M/I Homes Inc (MHO) 2017 Q4 法說會逐字稿

Good day, and thank you for standing by. My name is Siu, and I'll be your conference operator today. At this time, I would like to welcome everyone to the M/I Homes Year-end Earnings Conference Call. (Operator Instructions)

I would then like to turn this call over to your host, Mr. Phil Creek. You may begin your conference.

Thank you. Thanks for joining us today on our call. With me is Bob Schottenstein, our CEO and President; Tom Mason, EVP; Derek Klutch, President of Our Mortgage Company; Ann Marie Hunker, our VP, Corporate 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, 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.

Also during this call, we disclose certain non-GAAP financial measures. A presentation of the most directly comparable financial measure calculated in accordance with GAAP and a reconciliation of the differences between the non-GAAP financial measure and the GAAP measure was included in our earnings release issued earlier today that is available on our website.

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

Thanks, Phil, and good afternoon, everyone. Thanks for joining us today. 2017 was a strong and successful year for M/I Homes as we achieved record-setting revenues, record-setting new contracts and record-setting homes delivered.

Revenues for the year reached $1.96 billion, 16% better than 2016. New contracts for 2017 equaled 5,299, 11% better than 2016. And during the fourth quarter of 2017, we sold a record number of fourth quarter homes with 1,220 new contracts. This was a 22% increase over 2016's fourth quarter. Homes delivered for the year totaled 5,089, a 14% increase over 2016. This combination of strong sales and closings resulted in a year-end backlog of 2,014 homes, 12% higher than a year ago; and year-end backlog sales value of $791 million, which is 15% higher than last year's $685 million. Our strong backlog puts us in solid position as we begin 2018.

Pretax income for the year, excluding the nonoperating items, equaled $137 million, which is a 19% increase over the $115 million that we earned in 2016.

Net income for the year, excluding the non-core items, improved by 25%. We were particularly pleased to gain additional operating leverage as we improved our pretax operating margin in 2017 to 7% compared to 6.8% in 2016.

In terms of gross margin, our full year margins improved slightly, coming in at 20.9% compared to 20.8% in 2016. For the fourth quarter, gross margins were 19.8%, 100 basis points lower than a year ago. Clearly, from quarter-to-quarter, there is always a bit of choppiness due to mix and other similar factors, and we experienced some of that in the fourth quarter of 2017.

M/I Financial, our financial services business, had very strong performance in 2017, setting a number of records, including originating and closing over $1 billion in mortgages for the first time. We continued to benefit from a profitable and very well-managed mortgage and title business, which helps us better serve our customers. Derek Klutch, President of our Mortgage Operation, will be presenting here in a few minutes.

In 2017, we were also successful in improving our sales absorption rate throughout our communities. Sales for the year were up 11%, as I mentioned earlier, while active communities, on average, were up by 4%. We opened 67 new communities during 2017, ended the year with 188 active selling communities and expect to further increase our communities in 2018 by approximately 10% over 2017's level.

We have always focused intensely on securing premier locations and building homes and communities where people want to live. Our strong sales growth over the past several years is an indication that we are succeeding in this effort. Included within our 188 active communities are a number of communities featuring our new line of more affordable homes, which we call our Smart Series. We launched our first Smart Series community in Tampa in late 2015 and today have 11 active and open Smart Series communities. We expect to have over 15 Smart Series communities opened by year-end, spread across over half of our 15 homebuilding divisions. We are excited about that.

Company-wide, we have a very strong land position with over 28,000 lots under control. This is an increase of 24% over 2016. And as Phil will discuss in a few minutes, we expect to increase our 2018 land spend by approximately 10% over the level spent in 2017.

Now before I finish, I'd like to provide a bit more detail about our specific markets, beginning first with our Southern region, which is comprised of our 3 Florida markets: Tampa, Orlando and Sarasota; and our 4 Texas markets: Houston, Dallas, Boston and San Antonio. The Southern region in the aggregate had 649 deliveries during the fourth quarter and 2,108 for the year. This is a 23% increase from a year ago and represents 41% of company-wide closings. New contracts in the Southern region increased 44% for the quarter with improved sales in all 7 of our markets compared to last year. The dollar value of our sales backlog in the Southern region at the end of 2017 was up 39%, and our controlled lot position in the Southern region increased 33% compared to a year ago. We have 87 communities in the Southern region as of the end of last year, which is an increase of 10% from December of the year earlier. As to our 4 Texas divisions, we had 55 active communities at year-end versus 49 a year earlier. We continue to make noticeable progress towards our goal of achieving better scale in all 4 of our Texas markets. This is particularly important as we look to continue improving our company-wide returns. The demand in our 3 Florida markets is solid. Each market is performing well with Orlando and Tampa, in particular, both continuing to be very strong markets for us.

Next is the Midwest region, which consists of Columbus, Ohio; Cincinnati, Ohio; Indianapolis, Indiana; Chicago, Illinois; and Minneapolis, Minnesota. In the Midwest region, we had 630 deliveries in the fourth quarter and 1,907 for the year. This was 13% better than a year ago and 38% of company-wide closings. New contracts in the Midwest were up 18% for the quarter. We are very pleased with the results in our new Minneapolis division with sales increasing significantly from the prior year. And frankly, all of our Midwest markets continued to perform at a higher level. Our sales backlog in the Midwest was up 13% from the start of the year at dollar value, and our controlled lot position in the Midwest increased 15% compared to a year ago. We ended the year with 69 active communities in the Midwest. This is 13% up from a year earlier.

Finally, our Mid-Atlantic region, which consists of our Charlotte and Raleigh, North Carolina markets as well as our activity in greater DC. Raleigh and Charlotte have been strong markets for us for a number of years, but we did experience a modest falloff in sales pace in both of these markets this year, in part due to community openings and closings. But the level of sales and overall market demand in both Charlotte and Raleigh remains healthy. We will continue to work to get new communities online as we sold out of a number of communities than the 2 Carolina markets in 2017. The DC market continues to be challenging. We have reduced our investment there, and then -- and we have also reduced the number of active communities we have in greater DC. Though our absorption pace in DC did improve in the fourth quarter compared with the year ago, it remains below-targeted company levels. We ended the year with 32 active communities in the Mid-Atlantic region. This is down 16% from the beginning of the year. And as a result of all these factors, both at Charlotte, Raleigh and DC, new contracts in the Mid-Atlantic region were down 5% for the quarter compared with 2016. And our sales backlog value was also down 18% from the start of the year. In terms of total controlled lots in the Mid-Atlantic region at the end of the year, they had increased 21% compared to last year.

Before returning the call over to Phil, let me just conclude by saying, first, our company is in the best shape we've ever been in. We have a strong and healthy balance sheet, an excellent land position, very good product, appealing to a broad segment of buyers and a high level of quality and customer service. Housing conditions are good with solid demand across most of our markets. With all that, we are well positioned for continued growth in 2018 as well as continued improvement and profitability.

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

Thanks, Bob. First, financial results. New contracts for the fourth quarter increased 22% to a fourth quarter record of 1,220, and our traffic for the quarter was up 10%. Our new contracts were up 27% in October, up 24% in November and up 16% in December. And as to our buyer profile, about 37% of our fourth quarter sales were the first-time buyers.

Our active communities were 188 at the end of the year, up 6% versus 2016's year-end. The breakdown by region is 69 in the Midwest, 87 in the South and 32 in the Mid-Atlantic.

During the quarter, we opened 19 new communities while closing 10. For the year, we opened 67 new communities and closed 57. And for the year, our average community count was up 4%. For 2018, our current estimate is that our average community count for the year should be up about 10% from the average of 183 communities in 2017.

We delivered 1,584 homes in the fourth quarter, delivering 67% of our backlog compared to 64% a year ago.

Revenue increased 19% in the fourth quarter over last year, reaching a fourth quarter record of $622 million. This was primarily a result of an increase in the number of homes we delivered as well as record fourth quarter revenue from our financial services operation. And for the full year, revenue of nearly $2 billion increased 16% compared to 2016.

Our average closing price for the fourth quarter was $372,000 compared to last year's $356,000. And our backlog average sale price is $393,000, up 3% from a year ago.

Land gross profit was $2 million in '17's fourth quarter and $2.8 million for the full year of 2017. This compares to $1 million in 2016's fourth quarter and $4.1 million for the full year of '16. We sell land as part of our land management strategy and as we see profit opportunities.

Our fourth quarter gross margin was 19.8%, exclusive of impairment charges versus 20.8% a year ago. For the full year of 2017, our comparable gross margin was 20.9% versus last year's 20.8%. We continue to see hard cost increases with estimated fourth quarter cost up about 1%. And for the full year 2017, we estimate our hard cost to increase about 3% versus last year.

We recorded $8 million of impairment charges in 2017's fourth quarter related to 3 Texas communities. These communities were purchased a couple of years ago with higher-priced lots.

Our fourth quarter SG&A expenses were 12.3% of revenue, improving 40 basis points compared to 12.7% a year ago. For the year, our SG&A expense ratio was 13%, flat when compared to 2016.

2017 was negatively impacted by $800,000 of hurricane-related costs and $3.9 million of increased land-related expenses. Our non-variable selling cost increases are primarily due to a significant increase in our new community openings. Our focus continues to be on controlling our SG&A costs as well as increasing the scale of our divisions operations. Certain of our divisions, including our Dallas and Sarasota startups, have not yet reached desired volume levels.

Interest expense increased $600,000 for the quarter compared to the same period last year and increased $1.3 million for the 12 months of 2017. Interest incurred for the quarter was $10.4 million compared to $7.9 million a year ago. We have $17 million of capitalized interest on our balance sheet. This is about 1% of our total assets.

In the fourth quarter, as a result of the tax act lowering 18 corporate tax rates, we recorded $6.5 million in additional tax expense for the remeasurement of our deferred tax assets. Exclusive of this, our effective tax rate was 34% in '17's fourth quarter and 36% for the year. We estimate that our 2018 effective tax rate will approximate 26%.

Our earnings per diluted share for the quarter increased 20% to $0.90 per diluted share, excluding the impact of the deferred tax asset remeasurement and impact of the impairment charges in each year. Diluted EPS was $2.88 for '17 compared to $2.32 per share in '16, a 24% increase. That excludes the impact of the deferred tax asset remeasurement and a $2.3 million noncash equity adjustment related to the redemption of preferred shares in the third quarter of 2017, along with stucco-related repair and impairment charges in each year.

With that, I'll turn it over to Derek Klutch to address our mortgage company results.

Thanks, Phil. Our mortgage and title operations pretax income decreased from $5 million in 2016's fourth quarter to $4.5 million in the same period of 2017. While our fourth quarter results include an increase in the number of loans originated and sold, this was offset by higher payroll and computer-related expenses. We also experienced lower margins due to competitive pricing pressures. The loan to value on our first mortgages for the quarter was 82% in 2017, down from 2016's 83%. 77% of the loans closed were conventional, and 23% were FHA or VA, the same as 2016's fourth quarter. Our average mortgage amount increased to $297,000 in 2017's fourth quarter compared to $293,000. Loans originated increased 9% from 1,073 to 1,165, and the volume of loans sold increased by 4%.

For the quarter, the average borrower credit score on mortgages originated by M/I Financial was 743, up from 740 a quarter earlier. Our mortgage operation captured about 82% of our business in the fourth quarter compared to 2016's 85%. Due to our typical high volume of fourth quarter closings, we included seasonal increases in our mortgage warehouse credit facilities with temporary availability of $200 million through January 2018. After which time, the total availability returns to $160 million.

At December 31, we had $128 million outstanding under the M/I warehouse agreement and $40 million outstanding under a separate repo facility. Both are typical 364-day mortgage warehouse lines that we extend annually.

Now I'll turn the call back to Phil.

Thanks, Derek. As far as the balance sheet, we continued to manage our balance sheet carefully, focused on investing in new communities while also managing our capital structure. Total homebuilding inventory at 12/31/17 was $1.4 billion, an increase of $199 million above December 31, '16 levels. This increase was due primarily to higher investment in our backlog, higher community count and more finished lots.

Our unsold land investment at 12/31/17 is $659 million compared to $589 million a year ago. At December 31, we had $247 million of raw land and land under development and $412 million of finished, unsold lots. We owned 5,362 unsold finished lots with an average cost of $77,000 per lot, and this average lot cost is 20% of our $393,000 backlog average sale price. Our goal is to maintain about a 1-year supply of owned finished lots. And the market breakdown of our $659 million of unsold land is $244 million in the Midwest, $219 million in the South and $125 million in the Mid-Atlantic.

Lots owned and controlled at 12/31/17 totaled 28,531 lots, 41% of which were owned and 59% under contract. We own 11,622 lots, of which 38% are in the Midwest, 47% in the South and 15% in the Mid-Atlantic. A year ago, we owned 10,355 lots and controlled an additional 12,709 lots for a total of 23,064 lots. During 2017's fourth quarter, we spent $78 million on land purchases and $64 million on land development for a total of $142 million. About 46% of the purchase amount was raw land. For 2017, we spent $529 million on land and land development, and about 35% of that purchase amount was raw land. Our estimate today for 2018 land purchase and development spending is $550 million to $600 million. At the end of the quarter, we had 477 completed inventory homes, about 3 per community, and 1,134 total inventory homes. Of the total inventory, 371 are in the Midwest, 589 in the Southern region and 174 in the Mid-Atlantic. At 12/31/16, we had 376 completed inventory homes and 996 total inventory homes.

We have $86 million of convertible debt due March 1, 2018, at a conversion share price of $32.31 per share. If conversion occurs, the notes will convert into about 2.7 million common shares, which will not affect our cash but will reduce our debt and increase our shareholders' equity. Our EPS will not be impacted as these shares are already included in our diluted share count for EPS. In the event that the debt does not convert, we expect to redeem the convertible notes for cash, drawing under our credit facility as needed.

Our financial condition continues to be strong with $152 million of cash, no outstanding borrowings under our $475 million credit facility, shareholders' equity of $747 million and a 46% homebuilding debt-to-cap ratio.

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

(Operator Instructions) And we have our first question, comes from the line of Alan Ratner.

So obviously, the order number is very impressive. I guess the one area that was a bit lighter than we were looking for was the homebuilding gross margin. And I know, Bob, you said you kind of talked a little bit about just the typical fluctuations and mix there. I guess when I hear some of your prepared remarks, the cost inflation, if I heard that correctly, of 1% seems very modest. And at the same time, it looks like your prices is trending higher. So I was hoping maybe you could just give a little bit of the puts and takes on the margin that you see in the business today and maybe talk a little bit about pricing power where you have it and to what extent and then any impact that mix might be having that -- on a longer-term basis on margin. I'm thinking about maybe your move more into entry-level or maybe as you look to gain some market share in some of your newer markets, are those becoming a bit more of a drag on your gross margin that we should be aware of? Or should we just think more broadly about the stable trends you've been reporting over the last couple of years?

Let me make a comment or 2, and then I think Phil has a comment or 2. He's going to make first. I think that cost information that Phil gave you was just for the fourth quarter, not for the full year. But he'll cover that momentarily. For -- with -- on these calls, we don't give margin guidance. We give guidance when it comes to community count growth and the land spend, which I think is a pretty good indication of how we feel about the business. But we've also said I think repeatedly over the last 12, 24 months that we believe our margins are in the 21% to 20% range, somewhere around there, maybe a little higher from time to time, might creep a tinge lower. I still think that, right now, the way we see the business, for us, the -- it is a 20% to 21% business for the most part. I think there have been some drags on our margin in terms of some of our newer operations, where not only do you not have scale, but maybe you -- as you learn the market, open up in the market, develop product in the market and so forth, sometime you hit the bull's-eye like we did in Minneapolis. Sometime you don't quite hit the bull's-eye as well. So I think there has been some of that. Going into 2017, quite honestly we expect that our margins to drop a little bit because we thought there'd be a lot of inflation and pricing pressure and frankly builder behavior that would contribute to it as well. We were pleased that our margins not only didn't drop but went up slightly. I think there were some mix issues and some things happening in the fourth quarter. We feel really good about the business in terms of our backlog going forward. Phil, I don't know if you want to add anything.

I guess just a couple of things, Alan. You were correct as far as the hard cost information I gave. The fourth quarter, we were up about 1%. For the full year, we were up about 3%. So we did see a little bit more increase toward the end of the year. Just to also add to what Bob said, I mean, in Texas, we did take an impairment there for a couple of older communities. We have had some margin drag in getting Texas up to the volume levels we would like to. We do feel pretty good about all of our volume levels today in Texas with the exception of Dallas. And again, there's the Sarasota start-up but there wasn't anything big going through the fourth quarter. Again, we felt pretty good overall about being almost at 21% for the year, which was a little bit above last year.

Got it. And then I guess just on Texas in general. Given the scale, it seems like that that's a market where labor can be tight, and scale is certainly important. I look at your balance sheet, your cash balance is among the highest in recent memory that I've seen. Is that a market or state where you would think about potentially pursuing M&A to perhaps try to take some more market share there and improve your overall positioning longer term? Or do you think that you can get to the desired scale there organically?

Look, you sort of go back to everyone's desire, which is for every land deal to be successful and for every transaction to work. No one's ever entered into any deal believing it wouldn't work. We've done several mini acquisitions in Texas as we opened up, certainly San Antonio as well Houston. It's interesting. Our Minneapolis start-up and our start-up in Chicago were A+. Our start-up, pure start-up, no acquisition in Austin, we give an A, too. Our San Antonio, Houston and Dallas, and we did a mini acquisition of another builder's assets in Dallas as well, those have been a C to a B- or maybe a B. So all in all, a decent grade. We'd like -- I wish all of them had been what -- like Minneapolis, Chicago and Austin. On the other hand, we think there's great opportunity. I said at the end of my remarks, the company is in the best shape it's ever been in. And that's as we look across all 15 divisions, the team we have now in the field, changes that we've made, new community openings, new product offerings, certainly the initial success of the Smart Series. We're not going to become a Smart Series company, but I see that whether it's 10% or 20% of our business going forward, I think that's incremental additive and very positive. So I think there's a lot of reason for optimism. Housing conditions are good, like virtually every builder that has had a chance to comment as well as most economists, we think likely to remain so. And that's why we're indicating land spend being 10 plus-or-minus percent higher than 2017, somewhere between $550 million and $600 million, opening up 10% more communities. They're sort of my overall assessment of our company and how we see things.

And your next question comes from the line of Jay McCanless.

So the first question I had on the 10% community growth projected for 2018, are you guys going to need to add some headcount to drive that community growth? Or can you accomplish it with the staff you have on hand currently?

Jay, if you look at where the headcount is now compared to a year ago, we're up a little less than 10%. When we look at '18, we would like to think we would be able to get some efficiencies -- sorry, and not have to increase the headcount that much. So we are...

Yes. Just to reinforce that, in '17, sales and closings grew by 10% plus. The headcount didn't. It was lower than that, and the goal is for that to continue.

Okay. That's good enough. And then the second question I had and wanted to find out if you guys have made any changes to your strategy. It looks like, looking at the 3Q '17 numbers, they seem fairly close to the 4Q '17 but I didn't know if you guys maybe try to get aggressive and clear out some older specs. And that was a drag on gross margin for 4Q. And then also just how you guys are thinking about the spec strategy for '18.

There really has not been any change, Jay. Bob talked about the 10-or-so Smart Series, more affordable-priced communities. There are, in general, a few more specs in those communities. We do think we will grow Smart Series communities this year. We pretty much stay consistent. It could be from that 2.5, 3, 3.5 finished specs per community. We have not seen much of a GP differential between margins on specs and to the builds, especially with the low inventory levels in the marketplaces, so not really any change. Again, we're planning on growing community count pretty significantly this year, and we are introducing a fair amount of new product. As you introduce new product, you tend to model 1 of those new products or 2 and maybe spec a couple or more of them. But no, not any significant change in our spec policy.

Okay, okay. And then the last question I had is on co-broker. Can you guys talk about what your co-broker cost was in '17 and how that's been trending as we move into '18?

Our co-broker percentage really hasn't moved a lot. It's about 2/3 of our deals. We are always looking at that compensation structure, things like do you just pay on base house, what is the rate. Now and then, you do spit those brokers depending on inventory levels or issues or competition. But overall, it's remained pretty consistent. In general, when you get into the Smart Series, that co-broker percent tends to be a little lower. But again, that is a big expense to us. It's something we pay a lot of attention to, so we're constantly looking at that.

Okay. And then just one other question on the -- because I know you guys are talking about the Smart Series. Can you remind me what percentage you said you wanted to grow Smart Series this year?

Yes. We opened up our first Smart Series community in Tampa in 2015. Today, we have approximately 11 active smart selling communities out about 190. By the end of the year, we should have slightly north of 15, maybe somewhere between 15 and 20. And you're always -- in terms of reacting to the market and so forth, trying to position yourself properly, I could easily see it becoming somewhere between 15-or-so percent of our business going forward. I said 10% to 20% earlier, and that's probably a pretty accurate range. So if we had 200 communities or 210 communities, maybe 15% to 21% or more, long term, would be Smart Series.

And is there any meaningful gross different -- gross margin differential between your stated gross margin for the company versus where Smart Series is or the average Smart Series home is?

I think I think, right now, that's -- first of all, the margins have been good, probably a little higher than company average. So that's been very encouraging. But I think it's too early to draw a clear conclusion until we get more geographic -- get more communities open and more different geographies. I think 8 or 9 of our 15 divisions will have an active Smart Series community by the end of this year. It will be easier for us to answer that question with more certainty. But so far, we're very encouraged by it.

And one thing we're really excited about, we just opened our first Smart Series community in Texas. We think that will be very big for us.

(Operator Instructions) And we have our next question, comes from the line of Alex Barrón.

I was curious about your orders, particularly in the Southern region, whether you guys were surprised at how good they were. Or do you feel like that's a reflection of just demand coming back after the hurricanes? Or what accounted for that?

Well, I'd say a couple of things. For some time now, we think that we have had a very strong operation in Tampa and Orlando. And they're both big markets for us, and they continue to perform at or above their respective market. So that's a contributor. And the other thing is I talk a lot about the differences between Austin, Dallas, Houston and San Antonio in terms of the quality of our operations in each. Austin always has been -- has been off -- was off to a good start, remained strong for us. The others are catching up. And I think as now we believe having right team on the field made some changes in these markets over the last 6 to 18 months, it takes time for some of those changes to take root and take hold. We're now beginning to see some real traction, and we're encouraged. And that's why I think you can sense the tone of optimism about our business as we sit here at the beginning of 2018. We have a lot of really strong operations, a lot of strong divisions. But some, frankly, need to improve. And we believe that, that is happening.

Okay. Well, that's encouraging. What about on the SG&A front? What accounted for some of the sequential increase, particularly in your corporate? Was there any onetime expense or something that accounted for that, Phil?

No. There was not really anything that went through. We did close a lot of houses in the fourth quarter. We had set some internal goals this year of selling and closing 5,000-plus houses. We've never done that before. We're very excited about that. Were there some other things we had talked a little bit about, SG&A. We had a little more write-off due to land deals we didn't pursue. Real estate taxes are higher because we have a little more inventory and those type things. But all in all, having the strong growth we did in income, Bob talked about the operating income up to 7% versus last year's 6.8%. Overall, we feel pretty good about things.

(Operator Instructions) And there are no further questions at this time. Please continue.

Thank you for joining us. Look forward to talking to you next quarter.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.