Hilltop Holdings Inc (HTH) 2006 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Affordable Residential Communities Incorporated third quarter 2006 earnings conference call. Today's call is being recorded.

[OPERATOR INSTRUCTIONS]

I would like to remind everyone that this conference is being recorded and would now like to turn the conference over to Mr. Scott Gesell, General Counsel for Affordable Residential Communities, Incorporated. Please go ahead, sir.

Thank you very much. At this time, management would like to inform you that certain statements made during the conference call which are not historical fact 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 are subject to various risks and uncertainties. The company can provide no assurance that expectations will be received and the actual results may vary.

Many of the factors and risks that could cause actual results to differ materially from expectations are detailed in today's press release, and from time to time in the company's filings with the SEC. The company undertakes no obligation to advise or update any forward-looking statements reflected in, or circumstances after, the date of this release.

We would also like to inform you that with respect to our previously announced agreement to purchase NLASCO, Inc., and enter into a rights offering and other financing arrangements, as well with respect to our special stockholders' meeting on those issues, we have made other announcements and filings regarding the same. Because we are in a proxy solicitation period, we apologize, but we will not discuss those matters on this call.

You should refer to the proxy and the S-3 currently on file at www.sec.gov and on our website at www.aboutarc.com and other filings that we may make from time to time with the SEC for more information regarding these matters. This conference call will not address these matters and management will decline to respond to questions regarding these matters on this call.

Results for the third quarter 2006 are detailed in the financial tables at the end of the earnings release. As is customary for us, we have provided some expanded financial information in our supplemental package, which is available on our website at www.aboutarc.com.

Having said that, I will now turn the call over to Mr. Larry Willard, Chairman and Chief Executive Officer. Larry, please go ahead.

Thank you, Scott, and thank all of you for joining this morning. In addition to Scott Gesell, our General Counsel, and myself, we have on the call today Jim Kimsey, our President and Chief Operating Officer, and Larry Kreider, our Chief Financial Officer.

This morning, I will focus on an overview of our third quarter 2006 operations and then turn it over to Larry Kreider to provide you some details on our financial results. We will then be happy to take questions.

It has now been four full quarters that I have reported to you since I came on as Chief Executive Officer at the end of September 2005, along with Jim Kimsey as President and Chief Operating Officer. In this quarter's report to you, I will describe how we have continued to execute on the operating initiatives identified on earlier calls, and I will compare and contrast some instances to last year's operating results.

To create sustainable benefits for our residents and our company, we have steadily focused on the community and our residents on a community-by-community basis. In doing so, we have emphasized consistent application of basic management processes. To that end, we have just completed our third detailed quarterly business review, in which we reviewed each communities results, challenges and operating plans. This quarter, we have integrated our review of actual results with a community-by-community budgeting process in anticipation of completing our 2007 budget and operating plan.

In the third quarter, we managed to continue many of the operating trends we achieved in the previous two quarters. With respect to our competition, we generally see ourselves as a market leader, given the quality that we have built into our communities. The rent increases we put into effect at the beginning of this year continue to hold steady and we have had improved levels of resident retention.

In our community operations, however, we've had increases in a few key expense areas. In our repairs and maintenance activities, we have had some seasonal increases in cost related to the summer months, when more maintenance normally occurs. In our repairs and maintenance spending also reflects an emphasis on making our remaining unoccupied owned homes fully ready for sale or lease.

This is especially important as we attempt to optimize our home productivity now that home renter occupancy is above the 90% level as of the end of the quarter. We also had increases in our salaries and benefits as we continue to transition our sales effort to the community manager level.

Finding the right community manager for our communities is one of our biggest priorities. We see a need for better training, quality staffing and a customer service approach at all levels of the organization. We have also focused on continuing optimum recovery of our utility costs. While our aggregate recoveries of all utility expenditures of 73% was approximately in line with recoveries in prior quarters in 2006 and well above recovery percentages in 2005, we believe we continue to have opportunities for improvement, particularly in the recapture of water and sewer costs.

Resident retention will continue to be top priority. Overall, we had relatively flat homeowner and lease with option to purchase resident activity in the third quarter. Approximately 48% of our home renters were under lease with option to purchase contracts at the end of the third quarter. In addition, we have increased our rental home occupancy in the third quarter to over 90% from about 88% at the end of the second quarter and 80% at the end of last year.

We also continue to engage in a number of sales and marketing initiatives that we hope over time will improve our homeowner resident base in an economical manner. These initiatives are both big and small. They include reviewing resident data for qualified homebuyers or participants in our lease with option to purchase program in our home renter pool, opening select retail centers to capture drive-by opportunities in areas where we have a concentration of communities, targeting competitor communities that have inferior appearance or that are closing, improving our website for more direct-marketing opportunities, setting up programs for custom homeowners, tying resident retention to community manager bonuses, improving relationships with independent dealers, contacting local employers whose employees might have housing needs, assisting current residents from relocating to other ARC communities in the event they are relocating and, as well as the continuation of purchases of repossessed homes already in our communities and select new homes, where market conditions warrant.

We also continue to maintain controls over collections, as we emphasized in prior quarters. We believe it is very important to have our community managers directly involved with their residents in the collection process and to act quickly to resolve issues. As a result, in the third quarter, we maintained our ratio of bad debt expense to our communities at 0.6% for revenue, as compared to 0.6% last quarter and 1.8% in the third quarter of last year.

We also continued executing on the basic management processes we reported last quarter. As I previously mentioned, we have completed another quarterly review of our operations on a community-by-community basis in addition to the first round of our annual budgeting and operating plan process for 2007. We continue to move forward with the administrative improvements we identified last quarter that are designed to provide for streamlined operating performance. We have now fully implemented the invoice submission and payment system that is virtually paperless.

Our internal audit program is fully in operation in reviewing our field and corporate operations and in implementing the controls validation and work required under Sarbanes-Oxley. We have also installed check scanning into a number of our communities to allow for faster deposit of rent payments and better utilization of cash, with less work. We expect to complete our check-scanning rollout shortly and to take advantage of a number of technical improvements that should be coming next year.

As previously mentioned, we continue to manage our operations in a measured manner for cash flow. In the first nine months of 2006, we have generated positive operating cash flow of over $25 million, as compared to $15 million in the first six months of 2006 and $300,000 in the first nine months of 2005.

We have controlled our capital spending for homes and property improvements to match closely the needs of our communities. Through nine months of 2006, we have spent nearly $11 million on home purchases, as compared to $107 million in the first nine months of 2005 and increased our occupancy of these homes to over 90%. We have also closely monitored our spending for community improvements in 2006 after spending heavily in 2005 and earlier. We are nearly complete with the vast majority of the community sales we planned last year.

We closed three sales during the third quarter of 2005, recording a gain of approximately $5 million. Your year-to-date gains on sales were approximately $31 million and our net cash generated has been approximately $84 million. We had one unsold community still under contract at the end of the quarter, and we will report our progress in our quarterly releases, at a minimum.

In July, as previously reported, we completed a refinancing of our variable-rate mortgage indebtedness in which we entered into a $230 million mortgage debt facility and repaid 175 million in mortgages in our variable rate and revolving credit mortgage facilities, generating additional liquidity at 65 million.

The new mortgages bear spreads over treasury rates that are significantly less than those of the refinanced debt and the excess funds allowed us to repay significant portions of higher-cost lease receivables in consumer-financed facilities. The lower rates, combined with our repayment of a portion of our debt, helped us lower our interest expense during the third quarter.

These operating, investing and financing activities have increased our liquidity, in addition to our ongoing cash flows. As Larry will discuss in more detail, we had $156 million in cash and excess liquidity under our lines of credit at the end of this quarter, as compared to 104 million at the end of the second quarter.

With that summary, let me turn the call over to Larry Kreider, who will provide you some details on the quarter.

Larry?

Thank you, Larry. I refer everyone to our earnings release and supplemental data package that we issued prior to this call. This morning, I will provide information on our financial results for the third quarter of 2006, primarily as compared to the second quarter of 2006.

For the third quarter of 2006, we had approximately the same net loss from continuing operations as in the second quarter. This reflects lower net segment income, offset by lower interest expense and depreciation and amortization charges, plus a charge for exit fees of debt repaid in our refinancing.

In our communities business segment, net segment income reflected flat revenues and increased expenses for an overall decrease of $2 million, as compared to the second quarter. In the third quarter, as compared to the second quarter, we had a decrease in resident homeowners, largely offset by an increase in resident home renters and lease with option to purchase renters.

During the third quarter, our home and lot rents remained steady. Community expenses increased as a result of higher repairs and maintenance, salaries and benefits and utility expenses. Repairs and maintenance expenses in comparison to the second quarter reflect seasonal increases in the summer months and a focus on getting the remaining homes in our community ready for lease, lease with option to purchase or sale.

Salary and benefits increases reflect the continued transition of home-selling responsibilities to the community level. Utility expense increases reflect seasonal water and sewer utility usage. We had 121 fewer residents in our communities at the end of the third quarter of 2006, as compared to the end of the second quarter.

This was due to lower levels of homeowners by 428 residents, partially offset by increased home renters by 307 residents, largely comprised of lease with option to purchase residents. While most of our occupancy trends were comparable to the second quarter, we had 125 fewer repossession move outs and 117 greater home renter move outs during the third quarter.

For the year-to-date period, we have made considerable progress towards our general resident retention programs, as well. For the nine-month period ended September 30, 2006, we had approximately 1,600 non-repossession homeowner move outs, as compared to approximately 2,100 last year and approximately 2,900 home renter move outs, as compared to approximately 3,700 last year.

Homeowner move ins were approximately 770 residents for the year-to-date period ended September 30, 2006, as compared to approximately 450 last year, an increase of 68%. With respect to our marketing activities, we have focused on filling our vacant home assets with longer-term residents and efficiently using these assets. To this end, home renter occupancy increased to over 90% at the end of the third quarter, from 88% at the end of the second quarter 2006 and 80% at the end of 2005.

We have also increased our home renters under our lease with option to purchase program to 4,155 contracts at the end of the third quarter, representing 48% of our home renter occupancy. Our average cost in refurbishing rental units increased principally as a result of increased emphasis on getting our remaining owned homes ready for sale or rent.

In our retail sales segment, we had a net segment loss in the third quarter 2006 of approximately $1.1 million, as compared to $1.7 million in the second quarter of 2006. This reflects lower sales volume, comparable gross margin on a dollar basis and lower expenses. The deceased expenses resulted principally from a revised home leasing commission format.

In our consumer finance and insurance segment, our net segment income increased relative to the second quarter of 2006, as a result of lower interest expense from repayment of our consumer finance line of credit with lower-cost proceeds from our refinancing. In terms of other expenses, property management expenses and general and administrative expenses in he third quarter 2006 were approximately the same as those incurred in the second quarter.

General and administrative expenses, however, in the third quarter include $300,000 for the non-cash cost of the stock option plan for senior executives of the company approved by the board in July 2006. Deprecation expense was slightly lower in the third quarter of 2006, due to efficiencies achieved in our capital improvements and home purchasing practices. Interest expense was also lower in the third quarter of 2006.

The reduction reflects lower debt balances and the refinancing of debt instruments in July, offset somewhat by higher prevailing short-term interest rates applicable to our variable-rate instruments. With respect to our balance sheet, we had cash and cash availability at September 30 of approximately $156 million, including our available cash position and undrawn availability on our lease receivables and consumer finance lines of credit.

The proportion of our fixed-rate debt to total debt was 90.8% and the proportion of our debt due in 2008 and beyond is 98%. Over 98% of our debt is mortgage debt or unsecured debt, due in approximately 20 years or more.

Now let me turn the call back over to Larry Willard for some concluding remarks.

Thank you, Larry. In summary, I believe we're making progress against the objectives we have previously communicated. We think this will be a long-term process and that it will require steady and diligent efforts on our part and a willingness to continuously improve and refine our strategy to maximize shareholder value.

We would now like to take any questions that you may have. As we mentioned at the outset of our call, we ask that you focus our questions on our third-quarter results. Please keep in mind that we will not be discussing any aspect of our agreement to purchase NLASCO, Inc., and engage in a rights offering and other financing arrangements. We refer you to publicly filed documents on these matters.

Operator, please queue up the participants for questions.

Thank you.

[OPERATOR INSTRUCTIONS]

And we'll go first to [David Brad] with Merrill Lynch.

Yes, good morning. The repos looked to be trending down pretty nicely, and I was curious, to what could you attribute this? And, also, how many of these 227 repos during the quarter did you purchase?

Do we have that number, on how many of those that we purchased?

Yes, we purchased about half of those repos in the quarter.

Looks like, based on our numbers, about half.

Okay, and then how many new homes were purchased?

Well, if you take the roughly 640 -- well, that's year to date. If you look at the supplemental back on page 15, you'll see the total number of homes purchased, and it would be the difference.

Okay, so there wouldn't be any other used homes being purchased from outside of the communities?

A few. We would look at those opportunities in addition to the repo opportunities.

Okay. And, just another question, you mentioned that about 48% of home renters are under the lease with option to purchase program at this time. What was that percentage a year ago?

Well, let's see here if we've got that.

Just one second, we've got that information. At the end of the third quarter 2006, we had -- 2005 -- we had 3,800 homes, divided by the total.

Okay, thank you.

Okay, thank you. And we'll go next to Paul Adornato with BMO Capital.

Hi, good morning.

Good morning, Paul.

I was wondering if you could tell us what FFO per share would have been in the third quarter.

Larry?

Well, we don't provide FFO per share, but I can give you, it's just a few calculations, and I would tell you that I think the method would be to take our income before discontinued operations and before minority interest. I would add back depreciation and amortization. I would then subtract an estimate of our equipment depreciation from prior quarters, which you could refer back to our previously filed public documents for that. And then the last thing I would do would be to add in a little bit of discontinued operations income that we had and then I would divide that by the approximately 44,600 shares that we have outstanding.

If I do that, I was coming up with approximately $0.12 per share. Does that sound ballpark?

I believe if you performed the calculation that I just described that's about what you would get.

Okay, thank you. And, also, I was wondering if you could comment a little bit on the lowest-performing group of properties, the 44 properties that have less than 70% occupancy. Now that you've had a couple of quarters to get your hands around these properties, what's going on there and what is your outlook for that group?

We will continue to work on that group. In some of our markets, because we're spread across a pretty big footprint, 24 states, you're going to find that the economies are not doing as well. Perhaps Wichita might be one of those, and we're continuing to look at ways to make those better and even in that environment to try to improve our operating margins, even though, perhaps, our occupancy isn't at the level that we would want it to be.

But that is one of the advantages to being a diverse organization that's spread over a lot of country from a geography point of view.

Is it possible that we might see some more asset dispositions over the next 12 months?

We will continue to look at that, but we're not in a mode to sell property unless we can get good prices for it, whether you're talking about operating properties or properties that we would consider in an HBU category.

And, finally, where do the net operating loss carry forwards stand as of quarter end?

Larry, do you want to?

Well, we'll soon disclose that, but the amount is approximately $350 million.

Okay, thank you.

Thank you. We'll go next to Steve Velgot with Cathay Financial.

Yes, a couple of questions for me. First is, could you talk about whether or not there have been increases implemented in terms of your rental rates and kind of going forward are you expecting to further implement some rent increases?

Steve, the way ours -- as it related to '06, anyway -- of course, our approach coming out of '05 with a different management philosophy, into '06, we were to really stabilize '06. And most of our increases went into effect in the first quarter of '06, and then, as you looked at the second quarter and third quarter, you really just don't have much in the way of increase. That's why that number would be relatively flat.

As we mentioned earlier, as we have gone through our third-quarter community reviews, we've also -- that's our quarter to also work on '07 budgeting and, again, we'd be looking at more like the first quarter of '07 as it related to our primary anticipated increases.

Okay, so you're talking about something similar to what you last implemented.

Yes, I think, ideally, if you were really looking from an analyst's point of you, you would [feather] these increases in where the numbers -- you had this gradual increase. But the way ours are currently working, most of those are going to occur in the first quarter.

Okay, thank you. And my second question concerns specific efforts in terms of increasing occupancy. How much of that is really in your control versus you think more macroeconomic related and somewhat outside of your control?

I think it's a little of all the above, but it's pretty logical. As we went into '06 and we made those increases, coming off of a total different management philosophy in '05, that we didn't know exactly what was going to happen, but we were certainly working towards bettering the communities, bettering our customer-service philosophy from a retention point of view in helps that that would offset anything that might occur as a result of those increases. I think the things that I mentioned earlier that we're doing to try to enhance our communities, make the communities a better living experience, where even though a community across the street might be 40 or $50 less, they choose to stay with us.

So, from that point of view, I think there are things that we feel like we're doing to enhance, but can we totally predict from the standpoint of an economic downturn as it relates to issues that might have to do with 20% of the Hispanics that live in our communities or other factors, just we do not control, and we think our best approach to it is just try to make each community the best we can possibly make it. And that really comes back to our continual review on a community-by-community basis, saying, what does this community in the way of opportunity give us? And how can we best respond to that, whether it's new homes or whether it's used homes or it's lease to purchase or it's rental of our homes or whatever.

Okay, and then, actually just one quick follow-up. The seasonal increase you had in property operation expense, is that something that you would therefore expect to see trend down in the fourth quarter?

Well, I think just the same way I mentioned that the rents really are not feathered in so you get this gradual increase, the same thing is true in the seasonal aspect of repairs and maintenance. Particularly in our northern part of the world, we're certainly not going to be in a position to be doing a lot of repairs and maintenance when you've got snow up to your knees. So a lot of that really falls in the summer months, so it, too, is going to have kind of a seasonal aspect to it, but we feel in no way are those numbers indicating that we're behind on repairs and maintenance. We think we've got control of that, we're very much on top of it, and we feel that you're going to have a little bit of up and down in that quarter to quarter, but I think you really -- you've got to look at our company, I think, more on a physical-year basis, full cycle, where all these things have had the opportunity to happen. They don't just happen in a very measured and even way.

Thank you.

Thank you.

Thank you.

[OPERATOR INSTRUCTIONS]

And we'll go next to Jonathan Litt with Citigroup.

Hi, it's Craig Melcher here with Jon.

Hi, Craig.

I just wanted to talk a bit about your home sales in the quarter. The homes you sold were about $21,000 a home, and I'm just trying to compare that to the quality of the homes that are in your existing home inventory, because the book value in your existing home inventory is about $21,000, $22,000 a home. So do you have any average age statistics or could you talk about the quality of the assets for the homes that you sold in the third quarter, relative to the quality in your inventory?

Jim, Larry? One of you guys want to --?

This is Jim Kimsey. Most of the homes that we sold in the third quarter were used homes. There is a market for repos that we can turn around very quickly in our community and sell, and those typically drive the lower price.

So would you expect -- so the quality of the homes in the third quarter was a bit lower than in the homes inventory?

Yes, go ahead, Jim.

Typically, they may be an older home than what we currently have in our existing inventory, but there's still a standard that we expect to maintain in our communities.

And what's the average age of your homes in your inventory?

About 3.7 years.

And just on the home purchases that you made, how do you go about coming up with a number that you've purchased? You got about half of them through repos and about half were outside purchases and the last two quarters have been that 250 home range. Is that a number that you look to do on a quarterly basis?

I wouldn't say that. I would say, again, we're going back and looking into each community and what that market gives us and what the opportunities are. And if the opportunities there tend to be more in the price range of a used unit, then that's where we're going to be. If the price point tends to be more in line with the new unit, then we'll be on top of that. And we're getting pretty quick turn on new units -- about 30 days, more or less, because there's just not a line at the manufacturing door. And that's really to our advantage in managing our inventory and managing our money.

As you ramped up some of the spending to get the vacant sites ready during the quarter, could that suggest that you're looking to maybe ramp up the number of homes you'll be buying, or is this more just getting in advance of, maybe, increasing home sales?

The fact that we've ramped that up means that we're really trying to be more efficient in that cycle time, and as we've hit the 90% mark in that particular segment, we've had to get better at that. And I think this is reflective of us in the process of getting better and making that happen.

But, again, part of our advantage is that the cycle time that we're improving in so many areas really adds to this.

Thank you.

Thank you. And we'll go next to Craig Leupold with Green Street Advisors.

Hey, guys, it's [Mark Barry] with [Andy McCullough].

Good morning, Mark.

I wanted to ask about the rent to own structure. My understanding is that the rate on those rentals incorporates some premium to just a straight rental for the purchase option. Does that premium run through your rental rate, and how much would that premium be as a percentage of a straight rent, let's say?

Jim?

There's no premium in the lease to purchase program.

Okay.

Although the straight rents do drive a higher -- and the straight rents do drive a higher margin, overall.

And there's a portion of the payment that they make that is put into escrow for purposes of if they exercise their option to purchase the home at the end of the contract, or during the term of the contract in accordance with the terms that's applied, they get a credit against the purchase price for it, but it's only a portion and it varies from contract to contract.

Roughly how would you say that purchase price relates to the your cost of the home? Is it a significant profit center built into that conversion option?

It's about a 15 to 20% margin.

Okay. And I noticed you don't have a lot of interest income on your P&L, but there is some, and it suggests you're still maybe originating some mortgages along with the home sales. What type of interest rates would se see on an ARC-originated mortgage today?

Well, on our ARC loans, we're at about the, I think, 12% level.

That would be your current rate?

Yes, 12, 13%.

I wanted to ask also about projections for free cash flow. Do you think that long term the business could be self funding? In other words, without a dividend requirement that you'd be able to plow enough free cash flow back into your business to fund the expanding rental home inventory?

That really comes under guidance and we're just really not in a position to talk about that.

All right. I wanted to ask on the homeowner side of the business, it looks like year-over-year we've seen a 10% increase in rents but about a 5% loss in occupancy. But quarter-over-quarter it looks like you weren't able to move those rents really any further. I mean, are we now in a situation where you've maybe hit a point where you can't push rents any further on the homeowners and will probably be in a situation to see continued occupancy loss?

That's back to what I mentioned earlier. Most of our rent increases are really falling more in that first-quarter timeframe and so you're not going to see generally that quarter-to-quarter increase or increment. I mean, you're going to have to look at a full-year cycle to see that.

Are you suggesting that in the first quarter of next year, you'll be pushing rents at a similar rate?

I wouldn't give guidance as it relates to a similar rate, but they're certainly under review and are part of our budgeting process.

Okay.

But I can say that our historical pattern has been to increase rents in the first quarter. And you can see that throughout our historical documents.

I noticed that the cost of homes sold was $1.5 million, and it looks like the proceeds from that group of home sales was $1.9 million. Just wanted to be sure I'm looking at that relationship correctly. It implies a fairly robust margin, but I wanted to be sure, Larry, that $1.5 million cost, is that a depreciated number?

Yes. Oh, yes.

Okay, last question, of the $2.9 million of expense related to retail home sales versus finance and insurance, do you have a breakout of what was the cost of sales number versus the finance and insurance portion?

Well, the cost of sales number is on the face of the financial statements and the press release.

I should say the retail selling expense versus the finance and insurance, the breakout of that --

No, we don't break that out. We do combine that. The bulk of the costs are in the retail area.

Okay, thank you.

And, with no further questions, I'd like to turn the conference back over to Mr. Willard for any additional or closing remarks.

Just, it's kind of early this morning, depending on where you're sitting, and we really appreciate you all taking the time to drop in and visit with us, and we certainly look forward to our next quarter meeting and the things that re going on in our company. Thank you all for being interested, and thank you for being here today. Have a good day.

And that will conclude today's conference. We thank you for your participation, and you may disconnect at this time.