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Executives

Ian Cockwell – President and CEO

Paul Kerrigan – EVP and CFO

Analysts

Joel Locker – FBN Securities

Alex Barron – The Agency Trading Group

J. T. King – Cape Investments

Ronald Redfield – Redfield, Blonsky & Co.

Brian Freckmann – Crown Capital

Brookfield Homes Corporation (BHS) Q1 2008 Earnings Call Transcript May 1, 2008 5:30 PM ET

Operator

Welcome to the Brookfield Homes Corporation conference call and webcast to present the company's first quarter 2008 results to shareholders. At this time, I'd like to turn the conference over to Ian Cockwell, President and Chief Executive Officer. Please go ahead.

Ian Cockwell

Thank you. Good afternoon, ladies and gentlemen, and thank you for joining us today for Brookfield Homes' first quarter conference call. Before we continue, please note that, in talking about our financial performance and responding to questions, we may make forward-looking statements. Forward-looking statements are subject to known and unknown risks and results may differ materially. For further information on such factors or risks, I would encourage you to see Brookfield Homes' SEC filings and the full text related to forward-looking statements in our Form 10-K and 10-Qs, which are posted on our Web site.

We've also posted a supplementary information package on the Web site under the Investor Relations section under Reports and Presentations. It provides details of operations and other key measures of performance.

Joining me for the call today are Paul Kerrigan, our Chief Financial Officer, and Linda Northwood, our Director of Investor Relations. I'll start today's agenda and then turn the call over to Paul, who will review our performance for the first quarter.

The overall challenges for the homebuilding industry have continued into 2008, with consumer confidence at all-time lows and amount of supply of resale and new homes for sale at all-time highs. We are addressing these challenges and have successfully increased our sales base during the first quarter 2008 when compared to the fourth quarter of 2007. This pace has continued into the second quarter of 2008 and we are targeting to have closed or in backlog 70% of our planned 2008 closings by early summer.

Our focus on monetizing our inventory of fully developed lots will enable us to achieve a target of at least $100 million of operating cash flow for 2008. Given our current level of finished lot inventory, we do not expect to invest any significant amount in developing the entitled land we own, but will likely use our operating cash flow to repay debt.

Recently, a number of larger land development projects and entitlement projects in California and Nevada have faced debt repayment issues. This is leading to new sources of capital coming into the markets to acquire the distressed land opportunities. Our management's skills in entitling and developing land are being sought after by those who wish to enter the market or are you wanting to monetize or enhance the value of land assets they may now own. Our business model of adding value at each stage of the land development process enables us to participate with either land owners or financial holders to enhance value.

The fundamental shift of economic ownership in land assets in California should work itself through the market over the next 12 to 18 months and we are aligning ourselves to participate in acquiring strategic land positions. I would now like to turn the call over to Paul, who will discuss our financial results for the quarter ended March 31, 2008.

Paul Kerrigan

Thank you, Ian, and good afternoon. Our net loss before taxes for the three months ended March 31, 2008 was $20 million compared to income of $5 million for the same period in '07. The decrease in net income before taxes of $25 million is primarily due to the following three factors: Lower margins on housing and a decrease in homes closed. And during the first three months of 2008, the company's gross margin on housing was 15.9%, consistent with the fourth quarter of 2007; however, lower than the 19.5% gross margin on housing recorded in the first three months of 2007. In addition, our home closings were 120 units, a decrease from the 151 units closed in the first three months of 2007. The company also recorded impairment charges on its housing land inventory of $6.2 million compared to nil in the first quarter of 2007. Impairments were recorded on six communities comprising 222 lots.

And lastly, the company entered into interest rate swap contracts during the period 2004 to 2007 totaling $260 million, which effectively fixed the rate on the company's floating rate debt at 6.8%. As a result of a further decline during this quarter in short-term interest rates, the fair value of these derivatives declined and the company recorded a mark-to-market loss of $9.3 million compared to a loss of $0.7 million in the same period last year.

The net loss after taxes in the first quarter was $12 million or $0.47 per share compared to net income of $29 million or $1.07 per share, in the first quarter of 2007. And just a reminder, the first quarter of 2007 included in income $26 million related to the reversal of an income tax liability. For the first quarter in 2008, we closed 120 homes and 18 lots for a total of 138 home and lot closings, which compares to a total of 169 home and lot closings for the same period last year.

Our housing revenue totaled $66 million for the first three months of 2008 compared to $104 million for the same period in '07. The decrease in housing revenue is primarily due to fewer home closings and the decrease in the company's average home selling price to $571,000 from $707,000 in 2007. The reduction of the average home selling price is partially a result of a change in product mix on our home closings and reduced selling prices and/or higher incentives offered to homebuyers. The gross margin on housing revenues for the quarter was $11 million, or 15.9% compared with $20 million or 19.5% for the first quarter last year. Land revenues were nominal at $3 million arising from the sale of 18 lots.

In terms of net new orders, they were 231 units, a significant improvement over the 104 units in the fourth quarter of 2007. Our cancellation rates are steady at 18%. The level of sales achieved in the first quarter, combined with our low level of home starts to date, position us well to reduce our construction inventory levels, which were high at the beginning of this year.

In terms of cash flow, during the first quarter, we used $32 million in our operations. However, given our inventory levels coming down, we are targeting at least $100 million in cash flow from operations in 2008, as we monetize this inventory. In terms of our balance sheet, our housing land inventory and our investments in housing land joint ventures comprise the majority of our assets, and these assets increased by $35 million for the first quarter in 2008 when compared to the year ended 2007. This increase is primarily due to the acquisition of our partner's 50% interest in a 2,600-lot community in the Coachella Valley in California for $14 million, of which $9 million was financed by a seller carry note. And additionally, we've consolidated this entity, which includes the remaining $9 million of the entity's seller carry note.

In terms of net debt to capitalization, it was consistent with our year ended '07. And with that, I'll turn it back to Ian.

Ian Cockwell

Thank you, Paul. Looking ahead, as I said, the United States housing industry will remain challenging, given the ongoing disruption in the credit markets as well as consumer confidence. Despite these challenges, the company continues to anticipate strong operating cash flow of approximately $100 million in 2008, as we continue to monetize our inventory of 3,400 developed lots.

I'll now turn the call back to the operator, who will moderate questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions) Our first question today comes from Joel Locker of FBN Securities.

Joel Locker – FBN Securities

Hi, guys. Just wanted to talk to you about, I guess, your lot sales and what do you target for 2008?

Paul Kerrigan

I think in terms of lot sales, Joel, I think our expectations aren't that great. You can see we sold 18 lots in the first quarter and we have some contracts where we expect to sell lots, maybe 50 to 100, right? But over and above that, I think we'll just take the market as it comes and look for the demand. But, I would suspect that's probably 2009.

Joel Locker – FBN Securities

Right. And if you back up a 15.9% for the housing gross margin, does that leave with you $2 million loss on the $3.3 million of land sales this quarter?

Paul Kerrigan

No. The margin on land sales were basically breakeven and the gross margin, when you take out the impairments of $6.2 million, was approximately 15.8%.

Joel Locker – FBN Securities

15.8%, all right. And just, I guess, one other question on just the SG&A. I noticed it was flat year-over-year, and just wondering if there's anything you can do there to lessen it on a dollar amount because I guess it's up to 25% or so of the housing revenue?

Paul Kerrigan

I think we said previously, our run rate on the sales and marketing is around that $15 million, $16 million range. We obviously have reduced our staffing levels but, on the sales side, we're probably spending a bit more to achieve the sales. But, we'll continually try to reduce it.

Joel Locker – FBN Securities

Right. All right. I'll jump back in the queue. Thanks.

Operator

Our next question comes from Alex Barron of The Agency Trading Group.

Alex Barron – The Agency Trading Group

Hey, guys. How are you?

Ian Cockwell

Very good.

Alex Barron – The Agency Trading Group

Wanted to ask you, what's the balance on the revolver this quarter with Brookfield Asset Management?

Ian Cockwell

The balance is $202 million.

Alex Barron – The Agency Trading Group

Okay. Now, as far as the way you guys calculate the net debt-to-cap ratio, what's the current number and what exactly goes into that calculation?

Ian Cockwell

In our supplemental, Alex – I guess it's posted on the Web site. I think we put it in there, don't we? It's not calculated there, but the definition isn't [ph] there. Our total debt – and I'm just reading the definition here for you – total debt minus cash, divided by our net debt, plus minority interests, plus stockholders' equity. So it's pretty straightforward I think. Just net debt divided by total debt, plus minority, plus equity.

Alex Barron – The Agency Trading Group

Okay. I guess I wasn't including the minority interest. I'm just kind of wondering, is there a plan here to start to reduce the debt level at some point?

Ian Cockwell

I think, when we say we are targeting the $100 million of operating cash flow this year, implicit in that is to use that, majority-wise, to pay down our debt.

Alex Barron – The Agency Trading Group

Okay. And what exactly, I guess, is causing the inventory balance to keep rising? Are you guys just continuing to build specs or are you just putting more money into land development, or what's causing the inventory number to go up?

Paul Kerrigan

I think, generally speaking, historically, we would invest in inventory in the first half of the year as we build [ph] our backlog. But if you compare it to last year, we've invested significantly less and that's because we started the year with higher inventories and as we go through the year sort of build the backlog, we would expect our assets to come down nicely sort of by the end of the year. So definitely we'll see that inventory line turn positive in terms of the cash flow statement.

Alex Barron – The Agency Trading Group

Okay. Switching subjects a little bit, you mentioned you bought out a joint venture partner. Was that another public builder and if so, can you say who it was and what did you guys find attractive in buying this deal out?

Ian Cockwell

Alex, it's an area, the Coachella Valley, we have taken as a strategic market and focusing in on increasing our holdings within that area. It was a public builder; we were 50:50 joint venture partners, and the opportunity arose and we found that it did – from a plan in the whole area, it made economic sense for us to acquire their position.

Alex Barron – The Agency Trading Group

But, is this undeveloped because I'm not aware that you guys had any position in this market?

Ian Cockwell

We have two positions within that market under options, both of them are options.

Paul Kerrigan

Under our San Diego/Riverside category (inaudible).

Alex Barron – The Agency Trading Group

Okay. But you don't have any active communities there at the moment?

Paul Kerrigan

No, we don't. No.

Ian Cockwell

It's similar to our situation up in the Sacramento area. We don't have any active communities up there either.

Alex Barron – The Agency Trading Group

Okay. But has this project been – currently at what stage of development, I guess, is it, then?

Ian Cockwell

It's in the entitlement stage.

Alex Barron – The Agency Trading Group

Entitlement stage. Okay. Thanks a lot.

**************************

Operator

Our next question comes from J. T. King of Cape Investments.

J. T. King – Cape Investments

Good afternoon. The revolver balance you said was a little over $200 million?

Paul Kerrigan

Right.

J. T. King – Cape Investments

Was it $90 million at the end of the year, was that the number?

Paul Kerrigan

Yes.

J. T. King – Cape Investments

So, did you use essentially – was the increase related – did you use some of the revolver to pay down some of the project finance?

Paul Kerrigan

Absolutely. So, if the amounts due to Brookfield Asset Management are up to the $202 million range, our project financings would be the difference. And they came down approximately – when you exclude the seller note on the acquisition of the Coachella property, the project financings came down around $60 million or $70 million.

J. T. King – Cape Investments

Okay. And then so you've got – do you have the full $48 million additional available under the revolver?

Paul Kerrigan

Yes, we do.

J. T. King – Cape Investments

Okay. And I guess – so when you say you are going to generate $100 million, I'm just trying to understand the cash flow numbers, $100 million for the rest of the year, that implies kind of $131 million over the next nine months then to a negative $31 million for three months?

Paul Kerrigan

Yes, very much so.

J. T. King – Cape Investments

And just the math on that, for those of us who are kind of trying to model it out, I guess is what I'm struggling with a little bit. If you just took the home sales and you picked a number like 700 homes closed and took some gross margin number on that and some steady state $15 million a quarter SG&A and you took an average home price of – pick a number, but call it $570,000 based on your first quarter, that doesn't square with the $131 million or even come close. So what else am I missing? Is it a bunch of lots you're going to sell that are not just home closings, or where else does the cash come from?

Paul Kerrigan

Well, at the end of the day, if we close 117 homes in the first quarter and our target is, say, 800 to 850, we've got 700 homes to close as you say. If you say the average selling price is $550,000 or $600,000 – let's say $600,000, that's $420 million of future receipts that we have coming in over the next nine months, right? And because, like I said in my notes, our inventory levels are elevated and they continue to be elevated, but we are selling well. And if we achieve these 700 home closings with $400 million of revenue, we don't have a lot of cost to put in the ground because quite frankly, a lot of these homes are built.

J. T. King – Cape Investments

And the assumption for that $100 million then, is that kind of consistent with the 800 home number for the full year?

Paul Kerrigan

Very much so, yes.

J. T. King – Cape Investments

So, not much down versus '07?

Paul Kerrigan

Right.

J. T. King – Cape Investments

4% or 5%. And then on the covenant flexibility and room you have there, those haven't changed since the last, I guess, 8-K, which is slight modifications with the revolver and that was it, but not with any of the project finance or JV?

Paul Kerrigan

No and we're all within our covenants, obviously.

J. T. King – Cape Investments

Right, okay. Well, thank you. That was all I had.

Paul Kerrigan

Great.

Operator

Our next question comes from Ronald Redfield of Redfield, Blonsky.

Ronald Redfield – Redfield, Blonsky & Co.

Hi, good afternoon. Two questions, one, since quarter end, have you been provided with any liquidity by Brookfield Asset Management or any of the related companies, any of their lending divisions or closed-end funds or any of their bridge lending groups, et cetera, and if so, how much?

Ian Cockwell

Our relationship with Brookfield Asset Management is on the facility that we have – the credit facility that we have with them and we have drawn $18 million.

Ronald Redfield – Redfield, Blonsky & Co.

Since April 30?

Ian Cockwell

No, since March 31.

Ronald Redfield – Redfield, Blonsky & Co.

I'm sorry, since March 31. And do any of their other entities provide liquidity to you for investments on their own end?

Ian Cockwell

As you'll see in our 10-Q, that is the only relationship that we have with Brookfield Asset Management or its affiliates.

Ronald Redfield – Redfield, Blonsky & Co.

Great. And then my other question, just curiosity, and I'm sorry if this was answered already and I wasn't focusing, just if you could describe a little bit about the average selling price going from per unit from $707,000 to $571,000 and what you're seeing and what – if you could just provide some color on that?

Paul Kerrigan

Like I mentioned again in my notes, the average selling price is a function of two things. Because we're a relatively small company and we build all kinds of different products, even within our 33 active selling communities, our average selling price has fluctuated in the past consistently and that's mainly because of product mix. But as you know, our margins have come down from the mid-30s since 2005, so we've obviously been reducing prices or increasing incentives. But I would say that the change in the selling price in the first quarter is largely due to the product mix. We have not reduced prices too dramatically and certainly in the first quarter.

Ronald Redfield – Redfield, Blonsky & Co.

So, a house in a certain neighborhood – a house that was selling for X in March of '07 isn't selling drastically from X at this point?

Paul Kerrigan

No. I was mentioning from the fourth quarter. They are certainly down from last year – from the first quarter of last year.

Ronald Redfield – Redfield, Blonsky & Co.

At what percentage, would you say?

Paul Kerrigan

5% to 10%.

Ronald Redfield – Redfield, Blonsky & Co.

5% to 10%? Great. And can you also give any color on the lending environment, the credit environment, for the buyers of the property or prospective buyers?

Ian Cockwell

With regards to mortgages, at this stage, I think a number of new programs coming in place. We know that FHA limits have been increased. But what it is, it has varied quite considerably during the first quarter but would seem to be stabilizing at this point with regards to the implementation and the understanding of the programs for buyers I think even just at the various interest rates, credit risk concerns, you could say, earlier on in the first quarter, they seem to have stabilized as well from a rate perspective.

Ronald Redfield – Redfield, Blonsky & Co.

Okay. And when do you expect to release the Q?

Paul Kerrigan

Probably in the next week or two.

Ronald Redfield – Redfield, Blonsky & Co.

Okay. Great, thank you.

Operator

Our next question comes from Brian Freckmann of Crown Capital.

Brian Freckmann – Crown Capital

Hey, guys. How are you?

Paul Kerrigan

Very well.

Brian Freckmann – Crown Capital

Maybe I missed it, just two quick things, how much do you guys now have on the line of credit with Brookfield, how much have you guys tapped that in?

Ian Cockwell

As of the end of March, it's $202 million.

Brian Freckmann – Crown Capital

$202 million, okay. And you said another $18 million, I think, is what you said?

Ian Cockwell

That's correct.

Brian Freckmann – Crown Capital

Okay. $202 million and another $18 million.

Ian Cockwell

That's $220 million.

Brian Freckmann – Crown Capital

And then just question, how much project financing did you pay down this quarter?

Paul Kerrigan

As I said earlier, approximately $70 million.

Brian Freckmann – Crown Capital

$70 million, okay. I'm sorry, I must have missed that. All right, well, thank you very much.

Operator

We have a follow-up question from Joel Locker of FBN Securities.

Joel Locker – FBN Securities

Hi, guys. On the JV equity, you have $127 million in equity, how much debt is against that? I remember you saying it was $85 million at the end of the year?

Paul Kerrigan

Yes, I think it's – at the end of the year, I think it was higher than that, but currently it is right around the $80 million range.

Joel Locker – FBN Securities

$80 million or so. And the lots that you purchased, it was $14 million for half the lots or call it 1,300 lots, so it's right around $1100 a lot, is that fair enough to say or is it fair …

Paul Kerrigan

Around probably $10,000 or $11,000 a lot, yes.

Joel Locker – FBN Securities

$10,000 or $11,000 a lot. And on the lot write-offs, I mean obviously, there was $6.2 million in impairments. Were there any other termination of lot charges or JV impairments or anything like that?

Paul Kerrigan

No, there was nothing else.

Joel Locker – FBN Securities

Nothing else, and that $6.2 million was just on consolidated land?

Paul Kerrigan

Exactly.

Joel Locker – FBN Securities

Right. All right, I'll jump back in the queue. Thanks.

Operator

We also have another follow-up question from Alex Barron of The Agency Trading Group.

Alex Barron – The Agency Trading Group

I'm sorry, maybe I didn't understand your answer to a previous question, but given that your orders I guess increased so much sequentially from the December quarter to this quarter, what was the incremental price cuts that you guys gave?

Paul Kerrigan

I think if you recall, Alex, in the fourth quarter last year, we had taken shall I say significant impairments and I think that was a result of cutting prices in December of last year and then perhaps in November. So I think come sort of the new season, what brought – January brought a lot more traction in our communities, better traffic, better qualified buyers, despite the credit challenges, and yes, the fourth quarter last year was a very difficult selling environment and we've been more successful this quarter for sure and that is continuing into April.

Alex Barron – The Agency Trading Group

Okay. Now, I know you guys haven't historically given average sales price for the orders, but are they in the same ballpark as your deliveries?

Paul Kerrigan

In terms of our backlog, what is the average selling price?

Alex Barron – The Agency Trading Group

Yes, either that or your orders.

Paul Kerrigan

I actually think they're slightly higher.

Alex Barron – The Agency Trading Group

Okay.

Paul Kerrigan

And again, that's related to product mix. It's nothing to do with depreciation.

Alex Barron – The Agency Trading Group

Okay. Now, when it comes to – when you guys – how you guys do the math for the impairments, what's the magic number I guess at which, either in sales pace or in operating margins, or what is it that causes you to take an impairment? Because I would have thought with the operating margins being where they are, we would have seen maybe a little bit more?

Paul Kerrigan

No. I think – well, certainly with a gross margin of 15%, 16% range, we are in a very comfortable zone. And if you look into our backlog, yes, the margin's probably a little lower, more like the fourth quarter of last year in the 12% or 13% range, but that doesn't quite get us to the impairment tax, but like I say, it doesn't generate great returns at the bottom line either.

Alex Barron – The Agency Trading Group

Right. I'm sorry, did you say the margins in backlog were 12% or 13%?

Paul Kerrigan

Yes, in that range.

Alex Barron – The Agency Trading Group

Okay. So was that – what is, I guess – if there is a magic number, is it 10% or what other factors factor into when you do take an impairment?

Paul Kerrigan

Like I explained before, if you look at your gross margin and you take off your incremental sales costs, is when you're in that sort of 8% or 9% range, right?

Alex Barron – The Agency Trading Group

Okay. Got it. All right, thanks.

Operator

There are no further questions at this time. I'll turn the conference back over to Ian Cockwell for any closing comments.

Ian Cockwell

Thank you operator. Thank you all for participating today in our conference call and we look forward to having you on it in the future again. Thank you all.

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