M/I Homes Inc (MHO) 2011 Q2 法說會逐字稿

Good afternoon. My name is Keena and I will be your conference operator today. At this time, I would like to welcome everyone to the M/I Homes Incorporated second quarter conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. (Operator Instructions) Thank you. Mr. Creek, you may begin your conference.

Thank you very much for joining us. Joining me on the call is Bob Schottenstein, our CEO and President, Tom Mason, our EVP, Paul Rosen, the President of our Mortgage Company, Ann Marie Hunker, our Corporate Controller, and Kevin Hake, our Senior VP.

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 with you directly. And as to forward-looking statements, I 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.

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

Thank you, Phil. Good afternoon and thank everyone for joining us to review our second quarter results. We recorded a pre-tax loss from operations of $3.5 million for the second quarter of 2011 compared with a gain of $1.7 million from operations in last year's second quarter. Last year's profit was driven by higher delivery volumes resulting from the federal tax credit, which was in effect at the beginning of 2010. Our deliveries for this second quarter were down 25% compared with a year ago and as most will recall, last year's second quarter deliveries were materially enhanced by the effect of the federal tax credit.

We were pleased to report that our new contracts for the second quarter this year improved 5% from the second quarter of 2010. That said, the balance of the spring selling season continued to be only a modest improvement from last summer and last fall, and our sales for the first six months were thus below our expectations. On our last call, we had graded the spring selling season through March for M/I Homes as B minus. If we were to continue with that same grading scale, we now would say that it may have slipped to a C or C plus.

Nationally, sales of new single-family homes in the second quarter were down 7% from last year. So with our 5% increase, we do know that we are doing better than most. Overall, we have experienced a modest improvement in sales conditions from the pace that we achieved in the last half of 2010 since the expiration of the Federal Tax Corp Credit, somewhere in the range of a 5% to 10% improvement in sales pace adjusted for seasonality. June, in particular, was slower than we would have expected. In our assessment, which we believe is widely shared by most other builders and analysts, demand for new homes continues to be impacted by the same factors. Weak consumer sentiment, particularly as it relates to big-ticket items, sluggish employment growth, restrictive mortgage qualification requirements, and depressed home values.

Clearly, consumers are also being spooked by the uncertainty surrounding the budget debate in Washington and the lack of a clear economic path for the country with regard to GDP growth and job creation. Given the macro conditions, we don't anticipate much improvement in the overall housing environment anytime soon, and as stated in this morning's press release, we will thus continue to manage cautiously.

Despite the challenging conditions, we remain very encouraged by several things, most notably our margin improvement. Specifically, our gross margins from a home building standpoint improved 70 basis points sequentially from the first quarter and a full point from last year's second quarter. This is important progress. This margin improvement is not only a result of improvements in our brick and mortar cost structure, but clearly and probably mostly the result of our continued efforts in opening, successfully opening new communities and building out our legacy communities. We opened 14 communities during the quarter and closed 10 older communities, thus ending the quarter with 115 active communities, representing an increase of 4%.

We also held expenses in check with G&A expenses at a level 6% below last year's second quarter, and we were able to increase our backlog by 11% over June of 2010. Another significant bright spot for the quarter was the closing of the acquisition of the assets of San Antonio based TriStone Homes on April 1st. This TriStone operation is a solid strategic fit for us and further expands our presence in the Texas markets. Our sales in San Antonio are on track and we are very pleased with our team and our performance.

We continue to operate with low leverage and ample liquidity on our balance sheet, ending the quarter with $114 million of cash and a very manageable level of debt. Our net debt to capital ratio was 37% at quarter's end.

Finally, we remain confident that housing conditions will improve and we feel very good about our position and our strategy as we strive to return to profitability. Before turning things back over to Phil, I'd like to take a few moments and review our regional performance and focus on specific conditions in some of our markets.

First, the Midwest region. Our deliveries declined 37% in the Midwest for the second quarter compared with last year. New contracts in the Midwest were down 1% compared with 2010. We have seen some modest improvement in sales conditions in Columbus, while Cincinnati has been challenging for us both with respect to sales and margins. Chicago continues to be a very good performer for M/I Homes and Indianapolis is largely holding steady. We ended the quarter with 58 communities in the Midwest, an 11% decrease from last year's second quarter. We have strategically grown our investment and communities in Chicago, with six active communities at the end of the quarter, while we have also strategically worked to reduce our investment levels and the number of open communities in our Columbus market. Our total lots under control in the Midwest is down 5% from last year.

Next, the Southern region, which for us is both Florida and Texas. We entered the Houston market in 2010 and as I noted earlier, we closed on our San Antonio acquisition at the beginning of the second quarter. In Florida, market conditions and demand for new homes continue to be challenging in both our Tampa and Orlando markets. Our sales in Florida were down in the second quarter from last year, although they were up 8% for the Southern region due to the impact of our new Texas operations. However, our backlog in Florida at the end of the quarter is up from June 30 last year, contributing to a 137% increase in total backlog for the Southern region, obviously impacted positively by our San Antonio acquisition and Houston startup. We ended the quarter with 24 active communities in our Southern region and our total lots under control was up 24% from last year.

Finally, our Mid-Atlantic region, which consists of Charlotte, Raleigh, and Washington, DC. Washington, DC continues to be, on a relative basis, one of the stronger housing markets in the country, though it clearly is very competitive. Raleigh is also one of the better performing markets and it continues to be one of our best performing divisions as well. Our Charlotte division is selling at a good pace, but margins remain under pressure, as the market is quite competitive. Total new contracts in our Mid-Atlantic region were up 16% for the second quarter compared with 2010. We ended the quarter with 33 active communities in our Mid-Atlantic region. This is a 50% increase from the prior year as we've continued to successfully shift more of our geographic focus and footprint into these markets. Our total lots under control in the Mid-Atlantic region is up 23% from last year.

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

Thanks, Bob.

New contracts for the second quarter increased 5% to 635, with a net absorption rate of two sales per community, per month. By region, contracts were down 1% in the Midwest, up 8% in the South, and up 16% in the Mid-Atlantic. Our cancellation rate for the second quarter was 20% compared to 2010's 16%.

Our traffic for the quarter increased 21%. Our sales were down 13% in April, while traffic was up 23%. Sales were up 34% in May and traffic was up 22% and our sales were up 10% in June and traffic was up 16%. Our active communities increased 6% from 109 last year to 115. The breakdown by region is 58 in the Midwest, 24 in the South, and 33 in the Mid-Atlantic. During the quarter, we opened 14 new communities while closing 10. Our current estimate is to end the year with about 125 communities, up about 15% from the beginning of the year. And as of June 30, about 60% of our active communities were new communities and we define new communities as those open since January of 2009.

We delivered 590 homes in the second quarter, down 25% when compared to 2010's 790 deliveries. About half of our second quarter deliveries were from new communities compared to 45% in the first quarter. We delivered 79% of our backlog this quarter compared to 84% a year ago, and our backlog of 833 homes is 11% higher than a year ago and our average sale price in backlog is $257,000, which is 4% lower.

In the second quarter, we recorded pretax charges for impairments of $5.4 million. The majority of these impairments were in older communities in the Midwest. This compares to $6.3 million in last year's second quarter. And for the six months, total charges this year were $16 million.

Our gross margin, exclusive of the impact of impairments, was 17% for the quarter, up about 100 basis points year-over-year, and 70 basis points higher than the prior quarter.

G&A expenses for the quarter were $13 million, decreasing 6% from last year's level. And selling expenses for the quarter were $11 million, down 24% from a year ago, primarily a result of volume decreases. In total, SG&A expense declined by $4.2 million in the quarter comparison.

Interest expense increased $1.4 million for the quarter and $3.3 million for the first six months compared to last year. The increase in the second quarter was due to incremental net interest incurred of $1.7 million, reflecting the impact of our new senior notes.

We had $3.5 million of pre-tax loss from operations for the second quarter, compared to a profit of $1.7 million during the second quarter of last year, primarily as a result of the decline in deliveries and higher interest expense. We generated our 8th consecutive quarter of positive EBITDA, producing $5 million of EBITDA and covering interest 1.1 times for the trailing four quarters.

We have $20 million of capitalized interest on our balance sheet, compared to $21 million a year ago, which is about 3% of our total assets. We reported a non-cash, after-tax charge of $3.8 million in the second quarter for a valuation allowance related to our deferred tax assets. As of June 30, our gross deferred tax asset is $138 million and it is fully reserved.

Now, Paul Rosen will address our mortgage company results.

Thanks, Phil.

Our mortgage and title operations pre-tax income increased slightly from $1.2 million in 2010 second quarter to $1.4 million in the same period of 2011. Loans originated decreased from 618 in 2010 to 448 in 2011. We continued to experience strong investor demand for our mortgage product.

The loan to value on our first mortgages for the second quarter was 88% in 2011, compared to 87% in 2010's second quarter. 53% of the loans closed were FHA BA and 47% conventional. This compares to 61% and 39% respectively, for 2010's same period. Over 90% of our communities are eligible for FHA financing.

Overall, our average mortgage amount was $208,000 in 2011's second quarter, compared to $213,000 in 2010's second quarter. The average borrower credit score on mortgages originated by M/I Financial was 734 in the second quarter compared to 724 in 2011's first quarter. These scores compared to 732 for the second quarter of 2010 and 734 for the first quarter. Our mortgage origination operation captured 85% of our business in the second quarter, compared to 2010's 84%.

At June 30, 2011, M/I Financial had $27 million outstanding under the $50 million M/I Financial Credit Agreement, and $5 million outstanding under the $10 million repurchase facility. Effective April 18th, 2011, M/I Financial entered into a secured mortgage warehousing agreement, which replaced M/I Financial's previous $45 million credit agreement. The M/I's warehousing agreement expires on March 31st, 2012 and provides a maximum borrowing availability of $50 million.

In the normal course of business, we receive inquiries concerning underwriting matters. And in 2011, we have received 12 such inquiries. We thoroughly review and respond to each inquiry, and even though we are not required to do so, we routinely engage an independent third party to review the files and information related to the origination of each mortgage.

Our reserve at June 30, 2011, with respect to these matters was $1.9 million. Our comparable reserve as of December 31st, 2010 was $1.4 million. M/I Financial has not repurchased any loans this calendar year.

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

Thanks, Paul.

As far as the balance sheet, lots owned and controlled as of June 30 totaled 10,300 lots, 71% of which were owned and 29% under contract. We own 7,300 lots, of which 55% are in the Midwest, 19% in the South, and 26% in the Mid-Atlantic. Total homebuilding inventory at June 30 was $463 million, an increase of $30 million above last year.

Our unsold land investment at June 30th is $249 million, which is 7,300 lots, compared to $232 million or 7,700 lots a year ago. Compared to a year ago, raw land and land under development decreased 5% and finished unsold lots increased 22%. At June 30, we had had $121 million of raw land and land under development, and $128 million of finished, unsold lots.

Our unsold finished lots total 2,800 lots with an average cost of $46,000 per lot, and this $46,000 average lot cost is 18% of our $257,000 backlog average sale price. The market breakdown of our $249 million of unsold land is $106 million in the Midwest, $35 million in the South, and $108 million in the Mid-Atlantic.

During the 2011 second quarter, we spent $17 million on land and $13 million on land development. About 22% of our land purchases were in the Midwest, 26% were in the South, and 52% were in the Mid-Atlantic. Year-to-date, we have spent $36 million on land purchases and $20 million on land development for a total of $56 million. As to the type of our 2011 land purchases year-to-date, about 80% have been finished lot pickups under option contracts, 15% have been bulk finished lot purchases, and about 5% have been raw land deals.

At the end of the quarter, we had a $58 million investment in specs, 167 units that were completed, and 375 specs in various stations of constructions. This translates into about 4.7 specs per community. And of the 542 total specs, 233 are in the Midwest, 160 are in the Southern region, and 149 are in the Mid-Atlantic. At June 30, 2010, we had 576 specs with an investment of $59 million. And as of March 31st, 2011, we had 441 specs with an investment of $55 million.

We continually focus on our capital structure, cash, and liquidity. We ended the quarter with $114 million of cash, which includes $45 million of unrestricted cash. Our restricted cash increased by $22 million during the second quarter, primarily due to us pledging $25 million with our banks under the terms of our credit facility, which is required for any period when both of our interest coverage ratios are less than 1.5 times. The full $140 million bank credit facility remains available. And as of June 30, the Company had no borrowings under our credit facility and the credit facility is available until June 2013. Our borrowing availability under this facility was $21 million at quarter end. That is based on the value of current pledged properties and this availability can be increased.

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

(Operator Instructions) Your first question comes from the line of Dennis McGill of Zelman and Associates.

Hi, good afternoon. Thank you, guys.

Hi, Dennis.

First question just around gross margin and pricing. Obviously a strong quarter in margins in the second quarter here. Can you maybe just talk about generally what you're seeing on price within the market and then as it relates to your specific gross margin. Maybe help us with where margins are sitting in backlog or what the outlook would be based on what you already know today?

Well, that's a good question. The -- first of all, we're very pleased with our margins given just what's going on in the market and how competitive is, in most of the cities in which we do business and certainly in a lot of the submarkets. We're very pleased with the margins in our new communities and as Phil said, roughly 60 of I think the 115 active communities we would deem to be new. And we're pleased that we continue to see some margin improvement.

As we continue to bring on new communities, we would expect there to be a positive lift to our margins and we would like to think that moving forward we would see gradual and sequential improvement in our margins. And of course, we also get some benefit from the fact that as each period of time goes there are fewer and fewer so-called legacy communities, which typically have been a drag on our margins. I don't know if that answers your question.

Well, it does. I guess your point is future margins are going to be more dictated by the mix of communities as opposed to what's happening with incentives and (inaudible) pretty flattish.

Yes, you've heard -- well, there's always the balance between trying to push for more sales by offering incentives and then trying to hold the line on margins. We feel very good that we had a 5% increase in sales and a corresponding 70 basis point increase in the margins that we reported. Obviously not every home that we sold during the quarter is yet closed.

Right. Kind of along those lines on the order front, one thing that we're trying to maybe get a little bit of a better grasp of is with community account expansion, finally positive for the industry and much more positive for you guys given the acquisition and also your initiatives in other markets. There's been a big divergence though in order performance and community expansion, implying that absorptions are down pretty materially. And even thinking about it in a region like the Mid-Atlantic for yourselves, which is a relatively healthy region and you're up 40-some percent on communities, but orders are up I think low double digits for the first half of the year.

I know it's up against a tough comp last year, but is there anything that you're seeing with the new communities that it's taking longer for them to start generating orders, or are they of different size? Is there anything that we need to incorporate as it relates to the growth of the communities relative to the growth in orders given the divergence that we've seen?

Well, I'll say one or two things about it and then maybe others here might want to chime in. To your point, footprint matters and even within a particular market, footprint matters probably even more. I mean we are in the subdivision business and location has always been paramount. And I think that in particular, and I'll use Raleigh's example where we have materially gained market share over the last number of years and have seen fairly strong results for our Company. I think it's because we've been able to secure strong locations that have contributed positively to our sales and our performance.

Beyond that, I don't know what else I might say. I don't know, Phil, if you have anything you want to add.

Well, I guess, Bob, maybe before Phil, you touch on it, I guess that's kind of my question. Because if you've gotten good locations in a market like Raleigh or DC and you're up 40% in communities then I would think that orders would be somewhat close to that. Or maybe it's just a lag and eventually orders will be up that much.

Yes, you've got to look at that, Dennis, I mean it's a situation that you need to get all the way out of the legacy community before they drop off. Also, demand is still challenging and you do want to make sure as you open new communities that you open new communities with strong pricing and strong margins because you don't want to get into appraisal issues, and you don't want to start out with real low margins, and some of those things also. So it's a balancing act.

If you look at us at the end of the year, starting this year we had 110 communities. Now, we're 115. I mean the Midwest has gone down three. The South has gone up five, obviously with Texas, and the Mid-Atlantic has gone up three. So as Bob says, we're definitely trying to tweak our footprint, get more stores open in the right places, but it does take a little bit of time to get through all that.

Okay, last question just having to do with the acquisitions or the Texas expansion. If I heard you right, I think it implies that the Texas business had maybe 20 orders in the quarter and I think it was out of five or six communities. I just want to confirm those numbers because it would seem like a lower sales pace. I'm just trying to gauge how we should be modeling the impact from San Antonio in particular, from the volume side.

We don't give out specific Texas information like that. San Antonio, as Bob said, we have been pleased with. That was an ongoing business that we acquired starting April 1st. Our Houston operation is still just getting communities open and from a community count, we had seven or eight communities open as of the middle of the year in Texas. But again, we're just kind of getting Houston going, et cetera.

Is there any negative impact on the margin from the purchasing accounting that wears off or was there any in the quarter?

It was not anything significant, the purchasing account. We are still incurring startup costs in Houston so that was a drag on the bottom line, but that's the color I can give you.

Okay. Thanks again, guys.

Your next question comes from the line of Alex Barron of Housing Research Center.

Hi, Alex.

Hey, guys. How are you?

Good.

I wanted to ask you on your debt, I know it's coming up due, part of it is coming up due in March --

April.

Okay, April. Is there any plans to retire any of that ahead of time or do you just kind of want to schedule when it comes due?

Well, this is Kevin, Alex. We always look at different possibilities. I wouldn't say we have any plans to do anything other than to take it out and it's not callable, I think, as you probably know. So we have to just expect that we won't be able to buy it in the open market or take it out otherwise. So we'll plan to have the cash available to take it out at maturity.

Okay, got it. And then as it pertains to your interest, I guess the run rate I get, I don't find the interest incurred for the quarter so maybe I missed it on the press release. But I'm assuming it's around $6 million, same as last quarter.

The interest incurred for the quarter, you're right, Alex, was about $5.5 million, same as the first quarter.

Okay, so if that's the case, you've been roughly expensing half of it through the cost of goods sold line and the other half below the operating line. I'm guessing as you guys grow your inventory, more of that is going to start shifting towards the cost of goods sold line. Do you have any idea when it might drop off from coming through the below the operating line?

That's hard to predict, Alex, as far as what goes on an activity. It's not just homebuilding activity, but it's also land development activity. So that's kind of a hard number to project. I mean the number on the balance sheet hasn't changed much as far as capitalized interest year to year, so we're not building anything up at this stage. But again, that's a hard number to project.

Okay, and my last question was, can you give a little color on the impairments, what drove them, how many communities, et cetera?

It was older communities in the Midwest and it was about five communities. We're always looking at all of our inventory. We talked about reducing our investment in the Midwest, trying to work through some of those assets and generate cash, et cetera. So again, it was about the five communities in the Midwest, older assets.

Thanks a lot, guys.

Your next question comes from the line of Michael Smith from JMP Securities.

Hi, Michael.

Hey, guys. How are you doing?

Good, thanks.

So just real quick, this is like the seventh one of these I've been on today, I'm wondering if you guys are noticing any starts or changes as far as kind of buyer confidence. I'm specifically wondering about all the mess that's going on in Washington and some of the headlines. Is noticing that having any kind of effect on people making the decisions to buy or wanting to come out, or is that just kind of not affecting people one way or the other?

Well, that's a really good question. As of this past weekend, I think the answer would have been probably too early to well on the one hand or minimal effect -- or minimal effect. But after this coming weekend, I think we're going to know yet a little bit more and frankly if something -- if our worst fears are realized, I've got to believe that it will not help our industry. The question is how much will it hurt it and that's anybody's guess.

I know one thing, it shakes the confidence of everybody so I have to believe that it will ultimately shake the confidence of our prospective buyers. It's not a good thing.

Yes, for a lot of reasons. I'm wondering, I guess what I'm trying to get at is, is the thing that's holding back demand out there more confidence, people feel that making the biggest purchase that they've ever made, it's not a good time to be doing that? Or is it that you guys are finding, and I'm specifically wondering about some of your Midwest markets because you don't get a lot of color from there as much from some of the other builders.

I think it's a combination of a number of factors. Clearly, consumer confidence, which I think is intrinsically tied to the employment picture in this country, it -- no one can be confidence if they're concerned about, A, losing their job or a friend of theirs, or a coworker losing theirs. So as we start to see job growth that should trigger an increase in consumer sentiment. So that's a big, big, big factor.

But I think another big factor, maybe not quite as big, is certain depressed home values and people maybe thinking that as things start to come back they'll capture some of the lost value in their home. And the -- so I mean I think those are the two big ones. And then there's also the tightening lending standards and just how much of a factor that is. That's going to vary from market to market. But I think the two big ones, and I don't think this is a very novel thought, I think it's widely shared by almost everyone in our industry, is consumer sentiment, which is also tied to job growth and then certainly existing home values.

And I was going to ask about the mortgage underwriting, if you guys -- I mean, a lot of people talked about how much tougher it's gotten. Have you seen that in your markets as well and can you give any color on the number of people who are maybe interested in buying, but you just can't get them qualified. Is that an issue for you guys?

Paul Rosen will respond to that.

I guess, yes, I'd like to break that in two pieces. We've seen a marginal increase in the complexity and difficulty in underwriting approval, but we've also seen a more of a marked weakness in actually the credit quality of some of our buyers where 10% to 15% of our buyers had very weak credit profiles in the past. Now, we see more, 20%, 25% of the shoppers coming into our homes have weaker credit profiles than in the past.

Having said that, if you have a credit score of 640, which is not a great credit score, there is great financing opportunities out there. Our customers can, with a 640 credit score, can get an FHA loan at 3.5% down at a three and seven-eighths interest rate for a 30-year loan. So there's great financing out there, but we are seeing a marked increase in credit impaired customers.

Just a follow-up real quick, I'm wondering why do you think that -- I mean is there any way to read that as a positive sign that people are a little lower income or a little harder credits, or maybe a year or two ago they wouldn't have even bothered. Now, they're starting to come out of the woodwork and show a little bit more interest in actually buying a home?

I'm not sure. I could read into that, but they are coming out more. They are looking more. They have experience that's pent up demand of wanting to get out there. But I'm not sure why we've seen that much of an increase in that buyer profile.

Okay. Thanks, guys. I appreciate it.

Your next question comes from the line of Lee Brading of Wells Fargo.

Hi, guys.

Hi, Lee.

I wanted to touch on the gross margin. Congrats on the improvement there. And wanted to just, is it simply just a matter of expansion of new communities and trying to get an idea of that angle and how much is it just a continuous process that you're going through on finding cost savings?

Mostly the first thing you mentioned.

Yes, Lee, it's mostly the new communities. The new communities have actually continued to perform pretty well. We target in our new communities to have 20% plus margins and in total they're just a little bit below that. Some of the challenges have been the legacy communities that continue working through those. We continue to work very, very hard on all of our costs to reduce them, including sticks and bricks, but sticks and bricks reductions in total at this stage of the cycle having gone through this for a few years are pretty challenged.

Okay, and on the land position, I think I heard right, land and land development year-to-date, roughly, what, $56 million. And just trying to think going forward, I think you've got, what, 2,800 finished lots. And just trying to think of the need that you have looking forward in this second half, and we hear some -- people are pulling back a little bit on the land side and just kind of thinking from your standpoint what are you guys thinking about going forward here?

Lee, we did not give any type of estimate for the rest of the year for different reasons. Our land position actually is pretty good, owning 2,800 finished lost. We tried to keep about a one-year supply of finished lots and in total we own about 7,300. Last year, we spent total about $150 million. We want to continue to buy really good sites that make a lot of sense, but again it just depends on the combination of the general economy, how our business is doing. We talked about being focused on our capital structure, cash, and liquidity. We balance all those things off. We think in general our land position really is pretty good.

And as we said in our press release, and as said in our remarks, we're going to continue to remain cautious. While we're confident that ultimately things will begin to improve on a slow and steady basis, there's -- in our view, there's no clear tangible signs out there right now that suggest that that improvement across our markets is underway. And we don't think things are getting worse, but right now, they're just sort of choppy.

Fair enough. And on the supplemental data, on the cash used in investing activities it was around like $30 million this quarter. What else would be in there other than the San Antonio acquisition?

There's the $25 million that Phil talked about in the conference call that we pledged to the banks. That shows up as dollars that's been invested.

Fair enough. Okay, great. All right. Thanks very much, guys.

Thank you.

Thanks, Lee.

Your next question comes from the line of Dennis McGill of Zelman and Associates.

Hi, just a quick follow-up on the comments that you had made on the debt coming due. Hypothetically, if you were to pay that from cash, that's essentially what you have today, which would mean we would need to get the restricted cash freed up. So if the covenants don't improve, what would be the process of freeing that restricted cash up over the next couple of quarters?

Dennis, that's not quite accurate. We don't -- we could borrow under our credit facility the $41 million and pay off those notes. We don't need to free up any restricted cash to --

I thought you said that there was this $20 million of capacity on the revolver given the borrowing capacity.

All we do is pledge enough mortgage collateral there for what we think we need at the time. So we can borrow $140 million if we put enough mortgage collateral to do so. We wouldn't want to pledge that much, but we can pledge more at any time.

Okay, that makes sense. I thought you were restricted by the covenants on the revolver. Got you. Okay, thank you.

Thanks, Dennis.

Your next question comes from the line of Jay McCanless of Guggenheim.

Hey, good afternoon everyone. Wanted to ask about the impairments declined roughly 50% sequentially. Can we expect that same type of decline rate going forward or what do you think about the impairments right now?

Jay, we don't make any predictions on that and that's a very difficult area. We continue to look at everything every quarter. In the first quarter of this year, we had some impairments in the Midwest and also in Florida. In the second quarter, we had some additional impairments in some of the Midwest legacy communities. There is still some risk, especially in the legacy communities. I will tell you the primary risk we have is in the Midwest, but that's where the biggest part of the old land is. But again, we don't make any predictions on that number.

Okay, then the other question I have is a hypothetical. In this quarter, if you took out the impairment expense, basically it looks like you're fairly close to break even on an EBITDA basis and you take out the impairment and before you get to interest. What, if you took down the number of specs per community, I think you said it was 4.5, down to 4 or down to 3.5, have you all ever quantified or could you quantify for us what type of SG&A savings that would provide to potentially have pushed X impairment, X interest expense, pushed this to a cash flow positive quarter.

Jay, we look at a lot of things. One of the things you have to balance off with your spec level is what's the impact going to be on sales and closings. In the last few quarters, sales of specs have been anywhere from a third to 50% of our business. With the economy the way it is, it's hard to keep certain in a to be built transaction for four to six months. So you try to have a reasonable amount of specs. I think when you compare our specs to the other builders, we're a little bit below average.

But having said that, you are right. We're not that far away, quote-unquote, from break even. Of course, we actually made some money from operations this quarter last year. Our break-even we think these days is about 700 units a quarter. Again, that depends on margins and those type things. So we don't think we're that far away from it, although we don't give any predictions on when that's going to happen. But we just try to balance everything off, sales, closings, cash, trying to work through the old communities. You have to balance all those things off. We have had positive EBITDA for eight quarters in a row. So we feel like we are making progress and we feel we're not that far away from making money, and we also think the improvement of our footprint is going to help us get there. But again, we're trying to balance a lot of things off.

Sure, sure, and just to follow-up on that one, what percentage of your closings this quarter and maybe versus last year were specs versus dirt starts?

It's a little bit less this year compared to last year, but it's still over a third of our business.

Over a third. Okay, great. Thanks, everyone.

(Operator Instructions) You have a follow-up from Alex Barron of the Housing Research Center.

Hey, Alex.

Hey, Phil, Bob. Wanted to ask you, what (inaudible) interesting about this acquisition or about the market that it was in?

I misunderstood the question.

The acquisition you just closed, what did you find interesting or what drew you to make that acquisition?

A bunch of things. A, we really liked the market in terms of the demographics, the current employment picture, the projected employment picture. We were very drawn to the builder in terms of its fundamentals and operating systems, a high quality builder with a strong commitment to customer service and we really like the people a lot. We felt that the leadership style and the operating philosophy fit very well with us.

So and candidly, the size, the size of the transaction was one that didn't pressure our balance sheet.

So is the top management team all staying with you guys for a while?

Yes, very much so.

Okay, good. And kind of on a different topic, I know you guys are very close to profitability and you can kind of said that a few minutes ago. But what do you thinks is going to sort of get you over the hump? Is it going to be further -- is there room to cut further on SG&A or is the main thrust just revenue growth and margin expansion?

I think it's primarily revenue growth and secondarily margin expansion, and we're very close, a little more volume consistent with what Phil said, where the break even is 230 sales a month, roughly 700 units a quarter. We're very close to that and the margin expansion hopefully we're not -- we have no guidance in terms of how we're going to do next quarter or the following quarters. But our best guess with the advent of more and more new communities and the burn off of legacy is we will continue to experience some sequential improvement in our margins and we just need a little bit more volume, and we think and believe very strongly that that will come.

So the margin expansion is primarily you think going to come from the lower cost basis of the land and the new communities? Or is there anything else that you guys are working on that you think would cause the margins to go up further?

Well, it's also the burn off of the legacy. So you end up with a better mix.

Got it. Okay, thanks.

And there are no further questions. Are there any closing remarks?

No, we really appreciate you guys joining us and look forward to talking to you next quarter. Thanks.

This concludes today's M/I Homes Incorporated second quarter conference call. You may now disconnect.