M/I Homes, Inc. (MHO) Q3 2015 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing-by and welcome to the M/I Homes Third Quarter 2015 Earnings 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. I would now like to turn today’s conference over to Phil Creek. Please go ahead.

Thank you very much and thank you for joining us. Joining me on the call today is Bob Schottenstein, our CEO and President; Tom Mason, EVP; Derek Klutch, COO of our Mortgage company; Ann Marie Hunker, VP and 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. Good afternoon, everyone. and thank you for joining our call to review our third quarter results. We are very pleased with our third quarter results as we had solid results on many fronts. We achieved continued growth and profitability in the third quarter, with record high third quarter revenue of $363.5 million which is a 10% increase over the third quarter of 2014. Pre-tax income in the third quarter was $26.5 million, a 19% improvement from last year’s third quarter. Net income for the quarter was $15.6 million or $0.51 per diluted share, representing a 14% increase over 2014's third quarter. Our growth in revenue was driven by a 9% increase in our average closing price to $349,000 of home and we delivered 994 homes during the quarter, which is an increase of 1% from last year’s third quarter. The increase in average sales price from last year was driven by a combination of the mix in our communities, as well as pricing increases in certain locations. During the quarter, we achieved gross margins of 21.5%, which is an improvement of 80 basis points from a year ago. As a result, our third quarter operating margin improved to 8.3% from 7.5% a year ago. In a few minutes Phil will discuss our margins and returns in a little more detail, but at this point let me just say this, our third quarter gross margins of 21.5% were down slightly from the second quarter margins of 21.8% as well as the first quarter margins of 21.7%. This slight decline was mostly due to mix. During the quarter, our SG&A came in at 13.2% which is the same as a year ago. Year-to-date, we have improved our SG&A ratio by 50 basis points and expect continued improvement going forward as we grow our revenues. We have continued to experience some delays and challenges in both land development and home construction in many of our markets, primarily related to the availability, as well as cost of labors and sub-contractors. To date, delays on the home construction side approximate roughly five days. It doesn’t sound like much but it does equate to a week of business. On the land development side, though very inconsistent from market-to-market, the delays were probably slightly more than a month. The good news however is that we do not believe these conditions change markedly for better or for worse during the quarter, and at least from a pricing standpoint, we’ve generally been able to raise prices to offset increases in construction costs. Overall, new home sales in most of our markets remained healthy during the quarter, which is generally a slower season for home sales than the spring months. We were able to increase our new contracts by 11% over last year, largely due to the opening of 42 new communities this year through the end of the quarter. We have increased our community count by 11% from 2014 year-end and remain on track as stated in our release to increase community count by 15% during 2015. Our backlog sales value also increased, up 27% from a year ago to $657 million, with a record high average selling price of $367,000. Our financial services business segment also continued to perform very well with pre-tax income of $4.4 million during the quarter, which represents a 31% improvement from last year. Year to date, we have earned $14.3 million from our financial services business, and in a few moments Derek Klutch will review this in more detail. Our balance sheet and liquidity remains strong, with $583 million of shareholder's equity in a ratio of net debt to capital at 50% at the end of the quarter. Looking ahead we expect to continue to expanding our community count and growing our market share and we will remain focused on continued improvement in both income as well as returns. Before turning it over to Phil, let me give a little bit more specific information our three regions. First, the southern regions, which is comprised of our two Florida and four Texas markets. In the Southern region, we had 377 closings for the quarter, which represented a 38% of our total volume. New contracts in the Southern region increased 22% year-over-year. We're achieving very solid results in our both of our Florida markets, which are Orlando and Tampa and we have been growing our position in each of these markets. In Tampa and Orlando, sales were strong during the quarter and we expect both of these markets to perform well for us for the remainder of year. In our growing Texas operation, both Dallas and Austin contributed significantly to our sales and deliveries, particularly compared with being in start-up mode in those markets a year ago. Our sales business in San Antonio was relatively flat year-over-year and I will note that have seen slight pickup in sales in Houston this quarter although we continue to monitor market conditions there as job growth in Houston has [indiscernible] has been well documented. The dollar value of our sales backlog in the Southern region at quarter's end was 51% higher than a year ago. And we had 62 communities across our Southern region at end of the quarter, which represents a 22% increase from last year's third quarter. As to our four Texas divisions, we had 35 communities versus 31 year ago and continue to be very excited about our growth opportunities throughout the southern region. Next is the Midwest region which consists of our Columbus Ohio, Cincinnati Ohio, Indianapolis Indiana and Chicago Illinois markets. We had 363 deliveries in the third quarter, a 5% decrease from a year ago, and those 363 closings represented a 37% of total company closings. New contracts in the Midwest were up 5% for the quarter. Sales backlog was up 12% from the end of the third quarter last year in dollar value and our controlled lot position in the Midwest increased 18% from a year ago. We ended the quarter with 67 active communities across the Midwest, which is 8% more than a year ago and at the end of the quarter demand in all four of these markets remained good. Finally, the Mid-Atlantic region which is Charlotte and Raleigh, North Carolina as well as DC; new contracts were up 3% for the quarter, compared with a year ago and backlog value was up 22% at quarter's end from year-over-year. We ended the quarter with 37 active communities in the Mid-Atlantic region, which is about 9% more than a year ago. We delivered 254 homes in this region, which was 25% of total company, and this volume was down 2% from last year. Our Charlotte operation had a particularly strong quarter with improvement in sales and delivery and while our deliveries in Raleigh were slightly off for the quarter; Raleigh continues to be one of our best performing markets. Demand in the DC market continues to remain a bit sluggish. Our total controlled lots in the Mid-Atlantic region decreased 15% from last year. And with that, I'll turn it back over to Phil.

Thanks, Bob. We continue to focus on improving our profitability on our returns. In the third quarter, our pre-tax income increased 19% on revenue growth of 10% and our pre-tax income percentage increased to 7.3% from 6.7% a year ago. New contracts for the second quarter increased 11% to 988, our traffic for the quarter was up 11%, and our community count was up 13%. Our new contracts were up 10% in July, flat in August and up 25% in September. As to our buyer profile, 38% of our third quarter sales were to first time buyers compared to 37% in 2015 second quarter, and 49% of our third quarter sales were inventory homes compared to 50% in 2015's second quarter. Our active communities were 166 at the end of the third quarter. The breakdown by region is 67 in the Midwest, 62 in the South and 37 in the Mid-Atlantic. During the quarter, we opened 14 new communities while closing three; and our current estimate is to end the year with about a 15% higher community count than we started 2015. We delivered 994 homes in 2015 third quarter, delivering 55% of our backlog compared to 60% a year ago. Revenue increased 10% in the third quarter compared to the same period last year, primarily as a result of an increase in the average closing price. Our average closing price for the third quarter was $349,000, a 9% increase over last year's $320,000 and our backlog sales price is $367,000, up 10% from a year ago. Our building cycle times for homes have been slightly higher this year than last year. Year-to-date our cycles times have increased about 4%. And our construction and land development cost have also increased. It looks like about 2% year-to-date. Our gross margins were 21.5% for the quarter, up 80 basis points compared to last year's third quarter and we've had 21.6% year-to-date gross margins versus 21.1% last year. Our third quarter SG&A expenses were 13.2% of revenue, flat compared to a year ago. Our variable selling expenses increased as a percent of revenue by two-tenth of 1% in the third quarter compared to a year ago, and our expenses associated with our increase in land inventory and higher community count increased as well. Year-to-date our SG&A percentage is 50 basis points below last year and we continue to focus on improving our efficiencies. Interest expense increased $1 million for the quarter compared to last year, and increased $2.3 million for the first nine months of 2015. These increases reflect higher borrowing cost -- higher borrowing amounts rather and cost. We have $17 million in capitalized interest on our balance sheet, compared to $16 million a year ago. That's about 1% of total assets. With respect to income taxes, during the quarter, we had a tax rate of 41%. Our rate during the quarter was unfavorably impacted by changes in a future state tax rate which, reduced the value of our NOL carry forward in the state by $600,000. Excluding this one-time impact, our effective tax rate for the quarter was 39% and we estimate that our tax rate for the remainder of this year at 39%. Our earnings per diluted share for the quarter were $0.51 per share. This per share amount reflects $1.2 million of dividends paid to our preferred shareholders. Now Derek Klutch will address our mortgage company results.

Thanks Phil. Our mortgage and title operations pre-tax income increased from $3.4 million in 2014's third quarter to $4.4 million in the same period of 2015. Our third quarter results include an increase in loans originated from 701 to 713, an increase in average loan amounts and higher margins on loans sold. In addition, we sold a portion of the servicing rights from our portfolio. The loan-to-value on our first mortgages for the third quarter was 84% in 2015, compared to 85% in 2014's third quarter. 70% of the loans closed were conventional, and 30% were FHA, VA. This compares to 73% and 27% respectively for 2014 same period. Overall, our average mortgage amount increased 6% to $286,000 in 2015's third quarter, compared to $269,000 in 2014. The average borrower credit score on mortgages originated by M/I Financial was 736 in the third quarter of 2015, compared to 743 in 2015's second quarter. Our mortgage operation captured about 80% of our business in the quarter, compared to 2014's 81%. At September 30th, we had $65 million outstanding under the M/I F credit agreement, which is a $110 million commitment that expires June 24, 2016. We also had $8 million outstanding under a separate repo facility, which expires November 3, 2015. Those facilities are typical 364-day mortgage warehouse facilities that we extend annually and we expect to have the repo facility extended prior to expiration. Now I will turn the call back to Phil.

Thanks Derek. We continue to manage our balance sheet carefully, focusing on investing carefully in new communities while also managing our capital structure. Total homebuilding inventory at 9/30/15 was $1.1 billion, an increase of $239 million above September 30, '14. The increase is primarily due to higher investment in our backlog, higher community count and more finished lots. Our land investment at 9/30/15 is $551 million a 29% increase compared to $426 million a year ago. At September 30 we had $282 million of raw land and land under development and $269 million unfinished unsold lots. We own 3,844 unsold finished lots, with an average cost of 70,000 per lot, and this average lot cost is 19% of our 367,000 backlog average sale price. The market breakdown of our $551 million of unsold land is $163 million in the Midwest, $214 million in the South and $174 million in the Mid-Atlantic. Lots owned and controlled as of 9/30/15 totaled 21,562 lots, 51% of which are owned and 49% under contract. We own 11,073 lots, of which 33% are in the Midwest, 42% are in the South and 25% in the Mid-Atlantic. During 2015 third quarter, we spent $83 million on land purchases and $63 million on land development for a total of $146 million. About 60% of the purchase amount was for raw land. Our estimate today for 2015 land purchase and development spending is $425 million to $450 million, which includes the $322 million we've spent year-to-date. At the end of the quarter, we had 360 completed inventory homes, two per community and 962 total inventory homes. Of the total inventory, 289 are in the Midwest, 428 are in the Southern region and 245 are in the Mid-Atlantic, and at 9/30/14, we had 305 completed inventory homes and 999 total inventory homes. Our financial condition continues to be strong, with 583 million in equity and net debt to cap ratio of 50%, and at 9/30/15, there was $156 million outstanding under our $400 million unsecured revolving credit facility. That completes our presentation. We’ll now open the call for any questions or comments.

[Operator Instructions] Your first question comes from the line of Michael Rehaut of JPMorgan.

It's actually Jason Marcus in for Mike. First question is on sales pace and pricing trend. So when you look at the sales pace for the quarter, it was flattish on the year-over-year basis and obviously that was a bit of deceleration from what you saw in 1Q and 2Q. I just wanted to get your thoughts on what you're seeing overall on sales pace, if that was a reflection of maybe keeping feeding prices firm in certain areas or maybe it was just weakening in a certain market?

I think it's both. I think you’ve nailed it pretty accurately. I think that obviously based on the tone of the call, our investment in our new markets and so forth in the land spend that Bill talked about, we're bullish about housing. We continue to believe that conditions in our markets will get better. And not to sound like a broken record, it's often uneven and a bit choppy. Certain markets tend to get soft when others don’t and then the pattern switches itself. And we have tried to be disciplined with our margins. We feel good about our margins. As I said even, though they were down slightly from first and second quarter, they are relatively in line when you begin the factor out mix and so forth. And of course our margins are net of nearly -- slightly more than 4% of selling expenses. So when you look at our margins for the quarter, at 21.5% we feel that those compare very favorably with other builders.

And one other comment I would make is that we feel pretty good about -- good at sales this year. We were up 13% in the first quarter, we were up 8% in the second quarter, we were up 11% in the third quarter and we’re also pretty pleased. We have focused on growing communities by 15% by the end of the year. So all-in-all, we feel like things are pretty solid.

Great next question on the land market, if you can just talk a little bit about what you're seeing in terms of the competition and pricing across the country? And then if you could go into some detail on the types of deals that you’ve been focusing on, and in which markets you're the most active in right now?

Probably the least active in DC, and as you look at the other 12, equally active and it's very competitive. And the strategy of our land really hasn’t changed. We’re intensely focused. There's a first, second and third priority on getting what we call from new locations. Hopefully you can get them on a finished lot basis, but it takes developing them ourselves and we’re able to manage of the risk appropriately, we do that. As Phil said about 60% of our deals were raw land during the quarter, and that’s about -- that’s close to about where we are company wide right now. We haven’t changed our underwriting in terms of the minimum hurdles from a return standpoint, which is all influenced by expected margin and pace based upon conditions the way they are now, not based upon what we think might happen to conditions going forward. But it is very competitive and Orlando, Charlotte, Tampa, Austin, all of them were quite competitive and but we are looking to grow in all of our markets. The one that we're the most concerned about because of just the sluggishness of it DC and we're probably being a bit more cautious there right now.

Your next question comes from the line of Ryan McKeveny of Zelman & Associates.

In terms of the one-week delay in a home construction that you referenced, is that labor related, and if you can just broadly speak about what you are experiencing from a labor perspective and how that might vary across the regions?

I don’t know that -- I'll let Phil take maybe how it might differ from region to region. That’s an average -- in some markets its two or three days, in other markets it might four or five or six days. It averages out to above five, if you look at 994 closings during the quarter, sometimes one week doesn't sound like a lot but it can equate to 50,60, 80 closings. I'm not saying that’s exactly how many have impacted, but certainly it did have an impact and I'm not sure if that answers your question.

It is like Bob said, it's kind of just market dependent. If you look for instance at Dallas and Charlotte, frame labor has been a little bit of an issue. When you start looking at Austin and Dallas, it's kind have been concrete labor and masons. So markets are little bit different, but again we think that like cycle time has been about 4% or, so which about a weak to us.

It doesn't -- I want to emphasize something I said, looking to change tomorrow, but as of right now, it doesn't seem like it's getting any worse. We feel like it's sort of gotten -- settled into about where it is. The situation has been more acute in terms of delays on the land development side. Obviously land development is a seasonal business and weather can certainly have a very significant impact on land development, much more so than it would have on home construction generally, and everybody likes to talk about the weather. But there have been contractor delays there as well. There is contractor shortages.

Great thanks that’s really helpful. Second on -- in terms the price points, I guess from a demand prospective, any notable trends between the different price points and then also in terms of the incremental investment, any changes in terms the price points that you are targeting going forward?

We really haven't changed our strategy. Often times its deal driven. About 20% or so of our business is probably -- maybe a little more than that right now, but close to 20% is attached town homes, which typically will bring the price down somewhat, but we have not launched any major new product initiatives with smaller houses designed in any significant way -- designed to appeal perhaps so some first time home buyer. We are watching that market carefully. There are signs that that maybe unhooking itself in some markets. Historically pre 2000 -- back in the early 2000s and 1990s we were very, very strong with sub 2000 square foot houses in markets and as that market -- if and when that market does it come back, I've got every confidence that we will be able to react at that time, but at least in terms of today, when you look at our mix, it really hasn’t changed a whole lot.

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

I wanted to ask -- so some builders have talked about labor challenges. I'm kind of wondering how are you guys going about it, dressing that so that it's not too much of an issue. Are you having to paying more? Are you starting more specs or how are you guys generally addressing that?

Every market is little bit different Alex. Our spec policy really hasn’t changed much. We're about the same number as we were a year ago, and about the same as far as completed specs. It just a local deal. You always are to trying bring in stuff that maybe from one market to another. That makes sense. You try to make sure that they understand and appreciate the volume that we can give them and the certainty of the payment et cetera, but each market is a little bit different. You come at a lot different ways. And it is very high to manage it. I think we're doing a really good job of managing it but there is no easy answer. Five years ago, or three years ago I should say, we were coming onto the housing recession, every builder was talking about how one of their big initiatives was to become better and smatter and reduce cycle time. And that was certainly a big priority here as well. But when you look at -- as housing is begun to come back and you look at the strength of the apartment market, a lot of people who used to build houses are building apartments. They are easier to build. Every one of them is the same and the houses require a little bit more time and maybe complexity. And so you manage it. As we said twice during this call, we've lost about five days and I'd rather have us pick up five days than lose five days but I think we're doing a pretty good job managing it. It has had an impact.

Okay. And any comments you can make on what gross margins might look like next quarter and also whether you expect to see some operating leverage? It looked like this quarter SG&A grew about the same rate as revenues. But just kind of wondering what you guys think about next quarter and into 2016?

Well, when you look -- in general they are businesses. If you close the motalisis [ph] in the fourth quarter [indiscernible] revenues up. So you hope to get more leverage in the fourth quarter and you tend to get the lower closings and the least amount of cut of leverage in the first quarter. But as Bob said, we continue to focus on the SG&A line. There wasn’t really anything that jumped up that much in the third quarter with the exception that variable selling was up two-tenths. Having more investment leads to more real estate taxes and HOACs [ph] and those types of things, opening more communities drive some of those selling expenses also. But as our volume hopefully continues to increase, hopefully we will get that leverage as far as the SG&A and the operating line. Don’t make any estimates as far as the gross profit line. Our GPs have been pretty much flat the first three quarters, which we feel pretty good about and 50 basis points year-to-date better than last year. We continue to focus on that. But no projections as far as GP line.

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

On the land side you guys talked about still competitive environment. I imagine that never changes but I think you are saying 60% of the land deals this past quarter were raw. Just wondering if you could talk about the timeline you look to turn around -- turn those into finished lots or turn those into deliveries. What\s kind of the timeline you look at when you evaluate the raw purchases?

That's really -- there's no specific answer on that. Every deal is different. But I don’t know if it's changed, it would have been the same answer a year ago, and a year ago and a year ago, and that is that every deal is different. Smaller deals, you turn to quicker, then you do larger deals. We don't generally take on larger deals like we used to, but typically the day -- I mean this is very, very general but the day that you buy a piece of raw ground, it takes about six months to develop an initial phase, and then another 90 days beyond that to get open for business. So this is so rough and dirty, it's probably not worth the words I'm using to describe it, but it's about a nine-month process from you time you buy the land until you begin to open for sale. And sometimes it can be -- that kind of stretched because of the things we talked about earlier on the call. But if you look at.

A lot of deals are stretching out a year.

But if you look at our land position Lee, as you know we would like to own a two to three-year supply, with about a year of those being finished lots and today we own a little under 4,000 finished lots and then we own like another 7,000 either raw or under development. So we are in really good shape for '16 and also a fair amount of '17. So we feel really good about our land position. We try to be all about premier locations. We think that means more to customers, being in the better school districts, near the better shopping, near the better transportation. We would love to be able to more land light as everybody would, but if we have to develop those premier sites, we will do that. We know when it takes more time and you take development risk in those situations. But again on those raw land deals and deals we develop, the hurdle rates also are higher to make sure we get rewarded for that. But overall we feel really pretty good about our land position.

The only thing I would add just the underscore what Phil said, I think comparatively speaking we have a very healthy land position. We own just a little bit over 11,000 lots, control another 10,000 on top of that, and when you look at what our growth goals have been and what they are going forward, I think we're in really good shape and I think it's managed very well, with over half of the owned and controlled of the books.

And to your first comment, I think you said, when you start answering is that your mindset or your approach hasn’t really changed.

No it's not.

On the balance sheet side, looking at the revolver, could you talk about that? How we should think about that is, are we at a peak or do you manage it towards a liquidity level or how do we look at managing your balance sheet?

I think Kevin is going to answer this one.

Yes, hi, it is Kevin. We have given some indication in our 10-Q as to where we think the peak will be this year, and it's been close to -- we had said it could be as high as 200 million. We have said -- at this point we've generally said it's probably not quite that high. It's probably more in the 175 range. We were around 150 outstanding at the end of September. There is a lot of swings week-by-week, $10 million or $20 million. So that’s really the only comment we’ve made and we certainly don’t have any projection out there for next year. But we did announce that we increased the commitment level on it to $400 million from $300 million and that was really just largely to give us extra comfort, to get us through the foreseeable future and with the current debt structure that we have. We feel very comfortable with it.

[Operator Instructions] Your next question comes from the line of Edward Okine of Basso Capital.

I was just wondering if you can comment on the Houston market, especially just try to give me some update on how things are moving there in that market?

I missed the last part of your question, you said the comment on the Houston market and…

Well I believe I mean well because of this -- I mean the oil prices in this scenario, the markets might be not as strong as it historically was and I was just trying to find out, how your view point on what is happening in that market?

Well, most of what you said us true. The Houston market has been negatively impacted by the decline in oil prices. It remains for the most part a very healthy economy in terms of the macro economy. I believe that it's still the largest new home sale of market in United States, though not quite as robust as people expected it to be a year ago at this time. It has affected our business slightly to be sure. Particularly as you get into the first and second move up, I think that’s more impacted than the lower price points there and it's -- I'd say the market is in very average condition right now based upon what it was. It was quite hot for a while, but we remain bullish about the long-term. We think it's a very healthy market in terms of the economy and home building in particular.

At this time there are no further questions. I would now like to turn the floor back over to management for any closing remarks.

Thanks very much for joining us. Look forward to talking to you next quarter.

Thank you for participating in today’s conference. You may now disconnect.