MHO

Business Context and Reporting Period

Company: M/I Homes, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2006
Business Overview: M/I Homes is a leading single-family homebuilder operating in Ohio, Indiana, Florida, North Carolina, Delaware, and the Washington, D.C. suburbs. The company operates through two primary segments: homebuilding operations (land acquisition, development, and home construction) and financial services operations (mortgage origination and title services).

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue: For the nine months ended September 30, 2006, revenue increased 4% ($37.2 million) compared to the prior year, driven by a 3% increase in homes delivered and a 4% increase in average sales price. However, for the third quarter alone, revenue decreased 8% due to an 11% drop in homes delivered.
• Profitability: Net income for the nine months decreased 16% ($9.6 million) compared to 2005. Income before taxes for the quarter dropped 40% ($15.5 million) due to lower revenue and a $1.9 million impairment charge on land held for sale.
• Operating Expenses: General and administrative expenses increased significantly ($21.3 million for the nine months) due to charges related to the resignation of the Chief Operating Officer, abandoned land transaction write-offs, severance, and the adoption of SFAS 123(R) for stock-based compensation.
• Backlog: Backlog decreased 28% in units and 19% in sales value to 2,533 homes ($923 million) as of September 30, 2006, reflecting a 51% decline in new contracts for the quarter.
• Cancellation Rates: Cancellation rates rose sharply to 41.7% in the third quarter of 2006, compared to 21.7% in the same period in 2005, attributed to market oversupply and competitor discounting.

Guidance, Outlook, and Risks

• Market Conditions: Management reports softened real estate market conditions across all regions, characterized by reduced traffic, weakening demand, and an oversupply of inventory. Competitive pressures have intensified with significant discounting by competitors.
• Land Strategy: In response to market conditions, the company reduced its projected 2006 land purchases from $260 million to approximately $165 million. Future purchases are being targeted to meet specific absorption and gross margin levels, primarily outside the Midwest.
• Liquidity: The company amended its credit facility on October 6, 2006, to a $650 million capacity (expandable to $1 billion). As of September 30, 2006, borrowing availability was $127.3 million. Management believes available financing is adequate to support operations through 2008.
• Risks: Key risks include the potential for further declines in new contracts and gross margins, high cancellation rates impacting 2007 results, interest rate sensitivity, and the possibility of natural disasters (specifically noting a tornado impact in Columbus in October 2006).
• Accounting Changes: The company adopted SFAS 123(R) on January 1, 2006, resulting in the recognition of stock-based compensation expense ($2.4 million for the nine months), which was not previously recognized under APB Opinion 25.

Investor Verification Checklist

• Land Impairment: Verify the extent of the $1.9 million impairment charge on land held for sale and assess if further write-downs are likely given the 51% drop in new contracts.
• Cancellation Trends: Monitor the 41.7% cancellation rate in Q3 2006 to determine if this trend persists into 2007, which could materially impact future revenue recognition.
• Debt Covenants: Confirm continued compliance with the tangible net worth covenants of the amended $650 million credit facility, especially given the reduction in projected land purchases.
• Stock-Based Compensation: Review the impact of SFAS 123(R) on future earnings, noting $8.8 million of unrecognized compensation expense related to unvested options.
• Regional Performance: Analyze the divergence between the Midwest (26% drop in deliveries) and Florida (46% increase in deliveries) to understand geographic risk exposure.