Equity Commonwealth (EQC) 2012 Q1 法說會逐字稿

Ladies and gentlemen, good day and welcome to the CommonWealth Reit first quarter conference call. This call is being recorded. At this time, I would like to turn the call over to Vice President of Investor Relations, Mr. Tim Bonang

Thank you, and good afternoon, Everybody. Joining me on today's call is Adam Portnoy President and managing trustee and John Popeo, Chief financial officer. The agenda for today's call includes a presentation by management followed by a question and answer session. Also note that the recording and retransmission of today's conference call is strictly prohibited without prior written consent of CommonWealth.

Before we begin today's call, I would like to read our safe harbor statement. Today's call contains forward-looking statements within the meaning of Private Securities of litigational Reform Act of 1995 and other securities laws. These forward-looking statements are based on CommonWealth's presently beliefs and expectations as of today May 3rd, 2012.

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 to filings with the Securities and Exchange Commission or SEC regarding this reporting period.

In addition, this call may contain non-GAAP numbers including funds from operations or F.F.O., normalized F.F.O., and cash available for distribution or C.A.D. A reconciliation of F.F.O., normalized F.F.O., and C.A.D. to net income is available in our supplemental package found in the Investor Relations section of the companies website.

Actual results may differ materially from those projected in any forward-looking statements. Additional information concerning factors that could cause those differences is contained in our form 10 Q, which we expect to file in a few days with the S.E.C., and in our Q! supplemental operatingand financial data package found on our website at www.CWHReit.com.

Investors are cautioned to not place under alliance any forward-looking statements, And now I would like to turn the call over to Adam Portnoy.

Thank you, Tim. Good afternoon and thank you for joining us on today's call. I want to begin today's call, by summarizing the recently completed public offering of our wholly owned subsidiary, selecting com Reit or S.I.R.

On March 12th, S.I.R. issued $9.2 million common shares as part of its it. IP.O., in commonwealth use proceeds, it received in connection with the IPO to repay debt. Today CommonWealth continues to own $22 million or 70.5% of SIR's common shares. And it is expected that we will continue to own a majority of SIR'soutstanding common shares for the foreseeable future.

SIRnow owns substantially all of CommonWealth's commercial and industrial properties located in Oahu, Hawaii as well as 23 suburban office and industrial properties located throughout the U.S.

As I mentioned on our last call, SIRintends to primarily own and invest in net least single tenant properties in commonwealth will continue its efforts to reposition its portfolio into high value C.B.D. office properties. Because our retained interest in SIRexceeds 50%, we continue to consolidate SIR'sfinancial position and results in our consolidated financial statements.

For the first quarter of 2012, we are reporting fully diluted normalized F.F.O. of $0.90 per share, compared to $0.85 per share during the same period last year. First quarter 2012 normalized F.F.O. includes approximately $3 million or about $0.03 per share, of nonrecurring items which John Popeo will discuss in more details in a few moments.

Excluding these nonrecurring items normalized F.F.A. for the first quarter, would have been about $0.87 per share, and this increase in normalized F.F.O. per share compared to the same period last year, is primarily the result of increased occupancy, and the growth in same store N.O.I.

We are definitely starting to see some positive signs in our consolidated operating metrics, especially in our C.B.D. office and industrial portfolios which represent a combined 66% of our consolidated N.O.I. Suburban office continues to be our weakest operating segment and it currently represents about 34% of our N.O.I.

As of March 31st, our consolidated occupancy rate was 84.8%, which is 20 basis points higher than our 84.6 occupancy rate on December 31st. Our occupancy rate for our wholly own properties can excludes results from SIRwas 80.6%as March 31st.

During the quarter, we signed over 150 individual leases for 1.9 million square feet. And continuing that trend, we started seeing in the second half of 2011, over half of our leasing activity was for new leases in second generation office space. unfortunately, the largest component of these new leases occurred in our suburban office portfolio which are often expensive leases for us to enter with low net effective rents. Overall, leasing activity this quarter resulted in an 8% decline in rents. Excluding leasing activity in our suburban office portfolio, resulted in flat or no change in rents.

Capital costs commitments associated with leasing activity this quarter was $19.39 per square feet, or about $3.08 per lease year. Importantly, the amount of capital cost commitments per year declined about 13% sequentially from last quarter

Also it was important to note that we have increased our disclosure by including free rent and tenant concessions in addition to tenant improvement and leasing costs is the calculations of leasing cost commitments for signed leases during the quarter. We think this increased disclosure provides greater transparency for investors.

Our C.B.D. office portfolio which represents our largest operating segment, with only 47 properties but about 46% of our consolidated N.O.I., continues to perform very well. Occupancy in our CBD business portfolio increased 50 basis points from 88% to 88.5% during the quarter and continued to track above the national average occupancy for CBD office buildings as measured by most independent third parties.

During the first quarter, we signed leases for 257,000 square feet in our C.B.D. office portfolio, at around 70 % with renewals and 30% were new deals. Our industrial and other properties portfolio also continued to perform well, with strong performance from properties in Oahu, Hawaii and Australia. Occupancy in our industrial properties increased 60 basis points from 87%, to 87.6% during the quarter.

In the first quarter, we signed leases for 653,000 square feet in our industrial portfolio, and about 40% renewals and 60% were new deals. On a consolidated same store basis, our occupancy remained flat at 83.9%, and N.O.I. increased by 3.7.%This improvement was primarily driven by increases in occupancy and rental income from our C.B.D. office and industrial portfolios, coupled with operating expense savings across the entire portfolio due to the mild winter.

In April 2012, we declared a dividend of $0.50 per share, which represents 55% of our first quarter normalized F.F.O. During the quarter, we spent $26.8 million on recurring capital expenditures, which includes tenant improvements, leasing costs and recurring building improvements. We generated approximately $44.9 million of cash availability for distribution, or C.A.D. during the first quarter, resulting in a rolling fourth quarter C.A.D. pay out ratio of about 104%.

Looking forward to the rest of 2012, we have 5 million square feet scheduled to, expire about 62% of this square feet is located in C.B.D. office buildings, and industrial properties, which we feel confident can be renewed or leased to new tenants at the same or higher rental rates. Even though the majority of our Hawaii holdings are owned by SIRwe continue to own over 70% of this company, and we continue to share and grow from rents in that market. The remaining 38% of our square feet scheduled to expire in 2012, is located in suburban office buildings, which we think can be renewed or leased to new tenants but the cost to do so may be high based on the current market environment.

As most of you know, in the last few years, we have been aggressively repositioning CommonWealth's portfolio into high value CBD office properties with a focus on topper forming secondary markets and second tier CBD assets and gate way city markets. We believe this repositioning into C.B.D. office buildings has helped CommonWealth's financial results this quarter and we think it positions the company well for the future.

Since announcing year end financial results on February 23rd, we have not entered into new agreements to purchase plots. However, since then we have closed on the previously reported acquisition of a downtown office property located in Hartford, Connecticut with approximately 868,000for purchase price of $101.5 million. This property is 98% leased to 20 tenants for a rate average lease term of 7.2 years. The going end cap rate was 9.6%, and the purchase price was well below replacement costs, at $117 per square feet square feet.

Also, we continued to pursue to the previously reported agreement to acquire CBD office property located in Austin, Texas, with approximately 172,000 square feet for $49 million. Including the assumption of approximately $29 million. This property is 99% leased to nine tenants for weighted average lease term of 4.3 years. Of course, this pending acquisition is subject to customary closing conditions and no assurance can be given that it will occur.

The company continues to actively market for sales several suburban office and industrial properties. But we have not made any material sales as of today.

Finally, I want to point out, that as of today, we have under restricted cash totaling $140 million nothing else standing on our $750 million revolving credit facility. This liquidity, provides us with more than adequate financial flexibility to fund any capital requirements in the future. I will now turn the call over to John Popeo, our CFO.

Thank you, Adam. I want to begin by pointing out some disclosure changes this quarter related to the sir IPO. As Adam mentioned earlier, our former wholly owned subsidiary completed its I.P.O. March 12 and became a separate and public company. But because we retained an ownership interest of over 50%, we continue to consolidate sir's financial position and results in our consolidated financial statements. Our consolidated balance sheet continues to include all of the assets and liabilities of sir, and all inter company accounted are eliminated.

In addition, we now separately report on the non controlling interest line, the portion owners equity attributable to the 9.2 million new sir common shares.

Our consolidated income statement, includes all of sir's income and expenses. The portion of net income attributable to non controlling interests is ducted just below the net income line. We continue to 70.5%, or 22 million of sir common shares.

We provided wholly owned and consolidated property summaries in the portfolio information section of our supplemental.

C.W.H.'s F.F.O., and C.A.D. calculations only include C.W.H.'s propionate of sir F.F.O., and C.A.D.

Now I will continue with the normal quarterly financial overview. Net income available for CommonWealth shareholders for the first quarter of 2012 was $9.9 million, compared to $37.8 million for the first quarter of 2011. Reflecting gains recognized in the prior year.

Rental income increased by 19.3%, reflecting rental income from properties acquired since January 2011. Property operating expenses increases by 15.1%, primarily reflecting property acquisitions, offset by same store utility and snow removal savings related to the relatively mild winter. Other expenses increased by 15.7%, reflecting property acquisitions.

Current quarter EBITDA increased by 17.8%. Interest expense increased by 3.6%, reflecting mortgage debt we assumed with properties acquired over the past year.

Our percentage share of dubs net income and normalized F.F.O. for the first quarter totaled $3 million. and $2.7 million respectively. We received over $4 million in dub dividends during the first quarter of 2012.

Income from discontinued operations in the prior year reflects operating results from properties sold in 2011. We recognized gains of $34.6 million on property sales during the prior year. The increased in preferred distributions reflects distributions on 11 million of our seven and a quarter series Z preferred shares issued in June 2011.

Normalized diluted F.F.O. available for commonwealth reap common shareholders was $0.90 per share for the first quarter of 2012, compared to $0.85 cents per share for the first quarter of 2011.

Year over year per share results primarily reflect property acquisitions net of sales, and approximately $3 million or $0.03 per share of percentage rents and other income attributable to 2011, that we recognize during the first quarter of 2012, offset by the issuance of new preferred and common shares in 2011.

Excluding the $3 million of nonrecurring items, normalized F.F.O. for the first quarter of 2012 would have been about $0.87 per share. For run rate purposes of further adjustment would need to be made to reflect the acquisition we close at the end of March, and non controlling interest deductions for a full quarter.

Turning to the balance sheet, on March 31st, 2012, we held $194 million of unrestricted cash, reflecting proceeds from the sir I.P.O. Proceeds plus cash on hand were used to acquire properties, repay commonwealth revolver balance, and redeem $150.7 million of our 6.95% senior notes and $5 million in mortgage debt. Rents receivable includes approximately $197 million of accumulated straight line present accruals as of March 31st. Other assets include approximately $136 million of capitalized leasing and financing costs.

On March 31st, we had $784 million of floating rate debt, including $227 million outstanding on sir's revolver, $762 million of mortgage debt, and $2.1 billion of fixed rate senior unsecured notes outstanding.

The weighted average contractual interest rate on all of our debt was around 5% at the end of the quarter, and the weighted average maturity was around four years. Our senior unsecured noted are rated B double A Q and triple B minus by Standard & Poor's. The under appreciated book value of our unencumbered pool totaled about $7.4 billion at the end of the quarter. Our secured debt represents 10% of total assets and our floating rate debt represents 21% of total debt.

At the end of the first quarter our ratio of debt to book captial ization was 50%. Our EBITDA ratios were 2.9 times and 2.2 times respectively. As of the end of the quarter we were comfortably within the requirements of our public debt and revolving covenants.

In summary, despite a challenging market environment, we continue to make meaningful progress towards repositioning our portfolio to be more heavily weighted high value C.E.D. properties. Our strong balance sheet with $140 million of unrestricted cash, and $750 million of available on our revolving credit facility as of today, position us to grow cash flow as the economy improves. That concludes our prepared, remarks, operator, we are now ready to take questions.

(Operator Instructions). please go ahead.

Good afternoon.

Hi, Mitch.

Just curious about your capital plan. You know, -- it seems like there was no needs -- maybe I will take a step back. If you can talk about your acquisition pipeline. Curious about the fact that you guys don't have anything under contract here. Any real reason behind that? Is it a product orIs it just nothing really fits your underwriting criteria now.

Talk about the acquisition pipeline, specifically. I think our criteria has just become quite narrow in our focus. We're -- we are looking very specifically at C.B.C. office properties. And they have to hit a certain return for us. Which are close to the historical cap rates you have seen us buy properties.

There's not a lot of that product on the market, there is some. We continue to evail wait those properties. I expect we will continue, and we may continue to do some more acquisitions this year. But I certainly think the acquisition of commonwealth has slowed and that's a combination of just -- less product to buy. We have a narrower focus. And I think we're just being extremely prudent and careful with our balance sheet. We do have capacity, we believe, to buy more. But we don't have unlimited capacity.

Adam, we're hearing pretty positive commentary about the supply demand imbalance in the investment markets. You guys took the -- I don't know probably the worst performing 20 assets and tried to sell them, why not look to trim your suburban exposure, if the ability for you to gain more C.B.D. exposure is through acquisitions and that's not really materializing why not look at asset sales in.

One, we are looking at asset sales and we have several properties that are being considered for sale. But two, there is a very -- there's a very different market out there for suburban office properties versed C.B.D. office properties. There is not a high degree of demand for suburban properties the same way there's demand for C.B.D. office properties. So the supply/demand imbalance, exists but it exists for certain segments of the market. I don't believe that this is a -- there are no a lot of buyers looking at suburban office properties. There are some, and we are considering selling some, but there are not -- there's not a lot of competition out there for that product.

And just a reference the assets that are for sale now, are those the ones that are pulled off back in the fourth quarter?

Some of those and then additional ones.

Okay. And then the question on the capital plan, I know it is a little far off, but you dough have upwards of $200 million of debt maturing next year, any thoughts to some of your capitol to continue buying back some debt here?

We would like at buying back some debt. It just doesn't trade at prices that would make much sense for us to buy it back. It is all trading above par. Especially the stuff that's shorter end of the curb. So doesn't make a lot of sense to buy that in today. But if it was available let's say below par, I think we would absolutely consider it, it's just not available.

And then last question on -- well, not really guidance, but John I missed your comments, did you say 87 is a true run rate? And then make the adjustments for -- any acquisition activity in the sir? Is that the way to look at it.

That's correct. So again, we acquired one property on March 31st, so that would have to be factored in as a positive. But as you say, you have to factor in a full quarters worth of a sir transaction, what you see coming through in the income statement FFO and CAD is only 19 days worth of a deduction.

And you haven't receive additive denned yet, right.

We have not, and we won't until the third quarter.

Will you be recorded that dividend as cash?

Indirectly, yes. Gauze we'll be reporting a proportion gnats hare of cash from SIR.

So you'll continue to show the cash flow in the 70%?

That's correct.

SIRand on top of that you'll be showing the dividend.

No, that would be a double count, no just the proportion gnats hare.

Okay, thanks.

Yep.

And we do have a question from the line of Dave Rodgers with RBC Capital Markets please go ahead.

Hey, Adam, you talked about most your leasing being in the suburban markets. Maybe give us a little more color, is that a function of greater availability for you in the suburbs, what type of activity are you seeing in your secondary C.B.D's in terming of leasing activity, and specifically maybe commenting around expansions verses contractions on some of those bigger leases that you got on your newer CBD assets.

Well, there's more leasing activity in the suburban for a couple reasons. One, it is where our biggest amount -- largest amount of cart vacancy exists. It is where we have a significant amount of roll as well. To it is just doing the math, it's where we have the greatest amount of availability. In the portfolio.

And it's -- it unfortunately happens to be where the toughest deals are getting done. We are seeing in certain C.B.D. markets, concessions are starting to back off. We haven't seen rental rates move yet, but we have certainly seen in places like for example, Austin, or Pittsburgh, or the few buildings we own in the silicon valley, or even up in the Seattle Washington area, concessions have clearly backed -- we are definitely seeing a back up in concessions, which is good. We haven't seen a lot of rental rate movement yet.

But in the suburban markets, the -- reason you're seeing an 8% drop in rental rates compared to last -- compared to previous rates is that's all being driven byte drop in what's going on in the suburban markets. It is just -- you know, the good news there's no a lot of new supply. People want building a lot that's really good. Unfortunately, the economy is growing but it's growing slowly. And as everybody reads, office users are -- there's a lot of office users are reconfiguring space and not using as much space per employee as they used to. And so all of that is having an effect, and most acutely in the suburban office product.

But with clearly -- we signed over 150 leases. We signed almost 2 million square feet, the biggest chunk of that is in suburban markets. We are doing a lot of activity. We are having a lot of showings. In terms of general direction, in terms of the leasing sentiments out there, it's modestly, or slowly getting better. But not -- it is either bouncing along the bottom or slowly getting better and that's what we are seeing.

And then maybe a question for John, John, on T.I.s and leasing commissions as you go forward with the greater percentage or half your portfolio now, on a per foot or per foot per year basis should we expect to see those numbers go up in the coming years with more and more C.B.D. explorations? Is that something that's in the budget and we should think about.

I would say yes. Typically -- yeah, definitely C.B.D. build outs are more expensive, but typically the leases at least in our portfolio, are longer term. When you look at a net effective basis you may end up close to the same place. You know, as far as sort of gauging our one year look out for pay out ratio, and CAPEX, which is of course the largest component, we're looking at pretty consistent CAPEX assuming we hold occupancy flat between December 2011 and 2012. Of course, if occupancy -- if we are fortunate enough to in presume occupancy, which is sort of a tough call as I sit here today, to say with any degree of conviction, of course CapEX would raise, and the pay out ratio would suffer but that would be a good thing for long term prospects for revenue growth.

Sure, all right, thank you, guys.

And if there are any additional questions at this time, please press star then one on your touch tone phone. We do have an question from the line of John Guinee from Stifle.

You have a run rate of FFO of about $0.85 last year, and you're guiding thwarts the start of 87, and I guess stepping up a little bit, is that correct, John?

No, we aren't guiding towards 87, we are just trying to bridge the gap between an unusually high F.F.O. points out the nonrecurring items of $3 million, bringing it down to 87. But there's still some additional work that would need to be done to come down to a run rate, we haven't served that up for you, but we would like you to make sure you take into account the acquisition that took place late in the quarter. But especially take into account the fact that there's only 19 days worth of deductions related to the sir transaction. So clearly you need to gross those up, which would reduce F.F.O. per share.

Okay. And then if I look at you guys borrowing out on your $750 million revolver, the end result is about $4.45 billion of debt, $800 million of preferred, and equity capitalization of about $1.56 billion which is essentially debt plus preferred is up to 77% of you total enterprise value. Can you keep your rating when you do that? And what's your thought in terms borough out on this revolver to acquire given the amount of leverage that you're just the amount overleaf advantage that you're increasing?

Sure. John, I don't think we could keep our rating if we did all that. So I don't think we would do that. But -- that's why way have $140 million of cash, just right now sitting on our balance sheet, unrestricted. And also I said earlier, I think we're being very prudent in our acquisition criteria. I can see us buying one or two other buildings this year, but I do not see us fully taking down the $750 million. On the revolver. And I think we could fund between using the cash, of $140 million as well as asset sales, and also keep in mind, we do own shares in give that could be a source of capital for the company as well.

So I don't think the scenario you are talking about is one that we would do. We would just take the revolver out, the $750 million fully drawn. But I do think we could be making some -- a few more -- we could take one or more acquisitions this year. From where I sit today -- of course that could change, but from I sit today, that's where I see it. And I don't see a big draw on the revolver as a result of that.

This is maybe a question for John, I'm not sure. As I look at page 25, is this X, excluding the sir assets?

Yes.

So essentially the end result is the suburban office portfolio is 21 million square feet, 80,000 square feet buildings on average, fairly generic buildings, and there's 76% occupied and then it looks like about 12 million of industrial and other. 90,000 square feet buildings kind of puts them in the more flex than industrial category, 76% occupied. Was that sort of the intent when you spun out sir.

There's no surprisings in these numbers when you say that's our intent. Remember, we own 70% of S.R.I., and it gets consolidated into our financial results and we very consciously decided we did not want to sell more than 50 of the -- of sir to the public. So the only reason we are showing these wholly owned numbers is because we thought people were going to ask us what does the portfolio look like without SIRSo we included this page just as increase disclosure, but I wouldn't look at this page and say this is what commonwealth is. CommonWealth continues to own 70 of SIRAnd gets the benefit from the growth and the rents we are going to receive from the Hawaii portfolio. When you say was this intent, there is certainly no surprises. I don't think anyone that has followed the closely and carefully would be surprised by these numbers.

And then the last question, the obvious question, as you are bouncing around $18, $19 a share, high ten's on a dividend, clearly when you're at that level, people are either anticipating a diminution, or decline in share value, and or a dividend adjustment. And it seems to me that -- if the stocks price can't get back up into the low to mid 20's, a dividend cut could be the prudent thing to do. In fact, if you cut the dividend down to $1.20 you would still have one of the halation dividends in the office industrial Reese space. What's your thought on process on all that?

I'm glad you asks that, John, because it is something a lot of investors have asked us about and it's the security of the dividend. Right now, we acknowledge that it certainly appears that the market is expecting a dividend cut. You know, we disclosed our payout ratios 104%. That is above 100%, it's not much above 100%. But we think we can maintain this dividend for the foreseeable future. If the pay out ratio were to balloon up, above 104%, well above 100%, and be there for quite some time, I think we'd have to seriously consider reducing the dividend, but right now, there's no intention from management, or the board, to do anything with the dividend.

Now that might change as circumstances change. But today we have no intention of changing the dividend. And I have to tell you, it is -- at times it is perplexing to us, because we look at our numbers and say we can afford the dividend, and it doesn't look like it should be at risk, yet the stock price seems to indicate that Everybody else doesn't see that. They think we are going to -- that there should be a dividend cut. Maybe they are anticipating something years from now, or a long time from now. But I don't -- it is -- sometimes it's as perplexing to us as to maybe you, John, but that's our thoughts on it.

Believe me, it's not perplexing to me at all. It looks to me over the last 5 quarters that your equity raises or debt raises essentially equity is about 28%, $278 million, preferred is about $275 million or 28%, and debt is about $440 million, so over the last four or 5-quarters, your incremental capital has been over 70%, either preferred shares or debt. And what you're doing is you're just levering up the company, well, not really generating any increased F.F.O. And then your ratios I think you mentioned was 104%, you're down at 85% occupancy, 80% occupancy, in the wholly owned portfolio, so you have to spend much more over the next two or three years to get yourself back over 90. So essentially what these assets are doing is just declining in value. At the end of the day, you are overpaying the dividend -- isn't there a time when this music stops.

I'm trying to understand what your question is, but --

It might be worth noting first of all, on the capital stack, John, with this has an impact on the ratios I'm not sure. But the preferred we issued was basically replaced preferred we redeemed nine months earlier.

Yeah. John, I mean we have talked about this ad nauseam with you and others. We have gone through a massive portfolio repositioning in this company. People can argue whether it was the right thing or wrong thing, but I feel pretty strongly that it was the right thing for this company. You know, and it was not an easy -- it has not been an easy repositioning. We have been trying and I think rather successfully, to reorient the company towards more high quality C.B.D. office properties. Those properties are the properties that are showing same store growth, and they are showing increases in occupancy, they are showing increased demand for leasing. They are the bright spot of the company, and be perfectly frank, I wish we owned more of it and were able to buy in the last few years.

The thing SHA is dragging us down is the stuff that we the legacy suburban properties. If we had not engages in this repositions started this two or three years ago, I think the results would be a lot worse today than what was showing. If we were an 80% automobile bourbons office read, it would be much tougher results than if we have close to 50% coming from C.B.D. office properties. So this was a very concerted well telegraphed business plan that we have engaged in. It's been I dare say if we hadn't dodge it things would be a lot worse. But that's exactly what we have been doing over the last few years and I think it's been the smart thing to do and the right thing to do for this company.

Okay. Thank you.

Yep.

And at this time it does appear there are no further questions from the phone lines I would now like to turn the conference back over to Adam Portnoy.

Thank you for joining us on our first quarter conference call, we look forward to seeing many of you at the J&P security conference 14th of May, is at the institutional investor conference in early June, thank you.

And ladies and gentlemen that does conclude your conference today, thank you for your participation and for using the AT&T Conference Service. You may now disconnect.