Sun Communities Inc (SUI) 2003 Q2 法說會逐字稿

Welcome to the Sun Communities second quarter annual conference call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and the instructs will follow at that time. If anyone should require assistance during the conference, please press the star then the zero key on your touch-tone telephone. As a reminder this call is being recorded.

At this time management would like me to inform you that certain statements made during this conference call which are not historical facts may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although the company believes the expectations reflected in any forward-looking statements are based on reasonable assumptions, the company can provide no assurance that expectations will be achieved. Factors and risks that could cause actual results to differ materially from expectations are detailed in this morning's press release and from time to time in the company's periodic filings with the S. E. C. The company undertakes no obligation to advice or update any forward-looking statements to reflect events or circumstances after the date of this release.

Having said that, I would like to introduce management with us today. Mr. Gary Shiffman, Chairman and CEO and Mr. Jeff Jorissen CFO. Gentlemen, you may please begin.

Good morning. Second quarter earnings as announced prior to the opening of the market today were funds of operation of $17.3 million or 84-cent per share compared to $17.3 million or 85-cent per share in 2002. Net income in the second quarter was $4.5 million or 25-cents per share compared to $7 million or 39-cents per share in 2002.

And revenues in the second quarter of 2003 were $43.2 million, compared to $40.2 million for the second quarter of 2002. In general, industry conditions are little changed from last quarter. Shipments of new homes continued to decline compared to 2002 and the current annualized rate would suggest that three shipments should be around 120,000 homes.

Repossessions appear to be burning off finally, which should give rise to strengthened new-home demands. During a recent call between Brian Fannin and Suns chief operating officer and executives at Conseco which is now known as Greentree, they indicated their current repo levels are down to around 11,000 and expected to be as low as 8,000 homes by the end of the year.

US Bancorp announced on June 27 that it has decided to become a dedicated retail lender to the MH industry and we will soon now, and we do know as of this morning, that Warren buffet will join the industry through his acquisition of Clayton Homes that was approved, I believe, this morning, by a majority of around 52%.

At Sun Communities, we are, of course, disappointed by our same property performance thus far in 2003. Analysis indicates the following: On about 38,000, 39,000 sites in the same site portfolio, revenue growth for the quarter was 2.5% versus our expectation of 4.5%.

The differential of that 2% is due in large part or just over 60% to the loss of rents on repossessions and the balances due to the loss of tenants, and the 260 basis point decline in occupancy would also break down in the same fashion, i.e., just over 60% would be related to loss of rents and repossessions that no longer are paying in their communities. Expenses were approximately $500,000 or 5.6% over our budget for the year. If they were on budget, they would have generated about a 4.5% NOI growth.

The $500,000 arose primarily from payroll of around $100,000 and repairs and maintenance of about $350,000, which were over budget. Both of these expenditures possessed seasonal and/or timing characteristics, some of which are related to our "home buying made easy" program, which I will talk about in a bit, and the balance as discussed last quarter relate to the expansion of our cable TV services, which will result in about $200,000 of additional cable TV revenue, and from costs related to the harsh winter, which were basically just additional snowplowing at our Midwestern communities which took place.

We have, of course, focused our operations personnel and all of these items and feel confident that they will be in line for the balance of the year.

Delinquencies are up $200,000 from March 31, 2003, but they are really a little change from June 2002, and in fact, $100,000 to $200,000 lower than third quarter and fourth quarter 2002. For the six months of 2003, bad debts were 64 basis points of income from property and bad debts increased by legal and court costs and decreased by late fees was a positive 15,000 dollars in the second quarter, as compared to a negative $86,000 in the first quarter.

We have raised about $24.3 million of equity through the issuance of common stock at an average sales price of $39.64. The dilutive effect of this issuance requires an adjustment of earnings guidance for 2003 FFO per share growth to a range of about 1% to 3% from 2% to 4%.

And normally, we would discuss origin at this time in some depth and be responsive to all of your questions during the Q&A session. Today, however, origin is actually actively involved in a financing and marketing of that financing, and we will be unable to respond to specific questions today.

We will, however, fully inform you as soon as we are permitted to and the expectation is that it will take place within the next 30 days. Now, what I would like to do is discuss our "home buying made easy" initiative, which we announced this morning in our press release.

This program is designed to address the needs of our customers in our communities, and I think that a little background would be appropriate, however, much of this has been discussed historically in our conference calls and as it relates to the industry.

Most of the problems that have plagued the manufactured housing industry over the last several years can be traced directly to the practices of certain specialized finance companies dedicated to our industry. In addition to weak underwriting standards, the promotion of 30-year loan terms and 5% or lower down payments undermine the manufactured home buyer's ability to build equity as a percentage of the home's cost. Encourage the financing of higher inflated home builder profits and retailer profits as well as other costs that did not add value to the home, and ultimately resulted in double-digit interest rates as the weak underwriting standards generated a torrent of repossessions that we have all experienced over the last few years.

The result has been a 60% decline in manufactured home reshipments due to the customer's perception of the homes as lacking value, combined with interest rates, 500 to 700 basis points higher than those available for site-built housing. Sun's new "home buying made easy" program addresses each of these issues. The key characteristics of the innovative financing program are as follows.

Homes must be purchased from Sun's affiliates, Sun home services, and the homes must remain in Sun's communities. This allows Sun to control the amount of profit in the home that is being financed, and to ensure that the customers acquiring a value-priced home, and we will talk more about that in a little bit. This applies to both new homes as well as previously owned homes.

The loans require a minimum down payment of 10% and new homes may be financed for no more than 20 years, while previously owned homes may be financed for no more than 15 years. This results in the buyer's equity as a percentage of the home cost nearly doubling or tripling the 10% down payment by the end of the fifth year, which should bode well for pride of ownership and the creation of realizable value in the home, and I can't overemphasize enough how important it is to build equity in the home.

Interest rates of 5% for 15 years or roughly 6% for 20 years, and this should substantially alter the image of the manufactured housing and reinstate the customer in a position of privacy as well as appealing to a more sophisticated buyer, attuned to financing alternatives that are available out there.

Currently, loans will be underwritten and serviced by Origin Financial, and we see substantial benefits at Sun Communities in the following ways. This program will clearly differentiate Sun from other Community owners in its markets.

Few others will be able to compete economically as it is a combination of home sale profit, loan interest, and net rental stream, which will drive the attractive returns to Sun that we discussed in our press release this morning.

This, we believe, will lead Sun to a unique position in most of its markets and provide the basis for more branding of Sun's communities as high quality neighborhoods where the customer has been reinstated in a position of privacy.

The compelling economic advantage that this program restores to the manufactured housing communities vis-a-vis apartments and site-built housing is as follows: The monthly financing costs on a new home with a $40,000 loan principal balance and a 20-year term at a 6% interest rate is $286.57 per month.

Adding the monthly site rented sum of $322, brings the monthly total to $608 per month for a home of approximately 1350 square feet on a 4500 to 6000 square foot site. This results in our overall cost of about 45 cents per square foot per month, which competes very, very favorably to multi-family today. The reduction in the aggregate monthly payments of our residents from these lowered interest rates allows for 4.5% to 5% rental increases for the foreseeable future, thereby ensuring continued growth at Sun communities.

For instance, the above-noted payment of $608 per month with the rental component growing at about 4.5% for the next 10 years would result in a $765 per month payment 10 years out. And that compares to a 30-year loan of the same amount at 10.5% today with a total monthly payment today of around $688 and 10 years out, around $845, or roughly $80 a month higher for each of the months during the next 10 years.

A previously owned home or used home at $25,000 with a 15-year term and a 5% interest rate has a current overall monthly payment of around $520, all in with the rent, growing to about $676 in 10 years, which is far less than the 30-year example today.

The success of this program would allow Sun in the near future to seek to acquire development communities which are or have encountered leasing difficulties at easily discounted prices. I think there is abundance of these types of properties available in the marketplace today, and purchasing such properties as below replacement value and increasing the leasing rate could provide excellent opportunities for both profitability and the quality of new modern homes and leasable sites in our portfolio.

Clayton Homes has been a model of what we refer to as the integrated efficiency in our industry, a manufacturer, retailer, financier, and owner manager of communities. It's been consistently profitable while remaining on full recourse for its loan originations, and it would surprise nobody if Burkeshire Hathaway found a home and its Insurance Companies for all of the loans being originated by Vanderbilt and the Clayton Finance subsidiaries today. Sun intends to use Origin as its underwriter in this new "home buying made easy" program.

Origin's standards for underwriting are today higher than the Vanderbilt standard and should result in what we believe will be much better experience. We will be originating loans on homes in our communities where we can guarantee the quality of the community, generate substantially better recoveries, which is of significance and great importance to the profitability of lending industry, and control profit margins and ensure the equity buildup as a percentage of home cost as we discussed.

The greatest value I point to the residents is that when Sun Homes Services can acquire a newly constructed repossessed home and able to buy it for 10 or 20 or thirty 30 cents of a dollar, pass those savings on to a Sun resident at a 5% or 6% interest rate.

The recovery on any repossessions that take place, we believe, will approach very nearly 100% of the principle balance on the loan in the future, thereby assuring strong recoveries in the resale of those homes at an amount equal to, if not perhaps, greater at sometime in the future for the principle balance due. And at this time, I would conclude our formal remarks and both Jeff and I are available for your questions.

Thank you. If you have a question at this time, please press the 1 key on your touch-tone telephone and if your question has been answered or you wish to remove yourself from the cue, then press the star key. Again, press 1 if you have a question.

Our first question today is from Art Havener of A.G. Edwards.

Good morning. Your guidance did not include your expense budget. Is there any reason for that? The fact that your expenses are above where they were running last year?

Well. They run above where they were running last year but they're not all that -- well, not all that far out of budget in a number of instances. It's just a few of the ones that Gary mentioned, like the payroll and same property, and we think that it's going to be -- turn out to be primarily timing in terms of repair and maintenance. So, the guidance is modified strictly -- at this point for the dilutive aspects of the equity offering.

So you're thinking that you can make up the $500,000 shortfall?

We're expecting that we will make a significant dent into that, yes, Art.

OK. In respect to the "home buying made easy" program, why was Indiana and Michigan -- I thought those were kind of the weaker markets?

I think that we have looked for places where we could have the greatest concentration to roll out the program in the most cost-effective and rapid manner and test it, and in those particular markets where there is an abundance of repossessions that can be acquired very cheaply and very high quality, we can offer the greatest value to those residents and couple that discounted value with those kinds of interest rates in what is basically our weaker market of Indiana in particular. We could most significantly have an effect on FFO.

OK, when do you expect to roll it out throughout the whole portfolio?

What we're looking at is a 30-day test in those two markets, and after we fine-tune it, it would be immediately made available on the balance of the properties.

OK, the 11 loans that you said that you already have identified, are those for new or used homes?Jeff, do you have the combination of breakdown?

Those are approximately half new and half used.

OK. One last question: Were there any one-time cost associated with the possibility of merging with another region?

Do you really think we're company B?

Well, I don't know. I'm just guessing.

There were some costs but they were not of substance -- they were not of substantial amount. So, they didn't have a significant effect on the second quarter.

OK, thank you.

Our next question is from Alexander Goldfarb, Lehman Brothers.

Good morning. First just a question on the Sun Home Services line. It seemed to be a positive $700,000 this quarter, which is a change from the previous losses. Is there a difference, a change in your guidance or expectations for the full year for that line, and what may have happened in the quarter that it went positive?.

Sun Home Services was available to have an outstanding opportunity to buy approximately 130 new homes deeply discounted. And what you're seeing in the first half are, particularly in Q2, are the profits that they're earning from the sale of those homes. They sold a little more than half of them at this point in time, so we expect some of that benefit at least to buttress their results in the second half.

OK, so before, where you were forecasting a $400,000 loss for the year, it sounds like it may be sort of flat?

Flat to maybe positive a little bit.

OK, OK. The next question is on the switch away from PWC to Grant Thornton, if you could just discuss that, and were there any changes that the new auditor has asked for?

Well, we went out -- or the audit committee actually determined to solicit Grant Thornton, P.W.C., who was our incumbent, in line with Deloitte Touche for audit proposals and then the chairman of the audit committee sat in on the meetings along with several members of management and we listened to the oral presentations, reviewed the written presentations, and decided on Grant Thornton.

Grant Thornton is the fifth largest firm in the accounting profession, and we also, before we actually went out for proposals, we asked both the rating agencies that cover us, if they were comfortable with the fifth and sixth largest firms also proposing on this engagement and they said they had absolutely no qualms whatsoever, so then the audit committee ultimately selected Grant Thornton and they have recommended no changes in any accounting methods, procedures, or principles as a result of their review of the second quarter.

OK, and as far as any assessment from FIN-46, will any -- either Sun Home Services or Origin need to be consolidated?

We will have a disclosure in the 10Q that says in our judgment, Sun Home Services where the company gets 95% of the operating income or loss, will be consolidated and as to Origin, that is pending current developments.

OK, so what are the effects then of Sun Home Services? Are they material or are they more cosmetic?

Well, all of the income and the net assets at Sun Home Services are already in our financial statements. So, the effect of it is going to be similar if you were to look at MHC's 12-31-02 financials, when they consolidated their sales subsidiary. I don't think the Analyst Community will find the clarity of the income statement enhanced as a result of the consolidation, but it looks to be the trend with 1046 so it's going to be there. Take a look at the income statement and I think you will see that it's much more complicated than year before.

OK. That sounds good. On the variable debt, is there any -- I know that some was fixed in this past quarter. Is there any move to either swap or fix any in the second half of the year?

There are currently no plans. We're down to 25% floating rates as a percentage of our total debt, and -

That's inclusive of the $75 million swap?

No, the swap is fixed.

OK.

So, that's considered fixed. So, you got 75 on the line and we got some others that come out to 25% floating which we think is reasonable. And we have fixed a lot of debt and refinanced a lot of short-term debts as we plan to this year already. So, I think for now we will just kind of watch what is happening and, you know, kind of assess opportunities as they develop.

OK. And on the share issuance, who bought those shares?

The public.

OK, and that was part of your trip program?

Docks program.

Docks program, sorry. So, is there anymore slated for this year, anymore equity raise or that's it?

Well, I think the way we view that Alex is from June '02 through June '03, debt as a company increased from $544 million to about $687 million, and we just basically determined that it was time to add a little bit of equity to the balance sheet and it was a question of whether or not we were going to do it -- equity transaction or this docks transaction, and basically, we had a $25 million goal and filled just a little over $24 million net to the company. So, for right now, there's no immediate plan.

OK, and how much more -- is there just a million left in that program or how much more is left potential in that docks program?

Well. That program really has no limitation. It's something that can be turned on and off at any particular time. But we have achieved the goal that we set out to achieve with them in that program. So, there's nothing actively going on with them now.

OK. And on the Sun Champ, the amortization, is there any change in that? It looked to be a little higher this quarter versus last.

Well. It's simply a matter of their operating results. So, I think they -- I mean, not surprisingly, they are also experiencing little bit slower leasing than was in their budget, so that gave rise to a slightly larger loss than had been budgeted.

Is it still forecast 16 cents for the year?

16 cents for the year?

I think it was $3.2 million or something of that sort?

Oh, you're talking about -- oh, --

Amortization addback.

I didn't understand what you're pointing to: It's probably going to be higher than that.

How -- like, $4 million?

Well, I guess we're going to have to kind of see how Sun Champs operations play out during the year.

OK.

But to the extent, there are losses allocable to Sun Communities, that reduce our obligations under the note payable to Champion Enterprises. So, they will be what they will be.

OK. And my final question, on the lending -- the new lending program, I see that your cost to debt is about 6% and you are charging anywhere from 5 to 6% on the mortgages. Can you just walk us through the economics?

Glad you asked that. If you take a monthly rent of $325, multiply it by 12, you have $3900 of annual gross rent. Because this is a marginal or incremental site to a community, it doesn't get a full load of expenses. So, let's assume it has got a 15% marginal expense to maintain the site. That takes your $3900 down to $3300. You earn 4% on the $40,000 mortgage per year and that is $1600 of interest and now you're at $4900 and that's to the company.

Now, we have got to pay for the financing of that. Well, 6% on $20,000 of the $40,000 loan would be $1200 of interest, so $4900 becomes $3700. If we then consider a $300 a year loan loss position, $3700 becomes $3400 and $3400 over the equity component of 20 grand is 17%.

OK. What did you say the loan loss once again?

It would be about 300 bucks a year, so it would be $3000 over what we're estimating to be a 10-year life of the loan per loan.

OK, thank you.

Our next question is from David Shulman, Lehman Brothers.

Yeah. Hi, it's a follow-on from Alex Goldfarb's question on the new finance program. It seems to me as the finance business really isn't a standalone business, it's really part of the marketing of -- basically, you're using finance to subsidize the rental of home sites. Is that a fair way of looking at it and then you're coming -- you try to generate -- you are generating a return on that equity, but it's really a method of subsidizing the rental of home sites. Is that a fair way of looking at it? -- it felt we like what GMAC does at General Motors.

I think that's reasonable. I mean this program only works because there are multiple revenue streams to support it.

Right. Because the finance company as a standalone doesn't work.

Yeah. I mean. That's right. You would not see Chase Manhattan Bank doing 5% MH loans.

Right, OK. And the normal MH loan rate would be something like in the current market would be somewhere between 11 and 13 right now?

Yeah, 10 to 12.

10 to 12. All right. OK. Somebody was asking 11 from me so, I guess, okay, you can get better finance.

It depends on your credit qualities.

Mine's pretty low. Thanks a lot, guys.

OK.

Our next question is from Jonathan Litt, Smith Barney.

Hi. It's actually Craig Melser (ph) here with John. Is this program really more for the get rid of the repos or is it going to be filling -- with new homes?

We think it will do both. The initial response that we put out to a couple of communities where 11 people were approved, I think Jeff indicated that about half and half, new and used, I think that we believe that the greatest value will be in the used or repossessed homes that are resold, walking it through that, you know, if a home three years ago had a principle balance of $45,000, and we're able to buy that home at $10,000 or $12,000 and turn around and sell it at $18,000 or $20,000, those homes that get repossessed at that level, you can turn around and, in theory, two years, three years, four years out, and again sell them at $18,000 to $20,000, and have almost a full recovery and still be giving a great value to the new resident, and the biggest problem in the financing that took place over the last five years is that homes were marked up so high with profits by the retailer and profits by the manufacturer that they began depreciating even before the ink was dry on the paper, and when that home was repossessed, the lender could only get, 10, 15, 20, 25, 30 percent recovery on that home and that broke down all the fundamental economics of profitability in lending history.

So, we think that this is really rationing down the amortization schedules are imperative to building equity and improving recoveries. And in essence of the Clayton model, by the way, the Clayton model put recourse back at their own retailer's level, so the retailer was then responsible for reselling a repossession on his retail lot or suffering the P&L consequences of losing money. So, it's just another version of guaranteeing high recoveries and more profitability in the industry.

And then how much capital do you expect to contribute to this program?

I think we are definitely going to run the program for a 30-day period of time and make a decision as we rolled it out in these two marketplaces and seek board approval for a definitive amount of capital to be designated. Right now, it's only in the test phase.

And how many repos are in your portfolio at the end of the second quarter?

There are 327 rent-paying repossessed homes in our portfolio at June 30.

OK, and non-rent paying?

282 non-rent pay.

And so that's down a little bit from the first quarter levels.

Yeah. It was 322 in Q1 and 337 at the end of the year.

OK. That's it. Thank you very much.

We have a follow-up question from Alexander Goldfarb and I remind you to press one if you would like to add to the question cue.

Follow up on the Sun Champ Trident lease up. Are there any NOI assumption changes for the lease up for Sun Champ for this year?

Well, no, there aren't. They have been able to reduce expenses to cover most of the leasing shortfall, so we haven't seen the need to make any revisions at this point.

OK, so it's still at that $1.8 million for the year?

That's right.

Okay. And then going back to the Sun Champ amortization, my understanding was that it was a set amount and it was just a matter of amortizing it, so more amortizing this year means that there will be less next year, correct?

That's correct. It's a finite amount.

OK, thank you.

We have a follow-up question from David Shulman of Lehman Brothers.

One more question: I assume on the Origin Financing that's out, I assume that is some form of equity financing?

David, as much as I would like to be talking about it, there's nothing we could say, and we have been backwards and forwards with counsel on this. Obviously my statement was to counsel, you know, we discuss it on each analyst conference call, and they wouldn't permit us to discuss it. I would expect, you know, within a 30-day period to be able to discuss it fully with the marketplaces. I think they will have completed the work that they're doing right now.

OK. Presumably this is a private financing rather than a public financing that is out there.

I couldn't comment on it.

Is there a document -- are you aware of a document on file with the F.E.C. right now?

I am aware of no document with the F.E.C.

OK, thank you.

OK.

We have a follow-up question from Art Havener, A.G. Edwards.

I noticed that the investments and affiliates increased to about $15.5 million, can that primarily be attributed due to loans to Origin?

That could be primarily attributed to the purchase of MH loans from Origin.

OK, thank you.

Again, if you have a question, please press 1. One moment please, just to see if there are any final questions. At this time, I am showing no further questions.

Well, we would like to thank everybody for participating in our analyst conference call and we look forward to our next call and being able to discuss details of Origin's transaction whenever they're available. Thank you.

Thank you, ladies and gentlemen, for your participation. You may please disconnect at this time and have a great day.