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

Alan Ratner - Zelman Jay McCanless - Wedbush 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 Second Quarter 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 the conference over to Mr. Phil Creek. Please go ahead sir..

Thank you for joining us. On the call today is Bob Schottenstein, our CEO and President; Tom Mason, EVP; Derek Klutch, 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.

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 will turn the call over to Bob..

Thanks, Phil. Good afternoon and thank you for joining our call to review our second quarter results.

We reported another strong quarter, highlighted by record second quarter new contracts, record second quarter homes delivery, record second quarter revenue, record second quarter new community openings and significant improvement in our overall profitability. During the quarter we sold 1400 homes.

That's the highest number of new homes sold in the second quarter in our 41 year history. The 1400 homes sold represent a 3% increase over last year. And with regard to that 3% increase, keep in mind that we were dealing with a very difficult sales comp, as our second quarter new contracts last year were up a significant 23%.

As Phil will detail in a few minutes, our sales during the quarter were essentially flat in April and May, that kicked up noticeably in June. Year-to-date, we have sold a record 2854 homes, which is 7% ahead of 2016’s then record level. In terms of closings, second quarter deliveries were record 1211 homes, 16% better than a year ago.

For the first six months of the year we have closed a record 2,249 owns, 17% ahead of the year ago. The number of homes in backlog increased 6% to 2409, and the sales value of our backlog increased 8% to a very strong $909 million.

During the quarter we took an $8.5 million pre-tax charge for stucco-related repairs in certain of our Florida communities, primarily located in Orlando. Excluding this charge, net income increased 27% to $22.4 million.

We were very pleased with our improved profitability, as our pre-tax operating margin increased 90 basis points from the first quarter 2017 and 50 basis points year-over-year to 7.4%. As indicated in our prior earnings calls, we continue to focus on improving returns and increasing profitability.

And on that point, I also want to note, that our adjusted gross margin improved 40 basis points over last year second quarter to 21.4%. Our financial services business also had another very strong quarter with pre-tax income up 28% over a year ago. Derek Klutch, the President of M/I Financial review this is in more detail later on the call.

In terms of community count, we remain on track to achieve our growth plans for the year, increasing our overall community count by 5% to 10% over a year ago. During the second quarter, we opened a record 18 new communities and finished with the quarter with 187 active communities, up 7% from a year ago.

And our balance sheet and liquidity are in very good shape with nearly $700 million of shareholders equity, a 46% net debt to capital ratio. And as announced last week, we have increased our credit facility by an additional $100 million to $500 million, which includes a $25 million accordion feature.

And we also extended the maturity date of that facility by 4 years. Now I’ll take a few minutes to more specifically review our three housing regions. Beginning with the southern region, which is comprised of our three Florida markets Tampa, Orlando, Sarasota, and our 4 Texas markets, Dallas, Houston, Austin and San Antonio.

We delivered 520 homes in the southern region during the quarter, which was a 31% increase from last year. And this represents 43% of the total volume. New contracts throughout the southern region increased 21% year-over-year.

We are achieving solid results in all 3 of our Florida markets, Orlando and Tampa sales, as well as Orlando and Tampa deliveries were strong throughout the quarter and Sarasota in its first full year of operations for us is off to a very solid start.

The dollar value of our sales backlog in the southern region at the end of the quarter was 14% higher than last year and our controlled lot position in the southern region increased by 31% compared to a year ago. We had 87 active communities in the southern region at the end of the quarter, which is 24% better than June of last year.

And with respect to our 4 Texas divisions, we had 56 communities at the end of the quarter versus 42 a year ago. And while demand, new home demand was mixed in our 4 Texas markets. We continue to be very optimistic about our growth opportunities throughout Texas.

Next is the Midwest region, which consists of 5 markets, Columbus, Cincinnati, Indianapolis, Chicago and Minneapolis. We delivered 437 homes in the Midwest region, which was a 10% increase from a year ago. This represents 36% of total company closings. New contracts in the region were up 5% for the quarter.

All 5 of our Midwest markets continued to perform very well.

We are particularly pleased with our results in our newest market Minneapolis and our affordable Smart Series line of homes with respect I should say to our affordable Smart Series affordable line of homes we opened got our first community offering that product in Columbus during the first quarter and traffic and sales have been very strong.

We look forward to launching additional Smart Series communities throughout many of our markets, not just in the Midwest, but companywide over the coming period of time. Our sales backlog in the Midwest was up 30% in dollar value and our controlled lot position in the Midwest increased 17% compared to a year ago.

We ended the quarter with 66 active communities in the Midwest. This is 2% more than last year. Finally, our Mid-Atlantic region, which is comprised of our Charlotte, Raleigh, North Carolina markets, as well as our operation in DC.

In this region new contracts were down 27% for the quarter, compared with a year ago and our sales backlog value was also down 12% at the end of the quarter from a year earlier. We ended the quarter with 34 active communities in the mid-Atlantic region, which is down 13% from a year ago. We delivered 254 homes in the quarter.

This is a 3% increase from last year and our closings in the mid-Atlantic region represent 21% of total company closings. Let me say a few more words about our various markets in the mid-Atlantic region. Our two big markets in North Carolina, Charlotte and Raleigh continue to be among our best performing markets.

We had very solid results there with improvement deliveries and we continue to have a lot of confidence in our ability to grow our market share in both Charlotte and Raleigh. On the other hand demand in the DC market remains sluggish it has so for some time and we are managing our investment in this market very carefully.

Our control lots - total controlled lots in the mid-Atlantic region at the end of the quarter increased to 9% compared to last year. Before I turn the call over to Phil, let me conclude by saying once again that we were very pleased with our strong second quarter results.

We feel really good about our business and continue to see favourable housing conditions in most of our markets. We look forward for continued growth and improved profitability and are on track for a strong 2017. At this point, Phil will discuss in more detail our financial results..

Thanks, Bob. We continue to focus on increasing our profitability along with improving our returns. We were very pleased that our second quarter adjusted pre-tax income was up 22% and our adjusted pre-tax income margin improved 50 basis points to 7.4%. New contract for the second quarter increased 3% to a second quarter record of 1400.

Our traffic for the quarter was up 2% and our community count was up 7%. Our second quarter sales comparison was difficult, as last year second quarter was up 23% over 2015. Our new contracts were down 1% in April, down 2% in May and up 15% in June.

As to our buyer profile about 35% of our second quarter sales were first time buyers compared to 37% in this year's first quarter. And 45% of our second quarter sales were inventory homes compared to 44% in the first quarter. Our active communities were 187 at the end of the second quarter.

The breakdown by region is 66 in the Midwest, 87 in the south and 34 in the mid-Atlantic. During the quarter, we opened second quarter record 18 new communities while closing 15. We are very pleased that we have opened 42 new communities the first half of this year.

For the full year 2016 we opened 52 new communities, and for 2017 our current estimate is that our average community count for the year should be up about 5% to 10% over last year levels. We delivered 1211 homes in the second quarter, delivering 55% of our backlog, compared to 53% a year ago.

Revenue increased 14% in the second quarter over last year, reaching a second quarter record $457 million. This was primarily a result of an increasing number of homes to delivered, as well as record second quarter revenues from our financial services operations.

Our average closing price for the second quarter was 366,000, an increase of 1% over last year 362 and our backlog sale price is 377,000, up 2% from a year ago. Land Gross profit was 150,000 in this year second quarter, compared to $1.3 million in 2016 second quarter.

We sell land as part of our land management strategy and as we seen profit opportunities. During the second quarter, we took an additional $8.5 million stucco charge for estimated future stucco related repair cost in certain of our Florida communities.

A majority of this charge was for Orlando market issues, while our 2016 charge was primarily related to our Tampa market. Our second quarter adjusted gross margin was 21.4%. This is 10 basis points higher than our first quarter comparable margin and 40 basis points above 2016 second quarter.

Our second quarter SG&A expenses were 13.2% of revenue, slightly higher than last year, due primarily to a higher headcount, higher land related expense, such as real estate taxes and costs associated with the increase in our community count.

Compared to last year second quarter, our G&A percentage was slightly lower and our selling percentage higher again, selling expenses higher due primarily to our community count growth. Interest expense decreased 475,000 for the quarter, compared to the same period last year.

Interest incurred for the quarter was $8.3 million, compared to $8 million a year ago. We have $16 million in capitalized interest on our balance sheet. This is about 1% of our total assets. And our effective tax rate was 33% in 2017 second quarter and we estimate our annual effective rate to be about 36%.

Our earnings per diluted share for the quarter were $0.55 per share and includes an $0.18 negative impact from stucco charges.

Also this per share amount reflects $1.2 million of dividends paid to our preferred shareholders and is calculated as if our convertible notes converted, adding back to convertible interest and treating the related shares if they are outstanding. Now Derek Klutch will address our mortgage company results..

Thanks, Phil. Our mortgage and title operations pre-tax income increased from $4.9 million in 2016 second quarter to $6.2 million in the same period of 2017. Our second quarter results include an increase in the number of loans originated and a higher volume of loan sold. The quarter also benefited from higher mortgage.

Loan to value on our first mortgages for the second quarter was 83% in 2017, down from 2016 to 84%, 75$ of the loans closed were conventional and 25% were FHA or VA. This compares to 74% and 26% respectively for 2016 same period.

Our average mortgage amount was $299,000 in 2017 second quarter the same as last year and loans originated increased 10% from 761 to 840. And the volume of loans sold increased by 23%. For the quarter, the average borrower credit score on mortgages originated by M/I Financial was 739, up slightly from 737 a quarter earlier.

Our mortgage operations captured about 80% of our business in the second quarter, compared to 2016 83%. At June 30th 2017, we had $60 million outstanding under the MIF warehouse agreements, which is a $125 million commitment that was recently extended and expires in June of 2008.

We also had $29 million outstanding under a separate repo facility which expires in October of 2017. Both facilities are typical 364 day mortgage warehouse lines that we extend annually. Now, I’ll turn the call back over to Phil..

Thanks, Derek. First the balance sheet, we continue to manage our balance sheet carefully, focused on investing in new communities, while also managing our capital structure.

Total home building inventory at June 30, ‘17 was $1.4 billion, an increase of $200 million above June 30, ‘16 levels, increase was due primarily to higher investment in our backlog, higher community count and more finish lots. Our unsold land investment at June 30, ‘17 is $612 million, compared to $542 a year ago.

At June 30th we hit $253 million of raw land and land under development and $359 million of finished unsold lots. We own 4,545 unsold finish lots with an average cost of 79,000 per lot and this average lot cost is 21% of our 377,000 backlog average sale price.

Our goal is to maintain about a 1 year supply of our owned finished lots and the market breakdown of our $612 million of unsold land is $205 million in the Midwest, $274 million in the south and $133 million in the mid-Atlantic.

Lots owned and controlled as of June 30, ‘17 totalled 26,700 lots, 41% of which are owned and 59% of which are under contract. We feel very good about our land position both from our location and a risk standpoint.

Meeting our stated goal of owning and controlling a 4 to 5 year supply of lots, but importantly owning only about 11,000 of these lots, which equates to slightly more than a 2 year supply on our books and of the 11,000 lots owned, 37% are in the Midwest, 46% in the south, and 17% in the mid-Atlantic.

During 2017 second quarter we spent $103 million on land purchases and $44 million on land development for a total of $147 million. About 44$ of the purchased amount was raw land. Our estimate today for 2017 land purchased and development spending is $550 million, which includes the $268 million spent year-to-date.

At the end of the quarter, we had 338 completed inventory homes, about 2 per community and 1093 total inventory homes and of the total inventory homes 308 are in the Midwest, 550 are in the southern region and 235 are in the mid-Atlantic. At June 30, ’16, we had 222 completed inventory homes and 877 total inventory homes.

Our financial condition continues to be strong with $693 million in equity in homebuilding debt to cap ratio of 46% and at June 30, ‘17 there was $138 million outstanding under our unsecured revolving credit facility.

And as we announced last week, we increased our borrowing availability under this facility from 400 to 500 and extended its maturity day to 2021. We have $58 million of convertible debt due September 2017 at a conversion share price of 238 per share. That concludes our remarks. We’ll now open the call for any questions or comments..

[Operator Instructions] Our first question comes from the line of Alan Ratner with Zelman..

Hey, guys good afternoon. Thanks for taking my question. Bob or Phil, just on the gross margin nice improvement this quarter both sequentially and year over year. And I know last quarter you kind of indicated it seems like at that time whatever maybe modest pricing power you had was being offset by cost inflation.

And in the last few months in our work that we've done we've seen a pretty nice acceleration in pricing power, a lot of that seems to be coming out west in markets you guys don't operate in. But we're starting to hear a little bit of chatter about improved pricing power within your footprint as well.

So I was curious within the margin improvement you saw this quarter and just some of your commentary there on the focus are you starting to see any pickup in pricing power in your markets of operation, and if so maybe if you could talk a little bit about the individual market or price points that you're seeing an improvement?.

The short answer is yes and no. I think that in certain markets we have communities where we've had very strong demand in communities for all, where we have been pushing prices and getting improvement in margin.

Some of that has been strengthened by the introduction last year of our Smart Series of affordable housing, which we think is very well-designed and very well appoints. And has thus far we launched in Tampa. We've now got a community that we opened up earlier in the year in Columbus and we've got a number of them online that will be coming on.

And the volume has been strong and we've been able to push pricing there. We've also got some very, very strong locations in a number of markets at the upper end of our price range, say 400 to 600 where there's been strong demand. Its very location driven, I wish Alan, I appreciate your comments.

I wish I could give you a more market specific comment, but I think its subdivisions specific, rather than market specific.

And you know, I think that we said during the last call and you asked about this, that we didn't expect a whole lot of margin improvement going forward that we felt that were sort of a 20%, 21%, maybe just approaching 22% of business on average across all markets.

I still believe that and I think where we have opportunity to improve margins we clearly will and we have.

By the same token, I think that where we have the ability to really grow our - or improve our returns I should say is more below the line through leverage and as we indicated we were you know, we were pleased to see pretty noticeable improvement in our pre-tax operating margin. So it improved by more than the gross margin.

So long answer to your question, I hope that gives you some indication..

Yes. That’s great. I appreciate the detail there. Second question if I could. You had a comment in the press release just regarding market share and a focus on gaining market share. I felt that back over the last couple of years you guys have been a really good job both organically, as well as through some select M&A in terms of taking share.

And now with the balance sheet definitely improved and congrats on that, you've got good liquidity. You've got the convertible debt coming or set to mature here in the next couple of months, which should further reduce your leverage ratio. So just curious as you look at the M&A environment today how does that look.

And are there any markets or even within a specific market you operate in today are there any ones that you're targeting or thinking about as far as taking some share perhaps through acquisition? Thank you..

We were – thank you. We were really very, very pleased with the transaction that we did with CalAtlantic, we both were buyers of the Mattamy assets in Minneapolis and that is – is they were electing to exit the market. We acquired just a little less than half of what they had.

And that has proved to really jumpstart what was already a growing new division for us. Now it's growing at even faster rates. We were very pleased with that. And certainly were - felt good that we could take advantage of that. We like the markets we're in, but we're also continuing to look at additional markets and we have the ability to manage it.

We've got the capital to be able to afford that. And while there's nothing to report other than we continue to look at additional markets and you know, it's possible that we would open in a new market within the next six to nine months. It's equally possible we might not.

We’re looking for the right deal, the right, you know, the right market conditions and that's about all I can say about that..

Thank you, Bob.

Do you have any thoughts just in general on what you're seeing as far as activity from people that might be interested in selling? Has that changed materially in recent months? I am sure you guys see a lot of books thrown your way, but just curious if the expectations have become more aligned with reality or are you still seeing a decent bid/ask spread right now?.

Look, Kevin can address that. I mean, you've probably seen the books too. You know, there's a little bookshelf of books out there right now.

Kevin, did you want to comment on that?.

Yeah, I would say there's really been a lot of change in terms of the year flow. Though as we talk to – right, if you look at different markets on around us as well, looking at buildings that are now offered for sale through the bankers. So I would say it’s been fairly steady. So this industry never can change..

Okay. I appreciate the color. Thanks, guys. Good luck..

[Operator Instructions] Your next question comes from the line of Jay McCanless with Wedbush..

Hi. Good afternoon, everyone. First question I had was on the monthly sales piece and now it seemed like it was pretty anaemic the first few months of the quarter and then really picked up in June.

Could you talk to what was behind that?.

Hey, Jay. Well, anaemic is kind of a bad word. I mean, if you look at the last seven quarters we've had double-digit sales improvement. So we're very pleased with that. The first quarter was probably a little stronger than we thought. Our traffic numbers were not up very much. So they were down a little bit in April and May.

We did not do any anything significantly different in June to generate more sales. But you know, as Bob said, you know, our comparables, we were up 23% last year in the second quarter. When you look at the comparables on a go forward basis you know, the third quarter last year was up 10%, the fourth quarter last year a similar number.

So we don't face quite those headwinds. Also we did open a lot of communities and a fair number of those communities did not get opened until right at the end. So you know, overall we were still pretty pleased with it. We continue to sell about 45% inventory homes and our margins were we felt pretty good. So overall we thought it was pretty good.

It’s hard every quarter to be exactly what you wanted, we feel pretty good about our first 6 month sales..

Jay, its Bob Schottenstein. The other thing I'd add, I didn't mention this when I talked about our markets. Obviously, Charlotte and Raleigh are among our best markets and we're very pleased with the strength of our operations there.

But I think we did feel some effects particularly in Charlotte of selling out of a number of communities earlier than we had expected in the first quarter. So sometimes there's a little bit of noise quarter-to-quarter and things like that happening.

Sometimes that's offset by new community openings that come earlier than expected and take off like a rocket. But anyway, I think that look our sales are up 7% year-over-year. We had strong sales comps last year. I think you know when the year is over our sales will look pretty good..

And also you know, community count, look at the community count at the middle of the year June 17 compared to June 15, our community counts are up a little over 20%. So we feel like we're growing at a pretty good pace trying to grow at a manageable control pace, but overall we feel pretty good about things..

It's good to hear. Thank you. The second question I had was on inventory homes, and it seems like the growth in both finished and then total inventory homes is running faster than where the community growth is.

Are you guys favouring inventory homes a little bit more just to help keep subs on the job side or what's the thinking there?.

That maybe a little bit of it, as far as they help from a production level or even flow. But if you look at the finished specs, you know, they continue to be about 2 per community, which we think is a very, very good manageable pace. Also we are producing a fair amount of new product, not just Smart Series.

Oftentimes when you start out with new products, if you want to hold [ph] more on the ground and also as you do, with attached town homes and those type things you know, we tend to start buildings here and there after we sell a house or two. But overall Jay, it’s a lot higher, but we do feel really good about where it is.

I feel like we're positioned pretty good for sales and closings for the rest of the year..

Okay, good. And then Bob, on your commentary about Texas, I believe you said there was mixed demand among those markets.

Could you break it down maybe Houston versus some of the other markets there?.

Only to say things Jay, only to say that by the way if you were here, you would see we're not anaemic. But I would simply say on that - the second question.

I think that our first position you know, we're still a relatively new builder in all four of the markets and our position in Houston and particularly we’re tilted towards the upper end by design when we opened up. And as a consequence, as that part of the market has been hit the hardest.

I mean, the ones - the one consistency you've seen in commentary from almost any public builder that operates in the Houston market is where their strength has been, say sub 350 and with most of our positions above 350, you know, yeah we would like to flip a switch and turn it around overnight and that takes time.

We're working through it, while we're working through it, you know, our income jumps 27% for the quarter. So this is a good time to be working through and it’s at companywide 27%.

I think that we're really optimistic about our future in Texas all the way across the board, as we continue to mature, get better and better operating teams on the ground, get a little bit more of a footing and not be a 1, 2, 3, 4 year old builder there and they are very competitive markets and we're confident about our ability to compete with each passing quarter more so.

So Houston probably, the most sluggish because of our positioning, but you know we're doing some things with product in all four markets frankly, including we will be introducing our Smartest Series in a number of year [ph] beginning either late next year or early late this year or early next. And we're really excited about that..

Okay. Good to hear. Thank you. I pressed you on the last quarter and I'm pressing again, where do you want that Smart Series to go in terms of total community count on a percentage basis. And I mean, how long….

Look, that's really hard to know….

You wanted to go….

Yeah, that’s really hard to know. It’s driven a lot by demand and what land we can find.

But I would say this, if we had you, know 200 communities just to use that is a round number, at some point a year from now or maybe more than that, you know, maybe at this point because it's so new to our business 5%, 6%, 7%, 8% but looking out two or three years, no one knows quite what's going to happen.

I think it could grow through as much as 10%..

Okay. That’s great. Thanks for taking my question..

But just 10% of communities doesn't necessarily equate to 10% of sales because frankly we expect to get greater absorption per smart community at a lower price point..

Got it. Thank you..

Thanks, Jay..

[Operator Instructions] Our next question comes from Alex Barron with Housing Research Center.

Yes. Thanks, guys. I was hoping you could comment on your tax rate.

What drove the slightly lower tax rate and what to expect going forward?.

Well, as far as just going forward our comment was that we estimate our annual rate for the full year to be 36%. I think we were lower this quarter, primarily mainly to some stock option exercises. But GAAP rules changed in 2017 and excess tax benefits go through the tax expense line where they used to go directly at equity.

So that drives our second quarter rate down to 33% Alex..

So the base rate is 37% but it could be affected by that issue?.

Sorry.

What did you say?.

Base rate is 37% but only 36% - but it could be affected by that issue if you exercise options in the future?.

Yes..

Okay. And my second question was, I wasn't sure if you commented or maybe I missed it.

On the orders in the mid-Atlantic region, why were they down was that just the community count issue?.

Couple of comments we made about, one, dealing with difficult comps, particularly in that region. But the other thing is in Charlotte in particular we did sell out to some communities in the early part of the year faster than expected.

And the other thing is our – there is only three markets and when one of them has particularly sluggish demand and we're reducing our investment level there that's DC, the percentage impact can be more noticeable..

Got it. Okay. Well, best of luck for the rest of year. Thanks..

Thanks. Thanks, Alex..

[Operator Instructions] At this time there are no additional questions in the queue..

Thank you very much for joining us..

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