Earnings Call Transcript - FPH Q2 2020

Operator, Operator

Good day, everyone. Welcome to the Five Point Holdings Second Quarter 2020 Conference Call. As a reminder, this conference call is being recorded. Today’s conference may include forward-looking statements regarding Five Point’s business, financial condition, operations, cash flow, strategy and prospects. Forward-looking statements represent only Five Point’s estimates on the date of this conference call and are not intended to give any assurance as to the actual future results. Because forward-looking statements relate to matters that have not yet occurred, these statements are inherently subject to risks and uncertainties. Many factors could affect future results and may cause Five Point’s actual results or activities to differ materially from the activities and results anticipated in forward-looking statements. These factors include those described in today’s press release and Five Point’s SEC filings, including those in the Risk Factors section of the most recent annual report on Form 10-K and quarterly report on Form 10-Q filed with the SEC. Please note that Five Point assumes no obligation to update any forward-looking statements. And now I’d like to turn the call over to Mr. Emile Haddad, Chairman and CEO of Five Point. Please go ahead, sir.

Emile Haddad, CEO

Thank you very much, operator. Hello, everyone, and I hope that as we have this call, everyone on your side is healthy and safe. In our last earnings call on May 21, we shared with you that the company had implemented a COVID-19 contingency plan, which was focused on preserving our strong liquidity position. The levers that we pull on to do so are: one, an ability to shut down two-thirds of our operational expenditures on short notice; and two, 50% of our employment-related G&A costs are discretionary. In May, we shared that in light of the uncertainty at that time, we had shut down all land development activities, except those needed to support our existing builders. We did that, assuming the economic conditions would hold land acquisitions by builders. We also shared that we had started seeing home sales return to a pre-COVID-19 level at the Great Park, but we didn’t have enough data to draw any clear conclusions. The good news is that today, we can look back and see a consistent sales base over the 12 weeks since our last call. The median number of home sales in the first quarter was 10 sales per week. In the second quarter, it was eight sales per week. So far, this quarter, it has been 12 sales per week. I am sure that most of you have seen the strong reporting of sales from the public builders. We see the positive sentiment that builders have reflected in the engagement we have with them on purchasing homesites in Valencia. We also see it in the continuation of construction by our existing builders. In addition, the feedback we are hearing is that many homebuyers, as a result of COVID-19, are making the move to lower density communities with extensive open space and trails and close proximity to employment and major health care facilities, thus making our communities very attractive. On the last call, we also shared with you the sale of 70 homesites in Valencia, which is reflected in our second quarter financials. This sale included the portion of the purchase price payable through seller financing that comes due in December 2020. Last week, the builder chose to pay off over 90% of the seller financing much earlier than the due date. Today, we closed the sale of two buildings at the Five Point Gateway Campus. When we announced the sale on June 26, the Orange County Business Journal reported that this sale was a new high in terms of price per square foot at $537 per square foot versus previous highs in the $400 per square foot range. Similar to other transactions, we retained the right to repurchase the buildings if the buyer decides to exit in the future. If you recall, that’s how we repurchased the campus from Broadcom. Our vision of building fully integrated multi-generational communities with world-class sports and entertainment amenities, as well as excellent public schools, has not only attracted home buyers but also investors and users of commercial space, all of whom can see the appreciation and value that is created by the synergy of the live, work, play, learn, and connect elements. Previously, I mentioned that I have been asked to serve on the government’s task force on business and job recovery. I am serving as a co-Chair of the Finance and Infrastructure Committee and can tell you that housing has been identified as a top priority as the lack of housing supply in our markets has not changed, and has only gotten worse as a result of COVID-19. This month, we launched our new website at fivepoint.com. If you have time at home, we encourage you to explore the site. It is a good tool to understand the company’s strategy and its approach to community building. Finally, I hope that you all stay healthy and that the positive trend we are seeing continues. Until we have more visibility on the road ahead, we will keep one foot on the accelerator and one foot on the brakes. Thank you.

Erik Higgins, CFO

Thank you, Emile. This is Erik. Our 10-Q was submitted on August 11, and a summary of our financial results was included in the earnings release issued earlier today. I’ll start with our consolidated results and then address each of our four segments and conclude with comments about our balance sheet and liquidity position. The company’s consolidated revenues for the second quarter totaled $24.3 million and primarily consisted of a land sale at Valencia generating $17 million and recognition of revenue generated from management services. We recognized $23.9 million in earnings from our two joint ventures, including earnings of $28 million from our 75% interest in the Gateway Commercial Venture. Total consolidated costs and expenses were approximately $34.3 million, including $11.9 million in cost of sales related to the land sale at Valencia, and $16.3 million of selling, general, and administrative expenses for the quarter. Net income for the quarter was approximately $14.2 million, of which $7.6 million was allocated to the non-controlling interests, leaving $6.6 million attributable to the company. Moving to the segments. The Valencia segment is consolidated for accounting purposes. Revenues for the Valencia segment were $17.9 million, primarily related to the closing of 70 homesites during the quarter for a base purchase price of $16.6 million. The sale generated a 30% gross margin and was structured with a 10% cash payment and a $14.9 million note due in December of 2020. As Emile mentioned, it was reduced by approximately $13.9 million during the third quarter, prior to the maturity date. The Valencia segment income for the quarter was $1.7 million. The San Francisco segment is also consolidated for accounting purposes. The San Francisco segment’s net loss for the quarter was $2.5 million, which was primarily SG&A expenses. The Great Park segment includes operations of the Great Park Venture, the owner of the Great Park neighborhoods, as well as management services provided by the management company to the Great Park Venture. As a reminder, we own 37.5% of the non-legacy percentage interest of the Great Park Venture and 100% of the management company. The Great Park Venture is an unconsolidated entity with our investment in the venture accounted for under the equity method of accounting. For segment reporting, we include the full results of the Great Park Venture as the venture’s historical basis of accounting. The Great Park Venture operates with no debt. The Great Park segment revenues were $6.8 million in the second quarter, primarily consisting of revenue recognized under the management agreement. The second quarter net loss for the Great Park segment totaled $10.2 million, consisting of $1.8 million of net income related to the management company and a loss of $12 million from the Great Park Venture operations. The company recognized a loss of $4.1 million on its investment in the Great Park Venture, which includes our share of the Great Park Venture’s loss. Our commercial segment includes operations of the Gateway Commercial Venture and management services provided by the management company to the Gateway Commercial Venture. We own 75% of the Gateway Commercial Venture and 100% of the management company. The Gateway Commercial Venture is an unconsolidated entity, with our investment in the venture recorded under the equity method of accounting. For segment reporting, we include the full results of the Gateway Commercial Venture as the venture’s historical basis of accounting. The commercial segment income was $37.4 million for the quarter, primarily related to the sale of 11 acres and a 189,000 square foot building to City of Hope. The real estate was sold for $108 million. The company recognized approximately $28 million of income on its investment in the Gateway Commercial Venture. The Gateway Commercial Venture made a $75 million cash distribution to its members during the quarter, of which Five Point’s 75% share was $56.3 million. As Emile mentioned, today the Gateway Commercial Venture sold two buildings currently occupied by Broadcom for $355 million. We expect the venture to make a cash distribution of approximately $100 million in connection with the sale, of which upwards of 75% will be distributed to Five Point. When combining this sale with the City of Hope and excess entitlement sale, the venture has generated approximately $481 million compared to the venture's $443 million acquisition price in 2017. The venture and its members have recovered the initial investment, and the venture still owns one of the four buildings on the campus and has development rights for future expansion. I’ll wrap it up with a few comments related to our balance sheet and liquidity position. As of June 30, 2020, total liquidity was approximately $339.7 million, which was comprised of cash and cash equivalents totaling $215 million and borrowing capacity of $124.7 million under our unsecured revolving line of credit. Our balance sheet is solid with a debt to total capital ratio of 25.4%. With that, I’ll turn it back to the operator. We’ll now open it up for questions.

Operator, Operator

Our first question will come from Alan Ratner with Zelman & Associates.

Alan Ratner, Analyst

Hey guys. Good afternoon. Great to hear you all doing well and congrats on all the progress, especially on the commercial side this quarter. First question on Valencia: I believe last quarter, you mentioned that you guys were halting land development, but still had about 500 lots that were either developed or pretty close to fully developed that you could sell if demand picked back up. It certainly seems like it has. So just curious if you can give us an update: is development activity back on in Valencia and do you expect to sell those 500 lots by year-end?

Emile Haddad, CEO

Hey, Alan, I’m glad to hear you as well. And thank you for your good wishes. Let me just clarify something: I think we have numbers that might be mixed up. We have about 1,038 homesites in the first phase that we did the land development further. Now I think the 500 you were referencing was what I was guiding in 2019 as a potential number of homesites. If you recall, the demand was higher than we expected, and we ended up actually selling 781 homesites, which left us with 257 homesites in terms of spending in between. I think the last time when we had the call, I mentioned that we had some interest from builders notwithstanding the situation back in May. The good news is, today, we have multiple builders engaging with us, and whereas we talked about potentially selling the 257 in inventory, today, there’s interest in more than 400 homesites, which means that we probably would go beyond what’s standing inventory and do more land development to meet the demand. So that’s where we are. It’s actually really doing very well. And I am happy to see that the builders are very excited to be up in Valencia. So the simple answer to your question is we are going beyond what we have in standing inventory. And we would be moving forward in some more land development once we formalize lease agreements with the builders.

Alan Ratner, Analyst

Got it. Yes, those numbers are matched up. I think I was just adding the 257 and I think you would given roughly another 200 or so that you mentioned you can move pretty quickly on. So I think we’re talking the same thing here. In any case, just to clarify there, so development, if I think about just from a cash flow perspective, things should be ramping back up pretty close to where they were pre-pandemic over the next quarter or two?

Emile Haddad, CEO

Well, I mean, look, we’ve been doing nothing but keeping an eye on cash and liquidity since March 16. There are some opportunities on the cash that we are contemplating, such as the closing of the deal today. It’s very hard to tell you, going forward, because we are still in a very new market condition. And as much as we are optimistic and we hope that things are going to stay, the four of us – the top four people in the company are here every day, and everybody else is removed. We really have our finger on the pulse during this time. So I’m hoping that we will be back to the same market conditions and cash flows. But I think it would be a mistake for me to extrapolate today until we see a little bit more of what’s going to happen over the coming few months. Especially as we enter an election season, we all know that this is going to be a little bit turbulent.

Alan Ratner, Analyst

Understood. Yes, it’ll be interesting few months for sure. And then just having Great Park, maybe you can give us a quick update just on the next phase there. I think we saw something about you guys doing some fee building relationships there, so I believe that’s new. So what’s the update there, if you can give us one?

Emile Haddad, CEO

Yes. So we are in – and thank you for the question. So in terms of the sales of homesites what we do at the Great Park, we measure on a weekly basis the velocity of sales and the burnout of each of the different product lines. We then start to match the next sale of homesites to the timing of when the build-out of a certain product might be similar to something we’re bringing to the market. It happens, and therefore, we don’t create an overlap that would then start creating downward pressure on pricing. Right now, in terms of homesite sales, we are not projecting any sales this year, but we are watching the velocity of sales. As I said, we’re seeing the higher median number of sales in the last few weeks. So if we see that the sales accelerate, we have the ability to very quickly bring homesites online earlier than expected. In terms of the fee building, here’s what has happened: We go to the builders now with different multiple products and we ask them for their price. In some cases, they might have a little bit of resistance to a certain price of homesites for a certain product. We will not discount our land. We’ve made it very clear that we are not going to discount our land. This is the value of our land. So if we find ourselves with a product that might not get the same type of appetite from builders, we will build it ourselves. We do not want to be a homebuilder, but we have a very good relationship with the New Home Company. Larry has been a friend and knows this market extremely well. And I think as well, he becomes our key builder. He doesn’t have the ability to buy as much as public builders can because of the price of land that we sell at, but this gives him an ability to be in the marketplace in a market he knows, and gives us the ability to ultimately get the price per acre that we expect for a product that certain builders might not be as willing to pursue. You’re probably going to see this continue even in Valencia, because when you develop 10, 15 different product lines and with the universal business sinking with consolidation, it used to be that I would go to 22 builders. Almost every product would have someone willing to pay the price. As you know, we don’t have that number of builders today, and someone who might say they don’t like this price at the high end might be concerning or certain builders might test down on me. So we are willing to do that. We believe in our own product.

Alan Ratner, Analyst

I know I asked a bunch of questions, but maybe just I can hang up.

Emile Haddad, CEO

That’s okay.

Alan Ratner, Analyst

Okay. I’m just curious how that might flow through your financials when that ultimately does come to fruition, because is it just going to come in like a homebuilder’s P&L revenue for the home sales? Or should we think about that differently?

Emile Haddad, CEO

No, it will come through just as homes that are sold.

Operator, Operator

And our next question comes from Truman Patterson with Wells Fargo.

Paul Przybylski, Analyst

This is actually Paul Przybylski on. I guess just kind of a bookkeeping question. First of all, how many lots do you have remaining at the Great Park?

Emile Haddad, CEO

I can give you the exact number, but I’m going to say we probably have about 4,000 lots. As we’re speaking, we are going to look up the exact number on that. And I’m going to get somewhat into 4,000. We’ll get you the number. If you have another question, by the time we answer back, we should have that number.

Paul Przybylski, Analyst

Okay. And then you mentioned looking at the cash distribution from the Gateway side, all of it this quarter. What type of gain are you expecting to book from that?

Erik Higgins, CFO

So on the sale that closed today, obviously, we still have to get through our accounting analysis and the transaction needs to be reviewed by our auditor. But I’d say based on the purchase price in our initial analysis, the venture will probably recognize a $70 million to $75 million gain on that sale, and then 75% of that will be pushed to Five Point.

Paul Przybylski, Analyst

Okay, that’s good. And then more of a theoretical question. The retail entertainment office environment has changed dramatically here over the past several months. How do you look at the commercial side of your business amongst the three projects and any kind of changes you might foresee in the future or the timing of bringing some commercial projects to some markets?

Emile Haddad, CEO

Well, way before COVID-19, we actually started pivoting more towards healthcare-related uses in each of the communities. The City of Hope transaction was a great example of that. And you’re going to see more of that happening. Healthcare, I would say, is going to become more in demand both in terms of treatment and research. In terms of entertainment, obviously, things are on hold right now. We have some facilities where we are working with our partners at City of Hope right now on doing a drive-in movie theater and working on activating some of the food and beverage for delivery outdoors. So it would be accretive as is for everybody else. We don’t have a large component of that. We just look at it as an amenity. But I can tell you, I think it would be a mistake to assume that the environment of social interaction, food, and entertainment is not going to come back. I’m willing to bet that once people know that divide is behind us, there’s going to be such a huge pent-up demand for people to socialize. We’re seeing it right now with people taking risks, but I think for that generation, the line is very low between social activities and work. If anything, I think that office spaces are going to become more interactive spaces. But again, let’s wait and see what the future looks like. For us, we are not making any changes and we don’t have anything that we need to be overly concerned about. In terms of the number of homesites, we have about 4,500 homesites.

Paul Przybylski, Analyst

4,500, okay. And just quickly again, the observation you gave earlier in the call, those were just for the Great Park, correct? Or are you actually selling now for Valencia?

Erik Higgins, CFO

You’re talking about the median numbers that I provided for sales?

Paul Przybylski, Analyst

Yes, the 10.8 and 12.

Erik Higgins, CFO

Yes, those are for the Great Park; we have not started selling homes yet.

Operator, Operator

And next, we will have Michael Rehaut with JPMorgan. Again, go ahead, sir; your line is open for questions.

Elad Hillman, Analyst

Okay. Can you hear me now?

Operator, Operator

Yes, we can.

Elad Hillman, Analyst

Hi. This is Elad Hillman on for Mike. Congratulations on the sale of the two buildings at the Five Point Gateway Campus. I was wondering if you could provide some more details on the purchasers, the timing around the cash distributions, and thoughts around any development plans for the last remaining building?

Emile Haddad, CEO

Yes. You’re coming in a little bit broken up, but let me just make sure that I understood the question. Your question was, you want to get a little bit more clarity on the distribution of the cash as a result of the Broadcom closing, and you wanted more of a feel for additional development within the Five Point Gateway? Was that the question?

Elad Hillman, Analyst

Yes, yes.

Emile Haddad, CEO

Okay. So for the distribution, I think it’s going to happen very quickly. I know that Erik went to expect the distribution to happen.

Erik Higgins, CFO

Probably within the next month, like 30 days.

Emile Haddad, CEO

Yes. This is something that’s going to happen quickly. This obviously adds to our strong liquidity, which again, every CEO in the country today, that’s the number one thing that we’re looking for, making sure that our liquidity is in a good position. In terms of the future, what we have right now, we have approvals for about 200,000 square feet of office space or we can build about 100,000 medical. Right now, I can tell you the thinking is to build the medical. We have demand right now for all of the medical space, which is very complementary to what we have with City of Hope. We also plan to bring back entitlements from the project, the larger project at the Great Park, and enhance Gateway as we start looking ahead. In terms of the near future, we are starting to work right now on planning a 95,000 square foot facility that will probably be an outpatient surgery, spine and imaging facility, where we have a demand for that right now and we have users who want to be there.

Elad Hillman, Analyst

Great. And my second question, I was just trying to understand a little bit better the development plans and sales in Valencia for the second half of the year. You mentioned that there was interest from homebuilders for another 400 homesites. You have 257 in inventory, another 230 largely completed. I’m just curious what the hesitation is in terms of being able to potentially close more deals there in the second half of the year? Is it more just market uncertainty? Is it constraints from labor or anything else—any other thoughts around Valencia?

Emile Haddad, CEO

No, we don’t have any constraints from labor. The thing that we look at is making sure that we structure a deal that is our price that we would like to see and puts the builders in a position to be comfortable as they execute. Today, you have builders who have more of an interest in a cash acquisition. Some builders have relationships with land banks, others are looking for takedowns, and some are looking for some type of rolling option. The good news for us is we can do any of those, and those are the discussions we’re having right now with different builders. We’ll pick the builders that we feel will optimize the value for the community and for us. We are not under any pressure to do anything by year-end, and all these discussions will conclude based on what makes sense for the business. In some cases, we will take somebody who might say they’re willing to pay a cash price. In some cases, we’ll be very happy to do more of a turn-type of a deal or even include some of these acquisitions in some of our relationships with land banks for those who might want to land from us. The sacred cow for us is the irreplaceable land that we’ve worked for two decades to get here, and we are not going to go ahead and do something that discounts their plan and disrupts the pricing structure for those who have already made a commitment from the builders' community. The good news is we have the cash and liquidity to be able to do that.

Elad Hillman, Analyst

Okay. Thank you.

Emile Haddad, CEO

Sure.

Operator, Operator

Our next question will come from Steve Kim with Evercore ISI.

Steve Kim, Analyst

Yes. Thanks a lot, guys. I appreciate all the color so far. I’ve got a few scattered questions here, but just generally, to start off at a higher level, Emile, you talked about the strength of the market, I believe being fluid was the word you used. You didn’t want to extrapolate demand too confidently into the next few months, which is understandable. But I wanted to clarify, have you actually seen volatility in your week-to-week demand traffic, that kind of stuff? Or has it been very steady and strong, but you’re just overlaying a dose of conservatism?

Emile Haddad, CEO

No, we have not seen volatility in our markets. What I have seen is more of a psychological reaction to numbers that are coming out on the virus and people talking about the second wave and third wave and things like that. People are talking about the economy. This feedback is not what I’m getting from our builders or the buyers. I’m looking at trends, and what I’m saying is if I am a buyer and I keep on hearing that the economy is going to be bad or that we have a second wave, I might hesitate, especially with the fact that we’re 2.5 months away from what appears to be a very polarized election. In a market like ours, where a lot of our buyers are specialists, and they have the ability to wait, I am very cautious about saying that because I’ve seen great five, six weeks before this trend might continue into what could be a storm of second wave concerns with the election. I’m cautious about these things, and I watch them closely. That’s where it’s coming from, Steve.

Steve Kim, Analyst

Yes, yes, that’s what I figured. Yes, sort of asymmetric risk when you’re a large landholder like you guys are. So I get it. That makes perfect sense. I just want to make sure it was squaring with what we were seeing because we had not seen any kind of volatility. It’s just been strong thus far, so I just wanted to clarify that. Following on, can you speak to how pricing has been progressing at Great Park? Have you seen any ability to have an upward inflection in pricing recently?

Emile Haddad, CEO

Yes. In all honesty, I have not followed pricing closely in the way we typically would in a stable market. We are looking more at what we’ve seen from builders in terms of number of sales, the quality of the buyers and their ability to qualify and close, but we haven’t heard anything in terms of price decline. I would bet that it’s probably more flattish in the last five, six weeks. I think builders are focusing on making the sale rather than trying to push prices 3% or 4% up.

Steve Kim, Analyst

Okay. And then with respect to Gateway, I think you – in addition to…

Emile Haddad, CEO

...the 100,000 square feet of medical space that you said could additionally be developed. I’m curious, are there trends in labs or other aspects of the health care demand such that you’re going to see a particularly strong premium for new builds? Just wondering if there are emerging trends on the health care side such that retrofitting space is not really conducive in the same way as moving into a new space like you could offer would be. Steve, I tell you, you’ve heard me say this many times over the years. What we’re seeing and hearing is that people looking at office space, whether it’s for health care or R&D, are not only considering the building. They’re looking at what else can they provide to attract talent. That’s why we have focused for so many years on building the communities we build where today, if you’re building a medical facility here, you have housing, public education, open space fields, and everything else. The synergy of these elements drives the premium. That’s what we are hearing: when people are looking at our office building, they’re assessing the entire community and the access people will have.

Steve Kim, Analyst

Yes, makes perfect sense. Sure. And then lastly, I think you alluded to the fact that there was some remaining acreage. I just wanted to get some clarity around – in addition to the 100,000 square foot medical space that you can develop, is there a certain amount of acreage that could also, at some point, be subject to future development rights?

Emile Haddad, CEO

Sure. Let me remind you that when we sold the land to Broadcom, we sold it with entitlements of 2 million square feet, and the first phase that Broadcom built was 1 million square feet with the idea that they would build another 1 million square feet as their headquarters. So obviously, we have the ability to build over 2 million square feet. So far, that’s only about 1 million square feet. The answer to your question is if we decide to intensify the land we have in the Gateway area, we can add probably another million square feet easily and build it.

Steve Kim, Analyst

Got it. Okay, that’s very helpful. Great. I think that was all I needed. Okay, thanks a lot, guys. Congrats.

Emile Haddad, CEO

Thank you, Steve. Stay healthy.

Operator, Operator

Thank you. That does conclude the question-and-answer session. I’ll now turn the conference back over to Mr. Haddad for any additional or closing remarks.

Emile Haddad, CEO

Well, I want to thank everyone for dialing in. I just want to clarify one number that we mentioned regarding the remaining number of homesites: it turns out that I was right with 4,000 and was off with 4,500, so it is indeed 4,000 homesites. Just to ensure the record is clear. I hope that we’ll have another call when everybody is healthy. We are always available for any type of discussions you might want to have after the call is over. Appreciate your dialing in. Please stay healthy until the next quarter. Thank you.

Operator, Operator

Thank you. That does conclude today’s conference. We thank you for your participation. Have a wonderful day.