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Good day and thank you for standing by. My name is Sue and I will be your conference operator today. At this time, I would like to welcome everyone to the M/I Homes' Year End Earnings 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 call over to your host Mr. Phil Creek. You may begin your conference.
Thank you. Thank you for joining us today on the call. With me 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, our 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 the non-GAAP financial measure and the GAAP measure was included in our earnings release issued earlier today that is also available on our website.
With that, I’ll turn the call over to Bob.
Thank you, Phil. Good afternoon everyone and thank you all for joining us today. 2017 was the strong and successful year for M/I homes, as we achieved record setting revenues, record setting new contracts and record setting homes delivered. Revenues for the year reached $1.96 billion 16% better than 2016. New contracts for 2017 equal 5,299, 11% better than 2016. And during the fourth quarter of 2017, we sold a record number of fourth quarter homes with 1,220 new contracts, this was a 22% increase over 2016 fourth quarter.
Homes delivered for the year total 5,089, a 14% increase over 2016. This combination of strong sales and closing earnings resulted in a year-end backlog of 214 homes, 12% higher than year ago and year end backlogs sales value of $791 million which is 15% higher than last year's $685 million. Our strong backlog puts us in solid position as we begin 2018, pre-tax income for the year excluding the non-operating items equal to $137 million, which is a 19% over the $115 million that we earned in 2016.
Net income for the year excluding the non-core items improved by 25%, we were particularly pleased to gain additional operating leverage, as we improved our pre-tax operating margin in 2017 to 7% compared to 6.8% 2016. In terms of gross margin, our full year margins improved slightly coming in at 20.9% compared to 20.8% in 2016. For the fourth quarter, gross margins were 19.6%, 100 basis points lower than year ago. Clearly, from quarter-to-quarter, there is always a bit of choppiness due to mix and other similar factors and we experienced some of that in the fourth quarter of 2017.
M/I Financial, our financial services business had a very strong performance in 2017, setting a number of records, including originating and closing over $1 billion in mortgages for the first time. We continue to benefit from the profitable and very well managed mortgage entitle business, which helps us better serve our customers. Derek Klutch, the President of our Mortgage Operation will be presenting here in few minutes.
In 2017, we were also successful in improving our sales absorption rate throughout our communities. Sales for the year were up 11% as I mentioned earlier while active communities on average were up by 4%. We opened 67 new communities during 2017, ended the year with a 188 active selling communities and expect a further increase our communities in 2018 by approximately 10% over 2017 level.
We've always focused intensely on securing premier locations and building homes in communities where people want to live. Our strong sales growth over the past over the years is an indication that succeeding in this area. Included within our 188 active communities, our number of communities featuring our new lines of more affordable homes which we call our Smart Series, we launched our first Smart Series community in Tampa in late 2015 and today have 11 active and open Smart Series communities.
We expect to have over 15 Smart Series communities open by year end, spread across over half of our 15 home building divisions. We are excited about that. Companywide, we have a very strong land position with over 28,000 lots under control. This is an increase of 24% over 2016 and this Phil will discuss in a few minutes. We expect to increase our 2018 land spent by approximately 10% over the levels spent in 2017.
Now before I finish, I’d like to provide a bit more detail about our specific markets beginning first with our Southern region, which is comprised of our three Florida markets Tampa, Orlando and Sarasota; and our four Texas markets Houston, Dallas, Boston and San Antonio. The Southern region in the aggregate had 649 deliveries during the fourth quarter and 2,108 for the year.
This is a 23% increase for the year ago and represents 41% of companywide closings. New contrast in the Southern region increased 44% for the quarter with improved sales in all seven of our markets compared to last year. The dollar value of our sales backlog in the Southern region at the end of 2017 was up 39% and our controlled lot position in the Southern region increased 33% compared to year ago.
We have 87 communities in the Southern region as of the end of last year, which is an increase of 10% from December of a year earlier. So our four Texas divisions, we had 55 active communities at year end versus 49 year-over-year. We continue to make noticeable progress towards our goal of achieving better scale in all four of our Texas markets. This is particularly important to us as we look to continue improving our companywide returns. The demand in our three Florida markets is solid. Each market is performing well with Orlando and Tampa in particular both genuine for the very strong markets for us.
Next is the Midwest region which consists of Columbus, Ohio; Cincinnati, Ohio; Indianapolis, Indiana; Chicago, Illinois; and Minneapolis, Minnesota. In the Midwest region, we had 630 deliveries in the fourth quarter and 1,907 for the year. This was 13% better than the year ago and 38% of companywide closings. New contracts in the Midwest were up 18% for the quarter.
We are very pleased with results in our new Minneapolis division where sales increasing significantly from the prior year and frankly all of our Midwest markets continue to perform at a high level. Our sales backlog in the Midwest was up 13% from the start of the year in dollar value and our controlled lot position in the Midwest increased 15% compared to a year ago. We ended the year with 69 active communities in the Midwest, which is 13% up from a year earlier.
Finally, our Mid-Atlantic region which consisted of our Charlotte and Raleigh, North Carolina markets as well as our activity in greater DC. Raleigh and Charlotte have been strong markets for us for a number of years, but we did experience a modest fall up in sales space in both of these markets this year in part due to community openings and closings, at the level of sales and overall market demand in both Charlotte and Raleigh remains healthy. We will continue to work to get new communities on line as we sold out the number of communities in the Carolina markets in 2017.
The DC continues to be challenging to be challenging. We've reduced our investment there and we've also reduced the number of active communities we have in greater DC. Though our absorption pace in DC did improve in the fourth quarter compared with year ago, it remains below targeted company levels. We ended the year with 32 active communities in the Mid-tlantic region. This is down 16% from the beginning of the year and result of all these factors led to Charlotte and Raleigh and DC.
New contracts in the Mid-Atlantic region were down 5% for the quarter compared with 2016 and our sales backlog value was also down 18% from the start of the year. In terms of total control of los at the Mid-Atlantic region of the end of the year, they've increased 21% -- increased 21% compared to last year.
Before turning the call over to Phil, let me just include by saying. First, our company is in the best shape with ever been in. We have a strong and healthy balance sheet and excellent land condition, very good product applying to a broad segment of buyers and a high level of quality and customer service. Housing conditions are good with solid demand across most of our markets. With all that, we're well positioned for continued growth in 2018 as well as continued improvement profitability.
And with that, I'll turn the call over to Phil.
Thanks Bob. For financial results, new contracts for the fourth quarter increased 22% to a fourth quarter record of 1,220 and our traffic for the quarter was up 10%. Our new contracts were up 27% in October, up 24% in November and up 16% in December. And as to our buyer profile, about 37% of our fourth quarter sales were the first time buyers. Our active communities were 188 at the end of the year, up 6% versus 2016 year end. To break it down by region, it's 69 in the Midwest, 87 in the South and 32 in the Mid-Atlantic.
During the quarter, we opened 19 new communities while closing 10. For the year, we opened 67 new communities and closed 57, and for the year our average community count was up 4%. For 2018, our current estimate is that our average community count for the year should be up about 10% from the average of a 183 communities in 2017. We delivered 1,584 homes in the fourth quarter, delivering 67% of our backlog compared to 64% a year ago.
Revenue increased 19% in the fourth quarter over last year, reaching a fourth quarter record of $622 million. This was primarily the result of an increase in the number of homes we delivered as well as record fourth quarter revenue from our financial services operation. And for the full year, revenue up nearly 2 billion increased 16% compared to 2016.
Our average closing price for the fourth quarter was $372,000 compared to last year’s $356,000 and our backlog average sale price is $393,000 up 3% from a year ago. Land gross profit was $2 million '17 fourth quarter and $2.8 million for the full year of 2017. This compares to 1 million in 2016 fourth quarter and 4.1 million for the full year of '16. We sell land as part of our land management strategy and as we see profit opportunities.
Our fourth quarter gross margin was 19.8%, exclusive of impairment charges versus 20.8 a year ago. For the full year of 2017, our comparable gross margin was 20.9 versus last year of 20.8. We continue to see hard cost increases with estimated fourth quarter cost up about 1%. And for the full year 2017, we estimated our hard cost increased about 3% versus last year.
We reported 8 million of impairment charges in 2017 fourth quarter related to three Texas communities, each communities were purchased a couple of years ago with higher price lots. Our fourth quarter SG&A expenses were 12.3 of revenue improving 40 basis points compared to 12.7 a year ago. For the year, our SG&A expense ratio was 13% flat when compared to 2016. 2017 was negatively impacted by 800,000 of Hurricane related costs and 3.9 million of increased land related expenses.
Our non-variable selling cost increases are primarily due to a significant increase in our new community openings. Our focus continues to be on controlling our SG&A cost as well as increasing the scale of our divisions operations. Certain of our divisions including our Dallas and Sarasota startups have not yet reached desired volume levels. Interest expense increased 600,000 for the quarter compared to the same period last year and increased 1.3 million for the 12 months of 2017.
Interest recurred for the quarter was 10.4 million compared to 7.9 million a year ago. We have 17 million of capitalized interest on our balance sheet. This is about 1% of our total asset. In the fourth quarter as a result of the tax act lowering 18 corporate rate. We recorded 6.5 million in additional tax expense for the re-measurement of our deferred tax assets. Exclusive of this, our effected tax rate was 34% in 2017 fourth quarter and 36% for the year. We estimate that our 2018 effective tax rate will approximate 26%.
Our earnings per diluted share for the quarter increased 20% and $0.19 per diluted share excluding the impact of the deferred tax asset re-measurement and impact of the impairment charges in each year. Diluted EPS was 288 for '17 compared to 232 per share in 2016, a 24% increase. That excludes the impact of the deferred tax asset re-measurement and a 2.3 million non-cash equity adjustment related to the redemption of preferred shares in the third quarter of 2017 along with stucco-related repair and impairment charges in each year.
With that, I'll turn it over to Derek Klutch to address our mortgage company results.
Thanks Phil. Our mortgage and title operations, pre-tax income decreased from $5 million in 2016’s fourth quarter and $4.5 million in the same period in 2017. While our fourth quarter results included increase in the number of loans originated and sold, this was offset by higher payroll and computer related expenses. We also experienced lower margins due to competitive pricing pressures.
Loan value on our first mortgages for the quarter was 82% in 2017 down from 2016 83%. 77% of the loans closed were conventional and 23% were FHA or VA, the same as 2016 fourth quarter. Our average mortgage amount increased to $297,000 in 2017’s fourth quarter compared to $293,000. Loans originated increased 9% from 1,073 to 1,165 and the volume of loans sold increased by 4%.
For the quarter, the average borrower credit score on mortgages originated by M/I Financial was 743, up from 740 a quarter earlier. Our mortgage operations captured about 82% of our business in the fourth quarter, compared to 2016’s 85%. Due to our typical high volume of fourth quarter closing, we include seasonal increase in our mortgage warehouse credit facilities with temporary availability of $200 million through January of 2018, after which time, the total availability returns to $160 million.
At December 31, we had $128 million outstanding under the MIF warehouse agreements, and $40 million outstanding under a separate repo facility. Those are typical 364 day mortgage warehouse lines that we extend annually.
Now, I’ll turn the call back over to Phil.
Thanks Derek. For the balance sheet, we continue to manage our balance sheet carefully focusing on investing in new communities while also manage our capital structure. Total home building inventory in 12/31/17 was $1.4 billion, an increase of $199 million above December 2016 levels. This increase was due primarily to higher investment in our backlog, higher community count and more finish lots. Our unsold land investment at 12/31/17 is $659 million, compared to $589 a year ago.
At December 31, we had $247 million of raw land and land under development and $412 million of finished unsold lots. We owned 5,362 unsold finish lots with an average cost of 77,000 per lot and this average lot cost is 20% of our 393,000 backlog average sale price. Our goal is to maintain about one year’s supply of our owned finished lots, and the market breakdown of our $659 million of unsold land is $244 million in the Midwest, $290 million in the south and $125 million in the Mid-Atlantic.
Lots owned and controlled as of 12/31/17 totaled 28,531 lots, 41% of which were owned and 59% under contract. We own 11,622 lots of which 38% are in the Midwest, 47% in the South and 15% in the Mid-Atlantic. A year ago, we owned 10,355 lots and controlled an additional 12,709 lots for a total of 23,064 lots.
During 2017 fourth quarter, we spent $78 million on land purchases and $64 million on land development for a total of $142 million, about 46% of the purchase amount was raw land. For 2017, we spend $529 million on land and land development and about 35% of that purchase amount was raw land. Our estimate today for 2018 land purchase and development spending is $550 million to $600 million.
At the end of the quarter, we had 477 completed inventory homes about three per community and 1,134 total inventory homes. Of the total inventory, 371 are in the Midwest, 589 in the Southern region and 174 in the Mid-Atlantic.
At 12/31/2016, we had 376 completed inventory homes and 996 total inventory homes. We have 86 million of convertible debt due March 01, 2018, at a conversion share price of 32, 31 per share. If conversion occurs, the notes will convert into about 2.7 million common shares which will not affect our cash, but will reduce our debt and increase our shareholders equity.
Our EPS will not be impacted the shares are already the included and our diluted share count for EPS. In the event that the debt does not convert, we expect to redeem the convertible notes for cash drawing under our credit facility as needed. Our financial condition continues to be strong with 152 million of cash, no outstanding borrowings under our 475 million credit facility, shareholders equity of 747 million and a 46% home building debt to cap ratio.
This completes our presentation. We’ll now open the call for any questions or comments. Operator?
[Operator Instructions] And we have our first question comes from the line of Alan Ratner. Your line is now open.
So, obviously, the order numbers are very impressive. I guess the one area that was a lit lighter than we were looking for was the home building gross margin and I know Bob you've said, you kind of talked a little bit about just the typical fluctuations and mix there. I guess when I heard from your prepared remarks, the cost inflation, if I heard that correctly of 1% seems very modest and at the same time, looks like your prices is trending higher. So, I was hoping maybe you could just a little bit of the puts and takes on the margin that you see in the business today? And maybe talk a little bit about pricing power where you have it and to what extent? And then any impact that mix might be having on a longer term basis of margin? I am thinking about maybe your move more to entry level or maybe as you look to gain some market share in some of you newer markets? Are those becoming a bit more of a drag on your gross margin that we should be aware of? Or should we think more broadly about the stable trends you've been reporting over the last couple of years?
Let me make a comment or two and then I think Phil has a comment or two, he is going to make first. I think the cost information that Phil gave you was just for the fourth quarter, not for the full year, but he'll cover that momentarily. On these calls, we don't give margin guidance, we give guidance when it comes to community count growth and land spent, which I think is a pretty good indication of how we feel about the business. But we’ve also said, I think repeatedly over the last 12 to 24 months that we believe our margins are in the 21% to 28% range, somewhere around there, maybe little bit higher from time to time; might creep a tinge lower. I still think that right now the way we see the business, for us it is a 20% to 21% business most part.
I think there have been some drags on our margins in terms of some of our newer operation where, not only do not have scale, but may be you -- as you learn the market, open up in the market, develop products in the market and so far, some time you hit the bulls eye like we did in Minneapolis, sometime, you don’t quite hit the bulls eye as well. So I think there has been some of that. Going into 2017, quite honestly, we expected our margins to drop a little bit because we thought there could be a lot of inflation in pricing pressure, and frankly builder behaviors that we would contribute to as well. We were pleased that our margin is not only didn’t drop but went up slightly, I think there was significant issue and some things happening in the fourth quarter. We feel really good about the business in terms of our backlog going forward. Phil, I don’t know if you want to add anything.
I guess just a couple of points, Alan. You know you were correct as far as the hard cost information I gave. The fourth quarter, we were up about 1%. For the full year, we were up about 3%. So, we did see a little bit more increase toward the end of the year. Just also add to what Bob said, I mean in Texas, we did take impairment there for a couple of older communities. We have had some margin drag in getting Texas up to the volume levels we would like to. We do feel pretty good about all of our volume levels today with Texas with the exception of the Dallas. And again, there is the Sarasota start that but what wasn't anything big going through the fourth quarter, you know, and we feel pretty good overall about being almost 21% for the year, which was a little above last year.
And then I guess just on Texas in general, given the scale and it seems like that the market where labor can be tied and scale is certainly important. I look at your balance sheet, your cash balances among highest and recent memory that I've seen. Is that a market or say where you would think about potentially presume M&A to perhaps try to take some more market share there and improve your overall positioning longer term? Or do you think that you can get to the desired scale there organically?
You sort of go back to everyone's desire, which is for every land deal to be successful and for every transaction to work. No one's ever entered into any deal believing it wouldn't work. We’ve done several many acquisitions in Texas as we opened up, certainly, San Antonio as well House. It's interesting, our mini startup and our startup in Chicago were A plus. Our startup, pure startup, no acquisition in Austin, I would give an A too. Our San Antonio, Huston and Dallas and we did many acquisitions of another builder's assets in Dallas as well. Those have been I see to a B minus or may be a B.
So all in all, a decent grade, we like -- I wish all of them have been what like Monopolies, Chicago and Austin. On the other hand, we think there is great opportunity. I said at the end of my remarks, the company’s is in the best shape it's ever been in and that’s as we look across all 15 divisions, the team we have now on the field, changes that we’ve made, new community openings, new products offerings. Certainly, the initial success with the Smart Series, We're not going to comment on Smart Series Company.
But I see that whether its 10 or 20% of our business going forward, I think that's incremental additive and very positive. So I think there is a lot of reason for optimism. Housing conditions are good like virtually every builder has had a chance for comment as well as most economists, we think likely to remain so, and that’s why we’re indicating lamp spend, being 10 plus or 10 percent higher than 2017, somewhere between 550 and 600 million, opening up 10% more communities. There is sort of my overall assessment of our company and how we see things.
Thank you so much. And your next question comes from the line of Jay McCanless. Your line is now open.
The first question I had on the 10% community growth projected for 2018. Are you guys going to need to add some headcount to drive that community growth? Or can you accomplish it with staff you have on the currently?
Jay, if you look at where the headcount is now compared to a year ago. We're up a little less than 10%, when we look at 18, we would like to thanks we would be able to get some efficiencies and-- sorry, and not have to increase the headcount that much. So, we are -- just to ensure than in 2017 sales and closings grew by 10% plus. The headcount didn't -- it was lower than that and the goal is for to continue.
And then, the second question. I had and wanted to find out just you guys have made any changes to our strategy. It looks like looking at the 3Q 2017 numbers, I think fairly close to the 4Q 17. But if you guys maybe try to get aggressive and clear out some old specs and that was a dragon for first margin for Q4? And then also just how you guys are thinking about the spec strategy for 18?
It really has not been any change, Jay. Bob talked about the 10-or-so Smart Series more affordable price communities. There are in generated a few more specs in those communities. We do think we will row Smart Series communities this year. We pretty much day consistent, it could be from that 2.5 to 3, 5.5 finished specs community. We have not seen much of a JP pay differential on 20 margins all specs and to be built especially when the low inventory levels in the marketplace. So, not really any change, again, we are planning on g rowing community count pretty significantly this year, and we are introducing a fair amount of new product as you introduced new products; if you tend to model one of those new products for 2 or maybe spec a couple of more of them, but no, not any significant change in our spec policy.
And then the last question I had is on co-broker. Can you guys talk about what your co-broker cost was 2017? And how that’s as we move in the 2018?
Our co-broker percentage really hasn't move to the lot, it's about two thirds of our deals. We are always looking at that compensation structure, things like. You just pay on base [ph] house what is the rate. Now and then, you do split those brokers depending on inventory levels or issues or competition, but overall it remained pretty consistent. In general when you get into the Smart Series like co-broker percent tends to be on a lower. But again, it is a big expense to us. It's something we pay a lot of intention to. So, we're constantly looking at that.
And then just one other question on -- I don't know you guys are talking about the Smart Series. Can you remind me what percentage you said you wanted to grow Smart Series this year?
We opened up our first Smart Series community in Tamps in 2015. Today, we have approximately 11 active smart selling communities out of 190. By the end of the year, we should have slightly north of 15 maybe somewhere between 15 and 20. And you know, you always in terms of reacting to the market and so forth, trying to position yourself properly, I would easily see it becoming somewhere between 15% to 7% of our business going forward. I said 10% to 20% earlier and that’s probably a pretty accurate range. So if we had 200 communities or 210 communities maybe 15 to 21 or more long term would be Smart Series.
And is there any meaningful gross different -- gross margin difference of between, you're saving the gross margin for the company versus Smart Series or the average Smart Series own those?
I think right now tests -- first of all, the launches have been good, probably a little higher than company average. So that's very encouraging, but I think it's too early to draw a clear conclusion until we get more geographic -- get more communities open and more different geographies. I think eight or nine of our 15 divisions will have an active Smart Series community by the end of this year and that will be easier for us to answer that question with more certainty. And so far, we're very encouraged by it.
And one thing, we're really excited about we just opened our first Smart Series community in Texas. We think that will be very big for us.
[Operator Instructions] And we have our next question comes from the line Alex Barron. Your line is open.
I was curious about your orders particularly in the Southern region whether you guys were surprised and how good they were? Or do you feel like that’s the reflection of just demand coming back after the hurricanes? Or what account for that?
Well, I say a couple of things. For some time now, we think that we’ve had very strong operation in Tampa and Orlando. And they are both big markets for us and they continue to perform at or above their respective market. So, that’s a contributor. And the other thing is, I talk a lot about the differences between Austin, Dallas, Huston and San Antonio in terms of the quality of our operations in each. Austin has always been off -- was off to a good, start remain strong us. The others were catching up.
And I think now we believe, having right team on the field made some changes in these markets over the last 6 to 18 months. It takes time to some of those changes to take root and take hold. We are now beginning to see some real traction and we’re encouraged, and that’s why I think you can sense the optimism about our businesses as we sit here in the beginning of 2018. We had a lot of really strong operations in a lot of strong divisions. But some frankly, we need to improve and we believe that that is happening.
What about -- on the SG&A front, what accounted for some of sequential increase particularly in your corporate? Was there any one-time expense or something that accounted for that, Phil?
No, there was not really anything that they went through. We did close a lot of houses in the fourth quarter. We had set them internal goals this year of selling and closing 5,000 plus houses. We've never done that before. We’re very excited about that. Were there some other things, we did talk a little bit about SG&A. We had a little more write-off due to land deal that we didn't pursue. Real estate taxes are higher because we have a little more inventory and those type things. But all-in-all having the strong growth we did an income, Bob talked about the operating income up to 7% versus last year 6 or 8. Overall, we feel prior good about things.
Thank you so much. [Operator instructions] And there are no further questions at this time. Please continue.
Thank you for joining us. Look forward to talking to you next quarter.
Ladies and gentleman, this concludes today’s conference call. You may now disconnect.