Franklin Street Properties Corp (FSP) 2008 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2008 Franklin Street Properties Earnings Conference Call. My name is Tawanda and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will facilitate a question-and-answer session towards the end of the conference.

(OPERATOR INSTRUCTIONS)

I would now like to turn the call over to Mr. Scott Carter, General Counsel. Sir, you may proceed.

Thank you. 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 may 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 annual report on 10-K for the year ended December 31, 2007, which is on file with the SEC.

In addition, these forward-looking statements represent the company's expectations only as of today, July 30, 2008. 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 up on as representing the company's estimates or views as of any date subsequent to today.

At times during this call, we may refer to funds from operations or FFO; a reconciliation of FFO 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. John?

Thank you, Scott. Welcome to our earnings call. We're going to talk with you about our second quarter 2008 results, and we'll start with a short overview. Afterward, George Carter, our CEO, will further discuss the quarter at FSP.

I'm going to be brief and I'll be referring to the earnings release and 10-Q that both went out last night. As we said before, we measure our performance with three key drivers which are: real estate operations, investment banking, and gains on sale of assets, or what we call GOS.

Investment banking and GOS are both transactional in nature and even in normal markets the quarter-to-quarter results from them can be very choppy. We believe our overall performance is better evaluated over the long-term.

For the second quarter of 2008, we had net income of $10.5 million and EPS of $0.15 per share. We measure performance of real estate operations and investment bankings through FFO, which for the second quarter was $20.3 million, or $0.29 per share. We did not sell any properties during the second quarter and as a result, there was no gain on sale, or GOS, during Q2.

Comparing the second quarter of 2008 to 2007, EPS was $0.31 lower in 2008, pretty much entirely as a result of GOS of that same amount per share tat we had in 2007, which we did not have this year. If you strip that out of 2007, EPS was $0.15 per share for Q2 of 2008 and Q2 of 2007.

FFO was up $0.01 at $0.29 cents in the second quarter of 2008, compared to $0.28 in 2007. The reason for the increase in FFO was primarily from performance of our real estate assets, which is about a million dollars ahead of the second quarter of '07.

The most significant reason for the increase was the benefit of leasing that we've had since the second half of 2007 that positively impacted the second quarter of 2008 compared to the second quarter of 2007.

The increase in FFO from real estate was partially offset by a decrease from our investment banking segment of about $650,000, which was because we had lower banking fees in the second quarter of '08 compared to the second quarter of '07.

We earn these fees from investment banking based on the value of the shares that we sell in private placements. For the quarter we sold shares of these private placements of about $49.9 million, which was much better than our first quarter of 2008. But, these sales were about $10.2 million lower than the comparative second quarter of 2007.

Income derived from the investment bank is essentially syndication and transaction fee revenues on our income statement, less the impact of direct expenses, which are commissions and related income taxes and some G&A. George will be talking more about investment banking and GOS, as we believe broader external factors in the market have affected these.

And that covers our financial performance. The press release and 10-Q filing go into further detail about our results. I also wanted to point out that the press release has our supplemental schedules, including information about the 12 single-asset [REITs] that we manage and include two of those that we currently have investments in. There's also our current-owned real estate portfolio in the press release if you're interested.

That concludes our 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 and Scott. Good morning, everyone, and thank you for taking the time to listen to our second quarter 2008 earnings call. My comments this morning, as usual, will follow the written comments in our earnings press release.

As John has said, total profits in the second quarter of 2008 were approximately $20.3 million or $0.29 per share. Franklin Street represents its profits as a combination of FFO, funds from operations, and GOS, gain on sale of properties. For the second quarter of '08, as in the first quarter of '08, there were no gains on property sales, so effectively 100% of the profits were FFO.

Very generally speaking, we believe the current market environment does not offer the best opportunity to achieve efficient and aggressive pricing on the sale of commercial properties. If you don't have to sell a property now, and we don't, a better market is likely to develop when more liquidity returns to the commercial mortgage product, if it is used to help finance the more traditional acquisition process.

Having said that, FSP does have a couple of smaller properties that we have owned for quite a while that we continue to receive activity on from potential purchasers and knowledgeable local brokers. It is possible that a sale of one or more of these properties could take place in the current mortgage environment.

However, we certainly cannot see at this time a broad-based dynamic property sales market returning this year. Consequently, GOS or gain on sale of property is not likely to play a significant role in FSP's profit picture in 2008 as it has in the last several years.

Our other transactional source of profit is our real estate and investment banking business. For the second quarter of 2008, our investment banking group raised about $49.9 million of equity capital, up substantially from the $2.7 million volume achieved in the first quarter of 2008, but as John said, still far short of the $109.2 million level of business done during the first half of last year.

As I mentioned on last quarter's earnings call, we expected to see a pick-up in our banking business in the second quarter, but I would tell you that I believe that we will continue to see extreme volatility quarter-to-quarter in that business at least for the balance of the year or at least for the foreseeable future.

While profits continue to suffer in the second quarter of 2008 from our transactional businesses being negatively impacted by the broader capital market conditions, our ongoing, recurring source of rental revenue from our portfolio of 27 properties continued to grow and provided $0.24 per share of the total $0.29 per share quarterly profit total.

The property portfolio remained about 93% occupied for the quarter, with very little lease turnover remaining for the balance of '08 and approximately 11.4% lease turnover scheduled for 2009 -- we're obviously working on those lease turnovers as we speak -- the property portfolio still has no property-secured debt associated with it.

However, the company does have approximately $110 million drawn on its $250 million line of credit, with those funds having been used for property purchases directly into Franklin Street Properties, as well as a current private placement offering of a sponsored entity through our investment banking group.

During the second quarter, FSP completed the $35.4 million purchase of its 27th property, a recently rebuilt 157,000 square foot office building located in Houston, Texas. This property was originally spec-developed by FSP through one of its investment banking-funded private placements. The property was completely in late-2006 and is now approximately 98% leased, and is adjacent to a look-alike sister building also owned by FSP.

It will be FSP's primary objective to continue to grow its property portfolio and rental income business during this period of liquidity-constrained capital markets by using its balance sheet strength to help finance and fund new acquisitions.

We continue to be very optimistic about FSP's position in the current commercial real estate investment market and the opportunities that may present themselves as a result of the current distress surrounding some aspects of those markets.

Before opening up to questions, I did want to make a couple of comments on the recent dividend cut. First, we cut the dividend because we were not earning it. Specifically, starting in the third quarter of '07, our two transactional businesses, the investment banking business and our property sale business, really took a hit -- really pretty much shut down. The capital market turmoil directly and quickly affected those businesses.

And, looking forward since the third quarter of '07, we cannot see sitting here today exactly how wide and deep this credit crunch canyon turn out to be. I think that while every quarter the board makes a decision on the dividend, I can tell you the board's philosophy is not to pay, for any extended period of time, a dividend that we are not earning, especially when there is no visibility into the future for the businesses that are causing the issue.

There was one year in our history that profits did not cover dividends. That was 2004 and we did not cover that year by about $0.01 per share. Again, we view dividends as a return on investment, not a return of investment. Our objective is to grow this company's real estate portfolio and ongoing, recurring rental revenues, not to shrink the company by paying out a dividend not covered by profits.

Quickly, if you know the history of FSP and its dividends, you know that 15 years ago in our predecessor firm, we started solely as an investment bank. Effectively, all of our revenues were investment banking revenues. About 10 years ago when we declared our first dividend, virtually all of those dividends were transactional investment banking fees; none of those were ongoing, recurring rental revenues.

Over the years, through acquisitions and mergers, we brought properties into Franklin Street and more and more of that dividend became ongoing, recurring rental revenue and less of that dividend as a percentage became investment banking. When we listed our company three years ago, we had a much higher percentage of our dividend as investment banking and we certainly kept that investment banking portion of our dividend.

This sort of watershed event that started as the credit crunch in the third quarter of 2007 has really, again as I said, hurt those two businesses in terms of current sales, but we very much believe in their long-term viability and long-term contribution, it was the right time and the right reason to reduce that dividend that was effectively generated from profits from those two businesses.

A second point that I want to make has to do with what I would call regular dividends versus special dividends going forward. Our real objective here is to grow the regular dividend, and to grow that regular dividend from our existing property portfolio and, as I mentioned on the last few calls, from new property acquisitions, adding to the ongoing, recurring rental income.

We do view, however, an annual special dividend as a real possibility, based solely upon the contributions in any one year from our investment banking and property sales transactional businesses.

I guess what I'm saying is that now that we've made this split, keeping the regular dividend associated with real estate operations and the special dividend on an annual basis, if there is one, based on the contributions from investment banking and property sales is certainly the philosophy that exists here at the company today.

To finish the dividend section here, I will say that one of the by-products of this dividend structure -- that is, a regular dividend and a special flowing from our transactional business -- allows us to add to our options of capitalizing on our balance sheet strength for growth. And that is by providing better access to traditional REIT space within the public, underline public, capital markets when and if the opportunities are right.

It is quite clear to us that public markets do not like regular dividends, or do not value them very much, coming from transactional sources of profit such as our investment banking and GOS. We have never accessed the public capital markets before. We have raised internally virtually every dollar that has grown this firm, equity-wise, ourselves and borrowed from our banking group to help us with that growth.

The reason most companies go public is to access those public capital markets. Three years ago, we simply listed this company. We've never done an IPO and never done any financing through public capital markets.

We are now adding that arrow to the quiver with the sole objective of now viewing the public capital markets simply as an option among many other options for us to raise capital of many different types to grow our property portfolio, and consequently, grow our ongoing, recurring revenue. With that, I will be happy to open it up for questions.

Thank you. (OPERATOR INSTRUCTIONS). Your first question comes from the line of Mr. Bill Ford from Reinhart Partners. Sir, you may proceed.

Hey, guys. I was just going through a couple things looking at it here and looking at how things have gone the past couple quarters. One thing being, you've talked about the acquisition environment and how it's becoming more and more of an opportunity in what you're seeing there.

Can you give a little more commentary on -- sequentially, do you feel like you're moving closer and closer to doing a more significant number of acquisitions now versus three months ago versus six months ago, or how is that progressing? What makes you -- what are the indications of where things are going there?

This is George. The short answer is yes, we see more opportunity today than we did three months ago or six months ago. I think the one thing that is pretty clear from this credit crunch, capital markets event that we're all witnessing, particularly as it relates to mortgages and real estate and liquidity financing for those products, is that patience may be a virtue here.

Every time that the market thinks that the bottom is in or the worst has happened, you sort of get another [leg] here. There clearly has been a move up in cap rates. We have, I believe, taken advantage of that in a couple of properties. We certainly have our eye on other properties. The owners of much of the commercial office properties that we would be interested in acquiring have loan deadlines for refinancing associated with those properties.

You know, a lot of the opportunity that may present itself and the pricing that may present itself is going to relate to how long this liquidity crunch goes, how deep and how wide this canyon is, and how much pressure owners of properties that are highly leveraged feel as they come to a point in time where they have to refinance the debt on those properties.

We are patient, we are disciplined, there are more opportunities today than there were yesterday. You know, what tomorrow brings and the future brings we'll all have to see, but we're optimistic that you'll see acquisitions by FSP using its balance sheet, that those acquisitions will be additive to our rental revenues and our ongoing recurring revenues and potentially significantly some in the future.

Okay. I mean, you mentioned the commercial mortgage financing market. I mean, obviously you guys have your line of credit and balance sheet. Is that what's going to fund the acquisitions or are you guys feeling any constraints in terms of availability or cost of commercial mortgage financing?

This is John, Bill. We are considering other forms of debt -- perhaps term debt, perhaps secured debt -- and have been talking with a number of bankers about that. Credit market is tightened up quite a bit. You can read that in the newspaper quite a bit, so I don't have any news there to talk about, but we do have a $250 million line of credit. We've got about $110 million drawn on it at this point, so we've got about $140 million available on that. Hope that answers the question.

No, that's fine. And then one other one would be as you guys look at your rental operations. Is there anything you're seeing, again sequentially and which sort of direction things are moving in terms of the credit outlook for your tenants? You guys have a lot of financial firms and real estate-related firms in our leases and what are your guys' thoughts on that and where do you see that going?

I can speak for the properties in the portfolio, the owned portfolio, we've been through a pretty good analysis of the financial service-related firms that may or may not be impacted by the credit crunch and looked at our bad debt reserves at the end of the quarter, same thing with the end of the first quarter. Feel pretty comfortable with it and feel like we're in good stead with the tenants we have, so I don't think we have any real holes there. Do you want to add to that George?

No, I agree. I think the credit quality and industries that our tenants are in, we feel real good there. I think the question is, Bill, and I think it's a question for everybody in commercial real estate and not just us, what kind of, you know, [Main Street], on the ground, economic environment do we have as we get lease roll, particularly in '09 and 2010?

Are we in a deep recession where companies are reducing space and laying off people, or are we in a stable and hopefully growing environment where companies are not reducing space and adding people? For us, I think that is the flex point. That is the point that will make the difference. Existing tenants appear real solid.

Okay. Thanks a lot, guys.

Thanks, Bill.

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

Yes, good morning. George, I wonder if you could elaborate just a little bit on the strategy that you're going to use given the credit environment in sort of deciding when to acquire properties for the investment bank for further syndication? In terms of if demand has fallen off in that area, at least temporarily, how will you manage that process so that it doesn't get too loaded up with stuff that you might have to sit with for a while?

Yeah. It's a good question, Eric. That process, acquisition for syndication, acquisition for the bank, has always been you buy too much or you buy too little. In this environment, clearly the -- our investor group who's been with us just a long time -- and we have a great group. These are mostly high net-worth investors and institutions, many of the institutions representing high net-worth investors. They have become very, very sensitive in terms of their confidence and mood for investing, really based upon the day-to-day headlines.

I think as I mentioned in the last quarter when the whole Bear Stearns thing happened and people thought that might have been a watershed and confidence flowed back into the capital markets and financial system, we definitely saw a pick-up in willingness to invest. And then the more recent downturn has, again, crimped that quite a bit.

So that's the environment, we see a more jagged than ever, volatile environment for investment banking business and it really lies with the investor. So we are going to have to, number one, limit product so we don't get caught with product for the bank, until, when, and if that starts to stabilize, which -- we did this in another life and we've been through these cycles before. It will stabilize again is our belief and we can be more consistent.

We will have to be careful, and when we purchase a property for syndication that we believe is a good syndication property, the real key for FSP is to make sure that property, while it's in inventory, carries itself on the line of credit, which is what we use to buy these properties with, i.e., that the NOI from that property will more than pay the debt service on the line so that it's not a negative-carry while we're holding it in inventory. But it's a little bit of an art form, I'll tell you, and it always has been.

Along those lines, I noticed in some of the material that your Phoenix Tower property it looks like it's got a fair amount of space available. Has that been remarketed or -- I think that's the one that had Capital One or WAMU in it?

Again, that is, we have an investment in that property, FSP does, but that is one of our private placement entities. It's [sits] out on its own, is a separate public company, and has its own separate reporting, but, and actually is a public company, you can look at the reporting on that company.

But I can tell you that that was a property that we syndicated that Washington Mutual had a large block of space in, that we pretty much anticipated when we bought the property that space was going to become vacant and available for us to release. That was a property that we were positioning dramatically in terms of physically recapitalizing the property. We actually are re-skinning the whole property, major lobby renovations, major work to the whole infrastructure of the property.

That work is continuing. That vacancy was anticipated. We are working on re-leasing that vacancy, the objective as stated in that public company that owns that property is to finish the leasing of that space and then assuming the markets are good, which right now as we speak today, Houston is a good market, one of the better markets in the country, to put that property on the market for sale.

And when that happens --

Sorry, this is John. On that property, there'll be a 10-Q filed on that in a couple of weeks which will update where we were for the last six months.

If and when that property does come on the market, will you look to buy it for cash, possibly, or sell it outright to another investor?

It is our anticipation that we would list that property with a third-party broker and it would be sold to the highest bidder.

And would Franklin Street be one of the potential bidders?

Franklin Street could be a bidder.

Okay. Thank you.

Yes.

At this time, there are no further questions. I would now like to turn the call back over to Mr. George carter for the final remarks.

Just thank you very much for attending the call. I hope that was helpful. Look forward to talking to you next quarter.

Thank you for joining today's conference. That concludes the presentation. You may now disconnect. Have a wonderful day.