MHO

Business Context and Reporting Period

Company: M/I Homes, Inc. (formerly M/I Schottenstein Homes, Inc.)
Filing Type: Form 10-K Annual Report
Period Ended: December 31, 2003
Business Overview: M/I Homes is a leading single-family homebuilder operating in nine geographic markets across Ohio, Florida, North Carolina, Indiana, and the Washington, D.C. suburbs. The company operates two primary segments: Homebuilding (98% of revenue) and Financial Services (mortgage origination and title services). In 2003, the company achieved record revenues and net income.

Key Financial Metrics

Operational Highlights:

• Homes Delivered: 4,148 (constant vs. 2002).
• Average Sales Price: $246,000 (up from $238,000 in 2002).
• Backlog: 2,658 homes with an aggregate sales value of $704.4 million.
• Land Inventory: Owned 11,908 lots and controlled an additional 11,177 lots under contract.

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 3.5% to $1.1 billion, driven by a 3.6% increase in housing revenue due to higher average sales prices. Land revenue decreased 10.3% due to fewer lot sales in Washington, D.C. and Orlando.
• Margin Expansion: Gross margin improved to 25.5% from 24.1%, attributed to higher selling prices, increased option sales, and favorable financial services results. Operating margin rose to 13.5% from 11.9%.
• Profitability: Net income increased 22.7% to $81.7 million. Income before taxes rose 23.7% to $135.1 million.
• Interest Expense: Decreased 30.3% to $9.6 million due to lower average borrowings and higher interest capitalization.
• Cash Flow: Operating cash flow turned negative ($38.7 million) compared to a positive $116.5 million in 2002. This was primarily due to a $220 million investment in land and increased mortgage loans held for sale.
• Debt Levels: Bank borrowings for homebuilding increased to $95 million from zero in 2002 to fund land acquisitions.

Guidance, Outlook, and Risks

Management Commentary & Outlook:

• Management believes available financing is adequate to support operations through mid-2005.
• The company intends to purchase an additional $300 million of land in 2004.
• Interest rate allocation for internal reporting will be adjusted in 2004 (12% for housing, 6% for land), which will lower allocated interest to the homebuilding segment and increase reported segment income.
• Stock repurchase program: $50 million authorized; $16.0 million remaining as of March 2004.

Risks and Contingencies:

• Interest Rate Sensitivity: Higher rates could reduce affordability and demand. The company uses interest rate swaps ($75 million notional) to manage risk.
• Land Development Risk: Significant resources are committed to land development; success depends on zoning, infrastructure, and market absorption.
• Market Concentration: Approximately 40% of operating income in 2003 was derived from the Columbus, Ohio market.
• Off-Balance Sheet: $315 million in contingent purchase contracts for land; $65.7 million in completion bonds and letters of credit.
• Guarantees: $378 million of mortgage loans covered under repurchase guarantees; $3.4 million accrued liability for guarantees and indemnities.

Investor Verification Checklist

• Land Inventory Valuation: Verify the realizability of the $366 million land and development inventory given the significant increase in 2003.
• Cash Flow Sustainability: Assess the impact of negative operating cash flow on liquidity and the reliance on bank borrowings ($95 million outstanding) to fund growth.
• Backlog Conversion: Monitor the conversion rate of the $704 million backlog into revenue, considering potential financing contingencies.
• Interest Rate Exposure: Evaluate the effectiveness of the $75 million interest rate swap portfolio in mitigating rising rate risks.
• Market Concentration: Review the specific performance and economic conditions of the Columbus, Ohio market, which drives 40% of operating income.