M/I Homes Inc (MHO) 2014 Q3 法說會逐字稿

Good afternoon. My name is Stephanie and I will be your conference operator today. At this time, I would like to welcome everyone to the M/I Homes third-quarter conference call. (Operator Instructions)

Thank you. I would now like to turn the call over to Phil Creek. Please go ahead

Thank you. Joining me on the call today is Bob Schottenstein, our CEO and President; Tom Mason, EVP; Paul Rosen; President of our mortgage company; Ann Marie Hunker, 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 turn the call over to Bob.

Thanks, Phil. Good afternoon, everyone, and thanks for joining our call to review third-quarter results.

As stated in our release, we had another solid quarter, highlighted by a 62% improvement in pretax income. For the quarter, our pretax income equaled $22.2 million compared to $13.7 million a year ago. The big increase in income was largely due to a 5% increase in homes delivered, a 13% increase in average closing price, and continued improvement in our returns.

Specifically, our gross margins were up 70 basis points year over year. Year to date for the first nine months our gross margins are 21.1% compared to 19.9% a year ago, a 120 basis point improvement. Improving our returns remains an important area of focus for us, and we were pleased to see our third-quarter operating margin increase to 7.5%, up 70 basis points from last year. For the first nine months of this year, our operating margin has improved 140 basis points year over year.

Our sales backlog at September 30 had a value of $518 million, 6% better than a year ago, and the average sale price in backlog at September 30 equaled $333,000 a house, approximately 10% higher than a year ago. Our backlogged units at quarter's end equaled 1,554 homes. This is a 3% decline from a year ago.

Obviously our backlog is a function of two things: sales and closings. In terms of sales, we have a number of comments. First, we continue to believe that the fundamentals have been in place, and remain in place, to support further improvement in housing conditions throughout our 13 markets. That said, there is no question that since the beginning of this year, and clearly during the third quarter, demand has been uneven in many of our markets. And these uneven and at times choppy conditions are reflected in our sales performance.

In the third quarter, our sales posted a 3% year-over-year increase following a 6% year-over-year decline in the first half of the year. For us, July and August were good, posting sales increases of 8% and 5%, respectively. On the other hand, this pattern shifted in September, when we experienced a 6% decline in sales.

In addition, we have throughout the course of the year experienced largely unexpected delays in getting our new communities opened. These delays have been mostly related to the increasing problems associated with permitting and entitlement for new communities. These delays have also impacted our sales. Still, our sales were up for the quarter and looking ahead our overall view of the US housing markets is positive.

Our balance sheet and liquidity remain strong. Our ratio of net debt to capital equaled 45% at the end of the quarter and our net worth stands at $533 million.

And earlier this week we successfully extended the maturity of our unsecured credit facility for four years, reduced the borrowing rate under the facility, and increased the credit availability to $300 million with a strong group of 10 banks.

We continue to stay keenly focused on improving our profitability and strengthening our returns and remain poised to have a very solid 2014.

Before turning the call back over to Phil, let me take a moment to briefly review our three regional housing markets, beginning with the Midwest, where we have homebuilding divisions in Columbus, Cincinnati, Indianapolis, and Chicago. The Midwest region had 381 deliveries in the third quarter, representing 39% of the Company total. Our deliveries increased 24% for the quarter compared to last year.

And new contracts in the Midwest region increased 2% for the quarter when compared to the same period a year ago. Our sales value in backlog in the Midwest was up 24% year over year, and our total controlled lot position in the Midwest region increased 6% compared to a year ago. We ended the quarter with 62 active communities in the Midwest, which was a decrease of 6% from a year ago. We have seen a continued improvement in profitability across all four of our Midwest markets.

Next is the Southern region, where we have operations in Tampa and Orlando, Florida, as well as Houston, San Antonio, Austin, and Dallas/Fort Worth, Texas. First let me say that we're making very solid progress with our recent market expansions in both Dallas and Austin, and are exceeding solid results in both Tampa and Orlando. Clearly we are growing our position in this region.

We delivered 344 homes in the Southern region during the quarter, which represented a slight, 3%, decrease from last year at 35% of total volume. The dollar value of our sales backlog at the end of the quarter in the Southern region was flat year over year. We were pleased to increase our total lot position in the Southern region by more than 2,000 lots, which is an increase of 27% from a year ago. And we had 51 active communities in the Southern region at the end of the quarter, which is an 11% year-over-year increase. Our new contracts increased 13% fourth quarter in the Southern region, in large part reflecting the progress we are making in our most recent market expansions in Texas.

Finally, the Mid-Atlantic region, where we have homebuilding divisions in Charlotte and Raleigh, North Carolina, as well as Washington, DC. In this region our new contracts were down 8% for the third quarter compared to last year and the dollar value of our backlog was down 13%. Deliveries decreased 6% in the Mid-Atlantic region compared with a year ago and the Mid-Atlantic region accounted for 260 closings, or 26% of companywide total.

We ended the quarter with 34 active communities in the Mid-Atlantic region, which was a 3% decrease from a year ago. Our total controlled lots in the Mid-Atlantic at the end of the quarter actually increased 12% from a year ago, with the vast majority of the increase being located in our Raleigh and Charlotte divisions, where we continue to achieve very strong results.

Now I'll turn the call over to Phil, who will provide more specifics on the results of our quarter.

Thanks, Bob.

Our pretax income increased 62% in the third quarter compared to last year on 20% revenue growth, and our pretax income percentage increased to 6.7% compared to 5% a year ago.

New contracts for the third quarter increased 3% to 892, and our traffic for the quarter was down 7%. Our new contracts were up 8% in July, up 5% in August, and down 6% in September. As to our buyer profile, 38% of our third-quarter sales were to first-time buyers compared to 40% in the second quarter. And 50% of our third-quarter sales were inventory homes, similar to the second quarter.

Our active communities at 147 were flat for the quarter when compared to the prior year. The breakdown by region is 62 in the Midwest, 51 in the South, and 34 in the Mid-Atlantic. During the quarter we opened 15 new communities, while closing 13. We continue to experience delays in getting our planned new communities opened. Our current estimate is to end the year with about 150 communities.

We delivered 985 homes in the third quarter, delivering 60% of our backlog this quarter compared to 56% a year ago. Our building cycle times were about the same in the third quarter as the second. However, certain markets continue to have challenges. Our construction and land development costs have increased slightly when compared to the third quarter of last year.

Our average closing price for the third quarter was $320,000 compared to last year's third quarter of $284,000 and $306,000 in 2014's second quarter. And our backlogged sales price is $333,000, up 10% from a year ago.

In the third quarter we recorded pretax charges of $622,000 for impairments. These third-quarter charges were for older land assets in our Midwest operations. We continue to work through these older assets. We are currently down to a couple of older Midwest communities.

Our gross margin was 20.7% for the quarter, up 70 basis points year over year. Year to date our gross margins are 21.1% versus 19.9% a year ago.

Our third-quarter SG&A expenses were 13.2% of revenue, flat when compared to last year's third quarter and down 10 basis points from the first nine months of 2014 (sic) a year ago. We continue to work on improving our SG&A efficiency. We are now delivering homes in both of our Texas startup markets, Austin and Dallas.

Interest expense decreased $800,000 for the quarter compared to last year and decreased $2.6 million for the first nine months of 2014, reflecting higher capitalization due to higher land development activity. We now have $16 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 recorded $8.8 million of tax expense related to the current quarter earnings. Our effective tax rate for the quarter was 39%.

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

Now Paul Rosen will address our mortgage company results.

Thanks, Phil.

Our mortgage and title operations pretax income decreased from $3.5 million in 2013's third quarter to $3.4 million in the same period of 2014. Our third-quarter results include an increase in loans originated from 689 to 701 and higher average loan amounts. Although still strong, margins on loans sold during the quarter were lower than those we were able to achieve in the third quarter of 2013.

The loan to value on our first mortgages for the third quarter was 85% in 2014 compared to 86% in 2013's second (sic) quarter. We continue to see a shift towards conventional financing with 73% of the loans closed conventional and 27% FHA/VA. This compares to the 66% and 34%, respectively, the 2013 same period.

Overall, our average mortgage amount increased 12% to $269,000 in 2014's third quarter compared to $240,000 in 2013's third quarter. The average borrower credit score on mortgages originated by M/I Financial was 740 in the third quarter of 2014 compared to 733 in 2014's second quarter. Our mortgage operation captured 84% of our business in the third quarter compared to 81% in the third quarter of 2013.

At September 30, 2014 we had $60 million outstanding under the $110 million MIF credit agreement, which expires March 27, 2015, and $20 million outstanding under separate $15 million repo facility, which expires November 5, 2014. We are in the process of extending the repo facility and expect to have it completed prior to the expiration date. Both facilities are typical 364-day mortgage warehouse facilities that we extend annually.

And now I'll turn the call back over to Phil.

Thanks, Paul.

As far as the balance sheet, we continue to manage our balance sheet carefully, focusing on investing in new communities while also managing our capital structure. Total homebuilding inventory at 9/30/14 was $894 million, an increase of $218 million above September 30, 2013, primarily due to higher investment in our backlog and increased land investment.

Our land investment at 9/30/14 is $426 million compared to $296 million a year ago. And at September 30 we had $260 million of raw land and land under development and $166 million of finished, unsold lots. We owned 2,750 unsold finished lots with an average cost of $60,000 per lot. And this average lot cost is 18% of our $333,000 backlog average sale price.

The market breakdown of our $426 million of unsold land is $121 million in the Midwest, $187 million in the South, and $118 million in the Mid-Atlantic. Lots owned and controlled as of 9/30/14 totaled 21,000 lots, 53% of which were owned and 47% under contract. Our owned and controlled lots of 21,000 is an increase of 16% versus a year ago.

We own 11,200 lots, of which 31% are in the Midwest, 45% are 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 and 46% of our land is in the Southern region and 25% is in the Mid-Atlantic.

During 2014's third quarter we spent $59 million on land purchases and $41 million on land development, for a total of $100 million. Year to date we have spent $277 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 total 2014 land purchase and development spending is approximately $375 million to $425 million. That includes the $277 million we've spent year to date.

At the end of the quarter we had $160 million in inventory homes, 305 that were completed and 694 inventory homes under construction. This translates into about seven inventory homes per community. And of the 999 inventory homes, 351 are in the Midwest, 398 are in the Southern region, and 250 are in the Mid-Atlantic. At September 30, 2013, we had 822 inventory homes, with an investment of $110 million, which was about six homes per community. We believe we are very well positioned with our inventory levels.

Our financial condition remains strong with $533 million in equity and net debt to cap ratio of 45%. At 9/30/14 there was $14 million outstanding under our then $200 million unsecured revolving credit facility. As we announced today, we have amended this facility, extending the maturity four years and increasing availability to $300 million, which will provide us with additional financial flexibility.

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

(Operator Instructions) Michael Rehaut; JPMorgan.

It's actually Jason Marcus in for Mike. First question: I just wanted to drill down a little bit more on some of the delays that you were talking about. I know you highlighted that permitting and entitlement were, I think, the main issues. But has [labor] availability also been an issue as well?

And then also, I think if you could just let us know what were some of the markets that were most impacted by this issue? And then I guess, finally, with the community count average being lowered, what are the biggest drivers there?

Let me take the first part of that. This is Bob Schottenstein and then perhaps Phil or someone else here will take the balance. It's not one thing that's contributing to the delay. But I'd say that the two most significant factors are permitting and entitlement. And then the third one which would also be in there is, frankly, labor shortages in terms of land excavators and so forth.

But the process has become protracted. Whether deals are being internally developed by us because we purchased them raw or whether we're buying finished lots from third-party developers, we're more often than not experiencing some delay. Frankly, a lot of the delays have been greater when there's third-party developers involved. But it also is very locale specific and there are certain markets and submarkets where it is just taking longer to get entitlements secured and then inspections signed off on by the appropriate municipal or county authority.

In terms of where the new community openings have been and haven't been I think I'll turn that over to Phil.

Yes. As far as the community count outlook, at the start of this year we thought we'd be opening about 75 communities for the calendar year 2014. And our current view is that will probably be about 60. So that is the biggest part. We are selling out of a few communities a little faster than we thought, but the big drop in the community count in expectation [is] opening about 15 less communities.

Should also remember that last year we actually opened about 20% more communities. So last year we did have a very strong performance there.

As far as where it is, they're really across the board, as Bob said. We obviously had more things opening in the Southern region. We really have a pretty good run rate right now in Houston and also in San Antonio. And the good news also is we're starting to deliver houses in the other two Texas markets. But we had delayed openings in every market in our company.

Yes. And I mean -- and this is of no consolation, but I think this is clearly industry-wide. And I think that it's known to be industry-wide. And a lot of the deals when our communities are delayed, there's other builders both public and private involved who are experiencing the same kind of delays.

Okay. Thanks. And the next question has to do with gross margin. So when you look at the gross margin and you look at stripping out the financial services income, looks like it declined about 50 points sequentially. So I was just wondering if you could quantify what the drivers of that were. Was it mix or was there something else going on?

And then just generally, when you look at the backlog we always think, oh, gross margin. How did that compare to what you just reported?

You know, we don't really give any type of projections or guidance for gross margins. We had been pleased -- when you look at the last three or four quarters, we had been pleased by the increase in the margins. Also had been pleased with the average sale price continued to increase. I wouldn't say anything has really changed a whole lot. We've worked through almost all of our legacy land in the Midwest, so those margins have been improving. And we talked about the DC market being a little more difficult for us. But other than that, we think our margins are in pretty good shape. We sure hope to improve them in the future, but no guidance or estimates on those.

Okay. Thank you.

Ivy Zelman; Zelman & Associates.

I guess the hard thing for us to appreciate right now is just how cheap your stock is. And when you look at where your stock is trading and the amount of capital that you have access to, I just would like you to comment on the prospects of a stock buyback at these depressed levels.

I'll take a crack at that and then see if anyone wants to answer. We think it's underpriced, too. But we also think that right now the best use of our capital is to deploy it in our divisions where we believe that in virtually every one we have really good opportunities to continue to grow and gain market share. And the goals of the Company today are to improve our profitability, to improve our returns.

And I want to just emphasize on improving the returns one of the biggest and most important aspects of that is, as we've talked about during the last two calls, is getting more scale, particularly in our newer Texas markets. And we're there in some of them now, or at least getting there. But in at least Dallas and Austin we're not where we need to be yet because we just haven't had enough time to get there. But we have a lot of opportunities ahead of us to invest in the markets, to grow our community count. We don't want to over-leverage the Company and we don't to use -- at least at this point there's no decision to use any of our capital to buy back stock. I don't know if, Phil, you or Kevin have anything you want to add to that.

No, I think that's [it].

I guess in fairness to shareholders and everyone that you're speaking to, I guess would you say that the returns that you can get on your stock, given where other builders are trading relative to book value, is not as good as the returns that you would buy on land? And isn't there room for both? And maybe you don't have to answer that directly, but is it something you would consider in the Board discussions? Because I guess it just comes down to the math of it and understanding right now where the stock is trading below book value and you've got other companies that are trading well above you. I just would like you guys to consider it, frankly.

Well, I appreciate the question. And, number one, we bought back stock in the past when we felt it was prudent to do so. It's not like it's not something we haven't done.

The other thing is, that it is something that we look at and we talk about. And it's something that we will look at and talk about in the future. But I think that you absolutely nailed the issue, is where can you get the greatest return on invested capital. And therein lies the debate and the discussion.

Okay. Well, I'll leave that and just to kind of go back to the fundamentals of the business. You talked about the challenges and sort of the choppiness of the market. Where you think about month to month and what you're seeing in the consumer with respect to the traffic being weak, you noted, Phil, year over year down in September. Is it, from your perspective, a sticker shock factor? Is it the consumer who lacks the urgency? Are you getting feedback that they just can't afford it, they can't sell their house? Can you walk us through a little bit? Because in recognizing in the market we're in it's a tenuous recovery so far with job growth accelerating and mortgage rates as low as they are.

So if you have any more feedback and maybe you could talk about your winners and losers. We know the DC market has been very challenging and there have been markets that have been better within Texas and a lot of it is related to job growth. So I think a little bit deeper would be helpful to everybody.

I'll just say a couple things. And you've identified a lot of the reasons. But first of all you have the whole, whatever they're called, the Millennial group, and they're not entering with any kind of meaningful impact the new home market at this point for a whole variety of possible reasons.

Leaving even that aside, though, the combination of credit not being as easy as may- -- and I don't want to use easy in an irresponsible way, but the ability to secure credit, for that to be as balanced as it should be. Buyer ignorance -- I think you were the one that put out the chart that showed how uninformed the average consumer is when it comes to what it takes to buy a house, whether it be a new or used house, in terms of the amount of down payment, and how just out of touch they are with things.

Right.

And the education process that we think we do a really good job of. But first you've got to get to them.

But the other thing is just some of the -- to be certain, some of the quirks in market to market. The first part of this year the Tampa market was particularly, and curiously, and unexpectedly slow. In the last number of months Tampa has become, has at least for us, come back quite strongly. Orlando, the Orlando market was quite strong through the first six, seven months of the year and then in the last few months it's been a little more up and down. You mentioned DC and how the buying conditions there have been just sort of so-so. The Texas markets have been for the most part good, but I think they've even slowed a bit here in the last -- at least for us in the last few months.

Look, I think, at the risk of sounding like a broken record, I think there's a whole lot more reasons to be optimistic than not. I think that housing has -- housing will have a positive trajectory. We believe that it will. That's why we're choosing to invest the way we are. We believe that there's opportunities for us to grow and that demand will continue to grow in the markets that we're in. It just may not happen in quite the linear way that maybe everybody expects.

I don't know where this year's going to end up nationwide on new homes sales, but it's going to be nowhere near what a lot of folks thought back in December and November of last year. I don't know if (multiple speakers) --

From our standpoint we went into this year thinking that we were going to spend perhaps $475 million to $500 million on land. And of course we just updated those numbers to $75 million or $100 million less. Still feel really good about our land position, owning 11,000 lots. But, again, things have definitely not been as strong as we would like them to be. We've really tried to adjust our business to that. The good news is price has moved up. Margin's moved up. The SG&A leverage has not been as good as we would like it to be. But, again, we've had a situation where that we're just starting to close houses in 2 of our 13 markets, plus with DC a little slow. And there's other things in SG&A. We've had increased benefit costs. We have walked away from a few land transactions.

But let's be clear about one thing, too. On a basically flat community count our sales were up 3%. And so up is up. Up is better than down. And the inability to get as many of our new communities, particularly in some of the markets where we were so excited to get them opened, has had an impact.

Sure.

So -- get them opened, rather. So I guess it's a whole lot of all of that.

I guess my last question -- and feeling sorry for the next question person asking, but you guys when you underwrite your ground and assuming it's not going to come on immediately, could be a year or two years later, are you underwriting to a two -- what type of absorption -- or are you keeping it at the depressed levels that today's environment is unfortunately experiencing? Or are you being more optimistic in your underwriting?

We underwrite based upon the conditions that exist today, unless there's some very significant not to. (Multiple speakers) --

So the fact that you bought -- when thing were stronger would they have been underwritten higher and therefore --

No. The absorption levels we project for any new land opportunity is based upon what we believe the selling conditions allow for right now. We don't think, well, in two years they'll be a lot better, so therefore we can sell twice as many per month. We don't do that.

And the one thing that has changed in our underwriting process is not the minimum levels of return; that has stayed the same, the return that we expect to get. But I think that we're now a lot more realistic about opening, when communities will open. Because a lot of the delays that we've experienced and others have experienced as well, were unexpected. They're not as unexpected anymore. So now we're building more in, which makes it more difficult for deals to pencil because if it takes longer to get something open that impacts the returns.

Thanks, Bob. Appreciate it. Thanks, Phil.

(Operator Instructions) Alex Barron; Housing Research Center.

So I wanted to see if we could focus a little bit on the SG&A . I think this year you guys have done a good job of growing the top line and (inaudible) the SG&A seems to be under control. But as I was looking at some figures here, there was a significant bump in the fourth quarter. I'm guessing that was maybe incentive compensation. But should we expect something similar to this quarter [in] the fourth quarter?

Well, if you look at the SG&A number, round figures, the 13% SG&A number in the quarter, about half of it is G&A and about half of it's selling. As we look at the selling, about two-thirds of that is variable selling. And our variable selling hasn't moved a whole lot. It's increased a little bit in certain markets. If incentives go up a little bit sometimes, just realtors and things like that, but by and large the selling variable has stayed about the same. The selling [number] will tend to be a little more stubborn because even though we're not opening as many communities as we'd like, we still are opening a fair amount of communities. So selling hasn't moved a whole lot.

G&A, as I briefly mentioned, I mean there are higher incentive compensation numbers in there this year than last year. Again, we talked about our profit going up 60% for the quarter. We also have some higher benefit costs in there. We also have had some higher land write-offs, deposits, prepaid items on land deals we've decided not to go forward with. Normally the way our business works, our SG&A percentage gets better as the year goes on because normally deliveries do increase. So, again, with starting to close houses in Austin and also in Dallas and the closings hopefully increasing in the fourth quarter, hopefully we'll see a little better results there. But we continue to work very hard on getting some more SG&A leverage.

Got it. And I was also hoping you could comment on how you guys are seeing October so far maybe versus third quarter. And I guess my last question as you guys are thinking about 2015 land spend, do you think you will continue to grow or are you kind of taking a pause to see what happens?

Well, as far as the first question, we don't give any comment on October sales, nor do we have any comments in there about 2015 expectations or land spend or whatever. But I will comment that, like I said to Ivy, we went into this year thinking we were going to spend maybe more $475 million to $500 million on land. Now the current estimate is more in the $400 million range. Owning 11,000 lots and having another 10,000 or so behind that under control we feel really good about. Normally we like to own about a year of finished lots. And we're a little bit below that right now, but that's okay.

But I would see our land staying in the owning the three-year type run rate. So, again, we think we're really in pretty good shape. I think the balance sheet's in really good shape. So, again, I don't see really our strategy and direction changing a lot. Hopefully business will be a little bit better. I don't have any guidance out there either as far as community count next year. But, again, we are off this year with about 15 communities opening. Those didn't just go away. So we are optimistic obviously about next year, as Bob said.

Right. Okay. Great. Thanks a lot.

(Operator Instructions) At this time there are no additional questions.

Thank you very much for joining us.

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