M/I Homes Inc (MHO) 2010 Q2 法說會逐字稿

Good afternoon, my name is Sabika and I will be your conference operator today. At this time I would like to welcome everyone to the M/I Homes second-quarter conference call. (Operator Instructions) After the speakers' remarks there will be a question-and-answer session. (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, our EVP and Corporate Counsel; Paul Rosen, President of our Mortgage Company; Ann Marie Hunker, our VP and Corporate Controller; and Kevin Hake, our VP and Treasurer.

First to address regulation and 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 non-public items from you directly.

And as to forward-looking statements, I want to remind everyone that the cautionary language about forward-looking statement 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.

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

Thanks, Phil, and good afternoon, everyone. I will first provide an overview of the quarter and then briefly review our operating regions.

As noted in today's release, our second-quarter results contained a number of positives. First, homebuilding revenues increased 71% driven by a 61% increase in closings. For the quarter, we closed 790 homes. Excluding asset impairments, we were pleased to record a pre-tax operating profit of $1.7 million for the quarter. This represented an improvement of more than $10 million over last year's second quarter.

A number of factors contributed to our core operating profit. One, through the first six months, we have opened 25 new communities while closing 17 older communities. As we have stated during previous calls, we expect our new communities to contribute positively to our earnings.

In addition, our SG&A as a percentage of revenue reached its lowest level in more than two years. We have now achieved four consecutive quarters of positive EBITDA, and these results demonstrate the effectiveness of our focus on returning to profitability.

We were as expected impacted by the expiration of the federal home buyer tax credit on April 30. And as we all now know, the impact has been more dramatic than most people anticipated. During the quarter, we experienced a noticeable decline in our sales activity for May and June. As a result, our sales for the quarter declined 21% year-over-year.

I want to remind everyone that our dropoff in sales followed six consecutive quarters where M/I Homes experienced year-over-year sales -- positive sales comps. Market conditions are clearly challenging. Consumer sentiment is low, demand is weak and there is little evidence from a macro standpoint of meaningful job growth.

Still we believe the economy is very slowly and very gradually improving, that things are likely to remain choppy and uncertain for the near term. With this continued uncertainty and housing demand, it is important that we have maintained our strong financial condition. With $129 million of cash, zero borrowings under our $140 million credit facility, and a very low 26% net debt to capital ratio.

We are confident that as conditions stabilize and then improve, we have the right strategy and the right people to return to consistent levels of profitability.

Now a brief word -- excuse me, a brief word about our regions. First the Midwest. Our new contracts or sales in the midwest were down approximately 25% during the quarter. During the quarter we opened six new communities in the Midwest, many of them in our relatively new Chicago market. At quarter's end, we owned approximately 4,000 lots in the Midwest versus 4,800 lots one year ago. Closings for the quarter were up approximately 80% year-over-year.

The Florida region. General market conditions are clearly challenging in both Tampa and Orlando. However, our new contracts in this region were up 20% during the quarter when compared to the same period of 2009. And our gross margins on new communities in Tampa were well above our internal goal of 20%, and we opened two new communities in Tampa during the second quarter. Homes delivered in our Florida region were up approximately 60%, and at quarter's end, we own nearly 1,600 lots in Florida versus 1,700 lots one year ago.

The Mid-Atlantic region. Both sales and units and backlog were down approximately 35%. We did, however, meet our sales absorption rate goal of 2.5 sales per month per community. Closings for this region were up approximately 30% for the quarter. And at quarter's end, we owned approximately 2,100 lots in the Mid-Atlantic region versus 1,200 lots a year ago, an increase of 900 lots.

Charlotte and Raleigh continued to show some signs of improvement. We're very excited about our operations there. Second-quarter gross margins on new communities in Charlotte and Raleigh met or exceeded our goal of 20%, and we opened two new communities in Raleigh during the quarter.

The DC market is clearly showing some signs of market stabilization in select submarkets. Our market share throughout the Mid-Atlantic region increased during the quarter.

Finally, a word about Houston. As announced in the prior quarter, we are entering the Houston, Texas market, and we remain very excited and very confident about our long-term success in this market. Earlier this month, we made our first lot purchase and anticipate to be open for sale in our first community by the end of the first -- end of the third quarter. Now Phil will review our financial highlights.

Thanks, Bob. New contracts for the second quarter decreased 21% to 602 with a net absorption rate of 1.8 sales per community per month. Sales were down 24% in the Midwest, up 18% in Florida, and down 33% in the Mid-Atlantic. Our cancelation rate for the second quarter was 16%, consistent with the comparable period of '09.

Our traffic for the quarter decreased 7%. Our sales were up 7% in April, and traffic was up 6%. Our sales were down 40% in May and traffic was down 32%, and our sales were down 31% in June, and traffic was down 11%.

Our active communities increased 3% from 106 last year to 109. The breakdown by region is 65 in the Midwest, 22 in Florida, and 22 in the Mid-Atlantic. During the quarter, we opened 11 new communities and also closed 11. Homes delivered in 2010 second quarter were 790, up 61% compared with '09's 492. We delivered 84% of our backlog this quarter compared to 59% in 2009. And our backlog of 748 homes is 32% lower than a year ago, while our backlog average sale price of $267,000 is 14% higher.

We did not record any additional charges relating to imported drywall in the second quarter. To date we have recorded a total of $13 million.

Turning to impairments. In the second quarter, we recorded pretax charges of $6.5 million, with about 47% of the impairments in the Midwest. 7% in Florida, and 46% in the Mid-Atlantic region. And for the six months ending June 30, 2010, total charges were $10 million.

Our gross margins, exclusive of the impact of impairments, were 16% for the quarter, compared to 14% in 2009, same period. While we experienced improvement year-over-year, on a sequential basis our margins declined 130 basis points from the first quarter of this year. This decline was primarily due to challenging market conditions, financing promotions that we ran to stimulate sales, and also our desire to generate cash in certain communities.

G&A expenses for the quarter were $14 million, decreasing 17% from last year's level. Selling expenses for the quarter increased $4.5 million from a year ago, primarily due to our increased volume. And our total SG&A was 14% for the quarter versus 22% a year ago.

Interest expense increased $268,000 for the second quarter and decreased $787,000 for the first six months 2010 compared to last year. Interest expense was 1.1% of revenue for the quarter, and interest incurred was $3.8 million for the quarter. We had $1.7 million of pre-tax income from operations for the quarter compared to a $9 million loss during the second quarter of '09.

Additionally, we generated our fourth consecutive quarter of positive EBITDA, producing $11 million of EBITDA for the quarter and covering interest 1.5 times for the trailing four quarters. We had $21 million in capitalized interest on our balance sheet at June 30, 2010, compared to $25 million a year ago, about 3% of our assets.

We recorded a noncash, after-tax charge of $2 million in the second quarter for a valuation allowance related to our deferred tax assets, and at June 30 our gross deferred asset is $122 million and it is fully reserved. Now Paul Rosen will address our mortgage company results.

Thanks, Phil. Despite the 45% interest in loans originated from 426 in 2009 to 618 in 2010, our mortgage and title operations pre-tax income decreased from $1.4 million in 2009's second quarter to $1.2 million in the same period of 2010. The decrease was the result of enhanced financing being offered to M/I Homes customers to help generate sales, thus lowering our overall margins on loan originations.

Our loan-to-value on our first mortgage for the second quarter was 87% in 2010, compared to 89% in 2009 second quarter. 61% of the loans closed were FHA or VA and 39% were conventional. This compares to 60% and 40% respectively for the 2009 same period. Over 90% of our communities are eligible for FHA financing.

Overall, our average total mortgage amount was $213,000 in 2010 second quarter, the same as 2009's second quarter. The average borrower credit score on mortgages originated by M/I Financial was 732 in the second quarter of 2010 compared to 734 in 2010's first quarter. These scores compare to 723 in 2009's second quarter and 718 in 2009's first quarter.

Our mortgage operation captured about 84% of our business in the second quarter compared to 2009's 88%. At June 30, 2010, M/I Financial had $34 million outstanding under the M/I Financial credit agreement. During the quarter, M/I Financial signed a new credit agreement with its current lender, increasing the facility to $45 million which expires in April 2011. Terms of the new facility are consistent with the previous one. Now I will turn the call back over to Phil.

Thanks, Paul. As far as the balance sheet summary, we continually focus on our capital structure, cash, and liquidity. We ended the quarter with $129 million of cash compared to $104 million a year ago on June 30 2009. Our operating cash flow for the quarter was $29 million prior to land purchases of $33 million, and land development spending of $9 million.

Lots owned and controlled as of June 30 totaled 9,561 lots, 80% of which were owned and 20% under contract. We owned 7,672 lots, of which 52% are in the Midwest, 21% in Florida, and 27% in the Mid-Atlantic. This compares to owned lots of 62% in the Midwest, 22% in Florida, and 16% in the Mid-Atlantic a year ago.

Total home building inventory at June 30, 2010 was $433 million, a decrease of $63 million below June 30 2009 levels. Our unsold land investment at June 30, 2010 is $232 million, which is 7,672 lots. This compares to $289 million or 7,732 lots at June 30, 2009.

Compared to a year ago, raw land and land under development decreased 15% and finished unsold lots decreased 24%. At June 30 2010, we had $127 million of raw land and land under development, and $105 million of finished, unsold lots. Our unsold, finished lots totaled 2,633 lots, with an average cost of $40,000 per lot, and this $40,000 average lot cost is 15% of our $267,000 backlog average sale price. And the market breakdown of our $232 million of unsold land is $112 million in the Midwest, $39 million in Florida, and $81 million in the Mid-Atlantic region.

While our inventories are lower than a year ago, we have grown our lot position in total inventory since the start of the year. The total home building inventory at June 30 2010 increased by $13 million or 3% from December 31 2009. During the second quarter, we purchased 1,250 lots, and for the year, we have purchased about 2,000 lots. Year-to-date, about 40% of our land purchases have been in the Midwest, 15% in Florida and 45% in the Mid-Atlantic.

As to our type of land purchases year-to-date, about 75% have been finished lot pickups under option contracts, 20% had been bought finished lot purchases, and about 5% have been raw land deals.

As to land development expenditures, we have spent $15 million year-to-date. At the end of the quarter, we had a $59 million investment in specs. 156 that were completed, and 420 specs in various stages of construction, and this translates into about five specs per community. And of the 576 total specs, 280 of the units are in the Midwest, 128 are in Florida and 168 are in the Mid-Atlantic. As of June 30 2009, we have 413 specs with an investment of $41 million, and as of March 31, 2010, we have 448 specs with an investment of $48 million.

At June 30, 2010, the Company had no borrowings under its new $140 million credit facility. Our borrowing availability under the terms of our new facility is currently $33 million, and this availability can be increased by pledging additional assets.

During the quarter, we added an additional $10 million secured letter of credit facility, bringing us to a total of five such facilities totaling $45 million. We moved substantially all of the remaining letters of credit from under our credit facility into these cash-secured LOC facilities, which are at a lower cost and, thus, a more efficient use of our cash.

As a result, the amount of restricted cash on our balance sheet pledged to secure letters of credit increased from $19 million at year end '09 to $34 million at June 30.

With respect to our $200 million of 6.875 senior notes that mature in March of 2012, our goal is to provide for their refinancing in advance of the maturity date. We continue to monitor the capital markets and review refinancing alternatives, including the estimated issuance costs of new debt and the estimated costs of redeeming our senior notes. And we weigh those factors in determining when to refinance the notes, being mindful of the maturity date as it approaches.

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

(Operator Instructions) Your first question comes from the line of Alan Ratner with Zelman Associates.

Good afternoon, guys. Thanks for taking my question. First question just from your comment about the spec comp, it looks like there was a fairly large pickup sequentially. I'm calculating about 30% or so, and my guess is had some of that might have been left over from the spec you were building for the tax credit. If not, please correct me.

But I was wondering if they're -- you're doing anything or are concerned at all about that level and doing anything on the pricing incentive front to try to move through that, or if you are comfortable with that current level of spec?

You know, Alan, we are comfortable with that level. You know, it's about five per community. We are excited about a number of our new communities that we are opening. And we think the use of specs can help us fund an area.

You're right in that at the end of March we had 448 specs, and at the end of June we had 576. But of the 576, you know, only about 150 were completed. We are managing that very closely, as far as our margins -- we obviously don't give any margin guidance, but we are very mindful of trying to make as good margins on those specs as we can.

On the other side, there are certain communities, especially some of the older ones, that we are trying to work through, generate cash. So again, we think it is a part of our business that we need to be focused on these days, and we are.

The only thing I'd add to that, if I could, Alan, is historically, I think we've been at least on the more conservative end of the spectrum when it comes to our approach toward specs. I think we still remain so. We haven't altered our strategy in any material respect, and I would just add that to what Phil said.

Great. I appreciate that. sAnd if I could just follow on in term of pricing in general. You did mention that in some of the sequential margin pressure was from some financing incentives that you offered. Just curious kind of what your strategy is here.

Another builder reported today and mentioned that they did bump up their discounts towards the end of the quarter in select communities. So I was wondering if you guys are doing that or maybe seeing that from some of your competitors. And kind of what you're baking into the back half of the year in terms of your expectations on that front.

I think that's a great question. Number one, at least in response to the first part of it, yes, there is more promotion going on in most markets and in most submarkets of most markets. conditions have toughened, in some cases significantly. There has been a noticeable dropoff in sales activity, not just with respect to our operation, but we believe many of our competitors, and that has triggered some increase in promotion.

It would be very, very difficult and I wouldn't even try, at least during this call, to quantify by market the extent to which promotions have increased on a percentage basis. But they have, nonetheless, increased, and I think for the back half of the year, based on what we know today, I think it would be ill-advised to plan for things to get much better if at all. There's -- these conditions are very uncertain. There's a very significant lack of clarity.

s I said in my comments and I think I've heard from many other builders and economists, things are very choppy right now, and are likely to remain so at least for some time. And until we start to see some tangible evidence of improvement, either on the job side or on the consumer sentiment side, and I think those two are joined at the hip, I think we're likely to continue to see margins at or about where they are right now. Maybe a little bit worse. Of course, a lot of that depends on things that we just don't know.

Great. I really appreciate that. Thanks.

Your next question comes from the line of Alex Barren with Housing Research.

Thanks, guys, how are you doing?

Good Alex.

I was hoping you could give us a little bit more, maybe month by month how the sales progressed or a better understanding of what you mean when you say the sales sort of dropped off after the tax credit ended.

You know, Alex, in my remarks I did make that comment and I'll go through it again. As far as sales, our sales were up 7% in April, and traffic was up 6%. Our sales were down 40% in May, and traffic was down 32%. And our sales were down 31% in June, and our traffic was down 11%.

Okay. Got it. That's very helpful. The other thing I guess I wanted to ask was have you guys -- has the nature of the incentives been more price-cutting or is it just more like giving free options, or how does that -- how has that worked for you guys? And what about broker commissions?

You know Alex, as we've always said, we're very much in the subdivision business. It depends very much on the demand we see. It depends on competition. It depends on a lot of different things.

I mean, we've run financing programs. We've run option programs. A few communities, some of the newer ones, we haven't really had to do much. It just really depends on the community and, being in 109 communities, you can't really just give a blanket type of answer.

But when you look at our margins going down from 17.3% to 16%, we obviously had downward pressure on those margins even though our average sale price and backlog went up a little bit. And we just continue to try to deal with those market conditions and try to make the best decisions we can, focused on profitability but being mindful of the balance sheet and our liquidity.

Okay. That was going to be my other question was, where do you guys actually run things such as closing costs or broker commissions? Does that run through SG&A, or does it run through the cost of goods sold?

The broker commissions run through SG&A --

The closing costs are in revenue.

And the closing costs run through the margin line.

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

Thanks, Alex.

Your next question comes from the line of Joel Locker with FBN securities.

Hi, guys. Just on the financial service income, I guess I expected it to be a little higher than it was. Was that just a lot of the mortgages haven't been sold yet? You might recognize those in the third quarter, on the second-quarter closings?

No. Really we had put out some pretty aggressive financing programs to help sell homes, and those programs have much lower margins than the homes traditionally loans that we originated. So it was really on a promotional basis that the margins came down.

Right. And the interest expense at $2.1 million, is that a good run rate going forward? I just thought it maybe tapering off a little bit.

You know, that's a tough number. That's dependent on, you know, a lot of different things as far as, you know, investment levels and our closing volume. That's just a tough number to estimate and we're trying to stay away from future projections and that type of thing, Joel.

Right. And the last thing, I guess, about the possible debt issuance. Obviously, you got, what, another year and a half or so until your fixed rate matures.

But just was wondering in the near future, I guess credit spreads came back in a little bit in the last few weeks or so, if that's a real possibility, just where you don't want to rely on specific short-term and other credit facilities working and everything's fine with that right now. But just based on maybe issuing enough fixed rate debt along with your cash where you can, you know, take the $200 million maturity out.

Joel, this is Kevin. As we have commented, we continue to look at and monitor the different conditions. We wouldn't look at current availability as very highly attractive, but -- and we're continuing to consider what the costs would be to -- and whether we could even get a sizable amount of the current notes taken out. So we're going to continue to monitor and look at those conditions.

And as we said, our goal is to take them out prior to maturity, when we think those kind of different costs weigh against each other at the most opportune moment. With recognition that as maturity gets closer, we would prefer to not feel the pressure of the maturity getting too close.

Right. All right. Thanks a lot, guys.

Thank you.

Thanks, Joel.

Your next question comes from the line of Jay McCannless with Guggenheim and Partners.

Good afternoon, everybody. Thanks for taking my questions. First question I had, looks like there was some sequential improvement in the monthly sales and traffic numbers from June to May. Did that carry into July?

Really aren't making any comments on that.

Yes, there's not a lot to be said other than we've not -- at least a number of quarters now, will not today comment on the current month.

Okay. Okay. Is there a level of sales or a dropoff -- continued dropoff in activity that would at least slow you down in Texas or make you rethink the entry into that state, or is that going full speed ahead no matter what?

Well, I mean, the short answer is yes, full speed ahead no matter what. But I mean, without -- the risk of people taking that out of context, we -- it's a decision that was made after an enormous amount of thought and due diligence. We have a lot of confidence long-term in Houston. We believe we can compete there. We do think that as tough as conditions are at least nationally, it -- at some point things will turn.

In the meantime, we want to -- we think we're better positioned as a company going forward. Beginning slowly but surely, developing a footprint in Texas.

And the other thing is that the amount that we have projected, you know, over the next coming months to be invested in the Houston market, we do not feel in any meaningful way impairs our ability to maintain what we consider to be, a good level of financial strength.

So when you sort of add all that up and shake it up, the answer is we're very committed. In hindsight, we would not change one thing. We've hired a very strong operator. We're very excited about the product we've developed. And we bought a few lots, and we're going to be open for business here during the next 60 to 90 days and we're eager to get started.

It will be at least a year or two before we have what we would call any kind of meaningful presence because it is a startup. And we're going to take our time.

Okay.

It's not a whole lot different, quite honestly, than what we did when we opened up in Chicago. And had a question nearly identical to this asked of us a couple of years ago. And we were concerned, too, because the markets eroded. That eroded a whole lot more than anybody thought they would shortly after we announced that we were going to open up in Chicago.

But our operation there has turned out to be one of our -- from a profit standpoint, one of our stronger operations. We have a number of new communities there as I noted in my comment at the beginning, and we're very excited about how that's worked out. It may not -- it's not quite at the volume levels that we had thought when we first opened, but we're very please with our progress.

Okay, that's great. Then on impairments, is the $7 -- $6 million from this quarter, is that likely to continue at that level or a little bit higher, assuming traffic and prices come down little bit more? Or as you open these new communities, is the likelihood of impairments lessened?

Obviously we don't make any projections on what impairments will be. It is dependent on a lot of factors, including market conditions.

As far as new communities that we're doing, we continue to have hurdle rates of our new investments of 20% ROIs in that community which is far above any impairment issues. When you look at the inventory we have at risk for impairments at June 30, we actually had unsold land of $232 million. And we talked about the breakdown of the $232 million, $127 million being raw land and land under development and $105 million being finished, unsold lots. And the $105 million of finished, unsold lots are an average of $40,000.

So when you compare our investment levels today to a year ago, they're dramatically different. But again, you know, impairments, we still have some based on market conditions, but it's primarily in the older communities.

Okay. Great. Thank you.

Thanks a lot.

Your next question comes from the line of Jim Wilson with JMP Securities.

Thanks, good afternoon, guys.

Hey, Jim.

Phil, could we get maybe a little color on what margins look like on the newly acquired communities or what you expect them to look like compared to your old stuff?

Jim, when you look at that -- as I talked about, our hurdle rates for our new communities, our goal is to have 20% GPs. We would like to have absorption levels of 2.5 a month and we would like to have ROIs of 20% in the subdivision, which includes interest built in.

In general, when you look at what we're selling in closing, the differential between new communities and old communities is in the 400 to 500 basis points area. And last year we talked about -- we opened about 24 new communities last year, is what we opened. And it --

We opened 25 in the first six months.

And we opened a similar number this year. So we've opened about 50 new communities in the last three quarters, and right now we're in 109. Have not given any estimate recently of what we expect community count to be but our view today would be we would expect it to go up a little bit the last part of the year. But again, our land spend and new openings will be determined to some degree by market condition and how our business is.

Okay. I was going to ask where you thought your community would go but you answered that. So that sounds like you could have, I don't know, 15%, 20% of your communities open be on new, better priced land by the end of the year?

It depends if we're looking at sales or closings. You know, it takes a while once you get open, the quarter or so to get sales going, another quarter or so before closings starts. But right now when you start looking at new communities, we're thinking the end of the year. You know, maybe in that 115 range, Jim, is kind of where we're thinking right now.

Okay.

Well, also as we talked about and you can see it from our land division as Bob talked about, I mean, our owned land has moved up quite a bit. You know, a year ago, we owned 52% of the land and -- excuse me, we owned 52% today of our own land in the Midwest. A year ago it was 62%. So the Midwest has come down 10% --

Although some of that's in the Mid-Atlantic.

And Mid-Atlantic has gone up from 16% to 27%. Florida stayed about 20%.

So one of the big shifts is that Charlotte, Raleigh and DC, which are our stronger markets, even though our sales were off in the second quarter, our sales were off in the second quarter in the Mid-Atlantic, primarily because of new communities and when they opened and closed. But our better markets these days are the Carolinas and DC, and we feel good that the majority of our land purchases, the majority of our subdivision openings, more of those are happening in the Mid-Atlantic.

Yes. All right. That's very good. Okay. That's all I have.

Thanks, Jim.

(Operator Instructions) You do have a followup question from the line of Alex Barren from Housing Research.

Yes, thanks guys. I was having a hard time finding another year where your revenues have been this low back in the early 2000s or so, had to go all the way back to 1996 I think it was. Anyway, I was trying to figure out like is there something more that you guys can do on the SG&A front to get to profitability, or do you think you've gone as low as you can go?

You know, Alex, as we said with the SG&A being down to 14% for the quarter, that's the lowest we've been in a couple years. We're working very hard every day to get our gross margins up. We continue to look very hard at SG&A. We have been doing more realtor business recently than in the past, so that's been taking our SG&A up. all that our promotion or whatever but that does impact our traffic and sales.

We're looking every day at expenses, looking every day at hard cost reduction, trying to get margins up. So we're continuing to attack it in all different ways, trying to get back to consistent profitability as Bob mentioned, so we're working at it all different ways.

Okay. Yes, no, I appreciate that because obviously I guess the expectations have changed versus three months ago where everybody kind of thought revenues were going to be I guess going up and to the right. And now it seems like we might be stuck in a lower level for a little while longer. But I appreciate you guys are doing that. I think that's all I got. Thanks.

Thanks, Alex.

At this time there are no further questions.

Thank you very much for joining us and we look forward to talking to you again next quarter.

This concludes today's teleconference. You may now disconnect.