M/I Homes, Inc. (MHO) Q2 2023 Earnings Call Transcript

Good morning, everyone, and welcome to the M/I Homes, Inc. Second Quarter Earnings Webcast Conference Call. I will now hand the call over to Phil Creek. Please proceed.

Thank you for joining us today. On the call is Bob Schottenstein, our CEO and President; and Derek Klutch, President of our Mortgage Company. 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. I'll now turn the call over to Bob.

Thanks, Phil. Good morning, everyone, and thank you for joining us today. We had a very strong second quarter. Despite higher interest rates and uncertain economic conditions, we are very pleased with our new contracts, homes delivered, margins, and income. We ended the quarter with our balance sheet in excellent shape. In terms of our new contracts, we sold 2,197 homes during the quarter, 21% better than 1,820 homes that we sold during the second quarter of 2022. The Smart Series, which is our most affordable line of homes, continues to be an important contributor to our sales performance. During the quarter, our Smart Series sales comprised about 55% of total company sales, roughly the same percentage as a year ago. We were operating in 15% more communities on average than we were a year ago. Our sales pace equaled 3.7 homes sold per community per month. We are on track to open a number of new communities this year, expecting to increase our community count for 2023 by approximately 15%, compared to the 196 communities we had opened at the end of 2022. We closed 1,990 homes in the quarter and continue to improve our construction cycle time throughout all of our divisions. Gross margins for the quarter were very solid at 26%, considerably better than expected going into this year. Our pretax income for the quarter was $155 million, down from last year’s record level, but we are still very pleased to produce pretax results of 15.3% of revenue. Now I will provide some additional comments on our markets. Our division income contributions in the second quarter were led by Dallas, Tampa, Columbus, Sarasota, Raleigh, and Orlando. New contracts for the second quarter in the Northern region increased by 31%. New contracts in our Southern region increased by 14%. Our deliveries in the Southern region increased by 7% from last year, while our deliveries in the Northern region decreased by 22% from last year. 61% of our deliveries came from the Southern region and 39% from the Northern region. Our owned and controlled lot position in the Southern region decreased by 18% compared to last year and decreased by 4% from last year in the Northern region. 36% of our owned and controlled lots are in the Northern region while the other 64% are in our Southern region. We have a very strong land position. Company-wide, we own approximately 23,000 single-family lots, which is roughly a three-year supply. Regarding our balance sheet, we ended the second quarter of 2023 with an all-time record of $2.3 billion in equity, which equates to a book value per share of $83. We ended the quarter with a cash balance of nearly $670 million and zero borrowings under our $650 million unsecured revolving credit facility. This resulted in a debt-to-capital ratio of 23%, down from 28% a year ago, and a net debt-to-capital ratio of just 1%. As I conclude, let me just state that we are in the best financial shape in our company's history. I feel very good about our business and we are well positioned to have another year of very strong results. With that, I'll turn it over to Phil.

Thanks, Bob. Our new contracts were up 6% in April, up 21% in May, and up 46% in June, and our cancellation rate for the second quarter was 10%. 58% of our second quarter sales were to first-time buyers and 55% were inventory homes. Our community count was 195 at the end of the second quarter compared to 168 a year ago. The breakdown by region is 100 in the Northern region and 95 in the Southern region. During the quarter, we opened 15 new communities while closing 20. We currently estimate ending 2023 with about 225 communities. We delivered 1,990 homes in the second quarter, delivering 60% of our backlog. As of June 30th, we had 4,500 homes in the field versus 6,300 homes in the field a year ago. We started 2,400 homes in the second quarter and 1,600 homes in the first quarter. Revenue decreased by 3% in the second quarter, and our average closing price for the second quarter was a record $493,000, which was a 3% increase compared to last year's closing price of $477,000. Backlog average sale price is $507,000, down from $519,000 a year ago. Our second quarter gross margin was 25.5%, down 180 basis points year-over-year and up 200 basis points from our first quarter. Our construction costs were flat in the second quarter compared to the first quarter, and we are starting to see some improvement in our building cycle time. Our second quarter SG&A expenses were 10.6% of revenue compared to 9.7% a year ago. Our second quarter SG&A expenses increased 6% versus a year ago, due primarily to higher third-party broker costs and expenses related to our higher community count. Interest income for the quarter was $4.7 million, and our interest incurred was $9.4 million. We are pleased with our returns for the second quarter. Our pretax income was 15%, and our return on equity was 23%. During the quarter, we generated $164 million of EBITDA compared to $195 million last year, and our effective tax rate was 24% in the second quarter compared to 25% a year ago. Our earnings per diluted share for the quarter decreased to $4.12 per share from $4.79 last year, and our book value per share is now $83, a $17 per share increase from a year ago. Now Derek Klutch will address our Mortgage Company results.

Thanks, Phil. Our mortgage and title operations achieved pretax income of $11.2 million, a 29% increase from $8.7 million in 2022's second quarter. Revenue increased 30% from last year to $25.3 million due to higher margins on loans sold and an increase in the average loan amount. The average loan-to-value on our first mortgages for the second quarter was 84%, which was slightly higher than last year. 71% of the loans closed in the quarter were conventional and 29% were FHA or VA compared to 80% and 20%, respectively, for 2022's second quarter. Our average mortgage amount increased to $402,000 in 2023's second quarter compared to $384,000 last year. Loans originated decreased to 1,281, which was down 5% from last year, while the volume of loans sold increased by 4%. Our borrower profile remains solid with an average down payment of over 16% and an average credit score of 743 compared to 748 in 2022's second quarter. Our mortgage operation captured 81% of our business in the second quarter compared to 77% last year. We maintain warehouse facilities that provide us with funding for our mortgage originations. As of June 30th, we had $186 million outstanding under these facilities. Now I'll turn the call back over to Phil.

Thanks, Derek. As for the balance sheet, we ended the second quarter with a cash balance of $668 million and no borrowings under our unsecured revolving credit facility. We have one of the lowest debt levels among public homebuilders and are positioned well with our maturities. Our bank line matures in late 2026 and our public debt matures in 2028 and 2030, and has interest rates below 5%. Our unsold land investment at June 30th is $1.3 billion compared to $1.1 billion a year ago. As of June 30th, we had $673 million of raw land and land under development and $587 million of finished unsold lots. During the second quarter, we spent $96 million on land purchases and $109 million on land development for a total of $205 million. As of June 30th, we owned 23,000 lots and controlled 41,000 lots. At the end of the quarter, we had 303 completed inventory homes and 1,737 total inventory homes. Of the total inventory homes, 827 are in the Northern region and 910 are in the Southern region. As of June 30th last year, we had 91 completed inventory homes and 1,732 total inventory homes. We spent $15 million in the second quarter repurchasing our stock and have $78 million remaining under our current Board authorization. Since the start of 2022, we have repurchased 8% of our outstanding shares. This completes our presentation. We will now open the call for any questions or comments.

Your first question will come from Alex Barron.

Yes. Thank you. And great job on the quarter, guys.

Thank you, Alex.

Glad to see the market is starting to reward you finally. I was hoping you could explain the improvement in the gross margin sequentially. What factors contributed to that? Was it due to raising prices or changes in lumber costs, or is there something else that explains the significant jump?

Yes. I'll start that, and maybe Phil will have some comments he'd like to add. Look, at the beginning of the year, I think the entire industry was quite concerned with rapidly rising rates and how much pricing leverage we might have. We had expected our margins to be somewhat lower than they obviously have turned out to be, despite the higher rates, and have been quite solid and remain so today throughout almost all of our markets. In fact, throughout all of our communities, we are currently limiting sales in about 15% of our communities, which is an indication of the demand in various places. I think our communities are exceptionally well located with a very strong product offering. The Smart Series is exceptional in terms of its appeal to first-time buyers, and I feel good about our move-up product as well as our attached townhomes. The combination of all those things, including the level of demand and the strength of our buyer profile, has given us the ability to maintain margins that are appropriate. As we've said over the years, we manage the company on a subdivision basis, and we have a number of communities throughout our company where our margins are considerably higher than the 26%, while also having some that are lower, on a subdivision-by-subdivision basis. No one knows what the future will bring, but I continue to have confidence that we'll maintain margins at a very acceptable level. Phil, do you want to add anything to that?

The only thing I would add, Bob, is we talked about opening 15 stores in the second quarter, and we had opened 19 in the first. So the 34 new stores we've opened this year are performing very well, even a little better than we thought they would. We also talked about costs being flat, so it's really about the product. As you said, every subdivision is a little different, and we continue to focus on sales pace.

Okay. Great. And then obviously, your cash balance is pretty significant compared to any time in your history. I was curious what you guys have that invested in? Because it looks like you generated almost $5 million of interest. And I'm assuming that's going to go higher unless you put the money to work. And if you are going to put the money to work, what's the most likely use? Is it to buy more land? Is it to just pay down debt at some point? Is it to buy back your stock? How are you guys thinking about uses of that cash?

I'll take the first part of that. Job one for us is to continue to grow our business. We think we have gained market share in nearly all of our markets over the last number of years, and we expect to continue growing market share. So job one for us would be to invest in our divisions, and that's how we'll likely be deploying most of the cash. Phil, do you want to comment on the rest of that?

Yes, I agree with that, Bob. We do expect to spend more money on land in the second half than we have in the first half. We did push back a number of land transactions in the second half of last year when the business slowed down. So we do expect land spend to accelerate. We feel very, very strong about our land position. As far as stock repurchase, we continue to look at that as the best use of our capital. As I mentioned, we did buy back $15 million of stock in the quarter, and in the last few quarters, we bought back 8% of the outstanding shares. So we will continue to balance all those things. We do not have any debt due as far as the public debt until 2028, and it's below 5%. So we'll still have some cash, and we'll continue to put that to the best use we can, Alex.

Your next question comes from Jesse Lederman at Zelman & Associates.

I remember last quarter you talked about your expectations for closings through the year, not to necessarily follow the typical sequential increase through the year. And your second quarter closings were roughly flat from the first quarter. Can you talk a little bit more about how you see that cadence trending through the balance of the year given the deviation or at least the stronger results in 2Q than at least we were expecting and maybe you were even expecting as well?

One thing I'd say that has helped our closings, is we've noted improvement in cycle time, and that varies by division. We have a number of divisions where we've improved our cycle time by more than 30 days year-over-year, while some have improved by 15 to 20 days. We expect to continue to improve cycle time and hopefully get it back to those pre-COVID levels seen in 2019 and before, which will certainly contribute to getting the homes in the field closed at a more rapid pace. Phil, do you want to add anything to that?

Yes. As we disclosed, Jesse, we do have fewer houses in the field at mid-year than a year ago. We did start a lot of houses in the second quarter, and we're pleased with that. Also, about 50% of our business is specs and some of those houses do sell and close in the quarter. We were pleasantly surprised, as we closed more houses in the first quarter than we thought we would, and we had a similar good experience in the second quarter, closing more houses than we thought. However, it is going to be a challenge for us to close as many houses in the second half as we did in the first half, but we're doing all we can.

That's helpful. And as you mentioned, on last quarter's call, your land spend nearly doubled sequentially, but it's still a little bit below the run rate over the last couple of years, and the percentage of communities that you're limiting sales inched a little higher to 15% of communities from 10% last quarter. What do you need to see for that percentage to trend lower here? And is there a risk that that moves meaningfully higher over the near term, at least until some of these recent deals end up being community openings?

Jesse, could you clarify the question? I'm not sure I completely understood it.

Yes. Just recognizing that the percentage of communities that you had to limit sales increased a little sequentially here. What do you need to see for that percentage of communities that you're limiting sales to trend lower here? And is there a risk that that percentage of communities will increase in the near term as you wait for these more recent land deals to filter through to community openings?

The reason that we're limiting sales where we are is simply to control the deliveries in a way that we think we can manage best. We don't want to get too far out over our skis, so to speak. In those communities where we are limiting sales, we're also getting very strong margins. The decision to limit sales has little to do with new communities coming on. Phil, I don't know if you want to add anything to that. I don't know if that answered your question.

Every community is different. It's a combination of the number of finished lots we have and the amount of time it takes to get houses built. When you quote a price to a customer today, you have to ensure you can build the houses on time and at the costs you have locked up. So it's somewhat good news when we're limited on sales, which can fluctuate each quarter based on market conditions in the local subdivisions. But projecting that number can be really tricky. However, I will note that the new stores we're opening, which are a big part of our business, are performing well.

Great. I appreciate it. And just one last question. On the cost side of the business, you've mentioned costs are stabilizing, they have been relatively flat the last few quarters, and you are seeing some cycle time improvements. But your ramp starts are pretty significant, and the industry broadly is also trying to increase their share of speculative starts. What are your expectations for costs, and even labor and material availability over the next couple of quarters? Do you expect to see any hiccups in the supply chain as the industry ramps their starts base? Or have you been relatively insulated from that due to your larger size?

Well, first of all, predicting the cost side is always tough. I feel really good about the supply chain issues throughout nearly all of our markets and with regard to almost every part of our business, except on the land development side, the time it takes to get all the approvals and entitlements to bring deals to market is still a concern for many builders, including us. We've had documented issues in certain markets with getting utilities in place, especially transformers. That continues to be somewhat of a challenge, but we feel that it's improving. I think we'll continue to see improvements in cycle time across all aspects of our business, and I do not foresee major cost increases in the near future. Phil, do you want to add anything?

The only thing I will add is that when we build houses and develop land, we build in a certain contingency for costs that could be between 2% and 5%. We remain hopeful about not facing anything significant for the rest of the year, but we'll continue to include those contingency amounts in our costs.

Your next question comes from Jay McCanless at Wedbush.

The first one I had, just wanted to get your take on this issue. We've heard from a couple of your competitors that they think gross margins, at least in the back half, may be a little bit softer just because they're finishing out the last of the closings for homes that they sold back in the fourth quarter of '22 when there was a lot of price competition. Just wondering how you're feeling about gross margins for the back half of the year? Any commentary you could provide around that?

Phil?

Jay, that's a hard estimate to give. As Bob said, our margins have been better in the first two quarters than we anticipated. When we look at what's in our backlog, our backlog margins are relatively flat. Again, we're selling about 50% specs. We plan on opening more stores in the second half than we did in the first. So, it's a challenging number to predict, but we still believe our margins will remain strong and respectable. We emphasize margin control since it’s crucial for us. We will continue striving to keep those margins as robust as possible even though it remains hard to pin down specific numbers.

Could you talk about pricing power or maybe how many communities on a percentage basis where you were able to raise prices or cut back on incentives this quarter?

Phil?

It's hard, Jay, to have that exact number since every subdivision is a little different. We focus more on helping people with their interest rates. Even though we have strong down payments, we are still in the payment business, and buying down rates a little is very effective for lowering payments. While rates have been somewhat sticky, they are still not that expensive to buy down, especially 30-60 days prior to closing. Generally speaking, incentives have decreased to some extent, but again, every community is different. However, I would say that incentives have lessened somewhat overall.

And just to add to that, as we are now in a seasonal period where activity traditionally declines, we haven't seen much of that. Although we're out of the spring selling season, the demand for the summer months has held up quite well. Additionally, there are no indicators suggesting that incentives will be increased.

You actually stole my next question, Bob, I was going to ask if there's any commentary you could offer up around July, which I'll see month to date.

Things are holding steady, Jay. You know as well as anyone, the inventory levels are at or near record lows. Somewhere between 50% and 75% of all the homeowners in this country are living in a home where their mortgage is perhaps below 1.5% or even lower than 4%, and the likelihood that those homes come to market anytime soon is not great. As a result, most buyers are purchasing new homes, and I believe this will continue for quite some time. This is a strong tailwind for our industry, which is why I think others are producing much stronger results than expected eight months ago.

Jay, we're really excited about the opportunity we have with all the stores that we are opening. We're focusing on sales pace, which matters tremendously. If you look at comparables last year, in the second quarter, we sold 1,800 homes. In the third quarter last year, we sold 1,300 homes. In the fourth quarter last year, we sold 1,000 homes. So our sales decreased significantly last year. We are trying to catch up regarding houses in the field. We started a significant number of houses in the second quarter. Bob discussed cycle time improvements. Our spec level is comparable to what it was a year ago, but we do have a few hundred more finished specs than we did a year ago. We're hoping to close the majority of those in the third quarter, which is a significant factor for our closing strategy.

Great. The last one is kind of a two-part question. For those who are newer to the story, could you walk through the Smart Series and some of the pace and gross margin advantages Smart Series has versus your traditional product? Also, as you think about the community openings you discussed, is there a path to getting Smart Series above 55% or toward a larger percentage with the openings you're planning for the rest of this year and next?

The Smart Series has been a home run for our company since we first launched it in Tampa in 2016. It now constitutes over half of our business. I believe that the 55% share of our business that it currently represents may fluctuate slightly, but it will likely hover between 50% and 60% for some time. The Smart Series primarily caters to first-time buyers with a well-designed lineup of homes, and it’s a narrow selection. There aren’t many opportunities for nonstandard changes following an efficient selection process. Smart Series buyers do not go through a design studio but select their options from a predesigned menu, which allows for quicker home sales. The average square footage for a Smart Series home is about 2,000 square feet, unlike the 2,400 or 2,500 square feet of our traditional product line, allowing us to build these homes more quickly. This contributes to better returns. Surprisingly, although we did not expect this initially, many of our Smart Series communities provide better margins due to the appeal and quality of the product. Furthermore, we have seen enhanced pace, improved cycle times, quicker sale-to-start timelines, and efficient operations, all contributing positively to our financial performance.

Your next question comes from Carl Reichardt at BTIG.

Nice to talk to you. Jay just stole the one I was going to ask regarding the Smart Series. So, I want to ask a bigger picture question. You have no maturities until 2028, and you're reasonably concentrated in some markets. As you look at the opportunity set over the next five years to grow the business, can we expect you to try to deepen share in existing markets? Or is new expansion into new markets on the table for you? Additionally, how are you thinking about the acquisition environment right now, especially with private firms?

No, good questions. First of all, we're just getting started in Nashville. We have multiple homes under construction, and we will generate our first sales in that market this year. We expect Nashville to allow us to grow to 300 to 500 homes a year over the next several years. Nashville will be a significant contributor to our growth moving forward. Likewise, in Fort Myers and Naples, we opened operations recently, and we have several communities planned there, anticipating that this part of Florida can be as strong a contributor to M/I Homes as Tampa, Orlando, and Sarasota have been. In terms of overall expansion, we have significant work to do to scale in Nashville and Fort Myers/Naples. Regarding additional expansion beyond this, we have no immediate plans. While we’re in 17 markets today, in five years, could we be in one or two additional markets? It’s feasible. However, I believe we can add more scale in our existing markets. Our current run rate is around 8,000 homes, and I am confident we can reach 12,000, 13,000, or even 14,000 homes, which is a strong goal for our company. Regarding acquisition, small privates or others may be possible, but we are primarily focused on organic growth, which we have had more success with moving forward. We are enthusiastic about the teams we've set up in Nashville, Fort Myers, and Naples, which excite us as we progress.

Your next question comes from Alex Barron at HRC. Mr. Barron, your line is open. Did you have a question?

Yes. Can you hear me?

Yes, we can.

Okay. Sorry about that. Another call was trying to intercept my question. Yes, I wanted to focus on the outside broker commissions. I think you mentioned they went up this quarter, and I guess as a percentage of revenues, it seems they were 5.3% versus 4.5% a year ago. Do you see this as just a temporary thing due to the slowdown that happened last year? In other words, is this percentage likely to trend back down? Or is this kind of a new normal for some reason?

Phil, do you want to take that?

Alex, that’s something we’ve worked hard on over the last few years. Some of our divisions got outside broker rates down to 2% or 2.5%, especially during the tough sales climate towards the end of last year and the start of this year. However, some of those rates have increased a bit in certain markets as we ramp back up, especially in those markets that we've just gotten started in. It's challenging to predict these rates going forward, but we continue to manage that closely, just like all our expenses. We're doing a good job on SG&A as well, with about 9% fewer employees than last year. We always focus on managing our overall cost structure, including these elements, and having 15% more stores is driving up our non-variable selling.

Okay. Great. I guess on that same front, just wondering what percentage of your sales generally come from brokers? And also, what are you guys doing in terms of digital marketing efforts? Can you talk about that?

As far as broker commissions over the last few years, it’s been in the 65% to 75% range depending on the market.

On the digital side, it's a major part of our marketing efforts, and nothing comes close. It’s been an area of emphasis for nearly five years as that aspect of our business has evolved substantially. We are maximizing online search engine optimization and everything associated with it, which is a significant focus across all divisions. We have dedicated personnel managing this aspect closely, and a substantial percentage of all leads originate online. This digital aspect of our marketing strategy is as crucial as constructing a home.

Yes. And I'm sure it's becoming even more competitive. All right. Well, thanks again, and great job.

There are no further questions on the phone line. So I will turn the conference back to Phil Creek for any closing remarks.

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

Ladies and gentlemen, this does conclude your conference call for this morning. We would like to thank you all for participating and ask you to please disconnect your lines.