Easterly Government Properties Inc (DEA) 2016 Q2 法說會逐字稿

Welcome to the Easterly Government Properties second-quarter 2016 earnings conference call.

(Operator Instructions)

As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ms. Meghan Baivier, Chief Financial and Operating Officer for Easterly Government Properties. Thank you. You may begin.

Thank you, Melissa. Good morning. Before the call begins, please note the use of forward-looking statements by the Company on this conference call. Statements made on this call may include statements which are not historical facts and are considered forward-looking. The Company intends these forward-looking statements to be covered by the Safe Harbor Provisions for forward-looking statements contained in the Private Securities Litigation Act Reform of 1995 and is making this statement for the purpose of complying with those Safe Harbor Provisions.

Although the Company believes that its plans, intentions, expectations, strategies and prospects, as reflected in or suggested by those forward-looking statements are reasonable, it can give no assurance that these plans, intentions, expectations or strategies will be attained or achieved. Furthermore, actual results may differ materially from those described in the forward-looking statements and will be affected by a variety of risks and factors that are beyond the Company's control, including without limitation those contained in item 1-A Risk Factors of its annual report on Form 10-K for the year ended December 31, 2015, filed with the SEC on March 2, 2016 and its other SEC filings. The Company assumes no obligations to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

Additionally, on this conference call, the Company may refer to certain non-GAAP financial measures, such as funds from operation and cash available for distribution. You can find a tabular reconciliation of these non-GAAP financial measures to the most comparable current GAAP numbers in the Company's earnings release and separate supplemental information package on the Investor Relations page of the Company's website at ir.easterlyreit.com.

I would now like to turn the conference call over to Darrell Crate, Chairman of Easterly Government Properties.

Thanks, Meghan. Good morning, everyone. Welcome and thank you for joining us for our second-quarter 2016 earnings call. Today, in addition to Meghan, I am joined by Bill Trimble, our CEO. The second quarter was another strong one for Easterly, including a number of operational and financial milestones for the Company. The Easterly team continues to hone its definable edge in the sourcing, underwriting, and managing of mission-critical federal government buildings. We continue to execute on our proven strategy, growing an outstanding portfolio of these assets and deploying capital accretively to drive material earnings growth.

Easterly remains the only internally managed public REIT that focuses solely on the United States Government leased assets. Our leases are backed by the full faith and credit of the US government, one of the strongest credits you can find. This base of stable cash flows, supported by a robust lowly levered balance sheet and access to capital, pairs with an acquisition and development strategy we believe that provides an attractive risk-adjusted return opportunity for our investors.

I am very proud of our team at Easterly. In the second quarter, we announced: our first portfolio acquisition since IPO; were awarded a lease for the development of an FDA laboratory; and successfully completed our first follow-on equity offering. We continue to report results and activities which are consistent with the expectations that we set out at the time of the IPO. We expect to continue executing upon our goal of delivering strong earnings growth year-over-year. Now, I'll turn the call over to Bill to provide more color on the Company's second-quarter performance.

Thanks, Darrell. Thank you, everyone, for joining this morning. I am pleased with the Company's operational performance and the accomplishments of the full Easterly team in the second quarter. At the end of the second quarter, the Company's portfolio totaled 38 properties comprised of nearly 2.8 million square feet of commercial real estate. 97% of our annualized leased income is backed by the full faith and credit of the United States Government.

On May 19, we were very pleased to acquire the 62,772 square foot National Park Service property in Omaha, Nebraska. The property houses the NPS Midwest regional headquarters and serves as a visitor's center for the Lewis & Clark National Historic Trail. Built in 2004, the property is leased to the GSA with eight years remaining on an initial 20-year lease. On June 1, the Company announced the agreement to acquire a 302,057 square foot portfolio of four US government leased properties for a purchase price of approximately $97.4 million. The portfolio consists of an FBI field office and a DEA district office, both in Birmingham, Alabama, as well as an EPA laboratory in Kansas City, Kansas and a FBI field office in Albany, New York.

Subsequent to the quarter end, the Company completed the acquisition of the first three properties. FBI Albany is slated to close in the fourth quarter of this year. Easterly's development team, led by Mike Ibe, remains active. On June 18, the Company was awarded a 20-year lease for the development of a 65,810 square foot Food & Drug Administration laboratory in Alameda, California. The Easterly team has significant experience in the development of GSA-leased properties, particularly laboratories. Our differentiated knowledge, experience and partnership with the GSA enabled Easterly to compete successfully for this lease award.

Our acquisition and development pipeline is robust, as the Company maintains rigorous underwriting standards focused on a well-defined target market. This market includes properties leased to a single tenant agency of the US federal government, which are the result of a design build award and are usually over 40,000 square feet in size. It is important to note that we underwrite the agency and the hierarchy of the mission of the perspective building before performing the deep dive in the actual bricks and mortar. I will now turn it over to Meghan for a discussion of the quarterly financial results and earnings guidance.

Thank you, Bill. Today, I will review our second-quarter financial results, provide an update on our balance sheet and recent financing activities and review our 2016 guidance. Additional details regarding our second-quarter results can be found in the Company's second-quarter earnings release and supplemental information package. For the second quarter, FFO was $12.1 million or $0.30 per share on a fully diluted basis. FFO, as adjusted, was $11.7 million or $0.29 per share on a fully diluted basis. Our cash available for distribution was $10.4 million.

Turning to the balance sheet, at quarter end, we had $198 million outstanding on our revolving line of credit and total debt of $280 million. Availability on our line of credit stood at $202 million. In terms of leverage, net debt to total enterprise value was 24%. Net debt to annualized quarterly EBITDA was 4.9 times, adjusted for the closing of the first three of four-portfolio assets leveraged at approximately 4.5 times.

In June, we successfully completed our first follow-on equity offering, raising gross proceeds of $84.9 million, with an additional $27 million in gross proceeds expected upon full-physical settlement of related forward sales agreements. Proceeds have and will be used in part to fund our recent acquisition of a four-property portfolio, repay borrowings outstanding under our senior unsecured revolving credit facility to fund other potential acquisition opportunities for general corporate purposes or a combination of the foregoing.

With regard to guidance, for the 12-months ending December 31, 2016, the Company is reiterating its guidance for FFO per share on a fully diluted basis to $1.19 to $1.23 per share. This guidance assumes acquisitions of $175 million in 2016, including the five properties acquired to date and the closing of FBI Albany in the fourth quarter of 2016. This guidance does not contemplate dispositions or additional capital markets activities.

Let me walk you through this guidance in more detail, at December 31, 2015, run rate FFO on a fully diluted basis was approximately $1.17 per share. At the end of the second quarter of 2016, having completed approximately $52 million in acquisitions, run rate FFO on a fully diluted basis was approximately $1.22 per share before considering the impact from the timing of our June follow-on equity offering.

Looking to the second half of 2016, we would expect the impact from the closing of our previously announced four-property portfolio; the equity successfully raised in June, including the greenshoe and on a forward basis; as well as approximately $25 million of additional acquisitions, to result in run rate FFO per share on a fully diluted basis at year end of approximately $1.21.

Given the Company's results year-to-date and this outlook for the second half, we are maintaining our guidance range for the year of $1.19 to $1.23 with a midpoint of $1.21. Finally, as previously announced this week, our Board of Directors declared a dividend related to our second quarter of operations of $0.23 per share. This dividend will be paid on September 13 to shareholders of record on August 26.

I will now turn the call back to the operator for questions.

(Operator Instructions)

Michael Carroll, RBC Capital Markets.

You guys have been successful completing investments this year, but given the Company's current concentration to the DEA and FBI, are you still interested in growing with these agencies? How do you think about the type of concentration you have with those two agencies?

Thanks, Michael. Good morning, it's Bill.

Certainly, I think that if you take the FBI and the DEA, they're two of the most mission-critical agencies in the United States federal government. I've said in the past that we don't think the FBI's going to be going out of business -- in fact it's doubled in size since 2001 and has a very robust budget. So we would be very pleased to acquire as many field offices of this important agency and the same goes for the DEA as well. However, I think that because of different ownership in many different places, including some owned by the United States federal government, that it won't be [FSIs] that I think will be -- would be too much. But we're very positive on those two agencies.

Okay. Then what are you actually tracking on the investment side right now? Are there any other smaller portfolio transactions similar to the one you announced a few months ago on the market?

I think that what I would like to state is that our $700 million that I've spoken of before in pipeline remains robust. We do have about $200 million that we are actively sourcing right now. We continue to do that. I'll sort of remind you, most of our transactions are off-market. In fact, we just did one or two last year that were marketed. So I think we continue to meet with our owners. We know the 500 buildings -- who owns those properties -- and chip away at them. There are some portfolios out there -- obviously, we are engaged in conversations with those that have the portfolios. If it's the right time and the right price, obviously, we will consider doing something there.

Are those smaller portfolios like the four- or five-type property portfolios? Or are there any larger ones out there?

There's a few larger portfolios out there, but most of them are ones and twos owned by various owners throughout the country.

Okay, great. Then could you give us some color on your upcoming lease expirations? I know it's fairly modest over the next few years. But in 2017, I think it ticks up a tiny bit. Who are these tenants? Have you started renewal discussions with them?

Obviously, we interact with the GSA and the underlying agencies constantly. That's, I think, where we differentiate ourselves. But we have not gotten in any direct negotiations with the larger leases that will be rolling in the next several years. But we are confident that federal government will remain in the buildings. We think we are the best solution for the long-term. As they come up, we'll obviously engage seriously with the GSA at that time.

Now, do you have an estimate of the mark-to-market on those leases? Are they well below market right now?

While I think the fact that -- basically, they are below market right now. Yes.

Okay, great. Thank you.

Manny Korchman, Citi.

Meghan, G&A looks like it's running above recent run rate as well above your guidance if I were to annualize it. Can you just give us color on what's happening there? Maybe revising guidance for G&A?

Manny, as we continue to grow the business and increase the scale of the business, I think you're going to see a modest increase in cash G&A. Obviously, nothing that outpaces the growth of our top line. The level in the third quarter is in line -- excuse me, in the second quarter is in line with our guidance for the year.

Then, Bill or Darrell, can you just give some sort of color, [let us in] on tenant? How long the process took to land the new FDA development? If you can at all, give us some idea of where you are on the process for other developments?

Sure. I will say, to begin with, we were quite gratified to win the FDA Alameda. By the way, it's the only development that would fit within our bullseye since we went public -- the only one. It took well over a year in discussions. Obviously, with Mike Ibe, who runs our development and acquisition team, who has developed over 25 of these properties, we were confident that we were going to come up with a good bid and work well with the federal government.

When it comes to pipeline, obviously we do have a number of lines in the water at all times and are entertaining buildings that would fit within that very targeted area that works for us. Consider -- basically, we are building, in this case, to a 20-year firm term lease with 100% occupancy on this property. It's very difficult for us to forecast projects, as the government needs and timing are not necessarily congruent with quarterly earnings. But you can certainly assume that the Easterly team over the next four to five years are going to be doing some terrific development projects that I think will be quite accretive to our earnings going forward

Maybe you can help me just reconcile just two things you just said: Mike has done 25 of these. Yet, you've found one since IPO that matches your underwriting or your desires. Was it easier to do in the past? Is it more competitive now? Are there just less projects out there -- less RFPs? What's going on that Mike's momentum has slowed since you guys have gone public?

I don't think Mike's momentum has slowed, knowing Mike Ibe pretty well. I'd say the federal government's appetite for new buildings certainly was curtailed with that little incident that occurred between 2008 and 2010, with the massive slowdown. But I will say that the federal government has its needs; buildings are getting older obviously. Obviously, our buildings are very young in our overall portfolio. But there are important facilities, certainly laboratories, and I'd also mentioned FBIs and so forth, where the government continues to invest in their important mission-critical infrastructure.

So, I think we will begin to start seeing some more development projects going forward. Obviously, we are seeing a lot of really terrific products in the VA area, as that's an agency that understands the importance of our servicemen and women over the decades to come. So we are seeing some development there. But you can be assured that we are concentrating on anything that would fit within our bullseye. We do believe that we're going to start seeing some more projects certainly in the next two to three years.

Thanks, Bill.

Thank you.

(Operator Instructions)

Bill Crow, Raymond James.

The question really is as follows: if you look back since the IPO, were there acquisitions that you bid on that you did not win? If you did not, what was the reason for that?

Bill, I'd say that, once again, to mention, 85% of our purchases were off-market. So if there were obviously conversations with people on buildings and maybe there was a couple that we did not close because obviously we are price-sensitive. We said to The Street that we want to purchase buildings between 6.75% and 7.25%, I am pleased to say we have done that. From a standpoint of marketed deals, we did win the FBI Richmond. I think that was -- we were very gratified to get that. There were some other properties that were larger that we felt that we did participate in from a marketed standpoint and did not purchase them because we're very disciplined on what we're going to pay for the properties.

Bill, it's Darrell. During the IPO, something that was very clear is that we are going to be defined as much by the deals that we do, do as those that we do not. The portfolio we are building today is one that, while we brought a -- what we think is a very strong portfolio forward during IPO, the acquisitions and the opportunities that we have in front of us lead to an even higher quality portfolio.

Appreciate that. Obviously, yields at 6.75%, 7.25% is very attractive today, especially where the tenure has gone since the IPO. Are you sensing more competition? Are you sensing any upward pressure on pricing that would cause you to fall out of that range?

I think as we look at the properties, we can certainly continue doing what we have told The Street and indicated for the foreseeable future in the range that we're talking about. Obviously, there will be opportunities as we go forward for buildings that are perhaps 20-year leases, 15-year leases, that might be at the lower end of that range. Obviously, if the cost of capital is appropriate, we will consider them. But from a standpoint of competitive, that's what our team does all day long is going and meeting with the owners -- I think we have a terrific relationship with them. We like to get there certainly ahead of others. We do not see any new competitors from where we started. We have been doing this for about five years now, the same usual folks. We are very gratified to be in that middle zone, where we are not competing against the largest REITs and again, not competing against the lower end, the doctors and dentists indicators.

Okay. I appreciate it. That's it for me. Thanks.

Thank you. Mr. Crate, there are no further questions. I'd like to turn the floor back to you for final remarks.

Great. Thank you, everyone, for joining DEA's second-quarter conference call. We are very excited about our execution path, with the goal to build the highest quality portfolio of US government-leased assets and providing investors with attractive compounding risk-adjusted returns over time.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.