Eastgroup Properties Inc (EGP) 2003 Q2 法說會逐字稿

First we will conduct a question-and-answer session and instructions will follow at that time. If anyone should require assistance during the conference, please press (CALLER INSTRUCTIONS) As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Mr. David Hoster, President and CEO. Mr. Hoster, you may begin.

Thank you, good morning 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 ask that you listen to the following disclaimer covering these statements.

The discussion today involves forward-looking statements. Please refer to the Safe Harbor language included in the Company's news release announcing results for this quarter that describes certain risk factors and uncertainties that may impact the Company's future results and may cause the actual results to differ materially from those projected. Also, the content of this conference call contains time-sensitive information that is subject to the Safe Harbor statement included in the news release is accurate only as of the date of this call.

Thank you. Operating results for the second quarter of 2003 met our guidance. Funds from operations for the three months was 61 cents per share, compared with 68 cents per share for the second quarter of '02. This is a decrease of 10.3 percent. But included in these figures are gains on securities of 1/2 cents per share in '03, and and 5.4 cents per share last year, an almost five cent per share difference.

For the first six months of the year FFO was $1.21 per share, versus $1.31 per share for the first half of '02. Gains on securities were two cents per share in '03, compared to 8 cents per share last year, a six cent per share decrease. Please note that we continue to calculate funds from operations based on NAREIT's definition of FFO, which excludes gains on depreciable real estate.

In the second quarter same-store results were down one percent on a GAAP basis, which included straight lining of rents, and down 1.1 percent without straight lining of rents. As stated in our last two calls, we expect same-store results to turn positive in the third quarter of this year. On a same-store GAAP basis for the second quarter, our best markets were New Orleans, which was up 30.1 percent; Dallas up 13.7 percent; and Jacksonville up 9.4 percent. These are the same top three markets as in the first quarter. All with higher occupancy making the difference as compared to last year. The market's significantly down were Fort Lauderdale, 15.5 percent; Hayward, California, 15 percent; Orlando, 14.1 percent; and Memphis 13.3 percent. Again, the decreases are primarily due to swings in occupancy levels between the two periods.

From a leasing perspective, the months of April and May were disappointing, with occupancy actually declining from our March 31 level of 89.8 percent. June, on the other hand, turned out to be our best leasing month in recent memory. For the month, we signed 15 leases for 338,000 square feet of vacant space, and 10 renewal leases for another 235,000 square feet. As a result, we ended the quarter at 91.1 percent occupied, an increase of 1.3 percent; and 92.4 percent leased, an increase of 1.9 percent. These increases are compared to the first quarter. Do our June leasing results represent a significant turn or just another big bubble of activity? So far, it is too early to tell. Leasing activity for the first three weeks of July, is not anywhere near June's level. But it is a continued improvement over activity for the first five months of the year.

We originally had over 20 percent of the square footage in our portfolio scheduled to expire in 2003. By the end of last year this total had been reduced to 15.8 percent. It now stands at 4.6 percent. Occupancy in our four core state of Florida, Texas, California and Arizona was 92.4 percent at June 30, as compared to 85 percent in our non-core markets. With both categories having experienced improvement from the end of the first quarter.

Looking at second-quarter leasing statistics, we renewed or released 68 percent of the one million square feet that expired. And leased 457,000 square feet of vacant space. Combining both renewals and new leases we experience the following; average lease length was 3.2 years, average lease size was 14,000 square feet. There was an average decrease in rents of 8.8 percent, consisting of 11.1 percent decrease on new leases and 6.1 percent decrease on renewals. And the average cost of tenant improvements was 70 cents per square foot over the life of the lease. Although we achieved higher occupancy, these statistics illustrate the continuing necessity of sacrificing rent for this occupancy. Free rent and lower rates are a current market fact of life. Fortunately, tenant improvements are not a hot issue for industrial tenants. And our per square foot TI expenses have actually declined for the second quarter in a row.

As always, we analyze the reasons tenants do not renew their leases. In the second quarter approximately 34 percent purchased or built their own facility, 32 percent had different space needs, and 14 percent vacated due to moving out of the submarket. Some a statistical standpoint, only one of our major markets showed slightly improved industrial occupancy figures for the second quarter, and it was Hayward, California. Four markets had deteriorated, Jacksonville, Fort Lauderdale, Tampa, and Phoenix. And it is too early to have updated statistics on the others. Overall, Memphis continues to be our (technical difficulty) weakest market with an industrial vacancy rate of approximately 20 percent. For EastGroup directly in the second quarter, Fort Lauderdale was our only market in which we experienced a meaningful decrease in our property occupancy performance.

At June 30, our development program consisted of seven properties; five properties containing 353,000 square feet were in lease up, and two with 157,000 square feet were under construction. These seven developments contained 510,000 square feet with a projected total cost of $28.2 million. This represents an average cost of $4 million and 73 thousand square feet per property. Our average projected cost per square foot is $55. The seven properties are currently 21 percent leased and are geographically diversified in three states and five different cities.

During the second quarter, we did not transfer any development properties to the portfolio or begin construction of any new developments. In August we will begin the development of San Tan Ten (ph), a 63,000 square foot business distribution building and Chandler, Arizona. Completion of construction is scheduled for January of next year. The Tempe/Chandler submarket has consistently outperformed the overall Phoenix market.

From a future development standpoint, we have 70 acres in Orlando under contract with anticipated closing in September. This land is a strategically located in-fill site along the beeline Expressway in an established submarket. And we project an eventual build-out of approximately 750,000 square feet and 10 buildings. As we repeatedly state, our development program has been and will continue to be a major contributor to FFO. In addition, development provides us the opportunity to add new state-of-the-art properties to our existing clusters of assets in targeted submarkets. The impact of our development program is illustrated by the fact that including properties in lease-up and under construction, we have developed over 20 percent of EastGroup's current total portfolio.

In the second-quarter we acquired in separate transactions two business distribution properties with 125,000 square feet located in Orlando and Phoenix, for a total price of $6.3 million. Both properties complement existing clusters of assets and their respective in-fill type submarkets. We did not dispose of any real estate assets during the quarter, but our 259,000 square foot brand (ph) of distribution center in Tulsa is now under contract for sale, with closing expected at the end of the third quarter. We also have a small parcel of land in Orlando under a sales contract which should close in the next 30 days.

I will now turn the call over to Keith McKey. Thank you.

Good morning. Since the first quarter, we have had a busy time with a productive series of capital transactions. In May we sold 571,429 common shares to a single investor and generated net proceeds of $14.6 million. In July we sold 1,320,000 shares of 7.95 percent cumulative redeemable preferred stock and raise net proceeds of $32.3 million. Also in July we redeemed all of our outstanding 9 percent cumulative redeemable preferred stock with a preference amount of $43.125 million. These three transactions together increased FFO by one cent a share annually. It allowed us to convert preferred stock to common stock and increased borrowing capacity. In addition, during the second-quarter, the holder of the Series D Cumulative Convertible Redeemable Preferred Stock converted half of his holdings, while 1.4 million shares to $1,590,960 shares of common stock. These common share transactions increased total common shares outstanding to 18,353,000, or a 13.4 percent increase from March 31st, 2003.

On the debt side, in May we signed an application with an insurance company for 45.5 million nonrecourse, first mortgage loan secured by 10 properties. The interest rate is fixed at 4.75 percent, and it will have a ten-year term with a 25 year amortization schedule. The loan is expected to close in August and we will use the net proceeds to reduce bank borrowings.

Debt to total market capitalization was 36 percent at June 30, with continued good debt ratios. For the quarter, the interest cover ratio was 3.8 times and the fixed charge coverage ratio was 3.2 times. In June, we paid our 94th consecutive quarterly dividend of 47.5 cents per share. This amount equipped to annualize dividend of $1.90 per share and represents a payout ratio to FFO of 78 percent for the second quarter. Total bad debt expense for the second quarter was $99,000, less than one cent per share. Which was 238,000 less than the first quarter of '03, and 129,000 less than last year's second quarter.

Lease termination fee income was zero in the second quarter of '03, and 152,000 in the second quarter of '02. We have reduced '03 FFO guidance to a revised range of $2.33 to $2.39 for the year. Nine cents per share of the reduction is due to the original issuance cost in 1998 of the Series A Preferred Shares, which we redeemed in July of 2003, and we lowered the upper range, upper end of the range by an additional two cents per share.

Now I'd like to talk a little about the original issuance cost. The original issuance cost is a difference in the redemption amount, which was the (indiscernible) of the stock and a carrying amount of the preferred stock in the stockholder's equity section of the balance sheet. These costs would seem to appear to be a charge to paid-in-capital, but they are accounting pronouncements from the emerging issues task force that KPMG, our auditors concur with, which state that the accounting treatment for the redemption is to record the excess of the redemption price over the carrying amount in a manner similar to the treatment of preferred stock dividends. Since there appears to be differences in the accounting treatment for this type of transaction among other REITs, the accounting for this transaction may change.

Earnings per share for 2003 should be in the range of 65 cents to 72 cents per share. This range is higher than previous guidance of 60 to 70 cents per share. The EPS guidance was reduced 10 cents per share due to the original issuance cost we just discussed, but increased 14 cents per share due to the conversion of the convertible preferred stock. No gains on securities or gains on the sale of depreciable property have been projected for the last two quarters. Now David will make some summary comments.

In summary, we remain cautiously optimistic about the balance of 2003. We finished the second-quarter on a very positive note. Our markets have a way to go before anyone can point to a real recovery in progress. We are continuing to sign leases in every market, but it is still a battle for each prospect. With the second-quarter capital transactions, we've improved an already strong and flexible balance sheet. We believe that we are well positioned for the future. Our strategy is simple and it is working. Quality multi-tenant buildings clustered around transportation futures in growth markets. One last note, I hope you saw Wall Street Journal article on June 18, which referred to our buildings in the World's Houston development as examples of high-quality and appealing architecture for industrial users. World's Houston is one of 20 warehouses and industrial parks featured in a new book entitled Exceptional Industrial Properties Beyond The Box. It is published by NAOP, the national association of industrial and office properties. Keith and I are now available to answer any questions you might have.

Thank you, if you have a question at this time please press one (CALLER INSTRUCTIONS) John Litz (ph) at Smith Barney.

Hi guys, I'm here with (indiscernible) Boston. Keith, can you take me through this convert one more time. I think I got some of it but not all of it.

When we originally recorded the preferred stock, we record the net of the issuance cost which were $1,768,000. GAPE P&G (ph) says that when we redeem that, that you redeemed at par, which was $1,768,000 more than what we had it on the books for. That amount should go as treated just like a preferred dividend. So it subtracts from net income to get to net income available for common shareholders.

You're deducting it -- it's almost like an -- the expense, the offering, you have to run to the income statement?

It's like allocating net income, you allocate net income to the preferred holders and then to the common shareholders so it would be an allocation to the preferred. So it would be a cost to the common shareholders.

Right. -- it was the stage that you were running through that cost --through your income statement?

That is correct.

The cost of the underwriting as opposed to simply capitalizing it?

Right.

And that is on the convert and you do that currently on straight preferreds as well?

Well, this is the only redemption we've had. On the convertible preferred we have not redeemed any and we don't plan to.

At the time that you redeem a preferred issuance, is when you have to do this?

That is right.

And your accounts you are saying are more conservative than the accounts of other REITs who are not requiring them to do that?

I can't speak for that.

There seems to be no consensus yet within the REIT world on exactly how this should be treated. Fortunately for us, we don't have to record it until third quarter, so were trying to be conservative and go along with how we read it and how our auditors read it, just in terms of discussing the forecast. I think this is an issue that NAREIT is going to have to be involved since they were the ones that created the whole concept of FFO to begin with. We're looking for some resolution on it before we actually have to record the third-quarter transactions, but we just wanted to bring it to everybody's attention, and I assume this is something a lot of other REITs are going to talk about in their conference calls now that it's come to the forefront.

I think this is the first one I've heard so far this quarter. On a separate topic, can you talk about what you think your NAV is and/or where you think your trading relative to NAV?

We have never published an NAV. We do state that we think that most of the self side analysts have us way low, specifically Smith Barney. But, my personal opinion is that REIT with a strong track record of creating value for its shareholders, should trade within a 5 to 10 percent range of NAV. And I think NAV has to adjust with what market cap rates are.

But would you say you are trading at a premium or discount today, I mean, not a specific number, but sort of general range?

At of the close yesterday, we are in the range I'm talking about.

Because I was curious that you are issuing equity at these levels given the uphill battle you're fighting from a fundamental perspective and wanted to see how you're NAV factors into your thought process on issuing equity?

We felt at the time we issued equity we were very close to our NAV. I think NAV has gone up actually since then. But what we look at it is blended cost to capital, because if you raise 15 million, you can raise another amount of debt to keep within your appropriate debt ratios and you get a blended cost to capital that it is below 8 percent, and we felt that we could invest the money on an accretive basis given those parameters.

Was the offering offered to multiple investors or was it priced at last sell?

It was priced -- it was to a single investor and it was priced over a 25 day weighted moving average. And we hit the top range of it.

So there was discount to (indiscernible) Not with a 20-day moving average --

No. No discount and because it was a private sale, our fees were if I recall correctly, about half of what they would've been under normal offering.

Gary do have any questions? Yes. In terms of you noted that these transactions strengthened what was already a pretty strong balance sheet, I'm just trying to understand there's anything that you're seeing on the acquisition front or -- my sense is that there is not a lot of new development activity to get going, but, what was it that sort of caused you to think that you needed to strengthen the balance sheet, what did you see on the horizon that you wanted to get some extra dry powder for?

A couple of reasons, one is usually when you need to strengthen your balance sheet, you can't do it or it's very expensive. So that we thought the transaction we did was big enough so that it helps, but not so big that there was any kind of serious dilution even if we didn't invest the money. We had about half of the money placed in the two properties that we mentioned that we acquired. Also, we're seeing a slight pick up in a number of properties being offered for sale over the last 30 to 60 days, as compared to what we saw in the first four or five months of the year. So we think you're going to be more opportunities to buy properties. We also have some interesting development opportunities out there, that is, if we sign some leases that are, where there are interested prospects right now, we could kick off some additional development before the end of the year. But it all depends on leasing progress.

Thanks.

Tony Howard (ph) of Hillard Lyons (ph).

Good morning, David and Keith. Several questions, you mentioned in your early part of your conversations as far the improvement in occupancy had to do partly due to the lower rents. I was wondering if there was some way to quantify this, how much of the occupancy improvement, especially sequentially, was due to being more competitive?

I think we have worked hard to be competitive over the last 12 months anyway. It's just that today tenants are pretty well-informed. Most anywhere from, any tenant with really a more than 10,000 square foot need has a tenant rep broker, so that they understand the market. They expect that rents are going to be lower than what they've been paying, wherever they've been, and they expect some free rent as an incentive for them to move, whether it's to our building or another. So that's just a fact of life in the marketplace. A couple of interesting statistics from that standpoint, that rule of thumb is with free rent in most marketplaces it's about a month per year of the lease, and looking back at our statistics, we haven't had to do quite that much. Another interesting statistic is that for leases under 10,000 square feet, and these are leases where we offered free rent or free rent was given, that on leases under 10,000 square feet, the average free rent was one and half months for a little over a three-year lease on the spaces. Over 10,000 square feet it was 2.8 months for about, for leases that average about 3.8 years. So I think it confirms something we've been talking about before that the bigger the tenant, the more competition for them, resulting in a bigger break in rent, and rent concessions with the free rent. If we look at renewals, less than a quarter of our renewals get free rent. Where on vacant space, almost 80 percent of the new tenants get some free rent. I think that says a lot, those statistics say a lot about what's going on in the marketplace.

I agree. A couple of questions similar to that on page 14 of your supplemental. Was it planned for your average term of the leases to decline so that you can reprice them sooner, or is that just a function again of the competitive market?

It sounds good to be able to say that if rents are going down you would like to have shorter term leases, we tend to do whatever it takes to lock up the tenant. One thing we are finding though the more sophisticated tenants, the bigger tenants, and these are 25,000 square feet and above, sophisticated for our portfolio anyway. They understand that its a deal today and they're pushing much harder for longer-term leases. They want to lock these lower rates, where the smaller tenants tend to still be maybe more nervous about the economy and are looking for the shorter, shorter term leases. So, the bigger the tenant, the longer the lease, but the more concessions. So we tend to do what the tenant wants but with a tendency to try to push them to a longer-term. We're going to have plenty of leases turning over the next couple of years to be able to raise rents, so we don't worry about individual leases that way.

On the same page, I notice that tenant improvement costs, especially for new leases went down from 236 in the first quarter, down to $1.06. That seems pretty dramatic, is there a reasoning for that?

I think that there is a trend that tenants are more concerned with what they're going to pay in rent and some concessions on free rent that allows them to move and cover the cost to the move with free rent than there are on getting fancier spaces. I mean, I think that is one of the advantages, major advantages, with industrial real estate versus office buildings. There's not a lot of office space to begin with, for most tenants it's real basic, so this is the second quarter in a row that TI expense has actually gone down on a per square foot basis. So I would like to think that's a trend and just a reflection of what's going on in the market.

Follow-up to prior questions. The last question too, you mentioned the conversion of the Series B Preferred, is there a particular reason why only one-half was done and not all?

The institutional holder that has that stock wanted to convert and sell in an as orderly a manner possible without having a derogatory effect on the trading of the stock and our stock price. And they did a very good job, as they sold over one million shares, the stock price actually rose. We feel good about it because it showed there was some real institutional demand for our shares. We don't know what they're going to do with the other half of their holdings in the near-term.

Thank you.

Bill Crowell (ph) of Raymond James.

Good morning guys. A couple of quick follow-up questions. As long as John opened the door to the NAV issue, can you see the hint that maybe cap rates were too high, would you like to express your opinion on where you think cap rates are today in your portfolio?

It's across the board from just your basic industrial properties in California are trading at a 7 to 7.5 cap rate. And those are not fancy ones, those are just the good old multi-tenant type of properties we have out there. That is at the low end. The high-end is in Memphis where properties are going to trade, the older properties that we happen to have there in a high 9 to a low 10. Our property in Tulsa, we've been pleased with the cap rate there, it certainly not an institutional market and we had a series of offer that put it in a low to mid 9 cap rate range, depending on exactly how you looked at cap rate, whereas a year and half ago or two years ago, that would have been 75 to 100 basis points higher.

In Central Florida, we're seeing properties that we don't think have some of the quality of ours that are trading at a mid 8. Some newer ones at a low 8. So those are the examples that we look at so that we think on average, anybody that has a cap rate above 9 on us is probably a little bit high.

The leasing activity in June, which is certainly encouraging, could you tell how much of that is tenants looking to expand, maybe moving into your buildings looking for more space, or is this still a zero sum game? You mentioned the markets continued to weaken in the second quarter, I think. So are you just gaining tenants at the expense of other landlords or is there some sort of sense on your part that the market is actually stabilizing a improving at this point?

We think it's certainly stabilized, whether it's improving we really have to go market by market and almost month by month. It's a real mix. We leased a vacant building in Houston to a tenant that was consolidating into Houston from some other markets. Jacksonville, we leased to a company that they got some new business and significantly expanded their space. Tenants tend to move when they need to when they need more or less space and most of the tenants I think we are picking up are tenants that are growing from where they were in earlier space. But on the same time we're still losing some tenants, we're consolidating out of our markets. So it's really too early to tell, but the positive, I think is that we're signing leases in every market as I said. I don't think we're going to be able to really call a turn upward until there is some sublease space that's absorbed and we start to see landlords inch up rents a bit. I think that will start to happen before we see elimination of free rent, that's harder to get rid of. Prospects have in their mind that they deserve free rent, in many cases that's more important to them than the rental rate that you're offering. When we finally have two tenants competing for a single space or all our vacancies with proposals, then we will be really excited.

Good solid quarter, guys, I appreciate it.

(CALLER INSTRUCTIONS) I am showing no further questions at this time.

As always, Keith and I are available for telephone calls on anything that you'd like us to clarify from the press release, supplemental data or anything we have said today. Thank you and I'll talk to you next quarter.

(technical difficulty) Ladies and gentlemen, thank you for your participation in today's conference. This concludes the conference. You may now disconnect and have a good day.

(CONFERENCE CALL CONCLUDED)