MHO

Business Context and Reporting Period

Company: M/I Schottenstein Homes, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2003
Business Overview: The Company operates in two primary segments: Homebuilding (development and sale of land and single-family homes) 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: Operating cash flow for the nine months was negative due to significant inventory build-up ($155.9 million outflow).

Material Changes vs. Prior Period

• Revenue:
  • 3 Months: Increased 3% to $268.4 million (vs. $261.5 million in 2002). Driven by a 2% increase in homebuilding revenue due to higher average sales prices ($248k vs. $235k) and a 41% surge in financial services revenue.
  • 9 Months: Decreased 2% to $718.7 million (vs. $735.5 million in 2002). Homebuilding revenue fell 3% due to a 5% decline in homes delivered, partially offset by higher prices. Financial services revenue rose 17%.
• Profitability:
  • Net Income: Increased 8% for the quarter ($19.4M vs. $17.9M) and 12% for the nine months ($56.8M vs. $50.7M).
  • Margins: Homebuilding gross margin improved to 21.9% (3 months) and 22.8% (9 months) compared to 21.5% and 21.9% in the prior year, respectively.
• Balance Sheet:
  • Inventory: Increased significantly from $449 million (Dec 31, 2002) to $615 million (Sep 30, 2003), driven by $180 million in land purchases and increased houses under construction.
  • Debt: Bank borrowings for homebuilding increased to $106 million (from $0 in prior year-end) to fund inventory growth.
• Backlog: Increased 20% in units and 26% in value compared to the prior year quarter, reaching 3,123 homes valued at $789 million.

Guidance, Outlook, Risks, and Unusual Items

• Management Commentary: Management attributes revenue growth to higher sales prices and favorable interest rate environments benefiting the financial services segment. The decline in home deliveries is attributed to weather conditions and permitting delays in certain markets.
• Unusual Items:
  • Like-Kind Exchange: Exchanged an airplane valued at $7.8 million plus $14 million cash for a new airplane; no gain or loss recorded.
  • Treasury Stock: Repurchased 506,300 shares for $13.5 million during the nine-month period. Approximately $34 million remains available under the buyback authorization.
• Risks and Contingencies:
  • Interest Rates: Business is sensitive to mortgage rates; higher rates could reduce affordability.
  • Market Concentration: Approximately 40% of operating income for the first nine months was derived from the Columbus, Ohio market.
  • Variable Interest Entities (VIEs): The Company is assessing VIEs existing prior to Feb 1, 2003, under FIN 46. Consolidation may be required for the year-end, though no significant impact is anticipated.
  • Guarantees: M/I Financial has provided indemnifications of approximately $6.3 million related to mortgage loan repurchase agreements.

Investor Verification Checklist

• Inventory Valuation: Verify the recoverability of the $615 million inventory balance given the significant increase in land holdings and houses under construction.
• Backlog Conversion: Monitor the cancellation rate (22.8% for the quarter) and the ability to convert the $789 million backlog into revenue in the coming quarters.
• Debt Covenants: Review the $315 million Bank Credit Facility terms and borrowing base calculations to ensure continued liquidity given the heavy inventory investment.
• Market Exposure: Assess the impact of local economic conditions in Columbus, Ohio, which contributed 40% of operating income.
• Accounting Changes: Confirm the final impact of FIN 46 on the consolidation of joint ventures and land option contracts for the full year 2003.