Alexander & Baldwin's (ALEX) CEO Stan Kuriyama on Q2 2014 Results - Earnings Call Transcript

Aug. 7.14 | About: Alexander & (ALEX)

Alexander & Baldwin (NYSE:ALEX)

Q2 2014 Results Earnings Conference Call

August 7, 2014, 5:00 p.m. ET

Executives

Suzy Hollinger - Director of Investor Relations

Stan Kuriyama - Chairman and Chief Executive Officer

Chris Benjamin - President and Chief Operating Officer

George Morvis - Vice President, Corporate Development

Paul Ito - Chief Financial Officer

David Haverly - Senior Vice President of Leasing, A&B Property

Analysts

Ian Zaffino - Oppenheimer

Sheila McGrath - Evercore

Wilkes Graham - Compass Point

Young Ku - Wells Fargo

Steve O’Hara - Sidoti

Operator

Good day, ladies and gentlemen, and welcome to the second quarter 2014 Alexander & Baldwin earnings conference call. [Operator instructions.] I would now like to turn the conference over to your host for today, Ms. Suzy Hollinger, Director of Investor Relations. Please proceed.

Suzy Hollinger

Aloha, and welcome to Alexander & Baldwin's second quarter 2014 earnings call. On the call with me today are Stan Kuriyama, Chairman and CEO; Chris Benjamin, President and COO; George Morvis, Vice President, Corporate Development; and Paul Ito, CFO. Also with us today is David Haverly, A&B Property's Senior Vice President of Leasing, who will participate in the question-and-answer portion of the call.

Before we commence, please note that statements in this call and presentation that are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that involve a number of risks and uncertainties that could cause actual results to differ materially from those contemplated by the relative forward-looking statements.

Factors that could also cause actual results to differ materially from those contemplated in the statements include, without limitation, those described on Pages 19 to 32 of the company's 2013 Form 10-K. These forward-looking statements are not guarantees of future performance, and we do not undertake any obligation to update our forward-looking statements.

Management will be referring to non-GAAP financial measures when discussing results in fourth quarter. In particular, we will be referring to net income opening when discussing leasing segment results and to adjusted EBITDA when discussing Grace Pacific's performance. Included in the appendix of today's presentation slides is a statement regarding our use of these non-GAAP measures and required reconciliation.

Slides from this presentation are available for download at our website, www.alexanderbaldwin.com. Slide 3 provides an agenda for today's presentation, after which we will take your questions.

We'll start with Stan, who will comment on results and review the highlights.

Stan Kuriyama

Thank you, everyone, for joining us this afternoon. As noted in our release, the company earned $0.19 a share in the second quarter. Improved performance from our two real estate segments and the addition of $8 million of operating profit from Grace Pacific drove these results and offset the $8 million year over year decline in agribusiness earnings.

Several Maui parcel sales and three Kahala Avenue lot sales helped our development and sales segment generate operating profit for the second quarter of $8 million. Leasing posted $12 million of operating profit, a 13% compared to the second quarter of 2013, and also generated $20 million of NOI, a 20% increase over last year.

These improvements were due to the expansion of the portfolio through the acquisition of Hawaii retail assets in 2013, as well as improved performance from our mainland office properties.

Turning to recent highlights, we sold 19 units at our Kukui'ula project so far this year. We’re pleased with not only the increase in sales activity, but also at the pricing we’ve been able to achieve. Chris will provide you with more details in a few minutes.

On Maui, we closed five noncore parcel sales in the second quarter, totaling 131 acres at an average price of $34,500 an acre, and we closed one residential lot sale at $1.6 million. In July, we closed the sale of a 6.4 acre bulk parcel at the Wailea resort for $10.6 million, or $38 a square foot.

And just this week, we received final zoning approval for a 600-unit residential project in South Maui. Grace Pacific also performed well in the second quarter, generating $11.4 million of EBITDA. Grace’s backlog was about $250 million at the end of June, 15% higher than last June.

In addition, the city and county of Honolulu recently increased its annual road-paving budget by 10% to $132 million for the 2014/2015 fiscal year. George will be reporting on Grace’s performance later in the call.

And finally, in July we invested $24 million in a 12-megawatt solar facility being developed by the Kauai Island Utility Co-op. This will be the largest solar facility in Hawaii when it’s placed in service this month, and complements our very successful 6-megawatt solar facility that we completed on Kauai in December 2012, which is currently the largest facility in the state. Paul Ito will be describing the tax and book implications of this investment.

Our agribusiness segment posted a small profit for the quarter, but this is not indicative of the segment’s underlying performance. As described later in the call, we are still projecting a full year loss in ag consistent with our prior guidance.

A few words now on the Hawaii economy. Hawaii’s tourism industry continues to performance at a very high level. As you know, 2013 was a record year for the state for both visitor expenditures and arrivals. Through the first six months of 2014, visitor expenditures have increased by 2.5% over 2013, and arrivals are on pace with last year.

Hawaii ranked first in the nation, with an average daily hotel rate of nearly $220 in May, up 4% from last year. RevPAR, or average revenue per available room, was up 5% to nearly $160 in May, while the hotel occupancy rate was 73%. Each of these figures is also among the highest in the nation.

This strength is driving improvement over the broader Hawaii economy. Unemployment at the end of June was 4.4%, compared to 4.7% last June, which is notable given that Hawaii’s labor force was 2% larger in June 2014 that last June.

Bankruptcy filings for the first half of this year were down 21% compared to the same period last year. Foreclosures were down 53% in June 2014, compared to last June. And debit and credit card same-store sales activity increased 5% in the second quarter, over the second quarter of 2013.

Construction continues on its upward trend. The value of statewide construction permits rose 17% for the first half of 2014, compared to last year. And Hawaii’s contracting tax base and construction jobs are expected to see gains of 8% and 6% respectively this year as well.

In June, the median home price on Oahu reached $700,000 for the first time ever, surpassing the previous record of $685,000 set in December 2013. For the first six months of the year, median home prices were $670,000, an increase of 7% over last year, and median prices for Oahu condominiums for the first half were also up 7% to $350,000.

Our Oahu retail and industrial vacancies remain low: a 4.4% vacancy in retail for the six months ended May 31 and 2.4% vacancy in industrial for the first half of this year. And asking rents have increased over those same time periods as well. Office vacancies have remained relatively stable for the first half of 2014 compared to 2013, while asking rents also have increased.

And with that I’d like to now ask Chris to update you on our real estate and agribusiness operations.

Chris Benjamin

Thanks, Stan. Well, following on that good economic report, I’m happy to report an increase in activity within A&B Properties. Perhaps most notable and encouraging is the recent sales activity at Kukui’ula that Stan mentioned.

As you can see from this slide, we’re marketing a wide range of product offerings at Kukui’ula. Through our vertical construction program, we have successfully broadened the range of products and price points, which, in turn, has helped fuel our recent sales momentum.

Of the 19 sales Stan referenced, we’ve closed eight units at Kukui’ula so far this year, a club bungalow and two club cottages at average prices of $2.7 million, four custom home lots at an average price of $1.8 million, or $73/square foot, and a spec home designed by well-known Bay Area architect Shay Zak, which was sold in June for $7.2 million, the highest price recorded to date at Kukui’ula.

In addition to these eight closings, we have 11 additional binding contracts in escrow, including a $6.1 million spec home, a $2.8 million cottage unit that is scheduled to close today, and another cottage scheduled to close later in the year. The remaining eight contracts are for homes that will be built and closed next year, including all six Club Villas units that have been released for sale and which were sold at an average price of $4.5 million.

As you can tell, the home building initiative has been instrumental in catalyzing sales activity, and we continue to work with several home builders to expand our product offerings and available inventory. The villas are now under construction, and we’ll be starting five bungalows within the next few weeks.

The pace of sales will depend on how quickly new product is released for sale, and so we could have some moderation in sales volume during the second half. But the excitement and high level of sales interest are very encouraging.

Moving to Oahu, we have another very positive story in our urban condo development efforts. Construction of our 340-unit Waihonua high-rise condo project is on budget and on schedule for completion later this year, with closings in January 2015.

As you can see on slide 15, construction of the structure is complete, and work is now progressing on the interior amenities and landscaping. As a reminder, this project was completely sold out in August 2013 at an average price of $727 per square foot.

Just down the street, at The Collection, which includes high-rise, mid-rise, and townhouse units, sales of the 397-unit high rise are going well, with over 65% of the tower units sold under binding contracts at an average price of $765 per square foot. The average size of the tower unit is about 900 square feet.

We’re on schedule to release 54 mid-rise loft units for sale later this month. Prices for these units will start in the mid $300,000 range, and the average unit size is 510 square feet. With a goal and expectation of breaking ground by year-end, we’ve lined up our capital partners and have made good progress on securing our construction loan for The Collection. We continue work on drawings and firming up our construction bids. This is an exciting project for us, and we’re quite pleased with the progress we’re making.

At our Kahala Avenue portfolio on Oahu, three lots closed in the second quarter, including a 25,000 square foot ocean front lot for $354 per square foot, bringing the total lots sold to date to 12 and total gross revenue to $58 million. We continue to see good interest in the lots, but the pace of sales may moderate as we target higher price points for the remaining homes and lots.

We also have some very positive news on Maui, where, as Stan mentioned earlier, we were pleased to receive final zoning approval for our Kihei residential project, a 600-unit primary residential subdivision situated on 95 acres in south Maui.

The project is planned to include a mix of single family and multifamily homes, targeted to provide affordable and primary housing to local residents. We’re moving into the infrastructure design and engineering phase, and currently expect the first homes to be delivered in 2018, although bulk parcel sales could occur earlier. We’ll provide additional information for the project as the design and engineering work progress.

Also on Maui, we were pleased to close, in July, the sale of a 6.4-acre hotel zoned parcel in the Wailea resort for $10.6 million, which is pictured on this slide, and we continue to advance the approvals for our 70-unit condominium project on a nearby parcel.

At Maui Business Park, market interest is picking up, and we expect continued activity over the next few quarters, though timing and magnitude of sales are difficult to predict.

Turning now to our commercial portfolio, on slide 22, our portfolio produced $19.6 million of NOI in the second quarter, an impressive 20% increase over the second quarter of last year. Because much of this increase was due to the expansion of the portfolio in the second half of 2013, we expect the rate of quarterly growth to moderate over the balance of the year. We currently are projecting full year NOI growth for 2014 of 12% to 14%.

Over 75% of total portfolio NOI for the quarter came from Hawaii assets, up from 45% in last year’s second quarter, reflecting the significant progress we’ve made in migrating the portfolio to Hawaii. We believe this migration has resulted in a substantial overall improvement in the quality of our portfolio.

Our Kailua Town investment, for example, the largest of our 2013 commercial acquisitions, is performing well, and we’re achieving targeted renewal increases.

Turning to slide 24, agribusiness earned $400,000 in the second quarter, bringing operating profit for the first half of 2014 to $3.5 million. These results, however, are not indicative of either the full year financial outlook or the underlying operating performance of the business.

Extremely wet weather conditions through May had an adverse effect on production, which, through June, is down 35% compared to the first half of last year. The lower production reduced the amount of loss recorded in the quarter, but as we produce and sell more raw sugar over the balance of 2014, recognized losses will increase.

There’s still a lot of moving parts in our financial outlook for agribusiness for the year. Our previous projections of operating loss of $6 million to $9 million for 2014 were based on sugar prices and production estimates at the beginning of the year.

Domestic sugar prices have increased since then, and the company has forward priced approximately 80% of the 2014 crop at prices that are higher than those contemplated in previous guidance. However, extremely wet weather conditions through May led to a significant reduction in sugar production year to date, and expectations for full year sugar production have therefore been reduced.

It’s extremely difficult to predict full year results accurately at this stage of the harvest, but the combination of higher prices and ongoing efforts to contain operating costs are expected to largely offset the negative impact of lower full year production. As a result, there are no changes to the previous agribusiness loss guidance for the full year.

With that, let me now turn it over to George to discuss Grace and our new solar investment.

George Morvis

Thanks, Chris, and good afternoon everyone. With improved weather conditions and fewer subcontractor delays than in the first quarter of 2014, Grace Pacific produced $11.4 million in EBITDA, or earnings before interest, taxes, depreciation, and amortization for the second quarter.

Grace’s future remains positive, with our consolidated backlog at the end of June standing at nearly $250 million, 14% higher than at year-end 2013 and 15% higher than at June 30, 2013. Most of the city and county of Honolulu’s $120 million paving budget for its 2014 fiscal year, and all of its recently approved $132 million paving budget for its 2015 fiscal year remain to be bid out, and therefore are not included in these backlog figures.

The challenge for Grace in maintaining its second quarter performance level over the balance of 2014 will be the pace at which contracts and pending bids are being awarded by the various sponsoring government agencies.

Turning to slide 28, which details our latest solar investment, on July 3, we invested nearly $24 million in Kauai Island Utility Cooperative’s 12-megawatt solar photovoltaic generation facility in Koloa, Kauai. The investment is expected to provide attractive risk-adjusted cash returns, principally through the utilization of available solar tax credits as Paul will discuss later.

As you can see from this photo, construction is nearly complete, and the facility is expected to be fully operational shortly. Once in service, the facility will generate sufficient clean energy to meet about 5% of Kauai’s annual electric consumption needs.

This investment reinforces Alexander & Baldwin’s century-long commit to generating clean, renewable energy for our island communities. We continue to actively seek out opportunities for additional renewable energy investments in Hawaii.

With that, I’ll turn it over to Paul Ito to talk about financial matters.

Paul Ito

Thanks, George. Stan covered earnings and the primary drivers earlier, so let me start with our balance sheet on slide 29, where we compare our balance sheet at the end of June to the balance sheet at the end of 2013.

Debt decreased from year-end due to a January repayment of a $50 million bridge loan for the Kailua portfolio acquisition but was partially offset by investments in working capital, principally related to the production of sugar in aggregate as well as continued investment in our real estate development projects. As of June 30, 2014, our debt to debt plus equity ratio was 36%, an 82 percentage point decline from the end of 2013.

Turning to the next slide, through June 2014 our growth capital investments totaled $37 million, most of which was for growth capital for active real estate projects, joint ventures, and Grace. The remainder was for maintenance capital. Although it’s difficult to predict the size and timing of the placement of additional capital, we’re continuing with our evaluated of various investment opportunities.

State and federal tax benefits associated with the $24 million solar farm investment George mentioned are expected to reduce our cash taxes by more than $27 million, of which nearly $15 million will be realized in 2014. In addition to cash tax benefits, the investment will generate roughly $1.25 million in annual pretax cash flow to A&B over an anticipated six-year investment horizon.

We are still in the process of finalizing the book accounting, but currently expect the tax benefits to lower our full year 2014 effective tax rate to between 20% to 25%. However, we also expect that these tax benefits will be largely offset by noncash reductions to our investment basis. In 2014, these above the line noncash writedowns are projected to be in the range of $9 million to $10 million.

Let me now turn the call over to Stan for closing remarks.

Stan Kuriyama

Thank you, Paul. Since separating from Matson two years ago, we’ve focused on positioning the company to capitalize on growth in Hawaii’s economy, and we’re seeing the benefits of this strategy. Both the Hawaii economy and the company are performing well, and there remains room for continued growth on both fronts.

We’re particularly pleased by the significant increase in sales activity at Kukui’ula and condo sales on Oahu remain strong. We’re also beginning to see a pickup in sales activity on Maui and hope to have more to report over the balance of the year.

We continue to expand our development pipeline by investing in both near and long term development projects and the 95 acres that were rezoned earlier this week on Maui will be an important addition to the pipeline.

Our commercial portfolio continues to perform well, and the integration of our 2013 acquisitions is proceeding smoothly. With more normal weather patterns and fewer subcontractor delays, Grace Pacific’s EBITDA improved in the second quarter, and although our long term outlook for Grace remains very positive, the pace at which bids are being awarded is a near term challenge.

In agribusiness, the recent increase in sugar prices is being offset by weather-related impacts on production and our prior guidance of a $6 million to $9 million operating loss for this segment remains unchanged.

Our $24 million investment in the new solar farm on Kauai is a solid financial investment for the company, just as our investment in the Port Allen solar farm was in 2012. But equally important, it’s a financial and environmental win for the community, with lower electricity costs for Kauai’s residents being generated from clean, renewable energy.

Finally, a word on the two hurricanes that are headed to Hawaii, as I’m sure all of you have heard about. Although all of our operating units are fully prepared for the worst, it appears right now that except possibly for the Big Island, the rest of the state will be impacted mostly by heavy rains and strong winds. Of course, these forecasts can change quickly, but right now any impact to our operations is expected to be limited.

And that concludes our presentation this afternoon, and we’d now be happy to answer your questions.

Question-and-Answer Session

Operator

[Operator instructions.] And our first question comes from the line of Ian Zaffino from Oppenheimer.

Ian Zaffino - Oppenheimer

Stan, when you mentioned the pace of awards at Grace actually slowing, is that just a result of budgets? Funding? Does it have anything to do with the backlog that’s been created by weather, and not needing to do any awards, since there’s so much backlog to work off? Can you give us a little more color on that, please?

Stan Kuriyama

Sure. What we’re referring to there is basically the government staff’s ability to issue these contracts and bids. As you know, we have a large backlog and the budgets, particularly for the city and county of Honolulu, which has the largest paving budget, those budgets have been approved and are in place.

So we have $120 million approved for fiscal year 2014, an increase of 10% to $132 million in 2015. So the money’s there, it’s been budgeted, it’s just now a matter of the staff being able to issue awards and bids as quickly as we would like.

Operator

Our next question comes from the line of Sheila McGrath from Evercore.

Sheila McGrath - Evercore

Question on Kukui’ula. Nineteen units have closed or are under binding contracts. I was wondering if you could talk about maybe the factors driving the improvement. Are there new marketing initiatives? The profile of the buyer? And are you and your partners now accelerating the vertical development?

Chris Benjamin

The factors driving it, I think, to a large extent, it clearly is the fact that we’ve been offering more built product, at various price points. So we have product now ranging from, as we indicated earlier, roughly the $7 million to $8 million range down to built product that we’re offering at the low $1.5 million for a one-bedroom bungalow. So that just opens us up to providing solutions for a wider range of buyers.

I would say the other intangible is just that this is creating momentum that then begins to build on itself. We have sold more custom lots this year than certainly we expected to, and I think it’s a result of just the overall momentum. So people are not exclusively looking for built product. It’s helping accelerate lot sales as well.

The buyer profile hasn’t really changed. They’re obviously high net worth individuals and mostly West Coast of the U.S. and Canada. But we’ve had some from as far east as the East Coast, New York State, Massachusetts, and some local buyers. But you know, the primary profile continues to be 40-, 50-, 60-something high net worth individuals from the West Coast. A pretty wide range.

Sheila McGrath - Evercore

And then are you accelerating the number of units that you’re going vertical on?

Chris Benjamin

The answer is yes, but the other part of the answer is we are increasingly looking for third parties to come in and do that, because as you’ll recall, our model never was to be a large-scale vertical developer at Kukui’ula.

So while we are, ourselves, looking at potentially some limited additional spec home development that we might do, and we are in the process of planning some additional potentially multifamily condo product within the project, and we’re catalyzing some of that, we are also working with third-party builders who are coming in and hopefully taking down land and developing either individual homes or neighborhoods on their own.

So that’s ultimately where we want to be. We want to be transitioning more to both other people’s money and third-party developers for this work. But we’re very pleased with what we’ve done so far in catalyzing some of this with our own balance sheet and the results are quite favorable.

Sheila McGrath - Evercore

Real quick, on the Wailea land sale, the 6.4 acres, just your thought process there on just selling the land rather than developing it, with the pricing so strong?

Chris Benjamin

First of all, we have a good inventory of land at Wailea. We have a number of development parcels there. And we expect to build some of them out ourselves, some of them in JVs, and we expect probably to monetize some of them.

And the decision on any individual parcel really comes down to what do we believe the residual land value is on a development deal versus what we can get by selling the parcel and letting someone else develop it. And in this case, that balance just directed us towards monetizing the parcel rather than developing it ourselves.

Sheila McGrath - Evercore

And then if I could just ask on the modeling of the solar asset, it’s a little bit confusing. It is going to impact 2014 based on a more favorable tax rate, but something’s offsetting that that we shouldn’t factor that full benefit into our estimates? If you could just clarify that?

Paul Ito

Yes, so, effectively, as you stated, there will be a favorable impact from the recognition of the tax credits in the income tax line, and that will reduce our full year effective tax rate. But at the same time, since the investment is primarily a tax-driven investment, because we received that value, we also have to reduce our investment basis in that asset as we take the credit. So there will be an above-the-line reduction in that investment basis as the tax credits are realized.

Stan Kuriyama

The point of distinction there, though, is the tax benefit is a cash benefit to the company, whereas the writeoff of the investment is a noncash writeoff.

Sheila McGrath - Evercore

That’s a good point. And then in addition to the tax and the offset, you will be receiving about a million and a quarter in pretax cash flow, separately? Is that correct?

Paul Ito

Correct.

Operator

And our next question comes from the line of Wilkes Graham from Compass Point.

Wilkes Graham - Compass Point

Just a couple of questions, maybe to follow up on Sheila’s question on Kukui’ula. Chris, when you were talking about maybe partnering up with home builders to build vertically, are you talking about a JV where they build the home before you sell the land to the resident, or is it a more traditional model, where you’re contemplating selling land to home builders?

Chris Benjamin

We’ve done it already within the project. We’ve done it both ways. One, where we have actually sold the land to the developer, who then develops the home, and we essentially get that revenue up front. And there may or may not be some profit participation on the back end. Typically, there will be.

And then another scenario, where we’ve gotten 25% of the lot value up front, but then 75% of the lot value comes when the developer sells it to the homebuyer. So there are probably going to be as many structures as there are projects within the development, but we’re flexible and can do it any number of ways.

I think that as time goes on, we’ll probably migrate more toward up front full cash land sales, but as we’ve been trying to catalyze some development, we’ve had to provide some incentives in terms of helping with cash flow for the developer as they built up the homes. But I think as we get more momentum, we may do less of that.

Wilkes Graham - Compass Point

As I try to understand how the environment is out there for land, I’m curious if you’ve seen, over the past quarter, or two quarters, or even a year, a pickup in interest from the mainland or from Asia or what have you, for entitled but undeveloped land, or unentitled land? You’ve got an anecdotal sale at Wailea, but are you seeing any pickup in interest in third parties acquiring your land before you develop it?

Chris Benjamin

Let me start with a broader answer about outside interest in Hawaii real estate, and I’m going to focus a little bit more on the commercial real estate side, and then I’ll get into the development side. I definitely think that there is a lot of money out there, and it’s chasing deals all over the country, and Hawaii is no exception. So I do think that on the commercial real estate side, and we’ve certainly seen that in cap rates over the last couple of years, there’s a lot of interest.

I would say that is, in a general way, translating into development activity, but I don’t know, Stan, feel free to jump in here. I can’t really say that there’s been a significant increase necessarily in the raw land or the entitled but undeveloped land segment.

Stan Kuriyama

I think I would agree with that, Chris. I think you see a lot of Asian interest in built product, whether it be existing commercial property or to be built condominium project, apartments for example. But the Asians aren’t particularly interested, and never really have been particularly interested in, buying vacant land for development. I think you see some increased mainland interest in those types of properties, but they’ve really never been that significant in Hawaii as well.

But you know, as Chris mentioned, with Kukui’ula, we have been successful in attracting some of the mainland home builders to a project, and I think that’s something we can expect to see more of over the coming years.

Wilkes Graham - Compass Point

If you feel comfortable, can you point us to the next land parcel that we should be paying attention to in terms of looking for entitlement progress, similar to what we just saw in Kihei?

Chris Benjamin

Yeah, first of all, Kihei, we still have more entitlements in terms of subdivision approval and that sort of thing. So we will be continuing to advance the Kihei property over the next 18 months or so. We continue to work on advancing our Wai’ale project on Maui. That’s a little bit longer term, in terms of when we would be delivering product there, because we still need final county zoning approval. But that’s one that we continue to work on.

And then the rest of our what I would call entitlement efforts are really probably around getting water, getting subdivision, sort of the later stages of the entitlement process on some of our other Maui parcels, like Hali’imaile and some of our Wailea parcels. Those are pretty much our areas of focus right now.

Wilkes Graham - Compass Point

And then maybe for George, just last question, back on Grace. As I think about modeling out Grace, Stan, I think you said the majority of the $120 million of contracts this year have not been bid out. And obviously, probably none of the $132 million for next year have been bid out. Even just looking at this year, will they be bid out this year? And if so, do we think about that $120 million, whatever percentage you win, that your spend on that occurs next year?

George Morvis

Well, my gut is that, even from a calendar, and I’m going to mix fiscal and calendar year here, because we’re on a calendar year, from a calendar year perspective, at this point in the year, even if some of the work got bid and awarded this year, Grace’s actual paving work would not likely commence until next year, just because there is roughly a 60- to 90-day lapse between calendar award and the start of paving, during which some other things are done, such as issuing the notice to proceed, and there’s some arborist work and some other concrete work that needs to be done before you could actually go in and do the paving work.

And so just from a pure operational perspective, it would be tough to get that work commenced this year. So really, we’re looking towards those two buckets right now to hopefully be put out to bid and bids awarded, and start building the backlog for next year, above and beyond the backlog that we have right now, which I would reiterate that we’re very pleased with.

Wilkes Graham - Compass Point

And then just to follow up on the backlog, the $250 million backlog, if that was just a melting ice cube and there were no more contracts to be bid out, how long would it take you to work through the $250 million?

George Morvis

Well, that’s sort of challenging to comment on, just because in a lot of those cases, it’s work that’s in the backlog but scheduled for between six and 18 to 24 months out. So a lot of these projects, the paving is actually a subcontracted job to a larger highway project or whatnot, and we’re not in full control of when that hits.

I would say, you know, if we could just ballpark it, I’d say that we would expect roughly half of that backlog to hit within 12 months and maybe half to two-thirds, and then the remaining balance to hit within the 12 to 24 month period. Although, as with anything else, with individual projects it can get moved up or pushed back on a project by project basis.

Operator

Our next question comes from the line of Young Ku from Wells Fargo.

Young Ku - Wells Fargo

Just staying with Grace for a little bit, it seems like the EBITDA margin for this quarter was meaningfully better than prior quarters. So I was wondering, do these fluctuate a lot? And what kind of margins should we assume going forward?

George Morvis

In terms of the fluctuation, a lot of it is because Grace is very much a throughput driven business. And so margins increase at higher volumes and higher volumes are associated with higher revenue levels and whatnot. So I would think that, you know, certainly we would be comfortable with looking at margins over a six-month period as being representative of what we would expect for a full year, understanding that if we have a slow quarter, they’re going to go down. If we have a good quarter, they’re going to be more like the ones in the second quarter. But I think if you look at the six months level so far, I think that’s a very comfortable level for us.

Young Ku - Wells Fargo

And then just going back to the tax impact, from what I gathered, there’s going to be a cash tax [unintelligible], but from a GAAP accounting perspective, it’s not going to have meaningful impact?

Paul Ito

No, from a cash tax perspective, it’s $15 million in 2014, from a book tax impact, there is a benefit to our income taxes, and that’s where our effective rate is reduced on a full year basis for all income to a 20% to 25% effective tax rate. So there will be a benefit for book purposes, but then it is somewhat offset by this writedown of the investment basis above the line.

Young Ku - Wells Fargo

So the net impact of the benefit and the reduction investment basis, could you tell us what kind of book impact that’s going to have?

Paul Ito

Right now, we are, as I mentioned, finalizing. And I’d rather not give you a specific number. If you model the effective tax rate at 20% to 25%, and then of course just assume we’ll have a reduction of our investment basis, that’s probably the best guidance I can give you at this point.

Young Ku - Wells Fargo

And Chris, I just want to see if you can comment on whether there has been any cap rate compressions in Hawaii that you saw over the past quarter or so?

Chris Benjamin

I don’t have any evidence of cap rate compression over the last quarter or so. I think that we’ve certainly been seeing transactions over the last 18 months in the five to mid-five range. Let me ask David to jump in here if he’s got something more.

David Haverly

I think you just see some strong activity and if you look at some of the examples of the Royal Hawaiian sale, you’ll see class A premier properties are definitely seeing lower cap rates. But overall in the market, I would agree with Chris. You’re probably seeing things being five or five and a half cap rate.

Young Ku - Wells Fargo

And your mainland portfolio, you guys obviously sold a lot of it off already, but I was wondering if you have begun to market the remainder of the portfolio, and when you expect to sell out of those?

Stan Kuriyama

Well, any sales on the mainland, as we’ve said before, are really going to be for the sole purpose of funding Hawaii acquisitions. So while we do expect, over time, to transition the portfolio back, it’s going to be driven by finding the right investment opportunities in Hawaii.

And although we look at a wide range of commercial properties at any point in time in Hawaii, we’ve not identified an acquisition opportunity in Hawaii right now. So we are not expecting to be selling any commercial properties on the mainland until and unless that happens.

Operator

Our next question comes from the line of Steve O’Hara from Sidoti.

Steve O’Hara - Sidoti

I was just curious, just going back to Grace again, in terms of the awards that are out there, if you keep your historical market share in that business, do you have the capital base to keep up with that? Is that something that you have to expand the business at all? Or are you comfortable with the platform you have?

George Morvis

I’d say by and large, we’re comfortable with the platform we have. We are coming off a substantial investment cycle on the [unintelligible] side, and so to the extent that we needed to add to that capital base, it would probably be selected pieces of rolling stock.

And you know, a lot of that comes down to how many spares do you want to keep on hand in case of breakdowns and stuff like that. But I think we’re comfortable that, given what we see coming, that we could handle a vast majority of that work that we believe we would get without a substantial increase in capital.

Steve O’Hara - Sidoti

And then in terms of the sales at Kukui’ula, how did that impact the quarter’s operating profit? You know, whatever closed in the quarter, is all of that factored into the operating profit? Or does that get prorated over the next number of quarters going forward?

Chris Benjamin

Well, yes and yes, and a little bit of everything. There certainly was some impact on the quarter, and I’m going to try not to dive into too much detail here, but first, we always have to remember that we have percentage of completion on any of these sales. The margin on these sales is based on our expected long term margin on the whole project, and that gets us, at the venture level, to an expected margin on the individual sale, which we then take a percentage of.

And by the time you do the math, it ends up being, because of percentage of completion, the gain on any individual sale ends up being relatively modest in the current period, and then we will get additional chunks of that as we go along in future quarters and years. So it will trickle in over time.

At the same time, we have some period costs that largely offset the sales driven earnings. So when you add it all up, over the last couple of years, and again, this year, the numbers are relatively modest by the time you offset the sales expenses and marketing expenses and operating expenses against the revenue. You don’t have a significant driver one way or the other. So we don’t expect Kukui’ula to be a significant driver of profitability for the year.

There’s the book impact that I just talked about, then there’s the cash impact, and the good news is that the cash impact we have not had to put any significant amount of money into the project this year or last year, and so we’re at a pace right now where we hope that that will continue and we won’t have to put any more cash in. And then over time, earnings will increase as we get a higher percentage of completion.

So I said I wasn’t going to get into too much detail, and I probably just lost all our callers.

Steve O’Hara - Sidoti

So it’s fair to say, in terms of maybe the economic impact, you’re maybe underreporting based on percentage of completion, in terms of the profitability? Is that kind of what you’re saying? And then maybe you’ll be over reporting as time goes on, just the way the accounting works?

Chris Benjamin

I think if you’re talking about the recognition for GAAP purposes of the earnings relative to when the event that drove them took place, I think that’s a fair summary.

Steve O’Hara - Sidoti

And then I don’t know if you mentioned this, but the NOI on a same-store basis, what was the kind of maybe natural improvement in the second quarter and maybe was it, again, in the first quarter?

David Haverly

NOI growth really has been a combination of two things. It’s a little bit of Hawaii’s natural growth, and then a larger percentage is the mainland office portfolio, [unintelligible] the pretty substantial growth over 2013. Total same-store growth basis, I think we’re reporting 12.7% same-store growth.

Steve O’Hara - Sidoti

And then I guess the other question I had, there was a story in the Star Advertiser, I think about kind of a local merchant in Kailua. And I’m just wondering, it seemed like he wasn’t going to be renewed. I was just wondering what the feeling is, how you manage that maybe turnover of that portfolio, if you’re comfortable talking about that at all.

Chris Benjamin

Well, first of all, as I think we’ve talked about, we are working through a number of lease renewals, and we’re very actively evaluating each of our shopping centers, our tenants, and engaging in discussions with the tenants as their leases come up for renewal. Our goal is to improve the overall tenant mix, customer experience in Kailua while also bringing tenants up to market rents, as we’ve indicated a desire to do so.

Overall, I would say that that has gone well. We have actually renewed about 10 of our local tenants. We’ve had one, unfortunately that’s the one that made the paper, and admittedly, that process could have been managed better at that individual tenant level, but I feel very good about both the thoughtful approach we’re taking to the tenant mix, and how we’re approaching it, and in general, how our renewal discussions are going with our tenants, although, again, I acknowledge that in that one case, there were probably some process breakdowns.

But overall, we’re pleased with the way it’s going, with the rents we’re getting, and with our ability to maintain the good, solid tenant mix, which includes a lot of local tenants, and has a real nice, local flavor in the community.

Operator

ladies and gentlemen, this will conclude question and answer portion of today’s call. And I would now like to turn the call back over to Suzy Hollinger for closing remarks.

Suzy Hollinger

Thanks, everybody for being on the call today. If you have any follow up questions, please call me at 808-525-8422. Aloha.

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