Equity Commonwealth (EQC) 2007 Q1 法說會逐字稿

Good day, and welcome to the HRPT Properties Trust first quarter 2007 financial results conference call. Today's conference is being recorded. 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, Gwen. Joining me on today's call are Adam Portnoy, Managing Trustee, and John Popeo, Chief Financial Officer. The agenda for today's call include the 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 HRPT's present lease and expectations as of today, May 4, 2007. The company undertakes no obligation to revise or publicly release results of any revision for the forward-looking statements made in today's conference call other than through filings with the Securities and Exchange Commission regarding this reporting period.

In addition, this call may contain non-GAAP numbers including funds from operations or FFO. A reconciliation of FFO to net income is available in our supplemental package found in the Investor Relations section of the company's website. 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 with the Securities and Exchange Commission and in our Q-1 supplemental and 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. With that, I would like to turn the call over to Adam Portnoy.

Thank you, Tim. Good morning and welcome to everyone that is joining us on today's call. For the first quarter, we are reporting FFO of $0.28 per share on a fully diluted basis compared to $0.31 per share for the same period last year. The primary reason for this decline was higher financing costs and less interest income earned during the quarter. I think it is important to note that the reason for the decline in FFO per share had nothing to do with core operating results. From an operations perspective, the company has seen great improvements with regards to increasing net effective rents and overall cash flow. Capital expenditures, which include tenant improvements, leasing commissions and building maintenance CapEx have decreased significantly from about $26 million to about $18 million between the first quarters of 2006 and 2007. As a further example, on a same store basis, occupancy decreased 80 basis points between 2006 and 2007. But same store revenues increased 128 basis points and NOI has remained constant at about $115 million. These strong operating results are largely a reflection of the initiatives we have been speaking about for the last couple of quarters, where we are more focused on increasing cash flow at the expense of some occupancy.

With regards to what we are seeing across our markets, leasing metrics have largely remained unchanged in the last quarter, but we are becoming concerned with some of the reported changes in other real estate metrics. For example, this is the first quarter in many years that we have seen a decline in overall office occupancy rates on a nationwide basis, which declined by 10 basis points as report by CoStar. This is largely the result of the steep decline in nationwide office net absorption that was reported during the first quarter. Although overall development activity is not increased nationwide, it has increased in several markets, including some of the markets where we operate, such as Washington, D.C., and Southern California.

With regard to our portfolio, we appear to be out performing the market on many fronts. We signed leases for just over 1 million square feet during the quarter and 61% of this square feet were renewals and 39% were new leases. Leasing activity during the first quarter resulted in a 1% roll up in rents and about $17 per square foot in capital commitments. The average lease term was 6.6 years and the average capital commitment per lease year was $2.55. And both of these key metrics are improvements sequentially from the fourth quarter of 2006. Overall company occupancy of March 31st was 92.8% which represents a 30 basis point decline between the current quarter and the fourth quarter of 2006. Again, I think we are doing a great job achieving the highest possible net effective rents when leasing, which is leading to an increase in our cash flows at the expense of some modest occupancy. With regard to our portfolio, all of our major markets are performing well with Austin, Texas, Oahu, Hawaii, and Southern California performing especially well. In Oahu and Southern California, the strong growth and same store NOI is primarily driven by rent increases, whereas the 12% increase in same store NOI in Austin represents increases in both occupancy and rental rates.

Our Philadelphia portfolio is also performing very well. Somewhat surprisingly, the Philadelphia leasing market has shown steady improvement during the last few quarters, especially in the downtown market where we own a large percentage of assets. I'm happy to report that as of today, we have preleased over 50% of the space Comcast will vacate in 2008. And we expect to report additional progress with this releasing efforts in the next few quarters. We continue to believe that we are very well-positioned in this market with less than 1% of our square feet rolling through the end of 2007, and in place rents equal to or below market rents. As I stated last quarter, the Washington, DC market that his really gone through a lot of changes in the last year, and we no longer characterize it as one of our strongest markets. Development activity has been robust in Washington, D.C. with more than 2 million of new square feet coming online per quarter. And net absorption is slowing considerably. In fact, during the first quarter, CoStar reported negative net absorption of over 250,000 square feet in Washington, D.C., and occupancy rates have been declining in this market for the last three quarters, especially in some of the suburban markets. Our overall occupancy in this market declined by 4.6% year over year reflecting 130,000 square ft. of space vacated during the quarter in the Maryland suburbs. Nevertheless, we remain well-positioned in the market with 90.8% occupancy and in place rents equal to or below market rents.

Boston continues to perform better than expected, with improving market occupancy and very limited new development activity. This improvement is being driven by strong economic activity in the region. In the first quarter of 2007, the state's economy grew at the fastest rate in nearly seven years, nearly four times the national average, fueling strong job growth. Unfortunately this is our only major market where we may have some lease roll downs and occupancy declines during the remainder of this year. In our other markets located throughout the country, our portfolio has generally experienced modest decreases in same store NOI, primarily as a result of lower occupancy. Looking forward, we are planning on our portfolio to remain stable and we are continuing to focus on increasing our net effective rents and operating cash flows to achieve maximum returns. We have 3.5 million square feet scheduled to expire during the remainder of the year, which represents approximately 6% of our total square feet and 7% of our annualized rents. This lease roll is spread out evenly throughout our portfolio with no market accounting for a disproportionate amount of lease expirations.

With regards to first quarter investment activity we have purchased four office buildings located in South Carolina and Massachusetts with 391,000 square feet or $42.6 million during the quarter. The weighted average going in Cap Rate was 9.8% and the buildings were 96.3% leased for 7.4 years on average. Going forward we will continue to focus on purchasing high quality and well leased office and industrial properties located in less high profile markets, as well as look for opportunistic development and redevelopment projects in select markets. We also will continue to actively look at selling some of our B and C class properties located in lower [tier] markets where we are unlikely to grow our portfolio.

Subsequent to the end of the quarter we purchased 14 buildings with 3.2 million square feet for $143 million. We will discuss these acquisitions in more detail during our second quarter call. As of today, we have two properties with 220,000 square feet under agreement to purchase for about $17 million. Of course, these agreements are subject to closing conditions, and the purchase of these properties may or may not happen in the future. As we end the quarter, the company's focus on increasing net effective rents and cash flows has started to result in improved operating performance and we expect this focus will allow HRPT to continue out performing the market in the future. When looking at our portfolio dynamics HRPT continues to be very well-positioned with among the highest occupancy rates, longest average main lease term, and highest credit quality tenants in the office [reach] sector. Furthermore, the diversity of our portfolio holdings and tenant base adds the security and stability of our cash flows and dividend payments. I'll now turn the call over to John Popeo, our CFO.

Thank you, Adam. Looking first to the income statement, rental income increased by 8.2% and operating income increased by 1% during the first quarter of 2007. The year over year quarterly increase in rental and operating income reflects increases from properties acquired between January 1, 2006 and March 31, 2007. Our consolidated NOI margins were 61% for the first quarter of 2007 and 62.1% for the first quarter of 2006. The decrease primarily reflects increases in escalatable expenses and the decline in portfolio occupancy. Current quarter EBITDA decreased by 2.2% from the same period last year, reflecting the sale of our investments in former subsidiaries in March of 2006 offset by property acquisitions. Interest expense decreased by 2.5% reflecting the repayment of debt with proceeds from the sale of shares of former subsidiaries and our preferred share offering during 2006, partially offset by property acquisitions and the 80 basis point increase in weighted average interest rates on our floating rate debt from 5.3% during the three months ended March 31, 2006 to 5.9% during the three months ended March 31, 2007.

Net income available for common shareholders for the first quarter of 2007 was $18 million compared to $131 million for the first quarter of 2006. The decrease reflects $116 million of prior year gains from the sale of shares of former subsidiaries. Diluted FFO available for common shareholders was $0.28 per share for the first quarter compared to $0.31 per share for the prior year. The decrease primarily reflects the sale of shares of former subsidiaries, the increase in floating interest rates and the decrease in interest income offset by properties acquired since January, 2006. In April, 2007 we declared a dividend of $0.21 per share which represents 72.4% of our first quarter FFO. Our board considers the dividend level on a quarterly basis and they are comfortable with this current payout ratio.

During the quarter we spent $17 million on tenant improvements and leasing costs and $1.6 million or $0.03 per square foot per recurring building improvements, including lobby renovations and elevator and other systems upgrades throughout the portfolio. We paid $7 million on development and redevelopment activities during the first quarter. Turning to the balance sheet on March 31st we held $23 million of unrestricted cash, the $9 million increase in rents receivable reflects straight line rent accruals during the first quarter. Rents receivable includes approximately $142 million of cumulative straight line rent accruals as of March 31st. Other assets includes approximately $88 million of capitalized leasing and financing costs. On March 31, 2007, we had $544 million of floating rate debt, $414 million of mortgage debt and $1.55 billion of fixed rate senior unsecured notes outstanding. The weighted average contractual interest rate on all of our debt was 6.3% at the end of the quarter and the weighted average maturity was 6.7 years. Our senior unsecured notes are rated BAA-2 by Moody's and BBB by Standard & Poor's. The book value of our unencumbered property pool totaled about $5.1 billion at the end of the quarter. Our secured debt represents 7% of total assets, and floating rate debt represents 22% of total debt. The end of the first quarter, our ratio of debt to market capitalization was 42%. Our EBITDA and fixed charge coverage ratios were 2.9 times and 2.1 times respectively. As of the end of the first quarter we were comfortably within the requirements of our public debt and revolver covenants. As of the end of the quarter we had $144 million outstanding on a revolving credit facility with $606 million of additional borrowing capacity.

In summary, we continue to believe HRPT's strong tenant base, limited near term lease expirations, strong balance sheet, and current annual dividend yield of close to 7% make HRPT a logical choice for long-term income oriented investors. That concludes our prepared remarks. Operator, we are now ready to take questions.

Thank you. If you would like to ask a question, at this time, (OPERATOR INSTRUCTIONS.) We'll go first to Srikanth Nagarajan with RBC Capital Markets.

Thank you. Obviously, you talked a little bit about the acquisitions that you did post quarter. But more importantly, you also talked about dispositions in noncore markets. I think you mentioned that in the previous call as well. Could you give some color on the volume of you know, acquisitions or the dispositions, and what has changed, if any, in your outlook for the net acquisitions that you are expecting for the year?

I don't think, hi Srikanth, thanks for the question. I'm not sure much has changed in terms of our outlook. You know, if you include the acquisitions that we announced that we did since the, subsequent to the end of the quarter, we are up to about 300 million for the year, so far. I don't -- maybe there would be another 100, 200 million on top of that. This is a guess. It could be more, could be less. In terms of dispositions, I think there will be some dispositions this year. I'm just not sure of the amount. We are looking at you know, we currently are considering a lot of different scenarios with dispositions.

Uh-huh.

Some smaller dispositions, as well as some larger dispositions and we haven't made a decision yet.

Okay, and again, once again, what do you consider, what would you consider as noncore assets? Because I mean, I think we went over the last call that you don't obviously go at it from a market by market basis, after all that is asset (inaudible.) Give us an example of what you would consider a noncore asset.

A noncore asset would be a property let's say that's located, here's a perfect example, and I'll tell you that I'll sell the building if somebody wants to buy it. It's up in Petersburg, Alaska. (laughter) That's not in a market that we think we can grow, and we bought that as part of a much larger portfolio back in 1996. That's why we own the building. We didn't go out looking to buy a building in Petersburg, Alaska. That's one example. There's other examples where -- San Antonio, Texas is a good example where we had an asset there. We announced, I think, last quarter where we sold it at the end of the fourth quarter last year where that was a building that was about 50,000 square feet, it was multi-tenanted. We had looked to grow in that market quite a bit, couldn't come up with an acquisition. So, decided the best thing to do was to exit the market. There are some other markets that we are currently in but I'm just not going to go into the specific markets yet. But I can tell you that we are evaluating a lot of different scenarios in terms of disposition activity.

Okay. Great. Thanks.

(Operator instructions) We'll go next to Charles Place with Ferris, Baker, Watts.

Good morning.

Good morning, Charles.

I was hoping you could maybe talk a little bit further -- I mean, obviously on a sequential basis office and industrial revenues were down. Can you talk a little bit further about, you know, what specifically happened in the Philadelphia and DC markets? I know that it's primarily, or I'm assuming it's primarily occupancy-driven. But what happened in Austin that saw the revenue drop so much quarter to quarter?

Well, Philadelphia, it is occupancy drops. In Washington, DC we talked about it. We lost 130,000 square feet, quarter over quarter. In Austin, Texas, I'm looking to John.

Yes, Austin, Texas what you have down there is we have a handful of triple net leases and you have fluctuations in escalatable expense recovery. So, it's an expense and it hits a revenue, but NOI, it has no impact.

Yes, I wasn't as focused on the revenue line. The NOI in Austin is increasing.

Yes.

And I think that's the headline we focus on at least.

Okay, and as you look out through the rest of the year and look at the lease expirations per on your major markets, you know, what's the activity like in DC? You said the market's soft. But I've also heard some people comment that inside the Beltway that it's still a pretty solid leasing environment. Can you maybe clarify a little bit more about your properties in DC that are having lease expirations and kind of where they're located?

Sure. I think we've taken the biggest hit we are going to have in DC in the first quarter with the 130,000 square feet that went vacant. That's out in the Maryland suburbs. Most of everything else, almost everything else we're going to re-lease in Washington, D.C., we feel pretty good about. A lot of that's downtown or inside the Beltway, as you put it, so we're not very concerned about the DC -- we're concerned that we lost 130,000 square feet in this quarter. But you know, going with the rest of what's rolling in DC we feel pretty good about it.

Okay. And as far as your -- you've commented that you know, we should anticipate maybe a little bit of roll down in the Boston market. But you also indicated that you know, there's pretty tight or limited new supply coming in there. But you also thought there would be some vacancy growth in Boston. Does that kind of counter your comments about the strength of the area?

Yes. No, look. As everything in real estate, it's by locality. Our stuff in the downtown Boston market or the CBD is doing really well. And some of our suburban properties are also doing well. That said, some of our -- the properties we're talking about that we're having, that I'm concerned about, are actually south suburban Boston, outside the 128 region where we have a couple buildings that are rolling. And I know that it's just going to be difficult to get tenants. Even one, to get tenants into the building, and two, to get them in there. I know they won't go in at the current rate that we got in there now. So, It's really a very specific issue we have with the Boston market in terms of rent roll downs. The majority of our portfolio generally in Boston is doing very well. And you know, the stuff that we have, again, downtown is, downtown is doing exceptionally well. I mean, people are actually, you know, there is a lot of showings out in the suburbs in the last quarter because the downtown market really has become very, very tight. So people are actually thinking about moving out of the downtown. You know, being in this business, it's amazing to watch how the cycles in the different markets and how it changes. I mean, two years ago all I would have talked about was DC and Southern California. And now, to be talking about how Philadelphia and Boston you know, coming back and have some strong dynamics, where as Southern Cal -- whereas Washington, D.C. has some weak dynamics. It's really interesting to see, and I'll put a little plug in for our company just by saying that I think that is one of the strengths of HRPT is the diversity of the portfolio, because we're not susceptible to just one variations of one market. There's always a couple markets doing well and a couple markets not doing so well, and our large portfolio allows us to generally outperform the market by having that diversity. I know that is a little more than what you asked. But that's my answer.

Good. (laughter) One final question. For the quarter, you had preferred distributions of $17.7 million where on the income statement, you know, you are reporting dividends of $15.4 million. Is that just a one quarter anomaly for some reason? Or is that -- am I missing something that's going on with the preferred?

No, there's a $15.4 million is the right run rate number.

So, what happened in the first quarter? Was it that made it 17.7?

The actual cash out the door on the statement of cash rolls, you mean?

Yes.

The dividend covers cross quarters.

Okay.

It's accrues interest or dividends at 6.5%. But the Preferred Series D were issued in October. The first payment wasn't made until January.

So it's a one-time.

So, it's from a cash flow thing going forward that will be 15.4 matching the income statement?

That's right.

Okay, great.

It's just dividend accruals were in the first payment, for the first payment.

Okay. Great. Thank you.

We'll go next to Phillip Martin with Cantor Fitzgerald.

Good morning.

And Phillip.

Well my question on Alaska, thank God, that was answered.

Okay. (laughter)

But I wanted to get a sense, just more of a global question here. But in terms of your, you know, looking at the leasing summary, I mean this jumps around quarter to quarter in terms of the capital commitment costs and the leasing costs, et cetera. And I know it just depends on the asset, the tenant you're dealing with and a number of factors. But, are you seeing, number one, are you seeing that you are gaining negotiating leverage with the tenants that you are renewing or talking to? Or that you are talking to on the leasing front? And I guess maybe a better way to ask this. Are you seeing a better return on investment on the leasing costs? Than you were, let's say a year ago? So, they might jump around and be a little bit higher this quarter versus last year or last quarter. But are you seeing a better return on investment on those costs?

Yes. Thanks, Philip, that's a good question. Yes, what we're seeing on the leasing market is generally across the country. Some markets more than others. People starting to push rate. Not only us, but a lot of our competitors, a lot of players in the market. They are pushing rate. And free rent is really exiting. You are not seeing a lot of free rent in the markets very much any more. What hasn't pulled back is the TI dollars. People are still spending the TI dollars. But what we're getting is compensation for that, and getting longer lease terms. So, the rate's being pushed up and the term is being extended, but the same sort of TI dollars are being spent. So at the end of the day, the net effectives are going up. So they are, but I'm just giving you the components. Maybe I'm answering more detail than you wanted. But the components are the rates moving up, free rents disappearing, the dollars going out the door are pretty much the same. But the amount of time that people are willing to sign. What we are doing, we are able to push people on the rate and the length of the lease. That's where we are able to push them.

Okay. So the net's there and you are actually seeing a real return here. Okay, thank you very much. Good. That was a good detailed answer, thanks.

Thanks.

(OPERATOR INSTRUCTIONS) We'll go next to John Guinee with Stifel Nicolaus.

Good morning.

Good morning, John.

Is it as nice in Boston as it is down here today?

Yes, it's a beautiful day.

Hey, we were candidly surprised that you didn't go to the equity markets in February when your stock got over $13. What was the thought process on that?

We didn't have a use of proceeds. But, no, honestly the answer is look, we did a big preferred deal. We haven't gone to the equity market since September, 2005. And I think we've done a pretty good job of managing the balance sheet without having to go to the equity markets. And look, just because the stock goes above $13 doesn't mean we're going to jump on it and decide to do an equity offering. You know, we look at the total return and it doesn't make sense to do a deal and you know, at the time, honestly, there wasn't a large use of proceeds. But you know I -- we issue equity because we are growing, but it's not like we are itching to issue equity at every corner and every turn. I know we have a little bit of a reputation that people like to tout that we're a consummate equity issuer. I appreciate your question because I think we showed a lot of -- I think we illustrated or demonstrated that we show restraint, and often show restraint. You know, we are -- one of the things I hope you and others on the call notice is that even though FFO came in a little bit disappointing for the quarter, if you calculate the FAD or the AFFO or the adjusted FFO, we had a great quarter. I guess what I'm saying is we are very focused on the fundamentals and trying to get as maximum return as possible on the investments and CapEx is way down, and same store NOI is basically flat with declining occupancy, which is telling me we are able to squeeze more out of anything and everything we're doing. And that's the story. Again, I'm answering a different question than you asked. But look, we're not going to issue equity all the time, every time the stock price might hit an all-time high doesn't mean we're going to the markets.

Okay. No, that's fine. The convertible preferred was an effective equity issue on 13 bucks, because I think that was the convert price.

That's correct. That's correct.

Second question. It looks like you're going to save in September, when you [re-fi] your $300 million of preferreds, you are going to save about a $1.1 million a quarter or $4.5 million a year. Any chance you'll increase the dividend at that time?

Well, we could consider it. Again, it depends on, you know, payout ratios and if we can maintain what we've been able to do this quarter and going forward. This is -- we would look at it. But that's just one piece of I would say a complex, you know, set of issues we have to look at. And things you have to consider in terms of increasing dividends. We always, I've got to tell you. Myself and the other members of the board, I think our bias generally is, if we can increase the dividend, we will. And we always are looking, but we have to make sure we can justify it. And you know, we can't, certain things you can't just increase it. That alone would not be the only reason we would think about an increase. It would have to be that coupled with, you know, payout ratios being low and feeling pretty good about the outlook going forward. Those are probably, some of the factors we would be considering.

One last question, just for John. John, I notice that last year at the beginning of the first half you had lower straight lines they tend to pop up at the end of the year. I know there is probably no seasonal thing, obviously, (inaudible) straight lines. But I was wondering, this year, your first quarter was kind of low compared to what we thought might be a run rate. Is there something permanent that's happening here that will lower your straight lines? Or, we looking like that's going to come back up?

Yes, we have one large tenant that actually pays semiannually. So this is a trend that you'll see this year, as well as that the second quarter. A good -- I'm sorry, a good straight line rent run rate for the next quarter is probably right around $5 million. And then the last two quarters of the year will be right in line with last year. Probably around $7.5 million per quarter.

On straight lines?

Yes.

All right. Thank you.

Thank you.

That concludes the question and answer session. I would like to turn the conference back over to Mr. Portnoy for any closing remarks.

Okay, thank you for joining us on our Q-1 conference call. We look forward to seeing you all of you in (inaudible) New York City this June. Thank you.

Thank you everyone. That does include today's conference. You may now disconnect.