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M I HOMES INC - 10-Q - : MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) OVERVIEW M/I Homes, Inc. (the "Company" or "we") is one of the nation's leading builders of single-family homes, having delivered more than 89,000 homes since we commenced homebuilding activities in 1976. The Company's homes are marketed and sold under the M/I Homes brand (M/I Homes and Showcase Collection (exclusively by M/I)). We also operate under the name Triumph Homes in certain communities in our Houston, Texas market. The Company has homebuilding operations in Columbus and Cincinnati, Ohio; Indianapolis, Indiana; Chicago, Illinois; Tampa and Orlando, Florida; Austin, Dallas/Fort Worth, Houston and San Antonio, Texas; Charlotte and Raleigh, North Carolina; and the Virginia and Maryland suburbs of Washington, D.C. Included in this Management's Discussion and Analysis of Financial Condition and Results of Operations are the following topics relevant to the Company's performance and financial condition: • Information Relating to Forward-Looking Statements; • Our Application of Critical Accounting Estimates and Policies; • Our Results of Operations; • Discussion of Our Liquidity and Capital Resources; • Summary of Our Contractual Obligations; • Discussion of Our Utilization of Off-Balance Sheet Arrangements; and • Impact of Interest Rates and Inflation. FORWARD-LOOKING STATEMENTS Certain information included in this report or in other materials we have filed or will file with the Securities and Exchange Commission (the "SEC") (as well as information included in oral statements or other written statements made or to be made by us) contains or may contain forward-looking statements, including, but not limited to, statements regarding our future financial performance and financial condition. Words such as "expects," "anticipates," "targets," "goals," "projects," "intends," "plans," "believes," "seeks," and "estimates," variations of such words and similar expressions are intended to identify such forward-looking statements. These statements involve a number of risks and uncertainties. Any forward-looking statements that we make herein and in future reports and statements are not guarantees of future performance, and actual results may differ materially from those in such forward-looking statements as a result of various risk factors. Please see "Item 1A. Risk Factors" in Part I of our Annual Report on Form 10-K for the year ended December 31, 2013 (the "2013 Form 10-K") for more information regarding those risk factors. Any forward-looking statement speaks only as of the date made. Except as required by applicable law, we undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise. However, any further disclosures made on related subjects in our subsequent reports on Forms 10-K, 10-Q and 8-K should be consulted. This 28 -------------------------------------------------------------------------------- discussion is provided as permitted by the Private Securities Litigation Reform Act of 1995, and all of our forward-looking statements are expressly qualified in their entirety by the cautionary statements contained or referenced in this section. APPLICATION OF CRITICAL ACCOUNTING ESTIMATES AND POLICIES The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. On an ongoing basis, management evaluates such estimates and judgments and makes adjustments as deemed necessary. Actual results could differ from these estimates using different estimates and assumptions, or if conditions are significantly different in the future. See Note 1 (Summary of Significant Accounting Policies) to our consolidated financial statements included in our 2013 Form 10-K for additional information about our accounting policies. We believe that there have been no significant changes to our critical accounting policies during the quarter ended September 30, 2014 as compared to those disclosed in Management's Discussion and Analysis of Financial Condition and Results of Operations included in our 2013 Form 10-K. 29 --------------------------------------------------------------------------------RESULTS OF OPERATIONS The Company's segment information is presented on the basis that its chief operating decision makers use in evaluating segment performance. The Company's chief operating decision makers evaluate the Company's performance in various ways, including: (1) the results of our 13 individual homebuilding operating segments and the results of our financial services operations; (2) the results of our three homebuilding regions; and (3) our consolidated financial results. We have determined our reportable segments as follows: Midwest homebuilding, Southern homebuilding, Mid-Atlantic homebuilding and financial services operations. The homebuilding operating segments that are included within each reportable segment have similar operations and exhibit similar long-term economic characteristics. Our homebuilding operations include the acquisition and development of land, the sale and construction of single-family attached and detached homes, and the sale of lots and land to third parties. The homebuilding operating segments that comprise each of our reportable segments are as follows: Midwest Southern Mid-Atlantic Columbus, Ohio Tampa, Florida Washington, D.C.Cincinnati, Ohio Orlando, Florida Charlotte, North Carolina Indianapolis, Indiana Houston, Texas Raleigh, North Carolina Chicago, Illinois San Antonio, Texas Austin, Texas Dallas/Fort Worth, Texas Our financial services operations include the origination, sale and servicing of mortgage loans and title services primarily for purchasers of the Company's homes. Overview We believe that housing market conditions, in general, remain healthy despite a moderation in the pace of new contracts in 2014's first nine months when compared to the same period in 2013. We believe this moderation is due to a number of factors, including (1) reduced affordability in certain markets as a result of higher average sales prices, (2) a tepid economic recovery and uneven job creation, (3) harsh weather conditions experienced early in 2014, which delayed the opening of certain of our new communities, (4) a general lengthening of our community development cycle time due to volume of overall new housing developments and (5) the imposition of lower loan limits on government-sponsored mortgages beginning in January 2014. Despite these factors, our new contracts improved by 3% in the quarter ended September 30, 2014 when compared to 2013's third quarter. Our new contracts declined by 3% for the nine months ended September 30, 2014. Although our new contracts declined during the nine months ended September 30, 2014 compared to our new contracts during the nine months ended September 30, 2013, we experienced improvements in most of our financial and operating metrics for the three and nine months ended September 30, 2014. During the nine months ended September 30, 2014, we reported revenue of $847.2 million, a 20.9% increase compared to the same period in 2013, and achieved net income of $39.8 million, of which $30.5 million ($0.99 per diluted share) related to our core profitability, and $9.3 million ($0.31 per diluted share) related to the accounting benefit from income taxes associated with the reversal of our remaining state deferred tax asset valuation allowance (see Note 9 to our Unaudited Condensed Consolidated Financial Statements for further information). We also achieved our highest year-to-date gross and operating margins since 2006, with gross margin and operating margin reaching 21.1% and 7.0%, respectively, for the nine months ended September 30, 2014. We believe our improved results of operations are attributable to (1) our strategic growth and investment in new communities, along with a shift in our mix of communities towards better performing locations within each of our markets; (2) our continued progress in shifting our housing investment to markets with stronger economic growth, including expansion into new markets; (3) our continued focus on controlling overall costs; and (4) the contributions from our financial services operations. Please see further discussion of our financial and operating metrics below in the "Summary of Company Results" and "Year Over Year Comparison" sections. Summary of Company Results Summary of Financial Results For the quarter ended September 30, 2014, we achieved net income to common shareholders of $12.4 million, or $0.44 per diluted share, which included $1.2 million of dividend payments made to holders of our Series A Preferred Shares and $0.6 million of pre-tax impairment charges. This compares to net income to common shareholders of $124.1 million, or $4.22 per diluted share, for the third quarter of 2013, which included a $111.6 million accounting benefit from income taxes due to the reversal of a majority of the valuation allowance against our deferred tax assets, offset partially by $2.1 million of pre-tax impairment charges, a 30 -------------------------------------------------------------------------------- $1.7 million charge related to the early termination of our $140 million secured revolving credit facility (the "Terminated Credit Facility") and $1.2 million of dividend payments made to holders of our Series A Preferred Shares. For the nine months ended September 30, 2014, we achieved net income to common shareholders of $36.1 million, or $1.30 per diluted share, which included a $9.3 million accounting benefit from income taxes associated with the reversal of the remaining valuation allowance against our state deferred tax assets, $3.7 million of dividend payments made to holders of our Series A Preferred Shares and $1.4 million of pre-tax impairment charges. This compares to net income to common shareholders of $132.5 million, or $4.79 per diluted share, for the nine months ended September 30, 2013, which included a $111.6 million accounting benefit from income taxes due to the reversal of a majority of the valuation allowance against our deferred tax assets, offset partially by $4.2 million of pre-tax impairment charges, a $2.2 million non-cash equity adjustment resulting from the excess of fair value over carrying value of our Series A Preferred Shares that were called for redemption in the first quarter of 2013 and $2.4 million of dividend payments made to holders of our Series A Preferred Shares. During the quarter ended September 30, 2014, we recorded total revenue of $330.8 million, of which $315.4 million was from homes delivered, $7.8 million was from land sales and $7.6 million was from our financial services operations. Revenue from homes delivered increased 19% driven primarily by a 13% increase in the average sales price of homes delivered ($36,000 per home delivered) and 48 additional homes delivered in 2014's third quarter compared to the same period in 2013. Revenue from land sales increased $5.2 million during the third quarter of 2014 primarily due to larger land sales in our Southern and Mid-Atlantic regions compared to prior year. Revenue in our financial services segment increased 13% to $7.6 million in the third quarter of 2014 primarily due to the factors discussed below in our "Year Over Year Comparison" section. For the nine months ended September 30, 2014, we recorded total revenue of $847.2 million, of which $809.4 million was from homes delivered, $15.9 million was from land sales and $21.9 million was from our financial services operations. Revenue from homes delivered increased 22% driven primarily by 264 additional homes delivered in the nine months ended September 30, 2014 compared to the same period in 2013 and a 9% increase in the average sales price of homes delivered ($26,000 per home delivered). Revenue from land sales increased $3.1 million from 2013's first nine months primarily due to larger land sales in our Southern and Mid-Atlantic regions compared to prior year. Revenue in our financial services segment decreased 2% to $21.9 million for the nine months ended September 30, 2014 primarily due to the factors discussed below in our "Year Over Year Comparisons" section. Total gross margin increased $13.6 million in the third quarter of 2014 compared to the third quarter of 2013, primarily as a result of a $12.7 million improvement in the gross margin of our homebuilding operations and a $0.9 million improvement in gross margin from our financial services operations. The increase in homebuilding gross margin for the third quarter of 2014 resulted primarily from the 13% increase in the average sales price of homes delivered ($36,000 per home delivered) and the 48 unit increase in the number of homes delivered. For the nine months ended September 30, 2014, total gross margin increased $39.5 million compared to the nine months ended September 30, 2013, which was largely the result of a $40.0 million improvement in the gross margin of our homebuilding operations, offset partially by a $0.4 million decline in gross margin from our financial services operations. The increase in homebuilding gross margin for the nine months ended September 30, 2014 resulted primarily from the 264 unit increase in the number of homes delivered and the 9% increase in the average sales price of homes delivered ($26,000 per home delivered). The increased sales prices for both the three and nine months ended September 30, 2014 were driven by the performance of our newer communities, the strategic shift in our geographic footprint, which resulted in more homes delivered in our better performing markets and a shift in the mix of homes delivered to higher priced and larger homes. We also experienced better pricing leverage in select locations and submarkets. The pricing and unit improvements were partially offset by higher average lot and construction costs related to both the mix of homes delivered as well as cost increases associated with homebuilding industry conditions and normal supply and demand dynamics. During the nine month period ended September 30, 2014, we were able to pass a majority of the higher costs on to our homebuyers in the form of higher sales prices and lower incentives. However, recent moderation in the pace of improvement in the homebuilding industry may make it more difficult to continue to fully offset any additional increases in lot, material, labor and land costs that we may experience going forward. Selling, general and administrative expense increased $7.4 million and $19.7 million for the three and nine months ended September 30, 2014, respectively, which offset, in part, the increase in our gross margins discussed above. For the third quarter of 2014, selling expense increased $4.0 million from the prior year's third quarter and increased slightly as a percentage of revenue to 6.6% compared to 6.5% in the third quarter of 2013.Variable selling expense for sales commissions contributed $2.2 million to the increase in selling expense due to the increase in the number of homes delivered and the higher average sales price. The increase in selling expense was also attributable to a $1.8 million increase in non-variable selling expense primarily related to a $1.3 million increase in expenses associated with our sales offices and models related to our new community openings and a $0.5 million increase related to our new Austin and Dallas/Fort Worth markets. General and administrative expense increased $3.4 million during the third quarter of 2014 and remained flat at 6.6% as a percentage of revenue for both the third quarter of 2014 and 2013. This dollar increase was primarily due to a $0.7 million increase in payroll-related expense, resulting primarily from the increase 31 -------------------------------------------------------------------------------- in our employee count, a $0.7 million increase associated with our new Austin and Dallas/Fort Worth markets, a $0.6 million increase in share based and variable incentive compensation expense associated with our improved financial performance, a $0.4 million increase in land abandonment charges, and a $0.4 million increase due to the absence of bad debt recoveries that occurred in the third quarter of 2013, and various other miscellaneous expense increases. For the nine months ended September 30, 2014, selling expense increased $10.8 million from the nine months ended September 30, 2013 and increased slightly as a percentage of revenue to 6.9% compared to 6.8% in the nine months ended September 30, 2013. Variable selling expense for sales commissions contributed $6.5 million to the increase due to the increase in the number of homes delivered and the higher average sales price. The increase in selling expense was also attributable to a $4.3 million increase in non-variable selling expense primarily related to a $3.3 million increase in expenses associated with our sales offices and models, resulting from the increase in our number of average communities compared to prior year's number of average communities, and a $1.0 million increase related to our new Austin and Dallas/Fort Worth markets. General and administrative expense increased $8.9 million compared to the nine months ended September 30, 2013 but improved as a percentage of revenue from 7.5% in the nine months ended September 30, 2013 to 7.2% in the nine months ended September 30, 2014. The increase in general and administrative expenses was primarily due to a $3.1 million increase in payroll-related expense, resulting primarily from a 19% increase in our employee count related to our average community count growth, a $2.4 million increase in share based and variable incentive compensation expense associated with our improved financial performance, a $1.7 million increase associated with our new Austin and Dallas/Fort Worth markets, a $1.1 million increase due to the absence of bad debt recoveries that occurred during the nine months ended September 30, 2013, and a $0.6 million increase in land abandonment charges. Overall, our selling, general and administrative expense was 13.2% and 14.1% of revenue for the three months and nine months ended September 30, 2014, respectively, compared to 13.2% and 14.2% for the same periods in 2013, respectively. We continue to focus on cost control and reducing our selling, general and administrative expense at both the divisional and corporate levels as a percentage of revenue. Summary of Operational Results In addition to the improving financial results noted above, certain of our operational metrics also improved. For the quarter ended September 30, 2014, we achieved a 5% increase in the number of homes delivered and a 13% increase in the average sales price of homes delivered compared to the same period a year ago. For the nine months ended September 30, 2014, we achieved an 11% increase in the number of homes delivered and a 10% increase in the average sales price of homes delivered compared to 2013's first nine months. We also experienced a 10% increase in the average sales price of homes in backlog and a 6% increase in the overall sales value of our backlog at September 30, 2014 compared to September 30, 2013, along with the 3% increase in new contracts for the three months ended September 30, 2014 compared to the same period in 2013. We continue to invest in communities and markets that we believe will help us attain improved profitability as housing markets improve and enhance our ability to establish market share and create a platform for future growth in our current markets. During the nine month period ended September 30, 2014, we opened 37 communities and closed 47 communities. However, new contracts declined by 3% during the nine months ended September 30, 2014 compared to the same period in 2013and the number of homes in our backlog at September 30, 2014 declined by 3% compared to September 30, 2013. Our absorption rates per community also declined from 2.4 for the nine months ended September 30, 2013 to 2.1 for the nine months ended September 30, 2014. We believe the declines in new contracts, units in backlog and absorption pace from 2013's first nine months resulted from the general moderation in the rate of improvement in the housing market during the nine months ended September 30, 2014 compared to 2013's same period. In addition, the timing of the planned opening of several of our new communities was unfavorably impacted due to both harsh winter weather conditions earlier in 2014 and a general lengthening of the cycle time for new community development due to the increased volume of overall new housing developments. Outlook Looking ahead, we continue to believe that the fundamentals supporting continued moderate improvements in the housing industry remain in place. We believe our results will remain largely dependent on (1) our ability to open new communities as planned, (2) traffic levels, (3) the extent of job growth and consumer confidence, and (4) stability in mortgage loan underwriting standards and interest rates. Given our expectations with respect to homebuilding market conditions, and consistent with our focus on improving long-term returns, we will continue to emphasize the following strategic business objectives: • profitably growing our presence in our existing markets, including opening new communities; • reviewing new markets for investment opportunities; • maintaining a strong balance sheet; and • emphasizing customer service, product quality and design, and premier locations. 32-------------------------------------------------------------------------------- With these objectives in mind, we took a number of steps during the nine months ended September 30, 2014 to position the Company for the remainder of 2014 and beyond, including investing $183.7 million in land acquisitions and $93.2 million in land development to help grow our presence in our existing markets. We currently estimate that we will spend a total of approximately $375 million to $425 million on land purchases and land development in 2014, including the $276.9 million spent during the nine months ended September 30, 2014. However, given varying results in each of our local markets, we will continue to adjust our strategies and investments based on housing demand and our performance in each of our markets. Despite our positive expectations, it is unclear whether our financial results will continue to improve at the rate they did in 2013 and the nine months ended September 30, 2014. Going forward, we believe our abilities to leverage our fixed costs, obtain land at desired rates of return, and open and grow our active communities provide our best opportunities to continue improving our financial results. However, we can provide no assurance that the rate of positive annual trends and/or sequential trends experienced in our financial and operating metrics in 2013 and the nine months ended September 30, 2014 will continue throughout the remainder of 2014. 33 -------------------------------------------------------------------------------- The following table shows, by segment, revenue; gross margin; selling, general and administrative expense; operating income (loss); interest expense; and income before income taxes for the three and nine months ended September 30, 2014 and 2013: Three Months Ended September 30, Nine Months Ended September 30, (In thousands) 2014 2013 2014 2013 Revenue: Midwest homebuilding $ 118,319 $ 82,689 $ 283,472 $ 222,890 Southern homebuilding 118,150 96,275 299,472 216,181 Mid-Atlantic homebuilding 86,718 89,550 242,357 239,061 Financial services (a) 7,580 6,681 21,915 22,343 Total revenue $ 330,767 $ 275,195 $ 847,216 $ 700,475 Gross margin: Midwest homebuilding $ 22,848 $ 13,406 $ 54,627 $ 35,156 Southern homebuilding 22,563 17,992 57,959 40,077 Mid-Atlantic homebuilding 15,518 16,830 44,472 41,863 Financial services (a) 7,580 6,681 21,915 22,343 Total gross margin $ 68,509 $ 54,909 $ 178,973 $ 139,439 Selling, general and administrative expense: Midwest homebuilding $ 10,046 $ 8,292 $ 27,856 $ 23,460 Southern homebuilding 12,348 9,721 33,218 24,855 Mid-Atlantic homebuilding 9,007 8,397 25,584 22,902 Financial services (a) 3,776 2,854 9,711 8,892 Corporate 8,502 6,996 23,126 19,663 Total selling, general and administrative expense $ 43,679 $ 36,260 $ 119,495 $ 99,772 Operating income (loss): Midwest homebuilding $ 12,802 $ 5,114 $ 26,771 $ 11,696 Southern homebuilding 10,215 8,271 24,741 15,222 Mid-Atlantic homebuilding 6,511 8,433 18,888 18,961 Financial services (a) 3,804 3,827 12,204 13,451 Corporate (8,502 ) (6,996 ) (23,126 ) (19,663 ) Total operating income $ 24,830 $ 18,649 $ 59,478 $ 39,667 Interest expense: Midwest homebuilding $ 450 $ 1,023 $ 2,211 $ 3,852 Southern homebuilding 968 1,405 3,927 4,510 Mid-Atlantic homebuilding 829 659 2,392 2,809 Financial services (a) 402 362 1,019 1,015 Total interest expense $ 2,649 $ 3,449 $ 9,549 $ 12,186 Equity in income of unconsolidated joint ventures (22 ) (278 ) (62 ) (278 ) Loss on early extinguishment of debt - 1,726 - 1,726 Income before income taxes $ 22,203 $ 13,752 $ 49,991 $ 26,033 (a) Our financial services operational results should be viewed in connection with our homebuilding business as its operations originate loans and provide title services primarily for our homebuying customers, with the exception of a small amount of mortgage refinancing. 34-------------------------------------------------------------------------------- The following tables show total assets by segment at September 30, 2014 and December 31, 2013: At September 30, 2014 Corporate, Financial Services (In thousands) Midwest Southern Mid-Atlantic and Unallocated Total Deposits on real estate under option or contract $ 4,671 $ 12,332 $ 4,635 $ - $ 21,638 Inventory (a) 310,559 315,169 246,598 - 872,326 Investments in unconsolidated joint ventures 2,980 37,789 - - 40,769 Other assets 10,806 23,995 11,069 212,551 258,421 Total assets $ 329,016 $ 389,285 $ 262,302 $ 212,551 $ 1,193,154 At December 31, 2013 Corporate, Financial Services (In thousands) Midwest Southern Mid-Atlantic and Unallocated Total Deposits on real estate under option or contract $ 2,003 $ 7,107 $ 5,255 $ - $ 14,365 Inventory (a) 248,218 236,505 191,847 - 676,570 Investments in unconsolidated joint ventures 5,331 29,935 - - 35,266 Other assets 10,571 982 11,050 361,372 383,975 Total assets $ 266,123 $ 274,529 $ 208,152 $ 361,372 $ 1,110,176 (a) Inventory includes single-family lots; land and land development costs; land held for sale; homes under construction; model homes and furnishings; community development district infrastructure; and consolidated inventory not owned. 35--------------------------------------------------------------------------------Reportable Segments The following table presents, by reportable segment, selected operating and financial information as of and for the three and nine months ended September 30, 2014 and 2013: Three Months Ended Nine Months Ended September 30, September 30, (Dollars in thousands) 2014 2013 2014 2013 Midwest Region Homes delivered 381 307 931 837 New contracts, net 325 318 1,093 1,062 Backlog at end of period 707 643 707 643Average sales price per home delivered $ 307 $ 269 $ 300 $ 263 Average sales price of homes in backlog $ 336 $ 297 $ 336 $ 297 Aggregate sales value of homes in backlog $ 237,407 $ 190,932 $ 237,407 $ 190,932 Revenue homes $ 117,113 $ 82,641 $ 278,974 $ 220,018 Revenue third party land sales $ 1,206 $ 48 $ 4,498 $ 2,872 Operating income homes $ 12,456 $ 5,110 $ 25,427 $ 12,681 Operating income (loss) land $ 346 $ 4 $ 1,344 $ (985 ) Number of average active communities 61 66 64 63 Number of active communities, end of period 62 66 62 66 Southern Region Homes delivered 344 354 949 794 New contracts, net 327 289 1,026 1,043 Backlog at end of period 526 590 526 590Average sales price per home delivered $ 328 $ 269 $ 307 $ 269 Average sales price of homes in backlog $ 323 $ 287 $ 323 $ 287 Aggregate sales value of homes in backlog $ 169,676 $ 169,547 $ 169,676 $ 169,547 Revenue homes $ 112,673 $ 95,315 $ 291,785 $ 213,518 Revenue third party land sales $ 5,477 $ 960 $ 7,687 $ 2,663 Operating income homes $ 9,905 $ 7,924 $ 24,284 $ 13,845 Operating income land $ 310 $ 347 $ 457 $ 1,377 Number of average active communities 50 43 51 40 Number of active communities, end of period 51 46 51 46 Mid-Atlantic Region Homes delivered 260 276 736 721 New contracts, net 240 262 771 889 Backlog at end of period 321 374 321 374Average sales price per home delivered $ 329 $ 319 $ 324 $ 322 Average sales price of homes in backlog $ 346 $ 341 $ 346 $ 341 Aggregate sales value of homes in backlog $ 111,003 $ 127,610 $ 111,003 $ 127,610 Revenue homes $ 85,571 $ 87,930 $ 238,682 $ 231,840 Revenue third party land sales $ 1,147 $ 1,620 $ 3,675 $ 7,221 Operating income homes $ 6,145 $ 8,116 $ 17,904 $ 17,397 Operating income land $ 366 $ 317 $ 984 $ 1,564 Number of average active communities 35 35 37 35 Number of active communities, end of period 34 35 34 35 Total Homebuilding Regions Homes delivered 985 937 2,616 2,352 New contracts, net 892 869 2,890 2,994 Backlog at end of period 1,554 1,607 1,554 1,607 Average sales price per home delivered $ 320 $ 284 $ 309 $ 283 Average sales price of homes in backlog $ 333 $ 304 $ 333 $ 304 Aggregate sales value of homes in backlog $ 518,086 $ 488,089 $ 518,086 $ 488,089 Revenue homes $ 315,357 $ 265,886 $ 809,441 $ 665,376 Revenue third party land sales $ 7,830 $ 2,628 $ 15,860 $ 12,756 Operating income homes $ 28,506 $ 21,150 $ 67,615 $ 43,923 Operating income land $ 1,022 $ 668 $ 2,785 $ 1,956 Number of average active communities 146 144 152 138 Number of active communities, end of period 147 147 147 147 36-------------------------------------------------------------------------------- Three Months Ended Nine Months Ended September 30, September 30, (Dollars in thousands) 2014 2013 2014 2013 Financial Services Number of loans originated 701 689 1,801 1,783 Value of loans originated $ 191,935 $ 165,660 $ 470,345 $ 426,637 Revenue $ 7,580 $ 6,681 $ 21,915 $ 22,343 Less: Selling, general and administrative expense 3,776 2,854 9,711 8,892 Interest expense 402 362 1,019 1,015 Income before income taxes $ 3,402 $ 3,465 $ 11,185 $ 12,436 A home is included in "new contracts" when our standard sales contract is executed. "Homes delivered" represents homes for which the closing of the sale has occurred. "Backlog" represents homes for which the standard sales contract has been executed, but which are not included in homes delivered because closings for these homes have not yet occurred as of the end of the period specified. The composition of our homes delivered, new contracts, net and backlog is constantly changing and may be based on a dissimilar mix of communities between periods as new communities open and existing communities wind down. Further, home types and individual homes within a community can range significantly in price due to differing square footage, option selections, lot sizes and quality and location of lots. These variations may result in a lack of meaningful comparability between homes delivered, new contracts, net and backlog due to the changing mix between periods. Cancellation Rates The following table sets forth the cancellation rates for each of our homebuilding segments for the three and nine months ended September 30, 2014 and 2013: Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 2014 2013 Midwest 19.0 % 18.0 % 17.1 % 18.6 % Southern 17.4 % 17.2 % 18.4 % 14.7 % Mid-Atlantic 10.1 % 15.2 % 9.4 % 11.6 % Total cancellation rate 16.2 % 16.9 % 15.7 % 15.3 % Seasonality Typically, our homebuilding operations experience significant seasonality and quarter-to-quarter variability in homebuilding activity levels. In general, homes delivered increase substantially in the second half of the year compared to the first half of the year. We believe that this seasonality reflects the tendency of homebuyers to shop for a new home in the spring with the goal of closing in the fall or winter, as well as the scheduling of construction to accommodate seasonal weather conditions. Our financial services operations also experience seasonality because loan originations correspond with the delivery of homes in our homebuilding operations. Year Over Year Comparison Three Months Ended September 30, 2014 Compared to Three Months Ended September 30, 2013 Midwest Region. Our Midwest region had operating income of $12.8 million for the three months ended September 30, 2014, a $7.7 million increase from our operating income of $5.1 million for the three months ended September 30, 2013. The increase in operating income was primarily the result of a $35.6 million improvement in our homebuilding revenue, offset partially by a $1.7 million increase in selling, general, and administrative expense. For the quarter ended September 30, 2014, homebuilding revenue in our Midwest region increased $35.6 million, from $82.7 million in the third quarter of 2013 to $118.3 million in the third quarter of 2014. This 43% increase in homebuilding revenue was the result of a 14% increase in the average sales price of homes delivered ($38,000 per home delivered), a 24% increase in the number of homes delivered (74 units) and a $1.2 million increase in land sale revenue. Our homebuilding gross margin improved $9.4 million and yielded a gross margin percentage of 19.3% for the quarter ended September 30, 2014, a 310 basis point 37 -------------------------------------------------------------------------------- improvement when compared to the same period in 2013. This gross margin improvement resulted primarily from the revenue improvements described above as well as a $1.5 million decrease in asset impairment charges taken in the third quarter of 2014 compared to the same period in 2013, partially offset by higher lot and construction costs related to both the mix of homes delivered and cost increases in labor and materials associated with housing market conditions and normal supply and demand dynamics. Selling, general and administrative expense increased $1.7 million, from $8.3 million for the quarter ended September 30, 2013 to $10.0 million for the quarter ended September 30, 2014 but declined as a percentage of revenue to 8.5% compared to 10.0% for the same period in 2013. The increase in selling, general and administrative expense was attributable, in part, to a $1.9 million increase in selling expense, which was primarily due to (1) a $1.3 million increase in variable selling expenses resulting from increases in sales commissions produced by the higher average sales price of homes delivered and number of homes delivered and (2) a $0.6 million increase in expenses primarily related to our design centers and sales offices. The increase in selling, general and administrative expense was offset, in part, by a decrease in general and administrative expense, which was primarily due to a decrease in land related expenses. During the three months ended September 30, 2014, we experienced a 2% increase in new contracts in our Midwest region, from 318 in the third quarter of 2013 to 325 for the third quarter of 2014. Backlog increased 10% from 643 homes at September 30, 2013 to 707 homes at September 30, 2014, with an average sales price in backlog of $336,000 at September 30, 2014 compared to $297,000 at September 30, 2013. We were able to achieve positive operating results in our Midwest region compared to prior year's third quarter due to higher-end product offerings, improving sub-market conditions and more attractive community locations. During both the three months ended September 30, 2014 and 2013, we opened four communities in our Midwest region. Our monthly absorption rate in our Midwest region increased to 1.8 per community for 2014's third quarter, compared to 1.6 per community in 2013's third quarter. Southern Region. Our Southern region had operating income of $10.2 million for the quarter ended September 30, 2014, a $1.9 million increase from our operating income of $8.3 million for the third quarter of 2013. The increase in operating income was primarily the result of a $21.9 million improvement in our homebuilding revenue offset partially by a $2.6 million increase in selling, general and administrative expense. During the three months ended September 30, 2014, homebuilding revenue in our Southern region increased $21.9 million, from $96.3 million in the third quarter of 2013 to $118.2 million in the third quarter of 2014. This 23% increase in homebuilding revenue was the result of a 22% increase in the average sales price of homes delivered ($59,000 per home delivered) as a result of a change in product mix to a higher priced product in 2014 than in 2013, partially offset by a 3% decrease in the number of homes delivered (10 units). Our homebuilding gross margin improved $4.6 million and yielded a gross margin percentage of 19.1% for the quarter ended September 30, 2014 compared to 18.7% for the quarter ended September 30, 2013. The improvement in our gross margin is primarily reflective of the revenue improvements described above partially offset by higher lot and construction costs related to both the mix of homes delivered and cost increases associated with housing market conditions and normal supply and demand dynamics. Selling, general and administrative expense increased $2.6 million from $9.7 million in the third quarter of 2013 to $12.3 million in the third quarter of 2014 and increased as a percentage of revenue to 10.5% for the three months ended September 30, 2014 compared to 10.1% for the third quarter of 2013 as a result of additional expenses related to our new Austin and Dallas/Fort Worth divisions. The increase in selling, general and administrative expense was attributable, in part, to a $1.8 million increase in selling expense, which was due to (1) a $1.1 million increase in variable selling expenses resulting from increases in sales commissions from the higher average sales price of homes delivered, (2) a $0.5 million increase related to expenses associated with our new Austin and Dallas/Fort Worth markets and (3) a $0.2 million increase in expenses related to our design centers and sales offices related to our increased average community count. The increase in selling, general and administrative expense was also attributable to a $0.8 million increase in general and administrative expense, which was primarily due to a $0.6 million increase in payroll-related and other miscellaneous expenses associated with our new Austin and Dallas/Fort Worth divisions and a $0.2 million increase in compensation expenses resulting from the increase in employee count related to our community count growth. During the three months ended September 30, 2014, we experienced a 13% increase in new contracts in our Southern region, from 289 in the third quarter of 2013 to 327 for the third quarter of 2014, primarily due to contributions from our new Austin and Dallas/Fort Worth divisions. Average sales price in backlog increased to $323,000 at September 30, 2014 from $287,000 at September 30, 2013 due to improvements in the product and market mix. However, backlog decreased 11% from 590 homes at September 30, 2013 to 526 homes at September 30, 2014 due to increased competition and the opening of certain of our new communities later in the quarter than we anticipated. During the three months ended September 30, 2014, we opened seven communities in our Southern region compared to nine during 2013's third quarter. Our monthly absorption rate in our Southern region was 2.2 per community in the third quarter of 2014, the same as in the third quarter of 2013. 38 -------------------------------------------------------------------------------- Mid-Atlantic Region. Our Mid-Atlantic region had operating income of $6.5 million for the quarter ended September 30, 2014, a $1.9 million decrease from our operating income of $8.4 million in the third quarter of 2013. The decrease in operating income was primarily the result of a $2.8 million decrease in our homebuilding revenue as well as a $0.6 million increase in selling, general and administrative expense. For the three month period ended September 30, 2014, homebuilding revenue in our Mid-Atlantic region decreased $2.8 million from $89.6 million in the third quarter of 2013 to $86.7 million in the third quarter of 2014. This 3% decrease in revenue was attributable to a 6% decrease in the number of homes delivered (16 units) and a $0.5 million decrease in land sale revenue, offset, in part, by a 3% increase in the average sales price of homes delivered related to a change in product and market mix. Homebuilding gross margin declined $1.3 million compared to the third quarter of 2013 and yielded a gross margin percentage of 17.9%, compared to 18.8% for the quarter ended September 30, 2013. This decline in gross margin percentage resulted from the decline in revenue described above as well as higher construction costs related to both the mix of homes delivered and cost increases in labor and materials associated with housing market conditions and normal supply and demand dynamics. Selling, general and administrative expense increased $0.6 million from $8.4 million in the third quarter of 2013 to $9.0 million in the third quarter of 2014 and increased as a percentage of revenue from 9.4% to 10.4% as a result of upfront community costs incurred that have not yet been leveraged by the related revenue from home deliveries. The dollar increase in selling, general and administrative expense was attributable to a $0.4 million increase in selling expense, which was primarily due to an increase in expenses related to our design centers and sales offices, and a $0.2 million increase in general and administrative expense, which was due to an increase in land related expenses. During the three months ended September 30, 2014, we experienced an 8% decrease in new contracts in our Mid-Atlantic region, from 262 in the third quarter of 2013 to 240 in the third quarter of 2014, as well as a 14% decrease in the number of homes in backlog from 374 homes at September 30, 2013 to 321 homes at September 30, 2014. These declines were primarily attributable to the opening of new communities later in 2014's third quarter than the prior year, a change in product mix and the closing of certain communities that made significant contributions to the strong pace of new contracts in the third quarter of 2013. Average sales price of homes in backlog increased, however, from $341,000 at September 30, 2013 to $346,000 at September 30, 2014. We opened four communities in our Mid-Atlantic region during both the third quarter of 2014 and 2013. Our monthly absorption rate in our Mid-Atlantic region declined to 2.3 per community in the third quarter of 2014 from 2.5 per community in the third quarter of 2013 due to the decrease in new contracts compared to prior year. Financial Services. Revenue from our mortgage and title operations increased $0.9 million (13%) from $6.7 million in the third quarter of 2013 to $7.6 million in the third quarter of 2014 as a result of : (1) a 2% increase in the number of loan originations, from 689 in the third quarter of 2013 to 701 in the third quarter of 2014 and (2) a 14% increase in the average loan amount from $240,000 in the quarter ended September 30, 2013 to $274,000 in the quarter ended September 30, 2014. Operating income remained flat in the third quarter of 2014 in our mortgage and title operations compared to 2013's third quarter. While revenues increased by $0.9 million, selling general and administrative expense also increased by $0.9 million. The increase in selling, general, and administrative expense was primarily due to payroll related increases as a result of staffing offices in our Texas market. At September 30, 2014, M/I Financial provided financing services in all of our markets. Approximately 81% of our homes delivered during the third quarter of 2014 were financed through M/I Financial which was the same rate as in the third quarter of 2013. Capture rate is influenced by financing availability and can fluctuate from quarter to quarter. Corporate Selling, General and Administrative Expense. Corporate selling, general and administrative expense increased $1.5 million, from $7.0 million in the third quarter of 2013 to $8.5 million in the third quarter of 2014. The increase was primarily due to a $0.5 million increase in payroll and variable incentive compensation, a $0.4 million increase due to the absence of a bad debt recovery that occurred in the prior year's third quarter, and various other miscellaneous expense increases. Interest Expense - Net. Interest expense for the Company decreased by $0.8 million, from $3.4 million in the three months ended September 30, 2013 to $2.6 million in the three months ended September 30, 2014. This decrease was primarily the result of a decline in our weighted average borrowing rate from 7.51% in the third quarter of 2013 to 7.03% for third quarter of 2014 and increased capitalized interest as a result of our increased land development during the third quarter of 2014 compared to prior year. Partially offsetting this decrease was an increase in our weighted average borrowings from $396.8 million in 2013's third quarter to $441.1 million in 2014's third quarter related to an increase in bank borrowings attributable to higher land investment during the 2014's third quarter compared to 2013's third quarter. 39 -------------------------------------------------------------------------------- Earnings from Unconsolidated Joint Ventures. Earnings from unconsolidated joint ventures represents our portion of pre-tax earnings from our joint ownership and development agreements, joint ventures and other similar arrangements. The $0.3 million decrease in 2014 as compared to 2013 was primarily attributable to third party lot sales that occurred during 2013's third quarter. Loss on Early Extinguishment of Debt. Loss on early extinguishment of debt was attributable to the write-off of unamortized debt issuance costs associated with the termination of our Terminated Credit Facility that was scheduled to mature on December 31, 2014. During the quarter ended September 30, 2013, we recognized a loss on early extinguishment of debt of $1.7 million. Income Taxes. Our overall effective tax rate was 38.7% for the three months ended September 30, 2014 and (811.2)% for the same period in 2013. Our 2014 effective tax rate primarily reflects tax expense of $8.6 million. The effective rate for the three months ended September 30, 2013 was not meaningful due to the effects of the deferred tax asset valuation allowance and federal and state tax net operating losses ("NOLs"), and there is no correlation between the effective tax rate and the amount of pre-tax income for the period. We expect our effective combined federal and state tax rate for the remainder of 2014 will be approximately 39.4% barring any changes in tax status and any change in our ability to recover remaining state tax loss carryforwards that did not meet the "more likely than not criteria." Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013 Midwest Region. Our Midwest region had operating income of $26.8 million for the nine months ended September 30, 2014, a $15.1 million increase from our operating income of $11.7 million for the nine months ended September 30, 2013. The increase in operating income was primarily the result of a $60.6 million increase in our homebuilding revenue, offset, in part, by a $4.4 million increase in selling, general, and administrative expense. For the nine months ended September 30, 2014, homebuilding revenue in our Midwest region increased $60.6 million, from $222.9 million for the nine months ended September 30, 2013 to $283.5 million for the nine months ended September 30, 2014. This 27% increase in homebuilding revenue was the result of a 14% increase in the average sales price of homes delivered ($37,000 per home delivered), an 11% increase in the number of homes delivered (94 units) and a $1.6 million increase in land sale revenue. Our homebuilding gross margin improved $19.5 million and yielded a gross margin percentage of 19.3% for the first nine months of 2014, a 350 basis point improvement when compared to the same period in 2013. This gross margin percentage improvement resulted primarily from the revenue improvements described above as well as a $2.8 million decrease in asset impairment charges taken in the nine months ended September 30, 2014 compared to the same period in 2013, partially offset by higher lot and construction costs related to both the mix of homes delivered and cost increases in labor and materials associated with housing market conditions and normal supply and demand dynamics. Selling, general and administrative expense increased $4.4 million from $23.5 million for the nine months ended September 30, 2013 to $27.9 million for the nine months ended September 30, 2014 but declined as a percentage of revenue to 9.8% for the nine months ended September 30, 2014 from 10.5% for the nine months ended September 30, 2013. The increase in selling, general and administrative expense was attributable, in part, to a $4.2 million increase in selling expense, which was primarily due to (1) a $2.4 million increase in variable selling expenses resulting from increases in sales commissions produced by the higher average sales price of homes delivered and number of homes delivered and (2) a $1.8 million increase in expenses primarily related to our design centers and sales offices. The increase in selling, general and administrative expense was also attributable to an increase in general and administrative expense, which was primarily due to a $0.9 million increase in compensation expense resulting primarily from the increase in employee count related to our backlog growth, offset partially by a $0.4 million decrease in professional fees and a $0.3 million decrease in land-related expenses. During the nine months ended September 30, 2014, we experienced a 3% increase in new contracts in our Midwest region, from 1,062 in the nine months ended September 30, 2013 to 1,093 for the nine months ended September 30, 2014. Backlog increased 10% from 643 homes at September 30, 2013 to 707 homes at September 30, 2014, with an average sales price in backlog of $336,000 at September 30, 2014 compared to $297,000 at September 30, 2013. Despite the impact of harsh winter weather conditions and a moderation in the overall housing market when compared to 2013's same period, we were able to achieve positive operating results in our Midwest region compared to prior year's first nine months due to higher-end product offerings, improving sub-market conditions and more attractive community locations. During the nine months ended September 30, 2014, we opened 10 new communities in our Midwest region compared to 14 during 2013's first nine months. Our monthly absorption rate in our Midwest region was 1.9 per community in the nine months ended September 30, 2014, the same as in the nine months ended September 30, 2013. Southern Region. Our Southern region had operating income of $24.7 million for the nine months ended September 30, 2014, a $9.5 million increase from our operating income of $15.2 million for the nine months ended September 30, 2013. The increase 40 -------------------------------------------------------------------------------- in operating income was primarily the result of an $83.3 million improvement in our homebuilding revenue, offset, in part, by an $8.3 million increase in selling, general, and administrative expense. During the nine months ended September 30, 2014, homebuilding revenue in our Southern region increased $83.3 million, from $216.2 million in the nine months ended September 30, 2013 to $299.5 million in the nine months ended September 30, 2014. This 39% increase in homebuilding revenue was the result of a 20% increase in the number of homes delivered (155 units), a 14% increase in the average sales price of homes delivered ($38,000 per home delivered), and a $5.0 million increase in land sale revenue (as our homebuilding operations occasionally generate revenue from the sale of land and lots in addition to home sales). Our homebuilding gross margin increased $17.9 million and yielded a gross margin percentage of 19.4% for the nine months ended September 30, 2014 compared to 18.5% for the nine months ended September 30, 2013. The improvement in our gross margin percentage was primarily reflective of the improvements in the average sales price of homes delivered and the number of homes delivered described above, offset partially by a $0.9 million decrease in profit from the sale of land, compared to the nine months ended September 30, 2013, as well as higher construction and lot costs related to both the mix of homes delivered and cost increases in labor and materials associated with housing market conditions and normal supply and demand dynamics. Selling, general and administrative expense increased $8.3 million from $24.9 million in the nine months ended September 30, 2013 to $33.2 million in the nine months ended September 30, 2014 but declined as a percentage of revenue to 11.1% for the nine months ended September 30, 2014 from 11.5% for the nine months ended September 30, 2013. The increase in selling, general and administrative expense was attributable, in part, to a $5.8 million increase in selling expense, which was due to (1) a $4.1 million increase in variable selling expenses, which resulted from increases in sales commissions due to the higher average sales price of homes delivered and number of homes delivered, (2) a $1.0 million increase related to expenses associated with our new Austin and Dallas/Fort Worth markets and (3) a $0.7 million increase in expenses related to our design centers and sales offices as a result of our increased average community count. The increase in selling, general and administrative expense was also attributable to a $2.5 million increase in general and administrative expense, which was primarily due to a $1.6 million increase associated with our new Austin and Dallas/Fort Worth markets, a $0.4 million increase in land-related expenses, and a $0.3 million increase in compensation expense resulting primarily from the increase in employee count related to our average community count growth, as well as other miscellaneous expense increases. Average sales price in backlog increased to $323,000 at September 30, 2014 from $287,000 at September 30, 2013 due to product and market mix. However, during the nine months ended September 30, 2014, we experienced a 2% decrease in new contracts in our Southern region, from 1,043 in the nine months ended September 30, 2013 to 1,026 for the nine months ended September 30, 2014. Backlog also decreased 11% from 590 homes at September 30, 2013 to 526 homes at September 30, 2014. We believe the declines in new contracts and backlog were attributable to increased competition, the opening of certain new communities later in the quarter than we anticipated, and the closing of certain communities that made significant contributions to the strong pace of new contracts in the third quarter of 2013. Additionally, comparing new contracts levels in the nine months ended September 30, 2014 with the nine months ended September 30, 2013 was challenging as a result of our strong level of new contracts in the nine months ended September 30, 2013, which represented a 48% increase compared to 2012's first nine month period. During the nine months ended September 30, 2014, we opened 15 new communities in our Southern region compared to 21 during 2013's first nine months. Our monthly absorption rate in our Southern region declined from 2.9 per community in the nine months ended September 30, 2013 to 2.2 per community in the nine months ended September 30, 2014 due to an increase in the number of average communities during the nine months ended September 30, 2014 compared to 2013's first nine months as well as due to the decline in new contracts discussed above. Mid-Atlantic Region. Our Mid-Atlantic region had operating income of $18.9 million for the nine months ended September 30, 2014, a $0.1 million decrease from our operating income of $19.0 million in the nine months ended September 30, 2013. The decrease in operating income was primarily the result of a $2.7 million increase in selling, general and administrative expense and a $0.6 million decrease in profit relating to the sale of land to third parties, offset partially by a $3.3 million improvement in our homebuilding revenue. For the nine month period ended September 30, 2014, homebuilding revenue in our Mid-Atlantic region increased $3.3 million from $239.1 million in the nine months ended September 30, 2013 to $242.4 million in the nine months ended September 30, 2014. This 1% increase in revenue was attributable to a 2% increase in the number of homes delivered (15 units) and a 1% increase in the average sales price of homes delivered ($2,000 per home delivered), offset, in part, by a $3.5 million decrease in land sale revenue. Homebuilding gross margin increased $2.6 million compared to the nine months ended September 30, 2013 and yielded a gross margin percentage of 18.3%, which represents an 80 basis point improvement when compared to 17.5% for the nine months ended September 30, 2013. This improvement in gross margin resulted from gains due to a shift in product and market mix partially offset by higher construction costs related to both the mix of homes delivered and cost increases in labor and materials associated with improving housing market conditions and normal supply and demand dynamics. 41 -------------------------------------------------------------------------------- Selling, general and administrative expense increased $2.7 million from $22.9 million in the nine months ended September 30, 2013 to $25.6 million in the nine months ended September 30, 2014 and increased as a percentage of revenue from 9.6% to 10.6% as a result of upfront community costs incurred that have not yet been leveraged by the related revenue due to delays in community openings. The increase in selling, general and administrative expense was attributable, in part, to a $0.9 million increase in selling expense, which was due to an increase in expenses related to our design centers and sales offices related to our increased average community count. The increase in selling, general and administrative expense was attributable, in part, to a $1.8 million increase in general and administrative expense, which was primarily due to the absence of a $0.7 million bad debt recovery that occurred in the first quarter of 2013, a $0.5 million increase related to higher incentive compensation due to improved operating results, a $0.4 million increase in compensation expenses resulting primarily from the increase in employee count related to our average community count, and a $0.2 million increase in land-related expenses. During the nine months ended September 30, 2014, we experienced a 13% decrease in new contracts in our Mid-Atlantic region, from 889 in the nine months ended September 30, 2013 to 771 in the nine months ended September 30, 2014 as well as a 14% decrease in the number of homes in backlog from 374 homes at September 30, 2013 to 321 homes at September 30, 2014. These declines were primarily attributable to delayed openings of certain new communities resulting from harsh weather conditions in the first quarter that impacted our new contract results and the closing of certain communities that made significant contributions to the strong pace of new contracts in the third quarter of 2013. The average sales price of homes in backlog increased from $341,000 at September 30, 2013 to $346,000 at September 30, 2014. During the nine months ended September 30, 2014, we opened 12 new communities in our Mid-Atlantic region compared to 12 during 2013's first nine months. Our monthly absorption rate in our Mid-Atlantic region declined to 2.4 per community in the nine months ended September 30, 2014 from 2.9 per community in the same period in 2013 due to the decrease in new contracts described above as well as the increase in our average community count compared to prior year. Financial Services. Loan originations of our mortgage and title operations increased 1% from 1,783 in the nine months ended September 30, 2013 to 1,801 in the nine months ended September 30, 2014, and we experienced a 9% increase in the average loan amount from $239,000 in the nine months ended September 30, 2013 to $261,000 in the nine months ended September 30, 2014. Despite these increases, our revenue from our mortgage and title operations decreased $0.4 million (2%) from $22.3 million in the nine months ended September 30, 2013 to $21.9 million in the nine months ended September 30, 2014. This decline in revenue was primarily attributable to lower margins on the loans sold compared to 2013's first nine months. During the first nine months of 2013, we experienced higher profit margins on our loan sales and servicing retained transactions as supply and demand factors were more favorable and the refinance market was stronger during that time. Additionally, the product mix of our loans sold continued to shift from government to conventional financing, which generally yields lower margins on sale. Competition in the industry has also recently increased, partially as the result of the mortgage industry's lower refinancing volume. We expect this increased level of competition, and a more challenging pricing environment, to continue for the foreseeable future. For the nine months ended September 30, 2014, we experienced a $1.2 million decrease in operating income in our mortgage and title operations compared to the nine months ended September 30, 2013, which was due to the decrease in revenue discussed above and an increase in selling, general and administrative expenses. Selling, general, and administrative expense for our mortgage and title operations increased $0.8 million for the nine months ended September 30, 2014 compared to the same period in 2013 primarily due to an increase in payroll related expenses as a result of staffing offices in our new Texas markets, offset partially by a $1.1 million decrease in expenses related to mortgage loans sold. At September 30, 2014, M/I Financial provided financing services in all of our markets. Approximately 78% of our homes delivered during the nine months ended September 30, 2014 were financed through M/I Financial compared to 79% in the same period in 2013. Capture rate is influenced by financing availability and can fluctuate up or down from quarter to quarter. Corporate Selling, General and Administrative Expense. Corporate selling, general and administrative expense increased $3.4 million, from $19.7 million in the nine months ended September 30, 2013 to $23.1 million in the nine months ended September 30, 2014. The increase was primarily due to a $1.2 million increase in share based and variable incentive compensation associated with our improved financial performance, a $0.7 million increase in payroll related expenses, a $0.4 million increase due to the absence of a bad debt recovery that occurred in the prior year, a $0.4 million increase in professional fees, and various other miscellaneous expense increases. Interest Expense - Net. Interest expense for the Company decreased $2.7 million, from $12.2 million for the nine months ended September 30, 2013 to $9.5 million for the nine months ended September 30, 2014. This decrease was primarily the result of a decline in our weighted average borrowing rate from 7.67% in the nine months ended September 30, 2013 to 7.23% for 2014's first nine months due to the addition of our 2018 Convertible Senior Subordinated Notes issuance, which has a significantly lower interest rate compared to our other debt outstanding in the first nine months of 2013, as well as an increase in capitalized interest 42 -------------------------------------------------------------------------------- related to our increased land development in the nine months ended September 30, 2014 compared to the prior year period. Partially offsetting this decrease was an increase in our weighted average borrowings from $387.2 million in the nine months ended September 30, 2013 to $416.5 million in nine months ended September 30, 2014 related to the issuance of $86.3 million aggregate principal amount of 2018 Convertible Senior Subordinated Notes in the first quarter of 2013 as well as due to an increase in bank borrowings during 2014's first nine months compared to the same period in 2013. Earnings from Unconsolidated Joint Ventures. Earnings from unconsolidated joint ventures represents our portion of pre-tax earnings from our joint ownership and development agreements, joint ventures and other similar arrangements. The $0.2 million decrease in 2014 as compared to 2013 is primarily attributable to third party lot sales that occurred during prior year's third quarter. Loss on Early Extinguishment of Debt. Loss on early extinguishment of debt was attributable to the write-off of unamortized debt issuance costs associated with the termination of our Terminated Credit Facility that was scheduled to mature on December 31, 2014. During the nine months ended September 30, 2013, we recognized a loss on early extinguishment of debt of $1.7 million. Income Taxes. Our overall effective tax rate was 20.4% for the nine months ended September 30, 2014 and (426.9)% for the same period in 2013. Our 2014 effective tax rate primarily reflects tax expense of $19.5 million, offset by the reversal of $9.3 million of our state deferred tax asset valuation allowance. The effective rate is not reflective of our historical tax rate or our effective tax rate in future periods due to our state deferred tax asset valuation allowance. We expect our effective combined federal and state tax rate for the remainder of 2014 will be approximately 39.4% barring any changes in tax status and change in ability to recover remaining state tax loss carryforwards that did not meet the "more likely than not criteria." LIQUIDITY AND CAPITAL RESOURCES Overview of Capital Resources and Liquidity. At September 30, 2014, we had $26.1 million of cash, cash equivalents and restricted cash, with $17.2 million of this amount comprised of unrestricted cash and cash equivalents, which represents a $111.6 million decrease in unrestricted cash and cash equivalents from December 31, 2013. This decrease was primarily a result of our increased investment in inventory during the nine months ended September 30, 2014. Our principal uses of cash for the nine months ended September 30, 2014 were investment in land and land development, construction of homes, mortgage loan originations, investment in joint ventures, operating expenses, and short-term working capital and debt service requirements, including the repayment of amounts outstanding under our credit lines. In order to fund these uses of cash, we used proceeds from home deliveries and the sale of mortgage loans, as well as excess cash balances, borrowings under our credit facilities, and other sources of liquidity. We are actively acquiring and developing lots in our markets to replenish and grow our lot supply and active community count. We expect to continue to expand our business based on the anticipated level of demand for new homes in our markets. Accordingly, we expect our cash outlays for land purchases, land development, home construction and operating expenses will continue to exceed our cash generated by operations in the remaining three months of 2014. For this reason, we expect to continue to utilize our revolving credit facility. During the nine months ended September 30, 2014, we delivered 2,616 homes, started 3,133 homes, and spent $183.7 million on land purchases and $93.2 million on land development. Based upon our business activity levels, market conditions, and opportunities for land in our markets, we currently estimate that we will spend approximately $375 million to $425 million on land purchases and land development during 2014, including the $276.9 million spent during the nine months ended September 30, 2014. We also continue to enter into land option agreements, taking into consideration current and projected market conditions, to secure land for the construction of homes in the future. Pursuant to these land option agreements, as of September 30, 2014, we have the right to purchase $475.6 million of land and lots during the remainder of 2014 through 2021. Land transactions are subject to a number of factors, including our financial condition and market conditions, as well as satisfaction of various conditions related to specific properties. We will continue to monitor market conditions and our ongoing pace of home deliveries and adjust our land spending accordingly. The planned increase in our land spending in 2014 compared to 2013 is driven primarily by our growth objectives as we expand our business. In addition, we expect that a larger portion of our land investment will continue to shift from developed lot purchases to land acquisition and development, which will result in increased inventory levels. Operating Cash Flow Activities. During the nine month period ended September 30, 2014, we used $106.7 million of cash in operating activities, compared to using $40.4 million of cash in operating activities during the nine months ended September 30, 2013. The increase in cash used in operating activities was primarily due to a $53.5 million increase in the change in inventory 43 --------------------------------------------------------------------------------due to our increased land investment compared with the nine months ended September 30, 2013, as well as a $10.5 million reduction in the net increase of accounts payable. Investing Cash Flow Activities. During the nine months ended September 30, 2014, we used $11.5 million of cash in investing activities, compared to using $32.9 million of cash in investing activities during the nine months ended September 30, 2013. The $21.4 million decrease was partially due to the change in restricted cash, which decreased $12.2 million from the nine months ended September 30, 2013, as the Company pledged less cash as collateral in accordance with our secured Letter of Credit Facilities. In addition, we invested $8.7 million more in our unconsolidated joint ventures during the nine months ended September 30, 2013 compared to the nine months ended September 30, 2014 primarily due to our entry into joint investments with other builders in two separate land developments in our Southern region in the first nine months of 2013. Financing Cash Flow Activities. During the nine months ended September 30, 2014, we generated $6.7 million of cash from financing activities, compared to generating $70.3 million of cash during the nine months ended September 30, 2013. The change in cash from financing activities was primarily due to the absence of any debt or equity capital financing transactions or preferred share redemptions in 2014, compared with the first nine months of 2013, when $140.9 million of proceeds were received from equity and convertible debt financings, and $50.4 million of cash was used for the redemption of preferred shares. At September 30, 2014 and December 31, 2013, our ratio of net debt to net capital was 45% and 39%, respectively, calculated as total debt minus total cash, cash equivalents and restricted cash, divided by the sum of total debt minus total cash, cash equivalents and restricted cash plus shareholders' equity. The increase compared to December 31, 2013 was due to a decrease in our cash balance compared to December 31, 2013 due to our increased investment in inventory during the nine months ended September 30, 2014 as well as an increase in shareholders' equity, primarily related to our net earnings. We believe that this ratio provides useful information regarding our financial position, for understanding the leverage employed in our operations and for comparing us with other homebuilders. We fund our operations with cash flows from operating activities, including proceeds from home closings and the sale of mortgage loans. We believe that these sources of cash, along with our balance of unrestricted cash and borrowing available under our credit facilities, will be sufficient to fund our currently anticipated working capital needs, investment in land and land development, construction of homes, operating expenses, planned capital spending, and debt service requirements for at least the next twelve months. In order to increase the amount available for borrowings under our credit facilities and enhance our liquidity, in October 2014 we increased the aggregate commitment amount and extended the maturity date of our primary homebuilding credit facility as described below. In addition, we routinely monitor current operational requirements, financial market conditions, and credit relationships and we may choose to seek additional capital by issuing new debt and/or equity securities to strengthen our liquidity or our long-term capital structure. The financing needs of our homebuilding and financial services operations depend on anticipated sales volume in the current year as well as future years, inventory levels and related turnover, forecasted land and lot purchases, debt maturity dates, and other factors. If we seek such additional capital, there can be no assurance that we would be able to obtain such additional capital on terms acceptable to us, if at all, and such additional equity or debt financing could dilute the interests of our existing shareholders and/or increase our interest costs. The Company is a party to three primary credit agreements: (1) a $300 million unsecured revolving credit facility dated July 18, 2013 (the "Prior Credit Facility"), as amended by a First Amendment dated October 20, 2014, with M/I Homes, Inc. as borrower and guaranteed by the Company's wholly owned homebuilding subsidiaries (as amended, the "Amended Credit Facility"); (2) a $110 million secured mortgage warehousing agreement, with M/I Financial as borrower, amended on March 28, 2014 (the "MIF Mortgage Warehousing Agreement"); and (3) a $15 million mortgage repurchase agreement, with M/I Financial as borrower, amended on November 6, 2013 (the "MIF Mortgage Repurchase Facility"). 44 -------------------------------------------------------------------------------- Included in the table below is a summary of our available sources of cash from the Prior Credit Facility, the MIF Mortgage Warehousing Agreement and the MIF Mortgage Repurchase Facility as of September 30, 2014: Expiration Outstanding Available (In thousands) Date Balance Amount Notes payable - homebuilding (a) 7/18/2016 $ 14,400 $ 165,992 Notes payable - financial services (b) (b) $ 73,778 $ 589 (a) The available amount under the Prior Credit Facility was computed in accordance with the borrowing base calculation, which totaled $358.6 million of availability at September 30, 2014, such that the full $200 million commitment amount of the facility was available, less any borrowings and letters of credit outstanding. There were $14.4 million in borrowings and $19.6 million of letters of credit outstanding at September 30, 2014, leaving $166.0 million available. The Amended Credit Facility will expire on October 20, 2018. (b) The available amount is computed in accordance with the borrowing base calculations under the MIF Mortgage Warehousing Agreement and the MIF Mortgage Repurchase Facility, each of which may be increased by pledging additional mortgage collateral. The maximum aggregate commitment amount of M/I Financial's warehousing agreements is $125 million. The MIF Mortgage Warehousing Agreement has an expiration date of March 27, 2015 and the MIF Mortgage Repurchase Facility has an expiration date of November 5, 2014. M/I Financial expects to enter into an amendment to the MIF Mortgage Repurchase Facility prior to its expiration that would extend its term for an additional year, but M/I Financial can provide no assurances that it will be able to obtain such an extension. Notes Payable - Homebuilding. Homebuilding Credit Facility. The Amended Credit Facility provides for an aggregate commitment amount of $300 million, including a $125 million sub-facility for letters of credit. In addition, the Amended Credit Facility has an accordion feature under which the Company may increase the aggregate commitment amount up to $400 million, subject to certain conditions, including obtaining additional commitments from existing or new lenders. The Amended Credit Facility matures on October 20, 2018. Interest on amounts borrowed under the Amended Credit Facility is payable at either the Alternate Base Rate plus an initial margin of 150 basis points, or at the Eurodollar Rate plus a margin of 250 basis points, in each case subject to adjustment based on the Company's leverage ratio. Borrowings under the Amended Credit Facility are unsecured and availability is subject to, among other things, a borrowing base calculated using various advance rates for different categories of inventory. The Amended Credit Facility contains various representations, warranties and affirmative, negative and financial covenants which require, among other things, that the Company maintain (1) a minimum level of Consolidated Tangible Net Worth of $353.9 million (which amount is subject to increase over time based on earnings and proceeds from equity offerings subsequent to June 30, 2014), (2) a leverage ratio not in excess of 60%, and (3) either a minimum Interest Coverage Ratio of 1.5 to 1.0 or a minimum liquidity amount. In addition, the Amended Credit Facility contains covenants that limit the amount of the Company's unsold owned land not to exceed 125% of the sum of tangible net worth and subordinated debt, secured indebtedness not to exceed $30.0 million, and the number of unsold housing units and model homes, as well as the amount of Investments in Unrestricted Subsidiaries and Joint Ventures. At closing of the Amended Credit Facility on October 20, 2014, we were in compliance with all closing conditions including all covenants. For more information regarding the terms of the Amended Credit Facility, refer to Note 12 of our Unaudited Condensed Consolidated Financial Statements. As of September 30, 2014, the Company was in compliance with all covenants of the Prior Credit Facility. Homebuilding Letter of Credit Facilities. The Company is party to three secured credit agreements for the issuance of letters of credit outside of the Amended Credit Facility (collectively, the "Letter of Credit Facilities"). During the three months ended September 30, 2014, the Company extended the maturity dates of two of the Letter of Credit Facilities for an additional year to August 31, 2015 and September 30, 2015, respectively. The maturity dates for the Letter of Credit Facilities range from June 1, 2015 to September 30, 2015. Under the terms of the Letter of Credit Facilities, letters of credit can be issued for maximum terms ranging from one year up to three years. The Letter of Credit Facilities contain cash collateral requirements ranging from 101% to 105%. Upon maturity or the earlier termination of the Letter of Credit Facilities, letters of credit that have been issued under the Letter of Credit Facilities remain outstanding with cash collateral in place through the respective expiration dates. The agreements governing the Letter of Credit Facilities contain limits for the issuance of letters of credit ranging from $5.0 million to $10.0 million, for a combined letter of credit capacity of $20.0 million, of which $2.3 million was uncommitted at September 30, 2014 and could be withdrawn at any time. As of September 30, 2014, there was a total of $8.6 million of letters of credit issued under the Letter of Credit Facilities, which was collateralized with $8.8 million of restricted cash. 45 --------------------------------------------------------------------------------Notes Payable - Financial Services. MIF Mortgage Warehousing Agreement. The MIF Mortgage Warehousing Agreement is used to finance eligible residential mortgage loans originated by M/I Financial. The Agreement provides a maximum borrowing availability of $110.0 million and an accordion feature which allows for an increase of the maximum borrowing availability of up to an additional $20.0 million (subject to certain conditions, including obtaining additional commitments from existing or new lenders). The MIF Mortgage Warehousing Agreement has an expiration date of March 27, 2015. The maximum principal amount permitted to be outstanding at any one time in aggregate under all warehouse credit lines is $150.0 million. Effective with the quarter ending September 30, 2014, the minimum required tangible net worth requirement applicable to M/I Financial increased from $10.0 million to $11.0 million and the minimum required liquidity requirement applicable to M/I Financial increased from $5.0 million to $5.5 million. M/I Financial pays interest on each advance under the MIF Mortgage Warehousing Agreement at a per annum rate equal to the greater of (1) the floating LIBOR rate plus 275 basis points and (2) 3.0%. The MIF Mortgage Warehousing Agreement is secured by certain mortgage loans originated by M/I Financial and that are being "warehoused" prior to their sale to investors. The MIF Mortgage Warehousing Agreement provides for limits with respect to certain loan types that can secure outstanding borrowings. There are currently no guarantors of the MIF Mortgage Warehousing Agreement, although M/I Financial may, at its election, designate from time to time any one or more of its subsidiaries as guarantors. As of September 30, 2014, there was $60.1 million outstanding under the MIF Mortgage Warehousing Agreement and M/I Financial was in compliance with all covenants. The financial covenants, as more fully described and defined in the MIF Mortgage Warehousing Agreement, are summarized in the following table, which also sets forth M/I Financial's compliance with such covenants as of September 30, 2014: Financial Covenant Covenant Requirement Actual (Dollars in millions) Leverage Ratio ? 10.0 to 1.0 6.52 to 1.0 Liquidity ? $ 5.5 $ 11.4 Adjusted Net Income > $ 0.0 $ 5.6 Tangible Net Worth ? $ 11.0 $ 12.6 MIF Mortgage Repurchase Facility. In November 2012, M/I Financial entered into the MIF Mortgage Repurchase Facility, an additional mortgage financing agreement structured as a mortgage repurchase facility with a maximum borrowing availability of $15.0 million, to provide the Company with additional financing capacity. The MIF Mortgage Repurchase Facility, as amended on November 6, 2013, has an expiration date of November 5, 2014 and is used to finance eligible residential mortgage loans originated by M/I Financial. M/I Financial pays interest on each advance under the MIF Mortgage Repurchase Facility at a per annum rate equal to the floating LIBOR rate plus 275 or 300 basis points depending on the loan type. The covenants in the MIF Mortgage Repurchase Facility are substantially similar to the covenants in the MIF Mortgage Warehousing Agreement. The MIF Mortgage Repurchase Facility provides for limits with respect to certain loan types that can secure outstanding borrowings, which are similar to the restrictions in the MIF Mortgage Warehousing Agreement. There are currently no guarantors of the MIF Mortgage Repurchase Facility. As of September 30, 2014, there was $13.6 million outstanding under the MIF Mortgage Repurchase Facility. M/I Financial was in compliance with all covenants as of September 30, 2014. As is typical for similar credit facilities in the mortgage origination industry, at closing, the expiration of the MIF Mortgage Repurchase Facility was set at approximately one year and is under consideration for extension annually by the lender. M/I Financial expects to enter into an amendment to the MIF Mortgage Repurchase Facility prior to its expiration that would extend its term for an additional year, but M/I Financial cannot provide any assurance that it will be able to obtain such an extension. 46 --------------------------------------------------------------------------------Senior Notes and Convertible Senior Subordinated Notes. 8.625% Senior Notes. In November 2010, the Company issued $200 million aggregate principal amount of 8.625% Senior Notes due 2018. In May 2012, we issued an additional $30 million of 2018 Senior Notes under our 2018 Senior Notes indenture for a total outstanding balance of $230 million. The Company may redeem all or any portion of the 2018 Senior Notes on or after November 15, 2014 at a stated redemption price, together with accrued and unpaid interest thereon. The redemption price will initially be 104.313% of the principal amount outstanding, but will decline to 102.156% of the principal amount outstanding if redeemed during the 12-month period beginning on November 15, 2015, and will further decline to 100.000% of the principal amount outstanding if redeemed on or after November 15, 2016, but prior to maturity. See Note 7 to the Condensed Consolidated Financial Statements for more information regarding the 2018 Senior Notes. 3.0% Convertible Senior Subordinated Notes. In March 2013, the Company issued $86.3 million aggregate principal amount of 3.0% Convertible Senior Subordinated Notes due 2018. The conversion rate initially equals 30.9478 shares per $1,000 of their principal amount. This corresponds to an initial conversion price of approximately $32.31 per common share, which equates to approximately 2.7 million common shares. See Note 7 to the Condensed Consolidated Financial Statements for more information regarding the 2018 Convertible Senior Subordinated Notes. 3.25% Convertible Senior Subordinated Notes. In September 2012, the Company issued $57.5 million aggregate principal amount of 3.25% Convertible Senior Subordinated Notes due 2017. The conversion rate initially equals 42.0159 shares per $1,000 of principal amount. This corresponds to an initial conversion price of approximately $23.80 per common share which equates to approximately 2.4 million common shares. See Note 7 to the Condensed Consolidated Financial Statements for more information regarding the 2017 Convertible Senior Subordinated Notes. Weighted Average Borrowings. For the three months ended September 30, 2014 and 2013, our weighted average borrowings outstanding were $441.1 million and $396.8 million, respectively, with a weighted average interest rate of 7.03% and 7.51%, respectively. The decline in our weighted average borrowing rate was attributable to increased capitalized interest related to our increased land development during the third quarter of 2014 compared to prior year. The increase in our weighted average borrowings related to an increase in bank borrowings during the quarter compared to 2013's third quarter. At September 30, 2014, we had $14.4 million outstanding under the Prior Credit Facility. During the nine months ended September 30, 2014, the average daily amount outstanding under the Prior Credit Facility was $4.9 million and the maximum amount outstanding under the Prior Credit Facility was $41.4 million. Based on our current anticipated spending on land acquisition and development in 2014, and associated increases in our investment in inventory, including land and houses under construction, we expect to borrow under the Amended Credit Facility during the fourth quarter of 2014, with the estimated peak amount outstanding not anticipated to exceed $100 million. The actual amount borrowed in the fourth quarter of 2014 (and the estimated peak amount outstanding) and related timing are subject to numerous factors, including the timing and amount of land and house construction expenditures, payroll and other general and administrative expenses, cash receipts from home closings, other cash receipts and payments, any capital markets transactions or other additional financings by the Company and any repayments or redemptions of outstanding debt. The Company may experience significant variation in cash and balances under the Amended Credit Facility from week to week due to the timing of such receipts and payments. There were $19.6 million of letters of credit issued and outstanding under the Prior Credit Facility at September 30, 2014. During the nine months ended September 30, 2014, the average daily amount of letters of credit outstanding under the Prior Credit Facility was $15.9 million and the maximum amount of letters of credit outstanding under the Prior Credit Facility was $19.6 million. At September 30, 2014, M/I Financial had $60.1 million outstanding under the MIF Mortgage Warehousing Agreement. During the nine months ended September 30, 2014, the average daily amount outstanding under the MIF Mortgage Warehousing Agreement was $25.3 million and the maximum amount outstanding was $68.2 million. At September 30, 2014, M/I Financial had $13.6 million outstanding under the MIF Mortgage Repurchase Facility. During the nine months ended September 30, 2014, the average daily amount outstanding under the MIF Mortgage Repurchase Facility was $5.6 million and the maximum amount outstanding was $14.9 million. Preferred Shares. On March 15, 2007, we issued 4,000,000 depositary shares, each representing 1/1000th of a Series A Preferred Share, or 4,000 Series A Preferred Shares in the aggregate, for net proceeds of $96.3 million. The Series A Preferred Shares have a liquidation preference equal to $25 per depositary share (plus an amount equal to all accrued and unpaid dividends (whether or not earned or declared) for the then current quarterly dividend period accrued to but excluding the date of final distribution). Dividends on the Series A Preferred Shares are non-cumulative and, if declared by us, are paid at an annual rate of 9.75%. Dividends 47 -------------------------------------------------------------------------------- are payable quarterly in arrears, if declared by us, on March 15, June 15, September 15 and December 15. If there is a change of control of the Company and if the Company's corporate credit rating is withdrawn or downgraded to a certain level (together constituting a "change of control event"), the dividends on the Series A Preferred Shares will increase to 10.75% per year. We may redeem the Series A Preferred Shares in whole or in part (provided, that any redemption that would reduce the aggregate liquidation preference of the Series A Preferred Shares below $25 million in the aggregate would be restricted to a redemption in whole only) at any time or from time to time at a cash redemption price equal to $25 per depositary share (plus an amount equal to all accrued and unpaid dividends (whether or not earned or declared) for the then current quarterly dividend period accrued to but excluding the redemption date). Holders of the Series A Preferred Shares have no right to require redemption of the Series A Preferred Shares. The Series A Preferred Shares have no stated maturity, are not subject to any sinking fund provisions, are not convertible into any other securities, and will remain outstanding indefinitely unless redeemed by us. Holders of the Series A Preferred Shares have no voting rights, except with respect to those specified matters set forth in the Company's Amended and Restated Articles of Incorporation or as otherwise required by applicable Ohio law, and no preemptive rights. The outstanding depositary shares are listed on the New York Stock Exchange under the trading symbol "MHO-PrA". There is no separate public trading market for the Series A Preferred Shares except as represented by the depositary shares. The indenture governing our 2018 Senior Notes limits our ability to pay dividends on, and repurchase, our common shares and Series A Preferred Shares to the amount of the positive balance in our "restricted payments basket," as defined in the indenture. The restricted payments basket was $145.7 million at September 30, 2014. We are permitted by the indenture to pay dividends on, and repurchase, our common shares and Series A Preferred Shares to the extent of such positive balance in our restricted payments basket. We declared and paid a quarterly dividend of $609.375 per share on our Series A Preferred Shares in third quarter of 2014 for $1.2 million and have paid $3.7 million for the nine months ended September 30, 2014. The determination to pay future dividends on, and make future repurchases of, our common shares and Series A Preferred Shares will be at the discretion of our board of directors and will depend upon our results of operations, financial condition, capital requirements and compliance with debt covenants and the terms of our Series A Preferred Shares, and other factors deemed relevant by our board of directors. Universal Shelf Registration. In October 2013, the Company filed a $400 million universal shelf registration statement with the SEC, which registration statement became effective on December 20, 2013. Pursuant to the registration statement, the Company may, from time to time, offer debt securities, common shares, preferred shares, depositary shares, warrants to purchase debt securities, common shares, preferred shares, depositary shares or units of two or more of those securities, rights to purchase debt securities, common shares, preferred shares or depositary shares, stock purchase contracts and units. The timing and amount of offerings, if any, will depend on market and general business conditions. CONTRACTUAL OBLIGATIONS There have been no material changes to our contractual obligations appearing in the Contractual Obligations section of Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2013, except for the First Amendment to the Credit Facility entered into on October 20, 2014, described above in Note 12 of our Unaudited Condensed Consolidated Financial Statements and the "Liquidity and Capital Resources" section. OFF-BALANCE SHEET ARRANGEMENTS Reference is made to Notes 2, 3, 5, and 6 in the accompanying Notes to the Unaudited Condensed Consolidated Financial Statements included in this Form 10-Q. These Notes discuss our off-balance sheet arrangements with respect to land acquisition contracts and option agreements, and land development joint ventures, including the nature and amounts of financial obligations relating to these items. In addition, these Notes discuss the nature and amounts of certain types of commitments that arise in the ordinary course of our land development and homebuilding operations, including commitments of land development joint ventures for which we might be obligated. Our off-balance sheet arrangements relating to our homebuilding operations include unconsolidated joint ventures, land option agreements, guarantees and indemnifications associated with acquiring and developing land, and the issuance of letters of credit and completion bonds. Our use of these arrangements is for the purpose of securing the most desirable lots on which to build homes for our homebuyers in a manner that we believe reduces the overall risk to the Company. Additionally, in the ordinary course of its business, our financial services operations issue guarantees and indemnities relating to the sale of loans to third parties. Land Option Agreements. In the ordinary course of business, the Company enters into land option agreements in order to secure land for the construction of homes in the future. Pursuant to these land option agreements, the Company typically provides a deposit to the seller as consideration for the right to purchase land at different times in the future, usually at predetermined 48 -------------------------------------------------------------------------------- prices. Because the entities holding the land under the option agreement may meet the criteria for VIEs, the Company evaluates all land option agreements to determine if it is necessary to consolidate any of these entities. At September 30, 2014, "Consolidated Inventory Not Owned" was $1.7 million, all of which related to specific performance obligations. At September 30, 2014, the corresponding liability of $1.7 million has been classified as Obligation for Consolidated Inventory Not Owned on our Unaudited Condensed Consolidated Balance Sheets. Other than the Consolidated Inventory Not Owned balance, the Company currently believes that its maximum exposure as of September 30, 2014 related to its land option agreements is equal to the amount of the Company's outstanding deposits and prepaid acquisition costs, which totaled $34.0 million, including cash deposits of $21.6 million, prepaid acquisition costs of $4.7 million and letters of credit of $7.7 million. Letters of Credit and Completion Bonds. The Company provides standby letters of credit and completion bonds for development work in progress, deposits on land and lot purchase agreements and miscellaneous deposits. As of September 30, 2014, the Company had outstanding $123.6 million of completion bonds and standby letters of credit, some of which were issued to various local governmental entities, that expire at various times through September 2019. Included in this total are: (1) $80.4 million of performance bonds and $14.0 million of performance letters of credit that serve as completion bonds for land development work in progress; (2) $14.2 million of financial letters of credit; and (3) $15.0 million of financial bonds. The development agreements under which we are required to provide completion bonds or letters of credit are generally not subject to a required completion date and only require that the improvements are in place in phases as houses are built and sold. In locations where development has progressed, the amount of development work remaining to be completed is typically less than the remaining amount of bonds or letters of credit due to timing delays in obtaining release of the bonds or letters of credit. Guarantees and Indemnities. In the ordinary course of business, M/I Financial enters into agreements that guarantee purchasers of its mortgage loans that M/I Financial will repurchase a loan if certain conditions occur. The risks associated with these guarantees are offset by the value of the underlying assets, and the Company accrues its best estimate of the probable loss on these loans. Additionally, the Company has provided certain other guarantees and indemnities in connection with the acquisition and development of land by our homebuilding operations. Refer to Note 5 of our Unaudited Condensed Consolidated Financial Statements for additional details relating to our guarantees and indemnities. INTEREST RATES AND INFLATION Our business is significantly affected by general economic conditions within the United States and, particularly, by the impact of interest rates and inflation. Inflation can have a long-term impact on us because increasing costs of land, materials and labor can result in a need to increase the sales prices of homes. In addition, inflation is often accompanied by higher interest rates, which can have a negative impact on housing demand and the costs of financing land development activities and housing construction. Higher interest rates also may decrease our potential market by making it more difficult for homebuyers to qualify for mortgages or to obtain mortgages at interest rates that are acceptable to them. The impact of increased rates can be offset, in part, by offering variable rate loans with lower interest rates. In conjunction with our mortgage financing services, hedging methods are used to reduce our exposure to interest rate fluctuations between the commitment date of the loan and the time the loan closes. Rising interest rates, as well as increased materials and labor costs, may reduce gross margins. An increase in material and labor costs is particularly a problem during a period of declining home prices. Conversely, deflation can impact the value of real estate and make it difficult for us to recover our land costs. Therefore, either inflation or deflation could adversely impact our future results of operations. 49-------------------------------------------------------------------------------- |