M/I Homes, Inc. (MHO) Q4 2014 Earnings Report, Transcript and Summary

Good afternoon. My name is Sara and I will be your conference operator today. At this time, I would like to welcome everyone to the M/I Homes Year-End 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. Mr. Phil Creek, you may begin your conference.

Thank you for joining us on our call today. With me is Bob Schottenstein, our CEO and President; Tom Mason, EVP; Paul Rosen, President of our Mortgage Company; Ann Marie Hunker, 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 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 turn the call over to Bob.

Thanks, Phil and thank you all for joining us today. As stated in our release, we are pleased with our fourth and full year results highlighted by earning $69.7 million a pre-tax income which represents a 69% increase over 2013. For the fourth quarter, our pre-tax profits increased to $19.7 million from $15.3 million a year ago which is a 29% improvement. There were number of factors that contributed to our improved profitability. We delivered 1,105 homes in the fourth quarter 3,721 homes for the year. The yearly closing total was a 7% increase over 2013. Our average sales price on home delivered was $313,000, this being a 10% increase over the average selling price in 2013. Revenues increased for the year by 17% to nearly $1.2 billion and we improved our margins with gross margins increasing by 90 basis points and our SG&A ratio decreasing by 30 basis points. More specifically for the quarter, we lowered our SG&A ratio to 13.7%, this represents a 60 basis point reduction from last year’s fourth quarter. I remind everyone that we’ve remained very focused on managing our expenses and expect to further improve our SG&A ratio in 2015. Our average sale price in backlog also increase in 2014, resulting an year-end backlog sales value of $425 million, 4% better than the end of 2013 than the highest year-end backlog level since 2006. Our financial services also posted very strong results in 2014. Shortly, Paul Rosen, the Head of our Mortgage Operation will discuss this in more detail. Beginning in 2010, when we first opened in Huston and for each of the next three years, we opened a new market in Texas. We now operate in Huston, San Antonio, Austin and Dallas. I’m pleased to report that in 2014, our expansion in the Texas began to contribute positively to our financial results. We delivered over 200 homes in both Huston and San Antonio in 2014 and we were pleased to close our first homes in both Austin and Dallas. We are expecting significant in Texas in 2015 as well as meaningful contribution to our 2015 financial results. From a sales standpoint, the pace of growing our business slowed in 2014, as we were definitely impacted by substantial delays [ph] in getting many of our new communities timely opened. As a result, the number of net communities opened for sale at the end of 2014 was 4% less when compared to the end of 2013 and our new contracts posted a 3% decline both the fourth quarter and the full year. For 2015, we expect to open a significant number of new communities thereby growing our community count by more than 15% over 2014. Phil will talk more about this in a few minutes. And so doing, we look to get back on track with growing our business. You may recall that in each of 2012 and 2013, we grew our annual new contracts by more than 25%. Housing conditions in 2014 were clearly choppy as we experienced inconsistent and uneven demand in most of our markets throughout the year. As we begin 2015, the combination of low interest rates improving consumer confidence, improving employment levels along with recent announcements by FHA that should improve mortgage availability, all bode well for our industry and suggest that housing conditions will improve and nationwide new home sales will increase in 2015. Over the past couple of weeks as other builders have released their results much has been said and questions have been asked about the ability to grow sales in the direction of gross margins. While no one can be certain as the feature sales and margin trends, we’re optimistic about our business. We feel good about the markets in which we operate. We believe we have solid growth opportunities in Texas as I’ve previously mentioned and we believe we have solid growth opportunities on our other markets. We feel good about the quality of our existing communities and are particularly excited about the quality of the significant number of new communities; we expect to open in 2015. From a sales standpoint, we are off to a good start as our January new contracts increased by 8% over last year. On the other hand, our year-end margins and backlog were down slightly from a year ago. In sum, providing housing markets continue as expected M/I Homes is positioned to grow its top line in 2015. We are positioned to sell and close more homes in 2015 and we are positioned to increase our profits and strengthen our returns. Now let me take a moment to talk about our various regions. Beginning with the Southern region where we operate in Tampa and Orlando, Florida, as well as the aforementioned Texas markets, Huston, San Antonio, Austin and Dallas. Our Texas expansion is contributing to our growth as I said and our new contracts in the Southern increased 24% during the quarter. We’re also achieving very solid results in our two Florida markets and we have been growing our position in both Orlando and Tampa. Sales in Orlando were strong throughout the year, while sales in the Tampa markets feel off a bit during the spring of last year compared with a very strong selling pace in Tampa during the spring of 2013. We have seen a pickup in sales again in Tampa over the past few months. The Southern region has 383 deliveries for the fourth quarter and for the year deliveries totaled 1,332 or 36% of our total business. Our fourth quarter deliveries in the Southern region were up 13% for the full year and the dollar value of our sales backlog at year’s end was up 11% from the beginning of the year in the Southern region. Finding in the Southern region we controlled our lot - we increased our controlled lot position by nearly 980 lots which represents an 11% increase from a year ago and has 50 communities in the Southern region at year’s end unchanged from a year earlier. Next the Midwest region where we operate in Columbus, Cincinnati, Indianapolis and Chicago. We had 445 deliveries in the fourth quarter and 1,376 deliveries for the year or 37% of the total. I want to note that this ratio of deliveries has declined from 53% of total company deliveries in 2009 to now 37% today. As we have intentionally and we believe successfully expanded and shifted our geographic footprint. Our deliveries increased to 11% in the Midwest for the fourth quarter compared with last, while our new contracts in the Midwest region were down 20% in the quarter. Sales backlog was up 4% from the start of the year in our controlled lot position in the Midwest decreased 6% compared to year ago. We ended the year with 62 active communities, a decrease of an 11% from a year ago. Chicago had a very solid year for us and continues to be one of our best performing markets. Indianapolis and Cincinnati both continued to improve with respect to closing and margins and achieved good results for the year. And our Columbus market has clearly improved in profitability even with less communities open and that’s a lower volume of deliveries. Lastly the Mid-Atlantic where we have operations in Charlotte and Raleigh, North Carolina, as well as DC. In the Mid-Atlantic, new contracts were down 9% for the fourth quarter compared with 2013. Now backlog value was down 6% at year’s end from the beginning of the year. We delivered 1,013 homes during the year or 27% of the total. Our Raleigh operation had a very strong year, while Charlotte and Washington DC deliveries fell off lately as we wine down in some of our better performing communities and our newer replacement communities were not net contributing fully. We expect Charlotte to perform quite well in 2015 as our new communities come online and we also expect improvement in DC. We ended the year with 38 active communities in the mid-Atlantic region up about 3% in the beginning of the year and our controlled lot position in the Mid-Atlantic region increased 6% from last year. Before turning things over to Phil, let me just say this. We ended the year with a very solid balance sheet which positions us for continued growth. We have $544 million of shareholder’s equity, $243 million of availability under a $300 million unsecured revolving credit facility and a healthy 47% ratio of net debt-to-capital. As we begin 2015, we will continue to focus on growing the business and improving our profitability and strengthening our returns. Phil?

Thanks Bob. As far as financial results, new contracts for the fourth quarter decreased 3% to 773. Our traffic for the quarter was down 3% and our community count was down 4%. We were up against tough comparisons as last year’s fourth quarter were up 18% and our community count was up 20%. Our new contracts were down 2% in October, down 12% in November and up 8% in December. As to our buyer profile, about 40% of our sales continued to be first time buyers and about 50% of our sales continued to be inventory homes. Our active communities were 150 at the end of 2014, the breakdown by region is 62 in the Midwest, 50 in the south and 38 in the Mid-Atlantic. During the quarter, we opened 19 new communities while closing 16 and for the year, we opened 56 new communities and closed 63. Our current estimate for 2015 is to open about 65 new communities and increase our 2015 end of the year community count by 15%. The majority of our new communities are opening in the second half of 2015. We delivered 1,105 homes in ‘14’s fourth quarter delivering 71% of our backlog compared to 70% a year ago. Revenue increased 9% for the fourth quarter and increased 17% for the year compared to the same period of ’13. Our average closing price for the fourth quarter was 322,000, a 10% increase over the last year’s 292 and our backlog sales price is 348,000, up 9% from a year ago. We’ve recorded pre-tax charges of $2 million and $3.5 million in the fourth quarter and for the year related to our Midwest legacy assets. We believe we now have addressed all of our legacy communities. Our building cycle time for homes were about the same in the fourth quarter, as the third quarter, certain markets continued to have challenges. Our construction land development cost increased slightly with compared to the fourth quarter of last year. Our gross margin was 20% for the quarter versus 99 a year ago and for the full year 2014. Our gross margin was 20.8%, up 90 basis points from prior year. Land gross profit was 834,000 in 2014’s fourth quarter and 3.6 million for the full year of 2014. This compares to 518,000 in 2013’s fourth quarter and 3.8 million for the year of 2013. Our fourth quarter SG&A expenses were 13.7 of revenue improving 60 basis points compared to 14.3 a year. And for the year, our SG&A expense ratio improved 30 basis points to 14.0. SG&A expense in 2014 included 1.4 million and 2.7 million of expense for deposits and other cost associated with land deals that we walked away from for the fourth quarter and the year. Excluding these costs, our fourth quarter SG&A percentage was 13.3 and our full year was 13.8. We expect to continue to gain SG&A efficiency in 2015. Interest expense increased slightly for the quarter and decreased 2.6 million for the 12 months of 2014. When compared to last year, this reflects higher capitalization for the year due to higher land development activity. We have 15 million in capitalized interest on our balance sheet compared to 14 million a year ago; this is about 1% of our total assets. We continue to focus on improving our profitability and our returns. In the fourth quarter, our pre-tax income increased 29% on revenue growth of 9% and our pre-tax income percentage increased to 5.4% from 4.6% a year ago. Our effective tax rate was 27% for the year and 44% in 2014’s fourth quarter. For the year, our tax rate benefited from the 9.3 million reversal of our state differed tax asset valuation allowance. And our fourth quarter rate was higher due to the impact of state tax rate changes on our differed state tax assets and also changes in our state of portion and factors. We estimate that are 2015 effective tax rate will approximate 38%. Our earnings per diluted share for the quarter was $0.36 per share, this per share amount reflects 1.2 million of dividends pay to our preferred shareholder during the quarter. Excluding our impairment and using our expected 2015 38% tax rate, our diluted EPS would have been $0.41 per share. Now Paul Rosen will cover our mortgage company results.

Thanks Phil. Our mortgage and title operations pre-tax income decreased from $2 million in 2013 fourth quarter to $3 million in the same period for 2014. Our fourth quarter results include a decrease in loans originated from 815 to 771 and an increase in the average mortgage amounts. For the quarter we experience an increase in the margins on the home sold and retain servicing. The long term value on our first mortgages for the fourth quarter was 86% in 2014 compared to 85% in 2013’s fourth quarter. We continued to see a shift towards conventional financing, certainly 3% of the loans closed were conventional and 27% were FHA, VA. This compares to 71% and 29% respectively for 2013’s same period. Overall, our average mortgage amount increased 9% to 269,000 in 2014’s fourth quarter compared to 246,000 in 2013’s fourth quarter. The average borrower credit score on mortgages originated by M/I Financial was 736 in the fourth quarter of 2014 and 740 in 2014’s third quarter. Our mortgage operation captured 80% of our business in the fourth quarter compared to 2013's 84%. At December 31, 2014, we had $70 million outstanding under the M/I Financial credit agreements which expires March 27, 2015. And 15 million outstanding under a separate repo facility which expires November 3, 2015, while the facilities are typical 364-day mortgage warehouse facilities that we extend annually. For the year ended December 31st, our mortgage operation and title operation achieved a free tax income of 14.2 million compared to 14.4 million in 2013. We’re able to obtain similar profit margins on loans sold and servicing retained transactions as on the previous year. 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 December 31, '14 was $919 million, an increase of $228 million above December 31, '13 levels. This increase is primarily due to higher investment in our backlog and increased land spend. Our land investment at year end '14 was $470 million, a 39% increase compared to$339 million a year ago. At December 31st, we had $246 million of raw land and land under development and $224 million of finished unsold lots. We owned 3,450 unsold finished lots with an average cost of 65,000 per lot and this average lot cost is 19% of our $348,000 backlog average sale price. The market breakdown of our $470 million of unsold land is $135 million in the Midwest, $196 million in the South and $139 million in the Mid-Atlantic. Lots owned and controlled as of 12/31/ '14 totaled 20,725 lots, 55% of which were owned and 45% under contract. Our owned and controlled lots are an increase of 5% versus a year ago. We owned 11,361 lots of which 31% are in the Midwest, 44% here in the South and 25% in the Mid Atlantic. We believe, we have a very good solid land position. During 2014's fourth quarter, we spent 54 million on land purchases and 51 million on land development for a total of a 105 million. And for 2014, we spent 382 million on land purchases and land development. And as you 2014 land purchases about 50% of our purchase amount was raw land. Our estimate today for 2015 land purchase and development spending is $400 million to $450 million. At the end of the quarter, we had 460 completed inventory homes, three per community and 979 total inventory homes. In the total inventory homes, 362 were in the Midest, 384 in the Southern and 233 in the Mid-Atlantic. In 12/31/'13, we had 321 completed homes and 798 total inventory homes. We believe we are well positioned with our expect levels. Our financial condition continues to be strong with $544 million of equity and net debt-to-cap ratio of 47%. At 12/31/'14, we had 30 million outstanding under our $300 million unsecured revolving credit facility. This 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 Michael Rehaut with JPMorgan.

Thanks. Good afternoon, everyone.

Hey Michael.

The first question I had was regarding gross margins. You had mentioned in your prepared remarks that the year-end margins in backlog were down slightly from a year ago, I was wondering if you could comment on how they compared to at 3Q and if you have any view of you given what you are expecting to open up and potentially you know certain mix might change as we get through the year from the newer communities, if you have a view on whether ’15 gross margins can hold versus ’14 or go up a little bit or go down a little bit?

That was a whole a lot of questions, Michael. I think we’ve pretty said you know what we wanted to say, we’ve been working very hard on improving our margins, we’re able to have pretty improvement in ’14 you know as Bob says you know there is a slight decrease in margins and backlog. We’re opening a lot of new communities, we have live hopes for those communities, it’s hard to predict margins went about 50% of your sales are inventory homes but cost pressures did not quite has been as much they having in the past. So we’re hopeful at the margin line, it’s not too very important, it’s very hard to predict very far over your skies as far as what margin to be.

I think is you know Michael the other thing that I think you know this very well and it’s been worn out by what we’ve heard over the past few weeks is that the ability to push pricing clearly moderated throughout 2014. And I think that that’s certainly was the case here. And that said and we said this before and this is an address specifically your question about where we think our margins are going to be in 2015, we do know that in backlog, they are slightly lower but we also believe that in terms of the bottom line, in terms of our net operating margins were poised to produce results in 2015 with the stronger bottom line in terms of returns.

And I appreciate that. I guess just though you know you said slightly down from a year ago, what about sequentially those I guess one of couple of question I had in there.

You know in the comment on that as far as 12/31/’14 versus 9/30/’14 backlog that type thing. That I’ve been commented on that, you know as we did pay also the majority of our new communities in ’15 are opening in the last two quarters of this year. So you our health was probably as strong spring selling season.

Okay, also just a modeling question Phil, you know interest expense for the year totaled 13.5 about 13.5 million down from nearly 16 and 13 - in 2013, can you give us a sense of what do you expect for ’15?

Well, you know we are borrowing from the banks, so when you are start looking at you know interesting curve changing are the interesting curve number is going to be higher in ‘15 that it was in ’14. As far as what is the bottom line, you know most depended on the amounted of interest capitalized and so forth. Having said all that our expectation would be interest expense for the year probably will be higher.

I mean that’s directly expensed in that line item?

That’s surely yes.

Can I just make one more sales pace, you know you had a nice improvement in orders in the December and January of 8%, you know didn’t seem like there was a dramatic change in community count year-over-year - toward the year-over-year, so we would seem that perhaps sales pace was the driver there. I am wondering if that’s the case and if so whether it’s very particular regions that drove that improvement?

I think that what we’ve seen is much as anything as improvement in traffic in more of our divisions. There is no particular - I cannot - I could not single up any specific region that distinguishes itself, I think it’s pretty much across the board.

Great, thanks guys.

Thank you.

Your next question comes from the line of Adam Rudiger with Wells Fargo Securities.

Thanks for taking my question. You noted in your release and your remarks and I think in past calls as well that you’ve have delays in opening communities. And so I was wondering if the guidance that you’ve given is conservative and taking into account that was kind of delays or if not how would you think those delays are behind you and things have normalized?

Well things have normalized but last year, we were more confident about our ability get communities opened as well. About 60% of our operation was unusually and vary materially impacted by a very severe weather, winter weather in the early part of last winter. So but as we sit here today and see what we expect to happen were I think we’re much more measured and is what we believe. We think we’ll get them open and it will be a majority of them will be back, is back half loaded as Phil mentioned but we think we get them open and we doubt with managed around most of the delays that we were dealing with before.

Okay, thank you. And the second question was in your prepared remarks you talked about Texas I think the you said, running towards used to meaning contribution this year. Can you discuss where you know because that is going to just a revenue impact or because you also talk about what in a SG&A leverage and what the gross margin impact directionally will be from that meaningful growth?

I think Phil can maybe add more to what I am going to say, but we think it will - that will be in all areas as we continue to grow in all four markets. We expect significant growth in the aggregate for the four markets. Our first sales in closing in Huston in 2010, San Antonio in 2011, Austin first sales in 2013, first closings that early ’14 and Dallas first sales and closing in ’14. So we had two, three, four relative startups that will be giving now some more than others to gain enough traction to where they help all those items. And we think this year, they will have the meaningful contribution in the positive way.

Okay, thank you.

Thanks.

Your next question comes from the line of Ivy Zelman with Zelman & Associates.

Hi guys, good afternoon, it’s Alan on for Ivy. Bob just following on the Texas commentary you know obviously you guys have been ramping growth there and it sounds like you are excited about the communities you got opening up. I think most of the builders even though they might not seen an impact yet from lower oil prices, seems like they have taken more conservative tone as far as the outlook for the year. So I was curious you know if you maybe could separate out the organic growth that you are seeing in the company from Texas versus what you are seeing in the market the trends there given the lower oil prices. Just little bit about the outlook in Texas [indiscernible].

I am not sure I completely understand your question but let me say this. I think that the sentiments that we’ve expressed by other builders I think it’s been well expressed that you know there is a little bit of caution but today I don’t think that we’ve seen anything significant or material. I think that the issues are probably more pronounced in Huston and maybe to a lesser extend San Antonio then certainly Austin and maybe slight or lesser extend Dallas. But it was your question, do we expect to grow other markets as well?

No, I guess I was just getting the fact that do you think that absorption pace in the market is likely to show prudent were declining in ’15 and I guess adding on to that you have been investing a lot there. Are you rationing back that a little bit and just focusing on opening up between and do you still look to invest a lot in land in Texas? And then I have a follow-up question.

I guess one thing to remember is that we - lot of our new communities that we open the last part of last year and also plan for this year are in Texas. So we’re not saying that the Texas markets is sort of to be any great growth. But for us to be opening you know two communities in Dallas and then be opening six communities in Dallas. You know and instead of closing three or four houses, they must be closing ten houses a month, those have big impacts on us. So our comments are more based on where can be find volunteer with our expectation that all four of our Texas markets is our plan and hope that our four of our Texas market will have significant growth. And again that’s more based on where we are, the new communities we’ve recently opened or plan to open.

Understood.

As far as pace overall, I mean we would like to think that pace will be a little better in ’15 than in ’14. You know Bob make comments about the market in general. I mean we’re hoping that markets in general are little better. We like to think that communities that we’re opening you know are little better well okay, little product, little better price fallings, those type things. So all those things make us optimistic that there is going to be a little bit better in ’15.

Got it and that’s helpful. And if I could just change gears quickly, on the balance sheet you know this is the lowest cash balance you guys have operated in quite a while and you mentioned that you are going to be borrowing from the back. So presumably you are comfortable with using a revolved to find the growth in ’15, I would imagine with the community growth you are looking at that you would expect to be a cash user again next year. So just curious you know longer terms is that something you are comfortable with maintaining a balance on the revolvers or perhaps looking more towards the loner debt market on that.

Alan, this is Kevin. We are comfortable, we’ve been borrowing actually since April or May on and off we are outstanding at the end of September, we are outstanding again at the end of the year. This year we would expect with our growth that we continue to make use of the revolver. As you are aware, we look that went very far on the road for refinancing of our existing senior notes in October and then the margin wasn’t receptor where we wanted to be. There is no dealing until 2018, we’ll continue to look at higher markets for opportunities but don’t feel at all any kind of a need to do increasing our value you know probably that market. We are comfortable with a group of banks and that’s a reason we took the facility up 200 million to 300 million in October and we’re comfortable with - we took maturity out and we’re comfortable making use of it. We don’t expect to get to a level of very high with the usage where we would be uncomfortable.

Great, thanks a lot guys. Good luck.

Thanks Alan.

Your next question comes from the line of Alex Barron with Housing Research. Alex, you line is open.

Yes, can you hear me out there?

Yes. Hey Alex.

Hey guys, how are you?

Good.

I was hoping you could talk a little bit your spec homes it seems like they are up a little bit year-over-year, I am wonder if that the change in strategy or was that intentional or unintentional, where do you guys see that your spec strategy moving in 2015?

You know as we say really pretty comfortable where we are you know having three completed specs for community realize that a little bit this time last year, we’re little over two, but where the market start schedule, we feel pretty good about that, not really a change in strategy. As far as our expectation, we would probably think overtime, that would probably come down a little bit, but again we feel really good about where we are.

Okay, sounds good. And then just going back to Texas, you mentioned that a couple of cities are now delivering over 200 units and I guess you know you need some scale to start showing profits. I am just kind of wondering if you could give us a better sense of what - how many - how much did you get in Texas in 2014 and maybe what percentage your pre-tax income came from Texas?

We don’t disclose that type of detailed information, of course you can look at our website and see the communities that have opened and so forth, but it’s - you know our plan that Austin and Dallas were significantly improved their closings in ’15. I am sure they will get to that you know 200 type level. But again well 200 type level for starts producing pretty good financial results even after our internal interest and allocation rages. And we also are hopeful that Huston and County will also grow from therefore team performance. So again we’re expecting as Bob said to have continued improved results from our four of those operations.

Okay, got it, thanks.

And there are no further question at this time.

Okay, we appreciate you joining us and look forward to talking you at the end of the first quarter. Thank you.