Forest City Enterprises Inc Class A FCE.A
Q1 2013 Earnings Call Transcript
Transcript Call Date 06/04/2013

Operator: Welcome to Forest City Enterprises First Quarter 2013 Earnings Conference Call.

The Company would like to remind you that today's remarks include forward-looking comments that are covered under 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 7.30 p.m. Eastern Time today. Both the telephone replay and the webcast will be available until July 4, 2013, 11.59 p.m. Eastern Time.

The Company would like to remind listeners that it will be using non-GAAP terminology, such as operating FFO, FFO comparable property net operating income and pro rata share in its discussions today. Please refer to the Forest City's supplemental package, which is posted on the Company's website 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 a listen-only mode. Participants on the call will have the 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 J. LaRue - President and CEO: Thank you, operator. Good evening, everyone. With me today is Bob O'Brien, our Chief Financial Officer. Our results for the first quarter went out after the close of the market today. As most of you are aware, our usual practice would have been to hold this call tomorrow at 11.00 a. m. Easter Time. In order to allow us to participate in NARIET REITWeek Conference, which begins tomorrow morning in Chicago, we've accelerated our filing of our quarterly results and this call.

Let me begin today with a recap and comments on two announcements we made within the past several days. At the end of last week, we issued notice that we will terminate put rights on remaining $61.1 million of our outstanding 3.625% Puttable Equity-Linked Senior Notes due 2014, effective June 20, 2013.

As you may know, under the terms of the indenture for these notes, if our stock maintained a volume weighted average price at or above $18.90 for 20 days and a 30-day period, we had the option to terminate the holders put rights. We reached that 20-day mark last Thursday and issued notice of the termination. Owners now have until June 20 to put their notes to the Company and receive approximately 69 shares of the Company's Class A common stock per 1,000 principal amount of notes together with cash for interest payable through October 14, 2013.

Yesterday, after the market close, we issued another important announcement that advances our strategic goals and objectives. We announced an agreement to create a strategic capital partnership with QIC, one of the largest institutional investment managers in Australia, to form joint ventures to recapitalize and invest in a portfolio of eight of our regional malls. The transaction values eight properties at a total of approximately $2 billion representing a cap rate of approximately 5.75% on projected 2013 net operating income. At closing, we expect to raise cash of approximately $330 million after transaction costs, and we expect the joint ventures to close in the third quarter.

Under the agreement, we will contribute our ownership interest in each of the properties to joint ventures and QIC will contribute cash to acquire a 49% interest. We will be the managing member of each of the joint ventures and will continue to be responsible for leasing operations, financing and asset management at the centers.

We are excited about this transaction for a number of reasons. It partners us with a well-respected global investor as we continue to maintain, upgrade, and improve these great assets. It's also another example of our strategy of securing capital partners to invest with us in both existing assets and new opportunities. This transaction also validates the tremendous value of these properties and allows us to unlock a portion of that value.

We plan to use the majority of the liquidity generated by the joint ventures to further our deleveraging efforts. This transaction does not change our current objectives regarding the sale of assets in non-core markets. We continue to pursue this opportunity to focus our portfolio and raise additional liquidity.

Together, the put termination and the QIC joint ventures represent further acceleration of our efforts to reduce debt and identify strategic capital partners.

Now, let me turn to some comments on the first quarter. As we have discussed with investors on past calls, our first quarter FFO and operating FFO saw results of the impact of decreased capitalized interest as we have reduced the size of our under construction pipeline. Investors' recall that at this time last year we just opened Lord & Taylor at Westchester’s Ridge Hill. The final phased opening was continuing at 8 Spruce Street in Manhattan and the construction was nearing completion on Barclays Center. This year with these three major properties fully online and operating but not yet stabilized we are seeing the impact of the increased interest expense, which was previously capitalized. In the first quarter, the FFO decrease from lower capitalized interest was $15.7 million.

Turning to net operating income, three primary factors impacted our comp NOI results for the quarter. In retail, comp NOI was basically flat and was impacted by the timing of vacancies in our New York specialty retail portfolio as well as by renovation and remerchandising initiatives at our regional malls. In the office portfolio, comp NOI was down driven mainly by vacancies at One Pierrepont Plaza in Brooklyn. And in residential, comp NOI was up modestly but was dampened primarily by underperformance of our apartments in non-core markets.

Let me offer a little color on each of these. In our New York specialty retail portfolio we made a decision to buy out the leases of an underperforming retailer with locations at Atlantic Terminal and Queens Place in order to remerchandise with higher quality and more productive tenants. At Atlantic Terminal, which is adjacent to Barclays Center, we already have signed leases for the vacated space at rents well above those of the lease that we bought out. However, timing was such that the spaces at both locations were vacant in the first quarter and our results reflect that impact.

In our regional malls, comp NOI was up as was our rolling 12-month sales per square foot. Our results also showed the timing of impact of renovation and remerchandising initiatives. These investments will expand and improve our tenant mix enhance customer experience and ensure that the centers remain highly competitive going forward.

Our office segment saw decreased comparable net operating income primarily due to vacancy at One Pierrepont Plaza, Brooklyn.

This is 200,000 square feet of vacant space. As discussed during the New York Property tour we continue to be encouraged by the level of activity and interest in the Brooklyn office market and the prospects to lease up this space.

Our residential comp NOI was up but results were below peer averages. As I mentioned under performance by apartments in non-core markets was a major contributor to this lower growth. Seasonal factors including increased utility and operating expenses, due to the harsher winter in several markets contributed to that under performance.

Bob will provide more detail on our results. In summary despite a mixed first quarter of many moving pieces we continue to see solid underlying fundamentals across our portfolio and in our core markets. As we indicated in our press release we are confident in our outlook for the balance of 2013.

With that let me turn it over to Bob.

Robert G. O'Brien - EVP and CFO: Thanks Dave. Good evening everybody. On today's call you'll be referring to our results and our earnings release and supplemental package, they are available through our SEC filings as well as in the investors section of our website. I'll focus most of my comments on results for operating FFO a metric we introduced in 2012.

We believe operating FFO provides investors with additional information in how our core operations are performing by removing transactional one time and non-recurring items that tend to distort total FFO for any given period.

A bridge depicting operating FFO results for the quarter can be found on Page 25 in the supplemental package. Looking at the bridge, you can see the primary factors impacting operating FFO in the quarter. We had a $3.1 million FFO pickup from new property openings. This was offset by reduced FFO of $3.1 million from property sold, $3.4 million as a result of lower NOI at One Pierrepont Plaza, and $3.9 million in other FFO, primarily as a result of higher overhead expense as the size of our construction and development pipeline has been reduced. As we ramp development back up, keeping it within the 15% target we set for ourselves, the majority of that overhead will again be capitalized to new projects.

As Dave mentioned earlier, the largest factor impacting our operating FFO results for the quarter was decreased capitalized interest of $15.7 million. Again, this is a function of the transition to reduce the pipeline. We expect the total FFO impact of reduced capitalized interest in 2013 to be roughly $35 million. As you can see from our results, approximately, half of that expected impact came in the first quarter.

Finally, our Corporate segment had an operating FFO decrease of $3.3 million primarily from increased interest expense formerly allocated to our Land Development Group. While we're speaking of land, I want to mention that during the quarter, we reached an agreement with our partner at Mesa del Sol, Covington Capital and with Mike Daly, a former Forest City executive, who ran that project for us. Under the agreement, we expect to transfer our ownership interest to Covington and Mike over the course of the next year. This will generate a small amount of cash and allow us to completely exit the project at the end of that time period. Mesa is the final element in lands held for disposition and we're pleased to have reached this agreement, while also allowing the project to move forward under a new ownership structure.

Turning to some of our operating metrics for the year, overall comp NOI decreased 1.9% during the first quarter compared with the same period in 2012, with increases of 1.7% in apartments, 0.5% in retail, and a decrease of 6% in office. Dave discussed the primary factors contributing to these comp NOI results and our press release and filings provide additional detail. It won't take time to comment further, but we can address any questions during the Q&A.

I do want to echo Dave's comments, however, that we are confident on fundamentals of our business and the outlook for 2013 results. Part of our confidence can be seen in other key operating results for the quarter, including stable occupancies, strong lease rollovers, and continued rent growth in multifamily.

At April 30, our comparable retail occupancies were 91.7% compared with 91.8% for the first quarter of last year. Regional mall sales averaged $476 per square foot on a rolling 12-month basis, up 4.4% from last year's first quarter. And new same space leases in the Company's regional malls increased 14.7% and more than 385,000 square feet on a rolling 12-month basis.

In the Residential portfolio, comparable economic occupancies for the first quarter were 94.5%, up from 94.2% last year. Average monthly residential rents in our comp apartments in core markets were $1,673 at the end of the first quarter, a 5.2% increase from 2012. Average monthly rents across all of our comparable apartments rose 4.1%.

As you can see from these measures, revenues grew nicely in this segment during the quarter, but results were impacted by increased expenses, as Dave alluded to earlier. Comparable office occupancies were 91% at the end of the first quarter compared with 91.9% last year. On a rolling 12-month basis, rent per square foot and new office leases increased 10.9% over expiring leases. I should point out that this pickup was driven primarily by a single large lease renewal at our University Park at MIT life science office park in Cambridge. Absent this lease, renewals in office were basically flat, in line with industry trends and economic conditions that continue to put pressure on the office market.

Now let me recap some of our financing and capital markets actions during the quarter. As part of our strategic driver to improve our balance sheet and debt metrics, we executed an exchange of $138.9 million of our 3.625% Puttable Equity-Linked Notes due 2014 for Class A common stock and cash; we also redeemed remaining $53.3 million of our 7.625% Senior Notes due 2015. As Dave mentioned earlier last week we announced a put termination on the remaining $61.1 million of the 2014 notes effective June 20, 2013.

Assuming substantially all of those holders puts their notes to the Company that's a total of approximately $250 million in recourse debt taken off the balance sheet between the 2014 exchanges, 2015 redemptions and now the put termination on the remaining 2014's.

In addition we also converted to redeem remaining shares of our 7% Series A preferred stock during the first quarter. With the substantial portion of the $330 million of liquidity we expect to generate from our capital partnership with QIC earmarked for debt reduction we are positioned to accelerate our deleveraging strategy even further.

Before I turn it over to Dave, let me just remind everyone again that we will be converting to a calendar year-end at December 31 of this year. We will report an 11 month transition year for 2013, including a two month stub period for November and December. Beginning January 1, 2014 we will commence reporting on a calendar year basis.

With that let me turn it over to Dave for an update on the pipeline and some closing thoughts.

David J. LaRue - President and CEO: Thanks Bob. As we said before all of our efforts including those that Bob just outlined are establishing a stronger company with solid foundation for future growth. As we continue our efforts we expect to see some volatility in our results quarter-to-quarter as we did in the first quarter of this year. We are confident in the strength of our portfolio and optimistic about the future.

Let me turn now to an update on our pipeline. Our press release and filings provide details. Let me just hit some of the highlights. At the end of the first quarter, we had eight projects under construction at a total cost of $350.9 million at our pro rata share or $435.1 million at full consolidation. That level is well within the 15% target we've established for projects under construction and development, giving us room to prudently add additional projects from existing entitlement or from new developments in core markets as opportunity in the markets dictate.

During the first quarter, we opened the Continental in Dallas at our Mercantile Place on Main development. Continental is a 203-unit, adaptive-reuse apartment community. First move-ins were in March and the property is 28% leased, on pace with our projected lease-up schedule.

Also in Dallas, construction continues on 3700M, a 381-unit multifamily project in uptown area of Dallas. Initial phased opening is expected in the third quarter of 2014. In mid-May, we announced the capital partnership with AIG Global Real Estate to share ownership and fund the equity requirements for 3700M.

Work continues on B2 BKLYN at Atlantic Yards which is being built using modular construction process in partnership with Skanska USA. 32-stoery tower will have 363 units, half of which will be reserved for low, moderate and middle-income households. Work on the foundation is underway and production of modules is expected to begin mid-summer at the factory at the Brooklyn Navy Yards. We expect B2 to be completed in the second quarter of 2014. B2 is the first asset included in our $400 million strategic capital partnership with Arizona State Retirement System. As a reminder, we expect that fund will drive total of approximately 1 billion multifamily development across five of our core markets. During the quarter we commenced construction on 2175 Market in San Francisco, the second asset to be part of the ASRS fund. We expect this 88 unit apartment community will be completed in the third quarter of 2014.

At The Yards in Washington, D.C., construction continues on two projects. The first is Lumber Shed, an adaptive reuse office building with street-level retail which we expect to be completed in the third quarter of this year. The second project is Twelve12, an apartment/retail project with 218 rental apartments above grocery and fitness facility. Twelve12 is expected to be completed in the third quarter of 2014.

In Denver, work continues on Aster Conservatory Green, our newest apartment community at Stapleton. The project will have 352 units and is our first multifamily project north of I-70 at Stapleton, taking advantage of the new interchange that opened in 2011, which substantially improved highway access and opens the northern portion of Stapleton for future development.

In Boston, construction continues on 120 Kingston, a 240-unit apartment building located on the Rose Kennedy Greenway near the border of the city's financial district and Chinatown neighborhoods. We expect completion of 120 Kingston in the second quarter of 2014.

Let me provide a brief update on Westchester's Ridge Hill and Yonkers. As you can see on our pipeline this quarter, we achieved 70% lease-up at this center, including an expansion to the anchor Lord and Taylor. Legoland Discovery Center and UNIQLO opened during the quarter. Many of the tenants that are open report that they are hitting or exceeding plans and seeing sales increases month over month on a comp basis where applicable. Current leasing momentum is picking up as we continue to target full stabilization in 2015.

I'd like to add a few additional comments regarding ICSC RECon that just happened in Las Vegas two weeks ago. ICSC estimated attendance at 33,000, which is up approximately 10% over the prior year. The feel of the convention was the most optimistic since 2008. This contrasts sharply with prior years and as evidenced we had no discussions including rent relief or store closings. Forest City had approximately 320 meetings with retailers that were interested in our properties. Again, we think this was a very successful convention.

Let me conclude by saying that we strongly believe in the quality of our retail portfolio, our strategic direction as a company, and the skill and creativity and determination of our associates. As we've said in our press release, we remain cautious as it relates to the economy and other factors outside of our control, but we are confident in the strength of our business and our ability to achieve solid full-year 2013 results.

With that let's take some questions. Operator?

Transcript Call Date 06/04/2013

Operator: Samit Parikh, ISI.

Samit Parikh - ISI: One question I had for you was in the retail portfolio you've been talking a lot about remerchandising that’s occurring and I know what happened with the specialty retail centers et cetera. Is this something that you think will be an ongoing sort of negative hit to same store NOI for the entire 2013 that will be a positive momentum for '14 or is this something that’s really just first half of '13, and you'll start seeing the benefits in the back half?

David J. LaRue - President and CEO: I think it differs across the portfolio I can note one is example for at Sunset Gallery at Sunset Henderson, Las Vegas. That project is undergoing a complete interior remodeling. So some of the cart income et cetera will be out and that generate significant income as you can imagine temporary spaces will be out for the entire length of the renovation. Some of the other remerchandising actions that we're taking should be completed during this year as we look forward though what I would add beyond what's happening now we have great opportunity in two of our shopping centers with regard to lease rollover. Short Pump Town Center opened in September of 2003. So we will be coming up on our 10 year anniversary and rent rollovers. So as we remerchandise that center and do renovations on that center the impact will continue through 2014. In the same regard, Victoria Gardens' 10 year anniversary is in 2014, and we continue again with strong sales performance out of both of those centers and expect to take merchandising, look at the merchandising and physical space, make the improvements and do that long-term improvement. So it's going to be affecting '13 and somewhat '14 on those big rollovers.

Samit Parikh - ISI: Is there a way to quantify that though? Is it that remerchandising opportunities are affecting 200 basis points this year or is there any way you could explain the numbers on that?

David J. LaRue - President and CEO: The silence I'm sitting here thinking if there's a way to quantify that into basis points, and I can't do that off the top of my head right now. Bob, I don't know if...

Robert G. O'Brien - EVP and CFO: No, I will have to look at it. We anticipate this year that we certainly see what our peers are doing in the first quarter. They were up significantly more than we were. Dave said we do think that these remerchandising and rehabs that are going on are going to have an impact in '13. So I would expect we will certainly underperform industry averages in '13 but as Dave talked, we expect these to bear fruit in '14 and beyond. As we said, Short Pump is the --late this year is to we'll begin to see some of that impact in '15 and '14, and Victoria Gardens roll over in '14, and we will see that in '15. Obviously, trying to quantify timing wise, the impact of the QIC joint venture is exactly when they come in is going to obviously impact annual results depending upon the timing of that.

Samit Parikh - ISI: Then just on the office portfolio, so I know there's the expiration and the downsizing the lease at Pierrepont this quarter, I believe that you also had a decent size Mount Sinai lease come on this quarter. Is that rent paying yet?

David J. LaRue - President and CEO: I don't know the specific answer whether the Mount Sinai lease had free rent in the period or not during this first quarter. So we can get back and answer that question.

Samit Parikh - ISI: I guess you talked about the New York Property Tour, is there any sort of specific comments in terms of the momentum or any comments positive or negative momentum comment that you could give us on leasing that's occurring in Brooklyn right now in the office space?

David J. LaRue - President and CEO: Well, again I think the New York team, MaryAnne and Mike, as they walk through the leasing that had been done in our own projects over the course of the last 12 months to 18 months was significant. I think that new tenants that are moving into Brooklyn, new businesses that are being created in the tech sector continue to give us that confidence in our ability to continue to release our space that is available, continue to upgrade our overall property environment to capture the, I guess, new tenant feel that they're looking for in office space. So, Brooklyn is a place to be not only from an office perspective, but from a residential perspective and it is a very hot market for us and we're well-positioned, we have the professional staff in our New York office on top of this opportunity and they're executing the program very well.

Samit Parikh - ISI: I guess last question. ICSC I was there, very bullish conference. You spoke a little bit about sort of some momentum happening at Ridge Hill. Is there anything that gives you confidence that you may be reaching your targeted stabilization prior to 2015 based on the conversations you're having with retailers about Ridge Hill right now?

David J. LaRue - President and CEO: Again, we've targeted the 2015 stabilization. I think in the past we've talked about just the sheer size and volume of leases that have to get done. So, we're at 70% now. To get that – to stabilization in that mid-90%, that's 25%, which is almost 220,000 feet of space, that we still have to lease to get to that stabilized number. We think that it's appropriate in realistic that we can do that over the next the 18 to 24 months. The discussions that we had and the tenants that we have ongoing discussions with will help us get there. But again, until we get leases signed and execute it, I don't think we are moving from that 2015 stabilization period.

Operator: Sheila McGrath, Evercore Partners.

Sheila McGrath - Evercore Partners: Could you talk, Dave, a little bit more about the mall transaction? Was that a negotiation that you had with several bidders or was that a negotiation exclusively with QIC?

David J. LaRue - President and CEO: I'll let Bob answer, Sheila, thank you for your question though.

Robert G. O'Brien - EVP and CFO: Hey, Sheila. We were prepared to go to market and we had a preemptive bid from QIC that led us to an isolated transaction of Discovery with them. We never intended to make it a broad marketed transaction. It was going to be very focused on strategic capital partners who could join us in a fashion similar to the transaction we announced yesterday, and it was purposeful to both this transaction in terms of joining us in retail with a look forward to other things we might be able to do together. The price they put on the table was compelling enough to us that we felt we could get through due diligence and get to closing in a much quicker fashion than if we took it to market. We are advised on the transaction by a number of folks who assisted us with ensuring that the valuation was appropriate, and we thought that it was in best interest of ourselves, of our centers, of our shareholders to do the transaction the way that we've announced.

Sheila McGrath - Evercore Partners: Bob, did you have that all along those eight specific malls or did they go through and target which centers that they wanted to invest in?

Robert G. O'Brien - EVP and CFO: So we have targeted a subset of our centers. The ones that we've excluded were excluded for one or two reasons; one is, existing partnership arrangements, where we felt it would've been complicated and difficult to bring a new partner into that partnership, as well as there are three or four centers which are – we've been open about, and that have been stabilized. And it's always difficult to obviously have an evaluation discussion when an asset is not yet stabilized. So, Ridge Hill is a good example. It wouldn't be appropriate at this time. We thought to try to assess the valuation until we get it stabilized, and that's true in a number of other situations as well. So, as those other assets stabilize, we'll take a look and have a conversation with them. There is no commitment on their part to add those on either our part or their part. But I think it may be a logical extension depending upon where these stabilize out.

Sheila McGrath - Evercore Partners: What kind of sits will you get from managing that kind of venture?

Robert G. O'Brien - EVP and CFO: So we have our – I would say our standard or in place fees related to the services we provide of property management, leasing, financing, any development or construction services we provide as part of the renovations will be a place as I said in property management, and then, an asset management fee to assist in the management of the venture itself and in overlooking the assets which is addition fees that is not paid on those properties today.

Sheila McGrath - Evercore Partners: That was such a large transaction. I didn't get a chance to look at what the cost basis was in the Q, but what is that or do you have a sense of what that does to your NOL situation this large sale?

Robert G. O'Brien - EVP and CFO: So, these transactions are keyed up to be structured as a contribution into a venture. So, it's not technically a sale. Each transaction is – we'll close it separately, so we will evaluate the appropriate structure, but it's intended to be primarily a tax deferred transaction, because we're contributing our interest there, contributing capital. Some of that capital is going to stay in this for the renovations we discussed and it will generate the liquidity through that transaction.

Sheila McGrath - Evercore Partners: And then another question. I just saw something mentioned in the Q on Ten Metrotech something about it. I was wondering if you – about kind of demolishing the building and then that was a mortgage that was – it seems there's a little bit going on there. If you could just explain what's happening with that building?

David J. LaRue - President and CEO: Sheila, it's a very good question, and there is a lot going on with that building. I think just some background. Ten Metrotech was I believe the second office building after Pierrepont that we constructed in the Brooklyn market back in the '80s. It was actually a rehab of an existing building, so it was a much older building than even that redevelopment that we did and had the IRS lease for a number of years. What we have determined that the tenant had moved out and actually moved into our Two Metrotech building earlier last year and based upon market conditions we had negotiation with the existing debt holders. A investor purchased the debt from the existing debt holder and we made an agreement with that new investor to take a look at what the best use of the property was. We have determined that the best use of the real estate is literally the land value and we are going to take the building down and it has zoning in place, that we can convert that building to residential property.

Sheila McGrath - Evercore Partners: And then just on Ridge Hill. I know we always focus on it. But in terms of I know you can't change the stabilization date from 2015. But I am just wondering on the 70%. With the conversations that you are going on right now. Do you think that we'll see that occupancy ramp up throughout the year or are most of the conversations with tenants likely to impact in 2014?

David J. LaRue - President and CEO: We are to expect that over the balance of this year and 2014 that we continue to make progress. I know the last number of quarterly reports and our year end filings had us at that 68% for long time. But at this point we believe that we'll continue to make steady progress towards stabilization the point that I think we made last quarter or at the year when we did our conference call it's now that this property is open. Now that we are expensing the interest that we talked about earlier and taking those FFO and operating FFO hits based upon not capitalizing the interest anymore, each dollar of rents that we get each square foot of rent that we collect is accretive to the company's operating statements and again we think we have tenants that are interested in place and action plan and strategy for executing it.

Operator: There are no additional audio questions in queue at this time. I would like to turn the call back over to Mr. David LaRue for closing remarks.

David J. LaRue - President and CEO: Thank you, Patrick. I'd like to thank all of you for accommodating us with this very quick conference call in regard to our filing which occurred just after market closed today. We look forward to seeing a lot of you and other investors this week at, tomorrow and Thursday at NAREIT in Chicago and look forward to our ongoing discussions and your questions regarding not only this quarter, but the outlook for the Company and our strategic plan and execution as we go forward. So again, thank you and have a good evening.

Operator: Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.