Kite Realty Group Trust (KRG) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2010 Kite Realty Group Trust earnings conference call. My name is Michelle, and I will be your Operator for today. At this time, all participants under a listen-only mode. We will be conducting a question and answer session later in today's conference. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I will now turn the presentation over to your host for today's call, Mr. Adam Chavers, Vice President of Investor Relations. Please proceed, sir.

Thank you, Michelle. If you've not received a copy of our earnings press release, please call Kim Holland at (317)578-5151, and she will fax or e-mail you a copy. Our June 30, 2010 supplemental financial package was made available yesterday on the Company's web site at kiterealty.com. The filing has also been made with the SEC in the Company's most recent form 8-K. The Company's remarks today will include certain forward-looking statements that are not historical facts and may constitute forward-looking statements within the meaning of the private securities litigation reform act of 1995. Such forward looking statements invole known and unknown risks, uncertainties and other factors which may cause the actual results of the Company to differ materially from the historical results or from any results expressed or implied by such forward-looking statements. The Company refers you to the documents filed by the Company from time to time with the SEC, which discussed these and other factors could adversely affect the Company's results.

On the call today from the Company are John Kite Chief Executive Officer, Tom McGowan Chief Operating Officer, and Dan Sink Chief Financial Officer. Now I'd like to turn the call over to John Kite.

Thanks, Adam. And good morning, and thank you for joining us. Last night we announced the redevelopment of River's Edge shopping center in Indianapolis. The addition of Indiana's first Nordstrom Rack and first Container Store confirms what we knew when acquiring this underperforming center two years ago. The real estate was strong and we were confident we could add value. We've attracted first class anchor tenants with long-term leases, and will reduce the shop space significantly. Consequently, generating higher quality cash flow and strong returns. We lack forward to finding more opportunities like River's Edge, which will allow us to utilize our value creation experience.

Leasing production continues to be critical to our operations. During the quarter, our leasing team completed 216,000 square feet of new and renewal leases, which exceeded our projections. We are seeing a clear, positive trend of our company-wide dedication to leasing. In the first half of this year, we leased 562,000 square feet, versus 304,000 square feet in the first half of 2009. The second quarter marks the fourth out of five consecutive quarter where our leasing production was over 200,000 square feet. And we're on track to announce another significant quarter on the next call.

As anticipated, our operating retail portfolio lease percentage increased 100 basis points quarter-over-quarter to 91%. While same-store NOI was down 1.5% for the quarter, it was 140 basis point improvement over last quarter. Over the past five quarters, we've executed 21 new and renewal anchor leases, totaling over 770,000 square feet ,with positive cash rent spreads of approximately 7%. Even more encouraging, the 7 anchor deals we completed in the first half of 2010 had a combined positive rent spread of nearly 15%.

In addition, we had positive net absorption on shop space during the quarter, and at 76% leased, our shop space is a source of additional upside for future quarters. As tenant and landlords emerge from the uncertainty surrounding our business, we are pleased to see that our real estate choices continue to be validated by the quality of retailers and the rents we are able to achieve. I look forward to sharing our leasing progress with you over the next quarter as well.

As I mentioned last quarter, this leasing productivity will drive our core FFO for the year. 90% of our FFO was generated from recurring revenue again this quarter, and should continue at that level throughout the year. In fact, recently signed anchors that have yet to start paying rent, comprise nearly $3.5 million of rent that will commence over the next 12 months. These rent commencements, the continued progress in our small shop leasing program, and the stabilization of our current developments, and redevelopments, are all critical components of our strategy to reduce net debt to EBITDA by approximately two times over the next 18 months.

In closing, we are coming through a very difficult macro economic environment, yet we are demonstrating our ability to grow occupancy and cash flow. We are encouraged to see our focused leasing efforts begin to post results, and we will continue to aggressively attack our remaining vacancy. We believe EBITDA growth is the most efficient path to improved operating metrics. Balance sheet strength, dividend growth, and ultimately shareholder return. Tom?

Thanks, John. I'd lake to start off by additional detail on our leasing activities. New leases were comprised of 136,000 square feet, or 63% of the total production for the quarter. And we're pleased with the 18% positive cash rent spreads. In addition, we completed 80,000 square feet of renewals during the quarter, at rental rates approximately 6% below previous rents. Excluding a strategic move to secure a single anchor renewal, rates would have been relatively unchanged. Overall, we are optimistic given this level of activity, and we're encouraged by the leasing spreads that our portfolio's commanding in today's market.

Looking forward, our leasing department has been able to maintain a healthy level of leasing activity. We are currently in negotiations on an additional 325,000 square feet of new and renewal leases for the third quarter, which puts us in a position to lease 1 million square feet this year. 1 million square feet would represent the highest annual production level in the Company's history. The activity within our current development pipeline continue to improve within the second quarter. Eddy Street Commons leased and committed percentage increased nearly 10% quarter-over-quarter to 85%. In addition, the 119-room Fairfield Inn and Suites successfully opened June 15. It's our goal to move Eddy Street Commons to the operating portfolio by the end of the year, in excess of 90% leased. Construction on our new Whole Foods at Cobblestone Plaza, in Florida, will commence this fall and is expected to significantly improve our overall shop leasing momentum.

Turning to redevelopment assets. Last quarter, I spoke about the role of our redevelopments, and how they'll play in growing our FFO stream. We are well underway on two of these projects and anticipate generating a return on our invested capital later this year. Bolton Plaza in Jacksonville, Florida, is a redevelopment of a former Wal-Mart box. The 65,000 square foot Academy Sports has been turned over to the tenant, with a schedule opening date in October. We're negotiating an LOI with another national retailer to take the balance of the vacant space. I look forward to updating you on that status in the coming months.

In addition, the former Circuit City box in Coral Springs, Florida, has been expanded to 46,000 square feet for Toys-R-Us, Babies--R-Us. Landlord work is 50% complete and we expect the store to open in the fourth quarter. Pursuant to our press release last night, our $15.5 million redevelopment of Rivers Edge will commence this month, led by two prominent national anchors, Nordstrom Rack and the Container Store. Turning to operating metrics, same-store NOI declined 1.5% for the quarter. This percentage is within our full-year guidance range and improved 140 basis points compared to the first quarter.

As we've discussed in previous calls, we have approximately 70,000 square feet of junior anchor space, that is scheduled to commence rent in the latter part of 2010. So we remain comfortable with our full-year same-store guidance range of zero to negative 2%. Given the same-store trend, our increased lease percentage, and our strong pro projected leasing activity, we are confident that we will continue to see additional improvement in our operating metrics through the balance of the year. Dan will now summarize our other operating results.

Good afternoon. FFO was $0.11 per diluted share for the quarter, compared to $0.15 per share for the prior year. Dilution related to the reequitization of our balance sheet in May of last year, and caused the majority of the $0.04 decrease year-over-year. As we anticipated, the contribution to FFO from transactions and construction and services declined from last year by approximately $1 million. And we continue to produce over 90% of our earnings from reoccurring rental revenue.

On the balance sheet, we have gun the process of refinancing or extending the 2011 debt maturities. Of the $111 million property level debt expiring in 2011, $43 million or approximately 40% of the maturities have built the extension of either one or two years. Of the remaining $68 million, we anticipate term sheets with our lenders on approximately $33 million by the end of the third quarter. We are confident in our abilities to refinance the remaining debt. As we discussed previously, we only have two CMBS loans maturing in 2011, with an aggregate loan balance of $20 million as of June 30. The two loans have solid coverage ratios, solid debt yields, and LTB ratios of less than 60%. Accordingly, we don't anticipate any principle paydowns upon refinancing. Our term lone matures in July of 2011, and we analyzing potential alternativesto pay off or refinance this debt that will strengthen our balance sheet. We are also beginning discussions with the lenders on our line of credit, which matures in February of 2011, and has a one-year extension option.

Turning to some specifics on the income statement. Our NOI to revenue margin was 71% and our recovery ratio was 72.2%. The NOI to revenue margin is up 340 basis points from the prior quarter. Construction and service margin before tax for the quarter was approximately $313,000 and in line with our expectations. Other property-related revenue includes approximately $300,000 in the sale of land and other income related to the completion and sale of several residential units at our Eddy Street Commons project.

Property operating expense was down from the first quarter, primarily due to a decrease in snow removal costs of $800,000, which had a similar impact on the associated recoveries. Depreciation expense was up in the quarter as we accelerated the depreciation over the shorter estimated useful lines of the assets and our redevelopments at River's edge and Coral Springs. We also anticipate incurring additional depreciation expense during the 3rd quarter, relating to the shorter useful lives as we approach commencement of construction.

Finally, the limited service hotel at Eddy Street Commons opened on June 15, and the net expense from unconsolidated entities of approximately $100,000 was incurred in the second quarter. The net expense related primarily to preopening expenses and we expect a positive NOI contribution the second half of the year, as students return to campus and the football season gets under way. We are reaffirming our full-year 2010 FFO guidance of $0.42 to $0.47, and at this time we are guiding to the lower end of the range. Thank you for participating in today's call. Operator, please open up the line for questions.

Thank you. (Operator Instructions) Please stand by for your first question. Your first question comes from RJ Milligan of Raymond James. Please proceed.

Good afternoon. John, at the beginning of the year, you were talking a lot about potential JVs to help delever, possibly make some acquisitions. Are those conversations still continuing and have they increased, decreased? Are you still looking at the JVs?

Yes, we are still looking at the JVs, RJ. Probably we've been more focused on internal execution, as you can see, but we are also, at the same time looking at external growth opportunities. I think the way we see it right now, the most effective thing for to us do is to be seeking out those opportunities, and when we find something that we think makes sense, hooking up with a partner at that time. You never know where this may go. That seems to make more sense to us right now than just dropping X number of assets just to do a JV, just to do a JV. We've focused on it. We think there is opportunity. There's clearly more appetite in the market for it. As I said, we like to the opportunity and then marry that up with the appropriate capital.

So your motivation would be more so for deleveraging versus out there acquiring more assets?

Yes. I think the EBITDA we would generate from it would help delever. Again, we can still -- that's on the JV front that I was talking about. As far as acquiring assets on the balance sheet, we're still looking at assets that we could do on our balance sheet vis a vis equity that would delever. Obviously, we'd be looking at the smaller deals than we would a large JV, kind of one at a time. There are opportunities. Frankly, we've been seeing some recently that we're interested in. Right now, most of the things that have upside associated with them would be -- would require us to maybe look at buying debt and then trying to get a deed in lieu at the time of acquiring the debt, so it's a little more complicated. There are opportunities, but I'll tell you, the last couple we've looked at we thought from a pricing perspective, they could be attractive. And the next thing you know someone comes in and the price is 30% higher than what you thought it should be. So it's a challenge, but we're looking for them.

Are those opportunities more redevelopment opportunities that you look at or is it pretty stabilized properties?

I think it's a combination. There is a situation that we are looking at where there were two assets with one lender. And one was clearly a potential redevelopment. The other could be a redevelopment or if the anchor tenant kind of stays in place, it's just a good yield that you wait for the upside. So, I would say most of the stuff we're looking at would have some sort of opportunity associated where we could create value. There are -- if we could find a more of a core type asset in a distressed sale because of some particular owner reason, that would be great too. Built those are obviously hard to find.

Thanks, John. Just a question for you, Tom. Were the two leases signed with Nordstrom Rack and the Container Store, were those included in the leasing spreads for the quarter?

Yes. The lease sign for -- this is John. The lease sign for Rack was in the overall leasing spreads. The lease sign for Container Store was not because that was subsequent for the quarter.

Great.

And by the way, just to add to that, the Rack is basically replacing the Office Depot, so that's why it's in the spread.

Yes.

I think as noted in the press release, we're very close on an additional anchor that will be announced here very soon.

Thanks.

You're next question comes from the line of Todd Thomas of KeyBanc Capital Markets. Please proceed.

Hi, good afternoon. I'm on with Jordan Sadler as well. Question on the leasing spreads in the quarter. Looks like after taking into account the leasing activity that occurred during the quarter, the expiring rents are even lower now on balance throughout the remainder of the year. When do you think that we'll see positive spreads on renewals?

Well, as we talked about, we basically had a slightly positive spread on renewals, but for one anchor deal. What we didn't say there is that one anchor deal allowed us to do other small shop deals at higher rents by repositioning. Basically, I think we're close to that. It's kind of on a case by case basis, Todd, just depends on each situation. But, I think in terms of -- as occupancy continues to climb, for us and for others, then you've got much greater ability to put pressure on renewals. It also depends on whether the renewal is an existing -- hitting an option or whether that renewal is a non-option. As we've talked to you before, these are relatively small pools of data, so it can move around. We feel like we're close to that renewal starting to push up.

Okay. That's helpful. Then the increase in occupancy that you saw in the shop ten and portfolio this quarter, do you think that, that's sustainable going forward or perhaps just a one quarter blip. What's your sense for what's happening there in the portfolio?

As we said on the call. First of all, again, the small shops are certainly subject to the macro economic environment because they're doing things more on a current basis than on a future basis like a larger national retailer is thinking out two, three, years out. The bottom line is we have a lot of activity, and as Tom said, we have a lot going on for the third quarter. And there is a fair amount of that small shop activity. So, we don't think it's a blip. We think there is real positive momentum there.

I think that's just across the board that we're pushing for better results in the third and better results in the four. That's the bottom line.

Okay. And then just lastly, in terms of -- you didn't really mention many discussion on property dispositions or as a way to raise capital, but when you look at Rivers Edge now or some of your other redevelopment projects, how do you think about recycling capital in some of those assets where you've created some value now?

I think we're thinking about recycling capital probably also from a geographic perspective. Where we want to focus our efforts. We have, as I said on the last call, we have a handful of assets in the portfolio that we don't view as core assets as it relates to where we're going to penetrate further in that geography. So, we'd start there. And we are in conversations about looking at values on certain assets that we view as non-core from a geographic perspective. Also, certain assets where we have multiple properties in a market that we may reduce our exposure there for one reason or another. As Dan said, we're looking at all kinds of different capital as it relates to strengthening our balance sheet. With our stock price where it is, maybe a more attractive to do that on an asset sale to recycle that capital to improve the balance site, but we can also use it to acquire another asset, trade into another asset. Bottom line is we're definitely looking at that. That is a definite alternative for us. And I would guess that you would see us do some stuff over the next six months.

Okay. Great. Thanks.

Thank you.

(Operator Instructions) Your next question comes from the line of Rich Moore of RBC Capital Markets. Please proceed.

Hello. Good afternoon.

Hi, Rich.

On Rivers Edge, do you have to shut down the existing tenants that are there or move them to percentage rent so that we might see a drop in contribution from the center while you are doing the redevelopment?

Rich, a project of this size is somewhat complex. To answer your question, we will have existing tenants remain open during the redevelopment. At this point, we are going to be working closely with monitoring sales, working as hard as we can on signage et cetera to help them maintain their sales level. So, that is going to be a work in process as we work with each and every one of them.

So, Tom, will they be percentage rent or should we just assume that the NOI you were getting from that center stays pretty constant?

Our goal is to maintain that NOI level based upon our existing tenancy.

What I add to that, Rich, is look, reality is, as we said before, these are our customers. We're going to stay close to them. If there's some serious evidence that someone's been hurt by this, we're going to work with them. It's possible that, that could happen in a case or two. We're going to monitor vis-a-vis their performance.

Yes. We've been face-to-face with each and every one of these guys, so we have a close working relationship. We're going to do the best we can and I think you know, after the Glendale redevelopment, we've got a lot of experience in terms of undertaking a massive redevelopment while maintaining occupancy.

Rich one more point on that is that Office Depot on the quarter, their lease and base rent expired as of the first quarter. So in the second quarter, they were only paying recovery. So that's the largest contribution to the NOI to that center. That already has in essence been pulled out of the second quarter.

Good. Thank you and certainly you did a good job on Glendale, so I follow you. Would you say, based on what you're seeing, John, that overall development is beginning to -- or might heat back up that interest from tenants in developments might be starting to increase?

Rich, I think it's like we talked about last time. The opportunities for tenants to expand is quickly dwindling because the existing inventory of high quality space is -- has shrunk a lot faster than anybody anticipated. I think when we went through the various couple of banckruptcies and store closings, people figured out pretty quickly that the good stuff was taken rapidly. So, bottom line is because you've got tenants looking out at 2012, 2013 and 2014, for sure, development will begin to come back to fill that void. I think it'll be done on a more conservative basis when you look at things that people are doing and you look at what we're doing. Doing projects in stages, being careful with speculative shop space. I think that'll probably happen -- that'll start off the development wave because it's going to be done by the bigger companies, by the public companies and the stronger private companies that are well capitalized. So, yes, I think we're clearly beginning to get -- we're noticing demand for these assets, and I think as we said before, these developments we have in the pipeline, people are starting to realize that they're an asset and not a liability.

Right. So, on that, think On that, I think Delray you were saying last time was probably going to break ground the first quarter of next year. Is that still what you're thinking?

Rich, as it ties back to Delray, we're going to maintain our same disciplined approach. We're going to take a measured perspective as we make that determination. If it is not late fourth quarter, I think we have every indication to believe it'll be early first quarter. We're going to let the numbers talk to us. We've set strong parameters as it ties back to our small shop lease up and we're going to hold to our guns, until we get to that point, we will not start. I will say one thing. We've been traveling across the country seeing a lot of properties, seeing a tremendous amount of carnage where projects got started long before they were ready from an occupancy standpoint. We are committed to not do that, but we feel very good about our progress. We're going to maintain that stance. It's either going to be late fourth, early first quarter 2011.

Okay. Great. Thank you. Dan, you were saying you were going to look at alternatives to the term loan. Are you thinking about preferred equity maybe or an unsecured note offering? What did you mean exactly?

We're keeping our eye on a number of things, Rich, but perpetual preferred is, we've been watching the yields on those to see where they stand. In this market it's tough for investors to find yield. If you can go out and people are pricing those at fairly attractive rates. So that's one option that we're looking at. As John mentioned, we're looking at asset sales from geographies that we are not going to penetrate further and/or non-core assets where there's very little growth if it's a single tenant asset, et cetera. That's another option. I think another option, as John mentioned, is acquiring assets with equity. There's an opportunity if we need to, to refinance the debt and potentially secure it with an acquired asset.

There's a number of options we're looking at. We have time. We're talking to a lot of people. That's high on our list of priorities. We know that if we can -- when we take that off the table, it will strengthen the balance sheet. That's a big objective of ours.

I think, Rich, it also helps us as we're in -- at that point we'll be in our line renewal. That'll put us in a much better position with line renewal. All in all, the flexibility that we have today versus what we had six months ago is tremendous. So, we feel pretty comfortable that we'll have more than one choice there.

Okay. Great. Thank you.

Thank you.

Your next question comes from the line of Quentin Velleley of Citi. Please proceed.

Good afternoon.

Hi, Quentin.

Just on Eddy Street, I might have missed this, but the 10% increase in the lease rate, could you just talk through some of the deals you did in the quarter?

Sure. Quentin this is Tom. The production really came from both office leasing and retail leasing. And those tied back to various restaurant deals, soft deals. We've had real nice -- real nice progress on the office component. At this point, we feel like there's deal flow to really let us close that office component out if things go well in various committees that are going to be taking place in the next 45 days. And then we have a couple two very significant retail deals that are on the table right now that are also waiting for committee approval. So, we feel very, very strong about Eddy Street. We feel very strong about the plan itself and what it's doing for the overall area campus, et cetera. Progress has significantly improved and we see a lot of bright issues in the future.

Very good. Just on Rivers Edge, just going to ask about the return expectations for that because I know originally you were expecting for million dollars of CapEx, but that's gone up 15 or 16. Did you get a commensurate increase in the return with that extra CapEx?

Yes, we did, Quentin. Like we've been talking about when we're looking at spending capital no matter what we're looking at the spending capital on, we're thinking about what's the best return we can get on that capital we're going to spend. In this particular case, there are a lot of reasons that end -- why the redevelopment progressed to a larger redevelopment. Generally speaking, it was because there was so much tenant demand and it was high quality tenant demand. So, when we bought the asset two years ago, we assumed that it would be a small renovation. We assumed that we'd back fill the Office Depot and in fact had a grocery user that we were talking to at the time. That would have supported a larger amount of small shops. So what we've done now is the yield on the additional capital we're going to spend is a double digit yield, but obviously the overall yield on the total asset is below that. Even against what we think the total yield would be, we're probably going to see 175, 200 basis points spread from that to the value creation.

So, we think we're going to make a lot of money off the deal. That's kind of the bottom line. Part of the reason is the income stream is being generated by the anchors and by very high quality credits, whereas before it was the reverse, more of a small shop income stream. So, that's basically a long way of saying we definitely analyzed this hard and we think that the return is going to definitely warrant the spend and we're excited about the tenant line up and clearly we'll be one of the best assets in the state.

Okay. And then just lastly, following up on some of the other questions on the shop space (Inaudible) which went positive this quarter, you said the level of full out drop. I'm just curious as to how some of the mom and pop or the local tenants are doing in their struggle to get financing. Did the fall out rate, was that a result of less mom and pop tenants falling out? You sort of started to do new deals with mom and pop tenants who previously probably couldn't get financing for their businesses?

Yes, well, two or three different things there. First of all, in terms of the fallout rate, when we look at our small shop composition, we still have a fair amount of our small shops that are national and regional tenants. Then we obviously have the mom and pops. I think in terms of the negative absorption that we had seen in the past, it probably was more driven by small shop mom and pop type tenants. The improvement in the availability of credit, I think that helps us with new deals, so probably isn't a big factor in terms of where someone's going to survive or not. I think there's been a lot of tenants that have really changed their business models and figured out how to survive and then there's those tenants that haven't. I think that has impacted small shops in the same way that it has on the national level.

Then going forward, we do think that the availability of credit will help, particularly on the franchise side of the business. There was a lot of pressure on franchisees six, nine months ago that appears to have been mitigated, much of that by the actual franchisers creating credit programs. So all in all, there's definitely positive momentum. We're always going to have guys closing and opening, but it clearly feels like the openings will be exceeding the closings. That's when you're going to really see our small shop percentage gain. We've said before, we typically are in the 80s. To be in the mid-70s there's a lot of upside there for us. We're excited about really continuing to pound on that.

Okay. Then just lastly, I'm not sure if you'll have the numbers there, but I know in the prepared remarks you said that you're going to get an extra $3.5 million from signed anchors that haven't started paying rent yet. I'm just curious, you spoke with reducing net debt to EBITDA by about two turns.

Right.

So you've got $3.5 million from those leases. You'll have some -- I don't know if you can break out what you're going to get from Eddy Street and Cobblestone, which will help out, but also what you're assuming from additional new leasing. I don't know if you have those numbers.

I can talk in terms of percentages. Essentially what we are saying is we have various things that we've already done that are going to lead to this EBITDA growth. First and foremost, it's the executed leases that we referred to that we talked about in the remarks. Next it's box leases that are in late stage negotiations that we're doing right now. Then there's the pro forma shop leasing that we're kind of referring to. And the stabilization of Cobblestone and Eddy Street would be the next. Obviously, the increase in the Rivers Edge scope at the kind of returns we're talking about. So, when you look at all of that, we believe over the next couple years we can increase EBITDA 25%, 30%. You can kind of do the math from there. But it is substantial, and that's why we think that, that's the best way for to us delever. If we bring in external activities such as acquiring some assets with equity and, Dan mentioned, enhancing the balance sheet through a preferred or something like that, then you begin to see real EBITDA FFO growth that we kind of talked about with you on the last call, which was, in turn would be similar substantial FFO growth.

Okay. Got it. Thank you.

Thank you.

Thanks.

Ladies and gentlemen, if there are no further questions, I will now turn the call back over to John Kite for closing remarks.

Okay. Thank you for taking the time with us today. Look forward to talking to you next quarter.

Thank you for your participation in today's conference. This concludes the presentation and you may now disconnect. Have a great day.