First Industrial Realty Trust Inc (FR) 2005 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen and welcome to the First Industrial Realty Trust second-quarter results conference call. At this time all, participants have been placed on a listen-only mode and the floor will be open for your questions following today's presentation. It is now my pleasure to turn the floor over to First Industrial.

Good afternoon, this is Sean O'Neill, Senior Vice President of Investor Relations and Corporate Communications. Before we discuss our results for the quarter, let me remind everyone that this call contains forward-looking statements about First Industrial.

A number of factors could cause the company's actual results to differ materially from those anticipated. These factors can be found in our earnings release that is available on our website at www.firstindustrial.com. Now, let me turn the call over to Mike Brennan, President and CEO.

Thank you very much, Sean, and welcome everybody to our second quarter 2005 earnings conference call and thank you for joining us during the lunch hour. With me from First Industrial senior management is Jojo Yap, our Chief Investment Officer, who will detail our investment performance and our pipeline. David Draft, Executive Vice President of Operations. And David will go through our portfolio performance and our outlook, and Mike Havala, Chief Financial Officer who will go through our capital markets activity, balance sheet and the guidance for 2005. And you have just heard from Sean O'Neill, our Senior Vice President of Investor Relations and Corporate Communications.

Getting into the results, the second-quarter results were solid in every respect. Occupancy rose to over 91%, our economic gains were $25.2 million producing an IRR of 15%, another outstanding performance on our investment side and our leasing side. We were as well a net investor in the second quarter by $20 million and investing 156 million and selling 136 million. Additionally, we closed new investments into both our Kuwait Finance House and our First Cal (ph) joint ventures, ventures that focus on long-term net lease and development, redevelopment properties respectively. The contribution from the above was that the FFO for the quarter came in at 86 cents for the second quarter and that was 1 cent above the mid-range for our guidance for the quarter. So net-net, all aspects of our business advanced in the second quarter. As much as I'm pleased by our second-quarter results, more significant is the further strengthening of our platform, a platform that we designed to deliver industrial solutions to corporate America.

Specifically we have the appropriate capital to match the numerous needs of our clients from the acquisition of a long-term net lease property to the disposition redundant assets. Our recent expansion into Northern California and Miami, the Inland Empire in Washington D.C., within the last year has improved our geographic coverage. As well, our emphasis on placing the very best talent in the field as well as in our home office is allowing us to take on any development or redevelopment or acquisition project that fits our investment criteria.

And so by having the right combinations of capital and geography and people, we have the infrastructure as we say to say yes more often. And all of that has driven both our acquisition and development pipelines to record levels. But of critical importance, the majority of our increased pipeline is derived from our corporate real estate transactions, an area of our industry where, as you know, we have devoted much time and energy. Corporations are the largest owners of industrial properties and as you also know real estate is very much on their mind. COO's are concerned with supply chains and CFO's with asset optimization a la Toys R' Us, Sears, Kmart, Boise Cascade,Temple Inland, and others. So with the right infrastructure focused on the right customer, our prospects for growth have never really looked better.

With that I would like to turn the discussion and second quarter over to Jojo.

Thanks, Mike. Let me start by discussing our on balance sheet performance. We put in a solid investment performance for the quarter. We were net investors by $20 million by investing $156 million in acquisition and placed in service developments. The yield spread of our investments exceeded the yields of sales by 198 basis points. This spread compares favorably to our five-year average of 137 basis points. Our being net investors in a creative investment should add to NOI and produce strong economic profits in the future.

In terms of net economic gain, we achieved 25.2 million for the quarter. I would just like to note that this is the 23rd consecutive quarter we have been executing on our capital recycling plans and we achieved an unleveraged IRR of 15% and an after tax profit margin of 18.5%, which compares favorably to our 14.3% average margin since 2000. We maximized value by selling these assets to the most aggressive buyers which included users, tax deferred investors, 10-31 exchange investors and institutional buyers.

In terms of the composition of economic gains for 2005, we project that the gain for merchant activity will be in the range of 60 to 70% while gains from existing building sales will be in the range of 30 to 40%. In terms of our on balance sheet investment pipeline it grew from $450 million in the first quarter to $773 million today. Specifically, acquisitions and redevelopments under agreement grew from $208 million in the first quarter to $475 million. This is due to a significant increase in corporate business and portfolio transactions. Development activity also increased from 242 million in the first quarter to 298 million. A $56 million increase is due to three additional building to suits under agreement.

I'll now make a few comments about our joint venture activity and pipeline. Our venture with CalSTRS is off to a good start and we have a total of $128 million of investment in our CalSTRS venture today. This represents a potential total investment of approximately $356 million assuming all the land is built out. In addition, we have 347 million of additional land development and redevelopment under agreement that is targeted for the venture. With regards to our venture with Kuwait Finance House, we invested 36 million in the last quarter and have $28 million under agreement.

Our total JV pipeline of $349 million is significantly higher than the 132 million we reported last quarter. In summary, we expect our joint venture activity to generate increasing fees, gains and promotes in 2005, 2006 and beyond. Before I conclude, I wanted to give you some additional highlights to our investment pipeline. It is very diversified and not relying on any single transaction as it is spread over 77 transactions across the country.

These were sourced from our wide local infrastructure that has the capability to buy, redevelop, develop, lease and sale. Other contributors to our investment pipeline is the new people we have added to the company. For example, as we mentioned to you in the past two quarters, we have added investment professionals to markets Miami, North California and the Inland Empire. Today there are deals under agreement of approximately $211 million. Our investment in additional people in new markets definitely is paying off. Another factor in the growth of our pipeline comes from the growth that we experienced and continue to see in our corporate business. For example, 50% of our acquisitions in the second quarter were corporate transactions. In fact, year-to-date we are already about 74% of all of last year's corporate business volume. This growth is the function of the increased focus of our calling and relationship building efforts with corporate America.

Hence we're able to leverage our national relationships and improve upon our customers' experience and in so doing expect to generate more repeat business.

That concludes my remarks in terms of our investment activity and pipeline and with that I'll turn it over to David.

Okay, well, thank you, Jojo. I just would like to begin with a few comments on the overall industrial market. I think that will provide some context to our own portfolio results in second quarter. Leasing activity across the country in the second quarter was strong. Result of wide ranging increases in overall business activity. Net absorption in the quarter was 54 million square feet. Now, that's a 30% increase over the prior quarter.

The outlook for net absorption remains favorable as well. I expect it to remain positive throughout the balance of 2005 and into 2006. There was also good news in that new deliveries of 27 million square feet in the quarter lagged net absorption by 27 million square feet. Now, it was that difference that caused the national occupancy rate to rise 30 basis points to 89.5 at the end of the second quarter. And notably we'd have to go back about three years to see a similar level of national occupancy.

Market rental rates also moving in a positive direction. In fact, Torto Wheaton has forecasted market rents to be positive over the next year by about 30 basis points and I'd also note that two-thirds of the 49 markets included in that forecast are expected to post increases.

Next I just would like to provide some information on a few specific markets. The strongest are L.A., Houston and northern New Jersey and another very strong market is Phoenix where occupancy costs there are relatively economical. The governmental units in Phoenix are business-friendly and the number of new rooftops the highest in the country, 60,000 last year.

Markets showing solid improvement include Minneapolis, where various medical companies, including Boston Scientific and Medtronic, have a significant presence and then I just mention also markets where demand is improving but where there is also more supply and those markets include Atlanta and Cincinnati.

In terms of industries, those that were particularly active in the quarter actually very similar to last quarter, logistics providers, and I would just refine that a bit by saying especially those associated with consumer goods and those types of products. Also manufacturers and suppliers to the building industry, pharmaceutical, medical companies of all types basically and businesses involved in, of course, international trade. So with that backdrop on the overall industry I'll just now turn to some of the key results within the First Industrial portfolio where we in fact did see very much improved results here in the second quarter. And starting with occupancy, the in-service portfolio increased in the quarter by 30 basis points and stood on June 30 at 91.1%. The improvement continues to be broad-based as well across our regional portfolios. The outlook for occupancy is also good. We expect to move over 92% by year-end, which is consistent with our forecast now for a number of months.

Turning to same-store net operating income, we saw a decrease of 2.3% in the quarter. And I just want to point out that that was due to two things. First of all, in the comparative quarter of 2004, our bad debt reserve requirement was lowered by about $1 million; that is one factor. Second, leasing activity in the second quarter of '05 was more weighted toward the latter part of the quarter.

Now, for the entire year of 2005, we maintain our prior expectations that same-store NOI will be in the previously stated range of 1 to 3% positive, no change there. And also I would just like to - I'd just like to make a couple of comments about total NOI, not just same-store but overall NOI. First of all, total year-to-date NOI is up about $2 million year-over-year and second, given the acquisitions that we closed in the second quarter, our quarterly run-rate going into the third quarter will be about $1.3 million higher. And that additional NOI, of course, will be added to other expected NOI increases that we expect from the portfolio.

Retention as well was very solid in the quarter, 72.8% of expiring square footage was renewed in the quarter and for the first half of the year retention has averaged just right around 80%. That we see as a result of industry-wide fundamentals but we also believe that our intense focus on responding to customer needs is having a favorable impact.

Regarding our progress in 2005 renewals, we're ahead of schedule there. Decisionmakers are more confident about the future prospects of their businesses and, therefore, are willing to make a renewal commitment earlier in the process. Certainly helps things out. Rental rate changes are also benefiting from these positive trends and I would like to note that the difference between expiring rents and market rents is improving. In the second quarter, cash-on-cash rents declined by 3.4% and that compares to a 6.3% decline in the first quarter.

In terms of the outlook for rental rate changes also favorable. One of the reasons is we're getting close to the end of renewing the leases originated in the late '90's and early 2000 when rates, of course, were much higher than they are today. And I would just also note that this accounts for most of our leases because our average lease term is about five years. Tenant improvement and lease commission costs for the quarter came in at $2.11 per square foot. That is a meaningful reduction from the 2004 average of $2.30 per square foot and is well within our projected range.

Looking forward, we expect TI costs will stay in check and may, in fact, further improve in response to higher occupancy levels. So I'll just finish up with a few reasons why we are confident that we'll see future performance increases from the portfolio. First of all, overall industry fundamentals as I mentioned earlier in the presentation, they look solid. With respect to net absorption and deliveries, the two largest variables and of course good news on those fronts means good news on the occupancy front, too. And that in turn means good news for rental rates and leasing costs.

Second, having just spent several days with our entire leasing team, our leasing people from all over the country, I can report that we're seeing an increasing level of activity, more showings, more RFP's, more decisions by tenants to move forward. And, two, all of our regions report that they are participating in this increased level of activity.

Third, and finally, we're seeing increasing benefits from our customer service focus. With our tenant base this is reflected in the 80% retention level I spoke of earlier, average for the first half of the year, and with respect to the brokerage community where most of our new leasing opportunities are sourced, we look at the results of a recently completed third-party broker satisfaction survey which showed that First Industrial ranked meaningfully higher than the competitive index and that index, by the way, included an impressive number of private and competitors.

Adding all these things up we look forward to more improvement in the second half of 2005 and will give us a very strong start as well in 2006. So I'll now turn the call over to Mike Havala.

Well, thanks, David. First let me provide more information on our $950 million joint venture with CalSTRS. The purpose of this venture is to invest in land to be developed and repositioning properties. Eventually we'll create value and then harvest that value through property sales that is capital recycling. And note that the investments in the venture will be additive to the investment levels that we're already doing on balance sheet. So, in other words, well be able to do a lot more business in this area. And also the venture should help add some more certainty and visibility to this part of our business.

Regarding the economic benefits of the venture, there are several. First, we'll have the higher return on invested capital. Second, we'll receive fees in five areas, and those five areas are, property management, leasing, development, portfolio management and sales. Third, we expect to receive promotes as we sell assets and, as Jojo mentioned, we already have assets where we've created value and those assets are now being sold so we should see some realization of the promotes already in 2005.

And this is a notable item because it is very different from many joint ventures where you might not see the promote for the first five, seven or ten years. The fourth area of economic benefit of the venture is that it helps us minimize the amount of low income producing assets such as land on our balance sheet. And then the last comment I wanted to make about the venture was that as you know, it was formed at the end of March and already in the first 90 plus days of the venture's existence, we've invested in $128 million of assets that have an estimated potential build-out value of about $356 million.

And when you couple this with a pipeline of prospective investments well over $300 million, we're off to a great start with this venture. Next, I'd like to make a few comments on the strength of our balance sheet and our ratios. For the quarter our interest coverage was 2.8 times, our fixed charge coverage was 2.5 times and these, of course, are very solid ratios which by the way should continue to improve in 2005. And then in looking behind the numbers related to these coverage ratios, it is critical and important to evaluate the qualitative factors as well. For example, are you coverage fixed rate debt or floating rate debt and are you covering long-term maturities or short-term maturities and so while our coverage ratios are very good or even better when you consider the fact that 100% of our permanent debt is fixed rate and then our weighted average debt maturity is nine years which is one of the longest in the REIT industry. So again, our coverage ratios are very good and especially when you consider both the quantitative and qualitative factors.

One item that I also wanted to mention regarding the balance sheet is that we anticipate increasing our line of credit capacity. And the reason we're doing this is just simply because our investment pipeline has grown dramatically and of course we'll announce the details of this once the transaction is completed.

Regarding earnings and guidance for the second quarter, our FFO per-share was 86 cents, which exceeded the midpoint of our guidance range by 1 cent. Let me also make a few comments about G&A. If you look back at the past four quarters, our G&A has been in the 11 to $12 million range in each of those quarters. So basically it is leveled off and we pretty much expect that to be a run-rate for 2005, maybe a little bit higher.

What is important to note is that in the G&A line item there are both fixed and variable costs. And an example of a variable cost is the incentive compensation that we pay to our transaction officers for directly producing investment gains. Thus, part of what is in the G&A line is the direct and variable cost of the investment gains that we produce. So as investment gains go up, so will the G&A expense and vice versa. But obviously the net effect on the bottom line is very positive.

Note also that now in the supplemental we've provided some additional detail on G&A with respect to the G&A that is directly related to producing gains. In talking about guidance as you saw we increased our 2005 guidance by 5 cents a share. We see FFO coming in at 3.45 to 3.65 and then we see GAAP EPS coming in at 1.65 to 1.85. And the main reason that we're increasing our guidance is because of our joint venture investment activity which as we mentioned before is quite robust.

One other comment I wanted to make with respect to 2005 is that as you saw our FAD payout ratio was 102% in the second quarter. And since our earnings in 2005 are expected to be quite a bit higher in the second half of the year, note that we fully expect that for the year our cash flow will exceed the dividend. And as you remember, our cash flow has always covered our dividend every year since our IPO 11 years running. So we're very comfortable that this will be the case for 2005 as well.

Just before I conclude I wanted to point out something that I think is very important. We've worked hard over the past number of years to put all the parts of our revenue stream in a position not only to be recurring but also to grow. You heard Jojo talk about new investments and our corporate real estate efforts which should result in growth in our investment profits. And you heard David talk about the portfolio and the improvements that we're seeing there which should give us a bigger run-rate on NOI going into 2006. And then I discussed the opportunities we have with our newest joint venture which should result in increased JV FFO and fees. And so when you put it all together, what you see is that we expect growth in all parts of our income stream and that is NOI, fees and promotes from ventures and then recurring investment gains.

I should also note while we have not provided specific guidance for 2006 and beyond, we would expect that what we are seeing here today should benefit us even more in 2006 than in 2005 simply because of what will already be in place as we start the year 2006. So as you can tell we're very excited about our prospects for 2006. I should also mention we are planning on having our annual investor day in September and when we do we anticipate rolling out our 2006 guidance at that time.

So with that let me turn it back over to Mike Brennan.

Thank you very much, Mike. Today we've outlined the growth potential from our three engines of growth, portfolio, NOI, our gains from recycling and JV income and hopefully we provided an objective basis for our optimism. There is a tendency to view these three components of our revenues as three separate businesses and they are of course not separate businesses but they are part of one business and they are inseparable from one another.

In the industrial business we see the great opportunity in corporate real estate. They are the big owner owning ten times more industrial real estate than all REITs and US pension funds combined. So they own lot. And as such the highest and best use of our infrastructure is to focus on a large complex market where versatility and service are valued and rare. That's the key to our investment success, doing what is difficult or impossible for passive investors to do. We made good progress in our goal to serve corporate America and with a much improved infrastructure we will make far better progress going forward.

Thank you very much and now, moderator, we would like to open it up for any questions that may be out there. And also, moderator, if we could try to limit -- I don't know how many there are but we generally try to limit it to one or two questions just in case. Thanks.

Thank you. [Operator Instructions]

Our first question is coming from Jay Leupp with RBC Capital Markets. Please go ahead.

Thanks good afternoon here with David Ronco. Just one, two-part question. Can you discuss a little bit further your plan to proactively grow occupancy from these levels? And also how that will translate into your rent growth strategy? And then maybe give us a little bit of color on the environment for portfolio acquisitions and specifically those that involve the issuance of OP units?

Sure, Jay and David. This is Dave Draft. With respect to growing occupancy, we, you know, we approach occupancy on multiple fronts obviously. One of the very sharp focuses we have had over the last couple of years has been the condition of our space, for example. We have, we think, and we hear this from the brokerage community as well, exceptionally great conditioned space in terms of the vacant space that we have yet to lease. So condition of space is important. We also put a very sharp emphasis, Jay and David and everybody, on our pricing of that space and we are competitive. We also have, as I mentioned in my presentation, a very fine reputation with a brokerage community and we nurture that. And we watch over that very closely and as I said, too, we test that. So we -- we have a lot of different ways in which we continually improve our relationship with the brokers and we're going to continue to work on that as well.

Our local operators are truly experts in their areas. They live and work in these regions. They know the competitive environment. They know how to efficiently go through the governmental processes necessary to put new tenants in quickly. And so I could obviously go on to a lot of different areas, but those are some of the ways in which we expect to grow occupancy as time goes on.

You mention also with respect to our, you know, rental rates and perhaps how that plays into rental rates. Obviously as national occupancy increases and we've always maintained, based on historical experience, that as the marketplace in general gets to around 90%, we start to see definitely more negotiating strength transferred over to the landlord and we're seeing that now. So we'll keep maintaining occupancy higher than the market. We'll march up together but we'll be incrementally higher and that will help rental rates, no question.

Jojo, do you want to take the next part?

Yes, Jay. You asked about the market for portfolio acquisitions. In '05 there are more volume in terms of properties being placed in the market in terms of portfolio transactions compared to 2004. The market has been more active and more competitive. As you may note in the information that we both have given to you that our focus has been more in the one-off acquisitions, redevelopment and development and corporate transactions wherein we have the competitive advantage because we could use our local infrastructure to do what is hard for others to do. So that is really our main investment pipeline, although we feel out portfolio transactions in the market. And then in terms of UPREIT, there has been a little bit more increase interest from investors on UPREIT transactions primarily because investors today have difficulty re-investing, that passive investors have difficulty reinvesting their dollars into the market and for First Industrial that is just one method of acquisition. We have a lot of different methods to invest money and I just want to point out that that is if an investor is desirous of a tax deferred transaction, the UPREIT structure makes a REIT like First Industrial very competitive because that is another competitive advantage they can use that a competitive investor whether it is a private investor or an institutional investor does not have that capability.

Does that answer your question, Jay? Thank you.

Thank you. [Operator Instructions]

Our next question is coming from Lou Taylor with Deutsche Bank. Please go ahead.

Jojo, I think you mentioned during your remarks that you expected the merchant activity to be roughly 60% of your gains this year. Is that the right number?

Yes. Hi, Lou, it is 60 to 70%.

60 - 70 okay. So that would put it at around 50 million or so, a little bit better than that. You have done about 14 year-to-date. So that would be another, you know, 35-40 to go. Looking at your development pipeline it is roughly 200 million which if you put a 15% average margin on there that would give you around another 30. So I don't quite kind of get to your 50 plus million. So are the margins likely to be higher or is there other . Is there some other stuff that you're working on that would go in there just help me get to your 60-70% range?

Yes, Lou. The margins are approximately closer to the average of 15%. Maybe you missed one data that I gave is that our pipeline has increased. If you add, Lou, the activity that is a speculative activity in our balance sheet plus all the built-to-suits plus all those built-to-suits that have been awarded to us, that is about 298 million. In addition to that, the acquisitions and redevelopment pipeline that we announced is in the 475 million, which is a significant increase from last quarter of 208 million. So the $475 million pipeline that I mentioned included redevelopments of which those are all merchant-type transactions.

Thank you. [Operator Instructions].

Our next question is coming from Paul Puryear with Raymond James. Please go ahead.

A couple of questions. Mike, the G&A line that you spoke about earlier, we notice if we look back to 2000, 2001 that number was about, oh, 17 million a year. Looks like it is 47 million, I think it is, this year. Why wouldn't you break that out so we could -- and break out the G&A that is associated with the -- with the asset sales and the development business so we could see that separately?

Are you talking about going back four to five years?

No, I'm talking about going forward.

Okay, if I think I'm answering your question correctly, we have broken that G&A out into, you know, the cost of producing economic gain in the supplementals.

That was the first time we did that though, right?

This is the first time we have done that and we did it for this quarter and the comparative periods as well.

All right, page six.

Yeah.

Okay, good. And then the second question, could you speak to the expected margin --net operating income margin property level margin that you expect for the year out of your portfolio? It is moving around quite a bit and this quarter dropped pretty substantially.

Yes. You know, that margin is a number that is very impacted by your recoveries and your expenses. If your expenses go up and down, your recoveries go up and down, and that could impact the margin quite a bit even though your NOI can be going up. So quite honestly that -- that margin is not a number which we find, you know, very useful, if you will, in the way we look at the portfolio and so forth. But that is one of the reasons that you have some volatility in that margin. And then also, of course, it depends on the -- you know, the composition of what is in -- what properties are in the portfolio at any one given quarter.

Thank you. Our next question is coming from (inaudible) with SB Equities.

Hi, it's actually John Litt. Here. I'm here with John Stuart and Crupel Ravel (ph). Question on your -- your gains that you reported on your income statement. I'm trying to reconcile the gains with your footnote on page 37 which walks through the gains in the second quarter by land sales, merchant sales and existing portfolio sales. That comes to about 25 million.

I'm trying to see how I can get to there from your income statement on page 4 where you show income from operations (ph) and then gain on sale of real estate.

Sure. In the supplemental and I'm not sure if yours is printed out the same as mine but it is on page 39 in my printout, there is a very detailed analysis or reconciliation of that gain so there is a number of parts that go there. There is gain, of course, from discontinued operations, there's gain on real estate that is in there as well. There is the going from book gain to our economic gain, of course, we subtract out the accumulated depreciation on amortization of real estate sold and then of course we subtract the taxes out of there, too. So it is in the footnotes on that reconciliation and it is footnote AA in the supplemental. So if you want, we would be happy to go through it with you even in further detail on the call or after the call. But it is laid out in that footnote and should take you right directly from book gains to our net economic gain because, you know, we know that is something that people want to, you know, reconcile and tie out and so that is why we provide that additional disclosure.

Thank you.

At this time I would like to turn the floor back over to Mr. Michael Brennan for any further closing remarks.

Okay, moderator, it seems like a quiet day on the question front, so we're going to close off for the quarter and thanks everybody for calling in. And we look forward to updating you in the future and as Mike Havala said, in September we're going to have our annual investor day so maybe we can catch up then. Thank you.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day.