Franklin Street Properties Corp (FSP) 2006 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2006 Franklin Street Properties earnings conference call. At this time, all participants are in a listen-only mode. We'll conduct a question-and-answer session toward the end of this conference. (OPERATOR INSTRUCTIONS).

I would now like to turn the call over to Mr. Scott Carter, Senior Vice President, In-house Counsel. Please proceed, Sir.

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, 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 quarter ended June 30, 2006, which is on file with the SEC.

In addition, these forward-looking statements represent the Company's expectations only as of today, August 3rd, 2006. While the Company may elect to update these forward-looking statements it specifically disclaims any obligation to do so. Any forward-looking statement 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.

Thanks, Scott. Welcome to our earnings call. We are very happy to talk with you about our second quarter and the first half of 2006.

What I plan to cover is, first, an overview of our results and some of the significant changes comparing 2006 to 2005; and then briefly I'll talk about the balance sheet. And after that George Carter, our CEO, will discuss more fully our results and activities.

As a reminder, we evaluate our performance based on EPS and AFFO. We believe each is an important measure and consider both when determining the amount and composition of distributions that are paid to shareholders.

We generally tend to look at our performance over the long-term. But it's important at this point for us to look at the quarter in the first half and see how we did, compared to our Flex points. We consider those Flex points to be contribution from real estate operations, investment banking, and gains or losses on sale of properties.

Our EPS for the quarter was $0.60 per share compared to $0.17 per share in 2005 and in dollars, net income was $40.5 million for the second quarter of '06 compared to $9.5 million for 2005 or about a $31 million increase.

On a year-to-date basis, EPS was $0.84 per share for 2006 compared to $0.37 in 2005. In dollars, our net income for 2006 year-to-date is $53.6 million compared to $19.9 million last year.

The significant increase in each area is primarily associated with gains we achieved on sales of three properties which were all sold in late May of about $28.1 million. The remainder is a pickup in investment banking and also some contribution from real estate.

Our FFO for the quarter was $0.30 per share compared to $0.28 last year which is a $0.02 increase per share and on a year-to-date basis, AFFO was $0.64 per share in 2006 compared to $0.55 in 2005, which is a $0.09 increase per share. On a dollar basis, AFFO was $20.1 million and $40.4 million for the second quarter and first half of 2006 compared to $15.7 million and $29.3 million for the second quarter and first half of 2005. The dollar increases were essentially from asset acquisitions, which benefited the second quarter in 2006 compared to 2005.

Our EPS of $0.84 per share exceeds our dividends paid of about $0.62 year-to-date by $0.22. And if you look at a payout ratio based on that, it is about a 69% payout ratio.

Now AFFO per share at $0.64 this year exceeds the dividends of $0.62 paid per share by $0.02; in the payout ratio, if you do it based on dollars, the payout ratio is 92%.

What is interesting is to look at adding our AFFO per share for six months at $0.64 with gains on sales of assets that we achieved in the first half of $0.44 per share. That totals $1.08. And if you look at that as a payout ratio, and we do consider that part of our performance - the gains on sale of real estate - , that payout ratio drops to 54%.

Getting back to real estate, briefly, the acquisitions we had impacted our results positively and I just want to go over what those were. The benefit of the merger we completed on May 1st of this year, was that we added five suburban office properties in the merger: two are in Texas, one in Colorado, Florida and one in Virginia. That impacted two months of Q2 and obviously we didn't have that last year.

The merger we completed last year was also a factor. We acquired four suburban office properties which we owned for the entire quarter of Q2 of this year and the year-to-date period, where in '05 we only had those properties for two months.

We also had two acquisitions in 2005 that we had for the full year. One was purchased midway through the first quarter in Colorado and one was purchased in the beginning of the third quarter in Indianapolis. So both those purchases were, again, 2005.

In 2006 we've had two acquisitions which benefited us. One was a property bought in the middle of the first quarter in Texas and the other one - which really didn't affect results that much - was a property we bought in Georgia on June 27. So we only had that property for about three days so far.

One thing we keep in mind with our performance in comparing 2006 to 2005 is that our EPS and AFFO is based on weighted average shares; and we had about 10.3 million more shares outstanding in the second quarter and first half of '06 compared to last year because of the merger.

The press release that you probably have all seen and the 10-Q filing go into a great amount of detail with our results, but I do want to mention investment banking which had a terrific quarter. And it was a significant factor in our results this year.

The results from investment banking are derived from gross proceeds on the sale of securities which was up for the second quarter. Gross proceeds were $55.2 million in the second quarter of '06 compared to $24.3 in the same period last year. So that is a pretty significant increase of about $30.9 million. For the year-to-date period our gross proceeds are $84.4 million compared to $61.3 for '05, which is an increase of about $23 million.

Our revenues and expenses arising from this business show up in our income statement as Syndication and Transaction Fee Revenue and Commission Expenses which, when you do the math after some G&A and tax impact, picked us up about $0.03 a share for the quarter and $0.02 a share for the year-to-date basis compared to last year.

The investment banking business is transactional in nature and over the last two years the direction has been decreasing sales; but that changed this quarter. Investment banking is important to us and we're very pleased with the results in the second quarter. That said, for the moment we reiterate what we've said on previous calls: we continue to be at a point in the real estate cycle where finding, appealing transactions to sponsor is difficult.

Currently the cap rate compression that we see can make these investments less desirable; and there are other points in the cycle when fundamentals are different particularly when interest rates are higher and cap rates are higher. And our investment banking business has historically done very well in those times.

We have seen more opportunity this quarter and George will cover this later.

Last, I wanted to cover the balance sheet - some of the significant changes in the balance sheet. Our cash at the end of the quarter is $58 million which is an increase of about $14 million from where we were at the end of March. Our cash balance moves primarily from property acquisitions and capital expenditures which are a key Flex point in our business and also by asset sales.

As of the end of June we had $9.2 million in debt on the balance sheet which we used to finance assets held for syndication. And you'll notice on our balance sheet we have an asset held for syndication of about $9.2 million as of June 30. I do want to point out, though, on July 24, we repaid the line of credit with our cash balance and we did that because we can get a better yield on the loan than we can with current banking rates. So as a result, once again, we have no debt outstanding at the Company at this time.

With the purchase complete for the property in Georgia we have now redeployed substantially all of the $200 million in proceeds from asset sales that we have achieved in the last 12 months. And we put those dollars into new properties for our portfolio. We have also added five properties via the merger which I talked about a few minutes ago - which was a value of about $230 million in assets on our balance sheet.

Collectively the impact of all this activity during this year increased our book value per share to $12.84 at the end of June, compared to about $11.00 per share at the end of 2005. So, although we have had some asset sales, we are increasing the book value per share.

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

That concludes the financial highlights and at this point our CEO, George Carter, will tell you more about the quarter and where we are. Thanks for listening. George.

Thank you, John, and good morning, everyone, and thank you for taking the time to participate in Franklin Street Properties' earnings call. As John has described, second quarter and first half '06 results have shown meaningful increases over the same periods in '05. However a reminder to all is that FSP's numbers, primarily because of the transactional timing nature of its property sales and investment banking business, can vary quite a bit quarter to quarter. Internally we assign much more trend projecting to annual results.

Having said that, the second quarter of '06 was a strong one for FSP by almost any metric you want to use and the whole first half of '06 was as well. Earnings and AFFO per share increased significantly in the first half of '06. Cash flows were excellent. And the balance sheet remained as strong as ever with no permanent debt; 58 million of cash; and growing shareholder equity per share. We continue to be optimistic about the balance of '06 and going into '07.

Through the first half of '06, all of FSP's key business segments and their associated Flex points - which John has illustrated - affected our performance and contributed to our results. Our main business segment and certainly largest Flex point by far is our existing portfolio of properties. We have about 5.3 million square feet of primarily suburban office space.

And in this business segment, we have two subsections of business. The A part of that business is rental operations; the B part is property sales. I want to emphasize the point that both parts of this business - rental operations and property sales - are equally important to FSP. Everything we do, every day, from the acquisition of a property, to its improvement or repositioning, to its ongoing operation, to its management and leasing is in an effort to maximize A, long-term rental cash flow from the property and to maximize B, its long-term potential for appreciation. And achieving that appreciation is a gain on sale.

While GAAP accounting does not present property sales as "continuing operations", it does include the gain or loss on sale of assets for net income per share purposes. Most REIT pro forma numbers like our AFFO exclude the effects of property sales.

For FSP, ultimate property sales are half the reason we invest in properties that must be measured - gains or losses. They are from a real business perspective an integral part of our continuing operations business model. This is one of the main reasons we use both GAAP net income numbers and AFFO pro forma numbers to help measure our performance.

To the A part of our existing portfolio, Rental Operations. The general good news continues in this area. Most of our office markets continue to improve with higher occupancies and higher rent statistics. especially, some of our markets with energy and natural resource exposure, like Houston and Denver. However there are still some rent rolldowns occurring from the last office market rental peak which occurred approximately between '97 and 2001. If you signed five-to-ten years releases during that period you still had some roll. But ,every year through time, and now the rental market improvement, these rolls are diminishing in number and impact.

More specifically, at the start of 2006 we had about 17.3% of our office space due to roll through lease expirations and our early termination rights. And as of 6/30/06 - halfway through the year - we are down to only about 7.3% remaining to roll with most of that roll occurring towards year-end.

Next year in '07, we are projecting only about a 12% lease roll which is a lower turnover year if you think of our average lease as about five years and then 20% sort of the benchmark. So, when you drop below that mark significantly you would call that a low turnover year.

At the end of the first half of 2006, our portfolio was approximately 91% leased, which is several percentage points better than the reported nationwide leased percentages for comparable types of office properties.

The B part of our existing portfolio is property sales and during the second quarter of '06, as John said, we sold three properties. Each asset had a property-specific and/or a local market situation which prompted us to consider the sale.

Proceeds from the property sales totaled approximately $80 million. Each property was sold at a gain with total gains equaling about $28 million. As of this earnings call, FSP has one additional property under contract to sell and is constantly reviewing the possibility of selling others in an effort to capture and maximize their investment value and to continually upgrade the portfolio with new acquisitions by using their sale proceeds for those new acquisitions.

The second business segment and major Flex point is Property Acquisitions and we acquired properties in the second quarter and first half. In the second quarter we acquired by merger five properties totaling approximately 1.1 million square feet. The value of that merger was about $235 million and it was done through an exchange of shares.

These were all with previously sponsored and syndicated REITs that FSP had banked. This acquisition effected only two months during the quarter, however, and will obviously continue to affect our performance going forward.

We also acquired the large Atlanta, Georgia property, that John mentioned, for about $86 million; and that took about $86 of the $88 million in proceeds from the sale of the three properties mentioned earlier. This property in the Atlanta area is a 15-story, 390,000 square foot newer office building. And, with this acquisition, our Atlanta portfolio properties count is five: two which FSP owns directly in its portfolio and one which is asset managed for others in a syndication we have done in the past. Other investment opportunities are being explored all the time, either for merger, direct cash investment or for syndication by our investment bank.

And, as a final note in this area, just again for information, as of this earnings call we have not purchased any FSP stock under our stock repurchase plan during 2006. Money, again, has been allocated to property purchases. There was merger activity in the first half and normal blackout periods and those among other things have been considerations for us not purchasing stock in the first half. However investment of the Company's cash into its own stock, under the provisions of the Company's stock repurchase plan, is always another investment option it has.

The third business segment and Flex point is our investment banking business. Second quarter business was strong with about $55 million of privately placed equity raised along with the first quarter proceeds of about $29 million closed in equity for the first half of 2006 totaled approximately $84.4 million: substantially ahead, as John said, of the same period last year.

The third quarter of '06 will likely see the completion of the Company's largest private placement in its history. This has been the syndication we have been working on for most of the year. It is one property and the syndication totals $105 million. This ability of investment opportunities for our bank for the remainder of the year and into '07 still remains questionable.

However rising interest rates and other factors are finally just starting to bite and just beginning to adjust cap rates upwards somewhat on properties we would like to syndicate. If this trend continues more property product will qualify under our investment criteria; and FSP's investment banking business - which has been lagging for two years during this recent cycle of cap rate compression - could rebound.

We are seeing more properties today priced at what we consider to be better prices, or reasonable pricing, more reasonable cap rate pricing than we have seen the last couple of years. So we are optimistic that possibly the traditional downcycle in our bank may be coming close to an end.

With that, I would like to open it up for questions.

(OPERATOR INSTRUCTIONS) [Bill Ford] with [Rinehart Mahoney].

I was wondering as you guys talk about these leases rolling down from their prior peak, you've mentioned that your average lease term was five years. So we are starting to get close to five years past the last peak, as you guys have described it. Can you give us an idea, sort of, what percentage of your square footage is left with leases that were pre-2000 or were signed at those peak rates and so we can, sort of, look at what the rolldown structure mitigates?

I don't know, specifically, the answer to that question. I'm going to, however, guess that right now we probably have 10 to 20% leases in place that are over in terms of current rental rate. What the current rental rates are in the markets those leases are in.

So the 64 thousand dollar question is, how fast do these recovery markets - which are broadly recovering around the country right now - how fast do those rental rates rise in those markets prior to the lease rolling which today may be currently over that market? That is a big moving target because you know when the lease expires but you don't know what the rental rates will be on that date. I mean, they could go down.

Yes. Absolutely.

But right now they are headed in the right direction. So that is probably as good a guess as I can give you.

And the other thing was just after going through the release you guys had yesterday for the property in Illinois that had the early termination at the end of the first quarter, how much of the quarter was that vacant for? I'm trying to back into rental rates. And it's, kind of a question as to which direction are they heading in? And based on what you have said it would have had to have been vacant for a while.

That's true. I think it was vacant for two months of the first quarter.

All right. You mentioned the rising rate environment in terms of what that does for the possibility of additional syndications. How do you view that as affecting you in terms of ability to acquire properties for the REIT portfolio in terms of the way the cap rates are moving and opening up opportunities to trade up in yield?

I think it is very positive for us. You know, for most REITs who have leverage, rising rates become a double-edged sword. They tend to reflect rising rental rates and rising business activity, rising occupancies, and that is good on the one hand.

On the other hand most REITs have some direct offset to that with their rising debt rates as their debt either rolls, matures, gets recast, or if they have floating rate, of course, it happens right away. We don't have that negative offset from debt because we have no debt. What we are looking for are investments.

One of the main ingredients for investment IRR is current yield. What's happening out there - and it's just started - is we have finally seen and I think it is fairly broadly based right now, a cessation of the compression of cap rates. We have seen cap rates moving back up slightly and there's a lot of property on the market for sale. And there's been a lot of buyers for that property. There is a lot of equity looking for property and there's a lot of property for sale.

But with these rates - rising interest rates starting to bite - we are optimistic that the investment banking business, which is really an important part of our Company, can get going again.

All right. Thanks a lot.

We have used our allotted time for question and answers. I'll turn the call back to Mr. Carter for any closing remarks.

Just to thank everyone again for attending the call and for your confidence and trust as shareholders in the Company.

Thank you for your participation in today's conference. This concludes the call and you may now disconnect.