Macerich Co (MAC) 2016 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to The Macerich Company's second-quarter 2016 earnings conference call. Today's conference is being recorded. (Operator Instructions)

I would like to remind everyone that this conference is being recorded and would now like to turn the conference over to Jean Wood, Vice President of Investor Relations. Please go ahead.

Good afternoon. Thank you, everyone, for joining us today on our second-quarter 2016 earnings call. During the course of this call, management may make certain statements that may be deemed forward-looking within the meaning of the Safe Harbor of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially due to a variety of risks, uncertainties, and other factors. We refer you to today's press release and our SEC filings for a detailed discussion of forward-looking statements.

Reconciliations of non-GAAP financial measures to the most directly comparable GAAP measures are included in the earnings release and supplement filed on Form 8-K with the SEC, which are posted in the Investors section of the Company's website at www.Macerich.com.

Joining us today are Art Coppola, CEO and Chairman; Tom O'Hern, Senior Executive Vice President and Chief Financial Officer; and Robert Perlmutter, Senior Executive Vice President and Chief Operating Officer. With that I would like to turn the call over to Tom.

Thank you, Jean. Consistent with past practice, we will be limiting this call to one hour. If we run out of time and you still have questions, please do not hesitate to give me a call or John Perry or Jean Wood as well.

Second quarter reflected continued strong operating results as evidenced by strength in most of our portfolios' key operating metrics. In addition, we completed our previously announced $1.2 billion share repurchase program and also completed some significant financing transactions. We'll talk about all those in greater detail later in the call.

For the quarter, FFO was $1.02 compared to $0.97 for the second quarter of last year. Same-center NOI increased by 6.5% compared to the second quarter of last year.

This was positively impacted by about $6 million of lease termination revenue in the second quarter of 2016. This timing is somewhat accelerated compared to our guidance, which had most of the 2016 estimated lease termination revenues forecast in the third and fourth quarter.

Our estimate for same-center NOI growth for the full year remains in the 4.5% to 5% range.

The gross operating margin at the center improved to 70.3% in the quarter, up from 69.8% in the second quarter of last year. Bad debt expense was a relatively modest $1.7 million for the quarter, down from $2 million a year ago.

As I mentioned, lease termination revenues at about $6 million for the quarter. That compared to $2.8 million last year. Year-to-date lease term fees are $9.4 million compared to $5.4 million for the first six months of last year, and our full-year assumption for lease term revenues this year unchanged at $15 million.

When we make the decision and negotiate a lease termination agreement, it's typically a trade-off for making the business decision to take the cash now and incur the higher vacancy loss of future minimum rent and charges until the space is re-leased.

During second quarter, the average interest rate was 3.52%, up slightly from a year ago, which was 3.47%. The balance sheet continues to be in great shape. At quarter-end our balance sheet metrics included debt-to-market cap at about 36% and interest coverage ratio a very strong 3.6 times, a forward debt-to-EBITDA of 7.2 times, and an average debt maturity of 6.4 years.

The financing market for high-quality regional malls remains very good. We have closed or committed on two life company deals, and we are currently in the market with a large CMBS deal.

On May 27 we closed a $375 million financing on Northbridge Mall. That bear -- it was a 12-year fixed rate loan at 3.68%, and we used a portion of those proceeds to pay off the old loan, which was $188 million with an interest rate of 7.50%. That was a life company transaction.

Another life company deal which will be closing here in the next week or so is at The Village at Corte Madera. We're putting a $225 million fixed rate loan in place, and that's a 12-year deal fixed at 3.50%. Again, some nice financing at historically low levels in terms of the interest rates.

On July 5, we closed on an extension of our $1.5 billion line of credit. That line of credit was set to mature in April of 2018 and, including our extension options on the new facility, goes out to July of 2021 and reduces our borrowing rate to about LIBOR plus 133, about a 17 basis point improvement from our old facility. (technical difficulty)

We've got some significant financings that will take place in the third and fourth quarter.

(technical difficulty) from Fresno, which is currently unencumbered. We're in the market with that right now. It's going to be a CMBS transaction; the term is expected to be 10 years. We're getting bids now, and we're getting some very, very strong quotes. We would expect that to close (technical difficulty)

We have Corte Madera and in addition later this year Eastland is an unencumbered asset that we will probably finance, and that could be as much as $175 million. So with that, it would comfortably put our line of credit outstanding balance at $500 million or less.

We concluded our third $400 million accelerated stock repurchase program on July 11. This was part of a Board-authorized $1.2 billion share repurchase program that was announced in October.

We've used three separate investment banks to execute these ASR programs. The summary results were we invested the entire $1.2 billion; the average share price on all three combined was $78.62; and the total number of shares repurchased was 15.3 million shares, roughly 9.6% of our shares outstanding.

On the guidance, again we reaffirm guidance today of $4.05 to $4.15 for the full year. Just to reiterate, the remaining two quarters we estimate of that FFO for the full year 25% or so will be in the third quarter and 29% of that total in the fourth quarter.

And with that I'll now turn it over to Bob to discuss leasing and tenant environment.

Thanks, Tom. Leasing activity during the second quarter remained strong, reflecting demand from the retailers for the Macerich portfolio. First let me talk about leasing spreads.

Trailing 12-months leasing spreads increased to 16.1% from 15.4% during the previous quarter. Regionally, East and West Coast properties have produced the highest leasing spreads. Average rent for leases signed during the trailing 12-month period was $57.31 per square foot.

During the second quarter, a total of 848,000 square feet of leases were signed, up from 733,000 square feet in the previous quarter. The average term signed in the second quarter increased to 6.0 years.

Occupancy. Leasing levels at the end of the second quarter were 95.0%. This represents a 50 basis point year-over-year decline, and a 10 basis point decline on a quarter-over-quarter basis.

As we discussed in the last earnings call, the decline in year-over-year occupancy was primarily caused by the movement of Fashion Outlets of Niagara and SouthPark out of the development portfolio into the stabilized pool. The occupancy also reflects the disposition of Capitola Mall and the acquisition of Country Club Plaza.

Temporary occupancy improved at the end of the second quarter, dropping 30 basis points from the previous quarter to 5.2%.

Sales. Portfolio sales were $626 per square foot, compared to $623 on a year-over-year basis. Same-center sales per square foot were $644 compared to $629 for the year-earlier period. This is a 2.4% increase.

Sales were strongest in the West Coast centers, and the categories that showed the strongest sales during the second quarter were beauty and cosmetics, athletic footwear, athleisure, and jewelry.

I want to take a minute and talk about tenant demand. Within our portfolio, tenant interest remains strongest in the higher productivity centers, the higher growth markets, and the coastal locations. This demand allows us to replace underproductive or struggling stores with those retailers looking to expand.

Demand is strongest among: one, core brands renewing and expanding existing locations; two, brand extensions from successful retailers; three, foreign-based retailers; and four, online retailers migrating to inline stores.

Within the last category of online retailers, we see many companies building the infrastructure to open brick-and-mortar locations in a traditional store roll-off program. Some examples of this include Blue Nile, Amazon, Peloton, Warby Parker, and Bonobos.

We are also focusing on bringing online retailers into the centers by reducing the physical and economic barriers to entry. Examples of this strategy include stores such as Combatant Gentlemen, Blink, Beta, and WithMe.

It is clear the universe of online retailers will expand in our shopping centers. Some will take a traditional approach to store rollouts and others will be nurtured through nontraditional canvassing and deal structures. This represents a growing opportunity within our portfolio.

Development. During the second quarter, we were pleased to announce the redevelopment of an existing Sears store located at Kings Plaza in Brooklyn. The center is one of three important assets owned by Macerich in the New York boroughs and serves a trade area of approximately 4 million residents.

Since Macerich's acquisition in 2012, we have worked to improve Kings Plaza's merchandise mix, anchor lineup, sales productivity, physical appearance, marketing, and property operations. Our goal has been to elevate Kings Plaza to the level that we have achieved at Queens Center. The redevelopment of the Sears building represents a major step in that direction.

Sears will be replaced with six to eight large-format retailers and restaurants, all orientated around a dramatic four-story atrium. The redevelopment will be anchored by new Primark and Zara flagship stores. We expect these retailers to generate a threefold increase in sales and foot traffic compared to the existing Sears box.

Equally as important, they will open the door to new specialty stores who have not historically been ready to locate at the center. From the perspective of Macerich's portfolio, we are able to significantly reduce our rental exposure to Sears while increasing our footprint with both Zara and Primark, as well as improving our position in the New York marketplace. Sears will no longer be a top-10 rent payer within our portfolio.

The Macerich portfolio is well-suited for Primark's entry into the East Coast markets. In June, Primark had a successful opening at Danbury Fair, which was followed in July with their opening at Freehold Raceway. Both of these locations repurposed a Sears anchor, and initial reports indicate a significant increase in foot traffic and sales at these centers.

Kings Plaza will represent Primark's third location with Macerich. We believe we have the opportunity to grow the number in the coming months.

And with that I'd like to turn it over to Art.

Thanks, Bob, and thanks, Tom. As you can see we had another very strong quarter from an operating viewpoint. More importantly from my viewpoint, we also are very pleased to have completed our portfolio management and capital allocation strategy through the completion of our share buyback program. You will remember that we announced of that program literally about nine months ago and unlike certain other folks we completed the program in very short order.

We did exactly what we said we were going to do. We're very happy to have it behind us. We think that it was a great transaction that gave us the capital to invest into the balance of our portfolio at what we feel is a substantial discount to our NAV, and we're pleased to have it behind us so that the focus going forward can be on the operating fundamentals of the Company as well as our very strong redevelopment and development pipeline.

I want to touch upon a topic that has been a justifiable topic in terms of questions that a lot of investors and the analytical community has asked themselves. And that has to do with rent spreads and whether or not, in an environment where you have decelerating sales or sales that are not growing like they used to grow, can you continue to have rent growth in the manner that we've enjoyed -- and our peers have enjoyed -- over a long period of time? Like I said, it's a legitimate question, and especially when you look at other property types, where it's not usual to have positive rent spreads continue year in and year out.

But it really comes back down to just the laws of supply and demand. We are in the real estate business, and supply and demand is the key to everything.

Looking backwards, past performance cannot be a guarantee of future results, as they say. But over the past 10 years, we've averaged 17.4% positive rent spreads over the past 40 quarters. We've had high-water marks of 28%, low watermarks in 2009 of 7%, give or take. But on average, we've averaged 17%.

I will tell you that if our rent spreads come in at 13% or they come in at 21%, I don't get excited about that one way or the other. Because I know that fundamentally, when I think about our mark-to-market, that the ability to generate mid-teens type of rent spreads is embedded within our portfolio.

As you look at our property type, and you look at regional Class A malls, and you think about the universe of the supply of that product, the supply of that product is, let's say, that it's 400 or 500 regional malls. And when we think about that product type in terms of supply, we can look to, by analogy, High Street retail, which is also a very low-supply, high-demand sector. There have been studies that have been done, more studies that have been done in the regional mall Class A sector as it relates to High Street: that it is a property type that has shown significant, well above average rent growth over very long periods of time.

And that's what we've enjoyed in our portfolio. That's what our peers with Class A malls have enjoyed in their portfolios. History has been our -- has supported that view, and the fundamentals that we're sitting on support our optimism for this to go forward.

When we think about the demand side of the transaction, in terms of tenant demand for space, a lot of folks tend to focus on the one or two names that have gone bankrupt recently, or the one or two names that people are worried about going bankrupt. But they tend not to focus on the 30 or 40 or 50 names of retailers that have got brand extension or are just growing their portfolio. Or now, with the recent events with Brexit, we have tenants that have got global expansion plans that are upping their expansion conversations about their expansion in the US, which is creating incremental demand.

You think about other factors that may or may not influence our demand. People worry at times about department stores, and you know, we've had more than one of our department stores has said the problem with their sales is mall traffic.

Mr. Les Wexner, had a great quote on this point and I'll probably butcher it, but basically he said the trouble with department stores is not mall traffic; the trouble with mall traffic is the department stores. What he's basically saying is the department stores are not pulling their weight.

You take a look at the parking lots of more than one of our department stores in some of our malls, and they're not as busy as the other parking lots. This creates opportunity.

We and our other Class A mall peers have had great history of replacing our department stores that have become unproductive over time with better uses, and we see this as a great opportunity going forward. Anecdotally we think that Kings Plaza re-merchandising opportunity is going to be dramatic in terms of what that's going to do for mall traffic.

People worry when they think about rent spreads about whether or not ecommerce is going to drain sales away from the malls and to reduce the demand for space in the malls. In fact, the advent of digital commerce creates new sources of demand for us in that it creates new tenants that are born digitally and then want to migrate to brick-and-mortar locations. And we are seeing this throughout our portfolio.

Finally, the thing that probably creates the most anxiety about mall spreads, rent spreads, is when people see sales flat for a period of time. Then that causes them anxiety.

And that's legitimate, for that anxiety. But what I would point to you is this: that if you have a fundamentally very strong portfolio, and you have no new supply being created, and you have demand increasing, then you're going to be able to lease that portfolio. And you're going to be able to lease it at strong rents.

We took a look a couple of years ago, and we dissected sales within our centers. We said, if we take the top two-thirds in each tenant category, what are those tenants doing in terms of sales productivity? And what are the bottom one-third of the tenants in our portfolio doing in terms of sales productivity?

Because that's generally the way we think about things. We tend to think about constantly the bottom 20%, the 30% of the producers in our malls as being merchandisers that we're going to want to recapture over a period of time and to replace with names that are more reflective of the merchants that people want to do business with today.

Here's some numbers. In our top 30 centers our average sales per square foot are $726 a square foot. That doesn't really tell the story.

Within each tenant category -- whether it be apparel, shoes, jewelry, general -- the top two-thirds within each category in these centers did $1,028 a square foot, and they comprised about 60% of the GLA in those centers. The bottom one-third of the retailers in each of the respective categories in those centers averaged about $313 a square foot.

So it's really a Tale of Two Cities here. You've got the great producers, and then you've got the folks that are lagging.

You've got two-thirds of your tenants within our top 30 properties are averaging over $1,000 a foot; one-third of our tenants by category are averaging $300 a square foot. So our job is simply to weed out the people that are unproductive and to replace them with the tenants that are more reflective of the top two-thirds.

When we look at the cost of occupancies within our portfolio, you can't just look at the homogenized number. Our average cost of occupancy in these 30 centers is 13.5%.

So you can debate all day about: Oh, can you push that number? But the reality is that our top two-thirds of the tenants in those top 30 centers, they do over $1,000 a foot and their occupancy cost is under 11%. So when those tenants, when their leases expire, they are sitting on substantial rent growth from the time that they signed their lease, and they can easily afford to pay rent that would generate in some 15% or so rent spreads for us.

And then when we think about pruning out the bottom part of our portfolio, we're seeking tenants that are going to produce sales that are going to be closer to the top performers. And even if you only got 10% or 11% of sales from tenants that are doing on average $1,000 a foot -- our top producers in our portfolio -- you're going to generate substantial increases.

That's why we have the confidence that these rent spreads are sustainable. We have history as our guide. And obviously, it doesn't guarantee future performance, but it is something that we are absolutely comfortable that rent spreads will continue to be a big driver of our same-center NOI growth going forward.

With that, we would like to open it up for questions.

(Operator Instructions) Christy McElroy, Citi.

Hi. Good morning to you, guys. There was a press report recently about an approval you won for an outlet project in Carson, California, near the 405. Can you provide some color on that and overall your intentions to build outlets in LA?

Well, we think it's a great site. We think it's a great location. It's true that we've entered into an exclusive negotiating agreement with the city of Carson to build a 500,000, give or take, square foot outlet mall there, and we're in the process of finishing up our development agreement with that, on that

(technical difficulty) is finished, which we hope to have done in the near future, then we'll go ahead and make a formal announcement about it. But you obviously picked up on either what's in the press or what's happening in local city council rooms. And it is true that we do have a plan to build an outlet mall at Carson. There's still some work to be done on the development agreement, but we're very bullish on it and we think it's a great opportunity for us.

Thanks. Then just sticking to LA, wondering if you can provide an update on your plans for redevelopment of Westside Pavilion, in the context of the progress that's been made at Century City and the scope of the project at Beverly Center, just considering the competitive environment in that market.

Sure. We see it as a great opportunity. It's a tremendous piece of real estate, and it's part of our core owning, holdings.

We have no intention of chasing the same customer that -- literally the Grove and Century City and Santa Monica Place and Beverly Center and Rodeo Drive, everybody is chasing the same customer, the high-end affluent customer in the West LA market. And we think that there is a different mouse trap that can be created at Westside.

We're not in a position to say exactly what that's going to look like, but we've got at least four or five different development alternatives that we are thinking about, each one of which are very interesting.

Thank you.

Alexander Goldfarb, Sandler O'Neill.

Good morning. Just two questions. One is, as you guys look at the department stores you spoke about, one, department store parking lots not being busy; and then separately you spoke about 30 of your in-line tenants at your top centers that are far less productive than the top-performing.

So in your view as you look at redevelopment and continuing to drive mall productivity, which is more important to you, getting back department store boxes or getting out those -- or replacing the tenants who are averaging $313 a foot?

They are both equally important. Sometimes you don't necessarily have the ability to recycle an anchor as quickly as you'd like to. So there are things that -- generally small space is going to be more accessible to you than department store space.

But, look, it's what we do every day. It's what we do for a living. We've got one department that does nothing but small shop space and another group that does nothing but the anchor stuff, and it's what we do.

And they are equally important. They're both really important.

And what's left, which I think is left a little bit unsaid, is that as the department stores potentially reduce in numbers in terms of conventional department stores in the United States, then that's not necessarily a bad thing. It really gives us an opportunity to bring in other traffic generators, whatever those might be.

But it also really creates more demand for in-line space, because as the number of department store locations reduce, then that reduces the distribution points that manufacturers and creative folks have to distribute their merchandise. So they become interested in in-line stores as a consequence.

Take a look at an outlet mall. Outlet malls that we have at FOC and FON, we've got over 400,000 feet of small shop space in these malls, and they're fully occupied. And that's because the manufacturers are not competing with the department stores as distribution points for them.

So, as this hand plays out over time, US malls will begin to look more like the malls around the world. You go to Canada, for example; you've got one, one and a half department stores, maybe two in most of those big malls in Canada. And the small shop space could be easily 600,000, 700,000, 800,000 square feet. I think the reason small shop space there is fully occupied and fairly productive is that it's the best distribution point for the manufacturers of the merchandise.

So, look, it's an evolutionary process, but we see that if you have must-have real estate, you're always going to have a good idea for it, so long as you obviously are in touch with the pulse of the market, which we are.

Okay. Then following up that, Art, now that you have the Sears box back at Kings Plaza, you have the redevelopment there bringing in six to eight new retailers there. But what about a bigger picture? The center, it abuts the water, so it's got potential on the backside. It just seems like there's a lot more potential than just redoing the Sears box.

So longer-term, what do you think we can expect to see out of this center over the next few years as you further the redevelopment plans, presumably?

Well, look, we've got a lot of work to be done here. We're on the right path.

We like to take things sequentially, Alexander, as you know. So we're going to stay with the step-by-step approach.

It's not a small task, the task that we have, to re-demise a 300,000 square foot four-level department store. But the opportunity is huge, and we think that the rewards are going to be big.

So we're thinking about the densification opportunities, but it's not anywhere close to being on the immediate horizon. The stronger we make the center, the stronger all of those other densification thoughts become.

Great. Thanks a lot.

Rich Moore, RBC Capital Markets.

Hello, guys. Good morning. I'm curious, on the Seritage venture that you guys have, you now have this Sear's box, which I don't think is part of Seritage anyway. Is there anything going on with the rest of -- or with the Seritage joint venture with regard to Sears boxes?

Nothing that we're in a position to announce right now. This was not part of the Seritage conversation. It was just a landlord-tenant relationship with Sears.

We're working with our partner, Seritage, to think about the redevelopment of the nine centers that we have Sears stores together in. And we think there are good opportunities at each of them, but nothing that we are -- we're going to be patient; I've said that before.

We may be a little bit of an outlier compared to our peers in terms of our willingness to be patient, but we're going to be patient.

Okay. I think, Art it takes six months or something -- I think you've got to give like a six-month notice to Sears before you do anything. I'm curious. Are we in that window yet? Or do we still have at least six months to go probably before we can do anything at the boxes?

Those are logistics, Rich, and we've got lots of alternatives available to us. We have a flat-out option to recapture space at each of those nine locations. But we have found it's relatively expensive to think about recapturing half of the space and then keeping Sears in business in the other half.

So, we're really thinking about our alternatives. I would note that we did just have Primark open in half of the space of the Sears store at Danbury and Freehold. So two of the nine are arguably done at this point in time.

Okay. Then last thing is, Tom, the shares you bought back in 3Q, because I noticed you went a little bit over into July for your buyback, what would the amount be in just 3Q? Do you have any idea?

The settle-up amount -- the way it's structured, Rich, is you get 80% of the shares when you start the program. So that was in the case of the third ASR roughly 4 million shares.

And then in July when the program concluded we got the remaining 1 million shares. So 4 million of the 5 million shares were during the quarter, and the remaining 1 million was on July 11 or so.

Okay, great. Thank you, guys.

Rich Hill, Morgan Stanley.

Hey, guys; good morning, I guess. Just a couple questions. One of the things that you mentioned at the very beginning was the competitive bids that you're seeing from the CMBS market. It caught my attention because I think in past commentary you've mentioned how weak CMBS market may have been.

Do you think that's more a reflection of the strength of the quality of property that you're bringing to market? I think it's doing maybe $635, $640 a square foot.

Or are you seeing broad interest? Or do you think it's broad interest and that's a real financing alternative?

Well, I think the market has gotten stronger. It is subject to being more volatile than the (technical difficulty) market.

But in this particular case Fresno is a very strong asset, as you said, doing over $600 in sales. And we got bids from probably eight different investment banks, and they were all pretty competitive, in the range of 200 over the underlying Treasury.

So it was good to see. It was encouraging to see, and I think that at the moment is a viable form of financing for probably A, A-, to B+ assets; some A assets may be competitive.

It's a big deal. It's a roughly $350 million deal.

So we're encouraged, but we're not looking for a lot of CMBS loans right at the moment, so I'm not sure we're in a perfect position to say exactly how deep it is. But for a quality asset, it's certainly there right at the moment, Rich.

Great, great. Thank you. And just one other question.

Obviously an impressive quarter for you guys. I'm curious; how should we think about that in the context of your earnings guidance being reaffirmed -- or your FFO guidance, should I say?

Right, well, as I commented in my remarks, a big part of the quarter is we had a significant amount of lease term revenue that happened in the third quarter, and one of our forecasts was for that to be in the third and fourth quarter -- I'm sorry, the second quarter. We had roughly $6 million historically and what we forecast for the year, we forecast $15 million, but the bulk of that we had forecast in the third and fourth quarters, so that got accelerated a little bit. And as a result of that moving earlier in the year, it's going to mean that we're not going to see the same kind of growth in the third and fourth quarter.

I think -- Bob, you may want to comment on this as well. I think also to the extent we have bankruptcies, we're going to feel that more in the third and fourth quarter. Some of those tenants remained in occupancy through the second quarter.

And also when you make the business decision -- and it is a business decision -- to take a lease termination payment, that means you're taking that, but in exchange for that you're going to lose minimum rent revenue in the second half of the year. And that's a little bit of what we're going to face in the third and fourth quarter.

Yes, from a bankruptcy standpoint, most of the store closures would occur in the back half of the year.

Great. Thank you very much. That's helpful.

Craig Schmidt, Bank of America.

Thank you. I have similar questions on the lease term. Was the acceleration of the lease term income at your choice? Is it something that you wanted to deal with now rather than postpone it? Or was there something else that caused the acceleration?

Well, I think part of it had to do with Sears, and I think in our forecast we had that happening in the third quarter, not the second. So that was a little bit of an acceleration on our part.

But generally speaking, it's a decision on our part. When we give our guidance at the beginning of the year, it's an estimate based on some facts that we may be aware of, but also a lot of it is history. For example in 2014 for the full year we had $9 million of lease term fees; in 2015, it was $11.5 million or so of lease term fees.

We felt there would be more in 2016, and part of that was as a result of specific conversations we'd had with tenants such as Sears. And the other part was just the environment we were in.

Yes, Craig; this is Bob Perlmutter. The only thing I would (technical difficulty) there was another large one and, candidly, it was accelerated because there was deals completed with replacement tenants.

Great. Then the management company business seemed more productive, with somewhat higher revenue but lower expenses. Was there anything that caused (technical difficulty)?

I think we had some lumpy expenses that hit last year. But we've got more JVs this year, Craig, because the JVs we did with the government of Singapore and Heitman were done in the fourth quarter of last year as well as January of this year; plus we have Country Club Plaza, which is a JV. So as a result of having more joint ventures, we're going to have more management company revenue.

Great. Thank you.

Michael Mueller, JPMorgan.

Yes, hi. I guess in terms of the ecommerce discussion, do you have a sense at this point as to how many stores could be opened in the portfolio, say, by the end of 2017?

How many digitally native retailers that are not currently in malls could be open with us by the end of next year?

Yes, exactly.

It's evolving. It's picking up steam.

We are finding that we're having good success in identifying retailers at an early stage in terms of their growth strategy. It's hard to put a number on it; and even if I had a number, which I don't, I'd hate to put it out there, because I see it as a growing number that's going to grow quarter by quarter and year by year for quite the foreseeable future.

So I wouldn't want to put a ceiling on it by even putting a number on it. It's a --

Okay.

It's early days, but it is definitely a big source of demand going forward.

Got it. So it feels like traction is there and stores are going to be opening throughout next year?

Well, there's no question that there is traction there, and there's no question that stores are going to be opening with us. We understand -- look, the reasoning -- it's interesting. Some of their reasoning is not necessarily sales-driven.

Combatant General which opened their first retail location with us at Santa Monica Place a couple weeks ago, they have 300,000 online customers; they've only been in business digitally for about three years. And they are not measuring success at Santa Monica Place by sales. They're measuring -- they are seeing the store as being more of a customer acquisition vehicle and a brand awareness vehicle.

Now, they are certainly happy to produce sales out of that location. But they -- and each of them have different views on it, but more than a few of the digitally native retailers view brick-and-mortar as being as much about brand awareness as sales productivity.

Got it; okay. Then separately, appreciate the comments on occupancy cost. So it looks like you're in the mid-13%s today; so for this portfolio do you have a sense as to where it was pre-downturn? Because it's obviously very different than where it was six, eight years ago.

Yes, pre-downturn, Mike, we work in the 12.5% to 13.5% range. Then obviously as a result of the downturn and decreasing sales, that metric went up significantly.

But the big difference today, Mike, we have a much higher quality portfolio. I mean, if you look at where we were sales per foot on the portfolio in 2007, I think we were probably $150 a foot lower quality productivity and sales.

We were at $467.

$467 versus almost in the mid $600s now. So we've got a significantly better portfolio, and the higher the quality of your portfolio the higher the occupancy cost as a percentage of sales that you're going to be able to generate and sustain.

Got it. Okay. Thank you.

Todd Thomas, KeyBanc Capital Markets.

Hi. thanks, good morning. Just first back to the guidance and Tom's Same Center-NOI forecast of 4.5% to 5% for the year. So you're at 7% year to date. I understand the lease term fee income was a little more front-end loaded this year versus last year. But it would imply 2% to 3%, I guess, in the back half of the year.

Is that the right read? Just trying to make sure expectations are --

Yes. I mean our bias would probably be to the top end of that today based on what we know today. But yes, roughly 3% on average in the last two quarters.

Again we're going against some very tough comps in the fourth quarter of last year, when I think we were north of 7% on average.

Okay, got it. Then, Bob, any Sports Authority exposure impacting the portfolio in the third and fourth quarter?

It's pretty small. I think we had four or five locations, most of which were non-mall locations. And I believe to date, one has been released by West Elm.

Okay. Any idea on the timing to re-tenant those? And maybe where rents were in place for Sports Authority and what you expect to be able to achieve on re-tenanting the space.

Again, we don't -- it's pretty immaterial in terms of our tenant base. My sense is the rents probably reflected the market, so it's probably more an issue in terms of loss of rent till they're re-leased as opposed to spreads.

Okay. All right, got it. Thank you.

Tayo Okusanya, Jefferies.

Yes, good afternoon. Could you just talk a little bit about operating margins? Again, it went up again this quarter, which was a pleasant surprise.

Just how sustainable is it at 70%-plus? And what else can you do to keep driving operating margins up?

Tayo, yes, we're over 70% this quarter. Part of that was buoyed by the lease term fees. But I think on average for the year, we're at 69%, over 69.5%, so directionally we keep moving up.

Last year we did it pretty aggressively with expense cuts, which are kind of a one-time exercise. We've been able to maintain those.

But now most of what we see is coming from revenue growth. You may have noticed other income was a little bit higher this quarter, and part of that was driven by Country Club Plaza being in for the quarter, but part of it was from the hotel being open at Tysons.

But we also had additional parking revenues and revenues that we're generating from our common area. So that's been a big emphasis this year, on generating more revenue from our common area; could be advertising, could be sponsorship income. It's basically non-real estate revenue, and that has been an emphasis and that's going to help us to continue to move that gross margin up.

Great. Then the second one for me, just around the tenant watchlist, if there's any update on maybe new names that that may be on the list, or tenants that people may not be fully aware of that may be having some issues.

Tayo, this is Bob Perlmutter. I don't think the watchlist has really changed the first six months of the year. The activity during the beginning of the year pretty much reflected what we had anticipated.

There are a number of groups that stay on the watchlist. The characteristics of these groups are more larger-store fleets, weaker brand, bad capital structures. Some are public companies, some are not.

So we continue to maintain them and, as a landlord, we do the same thing. We try to mitigate our exposure to them while we can and prepare as best we can. But we don't see a big change and the marketplace on the back half of the year.

As I mentioned, Tayo, in my comments, from my viewpoint the opportunity list is a lot more robust than the watchlist.

Got you. Thank you.

Vincent Chao, Deutsche Bank.

Hey. Good morning, everyone. Wanted to just get a sense of what is embedded in the outlook for the back half for Aero and PacSun.

Aero and PacSun are working through restructurings. PacSun appears to be making more progress.

We have packages that have been worked out with both of them in general. There's a few store closures, some rent relief, and some assumptions.

So the impact on the back half of the year is factored into the projections. It's not a material number either way.

Okay. Thanks for that. And just curious, on the WithMe partnership at Santa Monica and Century 21, just curious if you could comment on how that went, what the lineup looks like for the rest of the year there, and maybe if there's been any discussions with Century 21 subsequent to their six-week venture there?

They were pleased with what they accomplished out of their exposure. I think in that case it also -- I think they measured success as much about extension of their brand awareness as they did the actual sales that they consummated.

We'll be announcing another new retailer that will be taking that space in the near term. And that partnership is going well. It's focused on a number of locations going forward.

The majority of those locations will be common area locations, because we think that's probably the most efficient way and the most interesting way to go ahead and deploy with their technology.

Okay, thanks.

Andrew Rosivach, Goldman Sachs.

Hi, good morning; this is Caitlin Burrows. I just had another question on the Kings Plaza redevelopment. It looks like the expected yields went from 7% to 8% down to 4%; and part is due to increased expected costs. So I was wondering what is driving that extra cost.

It's really I think just the fact of demising it into multiple locations, a few more than we had otherwise anticipated. It was a placeholder before; that's why we put it into the shadow pipeline.

But, it's evolving. These are the numbers that we see today.

I think it is important to note that we believe we're being very conservative in the way that we are reporting this return to you. I'm aware of other owners of malls that, when they bring in a replacement department store, sometimes they include what they think is going to be the uplift in market rents for the entire mall into the return they expect to get from that department store. And I'm not saying that in a critical way; I'm saying that because I'm just aware there are different ways of thinking about what your return is when you replace a department store.

We're not doing that in this situation. We're looking at it, comparing it to the very substantial rent that Sears would have been paying over the next couple of years.

Now, Sears, their lease expired anyway in a couple years, so you could argue that the 8% return is really the more realistic return. But we wanted to -- look, we know that a lot of you are trying to do models based upon this information, and that that's as important as the return that we're reporting. So we wanted to help you with the model and let you know that it's really 4% over what we're getting right now.

As we think about it, look, we do think about it long-term and we think about any investment in a replacement of a department store or any investment of the that size in terms of IRRs over an expected holding period also. The actual IRR on that particular investment -- and this is just, again, going over the current rent that Sears is paying -- approaches 10%. So the Company and the Board felt very comfortable going forward with that. Go ahead, Bob.

Caitlin, the only thing I would add is, as we got into the redevelopment of the box, we clearly felt it was more than just taking the box and dividing up for tenants. We felt it was an opportunity to really create a front door to the shopping center which it's really lacking now, an opportunity to really open up the facade, an opportunity to get vertical transportation from the parking deck into the fourth-floor tenant.

So we definitely felt that it was a major redevelopment for the property and there's a lot of items in there that are (technical difficulty) carving it up and maximizing the revenues.

Okay, yes. Then on just that idea of when you guys were talking about being conservative and thinking about it like this is the new rent you'll get, above and beyond what Sears was paying before, when you think about the other redevelopment projects you have, is that similar to how you calculate the returns then? Again, thinking about who's there now and what the incremental add will be as opposed to the total.

Yes. Looking at it and stepping away from it, for example, when we thought about the return that we were going to be seeing at Walnut Creek, we looked at: What was our opportunity cost? What would the income be? Which, it was averaging around $15 million at the time.

So we measured the return on investment over the income that was in place before we started tearing down buildings. So after we got done tearing down buildings, we took that income down to around $8 million or $9 million.

We didn't measure our incremental return from the reduced level. We measured it from what it used to be in a do-nothing scenario.

Paul Morgan, Canaccord.

Hi, good morning. I appreciated the discussion about rent spreads and the top two-thirds and bottom one-third, and I just wanted to follow up on that. How much of that discrepancy in sales productivity is something that you think you can just monetize, we can just take a mark-to-market approach?

Versus it feels like there would be some other factors like what specific malls, maybe the locations in the mall. It would seem like there's going to be certain locations that are just always going to be less productivity, if it's near an end-cap with a weaker anchor. Things like that.

How easy is it to just map that difference, $313 to $1,000 a foot, to what your upside is going to be?

Well, since this is what I've been doing for a living for over 40 years, and since it's been this way every day of those 40 years, and since there really hasn't been any change, I feel very comfortable with our ability to continue to recycle tenants. It's what you do. It's the nature of the business.

But remember, I think one of my peers indicated to you in a call a few quarters ago -- I think he was observing that of his top 10 tenants when he went public 20-some years ago, that only two or three of them are still in business.

Does that mean that the business went bad? Or does that mean that we have eight great new top-10 tenants? Frankly, the answer is we've got eight really good new guys; and the eighth guys that went away, they went away because they had matured.

I feel, look, it all comes back to supply and demand. We can dissect this to the nth degree, but the way that we look at things is that we think about not what is but what can be.

So we don't think about a space where a tenant is doing $300 a foot and say: That's a $300 that space. We look at it and say: Potentially that's a $300 space because it's a crappy tenant.

We had a tenant at Santa Monica Place on the second level that I think was doing $300 a foot, a 10,000 foot tenant, an apparel tenant. And we didn't say: Oh, that's a $300 a foot location. We replaced them with a really good new tenant who's doing probably 3 times that, which -- that's what we do every day.

And by the way, it's not just us. It's our peers do that also.

Now, I will tell you that we're able to do that because we have properties that are must-have properties. If we had commodity type of properties, or we were located in some really secondary or tertiary markets, or we were dealing with a portfolio of significantly lower-quality properties, we wouldn't be in a position to have this conversation.

But we're in high-demand locations with great real estate, somewhat similar to High Street retail in the demand characteristics and returns and rent growth that those have enjoyed over the years. It's supply and demand. It all comes down to that.

It sounds like you would attribute a lot of that difference in sales productivity to things that are specific to the retailer rather than, like, being on an end-cap, say, typically?

Absolutely. Right. Now look, there are certain locations that are always going to be less productive, but that's all baked into the numbers.

When we looked at and we said the top two-thirds of our tenants in each category do over $1,000 a foot and the bottom one-third by category do $313 a foot, to average $726, that wasn't location-specific. It was just saying: All right, if I got nine tenants in this category, what are the top six doing and what are the bottom three doing? And it doesn't matter where they're located.

So it is a function, frankly, of: Are you selling the merchandise that people want to buy?

Okay. Then just going back to the Kings redevelopment number, I definitely appreciate the clarity of that 4%, which we don't necessarily often see. But how should I think of that number being specific to Kings, versus when we look at all the other Sears where you have -- or other anchors where you have anchor redevelopment opportunities?

Is the gap between your gross yield and your net yield that meaningful there? Or is it just because of the complexity and urban nature of Kings and the fact that Sears was paying pretty material rent that the difference is so wide?

Well, I think as Bob mentioned, there's a fair amount of work that's being done within that box that is really common area in nature and is really mall specific and not tenant specific. We're creating a new atrium entrance to Flatbush Boulevard, which really has nothing to do with re-demising the space.

But I will tell you that when it comes to anchor replacement, we don't expect that to be returns that are going to be the normal 8% to 10% types of return. And if we can achieve returns that we think are adequate -- and we think about that both cash-on-cash, we think about it in terms of a 10-year hold, we think about its impact on the mall and everything considered -- we're going to be willing to, if we believe that we can dramatically improve the quality of the draw, we're very happy to take a mid single-digit type of a return on a replacement. Very happy to do it, and it's the right thing to do.

Okay. Great, thanks.

That is all the time we have for questions today. I'll turn the conference back over to you, Art, for any additional or closing remarks.

All right. Well, thank you all for joining us. Enjoy the rest of your summer and look forward to seeing and speaking with you again soon. Thank you very much.

This concludes our presentation for today. Thank you for your participation. Have a great day.