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Equity One, Inc. (NYSE:EQY)

Q3 2008 Earnings Call Transcript

November 5, 2008, 9:00 am ET

Executives

Feryal Akin – Director, IR

Jeff Olson – CEO

Tom Caputo – President

Greg Andrews – EVP and CFO

Analysts

Durell Gilroy [ph] – FBR

West Holiday – RBC Capital Markets

Paul Adornato – BMO Capital Markets

Craig Schmidt – Merrill Lynch

Operator

Good day ladies and gentlemen and welcome to the third quarter 2008 Equity One earnings conference call. My name is Lacy and I’ll be your coordinator for today’s call. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference.

(Operator instructions)

I would now like to turn the presentation over to your host for today’s call, Ms. Feryal Akin, Director of Investor Relations. Please proceed.

Feryal Akin

Thank you, Lacy. Good morning ladies and gentlemen. Thank you all for joining the Equity One third quarter 2008 earnings call.

With me on the call this morning are Jeff Olson, Chief Executive Officer; Tom Caputo, President; Greg Andrews, Chief Financial Officer; Tom McDonough, Chief Investment Officer; Arthur Gallagher, General Counsel; and Lauren Holden, VP of Portfolio Management.

Before we start, I would like to address forward-looking statements that may be addressed on the call. Forward-looking statements involve risks and uncertainties. Actual future performance, outcomes and results may differ materially from those expressed in forward-looking statements. Please refer to the documents filed by Equity One with the SEC, specifically the most recent reports on Forms 10-K and 10-Q, which identify important risk factors that could cause actual results to differ from those contained in the forward-looking statements.

We will open the conference up for Q&A after the presentation. I will now turn the call over to Jeff Olson.

Jeff Olson

Okay. Thank you, Feryal, and good morning. Welcome to our third quarter 2008 earnings call. Consistent with previous calls, I would like to share with you the positives and negatives of the quarter as seen from our vantage point and then discuss how we have positioned ourselves in this capital-constrained economy.

First, on the positive side, we significantly improved our balance sheet. During the quarter, we raised $55 million in an equity offering, $65 million in a mortgage financing, and renewed our line of credit for an additional three years. None of these transactions have been easy to complete given the state of the credit markets. So, we are very proud of our finance, accounting, and legal teams who worked tirelessly day and night to complete that.

Second, operating fundamentals remain sound especially in light of the overall economic landscape and the fact that the summer months tend to be the most difficult for retailers in Florida due to seasonality.

Our cash same property NOI was flat, up from negative 2.9% last quarter. Occupancy was relatively stable at 92.3% which was down 40 basis points on a same property basis when compared to Q2 2008. But you'll recall, our occupancy was up 40 basis points on a sequential basis last quarter, so now we’re back to even.

Cash rent spreads were high 22% on new leases and 8% on renewals. I think what’s most encouraging is our leasing pipeline continues to be healthy with over 167,000 square feet of leases in negotiation.

Third, we closed on the acquisition of three properties located in South Florida with DRA Advisors for an aggregate purchase price of approximately $53 million. Our share of the equity amounted to $3.2 million. We are delighted to have DRA as our partner and expect this joint venture will grow significantly in the future.

Fourth, our redevelopment and development projects are progressing well. Kohls held its grand opening on October 1 in our Sheraton Shopping Center in Hollywood, Florida. We are pleased with the addition of sales, traffic, and jobs this has created for the area. Whole Foods will open its door at Mandarin Landing in Jacksonville, Florida in the fourth quarter, and Publix will open at Sunlake near Tampa, Florida this December.

On the negative side, first, we took a $32.7 million non-cash impairment charge on our investment in DIM as a result of recent changes in market conditions. Second, we reduced our 2008 FFO guidance slightly to account for a more difficult leasing and operating environment and some dilution related to our large cash and short-term securities holdings.

Third, we took one property off our redevelopment list, Atlantic Village. The cost relative to the returns simply did not work. Therefore, we took a write-off of approximately $200,000 during the quarter.

Overall, we were pleased with our third quarter results. We feel well-positioned to weather the capital-constrained market that is weakening our economy. Over the past three years, we have executed on a business plan based on reducing risk and increasing our liquidity. Some of these initiatives included the sale of $500 million in non-core assets, the contribution of $200 million in assets to our joint venture with CalPERS, the termination of 15 ground-up developments in the first quarter of 2007, and most importantly, a repositioned balance sheet with low leverage, minimal near-term maturities, and access to capital through our line of credit and joint venture partners.

We intend to use this time period to continue building a best in class infrastructure that will allow us to accomplish three things. One, maximize the value of every shopping center we own through smart leasing, expense management, and asset intensification. Two, attract institutional capital partners like CalPERS and DRA Advisors that wants to tap in to our operating and investment platform, and are willing to reasonably compensate us for this service. Three, seek opportunities from four sellers on attractive assets, corporate transactions, and real estate debt.

At this point, Tom Caputo will walk us through operations and then Greg will take us through the numbers.

Tom Caputo

Thanks, Jeff. Consumers continue to be very price sensitive and have significantly refused discretionary purchases. Weaker retailers will continue to be under pressure for the future and we expect additional store closings over the next 6 to 12 months. So far, Equity One has not been materially affected by most of the troubled retailers in the news.

We are fortunate that our portfolio does not include any leases with Linens ‘n Things, Steve & Barry’s, Mervyns, or Shoe Pavillion. Equity one has been shielded from the fallout of almost all the troubled Big Five Tenants due to defensive nature of our portfolio which is dominated by centers anchored by highly productive supermarkets.

However, we do have our fair share of shop vacancy. Maintaining a high occupancy rate in our portfolio is one of our highest priorities. In August and September, the company’s senior management visited approximately 80% of the shopping centers in our portfolio on three separate bus tours. We were joined by the leasing and management teams for each region. We walked each site, went inside every vacancy, reviewed all near-term renewals, and discussed any tenants who may be at risk.

During the third quarter, we executed 45 new leases totaling 104,200 square feet at an average rental rate of $22.65 a foot. It’s important to know that 44 of the 45 new leases were with a combination of national, regional, or local shop tenants under 5,000 square feet. The most significant lease completed in the quarter was a very creative transaction with Walgreens for 18,000 square feet at Coral Reef, a center located in an in-fill area of Dade County.

In order to complete this transaction, Walgreens purchased the business of a local pharmacy who occupied 10,000 square feet. The existing pharmacy will be expanded into an adjacent 8,000 square foot vacancy. The end-result was a win-win for both Walgreens and Equity One.

As Jeff noted, our cash-leasing spreads in the third quarter continued to be strong at 22% for new leases and 8% for renewals. Occupancy declined 40 basis points in the third quarter from 92.7% to 92.3%. We are encouraged about the prospects for the fourth quarter because our leasing pipeline appears to be very solid with leases totaling in excess of 100,000 square feet in advanced stages of negotiation.

In addition, we have hired three additional senior leasing agents for our Florida team and we continue to conduct portfolio reviews with national and regional tenants on a regular basis.

As Jeff noted, our same property net operating income was flat for the quarter. However, it’s important to note this comparison does not include over $2.5 million in minimum rent from tenants who have executed leases but will not commence paying rent until their stores are ready for occupancy.

The acquisitions market for institutional quality properties continues to be extremely difficult primarily due to the credit markets, which are virtually shut down. Spreads for fixed rate loans from life companies spiked in the last 45 days from a range of 225 to 250 basis points over comparable treasuries, the 350 to 400 basis points over treasuries, and that assumes you can even obtain a quote.

Two years ago, no one was interested in acquiring properties with existing finances. Today, desirable properties with attractive in-place debt are in high demand. We are in the process of finalizing a transaction to acquire a 69,000-square foot neighborhood shopping center located in an in-fill section of Boca Raton for $23.5 million. The property has attractive in-place debt and will be added to our joint venture with Global Retail Investors.

Our new joint venture with DRA Advisors closed on a $53 million value added portfolio during the quarter. This 503,000 square foot portfolio includes a Winn-Dixie anchored center in Broward County; a center in Palm Beach County anchored by Penn Dutch, a highly productive regional supermarket; and an office complex in Boca Raton.

We are exploring several other opportunistic investment opportunities with DRA. We continue to have productive discussions with several prospective institutional partners who are interested in joint venture opportunities with Equity One. We expect these ventures will gain traction once the investment sales market returns to some form of normalcy.

And now I’d like to turn the call over to Greg Andrews for his comments about our financial results.

Greg Andrews

Thank you, Tom. Two years ago, a group of institutional investors came in to assess Equity One and the then new management team. One investor asked why we didn’t increase our leverage to enhance the return on equity. My answer was that we did not believe that leveraging the balance sheet further would create value, that the real estate business was cyclical, and that we needed to position our company to be able to weather through all parts of the cycle.

Little did any of us imagine at the time that the downcycle was right around the corner and that it would be as severe as what is now occurring. I relate this story to emphasize that prudent balance sheet management is nothing new at Equity One.

I’d like to cover four topics this morning. First, I’d like to review three significant capital-raising events that occurred during or subsequent to the third quarter. Second, I’ll discuss the use of the cash proceeds we raised. Third, I’ll walk through our third quarter income statement. And finally, I’ll review key drivers that are likely to affect our results next year.

First the balance sheet, we ended the quarter in a strong position, with debt-to-market capitalization of 39.5%. More importantly, we enhanced our liquidity to provide ourselves with considerable insulation from the current turmoil in the capital markets during 2009.

Let me review our three capital-raising events. First, during the quarter, we issued 2.6 million shares of common stock, raising net cash proceeds of approximately $54.7 million. We believe that de-leveraging the balance sheet in the face of highly uncertain credit markets is prudent management. Second, also during the quarter, we obtained a $65 million 10-year non-recourse mortgage loan on Sheridan Plaza. This loan bears interest at 6.25%.

Our high number of unencumbered properties, over 100 of them, makes mortgage financing feasible for us. Third, subsequent to quarter end, we closed on a $227 million revolving line of credit. The line has a term of three years plus a one year extension option and bears interest at LIBOR plus 140 basis points. There are currently no outstandings under the line. We are very pleased with the vote of confidence shown by our bank group.

Now, let me turn to our use of the approximately $120 million in proceeds that we raised through the equity offering and the mortgage placement. During the quarter, we added to our investments in short-term investment grade corporate debt securities by approximately $57 million. Our current holdings of $120 million mature in 2009 and are intended to repay our $188 million of funds due on April 15, 2009. We also repurchased $29 million of our own debt, including nearly $10 million of our debt due in April of 2009.

During the quarter, we also prepaid without penalty a 9.2% mortgage loan in the amount of $5.8 million and we reduced principal on remaining mortgage loans by $2.5 million through scheduled principal amortization. Finally, we added $35.7 million to cash and ended the quarter with $55 million of cash on hand.

During the fourth quarter, we will be prepaying without penalty two more mortgages due in 2009, with proceeds from the closing of two properties that we have sold to our joint venture with GRI. Following this, our only debt maturity next year, other than scheduled principal amortization, will be our $188 million of notes due in April, for which we have stockpiled over $175 million of cash and securities.

Turning to the income statement, let me first review our impairment of our investment in the common stock of DIM Vastgoed. We own approximately 3.8 million shares or 46.5% of the outstanding common stock of DIM. DIM is a Dutch investment company whose primary assets are 20 shopping centers in the southeastern US. We record our investment using the cost method because we have neither control nor influence over the affairs of the company.

For the quarter, we recorded a non-cash impairment charge of $32.7 million based upon a decline in DIM's stock price compared to our cost basis. It is important to note that we have always recorded our investment in DIM on our balance sheet at fair value. So, although the impairment is worth $32.7 million, the decrease in the fair value of DIM stock for the quarter was only $9.8 million. It is also important to note that this impairment does not jeopardize our compliance with any debt covenants.

DIM shares are very thinly traded. In contrast with the decline in its stock price, DIM’s properties continue to perform in a stable and consistent manner. At September 30, DIM’s portfolio occupancy was 94.9% and year-to-date NOI was level with last year.

DIM’s balance sheet is also healthy. Except for two mortgages totaling $51 million due in the second half of 2009, the company has no mortgage debt due until the middle of 2012 or later and all of its mortgage debt is fixed at an average rate of approximately 6%. While we are disappointed in the performance of DIM’s stock price, we remain confident in the stability of the cash flow generated by the properties, given their high occupancy, solid locations, and the fact that they are mostly grocery-anchored neighborhood centers.

Now, let’s review the key drivers of our $0.31 of FFO for the third quarter, excluding the impairment of DIM. Our same-property NOI was flat compared to last year. This reflects modestly lower occupancy by 110 basis points, offset by rent escalations and healthy spreads on new leasing. Our management fee income of $326,000 reflects our DRA joint venture, which closed on three properties this quarter as well as our existing GRI joint venture.

Investment income of $1.3 million reflects the income on our $120 million of short-term debt securities. Other income includes, among various items, compensation from a local municipality for the use of part of one property under several easement agreements. G&A expense was higher than expected as a result of additional staffing, IT system initiatives, and the previously mentioned pre-development write-off at Atlantic Village.

Interest expense was lower, reflecting the assumption of debt last quarter by our GRI joint venture, our repurchase of our own bond, partly offset by interest on our new mortgage insurance [ph]. And finally, the repurchase of bonds at a discount resulted in a gain on debt extinguishment of approximately $2.3 million.

Now, let me turn to 2009. As in the past, we will provide FFO and earnings guidance for the coming year on or before our fourth quarter earnings call, but I would like to review the key challenges and opportunities we are facing as we head into 2009.

Our main challenges are; one, we are repaying very low coupon debt next April with capital that is more costly reducing our FFO by approximately $0.06 per share. Two, we’ve recorded $5.4 million or $0.07 per share of debt extinguishment gain so far this year and those may not recur next year. Three, as noted last quarter, DIM has altered its dividend policies such that we will receive $0.03 per share less next year than we did in 2008.

On the other hand, our key opportunities are, we have substantial upside available by increasing NOI through lease-up or shop vacancies, we can implement efficiencies to reduce G&A expense and we are well-capitalized to take advantage of market dislocations that could generate strong returns.

In short, notwithstanding the challenges presented by (inaudible) property market conditions, we are optimistic in our ability not only to manage through these conditions, but to take advantage of them.

At this point, I would like to turn the call back over to the operator for Q&A.

Question-and-Answer Session

Operator

(Operator instructions) Our first question will come from the line of Durell Gilroy [ph] with FBR. Please proceed.

Durell Gilroy – FBR

Good morning. That’s actually Durell Gilroy. My first question is you mentioned that you are interested in getting institutional JV partner. I was wondering if you can give some color as to your new term appetite with this institutional JV partners for acquisitions.

Tom Caputo

Our institutional partners have been really ready to join us probably for the last six months, but the opportunity that has been present in the marketplace have been almost nonexistent. And I think that as soon as you see transactions starting to occur in a fairly normal basis, even if it might be distressed debt, it might distressed properties, as Jeff mentioned, sellers who are forced to sell because their debt is maturing, or if we get back to just normal sales that you will see our joint venture business expand pretty quickly. But quite frankly, there have been almost no transactions that have occurred over the last, certainly last six months of the last year, and so because of that it’s very difficult to start joint ventures without properties that you can put into them.

Durell Gilroy – FBR

So, therefore it is safe to assume then that activity is pretty much down from the next few quarters, correct?

Tom Caputo

I don’t think I would be safe for the next few quarters. I think that for the first time in the last 15 months, we’re starting to see opportunities that sound like they’re realistic. I think if you would ask the questions – the same question last quarter or the quarter before, there were almost no opportunities that looked like they might be possible, but I think in the last month or so, we’ve seen opportunities that we think we might be able to execute on and if we can we’ll be there with joint venture partners.

Durell Gilroy – FBR

Thank you. And I have one more question. Have you – on the topic of acquisitions, have you seen any opportunities to participate in distress acquisitions in Florida?

Tom Caputo

I think we have seen opportunities to participate distress acquisitions everywhere.

Durell Gilroy – FBR

Okay. But in terms of the Florida market, has there been more of opportunities or –?

Greg Andrews

I would say no. The bigger side of the distress today are really coming from developers that were in it for the short-term that may be have completed their projects or have come close to completing their projects, that really haven’t put the permanent financing in place and never had an intent to own the projects longer term, and we’re seeing that all over the country.

Durell Gilroy – FBR

Okay. All right, thank you.

Operator

(Operator instructions) Our next question will come from the line of West Holiday. Please proceed.

West Holiday – RBC Capital Markets

This is West Holiday. Quick question on the small shop leasing, are you noticing a need for more concessions and a longer duration between renewal leases or new leases?

Tom Caputo

I think that shop vacancy is clearly our biggest challenge in our portfolio and I think that we have really gone back to very basic blocking and tackling to get these leases done. We’re doing a lot of cold calling and canvassing. We’re doing, as I mentioned, portfolio reviews with regional and national retailers. Though it’s certainly taking longer to get deals done, but we are getting them done. And as we noted, we did 44 shop leases last quarter, and we have a number in the pipeline this quarter.

West Holiday – RBC Capital Markets

And would that – I guess the pipeline would be a lot more, I guess, mall shop versus –?

Tom Caputo

The pipeline for this quarter is actually a mixture of junior anchors ranging up into the 20,000 and 30,000 square feet, and some 10,000-foot tenants and then lots of shops.

West Holiday – RBC Capital Markets

Okay, yes. And next question will be, I guess, with the capital market slowdown, are you guys still active in buying back your debt?

Greg Andrews

We did buy back some additional debt in the fourth quarter, totaling about $11 million, West, and the debt trades thinly and sporadically, but we look at it when we’re presented with it.

West Holiday – RBC Capital Markets

Okay. Thanks guys.

Operator

And our next question will come from the line of Paul Adornato with BMO Capital Markets. Please proceed.

Paul Adornato – BMO Capital Markets

Hi, good morning. Given the decline in DIM’s stock price, does that investment have any appeal to you in terms of, perhaps, looking to acquire the rest of the outstanding stock?

Tom Caputo

I think it certainly helps but again, we’ll look at it in the context of the overall environment. But certainly, a cheaper stock helps facilitate a transaction.

Paul Adornato – BMO Capital Markets

Okay. And Greg, you mentioned that there would be the potential for some G&A savings. I was wondering if you could give us a little bit more detail on where you might see some savings coming from. And also, could you just review where EQY has offices throughout the country and what the plan is for regional expansion?

Greg Andrews

Sure. I think, with respect to G&A, the theme that we’ve been communicating for some time now is that we’re trying to build an efficient organization that leverages off of our systems, and so there’s – it’s a double-edged sword, Paul, where we need to make investments in the system and the use of the system and training people to also harvest efficiencies from that, so that’s the process we’re going through. It’s hard to be specific about the timing and quantity of savings that we’ll reap, but certainly we’re convinced that it’s the right way. It’s the right investment to make.

And then with respect to our offices, I think we’ve disclosed that we have an office in California that we’ve had for about a year looking at opportunities in the western US; and then we have a big office in Atlanta that’s been there since we did the IRT merger five years ago; and we have an office in Florida [ph] as well. So, those are our main regional offices, and then we have smaller satellite offices that deal with properties in the regions in which we operate.

Jeff Olson

And, Paul, in terms of regional expansion, I mean, I think we have (inaudible) regional offices in total throughout the country, dealing with an ability to invest and operate in all of the markets that we want to be in. And those markets are primarily the supply-constrained markets, which would be the coastal markets up and down East Coast and also throughout certain states of the West Coast but most notably California.

Paul Adornato – BMO Capital Markets

Okay, thank you.

Greg Andrews

Thanks, Paul.

Operator

And our next question will come from the line of Craig Schmidt with Merrill Lynch. Please proceed.

Craig Schmidt – Merrill Lynch

Good morning.

Tom Caputo

Hi, Craig.

Craig Schmidt – Merrill Lynch

It sounds like you’re still looking for some more JV institutional partners. I wonder how many you think you might settle on. And were you looking for any joint venture partners with particular commercial retail real estate strategies that would work well with CalPERS and DRA?

Tom Caputo

Well, Craig, in terms of the number of partners, it’s always hard to know. We have two now, and I think that you could see us with five or six pretty easily within six months to a year after the markets return to some sense of normalcy. And in terms of strategy, I think that CalPERS is interested in what I think I would describe as core plus. DRA is interested in opportunistic and I think that we’ll just fill in the other opportunities. Some will be value adds that may or may not be for DRA. Some will be core, but I think that you’ll find probably maybe four different strategies that will be employed with five or six partners.

Craig Schmidt – Merrill Lynch

That’s helpful. And the second one is while we’re really encouraged by Chaim Katzman activity and purchase of the stock, I just want to make sure he wasn’t buying on margin.

Tom Caputo

Yes. I mean we’re not privy to any specifics on those pledges, Craig, but like you know, we know that he’s been buying some shares which we can show some confidence in our program going forward.

Craig Schmidt – Merrill Lynch

Okay. Thank you.

Operator

(Operator instructions) At this time, I’m not showing any questions in queue. I would now like to turn the call back over to Jeff Olson for closing remarks.

Jeff Olson

Okay. We appreciate everyone’s interest in our call and we look forward to our fourth quarter call coming up.

Operator

Thank you for your participation in today's conference. You may now disconnect.

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