Cousins Properties Inc (CUZ) 2003 Q2 法說會逐字稿

2003, Q2 Cousins Properties earnings conference call, 5 August 2003.

Good day and welcome to the Cousins Properties Incorporated conference call.

Today's call is being recorded.

At this time for opening remarks and introductions, I would like to turn the call over to the President and Chief Executive Officer, Mr. Tom Bell please go ahead.

Good morning, everyone, I'm Tom Bell, President and CEO of Cousins Properties and with me today are Dan DuPree, Vice Chairman of the Company and Tom Charlesworth, Executive Vice President and Chief Financial Officer and Chief Investment Officer.

I would like to welcome you to our second quarter conference call and at this time I will ask Tom to review the second quarter financial results.

Tom?

Good morning, and thank you for your interest in Cousins Properties.

First let me point out that certain matters we'll be discussing today are forward-looking statements within the meaning of the federal security laws.

Actual results may differ materially from such statements please refer to our filings with the Securities and Exchange Commission including our form 8 K filed March 9, 2001, for discussion of the factors which may cause such material differences and I would also point out that certain items we may refer to today are considered non-GAAP financial measures within the meaning of regulation G as promulgated by the Securities and Exchange Commission.

For these items and comprable GAAP measures and related reconciliations may be found through the quarterly disclosures link and the supplemental SEC information link on the Investor Relations page at our website at www.Cousins Properties.com.

Let me start off with a brief previous discussion of the financial highlights for the quarter.

Net income per share increased 1,068% in the 2nd quarter if 2003 as compared to the 2nd quarter of 2002.

This increase in net income is largely due to the recognition of gain on the sale of three properties, and the recognition of previously deferred gain resulting from the formation of the CP venture mixing bowl in 1998.

We sold Mira Mesa Market Center in May of 2003 and the two AT&T wireless office buildings in Serretos Corporate Center in June 2003.

These sales generated a combined gain of 43 million for both purposes and the net sale prices on these assets was approximately 27% in excess of their undepreciated cost or as we tend to say the sales reflect 27% value creation overall.

The quarter's results also include the recognition of approximately $90 million of previously deferred gain related to the formation of the C P venture mixing bowl in 1998 and we contributed nine properties to this venture at that time and booked on the balance sheet approximately 121 million of deferred gain with respect to these assets.

The gain was being amortized in income at a rate of approximately $4 million per year under GAAP.

Since Mira Mesa was developed in CP venture, when we distributed the Mira Mesa sale proceeds to the company from CP venture the recognition of $90 million of this gain was triggered under GAAP rules.

The balance of the deferred gain will continue to be amortized into income over the remaining economic life of the properties originally transferred into the venture or until such time as these properties are sold.

I would point out that there has been no change in the economics of the CP venture deal, and there was no tax gain resulting from this distribution of the Mira Mesa sale proceeds.

Because all of these gains, both the current sale gains and the CP venture gains relate to previously depreciated operating properties they are excluded from the calculation of FFO and collectively the total of approximately 133 million of backed gains on sale represent approximately $2.70 per share of net income.

Funds from operations per share decreased by 4% in the 2nd quarter of 2003 as compared to the 2nd quarter of 2002.

This decrease is primarily due to the loss of rental property revenues from tenants who effected early terminations of their leases in previous periods, and from the loss of rental property revenues from the Mira Mesa sale.

These decreases were partially offset by a decrease in net interest expense primarily as a result of the pay down of debt with the proceeds received from the property sales mentioned earlier.

We received $1.4 million dollars of termination fees in the 2nd quarter of 2003.

The same amount received in the 2nd quarter of 2002.

For the six months ended June 30, 2003, we have received termination fees of $22.4 million dollars from 11 tenants, as compared to $1.6 million dollars of termination fees received for the six months ended June 30, 2002.

Adjusted debt to total market capitalization was 35% at the end of the quarter, while recourse debt to total mark capitalization was only 1% at the end of the quarter, both indicating a strong financial position and financial flexibility.

Both statistics reflect reductions in our line of credit due to the pay down of the line with the proceeds received from the sales at Mira Mesa and Serretos.

Our financial flexibility is also evidenced by the July 24, 2003, closing of our public offering of 4 million shares of 7 3/4% series A cumulative redeemable perpetual preferred stock resulting in net proceeds of approximately $96.5 million.

According to our underwriters this coupon is the lowest ever achieved in a public preferred stock offering and unrated real estate investment trust.

In addition to the closing of the preferred offering in July, we closed a $55 million non-recourse mortgage loan in May of 2003, which is secured by our Emery Crawford Long Medical Office Tower, a joint venture project in which Cousins is a 50% partner.

This loan amount represents 100% of the project's estimated cost demonstrating strong value creation in excess of the cost of the project.

Those are the highlights of the second quarter.

Before I get into the details of our net income and FFO for the quarter, let me point out some changes we have made to our quarterly disclosure package.

On the net income and the funds from operations supplemental detail and reconciliation schedule, we have added information at the bottom of page one for aggregate straight line rents and for aggregate termination fees as well as same property growth percentages.

We define same properties as those that have been fully operational for two consecutive recording periods.

Same property growth has been calculated excluding lease termination fees and straight line rents for both office properties and retail properties, as well as in total.

The corresponding reconciliation of this non-GAAP financial measure is detailed on page 15 of the net income and funds from operations supplemental detail and reconciliation schedule.

We have also restructured the inventory of residential lots under development schedule to add information on project commencement date and expected project life.

Now I'll discuss the details of the second quarters income and FFO, which you can follow, beginning on page 2 of net income and the funds from operations supplemental detail and reconciliation schedule.

Consolidated rental property revenues less rental property operating expenses decreased approximately 20.9 million from the 1st quarter of 2003.

Termination fees received from 7 tenants in the 1st quarter of 2003, along with the loss of rents following their terminations, accounted for a reduction in rental property revenues, less rental property operating expenses of approximately $22.5 million dollars.

Offsetting this decrease are termination fees of approximately $1.4 million dollars received from nine tenants in the 2nd quarter of 2003, most of which occurred at two properties, 555 North Point Center East, and 333 John Carlyle.

In addition to termination fees and the resulting loss of rents, Avenue of the Peninsula experienced a additional decrease of approximately $500,000, $200,000 of which resulted from percentage rents received in the 1st quarter of 2003 with no corresponding amounts in the 2nd quarter, along with $300,000 of legal fees incurred in the 2nd quarter of 2003 related to a lawsuit that has now been settled.

Although we have expensed these legal fees, we are pursuing recovery of the fees from our insurance company.

Discontinued operations reflects the results of Mira Mesa and Serretos as well as presidential market center which was under contract for sale at June 30.

I would point out that the Mira Mesa results are lower than the prior quarter due to the sale occurring near the end of May.

Tom will comment further on the property sales later in the call.

Residential land division results for the 2nd quarter of 2003 increased $259,000 over the 1st quarter of 2003. 150 lots were sold in the second quarter, compared to 195 in the 1st quarter.

Of the 150 lots sold, 15 were sold at Hidden Lakes and 38 were at Summer Creek Ranch, two of our newly acquired residential developments.

This decrease in lot sales was offset by the simultaneous purchase and sale of 98 acres of land in Temco, our venture with (inaudible) inland, which occurred in the 2nd quarter, resulting in a net gain of $430,000.

Compared to the 2nd quarter of 2002, the total residential land division contribution for the quarter increased by approximately $1 million.

The schedule titled inventory of residential lots under development contained in the quarterly supplemental information shows several new residential developments that are being undertaken by CL realty, our joint venture with lumber man's investment company a subsidiary of Temple Inland.

These new developments have expected lives of two to ten years and will add over 6,000 lots to the ventures residential development pipeline.

The company's share of total estimated lots to be developed for all residential lot and development activity as shown on the inventory of residential lots under development -- under development -- development schedule is about 5500 lots.

Continuing on page three of the net income and funds from operation supplemental detail and reconciliation schedule, development income, management fees and leasing and other fees, all increased from the 1st quarter of 2003, largely as a result of increasing the leasing activity and from recognizing a termination fee of $100,000 on a third party development contract.

Interest income and other for the 2nd quarter increased $471,000.

Largely as a result of recording an increase in the fair value of warrants resulting from an increase in the stock price of atherojeanics.

These warrants were issued to us in connection by their lease for one of our pointing at north point in Atlanta.

Let me mention here that any material fluctuation in their stock price will result in a corresponding adjustment in our income statement in future periods, reflecting changes in the fair-market value of the warrants.

General and administrative expenses for the second quarter increased over the 1st quarter of 2003, primarily due to some additional personnel costs and an adjustment in the amount of accused incentive compensation for the year 2003.

Consolidated interest expense, decreased by approximately $860,000 from the 1st quarter of 2003, primarily due to the pay down of debt with the proceeds received from the previously-mentioned property sales, and an increase in capitalized interest on projects under construction.

Proceeds from the three property sales were used to reduce our line of credit, as I mentioned earlier.

That concludes my discussion regarding our FFO highlights for the 2nd quarter.

The next several items on page 5 of the net income and funds from operations supplemental detail and reconciliation schedule address details of line items that are excluded from FFO, but are included in the calculation of net income.

Immediately below the consolidated FFO line on page 5 is a section on gain on sale of depreciated investment properties, and the first category here is continuing operations.

The 90.9 million dollar gain here is the CP venture gain mentioned earlier, approximate approximately $1 million of quarterly amortization of the C P venture deferred gain.

The next line reflects the gains in the sales of Mira Mesa and Serretos that I spoke of earlier.

As I said, because all of these gains relate to the previously depreciated properties they are excluded from FFO and reconciling items in determining net income.

I would note that we expect to close in the 3rd quarter the sales of presidential center and the Expo.

Both of these projects are under contracts for sale at this point.

Again, Tom will have further comments on sales in a moment.

Depreciation and amortization of real estate, the next category on page 5, decreased in the 2nd quarter of 2003 from the 1st quarter of 2003 by approximately $2.4 million dollars.

Of which $1.1 million dollars was the result of stopping depreciation from being recorded on properties that are held for sale.

The remaining $1.3 million decrease is due to decreases occurring as a result of the writing off unamortized tenant improvements and related costs associated with tenants who terminated their leases in previous periods, offset by accelerating the write off of those same costs associated with least terminations in the current period.

Finally, net income increased by $551,000 dollars as a result of a impairment charge recorded in the 1st quarter of 2003 on a previously depreciated property held for sale.

The sale of this property occurred in the 2nd quarter of 2003.

But there was no gain or loss recognized in the 2nd quarter, since the impairment charge had been recognized in the 1st quarter.

At this time, I'll turn it over to Tom.

Thank you, Tom.

As the old saying goes these were the best of times, they were the best of times, and they were the worst of times and I think that that aptly described today's real estate market.

On the one hand, we've got a lingering recession followed by what seems to be a painfully anemic recovery and as an office developer we continue to face very difficult markets and scarce development opportunities.

On the other hand, the markets have offered us the sellers of office and retail assets of excellent opportunities as Tom has outlined and we've benefited enormously from these markets.

Today I would like to spend a few minutes reviewing how some of the recent events at Cousins fit into our overall strategy and philosophy.

As we've said many times, our primary objective is to generate exceptional total shareholder returns over time.

We do this primarily by creating value through the development of real estate, as most of our investors know our strategy for actively managing our portfolios with the periodic harvesting of that value.

We see this as an essential ingredient in maximizing value creation and total return to our shareholders.

When we harvest value through an asset sale, we typically capture a high price, provide capital for reinvestment in new development opportunities and at the same time keep the capital base down, especially if our gains are distributed.

Keeping the capital base down helps us to enhance future shareholder returns.

On the financial management side, we also try to manage our capital, based to maximize our shareholder returns by, again, taking advantage of opportunities that the market provides us.

In the recent past, our financial strategies have included buying back 5% of our stock, and this past month raising capital from perpetual preferred stock at what we are told is the lowest ever unrated coupon for a REIT.

We expect this offering will be appreciated by our shareholders as time goes by.

Let me focus a bit now on our asset sales.

The property markets are offering previously unheard of prices for certain of our assets and when we see prices like these, historic highs which we feel will not be seen again in the foreseeable future, we are sellers.

We believe that capturing this value is the right thing to do for our shareholders.

The book gain on the Mira Mesa retail center sale is $34 million and the tax gain is $41 million.

On Serretos, the book gain of $9 million and the tax gain is $17 million.

If we close both the perimeter Expo and presidential market center retail center sales at the current contract prices, which we expect to do, we'll generate an additional $52 million of booked gain and $52 million of additional REIT tax gain.

Added together, this gives us $95 million of total potential book gain and $110 million of total potential REIT gain or REIT tax gain from these transactions.

Book gains before depreciation recapture reflecting what we call our value creation which would be about $77 million on these four sales, that is approximately 43% value creation.

By that I mean the ultimate value that we received is 43% over our undepreciated cost.

Of course, I must say that although we expect our two pending sales to close shortly, we do, I have to say that I cannot guarantee that any sale will close until, of course it's closed.

The sale of Mira Mesa and the distribution of the proceeds from the CP venture that own the center had another interesting consequence which you know (inaudible) .

As Tom Charlesworth mentioned 90 million of the gain deferred upon the formation of the CP venture was recognized under GAAP in the 2nd quarter.

This, once again, represents value creation which we captured upon the contribution of approximately $230 million dollars of assets to this venture five years ago.

It is now being reflected in our income statement and the equity section of our balance sheet.

One question we have been asked of late is: What will you do with the cash from these asset sales and the preferred offering?

Of course, some was used to pay down existing debt.

Other amounts will be used to fund future investments, and there are other miscellaneous uses which will arrive in the normal course of business.

We have also indicated it is typical for a REIT to distribute its tax gain from asset sales, and as we have previously disclosed we have a private letter ruling from the IRS that would permit us to distribute 20 to 30% of the gain in cash, and the rest in stock.

We have also previously disclosed that our board will soon consider a number of factors in deciding whether to use all cash or a combination of stock and cash to distribute the large tax sale gains.

Some of the factors that the board will consider include such things as anticipated cash uses including potential investments and other operating expenditures, as well as available funds future sources of cash and potential financing.

Obviously, the successful completion of the asset sales we have discussed and the recent preferred offerings certainly make it easier for the board to decide to distribute the gains in cash if they chose to do so.

The board will make this decision sometime between now and year end.

I would note that all of the project sales we have discussed today qualify for the new 15% federal capital gains tax rate with the exception of the small component, less than 15 million of sale gain that will be subject to the 25% depreciation recapture tax rate.

The way that I see it, if it is -- see it is if a significant special distribution could be made in cash, we would be rewarding our common shareholders, and increase -- decreasing their investment without hurting the ability of the company to create value and deliver future growth.

This would serve to enhance total shareholder return over the long term which, as you know, is our ultimate goal.

So how do we see our growth prospects going forward from here?

Well, this is in a large measure a function of the business cycle and long awaited recovery, monetary and physical policy as well as the direction of the dollar have all been adding stimulus to the economy and there may be something to the fed chairman view that we will have a healthy GDP growth rate for the rest of this year and next year, though we've heard this story before.

Some recent news on this front adds encouragement and our sense of our retail business is consistent with the view.

The avenue west cop is now 84% leased and 87% committed with active negotiations underway for additional deals.

We've never had a avenue center this highly leased before opening.

In addition, our shadow pipeline in the retail area is deepening with new opportunities added and good progress in the pre-development process of other opportunity.

We are optimistic that a improving economy will solidify the trend and allow us to try additional retail developments in the coming quarters.

This would be consistent with the recovery from the last recession when retail development led the way.

Our residential lot development business is also doing well.

Of course, a economic recovery will at some point will lead to rising interest ates, including mortgage rates, and this we expect will have some negative impact on residential development.

We do believe, however, there is solid long-term demand growth for this business.

And we would not expect a pullback, if it were to occur, to be deep or long-lasting.

We are not as optimistic however about our office business.

Most of our office markets are still experiencing some deterioration and more weakness could occur.

Lease rates continue to deteriorate and vacancies remain high.

Right now the most significant question for our office portfolio is what will happen with Merrick.

As you most likely know, Merrick occupied a 362,000 square foot building at 111 Perimeter Center.

We have 50% ownership in this project.

Merrick is in bankruptcy and has a right under bankruptcy rules to terminate our lease.

We do not yet know what Merrick will do.

Our disclosure on the economics of this project, and I might say all of our projects, is quite good and the range of potential impact is easily calculated with a final impact depending on what Merrick decides to do.

And we have not yet received direction from Merrick and I do not expect that we will know their plans until later in the year.

At this time, we do not see any additional significant issues in our office portfolio.

We hope one result in a improving economy will be the stabilization of the office tenant base.

If the economy is indeed improving, we hope to see signs of it in the near future.

But even if this starts to occur, it is clear that the substantial vacancy overhang which exists in most of our major markets will be with us for awhile, taking some years to work itself off.

As a result we will continue to be extremely selective in taking on new office development opportunities until we see sustained economic and job growth.

One of my points today is that we are driven by creation of value over time for our shareholders.

And that towards this end, we will make good, long-term decisions, even when these may have short-term negative consequences.

One example of this is asset sales, capturing value created through asset sales can have substantial positive long-term impacts for our shareholders, however, loss of property income in the short term can lower FFO.

In the case of our asset sales this year, we believe we made the right long term decisions and are not deterred at all by short term negative consequences.

A further comment on expectations for the remainder of 2003 and 2004 might also be helpful.

Some analysts have projected a significant reduction in FFO per share in 2004.

To be sure, there are reasons to expect reduced FFO in 2004.

Mostly related to the office business, the recognition of the $20 million dollar cable and wire less lease termination fee in the 1st quarter of the year is not likely to be repeated in 2004 and similarly rental income from terminated office leases will not be fully replaced in 2004.

However, I would like to remind you that we are a diversified development company.

While it is possible for FFO pretty sure to be lower in 2004, one should not focus solely on the negative possibilities in addition to new FFO in 2004 from the Avenue West (inaudible) Prospect Tower we have significant potential contributions from our land and residential divisions.

For example, for the last year we have been actively pursuing the rezoning of our 217 acres of land on the west side of Georgia 400 at north point.

Various residential and other uses are being added to the land plan.

And while one can never be certain, we expect to be successful in this rezoning and are having great success in negotiating contracts for the sale of a number of these tracks, at very good pricing.

If the rezoning stays on schedule, we expect to see the fruits of our labor starting in the 4th quarter of this year, and in the years that follow.

The sales and related FFO in 2003, and 2004 could be substantial.

I hope to be able to be more specific on this at next quarter's earnings call.

In addition, the land group expects increased residential lot sales activity from our new CO realty venture.

All of this will help offset dilution from asset sales and weakness in the office portfolio.

Over the longer term it is of course our plan and goal to build up our pipeline of quality development projects as the recovery unfolds and to begin delivering new FFO from these projects in due course as much as we did in the last business cycle.

In conclusion two of our three primarily businesses retail and residential land look pretty good at this point.

The long anticipated and hopefully soon to be realized recovery will certainly help these business and should also help solidify the office (inaudible) as well.

Looking forward into the recovery we expect to see more opportunities in the market place for our various asset classes and I have great confidence in our team's ability to capture our fair share of these opportunities.

Couple these factors with a very strong financial position and I must say that I look forward to the coming years with some optimism.

That concludes my remarks.

I would like to open the floor to questions.

Do you have any questions for us.

And thank you ladies and gentlemen if you would like to ask a question at this time, you may do so by pressing the star key followed by the digit one on your touch tone telephone.

Once again, that was star 1.

If you are using a speaker phone please make sure your mute function is turned off to allow your signal to reach our equipment.

Again that was star 1.

And we will take our first question from David Shulman with Lehman Brothers.

Good morning.

Good morning, everybody.

First up, first question is, is for Tom.

Is -- is on -- you said there was no taxable gain in the -- in the CP mixing bowl?

That's correct.

When were the taxes paid, or when would the taxes be paid on the gains that occurred?

If there are no taxes now?

Well, the -- you may or may not remember from some years ago when we created CP venture, it is a mixing bowl and for tax purposes the gain is deferred for an indefinite period.

We don't anticipate recognizing at any time in the near future. .

It is a LLC until that winds up, right?

Well, it -- it has no definite windup date.

So it continues.

And we -- we are not forecasting any triggering of that tax gain at this point.

I mentioned that it was at the distribution and proceeds out of the venture triggered a GAAP gain but not a tax gain.

Right.

Just to make sure that you understood that.

That, I understand.

I saw the GAAP gain.

I was not clear on the tax gain.

Yeah yeah.

Next question is according to what, I guess Tom Bell ran through is -- is that you will have $110 million of REIT taxable gains assuming that the two sales go through this year.

That's correct.

And it is possible, I just wanted to -- it is possible that all of that could be distributed this year, possible, not saying that you will.

Well, let me answer your question this way: I think you know the REIT requirement is that taxable income, including the capital gains, be distributed in order for the REIT to avoid paying taxes.

Right.

And when you determine our taxable income, there are obviously unknowns between now and year end, including the extent to which we may trigger gain at north point.

What happens to Mira, et cetera, et cetera.

But currently we estimate that the regular dividend will carry out about 10 million of the capital gain, if this is correct, and if we do sell Perimeter Expo and presidential market center as we expect to do, that would leave roughly $100 million of gains on the four large asset sales to be distributed to avoid REIT taxes.

Okay.

Further asset sales later in the year could modify that, that is a rough number at this point.

As Tom said, we have a choice of doing that either in cash or a combination of cash and stock.

Okay.

So -- so -- so in theory that could be all cash, or 20 -- or 20, 35% in cash and the rest in stock or --

Yes.

Depending on what the board decides at the time.

That's correct.

Okay, next question is -- is -- is assuming the land sale gains on -- on west of the 400, that would be treated as a capital gain, right?

Those are, yes, capital gains, principally capital gain.

There may be a small amount of other, but I do not think --

Because you are not acting as a subdivider, so it is not used as a trader of business.

The land has been owned by us for a long period of time.

You are selling it to someone else who will do the subdividing and all of that other --

Correct.

Therefore that would be -- in a normal world it would be treated as a capital --

Yes.

-- cap table gain.

Our tax people are comfortable it is a capital gain.

Treated as a capital gain.

Next question is if -- if -- if you look at what is going on, just in the hypothetical, you raise $96 million on -- from the sale of the preferred, and if $100 million gets distributed from the -- the gains, aren't you really just doing leveraging up the company?

Leveraging up the company with what?

With the preferred stock.

Preferred stock.

Preferred as leverage.

Yes.

Well, it is -- it could be viewed as a form of leverage.

On the other hand, you know, especially if, and I say if, we did make the distribution to the common shareholders in cash, we would end up with a balance sheet that has added to it inexpensive, long-term perpetual preferred stock and less common investment.

Right.

And in the long term, that should be positive for our shareholders total return.

Some would call that leverage.

You could.

To the common shareholder.

You could.

Some of us could call that leverage.

Leverage, but a softer kind of leverage.

It is softer, because you do not have to pay it back.

Never have to pay it back.

And no due date.

Next question on mundane things in operation, what is going on at north point where the occupancies seem to continue to be weak?

Well, you know, at north point we've had the regas bankruptcy where three floors went to two floors, you remember that.

Yes.

Three floors went to one floors, you remember that from past calls?

Yeah, yeah.

And then secondly, we recently will -- what was that --

Alltel.

Alltel go out of one of our -- our north point buildings.

It is principally two tenants, David, and that resulted in substantial decrease in occupancy at those two properties.

It is a tough market.

There is a -- it is going to be tough leasing that up.

Our guys are working at it.

And, for what it is worth anecdotaly, they are seeing more traffic recently.

Do not know what will happen but, you know, we're hopeful that we can get some activity, although it is a very tough mark.

Two Alltel floors there.

Two Alltel floors, okay.

Now that is a good tenant.

Last question, it seems that the costs on the Boston project seems to be creeping up.

Is that due to higher TI's than originally anticipated.

Primarily.

Okay.

Thank you very much, guys.

Yes.

And once again, leads and gentlemen, that was star one if you would like to ask a question.

And, gentlemen, we are standing by with no further questions at this time.

All right.

Well, thank you everyone.

We appreciate your attendance this morning.

David, we appreciate you asking all of the questions.

And, as you know, and always the case here, if you need more specific information, or you have additional questions, you can always call Mark or Tom.

Thanks very much.

Thank you.

Once again, ladies and gentlemen that does conclude today's call and thank you for your participation.

You may now disconnect.