Good day, ladies and gentlemen. And welcome to the Second Quarter 2012 Alexander & Baldwin Earnings Conference Call. My name is Kim, and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session at the end of today's conference. (Operator Instructions).
I will now like to turn the call over to your host for today's conference, Ms. Suzy Hollinger, Director of Investor Relations. Please proceed.
Thank you, Kim. Aloha and welcome to Alexander & Baldwin's second quarter 2012 earnings call. On the call with me today are Stan Kuriyama, A&B's Chairman and CEO; Chris Benjamin, A&B's President and Chief Operating Officer; and Paul Ito, A&B'S Chief Financial Officer. Also with us today, is David Haverly, A&B Properties Senior Vice President of Leasing.
Before we commence, please note that statements in this call and presentation that set forth expectations or predictions are based on facts and situations that are known to us as of today, August 1, 2012. Actual results may differ materially due to risks and uncertainties, such as those described on Pages 20 through 39 of our Form 10 and our other subsequent filings with the SEC.
Statements in this call and presentation 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 for the quarter. In particular, we will be referring to adjusted net income and diluted earnings per share that exclude the impact of separation expenses and a non-cash reduction in the carrying values of two mainland development projects. We will also be referring to cash net operating income.
Included in the appendix of today's slide presentation are reconciliations of these GAAP to non-GAAP financial measures, and a statement regarding our use of these measures. Slides from this presentation are available for your download at our website www.alexanderbaldwin.com. This slide provides you an agenda for our presentation, after which we will take your questions.
We'll start with Stan, who will comment on the quarter.
Thank you everyone for joining us today. As you know, this is our first call since the separation of our land and transportation businesses on June 29. We remain very excited about our company's prospects, and we are pleased by the number of positive value creating events that have occurred since the first quarter.
For those of you not completely familiar with the new A&B, our overarching strategy is to leverage both our extensive track record, and experience in Hawaii, and our strong financial position to optimize the value of our substantial real estate assets, and to maximize long term growth and shareholder value.
We will accomplish this through a coordinated program of building and realizing value in our historic land holdings, through our planning entitlement and sale activities; investing in high return real estate opportunities in Hawaii, building our development pipeline for market recovery, increasing the cash flow and profitability of our commercial portfolio, and over time, migrating the commercial portfolio back to Hawaii and derisking the earnings stream from our agri business segment.
We know that until we see a full recovery in our real estate markets, earnings from our development and sales activity will be relatively modest. We do however expect to create shareholder value throughout the cycle, by our investments in Hawaii and the other strategic initiatives I just mentioned and we will highlight our progress on these initiatives in our earnings calls.
There were two primary separation related impacts reflected in this quarters financial results. First, most of the costs to affect the separation were incurred in the second quarter, about $4.4 million. Second, as a result of our strategic decision to focus our future development activity, almost exclusively at Hawaii, we evaluated the three development projects we have on the mainland, and recorded a non-cash write down at two of those projects. The write downs amounted to $9.8 million, leaving the two projects with a book basis of $12.9 million. The third project has a book basis of about $4.7 million.
Excluding the net of tax effects of these charges, A&B's net income for the second quarter was $5.5 million or $0.13 a share. Notwithstanding our focus on separation and the resulted impact on second quarter financial results, our operations performed well in the quarter. Performance in our leasing and agribusiness segments were steady, and we achieved a number of positive milestones in our operating businesses, which Chris will highlight in his remarks.
An important part of the investment thesis for A&B, is that Hawaii is at a positive inflexion point in the economic cycle.
Tourism which of course is the state's primary economic driver, continues to perform at an extraordinary level. Through June 2012, total visitor expenditures were up 21%, compared to last year. Visitor arrivals were also up for the same period by 10%, with increased arrivals from all major markets. Results so far this year put tourism on track to set the stage all time high for expenditures and arrivals.
This outlook in tourism coincides with positive trends in other Hawaii economic indicators. The unemployment rate at the end of June was 6.4%, down from 6.7% last year, and well below the national unemployment rate of 8.2%.
Bankruptcy filings are down for the first half of 2012 at 26%. The median price for home on Oahu for the first half of the year, were $620,000, which is 9% higher than last year's median price.
Months of available inventory remained low at 3.9 months for Oahu homes, compared to the 2011 average of 5.7 months, and these lower inventory levels are expected to continue to support a positive trend in medium prices.
Hawaii commercial markets have been relatively stable. Retail and industrial vacancies remain below 5%, and rents have remained steady over the last several quarters. All of this means, Hawaii's economy is headed in the right direction, and this should provide a stable or improving environment for primary housing and commercial properties in the state.
Let me now turn it over to Chris to discuss the performance of our operations. Chris?
Thank you, Stan. There were a number of positive developments in operations during the first quarter, which I will highlight throughout my operational update. A significant accomplishment in the quarter was getting final subdivision approval for a 286 acre non-core agricultural land sale, which subsequently closed on July 26, and will be reflected in third quarter results. The property was sold to an agricultural user for $8.3 million or roughly $29,000 per acre, which compares favorably to historical sales prices achieved on similarly sized parcels.
Pricing of ag line of course depends on the property's characteristics, including location, usable acreage, and access to water.
In June, the State Land Use Commission approved a reclassification of a 545-acre Waiale Master Plan community in Central Maui from the agriculture to urban land use classification, which is a significant milestone in the entitlement process for this project. We are now pursuing county zoning for this project.
Turning to development, Stan has already described how and why our quarterly financial results were affected by the write-down of two mainland development projects, and of course the timing of sales closings affected earnings as well. But we are encouraged by forward progress at our various Hawaii development projects.
We continue to achieve excellent presales results at our 341 unit Waihonua high rise project in urban Honolulu, near the Ala Moana Shopping Center, validating both the pent-up demand for high rise condo product in Honolulu and the strength of our project.
Through yesterday, we have sold 227 units under binding contracts, and have non-binding sales contracts for an additional nine units. The total sales value of these binding contracts is $161 million. With this outstanding performance, we have presold more than enough units to obtain financing and move forward with construction.
We are finalizing terms of the $120 million construction loan, and will continue to pursue development of this project through joint venture. We could break ground on the project as early as September.
On-site and offsite work at our 179-acre Maui Business Park II project is in full swing. We received subdivision approval for 65 lots within the first increment in June, allowing for the formal launch of marketing efforts in July.
Prior to the launch, we sold a four acre parcel to Costco, from which we recognized $3.7 million of margin in the second quarter. We are seeing interest in parcels of the project from a wide range of buyers, but it's too early to gauge the timing and magnitude of sales.
Momentum at our Kukui'ula project on Kauai remains positive. In June, the project added to its long list of accolades, with the inclusion of its golf course in Robb Report's Best Of The Best 2012 Luxury issue. This is perhaps the biggest feather in our cap to-date.
As I discussed last quarter, together with our joint venture partner DMB Associates, we've modestly expanded our vertical development program in order to stimulate additional development, and in turn, drive more sales interest. (Inaudible) product is selling better than custom lots in the current environment. In addition to our vertical development program, we kicked off a second builder program in the quarter, and have a third under negotiations.
As a sign of the value of these builder programs, four deluxe cottages under construction are in escrow at prices ranging from $2.5 million to $2.75 million.
During the quarter, we also made the second of our commercial investments in Mililani Mauka, a Central Oahu community of over 20,000 people, whose next closest commercial center is three miles away. The first investment made last December in the gateway of Mililani Mauka Center consists of 5,900 square feet of existing retail space, and four acres for development of an additional 28,400 feet of space.
We broke ground in late June in the first of three buildings at 11,500 square feet of space, and are encouraged by the strong leasing interest we have received from local retailers.
The second investment, which closed in June, is located across the street, and we refer to it as Gateway South. The property consists of 18,700 square feet of existing office space, and 1.6 acres for an additional 20,000 square feet of commercial space.
These two investments are aligned with our strategic initiative to migrate the portfolio back to Hawaii over time. 89% of the $19.5 million purchase price for these two properties was funded with 1031 proceeds from the sale of mainland properties.
The investments are good examples of how our local presence translated into an opportunity to migrate a small portion of the portfolio back to Hawaii, using 1031 exchange proceeds, and to develop additional square footage for the Hawaii portfolio.
Also in the quarter, we eliminated about half of our 2013 rollover exposure with the renewal of the 1 million square foot Savannah Warehouse lease of Matson Logistics. The lease now runs through early 2017. The base rent was reduced by an average of 23% over the term of the lease, reflecting the softening of the Savannah markets since 2008, when the original lease was executed. But the lease has attractive step-ups and greatly reduces lease rollover risk.
In agribusiness the company has now locked in sugar prices for virtually all of this year's raw sugar crop and most of the 2013 crop. The prices we have locked in for 2012, and for 60% of the 2013 crop approximate 2011's favorable levels.
We experienced a sugar production shortfall in the quarter due to a combination of boiler downtime, which reduced the pace of factory and field operations, as well as weather related delays in the harvest. The pace of the harvest has improved since then, and we expect to complete all scheduled acres by year end.
While there is always unpredictability in a harvest, we currently expect to erase the year-over-year production shortfall over the balance of the year.
Finally, we also commenced construction of our 6-megawatt solar project at Port Allen on Kauai and it's coming on very well. These photos of the 20-acre site were taken on July 27. We expect to place the project in service later this year. Total project costs are projected to be $25 million, of which approximately 70% is expected to be recovered this year through renewable energy tax credits and accelerated tax depreciation.
We have negotiated a long-term power purchase agreement with the Kauai Island Utility Cooperative to sell the electricity produced at this facility for $200 per megawatt hour. I was at the site just last week and I can say that it's an exciting project and further demonstrates our ability to create value in myriad ways on our Hawaii landholdings.
Overall, we feel good about the operational progress we've made in the quarter and about the sales interest and activity that we are seeing at our projects. While our earnings expectations in the near term remain tempered, we will continue to focus on laying the groundwork for stronger sales, creating value even before market recovery occurs.
With that, I would like to turn the call over to Paul to update you on financial matters.
Thanks, Chris. This slide breaks down operating profit by business segment. We saw relatively stable operating performance in our leasing and agri business segments. However, the write-downs of the two of the three development projects on the Mainland previously mentioned impacted operating profit for real estate development in sale segment, while one-time separation costs caused an increase in corporate expenses.
Leasing operating profit was up slightly compared to last year. As you can see from the slide, portfolio occupancy and NOI remained relatively stable. Hawaii occupancy was 91% for the quarter, the same as last quarter and last year. Mainland occupancy was 93%, also consistent with last quarter and last year.
Besides the write-downs comparative results for the development and sales segment for the quarter were also impacted by the timing of sale. In the second quarter of 2012, we've recognized $3.7 million of margin on the sale of a 4-acre lot at our Maui Business Park II project. In contrast, sales in the quarter of 2011 included a retail shopping center in Texas and four Hawaii properties, which generated margin of $10.8 million.
Agri business operating profits for the second quarter of 2012 were $7 million or $1.5 million lower than last year. Although company sold a similar amount of sugar in the second quarter of 2012 as it did in 2011, it received higher pricing on a vessel load shipped in the second quarter of 2011. However, as Chris mentioned, on a full year basis, we expect that average sugar pricing and volumes in 2012 will be similar to 2011.
We incurred approximately $4.4 million in one-time separation related costs in the quarter consisting of $3.6 million of professional fees to effect the separation and another $800,000 in non-cash expenses to convert pre-separation stock options to A&B-only options and additional $1.2 million of non-cash equity conversion costs will be recognized over 2.5 years.
Due to accounting rules the exchange of options results in incremental non-cash expenses but no new awards were granted and the intrinsic value of the existing awards were unchanged. Future separation expenses are not expected to be material.
Our priority in preparing for separation was establishing a solid capital structure for our company. As part of the separation we allocated debt in 50-40 ratio between Matson and A&B through a cash contribution from Matson which allowed us to reduce our debt to $252 million at the end of the quarter.
As you can see from the slide, our debt to equity ratio was a low 22% at the end of the quarter. In June, we announced financing arrangements, which included establishing a $260 million revolving credit facility to fund future operating and investment needs and extending the maturities of $207 million of existing long-term notes.
These arrangements together with the cash generated by our businesses provide us with a strong financial platform from which to pursue growth opportunities. At quarter end, available borrowing capacity was $325 million.
Cash flows used in operating activities were $24 million for the first half of the year, an increase of $15 million compared to last year. The increase was due primarily to $17 million of increased real estate development capital expenditures principally related to Maui Business Park II and $12 million of increased shipping in inventories.
Cash flow related to financing activities included the cash contribution from Matson previously mentioned which allowed us pay down a significantly amount of debt. The bottom of the slide shows the reconciliation of capital expenditures shown on the cash flow statement to total capital expenditures including amounts invested in joint venture developments and real estate held for sale.
Through the second quarter our capital expenditures amounted to $50 million which included $30 million of development capital for active projects and joint ventures, $4 million for the Port Allen Solar Project in ag, other and $9 million in 1031 reinvestments with the remainder primarily for maintenance CapEx in leasing and ag.
For the full year we anticipate capital expenditures will total $135 million. In development and sales, we had earmarked $15 million for undesignated growth investments and $65 million for our development projects.
In the agri business line, $15 million of the $25 million total is for the planned construction of the Port Allen Solar facility. As in prior year these budged figures are subject to change based on investment opportunities, market conditions and other factors.
I will now turn the call over to Stan for closing remarks.
Thank you, Paul. We've made good operating progress this quarter on a number of fronts. We are encouraged by the continuing strong performance of our tourism industry and what that bodes for the Hawaii economy. We have a development pipeline that is well positioned for market recovery and we have a strong financial platform which to pursue future growth opportunities as and when they arise.
Separation of cost was a historic event for the company and we are all looking forward to the new role that lies ahead.
That concludes our presentation today and we'd now be happy to take your questions. Thank you.
(Operator Instructions). Your first question comes from the line of Ian Zaffino with Oppenheimer & Co. Please proceed.
Ian Zaffino - Oppenheimer & Co.
Hi, thank you very much. I guess the two questions. The first one was the noncore land sales that was used for, was it water access, can you give us a little bit better description about what happened there? And then also I know you had talked about showing them a lot of your Mainland portfolio should they want to Hawaii, where are we in that process, how long that will take? Thanks.
Yes. Thanks, Ian. Let me take them in that order. As far as the non-core ag land sale, this is land that is in agricultural use. We sold it actually to a company that has leased land from us for a while, but the characteristics of this land are relatively good ag land. It is very distinct from our mill and it is not the ideal land for farming sugarcane. It's more suited to some other uses.
And we sold – the land actually was sold to an existing tenant, but it's a little bit different than the footprint that they had been leasing and it enabled us to get back actually some better sugarcane land that they have been on and move them to this particular parcel.
So it actually worked out well for us not only financially but operationally. The water has access – the land has access to County water, but there were no water rights that we transferred ourselves. So I would overall characterize it as a win, win for us and for them. And in our case, as I said, we're actually able to get back some superior sugarcane land that they had previously been leasing.
As far as the answer to the second question, we've always said from Day 1 that it's going to be unpredictable the pace at which we can bring our portfolio back to Hawaii. We have been pleased with the two modest transactions that we've done in Mililani Mauka over the last six months. And we have a very active program right now of looking at Hawaii based properties. We have a number of assets that we are currently looking at and talking to prospective sellers.
So I would say we are very active, but it's difficult to predict the timing. I would say that even if we hit on a couple of these opportunities, it's still going to be consistent with a multi-year process for transitioning the portfolio back and we've also acknowledged that we may never transition all the portfolio back, it's going to be very opportunistic and we will see how it goes, but we do feel good about the assets we've identified and want to have to see if we can land any of them.
Ian Zaffino - Oppenheimer & Co.
All right. Perfect. Thank you.
Your next question comes from the line of Brendan Maiorana with Wells Fargo. Please proceed.
Brendan Maiorana – Wells Fargo
Thanks. Good afternoon. Chris, you mentioned the Savannah lease down 23%, you may have mentioned this so I apologize, but was that a cash change or was that a GAAP change over the term and is that basically going from roughly a $4 number down to the $3 number?
Yes. I’m also going to invite David to jump in here and provide more color, but that the number that I gave was a GAAP number. David, do you want to elaborate on kind of the comparison of the old versus new?
Sure, Brendan. He is going to talk to you. The rents actually came down from approximately $4 average rent number to a little over $3 average rent number for the term of the lease which resulted in the percentage recorded in the change. It does include significant increases year-over-year on the rent step ups. So on a long-term basis, I think we're very comfortable with this and the market deal for Savannah.
Brendan Maiorana – Wells Fargo
Right. So it's out there, but that GAAP number includes the bumps over the term, it's a $3 average over the remaining term of 5 years versus a $4 average over the prior term.
You are correct.
Brendan Maiorana – Wells Fargo
Okay. Great. And then, is there on the Waihonua project, it still sounded like you guys are close to getting a construction financing or at least down that path $120 million, but then I hear you correctly and that you are looking to JV that project and what's the – why JV and if you got construction financing for, it sounds like that's a large portion of it?
Yes. This is Chris. We do. We are just about – we are very close to finalizing the construction loan and that's looking very good. And it's a good question, why do we JV it? I think the reason, we feel very, very good about the project, but our focus has been always on having a diverse pipeline of development activities.
And when we have large projects like this, our preference is to approach it through JV. It helps with obviously not only with risk mitigation but also with capital allocation allows us to allocate our capital across a larger number of projects, get a little bit more diversity and get a little bit of risk mitigation.
In this case, clearly the risk is relatively – there is always risk in a high rise condominium development. It is lower because of the presales, but it is not, it's not nonexistent and so we feel that there is that benefit and then probably importantly it's just reserving some of our capital for other things that we have in our investment pipeline and the growth objectives that we have.
Brendan Maiorana – Wells Fargo
So as we think about the presales that you guys have done and bringing the partner and added the value creation, I think you guys typically target, call it 20% return on a project like this, maybe it's a little bit higher, maybe a little lower. Is it fair to say that call roughly half of the value creation you would sort of keep – that you targeted thus far given the presales that you have done and maybe the partner that you bring in would get roughly half of their interest or half of the total?
Well, certainly in terms of profit distributions on our investment like this, they would be disproportionately to us in this structure. The structure that we are contemplating we don't have – we haven't finalized agreements at this point, but would be for a preferred return kind of a maze sort of structure for the third party investor or investors with a more modest share of profits so, but that's majority of the profits would accrue to us.
Brendan Maiorana – Wells Fargo
Okay. All right. That's helpful. Paul last question for you the Port Allen solar, I think it has been pretty clear for a while that the tax credit is likely to hit in the fourth quarter. I guess, I was unclear is that a gain on that just for income statement purposes in fourth quarter or does that going to amortize over the life of the project, how should we think about that?
Well, there's two components of the tax benefits related to the project, of which some of the tax benefits actually flowed through the income statement lines so, that will – we'll see some of that this year. Our effective tax rate for the full year from continuing operations is projected to be in the 32%, 33% range because, some of these credits come in.
And then the other product, that the benefit is, it will come through lower depreciation. So when we get for example the cash, a cash credit that reduces the basis of the property. So it's a little bit convoluted in terms of fully seeing the benefit in one place its split.
Brendan Maiorana – Wells Fargo Securities
Okay. So it's going to be more recognized throughout the balance of year or not just in the fourth quarter?
Well, we're actually starting to in terms of on a cash basis. We're actually already receiving part of the benefit because we reduced our estimated tax payments that we make.
Okay. P&L. From a P&L standpoint I don't think there's any recognition of a gain on, as a result of the tax credits so just…
Yeah, I wouldn't characterize that as a gain, I would characterize it as a reduction in our…
In our taxes.
Brendan Maiorana – Wells Fargo Securities
Okay. And maybe we can follow up offline. All right and then last question I had kind of probably for Stan, but it sounds like the economic conditions are continuing to get better in Hawaii, we've sort of talked about this for the number of quarters now. Are you seeing any of that materialize into the Resort Residential market, and as you think about migrating the company longer term.
Your development pipeline is still you more oriented toward Resort Residential than any other sort of product type as Kukui'ula goes throughout its life cycle and ultimately becomes much smaller investment. And you have less development with Wailea over time. Do you think that Resort Residential is an area that will be less emphasize for the new A&B going forward versus how it's been over the past few years as a large portion of your development value creation pipeline?
Yeah, Brendan, I think that is the first statement. As we look at our overall portfolio, right now we are fairly concentrated in the Resort Residential product. Clearly now, the primary housing market is doing better. We expect it to continue to improve and so that's – that end of the market is where we're concentrating our focus right now.
So beside the Waihonua new project we're also looking at for example. Other high-rise opportunities in the urban core another urban core. So, I think going forward over the next few years given where we expect to see the immediate improvement in the market it's going to be in primary housing.
Resort Residential, for us is mainly a mainland buyer profile, West Coast buyer market for us. So until you see, I think that broader recovery of mainland economy and increase in buyer confidence and increase in disposable income, you're probably not going to see as quick a return of the Resort Residential market for us.
The interesting things as though as you probably have figured out, the large part of the increase in tourism is driven by increase in Asian visitors to Hawaii. So part of the question for us is whether we can capture some of that increase Asian interest in Hawaii and some other Resort Residential projects and that's going to be a new area of focus for us going forward for this projects.
Brendan Maiorana – Wells Fargo Securities
But are you seeing any of the large increases than just arrivals that are happening show interest in buying, resort residential product or is it more just that, they're – want to feel like – it's a nice place to take a vacation?
Oh, no. you definitely see – see that translated into the purchase of residential our product in Hawaii. The Japanese consistently buy residential product here. They are increasing the purchases particularly as the exchange rate remains favorable. You can see an actual increase in a number of Japanese purchasers in the residential market and the question is to what extent can this also be evidenced by in the Chinese and Korean tourism segments of the market.
So, it occurs it does make an impact one of the projects we're looking at right now, for example, even though its located in the Honolulu Urban core, it's likely to have a strong appeal to Japanese buyers for example.
As you know, we continue to take prospective buyers to Kukui'ula project and I've taken an increased number of Japanese visitors to that project and they love it. But it is -- that type of product is a little bit new for the Japanese, we we'll have to see whether over time we can translate some of that interest into actual sales.
Brendan Maiorana – Wells Fargo Securities
Sure. Okay. All right. Thanks guys.
Thank you, Brendan.
(Operator Instructions) I have no further questions at this time. I would now like to turn the call back over to Ms. Hollinger for closing remark.
Thanks, Kim. If you have any questions, please call me at 808-525-8422. Thanks for being on the call today. Take care.
Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a great day.
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