Macerich's (MAC) CEO Arthur Coppola on Q2 2016 Results - Earnings Call Transcript

| About: Macerich Co. (MAC)

Macerich Co. (NYSE:MAC)

Q2 2016 Earnings Conference Call

August 1, 2016 02:00 PM ET

Executives

Jean Wood – Vice President, Investor Relations

Thomas O'Hern – Senior Executive Vice President, Chief Financial Officer and Treasurer

Robert Perlmutter – Chief Operating Officer & Senior Executive VP

Arthur Coppola – Chairman & Chief Executive Officer

Analysts

Christy McElroy – Citigroup Global Markets, Inc.

Alexander Goldfarb – Sandler O'Neill & Partners

Rich Moore – RBC Capital Markets

Richard Hill – Morgan Stanley & Co.

Craig Schmidt – Bank of America Merrill Lynch

Michael Mueller – JPMorgan Securities

Todd Thomas – KeyBanc Capital Markets, Inc.

Omotayo Okusanya – Jefferies

Vincent Chao – Deutsche Bank Securities, Inc.

Caitlin Burrows – Goldman Sachs & Co.

Paul Morgan – Canaccord Genuity, Inc.

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Macerich Company's Second Quarter 2016 Earnings Conference Call. Today's conference is being recorded. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue up for questions.

I would like to remind everyone that this conference is being recorded, and would now like to turn the conference over to Jean Wood, Vice President of Investor Relations. Please go ahead.

Jean Wood

Good afternoon. Thank you, everyone, for joining us today on our second quarter 2016 earnings call. During the course of this call, management may make certain statements that may be deemed forward-looking within the meaning of the safe harbor of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially due to a variety of risk, uncertainties and other factors. We refer you to today's press release and our SEC filings for a detailed discussion of forward-looking statements.

Reconciliations of non-GAAP financial measures to the most directly comparable GAAP measures are included in the earnings release and supplement filed on Form 8-K with the SEC, which are posted in the Investors section of the company's website at www.macerich.com.

Joining us today are Art Coppola, CEO and Chairman; Tom O'Hern, Senior Executive Vice President and Chief Financial Officer; and Robert Perlmutter, Senior Executive Vice President and Chief Operating Officer.

With that, I would like to turn the call over to Tom.

Thomas O'Hern

Thank you, Jean. Consistent with past practice, we will be limiting this call to one hour. If we run out of time and you still have questions, please do not hesitate to give me a call or John Perry or Jean Wood as well.

Second quarter reflected continued strong operating results as evidenced by strength in most of our portfolio's key operating metrics. In addition, we completed our previously announced $1.2 billion share repurchase program and also completed some significant financing transactions. We'll talk about all those in greater detail later in the call.

For the quarter, FFO was $1.02 compared to $0.97 for the second quarter of last year. Same center NOI increased by 6.5% compared to the second quarter of last year. This was positively impacted by about $6 million of lease termination revenue in the second quarter of 2016. This timing is somewhat accelerated compared to our guidance, which had most of the 2016 estimated lease termination revenues forecast in the third quarter and fourth quarter. Our estimate for same center NOI growth for the full year remains in the 4.5% to 5% range.

The gross operating margin at the center improved at 70.3% in the quarter, up from 69.8% in the second quarter of last year. Bad debt expense was relatively modest, $1.7 million for the quarter, down from $2 million a year ago. As I mentioned, lease termination revenues at about $6 million for the quarter, that compared to $2.8 million last year. Year-to-date lease term fees are $9.4 million compared to $5.4 million for the first six months of last year.

And our full-year assumption for lease term revenue this year changed at $15 million. And when we make the decision and negotiate a lease termination agreement, it's typically a trade-off for making the business decision to take the cash now and incur the higher vacancy loss at future minimum rent and charges until the space is released.

During second quarter, the average interest rate was 3.52%, up slightly from a year ago, which was 3.47%. The balance sheet continues to be in great shape. At quarter-end, our balance sheet metrics included debt to market cap that's about 36%; and interest coverage ratio, a very strong 3.6 times; a forward debt to EBITDA of 7.2 times; and average debt maturity of 6.4 years.

The financing market for high quality regional malls remains very good. We have closed or committed on two life company deals and we're currently in the market with a large CMBS deal. On May 27, we closed a $375 million financing on North Bridge Mall that fared – there was a 12-year fixed rate loan at 3.68%, and we used a portion of those proceeds to pay off the old loan, which was $188 million with an interest rate of 7.20%.

And that was a life company transaction, another life company deal, which we'll be closing here in the next week or so. It is at The Village at Corte Madera. We're putting a $225 million fixed rate loan in place, and that's a 12-year deal, fixed at 3.50%. Again some nice financing at historically low levels in terms of the interest rates.

On July 5, we closed on an extension of our $1.5 billion line of credit – our line of credit was set to mature in April of 2018 and including our extension options on the new facility goes out to July of 2021 and reduces our borrowing rate to about LIBOR plus 1.33%, about a 17 basis point improvement from our old facility. At quarter end, the balance on that facility was about $1 billion; however, we got some significant financings that will take place in the third quarter and fourth quarter.

We should generate 350 million of excess proceeds from Fresno, which is currently unencumbered. We're in the market with that right now. It's going to be a CMBS transaction. Term was expected to be ten years. We're getting bids now. We're getting some very, very strong quotes. We'd expect that to close in September. In addition, we'll have about $75 million of excess proceeds from the closing of Corte Madera. And in addition, later this year Eastland, is an unencumbered asset that we will probably finance and that could be as much as $175 million. So, with that, it would comfortably put our line of credit outstanding balance at $500 million or less.

We concluded our third $400 million accelerated stock repurchase program on July 11. This was part of the board authorized $1.2 billion share repurchase program that was announced in October. With these three separate investment banks to execute these ASR programs, the summary results where we invested the entire $1.2 billion, the average share price on all three combined was $78.62 and the total number of shares repurchased was 15.3 million shares, roughly 9.6% of our shares outstanding.

Just on the guidance, again, we reaffirm guidance today of $4.05 to $4.15 for the full year. And just to reiterate, the remaining three quarters, we estimate of that FFO for the full year 25% or so will be in the third quarter and 29% of that total in the fourth quarter.

And with that, I'll now turn over to Bob to discuss leasing and tenant environment.

Robert Perlmutter

Thanks, Tom. Recent activity during the second quarter remained strong, reflecting demand from the retailers for the Macerich portfolio. First, let me talk about leasing spreads. Trailing 12 months leasing spreads increased to 16.1% from 15.4% during the previous quarter. Regionally, East Coast and West Coast properties have produced the highest leasing spreads. Average rent for leases signed during the trailing 12-month period was $57.31 per square foot. During the second quarter, a total of 848,000 square feet of leases were signed, up from 733,000 square feet in the previous quarter. The average term signed in the second quarter increased to 6.0 years.

Occupancy. Leasing levels at the end of the second quarter were 95.0%. This represents a 50 basis point year-over-year decline and a 10 basis point decline on a quarter-over-quarter basis. As we discussed in the last earnings call, the decline in year-over-year occupancy was primarily caused by the movement of Fashion Outlets in Niagara and South Park out of the development portfolio into the stabilized pool. The occupancy also reflects the disposition of Capitola Mall and the acquisition of Country Club Plaza. Temporary occupancy improved at the end of the second quarter, dropping 30 basis points from the previous quarter to 5.2%.

Sales. Portfolio sales were $626 per square foot compared to $623 per square foot on a year-over-year basis. Same center sales per square foot were $644 compared to $629 for the year earlier period. This is a 2.4% increase. Sales were strongest in the West Coast centers, and the categories that showed the strongest sales during the second quarter were beauty and cosmetics, athletic footwear, and leisure and jewelry.

I want to take a minute, and talk about tenant demand. Within our portfolio, tenant interest remains strongest in the higher productivity centers, the higher growth markets, and the coastal locations. This demand allows us to replace underproductive or struggling stores with those retailers looking to expand. Demand is strongest among, one, core brands renewing and expanding existing locations; two, brand extensions from successful retailers; three, foreign-based retailers; and four, online retailers migrating to in-line stores.

Within the last category of online retailers, we see many companies building the infrastructure to open brick-and-mortar locations in a traditional store rollout program. Some examples of this includes Blue Nile, Amazon, Peloton, Warby Parker, and Bonobos. We are also focusing on bringing online retailers into the centers by reducing the physical and economic barriers to entry. Examples of this strategy includes stores such as Combatant Gentlemen, Blink, Beta and WithMe. It is clear, the universe of online retailers will expand in our shopping centers. Some will take a traditional approach to store rollouts, and others will be nurtured through non-traditional canvassing and deal structures. This represents a growing opportunity within our portfolio.

Development. During the second quarter, we were pleased to announce the redevelopment of an existing Sears store located at Kings Plaza in Brooklyn. This center is one of three important assets owned by Macerich in the New York boroughs, and serves a trade area of approximately 4 million residents. This Macerich's acquisition in 2012, we have worked to improve King's Plaza's merchandise mix, anchor lineup, sales productivity, physical appearance, marketing and property operations.

Our goal has been to elevate King's Plaza to the level that we have achieved at Queens Center. The redevelopment of the Sears building represents a major step in that direction. Sears will be replaced with six to eight large format retailers and restaurants, all oriented around the dramatic four-story atrium.

The redevelopment will be anchored by new Primark and Zara flagship stores. We expect these retailers to generate a three-fold increase in sales and foot traffic compared to the existing Sears box. Equally as important, they will open the door to new specialty stores who have not historically been ready to locate at the center.

From the perspective of Macerich's portfolio, we are able to significantly reduce our rental exposure to Sears, while increasing our footprint with both Zara and Primark as well as improving our position in the New York marketplace. Sears will no longer be a top 10 rent payer within our portfolio.

The Macerich portfolio is well suited for Primark's entry into the East Coast markets. In June, Primark had a successful opening at Danbury Fair, which was followed in July with their opening at Freehold Raceway. Both of these locations repurposed as Sears anchor and initial reports indicated significant increase in foot traffic and sales at these centers. Kings Plaza will represent Primark's third location with Macerich. We believe we have the opportunity to grow the number in the coming months.

And, with that, I'd like to turn it over to Art.

Arthur Coppola

Thanks, Bob, and thanks, Tom. As you can see, we had another very strong quarter from an operating viewpoint. More importantly, from my viewpoint, we also are very pleased to have completed our portfolio management and capital allocation strategy through the completion of our share buyback program. You'll remember that we announced that program literally about nine months ago and unlike certain other folks, we completed the program in very short order. We did exactly what we said we're going to do. We're very happy to have it behind us. We think that it was a great transaction that gave us the capital to invest into the balance of our portfolio that what we feel is a substantial discount to our NAV and we're pleased to have it behind us so that the focus going forward can be on the operating fundamentals of the company as well as our very strong redevelopment and development pipeline.

I want to touch upon a topic that has been – a justifiable topic in terms of questions that a lot of investors and the analytical community has asked themselves and that has to do with rent spreads and whether or not in an environment where you have decelerating sales or sales that are not growing like that used to grow, can you continue to have rent growth in the manner that we've enjoyed and our peers have enjoyed over a long period of time.

Like I said, it's a legitimate question and especially when you look at other property types where it's not usual to have positive rent spreads continue year-in and year-out, but it really comes back down to just the laws of supply and demand. We are in the real estate business and supply and demand is the key to everything.

Looking backwards, past performance cannot be a guarantee of future results, as I say. But over the past 10 years, we've averaged 17.4% positive rent spreads over the past 40 quarters. We've had high watermarks of 28%, low watermarks in 2009 of 7% give or take. But on average, we've averaged 17%. I will tell you that if our rent spreads come in at 13% or they come in at 21%, I don't get excited about that one way or the other, because I know that fundamentally when I think about our mark-to-market that the ability to generate mid-teen type of rent spreads is embedded within our portfolio.

As you look at our property type and you look at regional Class A malls and you think about the universe of the supply of that product, the supply of that product is, let's say, that it's 400 or 500 regional malls. And when we think about that product type in terms of supply, we can look to by analogy High Street retail, which is also a very low supply, high demand sector. And there have been studies that have been done – more studies that have been done in the regional mall Class A sector as it relates to High Street that it is a property type that has shown significant well above average rent growth over very long periods of time.

And that's what we've enjoyed in our portfolio, that's what our peers with Class A malls have enjoyed in their portfolios. History has been our – had supported that view and the fundamentals that we're sitting on support our optimism for this to go forward.

When we think about the demand side of the transaction, in terms of tenant demand for space, a lot of folks tend to focus on the one or two names that have gone bankrupt recently or the one or two names that people are worried about going bankrupt. But they tend not to focus on the 30 or 40 or 50 names of retailers that have got brand extension or are just growing their portfolio or now with the recent events with Brexit, we have tenants that have got global expansion plans that are upping their expansion conversations about their expansion in the U.S., which is creating incremental demand.

You think about other factors that may or may not influence our demand, and people worry at times about department stores. And we've had more than one of our department stores and so the problem with their sales is mall traffic. Mr. Les Wexner had a great quote on this point and I'll probably butcher it, but basically he said the trouble with department stores is not mall traffic, the trouble with mall traffic is the department stores. What he is basically saying is the department stores are not pulling their weight. You take a look at the parking lots of more than one of our department stores and some of our malls, and they're not as busy as the other parking lots. This creates opportunity. We and our other Class A mall peers have had great history of replacing our department stores that have become unproductive over time with better uses.

And we see this as a great opportunity going forward. Anecdotally, we think that the Kings Plaza remerchandising opportunity is going to be dramatic in terms of what that's going to do for mall traffic. People worry when they think about rent spreads, about whether or not e-commerce is going to drain sales away from the malls, and to reduce the demand for space in the mall. In fact, the advent of digital commerce creates new sources of demand for us and that it creates new tenants that are born digitally and then want to migrate to brick-and-mortar locations, and we are seeing this throughout our portfolio.

And finally, the thing that probably creates the most anxiety about mall spreads, rent spreads, is when people see sales flat for a certain period of time. And then that causes them anxiety. And that's legitimate for that anxiety. But what I would point to you is this – that if you have a fundamentally very strong portfolio and you have no new supply being created and you have demand increasing, then you're going to be able to lease that portfolio and you're going to be able to lease it at strong rent.

We took a look a couple of years ago and we dissected sales within our centers. We said if we take the top two-thirds in each tenant category, what are those tenants doing in terms of sales productivity and what are bottom one-third of the tenants in our portfolio doing in terms of sales productivity. Because that's generally the way we think about things. We tend to think about constantly the bottom 20% to 30% of the producers at our malls as being merchandisers that we're going to want to recapture over a period of time and replace with names that are more reflective of the merchants that people want to do business with today.

Here is some numbers. In our top 30 centers, our average sales per square foot are $726 a square foot. That doesn't really tell the story. Within each tenant category, whether it'd be apparel, shoes, jewelry, general, the top two-thirds within each category in these centers did $1,028 a square foot and they comprised about 60% of the GLA in those centers. The bottom one-third of the retailers in each of the respective categories in those centers averaged about $313 a square foot. So it's really a tale of two cities here. You got the great producers and then you got the folks that are lagging. You got two-thirds of your tenants within our top 30 properties are averaging over $1,000 a foot, one-third of our tenants by category are averaging $300 a square foot. So our job is simply to weed out the people that are unproductive and to replace them with the tenants that are more reflective of the top two-thirds.

And when we look at the cost of occupancies within our portfolio, you can't just look at the homogenized number. Our average cost of occupancy in these 30 centers is 13.5%. So you can debate all day about oh, can you push that number. But the reality is that our top two-thirds of the tenants in those top 30 centers, they do over $1,000 a foot and their occupancy cost is under 11%. So when those tenants, when their leases expire, we're sitting on substantial rent growth from the time that they've signed their lease and they can easily afford to pay rent that would generate in from 15% or so rent spreads for us.

And then, when we think about pruning out the bottom part of our portfolio, we're seeking tenants that are going to produce sales that are going to be closer to the top performers. And even if you only got 10% or 11% of sales from tenants that are doing on average $1,000 a foot our top producers in our portfolio, you are going to generate substantial increases. That's why we have the confidence that these rent spreads are sustainable, we have history as our guide and, obviously, it doesn't guarantee future performance, but it is something that we are absolutely comfortable that rent spreads will continue to be a big driver of our same-center NOI growth going forward.

And, with that, we'd like to open it up for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And we will first go to Christy McElroy from Citi.

Christy McElroy

Hi. Good morning to you guys.

Arthur Coppola

Hi, Christy.

Christy McElroy

Hey. So there was a press report recently about an approval you won for an outlet project in Carson, California near the 405, can you provide some color on that and overall sort of your intentions to build outlets in LA?

Arthur Coppola

Well, we think it's a great site. We think it's a great location. It's true that we've entered into an exclusive negotiating agreement with the City of Carson to build a 500,000 give-or-take square foot outlet mall there and we are in the process of finishing up our development agreement on that. Once the development agreement is finished, which we hope to have done in the near future, then we'll go ahead and make a formal announcement about it. But you obviously picked up on either what's in the press or what's happening in local city council rooms and it is true that we do have a plan to build an outlet mall at Carson. There is still some work to be done on the development agreement, but we're very bullish on it and we think it's a great opportunity for us.

Christy McElroy

Thanks. And then just sticking to LA. Wondering if you could provide an update on your plans for redevelopment of Westside Pavilion in the context of the progress that's been made at Century City and the scope of the project at Beverly Center just considering the competitive environment in that market?

Arthur Coppola

Sure. We see it as a great opportunity. It's tremendous piece of real estate and it's part of our core holdings. We have no intention of chasing the same customer that literally The Grove and Century City and Santa Monica Place and Beverly Center and [indiscernible] everybody is chasing the same customer, the high end affluent customer in the West LA market. And we think that there is a different mousetrap that can be created at Westside. We are not in a position to say exactly what that's going to look like, but we've got at least four or five different development alternatives that we're thinking about, each one of which are very interesting.

Christy McElroy

Thank you.

Arthur Coppola

Thank you.

Operator

We'll next go to Alexander Goldfarb from Sandler O'Neill.

Alexander Goldfarb

Hi. Good morning.

Arthur Coppola

Hi, Alex.

Alexander Goldfarb

Hey, how are you, Art? Just two questions. One is, as you guys look at the department stores, you spoke about, one, sort of department store parking lot not being busy and then separately, you spoke about a third of your inline tenants at your top centers that are far less productive than the top performing. So, in your view, to drive – as you look at redevelopment and continue to drive mall productivity, which is more important to you, getting back department store boxes or getting out those or replacing the tenants who're averaging $313 a foot?

Arthur Coppola

They're both equally important. Sometimes you don't necessarily have the ability to recycle an anchor as quickly as you'd like to, so there are things that – generally, small space is going to be more accessible to you than department store space. But look, it's what we do every day, it's what we do for a living, and we got one department that does nothing, but the smaller shop space is facing it another group that does nothing, but the anchor stuff and it's what we do. And they're equally important, they're both really important.

And kind of what's left, which I think is left a little bit unsaid is that as the department stores potentially reduce their numbers in terms of conventional department stores in the United States, then that's not necessarily a bad thing. But it really gives us an opportunity to bring in other traffic generators, whatever those might be, but it also really creates more demand for inline space because as the number of department store locations reduce then that reduces the distribution points that manufacturers and creative folks have to distribute their merchandise. And so they become interested in inline stores as a consequence.

Take a look at an outlet mall, outlet malls that we have at FOC and FON, we've got over 400,000 feet of small shop space in these malls, and they're fully occupied, and that's because the manufacturers are not competing with the department stores as distribution points for them. So, as this goes, if this hand plays out over time, U.S. malls will begin to look more like the malls around the world. You go to Canada, for example, you've got 1.5 department stores, maybe two in most of those big malls in Canada, and the small shop space could be easily 600,000, 700,000, 800,000 square feet. And I think the reason small shop space there is fully occupied and fairly productive is that it's the best distribution point for the manufacturers of the merchandise.

So, look, it's an evolutionary process, but we see that if you have must-have little space, you're always going to have a good idea for it so long as you, obviously, are in touch with the pulse of the market, which we are.

Alexander Goldfarb

Okay. And then, sort of following-up that, Art. Now that you have the Sears box back at Kings Plaza, you have the redevelopment there, bring in six to eight new retailers there, but what about sort of a bigger picture? I mean, the center, it abuts the water so it's got potential on the back side, and it just seems like there is a lot more potential than just redoing the Sears box. So, longer term, what do you think we can expect to see out of this center over the next few years as you further the redevelopment plans presumably?

Arthur Coppola

Well, look, we got a lot of work to be done here. We're on the right path. We like to take things kind of step – sequentially, Alexander, as you know, so we're going to stay with the step-by-step approach. It's not a small task, the task that we have to redemise the 300,000 square foot four-level apartment store, but the opportunity is huge. And we think that the rewards are going to be big. So we're thinking about the densification opportunities, but it's not anywhere close to being in the immediate horizon. The stronger we make the center, the stronger all of those other densification thoughts become.

Alexander Goldfarb

Great. Thanks a lot.

Arthur Coppola

Thank you.

Operator

And we'll now go to Rich Moore from RBC Capital Markets.

Rich Moore

Hello, guys. Good morning.

Arthur Coppola

Good morning, Rich.

A - Thomas O'Hern

Hi, Rich.

Rich Moore

Thank you. I'm curious on the Seritage venture that you guys have. You now have this Sears box, which I don't think is part of Seritage underway. Is there anything going on with the rest of or with the Seritage joint venture with regard to Sears budget?

Arthur Coppola

Nothing that we're in a position to announced right now. This was not part of the Seritage conversation. It was just a landlord-tenant relationship with Sears. We're working with our partners – Seritage to think about the redevelopment of the nine centers that we have Sear stores together in and we think there are good opportunities at each of them, but nothing that we're – we're going to be patient. I've said that before. We maybe a little bit of an outlier compared to our peers in terms of our willingness to be patient, but we're going to be patient.

Rich Moore

Okay. And I think, Art, it takes like six months or something – I think you got to give like a six-month notice to Sears before you do anything, and I'm curious are we in that window yet or do we still have at least six months to go probably before we can do anything at the boxes?

Arthur Coppola

So, those are logistics, Rich, and we've got lots of alternatives available to us. We have a flat-out option to recapture space at each of those nine locations, but we have found it relatively expensive to think about recapturing half of the space and then keeping Sears and business in the other half. So we're really thinking about our alternatives. I would note that we did just have Primark opened in half of the space of the Sears store at Danbury and Freehold. So, two of the nine are arguably done at this point in time.

Rich Moore

Okay. And then last thing is, Tom, the shares you bought back in 3Q, because I know, as you went a little bit over into July for your buyback, what would the amount be in just 3Q, do you have any idea?

A - Thomas O'Hern

The settle-up amount, the way it's structured, Rich, is you get 80% of the shares when you start the program, so that was in the case of [indiscernible] roughly 4 million shares. And then in July when the program concluded, we got the remaining 1 million shares. So 4 million of the 5 million shares were during the quarter, and remaining 1 million shares was on July 11 or so.

Rich Moore

Okay. Great. Thank you, guys.

A - Thomas O'Hern

Thanks, Rich.

Operator

And we'll now go to Rich Hill from Morgan Stanley.

Richard Hill

Hey, guys. Good morning, I guess. Just couple of questions. One of the things that you mentioned at the very beginning was the competitive bids that you're seeing from the CMBS market. It caught my attention because I think in past commentary you've mentioned how weak CMBS market may have been. Do you think that's a more reflection of the strength of the quality of property that you're bringing to market? I think it's doing maybe $635 a square foot, $640 a square foot, or are you seeing broad interest – or do you think it's broad interest in that sort of a financing alterative?

A - Thomas O'Hern

Well, I think the market has gotten stronger. It is subject to being more volatile than the bank market, the life company market, but in this particular case, Fresno is a very strong asset, as you said, doing over $600 in sales, and we got bids from probably eight different investment banks and they're all pretty competitive in the range of $200 million over the underlying treasury. So it was good to see, it was encouraging to see, and I think that at the moment is a viable form of financing for probably A – A minus to B plus assets, some A assets may be competitive, it's a big deal, it's roughly $350 million deal. So we're encouraged, but we're not looking for a lot of CMBS loans right at the moment. So I'm not sure we're in a perfect position to say exactly how deep it is. But for a quality asset, certainly they're right at the moment, Rich.

Richard Hill

Great. Great. Thank you. And just one other question. Obviously, an impressive quarter for you guys. I'm curious, how should we think about that in the context of your earnings guidance being reaffirmed or your FFO guidance, should I say?

A - Thomas O'Hern

Right. Well, as I commented in my remarks, the big part of the quarters we had, we had a significant amount of lease term revenue that happened in the third quarter and moreover our forecast was for that to be in the third and fourth quarter – I'm sorry, the second quarter, we have roughly $6 million historically and what we forecast for the year, we forecast $15 million, but the bulk of that we had forecast in the third and fourth quarter. So, that got accelerated a little bit and as a result of that moving earlier in the year, it's going to be in that – we're not going to see the same kind of growth in the third and fourth quarter.

And I think – Bob, he may want to comment on this as well. I think also to the extent we have bankruptcies, we're going to feel that more in the third and fourth quarter. Some of those tenants remained in occupancy through the second quarter. And also when you make the business decision, and it is a business decision, and take a lease termination payment, that means you're taking that, but in exchange for that you're going to lose minimum revenue in the second half of the year. That's a little bit of what we're going to face in the third and fourth quarter.

Robert Perlmutter

Yeah.

Richard Hill

Thank you.

Robert Perlmutter

From a bankruptcy standpoint, most of the store closures would occur in the back half of the year.

Richard Hill

Great. Thank you very much. That's helpful.

A - Thomas O'Hern

Thanks, Rich.

Operator

And we'll now go to Craig Schmidt from Bank of America.

Craig Schmidt

Thank you. Similar questions on the lease term. Was the acceleration of the lease term income at your choice? Is it something that you wanted to deal with now rather than postpone it or was there something else that caused the acceleration?

A - Thomas O'Hern

Well, I think part of it had to do with Sears and I think on our forecast we had that happening in the third quarter, not the second, so that was a little bit of an acceleration on our part. But, generally speaking, it's a decision on our part. When we give our guidance at the beginning of the year, it's an estimate based on some facts that we may be aware of, but also a lot of it is history. And, for example, in 2014, for the full year, we had $9 million of lease term fees; in 2015, it was $11.5 million or so of lease term fees. And we felt there'd be more in 2016, and part of that was as a result of specific conversations we'd had with tenants, such as Sears, and the other part was just the environment we were in.

Robert Perlmutter

Yeah. Craig, this is Bob Perlmutter. The only thing I would add is, on Sears and with another large one, candidly it was accelerated because there was deals completed with replacement tenants.

Craig Schmidt

Great. And then the management company business seemed more productive with somewhat higher revenue, but lower expenses. Was there anything that caused that?

A - Thomas O'Hern

Well, we've got – I think we had some lumpy expenses that hit last year, but we've got more JVs this year, Craig. Because the JVs we did with the Government of Singapore and Heitman were done in the fourth quarter of last year as well as January of this year, plus we have Country Club Plaza, which is a JV. So, as a result of having more joint ventures, we're going to have more management company revenue.

Craig Schmidt

Great. Thank you.

A - Thomas O'Hern

Thanks.

Operator

And we'll now go to Michael Mueller from JPMorgan.

Michael Mueller

Yeah. Hi. I guess, in terms of the e-commerce discussions, do you have a sense at this point as to how many stores could be opened in the portfolio, say, by the end of 2017?

Arthur Coppola

How many digitally native...

Michael Mueller

Yeah.

Arthur Coppola

...retailers that are not currently in malls could be open with us by the end of next year.

Michael Mueller

Yeah, exactly.

Arthur Coppola

It's evolving, it's picking up steam. We're finding that we're having good success in identifying retailers at an early stage in terms of their growth strategies. It's hard to put a number on it. And even if I had a number, which I don't, I'd hate to put it out there, because I see it as a growing number that's going to grow quarter-by-quarter and year-by-year for quite the foreseeable future. So I wouldn't want to put a ceiling on it by even putting a number on it.

Michael Mueller

Okay.

Arthur Coppola

It's early day, but it is definitely a big source of demand going forward.

Michael Mueller

Got it. And so, it feels like traction is there and stores are going to opening throughout this year?

Arthur Coppola

Well, there's no question that there is traction there, and there is no question that stores are going to be opening with us and we understand, look, the reasoning, it's interesting. Some of their reasoning is not necessarily sales driven, Combatant General (sic) [Combatant Gentlemen] (40:35), which opened their first retail location with us at Santa Monica Place a couple of weeks ago, they have 300,000 online customers, they've only been in business digitally for about three years, and they are not measuring success at Santa Monica place by sales. They are seeing that store as being more of a customer acquisition vehicle and a brand awareness vehicle. Now, they are certainly happy to produce sales out of that location, but they – and each of them have different views on it, but more than a few of the digitally native retailers view brick-and-mortar as being as much about brand awareness as sales productivity.

Michael Mueller

Got it. Okay. And then, separately, appreciate the comments on occupancy cost. So it looks like you're in the mid 13%s today. So, for this portfolio, do you have a sense as to where it was pre-downturn, because it's obviously very different than it was six, eight years ago?

Arthur Coppola

Yeah. Pre-downturn, Mike, we were in the 12.5% to 13.5% range. And then, obviously, as a result of the downturn and decreasing sales, that metric went up significantly. But the big difference today, Mike, we have a much higher quality portfolio. I mean if you look at where we were sales per foot on the portfolio in 2007, I think we're probably $150 a foot lower quality productivity and sales...

Arthur Coppola

We're at $467...

A - Thomas O'Hern

$467 versus almost in the mid $600s now. So, we've got a significantly better portfolio, and the higher the quality of your portfolio, the higher the occupancy cost as a percentage of sales that you're going to be able to generate and sustain.

Michael Mueller

Okay. Thank you.

Operator

And we'll now go to Todd Thomas with KeyBanc Capital Markets.

A - Thomas O'Hern

Hey, Todd.

Todd Thomas

Hi. Thanks. Good morning. Just first back to the guidance and comp center [indiscernible] forecast of 4.5% to 5% for the year. So you're at 7% year-to-date. I understand the lease term fee income was a little more frontend loaded this year versus last year, but it would imply 2% to 3%, I guess in the back half of the year. Is that the right read, just trying to make sure expectations are?

A - Thomas O'Hern

Yeah. I mean our bias would probably be at the top end of that today based on what we know today, but yeah, roughly 3% on average in the last two quarters. And again we're going against some very tough comps in the third quarter and fourth quarter of last year, when I think we were north of 7% on average.

Todd Thomas

Okay. Got it. And then, Bob, any sports authority exposure impacting the portfolio in the third quarter and fourth quarter?

Robert Perlmutter

It's pretty small. I think we had four or five locations, most of which were non-mall locations, and I believe today one's been released by [indiscernible].

Todd Thomas

Okay. Any idea on the timing to re-tenant those and maybe where rents were in place for Sports Authority and what you expect to be able to achieve on re-tenanting the space?

Robert Perlmutter

Again, we know it's pretty immaterial in terms of our tenant base. My sense is the rents probably reflected the market. So, it's probably more an issue in terms of the loss of rental released as opposed to spreads.

Todd Thomas

Okay. I got it. Thank you.

Operator

Tayo Okusanya from Jefferies has our next question.

Omotayo Okusanya

Hi, yes. Good afternoon. Can you just talk a little bit about operating margins, again went up again this quarter, which was a pleasant surprise, just how sustainable is it at 70% plus? And what else can you do to keep driving operating margins up?

A - Thomas O'Hern

Tayo, yeah, we're over at 70% this quarter. Part of that was buoyed by the lease term fees. But I think on average for the year, we're at 69% – over 69.5%. So directionally we keep moving up. Last year, we did it pretty aggressively with expense cuts, which is kind of a one-time exercise. We've been able to maintain those, but now, most of what we see is coming from revenue growth and may have noticed other income was a little bit higher this quarter and part of that was driven by Country Club Plaza being in for the quarter, but – and part of that was from the hotel being opened at Tysons, but we also had additional parking revenues and revenues that we're generating from our common areas.

So, that's been a big emphasis this year on generating more revenue from our common area, could be advertising, could be sponsorship income. It's basically non-real estate revenue, and that has been an emphasis and that's going to help us to continue to move that gross margin up.

Omotayo Okusanya

Great. And then the second one for me just around the tenant watch list if there's any. Can you update on maybe new names that may be on the list or tenants that people might not be fully aware of that, maybe having some issues?

Robert Perlmutter

Tayo, this is Bob Perlmutter. I don't think the watch list has really changed in the first six months of the year. The activity during the beginning of the year pretty much reflected what we had anticipated. There are a number of groups that stay on the watch list, the characteristics of these groups are more larger store fleets, weaker brands, bad capital structures, some are public companies, some are not. So, we continue to maintain them. And as the landlords, we do the same thing, we try to mitigate our exposure to them while we can, and prepare as best we can. But we don't see a big change in the marketplace on the back half of the year.

Arthur Coppola

And as I mentioned, Tayo, on my comments from my view point, the opportunity list is a lot more robust than the watch list.

Omotayo Okusanya

Got you. Thank you.

Arthur Coppola

Thanks.

Operator

And we'll now go to Vincent Chao from Deutsche Bank.

A - Thomas O'Hern

Hi, Vin.

Vincent Chao

Hey. Good morning, everyone. I just wanted to – just get a sense of what is embedded in the outlook for the back half for Aero and PacSun?

Robert Perlmutter

Aero and PacSun are working through restructurings. PacSun appears to be making more progress. We have packages that have been worked out with both – in general, there is a few store closures, some rent release and some assumptions. So, the impact on the back half of the year is factored into the projection. It's not a material number either way.

Vincent Chao

Okay. Thanks for that. And just curious on the WithMe partnership at Santa Monica and Century 21. Just curious if you could comment on how that went, what the lineup looks like for the rest of the year there and maybe, if there has been any discussions with Century 21 subsequent to their six-week venture there?

Arthur Coppola

First, they were pleased with what they accomplished out of their exposure and I think in that case it also – I think they measured success as much about extension of their brand awareness as we did the actual sales that they consummated. We'll be announcing another new retailer that will be taking that space in the near term. And that partnership is going well. It's focused on a number of locations. Going forward, the majority of those locations will be common area locations as if you think that's probably the most efficient way and then the most interesting way to go ahead and deploy with their technology.

Vincent Chao

Okay. Thanks.

Arthur Coppola

Thank you.

Operator

And we'll now go to Andrew Rosivach from Goldman Sachs.

Caitlin Burrows

Hi. Good morning. This is Caitlin Burrows. I just had another question on the Kings Plaza redevelopment. And it looks like the expected yield went from 7% to 8% down to 4%, in part is due to increased extracted cost. So, I was wondering, what is driving that extra cost?

Arthur Coppola

It's really I think just the fact of demising it into multiple locations, a few more than we had otherwise anticipated. It was a placeholder before and that's why we put it into the shadow pipeline. But it's evolving. These are the numbers that we see today. I think it is important to note that we believe we're being very conservative in the way that we are reporting this return to you.

I'm aware of other owners of malls that when they bring in a replacement department store, sometimes they include what they think is going to be the uplift in market wrench for the entire mall into the return they expect to get from that department store. And I'm not saying that in a critical way. I'm saying that because I'm just aware there are different ways of thinking about what your return is when you replace the department store.

We're not doing that in this situation, and we're looking at it, comparing it to the very substantial rent that Sears would have been paying over the next couple of years. Now, Sears, the lease expires anyway in a couple of years, so you could argue the 8% return is [indiscernible] the more realistic return. But we wanted to – look, we know that a lot of you are trying to models based upon this information, and that that's as important as the return that we're reporting. And so, we wanted to help you with the model and know that it's really 4% over what we're getting right now.

As we think about it we – look, we do think about it long-term, and we think about any investment in a replacement of the department store or any investment of that size in terms of IRRs, so we didn't expect it holding period also and the actual IRR on that particular investment, and this is just again going over the current rent that Sears is paying approaches 10%. So the company and the board felt very comfortable going forward. Go ahead, Bob.

Robert Perlmutter

Caitlin, the only thing I would add is, as we got into the redevelopment of the box, we clearly felt it was more than just taking the box and dividing up for tenants. We felt there was an opportunity to really create a front door to the shopping center, which it's really lacking now, an opportunity to really open up the facade, an opportunity to get vertical transportation from the parking deck into the fourth floor tenant. So, we definitely felt that it was a major redevelopment for the property, and there is a lot of items in there that are more than just taking the box and carving it up and maximizing the revenues.

Caitlin Burrows

Okay. Yeah. And then, on just that idea of when you guys are talking about being conservative, and thinking about it like this is the new rent you'll get kind of above and beyond what Sears was paying before, when you think about the other redevelopment projects you have, is that similar to how you calculate the returns then, again, thinking about who is there now and what the incremental add will be as oppose to the total?

Arthur Coppola

Yes. Looking at it, stepping away from it, for example, when we thought about the return that we will be seeing at Walnut Creek, we looked at what was our opportunity cost, what would the income be, which [indiscernible] averaging about $15 million at the time. And so we measured the return on investment over the income that was in place before we started tearing down buildings. And so after we got done tearing down buildings, we took that income down to around $8 million or $9 million. We didn't measure our incremental return from the reduced level. We measured that from what it used to be in the kind of do nothing scenario.

Operator

And we'll move on to Paul Morgan with Canaccord.

Arthur Coppola

Hey, Paul.

Paul Morgan

Hi. Good morning. Appreciate the discussion about rent spreads and top two-thirds and bottom one-third and I just want to kind of follow up on that. I mean how much of kind of that discrepancy in sales productivity is something that you think you could kind of dismonetize, we can just sort of take kind of a mark-to-market approach versus – it may feel like there'll be some other factors like what specific malls, maybe the locations in the mall [indiscernible] would seem like there is going to be certain locations that are just always going to be less productivity if it's near in cap with a weaker anchor or things like that. I mean, how easy is it to just map that difference $313 to $1,000 a foot to kind of what your upside is going to be?

Arthur Coppola

Well, since this is what I've been doing for a living for over 40 years and since it's been this way every day, those 40 years, and since there really hasn't been any change, I feel very comfortable with our ability to continue to recycle tenants. This is what you do. It's the nature of the business. But if you remember, I think one of my peers indicated to you in call a few quarters ago, I think he was observing that because top 10 tenants when he went public 20 some years ago that only two or three of them are still in business. Well, does that mean that the business went bad or does that mean that we had eight great new top 10 tenants?

And frankly, the answer is, we got eight really good new guys and the eight guys that went away, they went away because they had matured. And I feel – look, it all comes back to supply and demand. And we can dissect this to the Nth degree, but the way that we look at things is that we think about not what is, but what can be. So we don't think about a space where tenants doing $300 a foot and say that's a $300 space. We look at it and say, potentially that's a $300 space because it's a crappy tenant.

We had a tenant at Santa Monica Place over the second level that I think was doing $300 a foot [indiscernible] $10,000 a foot tenant and a payroll tenant, and we didn't say, oh, that's a $300 foot location and we replace them with a really good new tenant, who is doing probably three times that, which – that's what we do every day, and by the way, it's not just us, it's our peers do that also.

Now, I will tell you that we're able to do that because we have properties that are must have properties. If we had commodity type of properties where we were located in some really secondary markets or territory markets or we're dealing with a portfolio of significantly lower quality properties, we wouldn't be in a position to have this conversation, but we're in high demand locations with great real estate somewhat similar to high street retail in the demand characteristic and returns and rent growth that those have enjoyed over the years. It's supply and demand, it all comes down to that.

Paul Morgan

So, I mean, it sounds like you would attribute a lot of that difference in sales, productivity, two things that are specific to the retail rather than like being on [indiscernible], typically?

Arthur Coppola

Absolutely. Right. Look there are certain locations that are always going to be less productive, but that's all baked into the numbers. And when we looked at and we said the top two-thirds of our tenants in each category do over $1,000 of foot and the bottom one-third by category do $313 a foot to average $726 a foot, that wasn't location specific. It was just [indiscernible] if I got nine tenants in this category, what are the top six doing and what are the bottom three doing and it doesn't matter where they're located. So it is a function frankly of, are you selling the merchandize that people want to buy.

Paul Morgan

Okay. And then just going back to the Kings redevelopment number. I definitely appreciate the kind of this clarity of that 4%, which we don't necessarily often see. But I mean how should I think of that number being kind of specific to Kings versus when we look at all the other Sears where you have or other anchors where you have anchor redevelopment opportunities? I mean, is the gap between your gross yield and your net yield that meaningful there or is it just because of the complexity in urban nature of Kings and the fact that Sears was paying pretty material rent, the difference [indiscernible]?

Arthur Coppola

Well, I think [indiscernible] that shouldn't – there is a fair amount of work that's being done within that box that is really common area in nature and is really mall specific and not tenant specific. So, we're creating a new Atrium interim to blacklist Boulevard, which really has nothing to do with redemising the space. But I will tell you that when it comes to anchor replacement, we don't expect that to be returns that are going to be the normal 8% to 10% types of returns.

And if we can achieve returns that we think are adequate and we think about that [indiscernible] cash-on-cash, we think about it in terms of a 10-year hold and we think about its impact on the mall and everything considered, we're going to be willing to if we believe that we can dramatically improve the quality of the draw. We're very happy to take a mid-single-digit type of return on a replacement, very happy to do it, and it's the right thing to do.

Paul Morgan

Okay. Great. Thanks.

Operator

And that is all the time we have for questions today. I'll turn the conference back over to you, Art, for any additional or closing remarks.

Arthur Coppola

All right. Well, thank you all for joining us. Enjoy the rest of your summer and look forward to seeing and speaking with you again soon. Thank you very much.

Operator

This concludes our presentation for today. Thank you for your participation. Have a great day.

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