MHO

Business Context and Reporting Period

Company: M/I Homes, Inc.
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2005
Business Overview: M/I Homes is a leading single-family homebuilder operating in nine geographic markets across Ohio, Florida, North Carolina, Indiana, Delaware, and the Washington, D.C. suburbs. The company operates two primary segments: homebuilding (approximately 98% of revenue) and financial services (mortgage origination, title, and insurance brokerage). In 2005, the company acquired Shamrock Homes in Florida to expand its Orlando market presence.

Key Financial Metrics

Operational Highlights:

• Homes Delivered: 4,291 (down slightly from 4,303 in 2004).
• Average Sales Price: $298,000 (up 11% from $267,000 in 2004).
• New Contracts: 4,314 (down slightly from 4,333 in 2004).
• Backlog: 2,807 homes with an aggregate sales value of $954.0 million.

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 15% year-over-year, driven primarily by an 11% increase in the average sales price of homes delivered and a 191% increase in land revenue ($28.4 million) due to lot sales to third parties.
• Profitability: Net income rose 10% to $100.8 million. However, the gross margin percentage declined slightly from 25.5% to 25.2% due to economic softness in Midwest markets and increased incentives.
• Expense Increases: General and administrative expenses increased 24% ($15.7 million) due to land-related costs, real estate taxes, and the absence of income from terminated interest rate swaps. Interest expense increased 69% ($5.8 million) due to higher borrowings and the issuance of senior notes.
• Debt Structure: The company issued $200 million in 6.875% senior notes due in 2012, using proceeds to pay down revolving bank borrowings. Total debt increased significantly to fund land acquisitions.
• Market Mix: Operating income reliance on the Columbus market decreased from 44% in 2004 to 33% in 2005, reflecting a strategic shift toward Florida, North Carolina, and Washington, D.C. markets.

Guidance, Outlook, and Risks

Management Outlook for 2006:

• Deliveries: Anticipated to be approximately 5,000 homes, with growth driven entirely by markets outside the Midwest.
• New Contracts: Goal remains 15% annual growth.
• Land Purchases: Expected to purchase approximately $250 million in land.
• Margins: Gross margins are expected to decline by 50-100 basis points due to sales incentives in Midwest markets and margin normalization in Florida and D.C.
• Accounting Impact: Net income in 2006 is expected to be impacted by approximately $3.0 million in expense related to the adoption of new stock-based compensation accounting standards (SFAS 123(R)).

Key Risks and Contingencies:

• Market Concentration: Significant exposure to specific geographic markets; adverse economic conditions in these areas could materially impact operations.
• Interest Rates: Higher rates could reduce affordability and demand. The company uses derivatives to hedge interest rate lock commitments.
• Land Availability: Dependence on acquiring land at favorable prices; inability to do so could reduce delivery volume or margins.
• Seasonality: Operations are highly seasonal, with the majority of deliveries occurring in the second half of the year.
• Regulatory/Environmental: Subject to zoning, building moratoriums, and environmental regulations that could delay development.

Investor Verification Checklist

• Midwest Market Exposure: Verify the extent of sales incentives and margin compression in Ohio and Indiana markets, which accounted for a significant portion of the decline in new contracts.
• Land Inventory Valuation: Review the $1.08 billion inventory balance and the $452.6 million in land option agreements to assess potential impairment risks if market conditions soften.
• Debt Covenants: Confirm compliance with the $735 million Credit Facility covenants, specifically tangible net worth requirements, given the increased leverage.
• Backlog Conversion: Monitor the cancellation rate (historically ~21%) and the ability to convert the $954 million backlog into revenue in 2006.
• Stock-Based Compensation: Assess the impact of the new $3.0 million expense related to SFAS 123(R) adoption on 2006 earnings per share.