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Edited Transcript of MHO earnings conference call or presentation 24-Apr-19 8:00pm GMT

Q1 2019 M/I Homes Inc Earnings Call

Columbus Apr 26, 2019 (Thomson StreetEvents) -- Edited Transcript of M/I Homes Inc earnings conference call or presentation Wednesday, April 24, 2019 at 8:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Derek J. Klutch

M/I Homes, Inc. - President & CEO of M/I Financial

* Phillip G. Creek

M/I Homes, Inc. - Executive VP, CFO & Director

* Robert H. Schottenstein

M/I Homes, Inc. - Chairman, President & CEO

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Conference Call Participants

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* Arthur Michael Winston

Pilot Advisors, L.P. - CEO, President, and Chief Operations Officer

* James C McCanless

Wedbush Securities Inc., Research Division - SVP of Equity Research

* Thomas Patrick Maguire

Zelman & Associates LLC - Senior Associate

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Presentation

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Operator [1]

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Good afternoon, ladies and gentlemen. My name is Sam, and I will be the operator assisting on the conference call today.

At this time I would like to welcome everyone to the M/I Homes, Inc. First Quarter Earnings Conference Call. (Operator Instructions)

Mr. Creek, you may begin your conference.

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Phillip G. Creek, M/I Homes, Inc. - Executive VP, CFO & Director [2]

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Thank you. Joining me 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 and Corporate Controller; and Kevin Hake, Senior VP.

First, to address Regulation Fair Disclosure, we encourage you to ask any questions regarding issues that you consider material during this call, because we are prohibited from discussing significant nonpublic items with you directly.

And as to the 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'll turn the call over to Bob.

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Robert H. Schottenstein, M/I Homes, Inc. - Chairman, President & CEO [3]

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Thank you, Phil, and good afternoon, and thank you for joining our call to review our first quarter results. We are pleased with our first quarter performance, especially considering the overall slowdown in housing demand that began in the latter part of 2018 and continued heading into 2019. These conditions contributed to a modest decline in our new contracts as well as a modest decline in our margins during the quarter.

We achieved first quarter record revenue of $481 million, which was an increase of 10% from last year, driven by a record level of 1,186 home closings during the quarter. That's a 6% increase over last year's first quarter and an average home closing price of $393,000, which is a 5% increase from a year ago.

Our pretax income for the first quarter decreased by about 2% to $23.5 million from $23.9 million a year ago. As a result of the tighter market conditions late last year that I noted earlier, which led to lower margins on our closings from the first quarter as well as lower pretax contribution to earnings from our financial services segment.

Our gross margin declined from last year's first quarter by about 130 basis points, excluding purchase accounting charges.

Importantly, however, our gross margin sequentially improved by 40 basis points from the fourth quarter. Net income for the first quarter was $17.7 million compared to $18.1 million in 2018's first quarter, while diluted earnings per share increased to $0.63 a share from $0.60 a share as a result of a lower share count.

We sold 1,644 homes in the first quarter, which is 5% less than the homes sold in last year's first quarter. Last year's first quarter was a difficult comp for us as it was the highest number of new contracts for a first quarter in our history and a year ago represented a 20% increase over 2017's level. It's worth noting, however, that this year's first quarter new contracts of 1,644 homes are the second highest quarterly in our company history.

We continue to experience good sales and good growth with our more affordably priced Smart Series line of homes. We added several new communities in the first quarter, and by the end of the quarter our Smart Series was being offered in 13% of total M/I communities and in 12 of our markets and comprised more than 16% of total sales. A year ago, for example, our Smart Series sales were less than 10% of total sales. So as noted in previous calls, we continue to experience good sales and good growth with our Smart Series line. Consistent with that, we have additional Smart Series communities being rolled out 2019 and expect that the end of this year to be selling Smart Series homes in 13 of our 15 markets.

Our backlog sales value at the end of the quarter was $1.1 billion, the same as last year's, and units in backlog were down slightly to 2,652 homes from 2,744 homes in 2018's first quarter.

We continue to make progress on our overhead expense ratio, and during the quarter we improved this ratio by 30 basis points from last year, with total SG&A at 12.9% of revenues for the first quarter. Our balance sheet and liquidity remained strong. We ended the quarter with a healthy homebuilding debt-to-capital ratio of 47%, and our shareholders' equity ended the quarter at $871 million, which is an 11% increase from a year ago and equates to a book value of $32 per share.

We opened an additional 18 communities in the first quarter and are on track to achieve our planned new community growth this year with 214 active communities at the end of the -- at quarter's end, which is up 4% from the same period last year. As we manage our growth in new investment, obviously, we'll continue to monitor housing sales and overall market conditions in our markets.

Now I'd like to provide more detail about our 3 regional markets. First, beginning with the Mid-Atlantic region. I want to start out by commenting and highlighting that in our Washington, D.C. operation, which is one of our 3 markets in the Mid-Atlantic region, we made a decision during the quarter not to invest any further in the D.C. market, and consistent with that we made the decision to wind down our operations in the D.C. market.

As we have been saying on these calls for several years, we have been unable to find land transactions that we believe provide acceptable returns to us in the D.C. market. As a result, we've only made minimal investments in new communities and locations over the past several years. We started this year selling homes in only 4 communities in D.C. and have only 1 active community where we're still selling, and we expect to be substantially completed and sold out of this community by the end of the year. For what it's worth, our investment in D.C today is minimal and not material as we own less than 75 unsold lots.

Elsewhere in the Mid-Atlantic region, our 2 divisions in Raleigh and Charlotte, North Carolina and these have been strong markets for us for quite some time and will continue to be so in the future, but in each of Charlotte and Raleigh we are working hard to open new replacement communities as we move into 2019.

Overall, in the Mid-Atlantic region, we ended the quarter with 28 active communities, which is a 7% decline from a year ago. And new contracts were down 12% in the quarter year-over-year, our sales backlog also was down in value 7% from a year earlier.

We delivered 135 homes in the Mid-Atlantic region during the first quarter, which is a 21% decrease from a year ago and 11% of company-wide total. Our total controlled lots in the Mid-Atlantic region at the end of the quarter actually increased by 2% when compared to a year ago.

Next, the Southern region, which is comprised of our 3 Florida and 4 Texas markets, we had 577 closings for the quarter, which was a 7% increase from a year ago and represented 49% of company total. New contracts in our Southern region decreased 9% for the quarter. The dollar value of our sales backlog in the Southern region at the end of the quarter was 2% higher than a year earlier, and our controlled lot position in the Southern region decreased 15% when compared to a year ago.

We had 96 communities in the Southern region at the end of the quarter, which is a 5% increase from March of last year. And we continue to make progress in growing our operation in our newest Southern region division, which is Sarasota, Florida with 10 communities now fully opened and selling.

And in this region we continue to make important progress in our Texas -- 4 Texas markets, with improving scale and financial performance. We have very strong market positions in both Orlando and Tampa, Florida and they each continue to be strong operations for us.

Finally, the Midwest region. Our 6 Midwest divisions had 474 deliveries in the first quarter, which was a 15% increase from a year ago and represent 40% of company total. New contracts in the Midwest were up 1% for the quarter. Sales backlog at Midwest was down 4% from the end of the year ago in dollar value, and our controlled lot position in the Midwest was up 6% compared to a year ago. We ended the quarter with 90 active communities in the Midwest, which is a 7% increase from a year ago, and overall, let me just say, we are very pleased with each of our 6 Midwest markets.

Before turning the call over to Phil, let me conclude by saying that we are very excited about our business, feel very good about our markets and are well positioned to have a very solid 2019.

With that, I'll turn it over to Phil.

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Phillip G. Creek, M/I Homes, Inc. - Executive VP, CFO & Director [4]

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Thanks, Bob. As far as financial performance, new contracts for the first quarter decreased 5% to 1,644 compared to last year's first quarter. The last year's first quarter was a 20% increase over the first quarter of '17 and an all-time quarterly record. This quarter's new contracts ranked second all time in our company history, and traffic for the quarter was up 5%. Our new contracts were down 9% in January, down 10% in February and up slightly in March. In March we had the highest sales month in our company's history.

As to our buyer profile, about 38% of our first quarter sales were to first-time buyers compared to 36% in last year's fourth quarter, and 47% of our first quarter sales were inventory homes compared to 52% in 2018's fourth quarter.

Our community count was 214 at the end of the first quarter, up 4% versus 2018's first quarter, and up 2% from year-end. The breakdown by region is 90 in the Midwest, 96 in the South, and 28 in the Mid-Atlantic. During the quarter we opened 18 new communities while closing 13. For 2019, our current estimate is that our average community count for the year should be up about 5% from the average of 205 communities in 2018.

We delivered a record 1,186 homes in this year's first quarter, delivering 54% of our backlog compared to 56% a year ago. Revenue increased 10% in the first quarter, reaching a first quarter record $481 million. This was primarily a result of an increase in number of homes delivered and a higher average closing price. Our average closing price for the first quarter was $393,000, a 5% increase when compared to last year's first quarter average closing price of $373,000, and our backlog sale price is $403,000, up 1% from a year ago.

Land gross profit was $55,000 in this year's first quarter compared to $404,000 last year's first quarter. We sell land as part of our land management strategy and as we see profit opportunities.

Excluding the purchase accounting adjustments from our acquisition during the first quarter of last year, our first quarter '19 operating gross margin was 19.3%. This is down 130 basis points year-over-year and is an increase of 40 basis points over the fourth quarter. We estimate that our construction and labor costs were flat when compared to 2018's fourth quarter. Our first quarter SG&A expenses were 12.9% of revenue, improving 30 basis points compared to 13.2% a year ago, reflecting greater operating leverage. Improving our operating efficiency continues to be a major area of focus.

Our first quarter pretax results were impacted by $400,000 of purchase accounting expenses, equivalent expenses related to the acquisition, last year's first quarter were $2.6 million. Interest expense increased $900,000 for the quarter compared to last year. Interest incurred for the quarter was $12.9 million compared to $11.8 million a year ago. This increase is due to higher outstanding borrowings in '19's first quarter as well as a higher weighted average borrowing rate.

We have $22 million in capitalized interest on our balance sheet. This is about 1% of our total assets. And our effective tax rate was 25% in 2019's first quarter compared to 24% in last year's first quarter. We estimate our annual effective rate in 2019 to be around 26%.

Our earnings per diluted share for the quarter increased to $0.63 per share from $0.60 per share last year, as a result of our lower share count. During the quarter, we repurchased $5 million of our outstanding shares.

Now Derek will address our mortgage company results.

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Derek J. Klutch, M/I Homes, Inc. - President & CEO of M/I Financial [5]

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Thanks, Phil. Our mortgage and title operations achieved pretax income of $5 million in the first quarter. Due to continued competitive pressures, we experienced lower pricing margins on loans originated compared to the first quarter of last year along with higher expense levels associated with the opening of new mortgage and title offices in certain markets.

Pretax income was $8.8 million in 2018's first quarter, which included additional income from the sale of a portion of our servicing portfolio. Loan-to-value on our first mortgages for the quarter was 82% in 2019, down from 2018's 84%. 76% of loans closed in the quarter were conventional, 13% FHA, 11% VA, compared to 77%, 13% and 10%, respectively, for 2018's same period. We expect to see a minimal effect on our FHA business with the recent underwriting changes.

Our average mortgage amount increased to $315,000 in the quarter compared to $302,000 last year. Loans originated increased 2% from 781 to a first quarter record 798, and the volume of loans sold was relatively unchanged.

For the quarter, the average borrower credit score on mortgages originated by M/I Financial was 745, down slightly from 747 a quarter earlier. Our mortgage operation captured about 79% of our business in the quarter, the same as 2018's first quarter.

At March 31, we had $72 million outstanding under the MIF Warehousing Agreement, which is a $125 million commitment that expires in June of this year, and we also had $32 million outstanding under a separate $50 million repo facility, which expires in October. Both facilities are typical of 364-day mortgage warehouse lines that we extend annually, and we don't expect any problems extending them prior to the expiration dates.

Now I'll turn the call back over to Phil.

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Phillip G. Creek, M/I Homes, Inc. - Executive VP, CFO & Director [6]

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Thanks, Derek. As far as the balance sheet, we continue to manage our balance sheet carefully, focusing on investing in new communities while also managing our capital structure.

Total homebuilding inventory at March 31 '19 was $1.7 billion, an increase of $150 million above March 31, '18. This increase was primarily due to higher investment in our backlog, higher community count and more finished lots. Our unsold land investment at quarter end was $796 million compared to $706 million a year ago.

At March 31, we had $347 million of raw land and land under development and $449 million of finished unsold lots. We owned 5,595 unsold finished lots with an average cost of $80,000 per lot, and this average lot cost is 20% of our 403,000 backlog average sale price.

Our goal is to maintain about a 1-year supply of owned finished lots. And the market breakdown of our $796 million of unsold land is $314 million in the Midwest, $338 million in the South and $144 million in the Mid-Atlantic.

Lots owned and controlled as of March 31, '19, totaled 28,000 lots, 52% of which were owned and 48% under contract. We own 14,510 lots, of which 41% are in the Midwest, 45% from the South and 14% in the Mid-Atlantic. A year ago, we owned 12,900 lots and controlled an additional 17,900 lots for a total of 30,800 lots.

During this year's first quarter, we spent $80 million on land purchases and $54 million on land development for a total of $135 million, about 49% of the purchase amount was raw land. Our estimate today for total 2019 land purchase and development spending is $550 million to $600 million, which includes the $135 million spent year-to-date. At the end of the quarter, we had 560 completed inventory homes, about 3 per community, and 1,278 total inventory homes.

Of the total inventory, 473 in the Midwest, 655 in the Southern region and 150 in the Mid-Atlantic. And at March 31, '18, we had 425 completed inventory homes and 1,104 total inventory homes.

As of January 1, '19, we adopted the new lease accounting standard resulting in the capitalization of $21 million of our operating leases on our balance sheet. Our financial condition continues to be strong with $871 million in equity and homebuilding debt-to-cap of 47%. And at March 31, '19, there was $219 million outstanding under our $500 million unsecured revolving credit facility.

We continue to focus on managing our leverage and liquidity and balancing this with our land needs. This completes our presentation. We'll now open the call for any questions or comments.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And your first question comes from the line of Jay McCanless from Wedbush.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [2]

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(inaudible) I've got three quick questions. First one, I wanted to ask about (inaudible) there are couple different things. Number one, knowing the (inaudible) selling (inaudible) Easter (inaudible) last (inaudible) and also (inaudible)

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Robert H. Schottenstein, M/I Homes, Inc. - Chairman, President & CEO [3]

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Jay, it's been our practice not to comment on the month of the quarter just begun. So consistent with that best practice, we'll stay with it.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [4]

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Right. Second question I had, you guys talked about how March (inaudible) your commentary was highest sales month (inaudible) just across the board (inaudible) would be a (inaudible)

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Robert H. Schottenstein, M/I Homes, Inc. - Chairman, President & CEO [5]

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I think it was pretty much across the board. And it was a very, very strong month. I think it reflected an improving housing conditions sort of crescendoing, if you will, from the beginning of the year. Year started out a little slow in both January and February, selling season I don't think got off to a very good start. And then things really began to take hold in March. In no small part I think because of the 50, 60, almost 70 basis point drop in interest rates over the 4-, 5-month period that preceded it.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [6]

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And then sales absorption for the Southern (inaudible) region was down a little bit worse (inaudible) Could you talk about which market you saw the most (inaudible) and how those responded?

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Phillip G. Creek, M/I Homes, Inc. - Executive VP, CFO & Director [7]

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Yes. We really don't get into any detail that way, Jay. I mean, overall, we talked about traffic being up 5% for the quarter. March was a little stronger than that. Cancellations were a little higher in January and February than they were in March. But overall we were very pleased, especially with our March sales.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [8]

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Got it. And then the last question I had. In terms of what you're seeing (inaudible) competitors and discounting incentive, are you seeing in measure (inaudible) what the private builders are doing, especially in move-up housing versus what public competitors are doing?

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Robert H. Schottenstein, M/I Homes, Inc. - Chairman, President & CEO [9]

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I'm not aware of anything. There might be some specific pockets where that's taking place. I think your point's an interesting one because the more move up, price point is a little more competitive right now. But I'm not really aware of anything in particular. I don't know if anyone else here is. I wouldn't feel comfortable commenting on it because I'm just not aware of it. I have not heard of it. And you know there aren't that many active (inaudible) other than Texas, and maybe Cincinnati, we're not dealing with a lot of what I call significant private builder competition.

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Operator [10]

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And your next question comes from the line of Thomas Maguire from Zelman & Associates.

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Thomas Patrick Maguire, Zelman & Associates LLC - Senior Associate [11]

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Just to stay on the incentive and demand side, were there any changes just to your incentive strategy during the month and were you able to peel back in March at all as these caused the demand to improve and orders come through?

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Robert H. Schottenstein, M/I Homes, Inc. - Chairman, President & CEO [12]

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You said, were there any changes in our incentive approach during the month, did you mean during the quarter?

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Thomas Patrick Maguire, Zelman & Associates LLC - Senior Associate [13]

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Correct, thank you.

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Robert H. Schottenstein, M/I Homes, Inc. - Chairman, President & CEO [14]

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Maybe a little bit. I think that the incentives that we had in place going into the selling season, we pretty much maintained them through the quarter, but began to scale back on a subdivision -- in certain subdivisions and/or markets as we move towards the end of the quarter, as we saw underlying demand begin to improve itself.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [15]

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Got it. That make sense. And then just quickly on the financial service business, just shifting gears, appreciate all the color on some of the challenging conditions there, but can you just talk about the competitive environment for that business and maybe where we are in terms of digesting some of the changes in the industry? And this quarter, from both a revenue margin perspective, was lowest we've seen in a number of years, does it feel like we're more balanced now and maybe have bottomed, thinking improvement here, just how would you think about that?

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Robert H. Schottenstein, M/I Homes, Inc. - Chairman, President & CEO [16]

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As Derek manages the mortgage company in great times and in challenging times, we'll have him answer that one.

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Derek J. Klutch, M/I Homes, Inc. - President & CEO of M/I Financial [17]

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Yes. Tom, thanks. We see like the other, the builder mortgage companies, with interest rates rising and the refinance business basically disappearing, the banks and the other mortgage lenders getting a lot more aggressive coming after the builder business. And that's caused us to reduce our margins just to stay competitive. I wouldn't say we are at the bottom, but I am seeing a little bit of leveling out with where the pricing pressure is. And if the interest rates stay in the low 4s, I think we should kind of be able to not get back to the margin we saw last year but stabilize a little bit.

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Operator [18]

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And your next question comes from the line of Art Winston from Pilot Advisors.

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Arthur Michael Winston, Pilot Advisors, L.P. - CEO, President, and Chief Operations Officer [19]

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I was wondering if it's feasible or possible to switch some of the lots into the lower price showcase mover up home from the normal $400,000 home, even though originally you had planned to build the more expensive home on these lots?

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Robert H. Schottenstein, M/I Homes, Inc. - Chairman, President & CEO [20]

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Our showcase brand is a really, really small part of our business, Art, just to be clear on that. In the quarter we experienced relatively good demand across most of our communities. What the Smart Series has done for us is incrementally improved our business. And it's not that the rest of the business was bad, we look at every subdivision all the time, and if we've got subdivisions that aren't performing, there's a whole lot of things we'll look at, with changing the product or perhaps even if we have the ability, even exiting the community if that's what it takes, and we've done that.

We look at our communities all the time, we have high expectations for each community. Each community has its own set of underwriting guidelines and certainly the product that we sell in those communities can be a big part. Sometime there's not a whole lot you can do with product because of restrictions and zoning and so forth that I know you understand, but the short answer is that -- we look at this all the time when our communities aren't performing. The good news is, most of our communities are performing at acceptable levels right now.

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Arthur Michael Winston, Pilot Advisors, L.P. - CEO, President, and Chief Operations Officer [21]

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Thanks. One other question, did I hear right that the traffic through your communities was up 5% but the sign ups and new contracts in these same communities were down 10%?

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Phillip G. Creek, M/I Homes, Inc. - Executive VP, CFO & Director [22]

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Contracts were down not 10%. Contracts were down 5% or 6%.

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Robert H. Schottenstein, M/I Homes, Inc. - Chairman, President & CEO [23]

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5% for the quarter.

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Phillip G. Creek, M/I Homes, Inc. - Executive VP, CFO & Director [24]

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Traffic was up 5%, Art.

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Operator [25]

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(Operator Instructions) And we do have a follow-up question from the line of Jay McCanless from Wedbush.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [26]

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(inaudible) I was going to ask the (inaudible) talk about what impact that (inaudible)

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Derek J. Klutch, M/I Homes, Inc. - President & CEO of M/I Financial [27]

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Yes. Well, as far as a couple of things, Jay, I mean, as we talked about, we're down now to about 1 community. When you look at the orders there, the first quarter of last year, it was like around 25. So it wasn't that many orders last year, also, nor does it impact the community that much. And then Bob mentioned that today we're down to less than 75 unsold lots. We hope to be out of the market by the end of this year, is what we hope, not really anticipating any type of significance there. We did have in the first quarter about $400,000 of severance cost, unfortunately, for some people that had been with us for a while. That will be staying with us parts or all of this year, but that situation we've been not investing in and working down for a while.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [28]

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And then on Detroit (inaudible) toward that (inaudible) last (inaudible) starting (inaudible) you guys have (inaudible) did you talk about how many order got (inaudible) quarter last (inaudible) what (inaudible) this year.

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Robert H. Schottenstein, M/I Homes, Inc. - Chairman, President & CEO [29]

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We actually picked Detroit up in March of last year. And round figures, it was about 25 orders this year. And this year it was about 50. So we sell some, but it's not significant.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [30]

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And then the other question I had, in general, talk about (inaudible) our (inaudible) you want to talk about community, region, (inaudible) like, you're getting net pricing or base pricing in flat premium that are making some of the discounting (inaudible) how much that exceed market (inaudible) and which market revenue were success of that?

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Robert H. Schottenstein, M/I Homes, Inc. - Chairman, President & CEO [31]

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I want to make sure I understand your question. You're saying, are we seeing the opportunity to move prices in various markets? Is that the question?

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [32]

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More than what you're having to do for incentives and discounts, et cetera.

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Robert H. Schottenstein, M/I Homes, Inc. - Chairman, President & CEO [33]

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Well, I think one of the more encouraging things with our first quarter results was sequentially our gross margins were up nearly 40 basis point on closings. And I don't think there's a whole lot of pricing power right now, but I also don't think there will be a whole lot more need for incentives, but we'll just have to see, and we'll wait to see and react.

We have been saying for quite some time, we get this question almost every call, where do you see margins? We think our business is at 20% to 20% business, and we sort of move between that, there may be a time where it dips slightly above 21% and slightly below 20%, but we see it as basically a 20% to 21% business. It's probably a lot closer to the lower end of that range now than maybe during a little bit better times. But that's sort of how we see the year playing out.

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Operator [34]

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And at this time, sir, we have no further questions.

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Robert H. Schottenstein, M/I Homes, Inc. - Chairman, President & CEO [35]

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

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Operator [36]

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Ladies and gentlemen, this does conclude today's conference call. You may now disconnect.