MHO

Business Context and Reporting Period

Company: M/I Schottenstein Homes, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: Three and nine months ended September 30, 2001
Business Overview: The Company operates in two primary segments: Homebuilding (construction and sale of single-family homes and land) and Financial Services (mortgage origination and related services). Operations are concentrated in the Columbus, Ohio market, with additional presence in Florida, the Carolinas, Virginia, Maryland, and Arizona.

Key Financial Metrics

Note: Total Debt includes Notes payable banks ($143,000), Note payable bank - financial services ($28,900), and Mortgage notes payable ($12,844). Senior subordinated notes of $50,000 are also outstanding.

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 8.6% for the quarter and 2.0% for the nine-month period compared to 2000. Homebuilding revenue drove the increase, supported by higher housing deliveries (89 more homes in Q3; 63 more in YTD) and improved gross margins.
• Profitability: Net income rose 21.3% for the quarter and 26.7% for the nine-month period. This was aided by a one-time cumulative effect of a change in accounting principle (SFAS 133) adding $2.7 million to nine-month net income.
• Cash Flow: Operating cash flow turned negative for the nine months ended Sept 30, 2001 ($12.4 million used), compared to positive $3.7 million in the prior year. This was primarily due to a $70.9 million increase in inventories (land and houses under construction).
• Backlog: Total backlog increased 11.5% in units to 2,683 homes, with a 17.5% increase in sales value to $648 million. The average sales price in backlog rose to $241,000.
• Debt: Bank borrowings for homebuilding operations increased by $27.2 million to $143 million to fund increased construction activity.

Guidance, Outlook, and Risks

• Management Commentary: Management attributes revenue growth to increased housing deliveries and improved operating efficiencies. Gross margins improved due to a focus on premier locations and operational efficiencies. Selling expenses increased due to higher commissions from increased deliveries.
• Accounting Changes: The Company adopted SFAS 133 in January 2001, resulting in a $2.7 million net income adjustment. Future adoption of SFAS 141 (Business Combinations) and SFAS 142 (Goodwill) is not expected to have a significant impact.
• Liquidity: The Company has $138 million of unused borrowing availability under its credit facilities. It extended its $50 million Senior Subordinated Notes for two years, maturing in August 2006.
• Risks and Contingencies:
  • Interest Rate Sensitivity: The business is highly susceptible to interest rate fluctuations affecting consumer affordability and the Company's floating-rate debt costs.
  • Market Concentration: A significant portion of revenue is derived from the Columbus, Ohio market.
  • Land Position: The Company risks significant capital to maintain land positions. It holds options and contingent purchase contracts for approximately $164 million in land.
  • Regulatory and Economic Factors: Zoning, environmental regulations, and general economic conditions pose risks to profitability.

Investor Verification Checklist

• Inventory Turnover: Verify the sustainability of the $70.9 million increase in inventory and its impact on future cash flow requirements.
• Backlog Conversion: Monitor the conversion rate of the $648 million backlog into revenue, noting the historical cancellation rate of approximately 14%.
• Interest Rate Exposure: Assess the impact of rising interest rates on the $184.7 million in variable-rate debt and the effectiveness of the $75 million interest rate swap hedge.
• One-Time Adjustments: Isolate the $2.7 million accounting change (SFAS 133) when evaluating core operating performance trends.
• Land Commitments: Review the $164 million in land options and contingent contracts to understand future capital expenditure obligations.