MHO

Business Context and Reporting Period

Company: M/I Schottenstein Homes, Inc. (M/I Homes)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2003
Business Overview: The Company operates in two primary segments: Homebuilding (development and sale of single-family homes and land) and Financial Services (mortgage origination and title services). Operations are concentrated in Ohio, Indiana, Florida, North Carolina, Virginia, Maryland, and Arizona.

Key Financial Metrics

Note: Debt figure includes Note payable banks ($82M + $20.5M) and Mortgage notes payable ($10.7M). Senior subordinated notes ($50M) are excluded from this specific line item but included in Total Liabilities.

Material Changes vs. Prior Period

• Revenue: Total revenue decreased 7% ($241.3M) for the quarter and 5% ($450.3M) for the six months compared to 2002. This decline was driven by an 8% and 7% decrease in Homes Delivered, respectively, attributed to unfavorable weather and permitting delays.
• Profitability: Despite lower revenue, Net Income increased 16% for the quarter ($19.5M vs $16.9M) and 14% for the six months ($37.4M vs $32.8M). Income before taxes rose 17% for the quarter and 16% for the six months.
• Interest Expense: Interest expense dropped significantly, down 54% for the quarter and 46% for the six months, due to lower average borrowings and increased capitalization of interest on land development.
• Backlog: Backlog increased 17% in units and 22% in value to $760 million, driven by a 24% increase in New Contracts for the quarter.
• Cash Flow: Operating cash flow turned negative ($52.3M used) for the six months ended June 30, 2003, compared to positive $46.0M in the prior year, primarily due to an $85.6M increase in inventory investment.

Outlook, Risks, and Management Commentary

• Segment Performance: The Homebuilding segment gross margin improved to 23.4% (from 22.1% in 2002) due to a favorable mix of homes delivered. The Financial Services segment revenue increased 10% for the quarter, aided by a favorable interest rate environment and higher average loan amounts.
• Market Risks: Management cites risks related to interest rate fluctuations, availability of financing, consumer confidence, and competitive overbuilding. The Company is exposed to interest rate risk through borrowings and uses swap agreements to hedge.
• Accounting Changes: The Company is evaluating the impact of FASB Interpretation 46 (FIN 46) regarding Variable Interest Entities (VIEs). While no VIEs were consolidated for this period, the assessment of pre-February 2003 entities is ongoing, with potential consolidation in the third quarter.
• Capital Resources: The Company has approximately $232 million in unused borrowing availability. It maintains a $50 million share repurchase authorization, with approximately $34 million remaining available as of June 30, 2003.
• Dividends: A quarterly dividend of $0.025 per share was paid in April and July 2003. A subsequent dividend of $0.025 per share was declared in August 2003.

Investor Verification Checklist

• Inventory Valuation: Verify the recoverability of the $298 million in land and lot inventory given the negative operating cash flow and potential market softness.
• Backlog Conversion: Monitor the conversion rate of the $760 million backlog into revenue, considering the 18% cancellation rate noted for the quarter.
• FIN 46 Impact: Confirm the outcome of the VIE assessment for pre-February 2003 entities, as consolidation could materially alter the balance sheet.
• Interest Rate Sensitivity: Assess the impact of rising interest rates on both the Company's borrowing costs (weighted average rate 11.4%) and homebuyer affordability.
• Phoenix Exit: Review the final financial impact of exiting the Phoenix market, which contributed to land revenue fluctuations and cost reductions.