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Equity Lifestyle Properties, Inc. (NYSE:ELS)

Q3 2009 Earnings Call

October 20, 2009 11:00 am ET

Executives

Thomas P. Heneghan - Chief Executive Officer

Michael B. Berman - Executive Vice President and Chief Financial Officer

Analysts

Andrew McCullough – Green Street Advisors

Bill Carrier - KBW

Todd [Sinzer] – Wells Fargo Securities

David Toti - Citigroup

Michelle Ko – Bank of America/Merrill Lynch

Operator

Thank you all for joining us to discuss the Equity Lifestyle Properties third quarter 2009 results. Our featured speakers today are Tom Heneghan, our CEO, and Michael Berman, our CFO. In advance of today's call management release earnings. Today's call will consist of opening remarks and a question-and-answer session with management relating the company's earnings release. (Operator Instructions)

Certain matters discussed during this conference call may contain forward-looking statements in the meaning of the Federal Securities laws. Our forward-looking statements are subject to certain economic risks and uncertainties. The company assumes no obligation to update or supplement any statement that becomes untrue because of this subsequent events.

At this time, I would like to turn the call over to Tom Heneghan, our CEO. Please proceed.

Thomas Heneghan

Good morning everyone. Thank you for joining us today. I am Tom Heneghan, Chief Executive Officer of Equity Lifestyle Properties. With me today is Mike Berman, our Chief Financial Officer. I would like to make a few comments and then turn it over to Mike. After our comments, we will open it up for your questions.

Our business continues to perform well. We believe this performance highlights the strength of our business plan and the quality of our cash flow. As we have discussed many times, we believe our customers are generally in better financial shape, are less exposed to job losses and have fewer credit problems than the broader economy.

Our properties represent an attractive and affordable option to empty nesters and retirees wanting to reduce the amount of capital tied up in their housing and still enjoy a high quality, active lifestyle. Most of our customers own their housing units outright.

We are pleased with our balance sheet and the increased financial flexibility created by our recent equity offering. It will take us until about mid 2010 to fully deploy the proceeds to reduce outstanding debt and as a result until then our results will bear a disproportionate amount of dilution compared to the longer-term positive impact of the reduced interest expense resulting from the offering.

2010 will also mark the first year that the Thousand Trails portfolio enters our core results. Since our acquisition of this operating company back in August 2008 we have been discussing the Thousand Trails business as a separate component of our results. The benefit was that we could introduce and explain some of the concepts particular to that business such as annual dues and membership sales. However, it has also slowed the assimilation of that business into our operations. Thousand Trails was in some sense separate because we treated it at separate. In actuality, that business and its customers are every bit of who we are and what we do.

Taking a step back and looking at the whole will allow us to focus on creatively using the best products and services for our customers across the whole portfolio. This changes how we discuss our business but I think you will also agree that this approach highlights the strength of our operating platform and business plan.

Although there is a growing sense of optimism with respect to the economy, we believe there are significant issues at play that impact our results and will continue to do so in 2010. We essentially see two main issues influencing consumer behavior. First, with respect to what I would call current income. We think consumers are focused on obtaining value. This desire for value is a net benefit for our business since we provide significant value to our customers both economically and from a community or lifestyle point of view. In addition a significant amount of revenue is derived from our customers’ current sources of income and not dependent on access to credit, providing stability to our revenue.

The second factor would be spending is dependent upon consumers’ access to capital or credit. Not only is access to credit influencing consumer behavior but so too is the willingness to take on credit for those customers who do have access. Spending of this type typically involves big ticket purchases like cars, housing, etc. We currently see consumer access to credit as essentially being bipolar. If your credit is somehow tied to the government then credit is generally available and at attractive rates. However, if your need for credit is not tied to some government program we would characterize credit as generally unavailable or available at higher rates and more restrictive loan terms.

Unfortunately, consumer loans for the purchase of factory built housing do not benefit from the significant government programs and as a result loans are only available on very restricted terms and at comparably higher rates. This has directly impacted our home sales capability. It is unfortunate that the one industry that can actually claim to provide affordable housing is in essence penalized at the expense of an extraordinary amount of government support being given to the single family housing industry.

We have successfully reacted to this situation during 2009 by converting our for sale inventory to new home rentals. The degree of government support to the single family home industry in 2010 and beyond will influence our ability to return our sales operation to its historical position as a major contributor to occupancy. Our guidance for 2010 assumes a static environment.

Now Mike will walk you through our results in more detail.

Michael Berman

Thanks Tom. I would like to go through our thoughts and assumptions underlying our 2010 preliminary guidance range. 2009 full year numbers are estimates. As always, I caution that I do not intend to precision my comments [applies].

Our core properties are defined as those properties we own and operate for two consecutive years. If you recall, we purchased the operating entity of Privileged Access in August of 2008. All of these properties will now be included in our core discussion on our core property operations.

2009 total property revenues for the 2010 core group is expected to be approximately $493.5 million and is expected to grow approximately 1-1.5%. Approximately 90% of this revenue comes from annual revenue sources and only 10% is what we refer to as seasonal and transient revenue streams. The annual revenue sources consist of community based rental income, annual revenues on our resorts, membership related income consisting of dues and right to use contracts and utility and other income.

2009 community based rental income for the 2010 core group is expected to be approximately $253.5 million and is assumed to increased 1.5-2%. We assume no change in occupancy but acknowledge the hard work that is necessary to manage this assumption in the current environment. By the end of October we will have noticed approximately 60% of our residents with rate increases reflecting this revenue growth.

On our last earnings call we indicated that revenue growth coming from CPI and minimum rent increases would be approximately 1%. The remaining growth we are forecasting comes from turnover to market which was not included in our prior analysis. 2009 annual resort based rental income for the 2010 core group is expected to be approximately $74 million and is assumed to increase 2.5-3% next year. Our forecast is primarily based on reservations in place. For the past several years we have been very successful in increasing the number of annual customers in our non-core properties. We are pursuing the same strategy in our membership properties and we will see some of this benefit in 2010.

Our 2009 transient revenues for the 2010 core group is expected to be approximately $27 million and are expected to be flat in 2010. The first and second quarters represent 40% of the total, almost evenly split between the two quarters and the third quarter represents 45% of the transient revenues.

For the first quarter of 2010 we are over 5% ahead on our reservation pace. At this time last year we were over 25% behind pace. Our 2009 seasonal revenues for the 2010 core group are expected to be approximately $20 million and are projected to be flat in 2010. Approximately 60% of our seasonal revenues occur in the first quarter. Our 2010 core properties generated approximately $12 million in the first quarter of 2009. Based on current reservations, we would anticipate a similar performance in the first quarter of 2010.

To date we have over $9.2 million in seasonal reservations for the first quarter, an increase of over 2.5% to last year. At this time last year our seasonal reservation pace was 15% behind the prior year. Reservation comparisons are point in time. We ended down in the first quarter 2009 versus 2008 but much less than the pace would have suggested. Overall we expect our resort based revenues for our 2010 core group to be approximately $121.5 million increasing approximately 2% for 2010 to $124 million.

Membership income consists of dues, income and right to use contracts. In 2009 we expect to achieve dues revenues of almost $51 million. We are forecasting to be down approximately 5-6% in 2010 to about $48 million. Continued attrition of the dues pace is offset by a modest rate increase. In 2009 we expect to achieve approximately $21 million in right to use contract revenues and expect to achieve a similar performance in 2010.

We expect core utility and other income, approximately $47 million in 2009 to grow approximately 1.5% in 2010. Core property operating expenses for the 2010 core group before property management is expected to be approximately $225 million in 2009 and are budgeted to increase approximately 1% in 2010 to $227 million. We expect utility, real estate taxes and insurance costs to be approximately $107 million in 2009 and increase by 2% in 2010 to $109 million. The remaining expenses are forecasted to show no growth next year.

In sum, 2009 core property operations before property management for the 2010 core group is expected to be approximately $268.5 million and is projected to grow 1-2% to $273 million. We expect a $1.8 million contribution from our non-core properties in 2010. These properties contributed about $1.4 million in 2009. Total forecasted income from property operations is therefore approximately $275 million.

In 2009 we expect to have $34 million in property management costs and $22 million in corporate G&A for a total of $56 million. We anticipate we will have $33 million in property management costs and $22 million in corporate G&A in 2010 for a total of $55 million.

For other income and expense items I am grouping together our sales operations and all of our other income and expense items. In 2009 we achieved $14 million of income. In 2010 we expect to achieve $11 million of income. In the first quarter of 2009 we reported approximately $3 million in one-time gains associated with joint venture sales and insurance recoveries. Interest expense is expected to be approximately $91 million as we put our cash balances to work.

During the fourth quarter of 2009 and the second quarter of 2010 we will generate approximately $74 million of proceeds on mortgage financings we have already locked rate on with Fannie Mae. We expect to pay off $32 million of mortgages during the fourth quarter of 2009, $100 million in April 2010 and $76 million in August 2010. Our preferred distribution is $16 million. We make no assumptions on the use of our free cash flow in our earnings model.

Overall FFO is approximately $113 million for 2009 and $124 million in 2010 at the midpoint of our range, an increase of almost 10%. However, our share count is expected to average 35.5 million shares in 2010 up from almost 33 million in 2009, an increase of almost 8%. At the midpoint of our preliminary guidance our FFO per share estimate is $3.49.

Given how our debt payoffs occur in 2010 and the impact of the June equity offering on our share count I also wanted to make a few comments about the first quarter, our largest. In 2009 we reported FFO of almost $38 million or $1.24 per share. This result included almost $0.10 per share of FFO from one-time events. In 2010 the first look at the first quarter indicates we expect $34-38 million in FFO or $0.98 to $1.08 per share. At the midpoint FFO increases approximately 234% adjusting for the one-time gains but the share count is up almost 16%.

With that I would like to open it up for questions.

Question and Answer Session

Operator

(Operator Instructions) The first question comes from the line of Andrew McCullough – Green Street Advisors.

Andrew McCullough – Green Street Advisors

On the new Fannie debt, especially the rate lock stuff, the rate is noticeably higher than what the apartment REIT’s have recently been paying. Maybe 100-125 basis points higher. Why do you think that is?

Michael Berman

Well we locked our rates, most of it back in May in the spring. Treasuries were higher. We also paid 50-60 basis points in order to get a one-year forward rate lock. Today’s spreads for manufactured housing is call it 2-2.25 over the ten year. I don’t think that is too far away from where the apartment deals are going. It is also hard to know exactly what the comparisons are. You need to know where the properties are located and what the underwriting is with respect to individual assets.

Andrew McCullough – Green Street Advisors

Where are those four properties located?

Michael Berman

One was in Florida and three were in California.

Thomas Heneghan

Appreciate, we decided to lock rate last year because if you remember we started to get some uncomfortable feeling as to how committed Fannie and Freddie would be to the manufactured housing industry. In essence we ended up doing an offering in light of that. There were decisions that were made at the time based on what we saw happening.

Andrew McCullough – Green Street Advisors

On your rental program, can you tell us how much that has expanded in the last quarter and how much you think that is going to expand in 2010 to maintain occupancy?

Thomas Heneghan

It hasn’t really expanded much in the last quarter. For the year I think we have done 300-325 net rentals. For next year we are forecasting a similar change.

Andrew McCullough – Green Street Advisors

Are you seeing any opportunities on the acquisition front that look attractive and what kind of cap rates are you seeing out there?

Thomas Heneghan

I would say we are seeing significantly more what I would call distressed asset opportunities. Most of it is on the family side. It is distressed as it relates to occupancy, market and in some cases even debt. Good located properties, however, especially age restricted properties we are not seeing any distress. In fact the pricing for that stuff is still pretty strong. If you can get financing through Fannie Mae again that also is a buffer under the pricing.

Andrew McCullough – Green Street Advisors

What sort of cap rate roughly for core age qualified stuff?

Thomas Heneghan

I am not seeing any age qualified stuff trading frankly. There were some guys down in Florida looking to sell a portfolio that would be less than 6 cap rate.

Operator

The next question comes from the line of Bill Carrier – KBW.

Bill Carrier - KBW

G&A costs were down quite a bit in the third quarter versus the second quarter. What was the driver of that decrease?

Michael Berman

The G&A costs on a quarterly basis are really a function of expenses as they come in. We are on pace for G&A being $22 million I think this quarter. I don’t have the number in front of me but I think this quarter is pretty much on that run rate.

Bill Carrier - KBW

So no one-time…

Michael Berman

No. Again just as it rolls through the quarter it can change but no real special event between then and there.

Bill Carrier - KBW

Used home sales in the third quarter were the highest for you in many years. Are you seeing increased demand for used homes in certain states or regions of the country?

Thomas Heneghan

I would say for quite some time we made comments about what I would call the organic resell environment that happens in our communities that continues to happen almost without much of a discussion. People are looking for attractive values and used home sales in our communities represent that attractive value so you are seeing on both a resell side and also on the used home sale side. In addition we are focused on moving some of our rental inventory through to used home sales so we are also just focused on turning our capital over as well.

Bill Carrier - KBW

Industry RV sales appear to have bottomed or are bottoming and are looking as though they will improve off of trough levels here. What kind of impact do you think improved RV sales could have on your 2010 results and is there historically some lag time between RV sales and results for Thousand Trails and Resorts?

Thomas Heneghan

We essentially deal with what we call the installed base of the eight million RV’ers out there so as frankly our RV sales fell precipitously in the last 12 months from I think there were 300,000 plus down to 200,000 plus and now they will be slightly over 100,000 in 2009 so you have seen a pretty dramatic fall off in RV sales over the last 24 months without really impacting any of our RV business.

Where you will see it is on the membership sales. We used to focus on the new RV owner as the main target for membership sales. We are actually taking a different approach now and trying to broaden our products to be much more attractive to the installed base. So at the margin you will see some impact from RV sales on our business but it is again 200,000 sales on a base of eight million so that is I would say the relative impact it is having on our business.

Bill Carrier - KBW

There has been some chatter about potential REIT IPO’s recently and possibly in the manufactured housing space. Do you anticipate any new manufactured housing REIT’s coming public?

Thomas Heneghan

I don’t anticipate any but that could happen. The one place you can get capital is in the public marketplace. I could see a number of people evaluating whether or not that makes sense. In some cases it very well might.

Operator

The next question comes from the line of Todd [Sinzer] – Wells Fargo Securities.

Todd [Sinzer] – Wells Fargo Securities

My first question is back to your home sales. What was the mix in the sales regarding the size? Did it seem more on the smaller size, the 800 square foot range versus the larger 1,500 square foot?

Michael Berman

We sold three homes that we would call manufactured home sales and we did 22 that we would call RV sales. The RV sales are the park models that average call it 400 square foot a piece. The other ones could be anywhere from 800 to 1,000 square feet give or take.

Todd [Sinzer] – Wells Fargo Securities

Any specific properties or markets that you see experiencing more success than others?

Thomas Heneghan

We are not seeing a lot of volume on home sales is the point to take away from this. You are seeing, again, demand for used homes and affordably priced new homes. We have been trying for quite some time to introduce new homes into the market at lower price points. We are now hitting price points underneath $50,000 with respect to it. Frankly even those homes are difficult to sell in this environment but easy to rent. Our customers are looking at financing options that are 8-10%, 10-20% down and very stringent with respect to FICO scores.

It may be a good deal economically but viscerally somebody is looking at a 9% interest rate when they know single family home interest rates are at 5% and there is just an impediment as a result of that comparison. It may be a great value but at the margin our customers are opting to rent and I think some of that has to do with just that comparison it has. On the face of it, it just doesn’t when it very well might be very attractive.

Todd [Sinzer] – Wells Fargo Securities

The debt you sourced in the third quarter, the $21.1 million, was that backed by Fannie Mae?

Michael Berman

Yes.

Todd [Sinzer] – Wells Fargo Securities

Can you share the loan to value, coverage and if any portion of that is interest only?

Michael Berman

No portion is interest only. I think it is a 30-year amortization schedule. The loan to value has generally been in the 70-75% range. I don’t remember the coverage numbers off the top of my head but they have generally been 1.2 or 1.3-ish depending on the property.

Operator

The next question comes from the line of David Toti – Citigroup.

David Toti - Citigroup

With regard to some of your efforts at the front line with lower price points, are you making any progress there? Are you finding that you need to do deeper promotional activity? A larger picture of what is going on in the front lines would be helpful.

Thomas Heneghan

We have essentially been testing two products. One we will refer to as kind of we call it a one park. Instead of having access to the whole portfolio of properties you have access to a limited number of properties starting out as few as one and up to call it three properties. I would say we have 400-500 of those sold. It hasn’t gone as well as we would have liked. We are finding out that actually customers view the portfolio as an attractive feature. In other words the flexibility of going to a number of locations is part of their decision making process. So we are trying to look at how we could adjust that low cost product to take that into account.

Another product we have introduced is what I call the hybrid membership, non-membership product is called the Ready Camp Go Card. We have actually introduced a couple of thousand of those to pretty good success. It hasn’t really gotten as much attention internally as trying to work through the one park issues but frankly maybe that is the product we spend a little bit more time on. Essentially that is a product that involves an upfront payment of as low as $50 to as high as call it $300. Then it has a pay per use privilege underneath that as you use your card at one of our properties you get the discounted rates at the properties so it has both an upfront component and a pay as you go component.

Frankly that has done pretty well without much effort. We are spending a lot of time internally to find out what is the best mix of products to introduce. I think we are going to continue to be working on that in 2010. We are not pleased with our ability to introduce those products efficiently and effectively at this point.

David Toti - Citigroup

Moving over to Thousand Trails, something you talked about in the last call were your efforts around utilization. Is there any way to quantify how that has changed in the last few months relative to those efforts?

Michael Berman

We have done a very nice job in the portfolio of extending significant number of customers whether they were seasonal or dry storage to an annual base. I would say we have done probably 750-1000 this year of what we would otherwise refer to as annuals. You are not getting a full incremental revenue pop because the customer was paying you something but on average they are paying us call it $2,500 or maybe $3,000 depending on the property. Again that is not all incremental revenue but I would say operationally we are looking at that as a good success so far.

David Toti - Citigroup

Popping over to the expense side of the equation you made pretty good progress in terms of trimming expense growth this year but it looks like it is going to be modestly up next year. Is that generally the mix of components you can’t control or is that your cost cutting efforts sort of have reached the maximum depth?

Michael Berman

In my remarks I broke out real estate taxes, utilities and insurance costs. I would like to say we can control those but we can’t. Those are forecasted to be up 2%. I am a little nervous on my utility expense. If you look at where natural gas prices are today they are at pretty low levels. If those start to pop up large I could have a negative variance although it does take time to go through the utility system before it hits your P&L. We are hedged to some extent on that but the utility number I get a little nervous about.

With respect to the rest of it I think we are doing a very good job of managing the expenses we can control. We are looking forward to doing that also in 2010 particularly with respect to some of our membership and RV properties.

David Toti - Citigroup

Relative to the CPI forecast and your underwriting for next year of around 1% do you think there is more risk to the upside or the downside to that number?

Michael Berman

For us we are essentially a laggard when it comes to the CPI. We see the CPI July, August and September as basically setting our forward rates for next year. If there is a massive spike up in CPI in the next few months it won’t really affect us that much in 2010 but will probably have an impact in 2011.

Operator

The next question comes from the line of Michelle Ko – Bank of America/Merrill Lynch.

Michelle Ko – Bank of America/Merrill Lynch

I was just wondering if you could give us more details on the increase in your 2010 core operating revenues to 1-1.5% from your prior estimate of about 1%?

Michael Berman

The difference there is really the mark to market on turnover. We have in any particular property an existing group of customers that is paying X dollars in terms of rent, next year when we negotiate rent increases they go to Y dollars. That mark to market process was not in our initial forecast. Our initial forecast was solely based on what we thought would be the CPI going forward on a 12 month basis as well as minimums that we have in our agreements. So the incremental dollars are coming from the turnover to market.

Michelle Ko – Bank of America/Merrill Lynch

Can you also tell me on the Montana asset that you sold, can you give us a sense for what the cap rate was on that?

Michael Berman

It was less than 7%. I think the asset was 70%-ish occupied at the time we sold it.

Operator

There are no further questions at this time.

Thomas Heneghan

Thank you everyone for joining us on our call today. As always if you have some follow-up questions please call Michael Berman and we look forward to updating you with our year-end results and our new outlook for 2010. Take care.

Operator

Ladies and gentlemen thank you for your participation in today’s conference. This concludes the presentation. Have a wonderful day.

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Source: Equity Lifestyle Properties, Inc. Q3 2009 Earnings Call Transcript
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