Granite Real Estate Investment Trust (GRP.U) 2007 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the MI Developments second-quarter 2007 conference call.

At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. (OPERATOR INSTRUCTIONS). As a reminder, this call is being recorded today, Friday, August 10, 2007.

I would now like to turn the conference over to Mr. John Simonetti. Please go ahead, sir.

Thank you, operator and good morning, everybody. Welcome to our conference call.

With me today is Richard Smith, MID's recently appointed Chief Financial Officer. Richard comes to us from Magna International, where he was employed for over three years, most recently as Vice President-Corporate Development. Richard has a very solid financial background and has built strong relationships with key Magna executives over that period of time. Richard also has a keen sense of Magna's operating culture and philosophies which, in my mind, is a very important attribute in maintaining our overall Magna relationship. I'm going to ask for Richard to take you through our 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, 2007. In addition, the Board declared a dividend of $0.15 per share for the second quarter payable on or about September 15, 2007 to shareholders of record at the close of business on August 31, 2007.

This morning we issued a press release with our second-quarter results. A copy of this press release is posted on our Web site at www.MIDevelopments.com.

I also remind our participants that this conference call may include forward-looking statements within the meaning of applicable securities legislation. For a description of the risks, uncertainties, material facts and assumptions associated with forward-looking statements, please 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.

I'm going to spend the first part of my comments this morning on matters concerning Magna Entertainment. Yesterday evening, MEC reported its 2007 second-quarter results. The results were disappointing and far from acceptable, given the capital MEC has invested in various projects over the years. More specifically, we are very disappointed and also concerned with the performance of Gulfstream Park, both in respect of the racing operations and the recently opened slots facility. As most of you are aware, MID has approximately $200 million of project financings outstanding in connection with the buildout of MEC racino facilities at Gulfstream Park in Florida and Remington Park in Oklahoma. Although these loans are currently in good standing and we believe that they are adequately secured by valuable land, the cash flows from Gulfstream are currently not sufficient to serve as principal and interest payments on its loans. As such, we are closely monitoring the situation, and we're in the process of analyzing our next steps accordingly.

Now, in respect of Gulfstream, part of the reason for the poor performance was due to factors beyond MEC's control. For example, legislation banning on-site automatic teller machines and check-cashing services had a significant negative impact on Gulfstream's EBITDA. Although new legislation is now in place that permits both these activities at Gulfstream, MEC has much work ahead of itself in order to steer Gulfstream and its overall operations onto a course toward profitability.

Now, I'd like to say that we at MID have been reviewing our structural relationship with MEC for some time. I'm sure that this doesn't come as a surprise to many of you participating in this conference call. After all, our investment in MEC has been the subject of considerable discussion, or shall I dare say, the subject of some good, constructive debate amongst some of our shareholders.

Some shareholders believe that, at all costs, we should immediately sever our relationship with MEC by spinning off our MEC shares to MID shareholders, and yet others have a different view. Well, as you can see from our second-quarter results, we wrote off approximately $2 million of costs in connection with evaluating certain transactions concerning our MEC investment that were ultimately not undertaken. The reason we did not undertake these transactions is that the situation at MEC is such that we do not believe it would be in the best interest of MID to sever our relationship with them today. Put simply, MEC must first and foremost drastically improve its financial picture so that it can support itself and its future business strategy as a complete stand-alone entity.

In order to achieve this, MEC must, at a minimum, grow its EBITDA to the point where it can support and maintain its ongoing annual capital expenditures. But improving EBITDA is not enough. Before entertaining any spinoffs or other type of strategic transaction, many factors need to be considered, including but not limited to the fact that MEC must also drastically improve its balance sheet, which remains over-burdened with debt.

Today, MEC's interest expense far exceeds its operating cash flows, a situation which must change, and change very quickly.

So the time has really arrived for MEC to make some tough decisions. These tough decisions started with MEC's press release announcing that it will be closing the Magna racino in Austria, relinquishing its racing license in Romulus, Michigan, and not proceeding with its racetrack initiative in Dixon, California.

MEC has taken a further positive step towards financial health by announcing that it has entered into a consulting arrangement with its former CEO, Tom Hodgson, who will be conducting a strategic review of MEC. During his tenure at MEC, Tom played a critical role in selling over $300 million of non-strategic assets, the proceeds of which were used to retire a significant amount of MEC debt. Tom's role will be critical -- will be to critically examine all of MEC's operations and more importantly, to assist MEC management to continue to sell and/or possibly raise equity in order to eliminate MEC's debt load. Now, we expect to hear more about MEC's next steps within a matter of a few weeks.

So what does this all mean for MID? Well, for starters, we have to seriously decide to what extent, if any, we will assist MEC going forward, both financially and also, in my mind, assisting with the implementation of the plan that MEC ultimately develops at the conclusion of its strategic review.

We own almost 63 million MEC shares, which today have a market value of almost $120 million or roughly $2.50 for every MID share. As you are aware, we have held our MEC investment since our inception as a public company, and the value of that investment fluctuates with the market price of MEC shares. We can't overlook the fact that, during our short life as a public company, the market value of our MEC shares has, at different points, been three to four times its current amount.

Clearly, our MEC investment is a significant asset, and we must now think about actively working with MEC in order to assist it in implementing its financial improvement efforts for the benefit of all MEC shareholders, including MID. Once MEC has completed its strategic review, we will be able to communicate how we might assist MEC in this regard.

At this time, I would like to say a few words about our real estate business. From an operational standpoint, no projects came onstream during the quarter and for that matter during the first six months of the year. Further, our ongoing development projects with Magna continue to be very late with no new Magna projects received during the second quarter.

Magna continues to rationalize its manufacturing footprint, particularly in North America, where we've been informed recently of four additional facilities which Magna tends to close within the next year. These four facilities comprise approximately 550,000 square feet of leasable area with annual lease payments of approximately $2 million. The net book value of these facilities is approximately $13.5 million.

From the time Magna began to rationalize facilities in 2005, 12 facilities in our portfolio have been closed or are slated to close. Of these 12 facilities, 4 have been sold for proceeds greater than their aggregate book value, one facility was subleased to a third-party tenant, and we anticipate redeveloping 1 of the facilities for residential use. The remaining six facilities comprise approximately 800,000 square feet of annual lease payments with annual lease payments of $3 million. We continue to explore solutions for these facilities that will be mutually acceptable to both MID and Magna.

Before I turn the call over to Richard, I want to emphasize that the financial situation for MEC is critical and that we recognize that MEC must quickly sell a huge amount assets in order to right the ship.

On the positive side, we do believe that MEC has valuable assets to sell. As always, however, the proof will be in the execution. I cannot overemphasize the execution part.

This ends my formal comments. I will now turn the conference call over to Richard Smith. Richard?

Thanks, John, and good morning, everyone.

First, let me say that I'm excited about joining MID and look forward to working with the management team. As John mentioned in his comments, we clearly have some immediate challenges managing our MEC investment. However, our core real estate business, while under some pressure from Magna plant rationalizations, remains financially sound and provides us with flexibility to deal with those challenges.

Before I begin, I'd like to remind you that my discussion this morning will focus only on the results of MID's real estate business, and all amounts in today's presentation are expressed in U.S. dollars.

I want to begin by highlighting that our second-quarter was significantly impacted by unusual G&A expenses. G&A expenses for the second quarter of 2007 include $2.1 million of advisory and other costs incurred in relation to our continuing assessment of our relationship with MEC. In addition, G&A expense includes a $2 million charge relating to our decision to contribute land located in Sims Port Louisiana to a not-for-profit organization in support of Hurricane Katrina redevelopment efforts. As you will recall, we acquired the land in 2005 for $2.4 million as our contribution to the humanitarian initiatives in the region. We agreed to donate a portion of this land in the fourth quarter of 2005. With this latest contribution, we have now agreed to donate the entire property to this worthy cause.

The final unusual item affecting our G&A expenses relates to our ongoing cost with respect to the Greenlight litigation. During the second quarter of 2007, we incurred $100,000 of costs in connection with our response to the Greenlight appeal. This compares to the second quarter of 2006, when we received an insurance recovery of $700,000 in respect of the initial litigation costs. These items, net of their income tax effects, are excluded from the remainder of my presentation.

Looking first at our annualized lease payments, we saw an increase of 4% from the beginning of the year, giving us annualized lease payments of $165 million at the end of the second quarter. On a sequential basis, annualized lease payments increased by $3.8 million from $161.2 million at the end of the first quarter. Changes in foreign exchange rates had the most significant impact, adding $5 million to annualized lease payments, primarily due to the weakening of the U.S. dollar against the Canadian dollar and the euro at June 30, relative to the previous quarter end.

Contractual rent increases in the quarter contributed an additional $200,000.

These increases were partially offset by a $1.4 million reduction relating to two properties affected by Magna's plant rationalization initiatives. Excluding unusual items, our Funds From Operations, or FFO, for the second quarter was $34.7 million or $0.72 per share. This represents a decline of 3% or $0.02 per share over the second quarter of 2006. On a sequential basis, FFO increased marginally by $400,000 or 1%. Higher revenues increased FFO by $1.3 million. However, this increase was partially offset by increases in G&A expenses, net interest expense, and cash taxes of approximately $300,000 each.

In terms of the $1.3 million increase in revenues, rental revenues contributed $1.1 million, driven primarily by the weakening of the U.S. dollar against the Canadian dollar and the euro, while interest and other income from MEC contributed $200,000 to the overall increase.

G&A expense increased by $300,000 in the second quarter as compared to the first quarter of 2007. This change was primarily driven by the impact of the weakening U.S. dollar on our reported results.

Net interest expense, as compared to the previous quarter, increased by $300,000, primarily due to the impact of the stronger Canadian dollar against the U.S. dollar on our Canadian-denominated interest expense and a reduction in interest income due to lower cash on-hand.

Cash taxes in the second quarter are higher because of the mix of the Company's taxable earnings in the different countries in which we operate and a delay in the timing of a portion of the deduction for tax purposes of the $2 million Hurricane Katrina donation.

In terms of our tax provision and to remind listeners that we are continuing to exclude the impact of previously discussed unusual items, for the second quarter of 2007, we incurred a total tax provision of $6.2 million compared to $2.9 million in the second quarter of 2006. The increase in the year-over-year tax provision is primarily due to a $2.1 million future tax recovery realized in the second quarter of 2006, resulting from the reduction in the future Canadian tax rate. Excluding this item, the tax effect of the previously discussed unusual items and a $1.9 million currency translation gain realized in the second quarter of 2006, which was not subject to tax, the real estate business' income tax expense for the second quarter of 2006 was $5 million, representing an effective tax rate of 16.9% compared to 20.2% for the second quarter of 2007. The increase 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 and a legislative tax change affecting one of our foreign operations.

Turning now to the balance sheet, our cash balance at the end of June was $148 million, representing a decrease of $11 million from the prior quarter. Sources of cash during the second quarter amounted to $40.3 million, including $31.7 million of cash from operations, $1.8 million of loan repayments from MEC, $4.6 million of proceeds on the disposal of a real estate property, and $2.2 million of other items.

Cash used during the second quarter amounted to $51.3 million, including $30.4 million of capital expenditures, $6.4 million of advances of loan facilities to MEC, and $14.5 million of dividend payments.

In respect of our capital expenditures, during the second quarter, we acquired a 205-acre parcel of land from MEC in Bosnall, California to be redeveloped as a residential community for approximately $24 million. The property currently has the San Luis Rey Downs thoroughbred training facility operated by MEC. We've agreed to lease the property to MEC on a triple-net basis for nominal rent while we pursue the entitlement and other approvals necessary to carry out our development plan for the property. The lease may be terminated by either party on four months' notice.

In terms of our Magna development work, at the end of the quarter, we had four expansion projects, three in Canada and one in the U.S., representing 64,000 square feet of leasable area with a budgeted cost of $16.7 million of which $12.7 million had been expensed by June 30. We anticipate that, when these properties come onstream, they will add approximately $1.6 million to annualized lease payments.

As previously mentioned, we advanced $6.4 million and received $1.8 million of principal repayments under the MEC project financings, bringing the total amount outstanding at June 30 to $200.7 million.

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

Thank you. Ladies and gentlemen, at this time, we will conduct a question-and-answer session. (OPERATOR INSTRUCTIONS). Steve Velgot.

Yes, John, I was hoping you could discuss your view on potentially acquiring additional properties from Magna International and give us some idea as to -- I think you've talked about the Greenlight litigation as one obstacle or potential obstacle to doing that. But is that something you think can be accomplished in 2008, or what's your view on it?

I think my view is, if we can buy more property from Magna, we certainly are game for that. I mean, our goal here is to grow our top line and our portfolio with Magna. Lately, it's been kind of static or on the verge of shrinking because they are trying to rationalize their manufacturing footprint.

But as I said in prior calls, clearly there's some obstacles that we are trying to get over. One is the Greenlight litigation. I've made it clear. These are key facilities and to the extent they are at risk because there's someone out there proposing that control of this company should be taken away from Frank's hands, when Frank also controls Magna, I just don't think see how that makes sense to try to drum up future business.

The other issue is I know Magna reported spectacular results yesterday, but again, they are looking to rationalize some of their manufacturing footprint. In fact, we had (inaudible) properties come up in the quarter. It's something that's going to happen in 2008. I'm not going to speculate, but I don't think the appeal is going to be heard. We heard, at that time, and we will have to just see what the environment is, but certainly, if we have the opportunity to do that, that's something we've always wanted to do.

Sorry, just the appeal is scheduled to be heard sometime in 2008, right?

That's right.

Jain Himalaya, Scotia Capital.

Good morning. Could you just, John, recap again how many properties do you have right now that you own where Magna has rationalized operations and is not paying you rent right now?

Well, Magna has -- properties that we will -- let me give you the rundown here. There's 12 facilities. Of the 12, we've effectively dealt with 6 of them. Four have been sold, so Magna is not paying rent on that. One we've released to a third party, and we are continuing to get the same amount of rent, so we are collecting rent on that, although it's not from Magna. One we plan to redevelop for residential use, and we are negotiating with Magna what do we do with the lease payments there on at one.

If we could have Magna terminate that lease, it's to our benefit, because we believe the property has some significant underlying value which we would like to surface by turning it into residential use.

The other six properties, Magna is still paying rent on those. So there's nothing -- nothing has been agreed to with Magna, but they are still bound by the term of the lease. Any way we could help them get out of it with not much cost to us, we will consider that, but right now, we are paying rent on those.

Okay. Are the actually in -- do they actually occupy those properties right now?

Of the six, I would say that five of the six they are occupying, one they are not. But they continue to pay rent.

Okay, great. Then just, on a go-forward basis, give us an idea as to what your cash tax rate should be, given the changes that were mentioned and given the change in mix and --?

Okay, let me have Richard answer that question for you.

You know, there are some unusual items affecting the tax rate this quarter, as I highlighted at the beginning. We are currently, on an effective tax rate, adjusted for almost items, and 20.2%. The change from -- on a year-over-year basis is really due to mix of earnings, as well as some legislative changes in one of our -- the countries in which we operate.

There are some opportunities to drop that rate into probably closer to the 18% to 19% range, but it's going to ultimately depend on some of the mix of earnings that we're going to going forward, which may not be entirely predictable.

Just add on that, I think the 20% tax rate that Richard quoted is more tax provision. On our cash tax basis, if you normalize it, we're coming in around 16%, 17% -- 15% to 17% right now.

Peter Sklar, BMO Capital Markets.

First, just an accounting question -- the $2 million land contribution, the charitable contribution, does that negatively impact your AFFO, the way you calculate it and published in the statements?

Published in the statements, Peter, it does affect the FFO. It's included in G&A expenses.

Okay. I want to just explore a little bit about Gulfstream Park. What is the amount of funds that you've advanced on the Gulfstream Park project financing?

I think there's $200 million in total, but Gulfstream is around 160 million, 165 million.

Okay. John, in your comments, you said that they are not generating enough cash flow to service the principal interest, so I mean what kind of -- do we have some covenant defaults at this time but they are still making their financial payments? What exactly is happening there?

I mean, both loans are -- I want to stress they are in good standing. There is no event of default under the loans. You know, we are concerned about the cash flow. We didn't expect the net wins at the slot facility to be as low as they are. They are working on getting them up, so that's good news. We structured the loans that we can also access the cash flow from Remington to service both loans, so that has helped us. But right now, the cash and -- the principal and interest payments are not being fully covered, and we're going to have to deal with that going forward. (multiple speakers)

But you have no recourse to Magna Entertainment; this is strictly project financing. Is that correct?

That's right. They are all ring-fenced with respect to the Gulfstream facility and the Remington facility.

There's no covenants with respect to the financial performance of the facility that they are in breach of?

Not right now, no.

Okay. On the $2.1 million you spent to consider a potential transaction with Magna Entertainment, can you talk a little bit more about what the nature of that potential transaction was?

You know, I really don't want to get into details of what these transactions are. We've said for a long time now that we're going to explore our relationship with MEC and any changes to that. We've put alternatives on the table and we've discussed those in prior conference calls of what those maybe, Peter. You know, but first and foremost, we understand, if we're going to explore any transaction with MEC, and as I said in my comments today, for example, a spinoff, there are certain things that we need to do to ensure that MEC is able to survive as a complete stand-alone entity. So we continue to look at these things. It comes to a point when we say, okay, we're not going to go there any more; we're going to have to write off those costs. But Peter, I don't want to be specific in terms of what that transaction could possibly have been.

Okay, so can we expect to see those kinds of advisory fees and other costs related to it continue in future quarters?

You possibly could see them, but to the extent that we wrote this one off means we've kind of stopped for now. If we start up later, we could always do that. But for now, we've said there's no transaction there, so we're not going to carry these costs on our balance sheet any more; we've got to write them off.

Okay. Lastly, growth with Magna International appears to be grinding to a halt here. So what plan is the Company considering to sustain growth?

Well, that's a very, very good question because we always said our primary goal as a growth vehicle would be with Magna. But you're right; that has stalled.

We have acquired some properties from MEC which we are continuing to push ahead with entitlements and looking forward to develop. We're certainly still going to try and see if there's a possible transaction we can do with Magna on the industrial side. If not, we're going to have to actively search and -- for work from third parties, and third parties -- I mean, by third parties, away from Magna and away from MEC. You know, those are things we all talk about very clearly at the Board level, because you're right. I agree with you; growth has stalled here for some time now.

Okay, thank you.

(OPERATOR INSTRUCTIONS). Sam Damiani, TD Newcrest.

Just on the idea of growth, what do you think of buying back your shares at these depressed levels?

I was waiting for the type of question, but you know what? Sam, obviously, I've flagged some calls over the last couple of days because our stock price has come down significantly over the last of weeks. But I will say this isn't a trend. I think it's isolated to MID. Market price of shares of other companies have come off significantly off their 52-week highs.

But in terms of buying back stock, you know, we've had a Normal Course Issuer Bid in place for some time now, but for a number of reasons, we haven't been able to act on it. Just like any other investor, Sam, you know, we can't trade on insider information. As you heard from my comments today, it's apparent that we have been working on strategic initiatives that are not -- the information of which is not public. That has really prevented us from acting on our NCIB.

We obviously cannot disclose to you whether or not we continue to be under blackout at any point in time. But I will say this. I mean, we do believe that buying back shares represents an attractive alternative for us, and hopefully, at some point, things can clear itself up and we can actually act on our NCIB.

Did you say that if, blackout were to go away, that, at these prices, there's no question you would step in and execute?

I will say, at these prices, our stock is attractive.

You are not willing to commit to executing at these levels?

I can never commit until I go back to the Board. But I can say to you, management's view is, at these levels, the price is attractive.

Okay. Just (inaudible) the Romulus land there, that's I believe still on your books?

It is.

What is the book value of that, and what are the plans? I'm assuming you're going to sell it and you expect to achieve book value when you do that.

Well, I think the book value of those LANs on our books is high 20s, close to 30, say 28 million, 29 million. You know, when we bought that property, I mean it is very well located. It's next to the Detroit Airport and we are reviewing our options. The property has very flexible zoning. We've always said we didn't specifically just buy this property because MEC could possibly put a racetrack on it. It is, like I said, flexible zoning. It\s possibilities include commercial, retail, even industrial, and even residential. So, we continue to explore, amongst with other properties we bought, how to best realize the value from that.

So there's no definitive plan at this point?

Not a definitive plan. I mean we do have alternatives, but it's not definitive.

Over the land you bought in the second quarter from MEC, it sounds like MEC can get out of the lease on fairly short notice here. If they were to do that, what would be the operating costs of that parcel of land, I guess whatever is on there now that would become MID's responsibility?

Well, I think we would only be responsible for property taxes. I mean, the (inaudible) center would close down and MEC is obligated to incur the closing costs. We certainly wouldn't keep that training center open if we're ready to develop that into residential use. So it would just be the property taxes, Sam.

Over to the projects that are being put back by Magna here, what is the average lease term loan on those remaining six facilities?

The average lease term of what's left? I'm just eyeballing this here. I would say five to six years on the remaining six that we have.

Can you tell us the locations of those facilities?

Sure. I mean most of them, like the remaining six, four are in the U.S. and two are in the greater Toronto area.

So as you compare to the previous six which you've fairly successfully dealt with, do you see, given the locations of these remaining six, any more difficult, or are these going to be easier ones to deal with, just given where they are and what alternative uses might be available?

You know, a sense -- some are going to be easier than others. I'm totally not concerned about the ones in the GTA. The market is still strong here and they are in very, very good locations.

You know, we've got a couple here in the Michigan area. Those might take a little bit longer to deal with. So, certainly we've got a mixed bag here. I don't think there is one right now that we're totally overly concerned with, and we will just have to deal with them accordingly.

Just with respect to the transaction that was abandoned, with respect to MEC, was MEC's precarious financial situation the only reason why that proposal was abandoned?

You know, Sam, I'm not going to get into details of why things were abandoned. So, I'm sorry but I'm just not going to give more detail on that question you asked. I don't think it's fair for me to say, so I'm just not going to get into it.

Okay. That's it for me. Okay.

Thank you. I'm showing that we have no further questions at this time. Please continue.

Okay. Well, listen. I know things were slow this quarter and we hope things will turn around, but we will have to wait and see. We will certainly be back to you shortly, if not us, MEC will, to give you the information on Tom Hodgson's review on the Company. Until that time, we're going to sign off. Thanks for participating. Bye.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may now disconnect.