Q1 2020 Earnings Call

Good morning.

And welcome to office properties income trusts first quarter 2020 Financial results conference call at this time for opening remarks and introductions. I would like to turn the call over to Olivia Schneider manager of investor relations.

Thank you and good morning everyone. Thanks for joining us today with me on the call or opi's president and chief executive officer David Blackmon Chief Financial Officer and Treasurer Matt Brown and vice president of a lotto and just a moment. They will provide details about our business and our performance for the first quarter of 2020 followed by a question-and-answer session with sell-side analysts first, I would like to note that Thursday morning and we transmission of today's conference call is prohibited without the prior written consent of the company also note that today's conference call contains forward-looking statements within the meaning of the private Securities litigation Reform Act of 1995 and other Securities laws, these forward-looking statements are based on opi's beliefs and expectations as of today, Friday May 1st, 2012 or an actual results May differ materially from those that we project the company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's,

Call additional information concerning factors that could cause those differences is contained in our filings with the Securities and Exchange Commission or SEC which can be accessed from our website. Yeah, I read or the website investors are cautioned not to place undue Reliance upon any forward-looking statements. In addition. We will be discussing non-gaap number that during this call including normalized funds from operations are normalized ffo cash available for distribution or adjusted ebitda and cash basis net operating income or cash basis. Noi a Reconciliation of these non-gaap figures to net income are available in our supplemental operating and financial data package, which also can be found on our website. In addition. We will be providing guidance on this call including normalized ffo and cash basis and we are not providing a Reconciliation of these non-gaap figures as part of our guidance birth.

A certain information required for such reconciliation is not available without unreasonable efforts or at all such as gains and losses or impairment charges related to the disposition of real estate dead.

Returning the call over to David. I would like to note that due to the Massachusetts shelter-in-place order. We are unable to conduct stays call from the same location as a result. There may be some delays during our question-and-answer session and there is a race car audio may not be as clear as normal David Bowie.

Thank you, Olivia. Hey, good morning. Welcome to the first quarter earnings call for office properties income trusts. Like most of you joined today's call the covid-19 pandemic has dramatically changed the way we conduct business the economic disruption brought on by the oil price War and the closing of non-essential businesses across the US has resulted in record unemployment claims not seen since the nineteen thirties and has adversely impacted businesses of all sizes throughout the global economy as I have work remotely these past 45 days focus on the continuity of our businesses home health and well-being of my family are stakeholders and tenants. I take comfort in the strength of the arm our organization and how we have positioned OPI to not only survive this economic show me what the likely Thrive coming out of it.

There are several.

Doctors that position to perform well in what will eventually be an economic recession one has minimal lease expirations for the remainder of the Year Eco only 4.7% of our annualized rent to Leverage is low on a net debt-to-ebitda basis at only five point nine times below our target range of 626 and 1/2 * 3 OPI has minimal debt maturities until 2022 with only forty million dollars of debt maturing.

For OPI has adequate liquidity with almost four hundred million dollars of availability under our 750 million dollar unsecured revolving credit facility and our investment-grade rating have recently been affirmed at triple d - BW3 with stable outlooks 5 OPI has one of the highest percentages of rent paid by investment grade rated tenants in the office sector at 62.2% of our annualized rent including more than 38% paid by government tennis.

6 OPI has granted minimal rent assistance to our tenants for the month of April through July equal to approximately 70 basis points of our contractual cash over that. And all of our top 20 tenants have paid April rent.

7 OPI has a well-diversified portfolio properties both geographically with limited exposure to Coastal Gateway markets that had been hardest hit by the Panthers and by 10:00 at industry with approx 78% of our annualized rent paid by tennis operating in Industries being essential.

Eight o p i first quarter c a d pay out ratio was 56.1% which is low for the office sector and below our Target payout ratio of 75% considering annual Capital spending will likely be below expectations. We also expect our full-year payout ratio will be low will be below our Target.

Chris and Matt will provide more detail in their prepared remarks that will further highlight. Opi's excellent results for the first quarter in summary normalized ffo with $1.48 per share which beat consensus estimates. We completed almost six hundred thousand square feet of new and renewal leasing for a 4.1% loss and rent.

Consolidated occupancy increase almost two hundred basis points year-over-year and same property Cash basis and increased 1.2% year-over-year.

As a reminder opi's disposition program to reduce leverage was completed at year end 2019. In addition. We successfully closed on the sale of all the phone numbers we had under agreement when we reported fourth-quarter results completing more than $85 billion dollars of assets sales under our Capital recycling program.

The 6th.

During the first quarter contained approximately seven hundred thousand square feet at an average age of 22 years an average occupancy of 94% off a weighted average lease term of six years eliminated more than twenty two million dollars of budgeted Capital over five years and resulted in a five-year average cash contribution yield of 4.1%

Once liquidity returns to the market, we will reinvigorate our Capital recycling program likewise. Our acquisition program will remain dormant until such time as we see in 13 opportunities that are appropriately priced for today's economic risk.

One final note is that a hundred percent of our buildings are operational and available to our tenants, but in most cases are being lightly utilized Chris will give greater detail in his prepared remarks, but our Mar as our property manager has implemented numerous protocols to protect the health and safety of our property management staff in order to keep our buildings open house. This has been balanced with managing property operating expenses to save costs for our tenants.

With that, I'll turn the call over to Chris to review Leasing and operating activity followed by Matt to review Financial results in the balance sheet Chris. Thank you David and good morning. Everyone had the strength of our portfolio and balance sheet should benefit us as we manage through the current economic challenges while it is difficult to determine the duration and implications of the covid-19 pandemic. Our business was largely unaffected during the first quarter. Opi's portfolio has several characteristics, which we believe help sustain us during times of economic volatility and keeps us down insulated from events such as covid-19 as David touched on 62.2% of our portfolio is made up of investment-grade right at tennis which includes 38.4% paid off government tennis.

Other large Industries in our portfolio, which we consider lower risk include technology Communications and legal while higher-risk co-working tendency makes up less than 15,000 square feet of our portfolio off. Our properties are geographically diverse and in many cases building attributes such as access to Transit and those with enhanced security infrastructure complement the needs of our tenants and there's always there for helping Drive retention further tenants involved in essential goods or services make up 78% of our annualized revenue and roughly 94% of our annualized Revenue wage considered low risk by industry as a quarter in the portfolios weighted average lease term is 5.6 years with occupancy of 91.5%

Turning two applications related to covid-19 as Matt will discuss in more detail to date. We have granted rental assistance to eighteen tenants in the form of rent deferral tenant request for assistance are reviewed on a case-by-case basis giving consideration to financial statements a business plan for managing through covid-19 and participation through the cares Act.

and the event

We Grant rent assistance. Our general position is to defer rent for one month at a time and re-evaluate as needed tenants are required to repay the total deferral over 12 month period beginning this fall off. We believe this approach provides greater assurances for collection while also partnering with those tenants who are experiencing a financial hardship to support the long-term success of their business thus preserving relationships retention and portfolio stability.

Nine of the 1810s. We've been granted assistance our restaurants ground floor retail or retail amenities. These higher risk tenants are generally located on the ground floor of our building and make up less than a half of a percent of our total annualized revenue through the armoire groups credit risk team. We routinely review both industry and tenant risk. Well considering various factors around financial industry just to name a few as noted earlier roughly 94% of the portfolio by industry is considered low risk, and for those Industries identified as high risk, approximately 28% of the tennis by annualized Revenue are investment-grade rated.

Yes communities across the country have moved to shelter-in-place orders 100% of our properties remain operable. We have established protocol to ensure the safety of our tenants and employees while also mitigating unnecessary costs given a temporary reduction in usage example of these protocols include first all our Mr. Employee management and Engineering employees were trained on covid-19 precaution procedures second prioritization of non-emergency tenant work orders to limit our employee and tenant interaction third enhanced cleaning protocols to focus on a sanitizing High touch points in common areas and restrooms for a focus on reducing operational costs with the implementation of energy reduction protocols for lighting and HV AC system and the reduction of non-essential Building Services such as the frequency of trash removal and lastly the shutdown of building amenities such as fitness centers and Conference facilities.

In addition to implementing enhanced operating protocols and social distancing guidelines are management teams that are more have established business continuity plans to prevent the spread of covid-19 and to ensure operational stability at our properties non-critical travel has been suspended Regional leadership Personnel have not been allowed to work in the same location at the same time and personal protective equipment is required of an employee still working to manage our properties armoires platform of more than 30 offices across the country has allowed us to continue quality management of our properties collect real-time information around involving changes and to maintain our strong relationships and Communications with tennis, finally while continuing to manage protocol to ensure safety of our employees and tenants. We are all waiting procedures for a post-pandemic work environment and reoccupancy of our buildings.

turning to our

Can results for the quarter while we have begun to see a Slowdown in tenant towards a new leasing activity renewal leasing discussions are continuing and we deliver positive results in the first quarter. We completely new leasing for an aggregate of 589000 square feet for a weighted-average roll up and rent a 4.1% The weighted average lease term of 4.8 years and leasing wage concessions in capital commitments of $4.60 per square foot for at least year.

Total portfolio occupancy has increased 190 basis points year-over-year to 91.5% our current leasing pipeline of one point six million square feet includes four hundred fifty thousand a square feet that could absorb vacant space across the portfolio. We anticipated near term conversion of 45% of our pipeline given the roughly seven hundred thousand square feet of current activity is in advance stages of the sign proposal or lease documentation review.

Despite an active leads pipeline. We anticipate new lease activity for the second quarter may slow during our fourth quarter call. We provided guidance on a same-store basis which included a year-end occupancy Target off of ninety-two ninety-three percent with a roll up and rents of to 3% We believe the near-term impact from covid-19. May delay tennis decisions to lease new space and therefore speculate rep 100 to 200 basis points of our Target year and occupancy. Is that risk?

Before we move into our financial review. I will highlight that last month. We announced that Opie. I received a 2020 energy star partner of the Year sustained Excellence award for its outstanding effort energy management. This is a third consecutive year that we have achieved partner of the Year recognition and the first year earning the sustained Excellence designation in the energy management category current 540 buildings in our portfolio or energy star-certified our manager. The armoire group was also honored with a 2020 energy star partner of the Year award for its outstanding efforts as a service and product provider for the second year in a row. I will now turn the call over to Matt Brown to provide details on our liquidity and this quarter's Financial results map. Thanks Chris and good morning everyone at David and Chris both highlighted. We are carefully monitoring the covid-19 pandemic and possible impact to our results in our liquidity.

April rent collections remain strong and consistent with friends over the prior months with 96.96 percent of rent obligations collected are top 20 tenants representing 58.6% of annual is rental income have paid their April rent obligations, as of April 28th. We have granted temporary rent deferrals 218 tenants. Generally these deferrals include one month of Base rent in exchange for 12 increased monthly payments beginning in the fall of two thousand twenty. The total amount of rent defer to date is one point four million dollars broken down as follows $452,000 on a $809,000 in May and seventy $1,000 in each of June and July in aggregate these deferrals represent 0.7% of the contractual cash Revenue over that. As these deferrals are deemed to be payment plans consistent with the recent account and guidance related to rent relief requests. We do not expect this rent assistance to impact our revenues. However, it will temperature.

reduce our cash flows

To date no rent has been forgiven or evaded at March 31st. We had 432 million dollars of liquidity including Thirty million dollars of cash and cash equivalents and 402 million dollars of availability on our 750 million dollar unsecured revolving credit facility at March 31st. Our net debt to annualized adjusted. Ebitda was 5.9 times remains below our Target leverage range for the second consecutive quarter. We currently have 395 million dollars of availability on our revolving credit facility and only 40 million dollars of debt maturities until 2022 our balance sheet remains strong and we have ample liquidity to whether the current disruptions facing the real estate industry.

Turning to Consolidated Financial results for the quarter normalized ffo for the first quarter was 67.6 million dollars or a dollar forty per share which be consensus of a dollar thirty-three per share with normalized ffo, exceeded our guidance estimate of a dollar 32 a dollar thirty-three per share for the following reasons a decrease in property operating expenses of $0.04 per share mainly due to snow removal costs come down below our forecast $550,000 or $0.01 per share of settlement income related to a dispute with a vendor that was not forecasted Market disruptions as a result of covid-19 impacted our estimate as follows a reduction in interest expense on a revolving credit facility of $0.01 per share due to a decline in library a reduction in business management fees within G&A expenses of $0.01 per share due to a decline in our share price in March c a d for the first quarter was forty seven point four million dollars or ninety eight cents per share, which resulted in a c a d pay outrageous.

56.1% in April, we declared a $0.55 per share dividend maintaining our previous level our dividend remains well covered and we expect it to remain real well covered for the June 2020 rental income property operating expenses and depreciation and amortization all declined as compared to q1 2019 due to the sale of 64 properties for aggregate proceeds of 934.2 million dollars since January 1st, 2018.

Gina expense for the first quarter was 7.1 million dollars compared to GNA expense of eight point seven million dollars for the first quarter of 2019. The decline in G&A expense is mainly the result of lower business management fees paid to RMR do to lower debt levels from property dispositions since January 1st, 2019 partially offset by an increase in opi's average share price month in addition. We incurred higher amounts of share-based compensation in q1 2019 as a result of increasing the number of Trustees on our board and the acceleration of unvested shares the service former CFO am retired from RMR in q1 2019. As a reminder. Our business management fee is paid based on the lesser of total Market capitalisation or assets under management and is currently being paid on Thursday market capitalization. We believe this calculation represents a strong alignment of interests with shareholders built into our management management contract with RMR.

Interest expense for the first quarter was 27.2 Million.

Compared to interest expense of 37.1 million dollars in the first quarter of 2019. The decline in interest expense is mainly the result of $750 of unsecured senior. No tree payments, July 1st, 2019 and $388 million dollars of term loans repaid since q1 2019.

Turning the property level results in capital expenditures.

For the first quarter of 2020 same property Cash basis noi increased 1.2% compared to the first quarter of 2019 which beat our guidance range of flat to down 2% wage increase was mainly driven by expense savings most notably decreases in snow removal costs and utilities partially offset by increases in property insurance premiums.

We spent sixteen point three million dollars on recurring Capital during the first quarter including nine point two million dollars on building improvements and 7.1 million dollars on leasing Capital as of quarter-end. We had approximately 57.3 million dollars of unspent leasing related Capital obligations of which 52% represents tenant Improvement allowance has managed by our tenants and 15.8 million dollars is leasing Capital designated and leases for future years based on our current forecast. We expect 2020 recurring Capital expenditures to be approximately $92, which is down from a forecast of $110 mainly due to the timing of capital projects and changes in speculative leasing Capital as a result of the covid-19 pandemic.

We expect normalized ffo per share to be between a dollar thirty three and a dollar $30 for the second quarter of 2020. We currently do not expect the material impact to our results from the covid-19 and Emmett as a result. This estimate excludes any potential loss of Revenue that could result from tenant bankruptcies or defaults on lease obligations and excludes any acquisition or disposition activities.

We expect our second quarter same property Cash basis. Noi growth to be between negative 0.5% and positive 1.5% as compared to the second quarter of 2019 Chef operator that concludes our prepared remarks. We're ready to open the call up for questions.

operator

Monday

Olivia yeah, we're trying to contact them now. Have we lost the call?

Let me check. We're still alive.

They're sending another operator over. She's having technical difficulties. Just hold a moment. Okay. Thank you.

Sorry about that. Our first question is from Bryan Mayer from Riley. FBR. Go ahead.

Good morning, everyone. And that was a pretty decent quarter you guys put up so congrats and it's difficult environment David. Can you tell us are you effectively dead now with the disposition process with the assets sold so far this year.

Brian yeah, we completed the the leveraging disposition process at the end of the year. Yeah, we came in to 2020 with the expectation that we would do a capital e capital recycling program selling somewhere between a hundred and three hundred million dollars, you know right now the the property sales Market is substantially Frozen because of the lack of availability of debt Capital. So we've elected not to bring anything to the market until such time as we start to see liquidity come back to the market. My hope is is that we can you know recommence with the capital recycling program. Sometimes during the second half of the year, but we don't have to sell anything.

So there's really no reason to bring anything to Market until we believe we can transact efficiently and it's decent pricing.

Okay, and then on the flip side of that are you getting any early any?

I'm sorry, Brian. I lost her.

Hey, our next question is from Morgan Stanley. Thanks for taking the question and uh and and definitely put up a a good quarter. Hope everyone is well and safe. This couple of questions are some of your peers have talked about, you know, lower expensive effects, you know going forward warnings can give a bit more color in terms of quantifying, uh, kind of how it affects good friend, you know over the near-term

Trivikram that's a good question. Matt you want to take that sure, you know with the with the initiatives that our property management team is put in place as a result of thousands of people in our buildings. We do expect to see a a decline in in operating expenses as a result of that. I don't have the the exact numbers. It is not overly material though. Okay, and then just a broader question, you know the whole uh-uh work from home experience. Certainly. There's a lot of debate as to whether or not this could permanently change the demand for office giving your concentration, you know on on the government side. I'm just curious and any early thoughts are discussions. You may have had thinking about future space needs from your tenant base.

Yes, Vikram another good question. In fact, we had a conversation with Dan Matthews this week who's Commissioner of GSA just to kind of check in with us to see how you know how our buildings were operating and how everything was going as a result of the pandemic, you know, GSA life has a lot of employees that work remotely and when they redid they're building a couple of years ago in Washington D. They took it a lot of hotelling stays so that they could increase the number of employees at work remotely. There are a number of federal agencies that don't have that luxury because they face the public they deal with a lot of paper and so I don't think there's going to be a material change.

As it relates to more remote working with the government tenants. I do think that they are having to rethink wage the increase in utilization rates that they have taken on over the last couple of years because they have a lot of people that sit back shortly much closer than six feet apart. They have a lot of collaborative spaces. And so I think over time they're going to have to rethink that I think on the whole private sector, you know, I think people have been very successful being productive working remotely, but by and large, I think most employees want to get back to the office. They miss the social interaction of being in an office they missed the opportunity to wage.

dementor and

Row and so while I think you may find more people working remotely going forward. I don't think it's a permanent remote work. I think it's probably maybe one or two days a week. So they'll continue to need space in an office in all likelihood. You're going to see some tenants actually want to have more space would be able to create a little bit better better physical distances. So we could actually see offers usage increase as a result of this but as you would expect it's it's still way too early to know.

That's fair enough. Thanks for the color. I just one quick numbers question the straight-line rent and the rent a motivation. Just been moving around over the last few quarters. Just wondering is there a a Runway can sort of expect or we should be modeling in?

What I'll say on the yeah, what I'll say on the street line red is that we had some free rent that burned off at the end of 2019, which was favorable to Cash & Ally this month about a million dollars, uh in as we move forward to Q2. We do expect about another one point four million of free rent to burn off and turn to cash start in Q2. Okay, great. Thank you Lisa amortization. We had a tenant contraction during Q4 and that tenant had I had it was in a below-market least position. So we had a right off of that. So the number that's currently in q1 is a good run rate for that number.

Great. Thank you.

Next question is from by Bryan Mayer from B Riley FBR. Sorry about before no problem. Can you hear me now? David? Yep, okay, following up on my spot, you know posted this position. I know it's really early Innings. What are you seeing or hearing of any stressed owners out there of assets that you might be able to make a run at home of the balance of 2020?

Right. I think it's it's still a tad early. Definitely. There are some distress owners that are are looking to sell assets off. There hasn't really been a capitulation in pricing though. So the properties that we've seen come to Market are still being proposed at relatively low capital. And so I think we're kind of in that time. Right now we're buyers have expectation for prices to come down and sellers haven't really dead capitulated to think that they're willing to do that but that, you know things continue as they are that could change in the second half of the year.

And to the extent that you do make any Acquisitions, I suspect that you wouldn't be or from your normal course of type of asset ownership and type of tenant. Is that a realistic?

That is the realistic expectation Brian. We don't have any intention of hearing from our business plans. And then lastly for me, you know, it looks like you guys have done a pretty good job of lowering your interest expense with what's going on both in the markets and retiring some debt. But when we look at your you know Capital stack on the debt side, there are a couple of team is still lingering out there and you know fairly locked the interest expense levels too in particular. Is there an opportunity to retire those early as well or or are you stuck with those bath mat?

It's a it's a good question. Our debt generally comes with prepayment penalties. And then you have kind of a window which is generally about 90 days where you can pay off without penalty. So we haven't kind of run the math if the prepayment penalty on those makes sense to do, uh, you know, we only have forty million of debt coming do between now and 2022. So we are very comfortable with our debt levels at the moment.

Yeah, thanks. That's all for me.

Again to ask a question, please. Press star then what our next question is from from go ahead.

Our next question is from Michael Carroll from RBC Capital markets. Go ahead.

Hey, this is Jason on from like it's a follow-up to vikram's question on the operating expense Trend. So I know you mentioned that you had the snow removal savings this quarter. So as far as the run-rate moving forward should we expect it to be relatively in line with the quarter-over-quarter values. That's a good question. I would expect for Q2 expenses to be slightly higher than q1. We will have kind of seasonal utilities picking up and then r&m activities are generally higher in Q2 over q1.

Okay, great. Thanks.

Our next question is from Toyota from me. Go ahead. Yes, just a quick question around Salem brand again. 27th. I know you had made some comments or your overall about your recent exposure. But could you kind of give us a sense of about what's happening with that particularly in giving that it's showing your tops off?

Sure, we received a request from them to defer rent, correct? And we agree. I thought we agreed to defer rent. Can you remind me how how many months we did that format? Two months, April and May, okay.

So you did it for three months for them specifically? Okay, that's helpful. And then on the acquisition front again, appreciate the comment you made about Capital recycling again, if the if the disposition side is getting delayed because of lack of debt capital of you mentioned. Does that necessarily mean you also delaying the acquisition site to match that up or down unless you're comfortable enough with your liquidity today that you could still go ahead and do a tractor transaction, even though you may not necessarily be selling assets on the other side of the quote unquote matches. It's a good question Tayo, you know, we did sell a little more than $85 million dollars of assets during the first quarter that were part of our capital cycling program.

You know on an after Capital basis the yield was about 4.1% So, you know, we have some capacity that we could make the magic actions on The Leverage neutral basis right now. We haven't seen any Acquisitions that are attractive. We're also you know below are targeted leverage rains so often do have the room who to take leverage higher, although I don't I don't think that we will go out and make dramatic number of new acquisitions unless we're comfortable continuing with our Capital recycling program. So we've got some capacity but I don't think we're going to see it be dramatic until we re-enter the disposition Market.

Gotcha, okay, and then lastly regards to you know, kind of upcoming lease maturities any tenants out there giving you in decisions about uh, possibly not renewal. I know we kind of talked about but the 2021 building I believe with the FBI, but is there anything else out there either through the rest of this year Kayo? We have a few tenants that represent about sixty basis points of our annualized rent that we know are going to vacation. We have about another 40 40 basis point where we feel like they're at risk based upon current negotiations. So nothing at all material.

Okay, and is that is that is that irrespective of the wanted to 2% of occupancy declined you were thinking could happen over the course of the rest of the year off just kind of given the flu down in in any of these things.

I think that's part of it. I thought of it. Okay. Yeah, cuz we what we what we're not sure at this point is given the fact lack of showings from Brokers and the inability of of office users to get out and view space right now how quickly that's going to pick back up. Once the once the various States reopen and the shelter-in-place orders are

All right, that's helpful. Thank you.

This concludes our question-and-answer session. I would now like to turn the conference back over to David Blackmon for closing remarks.