FINAL TRANSCRIPT FSP - Q1 2008 Franklin Street Properties Earnings Conference Call Event Date/Time: Apr. 30. 2008 / 9:30AM ET www.streetevents.com Contact Us
CORPORATE PARTICIPANTS Scott Carter Franklin Street Properties - General Counsel John Demeritt Franklin Street Properties - CFO George Carter Franklin Street Properties - CEO CONFERENCE CALL PARTICIPANTS Bill Ford Reinhart & Mahoney - Analyst Eric Anderson Hartford Financial Management - Analyst PRESENTATION Operator Good day, ladies and gentlemen, and welcome to the First Quarter 2008 Franklin Street Properties Earnings Conference Call. My name is Jasmine and I'll be the operator for today. At this time, all attendees are in a listen-only mode. We will conduct a question and answer session towards the end of this conference. (OPERATOR INSTRUCTIONS) I would now like to turn the presentation over to your host for today's call, Mr. Scott Carter, General Counsel. You may proceed. Scott Carter - Franklin Street Properties - General Counsel Good morning, everyone, and thank you for participating in this call. With me this morning are George Carter, our Chief Executive Officer, and John Demeritt, our Chief Financial Officer. Before I turn the call over to John, I must read the following statement. Please note that various remarks that we may make about future expectations, plans and prospects for the Company may constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in Item 1A, Risk Factors of our Annual Report on Form 10-K for the year ended December 31, 2007, which is on file with the SEC. In addition, these forward-looking statements represent the Company's expectations only as of today, April 30, 2008. While the Company may elect to update these forward-looking statements, it specifically disclaims any obligation to do so. Any forward-looking statement should not be relied upon as representing the Company's estimates or views as of any date subsequent to today. At times during this call, we may refer to funds from operations, or FFO. A reconciliation of FFO to GAAP net income is contained in yesterday's press release, which is available in the Investor Relations section of our website at www.franklinstreetproperties.com. Now I will turn the call over to John Demeritt. John? www.streetevents.com Contact Us 1
John Demeritt - Franklin Street Properties - CFO Thank you, Scott. Welcome to our earnings call. We're going to be talking with you about our first quarter 2008 results and I'll start with a short overview. Afterward, George Carter, our CEO, will further discuss the quarter and FSP. I'm going to brief and will be referring to the earnings release that went out last night. As we've said before, we view our performance over the longer term rather than on the quarter-to-quarter measurement because two key drivers of our business are transactional in nature. Those are investment banking and gains on the sale of real estate, or what we call GOS, both of which can be choppy. That said, for the first quarter of 2008, we had net income of $7.4 million, or EPS of about $0.10 per share. We measure performance of properties that we own and investment banking through our FFO measurement, which for the first quarter was $15.6 million, or $0.22 per share. We did not sell any properties during the first quarter and as a result, there is no gain on sale, or GOS, on our results for the first quarter. Each of these metrics were lower in the first quarter of 2008 compared to the first quarter of 2007. Our net income decreased $2.3 million and FFO decreased $3.9 million, comparing the first quarter of 2008 to 2007. The reason for the decreases in net income and FFO are primarily related to performance of our investment bank. We earn fees from this business based on the value of shares we sell in private placements. For the first quarter, we sold shares of these private placements of only $2.7 million compared to about $28.3 million in the first quarter of 2007. Income derived from the investment bank is essentially syndication and transaction fee revenues on our income statement plus the impact of direct expenses, which are commissions and related income taxes. For the first quarter, investment banking net income and FFO decreased $3.6 million to about $600,000 as compared to $4.2 million in the first quarter of 2007. George will be talking more about this as we believe broader external factors in the market have affected our sales. This is essentially the decrease in FFO. The decrease in net income is somewhat less primarily as a result of the exclusion of equity interests we have in preferred stock and depreciation, which are non-cash items, the addition of cash received from the preferred stock investments that we hold, and some other less significant items. That covers our financial performance. The press release and 10-Q filing go into further detail about our results and the 10-Q has been filed. I also wanted to point out that the press release has our supplemental schedules, including information about the single asset REITs that we own and manage. There's also a current owned real estate portfolio there if you're interested. That concludes the financial highlights and at this point, our CEO, George Carter, will tell you more about the quarter and where we are. Thanks for listening. George? Thanks, John. Good morning, everyone, and thank you for taking the time to listen to our first quarter 2008 earnings call. My comments this morning, as usual, will follow my written comments and our earnings press release, released yesterday. As John has said, total profits in the first quarter 2008 were down. There were no gains on property sales, or GOS, because there were no properties offered for sale. I think, generally speaking, this is not a particularly good time to sell properties if you don't have to and we don't have to so we have no properties listed, although we do get inquiries on properties from time to time and at the right price with the right qualified buyer, we do follow up on those. We have some activity in that area going on. www.streetevents.com Contact Us 2
Investment banking business totaled only about $2.7 million for the quarter versus a more historical level of $20 million to $40 million for the quarter and we actually lost money for the quarter on our investment banking business. Broadly speaking, most investment firms, investment banking business in the first quarter of '08 was tough, and certainly ours was no exception. So these two transactional businesses, property sales and real estate investment banking, continued to be affected by the turmoil in the credit and real estate markets. These two important businesses of FSP really came under pressure starting in the third quarter of 2007. So far, we have operated through three quarters of this credit crunch environment and it's very negative effect on these two transactional businesses. On the property and rental income side of life, the news was much better for the first quarter with our on-leverage portfolio of properties maintaining about 93% occupancy and providing steadily rising income. A quick look at the income statement in the press release shows this contrast between the rental revenue on our portfolio and our transactional businesses. However, even in the area of rental income, one of our most significant properties located in the Chicago central business district contributed nothing to the quarter's profit picture because of our ownership structure of that investment. FSP owns the Chicago property via a preferred stock purchase of approximately $83 million made at year end 2007. This stock purchase by FSP was part of an all equity capitalization of this property carried out by our investment banking group syndication of the property as a private placement REIT. This was effectively one of FSP's largest property purchases ever. The property is a 28-story, approximately 860,000-foot, multi-tenant office tower actually located at 303 Wacker Drive. It's the CBD of Chicago. The original syndication offering was approximately $221 million and this property is owned without debt. It is well occupied and produced substantial rental income for the first quarter of '08. It's just that our ownership of stock requires the dividend to be paid for first quarter operations in the second quarter and so we don't recognize that income until that dividend is paid in the second quarter, but understand that that property did produce substantial income and this initial quarter delay obviously gets made up on the backside when the property is ultimately disposed of as we would get that extra quarter on the back after the property is sold. This is fairly significant for FSP and in terms of capital allocation to properties in the portfolio, this is almost like, for the quarter, our vacancy going from about a 7% vacancy rate to a 14% vacancy rate. Again, if you look at the income statement, particularly the rental revenue and picture this very large property not a part of that and add what was earned back in, you can see that we really are making progress on our rental revenue on our rental FFO. As previously mentioned on our last earnings call, FSP will now consider using moderate property secured leverage to take advantage of possible property acquisition opportunities that may become available in this market and so build a larger portfolio in the process and endeavor to achieve, from a mini-investment objective, an immediate rent-to-debt constant accretive spread and thus increase the portfolio's rental FFO. In the first quarter of '08, there were no acquisitions consummated of new property under this format but, as announced, FSP did make an offer to purchase effectively one of its properties, one of its sponsored properties, FSP Park Ten Development. This was a spec office building that was built by Franklin Street and is in Houston. It is built on time, on budget, leased up very nicely, and we made an offer to acquire that property for $35.4 million. We anticipate that deal to close on or about May 15th so the accretive impact of that FFO, and it is accretive to the Company, will only show about a half a quarter for the second quarter but first full quarter will be quarter three of this year. We continue to be very, very active in working on the execution of this new leverage property acquisition plan. Our efforts in this area are broad based and include outside properties, as well as our sponsored REITs, and many properties that we are www.streetevents.com Contact Us 3
working on now have already associated with them some attractive existing leverage combined with potential leverage off of our existing portfolio. We continue to be very optimistic about our future potential here. But it is a process and we will continue to be patient looking at these acquisition opportunities out there and we'll be patient in taking advantage of them. We're not going to just use up our borrowing power just to grow the portfolio. It has to be the right property at the right price and we are in full cry on that effort. Before closing the presentation part of this earnings call, I would like to again highlight to shareholders that FSP is a somewhat different kind of real estate investment firm in that we do have large transactional components of our profit stream that can be very erratic in the profit contribution and can be quickly affected, positively or negatively, by broader financial market activity and that we have not, to date, grown our company's real estate portfolio by the use of permanent property secured mortgage debt, but instead have realized individual property gains and value through sales of those properties using 1031 exchange mechanisms to reinvest the bulk of those sale proceeds and profit gains into new properties rather than use debt financing against their value increases as a way to purchase additional property, thus achieving gain on sale, or GOS, profits rather than financing spread FFO between rental and debt constants. Again, this is something now that we are moving into in this economic environment. And we have a meaningful investment banking component of our profit stream that historically has not only provided banking profits but also a significant pool of sponsored real estate assets that had historically provided the Company with potentially attractive acquisition opportunities and the most recent FSP Park Ten Development transaction is the most recent example of this. I think an important perspective about FSP that directly relates to its profit make up in the current economic environment is that while profits from our transactional businesses are currently being negatively affected, unlike many investment companies, investment banks, ore real estate companies with significant leverage associated with their real estate portfolios, FSP does not have to borrow money or refinance mortgages or loans to keep its property portfolio intact. Instead, we now have significant borrowing power for the right property acquisition opportunity that may become available. And FSP does not have to sell any of its real estate assets in a poor market environment to relieve or repay short-term or maturing debt or just to reduce leverage for better coverage ratios. And FSP does not have to issue any new equity in a low stock price environment to reduce debt or pay off short-term or maturing debt thereby significantly diluting shareholders. I guess my point about perspective is that while FSP has a significant current profit drop in its transactional business that is directly influenced by the current financial market conditions, it is just that and only that, a profit drop. Our real estate assets, as well as those transactional businesses, are intact and not in any more significant risk now than before the current credit crisis. Our properties and our transactional businesses maintain all of their potential growth possibilities and I believe they are extremely well positioned to resume delivering that growth in time relative to the current economic and financial cycle. And relative to time and cautiously optimistic that at least in our investment banking business the last three quarters, that would be the third and fourth of '07 and the first in '08, may have been the low for us in this business in this cycle. And the reason I think this is really twofold, first, in talking to some of our long established investors, which are mostly high net worth individuals, and the institutions that help manage their money, it's become clear that recent efforts by the Federal Reserve and the Treasury to put confidence back into the U.S. financial system has really made a difference in our investors' minds about the certainty about that financial system and the ability to invest through it and looking more at the economy and where to position money positively or negatively with your opinions on the economy on properties or locations. www.streetevents.com Contact Us 4
It is clear that there was a high degree of concern and uncertainty about the integrity of the financial system and that that concern has been somewhat alleviated. And I think our experience here in this area is not much different than the rest of the financial industry or investment banking firms around the country. There definitely has been a shift in this area to the positive. And the second reason I say this is what we're seeing on the ground and that is we're seeing a significant increase in our investment banking business so far in the second quarter. As far as a future property sales go and a vibrant market reestablishing itself for that business, I do not have any visibility or feeling about that yet. Real and significant increases in liquidity relative to commercial property mortgage lending from all sources, including the CMBS market or a similar like-type financing mechanism would be key to this recovery. And at this point in the credit crisis, it's hard to see that on the horizon. But sooner or later, all the new equity capital flowing into the various financial institutions to replenish the balance sheets that have been devastated by the massive write downs will demand a return. So lenders will have to get back to business again and lend. I believe FSP will have some very attractive properties that we may consider for sale when that environment reestablishes itself. In the meantime, FSP's geographically-diversified property portfolio is in sound shape with many of our properties in locations around the country that seem to be faring relatively well because of their particular macroeconomic drivers, such as energy, food, and international trade. I continue to be very optimistic about FSP's position in the market and profit future. And with that, operator, we'd be happy to open it up for questions. QUESTIONS AND ANSWERS Operator (OPERATOR INSTRUCTIONS) And your first question comes from Bill Ford. You may proceed. Bill Ford - Reinhart & Mahoney - Analyst Hey, guys. I was wondering, John, could you give us an idea of the quarterly dividend dollars from Wacker Drive or what that would be, what the dividend's supposed to be or the declared dividend is on that investment? John Demeritt - Franklin Street Properties - CFO It would be about $1.3 million for the quarter and so many things continue with the property will be pretty much that each quarter going forward. Bill Ford - Reinhart & Mahoney - Analyst Okay. And then the only other thing was, George, can you comment a little bit on sequentially how things have changed since the last quarterly call or the last time we spoke in terms of acquisition opportunities for properties you would want to buy to bring into the portfolio and especially sort of how cap rates on A properties move given the commercial mortgage market seize up and other things that might create opportunity for you guys to use your balance sheet? www.streetevents.com Contact Us 5
Yes. Hi, Bill. We definitely, since the last quarter, have seen cap rates move up a bit on quality core properties, which is really the group of properties that we're looking at. But they haven't moved up yet as much as you would think. I think there are owners of properties that are getting very, very pressed and clearly are selling properties because they have to and we're all over those situations. But it is also clear that a large part of the fundamental basis for the commercial office market, which is what we're really dealing with, is in pretty good shape and occupancies still are pretty good and a lot of owners are not that hard pressed. So to think that there are massive moves in cap rates and massive opportunities out there just hasn't yet shown themselves to be that and that's a good news/bad news scenario for people that own, people that want to buy. It cuts both ways. And I would tell you too, Bill, that there does seem to be money out there that wants to flow back into real estate. The problem, far bigger, is financing. And while we've got a great balance sheet and have great borrowing power, rates and terms on loans and actually getting loans, getting money into the system on a mortgage basis is still pretty tough. Some of the best opportunities that we're seeing come from companies or owners that really, really need to sell some property to reduce debt. They aren't fire sales but they have to sell to reduce some debt. These properties had existing very attractive debt on them that can be assumed and so you might be able to assume 50% or 60% existing debt on those properties at a very attractive rate and then go ahead and borrow effectively the balance off of our balance sheet. And the blending of those two, I think, will offer us some excellent opportunity but again, we're not seeing any wholesale move in cap rates on the quality properties, that's for sure. Bill Ford - Reinhart & Mahoney - Analyst Okay. But would you say the trend is becoming more or less favorable from three months ago on the last call? Absolutely. It's definitely becoming more favorable but I would say this. That if you asked me to look into the future, where will the biggest spread widen from? Will it widen from the cap rate side or the debt side, my guess it'll be from the debt side. Bill Ford - Reinhart & Mahoney - Analyst Sure. Okay. Thanks, guys. John Demeritt - Franklin Street Properties - CFO Okay, Bill. Operator (OPERATOR INSTRUCTIONS) And your next question comes Eric Anderson. You may proceed. www.streetevents.com Contact Us 6
Good morning. George and John, I wanted to compliment you on sort of the subsequent quarterly release of additional information. The reports are getting a lot more detailed and that's a good thing. First question is that with the syndication market, you talked about being soft but getting a little bit better. Does that kind of imply that you may be more inclined to buy a building for FSP's own portfolio versus sort of the traditional way you have been doing it, that is sort of standalone properties for the brokerage side in this kind of market? Eric, this is George. Well we are -- again, one of the big changes that we really announced last quarter was the fact that we are actively trying to buy directly for the FSP portfolio now using our balance sheet for the first time to help in that regard, i.e. property-secured debt in that regard. This property in Houston, FSP Park Ten Development, is the first of those. So we would anticipate buying directly into the portfolio a lot more property over the coming months and years, again, depending upon, as Bill Ford just talked about, what kind of spreads and what kind of opportunities are available out there. From the syndication point of view, again, a lot of our syndication properties have a real value-add component to it. Not all, but most of them have a very value-add component to it. Example would be this Park Ten Development, which was a spec office building. We built it spec and didn't generate any cash flow for two years. And when it got leased up, then it becomes more of a core holding, long-term lease to a credit tenant and attractive for FSP. But the investment banking business, the syndication business, has really, for three quarters, almost been virtually shut down simply because our group of investors, who've been with us for a long time and actually in a previous life before FSP is where many of them started, they have just been so uncertain about really the financial system and operating within it, that they just had sort of shut down any investment, particular as it regards real estate and the liquid real estate, which is what these single-asset syndications are. But that has opened up now and it's been dramatic. You've seen it in the stock market, you've seen it in investment banking offerings with other investment banking firms. There clearly is a see change out there. Now we all hope it holds on. Assuming that this business continues now, trending up the way it's clearly doing, you will see us also do a lot more acquisition for syndication and we have properties in our sights right now for further syndication in the investment banking business, as well as properties to buy directly into the portfolio. Okay. So it's not that one will take priority over the other. No, not at all. Okay. Just a quick follow-up question in regards to some of the REITs disclosure, supplemental information that you're making. I want to make sure I'm reading this correctly that you have a total of nine standalone REITs and in three of them, you have an investment. Is that the correct way to read this? www.streetevents.com Contact Us 7
John Demeritt - Franklin Street Properties - CFO No, actually, Eric, it's John and thanks for the compliment on the earnings release, by the way, from the beginning of the call. We actually have 12 single-asset REITs that we have syndicated that sit outside of the Company. We have investments in three and then there are nine others that we don't have investments in. Now is that just because at the time you weren't buying in part of the deals or is that just sometimes you would make an investment, other times you would not? Or is there a change in strategy then or -- Yes, it really depends on the specific transaction and whether or not -- again, we have been, until very recently, an all-cash REIT and if cash was available for investment and that investment that we were syndicating was appropriate for the Company, i.e. a core type of property that was producing high cash flows, we do invest in those properties. And we may, in the future, invest in our single-asset REITs. But again, a lot of the properties in the single-asset REITs are in some stage of value-added play and are not necessarily where FSP, the parent corp, would put its money. It's just a different risk/reward parameter in the single assets. For example, the Phoenix Tower, that looks like a big tentative left in terms of the 63% leased status. Yes, that's exactly the type of deal where we have a property that we bought, knowing that in virtually a year and a half to two years after we purchased it there was going to be a big hole in that property. You get it for the right price, knowing that, and that property also has a huge physical value-added play we're doing to the actual physical asset. But yes, and when and if that space gets leased up and that building re-stabilized, then that property becomes a valuable candidate for sale in the open marketplace and obviously FSP can and may participate in any of that marketplace activity on that property. So again, that's a property, and there are other properties where you'll see maybe high cash flow for a year or two and then it'll drop off because of an early termed lease. Again, we knew that when we purchased the property. You purchase it at a price that reflects that and you try to add that value through that release. All right. Thanks for the details. Operator You have no questions at this time. I would like to turn the call back to Mr. George Carter. www.streetevents.com Contact Us 8
Thank you, everyone, for listening and participating in our earnings call. I hope to see some of you in New York for the week of June 4, 5, and 6 for REIT Week. Have a great day. Operator Thank you for attending today's conference. This concludes your presentation. You may now disconnect. Good day. DISCLAIMER Thomson Financial reserves the right to make changes to documents, content, or other information on this web site without obligation to notify any person of such changes. In the conference calls upon which Event Transcripts are based, companies may make projections or other forward-looking statements regarding a variety of items. Such forward-looking statements are based upon current expectations and involve risks and uncertainties. Actual results may differ materially from those stated in any forward-looking statement based on a number of important factors and risks, which are more specifically identified in the companies' most recent SEC filings. Although the companies may indicate and believe that the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could prove inaccurate or incorrect and, therefore, there can be no assurance that the results contemplated in the forward-looking statements will be realized. THE INFORMATION CONTAINED IN EVENT TRANSCRIPTS IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES THOMSON FINANCIAL OR THE APPLICABLE COMPANY ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY EVENT TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. 2008, Thomson Financial. All Rights Reserved. 1830126-2008-05-01T15:09:21.127 www.streetevents.com Contact Us 9