Hudson Pacific Properties Inc (HPP) 2024 Q2 法說會逐字稿

Hello, everyone. Thank you for attending today's Hudson Pacific Properties second-quarter 2024 earnings conference call. My name is Sierra, and I'll be your moderator for today. All lines will be muted during the presentation portion of the call, with an opportunity for questions-and-answers at the end. (Operator Instructions) I'd now like to turn the conference over to our host, Laura Campbell, Executive Vice President of Investor Relations and Marketing. Please proceed.

Good afternoon, everyone. Thanks for joining us. With me on the call today are Victor Coleman, CEO and Chairman; Mark Lammas, President; Harout Diramerian, CFO; and Art Suazo, EVP of Leasing. This afternoon, we filed our earnings release and supplemental on an 8-K with the SEC and both are now available on our website.

An audio webcast of this call will be available for replay on our website. Some of the information we'll share on the call today is forward-looking in nature. Please reference our earnings release and supplemental for statements regarding forward-looking information as well as the reconciliation of non-GAAP financial measures used on this call. Today, Victor will discuss industry and market trends as well as other highlights from the quarter.

Mark will provide an update on our office and studio operations and development, and Harout will review our financial results in 2024 outlook. Thereafter, we'll be happy to take your questions. Victor.

Thank you, Laura, and good afternoon, everyone, and welcome to our second-quarter call. The results we reported this quarter were in line with our FFO outlook with our office portfolio performing better than our expectations. This quarter or team's strong execution resulted in leasing over 0.5 million square feet. This is our highest leasing activity since the second quarter of 2022. And our year to date leasing was up 40% compared to last year. Two-third of those leases were new, the most since first quarter 2019.

Even after another strong quarter of leasing, our pipeline of deals in leases, LOIs or proposals is healthy at 2 million square feet with an average requirement of above 15,000 square feet, up from about 9,000 square feet two years ago. All of this is a testament to our team's ability to attract and capture demand and successfully move leases through the pipeline to execution.

And while still challenging, there's a gradual strengthening across our West Coast office markets, almost uniformly relative to the trailing four quarter average available sublease space is declining, development pipelines are diminished, tenant requirements are growing, crime is falling, and transit ridership is improving. Nowhere is this more evident than in San Francisco.

The city had its second best leasing quarter in two years at 2 million square feet, with several submarkets experiencing positive or near positive net absorption. There were 13 deals signed over 40,000 square feet, the highest number since the third quarter of 2021 and kudos to our team for signing 2 of the 10 largest deals.

Tenant requirements continue to increase, reaching 6.8 million square feet this quarter, up 50% year over year to levels not seen since late 2019. Continued strong investment in AI is reigniting the San Francisco office market and spilling over into our other markets, especially Silicon Valley and to some extent, Seattle.

With over 600,000 square feet of a high leases signed in San Francisco year to date and 740,000 square feet of AI tenants already in the market, 2024 is on pace to be another significant AI leasing year. Second quarter US VC investment of $56 billion was the highest quarter in two years, driven by AI megadeals.

Reportedly, investors are gaining confidence in the US markets relative performance and getting more pressure from LPs to allocate nearly 300 billion of dry powder. The Bay area, where we have obviously a significant presence, continues to receive the largest allocation of VC funds, along with about 75% of all AI funding in the first half of the year.

We're energized by this positive leasing momentum and by significant funding for businesses that are choosing to locate in our core markets. While we cannot control the timing on leases closing, we expect our office fundamentals will gradually strengthen further as we move ahead.

As for our studios, last week, the Teamsters ratified their contract with the alliance of motion picture and television producers, finally clearing the way for production activity begin to normalize. This favorable resolution follows an unprecedented 18 months of strikes and difficult negotiations, which delayed greenlighting and overshadowed typical seasonality.

Presently, we estimate that there are only about 80 productions only in Los Angeles compared to approximately 100 during much of the second quarter, as the potential for additional strikes weighed on demand in July. While we expect some level of increase reduction through the balance of the year to what levels will remain unclear. Beyond the strikes, consolidation, cost cutting and shifting content mix are altering not just show counts, but also production type, number of episodes, and budgets. All these factors influence demand for our stages and services, both in Los Angeles and outside of Los Angeles.

While we believe Los Angeles will remain the epicenter of entertainment, in recent years, the city has lost some of the substantial lead in global production. Other locations have enhanced their infrastructure and implemented favorable state film tax credits and sector-specific incentives. While a strike exacerbated this trend from 2021 to 2022, growth in the Los Angeles region's total scripted production capture was up less than 1% compared to 4% in total scripted industry output.

In 2022, Los Angeles lost nearly $1 billion of production spend due to projects leaving State for tax credits. While we are working closely with Los Angeles' Mayor Bass, governing use and other elected officials and industry experts on this front, Mayor Bass is committed to ensuring the industry continues to thrive in the city of Los Angeles and has established a commission to strategize on incentives and related topics.

All of these dynamics are very fluid, and as a result, we currently lack the visibility to assess with reasonable certainty, how and when our studio operations will normalize. But they will normalize. And we believe that by the fourth quarter, production should start to get better even as new content investment remains cautious and more globally distributed.

Importantly, we did not require production to return anywhere near our 2021 peak levels for our studio businesses to create meaningful value. . At a point of reference during the fourth quarter of 2022 when we began to experience the early impacts of pending WGA and SAG after strikes, we estimate there were approximately 120 productions filling in Los Angeles.

During that same period, our in-service studios generated an annualized NOI of $37 million, and our TOD businesses generated an annualized NOI of $41 million. Finally, turning to our balance sheet. Further, deleveraging remains our top priority. We have no debt maturities until the end of 2025. And while we have already seen improvements in some of our leverage metrics, which Harout will comment on shortly, we anticipate that increasing studio cash flow will further strengthen these organically.

As part of our proactive multipronged approach to managing our leverage, we will continue to pursue opportunistic dispositions and have strong buyer interest on several assets. We expect to be able to execute successfully on these type of transactions just as we did last year. With that, let me turn it over to Mark.

Thanks, Victor. This quarter, we signed 540,000 square feet of new and renewal leases. On our first earnings call this year, we indicated our occupancy and lease percentages would likely dip in the first half with the potential to improve thereafter.

The 30 basis points and 50 basis points decline in occupancy and lease percentages this quarter are consistent with those early indications. Our GAAP rents grew 2.6%, while our cash rents were off 13.3%.

Excluding our 150,000 square foot at 21 year lease with the city of San Francisco at 1455 Market, our GAAP and cash rents would have increased up 8% and 0.9% respectively. Note that more than half of the square footage leased by the city with former block space signed at peak of market $80-plus rents, whereas the rent delta on the yet to be leased box space, most of which was signed in the mid-2010s would be significantly less. The notable increases this quarter in both net effective rent to $57 per square foot and turned in nine years were driven by mid- to large-sized renewal leases in the Bay Area some signed at $100-plus square foot rents.

We had roughly 1.4 million square feet of unique office tours again this quarter, up 20% from this time last year. Comparative first quarter tour activity increased 60% in San Francisco and 14% in Seattle. Year-to-date at Washington 1,000, we have toured tenants representing in aggregate over 600,000 square feet of mid- to large-sized demand.

We also have planned tours for that project representing another 80,000 square feet. To underscore, this represents only very early interest, but we are pursuing all prospects from the entire region with bigger. Washing 1,000 is among the best, if not the best, product in the Seattle CBD. On the heels of yet another strong leasing quarter, as Victor mentioned, our over 2 million square foot pipeline is up 8% from last quarter and five 5% compared to second quarter last year. This includes 48% and coverage, including deals and discussion on our remaining 2024 expirations.

On our top 10 vacancies, which collectively total about 2 million square feet, we have 47% coverage. This should allow us to begin to increase occupancy at assets like 1455 Market, 505 First, Page Mill Hill, 901 Market and 83 King. To put a finer point on our upcoming office expirations, we have roughly 800,000 square feet expiring through year end and 2 million square feet expiring in 2025.

Over the last three years, we have leased 470,000 square feet per quarter on average. Assuming we continue to accomplish only that and nothing more, over the next six quarters, we would have leased a total of 2.8 million square feet, exactly enough to address all remaining 2024 and 2025 expirations.

Thereafter, our annual office expirations become substantially lower, including in comparison to majority of office peers. If our pace of leasing continues or even modestly accelerate as market conditions improve, there is a clear path whereby we will not just preserve that achieved sustained growth in occupancy.

Turning to studios, on a trailing 12-month basis, our in-service stages were 78.1% leased compared to 79.4% in the first quarter, which reflects an additional vacant stage at Sunset Las Palmas. Our TOD stages were 32.8% leased, up from 29.8% last quarter due to increased stage occupancy, Quixote North Valley.

We currently have signed leases are in contract or have client interest on 38 of our 59 film and TV stages. In May, we held our grand opening event for clients at Sunset Glenoaks with major studios streamers and networks in attendance. Year to date, we have conducted over 20 unique tours at that asset, representing 11 active requirements, which resulted in three lease stages with a four stage in negotiations.

Transportation utilization increased approximately 300 basis points to 24% compared to first quarter. We had more activity in the early half of the second quarter and have been gaining market share even as activity declined with production levels later in the quarter. This is a testament to what our sales team and unique integrated offering can accomplish as production normalizes.

Our studio revenue grew 8% relative to first quarter. This is due to $2.1 million of additional stages studio ancillary revenue from higher occupancy, Quixote North Valley, more Netflix production at Sunset Gower and initial occupancy and production at Sunset Glenoaks, it also includes $1 million of incremental services revenue from higher transportation and location services utilization.

Finally, I'll note that construction at Sunset pier 94 is on budget and on time for planned opening in end of 2025. As Manhattan's first purpose-built studio, the project has garnered significant interest from high-profile, studios and productions, and we are in discussions with multiple tenants for multi and single stage leases.

And with that, I'll turn the call over to Harout.

Thanks, Mark. Our second quarter 2024 revenue was $218 million compared to $245.2 million in second quarter last year, primarily due to asset sales and to move-outs, one to 1455 Market and one at Sunset Las Palmas Studios, partially offset by improved studio ancillary revenue from increased production activity at Sunset Gower.

Our second quarter FFO, excluding specified items, was $24.5 million or $0.17 per diluted share compared to $34.5 million or $0.24 per diluted share in the second quarter last year. Specified items consisted of transaction related income of $0.1 million or $0.00 per diluted share and a one-time derivative fair value adjustment of $1.3 million or $0.01 per diluted share.

The year over year change in FFO is mostly due to the items affecting revenue, along with less FFO allocated to noncontrolling interests following our purchase of our partner's ownership interest in 1455 markets. Our second quarter AFFO was $24.2 million, or $0.17 per diluted share compared to $31.1 million or $0.22 per diluted share in the second quarter last year, with the change largely attributable to the previously mentioned items affecting FFO, partially improved by reduced noncash revenue adjustment and $4 million less in recurring CapEx spend.

Our second quarter same-store cash NOI was $105.2 million compared to $119.3 million in the second quarter last year, mostly driven by previously mentioned tenant move-outs at 1455 Market and Sunset Las Palmas. At the end of the second quarter, we had $706 million of total liquidity comprised of $78 million of unrestricted cash, cash equivalents and $628 million of undrawn capacity on our unsecured revolving credit facility.

There is also additional capacity of approximately $196 million, specific to our Sunset Glenoaks and Sunset Pier 94 construction loans, our share, which represents $54 million. We continue to take proactive steps to reduce leverage and strengthen related metrics. Compared to a year ago, we improved our share of net debt relative to our share of undepreciated book value by 140 basis points to 37.3% and increased our percentage of debt fixed or capped by 690 basis points to 92.2%. Importantly, as Victor noted, we have no maturities until November 2025.

One housekeeping matter before we discuss our outlook. With construction on Sunset Glenoaks complete as of second quarter, we are now accounting for it as a consolidated property.

Turning to our outlook, we are providing third quarter FFO outlook $0.08 to $0.12 per diluted share with no specified items.

Our third quarter outlook, I see that our in-service studio and security businesses NOI is lower in the third quarter, given the operating conditions are currently less favorable than the first half of the year, and it will take time following the recent ratification of the Teamsters agreement to greenlight and prep for new production.

Our office leasing performance in the second quarter was ahead of our expectations. However, our third quarter outlook assumes lower average occupancy and NOI driven by lease expirations in the second and third quarter, even though we anticipate occupancy has the potential to be flat at the end of the third quarter.

Regarding our full year FFO assumptions, we are lowering the range of same-store property cash NOI growth to negative 12.5% to 13.5% due to the same-store studios, specifically lower absorption at Sunset Las Palmas. For a reminder that our same-store portfolio excludes our security business and now consolidate Sunset Glenoaks Studio.

As always, our outlook excludes the impact of any potential dispositions, acquisitions, financings and or capital market activities. We will return to providing full year FFO guidance outlook, once we believe production levels have normalized to a point that we can more accurately anticipate and project future cash flows relate to show by show lease studio and service assets primarily at our security business.

Now we'll be happy to take questions. Operator?

Thank you. We will now begin the Q&A session. (Operator instructions)

Blaine Heck, Wells Fargo.

Great, thanks. Good afternoon. Victor, I was hoping you could comment maybe a little bit more on the asset sales that you talked about last quarter and again, a little bit this quarter. Maybe just how the reception been where you guys might be in that process? And maybe any color on potential pricing?

Yeah, Blaine, thanks. Good to hear your voice. So the asset sales, we are still in active discussions and on in beyond just on conversations on at least a few assets. I don't want to get into details of numbers, and I don't want to get into details on that the amounts, but we're confident that we're going to execute on our asset sales like we did last year.

Okay. That's helpful. Just to quickly follow up on that. Are these the same assets that you were targeting last quarter? Or has there been any change to kind of the composition of those potential sales?

Let me think about it. They're predominantly the same assets with the exception of one.

Okay, wonderful. Okay, got it. And then I had asked last quarter about whether there were any kind of strategic alternatives you guys might be exploring. And I thought you gave a very candid answer that essentially all options were still on the table. So just wanted to follow up there and maybe get any update to your thoughts on that subject and weather larger changes are still a consideration for you guys.

Well, as I said last time, listen, as a company, as the Chairman, as the Board of Directors always evaluate all potential opportunities, we're going to determine whether they're viable and obviously, they're going to be acutely discussed to look at what would maximize long-term value for our shareholders. There is nothing imminent at all that is currently in place today. But as I said, we're always evaluating and looking at alternatives.

Great. Thanks. I'll leave it there.

Thanks, Blayne.

Ronald Kamdem, Morgan Stanley.

Hey, just two quick ones for me. Just one, is there a quick way to sort of bridge going from $0.17 to $0.10 quarter to quarter? Just what are the components of that? Just trying to figure out, what pieces are driving that.

Sure. So the main drivers are lower same-store NOI at Quixote in our same-store studios. And that's related to a drop in activity at Gower and lower show counts in general. And then also lower office NOI in our relate to second and third quarter expirations which results in lower average occupancy in the quarter. We still expect, however, that by the end of the third quarter, we could be in line with what we reported in the second quarter in occupancy.

Got it. That makes sense. And then we noticed that you disclosed 239,000 square feet of early termination in the quarter. Just curious what was that driven by? Were there sort of any one-timers in the office rent figures that we should be thinking about? Thanks.

Yeah, this is Harout there were really two major drivers. One was we work in totality for 112,000 square feet, and then there was a default for 40,000 square feet. And those are the big ones. The good news on those is there is good news on those is that we already have pipeline behind that, we're in negotiations to backfill most of that space.

And to answer the second half that question, we did not get any lease termination revenue from the WeWork. So that's not in any of the numbers.

Okay, great. That's it for me. Thanks so much.

Nick Yulico, Scotiabank.

Thanks. I think earlier, Mark, you said something about the coverage on the expirations for this year, I thought you said 48%. I just want to make sure that was right. And then I don't know if you have a number you could share on 2025 expirations?

Yeah. So you're right on the 48%, that's the coverage on the 800 or so expires about back half of the year on '25 and just looking at our --

Yeah, so '25 right now, we're sitting at about 25% coverage on it on a finer point on the 48%, our average tenant size is below 7,000 square feet. Lot of these guys are just barely engaging right now. So that number that 48 can go up very clearly.

Okay. Thanks. And then I guess turning to AI you talked about a bit earlier. What we've heard is that in many cases these firms will want to have more prebuilt space or that they've taken sublease space because of that issue that I want to put much capital.

And can you just talk about maybe how you're situated your portfolio, whether it's on spec suites or anything else and that you think you can be competitive to create that tenant in the city of San Francisco versus the Valley?

Yeah. So it's bifurcated right do talking about AI with big large with the large growth and you're talking about kind of the early stage AI, that we deal with on the peninsula into the valley. I'll deal with the second one first. In the Valley, our prebuilt space, which we have about 300,000 square feet of in the Valley and we've it's been our bread and butter that space is attracting these tenants because they don't have to get off the planet, they don't have to think about it and we get immediate movements. So we're doing really well in those.

On the larger spaces, oftentimes we'll pre-built a single floor in this case, if they're looking for multiple floors. We haven't built out multiple floors, which is why a lot of nor has anyone for that matter, which is why they have been gravitating to really top end sublease space.

Okay, thanks. And if you're able to just share just following up on term in terms of like the pipeline or some of the leasing activity you've done, what the composition has been of AI firms?

AI and tech, yeah, I'll share with you. So as we mentioned in our prepared remarks, it's still a little bit more than 2 million square feet that's grown quarter over quarter. It's chiefly 65% new to renew deals. And I will say this, year over year, our tech as the composition of the pipeline has grown 15% to almost 40%, right?

So we're starting to see more and more tech in the pipeline. We're also seeing the size of the tenant grow. So kind of the midsize tenant is carrying the day 20,000 to 60,000 square feet, and that's up actually 40% year over year. Of that, most of that is in the city. Most of the AI, as you've seen is in the city for the larger users.

We've seen it in the Valley again, in really the startup realm. We've seen maybe three or four midsize AI deals in Seattle. But the preponderance of all of that is in San Francisco. And of the tech that I just mentioned to you. I would say that maybe 20% of that is AI.

Okay. (multiple speakers)

If we carry 40% tech, 20% of that is AI.

Appreciate it.

Caitlin Burrows, Goldman Sachs.

Hi, good afternoon, everyone. I was wondering if you could talk a little bit about office retention on what it's been this year and maybe how it compares to history, the expectation for the rest of the year. And then as you look forward into 2025, would you have any insight yet one way or the other on any of that maybe larger lease expirations?

Sure. This is Harout. Market mentioned, it's about 48% the retention, we think we can get a better than that why because there's a lot of smaller tenants that still haven't engaged yet in the fourth quarter. So we can get that north of 50%.

We feel we can get it north of 50%. That stacks up to the last, I would say the last three or four years for sure. But 25%, again, it's very early, and we have about 25% coverage on those expirations. So obviously, that number is going to grow.

And just to clarify that 48% retention, is that just coincidentally, I think you mentioned 48% coverage for the second half expirations and there are two different stuff that just happened to be 48%.

Okay. And then just (multiple speakers) but two different stats that happened to us before 48%.

No, he just saying we have coverage on the 800,000 feet. That represents the ability to retain that expiration.

And okay. I think I got that. Maybe I could circle back on that, but and then maybe on the dividend. So it's at $0.05 a quarter now. Wondering if you can comment on how that compares to your expected taxable income for the year? And what could cause on any incremental change to the dividend one way or the other at this points?

Sure. It's a bit early to compare to taxable only because first half of the year left, like we always evaluate dividend every quarter is really the Board's decision when it comes to the status of our dividend.

Okay. So early in the year. Got it. Thanks.

John Kim, BMO.

Thank you. I still don't really understand guidance for the third quarter. You have it at $0.1 a midpoint, that's down 41% sequentially. Your original guidance provided six months ago implied $0.29 per quarter and second to fourth quarter and I understand Studios down by at its peak, the studio is only 11% of NOI.

So I guess a lot of this is from occupancy, but the expirations was known a few months ago. So I just don't really understand how it could drop so much in one quarter. And I was wondering if there was anything that surprised you or anything incrementally new looking at the third quarter?

So it's a good question. So like we said, our office is actually a little bit improved basis compared to our previous guidance or even our full year guidance that we provided earlier in the year. It is really due to the both Quixote business and the same-store studio business. They're just not performing in line with our projections, both the full year and next quarter. That's the driver.

I know again from the percent you're quoting in terms of -- percentage of the company, that's a percent of NOI, but that's a percentage of FFO. The FFO is also driven by the interest and the G&A, which there's a larger movement as a result. So it's not just if you just take a percentage NOI.

Yes, it feels large but when you compare to FFO it's a bigger number. And you know it assuming our understanding is correct in our recoveries, it does go into turnaround pretty drastically once studio activity picks up and number of shows increased.

So same-store studio NOI was $7.6 million in the second quarter, does that become a significantly negative number in the third quarter?

No, the 7.6% is the -- I think, in service studio number. So we expect that to come down and same with Quixote.

So we expect that to come down and same with mean, let me just maybe take a somewhat different tact on it. Harout gave you the drivers of the difference between the $0.17 or $0.16 under Navy definition and a $0.1 midpoint, right? That's half studio related half average office occupancy related. And hopefully that's fairly clear as it relates to your sort of reach back to the earlier guidance and sort of trying to on bridge, if you will, to that early, early number and the $0.10.

I think what you have to appreciate is that the Quixote business, especially is highly, highly leveraged to its fixed cost. And so if show counts and the other drivers that really drive that business markedly improved, you can generate a heck of a lot of incremental FFO off that. And if they don't improve, which for the time being at least show counts are pretty stagnant what you realize is that you're kind of bumping along not too far away from say where we reported NOI negative $3 million.

And as we sit today on our third quarter expectations is that it's going to take a little while for the show counts to meaningfully improved. And so we just haven't been able to really get the real lift off if you will in terms of the impact that Quixote has the potential to make on FFO?

Mark, you mentioned that the fixed cost nature of security. I just wanted to ask about as same-store studio expenses being up 33% this quarter, I would thought it would be a lower number than that.

The sequential -- Harout's looking at it.

I apologize. I wasn't prepared for that specific question?

It's just the same-store studio expenses. It was up a lot.

Yeah, it could be and we did enjoy pretty high production levels at Sunset Gower in the quarter, in fact, higher than we had initially projected lighting and grid when production levels are high, it tends to mean a lighting and grip is high and they carry with it higher operating expenses. So that's likely the reason for the sequential increase.

Great. Thank you.

Alexander Goldfarb, Piper Sandler.

Hey, good afternoon. Good afternoon down there. Just two questions first, and sort of I'm piggybacking on John Kim's question on the earnings. Yeah, it seems like the earnings this year, obviously come down pretty quickly just given the issues that you guys have been dealing with, especially on the studio front, when things rightsize and occupancy for office improves studios rebound, should we think about the quarterly progression of earnings rebound be as sharp and upward as it has been on the down.

Just trying to get a sense of, how long it will take to get earnings back where it was with expectations at the beginning of the year versus where we stand right now?

Yeah, I mean, it could be very sharp. What I was just walking you through in the prior question, point to that, I mean, Quixote has the potential, as you know, to generate, considerably higher NOI the negative three or previous quarters before that. And if you just run the math, I mean, there's not that much incremental cost associated with improving that NOI and so it essentially drops to the bottom line and FFO would could go up pretty quickly and significantly when that happens.

Okay. And then the second question is, Victor, on the asset sales that you're contemplating, as you guys look at the portfolio and especially where some of the assets may have been weaker as of late, is there do you envision a scenario where, maybe surgically you can remove some of the weaker assets and that way end up with, Hudson that, it's much more concentrated in the top tier assets across the portfolio and that the laggards you can remove or it's easier done than said than done.

So, listen, on a general comment as you well know, once the debt markets open up, the disposition market is going to increase and so we have allocated our energy around two tiers, right that the assets that we don't think our long-term assets for the portfolio going forward, which will make the enterprise a much higher quality enterprise and those assets are already identified and to some extent are in conversations we've looked at, there are a couple of assets that are in that bucket that clearly are not salable in this market, given where the debt markets are.

The other alternative is for us to also look at where we get a much higher capital amount to the bottom line of the company. And as a result, we would look at a couple of the maybe better assets in the portfolio, but the goal is exactly how you sort of stated it, we're looking at having a much higher quality portfolio with high-quality assets that are going to be performing. It's just taking us some time to get through that, but they have already been identified.

Okay. Thanks. Thank you, Victor.

You're welcome.

Tom Catherwood, BTIG.

Thank you and good afternoon, everybody. Maybe Mark and Harout. Sorry to keep sticking this guidance here. But following up on John's question, if we do a quick back of the envelope on the guidance swing quarter over quarter, it implies studio performance could be pretty close to in line with the 4Q '23 numbers, which was the peak of the strike impact is that really what's your building into guidance for next quarter?

And I don't think it's exactly that low. And like I said it, but I don't know if I gave estimates around the numbers, we expected sequential drop. And I think we expect one to be as low as Q4 2023.

I don't think so either or not. I mean, just by if you look at Q4, Quixote NOI, it was $11.8 million negative. The most recent quarters $3.9 million seeing show count sort of stay at around -- in the 80s level, which they did in July and probably don't really start showing meaningful improvement until maybe late September on you're not even at that level, I don't think you're approaching $10 million negative $11.8 million on Quixote. And that's, so we're not making that level of assumption on Quixote business. We're really assuming it sort of stays more or less where it is today.

Maybe similar to Q1 for Quixote now?

Yeah. Thank you for that clarification. And then, Victor, following up on your response to Blaine's question about the asset sales. You mentioned one more being added to the bucket. Just to clarify, was that one in addition to kind of what has been expected before? Or did something fall out of that potential sales pool?

Something fell out of the sales pool. This was the reverse inquiry by a user that we're talking to. And they're almost rough the same valuation. This one's a little higher.

Got it. Appreciate that. And last one for me, just quickly, if I can. Art, in terms of the leasing your pipeline specifically in Silicon Valley and the Peninsula. Do you have a sense of how much of that is tenants relocating from properties within the market and submarket versus tenants may be relocating from other markets?

Generally there it's not relocating from other markets. Generally, it's growth, right? Because our bread and butter is kind of the 5,000 foot, perhaps start-up high growth company that we're banking on and those are taking more space beyond that, it's space within the market, but we're seeing more and more of that growth users taking additional space.

Appreciate the answers. That's it for me. Thanks, everyone.

Michael Griffin, Citi.

Great. Thanks. Victor, I want to go back to your opening comments around how you don't think studio production needs to return to peak levels for its start contributing to your business. I was wondering if you could expand on this a bit, does this mean that just the rate of change and the recovery is going to be beneficial?

And I recall when you initially did the Quixote deal, I think it was about $80 million of run rate EBITDA kind of initial speculations. Do you think that's still possible as the business recovers?

This is Mark, I'm going to start at the top of that, would it really starts with LA show counts improving to levels consistent with periods less affected by either a pandemic or a strike such as 2019 or 2022, the average of which is about 120 shows on even if we assume that current production budgets, which are reflecting real cost-cutting measures, even if we assume those cost-cutting measures continue to limit the number of trailers and other production vehicles that say, seven vehicles per production and also would hinder our ability to push stage and service rates back to more historic norms.

As long as LA show count, simply read something like 115 or 120 shows, our Quixote stages should get to about 65% to 70% occupied. And our projected annual NOI for Q2 should reach between $45 million and $50 million. From there any number of improvements have the potential to push an ally to $60 million and above $60 million, for example, if you get to 75% Quixote stage occupancy, that drives another $5 million NOI increase.

And if trailer another vehicle counts go from the current seven or so, vehicles took back to historic levels of 8% to 8.5%. That drives another $7 million to $10 million of NOI. And then, of course, obviously, as market conditions tighten with show counts improving, we could then look to potentially push rates, it may we might be able to increase our market share a little bit.

In all of those would ultimately contribute to getting that NOI number, not just to $60 million, but somewhere in well north of that.

Appreciate the color on that, Mark. And then maybe for Harout, just updated thoughts maybe around issues with potential covenants. I imagine that EBITDA is expected to decrease with the third quarter relative to the second quarter, I think you might be pushing up on a couple of covenants there. So any thought or updated around how we should think about that?

Hey, Michael, it's a good question. So we always project out our covenants. And like this quarter, our projections came in -- our actuals came in better than our projections and all of our covenants and our results. So given that our even our lower expectations in the future, we don't think we're going to break any covenants or I think maybe next four might be similar to this quarter. So we feel pretty confident, but our projections are solid in terms of our expectation.

Great. That's it for me. Thanks for the time.

Thanks, Mike.

Dylan Burzinski, Green Street.

Thanks for taking the question, guys. Just wanted to go back to your comments around kind of demand or tenant requirements picking up in San Francisco. Can you kind of talk about some of the drivers of that? Obviously in search with a pickup in activity from AI companies.

But if you can sort of give any other details as to the other drivers of that and then sort of a parallel to that, a lot of the reason why market vacancies have continued to go higher in terms of scope because of space givebacks by big tech.

Can you kind of just talk about expectations for there to be a continuation of this change in this because as we sort of think about where big tech is investing, their capital today is primarily in the AI and data center infrastructure. And so just curious if you can give us any insight into that any potential further space givebacks in this segment of the market?

Sure, Dylan. This is Art. Listen, the AI been clearly driving the market last year that was responsible for about 1.7 million square feet. We started off the first half of the year, strong with about 600 -- a little over 600,000 square feet in the active AI pipeline.

The demand sits I mean, I think we reported, it was somewhere around 7%, but it's -- since this guy went to cohort went to print. I mean, we're literally looking at and pushing up against another 1 million square feet. So we're tracking as we did last year.

But don't forget, yes, AI is driving the market now, tech is coming back in the market in a more meaningful way. But the bread and butter not just for San Francisco. But for all the markets through the pandemic was professional service law firms are leasing space.

That continues, and it's just been overshadowed in the headlines, because of AI, because of tech coming back, everybody is anxiously awaiting, but that sector has continued to grow as well, not at the same rate, but it also, like I said, it's going to bolster the market. Relative to tech -- big tech givebacks, and we were seeing them wholesale for a while. I think these givebacks have become more measured.

I think some of these big tech have just made decisions about how they're going to give back or how they're going to utilize space and how they're going to give it back listen, they're up against some expirations in the next year and half, and I think they're going to deal with it then.

But I think we've seen a more far more measured approach about what that means going forward. And I think that the demand that you're seeing in the market when executed is going to ultimately more than offset any of those givebacks.

Dylan, it's Victor. Also, I just want to just give some macro highlights in the city, and I know you guys are on top of this stuff, but we follow this very closely. And when I made in my prepared remarks, the reduction in crime, I mean, we're seeing that it's hitting its lowest mark in the last five years.

We're seeing obviously, activation centers, areas that are being capitalized for activation centers in the city that is going well. Barred exits have gone up almost 7%. The San Francisco tent counts are down since 2018. They're at their lowest levels that they're at a 41% reduction in tents.

And the home business is down 13%. So these are all factors that are helping the macro basis for growth in San Francisco. And I've always said when San Francisco fiscal turns, it will turn quicker than people think. And I think that's what's driving some of this activity.

And one more thing, Dylan. Other than the obvious demand drives, gross leasing and things like that. The number I'm looking at is the sublease1, yeah, sublease availability. It was assuming the net absorption, which was negative 290,000 square feet, which seems like normally high number.

It's been trending through the pandemic. It's been trending to about $1.1 million, right? So if you think about it, it's come down over the last few quarters, but it was trending at $1.1 million. It's now kind of moving back to and a manageable number.

Appreciate those comments. And then maybe just a follow-up to some of that. I mean, are you seeing -- and I know Governor Newsom recently ordered the state agencies to address homeless and cabins. Are you seeing that sort of be obviously that's recent news but are you seeing that sort of be talked about in recent discussions?

And then, obviously it seems like recession odds are higher today than they were two or three weeks ago. And so are you at all here in any discussions on that with tenants or?

I think we've been on the recession, it's too early to tell, right this is, it's sort of new news that's come out in the last 30 -- less than 30 days. In terms of in governor's of movement to move the encampments?

Yeah, absolutely affected San Francisco, I think better more so than it has for sure in Los Angeles because there's an election in San Francisco, right? So London Breed is up for reelection. And so she is going to push on that as a platform where Karen Mass, Mayor Mass doesn't have to do that. She's got another two-plus years ago.

Great. Thanks for the detail, guys. Really appreciate it.

Thanks, Dylan.

Peter Abramowitz, Jefferies.

Yeah, thank you for taking the questions. Just wanted to go back to those comments about kind of the ability to drive some meaningful value in the studio portfolio, even if things don't get back to where they were before the strike. I guess is there anything you can do or anything you're expecting to do on the expense side to kind of close some of the gap and get back to the NOI run rates you sort of underwrote when you did the Quixote day deal on that, just to sort of close that gap because obviously demand and the revenue side is not going to be quite where you were probably expecting it a couple of years ago.

Yeah, there are some measures we can do and are doing. I mean, we did on the heels of the acquisition of Quixote, the third of the three companies in the fall of '22, we did implement a lot of efficiency measures, including two pretty sizable risks. And so we believe we've largely rightsized the headcount and there are other things we are looking into really at the operations level, looking at our footprint in terms of our various facilities, ways to save costs there on looking at efficiencies on the manufacturing side, in terms of our trailer manufacturing.

And we'll just continue to pursue those and tried to make inroads on the cost side trying to help improve those markets.

Okay. That's helpful. And then you published an interesting chart. I think in your name representation, the utilization, a transportation utilization. The studio business has gone from about 10% during the back half of last year, up close to April 30, apologies if I missed this upfront, you already covered it, but can you just provide an update on where that is as of July?

Yeah. Well, we mentioned in our prepared remarks of the 24%. I would venture that if you think about where we finished the quarter at 82 shows in LA and it to be at 24% utilization, it show counts at that level really points to a lot of potential here. I mean, 30% was back when show counts were in the low 100 range to put a finer point on it, we averaged 96 in the second quarter, and we only just taper down to 80 towards the end of June. We're sitting at about 80 as of the end of July. We might -- hopefully, we've starts coming off that bottom soon.

But and if we're at 24% at 80% we could easily get to 30% quickly, -- we think we are picking up market share on the trailer side through there. A lot of credit to our sales team are picking up on, improving relations picking up just more sales. So well, I think 30s, suddenly can get too quickly and then if show counts get to the levels. We were just talking about the 115, 120 level, we should be back about 50%-plus utilization.

That's all for me. Thank you.

Rich Anderson, Wedbush Securities.

Thanks. Good afternoon. I was asked and I asked a similar question on clarity specifically on the expense side, the $25 million you run roughly per quarter something a lot of that is lease expense. Have you have you enquire thought about sort of a rent restructure for the '23 leased studios? Or has it not gotten that base?

Rich, no. What we have done is we are I mean -- you're actually right, a lion's share of that is lease costs, but we are also looking at some consolidations that are not studio lease cost, but transpose storage lease costs in the likes of that in consulting, we're in conversations on that where you have several leases that expire in the next at 24 to 36 months that we're working on a master plan around that. So that will also help the overhead process.

Is there any scenario where you could own some of those studios some point down the road?

Yeah.

And then last question on the someone brought up recession and I had on my list, too. What -- let's put all the noise and everything that's happened to the term strikes and so on aside, what does a recession due to the production business generally, like how if you look back in history, what happens?

I mean, historically, the entertainment industry has performed exceptionally well during recessionary times because it's providing a cheaper form of entertainment clearly and so on. Not to say that anybody wants a recession, but at the end of the day, it's always performed well. And that was sort of part of the prepared remarks as saying, it even in a downturn of content will be produced.

Okay. That's all I had. Thanks very much.

Thanks, Rich.

Thank you all for your questions. There are no further questions in queue. So I'll pass the conference back over to Victor Coleman for any closing or further remarks.

Thank you so much for participating in our second quarter call, and we look forward to speaking you guys all soon.

That will conclude today's conference call. Thank you all for your participation. You may now disconnect your lines.