Equity Commonwealth (EQC) 2013 Q2 法說會逐字稿

Good day and welcome to the CommonWealth REIT second quarter financial results conference call. This call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Vice President of Investor Relations, Mr. Tim Bonang. Please go ahead, sir.

Thank you and good afternoon. Joining in on today's call are Adam Portnoy, President and Managing Trustee, and John Popeo, Treasurer and Chief Financial Officer. 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 other securities laws. These forward-looking statements are based on CommonWealth REIT's present beliefs and expectations as of today, August 7th, 2013. Forward-looking statements are not guaranteed to occur.

Actual results may differ materially from those projected or implied by any forward-looking statements. Information concerning factors that could cause those differences is contained in our annual [port] on form 10-K, our first quarter quarterly report on form 10-Q, and our current reports on form 8-K filed with the Securities and Exchange Commission or SEC, our second quarter quarterly report on form 10-Q which we expect to file with the SEC later this week and in our Q2 supplemental operating and financial data package which can be found in the Investor Relations section of our website at www.CWHREIT.com.

Any matters described in forward-looking statements are not guaranteed to occur. the Company undertakes no obligation to revise or publicly release the results of any revisions of the forward-looking statements made in today's conference call as a result of new information, future events, or otherwise. Investors are cautioned not to place undue reliance upon any forward-looking statements. In addition, this call may contain non-GAAP numbers including funds from operations or FFO, normalized FFO, cash available for distribution or CAD, earnings before interest, taxes, depreciation and amortization, or EBITDA, property net operating income or NOI, and cash NOI.

A definition of each of these non-GAAP measures and a reconciliation of each of them to net income and a reconciliation of normalized FFO to FFO are available in our 2Q supplemental operating and financial data package. I would also note the transcripts recording and retransmission of today's conference call is strictly prohibited without the prior written consent of CommonWealth REIT. Now I would like to turn the call over to Adam.

Thank you, Tim. Before I review our second quarter results I would like to remind everyone that the Company, its manager, and its trustees are still involved in various lawsuits including litigation concerning the ability of certain shareholders to undertake a written consent solicitation to remove our board of trustees. During today's call, we will only be discussing matters relating to the Company's results of operations and we will not be commenting on or answering questions regarding pending litigation, the purported consent solicitation or any purported offer to acquire the Company. The purpose of today's call is to discuss the Company's second quarter results.

When we open the call up for Q&A, I ask you please focus your questions on the Company's results of operations. The one comment I will make regarding pending litigation is that with respect to Corvex related, the legal disputes are being resolved, as provided in our by-laws, by arbitration. The arbitration panel held a hearing regarding certain motions on July 26th. As of today, there has not been a ruling by the arbitration panel regarding these motions and we don't know when the panel will rule.

Also I wanted to let you know in response to share holder requests we have increased our disclosure in our supplemental operating and financial data package this quarter. In order to provide more details about our portfolio , we have added an exhibit which provides individual property level data for our entire 345-property wholly owned portfolio. We hope this additional information will help investors to better annualize and value the Company.

Turning to our second quarter results for the quarter ended June 30th, we are reporting fully diluted normalized FFO of $0.63 per share compared to $0.83 per shareduring the same period last year. During the quarter we continued to implement our business plan of focusing on the ownership and operation of high quality central business district or CBD office properties and selling suburban properties and other assets.

As of June 30th , CBD office properties accounted for 58.4% of wholly owned property NOI. On a consolidated basis during the quarter we signed over 130 individual leases for 1.6 million square feet, with 60% of the square feet representing renewals and 40% representing new leases. The average term for the leases entered into or renewed during the quarter was 6.9 years and the weighted average cash rental rates were essentially unchanged from prior rents for the same space down about 0.2%.

Capital cost commitments associated with leasing activities this quarter were $31.35 per square foot or about $4.54 per square foot per lease year. A large part of the increase in leasing capital commitments per square foot this quarter compared to last quarter reflects 354,000 square feet of new leases signed in our CBD office portfolio which typically has longer lease terms, but higher CapEx commitments.

Of the 1.6 million square feet of leasing activity during the second quarter, 39% of the square feet in both CBD office properties which had a 7% roll up in cash rents and 32% involved industrial properties which had a 0% change in cash rents. The remaining 29% of our square feet leased during the quarter involved our suburban office properties which had a 10% roll down in cash rents. As of June 30th our consolidated occupancy was 89.2% which was 80 basis points lower than our first quarter 2013 occupancy rate.

The principal reason for the decline in occupancy was the 608,000 square foot vacancy at 1 Franklin Plaza in Philadelphia as a result of the GlaxoSmithKline lease expiration that occurred during the quarter. Negotiations to re-lease this property to a full building user fell through during the second quarter and we are now weighing various options including retrofitting this building to accommodate multiple tenants or listing this property for sale. This property accounted for roughly 84 basis points of consolidated occupancy and $2.8 million of NOI per quarter.

On a consolidated same property basis , our occupancy declined by 130 basis points to 88.4% and cash NOI increased by 2.3%. The principal reason for the decrease in same property occupancy was increased vacancy in our CBD office portfolio which was driven by the GlaxoSmithKline vacancy during the quarter. The principal reason for the increase in same property cash NOI was the result of rent increases in Oahu, Hawaii, contractual rent increases in our wholly owned portfolio, and lower than expected operating costs.

Overall our CBD office properties continue to out perform our suburban office properties in terms of leasing activity, occupancy rates, and NOI growth. The Chicago market represents the Company's largest market area with 10.1% of our consolidated NOI followed by our Oahu, Hawaii and Philadelphia markets which represents 10.1% and 8% of consolidated NOI respectively. Almost 90% of our NOI from our Chicago and Philadelphia markets comes from CBD office properties.

Within our other market segment, the strongest leasing areas for our portfolio are Australia, Austin, Texas, Seattle, Washington, Pittsburgh, Pennsylvania, Boston, Massachusetts, the San Francisco bay area and Southern California. About 22% of our wholly owned property NOI in the second quarter was generated from these seven market areas. In addition we are starting to see improvements in office market fundamentals in other areas across the country. Through year-end 2013 we have 2.7 million consolidated square feet scheduled to expire which represents about 4% of our annualized rental income as of June 30th.

About 63% of our 2013 consolidated expiring square feet is located in our CBD office or industrial portfolios. We are hopeful we will be able to renew or lease the space in these CBD and industrial properties at rental rates that are on average equal to or higher than current in place rents. Our occupancy and NOI from our wholly owned properties which excludes properties from our majority owned consolidated subsidiary Select Income REIT or SIR was 85.8% as of quarter end and $128.1 million for the quarter ended June 30th respectively.

This compares to 86.9% occupancy at the end of the first quarter and $129.4 million of NOI for the quarter ended March 31st. Excluding the GlaxoSmithKline vacancy during the quarter, both occupancy and NOI for our wholly owned portfolio would have increased sequentially between Q1 and Q2.

As mentioned earlier for the last several years we have been executing our business plan to reposition the Company's portfolio into high value office properties located in CBD locations. Since January 1st 2008, we have acquired $3.7 billion worth of property and the majority of these acquisitions have been high quality CBD office buildings. During the same period we have sold $1.5 billion worth of properties largely consisting of suburban office buildings.

Since the middle of 2012 and excluding transactions at SIR the Company has not entered into any agreements to purchase properties. During the six months ended June 30th, the Company completed the sale of 24 properties with a combined 2.3 million square feet for a total of $42.6 million. As of June 30th , we had 70 properties with a combined 4.4 million square feet located throughout the United States listed for sale with third party brokers and classified as held for sale.

As of today 49 of these properties with a combined 2.3 million square feet are under agreements to be sold for a total of $67.5 million. We currently expect to complete the sale of the 49 properties currently under agreements to be sold and the remaining 21 properties listed for sale before year-end 2013.

However no assurance can be given that any of these properties will be sold in that time period at all. As you can likely tell from the sales price per square foot the properties we have sold or agreed to sell to date are among the properties we consider to have very weak long-term prospects. I think it may be important to point out that the prices achieved for these properties should not be considered to be representative of the value of our portfolio as a whole or even the values of our remaining non-core suburban properties generally.

Before turning the call over to John Popeo I want to point out that the Company has made substantial progress in implementing its business plan in the last few years. Today almost 60% of the Company's NOI from wholly owned properties comes from CBD office buildings which is more than double the percentage of NOI it received from CBD office properties a few years ago. We continue to be focused on executing the Company's business plan and we are making good progress selling the weakest suburban, non-core properties and simplifying the Company's operations.

As the market conditions for the purchase and sale of office properties has evolved during the past year, the Company has shifted its focus from buying CBD office buildings to selling our non-core suburban properties. Both of these activities are intended to further our business plan to become a nationwide owner of high quality CBD office buildings. Also as a result of our first quarter capital raising activities the Company's balance sheet is well positioned to allow us a reasonable time to complete our business plan. I will now turn the call over to John Popeo our CFO.

Thank you, Adam. Net income available for CommonWealth REIT common shareholders for the second quarter of 2013 was $7.7 million compared to net income of $2.2 million for the second quarter of 2012.

The 10% increase in rental income and 6.5% increase in operating expenses primarily reflect property acquisitions since April 2012. The $9 million or 72% increase in general and administrative costs primarily reflects legal and consulting fees related to ongoing litigation. Current quarter adjusted EBITDA increased by 2.1% compared to the prior year.

Interest expense decreased by 12.9% primarily reflecting interest on $670.3 million of unsecured senior notes repaid pursuant to the tender offer completed during March 2013. The decrease in equity and earnings of investees reflects the sales earning March 2013 of all 9,950,000 of our common shares of Government Properties Income Trust or GOV for approximately $240 million net of commissions and expenses. Loss from discontinued operations includes NOI plus G&A expenses related to the 94 properties classified as held for sale at the beginning of the year including the 24 properties sold since then.

Loss on asset impairment from discontinued operations of $4.6 million reflects the additional net write down to estimated fair value of 15 properties sold or classified as held for sale as of June 30th, 2013based on recent purchase offers. In addition gains on sales of properties of $2.1 million reflect sales proceeds in excess of pre-impairment book values at six properties sold during the quarter.

Net income and normalized FFO attributable to the non-controlling interest in SIR totaled $10 million and $13.3 million respectively during the second quarter. CWH ceased to own a majority of SIR's common shares after SIR completed a common share offering in early July. Accordingly, beginning with the filing of CWH's third quarter form 10-Q, CWH will deconsolidate its investment in SIR and account for its investment in SIR under the equity method. CommonWealth REIT continues to own 22 million or 44.2% of SIR's common shares.

Normalized FFO available for CommonWealth REIT common shareholders was $0.63 cents per share for the second quarter 2013 compared to $0.83 cents per share for the second quarter of 2012. Year-over-year per share results primarily reflect the issuance of new common shares in March 2013. The increase in G&A expenses and the sale of our GOV shares partially offset by property acquisitions during 2012 and 2013, and interest savings resulting from the purchase of notes pursuant to our debt tender offer during the first quarter.

During the second quarter we spent $35 million on recurring capital expenditures which includes tenant improvements, leasing costs, and recurring building improvements. We generated $37.3 million of cash available for distribution or CAD during the second quarter resulting in a rolling four quarter CAD payout ratio of about 69.4% based on an annual dividend of $1 per share.

Turning to the balance sheet on June 30th, 2013, we held $77.5 million of unrestricted cash. A portion of this cash will be used later this month to pay the dividends we previously declared on our preferred and common shares outstanding. Rents receivable includes approximately $245 million of accumulated straight line rent accruals as of June 30th 2013.

Other assets include approximately $155 million of capitalized leasing and financing costs. The $128.5 million worth of properties held for sale represents the net book value of 70 properties held for sale as of June 30th , 2013. On June 30th, 2013, we had $1.2 billion of floating rate debt including the $350 million SIR term loan and $235 million outstanding on SIR's revolving credit facility.

At the end of the second quarter we had $947 million of mortgage debt and $1.5 billion of fixed rate senior unsecured notes outstanding. The weighted average contractual interest rate on all debt was around 4.6% at the end of the quarter and the weighted average maturity was around five years. At the end of the second quarter our ratio of debt to book capitalization was 47%.

Our adjusted EBITDA to interest and our fixed charge coverage ratio was 3.3 times and 2.6 times respectively. Also our debt to adjusted EBITDA ratio was 6.4 times.

These strong credit metrics primarily reflect a repayment of approximately $670 million of unsecured senior notes with proceeds from our equity offering and the sale of our common shares of GOV in March of 2013. In conclusion we believe CommonWealth REIT is well positioned to benefit from the slow recovery in the office market during the next couple of years as the Company continues its transition from an owner of suburban properties to a nationwide owner of CBD properties.

Before we turn to the Q&A portion of today's call I want to reiterate the purpose of today's call is to discuss our second quarter financial and operating results. We will not be answering any questions related to the pending litigation, the purported consent solicitation or any purported offers to acquire the Company and I ask for and appreciate your cooperation in this regard. Operator, we are now ready for questions.

(Operator Instructions) Our first question today comes from the line of Josh Addy with Citicorp. Please go ahead.

Good afternoon and thank you for the additional disclosure on the property list. John, can you tell us exactly how much legal and consulting fees were included in G&A in the quarter just to help us think about the underlying G&A run rate going forward?

Hi, Josh. This is Adam. I will take that question. I think it is just about $9 million. It is probably somewhere between $8 million and $9 million with just legal and consulting fees.

In answering that question I want you to keep in mind that CommonWealth did not start this litigation. It was started when Corvex and related brought litigation to stop the CommonWealth equity offering the during the first quarter. That litigation has spawned copycat litigation from others repeating various false charges made by Corvex and related.

We now have cases pending in three different courts and an arbitration proceeding. Also I think you should keep in mind that a few years ago the shareholders of CommonWealth adopted an amendment to our declaration of trust which makes shareholders who cert false claims against the Company liable to indemnify the Company for the expenses CommonWealth incurs defending these claims including legal fees.

We believe the litigation to stop the equity offering and alleged consent solicitation undertaken by Corvex and related were improper and when we win, we expect Corvex and related may be required to indemnify CommonWealth for some of these costs. We have an asserted counter claim in the pending arbitration for that reimbursement based upon our declaration and our by-laws. The bottom line is we did not start this litigation. In the present circumstances we intend to defend against the false charges which are being made against us and against the improper consent solicitation by Corvex and related.

Thanks and I appreciate that. Just to help us think about earnings going forward, is the $8 million to $9 million, is that something we should expect every quarter when we think about your FFO going forward, or are most of the costs behind you? What is the right way for us to think about that?

Josh, That's a really difficult question to answer. It all depends on the volume of activity related to the various cases that are currently in play.

Is it fair to say there will be some element of that cost going forward for at least the next several quarters?

I think That's a fair statement.

Again Josh, not that -- not to change what John said, but it all depends on where this goes. Yes through the third quarter it will be some legal expenses because we are in August and I can tell you things are still going forward through July, but it all depends on what happens.

Thanks. Second question separately , your interest in SIR has come down as a result of their equity issuance. As you think about that longer term is there a strategic reason for you to continue owning the stock of that company? How do you think about your long-term ownership?

Josh , today we are currently under a lock up that expires sometime in the late -- in the third quarter. We can't even do anything with the shares even if we wanted to today. I can tell you our current -- we have no current plans to dispose of those shares as of today.

Adam, it is Michael Billerman and I echo Josh's comment in terms of getting the additional detail on the assets in there. I had a question and this is not in regards to litigation or the consent to solicitation or the purported offer. It was a comment you had made in the New York times article back in late July. You had said at the end you said "Everything we have always done has been in the best interest of shareholders. When we come to work every day our focus is on the common shareholders and executing our business plan."

I am trying to reconcile that comment and the way you talk about that relative to your share ownership. You currently own 40,000 shares. Your father owns just under 240,000 shares so it is combined a quarter of a percent which is probably the lowest insider ownership of any of the companies we follow. I am just trying to figure out the alignment of interest on the one hand where you say you come and work for a common shareholder and wouldn't you want to be a more material shareholder in sort of saying that?

A lot of that stock had been either through the drip plan, either through the comp plan, through board fees. So it wasn't even like it was bought. I am just trying to really understand the comment relative to the ownership.

Couple things to respond. I stand by all the comments I said in that article. The second thing I point out is many of our competing REITs, they were formed largely through upreach structures where existing owners or families that owned real estate then took their business public. And so when they took it public they owned a large percentage of the company prior to it going public and then it got diluted down through the offering itself.

As you may know CommonWealth was not formed that way. And so there was no large number of properties that were held privately which were then taken public per se through an offering. We were formed a little differently than many other companies. That's the only other thing I would add. It may be part of the reason for the discrepancy between share ownership and some of our competitors and us.

No, That's a fair point, but it hasn't stopped others from buying and accumulating large sums of stock and certainly at the RMR entity which is -- we don't have much purview into in terms of the profitability or the -- [inaudible]. Capital there. Some of that could have been rotated back into the underling companies which -- you look at the ownership of each of the RMR entities, and it is all-around the same sort of level in terms of percent of ownership. I'm just trying to get a better understanding if there is a change in the way you're thinking of ownership and trying to align yourself more with the common shareholders of an ownership.

Is there a change? There has been no change. I stand by the comments we made in that newspaper article and I think the large reason that there is a big difference in the share ownership is principally how we were formed versus others. I will leave it there.

That's helpful. Thank you.

We do have a question from the line of Rich Moore with RBC Capital Markets. Please go ahead.

Hi, Good afternoon, guys. The rough cap rate, you may not want to give the exact numbers at the moment, but on the $67.5 million you guys have under contract, a rough cap rate range on that would be probably what?

It is probably not the right way to look at it, Rich because it is really -- many of those builds are perhaps vacant and they are negative cash flow. So it's not really -- unfortunately as we say in the prepared remarks they are not really representative of the portfolio. These are the weakest properties in the portfolio, many of which have negative cash flow. Cap rate is not something -- I think the more relative metric may be price per foot.

Do you have a number for that? I assume the cap rate would just be very low so price per foot would be probably low as well.

If there is cash flow with the property, yes, it is very low. It is probably just barely breaking even. If it is a property cash flowing in those groups. The price per foot you can do the math very simply. It is about $35 per foot.

Fair enough. Thank you. And none of those I assume, Adam, are included in the exhibits you gave us at the back which I liked as well. Thank you for doing that. None of the assets held for sale are back in there, right?

That's correct. We only included the wholly owned from continuing operations. That's correct. None of the assets held for sale are in that list.

Great. And you have -- you sold six this quarter by my calculation and you have 49 under contract, 21 to go. We talked about this before, but is there another wave behind this? You indicated a couple of quarters ago that there would be other waves behind this and it looks like you've made excellent progress on the first wave. It is just about wrapped up. Are we teeing up a second wave here or are we done with the dispositions for awhile?

I don't think a final decision has been made, but we are seriously considering I guess you can call it a second wave. I think when we talked in the past we said we wanted to see how the first wave of dispositions went. I think it has gone reasonably well, and I think that is leading us to have some serious discussions internationally about whether or not there'll be a second wave. No final decision has been made, but I can tell you we are seriously thinking about it.

And when you think about CapEx and TIs and leasing commissions, etc. for the -- going forward, was there a lot of TI-type dollars, leasing commission dollars, sales commission dollars associated with what you've been working on this first hundred or so properties you have been working to get rid of , and then we see a lessening of that? Is that really not what happened? We will see the same level of TI's going forward?

It is a good question, Rich. What is happening in the TI's and the LC's is a few quarters ago I characterized our portfolio, I broke it out between non-core and core and we talked about how in the non-core we may do some aggressive leasing to get it leased up. What we have ended up doing the first six months of the year is actually a little bit less of that aggressive leasing in that non-core portfolio and have been more focused on the core portfolio. I think the vast majority of numbers you are seeing run through our leasing commitments, is really what you would consider the core portfolio. It is less of what we might have -- what we have past described as the non-core portfolio.

I know a few quarters ago we talked about how we might get very aggressive on leasing in some of that. We ended up not being as aggressive as we originally intended to be and being more focused on making sure we kept a core portfolio well leased. In that non-core portfolio decided that in some cases when we were looking at leases that really just did not make economic sense for the building. Weren't going add value to the building, weren't going to enable us to get a higher price if we sold it and we decided not to move forward with the lease. That's what is going on with those numbers.

All right, good. Thank you very much.

At this time there are no further questions in queue. I would like to turn the conference over to Adam Portnoy for closing comments. Please go ahead.

That concludes our presentation. Thank you everyone for joining us today.

Ladies and gentlemen, that does conclude your conference for today. Thank you for using the At&T executive teleconference service. You may now disconnect.