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Lexington Realty Trust (NYSE:LXP)

Q2 2012 Earnings Call

August 7, 2012 11:00 am ET

Executives

Joseph S. Bonventre – General Counsel and Executive Vice President

T. Wilson Eglin – President and Chief Executive Officer

Patrick Carroll – Executive Vice President, Chief Financial Officer and Treasurer

E. Robert Roskind – Chairman

Analysts

Erin T. Aslakson – Stifel, Nicolaus & Co., Inc.

Todd Stender – Wells Fargo Securities LLC

Anthony Paolone – JPMorgan Securities LLC

Operator

Good morning and welcome to the Lexington Realty Trust Second Quarter 2012 earnings conference call. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following the presentation. Today’s conference is being recorded. It is now my pleasure to turn the floor over to your host Mr. Joe Bonventre. Please go ahead sir.

Joseph S. Bonventre

Hello, and welcome to the Lexington Realty Trust Second Quarter Conference Call. The earnings press release was distributed over the wire this morning, and the release and supplemental disclosure package will be furnished on the Form 8-K. In the press release and supplemental disclosure package, Lexington has reconciled all historical 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 Lexington’s website at www.lxp.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 Lexington believes the expectations reflected in any forward-looking statements are based on reasonable assumptions, Lexington 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 today’s press release and from time-to-time in Lexington’s filings with the SEC. Except as required by law, Lexington does not undertake a duty to update any forward-looking statement.

Joining me today from management are, Will Eglin, Chief Executive Officer; Robert Roskind, Chairman; Pat Carroll, Chief Financial Officer; and other members of management.

T. Wilson Eglin

Thank you, Joe, and welcome to everyone. Thank you for joining the call today. As usual I’d like to begin by discussing our operating results and accomplishments for the second quarter.

For the second quarter, our company funds from operations were $0.24 per share and we executed well in all areas that impact our business. The quarter was characterized by, first, continued and solidly seen activity were approximately 700,000 square feet of new and renewal leases singed leading to an overall portfolio occupancy rate of approximately 97.6% at quarter end, leaving just approximately 770,000 square feet subject to leases scheduled to expire this year.

Second, we made additional progress on the investment front in the quarter with one build-to-suit project completed and closed totaling $12.9 million brining total investment volume for the year to $89.4 million, and we believe our pipeline of similar opportunities continues to be robust.

Third, we also had further success on the capital recycling front with $82 million of non-core disposition including the sales of our interest in Concord, a former joint venture loan portfolio. And fourth, we continue to drive down our cost of capital as we took advantage of the significant refinancing opportunities in our portfolio.

In the second quarter of 2012, we drew $45 million on our 7-year term loan facility and swapped the LIBOR rate into a fixed LIBOR rate of 1.25% for seven years. So that the interest rate today is fixed at 3.5% on such borrowings. We also closed a $55 million 11-year mortgage on Transamerica Tower in Baltimore at a fixed rate of 4.32%.

In the second quarter and through July, we retired $118.2 million of debt in preferred stock, which had a weighted average coupon of approximately 7.2%. And in August, we drew down the remaining $9 million on the seven year term facility and are in preliminary discussions with our bank group to expand the facility.

Turning to leasing, as of June 30, 2012 we had $1.7 million square feet of space subject to leases that expire in 2012 or which are currently vacant. Significant accomplishments in the second quarter include the 25,000 square foot lease expansion with Wyndham at our property in Orlando, Florida raising Wyndham’s occupancy to 259,000 square feet. A 184,000 square foot extension with Lockheed Martin also in Orlando, Florida. A 77,000 square foot lease extension in a new 59,000 square foot leased with Capital One in Richmond, Virginia.

We are also pleased to report today a significant third quarter lease extension with Xerox at our Palo Alto, California property. This lease extension is for 10 years at an average annual rent of $7.1 million, an increase of $3.6 million, or 102%. This substantial rent increase offset much of the decline from the IBM lease extensions on our buildings in Atlanta, which were at fair market value. The IBM buildings are subject to a non-recourse loan of $140 per square foot that matures next year and all the renewal rents are payable after the debt matures.

Another positive result is that our same-store NOI growth was 0.8% for the six month period compared to the same period last year.

Overall this year, we have extended 30 leases at annual rents of $24.3 million, a modest decrease of 1.8 million compared to the previous rent. And we view this as a good result in what continues to be a sluggish economy.

As we look ahead on the reminder of 2012, we expect to result either through leasing or disposition, approximately 700,000 square feet of expiring or currently vacant space over the balance of the year. Accordingly, we expect year-end occupancy to stay at a high level.

Supplementing our leasing and refinancing success was ongoing progress on adding value through accretive acquisitions. We closed on one build-to-suit project in the second quarter and we now have six build-to-suit projects underway for a total capital commitment of $149.5 million, of which $60.8 million has been invested through June 30, 2012.

The property investments underlying these projects have an initial yield of 8.8% and 9.9% on a GAAP basis, and our supplemental reporting package contains an estimated funding schedule for these projects. In addition to the build-to-suit projects, we invested approximately $23 million in the sale leaseback with Vulcan Materials.

We believe our investment pipeline of good prospects now totals approximately $200 million and that these are very attractive opportunities for us since there are long-term net leases at going in Cap rate of about 8.5% and 9%, which generally equates to 10% to 10.5% on a GAAP basis. However, we can give no assurances that these expectations will be realized.

We believe the addition to our portfolio of long-term leases with escalating rents will further strengthen our cash flows, extend our weighted average lease term, reduce the average age of our portfolio and support our dividend growth objectives.

Our successful capital recycling program has helped drive down our cost of capital as it has continued to produce funds for accretive acquisitions and deleveraging. We expect to continue to recycle capital with a focus on maximizing the value of our multi-tenant and retail properties and certain single tenant office properties.

In the second quarter, we completed the sale of 1500 Hughes Way for $69 million. We had a 55% interest in this unleveraged multi-tenant property. Over the balance of the year, our objective is to dispose a $40 million to $50 million of properties, which is depended on many factors including achieving the desired sales price.

We continue to work on creating liquidity in net leased strategic assets fund our joint venture with Inland American. We sold one property in the quarter for $2.7 million and have two others under nonbinding letter of intent for about $50 million. We have entered into an agreement with our joint venture partner to on October 1, either sell our interest to our joint venture partner for $219.8 million less remaining distribution, which will be payable with a note that matures in December 2012 or two, purchase our joint venture partners interest for $9.4 million, which approximate the remaining distribution favored right into 2012.

Our partner has until September 17, 2012 to elect the sale or purchase. The joint venture is working with Jones Lang LaSalle with respect to assisting the owners in maximizing value, although there can be no assurance that the portfolio will be sold. In the event that our partner elects to sell to us or the portfolio is not sold to a third party, Lexington will become the outright owner, which we expect will result in a significant accretion through our funds from operations and taxable income per share.

NLS generated about $9 million of funds from operations in the second quarter, Lexington share which was $4.3 million. We have added on page 42 of our supplemental reporting package additional information on the NLS portfolio and balance sheet.

Now, I’ll turn the call over to Pat, who will take you through our results in more detail.

Patrick Carroll

Thanks Will. During the quarter, Lexington had gross revenues of $83.9 million comprised primarily of lease rents and tenant reimbursement. Under GAAP, we are required to recognize revenue on a straight-line basis over the non-cancelable lease term plus any periods covered by a bargain renewal option.

In addition, the amortization of above and below market leases are included directly in the rental revenue line. In the quarter, GAAP rents were in excess of cash rents by approximately $6.5 million, including the effect of above and below market leases.

For the six months ended June 30, 2012, cash rents were in excess of GAAP rents by about $2.2 million. We have also included on page 41, in the supplement our estimates of both cash and GAAP rents for the remainder of 2012 through 2016 for leases in place at June 30, 2012. Page 41, also contains same-store NOI data.

In the second quarter of 2012, we recorded $3.1 million in non-cash impairment charges and $2.7 million on gains on sales of properties. On page 38 of the supplement we have disclosed selected income statement data for our consolidated, but non wholly-owned properties and our joint venture investments. We have also included non-cash interest charges recognized in the six months ended June 30, 2012 on page 39 of the supplement.

Interest expense decreased $2.6 million primarily due to deleveraging of balance sheet and refinancing our debt at lower rate. This has resulted in an interest coverage of approximately three times, fixed charge coverage of approximately 1.8 times and debt to EBITDA of approximately 6 times. The equity and earnings from joint venture increased $2.7 million primarily due to the sale of our interest in Concord offset by a reduction in the equity pick up for NLS investment.

In addition, we recorded a 2.8 million reserve for the outcome of the litigation we were involved in.

In terms of balance sheet, we believe our balance sheet is strong and we have continued to increase our financial flexibility capacity. We had $80.7 million of cash at quarter end including cash classified as restricted. Restricted cash balances relate to money held with lenders as desperate deposits on our mortgages. At quarter end, we had about $1.7 billion of consolidated debt outstanding, which had a weighted average interest rate of 5.5% almost all of which was at fixed rate.

The significant component of other assets and liabilities are included on Page 39 of the supplement. And during the quarter ended June 30 2012, the company paid approximately $1 million in lease costs and approximately $3.7 million in tenant improvements. In our press release, we have a reconciliation of company FFO to company FAD.

Also on Pages 29 through 33 of the supplement, we disclosed the details of all consolidated mortgages maturing through 2016. And on Page 15 of the supplement the funding projections for our six current build-to-suit projects are included. We’ve also added on Page 40 of the supplement a summary of our credit statistics.

Now, I’d like to turn the call back over to Will.

T. Wilson Eglin

Thanks, Pat. In summary, we had a great first half. We continue to execute on leasing opportunities in order to maintain high levels of occupancy, realized values on non-core properties, capitalized on our substantial refinancing opportunities helping to drive down our cost of capital, and invest in build-to-suit properties and other accretive investment opportunity.

Even though our shares have returned 142.4% in the last three years and have been a top performer, we believe Lexington continues to offer compelling value in total return potential for investors. With opportunities to refinance our debt at considerably lower rates, acquisitions that improve cash flow and upgrade the quality of our portfolio, a very attractive dividend yield combined with a conservative payout ratio and levels of debt that will come down over time, we believe we are very well positioned to create even more meaningful value for our shareholders.

In view of the progress we have made, today we increased our guidance for 2012 company funds from operation by $0.01 per share to a range of $0.93 to $0.96 per share. Our guidance is forward-looking and reflects the comments that we have made on today’s call and a diluted share count of roughly 181 million shares, which include 16.4 million shares underlying our 6% convertible guaranteed notes.

Operator, I have no further comments at this time. So we are ready for you to conduct the question-and-answer portion of the call.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And we will take our first question from Erin Aslakson with Stifel, Nicolaus.

Erin T. Aslakson – Stifel, Nicolaus & Co., Inc.

Hi, good morning, guys. How are you?

T. Wilson Eglin

Hi, thanks.

Erin T. Aslakson – Stifel, Nicolaus & Co., Inc.

First question in your – would build a – are you in liberty to handicap the outcome in the JV transaction?

T. Wilson Eglin

I don’t think so, Erin, it’s – our partner has the choice to either buy or sell that as effective with notice on September 17. So it’s really not in our hands. We have provided some additional disclosure, which I think will be informative for investors with respect to understanding the impact of the outcome to the extent we do. Get ownership of those properties, we have a lot more funds from operations in taxable income than we otherwise would have, but I think it’s premature to predict the outcome.

Erin T. Aslakson – Stifel, Nicolaus & Co., Inc.

All right, okay, thank you. And then the new lease with Xerox, when does that rent actually commence?

T. Wilson Eglin

At the end of the current lease which expires in 12/2013.

Erin T. Aslakson – Stifel, Nicolaus & Co., Inc.

Thanks. And then the IBM rolldown, timing of that actually?

T. Wilson Eglin

The rent stays the same through the mortgage maturities which is May of next year, and then after the mortgage matures the rent rolls down to the numbers we disclosed.

Erin T. Aslakson – Stifel, Nicolaus & Co., Inc.

Okay, great. Thank you. And then just with respect to the litigation, is there anything additional you could – tell us about that, what’s that related to?

Patrick Carroll

We disclosed this litigation and it relates to what we call the Deutsche Bank litigation. I think it was in 2006, Lexington saw bankruptcy claims for two of our properties that were leased to Dana. We collected about $11 million in bankruptcy in the settlement of those claims. Deutsche Bank settled with Dana for a lesser amount and came to us for the difference in what they paid us and what they settled with Dana, we didn’t think we owed them that, we went to litigation for the last six years and we came out on the short-end of it. So we reserved 2.8 million and we’re going to have to pay $2,775,000 by the end of August.

Erin T. Aslakson – Stifel, Nicolaus & Co., Inc.

Okay. So that’s a…

Patrick Carroll

It’s been disclosed – we disclosed it in all the Ks and the Qs that we filed in the litigation footnote.

Erin T. Aslakson – Stifel, Nicolaus & Co., Inc.

Yeah, great. Okay, thank you guys.

Operator

And we will take our next question from Todd Stender with Wells Fargo.

Todd Stender – Wells Fargo Securities LLC

Good morning, guys. Thanks. So, Will, you mentioned $40 million to $50 million of the expected dispositions in the second half, what’s the mix of vacant properties in there versus stuff that’s fully occupied?

T. Wilson Eglin

Well, I think two pending vacancies that we see going away, one is the building lease of our fire insurance company, which comes off lease at the end of the year, and then we have another building leased to Kraft, which comes off lease later this year. We are hoping to sell one of our industrial properties, which has some vacancy in it, and then the balance is retail, which comes off lease – we’ve been working pretty hard on some smaller retail sales.

Todd Stender – Wells Fargo Securities LLC

So just on a timing perspective, if there is any operating expense savings from those vacant properties, we may not see that this year, maybe that’s pushed into next year if any?

T. Wilson Eglin

It will be, if there is any, it will be very small in the current year.

Todd Stender – Wells Fargo Securities LLC

Okay. So the upside in guidance, you think that was more of a reflection of the capital refinancing that you did?

T. Wilson Eglin

Yeah, that’s part of it.

Todd Stender – Wells Fargo Securities LLC

Okay. And you did address the net lease strategic asset outcome. Do you have a preference, do you have a first choice, does it meaningfully add to kind of the direction you’re taking in the portfolio?

T. Wilson Eglin

Well, both are good outcomes for us Todd. On the one hand, if we get a big source of cash that would put us in an extremely liquid position and be very good for our balance sheet obviously. On the other hand, getting the assets back is substantially accretive to us, it has a very positive impact on our taxable income, which would likely lead to dividend growth greater than we otherwise would have. That’s a good outcome as well, and we’ve made some progress with respect to selling some one-off assets there to begin creating liquidity in the program.

So they honestly both are good for us. The balance sheet and our assets become really leverage balance sheet overtime and actually there is more investment credit rate of tenants in that portfolio than in the current Lexington portfolio. And debt-to-EBITDA in that portfolio is sort of in the low fives compared to Lexington’s levels. The big outcome for us to get the asset back, it’s just too early to tell what the outcome would be.

Todd Stender – Wells Fargo Securities LLC

Okay. Thanks. And just finally, is there any implied pricing from a CapEx perspective on the interest you’d require for 40 million?

T. Wilson Eglin

So you mean that the debt plus our cost around 10 in the quarter, John.

Todd Stender – Wells Fargo Securities LLC

Okay. Thank you.

Operator

(Operator Instructions) And we’ll take our next question from Anthony Paolone with JPMorgan.

Anthony Paolone – JPMorgan Securities LLC

All right, thanks good morning. Well, I may have missed this, I jumped on late. But can you just talk about the deal pipeline size of it, how much in build-to-suit straight up acquisitions and so forth?

T. Wilson Eglin

We think we have pretty good visibility about $200 million of deals and almost everything is build-to-suit time, and we’re optimistic that in the next month or so, we can get a few more under contract and underway. So I think we’re making good progress and we feel, we’re pretty confident that we’ve got a business that’s sort of sustainable at a couple of hundred million a year. Obviously it will be better for us if the business was bigger, but we still have been able to meet our pricing objectives without really stretching too far. So we feel very good about it, we have pretty good visibility on pipeline right now.

Anthony Paolone – JPMorgan Securities LLC

Any change in yields given the rate environment or added competition from others that are looking for something like a long-term net lease right now?

T. Wilson Eglin

Well, we see – CapEx may have come down in absolute terms relative to where sort of alternative corporate bond yields are spread or sort of close to where they’ve been. So we feel like we’re still meeting our objectives with respect to the spread. There is certainly a lot of competition in the auction market for properties that are currently deliverable, now let’s say on the build-to-suit area. And so hopefully we’ll have the opportunity to originate at attractive yield in the forward market by focusing on build-to-suit and in many cases we may just hold some of these assets on a five year basis and then look to sell under the auction market and get that retail price.

Anthony Paolone – JPMorgan Securities LLC

Okay. And then the, again I many have missed this part, just maybe a – but the rehab facility I know is small dollars but just what’s the story behind in that investment?

T. Wilson Eglin

Well, we have an offshore client that’s interested in investing in long-term leases especially in the healthcare space and this is a client that we had acted as an advisor too in the past. They have a preference for joint venture investment. So in cases where we can find opportunities that meet their yield expectations and ours, we will stay in the transaction for – it’s roughly 15% equity stakes, so it’s not big dollars. But our return on equity is enhanced by earning fees and also having promoted interest on the backhand sale. So we are all actively working with them, but to try to find some similar opportunities.

Anthony Paolone – JPMorgan Securities LLC

So how big is – so it sounds like, it is a bit of a mandate from this investor like how big can this be or how big is that pipeline?

T. Wilson Eglin

It’s really on a case-by-case basis, we are looking two modestly sized transaction with them right now, but they are – honestly, can’t give any assurance that we will do more deals with them, we like to. It’s a good way for us to earn higher return without putting a whole lot of meaningful capital into assets that are served outside of our mandate. So we just have to take it case-by-case and update you on a quarter-to-quarter basis.

Anthony Paolone – JPMorgan Securities LLC

Okay. Thanks.

Operator

And that concludes today’s question and answer session. Mr. Eglin, at this time, I’d like to turn the conference back over to you for any additional or closing remarks.

T. Wilson Eglin

Thank you again for joining us this morning. We’re very excited about our prospects for the balance of this year and beyond, and as always we appreciate your participation and support. If you would like to receive our quarterly supplemental package, please contact Gabriela Reyes or you can find additional information on the Company, on our website at www.lxp.com. In addition, you may contact me or the other members of our senior management team with any questions. Thanks again and have a good day everyone.

Operator

Ladies and gentlemen, that concludes today’s conference call. We thank you for your participation.

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