M/I Homes, Inc.

Good morning, ladies and gentlemen, and welcome to the MI Homes, Inc. Second Quarter Earnings Webcast Conference Call. At this time, all lines are in listen-only mode. Following the presentation, we will conduct a question and answer session. If at any time during this call you require immediate assistance, please press star zero for the operator. I would now like to turn the conference over to Phil Kreeke, Please go ahead, sir.

Thank you for joining us today. On the call is Bob Schottenstein, our CEO and president, and Derek Clutch, 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 nonpublic items with you directly. And as to forward-looking statements, 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 were very pleased with our new contracts, homes delivered, margins, and income. And 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 last year. during 2022 second quarter. 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. During the quarter, 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. We expect to increase our community count for 2023 by approximately 15% of the 196 communities that we had open 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 a very solid 26%, considerably better expected going into this year. Our pre-tax income for the quarter was $155 million, down from last year's record level, still very pleased to produce pre-tax 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. Our deliveries in the northern region decreased by 22% from last year. 61% of our deliveries came out of the southern region, and the balance of our deliveries, 39% out of the northern region. Our owned and controlled lot position in the southern region increased by 18% compared to last year. increased 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. In regards to our balance sheet, we ended the second quarter of 2023 with an all-time record $2.3 billion of equity, which equates to a book value per share of $83. We also 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%. I conclude, let me just state that we are in the best financial condition in our company's history, very good about our business, and 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, and 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. And at June 30th, we had 45 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 3% in the second quarter, and our average closing price for the second quarter was a second quarter 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 get 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 a 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 pre-tax income was 15%, and our return on equity was 23%. During the quarter, we generated $164 million of EBITDA compared to $195 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 Clutch will address our mortgage company results.

Thanks, Phil. Our mortgage and title operations achieved pre-tax 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% 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. Also, we maintain warehouse facilities that provide us with funding for our mortgage originations. At June 30th, we had $186 million outstanding under these facilities. Now I'll turn the call back over to Phil.

Thanks, Derek. 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 of the public home builders 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. And at June 30th, we had 673 million of raw land that landed 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. And at June 30th, we owned 23,000 lots and controlled 41,000 lots. At the end of the quarter, we had 303 million completed inventory homes, and 1,737 total inventory homes. And of the total inventory homes, 827 are in the northern region and 910 are in the southern region. And at 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. And 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.

Thank you, sir. Ladies and gentlemen, we will now begin the question and answer session. If you would like to ask a question, please press star, followed by the number one. on your telephone keypad. If your question has been answered and you would like to withdraw from the queue, please press star followed by the number two. And if you are using a speakerphone, please lift your handset before pressing any keys. One moment, please, for your first question. Your first question will come from Alex Barron. Please go ahead.

Yes, thank you. And great job on the quarter, guys. Glad to see the market is starting to reward you finally. Yeah, I was hoping you could walk us through the improvement sequentially in the gross margin. Anything that drove that? Was it just you started to raise prices or lumber costs were lower or anything that explains the big jump sequentially?

Yeah, I'll start that and maybe Phil will have some comments he'd like to add to it. 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. And we had, frankly, expected our margins to be somewhat lower than they obviously have turned out to be. Despite the higher rates, the end has been quite solid and remains so today throughout almost all of our markets. Act throughout all of our communities Currently limiting sales and in about 15% of our communities Which is an indication of the demand, you know in various places Think our communities are exceptionally well located a very strong product offering smart series is is is exceptional in terms of its appeal to first-time buyers and good about our move-up product as well as our attached townhomes and the combination of all those things including the level of demand strength of our buyer profile given us ability push margins where appropriate and you know we as we've said over the years 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%. Also have some that are lower. Subdivision by subdivision basis. No one knows what the future will bring. It continues to stay about where it is today. A fair amount of confidence that we'll continue to have margins that are at a very acceptable level. Bill, 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 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 and so forth. And again, just a lot of time, as you said, on product, Every subdivision is a little different, trying to open these new stores the right way, really trying to emphasize sales pace. So we just continue to be focused on that.

Okay, great. And then obviously your cash balance is pretty significant compared to any time in your history. I was curious, you know, what you guys have that invested in because it looks like you generated almost $5 million of interest and I'm assuming that that's gonna go higher unless you put the money to work. And if you are gonna put the money to work, what's the most likely use? Is it buy more land? Is it 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 to 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. Bill, 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 the first half. We did push back a number of land transactions 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, what is the best use of our capital. As I mentioned, we did buy back, you know, $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, you know, 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.

All right, guys. We'll keep it up, and I'll get back in the queue. Thanks.

Your next question comes from Jesse Letterman at Zellman & Associates. Please go ahead.

Hi. Congrats on a great quarter, and thanks for taking my questions.

Thanks, Jesse.

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?

Well, one thing I'd say that has, I think, helped our closings, and I suspect will continue to, is we 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. Some have improved by 15 to 20 days. And we expect to continue to improve cycle time and hopefully get it back to those pre-COVID levels that we were seeing in the year 2019 and before. And that will certainly contribute to getting the homes in the field closed at a more rapid pace. Phil, you want to add anything to that?

Yeah, as we disclosed, Jesse, we do have less 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 a little surprised pleasantly. 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. But again, you know, we're trying to get all the good quality, fully completed homes closed we can every quarter. But, you know, it is going to be a challenge for us, you know, to close as many houses in the second half as we did the first half. But, you know, we're doing all we can.

Thanks. That's helpful.

And as you mentioned was likely on last quarter's call, your land spend is you know, 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 at inch 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, you know, end up being community openings.

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

Yeah, just, you know, recognizing that the percentage of communities that you had to limit sales and increase a little bit sequentially here, you know, what do you, is there any risk to that percentage of communities that you're limiting sales and increasing in the near term? as you wait for these more recent land deals to filter through to community openings?

Well, first of all, the reason that we're limiting sales where we are is simply to control the deliveries in a way that we think we can best manage. We don't want to get too far out over our skis, so to speak. And in those communities where we are limiting sales, We're also getting, you know, very strong margins, and we just think that's the smartest way to run the business. The decision to limit sales has little, if anything, to do with new communities coming on. Bill, I don't know if you want to add anything to that, and I don't know if that answers your question.

No, every community is different, and it's a combination of, you know, the number of finished lots we have, The amount of times to get the houses built. When you lock a price in to a customer today, you got to make sure you can get the houses built on a timely basis at the cost you have locked up. It's good news when we are having to limit sales. that number kind of moves around every quarter, you know, based on, you know, what's going on in the local subdivisions. But that would be a really hard number, you know, to project. But, again, I will say that the new stores we're opening, which are a big part of our business last year and this year, you know, we're very pleased with the way they are performing.

Great. Thank you for clarifying that. I appreciate it. And just one last one on the cost side of the business. You've mentioned costs are stabilizing. They've been relatively flat the last few quarters here, and you are seeing some cycle time improvements. But you ramped starts pretty significantly, 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 quarters? Do you expect to see any hiccups as it pertains to the supply chain just with the industry broadly ramping their start space? Or have you been relatively insulated from that just because of your relatively larger size?

Well, first of all, to know what's going to happen on the cost side is always a toughie. But I feel really good about the supply chain issues throughout nearly every one of our markets. and with regard to almost every part of our business. The one issue that continues to be a concern, I think, for all the builders is on the land development side and the time it takes to get all of the approvals and the entitlements to bring deals to market. And even, you know, it's well documented the issues that that a lot of the builders, including us, have had in certain markets with getting all the utilities in place, particularly transformers. That continues to be somewhat of an issue. I think it's getting a little bit better. But I feel pretty good about the supply side of the business, and I think that we'll continue to see improvement in cycle time across all the parts of our business. And I think that the cost side... I don't see a lot of risk in big cost increases right now. Phil, do you have anything you want to add to that?

The only thing I will add is we do, when we build houses and develop land, build in a certain contingency for cost. That could be 2%. That could be 5%. But we are hopeful, like Bob said, of not having anything significant the rest of the year, but we'll continue to keep those contingency amounts in our costs.

Great. Thanks so much for all the insights. I appreciate it.

Thanks.

Your next question comes from Jay McCandless at Wedbush. Please go ahead.

Good morning. Thank you for taking my questions. 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 of 23, maybe 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 22 when there's a lot of price competition. I'm just wondering how you're feeling about gross margins for the back half of the year and any commentary you could give around that.

You know, Jay, that's a hard estimate to give. You know, as Bob said, our margins had been better the first two quarters than we thought. When you look at what's in our backlog, you know, our backlog margins are relatively flat. Again, we're selling about 50% specs. We plan on opening more stores the second half than we did the first. So that's kind of a hard number to come at. But I would answer it the same way Bob. Bob did, that we still think our margins will be good and respectable. It's just hard to pin down a number. We have a lot of emphasis and focus on margins because it's so important to us. So we'll continue to do all we can to keep those margins as strong as we can. It's just really hard to estimate what they'll be.

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

It's hard, Jay, to have that exact number. What we tend to do more than anything, and every subdivision is a little different, is help people with an interest rate Again, even though we have strong down payments, we are still in the payment business. Buying the rate down a little bit is very effective to get those people's payment down. Even though rates have been a little bit sticky, it's still not that expensive to buy down rates 30, 45, 60 days prior to closing. In general, the incentives have lessened some. But again, every community is a little bit different. But I would say in general, incentives have come off a little bit.

And the only thing I'd add to that is obviously we're in a time of the year where seasonally and typically falls off a little. We haven't seen much of that. And while we're no longer in the spring selling season, the demand for these summer months has held up quite well, and there's nothing happening right now to suggest that incentives are going to increase.

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

I mean, things are holding steady. Look, Jay, you know as well as anyone, the inventory levels are at or near record lows. Somewhere between 50 and, I don't know, maybe 75% of all the homeowners in this country are living in a home where their mortgage is maybe 1.5% or lower, probably even lower than 4%. The likelihood that those homes are going to come to market anytime soon is not great. And as a result, the demand that's out there is largely buying new. And I think that's going to continue for quite some time. And I think that's a very strong tailwind for our industry, which is why I think holders in general are producing much stronger results than anyone would have thought eight months ago.

You know, Jay, we're really excited about the opportunity we have with all the stores, you know, that we are opening. We're obviously focusing on sales pace. That really matters. Of course, if you look at comparables last year in the second quarter, we sold 1,800. Third quarter last year, we sold 1,300. In the fourth quarter last year, we sold 1,000. So our sales decreased significantly last year. We are trying to catch up as far as, you know, houses in the field. We did start a lot of houses in the second quarter. You know, Bob talked about cycle time. Cycle time is improving. Our spec level is about the same it was a year ago. We do have a couple hundred more finished specs than we did a year ago. We're obviously hoping to get the majority of those, the big majority of those sold and closed the third quarter. you know, that's the big swing item on our closing. How many of those, you know, finished specs and specs that are almost finished today that we can get closed, can we get through the third quarter? And those are all the things that we're focused on.

Great. And then the last one is kind of a two-part question, I guess. Number one, maybe for people who are newer to the story, could you walk through the Smart Series and some of the the pace and gross margin advantages Smart Series has versus your traditional product? And then also, as you think about the community openings you talked about, is there a path to getting Smart Series above 55% or getting to a bigger percentage with the openings you're going to do through the rest of this year and into 24?

Well, the Smart Series has been a grand slam home run for our company. We first opened it in Tampa in 2016. It's grown to over half of our business. I think that the 55% or so of our business that it represents today may go up a little, but I think it'll hover between 50% and 60% here for quite some time. It primarily caters to a first-time buyer. It's a very well-designed lineup of homes. It's a tight lineup. Not a lot of opportunity for, I'd call, non-standard changes. The selection process is very efficient. Smart Series buyers do not go through a design studio, per se. They select their options off of a pre-designed menu, which gets homes from sale to start much quicker. And then once the homes start, because... average square footage on a Smart Series home is probably around 2,000 square feet versus maybe 24, 2,500 for the rest of our product line. We're able to build these homes quicker, which contributes to returns. And frankly, while we didn't expect it when we first designed it to sell for better margins, in many, many of our Smart Series communities, Our margins are better, and I think it's just because of the appeal and the quality of the product. And the other thing is we're getting better pace. So cycle time better, sale to start quicker, better pace, streamlined offerings, efficient way of running that part of our business. All of that is contributed to our top line and our bottom line.

That's great. Thank you for taking my questions. Thanks, Jay.

Your next question comes from Carl Reichardt at BTIG. Please go ahead.

Thanks. Thanks for taking my questions, guys. Nice to talk to you. Jay just stole the one I was going to ask on Smart Series. So I want to ask another sort of one bigger picture one. So no maturities until 2028. And, you know, you're reasonably concentrated in some markets. As you look out at the opportunity set over the next five years to grow the business, would we expect you to try to deepen share in existing markets or is new expansion to new markets on the table for you? And then how are you thinking about the acquisition environment right now of privates is really what I'm focused on, but even of publics. I'm just curious your thoughts there. Thanks a bunch.

Yeah, no, good questions. First of all, we're just getting started in Nashville. We have a number of homes under construction and we will be generating our first sales in that market this year. We're in Nashville to grow over the next several years to three to 500 homes a year. Nashville is going to be a big contributor to growth as we move on down the line here over the next couple of years. Likewise, in Fort Myers and Naples, we just got open there within the last year. We've got several communities, and we expect to have a significant operation in Fort Myers, Naples as well. We're very bullish about that particular part of Florida. and think it will be just as strong a contributor to MI Homes as Tampa, Orlando, and Sarasota have been. So in terms of expansion, we have a lot of work to do to get scale, and we're confident we'll be able to do so. A lot of work to get scale, both Nashville and Fort Myers, Naples. As far as additional expansion beyond that, no real plans at this point. But in five years, if we're in 17 markets today, I should say in five years, might we be in perhaps another one, 18 or maybe 19? I think it's possible. But I also think that we have the ability, and we've said this before, you know, our current run rate's around 8,000 homes. Within the markets we're in, we think we can get to 12, 13, 14,000 homes and are poised to do so. And that is a very strong goal of our company. As far as the acquisition side, small privates or what have you, it's possible. It's not something that we're laser focused on. If an opportunity presented itself in a market that we're in, or perhaps even a market that we're not, we always would look at it. But I think that in general, organic growth rather than acquisition, we've done both. had more success with organic very candidly. And we're really excited about the teams that we have on the field in both, well, first of all, all of our markets, but in particular Nashville and Fort Myers-Naples. And that's very exciting for the company as we go forward. Phil, I don't know if you have anything.

That sounds great, Bob.

Thank you, Bob, and thank you, Phil. Thank you, Carl.

Your next question comes from Alex Barron at HRC. Please go ahead.

Mr. Barron, your line is open.

Did you have a question?

Yes, can you hear me?

Now we can. OK, sorry about that. Another call was trying to intercept my question. Yeah, I wanted to focus on the Outside broker commissions, I think you mentioned they went up this quarter, and I guess there's a percentage of revenues that seemed 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 in the last, you know, at the end of 2022? In other words, is this percentage likely to trend back down, or is this kind of a new normal for some reason?

Bill, you want to take that? You know, Alex, that's something we've worked very hard on the last few years, and we had some divisions that got outside broker rates down to, you know, 2%, 2.5%, you know, especially with sales toughening, you know, the last half of last year and the first of this year being a little slow also. So some of those rates have gone back up. in certain markets where we're kind of getting started up. Like Bob mentioned, some of those realtor rates have moved up a little bit as far as percent of business. It's very hard to predict what that's going to be. It is something we obviously focus on. It's a big item to us, but we try to manage that just like we do all of our other expenses. We think we're doing a pretty good job on SG&A. Today, we have about 9% less people than we did a year ago. So we focus always on our cost structure, including all those items. Another thing, of course, is having 15% more stores. That's driving the non-variable selling up. So we'll continue to focus on all those things.

OK, great. I guess on that same front, just wondering, you know, what percentage of your sales generally come from brokers and also, you know, what are you guys doing in terms of digital marketing efforts? You know, can you talk about that?

Well, as far as the broker, if you look at the broker commission, the last few years, every market's a little different, but we've been in the 65 to 75% range. On the digital side,

biggest part of our marketing. Nothing even comes close. Formous area of emphasis for close to four years, five years now since that part of our business has changed so much.

Everything that we can possibly do to maximize found online search engine optimization and

all the things associated with that. A giant area of focus in every one of our divisions. There are people exclusively dedicated to that. A significant percentage of all of our leads are all start online. We very intensely manage that online part of our business. It's as much a part of the blocking and tackling of our business constructing a home is internet, marketing, online, marketing, digital side of our business. That's a critical key part of our business. I can't emphasize it enough.

Yeah, and I'm sure it's only getting more competitive. All right, well, thanks again and great job. Thanks.

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. 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