M/I Homes, Inc. and subsidiaries (the “Company” or “we”) is one of the nation’s leading builders of single-family homes. The Company was incorporated, through predecessor entities, in 1973 and commenced homebuilding activities in 1976. Since that time, the Company has sold and delivered nearly 76,000 homes. We sell and construct single-family homes, attached townhomes and condominiums to first-time, move-up, empty-nester and luxury buyers. In 2009, our average sales price of homes delivered was $231,000 compared to $274,000 in 2008. Weak conditions in the general economy combined with a severe recession in the housing industry have resulted in a decrease in the size of our operations during the last three years. During the year ended December 31, 2009, we delivered 2,409 homes with revenues of $569.9 million and a net loss of $62.1 million. At December 31, 2009, we had 650 homes in backlog with a sales value of $177 million compared to 566 homes with a sales value of $139 million at December 31, 2008.
Our homes are sold in the following geographic markets - Columbus and Cincinnati, Ohio; Indianapolis, Indiana; Chicago, Illinois; Tampa and Orlando, Florida; Charlotte and Raleigh, North Carolina; and the Virginia and Maryland suburbs of Washington, D.C. In late 2007, we exited the West Palm Beach, Florida market. Hence, the results of operations and financial position of this division have been reported as discontinued operation. We are the leading homebuilder in the Columbus, Ohio market, and we believe we are one of the top ten builders in each of our other markets, based on the number of homes delivered in 2009, with the exception of Chicago, which we entered in 2007.
We believe that we distinguish ourselves from competitors by offering homes in select areas with a high level of design and construction quality within a given price range, and by providing customers with the confidence they can only get from superior customer service. Offering homes at a variety of price points allows us to attract a wide range of buyers.
In addition, we support our homebuilding operations by providing mortgage financing services through our wholly-owned subsidiary, M/I Financial Corp. (“M/I Financial”), and title services through subsidiaries that are either wholly- or majority-owned by the Company.
Our financial reporting segments consist of the following: Midwest homebuilding, Florida homebuilding, Mid-Atlantic homebuilding, and financial services. Our homebuilding operations comprise the most substantial part of our business, representing 98% of consolidated revenue during 2009. Our homebuilding operations generated over 99% of their revenue from the sale of completed homes, with the remaining amount generated from the sale of land and lots. Our financial services operations generate revenue from originating and selling mortgages and collecting fees for title insurance and closing services. Financial information, including revenue, operating income and identifiable assets for each of our reporting segments, is included in Note 22 to our Consolidated Financial Statements.
Industry Overview and Current Market Conditions
Housing is, and for many years has been, a large and important part of the United States’ economy. Spending on new home construction and remodeling has averaged nearly 5% of the United States’ gross domestic product since the 1950’s. Over the same period, housing has averaged nearly 21% of gross domestic product when rents, furnishings and other housing related costs are included.
In any year, the demand for new homes is closely tied to job growth, the availability and cost of mortgage financing, the supply of new and existing homes for sale, and consumer confidence. Consumer confidence is perhaps the most important of these demand variables and is often the most difficult to predict because it is a function of, among other things, consumers’ views of their employment and income prospects, recent and anticipated future home price trends, localized new and existing home inventory, the level of current and near-term interest and mortgage rates, the availability of consumer credit, valuations in stock and bond markets, and other geopolitical factors. Moreover, because the purchase of a home represents many buyers’ largest single financial commitment, it is often also associated with significant emotional considerations.
The supply of new homes within specific geographic markets consists of both new homes built pursuant to pre-sale arrangements and speculative homes built by home builders prior to their sale. The ratio of pre-sold to speculativehomes differs both by geographic market and over time within individual markets based on a wide variety of factors, including the availability of land and lots, access to construction financing, the availability and cost of construction labor and materials, the inventory of existing homes for sale, and job growth characteristics. Consumer preferences also play a role.
In general, high levels of employment and job growth, low mortgage interest rates, and low new home and resale inventories contribute to a strong and growing homebuilding market environment. Conversely, rising or continued high levels of unemployment, higher interest rates, and larger new and existing home inventories generally lead to weak industry conditions.
While the long-term fundamentals for new home construction remain intact, beginning in late 2005, accelerating through 2008 and continuing through 2009, homebuilding conditions deteriorated against a backdrop of a world-wide macroeconomic recession, declining consumer confidence, and significant tightening in the availability of home mortgage credit. Throughout this period, most housing markets across the United States suffered from an oversupply of new and resale home inventory, reduced levels of consumer demand for new homes, high cancellation rates, aggressive home sale price and buyer incentive competition among homebuilders, and a growing supply of foreclosed homes typically offered at substantially reduced prices. The housing downturn intensified in 2008 and by early 2009, homebuilding and home prices had fallen more sharply than at any time since the 1940’s. Although the cost of purchasing a home has dropped dramatically in many markets, staggering job losses, double digit unemployment, rising foreclosures, and the ongoing credit crunch are downsizing demand. As record foreclosures continue to drive down home prices, homeowners are unable to sell their homes at a profit and many first-time homebuyers are on hold waiting to see if prices will fall further. Although we have recently begun to see signs that certain of these negative market trends may be moderating at both local and national levels, key macroeconomic indicators remain soft or mixed and there is still uncertainty in the market. The supply of new and resale homes in the marketplace has decreased recently, but it is still excessive for the current level of consumer demand.
In February 2009, the $8,000 First Time Homebuyer Tax Credit was enacted into law. This law enables homebuyers who have not owned a home in the past three years, subject to certain income limits, to receive a tax credit of 10% of the purchase price of a home up to a maximum of $8,000. In November 2009, this tax credit was extended by Congress to June 2010 and the new law increased the annual income limits for qualification. In addition, the new law also added a $6,500 tax credit for qualified existing homeowners who elect to purchase a new home. Certain states also enacted laws which enabled certain homebuyers to receive additional state tax credits. Although it is not possible to quantify the precise impact, availability of these tax credits appears to have incentivized certain homebuyers to purchase homes during the second half of 2009.
Having experienced the worst housing crises in more than 50 years, we, like many other homebuilders, have suffered a material reduction in revenues and margins and have incurred significant net losses in 2007 through 2009. These net losses were driven primarily by asset impairment and lot option abandonment charges incurred in 2007, 2008 and 2009. For information and analyses of recent trends in our operations and financial condition, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of this Form 10-K, and for financial information about our revenues, earnings, assets, liabilities, shareholders’ equity and cash flows, please see the accompanying consolidated financial statements and notes thereto in Item 8 of this Form 10-K.
Over the past three years, we have responded to this challenging environment by employing a disciplined, defensive operating strategy designed to strengthen our balance sheet, improve liquidity and generate cash flow, improve our cost structure, reduce our overhead, and improve certain operating processes and procedures. While conditions have improved slightly, we believe that there may be further volatility in the housing market in 2010 and that the homebuilding industry is likely to experience a prolonged and uneven transition before a sustainable recovery takes place. Based on this view, we intend to continue to execute on our predominantly defensive operating strategy.
This strategy is focused on the following initiatives:
maintaining cash and preserving liquidity;
emphasizing customer service, product design, and premier locations;
improving affordability through design changes and other cost reduction efforts;
strategically and cautiously investing in new communities and/or markets; and
obtaining meaningful presence in all of our markets.
Sales and Marketing
Throughout our markets, we market and sell our homes exclusively under the M/I Homes trade name, except in Columbus, where we also market a collection of homes under the Showcase brand. Company-employed sales personnel conduct home sales from on-site offices within our furnished model homes. Each sales consultant is trained and prepared to meet the buyer’s expectations and build their confidence by fully explaining the features and benefits of our homes, helping each buyer determine which home best suits their needs, explaining the construction process, and assisting the buyer in choosing the best financing. Significant attention is given to the ongoing training of all sales personnel to assure the highest level of professionalism and product knowledge. As of December 31, 2009, we employed 93 sales consultants in 101 communities.
We advertise using the internet, newspapers, magazines, direct mail, billboards, radio and television. The particular marketing mediums used differ from market to market based on area demographics and other competitive factors. In recent years we have also significantly increased our advertising on the internet through expansion of our website at mihomes.com and through certain third party websites. Our messaging across all of these mediums, promotional or otherwise, is unified, highly synergistic, and designed to build strong equity in the M/I Homes brand. In addition, we encourage independent broker participation in the sales process and, from time to time, utilize promotions and incentives to attract interest from these brokers. We believe our commitment to quality design and construction, along with our reputation for superior service, has resulted in a strong referral base and numerous repeat buyers.
To further enhance the selling process, we operate design centers in most of our markets. These design centers are staffed with interior design specialists who assist buyers in selecting interior and exterior colors, standard options and upgrades. From time to time, we also aid the selling process by offering below-market financing options to our customers. M/I Financial originates loans for the majority of the purchasers of our homes. The loans are then sold, along with the servicing rights, to outside mortgage lenders. Title-related services are provided to purchasers of our homes in the majority of our markets through affiliated entities.
We generally begin construction of a home when we have obtained a sales contract and preliminary oral advice from the buyer’s lender that financing should be approved. In certain markets, contracts may be accepted contingent upon the sale of an existing home, and construction may be authorized through a certain phase prior to satisfaction of that contingency. In addition, speculative, or “spec,” homes (i.e., homes started in the absence of an executed contract) are built to facilitate delivery of homes on an immediate-need basis and to provide presentation of new products. We have increased our speculative home production in order to meet the needs of our increasing base of first-time homebuyers. Speculative homes can meet the needs of buyers who need to be closed in 60 days or less, while also satisfying their needs to be able to fully visualize the home.
Design and Construction
We devote significant resources to the research, design and development of our homes in order to meet the demands of our buyers as well as the changing markets. Across all of our divisions, we currently offer approximately 400 different floor plans designed to reflect current lifestyles and design trends. We continually review all of our floor plan offerings for design and construction efficiencies and add or delete plans according to our customer’s needs. We spent $1.8 million, $1.7 million and $2.5 million in the years ended December 31, 2009, 2008 and 2007, respectively, for research and development of our homes.
In spring 2009, we unveiled the “eco series,” a line of value-oriented homes designed for attractive pricing and to offer plan flexibility to our buyers. We have introduced eco throughout the Midwest regions, the Carolinas and developed a unique Eco line specifically for our Florida Divisions.
The construction of our homes typically takes approximately four to six months from the start of construction to completion of the home, depending on the size and complexity of the particular home being built. In 2009, we reduced our contract-to-close build time, excluding speculative homes, by 13%, from 223 days in 2008 to 195 days in 2009.
The construction of each home is supervised by a Personal Construction Supervisor who reports to a Production Manager, both of whom are employees of the Company. Buyers are introduced to their Personal Construction Supervisor prior to commencement of home construction at a pre-construction “buyer/builder conference.” The purpose of this conference is to review the home plan and all relevant construction details and to explain the construction process and schedule. We encourage our buyers to actively monitor and observe the construction of their home and see the quality being built into their home. All of this is part of our exclusive “Confidence BuilderProgram” which, consistent with our business philosophy, is designed to “put the buyer first” and enhance the total home buying experience.
We also focus significant attention on strategic alignments with national product suppliers and manufacturers, through which, all of our divisions benefit from product visibility and a streamlined supply chain. These relationships aid us in offering high quality products to our customers while continuing to reduce our brick and mortar costs.
Homes generally are constructed according to standardized designs and meet applicable Federal Housing Administration (“FHA”) and United States Veterans Administration (“VA”) requirements and all local building codes. To allow maximum design flexibility, we limit the use of pre-assembled building components. The efficiency of the building process is enhanced through the use of standardized materials available from a variety of sources. We utilize independent subcontractors for the installation of site improvements and the construction of our homes. Our on-site construction supervisors manage the scheduling and construction process. Subcontractor work is performed pursuant to written agreements. The agreements are generally short-term, with terms from six to twelve months, and specify a fixed price for labor and materials. The agreements are structured to provide price protection for a majority of the higher-cost phases of construction for homes in our backlog. We did not experience any significant issues with availability of building materials or skilled labor during 2009. As of December 31, 2009, we had a total of 650 homes, with $176.7 million aggregate sales value, in backlog in various stages of completion, including homes that are under contract but for which construction has not yet begun. As of December 31, 2008, we had a total of 566 homes, with $139.5 million aggregate sales value, in backlog. Homes included in year-end backlog are typically included in homes delivered in the subsequent year.