Hilltop Holdings Inc (HTH) 2006 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Affordable Residential Communities Inc. Fourth Quarter 2006 Earnings Conference Call.

[OPERATOR INSTRUCTIONS]

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

Thank you very much. Good afternoon. 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 are subject to various risks and uncertainties. The company can provide no assurance that expectations will be achieved and 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 revise or update any forward-looking statements reflected in or circumstances after the date of this call.

The results of the full-year and fourth quarter of 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 at 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. 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 afternoon, I will recap our full year of 2006 and then turn the call over to Larry Kreider to provide you with some details on our financial results. We will then be happy to take questions from you.

As Larry will explain in further detail, we had operating results in the fourth quarter of 2006 that were very consistent with the trends established in prior quarters this year. As I have now completed my first full year, I thought it would be useful to recap 2006 and compare it to 2005. We believe this will illustrate the consistent management practices that we expect to continue to employ.

First, let me discuss some key financial metrics. Our net loss from continuing operations before the non-cash effects of income taxes and minority interest was approximately 51 million as compared to 181 million in 2005 as reported, or approximately 77 million after excluding certain large charges for goodwill write-off, assets impairments, and severance.

The improvement of 26 million was reflected in our operational cash flow, which was 37 million in 2006 as compared to 7 million in 2005, an increase of 30 million. We also made strides in strengthening the company's balance sheet through a reduction in long-term debt and improved terms on some of our lines of credit.

Let me outline the key areas of change in 2006 as compared to 2005. In our community operations, net segment income increased by 23 million to 142 million from $119 million. This was driven by our rent increases of over 8% as we sought to get rent levels to the point where they recognize the significant community improvements we have made over the last couple of years.

These improvements have put us in a position of being the market leader in quality and pricing in many of our locations. While we don't expect this magnitude of year-over-year increase to continue, we do expect to remain a market leader.

As we discussed throughout last year's earnings calls, we also increased our recovery of utility costs from 55% in 2005 to over 75% in 2006. We have also controlled community expenses, recording a decrease of over 2 million in the areas of community level salaries, benefits, repairs and maintenance, and bad debts expense, partially offset by an increase in property tax expense.

In the area of salary and benefits, we are addressing community staffing and training and have some initiatives to reduce turnover and increase the level of bench strength.

In the area of repairs and maintenance, I would note that year-over-year spending was lower, resulting principally from the first two quarters of the year, where the prior year's high spending levels justified this decline. Since then, we have resumed spending at an appropriate level to maintain our communities at a high level of appearance and function.

In the area of rent collections, we focused on this all year and are gratified at the decrease in bad debt expense to a approximately 0.6% of revenue versus 1.3% in 2005. While the dollar amounts are fairly modest, we believe bad debt collection is an important indicator of our effectiveness in managing our communities.

Lastly, in the area of real estate taxes, we believe the year-over-year increase aligns them to a level that recognizes the cost we paid for the communities that were purchased at our IPO in 2004.

In retail operations, net segment loss decreased from approximately 12 million to 5 million. In last year's fourth quarter, we first focused on these operations by getting control of the cost structure. And we initially eliminated 150 management positions.

Next, throughout 2006, we focused on building a sales and marketing organization at the community level that would make sales and leasing transactions, at least, at reasonably profitable levels, maintain the creditworthiness of our customer base, seek ways to retain our resident base, and reach out to dealers and others to attract new residents without incurring costly investment activities.

We have spent all of this year building the effectiveness of our program and believe it is still a work-in-progress. These include identifying qualified customers for sale or lease with option to purchase transactions from our existing home renter residents; continuing to refine our sales and leasing incentive plans; opening select retail centers for communities with limited exposure to drive-by traffic; targeting qualified residents in neighboring communities that are closing or inferior; improving dealer relationships; including offering our financing platforms to selected dealers; improving our website to provide more useful information on our communities and available homes for sale or rent to a broader customer base; implementing a customized home-ordering process which we refer to as our shop program where there is limited inventory; referring current residents who are moving to other cities where we have ARC communities; implementing procedures to attract the effectiveness of our advertising, reaching our to local corporations to address potential residents within their employee groups; continuing to repurchase repossessed homes in a cost advantageous manner and new homes in select communities with demonstrated demand; and implementing programs to enhance resident retention, including aligning compensation programs and establishing community service programs.

As a result of our activities, our retail cost decreased from approximately 14 million to 7 million, while our aggregate margin on sales remained approximately constant at about 2 million. And while our combined sales and lease with option to purchase transactions and our regular home leasing activities decreased in 2006, we made transactions that gave us a more acceptable, though still modest level of profit with customers having higher credit standards.

All in, we experience exceptional levels of residential retention in 2006 and made progress in retaining our existing residents. We had lower levels of homeowner and home renter move-outs and a higher number of move-ins of residents who own their own homes. And we have also had lower move-outs of repossessed homes owned by finance companies.

With respects to external market conditions, we believe that we stand ready to receive additional new residents who formerly were more able to find other competitive housing alternatives as these alternatives become more costly due to higher short-term interest rates, higher apartment rent levels, and toughening credit standards in the sub-prime mortgage market.

Under the heading of other corporate matters, we also worked diligently to improve all other more administrative and management aspects of the business.

In the area of community sales, we completed the sale of 40 communities in 2006 with one more yet to close. These generated over 85 million cash, net of 75 million in debt repayments, resulting in a net book gain of 32 million.

Under the REIT status and NOLs in connection with these sales at the beginning of 2006, we eliminated our REIT status that could have caused us to incur a substantial penalty tax on these gains on community sales.

We also put in place protection for the substantial net operating loss carry-forward that we presently enjoy. These protection originally took the form of a shareholder right plan put into place by our board of directors and then took the form of a charter amendment to our bylaws, following ratification by our shareholders.

And then our NLASCO acquisition at the end of January 2007. As previously disclosed, we completed the acquisition of NLASCO, a property and casualty holding company operating mainly through two insurance companies for $118 million. We will include NLASCO's results in ours beginning February 1, 2007.

With respect to our finances, we've accomplished a substantial refinancing of 175 million of our variable rate lines of credit. This helped us to reduce our interest expense and increase our proportion of fixed-rate debt.

In our budgeting process, going out into 2006 and 2007, we completed a rigorous community-by-community, department-by-department, budgeting process by which to manage the business, provide accountability, and enhance management controls at all levels.

During the year, we held quarterly, detailed business reviews that reinforced these concepts and allowed us to react to changing conditions and to make changes accordingly. We intend to continue these activities.

We've also made other improvements that should provide lasting benefits to our operating effectiveness. Using our web-based IT backbone, we improved our bill paying process with virtually no incremental costs, allowing us to reduce staff. We put in place an automated system for scanning our resident's monthly rent checks at the community level that should increase our cash flow and automate the posting process.

We brought our basic Sarbanes-Oxley control process in-house and substantially reduced our compliance cost. We also increased our internal audit function to provide for better control over our communities that are located throughout the United States.

In conclusion, we've attempted in 2006 to create a company that will serve its residents well going forward and create a solid base by which to successfully complete our future activities. I would now like to turn over the call to Larry Kreider, who will provide some details on our results in the fourth quarter.

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

For the fourth quarter of 2006, we had approximately the same net loss from continuing operations before income taxes as in the third quarter. This reflects slightly higher net segment income in the absence of a charge in the third quarter for exit fees related to debt repaid in our refinancing, partially offset by higher property management and general and administrative expenses.

In our community business segment, net segment income reflected comparable revenues and expenses for an overall increase of $100,000 as compared to the third quarter. In the fourth quarter, we had a decrease in our resident base by 502 residents. This reflects lower levels of new residents, both homeowners and home renters and relatively constant overall resident move-out trends.

We believe the lower levels of new resident activity may have a seasonal component. Larry has enumerated the actions we have taken in 2006 to address these trends. And during the fourth quarter, our home and lot rents increased slightly.

In our retail sales segment, we had net segment loss in the fourth quarter of 2006 of approximately $1.1 million, level with the third quarter.

In our consumer finance and insurance segment, our net segment income increased relative to the third quarter of 2006 as a result of lower interest expense from the repayment of our consumer refinance line of credit with lower cost proceeds from our refinancing.

In terms of other expenses, property management expenses and general and administrative expenses in the third quarter of 2006 were somewhat higher in the fourth quarter, reflecting a small adjustment to incentive compensation accruals including stock options.

Depreciation and amortization and interest expense were virtually flat in the fourth quarter of 2006. Interest income improved by $700,000 in the fourth quarter, reflecting an adjustment to accruals for bad debt on loans acquired in the hometown acquisition in the third quarter.

The company sold one community in the fourth quarter of 2006 as compared to the sale of two communities in the third quarter. The company has one community held for sale that it expects to complete in 2007 or early 2008.

With respect to income taxes, the company has incurred no income tax for the year. However, in accordance with applicable accounting requirements, we have provided a non-cash intra-period income tax benefit to the loss from continuing operations based on a non-cash income tax expense ascribed to the gains of sales of discontinued operations in the first three quarters of 2006. As a result, we recorded a larger net income tax benefit in the fourth quarter as compared to the third quarter.

With the respect to the restatement of our first three quarter's 10-Qs, you can find more details in the 8-K and the amended quarterly statements that we filed yesterday and this morning. The bottom line is that the effect of this on the annual statements is zero.

At no time has the company actually incurred any tangible income tax benefit or expense and we do not want to convey the expectation that we will record any ongoing or continuing income tax benefits in the future.

And with respect to our internal controls, we expect to report no exceptions for this item or any other in our year-end certifications.

With respect to our balance sheet, we had cash and cash availability at December 31, 2006 of approximately 158 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 91% and the proportion of our debt due in 2009 and beyond is 93%. Over 98% of our debt is mortgaged debt or unsecured debt due in approximately 20 years or more.

As a result of the community sales, the above refinancing, and cash flows from operations, we reduced our aggregate debt by $100 million in 2006 and reduced its effective rate to 6.6% at the end of 2006 from 7.0% at the end of 2005.

On January 31, 2007, as previously announced, the company completed the acquisition of NLASCO for $118 million, the completion of a 10 million share rights offering in private placement for $80 million and the sale of 2.2 million shares of common stock to Flexpoint partners. The $118 million purchase price consisted of $106 million of cash and 1.2 million shares valued at $12 million.

To complete the transaction, the company made approximately $17 million of cash payments to fund the cash purchase price not covered by the rights offering in Flexpoint's stock sale, the repayment of certain debt, and the payment of certain equity distributions. To fund these payments, the company used its own cash and other sources available on its balance sheet.

In connection with the NLASCO acquisition, we have also increased retroactively, in all time periods, the number of shares outstanding by approximately 2.6 million shares. This represents the effective of issuing shares in the rights offering at $8.00 per share, which was below market at that time.

In January 2007, the holders of the Series C Preferred Partnership units elected to redeem their holdings and the company issued them 1.6 million shares of common stock representing an aggregate value of $17.6 million.

Let me now turn the call back over to Larry Willard for some concluding remarks.

Thank you, Larry. In summary, I believe we have reported the results of the initiative we've put in place in 2006. We're excited about bringing NLASCO into our company in 2007. We intend to make steady and diligent efforts on our part and continuously improve and refine our strategy to maximize shareholder value.

We would now like to take any questions that you may have. Operator, please queue up the participants for questions.

[OPERATOR INSTRUCTIONS]. We'll go first to Steve Velgot with Cathay Financial.

Yes, Larry, I know you touched on what's going on in the sub-prime market, but could you elaborate a little bit more on how you think things play out in terms of potentially attracting more people toward a manufactured home or generally what kind of conditions you're seeing in terms of credit available to manufactured home buyers?

Steve, as we said in our prepared remarks, we believe the effect of the difficulties in the sub-prime mortgage lending markets -- should be beneficial to us. First of all, our residents have weathered the tightening of credit standards that occurred since the early 2000s following the contraction of the mobile home [chattel] lending market. As we indicated in our remarks, you can also see that gradual decline of repossession activity in our communities.

Secondly, the sub-prime market difficulty should bring us residents over time. Our housing alternative becomes more attractive to our target residents as entry-level mortgage credit standards become realistic and low, short-term rate ARM products become less available. The net result is that we feel like it's very positive for us.

Okay. And then just a follow-up question on the quarter. I'm not sure if, Larry, you mentioned this in terms of property operations. I know there was some seasonality in the third quarter, having to do with expenses or maintenance that you do in more of the summer time, but why was that number flat as opposed to trending down from third quarter to fourth quarter?

Jim, do you want to try to answer that?

That's a $18.8 million of property operations expense.

Good afternoon. This is Jim Kimsey. The fourth quarter, we experienced a lot of weather impacts in our community that would have affected our repairs and maintenance. Typically, our third quarter addresses the utility expense and repairs and maintenance for our summer months and increased maintenance there. But, we were impacted in the fourth quarter by those additional expenses for weather.

Okay. So, I know you guys don't give guidance, but I'm just not sure how -- does that have to do with like snow removal and whatnot or --?

That's correct.

Okay. All right. Thank you.

[OPERATOR INSTRUCTIONS] And we'll go next to Ron Bobman with Capital Returns.

Hi, thanks. I have two questions, somewhat related, somewhat not. I was first curious to know how much exposure NLASCO has to Florida and if there's any relevance to, sort of, the recent legislative changes there for homeowners insurance impacting their business? And then, secondarily, does NLASCO provide wind coverage as part of its product or not? Thanks a lot.

As far as the Florida exposure, there's just virtually none. At one point, they had some, but they've pulled out of that market. And we do have some wind coverage.

In Texas, I guess.

Texas is the biggest market for NLASCO. This is Larry Kreider.

Okay. Thanks a lot.

We'll go next to Jonathan Litt with Citigroup.

Hi, it's Craig Melcher here with Jon.

How are you doing?

Can you talk a bit about the manufactured housing lenders out there today and with the sub-prime market of the credit standards increasing, what you think may happen on the MH lending side?

Larry, do you want --?

Well, I can tell you this -- this is Larry Kreider -- we don't see any growth in organized, significant new lending capabilities to our residents. We have not observed that. We do offer a product ourselves, however.

So, on the homeowner activities -- the new homeowner activity you're saying, how much is the activity from your product versus third party lenders?

Well, I guess, when you look at our data, if you look to the homeowner move-ins, all of those homeowner move-ins have their own -- bring their own financing or get their own financing from other sources.

Okay. And then, there hasn't been -- you haven't seen any changes on the credit standards recently from those lenders?

As far as our own standards, we're remaining very consistent and we've been very pleased with what ours is looking like.

Would you say your standards are pretty close to what the industry is currently offering?

I don't know that I could answer what others are offering. We've just been pretty consistent in ours and we've been very pleased as to the outcome.

And then, Larry, you mentioned that you continue to expect to be a market leader in rental rate growth in 2007. Can you quantify that a bit? I would assume you've got some of the letters already out there in terms of increasing rent for this year.

Well, I think we addressed that in our presentation as we talked about '06 as it being around 8% and that we really didn't expect to see that necessarily in future years. But, I think we bring a quality product to the market place and we see ourselves as being a leader in the quality area and the net result is our pricing will be, more times than not, at the top of the list rather than the bottom.

Thank you.

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

Hi, good afternoon. Following on, I guess, on that last question, it looks like your rental rates have kind of stagnated over the last few quarters, both in terms of renter income or renter rents and also homeowner rents. Is that a reflection of you guys, sort of, taking your foot off the accelerator there or is it -- does it reflect any kind of seasonality in terms of when you typically implement rent increases?

It reflects seasonality. The way our structure works -- the most of our increases, although you'll see them dribble in all throughout the year, are primarily in the first quarter. So, that's why you see that and then you see -- or what you're calling a rather static or stagnant rate.

Okay. And then, I guess, turning to CapEx -- looking at your CapEx, page 15, it looks like this last year you spent, in aggregate, about $5 million or so. What's the outlook for '07?

Well, our approach to that is we worked on it and made significant improvement in it and I think we've reported before that we see our expenditures being more in the 10 to $12 million range. At the same time, we really organized that system and prioritized it such that we have it very much under control and feel very comfortable with that level.

But, I would say again, as we look at the '07 timeframe, that what we said in the past would be closer to right.

Okay, so '06 was maybe an abnormally low year, given all the spending you done in prior years?

Because of that, and then, as you recall, we came in that last quarter and we had a lot of stuff on our plate to get done. And the net result -- we were kind of slow at coming out of the blocks in '06 in that expenditure, as a result of other things that were on our plate.

Okay. And then, one last question, I guess, kind of related to the home rentals. How long are your typical lease-to-own leases? I mean, what's the average maturity of those as you sign new ones?

Typically, four years.

Because, if I look at page 12 from your information on home renter move-outs, it looks like your annual turnover is about 46%. And is that a reflection of the old types of leases you used to have in place versus the new ones you're putting in place now, or is that a reflection of people, I guess, terminating or vacating their leases prior to maturity?

I think you're statement was correct. It would be impacted by those -- a lot of those older leases.

Okay, great. Thanks.

And we'll go next to [Bill Giddens] with Locust Wood Capital.

My questions were asked and answered. Thank you.

[OPERATOR INSTRUCTIONS] We'll go to Howard Flinker with Flinker and Company.

I have a thought. Are you guys planning to get involved in the insurance of mobile homes?

The company that we bought, NLASCO, does have -- of its two companies, one of them does insure manufactured housing.

Isn't that a small part of their business right now?

It's the smaller, but it's a fairly significant part of the business and if you wanted to find out more about it, you can look at the proxy statement we issued earlier and there's lots of details in there on that.

Do you guys see an opportunity there in that marketplace?

Well, we do see an opportunity and we move towards it cautiously. I mean, we're sitting here with 48,000 homeowners that are either renters or homeowners and that could utilize some form of insurance. And we've had a product line, which we've not underlined or emphasized or done very well with but we think through NLASCO that we can do a much better job in that area.

Fair enough, thank you.

And there are no further questions at this time. And I'd like to turn the conference back over to Mr. Willard for any additional or closing remarks.

I'd like to thank all of you for tuning in today. It's certainly always our pleasure to talk about our company. We're proud of it, we're proud of our progress, and we look to the future with a lot of excitement. And we want to thank all of you for your support and your interest. Have a great day.

Thank you, everyone. That does conclude today's conference. You may now disconnect.