Phil Creek - Executive Vice President and Chief Financial Officer Bob Schottenstein - President and Chief Executive Officer Tom Mason - Executive Vice President Derek Klutch - Chief Operating Officer and President, Mortgage Company Ann Marie Hunker - Vice President and Corporate Controller Kevin Hake - Senior Vice President.

Ryan McKeveny - Zelman & Associates Alex Barron - Housing Research Center.

Good afternoon. My name is Stephanie and I will be your conference operator today. At this time, I would like to welcome everyone to the M/I Homes Third Quarter Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Phil Creek. Please go ahead, sir..

Thank you for joining us today. On the call is Bob Schottenstein, our CEO and President; Tom Mason, EVP; Derek Klutch, our Chief Operating Officer and President of our Mortgage Company; Ann Marie Hunker, our 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 forward-looking statements, I want to remind everyone that the cautionary language about forward-looking statements contained in today’s press release also applies to any comments made during this call. Also, be advised that the company undertakes no obligation to update any forward-looking statements made during this call.

Also during this call, we disclose certain non-GAAP financial measures.

A presentation of the most directly comparable financial measure calculated in accordance with GAAP and a reconciliation of the differences between the non-GAAP financial measure and the GAAP measure was included in our earnings release issued earlier today and is available on our website. With that, I will turn the call over to Bob..

Thanks, Phil and thank you for joining us on our call today. We are pleased with our third quarter results, highlighted by continued improvement in a number of key metrics. Combined with our strong first and second quarter results, our third quarter performance solidly positions us to have a very good year.

The number of homes closed in the quarter increased 15% to 1,148, and the average closing price improved 5% compared to a year ago. This led to a 22% increase in total revenues, equaling a record $442 million. Year-to-date, our revenues are $1.17 billion, which is 23% higher than a year ago.

New contracts increased 10% for the quarter and are 18% better year-to-date. Community count was up 5% for the quarter, so we were successful in improving our sales pace per community. We also reached our highest third quarter backlog level in 10 years, with a sales value of $821 million, 25% higher than 2015’s third quarter.

Homes in backlog increased 24% to 2,221 compared to 1,788 homes a year ago. Our net income for the quarter equaled $10.9 million, down from a year ago. But this quarter’s results include a $14.5 million pretax charge for known and estimated stucco-related repair costs in certain of our Florida communities.

Excluding the charge for stucco repairs, net income was very strong, improving by 28% over last year, and our pretax operating margin increased to 7.4%. Our SG&A expense ratio also improved, declining to 12.8% compared to 13.2% a year ago. And our SG&A expense ratio also improved sequentially from the first half of the year.

Gross margins, excluding the impact of the stucco charges I mentioned earlier, were down slightly from a year ago, coming in at 21.1%. This is a 10 base – this is 10 basis points higher than our second quarter’s gross margins.

The Stucco charges we incurred during the third quarter, along with the charges we incurred in the first half of 2016, cover all costs incurred to date plus our estimate of all repair costs that we may incur in the future.

In terms of our financial services business, that part of our operation also continued to perform at a very high level, with pretax income increasing 21% to $5.4 million for the quarter. The increase was driven by two things, higher volume and improved margins.

Year-to-date, we have earned $1.6 million from our financial services business, which, as you know, includes both mortgage and title operations. Now, I will take a few minutes to provide a little bit more detail about the operations in our three housing regions.

The Southern region is comprised of three Florida markets, Tampa, Orlando and Sarasota as well as four Texas markets, Houston, San Antonio, Austin and Dallas/Fort Worth. In the Southern region, we had 410 homes delivered for the quarter, which represented 36% of total volume. New contracts in the Southern region increased 10% during the quarter.

Orlando sales were strong and Tampa’s were solid as well. And our newest division, Sarasota, is off to a very solid start in what is now its first full quarter of operations for us. We are very excited about our new division in Sarasota.

In our Texas operations, both Austin and San Antonio had pretty good third quarter results while Dallas and Houston were weaker. The dollar value of our sales backlog in the Southern region at the end of the quarter was 16%, at 16% higher than a year ago.

And we had 74 communities in the Southern region at the end of the quarter, which represents a 19% increase from last year. As to our four Texas divisions, we had 46 active communities at the end of the quarter and continue to be very excited about our growth opportunities throughout Texas and in Florida as well.

Our Midwest region consists of our operations in Columbus and Cincinnati, Ohio, Indianapolis, Indiana, Chicago, Illinois, as well as Minneapolis/St. Paul. In the Midwest, we had 443 deliveries in the quarter, 22% more than a year ago and 38% of total company deliveries. New contracts in our Midwest region were up 19% during the quarter.

And our sales backlog in the Midwest was up 34% from a year ago in dollar value. We ended the quarter with 60 active communities in the Midwest, which is actually a 10% decrease from a year ago. Demand in our Midwest markets is solid. Each of our five markets is performing well. Chicago continues to be very strong and Minneapolis/St.

Paul is off to a very solid start in just its third full quarter of operations for us. We also had strong growth in Cincinnati and Columbus and Indianapolis also had very good quarters. Lastly, the Mid-Atlantic region where we have operations in Charlotte, Raleigh and Washington, DC, new contracts in this region were down 2% for the quarter.

Sales backlog was up 25% from a year ago in terms of dollar value. We ended the quarter with 40 active communities in the Mid-Atlantic region, which is 8% higher than a year ago. We delivered 295 homes in the Mid-Atlantic region, which is a 16% increase from a year ago and represents 26% of total deliveries.

Both Charlotte and Raleigh continued to be strong and had very solid quarters, where our operations in DC and the demand in that market remains sluggish. Our total controlled loss in the Mid-Atlantic region at the end of the quarter was basically flat from a year ago.

Before I turn the call over to Phil, let me just say once again that 2016 is shaping up to be a very good year for M/I Homes. We have a very strong backlog going into the fourth quarter and housing conditions throughout most of our markets remain favorable. Our financial condition and balance sheet are strong.

And we will continue focusing on increasing profitability, improving returns, growing our market share and investing in premier locations and attractive land positions. And with that, I will turn the call over to Phil..

Thanks Bob. One correction as far as financial services, their pretax income for the first 9 months is $16.1 million compared to last year’s $14.3 million. As far as financial results in general, we continue to focus on improving our profitability and our returns.

New contracts for the third quarter increased 10% to 1,088, and our traffic for the quarter was up 4%, and our community count was up 5%. Our new contracts were up 9% in July, up 17% in August and up 5% in September. As to our buyer profile, about 42% of our third quarter sales were to first-time buyers compared to 41% in 2016 second quarter.

And 48% of our third quarter sales were inventory homes compared to 46% in the second quarter. Our active communities were 174 at the end of the third quarter. The breakdown by region is 60 in the Midwest, 74 in the South and 40 in the Mid-Atlantic. During the quarter, we opened 11 new communities while closing 11.

We estimate that our average community count for the year should be about 10% over last year’s levels. We delivered 1,148 homes in the third quarter, delivering 50% of our backlog compared to 55% a year ago.

Revenue increased 22% in the third quarter compared to last year, primarily as a result of the increase in the number of homes delivered and average closing price. And our average closing price for the third quarter was $365,000, a 5% increase over last year’s $349,000. Our backlog average sale price is $370,000, slightly up from a year ago.

Land gross profit was $1.1 million in the third quarter compared to $900,000 in 2015’s third quarter. We sell land as part of our land management strategy and as we see profit opportunities. Our third quarter gross margin was 21.1%, excluding our stucco charge.

This is 10 basis points higher than our second quarter and 40 basis points below 2015’s third quarter. The decline from last year’s third quarter is due primarily to higher land cost.

Our third quarter SG&A expenses were 12.8% of revenue, improving 40 basis points compared to 13.2% a year ago, reflecting greater leverage from our higher closing revenue. We continue to focus on improving our operating efficiencies.

Interest expense decreased slightly for the quarter compared to last year primarily due to the lower weighted average borrower rate and higher capitalization due to increased land development activity. Interest incurred for the quarter was $7.9 million, flat with the year ago.

We have $17 million in capitalized interest on our balance sheet, the same as a year ago and this is about 1% of our total assets. Our effective tax rate was 41% in ‘16’s third quarter primarily due to the tax impact of state rate changes and lower than anticipated manufacturing deduction. We expect our annual rate to approximate 38%.

Our earnings per share for the quarter were $0.35 per share and includes a $0.30 negative impact from stucco charges. This per share amount also 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 pretax income increased from $4.4 million in 2015’s third quarter to $5.4 million in the same period of 2016. Our 2016 results include a 19% increase in loans originated from 713 to 848, an increase in average loan amounts and higher margins on the loans sold.

The loan to value on our first mortgages for the third quarter was 83% in 2016 compared to 84% in 2015’s third quarter. 78% of the loans closed were conventional and 22% were FHA or VA. This compares to the 70% and 30% respectively for 2015’s same period.

Our average mortgage amount increased 3% to $295,000 in 2016’s third quarter compared to $286,000 in the prior year. For the quarter, the average borrower or credit score on mortgages originated by M/I Financial was 739, up from 736 a year earlier. Our mortgage operation captured about 85% of our business in the third quarter compared to 2015’s 80%.

At September 30, we had $77 million outstanding under the MIF Credit Agreement, which is a $125 million commitment that expires June 23, 2017 and we had $14 million outstanding under a separate repo facility, which expires November 1, 2016.

Both facilities are typical 364-day mortgage warehouse lines that we extend annually and we expect to have the repo facility extended prior to its expiration. Now, I will turn the call back over to Phil..

Thanks, Derek. 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 9/30/16 was $1.2 billion, an increase of $92 million above a year ago levels primarily due to higher investment in our backlog and higher community count. Our land investment at 9/30/16 is $538 million, a 2% decrease compared to $551 million a year ago.

At September 30, we had $233 million of raw land and land under development and $305 million of finished unsold lots. We own 3,765 unsold finished lots with an average cost of $82,000 per lot. And this average lot cost is 22% of our $370,000 backlog average sale price. Our goal is to maintain about a 1 year supply of owned finished lots.

And the market breakdown of our $538 million of unsold land is $182 million in the Midwest, $213 million in the South and $143 million in the Mid-Atlantic. Lots owned and controlled as of 9/30/16 totaled 23,219 lots, 44% of which were owned and 56% under contract.

We own 10,127 lots, of which 38% are in the Midwest, 42% in the South and 20% in the Mid-Atlantic. During 2016’s third quarter, we spent $50 million on land purchases and $48 million on land development for a total of $98 million. And about 34% of the purchased amount was raw land.

Our estimate today for 2016 land purchase and development spending is $425 million to $450 million, which includes the $269 million spent year-to-date. At the end of the quarter, we had 282 completed inventory homes, 2 per community and 973 total inventory homes.

And of the total inventory, 264 in the Midwest, 509 are in the Southern region and 200 are in the Mid-Atlantic. At September 30, 2015, we had 360 completed inventory homes and 962 total inventory homes. Our financial condition continues to be strong, with $632 million in equity and homebuilding debt-to-cap ratio of 46%.

At 9/30/16, there was $85 million outstanding under our $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 now will open the call for any questions or comments..

[Operator Instructions] Your first question is from Alan Ratner with Zelman & Associates..

Hi, thank you. This is Ryan McKeveny actually on for Alan. Thanks for all the detail in the prepared remarks. One question I had, I was hoping to just get a little more color on what you’re seeing in terms of managing the stick and brick and labor costs in your markets.

It certainly looks like you’re doing a good job of balancing that with home prices, but an update there would be helpful?.

Well, when you look at sticks and bricks and labor cost when you compare the third quarter to a year ago, sticks and bricks looks like they were up in the 1% range. Markets are a little different. There is lumber creeping up in some markets. There is framing labor in some, brick and stone masons in a couple of markets.

Labor – the labor side of it is up a little more than that 1%, but we feel like that has gotten better. It is stabilizing. Our biggest challenges have really been on the cost side of the land versus sticks and bricks and labor..

Got it. Thank you.

And one bigger picture question on the entry-level exposure, obviously, you have good exposure there to begin with, but any outlook on product positioning going forward? Is it a strategy to further expand the percentage of your business that’s in that entry level segment or are you kind of okay with where you sit today which already is at an above average level?.

I think that there is two parts to that question. This is Bob Schottenstein. Number one, over the last number of quarters, we have begun in a number of our markets to introduce what I would call more affordable housing that could and in many cases does appeal to the entry level or just someone that doesn’t want to spend as much.

And going forward, we will continue to do that.

I don’t think it will radically change the nature of our business, but I think that one of the reasons you’ve seen the less escalation of our average selling price is the mix brought about as a result of more – a smaller product or even in some markets, more attached product, all of which is designed to reach a smaller price point.

But I will say this, that it’s something we are focused on, and we have been focused on it. And we continue to, as part of just the strategic review of our product and the competitiveness of our project, look at ways to design more affordable product..

Very helpful. Thank you..

[Operator Instructions] Your next question is from Alex Barron with Housing Research Center..

Thank you. Good job on the quarter guys.

Just had a question on the impairment, can you touch on that a little bit? Was that one project? Was that several projects over one region? Just kind of what was the issue there? And is there anyway that you can go after a sub or a vendor or insurance or something like that to cover that? And is this the full extent of your expected loss there?.

Well, first of all, you mentioned impairment. I think what you are talking about is the stucco charges..

Yes, definitely..

So just – so we are not talking about the same thing because we didn’t have any impairments in the quarter. We took charges in the first and second quarter as you know. And in this quarter, the charge was quite a bit more.

And as I said in my remarks and I tried to make it as clear as I could, that the charges we took during this quarter are designed to cover not only the actual costs that we incurred for repairs during the quarter but our best estimate of all future repair charges as well, at least at this time.

And all of these charges relate to certain of our Florida communities. Whether and if we are able to recover that which we’ve already incurred remains to be seen, but we will manage it as effectively as we can. I don’t know if you want to add anything, Tom..

No. I mean, we are reviewing obviously insurance carriers from the subcontractors that we use as well as our own, but at this time we can’t estimate any recovery in that regard..

Okay. And then I guess you did mention that you have been focused on rolling out a little bit more affordable product.

Any thoughts on do you guys do or what percentage of your business is active adult and where do you see that going forward?.

We have product offerings in nearly every one of our markets – not all of them at this point, but almost all – that are designed to appeal to empty nesters.

We approach it a little bit differently maybe than some builders have in that we do not develop any of these large master-planned exclusively active adult communities rather we tend to do it in smaller communities, but it’s a part of our business.

If I had to guess, it’s probably somewhere around 10% to 15% of our business in terms of total sales right now versus – and which is up from probably 3, 4 years ago. And I think it will continue to be at 10%, 15%, could even be maybe as much as 20% of our business going forward. We think we have great product that appeals to empty nesters.

It’s in virtually all of our regions we have got something developed. And I think that it’s a natural and normal part of our business and will remain so for the foreseeable future..

Okay. And then last question on margins, I think your margins this quarter came in quite a bit better than we expected, up sequentially excluding net charge.

But I am just kind of looking at the outlook next quarter and into the future, if you guys continue to see pressure from labor and land and where you think margins are going to head?.

We don’t have any guidance nor do we provide. We haven’t given any guidance nor are we going to give any guidance today, I should say, on margins going forward. Broadly speaking, I think that this industry over the course of time is around a 20% business. I have said that on prior calls.

We probably said that a half a dozen times over the last number of years. We still believe that. Our margins were down year-over-year about 40 basis points but up from the second quarter. We feel good about our margins. We think our product commands the margin it’s getting right now.

And we have been dealing with cost pressures not just on sticks and bricks side, but as Phil mentioned a few moments ago in response to an earlier question, we have been dealing with cost pressures on the land and land development side, but we think we are managing it well. We are very focused on not just the top line, but the bottom line..

It sounds good. Good luck for next quarter. Thanks..

Thanks a lot..

Thanks, Alex..

[Operator Instructions] At this time, there are no additional questions..

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

Thank you. This concludes today’s conference. You may now disconnect..