M/I Homes, Inc. — Q3 2014 Form 10-Q
Business context and period: Homebuilder and mortgage/title services provider operating across Midwest, Southern and Mid-Atlantic regions. This unaudited filing covers the quarter and nine months ended September 30, 2014; comparisons are with the corresponding 2013 periods. Dollars are in millions unless stated otherwise.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $330.8 | $275.2 | $847.2 | $700.5 |
| Gross margin | $68.5; 20.7% | $54.9; 19.9% | $179.0; 21.1% | $139.4; 19.9% |
| Operating income | $24.8 | $18.6 | $59.5 | $39.7 |
| Income before taxes | $22.2 | $13.8 | $50.0 | $26.0 |
| Net income | $13.6 | $125.3 | $39.8 | $137.2 |
| Net income to common shareholders | $12.4 | $124.1 | $36.1 | $132.5 |
| Diluted EPS | $0.44 | $4.22 | $1.30 | $4.79 |
| Operating cash flow | Not separately provided for quarter | Not separately provided for quarter | $(106.7) | $(40.4) |
- Revenue grew 20.2% in Q3 and 20.9% year to date. Home deliveries were 985 in Q3, up 5%, and 2,616 year to date, up 11%. Average selling price rose 13% in Q3 and 9% year to date, to $320,000 and $309,000, respectively.
- Q3 net income fell sharply from 2013 because the prior-year period included a $111.6 million deferred-tax valuation-allowance reversal. The 2014 nine-month result included a $9.3 million tax benefit from reversal of the remaining state allowance; management identified $30.5 million of nine-month earnings, or $0.99 per diluted share, as core profitability. The prior-year comparison also included a $1.7 million debt-extinguishment loss in 2013.
- YTD operating margin was 7.0%, which management described as the highest year-to-date level since 2006. Selling, general and administrative expense was 13.2% of revenue in Q3 and 14.1% year to date.
- Cash, cash equivalents and restricted cash totaled $26.1 million at September 30, including $17.2 million unrestricted, down from $142.6 million combined at year-end 2013. Inventory rose to $894.0 million from $690.9 million. The company attributed cash consumption mainly to increased inventory investment.
- Total debt was approximately $468.8 million, versus $459.6 million at year-end 2013; net debt was approximately $442.8 million after cash and restricted cash. Net debt to net capital increased to 45% from 39%. Total liabilities were $659.9 million and shareholders’ equity was $533.3 million.
Changes, operating indicators and liquidity
- Q3 new contracts increased 3% to 892; YTD contracts declined 3% to 2,890. Backlog was 1,554 homes, down 3% year over year, though its aggregate sales value rose 6% to $518.1 million and average backlog price increased 10% to $333,000. YTD absorption declined to 2.1 homes per community from 2.4.
- Regional performance was mixed. Midwest and Southern operating income improved; Mid-Atlantic Q3 operating income declined to $6.5 million from $8.4 million. Management cited delayed community openings, weather, competition and slower market improvement as factors affecting contracts and absorption.
- At September 30, the homebuilding revolver had $14.4 million drawn and $166.0 million of net remaining availability. On October 20, after quarter-end, the facility was amended: commitment increased from $200 million to $300 million, maturity extended to October 2028, and initial borrowing margins were reduced. The amendment also raised the letter-of-credit sublimit to $125 million and added/modified covenants.
- Management expected fourth-quarter 2014 cash outlays for land, development, construction and operating costs to exceed operating cash generation, and expected to use the revolver; estimated peak fourth-quarter borrowing was not expected to exceed $100 million. It forecast $375–$425 million of total 2014 land purchases and development, including $276.9 million spent through September.
- Management said available cash and credit capacity should fund anticipated needs for at least 12 months. The mortgage repurchase facility was due to expire November 5, 2014; an extension was expected but not assured. The amended primary revolver and mortgage facilities have financial and other covenants.
Outlook, risks and contingencies
- Management expected moderate housing-market improvement but cautioned that the pace of improvement in financial results may not continue. Results depend on community openings, traffic, job growth, consumer confidence, mortgage underwriting and interest rates. It provided no specific earnings or revenue guidance.
- Higher land, construction, labor and material costs may pressure margins if the company cannot pass them through in prices. Higher mortgage rates could also affect affordability and demand. Management said increased competition and a challenging pricing environment in mortgage lending could persist.
- Land purchase options and contingent agreements represented approximately $475.6 million of potential purchases. Outstanding completion bonds and standby letters of credit totaled about $123.6 million. Legal matters were described as ordinary-course; management did not expect a material overall effect, but acknowledged resolution costs could differ from reserves and materially affect income in the period resolved.
- Mortgage loan repurchase guarantees covered about $45.1 million of loans at September 30; no loans were repurchased under these guarantees during the first nine months. A separate $2.4 million liability was recorded for guarantees to government-related insurers.
- Inventory impairment charges were $0.6 million in Q3 and $1.4 million year to date. Management’s valuations rely on estimates of selling prices, costs, absorption and discount rates; changed market conditions could lead to additional impairments.
Important facts for investors to verify
- Underlying earnings excluding the $9.3 million state tax benefit, and comparability with 2013’s much larger tax-allowance reversal.
- Cash use, inventory growth and planned land spending relative to deliveries, new contracts, backlog and absorption.
- Availability and covenant compliance under the October 2014 amended revolver, and whether the mortgage repurchase facility was extended.
- Whether higher selling prices and improved gross margins can offset rising build costs and regional weakness.
- Potential exposure from land options, completion guarantees, mortgage repurchase obligations, warranty reserves and litigation.