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Brookfield Residential Properties Inc. (NYSE:BRP)

Q4 2013 Earnings Conference Call

February 12, 2014 11:00 a.m. ET

Executives

Alan Norris – President & Chief Executive Officer

Craig J. Laurie – Chief Financial Officer & Executive Vice President

Analysts

Dan Oppenheim – Credit Suisse

Adam Rudiger – Wells Fargo Securities

Samuel McGovern – Crédit Suisse

Scott Schrier – Citigroup

Frank Mayer – Vision Capital

Operator

Thank you for standing by. This is the Chorus Call conference operator. Welcome to the Brookfield Residential Properties Inc. conference call and webcast to present the company's 2013 fourth quarter results to shareholders. As a reminder all participants are in listen-only mode when the conference is being recorded. After the presentation there will be an opportunity to ask questions. (Operator Instructions).

At this time, I’d like to turn the conference over to Mr. Alan Norris, President and Chief Executive Officer. Please go ahead, Mr. Norris.

Alan Norris

Thank you very much. Good morning, ladies and gentlemen, and thank you for joining us for Brookfield Residential's 2013 yearend conference call. With me today is Craig Laurie, our Chief Financial Officer.

I would, at this time, remind you that in responding to questions and in talking about new initiatives and our financial and operating performance, we will make forward-looking statements. These statements are subject to known and unknown risks and future results may differ materially. For further information, I would encourage investors to review the corporate profile on our website.

2013 was a rewarding year as we continued to harvest what has been for many years solid and reliable income and cash flow from our Canadian operations, while the U.S operations capitalized on significantly improved housing market conditions. Our income before income tax increased 33% to $172 million and the net income attributable to Brookfield Residential increased 33% to $1.21 per diluted share. We achieved these results while continuing to build on our well located land asset portfolio. In 2013 we completed $358 million in strategic land acquisitions, split almost equally within Canada and the U.S. And at yearend we controlled over 110,000 lots which positions Brookfield Residential as one of the leading asset-rich land and housing companies in North America.

As we anticipated, the U.S housing market continued to rebound in 2013. While there was a small bump along the road midway through the year related to the tapering discussions and U.S government shutdown, the U.S market finished the year with new house prices up year-over-year. While the pace of recovery and supply has varied from region to region, demand has improved over past years, which has led to rising home prices. Our Canadian operations in Ontario and Alberta remained solid in 2013. In Ontario, our operations continued to perform well and the supply constrained market is expected to be a strong contributor to our results going forward. In Alberta we continued to benefit from our strong market share within the energy focused market. We have a strong base supporting steady sales, and positive economic fundamentals continued to drive housing demand and pricing.

In 2013 we increased our active housing community count, including our share of unconsolidated new entries from 33 to 47 and we expect to open 19 new communities during the remainder of 2014, with much of the financial impact to be reflected in 2015 and beyond. With the strength of the U.S market, we’ve been able to advance the development of several new projects which were originally planned for 2016 into 2014. So adjusting for communities that are projected to sell out in 2014, we expect to end 2014 with approximately 57 communities in active selling areas, including the unconsolidated entities.

Our strategy in 2014 will see us increase our involvement in mixed use projects across North America. We have been developing commercial properties within our master-planned communities for decades and our disposition of these assets is consistent with past practices whereby we create volume in the retail assets by entering into leases, then selling to a REIT or other parts of income properties thereafter. In Calgary, we have a very exciting project called Seton which sits on 365 acres and is one of the largest mixed use developments of its type in North America. Our vision of Seton began years ago, but came to fruition when construction began on the $1.4 billion 45 acre South Health campus which opened in 2012.

Our development plans includes 2.5 million square feet of office and retail space, light rail transit, a regional park, a public library, high school, regional recreation facility, hotel and over 1,300 multi-family residencies. We’re also developing full residential master-planned communities in proximity to Seton. In November 2013, we entered into a contract to sell the first phase of Seton, which included 128,000 square feet of retail space and is currently 96% leased. This asset is under contract for CAD$73 million and it is expected to close in the first quarter of 2014. The forecasted net gain on the sale will be approximately CAD$35 million.

Thanks to our sizeable land holdings within our master planned communities, we have considerable control over product segmentation, allowing us to meet the needs of our multi-markets. Affordability remained strong despite price gains experienced in 2013 and we predict further home price increases in 2014, albeit at a slower pace. It is important to remember that due to the multiplier effect, a small increase in a house price can often translate into a large increase on the underlying land value. Our residential 2014 is positive and we anticipate that based on current market conditions, income before income taxes for 2014 will be measurably higher than 2013.

We offer the following limited operational guidance for 2014. Canadian operations are projected to close approximately 1500 single family lots, 30 acres of multi-family, commercial and industrial parcels as well as 1,400 homes. California operations are expected to close approximately 750 single family lots and 525 homes. Central and eastern U.S operations are expected to close approximately 1,000 single family lots and 450 homes. Our share of investments in unconsolidated entities, are projected to close 600 single family lot equivalents and 70 homes. This limited guidance does not include material bulk lot sales or other transactions such as the sale of the commercial assets that may occur in Canada or U.S. Many of the lots and acre closings are projected for the end of 2014 and are subject to the normal timing risks of approvals and the development of closing process. As a result, if they do not close in 2014, we would anticipate it will occur or happen in 2015.

With respect to Brookfield Residential’s prospects going forward, we believe that we’re one of the best positioned land and housing companies in North America. Our strategy of going long on land when it was out of favor, should allow us to reap the benefit of increasing land values as markets continue to improve. We obviously have a number of disposition alternatives available to us in a rising and recovering market. We will also continue to evaluate large corporate initiatives as they are presented to us. However, our approach is disciplined and we will only enter transactions if they are strategic and accretive value to our company. While not giving specific earnings guidance, based on our current assumptions and forecast, we would anticipate 2014 income before income taxes, including the Seton commercial sale, to be roughly a linear progression to the goal of 2015 U.S results equating that currently experienced in Canada.

I'll now pass the call back to Craig to speak to our financial results.

Craig Laurie

Thank you, Alan, and good morning, everyone. As Alan outlined, Brookfield Residential had strong results in 2013. At yearend, net income attributable to Brookfield Residential was $79 million or $0.67 per diluted share for the 3 months ended December 31, and $142 million or $1.21 per diluted share for the 12 months ended December 31. This was an increase of $23 million and $49 million, respectively, when compared to the same period in 2012 and was the result of the increased gross margin from higher home closings, combined with a decrease in income tax expense, which was partially offset by higher sales and marketing costs and general administrative expenses.

Land revenue for the 3 months ended December 31, 2013 totaled $146 million compared to $407 million during the same period in 2012. The 2012 land operations include the Playa Vista sale of 195 lots and 22 multi-family acre parcel sales that resulted in $264 million of revenue and $nil margin. With the inclusion of the Playa Vista sales, land revenue -- without the inclusion of the Playa Vista sale, land revenue increased by $3 million over the same period in 2012.

Land gross margin was $63 million, a $2 million increased compared to the same period in 2012. For the 12 months ended December 31, 2013, land revenue totaled $373 million compared to $622 million in 2012. Adjusting for the sale of Playa Vista, land revenue increased by $15 million. Compared to 2012, gross margin was stable.

Housing revenue was $409 million for the 3 months ended December 31 compared to $308 million for the same period in 2012. Housing gross margin for the same period of 2013 was $85 million, a $35 million increase compared to the prior year. The increase in housing revenue gross margin was due to higher volumes with 131 additional closings, an increase in gross margin and a mix of sales between the operating segments.

Housing revenue was $983 million for the 12 month ended September 31, 2013, compared to $718 million for the same period in 2012. The increase was the result of additional home closings in all operating segments, with California seeing the largest increase. Gross margin increased $82 million as a result of a 23% increase in home closings and a 12% increase in the average selling price when compared to the same period in 2012.

As at September 31, 2013, our total backlog, including our share of unconsolidated entities, had grown to 915 units, representing $448 million of value. This was up 10% and 23%, respectively, when compared to December 31, 2012. Canadian operations continue to be strong with a steady increase in sales and a 7% increase in back log year-over-year. California operations experienced the most substantial price increases as well as increased activity, and new community openings when compared to the same period in 2012. The Central and Eastern U.S. regions saw increased connectivity, primarily in the Washington D.C market and in our Denver market as our home building operations were launched in 2013.

Our selling and general, administrative expense was $170 million for the 12 months ended December 31, 2013, an increase of $42 million when compared to the same period in 2012. As a result of the increased activity, general and administrative expense increased $23 million, primarily driven by labor and head count cost, while share based compensation increased $5 million.

Our sales and marketing expense increased $14 million as a result of the increased activity in all our operating segments when compared to the same period in 2012. Our land and housing inventory investments and unconsolidated entities are our most significant assets, with a combined book value of $2.6 billion or approximately 78% of our total assets as at December 31, 2013. The land and housing assets increased when compared to December 31, 2012 due to acquisitions of $358 million, development activity and a strong backlog, partially offset by sales activity.

In 2013 we strengthened our capital position with an issuance of $500 million of senior and secured notes due in 2022. The coupon is fixed at 1.25%. Together with the new unsecured $250 million U.S revolving credit facility, we’ve improved the overall liquidity level to over $1.1 billion, including $320 million of cash on hand and reduced out net debt to capital ratio to 42%.

Annually, we disclose our projections for undiscounted net cash flow from our land held for development and optioned land inventory. In last year's business plan, this amount was forecasted to be approximately $5 billion. In this year’s business plan, the forecast has grown to approximately $5.5 billion. These cash flow projections represent the net cash flow through the development and monetization processes.

Cash flows from joint ventures are shown at Brookfield’s proportionate share. Inflation has not built into the Canadian and the U.S. cash flow projections. In previous years, certain long term land assets, cash flow forecasts assumed a return to a stabilized market condition. These assumptions have now been met. This number will fluctuate with the composition of the company’s inventory as land business development or the monetized through the sale of joint venture structures.

Canadian cash flow projections comprise approximately 60% of the total future cash flow. The Canadian cash flow projections increased approximately 5% on a year-over-year basis. Over 70% of the future cash flows are projected in Canada are projected within the next 10 years, with approximately 30% in the next five.

U.S. cash flow projections comprise approximately 40% of the total future cash flows. U.S. cash flow projections increased approximately 15% on a year-over-year basis. In addition, we are advancing development on a number of projects with approximately 85% of future U.S cash flows projected within the next 10 years, with approximately 45% in the next five.

Thank you for joining us in our quarterly conference call. I’ll now turn the call back to the operator who’ll moderate questions.

Question-and-Answer Session

Operator

(Operator instructions). The first question is from Dan Oppenheim of Credit Suisse. Please go ahead.

Dan Oppenheim – Credit Suisse

I was wondering if you can just talk, as you think about 2014, you’re talking about some of the projects in terms of land sales and section approvals and much coming at the end of the year. If you can provide a bit more clarity then also a bit in terms of the mix as you think about that I guess especially within California in terms of the mix of land sales.

Alan Norris

Hi Dan, it’s Alan. Yeah, I think -- we have a couple of projects just that come to mind that we’re finishing off the entitlements and we’re probably a month away and we’re literally letting construction contracts go in the beginning of Q2, which we would then be hopefully finishing off all of the onsite work required to sell lots by October, November, early December. So we have a number of lot sales that fit into that category. So we have a few moving parts to get to that. That’s really the point we’re trying to make and those are specifically in California. So with respect to the mix from a housing perspective, we still have a fairly high average sales price going forward in California, with a lot of the projects up (inaudible) in northern California. And then we will now start to see some even coming from the Playa Vista project for instance in 2014 which is obviously a high ASP as well. Craig, did you have --

Craig Laurie

That’s very helpful for housing. I apologize. Sorry. That was on the housing side that last part. The first part was on the lot sales.

Operator

The next question is from Adam Rudiger from Wells Fargo Securities. Please go ahead.

Adam Rudiger – Wells Fargo Securities

I wanted to talk a little bit about land gross margins if we could. Obviously they’re a bit volatile and we understand the one-time nature of certain transactions can impact that. But I think many people, myself included, try to use that metric as a way of valuing the rest of the inventory. So could you talk about what drove the change? Last quarter it was 58%, this quarter 43%. So what happened this quarter? And then what would be an appropriate range for us to try to think about going forward and if you try to smooth line is all.

Craig Laurie

This is Craig. So I think, as we talked Canada has been relatively stable usually between say 50% to 60%. That level will vary depending on the mix really between Edmonton and Calgary. We talked about Edmonton had a slightly lower gross margin percent. In California, the land gross margin had about 36% gross margin. We’d normally anticipate that it would be between 25% and 35% in California. In Central and Eastern, the average 9% for the quarter, 7% for year. As we talked about, the big driver of that is just we had not been selling enough lots to really cover the inherent operating costs. In 2014 I think we would look to, with the unit (inaudible) that we should be past that and again we would target the 25% to 35% gross margins on lot sales in central and eastern.

Adam Rudiger – Wells Fargo Securities

Okay. And then the second question I had, if you look back at what happened in 2013 and the way the year started and then the way that changed throughout the year, did that do anything to impact the multi-year disposition of lots in the U.S., meaning did it accelerate your thoughts at all? Or did you -- just any change I guess is the question.

Alan Norris

No, it’s a good point, Adam. It’s Alan here. We obviously saw things slowing down somewhat in Q4. I think everybody did. The trajectory that was going on in the first seven, eight months of the year was quite rapid in most regions. But what we closed in Q4 from a lot sales point of view on housing closings was exactly as we had anticipated. We’ve continued with them. We’re still bullish on where the world is going and where we are in the stage of the recovery specifically from a U.S. point of view. So we’re continuing to move ahead on a consistent basis as to what we originally thought was as a progression in 2014 and getting in 2015 as I touched on in my prepared remarks, getting the U.S. operations up to a level of profitability equal to where Canada is at this point by 2015.

And we think we’ll get there through a natural almost linear progression quite honestly. And so we’re still comfortable on the stage of where we are in the recovery. We definitely still need to see better jobs numbers and all that stuff. We’re still not quite sure like anybody is on the December and January numbers that came out, whether that -- everybody keeps talking weather and other things. But we’d like to see a little bit more improvement on that side. But I still think we’ve got a fair ways to go on the affordability side in many of the markets and still also from an absorption point of view and getting up to a more normalized rate of sales for the country nationally.

Operator

The next question is from Sam McGovern from Credit Suisse. Please go ahead.

Samuel McGovern – Crédit Suisse

Just to build on the previous question. Other than the slowdown that hit the entire industry in the fourth quarter, have you guys seen any change in the appetite or demand for land from the builders on a go forward basis?

Alan Norris

Sam, it’s Alan. Actually it’s a good question because we’re down in Los Angeles, just finished some meetings with our people down here. I think I would say that there was some trepidation probably in Q4, but I think has rebounded and California specifically had a very good January. I think not just us, but many other builders as well. So we’ve been having discussions with many builders of lot sales for later in this year as I touched on earlier on. I think there is still a good sense of optimism and many interested parties coming to the table expressing a desire to buy lots. So I think it’s. We’ll obviously see the spring selling season, but at this point in time we’re not seeing anybody holding back.

Samuel McGovern – Crédit Suisse

And then just to delve into a specific market, you guys talked a little bit in your press release about the Ontario market and relative strength there versus probably expectations. Can you talk a little bit about what you’re seeing there? I think obviously there’s prognosticators are talking about a potential slowdown there. Have you seen any indications of that happening or is it still steady there?

Alan Norris

We’ve probably seen some more incentives been offered on the high rise market which we’re obviously not a party to other than on the periphery. We’re only in the low rise business. And we consistent with past calls I think I would say that our pricing was reasonably flat during 2013. But we’re opening up some new communities as we speak and we’re getting excellent number of parties. We’ve got a new community opening up in Ontario. We have 3,000 people have registered to express desire of looking at some of the homes we’re going to be opening up. There’s still a pent up demand. I still think there’s a shortage of infrastructure deficit in that marketplace. No question the high rise business still has some question marks around it, but we’re not seeing much of an offshoot from that in the low rise business. So we’re still comfortable. We occupied over 500 homes there last year and we’re anticipating somewhere in that region again for 2014 and we’re sitting roughly with a 70% backlog, if not slightly higher at this point in time for 2014.

Operator

The next question is from Will Randow of Citigroup. Please go ahead.

Scott Schrier – Citigroup

It’s actually Scott Schrier on for Will. I wanted to ask you, your 2014 guidance assumes that you plan to close homes and lots. That represents a smaller percentage of your total controlled lots as compared to your average back in the early 2000s. And now as we’re ramping up toward mid cycle, just wanted to see, what’s holding you back from getting the closings and lot sales up to that kind of percentage that you had back then?

Alan Norris

It’s not a conscious decision on our part. I think it’s really just the state of each of the parcels where we’ve re-entitled some and some of that will happen in 2014 or -- either late 2014 or going into 2015. We continued to see a ramp up over a period of time. Many of the municipalities still don’t have as many individuals in on the planning and entitlement. These happened to be a backup again. So it’s taking some time to get some of those back through a re-entitlement process. But we’re comfortable with the stage of progress that we’re going through. Consciously in 2013 we were backing off a little bit to go more even flow so we were not preselling lots to builders who were going to participate in the upside. But I think we’re really just showing a natural progression as we go along. We could accelerate some of those if we felt it was appropriate if we get the re-entitlement side of things done in time. And that goes region by region. Austin is a prime example of that where we’ve been hoping to bring those projects on. We have two of them anticipated coming in, one in Q2 of this year and the other one is going to be closer to the backend of the year with respect to that. But there’s still some re-entitlement going through in that process just to get it to that point where we can service and sell.

Scott Schrier – Citigroup

And from an absorption standpoint, it looks like the absorption rate you’re assuming in 2014 might be a little lower year on year. Is that true and what kind of absorption rate are you assuming as we go into 2014 and will that accelerate?

Craig Laurie

This is Craig. I would say that we would assume our normal absorption rate is going to be similar to what we had in 2013. I think probably why you raise that point is we obviously show an increase in the community count from 47 to net 57. One of those new communities starts to come on towards the end of the year and I think that’s probably what’s distorting the numbers somewhat.

Operator

(Operator Instructions). The next question is from Frank Mayer of Vision Capital. Please go ahead.

Frank Mayer – Vision Capital

Congratulations on a fine year. You indicated that you purchased a whole bunch of land last year, $358 million, of which the majority was in Canada. Could you give us some color on what was purchased and what holes they filled in terms of the scheduling of development and so on?

Alan Norris

I think it was equal between Canada and the U.S, Frank. So it’s roughly half and half. I’m just trying to remember specifically. A number of them would have been some continued to fill the pipeline in Ontario and I’m just trying to think back. We did a few more deals in northern California, some shorter term deals up in the Bay Area. I don’t have the list right in front of me, but nothing of any major consequence. We did some medium-term stuff in Alberta, some outlying area just outside of Calgary for instance. But nothing that jumps out as a major one off or anything like that. There was just a number of different small pieces. I can try and give you a better sense of that later on. I just don’t have it at the top of my head right now.

Frank Mayer – Vision Capital

That would be helpful. With regard to the increase in the cash flow to $5.5 billion from roughly the $5 billion level, how did you deal with the exchange rate fluctuations in the course of 2013? In other words, was the $5.5 billion would have been greater if the Canadian dollar hadn’t come down during the course of the year?

Alan Norris

Yeah, I think it was -- I think, it was $0.95 we used. Is that right?

Craig Laurie

Yeah. Frank, it’s Craig. We assume obviously in a mid and long term perspective that power for the dollar.

Frank Mayer – Vision Capital

I’m sorry? Say that again. I didn’t hear you.

Craig Laurie

We assume rates past the next year or two that we have power for the Canadian, U.S dollar.

Frank Mayer – Vision Capital

You assume power?

Craig Laurie

For the next couple of years.

Frank Mayer – Vision Capital

Now, the second question I have regarding the $5.5 billion, clearly that would throw off a lot of cash flow and earnings to all the investors in your company. What is deemed to happen through that cash flow in this model, in this calculation? In other words is it paid out? Is it reinvested? Does it still there sterile?

Craig Laurie

Yeah. That number for purposes is really just showing a static cash flow kicks off of the existing assets that we own at this point in time. Obviously as we go forward, we would be reinvesting or distributing, looking at all the various options with respect to that cash flow as we go forward. It’s not going to be a wide document that way.

Frank Mayer – Vision Capital

So in other words, that’s a very -- that’s like an extremely conservative cash flow on the premise that management is capable of reinvesting whatever portion of the funds it chooses not to distribute to the investors, that number could be enhanced in the future.

Craig Laurie

Yes. It’s just intended to show what cash flow would take off of existing assets. That’s really all -- you’re exactly right.

Operator

There are no more questions at this time. I’ll turn the conference back over to Mr. Norris.

Alan Norris

Thank you. So thanks very much for dialing into our yearend earnings call. At this time we’d like to thank all the shareholders for your confidence and support in our company and we look forward to building on our 2013 results and continuing to reward your investment in us in the coming us. So thank you very much, indeed.

Operator

This concludes today's conference call. You may now disconnect your lines. Thank you for participating and have a pleasant day.

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