Granite Real Estate Investment Trust (GRP.U) 2006 Q2 法說會逐字稿

Welcome to the MI Developments second-quarter results conference call. (OPERATOR INSTRUCTIONS). I would like to remind everyone that this conference call is being recorded on Thursday, August 10, 2006 at 10:30 AM Eastern Time. I will now turn the conference over to Mr. John Simonetti, Chief Executive Officer. Please go ahead, sir.

Thank you and good morning, and welcome to our conference call. With me today are Richard Crofts, our General Counsel, and Bob Mintzberg, MID's Controller.

As we previously announced, our former chief financial officer resigned from the Company effective July 7th and will be replaced by Robert Kunihiro. Robert is currently the CFO of Xenos Group, a leading global provider of software solutions, and a public company listed on the Toronto Stock Exchange. Before Xenos, Robert held several senior finance positions with other Canadian companies, including Pet Valu Canada and The Molson Companies. I'm very pleased that Robert will be joining our management team. But given that Robert's start date will be next week, rather than me speaking for the next half-hour, I'm going to ask Bob Mintzberg to take you through our 2006 second-quarter results later in the call.

Our Board of Directors met yesterday and approved our financial results for the second quarter and six months ended June 30, 2006. In addition, the Board declared a dividend of $0.15 per share for the second quarter, payable on or about September 15, 2006 to shareholders of record at the close of business on August 31, 2006. This morning we issued a press release with our 2006 second-quarter results. A copy of this press release is posted on our Website at www.MIDevelopments.com.

Before getting into our formal remarks, I'm going to ask Richard to read our forward-looking statements disclaimer and provide you with an update on the status of our litigation with Greenlight.

Thanks, John. We wish to caution listeners that this conference call may include forward-looking statements within the meaning of applicable securities legislation. For a description of the risks, uncertainties, material factors and assumptions associated with forward-looking statements, pleased refer to this morning's press release, which includes a discussion of these matters at the end of the text. The press release also includes a reconciliation of the net income of our Real Estate Business to funds from operations.

As most of you know, in August 2005 Greenlight Capital Inc. brought an Oppression Application seeking extensive [release]. The respondents to the Application are MID, as well as certain of MID's current and former directors and officers. The Application was heard in the Ontario Superior Court in late 2005 and early 2006, concluding on March 1st, 2006. At the conclusion of the hearing, as is typical, the judge reserved judgment.

On July 14, 2006, the applicants filed with the Court a supplementary factum and supporting materials for the purpose of providing the court with an update concerning events at MID and MEC, subsequent to the conclusion of the hearing. On July 20, the respondents filed supplementary [facta] and supporting materials responding to the materials filed by the applicant.

As we have stated previously, MID continues to believe that the Greenlight Application is without merit, and we have vigorously defended against it. We hope that a judgment will be forthcoming within the next few months, but can provide no assurance as to the timing. As the matter is still before the court, MID will not be making any further comment on these issues at this time, and we will not be responding to any questions relating to this matter today.

I will now turn the conference call back over to John.

Thanks, Richard. Let me start by saying that our Real Estate Business continues to post strong financial results.

In terms of our second-quarter results, on a sequential basis, total revenues increased 6%, driven primarily by revenue increases in our core rental portfolio, and funds from operations increased 9%. On a year-over-year basis, total revenues increased 29%, including a 10% overall increase in rents, and FFO increased 37%.

These are impressive numbers and we hope to continue to post similar results going forward. But based on the nature of our historical business, three key elements are necessary to make that happen, and those are -- first, continued growth by Magna; second, Magna deciding to outsource their real estate needs; and third, Magna's willingness to outsource their real estate needs to us.

And speaking about our Magna-related work, during the second quarter we brought onstream five projects representing 454,000 square feet of leasable area. Four of these projects were expansions to existing facilities, which added 111,000 square feet at a cost of just under $10 million.

In addition, we announced on our last conference call -- in late April we closed the purchase of a 343,000 square foot facility in Saltillo, Mexico at a cost of $11.9 million. Roughly 60% of this facility is leased to a Magna tenant, with the remaining portion leased back to the vendor. On a year-to-date basis, this brings the total amount of Magna-related projects coming onstream to 594,000 square feet at a total cost of $29 million.

In terms of our active developments, we are currently working on four minor expansion projects for Magna, which are expected to add another 159,000 square feet to our portfolio with a budgeted cost of $15.1 million.

Our development pipeline is light and, in my view, this can be partly attributed to the plant rationalization Magna is currently implementing. But I also believe that the slowdown in our Magna work may be partly a result of the uncertainty that continues to surround our company pending the resolution of the Greenlight litigation, and clarity with respect to our operating framework.

The bottom line is that the most significant asset we have, that bears on whether and to what extent Magna continues to use us as their landlord of choice, is our know-how. And when I say know-how, I want to reinforce that it's not just being able to build plants on time and on budget. With some practice, other development companies can learn how it's done. And it's not solely about providing the most competitive rents either. Instead, to me, know-how means Magna know-how, which means understanding and being sensitive to the challenges of the tough automotive industry.

From the standpoint of our landlord/tenant relationship, it means establishing and maintaining a framework between us and Magna that continues to provide Magna with the flexibility they need in order to maintain their leading industry position. And I believe that in order to continue to win Magna's business, we must be able to demonstrate flexibility, not only when times are good and Magna is growing, but even more so -- even more so when times are tough and they need to tweak their operations, such as they are currently doing with their plant rationalization.

So I want to reinforce how important it is for us to try to solidify our working relationship with Magna. And as I just mentioned, one of the key components to achieve this is our willingness to be flexible. Flexible so that Magna can deal with their facilities as if they continued to own them, even though they are leased from us. If we can arrive at some sort of working principles that are acceptable to both Magna and us, I believe that when Magna decides to outsource their real estate in the future, it really should be our business to lose. Working on ways to strengthen our relationship with Magna will be a priority for us as we strive to continue to grow our rental portfolio.

Let me turn my discussion over to Magna Entertainment. On July 26 we announced amendments to our Gulfstream Park project financing facility and our MEC bridge loan.

With respect to Gulfstream project financing, we agreed to provide a new tranche of up to $26 million to MEC's subsidiary that operates the Gulfstream Park racetrack. This financing is earmarked to fund the design and construction of a 500 slot machine facility to be located in the existing Gulfstream clubhouse buildings. The additional slots at Gulfstream will improve overall cash flows and enhances our already strong security package related to the Gulfstream and Remington project financing.

I should add that we also agreed to permit the release of up to $10 million of funds from the subsidiaries that operate Gulfstream and Remington that will be used by MEC to fund ongoing operations. Under the terms of the project financing, these funds would have been trapped in these subsidiaries and are over and above the funds needed by them in order to meet their repayment obligations, including the cash flow suite provision.

In terms of our MEC bridge loan, we agreed to extend its maturity date by approximately three months, from August 31st to December 5, 2006, in anticipation of the final closing of MEC's sale of The Meadows racetrack in Pennsylvania. As we have discussed before, we anticipate that MEC will be able to repay the bridge loan with part of the proceeds from the sale of The Meadows.

MEC will continue to have financial challenges until it is able to significantly reduce its debt burden and improve its operating cash flows. The amendments to the MEC project financings and bridge loan are intended to allow MEC to continue to work on these initiatives without impairing its future value.

MEC continues to be an important investment for us, and at the end of the second quarter our MEC investment, represented by almost 63 million shares, had a market value of $330 million.

This now ends my formal comments, and I will now turn the conference call over to Bob.

Thanks, John, and good morning, everyone. Before I begin, I'd like to remind you that my discussion this morning will focus solely on the results of MID's Real Estate Business.

Annualized lease payments at the end of the second quarter were $158 million, representing an increase of 9% from the beginning of this year. On a sequential basis, annualized lease payments increased by $8.4 million, or 6% from the end of the first quarter. The main driver of this improvement was foreign exchange, which increased annualized lease payments by $5.5 million as the value of both the euro and the Canadian dollar strengthened against the U.S. dollar during the quarter. Projects coming onstream and rent increases in the quarter added a further $2.4 million and $500,000, respectively, to annualized lease payments.

In terms of our funds from operations, for the second quarter of 2006, FFO amounted to $36 million, representing an increase of $9.7 million, or 37% over the second quarter of 2005. FFO per share was $0.75 on a fully-diluted basis, representing an increase of $0.20 per share over the prior year. On a sequential basis, FFO increased $2.8 million, or 9%.

On the positive side, increased revenues and lower general and administrative expenses increased FFO by $2.8 million and $1.1 million, respectively. On the negative side, we incurred higher net interest expense and cash taxes of $400,000 and $700,000, respectively.

In terms of the $2.8 million increase in revenues, interest and other income from Magna Entertainment contributed $1.1 million, while rental revenues added $1.7 million to the overall increase. The increase in rental revenues is due to projects coming onstream which added $300,000, and contractual rent increases which added $100,000, changes in foreign exchange rates which increased revenues by $1.1 million, and our straight-line adjustment, net of other items, which increased revenues by $200,000.

The decrease in G&A expense from the first quarter is primarily due to the recovery of $700,000 of costs incurred in association with the Company's defense against the Greenlight litigation under the Company's insurance policy. In addition, G&A expenses in the first quarter included $500,000 of repair and maintenance expenses relating to the Company's portion of the cost for a complete roof replacement on an income-producing property.

The increase in net interest expense was primarily due to a $300,000 reduction in interest income due to lower cash on hand. And finally, cash taxes are higher because the Company's -- because of the Company's increased earnings.

In terms of our tax provision, for the second quarter of 2006 we reported a total tax provision of $3.2 million, or an effective tax rate of 9.8%, which is significantly lower than usual for two reasons.

First, during the second quarter, the Company realized a future tax recovery of $2.4 million as a result of the reduction in the future Canadian tax rate. And second, during the quarter we realized a $1.9 million currency translation gain, which is not subject to tax. This gain was previously included in the currency translation adjustment component of shareholders equity and resulted from the impact of the weakening of the U.S. dollar on our foreign assets over time.

During the second quarter, a portion of this gain was realized and included in net income as a result of the Real Estate Business repatriating funds from certain of its foreign operations. For greater certainty, I want to clarify that this currency translation gain is not included in the calculation of the Company's FFO.

Excluding these two items, our income tax expense for the second quarter of 2006 was $5.6 million, representing an effective tax rate of 18.2%. Excluding property disposal gains and related taxes from the prior year, our effective tax rate for the second quarter of 2005 was 19.1%. The decrease in the year-over-year effective tax rate is due to the mix of the Company's taxable earnings in the different countries in which we operate.

On a year-to-date basis, funds from operation were $16.4 million higher at $69.3 million, or $1.43 per share on a fully diluted basis, compared to FFO of $52.9 million, or $1.10 per share on a fully diluted basis for the six months ended June 30th, 2005. This represents an increase in FFO of 31%.

On the positive side, increased revenues and lower G&A expenses increased FFO by $17.6 million and $2.4 million, respectively. And on the negative side, we incurred $2 million of higher net interest expense and $1.6 million more of cash taxes because of the Company's increased earnings.

Turning to our balance sheet, our loans receivable from MEC at June 30, 2006 amounted to $261.1 million, including $100.5 million under the bridge loan and $160.6 million under the project financing. This represents an increase of $21.9 million since the end of the first quarter of 2006.

The net increase during the second quarter consists of advances under the bridge loan and the project financing facilities of $10.4 million and $8.4 million, respectively, $4 million of deferred interest under the project financing facility, and $0.9 million of accrued interest under the bridge loan. The increases were partially offset by a $1.8 million repayment of deferred interest required under the cash suite provisions of the project financing.

Looking at our cash flows, our cash balance decreased by $15 million since March 31, 2006, to $66.7 million at the end of the second quarter. Sources of cash during the second quarter amounted to $36 million, including $26.6 million of cash from operations, the $1.8 million cash repayment I mentioned previously, and $7.6 million of other items.

Cash used during the second quarter amounted to $[51] million, including $18.8 million of advances under the loan facility to MEC, $17.4 million of capital expenditures, $14.5 million of dividend payments, and $0.3 million of other items.

This concludes my formal remarks. Operator, we will now open the lines for questions.

(OPERATOR INSTRUCTIONS). Sam Damiani, TD Newcrest.

Just on your opening comments, John, you spoke a lot about the relationship with Magna and, obviously, the concern that you might get less of an opportunity to participate in real estate outsourcing. Have you seen a trend so far over the last year, I guess, with this, as you call it, increased uncertainty regarding MID of Magna's outsourcing to other real estate players?

No. I haven't really seen Magna begin outsourcing to other real estate players. I just made a note that our development pipeline is light, and I think it's light for a couple of reasons. One, it's just the state of the industry right now. There's more focus on rationalizing plants as opposed to putting up new ones. But am I saying they're not putting up any plants? I think they are putting up some plants. Not many. And there's got to be another reason why that work is not coming our way. And let's be honest here, we've got to get the cloud over our head cleared. And the judgment on the Greenlight litigation will hopefully do that for us.

But you're seeing yourselves perhaps not losing business, so far anyway, to third parties, but you might be losing business to Magna itself, which is just taking the opportunity to take care of its own real estate needs in an increased fashion for the time being? Is that what you're implying?

Yes, I am.

Could you quantify that perhaps? Like if the sort of historical trend of outsourcing had continued, how much in maybe incremental business you might have seen over the last --

I can't quantify that.

Any change in your outlook from the impact of plant rationalizations from the last time you talked about that (inaudible)?

No. I think the list that we had last time -- I think there were six plants. They're still the same six. We haven't heard of anymore in our portfolio that Magna is attempting to rationalize.

Any sense as to the potential for that to increase in the coming months?

I guess it could always increase, but I think Magna's already -- whatever they need to rationalize that we own, we've already been informed of those. I don't expect more to come. You never say never, but I think that's it for us.

With, I guess, the news out of MEC earlier this week on the Gulfstream -- there was a court ruling there requiring potentially a trial there. They may put in question the ability to get the slot license there. That would appear to increase the risk of your loan at Gulfstream, and also the additional $26 million funding. Would you agree with that? Any comments on that?

I think there are -- what happened in Florida not only impacts MEC, but there are others down there who are currently putting up slot facilities. I think the general trend is -- and MEC put out a press release this morning, and all those other players have put out press releases yesterday as well -- that notwithstanding what's transpired, they're going to continue with putting up their facilities.

I think from our point of view, we have approved funding for Gulfstream -- of the 26 million, we have approved funding approximately 3 million, so they can apply for their license. But going forward, we're going to have to assess exactly what this all means before we go ahead and provide additional funding. And we're going to wait to find some more information, get some more facts around what happened out there, and we'll have to assess it at that time. Clearly we don't like the news, but we do gain a little bit of comfort that it's not only MEC that's proceeding, but these other players down there are proceeding nevertheless.

So there's no way that you could, I guess, stop the funding, given what you've already sort of agreed to do?

I'm not sure about that. I think the way the loan has been drafted is if there are events that we believe could impact the value of our loan, we don't necessarily have to continue the funding. So we can stop it if we want. But like we said, like I just said, we have to be careful just -- really need to understand what's around this lawsuit, if there's any meat to it, and then we'll make our call accordingly. But we do have outs, and we don't have to continue to fund if we don't think it's appropriate to do so.

The $700,000 insurance recovery -- could you maybe go into a little more detail? What was the event that triggered that recovery? What kind of insurance did you have?

Maybe -- Richard is here with me; he's been working a lot on that, so I'll ask Richard to answer that question for you.

It's our D&O insurance, and it's the regular course of reviewing the cost and expenses under the litigation with the insurers, and then finalizing the recovery payments. We had made an estimation of the recovery earlier, and in fact we recovered amounts higher than what we had previously estimated. So, that's why we had the recognition this quarter.

Year-to-date we've recovered 1.3 million of costs. We thought we were -- it was 600,000. We booked that in the first quarter, but we actually got 1.3 million back in cash. So we picked up the remaining 700,000 and booked it in the second quarter.

Your insurance company is paying you in respect of costs, I guess, with legal and professional fees the directors and officers [have] paid, I guess -- or the Company's paying on behalf of the directors and officers in regards to this case, and there was coverage (multiple speakers)

That's correct. That's right.

Finally, the cash tax rate -- on a go-forward basis, do you still sort of see it in the low to mid teens?

The cash tax rate -- I always look at it as a percentage of revenue. And right now we're sitting roughly at 8% of revenues, which is down a percentage point from last year. That should trend down, assuming we continue to grow outside Canada. So I think right now, 7.5, 8% of revenue is where we're sitting.

Slightly lower in future quarters?

It should be, as long as we continue to grow outside Canada.

Steve Velgot, Cathay Financial.

A few questions from me. John, was the Company restricted from repurchasing stock during this Greenlight litigation? And if so, is this why the normal course issuer bid was not renewed?

We're not restricted to buy stock back. I'm looking at Richard. I don't think we're restricted to buy stock back simply because of the Greenlight litigation. We have been on kind of a continuing blackout for things we're working on, and it's for that reason why we haven't bought back any stock. And when it came up to renew the normal course issuer bid, we were still under that blackout. So we thought it doesn't make any sense to renew it, and we'll revisit it once the blackout is lifted.

I spoke with Bob's predecessor about this, but would MI Developments consider swapping its stake in Magna Entertainment with Magna International in exchange for additional properties?

Would I -- your question -- would I give Magna my 63 million shares in exchange for additional investor properties from Magna?

From Magna to MI Developments. Is that something that you would be comfortable exploring?

I think the right question to ask is if Magna would be comfortable in exploring that. And unless there's two sides to deal that are comfortable in going ahead, I'm not sure there's a deal there to be had.

(OPERATOR INSTRUCTIONS). Mr. Simonetti, there are no further questions at this time. Please continue.

Thank you. I want to thank Bob Mintzberg, first of all, for stepping in before Robert Kunihiro starts next week. I think Bob did a good job. I made some comments on the Magna relationship. I take that vary -- I take those very seriously. I truly believe that as long as we do things right, there is a relationship there to be had going forward, and we're going to continue to work on that as a management team. So, until the next conference call, I just want to thank everybody for participating. Thank you.

This concludes the conference call for today.