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Retail Opportunity Investments (NASDAQ:ROIC)

Q2 2012 Earnings Call

August 02, 2012 12:00 pm ET

Executives

Stuart A. Tanz - Chief Executive Officer, President and Director

John B. Roche - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Richard K. Schoebel - Chief Operating Officer

Analysts

Craig R. Schmidt - BofA Merrill Lynch, Research Division

Jason White - Green Street Advisors, Inc., Research Division

Paul E. Adornato - BMO Capital Markets U.S.

R.J. Milligan - Raymond James & Associates, Inc., Research Division

Michael Demaray - Elevated Capital LLC

Jeffrey Lau - Sidoti & Company, LLC

David McKinley West - Davenport & Company, LLC, Research Division

Operator

Welcome to Retail Opportunity Investments Second Quarter 2012 Conference Call. [Operator Instructions] Please note that certain matters discussed in this call today constitute forward-looking statements within the meaning of federal securities laws. Although the company believes that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, the company can give no assurance that these expectations will be achieved.

Factors that could cause actual results to differ materially from current expectations include, but are not limited to, changes in economic conditions and the demand for retail space in the markets where the company operates, the financial success of its tenants, the availability of properties for acquisition, the company's ability to successfully integrate newly acquired properties and other risks, which are more fully described in the company's filings with the Securities and Exchange Commission.

Now I would like to introduce Stuart Tanz, the company's Chief Executive Officer.

Stuart A. Tanz

Here with me today is John Roche, our Chief Financial Officer; and Rich Schoebel, our Chief Operating Officer.

I am pleased to report that we had another strong and productive quarter. We continue to broaden our portfolio and operating platform in our core markets on the West Coast. We also achieved exceptional property operating results which helped to drive our financial results to new heights, and we enhanced our strong balance sheet. Before going through the details of the quarter, I would like to first touch on our announcement this morning regarding the companies moving its headquarters to the West Coast.

As many of you are aware, when we commenced operations at a shopping center REIT back in 2009, our target markets for acquiring shopping centers was the West and East Coasts. Notwithstanding giving careful consideration to numerous opportunities on both coasts, today, our acquisition activity have focused southwest, where we continue to find exceptional opportunities. With that in mind, during the second half of the year, we will be moving our corporate operations from New York to San Diego, combining corporate functions with property management and leasing functions in one location.

Additionally, once the transition to the West Coast has been completed, John Roche will step down as CFO. John's leadership and invaluable contribution has been instrumental to the company's growth over the past 3 years. The company will soon commence conducting executive search. In the meantime, John will continue to serve as CFO.

Turning to the company's activities during 2012, starting with acquisitions. We continue to source unique opportunities across our core West Coast markets to acquire off-market, direct-to-owner transactions, exceptional grocery-anchored shopping centers. Thus far in 2012, we have acquired 9 properties totaling $134 million, including $49 million acquired in the second quarter. Of the 9 properties acquired year-to-date, 3 of the shopping centers are located in the Pacific Northwest with 2 in the Seattle market and one in the Portland market. Three of the properties are located in Northern California including in the San Francisco and Sacramento markets and 3 are in southern California with one in San Diego and 2 shopping centers in Los Angeles market.

The property we acquired during the second quarter in the Los Angeles area is an excellent example of our ability to capitalize on our relationships and market knowledge to acquire truly irreplaceable shopping centers on attractive off-market terms. The property was developed just 2 years ago and is a trophy asset that is the primary grocery-anchored shopping center serving an award winning master-planned community right on the Marina and Oxnard just north of Malibu. The owner came directly to us. He was facing significant near-term debt issues and was well aware of our track record of working quickly and successfully to resolve owner and lender issues. Needless to say, we jumped at the opportunity. Knowing the market and the property very well, we underwrote and closed the transaction within a few short weeks, including first acquiring the debt at a discount followed by acquiring the property outright just a few days later.

Another good example of how we are capitalized on our relationships to build an exceptional portfolio is our ground-up development joint venture in Portland, Wilsonville Old Town Square. Yesterday, we completed the final step whereby we acquired our development partner's equity interest in the project so we now own the property 100% outright, and we retired the construction loans so the property is now unencumbered. You may recall that we initiated the joint venture in 2010 as part of acquiring an existing 4 shopping-center portfolio in the Portland market from a local developer that we have known for years. The development as a grocery-anchored shopping center is currently 91% leased. With the closing yesterday, our total investment in the newly developed center is approximately $21 million and our NOI yield is a strong 7.75%.

With respect to leasing, demand for space continues to be strong across our portfolio. We are working hard to make the most of this, as Rich will discuss. We had one of the most active and successful quarters to date, securing a number of key new leases and anchor renewals, helping to drive occupancy to a new high for the year and helping to generate strong same-center NOI results.

Lastly, based on our continued success and steadily growing our business, I am pleased to announce that the company has again increased its cash dividend. The quarterly dividend, which will be paid on August 31, will be $0.14 per share representing a 7.7% increase over our previous dividend. This latest increase represents the sixth increase in our dividend over the past 8 quarters since the company commenced paying cash dividends. And now, I'll turn the call over to John to discuss the company's financial results. John?

John B. Roche

Thanks, Stuart. Starting with our income statement. For the second quarter, the company had $18.1 million in total revenues, as compared to $11.5 million in total revenues for the second quarter of 2011. The significant increase in revenues reflects the growth in our portfolio from acquisitions over the past year, as well as strong leasing activity. And as Stuart noted, same center net operating income increased significantly again, specifically by 8% on a cash basis for the second quarter. The 8% number is based on the 22 shopping centers that we owned as of the second quarter of 2011.

In terms of net income and funds from operations, during the second quarter, the company had net income of $4.4 million equating to $0.09 per diluted share as compared to $0.02 per diluted share in the second quarter of 2011. FFO was $12 million or $0.24 per diluted share for the second quarter of 2012 as compared to $0.14 per diluted share in the second quarter of 2011. The significant increase in net income and FFO per share is attributable to 2 things: one, the growth of our portfolio over the past year; and two, the results were positively impacted by a bargain purchase gain of $3.9 million related to the conversion of the 2 mortgage loans that were both acquired in the second quarter and then quickly converted to fee interest, including the property in Los Angeles that Stuart discussed, as well as the property in our Northern California market.

Turning to our balance sheet. At June 30, the company had a total market cap of $888 million, with $235 million of total debt outstanding, equating to a conservative debt to total market cap ratio of approximately 26%. With respect to the $235 million of debt, 74% of that or $174 million is unsecured and only $61 million is secured. And during the second quarter, we repaid a small $6.8 million mortgage, which was the only debt we have maturing through the end of 2013.

And as we've previously discussed, an integral part of our growing business is maintaining a strong and flexible balance sheet geared towards achieving an investment-grade rating down the road. One of the key components to achieving this goal is maintaining a large unencumbered pool of assets. To that end, on a square footage basis today, over 90% of our portfolio is unencumbered. And in terms of our investment activity, thus far in 2012, of the 9 properties acquired today, only one of these is currently unencumbered. In addition, we are carefully managing our debt composition.

We are also prudently raising equity through our ATM program to help fund our growth. During the second quarter, we raised approximately $11 million through the program at an average net price in excess of $12 a share. With our conservative low-leverage balance sheet with no near-term debt maturities and our growing unencumbered asset base, together, with our ability to efficiently access equity capital on an as-needed basis, we continue to have the financial wherewithal to prudently fund our growth objectives.

Lastly, in terms of FFO guidance for 2012, notwithstanding being a $0.41 a share for the first 6 months, in part due to the $3.9 million bargain purchase gain in the second quarter, we continue to expect FFO to be between $0.68 and $0.78 per diluted share for the full year. This takes into account anticipated costs for approximately $3 million to $3.3 million associated with relocating our corporate offices to the West Coast during the second half of the year.

Now Rich Schoebel, our COO, will discuss property operations. Rich?

Richard K. Schoebel

Thanks, John. At June 30, our portfolio totaled 38 shopping centers, encompassing approximately 4.1 million square feet of gross leasable area, geographically diversified and balanced across the West Coast. 11 of our properties, or 27% of our GLA, is located in the southern California, most notably in the Los Angeles and San Diego markets. 10 of our shopping centers are located in our northern California region, representing 28% of our total GLA, primarily in the San Francisco and Sacramento markets. Nine properties, represented 23% of our total GLA are located in the Portland, Oregon market, and 22% of our GLA is in the Seattle market where we currently own 8 shopping centers.

As Stuart indicated, demand for space across our portfolio continues to be strong, and we continue to work diligently to capitalize on this. In fact, during the first quarter, we increased our overall portfolio occupancy to a new high for the year of 92.8% as of June 30, driving our occupancy higher with another busy quarter leasing as we continue to aggressively work our properties and tenant base. In fact, the second quarter was our most active to date in terms of total GLA leased. Specifically, during the second quarter, we executed 56 leases totaling approximately 284,000 square feet. And through the first 6 months of 2012, we have executed 109 leases, totaling 457,000 square feet.

Breaking down our second quarter leasing activity between new and renewed leases. During the second quarter, we executed 32 new leases totaling 109,000 square feet, which is about double what we leased in the first quarter. An integral part of our re-leasing strategy is to proactively seek out opportunities to improve the tenant mix and cultivate embedded growth. As an example, during the second quarter, we executed a transaction whereby we replaced an anchor tenant that have been struggling for some time which we identified when we initially underwrote and acquired the property. The tenant was hanging on in part because the rent which was substantially below market. Rather than wait until the tenant lease expired, we instead lined up a new much stronger anchor tenant and worked the transaction where, one, there is no downtime between the leases; two, we received an early termination fee from the prior payment; and three, the new tenant took the majority of the space at the much higher market rent for anchor space. The net result is significant increase in the property's rental revenue, plus we now have some additional in-line space at the center, which general leases that higher rent than anchor space. And we are already in discussion with several retailers for the space.

With respect to renewal activity, we also had another very strong quarter. Specifically, during the second quarter, we renewed 24 leases totaling 175,000 square feet. Very important, during the second quarter, we renewed 5 key anchor leases including renewing several leases while [ph] schedule expiration. As a result, looking ahead, we have no anchor leases expiring for the remainder of 2012 so we have no anchor leases expiring in 2013.

In terms of in-line space, we currently have 51 non-anchored leases scheduled to expire in the second half of 2012 totaling 102,000 square feet which represents about 3% of our total lease GLA. As always, we intend to aggressively pursue releasing the space capitalizing on every opportunity to enhance the underlying value of our portfolio.

Lastly, in terms of same-space comparative numbers, cash rent increased by 10% on average for new and renewed leasing activity during the second quarter. While achieving a positive spread is important, equally important to us is securing the right mix of tenants particularly at newly acquired properties. Having the right mix of tenants and enhances consumer traffic at our centers and drive the demand for space, which in turn will enhance our ability to drive up rental rates going forward. Our strategy is to aggressively work our tenant base with the goal of enhancing not only near-term value but also long-term value at each shopping center. Now, I'll turn the call back over to Stuart.

Stuart A. Tanz

Thanks, Rich. With our strong results for the first half of 2012. We are heading into the balance of the year with good momentum. We are excited about our upcoming corporate move to San Diego. As many of you know, our team has operated successfully on the West Coast for over 25 years, acquiring, leasing and managing over $5 billion of shopping centers during that time.

Since ROIC commenced operations in the shopping center REIT in 2009, we've been the most active acquirer of neighborhood and community shopping centers on the West Coast. We have carefully built an exceptional portfolio that now totals over 4 million square feet with a solid presence in key, demographically strong metropolitan markets across the West Coast. We built our portfolio not by chasing widely-marketed deals but instead by carefully seeking out off-market transactions, many of which have unique circumstances such as stressed sellers in need of a quick, discreet transaction, or properties that have been perceived near-term leasing challenges that with our team's skill set, market knowledge and relationships, we see the opportunity to create value.

We look forward to having our full team based in San Diego and are excited about the future prospect of our business and our ability to continue delivering solid results. Now, we will open up your call for questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Craig Schmidt of Bank of America.

Craig R. Schmidt - BofA Merrill Lynch, Research Division

Just to be clear, are all acquisitions going forward going to be based on the West Coast? I mean, you're not still looking at assets in the East?

Stuart A. Tanz

Well, our focus will continue to be primarily the West Coast. However, I always want to leave open the door of doing other types of transactions. So going forward, again, the focus is the West Coast, but we won't rule out the possibility in terms of the East given that the opportunities that we're looking at.

Craig R. Schmidt - BofA Merrill Lynch, Research Division

Okay, great. And then on the purchase gain, other than a conversion of the mortgage loans to fee interest, would there be any instances where you might also have purchase gains on some of your acquisitions?

Stuart A. Tanz

I would not expect that, no. Again, directly related to those situations where we have acquired debt as well, we recognize gains.

Operator

Our next question comes from Jason White of Green Street Advisors.

Jason White - Green Street Advisors, Inc., Research Division

I have a question for you about your anchors and with the SUPERVALU news and previous A&P news and grocers struggling. Do you have any groceries in your portfolio that are giving you a hard time, that you think might have a struggle going forward?

Stuart A. Tanz

No. Not that we know of. A lot of our groceries continue to do very well and surprisingly so, we've got some percentage rent in the first quarter from a couple of groceries that was not expected. In terms of Albertsons, we have 4 centers with Albertsons in them. They account for just under 2% today of our total base rent. But the occupancy cost of our portfolio for Albertsons are only 1% or 2%, which is a very low by industry standards. So in most cases, the rents are well below the market and the sales are fine, so we're not that concerned, but we're keeping a careful eye out.

Jason White - Green Street Advisors, Inc., Research Division

Okay, that's helpful. And then you're transitioning to rent as you're out there in the market leasing some of the space. Obviously, when you acquire these properties, you acquire them a lot of times with -- at lower occupancy rates. What are you seeing in terms of rent? Are they trending upward, or are they flat? What are you seeing in the market?

Stuart A. Tanz

We're getting really good rents on the acquisitions. Typically, we're very conservative on our underwriting and we're able to exceed that on the lease up.

Unknown Analyst

Okay. And then final question, I would direct towards you, Stuart, on where are you seeing the transaction market, across the West Coast or core assets, B assets? I guess, what are you seeing out there as your market?

Stuart A. Tanz

The market. Well, our pipeline is very strong. We continue to get a lot of inquiries in terms of opportunities both off-market and widely marketed assets. On the -- for assets that are considered As, those are now trading under -- in the 5.5 to 6.5 cap range. Bs are trading in the 6 to 7 cap rate. And Cs, which we don't spend a lot of time looking at, are probably traded down about 50 to 75 basis points. So today, they're in 7.5, 8.5 range.

Operator

Our next question comes from Paul Adornato of BMO Capital Markets.

Paul E. Adornato - BMO Capital Markets U.S.

Stuart, I was wondering if I could just follow on to your last comment. Just trying to get a sense of the cyclicality of your business model, that is, right now, you're taking advantage of some great acquisition opportunities. What's kind of the next phase? Or does this rich acquisition environment kind of continue for the longer term?

Stuart A. Tanz

We're going to continue doing what we've done over the last 3 years. There's still a lot of debt that has come due in the market. And we continue to see stress in the market as it relates to sellers and their balance sheets. So the opportunities are still out there. We currently have another $50 million or $60 million under contract today. And we're very excited about what the future looks like in terms of continuing to do what we've done in the past.

Paul E. Adornato - BMO Capital Markets U.S.

Okay, great. That's helpful. And perhaps a related question. Looking at the same property numbers which continue to be very, very strong. If we were to look at the different components of that growth, could you perhaps give us a little bit of color about where that's coming from: from lease up, from existing rent coming [ph] from any other sources?

John B. Roche

Yes, Paul, this is John Roche. I would say the bulk of that is really lease up, and that portfolio we're up 120 basis points from last year. Expense control is a factor, but primarily occupancy.

Operator

Our next question comes from R.J. Milligan of Raymond James & Associates.

R.J. Milligan - Raymond James & Associates, Inc., Research Division

Quick question on dispositions and what you seeing out there in terms of opportunities to recycle out of some of the assets that you've already purchased or leased up?

Stuart A. Tanz

Sure. We continue to look at dispositions in terms of recycling capital. We do have an offer on the table for a non-core assets that we're contemplating selling at a substantial profit. The IRR on that deal could to get as high 44%, 45% if we decide to sell it. It is a non-core asset. We are leaning towards selling the asset. So we are continuing to look at value -- to maximize the value creation that we have had. As we move into the balance of the year, we're continuing to look at those opportunities depending on our pipeline and really go from there. But we are looking at potentially doing some dispositions and more importantly, to show the market about the amount of time and value that we've created for shareholders over the last several years.

R.J. Milligan - Raymond James & Associates, Inc., Research Division

And a follow-up on, I guess, Paul's questioning. In terms of the off-market pipeline, would you say that it's a greater percentage of financial distress with the owners or is it more of a -- it's a lease-up story and they just don't have the capital to put into the center?

Stuart A. Tanz

It's a combination of both, but primarily distress. It's -- one of the advantages that we've had in the market is that we have the market to ourselves for a period of time where there's been a lot of roll-down in NOI, so sellers continue to struggle in terms of meeting their debt obligations. And that's proved to be very advantageous from our standpoint.

John B. Roche

And one lease to the other because the distressed owner ultimately doesn't have the capital to reinvest in the center and ultimately impairs the asset, that we can cure in relatively short order.

R.J. Milligan - Raymond James & Associates, Inc., Research Division

Okay, and Stuart you said that you had the market to yourself for a while. Are you seeing more competition for the types of assets you're looking at, whether it be on a marketed basis?

Stuart A. Tanz

On a marketed basis, yes. Institutional capital, some private capital, certainly on the A assets where we do focus and spend a lot of time on. However, again, our expertise and our reputation in the market gives us the ability to go out and really source what I would call transactions that are not widely marketed.

Operator

Our next question comes from Michael Demaray of Elevated Capital.

Michael Demaray - Elevated Capital LLC

Can you help eliminate the decision to use the ATM versus the credit facility? I mean, given the relative cost there?

Stuart A. Tanz

Sure. We, again, maintain the flexibility of our balance sheet. It's an integral part of our business plan. And based upon the opportunities that we see going forward, we got to accretively access capital of these levels as we did selectively this quarter. Again, the net to the company on the cost on the shares issued with an excess of $12 a share.

Michael Demaray - Elevated Capital LLC

Okay, do you guys -- okay, can you give me the average price or just in excess of 12, you're saying?

Richard K. Schoebel

Then excess of 12, we will disclose that when we file the Q.

Operator

[Operator Instructions] Our next question comes from Jeff Lau, Sidoti & Company.

Jeffrey Lau - Sidoti & Company, LLC

First question just regarding I guess the relocation expenses. Is it fair to assume kind of I guess a similar number, I guess, in regards to G&A from 2011, I guess, just $3 million to $3.5 million higher or should we be going about that differently?

Stuart A. Tanz

Well, we have said $9 million to $10 million and as a function of this, it will be between $12 million and $13 million. And again, on a longer-term basis would expect to move to reduce costs on a longer term.

Jeffrey Lau - Sidoti & Company, LLC

Okay. And regarding Novato. the shopping center Novato, is there any, I guess, plan in place already about the expansions or any date or is that just kind of an idea right now?

Stuart A. Tanz

Well, this is a very exciting transaction for us, Novato. It's one of the great locations in Marin County, which is a very dense, very high income area just north of San Francisco, the city of San Francisco. So in terms of Novato, we are -- our plan there is to build out. We've got one parcel there has got -- entitled to build the 55,000 square feet of retail, and then there's another part of the site that is entitled for multifamily. We are moving ahead with the retail and we're very excited about that. We've been in the market. A lot of demand in the market, even though we disclosed the transaction a couple of weeks ago. But what we plan to do is, going forward, is to build out that part of the project and we're expecting an unleveraged yield on that 55,000 square feet to be between 12% and 13%. Again, a very exciting project in a year for, in my view, an irreplaceable piece of real estate.

Jeffrey Lau - Sidoti & Company, LLC

Okay. And my last question is just regarding the comment Rich made. I do know if it was noted anywhere if you said it. What was the underperforming anchor that was replaced with the new one?

Richard K. Schoebel

It was a Raleys up in Sacramento. I think, as many of you know, Raleys has been under some significant pressure up there.

Jeffrey Lau - Sidoti & Company, LLC

So who went in that space?

Richard K. Schoebel

It is a regional operator who is a former Food 4 Less franchisee up in the Sacramento market who has now rolled out a new warehouse concept to kind of emulate the Food 4 Less franchise that he used to run.

Operator

Our next question comes from David West of Davenport & Company.

David McKinley West - Davenport & Company, LLC, Research Division

It sounds like you've been so opportunistic in your acquisitions. Are you participating in any options at all?

Stuart A. Tanz

No.

David McKinley West - Davenport & Company, LLC, Research Division

And just one clarification. In your list of largest tenants, JPMorgan is listed. Are these all branch facilities?

Stuart A. Tanz

Correct. Yes, those are the bank branches that Chase JPMorgan have been very active in building out their West Coast presence.

Operator

We do have a follow-up question from R.J. Milligan of Raymond James & Associates.

R.J. Milligan - Raymond James & Associates, Inc., Research Division

I'm sorry if I missed this but, Richard, did you say what the leasing spreads were on the renewals in the quarter?

Richard K. Schoebel

No, I didn't. But the -- where are we. So the [indiscnerible] space cast [ph] rents from new leasing, where they were up about 34%, which is largely driven by that anchored lease in Sacramento. Renewals were down just the little bit, which was largely driven by another anchor space which a tenant was paying substantially above market, which we identified when we underwrote the property.

R.J. Milligan - Raymond James & Associates, Inc., Research Division

Is there a way to break out those 2 anchors for the new leases and the renewals to get, maybe, a normalized look at what the spreads where?

Richard K. Schoebel

It would be -- we could be broken out, but it will be fairly insignificant data point I believe.

R.J. Milligan - Raymond James & Associates, Inc., Research Division

Okay. So about neutral on both?

Richard K. Schoebel

Yes.

Operator

We do have a follow-up from Jason White the Green Street Advisors.

Jason White - Green Street Advisors, Inc., Research Division

One more question. I was curious on the in-place cap rate for your acquisitions. I realize that some of them are notes. But on purchase price, do you have an average of what that rolled up to?

Stuart A. Tanz

Yes, on average, it was about 7.5 on a cap rate basis with about 100 basis points of additional growth from primarily lease uptakes in over the next 12 to 18 months.

Operator

I'm showing no further questions at this time. I would like to turn the conference back over to Mr. Stuart Tanz for any closing remarks.

Stuart A. Tanz

In closing, I would like to thank all of you for joining us today. If you have any additional questions, please contact John, Rich or me directly. Thanks again and have a great day, everyone.

Operator

Ladies and gentlemen, this does conclude today's conference. You may all disconnect and have a wonderful day.

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