M/I Homes Inc (MHO) 2006 Q3 法說會逐字稿

At this time I would like to welcome everyone to the M/I Homes, Inc. third quarter's earnings call.

[OPERATOR INSTRUCTIONS]

It is now my pleasure to turn the floor over to your host, Mr. Phil Creek. Sir you may begin your conference.

Thank you for joining us today.

Joining me on the call from Columbus, Ohio is Bob Schottenstein, our CEO and President. First to address Regulation Fair Disclosure, we encourage you to ask any questions regarding issues that you consider material during this call, because as you know, we are prohibited from discussing significant nonpublic items with you directly.

We provided our 2006 earnings guidance in our press release. As to forward-looking statement this presentation includes forward-looking statements as characterized in the Private Securities Litigation Reform Act of 1995. Any statements that are not historical in nature are forward-looking statements that involve risk and uncertainties that could cause actual results to differ materially from those in the forward-looking statement.

Please refer to our most recent 10-K, 10-Q, and earnings press release for other factors that could cause results to differ. Be advised that the Company undertakes no obligation to update any forward-looking statements made during this call, the audio of which will be available on our website through October 26, 2007.

With that, I will turn the call over to Bob.

Thanks, Phil. Good afternoon. Thanks for joining us today.

Our results reflect the challenging conditions we are currently facing in most of our markets, along with the impact of defensive steps we are taking to manage through this cycle.

As we previously reported, our new contracts were negatively impacted by increased cancellation rates, an excess supply of both existing and new home inventory, and generally weak buyer demand. Homes delivered, while slightly up year-to-date versus last year, declined when compared to 2005's third quarter.

We are pleased that our gross margins and operating margins for the quarter, exclusive of certain special charges taken, remain solid at 25% and 10% respectively. While income for the quarter was down approximately 37% from last year, and 14% for the first 9 months, our year-to-date income was essentially flat with last year, after taking into account a $0.53 charge relating to certain special items. We believe this performance measures up very well in comparison to many other builders.

We continue to focus on our balance sheet, in particular, our land position. At September 30th, we owned 7% fewer lots than just three months ago. Currently, we estimate that we will close or deliver approximately 4,000 homes this year and earn between $5.25 and $5.75 per share on a fully diluted basis.

Before I turn things back over to Phil, I thought I would take a few moments to just offer up some general macro comments about the home building industry and some comments also about the markets in which we operate. As everyone knows, but I think many of us perhaps may have forgotten, homebuilding is a cyclical business, it always has been and it always will be.

While the length and severity of this current down cycle is not certain, we firmly believe, and we think this is a view widely shared by others, that the long-term outlook for housing is very good. Once the inventory oversupply begins to burn off, and demand improves, we believe that there is no question that we will see a return to more stable conditions.

The question is, when will this happen? Obviously, no one knows. However, from a planning standpoint, it is our view that we don't believe that things will get better next year and, perhaps, for as much as half of 2008.

During this period, we will, from a planning standpoint, remain focused on those things which is we can control and those things which we believe are key to being successful in the homebuilding business. Namely, premiere locations, designing and building quality homes, and taking -- and making every effort to take care of our customers. We believe that those builders who can differentiate and distinguish themselves particularly in these areas will prosper, not only during the difficult market conditions which we currently find ourselves in, but well into the future.

This has always been the case in the past and we believe it will be the case in the future. As for our ongoing strategy during this cycle, we remain committed to what we refer to as a quality over quantity approach. Balancing our sales pace with our desire to preserve margin integrity, we have great communities and we don't want to compromise margins unless we have to.

We are reducing margins in certain communities when it makes business sense to do so, make no mistake about that, but not as an overall blanket strategy. We do not believe that taking zero or negative margins simply to turn inventory is the most prudent position to take at this time, and, frankly, we don't think that does anyone any good.

We're a focused company, we're in the subdivision business and we will adjust our operational actions as need. We have dramatically slowed land purchases to adjust to the current environment. We will continue to vigorously and very carefully review our current land positions -- both land that we own and land that we have under contract, as we finish out this year and look forward to 2007.

We have and will continue to pursue contract modifications relating not just to pricing but also terms. And we will continue to review and work on selling positions to third parties as needed. We have terminated certain contracts and we will continue to review this and will not go forward with any deals unless they meet our stringent hurdle rates.

We have been aggressive in selling certain parcels and as of September 30th of this year, we have approximately $50 million of land under contract, which we expect to close during the next several quarters. We also will continue to be proactive in managing our expenses and right sizing our operations, balancing headcount needs with our current and projected demands.

We continue to review the responsibilities of our management team, and we feel very confident in our abilities to manage through this downturn. We've recently added a Midwest Region President to our mix, who adds to an already experienced management team, each of whom have been through difficult times before.

Let me just take a few moments to talk about our regions. First, the Midwest. Conditions continue to be challenging, may have even softened ever so slightly more so than they had during the past quarter. We continue to offer incentives to stimulate business.

We have significantly reduced our workforce in the Midwest, and we continue to monitor this as needed. Currently, our gross margins in our active communities average between 15% and 18% in Columbus, Cincinnati, and Indianapolis.

Florida continues to be a solid performer despite very difficult and challenging conditions in the greater West Palm Beach market and softening conditions throughout the state. Our September 30, 2006, average selling price of backlog units in Florida is higher than last year by nearly 30%. We are on pace to increase our community count as planned this year. And while our Tampa and Orlando markets have clearly slowed, we still continue to see fairly good margins on homes sold, ranging between 20% and 25% -- probably closer to the lower end of that range.

Our North Carolina market, specifically Charlotte, has shown very strong results this year and continues to. Traffic is good, we've increased our community counts, we're growing significantly and continue to see improving margins in our backlog in Charlotte.

We're hopeful that our competitors, perhaps with a view towards trying to get volume in this market, frankly don't trash it, because this is a good market today. We expect to close nearly 500 homes -- 550 homes in North Carolina this year, compared to less than 400 last year. We are expecting additional growth in 2007.

Washington, D.C., has experienced slower new contracts and a higher cancellation rate, similar to what other builders are experiencing. Sales prices and consequently margins are dropping considerably in this market, as we struggle with the three I's -- investors, and the overhang from investor resale; inventory, the excess supply; and incentives, the deep discounts and heavy promotions being offered by many builders in this market. We are evaluating each of our communities in the D.C. market, making pricing decisions specific to each in order to stimulate sales and in the course of doing so, currently have a margin run rate at slightly below 20%.

And with that, I'll turn things over to Phil to more thoroughly review our financial performance.

Thanks, Bob.

As we reported, new contracts for the quarter were down over a 50% on a comparable basis. For the quarter, traffic decreased 11%, and our cancellation rate was 42%, compared to 22% in last year's third quarter.

Our second quarter of this year cancellation rate was 30%. Our sales were down 53% in July with traffic down 12%. Sales were down 42% in August with traffic down 16%. And our sales were down 57% in September and traffic was down 4%.

Gross new contracts were down 34% for the quarter. Our active communities increased from 140 a year ago to 170. We are on target to increase our active communities to 175 by year-end with the breakdown by region as follows -- 85 in the Midwest, 50 in Florida, and 40 in North Carolina and D.C.

At the beginning of the year, we had planned for 190 communities by year-end, but have pared that back as a result of market conditions. Homes delivered in the third quarter reached 927 compared to 1,047 for last year's third quarter, an 11% decline.

As expected, the mix of our closings shifted as 50% of our deliveries were in our Florida, North Carolina, and D.C. markets, versus 40% a year ago. We delivered 32% of our backlog this quarter, consistent with a year ago.

Our gross and operating margins for the quarter, exclusive of charges to be discussed in a minute, remain solid at 25% and 10% respectively. We currently believe gross margins will decline in the fourth quarter, resulting in an annual rate for 2006 of about 25%, which is slightly below last year's 25.2%.

Land gross profit was $1.7 million in the third quarter, compared to $2 million in last year's third quarter. And for the 9 months ended September 30, 2006, land gross profit was $2.8 million versus $4.7 million for '05, the 2006 quarter and year-to-date amounts reflect a pretax impairment charge of $2 million on land located in the Midwest that we have under contract to sell.

Overall, our land gross profit was down approximately $280,000 for the quarter and $1.8 million year-to-date. Land gross profit was 12% for the quarter versus 22% a year ago and 15% for the first nine months compared to 17% last year.

Last year, we had $7.3 million of land sales gross profit. We currently estimate that we will slightly exceed that amount in '06. As Bob said, we currently have about $50 million of land under contract to sell to third parties. This had been classified separately on our balance sheet.

Our G&A costs in the third quarter increased $4 million to 8.2% of revenue from 6.3% of revenue in the prior-year third quarter. About half of the dollar increase for the quarter relates to charges totaling $2.3 million for the write-off of pre-acquisition cost primarily in the Midwest and for a workforce reduction cost. The remainder of the increase was primarily related to the $1.4 million of higher cost related to our investment in land and the expense of $1.1 million for equity compensation.

The impact of these charges and equity compensation costs on diluted EPS for the quarter is $0.10 and $0.05 per share respectively.

Year-to-date, G&A costs were 8.5% versus 6.4% of revenue for the same period of '05, reflecting the cumulative impact of deposit and pre-acquisition cost write-off of $3.3 million and separation costs of $6.8 million with a total impact on diluted EPS of $0.45. Exclusive of the aforementioned charges, G&A costs were 7.4% of revenue, both for the quarter and year-to-date.

Selling expenses for the quarter and year-to-date increased 60 and 80 basis points respectively to 7.0% and 7.5%. The percentage increase in both periods was due to the increases in non-variable selling costs associated with current market conditions and our community count growth. And for the quarter and year-to-date, advertising costs increased $1.2 million and $3.7 million while community-related costs increased $800,000 and $3.5 million. Overall, our SG&A expense increased to 15.3% of revenue in the third quarter, compared to 12.8% in last year's third quarter.

If you exclude the previously mentioned charges the percentage for the quarter and year-to-date were 14.5% and 14.8%. We continue to work on right-sizing our business. We have reduced our headcount by about 30% in the Midwest and by 10% at corporate this year.

Operating income in the quarter was 8.6% of revenue and year-to-date was 10.2% compared to 12.7% for the third quarter of '05 and 12.3% for the first 9 months of '05. Our operating margin for the quarter, exclusive of charges taken, remains solid at 10%. Interest expense decreased $325,000 for the third quarter, but increased $2.3 million for the first 9 months of '06 compared to last year.

The decrease in the third quarter was primarily due to a $4.2 million increase in capitalized interest as we had more inventories under development when compared to the third quarter of last year. These decreases were offset by an increase in the weighted average borrowings from $508 million in '05 to $669 million as of September 30, 2006. Additionally, our weighted average borrowing rate increased to 7.4% from 6.4% a year ago.

We have $34.5 million in capitalized interest on our balance sheet at September 30, compared to $18.9 million a year ago and $19.2 million at '05's year-end. This amount is approximately 2% of our total assets, which is consistent in the past. Our effective income tax rate for the third quarter and for the first 9 months of '06 is 33.6% and 36.7% compared to 34.7% and 37.3% for the same periods in '05.

Our effective tax rate for '06 primarily reflects changes in results from the clarifications of the American Jobs Creation Act of '04, so for the third quarter net income was $15.2 million, down 39% from last year's third quarter of $25.1 million and net income for the first 9 months decreased 16% to $49.8 million. Diluted EPS was $1.08 for the quarter and $3.51 for the first 9 months of this year. This includes the $0.18 and $0.53 per diluted share impact of the charges incurred during the quarter and year-to-date and $0.05 and $0.11 per share for the expensing of equity compensation for the quarter and year-to-date.

M/I Financial which includes our title operations -- our mortgage and title operations pretax income decreased from $4.2 million at last year's third quarter to $2.4 million in the same period this year. The decrease was due to increased competition which reduced margins and overall capture rate. In addition, the change was the result of a 10% decrease in loans originated from 692 last year to 625 this year, and a change in our product mix.

Loan to value on our first mortgages in the third quarter was 80% in '06 and remained unchanged from the same period in '05. For the quarter, 89% of our loans were conventional with 11% being FHA/VA, and this compares to 87% and 13% from last year. The FHA maximum limits in the markets that we operate range from $200,000 to $363,000.

Approximately 29% of our third quarter closings were adjustable rate mortgages. This compares to 49% in the third quarter of '05, and 28% of our first 30% of our second, and 31% of our third quarter '06 applications were adjustable rate mortgages. And of the mortgages closed during the third quarter, 11% were interest-only loans. And that compares to 27% in 2006's second quarter. And overall, our average total mortgage amount was 237 in the third quarter. The average borrower credit score on mortgages originated by M/I Financial was 732 in the third quarter of '06 compared to 719 last year. And those scores compare to 712 in '05's second quarter and 718 in '05's third quarter.

The percentage of customers that received down payment assistance in the third quarter was 6%, unchanged from last year. And in the third quarter, the average mortgage balance on these down payment assistance originations was $176,000, also unchanged from last year and the majority of these customers are in our Midwest market and buy our entry level product.

We sell along our mortgages along with their servicing rights. Our contingent repurchase obligation due to loan delinquency is primarily limited to the first couple of payments being made timely. This year, we have not repurchased any loans due to borrower delinquency. Our mortgage operation captured about 80% of our business in the third quarter compared to last year's 84%.

We believe there will be continued pressure on our capture rate due to increased competition. We are constantly putting programs in place that we believe will help our capture rate. We focused on our capture rate as our mortgage operation primarily serves M/I Home customers, and overall our mortgage and title business produced 9% of our operating income during the third quarter and 12% year-to-date. Last year it was 10%, 13% in those periods.

As far as the balance sheet, our home building inventories at September 30, 2006 increased $269 million, a 24% increase over a year ago. Compared to a year ago, raw land decreased 14%, land under development was flat, and finished unsold lots increased by 160%. At September 30, 2006, we had $248 million of raw land, $242 million of land under development and $339 million of finished unsold lots. Our total unsold land investment at September 30, 2006 is $829 million, which compares to $661 million a year ago. And the market breakdown of the $829 million of unsold land is $262 million in the Midwest, $313 million in Florida, and $254 million in North Carolina and D.C. Also, compared to June 30, 2006, our raw land decreased by $30 million, and our land under development went down by $112 million. Also in the third quarter, we purchased $18 million of land. We currently anticipate purchasing another $9 million of land during the fourth quarter, which makes our estimate for '06 of land acquisition of $165 million compared to $320 million a year ago. And the '06 breakdown of these land investments should be approximately 17% in the Midwest, 45% in Florida, and 38% in North Carolina and D.C.

During the quarter, we reduced our overall land position by over 15% from the previous quarter end, walking away from deposit and pre-acquisition costs on deals that no longer pencil in today's environment. We currently have only about 2% of our equity at risk or about $13 million in deposits, letters of credit and pre-acquisition cost for 3,550 lots that we have under control off our books.

Approximately 40% of this exposure is in our growing North Carolina markets. As previously mentioned, we took a $2 million pre-tax charge related to the impairment of one of these parcels. Otherwise, we expect to break even or make a profit on these land sales. We talked about $56 million being under contract, the majority of which are expected to occur in the next few quarters. We evaluate the value of our existing inventory positions including deposits, pre-acquisition costs, raw and underdeveloped ground, developed communities and investment and joint ventures on a quarterly basis in accordance with the appropriate GAAP standards. These evaluations require the use of assumptions that may change from quarter to quarter based on changes in the market and management's intention to respect to our inventory positions.

We owned 18,920 lots at September 30, 2006 and have an additional 3,550 under our control for a total of 22,470 lots under control, which is about 4,500 fewer than we had three months ago. Additionally, this is about 6,400 fewer lots than we had a year ago with the majority of this decrease occurring within the Midwest. The breakdown of the lots under control were provided in today's press release.

Since last year, we have decreased our Midwest owned lots 12% and increased our Florida market and North Carolina and D.C. market owned lots by 25% and 7%. In total, by percentages, our controlled land is now 39% Midwest, 43% Florida, and 18% North Carolina and D.C.

At September 30, 2006, we had $50 million invested in joint ventures with approximately $32 million of this being in Florida. These JVs are for land acquisition and development purposes only and are with homebuilding partners including Beezer, Centex, and Avatar. Three of these ventures have third party financing and are conservatively leveraged with equity from the partners being approximately 40%.

At the end of the quarter we had a $107 million investment in specs, 204 specs were completed and 459 specs were in various stages of construction for a total of 663 specs which translates into about 4 specs per community. Of the 663 specs, 309 are in the Midwest, 201 are in Florida and 153 are in North Carolina and D.C.

At the end of the second quarter, we had a $77 million investment in specs, 139 of which were completed, 421 in various stages of construction for a total of 560. Last year at this time, we had 365 specs and $44 million of investment. The increase in spec levels reflects our increase in community count, the impact of cancellations as well as our efforts to stimulate sales and showcase new product lines across certain of our markets.

At September 30, 2006, there was $491 million outstanding under our revolving credit facility as compared to $303 million last year. In October, to aid us in our financial flexibility, we extended the term of our revolving credit facility. This facility now matures in October, 2010 and is led by our longstanding banking partners, JPMorgan Chase, and Wachovia.

As stated earlier this year, we expect to peak borrow at about $500 million this year. We currently estimate that our borrowings will be below $400 million at December 31, 2006. During the quarter, our cash flow used in operations was approximately $45 million. The majority of this use related to cash used in land development of $42 million and the aforementioned purchase of about $18 million of land which was offset by cash earnings from operations.

Long term debt at September 30, 2006, totaled $708 million compared to $523 million a year ago. This includes $200 million of public senior notes that matures in 2012 with a fixed rate of 6.875%. Home building debt to equity was 111% at September 30, 2006, versus 92% a year ago and homebuilding debt to cap was 53% versus 48% a year ago. We currently expect our homebuilding debt to cap to decline to about 48% by year end. Our target remains to be at 50% or lower in homebuilding debt to cap.

Our interest coverage for the quarter remains strong at 4.3 times EBITDA. EBITDA for the quarter was $32 million, interest incurred for the quarter was $12 million compared to last year's third quarter $8.1 million. And at September 30, 2006, shareholders equity was $627 million with a book value per share of $45.00. We did not repurchase any treasury shares during the third quarter. At quarter end, we had 3.7 million shares in treasury, at an average price of $20.00 per share.

Year-to-date, we have repurchased $18 million in stock. While share repurchases may be a sound use of our capital at current prices, which currently is about 80% of our current book, we will continue to be thoughtful about future stock buybacks so as not to undermine the strength of our balance sheet and our credit quality.

We review our share repurchase program at our quarterly board meeting and currently have about 7 million of repurchase authority. In summary, our financial performance reflects the difficult conditions in the industry. As Bob mentioned, and also our press release, we currently estimate 2006 deliveries to be approximately 4,000 homes with diluted EPS guidance of between $5.25 and $5.75 per share. This guidance includes all the charges we talked about and approximately $0.14 per share for the expensing of equity compensation.

This completes our presentation. We will now open the call for any questions or comments.

[OPERATOR INSTRUCTIONS]

First question is coming from Ivy Zelman from Credit Suisse.

Good morning, guys. Or afternoon, my day is a little confused with all the earnings we've had.

It's morning somewhere.

Somewhere.

Your gross margins were pretty impressive and what you have in backlog to look for your full year to be at 25 is pretty impressive given what everybody else is doing. So I commend you on that.

Looking at your cans, can you tell us of the 42% can rate that you had, what percent of those would be late stage?

Do we have that, Phil?

That's a pretty hard number to estimate. It's definitely been going up because we have more completed specs.

Ivy, if you assume the normalize can rate, say, it's 20% for all the builders and now it's in the upper 40s so that incremental can rate, what percentage of the incremental 25% (Multiple Speakers) Hello?

That's not me.

If -- what percent of the incremental 25% happened before construction commences? A small number of them, the increase cans have clearly increased our specs. How late -- I don't know if we have that.

No, that's -- we don't have that data. It's definitely gone up, though, Ivy.

Okay. The other thing, just a few on that same idea. If you look at the number of closings that you did in the quarter, how many of those closings would you say were rewrites -- rewritten contracts that you were having to renegotiate at closing?

I'd say there was some issue with at least a third of them, Ivy, and every subdivision is a little different as far as how much you have to give back. What we have kind of been seeing is something in the 100 to 200 basis points overall, as far as if I look at what's in my backlog and what closes the next quarter or two, I'm losing 100 to 200 basis points it looks like due to things like that.

Okay. And then on that front with respect to incentives as a percent of base average throughout the Company for the third quarter and how that compare to 2Q?

Most of ours are a reduction in sale price. And we are getting some reduction in our hard cost. But I think if you look at our incentives in general, it's been going up 100 or 200 basis, kind of a quarter the last couple of quarters, Ivy, because that's what our margins are coming off.

Are you in the 5% as a percent of ASP?

I would think we're not quite that high.

Yes, I know you didn't ask it, but somewhat related to it -- I mean, the market that we've seen -- the biggest drop in margins is the D.C. market. And I don't think there's any market where we've seen our margins drop as much as they had--now they were up pretty high, but they've dropped significantly there.

Would you say that the orders that you're-- the contracts where you're writing today, are they predominantly on standing inventory as opposed to preselling where you'd have to break ground and start construction on new sale?

No. I think that well over--well over half of them are on new builds. We don't have--we've never been a big spec builder. And over the last, during the last 90 days I would guess that 70% of the contracts that we reported were new builds.

About a third. It's about a third specs, Ivy.

So of the new builds, how much do you require for a down payment in places like Tampa and other parts of Florida?

If you looked over at our backlog, Ivy, we're 3% to 5% is where we are. So if our average sale price is $350,000 that's like $10,000. In Palm Beach at a higher price point, we try to get a little more, but overall, we're like 3% to 4%.

So looking at that, what's the--isn't there a risk that those are really in a buyer's mind a free option and that you get closer to closing, that they can get lured away by another builder who is offering a more competitive deal? How do you protect your backlog, knowing --

It's a daily fight. You're absolutely right. It's one of the issues that we've been discussing, not just in the last few days or weeks, but over the last number of months is the deposit policies. But this--that's the reason why a lot of builders are unwilling for good reason, to give any guidance, because of the lack of clarity in the backlog.

We try to make sure that we stay in touch with the customer periodically. Of course, hopefully most of them are getting, 80% of them are getting their mortgage through you us. So we're touching them constantly from the mortgage side, but we also have our management team touching those people. But like you very well know, there's a lot of competition right out there, at different price points.

And then I guess I'll ask one more and I'll ask you if anyone else wants, otherwise I can come back.

But with respect to the progression of the quarter, have you seen any improvement in your mind that would change your view and make you more optimistic that we're getting closer to a bottom overall and then in any market particularly where it may have gotten better or is there markets where you've seen it even get worse?

There's markets where we've seen it get worse.

Like --

I've listened to and felt good listening, frankly, to some of the other builder calls where there's been some hint of optimism. But honestly, we haven't seen it. Maybe we're just not looking hard enough.

I think things are still bumping along the bottom, maybe getting a little worse here, a little worse there. Charlotte remains -- we've seen no dropoff in Charlotte yet. And I underscore yet because I just think that housing is just as much a cyclical business there as anywhere else.

Bob, on that note, if you were to pick a market where it's getting scary worse, in any particular market where it's, like, chances builders can be losing money if it continues on that slide?

I don't know. I mean, don't know if it's getting scary worse anywhere. It's already pretty bad some places.

On your radar of markets where you have radar, which is the worst and which is the best, Charlotte's the best?

Charlotte is our best without a doubt. I think the toughest markets that we're in, today would be Southeast Florida, which we fortunately have a very small position.

But, it's still a tough market, tremendous excess inventory there, and I think the Washington market is very difficult right now. And we do have a much larger investment there.

The Midwest continues to be a tough struggle, but it's been bad since the second quarter of '04 so maybe we've gotten used to it.

Great. Appreciate all the detail, no one gives as much detail as you guys, thank you very much.

Thanks, Ivy.

Next question coming from Alex Barron from JMP Securities.

Given that you mentioned the Washington, D.C., market you're seeing kind of the biggest drop in margins, I was just hoping you could help us quantify how much margins have dropped from peak levels to what you're seeing today.

We were -- at peak levels, we were in the low to mid-30s. Today, we're below 20.

Okay.

And that's basically over the last three or four quarters, Alex.

Okay, got it. And so where do you guys kind of see margins, I mean, what kind of margins are you guys seeing overall in your new orders versus, maybe say, a year ago?

We tried to give a little hint of that in my comments. In the Midwest right now, we're 15% to 18%. In D.C. I just mentioned; Charlotte, Raleigh, we're in the low 20s, 22%, 23%. And in Florida, margins are, depending upon the market, 20 to 25, but much closer to 20 than 25.

I'm just kind of curious, some of these bigger builders have shown or expressed a willingness to continue to push volume at ever greater discounts (Multiple Speakers)

It's a different approach.

And are using spec building to kind of maintain that. I'm wondering how you guys are responding to that and if you're facing some communities where you're going head to head against that?

Well, look, everybody's got to do what they believe is the best thing for their business. When there's already an excess supply of inventory, I don't think it helps to put more on the ground. And I don't think it creates any kind of -- I'm sure there's good reasons for, for the pursuit of that strategy.

But it's hard for me to see where that does any good to anyone, because I don't think it helps create confidence in the mind of the buyer when the buyer's already wondering when the next best deal is around the corner. And so it's a fight.

And it's a fight that sometime results in just very, very weak demand. Because frankly, even, even amongst those builders that are the most aggressive at pursuing that strategy, their sales are still down.

Right. Switching topics a little bit. As far as land investment, did you guys buy any land this quarter? Or are you just putting money into land you had already bought and you're just developing?

We actually bought $18 million of land for the quarter and we anticipate for the year, buying about $165 million. We went into this year thinking we would buy $260 million, Alex, but we brought that down quite a bit.

In what markets did you still find some attractive investments?

When we look at the overall land purchases for '06, about 17% will be in the Midwest, 45% in Florida, and about 38% North Carolina and D.C.

Okay. And one last one, I might have missed it. What was the, if any, option write-offs or any other sort of write-offs you might have taken in this quarter?

What we wrote off in the quarter was about $2 million -- was $2.3 million in pre-acquisition costs and deposits and then we also took a $2 million impairment.

Got it. And what markets were those in?

The $2 million impairment was in Columbus, Ohio. And the deposit and pre-acquisition costs was also primarily in the Midwest.

Okay.

And what we have left on the books today is about $13 million at risk. That $13 million is the deposits and the LCs for the 3,600 lots we have off the books.

Okay. All right. Thanks. I'll get back in queue.

Thanks, Alex.

Next question is coming from Timothy Jones from Wasserman & Associates

Hi, Tim.

A couple of questions, please. First of all there's a quick one. How bad-- Palm Beach folks came out today with an article that said inventories in Palm Beach had gone slightly over four years doubled, actually, quadrupled as home sales have gone down 53%. And prices are down 9%. How really bad is that market? It sounds pretty bad.

Palm Beach continues to be pretty much our most difficult market, as Bob said. Last year, we delivered about 100 homes in Palm Beach. We went into this year hoping to deliver about 225.

It looks like we're going to be a little short of 200. Our cancellation rate has continued to get higher as the quarters have gone on. So we think that market is very difficult.

I think the southern third of Florida is really swampy. It's tough.

That's where I live. Never mind.

Well, sorry.

Secondly, you gave us the -- I think year to year, you went from spec homes of 365 to 663. Can you give me the amount of units in both quarters that you had under construction, please?

As far as specs, Tim?

You had those. You gave me the specs. But, I want to know what percentage of that are the units you have under construction?

At September 30, we had 663 specs in total. The investment dollars were $107 million. 459 of them were in different stages of construction.

I know that, I just wanted to know how much had you under construction?

204 were completed.

What you had sold and everything -- the total amount of units you were building during that period. It's usually running between 20% and 40% for builders.

That's higher than we are. When you look at us this year, doing 4,000 units, if we end up, we tend to be more in the 10% to 15% range.

Historically we've always been, Tim, we've always been probably the lowest percentage of any public builder. That's by design and by strategy.

That's about four per community, which is a little high for us, whereas some other builders run 10, 15 per community.

Now, Bob, you're saying that you're doing about--your 663 represents around 15% of the units you have under construction right now, is that correct?

No, I'm comparing that to the 4,000 units we're going to deliver this year

How about what you have under construction? Do you have that number?

I don't have that handy. Of course you know what my backlog is.

Okay, you can give me a call and we can go into it. I'm sort of wondering -- you perhaps had the highest FICO scores of any builder that--and I follow virtually all of them, of 732 and up from 719. Are you--why is it so high and are you perhaps being overly stringent on your underwriting criteria?

I think one of the things is our price point. Even though 40% of our business is still in the Midwest, our average sale price in backlog is $365,000 and we talked about our average mortgage being around $250,000. So part of it is just the nature of where our price points are, and we don't have hardly anywhere subdivisions 150 or under. So we tend to deal with higher price points, higher income-type people.

In addition, Tim, from an underwriting standpoint, what we do sometimes in questionable credit-type things, is sometimes those transactions will not actually go through our mortgage company, they will go through somebody else, that obviously we want to make sure they're qualified, not getting a house they can not afford. But again, we'll oftentimes have those people go somewhere else, because we don't want to take the risk on the back side of those mortgages.

Okay, and lastly, something very strange on your -- actually positive to you, so don't get worried. If you take the $1.08 you reported this quarter per share and add the $0.18 back it'd come out to $1.26. To get to the low end of your $5.25 estimate -- forget the high end -- means you're at $1.75 in the next quarter?

That's right.

Virtually every builder has the next quarter down below this quarter. Could you give me some light on that, please?

Big thing, Tim, is that we delivered less than 1,000 units in the second quarter and the third quarter. In the fourth quarter, we expect to deliver about 1,250 units. So we'll be delivering 30% more homes. In addition, with our backlog continuing to go up, we expect the average sale price to be higher in the fourth quarter than in the third.

In addition, we talked about land sale gross profits. We still expect to exceed last year's land sale gross profit. So we'll be making more money selling land. We talked about the $50 million under contract. (Multiple Speakers) land sale gross profit, too.

What is that land profit for the fourth quarter versus a year ago?

In the fourth quarter a year ago, our land sale gross profit was $2.5 million pretax, Tim.

Yes?

And last year, which we talked about, we made a little over $7 million pre-tax selling land. We expect this year at this time to make something in the $4 or $5, $6 million pre-tax range, maybe a little more selling land in the fourth quarter. It's more closings, higher average sale price, land sale profit.

And I think maybe one other slight variable there, Tim, is the fact that we have over a third of our divisions in weather-impacted locations in terms of our geography, where the fourth quarter historically has always been our biggest closing quarter because of the nature of the seasonality. In other words, we don't have over half of our markets in full-year-round building cycles.

One other implied answer, and if you can see I'm right in this, is that you do not expect either land--meaningful gains in land impairment or option write-off cost in the fourth quarter as opposed to a couple of very notable big builders?

Well as far as deposits and preact costs, we talked about--we have about $13 million on our books.

I'm talking, I'm more worried about the other -- I'm more worried about the land impairment costs.

We continue to go through all of our subdivisions and as you know, a big factor there is what margin are you selling at, what assumptions you're making, so we continue doing that every quarter. And that's a number that's impossible to predict.

It is. But the guidance we've given, I mean, we got there the way we just explained.

Great breakdown, thank you.

Thanks, take care.

Next question is coming from Peter Reid from Mass Capital Management.

Good afternoon.

Hi, Peter.

I was hoping you could give a little more color on the land that you're holding for sale, if you're willing, where some of these pieces might be? And maybe even when these had been purchased?

When you look at the land, Peter, we talked about $50 million. The majority of it is in Tampa, Florida. Where we have purchased, tied up and purchased a lot of land the last couple of years. Some of it is in the Midwest. And we talked about the impairment we took for $2 million. That's on a piece of land in the Midwest that's under contract, that we expect to close in the fourth quarter, but again, we expect to lose $2 million on that. A little bit is in D.C., and so forth, but the two biggest places are Tampa, Columbus and a little bit in D.C.

Thank you very much.

Next question is coming from Joel Locker from FBN.

Hi, Phil. Just wanted to get the breakdown -- the gross margin for the year being 25%. Does that assume the third quarter was 25% or 23.9% with the charge?

No, when I give you numbers, it's got all the charges in it and everything.

So that includes the charges?

It includes the charges.

So you take a blend of the first three quarters with the 23.9%?

Yes, because when you look at it, the first quarter was 27.3%.

Right.

The second quarter was 27.6%. The quarter we just reported was 23.9%. And so (Multiple Speakers)

So you're assuming something around 22.1%, 22.2%?

Between 22% and 23%. And partially also on the land sales profit and those type things.

Right, and I'm just wondering, I know you guys sometimes don't comment, but just how October sales were versus July, August, September.

It's just too early, even though the month's almost over we'd rather not comment at this point.

Right. But just wondering--kind of a hypothetical with the owned land being almost 19,000 lots, if your run rate drops down to 3,000 deliveries a year, are there any steps you would take to try to sell some of that, or just because it would be over six years of owned?

You've isolated a very good point. We've got too much owned land. And we have felt that way for some time, given the, how quickly the slowdown is occurring, at least outside the Midwest.

And we've been aggressively taking steps to do that. And we'll continue to. It's--there's no way to, to answer other than to say we're on top of it and we hope that over the next several quarters, we'll be able to continue reporting improvement in our owned and optioned land holdings as we did today.

You may remember at the end of March, we had 21,300 owned, at June 30th, we had 20,300, now, it's 18,900, it is coming down.

It's definitely going the right direction. I was just thinking out loud on what would happen if you close the 3,000 homes versus the 4,000 you are this year, if that's just a new run rate. It just seems like even though it's cut down, all the sudden you thought it was 5 years and it's still 6.5 with bringing it down.

Exactly. I mean, historically, we've always tried to and it's very difficult particularly when you're in a growth mode like we were in 2 years ago at this time. But historically we've tried to own or control a 3 to 5-year supply in every market. Well, when your sales drop by 40% or 50%, the arithmetic goes in the wrong direction.

Just, your comments on the land market in general, I mean, we're hearing a lot that the spread between the bid and the ask are sometimes 30% or 40% -- nobody wants to drop an offer and the bids are so far below. Are you seeing a lot of that where just nothing's getting done because the buyers and sellers are just so far apart?

Well, I think all of us have anecdotal evidence. Because what, by that I mean, what we know is about the 1 or 2 or 5 deals that we happen to be working on, which may not be indicative of what's happening everywhere.

And a land deal in one part of Tampa could be radically different than what's happening on a land deal in another part of the same market. But we've seen in the D.C. market, a tremendous drop in ask -- in the ask, not the bid -- the selling price -- on the ground. We're still not buying it, but we've seen prices drop significantly.

A significant drop, is that like 30% or are you talking 10%?

30.

30 or so.

In one or two cases.

Right. So it just all depends on the market?

And we're still not buying it.

I can understand why.

But all of those are deal-specific.

Right. In Florida, in other parts in Florida -- I can imagine Palm Beach in a similar situation?

It's--we're all applauding the best deals that we've ever done--that we ever did right now. Those are the deals that we elected not to do last year.

There's just so few buyers right now it's really hard to gauge what the market is.

All right. Thanks a lot.

Thank you.

The last question is coming from Alex Barron from JMP Securities.

Yes, thanks, can you guys give us a breakdown of your deliveries by region for the fourth quarter, you're kind of expecting?

As far as what we're expecting in the fourth quarter or for the whole year?

Either one.

What we're expecting right now, when you look at the deliveries for the year, we're thinking about 1,750 in Ohio, 1,600 in Florida and 650 in North Carolina and D.C.

First one was Ohio and Indiana.

Ohio and Indiana. So it's 1,750 in the Midwest, 1,600 in Florida and about 650 in North Carolina and D.C. That gives you the breakdown of the 4,000 for the year.

Okay, and can you talk a little bit about this expected land sale? Who is buying this land? A public builder or what?

It's different people. The majority of it tends to be more smaller, private builders (Multiple Speakers)

It depends, we've got a couple of parcels that multifamily apartment developers are highly interested in. And then you've got people who--who think now is a good time to buy.

We're in a very strong buyers' market right now. And if this is at or near the bottom, no one's going to know until we have a chance to look back and see. But there's some very good deals out there. And people that don't have to worry about what Wall Street thinks are taking advantage of it.

Great. If I could ask one other one. You mentioned your margins in Florida today are in the low 20s. What were they also at peak level?

In the low to upper 30s, depending upon the market. So say 32 to 38.

Okay. Yes, I guess I was just a little surprised there were still, what I consider to be still pretty good margins.

And they're probably going to drop. I don't think they're going to--that's current rates. I would suspect it's more likely than not that they will drop.

Drop further?

Of course keep in mind that at September 30, we still have 1,200 houses in backlog that have very good margins in them, so we're in the subdivision business. But we're trying to make sure we protect those margins as best we can and get those houses closed and make our numbers this year.

Right. Now, I know for a lot builders, delivery times in Florida got as high as 18 months, somewhere between 12 or 18 months. Where are you guys at today versus where you were a year ago in Florida?

Probably come down a little bit. In general, we've never gotten out that far, 18 months. In general, we try to always deliver homes within 12 months of putting them under contract. So it's definitely come down a little bit overall.

What I think, as you probably know, Alex, stretched out those delivery times so much, was the desire in the face of tremendous demand -- the desire for builders to capture that demand, to strike while the iron was hot and to write contracts prior to the completion of community development so that everybody got a little bit way out ahead of themselves because they wanted to freeze the buyer, take them off the market, write the deal at 30% to 35% or 40%, knowing full well they weren't going to deliver the house for 12, 17, 18 months. And in a very, very hot market, that's a tempting thing to do. And I think that's what caused a lot of that. We're not in that mode anymore.

Right. Are you guys seeing any sort of price concessions or can you give us a sense of in terms of your labor guys, or materials guys?

Anywhere from 2% to 5%. But will that be reflected in results? Yes, but discounting is certainly going to eat up the lion's share of it. But it just depends upon the market. In some places we've been fortunate enough to get very close thus far. And we may be going back again. We probably will be. Negotiating close to 5% price cuts across the board on sticks and bricks. But on average, I'd say it's probably 3%.

Okay. And one last one. You mentioned that you were reconsidering your deposit policy. I assume that means you're trying to raise them?

Well, we're looking at it, in light of current conditions. It's not something that we just decide. We--periodically we do that anyway. But we're particularly focusing on that now.

And again, the issue is what's happening in the market and so forth. And what's the competition doing, and it's--all these issues are delicately balanced. But, it's part of the business. And right now, it's part of a cyclical business.

There appears to be no further questions. I will now turn the floor back over to the host for any closing remarks.

Thank you very much for joining us and we'll look forward to reporting year-end results. Thanks.

This concludes M/I Homes, Inc. third quarter earnings call. You may now disconnect.