LXP Industrial Trust (LXP) 2011 Q3 法說會逐字稿

Good morning and welcome to the Lexington Realty Trust third quarter 2011 earnings conference call. (Operator Instructions) Today's conference is being recorded and it's now my pleasure to turn the floor over to your host Ms. Gabby Reyes, Investor Relations for Lexington Realty Trust. Please go ahead, ma'am.

Hello, and welcome to the Lexington Realty Trust third quarter conference call. The earnings press release was distributed over the wire this morning, and the release and supplemental disclosure package will be furnished on a Form 8-K.

In the press release and supplemental disclosure package, Lexington has reconciled all historical non-GAAP financial measures to the most directly comparable GAAP measure, in accordance with Reg G requirements. If you did not receive a copy, these documents are available on Lexington's website at www.lxp.com in the Investor Relations section. Additionally, we are hosting a live webcast of today's call, which you can access in the same section.

At this time, we would like to inform you that certain statements made during this conference call, which are not historical, may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although Lexington believes expectations reflected in any forward-looking statements are based on reasonable assumptions, Lexington can give no assurance that its expectations will be attained.

Factors and risks that could cause actual results to differ materially from those expressed or implied by forward-looking statements are detailed in today's press release and from time to time in Lexington's filings with the SEC. Lexington does not undertake a duty to update any forward-looking statements.

Joining me today from management are Will Eglin, Chief Executive Officer; Robert Roskind, Chairman; Rick Rouse, Chief Investment Officer; Patrick Carroll, Chief Financial Officer; and other members of management.

Thanks, and welcome, everyone. Thank you for joining the call today. I'd like to begin by discussing our operating results and accomplishments for the third quarter.

For the quarter, our Company funds from operations were $0.23 per share and the quarter was characterized first by continued strong leasing activity of 1.2 million square feet of new and renewal leases signed, leading to an overall portfolio occupancy rate of 95.6% at quarter-end.

Second, progress on the investment front, with one purchase of approximately $6.1 million; three previously announced projects now being funded for $44.1 million; and three new build-to-suit projects under contract for $72.6 million, for a total committed pipeline of $116.7 million.

Third, further success on the capital recycling front with $15.6 million of property sales closed, bringing our total for the year to $145 million at a 6.8% cap rate. And fourth, an additional $15.8 million deleveraging of the balance sheet.

Based on our accomplishments this year, we announced an increase of 8.7% in our quarterly common dividend.

Our portfolio occupancy at quarter-end was approximately 95.6%, as our leasing efforts continued to be steady in the quarter, with 11 new and renewal leases executed for 1.2 million square feet. During the quarter when we had one 81,000 square foot industrial lease expire that was not renewed by the prior tenant.

Of particular note was the new full-building lease in Cary, North Carolina where we had previously forecasted a vacancy.

As of September 30, 2011, we had 1.9 million square feet of space subject to leases that expire in the last quarter of 2011, or which are currently vacant. In 2012, we have 3.2 million square feet of leases expiring. Of this 5.1 million square feet, we expect new leases and lease extensions of approximately 2.7 million square feet.

With respect to specific vacancies, as previously disclosed, in our office portfolio, we expect a vacancy later this year in Farmington Hills, Michigan and vacancies next year in Clive, Iowa, and Southington, Connecticut. In addition, we are now expecting a vacancy in our office property in Suwanee, Georgia.

These four properties are encumbered by non-recourse mortgages totaling $45.6 million in balloon payments or $108 per square foot. And these properties currently generate recurring annual net operating income of $6.8 million, with annual debt service of $3.3 million.

Supplementing our leasing success was a very active quarter in investments in acquisitions. As stated previously, we closed on one sale leaseback totaling $6.1 million and we have six build-to-suit projects underway or under contract for $116.7 million, of which $20.9 million have been funded through September 30, 2011. These property investments have an initial yield of 9.1% and 10.1% on a GAAP basis.

We've continued to make very good progress on new originations. Our investment pipeline of good prospects now totals approximately $150 million and we believe these are very attractive opportunities for us since they are long-term net leases at an average going-in cap rate of about 9% which generally equate to 10% to 11% on a GAAP basis.

Our new acquisitions are being acquired at cap rates that are well in excess of the average cap rates, which we've been selling our properties, which is a strong positive for our cash flow. And the addition to our portfolio of long-term leases with escalating rents will further strengthen our cash flows and support our dividend growth objectives.

On the deleveraging front, we are pleased with the progress that we've made this year in reducing our debt by about $80 million. Going forward, we plan to address our capital needs for refinancing, debt reduction, and acquisitions by continuing our capital recycling program, focused on our multi-tenant and retail properties and we are working on refinancing our 2012 mortgage maturities in order to lower our financing costs.

Aside from asset sales, we expect other sources of liquidity going forward to include our capital position in Net Lease Strategic Asset Fund of $191.6 million, $50 million to $100 million of permanent mortgage proceeds, repayments in our loan portfolio of approximately $45 million, and retain cash flow.

During the last three years, we've sold 63 properties for $495 million at a blended 5.7% capitalization rate. We believe we have accomplished a significant upgrade to the portfolio, as reflected in our occupancy level and high tenant retention rate, and substantially improved our balance sheet as well.

However, the byproduct of these efforts has been non-cash impairment charges, arising from the fact that our sales efforts have been largely focused on the lower quartile of our portfolio. We believe we are well positioned to continue reducing our leverage as maturities arise, lower our financing costs, and add new long-term leases to the portfolio on an accretive basis.

Now, I'll turn the call over to Pat, who will take you through our results in greater detail.

Thanks, Will. During the quarter, Lexington had gross revenues of $84 million, comprised primarily of lease rents and tenant reimbursements. Under GAAP, we are required to recognize revenue on a straight-line basis over the non-canceled lease term, plus any periods covered by a bargain renewal option. In addition, the amortization of above and below-market leases are included directly in rental revenue.

In the quarter, GAAP rents were in excess of cash rents by approximately $700,000, including the effects of above and below-market leases. For the nine months ended September 30, cash rents were in excess of GAAP rents by $2 million. We have also included on page 39 in the supplement our estimates of both cash and GAAP rents for the remainder of 2011 through 2015 for leases in place at September 30, 2011.

In the third quarter of 2011, both tenant reimbursement revenue and property operating expenses increased due to higher occupancy than the comparable period in 2010. Reimbursement percentage remained constant at approximately 50% of costs.

In the third quarter 2011, we recorded $23.9 million in non-cash impairment charges on properties held and used in continuing operations. To determine this impairment, we looked at the carrying values of one property that's been target for sale, properties in which we have agreed the prices with third parties, properties which have a probability of being conveyed to lenders, all properties with lease percentages less than 70%, and properties although greater than 70% leased have less than one year remaining in their lease term.

This analysis resulted in the impairment charges comprised of the following. A $1.8 million charge on a retail property since we have received a cash offer that we are willing to accept.

Two, a $5.6 million charge in an office property due to a change in re-leasing assumptions. This property is in Suwanee, Georgia. We wrote this asset down with estimated fair value of $4.2 million and it is encumbered by an $11.1 million non-recourse mortgage.

Finally, we had a $16.6 million charge, of which $1.1 million of our partner share, on potential sale of two multi-tenanted properties. In this analysis though, we increased the probability of selling these properties and we lowered the holding period before the estimated sale date. In addition, we had non-cash impairment charges of $2.1 million and $200,000 on gains on sales of properties, relating to properties that were exposed. These are included in discontinued operations.

On page 36 of the supplement, we've disclosed selected income statement data for our consolidated, but non-wholly-owned properties, and our joint venture investments. We also have included non-cash interest charges recognized in the nine months ended September 30, 2011 on page 37 of the supplement.

Our general and administrative expenses were $500,000 lower in the third quarter 2011 compared to the second quarter of 2011 due to reduced personnel costs. Interest expense decreased $2.5 million due to the deleveraging of the balance sheet. This has resulted in an interest coverage of approximately 2.6 times, fixed charge coverage of approximately 1.8 time, and debt-to-EBITDA of approximately of 6 times.

Equity in earnings from joint ventures increased $3.6 million, primarily due to $2.5 million distribution we received from [Concord]. Of this $2.5 million, we've only included $600,000 in our FFO calculation.

Now, turning to our balance sheet, our balance sheet is strong and we've continued to increase our financial flexibility and capacity. We had $99.1 million of cash at quarter-end, including cash classified as restricted. Restricted cash balances relate to money primarily held with lenders as escrow deposits on mortgages.

At quarter-end, we had about $1.7 billion of consolidated debt outstanding, which had a weighted average interest rate of 5.8%, all of which is at fixed rates. The significant components of other assets and liabilities are included on page 37 of the supplement.

During the quarter ended September 30, 2011, we paid approximately $1.8 million in lease costs and $7.2 million in TI and capital improvements, including $4.7 million spent on the Transamerica Tower in Baltimore.

Starting on page 26 through page 30 of the supplement, we disclosed the details of all consolidated mortgages maturing through 2015. We've also added on page 38 of the supplement a summary of our credit statistics.

Now, I'd like to turn the call back over to Will.

Thanks, Pat. In summary, we've had success this year by maintaining high levels of occupancy, strengthening our balance sheet, reducing debt levels, selling non-core properties to good prices, and originating new investments that improved the quality of our portfolio.

We are hard at work, addressing areas of investor concern with respect to next year's lease expiration and debt maturities, and expect to make substantial progress prior to our next earnings call.

On the investment side, we are very pleased with our investment pipeline of accretive opportunities and we believe our pipeline matches well with our current sources of liquidity.

Our guidance for 2011 funds from operations is for a range of $0.91 to $0.93 per share, as we actually raised the low-end by $0.01 this morning. Our guidance reflects the comment that we've made on today's call and a diluted share count of roughly 180 million, which includes 16.2 million shares underlying our 6% convertible guaranteed notes.

Our recently announced quarterly dividend of $0.125 per share equals an annualized dividend of $0.50 per share and represents a payout ratio of roughly 54%, which is still conservative relative to our industry.

We believe we are positioned to provide our shareholders with an investment that has strong total return potential, based on, one, our dividend yield of 6.5%, as of last night's close; two, a conservative payout ratio of approximately 54% of funds from operation; three, continued execution of our capital recycling program and ongoing debt reduction; four, attractive external growth prospects, as evidenced by our activity this year and a good pipeline; and fifth, leasing success that has improved occupancy substantially.

And operator, I have no further comments at this time, so we are ready for you to conduct the question-and-answer portion of the call.

Thank you, sir. (Operator Instructions) We'll take our first question from Sheila McGrath with KBW.

Yes. Good morning. Will, I was wondering if you could update us on the anticipated timing and status of the Baltimore and Inland JV dispositions. And with those dispositions, what leverage level will that get you to?

Well, Sheila, right now, we're in the process of figuring out how to best monetize our Baltimore investment and maximize our value. We would expect to be able to have something pretty specific to report to you by the next time we report our earning.

With respect to Inland, the buy/sell date there is in February and so we're intending to exercise our rights into that agreement. Our capital position there is $191.6 million. So we do think that between those two events, we are in a position to create a substantial amount of liquidity for the Company next year, which we can use both to fund our pipeline and bring down our leverage.

Okay. And also, in terms of mark-to-market or roll-down of rents, you previously guided that this will continue throughout 2012. I was just wondering if you've seen any improvement in those estimates or should we still expect that to happen and then kind of be at market in 2013?

Yes, I think that just given the progress we've made on 2012, I think our mark-to-market there is probably in the $4 million neighborhood at this point. And with respect to 2013, our expectation right now is overall, we could be up a little bit. It will be lumpy as we take those leases, but we know that we have one lease in Palo Alto, California that's way below market, and that would help us to the extent our rents and other leases come down.

Okay. Thank you.

And we'll take our next question from John Guinee with Stifel Nicolaus.

Hi, a nice call, guys. Can you elaborate for Sheila and I a little bit more on the buy/sell? Is that something that Inland's got the money in the bank and they're going to write you a check someday in February, or is that the beginning of a long drawn-out process? And then, also, which line item on the income statement are affected by that transaction?

The Inland entity, that's our joint venture partner, has a $10 billion balance sheet of its own. So it certainly does have the ability to take us out of the investment if that's how it were to go. With respect to the line items on the balance sheet, it's on the P&L, John, it's equity in earnings of non-consolidated entities. On the balance sheet, it's investments in advance to the non-consolidated entities.

And what's the amount on the investments in advance?

On the balance sheet, our investment in the joint venture -- remember that that was a carryover cost basis. So it is approximately $80 million on our balance sheet and on the P&L, the equity in earnings for that joint venture was roughly $15 million for the nine months.

It was $15 million for nine, so $20 million annualized?

Approximately, yes.

Okay. And then, if I recall, this is essentially an equity -- a preferred equity position on the portfolio. Can Inland actually write a check out of their greater company or is this fully tied to asset sales? And if it's totally tied to the asset sales, are those assets in the market for sale right now?

No, I mean I think the Inland entity certainly has the financial resources to write the check. We are not in the market presently with the assets.

Okay. Just on a percentage basis, what's your degree of likelihood that come the end of February, you'll have $191.6 million more in your pocket?

Well, it wouldn't happen at the end of February, it would happen later in the year.

Because (multiple speakers) and then when do they actually have to make good?

Our expectation is that it's a June event, John.

Okay. Got you. I'm sorry. Okay, and then -- that's it. Thank you.

Okay. Thanks.

We'll take our next question from Geoff Dancey with Cutler Capital.

Thanks. A couple of questions for you. I was wondering, first, on the build-to-suit, how come you did this one in a JV, the larger build-to-suit?

The Long Island City property?

Yes.

Yes. There, the developer preferred that structure so that they have an opportunity to participate in the upside from the asset. So we offer a range of financial solutions to merchant builders in the build-to-suit area which include joint venture structures, mezzanine-financed construction loans, with takeouts by themselves. So there is a variety of ways that we can bring solutions to whatever their capital needs are. In that case, the builder chose a joint venture structure.

So how much of that do you own?

We'll have like $46 million of the investment out of around $54 million.

Right.

Okay. And I saw there was a maximum $4.4 million that you may have to loan, can you just give me more details on that, please?

If there is any cost overruns, we have the ability to make a loan into the joint venture.

Okay. And would the JV partner contribute their percentage of pro rata share? Or are you --?

No, in that case, it would be a straight loan at an interest rate of, I think, 15%.

That's correct.

Which would kick up to 24% if it stayed outstanding for a second year.

I see. Okay. Also, you extended a lease that was going to be expiring in 2018, I was just wondering why you guys extended that now, instead of waiting -- Carlson Restaurants.

Yes, it was the Carlson Restaurants lease and there, we had a tenant that wanted to lock in to a long-term lease extension rather than even though it was very far forward, we wanted to take advantage of the opportunity to keep them in place.

Okay. So the tenant came to you?

That's right.

All right. So these upcoming mortgage maturities that you have over the next few years, I see there is -- the same situation should be arising where you have a loan coming due and you have a lease expiring at about the same time. Do you see more issues down the road? How do you feel about the next --?

We said on today's call that we have four, where there is visibility right now, where the non-recourse loan amounts at the end are worth more than empty building value. Now, last year, around this time, I think we pointed out for you, at that point, two of them have worked out well, where we had Cary, North Carolina, for example, where we just got a full building lease in place. So actually, two of those potential foreclosures worked out well, where we had continued occupancy or a new occupancy at a rent that's fairly high debt yield. So the four that we referenced on the call are certainly the four that we see right now.

Okay. Now, if you could just remind me, those four, was that looking out just for 2012, or 2012 and '13, '14?

Well, it relates -- one is Farmington Hills, which is a lease expiration at the end of this year, but a maturity next year. And then, the -- no, some of the loans don't mature next year, but where they are coming off lease.

Okay.

Of the maturities, it's really Farmington Hills that's a '12 maturity, but I think the other ones are actually further forward.

That's correct.

Okay. That's what I was looking for. Okay. Thanks to you all.

We'll take our next question from Todd Stender with Wells Fargo Securities.

Hi, guys. Thanks. Can you go over some of the -- who the tenants are in the credit profile of the two acquisitions you made. The one in Columbus in the third quarter and then, the second one that you made subsequent to Q3?

Yes, the tenant on the second one is a company called Kitchen Collection and the sale leaseback was with a private company called MS Consultants.

Is the credit profile with Kitchen Collection better, I guess just because you got the lower initial lease yield rate versus, say, some of your other acquisitions?

Yes, we rated Kitchen Collection being a much larger company, we underwrote them as a BB equivalent.

Okay. And just entering the JV in Long Island City, that initial lease yield is 8.5%. Is that part of the reason you entered the JV, just didn't have the initial lease yield as, say, some of the other ones?

Well, the other thing there is that the company on the lease is an extremely high credit quality tenant and a Fortune 100 company where -- so we think one of the reasons why we ended up doing a joint venture there is we might be able to -- we would expect to be able to sell it at a much lower cap rate than the initial yield that we're going in at.

Okay. Thanks. Just the last one, can you discuss just your current lease negotiating leverage you have and maybe compare with, say, six, eight months ago?

It varies situation to situation, Todd, but I would say, it's about the same as it was six months ago. We haven't -- I haven't noticed any real change either way. We've had good visibility on who's staying next year for quite a while and we haven't seen any change to what we think the outcomes are.

Okay. Thanks, guys.

We'll take our next question from Anthony Paolone with JPMorgan.

Thanks. Good morning. One of the reasons you guys tend to go into a build-to-suit business here is because it seemed like a lot of capital was starting to get back out into the market and bid things up for some of the more regular way net lease deals. And so, just wondering over the last few months, you've seen the CMBS market become a bit more challenging just generally, the macro environments downshifted and just wondering if you've seen pricing change in just the more normal transaction environment or if that's become a bit more attractive of late?

I would say, for long-term net leases, we haven't seen any increase in cap rates over the last six months. So the auction market for things that are in the market to close now with cash flow continues to be very strong. And for long-term leases, there is still a pretty aggressive mortgage [battle], although not necessarily at high loan-to-value. We're in the market with some properties right now for sort of 50% leverage and five-year to seven-year financing sort of in the 4.25% to 4.5% range, in many cases. So the fact that there is still meaningful spread between cap rates and financing costs has, I think, supported pricing in the net lease area.

Okay. Thanks. That's all I had.

And we'll go next to Arthur Winston with Pilot Advisors.

Thank you. I can't begin to understand the small dividend increase, given your guidance for cash flow and the fact that the dividend used to be $1.40 or something like that historically. And I was wondering was it management had told the directors to do this, or the directors in their own genius wisdom decided on such a small dividend increase and it takes it so much little cash to increase it more based on the number of shares; I mean, another $0.04 or something doesn't amount to much. So what could -- I can't imagine what the explanation is?

Well, when we look at almost a 9% -- 9% dividend growth is probably quite a lot in the context of the REIT sector in general. You are right, that after the financial crisis, we cut our dividend way down and we've had an extremely low payout ratio. I think the selloff that we experienced in third quarter, which was probably mainly related to developments in Europe, reminded us at least in the eyes of some market participants that we're not finished deleveraging our balance sheet and bringing leverage down.

So, we thought it was a healthy increase, but one that allows us to continue to retain a lot of cash flow to drive our debt down and also use to reinvest in our portfolio to keep it full because we're still in an environment where we have to use retained cash flow to keep our portfolio full.

Two questions. The $3 million to $4 million increment would have been a big deal, that's my first question to this Company and which it hopefully wouldn't. And number two, [is that] the management or the board or everybody?

No, $3 million to $4 million a year isn't a big deal to the Company. Dividend decisions are made by the board with the input and recommendation of management. So my recommendation was to increase the dividend by $0.04 on an annual basis.

Give more than $0.04.

No, on an annual basis, we went from $0.46 to $0.50.

Okay. I'm finished.

(Operator Instructions) We're going next to a follow-up question from John Guinee with Stifel Nicolaus.

Hi, I just was walking through your very well-done supplemental. Congratulations, Pat. CEVA Logistics, TNT Logistics Holdings next year, it's not much in the way of rent. These guys are paying fairly low numbers, at least in South Carolina, but do you expect to keep them in South Carolina and Michigan?

We do.

Okay. Rent rolldown, rent rollup, in case they're listening there.

In case they're listening right now, we have no comment, but rents on a per square foot basis there are pretty low.

Got you.

All right, yes.

And we'll go next to a follow-up from Sheila McGrath with KBW.

Yes. Will, I was wondering if you could give us your thoughts -- kind of big-picture thoughts on the suburban office sector. Are you seeing stabilization there? And along the same lines, can you give us your thoughts, if any, on Blackstone making a big investment in suburban office?

From a leasing standpoint, it feels to us like markets have stabilized pretty much and to me, it's always a question and in our case, what's probability of tenant retention and where rents are going. So we sort of felt like in the last 12 months that we weren't really experiencing further deterioration in the market.

On the Blackstone transaction, I think it was one that works very well for Duke from a strategy standpoint and I think that the companies like us that have exposure to suburban office have benefited from the fact that a large and sophisticated investor has come in and obviously made a big investment in the space. And if you look at the math at portfolios, the buildings are of pretty good or is about 85% occupied, I think. And the yield was maybe 8.5% or 9% in current cap rate. I don't think there's much risk of occupancy eroding much in that portfolio and rents have probably bottomed out.

So if you look at that cap rate and add in some financing at 4.5%, I mean, the spread is compelling and the price per square foot is of great value relative to, at least in our mind, the great push from investors then to try to chase CBD office buildings in the top five markets and pay four or five times as much and have only a nominal spread between going-in yield and leverage. So I think it sort of supports investing in the asset class from a value standpoint and a current return on equity standpoint.

Okay. And Pat, one last question, on the forward equity commitment, can you remind us how that settled out and when that stops flowing through results?

We settled it already subsequent to quarter-end. We made a payment of roughly $4.024 million and we retired roughly 4 million common shares.

So, when you -- go ahead.

When we report fourth quarter earnings, you will see a slight P&L impact from October 1 to October 31, and then it will be gone.

Okay. And so the --

Our outstanding shares on our balance sheet will be 4 million less than you'd see at December 30.

Okay. Thank you.

Okay.

And we do have a follow-up question from Anthony Paolone with JPMorgan.

Yes. Thanks. I just wanted to touch on those three assets, I think next year that you said they won't be renewing. I think the one in Iowa, Georgia, and then Connecticut. You gave the loan balance on those and the NOI that you're currently receiving. I mean, I just -- is the takeaway there that if there's not another tenant lined up that these are likely to be kicked back and I didn't quite gather, and maybe they're somewhere in the supplemental, but are those mortgages tied to each other or are they all individual mortgages?

They are all individual mortgages and there is certainly a chance that if the lenders are willing to write down the amount of their loans or offer restructure terms that they could be worked out. But I guess the base case would be that we've essentially sold the buildings for $108 a foot. So, often what happens is you'll continue to work the asset, maybe you'll have some leasing success, which would allow you to go and essentially restructure the loans or what have you. So, I wouldn't say that it's over and there could be a better outcome. But, I think at a minimum, we should feel it as a sale at the loan balances.

Okay. Thanks.

And there are no further questions left in our queue. I'd like to give everybody a final opportunity today to ask a question. (Operator Instructions) Mr. Eglin, there are no further questions in the queue. We'll turn the call back over to you for any closing remarks.

Well, thanks, again, to all of you for joining us this morning. We continue to be very excited about our prospects for the balance of this year and beyond; and as always, we appreciate your participation and support.

If you would like to receive our quarterly supplemental package, please contact Gabriela Reyes, or you can find additional information on our Company, on our website at www.lxp.com. And in addition, as always, you may contact me or the other members of senior management with any questions. Thank you, again, and have a good day, everyone.

This does conclude today's conference. We appreciate your participation. You may disconnect at this time.