Hilltop Holdings Inc (HTH) 2004 Q3 法說會逐字稿

Good afternoon and welcome to the Affordable Residential Communities third quarter 2004 conference call.

We apologize for the delay in earnings going out over the wires. If anyone did not receive this please call area code 203-247-5496 and we'll send one to you immediately.

At this time, management would like to inform you that certain statements made during the conference call, which are not historical facts, may be deemed forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934 as amended by the Private Securities Litigation Reform Act of 1995.

Although the company believes that expectations reflected in any forward-looking statements are based on reasonable assumptions, they're subject to economic risks and uncertainties. The company can provide no assurance that expectations will be achieved and actual results may vary.

Factors and risks could cause actual results to differ materially from expectations and are detailed in today's press release and from time to time in the company's periodic filings with the SEC.

The company undertakes no obligation to advise or update any forward-looking statement reflected in or circumstances after the date of this release.

Having said that, I would now like to introduce Mr. Scott Jackson, Chairman, CEO, and Chief Co-Chief Operating Officer. Sir, please go ahead.

Mr. Jackson, please go ahead.

OK.

Thank you and good afternoon everyone.

We appreciate you dialing into the call. With me here today is John Sprengle, my partner and our new President and Co-Chief Operating Officer and Larry Kreider, our new Chief Financial Officer.

After my opening remarks and John, who is our CFO during the third quarter, will review the financial results. I will then wrap up our formal remarks before we conclude the call with a question and answer period.

As you have probably seen from our press release on Monday, George McGeeney, our former Chief Operating Officer, has resigned from the company. We wish him well. And we are comfortable that ARC has significant bench strength and that John and I are fully capable of assuming those duties. John is President and Co-Chief Operating Officer.

Interestingly, John and I both served in this role and shared the title of COO during the first 6 years of the company's history. We're both stepping back into familiar territory and together, with the support of our experienced management team and our field management team, we'll execute on our strategic plan. And we plan to continue to build our brand in the manufactured housing space.

In our new capacities John and I will plan to spend even more time in our communities, making sure that our employers have a very clear message on what needs to be accomplished to meet both our customer needs as well as our investment goals and drive our strategic plan to meet our long-term financial goals.

We believe the industry has excellent long-term prospects and favorable demographics. However, there is some near-term challenges. Most notably with regard to increasing and driving our occupancy and improving our affordability.

Our strategy is predicated on providing clean, attractive, and affordable places to live that generate profits for you, our investors, and is competitive with other forms of housing and provides real value to our customers.

And to that end we've built a plan that provides affordability and value in the home, in the financing of that home, and in our communities. In the long run, creation of stable of cash flow and FFO is largely driven by homeowner's satisfaction both with their perceived value in their homes and the quality and affordability of the community.

Our strategic plan is premised upon the fact that in today's market a community owner, whether that is us or any of our competitors, must provide a home in order to fill a home site.

But in the long-term, homeowner's satisfaction plays the most important role in creating stable and increasing cash flow. We believe our business model will maximize performance in the short run and more importantly improve the stability of long-term cash flow because of our compelling value proposition for our customers.

If there's one thing I've learned well over the last few months is that we need to do a much better job in communicating our message to the investment community. And we fully intend to do so.

I've laid out several important thoughts to help you, our shareholders, understand, have a better understanding of our company and its operations. We are particularly focused on selling our late model rental homes as they roll off our traditional 12-month leases and the sale through our lease to own products, particularly in our new home inventory to drive our occupancy.

Both these activities add to our occupancy and provide for a long-term, stable cash flow base and a longer-term duration stay for our customers.

Further, these activities add to occupancy. In addition, the sale of previously owned homes generates cash and reduces ongoing expenses of maintaining that rental fleet.

How are we going to do this or how are we doing this today? First of all we're leveraging our community managers, our leasing managers, and our district level marketing managers. We know that by directing our marketing efforts at a local level and at a park level, utilizing those employees who know their communities best, we can better identify our customer base and satisfy our customers' needs.

I'll try to highlight momentarily recent market initiatives that have stimulated sales to significantly increase sequentially quarter over quarter and month to month.

We also utilize, as we previously have discussed, marketing strategy of hosting introductory home sale events called Fiestas. And to that end, this is used to educate our identified demographic and to bring those new customers through our communities. The return on this investment, while in the short term may be dilutive to earnings, or FFO, continues to drive top line growth. While the expenses of our Fiesta events are not considered a GAAP asset, we believe we have created brand awareness, value, and customers to create value and create customer prospects that will benefit ARC well into the future.

Our strategic plan has always been focused on the creation of value by purchasing and filling vacancy. This would include home sales, filling that vacancy through home sales, lease to own, and home rentals.

We're in the market with 3 primary strategies today. Selling existing, previously occupied homes from our rental inventory primarily for cash and also tied to a long-term land lease for that new owner, lease of newer homes, lease to own of newer homes focusing on our lease with option to purchase product and the sale of new homes both for cash and through our financing entity, Inspire.

Three marketing initiatives have been effective in capturing our target audience, the Hispanic community. Fiesta event, coupled with the creation of an infrastructure, of that infrastructure to support them, we have generated about 24,000 sales and leasing adds, which our sales and marketing teams are pursuing. And to date this has resulted in approximately 1,300 transactions.

We've also created and used in conjunction with our Fiesta events, a 15-minute infomercial, which is given both in Spanish and English and runs in conjunction with those events and has become a very cost effective means of creating awareness in both our large and our small markets.

We have created, or the creation of street marketing teams and referral programs utilizing our Hispanic resident base, basically networking within the Hispanic community. This provides the added benefit of driving a significant amount of referral business on an ongoing basis.

Success in marketing to the Hispanic demographic is driven by referral and this requires a significantly longer sales cycle than we had initially anticipated and certainly a longer sales cycle than the historic standard for our industry.

The Hispanic customer prefers to purchase a home for cash and they tend to focus on price points below $15,000. This has presented to us a significant challenge in the education of the demographic on the benefits of our product, which would include buying new homes as well as associated financing and most importantly, to overcome their past unfavorable experience within our own industry.

We believe our monthly sales results indicate that we are starting to capture this customer. We understand that this is an education process for the customer and we believe over time we will be able to migrate this customer into new products, both homes and financing options, which will create long-term benefits both for them as customers and for us as shareholders.

That being said, it's still premature to predict the sustainability of the increases for the balance of the year, as fundamentals remain begrudgingly weak. However, we intend to place our primary focus where it belongs, doing what is best for our brand and for our communities on a long-term basis, which is one of our major, our proactive approach to fill is really one of the major, unique characteristics of our company that we believe differentiates it, us, from our peers.

I'd like now to address a few key points that I believe will hopefully clear up some near-term concerns that seem to be on many of your minds with regard to our strategy and our financial posture.

First, trend in home sales. As many of you might remember from our IPO road show, we showed an important slide demonstrating the trend line in used home sales. The average age of our used home is just under 4 years with an average blended cost of approximately $13,000.

In the June to October timeframe, and remember our October results are still preliminary, the trend has not only been positive sequentially but accelerating. Of course we can't accurately project the future, but we are quite excited by these results. In other words, we do not see sales growth as linear, as we have previously stated.

But as depicted on the slide, which is included on the Web site, that includes trends of sale of homes. Our monthly home sales from June to October were 35 in June, 64 in July, 72 in August, 164 in September, and slightly over 300 for the month that just ended in October. Given the trend is increasing at an accelerating rate, as we'd discussed on the IPO road show.

Second point, redeployment of capital, as we stated in our IPO road show we were excited, very excited, about the hometown communities that we acquired. Most of the communities dovetailed nicely with our core markets and provided us with complimentary locations.

We also understood that we would more than likely divest some of the communities, which we had to buy, that had low occupancy or would require too much time or too much investment to make them meet our ROI criteria. To that end we announced the sale of 15 communities in the third quarter. I'll go into more detail on that in a few minutes.

We are constantly evaluating the performance and prospect of all of our communities. The sale of communities is entirely dependent on how it will affect our ROI and whether it justifies the continued investment or whether capital and time and human resource could be better deployed elsewhere.

In communities with low occupancies that are outside of our core markets that we do not feel offer us FFO growth opportunities or provide us any competitive advantage to turn things around, we have no reservation of disposing of these assets and securing higher investment returns somewhere else.

In late September we auctioned 12 manufactured home communities comprising approximately 2,900 home sites in non-core markets, part of those being part of the hometown acquisition. These communities averaged 57% occupancy, which was far below our company average of 81%, which in our opinion provided limited opportunities to turn things around dramatically without significant capital infusion and requirements of time. The sale also included 2 parcels of undeveloped commercial land located adjacent to one of our communities.

Net proceeds from these sales were 21.6 million after repayment of associated debt represented a capitalization rate of approximately 8.8%. Three of these community sales have closed, with the remainder scheduled to close over the next 30-to-45 days. We also contracted to sell 3 other communities with similar characteristics for 5.9 million. All 3 of which have closed, and the remaining communities scheduled - all of which have closed actually, all of which closed today.

We also purchased 2 communities, 282 home sites in the Salt Lake City market for 7.4 million, and we now own 19 communities with over 3,800 home sites in our Salt Lake City MSA. Overall, our cap rates on these purchase and sell transactions are in line with the market.

For example, we bought the D.A.M. communities at the end of the second quarter at a going end cap rate of 8.5%, while in the sale of our non-core, lower occupancy communities in the third quarter, we had an 8.7% cap rate. In Salt Lake City, those acquisitions in the second and third quarter, we had going end cap rates of around 6.7, but with significant opportunity to bring rents to market and improve the yield of those assets.

Financial liquidity, our company has a very strong balance sheet and plenty of financial liquidity. The 15 properties we sold, which I just discussed, will yield 27 million in cash in the fourth quarter, assuming the buyers put form under the remaining contracts. We also have an additional 15 properties with approximately 3,100 home sites that we intend to sell through auction, but through other conventional negotiation processes, that will also add significantly to our cash position the first quarter of 2005. ] Additionally, these will probably result in non-cash impairments similar to the ones that we incurred in the third quarter of those that are in the process of closing today. We've also negotiated a more favorable asset lending facility that provides greater flexibility. Our balance sheet has an additional $157 million worth of home inventory that is not pledged for financing.

This enables us to further leverage our asset base if needed. We view this 157 million of inventory as a unique and a competitive advantage in driving occupancy and building more stable, long-term rental revenue. More than 3 years ago, we understood the industry was changing. We made a conscious decision to enter into the leasing and rental business to drive our performance.

While it has proved to be a successful short-term strategy, we will now be positioned to further harvest this asset that is embedded within our balance sheet. As those homes come off the lease, we're in a position to sell those homes at fair market price that closely matches our targeted demographic price point, raising cash and creating a new five-year commitment of lease payments to improve community occupancy.

Let me share some of the details on this $157 million opportunity. This includes approximately 1,000 vacant older homes and approximately 4,200 occupied older homes coming off lease in the next 12 months. In addition, it includes approximately 2,800 newer homes of which approximately 2,400 of those are occupied and 360 are vacant and available for sale or lease. Specifically, the sale of those homes at approximately $13,000 per unit at roughly a conservative run rate of 250 homes per month would offer us a monthly run rate of almost 3.3 million in additional cash.

In addition, each sale involves the creation of a customer commitment to a full five-year lease on the property creating a substantially more stable revenue stream. Finally, .4 are dividend. There seems to be concern about the stability of our dividend as well as our ability to pay it. Our board has reviewed our strategic plan and is comfortable with our policy at this time.

As (inaudible), we've committed to the dividend policy and our board will evaluate our current dividend every quarter, but where we are today, we feel comfortable with that policy. Based on today's closing price, our current dividend yield is 9.4%.

With that, I'll turn the call over to John.

Thanks Scott. Let me start by stating that the prior period numbers have been recast to reflect the exclusion of the 15 properties held for sale in the third quarter. For the 3 months ended September 30, 2004, our net loss available to common shareholders was 17.2 million, or 42 cents per share on a fully diluted basis, compared to 7.1 million for the 3 months ended June 30, or 17 cents per share.

We reported FFO of 2.6 million or 6 cents per share on a fully diluted basis in the third quarter, versus 9.3 million and 23 cents per share in the second quarter.

Additionally, net loss to common shareholders and FFO in the third quarter included charges of a half a million dollars or 1 cent per share related to property damage sustained during the recent hurricanes in the southeast, 3.3 million or 8 cents per share related to the revolving line of credit that was cancelled and replaced in the third quarter, and 2.1 million or 5 cents per share of marketing and promotion costs related to establishing our Hispanic marketing program and our larger sales organization.

Revenue for our real estate segment for the three months ended September 30, 2004, increased 3.1 million or 5.6% to 58.3 million compared to 55.2 million for the three months ended June 30, 2004. This increase resulted primarily from the D.A.M. and other acquisitions. Expenses for our real estate segment for the three months ended September 30th were 26.6 million, compared to 22.9 million for the three months ended June 30.

The increase is due primarily to increases in expenses of 1.9 million from the D.A.M. acquisition, and 1.8 million from expense increases in the other communities, primarily repairs and maintenance, the hurricane cost and some bad debt expense. As a result, our real estate net segment income for the three months ended September 30 was 31.8 million, as compared to 32.3 million for the 3 months ended June 30.

Revenue for our retail segment for the three months ended September 30 improved 100% to 4 million compared to 2 million for the three months ended June 30. The increase resulted primarily from the increased number of homes sold, up to 282 homes from 125 homes in the second quarter, driven by our in community retail home sales and financing initiatives.

Expenses for our retail segment for the three months ended September 30 were 6.3 million, compared to 3 million for the three months ended June 30.

The $3.3 million increase is primarily due to the increased number of homes sold and roughly $1.9 million in advertising expenses and other expenses primarily related to the creation and execution of the fiesta events. As a result of the foregoing, our retail home sales net segment loss for the three months ended September 30 was 2.3 million, compared to a $1 million loss for the three months ended June 30, 2004.

Looking at this on a same community basis, comparing the third quarter of 2004 to the third quarter of 2003, real estate net segment income was down 9% to 19.6 million from 21.5 million. This decrease was a result of relatively flat same community revenues and a 16% increase in same community real estate expenses.

The increase in same community expenses came primarily from an increased R&M, salaries and benefits, and bad debt expense, some utility expense and the insurance expenses. Turning to the 9 months ended September 30, our net loss available to common stockholders was 59.3 million or $1.60 per share on a fully diluted basis.

We also reported FFO of a negative 10.4 million or 28 cents per share on a fully diluted basis for the 9 months ended September 30. Average occupancy for the third quarter of 2004 was down four-tenths of a percent to 81.1 percent compared to 81.5 for the second quarter of 2004. Occupancy at the end of the period on September 30 was 81% compared to 81.3% on June 30, 2004.

Scott spoke a little bit, but with respect to the acquisitions during the 3 months ended September 30, we acquired 2 of the manufactured home communities with 282 home sites in Salt Lake City for approximately 3.6 million in cash and 3.8 million in assumed debt.

Now I'll turn this call back over to Scott.

We stated previously we're committed to our vision of building long-term shareholder value. Not only will we support our core communities and maximize their occupancy, but we will also sell communities that do not offer favorable long-term growth prospects. We plan to utilize our cash flow to generate higher capital returns. To that end, our balance sheet remains strong.

We have more than 157 million of non-pledged assets consisting of homes with an average age of just less than 4 years. As the older homes come off lease, we intend to sell them at prices that fit well under our demographic focus, and this, we believe, will result in a stable resident base, higher occupancy and increased cash flow over the long term.

So at this point, we would like to open it up to questions and hopefully, we will do a reasonable job here in clearing up some of the confusion in the market.

Thank you sir. Ladies and gentlemen, if you do wish to ask a question, please press star, followed by one, on your touch-tone telephone. If you wish to withdraw the question, press star, followed by two. We'll pause a moment to compile the questions.

And your first question comes from the line of Paul Aternato (ph) of Mass Core (ph) Financial. Please go ahead.

Hi. Thanks. Good afternoon. I think it was on the last conference call where you mentioned that you needed to replace more community level managers than you had previously anticipated. Could you talk about that? Where do you stand on the ground level of personnel at this point?

That was primarily in the Atlanta market, Paul, and primarily in the Hometown acquisition. We have substantially replaced the majority of those managers. I believe we have 1-to-2 openings left; however, the majority of those park managers that we decided we no longer wanted to keep in our employ are gone.

And so at this point, would you say that portfolio wide, you're happy and satisfied with the ground level of personnel?

I think we're in pretty good shape with park managers. We're supplementing our regional operating infrastructure by adding a new position in some of our smaller metropolitan markets that may be not in the mainstream, meaning a market for example like Birmingham, Huntsville, Alabama and Nashville, Tennessee, with the creation of an operating manager who will report to the regional or to the district manager.

I believe we are in the process of adding 3 of those system wide. We are also adding 2 new district managers, both of which have been hired and they were hired from within, so they are quite familiar with our operation.

We have also added a third regional vice president, who although not from the manufactured housing industry, has a long tenure in managing convenience stores and various other real estate based retail outlets, including his own company which he recently sold to his son.

OK. And what are the G&A implications of these managerial additions?

In general, it isn't significant and it is not significant in light of elimination of a number of headquarter staff.

OK. Moving to asset sales, you described a few assets that you were planning to sell. Looking at the stock price these days, does it make sense to ask the board to authorize a stock repurchase program?

The board is looking at that. I think that they want to see our progress over the course of the next quarter or so, but clearly, as we generate cash, we'll consider the very best investment alternatives for that cash.

OK. And regarding the impairments that you're taking on the assets that you're selling, what's giving rise to the impairments? Are these - these are assets that you bought from Hometown? Or were these other assets?

Paul, we don't recognize a gain or a loss on the sale of the communities we bought from Hometown, at least for the first year it results from an accounting standpoint and a reallocation of the original purchase price. So these impairments that we recognize are with respect to the communities that were owned by ARC originally.

OK. OK. OK. I'll yield the floor right now. Thanks.

Thanks.

Thank you sir. And your next question comes from the line of Lee Cooperman of Omega Advisors. Please go ahead.

Thank you. First, if I could attempt to give you a helpful suggestion, it's very unusual, but the call got started around 5:00. Your press release didn't cross the wires until 5:20 according to Bloomberg. I think in fairness to anyone who's interested in the company, myself included, to have the release for a while to review prior to the call would probably be very advisable. And also, you referred to some slides.

I can't find them on your Web site. I certainly don't find them on Bloomberg. So you might want to maybe release earnings a couple of hours before the call so people can study and look at them to form their questions. That's just a suggestion.

Now I'll get to my questions. You didn't really say much about the dividend. All you said was that the board would review the dividend quarterly, which is the case if you earned it 10 times over or if you don't earn it. Clearly, myself and others that are looking at the company, we see we're in a situation we're not presently earning a dividend.

Given liquidity and the budgets that the management is presenting to the board, do you think the board is of the mind to maintain dividend until the funds from operations cover the dividend?

Yes, I do, Lee.

OK. The second question, you've been selling a lot of properties and I assume like it normally happens, you sell properties that are less attractive than the ones you keep. If you were to look at the cap rate that you're getting on your inferior, less occupied, less strategic properties, and try to interpolate that into the significance of the remaining properties, do you have an opinion?

And I realize an opinion is no guarantees in life, but do you have an opinion as to whether the remaining assets are worth more than the stock price or less than the stock price? I guess what I'm really asking, if you turned around and decided to sell the entire company, ...

If we were to liquidate?

If you were to liquidate the company, forgetting about tax implications, which I assume wouldn't be too severe because the dividend is largely tax-free return to capital for the moment, do you believe the liquidating value of this company is more in line with the IPO price or well in excess of the last sale or is that not in your mind clear?

No. In my mind, it's clear. And I believe on a personal basis that the value of these assets are still the value of these assets. And whether or not we have missed numbers doesn't affect the underlying value, and I would simply look at the situation of Chateau Communities. That was a company trading at $18, it was put in play and traded at $29 in the merger market.

Am I correct that the tax status of the distribution at the current level is largely called 90% or so return on capital?

Yes.

Yes, that's correct, Lee.

OK. Got you. OK. And when would you hope, based upon your business plan, that your FFO would cover your dividend? Is that kind of a mid '05 kind of occurrence?

Obviously it depends on absorption, but we believe that we'll be in that position certainly some time next year.

Thank you. And I gather from what you said, I'm going to listen to the replay, you have ample liquidity, room on your lines, et cetera, that there are no financial issues at the company?

That is correct.

OK. Thank you. Good luck in your turnaround.

Thank you.

Thank you sir. And your next question comes from the line of William Atchison (ph) of Merrill Lynch. Please go ahead.

Yes, thank you. On your sales activity for the third quarter, the numbers that you gave out, it seems to add up to sales of 300 homes, July, August, September. Is that correct?

That's right Bill.

Okay, I'm a little bit - the occupancy was actually down second quarter to third quarter, so I take it this wasn't enough to move the occupancy rate?

It still was not enough to move the occupancy rate that is correct, but it certainly helped us sort of maintain even. I think one of the things that we're adjusting through the system is as we focus more on cash sales, we're pulling homes out of the lease (inaudible) holding them for sale - selling those and clearly that is a new activity for our community managers and our sales and leasing people so they're still balancing that. Also as it relates to our traditional leasing model and our lease to own as you recall we introduced the "Lease to Own" the - really the first part to the middle part of the third quarter and although we don't have those numbers here those are starting to increase and we are focusing our field personnel on emphasizing that "Lease to Own" product over our historic leasing product.

Okay. I guess the other factor that affects the metrics here is the trend in repossessions. Do you have comparable statistics for that?

I don't have the exact numbers here with me, but the repos were down slightly in the third quarter versus the second quarter I think from a little over 300 repos in the portfolio in the second quarter versus a little under 300 in the third quarter.

That's still not material and certainly not demonstrating any sort of positive trend from our point of view.

Do you have an occupancy rate for the end of October?

Yeah, we're about flat at the end of October.

Okay. How about employee turnover? For those people that you deem should stay with the company what's the experience been there?

No - can you give that to me again?

Yeah, at the park level what is your experience with employee turnover aside from the ones that you have purposely removed from management?

Well ex-maintenance people we have very good experience at keeping and maintaining our management at the community level.

Okay thank you.

You bet.

Thank you sir and your next question comes from the line of David Rodgers of Key McDonald. Please go ahead.

Yes. I think over the past several months - and you didn't mentioned it in your comments that there's been a significant amount of turnover not only on the community level but also at the headquarter level. You said in your comments that you had sufficient bench strength. Can you give us some ideas so that we can have some confidence that there is something there given the turnover that you have and can you explain a little bit some of the reasons for the turnover at the corporate and executive levels.

Ah sure. First of all let me talk the bench strength. Today in our regions we have two individuals that have been with us over five years and have gone through the ranks of who are both regional senior vice presidents. They essentially prior to George's departure were running the entire operating site of the company on a day-to-day business albeit a portion of the Western part of the United States. Both of those individuals have significant experience in the - one worked for Host Marriott for many years. One worked for Motel 6 for many years. They then consistently successful in meeting their numbers year-over-year. They've both been with the company now five years.

We are helping them to supplement by adding this third regional vice president and bringing one of our very top district managers into sort of a training position with the thought that eventually we'll have four regional vice presidents. We've also sort of sliced and diced the portfolio and we've pulled out basically 50 of our largest most vacant communities which we're deeming as our high focus communities which is similar to what we've done historically when we really built our business based on buying, fixing, filling and running.

We're adding additional resources that were sort of re-deployed from other areas and I guess overhead associated with at least two of the people that resigned which were really capital market deal people. Earlier in the year we've been able to create that group which is called our strike force group there. A number of them are legacy employees that have done many, many different things within the company. Some of them are outside hires but are people that we've known well that have been in the industry and that group in conjunction with our regional group have developed some programs to focus on those communities that have the highest vacancy and need the most intellectual capital and resources applied to it.

As you can imagine that group is compensated significantly different than our capital markets people and really in that area of capital markets those folks were paid basis that were competitive with sort of Wall Street type wages. So we've been able to add more people.

In terms of financing, are you seeing any change in the financing side of the business that gives you any greater confidence for sometime in 2005 that there'll be more availability of dollars?

No. I think our business plans which is almost completely focused towards us providing in a proactive nature the fill side of this business. We're glad we have it. In fact if anything, we're seeing less and less activity from the industry in fill other than specifically homes and financing from Clayton. Other than that, the channel business at least from where we are is almost non-existent.

Thank you.

Thank you sir. Our next question comes from the line of Jordan Sadler. Please go ahead.

Hey Scott. It's John Litt. Can you here me?

Hi John. Yes.

I think Jordan's on as well.

Hi Jordan.

A couple of questions. One of the strategies that you outlined that your IPO was to buy these rental homes and lease them out so I was wondering if you could talk about how that's progressing?

Sure and I know there was a fairly ramped rumor that we'd cancelled orders from our major supplier Fleetwood which is not true and in fact we just completed an order of almost 700 homes. What we did do however was we slowed down the order, we backed up and we made sure that we had the right capital allocation into the right communities and also the right mixture of new homes versus price points in those communities versus customer identification. In other words, who were the customers in those specific communities and how we got that inventory into those communities trying to make it the most efficient.

We had a point of view that clearly we know that we can fill rental homes. There's absolutely no doubt about it and in fact you know we do that every day, but we also know that from a long-term perspective, if you look at our business plan, ultimately those rental homes are going to work themselves into homeowners whether it's the existing tenant or whether it's a new tenant and we wanted to make sure that we didn't have new homes in markets that simply could not support reasonable rates of return on the costs of those new homes.

So how many homes have you purchased and how's the rent up going?

We have purchased roughly 3,500 homes since the beginning of the year of which I think the last 900 of those were delivered to us in August. Right now on a total portfolio basis they are about 70% occupied. There is a portion of those homes which are being held out from the rental fleet to be used as display homes as we develop both our finance sales business as well as our Lease to Own business on a sort of a pre-sold basis to make our inventory management more efficient.

How many homes do you have left on order?

We have - we have actually scheduled out orders and we've put in a system which basically sort of self - monitors itself so that we are never over 12 vacant homes in any community and I believe we have scheduled approximately 9,000 homes to be ordered between now and roughly 12-18 months depending on demand.

Okay. The second strategy you had was to sell homes and provide the financing with the Merrill [Shadow] line-

That's correct.

Can you give us an update on what activities happened there?

Sure. For example, in October we sold roughly 305 homes. Of those, 35 of those represented basically new home sales that were financed. - the majority being new.

Three hundred and five homes.

Three hundred and five homes for October.

How many of those were new?

About 35.

Thirty-five were new homes?

Right.

So the rest were used homes that were either repos or the leases rolled over or something?

That's correct and the majority of the rest of those were homes that were coming off the lease, becoming vacant, made ready and sold into the cash market. So--

What type of price are you getting on the used versus the new?

Roughly around somewhere between 11 and $14,000 depending on market and age and size of the home. Probably high point we actually had a couple of cash sales that were approaching 50,000 in some of our higher end markets and probably on the low side was some of our oldest rental homes we were selling those homes for roughly 4,000 a piece.

And then on the new?

And on the new basically I believe our average new single wide home is about 24,000 - 23-24,000 and our double-wide is slightly over 30,000.

And you're taking the losses on the used ones is that right?

No, not necessarily. The majority--

Are you taking losses on new homes?

No. We are basically selling new homes at our cost.

So the losses that you're incurring are on previously owned market assets that are being sold below what you're carrying them for?

No, I think two things to be clear. One, the gains or loss on the sale of an individual home is dependent upon our net book value of that home at the time of sale and through the second quarter we actually generated a slight gross profit on the sale of those homes. Larry do you know on the third quarter? I think we were relatively breakeven during the third quarter, but I'd have to double check that.

The losses primarily associated with the retail operations John are associated with building the sales force and the associated costs to back and our marketing efforts to create our brand identification with the fiestas.

Maybe I'll move on to G&A and some of your costs. With some of the turnover you've had in senior management are there any charges that we may expect in the fourth quarter either for the resignation of some of these people and or the hiring of new people?

Jonathan we will take a charge of somewhere between one and a half and two cents in the fourth quarter related to George's resignation and the charges with respect to - the other severance charges that we've incurred we took in the second quarter.

And what about a ramp up either replacing these people or a ramp up - it sounds like your ramping up sales staffing. What other things that you hadn't anticipated at the time of the IPO that you're now ramping up? Maybe you can give us some sense of where those costs are going.

I would say the biggest expense associated with operations that we had not anticipated was the costs of really getting out and educating the marketplace through the initial fiesta events and creating that brand awareness creating those various medians of amortizing. Today, we now have that event significantly more cost efficient and to the use of the infomercials and the sort of in park referral business and street marketing we feel like we've gotten that to a point where that's a very, very efficient method of both attracting traffic to the platform as well as sort of long-term costs of acquisition of new customers.

You said that was up about $3.0 million in the third quarter. Do you think that's a good run rate or do you think that there might be another couple of million that will come in on top of that?

We actually think that that is - the majority of that is certainly associated with the fiesta events is somewhat of a onetime flow through to kind of get ourselves completely prepared and understand what it takes to reach those customers in an effective manner.

Clearly we have added staff in the marketing area. However for the most part that was anticipated. As it relates to G&A at the corporate level between the three individuals that have left the company that were senior executives long term I believe based on where their salary levels were and where we believe we need human resource I don't anticipate a significant amount of increase in corporate G&A and in fact I think overtime it will be probably be a reduction on a run rate basis.

Can you discuss the circumstances surrounding George's departure?

I guess not. Let me say I think very quickly it was simply a disagreement on how we delivered a clear message to the field and what was the job that we absolutely had to do. It was an honest disagreement and we wish George well.

I just want to double back to the rental units.

Yes.

You purchased 3,500 units year to date and just to clear you said that they're 70% occupied?

That's correct.

And - I'm just trying to get a sense if that's hitting the pace you expected it to. Clearly your occupancies I think you thought would have been much higher by now than they are. What's your sense of where occupancies are going to go either in the fourth quarter or the first or second quarter of next year?

I think right now Jonathan it is just too hard to tell and I think part of that is a function of no third party move-ins from the industry and still having an unclear picture on repossessions. Clearly if we would have been hitting our stride in sales like we did in October we would have a much higher occupancy.

What do you mean no third party move-ins?

Literally the industry - third parties move-ins from other retailers are almost non-existent across not only our platform, but all the other operators that I've been talking to.

But your strategy at the IPO was that you were going to sell homes and finance them and that you were going to rent up homes that you purchased. It really didn't involve a lot of third party activity.

Well it involved almost 1,500.

Yes and in the third quarter Jonathan we did about 120 third party move-ins.

In the which, third quarter?

Yes.

We just - I would say the two places that we missed and we've had a dramatic change in the industry is in repossessions which we thought would significantly decrease throughout the year and secondly in those third party move-ins.

Yes, we did anticipate you know from what we heard earlier with these other lenders talking about getting into the chattel business, we thought by the second half of '04 that they would be in this business, but we're just not seeing it.

John what I would say as it relates to home sales that two things that are significantly different. We are getting much higher home sales in the cash business than we anticipated and we are getting home sales in the cash business than we anticipated and we are getting lower home sales in the finance business. And part of the reason for that, I think, is two-fold. One we have changed our down payment bucket. Actually we've raised it from 15% to 20% and our middle bucket, which was no previous credit history and no bad credit history, a tax ID number and some various associated things primarily directed towards our newly immigrated customer.

The second piece really is that we believe that the traditional buyer today, who would qualify for a 10% down, right now because of continued low interest rates and the stick built market we have significantly lost that demographic.

I just wanted to ask, any defaults so far either in the rental home business or in the financing business?

Well, in our traditional leasing business, we always have a certain amount of defaults and that has not changed materially from what it's been over the last few years.

As it relates to our financing portfolio, performance is quite good. And as it relates to our leased to own portfolio, frankly it hasn't been in place long enough to really derive any sort of point of view there.

OK. I think Jordan has some questions as well.

Yes, thanks. Scott, I was just - on this occupancy thing, I mean, you have a few engines of growth you mentioned - the sale of new homes, the lease-to-owns and the rentals. Just on a monthly basis, as well as, now you've got some third-party move-ins coming in it seems, if you offset those with the repos, on a monthly basis what is it - is it a net flat that you're still seeing in October, November, December?

It's not flat. Frankly, we could probably be net positive if we had not slowed down our new inventory orders, but we've done that purposely to make sure that we're allocating our capital correctly and we're not getting homes into markets that we don't think deem - that generate the appropriate return on that asset.

OK.

So, I think, over time, as we continue to sell these homes coming off of our 12-month leases in an efficient manner, then you will start to see that growth in occupancy.

And I don't mean just purely rental occupancy. I'm just saying sites filled. If you're selling 250 a month, it sounds like you said you could do, and repos are, let's say, 150 a month, I don't know what the other pieces are, but are you up net 100 just people moved in versus people moved out?

We actually - quarter-over-quarter we're up net in sort of a decreasing negative. We're about 400 residents better than we were first to second quarter. So, we are actually making headway there.

I think another way to say that is...

Second or third quarter?

Yeah. Exclusive of the - if you look at all of our movement and move-out activity, including the rental homes, our quarterly change - in the second quarter we were down about 800 occupied home sites. In the third quarter we were down about 800 occupied home sites. In the third quarter we were down around 300.

So, we were still down, but to Scott's point, at a lower rate than the loss in the second quarter.

OK. Sounds like that trend reversed September, October.

Right.

Because your home sales are good.

And I think we have a bullish outlook on home sales. I think clearly they'll be affected by the holidays. You're going to have three weeks of selling activity in November. You're going to have probably, at most, two weeks in December. They're always tough months, but we feel like January - we've laid a lot of track over the course of the last six weeks.

And, in fact, if you look at September, October sales plus lease-downs, we've had a fairly successful six to eight weeks.

OK. Now I know you say you've purchased 3500 homes year-to-date. What was the ending inventory of homes you guys owned or what is it today?

Let me pull that up. Just a second.

I know it was about 8500 at the end of the second quarter.

Just under 8800 at the end of September.

OK. And are you still buying from lenders as well?

We are actively purchasing repossessions, but again, we find that those homes are, in certain markets, incredibly pricey for the type of home that we're buying. So, we continue to be pretty guarded at what we're bidding on those homes. We're looking at that policy. We're specifically looking at that policy in these 50 focused communities to see if it makes sense to be paying a little more to buy those homes or if it makes sense, on the flip side, to clear those homes out of our communities and just sort of get it out of the way.

OK. And you mentioned, in terms of purchases going forward, you said as many as, I thought you said a number 9,000...

That's correct.

The next 12 to 18 months. Is that right?

Subject to demand. That's right.

Oh, subject to demand.

Right.

You're not just going to order a big lot. How much would be the largest lot you would order in advance without having a better gauge of demand? 2,000 at a time or...?

Jordan, I can't really say that because it really is driven by demand at the park level and it depends on how their absorption is and where they stand at the point in time that we're - but we don't order homes into those communities unless they've met our criteria and that they've got the absorption and the occupancy in their existing portfolio to meet those criteria.

I guess my question is, it implies - I mean, it seems like you would have to sell or rent 8,000 or 9,000 homes over the course of the next 12 to 18 months to make that work. Is that what you're suggesting?

Right, that's exactly right.

That's about right.

Yeah, we wouldn't be buying stuff that we didn't think we could sell or rent.

And if you kind of look at our run rate, Jordan, we basically are - we think that we're approaching our run rate on used home sales. We don't think we're approaching our run rate on new home sales, but we're working on that. So, on a combined basis, that should be somewhere between 250 and 400 home sales a month during normal months, certainly not during the holidays.

We're leasing somewhere between 500 and 600 homes a month. We're trying to move that lease business to our lease-to-own business. And so, total total between those three buckets or four buckets, we should be pushing somewhere in the range of 800 to 1,000 transactions a month. So, that, depending on as we pull homes out of the rental suite, because remember we have - on our lease business in general, our tenant stays approximately 10 months. That starts to eliminate that turnover.

So, what we believe we'll see, over time, is decreasing turn on tenants and increasing sale and lease-to-own of homes. But we schedule it in so that we are never out in front with too much inventory.

All right. And last question, and I'll yield the floor. Where do you guys stand, and have you explored selling some portfolio of these lower occupancy assets, like these 50 target communities, into a joint venture? Have you explored that at all? Where is that right now?

We're discussing that with the board and we're discussing it with some outside equity sources.

Potential size, would you venture a guess?

I don't think I can at this time, Jordan. Sorry.

Thank you.

Thank you, sir. And your next question comes from the line of Craig Leopold (ph) of Green Street Advisors. Please go ahead.

Good afternoon. Kind of touching on some of your answers to the last question. If your third quarter sales were about 300 units, you were saying repos were about 300. What were leased transactions in the rental home leases in the third quarter?

Craig, let me correct one thing as I actually have looked at some numbers here. Our repos in the third quarter were closer to 400.

OK.

And our leasing transactions within the third quarter were roughly 1900.

Where is the loss in occupancy coming from second to third quarter? If repos are roughly 100 units over sales, leases are 1900.

But that's gross leases, Craig. Net leases were 560.

OK. But still a positive number. So, you're just seeing natural move-outs?

Yeah, we had natural move-outs which, frankly, as we've talked about on our previous calls are what we call organic move-outs or physical move-outs by someone other than a finance company are pretty much in line with historical experience in communities, but that was close to 700 in the third quarter.

That given the fact that we also - a number of those third-party move-outs are move-outs that are stimulated by us into some of these new communities where we either don't have the tenant quality that we perceive we need, we have bad debt that was cleaned up prior to acquisition or a number of reasons.

Is there much difference in this activity, this transaction activity, between the hometown portfolio versus what you owned previously?

Hometown portfolio significantly less rental activity today. However, we are working on that. That is the function of two things. One is just new personnel and sort of priming that pump and two, lack of inventory in those communities.

How about from an organic move-out standpoint, in terms of - you know, you indicated that you're trying to get the resident base where you want it. Is there more activity on that front in the hometown portfolio?

Yes, there is.

OK.

And that would be expected.

OK. What is it, you mentioned that sort of the rental home defaults haven't changed much over the last few years. I guess one, it sort of, that sounds surprising given that repos are up as much as they are. What is your typical default rate on leases?

The way we look at that, Craig is kind of on an average day basis, which I think the last time I looked was between 10 and 11 months for a typical resident. So, depending - most of our leases are 12-month leases, so that default rate, I don't have a specific number there, but looking at that stay...

A month or two?

Yeah, of vacancy. That's right.

Pretty similar to multi-family.

So, maybe 8% to 16%, something in there. OK. The Fiesta marketing and promotion cost, I think, Scott, your answer to the previous question was that's largely behind you?

It's largely - the R&D involved in it, the finding of the right medians, the contacting of the centers of influence, the intense sort of make-ready to get those events so that we can move them across the system in an orderly fashion, the majority of that is now behind us.

OK. And how - and of the increase - I guess, so how much of a reduction, I guess, might we expect in terms of expenses related to Fiesta?

It's kind of a function of how many we put on, but to give you some example, our first Fiesta in Dallas, I think, roughly cost us about 350,000. Today our average Fiesta event is roughly, with media, over a weekend is about 60,000 to 65,000.

OK. All right. Can you just kind of talk philosophically about the home rental business? And I know you're using it sort of as a feeder to get people to either lease to own or to eventually sell the home and keep them in that community, but to what extent is there a trade-off in terms of diminishing the appeal of the community if you have too many renters in a manufactured home park?

To what extent does that preclude you from selling new homes or having other move-ins come into the community where they'll own the home? Is there sort of a negative stigma attached to a community that has too many rentals?

Well, I think if a community has too many rentals, yes, there might be a negative stigma. I think there's a great misunderstanding of our rental fleet in the marketplace and that rental fleet has always been built to facilitate us building the right kind of database to know who those people are, what their price points are and also to ultimately cut down our acquisition costs of the new customer and to make that home, rather than - you know, traditionally this industry buys inventory in advance, sets it on a home site or sets it in a retail lot.

It can sit there anywhere from one month to three years, and clearly there's lots of spoiled inventory out there. We took the approach of getting a yield on that asset immediately using our own depreciation schedule and ultimately making that home more affordable for our customer.

On a real-time basis, the actual market depreciation of a house, say a 2000 model house and a '97 model house roughly trade at the same price out there in the marketplace. So, what we've been able to do is really help that customer have a lower cost basis as they become an owner, which we think, long term, creates a better credit for the underlying lot lease, and the tradeoff that we've been getting, which we think is pretty valuable, is tying that home sale to a long-dated term lease of five years on that house.

OK. Is it possible maybe offline, I don't want to tie up the call here, but to maybe have you walk me through the economics of the rental business at some point?

Well, as we've said to you guys before, we invite you to come out and we'll show it to you.

All right, great. I'll take you up on it. Thanks.

Thank you, sir. And your next question comes from the line - it's actually a follow-up question from William Atchison of Merrill Lynch. Go ahead.

Thank you, guys. I was trying to work at getting a run rate here. If you take the FFO, you reported 6 cents, and start adding back the impairments, the charges and extra costs you get back to a total of 26 cents for the quarter. Now if you assume half or a little bit more than half of the Hispanic branding program goes away, that could refer a run rate of something on the order of 24 cents.

Now I'm just wondering, on a recurring basis, this is the third time it's been asked, I guess, how much do you expect to spend over and above what you initially expected to spend? And is 24 cents in the ballpark?

I think those numbers speak for themselves, Bill and you just need to look at it. And at this time, we simply are not going to give guidance on earnings.

OK. But in terms of the Fiesta/Hispanic marketing program, something on the order of 1.5, 2 cents per share per quarter?

I think that's a very hard question to answer. What I would tell you is, we think we have significantly educated that customer base in all of our markets. We're now working on a referral business for customers we've already attracted. We're working in our fulfillment referral business for our current Hispanic, existing Hispanic customers, which dramatically cut our expenses.

And part of the theory behind this demographic is the way they do business, which is by word of mouth. And we believe that if we give them good value and good service they will become our best marketing vehicle.

OK. I mean, to what extent are you running into resistance? I mean, you said that this market likes to pay cash. Are they adverse to financing?

They are scared of financing, Bill. I don't know that they're adverse. I think that it's an educational process over time, and I think it has a lot to do with who is offering that financing to them. They've all got cousins and uncles and friends who've been extremely burned by other people in this industry.

And that's not to throw stones, because those were clearly industry practices over the last 5 to 7 years, but in general, what we're seeing now is, we're starting to develop a significant amount of referral business from our existing Hispanic customers and we think, over time, with some redefinition of practices we will eventually be able to educate them into, rather than wanting to buy a used home for $12,000, using that $12,000 to buy a new home for $25,000 and using that as their down payment.

To what extent are you recruiting out of the Hispanic community to help in the effort?

Significantly.

All right, thank you.

Thank you.

Thank you, sir. And your final question comes from the line of David Rodgers of Key McDonald.

I just had two follow-ups. The first, how many of the leasing and sale transactions in, say, September and October were in Florida? Or in other words, how many may have been impacted unusually by the storms?

David, I do not have that information here with me on a bi-market basis. Generally speaking, with respect to the storms, I think that we found less loss of - most of our properties in Florida that were hit were primarily home owner occupied versus home renter. And we did - those home owners suffered less damage to their homes or at least - we had some concern at one point that we may just lose quite a few residents, and most of them have either repaired their home or otherwise been able to stay in the community.

I don't think anybody yet, and we're still trying to get a better feel for this, but I don't think anybody yet has felt a pop of new home sales or leasing activity in that market, at least what they expected given the damage down there.

In fact, it's our understanding that sort of post event, that FEMA has actually cancelled or significantly delayed many of those orders. To speak to, just in general - for example, in our October sales numbers, about a third of those sales represented sales out of our, primarily our Dallas market, which is very encouraging to us.

And the last question. In terms of the rental homes coming up for lease, can you repeat again how many are coming up in the fourth quarter and then what are you seeing in terms of - what percentage go back into the leasing mode and which get sold and how many get sold?

We basically - if a home is basically older than 2002, that home gets put into a sale category, first priority cash sale, second priority finance sale, third priority lease-to-own. We have roughly 300 to 400 of those homes coming available on a monthly basis across the platform. Now we have a significant number of communities today that we are completely stocked out of inventory, but that inventory renews as we move those homes out of that for lease category into a, sort of a for sale transaction.

OK, thanks.

You bet.

Thank you, gentlemen. There are no further questions.

Thanks.

We'd like to thank you for your participation in today's conference call. This concludes your presentation and you may now disconnect your line. Have a great afternoon.