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Taubman Centers, Inc. (NYSE:TCO)

Q2 FY08 Earnings Call

July 25, 2008, 11:00 AM ET

Executives

Barbara Baker - VP, IR

Robert S. Taubman - Chairman, President and CEO

Lisa A. Payne - Vice Chairman, CFO

Analysts

Thomas Baldwin - Goldman Sachs

Paul Morgan - FBR

Louis Taylor - Deutsche Bank Securities

Christine Mcelroy - Banc Of America Securities

Steve Sakwa - Merrill Lynch

Ambika Goel - Citigroup

Benjamin Yang - Green Street Advisors

Craig Schmidt - Merrill Lynch

Michael Mueller - J.P. Morgan

Operator

Welcome to the Taubman Centers' Second Quarter Earnings Conference Call. The call will begin with prepared remarks and then we will open up the lines to questions. [Operator Instructions].

On the call today will be Robert Taubman, Taubman Centers' Chairman, President and CEO; Lisa Payne, Vice Chairman and Chief Financial Officer; and Barbara Baker, Vice President of Investor Relations.

Now, I will turn the call over to Barbara for opening remarks.

Barbara Baker - Vice President, Investor Relations

Good morning, and welcome to our second quarter conference call. I'm Barbara Baker, Taubman's Vice President of Investor Relations and joining me on the call today are Robert Taubman, our Chairman, President and CEO; and Lisa Payne, our Vice Chairman and Chief Financial Officer. Yesterday, we released our second quarter results and our supplemental information package. Both are available on our website, www.taubman.com.

As you know, during this conference call, we will be making forward-looking statements within the meanings of the federal securities laws. These statements reflect our current views with respect to future events and financial information, although actual results may differ materially. Please see our SEC reports, including our latest 10-K and subsequent reports for a discussion of the various risks and uncertainties underlying our forward-looking statements.

During this call, we will also discuss non-GAAP financial measures as defined by SEC Regulation G. Reconciliations of these non-GAAP financial measures to the comparable GAAP financial measure are included in our earnings release and in our supplemental information. In addition, a replay of the call is provided through a link on the Investor Relations section of our website.

For our agenda today, first Bobby will be providing an overview of the quarter and the year, then he'll be discussing the company's operating statistics and our development projects. Then Lisa will discuss our financial performance and balance sheet. Bobby will return with closing comments and then we will be available for your questions.

With that, let me turn the call over to Bobby.

Robert S. Taubman - Chairman, President and Chief Executive Officer

Thanks, Barbara. Good morning everybody and welcome to our call. We're pleased with the results of our operations this quarter. Sales per square foot increased 3.3%. Occupancy was a solid 90%, in line with our forecast. Comp center NOI was also up 3.3%, largely driven by rent per square foot growth. And despite the economic slowdown, bankruptcies remain at very low levels. Nonetheless, we're disappointed to report a quarterly year-over-year decline in our FFO per share, although we're up against a record level of lease termination income last year. This combined with a delivery buildup in our predevelopment areas, especially Asia, are the principal variances in our quarter. This buildup are important investments in our future.

Now, let's talk about the fundamentals. Sales per square foot increased a healthy 3.3% for the quarter and 3.2% year-to-date. Junior apparel, fast food, and electronics were our strongest categories. We're seeing softness in women's accessories, home furnishings, and to a lesser extent women's apparel.

Like the first quarter, there are no discernible trends regarding luxury versus upper moderate centers or particular geographies. Our strongest performers were Dolphin, Westfarms, Willow Bend, and Stamford. We feel very good about our leasing activity, which continues unabated. Retailers with strong balance sheets that have confidence in their business models are making yields.

When assets are highly occupied, retailers need to be looking two years out to position themselves appropriately. This continued demand for space in our shopping centers is showing up in average rent, occupancy, and leased space statistics, all of which are strong. Rent per square foot across the portfolio, including both consolidated and unconsolidated properties, was up 4.6%. Occupancy at quarter end was 90% and leased space was 92.6%, both grew slightly from last year. This led to solid core NOI growth, excluding lease cancellation, of 3.3% on track for about 4.5% for the year. In summary, our centers continue to perform very well in a weakening economy.

Now I'd like to provide an update on our development projects. Our pipeline today is as full as it's ever been. We're very pleased to announce our participation in University Town Center in Sarasota, Florida center that will be anchored by Neiman Marcus, Nordstrom, and Macy's. Sarasota is a terrific market. It's a significant trade area of well over 1 million people. In addition, there are nearly 5 million tourists each year, and approximately 125,000 seasonal residents with second homes, most with significant incomes. Sarasota is greatly underserved by luxury retailers. This would be the first upscale center in the region. We're in conversations with all the high-end retailers and believe that we can lease this center to a significant percentage if unique to the market concepts. The retailer reaction has been just tremendous, as strong as we've seen for new assets. We're planning a fall 2008 construction start and a November 2010 opening.

Turning to other developments. At Oyster Bay, we applaud the recent court decision in which the judge definitively ruled that the town has no basis to delay our project. We encourage you to go on our website and read the decision located in the Investors section. As expected, the town has appealed. We have filed a motion to expedite the process, which if successful will likely reduce the total time to 7 to 12 months. So, absent a settlement, it's likely to be the middle of 2009 before we can begin construction. From the construction start it is less than a two-year process. As of June 30th, we have $149 million invested in the mall, up $3 million from March 31st.

At the ICSC Convention in May, we introduced several other new projects. We're particularly excited about the opportunity we're working on in San Juan. Over the years, we have looked at many sites in Puerto Rico, but getting inside amongst there is not easy. This site is owned by one of the most successful families on the island. After nearly 12 years, we are able to entitle a wonderful site for substantial retail of hotel and office. In addition, they have been able to obtain a gaming license for a 20,000 square foot casino, which would be the largest on the island. The demographics are terrific. Puerto Rico has nearly 4 million people and 2.8 million in the San Juan area. In addition, there is very little luxury kind of representation and based on preliminary discussion we believe strongly, there is an opportunity to bring a significant collection of luxury brands. We are in serious discussions with potential anchor stores, although we are not ready to make any announcements. Importantly, we are also in the process of confirming that we can reach acceptable returns on our investments.

At ICSC, we also announced M Resort. We are working with the Marnell family on a terrific mixed-use site just south of the Las Vegas Strip. The Marnell family has been the design/build contractors for more than 40 major casino projects, including Bellagio and Mirage. In addition, they've been in the gaming business for a number of years, for example they built, owned and then sold the Rio. They are equal partners with MGM in the M Resort. The site is located about 10 miles south of the middle of the strip just east of the I-15 at the St. Rose Parkway. They've got all the entitlement and have started construction on the casino and the first hotel tower of 400 rooms. It will open March 2009. A second tower of 600 rooms has already been announced.

Las Vegas has grown from about a 0.5 million people to over 1.8 million people over the past 20 years at extraordinary pace. Our site is the epicenter of the Southern growth, which we expect to continue substantially over time. Also, the richest people in Las Vegas live in the nearby Anthem and Southern Highlands communities. With the huge new international airport that is planned to the south of us, this part of the I-15 corridor will likely become the densest, most affluent market in Las Vegas within the next generation. We are in serious discussions with anchor stores and are hopeful that we can put all the pieces together over the next year or so. Both Puerto Rico and M Resort are two great examples of what we like to call good stories. But a story doesn't become real until we put a shovel in the ground. We need to work on a lot of good stories to build a single project. That's what building a pipeline is all about.

Moving to Asia, at the time of the last call, we anticipated that the partners in the Macao Studio City project will have completed their financing by now. But given the current capital market conditions, it has taken much longer than any of us anticipated. While we are not a partner in the integrated resort, we are owners of 25% of the retail space. All parties, including us, are participating in a 24/7 effort to complete the financing and move forward on the project. This delay has negatively impacted our results largely for two reasons. First, we have created the necessary capabilities to develop and lease the project, but we aren't yet collecting fees. Second, you recall when we completed our documentation in February, we made a $54 million deposit, which is in escrow until the financing is completed.

At the time, we anticipated the funds would come out of escrow quickly and then we could begin capitalizing our interest on our investments. Unfortunately, as the deposit sits in escrow, we are forced to expense the related interest. As a result, the continued delay is costing us about a penny a quarter of FFO. Meanwhile, leasing is progressing extremely well. Over half the center is committed in one form or another and the majority of tenants have posted deposit. This is the custom in Asia in order to secure locations while leases are being finalized. Based on current leasing, this center is shaping up to be the highest level of luxury merchandising in our history. Now, we just need to finish the financing.

At Songdo in South Korea, we continue to provide services as the regional mall progresses. Construction of the center has begun with the foundations, underground parking, subway connections and the like. Full construction of the mall is expected in the fall. At that point, we'll begin to recognize incremental fees. The opening date is now expected to be 2011. We're pleased with the progress of our leasing, most significantly the 522,000 square foot Lotte Department Store that we announced during the quarter. We're excited to be part of this world-class, mixed-use development. It has enabled us to build a platform in Korea and increase our flow of opportunities in this market.

Our Asia offices have continued to enjoy access to a vast pipeline of development opportunities across all the strategic markets we have identified.

Now I would like to turn the call over to Lisa, then as always I'll return for some final remarks.

Lisa A. Payne - Vice Chairman, Chief Financial Officer

Thank you, Bobby. This quarter we reported FFO per share of $0.66, down $0.02 from last year. As always, I'd like to add some color to the second quarter variances highlighted on page eight of our supplemental. Let's begin with rents. Rents were very strong, up $0.06 from last year. Occupancy was up modestly still at 90%. The real driver this quarter was rent per square foot. As Bobby stated earlier, total rent per square foot was up 4.6%.

We continued to be on target for about a 3% growth for the full year. The Mall at Partridge Creek, which opened last October, contributed $0.02 to our results. This property is very well leased and will contribute to our growth all year. Lease cancellation revenue was down $0.04 from last year's record second quarter. As we've discussed many times, this line item is difficult to predict. During the second quarter, we had collected $2.7 million and had deals for another $600,000 in July. Although we are maintaining our guidance of $7 million to $8 million for the year, we believe there is increased risk in this line item.

Other operating expenses were unfavorable by $0.06 from last year. Half of it or $0.03 was an increase in predevelopment costs. As Bobby said, this is primarily in Asia due to our infrastructure ramp up. The remaining operating expense variance was due to a number of items, including bad debt, which was abnormally low last year. General and administrative expense was also a penny unfavorable to last year due to an increase in compensation, professional fees, and travel. This is in line with our run rate of about $8 million a quarter.

Land sale gains in the quarter were approximately a penny over last year, as we had no land sale gains in the second quarter of 2007. As you know, land sales are always difficult to predict and the current financing market exacerbates this. We still believe that our $3 million to $4 million forecast for the year is achievable, but there are some risk to this line item. In light of these capital markets, we are very pleased our balance sheet is as strong as ever been. Our debt-to-total market capitalization stood at 42.2% at the end of the quarter. Our interest coverage was 2.5 times and 80% of our debt is fixed. We have no debt maturities until fall 2010. We are making the following changes to our line item guidance for the year. First, we are increasing our forecast of predevelopment expense to $15 million to $16 million. This is largely in Asia where we said the buildup of overhead has not yet been covered by fees. And second, we are increasing interest expense by $0.02 due to the delay in getting our Macao funds out of escrow, which prevents us from capitalizing interest as we previously had forecasted. Taken together, this has a $0.05 impact on 2008 results.

And with that I'd like to turn the call back to Bobby.

Robert S. Taubman - Chairman, President and Chief Executive Officer

Thanks, Lisa. As we said in our release, we are revising our 2008 FFO per share guidance to the range of $3.01 to $3.07 from $3.05 to $3.12. While lower this new range represents a growth rate of 4.5% to 7% over 2007. In summary, in light of the challenging environment, we had a good quarter. Our core continues to be strong, our development pipeline is growing and our balance sheet is in great shape. Even in this environment, we are very confident this company is well positioned for continuing growth and profitability.

Now, we'd be happy to open the call up to questions. Britney, are you there?

Question and Answer

Operator

I am, sir.

Robert S. Taubman - Chairman, President and Chief Executive Officer

Go ahead.

Operator

[Operator Instructions]. Your first question comes from the line of Thomas Baldwin with Goldman Sachs.

Thomas Baldwin - Goldman Sachs

Good morning, guys. This is actually a question for Lisa. I know that fee income is going to be an important component of your growth over the course for next few years. Can you just refresh us on your internal assumptions with regard to how you expect that fee income to be recognized as we move forward?

Robert S. Taubman - Chairman, President and Chief Executive Officer

Sure. First I'd like to say that these... this fee income is very hard to predict, I know we say it, but I want emphasize is that we saw it... we're seeing it right now with the current financing market. We're making certain assumptions about when projects are going to get started, when you're going to start collecting those fees, and the timing of recognition of fees depends very much on obviously when the project gets started and when it opens. So, there are many, many, many assumptions that go into trying to get some guidance. With having said that, internally we are projecting to get to about $35 million of fees over the period of 2009 to 2011. That's... we've now extended it out a year because of the delay that we've seen in Macao and even New Songdo, we had expected it to start earlier and now it's going to start in September. So, we're in the $35 million range and we expect given the 2009 to 2011 time frame that the peak of this fee recognition will happen in the middle in the 2010 year and then drop off. So, you'll have some next year in '09, peak in 2010, drop off a little bit in 2011 as you look at that total $35 million number.

Thomas Baldwin - Goldman Sachs

Okay, thanks a lot. And then related to the financing from Macao, perhaps you could elaborate a little bit on what exactly it is about the project that might be prompting the lenders to be a bit more hesitant than they otherwise would be apart from generalized risk aversion today in the credit markets?

Robert S. Taubman - Chairman, President and Chief Executive Officer

Well, I think you said it. I mean the credit markets are just terrible and I think all of you on the call know that. And it doesn't matter where the project is, it doesn't matter what kind of project it is, it doesn't matter what product type it is, the markets are tough. And the adjustments for people that expected one thing and are looking at another thing, sometimes it impacts their whole sort of perspective on the project. So, you've... there is adjustment going on all over the world, not just in this country, all over the world given these capital markets and yields at expected X amount of equity are now looking at multiples of X amount of equity and that adjustment is not always easy.

Lisa A. Payne - Vice Chairman, Chief Financial Officer

I'd also add that we have this project more leased from the retail perspective than when they were originally looking at the financing. So, if anything, we've proven the project. So, it really had nothing to do with the project. It is all about the capital markets that are out there. And the good news here is our partners that we have with us are... do have very good balance sheets, but as Bobby said, it takes some time to figure out kind of what structure is going to work in this financing market to get the project off the ground. But we are quite confident that with the partners we have, we are going to work through the issues.

Thomas Baldwin - Goldman Sachs

Okay. Thanks. And then just as a quick follow up, is there any possibility that in order to get the financing done, you or your partners might have to change the size or scope of the actual project or perhaps contribute more equity?

Robert S. Taubman - Chairman, President and Chief Executive Officer

Well, there is no reason at all that the program should change, but the program is absolutely correct and what it should be. And any lender, he must have looked at the program, likes the program. The issue... it's whether or not we're in a position where we would have to do something, absolutely not, but if the right opportunity showed up, we might do something. But we are focused on retail and this is a integrated resort with hotels and gaming and all kinds of things, and it's not the reason that you guys have invested in us. So, I don't want to say absolutely not, but on the other hand, it would have to be a strange set of circumstances for us to want to do that.

Thomas Baldwin - Goldman Sachs

Okay, great. My last question, just asking for a quick update on North Atlanta and how that's proceeding?

Robert S. Taubman - Chairman, President and Chief Executive Officer

We have been very pleased that we were able to get the... nearly 4 million square feet of entitlement. This is the project out, Georgia 400 and MacFarland Road, and we think it's a great site. We're working with the department stores. As I said earlier, it's a very good story. Until we bring the department stores to the site, make it all happen, it's just a story. So, we're... but we are working on it and we are very excited about it.

Thomas Baldwin - Goldman Sachs

Great. Thanks a lot.

Operator

Your next question comes from Paul Morgan with FBR.

Paul Morgan - FBR

[inaudible] looks like you are adding some new contracts that might be in sort of late 2010, 2011 window [inaudible] factor that range?

Lisa A. Payne - Vice Chairman, Chief Financial Officer

Paul, we didn't hear your...

Robert S. Taubman - Chairman, President and Chief Executive Officer

Paul, it's really hard to hear you. I think you need to get close to your speakerphone.

Paul Morgan - FBR

Can you hear me now?

Robert S. Taubman - Chairman, President and Chief Executive Officer

Yes.

Lisa A. Payne - Vice Chairman, Chief Financial Officer

Okay.

Paul Morgan - FBR

Okay. Sorry. On the development pipeline, you've added some projects that look slated for around the 2010, 2011 window or at least that might be added to that, as well as some that have been pushed back potentially to that area. I just want to get a comment on what your comfort zone is with dollar investments of deliveries in one or two-year period and how you are going to be able to stage it so that, given what's going on with individual projects, you stay within that sort of risk tolerance level?

Robert S. Taubman - Chairman, President and Chief Executive Officer

Well, Paul, I think it's a good question. You work out all these things and you'd hope that you're going to build one or two of them, and what we've talked about a lot is building one or two here and building one or maybe even two over in Asia over time. Sarasota is now on the books for 2010, we obviously are working on Songdo and Macao as soon as we can get them done. And my guess is that Macao is going to be 2010 to 2011, Songdo we just said it's 2011. We've got Salt Lake City that's coming in 2012. Then you've got the new group, that we began talking about, which is San Juan and M Resort and Duan [ph] and some of these other projects.

Unfortunately, we are not going to be able to build them all. Some of them will fall by the wayside, and we will end up building out the kind of... with the kind of program, one or two year we talked about. Now, overlaying all of that is also Oyster Bay, which we believe is going to be now a 2011 opening. So, we are... that's domestic, if you think about what's domestic and what's Asia for a minute, you got Sarasota as domestic, Oyster Bay as '11 domestic, Salt Lake City is domestic 2012, and then something else will happen. So, I think it's layering nicely, and the investments that we are making now is an investment in our future.

Lisa A. Payne - Vice Chairman, Chief Financial Officer

I'd also say number one, we are very focused on exactly what your... you've discussed here. We are not at this point concerned because, as Bobby said, you never know what's truly going to happen. And of the one Bobby just said, we are not primarily only leasing the Sarasota, the folks are with us and actually are doing the construction. So, you have two resource constraints here. One is leasing, and one is the construction/development. And you also have to look at the square footage.

In 2001, which is when we had the real bubble or a significant, the size of each of those centers and you add them up, even if you do that with everything we have going here, you are not even close. But we are focused on it and we are going to watch it carefully. And obviously we now have the international side, but we have a whole leasing department there that is doing that work. And so, really looking today, we are quite comfortable and actually like the fact that we've got this pipeline because, if anything, I worry, we're not going to have enough external growth versus that we had demand [ph] much.

Paul Morgan - FBR

Okay, thanks. And then on the... you mentioned the potential downside risk to the lease cancellation revenue, is that... is that related to retailers who are going Chapter 11 that you didn't anticipate you're going to try to negotiate with or is... what's the downside risk due to there?

Lisa A. Payne - Vice Chairman, Chief Financial Officer

Well, actually, when people file bankruptcy, we do not get lease... that doesn't really end up in lease cancellation.

Paul Morgan - FBR

As I'm saying, is it due to having tenants who weren't... who you didn't anticipate who actually are going Chapter 11.

Lisa A. Payne - Vice Chairman, Chief Financial Officer

Well, it's really because of how difficult this is to predict. I know we've said that to everybody so many times and it's coming home to root this year because we had a budget and right now we're holding our budget firm and we're still expecting $7 million to $8 million, but we're sitting here today at a total for the year of, what we said the year 2...

Robert S. Taubman - Chairman, President and Chief Executive Officer

2.7.

Lisa A. Payne - Vice Chairman, Chief Financial Officer

$2.7 million.

Robert S. Taubman - Chairman, President and Chief Executive Officer

600,000.

Lisa A. Payne - Vice Chairman, Chief Financial Officer

Right. So, we're going to be at 3.2 and really we're saying, we don't have identified deals in hand to get to that $7 million to $8 million, but we think that kind of knowing what's out there that we have a pretty good shot, so we're not changing our guidance. But it's not like we've got $10 million out there that we think we'll get to the $7 million or $8 million. It's really we'll just barely make it and if not, we may... we just rest to that number.

Robert S. Taubman - Chairman, President and Chief Executive Officer

And Paul, remember that if you look at our history, the five-year range is $7.5 million to $13 million. We were at $13 million last year and the second quarter year ago was a record quarter for us at $4.8 million. It was the best second quarter we'd ever had. This year we have $1.6 million. So, it's... and the range in the last number of years has been 1.3 up to last year's 4.8. So, you are getting a number... there are several things happening at the same time. You're having this comparison, we're having sort of a normal year, but at the lower end on the second quarter versus the highest we ever had. And we're having a lower end on the total for the year. So, it's very hard to predict. And it seems counterintuitive because you would assume in a difficult economic environment that you would get more lease termination and we are actually not. So, it's again hard to predict, but we are maintaining our guidance and we think there is some risk to it, but we think we will achieve it.

Paul Morgan - FBR

Okay. Thanks. Last question, just is there an update on Stamford Town Center and the process there?

Lisa A. Payne - Vice Chairman, Chief Financial Officer

Let me guess.

Paul Morgan - FBR

Sure.

Lisa A. Payne - Vice Chairman, Chief Financial Officer

Yes. There has been lots of interest in this center. There has been quite a few property tours and Eastdale was representing us on this. But I will say that everyone is very cautious because of the capital markets. And the marketing is ongoing, but I think today we expect to kind of make the decision by year-end. As we've said from the very beginning, we are quite price sensitive here. This is driven primarily by our partner although if we've found that we had a good price, we were willing to go along with the sale. We're very prepared to own this and manage it, the expansion is doing extremely well. I think Bobby indicated in his comments that Stamford was one of our best performing centers from a sales growth perspective this quarter. So, it has nothing to do with the asset as to this marketability, it just may be a very tough time. And so, we're not done yet, but we're coming to the end and if it doesn't sell, we're going to operate it as one of our children and be very happy. So, we should know, I would say we'd have a lot more color by the next quarter. In our numbers, we don't assume a sale, so our guidance is not assuming a sale this year.

Paul Morgan - FBR

Thanks.

Operator

Your next question comes from Lou Taylor with Deutsche Bank.

Louis Taylor - Deutsche Bank Securities

Thanks, good morning. Lisa, just a follow-up on that. Do you guys have... a last look was in the partnership?

Lisa A. Payne - Vice Chairman, Chief Financial Officer

No. I mean when I say that, the partnership is a very, very old partnership. We do not have a last look. But even more importantly, we are... the way we treat our partners here is we were very clear we had a range of pricing we were all comfortable with, very transparent with them and we said within this range we are comfortable selling, with outside this range, we're not. But no, we don't really have a classic way to look.

Louis Taylor - Deutsche Bank Securities

Okay. And then taking that a step further, in terms of that range that you would sell, if for some reason that the prices came in well below that, is there a price that you've discussed with your partner where you'd be the buyer?

Robert S. Taubman - Chairman, President and Chief Executive Officer

We haven't had a specific price discussion. I think our partner is going to have to think about what they want to do in this capital market. Would we... at some point, would there be a price we buy? Sure. We think this is a great asset. We obviously are managing it. We are leasing it. It's been our portfolio. But at this time, our real goal with our partner was to sell a 100%, but as we roll forward and go, finish the marketing, we are going to look at all options at that point.

Louis Taylor - Deutsche Bank Securities

Okay. And then just to clarify on the predevelopment cost, if you will, it sounds like it's not an issue... the predevelopment costs were high, just that you didn't get the fees to offset that, is that a fair characterization?

Lisa A. Payne - Vice Chairman, Chief Financial Officer

I'll answer that. I'll go first and then Bob. I think it is two components. First of all, we've obviously built up... we are... we have a full leasing staff in Asia that's now leasing both Songdo and Macao. So, we have more people there and we even said to all of our investors our ramp up there was to grow from like 30 to 60... it's about 60... over 50. But we hadn't gone that far, but yes, we've had ramp up in cost this year. So, yes.. so, it is not just because we didn't get fees, but we had ramped up the cost thinking we were going to start to see that was going to net down to the normal level. So costs are a little higher, and then we didn't get the fees. So it is a combination of both.

Robert S. Taubman - Chairman, President and Chief Executive Officer

Yes. And then the third thing is the Macao escrow. So, when you put those three things together, you are really looking at the $0.05 difference right there.

Louis Taylor - Deutsche Bank Securities

Okay. And then last question for Bobby. Can you just given us some color in terms of what impact you thought that the tax rebate may have had on mall traffic, May, June and any color as to so far in July?

Robert S. Taubman - Chairman, President and Chief Executive Officer

I don't think there is any question that the tax rebate did help in May, June, whether or not they continue, I don't know. Just this morning, University of Michigan that put out their consumer confidence, there was an uptick. I don't know if that's something that is going to sustain itself or not. It wasn't that long or a year ago that consumer confidence was rated above 90%. It was... went up to something like 61% or 62% this year, or this morning. We are... we are not getting push-back in any measure from our retailers. We have nearly completed our early '08 leasing and '09 is leasing very well. We are cautiously optimistic.

Leasing continues to be good, especially at the high end. Those tend to be longer term decisions as they are not opening that many stores. And we are... I think based on we were a year ago with the exception of Stanford and Twelve Oaks, where we opened the big projects. So, I think we feel good from the retail standpoint that our quarter will continue to stay in good shape and we are hopeful that the customer... the consumer stays at the party. I happen to be one that believes that we are in a slowdown, but it is not a technical recession and that this slowdown will eventually recover, whether it's six months or 12 months, [inaudible] into '09, but it is a slowdown, it's very different than a real recession. And if, in fact, all the... all the delays, it's all over everyone there from the home prices and following balance sheet and things like that. If that continues, it could be worse. So, we are being cautious. But nonetheless our sense is that we will come through this over the next six to 12 months.

Louis Taylor - Deutsche Bank Securities

Great. Thank you.

Operator

Your next question comes from Christine Mcelroy with Banc Of America Securities.

Christine Mcelroy - Banc Of America Securities

Hi, good morning guys. Can you guys just give us a little bit of additional color on the leasing environment. Can you talk about how receptive retailers have been in taking new space kind of now versus six months to a year ago. If there is a difference in demand for space at your more highly productive centers versus your lower productivity centers and if you could touch on development leasing in general a little bit?

Robert S. Taubman - Chairman, President and Chief Executive Officer

Well, as I said, I think that the leasing is doing well, we are at the same pace that we were at. When you are 90% occupied in shopping centers and 92.6% leased, the difference is largely frictional vacancy. The turning over of tenants as they come and go, it could be a little higher. Yes, but we will be a little higher at year-end. So, when you look at the sort of all of our fundamentals. When you look at occupancy, lease space sale, average rate growth, all the staff. We are not seeing... look at bankruptcies, bankruptcies are very low this year. When you look at all of those pieces of data, you have to step back and say, "We are not seeing yet in our portfolio the kind of stress that you might see in other portfolios." And I think that does speak to the high-quality of our assets.

Now, I can't speak for other companies. They maybe getting more push back. But what we're seeing is that people want to be in our shopping centers. Now with development, the good news is also the bad news. We would like to be underway with more development right now and our next big opening is Sarasota. So we only have that project that is under full lease here in this country. In addition, we are now working on Salt Lake City, it's a 2012 opening. Obviously, in Asia we are working on Macao and I already commented on that, the leasing has been spectacular. And we are just starting on Songdo now as well and very good feedback. So, part of the opportunity longer term for this company of being in two different markets is to have that diversity both from a development standpoint as well as from a leasing and an income standpoint. So, I said, we feel very confident about our company's position and platform and our balance sheet is really good and all that together makes us feel positive about our opportunities.

Christine Mcelroy - Banc Of America Securities

Are you still comfortable at this point in the 4.5% to 5% same store NOI growth that you've kind of told us in the past for this year?

Robert S. Taubman - Chairman, President and Chief Executive Officer

We said about 4.5%, Lisa did in her comments. That is the direction that... that is what we feel for the year at this point.

Christine Mcelroy - Banc Of America Securities

Okay. Great. And then just lastly following up on the predevelopment cost, is the $16 million something that we should look at is a good kind of annual run rate given all the projects that they are exploring right now or was there anything kind of one time in there that they wouldn't be repeated next year?

Robert S. Taubman - Chairman, President and Chief Executive Officer

Well, I think we've talked about it a bit. We are not yet comfortable with the $16 million level of the annual run rate. We've been talking about in the $13 million range more recently. That difference largely is the lack of the fees to offset the cost and we try to explain that in the context of Asia.

Lisa A. Payne - Vice Chairman, Chief Financial Officer

We've not done our budget for next year, but suffice it to say that our intent is to have Macao underway for sure, but we are not going to be averaging $16 million a year in predevelopment on an ongoing basis because like I said we expect Macao to be on the way and contributing fees to offset that.

Robert S. Taubman - Chairman, President and Chief Executive Officer

But Lisa has just said there will be a lot of push back on the budget, as I said $16 million.

Lisa A. Payne - Vice Chairman, Chief Financial Officer

Yes

Christine Mcelroy - Banc Of America Securities

Thank you.

Operator

The next question comes from Steve Sakwa of Merrill Lynch.

Steve Sakwa - Merrill Lynch

Good morning. Bobby, could you just talk a little bit about how you are may be changing your underwriting criteria as you look at new projects whether you're thinking about higher returns stretching out your leasing being more conservative with some other assumptions. Just help us think through how those assumptions may have changed and what kind of return hurdles are you looking for today versus a year ago?

Robert S. Taubman - Chairman, President and Chief Executive Officer

Steve, I really don't believe that our underwriting has changed. We have been talking about 9% to 10% unlevered returns, and as long as we can achieve 9% to 10% of leverage returns over a long periods of time, we think that we're going to make money. We have to look at what long-term financing cost is, what our cost of equity is and if we confine to 300 basis point spread, which at this point, we think 9% to 10% does that. Then, we think we're making very accretive investments both in the short and in the long term.

Now when you talk about financing today and what does it take to finance, say Sarasota today. We're in the market, we are just beginning in the market right now. There is no question that the equity requirements of buildings say Millennia, which we built with this partner. We opened in 2002. We had something like 15% or 20% equity requirements with no guarantees of repayment, but guarantees to complete, the sort of the normal historical kinds of construction financing. There is no question that Sarasota is going to require greater levels of equity in order to get this thing built. It's a great asset with great market with great anchors and great... good sponsors. So, we believe that we are going to get the best deal out there. So should we in fact change our 9% to 10% because the equity requires... may require a little bit more in this cycle of this economy at this moment in time. I see it passing yes. But at the end of the day, when a window of opportunity opens up to build a shopping center, with Neiman's, Nordstrom's, and Macy's in a market like Sarasota, you're going to get this thing built because you're going to build an awful a lot of value for our shareholders.

Steve Sakwa - Merrill Lynch

Okay. So it's fair to say the ROE in theory could be a little bit lower on this deal just given the debt markets?

Robert S. Taubman - Chairman, President and Chief Executive Officer

I think that's fair to say, yes.

Lisa A. Payne - Vice Chairman, Chief Financial Officer

In the short-term, we're hoping on a stabilized financing basis, which is many years from now. We never finance our project at the crazy multiple that were being done. So we still feel very good that we're going to be at about 10 times EBITDA kind of number. We're not going to be at 15 times EBITDA at a permanent financing, but at that level, we're still going to get a very good ROE over a period of 10 years. You can't just look at the construction financing as which is really where I think, you've got the most difficulty right now as your ROE.

Steve Sakwa - Merrill Lynch

And Lisa, I guess what are the discussions like with basically the banks as you're kind of going through, trying to get construction financing?

Lisa A. Payne - Vice Chairman, Chief Financial Officer

I think, I am very interested in how we're going to go. Sarasota is going to be the first big test for us Steve and we literally just have books put together. So, I think we're going to be very happy. I've read, you know the various ones that have been done recently. I think, you've got a little of a different, number one this project when you have the anchors we have is this is a totally spec office building that has been attempted to be financed. But having said that, typically we've been at 75% to 80% of cost. We've said that before to you. I expect... I'm hoping we can achieve... to achieve that. If we can't we have plenty of capital to put in. So I do think we're going to see a real judgment here as to how the banks are looking at regional mall development, financing, because this will be the first one that's been financed in this market.

Robert S. Taubman - Chairman, President and Chief Executive Officer

And I would also comment that our partners are too very successful.

Lisa A. Payne - Vice Chairman, Chief Financial Officer

Great sponsorship.

Robert S. Taubman - Chairman, President and Chief Executive Officer

Very successful private owners. These guys aren't looking at tomorrow's numbers. They're looking at the way down the road. And these guys are very successful because they've done that. They're not looking at the vagarities [ph] of the... of any economic cycle. They're saying we're building a great asset here that we're going to own forever, and that's how we feel it. So this is a great market, this is going to keep growing and we are just delighted to be part of this asset.

Lisa A. Payne - Vice Chairman, Chief Financial Officer

I want to make it. We also always do completion guarantees that have a burn off at certain debt service coverages. I am expecting we're going to... some people actually try to get non-recourse construction financing. That's not been our practice and I think today that market is not there. The question is when does the burn-off happen and how quickly et cetera? But I think all those are the terms that we are going to be negotiating, but with a very good project and very good sponsorship.

Steve Sakwa - Merrill Lynch

And do you think you'll have that done in '08 or is that build into next year?

Lisa A. Payne - Vice Chairman, Chief Financial Officer

I think... we're not in any big rush, but I would say by the end of '08 we should have it in, I'm expecting to be. But I'm not looking... I don't take it as if it turns into first-quarter it's a big problem. I think it will depend on the pacing of the project, and the Forbes is doing the... the Forbes Group along with us are doing the financing together. They're taking the lead, but we're working very hand in glove. And so I would expect to be done by the end of the year.

Steve Sakwa - Merrill Lynch

Okay. And then just one other question. Could you just maybe update on the peers down in Atlantic City. I known there were some leasing to do up on some of the top levels. Have you made progress there and how would you characterize kind of the leasing season in the summer sales season there?

Robert S. Taubman - Chairman, President and Chief Executive Officer

We have made progress there. And we now have about 90 stores open, especially the first and second levels are all leased, I mean maybe there is one or two stores there that are open. Caesars, Atlantic City is the market is obviously down, it's a combination of the drive-in market as well as the... Philadelphia, Pennsylvania casino stuff. But Caesars is doing better than the market, and then those numbers you can see on a monthly basis.

As I said, we have made progress on third and fourth floor. We recently executed a lease for a very large event venue that's 23,000 square feet that's called One Atlantic, which is a terrific tenant that's... it's going to be catered by a very well known chef, Jon Weinrott who runs an operation called Peachtree & Ward out of Philadelphia, and they are going to be opening in spring 2009. We are also finalizing with a very significant 17,000 square foot night club operator now, and the combination of those two things above 40,000 square feet will... we think make a big difference up there around that third and fourth level. So, I think that generally, we continue to be long-term optimistic in the assets. Obviously, the market is experiencing a slowdown, given the price of gasoline and all that right now, but there is very significant investment that's being pumped into that market, that's going to go forward and that will create the continuing growth and destination that it's in.

Steve Sakwa - Merrill Lynch

Okay, thanks.

Operator

Your next question comes from Michael Bilerman with Citi.

Ambika Goel - Citigroup

This is Ambika with Michael. Could you give some color on the rents that you are getting at Sarasota. I was just looking at the cost per square foot of the project and it seems fairly high. I just wanted to see how you're getting to those development yields?

Robert S. Taubman - Chairman, President and Chief Executive Officer

Well, we haven't...we don't comment usually on rent per square foot of individual assets. We do believe that the sales productivity, opportunity of this asset will be very high. And when you think about a center, you look around the United States centers that have Neimans, Nordstroms, and Macy's as anchors, it's not unusual to see centers like that doing well over $600 a square foot. So, we would hope certainly that this center would be able to do that kind of volume and perhaps even more, but we think again it's a terrific center and a terrific market and we think that we will achieve very, very strong rents in this location.

Ambika Goel - Citigroup

Okay, great. And then on the predevelopment expense, should we be... when you mention that the Macao fees were supposed to offset the domestic and non-U.S. development charge. Should we be thinking of the management income, net of the domestic and non-U.S. development charge and so... and that number on a net basis, is there kind of a cap that you're trying to limit it at?

Lisa A. Payne - Vice Chairman, Chief Financial Officer

I'm not sure. I think I need more clarity to your question because we don't want to answer the wrong question. So, if you could run by it again, what do you mean by management fees? I mean the line item includes management and development fees, leasing and development fees for third parties.

Robert S. Taubman - Chairman, President and Chief Executive Officer

Ambika, are you talking about essentially... the fees that we're talking about are really reimbursement for cost that we have, that are costs that we're incurring right now. As we built up our leasing department, built up the ability to file construction and new tenant coordination and all that stuff, those are people that we brought on that we would expect to get reimbursement for, but because the financing is not closed, we're not getting the reimbursement fees. That's really the difference that you're seeing in the several cents of cost and build it up in the pipeline.

Ambika Goel - Citigroup

Okay, so just on the income statement, on the fees, the income statement, where would we see those fees running through, the management income line or the development charge line?

Lisa A. Payne - Vice Chairman, Chief Financial Officer

The development charge line.

Ambika Goel - Citigroup

Okay. And then is there, given what's going on in the economy and you're seeing some slowdown globally, are you trying to limit that line item to a certain level?

Lisa A. Payne - Vice Chairman, Chief Financial Officer

Well, wait, let me just say, right now the costs are building up the infrastructure there. It is in other operating expense, as is our predevelopment charge, the whole predevelopment cost of Asia and the U.S. is in other operating expense and we expect it to be now $15 million to $16 million, up from around $13 million. When we get fees and the projects going, then the fees go through third-party leasing and development with offsetting costs and so the net fee is up there, just like now we do the same thing in Woodfield for Woodfield, Salt Lake City, any of those. Okay. So, the way we've been budgeting is, what we try to do is keep predevelopment charges, which is going to other operating expense, domestic and Asia. We said we were trying to hold that to $13 million and we felt good with that number, both combining U.S. and Asia. It's grown to $16 million because we thought we were going to flip and the Macao piece was going to... going to be now a fee generator up in the third-party line with costs allocated to it, which would have reduced the $16 million down and we would have gotten revenue up there and the net, we probably would have gotten the net margin of some, a positive margin, but for sure the costs we are going to get covered.

Ambika Goel - Citigroup

Right.

Lisa A. Payne - Vice Chairman, Chief Financial Officer

So, when you ask what we are... we're trying to hold predevelopment to the $13 million number.

Ambika Goel - Citigroup

Okay. So, as you continue to build out the platform, you just think that you can limit it at $13 million because you will have additional fees coming in?

Lisa A. Payne - Vice Chairman, Chief Financial Officer

We're going to get fees from New Songdo, which also haven't been reported yet because right yet the project hasn't gone off the ground and we're just covering at a multiple payroll there, but we are going to get more fees when the project starts in September and we're going to have Macao. And the third-party revenue, which we've discussed of $35 million over the next three years, certainly we feel with those projects going that we'll be able to keep predevelopment at $13 million.

Ambika Goel - Citigroup

Right. And then at New Songdo, is that agreement basically set at this point, once you do start development in September?

Lisa A. Payne - Vice Chairman, Chief Financial Officer

Yes. We have a fully executed agreement. It's all about timing of when they start. That project, the partner has informed us they have the financing, they've left the contract. It's now just a matter of... the fees get triggered when they actually put a shovel in the ground, which we believe should be in September.

Ambika Goel - Citigroup

Okay. And then taking an interest in New Songdo, has that been finalized, if that's going to happen yet or not?

Robert S. Taubman - Chairman, President and Chief Executive Officer

No. It has not yet been finalized. As we said before, we continue to negotiate with them about an investment there, and when we are able to announce something, we will. It's... obviously, we have a great profitable management agreement here, but that's not why we are doing all this. We want to get an investment in this project and we are negotiating to that end, and as the financing has now been solidified, I think it will be... our ability to finalize that will now... is now in front of us.

Lisa A. Payne - Vice Chairman, Chief Financial Officer

I do want to... this is a good thought [ph] for me just meant to emphasize, it is in our Q and we disclosed it that the $35 million of fees is today, assuming we don't take an equity interest in Songdo. Any time you take in an equity interest, obviously you don't get fees recorded for your interest. The reason we're showing it is number one, we don't know if we're going to take an equity and just number one. Number two, we don't have any clue how much of an equity interest we're going to have. So, the disclosure today is assuming no equity interest. It obviously records the equity interest we have in Macao because we know that, and so the fees represents what our net equity is there impacted for our equity position. If we do a Songdo deal that has equity, it would reduce the profitability on fees, but we would still rather have the equity position than just fee income.

Ambika Goel - Citigroup

Right. That makes sense. And then, can you give some color on the cost of financing for New Songdo?

Robert S. Taubman - Chairman, President and Chief Executive Officer

No. I don't think that we can... it's not our... it's not appropriate for us to comment on our partner's financing.

Ambika Goel - Citigroup

Okay. Thank you.

Operator

Your next question comes from Ben Yang of Green Street Advisors.

Benjamin Yang - Green Street Advisors

Good morning. Bobby, earlier in the call, you talked about seeing no discernible sales trends geographically. And you also mentioned a few malls that were doing particularly well. I don't know if I caught a mall, but it didn't sound like anywhere located in Detroit or Florida. Are those particular markets holding up as well, given the challenges that they face?

Robert S. Taubman - Chairman, President and Chief Executive Officer

Actually, one of them was in Florida, which was Dolphin. We mentioned Dolphin, Westfarms, Willow Bend, and Stanford, as the four assets that are at the top of the heap. I will say that Florida generally is weaker just as you've said and Michigan is weaker. We said on the first call that Michigan was not performing at the same level as the others. Having said that, Michigan, two out of three of our assets here are actually in positive territory for the second quarter. So, it's now like a huge disproportionate difference and I remind you that both Partridge Creek and Twelve Oaks leased very well and the returns are strong. So our sense is that not withstanding the storm that is in Michigan. We are weathering it pretty well.

Benjamin Yang - Green Street Advisors

And then for Florida, how many of those assets are reporting positive sales growth during the second quarter?

Robert S. Taubman - Chairman, President and Chief Executive Officer

Well, I don't think we've been specific in the past as exactly how many and we did mention Dolphin. I don't think there is significant difference to the rest of the portfolio, but it is weaker.

Benjamin Yang - Green Street Advisors

Thank you.

Operator

Your next question comes from Craig Schmidt with Merrill Lynch.

Craig Schmidt - Merrill Lynch

You've reported that Willow Bend was one of the properties that had stronger sales gains and you have been talking how that property has been doing better. I'm wondering what sort of quartile it would sit in now in terms of sales per square foot in regards to the sales productivity?

Robert S. Taubman - Chairman, President and Chief Executive Officer

Well, I think that we'd still certainly be in the lower half. I don't want to get specific as to quartile, but it would certainly be in the lower half. The increases for some time have been above the portfolio average and we have about 150 stores opened there and the Dallas economy is very, very much on the upswing and we feel like we're finding the right solutions there as we are long-term bullish on Dallas, we're long-term bullish this specific market in Dallas, the North Dallas market and we think we have a very good asset that overtime will in fact prove out all of our efforts with it.

Craig Schmidt - Merrill Lynch

Okay. And in Songdo Shopping Center, the Lotte Department Store, will they own their property or are they leasing that?

Robert S. Taubman - Chairman, President and Chief Executive Officer

They are leasing it.

Craig Schmidt - Merrill Lynch

Okay. Are there any other anchors that would be anchorage would be in addition to that 522,000?

Robert S. Taubman - Chairman, President and Chief Executive Officer

Yes there are two other, what we call anchors that will be going in, one will be a hypermarket and one will be a very large movie theatre. We are not yet able to make any announcements on those two things, but we hope in the near term that we will be able to.

Craig Schmidt - Merrill Lynch

Okay. Thanks a lot.

Operator

Your next question comes from Michael Mueller with J.P. Morgan.

Michael Mueller - J.P. Morgan

Hi. Just a couple of quick housekeeping items. First Lisa, what does guidance assume for the timing of actually getting the Macao financing?

Lisa A. Payne - Vice Chairman, Chief Financial Officer

At the present time, we are not assuming any additional fee income from Macao here. So, we are hopeful it happens faster than that, but for purposes of our guidance, we are not recording any income and mostly it's because... look I assume they are actually going to get the financing sooner than that, but then the contractor has to get... there is a lot of things that have to happen. So, for conservative purposes, we've eliminated it from income this year and that's what drove the $15 million to $16 million guidance for predevelopment expense.

Michael Mueller - J.P. Morgan

Okay, great thanks. And then, with respect to the third quarter, is there any thing known at this point, in terms of significant gains or lease term that should be hitting in the quarter?

Lisa A. Payne - Vice Chairman, Chief Financial Officer

We don't have, I mean it is suffice to say we have some pipeline, which is why we are maintaining guidance. And so, we are expecting to have lease cancellation enough to get to the $7 million to $8 million in the next two quarters. So, there should be some nice numbers, but I don't have any specifics to give you.

Robert S. Taubman - Chairman, President and Chief Executive Officer

Lisa did mentioned in her comments that we do also, in addition to the $2.7 million that we have through the second quarter, we did announce another $600,000 that we know about in July that we've closed down. So that $3.3 million at this point plus what Lisa just said about what's in the pipeline?

Lisa A. Payne - Vice Chairman, Chief Financial Officer

Well we need to get... we need another $4 million to $4.5 million, which we would expect to come in over the next two quarters.

Michael Mueller - J.P. Morgan

Okay, thank you.

Operator

[Operator Instructions]. There are no further questions at this time, are there any closing remarks?

Robert S. Taubman - Chairman, President and Chief Executive Officer

Thank you, Britney. We are delighted everybody to join us and again we feel good about the fundamentals in the business. We're delighted about Sarasota and we're really delighted about our Oyster Bay ruling. So, we look forward to talking to you in the rest of the quarter and thank you again for joining us. Bye-bye.

Operator

This concludes today's conference call. You may now disconnect.

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Source: Taubman Centers, Inc. Q2 2008 Earnings Call Transcript
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