Franklin Street Properties Corp (FSP) 2006 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2006 Franklin Street Properties Earnings Conference Call. My name is Shaquana and I will be your coordinator for today. [OPERATOR INSTRUCTIONS] I would now like to turn the presentation over to your host for today's call, Mr. Scott Carter, Senior Vice President and 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 President and 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 quarter ended September 30, 2006, which is on file with the SEC.

In addition, these forward-looking statements represent the Company's expectations only as of today, November 1, 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.

Thank you, Scott. Welcome to our earnings call. We're very happy to talk to you about our third quarter and nine months results today. What I plan to cover is first an overview of our results and some of the significant changes comparing 2006 to 2005. And second, I'll talk briefly about our balance sheet and a couple of other items. Afterwards, George Carter, our CEO, will discuss more fully our results and activities.

As a reminder, we evaluate our performance based on both EPS and AFFO. We believe each is an important measure and consider both when determining the amount and composition of distribution that we pay to shareholders. We generally tend to look at performance over the long-term, though it's important at this time to look at the quarter and the nine months of where we are compared to what we call our flex points.

That said, this particular quarter is a great example of longer term results being more meaningful. Our results for the comparative three month period show a decrease over 2005 results, while the comparative nine month periods show an increase. We'll cover that in a minute but the three main drivers of flex points or flex points in our business are -- 1) contribution from real estate operations; 2) investment banking; and 3) gains on sale of properties.

Our EPS for the quarter was $0.25 per share compared to $0.44 per share in 2005. And dollars net income was 17.8 million for the third quarter compared to 26.8 million for 2005 third quarter or a $9 million decrease. On year-to-date basis though, EPS was $1.08 per share for 2006 compared to $0.84 per share for 2005 or an increase of $0.24 per share and in dollars our net income was 71.4 million for 2006 compared to 46.7 million for 2005 or an increase of about $24 - $25 million.

The significant increase over the comparable nine month periods was primarily associated with gains on sales of properties that consisted of three properties that we sold in late May or in our second quarter for a total gain of about 28.1 million and one property that we sold in the third quarter at a gain of about 6.4 million. So in total, we have 34.5 million in gains on sale of properties. For the comparable 2005 period, we had net gains on the sale of properties of about 13.3 million. We had contributions from various real estate acquisitions and mergers that we've made over the last 12 months in this year which were slightly offset by an increase in unoccupied space during the third quarter primarily from one lease expiration late in the third quarter.

Separately, we also received termination payments of 1.7 million for the third quarter that brings our year-to-date total for termination fees to about 6.6 million compared to $700,000 in the three to nine month period of 2005. A substantial amount of space of the related properties where we receive termination fees has been re-leased.

These increases were partially offset by our investment of banking activity which was significantly lower comparing the third quarter of 2006 and 2005, so it was much closer on a year-to-date basis and this helps to illustrate the importance of our longer term view or longer term perspective.

Gross proceeds from the sale of securities which our revenue and expenses in investment banking are directly related to. These proceeds decreased 28.1 million in the third quarter of '06 compared to 2005, but were only down 5 million on a year-to-date basis. This means that through nine months of this year we've sold securities with a value of about $100.2 million compared to 105 million last year which is fairly close.

The quarters though are much different, and simply comparing Q3 for each period can lead you to the wrong conclusion. Our per share AFFO results reflect AFFO for this quarter of $0.27 per share compared to $0.31 in 2005 which is a $0.04 decrease, but on a year-to-date basis AFFO was $0.90 per share in 2006 compared to $0.86 per share in 2005 which is a $0.04 decrease. On a dollar basis, AFFO was 19.3 million and 59.7 million for the third quarter and nine months of this year compared to 18.7 million and 48 million for the third quarter and nine months of 2005.

Year-to-date earnings of 71.4 million exceeded our dividends paid of 59 million on a year-to-date basis by about 12.4 million or $0.15 per share. This calculates to a payout ratio based on dollars of about 83%, which is better than the same period in 2005 when we were at a 104% payout ratio.

AFFO in dollars was 59.7 million through nine months and that exceeds our distribution as paid at 59 million which works out to be about a 99% payout ratio which is also better than the same period last year when we were at a 101% payout ratio.

The reason the per share ratios calculate differently comparing a per share calculation versus dollars is because of the impact of shares that we issued in a merger that we completed in May that added about 10.2 million weighted average shares to our calculations and based on the timing of distributions paid it's more accurate to use dollars rather than the per share amount to calculate these ratios.

What we find interesting is a way of looking at our three main flex points in one number. Our AFFO of $0.90 per share added together with gains on sale of assets raises our per share total to $1.43 that exceeds dividends paid by $0.50 per share. On a dollars basis, that's adjusted payout ratio of about 63%. Going back to 2005, that comparable number was $1.10 and the payout ratio was somewhat higher.

The press release and our 10-Q filing goes into further detail about our results but I wanted to briefly cover a couple of items on our balance sheet since year-end. Our cash balance at quarter end was 61 million which was a decrease of about 8.7 million from December. The decrease was from a number of items but primarily it's the value of the properties that we acquired which exceeded the sales proceeds that we got this year by about that number. Our cash balance moves primarily from asset sale proceeds, property acquisitions, capital expenditures on our properties and investments in sponsored REITs such as the one we made this quarter. Each relates to key flex points in our business.

As of September 30, '06 and December 31, '05, we had no debt outstanding on our balance sheet. We've disclosed the sale of four properties this year, completion of a merger and we've also made some acquisitions. Collectively, the impact of all of this activity and our results for the nine months this year have increased our book value per share to $12.78 per share from about $11.00 per share at year end 2005. I've spent some time presenting our results and also wanted 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.

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?

Thanks, John. Good morning, everyone and thank you for taking the time to participate in Franklin Street Properties earnings call. For this call, I will try to follow my written comments in our earnings press release yesterday fleshing in some information and perspective that hopefully will be helpful.

As John said, our third quarter 2006 results were below the comparable period last year while our 2006 nine month results were above the comparable period last year. The quarter and nine month period variances over last year serve to illustrate a fact of FFP's quarter-to-quarter financial results and that is they can be quite variable because of the transactional/timing nature of two out of three of our major businesses -- that is our Investment Banking business and our Property Dispositions business.

Our first and largest business is our relatively steadier rental operations. And as I have said on previous earnings calls, internally we assign much more trend projection to our annual financial results versus any particular quarter because of the transactional nature of these two key business segments, Investment Banking and Property Dispositions.

Having said that, the third quarter 2006 results were the weakest of the year. We remain, however, very optimistic about our potential fourth quarter and full year 2006 results and believe they will show meaningful growth over full year 2005 in virtually every relevant measure.

Taking a look at these three key business segments and again following my comments in the earnings release, our first and primary business segment is Rental Operations. In general, news continues good with continued growth in our markets in both occupancies and rents. However, in the second half of '06, we have seen slower growth in those diversified markets and both in terms of occupancies and rents. This may reflect a more cautious attitude by the decision makers of companies who lease space and may reflect the slowdown that is occurring in the economy, the uncertainty relative to interest rates and energy costs, impact on the consumer, et cetera. Again, we're still showing positive growth in all those areas, but again, growth has slowed in the second half of '06 over what it was in the first.

At the start of 2006, we had projected about 17.3% in lease rollover and during the first half we handled a lot of that very well. As of the end of the second quarter of this year we had only about 7.3% lease rollover remaining, but I think it is important for you to know that a lot of that lease rollover is, in fact, in two single tenant properties that we know will be vacated by those tenants and we had planned for that. One property as John mentioned did become vacant in the third quarter. This is a 117,000 square foot [Baucus] property in the greater Seattle-Tacoma area and the other property will vacate very much towards the end of the year in December. That property is about 146,000 square feet and is located in the north San Jose- Silicon Valley area.

Both of these properties we like very much and we had planned for this vacancy and had planned to reposition both properties into multi-tenant properties. We think we can add a lot of value to those properties and consequently to our company by doing that repositioning. And consequently until the capital is expended and those properties are repositioned, leasing efforts in those properties will be slow or nil and so you are likely to see an impact on our occupancy and vacancy numbers, two properties going almost entirely vacant out of 31 has that impact. But it's important for you to know that it has been planned, and again, we are repositioning those properties and believe in them very much.

We are projecting about 12% new lease rollover for '07 which is fairly low for our portfolio but when you look at '07 you have to think about the repositioning and re-leasing efforts going on for these two single tenant properties in Seattle and San Jose. We will be busy in '07.

Our second business segment, Property Dispositions. During the third quarter of '06, we sold one small property. The sale price of this property was about 16 million and that is versus 88 million in proceeds from the sale of three properties in the second quarter. Again, the differential in this transactional business from 16 million to 88 million quarter-to-quarter shows you - illustrates really the transactional nature of this business.

Our third quarter property sale produced a gain on sales of about 6.4 million versus about $28 million gains on sale for the three properties sold in the second quarter of '06. The property sold in the third quarter was a smaller industrial property originally purchased by us in 1995. It actually was the third property that we purchased in building our company and between last year and this year we've now sold the first three properties that we had purchased.

Many of our early properties we are looking at as they are maturing and making decisions on whether we're going to put the capital in them to run them for a number of more years or whether it might make better sense to sell them. So some of these early properties I think you'll see in the future are either capital expenditures on in terms of repositioning or bringing up-to-date modernizing, et cetera or outright sales. Again, the differential in the amount of gain for the two quarters, second quarter and third quarter show the dramatic transactional nature of this business and the impact it can have from quarter-to-quarter on our numbers.

We continue to evaluate all of our properties in our portfolio for possible sale and the potential to reinvest those sales proceeds in other properties that we believe have a better future risk-reward profile. With no mortgage debt, we are unaffected by things like debt covenance and cross-collateralizations, maturing loans, prepayment penalties, changing interest rates - with one class of ownership [i.e., common stock no preferreds] which have sort of a debt characteristic to them.

Our view of our assets is fairly pure and simple from an investment decision process. It's simply highest best use of that capital risk-reward adjusted for future rates of return. Generally, when we look at property dispositions we don't consider them unless we believe we have a very valid and opportune position to take in a new property which we think we'll do better than the one we own in the future.

It is important to remember that FSP did not start with a portfolio that was previously owned. We purchased each one of our properties one in a time over our history. We invest in all of our properties from the start for two elements of return and that is rental income and long term capital appreciation. Both the purchase and management of all of our property are decided based upon those two elements of return and trying to achieve the maximum between those two elements of return rental income and long term capital appreciation.

Our third business segment is Investment Banking. The investment banking business for the third quarter of '06 totaled about $15.8 million and that versus the second quarter of '06 where in the second quarter we did about $55 million of business. And in the first quarter of '06, we did about $29 million of business. Again, this big variability in investment banking quarter-to-quarter again illustrates the transactional nature of this business and again is important to consider when looking at the company.

For the third quarter we did finish our largest private placement offering ever. This was $105 million offering and we are very proud of that. Franklin Street Properties actually purchased the last basically $5 million of that offering. We wanted to participate so our internal banking group actually placed 100 million with outside investors. Our previous largest single offering was $86 million. So again, this was a real good effort on our banking group's part.

I think it is very important to understand that for most of the third quarter of 2006, we did not have a banking transaction. The 15.8 million that was done in the third quarter was basically all subscribed for in July. In August and September, our bank really had no business at all to do and so consequently the quarter was affected by that. The real good news is we've started a new $70 million private placement syndication early in October which we are very excited about.

For all of 2005 - last year investment banking business totaled about 135 million. Having syndicated 100 million in the first nine months of 2006 and now having a $70 million offering available during the fourth quarter, we believe that our banking group can improve on last year and show the first year-over-year increase in its business within the last three. However, significant capital inflows into the real estate asset class, generally low cap rates and increased competition for quality property still make future acquisitions for this part of FSP's business somewhat uncertain.

I can add one thing to that caveated statement and I'm not prepared to say that there is a sea-change going on, but for whatever reasons, whether it's lower interest rates or just a little bit of capital inflow exhaustion to real estate, we are seeing more properties today that are of the potential to hit our investment banking return targets than over the last three years. Our visibility of investment banking transactions for the fourth quarter of '06 and going into '07 have been the best they have been in three years. Again, I'm not prepared to say that that is a sea-change forever but it certainly is a welcome change from the past three years.

With that, we will open it up for questions.

[OPERATOR INSTRUCTIONS] Your first question comes from the line of Marvin Loh with Oppenheimer. Please proceed.

Hi. Afternoon gentlemen. When looking at the new sponsored transactions that you mentioned George, can you give us a little bit more detail as to location and timing that you expect of that transaction and whether or not it will pretty much look like the previous deals that you've put through the investment banking channel?

Hello, Marvin. Before trying to answer your question, I think it's informative for investors on this earnings call to know that Marvin Loh is a senior research analyst with Oppenheimer & Company and Oppenheimer & Company via Marvin initiated research coverage on Franklin Street Properties on October 5th.

Relative to your question Marvin, one of the problems about talking specifically about these transactions on a public earnings call like this is that these transactions are offered as private placements under Reg. B and consequently public description in detail of these transactions is not appropriate. I can tell you that we are very excited about this transaction. It is somewhat different than others that we've done and it is $70 million in size. When this transaction is complete, I would be happy to discuss it in detail on a call or in the public.

Okay. But just so that I understand. The property - I guess just the structure of it - the property is presently owned by FSP or by a subsidiary of FSP and you're currently opening up for solicitations via the private placement investors to that deal right now?

The property will be owned by a subsidiary or a sponsored entity as we call it of Franklin Street Properties just as it has been in the past. So it will be a separate company that owns the property and we will be raising money to acquire that company whose sole asset will be this property via a preferred stock private offering.

Okay, great. And you expect full fund raising efforts to be going on throughout the better part of the fourth quarter?

Absolutely.

Okay. And maybe not with this transaction but it appeared the one that you had just closed took about three quarters to close. Is that typical for these private placement transactions or was that a little bit longer than normal?

The actual fund raising only really took about six months, but between raising the money and closing the money, because we have several investor proposals along the way, that timeframe is not atypical for recent times. This transaction that we just finished, the $105 million transaction, was a significant reposition of an office building in Houston, Texas and was our largest transaction in total equity raised but also was our largest transaction ever in terms of a major repositioning. And so again, it was a little bit different than other transactions we've done. But it really varies Marvin from - not all transactions move at the same rate and they move in terms of capital raising efforts for different reasons at different rates. So it's very hard to sort of plug in this is how much money we can raise in a month or two months for any particular transaction. It varies a lot.

Okay, sure. When looking at your pipeline becoming more full it's certainly encouraging to hear that it's been the most visible that it's been in the last three years. If the market is actually moving into a more optimal type situation for the investment banking business would you expect that revenues would be less lumpy in that type of environment?

Yes, I would assuming that we have a more continual product. The big lumpiness in the banking revenues is that we don't have continual product. We don't have continual offerings that we have big downtimes between the offerings. And so to the extent that we can - as we did three years ago and really for the first 10 years of our history where we can have investment banking inventory where we finish a transaction and move directly into a new transaction, you really do take out a lot of the lumpiness.

Okay, excellent. When looking at some of the rental roles that you're talking particularly coming off the highs of the lease payments that were signed about five years ago, what type of discount are you seeing relative to those older rents?

Again, I don't mean to dodge the question, but there's no bullet answer for that. It really depends a lot on the market we're in. And as you know, our properties are spread in a variety of different markets. If you - you can look at one market and you don't get much of a discount at all or none, you can look at another market like Silicon Valley, for example, and you still have fairly steep discounts depending upon the original property and original lease you bought. If you bought a lease that was at the height of the telecom, dot.com tech boom, you're still having roll downs in those properties of 20, 30 or more percent. If you bought one of those properties a year or two after that you're not having any roll downs. So it's property specific, it's lease specific, it's market specific. If you are going to stay in your whole portfolio if it was all turning today which of course it's not, it turns over time and markets change over time. Is there some average percentage roll down? It might be 5%, maybe. But again, that's a real generalization and market specific properties could be very different.

Okay. How about approaching it from a different perspective. Is there an insight that you can give us into where properties are located of the - I believe you said 17% or so that we're looking at next year?

I think they're fairly diversified and there's no big one or two properties like there is this year. This year was fairly significant in that we had three properties that were single tenant properties that are turning this year. One was in the Chicago area property which we had re-leased literally ahead of the tenant vacating. And the other two - and we leased it to another single tenant - it went from the single tenant property to a single tenant property. The other two properties, the Seattle property which I mentioned and the San Jose property we had planned to take those multi-tenant from the start. And so the rest of the space, the turns - again, other than Seattle and Silicon Valley which we will be dealing with in '07 is fairly broad based.

Okay, okay. And what would you anticipate the transition period being for single tenant properties like that which you're trying to convert to multi-tenants?

In the Seattle-Tacoma property, I think that is such a major repositioning of the property that our repositioning and consequently the big effort to start leasing is probably at least three to four months away. In the north San Jose property we are working on leasing simultaneously with capital improvements on the property and in fact in that property have - it appears one tenant already for half of one of the two buildings. So I would say the north San Jose property is simultaneous. The Seattle property probably three to four months away.

Okay. Okay, excellent. And just one more area that I wanted to touch on and I'll get off and let some other people ask some questions. But when approaching mergers with some of the sponsored properties are there any targets that we could grab hold of to give us an idea of when we would expect some additional mergers or any insight into the properties that are out there that you might be considering for merger?

Unfortunately, there really is not [inaudible - background noise] that target. We constantly look at our sponsored REITs which is the group you're talking about. We constantly look at them for the possibility of either selling those properties for those shareholders which may be their best alternative or the possibility of offering those shareholders the opportunity to merge with them into Franklin Street. It is a situation which requires us to exercise broad fiduciary responsibility on two sides of the ledger to obviously our Franklin Street Properties' public shareholders as well as the private placement shareholders of the sponsored REITs.

There is when you look at the dynamics of owning a single property that is still liquid, i.e., the sponsored REIT properties, and the dynamics of owning a portfolio of properties that is liquid, i.e., traded on the AMEX via Franklin Street Properties, there is a dynamic of spread there which can logically and intelligently be made to be very viable for both sides of that equation.

We look at that all the time Marvin and between the value of the properties at the sponsored REIT level and the value of our stock in the public markets, that process goes on all the time and there's not really a definitive timeframe which you can pinpoint it. We have done these mergers at different times of the year. We have done one merger a year. Sometimes we will look at a potential of two mergers a year. Sometimes we will look at no mergers. So it's across the board.

Okay. Thanks very much guys.

You're welcome.

[OPERATOR INSTRUCTIONS] At this time, I would like to turn the call over to Mr. George Carter for closing remarks.

Well thank you very much everyone for participating in this call. Again, I would reiterate to you that Franklin Street Properties is very excited about the balance of the year and going into '07. Look forward to speaking with you on our next earnings call.

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