M/I Homes Inc (MHO) 2014 Q2 法說會逐字稿

Good afternoon. My name is Lindsay 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. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you. Phil Creek, you may begin your conference.

Thank you and thank you for joining us today on our call. On the call is Bob Schottenstein, our CEO and President; Tom Mason, EVP; Paul Rosen; President of our mortgage company; Ann Marie Hunker, our VP, Controller; and Kevin Hake, Senior VP.

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.

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

Thank you, Phil. Good afternoon everyone, and thank you for joining our call to review our second-quarter results.

As reported earlier this morning, we had another solid quarter, highlighted by pretax income of $15.3 million, which was more than double the pretax income recorded in last year's second quarter. Also want to note that our pretax income for the first half of 2013 was also more than double the income that we earned during the first six months of 2013.

A number of factors contributed to our improving profitability. Total revenues for the quarter were up 20% as a result of a 13% increase in closings, as well as a 9% improvement in our average selling price. And our gross margins improved by 150 basis points, increasing to 21.2% in the second quarter compared to 19.7% one year ago.

Our balance sheet liquidity remained strong. We have no outstanding borrowings under our $200 million unsecured credit facility and our net debt to capital ratio stands at a very healthy 43% at quarter's end.

Also at quarter's end, the sales value of our backlog equals $546 million, which is 11% higher than it was a year ago. Our new contracts for the quarter were down 6% compared with last year's second quarter, primarily due to delays in new community openings as well as lower traffic levels and frankly somewhat choppy market conditions.

I'll have some closing comments in a few moments, but at this point, I'd like to talk more specifically about our three operating regions.

I'll begin with the Midwest region where we have home building operations in Columbus, Ohio, Cincinnati, Ohio, Indianapolis, Indiana, and Chicago, Illinois. Our Midwest region had 291closings during the second quarter, which represented one third of total companywide closings. Deliveries decreased 2% in the Midwest for the second quarter compared to last year and our new contracts in the Midwest region were flat year over year.

Our sales value in backlog in the Midwest was up 39% from the second quarter of last year and our total controlled lot position in the Midwest was flat year over year. We ended the quarter with 60 active communities in the Midwest, which is a year-over-year decrease of 8%. I do want to note that we have seen continued improvement in profitability across all four of our Midwest markets.

Next is the Southern region, which consists of our Florida operations in Tampa and Orlando as well as four Texas operations in Houston, San Antonio, Austin, and Dallas. We continue to be very excited about our progress and growth in our four Texas markets, and we are achieving solid results in both Tampa and Orlando, though somewhat tempered from last year's pace. And we have been growing our position across our markets in the southern region.

We delivered 330 homes in the Southern regions for the quarter, which was a 33% increase over last year. This represented 37% of closings companywide. The dollar value of our sales backlog at the end of the quarter was 1% higher than a year ago. We increased our controlled lot position in the Southern region by more than 2,100 lots, which is a 30% increase from a year ago. And we had 50 communities in the Southern region at the end of the quarter. This represents a 25% increase over last year. Our new contracts decreased 3% for the quarter in the Southern region, in part due to particularly difficult sales comps in Florida, which contributed to the drop in sales.

Finally, the Mid-Atlantic region, where we have operations in Charlotte and Raleigh, North Carolina, as well as Washington, DC. In the Mid-Atlantic region, our new contracts were down 16% year over year and our backlog sales value was also down 11% at the end of the quarter. Deliveries increased 13% in the Mid-Atlantic region compared with last year, and this region accounted for 273 deliveries, or 30% of total closings companywide.

I want to note that our North Carolina markets have been performing quite well and we continue to grow our positions in these markets. We ended the quarter with 35 active communities in the Mid-Atlantic region, the same as last year. Our total controlled lots in the Mid-Atlantic region at the end of the quarter increased by more than 1,600 lots, which is a near 40% increase year over year.

Let me make a few closing comments before I turn it over to Phil. Despite uneven and at times choppy market conditions during the first half of 2014, we continue to be very optimistic about our business and the outlook for housing. As stated in our release, we continue to believe that the fundamentals are in place, notably declining unemployment, improving job growth, low inventory levels, increasing household formation, and a gradually improving US economy to support further improvement in housing conditions. With the strength of our backlog, our planned community openings, and the quality of the various markets in which we operate, we believe we are very well positioned to have a solid 2014.

And with that, I'll turn it over to Phil.

Thanks Bob. New contracts for the quarter decreased 6% to 1,016 and our traffic for the quarter was down 8%. Last year's second-quarter sales were up 37% over 2012's second quarter. Our new contracts were down 13% in April, down 9% in May, and up 10% in June. As to our buyer profile, 40% of our second-quarter sales were to first-time buyers compared to 42% in 2014's first quarter. And about 50% of our second-quarter sales were inventory, homes similar to the first quarter.

Our active communities increased 4% from 140 at the end of June last year to 145 this year and the breakdown by region is 60 in the Midwest, 50 in the South, and 35 in the Mid-Atlantic. During the quarter, we opened nine new communities, while closing 22. We had delays in getting our planned new communities opened, primarily from the land side of our business. Our current estimate is to end the year with about the same community count as we began 2014.

We delivered 894 homes in the second quarter, delivering 59% of our backlog this quarter, compared to 57% a year ago. Our building cycle times were about the same in the second quarter as the first quarter; however, certain markets such as Houston continue to have challenges. Our construction and land development costs increased slightly in the second quarter, slightly less of an increase than the first quarter. Our average closing price for the second quarter was $306,000 compared to last year's second quarter of $281,000 and $299,000 in 2014's first quarter. And our backlog sale price is $332,000, up 13% from a year ago.

In the second quarter, we recorded pre-tax charges of $804,000 for impairments. These second quarter charges were for older land assets in our Midwest operations. We continue to work through our older assets. We are currently down to a couple of older Midwest communities. Our gross margin was 21.2% for the quarter, up 150 basis points year over year. Sequentially our gross margin declined slightly when compared to the 2014's first quarter, primarily due to a lower land sale gross profit percentage and lower mortgage company market contribution.

Our second-quarter SG&A expenses were 14.7% of revenue, flat when compared to last year's second quarter and down 20 basis points for the first half of 2014. We continue to focus on improving our expense leverage. We are now delivering homes in Austin and expect to start Dallas deliveries later this year. These increased deliveries will aid our expense ratios.

Interest expense decreased $1.7 million for the quarter compared to last year and decreased $1.8 million for the first six months of 2014. This reflects higher capitalization due to higher land development activity. And we have $15 million in capitalized interest on our balance sheet compared to $14 million a year ago, about 1% of our total assets.

With respect to income taxes during the quarter, we reversed an additional $4 million of our state deferred tax asset valuation allowance. This reversal was due to a change in estimate based on our improved financial results and projections. This reversal was offset by $5.7 million of current tax expense related to our current-quarter earnings. Excluding the reversal, our effective tax rate for the quarter was 37% and we expect our effective tax rate for the remainder of 2014 to approximate 39%.

Our earnings per diluted share for the quarter was $0.44 per share and this per share amount reflects $1.2 million of dividends paid to our preferred shareholders.

Now, Paul Rosen will address our mortgage company results.

Thank you, Phil. Our mortgage and title operations pretax income decreased from $3.8 million in 2013 second quarter to $3.1 million in the same period of 2014. Our second-quarter results include a slight increase in loans originated from 597 to 607 and higher average loan amounts. While still strong, margins on loans sold during the quarter were lower than those we were able to achieve in the second quarter of 2013. A shift in product mix from FHA to conventional as compared to 2013 same period also impacted margins.

The loan to value on our first mortgages for the second quarter was 86% in 2014 compared to 87% in 2013's second quarter. We continue to see a shift towards conventional financing. 68% of the loans closed were conventional and 32% were FHA VA. This compares to 65% and 35% respectively for 2013's same period.

Overall, our average mortgage amount increased 8% to $254,000 in 2014's second quarter compared to $234,000 in 2013's second quarter. The average borrower credit score on mortgages originated by M/I Financial was 733 in the second quarter of 2014 compared to 736 in 2014's first quarter. Our mortgage operation captured 80% of our business in the second quarter compared to 77% in the second quarter of 2013.

At June 30, 2014, we had $49 million outstanding under the $110 million M/I Financial credit agreement, which expires March 27, 2015, and $13 million outstanding under a separate $15 million repo facility, which expires November 5, 2014. Both facilities are typical 364-day mortgage warehouse facilities that we extend annually.

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

Thanks, Paul. We continue to manage our balance sheet carefully, focusing on investing in new communities, while also managing our capital structure. Total homebuilding inventory at June 30, 2014 was $816 million, an increase of $201 million above June 2013 levels, primarily higher due to higher investment in our backlog, higher community count and increased land investment.

Our land investment at June 30 was $393 million compared to $271 million a year ago. At June 30, we had $249 million of raw land and land under development and $144 million of finished unsold lots. We owned 2,460 unsold finished lots with an average cost of $59,000 per lot and this average lot cost is 18% of our $332,000 backlog average sale price. The market breakdown of the $393 million of unsold land is $107 million in the Midwest, $177 million in the South, and $109 million in the Mid Atlantic.

Lots owned and controlled as of June 30 totaled 21,000 lots, 52% of which were owned and 48% under contract. And our owned and controlled lots of 21,000 is an increase of 22% versus a year ago. We owned 10,900 lots, of which 30% are in the Midwest, 46% in the South and 24% in the Mid-Atlantic.

We believe we have a very good solid land position. 29% of our owned controlled lots are in the Midwest, 43% of our land is in the Southern region and 28% is in the Mid-Atlantic. During 2014's second quarter, we spent $72 million on land purchases and $34 million on land development for a total of $106 million.

Year to date, we have spent $177 million on land purchases and land development. And as to our 2014 land purchases, about 50% of the purchase amount was raw land. Our estimate today for a total 2014 land purchase and development spending is approximately $425 million to $475 million, including the $177 million we've spent year to date.

At the end of the quarter, we had $134 million in inventory homes, 279 that were completed, and 669 inventory homes under construction. This translates into about 6.5 inventory homes per community. Of the 948 inventory homes, 327 are in the Midwest, 367 are in the Southern region, and 254 are in the Mid-Atlantic. As of June 30, 2013, we had 703 inventory homes with an investment of $86 million, which is about five homes per community.

We believe we are well positioned with our inventory levels, and our financial condition continues to be very strong with $44 million of cash, $520 million in equity and a net debt to cap ratio of 43%. And the Company has no borrowings under our $200 million unsecured credit facility.

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

Thank you. (Operator Instructions) Your first question comes from the line of Ivy Zelman with Zelman & Associates.

I guess I want to dig in little bit with you in understanding, you had some big misses, at least you mentioned as well, delays in community count and realizing if you can make it up, or what we should be thinking about guidance. Should we be still thinking 5% to 10% year end, up from a year ago?

And then, looking at the Mid-Atlantic orders, they were down pretty substantially and recognizing it's pretty soft there. And you've mentioned North Carolina being so strong, or relative strong, Bob. Can you just dig in a little bit further there? So those are the two questions I'll start with. Thank you.

Sure. Let's take community count first, or community openings first and then maybe I'll let Phil restate that which he already indicated with respect to where we think we will be year end on community count. The one thing that we're seeing pretty much across the board is that new communities, whether they are developed by third parties or developed internally by us, are coming on anywhere from in some case 60 days late to almost as much as six months or more late. An average would be misleading because they are all a little bit different. But almost none are getting done on time and most because of just the stresses on the system as housing begins to come back, and the contractors required to finish, developments are stressed because of what's happening within the markets.

What you are seeing somewhat on a look back, it appears that it was somewhat foreseeable, but at the time, I don't think we expected anything close to the kind of delays we're experiencing. In some cases, these are deals that we are in with other builders where they're having the same delay we are. When the lots are developed by third parties, frankly, the delays are greater.

And the other side of it is -- and these aren't excuses, this is just the reality of it. Even communities that we're able get open, they're not getting open maybe with the final coat of paint, if you will. They're just not as finished as we would like them to be when we are opening because everyone is rushing to try to get the play open on time.

So that's an issue. It's an issue that we're dealing with. We think we're managing it very well. Does it impact sales? Yes, it does, as well as a tough comp last year impacts sales, the fact that our sales were up in June and improving each month through the quarter -- all those things are true.

But the other side of it is, is I just think that even though there's so many more reasons to be optimistic about housing than not -- and we are optimistic. We are optimistic about our business and, as I said, we think that most of the fundamentals that are out there suggest that housing conditions will continue to improve.

The pace of improvement at times is going to moderate or -- you've written a lot about this already -- be somewhat uneven. And I think that's what we're seeing. And I don't think there is anything -- you watch it closely and you would rather see the other. I actually think this kind of growth is healthy for the industry and it's healthy for all us to try to work through what otherwise are the strains on the system with shortages of contract or cycle time being extended and certainly, shortages to get communities open on time.

I'm saying a lot of different things. We have a lot of confidence in our three Mid-Atlantic regions, our Mid-Atlantic divisions I should say. We're particularly bullish about our operations in Raleigh and Charlotte. Phil, you just want to reaffirm what you said before relative to community count?

Yes, as far as the community count, we believe currently that we'll be in about the same number of communities the end of this year as we went in starting this year. We ended last year with about 157 active communities. We had previously thought we would be opening 5% to 10% more. Today, we're in about 10 communities less than we thought we would be due to these delays that we've talked about. But again, we think we'll be about even the end of the year.

Also, as Bob said, if you look at the second quarter of last year our sales were up 31%.

(Inaudible.)

Yes. We had very strong sales in the Carolinas, very strong sales in Florida, and that is kind of what is hurting our comp.

Thanks for that. I appreciate both of you. So just to reiterate on the community count, we're still comfortable using 5% to 10% for the full year for 2014; is that correct?

No, we think we will be flat. We think will be flat at the end of this year. Same number we came into the year with.

Okay. And going back to the general trends and knowing the growth in June, which is nice to see the double-digit growth. When we go into the back half of the year, just how we -- maybe you could just comment if I am thinking about it correctly. But we had the government shut down. Each month it got seasonally worse -- it was worse than normal seasonal sequential declines, as we were dealing with the backup in rates married with the surge in pricing that spooked a lot of potential buyers.

It would seem as if you've got pretty easy comps going into the second half as compared to the first half and therefore you should see a nice acceleration with year-over-year order growth, even if your communities are now going to be flat. Do you feel that you can get a nice juiced momentum, should accelerate into the back half, assuming, as you said, business deals -- it is lumpy, Bob. I think you did a nice job describing it and we know it's not a straight line. So are we thinking about it right?

Well, three or four comments on that. Number one, we're not giving any guidance or projections on sales. Number two, we do have much easier sales comps in the back half of the year. Number three, I think right now, nationally, new home sales are down year over year. But the fourth thing is, I and we are a lot more optimistic about housing conditions improving even though it won't be a straight line than not.

Bob, don't -- Bob, Bob --(multiple speakers) --

So we feel we have a really solid year and we feel good about our business.

And we're also just continuing to be really focused on profitability. I mean the margins are up 150 basis points. Our returns are better. Our average sales prices are getting stronger. So we're trying to make sure we're focused on improving our returns also as opposed to just discounting a lot of things and running through our inventory.

And I was just going to laugh, Bob. Please don't tell me you think that new home sale number is a good data point, because your sales and the rest of the nation, as May showed -- I mean it's kind of silly, but you really don't believe those numbers, do you?

Are you asking if I believe what I hear and read?

(Laughter) Anyway, I'm willing to admit -- (multiple speakers) --

No, no. They all get modified, but it's -- the one thing we do know is that it appears that this year might be -- is either going to be a little down, flat, best case may be a little up over last year.

Okay. Thanks, guys.

Your next question comes from the line of Will Randow with Citi.

Hi, good afternoon. This is actually Scott Schrier in for Will. Thanks for taking my question. I wanted to talk a little more about the delays in opening up the communities. And I just wanted to see -- you kind of mentioned you had contractors. Is this a labor issue? And if so, is this going to --

It's a combination of lot of things. It's -- I don't want to make more out of it than it is number one. But I -- in order to open up a new community, there are inspections, governmental, there's governmental processes and approvals that are needed. The system has been stretched. Things that you thought you could do in 30 days are taking 45 or 50 and these things need to happen then sequentially. And a two week delay here, a three week delay here, another. Then you run into weather, this, that, and the other. And pretty soon, you begin to lose an opening that might have otherwise occurred at a more seasonally appropriate time.

On the other side of it is, yes, the dirt contractors, and the pavers, and the folks that put the underground utilities and the grating and all that goes with subdivision improvement -- there is stretch on that part of the system. So some are doing highway work, they're not working on communities anymore. And so you get into just -- as the US economy begins to rebound, you end up with strains and stresses and shortages and you end up with these delays. Many of -- some of our greatest delays are coming in areas where we've got third-party developers who are three, six, seven, eight months behind. And not all the months are the same too because if you start to move into a period where it's raining or bad weather you can -- the situation exacerbates itself.

So we're just dealing with it and -- the communities aren't lost. They will open and we're very excited about them, and we think they're going to be very solid contributors to the Company.

Got it. And as they open, is there going to be an effect as far as the backlog conversion on the labor side? Will that kind of maybe dip how longer builder cycle times may be 12 months or so?

Yes. Phil spoke about that in his comments and we did see that begin to happen about a year ago. That appears to have somewhat leveled out. We didn't really see any impact in longer cycle time this quarter over the previous quarter. But the cycle time has been extended, but it appears to have leveled off.

Okay. And then my follow-up question is on the cost increases and the gross margin expansion, are you -- how are you seeing the cost increases versus the amount of ASP growth that you're able to get?

^ Well, again our margins have been moving up. We're up 150 basis points versus a year ago. Our average sale price has moved up pretty nicely. As I said earlier, we continue to have some stick, brick land development cost increases, but the second quarter was a little less than the first quarter so we feel good about that. Not making any average sale price or gross margin projections, but we have been pretty pleased with those increases the last couple of quarters.

Great, thank you very much for taking my questions.

Thank you.

(Operator Instructions) Your next question comes from the line of Michael Rehaut with JPMorgan.

The first question is back to gross margins for a minute. So if you kind of look at the core home building gross margin, stripping out the land and the financial services, it's kind of been in that 20% range for the last several quarters or so. And just I guess as we think about this going forward, do you think there is much room for more improvement from here? And how are you thinking about weighing price versus pace? And I guess finally, in terms of the new land deals that you're doing, what type of gross margin are you [run rating] to?

I guess to go with the first one, we're always working very hard on trying to improving price and margins, opening up a lot of communities. It depends on the community, as far as what you start out and so forth. We are getting to the stage where we have pretty good critical mass in Houston and San Antonio. So we feel good about those markets. We're starting to close houses in Austin and hope to close a few houses in Dallas this year. And hopefully as we get more presence in those markets, our margins and results will continue to improve there. So again, no projections as far as gross profits, but obviously that's a very, very key part of our business that we're focused on every day.

And as far as the underwriting, Michael, in terms of -- that has not changed in any material respect. We underwrite based on conditions as they exist today. We don't bake inflation into either the revenue or the expense side of our underwriting on new land deals unless there is some material -- something material we know of that would suggest that we should. But basically what we seek to achieve at the very high level is a minimum 20% internal rate of return fully loaded with all of our expenses.

Okay, thanks. And then, next question is around SG&A. I think you've seen some improvement over time in the SG&A. But I think overall, the incremental SG&A and the overall SG&A is a little bit higher than some of your peers. And so I was just hoping if maybe you could discuss trends that you're seeing there, maybe give us a little more color around that. (Inaudible.)

Yes, the one thing I would say about that, point well made, is that -- and Phil touched on it. Four of our 13 markets are relatively new. Two or three of them we don't have near the scale of them we'd like to have yet. We're getting -- as each quarter that goes by that condition begins to get better and better. We'll be closing our first homes in Dallas this year. The Austin market is really beginning to take hold for us. There is no question that will improve some of our ratios. And I will just say it doesn't help when you have the delays in community openings, but I think that's more of a generic issue across the industry. So clearly with the growth of our newer Texas markets, we know that we'll see some improvement in our ratios.

We are working hard on the cost side that's for sure, but where we're going to get the biggest bang for the buck is increasing the revenue side. And again, we thought we would be doing a little more business than we are now from a sale and a closing standpoint. We did have some choppiness in the market. We also have had some delay in community openings. So as we continue to deliver more homes, the sales price average increase has helped us. So, again, we gotten a little bit of leverage this year year to date, not as much as we would like, but we're sure focused on trying to get more leverage as we move through the year.

Okay, thanks.

And there are no questions at this time.

Thank you for joining us. We look forward to talking to you again next quarter.

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