Meruelo Maddux Properties, Inc Q4 2008 Earnings Call Transcript

Meruelo Maddux Properties, Inc. (MMPI)

Q4 2008 Earnings Call

March 12, 2009 1:00 pm ET

Executives

Lasse Glassen – Investor Relations

Richard Meruelo – Chairman of the Board & Chief Executive Officer

John Charles Maddux – President, Chief Operating Officer & Director

Lynn Beckemeyer – Executive Vice President Development & Director

Andrew Murray – Chief Financial Officer

Fred Skaggs – Chief Accounting Officer

Analysts

Analyst for Jordan Sadler – Keybanc Capital Markets

Michelle Ko – UBS

Wilkes Graham – Friedman, Billings, Ramsey & Co.

Presentation

Operator

Welcome to the Meruelo Maddux Properties fourth quarter 2008 conference call. During today’s presentation all parties will be in a listen only mode. Following the presentation the conference will be opened for questions. (Operator Instructions) This conference is being recorded today, Thursday, March 12, 2009. I would now like to turn the conference over to Lasse Glassen.

Lasse Glassen

Welcome to Meruelo Maddux’s 2008 fourth quarter and full year conference call. With us today are Richard Meruelo, Meruelo Maddux’s Chairman and Chief Executive Officer; John Maddux, President and Chief Operating Officer; Lynn Beckemeyer, Executive Vice President of Development; Andrew Murray, Chief Financial Officer; and Fred Skaggs, our Chief Accounting Officer.

Before I turn the call over to management please remember that our prepared remarks and responses to questions may contain forward-looking statements. Words such as may, will, expects, believes, estimates, could and variations of these words and similar expressions are intended to identify forward-looking statements that are subject to a number of risks and uncertainties including statements about our planned development activities and general market conditions.

Actual results may differ materially from those set forth in these statements due to the risks and uncertainties inherent in our business including those detailed in the risk factor section contained in the documents we filed with the Securities & Exchange Commission. We undertake no obligation to revise or update information herein to reflect events or circumstances in the future even if new information becomes available.

With that, it’s now my pleasure to turn the call over to Meruelo Maddux’s Chairman and Chief Executive Officer Richard Meruelo.

Richard Meruelo

Today I will discuss our liquidity situation and recent business highlights from this past quarter and year. I will then give you an update on the key initiatives that we are currently focusing on. Andrew Murray our Chief Financial officer will then provide additional capital market observations and further details on our liquidity position and related strategies. Fred Skaggs our Chief Accounting Officer will follow Andrew with details on our fourth quarter and year end operating results. Following our prepared remarks we will then take questions.

Hopefully each of you has received and had an opportunity to review our fourth quarter and yearend earnings press release. This earnings press release was issued yesterday afternoon after the market closed. I would also like to invite you to download our supplemental package that was posted yesterday afternoon on our website at www.MerueloMaddux.com in the investor relations section under the heading presentation and webcasts. We expect to file our annual report on Form 10K tomorrow.

Although we are upbeat about the long term growth opportunities in our markets, these are very challenging times. We recorded a net loss of $85.8 million in the fourth quarter of 2008. This result was derived in large part from the decision to take $117.4 million of non-cash impairment charges in the fourth quarter. We are a development company and experienced significant recurring cash shortfalls. We need to generate additional cash of approximately $28 million annual to fund such shortfalls.

We have stopped making interest and principal payments on and therefore are in default under 26 of our 30 loans totaling $266 million. We are currently seeking loan workout agreements with four depository lenders on loans that total approximately $177.8 million. Additionally, we expect to receive a growing concern opinion from our independent auditors with respect to our audited financial statements to be included in our annual report on Form 10K for the year ended December 31, 2008.

In order to resolve our liquidity issues, in addition to seeking loan workouts we have suspended all substantial development efforts except for the funded development activity at our 717 West 9^th project. We are also examining all feasible strategic alternatives. Potential strategic alternatives include a voluntary bankruptcy filing under Chapter 11 of the US Bankruptcy Code. Later Andrew will address in greater detail our liquidity situation and our related strategies.

Amid the liquidity difficulties just cited, we continue to focus on development and leasing activities in all of our properties. Two of such projects are 717 West 9^th Street project which is currently under construction and the Union Lofts Apartment project in lease up. We are pleased with the progress being made at our 717 West 9^th Street Apartment project. The glass curtain wall was fully installed during the fourth quarter and interior framing, plumbing, electrical and drywall work are in progress. The project is on schedule and we anticipate move ins to begin during the fall of 2009.

We have leased an additional 19 units at our Union Lofts Apartment project since our third quarter earnings release when we had 27 units leased. As of March 11, 2009 we have 46 units leased at $2.90 per rentable square foot net of concessions.

In the fourth quarter we also closed three asset sales, the Overland Terminal property, property at 801 East 7^th Street and at 816 Stanford. We generated gross cash proceeds after debt payoffs of approximately $8.3 million on these sales. In January of 2009 we obtained the final tranche of our $84 million construction loan to complete our 717 West 9^th Street project.

I would now like to highlight some important points about our market place. The downtown Los Angeles market for distribution and industrial space remains relatively strong. Cushman & Wakefield reports that while this market remains the strongest in the country, the vacancy rate for central Los Angeles market has climbed to 3.3%. The container volume handled at the combined ports decreased by 8.5% in 2008. The slowing trade volume, the still struggling housing market and the overall recessionary times will continue to dampen demand for industrial product. Cushman & Wakefield believes that these factors will reduce industrial rents by 5% to 10% during 2009.

In the residential sector, Los Angeles County continues to feel the impact of the weakening economy. According to the state of California Los Angeles County loss 17,800 non-farm jobs for an annual gross rate of -.4%. The County’s non-farm unemployment rate increased to 9.5% in December of 2008. Downtown Los Angeles has seen a significant slowdown in condominium sales and several condominium buildings have converted temporarily to rentals creating additional rental market supply in some downtown sub markets.

Accordingly, the apartment vacancy rate for downtown had dropped. Rental rates however for one and two bedroom apartments comparable to the Union Lofts are holding steady. The generally strong downtown real estate market affords us the opportunity to sell certain assets once the financial crisis abates and credit becomes available. Being able to monetize certain assets will provide us additional liquidity.

We have received offers on certain properties that we are considering. Some of these offers have perceived signed purchase and sales agreements. Generally we will discuss particular transactions only after they have closed. In looking at our operating portfolio and excluding the above mentioned impairment charges and the increases in expenses attributable to suspending activities at 13 of our development projects, our fourth quarter results were generally in line with our expectations.

On a linked quarter basis rental income and total revenues for the fourth quarter were nearly identical to the third quarter. Certain operating expenses such as rental expense and interest expense were affected largely by the increase of these expenses due to suspending 13 of our development projects which will be discussed later by Fred.

With respect to leasing activities, we completed or renewed a total of 23 residential and commercial leases during the fourth quarter for a total of approximately 47,000 square foot of lease spaced. This was offset by commercial lease expirations totaling 36,000 square feet. Union Lofts currently has 46 of 92 units leased for a 50% occupancy at $2.90 per square foot per month net of concessions.

We have chosen to maintain high tenant credit quality standards of leasing at this property. Some of our competitors have chosen to forego credit checks on perspective tenants and only ask for minimum deposits prior to move in. While we are very focused in leasing up this project, we believe it is prudent to maintain appropriate credit standards to avoid the inevitable consequences of evictions and non-collection of rents caused by lax underwriting standards.

With that, I will now turn the call over to Andrew Murray, our CFO for a closer look at the fourth quarter capital markets and liquidity situation.

Andrew Murray

As Richard mentioned in his remarks, I’d like to review our liquidity situation. We are a development company and must generate cash of approximately $28 million annually to fund cash forward calls from our operating activities, our recurring investment activities such as the carrying costs for interest payments, real estate taxes and other unfunded development expenditures and capital expenditures on existing rental properties.

Assuming no new development of any of our projects other than the project at 717 our cash requirements for 2009 include but are not limited to the a $38.7 million to fund the ongoing construction of 717 and approximately $172.5 million to satisfy borrowings that mature in 2009 and approximately $3.5 million of planned but uncommitted capital improvements to our operating properties.

As a result of the foregoing needs and our combined annual negative cash flow from operating activities and capital and development expenditures, we will require substantial amounts of new capital to meet our contractual obligations in 2009 before any discretionary development. However, we do have a fully funded construction loan in place at 717 to satisfy the $38.7 million of construction needs at our 717 project.

Our primary expected source of new capital will be coming from the extension of existing loan maturities and the sale of non-core properties as we’ve discussed in prior calls. However, current market conditions have changed dramatically and have made it more difficult for us to extend loans or secure new debt financings. As previously mentioned, we are likely in default on three loans that recently matured totaling $86.9 million that came due in the first quarter. We have also stopped making regular interest and principal payments on 26 of 30 of our loan which include the three loans we just mentioned and that totals $266 million of loan principal balances.

As a result of this we are currently behind on $3.6 million in accrued interest and principal payments on these 26 loans. Also, on December 15^th we defaulted on a $4 million principal repayment on a $17 million land loan. Later the lender verbally agreed to defer this principal repayment however, another $5 million in principal on this loan comes due on March 15^th. We currently don’t have the financial wherewithal to make these particular principal repayments.

We are however, attempting to generate liquidity by selling many of our properties. Obviously, selling in this market is difficult as there are fewer buyers than we’ve had historically with the financial wherewithal to consummate a transaction. We expect but are not assured that there’s adequate equity in the sales of these properties that will generate sufficient cash flow to pay off the debt that’s typically on these properties.

We also may generate liquidity from obtaining debt on some of our unencumbered properties which we are currently seeking to do. Specifically, we are in advanced discussions with four of our depository lenders and are seeking loan workout arrangements on approximately $177.8 million of loans. We are however, likely in default with some or all of our lenders as a result of some of the things we just mentioned.

We do however, have two exceptions. We do have an $8.5 million loan and a $7.2 million loan where the lender has formally demanded payment or commenced foreclosure actions. Our future financial performance will largely be affected by our lenders’ willingness to agree to workout terms and our ability to sell properties in this market. These factors along with the general economy, the current equity and debt capital markets and other factors many of which are beyond our control will impact our results. There can be no assurance that our plan to ensure continuation is a going concern if we will be successful.

During the fourth quarter cash in flows were comprised of approximately $27.7 million in gross proceeds from the sale of three properties previously mentioned. Other material cash in flows came from restricted cash balances used primarily to fund costs at our 717 West 9^th Street project and interest expense at our Pomona West project. The cash in flows from restricted cash amounted to $10.3 million net of cash out flows to restricted cash for additional tax and tenant improvement reserves and additional cash collateral for lenders.

Cash out flows during the fourth quarter were comprised primarily of $14.6 million of expenditures for improvements in real estate, $11.4 million of which went in to the 717 West 9^th Street project, $19.4 million of loan balance repayments related to the three projects sold, $1.7 million of scheduled amortizations and one loan payoff and approximately $5.4 million to cover net cash shortfalls from operations.

Subsequently, the company’s unrestricted cash balance decreased by $2.9 million during the fourth quarter of 2008 which left us with $4.5 million of unrestricted cash at 12/31/2008. I just want to direct people to some new information that we’ve put in to our fourth quarter supplemental on pages 16 and 17 we’ve added a lot more detail as to the land square footages on our rental properties and land and building square footages on our development properties and on page 19 we’ve listed the per square foot sales prices of the properties we sold during 2008.

With that I’ll turn the call over to Fred Skaggs who will provide details on our fourth quarter operating results.

Fred Skaggs

Our 2008 fourth quarter financial results include a few items that we did not have in the fourth quarter of 2007. First, we recorded an impairment loss of $117.4 million. Because of our liquidity situation we determined that we must sell many of our assets and accordingly wrote down these assets to their estimated fair market value less costs to sell. We also decided based on current market conditions to terminate our purchase agreements at various projects and wrote off our deposits and other capitalized costs on these projects.

Second, we recorded a benefit for income taxes of approximately $47.4 million. We did this because in the near term we expect to utilize tax losses to offset tax liability on the sale of the assets including those that we have impaired. Third, we reflected in the fourth quarter of 2008 the effect of income taxes of approximately $9.6 million in discontinued operations and the corresponding offsetting impact in benefit for income taxes.

In 2008 we had pre-tax income from discontinued operations of approximately $24.2 million which consisted primarily of the gain on sale of real estate. As a result of recording the full tax impact in the fourth quarter of 2008 partially offset from income from discontinued operations during the fourth quarter, our income from discontinued operations became a loss of approximately $8.7 million.

Looking at our operating results for the three months ended December 31, 2008 total revenue increased 3.7% to $6 million compared to $5.8 million in the same period in ’07. The increase was largely due to higher rental income attributable to rental operations at projects acquired or placed in service during 2007 or 2008 which had partial or no operations in the prior period.

Moving to the expense side of the income statement, excluding the $117.4 million in impairment charges, our fourth quarter 2008 expenses were $13.5 million versus $9.1 million in the fourth quarter of 2007. Compared to the fourth quarter last year, the increase was due to higher depreciation and amortization expense due to the increase in rental properties or the number of rental properties as a result of property acquisitions and development projects placed in service during the year.

In addition, rental and interest expenses increased in the fourth quarter of 2008 compared to the fourth quarter of previous year and earlier quarters in 2008 due to the suspension of the development activities at 13 of our projects. Cost of these projects were previously capitalized but in the fourth quarter of ’08 we began expensing these costs.

General and administrative expenses were unchanged at $2.2 million in the fourth quarter of 2008 compared to the fourth quarter of 2007. Net loss for the quarter was $85.8 million or $0.98 per basic and diluted share compared to a net loss of $2.6 million or $0.03 per basic and dilute share in the fourth quarter last year. Net loss for the year ended December 31, 2008 was $96 million or $1.11 per basic and diluted share compared to a net loss of $11.9 million or $0.14 per basic and diluted share for the period January 30, 2007 through December 31, 2007.

Now, moving to the balance sheet, as of December 31, 2008 our stockholders’ equity decreased by $85.3 million during the fourth quarter mainly from our net loss of $85.8 million. During the quarter both our rental properties and our real estate held for development decreased by $58.3 million and $76 million respectively largely from the impairment of assets and sale of assets partially offset by construction costs incurred at our development project at 717 West 9^th Street.

Our notes payable secured by real estate decrease by $20.6 million largely from the sale of two projects and the retiring of the related secured debt at Overland Terminal and 801 East 7^th Street. As of December 31, 2008 we had cash and cash equivalents of $4.5 million and our debt to total asset ratio was 48.1%.

That concludes our prepared remarks. Thank you for your attention. At this time I’d like to open the call up to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Analyst for Jordan Sadler – Keybanc Capital Markets.

Analyst for Jordan Sadler – Keybanc Capital Markets

I just want to try to better understand your process and strategy and so what exactly would be the benefit in declaring Chapter 11? I see several properties that are 100% occupied or about six or seven that are over 90% occupied and so I guess first, what loans exactly are recourse to the company? And then second, why wouldn’t you essentially hand the keys back to the lender on the vacant buildings or underperforming assets, reduce your expense load and just continue operating the remaining assets?

Richard Meruelo

The great majority of our loans are either directly or indirectly recourse to the operating partnership or the company and so handing back keys is not enough of a solution.

Analyst for Jordan Sadler – Keybanc Capital Markets

So most of the loans are recourse in some form or another? Were they non-recourse and now because of non-payment or a trigger of some sort of default they are recourse?

Richard Meruelo

No but, many of them from the beginning had some form of recourse and as they’ve been modified over the last year it’s continued to increase the level of recourse. We’ve been modifying these loans now for over a year in short term extensions and recourse issue has become most prevalent in all of our loans except in just a few.

Analyst for Jordan Sadler – Keybanc Capital Markets

On the non-recourse loans, when you say a few, can you just give a better sense of maybe what the NOI on those are which ones?

Richard Meruelo

We have amount of non-recourse debt is how much Andrew?

Andrew Murray

$74 million.

Richard Meruelo

$74 million of our debt is non-recourse.

Andrew Murray

We haven’t calculated the NOI on those properties but our overall strategy though is to continue to work with four of our lenders again, as we mentioned in our press release and in our comments to come up with an agreement with these four lenders that should deal with our cash flow matter, the cash flow issues we have in the company. We’re in advanced discussions with these four lenders. We’ve been having conversations with them daily now for several weeks and we continue to work towards a solution with them. That’s our primary focus right now.

Analyst for Jordan Sadler – Keybanc Capital Markets

So the properties that are 100% occupied or in the 90% range, those are likely recourse or have some form of recourse to the company?

Andrew Murray

If we have a performing property and it has recourse we want the relationship with that particular lender on that property to be in good standing.

Analyst for Jordan Sadler – Keybanc Capital Markets

I guess moving over to 717, when would you need to start making cash payments outside of the interest reserves? And also I guess on the other three properties that you’re currently funding loan payments through interest reserves?

Richard Meruelo

We have extensive interest reserves on the 717 project and the project starts leasing up this fall say September/October. All those cash flows also support the interest payments. The remaining interest reserves typically cover – whatever they’re on typically cover through maturity.

Analyst for Jordan Sadler – Keybanc Capital Markets

Then just on the American Apparel is there any update on their lease at Alameda square?

Richard Meruelo

They are currently paying rent. They’re physically here. We don’t really comment on ongoing lease negotiations but we have ongoing lease negotiations with them.

Operator

Your next question comes from Michelle Ko – UBS.

Michelle Ko – UBS

I was just wondering if you could give us a little bit more color on some of those asset sales that you spoke about? How soon do you think you can close on some of those and overall can you give us a sense of how much you intend to get from the asset sales that you’re marketing?

Richard Meruelo

Just one thing to note on page 19 of our supplemental we talked about the asset sales and in particularly the ones we closed in the fourth quarter just to give you some color on the marketplace in terms of valuations, etc., that’s sort of one data point. We have numerous properties in escrow, we have some other properties where we have signed purchase and sales agreements.

The timing of all of these properties varies from short term to long term but we generally try not to comment on the likely outcome of any of these escrowed properties or purchase and sale agreement properties because the nature of the marketplace that we’re in today and sometimes they don’t close or sometimes they close at a different point in time. For example 801 East 7^th which closed last year took an extra six months. We thought it was going to take three months and it took nine months.

We do have things in the pipeline but it’s hard for us on a practical point of view to be very specific about when something is expected to close because it’s just too hard to gage at this current time.

Michelle Ko – UBS

Could you give us may more of a sense of has it become more difficult since the fourth quarter to get some asset sales done? Are you seeing more difficulty on the interest side or buyers can’t get financing?

Richard Meruelo

It is more difficult. I think the economy has changed dramatically in the first quarter 2009 versus the fourth quarter 2008. However, the one positive is that most of the buyers of our real estate or people we’re trying to sell the real estate to are tenants or end users and an end user on a small building is likely to find some form of financing as compared to an investor who is buying a large property which isn’t the case in most of what we’re looking at. An investor who is looking to buy a large dollar amount property is going to find it a hard go to get financing.

However, we are encouraged by the fact that there are end users who are interested in buying our properties and these end users due tend to attract debt capital to allow them to purchase an owner occupied building.

Michelle Ko – UBS

Then can you just give us a sense more details about the impairments and just in general what percentage you’ve written off on those assets?

Andrew Murray

We have written off on those assets roughly 20%, between the 20% and 30% range from our book value and we’re just being very careful in putting what we believe are realistic and conservative numbers on these assets.

Fred Skaggs

There’s a lot of impairing going on coming from the auditor world. They’re seeking to make sure that any assets that could be impaired sort of get impaired. This is a non-cash event for us but to some degree it does represent a mark-to-market of today’s market and all its unvarnished ugliness.

Michelle Ko – UBS

Just lastly, it seemed impressive that you did lease up 14 units at Union Square Lofts in the fourth quarter, what kinds of concessions did you have to offer?

Richard Meruelo

Typically one and a half months and the number we have at $2.90 a square foot is net of those concessions. So, it would be one and a half months on an 18 month lease.

Fred Skaggs

I just wanted to follow up on the impairment issue, what we did is we wrote down many of our assets because we believed within the next year we may have to sell quite a few of these assets so we wrote them down to their estimated fair market value as of December 31^st less cost to sell. We took write downs on maybe 20 different projects in our portfolio. So, a few projects were also written down that we don’t really believe we’re going to sell in the current year or that we don’t think are highly likely that we’ll sell that we just impaired them for other reasons, we just thought the fair market value we would not be able to realize on a cash flow on an undiscounted basis over its holding period.

Operator

Your next question comes from Wilkes Graham – Friedman, Billings, Ramsey & Co.

Wilkes Graham – Friedman, Billings, Ramsey & Co.

Just a couple of questions on the apartment market down there and your assets, I think it was just mentioned you guys leased a fair amount of units at Union Lofts, can you just talk about what the apartment market has been like the past couple of months specifically the A rent market and what you’re seeing at the Olympic asset and kind of what your expectations are for the timing on leasing at 717 West 9^th Street.

Richard Meruelo

Well, I think the market is tougher primarily because there are projects that were suppose to be condominiums that are converting to apartments and we mentioned that before, there’s a property called The Chapman, near the Union Lofts that was a condo that went rental. Specifically at Union Loft, it’s picked up its velocity, it’s been improved since a lot of our marketing plans and efforts have started to bear fruit but it’s still a difficult market out there.

The 717 project, we’re anticipating to begin pre-marketing with our third party leasing and property management folks probably in May and June and July. They can actually start delivering occupied unites in September/October. So, we might actually get some better sense of the market if we start signing leases in August. But, we’re trying to get a head start specifically on the 717 project because we’re going to do some pre-leasing and reaching out to the community and corporate users, etc.

Wilkes Graham – Friedman, Billings, Ramsey & Co.

Can you just remind me, I think it’s in the supplemental but how much money you have spent so far at 717 and how much you have left to spend?

Fred Skaggs

We have approximately $38 million left to spend there to bring us to completion.

Wilkes Graham – Friedman, Billings, Ramsey & Co.

$38 million over the course of the rest of this year?

Richard Meruelo

Yes.

Wilkes Graham – Friedman, Billings, Ramsey & Co.

I’m assuming you’re going to fund that construction with proceeds from asset sales.

Richard Meruelo

It’s a fully funded construction loan at this time. Unless, we have a very large restricted cash balance at year end and a good chunk of that is the proceeds from the Canyon loan and subsequent to year end we received the second tranche, another $42 million so we’ve received a total of $84 million in cash proceeds from the Canyon loan.

Wilkes Graham – Friedman, Billings, Ramsey & Co.

That’s 100% of that loan, right?

Richard Meruelo

Yes.

Operator

At this time we have no further questions in the queue. I’d like to turn the call back over to management for any closing remarks.

Richard Meruelo

Thank you for joining us today on this call. While significant challenges remain ahead I am proud of the hard work and dedication of the Meruelo Maddux team during the last quarter as well. We look forward to keeping you appraised on our efforts going forward. Thank you again and have a great day.

Operator

Ladies and gentlemen this concludes the Meruelo Maddux Properties fourth quarter 2008 conference call. If you’d like to listen to a replay of today’s conference, please dial 303-590-3000 or 1-800-405-2236 followed by pass code 11127860. ACT would like to thank you for your participation, you may now disconnect.

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