Franklin Street Properties Corp (FSP) 2007 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the First Quarter 2007 Franklin Street Properties Earnings Conference Call.

(OPERATOR INSTRUCITONS)

I would now like to turn the call over to Mr. Scott Carter, Senior, VP In-house Counsel. 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, 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 provision under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as result of various important factors, including those discussed in Item 1.A. Risk Factors of our quarterly report on Form 10-Q for quarter ended March 31, 2007, which is on file with the SEC.

In addition, these forward-looking statements represent the company's expectations only as of today, May 2, 2007. 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 and the 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. John?

Thank you, Scott. Welcome to our earnings call. We're very happy to talk with you about our first quarter results. What I plan to cover is, first, an overview of our results for the first quarter of '07 compare to 2006 and some of the more significant changes. And second, I'll talk about our cash flows on the balance sheet. Afterward, George Carter, our CEO, will discuss with you our view of FSP and 2007.

We generally prefer to look at performance over the longer term rather than on quarter-to-quarter measurement, though it's important to look at the quarter to assess where we are at this point of the year. One of the reasons we do this is because two of the key drivers of our business are transactional in nature. These are gains on sales real estate and investment banking. The non-transactional driver is our ongoing real estate operations from our portfolio.

We evaluate our performance based on some metrics that relate to these key drivers, which are EPS, AFFO and AFFO plus gains on sales real estate. These measures reflect the ongoing and transactional pieces of our business. AFFO plus gain on sale of real estate refers to AFFP plus those gains. In the first quarter, we did not have any gains or losses on the sale of real estate. That doesn't mean we won't have asset sales in the future. It just means we didn't have any this quarter. The other transactional business is investment banking, which was significantly ahead of last year's first quarter.

Referring to the earnings release for the quarter, the results were, quickly, on a dollar basis, net income for the quarter was $3.4 million lower than 2006 at $9.7 million. Our AFFO decreased $2 million to $18.3 million. On a per share basis, the results were a decreased EPS of $0.08 per share to $0.14, and a decrease to AFFO per share of $0.08 to $0.26 per share.

The $3.4 million decrease to net income came from three main factors. The most significant of these is the decrease in termination fee income, which is included as part of our rental revenue on our income statement. During the first quarter of 2007, we earned $61,000 of income of this nature, compared to $4,722,000 in the first quarter of 2006. The termination fee that we received in 2006 was from a property that we released in the first quarter of last year. However, the income pickup from that in the first quarter of '06 will be a comparative book for us for the rest of the year.

This decrease of $4.7 million was partially offset by a couple of other things. We had some increases to income from real estate operations as a result of some of the mergers and acquisitions we have done in the last year. Although we had an overall increase from ongoing real estate, it was softened by some vacancy issues that we talked about in the press release.

In September and December of '06, we had leases of two single-tenant buildings that expired, which we talked about at year-end. During the first quarter, we began some renovation work with those properties. But the essence of it was we had some lack of income from those properties in Q1. So, that somewhat softens the increases from M&A.

Sitting beside the real estate segment was investment banking, which had a great quarter. The investment banking segment, like property dispositions, is transactional. Our investment banking business is based on gross proceeds achieved from the sale of securities, which increased $20 million to $49.2 million for the quarter ended March 31, '07, compared to the same quarter of '06. On a segment basis, this accounted for about $300,000 in AFFO. But the real estate segment also benefited from increased transaction fees.

Lastly, for a point of reference, the per share calculations were affected by the increase of about 11 million shares for the three months ended March 31, '07 compared to '06 as a result of the merger we completed in April of last year. This covers the earnings, and our press release and 10-Q go into further detail about our results. But I want to briefly cover a couple of items on our cash flow statement and balance sheet since year-end.

Our cash balance at the end of the quarter as about $74 million, including $5 million that was classified as a CD. That CD actually matured three weeks ago. This represents a $1.2 million decrease in cash from the same accounts we had at year-end. And I want to cover some of the key sources and uses for the quarter.

Key sources were an asset held for sale that we reported December 31, '06 of $5.8 million, which we converted into cash on January 31, when that building was sold. AFFO provided $18.3 million of our cash. The use of our line of credit provided $130 million in cash on a net basis.

And uses of cash were payment of our dividend, which was $21.9 million; capital expenditures for the quarter, which were detailed in the press release of about $3.5 million; and roughly $8.5 million in payment of accounts payable and accrued expenses that we had at the end of the year and during the quarter.

On an update, since we also used about $121.4 million of our cash for the assets that we hold for syndication on our balance sheet. On the balance sheet, as of March 31, '07, we had $130 million drawn on a line. However, we note that on April 4, we repaid $30 million of that line, which coincided with the LIBOR contract renewal -- or maturity, I'm sorry. The borrowing was used for the syndication that we have in process. At December 31, we had no debt outstanding.

I'll spend some time presenting our results and also wanted to point out that the press release has our usual supplemental schedules attached to the back that, sort of, slice and dice the real estate portfolio, if you're interested in that. 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. Welcome to our earnings call. And thank you for taking the time to listen in. As in past calls, I will try to follow my written comments in our earnings press release and attempt to flesh them in a bit more.

First, let me repeat what I have said on each quarterly earnings call since our public listing, and that is that Franklin Street Properties' quarterly earnings can be quite volatile and erratic, because of the transactional nature of significant portions of our real estate investment business.

The timing of the contributions from our various business components has historically balanced out over the course of a full year. And consequently, we consider annual financial results to be much more meaningful for performance and trend measurements than any individual quarter.

As John has said, Q1 2007 financial results were significantly below comparable period last year. However, I am more optimistic now than at the start of the year about FSP's full-year 2007 performance potential and growth prospects. Also, let me repeat again from past earnings calls that Franklin Street Properties is an investment firm specializing in and focusing on the asset class of real estate.

Our company has three major business components that contribute to its profitability. They are rental income from properties, gains or losses on the sale of properties and fee income from real estate investment banking activities. These business components have been developed by FSP in an attempt to generate competitive risk reward adjusted financial performance and our specifically designed to use the structural capabilities of our no-debt model.

FSP has no permanent debt of any kind on its property portfolio or corporate business units. FSP also has no preferred stock outstanding. Consequently, 100% of all revenues and profits at FSP from all business sources are owned by one class of security, our common stock.

Our first business component is rental income. And the rental income component of our business during the first quarter of 2007 was about as expected with lease square footage of our 29 properties averaging 86%. Significantly, the two properties that John mentioned totaling approximately 263,000 square feet -- one in the greater Seattle area, and the other in Silicon Valley -- did not contribute meaningful rental income, as each was substantially vacant. Both properties are in the process of being physically repositioned in their respective markets from single to multi-tenant configurations.

Construction and lease-up of these two assets is likely to take up a good portion of 2007 and possibly beyond. The Seattle property has begun active leasing with the signing of our first 9,000-plus square foot lease. And we have several more lease negotiations in process there. Silicon Valley is still a construction site but should be complete and ready for active leasing within the next couple of months.

Once repositioned and released, we believe these two properties can add meaningful rental income and value to FSP. To date, approximately 42% of our 526,000 square feet of expected 2007 lease expirations have been released or renewed. Also, rental income should begin later in the year to FSP from its interest in Park Ten Development. This is our first spec construction project done in the Houston Energy Corridor.

We syndicated this investment and contributed land that we owned to it for an interest in the investment. This is a six-story office building, approximately 155,000 square feet. We did bring that project in basically on time and on budget. It is now 80% leased. Four of the six floors are leased on a ten-year lease to a New York Stock Exchange tenant with no early term. And we're very excited about that project and look forward to the rental income that will start later this year.

Our next business component is property sales. And as a side bar that is again repetitive from other earnings calls, I would like to remind investors what an important part of FSP's financial profit matrix property sales are. Every property we invest in, from its purchase and acquisition pricing decisions to its physical management -- i.e., CapEx and repositioning capital, etc. -- to its leasing, is done with an eye to disposition and achieving a property-specific IRR that has, as a major component, gain on sale or GOS.

The major difference in component return metric to a no-debt real estate model like FSP versus more traditionally leveraged REIT is gain on sale or GOS. To ignore property sales is to ignore a major element of how a no-debt model, like FSP, grows. That said, there were no new property sales for the first quarter of 2007.

However, we have identified several potential properties in our portfolio that we believe are good potential disposition candidates in 2007. Proceeds from any property sales would be designated for reinvestment into newly acquired real estate assets that we believe would perform better in the future than the properties that were sold.

Acquiring replacement properties that continue to upgrade the quality of our portfolio is an ongoing effort. Identifying a replacement asset before completing a property sale is not always feasible. But for FSP, it is the preferred way to operate. The good news here is that the first quarter of '07 has given us the best visibility of potential attractive replacement assets that we have had in several years. Property sales for the full year 2007 could be significant.

Our last business component is investment banking. And our investment banking activity for the first quarter of 2007 totaled approximately $49.2 million. In January of 2007, an affiliate of FSP purchased a property for investment syndication. Permanent equity capitalization of the property was structured as a private placement preferred stock offering totaling $221 million.

This offering is the largest single investment syndication in FSP's history. The $49.2 million of proceeds raised in the first quarter reflected the offering being available for subscription for only a portion of the quarter.

As of April 30, 2007, additional equity in the amount of approximately $24.8 million was closed into the transaction. Capital raising efforts on this offering remain strong. And we anticipate the second quarter of 2007 to be a full quarter of activity producing excellent results. Our acquisition executives continue to work on other property investment opportunities and are currently more optimistic about potential future investment banking product than in the past several years.

Last year, 2006, was the first year in the last three to see a measurable uptick in our investment banking business from approximately $139 million in 2005 to approximately $170 million last year. Investment banking business at FSP is off to a solid start this year. And we are optimistic about this business segment's potential for increased contribution for full year 2007.

Now, we would be happy to open the earnings call for questions.

(OPERATOR INSTRUCTIONS)

Your first question comes from the line of Marvin Loh with Oppenheimer. Please proceed.

Good morning, gentlemen.

Good morning.

Good morning.

George, I'd like to start with kind of a philosophical question. I mean, we've discussed the no-debt strategy fairly extensive. And clearly the benefits of actively managing your portfolio with sales used to facilitate repositioning of properties. But the market's clearly looking for faster AFFO growth, which ultimately would drive increases in dividends, which we haven't seen for several quarters now, despite a lot of the recomps reported higher dividends.

Are you concerned that -- and I understand managing the business to a longer term -- but with the stock price kind of just gravitating around this area, that you possibly risk alienating not only the current investor base but possibly future investors? I understand that a lot of the private placement investors look to FSP stock as a cash-out avenue. Have you had any push-back on that?

Do I worry about our investors? Of course I do, all the time. But I think, Marvin, the philosophical question you ask is really the key one, because it is really a philosophical difference between us as a no-debt model and a traditional debt REIT. And when you talk about traditional debt REITs, I think about preferreds as well as mortgage leverage.

And fundamentally, if you just stop and think for a minute, if you thought about some of the good and well-known property managers, investment managers like AEW or RREEF or Heinz, for example, who we're developing a relationship with -- if a large pension fund did a no-debt investment with Heinz, for example, on a piece of real estate, an investment piece of real estate, that no-debt investment would be measured by fundamentally two things.

The cash flow it generated from rent, and what the appreciation or lack thereof was. And if you exclude the appreciation, you exclude one of the main reasons for investment. And clearly that pension fund wouldn't invest with Heinz in my example.

That is the same with all these private property managers. And we are quite like that. We look at every property on an IRR basis. And it has its own model, and its own value add, and its own objective. Maybe to even philosophically take it to a specific example, which happened just recently in our company -- we have a property, for example, in Southern California that we purchased five years ago. This is a property that is leased to a large national defense contractor.

When we bought that property -- and this is a single-tenant property, a large box basically. When we bought that property, it was under construction. And the primary lease term with this defense contractor was five years. And we got that property at a tremendous cap rate -- about a ten cap -- and a tremendous price per square foot.

The reason we did is because it was only a five-year lease with the defense contractor, who most people view as if they don't get contracts and so on, they're going to leave. In other words, you only had five years, and then you were going to have a potentially vacant box, if they didn't exercise their renewals.

Our no-debt model is really the underwriting tool that allows us to buy that property at that kind of cap rate and that kind of price. In other words, that was our advantage going in with a no-debt model. Just recently, that tenant has renewed for another five years. We have owned that property for about five years.

And the tenant is doing very well. The property has worked out as we had researched. And it has become really a critical property for the long term business model of this tenant. And we have gotten, for the first five year renewal of what we believe will probably be -- hope to be several increases in rent.

Now, if we were a debt REIT, Marvin, what most debt REITs would do is say, okay, we've got a good increase in rent here. How do we maximize that? Well, if they had debt on the property originally, you would be getting that leverage to the equity. If you had more rent, you might add more debt to that property, which could give you more leverage to the equity immediately. And you could take that debt and buy another property with it that would generate potentially more rental income.

We are a no-debt model. We want to remain a no-debt model, because we believe that debt has a level of risk. And no-debt is less risky in our model. And so, the way we get the value out of that rent, which turns into FFO, is to sell it. In other words, we're sellers of FFO to generate the IRR on the property. And then we turn around with our no-debt model and try to make another wise investment with those cash proceeds to do the same IRR over and over again.

So, if you look at the market and you say, in the last several years, FFO has sold for better cap rates, higher multiples than ever before, clearly this part of the cycle would be a part of the cycle that a company like ours would be looking to sell FFO into. And when you sell that FFO, your biggest challenge is obviously reinvesting it in something that will hopefully do as well or better. And while your FFO stays static, your earnings per share soar.

So, if you look at our earnings per share, our earnings per share growth over the last two years has been phenomenal. Since we've been public, our earnings per share growth has been 132%. And our last year's growth on earnings per share was 71%. And our last year's earnings per share growth was 25%.

And where you see -- because earnings per share include gain on sale. We pay our dividend, and we see the differential in shareholder equity growth. So, our shareholder equity has grown, since we've listed, from $10.14 a share to $13.03 a share, a 28.5% increase in shareholder equity over that two-year period.

Leveraged debt REITs don't get that shareholder equity growth, because they are constantly buying more properties with their leverage. It's different financial metrics. If you look at investment firms, which is what we are, and you measure the great investment firms, and you measure Berkshire Hathaway, they look at shareholder equity growth. They look at earnings per share -- Merrill Lynch, Cohen & Steers. I mean, we are far more in that model than leveraged REITs.

And so, you would naturally think, in this part of the cycle, that when we realize FFO increases, that we will sell them to maximize the IRR on our properties versus leverage them. And our financial metrics in areas that leveraged REITs show poorly are just excellent. It's just a different kind of firm.

Well, as you're going through this larger syndication, I'm sure these investors, these potential investors who many of them are existing investors, are looking at your stock price, looking at how it's trading -- have you gotten concerns from them as part of this process with regard to the performance of the stock?

Well, we have gotten concerns from all of our shareholders relative to the performance of the stock, not just shareholders that may also be interested in buying our private placements, which we do have some. But our private placement investments stand on their own.

Investors buy that real estate, because they believe in that single piece of real estate. We acquire a piece, we show them that piece of real estate. It's not a pool. It's not a blind pool. And they are investing based upon their judgment of the merits of that piece of real estate. This particular private placement that we're involved in now, again our largest, has shown the best sales of any private placement we've ever done.

Okay. That's great. Are you able to provide us when you opened that transaction to investors? Just trying to get a sense of if it's consistent with the $25 million or so that you posted in the April month alone.

We have to just leave it at the fact that it was later in the first quarter.

Okay. Now, you mentioned that that pipeline is -- and actually, I guess, several of your businesses are looking stronger than the last couple of years. But the investment banking pipeline, certainly you seem enthusiastic about. Given the large size of this transaction, do you expect your investor base to be able to absorb additional large transactions? Or, is this kind of a full-year event given the large size of it in your mind?

You know, I don't know the answer to that, Marvin. I mean there's -- we definitely have a very significant investor base that has been with us a long time. And their total interest in this particular transaction and where it starts to wane or be depleted is just unknown. Again, at this point, interest is strong.

Okay. Looking at the real estate portfolio, could you provide us a little of an overview? I usually ask every quarter on your markets and what you're seeing absorption, demand for product, rent, things like that.

The broad general answer is that, with maybe the exception of the Detroit area, I think all office REITs, we are seeing generally improving conditions. Now, we have seen -- really starting in the fourth quarter and through the first quarter, some slowing of what had been stronger demand in most markets in the first three quarters of last year.

But as all the REITs reports and CV reports and so on that come out are saying, the general tone is increased absorption, increased occupancy, and in most markets increasing rents. Again, we have one property in the Detroit area, which I would say that fundamental market is tough. But I think all the other markets are generally looking good.

Okay. And then when you kind of look forward and make the statement that you could have some fairly high property sales and reinvestments, what's driving that -- just bifurcations in markets, you're calling tops on certain ones of them and looking at things that are on the way up at this point?

Yes.

Are you seeing them more broadly than you had in the past?

It's very property-specific, and it's very market specific. But again, the model -- and this is what we talked about before this philosophical question of the no-debt model. The model allows us -- and really, it's what we do -- is to move into markets when we think they're at their worst or low on acquisitions, or when a specific property within a market we think is at its worst or low.

When we add that value, either property-specific physical addition of value or market tops or peaks, or even if the market isn't peaked where we think growth will slow enough, that we can get better growth in another market, the way we grow organically is to sell, so we can show a much better IRR on that property by selling and taking that gain and hopefully doing the same thing at another property.

Okay. Thanks, very much.

You're welcome.

Your next question comes from the line of Eric Anderson with Hartford Financial. Please proceed.

Good morning, gentlemen. Just following up briefly on the first question about the no-debt model -- do you feel that it sort of gives you any pressure to sell properties over time that you would be more inclined to hold?

Oh, absolutely not. Again, it's the business plan. And the IRR model -- which again most private real estate companies who manage money for individuals or institutions use, and we use -- is pretty disciplined. You run your assumptions. And when by holding, your IRR starts to drop, there's a reason to take that gain. And that's what we do.

The question, I think, that a lot of people look at is they say if your AFFO is X and your dividend is Y, why your AFFO is maybe not covering your dividend. And you have to add gain on sale there. You can't pay out the dividend we're paying over the last two years and have cash grow by 42% and shareholder equity grow by 28% after paying the dividend and not be increasing the value of the -- it just doesn't work.

So, it's just another way to skin the cat and to not look at what we are, which is an investment company, no different in some ways than a mutual fund company that says dividends are part of the game on the stocks we own. And what we sell them for, at a gain or a loss, is part of the game, is really exactly what we are.

It's just -- we're in this REIT wrapper. And the REIT wrapper is one that grows by the addition of debt and preferreds which uses its FFO to do that. We grow in a different way. And so, our financial metrics that flow from that are different.

Right. Well, I think long-term holders would probably not want to see you feeling like you're under the gun, you have to sell things that you'd just as soon keep, just because you have to meet some type of a quarterly expectation or some type of an annual bogie that is going to change from time to time.

Oh. Absolutely not. And the big difference between us and, in fact, a private real estate investment firm is that we have to reinvest. It's the reinvestment part. In other words, when we look at a property that we believe the IRR will start to decline on if we hold it, we are not going to sell that property under any circumstances unless we believe we can reinvest those proceeds in a property that can generate a better IRR going forward than holding that one.

But we're not selling for performance. I mean, clearly the performance metrics that we've put forward over the last couple of years don't do much. I mean, our growth in all of our key financial metrics have been better than almost any of the REITs out there. And we're not getting credit for it yet in the stock price. So, that clearly is not the point. The point is to do the right thing under our model.

I would say this. The question that always comes to me is why do you do this, George? Why this model? Why the no-debt model? Why don't you do it like everybody else? Why don't you use debt? And there's nothing wrong with a good debt model. But there's also nothing wrong with a good all-cash model. It's just different. And I believe that one of the biggest risks in real estate is timing. I'm old enough to know about the times when occupancies drop, rental rates drop and interest rates don't drop. They stay the same or go up.

And I've been around in the real estate business when the blood is in the streets. I've never seen a real estate investment firm or a REIT cut a dividend or lose significant shareholder equity per share that was all cash unleveraged. Every one that's cut a dividend and not been able to fund a mall development or had to sell a group of properties to pay off debt, every one of those had leverage. And I've never seen one cut their dividend or lose share over equity that didn't.

Okay. Just two quick follow-up questions -- on the balance sheet where you're listing assets held for syndication of $125 million, how many properties are in that figure -- these buildings?

Just one.

Just One?

Just one.

Okay. So, that's the big one that you're referring to.

That's right.

Okay. And the last question is what is left on your authorized buyback of stock? You purchased about 734,000 shares, something like that.

About $21 million.

$21 million?

Right.

Right.

Okay. Thank you very much, gentlemen.

You're welcome.

And just as a reminder, ladies and gentlemen, to ask a question press Star 1. Your next question comes from the line of Bill Ford with Reinhart Partners. Please proceed.

Hey, guys. Good morning.

Hi, Bill.

Good morning.

Hey. Just a couple things to go through -- one of them was, as you talked through the model of selling the properties and looking for where you can redeploy that capital for a higher IRR, sort of entwining that with where the stock price is right now and darn near 7% dividend yield that you're paying on your stock price,

Does that mean conceptually, as you guys are looking to redeploy, that you're looking for at least a 7% annual IRR on a property you invest in -- hopefully more, because that's going to be more risky than just not having to pay the dividend on any stocks you bought back?

Yes. The answer, generally, is yes to that question. IRRs that we look for in individual property certainly are relative to what we perceive the risk and reward is of that individual property. But I think your broader question is --

I mean, is --?

-- is the stock at this level also a consideration? And the answer is yes.

Okay, okay. And where are you guys in terms of your thinking on buybacks at this point? And with the stock at this level, is there some point at which you start to step in? Or have you been -- over the past couple months, where is your thinking on buybacks right now?

We continue to watch it. It is a decision that would be made by the board to activate that program again. We have not, Bill, in '06 or in the first quarter of '07 been participating in buybacks.

Okay.

We, in fact, believe just what you have alluded to, that the IRR potential on the properties we have been buying in '06 and in the first quarter of '07 are pretty exceptional. And we think that's the best place for the money.

Okay. Fair enough. The other thing would be flipping to the investment banking side of the business. Obviously, you guys have got a very large syndication going on right now -- larger than usual. But it sort of looks like, in the first quarter, if I just sort of go through some of this, that the interest cost that it's costing you to carry this big asset in order to drive the syndication revenues.

As you guys move towards bigger deals, do you think you'll be able to sell these larger deals at a fast enough rate, that you don't have to carry the asset for so long and pay the interest on it? Because it seems like that's kind of eating up some of the profits you're making from the investment bank side.

Well, we actually charge the single-asset REIT, the amount of interest it costs us to carry that debt.

Okay.

And so, it doesn't impact us.

Oh, okay.

But you probably noticed, on the income statement, that our interest income from loans number is south of the interest expense on the income statement. And the reason for that has to do with some of the GAAP consolidation rules related to the syndication business we're in. But on a cash basis, we're recovering that. And that's adjusted out in the AFFO calculation.

Okay, okay. That was all I had. Thanks, guys.

Okay.

And there are no further questions at this time. I would now like to turn the call back over to Greg Carter.

Just thanks, everyone, for listening in on this earnings call. And I hope to see some of your at our annual meeting on May 11 and at the REIT Week Investor Forum in New York June 5, 6 and 7. Again, thank you.