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

Q2 2019 M/I Homes Inc Earnings Call

Columbus Jul 26, 2019 (Thomson StreetEvents) -- Edited Transcript of M/I Homes Inc earnings conference call or presentation Wednesday, July 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

* Kevin C. Hake

M/I Homes, Inc. - Senior VP of Finance & Business Development and Treasurer

* 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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* Alex Barrón

Housing Research Center, LLC - Founder and Senior Research Analyst

* James C McCanless

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

* Thomas Patrick Maguire

Zelman & Associates LLC - Senior Research Associate

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Presentation

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Operator [1]

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Good afternoon, ladies and gentlemen. My name is Jerome, and I will be your conference operator today. At this time, I would like to welcome everyone to the M/I Homes Second Quarter Earnings Conference Call. (Operator Instructions)

Now it's my pleasure to hand the call over to your host. Mr. Phil Creek, the floor is yours.

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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, our 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 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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Thanks, Phil. Good afternoon, and thank you for joining our call to review our second quarter results. We had a very strong second quarter, highlighted by second quarter records in new contracts, homes delivered, revenue and income.

During the quarter, we sold a record 1,731 homes, which was 6% better than a year ago.

Our communities were up about 5% on average for the quarter, so our absorption pace was slightly better than last year. And in last year's second quarter, our sales set the previous record which created a very tough comparison for this year. Last year, we sold 1,631 homes, which was 17% better than 2017. So obviously, we were very pleased to beat last year.

We achieved record second quarter revenue of $624 million, an increase of 12% from 2018's second quarter, driven by a second quarter record level of 1,538 home closings during the quarter. This was a 9% increase over last year's second quarter. The average sale price on homes closed was $389,000, up 1% from a year ago.

Our pretax income for the second quarter increased by 23% to $41.2 million, also a second quarter record, as a result of the increased volume that I just mentioned along with an 80-basis-point improvement in our SG&A expense ratio when compared to 2018's second quarter.

Gross margins held steady at 19.2%, down 10 basis points from the first quarter and a decline from last year's second quarter of about 80 basis points, excluding the impact of 2018 purchase accounting charges.

Net income for the second quarter increased to $30.2 million compared to $27.9 million in 2018's second quarter, and our diluted EPS increased to $1.08 per share from $0.96 per share last year as a result of a lower share count offset in part by a higher tax rate in 2019.

Our financial services business also had a very good quarter, you will hear more about that in a few minutes, with $6.7 million of pretax income, which is a 28% improvement from 2018's second quarter.

We continue to experience strong sales and strong operating results with our most affordably priced Smart Series line of homes. We opened a number of new Smart Series communities in the second quarter. And by the end of the quarter, our Smart Series was being offered in 44 of our total communities or 20% of M/I communities.

This represents 13% -- 13, rather, of our markets and comprises more than 20% of total sales in the second quarter.

We have been commenting on the success of our Smart Series collection during these calls for the past several years, and our results frankly have exceeded our expectations.

We have additional Smart Series communities being rolled out in 2019, and we continue to achieve healthy margins in these communities. So we are very enthused about this segment of our business.

Company-wide, our backlog sales value at the end of the quarter was $1.1 billion, down slightly from a year ago, and units in backlog were down 4% to 2,845 homes compared to 2,966 homes in last year's second quarter.

Our balance sheet and liquidity remain strong. We ended the quarter with a healthy homebuilding debt-to-capital ratio of 45% and shareholder's equity of $904 million, which is an increase of 11% from the second quarter of 2018, and this equates to a book value of roughly $33 per share.

We also continue to grow and invest in our business. During the quarter, we opened an additional 24 communities and are on track to achieve our planned, roughly 5% annual community count growth this year. With 220 active communities at quarter's end, this is up 5% from the same period last year.

Now I'll provide a little bit more detail about our regional housing markets. Before I do, I first want to clarify a change that we are making in the reporting of our geographic regions.

Earlier this year, when we reported our decision -- earlier this year rather, we reported our decision not to invest further in the Washington, D.C. market. And presently, we are in the process of winding down that operation. As a result, we reevaluated our reportable segments and made a decision to realign our 2 North Carolina markets, which are Charlotte and Raleigh, into our Southern region, and we renamed our Midwest region, the Northern region. So we are now reporting with 2, not 3 regions, and those 2 regions are the Southern region and the Northern region. The Southern region is comprised of our 3 Florida markets, Tampa, Orlando and Sarasota; our 4 markets in Texas, Houston, Austin, Dallas and San Antonio; and the 2 North Carolina markets I mentioned, Charlotte and Raleigh; along with, at least for the time being, the remaining wind down operations in D.C.

All past region results have been restated to reflect this change in our reportable segments. The Northern region consists of the same 6 markets that we previously reported as our Midwest region.

With respect to the D.C. market, let me note that we expect to be substantially completed and sold out by the end of this year. Our investment in D.C. today is minimal with 0 unsold lots remaining.

Now with a little bit more color about the Southern region. Within this revised region alignment, we had 924 deliveries in the Southern region for the quarter, which is an 8% increase from last year and 60% of the total.

New contracts in the Southern region increased 5% for the quarter. We experienced very solid increases in both sales and closings in Dallas, Houston and Charlotte, and are making significant progress in growing our operation in Sarasota, Florida, with 11 communities now open and selling, which is more than double the number we had a year ago, and this has led to substantial increases in both new contracts and deliveries in Sarasota.

Orlando and Tampa continue to be 2 of our strongest markets and 2 of our strongest operations, and we also continue to produce very solid results in Austin, Texas.

The dollar value of our sales backlog in the Southern region at quarter end was 3% lower than a year earlier, while our controlled-lot position in the Southern region increased 26% compared to last year.

We had 132 communities in the Southern region at the end of the quarter. This is an increase of 8% from June of the year ago.

Moving to the Northern region, which was formerly our Midwest region, as I mentioned, and this consists of our Columbus, Cincinnati, Indianapolis, Chicago, Minneapolis and Detroit markets. That region had 614 deliveries in the second quarter, an 11% increase from last year and 40% of company-wide total.

New contracts in the Northern region were up 7% for the quarter, while our sales backlog was down 5% from the end of quarter 2 last year in terms of dollar value.

Our controlled-lot position in the Northern region decreased 6% compared to last year, and we ended the quarter with 88 active communities in the Northern region, an increase of 1%.

Overall, all of our divisions in the Northern region continue to perform well. We experienced significant increases in closings and sales in Indianapolis and are on track to achieve higher volumes this year in our fairly new Detroit operations. Columbus is a very strong market for us, and we are especially pleased with our performance and growth in Minneapolis.

We have, I should note, felt a bit of a slowdown in Chicago from the very strong, solid results that we've experienced there in recent years.

Before turning the call over to Phil, let me conclude by saying again that we are very pleased with our results. Buyer demand is solid, and we are well positioned to have a strong 2019. We think we are executing at a high level, and great credit and thanks goes to our region and division leaders and their respective teams as well as our mortgage operations and our entire corporate staff.

And 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. New contracts for the second quarter increased 6% to 1,731 compared to 1,631 for last year's second quarter, which was a 17% increase over 2017's second quarter. This quarter's 1,731 new contracts are a second quarter record for our company. Traffic for the quarter was down 5%. We were pleased that our sales increase was across the board with our Northern region up 7% and our Southern region up 5%. If you exclude D.C. from the Southern region, sales were up 9% in that region and total company sales increased 8% for the quarter.

Our new contracts were down 3% in April, they were up 10% in May and up 13% in June. As to our buyer profile, about 43% of our second quarter sales were to first-time buyers compared to 38% in the first quarter, and 48% of our second quarter sales were inventory homes compared to 47% in the first quarter.

Our community count's 220 at the end of the second quarter, up 5% versus 2018's second quarter, and up 5% from year-end. The breakdown by region is 88 in the Northern region and 132 in the Southern region.

During the quarter, we opened 24 new communities while closing 18. We opened 42 new communities during the first half of the year. And 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 second quarter record 1,538 homes in the second quarter, delivering 58% of our backlog compared to 51% a year ago.

Revenue increased 12% in the second quarter, reaching a second quarter record $624 million. This was primarily a result of an increase in the number of homes delivered and a higher average closing price.

Our average closing price for the second quarter was $389,000, a 1% increase when compared to last year's second quarter average closing price of $387,000, and our backlog sales price is $395,000, down slightly from a year ago.

Land gross profit was $400,000 in the second quarter compared to $82,000 in last year's second quarter. And our second quarter 2019 operating gross margin was 19.2, down 80 basis points year-over-year and down 10 basis points from the first quarter.

We estimate that our construction and labor costs were flat when compared to 2018's second quarter, with lower lumber costs offsetting higher labor costs.

Our second quarter SG&A expenses were 11.8% of revenue, improving 80 basis points compared to 12.6% a year ago. This reflects greater operating leverage, and improving our operating efficiencies continue to be a major area of focus.

Our second quarter pretax results in 2018 were impacted by $3 million of acquisition-related expenses related to our Detroit acquisition, which closed March of last year. And 2019's second quarter expenses were $100,000. Interest expense increased $300,000 for the quarter compared to last year. Interest incurred for the quarter was $13.2 million compared to $12.1 million a year ago. And this increase is due to higher outstanding borrowings in the quarter as well as the higher weighted average borrowing rate.

We have $22 million in capitalized interest on our balance sheet. This is about 1% of total assets. And our effective tax rate was 27% in 2019's second quarter compared to 17% in last year's second quarter.

2018's rate included tax benefits from Energy Tax Credits that did not reoccur in 2019's second quarter. And we estimate our annual effective tax rate this year to be around 26%.

Our earnings per diluted share for the quarter increased to $1.08 per share from $0.96 per share last year as a result of lower share count and improved earnings.

During the first quarter of this year, we repurchased $5 million of our outstanding shares. We did not repurchase any shares during the second quarter of this year.

Now Derek Klutch 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 $6.7 million in the second quarter, 28% increase compared to $5.2 million in 2018's second quarter.

Revenue was up 20% to a second quarter record of $14.3 million, due to a higher volume of loans closed and sold along with some improvement in pricing margins.

The loan to value on our first mortgage for the second quarter was 82% in 2019, the same as 2018's second quarter.

77% of the loans closed in the quarter were conventional and 23% were FHA or VA compared to 80% and 20%, respectively, for 2018's same period.

Our average mortgage amount increased to $308,000 in 2019's second quarter compared to $306,000 one year ago. Loans originated increased 12% to a second quarter record of 1,037 and the volume of loans sold increased by 11%.

For the quarter, the average borrower credit score on mortgages originated by M/I Financial was 745, which is the same as last quarter. Our mortgage operation captured about 79% of our business in the second quarter, down slightly from 80% last year.

At June 30, we had $78 million outstanding under the MIF warehousing agreement, which is a $125 million commitment that was recently extended and expires in June of 2020, and we also had $26 million outstanding under a separate $50 million repo facility, which expires in October of this year.

We expect to extend the repo facility prior to its expiration. Both facilities are typical, 364-day mortgage warehouse lines that we extend annually. 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, focused on investing in new communities while also managing our capital structure.

Total homebuilding inventory at June 30, '19, was $1.8 billion, an increase of $111 million above June 30, '18 levels. This increase was primarily due to higher community count and more finished lots.

Our unsold land investment at June 30, '19, is $797 million compared to $707 million a year ago. And at June 30, we had $368 million of raw land and land under development and $429 million of finished unsold lots.

We owned 5,356 unsold finished lots with an average cost of $80,000 per lot and this average lot cost is 20% of our $395,000 backlog average sale price. Our goal is to maintain about a 1-year supply of owned finished lots.

And the market breakdown of our $797 million of unsold land is $330 million in the North region and $467 million in the Southern region.

Land owned and controlled as of June 30, '19 totaled more than 29,000 lots, 51% of which were owned and 49% under contract. We owned more than 14,800 lots, of which 43% are in the Northern region and 57% in the Southern region.

A year ago, we owned 13,000 lots and controlled an additional 15,000 lots for a total of 28,000 lots.

During 2019's second quarter, we spent $86 million on land purchases and $62 million on land development for a total of $148 million, and about 42% of the purchase amount was for raw land.

Our estimate for total 2019 land purchase and development spending is $550 million to $600 million, which includes the $283 million spent year-to-date. And this compares with $552 million in total land spending last year.

At the end of the quarter, we had 464 completed inventory homes, about 2 per community, and 1,413 total inventory homes. And of the total inventory, 522 are in the Northern region and 891 are in the Southern region.

At June 30, '18, we had 374 completed inventory homes and 1,272 total inventory homes. Our financial condition continues to be strong with $904 million in equity and homebuilding debt-to-cap ratio of 45%.

At June 30, '19, there was $174 million outstanding under our $500 million unsecured revolving credit facility. We have continued to focus on managing our leverage and liquidity and balancing this with our land needs.

This completes our presentation. We 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) Your first question comes from the line of Thomas Maguire with Zelman Associates.

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Thomas Patrick Maguire, Zelman & Associates LLC - Senior Research Associate [2]

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Great job this quarter, really impressive execution. Just first, I appreciate all the color on the demand and the orders by month. But drilling in there, can you qualitatively talk about just today's demand environment and how it's progressed since the beginning of the year? And kind of how do you think about the drivers of what seems like steady improvement in the market? Is it interest rates? Or what other dynamics do you think are at play? And just any thoughts on how July is trending thus far?

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

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Yes, Thomas. Thank you for your comment. As far as the question, I think that we've seen -- the biggest change that we've seen, and of course, you know this very, very well, is at the beginning of the year, rates were very close to 5% and now they are very close to 4%. And I think that, that is a -- there's tremendous -- particularly, with first-time buyers or first-time move-up, maybe, I think that there is -- we've now learned that there is significant rate sensitivity. And for many of us, a 5% rate is a wonderfully low historic rate.

But for people that are just entering the market, or that maybe have gotten used to rates in the 3s over the last number of years, as the rates jumped up in the latter part of last year, I think it had a pretty obvious chilling effect on buyer demand with respect to new home purchases. As we've seen those rates fall, since January, roughly 75 or more basis points, depending upon the day, there's been a corresponding increase, I think it's fair to say, in buyer demand. Our sales have crescendoed since the beginning of the year, subject to the specific month-to-month numbers that Phil just mentioned. We don't comment on July, but we're optimistic about the conditions right now.

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

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And just to add a little bit, we're excited about getting to scale on some of our markets, especially in Texas. We have more communities open there than we did. Also we mentioned the growth in Sarasota. The acquisition for Detroit, we're progressing with additional units. So a lot of the plans we put in place and been working very hard on the last couple of years are coming out of the ground now. So we're very excited about that.

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

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And the other thing too is, just to be very frank, we're not in a runaway demand situation by any measure. We are not, nor is any other builder. There may be a few pockets in the country where demand is off the charts. And if so, it probably doesn't matter what you do, you probably sell it anyway. But I think that, I mentioned this before, you mentioned it, I think we've had pretty solid, not across the board, we've certainly made our share of mistakes, but I think we've had pretty solid execution in a whole lot of different places, particularly with some of our newer markets. And I think we're beginning to see the effects of that.

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Thomas Patrick Maguire, Zelman & Associates LLC - Senior Research Associate [6]

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Absolutely. And it's great to see. And then just, if we think about the demand environment and the improvement that you talked about, how has that changed just the competition in the market between builders? Have you seen incentives and competition ease? I know there's a lot of seasonality that goes into that, particularly as we get to the summer. But just can you take a high-level view and talk about the competitive environment today? And maybe any comments on pricing power you have across your portfolio?

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Robert H. Schottenstein, M/I Homes, Inc. - Chairman, President & CEO [7]

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That's a hard question because I think it's -- I don't think we can paint all soon to be -- we've been operating in 16 markets but D.C. is basically a closedown. So let's just talk about our 15 markets that we're going with. I don't think you can paint them with quite that broad a brush. The situation's different from market to market. I don't think we've seen much more discounting over the last 30, 60, 90 days than maybe we were seeing before. I mean you see here and there and so forth. But in terms of pricing power, maybe in select communities, but I would not -- I think our margins, they might stay about where they are.

There may be a 10- or 20- or 30-basis point movement up or down throughout the year. I don't see where there's significant pricing power. And the good news is, out of 220 communities, we do have a handful of them where we have some really good pricing power. There we'll take full advantage of it. It is a subdivision business. And in the same city, you may have a subdivision where your -- you can pull 26%, 28% margins; you may have another one where it's the exact opposite. So we manage by subdivision. We do have a handful, maybe several handfuls of them, where we have pretty good pricing power.

But all in all, I think margins are going to be relatively stable. But a lot of that will depend upon the rate environment and probably a lot of factors that we don't have a whole lot of control over. But we are very optimistic about our business, not that it's going to go crazy through the roof, but it's in a very steady growth trajectory.

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Phillip G. Creek, M/I Homes, Inc. - Executive VP, CFO & Director [8]

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And we're opening a lot of stores. Last year, we opened 67 new stores, and we've opened 42 new stores in the first half of the year. So we're trying to do a really good job on having the right product at the right price. We only get one chance to open. We try to open the right way. We don't open, most of the time, too many lots for sale. We try to open a few and get a good feel for who really the buyers are and the price point, as Bob said, we could have a low pricing power to take that pricing up. But with opening, basically, 100 new stores in 6 months, that's been a heck of an opportunity for us. And we have a number of stores scheduled for the second half of this year. So we're trying to pay a whole lot of attention to that.

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Operator [9]

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Your next 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 [10]

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The first one I had, the SG&A margin improvement last year to this year was pretty impressive. Do you guys believe you all can pull that off in 3Q and 4Q if volumes hold up where they are?

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Robert H. Schottenstein, M/I Homes, Inc. - Chairman, President & CEO [11]

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I think that I'm going to let Phil give a much more detailed answer. We believe we still have an opportunity to improve at that level. A year ago, we felt we had more opportunity because we had so many new markets that weren't even getting close to scale yet. We still think there's some upside there. At some point, it clearly levels off. So we are -- we remain focused as a high priority on continuing to get as much operating leverage as we can. Phil, I don't know if you want to add anything.

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Phillip G. Creek, M/I Homes, Inc. - Executive VP, CFO & Director [12]

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No. Not really. I mean like you said, we are excited about getting scale in our Texas markets, working on Detroit and Sarasota. There's always the challenge, it does take more people. What our selling expense is running, we try to pay a lot of attention to cooperates and those types of things. But we've been working very hard on this for a couple of years and we'll continue to.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [13]

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Great. That was -- it was impressive leverage. The second question, could you tell us as a percentage, maybe, of closings and orders this quarter and last year's second quarter, what percentage were Smart Series?

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Phillip G. Creek, M/I Homes, Inc. - Executive VP, CFO & Director [14]

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Of closings?

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

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Yes. Of closing and orders?

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Phillip G. Creek, M/I Homes, Inc. - Executive VP, CFO & Director [16]

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Jay, it would be a little less than sales because it takes a little while for them to get through the pipe. But if I were guessing, we talked about sales being 20%, I would guess the closings would be in the 15% range.

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Robert H. Schottenstein, M/I Homes, Inc. - Chairman, President & CEO [17]

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And maybe even less than that because we've actually opened quite a number of Smart Series communities in the last 6 months, and a lot of that stuff is just in the process of beginning to come to closing. I mean we're not pulling closings forward. We're closing houses when they are done and not until. And the encouraging thing about the Smart Series is not just the pace, which has been strong, and the buyer acceptance, which I guess is the most important thing, but we've gotten -- I mentioned strong operating results there both with margins. And even below the line margins, I mean, many of our Smart Series communities are broker cooperated, slightly less than it would otherwise be with other non-Smart communities. And all of that finds its way eventually to the bottom line, let alone a quicker cycle time and just a lot of things that at least in terms of margins can be strengthened by the continued success of Smart Series.

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Phillip G. Creek, M/I Homes, Inc. - Executive VP, CFO & Director [18]

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And if you look at year-to-date, the average sale price, Jay, on Smart Series sales is right at $300,000 compared to our overall average of almost $400,000. And as Bob said, it's above average, it's above company average, on absorption pace and also on margins. So that's been good.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [19]

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Absolutely. And where -- by the end of the year, or even maybe into next year, what percentage of total communities do you guys expect Smart Series to be?

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

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6 or 8 months -- 6 or 9 months ago, I guess, I got to think in 3-month increments when we have these calls, I think that we said that we had hoped that Smart Series would represent about 15% of the communities, and maybe a slightly higher percentage of sales by the end of this year, and it's running 20% of sales now. So that's why I mentioned that it's exceeded our expectations. I think it's going to be pushing 25% within several quarters of company backlog. And if it gets to that point, we'll -- you'll ask a question again, and we'll give you an update.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [21]

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Absolutely. And then the next question I had on ASPs, it's -- the ASP has bounced or the average closing price has bounced around over the last 5 or 6 quarters. I know you guys don't like to give guidance, but if you have a notion of where you think ASPs might end up the year, if they're going to continue maybe to trend down a little bit more, just some help on the modeling side, so we can think about what total revenues might look like [if the sale's big].

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

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Jay, probably -- we think it's going to trend down a little bit more. Now is that 3,000, 5,000, who knows? But that's kind of our thoughts. We kind of thought it might -- it trended down a little faster than it has already. That's hard to predict because with us doing 45% to 50% of specs that influences that also. But our guess is that it's going to trend down a little bit more as we go through the year.

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

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And I think that range that Phil gave is probably very accurate. I don't think it's going to be a significant number.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [24]

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And then on the gross margin. Have -- I know, Bob, you said, I think in an answer to a question, that the gross margin or margin probably don't move much from here. But are we through the worst of some of the dirt sales that you guys did in second half of '18, where you might have had to do a little extra discounting? Could that potentially be some incremental tailwind to gross margin as we move into the back half of the year?

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Robert H. Schottenstein, M/I Homes, Inc. - Chairman, President & CEO [25]

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I don't know. I don't really think about it that way. A year ago, I think we said we thought this was roughly a 20% margin business. And some quarters, we might be 20.5% and others, we might be 19.5% and it will move around a little bit. We're maybe a few basis points lower than that now. I feel like the margin situation, you're right, we do not give guidance on it. But if you have to come down somewhere, no one really knows. One of the reasons we don't give guidance on it, I mean we know our margins and backlog but one of the reasons we don't give guidance on margins is because you're, to a certain extent, playing in the dark. You really don't know what's going to happen. But I think in terms of what we believe, we think that they're probably going to stay about where they are. They may tick up a little bit because of the Smart Series impact and we talked about that. So I think that's where we come down.

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Phillip G. Creek, M/I Homes, Inc. - Executive VP, CFO & Director [26]

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Also, Jay, I mean if you look at end of the fourth quarter of last year, the operating [GP] was like 18.9%; we were 19.3%, the first quarter; 19.2%, the second. We're hopeful that some of these markets as they get a little bit bigger and we get a few more communities, hopefully that will help us give a little room to operate as far as trying to get volume up and get to profitability and so forth. But it's something that we focus on very, very much because with the anticipated revenue number of over $2 billion, there's a lot of dollars there. But right now, we kind of have been a little stable over the last 3 quarters. But obviously, we're working on trying to improve that.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [27]

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Sure. And the last one for me. The deliveries certainly were higher than what we were looking for. Was there any type of weather impact during the quarter? And what -- were there any extenuating circumstances that helped you guys close a little bit, probably a little bit faster, I think, than what the Street was looking for in terms of your closing volume?

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Phillip G. Creek, M/I Homes, Inc. - Executive VP, CFO & Director [28]

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Jay, if you look at the cycle time, it's kind of stayed where it is, maybe gotten a day or 2 worse. But it's not getting worse than what it was by week or so or a year or so ago. If you look, the last few quarters, we've been closing -- 45% to 50% of our closings were specs. In the second quarter, we closed a little over 50% specs and that does help the cycle time a little bit. We also have a few more houses in backlog further along in the construction stage than it was the prior. But we were pretty pleased with the closing number in the quarter. But those were just a couple of minor things. I wouldn't say anything significant as far as weather. Builders always use weather and mix. But I think it was a little more just getting a few more specs in the system and the beginning backlog having a few more houses further along.

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Operator [29]

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(Operator Instructions) Your next question comes from the line of Alex Barrón with Housing Research Center.

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Alex Barrón, Housing Research Center, LLC - Founder and Senior Research Analyst [30]

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Great job on the quarter. I wanted to ask as far as the Smart Series, so you gave us an idea of closings and orders, what about your land dollars? What percentage of your future communities are you guys kind of allocating your investment dollars towards Smart Series?

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

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It's a very division-by-division analysis. I said a couple of minutes ago that we're in the subdivision business and that we manage by subdivisions. Those subdivisions, I don't mean to be simplistic, but they exist in cities or divisions. And what we build, where we build, what price point and how much, it's all part of a constantly changing and iterative strategic, sort of, blueprint for every division. And when I say constantly changes, it doesn't change weekly and it doesn't even change monthly. But from time to time, once or twice a year, we're constantly revisiting that plan. Are we positioned properly? Is -- what pieces and parts of the markets are most conducive to more entry-level housing, how much, how big, what type? So that's -- other than to say that it may grow to 25% of our backlog, which means that we're bullish about it and we plan for it to continue to increase, I'm not sure I could be more specific, Alex.

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Phillip G. Creek, M/I Homes, Inc. - Executive VP, CFO & Director [32]

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I mean certain markets, San Antonio, which is a more affordable market for us by nature, end up with more Smart Series than say Austin, Texas. But it's really driven more by the competitive landscape. Our leadership teams, what we think we're good at and can do, what the availability is of land, a key part of Smart Series is we still like to have a well-located piece of land. Our strategy is not to go way out, maybe to -- and helps growth, grows that way. So every market's just a little bit different. Some will have more Smart Series than others will.

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Alex Barrón, Housing Research Center, LLC - Founder and Senior Research Analyst [33]

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Got it. And is there any way you can maybe, roughly quantify how much better the margins are and how much better the sales pace is? Are we talking, like, is the sales pace like 20% better or 50% better or even 100% better than your other type of communities?

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Phillip G. Creek, M/I Homes, Inc. - Executive VP, CFO & Director [34]

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We don't really get into that type of detail, Alex. The margins are better and the pace is better. But we'll just kind of leave it at that.

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Alex Barrón, Housing Research Center, LLC - Founder and Senior Research Analyst [35]

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Okay. One last one. As far as the interest allocation between what goes into cost-of-goods sold and what gets expensed, is there any reason not expect the corporate interest expense to trend down as you get bigger?

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Phillip G. Creek, M/I Homes, Inc. - Executive VP, CFO & Director [36]

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Why don't you repeat that, Alex?

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Alex Barrón, Housing Research Center, LLC - Founder and Senior Research Analyst [37]

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So some of your interest goes through cost-of-goods sold, right? And the rest goes -- gets expensed below the operating line. So I'm just kind of looking forward into next year, whether we should expect the interest portion that is expensed, not in the cost-of-goods sold, to start trending down?

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Phillip G. Creek, M/I Homes, Inc. - Executive VP, CFO & Director [38]

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We don't really get into projections like that. We put -- we try to run the business as far as what the business needs as far as capital structure and then what's the best capital structure. Interest incurred for the quarter was up about $1 million. We try to not get too much capital interest on our books. But we kind of look at the business kind of that way. We don't really get into what goes through here or there.

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Kevin C. Hake, M/I Homes, Inc. - Senior VP of Finance & Business Development and Treasurer [39]

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Yes. Alex, this is Kevin. We have a fairly conservative capitalization policy. So we do capitalize in the expense through cost of sales. But if you just combine the 2 and compare us with other builders, I think we have a fairly low total interest expense percentage. And it has been trending down just as a percentage of revenues for the last several years. And yes, I think as we grow it, when and where our leverage goes and where rates go and then having a trend down.

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Operator [40]

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(Operator Instructions) At this time, there are no further questions on queue. Presenters, you may continue.

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Phillip G. Creek, M/I Homes, Inc. - Executive VP, CFO & Director [41]

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Thank you very much. Look forward to talking to you next quarter.

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Operator [42]

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Thank you, and that concludes today's conference. Thank you all for participating. You may now disconnect.