Office Properties Income Trust (OPI) 2015 Q1 法說會逐字稿

Good day and welcome to the Government Properties Income Trust first-quarter 2015 results conference call.

(Operator Instructions)

Please note this event is being recorded. And now I would like to turn the conference over to Jason Fredette, Director of Investor Relations. Please go ahead, sir.

Thank you Denise and good afternoon everyone. Joining me on today's call are our President David Blackman and Chief Financial Officer Mark Kleifges. They will provide insight about our recent accomplishment and results for the first quarter and we'll then take your questions.

Please note that the transcription, recording and retransmission of today's conference call is prohibited without the prior written consent of the Company. 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 GOV's present beliefs and expectations as of today, April 30, 2015. The Company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call other than through filings with the Securities and Exchange Commission or SEC regarding this reporting period.

Additional information concerning factors that could cause those differences is contained in our filings with the SEC and these can be accessed from the SEC's website or the investor section of our website at GOVREIT.com. Investors are cautioned not to place undue reliance upon any forward-looking statements.

Please note that we'll be discussing non-GAAP financial metrics during this call including normalized funds from operations or normalized FFO. A reconciliation of these non-GAAP figures to net income and the components to calculate cash available for distribution or CAD are available in our supplemental offerings and financial data package which again can be found on our website.

And now I will turn the call over to David Blackman to begin our quarterly discussion. David?

Thank you Jason. Government Properties Income Trust generated a solid year-over-year increase in normalized funds from operations for the first quarter of 2015. This increase was primarily driven by the pro rata share of normalized FFO that we recognize from our investment in Select Income REIT.

As of March 31 GOV owns 71 properties containing 10.7 million square feet in continuing operations. Consolidated occupancy at quarter-end was 94.8% and same property occupancy was 94.5%. These figures are respectively down 30 and 40 basis points year over year driven mainly by the FDA vacating approximately 100,000 square feet at our Rockville, Maryland property in December 2014 which we have discussed on previous earnings calls.

GOV's weighted average lease term based upon revenue was 4.7 years. The US government continues to be our largest tenant and combined with 12 state governments and the United Nations contributed nearly 93% of our annualized rent as of March 31. Note that we had 300,000 square foot sequential decline in our consolidated and same property portfolio during the quarter as a result of a property sale to the US government in February.

Now let's review our first-quarter activity. Although we had a positive net absorption during the quarter, leasing activity was modest. We generated approximately 83,000 square feet from seven new and renewal leases that had a weighted average lease term of 7.5 years and average rolled out in rent of 6.3% and leasing capital commitments of $3.59 per square foot per lease year.

Approximately 90% of our leasing for the quarter was with non-government tenants. These three leases -- these three executed leases were for approximately 75,000 square feet and resulted in a 5.3% rolldown in rent, a weighted average lease term of 7.8 years and leasing capital commitments of $3.46 per square foot per lease year. Our four non-government leases were for only 8,200 square feet, had a 12.1% rolldown in rent, a weighted average lease term of five years and leasing capital commitments of $5.43 per square foot per lease year.

As I mentioned earlier, we completed the sale of our property in College Park, Maryland for $30.6 million in gross proceeds on February 18. This property contributed $980,000 to GAAP NOI during the quarter which is about $0.015 of normalized FFO per share.

One additional property in Falls Church, Virginia remains held for sale and is under agreement. As a closing condition this property is being rezoned to multifamily use and is expected to close later this year.

We expect to add to our capital recycling program during 2015. Likely sale candidates are vacant buildings located in weak markets and where the cost to release the buildings is uneconomical.

We continue to pursue potential acquisitions but remain disciplined and committed to our acquisition criteria. As a result of aggressive leverage buyers and in certain instances aggressive core funds we have been unsuccessful in placing any properties under agreement. We remain active, however, and are confident that we will win our fair share of deals over time.

We did, however, purchase additional common shares of Select Income REIT during the quarter. We consider this a compelling long-term investment for GOV. As of March 31 we are Select's largest shareholder owning approximately 28% of its outstanding common shares.

Looking ahead to the remainder of 2015 and all of 2016, we have 90 leases contributing 20% of GOV's annualized rents subject to expiration. On our last earnings call we identified 13 tenants contributing 2% of rents that we expect to vacate and 11 tenants contributing 3.4% of rents to derisk of downsizing or vacating at expiration. Based upon our latest tenant discussions we currently expect 13 tenants contributing approximately 2.1% of annualized rents to vacate over this time frame with the majority of these exits taking place in 2015.

We have also identified nine tenants with leases expiring prior to the end of 2016 that we believe are at-risk of vacating or downsizing. In total these nine tenants contribute approximately 1.7% of our annualized rent and are equally weighted between 2015 and 2016. The percent of tenants categorized as at-risk has reduced from last quarter as a result of improved lease negotiations.

As I stated on our last earnings call we are attempting to provide the market real-time insight into our lease expirations based upon the best information available to us. Tenants categorized as expected to vacate tend to be leases where we are highly confident the tenant intends to vacate whereas tenants described as at-risk are determined more subjectively based upon recent lease negotiations. As a result, you should expect our disclosure of at-risk tenants to be more fluid.

We continue to focus on maximizing tenant retention and building a pipeline of leases for prospective new tenants. Currently we have about 230,000 square feet of potential new leases that include more than 100,000 square feet of leases under letters of intent.

The US government has created many challenges for our business over the past two years from freezing the footprint, increasing employee utilization rates at leased buildings and consolidating into government-owned space. Overall we believe we have risen to these challenges and have performed well.

I'll now turn the call over to Mark Kleifges to provide more detail on our financial results.

Thanks, David. Let's begin with a review of our property level performance for the 2015 first quarter.

When compared to the year-ago quarter GOV's rental income increased by $2.8 million or 4.7% to $62.7 million. This growth was primarily generated by our property acquisitions since April 1, 2014 which were partially offset by the sale of our property in College Park, Maryland in February and the FDA moveout at our Rockville, Maryland property in December 2014.

On a same property basis first-quarter rental income declined by 1.2% year over year to $56.6 million largely as a result of the FDA moveout. Consolidated net operating income or NOI for the 2015 first quarter grew $2.2 million, or 6.1% year over year to $38.5 million.

Consolidated cash NOI for the first quarter grew by $2.8 million, or 7.8% to $38.1 million. As a result, our consolidated GAAP and cash NOI margins for the 2015 first quarter increased by 80 and 120 basis points respectively year over year to 61.4% and 61.2% respectively.

From a same property perspective our GAAP NOI declined by 1.9% year over year to $34.2 million. Cash basis NOI remained flat at approximately $33.9 million over this same period despite the FDA moveout. This resulted in same property GAAP NOI margin of 60.4% and the same property cash NOI margin of 60.2% for the 2015 first quarter.

Adjusted EBITDA for the 2015 first quarter was $54.4 million. Our debt to annualized adjusted EBITDA ratio remained flat sequentially at 5.2 times as of March 31 and our adjusted EBITDA to interest expense ratio was 5.9 times, up from 5.5 times for the 2014 fourth quarter.

On our income statement you will note that we took a non-cash charge of approximately $40.8 million in the first quarter. This was triggered by SIR's issuance of more than 28 million new common shares in connection with its acquisition of Cole Corporate Income Trust in January 2015. The stock issuance was made at a price below the per share carrying value of our SIR investment which prompted the charge and results in GOV reporting a GAAP net loss for the 2015 first quarter.

Normalized FFO for the first quarter which exclude this non-cash charge was $40.8 million, up from $28.8 million for the 2014 first quarter. On a per share basis, normalized FFO per share grew by 9% from $0.53 per share in the year ago quarter to $0.58 per share for the 2015 first quarter. Again these increases were primarily the result of our accretive property acquisitions and our investment in SIR.

During the first quarter of 2015 we received cash distributions from SIR amounting to $13.5 million. This includes both a regular quarterly dividend payment as well as a prorated distribution for the period January 1 to January 28, 2015. As David mentioned earlier, we increased our investment in SIR during the 2015 first quarter and now own approximately 28% of its outstanding common shares.

SIR also recently increased its quarterly dividend from $0.48 per share to $0.50 per share. Both of these factors will lead to greater cash flows for GOV going forward.

We paid a $0.43 per share dividend to GOV's shareholders during the first quarter which equates to a normalized FFO payout ratio of approximately 74%. We also spent approximately $750,000 on building improvements and $2 million on tenant improvements and leasing cost in the 2015 first quarter. As of March 31, we had approximately $7.4 million of unspent leasing-related capital commitments.

In terms of our balance sheet and liquidity at March 31 our debt to total book capitalization was 48%. While this is slightly above our targeted leverage of 45% we are comfortable operating the business at this level. At quarter-end we had $695 million of availability under our revolving credit facility.

Operator, that completes our prepared remarks. We're ready to open up the call for questions.

(Operator Instructions) Sumit Sharma, Morgan Stanley.

Hi, good afternoon everybody. Sumit in for Vance today.

So three quick questions. Of the 675,000 square feet of expirations this year what's the mix of government or non-government clients?

It's a good question. It's not necessarily -- we don't really look at our lease expiration schedule that way. So I don't have that number off the top of my head.

Okay. I guess what I was trying to drive to was as a follow-up your renewal spreads seem to have been usually very positive for government tenants, and while non-government tenants including this time around have been slightly negative. So is there a reason for this difference, are you seeing some kind of pricing competition on the non-government private side or could you provide a little more commentary around that particular aspect?

So what you're really asking is what is the color around why we tend to have rent roll downs with our non-government tenants?

Yes.

I don't know that there's any specific reason. It could be market dependent, it could be just the time frame into which we are renewing those tenants. I don't think there's any specific theme or reason.

They tend to be relatively minor tenants in our buildings. So it's really not something we spend a lot of time focusing on. We tend to focus more time on renewing our government tenants in place.

All right, thanks for that. Just another follow-up.

So there was a market extension done this time and I guess that's largely driven by the non-government leases. Are you still not seeing any extensions beyond five years on the government side because that's been relatively steady around the five mark?

The GSA is focused on trying to extend out its leases at renewal. They seem to be very focused on trying to do more 10-year renewals. We are seeing some that.

This quarter we only had 8,200 square feet of leasing with the government. But we are in our dialogues with renewals. We are seeing, we are having conversations with longer renewal periods.

Great, thank you so much. That sort of answers oh my questions.

Tayo Okusanya, Jefferies.

Yes, good afternoon. David, could you just tell us what the end goal in regards to the Select Income REIT investment? Like how do you see this playing out that it generates shareholder value?

Because each time you've bought the stock you've bought it at a premium versus where it was trading in the public market. And your average price or your cost basis on the asset or on the securities is probably close to $30 and the stock is trading at $23 and change.

Yes, we currently think the stock is undervalued. We think it generates a very compelling dividend yield. We think that dividend has a potential of growing over time and we certainly believe that the share price will increase over time as well.

So I wouldn't say there's a specific end game in our ownership in Select. We think it's a compelling investment that adds accretively to our cash flow that allows us to do the things with our core business in terms of spending capital to renew tenants in place and growing the business when there's opportunities presented.

Yes but why pay a premium for it each time though? Why don't you just buy the shares in the public market?

Well any time you try to buy a large block of shares in the public market, particularly when you already own a large block you're going to pay a premium. So I don't believe we paid more of a premium than we would by simply having to go and do a tender offer or just try to pull a large block together. I mean Mark --

We believe we'd have to because of our existing position in SIR when we made the acquisition in March we would have been subject to disclosure requirements once we went out into the market to start acquiring shares. So you know how the market is going to react when we announce that we're out in the market trying to acquire a 3.4 million block of SIR shares.

I mean, think about it. The average trading volume for GOV is probably between 600,000 and 700,000 shares a day.

All right, fair enough. And then Mark this one is for you. The SIR investment, is there any reason you carry it using the equity method rather than just looking at it as just pure securities that are trading or available-for-sale?

We're required under GAAP to carry it because we own more than 20% and less than 50% we're required to use the equity method of accounting.

So it's the 20-50 rule. Okay, that's fair enough. And then lastly, David again thank you for indulging me, the assets that you're targeting for sale, again the empty buildings where the cost of refurbishing them to try to lease them is just not worth it, how much of that stuff is in the portfolio at this point?

It's relatively insignificant. It's probably $10 million plus or minus.

Okay, thank you.

Michael Carroll, RBC Capital Markets.

Thank you. David can you give us some color on the investment pipeline?

I know previously indicated that GOV may have a competitive advantage acquiring assets with less than 10 years of lease term remaining. Is that still the case and if so how many of those deals are actually in the investment pipeline?

Sure, Mike. We have a relatively small pipeline of potential acquisitions at GOV mostly because we're just not seeing a lot of deals trade. The financing markets have become pretty aggressive and so I think what's happening is there are a number of owners that are choosing to refinance at compelling interest rates rather than selling.

With that said, we probably have $150 million to $200 million of potential acquisition opportunities. They tend to be both state and federal, federally leased deals and probably maybe 25% of it, 30% of it are deals that have shorter average remaining lease terms.

And how many of those our state deals?

I don't know, maybe 30%.

Is there less competition for the state deals? Do you think you have a better chance of acquiring more state versus federal lease properties?

There is less competition for state deals from large funds. Most of our competitors on the GSA lease properties tend not to focus on state lease deals.

Okay. And then related to the SIR investment should we expect additional investments into that company or are you fine with where you're positioned in that right now?

There is no active dialogue at this point about buying any additional shares. We do consider it a long-term investment and we think it's compelling. But there's no current discussion about buying any additional shares.

Okay great. Then Mark, can you remind us what your leverage targets are if you're comfortable with your current level and do you want to reduce it going forward?

We have recently been operating the Company with a target leverage book to total debt capital -- debt to total book capitalization of about 45%. We are at 48% at the end of the first quarter.

I think until we given the lack of an acquisition pipeline right now the fact that we're kind of working through what if any dispositions we're going to make in 2015 I think we're comfortable where we are right now with leverage. Should the acquisition pipeline increase something we would consider is the equity markets. But once again I think where our stock price is will play into both how we underwrite any potential acquisitions as well as our decision whether or not to access the equity markets.

Okay, great. Thank you.

(Operator Instructions) Young Ku, Wells Fargo.

Great, thank you. David, did I hear you correctly when you're talking about the lease at-risk that went down from 3.4% to 1.7%? Is that right?

That is correct.

And how does that 1.7% divide between potential moveouts versus contractions?

We have in terms of potential contractions, I think take it from this perspective. We have nine tenants that we've identified at-risk.

Of those nine tenants, we have three that we think are contractions. The other six would be potential moveouts.

And for those three that could potentially contract, by how much do you think that they would reduce space?

Well, they're relatively small tenants. In total they represent about 12,000 square feet and we think they could potentially downsize by 45%.

I see, got it. Thank you for that.

And so does that mean that you have 2% of rents that are going to move out and then 1.7%. So 4% in total at-risk, so does that mean the remaining 16% for 2015 and 2016 expirations are pretty much that you're confident that you could renew them?

What that means is that the remaining 16% we don't have any reason to be concerned about not being able to negotiate renewals.

I see. So how would you put your confidence level for those?

I'm sorry, I didn't get that.

What kind of a confidence level would you put in terms of renewing all of them?

Well, as I said in my prepared remarks we are trying to give you real time information based upon our current discussions. Those discussions are fluid.

Right now we have good confidence in the expiring leases that we have end categorized as either no moveouts or at-risk. But I also said it's a fluid process. But it's the best information we have available to us at this time.

Okay, got it. That's fair. And so in terms of your potential dispositions, so as some of the assets that you have now are vacated would you consider selling those?

I'm sorry what's vacated?

Yes if some of the 2% in terms of the rents that are going to be vacated from your portfolio would you consider selling those assets?

At this point we haven't identified any of those as potential disposition opportunities. We will evaluate them and if we believe that the capital required to release the buildings or on economical then we may consider disposition. But at this point none of them are in a disposition plan.

Okay, thank you.

Ladies and gentlemen, this will conclude our question-and-answer session. I would like to turn the conference back over to David Blackman for any closing remarks.

Thank you operator and thank you for attending our call today. That concludes our remarks.

Ladies and gentlemen, thank you for attending today's presentation. The call has now concluded. You may now disconnect your lines.