Executives: Phil Creek – Executive Vice President and Chief Financial Officer Bob Schottenstein – Chief Executive Officer and President Derek Klutch – President-Mortgage

Company
Analysts: Alan Ratner – Zelman & Associates Jay McCanless – Wedbush Alex Barron – Housing Research

Center
Operator: Good afternoon. My name is Hillary and I will be your conference operator today. At this time, I would like to welcome everyone to the M/I Homes Year End Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session.

[Operator Instructions] Thank you. I would now like to turn the conference over to Phil Creek. Please go ahead.

Phil Creek: 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 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 non-public items with you directly. And as to forward-looking statements, I want to remind everyone that the cautionary language about forward-looking statements contained in today’s press release also applies to any comments made during this call. Also be advised that the company undertakes no obligation to update any forward-looking statements made during this call. 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 non-GAAP and the GAAP measure was included in our earnings release issued earlier today that is available on our website.

With that, I will turn the call over to Bob.

Bob Schottenstein: Thanks, Phil. Good afternoon everyone and thank you for joining our call to review our 2016 fourth quarter and full year results. We are pleased with our strong performance in 2016, highlighted by solid growth in revenue and earnings and record level of home closings and new contracts for the year. Homes delivered in 2016 increased 15% to a record high of 4,482 closings and the new contracts also reached an all time record of 4,755 homes in 2016.

This was a 16% increase over 2015. In addition to the full year records, we also achieved record sales for our fourth quarter with new contracts up 11% from 2015’s fourth quarter, closings were 13% higher in the fourth quarter than in 2015. Our new contracts have increased at an annual compound rate of 12% since 2008 and our revenues have grown at 14% compound rate over the same period. These are solid growth rates over the past eight years and in our view represented one of highest growth rates in the industry. As a result of our strong sales, the value of homes and backlog at December 31, 2016 increased 20% over last year to a value of $685 million with backlog units increasing 18% to 1,804 homes.

For the full year, total revenues increased 19% to a record $1.7 billion. Pre-tax income for the full year of 2016 increased 17% to more than $111 million excluding charges for stucco-related repairs in 2016 as well as debt extinguishment charges that were incurred in 2015. Net income increased 21% to $69 million, or $2.24 per diluted share, for 2016 and this also excluded stucco and debt extinguishment charges. Our SG&A expenses ratio declined 13% for the year compared to 13.3% a year ago. Our SG&A expense ratio has now declined by 100 basis points over the last two years.

We continue to gain leverage with these costs that expect to make further progress and reducing this ratio going forward as this remains a major area of focus. Phil will discuss this in more detail momentarily. Our financial services business also recorded another strong performance in 2016 setting a number of records with pre-tax income increasing 9% to $21.2 million for the year. Our mortgage operation originated and closed nearly 3,300 mortgages with the total value of mortgages originated approaching a record $1 billion. We continue to benefit for the profitable and well managed mortgage entitled business led by Paul Rosen and Derek Klutch.

You will hear from Derek in a few minutes. We have significantly expanded the company since coming out of the downturn over the last number of years adding people and communities and our established divisions and launching new operations in six new markets. We have achieved this growth by building teams with capable and dedicated individuals and leaders that share commitment and passion to building and selling high quality homes and taking care of our customers. 2016 was the milestone year for our company. It was our 40th year in business having been founded in 1976.

In addition to the many operational records, I have mentioned earlier, we also sold our 100,000 home during 2016. Looking ahead, we feel very good about our business. In terms of the economy, housing conditions are generally good and we believe that are likely to remain so. We continue to make meaningful progress in our newer divisions. We have an excellent land position and an active pipeline of new opportunities throughout our company.

And I'm excited to share with you that we recently launched a new series of more affordable homes that we believe will positively contribute to future results. We are well positioned as we started the year with more than 23,000 lots under control, an increase of 3% over a year ago. We ended the year with a solid balance sheet, $654 million of shareholders' equity and a healthy 43% ratio of homebuilding debt to capital. Phil will talk more specifically about our expectations for community growth in 2017. Let me just say that at year end, we had 178 active communities opened for sale and our average communities throughout the year were up about 10% in line with the guidance we gave last year at this time.

With our strong year-end backlog, the strength of our land position and the quality of our communities, we are well positioned to grow and to achieve further improvement in our profitability in 2017. Now, I will provide a little more detail about our three region housing markets. First the southern region, which is comprised of our three Florida and four Texas markets. In the southern region, we had 550 deliveries during the fourth quarter, which represented 39% of total volume. New contracts in the southern region increased 12% year-over-year for the quarter.

We are achieving solid results in all three of our Florida markets. Tampa and Orlando sales were strong throughout the year and we expect both of these markets to continue to perform at a very high level in 2017. Our newest Florida market, Sarasota, is of to a very solid start in its first six months of operation and we are excited about the prospects for this new division. In our Texas operations, Austin, San Antonio and Dallas, contributed significantly to deliveries compared to performance a year ago. Houston deliveries declined from the prior year.

However with our new Houston leadership team now firmly in place, we expect meaningful improvement in Houston in 2017. The dollar value of our sales backlog in the southern region at year-end was up 20% from the start of the year and our controlled lot position in the southern region increased slightly from one year ago. We have 79 communities in the southern region at the end of the year. This represented an increase of 20% from a year ago. As to our fourth Texas divisions, we have 49 communities at year-end versus 38 a year ago.

We continue to be excited about the opportunities we have to grow in all seven of our southern region markets. Next is the Midwest region, which consists of five markets. We delivered 527 homes in the Midwest during the fourth quarter and 1,690 for the year. This was a 19% increase from last year and represent 38% of total company deliveries. New contracts in this region were up 20% for the year with improved sales and very solid performance in all five of our Midwest markets.

Our sales backlog in the Midwest was up 16% from the start of the year in dollar value and our controlled lot position in the Midwest increased 14% from a year ago. At the end of the year was 61 active communities in the Midwest, which was actually a decrease of 16% from December of a year ago. The demand throughout our Midwest markets is solid. And I'm happy to say that each market is performing at a high level. Minneapolis/St.

Paul, our newest Midwest market, had an excellent solid start at its first full year of operation for us. Lastly, the mid Atlantic region, which is made up of

three markets: Charlotte, Raleigh, North Carolina as well as D.C. In the Mid Atlantic region, new contracts were up 9% for the quarter compared with 2015. Our sales backlog value was up 32% at year-end from the start of the year and we ended the year with 6% more communities than a year ago with 38 active communities in the mid Atlantic region. We delivered 339 homes out of our Mid Atlantic region during the fourth quarter.

This was up 8% from a year ago and we delivered 1,084 homes in this region during 2016, this represent a 24% of total company delivers. Both of our Carolina markets, Charlotte and Raleigh, had very good years with improvement in sales and deliveries and they are among our top performing markets company wide. On the other hand, demand in our D.C. market continues to be sluggish. With that I'll turn the call over to Phil for more financial result details.

Phil Creek: Thanks, Bob. New contracts for the fourth quarter increased 11% to a fourth quarter record of 999. Our traffic for the quarter was flat while our community count was up 2% at year-and. Our new contracts were up 7% in October, up 7% in November and up 22% in December. As to our buyer profile about 45% of our fourth quarter sales were the first time buyers.

This compares to 42% in the third quarter and 47% of our fourth quarter sales were inventory homes compared to 48% in the third quarter. Our active communities were 178 at the end of the year. The breakdown by region is 61 in the Midwest, 79 in the south and 38 in the Mid Atlantic. During the quarter, we opened 18 new communities while closing 14. For the year, we opened 52 new communities and close 49 and for the year our average community count was up 10%.

For 2017, our current estimate is that our average community count for the year will be up 5% to 10% over 2016 levels. We delivered 1,416 homes in the fourth quarter delivering 64% of our backlog compared to 70% a year ago. Revenue increased 12% in the fourth quarter compared to last year primarily as a result of an increase in the number of homes delivered. For the full-year, revenue increased 19% compared to 2015. In 2016’s fourth quarter, our average closing price was 356,000, which was lower than our third quarter average closing price of 365,000.

This decrease was primarily due to our closing mix. In the fourth quarter of this year compared to the third quarter, we closed a higher percentage of our homes from the southern region at a lower percentage from the Mid Atlantic area. Our fourth quarter gross margin was 20.0% versus 20.2% a year ago. For the full year, our gross margin exclusion of stucco related charges was 20.6 down 60 basis points from prior year. The decline from prior year is due primarily to higher land cost.

We recorded $4 million of impairment charges in the fourth quarter. The majority of this charge was for higher priced lots in two communities in Texas. Our fourth quarter SG&A expenses were 12.7 of revenue slightly harder than last year due primarily to a higher hand count. For the year, our SG&A expense ratio improved 30 basis points to 13% from last year and 100 basis points from 2014’2 level. Improving our operating efficiencies has been a major area of focus for us for the last few years and will continue to be so.

We believe we will continue to see improved operating leverage as our newer divisions increased their volume and gain better scale. Interest expense decreased $1.2 million for the quarter compared to last year and increased slightly for the year. Interest incurred for the quarter was $7.9 million compared to $9.7 million a year ago. We have $16 million in capitalized interest on our balance sheet. This is about 1% of our total assets.

And our effective tax rate was 39% in the fourth quarter, primarily due to the impact of changes in certain state tax rates. Our annual rate was 38% and our earnings per diluted share for the quarter were $0.67 per share. This per share amount reflects $1.2 million of dividends paid to our preferred shareholders. Now, Derek Klutch will address our mortgage company results.

Derek Klutch: Thanks, Phil.

Our mortgage and title operations pre-tax income decreased slightly from $5.1 million in 2015’s fourth quarter to just over $5 million in the same period of 2016. The income comparison was primarily affected by the reversal of loan loss reserves in 2015 and some modest delays in investor fundings. The loan to value on our first mortgages for the fourth quarter was 83% in 2016, the same as two 2015’s fourth quarter. 77% of the loans closed were conventional and 23% were FHA or VA. This compares to the 74% and 26% respectively for 2015’s same period.

Our average mortgage amount decreased 2% to $293,000 in 2016’s fourth quarter compared to $299,000 in the prior year while loans originated increased 18% from 906 to 1,073. For the quarter, the average borrower or credit score on mortgages originated by M/I Financial was 739, up from 738 a year earlier. Our mortgage operation captured about 85% of our business in the fourth quarter compared to 2015 to 82%. Due to the high volume of fourth quarter closings, we added seasonal increases to our warehouse facilities with temporary availability of $185 million through January 2017. At December 31, we had $120 million outstanding under the M/I of credit agreement, which is $125 million commitment that expires in June of 2017 and also $33 million outstanding under a separate repo facility, which expires in October of 2017.

Both facilities are typical 364 day mortgage warehouse lines that we extend annually. Now, I will turn the call back over to Phil.

Phil Creek: Thanks, Derek. As far as the balance sheet, we continue to manage our balance sheet carefully focused in on investing in new communities while also managing our capital structure. Total home building inventory at 12/31/2016 was $1.2 billion, an increase of $104 million about 12/31/2015 levels.

This increase was primarily due to higher investment in our backlog, higher community count and more finished lots. Our land investment at 12/31/2016 is five hundred $589 million compared to $597 million a year ago. At December 31, we had $207 million of raw land and land under development and $382 million of finished unsold lots. We owned $4,735 unsold finished lots with an average cost of 81,000 per watt and this average lot cost is 21% of $380,000 backlog average sale price. Our goal is to maintain about a one year supply of own finished lots.

The market breakdown of our $589 million of unsold land is $197 million in the Midwest. Two hundred thirty two million in the south and a $160 million in the mid Atlantic. Lots owned and controlled at 12/31/2016 totaled 23,064 lots, 45% of which were owned and 55% under contract. We owned 10,355 lots of which 36% are in the Midwest, 43% are in the South, and 21% in the Mid Atlantic. During 2016’s fourth quarter, we spent $81 million on land purchases and $58 million on land development for a total of $139 million.

And for 2016, we spent $408 million on land purchases and land development and about 35% of the purchase amount was raw land. Our estimate today for 2017 land purchase and development spending is $500 million to $550 million. At the end of the quarter, we had 376 completed inventory homes or 2 per community and 996 total inventory homes. And of the total inventory, 300 are in the Midwest, 519 are in the Southern region and 177 are in the Mid-Atlantic. At 12/31/2015, we had 483 completed inventory homes and 872 total inventory homes.

Our financial condition continues to be strong, with $654 million in equity and homebuilding debt-to-cap ratio of 43%. At 12/31/2016, there was $40 million outstanding under our $400 million unsecured revolving credit facility. And we have $58 million of convertible debt due in 2017. This completes our presentation. We now will open the call for any questions or comments.

Operator: [Operator Instructions] Your first question comes from the line of Alan Ratner with Zelman & Associates.

Alan Ratner: Hey, guys, good afternoon. Thanks for taking my question. Bob, my first question is just on the new affordable line you mentioned in your prepared remarks. I’m just curious if you could expand on that a little bit.

And how does that product compare to your current first time buyer product, which is about 45% of your business and which markets are you targeting and just generally how big should we expect that to become as part of your business over the next couple years?

Bob Schottenstein: Really good question. It’s different than anything that we've built thus far. We have one community that is open and operating and that’s off to a very good start. And we have several others that will likely be opening during the first part of this year and then a number of others that are being planned that will open at some point subsequent to that. In terms of what percentage of our total business it might become, that’s hard to say because you know we're going to react.

But if my sense is that it could become as much as 10% or 15% of our business over the next 12 months to 18 months incrementally at that kind of unit growth. So in other words we don't have the product right now. So that would be the expectation.

Alan Ratner: And if this product…

Bob Schottenstein: Exactly, where we're doing it, you know, I'm not going to say where we're planning it and where we’re doing it because I feel like until we open that sort of proprietary.

Alan Ratner: Got it.

Is the product itself though and how do you think about it vis-à-vis the current portfolio? Is it smaller or is it – what type of price point are you aiming at here. I am trying to get a feel for. Is this kind of in the express mode?

Bob Schottenstein: Yes, it’s very difficult for us in the markets that we're in now just given all of the issues associated with land prices and zoning limitations to create product that is meaningfully under $2000. The community that we have opened up, we have a couple of models that to priced out just under 2000, but it would be our hope that that once this up and rolling with 2, 3, 4, 5, 8 communities that maybe a year from now that it will be maybe will peak into the high ones, but likely in the very low twos, the $200,000, $250,000 dollar price point. And with the benefit of FHA financing and in some cases even USDA zero down financing depending upon the location, we think this is something that look we're obviously not the first or even the second or third builder to do it, but there is clearly demand for it.

There's nothing dumbed down about, it is just smaller and obviously it's less expensive, but it still carries with it our student warranty and energy efficiency construction and so forth.

Alan Ratner: Great, thank you for all that detail. And if I can get in one more Bob or maybe for Phil. You guys have obviously put a great growth over the last several years, you highlighted that in your script. And generally the SG&A leverage has been very, very solid as well.

This quarter moved in the opposite direction. And I know you mentioned, you continue to focus on that part of the business. I am curious if you can give us any more color why that flipped the opposite way this quarter if there were only one-time items in there? And then going forward how we should think about that that leverage trending if we should kind of ignore this quarter and we look at more of the recent track record or if we should temper of those expectations? Thank you.

Bob Schottenstein: I want to just take a crack or just a summary comment or an overview comment and then turn it over to Phil. I think quarter to quarter some time a lot of things can move in and not necessarily be indicative of an annual trend, but our SG&A dropped 70 basis points from 2014 to 2015, 30 during this past year, and we're looking for it to continue to drop and it is an area of focus.

With that I will turn it over to you Phil.

Phil Creek: Well one of the challenges of course have been, we have been expanding a lot as Bob talked just in the last four or five years for Texas markets. A small acquisition in Minneapolis, which we're growing also starting up in Sarasota. So, obviously, we have embedded in our results a lot of growth and also with our backlog being up 18% units, I mean, our growth plans are continuing and one of those situations where you do need a certain amount of people. We are opening a lot of communities.

Our communities have increased, hopefully will continue also in 2017. So again there's a lot of things going on mostly good. We're always focusing on those efficiencies, but sometimes quarter-to-quarter results get a little bit lumpy.

Alan Ratner: Got it, thanks a lot guys. Good luck.

Phil Creek: Thanks, Alan.

Operator: Your next question comes from the line of Jay McCanless with Wedbush.

Jay McCanless: Hi, good afternoon, everyone. First a housekeeping. Phil, could you please repeat what the inventory homes sales numbers were for Q4 this year and last?

Phil Creek: The inventory detail ones…

Jay McCanless: Yeah.

Phil Creek: Spec homes...

Jay McCanless: Yes, yeah, spec homes…

Phil Creek: Yeah, Jay, as far as the spec homes, at the end of the quarter, we had 376 completed inventory homes, two for community and 996 total inventory homes. And of the total inventory homes 300 in the Midwest, 519 in the southern region and 177 in the Mid-Atlantic and at 21/31/2015 we got 483 completed inventory homes and 872 total inventory homes.

Jay McCanless: Okay…

Phil Creek: We are also asking about how many of our sales…

Jay McCanless: Yeah, that’s what – yeah, I want to know that also. What were the [indiscernible] details this year and last year?

Phil Creek: 47% fourth quarter of sales this year were spec homes and 48% in last year’s.

Jay McCanless: Okay, great. Thank you. I turn it over…

Phil Creek: And that 48% was third quarter, 48%, so that’s sequential.

Jay McCanless: Okay, 48% 3Q. What tax rate are you guys modeling for this year?

Phil Creek: For the full year of this past year, the tax rate was 38%.

It was a little higher in the fourth quarter, but 38% for the year Jay.

Jay McCanless: Okay. Yeah, and you think it’s going to be somewhere for 2017?

Phil Creek: Not, 37%, I would think it would be pretty much the same thing. Of course there is discussion of different things, but 37%, 38% something like that kind of what we’re thinking.

Jay McCanless: Got it, okay.

The next question I had in terms of the 5% to 10% community growth for 2017, are there – are you guys going to have more of a geographic focus on one market versus another just with the plans you have laid out now.

Bob Schottenstein: I think that this is Bob Schottenstein. I think that right now approximately 38 or so percent of our business is in the Midwest. A similar percentage is in South – of course there is five divisions in the Midwest. There's seven in the south, I expect the southern region – the balance is Mid-Atlantic.

I expect that Southern region to grow more through the southern divisions, they have got more teams, more players on the field. So they should. So I think a greater number of communities are likely to be coming on in the south. And then I think the Mid-Atlantic, which is three divisions, two of which are performing at a very high level as

I mentioned: Charlotte, Raleigh, D.C. We continue to see inconsistent and frankly sluggish demand.

So we're less willing to – we're less bullish about community expansion there. So you may see a slight decline in the Mid-Atlantic most of that would probably be as a consequence of the D.C. market.

Phil Creek: And I try to give you some specifics, when you look at the breakdown of the communities at 12/31/2016, the Midwest was 34%, the South was 44%, Mid-Atlantic was 22%. We opened 52 communities in 2016.

We achieved 10% average community count growth. We’re thinking for 2017, 5% to 10%. I think Bob gave directionally, we’re going to continue growing. We got more divisions in the south, but we had put a lot of money in Texas in the last a year or two. But overall with Mid-Atlantic being in that, you know, 15% to 20% range, you’re probably there and the South and the Midwest being the bigger hitters of course.

Jay McCanless: Got it, okay. All right, well, that’s all the questions I had. Thank you very much.

Phil Creek: Thanks, Jay.

Operator: Your next question comes from the line of Alex Barron with Housing Research Center.

Phil Creek: Hey, Alex.

Alex Barron: Hey, guys. How are you? Good job. I wanted to ask if you can share any comments on what you guys are seeing in Houston in the last few months in terms of order demand. I think you mentioned closings has probably been down a little bit, but what's happening on the order side of things?

Phil Creek: Our business, the last couple of quarters has been improved in Houston.

Bob talked about a fair amount of senior management changes made in the midlevel last year. We have worked hard on getting our price points more affordable. You did hear the comment on impairments, you know with those impairments being in two communities in Texas where we had some higher priced type lots. But the short answer is our business is getting better in Houston, so we’re in better shape.

Bob Schottenstein: And Alex, what I would add to that is that, you know, I think that some of the struggles that we had in Houston were unforced errors.

We have a new leadership team now in place there. It has been for the last several quarters and we've got a lot of confidence in our future results in Houston.

Alex Barron: Okay, it sounds good. Can you also comment on what if any impact you've seen from you know since rates have gone up since the election. And if rates were to stay here, what’s kind of your feel for what will happen this year and how you guys plan to address it?

Bob Schottenstein: Well, you know, rates have gone up as you know roughly 80 basis points.

I am looking at Derek and he is nodding approvingly, so is the one that really follow that more closely than I have. We think we’ve had a good sales since then. And our traffic, what we’ve seen, it gives us a fair amount of confidence about the spring selling season. I mean we’re – look I said in my remarks that we were optimistic about our business, excited about where it is, believe housing conditions are likely to remain good. And look I think rates are going to go up again.

I don't think they're going to go down. I do think they're going to go up again, but it’s – I think that there's still a lot of fundamentals that suggest good demand. And I think we can manage our way through, but I don't think this is something that's going to – look from a historical standpoint, I mean I don't even say this to you, rates are still incredibly low, but they have moved up quite a bit in the short period of time, but it hasn't show brings too much. I mean we haven't lost our optimism by any stretch.

Alex Barron: And that’s good to hear.

And lastly, any comment you can make on order traffic activity in January?

Phil Creek: We don't make any comment on that, but we talked about how orders were strong in December.

Alex Barron: Okay, thanks guys.

Phil Creek: Thanks.

Operator: [Operator Instructions] And there are no further audio questions at this time.

Phil Creek: Thank you very much for joining us.

Look forward to talking to you next quarter.

Operator: This concludes today’s conference call. You may now disconnect.