Cogdell Spencer Inc. Q1 2010 Earnings Call Transcript

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 |  About: Cogdell Spencer Inc. (CSA)
by: SA Transcripts

Cogdell Spencer Inc. (NYSE:CSA)

Q1 2010 Earnings Call

May 7, 2010 10:00 AM EST

Executives

Jim Cogdell – Founder and Chairman

Frank Spencer – President and CEO

Chuck Handy – SVP, CFO and Secretary

Scott Ransom – President, Cogdell Spencer ERDMAN

Analysts

Michael Bilerman – Citi

David Shamas – Citi

Karen Ford – KeyBanc

Dan Donlan – Janney Montgomery Scott

Tayo Okusanya – Jefferies

Buck Horn – Raymond James & Associates

Jordan Sadler – Keybanc Capital

Operator

Good day and welcome to the Cogdell Spencer Incorporated first quarter 2010 earnings conference call and webcast. All participants will be in a listen-only mode. (Operator Instructions). After today’s presentation, there will be an opportunity to ask questions. (Operator Instructions). Please note that this event is being recorded.

I will like to turn the conference over to Dana Crothers. Ms. Crothers, the floor is yours ma’am.

Dana Crothers

Thank you. And welcome to Cogdell Spencer’s first quarter 2010 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 in the Investor Relations section. Additionally, we are hosting a live webcast of today’s call, which you can access in the same section.

At this time, we would like to inform you that certain statements made during this conference call, which are not historical, may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Although Cogdell Spencer believes the expectations reflected in any forward-looking statements are based on reasonable 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 would like to begin the call with Jim Cogdell, our Founder and Chairman of the Board. Jim?

Jim Cogdell

Good morning. Welcome to our first quarter 2010 earning call. Joining me this morning are Frank Spencer, Chuck Handy, and Scott Ransom. After our review, we will be available to answer your questions.

It seems like just yesterday, we were here with you discussing the closeout of 2009. But a lot has happened with healthcare and at Cogdell Spencer ERDMAN. In these few short months, district legislature was passed and a huge overhaul to the healthcare insurance system is underway. Many articles have been published since the March discussion. Decision discussed in the potential benefits, shortfalls, and changes this could bring to healthcare and real estate.

Before we discuss the first quarter results, I want to acknowledge the announcement earlier this week concerning our leadership transition. As you all know, Frank Spencer will be stepping from daily responsibilities as the CEO at the end of October. Frank has provided outstanding leadership for us through the years and I am happy to say he will continue as a member of our Board.

While I am announcing this know, Frank has provided us with a transition period that will minimize our efforts on company operation. We have created a search committee led by Chris Lee, the Chairman of our Compensation Committee and the Board intends to conduct a national search to bring the very best talent to the CEO role.

At this point, I would like to turn the call over to Frank Spencer, now to give us a detailed review of the quarter and talk about some existing projects we have got coming on line.

Frank Spencer

Thanks Jim. Good morning, thank you every one for joining us today. Before we get to the review of the quarter, I would like to take a moment to address my transition that was announced earlier this week.

The first thing I wanted to remind everyone of is the timeframe in which this exists. While we have only been a public company for not quite five years, I have been in this chair for almost 15 years. And so, I have reached a point where there are other things that I want to pursue in my life, other interests, some business, some non-business, and realized that the CEO role is so demanding that that really can’t be done without creating an intentional transition period.

I feel comfortable in doing this, because we have an outstanding team of men and women here at Cogdell Spencer-ERDMAN. The operations group, the department heads, all those who work in every aspect of our business are the best the industry has. They don’t really need my guidance on a day-to-day basis for the operations. They are the experts themselves. And so, I feel very confident in the timing of this transition, because of the outstanding team we have in place.

So this announcement is good for me. It provides me with some things I want to be able to do in my life. But I think we have also done it in a way that’s best for the company. We have created a transition period. I will remain as part of the Board and continue provide vision and strategic leadership. But we will have the opportunity to bring in new energy and new excitement and new vitality into the CEO role. And so, I am very excited about that and think it’s in the company’s best interest as well.

I remain committed to our franchise, our value proposition, and I am thrilled that I will be able to be a part of that going forward. And I am confident that we will continue to excel in the healthcare facilities, design build, investment and management business.

With that, let’s turn to first quarter. We are extremely pleased with our $11.1 million FFOM reflecting a per share FFOM of $0.22, and a 38.3% increase from the first quarter 2009 normalized FFOM of $8.1 million. We achieved these outstanding results through continued team effort to control cost, strengthen our portfolio through client relationships, and another quarter of substantial margins in design build.

We saw positive variances during the first quarter across our platform and throughout our G&A expenses. In fact, we have seen continued improvement in our financial results in each of the last four quarters. Revenue income from operations, net income, FFOM, interest coverage and fixed charge coverage, all stand at better levels quarter-over-quarter. Chuck will go through some of those details shortly.

We are reaffirming guidance for 2010 FFOM to be in the range of $0.42 to $0.50 per fully diluted share and unit. While we are pleased with the outsized margins of the first quarter, we do not expect this trend to continue through 2010. During the first quarter, we closed out a number of third-party contracts where profits were fully recognized in the P&L.

As we move through the balance of the year, an increasing percentage of our activity will be for our own balance sheet, and thus, we will see a reduction in overall costs yielding a higher overall return on our assets, but no higher FFOM in the short run. Those benefits will be recognized in future years as development projects come on line.

In March, we opened Medical Center Physicians Tower in Jackson, Tennessee, a 106,000 square foot medical office building and ambulatory surgery center. We were the developer on the project and currently hold 100% ownership, although we are offering for sale 50% interest for the hospital and/or physician groups practicing in the facility. The project is currently 75% leased and we are in negotiations that would lease up all of the remaining space.

We have a pipeline of active projects and advance planning, design build, and development in various stages. Just last week, we signed a contract for $17.7 million on the Bonney Lake project in our Northwest region. A press release went out on that project yesterday. Additionally, we will be moving forward on a second project in the Northwest. That on-campus project represents another $24.7 million breaking down in Q2 for a total development investment of $42.4 million. We will be announcing other build-to-suit investments as the year unfolds.

Occupancy for the first quarter dipped slightly to 90.6%. This was budgeted for and due in part to known lease expirations. And in many cases, the occupancy drops in specific projects are temporary. For example, our professional office building 1 in Augusta, Georgia is a case where 14,000 square feet are currently under renovation with the lease signed, but the tenant will not occupy until the conclusion of the upset during the third quarter. As is our policy, we only report occupied lease not just leased occupancy.

At Rocky Mountain Medical Plaza, we are currently completing a full design build and construction outfit on an incremental 7,000 square feet for the (inaudible) Clinic, another example of occupancy in progress.

With that said, I would like to turn things over to Chuck Handy, for a more in-depth look at the financials. Chuck?

Chuck Handy

Thanks Frank, and good morning, everyone. As noticed in our – or noted in our earnings release, FFOM for the first quarter was $11.1 million or $0.22 per share in unit. Net income for the first quarter was $3.3 million or $0.08 per share. Our total revenue for the first quarter totaled $57.6 million. Rental revenue for the quarter totaled $21.2 million; while revenue related to design build contracts and development totaled $35.5 million. Property management and leasing fees as well as expense reimbursements totaled approximately $800,000 for the quarter.

Selling, general, and administrative expenses for the first quarter totaled $5.8 million, which included approximately $2 million of corporate G&A. Although our first quarter actual G&A would suggest a lower amount on a run rate basis, we continue to expect corporate G&A to be approximately $9 million for 2010, exclusive of expense related to retirement benefits for Frank Spencer. This is due to primarily to the cyclical nature of certain G&A expenses between quarters, particularly with professional fees.

At March 31st, approximately 83% of our debt was at fixed rates and our average interest rate on real estate mortgages was approximately 5%. Our total debt had a weighted average term of approximately 3.6 years. And we had $80 million outstanding on our $150 million revolving line of credit at quarter-end.

For the first quarter, our interest coverage was 3.6 times and our fixed charge coverage was 3.0 times. On April 21st, we paid a dividend for the first quarter of $0.10 per share to shareholders of record on March 26th. At March 31st, we had approximately 635 leases at our consolidated properties with an overall occupancy of 90.6%. No single tenant accounted for more than 7.1% of annualized rental revenue.

Tenant improvements related to second-generation leases totaled approximately $208,000 or approximately $0.06 per share across our consolidated portfolio for the quarter.

Now let me speak to our 2010 earnings guidance. We expect FFOM per share and operating unit for the year to be in the range of $0.42 to $0.52 per share in unit, which excludes a one-time after-tax charge to compensation expense of approximately $2.6 million or $0.05 per share in unit, which will be recorded during the second quarter related to Frank’s retirement.

Now I would like to turn it now to Scott Ransom to give us a quick review of our design build business and pipeline. Scott?

Scott Ransom

Thanks Chuck, and good morning. As we worked through the first quarter of 2010, we are very pleased that we have been able to continue to recognize better margins in the design build business. Through our focused project management and oversight program, we have seen very positive results on this end. They will fully expect that we will see a return to historical margin levels as we progress through 2010.

We will continue to aggressively pursue our dual strategy of third-party design build work and design build projects for our own balance sheet. Two such projects for our own balance sheet, Brandon, Mississippi; and St. Cloud, Minnesota are both on track for completion this quarter, closing out these projects and bringing new products on line. We are exploring several deals currently that would fit into both third-party design builds and on balance sheet categories.

Two additional projects that include joint ownership as Frank previously mentioned are our new project set to break ground this quarter in Washington State. Good Samaritan Hospital will serve as the anchor tenant of a three-storey MOB in Bonney Lake, Washington, leasing approximately 35% of the rentable space. They will also hold 1% ownership in this project and a joint venture with private physicians owning 37% and Cogdell Spencer ERDMAN owning the remaining 62%.

Good Samaritan Hospital will offer specialties including internal medicine, E&T, OBGYN, orthopedics, and physical therapy with onsite laboratory and pharmacy. Anticipated private physician practices include primary care, pediatrics, ophthalmology and dermatology, foot and ankle, imaging and diagnostics, and oncology. The project located on 4.75 acres in Bonney Lake, Washington is a 100% preleased and scheduled for completion in summer 2011.

A second four-storey project with Good Samaritan Hospital will be breaking ground this quarter in Puyallup, Washington. This 83,700 square foot MOB has a total contract of approximately $24.6 million and it’s also scheduled for completion during summer 2011. Good Samaritan Hospital engaged Cogdell Spencer ERDMAN in late 2008 to develop and own these two facilities. MultiCare Health System is the owning entity of Good Samaritan Hospital and will serve as the anchor tenant of this facility as well leasing approximately 38% of the total leasable space.

Good Samaritan Hospital will offer services including family practice, OBGYN, orthopedic surgery, pain management, neurology, and neuro surgery, pulmonary imaging and diagnostics. The facility will also house an unsigned pharmacy and laboratory services. Good Samaritan Hospital is a not-for-profit 225-bed acute care facility fully accredited by the Joint Commission on the Accreditation of Health Care Organizations. The Puyallup facility is intended to quality for LEED Silver Certification upon completion and will include a 47-space underground parking garage for private physician use.

With that, I would like to go back to Frank to wrap up, and we will take any questions you may have.

Frank Spencer

Thanks, Scott. A lot of exciting things going on in our Northwest region, and we are very happy about where the development pipeline is headed.

With that, operator, I would like to open up the call to any questions.

Question-and-Answer Session

Operator

Yes sir. We will now begin the question-and-answer session. (Operator Instructions). And the first question we have comes from Michael Bilerman with Citi. Please go ahead, sir.

Michael Bilerman – Citi

Yes, good morning. David Shamas is on the phone with me as well. Jim, I was wondering if you can provide some perspective. In the fourth quarter, you announced that you had gone through a strategic alternative process and it spent $2.6 million which is a lot of money to just maintain the course and not have any outcome. And now with Frank’s retirement and paying out another $2.2 million, it’s almost $5 million that has been spent. And now the company has to go through a search process, not have a CEO and has some dislocation. And I am just wondering, what happened in the fourth quarter that if you decided to remain independent, why there wasn’t a commitment from have a CEO? And if you knew there wasn’t going to have that commitment, why not have a process in place at that point or gone down the road and actually sold the company? And so, can you just help us understand the process of events and the money that has been spent to date?

Jim Cogdell

Well, let’s work in reverse. On the decision of the $2.2 million to Mr. Spencer, Frank and the Board worked out a transaction which was best interest to – for Mr. Spence and best interest for the company. And as you have been heard and told by Mr. Spencer, he will continue on – on the process with us through October of next year in the day-to-day operation.

Frank Spencer

October of this year and stay on the Board.

Jim Cogdell

And Mr. Spencer will stay on the Board. As to the transaction of the last quarter, I think we answered that. We just felt, the Board felt it was the best interest not to pursue any long with that direction.

Michael Bilerman – Citi

But I am still confused. You spent $2.6 million, which is not an insignificant amount. And if you look at the proxy from this year and all respect to Frank and I certainly respect all the work that you have put in and deserving of a payment, but if you resign with – if you resign from the company, you are entitled not to get anything. So I am just trying to think about leaving the company, having made the decision in the fourth quarter and effectively leaving the company, and all the money that was spent. I mean $5.2 million, the combination of both charges relative to an enterprise value of $750 million is a lot to sort of maintain the course and be without a CEO. Well, I am just trying to figure out, what did you – what have you – how does that all fit together?

Jim Cogdell

Frank was looking to me and I think Frank wants to answer that.

Frank Spencer

Mike, I think the analysis of trying to put those two things together I think is the improper analysis. The strategic process that we discussed last quarter and obviously shared in our financial results was a decision by the Board that the entire Board is supportive of that it was in the company’s best interest to remain independent going forward. That was a discreet decision and we have certainly talked a lot about that on past calls and in past conversations.

The decision on my retirement from the company and the desire to create a transition period for the company is a completely independent decision. And so, I think the wrong analysis to tie those two things together and the agreement that we have reached serves my needs, but it’s also in the best interest of the company. And the Board and I worked together to develop that agreement and we have provided that to you in 8-K, and I think it’s pretty straightforward.

Michael Bilerman – Citi

So, I guess you are saying at the time you decided to remain independent in the fourth quarter, you Frank did not – you at that point thought you were going to be there for the long term and that’s what the Board thought, because ideally if you want to – if the Board decided they want remain independent, they knew they were going to have to have a CEO in place for, I would assume at least the next five years. That decision process, you are saying is a more recent development in your mind that has zero tied to the process you went through in the fourth quarter?

Frank Spencer

That is correct.

Michael Bilerman – Citi

And in terms of the process to go by, replacements, is there an internal process, an external process? What’s – how will that occur?

Frank Spencer

The Board has created a search committee that Chris Lee is the Chairman of the Search Committee. I will have input, but I think it’s very important that the Board select my successor, so I am not a member of that Search Committee. It will be – we will be engaging a search firm and we will have a national search to bring the best talent to the company. And I am excited about the new energy that portends.

David Shamas – Citi

Hi guys. This is David Shamas. If I am looking at your guidance correctly, it basically implies that there is no design build FFO for the remainder of the year. I am just wondering how realistic of an assumption that is? And then, also, how would you get to the low end of your range?

Chuck Handy

Well, I think one thing to consider and to think about on our design build, and I think we talked about this last quarter, certainly is with respect to current earnings as we are – and we are developing more and design building more assets for our balance – for our own balance sheet. Those design build profits will be eliminated in determining FFOM. So I think that’s one – certainly one factor that that you got to keep in mind in looking at the annual guidance.

So as we go through 2010, there will be a larger mix or a large component on a percentage basis certainly of development for our own balance sheet versus third-party design build which will, of course, would be accounted in earnings. So I think that’s one significant factor to – that needs to – that everyone needs to keep in mind with respect to our guidance.

Frank Spencer

Now, you will see those revenues reported in our segment reporting before elimination.

Chuck Handy

That’s correct.

Frank Spencer

But it doesn’t show up in FFOM.

David Shamas – Citi

Thank you guys.

Operator

The next question we have comes from Karen Ford with KeyBanc.

Karen Ford – KeyBanc

Hi, good morning. Just another question on the CEO search process. What are the primary talents are you going to be looking for? Are you looking for someone with MOB experience, public company experience, REIT experience? Well, how do you rank what you will be looking for in the new CEO?

Frank Spencer

The Committee will develop that – those criteria with the search consultant and it wouldn’t be appropriate for us to conjecture on that right now.

Karen Ford – KeyBanc

Okay. The new developments, can you talk about what your expected yields are going to be on those and what the funding plan is?

Frank Spencer

I will talk a little bit about the yields and then let Chuck talk about the balance sheet side of things. Both of these projects are being built to low 9s kind of yields. And then, the ultimate resulting return Karen as we have discussed in the past, becomes a function of what kind of margin we are able to experience in the actual production of the product, because this is the positive flipside of the FFOM discussion, how ever much money we make by using our integrated delivery platform ends ups being a reduction in cost. And so we know going in that the yield will be higher than those low 9s. The final outcome of explicitly what the yield is, is determined in the actual billed out of the job. But we would certainly expect both of those projects to end up easily into a double-digit unlevered yield for our shareholders.

Karen Ford – KeyBanc

Okay.

Frank Spencer

Chuck, you want to talk about the balance sheet?

Chuck Handy

Sure. And with respect to the financing of the two projects, of course, one of our internal criteria is we don’t start pay new development project, unless they are substantial preleasing which, of course, is the case here.

But also, we won’t start unless we have construction loan commitments in place or in hand, and those certainly are in place. And we have 65% of cost that we can draw on those loans and those construction loans.

And then, also, of course, as Scott mentioned, there is equity coming from physician investors as well. So – but construction loans are in place for both of those projects or commitments are anyway.

Karen Ford – KeyBanc

Great. Can you tell us how big the pipeline is for both third party, ERDMAN design build business as well as the pipeline for on-balance sheet? And whether that – those pipelines have trended bigger or smaller recently?

Scott Ransom

Frank, you want me to take that one?

Frank Spencer

Sure. Jump in.

Scott Ransom

Hi Karen. I would say and we have talked about this on a few of the previous calls instead from a momentum and an uncertainty standing in dealing with literally several dozen clients on a daily basis is I think we are in a much better position from a design making and confidence than we were in the first quarter of 2009 when there was essentially a lot of nervousness and almost panic about capital, economy, healthcare reform. And so, I would say that we are trending upward there.

I think we are – we have mentioned in our previous calls, we are seeing a lot more engagements in where we are actually starting to really do the planning. As you know, there is a long gestation period, you are making 30-year plus type decisions to get into market. So – but we will certainly see that trending upward. And when we got back to the level of 2008, it’s going to take a little bit of time, but from that standpoint, we are seeing an increase in pipeline in consulting agreements that lead to MOBs and third-party design build contracts.

And we are also seeing a significant amount of increase from this time last year in our targets and opportunities where I would say we are down to two or three firms being selected and some times, it’s just making a decision, we are already the lead horse. So from there, I see a real positive momentum. It comes down to when you actually try to roll forward and project your revenues by month, it’s still depending on those types of decisions and pretty long gestation periods.

But overall, I would say there is very positive trends when you look at it year-over-year. And yes, on balance sheet, I would give you a kind of a rough estimate of what we are looking at right now is somewhere around a third would be on balance sheet and two-thirds would be direct design builds for third parties.

Karen Ford – KeyBanc

It’s helpful.

Scott Ransom

We are really – we have consciously said we are not going to at least speak to the public, publishing those numbers on a quarterly basis.

Karen Ford – KeyBanc

Okay. Just a question back on the guidance and sort of the run rate. And our numbers too it looks like ERDMAN’s EBITDA would have to be zero to hit sort of the low-to-midpoint of your guidance today. Is that feasible given sort of the revenue backlog and with the margin trends that you guys talked about or do you think we will see positive EBITDA from – in ERDMAN from here?

Scott Ransom

Chuck do you want to grab that one or do you want me to?

Chuck Hardy

I will be happy to jump in. I mean, I think Karen what the – as you guys all know, we have provided annual guidance and we have not tried to provide quarterly guidance. And I know that makes it a little bit harder for your models that needs some kind of quarterly input. But the fact of the factor is, is that our overall guidance for the year took into account obviously the on-balance sheet projects that we just announced and others that we are working on and expect to announce through the year.

But the fact that we are announcing the first two now here in May lets you know that the on-balance sheet development was backend loaded and that the close out of third-party contracts in the first quarter is something we also knew about. And so, we are still in the same range of guidance on ERDMAN, not because the design build business in anyway is losing money going forward, but you got a fundamental shift in the mix of the timing.

And I think what you will see as the year unfolds is that the segment reporting is really the place to keep your eye on, because you will see revenues that then get eliminated from our FFOM. But it’s really driven by backend development on balance sheet activity, whereas the frontend of the year had a much higher mix of third-party development.

Karen Ford – KeyBanc

Okay.

Operator

And the next question we have comes from Dan Donlan with Janney Montgomery Scott.

Dan Donlan – Janney Montgomery Scott

Thank you, good morning.

Frank Spencer

Hi Dan.

Jim Cogdell

Hi Dan.

Dan Donlan – Janney Montgomery Scott

So can we go to the guidance here? Are you guys still confirming that your total revenues for ERDMAN will be essentially flat or is that changed at all?

Chuck Hardy

We are – the reported revenues, once the eliminations are done will yield a lower revenue than was reported last year.

Dan Donlan – Janney Montgomery Scott

Right.

Frank Spencer

The overall activity in terms of total production, we are still in the flat to slightly down as we talked earlier that 10 would be the bottom of the trough.

Dan Donlan – Janney Montgomery Scott

Okay. So ERDMAN’s definitely free cash flow positive. It’s just once we refactor in all these what you are doing on balance sheet, I think that’s why it’s kind of look like it would be unprofitable, it’s just because of the on-balance sheet stuff.

Frank Spencer

ERDMAN is definitely cash flow positive.

Dan Donlan – Janney Montgomery Scott

Okay. Second point, I guess, Chuck, could you talk about the taxes that were recognized in the first quarter and what was driving that and what we can expect there going forward?

Chuck Hardy

Yes, I – sure. And this is sort of a GAAP – I will give you a GAAP answer. The – certainly, the – I think we talked about on the last call the fact that trying to helping with preparing models and all that. $15 million of EBITDA is kind of the breakeven point on taxes. To the extent we have in excess of $15 million, we will be paying taxes on roughly 40% of that excess. To the extent we are below $15 million, then there wouldn’t be a tax liability.

Certainly in the first quarter, we had – I think our NOI anyway or which is probably most closely recorded number we have to EBITDA is about $7.5 million. And the way a tax provision works for GAAP purposes is as you look at it on a standalone quarter basis, what you did in the quarter, look at that what it would – you look at that in terms of what it would be on an annual run rate. And then you apply tax – you apply a tax rate to that within the quarter.

Dan Donlan – Janney Montgomery Scott

Okay.

Chuck Hardy

So as the quarters change and as taxable income quarter-by-quarter changes, then that tax provision will be looked at sort of both on the – for the quarter, but also in context of the annual results, and I know that’s a bit of an involved answer. But sometimes GAAP – the GAAP answer is not necessarily intuitive, but it’s just quarterly – from a quarterly tax provision standpoint, it’s a little – it can be a little counterintuitive.

Dan Donlan – Janney Montgomery Scott

Okay, that’s very helpful. And then on the Brandon, Mississippi project, that went from a total cost of about $13.9 million to $16.4 million. What’s driving that?

Chuck Hardy

There was some incremental up fitting build out that signed, some additional work that wasn’t contemplated in the original budget, in the original investment. And so we had some – that’s really all turned up fitting with the footprint or the fundamental project was not changed, it’s just that there was additional up fitting added in answer to tenant needs.

Dan Donlan – Janney Montgomery Scott

Okay.

Frank Spencer

For which were being paid.

Chuck Hardy

That’s correct. So that’s a good capital outlet if we get an incremental return on.

Dan Donlan – Janney Montgomery Scott

Okay. And then, when did the Medical Center Physicians Tower start paying rents?

Chuck Hardy

That – let’s see.

Frank Spencer

I think that was March 1st

Chuck Hardy

It was in March and I won’t say it was March 1st.

Dan Donlan – Janney Montgomery Scott

March 1st.

Chuck Hardy

It just started at the end of the first quarter.

Dan Donlan – Janney Montgomery Scott

Okay. And then, you said that you have got – you announced the one development and then you announced another one, but I don’t think there was a press release out on. That second development, is that in Washington, that’s $24.6 million?

Frank Spencer

Yes.

Scott Ransom

Yes, Puyallup.

Dan Donlan – Janney Montgomery Scott

And did you – how – what percentage of that was preleased?

Frank Spencer

It’s 73% preleased right now.

Dan Donlan – Janney Montgomery Scott

Okay. And, I guess going back to Karen’s question, if we look at – forgetting the lower – when you recognize and see that lowers your cost basis in the projects. If that didn’t – and let’s say that didn’t occur, are you trajecting like a 9% to 10% GAAP yield on those projects, on total costs?

Frank Spencer

Yes.

Dan Donlan – Janney Montgomery Scott

Okay. Alright, that’s it from me. Thank you.

Operator

(Operator Instructions). The next question we have comes from Tayo Okusanya with Jefferies.

Tayo Okusanya – Jefferies

Yes, good morning, everyone. Just a couple of questions. Back to the tax question. Thanks for that clarification of looking at it on a standalone quarter basis. The question I have is as the quarters progress, for example, if it’s second quarter, do you just look at second quarter in a standalone basis as well or do you kind of look at cumulative first and second quarter and then annualize that number to come up with the reserve?

Chuck Hardy

It’s the latter. It’s the latter. So as we go, we will see what taxes – as we go through the year, we will – you will look at what the year-to-date results are. You will look at what taxes had been provided through that point in time. And then, in essence, it’s a true-up if you will, if you want to look at it that way to provide the right provisional accumulative basis or a year-to-date basis at that point in time.

Tayo Okusanya – Jefferies

Got it, that’s helpful. And then, again, I hate to beat the dead horse. But as you can tell from the call, a lot of question is just about the guidance. It is – I understand the idea of – in the first quarter, a lot of what you had was the third-party developments, that all accounts towards your bottom numbers. I understand the idea that – way down in the year, you are projecting most of what you are licensed to do will be on balance sheet and gets eliminated. But there is a lot of positive commentary coming from you in regards to the outlook for the ERDMAN business. Hospitals themselves, now that healthcare reform has now been resolved, being a little bit more proactive with regards to looking at the MOB development.

And just like Karen and some of the other analysts on the call, what we kind of do a back-of-the-envelope that also suggest that for the next three quarters, the ERDMAN business will basically generate zero earnings for you. It’s just very hard to reconcile that idea versus everything you have said and everything we are hearing in the market that there will be additional third-party businesses, because if that does end up being the case, that’s going to be extremely disappointing in my view in regards to the ability of CSA to actually land business, because that would more or less imply to me you are losing market share and the business is going elsewhere.

Frank Spencer

I don’t think that is the intent of our communication. What we are saying to you is that we are one quarter into the year. We provided this guidance in February. We don’t think it’s appropriate to change the annual outlook, because we know our – we expect our margins to return to a more normalized rate and we know this change in mix is working its way through the system. It’s just not a point where we want to be changing our annual guidance, less than 90 days after we gave it to you. The other thing that I think this implies and I realize this is hard to model. But is – what Scott was talking about in terms of gestation periods.

Let me remind everybody what the strategy of the company is and what the fundamental value proposition is. If you look at the components of our FFOM, overwhelmingly that is generated by the rent in our portfolio. The reason we have the integrated platform and the reason we believe it’s such as compelling value proposition is, that it allows us to find those opportunities that grow the NOI in a way that is much more beneficial to shareholders, then trying to be an acquisitions based company.

Just the four projects that have come on or are coming on line in December Q1 and the two in Q2, those four projects alone on an annual run rate increase our net NOI to the company 8% to 10%. We are announcing today another $40 million of design build, pre-leased product for the balance sheet and we are working on others. So I think what you are going to see is a continued expansion of the percentage of our dollars that come from rent. And I think what’s Scott is saying to you guys and it is two-fold.

One, we have got a long gestation period on these projects, because they are complex and uniquely cited. But the second thing is that we are not predicting for ourselves outsized operations margins on the going forward basis. And we think that may be a conservative assumption. But we think that is the proper stance to have at this point, because we don’t believe we can outperform the industry margins forever. And so we are in a planning mode that puts us back to a normalized profitability.

And I think when you add up all of those components, that’s why we are not changing our annual guidance at this time, and it is indeed annual guidance for the year.

Tayo Okusanya – Jefferies

That’s helpful. And just back to the point of normalized profitability, and again this is a question more for Scott. Scott, on the earnings call last quarter, you and I had a lengthy conversation about this, the ability to keep generating outsized margins. You seem to suggest that that would vain fairly quickly. But again here you are first quarter delivering 20% margins in the ERDMAN business again. I was wondering if you could talk about – performance this quarter?

Scott Ransom

Without getting into explicit details is that, some of those margins that were realized in the first quarter, a good portion of more some things that were started in 2008, put on hold closed. And so that’s what – and those are not sustainable. As we talk about it, we saw the biggest price swinging commodities we are about to see an uptick. It started over the last three to six months in increasing commodity prices that’s still not back to where they were in 2008, but increases there.

We saw the biggest flip in material prices, both upswing and down swing that we have seen in the last at least 75 years in this industry. So that’s what Frank is referring to and I am referring to what we saw in the first quarter. And we haven’t historically – if you go back 25 years, seen those types of margin upticks or really even downtick. So what Frank mention is we are planning really a more normalized environment.

The thing is, is that we are working feverishly on is to anything – let’s say, what you are reading about healthcare ticking back up and some maybe major projects that were put on hold, they are finally going forward with, several hundred million dollar bed towers, new hospitals.

When you look at the MOB, the outpatient space, these things that are now that people put them on the backburner, because they are dealing with kind of a current prices as opposed to long-term planning, these things that what we are talking about and I am referring to are really going to build the revenues for 2011.

We can win something today and it’s going to go into a planning stage, a design, engineering stage, and your meaningful revenues are going to be really more so in the first half into the third quarter of 2011.

So when I am referring to a positive trends which is good for everyone in the healthcare facility space, but that we have let into a pretty difficult 18-month period and we are digging our way out. And every indication is, is that it’s going to have a very good mid-to-long-term uptick in the need for space.

Tayo Okusanya – Jefferies

Okay. That’s very helpful. Just one more quick question. I appreciate your indulge in me. But isn’t fair to argue that in the near term the projects you are going to get from third parties are likely again to be the stalled projects from late ‘08 and ‘09, when those deals were struck, where construction costs were much higher and you are not going to be able to build those things at lower cost and still maintain 20%, 25% margins at least for the next few quarters if those are the kind of projects that end up coming on line?

Scott Ransom

The projects that got stuck that were not necessarily priced – we have one right now that potentially came off hold, it’s a good sized project. We haven’t finalized the price on and it will go through and completely reprice it, and that’s what a client would expect, and give him the best pricing possible based on the current market conditions, not market conditions from 2008, which could take 10% of the project cost.

So like Frank said, we are really trying to plan this is in a more normalized – from a cost of construction and architecture and engineering and plan that accordingly and not plan on 20% swings over an 18-month period in pricing. That’s just historically not – it hasn’t happened and it’s not sustainable to plan on that.

Tayo Okusanya – Jefferies

I appreciate that. Thank you.

Operator

And the next question we have comes from Buck Horn with Raymond James & Associates.

Buck Horn – Raymond James & Associates

Good morning. Kind of shifting gears to the core medial office portfolio if you could, and thinking about some of the leases that are coming up and what’s come due. Just wondering if you have started to see any sort of pricing power on the expiring leases or maybe help us quantify what the spread is between new lease pricing versus the existing leases in place and if you still need to fill occupancy to get any sort of pricing power?

Frank Spencer

Yes, I’m happy to address that one Buck. The way I would characterize at this point is that we are successfully renewing with no roll down of any significance. Now that’s a portfolio wide statement there are specific places where of course we would deal to get up tenant down and there are other places where we’ve got much higher demand for space.

But by enlarge we are renewing flat, we are not able to increase rents at the moment in any significant way, because I think there is still even though our portfolio of occupancy is substantially better than the industry as a whole that obviously is because we’ve got some franchise locations, but I think the other vacancy that is still in the market is not going to allow us to really move rents, but we are successfully renewing essentially flat when you look at the portfolio in aggregate.

Buck Horne – Raymond James

About what kind of occupancy do you think you would need to get to before you start to be able to move the needle, in terms of pricing or maybe in terms of what you think industry wide occupancy needs to be?

Frank Spencer

I don’t know if there is a number, I think what you discover is that that becomes explicitly building specific. There are certain markets where the dynamics are going to allow us to move pretty steadily at a CPI kind of increased rate.

There are other markets where there maybe dynamics created vacancy in the market that we’re not going to be able to get that. So it is so market specific that I wouldn’t try to put a total, if we get to 92% then we can expect to increase rents 5% a year, I don’t think our portfolio works like that and I guess there is nobody else’s does either.

Buck Horne – Raymond James

Okay, thanks.

Operator

The next we’ll have comes from Karen Ford with Keybanc Capital Markets.

Jordan Sadler – Keybanc Capital

Hi it’s Jordan Sadler with Karin. Just wanted to follow-up on the questioning, Michael’s questioning a little bit earlier and not to beat dead horse here but just going back to the strategic view process for a second here. Do you think the outcome would have changed in terms of or the decision would have changed by you all in the board, if you knew then that Frank was on his way out the door?

Jim Cogdell

Absolutely not.

Jordan Sadler – Keybanc Capital

So you couldn’t see yourself reengaging as a result of Frank’s departure.

Jim Cogdell

Absolutely not.

Jordan Sadler – Keybanc Capital

Okay, that’s fair. Thank you.

Operator

And the next question we’ll have is a follow-up from Dan Donlan with Janney Montgomery Scott.

Dan Donlan – Janney Montgomery Scott

Thanks, just two quick ones for Scott. Scott, I just wondered, could you talk about the project you guys are working on and what is a typical completion, I mean are they more of a year completion or is a year and a half or two years or to run the gamut?

Scott Ransom

Well, it does a little bit to run the gamut depending on we’ve got some quick hit things that would be infill on a current development project. We get at least, we got an opportunity for a $5 million project that could sign in July. If that was a freeze and we could probably do most of the completion not know the exact date.

But having done in the first quarter of next year and then if you had a pre-standing facility that was of that scale it may take longer and then you get into complicated let’s say demographic area where we’re looking at what are the service line offerings, what is the real patient origin and Medicare, Medicaid reimbursement type mix in that market to, that could be a very complex center and clients by enlarge even though you are selected on those and they’re great projects and they can be on balance sheet with very under writable tenants is that, those things tend maybe be in a planning stage that can be six months to 12 months and that’s what Frank and I were referring to is the gestation period.

So and that’s what we’re seeing more off, that people are ready to start strategically thinking about their business long-term. Especially that there is and you can’t say there aren’t still lot of uncertainties in the overall economy and global economy but they’re feeling better than they did a year ago and they know they’re going to move on, they know there is healthcare reform, there are still lot of questions with that but you’re really correct to say they can have a crossed the gamut.

Now we’re not actively pursuing a dozen, $250 million 200 bed top bed additions to hospitals because those things can have five to six year gestation period. So our sweet spot is still in that out-patient, on-campus with market dominant community down for profit hospital working with independent position groups and usually most projects include hospitals and physicians come together and they just, the planning can be anywhere from 90 days to up to a year on those and typically the construction period is going to be somewhere around give or take a few months around 12 to 14, 16 months on most of these projects.

Dan Donlan – Janney Montgomery Scott

Okay, and then just last one, I promise. What, as you look at your competition for somebody’s development, could you maybe characterize how its different than maybe where it was in ‘07 and ‘08, I mean are you seeing less competition, or you seeing increased competition because everybody is trying to get these developments, I mean could you maybe characterize the.

Scott Ransom

I would say when you look at – when you certainly have if you’re surely looking to add architecture and construction the industry by enlarge, if you’re in the – if you’re in architectural firm, architectural engineering or construction firm this has been, is tough as a period as anyone has had to deal with, staffs are substantially down and they’re just trying to kind of maintain their core talent and ride this out.

So there is a lot of competition when you get into markets and there is also, maybe more that are but it’s still a very specialized capability. You’re not seeing people that are just because they are large local contracting firm getting in on bids if they’ve never worked on a healthcare facility. They’re just too much industry knowledge and experience that’s required there, so but the pricing is, in the bidding, people are bidding where they’re just hoping they can make it up on buy or do it more effectively and they’re taking more risk than they probably have it a long time in this industry in the AEC industry.

And I think as the economy picks up and the general commercial building picks up and hospitality and retail and other types of developments that will ease up a little bit over the next let’s say 24 months, but we are seeing and you’re also seeing local players wanting to do whatever they can to keep their local people busy but typically a project of any scale is going to include pretty much national players.

And especially on the development side, you’re not seeing the local small, more of local regional base development from coming in because of the equity that’s required to get deals done. If it needs to be (inaudible) equity now, it maybe 35% on cost.

Dan Donlan – Janney Montgomery Scott

Okay.

Scott Ransom

So it’s varying and it’s certainly has been an easy business platform to be in over the last 18 months whether your in development or I think it’s stuck.

Dan Donlan – Janney Montgomery Scott

Okay, thank you.

Operator

The next question is a follow-up from Michael Bilerman with Citi.

Michael Bilerman – Citi

Yes Chuck, can you just walk through sources uses the next couple of years, sounds like there is a lot more on balance sheet development in this industry a little bit more specific of how you’re planning on funding those transactions in addition to dealing with some of the debt maturities that will eventually come?

Chuck Handy

Well I think certainly through construction financing for the own balance sheet is 65% roughly loan to cost, certainly part of our plan, also again as we joint venture with physicians or other owners, other joint venture partners end-user type joint venture partners, there will be significant equity real equity coming in from them as well which will reduce our net outlay and I think the other key consideration to keep in mind with new development activity is the ability for us to as we’re capturing our full value chain with, design-build and the elimination of the design-build projects if you will, that effectively reduces our equity contribution as well as we’ve described in the past.

So I think and looking at new development, we’re certainly focused on those areas where we are the design builder and so they are significant implied equity there from capturing those profits and design-build, but there is also significant real equity coming in through joint venture partners.

With respect to upcoming maturities, normal mortgages that we have coming dues this year are, there is nothing that stands out every things to well leased properties where loan-to-values or very much inline and so as we shown historically we don’t believe there are any significant issues or any issues at all with refinancing those upcoming maturities in the normal force. And of course we do have our term loan with our taxable subsidiary as well as our revolving line of credit that mature in March of 2011 and those both have one year extension options on those.

So certainly we are – we continue to monitor the balance sheet and where our maturities are coming, but coming from or going to be but that’s just sort of I think an overview of where we see things.

Michael Bilerman – Citi

Well can you be still little more specific in terms of builds that suite in the developments, you certainly have a certain amount of construction in progress to-date which requires 37 of which you’ve spent 29 already. But it sounds like a future project, so just can you be very clear, how much are you starting, what financing you expect to get, what’s you equity commitment for those this year, next year, and the year after? You’ve announced two projects on this call, you’re saying you’re targeting others but try to put some brackets around what those are?

Chuck Handy

We’ve announced the calls or the deals on this call and with both of those we have 65% financing as I had said, we are also they’re design-build projects which we’re doing internally as well and we have slated physician investors and hospital investors in those projects.

So I think that’s consistent with what I just said and that’s also the deals that we’ve already announced, that are reflected in our supplemental that we’ve already have under development, of course those are the same targets there, so those numbers have been disclosed and that the other deals that we will be – that we expect to be announcing later this year will really follow in the same framework as those.

Michael Bilerman – Citi

And what’s the size of the expected future projects you’re going to do on balance sheet?

Chuck Handy

Our policy, we’re not going to announce those until the time they’re signed and they are ready to go and those we’ll announce those at the time of ground breaking.

Michael Bilerman – Citi

And your equity commitment into those, how do you envision funding that?

Chuck Handy

Again there will equity from joint venture partners, there will be some equity required from our balance sheet and then they will also be, that’s where the equity will come from and but there will be significant.

Frank Spencer

And the profits from the process itself.

Chuck Handy

And the profits from the process itself through design-build.

Michael Bilerman – Citi

Right, I’m trying to get a sense of how much you can use your own balance sheet, but how much equity are you’re marketing for these projects. Are you going to be selling assets, do you want to sell additional common equity, how much capacity do you think you have today on your balance sheet to pursue these sorts of on-balance sheet activities?

Frank Spencer

Well I think you can look at the supplemental and we’ve got still substantial liquidity on our own balance sheet, certainly far and excess of anything we’ve announced to-date. So we’re not – I think that’s as far as we’re going on the discussion of specific projects.

Michael Bilerman – Citi

Okay, thank you.

Operator

And it appears that we have no further questions at this time. I will turn the conference back over to Frank Spencer for any closing remarks. Mr. Spencer.

Frank Spencer

Well again thanks to everyone for your interest in our company. We’re excited about the value proposition we intend to remain a leader in our industry and the transition that is in place related to me we’ll be carried out in such a way that we don’t disrupt our operations and that we bring new vision and energy and excitement to the company and as that process unfolds we will keep you posted.

Until next quarter, good bye and good luck.

Operator

And thank you gentlemen for your time. The conference is now concluded. We thank you all for attending today’s presentation. At this time you may disconnect your lines.

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