Q3 2023 Orion Office REIT Inc Earnings Call

[music].

Greetings and welcome to Orion Office, REIT third quarter 2023 earnings call.

As a reminder, this conference is being recorded I would now like to turn the call over to Paul Hughes General Counsel for Orion. Thank you you may begin.

Thank you good morning, everyone yesterday, Oh, Ryan released its financial results for the quarter ended September 32023 filed its Form 10-Q, with the Securities and Exchange Commission and posted its earnings supplement to its website.

These documents are available in the investors section of the Companys website at <unk> Dot com.

Certain statements made during this call are not strictly historical information and constitute forward looking statements.

These statements, which includes the company's guidance estimates for calendar year 2023 are based on management's current expectations and are subject to a number of risks that could cause actual results to differ materially from our estimates.

The risks are discussed in our earnings release as well as in our Form 10-Q, and other SEC filings. The company undertakes no duty to update any forward looking statements made during this call.

Additionally, during the conference call today, we will be discussing certain non-GAAP financial measures such as funds from operations or <unk> and core funds from operations or core <unk>.

The company's earnings release and supplemental include a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measure.

Our presentation of this information is not a substitute for the financial information presented in accordance with GAAP.

Hosting the call today are Paul Mcdowell, the company's Chief Executive Officer, and Gavin Brandon The Companys Chief Financial Officer.

And joining us for the Q&A session are Gary laundry out, our Chief investment Officer, and Chris Day, our Chief operating officer.

With that I am now going to turn the call over to Paul Mcdowell Paul.

Good morning, everyone.

Welcome to Orion office suites third quarter 2023 earnings call.

On behalf of our team I want to thank you all for joining us today.

I will discuss our portfolio performance and operations for the third quarter and highlight our ongoing progress in executing our business strategy of owning a diversified portfolio of high quality office properties leased to primarily on a single tenant net lease basis in markets across the United States.

I will then turn the call over to Gavin to provide an update on our financial results.

Our outlook for the rest of the year.

At quarter end, we owned 79 properties and six unconsolidated joint venture properties, comprising $9 5 million rentable square feet that were 85% occupied.

Adjusted for properties that have been sold subsequent to quarter end or currently under agreement to be sold our occupancy rate was 88, 7% as of September 32023.

The properties in the portfolio are predominantly either triple or double net leased to credit worthy tenants.

As a percentage of annualized base rent as of September 32023.

72% of our tenants were investment grade up from 69, 9% as of September 32022.

Our strong portfolio of assets is well diversified by tenant.

And in industry and geography.

Our largest tenant by annualized base rent is the United States government.

In our two largest tenant industries are health care and government, representing 14, 7% and 13, 7% of annualized base rent respectively.

Over 30% of our annualized base rent is derived from Sun belt markets are.

Our largest market by state remained Texas and New Jersey.

Which represented 16, 7% and 13, 2% of annualized base rent perspective.

Our portfolio's weighted average lease term stayed steady at three nine years at quarter end.

Maintaining a strong capital structure that can support the necessary investments in our core portfolio is a critical part of our business plan beyond being proactive in our approach to new and renewal leasing.

Carefully balancing our leverage asset sales and capital investment is the right strategy since we cannot control the macro environment or the financial climate for the office sector, which continues to be very difficult.

To that point the continued negative sentiment has certainly weighed on valuation for not just our Ryan but also the entire office and net lease sectors.

In September we learned that Orion would transition out of certain stock indexes, resulting in a significant temporary spike in trading volumes and added selling pressure on our shares as investors rotating out of their ownership positions.

Given the dislocation we executed a repurchase of 900000 shares of our common stock for $5 million at a weighted average price of $5 46 per share as part of the company's previously announced $50 million share repurchase program.

Beyond that investment we continue to prioritize current and expected future capital spend for building improvement allowances and lease incentives to retain and attract new tenants and enable us to maintain and extend our existing portfolios weighted average lease term to drive sustained cash flows.

We spend a significant amount of time on capital allocation decisions and remain guided by ascertaining, which properties will provide the greatest return over time.

We still believe that the best use of our capital is to.

<unk> to stabilize and reposition the existing portfolio.

And recycled capital as appropriate through the sale of properties that do not align with our long term strategy.

During the third quarter and shortly thereafter.

We closed on the sale of three vacant properties, representing 452000 square feet.

For an aggregate gross sales price of $15 4 million or $34 per square foot.

We also have agreements to sell nine additional properties.

Representing 779000 square feet.

Were approximately $47 million.

Regarding the six property former Walgreens campus in Deerfield, Illinois that we've had under contract to sell for the past several quarters.

The buyer continues to progress with its redevelopment plans.

For the properties, despite the challenging financing environment and has reached an additional milestone therefore, adding to their at risk deposit towards the purchase price.

We are now targeting the sale to close sometime in mid 2024.

The reason this is so important to execute on these sales of vacant noncore assets is the costs that are associated with maintaining a vacant building.

In our retail lending opportunities over the near to intermediate term appear unlikely.

During the nine months ended September 32023.

We estimate that we have spent $8 $2 million in carrying costs on vacant and partially vacant properties as shown on page 18 of the supplemental.

As we've said before.

While asset sales reduced operating expense drag in the short term it will pressure our ability to grow earnings in the future as it becomes smaller with fewer buildings.

That said.

We believe that in this environment is the right approach to maximize the long term value of the overall portfolio and position the company to grow profitably in the future.

Leasing continues to be challenging and we did not sign any leases during the third quarter despite decent activity.

In October we secured a 10 year early lease renewal for approximately 90000 square feet in Memphis, Tennessee.

The investment grade tenants lease term will now run until December 31, 2034.

We also entered into a new 10 year lease for approximately 3000 square feet of retail space.

On the ground floor in our building in Covington, Kentucky leased primarily to the United States of America.

From an office sentiment perspective, we have not seen or heard of much change from what we shared over the summer on our return to office for many employees.

But anecdotally the parking lots do seem a bit fuller as we travel throughout our markets.

We also are seeing an increase in conversations and showing that some of our properties and while there is a long road to convert market interest into new leases.

It is definitely a positive step forward for office space demand relative to the sentiment over the summer.

Despite these green shoots we do not think that office utilization will revert back to historical norms.

Even as return to office gains traction.

Hybrid work practices are not going away and lower utilization will likely continue to result in office tenants seeking less square footage on renewal for the foreseeable future.

Tenant retention remains our highest priority.

As we've provided in our supplemental filing.

We do have significant lease roll in 2024 of approximately one 9 million square feet.

And several of our larger tenants have publicly indicated they do not intend to renew with us which will impact revenues until those properties can be re tenanted.

From the leasing pipeline perspective, however, we continue to be in various stages of discussion and negotiation for new leases and renewals of over one 5 million square feet, including at some of our properties, where we have lease roll next year.

While our pipeline is encouraging corporate decision, making remains slow and converting interest into signed leases can be a slow and uncertain process.

Given the timing of leases and the size of our portfolio.

Retention will remain volatile quarter over quarter, depending on the needs and timing of tennis decisions.

Our strategy remains intact.

<unk> tenants.

Lease vacant space and dispose of non core assets.

We know will take a few more years to fully reposition our portfolio, but we continue to progress towards overcoming the challenges and are building a solid foundation from which we intend to grow our core portfolio and produce sustained cash flow to create value for our shareholders.

With that I will now turn the call over to GAAP Gavin.

Paul I will start by discussing Orion's GAAP results for the third quarter.

We generated total revenues of $49 1 million as compared to $51 8 million in the same quarter of the prior year.

We reported a net loss attributable to common stockholders of $16 5 million or 29 cents per share as compared to a net loss of $53 million or 94 cents per share reported in 2022.

The change year over year was primarily due to impairment charges of $11 4 million for the third quarter of 2023 compared to $44 8 million for the same quarter in 2022.

Core funds from operations for the quarter was $24 1 million or <unk> 43 per share as compared to $25 6 million or <unk> 45 per share in the same quarter of 2022.

Adjusted EBITDA was $30 million versus $32 1 million in the same quarter of 2022.

Changes year over year are primarily related to vacancies and the disposition of properties.

G&A was $4 4 million compared to $4 7 million in the third quarter of 2022 due to bonus accrual adjustments in the prior year.

Offset by higher compensation expenses as a result of achievement of optical head counts during 2022, and an additional year of stock awards and the associated stock based compensation expense.

Capex this quarter was $8 4 million compared to $3 7 million in the third quarter of 2022, including property improvements of $6 3 million and leasing costs of $2 1 billion.

As a reminder, capex timing will be dependent on when leases are signed and work is completed on properties cat.

Capex will likely increase over time as leases rollover and new and existing tenants draw upon tenant improvement allowances.

Turning to the balance sheet, we ended the quarter with strong liquidity of $316 2 million comprised of $33 million of cash and cash equivalents, including the company's pro rata share of cash from our street joint venture.

$250 million of available capacity on the company's $425 million revolving credit facility and $33 2 million of restricted cash deposits with our credit facility lenders, which will be used to prepay borrowings on the revolver this month and thereby increase the company's borrowing capacity.

Oliver by the equivalent amount.

We have $557 3 million of outstanding debt, which is 100% fixed rate or swapped to fixed rate. However, only until November 12, 2023 in the case of our revolving credit facility until May 27, 2024, and the case of our share of the arch Street joint venture.

<unk> debt.

The exploration of the interest rate swap agreements the outstanding borrowings on our revolving credit facility will no longer be effectively fixed the interest rate and the associated interest expense will rise materially to reflect current conditions.

Company, they enter into new derivative transactions in the future to fix the borrowing cost on all or part of it is floating rate borrowings under the revolver.

Net debt to annualized adjusted EBITDA was 4.09 times at quarter end and the weighted average interest rate was 465%.

Because the market for financing office real estate assets is still dislocated. It remains our intention to maintain significant liquidity on the balance sheet for the foreseeable future given the expected capital commitments in our future leasing that efforts and the necessary financial flexibility to execute on our business plan over the next several years.

Yeah.

Orion's Board of directors declared a quarterly cash dividend of 10 cents per share for the fourth quarter of 2023 to be paid on January 16, 2024 to stockholders of record as of December 29, 2023.

Finally, we are updating our expectations for our full year 2023 guidance for core <unk> and net debt to adjusted EBITDA.

Core <unk> is now anticipated to range from $1 65 to $1 68 per diluted share up from $1 59 to $1 63 per diluted share much of the increase is attributable to one time items and includes the impact of property operating expense reimbursements lower.

Public company costs than anticipated and lower share count due to share repurchase activity.

Net debt to adjusted EBITDA is now expected to range from $4 Zero times, the $4 seven times down from four three times to 5.0 times.

<unk> expectations are unchanged.

<unk> from $18, two 5 million to $18 $75 million.

One additional note while we do not provide quarterly guidance given scheduled lease vacancies. During this year and next we expect to continue to have sequential reductions in the quarterly amount of earnings and core <unk> on a per share basis as we move through the rest of the year and into the coming year.

As we head towards the close of the year the capital allocation decisions that we have made have put the company in a strong financial position, which is further supported by our cash from operations and property sales that should enable us to reach our near and long term objectives, we remain focused on creating value by effectively executing our business plan.

With that we will open the line for questions operator.

Thank you at this time, we will be conducting a question and answer session. If you'd like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate your line is in the question queue. You May Press Star two if you would like to remove your question from the queue for participants using speaker equipment. It may be next.

Soon it pick up your handset before pressing the star keys.

Our first question comes from the line of Mitch Germain with JMP Securities. Please proceed with your question.

Hi, Good morning, how are you guys.

Well Mitch thank you.

I'm curious what was the timing in the quarter of win.

Walgreens and experience when was that move out dates I'm trying to figure out how much of that had an impact on the quarter.

I think walgreens their lease expired.

In.

In the end very end of July beginning of August.

Walgreens was $8 31.

831.

Okay, Thanks, Chris and Experian was $7 31.

Okay. So you have the swap.

Yes, again my mistake.

That's okay and okay, that's perfect and then.

I'm trying to.

Help me out here, Paul I mean, you started the year with 4.1 year average Walt.

He did some leasing your.

You sold some vacancy.

And here you enter <unk> with $3 nine.

Average well when this is pressure begin to moderate because most of the leasing that you've been doing.

Obviously, it's been 10 years, its just a function of a shrinking base of assets that just.

Causing that to not really changed much.

Yeah to some degree and it's a function of <unk>.

Not as much new leasing as as we'd like to achieve and hope to achieve in the future Mitch.

I think we're going to continue to see pressure on our walls throughout next year, because we've got quite a number of leases that are rolling over.

And then hopefully in the out years that is 25 and beyond we will start to see gradual increases in Walt as we both renew leases and add new leases.

Okay.

That's helpful. And then you referenced I think this is the first time you've ever provided some perspective on the.

Volume in your leasing pipeline unless some incorrect.

I think you said $1 5 billion square feet is that correct.

That's correct, Yeah, I mean, I think from time to time.

In the past, we've said, we sort of given indications of where our volumes are so I think what we're trying to say is on the one hand.

In 2024, we've got a lot of lease role and we've got some vacancy coming up.

And that will have a material negative impact on revenues.

On the other side of that coin. We have also got some significant amount of interest.

Interest both from in tenant interest both from a renewal perspective.

And from a new lease perspective.

Which would fill which we would hope would fill some of our vacancy. So we got good leasing activity and by that I mean people visiting our properties.

US exchanging a request for proposals and the like.

But it's a long way from people visiting a property or ask or asking us to respond to an RFP to a signed lease.

One of the things we found over the past year is that decision making cycle at the corporate level can take a long time. So we've got good <unk> got good momentum in leasing, but getting from that momentum to a signed lease can take some time, but.

But we're over the intermediate term, we're quite optimistic about being able to fill up some of these vacancies that we have coming out.

And this is the second quarter in a row, where you've referenced a little bit of an uptick in activity. So I.

I guess do you feel like we're nearing a bottom here and you know kind of moving a little bit.

Maybe up or do you think that there's still a little bit more pain.

Not just your portfolio, but just in the in the office sector in general.

Yeah, I guess I have a couple of responses to that.

Which one is I certainly hope this is the bottom.

Certainly it's been painful.

Getting to where we are today.

The overall market is under a fair amount of stress with a lot of vacancy across the office markets.

For overall, and we're a little different and by that I only mean because of our size.

And we have single tenants were so granular. So we've got a lot of lease roll in 2020 for a couple of several properties of our larger properties, where the tenant has said theyre going to move out.

So that we have some pain to come looking forward.

But when we think about refilling that vacancy.

I would say, we're more optimistic about that today than we probably were six months ago. So hopefully both for Orion and for the industry at large.

If we're not at the bottom maybe we can see it from here.

Got you Okay. The last one for me your guidance implies a pretty significant deceleration in the fourth quarter.

You know you get the benefit of a lower share count.

And you're offsetting that against some of those vacancies or Walgreens and experience not being in a full quarter of <unk> some new vacancies.

I'm just trying to understand you know what I mean.

How do you bridge me from <unk> to <unk> to get to kind of midpoint of your guidance.

Yeah, I mean, I think we've got a fair amount of deceleration in.

In revenues as a result of Walgreens being moved out.

And we also were helped recently with some one time items that won't be recurring.

You know, we did a little bit better on some tax appeals and some property expenses.

So there.

A number of items that sort of have helped us in the past and won't be helping us in the fourth quarter. Obviously the share repurchase will continue to help us to some degree.

But I think it's really the things I just mentioned that is deceleration in.

Revenues, coupled with the positive impacts of some one time items that won't be recurring.

Great appreciate it thank you.

Thanks Rich.

Yeah.

And again as a reminder, if anyone has any questions you May press star one on your telephone keypad to join the question and answer queue.

And we have reached the end of the question and answer session and I'll turn the call back over to Paul Mcdonald for closing remarks.

Thank you all for joining us today on our third quarter call and we look forward to updating you further in the beginning of next year.

Yeah.

And this concludes today's conference and you may disconnect. Your lines at this time. Thank you for your participation.

[music].

Okay.

[music].