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M/I Homes Inc  (NYSE:MHO)
Q1 2019 Earnings Call
April 24, 2019, 4:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon, ladies and gentlemen. My name is Sam, and I will be the operator assisting on the conference call today. At this time, I would like to welcome everyone to the M/I Homes Incorporated First Quarter Earnings Conference Call. (Operator Instructions) After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions) Thank you.

Mr. Creek, you may begin your conference.

Phillip G. Creek -- Executive Vice President and Chief Financial Officer

Thank you. Joining me on the call today are Bob Schottenstein, our CEO and President; Tom Mason, EVP; Derek Klutch, President 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 nonpublic items with you directly. And as to the forward-looking statement, 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.

Robert H. Schottenstein -- Chairman, President and Chief Executive Officer

Thank you, Phil, and good afternoon, and thank you for joining our call to review our first quarter results. We are pleased with our first quarter performance, especially considering the overall slowdown in housing demand that began in the latter part of 2018 and continued heading into 2019.

These conditions contributed to a modest decline in our new contracts as well as a modest decline in our margins during the quarter. We achieved first quarter record revenue of $481 million which was an increase of 10% from last year, driven by a record level of 1,186 home closings during the quarter that's a 6% increase over last year's first quarter and an average home closing price of $393,000 which is a 5% increase from a year ago.

Our pre-tax income for the first quarter decreased by about 2% to $23.5 million from $23.9 million a year ago as a result of the tighter market conditions late last year that I noted earlier, which led to lower margins on our closings in the first quarter as well as lower pre-tax contribution to earnings from our financial services segment.

Our gross margin declined from last year's first quarter by about 130 basis points excluding purchase accounting charges. Importantly, however, our gross margin sequentially improved by 40 basis points from the fourth quarter.

Net income for the first quarter was $17.7 million compared to $18.1 million in 2018 first quarter while diluted earnings per share increased to $0.63 a share from $0.60 a share as a result of a lower share count. We sold 1,644 homes in the first quarter which is 5% less than the homes sold in last year's first quarter. Last year's first quarter was a difficult comp for us as it was the highest number of new contracts for a first quarter in our history and a year ago represented a 20% increase over 2017 as well. It's worth noting however that this year's first quarter new contracts of 1,644 homes are the second highest quarterly amount in Company history.

We continue to experience good sales and good growth with our more affordably priced Smart Series line of homes. We added several new communities in the first quarter and by the end of the quarter our Smart Series was being offered in 13% of total M/I communities and in 12 of our markets and comprised more than 16% of total sales. A year ago, for example, our Smart Series sales were less than 10% of total sales. So as noted in previous calls, we continue to experience good sales and good growth with our Smart Series line. Consistent with that, we have additional Smart Series communities being rolled out in 2019 and expect at the end of this year to be selling Smart Series homes in 13 of our 15 markets.

Our backlog sales value at the end of the quarter was $1.1 billion, the same as last year's, and units in backlog were down slightly to 2,652 homes from 2,744 homes in 2018's first quarter. We continued to make progress on our overhead expense ratio and during the quarter we improved this ratio by 30 basis points from last year with total SG&A at 12.9% of revenues for the first quarter.

Our balance sheet and liquidity remain strong. We ended the quarter with a healthy homebuilding debt to capital ratio of 47% and our shareholders' equity ended the quarter at $871 million which is an 11% increase from a year ago and equates to a book value of $32 per share.

We opened an additional 18 communities in the first quarter and are on track to achieve our planned new community growth this year with 214 active communities at the end of the -- at the quarter's end which is up 4% from the same period last year. As we manage our growth in new investment, obviously, we'll continue to monitor housing sales and overall market conditions in our markets.

Now I'd like to provide more detail about our three regional markets, first, beginning with the Mid-Atlantic region. I want to start out by commenting and highlighting that in our Washington, D.C. operation which is one of our three markets in the Mid-Atlantic region, we made a decision during the quarter not to invest any further in the D.C. market. And consistent with that we made a decision to wind down our operations in the D.C. market.

As we have been saying on these calls for several years, we have been unable to find land transactions that we believe provide acceptable returns to us in the D.C. market. As a result, we've only made minimal investments in new communities and locations over the past several years. We started this year selling homes in only four communities in D.C. and have only one active community where we're still selling, and we expect to be substantially completed and sold out of this community by the end of the year.

For what it's worth, our investment in D.C. today is minimal and not material as we own less than 75 unsold lots. Elsewhere in the Mid-Atlantic region our two divisions are Raleigh and Charlotte, North Carolina and these have been strong markets for us for quite some time and will continue to be so in the future. But in each of Charlotte and Raleigh we are working hard to open new replacement communities as we move into 2019.

Overall in the Mid-Atlantic region, we ended the quarter with 28 active communities which is a 7% decline from a year ago and new contracts were down 12% in the quarter year-over-year. Our sales backlog also was down in value 7% from a year earlier. We delivered 135 homes in the Mid-Atlantic region during the first quarter which is a 21% decrease from a year ago and 11% of companywide total. Our total controlled lots in the Mid-Atlantic region at the end of the quarter actually increased by 2% when compared to a year ago.

Next the southern region which is comprised of our three Florida and four Texas markets. We had 577 closings for the quarter which was a 7% increase from a year ago and represented 49% of the Company total. New contracts in our southern region decreased 9% for the quarter. The dollar value of our sales backlog in the southern region at the end of the quarter was 2% higher than a year earlier and our controlled lot position in the southern region decreased 15% when compared to a year ago. We had 96 communities in the southern region at the end of the quarter which is a 5% increase from March of last year and we continue to make progress in growing our operation under our newest southern region division which is Sarasota, Florida with 10 communities now fully open and selling. And in this region we continue to make important progress in our Texas -- four Texas markets with improving scale and financial performance. We have very strong market positions in both Orlando and Tampa, Florida and they each continue to be strong operations for us.

Finally the Midwest region. Our six Midwest divisions had 474 deliveries in the first quarter which was a 15% increase from a year ago and represent 40% of Company total. New contracts in the Midwest were up 1% for the quarter. Sales backlog in the Midwest was down 4% from the end of a year ago in dollar value and our controlled lot position in the Midwest was up 6% compared to a year ago. We ended the quarter with 90 active communities in the Midwest which is a 7% increase from a year ago and overall, let me just say, we are very pleased with each of our six Midwest markets.

Before turning the call over to Phil, let me conclude by saying that we are very excited about our business, feel very good about our markets and are well positioned to have a very solid 2019.

With that I'll turn it over to Phil.

Phillip G. Creek -- Executive Vice President and Chief Financial Officer

Thanks Bob. As far as financial performance, new contracts for the first quarter decreased 5% to 1,644 compared to last year's first quarter. The last year's first quarter was a 20% increase over the first quarter of '17 and an all time quarterly record. This quarter's new contracts ranks second all time in our Company history. And traffic for the quarter was up 5%. Our new contracts were down 9% in January, down 10% in February and up slightly in March. In March we had the highest sales month in our Company's history. As to our buyer profile, about 38% of our first quarter sales were the first time buyers compared to 36% in last year's fourth quarter and 47% of our first quarter sales were inventory homes compared to 52% in 2018's Fourth quarter.

Our community count was 214 at the end of the first quarter, up 4% versus 2018's first quarter and up 2% from year-end. The breakdown by region is 90 in the Midwest, 96 in the South, and 28 in the mid-Atlantic. During the quarter we opened 18 new communities while closing 13. For 2019 our current estimate is that our average community count for the year should be up about 5% from the average of 205 communities in 2018. We delivered a record 1,186 homes in this year's first quarter, delivering 54% of our backlog compared to 56% a year ago.

Revenue increased 10% in the first quarter, reaching a first-quarter record of $481 million. This was primarily a result of an increase in the number of homes delivered and a higher average closing price. Our average closing price for the first quarter was $393,000, a 5% increase when compared to last year's first quarter average closing price of $373,000. And our backlog sale price is $403,000, up 1% from a year ago.

Land gross profit was $55,000 in this year's first quarter compared to $404,000 in last year's first quarter. We sell land as part of our land management strategy and as we see profit opportunities. Excluding the purchase accounting adjustments from our acquisition during the first quarter of last year, our first quarter '19 operating gross margin was 19.3%. This is down 130 basis points year-over-year and is an increase of 14 basis points over the fourth quarter. We estimate that our construction and labor costs were flat when compared to 2018's fourth quarter.

Our first quarter SG&A expenses were 12.9% of revenue improving 30 basis points compared to 13.2% a year ago reflecting greater operating leverage. Improving our operating efficiencies continues to be a major area of focus. Our first quarter pre-tax results were impacted by $400,000 of purchase accounting expenses. Equivalent expenses related to the acquisition in last year's first quarter were $2.6 million. Interest expense increased $900,000 for the quarter compared to last year. Interest incurred for the quarter was $12.9 million compared to $11.8 million a year ago. This increase is due to higher outstanding borrowings in '19's first quarter as well as a higher weighted average borrowing rate. We have $22 million in capitalized interest on our balance sheet. This is about 1% of our total assets and our effective tax rate was 25% in 2019's first quarter compared to 24% in last year's first quarter. We estimate our annual effective rate in 2019 to be around 26%.

Our earnings per diluted share for the quarter increased to $0.63 per share from $0.60 per share last year as a result of our lower share count. During the quarter, we repurchased 5 million of our outstanding shares.

Now Derek will address our mortgage company results.

Derek J. Klutch -- President and Chief Operating Officer

Thanks, Bill. Our mortgage and title operations achieved pre-tax income of $5 million in the first quarter. Due to continued competitive pressures we experienced lower pricing margins on loans originated compared to the first quarter of last year along with higher expense levels associated with the opening of new mortgage and title offices in certain markets.

Pre-tax income was $8.8 million in 2018's first quarter which included additional income from the sale of a portion of our servicing portfolio. Loan-to-value on our first mortgages for the quarter was 82% in 2019, down from 2018's 84%. 76% of the loans closed in the quarter were conventional, 13% FHA, 11% VA compared to 77%, 13% and 10% respectively for 2018's same period. We expect to see a minimal effect on our FHA business with the recent underwriting changes.

Our average mortgage amount increased to $315,000 in the quarter compared to $302,000 last year. Loans originated increased 2% from 781 to a first quarter record of 798 and the volume of loans sold was relatively unchanged. For the quarter, the average borrower credit score on mortgages originated by M/I Financial was 745, down slightly from 747 the quarter earlier.

Our mortgage operation captured about 79% of our business in the quarter, the same as 2018's first quarter. At March 31st, we had $72 million outstanding under the MIF warehouse agreement which is a $125 million commitment that expires in June of this year and we also had $32 million outstanding under a separate $50 million repo facility which expires in October. Both facilities are typical 364-day mortgage warehouse lines that we extend annually and we don't expect any problems extending them prior to the expiration date.

Now I will turn the call back over to Phil.

Phillip G. Creek -- Executive Vice President and Chief Financial Officer

Thanks, Derek. As far 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 March 31 '19 was $1.7 billion, an increase of $150 million above March 31, '18. This increase was primarily due to higher investment in our backlog, higher community count and more finished lots. Our unsold land investment at quarter end was $796 million compared to $706 million a year ago. At March 31st, we had 347 million of raw land and land under development and 449 million of finished unsold lots. We owned 5,595 unsold finished lots with an average cost of $80,000 per lot. And this average lot cost is 20% of our $403,000 backlog average sale price. Our goal was to maintain about a one year supply of owned finished lots. And the market breakdown of our 796 million of unsold land is 314 million in the Midwest, 338 million in the south and 144 million in the Mid-Atlantic. Lots owned and controlled as of March 31, '19 totaled 28,000 lots, 52% of which were owned and 48% under contract. We own 14,510 lots of which 41% are in the Midwest, 45% from the South and 14% in the Mid-Atlantic. A year ago we owned 12,900 lots and controlled an additional 17,900 lots for a total of 30,800 lots. During this year's first quarter we spent $80 million on land purchases and $54 million on land development for a total of $135 million. About 49% of the purchased amount was raw land. Our estimate today for a total 2019 land purchase and development spending is $550 million to $600 million which includes the $135 million spent year to date. At the end of the quarter we had 560 completed inventory homes, about three per community, and 1,278 total inventory homes. Of the total inventory, 473 in the Midwest, 655 in the southern region and 150 in the Mid-Atlantic. And at March 31, '18 we had 425 completed inventory homes and 1,104 total inventory homes.

As of January 1, '19 we adopted the new lease accounting standard resulting in the capitalization of $21 million of our operating leases on our balance sheet. Our financial condition continues to be strong with $871 million in equity and homebuilding debt to cap of 47%. And in March 31, '19 there were $219 million outstanding under our $500 million unsecured revolving credit facility. We continue to focus on managing our leverage and liquidity and balancing this with our land needs.

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

Questions and Answers:

Operator

(Operator Instructions) We will pause for just a moment to compile the Q&A roster. And your first question comes from the line of Jay McCanless from Wedbush.

Jay McCanless -- Wedbush Securities Inc. -- Analyst

Hey. Good afternoon guys. (technical difficulty).

Robert H. Schottenstein -- Chairman, President and Chief Executive Officer

Thanks Jay.

Jay McCanless -- Wedbush Securities Inc. -- Analyst

(technical difficulty) First one, wanted ask about (technical difficulty)

Robert H. Schottenstein -- Chairman, President and Chief Executive Officer

Jay, it's been our practice not to comment on the month of the quarter just begun. So consistent with that past practice, we'll stay with it.

Jay McCanless -- Wedbush Securities Inc. -- Analyst

Right. Second question I had, you guys have talked about (technical difficulty)

Robert H. Schottenstein -- Chairman, President and Chief Executive Officer

I think it was pretty much across the board and it was a very, very strong month. I think it reflected an improving housing -- improving housing condition. (inaudible) if you will from the beginning of the year, year started out slow in both January, February. Selling season, I don't think got off to a very good start and then things really began to take hold in March in no small part, I think because of the 50 basis point, 60 basis point, almost 70 basis point drop in interest rates over the four, five month period that preceded it.

Jay McCanless -- Wedbush Securities Inc. -- Analyst

And then the sale absorption (technical difficulty). Could you talk about which market do you saw the most benefit, how those responded?

Phillip G. Creek -- Executive Vice President and Chief Financial Officer

Yeah, we really don't get into any detail that way, Jay. I mean, overall we talked about traffic being up 5% for the quarter, March was a little stronger than that. Cancellations were a little higher in January and February than they were in March. But overall we were very pleased, especially with our March sales.

Jay McCanless -- Wedbush Securities Inc. -- Analyst

Got it. And then the last question I had in terms of what you're seeing (technical difficulty) discounting. Are you seeing (technical difficulty) what the private builders are doing, especially in mover (ph) housing versus what public competitors are doing?

Robert H. Schottenstein -- Chairman, President and Chief Executive Officer

You know I'm not aware of anything. There might be some specific pockets where that's taking place. I think your point is an interesting one because the more move up, price point is a little more competitive right now. But I'm not really aware of anything in particular. I don't know if anyone else here. I wouldn't feel comfortable commenting on it because I'm just not aware of it. I have not heard of it. And you know there aren't that many active -- other than Texas and maybe Cincinnati, we're not dealing with a lot of what I call significant private builder competition.

Jay McCanless -- Wedbush Securities Inc. -- Analyst

(technical difficulty)

Robert H. Schottenstein -- Chairman, President and Chief Executive Officer

Thank you.

Operator

And your next question comes from the line of Thomas Maguire from Zelman and Associates.

Thomas Maguire -- Zelman & Associates -- Analyst

Hey guys. Nice job navigating a tough environment here. Just to stay on the incentive and demand side, were there any changes just to your incentive strategy during the month? And were you able to peel back in March at all as you saw the demand improve and orders come through?

Robert H. Schottenstein -- Chairman, President and Chief Executive Officer

You said were there any changes in our incentive approach during the month. Did you mean during the quarter?

Thomas Maguire -- Zelman & Associates -- Analyst

Correct. Thank you.

Robert H. Schottenstein -- Chairman, President and Chief Executive Officer

Maybe a little bit. I think that the incentives that we had in place going into the selling season, we pretty much maintained them through the quarter but began to scale back on a subdivision -- in certain subdivisions and/or markets as we moved toward the end of the quarter, as we saw underlying demand begin to improve itself.

Thomas Maguire -- Zelman & Associates -- Analyst

Got it. That makes sense. And then just quickly on the financial service business, just shifting gears, appreciate all the color on some of the challenging conditions there. But can you just talk about the competitive environment for that business and maybe where we are in terms of digesting some of the changes in the industry? And this quarter from both the revenue margin perspective was the lowest we've seen in a number of years. Does it feel like we're more balanced now and maybe bottomed and can improve from here or just how would you think about that?

Robert H. Schottenstein -- Chairman, President and Chief Executive Officer

Since Derek manages the Mortgage Company in great times and in challenging times, we'll let him answer that one.

Derek J. Klutch -- President and Chief Operating Officer

Hey Tom. Thanks. We see like the other builder mortgage companies with interest rates rising in the refinance business basically disappearing. The banks and the other mortgage lenders getting a lot more aggressive coming after the builder business. And that's caused us to reduce our margins just to stay competitive. I wouldn't say we are at the bottom but I am seeing a little bit of leveling out with where the pricing pressure is. And if the interest rates stay on a low course, I think we should be able to -- not get back to the (inaudible) year but stabilize a little bit.

Thomas Maguire -- Zelman & Associates -- Analyst

Got it. Thanks guys. Have a great day.

Robert H. Schottenstein -- Chairman, President and Chief Executive Officer

Thanks Thomas.

Operator

And your next question comes from the line of Art Winstone from Pilot Advisors.

Art Winstone -- Pilot Advisors -- Analyst

Thank you. I was wondering if it's feasible or possible to switch some of the lots into the lower priced showcase to move it up from the normal $200,000 (ph) homes even though originally you had planned to build some more expensive homes on these lots.

Robert H. Schottenstein -- Chairman, President and Chief Executive Officer

Our showcase brand is a really, really small part of our business, Art, just to be clear on that. In the quarter, we experienced a relatively good demand across most of our communities. What the Smart Series has done for us has incrementally improved our business and it's not that the rest of the business was bad. We look at every subdivision all the time and if we've got subdivisions that aren't performing there's a whole lot of things we'll look at with changing the product or perhaps even if we have the ability even exiting the community if that's what it takes. We've done that. We look at our communities all the time, we have high expectations for each community. Each community has its own set of underwriting guidelines and certainly the product that we sell in those communities can be a big part. Sometimes there's not a whole lot you can do with product because of restrictions, zoning and so forth that I know you understand. But the shorter answer is it's tough. We look at this all the time when our communities aren't performing. The good news is most of our communities are performing at acceptable levels right now.

Art Winstone -- Pilot Advisors -- Analyst

Thanks. One other question, did I hear right that the traffic through your communities was up 5% but the finance on new contracts in these same communities were down 10%?

Phillip G. Creek -- Executive Vice President and Chief Financial Officer

Yeah, contracts were down, not 10%, contracts were down 5% or 6%.

Robert H. Schottenstein -- Chairman, President and Chief Executive Officer

5% for the quarter.

Phillip G. Creek -- Executive Vice President and Chief Financial Officer

Traffic was up 5%, Art.

Art Winstone -- Pilot Advisors -- Analyst

Okay, thank you.

Operator

(Operator Instructions) And we do have a follow up question from the line of Jay McCanless from Wedbush.

Jay McCanless -- Wedbush Securities Inc. -- Analyst

(technical difficulty)

Phillip G. Creek -- Executive Vice President and Chief Financial Officer

Yeah, well as far as a couple of things Jay. I mean, as we've talked about we're down now to about one community. When you look at the orders there, the first quarter of last year it was like around 25. So it wasn't that many orders last year also nor is an impact the community count that much. And then Bob mentioned that -- today we're down to less than 75 and so lots. We hope to be out of the market by the end of this year is what we hope. Not really anticipating any type of significance there. We did have in the first quarter about $400,000 of severance cost unfortunately for some people that had been with us for a while that will be staying with us parts or all of this year, but that's the situation we've been, not investing and working down for a while.

Jay McCanless -- Wedbush Securities Inc. -- Analyst

(technical difficulty)

Robert H. Schottenstein -- Chairman, President and Chief Executive Officer

We actually picked Detroit in March of last year. And round figures it was about 25 orders this year and this year it was about 50 -- so -- we've had some (ph) but it's not significant.

Jay McCanless -- Wedbush Securities Inc. -- Analyst

And then the other question I had in general talk about (technical difficulty) you want to talk about community, region feel like you're getting net price base pricing technical difficulty).

Robert H. Schottenstein -- Chairman, President and Chief Executive Officer

I want to make sure I understand your question. You're saying are we seeing the opportunity to move prices in various -- is that the question?

Jay McCanless -- Wedbush Securities Inc. -- Analyst

More than what you were able to do for incentives and discounts et cetera..

Phillip G. Creek -- Executive Vice President and Chief Financial Officer

Well, I think one of the more encouraging things with our first quarter results was sequentially our gross margins were up nearly 40 basis points on closings. And I don't think there's a whole lot of pricing power right now. But I also don't think there'll be a whole lot more need for incentives but we'll just have to see and we'll wait and see and react. We've been saying for quite some time, we get this question almost every call, where do you see margins. We think our business is that 20% to 20% business and we sort of move between that. There may be a time where it dipped slightly above 21% and slightly below 20%. But we see it as basically a 20% to 21% business, probably a lot closer to the lower end of that range now than maybe during a little bit better times. But that's sort of how we see the year playing out.

Jay McCanless -- Wedbush Securities Inc. -- Analyst

Got it. Okay, great. Thanks for taking my follow-up.

Operator

And at this time sir, we have no further questions.

Robert H. Schottenstein -- Chairman, President and Chief Executive Officer

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

Operator

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

Duration: 36 minutes

Call participants:

Phillip G. Creek -- Executive Vice President and Chief Financial Officer

Robert H. Schottenstein -- Chairman, President and Chief Executive Officer

Derek J. Klutch -- President and Chief Operating Officer

Jay McCanless -- Wedbush Securities Inc. -- Analyst

Thomas Maguire -- Zelman & Associates -- Analyst

Art Winstone -- Pilot Advisors -- Analyst

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