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Q4 2007 Earnings Call Transcript

Published: 29 Feb 2008

[Operator:]

Hello and welcome to the Cogdell Spencer fourth quarter and year end 2007 conference call. (Operator Instructions) Now I'd like to turn the conference over to Dana Crothers. Ms. Crothers.

[Dana Crothers:]

Thank you. Welcome to Cogdell Spencer's fourth quarter 2007 conference call. The press release and supplemental disclosure package were distributed yesterday afternoon, as well as furnished on Form 8-K, 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 website at www.cogdellspencer.com under Investor Relations section. Additionally, we are hosting a live webcast of today's call, which can be accessed 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 with the meaning of the Private Securities Reform Act of 1995. Although, Cogdell Spencer believes the expectations reflected in any forward-looking statements are based on reasonable assumptions, 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:]

Thank you, Dana. Thank you and good morning everyone. Welcome to Cogdell Spencer's fourth quarter '07 earnings call. We'll be joined first this morning by Chuck Handy, our CFO with the detailed look at the quarter's financials, then by Frank Spencer, our President and Chief Executive Officer. Following our remarks, we will be available for questions you might have. So, starting this of, I'd like to give a quick overview of highlights of some of our accomplishment during the fourth quarter of 07. In December, our development department announced the ground breaking of the largest project to-date, St Luke's Riverside Outpatient Campus, broke ground in late December 07 for nearly 400,000 square feet and a four building complex. This $100 million project is scheduled for completion during the third quarter of '09. Also in December, our acquisition team announced addition of two medical office buildings in East Tennessee, Healthpark Medical Office Building and Peerless Crossing Medical Center, representing a [13th estate] in Cogdell Spencer's portfolio and a combined 92,000 square feet. Of course the most talked about announcement, recently made by Cogdell Spencer, was a merger with Marshall Erdman and Associates. We are especially pleased to have Scott Ransom, Erdman's President and CEO, joining us for this morning's call to answer any questions you might have. Now, I would like to turn over to Chuck Handy, our Chief Financial Officer to take a look at our financials for the quarter.

[Chuck Handy:]

Thanks Jim. It's good to be speaking with all of you today. The period being discussed began on October 1st, 2007 and ended on December 31st, 2007. As noted in our earnings release FFO for the fourth quarter ended December 31st, 2007 was approximately $5.1 million or $0.31 per share and unit. Net loss for the quarter was $1.3 million or $0.11 per share. For full year 2007 FFO was approximately $18.3 million, or $1.17 per share. 2007's net loss was approximately $6.3 million or $0.57 per share. At December 31st, our total enterprise value was approximately $580 million, which included $316.4 million in debt outstanding for total leverage of 55%. Approximately 89% of our secured debt was at fixed rates as of December 31st and our average interest rate on mortgages was 6.2%. Our secured debt had a weighted average remaining term of approximately 5 years. We had $79.2 million outstanding on our $130 million unsecured line of credit at December 31st. Our fourth quarter revenue totaled $18.9 million, fee revenue including property management and leasing fees, as well as, expense reimbursements totaled $872,000 for the fourth quarter. Our full year 2007 revenue totaled $67.9 million, fee revenue for the year totaled approximately $4 million. General and administrative expenses totaled $2 million for the fourth quarter and approximately $7.48 million for the year. For the quarter ended December 31 2007, our interest coverage was 2.2 times and our fixed charge coverage was 1.8 times. On January 21st, we paid a dividend of $0.35 per common share to shareholders of record on December 31st. In January 2008, the company issued 3,448,000 common shares at a price of $15.95 per share, resulting in gross proceeds of $55 million. The net proceeds from this private offering were used to reduce borrowings under our unsecured revolving credit facility. At December 31st, we had approximately 646 leases at our wholly-owned properties with an occupancy rate of 93.4%. No single tenant accounted for more than 7.6% of annualized rental revenue. Recurring capital expenditures for 2007 totaled approximately $2.2 million or approximately $0.71 per square foot across our wholly-owned portfolio. Tenant improvements related to second generation leases totaled approximately $4.2 million for 2007 or approximately $1.35 per square foot across our wholly-owned portfolio for the year. Planned capital expenditures associated with property acquisitions totaled approximately $881,000 for the year. On December 21st 2007, we acquired Healthpark Medical Office Building in Chattanooga, Tennessee and Peerless Crossing Medical Center in Cleveland, Tennessee for approximately $28.4 million. This acquisition was funded through a combination of cash and the assumption of approximately $16.2 million of existing debt with a blended interest rate of 5.68%. Both buildings were 100% occupied at December 31st. Construction continues to progress very well on our 60,000 square foot medical office building in Mebane North Carolina, which will be anchored by Alamance Regional Medical Center. This project is currently 69% pre-leased and is expected to open during the second quarter of 2008. Our total investment in this project is expected to be $16.2 million. Now, let me discuss our guidance for 2008. As a result of our merger with Erdman, we'll be required to incur a significant non-cash amortization expense related to certain acquired intangible assets. Since this amortization expense will not be real estate related, it will not be added back to net income or loss for the determination of traditionally defined FFO. Because of the non-cash nature of this charge, we believe that it will be most relevant to look at FFO, excluding this non-cash amortization expense. In addition to reporting FFO, we'll begin reporting FFO modified or FFOM that will simply add back this amortization expense. We expect the related intangible assets to be fully amortized after approximately 5 years. And we expect the initial year's amortization expense to be in the range of $10 million to $12 million. After taking into account our merger with Erdman, we expect 2008 FFOM to be in the range of $1.20 to a $1.24 per fully diluted share and unit. Now I'd like to turn the call over to Frank Spencer our President and CEO. Frank

[Frank Spencer:]

Thanks Chuck. As Jim mentioned, we were very pleased with the announcement of the development agreement for St Luke's Riverside Outpatient Campus, located in Bethlehem, Pennsylvania. This $100 million project will consist of a cancer center and outpatient healthcare pavilion and two medical office buildings. The two medical office buildings, valued between $35 million and $40 million, will be owned in a single investment entity by Codgell Spencer and physician investors. True to the company's roots, Codgell Spencer continues to offer individual investment opportunities to physician tenants and remains a market leader in this approach. Our Mebane project, Alamance Regional Outpatient Medical Center, was introduced to regional leaders and the community at large in a successful preview event last week. Over 500 people attended free health screenings and a presentation on the future service offerings at the facility. The project is on schedule for completion in April, and Codgell Spencer will likely retain approximately one third of the available equity. We had construction starts of $40 million for owned properties in 2007. Our development pipeline remains robust, with projects in five states under development. We believe that the additional opportunities leveraged with the offerings of the Codgell Spencer Erdman pipeline, will lead to an accelerating pace of development in 2008 and 2009. As we wrapped up 2007, we announced the acquisition of two medical office buildings located in Eastern Tennessee bringing us $88.6 million in property acquisitions for the year. Healthpark Medical Office Building in Chattanooga, Tennessee and Peerless Crossing Medical Center in Cleveland were purchased for approximately $28.4 million in a single transaction, and represent a new market for Cogdell Spencer. The acquisitions in Tennessee represent a new client as well Erlanger Health System, the dominant system in Chattanooga is a non-profit system, with strong local decision making. Images of these and other Cogdell Spencer facilities are available on our website under featured properties. As we maintain the Cogdell Spencer business strategy, we will continue to move into new market where we can build relationships with non-profit hospitals that hold dominant market share and both strong local decision making, like Erlanger Health. As we grow, we continue to research options to enhance our expansion through development, acquisitions and the formation of new partnerships within the healthcare industry. Looking into 2008, we are well positioned to team up with the joint-venture partner to expand our acquisition capabilities, while retaining a strategy of capital deployment through development. With our extended geographic reach coming through the Erdman merger, we expect our current volume of approximately $100 million in acquisitions to increase substantially. An important part of our strategy in acquisitions is to bring in an institutional joint-venture partner. We are currently exploring potential partners. Already in 2008, we have announced approximately $24.3 million in acquisitions; our first in Richmond, Virginia is an example of existing client relationships leading to new op market opportunities. Bons, Secours Richmond Health System brought us the opportunity to acquire the lease hold on two floors of space in St. Mary's North Medical office building, a building already managed by our subsidiary management company, Consera Healthcare Real Estate. Just yesterday, we announced the acquisition of East Jefferson Medical Plaza, located on the campus of East Jefferson Memorial Hospital. This facility adds approximately 120,000 square feet to our existing portfolio in the New Orleans area, which now totals over 250,000 square feet. We are pleased with our expanding relationship with East Jefferson Memorial Hospital, which as a tenant currently leases approximately 86,000 square feet of the 100% leased facility. This is our second acquisition for the first quarter and we are poised to continue as the year progresses. Moving on to our existing owned portfolio, current results are consistent with our budgets and our historical track record. Total portfolio NOI margins for Q4 '07 were 64% inline with historical results. Our occupancy rate dropped quarter-over-quarter from 94% to 93.4%, but remains fundamentally stable. I'd like to talk a little about the Erdman merger, which is expected to close within the next 10 days. As mentioned in last quarter's call, we were looking for unique opportunities with a private company, where we [contain] assets and/or development synergies and the merger with Erdman clearly sets the turn for this. Combined Cogdell Spencer and Erdman form a fully integrated healthcare facilities company that will provide a total solution to our clients, from the advanced planning and concept stage, to long term ownership, operations and management. The merger with Marshall Erdman strengthens Cogdell Spencer's existing geographic presence across the US. In addition to the Erdman Corporate headquarters in Madison, Wisconsin, Cogdell Spencer now has regional offices covering the entire United States, opening new markets and stimulating growth. Our organization has a unique ability to source off-market acquisition and development opportunities through this proprietary pipeline. The combined companies post over 90 years experience and have delivered over 5000 healthcare facilities nationwide. From a financial perspective the formation of these combined entities allows us to shift the focus of our capital deployment. Let me talk for a moment about that strategy. Traditionally, we have had approximately two thirds of our capital going through acquisitions, one third through development and that pattern was consistent in 2007. What we plan to do in this new venture is shift that ratio, such that the majority of our capital is deployed through development. We are doing this by bringing in an institutional JV partner for cash acquisitions and through the synergies of the two firms increasing our development volume. The result will be an accelerating growth in earnings per share results, as we look forward into '09 and '10 and beyond. We really think this is a unique model; we are going to be able to shift the capital deployment, without hitting current earnings, because of Marshall Erdman's current profitability. So, it's going to give us a company that, even as REIT, is now seeing the majority of its growth in future years through the development process. At this point, I would like to turn things over to Scott Ransom, who will continue to run Erdman to talk a bit about what this means to them and the complementary services offered by the expanded entity. Scott, welcome back to Charlotte, if you could take a few minutes to talk about Erdman's perspective on the recent merger, I think everybody would like to hear that.

[Scott Ransom:]

Well, thanks Frank. It's a pleasure to be here in Charlotte this morning certainly much warmer climates than we've been experiencing in Madison lately. We are extremely pleased with the integration process so far, of both executives team, and would like to give you a quick overview of the Erdman offerings that we will soon be part of Cogdell Spencer's overall platform. From advance planning to design build capabilities we offer a ground floor entrance into the market place of real estate. Our focus on advanced planning services, such as strategic consulting and visioning allows us to enter the client's process well in advance of most development firms. With our business model the project delivery process is fully mapped from conception and our healthcare facility projects are delivered to single source delivery contracts with guaranteed maximum price structure. Our record and reputation with our clients speaks for itself, with repeat customers accounting for 90-plus percent of our business. 2007 was a record year for Erdman both in revenues and profit, and our current backlog of contracts gives us strong confidence in our ability to meet or exceed those levels in 2008. And we talked a bit about what the merger means to Cogdell Spencer, but I'd like to talk for a minute on what this merger means to Erdman and our clients and employees. Not only does this merger expand our resources and capabilities in meeting all of the client's needs, it substantially expands our ability to offer our clients capital solutions. Erdman and Cogdell Spencer both have a very strong relationship based platform to build on. All-in-all this combination of expertise in the healthcare real estate market brings an unprecedented product and serve offering to clients, tenants, employees and investors. We are extremely excited about the future of our combined company and with that I will turn it over to Frank and look forward to questions later on.

[Frank Spencer:]

Thanks so much Scott and again we are pleased to have you and your team on-board. I'd just like to add a few words to Scott's comments on the true depths and breadth of this merger that what it brings to our clients, investors, tenants and employees. Cogdell Spencer can now offer full service capabilities to our clients, from advanced planning and design, to long-term property management. With over 600 employees nationwide, we now offer an unparalleled product and service [caring] to health care providers throughout the Continent of United States. Our company now has the benefit of additional cross company and cross departmental resources, with access to a broader base of expertise, knowledge and best practices that can be shared companywide. The merger is been very well received, both externally and internally, with the new platforms sparking national media interest in the healthcare real estate market. With that, I would like to open up the call to any questions you may have.

[Operator:]

(Operator instructions) Our first question comes from Rich Anderson of BMO Capital Markets.

[Rich Anderson:]

Good morning everybody.

[Frank Spencer:]

Hi, Rich.

[Rich Anderson:]

Just a couple of questions, has any of the acquisition or development activity that you have announced, so far this year, been as a consequence of the relationships that Erdman has in place or has that yet to be materialized in a concrete way?

[Frank Spencer:]

That is yet to materialize although our combined teams are already working on half a dozen proposals together.

[Rich Anderson:]

Okay. All right, you mentioned Frank the shift to development from acquisition is traditionally as where your capital will go? I guess my first question would be, the full near term FFO growth seems like that would be tougher to accomplish then may be acquisitions, due to the lag in leasing process that comes with development, so how does a focus on development gets FFO going quicker than acquisition would?

[Frank Spencer:]

That's a fair question, we are not getting out of the acquisition business., What we intend to do and we are in the process right now, we are exploring institutional JVs to allow us to continue acquiring, even at an accelerated pace, that will allow us to be in the market and actually earn a higher overall yield when you account for fees and incentives and splits. But the bridge is actually Marshall Erdman's own profitability and that will contribute to near term FFO growth, while those projects come on. And you are right. We are actually projecting the most significant growth to really be in 2010. But we will continue to grow between now and then, as we create additional free opportunities and have both the acquisitions in the current development pipeline come on online.

[Rich Anderson:]

Okay. So, is one third of your capital going towards acquisitions, in terms of absolute dollars greater than the $100 million that you deployed as in the predecessor organization?

[Frank Spencer:]

Probably not, it'll probably be a smaller absolute amount going into acquisitions, but we expect to earn a superior return. And so, on a per share basis it should be incrementally positive.

[Rich Anderson:]

What are the specific acquisitions and development expenditures expected in your 2008 guidance?

[Frank Spencer:]

We have not published that, well, let me say that the development projects are announced and are in the supplemental, so, you can see those projects that we've talked about. So, in '08, what's coming online is predictable. And in terms of acquisitions, if we did not do the merger, we would still be expecting to run at approximately our $100 million a year pace. We believe, with the merger we're going to have significant other opportunities. We have not quantified that, in terms of a specific guidance number.

[Rich Anderson:]

Okay. Just one more, how deep is the line of interested parties to partner with you for a joint venture, an acquisition joint venture?

[Frank Spencer:]

I think, that would be inappropriate to discuss at this point in the process.

[Rich Anderson:]

All right, well since you're not answering that one, let me ask you one more than.

[Frank Spencer:]

Sure, go ahead.

[Rich Anderson:]

The fee exposure, how close are you to the maximum in your taxable REIT subsidiary with all the fee income that Marshal Erdman will bring it to table?

[Frank Spencer:]

That is clearly something we've looked at closely. I am going let Chuck speak to the specific percentage.

[Chuck Handy:]

Yeah and of course Marshall Erdman will be in a taxable REIT subsidiary, given the nature of the fee income of course. And so, the thing that we are focused on is from a REIT asset test standpoint, this is the relation from an asset standpoint to size of the taxable REIT subsidiary compared to the REI. And that there is a 20% threshold that we need to stay under in that testing and we are comfortably below the 20%, although we are in the high teems, mid to upper teems percentage wise. But what we also are seeing that is with the enhanced opportunities and the enhanced development pipeline and acquisition pipeline is that our balance sheet will grow at a pace that will provide comfortable head room as we go forward.

[Rich Anderson:]

Hey, sounds good. Thanks.

[Operator:]

Our next question comes from Craig Melcher of Citigroup. Craig Melcher - Citigroup Thank you. Can you comment on the cap rates you've achieved on the acquisition so far this year and then in the fourth quarter? And how they may have changed for the last six to nine months?

[Frank Spencer:]

Well I think those are two different questions. I'll, leave the general MOB cap rates to you guys to knock around. There obviously have been some giant transactions announced recently at some very low cap rates, but we have consistently been able to beat that market by a wide margin. If you look at the breadth of those acquisitions, the off-market deal that we did, enrichment on a smaller deal was north of eight and the other three which were much more significant deals averaged for us above 7.5. Craig Melcher - Citigroup Okay. And with access to JV or institutional partner, would you look to do larger deals or do you think you will stay with needs and stick with the smaller acquisitions to get the better cap rates?

[Frank Spencer:]

I think it's sum of both Craig, I mean, our strategy, in part that depends on several things, one is what are the expectations, returns of this specific joint venture partner with whom you negotiate. As you well know, different entities are going to have a different focus in that part what we're exploring right now. The other thing that's important for Cogdell Spencer is what kind of relationship does that bring us to, does it bring us to a new campus, that's a target campus and as we've always said will pay more for those opportunities than one-off deals. Now, we have another consideration, if it fits the joint venture partner's profile, does it help support existing Marshall Erdman relationships. And so, that's another factor that we will look at. And finally, there will also, always be as part of our strategy, things that would not go into the JV, where we are partnering with the physicians and/or hospital end-users of the building. And we would intent for those types of ventures to remain directly on balance sheet. So, I think what you're going to see from us is a broader reach, probably a broader mix, and a wider range. But I think all of the things that we have traditionally done. Craig Melcher - Citigroup Okay. And in terms of your guidance what are your expectations for occupancy in '08?

[Frank Spencer:]

We are projecting occupancy flat for '08. Craig Melcher - Citigroup Okay. Thank you.

[Operator:]

Our next question comes from Karin Ford of Keybanc Capital Markets.

[Karin Ford- Keybanc Capital Markets:]

Hi, good morning. Just a follow-up on the cap rate question, we heard on another call that there is a stark differential in medical office cap rates, depending on your geography, on the West Coast versus other areas of the country, do you agree with that, and if so is there a differential in growth potential on the West Coast, is it land values, what do you think could be attributing that?

[Frank Spencer:]

Well, I can't imagine which call you are thinking of. But seriously, is there a difference in cap rates on the West Coast? I think there clearly is. I mean, the market data confirms that, you don't need to ask me that to recognize it. Why do I think that is? I don't know. I don't think it's necessarily the growth potential, I think it's probably related to the difficulty of entitlements, particularly in the California markets and a limited supply, I mean, you'll see the same kind of pattern across other real estate types, not just MOBs. And so there is a difference. I don't know that it is driven by total return expectations, and that's the part that leaves us scratching our heads a little bit.

[Karin Ford:]

That's helpful thanks. Next, you said you are working on half a dozen potential opportunities already with the Marshall Erdman folks. Can you give us an estimate as to when you guys might be able to sign something up if you are closing the deal in the next 10 days?

[Frank Spencer:]

No, I don't think we can give you that estimate. I think what we intend to do is continue our philosophy, if its going to be an on-balance sheet development transaction, of announcing when we break ground, just so, that we are being able to give you the most defined information we can. So, I would not venture as to when that first press release will hit the wire.

[Karin Ford:]

Okay. Is turmoil on the debt markets affecting the healthcare system that you and Marshall Erdman would be targeting? And is that helping your cause; with sort of discussing using Cogdell's balance sheet on their behalf?

[Frank Spencer:]

We are certainly seeing some of that turmoil, certainly cause of concern for some of our not-for-profit CFOs. My sense is, this is a short-term dislocation, but that's pure speculation on my part. It may create a short-term window for us to provide capital in situations that we might not otherwise have been able to do. But, I would not say it's an opportunity to shift strategy, but certainly there is concern in the auction markets for the tax exempt debt over the last couple of weeks.

[Karin Ford:]

Okay. Last question is just on G&A. It's picked up in the fourth quarter? And I wanted to see what are the G&A assumptions that were embedded in the early guidance?

[Chuck Handy:]

Yeah, the increase in the fourth quarter is really a seasonal increase. We had a lot of ramped up audit and Sarbanes-Oxley compliance calls that fell into the fourth quarter. So, if you look at third versus fourth quarter there was about $0.5 million increase and that was attributable to those services that were performed in the fourth quarter. And one another factor is we've actually accelerated some tax work into fourth quarter that's typically being done in the first quarter this year. So, that was a small piece of it. But it's primarily audit and Sarbanes-Oxley, internal audit and external audit calls that resulted from work preformed in the fourth quarter. For 2008, clearly with the merger with Marshall Erdmann our G&A line will increase significantly. However, as a percent of total revenue we see that number decreasing, actually. So, one of the things that is in the Erdman G&A line or SG&A line is cost related to the production of their design build function, as well as, advanced planning and really just producing their revenues. So, there will be a dramatic increase in total dollars, but as a percentage of revenue we see that number actually coming down from the 2007 level

[Karin Ford:]

Can you just give us an estimate on the dollar amount?

[Chuck Handy:]

Probably the gross number is $35 million plus or minus number?

[Frank Spencer:]

Karin, obviously, we are going to be producing [305] audit here shortly. And I think, you'll be able to benchmark where the Erdman numbers are, when you take a look at that audit.

[Karin Ford:]

Okay, thanks

[Operator:]

Our next question comes from Stephanie Krewson of Janney Montgomery Scott

[Stephanie Krewson:]

Good afternoon, gentlemen. Can you hear me alright?

[Frank Spencer:]

Yeah, Hi Steph.

[Stephanie Krewson:]

Hey, there. Sorry, we had little phone issue this morning, so I just wanted to make sure. Most of my questions have been answered, a couple of quick ones. Have you already addressing the mortgages that you have maturing in 2008, talking with lenders?

[Chuck Handy:]

Yes, we have and we're underway on refinancing the ones that are coming up near term, we're well on our way in that process, even though we have a few that are rolling in 2008, we are not really seeing any issues with refinancing those. The loans or the properties for which those mortgages are maturing have relatively low loan-to-value ratios so, we see that the bank financing market been just fine. And we're not really seeing any issues there.

[Stephanie Krewson:]

Okay. And with the yield on the tenure so low, is it reasonable to expect no material change in your all-in cost on refinancing?

[Chuck Handy:]

I think that's a reasonable expectation, yes.

[Stephanie Krewson:]

Okay. And then, what was your capitalized interest in the fourth quarter Chuck?

[Chuck Handy:]

It was roughly $45,000 or something like that.

[Stephanie Krewson:]

Okay. And that's it, thanks guys.

[Chuck Handy:]

Thanks Stephanie.

[Operator:]

(Operator Instructions)

[Frank Spencer:]

Well, if there are no other questioners in the queue, let me thank everybody again for joining us and for your continued interest in Cogdell Spencer. This is an exciting time for us, with the transformative event in 2008. And we're excited about the future, and look forward to keeping you up-to-date and talking with you on future calls. Thanks for your attention.