Simon Property Group Inc (SPG) — Q1 2018 Earnings Call Transcript

Thank you, Christy. Good morning, everyone. Thank you for joining us today. Presenting on today’s call is David Simon, Chairman and Chief Executive Officer. Also on the call are Rick Sokolov, President and Chief Operating Officer; Andy Juster, Chief Financial Officer; and Steve Broadwater, Chief Accounting Officer. Before we begin, a quick reminder that statements made during this call may be deemed forward-looking statements within the meaning of the Safe Harbor of the Private Securities Litigation Reform Act of 1995, and 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 the risk factors relating to those forward-looking statements. Please note that this call includes information that may be accurate only as of today’s date. Reconciliations of non-GAAP financial measures to the most directly comparable GAAP measures are included within the press release and the supplemental information in today’s Form 8-K filing. Both the press release and the supplemental information are available on our IR website at investors.simon.com. For our prepared remarks, I’m pleased to introduce David Simon.

Good morning, everybody. We’re pleased to report a strong start to the year. Retailers are performing better following a strong holiday season and decent start to the year. Demand is picking up for our space and traffic and sales are up. We continue to invest in our product with a long-term view of creating compelling, integrated environments for consumers to live, work, stay, play, and of course shop. We completed several significant redevelopment projects, are under construction on others, and announced more activity that will further enhance the value of our real estate and grow our cash flow. And we continue to identify unique, strategic, new development opportunities globally, that will extend our reach and create world-class destinations. Before I turn to the results of the quarter, I would like to provide some perspective. First, we expect to generate in excess of $4 billion in earnings this year, that’s FFO. There are only 40 companies in the S&P 100 that are projected to generate over $4 billion in earnings this year and have an A rated balance sheet. Simon is one of them. Second, we expect to distribute approximately $3 billion in dividends this year, which would make us one of the top 40 dividend paying companies in the entire world and country and obviously, in the S&P 100. Finally, our stock is trading at a 12 times multiple, which is a 30% discount to our historical average multiple of approximately 18 times. This is the lowest multiple SPG has traded at over the last eight years, despite a compound annual growth rate of more than 11% in earnings and 14% in dividends over that period of time. And as you know, our numbers speak for themselves. Results in the quarter were highlighted by FFO of $2.87 per share, an increase of 4.7% compared to the prior year and exceeding the first-call consensus estimates by $0.04 per share. This marks the first time we generated in excess of $1 billion of FFO in the quarter. We continue to grow our cash flow and report solid key operating metrics. Total portfolio NOI increased 4.8% or more than $70 million in the quarter and our comp NOI increased 2.3% for the quarter. And as you remember, and I want to reiterate, they do not include lease settlement income. Linking activity remained solid, continues to improve. Average base minimum rent was $53.54, up 3.3% compared to last year. The mall-only outlets recorded leasing spreads of $8.45 per foot, an increase of 12.6%. And we are pleased that retail sales momentum continued to pick up in the first quarter. In fact, each of our platforms posted record sales productivity for the period. Reported retailer sales per square foot for our malls and premium outlets was $641 compared to $615 in the prior year period, an increase of 4.2%. As a reminder, this sales metric is based on information reported by the retailers. As a point of reference, while reported retail sales grew strongly at 4%, we know there are a significant number of retailers who are underreporting their sales number because they’re deducting returns of online sales that were not previously reported as store sales. This is not allowed under our leases. Although we plan to continue to provide reported retailer sales, it is important for the investment community to understand that we believe this metric is understated. Our malls and outlets ended the quarter at 94.6% occupancy, which is down compared to last year due to the timing of the bankruptcies processed last year and the first quarter of this year, as well as the addition of new space brought online last year that is slightly lower than the overall average for the quarter. On an NOI-weighted basis for our operating metrics, reported retail sales on an NOI-weighted basis is $804 per foot compared to $641. And again, this number we believe is still understated. Occupancy is 95.6% compared to 94.6%. And average base minimum rent is $70.34 compared to $53.54. Just to turn to new development. In Edmonton, Canada, the Premium Outlet Collection will open next Wednesday, May 2nd, marking our fourth outlet center in Canada. Construction continues on four additional new outlets: Denver, Colorado, opening in December; Queretaro, Mexico, which will open in December; Malaga, Spain, which will open in the spring of ‘19; and Cannock, United Kingdom, which will open in the spring of 2020. We have redevelopment expansion projects underway at nearly 30 of our properties across all of our platforms in the U.S. and internationally, and we continuously evaluate our portfolio for additional opportunities. During the quarter, 175,000 square feet expansion opened at Aventura Mall, one of the most productive retail centers in the U.S. During the quarter, we started construction on a significant redevelopment at Southdale; we’re replacing a former JCPenney box with a Life Time Athletic, Life Time Sports and Work, specialty shops, restaurants, and a 146-room Homewood Suites, as well as the Restoration Hardware and Shake Shack restaurant. We’re also working through the entitlement process for our transformative redevelopment projects of the former department store spaces at Phipps, Plaza and at King of Prussia. Phipps has started construction, KoP will start, we hope, by the end of the year. Lastly, we announced our plans to redevelop five Sears locations: Brea, Burlington, Midland, Ocean, and Ross Park Mall. Each of these projects has unique plans depending upon the needs of the communities in which they are located, including entertainment, fitness, dining halls, restaurants, residential, hotels, offices, and of course, new-to-market retailers. These are all go projects. Our industry-leading balance sheet continues to differentiate us. During the quarter, our A/A2 unsecured credit ratings were confirmed with a stable outlook by S&P and by Moody’s. And by the way, similar A and A2 rated companies in our sector do not come close to our financial characteristics. However, it is what it is. We amended and extended our $3.5 billion revolving credit facility with a lower pricing grid for five years. We closed and are committed on six mortgages, totaling $513 million for roughly five years at 3.4% interest. Keep in mind, we have no unsecured senior notes or consolidated secured debt maturing for the remainder of this year and little for 2019. Net debt to NOI was 5.5 times. Our coverage was 5 times. Only 6% of our total variable debt is variable. Our liquidity is more than $7 billion. And during the quarter, we repurchased 1.5 million shares for $228 million. We announced our dividend of $1.95 per share for the quarter, a year-over-year increase of 11.4%. We’re increasing our FFO guidance from $11.95 to $12.05 per share. This represents approximately 6.5% to 7.5% growth compared to reported FFO of $11.21 per share for 2017. To conclude, strong start to the year. We expect to generate $1.5 billion in excess cash flow, which will allow us to fund our new development, redevelopment, execute on our share repurchase authorization, or decrease our leverage, which is already significantly below our peer group. We welcome and encourage your questions.

Hi. Just a couple of quick things here. So, it looks like a lot of the operating metrics have pointed up in the right direction, leasing spreads improving, sales improving. I know occupancy can bounce around and there have been some store closures and a few bankruptcies, but I also know that some of the new developments that are brought online tend to kind of pull that number down. So, I was wondering if you or Rick could just first share how much of the 100 basis-point occupancy decline was maybe development related and then, how much of it was natural store closings or bankruptcies.

Well, I would say over the majority is related to bankruptcies. And remember, Steve, we are very focused on putting the right tenant in the right space. And when we’re at the mercy of bankruptcy court. So, the reality is, if you file Chapter 11, you can reject the lease at any time, and as you know, the build-out and getting the space leased takes some time. We do expect that we will get back to where we were last year, maybe a little bit better. But again, that will depend upon if there are a few more bankruptcies or not. So, it’s pretty much what we expected. Remember, as we gave guidance, we thought we would get back to where we are. We’re processing the bankruptcies. And then, I would say, I don’t know, 20, 30 basis points are probably just the new space that we’ve added on, so in that range of 70-30, somewhere in that range.

Okay, great. That’s helpful. Secondly, it’s a little more of a housekeeping item. But, we noticed on the other income that you had a large jump in interest, dividend and distribution income. I think, the lease settlement income sort of speaks for itself. But, can you just provide any color on what the large jump was in the quarter and is that recurring or is that just a one-time number.

It is recurring. It’s just we don’t know when it recurs. So, that is basically the distribution we get from our interest in value retail. And so, it does manifest itself. Just so you know, I know a little bit about accounting. So, we cost account for that. We do not equity account. And so, when you cost account, you basically only record cash. That happens to be a cash distribution. And it does happen. It’s happened every year for the last several years. It is lumpy. And that’s what it was from. We’ve put that in that line item because it’s technically a distribution. Now, that’s a function of cash flow, refinancing activity, I mean, it all goes into a pot there. But, we cost account for that. And then, we only book it when we receive the actual cash.

Thanks. And then, just last for me, just share repurchase. I know you didn’t do anything in the fourth quarter, but you obviously took advantage in the first quarter. How should we just think about your buyback activity over the course of the year?

I think it’s going to continue at these levels. We are, if you look at our balance sheet and you look at very little exposure to potential rising rates, the underperformance of our stock price, the kind of the mood is getting better, retail demand increasing. The market’s now recognizing it, why not buy stock back? So, I think we will continue that. I think, just like anything else, like we typically do, we will be cautious about it. But, it’s certainly in our plans.

Hey, David. It’s Michael Bilerman here with Christy. Two questions. The first, in your shareholders letter, you talked about the fifth platform being focused on the consumer. And I was wondering if you can delve a little bit deeper into the resources that you’re committing to that. How you’re going to measure success? How much capital you want to put forth that I’m not sure if you’re thinking grander of like what Westfield did with Westfield Labs and OneMarket. And I know, there are a lot of different things that you’ve done, whether it’s a Snapchat the Family app, the Facebook, Happy Returns, all these things that you’re trying to get together with the consumer but you can delve a little bit deeper into how you envision that going forward?

At this point, given the circumstances, I don’t have much concrete information to share, except that we’re putting resources and effort into it. I hope to have updates for the market later this year. I wouldn't draw comparisons to Westfield Labs; I’m not really clear on that. We are actively working on this and constantly thinking about it. As a retail real estate company, we have the flexibility to explore other investments and ways technology can enhance our consumer experience without compromising our core business. This is a major focus for us. Even though Tom wanted me to omit it from my letter, I did mention our marketing connection to consumers, which is included in the letter. Thank you for reading it. It is real money and a legitimate business, depending on how you choose to capitalize it. We have a strong connection to consumers, with 100 million consumers and 2 billion visits each year. There’s much happening in that area. However, I’m not prepared to go into details yet, but I hope to provide more information by the end of the year.

But, is that something that you feel like you want to go and acquire something or is it all being built and investing in-house?

Currently, we are focused on building, but I wouldn't dismiss the possibility of making strategic investments. At the moment, it's challenging for us to commit to any investments. We are analyzing how various values stack up against ours. However, we have significant flexibility in how we continue to grow our business due to our current position. We will keep exploring all options. As you know, we make investments through our venture group. While we've mostly made relatively small investments, larger ones could be on the table. We're developing something right now that I believe will be quite interesting, and I hope to share more details by the end of this year. Building something is a complex process, and while it isn't exactly like constructing a mall, there are many similarities.

Hey, David. It’s Christy here, just a quick one for me. It seems like the property expense recovery rate was down in the quarter from recent trends. Just wondering if there was anything onetime in there and how we should be thinking about the property level expenses going forward.

Not really. The first quarter had utility expenses, and there was a little bit of a spike in those. We’re also adding some properties, so those numbers tend to fluctuate. Basically, our utility and snow expenses are affected. As you know, spring hasn't fully arrived yet. Perhaps it’s springing right now as we speak. So it's mainly due to that. I wouldn’t interpret anything else from it.

Hey. Good morning, David. Maybe a quick question for you. One of the things that we were looking at was maybe a little bit of increase in the month to month leases. It looks like they increased to around 3.5 million square feet versus around 1.6 million square feet. I recognize that’s still small overall. But, I’d be curious if you could give us any color as to whether that’s timing related, the change in strategy. How you’re thinking about that?

When you get bankrupt space back, you wait for the right tenant. It’s really just typically part of our strategy here that we are looking at the regional local markets a little bit more in detail. So, we tend to do those a little bit shorter-term sometimes. But, it’s really just a function of us recycling our portfolio through. Now, remember, in our occupancy, we only include leases that are over a year. So, the 94.6 just concludes; that doesn’t include like short-term leasing that is just three, six months. But, all of that is about a year.

The only thing I would add is that we’re maximizing our revenue. So, we go out of our way and try and make sure that we have as much space occupied for as long as we can. And we’re also able to incubate tenants out of that program. We’ve got a number of tenants that have started with us temporary tenants which in fact end up going longer term leases because they find they can make money and like the experience.

And can you remind me, maybe going back to Christy’s comment here a little bit. Do those month-to-month leases pay reimbursements or is it just like typical lease…

Yes. Keep in mind that many of those month-to-month leases are still under negotiation. For instance, if we consider a major retailer based in San Francisco, we may not have finalized negotiations with them yet. They won't leave and then return, which is why those leases often continue on a month-to-month basis. The information you're seeing in the 8-K represents that backlog. It's important to distinguish between short-term leasing and month-to-month leasing. Month-to-month effectively comprises our entire portfolio, including many national retailers from 2018, which are typically completed throughout that year. Although we strive to finalize everything, there may be strategic reasons for not completing all agreements. Therefore, it's essential to differentiate between these two categories. The month-to-month leases are largely with national retailers that just haven't been finalized yet. Additionally, many of our leases expire on January 31, which can delay completions until May and June. This pattern has persisted year after year. I hope this clarifies the difference.

No, I believe.

Let me repeat. So, you see in the 8-K is mostly the vast majority of national tenants that we have finalized our deals, they automatically go to month-to-month, in our 94.6 only leases that are a year or older in that number.

Thank you. We see that you’re continuing to ramp up your densification pipeline. I was just wondering, as you look out your portfolio, how many projects you think you could be pursuing a densification effort on? It seems primarily hotels have been your densification effort of choice. Do you see more office and residential efforts as you densify?

Yes. From what I can recall, we have at least 20 major projects, with one currently under construction. We need to relocate the fire station at Phipps, which is a notable example where we are constructing a hotel in partnership with Nobu, along with a restaurant and an office building. There will be no residential component in this project. However, we have already incorporated residential elements in our previous developments in the area. Additionally, we have substantial residential projects planned. For instance, in places like Stoneridge and the East Bay, a significant amount of residential will be included in the Sears redevelopment, as well as in Brea in Orange County. Therefore, I wouldn’t say it’s predominantly hotel projects. In reality, you’ll observe a growing number of residential developments. Overall, there are at least 20 projects, including a hotel at Sawgrass. It's quite diverse, and we are excited about it, allocating more capital and human resources to these efforts.

Great. And then, regarding Bon-Ton, maybe you could share some of your future plans for the repurposing efforts of those department stores.

I’ll let Rick speak, other than Bon-Ton is a non-material event for us. We’ve already got users identified. Again, we don’t own all of the real estate. So, some of it will be out of our hands, at least for some period of time. But Rick, you can add to that.

We basically have already identified users for virtually every one of the stores. And as David said, there are some that we own that we’re moving aggressively on right now; there are some that Bon-Ton owns, some that are third-party owned. But, we have users. They have said yes, let’s finalize economics. And we would hope to have information about that later in the year. The stores aren’t going to even come back till third quarter while they finish their process.

We have two questions. First, David, in your opening comments, you mentioned internet returns and how you ensure that the tenants aren’t underreporting their sales. Can you expand on that? It seems that you receive a complete detailed profit and loss statement and can verify that the retailers aren’t omitting anything that would understate their figures. Could you provide more detail on this?

There isn't much more to say except that we don’t receive profit and loss statements; instead, we have audit rights. Through our usual procedures, we noticed some irregularities in sales. Despite the retailer having audit rights over us in certain situations, we have exercised our own audit rights. Historically, we dealt with numerous CAM audits, but with the transition to a fixed CAM structure, that has become less of an issue. What stands out to me about the internet, which is often overlooked, is that discussions usually focus on gross sales rather than net sales. Generally, physical stores experience returns of 30% to 40%, with many of those returns happening in-store, which benefits retailers as they can issue credits or exchanges. However, we’ve noticed that internet returns have been impacting us negatively, despite the fact that they shouldn't be able to do that. The reality is that they can only offset sales with returns from the store, and we often restrict the total returns that can be netted against us. This is a concern, and while I don’t want to make it a major issue, it’s important to convey that when the market is focused on sales per square foot, we need to present the other perspective. The situation and how it is resolved is uncertain, but this is part of our lease negotiations. We want to inform the market that our reported sales are actually lower than the reality due to internet sales returns. I can't provide a specific figure, but I believe it's significant enough to note.

I understand your point. The second question is about your redevelopment efforts, particularly the upgrades to the food courts, which often go unnoticed. For instance, the changes at Woodbury and Westchester are quite significant compared to how they were before. However, in terms of measuring returns, like at a restaurant where we can see a clear increase in net operating income or foot traffic with the addition of new retailers or a hotel, I'm curious about the food courts. Are they genuinely driving higher sales and net operating income, or are these upgrades more about making things look appealing, maintaining sales levels similar to before? If we're going to make improvements to the center, do we see it as a necessary expense, or are there tangible returns from these upgrades?

I believe that both offense and defense are important aspects. The numbers reflect all of this, and it’s not crucial to label it as one or the other. When we invest in our food hall operations, that expense and the corresponding income are included in the financials shared by Tom in his 8-K. It's important to note that the 8-K contains only the projects approved by our capital committees. Upcoming projects, like the Phipps deal and the Sears redevelopment, are not included yet; however, they represent a substantial amount of investment that we expect will yield positive returns. In simple terms, it encompasses both offense and defense. The associated costs and income are part of our financials. Customers are looking for new experiences, healthy food options, and community spaces. There are many excellent operators in this space, and we aim to increase our efforts in this area, similar to what our peers have accomplished. We believe it will continue progressing. In some cases, we might choose to forgo certain projects if we identify more beneficial opportunities. Ultimately, real estate trends matter, but it all comes down to location, demographics, and other unique factors that define the value of real estate.

This is Ki Bin. So, David, for a couple quarters, you’ve mentioned that you think the retail demand or environment is getting better. So, what is it that you’ve seen or you see it every day that’s not apparent in the supplemental snapshot every quarter?

We talk to our sales teams, and they indicate that demand is increasing. However, leases take time to finalize, while bankruptcies happen quickly. When a lease is rejected, it's uncertain whether it will be accepted later, leading to a lot of uncertainty. Still, we have one of the strongest leasing teams in the country. I trust their insights, and they tell me demand is improving. I also engage with retailers, and we acknowledge that past results do not predict future performance. We have a more positive outlook on business compared to 2017. We believe bankruptcies will be fewer than 18, and so far, we have been correct. While our estimates are not flawless, we have significant experience in this field. The individual overseeing leasing informs me about positive signs. Sometimes I have doubts, but John and I have collaborated for a long time, and I trust his judgment. Rick, feel free to add your thoughts. What’s your perspective?

Interestingly, we have meetings every week with tenants where we’re in their offices and they are coming in the Indianapolis and we’re going over the portfolio. And that optimism is being generated out of those meetings where we are exposing opportunities to them. And where last year they would have said, we exposed 20 and they were interested in three and now they are interested in twelve. So, there is definitely a more optimistic view; they have more capital to spend and they are more focused on new opportunities than they were last year and that’s because of our optimism.

That’s helpful. Is that just broad-based or is there a certain segment, it’s a new type of tenants, is it the old guard? Just curious, how that looks like?

It’s a combination. Each company is different, but if you look at Old Navy, they are growing their business now, whereas they may not have been two or three years ago. The positive aspect of our industry is that there are more entrepreneurs in both food and retail. Our new business group is constantly discovering new deals and ideas. Our business model has been successful for so long, thanks to a product that has been around for 70 years. Unfortunately, the media tends to focus on a single narrative, which doesn’t reflect reality. Look at our numbers; we’re projected to make $4 billion this year. While things aren't perfect, and I would prefer not to see a slight decrease in occupancy and other concerns, we are in good shape. Generally, the business appears to be stabilizing. I wrote about my concerns regarding leverage in retail in my shareholder letter in 2015, warning that excessive leverage could cause issues. The two significant bankruptcies this year, Claire’s and Toys R Us, were largely due to too much leverage rather than operational issues. When you examine the facts, you'll see the truth. Traffic, sales, and demand are on the rise, and our numbers are improving.

I just want to continue on your comments about getting better and retailer demand increasing. I’m wondering what you’re seeing from your tenants in terms of reinvesting in their existing stores. Are you seeing encouraging activity here relative to maybe a year ago?

I think, our tenants that are now recognized being that they are only going to be able to increase their share by giving the consumer a better environment. And Dave has been talking about that for the last quarters, asking our retailers to invest in the store. And we’re seeing that more now. And that is in fact encouraging. One of the things that we’re very focused on is right sizing our tenants. So, where we have a tenant that we believe is too much space, we will work with them and reallocate that space, get them to a smaller store, it’s more productive, we make money and we get back more space that we can lease to another productive tenant. And that’s just like manufacturing new space without having to build it. And so, we’re very focused on that. And the tenants are now more implying to work with us than they were in the last year or so.

Great, I appreciate that. And then, just switching gears in terms of those Sears boxes, the five redevelopments you recently announced plans for, you mentioned earlier that those construction spend numbers aren’t in the pipeline yet. But, given it sounds like those can be some pretty significant projects here, adding additional uses, the hotels, office, residential. Just wondering if you can give us any sort of sense of how much capital those five could total here.

We have reached an agreement with Sears to take control of 12 locations, which also includes Seritage. Our total investment for this is approximately $1.2 billion, although some of this will not occur this year; five of them will be completed this year. You should consider the total amount rather than just the five. You'll see the five reflected in our upcoming disclosures, but keep in mind that looking at the overall 12, the investment sums up to about $1.2 billion in total.

I guess, also just on those densification projects, in the supplement, and I know another example is Northgate Mall outside of Seattle, which was in the news. That one mentioned it could have housing and offices but reduced square footage of retail. So, just wondering to what extent the project you’re doing could involve a reduction of retail square footage so that even though the end result might be or should be an increase in NOI that there could be some decline in between?

Yes. There is no question that that will have a reduction in retail space. Because remember, we have Penny, Macy’s, Nordstrom, and it’s a tight size, but it’s a great piece of real estate. And ultimately, it will be a residential, office and still retail. But, I’d say, roughly retail would be cut in half, more or less, in that range. Obviously, this is a process over time. We’ve got to go through the approval process, but the retail there will be dramatically reduced.

I guess, when you think about the densification projects overall, is that normally the case, or more often is it like on a parking lot on the side that wouldn’t end up impacting the retail portion?

A lot of this relates to our Sears operations. If we view Sears as a retailer, it essentially removes that aspect. Currently, we’re mostly adjusting the mix, but it will still involve retail. I would say much of this involves decreasing department store space rather than small shops. The income potential is significantly improved because, as you know, either they pay minimal rent or acquire the space in a way that benefits us financially, as we obtain higher rents from small shops or pursue mixed-use developments. Overall, retail space will be reduced, primarily focusing on cutting down department stores rather than smaller retail outlets.

And I would tell you that a great example of that focusing not just on the box, the land at King of Prussia, the Penny store is going to be demolished. That gives us 17 acres of land adjacent to King of Prussia mall and that is going to be a significant mixed-use project with hotel, office, residential, restaurants, retail, and amenities. And so, that’s a major opportunity for us to substantially upgrade what is already one of the best properties in the United States.

And then, just last one using Northgate or on this topic but just using Northgate as an example, is the reason that’s not listed yet just because the decision-making process is pretty early stage?

It’s early. The critical path involves approvals, and once those are obtained, we will begin construction. Seattle is a great market and city, and this is a prime piece of real estate. The new metro line will have access directly from our parking lot. However, this is a multiyear process. The most exciting project that the market could focus on right now is Phipps. Phipps’ Belk is leaving in August of this year, and we will demolish the store. The process is a bit complicated because we need to demolish a part before we can move upward, but that will take place. We are finalizing all the numbers, and this will likely reflect in next quarter or shortly thereafter. In all respects, it’s a confirmed deal, estimated at around 350 million dollars, and it will greatly enhance the value of that real estate. The only potential variable is the office component, but we believe a brand new building in that area, with ample parking and amenities, will be very appealing. Additionally, we will introduce a new food hall, along with Life Time Work and Fitness and Sport, and a Nobu hotel restaurant. This is a project that is actually moving forward. The Northgate project will take about a year, but the other major projects to watch will be Brea, Stoneridge, and King of Prussia. Those are the key four projects that will be developed in the next year or so.

And then, just switching topics, the income and other taxes line item was historically an expense last year and the first quarter was positive, I think due to a loss from Aero this year, back to an expense. Just wondering if you could go through the impact Aeropostale had to your earnings this quarter and the outlook for that investment.

Last year had both good and bad aspects. The first quarter of retail operations usually shows a loss, but we benefited from tax advantages last year. This year, with lower taxes and improved operations, we've seen a reduced tax benefit. The Aero business is performing as expected; with some effort, we should focus less on comparable sales. Our operating business is anticipated to generate an EBITDA of about $35 million, even though we only own 49%. We acquired it for roughly one times EBITDA, and while I've faced criticism for that decision, it seems to be paying off. Additionally, they're preparing to take on the Nautica operations, which we believe is another opportunity for profitability in the Aero company. Our partner, Authentic Brands Group, is also doing an outstanding job developing both the Aero brand and others, including Nautica, which we expect to finalize in the next 30 days. Overall, we have a positive story to share regarding our retail investments.

Good morning, everyone. Looking at the increase in tenant sale per square foot trying to figure out how much is attributed to turning out weaker tenants from the portfolio versus sales growth. And so, could we get some perspective on what is the average sales per square foot for tenants that have thrown out of the portfolio through bankruptcy in the quarter and in the last year?

We don’t have those numbers there. But we have such huge portfolio we lost 1 million square feet in bankruptcies. Our small shops are 65 million. So, no matter how you want to do that Nick, it’s not going to be material. Okay? You can make up a number and do it yourself and you will see that’s not material. 65 million square feet is still 65 million square feet.

And then, on the development page, recognizing these numbers can fluctuate. But, the expected return is now 8%, it was 9% last quarter. What’s driving that? Is it tougher construction costs or some change in product mix, location?

Things come in, things go out; we round it. So, there is some rounding up and rounding down, but nothing out of the ordinary mix change. That’s it.

I just want to go back to the Aeropostale conversation a little bit. Obviously, you’ve done a good job stabilizing it on a big basis. But I am just curious there were some special circumstances when you bought that. I guess, what’s the longer term plan there? It seems like not something you would necessarily keep long-term but just curious how you’re thinking about the long-term for that investment?

It's a relatively small investment, under $30 million. It's certainly a solid investment, and we were fortunate in our acquisition. The team has performed well. However, my focus is primarily on ensuring that operations continue to progress positively, which they have. For an investment of $30 million, I'm not overly fixated on it. Nonetheless, I remain open to any suggestions you may have.

Leverage buyout, okay?

That’s the one thing we’ll not do. Okay.

I have another question about the significant progress you mentioned that will be coming into the pipeline. You noted an increase in your net cost reporting numbers for the first time in a while. By the end of the year, what do you anticipate the pipeline will look like? Will it exceed 1.5 billion, considering some of the new additions? Also, from a delivery standpoint, will this lead to an increase in net operating income in 2020?

What I can tell you is that what we're currently working on has a lot to do with timing. The advantage we have is that we're not in long development phases, so we can easily switch projects on and off, similar to how we manage our balance sheet. I want to emphasize that what's in the pipeline now exceeds $4 billion. I would describe this as a real pipeline rather than just a shadow one. The challenge in answering your question lies in predicting exactly when these projects will become operational. However, as Tom mentioned, I anticipate a contribution of over $1 billion per year. I still believe that's an accurate estimate since we have this clear $4 billion pipeline, but the timing may vary, with some years possibly seeing $2 billion and others only $1 billion. Many factors are beyond our control, particularly the approval process. The solid figure is $4 billion, and all of this is currently in progress. This is why I maintain that anticipating over $1 billion annually is reasonable, considering it will take three to four years to fully realize these projects, plus we will introduce more as we grow. Even though we currently have 12 Sears stores, that number will increase—this is just the beginning.

I appreciate the color on the development pipeline. I guess, the one question I have left is this first quarter lease term, how much of that was contemplated in guidance? And is there anything else material that you expect in the balance of the year.

Yes, it was all included in our initial guidance because it was a unique situation we anticipated would be resolved.

And for the balance of the year, anything else material in there?

On lease term, not really. It's always been part of our business, and it's an acceptable part of it. If you can get the present value of the lease obligation and then reclaim the space, it's not too bad, as my hero would say. However, I don’t anticipate anything that’s going to be particularly extraordinary. And remember, Michael, it’s not included in our comp NOI.

David, you've established yourself as a skilled capital allocator. As you evaluate the different platforms where you're directing capital, including your U.S. mall business, outlet operations, international ventures, and stock buybacks, could you discuss the appeal of each of these capital uses from your current perspective? It’s clear that you are still investing and reinvesting in your U.S. mall assets, but can you provide insights on the relative attractiveness of these options, especially in relation to your stock?

Right now, the valuation is approximately 12 times, which is quite appealing. The only limitation we see is that it hasn’t really impacted our multiples. I value the flexibility our strong balance sheet provides and wouldn’t want to lose that. We could repurchase a significant amount of stock, but we prefer to remain cautious because we want to maintain this robust balance sheet for future opportunities, to manage unforeseen challenges, and to improve our properties. Remember, Rick and I have experience from the workout days. When I returned to real estate in 1990, I spent several years focused on workouts, and Rick did the same.

Yes.

Andy is cautious, and we will never compromise our balance sheet. While I believe we don't receive the recognition we deserve for this approach, that’s acceptable. We’re not going to be overly aggressive with stock repurchases because we value our flexibility. Our main priority remains stock buybacks, but we are particularly enthusiastic about our mixed-use projects and significant initiatives, which represent the future of our investment and growth. We might explore different directions for the company, as Michael Bilerman suggested regarding the consumer space. I certainly wouldn't dismiss innovative opportunities for us in the future, as I believe we have the capacity to explore such avenues. Thankfully, we have a $1.5 billion cash flow after dividends available for reinvestment in the business, and we are managing our resources wisely. If we face a challenging recession, we will not engage in risky leveraging practices that the development community tends to adopt for higher returns. That's simply not part of our philosophy. So, while it’s a lengthy explanation, we will continue our current strategy but remain flexible to adjust as needed. We keep our options open for any necessary changes in our approach.

One other question, David, I’d love to get your color on what you think the Unibail entry into the U.S. by Westfield means for the global retail dynamics and also for the U.S. mall dynamics?

First of all, I want to highlight a couple of points. First, for those looking at valuation marks, it's a very healthy mark. Secondly, operationally, I remain cautious; however, I don't anticipate any major changes. Westfield performed well in the past, and I believe they will continue to do so. The key takeaway is that there is a robust mark available for those interested. From our perspective, we expect little to no impact.

Do you have any comments on 1Q traffic across the different property types? What kind of uptick are you seeing, given improved trends coming out of the better holiday season?

I would say that overall, it wasn't a significant increase; it was about 1% across the board, regardless of whether we were looking at outlets or malls. This trend was consistent everywhere. The outlets usually perform a bit better due to weather conditions, but they were still up as well.

Are you seeing tourism come back to the outlet?

Yes, we are, even though it’s not as robust as it has been. It continues to move. Outlet sales were really, really nice in the first quarter. So, a lot more retailers are doing better. So, we were very pleased generally with the outlet results.

Great. And then, can you offer some insights on Klépierre walking away from its bid of Hammerson. What might have been the thinking behind that?

It's important to note that there is a supervisory board and an executive board at Klépierre. We are part of the supervisory board, but the executive board is responsible for running the company and making decisions. Therefore, it is crucial to hear from them regarding this matter. The transaction was primarily initiated by Klépierre, and while they did seek approval from the supervisory board, this question is best directed to the executive board.

Hey. David, it’s Michael Bilerman with two quick follow-ups. Is there anything with all the things going on with all of your competitors, whether it is the Westfield-Unibail merger, the GGP-Brookfield deal, clearly you’ve had management changes that may assert in financial activism, the activism. Does this allow Simon at all to take advantage of all those things going on for shareholders at all, in terms of just operations and dealing with things and there is just more on uncertainty at all your competitors, not from an M&A perspective.

I don’t think so. I believe they are all managing their businesses very effectively. I do not see any issues there. The companies you mentioned all have strong properties and capable management teams. I imagine that everything is business as usual, regardless of any corporate activities happening. So, I don’t think so.

You’re not hearing that from retailers that just may like love the drama going on in C suite or corporate at all?

Not at all.

And then just going back to this whole thing there, returns and the leases and you’re comment about the CAM audits and the movement towards fixed CAM and how that changed. Is there any change in the way you’re doing new lease agreements to address this for you to make sure that you’re getting your fair share, percentage rents and the right rent at the end of the day for a space?

That's a great question and it's quite significant. Each retailer has its own unique situation. Rick, myself, John Rulli, and his team are all aware of this. We are very focused on the issue, and while there isn't a standard response yet, it's crucial to address it in future leases. We don't mind internet sales, as we recognize that they come with a lot of returns. We prefer those returns to happen in our stores since it encourages customers to visit, which benefits retailers overall. We need to ensure this is handled properly. It's not an adversarial situation; it just requires appropriate attention. We are currently figuring out the best approach, but there’s no one-size-fits-all answer since every retailer operates differently. We want returns to occur in-store and appreciate the customer foot traffic. I know I've been cautious about sales, which might not be popular with the market, but the gap is growing as online business increases, leading to more returns. Customers prefer to make returns in-store. Additionally, the sustainability aspect is important—years ago, we discussed our desire for greater sustainability regarding energy consumption. The reality is that the internet creates a lot of packaging and returns, which is less environmentally friendly than customers making a complete trip to the store. There's much to consider, and while I don't have a definitive answer yet, we are collaborating with our clients to determine the best solution. This isn't about fairness; it's essential for the market to recognize this ongoing issue since we have to report those numbers.

And I wanted to congratulate Andy on his retirement, next to go out with a $30 billion balance sheet at under 3.5% rate with a seven-year average maturity, certainly calling it probably the peak from that perspective. But, is there any comments in terms of CFO process? What you’re go through internal versus external and how you think that’s going to be, timing wise?

First of all, Andy, we'll say goodbye to you, not until the end of this year. But you've done a fantastic job, as we all know. When I commented on your retirement, I truly meant it. I really felt strongly about what you have accomplished. You have done such a tremendous job that we don’t need to arrange any financing at the moment. It’s a bit ironic, isn't it? Here is a CFO who has performed so well that, in reality, there's nothing to address right now. Just kidding; there's always work to be done. But simply put, we are focusing more internally and considering some excellent internal candidates. I'm leaning towards that rather than looking externally. I haven't made a final decision yet. Andy, you have done an incredible job with the balance sheet, and we have worked together for 25 years. You have the best relationships in the banking industry, and we will certainly miss you. The reality is, you’ve done such a great job that there's nothing that needs fixing.

David, it’s Christy, just one more quick one for me. You suggested buybacks are likely to continue. To what extent are assumptions for additional buybacks from here contemplated in the current FFO guidance range?

They really aren’t other than what we’ve already done.

All right. Thank you everyone. I appreciate your questions and your comments.