M/I Homes, Inc. (NYSE: MHO) — 2012 Form 10-K
Reporting period: Fiscal year ended December 31, 2012. The filing also reports fourth-quarter results; it is an annual report, not a standalone quarterly filing.
Business context and reporting period
M/I Homes builds and sells single-family homes, townhomes and condominiums, primarily in the Midwest, Southern and Mid-Atlantic regions. Its financial services business originates mortgages and provides title services, largely for its homebuyers. Homebuilding accounted for 97% of consolidated revenue. At year-end, the company operated in 11 markets across nine states, with 131 active communities; it entered Austin, Texas, in October 2012 and planned its first community there for 2013.
Financial and operating metrics
| Metric | 2012 | 2011 |
|---|---|---|
| Revenue | $761.9 million | $566.4 million |
| Gross margin | $147.9 million (19.4% of revenue) | $77.3 million (13.6% of revenue) |
| Operating income (loss) | $28.8 million | $(18.9) million |
| Net income (loss) | $13.3 million; diluted EPS $0.67 | $(33.9) million; diluted EPS $(1.81) |
| Cash from operating activities | $(47.0) million | $(34.0) million |
| Cash from investing activities | $25.3 million | $(9.3) million |
| Cash from financing activities | $107.4 million | $21.9 million |
| Unrestricted cash at year-end | $145.5 million | $59.8 million |
| Inventory | $556.8 million | $466.8 million |
| Shareholders’ equity | $335.4 million | $273.4 million |
Homes delivered rose 21% to 2,765, and average delivered price increased 9% to approximately $264,000. Net new contracts increased 27% to 3,020. Year-end backlog rose 43% to 965 homes, with an aggregate sales value of $282.5 million, up 56%. Total revenue increased 35%; home-delivery revenue rose 32%, while financial services revenue increased 62% to $23.3 million.
Gross margin improvement reflected higher prices and deliveries, fewer impairment charges, and a more favorable community and geographic mix. Selling, general and administrative expenses increased in dollars but declined to 15.6% of revenue from 17.0%. Impairment charges on inventory and unconsolidated investments were $3.5 million, down from $22.0 million. The company also reported a $3.0 million recovery related to defective drywall and increased land-sale profit.
Operating cash use increased year over year, principally as inventory grew amid higher land and development spending. Land purchases and development totaled $195.2 million in 2012. Financing cash flow benefited from debt and equity issuance. The filing reports $296.3 million of indebtedness excluding financial-services warehouse and repurchase facilities; the balance sheet separately shows $68.0 million of financial-services bank debt, $11.1 million of other notes, $57.5 million of convertible notes and $227.7 million of senior notes, net of discount.
At December 31, 2012, the company had $154.2 million of cash, cash equivalents and restricted cash, including $8.7 million restricted. The homebuilding revolver had no borrowings, with $47.3 million of net availability after outstanding letters of credit. Net debt to net capital was 39%, compared with 42% in 2011. The company reported compliance with its credit-facility covenants.
Fourth-quarter 2012 revenue was $250.9 million and net income was $5.0 million, compared with revenue of $176.8 million and a net loss of $3.0 million in fourth-quarter 2011. Fourth-quarter gross margin was $47.6 million.
Material changes versus the prior comparable period
- The company returned to annual profitability after losses in 2011 and 2010. All three homebuilding regions reported operating income in 2012; Midwest and Southern moved from operating losses to profits.
- Southern operations expanded with the April 2012 acquisition of a privately held Houston builder’s assets and entry into Austin. The company opened 46 communities and closed 37 legacy communities.
- Controlled lots increased 37% to 14,203. New communities represented more than 77% of active communities and generated average gross margins about 460 basis points above legacy communities.
- Debt and equity transactions strengthened liquidity: the company issued $57.5 million of 3.25% convertible notes and 2.53 million common shares in September, raising combined net proceeds of $99.6 million; it also issued $30 million of additional 2018 senior notes and repaid $41.4 million of 2012 senior notes at maturity.
- Inventory impairments declined materially, but inventory and land investment increased as management positioned for growth.
Outlook, risks and unusual items
Management expected gradual housing-market improvement and said it believed 2013 leverage and profitability would improve, while cautioning that trends were not assured. It planned approximately $195 million for land purchases and $112 million for land development in 2013; elsewhere, it estimated total land purchases and development spending of $250 million to $300 million, reflecting differing presentation of the plan. Management expected the year-end community count to increase by more than 25% during 2013 and continued to prioritize profitable growth, new markets, balance-sheet strength, customer service and product design.
- Liquidity and refinancing: M/I Financial’s $70 million mortgage warehouse agreement was due to expire March 30, 2013; failure to renew or replace it could constrain mortgage operations. Its separate $15 million repurchase facility was due to expire in November 2013.
- Housing and execution risks: Results remain sensitive to mortgage availability and rates, employment and buyer confidence, home prices, cancellations, competition, land values, construction costs, labor and materials availability, and weather. A downturn could cause further inventory impairments.
- Debt and capital structure: The company had $230 million principal amount of 8.625% senior notes due 2018 and $57.5 million of 3.25% convertible subordinated notes due 2017. The convertible notes may convert at an initial price of about $23.80 per share and include a holder repurchase right upon a defined fundamental change. Debt covenants restrict certain actions, including dividends and share repurchases.
- Tax assets: A full valuation allowance of $135.7 million remained against deferred tax assets. Federal NOL carryforwards were approximately $82.3 million; their use depends on future taxable income and could be limited by an ownership change.
- Defective drywall: The company identified 93 affected Florida homes and had repaired 90; three homeowners had not authorized repairs. It had accrued approximately $13.0 million for repairs and received a $3.0 million settlement in 2012. Separately, the company stated that no accrual was recorded for the related litigation because it could not assess the probability or estimate a loss; outcomes could be material.
- Other contingencies: Warranty reserves were $10.4 million. Mortgage-loan sale representations, repurchase obligations, land-development guarantees, completion bonds and letters of credit create additional potential exposure. Outstanding completion bonds and standby letters of credit totaled $61.8 million.
- Regulation: New CFPB mortgage rules were scheduled to take effect January 10, 2014 and could make financing more difficult for some buyers.
The independent auditor issued an unqualified opinion on the financial statements and on internal control over financial reporting. Management also concluded disclosure controls were effective at year-end.
Important facts for investors to verify
- Whether M/I Financial renewed or replaced the warehouse facility that was due to mature in March 2013, and the resulting borrowing capacity and cost.
- Whether planned 2013 land spending and community growth translated into profitable deliveries, cash generation and sustainable margins.
- How much of 2012 earnings depended on lower impairment charges, land-sale profit and the drywall settlement, and whether operating cash flow improves as inventory turns.
- The status and potential financial exposure of drywall-related claims, including any amounts beyond the repair accrual and recoveries from insurers or other parties.
- Debt covenant headroom, near-term financial-services borrowings, and the impact of convertible-note dilution or repurchase rights.
- Whether future taxable income supports realization of NOLs and deferred tax assets, and whether ownership changes could restrict their use.