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Sun Communities Inc. (NYSE:SUI)

Q3 2007 Earnings Call

November 8, 2007 11:00 a.m. ET

Executives

Gary Shiffman - Chairman and CEO

Jeff Jorissen - CFO

Karen Derring - Corporate Controller

Analysts

Skyler Cho - Citi

Paul Adornato - BMO Capital Markets

John Stewart - Credit Suisse

Andy McCulloch - Green Street Advisors

Steven Rodriguez - Lehman Brothers

Operator

Greetings, ladies and gentlemen, and welcome to the Sun Communities' Third Quarter 2007 Earnings Results. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference 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 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 its 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 SEC. The company undertakes no obligation to advise or update any forward-looking statements to reflect events or circumstances after the date of this release.

Having said that, I'd like to introduce management with us today Gary Shiffman, Chairman and Chief Executive Officer; Jeff Jorissen, Chief Financial Officer; and [Karen Derring], Corporate Controller. Mr. Shiffman you may begin.

Gary Shiffman

Thank you and good morning. The third quarter earnings as announced prior to the market opening today were funds from operations of $11.8 million or $0.58 per share, compared to $11.8 million or $0.59 per share in '06.

For the nine months, funds from operations were $41 million or $2.02 per share compared to $39.5 million or $1.97 per share in 2006. And at this time, we would like to review the portfolio with you.

Rental increases have been implemented for nearly 33,000 of our occupied sites to the first nine months of '07. The weighted average increase for these sites is 3.6% or just slightly higher than the 2007 budget of 3.5%.

Through September 30, '07 occupied manufactured housing sites have declined by 65, this represents a loss of 160 sites in Q3,'07 compared to a loss of 263 sites in Q3,'06 or an improvement of about 40%.

These site losses are concentrated in a few Midwest communities, two communities have accounted for more than the net loss sites year-to-date and 15 communities accounted for the 160 net sites lost Q3, of '07.

We continue to manage aggressively to counter and/or mitigate the historical second half loss of sites that we have discussed in prior call and we do feel good about the progress and improvement that we made in third quarter.

The net operating income of community operations increased by just under $600,000 over third quarter of '06, while the operating income of the home rental operations increased by just over $160,000 together these account for a third quarter year-over-year improvement of $762,000 or approximately $0.04 per share.

The number of homes rented in our communities increased by 108 in third quarter to 5,134 while the number of rental homes sold was 90 for the quarter and 281 for the nine months which compared to a total of 131 in the first nine months of '06.

Rental rates for the homes have increased by 5.6% over the last year, to an average of $716 per month at September 30, '07.

Repos have continued to decline and are running at slightly less than 30% below '06 levels and nearly 50% below '05 levels. Similar declines have reduced the existing number of Repos in our community to a level of 248 at September 30, '07.

Our same site portfolio generated a 2% increase in net operating income, for the nine months, consisting of 1.9% increase in revenues and a 1.7% increase in expenses.

Occupancy declined from 82.7% at December 31, to 82.5% at September 30, in '07.

Rental applications, are running 60% ahead of third quarter of '06, while applications to buy the rental homes are running nearly 50% ahead of the '06 quarter.

Applications for the purchase of other new and pre-owned homes declined from 310 in 2006 to 176 in 2007.

In Florida, both new home sales as well as profitability of sales, has fallen short of our budget. So, we have seen a slowdown in Florida.

And I think, for those of you who were on the call last quarter, we noted that we have been working with manufacturers of our product or manufactured homes to design a new and more attractive product. These homes highlight front entrances nine-foot ceilings, drywall and really a dedication, the quality and distinguishing features which we think compete very favorably with comparable size new site-build homes.

We ordered and took delivery of seven prototypes and played 75 Midwest communities, all of those have sold after we released them and really based on those results, an additional refinements that we've made to the homes after each prototype was delivered. We've ordered 40 additional "Signature" homes to be placed in 16 of our Midwest communities.

As of today, 23 of those homes are delivered and being set-up and all models should be delivered to set-up and ready to show by mid-December where we will roll-out the "Signature" program. The program really was designed in part to attract those who are now shut out of the site-built home market and in that regard, we've entered into discussions with various real estate brokerage firms to familiarize them with the product and to provide them with really another source of commission for their customers who can no longer get approved for the typical site-built housing but you can be approved for our "Signature" products which is priced in the $45,000 to 65,000 range.

So to summarize, the portfolio fundamentals relating to existing repos and incoming new repos have returned and continue to operate really at levels of normalized operations of their stabilized improvement to the past six years.

Sales of homes in our rental programs have been above budget and trending positively, as we convert renters into owners and rental rates in overall occupancy and our rental program remain strong.

Regional economics in the Midwest continue to impact growth of occupancy and further increases of NOI in two different ways. Costs associated with the seasonality in the second half related to increased turnover in the rental homes and the lack of new home sales that really generate gains from increased net revenue producing sites, and I've reminded everybody keeping our rentals flow doesn’t increase revenue producing sites bringing a new home into the community, does increase our revenue producing sites and it’s what we're looking to do with our "Signature" program.

So, while management continues to aggressively battle, what has been historical fourth quarter seasonality, which is the turnover in the rental program, I'd just referred to. We will also be focused on growing the initial success on new home sales in the Midwest with our "Signature" home sales program as we roll that out.

The quality and value proposition created in partnership with our manufacturers, we believe should compete very favorably with site-built product that is once again out of the reach of our typical customer and each of these sales would represent a net positive revenue producing sites starting when we roll this out fourth quarter.

This time both Jeff, I and Karen would be available for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Jonathan Litt with Citi.

Skyler Cho - Citi

Hi, this is Skyler Cho calling with Jonathan Litt. Could you give us a break down of what was in other income, it looks like there may have been some kind of loss due to disposition of assets?

Gary Shiffman

Well, there's always a lot of disposition of assets in that line item. Last year in the third quarter that number was 844,000, and this year it's 1,118,000, and that's generally assets at the community level that are disposed or traded in, in the normal course of business.

Skyler Cho - Citi

Okay. And I guess, this number's kind of bounced around quite a bit. So, what kind of contribution should we expect in 4Q and I guess, going forward into 2008?

Gary Shiffman

Well, we don't have our 2008 budget done but the primary item of stabilities are the two items that are tend to be recurring in this category are brokerage revenues, which were down this year because of the slowdown in activity in Florida because people can't sell their homes up north and therefore, they are not buying in Florida and assets disposals. Other things are dramatically less predictable like last year in Q3 we have -- or in the nine months, we had a lawsuit settlement, so it will be adds and in. So, it's not all of this stuff is susceptible to prediction or budget.

Skyler Cho - Citi

Okay. And I guess, my other question is about guidance, you think that the range of 266 to 272 is still achievable given that FO was $0.58 you need may be $0.64 to hit the low end?

Gary Shiffman

Yes, I think that we would feel very comfortable affirming that guidance.

Skyler Cho - Citi

Okay. Thank you.

Operator

Our next question comes from Paul Adornato with BMO Capital Markets.

Paul Adornato - BMO Capital Markets

Hi, thanks. I was wondering if you could talk about the two communities that accounted for the bulk of the move outs, what was happening there, is it close to auto plant or other economic factors?

Gary Shiffman

Yeah, sure. There are two communities in around the Indianapolis and I think that definitely is rough both related, where we have seen some layoffs in job related repossessions and deeds in lieu of that exist in those two communities, and they grew very close to each other. We think we are through the worst of them. But they definitely have an impact up there.

Paul Adornato - BMO Capital Markets

Is there any action that you could take in order to ameliorate the situation in those two communities work with the tenants in any certain way or is it really a tough situation for them?

Gary Shiffman

Paul, I think that certainly there is always action that we can take. I think, that when we refer to what we are trying to accomplish is here, I would remind everyone on the call that in looking at occupancy for 2007. We made the decision to reflect the occupancy trends of actual in 2006.

So, our '07 budgets reflect a negative occupancy roughly 500 sites. So, everything that management has been focused on, has been reversing that trend, so, that we would be more favorable to our budget. I think that we did a successful job, in third quarter by improving the lost sites by about 40% year-over-year and losses in our rental program. And I think, we'll look to do that in fourth quarter where we really can have a positive impact on our budget, and when we get to these two communities because they made up roughly all of the 60 lost sites, there is an awful lot of focus on how we can work with the residence in there to make sure that we are doing the best job we can, whether it would be by working with them on a payment plan or by working with them to move from one type of home to another type of home. But I think, what you see is in large part the reflection of -- a give-back of some older homes, where again once again the amount of money that they owed on those homes was greater than the actual value of those homes in today's market. And they have to recirculate in the form of repossession or in the form of rentals for us to make any progress there.

Paul Adornato - BMO Capital Markets

Okay. And looking at the "Signature" program, the home set you've already sold those prototypes, do they occur in the third quarter or is that fourth quarter activity?

Gary Shiffman

I think that five of those homes closed in third quarter and two of those are due to close right now actually in fourth quarter, and interestingly enough while we had been prepared to finance this program that sale of some homes in this program, to jump start if you will, the understanding of the value proposition of buying one of these homes. Four of the five homes that sold so far were financed by third-party financing, and either one or two of the additional homes to be closed are also third-party financing. So, we've been very pleased at the fact that third-party financing has stepped in and these people have qualified for it.

Paul Adornato - BMO Capital Markets

And those third-party lenders have they financed the product traditionally are they manufactured home lenders?

Gary Shiffman

I can't answer that positively, I am looking at some data and all sales homes. I think, it's a combination of one, two, three traditional sources that I could identify that are valuable triad, one origin, one looks to be cash which we don’t know if that’s a local bank or not, so that’s just the best information I can provide.

Paul Adornato - BMO Capital Markets

And you talked about reaching out to the traditional brokerage community, have traditional brokers ever sold the products before?

Gary Shiffman

I think that the answer to that is basically no, there have been an occasional broker that over my 30 years that might specialize in brokering used homes in a specific community usually enough scale community, but it's definitely not the norm and there has never been any real significant participation in a program like this. So, I think that we have approached basically one regional, large regional and one national brokerage firm and have been working and there is interest on both sides of the potential whereby we can bring them a commission of $2,000 to $4,000 that they wouldn’t otherwise be able to have and we can gain a marketing vehicle to a customer who may want to look at $175,000 similar site-built home but can no longer get it qualified for that and obviously shouldn't have been with them with sub-prime lending that took place and now that broker can bring them to this new product and say, I know, you never thought about a manufactured home, but I think you are going to be pleasantly surprised, let's drive over there. And that's a kind of, so.

Paul Adornato - BMO Capital Markets

Okay. And are there any licensing issues or other kind of structural issues that might prohibit them from participating?

Gary Shiffman

None that I remember, that we've encountered, so far. My comment that we really picked our toughest market first, which is the Midwest market to roll this program out because we think there's so much value to the customer out there. We are not marking these homes up, we are strictly interested in supporting the interest of new home buyers in our communities again and therefore, the value proposition that they are paying for these homes, we think will attract them and based on the limited success initially and getting ready for this program, we would look to roll it out in the rest of our portfolio, first quarter.

Paul Adornato - BMO Capital Markets

Any thoughts on volumes going forward or is it too early to?

Gary Shiffman

I think it's too early. I think that we'd like to share those with every one based on the experience that we have fourth quarter. When the homes are actually setup and after we've marketed and some promotion on them and hopefully brought in some of the brokerage community.

Paul Adornato - BMO Capital Markets

And are there any community sale data points to point to this quarter?

Gary Shiffman

I am just not sure.

Paul Adornato - BMO Capital Markets

Within your regions that is, now all-age communities in the upper Midwest have there been any transactions that you have noticed and if you so what has the pricing been?

Gary Shiffman

Transactions on the sale of communities or?

Paul Adornato - BMO Capital Markets

On the sale of communities.

Gary Shiffman

There are none that we are really aware of as we follow the market pretty intensively, both in the Midwest and other parts and we have looked in a couple of transactions that Sun and other of our competitors have been involved in. One of the things that we have seen, is due to the instability of the debt market place from the increased cost of debt, a number of transactions that were moving forward, did not move forward and I don't have any specific cap rate points that I would suggest have changed. It's kind of been a quiet market place. The debt markets have been so unstable.

Paul Adornato - BMO Capital Markets

Okay. Thank you.

Operator

Our next question comes from John Stewart with Credit Suisse.

John Stewart - Credit Suisse

Thank you. Gary, I wanted to go back to Skyler's question on the guidance. What is it that makes you very comfortable affirming guidance, just given the big step up that you would need in the fourth quarter? Just to hit, the lower one, of the range, particularly given the historical slowdown you have seen in the second half?

Gary Shiffman

Well Jeff, if you want to talk about budget and what usually happens in fourth quarter.

Jeff Jorissen

Well, after each quarter we forecast the rest of the year. So, we have just completed that exercise actually, independently. Karen did it and I did it and we do that on a fairly conservative basis. And given that approach, we do expect to attain the guidance so that's why Gary's pretty confident because Karen and I have told him that we should be there. And the fourth quarter budget, if you recall, is patterned after the fourth quarter of last year in terms of occupancy changes, so it's not exactly - it's not a stretch, it should not be stretch budget. So we've considered other costs that we are aware out there likely to occur in the fourth quarter so that's why.

John Stewart - Credit Suisse

Yeah, but even excluding charges in the fourth quarter last term it was, you are roughly flat in the third quarter to fourth quarter?

Gary Shiffman

While traditionally, the fourth quarter is stronger than third quarter, fourth quarter, if you went back over the years, would be our second best quarter. First quarter is strongest, fourth quarter is second strongest and then second quarter and then third quarter is the weakest quarter. So the other thing that happens in the fourth quarter is that generally the copy operating and maintenance expenses recede from the levels of summer because obviously you are not doing landscaping and that kind of stuff and with any luck at all you are not going to have snow removal in the Midwest until January. So December is expense structured and the property level tends to be more favorable for profitability.

John Stewart - Credit Suisse

Okay, I understand you haven't completed the budget for 2008. But just broad brush looking forward, do you think that it's fair I guess when you first kind of gave a '07 guidance you basically -- you said you kind of expected it to look a lot like 2006, is that fair for 2008 or do you think that given the slowdown that you talked about in Florida and the regional economic conditions in Michigan that it would be a stretch to even stay on pace with what we did in '07?

Gary Shiffman

I think we are looking for the budget to actually to come into us over the next four weeks but then working through with all of our operational management we are seeing modest improvement in the areas that we talked about, which are very helpful re-possessions, conversions of renters to buyers, which is more profitable for the company than just renting now. And if we see a continued positive progress, for example, as we're seeing in renewing existing renters, the cost associated with a fewer renewals and less of a turnover positively impacts the company and that is the progress that we did make this year with our management programming. We hope to make it continue it in '08 and finally, if we're able to forecast modest net revenue producing growth through the sale of "Signature" and our other sales program. "Signature" is just one or two, we have much more [down and dirty] sales program that we are rolling out and that we think will give another buyer a spectrum of the market and what we mean by that is just a very strip down of that can capture another form of a customer who would rather again in a different product but can only afford the lower end of the manufactured housing product. Through the increase in those sites we hope to continue to slowly gain back where we've been for the last two or three years. So we cautiously are anticipating some progress in '08 but again we are very cautious to see what happens in the fourth quarter. So, fourth quarter will be the pivotal quarter where we can judge where we think guidance will be for the coming year.

John Stewart - Credit Suisse

Okay that's helpful. Gary I did want to talk about the "Signature" program for just a minute. I guess in particular I wanted to get your perspective on the Michigan single family market because I am just -- I wonder whether at $45,000 to $70,000 for these homes I understand that it's much more difficult to get a mortgage today than it was two years ago but I just wondered, to what extent those prospective buyers wouldn't be looking at single family given home pricing?

Gary Shiffman

John, I think it's a good question and I think it's really important to differentiate and distinguish the type of buyer that we're talking about. This buyer is $40,000 to [$65,000] to $70,000 is going to be a one or two income wage earner at home and they are just not going to qualify for any type of site build housing. When you look at competitive product certainly in the 1500 to 1800 square foot range, its $175,000 to $200,000 at the peak of the market. Then it could drop down to $150,000 and $140,000 and $130,000 and these people are still not going to qualify for that housing. Not under today's lending environment, so we are looking for a small segment if you will, that on the more affordable side is only going to be able to afford this type of housing and if you consider that a huge difference for this company was a sale a month, two sales a month, would be progress we haven't seen in the last six, seven years.

John Stewart - Credit Suisse

For community?

Gary Shiffman

For community, I am sorry. That's the type of progress that multiplies by 30 communities by 12 months, by our average rent, begins to reverse the trend that we have seen over, a long period of time now. So, I think that we will continue to see a very weak housing market in the Midwest that I don't foresee anything on the next year or two to change that.

But, I think that we will continue to compete very, very favorably on all different fronts and lower priced housing that I discussed and the rental homes that we bought for an average cost of $14, $15 complete that we were converting through sales on our rental program and on the "Signature" program, which allows someone for $65,000 for example, to get in there with a monthly payment of around $800, $850 even with a rent depending upon the amortization and the interest. We will compete very favorably with anything else that is out there.

John Stewart - Credit Suisse

Good points, but I guess just looking at the listings in the trade it seems like there is plenty of single family homes available for 100,000 or 170,000. I guess my other question would be what is the price range for the strip down model that you talked about?

Gary Shiffman

I don't know the exact prices. It's, I know our prices are out for a month we are gearing it for $650 all in payment per month with I think $325 average rental both into it.

John Stewart - Credit Suisse

Okay, thank you.

Gary Shiffman

Yup, the only other thing I would add the markets where our communities are you know, I don't what comp you are looking at average pricing in the trade but obviously there is a wide variation between the city of the trade and the outline metropolitan suburbs, which is where all of the communities are.

Operator

(Operator Instructions). And next question comes from Andy McCulloch with Green Street Advisors.

Andy McCulloch - Green Street Advisors

Hi, Good morning. Are you guys sort of expecting seasonal RV revenue roughly $5.3 million for the year?

Jeff Jorissen

Let's see, I don't think I have a budget in front of me. I'd have to get back to you on that Andy.

Andy McCulloch - Green Street Advisors

Okay, continuing on RV are you seeing any weakness or expect to seen any weakness coming on the RV side due to rising gas prices?

Jeff Jorissen

No.

Gary Shiffman

You know, that's really been a pleasant surprise, Andy is that, obviously there are different forces that were favorable and unfavorable and with regard to gas prices, Karen do you have an answer on seasonal RV?

Karen Derring

Just --let me add, our seasonal RV is about $3.7 million through September 30th though I don't think $5 million would be bottom line.

Andy McCulloch - Green Street Advisors

And you do expect sort of a third of that to come in the fourth quarter, right, of total?

Karen Derring

It will be higher than that.

Andy McCulloch - Green Street Advisors

It will be higher. Just one more question on G&A. Can you guys give us some color on what you expect for the year there?

Gary Shiffman

I am sorry, on what?

Andy McCulloch - Green Street Advisors

On G&A?

Jeff Jorissen

Well, I would think that the fourth quarter should be, may be slightly higher than the third quarter depending on some factors that are not within our control.

Karen Derring

Andy.

Andy McCulloch - Green Street Advisors

Yeah.

Karen Derring

I think guidance had G&A at about $15.9 million and I think that's a good estimate.

Jeff Jorissen

Okay and that would make for about roughly of $4 million down our Q4.

Andy McCulloch - Green Street Advisors

Great. Thanks guys

Operator

Our next question comes from Steven Rodriguez with Lehman Brothers.

Steven Rodriguez - Lehman Brothers

Hi guys. Just a quick question on CapEx, seems like it increased during the quarter what do you guys see going forward with that?

Jeff Jorissen

Generally, the fourth quarter is very low in the CapEx, through nine months recurring CapEx was $5.5 million compared to last year for the full year of $6.9 million. So, perhaps $6.2 million to $6.3 million when we are done with this year maybe $6.4 million kind of sometimes recurring CapEx that you have to take care of certain emergencies if they should arise, so you always are going to have a little kind of contingency in your mind for that, but certainly should not exceed last year's level and we would expect it to be lower.

Steven Rodriguez - Lehman Brothers

Any drivers in the third quarter, why is it so high?

Gary Shiffman

I am not aware of any.

Jeff Jorissen

No, I don't think there could be any one of a given program that went into a community or communities that the operations would have done that we are not typically aware of.

Steven Rodriguez - Lehman Brothers

Okay. Thanks.

Jeff Jorissen

If you want more information on that we can get back to you.

Steven Rodriguez - Lehman Brothers

Okay. Thanks.

Operator

(Operator Instructions). Mr. Shiffman there are no questions in the queue at this time.

Gary Shiffman

Well we would like to thank everyone for participating on the conference call. Obviously we look towards the fourth quarter to be an important factor and recovery that we are all very working hard for and in our industry and within the portfolio and we will advise everybody as soon as the quarter is over as to how things have gone with regards to the new programs and the existing programs with and I'll stop. Thank you.

Operator

This concludes today's conference. Thank you for your participation you may disconnect your lines at this time.

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