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BioMed Realty Trust, Inc. (NYSE:BMR)

Q1 2009 Earnings Call

April 30, 2009 1:00 pm ET

Executives

Rick Howe - Director of Corporate Communications

Alan Gold - Chairman and CEO

Matt McDevitt - EVP of Acquisitions and Leasing

Kent Griffin - President and CFO

Analysts

Paul Puryear - Raymond James

Brendan Maiorana - Wachovia Securities

Tayo Okusanya - UBS

Dave Aubuchon - Robert Baird

John Guinee - Stifel Nicolaus

Analyst for Jordan Sadler - KeyBanc Capital Markets

Dave Rodgers - RBC Capital Markets

Operator

Welcome to the first quarter 2009 BioMed Realty Trust, Inc. earnings conference call. (Operator Instructions) I would now like to turn the call over to Mr. Rick Howe, Director of Corporate Communications. Sir, you may proceed.

Rick Howe

Thank you and welcome, everyone. We are trying something new for BioMed today with a slide presentation to accompany our prepared remarks. If you are not currently viewing the slides and would like to please go to our recently enhanced and expanded website, www.biomedrealty.com, click on the Investor Relations tab on the left and then click the Q1 2009 BioMed Realty Trust Inc. earnings conference call link. We will also post these slides on our website shortly after this call. We encourage you to explore the interactive website again at www.biomedrealty.com, and to access our 2008 online annual report for additional, in-depth information on our strategy, achievements to date and goals for the future.

Presenting today are Alan Gold, Chief Executive Officer and Kent Griffin, President and Chief Financial Officer. In addition, Matt McDevitt, Executive Vice President, Acquisitions and Leasing is on the line to participate in the Q&A.

Before we begin, I would like to remind everyone of the Safe Harbor statement included in yesterday's press release. The Private Securities Litigation Reform Act of 1995 provides a Safe Harbor for certain forward-looking statements including statements made today during the course the conference call. These forward-looking statements are based on the company's current expectations and involve significant risks and uncertainties, some of which are beyond the control of the company and are subject to change based on various factors. Actual results may differ materially from those expressed or implied by the forward-looking statements.

For a detailed discussion of some of the ongoing risks and uncertainties of the company's business I refer you to the press release issued yesterday and filed with the SEC on Form 8K as well as the company's other SEC filings including its most recent Annual Report on Form 10K and quarterly reports on Form 10Q. The company disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

Again, if you are not currently viewing the slides and would like to please go to our website, www.BiomedRealty.com, click on the Investor Relations tab on the left and then click the Q1 2009 BioMed Realty Trust Inc. earnings conference call link.

With that said, I would now like to turn the call over to Alan Gold. Alan?

Alan Gold

Thanks Rick. We welcome all to BioMed’s first quarter earnings call. Once again BioMed continued to deliver outstanding operating and financial results in the first quarter despite the general economic environment and continued instability in the credit markets. We have a lot of good things to discuss on the call today and we will be concise as we know this is a busy day for many of you but we are going to take the time to review our key areas of interest for our investors.

First I’m going to walk through the highlights of the first quarter. Then I’ll review the current state of the Life Science industry and finally I will spend some time talking about our tenants. I will then turn it over to Kent who will discuss our key financial results for the quarter, our progress on refinancing loans on our Center of Life Sciences Boston, our updated outlook and FFO estimates for 2009, our dividend expectations and finally our further enhanced liquidity position. Then of course we will open it up for questions.

First things first. This quarter was just another tremendous quarter for BioMed coming on the heels of similarly solid results over the last several quarters. I feel like a bit of a little bit of a broken record on this but despite the broader challenges facing the economy as a whole and as well as the Life Science industry we continue to deliver very strong results. The key to our sustained success is of course our robust business model and company built to thrive with a foundation centered on a world-class property portfolio located in the strongest core Life Science market. Our talented team continued to perform, executing our plan with great discipline and focus. We continue to effectively execute on our leasing strategy with over 400,000 square feet of gross leasing in the first quarter alone.

We completed and delivered one of the top research facilities in the world, The Center for Life Science Boston, which achieved Gold LEED certification during the quarter and is now 91% leased. Our joint venture with Prudential refinanced more than $200 million from its syndicated banks and with disciplined property management and cost controls we delivered strong same-property operating results and lower than anticipated G&A expense. All of these factors contributed to our record revenue and record FFO results for the quarter.

All of this was achieved against the economic backdrop which saw no material improvements in the general market conditions as the weakened global economy and the constrained credit markets continue to impact every industry including the Life Science industry. Of course the over-arching issue for all sectors of the economy today and especially for the Life Science industry is access to capital.

I am going to move onto the Life Science industry. When we think about the Life Science industry we consider all of the various forms of capital that sustain the wide variety of potential tenants including University and Research Institutions, big pharma, big bio tech, mid staged biotechnology companies and early stage start up. Each relies on a variety of sources of capital depending on their organization. These sources include government grants, public capital markets, private equity, venture capital, M&A and partnership transactions, most of which are constrained today but by and large all of which are still available.

The one particular bright spot in the current environment is government funding. The picture looks pretty positive for government funding. The stimulus package implemented in February includes almost $22 billion for Science and Research spending and we see positive signs this funding is not just approved but the mechanisms are in motion to deploy this capital in the very near term. We expect this has the potential to be a significant positive catalyst for the University’s and Institutions in the short-term but also for the future of smaller biotech’s spawned by technology that is advanced further with this government support.

Current public capital markets are far from healthy or robust but we are seeing some capital raising for Life Science companies. Public companies in the quarter raised $579 million through follow on offerings and $302 million in pipes. Venture capital funding in general was down for the quarter yet biotech venture capital funding was up year-over-year with $1.5 billion raised in the first quarter of 2009 versus $837 million in the first quarter of 2008.

M&A activity has been robust for the larger transactions within the U.S. Total deal volume for the quarter was valued at $215 billion. Highlights for the quarter include Pfizer’s acquisition of Wyeth and Merck’s acquisition of Schering Corporation and Roche’s acquisition of Genentech, among several others.

The activity thus far has largely focused on big pharma and big biotech’s which we expect will create a lot of opportunity as corporate and sales force units can be consolidated and organized efficiently, allowing capital to be deployed into research and development.

I think most importantly we expect the mid-stage and smaller biotech’s to continue to be targeted as big pharma seeks to replenish its pipeline. Partnership activity is continuing at a pretty healthy pace punctuated by $4.8 billion in biotech partnering transactions for the quarter. In fact, partnering increasingly seems to be working as a tool to bridge the implicit bid ask spread that would otherwise produce more M&A activity. By licensing technology big pharma can test drive a new opportunity without paying full value for the whole organization and the smaller biotech’s can get much needed capital without giving away valuable assets.

So while capital is constrained it is not unavailable. As quality companies continue to fund their research operations we will see that the weakest companies struggle and all companies taking aggressive actions to manage their cash position whether it is big pharma or established biotech’s or mid-stage biotech’s or even smaller scale companies. Conserving cash is particularly prudent in this environment and is what I think all organizations are focused on. This cash conservation is having a direct effect on the leasing environment.

With very little new supply of lab space and a generally longer term leases, we have seen a limited increase in direct vacancies really across all of our markets. What we are seeing is a pick up in sub-leasing availability partly as companies try to conserve cash potentially by sharing their occupancy costs with others. We do expect this trend to continue.

Looking at our leasing goals, we are still tracking well ahead of our five-quarter schedule. After two quarters we are 40% of the way through the five-quarter program and we have achieved basically 60% of our leasing goals. While on the one hand we are ahead of schedule on the other hand we think leasing will remain very challenged for the foreseeable future.

Now I would like to spend some time talking specifically about what is going on with the tenants in our portfolio as it has been a very eventful quarter both in terms of scientific advancement and importantly in raising capital.

Stepping back just as a brief reminder our portfolio includes state of the art research facilities in the core Life Science market which attracts stronger, longer, larger, well established tenants. Accordingly, we have divided our Life Science tenant roster into five categories starting with the research institutions. 15% of our rents come from research institutions. Within the quarter Beth Israel Deaconess Medical Center was just named one of the top 100 hospitals in the United States based on overall organizational performance according to an annual study by the Healthcare Business of Thomson Reuters and in partnership with the Broad Institute in MIT they recently uncovered a vast new class of previously unrecognized mammalian genes.

Also Dana Farber Cancer Institute uncovered a novel clue about the basic biology of pancreatic cancer and has confirmed a decades-old discovery of a link between blood type and the risk of developing the disease. They also recently announced in partnership with the Burnham Institute that they have identified a human monoclonal antibody and neutralized unprecedented range of influenza A viruses including Avian influenza.

Onto our A rated public companies, 15% of our rents come from big pharma and big biotech companies with A ratings. In the quarter Genzyme Corporation received FDA approval for a product intended for pain relief associated with osteoarthritis. Schering Corporation is being acquired by Merck in a $41 billion transaction.

Given the limited presence Merck has in Cambridge we don’t currently anticipate any effect on our existing lease in the Cambridge market. The large established biotech’s, one of the key strategies of our business model is to focus on the large established biotech’s which contribute approximately 43% of our annualized rents. In fact our two largest tenants had really positive announcements this past week.

Human genome scientists which had previously reported preliminary positive results in the second quarter in a second of two three phase trials of Albuferon back in March but they followed that up Saturday with a confirmation of the positive trial results particularly as the final results of the two pivotal phase III trials demonstrated that Albuferon met its primary end point of non-inferiority. As a result, the company plans to file global marketing applications in the fall of 2009 with the expectation that Albuferon could become a leading treatment for chronic hepatitis C.

It also initiated deliveries of their ABthrax vaccine to the government in the quarter; they received a $9 million milestone payment from GlaxoSmithKline as they initiated phase III clinical trials for their diabetes treatment and just yesterday announced their first quarter results with $177 million in revenues, well ahead of expectations and improving cash position to almost $400 million.

Also Vertex Pharmaceutical continues to demonstrate positive trial results for their leading drug candidates. Telaprevir just this week announced unprecedented sustained bio-response rates in the proof three trial. As you may have seen they raised $320 million of follow-on offerings in the first quarter.

Arena Pharmaceuticals received positive top line results, the first of two pivotal phase III clinical trials evaluating the safety and efficacy of lorcaserin for obesity. They have also restructured their organization to lower their burn rate and annual operating costs by $25 million and announced a $50 million equity commitment. The combination of these events would extend their cash position from just shy of a year up an estimated 1.6 years.

We also had Illumina who had a 36% increase in revenues for the quarter and now has over $700 million of cash and investments. InterMune priced a follow-on public offering raising net proceeds of approximately $63 million in February.

On to our mid-stage tenants, our mid-stage tenants represent 20% of our rent. Just over half of which are public companies. In this group Novovax reported favorable pre-clinical results for a new vaccine candidate for influenza that provided protection against several H5N1 virus strains. They also sold common shares and raised $11 million.

EpiCept priced a convertible notes offering generating over $15 million in their proceeds in February. Our smallest tenants, generally our early stage start ups represent about 2.6% of our rents. We don’t have a lot of tenants in this bucket so we don’t usually give a lot of news here. But I did see that Axikin here in San Diego raised $3 million in the first quarter.

Looking at some of our challenged tenants, just a quick update on Ardus Medical which had declared bankruptcy in December. They were selling a product but ultimately were unable to roll their debt and the lender forced them into bankruptcy. We terminated their lease at 5880 Pacific Center Boulevard in San Diego in the first quarter and subsequent to the quarter end we have entered into a new lease for the other property, 5870 Pacific Center Boulevard representing approximately 35,000 square feet.

Also during the quarter we terminated our lease with Cell Genesys. They were leasing approximately 100,000 square feet of our Bridgeview Technology Park property in the San Francisco Bay area with cash rents of $18 per square foot, significantly below market. As a result of the termination we received cash and shares of stock representing approximately two years of rent. We have one tenant working through the bankruptcy process. Not a biotech but a large, diversified chemical company, [Cantura] Corporation which leases approximately 180,000 at Landmark in New York.

They had sales of $3.5 billion in 2008 from a range of businesses including everything from agricultural products to plastics and products to cleaners. They entered into Chapter 11 bankruptcy in early March with roughly $190 million of debt or [in possessed] financing. 80% of their space, or 143,000 square feet, is sub-leased to two tenants, Progenics and [Momentys].

MDRNA which has been on our watch list for some time now has gone through a major restructuring. As part of their restructuring we have entered into a lease amendment with them whereby we receive up front cash and stock and more importantly giving us access to the space so that we can market the property for lease and terminate their lease at our option. Needless to say, this amendment was the right thing for us as it allows us to get a head start on securing a new tenant and ultimately helping MDRNA restructure in a way that provides a win-win solution for both parties.

This is a really good example of the benefit of having early insight into your tenants and how it helps us manage risk. Now incidentally, just two weeks after we executed our lease modification MDRNA was able to enter into a partnership transaction with Novartis giving them $7.25 million in cash for a nonexclusive right to evaluate some of MDRNA’s siRNA technology. In addition they announced achievement of milestones resulting in an accelerated $1 million milestone payment from Amylin Pharmaceuticals. MDRNA could receive an additional $79 million in future milestones and royalties under that agreement.

Also on our watch list is Emisphere. Emisphere has been on our watch list. They lease roughly 80,000 square feet from us at our Landmark property in New York. However, I am very proud to announce that we have just terminated our lease with Emisphere and leased all of their space to Regeneron for 15 years. Now they have obviously come off our watch list.

Also on our watch list we now have two public non-Life Science tenants and two public Life Science tenants that aggregate approximately 390,000 square feet. Less than 3% of our annualized base rent. That includes [Penrel] whose space is primarily sub-leased as we have described. Our private company tenants that we are watching closely that total less than 275,000 square feet, also less than 3% of our annualized base rents.

BioMed’s tenant roster is comprised predominately of leading research institutions and large, well established Life Science companies that have the resources to continue funding their important research and development efforts while navigating through this environment. We closely monitor all of our tenants with special attention paid to companies with less than one year of operating cash on hand. We have always been well served and will continue to be well served by having tremendous visibility into our tenant base.

Today over 86% of our annualized base rents come from research institutions and public companies. We leverage this information in combination with our proactive approach in working to address tenant issues and needs to mitigate risk.

With that I would like to turn the call over to Kent. Kent?

Kent Griffin

Thanks Alan. The first quarter financial results were very solid. As previously mentioned we generated record quarterly revenues of $94 million, an increase of almost 40% over the first quarter of 2008 largely driven by our sustained leasing success in delivering our development program including at the Center for Life Science Boston.

Same property net operating income was up 6% on a cash basis, also driven by the sustained success we have been experiencing over the last 12 months, along with scheduled rent escalations. The first quarter financial results included approximately $2.3 million of rental revenues, $3.8 million of other income and $3.4 million of operating expenses associated with lease terminations for a positive net effect on FFO of approximately $2.8 million or $0.03 per diluted share.

Our operating expense recovery ratio was 72% for the quarter including the effect of lease terminations. Excluding the impact of the lease terminations the recovery ratio would have been approximately 81%, in line with the prior quarter.

G&A expenses declined almost 15% from the first quarter 2008 because of lower senior management compensation, general expense controls and cost containment. Net income attributable to common stock holders was up 54% over the first quarter of 2008 and on a per share basis net income attributable to common stock holders was $0.23 per diluted share compared to $0.19 per diluted share in the first quarter of 2008.

Funds from operations for the quarter were $47.7 million or $0.56 per diluted share compared to $31.1 million or $0.45 per diluted share in the first quarter 2008 on a comparable basis. Excluding the gain from the purchase of the exchangeable notes, FFO per diluted share for the quarter would have been approximately $0.51.

As we have discussed in more detail in our press release and even more detail in our coming 10Q we were required to adopt a number of new accounting standards, the effects of which are reflected in the numbers we are discussing today. This includes the effect of adopting FSP 14-1 which changed the accounting for our converts as we have described in previous calls.

I would also like to touch on a few minor improvements we have made to our supplement. We take great pride in providing best-in-class disclosure and so in response to some of you we have updated our re-development schedules to reflect the total anticipated cost for each property individually versus in aggregate and as many of you have requested we have revised our disclosure of expected total cost to reflect what we expect to spend to complete these projects excluding any assumptions with respect to speculative leasing.

I would also like to take the opportunity to encourage investors to visit our website where you can access our 2008 online annual report. This new mixed media format including videos, audio and schedules that can be downloaded it is really the whole ball of wax offers a truly unique opportunity for investors to access a wealth of information about our strategy, our portfolio and our people and I hope you will take the time to explore it.

Now turning to the balance sheet, in February our joint venture with Prudential closed on a $203 million secured loan in which BioMed has a 20% interest. As we said on our last call, the significance of this transaction lies not only in the improvement to our debt maturity schedule but also the underlying strength of our lending relationship and sponsorship of our joint venture with Prudential.

During the quarter we repurchased senior exchangeable notes with a face value of $12 million for approximately 58% of par, resulting in a gain of approximately $4.4 million. So we closed the quarter with a debt to total assets ratio of 43% and no unextendable debt maturities remaining for the balance of 2009.

As many of you may recall, we had four forward starting swaps of varying notional size that aggregated approximately $400 million notional. The liability for these swaps was approximately $103 million as of the end of 2008. Prior to March 31 we settled the first of these swaps representing a notional amount of $50 million for approximately $8.9 million. The liability for the three remaining forward starting swaps was just over $79 million as of March 31. We have since settled these swaps roughly equivalent to where they stood at the end of the quarter.

We anticipate recognizing the unamortized portion of these swaps of approximately $69 million in equal increments of approximately $1.7 million per quarter or $0.02 per diluted share beginning in July however actual results will depend on the exact timing and terms of our anticipated construction loan and financing.

Which brings us to the Center for Life Science pre-financing. We are very pleased to report we are in the process of finalizing the terms of the new financing. Having agreed to the key terms in making solid progress on the remaining deal points we believe we will be in a position to close the financing by mid-year. At this point the principle expected terms are as follows: Three specific lenders with a loan size of $350 million with a five-year term with an interest rate in the high 7’s with a targeted closing date in June.

The transaction is still subject to a variety of closing business and there can be no assurances that the loan closes on these terms or at all. In the unexpected event we were not to close the loan prior to July 31 we would expect to exercise our extension option with the current lenders. However, we are pleased with our progress to date and look forward to our targeted closing in June.

In addition, you may recall that last year we completed a build-to-suit for Illumina at our Town Center Drive property here in San Diego. We are now in the late stages of negotiations regarding a potential loan for that property and currently anticipate proceeds of approximately $18 million representing just over 60% of cost and a fixed interest rate of 7.95% over the course of the four-year term. We are also targeting closing on this financing in June.

We continue to benefit from a strong credit file highlighted by our 43% debt to total asset ratio as well as our healthy fixed charge coverage ratio. In addition, we have tremendous financial flexibility with 59% of our rents unencumbered as of quarter end.

Now looking forward, starting with the $0.51 of reconcile FFO for the first quarter we do anticipate a sequential reduction in FFO from Q1 to Q2 with roughly $0.05 related to two specific items. The first we expect approximately $0.04 of FFO in the first quarter related to lease terminations including a loss income from those tenants on a go-forward basis. We also expect to incur an additional $0.01 of interest expense in the second quarter associated with writing off the unamortized financing costs related to the construction loan on Center for Life Science. Beyond that we also expect a modest reduction in FFO in Q2 related to the remaining 9% of Center for Life Science costs in being placed into service and higher G&A more than offsetting anticipated lease termination associated with Emisphere just announced.

Looking further out we have discussed previously from Q2 to Q3 we anticipate a reduction in FFO largely driven by the anticipated refinancing activities. Specifically, roughly $0.065 per quarter related to the full quarter effect of increasing the interest rate on $368 million of debt by approximately 600 basis points over the current levels. Plus approximately $0.02 related to the full quarter effect of the amortization of forward starting swaps as I described earlier.

Aside from these items, we generally expect the impact of in-place pre-leasing and modest new leasing to offset the dilution associated with placing our remaining development and re-development projects in service.

Factoring all of this in, based on our increased comfort with respect to the timing and principle terms of the construction loan refinancing, we have elected to narrow our guidance range from a $0.20 range to a $0.10 range. Furthermore, based on the strong first quarter results we have increased our guidance with a new revised range of $1.72 to $1.82 per diluted share. This revised range includes the actual results for the first quarter of $0.56 per diluted share and our estimated results for the balance of the year including any future potential gains associated with potential repurchases of exchangeable notes or future potential gains or losses associated with the forward starting swaps.

Now I would like to discuss the dividend. As we have indicated previously we have a strong bias towards cash distribution to our stockholders as a very significant component of the total return. However, in light of the current market conditions we believe it is more important in this environment to protect and reward our stockholders by further reducing our aggregate debt over time.

Accordingly, commencing with our next quarterly dividend which has not yet been declared we anticipated resetting our annualized dividend rate at approximately $0.44 per diluted share. Of course we will retain the flexibility to evaluate our dividend on a quarterly basis and make any adjustments at those times that are in the best interest of our stockholders to ensure that we comply with our redistribution requirements.

We anticipate using excess cash flow to pay down debt and create value for stockholders by increasing the underlying net asset value. The revised dividend level will results in approximately $76 million annually of retained cash flow that can be used to pay down debt and further enhance the company’s strong liquidity position and ultimately position the company well to be opportunistic in the future.

Now looking at our sources and uses, on the sources front for 2009 we had approximately $32 million of unrestricted cash on hand at the end of the quarter and almost $400 million of capacity on our unsecured revolving credit facility. We have anticipated proceeds of approximately $368 million related to the two financing’s I discussed plus now we expect to retain $38 million of dividend savings related to dividends that would have otherwise been paid in July and October.

On the uses front for 2009, $78 million was just used to settle our remaining forward starting swaps. We expect to use $507 million to repay the construction loan in June and we expect to spend $63 million to complete our development and redevelopment projects. This summary does not include speculative leasing costs which we estimate at a potential $30 million for the balance of 2009. Actual amounts for 2009 and beyond will of course vary upon the pace and terms of leasing activity including the nature of the space that is leased.

As you can see we have sufficient sources to address our anticipated capital needs moving through the balance of 2009 and well beyond. We have throughout our history worked diligently to maintain our conservative capital structure and we have taken this bold step today to further enhance our liquidity position and allow ourselves the flexibility to most effectively operate our business for the benefit of stockholders. We are excited to be in what we consider an advantageous capital position and we appreciate the continued support we have received from our lenders and our investors.

With that I will turn it back to Alan.

Alan Gold

Thanks Kent. I think that is going to conclude our prepared remarks. Operator we can now open the call up to questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Paul Puryear - Raymond James.

Paul Puryear - Raymond James

Alan, last fall as you were looking out into 2009 you made the statement that if funding didn’t loosen up you were going to have some tenant issues sort of the latter part of the year and into 2010. I guess based upon the comments we have heard things are better. Is that a fair assessment? How do you assess the overall situation at this point?

Alan Gold

I think we have had tenant issues and we currently have tenants on our watch list. I think that there is going to be continued positive and negative news that is going to come out of our tenants. I still am very confident that our tenants have sufficient capital to navigate through many of the things we anticipate occurring over the next year but it still looks to us that the capital market is constrained. We don’t see any real acceleration in the access to capital for those tenants. I think we are really very proud and I feel very positive about our existing tenant base and have dealt with the majority of our tenants that we consider to have a weaker balance sheet.

With that statement, I leave with a very positive feeling.

Paul Puryear - Raymond James

Would you identify sort of the two or three highest profile watch list issues you have?

Alan Gold

I think we have identified those. MDRNA still remains to be the top one. We have a very small tenant, about 10,000 square feet with EpiCept and perhaps [Cantura] going through their bankruptcy seems to be the biggest size. That is probably where most of our concern is right today.

Paul Puryear - Raymond James

Turning to leasing, again just to sort of be sure that we are getting the message you are trying to deliver, you are talking about the challenges out there but by the same token you turned in some very good leasing numbers in the quarter and as we headed into the year I know you made the comment that things have picked up relative to sort of the end of 2008. Could you square that for us? Are you still seeing an improvement in traffic? You are ahead of plan. You are confident you are going to achieve the plan. Is that accurate?

Alan Gold

Leasing, the velocity of demand is slowing. We set out a very, I think, aggressive but makable target in leasing. We believe that if the general economy doesn’t significantly deteriorate from here we will be able to achieve that leasing. That is why we continue to forecast that leasing in our numbers. But that all being said, I think what we are seeing is that there is a lot of tenants that are on the fence line of deciding what to do and what not to do. Positive news will move them forward. Negative news will push them backwards. That is what we are trying to explain. We think the leasing is going to be difficult because of the greater economy and it is going to be harder to convince these tenants to make those big decisions that we need them to make in order to move our leasing forward. There is and there will be continued demand for this product type moving forward.

The other thing we are also seeing and I alluded to in our prepared remarks is the increase in sub-leasing activity. While less than 2% of our portfolio is currently potentially up for sub-lease, it creates a situation which makes it very hard for new leasing to occur. It is very hard to compete with existing sub-lease space. So we have to be very cautious about what we think can happen going forward.

Operator

The next question comes from Brendan Maiorana - Wachovia Securities.

Brendan Maiorana - Wachovia Securities

I just wanted to circle up on the sources and uses. If I am looking at it, as you say, for this year and really for next year you are in reasonable shape because you have a lot of capacity on the line, even coming out of pocket I guess $160 million on the Center for Life Science deal plus another $8 million on the swaps. You still have plenty of capacity there so it sort of begs the question what cutting the dividend and retaining more cash flow and paying down more debt over time, how are you thinking about your line over the long-term on that even if it matures in 2011 or 2012 depending on whether or not you extend it versus the secured market and given the roughly 60% of outlay you could get new secured financing?

Kent Griffin

That is a good question. In this environment the credit markets are constrained really across the board and everybody is aware the CMBS market remains effectively dead and the bank market while available is certainly tough and competitive and difficult. The secured lending market outside of CMBS is available but it is not necessarily always at the greatest terms. So we are having to explore all of these things. In adjusting our dividend level it gives us greater flexibility so that we can explore and we do expect to continue to explore various financing alternatives. We are not necessarily going to encumber the entire portfolio overnight either. I think we are going to continue to explore all of our options. We are just going to be opportunistic as we are being with the Town Center Drive financing.

Brendan Maiorana - Wachovia Securities

So to your comments about lowering your debt levels over time is that more additive or do you feel that your capital ratios over a long term horizon are reasonable today but given where the credit markets are you would just like to lower them out of an abundance of caution or do you feel like over time you would like those to migrate lower or in a more conservative manner?

Kent Griffin

I think always, since inception, we have sought to be a conservatively capitalized company. I mean, you may recall years ago we targeted being 30% leveraged when the market was more like 40 and then we migrated closer to 40%. We are at 43% today when the market was more like 50. So we have always sought to be lower leveraged than sort of the industry average and sort of the standards set in the sector. We have always wanted to be less than average. What you obviously see today is companies that thought that 50/50 was fine are finding it harder and harder to operate. While 40-43% is pretty conservative on any kind of historical perspective we think today we would like to be lower and it is hard for us to pinpoint what that target should be. What we do know is we want to continue to improve our liquidity and our leverage profile for some period of time and we will continue to evaluate that as the market evolves over the next several years.

Brendan Maiorana - Wachovia Securities

In terms of the financing question the Center for Life Science deal, how would you characterize the terms of that deal given that it is a primary market trophy asset, large asset relative to sort of your more typical assets which clearly are not quite as large? Are your loan to values higher or lower or your rate terms the same? Just looking for some color there.

Kent Griffin

I think we have sort of two competing factors in terms of how that financing comes about. On the one hand it is the world’s leading research facility and it is in the absolute best location you could possibly have with a tremendous tenant roster. On the other hand, it is an extremely large size in a market where lenders do not want to provide large loans. So if that same asset was a $50 million loan size I think you would get significantly better terms. That said, if it was a traditional office building or traditional lab building you wouldn’t get anywhere near the terms we are getting where we are. I think those two things are sort of balanced out which is why we are talking about a coupon in the high 7’s.

Brendan Maiorana - Wachovia Securities

On PRC on the development schedule I think it listed that your percent in service was 49%. Leased rate around the 25. Are you expensing interest on that 49% in Q1?

Kent Griffin

That is a good question. Yes, you are correct. We had anticipated the entire campus going into service around mid-year. During the first quarter we placed the south side of the campus, buildings 8-10 and the development pads are also in service. So we started capitalization or seized capitalization on that portion of the campus in the first quarter. Ahead of our original expectations. In part recognizing that the leasing environment is more challenged and our expectation is that leasing will take longer.

Brendan Maiorana - Wachovia Securities

Alan, with respect to the stimulus package you talked about the government funding. How do you think the deployment of that capital and trickling through to kind of your major tenant base in both the large biotech and the mid-stage biotech’s how long before you think there is an impact of those dollars getting allocated and having an impact for those tenants?

Alan Gold

I don’t think the large biotech’s or the mid-stage biotech’s those funds will have any impact on them at all. I think that money is going to affect and be directed and it should be directed to the basic research and basic scientists which is going to support the research institutions and the smaller biotech’s that are going to pop out with new technology from that. Our A rated and large biotech’s are well beyond that type of capital need.

Operator

The next question comes from Tayo Okusanya – UBS.

Tayo Okusanya - UBS

CLS and the trimming out of the construction loan in the high 7’s, I understand what you are saying in regard to the overall environment and why the rate is what it is, but it seems to me that trimming it out to the high 7’s but yet the development yield of the project was in the low 6’s. Am I correct with that assumption?

Kent Griffin

Yes.

Tayo Okusanya - UBS

So the project itself kind of has a negative spread at least for the period that you are putting this loan on unless you end up refinancing at some point if the credit markets come back?

Kent Griffin

The answer is yes it has a negative spread during this first financing. Obviously the interest rate holds constant and the yield over time increases. Obviously we will have an opportunity to readdress that as one of the benefits of having a five-year term is you have a better opportunity to readdress the financing sooner rather than the 10-year financing we had considered previously.

Tayo Okusanya - UBS

With regard to PRC and normal leasing activity I think you are generally more cautious on leasing going forward. Can you kind of give us a sense of if you are still seeing prospective tenants visiting the property and kind of what that process looks like right now?

Alan Gold

We continue to see activity at PRC. However, the greater bay area is experiencing a tremendous amount of difficulty. The non-Life Science sector there are a lot of availability. A lot of new products coming on line certainly without much higher basis than PRC but the fact is there is a lot of that product coming on line and in addition to that on a non-Life Science basis there is a tremendous amount of sub-lease space coming on line that hasn’t been fully even reported in the market and it is affecting the demand that exists out there.

On the Life Science space we are continuing to see activity in the sub market. We have had opportunities and are pursuing them but as I said in the past these are large transactions that take a long period of time and PRC is subject to that and the time that it takes to put large transactions together.

We are focused on leasing that space. We are confident that we will be able to be competitive with any transaction out there in that market for space that does come available and for tenants that are interested in space.

Tayo Okusanya - UBS

In regard to the guidance, prior to the new numbers you were at $1.60 to $1.80 you tack on the $0.05 debt extinguishment and the $0.04 of termination fees and then get some slight accretion of a couple of pennies from the CLS being refinanced in mid-year rather than being in the process kind of gets me to a revised guidance of between $1.72 to $1.92. I’m just wondering why the top end of your numbers is at $1.82?

Kent Griffin

The way we thought about the guidance was first and foremost we had to provide a range largely to contemplate the variability surrounding timing of Center for Life Science. The first thing is to narrow the range from $0.20 to $0.10. The second real issue is adjusting our guidance for really the results of the first quarter. The results of the first quarter included an extra $0.05 of gain related to the repurchase of the notes. We then increased our guidance very modestly about $0.02 above that based on some of the lease termination income benefit that we got and the income we would have gotten from those tenants over the balance of the year had we not terminated them. Otherwise our guidance holds relatively constant. Our general expectations generally hold.

Operator

The next question comes from Dave Aubuchon - Robert Baird.

Dave Aubuchon - Robert Baird

I appreciate the comments on leasing but would like a little bit more detail if you could provide it. When you are having your conversations with tenants what is their mindset? What gets them off the fence and make those leasing decisions? The stats you gave suggest that the capital is still there and not only there but increasing. Do you think at the end of the day these companies are just like all the rest out there and they need to see growth in the general economy to actually make those deals?

Alan Gold

I think that is one of the big factors in their decision that they need to see not necessarily growth in the general economy but they need to see that there is a positive capital formation, positive stock market certainly helps them out, positive valuations and increase in their valuations certainly helps them be able to raise additional capital. So that is what they are really looking for. I think that a lot of what is occurring right now is tenants girding themselves for a longer period of time of constrained capital than they have seen in the past. We have seen the typical capital cycle ranging anywhere from 18-36 months and now I think some of the companies, we are already 12-15 months into that type of a cycle or maybe even longer, and I think companies are now thinking it is going to be more like 24-36 months to 48 months. So with that in mind, companies are having a laser focus on their most valuable products and trying to focus their cash resources on that as opposed to trying to bring the next round of new products into the pipeline.

As they see capital free up, as they see valuations increase, as they see other ways of raising capital they will move those other products forward and therefore will need more space. That is the thing that we need to see and I think the tenants need to see.

Dave Aubuchon - Robert Baird

Kent, on the guidance is there any same store NOI forecast implicit in that?

Kent Griffin

We have always assumed some same store growth. We have highlighted the cash because that is the way we think about things. The GAAP same store is a little bit different which is included in our supplement. Our expectations are generally 2-3% and that is generally what our expectations include and we haven’t changed that expectation since the last call or before when we originally gave guidance.

Dave Aubuchon - Robert Baird

So that clearly would assume given the 6% increase in Q1 a pretty rapid slow down for the balance of the year?

Kent Griffin

Well the 6% includes a number of leases that we have executed over the course of the year so some of that is the benefit of new leases being signed and getting the benefit of catch up rent.

Dave Aubuchon - Robert Baird

This is probably the furthest thing from your mind, but the terms that you are contemplating for the CFLS loan do you have the ability to repay that early?

Kent Griffin

We are still working through the specifics of the loan but in general we would expect it to be a five-year term. So we are looking at a fixed rate financing unlike a floating rate with a cap or something like that where you might have an easier opportunity to pay it off sooner.

Operator

The next question comes from John Guinee - Stifel Nicolaus.

John Guinee - Stifel Nicolaus

Nice job Alan explaining a very complicated subject. First, Center for Life Science are the three lenders you are working with are they in the construction syndicate now?

Kent Griffin

One is and two are not.

John Guinee - Stifel Nicolaus

Second, are you contemplating selling any vacancy? I think Alan you did an excellent job explaining sort of the difficulties of lease up but the obvious answer is just to off load some vacant buildings at the clearing price.

Alan Gold

I think as we talk about all of our decisions we look at all opportunities. If an opportunity presents itself and makes sense based on what we perceive is going on in the market then we will certainly look at it. We really don’t have anything held for sale today.

John Guinee - Stifel Nicolaus

From a macro perspective I think you did a great job explaining sources and uses but I think the paramount issue might be really that you have about $1 billion to $1.1 billion of near-term debt maturities with an average cost of capital about 2%. Should we model in 7% on the next go around?

Kent Griffin

Forecasting interest rates is certainly not something we want to do. Clearly I guess if you do step back, 2-5 years ago we used to see more average cost of debt across all the different forms, adjusting for a mix of fixed and floating in the 6% range. Based on what we are looking at with Town Center Drive as a proxy that is clearly today up closer to 8. Do we expect it to continue? I don’t know if we want to speculate which direction it goes from here but from where it looks like today that is where it is.

Operator

The next question comes from Jordan Sadler - KeyBanc Capital Markets.

Analyst for Jordan Sadler - KeyBanc Capital Markets

Kent, does the same store and a lot of the cash number does that include lease termination fees?

Kent Griffin

No.

Analyst for Jordan Sadler - KeyBanc Capital Markets

So that is a clean number?

Kent Griffin

Correct.

Analyst for Jordan Sadler - KeyBanc Capital Markets

Moving back to guidance I just want to make sure I have this correct, none of your underlying assumptions changed. It is basically just now you are in a range to $0.10 and accounting for the one-timers?

Kent Griffin

I don’t think it is fair to say none of our assumptions changed because we are obviously doing a fairly detailed review on a property by property basis. As we have leasing success and as we get more information and as terms change we put all of those factors in the mix. In aggregate, collectively there hasn’t been a material change. We have had more success early from the leasing front but our expectations with respect to the balance of the year we think it is going to be a lot tougher so those things have generally offset.

Analyst for Jordan Sadler - KeyBanc Capital Markets

On the swap, modeling that in you said it was going to be 1.7 million starting in July. Is that going to be quarterly for a certain amount of time?

Kent Griffin

It was roughly $1.7 million upon conclusion of the financing. So it actually starts if we meet our expectation of closing in June it would start at whatever point we closed that financing. There could be some leakage or dilution in the second quarter depending on the timing of when we close. The first full quarter effect would be Q3 where you would have $1.7 million per quarter for the next 10 years.

Analyst for Jordan Sadler - KeyBanc Capital Markets

Does that run through FFO?

Kent Griffin

It does affect FFO. We would adjust it for AFFO because the cash is out the door already. There is no recurring cash obviously.

Analyst for Jordan Sadler - KeyBanc Capital Markets

You are totally covered on the swaps? There is no other trench that could come that you need to settle?

Kent Griffin

They are settled. If the timing on when we close the permanent loan changes it could affect a little bit the amortization but at this point I would stick, or we are sticking with the assumption of $1.7 million per quarter beginning some time late June.

Analyst for Jordan Sadler - KeyBanc Capital Markets

Alan, the last question you kind of touched on it briefly with the competing space for PRC. Have you quantified how much the Sun Oracle merger would put back on the market and whether that would be real competitive space to PRC or just more traditional office?

Alan Gold

First, we are monitoring it very closely as we are monitoring the entire market very closely. If more office space in that area comes on line for lease or sub-lease it would absolutely compete directly with our office space we have available at PRC. But keeping in mind that when we talk about laboratory we have built only 30,000 square feet of lab there and the balance is just shell to be built out either as lab or as office depending on the demand. So more office space coming on line would compete with our office but not with the lab side.

Analyst for Jordan Sadler - KeyBanc Capital Markets

Have you talked to Day Star? Are they eligible for any of the stimulus package with the alternative energy at PRC? How good do you feel about them?

Alan Gold

We think they are in the right sector with the alternative energy. There is a tremendous amount of funding for alternative energy coming out of the stimulus package. We believe that their end users of their product will have direct access to the stimulus package. We haven’t heard directly from them that they are receiving any stimulus funds.

Operator

The next question comes from Dave Rodgers - RBC Capital Markets.

Dave Rodgers - RBC Capital Markets

On the Center for Life Science refinancing do you think that at lower terms or reduced terms to you that you might have been able to get more proceeds or just given the financials of the market that is where the deal is going to get done?

Kent Griffin

I think based on where we are in this credit market and doing a loan of this size I think we are getting the most efficient terms.

Dave Rodgers - RBC Capital Markets

Any covenant constraints or anything related to refinancing on that loan?

Kent Griffin

No.

Dave Rodgers - RBC Capital Markets

With respect to your overall guidance, from original guidance you gave late in 2008 to the current guidance now what was the embedded improvement in FFO related to the delay in Center for Life Science refinancing partially offset by the higher rate?

Kent Griffin

As you probably recall our original guidance we were expected to launch the whole financing effort earlier and close some time in the first quarter and now we have pushed it out to the second quarter. So we did get the benefit of not having refinanced that earlier. That was offset by the fact that the terms we are talking about are significantly higher rate and more importantly the swap liability moved up dramatically. So when we gave our original guidance the swap had been $22 million and less leading up to that. Ultimately we settled for obviously a lot higher and that has a significant implication on a quarterly basis.

Dave Rodgers - RBC Capital Markets

Can you quantify any changes that might be embedded in your FFO with respect to slower leasing? You have been clear on the call that leasing has been good but slow and we have seen leases like Regeneron and Emisphere which net/net is a good thing for BioMed and not to take away from that. Given that wasn’t contemplated but is now part of that million square feet does that have a or what is the quantification of that impact on FFO for 2009?

Kent Griffin

I think in aggregate as we have said we are ahead on leasing for the first two quarters but we haven’t increased our expectations with respect to aggregate leasing because we do think the leasing environment if you look back from where we are now to where we were in September, six months ago, it is a very challenged world. We think it is appropriate and prudent to keep our leasing expectations in check for what we think is going to be a tougher environment. So if we had accomplished what we have accomplished over the last few quarters and the environment looked like it did a year ago we would probably be raising our guidance further.

Dave Rodgers - RBC Capital Markets

With respect to the Regeneron space coming due in the third quarter I am assuming that is still coming due I think in July. Any prospects for re-leasing that or any ability or desire on Regeneron’s part to stay in that wall to expanding to Phase II?

Kent Griffin

I think we are expecting them to roll out of that space. That is in our expiration schedule and we would not expect that to renew as Alan mentioned. They have agreed to take over the Emisphere space. In exchange for that we have allowed them off the hook for 40,000 square feet that they were going to take. Beyond that we don’t expect them to take any additional space at the current time.

Dave Rodgers - RBC Capital Markets

Prospects for re-leasing that space? Will that stay in the operating portfolio or be in any type of redevelopment going forward?

Kent Griffin

No that will stay in our operating portfolio.

Dave Rodgers - RBC Capital Markets

With respect to sub-leased space Alan you were clear about Northern California. Can you address anywhere else that sub-leasing may be affecting you directly or indirectly?

Alan Gold

I think the economic situation affects all parts of the country. I think all parts of the country are being affected by sub-leasing opportunities. I think every market has some sort of sub-leasing activity going on. Certainly for office and for laboratory space.

Operator

You have a follow-up question from the line of Tayo Okusanya – UBS.

Tayo Okusanya - UBS

Just a quick couple of follow-up questions. Arena, just given the restructuring that companies are going through right now, any particular reason why they took additional space in the first quarter?

Alan Gold

I think if I heard the question right the question is Arena is going through restructuring. They have taken some additional space from us and how those two things mesh together. Right? One, the space was recently completed and they had already planned on what we believe is moving their headquarters from one building into this space. So we think they are going to continue to do that. More importantly, I think Arena is a very viable company with a very viable product with a very strong pipeline. They are going to continue to grow over time and what they are doing is just preparing themselves so that they have sufficient time to get through the next set of milestones so that they can continue their growth. We are very excited about what is going on with Arena. We think they are doing the right thing with staying at runway. At the same time we believe that this new space will make their operations more efficient.

Tayo Okusanya - UBS

You didn’t build this building specifically for them did you? This was a spec building correct?

Alan Gold

Yes.

Tayo Okusanya - UBS

It was a spec building when they moved into it?

Alan Gold

You are breaking up a little bit but I think the question is it is a spec building. Effectively this is an agreement we entered into some time ago where they had the opportunity to and actually I think we disclosed this when we bought the original buildings for Arena and we included some detail about this in our K’s or Q’s back then. Effectively we agreed that if they expected to need the expansion space at the time and so we agreed at the time that if they did build it out we would buy it from them effectively and they would enter into this lease.

Tayo Okusanya - UBS

So this is kind of like more of a sale lease back with them?

Alan Gold

Correct.

Tayo Okusanya - UBS

CLS, if you end up not going through with the refinancing can you just remind us what terms you could extend the loan?

Kent Griffin

We have a one-year extension option.

Tayo Okusanya - UBS

There is some type of pay down?

Kent Griffin

We would expect to pay it down. It is a formula based on the actual operating costs at the time and a debt service coverage ratio. We expect if we were to make that pay down it would be in the $75 million or more range. Obviously we don’t expect to exercise that extension. We expect to do the financing.

Tayo Okusanya - UBS

The swaps, it is based on the termination of the $0.02 hit to FFO every quarter for the next ten years correct?

Kent Griffin

Correct.

Operator

The next question comes from Dave Rodgers - RBC Capital Markets.

Dave Rodgers - RBC Capital Markets

I think you said earlier that you have received a small amount of stock either in lieu of or as a deposit for rent. How is that treated from an accounting perspective on a quarter-to-quarter basis?

Kent Griffin

We record it at the basis of the time we receive it. What we have received is in aggregate diminimous. Less than $1 million I believe. Changes in that would be mark-to-market but the fluctuation would go through OCI and would not reflect our earnings. No, it would not impact earnings unless we were to sell the shares.

Dave Rodgers - RBC Capital Markets

So the underlying space though you would then cease to recognize revenue again, small to date, but if it got bigger you don’t recognize revenue on the space while holding those shares?

Kent Griffin

The consideration for the shares is a different issue than revenue recognition going forward. We have already recognized the lease termination income related to the consideration that was paid in form of both cash and shares.

Dave Rodgers - RBC Capital Markets

So in the case of MDRNA there is no recognition of revenue beginning in the second quarter with respect to that space?

Kent Griffin

No.

Operator

This does conclude the question-and-answer portion of the conference. I would now like to turn the call over to Mr. Alan Gold for closing remarks. Sir you may proceed.

Alan Gold

With that I would like to thank you all for joining us here today and we look forward to talking with you soon for the second quarter call. Thank you all.

Operator

Thank you for your participation in today’s conference. This does conclude your presentation. You may now disconnect and have a great day.

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Source: BioMed Realty Trust, Inc. Q1 2009 Earnings Call Transcript
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