M/I Homes, Inc. — Q2 2014 Form 10-Q
Business context and period. M/I Homes is a U.S. single-family homebuilder, with Midwest, Southern and Mid-Atlantic homebuilding regions and a mortgage and title services business. This unaudited quarterly report covers the three and six months ended June 30, 2014; balance-sheet figures are as of June 30, 2014, compared with December 31, 2013.
Financial and operating results
Amounts are in millions except per-share data. Comparisons are with the corresponding 2013 period.
| Metric | Q2 2014 | Q2 2013 | First half 2014 | First half 2013 |
|---|---|---|---|---|
| Revenue | $281.6 | $234.6 | $516.4 | $425.3 |
| Gross margin | $59.6 (21.2%) | $46.2 | $110.5 (21.4%) | $84.5 |
| Operating income | $18.1 | $11.8 | $34.6 | $21.0 |
| Income before taxes | $15.3 | $7.4 | $27.8 | $12.3 |
| Net income | $13.6 | $7.3 | $26.2 | $11.9 |
| Net income to common shareholders | $12.3 | $6.0 | $23.7 | $8.4 |
| Diluted EPS | $0.44 | $0.25 | $0.85 | $0.36 |
- Homebuilding drove growth: Q2 deliveries rose 13% to 894 and average delivered home price increased 9% to $306,000. First-half deliveries rose 15% to 1,631 and average price rose 7% to $303,000. Home-delivery revenue was $273.4 million in Q2 and $494.1 million for the first half.
- Management reported first-half gross and operating margins of 21.5% and 6.7%, respectively, its highest year-to-date levels since 2006. Higher prices, deliveries and improved product/community mix contributed; higher land, labor and construction costs partly offset gains.
- Financial services revenue declined 11% in Q2 to $6.5 million and 8% in the first half to $14.3 million. Management attributed the decline mainly to lower mortgage-sale margins, a less favorable loan mix and weaker refinancing conditions.
- Operating cash flow was negative $66.7 million for the first half, versus negative $25.2 million a year earlier, mainly reflecting increased inventory investment. Investing cash outflow was $9.2 million; financing cash outflow was $19.2 million. Cash and cash equivalents fell $95.1 million to $33.6 million; cash including restricted cash was $43.7 million.
- Total liabilities were $606.6 million and shareholders’ equity was $520.1 million. Debt shown on the balance sheet totaled approximately $441.7 million, including financial-services bank borrowings; net debt to net capital was 43%, versus 39% at year-end 2013.
- The $200 million homebuilding revolving facility had no borrowings and $182.8 million net availability after letters of credit. Financial-services facilities had $61.9 million outstanding and $0.8 million available at period-end. The company reported compliance with applicable debt covenants.
Material changes and management commentary
- Revenue rose 20% in Q2 and 21% for the first half; first-half operating income increased to $34.6 million from $21.0 million. Growth reflected more homes delivered and higher average prices, with the Southern region a major contributor.
- New contracts declined 6% in both Q2 and the first half. At June 30, backlog was 1,647 homes, down 2% year over year, although its aggregate sales value rose to $546.2 million from $490.8 million and average backlog price rose 13% to $332,000. First-half absorption declined to 2.2 homes per community from 2.6.
- Management cited higher mortgage rates, affordability pressure, uneven economic and job growth, lower government-backed loan limits, harsh winter weather, delayed community openings and lower traffic as factors affecting demand. It expects housing conditions to remain positive but new-contract growth to be more moderate than in 2013.
- The company spent $176.8 million on land purchases and development in the first half and estimated 2014 spending of $425 million to $475 million. Management expects cash outlays to exceed operating cash generation in 2014 and anticipates using the revolving facility, with peak borrowings not expected to exceed $100 million. It stated available resources should cover anticipated needs for at least 12 months.
Outlook, risks and unusual items
- Management expects positive year-over-year financial comparisons through the rest of 2014, but cautioned that improvement may not continue at the recent rate. Demand depends on community openings, traffic, employment and consumer confidence, mortgage rates and underwriting standards.
- The effective tax rate was unusually low: the first-half provision was $1.6 million, including a $9.3 million benefit from reversing the remaining state deferred-tax-asset valuation allowance. The benefit increased reported earnings and is not indicative of management’s expected tax rate; it estimated approximately 39.2% for the remainder of 2014, subject to stated assumptions.
- Q2 and first-half impairment charges were $0.8 million, compared with $1.2 million and $2.1 million, respectively, in 2013. Inventory valuation depends on estimates of selling prices, costs, absorption and discount rates; management warned changed market conditions or assumptions could require further impairment.
- Other exposures include $441.4 million of contingent land and lot purchase agreements, $110.2 million of completion bonds and standby letters of credit, mortgage-loan repurchase/indemnification guarantees, and ordinary-course legal matters. Management did not expect the legal matters to have a material overall effect, but acknowledged outcomes could differ from recorded estimates.
- Debt includes $230.0 million principal of 8.625% senior notes due 2018 and convertible subordinated notes due 2017 and 2018. The 2018 senior-note indenture limits dividends and share repurchases; the Series A preferred shares carry a 9.75% stated dividend rate when declared.
Most important facts for investors to verify
- Whether new-contract trends, absorption, cancellations and backlog develop as expected, particularly in the Southern and Mid-Atlantic regions.
- Whether the planned $425–$475 million land investment and expected revolver use remain consistent with cash generation, liquidity and covenant headroom.
- How much reported earnings depended on the $9.3 million state tax valuation-allowance reversal, and whether tax assets are ultimately realized.
- Whether home prices and margins can offset rising land, materials and labor costs, and whether mortgage-financing competition continues to pressure financial-services margins.
- Whether inventory assumptions, land commitments, guarantees, bonds and legal contingencies result in additional costs or cash requirements.