Franklin Street Properties Corp (FSP) 2006 Q1 法說會逐字稿

Good day ladies and gentlemen and welcome to the First Quarter 2006 Franklin Street Properties Earnings Conference Call.

[OPERATOR INSTRUCTIONS]

I would now like to turn the call over to Barbara Fournier, Chief Operating Officer. Please proceed.

Good morning everyone and thank you for participating in this call. With me this morning are George Carter, our Chief Executive Officer and John Demeritt, our Chief Financial Officer. Before I turn the call over to John Demeritt I must read the following statement.

Please note that various remarks that we may make about future expectations, plans, and prospects for the company constitute forward-looking statements for purposes of the Safe Harbor Provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors including those discussed in Item 1A, Risk Factors of our Quarterly Report on Form 10-Q for the period ended March 31, 2006, which is on file with the SEC. In addition, these forward-looking statements represent the company's expectations only as of today May 9, 2006. While the company may elect to update these forward-looking statements it specifically disclaims any obligation to do so. Any forward-looking statements should not be relied upon as representing the company's estimates or views as of any date subsequent to today.

At times during this call we may refer to adjusted funds from operations or AFFO. A reconciliation of AFFO to GAAP net income is contained in yesterday's press release, which is available in the Investor Relations Section of our Website at www.franklinstreetproperties.com. Now, I will turn the call over to John Demeritt, our Chief Financial Officer.

Thank you Barbara. Welcome to our call. We're very happy to talk to you about our first quarter.And, what I plan to cover today is first, to do an overview of the results of our quarter. Second, I'll highlight some significant changes comparing the first quarter of '06 to '05. Then I'll talk briefly about our balance sheet; and lastly I'll cover some basics of the merger that we just completed and announced last week. Afterward, George Carter, our CEO, will discuss more fully our results and activities.

As a reminder we evaluate our performance based on EPS and AFFO and we believe each of them to be an important measure and consider both when we determine the amount and composition of distributions that we're going to pay to shareholders. Generally we don't get too carried away with quarter-to-quarter results because we look at performance over a longer term, but it's important at this point in our first quarter to look at the key drivers of our business and we consider them to be the following three points; contribution from real estate operations, investment banking, and gains or losses on sales of property. This quarter we didn't have any gains or losses on the sales of property so we're going to focus more on real estate operations and investment banking.

Our EPS for the quarter was $0.22 per share compared to $0.21 per share in the first quarter of 2005 and in dollars, net income was $13.1 million for the first quarter of '06 compared to $10.4 million for '05.

Our AFFO for the quarter was $0.34 per share compared to $0.28 in 2005, which was a $0.06 increase per share. On a dollar basis, AFFO was $20.3 million in the first quarter of '06 compared to $13.7 million for '05.

The dollar increases were essentially from asset acquisitions that we have done over the last 12 months, including the merger of four properties that we finished in the second quarter of last year. One thing to keep in mind when comparing our '06 to our '05 numbers is that we have about 10.2 million more shares outstanding this year in the first quarter as compared to last year: the merger brought in about 10.9 million shares last year in the second quarter and during our fourth quarter of '05 we bought back about 700,000 shares in a stock repurchase program.

The press release and the 10-Q were both filed last night and they contain a lot of details of the quarter and what I'm going to do is quickly go over the three most significant factors that affected EPS and AFFO for the call.

First was real estate operations, which increased from acquisitions that I mentioned just a few minutes ago.During the last 12 months we acquired three properties; one in Colorado in February of '05, one in Indianapolis in July of '05, and another in Addison, Texas, which is near Dallas, in February of '06. Those three property acquisition plus the merged properties contributed quite a bit to our increase in dollars in the real estate segment and the per share impact was somewhat mitigated by the increase in the shares outstanding which I mentioned.

Second, we received a significant termination payment of about $4.6 million during the first quarter from a single tenant property that we have in Illinois which positively impacted our results. The termination payments are a recurring/non-recurring item. They happen all the time but are individually significant from time-to-time. This is good news for this quarter, for us, but it's also even better news because we signed a new lease for the property: it's been re-leased. George is going to cover more of that in a few minutes.

Third was the impact of our investment banking results for the quarter, which was down following the trend that we've seen over the last year or so. But an important difference this quarter compared to last year was that we only worked on one syndication for part of the quarter in '06. We started the current syndication at the end of February and worked on it through March, as compared to last year in '05 where we completed a syndication at the beginning of January and worked on another syndication for the whole quarter. So, the fact that we're down is partly because we didn't have a syndication to work on through the whole quarter.

That said, our revenue and expenses from the investment banking business show up on our income statement as syndication and transaction fee revenues and commission expenses: which, when you do the math, are down about a penny for the quarter. For the gross fee from the syndication of these sales we had $29 million in the first quarter of '06 compared to $37 million in '05, which was the $8 million drop on which those numbers are based..

The investment banking business is very transactional which is obvious when looking at this quarter compared to the last one: but, it's a very important part of our business model. We try to look at this over the long-term and the investment banking is an integral part of what we'll do going forward. At the moment, we're at a point in the real estate cycle where finding appealing transactions to sponsor is difficult. Currently the CAP rate compression that we see is making these investments less desirable; and there are other points in the cycle when fundamentals are different, particularly when interest rates and CAP rates are higher, when our investment bank has historically done very well. We look forward to those times going ahead.

I'd like to cover some changes to our balance sheet as well. First, as I mentioned earlier, we acquired a property in Addison, Texas, which is near Dallas, in February for about $26 million. With this purchase completed, we've now redeployed substantially all the proceeds we raised from asset sales over the past year, about $112 million, into three properties acquired also within the last 12 months. We have an agreement to sell property in Virginia, during the second quarter, The El Therese Property, which we expect to close in the second quarter at a gain, and have classified that property as held-for-sale on our balance sheet, along with the property that we have in Santa Clara, California, which was under agreement at year-end.

This brings up a point, within our financial statement, I want to reiterate. For the six properties we sold last year and the two we have held-for-sale at the moment, the revenue and expenses associated with those properties are classified as discontinued in our financial statements for all periods represented, which is a GAAP requirement.

Going back to the balance sheet, we have $41 million in debt outstanding at the end of March and that's related to the syndication we have in process. At year-end we didn't have one so we had no debt. We financed the acquisition of the property and it sits on our balance sheet as assets held for syndication of $51 million and the difference between the $51 million that you see on the assets side of our balance sheet and the $41 million in debt that you see on our balance sheet is $10 million of our own cash that we put into the syndication in process.

In fact, we actually put about $36 million worth of our cash to work in the last three months. We closed the year above $69 million in cash and we have $33 million as of the end of March; $10 million of the $36 million decrease in cash went into this temporary investment syndication, which we'll recoup as we sell off that syndication; and the other $26 million portion was the price of the property in Addison, Texas that I mentioned.

I've spent some time presenting our results and I also want to point out that the press release has our usual supplemental schedules, including some that slice-and-dice the current real estate portfolio, if you're interested in that.

The last thing I want to cover is the merger update. On May 1st we announced the completion of a merger of five properties and on May 4th we filed an 8-K with some pro forma information on financials related to the merger. Effectively we issued 10.972 million shares subject to some minor changes for cash-in-lieu of fractional shares and the value of the shares issues was about $230 million. The pro forma value of the shares is about $235 million. The difference between those two is the 8% interest that we held in Blue Lagoon, for which obviously we wouldn't issue shares(to ourselves); and some acquisition costs related to the merger.

That concludes the financial highlights and at this point I'm going to pass the call to our CEO, George Carter, and he'll tell you more about the quarter and where we are. Thanks for listening. George.

Thank you John. Good morning everyone and thank you for your interest in FSP and for taking the time out of your day to participate in this earnings call. John has summarized the first quarter numbers and as with all our earnings press releases there is a written message from me in which I try to give my view of the quarter and year-to-date activity of the company. I encourage you to read this section of the earnings release every quarter; as hopefully it will provide some written continuity to the on-going activity, as well as summarize our company's activities in print probably better than I can do verbally on this call.

For this morning's call, I will stay with the key theme from our last quarter's earnings call, year-end call; the theme of flex points. Flex points, as we call them internally, are those areas of our business that are over and above the primary day-to-day recurring operations that must be executed with proficiency to run a successful real estate investment company. Flex points are those areas of our business that are likely to have a meaningful impact, positive or negative, on our 2006 results above or below the normal recurring operating activity.

Flex point number one is our real estate investment banking business. John has talked a little bit about it. Its lower activity in 2005 was one of the principle factors negatively affecting our AFFO last year. The primary problem with investment banking continues in the first quarter of '06 and that is to acquire properties that fit our investment criteria. Capital has flooded into the real estate asset class. It has driven up prices.

Most of the properties that we are looking to acquire for our investment banking business are value-added type of properties and we think we can bring something to the property in the fairly near term to increase its value. You would think with rising interest rates that prices would have tailed off a bit and there would be more opportunity for us; but, in fact, so much capital has been committed to the asset class that has not yet gotten invested that so far we're not seeing much of a break in pricing; and again properties that fit our criteria are tough to find.

The negative news, for the first quarter of '06 is that we closed on approximately $29.2 million of investment banking syndication business versus $37 million for first quarter of '05. So sales were down a little bit over 20% between the first quarter of '05 and first quarter of '06.

The good news, again as John has mentioned, is that we started late in the first quarter on our largest private placement ever; and the $29.2 million closed in the first quarter represents only a portion of that transaction. If second quarter capital funding efforts for this project are successful, the second quarter of '06, and by extension the whole first half, have the potential to reflect a meaningful increase in business over the second quarter and first half of last year. This is quite a large transaction and we're very excited about it.

Visibility however, of investment banking business for the second half of '06 is still very uncertain. Although we are currently working on several interesting opportunities, and there's certainly no lack of potential properties that we would be interesting in purchasing, it's just price; and again until some of the capital gets placed and/or prices start to move back in the right direction we probably will continue to have issues in acquisitions for our investment banking business.

The second flex point is our existing portfolio properties; and when we talk about our existing portfolio properties there's always an A and a B part. The A part is rental operations and the B part is property sales. Both are equally important to FSP. Everything we do every day from the acquisition of a property to its ongoing operation, management, and leasing to its ultimate disposition is in an effort A) to maximize the long-term amount of cash flow from the property and B) to maximize its potential for appreciation and achieving that appreciation as a gain on sale; and while GAAP accounting does not present property sales as "operations" it does include the gain or loss on sale of assets for net income per share purposes and most REIT pro forma numbers, like our AFFO number, exclude the affects of property sales.

For FSP, property sales, gains or losses, are half of the reason of the investment in properties. They are, from a real business perspective, an integral part of our operations and measurement of our performance. We view our portfolio much like a mutual fund manager would view a portfolio of stocks. Our stock equivalent here is our individual properties. We invest for income and capital appreciation, if you want to do a crude analogy it's an income and growth portfolio. Not to report either the gains or losses from the sale of our properties and only the dividends they yield would only be half the story; and, that is really why FSP looks at both numbers. That is to say, we look at the net income number under GAAP as well as the AFFO numbers. They are both important and both tell a story.

So if you take a look at the A part of our existing portfolio of properties, that is rental operations. Under rental operations the news is generally good -- continues to be good in that virtually all of our office markets continue to improve with higher occupancies and higher rent statistics. However, there are still properties with leases that will roll are rolling, or will roll, that were signed at the height of the rental market and this is approximately between 1997 and 2001, and if you're talking about a five to ten year lease those leases are coming up; that at today's average rental rates would have a roll down. But that roll down is getting less and less as rental rates continue to rise broadly in most of the office markets around the country right now.

More specifically, relative to rental operations, as we talked about in our last earnings call, FSP had about a 17.3% rollover of office tenant leases projected for 2006 at the beginning of the year; and that is a higher percentage than we have had in sometime. How we do with this lease rollover is definitely going to be a key flex point for the year; and so far we are doing pretty well on that rollover, which is right now down to about 10.9% from the 17.3% at the beginning of the year.

A big contributor was one of our single tenant buildings located in suburban Chicago. Built in 1999 and containing approximately 177,000 rentable square feet, it became 100% vacant through the exercise of an early lease termination option by the tenant in the first quarter. The termination had been planned for by FSP and was included in the 17.3% 2006 lease rollover projection. Included with other lease expirations during the quarter overall vacancy increased from an 8% rate to 14% as of the end of the quarter.

However, in April we re-leased 100% of the property to Citicorp Credit Services, Inc., which is a wholly owned subsidiary of Citigroup Inc. That lease is guaranteed by Citigroup Inc. and is for a term of 10 years with no early termination option. The signing of this lease on the pro forma basis has now decreased our overall vacancy rate to 9% as of this call and reduce our lease expirations percentage for the balance of 2006 from 17.3% at December 31, '05 to currently about 10.9%; and of that 10.9% a lot of that lease turnover actually occurs very late in this year.

The B part of our existing portfolio is property sales. How we do here, either gains or losses will have a big effect on our GAAP earnings and on our ability to replace those sales with accretive new investment projects. During the first quarter of 2006 the company did not dispose of any properties. However, the remaining proceeds from fourth quarter 2005 property sales and cash from the balance sheet were used to purchase a 218,000 square foot office building for the FSP portfolio. John referred to this property as the property in Addison. This property was purchased for all cash and continues to be on without any mortgage debt as is every other property in FSP's portfolio.

So just to take one-step back, in '05 we sold six properties Blue Ravine,[ Madison] in the Park, Gateway, Essex Lane, Gael, and Telecom. The proceeds from those sales were approximately $112.03 million. We have reinvested those proceeds into three larger properties. Two we bought in '05, Greenwood Plaza and River Crossing; and Liberty Plaza, the most recent property in Addison, we just purchased in the first quarter. So we generated proceeds from sales of $112.030 million. We reinvested $112.127 million in properties. Now that reinvestment in properties is complete.

As you know, also in the fourth quarter of '05, we purchased some stock under our repurchase program. We did not purchase any stock under our repurchase program in the first quarter and that primarily was because of two things. Number One, the fact that we found this property in Addison, Texas and thought it was a great use of cash; and Number Two, we did have, as John mentioned, the merger transaction in place during the quarter and certainly that's not to affect the stock price at all with a purchase program since we are using our stock as currency for that merger.

Finally, we have several properties that we anticipate selling this year. We have two that John has mentioned, but as I tell everybody they're never sold until they're sold; and we have several properties that we anticipate purchasing to replace them, but they're never purchased until they're purchased. We will, obviously, report property sales and reinvestment into new properties with press releases as soon as they happen. If we sell in properties of significant gains we are likely to continue to try to use 1031 exchange mechanisms to protect the full gain for reinvestment purposes. As you can see, we did do that last year and we did use those 1031 mechanisms to fully invest the proceeds from sales.

The last flex point is our property acquisitions and we acquire property in four basic ways. One is acquiring direct into the company by investing cash from the balance sheet; and two directly into the company by reinvesting proceeds from property sales. The money is all fungible. It's sometimes hard to separate those two. We clearly do internally but we've already mentioned that relative to those two methods of acquisition we purchased Liberty Plaza, the 219,000 square foot suburban office building in Addison in the first quarter.

The third way we acquire properties is for syndication by our investment bank and we have already mentioned the largest transaction that we have ever acquired for syndication was made during the first quarter. We have raised $29.2 million to equitize that transaction and have quite a bit of that transaction to go in the second quarter and are working on it; and again, very excited about its potential, and of course, its size. We still as I mentioned earlier relative to the second half of '06 have limited visibility relative to potential acquisitions and investment banking, although we are working on a lot of things.

The fourth way that we acquire properties is via merger. As John mentioned we did not have a merger in the first quarter but, in fact, completed one of the largest mergers we've ever done on May 1st. This was a five-property merger, all suburban office buildings. It was over 1,115,000 square feet; approximate value $235 million. There will be no effect of this merger on our first quarter numbers but in our second quarter numbers they will impact both the month of May and June; and we certainly will see that effect.

Even after this merger we still have out there 9 independent property REITS, original syndication values for those nine properties exceeds $400 million. We continue to evaluate constantly all of our independent REITS, monitor their progress and determine if and when they may be interesting to us for potential future acquisitions, as well as other third party properties and real estate businesses that might be interesting for us for acquisition.

To sort of summarize or close this part of the call I would say that looking at the flex points they are definitely flexing in a positive direction and we are, I think, all of us internally as optimistic at the end of the first quarter or more so than we were at the start of the year. We are optimistic for a number of general and specific reasons. Generally, and most importantly, we have a fundamentally improving office market around the country. You cannot fight the fundamentals of occupancies and rental increases. The economy is now starting to reabsorb that space that got caught in the tech, telecom, Internet crash and this tends not to be a linear type of cycle with office properties and so we're very hopeful that the economy will obviously continue strong and the space will absorb faster than ever. Occupancy and rents are headed in the right direction finally after many tough years in the office market.

More specifically, however, our portfolio is very, very well positioned. If you were to ask most savvy investors to apprise the most important things affecting the economy over the next year or two, probably two of the top things would be interest rates and energy. When you talk about rising interest rates you are talking, in most cases, about people that own real estate that will have to deal some time in the future with the offset of rising interest rates to, hopefully, continue rising rents and rising occupancies. We do not have of that offset. We do not have any permanent debt on our properties. We have lots of cash, which now earns more by higher interest rates with no offset from rising rents via rising interest rates on our mortgage debt.

In addition to that a lot of our properties are, and were, consciously purchased in primary big cyclical markets that are exposed to energy and natural resources. Houston would be a prime example, Dallas to some extent, the Denver for sure. These big cyclical markets were properties that were acquired when people were not interested in them. They are definitely interested in them now. Growth in employment in those markets is increasing and we think that we have a very, very good and exciting chance to increase occupancies and rents in the bulk of our portfolio in those markets as fast or faster than any place in the country.

In addition, when we talk about energy a lot of our suburban office properties are located in communities where either the very live where you work or work where you live type of environment where commuting times, et cetera are short and we think this long-term will play very, very well into our occupancies and rental levels of those properties as well.

That closes my part of the call. We will now open it up for questions.

[OPERATOR INSTRUCTIONS] Our first question...

If there are no questions...

There's actually one question.

Okay.

Our first question comes from the line of [Todd Craig] with Reinhart and Mahoney. Please proceed.

Hi. Could you give an update on any progress in selling the Phoenix Tower property?

This is George. The problem there Todd is that this is a private placement and it is offered under Reg D; and talking too much about its particular progress or its characteristics is a tough one. Suffice it to say that the transaction is the largest transaction we have undertaken so far. We did do $29.2 million of the transaction in the first quarter. The total transaction is approximately $110 million and progress is good and accelerating in the second quarter.

Okay, great. The second question, if I can, is what's the percentage of your properties that are in Dallas, Houston, and the Denver market?

I think that's in the press release. About 30% of our properties are in Texas and they are primarily in Dallas and Houston.

And will that go -- will that change after the merger that's in the process now? I know of at least one, the Eldridge Green is in Texas, right?

Right. The Eldridge Green. that was one property in the merger. In fiscal 2006 done by the end- there are two properties in Texas that we're adding and then we have properties in three other states, that were the remaining three. So we actually don't have a pro forma percentage for you on that but it looks like it may rise slightly.

So it may be around a third in Texas?

Yes, we're high on Texas. It's in the energy corridor in Houston and also Dallas is a good driver from that industry as well. Obviously that industry is doing quite well these days.

Todd Craig, Oh, that's great. Thank you very much.

You're welcome.

Again ladies and gentlemen, if you would like to ask a question please * one on your touchtone telephone.

If there's no other questions...

It does look like we do have a question now from Todd Litton with UBS. Please proceed.

Hi gentlemen sorry I joined the call a bit late but I had a question. You all mentioned a '97 to '01 peak cycle for your leases. I was trying to figure out if you can tell me just what percent of your leases were signed in '97 to '01 and what percent might be expiring in the next two years?

Actually Todd if you - in the press release we have a supplemental schedule that shows our maturities. I couldn't tell you the percentage which we signed in that '97-'01 period but we do show the maturity percentages. In the next two years we've got about 25% of the portfolio maturing; and our average lease is about five years in length so you can anticipate about 20% lease maturity each year so that's a little lower than what you might expect.

Okay, and then do you all see any significant departures, just out of curiosity, this may be more anecdotal but I'm curious, you know, with the wave in outsourcing kind of increasing now in the white-collar areas what is the effect with respect to your tenant leases?

We definitely have seen some of it but that boogie man that everybody has been talking about a lot for the last couple of years has really not materialized in any significant way, at least in our portfolio.

Has it leveled off if you saw some in the beginning at all?

You know, it has more to do with the large floor plate B office flex call center type of properties, which is just not the bulk of our portfolio so we're probably not a good source to tell you what the real impact of that is out in the office marketplace.

Okay, and do you all break down anywhere just kind of the sector, if you will, of your tenants? I mean as far as like law firms, accountant pieces, building firms, and like you said, call centers and things of that nature. Do you all break that down anywhere?

Not really. I think if you look at Item 2 in the 10-K we do list in there who some of our largest tenants are in the buildings. Most of them are notable names that you can tell what businesses they're in but that might be a way to just sort of scan it; but we generally don't have that kind of a...

Okay, thanks so much for your time.

You're welcome.

There are no further questions at this time. Mr. Carter, do you have any closing remarks.

Just to thank everybody for attending the call. I'm sorry it got messed up at the start but hopefully people will tune in and play it later. I would like to tell everybody that we'll be at - Franklin Street Properties will be at the May REIT Investors Forum in New York between June 6th and 8th; and anybody who would like to visit with us there please give us a call and we'll try to set something up. Thank you.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a good day.