Q3 2019 Earnings Call

After today's presentation, there will be an opportunity to ask questions to ask a question you may <unk> star than one on your telephone keypad to withdraw your question. Please press start into.

Please note this event is being recorded.

I would now like to turn the conference over two Olivia Snyder manager of Investor Relations. Please go ahead.

Thank you want good morning, everyone Stanford already have today.

Me on the color of President and Chief Executive Officer, David <unk>, Chief Financial Officer into her math Brown, and Vice President Crispell Lotto.

The moment they will provide details about our business in our performance for the third quarter of 2019. We will then opened the cost one question any exercise <unk>.

I would like to note that the recording and retransmission holidays conference call. It for habit is out there prior written consent company.

Also note that they've conference call.

Lookingstatements within the meaning of private Securities Litigation Reform Act of 1995, and other security thought.

Before looking statements are based on Oh, Yeah, I believe it's an expectation that of today Friday November 1st 2019, and actual results make different materially from those that we project.

Company undertakes no obligation to revive her probably release the results of and you were designed for the for looking statements made in today's conference call additional information concerning factors that could cause those differences.

Even our filing took the securities and Exchange Commission, R.I.P.C., which can be accessed from our website, Oh, P. I read dot com or the F.B.C.'s website.

Investments.

<unk> not to place under you rely on any foreign looking statement.

In addition, we'll be discussing nongaap numbers during this call, including normalized funding from operation a normal life F.F. out and cast basis net operating income for cash basis and why.

Conciliation up these nongaap figures Tonight income and the components to calculate cash available for distribution or C.A.D. are available in our supplemental operating in financial data package, but also can be found on our website.

And now I will turn the call over today, but.

Thank you Eluvia good morning.

Welcome to the third quarter earnings call for office properties income drunk.

As Matt we'll discuss in greater detail. This morning, we announce normalized F.F. Oprah share of one dollar and 45 cents, which beat consensus estimates by five cents for sure.

We also announced followed third quarter leasing activity would almost 760000 square feet of new and renewal leases for an average least or I'm, almost 13 years, 5% roll up in Iraq and leasing capital of only one dollar and 82 cents per square foot publisher.

In addition, we increase consolidated occupancy by 170 basis points from the second quarter of 2000 or 19, 93.3%.

Critical provide greater detail on these results when he reviews our operations.

A major strategic focus for 2000 or 19 has been rightsizing our leverage.

Here today, we have sold or entered agreements to sell 60 buildings for $731.5 million at a camp raid 5.6%.

For buildings that have an average age of 22 years, an average occupancy of 71%.

And an average remaining lease term 4.5 years.

Keyboard volumetrics or less favorable than the portfolio metrics about T.I.'s consolidated portfolio.

We also eliminated more than $170 million of capital costs at O.P.I. over the next five years by selling these assets.

Since the end of the second quarter, we sold 12 buildings for $298.1 million.

As of today have agreements to sell 10 buildings for $135.9 million.

In July we so all of our common shares in the arm our group for net proceeds of $105 million, which increases are aggregate asset sales proceeds because the end of the second quarter to more than $400 million.

Not only have these assets sales improve the number of key property metrics <unk>. We also reduce their leverage ratio to 6.2 times, which is but one of the midpoint abort targeted ranch.

Assuming we sell the 10 buildings under agreement for $135.9 million or pro forma leverage declines to approximately six times, which is the low end up more targeted range.

As a result of achieving our leverage target during the third quarter, we're transitioning or principle strategic bogus from d. leveraging two acquiring core properties with proceeds from asset sales, which we refer to as our capital recycling program.

The goal of our capital recycling program is to create long term dividend growth by acquiring properties with higher cash flow. After capital costs, then properties we're selling.

As additional benefits, we expect our capital recycling program, where reduce the average age of our properties extend a weighted average term of our leases improve the prospects of renewing tennis.

And help us shape, the geographic intend it diversification across our portfolio.

Or acquisition same is busy identifying single panel buildings with average ages of 10 years or less.

That are encumbered with first generation leases for seven years or longer term and that are located in markets, where we believe we can grow rests over time.

We also expect to continue acquiring building beliefs, the government tenets, which can be both single panel and Multitenant buildings, but most importantly, where the agency occupant has high security requirements, which we believe improves the prospects of renewing tenant leaves us.

This is an exciting transition for our company and we look forward to updating you on our capital recycling progress during future calls.

I went out protocol over to Chris Blotter to review O.P. I believe seem activity operating statistics, Chris. Thank you, David and good morning, everyone.

The September 30th O.P.I. portfolio consisted of 200 and buildings containing 27.3 million square feet with a weighted average at least term with 5.7 years during the quarter occupancy increased 170 basis points from the second quarter to 93.3% primarily as a result of our property.

Yourself.

63.9% of our analyze rent as paid by investment grade rated tennis, which we believe is one of the highest percentages of revenue from investment graduated tennis and the office respect or.

The U.S. government remains our largest tenet accounting for 25.8% of annualized threat and no other tended accounts for more than 3% evangelize right.

Turning to our biggest thing an operating results for the quarter.

During the third quarter. We continued are strong leasing activity entering into new and renewal leases for 759000 square feet with a weighted average at least from of 12.7 years leasing concessions in capital commitment of only one dollar at 82 cents per square foot previous here and a weighted average rolling around 5%.

You're the date or at least thing activity has generated a weighted average grow up in rent a 5.5% and a weighted average at least term of 9.1 years, helping to advance our goal than driving internal growth and extending our consolidated weighted average at least term.

As a result of our third quarter leasing activity, we anticipate a full year 2019 roll up in a red instead of remaining flat for the year.

We continue to have a robust leasing pipeline as we are an active discussions intended for more than 2.1 million square feet of space, including 336000 square feet that would absorb bacon face across the portfolio.

Now to highlight a few leasing transactions that helped try third quarter result.

Entered into new we entered into two large renewal of government tenants. One is a 20 year transaction with the defense Intelligence agency for 16.9% real open rat on a 266000 square foot single 10, a building.

There is a transaction with the department of Homeland Security for 170000 square feet for approximately five years.

And one of our West coast buildings, we renewed a non government tenet and 61000 square feet, what the 58% roll up in right and a weighted average leaves term a 7.8 years. We believe these renewal compliment Opie I'd business plan for having high tenant retention and for lengthening our consolidated weighted average least term.

As we continue or do you leveraging efforts, we will continue our focus on tenant retention and operations through leveraging the alarm our groups asset and property management teams. We believe the combination of our experience and are more vocal presence in more than 30 offices across the U.S. provided distinct advantage for having competitive buildings.

Tracking market trends and demand drivers and building strong relationships with both or tennis and losing broker.

Turning the operations.

Harvesting new technology them data analytics to drive operating efficiency and to be a market leader in environmental sustainability. An example of these efforts as they use the real time energy monitoring and data analysis to manager energy performance in approximately 25 per cent of L.P.I. portfolio.

Phase one of this effort has resulted in a year to date reduction in energy consumption of 6 million kilowatt hours that has a payback of less than one year.

Implementation of this program has resulted in measurable are pretty expensive things of $800000 a year to date limit opiates exposure to increasing energy costs and supports L.P.I.s initiative to reduce the portfolios carbon footprint there was sustainability efforts.

In addition to receiving a number of property low Environmental awards. This year <unk> earned the distinguished Energy Star partner The year Award. The Armorgroup also won the real estate Management Excellence Award for employee in leadership development from the Institute of real estate management.

And at his 2019 global summit in September .

It's a water recognizes our Mars programs in initiatives for recruitment Onboarding retention and professional development.

We believe the bread strengthened recognition of these programs help or more attract and retain high quality employees and our testament to the benefits we receive from our shared services platform.

Altering the call over to Matt Brown to provider overview of our financial results balance sheet and capital names Matt.

Thanks, Christine good morning, everyone.

<unk> results for the third quarter and nine months ended September 30th 2019 include the impact of the merger with select income read or Sir which clothes on December 31st 2018. In addition, Opie I have sold $585 million of properties. During the nine months ended September 30th 2019.

Including $287 million during the third quarter.

The impact of these events has driven the majority of the changes in Opie eyes consolidated financial results as compared to the same period in the previous year.

As a result, our discussion on consolidated results will focus on changes as compared to the second quarter of 2019.

Earlier today, we were Puerto normalize funds from operations were normalize F.F. vote for the third quarter of $69.7 million or $1.45 per diluted share. This compares to normalize F.F., a a $79.3 million or $1.65 per diluted share for the second quarter of 2019.

The decline to normalize F. I Wanna sequential basis is a result of our property dispositions during the third quarter and certain items to increase net revenue by approximately $8.2 million or 17 cents per diluted share in the second quarter that were discussed on last quarter's call.

<unk> for the third quarter was $8 million, which compares favorably to G.N.A. expensive $8.7 million for the second quarter of 2019. The decline in G.N.A. expense is mainly the result of a reduction in our business management fee paid to arm are due to the reduction in our total market capitalization from the debt repaid with this.

Addition, proceeds partially offset by appreciation and Opie I share price.

As of September 30th Opie I did not a crew any estimated business management incentive fees.

Interest expense for the third quarter was $32.4 million, a decline of 8.4% as compared to interest expense of $35.3 million in a second quarter of 2019.

The decline in interest expense is mainly the result of $711 million of debt repayments. During the nine months ended September 30th 2019, including $375 million repaid and the third quarter national borrowings on a revolving credit facility.

Now turning the property level results for the quarter.

We have included quarterly pro forma same property information in our earnings released in supplemental as if the Sir merger had closed on January 1st 2018.

On a pro forma same property basis for the third quarter of 2019 property cash basis, and that operating income or N.Y. declined 7.1% compared to the third quarter of 2018.

Decline was mainly driven by a decline and same store occupancy of 250 basis points from 95.8% at September 30th 2018% to 93.3% September 30th 2019, and a collection of previously recorded bad debts of $2.6 million in the third quarter of 2018 due to.

Attendant settlement.

On the property operating expense front, we incurred increases in real estate taxes repairs and maintenance and insurance costs offset by a reduction and utilities have approximately $612000, mainly due to the efforts of our Mars corporate engineering and sustainability team that Chris previously mentioned.

I'd like to take a moment to highlight the efforts of arm ours real estate tax abatement program through widgets managed companies benefit from aggressive pricing due to the size of the are more manage companies platform.

Over the past five years. This program has successfully reduced aggregate assessed value by $1 billion for all companies and has generated real estate tax savings in excess of $20 million Oh.

<unk> benefit from this program over the past five years is approximately $700 million in assessed value reductions in real estate tax savings in excess of $13 million.

Oh, now switch focus to discuss capital and ongoing d. leveraging efforts.

He spent $27 million on work on Capitol during the third quarter, including $11 million I'm building improvements in $16 million on tenant improvements in leasing costs.

Recurrent capital is below or 2019 estimate mainly due to the timing of leasing capital.

This is created greater cushion in our current V.A.D. payout ratio than our target payout ratio of 75%.

As a quarter end, we had approximately $56.5 million of unspent leasing related capital obligations of which 45% represents tenant manage T.I.'s and $17 million cannot be spent until future years.

Lastly, as it relates to capital expenditures. It is important to know that we have eliminated approximately $87 million the future capital over the next five years from properties, we have sold during 2019.

As mentioned on last quarter's call in July we sold our 2.8 million shares of the arm our group and received net proceeds of approximate $105 million, which was used to pay down our terminal.

<unk> September 30th Opie, I had $210 million outstanding on our 750 million dollar revolving credit facility during the quarter, we repaid $170 million remaining on our term loan and repaid r. $350 million unsecured senior notes that were due in August 2019 with proceeds from assets.

Sales and borrowings under our revolving credit facility.

As David previously stated we are pleased to announce Opie eyes net debt to analyze adjusted EBITDA R.A. is within our long term target range and ended the quarter at 6.2 times.

We currently have $185 million outstanding on a revolving credit facility, which we plan to reduce with the proceeds from the properties currently under agreement to sell.

Operator that concludes are prepared remarks, we're ready to open the call up for questions.

Thank you we will now begin the question and answer session to ask a question you may <unk> star than one on your telephone keypad, if you're using a speaker phone. Please pick up your handset before pressing the keys to withdraw your question. Please press star than two.

At this time, we will pause a month momentarily to assemble a roster.

<unk>.

The first question will be from Mitch Germane with J.M.P. Securities. Please go ahead.

Oh Good morning, you know you previously.

Had talked about occupy your in occupancy level I think it was mid 91% area I know you've got a pretty elevated amount of explorations in the fourth quarter for you know, it's just a traditional quarter. They get some more than next year's number how should we think about.

How that plays out over the course for the next you know a couple of months.

Mhm.

Yep. This is Chris good morning.

I think the way you would want to look at that is you know over the next four quarters, we have about 2.7% of revenue that will expire do the tenant vacancy.

You know roughly one point father that is revenue in 2019, and so you know as noted in our pre marked earlier, where you know we're an active discussions with you know 10 that represent about 2.1 million square feet with absorption potential of 336000 square feet.

We see that as a measure to help drive occupancy.

Yeah, So Mitch.

Yes, we finish the year, we expect that we're going to have some tennis move out and assuming no new absorption.

We could have about you know hundred hundred and 20 basis points of pressure on occupancy your n.

And then maybe another hundred and 20 a basis points.

In 2020.

Mm.

That's helpful.

David I, you know I really appreciate all the color on asset sales I I think some of the sales that you.

Had mentioned that were completed were part of the original F.P.O.D. leveraging plan. So.

I guess, what I'm trying to figure out is as of last quarter. You said, you've got about 630 million of of sales that were targeted for.

The Sir golf merger and I'm, just kinda curious where that 630 stands for his that 630 changed.

[noise] so niche.

In the in the number I quoted the $761 million roughly 195 million of that completed.

The d. leveraging from the first Potomac acquisition, the balance is associated with D. leveraging from the merger with Sir.

We have in addition to the 10 properties we have.

Under agreement to sell for $135.9 million.

We have another eight buildings that we are actively marketing.

Which would have proceeds you know anywhere from call at $50 million to $100 million.

We've also identified.

A few other properties that would be targeted.

As part of our capital recycling program.

Where we are targeting with brokers evaluating their marketing plans are trying to decide who we might want to hire to sell those assets.

Mm.

Excellent that's a gray color. Thank you.

My last question is the February notes that are coming due in 2020, and I think is 400 million a 3.6% coupon.

<unk> curious about what your plan is for that.

Hey, this is Matt. So today, we have $185 million outstanding our line of credit we have about 136 million of properties under agreement to sell so we have plenty of capacity on our line of credit to pay down those 400 million of nodes coming due in February .

So the goals to pay them off rather than to re issue or something.

At the current moment, yes.

Thank you guys.

Back to match.

The next question comes from Michael Carroll was RBC capital markets. Please go ahead.

Good morning Gods.

I'm just wondering what are the expectations for closing of these additional disposition and well the properties that are still wonder agreement or you plan on having those close by.

Some of those can be pushed him to 2020.

Yeah. It's good questions. So the properties do we have under agreement are all in various stages of diligence right now.

I think the vast majority would close by year end, but we have a couple that could close in January or February .

But I would expect that assuming diligence completes as expected.

They will all be close by the time, we have.

Our fourth quarter earnings call.

It's hard to say on the stuff that we're marketing.

I think that I think the real take away is that we have achieved our target leverage.

We're now more focused on replacing assets as we sell asset. So we are actively looking to buy properties.

And to do it in a way that increases our cash available for distribution.

So the additional properties that are being marketed we shouldn't necessarily expect those to come in a big chunk like you've been doing over the last few quarters that might be.

A little more opportunistic and you know not all at once.

Yeah, I think that's generally corrects I mean.

What we have marketing right now is not what I would consider material. So it's it's not going to have a big impact on.

F.F. or C.I.D.

And and assuming we are successful in a in identifying assets touched by you know you will see us begin to replace.

That F.F.O.'s and see I do.

Okay I'm on last question. So now that you're turning your eye toward deployment I'm, just wondering kind of what's your plan on the acquisition from what type of capital recycling opportunities, you're saying in the market and if there's any specific markets.

But specifically are catching your.

We are predominantly focus on live work play markets, where we believe there's employment.

And population growth.

That will help drive our ability to grow rents overtime.

You know those tend to be markets like a you know southeast markets like God North Carolina.

Some of the you know, Texas markets like Austin, Yeah. Those those are the types of markets that we find attractive right now.

Mostly because we think we can grow runs over time, which we think is important.

Okay. Thank you guys.

Mmm.

Alright, X. question comes from Adam Lebowski with Morgan Stanley . Please go ahead.

Hey, guys. Thanks for taking a question just as you've gotten a little bit deeper into the asset disposition plan can you just talk a little bit about what you're seeing as far as pricing you know relative to your initial expectations that come in a little above a little below are sort of roughly in line with what you were expecting.

Well I think when we use first started talking about our disposition program with talked about selling assets at an average cap raider between seven 7.5%.

Yeah, what we have sold here today, it's add a 5.6% cap right. So I think we've been reasonably <unk>. Please.

When the pricing for the assets we sold.

Great. Thank you and then just a one more I talked a little bit about the the moving pieces for occupancy at year end and into 2020 or are there any major known moveouts over the next 12 months, where the tents already communicated to you that they're planning to vacate that are are going to become catch a holding the portfolio.

Yeah, I think Chris talked about approximately 2.7% <unk> via expired over the next 12 months that we think are are would tenets it'll vacation.

Approximately.

1.5% of that would be in the fourth quarter with a balance between 2020.

Got it thank you.

Again, if you have a question please <unk> star than one.

The next question comes from Brian Mar with B. Riley F.B.R. Please go ahead.

Yeah. Good morning, So a lot of helpful information there on me disposition that you have under contract or they also added similar roughly 5.6% cap radar or something different.

Mhm.

Oh, the 5.6% cap raise includes those properties that are under purchasing sale agreement currently.

Okay great.

And then on your balance sheet with leveraged now down around 6.2 edited it seems closer to six times I'm, assuming that seek chairs your investment grade rating on the <unk>.

Yes, SNP published a report on US last week reaffirming our investment grade reading with a stable outlook, we expect Moody's to go to committee and the next month or so.

And that's where we are currently.

Okay.

And they can you talk a little bit about what the potential for rent increases are on the portfolio. Once the dispositions are completed you know as we look out the 2020 and 2021.

Mm mm.

Yeah, I mean, I think that you know we're still you know looking at that 2% to 3%, which is you know the number that we've continue to talk about I think that's consistent kinda with what we're seeing with you know just the overall roll up and rent a with leases that are being completed yeah.

Brian you know a lot of that depends on how the economy continues to perform.

I read a piece this morning, where an economist is expecting continued growth in G.D.P. over the next three to five years, if that is true and plays out that way.

That will help us continue to dry grass, but if you see a contraction in the business cycle, a quicker than that you know that'll obviously have pressure.

On ranks.

<unk> to kind of circle back on the investment grade rating.

You know Moody's has not been clear with us as to how they expect committee to go we feel like we've done what they.

Asked of us to do our languages, while online and and you know we're turning our eyes towards grows so we're relatively optimistic but we we still you know we we obviously don't control what Moody's decides to do with R. rating.

Okay, and they kind of lastly for me a two part question Yeah. What is the supply outlook looking like Oh in your key markets and and where do you see the biggest opportunities over the next 12 18 months to drive occupancy higher.

Well I would say, there's one market in the country.

Where there is supply gross that could have a negative impact on us over the next call. It three years and that Sacramento, where there's a couple of buildings being built downtown.

That's really the only market that we have exposure to with increasing supply.

So you know I think that's why you know in Christmas comments were relatively bullish on our ability to.

<unk>.

Mmm.

Ladies and gentlemen, this concludes our question and answer session.

I would like to turn the conference back over to David Blackman for any closing remarks.

Thank you operator, when we announced our merger with select income REIT said, we would sell assets to reduce our leverage ratio to between six and six and a half times and we have done.

Exactly that we're now transitioning our attention to a capital recycling program that we expect will create long term dividend growth and positively reshape our portfolio.

This is in addition to our continued commitment to successfully operating our properties renewing leases growing rents and leasing vacant space across our.

Folio. Thank you for joining us today, operator that concludes the call and thank you Sir.

Has now concluded. Thank you for attending today's presentation you may now disconnect.