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Rouse Properties (NYSE:RSE)

Q1 2013 Earnings Call

May 03, 2013 10:00 am ET

Executives

Steve Swett

Andrew P. Silberfein - Chief Executive Officer, President and Director

John A. Wain - Chief Financial Officer

Benjamin Schall - Chief Operating Officer

Analysts

Alex Avery - CIBC World Markets Inc., Research Division

Daniel Busch - Green Street Advisors, Inc., Research Division

Operator

Greetings, and welcome to the Rouse Properties Inc. First Quarter 2013 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Steve Swett, moderator of ICR. Thank you, sir. You may begin.

Steve Swett

Good morning. We would like to thank you for joining us today for Rouse Properties' First Quarter 2013 Earnings Conference Call. In addition to the press release distributed last evening, we have filed a Form 10-Q with the SEC and posted a quarterly supplemental package with additional detail on our results in the Investor Relations section on our website at www.rouseproperties.com.

On today's call, management's prepared remarks and answers to your questions may contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements address matters that are subject to risks and uncertainties that may cause actual results to differ from those discussed today. Examples of forward-looking statements include those related to revenue, operating income, financial guidance, as well as non-GAAP financial measures such as same-store results, FFO and core FFO. We also caution that prior period results that are referenced in any comments today may not necessarily be reflective of the results had Rouse truly been a standalone entity during the periods presented. As a reminder, forward-looking statements represent management's current estimates. Rouse Properties assumes no obligation to update any forward-looking statements in the future. We encourage listeners to review the more detailed discussions related to these forward-looking statements contained in the company's filings with the SEC and the definitions and reconciliations of non-GAAP measures contained in the supplemental information package available on the company's website. This morning's conference call is hosted by Rouse Properties President and Chief Executive Officer, Andrew Silberfein; Chief Operating Officer, Benjamin Schall; and Chief Financial Officer, John Wain. They will make some introductory comments, after which we will open up the call to your questions.

Now I will turn the call over to Andy.

Andrew P. Silberfein

Thank you, and good morning, everyone. I will begin with a brief overview of our operating performance for the first quarter and update you on our accomplishments as we continue to execute on our strategic initiatives. I will then turn the call over to John who will review our balance sheet and provide more detail on our financial results for the quarter.

As we have communicated to you over the past year, we are in the early stages of executing our long-term plan. We achieved another quarter of strong progress with solid leasing, continued improvement in the operating metrics of our portfolio and the implementation of our capital improvement initiatives.

Let me start with a review of the quarter's leasing activity. We signed 89 leases in the first 3 months of the year, totaling nearly 530,000 square feet. This production was 130% greater than the first quarter of last year, representing the fourth straight quarter of achieving leasing totals in excess of 525,000 square feet. Our portfolio is 89.2% leased at the end of the first quarter, an increase of 172 basis points year-over-year, including anchor tenants, our portfolio is 91.8% leased. We also continued to make substantial progress on improving the portfolio's composition of temporary and permanent tenants. The percentage of permanent leased space improved by 381 basis points and temporary leased space decreased by 208 basis points compared to the first quarter of 2012. Although it has only been 15 months since our formation, we are about 1/3 in the way to achieving our targeted goal in terms of overall leasing levels and permanent and temporary lease ratios for the portfolio.

Our portfolio of sales increased to $296 per square foot, up 2.1% on a comparable basis. At the end of the first quarter, our occupancy cost ratio was 12.6%, a substantial reduction from 13.3%, which we reported in the first quarter last year. For the quarter, initial lease spreads on a suite to suite basis improved 11.8% as a whole, including a 27.9% increase on new leases and 4.6% increase on renewal leases.

Leasing spreads in the first quarter were substantially up from the 3.5% we achieved in 2012, but we remind you that the quarterly averages will have some volatility. We continue to see solid demand across our portfolio and our markets from both our large size and inline tenants. Among the more substantial leases we executed are 5 new box leases totaling 180,000 square feet. That means that in this quarter alone, we have executed big box leases equivalent to 40% of our total new box leasing activity achieved in all of 2012. As we've previously reported, Sears closed 2 acre stores at 2 of our malls at the end of January of this year upon the natural lease expiration date. For the 30 days, we released one location to Dunham's Sporting Goods for their flagship store, and we are close to executing a lease for the second location with another major retailer. Both of these replacement tenants will be at significantly higher rental rates than what Sears was previously paying. These transactions are solid examples of our active management platform and the speed to the market is exhibited by our entire leasing team.

As we have stated in the past and is worth mentioning again, a significant portion of the leasing we have achieved in the past few quarters has yet to impact our results as it takes time for new tenants to build out, occupy and open their premises for business. At the end of the first quarter, we had approximately 680,000 square feet of SNO for tenants who have signed leases that have not yet opened. Of that number, approximately 450,000 square feet consist of tenants that will occupy currently vacant space. We continue to expect that the positive and significant impact on same property NOI from these leases will be felt in the second half of 2013, with most of it being seen in the fourth quarter. In addition, as John will discuss later, our same property NOI was up slightly this quarter compared to last year. We can clearly see the first signs of the stabilization in the NOI of our portfolio.

Now turning to our capital projects. We continue to focus on our strategic and cosmetic capital improvement plans throughout the portfolio. We are committed to improving the physical quality, customer experience and retailer offerings of our portfolio as evidenced by our extensive and ongoing improvement projects at our various malls. We have to strategic projects currently underway, with total projected cost of approximately $18 million. Our Lakeland Square Mall project is on schedule, with the Sports Authority and Cinemark Theater openings planned for the fourth quarter of 2013. At Silver Lake Mall in Coeur d'Alene, Idaho, we are finishing the reconfiguration and conversion of an anchor box and unproductive inline space with Jo-Ann Fabrics already opened and the Sports Authority already opening within the next couple of weeks.

During 2013, we expect to commence an additional 3 to 4 strategic capital projects and 3 or 4 cosmetic renovations throughout the portfolio. The total capital spend on these projects, inclusive of the projects we have already commenced, is estimated to be between $70 million and $80 million with completion expected in the next -- within the next 12 to 18 months. As we have indicated the [indiscernible] and the planned reinvestment in our portfolio, determined on an asset by asset basis, is a crucial component of our long-term strategy to maximize value and increase cash flows. We look forward to updating you on our progress as these programs unfold.

Now turning to our external growth. We believe we're one of the few companies with the size and established operating platform, retailer relationships and balance sheet strength necessary to successfully operate middle-market malls on a national basis. We have primarily focused our efforts to date on building our company's personnel, systems and infrastructure and significantly improving the metrics of the existing portfolio. We expect going forward to increase our focus on acquisitions and to grow our asset-base. We continue to pursue a pipeline of potential opportunities that fit our criteria. We'll remain selective but are confident in our ability to source and close attractive investment opportunities.

With that, I will turn the call over to John to discuss our financial results.

John A. Wain

Thank you, Andy and good morning, everyone. In my comments today, I will first address our balance sheet including recent financing transactions and their impact on our capital structure and liquidity; then I will review our first quarter operating results; and finally, I will discuss our 2013 guidance for core FFO.

Starting with the balance sheet. As we have previously communicated, we continue to make significant progress in executing on our 4-point strategy to strengthen our balance sheet by decreasing the amount of our recourse financing, lowering our interest rate, extending and laddering our maturity and generating excess refinancing proceeds to further support our growth strategy. On the financing front in March, we closed on a $70 million 10-year 4.17% fixed rate CMBS loan on Lakeland Square Mall. This financing satisfied our only 2013 debt maturity and provided us with approximately $13.4 million of excess proceeds net transaction and defeasance cost on the retired loan. In addition, during the quarter as previously disclosed, we reduced our outstanding term loan balance by $100 million, while simultaneously increasing our revolver by the same $100 million to a new amount of $150 million. This enabled us to substantially reduce our interest expense, while maintaining the same level of liquidity for the company.

At the end of the third quarter, we had total debt of $1.23 billion, including fixed rate mortgage debt of $1.04 billion with a weighted average interest rate of 5.25%. We had $187.9 million outstanding on our term loan facility and 0 outstanding on our $150 million revolving credit facility. Since our spin date, we have included the weighted average interest rate on our debt to 5.17% from 5.55% and extended our weighted average term to maturity to 4.12 years from 2.93 years.

With regard to our financial flexibility, we ended the quarter with approximately $303.3 million of liquidity, including $53.3million of cash and deposits a $150 million bank revolver fully undrawn and a $100 million subordinated revolver, also fully undrawn. This provides us with sufficient capacity to support our operational and strategic growth objective. We have no maturity through the remainder of 2013, but I would also remind you that we have $514 million of existing CMBS property debt carrying the weighted average interest rate of 5.58% and the weighted average term to maturity of 2.4 years, which is freely prepayable without penalty. This affords us tremendous flexibility in being able to refinance these loans at any time without incurring new cost or other penalties. We continue to receive strong interest from a number of CMBS, as well as balance sheet lenders and anticipate that we will continue to take advantage of favorable rates and market condition as we fully execute on our refinancing strategy.

On another note, as we've communicated previously, in January, our Boulevard Mall loan in Las Vegas was transferred to special servicing. Also during the first quarter, we recognized an impairment of $21.7 million on The Boulevard. While we have no resolution to report at this time, we believe any such resolution would have an immaterial impact on FFO. We will continue to update you on this asset as discussions advance and as we have greater visibility on the ultimate resolution.

Now let me turn to our results for the first quarter of 2013. Our core funds from operations increased by 22% to $18.3 million or $0.37 per share compared with $15 million or $0.30 a share in the prior year. The prior-year results are still not entirely comparable to the current year. Our spinoff occurred on January 12, 2012. So the first quarter of 2012 included a partial period, which was a carve out of the historical financial statements of General Growth Properties. That said, the year-over-year increase in core FFO is primarily attributable to 3 items. One, net operating income was up $2.5 million, which is primarily related to full quarter contribution of 2 assets acquired in 2012, Grand Traverse and Turtle Creek. In addition, same property NOI was up 0.25%; two, G&A expenses were approximately $300,000 lower than the prior year; and three, interest expense was $229,000 lower mostly due to $2 million in savings from lower interest rates and lower debt levels on our original portfolio, offset by $1.8 million of additional interest expense on the debt associated with our 2 2012 acquisitions.

On May 2, 2013, our Board of Directors approved the quarterly dividend of $0.13 per share. This dividend will be paid on July 31 to stockholders of record on July 15.

Looking forward to the balance of 2013. We are reaffirming guidance for core FFO in the range of $1.49 to $1.55 per diluted share for the year ending December 31, 2013. This range represents 18% to 23% growth compared to 2012 core FFO of $1.26 per share. Please note that our guidance does not include the effects of any future property acquisition, dispositions or refinancing.

With that, I'll turn the call back to Andy for some concluding remarks.

Andrew P. Silberfein

Thanks, John. We are pleased with our progress in early 2013, building off of our successful accomplishments in 2012. We continue to pursue the same principal goals that I have communicated for more than a year now. As we look forward, our portfolio metrics continue to improve, our tailored asset by asset capital programs are underway, and we are well-positioned from a capital standpoint to pursue additional growth opportunities as they arise.

With that, we would be happy to answer any questions that you may have. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Alex Avery with CIBC.

Alex Avery - CIBC World Markets Inc., Research Division

Just wanted to, I guess, dig into some of the leasing that happened in the quarter. Certainly, a lot of progress year-over-year, 170 basis points higher occupancy. But I was just looking more from Q4 to Q1. Obviously, Q1 is a quarter when you have a higher degree of tenant turnover. It looks like you took care of about 300,000 square feet of your 2013 lease maturities. But can you talk about the stuff outside of that, what the gives and takes were, to take your, I guess, lease occupancy down 60 or 70 basis points?

Benjamin Schall

Sure, Alex. This is Ben. Most of that variation as you mentioned, between the fourth quarter and the first quarter was typical for our business and for Rouse. We've been able to, as Andy mentioned, continue our significant leasing pace, and you're seeing that reflected in our sign on open leases, and you're continuing to see that leasing pace reflected in the differential between our lease occupancy and our occupied space, which today is to the tune of 340 basis points. During the quarter, we had a relatively strong quarter on the box leasing front. A number of key anchor deals reflecting a continued interest from junior and big box anchors in our portfolio. We mentioned Dunham's Sporting Goods in Colony as an example. We also signed a key lease with [indiscernible] in Southland, California, as well as the new deal with Sports Authority in West Valley. The pay -- the inline side is also -- remains strong. We've been very active with a number of our key national tenants. The tenants that are big pieces of our existing portfolio and looking to grow with us in this quarter and our current pipeline reflects activity with retailers like Maurice's, rue21, P.S. by Aéro, Forever 21 that recently opened in Southland, Michigan, Francesca's also [indiscernible] to give you an example. So we're pleased with our pace, to have another quarter of over 525,000 square feet, and we're confident in the trend continuing

Andrew P. Silberfein

Alex, this is Andy. We spent the better part of 15 months really playing a lot of defense as we stabilized the portfolio. So our strategic and cosmetic capital projects, as they take hold they've been very well-received by the customers at the mall and also by the retailers. So we're starting to be able to play some offense in general, which is helping not only in terms of pushing rents but occupancies, and also its enabling us to attract the higher-quality retailers throughout the portfolio.

Alex Avery - CIBC World Markets Inc., Research Division

Okay, and so, I guess, this might be a little bit difficult to answer but, I guess, the experience in Q1 as far as new leasing versus either tenants that are leaving on expiry or, I guess, not surviving. I guess, if you could provide us with a little bit of context perhaps how this year compared to last year compared to the year before, what I'm looking for is kind of like what the seasonal influence is normally in the business. And, I guess, what the trend is over the last few years to the extent that you guys can put that stuff together.

Benjamin Schall

If you look at our quarter 1 2012 relative our quarter 1 2013, our renewals activity was up slightly. We had about 150,000 square feet of renewals in the first quarter of '12 that's increased 225,000 feet in the first quarter of '13. The significant increase was on the new lease activity. So that was in the first quarter of '12, about 78,000 feet and that's increased slightly over 300,000 feet this quarter.

Alex Avery - CIBC World Markets Inc., Research Division

Okay, and then the I guess, the natural turnover of tenants in the portfolio, would that have been down year-over-year and do you have that data going back 2 years?

Andrew P. Silberfein

We don't really have that data, but I think are sense is that it certainly decreased from what we've seen over prior years.

Alex Avery - CIBC World Markets Inc., Research Division

And part of that would be, I guess, your management of the malls and part of that would just be more of the general retailing environment or...

Andrew P. Silberfein

I think it's a combination of both. I think you obviously have seen the retailers doing better financial health as they've been for years and also, we have seen retention in investment in the focus that we are putting on the mall. So it all goes hand in hand.

Alex Avery - CIBC World Markets Inc., Research Division

And then just more broadly in the portfolio of leases that you have, can you give us a little bit of detail about how the percentage rent works and I guess what kind of work you have in terms of incremental NOI. As you see occupancy go higher, hopefully sales continue to go higher and what the -- I guess, what the sensitivity is to that...

Andrew P. Silberfein

First thing that I would say is certainly in many of the deals, especially a lot of the renewals that we've done, where we've agreed to lower rent than we would have liked, we really ratcheted down the break point. So we expected that to be more in the upside. So as sales grow and as we improve these assets, we would expect the percentage of that to grow as well.

Alex Avery - CIBC World Markets Inc., Research Division

Do you have a sense of perhaps what percentage of your leases are, I guess, over the breakpoints at this point versus close to you, versus deep out of [indiscernible]

Andrew P. Silberfein

We don't really have that figure available, but I would say that the majority really certainly that percentage rent components and [indiscernible] history really to answer that question. We need to see what happens to sales this year. But I can tell you that we've had [indiscernible] that, if you will, to be able to benefit on that upside.

Benjamin Schall

I will add Alex, in the first quarter -- year-over-year so first quarter -- the first quarter as you'd expect given our sales improvement, our percentage rent income was up slightly.

Alex Avery - CIBC World Markets Inc., Research Division

Okay, on I guess, on FFO, $0.37 of core FFO, comes in line with the bottom end of your guidance for 2013 if you just annualize it based on Q1. Obviously, Q4 is a huge quarter for you. Can you just remind us what the annualized NOI that you're expecting to start to kick in, I guess, Q3, Q4 of this year and I guess that would probably put you closer to the higher end of that guidance range?

John A. Wain

Yes, I think you have to understand that we do expect that the second quarter to be flat to down modestly. Our occupancy dipped in the first quarter and this can be felt really in the second quarter. But as the year progresses, you will start to see the gradual upswing and most of it being felt on the increase of the [indiscernible] coming online. Most of that will be in the fourth quarter, and you could tell when you obviously -- you take the first, second, third and fourth quarters as I've laid it out. To get to same property NOI guidance of 1.75% to 2.5% it's going to be a pretty substantial pickup in the fourth quarter.

And that full year Alex full year total NOI of $160.8 million, $162 million.

Operator

[Operator Instructions] Our next question comes from the line of Daniel Busch with Green Street Advisors.

Daniel Busch - Green Street Advisors, Inc., Research Division

John, you spoke a little bit about the mall that are prepayable without penalty. Can you give us a little more color on -- it looks like some of those are at higher rates, particularly the 16 maturities. Why haven't you been a little more aggressive given what seems to be a pretty healthy financing environment for stable malls?

John A. Wain

Sure, thanks. It takes some time for us to make the improvements to the assets and improve the metrics of each mall. So since permanent financings are mostly 10 years, we only get one chance over a very long period of time to execute in both -- in terms of rate and getting a good level of proceeds. So while we're very focused on this because today's rates are great, the market conditions are very firm, some properties may not be at their optimal positioning. So we want to work on it a little bit and then we'll go to the market when we feel that the NOI has gotten to a level that we're comfortable with. So listen, you may even see us do a couple of more bank loan floaters, bridge loans to get to that period but...

Andrew P. Silberfein

This is Andy. Dan, I do think that it's fair to say we will be active this year in the financing process.

Daniel Busch - Green Street Advisors, Inc., Research Division

Okay, and Andy -- so John, is it fair that some of these malls that are prepayable are in that 3 to 4 strategic capital plan or those more of cosmetic type of redevelopments?

John A. Wain

It's actually both.

Daniel Busch - Green Street Advisors, Inc., Research Division

Andy, the outline on the redevelopment plan was helpful. You have the 2 on there and you said you alluded to 3 to 4, I guess, more. What type of spend are you doing on just the cosmetic improvements compared to what you would consider the strategic redevelopment? Is it just a couple of million dollars of lighting and brightening? Can you give us a little more sense on what you're doing and what percentage of the portfolio is getting that type of treatment?

Andrew P. Silberfein

We don't really see the numbers on the cosmetic spend, but in a general sense, the way I think about it is our total spend is probably 25%, 30% of the allocated towards the cosmetic end of the portfolio. And in terms of those projects, it's done on a project by project basis. We do have some portfolio-wide initiatives. We're putting Wi-Fi in every mall, we're doing energy management installations in every mall, we're doing a lot of soft seeding, a lot of things you'd expect from us to do. So all the properties will be touched in one way or the other, whether it's a cosmetic project or a strategic project or doing some of our company-wide initiatives.

Daniel Busch - Green Street Advisors, Inc., Research Division

And then maybe one final one for Ben. Do you guys have a sense, I guess, at this point you would -- you know what percentage of the JCPenney boxes in your portfolio are receiving or were receiving the new layout?

Benjamin Schall

We have 26, Dan. We have 26 JCPenneys in our portfolio. Half of those are under 70,000 feet and half are over 70,000 feet. This is true for JCPenney throughout their portfolio of larger stores. All of our larger stores have gotten the JCPenney store with in-store program. Our smaller stores again, similar to the rest of the JCPenney program, don't get the physical store but are getting the new merchandise that have been rolled out.

Daniel Busch - Green Street Advisors, Inc., Research Division

Okay, and then obviously JCPenney hasn't announced any type of meaningful store closing program, but do you guys have contingency plans in place, I guess, or have you been actively seeking potential replacements in the malls where you would think that a JCPenney closing would be a possibility?

Andrew P. Silberfein

This is Andy. Obviously, we've taken a close look at our JCPenney exposure. Out of the 26 stores they have with us, 15 of them are Rouse owned. And we take a look at those 15, of those 15 the average is about 70,000 square feet. So our ability to chop it up and recycle that space is very high. In addition, about 87% are single level. So that means they're easily dividable, they're very workable and they don't pay a lot of rent. So we think oftentimes, it's done in a certain way. They created an opportunity for us. And as an example, we had 2 Sears that closed at the end of January in our portfolio as a natural lease expiration. We already signed 1 lease replacement Dunham's sports, a flagship concept, at a substantially higher rent, and we're very close to getting the second lease done, also at multiples with what Sears was paying. So we sometimes offer you substantial upside opportunities and that's something that we don't think -- we know we can deal with it and we have been doing our contingency plans. We have as well, had discussions with JCPenney about possibly buying some of the stores, but at this particular point in time, they haven't shown any interest or inclination to allow that to happen. So we're going to continue to have these discussions with them but by now, we don't see any changes.

Operator

Mr. Silberfein, there are no further questions at this time. I would now like to turn the floor back over to you for closing comments.

Andrew P. Silberfein

Yes. Thank you, everyone, for joining us this morning, and we look forward to sharing our future progress review at the end of the second quarter.

Operator

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.

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