M/I Homes Inc (MHO) 2009 Q3 法說會逐字稿

Good afternoon. My name is Melissa and I will be your conference operator today. At this time, I would like to welcome everyone to the M/I Homes third quarter conference call. (OPERATOR INSTRUCTIONS.) Thank you. Mr. Creek, you may begin your conference.

Thank you very much. And thank you for joining us today. Joining me on the call is Bob Schottenstein, our CEO and President; Tom Mason, Executive Vice President and Corporate Counsel; Paul Rosen, head of our mortgage company; and Ann Marie Hunker, our Corporate Controller.

First, to address Regulation Fair Disclosure. We encourage you to ask any questions regarding issues that you consider material during this call because we are prohibited from discussing significant nonpublic items with you directly.

And as to forward-looking statements, want to remind everyone that the cautionary language about forward-looking statements contained in today's press release also applies to any comments made during this call.

Also, 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, 2010.

With that, I'll now turn the call over to Bob.

Thanks, Phil. Good afternoon, everyone.

During this call I will take a few minutes to discuss highlights from our third quarter performance along with the progress we are making in managing our business to return to profitability. I will also briefly review our markets and then make a few comments concerning our outlook, then turn things back over to Phil, who will give a more thorough review of our financial results.

As you could see from our press release this morning, we've continued to make progress amidst mixed market conditions. First, with respect to our third quarter and year-to-date results. Number one. We experienced a 36% increase in new contracts for the quarter. This marks our fourth consecutive quarter of increased year-on-year sales.

It's also worth noting for the quarter that each of our geographic regions experienced a year-over-year increase in sales. For the year our sales are up 33% compared to the first nine months of last year. And our strong sales were achieved despite a 24% decline in community count from a year ago.

Second, our homes delivered during the quarter increased 20% when compared to 2008. That's our second consecutive quarter of increased year-over-year closings.

Three. We're also pleased to report that we had our third consecutive quarter of increased year-over-year units in backlog. And we were also pleased to see a slight uptick in the average selling price of homes in backlog from that which was at the last -- at the second quarter.

Four. In looking at our financial results, several comments that I'd like to make. One, our gross margins have sequentially increased during each of the past four quarters. By staying focused on specific and measurable ways to improve our operations, we have had considerable success in reducing hard costs and we continue to work on this very diligently.

Our SG&A expenses continue to decline from prior year levels as we continue to see positive results from our focus on reducing expenses.

The combination of all these factors resulting in a near breakeven operating result for the quarter, with a loss of just over $1 million, and positive EBITDA of $1.2 million for the quarter.

While we are certainly pleased to see our loss narrowing to near breakeven, we are obviously not where we need to be or where we want to be. We are intensely focused on returning to profitability as soon as possible.

During the past nine months we've also made considerable progress in repositioning our product offering to specifically target first time and value-focused home buyers. Our recently launched and value-engineered product line, which we call our Eco Series, in both Columbus and Cincinnati has been specifically designed to appeal to the first-time home buyer. The market reaction to our Eco Series homes is quite strong and we are now expanding it into other markets.

Finally, turning to our balance sheet, I simply want to note that, at the end of the third quarter, we had $103 million of cash and our net debt to capital ratio stood at 23%, which is one of the lowest levels in the entire home building industry. Our shareholders' equity is $319 million and we have no significant debt maturing until 2012.

Now, to briefly review our regions. First, the Midwest region. Housing conditions continue to be challenging throughout the Midwest. However, we continue to see positive trends. As I've mentioned, we've seen success in our new product line, the Eco Series, which is specifically aimed at the first-time home buyer. We've also entered into the Northern Kentucky submarkets surrounding Cincinnati and have had some success there as well.

In the Midwest region, our new contracts were up 35% during the quarter and we are gaining market share in all of our Midwest markets. At September 30th, we owned approximately 4,400 lots in the Midwest versus 5,400 lots a year ago. Homes delivered for the quarter were up nearly 45% compared to this time last year.

I also want to simply mention, for the second year in a row, our Columbus operation received first place from J.D. Power for highest in customer satisfaction.

Next, the Florida region. General market conditions in both Tampa and Orlando continue to be difficult and challenging. New contracts, however, were up nearly 45% when compared to a year ago. At September 30th, we owned approximately 1,600 lots in Florida compared with 2,300 a year ago, which is a 30% decrease.

Last, the Mid-Atlantic region. New contracts were up 30% for the quarter and homes delivered were about the same when compared to this period last year. At quarter's end, we owned approximately 1,300 lots throughout the Mid-Atlantic versus just over 1,700 a year ago, which represents a 25% decrease in lots owned.

It appears to us that the DC market is improving slightly. And we also believe that Raleigh is slightly stronger than Charlotte in terms of market conditions.

Finally, let me just say this in terms of our outlook. Though we experienced a near breakeven quarter from operations and are starting to see some signs of improved market conditions, it's also clear to us that the strength of the general economy remains tenuous at best. We will therefore continue to manage in a largely defensive way.

We also believe that, by continuing to execute on our current strategies, we can achieve the important and overarching objective of returning to profitability as soon as possible.

And with that, I'll turn it over to Phil, who will more thorough review our financial results.

Thanks, Bob. New contracts for the third quarter increased 36% to 619, with a net absorption rate of 2 sales per community per month for the quarter versus 1.1 a year ago. The cancellation rate for the third quarter was 20%, down from 32% in the third quarter of '08.

Our traffic for the quarter decreased 3%. Our sales were up 30% in July, while traffic was down 1%; our sales were up 50% in August and traffic was up 2%; and our sales were up 29% in September, while traffic was down 9%. Our active communities decreased 24% from 138 to 105; the breakdown by region is 62 in the Midwest, 21 in Florida and 22 in the Mid-Atlantic. During the quarter we opened 10 new communities while closing 11 for a net decrease of 1 in the quarter.

Homes delivered in the third quarter were 665, up 20% when compared to '08's 555, and we delivered 60% of our backlog this quarter compared to 63% in '08. Our backlog of 1,060 homes is 36% higher than a year ago, plus our backlog average sales price of $248,000 is higher than June 30th's $235,000.

Third-party land sales were $92,000 in '09's third quarter compared to $6 million in '08's third quarter. Our third quarter results include cost of sales expense of $4 million related to imported drywall issues. And we have recorded a total of $9.7 million in drywall-related charges for homes that we delivered in our Florida operations.

Turning to impairments. In the third quarter we recorded pretax charges of $15 million. These impairments represented approximately 700 lots in 18 communities, with about 60% of the impairments in the Midwest and 40% in Florida. And for the nine months ending 9-30-09, total charges were $34 million, representing approximately $33 million for impairments and $1 million for write-offs of deposits and pre-acquisition costs.

We have impaired 70, or about two-thirds, of our active communities. Approximately $21 million of previous impairment reversed into housing gross margins in the third quarter of '09. And our gross margins, exclusive of the impact of impairments and dry wall charges, were 17% for the quarter compared to 13% and 15% in '09's first and second quarter.

G&A expenses for the quarter were $14.4 million, down 17% from a year ago. Selling expenses for the quarter decreased $3 million, down 21% from a year ago. SG&A totaled $26 million, or 17% of revenue. This compares to 20% of revenue a year ago and 22% last quarter.

We currently employ about 525 people, which is down about 15% from a year ago.

Interest expense decreased $850,000 for the third quarter and $2.4 million for the first nine months of '09, compared to the same period in '08. The decrease in the third quarter was primarily due to a decline of $385,000 in net interest incurred to $4.2 million, which is the direct result of a reduction in weighted average borrowings from $242 million last year to $208 million this year. And this is partially offset by an increase of our quarterly weighted average borrowing rate of 8.5%, compared to 7.7% a year ago.

We had a $1 million loss from operations for the quarter compared to $9 million in the second quarter. We focus daily on getting back to profitability. We have $25 million in capitalized interest on our balance sheet at 9-30-09, compared to $27 million a year ago, about 4% of our total assets.

We reported a non-cash after tax charge of $8.2 million in the third quarter for a valuation allowance related to our deferred tax assets. At September 30th, '09, our gross deferred tax asset is $136 million, which is fully reserved. We do not expect to record any additional tax benefits until we return to profitability.

Congress is currently considering expanding the NOL carry-back period. Benefits available would depend on the final form of the legislation.

Now, Paul Rosen will address our mortgage company results.

Thank you, Phil. Mortgage and title operations' pretax income increased from $618,000 in 2008's third quarter to $2 million in the same period of 2009. The increased income was the result of a 28% increase in loans originated from 439 in 2008 to 564 in 2009. This was due primarily to a higher capture rate and favorable servicing release premiums.

The loan-to-value on our first mortgages for the quarter was 89% in 2009, the same as 2008's third quarter. 66% of the loans closed were FHA/VA and 34% were conventional. This compares to 53% and 47%, respectively, for 2008's same period. Over 80% of our communities are now eligible for FHA financing.

Overall, our average total mortgage amount was $199,000 in 2009's third quarter, compared to $246,000 in 2008. The average borrower credit score on mortgages originated by M/I Financial was 729 in the third quarter of 2009, compared to 723 in 2009's second quarter. These scores compared to 718 in 2008's third quarter and 716 in 2008's second quarter.

Our mortgage operations captured approximately 88% of our business in the third quarter, compared to 2008's 84%.

On September 30th, 2009, M/I Financial had $26.6 million outstanding under the M/I Financial credit agreement. During the quarter we amended our secured credit agreement to provide up to a $30 million secured mortgage warehouse line.

Now, I'll return the call back to Phil.

Thanks, Paul.

As far as the balance sheet, we continually focus on our capital structure, our cash and liquidity. We ended the quarter with $103 million of cash. Our operating cash flow for the quarter reflected funding our growing backlog, which increased our investment by $19 million during the quarter.

Lots owned and controlled as of 9-30-09 totaled 9,250 lots, which included our share of joint venture lots. 79% of these lots were owned and 21% of controlled, reflecting a reduction of 17% from prior year levels.

The mix of lots owned and controlled are 60% Midwest, 18% Florida and 22% Mid-Atlantic. With respect to our lots under contract, we have $1.6 million at risk in deposits, letters of credit and pre-acquisition costs as of 9-30-09.

Total home building inventory at September 30th, '09 was $494 million, a decrease of $124 million or 20% below 9-30-08. Our unsold land investment at 9-30-09, again, including our share of JV lots, is $259 million, which is 7,300 lots, compared to $370 million, which was 9,530 lots at 9-30-08.

Compared to a year ago, raw land and land under development decreased 8%, and finished, unsold lots decreased 47%. At September 30th, '09 we had $150 million of raw land and land under development, and $109 million of finished, unsold lots. And the finished, unsold lots totaled 2,446 lots.

And the market breakdown of our $259 million of unsold land is $129 million in the Midwest, $45 million in Florida and $85 million in the Mid-Atlantic region.

In the third quarter we purchased $8 million of land and have purchased $22 million this year. As for land development expenditures, we spent $5 million in the third quarter and have spent $13 million for the year.

Our targets for new communities are for 20% gross margins and sales pace of 2.5 per month. As of 9-30-09, we had $8 million invested in joint ventures, down from $23 million a year ago. These joint ventures are for land acquisition and development purposes only and are with home building partners. We have one joint venture with third-party financing. We are 50/50 partners with a large public builder and this loan has a loan-to-value maintenance ratio and this venture has debt of $11 million.

At the end of the quarter we had $42 million invested in specs, 100 of which were completed and 288 specs in various stages of construction. This translates into about four specs per community. Of the 388 total specs, 190 of these units are in the Midwest, 108 are in Florida and 90 in the Mid-Atlantic. At September 30th of '08 we had 479 specs with an investment of $82 million. And at June 30th '09 we had 413 specs with an investment of $41 million.

At 9-30-09 we had no borrowings under our $150 million credit facility. Our borrowing availability at 9-30-09 was $65 million, less outstanding letters of credit, or $50 million. This availability can increase if we secure assets or add value to assets that have been secured. And our credit facility matures in October of 2010.

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

(OPERATOR INSTRUCTIONS.) Your first question comes from Ivy Zelman with Zelman & Associates.

Hello, guys. It's Dennis on for Ivy.

Hey, Dennis.

Hey. I was hoping you could go into a little bit of maybe the components of the gross margin expansion. Maybe how much was just mix-shift of closing out of some less profitable communities and benefiting from the newer ones? How much is maybe reducing incentives, reducing costs? So, just some more color to really understand the jump that we saw this quarter.

That's a real tough question, Dennis. We think there were a lot of things that contributed to that. As Bob said, we've been working very, very hard on the stick and brick reduction. We also had been opening -- we opened 10 new communities last quarter. We had been able to get a little better pricing power in the DC, even in Raleigh, a little bit in Cincinnati.

And some -- that's a really good question, Dennis. Phil and I were arm wrestling over who would try to answer it. But the other side of it is, very frankly, we haven't bought much land this year, but the few new communities we've opened, most of them are penciling out at or above our targets. So, I think that it's a whole combination of things.

I think the single most significant, though, is probably the efforts that -- the successful efforts we've had in reducing our brick and mortar.

And can you give us a frame of reference on how much you guys are down on a year-over-year per square foot basis, or something to put that into context?

Oh, boy. It varies quite a bit from division by division. I would say a minimum of -- again, this would be comparing strictly cost per square foot. I'd say a minimum of 7% and some of our divisions have done quite a bit better.

We set target by division every six months or so. And again, that varies on the market. And in some areas we've been able to achieve double-digit savings. But we are pleased with that progress and continue to work very hard on that, Dennis.

And part of that's changing the construction of the home itself as opposed to the drop in commodities or something along those lines?

Well, not that -- no. That -- what we're talking about is apples to apples, not changes in specifications.

Okay. Gotcha. And then maybe on the 10 communities that you opened, you said they're penciling above your hurdle. What type of margins are you guys underwriting those from? And I realize that's probably regional as well. Maybe you could give us a sense of where those are coming out.

Well, across the board, I think that Phil mentioned in his comments, prepared comments, that our target gross margins are 20% in all new land deals. And we look for a minimum of 2.5 sales per month per community in terms of measuring cash flow and return.

Okay.

And you look at the change of the communities, we have been in what we feel are the better markets. We have opened a couple of new communities in the Carolinas. We've also in select areas in the Midwest, in Cincinnati, we've been able to open some new communities. But again, working very hard to find communities that make good economic sense for us.

Okay. And then how about on the SG&A side? It looks like you're kind of in that maybe $25 million type run rate. Is that a fair number to think about going forward or are you able to pull that down even further?

Don't have any projections on that, Dennis. If you look at what we've been able to do in the last year, we've talked about we had a target to get our costs down in that 30% range over the last 18 months or so and we've been able to do that. I don't think you're going to see our fixed cost move down much. What tends to happen is the variable costs, as far as the commissions and more homes closing and that type thing, that's kind of what the change is now.

But again, we were pleased to get those costs down in the quarter. And when you look at our growing backlog and our revenue projection, again, we think that our numbers overall should be improving a little bit in the short term with our improvement in sales and so forth.

Okay. And then the last thing -- Phil, you touched on this a little bit but I was hoping you could maybe bookend it for us. If the NOL carry-back goes through, I know there's a couple different provisions. Maybe it's 2008 you can look back from or 2009, can you give us a sense of maybe what the best case would be in that scenario?

I think it's bad luck to talk about it until it's approved.

Alright. Well, if--.

I think when you look at it, Dennis, again, we're estimating numbers based on what we think our tax situation will be by the end of the year. Our best guess today would be, with what's being recently discussed in legislature, is that we would probably get about a $20 million cash tax refund next year. It is our best guess right now. But again, that could change based on what our fourth quarter ends up being and also what the actual legislation ends up looking like. So, that's kind of our best guess right now, about $20 million cash next year.

Okay.

A lot of moving parts to that.

We'll pretend we didn't talk about it.

We'll pretend we didn't hear it.

Okay.

And then just the only other thing, realizing the capital markets have kind of opened up. I know you guys did a great job accessing on the equity side. Any thoughts of trying to term out the 2012 notes?

Dennis, we think from a capital structure standpoint that we're really in pretty good shape. We're always looking at what might make sense to us. But we think we are in pretty good shape right now with $100 million in cash, relatively low leverage. Our interest incurred for the quarter was less than $4 million.

So, it's something we'll continue to look at. Obviously, our bank line maturing in the fourth quarter of next year will be something that we're already starting to take a look at. But I wouldn't say we have any specific plans today, but we are continuing to look at alternatives, just like we did from an equity side.

Great. Congrats again on the jump in profitability.

Thanks.

Your next question comes from Alex Barron with Agency Trading Group.

Hey, guys. How you doing?

Great.

Hi, Alex.

I had a few questions here. The first one was you guys talked about having some -- I think it was $150 million of raw land. How is that split up geographically?

That's not something that we have disclosed in the past. We break down our total unsold land inventory by market. When you look at the $150 million of raw land and land under development and $109 million of finished lots, that's a total of $259 million. And the $259 million of unsold land is $129 million in the Midwest, $45 million in Florida and $85 million in the Mid-Atlantic. So, we give you a total breakdown that way.

Okay. Alright, that's helpful. My other question had to do with I guess the way people are financing their homes. I think you mentioned it. It maybe went a little bit too fast for me. What percentage of the people this quarter used an FHA loan? And also, do you know what percentage bought using the $8,000 tax credit?

We'll let Paul answer the FHA and it is a fairly high percentage. But go ahead, Paul.

Yes. Let's see--.

60-some percent, if I recall.

Yes. About 66%, excuse me, used the FHA/VA financing, primarily FHA. We do not specifically keep track of those customers that are eligible for the first time home buyer tax credit, but in excess of 40% of our customers, we believe, are trying to take advantage of the first time home buyer tax credit.

Okay. That's helpful, too. And then I think, Phil, you mentioned the benefit of previous impairments to your gross margin. But I think it went a little too fast. Do you have it for this quarter and last quarter?

What actually went through this quarter? $21 million of previous impairments reversed into housing gross margins this quarter. So, $21 million, Alex.

Okay. And do you have the number for last quarter as well?

$14 million.

Okay, thanks. And if I could ask one last one--.

Sure.

Your ASP looks like it went up in the orders, backlog, everything this quarter. I was just kind of wondering, does that reflect a mix in the communities that are being left over versus the ones that are closing out, or is that reflecting some pricing power? Or what's kind of going on there?

Well, if you look at it compared to the last quarter, we went from 235 to 248 in backlog.

Right.

The Midwest was up 12,000; Florida was up 7,000 and the Mid-Atlantic was up 20,000. So, all three regions were up, Alex. So, I think it's a combination that we are focused on more affordable product. But also, people have the opportunity to add options to those.

And I think you're getting a little bit -- in terms of mix, a little bit more action by virtue of stronger sales in DC and in Raleigh, where our average price is a little bit higher. And frankly, a year ago, Chicago was essentially not represented in our backlog and it is now. And at least, as among our Midwestern markets, Chicago has the highest average selling price. So, I think it's a lot of mix as much as anything.

Okay. Well, good progress, guys, and I'll get back in the queue.

Thanks a lot.

Thanks.

Appreciate it. Next question?

(OPERATOR INSTRUCTIONS.) Your next question comes from Jim Wilson with JMP Securities.

Good afternoon, guys.

Hey, Jim.

Hey, Jim. How you doing?

I'm doing just fine. So, my question -- I got a lot of them answered already but, on the land side in the deals you did, I wonder if you could give a little more color how competitive you're finding it, even maybe within your three regions? And then are you paying or having to pay cash on the deals or have you been able to strike some option agreements?

Well, really good questions. Let me start first with the Mid-Atlantic region. For the good deals, of which there are so few, it's very competitive. Probably no market is more competitive, at least of the ones -- all I can speak to is the markets that we're in. But of all the markets that we're in, none is more competitive when it comes to trying to find new deals than DC. We need more land in DC. So, if anyone on this call has anything that they want to talk to us about, please get in touch with us. But seriously, it's very, very competitive there.

We're not nearly as active in looking at pieces in Tampa and Orlando. The market there and the opportunities just don't seem to be presenting themselves with quite the frequency.

We've looked at a number of deals in Chicago, as I think you know as well as anyone, on a percentage basis, a good number of builders have gone into very difficult situations or bankruptcy in Chicago and that's presented some opportunities for us. And we've capitalized on one of them and are looking at several others right now.

We did -- and we've been able to do some deals in Cincinnati; mainly, Northern Kentucky, where we were in a situation where another builder was needing to sell some excess land and we think we made some pretty good deals.

But there's not a lot of deals out there. And certainly, no one should interpret these comments to suggest that there's a lot of opportunities. They're very few and far between and we're trying to put a pretty strict sensitivity analysis on them and fairly decent hurdle rates, both with respect to margin and absorption.

Okay. And then the cash or option structure, or they've been mostly cash?

I think it's a little bit of both. I mean, probably more option than cash, though.

Okay.

It just continues to be very hard to find A locations at a good price on good terms. A few of the deals we have been doing have tended to be smaller bulk deals where maybe we've bought 25 to 50 lots. And maybe we've optioned a similar amount a year or so down the road. But we do have 2,500 finished lots that we're trying to work through, also.

And this may not be an accurate statement, but it's my impression that some of the better deals that we've found were cash bulk deals but either, A, they were purchases out of bankruptcy or in highly distressed situation, or deals that we essentially made through a bank or a builder exiting a market where there was only one way to go and that was to take -- essentially take it all at once, or maybe even two traunches, but those are cash deals. But those so far have worked out very well for us.

Okay. Then my other question on -- thanks for the color on both traffic and orders through the quarter. Even if you look through into October, and I know you don't comment on the current month. But are you -- a general comment. Are you feeling or sensing, is demand patterns acting fairly normal seasonally or have you felt any aberrations one way or the other over the last few months, including up to today?

I'd say two things, some seasonal, but I also think things have been -- the traffic has begun to slow perhaps slightly more than seasonal. And I think that's what we're hearing not just from our own divisions, but throughout the home building sector. I think most builders are saying the same thing.

Do you think that's tax credit related or is it hard to tell?

It might -- some of it certainly might be tax credit related and some of it might be hard to tell.

And also, if you look at our numbers last year, Jim, last year in the third quarter we sold 456. Last year in the fourth quarter we sold 339.

Yes. So, that's probably more than normal seasonality from last year, I guess, obviously.

And the fourth quarter of '07 we sold 322. So, the fourth quarter tends to be the lowest.

Yes. Alright. Okay, very good. Thanks.

Okay.

Thank you.

Your next question comes from Alex Barron with Agency Trading Group.

Thanks again, guys. I was curious about this question of the five-year NOL thing. If it does get passed, I mean, would it make sense for you guys to look at selling some land as a way to maximize what you can get out of it?

Alex, you're always looking at what the best use is of your assets. And when a tax situation, if it were to come up, would that be something that we look at, sure. We're always thinking about the best use of that.

When you look at our land, again, we have 2,500 finished lots and we have other land that's raw and under development. And we all know kind of how the land market is these days. But is it something we would be looking at? Sure. But it is already November almost, so you don't have much of a window to do some of those things. So again, we'd have to look at that.

Okay. And then, I was looking at your option land position and noticed it went up in the Midwest and in the Mid-Atlantic. So, on those deals that you guys are putting on there, are they kind of along the lines of this underwriting criteria you were talking about, or are they much higher than that?

Well, keep in mind, I mean, if you look at it, it did go up quite a bit. But the numbers had gotten down so small -- at 6-30 we had about 14 lots under contract and now we have about 2,000. So again, you're starting from a pretty low base. Many of the deals are along the lines that we talked about, that in the community you might perhaps buy a few lots and then you option some after that. And again, as we talked about earlier, we have less than $2 million at risk for those 2,000 lots under contract. So, it's not like we have any sizeable risk dollars up.

Okay. Well, that's pretty interesting. Okay. Thanks a lot.

Okay.

There are no further questions.

Thank you very much for joining us and look forward to talking to you at year-end.

This concludes today's conference call. You may now disconnect.