt: Homebuilding debt was approximately $667.8 million, excluding financial-services borrowings; mortgage warehouse and repurchase borrowings totaled $153.2 million. The $500 million revolving credit facility had $329.9 million available at year-end. The company reported compliance with debt covenants. Senior notes include $300 million at 6.75% due 2021 and $250 million at 5.625% due 2025.
  • Operating indicators: New contracts rose 10% to a record 5,845; deliveries rose 14% to a record 5,778. Average delivered home price increased 4% to $384,000. Year-end backlog rose 9% to 2,194 homes, with aggregate value up 13% to $896.7 million. Cancellation rate increased to 14.6% from 13.8%.

Material changes versus prior year

  • Revenue and deliveries reached company records. Midwest and Southern revenue grew 26% and 27%, respectively; Mid-Atlantic revenue declined 14%, partly due to delayed community openings following hurricanes and heavy rainfall.
  • Southern operating income increased to $72.6 million from $36.8 million, while Mid-Atlantic operating income fell to $23.3 million from $35.6 million. Midwest operating income rose to $86.1 million from $81.5 million.
  • The company acquired Detroit-area builder Pinnacle Homes for $101.0 million in March 2018, adding $16.4 million of goodwill. The acquisition contributed $5.1 million of purchase-accounting charges and $1.7 million of acquisition and integration costs.
  • Homebuilding debt increased from no year-end revolving-facility borrowings in 2017 to $117.4 million in 2018. Cash declined substantially, reflecting land and construction investment, the acquisition, debt repayment and share repurchases.
  • The effective tax rate fell to 23.8% from 40.1%, mainly following the reduction in the federal corporate tax rate under the 2017 Tax Act. The 2017 rate included a $6.5 million non-cash deferred-tax remeasurement charge.

Outlook, risks and unusual items

  • Management reported softer housing demand in the second half of 2018, which it attributed to higher mortgage rates and home prices affecting affordability. It cited employment, wage growth, consumer confidence and constrained housing supply as supportive factors.
  • For 2019, management planned to expand in existing markets, increase availability of more affordable Smart Series homes, evaluate new-market opportunities and maintain a strong balance sheet. It estimated 2019 land purchases and development spending of $575 million to $600 million and expected average community count to increase approximately 5%. These are operating plans, not earnings guidance; the company cautioned that prior positive trends may not continue.
  • Florida stucco claims remain a significant contingency. The company recorded $28.4 million of stucco-related charges during 2015–2017; the 2018 fourth-quarter additional $1.0 million charge was offset by $1.0 million of insurance recoveries. The year-end reserve was $6.3 million. Repair estimates remain subject to uncertainty and claims are ongoing.
  • Key risks include rising interest rates and affordability pressures, competition, higher labor and material costs, land and inventory valuation risk, weather and permitting delays, warranty and legal claims, and access to mortgage-loan buyers and financing. The mortgage warehousing facility was due to expire June 21, 2019; management expected to extend it but gave no assurance.
  • The company adopted ASC 606 in 2018 with no material financial-statement impact. Adoption of the lease standard in 2019 was expected to add $18 million to $23 million of operating lease liabilities and corresponding right-of-use assets.
  • Deloitte issued unqualified opinions on the financial statements and internal controls; management also concluded disclosure controls and internal control over financial reporting were effective at year-end.

Most important facts for investors to verify

  • Reconcile the adjusted housing gross margin percentage: the narrative reports 18.1%, but the reconciliation table reports 17.8%.
  • Track sales pace, cancellations, backlog conversion and affordability trends after the second-half demand slowdown.
  • Assess whether projected 2019 land spending and community growth can be funded while preserving liquidity and covenant headroom.
  • Monitor renewal or replacement of the mortgage warehouse facility and the company’s floating-rate borrowing exposure.
  • Review developments in Florida stucco claims, repair costs, insurance recoveries and adequacy of the $6.3 million reserve.
  • Evaluate whether labor, materials and lot-cost inflation continues to pressure housing margins, particularly in the Mid-Atlantic region.