Easterly Government Properties Inc (DEA) 2017 Q3 法說會逐字稿

Greetings, and welcome to the Easterly Government Properties Third Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Lindsay Winterhalter, Vice President, Investor Relations. Thank you, Ms. Winterhalter, you may begin.

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 (sic) [Private Securities Litigation Reform Act of 1995] and is making this statement for the purpose of complying with the 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 would be attained or achieved. Furthermore, actual results may differ materially from 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 1A, Risk Factors, of its annual report on Form 10-K for the year ended December 31, 2016, filed with the SEC on March 2, 2017, 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 operations 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.

Thank you, Lindsay. Good morning, everyone, and thank you for joining us for the third quarter conference call. Today, in addition to Lindsay, I'm joined by Bill Trimble, our Chief Executive Officer; and Meghan Baivier, our Chief Financial Officer and Chief Operating Officer.

Through the third quarter of 2017, Easterly continues to deliver strong and consistent financial results. Management continues to execute on 2 strategic goals. The first, to achieve consistent, long-term FFO growth of 5% to 7% through the re-leasing, acquisition and development of Class A mission-critical properties leased to United States Federal Government. The second, to scale the business with high-quality accretive assets in order to materially increase float, and thereby, reduce the cost of entry and exit for our investors in our common stock.

The team continues to hone its definable edge in identifying, underwriting and servicing portfolio buildings leased to and backed by the full faith and credit of the United States Government. Easterly, is a brand in the federal leasing community. Reputation matters, but particularly in the area of public-private commerce. We strive to be the government's partner of choice when acquiring, developing or managing a government-leased building.

2017 has been marked by the purchase of larger flagship assets like FBI - Salt Lake City and VA - Loma Linda. And I'm proud to note that we materially scaled the company, growing enterprise value by 40%, and simultaneously deepening our relationship and stature with 2 important mission-critical agencies.

Since September 30, 2016, we've generated a total return for shareholders of 13.7%, well in excess of the 2.6% returned by the broader REIT market. We also achieved our goal of delivering FFO growth while materially reducing our future earnings of volatility related to possible interest rate increases. With over 97% of our revenue backed by the full faith and credit of the United States Government, we are grateful to have the highest tenant credit quality of any REIT. This has been a great year for Easterly. We'd like to thank our team for their hard work and thank our shareholders for their partnership as we work to complete 2017 and start generating value in 2018.

With that, I will turn the call over to Bill to provide color on the initiatives at Easterly that drive shareholder return.

Thanks, Darrell, and good morning. I would like to begin by highlighting the company's achievements in the third quarter of 2017. This quarter, we announced and closed on a 169,000 square foot FBI field office located in Salt Lake City, Utah. The Class A, LEED Gold certified, 4-story, single-tenant facility is located on a 7.5 acre campus and overseas Federal operations in all of Utah, Idaho and Montana. FBI - Salt Lake City is 1 of 56 FBI field offices strategically located throughout the United States and serves as a regional headquarters, directing 18 satellite offices, also known as resident agencies, located throughout Utah and the 2 surrounding states. The build-to-suit construction was completed in 2012 and is 100% occupied by the FBI through October 2032 for initial, noncancelable lease term of 20 years. Upon closing of this important government-occupied facility, Easterly Government Properties now owns 7 of the 56 FBI field offices, thus making Easterly the single largest private owner of FBI field offices in the country.

As we mentioned on prior calls, Easterly is also under contract to acquire a VA outpatient facility that is located just outside of South Bend, Indiana. The outpatient facility is now complete and is seeing local veterans on a daily basis. We expect to close on this property in the coming quarter and look forward to welcoming this highly important, mission-critical facility into our growing portfolio. As a reminder, the VA - South Bend outpatient clinic is very similar to VA - Loma Linda, but on smaller scale of 86,000 square feet. The outpatient facility is leased to the VA for an initial 15-year noncancelable term. Once the VA- South Bend acquisition is complete, Easterly will own 2 new, state-of-the-art Class A VA outpatient facilities, totaling a combined 414,000 square feet of leased space, all backed by the full faith and credit of the U.S. Government.

While on the top of the VA, the nearly 328,000 square foot Loma Linda outpatient care center has had its first full quarter of operations under Easterly's ownership, and we are pleased to report everything is going well in the state-of-art Class A facility. In fact, our asset management team recently received a number of requests from the VA to make tenant-funded enhancements, valued at over $1.5 million, to this almost brand-new facility. Our asset management team is doing a wonderful job of addressing the needs of our tenants, and at quarter-end, we're managing 16 active value-enhancing tenant-funded projects across the portfolio.

Turning to development, Mike Ibe and his team have made meaningful strides in building the pipeline of development opportunities that we expect will serve us well for the next several years. Development opportunities are not only accretive, as we add real value to both the government and our shareholders, but they also give us longer, valuable leases, many even in 20 years in duration, which can provide earnings stability and additional opportunities to be opportunistic in managing our liabilities.

As you may recall, we have 2 active development projects underway, both to be occupied by the FDA. The first is a 70,000 square foot laboratory located in Alameda, California. We are pleased to report that we have completed the initial demolition of the current site and now have all shell permits and the first-stage TI permits in hand. We are working hand in hand with the GSA and FDA to incorporate some design changes to make sure the facility functions to the highest and best use of tenant agency. The estimated completion date for this project is the first quarter of 2019. The second laboratory located in Lenexa, Kansas, just outside of Kansas City, is roughly 53,000 square feet, and we are currently finalizing the design intention drawings. We anticipate an early third quarter 2019 completion for this laboratory. Upon completion of these 2 facilities, 2 brand-new, noncancelable 20-year leases will commence.

Our acquisition team is constantly sourcing new, high-quality opportunities that mirror our average portfolio building size and drive FFO growth. We have a robust pipeline of bull’s-eye opportunities that fall within the $20 million to $40 million acquisition range and remain in constant contact with developers looking to sell properties so that they can move on to their next development project.

To reiterate, our target market includes buildings leased to a single tenant of the U.S. Federal Government. They are often the result of a design build award and are usually over 40,000 square feet in size. If a building of this nature is occupied by the right tenant, fulfilling the right mission and meets the traditional real estate underwriting requirements, then we will evaluate a potential acquisition. These bull's-eye elements are very important from a re-leasing perspective as we look to achieve renewal rates at an increase in the high teens to low 20s.

Finally, to summarize our acquisition and development activities since third quarter of 2016, we have acquired 5 new assets, soon to be 6, adding 700,000 square feet to the portfolio. We welcomed 2 new tenant agencies to the portfolio, the VA and OSHA, and we've grown our relationship with the existing tenant agencies like the U.S. Courts and the FBI. We were awarded the development rights for a brand-new, state-of-the-art FDA laboratory in Lenexa, Kansas, marking 2 active development projects for the company. Through this growth, we have reduced the age of our portfolio and extended the average remaining lease term despite the progression of time working against us. As the company's CEO, I'm quite proud of all we have accomplished in the past year.

With that, I'll now turn the call over to Meghan for a discussion of the quarterly results and earnings guidance.

Thank you, Bill. Today, I will touch upon our current portfolio, discuss our third quarter results, provide an update on our balance sheet and review our 2017 and 2018 guidance. Additional details regarding our third quarter results can be found in the company's third quarter earnings release and supplemental information package.

As of September 30, we owned 46 operating properties, comprising approximately 3.7 million square feet of commercial real estate. The weighted average remaining lease term for our portfolio was 6.9 years, the average age of our portfolio was 12 years and our portfolio occupancy remained at 100%. In addition, over 97% of our annualized lease income was backed by the full faith and credit of the United States Government.

For the third quarter, net income per share on a fully diluted basis was $0.02, FFO per share on a fully diluted basis was $0.32 and FFO as adjusted per share on a fully diluted basis was $0.28. GAAP measures and reconciliations to GAAP measures have been provided in our supplemental information package.

Turning to the balance sheet. At quarter-end, the company had total indebtedness of $539.9 million, which was comprised of $59.3 million outstanding on our unsecured revolving line of credit, $100 million outstanding on our unsecured term loan facility, $175 million on senior unsecured notes and $205.7 million of secured mortgage debt. Availability on our line of credit stood at $340.8 million. As of September 30, 2017, Easterly's net debt to total enterprise value was 33.3%, and its net debt to annualized quarterly EBITDA ratio was 6.1x, pro forma for a full quarter of operations from FBI - Salt Lake City, which the company acquired on September 28, 2017.

On September 11, 2017, the company physically settled the forward equity sales agreements entered into on March 27, 2017, by issuing 4.945 million shares of the company's common stock in exchange for approximately $92.7 million in gross proceeds. The forward equity sales agreements were entered into in conjunction with the closing of an underwritten offering on a forward bases and the announcement of the VA - Loma Linda and VA - South Bend acquisitions.

As noted on the second quarter earnings call, the company recently completed $175 million private placement of senior unsecured notes and $127.5 million mortgage financing on the VA - Loma Linda outpatient care facility. These 2 capital market activities meaningfully extended the average maturity of the company's liabilities and shifted its ratio of fixed versus floating rate debt. The company believes the strength of the execution on both its private placement senior notes and the VA - Loma Linda mortgage speaks to the superiority of the company's portfolio and the high credit quality of its underlying tenant, the U.S. Government.

Turning to the company's guidance. For the 12 months ending December 31, 2017, the company is narrowing its guidance for FFO of $1.26 to $1.29 per share on a fully diluted basis. This guidance assumes acquisitions of 385 million in 2017, including the OSHA-Sandy acquisition completed in the first quarter; the VA - Loma Linda acquisition completed in the second quarter; the FBI - Salt Lake City acquisition completed in the third quarter; as well as the announced VA - South Bend acquisition, with an anticipated closing date in the fourth quarter of 2017.

The company is also introducing its 2018 guidance of FFO per share on a fully diluted basis in a range of $1.31 to $1.35. This 2018 guidance assumes $250 million of acquisitions and between $75 million and $100 million of development-related investment during 2018. The company's 2017 and 2018 FFO guidance is forward-looking and reflects management's view of current and future market conditions.

As previously announced, last week, our Board of Directors declared a dividend related to our third quarter of operations of $0.26 per share. This dividend will be paid on December 21, 2017, to shareholders of record on December 6, 2017. This increase in the dividend is consistent with our pattern of growing the dividend by $0.01 every other quarter since IPO, and we expect to continue targeting future dividend growth commensurate with earnings growth.

Finally, before turning the call over to the operator for questions, allow me to step back and look at how far we have come since this time last year. Since the third quarter of 2016, we have grown our FFO by 7% while extending the duration of our liabilities and maintaining a conservative balance sheet. Our average debt maturity has been extended by over 80% to 8.5 years, beyond our average remaining lease term of 6.9 years. Additionally, 1 year ago, our debt structure was 77% floating and today is 86% fixed rate.

Using the strength of our growing portfolio, we have been active in the capital markets to term out our debt, both through the unsecured private placement market and with the secured mortgage on VA - Loma Linda. We raised equity accretively in connection with the announcement of VA - Loma Linda and VA - South Bend, thus increasing the liquidity of our stock. And we commenced an activate ATM offering program. It's been a great year for the company and we would like to thank our capital providers for their ongoing partnership.

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

(Operator Instructions) The first question comes from Manny Korchman with Citigroup.

Bill, maybe this one is for you. Can you talk about what you've seen in terms of yield trends over the last months or quarters? Has there been any tightening or loosening of yields versus where you sort of first came out a couple of years ago?

Good morning, Manny. We have not really seen much in the way of change. We'd except at some point that, that would happen, but it is definitely lagged. I mean, we're basically purchasing those sort of bull's-eye properties at the same rates we were -- we have been purchasing for the last several years.

And Meghan, I got a couple for you. One, just your thoughts on longer-term leverage targets. You're over 6x now, is that something you're comfortable with? And for next year's guidance, the $75 million to $100 million of development spending, is that just related to the 2 projects that you've mentioned earlier? Or is there a new a project or two assumed in that?

Sure. So on your first point, Manny, we remain consistent in our -- on our comfort level with 40% to 50% leverage on triangulating to 6 to 7x on an operating bases, not moving that target. And then with regard to the development guidance, that $75 million to $100 million, correct, that is -- that relates to FDA Alameda and FDA Lenexa.

The next question is from Brian Hawthorne with RBC Capital Markets.

Can you talk about the GSA build-to-suit market in general, and if you're seeing any activity picking up there?

I think that having been in this business for a while and we saw the huge amount of construction during the 2005 to 2007 time frame, which obviously slowed down massively. We are beginning to see some of the picking up at this point. I will say that we have won, actually, every single mandate since we've been public that -- for projects that would fit within our bull's eye. Obviously, can't guarantee that will go on forever, but we're beginning to see, obviously, some new laboratories in the FDA and a few other projects beginning to percolate up. And obviously, we're keenly interested in addressing those needs for the Federal Government.

Okay. And then one more. The VA - South Bend acquisition, any reason that was pushed back into 4Q?

Not really. I was out there for the opening, which was a spectacular day in South Bend, Indiana, about 3 -- 4 weeks ago, I guess. We're just getting through some punch list items, and as soon as those are cleaned up, it's an absolutely gorgeous facility, we will take ownership and look forward to serving the VA for 15 years to come.

(Operator Instructions) Our next question comes from Michael Lewis with SunTrust Robinson Humphrey.

On Alameda, I don't know why, I was under the impression that, that would be like more of a mid-'18 completion. Is that true that, that -- it has up and moved back? And has there been any change to the expected yield on that project?

Michael, good morning. Alameda is now targeted for early 2019, as we said earlier. Obviously, the GSA and the tenant and us are ongoing in just making this facility even more functional for the FDA. And its yield is still consistent with that 50 to 75 basis points premium to where we're acquiring.

Okay. And then in terms of the funding sources for '18, is it safe to assume a mix of equity and debt that's sort of consistent with what you've been running at?

I would tell you back to our leverage targets, and that's 6 to 7x.

Okay. And then just finally for me, I know I ask this every quarter, but are there any potential move-outs you see down the line? And I assume I -- that I could assume your renewal percentage for -- in your 2018 guidance is 100%.

I think that's correct, and we continue to -- obviously, we're renegotiating and dealing with the government on 3 properties right now and have renewed to, which we discussed before, very successfully. The DEA warehouse is 25% up, and Social Security facility, but you are correct.

Our next question comes from Jon Petersen with Jefferies.

Yes, just one question. I'm curious with upcoming tax reform, if you're seeing any changes in buyer and seller behavior in your market, or maybe any expectations of changes and any opportunities or challenges that might present for you guys?

Yes. I think, actually, of more interest to us, and I've said this in prior calls, which doesn't necessarily seem to make as much sense, but we buy most of our properties off market, in fact, way more than half. And as we see a modest increase in interest rates, we believe that we're going to see a -- even though we have a very strong $350 million and $700 million overall in our active pipeline, but we're actually going to see an uptick in the opportunities going forward as a lot of these owners feel that maybe they've reached the point that it would make sense to depart with their property. So Meghan, anything you have to say on the tax?

I think the retention of 1031 exchange is also certainly helpful and beneficial as we -- as our public-grade currency is useful to sellers.

There are no further questions at this time. I would like to turn the floor back over to Darrell Crate for closing comments.

Okay. Thank you, everyone, for joining the Easterly Government Properties third quarter conference call. We appreciate your interest and you support, and we look forward to continuing to build a very high-quality portfolio of leases backed by the full faith and credit of the United States Government in an effort to deliver strong, compounding returns to shareholders.

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