M/I Homes, Inc.
Q3 2008 Earnings Call Transcript

Published: 31 Oct 2008

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to the M/I Home’s third 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. (Operator Instructions) It would now like to turn the conference over to Phil Creek. You may begin your conference.

[Phil Creek:]

Thank you very much. Joining me on the call today is Bob Schottenstein, our CEO and President; Paul Rosen, the President of our Mortgage Company; and Ann Marie Hunker, our Corporate Controller. First to address regulation per 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. As to forward-looking statements, before we began I would like 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. The audio of which will be available on our website through October 2009. With that I will now turn the call over to Bob.

[Bob Schottenstein:]

Thank you, Phil and good afternoon. We are undoubtedly facing, what may well be the most difficult time in the history to homebuilding industry. After experiencing difficult conditions throughout most of 2006, all of 2007 and the first half of 2008, market conditions for housing in the overall economy for that matter deteriorated even further in the third quarter. Demand remains weak, inventory levels are too high in most markets, consumers confidence is at or near an historical low, unemployment is on the rise and if all that weren’t enough, mortgage lending standards have tightened and the recent unprecedented turmoil in the financial markets have further contributed to very tough conditions for home builders. No one knows how long these conditions will last or whether we have hit the bottom. What we do know is this; in this increasingly uncertain and challenging environment it is absolutely essential that we focus on what we can control and that we continue to execute on the predominantly defensive operating strategy that we first began to deploy over two years ago. That strategy which is squarely aimed at strengthening our balance sheet, reducing our debt and inventory levels, generating cash and optimizing the overhead structure of our operations has served us well. As we have may considerable progress on a number of important fronts. One, debt reduction

[Phil Creek:]

Thanks Bob. New contracts for the quarter decreased 16% to $456. Our cancellation rate in the third quarter was 32% up from 22% last quarter, but down from the 37% in 2007’s third quarter. Our traffic for the quarter decreased 27%. Our sales were down 10% in July, while traffic was down 37%. Sales were up 12% in August, while traffic was down 21% and our sales were down 38% in September while traffic was down 22%. Overall gross new contracts were down 23% for the quarter. Our active communities decreased 13% from our prior year third quarter of 159 to 138, at 9/30/08. The breakdown by a region is 80 in the Midwest, 26 in Florida and 32 in the Mid-Atlantic. Homes delivered in the third quarter were 555, down 27% compared to last year’s 765 and we delivered 63% of our backlog this quarter compared to 47% in ’07. Revenue in the third quarter declined 31% when compared to last year, primarily due to a 27% decline in homes delivered and an average sale price decrease of 6% to $273,000. Third-party land sales were $6 million for the quarter with sales in our Midwest and Florida markets. The company’s results for the ’08 third quarter include pretax charges of $43.5 million in impairments consisting of $27.8 million related to land that we intent to build homes on and the $27.8 million breakdown is $15.9 million in the Midwest, $1.7 million in Florida and $10.2 million in the Mid-Atlantic. We also wrote-off $356,000 of deposits and pre-acquisition costs for land and lot deals we no longer intent to pursue. We also had $11.6 million related to land that we sold or intend to sell and the breakdown of 11.6, is 4.2 in the Midwest, 7.1 in Florida and 310,000 in the Mid-Atlantic, and last we had $3.7 million related to our investment in JVs and the breakdown with the 3.7 was 1.2 in the Midwest and 2.5 in Florida. This quarter right now impacted approximately 3200 lots in 45 communities with nearly 50% of our impairments in the Midwest. In 2008 third quarter we reduced our owned Midwest lots by 10% and for the nine months ended 09/30/08 total charges were $105.7 million representing $104.1 million for impairments and $1.6 million for the write-off of deposits and pre-acquisition costs. Over the last nine quarters we have incurred pretax charges totaling $383 million of impairments and currently have 46% of our total owned lots impaired. With respect to impairments taken to-date approximately $8 million reversed into housing gross margins in the third quarter of ’08 and at September 30, ‘08 of our 138 current active communities we have impaired 71% or 51% of our active communities. We continue to evaluate our assets each quarter. As applied to the standards of FAS 144, it is possible depending our market conditions that we will incur additional impairment charges in the future. Our gross margin exclusive of the impact of the aforementioned inventory and investment impairment charges were 11.8% for the quarter and 13.6% for the first nine months of this year. G&A cost in ’08 third quarter decreased $6.5 million compared to the prior year, we had about $800,000 of severance and abandonment charges for the quarter and year-to-date, G&A cost decreased $18.4 million compared to the prior year. Selling expenses for the quarter and nine months ended September 30, ‘08 decreased $5 million and $14.1 million. Overall our third quarter SG&A expense decreased $11.4 million. We continue to work on reducing these expenses and we have already had additional workforce reductions this quarter. We currently employ about 590 people, which is down about 35% from a year ago. Interest expense decreased $2.5 million for the third quarter and $2.7 million for the first nine months of ’08 compared to the prior year. The decrease in the third quarter was primarily due to a decline of $4.5 million on interest incurred to $4.2 million that was primarily due to a reduction in our weighted average borrowings from $479 million last year to $242 million this year. Our quarterly weighted average borrowing rate was 7.7% compared to 8.1% a year ago. We have $27.2 million in capitalized interest on our balance sheet at September 30, ‘08 compared to $33 million a year ago, which represents about 3% of our total assets. We continue our policy of expensing interest when land is raw and when lots are developed. We capitalize interest when land is under development and when homes are under construction. We recorded non-cash after tax charge of $21.6 million for the third quarter and $79.6 million for the first nine months of ’08 respectively for evaluation allowance related to our deferred tax assets as required by FAS 109. At 09/30/08 we do not have any net deferred tax asset remaining on our balance sheet and we do not expect to record any additional tax benefits for the reminder of the year. As Bob stated, we do have a $39 million tax receivable on our books. We expect to receive that cash refund in the first quarter of ’09 as a result of carrying back ’08 taxable losses to the ’06 tax year. Now, Paul Rosen will cover our mortgage company results.

[Paul Rosen:]

Thank you Phil. Mortgage and title operations, pretax income decreased from $2 million in ’07 third quarter to 618,000 in the same period of 2008. The change is partly a result of a 20% decrease in loans originated from $549 in 2007 to $439 in 2008. Additionally, enhanced financing is being offered to M/I Home’s customers to help generate sales, lowering our overall margins. Loan-to-value on our first mortgages for the third quarter with 89% in 2008 compared to 85% in 2007’s third quarter. For the quarter, 47% of our loans were conventional with 53% being FHAVA. This compares to 90% and 10% respectively for 2007 same period. Approximately 80% of our communities are now eligible for FHA financing. The percentage of closings in the third quarter, where customers received down-payment assistance was 32% versus 7% for the same period in 2007. Overall, our average total mortgage amount was $245,000 in 2008 third quarter. The average borrower credit score on mortgages originated by M/I Financial was $718,000 in the third quarter of 2007 compared to $716,000 in 2008 second quarter. This of course compared to $726 in 2007 third quarter and $714 in 2007 second quarter. We sell our mortgages along with their servicing rights to a number of secondary market investors. Our main investors in the third quarter were CitiMortgage, Wells Fargo, Chase and Countrywide. We have not repurchased any mortgages this year. Our mortgage operation captured about 84% of our business in the third quarter, compared to 2007’s 77%. I’ll now turn the call back over to Phil.

[Phil Creek:]

Thanks, Paul. Now as far as our balance sheet, as Bob stated we continue to focus on our cash to generate and our liquidity. Total home building inventories at 09/30/08 decreased $401 million or 39% below a year ago. Total building sites owned and controlled as of 09/30/08 decreased 40% from a year-over-year. We now own 9,530 lots, which includes our share of joint ventures and have an additional 1,626 lots controlled and for the nine months ended 09/30/08, we reduced our building sites owned and controlled by about 5,000 lots. With respect to our lots under contract, we have approximately $5 million at risk in deposits LCs and pre-acquire cost at 09/30/08. Our wholly owned unsold land investment at 09/30/08 is $350 million, 8,250 lots and that compares to $614 million or 15,030 lots a year ago. Compared to a year ago, raw land has decreased 59%, land under development decreased 24% and finished unsold lots decreased 41%. At 09/30/08 we had $69 million of raw land, $75 million of land under development and $206 million of finished unsold lots and the $206 million of finished unsold lots is a little over 4,000 lots. We’re constantly focused on getting our finished lots through our systems to generate cash flow. The market breakdown of our $350 million of unsold land is $156 million in the Midwest, $67 million in Florida and $127 million in the Mid-Atlantic region. In the third quarter we only purchased $3 million of land, we are selling lots of land opportunities, but are being very careful as to purchase. Our current estimate for ’08 land acquisition is approximately $30 million and as to land development expenses, we currently estimate we will spend about $40 million developing land this year. As of 09/30/08, we had $23 million invested in join ventures down 46% from last years $43 million. Approximately $11 million of our current investment represent joint ventures in our four region. These joint ventures are for land acquisition and development purposes only and are all with homebuilding partners. In the third quarter of ’08, we wrote-off our remaining $2.5 million investment in one of our joint ventures in Florida with outside financing. We have one remaining joint venture with third-party financing. In that JV we are 50/50 partners with a large public builder that as a loan, with a loan-to-value maintenance ratio and in that remaining JV debenture had debt of $12 million in partners equity of $14 million. At the end of the quarter, we had $82 million invested in specs, 190 of which were completed and 289 specs in various states of constructions were total of 479 specs. This translates into about 3 specs per community and that will be 479 specs, 240 are in the Midwest, 129 are in Florida and 110 are in the Mid-Atlantic and at June 30, ‘08 we had $580 specs with an investment of $93 million. Our unsecured $250 million homebuilding credit facility which matures in October 2010, has excess borrowing base capacity at 09/30/08 of $142 million. At 09/30/08 we had no borrowing on this facility; we do have $35 million of letters of credit outstanding. Our most restricted bank covenant is minimum net worth; our current minimum net worth cushion is about $70 million. During the quarter we generated $17 million of cash from operations. This was aided by our spec inventory reduction of $11 million and proceeds from land sales of about $6 million. It was our eighth straight quarter of positive operating cash flow. In the third quarter of ’08, we did not pay any cash dividends and only we repurchased any stock. We are currently restricted from paying any dividends or repurchasing any stock due to restrictive payments basket covenant and our senior note agreement, and at 09/30 this basked had a negative 70 million. We continually focus on our liquidity and capital needs. In summary we continue to see very challenging market conditions and continue to focus on reducing inventory expand debt levels and generating cash. This completes our formal presentation. We will now open the call for any question or comments.

[Operator:]

(Operator Instructions) Your first question comes from Ivy Zelman - Zelman & Associates.

[Ivy Zelman:]

I think that one of the biggest concerns as it relates to builders right now is understanding the cash flow needs and cash generation in 2009 and realizing you’ve got a lot of finished lots which means you don’t have to develop a lot, that’s good. I don’t if you said this Phil and I apologize if you did, but can you give us your expectation for land spend in 2009 both for option takedown as well as land development. Then to follow on that to talk a little bit about, what your expectations for cash flow would be even if orders where to continue to weaken, can you in fact generate even in this declining market environment given you’re selling a lot of spec possibly as well as other land sales you can generate?

[Phil Creek:]

Those are really good questions and things that we focus on constantly. We do a lot of different financial scenarios and projections putting those type of projections out publicly in today’s world is pretty difficult. We obviously want to continue generating positive cash every quarter and we are really focused on that. You are exactly right; we do have fair values on lots that we want to push through our pipeline. We also have been managing our spec levels a little tighter and we push those down, some during the third quarter. We do have the cash tax refund coming in next year. As far as land spend on the new land and also land development, we talk this year about spending, 30 on land and 40 on development. It’s hard to project those numbers. We are trying very hard to continue generating cash every quarter. As I said before we only spent $3 million on land in the third quarter. We are seeing a lot of opportunities, we are being very, very careful, but its just hard to project those numbers.

[Bob Schottenstein:]

And the only other I’d say, while on the work end we’re pleased to state that our SG&A was down 30% from a year ago, it’s still too high and we are in the process of further of taking further steps to hopefully achieve some meaningful reduction in our expense levels as we begin next year.

[Phil Creek:]

We’re trying to minimize our operating losses as much as we can, but those are just difficult numbers to project.

[Ivy Zelman:]

Phil, if you look at your absorptions, they are only down 6% in the quarter and clearly you said that Midwest and Columbus you actually had positive orders. Do you think that the Midwest is likely to require less incentives going forward? I mean you’re doing better than the rest of the country?

[Bob Schottenstein:]

Well, I don’t know I mean I guess there is a sense that the markets have been so sluggish, at least what we primarily operated in. Chicago is new and it’s a very small and we ended very cautiously there, but Columbus, Cincinnati, Indianapolis have been under serge frankly since ’05. They first begin to slow towards the end of ’04. They have not gotten any better. I’m not sure they really deteriorated much further either or their permanent levels were down, there is less competition, builders are pulled out of the market, we feel that we are gaining market share clearly in Columbus we are and we’re probably gaining market share ever since slowly in Cincinnati as well. I’d like to think that we’re sort of incentives out in those markets, who knows.

[Phil Creek:]

I mean at one time we owned 20,000 lots and now we’re down to 9500. We really would like to drive those owned lots down to two or three years supply and at current run rates that would be a 4000, 5000, 6000 lots supply and one of the reason that we had a fair amount of impairments in the Midwest in the third quarter is again we’re being a little more aggressive there trying to drive through some of this land, especially the finished lots. Also some of our land sales or we’re in the Midwest in the third quarter. So we’re trying to balance everything of, but most importantly trying to make sure we generate cash and stay liquid and those type of things.

[Ivy Zelman:]

In terms of the impairments you took in the Midwest and if you did this again, I apologize, but can you break out the land in part impairments by market and JV impairments and then looking at your change in price, your closing price down 8%. One other things that we’re looking at is near sticks and bricks, excluding land, are you finding that you’re at a point right now where there is some markets where it doesn’t make sense to move forward because the economics are not there and maybe there is competition from foreclosures, where they are competing below replacement cost, maybe you could elaborate on if you are seeing any challenges in that arena after the impairments please?

[Phil Creek:]

When you look at what we did in the third quarter, the impairments were about $44 million and out of that $44 million about $28 million of it was on land we intent to build homes on and when you break that down about half of that was in the Midwest. Then when you start looking at the land piece, the land piece was about $12 million and that was either on land we’ve sold or intent to sell and when you break that $12 million down there was about $4 million in Midwest, about $7 million in Florida and a little bit in the Mid-Atlantic. So, again overall about half of our impairments in the third quarter were in the Midwest, but just in the third quarter we drove our own Midwest lots down by 10%.

[Ivy Zelman:]

What about the JVs?

[Phil Creek:]

JVs we actually impaired down $3.7 million and of the $3.7 million the biggest part was Florida in the one JV they had outside financing on it that was $2.5 million and the other $1.2 million within the Midwest.

[Bob Schottenstein:]

We’ve been asking that especially to the foreclosure question, we’ve been asking that same question of our managers. Just to provide its worth, I drove 14 communities yesterday of our communities in Columbus and probably another half a dozen of our competitors communities and quite honestly in those communities to the extent she could tell did not see much evidence and any negative impact from foreclosures directly on those communities. Now, clearly it’s a cloud over the industry, clearly it’s going to effect in some respect appraisals in certain levels, if the house is foreclosed and you were trying to sell a new house and the foreclosed house is within the relevant submarket. I’m sure its going to have an impact on appraisals and so forth. It’s very, very difficult to know exactly what the direct impact of that is. I know it’s out there, but we don’t seem to seeing it as something that’s hurting our sales day today, at least at this point.

[Ivy Zelman:]

Within Columbus?

[Bob Schottenstein:]

Frankly any of our cities; I mean we’ve asked that question and we are trying to get our arms around it right now. Its out there, there is no question. I’m not saying it doesn’t exist and I know that there was an impact from, as I said in terms of the appraisals lines and so forth, but we don’t seem to be fighting at in our community is tending large extent. However, you would be closer to it than my financial.

[Phil Creek:]

I guess the one other item, this is the foreclosure that depends on a new construction site to be very, very concentrated and maybe you were hurt very badly by them or you were not and so when it’s going through our subdivisions, we don’t seem to have any concentration of foreclosures. They certainly don’t have a significant impact on our appraisals yet, but we will continue to look at it.

[Bob Schottenstein:]

The new home communities that seem to be really played by heavy foreclosures tended to cater to the low end of the low end and I’m not saying this is the only once, I mean there is examples of foreclosures even the custom home area out there, but the preponderance to foreclosures appear to be at the very low end of the volume spectrum and that’s not ever been our business.

[Phil Creek:]

Because, if you look overall at 09/30 around figures are at resale price and backlog in the Midwest is to 250, in Florida its 300. The biggest reduction we’ve had in sales prices have been at the Mid-Atlanta, today we’re like a little over 300, but a year ago in the Mid-Atlantic, we were at little lower 400. A lot of that’s been driven by DC. So, it really our subdivision price point location business, I mean it’s definitely out there, but it’s just very, very hard to get a gauge on, but we’re definitely looking forward very carefully.

[Operator:]

Your next question comes from Alex Barron - Agency Trading Group.

[Alex Barron:]

Wanted to ask you, Phil if have like the benefit of prior impairments on your gross margin this quarter?

[Phil Creek:]

The number we gave out Alex was $8 million for our housing gross margins.

[Alex Barron:]

Okay. The other questions I wanted to ask you was, as it pertains to your cash flow. Do you have some kind of ballpark number of how much cash you guys are generating for Home at this stage?

[Phil Creek:]

No, that’s kind of hard to comment, obviously it differs. We’re trying to drives at most of our businesses over those 4,000 finished lots, because we spent all those dollars but right now depending on the community, a third to half of our business right now also tends to be counted from specs. So, that’s the hard question to answer. When you’re looking again at the $17 million generated in the third quarter, we did get $6 million from land sales. We’ve had land sales of $30 million so far this year, and then we did drive the spec levels down about 11, but we’re trying to drive down our community count, as Bob said. So, we get down to the last 5 or 10 communities in the subdivision; sometime we’ll spec those out a little more aggressive, but we can’t make any kind of decent deal to sell the lots, but you have to look at each one a little bit different, but we’re definitely trying to focus on those 400,000 finished lots and one time we had almost 6000.

[Alex Barron:]

I mean when you say focus, is there a chance you guys might repeat like a bulk sale this year to take advantage of ‘06 factors?

[Phil Creek:]

We already have the bucket full as far as ’06 taxes Alex, getting that $40 million we already got that bucket full.

[Bob Schottenstein:]

Alex we could repeat that right now, I don’t believe. My guess is and I’d say this just to be perfectly blunt. If went back, there was 14 different transactions that closed during the fourth quarter of last year that made up than nearly 4000 lots. My guess is if we went back to all 14 buyers and say would you like to resell, they would say yes. I think that on average we generated in terms of before any tax credits $0.40 on the dollar, you wouldn’t get that today. Now, we didn’t know that things would deteriorate so much further; we did it because we did we felt it was there and lets do it lets move forward. I don’t the opportunities are there to do that now. The remaining opportunities we have to sell land are sort of on a much more isolated and a less meaningful basis.

[Phil Creek:]

I mean we are trying to generate a certain amount of land sales every quarter for different reasons; we’re trying to reduce our lot count, we’re trying to generate cash and again we have sold $30 million this year, but we’re trying to also make sure that when we come through this, we also as much as possible have good locations and good price points. It’s just hard and we’ve also done almost all of our deals cash and carry, but there hasn’t been any type of hooks on the backend to us whatsoever, because we have too much land, but it is just kind of harder and harder. Same thing we see really above $3 million in land because we think that it’s still early to be buying significant amount for land.

[Alex Barron:]

Well, I guess the [hind side] build was a really good move so that was a good thing. As it pertains to down payment assistance I know you guys gave the number. I am just kind of curious, what impact you’ve seen in the month of October and is there anything you guys are doing trying to do to kind of replace maybe the buyers that some other incentive to get those buyers maybe aren’t able to BPA anymore?

[Phil Creek:]

Interestingly enough, we have come back with a work equity program, which was really the grandfather of down-payment assistance, but in reality we see a lot of the customers that are in the market today are working very hard to come up with a down-payment and I don’t know that we can really point to anything at this point to say we are not selling as many houses because of down-payment assistance.

[Bob Schottenstein:]

Long-term the best thing that could happen to our industry -- I mean this is not going to win any popularity contest, at least within the homebuilding industry, but long-term the best thing that could happen is for down-payment assistance never to comeback, unless it’s a buyer that elects by his/her own choice to finance a 100%, because they have clear credit and where we’re going to do so. It was never a great thing, never a big part of our business and I think that long-term it’s not something that served the industry well and I see that now with hind site, but also I believe it.

[Alex Barron:]

Yes, now I would agree with you, but not sure the NAHB would degree, but one last question if I could. I know you said you’ve already obviously cut pretty hard on the SG&A front, but if volumes head a little bit lower into ’09, is there are more room to cut on the corporate side, in other words the fixed portion of cost?

[Phil Creek:]

Alex there is definitely room and we’re working on that everyday and we do different scenarios as far as what we think our sales and closing volume will be next year. So, we are continuing to cut cost; unfortunately including headcount. The issue also as you know is what happens to average sale price and what happens to gross margin? So, we’re trying to work very hard on all those things.

[Bob Schottenstein:]

I suspect that you will see SG&A further reduction as we work into the first quarter of next year.

[Operator:]

Your final question comes from Ivy Zelman - Zelman & Associates.

[Ivy Zelman:]

I just want to go back because Bob, it’s a little confusing to me on the 3.5% down payment that was 3% that was eliminated for down payment system because in essence isn’t that what you’re proposing as part of the builders plan; is to basically gets down payment again and then use the mortgage rate buy down? So I guess, one of my confusions on this plan is why is it any different than DPA. In fact it is DPA, but now you’re putting a mortgage rate buy down with it?

[Bob Schottenstein:]

Because we’re in a crisis and we’ve got to stop falling prices.

[Ivy Zelman:]

But isn’t a risk if a lot of those peoples say “buy a Home until the fall.”

[Bob Schottenstein:]

You know what, they’re going to have to meet the new underwriting and if they meet the new underwriting standards and it begins to stand the tide time and bring buyers back in. If one thing, if markets were more normal right now and the elimination of the down payment assistants could sort of quietly go away and just shut the door, but I think that we have an extreme situation right now. I’m talking those sides, but I think that we have an usually severe situation right now and I think, if we’re fortunate enough to see a housing package that provides you tax credit, I think it should be for a very short period of time whether it’s three months, four months, six months, nine months certainly no more than that; enough to help us store some essence of demand and start to stop the falling prices. Until prices quit falling, I don’t think we’ve solved the problem.

[Operator:]

Your next question comes from Jennifer Morrison - Principal Global Investors.

[Jennifer Morrison:]

What did you say the tax refund would be that you have coming in next year?

[Bob Schottenstein:]

Nearly $40 million.

[Jennifer Morrison:]

Would you expect that in the first quarter or you’re not release timing that?

[Bob Schottenstein:]

It could be up to when the government writes the check.

[Phil Creek:]

But we hope to get it in February or March, yes.

[Operator:]

At this time, there are no further questions.

[Phil Creek:]

With that we appreciate that you joining us and look forward to talking to you at the end of the year. Thank you.

[Operator:]

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