Eastgroup Properties Inc (EGP) 2002 Q2 法說會逐字稿

Welcome to the Second Quarter Earnings Release Conference Call. At this time all participants are in a listen-only mode. Later, we will conduct a question and answer session and instructions will follow at that time. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. David Hoster, CEO and President. Mr. Hoster, you may begin.

Thank you. Good afternoon and thanks for calling in. We appreciate your interest in EastGroup. Keith McKey, our CFO, will also be participating in the call.

Since we will be making forward-looking statements today, we refer to the cautionary language in the disclaimer on these forward-looking statements located, both in our press release and on the second page of our Supplemental Information Package.

With corporate accounting and reporting currently at the forefront of both the business and national news, we felt that it was important to address a number of these issues at the beginning of this call. First, Keith and I will certify EastGroup's financial statement filings beginning with the second quarter 10-Q, as provided in the proposed SEC Rule. Secondly, EastGroup will start expensing the cost of stock options. We estimate that the expense will have an income statement, an FFO affect, of less than $0.01 per share per year.

Now turning to results. As reported in yesterday's press release, total fund from operations for the second quarter were $0.68 per diluted share, as compared to $0.70 per share for the second quarter of last year, a decrease of 2.9 percent. FFO before gains on securities was $0.63 per share, a decrease of 4.5 percent from the second quarter of '01. The gains in both periods were generated by the sale of [Reed Securities].

For the first six months of the year, total FFO was $1.31 per share, as compared to $1.32 for the first half of 2001. Before gains on securities was $1.24 per share versus $1.28 per share last year, a decrease of 3.1 percent.

Please note that we continue to calculate funds from operations based on [indiscernible] definition of FFO, which excludes gains under depreciable real estate.

Same-store results were down by 4.5 percent for the second quarter and down 4.1 percent for the first six months of the year. This was totally due to lower average occupancy for both periods. On a same-store basis for the second quarter, our best major markets were Hayward, California with NOI up 6.5 percent and Houston up 4.8 percent. The down markets were Memphis, 23 percent, New Orleans, 21 percent, and Jacksonville, 11 percent. Markets that have begun to show improvement from the first to the second quarter were Dallas, Phoenix and New Orleans. Looking forward to the end of the year, we anticipate some improvement in Memphis but a decline in Houston due to two large vacancies.

If you look at page 15 in our Supplemental Information Package, you will see expanded operating statistics by core market. These include same-store results, leased in occupied figures, rental rate increases and lease expirations.

In last year's -- in last quarter's conference call, we stated that the occupancy had hit bottom and that we expected to experience gradual improvement for the balance of the year. Fortunately, so far, we have been right. May and June turned out to be the best leasing months for EastGroup in the past 13 months. We executed 18 leases on 527,000 square feet of vacant space. As a result, we finished the quarter at 89.7 percent occupied and 91.0 percent leased, increases of 90 basis points for both statistics.

EastGroup's assets in the four-core market states of Florida, Texas, California and Arizona were 91.8 percent occupied and 92.9 percent leased at the end of the quarter as compared to our markets outside these core states, which were 79 percent occupied and 81.4 percent leased.

On the opposite side of the ledger, we are still losing tenants to the economy. As a consequence, we expect to further increase occupancy over the rest of the year, but at a slower pace than both we would like or previously anticipated.

Looking specifically at second quarter leasing statistics, we renewed or released 74 percent of the 657,000 square feet that expired and renewed an additional 238,000 square feet, expiring in future periods. These statistics represent a real improvement over previous quarters. Combining both renewals and new leases, we experienced the following: average lease length was 3.4 years, average lease size was 12,800 square feet, there was an average increase in rents of 2.4 percent, consisting of a 2.6 percent decrease on new leases, and a 5.9 percent increase on renewals. And the average cost of tenant improvements was $1.51 per square foot over the life of the lease, not per year.

As always, we analyze the reasons tenants do not renew their leases. In the second quarter, 34 percent of the square footage that was vacated was due to bankruptcy or a closing down of the business. And 26 percent was due to the tenants' changing space needs.

Since we were only three weeks past the end of the second quarter, we do not yet have updated and meaningful vacancy statistics for our major markets. Looking at direct experience in the field, our best results have been in Dallas, where we are now 100 percent leased. We are also encouraged by at least increased leasing interest in New Orleans and Memphis, which have been our weakest markets. The big question is how strong activity will be between Labor Day and Thanksgiving, which is traditionally been a good leasing period.

At the end of the second quarter, we transferred three development properties with 275,000 square feet to the portfolio. One of the three had reached stabilized operations and the other had been completed for 12 months. World Houston 12, with 59,000 square feet, is 100 percent leased and increases our World Houston ownership to almost 1.1 million square feet. The 90,000 square foot Walden Distribution Center, on the far-east side of Tampa, is 63 percent leased and we project lease-up by the end of the year. Techway distribution center with 126,000 square feet of southwest Houston is currently vacant. We project it to be leased over the next nine months.

During the quarter, we began construction of three new developments and an expansion of an existing building. World Houston 19 and 20 will contain 128,000 square feet in our World Houston development at Intercontinental Airport, where we are currently 100 percent leased.

Expressway Commerce Center, which is in the Tampa International Airport submarket, will have 108,000 square feet in two buildings. Our 800,000 square feet in this submarket were 100 percent leased at the end of the quarter.

We have also begun a 34,000 square foot pre-leased expansion of our Chamberlain Distribution Center in Tucson. When completed, the lease on this 154,000 square foot building will run to 2011 the CPI rent [indiscernible] 30 months.

Even though overall markets statistics show that most cities are still experiencing increasing industrial vacancy rates, we have been able to identify specific submarkets in which we see development opportunities for our business distribution-type product. Given the average size of our new projects and the high occupancy experienced in these submarkets, we believe the risk reward of new development continues to make sense in selected cases.

With that said, we do not plan to initiate any new construction in the third quarter. Fourth quarter starts will depend on leasing over the next 90 days.

Our development program currently consists of the -- three properties with 240,000 square feet in lease-up and seven properties with 587,000 square feet under construction. These ten developments total 827,000 square feet for the total projected cost of $44 million. This translates to an average cost of 4.4 million and 83,000 square feet per property. Our average projected cost per square foot is $53.00 and these ten properties are 43 percent leased.

As we have repeatedly stated, our development program has been, and will continue to be, a major contributor to FFO. With both the properties currently under construction and a good inventory of developable land and our existing submarkets, we believe EastGroup is well positioned to take advantage of development opportunities as the economy recovers. From the land standpoint, we currently have a development land inventory of 130 acres, all of which is in submarkets where we are already operating.

During the second quarter, we acquired two buildings totaling 79,000 square feet in the Broadway Industrial Park in Tempe, Arizona for a purchase price of $3.0 million. The buildings are 100 percent leased to three tenants and increase our ownership in Tempe to eight properties containing 446,000 square feet. The GAAP and cash yields on this new investment are projected to be 10.35 percent and 10.25 percent, respectively. The transaction was partially funded utilizing the proceeds from the sale of the Lakeside Distribution Center last December through a Section 1031 exchange.

Earlier this month, we acquired the 188,000 square foot Freeport Tech Center in northwest Houston for a price of 6.3 million. The building was completed in 2001 and is 66 percent leased to tenants. In 2000 we made a construction loan for the development of Freeport with an option to purchase the property after completion. As a part of the exercise of the option and purchase transaction, the construction loan was repaid in full. At closing the loan had a balance of 5.8 million and an interest rate of nine percent. When 100 percent leased, Freeport is projected to generate stabilized GAAP and cash yields of approximately 10.9 percent and 10.7 percent, respectively. At its current occupancy, the property is projected to experience GAAP and cash yields of 6.3 percent and 6.2 percent, respectively. As a value investor, the exercise of our option gave us the opportunity to purchase a recently completed state-of-the-art facility and, at the same time, achieve a full development level yield with only a limited amount of leasing risk.

We also currently have two properties totaling 62,000 square feet under contract to purchase in Orlando Central Park. On the disposition side, our Seventh Street Distribution Center in Phoenix is under a sales contract. It is a 39,000 square foot service center and they've consummated the transaction are to result in a small gain. We also hope to sell several of our smaller Memphis assets before the end of the year.

I will now turn the call over to Keith McKey to cover the financial side.

Good afternoon. Our capital structure is solid. Debt to total market capitalization was 36.3 percent at June 30 with good debt ratios. For the quarter, they [indiscernible] ratio was 4.5 times and the fixed charge coverage ratio was 3.6 times. Voting rate debt of 96.5 million is 11.7 percent of the total market capitalization and this will be reduced because we signed an application for a $40 million non-recourse mortgage loan and that loan has a ten-year term, a 25-year amortization and an interest rate of 6.86 percent. The loan is expected to close in the third quarter.

In June we paid our 90th consecutive quarterly dividend. This dividend of $0.47 per share equates to an annualized dividend of $1.88 per share and represents a payout ratio to FFO of 69 percent for the second quarter. Adjusted FFO was $0.63 per diluted share. Major adjustments from FFO to adjusted FFO were straight-lined rents of $0.02 per share, leasing commissions of $0.02 per share and capital expenditures of $0.03 per share. The dividend payout ratio to adjusted FFO was 75 percent.

Total bad debt expense for the second quarter was 228,000 and lease termination fee income was 152,000 for the quarter. We have reduced our FFO guidance for '02 to a range of $2.49 per share to $2.53 per share before gains on securities. The reduction results from the timing of improvement and occupancy.

Although we believe that we are past the bottom for occupancy, we are projecting FFO for the third quarter at a lower range to be below second quarter FFO for the following reasons. The second quarter included the collection of $290,000, one half cent a share from an investment written off over 20 years ago. And this amount was included in other income. Also, we collected termination fees of 152,000, which we discussed earlier, in the second quarter and project none in the third quarter. In addition, we expect a new $40 million mortgage to close at the end of August. Interest rate on this mortgage is 6.86 percent and we will reduce bank debt, which currently has a rate of approximately three percent with the proceeds.

All of our [indiscernible] shares, except Pacific [Gov] were sold during the second quarter for gains of $0.05 per share. The $0.02 gain on securities projected it the third quarter is from the expected final payment from the Pacific Gov liquidation. And also, we did not include gains on depreciable real estate in FFO consistent with the definition endorsement [indiscernible].

Earnings per share before gains on depreciable property should be in the range of $0.90 to $0.94. And I know some of you are worried that since we're headquartered in Mississippi, we might not know how to account for capital expenditures, but we have included a new detailed capital expenditures schedule on page 13 of the Supplement Information. And this report details costs for capital expenditures and leasing commissions.

Now David will make some summary comments.

In summary, although there is still a lot of work to be done on leasing, we believe that we have turned the corner and see a good deal of upside potential as we increase occupancy. In addition, we have a strong and flexible balance sheet and we are well positioned to take advantage of future opportunities. We feel that our strategy is simple and it is working. Quality multi-tenant buildings clustered around transportation features in growth markets.

Now Keith and I would be happy to answer any questions anyone might have. Amy?

Thank you. If you do have a question at time, please press the "1" key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the cue, please press the "#" key. One again, if you do have question, please press the "1" key. Our first question is from [Paul Adoornuckle] with Mercury Partners.

Hello. Good afternoon. Had a question on the development pipeline. It looks like the second quarter deliveries are just a shade lower than, in terms of the stabilized yields, the second quarter deliveries are just a little bit lower than what's currently in the pipeline. I was wondering if you're still confident with the projected yield in the properties under construction and in lease-up. And if you are updating those projections as market conditions warrant.

Yes, Paul. We are updating each quarter -- taking another hard look into each one of the yields. On the three properties that came into the portfolio in the second quarter -- the one that was 100 percent per-leased in Houston, came in a little bit lower than originally anticipated because we're able to pre-lease it and we're willing to take a little lower yield in knowing that there was limited risk on it. Also, we ended up with a ten-year lease there instead of five-year lease so that we were capitalizing a commission over ten years rather than just five. The other two, because of market conditions, we have lowered very slightly the expected rent that we planned to achieve. And also, we ended up capitalizing during the holding period a little more than was originally projected. So that's the reasons for those numbers having come down a bit.

Okay. Great. Thanks very much.

Thank you. Our next question is from [Brian Leg] with Merrill Lynch.

Hey, David. First of all, Keith, I missed the size of the mortgage that you plan to issue.

Forty million.

Forty million. Okay. And I just want to clarify the last question. I mean, just doing, it looks like a weighted average of maybe eleven three yield on $53.00 a foot, implies like $6.00 rents. Have rents fallen significantly from what your pro forming?

No. No, they haven't. Our issue has not been on the rental rates. It's been much more on the number of prospects out there and we have intended to give, in several cases, free rent or period before the rent commences, versus a lower rent or significantly higher TIs. It's been much more issue of prospects rather than the cost.

And can you talk about the prospects? Are you seeing more people touring your properties? Are you seeing more interest level? And I assume, from what you're saying, rents haven't really fallen but concessions may be and TI packages might be up.

I would say that our experience over the last 90 days is that rents are falling on the larger spaces and that's because there seems to be more competition for those size tenants and people are showing nervousness about large vacancies so the bigger the space, the more the rent has dropped. And that's what we're seeing. The smaller tenants don't have as much power in negotiating their leases. They're less alternative. Landlords are more confident about the smaller spaces. The real rent falling has been in the bigger spaces. TIs have never been a really big issue with us just because of the office build-out of our spaces. But we generally do whatever it takes to put a tenant in a space.

And the $1.51 -- is that a good run rate going forward? And what would you say are your TIs for new space versus renewal space?

Our answer to your first question. We have been averaging much closer to $1.00 in pervious quarters. We had a big lease renewal at our University Business Center in Santa Barbara, which is an R&D project and, as a result, had much higher TIs. That skewed that number upward and so we believe that we'll be back down closer to the $1.00 as a run rate.

And -- sorry [indiscernible] what were the new space TIs be verses renewal?

Let me look on my sheet here.

And do you think --

Okay.

I'm sorry the 74 percent renewal rate sound right going forward?

We'll probably be a little bit lower than that. We've been averaging right around 50 percent, so this is an exceptionally good quarter for us. In the second quarter, our renewal leases actually had some higher TIs than the new leases but that generally not what happens.

Okay. But averaging, it should be about $1.00.

Yes.

Okay.

And again, the renewal on the UBC tenant skewed that one up.

Okay. And I -- Keith, I like the table on page 15 but it would be nice to also look at what year-over-year changes in occupancy by market have been and also what revenue and operating expense changes year-over-year with [indiscernible] but is very helpful.

We will look at -- on the leasing, the operating expenses tended to simply go up and down along with vacancy.

Right.

Because as with primarily [triple net] leases, we're passing through operating expenses so as vacancy goes up, the expenses go up.

In your aggregate number of 4.5 percent decline in NOI, can you break that out in terms of operating expense growth and revenue decline?

I would -- don't have an exact figure for you. We can take another look at that. But it's again primarily 85 to 90 percent drop in occupancy.

Okay. And, Keith, what were the termination fees again?

152,000.

152,000. Okay.

[multiple speakers]

And, Brian, last year we had 224,000.

Okay. Okay. And both those numbers are included in your 4.5 percent decline, right?

Correct.

Okay. And last question. Can you just talk about your purchase of an asset in Phoenix when the occupancy is 86 percent for your Phoenix portfolio? And what would be your Tempe occupancy rate?

Tempe is the close-end market -- Broadway Industrial Park is infill-type park with almost no land left for new development and that's our favorite location in the Phoenix metropolitan area. I have to grab another sheet. Now I'll have to get back to you on specifically what Tempe is but it's a lower vacancy than the rest of the Phoenix market.

But it's -- there's more demand there at least tighter supplies in Tempe [indiscernible].

Exactly. Because there's been a whole lot less new construction and Tempe is closer to most of the executive housing so that the smaller size tenants are drawn to that location. With the larger tenants, the more bulk-building type users are out on the West side of town where the greater vacancy is.

And how long is that lease in the Tempe?

My recollection is one had three years to go on it and the other had like a year and a half. I'll have to check that.

Okay. Alright. Thank you.

Thanks, Brian.

Thank you. Our next question is from [Gary Boston] with Salomon Smith Barney.

Good afternoon. Couple questions. First on the -- on your development schedule, Worlds Houston 14 is showing a 77 percent leased but -- in the current quarter, but it doesn't look like there's any pick-up in occupancy through the end of the year. Can you sort of explain that?

We're being very conservative.

Okay. What you're saying is that you have 50 percent occupied in the 3Q and the 4Q, even though it's 77 percent leased.

We have some collection issues with that tenant.

Oh. Okay.

And so we're just being real conservative there.

Okay. Well, I guess on that note, Keith, you gave us the bad debt expense for the quarter. Can -- any color on just sort of the trends in that?

We've been about a cent a quarter and it's been fluctuating a little. I think last year was seven hundred and some thousand and so far this year we're at -- around 410 -- so it's a little bit more but not significantly anymore.

Okay. I do appreciate the additional disclosure on capex. I knew it didn't have anything to do with you being in Mississippi. But, in terms, of that -- could you just, help me out on the capitalized interest for the quarter and how much G & A you guys capitalized in tiered development pipeline?

Capitalized interest was 556,000 and that is noted in the Supplemental on page five.

Okay.

And then on development, the G&A cost that we capitalized -- it was 412,000 for the quarter.

And that does not include any of Keith or me.

Okay. In terms of capitalized interest space, am I right in assuming that since things have -- I mean, you are still are adding things to the pipeline but it has slowed down a bit. Should that number be coming down over the next 18 months or so?

You should be able to take, on our schedule -- development schedule and follow it from there because if we lease part of it, we'll take that portion that's leased out of it.

And then as you add on additional cost.

Right.

Okay.

And the new development, Gary, is going to be totally tied to how much leasing we do with both what we're developing now plus the properties that are in those individual submarkets.

Right. In terms of the option property in Houston, what's your outlook in terms of how it's going to take you to get that leased-up to a stabilized level?

I kind of hate to mention it but we have a real good prospect to take half of that space. Hopefully at our next conference call, we'll be talking about having had leased half the balance. Then, with a little bit of luck, we should have it done by the end of the year.

Okay. And I guess last question. You've been able to consistently, sort of, pick up a property or two per quarter, in terms of acquisitions. I mean, even though everything we hear about the industrial sectors is how tight the market is in pricing. Any expectations on the level of acquisitions over the balance of the year into '03?

Just the two small properties right now that we would hope to close in August and would like to be able to do between three and five million each quarter but that's all going to depend on what's out there. We see a number of packages and it can be a real mix of quality and geographic location even within a single larger market, so we are usually bidding on one or two properties out of a larger package and what we bought in Tempe and what we hope to buy in Orland are both examples of that, where it was a larger package and we just bid on what fit for us. But we are not seeing a lot of product being offered, especially in Florida. Just very little is for sale there.

Great. I appreciate the time.

Thank you.

Thank you. And once again, if you do have a question, please press the "1" key. One moment for question. Our next question is from [Bruce Garrison] with [Pinnacle Trust].

Hey, David, could you just address how you think you're doing in your submarkets vis-à-vis competition, in terms of dealing with the occupancy issues.

That's a tough one to answer because of each one is so different.

Right.

And as soon as you have a large tenant move out, that distorts that.

But anecdotally though, can you sense from your reaction from tenants that you're talking to that you're able to offer a better package to them or are things still so competitive in that -- in the industrial field that it really doesn't matter.

I think our edge is one, the quality of the properties, two, how we maintain and service the tenants, and three, in a leased negotiation probably the most important, is very quick response. Each one of our asset people has the authority to make a decision over the telephone so that when a lease proposal or a counter is received, we're responding immediately. It makes life a whole lot easier for the brokers and keeps the negotiation moving quickly so that we can -- once we do have a prospect that's for real, we can move very, very quickly in terms of trying to meet their needs, make the broker happy and bring it to a conclusion quickly. And there just a lot of -- especially institutional owners who just don't or can't operate that way.

Right. Okay. Very good. Thank you.

Thank you. I am showing no further questions at this time.

Well thank you very much for call in. As always, we ask you to call either Keith or me with anything that we might not have touched on to clarify any of the information that we've put out and hope to hear from you next quarter. Thank you.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation. You may disconnect at this time and have a good day.