Forest City's (FCE.A) CEO David LaRue on Q3 2017 Results - Earnings Call Transcript

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About: Forest City Realty Trust, Inc. Cl A (FCE.A)
by: SA Transcripts

Forest City Realty Trust, Inc. Cl A (NYSE:FCE.A) Q3 2017 Earnings Conference Call November 3, 2017 10:00 AM ET

Executives

David LaRue - President and CEO

Bob O'Brien - CFO

Analysts

Michael Bilerman - Citi

Sheila McGrath - Evercore ISI

Scott Freitag - Bank of America Merrill Lynch

Christy McElroy - Citi

Operator

Good day, ladies and gentlemen, and welcome to Forest City Realty Trust Third Quarter and Year-to-Date 2017 Earnings Conference Call. The company would like to remind you that today's remarks include forward-looking comments that are covered under the Federal Safe Harbor provisions. Actual results could differ materially from those expressed or implied in such forward-looking statements due to various risks, uncertainties and other factors.

Please refer to the risk factors outlined in Forest City's annual and quarterly reports filed with the SEC for a discussion of factors that could cause results to differ. This call is being recorded and a replay will be available beginning at 3:00 PM Eastern time today. Both the telephone replay and the webcast will be available until December 3, 2017 at 11:59 PM Eastern Standard Time.

The company would like to remind listeners that in addition to using GAAP terminology, such as net earnings, it will be using non-GAAP terminologies such as operating FFO; FFO, net operating income or NOI, comparable property NOI or comp NOI; and net debt to adjusted EBITDA in its discussions today. Please refer to Forest City's annual report filed with the SEC and supplemental package which are posted on the company's web site at www.forestcity.net for an explanation of these terms and why the company uses them, as well as reconciliations to their comparable financial measures in accordance with Generally Accepted Accounting Principles. At this time all participants are in listen-only mode. Participants on the call will have an opportunity to ask questions following the company's prepared comments.

I would now like to turn the call over to Forest City's President and CEO, David LaRue. Please go ahead, Mr. LaRue.

David LaRue

Thank you, Derrick, and good morning everyone. With me today is Bob O'Brien, our Chief Financial Officer.

On our call with investors last quarter, we said we expected performance to accelerate in the second-half of the year as we continued to execute our strategies and transform Forest City. Our results in the third quarter reflect just that. We had a strong quarter with solid growth, and FFO, operating FFO, and comp NOI. Year-to-date operating FFOs up 13% on a per share basis, and was up 14% for the quarter. Drivers in that growth include lower interest expense, reduced overhead, growth in a mature portfolio, and contributions for new property openings, among other factors. All of these positive factors align with, and are a direct result of continued execution of our strategies by our associates.

Comp NOI growth in apartments and office was particularly strong, with increases of 5% and 4.3% respectively. Comp NOI in retail was up 0.3%, and was impacted by remerchandising at San Francisco Center that will be completed in December. Without that center, retail comp NOI would've been up 3.2%. We expect to achieve total comp NOI growth for the year in the 3% range excluding retail where, as you know, we are in the process of exiting substantially all of our stand-alone retail assets. Our year-to-date also reflects a positive impact of our efforts to drive margin improvement. Year-to-date margins on comp NOI are up 150 basis points from year-end 2016. Our adjusted EBITDA margins are up 180 points on a 12-month rolling basis, compared with year-end 2016.

We expect the improvement to continue and are confident in our ability to achieve a run rate of 400 to 500 basis points of improvement from our 2016 baseline by mid-2018. These margin improvements are being driven primarily by strong performance from the portfolio, including new properties, together with reduced overhead expense, and strategic disposition of lower margin assets in lines of business.

As we indicated in the press release, we recognized two impairments in the quarter, so let me provide context on those. But first, $10.6 million of Westchester's Ridge Hill adjusts that property to its final agreed upon value in our regional mall transaction with QIC. As you know, we announced the signing of final definitive documentation for the transaction on October 2, and then this pricing adjustment was one of the final pieces of the negotiation process. To place the impairment in context of the overall transaction with QIC, the deal values our share in the 10-mall portfolio at $1.55 billion, which represents about a 1.5% cap rate -- excuse me, 5.1% cap rate but a 2016 actual NOI, and we expect to recognize gains over time for financial statement purposes in excess of $600 million in the aggregate. So given the magnitude of the overall transaction, we agreed to make these last adjustments to reach the definitive signing.

The second impairment, $44.3 million on 461 Dean Street is a result of our recent decision to market the property for sale, which then required us to changer our long-term hold [ph] assumptions for accounting purposes. The sale of the property, which is unencumbered, will generate significant liquidity, and will also allow us to realize tax losses that we can use together with existing NOLs to offset some of the gains from the QIC transaction. We executed definitive documentation for both QIC and Madison International transactions near the end of the quarter. With QIC, we're selling six of 10 malls outright. We expect to close on those six as lender approvals are obtained over the next few months. We announced the closing of the first sales, the shops at Northfield Stapleton, on October 24. Once we close on the sale of the first six, we expect the remaining four malls to close as we secure replacement assets into which we would deploy our ownership stake.

The Madison transaction values 12 specialty centers at approximately $415 million at our share. We expect to close on the conversion of a majority of our common interest to preferred interest in the fourth quarter, and which we will close on individual centers as replacement properties are identified.

I have some additional comments before we go to Q&A, but now let me turn the call over to Bob.

Bob O'Brien

Thanks, Dave. Good morning everybody. As Dave indicated, it was a strong quarter with operating FFO per share up 14%. Let's take a look at the components of that growth and the bridge illustration that appear on pages 26 and 27 in our supplemental package. As the quarter-over-quarter bridge on page 26 shows, the largest positive impact on Q3 operating FFO was reduce interest reflecting our continued commitment to lower leverage.

We had meaningful improvement our corporate G&A/NOI most of which reduced overhead expense as we continue to focus the business and drive profit improvement and efficiency. A mature portfolio together with new properties also contributed significantly to the FFO increase in the quarter. And we had increased earnings FFO from land sales both the Stapleton and other land that we sold during the quarter.

The contributions of new properties is noteworthy. These are assets that have been recently completed are in lease up, but not yet stabilized. Just in this past year we are opened or begun phased openings of 11 properties representing more than 750 million of assets in our share. More than 2600 rental apartments and more than 300,000 sq ft of commercial GLA, including both office buildings and managerial retail associated with multi-family properties.

It's great to see this kind of pick up for new properties because it demonstrates solid execution by our development and construction teams. These new properties are making meaningful contributions to our results as we open them in our strong core markets. These are high quality products that are competing effectively achieving timely lease up and hitting or exceeding pro forma rents.

Turn back to the bridge, the positive factors in the quarter were partially offset by reduced interest capitalize to active development projects and non-recurring 2016 development fee we received related to [indiscernible] quarter and reduced operating FFO from properties we sold. Let me take just a minute to touch on the first of these offsets, reduced capitalized interest.

Net reduction reflects the completion and delivery of properties from our pipeline and into our portfolio, those contributing new properties I just mentioned. Reduction in capitalized interest is due to an overall low level of development activity and reduced risk. We indicated last quarter that we are targeting a development ratio of less than 7.5% of total assets.

Notably, our development ratio at the end of the third quarter was 5.8%. I want to highlight another milestone we hit during the third quarter. Those of you who have followed us for awhile may recall that the end of 2011 when we first implemented our strategic plan and began our transformation, our ratio of net debt to adjusted EBITDA was over 13x. At the end of the third quarter that ratio was 7.8x.

Our near-term goal is to reach a ratio of 6.5x, and we believe our demonstrated progress of improving our balance sheet evidences our commitment to and our confidence in our ability to get there. Before I turn the call back to Dave, I just ask all of you on the call reflect on the magnitude of the changes we have implemented at Forest City over the past few years.

Under David's leadership we have and continue to truly transform our company. Our results reflect a multitude of positive changes we are making, building a strong sustainable balance sheet, simplifying and focusing our business, reducing our risk profile particularly in development, driving operating margin improvements and meaningful reductions in G&A.

I believe that the actions we have taken are testament to our focus and commitment to drive shareholder value. But it's also important for me to highlight that these results were achieved and continued the execution of our strategies are being driven by a dedicated team of associates across our company. They are doing great work to drive shareholder value day in, day out as we continue to navigate significant change and are grateful for their continued commitment and professionalism.

With that, back to you, Dave.

David LaRue

Thanks, Bob. I want to echo Bob's comments on what our associates are achieving every day. As CEO is gratifying and humbling for me to lead this team of talented, creative, and committed associates, I cannot be more proud of what we have built and what we are achieving together. As always information on our under construction pipeline is included in our press release. And Bob just talked about the contributions of our new properties and our current development ratio.

We will be happy to answer any questions about the pipeline during Q&A. Along those lines, I would like to share updates on two exciting long-term opportunities we have been cultivating for some time in San Francisco, 5M and Pier 70. 5M is an arts and community-oriented district planned for four acres site in Downtown San Francisco where we are working with the Hearts organization. At completion, it will include the renovation of three historic buildings, as well as a new office building, a new multifamily rental building, a condominium building, and over an acre of new public open space. In October, the Hearst organization agreed to sell us land at 5M for one multifamily building and the office building, giving Forest City control over these opportunities. The land for the multifamily building is expected to close this year, and the office parcel in 2018.

Pier 70 is a 69 acre property owned by Port of San Francisco on city's central waterfront. Forest City is the developer of the waterfront site, an approximately 28 acre portion of Pier 70 that will include a variety of uses, including arts and creative spaces, housing, local retail, and nine acres of waterfront parks. The project passed an important milestone recently with unanimous approval by the city's board of supervisors on the first reading of our overall development plan. While we have had assets in San Francisco market for many years, these projects will significantly grow our footprint there brining additional geographic balance to our portfolio, and gives us the opportunity to do innovated urban place-making akin to what we have achieved at The Yards, in D.C., our University Park in Cambridge, or Stapleton and Denver.

As you saw in our press release, we continue to expect to achieve full-year 2017 operating FFO per share in the range of $1.50 to $1.55. We plan to update investors on our expectations for 2018 operating FFO when we speak to you again in February with our year-end results.

In summary, we are pleased with our performance for the third quarter and year-to-date. We continue to execute our strategies, and we are seeing direct benefit of those strategies and improved results, and increased positive momentum in the business. We are confident in our outlook and our ability to continue to achieve goals we have set, and continue to grow stockholder value.

Before we go to Q&A, I'd like to briefly comment on the process the Board announced, in September, to consider a broad range of alternatives to enhance stockholder value. The process is well underway, and our advisors are working closely with the Board. As you can appreciate, it is not appropriate for us to comment further on that process until our Board has completed its review, and determined a definitive course of action. For those of you familiar with such processes, this comes as no surprise.

With that, we'll open up the call for questions. Derrick?

Question-and-Answer Session

Operator

Certainly. [Operator Instructions] And our first question will come from the line of Christy McElroy, Citi.

Michael Bilerman

Hi, it's Michael Bilerman, here with Christy. So I'm not going to ask you about the progress with the status, but I do want to at least get the perspective of why you started the process. And then I had a follow-up to that. So maybe you can just talk about what drove the decision to actually begin a much more robust strategic alternatives process?

David LaRue

Well, Michael, thanks for the question. And you're right; we're not going to comment about the process. But as our press release indicated coming out of our August Board meeting, the Directors of the company decided that for our company, as it stands today, it was best to enter into this strategic review to determine the best way to enhance shareholder value for all shareholders in the company. They very much support the strategic direction the company has been running on and the progress against those strategic objectives. However they felt that it was their obligation to make sure we were looking at all opportunities for shareholder value.

Michael Bilerman

I guess when you think about what has been put out, three major verticals, right. An accelerated -- an enhanced operating plan, number one. Number two, structural [technical difficulty] facets which I assume putting [indiscernible] departments into another, or something like that, and then the third being the traditional M&A sale type process, can you at least talk a little bit about how those three work streams are being tackled, and how much time is being spent on each of them, and whether anything has precedence over each other?

David LaRue

No, we can't comment on those, Michael. Again, as the Board indicated, those options, the way you've broken them down into, strategic review, I think the press release said merger acquisition or potential. Those are the areas of review that the advisors, the Board, and the company are looking in.

Michael Bilerman

Okay. We'll requeue. Thanks.

David LaRue

Thank you.

Operator

Your next question will come from the line of Sheila McGrath, Evercore.

Sheila McGrath

Yes, good morning. Dave, I was wondering if you could give us some insight on any more use of proceeds for 10/31. I gather you're going to target buying out the partner at 5M, and so any other acquisition of JV opportunities that you're targeting with the proceeds from the retail.

Bob O'Brien

Yes, Sheila, I'll take that. As we talked about, the good news is we finalized our transaction both with Madison and QIC. Madison is what's described as a mixing bowl kind of structure. And we've begun discussions with some of our partners as well as looking at a few other assets as potential acquisitions to redeploy our current retail events then into apartment or office assets generally in the places where we have partners. And we would expect at our year-end call to be able to provide some update there as that continues forward. But the signing of those transactions obviously let us kind of give us more confidence that the retail is going to close, and therefore we have the capital that we can therefore redeploy into more legs in that acquisition and partnership interest.

The 5M transaction where we've agreed that Hearst too, they take control of the condo sites, and they [indiscernible] Chronicle building, we take control of the rental apartment building and the office building over time gives us full control. That could be or is a candidate for a 10/31 exchange from some of the QIC assets into those. That will depend upon the timing of both the closing on those assets as well as the closing with QIC and the four remaining assets that we need to finalize. So the good news is we have the retail executed, and have confidence in our ability to go now identify those replacement assets.

Sheila McGrath

Okay, and then just as a follow-up, I apologize if you've mentioned this already. On the 42nd Street retail asset, is that all buttoned up in terms of the ground lease and moving to Madison, or where does that stand?

David LaRue

No, Sheila, that is still an open issue that we are, as our investors are aware, there's the city -- we were negotiating with the city to extend that ground lease. The city filed suite on that ground lease, and we're just proceeding through that legal process, which obviously we want to get resolved as soon as possible. The deal that we have signed and executed with Madison contemplates that coming into that same structure upon completion. And it's in settlement of this ground lease issue.

Sheila McGrath

Okay. Thank you.

Operator

Your next will be from the line of Scott Freitag, Bank of America.

Scott Freitag

Hi, guys, good morning. To start, you had a strong third quarter of operating FFO and portfolio operations but kept the full-year guidance. I know you mentioned the 3% capitalized interest dispositions in some of the other items. But could you give some more color on why you kept the full-year guidance and maybe an update to the numbers around the underlying assumptions behind the range.

David LaRue

Well, why we kept the full-year guidance where it is in -- well, again, so had said throughout this year, and again you can look, I guess, at the quarterly historical trends from an NOI perspective and comments that we've made regarding the transformation and margin improvement, that those, again just to focus on NOI, has started to soften at the beginning of the year, which was a reverse from the prior year where we started very strong in that first quarter of '16. And we noted that it would be building through the year based upon strategies and efforts we were putting in place with regard to leasing efforts and as this regard to cost control. And so we see that taking affect as we had planned and as we had projected.

So as we look at where we stand today, the work that still has to be done in markets, residential in particular that have more supply coming on, we feel that the momentum is evident. We feel comfortable in our projection that again at this point they'll feel that increasing it would be appropriate action to take or methods to send to our investors.

Scott Freitag

Okay. Could you also just talk about your latest thoughts on competitive supply in your markets, and maybe what your leasing pipeline looks like across those markets?

David LaRue

You mean for the multifamily apartments?

Scott Freitag

Yes.

David LaRue

Yes, so again it's again not news to anybody on this phone or in the real estate industry that there's a supply coming into all markets. But if you look at the coastal markets and where we have a great percentage of our portfolio, there is new supply opening in all of those markets. So what we are focused on, more deals clearly with our own property, and where we sit in that submarket, and the success that we believe we can have based upon the environment, that we talk about the power of place, and the benefits of creating more than just a standalone apartment building with our assets. And that's what we believe we have done and will continue to be able to benefit from.

So we saw in the report that the pace of rental increase I think in residential is 1.2% for the quarter. And so, yes, we are having the supply impact that, as well as a slight decline in occupancy. But as we look at all of the factors that drive value and NOI, it's that focus on cost and margin expansion that's given us the, I guess, comfort to deal with the supply coming in and achieve the projected results that we have set out.

Scott Freitag

Okay. Thank you for taking my questions.

David LaRue

Thanks, Scott.

Operator

We have a follow-up question coming from the line of Christy McElroy, Citi.

Christy McElroy

Hi guys, it's Christy. Just regarding 461 Dean Street, was the motivation to sell more about the tax advantage or also about your view of fundamentals in Brooklyn and reducing exposure there? And are there any other asset sale possibilities that you can use to sort of realize tax losses to offset the QIC gains as well?

Bob O'Brien

Yes, thanks, Christy for that. It certainly should come as no surprise. We obviously are well aware that there was embedded in 461 Dean a tax loss compared to market based upon the impairment we took when we had the dispute with Skanska. This quarter's impairment really reflected the challenges of really understanding the overall cost to complete when you're taking over a job in the middle of that. But what really drove it was compelling values in that marketplace that seems to remain. The added benefit -- obviously -- those generated tax loss which certainly in my head is targeting and thinking about as we agreed to outright sell the six retail centers to QIC. And so I think that it was -- we believe we got tremendous value in that marketplace which reflects the long-term demand for multi-family property in Greater New York and in this case, specifically, Brooklyn.

As you are well aware, we continue to own real estate -- rental residential real estate in Brooklyn at [indiscernible]. We are in the process of opening the two affordable buildings at Pacific Park. So it's -- we are not backing down from our commitment to our belief in the long term in the Brooklyn market.

Certainly there is as Dave just eluded to supply issues in Brooklyn and in Manhattan overall from a residential standpoint. There is a lot of construction and lot of new units coming on line. And we think that that will have a near-term impact on rental growth. But overall, it still remains one of the strongest markets in the country and we believe in the long term.

Christy McElroy

Okay. And then just on the retail sales, I know I asked this last quarter, but I am going to try again. Now that it's closed and you also mentioned some adjustments that were made in the pricing sort of before close, maybe you could break out for us the 5.1 between Madison and QIC. Just maybe give us a little bit more color there between the malls and specialty. Thanks.

David LaRue

Yes, Christy, I think if you look at any of the component schedule, you'll see that the cap rates are almost identical or right in the same neighborhood between the two.

Bob O'Brien

So, we have identified the NOI associated with these portfolio that's now under contract.

Christy McElroy

You did.

Bob O'Brien

And you can back into it, but it is on average for each of those portfolios [indiscernible] and between them very similar.

Christy McElroy

Okay, thank you.

Operator

[Operator Instructions] And we do have a follow-up coming from the line of Sheila McGrath, Evercore.

Sheila McGrath

Yes, just on San Francisco Center that dragged retail lower because you are repositioning it. When will that cycle through that -- or stabilize that it would not be a drag?

Bob O'Brien

Yes, thanks for the question. That should be -- those tenants should be in occupancy in December. So, we will start seeing a slight benefit of that in the fourth quarter. But when you get to the first full quarter and those tenants on occupancy, that remerchandising impact should be -- should have been reversed.

Sheila McGrath

Okay. And then, just on the San Francisco developments, 5M and Pier 70, are both of those limited by Prop. M or are they like [indiscernible]? Just curious on that.

Bob O'Brien

On 5M office portion of the building that is already been allotted. It's 5M limitation so that does not -- that will not be impacted. So once we work through the final, I guess, legal issues with the legal challenge on that entitlement that site will be up and fully entitled and ready to go.

With regard Pier 70 those will have to go through the process. But again as we look at to where that starts, we have a lot of planning and investment in infrastructure before we get to, I think, significant office issues that the 5 of the Pier 70 piece of our development plan.

Sheila McGrath

And Dave, would you be looking to bring a partner into that project or get it further along and then bring a partner?

David LaRue

That's a very good question. As we look to balance the opportunity with the value that is being created by the company through this development process, we will look where we sit in terms of the progression of all of our strategies as a whole, where the market sits, where the opportunity is, and what type of partnership we could use. So -- because each of these developments 5M and Pier 70 really give us a great deal flexibility in terms of how they are structured. And again we will structure those to greatest advantage and value creation opportunity for our stockholders.

Sheila McGrath

Okay, thank you.

David LaRue

Thank you.

Operator

We do have a follow-up from the line of Christy McElroy, Citi.

Michael Bilerman

Hey, it's Michael Bilerman again. I remember 461 Dean was not in the TRS, does that complicate anything in terms of being able to use the tax loss at all?

David LaRue

Obviously, we filed to tax returns. So there is a -- we have to make sure that we are generating gains and/or losses to offset one another. So while they are complicated. We recognize where those losses are going to occur and we're pursuing the appropriate strategies to maximize the benefits from those tax losses.

Michael Bilerman

And the loss is circa $190 million or something?

David LaRue

No, I am not going to give you the tax loss. We provide GAAP statements and GAAP gains and losses. And the tax books are obviously separate. And we acknowledge what our NOLs are in the aggregate and in our financial statement, but it should approximate the GAAP impairments that we took, Michael.

Michael Bilerman

Right. Which if I remember the first one was like $146 million that's 144, so I just didn't know if I was missing something in the numbers at all.

David LaRue

No, some of the original write-off was related to the factory at [indiscernible].

Michael Bilerman

Right. And then just going back to the process, I'm not going to ask you about the progress or the status, but just you kept on mentioning the board running the process. Can you talk a little about how management is involved or not involved in this process? And I asked the question just because I know, Dave, you sort of excused yourself when the whole B share process was going on so that you and Bob can focus on running the company and manning the business. I am curious as how you guys are acting in this process that's going on?

David LaRue

Yes, so again two really different situations. There is nothing Bob or myself for the knowledge of the real estate business would have been able to add to the discussion regarding the B share in the class so that was strictly handled outside. Obviously with the review of our entire operating strategy whether to enhance and accelerate, whether to merger, whether to acquire, or whether to sell, we clearly have input and knowledge of that will be beneficial to the overall outcome of and inform the decision of the board.

What we are doing is limiting involvement for the balance of our management teams to allow them to focus on the execution of the strategy. So, yes, we are clearly involved in something that is impacting the overall business which we are responsible and run under the board's direction and under the strategy we stated. So, yes, it is a different level of involvement. But we are trying to keep it focused at the highest levels as possible. So these great results that keep coming up can be continually driven by the balance for our management team and associates across the company.

Michael Bilerman

Right. And then, just lastly typically in the situation it's not the whole board that's managing the process. Billboard is kept up to date, but it's usually a sub-committee of the board. Can you share with us who those members are that are running this process and does it involve any of the new board members like Macnab or -- hunt for name as I am thinking about it. Jamie Behar or does it involve family? So who is part of that committee that's running the process?

David LaRue

I can't comment on any of that, Michael.

Michael Bilerman

Okay, thanks.

Bob O'Brien

All right, thank you. All right.

Operator

At this time, I am showing no further questions in queue, I would like to turn this conference back over to Mr. David LaRue for any closing remark.

David LaRue

Thanks, Derrick. And then thank you everyone for joining us this morning. Our results for the quarter and year-to-date continue to demonstrate a positive impact. Our strategies and execution of those strategies are having and driving improved performance and positioning Forest City to compete, succeed, and most importantly grow the value for stockholders. As you heard me say before, we come to work everyday focused on creating value for stockholders, for associates, and for the communities we serve. That's an ongoing commitment, our pledge to fellow stockholders.

Again, I want to thank our Forest City associates for their focus, their efforts, and most importantly the achievements that come from both of those things. Thank you all, again. Have a great day, and we will talk to you soon.

Operator

Ladies and gentlemen, that concludes today's conference. We thank you for your participation. You may now disconnect. Have a great weekend.