Equity Commonwealth (EQC) 2005 Q1 法說會逐字稿

Good day, and welcome to the HRPT Properties Trust first quarter 2005 earnings results conference call. At this time, for opening remarks and introductions, I would like to turn the call over to the Manager of Investor Relations, Mr. Tim Bonang. Please go ahead, sir.

Thank you, Vicky. Good afternoon, everyone, and well to HRPT Properties Trust's first quarter 2005 investor conference call. My name is Tim Bonang. I am the Manager of Investor Relations for HRP. Joining me on today's call are Adam Portnoy, Executive Vice President, and John Popeo Chief Financial Officer. The agenda for today's call includes a presentation by management followed by a question-and-answer session.

Before we begin today's call, I would like to read our Safe Harbor statement. Today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and federal securities laws. These forward-looking statements are based on HRP's present beliefs and expectations as of today, May 5, 2005.

The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call other than through filings with the Securities and Exchange Commission regarding this reporting period. Actual results may differ materially from those projected in these forward-looking statements.

Additional information concerning factors that could cause those differences is contained in our Form 10-K filed the Securities and Exchange Commission, and in our Q1 supplemental operating and financial data found on our website at www.hrpreit.com. Investors are cautioned not to place undue reliance upon any forward-looking statements.

Now, I would like to turn the call over to Adam Portnoy.

Thank you, Tim. Good afternoon, and welcome to our first quarter 2005 investor conference call. Before I begin with the specifics of the quarter, I wanted to mention a couple things we've done recently to help investors better understand HRP.

In early April, we launched a new website for the company. In addition to a more user-friendly design, HRP's new website provides investors with an increased level of information about the Company's management, business strategies, and financial and operating performance.

A prominent feature of the new website is a property section, with interactive maps of the United States, that allows users to view individual pages for the properties that HRP owns.

In addition, after taking into consideration comments we received from analysts since our last conference call, we've expanded parts of our supplemental operating financial data package. We now include a section that analyzes our covenant compliance for our public debt, and we have expanded the amount of disclosure regarding the characteristics of our properties within each of our major markets.

I would now like to focus on some of the specifics regarding the first quarter results. In summary, HRP experienced a solid first quarter, 2005, on many fronts. First, we have grown FFO per share by over 10% in the first quarter. We are reporting FFO per share of $0.32, compared to $0.29, per share for the comparable period last year. We not only grew FFO per share by over 10%, but our FFO payout ratio continues to improve. Our payout ratio was 65.6% for the first quarter of 2005, compared to 68.1% last year. This decline occurred despite HRP having raised its dividends by 5%, to $0.84 per year, in mid-year 2004.

We signed leases for over 1.5 million square feet in the first quarter of 2005. One of the more significant leases we signed in the quarter was a 13-year lease renewal with Constellation Energy in Baltimore for 183,000 square feet. We also signed a 10-year lease renewal with the Commonwealth of Massachusetts Executive Office of Environmental Affairs in Boston for just under 100,000 square feet. We continue to not only maintain one of the highest occupancy rates in the industry, but we are doing an excellent job of increasing occupancy at our properties.

Overall occupancy stood at 93.7% at the end of the quarter, compared to 93.2% for the year-ago period, and 93% last quarter. What is especially noteworthy about this increase in occupancy during the first quarter is that it was completely attributable to increases in occupancy on a same-store basis. Occupancy in properties we have owned continuously since January 1, 2004, increased 120 basis points, and 94.3% leased at quarter end. This increase in same-store occupancy occurred among all property types and across all major markets.

In terms of leasing activity, we did experience about 11 % rolldown in rent in the first quarter, but this was largely offset by substantially reduced up-front capital commitments. We committed to just over $18 per square foot of up-front capital commitments in the first quarter of 2005, which is a 41% decline compared to the fourth quarter of 2004. This quarter's leasing results were different than what we have been experiencing over the last couple of quarters.

During the third and fourth quarters of 2004, we experienced flat to slightly positive changes in rent, but we also experienced high up-front costs for capital commitments. This quarter was different because we had some rent rolldown, but we also had substantial declines in up-front capital commitments. Leasing activity continues to improve in all of our major markets. Each of our major markets had overall positive net absorption and job growth in the first quarter of 2005. This translated into flat to increased occupancies in all of our major markets as of the end of the first quarter.

Same-store NOI also increased in all of our major markets, except Philadelphia and Boston, during the first quarter of 2005. Overall, same-store NOI declined 1.2% during the first quarter of 2005 but, on a rolling quarterly basis, same-store NOI continues to improve. Said another way, our 1.2% decline in same-store NOI in the first quarter is better than the 5.4% decline we experienced during the first quarter of 2004, and is better than the 2.9% decline we experienced during the fourth quarter of 2004.

Our largest market, Philadelphia, is 93.8% leased at the end of the first quarter, which was significantly better than the overall occupancy for this market of around 85%. Same-store NOI in this market declined 11% during the first quarter of 2005. Same-store occupancy remained constant at about 94%, but we experienced rolldown in rents as part of our leasing activity in this market during the last 12 months.

The good news is we have worked through a lot of major leasing issues in this market in 2004, and we believe that we are currently the best positioned commercial office property owner in Philadelphia. We have limited lease-roll in this market over the next few years, with 84% of our annualized rents expiring in 2008 or thereafter.

Washington, D.C. continues to be one of the strongest office markets in the country, as well as one of our best performing portfolios. We were 95.2% leased in Washington, D.C. at the end of the first quarter, which compares favorably to this market's overall occupancy of around 90%.

Same-store NOI in this market increased 7% in the first quarter of 2005. This increase was the result of greater same-store occupancy and a rollup in rents during the last 12 months. Our properties in Washington D.C. continue to outperform the market because of our concentration of leases with the U.S. government and medical-related tenants. We have limited lease-roll in this market over the next few years, with 75% of our annualized rents expiring in 2008 or thereafter.

Our Boston portfolio is 93.3% leased at the end of the first quarter, which was better than this market's overall occupancy of around 86%. Same-store NOI decreased 8.2% during the first quarter of 2005. Although same-store occupancy increased 250 basis points, the 92.4% same-store NOI decreased because of a rolldown in rents during the last 12 months.

Although the Boston market continues to be a challenging area, we have been able to outperform with regards to occupancy in this market by having limited exposure to the Boston central business district and by focusing on medical-related tenants. 64% of our annualized rents in this market expire in 2008 or thereafter.

Our Oahu, Hawaii leased commercial and industrial lands continue to be one of our most secure portfolios. As of the end of the first quarter, our properties were 99.4% leased for an average of 21 years. Oahu continues to be one of the tightest industrial markets in the country, with around 98% overall market occupancy. We also continue to make progress with our business plan of increasing our return on this investment. We increased same-store NOI in this market by close to 1% in the first quarter. This increase was primarily because of a growth in same-store occupancy by 80 basis points during the last 12 months. We have virtually zero lease expirations in this market over the next three years.

Our southern California portfolio continues to perform very well. We were 96.3% leased at the end of the first quarter, which compares favorably to the overall occupancy for this market of around 90%. Same-store NOI increased in this market by 7.5% during the first quarter. This increase was the result of significant growth in same-store occupancy by 360 basis points, and 97.7%, and a rollup in rents during the last 12 months. We continue to outperform the market in southern California because we have a very secure portfolio. It is primarily leased to the U.S. government and medical-related tenants. 64% of our annualized rents in this market expire in 2008 or thereafter.

Our Atlanta portfolio continues to outperform the market. Our properties were 91.6% leased at the end of the first quarter, which is better than the overall occupancy of this market of around 85%. We do not have any same-store operating results for this portfolio because we purchased our properties in this market in mid-year, 2004. Our occupancy rates are better than market because we have a stable portfolio of properties that primarily lease to the U.S. government. We also have modest lease-roll in this market over the next few years, with 76% of our annualized rents expiring in 2008 or thereafter.

Our Austin portfolio continues to be our most challenged major market, but things are starting to slowly improve. As of the end of the first quarter, our Austin portfolio was 84.6% leased, which is about equal to the overall market occupancy. The good news is that, for the first time in a long time, same-store NOI actually increased in our Austin portfolio by a modest 1.4% during the first quarter of 2005. This increase was largely driven by an increase in same-store occupancy by 670 basis points during the last 12 months.

We continue to experience rolldown in rents in Austin, but we are optimistic that, as the economy improves, this market will also see more improvement. 66% of our annualized rents in this market expire in 2008 or thereafter.

Although we have properties located throughout the country, because of our focus on buildings leased to the U.S. government and medical-related tenants, we also have modest concentrations of properties in some other markets, such as Baltimore, Denver, Pittsburgh, Albuquerque, Minneapolis - Saint Paul and Phoenix Arizona.

Overall, our other markets experienced generally positive growth during the first quarter of 2005. Specifically, same-store NOI grew by 1.6 % during the first quarter. This increase was primarily the result of a modest rollup in rents in these other markets during the last 12 months. Same-store occupancy was unchanged at 92.6%. We also have modest lease-roll in these other markets over the next few years, with 73 % of our annualized rents expiring in 2008 or thereafter.

As of the end of the first quarter of 2005, HRP is still very well positioned in the marketplace. We continue to have one of the most secure revenue streams in the industry, with 64% of our annualized rents coming from government tenants, medical-related tenants, long-term leased lands, and other investment-grade rated tenants.

Our largest tenant continues to be the U.S. government, which represents close to 16 % of our annualized rents. We also continue to have one of the longest average remaining lease terms in the industry, at 9.3 years based on square feet and 6.9 years based on annualized rents. Overall, we have limited lease-roll over in the next few years, with 75% of our annualized rents expiring in 2008 or thereafter.

Before turning this presentation over to John Popeo to run through some of the financials, I want to briefly go over our acquisitions activity. During the first quarter of 2005, we did not close on any acquisitions. This is different than the trend we saw during 2004, when we acquired $818 million worth of properties throughout the year. This slowdown in acquisitions is the result of a more competitive market for the purchase of properties. Nevertheless, we continue to evaluate many acquisition opportunities, and we are in different stages of discussions regarding the acquisition of several properties at this time.

Even though we did not close on any acquisitions in the first quarter, we have committed to $191 million worth of property acquisitions as of March 31, 2005. In February, we committed to acquire 8.2 million square feet of additional industrial lands in Oahu, Hawaii from the estate of James Campbell for $115.5 million. The characteristics of these lands are very similar to our existing commercial and industrial land holdings in Hawaii.

For example, the investment is very secure because the lands are currently 95% leased for an average remaining lease term of 15 years. The going-in cap rate for this acquisition is approximately 7.5%, and our business plan for these lands is the same as our existing industrial lands in Oahu. We plan to increase the return on our investments in the future by working with existing tenants to extend the lease terms in exchange for higher contractual lease payments.

As a result of this acquisition, HRP will be one of the largest industrial landowners in Hawaii with close to 16 million square feet or 412 acres. This acquisition is expected to close sometime before year-end, 2005.

As of the end of the first quarter, we also had one other property under contract for $75.5 million, but this acquisition is subject to closing contingencies, and we may or may not close in the second quarter.

I will now turn the presentation over to John Popeo, our Chief Financial Officer, to provide some more details regarding our first quarter results.

Thank you, Adam. Before getting into the details regarding the quarter, I want to briefly note where we ended 2004 with regard to compliance with new Sarbanes-Oxley rules. We filed our 2004 full-year audited financial results with an unqualified opinion from our auditor, Ernst and Young, regarding the effectiveness of our internal controls over financial reporting.

Looking first to corporate finance, total debt to book capitalization was just over 50% at the end of the last quarter. During January of 2005, we amended our existing $560 million unsecured revolving credit facility to increase the maximum borrowing amount to $750 million to reduce the interest rate and to extend the maturity date to April, 2009. We also repaid $100 million of 6.7% senior notes when they became due in February by drawing on our revolving credit facility. In March of 2005, we issued 22.5 million new common shares, and applied the net proceeds of $259 million to reduce debt. Book leverage was reduced to just under 46% on March 31, 2005, and we had $670 million available for borrowing under our revolving credit facility.

Turning to the income statement, rental income and operating income increased by 23% and 17% respectively during the first quarter of 2005. The increase in rental and operating income reflects over $800 million of properties acquired during 2004, partially offset by the 1.2% decline in same-store NOI.

Current quarter EBITDA increased by around 18% over the quarter ended March 31, 2004. Interest expense increased by 35%, reflecting the 2004 issuance of $400 million of unsecured senior notes due in 2016 and our $350 million term loan due in 2009. Proceeds of these 2004 financings were used primarily to fund 2004 property acquisitions.

FFO for the first quarter of 2005 was 14% higher than the prior-year amount. On a per share basis, FFO increased 10%, from $0.29 cents per share in the first quarter of 2004 to $0.32 cents per share in the first quarter of 2005. The 2005 per share amount partially reflects the issuance of 22.5 million common shares in March of 2005. The effect of this equity offering and debt repayment will be fully reflected in second quarter results.

Net income available for common shareholders for the first quarter of 2005 was $20.7 million, a 45% decrease from the first quarter of 2004. The decrease reflects almost $15 million worth of gain from the sale of some of our Senior Housing common share investments during January and February of 2004. In addition, we recognized over $5 million of gains in the prior year related to the issuance of shares by Senior Housing and Hospitality Properties Trust. The 11% decrease in equity and earnings of equity investments reflects the sale of over 4 million of our Senior Housing common shares during 2004.

The loss on early extinguishment of debt during the first quarter of 2004 represents the write-off of deferred financing fees associated with the repayment of $143 million of our senior notes due in 2013.

Turning to the balance sheet, on March 31, we held over $20 million of unrestricted cash. The book value of our equity investments in former subsidiaries was $206 million compared to a combined market value of $306 million. The decrease in accounts payable reflects the timing of semi-annual senior note interest payments and operating expenses. And, the $25 million increase in other assets includes the purchase deposit for the Campbell industrial lands that Adam discussed.

On March 31, we had $430 million of floating-rate debt, $441 million of mortgage debt, and $1.3 billion of fixed-rate senior unsecured notes outstanding. The book value of our unencumbered asset pool totalled $3.8 billion at the end of the quarter. Our senior unsecured notes are rated Baa2 by Moody's and BBB by Standard & Poor's. Our secured debt represents only 9% of total assets, and floating-rate debt represents less than 20% of total debt. Total debt represents less than 43% of total market cap at the end of the quarter.

The weighted-average contractual interest rate on all of our debt was 6% at the end of the quarter, and the weighted-average maturity was 8.4 years. We intend to repay $76 million of 8.7% mortgage debt that we assumed with our 2004 acquisition of Hallwood when it becomes pre-payable without penalty in July of 2005. After that, the next scheduled maturity over $50 million is not until 2009.

We have 8 million Series A preferred shares outstanding, with a face value of $200 million and a distribution rate of 9.875 %. These shares are callable in February 2006 at par. We also have 12 million Series B preferred shares outstanding with a face value of $300 million and a distribution rate of 8.75% that are par-callable in September of 2007. We had 179.8 million weighted-average common shares outstanding during the quarter, and 199.8 million actual shares outstanding on March 31, 2005. The difference reflects the issuance of 22.5 million shares in March.

We committed $27 million in tenant improvements and leasing costs to 1.5 million square feet of space leased during the quarter. We spent around $15 million during the quarter on tenant improvements and leasing costs. As of March 31, 2005, we had $107 million of total committed, but unpaid, tenant improvements and leasing costs related to leasing. That took place last year and during the first quarter of 2005. The majority of this amount reflects several large blocks of space that we were able to lease during 2004 for terms that span up 16 years. We expect to pay $90 million of this amount during 2005.

During the first quarter we paid almost $5 million, or $0.11 cents per portfolio average square foot, for building improvements including lobby renovations and elevator and other systems upgrades throughout the portfolio. We committed to acquire a total of $191 million of properties during the first quarter, including the $115.5 million acquisition of the Campbell lands. We expect to close these acquisitions before year-end by drawing on our revolving credit facility, but some of these acquisitions are still subject to customary diligence and closing contingencies.

Second quarter earnings results will fully reflect the March equity offering and repayment of debt, and will partially reflect acquisitions we closed during the second quarter. At the end of the the first quarter, our ratio of debt to book capitalization was 45.8%, and debt to total market capitalization was 42.6%.

EBITDA and fixed charge coverage ratios were 3.0 times and 2.2 times respectively. Our public debt leverage ratio was 41.9%, compared to the 60% maximum leverage limit, and our secured debt ratio was 8.5% compared to the 40% maximum secured debt limit. Our public debt coverage ratio was 3.2 times compared to do a 1.5 times minimum limit. Unencumbered assets to unsecured debt was 242.2%, compared to a 200% minimum limit.

That concludes our prepared remarks. Operator, we are now ready to take questions.

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from Brett Johnson with RBC Capital Markets.

Hi, good morning. Brett Johnson with Jay Leupp here. A couple of quick questions. First, given your announced acquisition of the additional industrial end in Oahu, can you give us an update on how your original Oahu investment is doing -- how the leasing efforts have been going, have you guys run into any larger-than-expected environmental cleanup costs?

Sure. Overall, I think we've done a pretty good job of increasing the yield on our investment just over the first year we had the portfolio. Really it took about -- the first six months was really just getting our hands around the operations and getting an office set up out there and meeting all the tenants. Then, the last six months of 2004 we were able to sign, I believe, it is four lease amendments with some tenants out there, as well as expand the same-store occupancy by about 80 basis points.

So, we were actually able to -- the limited amount of vacant land we had we were able to actually lease. So, overall, we were able to increase same-store NOI slightly. I would say that things are moving pretty much on course as to what we expected.

With regards to environmental costs, the environmental costs are actually -- I think when we first budgeted -- when we first did the underwriting back in December of 2003 , we were budgeting somewhere around $10 million in our internal calculations for environmental costs. I can tell that it is going to come in well less of 50% of that number - the final number for environmental costs. So, it is actually been a surprise on the positive for us in terms of some of those cleanup costs.

So I think overall the investments -- the only negative that we've come out of Hawaii, if there is any negative, is that we wanted -- we told the world we were going to really work to improve the yield on that investment over a five-year period. And, we all sort of thought internally, "Well, maybe we could do that over three or four years."

I think it is going to take the full five years. And, that is not because opportunities don't exist. I don't how else to say this other -- than things move slowly in Hawaii. And, it just takes us longer to execute things or renegotiate leases there than they do in other parts of the country.

So, I think we are on track. It may just take -- it is probably going to take the full five years to accomplish what we wanted to do out there.

In addition to the acquisitions that you've announced there for the additional -- what is it, 115 million -- are there opportunities for more acquisitions similar to that acquisition?

I don't think there is many more opportunities to be buying leased industrial land in that market. I mean, if there is anything, we take a look at it. But, I can tell you that it is just very unusual to see large tracts, like the Damon estate and the Campbell estate, come to market.

We do look to try to expand our portfolio there, but I would say that it is going to be, maybe, one-off, smaller deals if we do any expansion. I don't think there will be a lot more big tracts of industrial land that are really just available.

Great. I know you guys are -- different question now. I know you guys are new to the Atlanta market, or somewhat new to the Atlanta market. What would be your pro forma same-store NOI performance there for the quarter? If you go back to the -- to how the assets have done over the last year?

I don't know. Do you have that number in

No. I think the run rate -- I don't think anything of substance has changed within that portfolio. So, I think the run rate that you see for this past quarter-end is probably a decent indication of what it would have been.

It is probably flat NOI same-store.

You guys have some leasing to do there this year. How are those efforts going in?

Good. I think the largest lease there with the CDC.. Their lease is actually -- it is for about -- it is just over 50,000 square feet. That is the only wild card we have in Atlanta. CDC, the way they operate is -- they really just don't tell us until near the end. We have ongoing discussions with them. But, they haven't committed and they haven't said, "No" either. We are hopeful we will renew with them in that market. But, I don't anticipate us knowing the answer to that until the third, or maybe even the fourth, quarter of this year.

Okay. And then, my last question. I know this may be premature because most of your leasing looks to be 2007, but with both Austin and Boston, it looks like you have about a third of your portfolio rolling, I guess, within the next three years. And, I assume you'll do a lot of that leasing next year.

But, in general, I know there was a large rent rule down in Boston this last quarter. Where do you estimate a lot of those leases are, current rent rates versus where you believe market might be today?

It is a good question. It really depends, every submarket is different. I would say, in a general [macro-comment], our leases in those markets are probably somewhere between flat to maybe as high as 10% above market. But, again, that's two to three years away. So, I can't tell you that there is definitely going to be rent rolldown. I can just tell you that it is somewhere between zero and, probably, 10%.

Great. Thanks a lot. Good quarter, guys.

Thanks.

Next, we'll here from Phillip Martin with Stifel Nicolaus.

Good afternoon, gentlemen. Again, good quarter. It is nice to hear some positive things coming out of office rates. See what happens when you have a conference call?

That is a good stuff.

Good stuff happens. Just one question here. Regarding the $18 a foot in capital commitments, tenant costs, et cetera, you mentioned that the 41% decline from fourth quarter '04 -- I know you went into some detail there, but is -- was there anything that occurred there that made that an anomaly, or is this more of a trend? Certainly, we are hearing some of the other office REITs talk about the same thing -- gaining a little on negotiating leverage, seeing tenant costs come down. But, is it your experience that this is probably the beginning of a trend here?

I think this number is probably a little bit more of a normalized number that we have this quarter. I think we had some anomalies in the fourth and third quarters of last year that really -- we signed some very large leases for very long terms that had significant TIs in them. So, I think maybe the anomalies, from our standpoint, from a TI perspective, really occurred in the third and, probably even more so, in the fourth quarter of last year.

So, I would argue that this year's TI -- this quarter's TI around 18 bucks is probably of a more normalized. There is really no outliers. But, that is not to say the next quarter we go sign a very large lease for a 15-year term that may have significant TIs that again might skew the number. But, I would say this quarter was pretty clean. There was no real huge leases in there that had above-market TIs or anything like that in it.

When you look at a more normalized lease term, let's say seven years, on the -- when you are negotiating the leases that are for a five- to seven-, six- to nine-year term -- are you seeing TI costs for those typical leases coming down? Compared to --

Well, we look at it -- it is partly TI. The way, I think, we look at it and the way everybody looks at it -- is sort of like net effective rent, and part of it is TI and it is the rate and term and everything.

I would say, generally, it is probably been pretty flat in terms of changing -- in sort of net effective rents over the last few quarters. I would say that it is probably -- it was starting to feel, in some markets, like there is an improvement.

Things were pretty bad in 2002, in 2003. And then the beginning -- I'd say the first half of 2004. The fact that we've had significant uptick in occupancy in markets like Austin is a really good sign, as far as we are concerned, that things are getting better.

And I would argue that, in our markets, we probably started seeing a little bit of a turnaround really in the -- it really happened about mid-year, 2004. And, I would say we are still sort of on that slow, steady, modest improvement quarter-over-quarter.

Okay. So, really, from mid-2004 was the point where you started seeing some ability to have a little more negotiating leverage that is growing slowly?

Yeah. That is fair. It is growing slowly. Look, the landlord is not in the driving seat yet. But, the -- but occupancies are going up, and rates are starting to move up in some markets. So, it is getting better, but getting better slowly.

Are you seeing any difference -- well, from the tenant's standpoint, the tenants you are seeing as you are seeing leasing velocity pick up -- are you seeing any change in tenants?

I know that one of the other office REITs this morning mentioned that they are seeing larger corporate tenants coming into the market, whereas last year it was -- leasing velocity was increasing, but it was smaller tenants. And now, there is larger corporate tenants. Are you seeing anything like that?

I don't know if I'd make that same statement, but I can say we are seeing -- what is sort of encouraging -- we've seen some expansion space requests -- tenants. That's been somewhat encouraging.

Okay. Perfect. I appreciate it. Thanks again.

Thanks.

At this time there are no further questions. Mr. Adam Portnoy, I would like to turn things over to you for any additional or closing remarks.

Thank you for joining us on our Q1 conference call. Before we go, I just want to let you know that we will be presenting at Bear Stearns Global Credit Conference in New York City on May 17th, and at the NAREIT Institutional Investor Forum in New York City on June 9th.

We look forward with meeting with the investment community at these conferences, as well as having the opportunity to update you on our progress next quarter. Thank you.

That does conclude today's conference. Thank you. Have a great day. You may now disconnect at this time.