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Q3 2008 Earnings Call Transcript

Published: 7 Nov 2008

Operator:

Hello and welcome to the Cogdell Spencer, Inc. third quarter 2008 earnings conference call. (Operator Instructions). Now, I would like to turn the conference over Ms. Dana Crothers. You may begin.
Dana Crothers:

Thank you so much. Welcome to Cogdell Spencer’s third quarter 2008 conference call. The press release and supplemental disclosure package were distributed yesterday afternoon as well as furnished on form 8K to provide access to the widest possible audience. In the supplemental disclosure package, the company has reconciled all 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 the company’s web site at www.cogdellspencer.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 Cogdell Spencer believes the expectations reflected in any forward-looking statements are based on reasonable assumption, it 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 yesterday’s press release and from time to time, in the company’s filings with the SEC. The company does not undertake a duty to update any forward-looking statements. With that, we’d like to begin the call with Jim Cogdell, our Founder and Chairman of the Board, Jim.
Jim Cogdell:

Good morning. Welcome to our third quarter ’08 earnings call. Joining me in Charlotte this morning are Chuck Handy and Frank Spencer. Scott Ransom, President and CEP of Erdman is joining us this morning from the Erdman’s headquarter office in Madison, Wisconsin. After our update on the quarter, we will be available with questions you might have. First, I’d like to acknowledge what is on every investor’s mind
Chuck Handy:

Thanks, Jim and good morning, everyone. Let me begin by providing you with an update on our capital activity during the past few months. As Jim mentioned, in September, we completed an equity offering of just over 2 million shares at a price of $18.50 per share. We used the net proceeds of $38 million to reduce the outstanding balance on our revolving line of credit. On the debt side, $13.5 million of mortgagees maturing during the fourth quarter of 2008 have either been addressed through refinance or repayment from our revolving line of credit. Of the $48 million in mortgage debt that we have maturing in 2009, $30 million has extension options of two years. The remaining 2009 maturities are related to well-leased properties that currently have low loan devalue ratios. With respect to our recently announced medical office and outpatient center in Pensacola, Florida, we obtained financing of $16.8 million. Terms of this financing provide for a term of 10 years, which includes an 18 month construction period. Interest-only payments during the construction period are at the rate of LIBOR plus 1.5%. After the construction period, the loan converts to an amortizing loan with monthly payments, based on a 25 year amortization schedule. We’ve entered in to a forward-starting interest rate swap that effectively fixes the interest rate at 6.21% after the construction period through maturity. Now, let me review our performance for the third quarter. As noted in our earnings release, FFO modified or FFOM for the quarter was $8.2 million or $0.33 per share in unit. This represents a 10% increase over third quarter 2007 FFOM of $0.30 per share in unit. Net loss for the quarter was 1.1 million of $0.07 per share. Revenue for the third quarter totaled $94 million. Rental revenue for the quarter totaled 19.6 million, while revenue related to design build contracts totaled approximately 72.9 million. Fee revenue, including property management and leasing fees, as well as expense reimbursements totaled 1.5 million for the quarter. Selling, general and administrative expenses for the third quarter totaled $7.6 million, which included 2.7 million of corporate G&A. During the third quarter, we refinanced the mortgage for Rocky Mountain MOB, LLC, which is a consolidated joint venture with physician investors located in Rocky Mountain, North Carolina. This refinance transaction generated approximately 1.2 million in excess proceeds, which were distributed pro-rata to our joint venture partners and to our operating partnership. Because the distribution would have resulted in a negative minority interest on our consolidated balance sheet, we were required to record a non-recurring expense of $730,000 for the quarter related to the distribution to our joint venture partners. This charge is reflected in the minority interests and real estate partnerships line on our consolidated statements of operations for the quarter. Based on our closing stock price on September 30, our total enterprise value was $868 million, which included $424 million in debt outstanding for total leverage of 49%. Approximately 76% of our debt was at fixed rates as of September 30th and our average interest rate on real estate mortgages was approximately 6%. Our total debt had a weighted average remaining term of approximately three and a half years and we had $90 million outstanding on our $150 million revolving line of credit at quarter end. For the third quarter, our interest coverage was 2.8 times and our fixed charge coverage was 2.5 times. On October 20th, we paid a dividend for the third quarter of $0.35 per share to share holders of record on September 26th. At September 30th we had approximately 670 leases at our consolidate properties, with an overall occupancy of 91.9%. No single tenant accounted for more than 7.1 percent of annualized rental revenue. Recurring capital expenses or capital expenditures for the third quarter totaled $392,000 or approximately $0.12 per square foot across our consolidated portfolio. Tenant improvements related to second generation leases totaled $1.1 million or approximately $0.34 per square foot across our consolidated portfolio for the quarter. Planned capital expenditures associated with property acquisitions totaled $268,000 for the quarter. We are reiterating full year FFOM guidance in the range of $1.20 to $1.24 per fully diluted share and unit for 2008. As we have previously discussed, we believe FFOM to be an important supplemental measure of operating performance because it adds back to traditionally defined FFO, the non-cash amortization of non-real estate related intangible assets associated with the purchase accounting for the Erdman merger. Now, for a review of where we’ve been and where we’re headed for the remainder of 2008, I’d like to turn the call over to Frank Spencer, our President and CEO, Frank.
Frank Spencer:

Thanks, Chuck. Good morning, everyone. As we are all aware, the country is facing economic uncertainty, but we have taken several steps to position ourselves and our balance sheet in the face of these volatile market circumstances. First, on the Wednesday between the Freddie and Fannie bailout weekend and ahead of the Lehman Bankruptcy and subsequent credit market dislocation, our equity raise lowered our leverage to total enterprise value and gave us almost 50 million in dry powder. Second, during the quarter we announced the formation of a $350 million joint venture with Northwestern Mutual for the purpose of making cash acquisitions. The JV called Cogdell Spence Medical Partners, LLC, allows for discipline and decision making from both partners because our partner is a balance sheet investor rather than a fund. There is no required investment timing as is often found in funds and thus, we jointly make decisions on a deal by deal basis. While Cogdell Spencer Medical Partners, LLC has not announced any deals since its inception, we have examined and underwritten several portfolios, which ultimately, we did not pursue. Two were substantial marketed deals where our existing relationships had us in the top three, but our discipline prevented us from coming out as the top bidder. True to our underwriting standards, we will only deploy shareholder capital when and where it will yield a substantial positive return. Our projected growth through 2009 and 2010, however, is not based on acquisitions, rather on capital deployment through development. Since the merger in March, we have signed new development agreements in five of our six regions, all of which should come online during 2010. While the uncertainty in the market may cause some customers to delay projects, it may also make our capital that much more attractive to organizations that are fundamentally healthy, but are looking to preserve their own cash. In fact, we are seeing opportunities to partner with smaller regional developers who have put a deal together, but now find themselves with a capital shortfall. Two such negotiations are under way right now and we believe this approach will provide attractive returns as well as opening new markets for us. We are, however, seeing some elements of weakness in the market. Even as our signed pipeline is at an all-time high, there is potential client pull-back and delay based on their own capital funding needs. Scott Ransom will give additional detail on our Erdman operations in this respect. I would like to note that while we expect some market slow-down, we remain very bullish on long-term demographic trends for healthcare. We are cautiously optimistic as we look ahead to 2009 and will continue to constantly monitor our backlog. We believe we will see FFOM per share grow in 2009, albeit at a slower pace than we would have predicted four months ago. As Chuck mentioned, our occupancy has slipped to just below 92% as we had a few larger suites vacated upon lease expiration. However, the majority of recently vacated space in Augusta is scheduled to be occupied next month through the relocation of a smaller tenant taking a significant space expansion. We also increased occupancy in three key markets during the third quarter. While our Mallard property in Charlotte, a lease was delayed, we anticipate an upfit start on that space shortly. Historically, our occupancy rates range from low to mid-90s, a stable and predictable trend that denotes our loyal tenant base and desirable on-campus and ambulatory locations. Our expectation is for occupancy to improve in the fourth quarter and again in 2009. We believe this is the silver lining to the financial storm clouds as tenants are renewing rather than considering the expense of a move. At this time, I’d like to turn things over to Scott Ransom, President and CEO of Erdman, to further discuss the design build portfolio and other aspects of the Erdman business.
Scott Ransom:

Thanks Frank, and good morning. The third quarter was one of the most profitable quarters in Erdman’s history. Our 2008 third quarter operating income was approximately 25% higher than the third quarter of 2007. We have been able to maintain projected profit margins on our design build work in light of significant fluctuations in both material costs and uncertainties in the marketplace. We are pleased during these times to maintain a 2008 projected profit forecast in line with the pre-merger forecast to support the 2008 FFO guidance that Frank previously mentioned. During the third quarter, the company announced the first capital development project since the merger, with a $22.4 million medical office building and outpatient center in Pensacola, Florida. This project is scheduled for completion in December of 2009. The project was a result of the leverage of the combined experiences of both Cogdell Spencer and Erdman. For those are interested, a rendering of this project is available on the supplemental document for today’s call. As Frank mentioned, we have signed several new development deals since the merger and we have other new opportunities we are expecting to sign in the next quarter. We at Erdman continue to experience strong market acceptance of the combined company’s value proposition as we take it to the market. And this includes bringing integrated solutions from advanced planning, design build, capital partnering, along with acquisitions, property, and portfolio management. We have increased our signed pipeline, as Frank mentioned, almost three times our annual revenues. And we have also doubled the amount of top target proposals year-to-date over 2007 and have increased our win rate significantly. We are, however, seeing delays in project decisions and capital spending due to current economic conditions. Although we are seeing delays in pipeline conversion due to these economic conditions, executive leadership has developed contingency plans to aggressively manage all costs and actively monitor pipeline conversion to insure Erdman achieves expected profit levels. After the New York Stock Exchange closing bell ceremony on July 28th, Erdman launched a national advertising campaign introducing our fully integrated service offerings under the new branding of Erdman, a Cogdell Spencer company. At Erdman we are both energized and excited with the response we’ve seen to the changes that the integration has brought about both internally and externally and I really look forward to answering any questions you may have at the end of this call. With that, I’ll turn it over to you Frank.
Frank Spencer:

Thanks Scott. Well, I think it is fair to say that the merger and integrated offerings have been very well received. It’s been personally gratifying to me and a lot of fun as well to be out with clients and doing proposals for a whole range of markets and institutions that I hadn’t been able to be in front of before and working with various aspects of the Erdman business development organization. We think the flexibility of our service offerings allows us to tailor solutions for our clients’ real estate needs across the entire spectrum and we look forward to continuing to grow our business in the years ahead. With that, we’ll take any questions that you may have.
Operator:

Thank you. (Operator Instructions) Our first question will come from Rich Anderson from BMO Capital Markets. Please go ahead.
Richard C. Anderson:

Hi, good morning everybody.
Frank Spencer:

Morning Rich.
Richard C. Anderson:

Just a few questions, first of all a maintenance one, the 730,000 of non-recurring expense in minority interest, was that included in previous guidance?
Frank Spencer:

No, it wasn’t Rich. It was not in our previous guidance. We had no specifically allowed for that and it was, as I stated, sort of an anomaly that resulted from required GAAP accounting.
Richard C. Anderson:

Alright, so in a sense, you actually raised your annual guidance net of this charge. Is that a fair way to look at it? To reiterate your guidance, you have a charge in the third quartet that you didn’t have in guidance, so didn’t guidance sort of trickle up?
Frank Spencer:

I think we would characterize it slightly differently, which is that we’re pleased that we had as good a quarter as we did in light of the fact that we took a charge during it. But the guidance of course is the same. You can parse it however you want.
Richard C. Anderson:

Okay, thank you. I will.
Frank Spencer:

I have no doubt.
Richard C. Anderson:

The joint venture was announced on August 21st and then you had your First Synergy deal on September 2nd when it was announced. Now, that is a joint venture itself with the doctors and I’m curious. You say the joint venture is the exclusive investment vehicle with some exception. How do you handle future business when you do have, very often time, doctors wanting to be aligned with you in certain investments and now they sort of can’t because you have this joint venture that you’re committed to.
Jim Cogdell:

We addressed that very specifically in structuring the joint venture. Northwestern recognizes that a part of our strategy is to partner with physicians and so transactions that include physician investment are excluded from this joint venture’s exclusivity clause.
Richard C. Anderson:

Okay, that makes sense. You talked about some potential slowdown in 2009 from the business plan as some potential clients pull back in this environment. Is there any chance that you’ll have a slowdown in this Pensacola situation?
Scott Ransom:

We’re not anticipating any. We’ve already closed the construction loan. It’s preleased and we’re moving forward full bore, and this is also part of the reason we partner with physicians, the tenants themselves are the joint venture equity partners. So all of that, the funding is in place and there should be no reason that’ll slow down.
Richard C. Anderson:

Okay, but do they have the right to if they want to put a stop to things?
Scott Ransom:

No.
Richard C. Anderson:

Okay, last question, I know you guys are always protecting and defending your dividend, but there’s a lot of groups out there now that are taking this opportunity to conserve capital and reduce the dividend. I was just wondering now with your dividend yield probably 12 plus percent, have you given any further consideration to cutting the dividend to conserve capital?
Frank Spencer:

In terms of the dividend, the board’s policy remains as it has been. There’s been no change in that. What I would say is that the board, every time it meets and on an ongoing interim basis, always looks at where we are in the external environment. This is a fast changing environment and the board will continue to make the decision that it thinks is in the best interest of the shareholders. But as of right now, we’ve made no change in our policy.
Richard C. Anderson:

Okay great, thank you very much.
Operator:

Our next question will come from Karin Ford from KeyBanc Capital Markets. Please go ahead.
Karin A. Ford:

Hi, good morning. You mentioned you had the $50 million of dry powder today. Does that amount of dry powder cover the five to six opportunities that you see in the pipeline today and how comfortable are you pushing that dry powder to the edge there?
Frank Spencer:

Well, you always want to be farther away from the edge rather than closer to the edge. Do we have funding for the deals that are in the pipeline? The answer is yes. A couple of them have significant joint venture money from the underlying clients and so it’s not exclusively a Cogdell Spencer equity requirement, which is obviously part of our business strategy. We’re in a situation I think that everyone is in which is we are very conscious of maintaining our liquidity. We’re being very careful about the capital commitments we make. And we will continue to monitor those situations. We don’t want to get up to the edge. We think we’ve got capacity, but it’s clearly something that is literally a week-by-week monitoring process of how we both commit capital and plan for the balance sheet.
Karin A. Ford:

That’s helpful. Is there any ability for Northwestern Mutual? Are there any means by which they could terminate their ability to contribute capital to the joint venture?
Frank Spencer:

There is not an out, if you will, in the joint venture, but I think we are very much aligned in our current view of the world, which is we only want to use capital for acquisitions if we find opportunities that we think create an outstanding return. And Northwestern is clearly in the same position that we are. They only want to deploy capital on an outstanding basis at this point. And so I think both of us would say between now and year-end, if that means no dollars go out in cash acquisitions, that’s okay if we don’t find the right opportunities.
Karin A. Ford:

Okay, and speaking of pricing on acquisitions, can you just talk about the cap rates that those two portfolios that you guys passed on priced at today.
Frank Spencer:

Well, one of them was pre-dislocation and it’s probably going to go low sevens if it closes. We’re out of the loop now, so I don’t know where that stands. The other one was being looked at really as the crisis was raging in late September, early October and we wouldn’t go past a certain point. And I don’t know where that’s going to end up. It would be pure speculation on my part. I guess what I’d really say Karin, on cap rates is that we haven’t found a deal we want to put money on in the last 90 days. And so I don’t know what a current cap rate would be. I can tell you that we are being much, much more selective in how we would look at putting out capital for acquisitions. We are really focusing on finding the right kind of development opportunities, which we think have a much better long-term shareholder return.
Karin A. Ford:

That’s helpful. Are the yields different on the two projects where you’re looking to provide capital to another local developer?
Jim Cogdell:

I wouldn’t say they are dramatically different, but I would say they are attractive. Our expectations there is that we’ll be looking at double digit cash-on-cash yields to provide that equity.
Karin A. Ford:

Great, last question is for Scott. Can you just remind us what Marshall Erdman’s profitability and revenue stream was in previous cycles?
Scott Ransom:

What its profitability and revenue stream was?
Karin A. Ford:

Yes, did you see revenues decline? Did revenues continue to grow even through past economic downturns over your long history?
Scott Ransom:

Yes, it’s been kind of a long 57 year steady growth. There’d be periods where we would kind of flatten out or go up or down maybe 10% or sometimes up a little bit higher than that, but we haven’t seen a significant downturn. We tend to see delays. The last one, I would say, of any kind of significance was right around when Clinton’s first election, there was a couple year kind of slowdown there. What we’re seeing right now, and I mentioned it on the call, we’re seeing, again, continued growth and profitability over last year. We’re looking at 2009 because we do have as healthy of a pipeline and that’s signed under development and design agreements. The pace at which those convert to design build contracts is what we’re monitoring closely. So we’ve never seen big, sharp drop-offs in our both revenues and profitability, at least as I’ve experienced in the history in the company. So we’re pretty positive we’re going to kind of weather this storm based on the current economic situation.
Karin A. Ford:

Thanks, that’s helpful.
Operator:

Our next question will come from Michael Bilerman from Citi. Please go ahead.
David Cody:

Good morning, it’s David Cody here with Michael.
Jim Cogdell:

Couple of questions for you, and I know you guys often don’t provide details, but can you just provide some color on the change in margins this quarter relative to the design build portion of the business?
Scott Ransom:

Chuck, do you want me to take that?
Chuck Handy:

Sure, that’s fine Scott.
Scott Ransom:

Yes, I mean we saw a spike in the third quarter. We kind of look at this typically on an annual basis because we can kind of project our pipeline and we’re monitoring it project-by-project. We re-forecast the margins every month. We are historically conservative as we close out projects. And in the third quarter, we did have over $100 million of projects that we actually closed out on our books. And we tend to release contingencies in the very later part of the projects just to be conservative to insure that we bought out and executed the project as planned.
David Cody:

So it’s typically a spike at the end of the booking period.
Scott Ransom:

Yes, and the booking periods can depend just on what stage your pipeline’s at and certain quarters into the year you could be closing more than you may middle of the year.
David Cody:

Are you guys finding that your contingencies are shrinking at this point in the cycle?
Scott Ransom:

We’ve been, in some respects, because of clients are expecting that, there’s more variability built into, and actually more contingencies because of the fluctuations and the uncertainties in pricing of material costs. So actually you’re building in more contingencies than you have historically and you’re sharing those with the clients because you have had. For example, oil prices and petroleum cost, which impact a lot of materials, going up 50% and dropping 50%, in the same cycle. The same thing has happened to steel cost where they spiked almost 60 to 70% in the first seven months of the year then they contracted back. So we’re not seeing a decline in contingencies. We’re building into jobs. And I think one benefit we have over our competitors is that we just focused on healthcare and design build of healthcare. So we’ve pretty much integrated all aspects of the cost.
David Cody:

Okay, great and then moving over to the Pensacola project, can you provide any detail in terms of the kind of rents you’re underwriting, initial TIs, your construction cost per square foot?
Frank Spencer:

I actually don’t have the package in front of me, but it’s—
David Cody:

I’m just trying to get a sense of sort of a typical set of underwriting assumptions that a project’s starting today.
Frank Spencer:

Yes, we’re in the mid-20s on rent. This has some higher acuity uses based on the partnership, I mean the tenant mix itself. And so we’re in the $250 a foot range on cost. So, and we're building to a little better than a 9 in terms of nominal return.
David Cody:

Okay, great. That's very helpful, and then my last question has to do with the joint venture that you formed with Northwestern. Forgive me if I missed some of the details, but did you talk about terms and your expected contributions?
Jim Cogdell:

Well, not sure exactly where you want to go on terms, but in terms of our contribution, it's a 20/80 deal. We're 20, they're 80. We are expecting to use market rate leverage in the transaction, which right now we're performing in the 60 to 65% range, and then part of the transaction is we get typical market rate fees for doing things like management and leasing and the on-the-ground property management.
David Cody:

Can we just go back to the Pensacola project for a second? You just talked about lining up the loan 75% to construction cost, where you're able to obtain that financing and how you feel about financing other types of projects like this and the depth of the lending market for it.
Charles Handy:

Yes, this is Chuck and I'll address that. I mean, we've been talking with our lenders on a regular basis, and what we've been finding is that for well-leased, high preleased projects the lenders are lending money. I mean, we're still finding construction loan opportunities out there. I think, as Frank mentioned, the loan to values are more in the—or loan to cost in the case of a construction loan—you're looking at a 50 to 65% kind of advance there of cost, but when you have high preleasing, then that tends to promote availability in the lending markets right now.
Frank Spencer:

Well, and I'd make the strategic follow-up to that, which is it's never been our position to take any significant speculative risk, and so, I mean, part of the reason the lender was perfectly comfortable closing the Pensacola deal is that you've got a preleased building. In other developments we're looking at, everything we do has a substantial preleasing requirement, and so, it's not as though we're building speculative suburban office in a part setting where you always try to have a new building inventory going. We're really building to specific tenant needs.
Michael Bilerman:

Right, and maybe you can just go back to just overall liquidity. Can you just walk through how you think about your sources and uses relative to where you view your liquidity today, what you have already set aside for commitments for the developments that are under way, for your joint venture, and for debt maturities. Really how much capacity do you think you have sitting here today to be able to fund what you already have committed to?
Frank Spencer:

Well, I think, and I'll let Chuck chime in, but in terms of the debt maturities, we feel those are taken care of. As Chuck pointed out, we've only got a little over 10% of our whole debt structure maturing in '09, of which $30 million is extendable by us at borrower's option. So, you've got $18 million, and those loans are at levels below which we can refinance those on an individual secured project basis. So, we don't think we have any debt maturity issues that aren't self resolving. In terms of the balance, we at this point are intentionally holding the bulk of our balance sheet capacity for those development deals, but several of the development deals are downstream doctor joint ventures. So, to do the kind of development we're looking at, we feel we are well funded in terms of capital. We are consistently meeting with lenders, looking at what options exist out there, and the other self-imposed requirement is that we're not going to pursue development without in-place construction financing committed. So, I think when you take all of those things into account, we're in a position where we can go forward and execute the '09 plan as we sit today.
Michael Bilerman:

Great. Thank you.
Operator:

(Operator Instructions) We have a question from a Stephanie Krewson from Janney Montgomery Scott. Please go ahead.
Stephanie Krewson:

It's Krewson. Thank you. Question for Scott. I know that you don't really provide guidance on what your book of business is, but can you talk about the nature of it? I understand that inversion of your pipeline is slowing. That's the understood, but what sort of a backlog do you have in terms of your pipeline? What's the chance really of existing business that you expect in '09 falling out or going away?
Scott Ransom:

Well, let me define existing business for you. Or I guess the way I assume you're looking at it would be revenues for next year, and we're typically out there looking. Our revenues for any given year are probably about 60 to 75% of them are already in place going into the year because of the gestation period to execute our design build contracts, which range somewhere in the average of probably 12 to 24 months. So, a lot of those revenues are in place. When we talk about the pipeline, in converting those to design build contracts, really anything that isn't converted in probably the first four to six months will have kind of minimal impact on revenues for next year. So, we're pretty close within a probably 80 to 95% understanding of where our revenues are going to be in 2009. So, we're already out looking past more in the last quarter of '09 revenues into 2010. But, so, we talked about a slowdown. I can say that we haven't had one project where we're working with a client, let's say, in a design stage where they said, we want to stop the project. It's just more that there's a lot of challenges. There's more scarcity in capital. There's a lot of margin pressure in healthcare, and that's coming from a lot of different angles. There's investment portfolios that have taken hits. A lot of the bigger not-for-profit hospital systems or community hospitals have endowment and investment funds that have taken hits like everyone else's. There's individual physicians. So, there's nervousness out there, but we aren't seeing things going away because, as Frank mentioned, there's a real long-term demand for facilities and demand for technology and healthcare that we see we're still in a very robust market. So, these are things that we're just monitoring on a day-to-day basis, but we're not seeing a big drop-off where our projects are just going away at all. If anything it's at an all-time high. It's just getting it converted and starting the construction on it.
Frank Spencer:

And Stephanie, I'd add just a little color to that. When we talk about pipeline, those are signed agreements where we're working in the planning stages. And when Scott talks about conversion, that's the movement from that planning agreement where they're already writing us checks and we are doing work for the client into the actual hard-line design construction phase. And I think the way I think about this, and I think this is probably instructive just in terms of what does delay mean? You know, if a medical center or a large multi-specialty clinic has determined that there is a need for additional cancer services within their marketplace, and that community has that need and they've got a growing cancer/oncology program. And they've said, okay, we really need a new outpatient treatment center. The need for that outpatient treatment center hasn't gone away because we're in a recession. But what we're seeing is CFOs going, wow, I may not want to issue bonds this quarter. And so, while I've still got that need for the cancer center, and still want to make sure the planning goes ahead, I'm just not ready to pull the capital trigger today. Let's take a look at it in the first quarter. Now if things stay crazy or get worse, that same CFO might say let's look at it in the second quarter. But the need for that outpatient oncology center hasn't gone away. And that's why I think it's instructive to understand that we've still got these projects progressing through our system. We just think the conversion cycle in '09 is going to be longer than it was in '07 or in '08 because of these external issues.
Stephanie Krewson:

That's really helpful because one of the I think some of the nervousness I hear from talking to investors about your dividends is the contractual nature of Marshall Erdmann's business and I think it's helpful to communicate the fact that, at least a year out, your revenues look pretty firm, and the worst case scenario, if I'm understanding you correctly, is that some of that revenue could be pushed into '10.
Scott Ransom:

Yes. And to give some extra—you asked the question, I don't think I directly answered it, but from a pipeline—and I mentioned in the call, that is—where Frank mentioned, this is our pipeline is actually contracts or projects that have been taken off the street either from existing clients or in a competitive new customer situation. Well, I can tell you three to four years ago we would typically have one and a half to maybe two times our annual revenues in that backlog of pipeline. And right now we have almost three times what we're projecting for revenues this year. So there's significant amount of work there. It's the pace at which you can convert it, which frank and I were talking about. To give you a little texture, there.
Stephanie Krewson:

Mm-hmm. Scott, would you be comfortable—I know you all aren't providing '09 guidance but, just trying to fine-tune the way we model the Marshall Erdman subsidiary now for Cogdell, would you be comfortable providing any sort of NOI margins? The reason I say this is because obviously they move around a lot, and I would anticipate that they would come down marginally because you have increased your advertising costs, which runs through SG&A.
Scott Ransom:

That's not a substantial dollar amount. I can tell you we are going to be budgeting margins that would increase over last year, if you're talking about actual percentages of revenues. It improved operating margins. Frank, I don't know—
Frank Spencer:

Stephanie, I think in terms of— first of all, just for everybody on the call, our annual guidance will be coming out as part of our year end conference call in February, and so we'll be giving the full annual guidance then as we traditionally have. I think from a modeling standpoint, Stephanie, I think we'd be comfortable in saying that our current expectations are that Erdman's margins are equivalent to what they have been in the past, and we are not modeling margin deterioration.
Stephanie Krewson:

Okay. That actually is helpful. And then one last quarter, if there's time. And that is could you explain again, Scott, I understand from our meetings that Marshall Erdman's business actually is cash flow positive. Could you perhaps give a little bit of color on that? Because once again, it gets back to the question of the day, which is dividend safety.
Scott Ransom:

Well, yes, as long as I've been at Erdman, we've been cash flow positive. Essentially the driver behind it is that a significant portion of our costs are sourced on a job by job basis. And so our variable cost is probably close to 75% of our revenues. And so we've been very successful over the history of the company in managing this thing with very strong cash flows, especially with the ability to look out and know what we have in revenues in a 12 to 18, sometimes 24 month forward view. So we don't see any scenario where we would have negative cash flow from operations. And I don't know if that answers the question.
Stephanie Krewson:

Actually, that is very helpful. Thank you.
Frank Spencer:

Yes, and again from a strategic standpoint, I would add that that was a key element in our understanding and doing the underwriting of the Erdman merger, because we knew that it was going to be a great deal sourcing mechanism, but it was equally important to understand the fact that it was not a capital drag for us. It was actually a net positive cash flow for us.
Stephanie Krewson:

Thank you gentlemen. Great quarter.
Operator:

Our next question comes from George Goetz, a private investor. Please go ahead.
George Goetz:

Yes, good morning.
Frank Spencer:

Good morning.
George Goetz:

I was wondering as far as the requirements for maintaining REIT status, there's a limit on the proportion of revenues that can come from an operating subsidiary of a REIT. Where does the company stand as far as that? Because I suppose Erdman is an operating subsidiary.
Frank Spencer:

Very good question, George. I'm going to let Chuck Handy take you through that briefly.
Chuck Handy:

Right. You're correct, there are limitations on revenue for REIT— non-real estate revenue as defined for REIT qualification purposes. From a structuring standpoint, what we did as part of the Erdman merger is that Erdman is contained in a taxable REIT subsidiary that's effectively taxed as a corporation. So it is a wholly owned subsidiary that is structured in a taxable REIT status. So by that structuring it does not create any revenue issues from a REIT compliance standpoint.
George Goetz -:

Okay. Well, thank you very much.
Chuck Handy:

You're welcome.
Operator:

Our next question will come from Rich Anderson from BMO Capital Markets. Please go ahead.
Richard Anderson:

Just a quick follow-up. Just out of curiosity, is this Pensacola transaction a potential acquisition for the northwestern joint venture?
Frank Spencer:

No. We intend to hold it on our balance sheet in partnership with the tenant physicians.
Richard Anderson:

Okay. Thank you.
Frank Spencer:

And actually, while we are waiting to see if there are any final questions, just as a tag-on to that Pensacola question, that is exactly what the idea of the strategy was, is to do development with its higher yields on balance sheet, and have the cash acquisitions, which is important from a strategy standpoint in terms of monetizing assets for our clients go into the JV with Northwestern Mutual. So the bulk of our capital deployment is going through the development process, with a minority of our capital investment being used in the acquisitions. And that's part of the overall per share growth strategy. Which is more than Rich wanted, but there you go.
Operator:

Gentlemen, we show no further questions at this time. I would like to turn the conference back over to Mr. Frank Spencer for any closing remarks.
Frank Spencer:

Great. Well, we thank you for your continuing interest. We look forward to speaking with you in the New Year when we look at the full year 2008 and provide our 2009 guidance. Until then, as always feel free to call us with any questions, and thank you for your participation.
Operator:

The conference is now concluded. Thank you for attending today's presentation. (Operators instructions.)

VictoryShares US Small Cap Volatility Wtd ETF Q3 2008 Earnings Call Transcript

Other VictoryShares US Small Cap Volatility Wtd ETF earnings call transcripts:

VictoryShares US Small Cap Volatility Wtd ETF
Q3 2008 Earnings Call Transcript