LXP Industrial Trust (LXP) 2004 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen and welcome to the Lexington first quarter 2004 earnings conference call. At this time, all participants are in a listen-only mode. Following today's presentation, instructions will be given for the question-and-answer session. If anyone needs assistance at any time during the conference, please press the star followed by the zero. As a reminder this conference is being recorded on Thursday, April 29th, 2004. I would now like to turn the conference over to Ms. Diane Heppler with Financial Relations Board. Please go ahead, ma'am.

Thank you. Good afternoon, thank you for joining us on Lexington Corporate Properties' first quarter conference call. The press release and supplemental packet of information were distributed this morning. If anyone did not receive a copy, they are available on the Company's website at www.lxp.com. Additionally, we are hosting a live webcast of today's call which you can access on Lexington's home page or at ccbn.com.

At this time, management would like me to inform you that certain statements made during this conference call which are not historical, may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although Lexington believes the expectations reflected in any forward-looking statements are based on reasonable assumptions, they can give no assurance that it's expectations will be obtained. Factors and risks that could cause actual results to differ materially from expectations are detailed in the press release and from time to time in the Company's filings with the SEC.

Having said that, I would like to turn the call over to management. With us today, we have Will Eglin, Chief Executive Officer and President; Pat Carroll, Chief Financial Officer; and Paul Wood, Chief Accounting Officer. With that, I will turn it over to Will.

Thanks, Diane. And welcome to all of you and thank you for joining our first quarter conference call.

Today Lexington announced funds from operations of 39 cents per share, a decline of 9 cents compared to the prior year. Factors contributing to the decline were an impairment charge that was taken against our Marlborough, Massachusetts property of 4 cents. 13% increase in our shares outstanding on March 3rd, 2004, without immediate corresponding acquisition activity, that's about 2 cents a share. The vacancy of our Phoenix, Arizona property, formerly occupied by Bank One had a 1 cent per share impact and increased G&A, also impacted funds from operations, and also substantial deleveraging of our balance sheet combined with higher-than-normal cash balances compared to the quarter last year.

Today we also lowered our 2004 FFO guidance by 10 cents per share, primarily to reflect the time it will take to invest cash balances arising from a number of sources. A significant event during the quarter was an equity offering of 6.9 million shares, including the green shoe, which raised net proceeds to the Company of $144.3 million. We also acquired $260.6 million of properties, obtained $104.8 million in new mortgage financing and sold two properties for $6.3 million.

Consequently, we ended with cash balances of $87.7 million and over the balance of the year we expect to generate additional cash proceeds from financing activities, a new joint venture program and property sales, all of which we view as long-term positives for net-asset value and the Company's long-term dividend growth. These are all new and we believe positive developments relative to the business plan we outlined at the beginning of the year. The negative, of course is that substantial cash balances are a drag on earnings that will not dissipate until the cash is invested.

Our acquisition volume for the second quarter of 2004 is expected to be about $200 million. So by the middle of the year, we expect to have exceeded last year's record activity. And we can say with some certainty that acquisition volume will exceed $600 million for the year. Again, this is a positive, and we believe that rising interest rates have a positive impact on the acquisition pipeline, both in terms of volume and hopefully higher capitalization rates. One of the benefits of having cash is that we can either be more aggressive and try to invest that cash today, or we can wait and see if cap rates increase over the balance of the year, if interest rates continue to rise.

During the quarter we closed on non-recourse property financings totaling $104.8 million at a weighted average interest rate of 5.57%, with terms of 7 to 11 years. And so far in the second quarter, we've closed on financings totaling $63.3 million, at a weighted average fixed rate of 5.7%. In addition, we have lock rated on $83.8 million of financing that would close over the balance of the year with a fixed rate of 5.32%. We view this as a real positive, as rates have moved since we locked rate, but note that loan proceeds will exceed what we anticipated earlier in the year and this will contribute to our cash balances before being invested in real estate.

Today we posted on our website our supplemental disclosure package. We improved it this quarter by adding summary information on all transactions during the quarter, including acquisitions, dispositions, the lease we signed and all of the financings that closed during the quarter. We view this as a big improvement to the supplement, and a necessity due to the increase in transaction activity.

So overall, Lexington is in great shape, with its main challenge being investing its capital in properties that meet our underwriting criteria and, of course, working on the leases that are expiring over the next few years. Leasing activity in the portfolio seems to be picking up. During the quarter we completed a new ten-year release on our Phoenix, Arizona health club, involving a six-year extension, and we expect to announce lease extensions every quarter during the balance of the year.

Turning to look specifically at the quarter. Obviously, a surprising development was the impairment charge taken against our Marlborough, Massachusetts property. This is one of the assets that we have spoken about on past calls as one that has an overmarket rent and a known vacancy when the lease expires in 2006. We put this property under contract to sell at the end of March, for $11.9 million, to a 1031 investor, and we feel like we can't afford to not sell the property at this price, but would note that sale proceeds will add to cash balances above what we expected at the beginning of the year. We also note that the loss of revenue from the asset is a factor in the lowering of our FFO guidance.

Also note that G&A has increased a lot. Factors include an increase in staffing over the last 12 months, substantial compliance costs due to Sarbanes-Oxley and larger office space to accommodate our growth. We expect that G&A will run at less than 7% of revenues when we are fully invested and run the Company at a normalized leverage of 40 to 45%. That G&A would be below the median level for net lease REITs and place us in the top third of our pier group.

Expenses unique to the first quarter are annual trustee retainer fees of $300,000 and our New York Stock Exchange listing fee of $100,000. Our 2004 G&A budget is $12.5 million and candidly we believe that our G&A is running about a year ahead of what it should be in relation to our total assets. In the last year we've added substantially to our organization in the asset management area, and enhanced our acquisition capacity. Both of which we believe were absolute necessities and so we think our Q2 through Q4 run rate for G&A should be about $3 million.

Also, we broke out a provisional on the income statement for income taxes. We are holding a couple of assets in a taxable subsidiary, pending resale or contribution to joint ventures, as those assets move out of the taxable sub over the balance of the year, we would expect the tax impact to decline, and that these expenses will be recouped. During the quarter our interest coverage was a very strong 3.1 times, compared to 2.6 times in the first quarter of last year. We have very strong credit statistics, especially compared to a year ago.

We also sold two retail properties in the quarter. Our Bally's Health Club in DeWitt, New York and a Wal-Mart store in Riverdale, Georgia, generating modest gains and that's consistent with our long-term objectives of selling our smaller properties, in particular our retail properties that are located in small markets. And recycling that capital with a view toward enhancing long-term capital appreciation, and we anticipate that sales like this will continue over the balance of the year.

Turning to look at the balance sheet, we've seen a very dramatic transformation over the last 12 months. Due to raising $400 million of common and preferred equity, in addition to our property financing and joint venture activity. At quarter end we had $87.7 million of cash which we acknowledge is well above normal. And we expect to run above normal cash balances at least through second quarter and probably for most of the year.

The quarter end we had $661.7 million of debt outstanding and an average rate of 6.69%, 97.7% of which was fixed rate. Over the last year we have taken out of our capital structure, virtually all of our exposure to floating rate debt and all of our debts are non-recourse. We have no liability of any significance maturing until 2008, so there are no negative refinancing implications from rising interest rates in the near term and, in fact, the average interest rate on our fixed rate debt is 6.75%, so rates would have to rise significantly for our refinancing opportunity to turn into a negative.

Our balance sheet debt is 36.2% of total capitalization at the end of the quarter and that continues to be quite low for us. And in addition, we are continuing to work off our debt quickly, we are amortizing about $102 million of debt through 2008. As we said before, this gives us the ability to continuously releverage the balance sheet as we grow and our debt balances at maturity total $422 million, that's only 23.2% of our present capitalization, and the positive of amortization is reduced future interest expense and debt service payments that will help to offset the impact of any vacancies or favorable renewal options held by tenants. In addition, we are retaining about $11.3 million a year through dividend reinvestment program participation.

On the acquisition side, we've had a great year so far. Year-to-date volume is $290 million and we have a very good chance of meeting our $500 million volume target by mid-year. That's very exciting for us, but even so, we expect to be in a surplus cash position, due to a new joint venture that we expect to form in the second quarter, combined with financing and disposition proceeds.

We believe that a rising interest rate environment is good for volume, because sellers want to sell before rates move above up again, and that would impact their values. Cap rates tend to rise with interest rates in our sector and we are hopeful that the competition will dwindle as some capital moves away from net lease to property types that are more sensitive to the economy. And the positive for us is that we have already priced a lot of the capital that we intend to deploy over the balance of the year. So we're in a position of having a lot of flexibility in terms of when we time the next round of acquisitions for the Company.

We made ten investments in the first quarter, and rather than discuss each of them in detail, I would refer you to our supplemental disclosure package, and the additional disclosure that we put in there, which provides acquisition information that I normally would give in my opening comments. Our average GAAP cap rate on first quarter acquisitions was 9.4%, which I feel was quite good, as it has been a competitive marketplace.

Overall, we are continuing to add assets that are accretive to our cash flows while upgrading the portfolio's tenant credit strength, weighted average lease term, property age and market location. Our pipeline is more active than it's ever been. Our volume year-to-date breaks out as about $232 million for Lexington. And $28 or $29 million for joint ventures and of the $200 million or so in the immediate pipeline, the mix has sort have shifted, about 20% for own account and 80% for joint ventures in the second quarter. So clearly relative to first quarter, a greater mix of the pipeline is going into our joint ventures and that, of course, is another factor contributing to the slowdown in the velocity of which we are deploying our own capital.

Looking at asset management on the leasing front, as I mentioned, we signed a new ten-year lease on our Phoenix, Arizona health club, which we think will allow us to sell that property on favorable terms later this year. And we would note that we believe that the leasing environment is improving and can say with some confidence that we expect to announce six lease extensions over the balance of the year.

Unfortunately, we have nothing new to report on our vacancy in Phoenix, Arizona or with our Hebron, Kentucky property, formerly leased to Fidelity. But just reviewing the three other main near-term occupancy challenges that we set forth on previous calls, one being our Milpitas, California property, second being the facility in Phoenix that we leased to Bull Information Systems, and third our Marlborough, Massachusetts property, obviously if the sale goes through in Marlborough, that will mitigate a significant 2006 risk.

We will be pursuing a multi-tenant strategy for Milpitas and believe that this property is much easier to lease broken up for multiple users, and we've noticed that in that market, even though it's weak, we're starting to see better leasing activity in the 10,000 to 25,000 square foot range and we're having promising discussions for Bull for 50% of their building in Phoenix. Taking together some of the near-term rollover exposure that we've discussed on prior calls is being mitigated. Nevertheless, as we said before, over the next two to three years, lease rollovers will be the most significant challenge facing the Company.

On the disposition side, consistent with our long-term repositioning plans for the portfolio, we're going to continue our focus on office and industrial and probably have a modest amount of sales in the retail area. And focus as we redeploy capital and grow on buildings that are easy to multi-tenant and in better markets than we are presently are located in.

In summary, Lexington continues to be in a very good position, notwithstanding the pressure on FFO created by operating the Company with significant cash balances. In the last year we've made some very important moves to position the Company to operate in a higher interest rate environment, by locking in long-term fixed rate debt and paying down virtually all of our floating rate debt. We've also increased our financial flexibility dramatically, so that we can execute a growth-oriented business plan for several years without needing to raise equity capital. And we have very large external growth capacity which we view as a necessity for us to be able to drive FFO growth over the next two to three years as we have heavy lease rollover and experience lower occupancy in the portfolio than we have had historically.

In the last year we've also dramatically improved our organization, particularly in the asset management area, which, again, was an absolute necessity, as we transitioned from being a REIT that acts like a corporate bond, i.e., one with very little lease rollover, to one that's much more sensitive to the real estate market, and we've also increased our acquisitions infrastructure so that we have the capability of much more external growth.

Over the last quarter, we've seen significant changes in our business plan as market conditions have changed and that was reflected in our decision to raise more equity. Also, we decided to lock into long-term financing at what we think may have been a market low, that's, again, a factor contributing to significant cash balances. And we will have some disposition activity over the balance of the year that will be opportunistic. And, of course, adding a third joint venture program to our existing programs we think is a great long-term positive for the Company. But it does come at some expense to near-term earnings as it does slow down how quickly we'll get our cash balances deployed.

Overall, we think Lexington is in great shape. Obviously, we are very well capitalized and we believe that as our capital is deployed, our goal of providing secure and growing dividends for our shareholders will be enhanced relative to what it otherwise would have been. We've talked a lot in recent weeks with shareholders and other interested parties about what effect rising interest rates have on our business, and I would point out that we have very little refinancing risk, and that the very best thing for this company is a growing economy with very good job creation, because jobs mean more demand for occupancy and, moreover, if cap rates rise with interest rates, as they usually do, we will do very well on our next cycle of external growth.

That ends my opening comments, and operator, we'll turn it over now for question-and-answer.

Thank you, sir. Ladies and gentlemen, at this time we'll begin the question-and-answer session. If you have a question, please press the star followed by the one on your push button phone. To decline from the polling process, please press the star followed by the two. Two you will hear a three-tone prompt acknowledging your selection. Your questions will be polled in the order they are received. If you are using speaker equipment, you do need to lift the handset before pressing the numbers. One moment, please for our first question. Our first question comes from Josh Federmann with J.P. Morgan. Please go ahead with your question, sir.

Hey, guys a couple of things here. First, can you guys put a number on your planned dispositions for this year? You have a lot sort of in the held for sale category. Do you have a target for that?

Well, if it's held for sale, obviously there's a potential that it would all be sold.

Mm-hmm.

But I would probably apply a factor of 50%.

Okay.

While it's held for sale, transactions often fall out of bed between when they go under letter of intent or contract and when they actually close.

Okay. Can you give us any more color on the Marlborough, Mass. in terms of magnitude or anything like that?

Well, we have brought it down to the net sale price. So from a standpoint of going forward there should be no more negative P&L impacts relating to it because we've already taken the charge all at once. To the extent the sale gets dragged out, obviously it will just be earnings to us because we'll still be collecting the rent during the period.

Okay. And that sort of moves me to my next thing here. Can you give us a run rate on the discontinued ops FFO or NOI contribution from the stuff that's held for sale, as opposed to the stuff that was sold in the quarter.

Well, very little was sold in the quarter. So when you look at our discontinued ops it's almost all related to items that are held for sale. So if there was no change in the category, I think what you see here, the $1,749,000 would be a run rate.

Okay. All right. Next, operating expenses were up a bit. Can you comment on that?

Sure. Comparing first quarter '03 to first quarter '04, the real change is if you look at the income statement, we do have, although we are economically net lease company, there are certain properties that we have operating expense responsibilities for that we are reimbursed for.

Mm-hmm.

We have now broken it out on our income statement. So if you look in our revenue section, you will see for the first time reimbursement revenue.

Yes.

So that's the largest increase in the first Q '03 to first Q '04 run up in operating expenses. So we had about $406,000 of operating expenses that we got reimbursed for.

Okay.

So the spread between the 13 and the 18 is really not that wide in the bottom line impact to the Company. The other big difference is the vacancy of Bank One. It added about $158,000 to that line item and then also last year past first quarter we made an agreement with K-Mart whereby we paid them a management fee of $.5 million a year in relation to their affirmation of the lease. So about $125,000 in property operating expenses is included in the '04 number that was not there in '03.

Okay. All right. Perfect. And then the last thing, just quickly on straight line rents, I noticed that it was actually a deduct to get from FFO to FAD this quarter. You guys talked in the past about it actually sort of being a reverse this year. Can you comment on how it looks at this point?

Sure. When we comment on those, it's always from a static portfolio basis.

Mm-hmm. Yes.

So as the portfolio looks today, I think next quarter will be about the same $500,000 and $550,000 adjustment.

Okay.

It will stay flat for the third quarter and then start dropping down by the fourth quarter. So for the full year '04 on the static portfolio we're projecting about $2.7, $2.8 million in straight line rent adjustments. And on a static portfolio that would drop to about $1.6 million in '05.

Okay, perfect. Thanks a lot.

Thank you.

Thank you. Our next question comes from Steve Swett with Wachovia Securities. Please go ahead, sir.

Hi, Will, how are you? On the sale of the Marlborough property, was that a buyer contacting you or was that a proactive sale on your part?

No, that was more of a -- there are people in the market who know that we are interested in selling the property, in this case we felt like it was an unusual situation where we had a buyer on a very short fuse, on a 1031 exchange so that there was an opportunity to in all likelihood to get a price for the property that was a couple of million dollars above what we would have expected to achieve if there hadn't been some tax motivation.

Is there a strategy to look at the sale of the other properties that you might consider trouble?

I wouldn't say so. Every property has its own best solution. We're not particularly interested in selling vacancy, when we think we're selling somebody an opportunity. But, if a buyer is willing to overpay for that opportunity, if you will, then we would be a willing seller. So I think, each one will have its own solution that makes the most sense for the asset.

Okay. And then the third joint venture that you referenced, what part of the market will you be investing in with that venture partner as opposed to your other two?

It will tend to be smaller transactions, i.e., less than $15 million. But in each joint venture program, you reach a point where, once a certain amount of dollars are invested, the exclusivity provisions get watered down. So there's a little bit more flexibility in terms of rotating acquisitions.

Is there any of the activity that occurred in first quarter that you might be sticking into that new venture.

There are certain properties that we are holding in our taxable subsidiary because we think that they will end up in joint venture.

And in the last question, what does that leave you guys to invest on your own? Is it basically just around the edges on transactions that your partners said no to?

The answer is that it is around the edges, but it will tend to be transactions where there might be a greater yield opportunity than our pension fund partner's target. We'll have situations where each of our joint ventures have leverage restrictions, so there will be opportunities where we are buying properties that have leverage in place that exceed those parameters. And also, each of these partners have large real estate portfolios where they will already have enough exposure to any given market, whereas they might not be interested in investing more in Dallas.

I still expect that there's going to be a fair amount of acquisitions that make it to the direct account and this third joint venture magnitude has an initial acquisition appetite of $120 million when it is finished, perhaps, although, of course we would love it if the client wanted to do another program.

That's total investment volume, not equity?

That's right. That's total acquisition costs.

Okay. Thanks a lot.

Thank you. Our next question comes from Michael Merone with Bear Stearns. Please go ahead with your question.

Good afternoon, guys. Just trying to relate the potential vacancy losses to your statement at the end of the press release that you expect earnings growth of 8 to 10% in '05. I think the last time we went through this, we identified about 8 to 10 cents in '04 related to -- I think it's the Phoenix, Arizona property, and the Hebron, Kentucky property in lost rent, and then perhaps another 10 or 11 cents in '05 for those rollovers.

I think the 10 to 11 cents, if I recall, was what I felt like our mark-to-market was, not necessarily in '05, but over a few-year period there.

Mm-hmm. Well, I was thinking about the Milpitas property, the Bull Information Systems property, they all roll in '05, right?

Yeah, they are very late in the year.

Okay. All right. So they won't -- okay. So I guess the bottom line then is, your forecast of earnings growth, obviously factors in the rollover from those properties.

Yes.

Okay. All right. I wonder if you would for a minute just talk about probably the two or three largest acquisitions in the quarter. The yields that you earned on them look pretty rich. And maybe you could talk about the Baker Hughes transaction, New Jersey Natural Gas and the Shaw Group. Maybe a little bit about the locations of the properties, and the tenants.

Sure. The Baker Hughes properties were four existing leases in Houston that we bought, obviously, a great credit and a big market that we haven't had much exposure to. And, yes, the cap rate there is high relative to the credit and the lease commitment, but it came to us with existing debt with an above-market interest rate.

Okay.

Which I think is the main reason that cap rate is in the double digits and, obviously, that's a factor in driving the total yields, the total gap yields on the acquisition program up to 9.4% for the quarter which was above what we thought.

The Shaw Group property, the class A property in suburban Denver. Again with a GAAP yield that was quite attractive and that one also came with existing debt on it, which was above market. And same comment, with respect to New Jersey Natural Gas. They're a class A credit -- I'm sorry, a class A building and an A credit, and a long lease term, but, again, we took it with existing debt that was above market. And that had an upward impact on the GAAP yield that we bought the asset at.

Okay. Thanks.

Thank you. Ladies and gentlemen, if there are any additional questions, please press the star followed by the one on your push-button phone. If you are using speaker phone, you do need to lift the handset before pressing the numbers. One moment, please for our next question. Management, at this time we have no further questions. Please continue with any further remarks that you would like to make.

Once again, everyone, we want to thank you for your continued interest in the Company and we will look forward to communicating to you our progress as we go through the year on the acquisition front and on the leasing front. Thank you again.

Ladies and gentlemen, this concludes the Lexington first quarter 2004 earnings conference call. If you would like to listen to a replay of today's conference, please dial in to 1-800-405-2236 or 303-590-3000. And use the access code of 577060. Once again, if you would like to listen to a replay, please dial in to 1-800-405-2236 or 303-590-3000. Using the access code of 577060. We thank you for your participation. You may now disconnect and thank you for using AT&T teleconferencing.