M/I Homes, Inc. (NYSE:MHO) Q2 2016 Earnings Conference Call July 27, 2016 4:00 PM ET
Phil Creek - EVP and CFO
Bob Schottenstein - President and CEO
Paul Rosen - President of Mortgage Company
Kevin Hake - SVP
Ivy Zelman - Zelman & Associates
Alex Barron - Housing Research Center
Good afternoon. My name is Bethany, and I will be your conference operator today. At this time, I would like to welcome everyone to the M/I Homes Inc. second quarter earnings conference call. All lines have been placed on mute to prevent any background noise. [Operator Instructions] Thank you.
I’d now like to turn the call over to Phil Creek. Please go ahead, sir.
Thank you. Thank you for joining us today. On the call is Bob Schottenstein, 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. Good afternoon and thank you for joining our call to review our second quarter results. Following our strong first quarter results, we had another very good quarter, highlighted by record-setting second quarter sales, solid increases in both revenue and profit and our highest second quarter backlog in 10 years. Our sales for the quarter were particularly strong, increasing by 23% over last year. For the year, our sales are 20% better than a year ago. All three of our operating regions posted solid second quarter increases in sales. Specifically, sales in the Midwest were up 28%. In the southern region, sales were up 27% and in our mid-Atlantic region, our sales increased by 12%. Obviously, we were very pleased by our sales strength and - we were very pleased with our sales strength in most of our markets.
Our traffic for the quarter was up 12%, implying greater sales conversion and in fact, our sales base for the quarter was 2.5 sales per community versus 2.4 sales a year ago. Homes delivered during the quarter increased by 13% and revenues during the quarter improved by 24%. Our net income for the quarter increased by 19%, and our pre-tax income, exclusive of stucco-related charges increased by 27%. Gross margins for the second quarter, excluding the stucco charges, were 21%, 50 basis points better than the first quarter, though 80 basis points below last year, primarily due to higher lot costs.
We’re also pleased to improve our operating leverage. Second quarter SG&A was 70 basis points lower than last year, coming in at 13.1% of revenue. We continue to focus on lowering our overhead ratio and improving returns. Our backlog sales value increased 28% to $842 million and our units in backlog increased 27% to 2281 homes. Our financial services segment, M/I Financial, also had another strong quarter with pre-tax income of $4.9 million. And we were pleased to achieve our goal for new community openings. We had 174 communities opened at the end of the quarter, which is 12% more than a year ago. We remain on track to achieve our planned community growth for the year, increasing average community count by about 10% over 2015.
Now, I’ll provide a little bit more detail about our three operating regions. Beginning with the southern region, our southern region is now comprised of seven markets, three in Florida and four in Texas. We had 398 deliveries during the second quarter, which was 38% of total volume. Our sales in the southern region, as I mentioned earlier, increased 27% during the quarter. Tampa and Orlando were very strong for us during the quarter, and we expect both of these markets to continue to perform well for us in 2016. In April, we announced plans to further expand our Florida business with the opening of our 15th division in Sarasota, Florida. Our new Sarasota division is now officially up and running and as of July 1, we have two active communities in Sarasota where we have begun selling homes. We’re very excited about our new division in Sarasota and confident that we can grow it and establish a meaningful presence there.
In Texas, both Austin and San Antonio had very strong sales growth during the quarter, while our Dallas and Houston divisions were steady. The dollar value of our sales backlog in the southern region at the end of the second quarter was 15%, that’s 15% higher than a year earlier. We had seven communities in the southern region at the end of the quarter. This represents an increase of 17% from June of last year. As to our four Texas divisions, we had 42 communities opened at the end of the quarter, versus 34 a year ago. We continue to be very excited and optimistic about our growth opportunities in all seven of our divisions in the southern region.
Next is the Midwest region, which is comprised of five divisions, Columbus, Cincinnati, Indianapolis, Chicago, and most recently, Minneapolis/St. Paul. The Midwest region had 398 deliveries during the quarter, which is 13% more than last year and again, 38% of total deliveries. New contracts in this region were as I said 28% higher than a year ago and our sales were up in all five of our Midwestern markets. Our sales backlog in the Midwest was up 36% from last year in dollar value, and we ended the quarter with 65 active communities across the Midwest, which is 5% more from a year ago. Demand in all five of our Midwest markets is solid and each is performing well, with Chicago continuing to be one of our strongest markets in terms of financial performance, and we’re very pleased to be off to a very solid start in Minneapolis/St. Paul, which is now in its second full quarter of operation for us. And I also want to add that Indianapolis showed strong growth during the quarter and our sales were very good in both Columbus and Cincinnati.
Finally, the mid-Atlantic region which is comprised of our two North Carolina divisions in Raleigh and Charlotte as well as our operation in Washington DC. New contracts were up 12% for the quarter, with sales up in all three markets. Our sales backlog value was up 38% at quarter end from a year earlier, and we ended the quarter with 39 active communities in the mid-Atlantic region, which is 18% higher from last year. We delivered 246 homes in the mid-Atlantic region, 4% less than a year ago. This represents 24% of total deliveries.
Our two Carolina markets, Charlotte and Raleigh had a very good quarter, with improvements in sales. Deliveries in the Carolinas were relatively flat, but I want to make clear that both Raleigh and Charlotte continues to be among our best performing markets. Demand in the DC market remains just fair, although conditions have shown modest signs of improvement during the quarter and our sales were up slightly in DC. Total lots controlled in mid-Atlantic region decreased 17% from last year, primarily as we continued to manage our investment levels carefully in our DC division. Before turning the call over to Phil, let me conclude by saying that we are very pleased with our second-quarter results. We are seeing very good execution by the division teams throughout most of our markets. We continue to focus on premier locations, well designed homes, quality construction, strong customer service and improving overall company profitability. With our strong balance sheet, relatively low debt levels and the quality of our backlog we are poised for strong performance in 2016, our 40th in business.
And with that I will turn the call over the Phil.
Thanks Bob, as far as the financial results, we continue to focus on improving our profitability and our returns. New contracts for the second quarter increased 23% to 1,354, which was second-quarter record for us. Our traffic for the quarter was up 12% and our community count was also up 12%. Our new contracts were up 26% at April, up at 31% in May, and up 11% in June. And as to our buyer profile, 41% of our second quarter sales were to first-time buyers compared to 40% in 2016’s first quarter and 46% of our second-quarter sales were inventory homes compared to 45% in 2016’s first quarter. Our activity communities were 174 at the end of the second-quarter, the breakdown by region is 65 in the Midwest, 70 in the South and 39 in the mid-Atlantic. During the quarter, we opened 10 new communities while closing 17. We estimate that our average community count for the year should be about 10% over 2015 levels. We delivered 1,042 homes in 2016 second quarter, delivering 53% of our backlog compared to 57% a year ago.
Revenue increased 24% in the quarter compared to last year, primarily as a result of an increase in the number of homes delivered and average closing price. And our average closing price for the second quarter was 362,000, a 7% increase over last year's 340,000. Our backlog sale price is 369,000, slightly up from a year ago. Land gross profit was $1.3 million in the quarter compared to 200,000 in 2015 second quarter. We sell land as part of our land management strategy and as we see profit opportunities. During the second quarter, we took a 2.8 million charge for cost associated with stucco-related repair cost in certain of our Florida communities. For the six months ending in June 30, ‘16 charges were 4.9 million. We continued to gather data with respect to this matter. Our second quarter gross margin was 21%, excluding our stucco charge this is 50 basis points higher than our first quarter comparable margin and 80 basis points below 2015 second-quarter. The decline from last year second-quarter is due primarily to higher land cost.
Our second quarter SG&A expenses were 13.1% of revenue, improving 70 basis points compared to 13.8% a year ago reflecting greater leverage from higher closing revenue. We are pleased with this and continue to focus on improving our operating efficiencies. Interest expense increased $600,000 for the quarter compared to last year primarily due to higher borrowings. We have $17 million in capitalized interest on our balance sheet compared to $16 million a year ago; this is about 1% of our total assets. And our effective tax rate was 37% in 2016 second-quarter, which approximates our expected annual rate. Our earnings per diluted share for the quarter was $0.52 per share and that includes a $0.06 negative impact from stucco charges. And this per share amount reflects 1.2 million to dividends paid to our preferred shareholders.
With that, I’ll turn it over to Paul Rosen to address our mortgage company results.
Thanks Phil, our Mortgage and Title operations pre-tax income for the second quarter was $4.9 million in 2016, the same as in 2015 second quarter. While over 2016 results include an increase in loans originated from 666 to 761, this was offset by tighter margins on loans sold and a modest delay in investment funding. During the quarter, we also experienced start-up expenses associated with opening new title offices in both Texas and Minneapolis. The loan to value on our first mortgages for the second quarter was 84% the same as 2015. 74% of the loans closed were conventional and 26% were FHA, VA, this compares to 75% and 25% respectively for 2015 same period. Overall, our average mortgage amount increased 9% to 199,000 [ph] in 2016 second quarter compared to 274,000 in 2015 second quarter. The average borrower credit score on mortgages originated by M/I Financial was 739 in the second quarter of 2016 compared to 734 in 2016 first quarter.
Our mortgage operation captured approximately 83% of our business in the second quarter compared to 2015, 79%. June of 2016, we renewed the MIF credit agreement for another 364 day term which that expires June 23, 2017 and increased the maximum borrowing availability to $125 million. The facility also includes seasonal increases to provide sufficient capacity for quarter end closings. At June 30, 2016 we have 80 million outstanding under this facility and 13 [ph] million outstanding under a separate repo facility, which expires November 1, 2016. Both facilities are a typical 364 day mortgage warehouse lines that we extend annually.
Now, I will turn the call back over to Phil.
Thanks Paul, as far as the balance sheet, we continue to manage our balance sheet carefully focused on investing in new communities while also managing our capital structure. Total homebuilding inventory at June 30, 2016 was 1.2 billion, an increase of 129 million of June 30 ‘15 levels. Increase was primarily due to higher investment in our backlog, higher community count and more finished lots. Our land investment in June 30, ‘16 is 542 million and 11% increase compared to 488 million a year ago. At June 30, we had 239 million of raw land and land under development and 303 million of finished unsold lots. We owned 3,789 unsold finished lots with an average cost of 80,000 per lot. And this average lot cost is 22% of our 369,000 backlog average sales price.
Our goal is to maintain about one-year supply of owned finished lots. The market breakdown of 542 million of unsold land is 163 million in the Midwest, 222 million in the South and 158 million in the mid-Atlantic. Lots owned and controlled as of June 30, ‘16 totaled 21,948 lots, 48% of which were owned and 52% under contract. We own 10,470 lots of which 35% are in the Midwest, 42% are in the South and 23% in the mid-Atlantic. During the 2016 second-quarter, we spend 45 million on land purchases and 42 million on land development for a total of 87 million. About 40% of the purchase amount was raw land. Our estimate today for 2016 land purchase and development spending is 425 to 475 million that includes the 171 million we’ve spent year-to-date.
At the end of the quarter, we had 222 completed inventory homes about one per community and 877 total inventory homes. Of the total inventory, 266 were in the Midwest, 432 were in the southern region and 179 in the mid-Atlantic. And at June 30, ‘15 we had 324 completed inventory homes and 917 total inventory homes. Our financial condition continues to be strong with 621 million in equity and net debt to cap ratio of 49%. At June 30, ‘16 there were 70 million outstanding under 400 million unsecured revolving credit facility. We have no debt maturing this year and only 58 million of convertible debt due in 2017.
This completes our presentation. We’ll now open the call for any questions or comments.
[Operator Instructions] Our first question comes from the line of Ivy Zelman with Zelman & Associates.
Good afternoon, guys. Congratulations on a solid quarter. I think Bob, it's hard to really have any major questions that you haven't already addressed, but you did come in a little bit light relative to our expectations on revenue and your backlog conversion is actually down year-over-year. Maybe you can talk about if anything, is that sort of what we should be modeling and the challenges around labor and constraints that might reduce backlog, are we at a new norm and then I have other questions if you don't mind, but I’ll stop there?
First of all, thanks for your comment. Let me make one comment about conversion and then I think Phil may want to add something to it. In most of our markets, cycle time has been extended slightly. I wouldn't call it significant, but it’s not, it's a week here, a week there and a lot of it is a result of just the stress on the system on subcontractor availability. Not every market is the same. For us frankly, it's been a little bit more acute in Texas than it has been perhaps in the Midwest, but I think we have felt a slight strain on getting houses done as a result, primarily of the situation with trades.
Phil, I don't know if you want to add anything.
Not really. I mean the cycle time does continue to be challenging, really hasn't moved significantly. Most markets seem to have an issue or two. Frankly, there seem to be issues in a couple of markets, some of the block trades in a couple of markets. So there have been a few delays here and there, but we would like to be closing 100% of our backlog, the percentage of specs hasn't moved much, but that continues to be a challenge for us.
So it just sounds like, Phil, maybe we should be modeling sort of that, if it’s 400 bps relative to a year ago, that may be a good way to think about conversion rates throughout the year or do you think that's little too conservative in terms of I know it changes quarter-to-quarter, based on seasonality and backlog conversions, but it sounds like those issues are not going to change is what you are saying?
Yes. I mean, that's something we continue to work on Ivy, but we’re having difficulty improving that.
Okay. And then just in terms of the SG&A leverage, which was impressive. I think Bob, you mentioned that you continue to strive to do even better. You guys really don't provide a lot of guidance around the forward gross margin or SG&A leverage, but maybe qualitatively directionally, can you give us little thoughts related to both the SG&A leverage opportunity and maybe where our gross margins?
Yes. At least on the SG&A front, let me try to address that. We’re very focused on continuing to improve it. We expect to improve it as our operations and volume improve. And as you know, the back half of the year is expected and generally produces a lot higher volume and closing level than the front half of the year. So we’re pleased that it’s down 70 basis points. We believe we can continue to improve it and we’re focused on doing so. Phil, I don't know if you want to -
Absolutely, that's something we think that there is definitely some more headroom on and with our backlog up the way it is, of course, we do have more people, but we’re trying to manage those costs. So we are looking for further improvement.
And I think you started to touch on.
No, I was going to ask you on gross margins, let me elaborate on the question and make it a little easier. With respect to labor inflation and all the cost inflation that we've had in the market, there was a lot of concern by the investment community that that cost inflation is going to result in margins probably seeing compression on sort of the out years and I'm just wondering just knowing the strength that you're seeing in the markets and you are fundamentally, with the exception I think in DC and Houston, I mean, some more challenging environments, maybe some other markets are really strong, do you think directionally margins even with cost inflation, you can see them stay within the range they’re in or would you expect that margins are going to compress with the cost inflation?
Look, we would enter this year, believing our margins will be down slightly for a number of reasons. One, we had benefited from some escalated margins in select communities where land had been bought really smartly and if we do not believe, we think all of our land purchasers are smart that we’re able to buy it before some land prices had increased as much as they now have. We still think there is a lot of good land deals out there, but I also think that our industry is settling in, and one of the other builders said this and I thought it was a very accurate comment. We all account a little different, but I think it's a 20%, 21% business and at least at the gross margin level and we still believe that it is, and there may be a little movement from quarter-to-quarter. We were pleased the second quarter was up 50 basis points and over the first quarter, lower than last year. We think most of the reduction was because our average lot price is up. We have been able to pretty much manage the brick and mortar piece, but I think things settle in, in that 20% to 21% range, with housing the way it is and that's sort of how we see it.
That's great. I'm going to sneak in one more, I'll come back in the queue, but last question, very impressive your performance in Chicago, given many others that are struggling there and the percent that you have provided, I think Paul on the first time buyer is pretty high. What’s changing that your business is accelerating on the order front? What are you seeing that's different, is it financing, more availability, whether it’d be Wells Fargo and other banks that are offering high LTV mortgages, is there anything changing you guys are seeing incrementally that gives you more conviction and confidence that it’s sustainable?
Our sales were up 3% in the second quarter last year. Last year at this time, I felt like we had great locations, very well trained salespeople and really good product. I do feel that our locations and our people are the strongest today they’ve ever been. I think that's contributed to the significant jump in our sales comps relative to the other builders. Admittedly, we’ve added a number of new markets. In the last four or five years, they are maturing, some faster than others, but as I said, I actually stumbled over the words. But as I try to say during my comments, we were very pleased with our sales strength in most of our markets and there is not runaway demand, but we think we are gaining and growing in market share. I don’t think I would attribute it necessarily to anything in the mortgage business. Paul Rosen is nodding his head, approving, agreeing with that and does that answer your question?
Yes. I’m just wondering like people, younger kids moving out of apartments because they’re getting married, having babies, anything you guys can point to, but again I will stop there.
I think with the beginning of the beginning of the beginning, if I could say it that way of millennial starting to buy, I think it's just beginning to rear its head just a little bit. I don’t think there is going to sea change there yet.
Great, thanks guys. Good luck.
Okay. Thank you, Ivy.
[Operator Instructions] Our next question comes from Alex Barron with Housing Research Center.
Hey, good afternoon, guys. I wanted to I guess focus a little bit on the SG&A, but just on the corporate side. So this quarter, we saw a sequential jump in the dollars and I guess on a year-over-year basis, the dollars were up 24%, in line with revenues. Is that mostly attributed to just the growth in community count or is there any one-time item in there?
One thing now, with our improved results, compensation levels that we expect, that was part of it. As part of it certainly not corporate programs and so forth as we grow our community count, as we start up service in Texas, but other compensation going up a little bit. Not really, I mean overall, like we said we’re looking at SG&A expenses, they were not up as much as revenue was for the quarter, plus we had some scale which is what we’re after but nothing major Alex.
But I guess for the second half of the year, you would expect that those dollars probably wouldn’t grow necessarily in line with revenues right?
That’s something really hard to project, we have a lot bigger backlog, obviously closing, very usually have more in the third and fourth quarters, so hopefully we’ll still get SG&A leverage in those pipelines but sometimes you get a little lumpy quarter to quarter, it just kind of depends.
And then, I guess on the balance sheet, on the inventory, obviously you guys had a pretty good quarter in terms of orders very good growth everywhere. Are you guys, at some I mean your cash is a little low, are guys at some point maybe considering raising some debt capital or something else to be able to sustain the growth?
This is Kevin, I don't think our cash is, it’s moved up and down a little bit, we tried to keep as lower cash as possible, we look at liquidity in combination to cash and the availability we have under our revolver, $400 million revolver that we’re not really planning now to use those, so we think we’re in great shape in terms of liquidity and availability. That's the way we looked at it.
[Operator Instructions] At this time, there are no additional questions in the queue.
Well, with that, thank you very much for joining us and look forward to talking to you next quarter.
Thank you. This concludes today's conference, you may now disconnect.
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